Strategic Business Reporting
Strategic Business
Reporting
Workbook - Questions &
Solutions
1
Strategic Business Reporting
Group Accounts
2
Strategic Business Reporting
Illustration 1
Almeria
Murcia
Tangible
100
100
Investment in Murcia
300
Non Current Assets
Current Assets
Inventory
40
200
Receivables
60
100
200
200
700
600
Ordinary Shares
160
100
Accumulated Profits
240
200
Equity
400
300
Non Current Liabilities
100
200
Current Liabilities
200
100
700
600
Cash
Additional Information
Almeria today acquired all the shares in Murcia for $300m.
The Fair Value of the NCI at acquisition was 0.
Required
Prepare the consolidated statement of financial position for the Almeria group
3
Strategic Business Reporting
Pro-Forma
Working 1 - Group Structure
Almeria
Murcia
Date Acquired
Parent Share
NCI
Working 2 - Equity Table
At Acquisition
At Year End
Share Capital
Accumulated Profits
Working 3 - Goodwill
Cost of Parent Investment
Fair Value of NCI at acquisition
Less net assets at acquisition (W2)
Goodwill
4
Strategic Business Reporting
Working 4 - NCI
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
Value of NCI at Year End
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
5
Strategic Business Reporting
SFP for Almeria Group
Almeria
Murcia
Tangible
100
100
Investment in Murcia
300
Group
Non Current Assets
Goodwill
Current Assets
Inventory
40
200
Receivables
60
100
Cash
200
200
700
600
Ordinary Shares
160
100
Accumulated Profits
240
200
Equity
400
300
Non Current Liabilities
100
200
Current Liabilities
200
100
700
600
Non Controlling Interest
6
Strategic Business Reporting
Solution
Working 1 - Group Structure
Almeria
↓
100%
Murcia
Date Acquired
TODAY
Parent Share
100%
NCI
0%
Working 2 - Equity Table
At Acquisition
At Year End
Share Capital
100
100
Accumulated Profits
200
200
300
300
Working 3 - Goodwill
Cost of Parent Investment
Fair Value of NCI
Less net assets at acquisition (W2)
Goodwill
300
0
-300
0
7
Strategic Business Reporting
Working 4 - NCI
$
Fair Value of NCI at acquisition
0
NCI% of Sub Post-Acq Profits
0
Value of NCI at Year End
0
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
240
Add: Parent % of the subsidiary’s post acquisition profits
Nil
240
8
Strategic Business Reporting
SFP for Almeria Group
Almeria
Murcia
Group
Non Current Assets
Goodwill
Tangible
100
Investment in Murcia
300
100
None (W3)
Nil
100 + 100
200
Cancel out
Nil
Current Assets
Inventory
40
200
40 + 200
240
Receivables
60
100
60 +100
160
Cash
200
200
200 + 200
400
700
600
Ordinary Shares
160
100
Parent
160
Accumulated Profits
240
200
W5
240
W4
Nil
Non Controlling Interest
1000
Equity
400
300
400
Non Current Liabilities
100
200
100 + 200
300
Current Liabilities
200
100
200 + 100
300
700
600
1000
9
Strategic Business Reporting
Illustration 2
Ant
Dec
Assets
500
500
Investment in Dec
350
850
500
Ordinary Shares
100
200
Accumulated Profits
250
100
Equity
350
300
Liabilities
500
200
850
500
Additional Information
Ant today acquired 160m of the 200m shares in Dec.
The Fair Value of the NCI was 50.
Required
Prepare the consolidated statement of financial position for the Ant group
10
Strategic Business Reporting
Illustration 2 Pro-Forma
Working 1- Group Structure
↓
Date Acquired
Parent Share
NCI
Working 2- Equity Table
At Acquisition
At Year End
Share Capital
Accumulated Profits
Working 3 - Goodwill
Cost of Parent Investment
Fair Value of NCI at acquisition
Less net assets at acquisition (W2)
Goodwill
11
Strategic Business Reporting
Working 4 - NCI
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
Value of NCI at Year End
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
12
Strategic Business Reporting
Statement of Financial Position for Ant Group
Ant
Dec
Assets
500
500
Investment in
Dec
350
Group
Goodwill
850
500
Ordinary
Shares
100
200
Accumulated
Profits
250
100
Equity
350
300
Liabilities
500
200
850
500
NCI
Illustration 2 Solution
13
Strategic Business Reporting
Working 1- Group Structure
Ant
↓
80%
Dec
Date Acquired
TODAY
Parent Share
80%
NCI
20%
100%
Working 2- Equity Table
At Acquisition
At Year End
Share Capital
200
200
Accumulated Profits
100
100
300
300
Working 3 - Goodwill
Cost of Parent Investment
350
Fair Value of NCI at acquisition
50
Less net assets at acquisition (W2)
-300
Goodwill
100
Working 4 - NCI
14
Strategic Business Reporting
$
Fair Value of NCI at acquisition
50
NCI% of Sub Post-Acq Profits
0
Value of NCI at Year End
50
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
250
Add: Parent % of the subsidiary’s post acquisition profits
Nil
250
Statement of Financial Position for Ant Group
15
Strategic Business Reporting
Ant
Dec
Goodwill
Assets
500
Investment in
Dec
350
500
Group
W3
100
500 + 500
1000
Cancelled in
Goodwill W3
Nil
850
500
Ordinary
Shares
100
200
Parent Only
100
Accumulated
Profits
250
100
W5
250
W4
50
500 +200
700
NCI
Liabilities
500
200
850
500
1100
1100
Illustration 3
16
Strategic Business Reporting
Evan
Dando
Assets
200
350
Investment in Dando
500
Current Assets
200
300
900
650
Ordinary Shares ($1)
200
200
Accumulated Profits
250
100
Equity
450
300
Non Current Liabilities
280
200
Liabilities
170
150
900
650
Additional Information
Evan acquired 150m shares in Dando one year ago when the reserves of Dando were
$40m. The Fair Value of the NCI on the date of acquisition was $100m.
Required
Prepare the consolidated statement of financial position for the Evan group.
Solution
17
Strategic Business Reporting
Working 1- Group Structure
↓
Date Acquired
Parent Share
NCI
Working 2 - Equity Table
At Acquisition
At Year End
Share Capital
Accumulated Profits
Working 3 - Goodwill
Cost of Parent Investment
Fair Value of NCI at acquisition
Less net assets at acquisition (W2)
Goodwill
18
Strategic Business Reporting
Working 4 - NCI
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
Value of NCI at Year End
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
Statement of Financial Position for Evan Group
19
Strategic Business Reporting
Evan
Dando
Assets
200
350
Investment in
Dando
500
Current Assets
200
300
900
650
Ordinary
Shares ($1)
200
200
Accumulated
Profits
250
100
Equity
450
300
Non Current
Liabilities
280
200
Liabilities
170
150
900
650
Group
Goodwill
NCI
Solution
20
Strategic Business Reporting
Working 1- Group Structure
Evan
↓
75%
Dando
Date Acquired
1 Year Ago
Parent Share
75%
NCI
25%
100%
Working 2 - Equity Table
Share Capital
Accumulated Profits
At Acquisition
At Year End
200
200
40
100
240
300
Working 3 - Goodwill
Cost of Parent Investment
500
Fair Value of NCI at acquisition
100
Less net assets at acquisition (W2)
-240
Goodwill
360
Working 4 - NCI
21
Strategic Business Reporting
$
Fair Value of NCI at acquisition
100
NCI% of Sub Post-Acq Profits
(25% x 60m)
Value of NCI at Year End
15
115
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
250
(75% x 60m)
45
295
Statement of Financial Position for Evan Group
22
Strategic Business Reporting
Evan
Dando
Goodwill
Assets
200
Investment in
Dando
500
Current Assets
200
350
300
Group
W3
360
200 + 350
550
Cancelled out
in W3.
Nil
200 + 300
500
1410
Ordinary
Shares ($1)
Parent Only
200
Accumulated
Profits
W5
295
NCI
W4
115
570
Non Current
Liabilities
280
200
280 + 200
480
Liabilities
170
150
170 + 150
320
1410
Illustration 4
23
Strategic Business Reporting
Virtual
Insanity
Assets
1000
800
Investment in Insanity
600
Current Assets
400
200
2000
1000
Ordinary Shares ($1)
800
100
Accumulated Profits
750
400
Equity
1550
500
Non Current Liabilities
250
300
Liabilities
200
200
2000
1000
Additional Information
Virtual acquired 60m shares in Insanity one year ago when the reserves of Insanity were
$60m. The Fair Value of the NCI at that date was $120m.
Required
Prepare the consolidated statement of financial position for the Virtual group
Solution
Working 1- Group Structure
24
Strategic Business Reporting
Virtual
↓
60%
Insanity
Date Acquired
1 Year Ago
Parent Share
60%
NCI
40%
100%
Working 2 - Equity Table
Share Capital
Accumulated Profits
At Acquisition
At Year End
100
100
60
400
160
500
Working 3 - Goodwill
Cost of Parent Investment
600
Fair Value of NCI at acquisition
120
Less net assets at acquisition (W2)
-160
Goodwill
560
25
Strategic Business Reporting
Working 4 - NCI
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
120
(40% x (500 160))
Value of NCI at Year End
136
256
Working 5 - Accumulated Profits
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
750
(60% x (500 160)
204
954
26
Strategic Business Reporting
Statement of Financial Position for Virtual Group
Virtual
Insanity
Goodwill
800
Group
W3
560
1000 + 800
1800
Cancelled in
W3
Nil
400 + 200
600
Assets
1000
Investment in
Insanity
600
Current Assets
400
200
2000
1000
Ordinary
Shares ($1)
800
100
Parent Only
800
Accumulated
Profits
750
400
W5
954
W4
256
NCI
2960
Equity
1550
500
1954
Non Current
Liabilities
250
300
250 + 300
550
Liabilities
200
200
200 + 200
400
2000
1000
2960
27
Strategic Business Reporting
Illustration 5
Jabba acquired 100% of the shares in Hutt two years ago.
The consideration was as follows:
1. Cash of $36,000.
2. 2000 Shares in Jabba (the share price is currently $3).
3. $30,000 to be paid four years after the date of acquisition. The relevant
discount rate is 12%
4. If the group meets certain targets there will be a further payment with fair
value of $60,000 at a later date.
Required:
(i) Calculate the fair value of the consideration which Jabba has given in
purchasing the investment in Hutt.
(ii)Show the value of the liability in the Statement of Financial Position
for the deferred consideration at the end of the current year.
(iii)What is the charge to the Statement of Profit or Loss in the current
period related to the deferred consideration?
28
Strategic Business Reporting
Illustration 5 Solution
$
Cash
Amount
36,000
Shares
Market Value (2000 x 3)
6,000
Deferred Consideration
30,000 x (1 / (1.124)
19080
Contingent Consideration
Fair Value
60,000
Total
121080
Year
O’Bal
Unwind (12%)
C’Bal
1
19,080
2,290
21,370
2
21,370
2,564
23,934
Illustration 6
On 1 October 2012, Paradigm acquired 75% of Strata’s 20,000 equity shares
by means of a share exchange of two new shares in Paradigm for every five
acquired shares in Strata. In addition, Paradigm issued to the shareholders of
Strata a $100 10% loan note for every 1,000 shares it acquired in Strata. The
share price of Paradigm on the date of acquisition was $2.
Calculate the consideration paid for Strata.
Solution
Share exchange ((20,000 x 75%) x 2/5 x $2)
10% loan notes (15,000 x 100/1,000)
$12,000
$1,500
29
Strategic Business Reporting
Illustration 7
Jimmy acquired 80% of Gent 1 year ago. The following information relates to
Gent at the date of acquisition.
Accumulated
profits at
acquisition
Cost of investment
Fair Value of NCI
at acquisition
$
$
$
150
800
160
An item of plant was valued at $200 in the Gent’s Financial Statements but
had a Fair Value of $300, the plant had a remaining life of 5 yrs at the date of
acquisition. Goodwill is to be calculated gross.
Jimmy
Gent
Investment in Gent
800
Assets
700
700
1500
700
Ordinary Shares ($1)
700
250
Accumulated Profits
500
350
Equity
1200
600
Liabilities
300
100
1500
700
30
Strategic Business Reporting
Solution
Working 1- Group Structure
Jimmy
↓
80%
Gent
Date Acquired
1 Year Ago
Parent Share
80%
NCI
20%
100%
Working 2 - Equity Table
At Acquisition
At Year End
Share Capital
250
250
Accumulated Profits
150
350
Fair Value Adjustment
100
100
Additional Depreciation
-20
500
680
31
Strategic Business Reporting
Working 3 - Goodwill
Cost of Parent’s investment
800
Fair value of NCI at acquisition (Market Value)
160
960
Less 100% net assets at acquisition in W2
-500
Gross Goodwill
460
Alternative working
$
Cost of Parent Investment
Less Parent % of the net assets at
acquisition (W2)
800
500 x 80%
-400
Goodwill attributable to Parent
400
Fair Value of NCI at acquisition
Less NCI% of the net assets at
acquisition (W2)
160
500 x 20%
-100
Goodwill attributable to NCI
60
Gross Goodwill on Acquisition
460
32
Strategic Business Reporting
Working 4 - NCI
Fair Value of NCI at acquisition
Plus NCI share of post acquisition profits
300
2200 x 25%
550
850
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
500
80% x (680 500) (W2)
144
644
Statement of Financial Position for Jimmy Group
33
Strategic Business Reporting
Jimmy
Gent
Goodwill
Group
W3
460
Cancelled
Nil
700 + 700 +
100 - 20
1480
Investment in
Gent
800
Assets
700
700
1500
700
Ordinary
Shares ($1)
700
250
Parent only
700
Accumulated
Profits
500
350
W5
644
W4
196
NCI
Equity
1200
600
Liabilities
300
100
1500
700
1940
1540
300 + 100
400
1940
34
Strategic Business Reporting
Illustration 8
Devil acquired 90% of Detail 2 years ago. The following information relates to
Gent at the date of acquisition.
Accumulated
profits at
acquisition
Cost of
investment
Fair Value of NCI
at acquisition
$
$
$
250
1000
55
An item of plant was valued at $300 in the Gent’s Financial Statements but
had a Fair Value of $200.
The plant subject to the fair value adjustment had a remaining life of 4 yrs at
the date of acquisition. Goodwill is to be calculated Gross.
Devil
Detail
Investment in Detail
1000
Assets
600
800
1600
800
Ordinary Shares ($1)
650
100
Accumulated Profits
250
500
Equity
900
600
Liabilities
700
200
1500
700
35
Strategic Business Reporting
Solution
Working 1- Group Structure
Devil
↓
90%
Detail
Date Acquired
2 Years Ago
Parent Share
90%
NCI
10%
100%
Working 2 - Net Assets Subsidiary
At Acquisition
At Year End
Share Capital
100
100
Accumulated Profits
250
500
Fair Value Adjustment
-100
-100
Additional Depreciation (2yrs)
50
250
550
300
36
Strategic Business Reporting
Working 3 - Goodwill
Cost of Parent’s investment
1000
Fair value of NCI at acquisition (Market Value)
55
1055
Less 100% net assets at acquisition in W2
-250
Gross Goodwill
805
Working 4 - NCI
Fair Value of NCI at acquisition
55
Plus NCI share of post acquisition profits
10% x 300 (W2)
30
85
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
250
90% x 300
(W2)
270
520
37
Strategic Business Reporting
Statement of Financial Position for Devil Group
Devil
Detail
Goodwill
1000
Assets
600
800
1600
800
Ordinary
Shares ($1)
650
100
Parent
650
Accumulated
Profits
250
500
W5
520
W4
85
700 + 200
900
NCI
Equity
900
600
Liabilities
700
200
1500
700
W3
805
600 + 800 - 100
+ 50
1350
2155
2155
38
Strategic Business Reporting
Illustration 9
Evaro Co. Acquired 80% of Stando Co. one year ago and the following detail
is relevant:
At Acquisition
$m
At Year End
$m
Share Capital
100
100
Accumulated Profits
250
500
At the date of acquisition the following was relevant:
i) An item of plant was valued at $100m in the Gent’s Financial Statements
but had a Fair Value of $50m, the plant had a remaining life of 10 yrs at the
date of acquisition.
ii)Stando Co. owns an internally generated brand worth $20m on the date of
acquisition that has a useful economic life of 20 years.
iii)At the date of acquisition a court case against Stando Co. is in process
which has resulted in a contingent liability of $25m being disclosed in their
financial statements. By the year end Stando Co. had won the court case
resulting with no payment as a result.
Required
Compete the Equity Table (W2) based on the above information for
Stando. Co.
39
Strategic Business Reporting
Solution
At Acquisition
$m
At Year End
$m
Share Capital
100
100
Accumulated Profits
250
500
Fair Value of Plant
-50
-50
Remove Depreciation (50/10)
Brand
5
20
Amortization on Brand
Contingent Liability
20
-1
-25
0
295
574
40
Strategic Business Reporting
Illustration 10
Brad acquires 80% of Angelina’s share capital in a share for share exchange.
Brad gives Angelina 2 shares for every one in Angelina. Angelina has 100
shares in issue with a nominal value of $1 Angelina’s share price is $8. Brad’s
share price is $5. At the date of acquisition the net assets of Angelina are
$600.
Calculate the gross goodwill and the NCI.
41
Strategic Business Reporting
Solution
Consideration
Brad is purchasing 80% of 100 shares = 80 shares
He is issuing 2 shares for each of the 80 he is purchasing (80 x 2) = 160
Each of the 160 shares is worth $5 so consideration is (160 x 5) = $800
Goodwill
Cost of Parent’s investment
800
Fair value of NCI at acquisition (Market Value)
160
960
Less 100% net assets at acquisition in W2
-600
Gross Goodwill
360
Alternative working
$
Cost of Parent Investment
Less Parent % of the net assets
at acquisition (W2)
800
600 x 80%
-480
Goodwill attributable to Parent
320
Fair Value of NCI at acquisition
(100 x 20%) x $8
160
Less NCI% of the net assets at
acquisition (W2)
(20% x 600)
-120
Goodwill attributable to NCI
40
Gross/Full Goodwill
360
42
Strategic Business Reporting
Illustration 11
Brad acquires 80% of Angelina’s share capital in a share for share exchange.
Brad gives Angelina 2 shares for every one in Angelina. Angelina has 100
shares in issue with a nominal value of $1. Brad’s share price is $5. At the
date of acquisition the net assets of Angelina are $600 and by the year end
they were $800.
Calculate the goodwill arising using the proportionate method and the NCI.
43
Strategic Business Reporting
Illustration 11 Solution
Consideration
Brad is purchasing 80% of 100 shares = 80 shares
He is issuing 2 shares for each of the 80 he is purchasing (80 x 2) = 160
Each of the 160 shares is worth $5 so consideration is (160 x 5) = $800
Goodwill
Cost of Parent Investment
NCI Value at acquisition
800
(600 x 20%)
120
Net assets at acquisition (W2)
-600
Goodwill
320
NCI
NCI at acquisition
NCI% Post Acquisition Profit
600 x 20%
120
(800 - 600) x 20%
40
160
44
Strategic Business Reporting
Illustration 12
(i)
Archie acquires 60% of Mitchell’s share capital with consideration of $900.
Mitchell has 200 shares in issue with a share price is $5. At the date of
acquisition the net assets of Mitchell were $800 and are $950 at the year end.
At the year end the retained earnings of Archie were $1,000.
An impairment review has been carried out on the goodwill at the year end
which has found it to be impaired by $40.
Calculate the gross goodwill, the retained earnings and the NCI at the year
end.
45
Strategic Business Reporting
Solution
Goodwill
Cost of Parent’s investment
900
Fair value of NCI at acquisition (200 x 40% x $5)
400
1300
Less 100% net assets at acquisition in W2
-800
Gross Goodwill
500
Impairment
-40
Post Impairment Goodwill
460
Dr W4
16
Dr W5
24
NCI
Fair Value of NCI at Acquisition
NCI% Post Acquisition Profit
NCI Share of Impairment
400
(950 - 800) x 40%
60
-16
444
46
Strategic Business Reporting
Retained Earnings
Parent
NCI% Post Acquisition Profit
Parent Share of Impairment
1000
(950 - 800) x 60%
90
-24
1066
47
Strategic Business Reporting
Illustration 12 (ii)
French acquired 75% of Shambles several years ago.
Cost of
Investment
Fair Value of
NCI at
acquisition
Net assets at
acquisition
Net assets at
year end
Goodwill
Impairment at
Y/E
$
$
$
$
$
1,000
300
800
3,000
200
If French has $1500 of retained earnings at the year end, calculate the gross
goodwill, retained earnings for the group and the NCI at the year end.
48
Strategic Business Reporting
Solution
Goodwill
Cost of Parent’s investment
1,000
Fair value of NCI at acquisition (Market Value)
300
1300
Less 100% net assets at acquisition in W2
-800
Gross Goodwill
500
Impairment
-200
Post Impairment Goodwill
300
DR W4
50
DR W5
150
NCI
Fair Value of NCI at acquisition
Plus NCI share of post acquisition profits
Impairment
300
2200 x 25%
550
-50
800
49
Strategic Business Reporting
Retained Earnings
Parent
NCI% Post Acquisition Profit
Parent Share of Impairment
1500
2200 x 75%
1650
-150
3000
50
Strategic Business Reporting
Illustration 12 (iii)
Pinky acquired 80% of Brain 4 years ago. The following information is
relevant:
Net Assets at
year end
Net Assets at
acquisition
Cost of
investment
Fair Value of
NCI at
acquisition
Recoverable
amount at
year end
$
$
$
$
$
150
100
175
25
230
Goodwill is calculated gross and is subject to an annual impairment review.
Pinky
Brain
Investment in Pinky
175
Assets
100
100
Inventory
140
200
Receivables
160
100
Bank
125
200
700
600
Ordinary Shares ($1)
160
50
Accumulated Profits
240
100
Equity
400
150
Non current liabilities
100
250
Liabilities
300
100
700
600
51
Strategic Business Reporting
Solution
Working 1- Group Structure
Pinky
↓
80%
Brain
Date Acquired
4 Years Ago
Parent Share
80%
NCI
20%
100%
Working 2 - Net Assets Subsidiary
At Acquisition
At Year End
Share Capital
50
50
Accumulated Profits
50
100
100
150
52
Strategic Business Reporting
Working 3 - Goodwill
Cost of Parent’s investment
175
Fair value of NCI at acquisition (Market Value)
25
200
Less 100% net assets at acquisition in W2
-100
Gross Goodwill
100
Impairment
Impairment Review
Carrying Value of asset
Net Assets + Goodwill (150 + 100)
Less Recoverable amount
250
-230
Impairment Loss
20
Goodwill after impairment
Gross Goodwill
100
Impairment Loss
-20
Goodwill after impairment
80
53
Strategic Business Reporting
Working 4 - NCI
Fair Value of NCI at acquisition
25
Plus NCI share of post acquisition profits
50 x 20%
10
Less Goodwill Impairment
20 x 20%
-4
31
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
Less Goodwill Impairment
Add: Parent % of the subsidiary’s post acquisition profits
240
20 x 80%
-16
80% x (100 150) (W2)
40
264
54
Strategic Business Reporting
Statement of Financial Position for Pinky Group
Pinky
Brain
Goodwill
Group
W3
80
Assets
100
100
100 + 100
200
Inventory
140
200
140 + 200
340
Receivables
160
100
160 + 100
260
Bank
125
200
125 + 200
325
700
600
Ordinary
Shares ($1)
160
50
Parent Only
160
Accumulated
Profits
240
100
W5
264
W4
31
NCI
1205
Equity
400
150
455
Non current
liabilities
100
250
100 + 250
350
Liabilities
300
100
300 + 100
400
700
600
1205
55
Strategic Business Reporting
Illustration 13 (i)
George owns 80% of the subsidiary Bungle. During the impairment review it was found
that the carrying value of Bungle’s net assets were $250 and the goodwill $300. The
recoverable amount of the subsidiary is $500 and goodwill is calculated on a proportionate
basis.
What amount of goodwill will appear on the group SFP?
56
Strategic Business Reporting
Solution
Gross up proportionate goodwill
Proportionate Goodwill
300
Gross this up (300 x 100/80)
375
We will use this grossed up value for goodwill in the impairment review.
Impairment Review
Carrying Value of asset
250
Grossed up Goodwill
375
Less Recoverable amount
-500
Impairment Loss
125
Goodwill on Balance Sheet
Proportionate goodwill
300
Share of Impairment (125 x 80%)
-100
Goodwill after impairment
200
57
Strategic Business Reporting
Illustration 13 (ii)
Event owns 90% of the subsidiary Horizon. During the impairment review it was found that
the carrying value of Horizons net assets were $5,000 and the goodwill $2,337. The
recoverable amount of the subsidiary is $6,000 and goodwill is calculated on a
proportionate basis.
What amount of goodwill will appear on the group SFP?
58
Strategic Business Reporting
Solution
Gross up proportionate goodwill
Proportionate Goodwill
2,000
Gross this up (2,337 x 100/90)
2,597
We will use this grossed up value for goodwill in the impairment review.
Impairment Review
Net Assets of Sub
5,000
Grossed up Goodwill
2,597
Less Recoverable amount
-6,000
Impairment Loss
1,597
Goodwill on SFP
Proportionate goodwill
2,000
Share of Impairment (1,597 x 90%)
-1,437
Goodwill after impairment
563
59
Strategic Business Reporting
Illustration 14
A Parent company has recorded an asset of $300 goods receivable with a subsidiary.
The subsidiary had recorded this as an initial liability payable of $300 but has just recorded
and sent a cheque payment to the parent of $50 leaving the payable balance of $250.
How should this be adjusted for on consolidation?
60
Strategic Business Reporting
Solution
When cross casting assets & liabilities:
Less Payables $250 (DR)
Plus Cash at bank $50 (DR)
Less Receivables $300 (CR)
61
Strategic Business Reporting
Illustration 15
Parent has been selling goods to subsidiary. The parent has recorded an asset of $500
receivable from the subsidiary.
The $500 includes goods worth $100 sent prior to the year end to the subsidiary who has
not received them. As a result the subsidiary has a balance of $400 recorded as a liability
in payables.
How should this be treated on consolidation?
62
Strategic Business Reporting
Solution
When cross casting assets & liabilities:
Less Payables $400 (DR)
Plus Inventory $100 (DR)
Less Receivables $500 (CR)
63
Strategic Business Reporting
Illustration 16
Arctic is the parent of a subsidiary Monkeys. Extracts of their SFPs are below
Arctic
Monkeys
Inventory
300
100
Receivables
200
250
Bank
100
50
600
400
420
220
Current Assets
Current Liabilities
The trade payables of Monkeys includes $35m due to Arctic. This was after the deduction
of $10m in respect of cash sent by Monkeys but not yet received by Arctic.
The receivables of Arctic at the year end include $70m due from Monkeys. $25m of these
goods had been dispatched by Arctic, but were not yet received by Monkeys.
Show the treatment on consolidation.
64
Strategic Business Reporting
Solution
Remember!
Add the goods/cash in transit
Subtract the inter company current accounts
+/-
Item
Where?
$m
+
Cash in transit
Cash at Bank
10
+
Goods in transit
Inventory
25
-
Inter Company Current Account
Payables
35
-
inter Company Current Account
Receivables
70
Arctic
Monkeys
Group
Inventory
300
100
300 + 100 + Goods in
transit of 25
425
Receivables
200
250
200 + 250 - 70 inter
company current account
380
Bank
100
50
100 + 50 + cash in transit
10
160
600
400
420
220
Current Assets
Current Liabilities
965
420 + 220 - inter company
current account 35
605
65
Strategic Business Reporting
Illustration 17
Sea is the parent of a subsidiary Lion. Extracts of their SFPs are below
Sea
Lion
Inventory
400
250
Receivables
100
100
Bank
150
100
650
450
90
140
Current Assets
Current Liabilities
The trade payables of Lion includes $20m due to Arctic. This was after the deduction of
$15m in respect of cash sent by Lion but not yet received by Sea.
The receivables of Sea at the year end include $50m due from Lion. $15m of these goods
had been dispatched by Sea, but were not yet received by Lion.
Show the treatment on consolidation.
66
Strategic Business Reporting
Solution
Remember!
Add the goods/cash in transit
Subtract the inter company current accounts
+/-
Item
Where?
$m
+
Cash in transit
Cash at Bank
15
+
Goods in transit
Inventory
15
-
Inter Company Current Account
Payables
20
-
inter Company Current Account
Receivables
50
Sea
Lion
Group
Inventory
400
250
400 + 250 + Goods in
transit of 15
665
Receivables
100
100
100 + 100 - 50 inter
company current account
150
Bank
150
100
150 + 100 + cash in transit
15
265
650
450
90
140
Current Assets
Current Liabilities
965
90 + 140 - inter company
current account 20
210
67
Strategic Business Reporting
Illustration 18
Inter company sales of $400 have occurred in Attila group at a mark up on cost of 25%. At
the year end 1/4 of these goods had been sold on. Attila has an 80% interest in Hun.
I.
Calculate the PURP.
II.
Show the accounting treatment if the parent company is the seller.
III. Show the accounting treatment if the subsidiary company is the seller.
IV. Do parts I - III if the goods had been sold at a margin of 30%.
68
Strategic Business Reporting
Solution (Mark-up)
Unsold Inventory
Mark-up
PURP
(400 x 3/4) = 300
25/125
60
Parent is seller
DR/CR
Account
DR
Accumulated Profits (W5) to decrease
CR
Inventory to decrease
$
$
60
60
Subsidiary is seller
DR/CR
Account
$
DR
Accumulated Profits (W5) with parent share to
decrease (60 x 80%)
48
DR
NCI (W4) with subsidiary share to decrease
12
CR
Inventory to decrease
$
60
69
Strategic Business Reporting
Solution (Margin)
Unsold Inventory
Margin
PURP
(400 x 3/4) = 300
30%
90
Parent is seller
DR/CR
Account
DR
Accumulated Profits (W5) to decrease
CR
Inventory to decrease
$
$
90
90
Subsidiary is seller
DR/CR
Account
$
DR
Accumulated Profits (W5) with parent share to
decrease (90 x 80%)
72
DR
NCI (W4) with subsidiary share to decrease
18
CR
Inventory to decrease
$
90
70
Strategic Business Reporting
Illustration 19
Argentina owns an 80% share of Messi which it purchased one year ago.
The information below relates to Messi at the date of acquisition.
Ordinary
Share Capital
Reserves
Fair Value of
the net assets
Fair value of
the NCI
Cost of the
investment
$m
$m
$m
$m
$m
200
400
800
200
1900
The income statements for both are:
Argentina
Messi
Revenue
8000
3000
Cost of Sales
-4000
-1000
Gross Profit
4000
2000
Operating Costs
-1500
-1500
Finance Costs
-1000
-200
Profit Before Tax
1500
300
Tax
-700
-100
Profit for the year
800
200
Other information
I.
Argentina sold goods to Messi during the year at a margin of 40% and worth $100m.
Half of these goods have been sold on by Messi by the year end.
II.
The fair value of Messi’s net assets were equal to their book value at the date of
acquisition, with the exception of some machinery which had a useful life of 5 years.
III. Calculate goodwill using the fair value of the NCI at the date of acquisition. At the year
end an impairment review has found that the goodwill has been impaired by 10%.
Produce a consolidated Income Statement for the Argentina group.
71
Strategic Business Reporting
Illustration 19 Solution
Working 1- Group Structure
Argentina
↓
80%
Messi
Date Acquired
1 Year Ago (No time apportionment)
Parent Share
80%
NCI
20%
100%
Working 2 - Inter Company
PURP
Unsold Inventory
Margin
PURP
(100 x 1/2) = 50
40%
20
As the Parent is seller
DR/CR
Account
DR
Cost of sales to increase
CR
Inventory to decrease
$
$
20
20
Remember to remove the total amount of the sales also from sales and cost of sales
DR/CR
DR
Account
Revenue to decrease
$
$
100
72
Strategic Business Reporting
DR/CR
CR
Account
$
$
Cost of sales to decrease
100
Working 3 - Goodwill
We don’t need the net assets at the year end, but we do need them at acquisition to
calculate goodwill. Be careful - we are given the total and told that the difference is
machinery - this will lead to an additional depreciation expense.
At Acquisition
At Year End
Share Capital
200
N/A
Accumulated Profits
400
N/A
Fair Value Adjustment (Balancing
figure)
200
N/A
800
N/A
The $200m asset has a useful life of 5 years so the extra depreciation will be $200m x 1/5
= $40m. The treatment for this is:
DR/CR
Account
DR
Cost of sales to increase
CR
Non current assets to decrease
$
$
40
40
We can then use this to calculate the goodwill on acquisition
Cost of Parent’s investment
1900
Fair value of NCI at acquisition (Market Value)
200
2100
Less 100% net assets at acquisition in W2
-800
Gross Goodwill
1300
Goodwill impairment
Gross Goodwill
Impairment Loss (1300 x 10%)
1300
130
73
Strategic Business Reporting
The treatment for this is:
DR/CR
Account
DR
Cost of sales to increase
CR
Goodwill Intangible Asset to decrease
$
$
130
130
Working 4 - Cost of Sales
$m
Parent
4000
Subsidiary
1000
Less Inter Company Sales
-100
Plus the PURP
20
Plus additional depreciation
40
Plus impairment loss
130
5090
Working 5 - NCI
$
NCI % of the subsidiary’s profits in question
200 x 20%
40
Less NCI share of additional depreciation
40 x 20%
-8
Less NCI share of Impairment of goodwill
130 x 20%
-26
6
74
Strategic Business Reporting
Income statement for Argentina Group
Argentina
Messi
Revenue
8000
3000
8000 + 3000 - 100 inter
company sales
10900
Cost of Sales
-4000
-1000
W4
-5090
Gross Profit
4000
2000
Operating Costs
-1500
-1500
1500 + 1500
-3000
Finance Costs
-1000
-200
1000 + 200
-1200
Profit Before Tax
1500
300
Tax
-700
-100
Profit for the year
800
200
810
Attributable to Parent (Balancing Figure)
804
Attributable to NCI (W5)
Group
5810
1610
700 + 100
-800
6
810
Statement of Changes in Equity Pro-forma
75
Strategic Business Reporting
Share
Capital
Share
Premium
Revaluation
Reserve
Accumulated
Profits
NCI
Total
O’Balance
X
X
X
X
X
X
Share Issues
X
X
Revaluation
Gains
X
X
Profit for
period
Less
Dividends
Cl’Balance
X
X
X
X
X
X
X
X
(X)
(X)
(X)
X
X
X
76
Strategic Business Reporting
Illustration 20
Nadal is a 90% subsidiary of Federer. It was acquired one year ago for $4000m. At that
time the accumulated profits were $800m.
Income Statements
Federer
Nadal
Revenue
20000
4000
Cost of Sales
-12000
-2000
Gross Profit
8000
2000
Distribution Costs
-2100
-300
Admin Expenses
-1400
-500
Operating Profit
1500
1200
Exceptional Gain
Nil
580
Investment Income
90
Nil
Finance Costs
-600
-150
Profit Before Tax
3990
1630
Tax
-700
-130
Profit for the year
3290
1500
Federer
Nadal
Statements of Financial Position
Investment in Nadal
Assets
4000
20000
5000
24000
5000
5000
1000
Accumulated Profits
15690
2200
Equity
20690
3200
3310
1800
24000
5000
Share Capital
Liabilities
Federer Statement of changes in Equity
77
Strategic Business Reporting
Share Capital
Accumulated
Profits
Total Equity
5000
12600
17600
Profits for the year
3290
3290
Less Dividends
-200
-200
15690
20690
Share Capital
Accumulated
Profits
Total Equity
1000
800
1800
Profits for the year
1500
1500
Less Dividends
-100
-100
2200
3200
Opening Balance
Closing Balance
5000
Nadal Statement of changes in Equity
Opening Balance
Closing Balance
1000
Other Information:
In the year Federer sold goods to Nadal at a margin of 20%. The total amount sold was
$100m, of which a quarter remain in inventory at the year end.
Also during the year Nadal sold $180m of goods to Federer. These goods were sold at a
mark up of 50%. Half of the goods remain in inventory at the year end.
At the date of acquisition the fair values of Nadal’s net assets were equal to their book
value with the exception of an item of plant that had a fair value of $200m in excess of its
carrying value and a remaining useful life of 4 years. Goodwill is to be calculated on a
proportionate basis.
Federer paid a dividend during the year of $200m while Nadal paid a dividend of $100m.
Federer has recognised the dividend received from Nadal as investment income.
Required
Prepare the consolidated Income Statement, consolidated Statement of Changes in Equity
and the consolidated Statement of Financial Position for the Federer group.
78
Strategic Business Reporting
Solution
Working 1- Group Structure & PURP
Federer
↓
90%
Nadal
Date Acquired
1 Year Ago
Parent Share
90%
NCI
10%
100%
PURP
Unsold Inventory
Margin
PURP
(100 x 1/4) = 25
20%
5
Parent is seller
DR/CR
Account
$
DR
Accumulated Profits (W5) to decrease
CR
Inventory to decrease
$
5
5
Unsold Inventory
Margin
PURP
(180 x 1/2) = 90
50/150
30
Subsidiary is seller
DR/CR
Account
$
DR
Accumulated Profits (W5) with parent share to
decrease (30 x 90%)
27
DR
NCI (W4) with subsidiary share to decrease
3
CR
Inventory to decrease
$
30
79
Strategic Business Reporting
Working 2 - Equity Table
At Acquisition
At Year End
Share Capital
1000
1000
Accumulated Profits
800
2200
Fair Value Adjustment
200
200
Additional Dep’n (200 x 1/4)
-50
2000
3350
Remember to take the $50m extra dep’n to the income statement!
Working 3 - Goodwill
$
Cost of Parent Investment
4000
Less Parent % of the net assets at
acquisition (W2)
2000 x 90%
-1800
Goodwill
2200
Working 4 - NCI
SFP
$
NCI % of the subsidiary’s net assets at the year end (W2)
3350 x 10%
PURP
W1
335
-3
332
Income Statement
$
NCI Percentage of profit from question
1500 x 10%
150
Additional Depreciation
50 x 10%
-5
PURP
W1
-3
142
80
Strategic Business Reporting
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
15690
PURP
Add: Parent % of the subsidiary’s post acquisition profits
5 + 27
-32
90% x (2000 3350) (W2)
1215
16873
Income Statement
Federer
Nadal
Revenue
20000
4000
20000 + 4000 100 - 180
23720
Cost of Sales
-12000
-2000
12000 + 2000 100 - 180 - 35 - 50
-13805
Gross Profit
8000
2000
Distribution Costs
-2100
-300
2100 + 300
-2400
Admin Expenses
-1400
-500
1400 + 500
-1900
Operating Profit
1500
1200
5615
Exceptional Gain
Nil
580
580
Investment Income
90
Nil
Nil
Finance Costs
-600
-150
Profit Before Tax
3990
1630
Tax
-700
-130
Profit for the year
3290
1500
Attributable to Parent
Attributable to NCI
Group
9915
600 + 150
-750
5445
700 + 130
-830
4615
(Balancing Figure)
4473
W4
142
4615
81
Strategic Business Reporting
Statement of Financial Position
Federer
Nadal
Group
Goodwill
W3
2200
Cancelled
Nil
20000 + 5000 + 200 - 50
-35
25115
Investment in Nadal
4000
Assets
20000
5000
24000
5000
Share Capital
5000
1000
Parent Only
5000
Accumulated Profits
15690
2200
W5
16873
W4
332
NCI
Equity
20690
3200
Liabilities
3310
1800
24000
5000
27315
22205
3310 + 1800
5110
27315
Statement of changes in Equity
Share Capital
Accumulated
Profits
NCI
Total Equity
5000
12600
200
17800
Profits for the
year
4473
142
4615
Less Dividends
-200
-10
210
16873
332
22205
Opening
Balance
Closing
Balance
5000
82
Strategic Business Reporting
Associates
(IAS 28)
83
Strategic Business Reporting
Illustration 1
3 years ago Star Ltd. bought 25% of the share capital of Wars Ltd. for consideration of
$400,000. Since that time Wars Ltd.has had the following results:
Year
Profit
Dividend Paid By
Associate
1
$200,000
0
2
$160,000
$150,000
3
$30,000
0
Due to poor trading results and customer service issues, Star Ltd feel that in the current
year the investment in Wars Ltd. has been impaired by $20,000.
Show the treatment of War Ltd. in the statement of financial position of Star Group
and in the Income statement for the 3 years of the investment.
Solution
Year 1 Investment In Associate (SFP)
Initial Investment
Parent Share of Post Acquisition
Profit
400,000
(200,000) x 25%
Investment in Associate
50,000
450,000
Year 1 Income From Associate (Income Statement)
Parent share of Current Year Income
(200,000 x 25%)
50,000
84
Strategic Business Reporting
Year 2 Investment In Associate (SFP)
Initial Investment
400,000
Parent Share of Post Acquisition
Profit
Share of Dividend
(200,000 + 160,000) x 25%
90,000
(150,000 x 25%)
-37,500
Investment in Associate
452,500
Year 2 Income From Associate (Income Statement)
Parent share of Current Year Income
(160,000 x 25%)
40,000
Year 3 Investment In Associate (SFP)
Initial Investment
Parent Share of Post Acquisition
Profit
400,000
(200,000 + 160,000 + 30,000) x 25%
97,500
(150,000 x 25%)
-37,500
Share of Dividend
Impairment
-20,000
Investment in Associate
440,000
Year 3 Income From Associate (Income Statement)
Parent share of Current Year Income
(30,000 x 25%)
7500
Impairment
-20,000
Loss From Associate
-12500
85
Strategic Business Reporting
Illustration 2
Inter company sales of $1,300 have occurred in Attila group at a mark up on cost of 30%.
At the year end 1/2 of these goods had been sold on. Attila has an 30% interest in Hun.
I.
Calculate the PURP.
II.
Show the accounting treatment if the parent company is the seller.
III. Show the accounting treatment if the Associate company is the seller.
86
Strategic Business Reporting
Solution (Mark-up)
Unsold Inventory
Mark-up
PURP
Group %
(1300 x 1/2) = 650
30/130
150
45
Parent is seller
DR/CR
Account
DR
Accumulated Profits (W5) to decrease
CR
Investment in Associate
$
$
45
45
Subsidiary is seller
DR/CR
Account
DR
Accumulated Profits (W5) to decrease
CR
Group Inventory
$
$
45
45
87
Strategic Business Reporting
Illustration 3
On 1 April 2009 Picant acquired 75% of Sander’s equity shares in a share exchange of
three shares in Picant for every two shares in Sander. The market prices of Picant’s and
Sander’s shares at the date of acquisition were $3·20 and $4·50 respectively.
In addition to this Picant agreed to pay a further amount on 1 April 2010 that was
contingent upon the post-acquisition performance of Sander. At the date of acquisition
Picant assessed the fair value of this contingent consideration at $4·2 million, but by 31
March 2010 it was clear that the actual amount to be paid would be only $2·7 million
(ignore discounting). Picant has recorded the share exchange and provided for the initial
estimate of $4·2 million for the contingent consideration.
On 1 October 2009 Picant also acquired 40% of the equity shares of Adler paying $4 in
cash per acquired share and issuing at par one $100 7% loan note for every 50 shares
acquired in Adler. This consideration has also been recorded by Picant.
Picant has no other investments. The summarised statements of financial position of the
three companies at 31 March 2010 are:
Picant
Sander
Alder
Property, plant & equipment
37,500
24,500
21,000
Investments
45,000
82,500
24,500
21,000
Inventory
10,000
9,000
5,000
Receivables
6,500
1,500
3,000
Total Assets
99,000
35,000
29,000
Ordinary Shares
25,000
8,000
5,000
Share Premium
19,800
0
0
Ret. Earnings B/F
16,200
16,500
15,000
For year to 31/3/10
11,000
1,000
6,000
72,000
25500
26000
7% Loan Notes
14,500
2,000
0
Contingent Consideration
4,200
0
0
Current Liabilities
8,300
7,500
3,000
Total Equity & Liabilities
99,000
35000
29000
88
Strategic Business Reporting
(i) At the date of acquisition the fair values of Sander’s property, plant and equipment was
equal to its carrying amount with the exception of Sander’s factory which had a fair
value of $2 million above its carrying amount. Sander has not adjusted the carrying
amount of the factory as a result of the fair value exercise. This requires additional
annual depreciation of $100,000 in the consolidated financial statements in the postacquisition period.
(ii)Also at the date of acquisition, Sander had an intangible asset of $500,000 for software
in its statement of financial position. Picant’s directors believed the software to have no
recoverable value at the date of acquisition and Sander wrote it off shortly after its
acquisition.
(iii)At 31 March 2010 Picant’s current account with Sander was $3·4 million (debit). This
did not agree with the equivalent balance in Sander’s books due to some goods-intransit invoiced at $1·8 million that were sent by Picant on 28 March 2010, but had not
been received by Sander until after the year end. Picant sold all these goods at cost
plus 50%.
(iv)Picant’s policy is to value the non-controlling interest at fair value at the date of
acquisition. For this purpose Sander’s share price at that date can be deemed to be
representative of the fair value of the shares held by the non-controlling interest.
(v)Impairment tests were carried out on 31 March 2010 which concluded that the value of
the investment in Adler was not impaired but, due to poor trading performance,
consolidated goodwill was impaired by $3·8 million.
(vi)Assume all profits accrue evenly through the year.
89
Strategic Business Reporting
Working 1- Group Structure
Picant
↓
75%
Sander
↓
40%
Alder
Sander
Date Acquired
1 April 2009 (1 Yr ago)
Parent Share
75
NCI
25
100
Consideration for Sander
Item
Share Exchange
$‘000
No. Shares Purchased (8000 x 75%) = 6000
Picant Shares Issued ((6000 / 2) x 3) = 9000
Total Value (9000 x 3.20) = $28,800
Contingent Consideration
Fair Value
28,800
4,200
Total Consideration
33,000
Consideration for Alder
Item
$‘000
Cash
Fair Value (4 x (5000 x 40%))
8,000
Loan Notes
(5000 x 40%) / 50 x 100
4,000
Total Consideration
12,000
90
Strategic Business Reporting
Working 2 - Net Assets Subsidiary
At Acquisition
At Year End
Share Capital
8,000
8,000
Accumulated Profits
16,500
17,500
Fair Value of Factory
2,000
2,000
Additional Dep’n
-100
Software
-500
26000
27400
Working 3 - Goodwill in Sander
$‘000
Cost of Parent Investment
$‘000
33,000
Fair Value of NCI at acquisition
(8,000 x 25%) x
$4.5
Less net assets at acquisition (W2)
9,000
-26,000
Gross Goodwill on Acquisition
16,000
Impairment
-3,800
Goodwill at year end
Impairment to Parent in W5 (3,800 x 75%)
Impairment to NCI in W4 (3,800 x 25%)
12,200
2,850
950
91
Strategic Business Reporting
Alternative Working
$‘000
Cost of Parent Investment
$‘000
33,000
Less Parent % of the net assets at
acquisition (W2)
26,000 x 75%
19,500
Goodwill attributable to Parent
13,500
Fair Value of NCI at acquisition
Less NCI% of the net assets at acquisition
(W2)
(8,000 x 25%) x
$4.5
9,000
26,000 x 25%
6,500
Goodwill attributable to NCI
2,500
Gross Goodwill on Acquisition
16,000
Impairment
-3,800
Goodwill at year end
Impairment to Parent in W5 (3,800 x 75%)
Impairment to NCI in W4 (3,800 x 25%)
12,200
2,850
950
Working 4 - NCI
$
Fair Value of NCI at Acquisition
NCI Share of Post Acq. Profit
Goodwill Impairment to NCI (W3)
9,000
(25% x 1,400)
350
-950
8400
92
Strategic Business Reporting
Alternative Working
$
NCI % of net assets at the year end (W2)
27,400 x 25%
6,850
Goodwill Attributable to NCI (W3)
2,500
Goodwill Impairment to NCI (W3)
-950
8400
Working 5 - PURP & Group Accumulated Profit
PURP
Total Unsold Goods
Profit on Goods
PURP
1,800
1,800 /150 x 50
600
DR Retained Earnings (W5)
600
CR Inventory (SFP)
600
Group Accumulated Profit
$
Parent’s Accumulated Profits
Add: Parent % of Sub’s post acquisition profits (W2)
Add: Parent % of Associate post acquisition profits
27,200
(27,400 - 26,000) x
75%
1050
(6,000 x 6/12) x 40%
1,200
PURP
Parent Share of goodwill impairment
Gain on contingent consideration
-600
W3
-2850
4,200 - 2,700
1,500
27500
93
Strategic Business Reporting
Working 6 - Associate
$‘000
Cost of Parent’s Investment (W1)
12,000
Post Acquisition Profits ((6000 x 6/12) x 40%)
1,200
13,200
SFP
Picant
Sander
Goodwill
Property, plant &
equipment
37,500
24,500
Associate Investment
Investments
Group
W3
12,200
37,500 + 24,500 +
2,000 - 100
63,900
W6
13,200
45,000
0
82,500
24,500
Inventory
10,000
9,000
10,000 + 9,000 - 600
+1,800
20,200
Receivables
6,500
1,500
6,500 + 1,500 - 3,400
4,600
Total Assets
99,000
35,000
Ordinary Shares
25,000
8,000
Share Premium
19,800
0
Ret. Earnings B/F
16,200
16,500
For year to 31/3/10
11,000
1,000
NCI
89,300
114,100
Parent Only
25,000
19,800
W5
27,500
W4
8,400
72,000
25500
80,700
7% Loan Notes
14,500
2,000
14,500 + 2,000
16,500
Contingent
Consideration
4,200
0
4,200 - 1,500
2,700
Current Liabilities
8,300
7,500
8,300 + 7,500 - 1,600
14,200
Total Equity & Liabilities
99,000
35000
114,100
94
Strategic Business Reporting
Increasing/Decreasing
Holding
95
Strategic Business Reporting
Illustration 1
Vic purchased 10% of the shares in Bob several years ago. The investment cost $17,000
and Vic currently carries the investment at cost in the accounts. Vic has subsequently
purchased 45% of the shares in Bob for $120,000. The net assets of Bob have a fair value
of $60,000 and the fair value of the original investment is $45,000. The fair value of the
NCI is $90,000.
Calculate the gain or loss arising on the subsequent acquisition of shares
Solution 1
Fair value of original investment
45,000
Less the cost of the original investment
-17,000
Gain taken to income statement
28,000
96
Strategic Business Reporting
Illustration 2
Vic purchased 10% of the shares in Bob several years ago. The investment cost $17,000
and Vic currently carries the investment at cost in the accounts. Vic has subsequently
purchased 45% of the shares in Bob for $120,000. The net assets of Bob have a fair value
of $60,000 and the fair value of the original investment is $45,000. The fair value of the
NCI is $90,000.
Calculate the gross goodwill arising on the acquisition of Bob.
Solution 2
Working 1- Group Structure
Vic
↓
10%
↓
45%
Bob
Date 10% Acquired
Years Ago
Date 45% Acquired
Now
Parent Share
55%
NCI
45%
1
Working 2 - Revaluation
Fair value of original investment
45,000
Less the cost of the original investment
-17,000
Gain taken to income statement
28,000
97
Strategic Business Reporting
Working 3 - Goodwill
Fair value of original investment
45,000
Fair value of consideration for second investment
120,000
165,000
Fair value of NCI at acquisition
90,000
Less 100% net assets at acquisition
-60,000
Gross Goodwill
195,000
98
Strategic Business Reporting
Illustration 3
Aldo purchased 15% of the shares in Giro several years ago. The investment cost $85,000
and they currently carry it at cost in the accounts. Aldo has subsequently purchased 75%
of the shares in Giro for $700,000. The net assets of Giro have a fair value of $750,000
and the fair value of the original investment is now $145,000. The fair value of the NCI on
acquisition was $180,000.
Calculate the gross goodwill arising on the acquisition of Giro.
Solution 3
Working 1- Group Structure
Aldo
↓
15%
↓
75%
Giro
Date 15% Acquired
Years Ago
Date 75% Acquired
Now
Parent Share
90%
NCI
10%
1
Working 2 - Revaluation
Fair value of original investment
145,000
Less the cost of the original investment
-85,000
Gain taken to income statement
60,000
99
Strategic Business Reporting
Working 3 - Goodwill
Fair value of original investment
145,000
Fair value of consideration for second investment
700,000
845,000
Fair value of NCI at acquisition
180,000
Less 100% net assets at acquisition
-750,000
Gross Goodwill
275,000
100
Strategic Business Reporting
Illustration 4
A parent has owned 70% of a subsidiary for a long period of time. The NCI in the
subsidiary is currently measured at $500,000. If the parent buys another 10% what will the
value of the NCI fall to?
Solution 4
$
Current NCI value (30% holding)
Proportion being purchased
New Value of NCI
500,000
(500,000 x 10/30)
166,667
(500,000 - 166,667)
333,333
101
Strategic Business Reporting
Illustration 5
A parent has owned 90% of a subsidiary for a long period of time. The NCI in the
subsidiary is currently measured at $300,000.
I.
The parent acquires all of the remaining shares for consideration of $250,000.
II.
The parent acquires 3% of the shares for $200,000 reducing the NCI to 7%.
What is the difference taken to equity in both situations?
Solution 5
I.
$
Amount of cash paid for subsequent investment
250,000
Decrease in the NCI
300,000
Difference to an equity reserve
50,000
II.
$
Amount of cash paid for subsequent investment
Decrease in the NCI
Difference to an equity reserve
200,000
300,000 x 3/10
90,000
-110,000
102
Strategic Business Reporting
Illustration 6
Inter purchased 70% of the shares in Milan several years ago. At that time goodwill of
$80,000 arose. The net assets of Milan are currently $100,000 and the NCI is $18,000.
I.
Calculate the gain arising on disposal if Inter sells it’s entire holding for $350,000.
II.
Calculate the gain arising on disposal if Inter sells 30% for $250,000 and the fair value
of the residual value is $30,000
103
Strategic Business Reporting
Solution 6
I.
$
Sale Proceeds
350,000
Less net assets of sub at date of disposal
-100,000
Less all goodwill remaining at disposal
-80,000
Plus all NCI at date of disposal
18,000
Plus fair value of any residual holding
Gain to group
Nil
188,000
II.
$
Sale Proceeds
250,000
Less net assets of sub at date of disposal
-100,000
Less all goodwill remaining at disposal
-80,000
Plus all NCI at date of disposal
18,000
Plus fair value of any residual holding
30,000
Gain to group
118,000
104
Strategic Business Reporting
Illustration 7
For several years Jeremy has owned 70% of Richard. The net assets of Richard at this
time are $250,000. The NCI is $68,000 and the gross goodwill is $200,000.
Jeremy has just sold 15% to take the holding to 55% for consideration of $150,000.
Calculate the difference arising that will be taken to equity.
105
Strategic Business Reporting
Solution 7
$
DR
Amount of cash received for sale of
subsequent investment
CR
Increase in the NCI (% of net assets &
goodwill)
CR
Difference to an equity reserve (Gain)
150,000
15% x (250,000 +
200,000)
67,500
82,500
106
Strategic Business Reporting
Vertical Groups
107
Strategic Business Reporting
Illustration 1
Consider a group with the following structure and detail:
P
↓
80% - 1 Year Ago
S
↓
60% - 1 Year Ago
S1
Cost of
Investment
Net Assets on
Acquisition
FV NCI on
Acquisition
S
250
200
60
S1
220
150
100
Required
Calculate the Goodwill & the NCI at the acquisition date.
108
Strategic Business Reporting
Working 1 - Effective Interest in S1
Working
Total
P’s Direct Interest in S
80%
Non Controlling Interest in S
20%
100%
P’s indirect interest in S1
Non Controlling Interest in S1
(80% x 60%)
48%
(Balancing figure)
52%
100%
Working 2 - Goodwill in S
$
Cost of Parent Investment
250
Fair Value of NCI at acquisition
60
Less net assets at acquisition
-200
Goodwill attributable to Parent
110
Working 3 - Goodwill in S1
$
Cost of Investment
Less indirect holding adjustment
220
220 x 20%
-44
Fair Value of NCI at acquisition
100
Less net assets at acquisition
-150
Goodwill attributable to Parent
126
Working 4 - NCI
109
Strategic Business Reporting
$
Fair Value of NCI at Acquisition in S
60
Fair Value of NCI at Acquisition in S1
100
Less indirect holding adjustment
-44
116
110
Strategic Business Reporting
Illustration 2
Ozzy acquired a 70% holding in Sharon 2 years ago. Sharon purchased a 60%
shareholding in Jack one year ago. The following financial statements relate to the Ozzy
group.
Statements of Financial Position
Investment in Sharon
Ozzy
Sharon
Jack
$
$
$
50
Investment in Jack
Other assets
17
25
18
20
75
35
20
Ordinary Shares
50
20
8
Accumulated profits
20
12
8
Equity
70
32
16
Liabilities
5
3
4
75
35
20
Ozzy
Sharon
Jack
$
$
$
Revenue
400
60
85
Operating Costs
-395
55
-83
Operating Profit
5
5
2
Tax
-3
-2
-1
Profit for Year
2
3
1
Income Statements
Accumulated Profits
Sharon
Jack
One year ago
3
4
Two years ago
2
3
111
Strategic Business Reporting
Fair Value of NCI based on effective shareholdings
Sharon
Jack
One year ago
8
10
Two years ago
7
6
Goods worth $8m were sold in the year by Jack to Sharon and by the year end all of these
had been sold to a third party.
An impairment review at the year end found the goodwill of Sharon to be impaired by $3m,
goodwill is to be calculated gross.
Prepare the consolidated statement of financial position and consolidated income
statement for the Ozzy group.
112
Strategic Business Reporting
Solution
Working 1- Group Structure
Ozzy
↓
70% - 2 Years Ago
Sharon
↓
60% - 1 Year Ago
Jack
Ozzy’s effective Interest in Jack
Working
Ozzy’s direct interest in Jack
Ozzy’s indirect interest (via Sharon)
0%
(70% x 60%)
Ozzy’s effective interest in Jack
Non Controlling Interest in Jack
Total
42%
0.42
(Balancing figure)
0.58
100%
Ozzy’s Direct Interest in Sharon
70%
Non Controlling Interest in Sharon
30%
100%
113
Strategic Business Reporting
Working 2 - Equity Table
At Acquisition
At Year
End
At Acquisition
Sharon
At Year
End
Jack
Share Capital
20
20
8
8
Accumulated Profits
2
12
4
8
22
32
12
16
Working 3 - Goodwill in Sharon
Cost of Parent’s investment
50
Fair value of NCI at acquisition (Market Value)
7
57
Less 100% net assets at acquisition in W2
-22
Gross Goodwill
35
Impairment
-3
Goodwill after Impairment
32
114
Strategic Business Reporting
Working 3 - Goodwill in Jack
Cost of Parent’s investment
17
Less indirect holding adjustment
-5.1
Fair value of NCI at acquisition (Market Value)
10
21.9
Less 100% net assets at acquisition in W2
-12
Gross Goodwill
9.9
Working 4 - NCI
Fair Value of Sharon’s NCI at acquisition
7
Fair Value of Jack’s NCI at acquisition
10
Less indirect holding adjustment
-5.1
Plus Sharon NCI share of post acquisition profits
(32-22) x 30%
3
Plus Jack NCI share of post acquisition profits
(16-12) x 58%
2.32
Less NCI share of Sharon Goodwill Impairment
3 x 30%
-0.9
16.32
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
20
Less Goodwill Impairment
3 x 70%
-2.1
Add: Parent % of Sharon’s post acquisition profits
10 x 70%
7
Add: Parent % of the Jack’s post acquisition profits
4 x 42%
1.68
115
Strategic Business Reporting
$
26.58
Working 6 - NCI (Income Statement)
Sharon
NCI % of Profit in Question
(30% x 3)
0.9
NCI Share Goodwill Impairment
(30% x 3)
-0.9
NCI Share Group Profit
Jack
(1 x 58%)
-0.00
Total
0.58
0.58
0.58
Financial Statements for Ozzy Group
Statement of
Financial Position
Ozzy
Sharon
Jack
$
$
$
Goodwill
Other assets
25
18
20
Group
W3
41.9
25 + 18 +20
63
104.9
Ordinary Shares
50
20
8
Accumulated profits
20
12
8
NCI
Equity
70
32
16
Liabilities
5
3
4
50
W5
26.58
W4
16.32
92.9
5+3+4
12
104.9
116
Strategic Business Reporting
Income Statement
Ozzy
Sharon
Jack
$
$
$
Revenue
400
60
85
400 + 60 + 85 - 8
(inter company)
537
Operating Costs
395
55
83
395 +55 + 83 - 8
+ 3 (G’will Imp)
528
Operating Profit
Tax
9
-3
-2
Profit for Year
-1
3+2+1
-6
3
Attributable to parent (Balancing figure)
2.42
Attributable to NCI (W6)
0.58
3
117
Strategic Business Reporting
Indirect Associates
118
Strategic Business Reporting
Illustration 1
The parent has an 60% holding in the subsidiary. The subsidiary has an associate in which
it holds 40%. The following information is relevant.
Subsidiary’s cost of investment in associate
200
Fair value of net assets in associate at acquisition
120
Fair value of net assets in associate at year end
300
Show the treatment for the associate in the group financial statements.
119
Strategic Business Reporting
Solution 1
Effective interest & NCI
Parent’s’s indirect interest (via Sub)
NCI
(60% x 40%)
24%
(Balancing figure)
16%
Parent’s effective interest
40%
Post Acquisition Profits
Fair value of net assets in associate at year end
300
Fair value of net assets in associate at acquisition
-120
Post acquisition profits
180
Carrying Value of Associate
$
Cost of Investment
200
Subsidiary share of post acquisition profits (40% x 180)
72
Carrying Value of Associate
272
Treatment
DR
Investment in Associate
40% x 180
72
CR
Equity W5 (Parent share of post acquisition
profits)
24/40 x 72
43.2
CR
NCI W4 (NCI share of post acquisition profits)
16/40 x 72
28.8
120
Strategic Business Reporting
Mixed Groups
121
Strategic Business Reporting
Illustration 1
The statements of financial position for 3 companies are as follows:
John
Paul
Ringo
Investments
675
200
Assets
900
700
400
1575
900
400
Share Capital
300
200
100
Accumulated Profits
700
400
100
Equity
1000
600
200
Liabilities
575
300
200
1575
900
400
Other information:
I.
John acquired a 60% holding in Paul for $600
II.
Paul acquired a 60% holding in Ringo for $200
III. John acquired a 30% holding in Ringo for $75
IV. All of the investments were made on the same date
V.
Goodwill is to be calculated gross and no impairment has been recorded
VI. The carrying value of assets & liabilities were the same as the fair values on the date
of acquisition
VII. On the date of acquisition the following information was correct:
Paul
Ringo
Accumulated Profits
250
60
Fair value of the effective NCI
100
60
Prepare the consolidated statement of financial position for John Group.
122
Strategic Business Reporting
Solution 1
Working 1- Group Structure
John
↓ ↓
30%
↓
60%
Paul
↓ ↓
60%
Ringo
Control
John Controls Paul.
Paul controls Ringo and in addition John controls another 30% of Ringo.
Ringo is therefore a subsidiary of John group.
Effective interest & NCI
John’s direct interest in Ringo
30%
John’s indirect interest in Ringo
(60% x 60%)
John’s effective interest in Ringo
36%
66%
Effective NCI in Ringo
100% - 66%
34%
Indirect Holding Adjustment
NCI in Paul
40%
Paul’s investment in Ringo
X
200
=
80
Use this to reduce the cost of investment in W3 and the NCI in W4.
123
Strategic Business Reporting
Working 2 - Net Assets Subsidiary
At Acquisition
At Year
End
At Acquisition
Paul
At Year
End
Ringo
Share Capital
200
200
100
100
Accumulated Profits
250
400
60
100
450
600
160
200
Working 3 - Goodwill in Paul
Cost of Parent’s investment
600
Fair value of NCI at acquisition (Market Value)
100
700
Less 100% net assets at acquisition in W2
-450
Gross Goodwill
250
Working 3 - Goodwill in Ringo
Cost of Paul’s investment
200
Cost of John’s investment
75
Less indirect holding adjustment
-80
Fair value of NCI at acquisition (Market Value)
60
255
Less 100% net assets at acquisition in W2
Gross Goodwill
-160
95
124
Strategic Business Reporting
Working 4 - NCI
Fair Value of Paul NCI at acquisition
100
Fair Value of Ringo NCI at acquisition
60
Less indirect holding adjustment
-80
Plus Paul NCI share of post acquisition profits
(600-450) x 40%
60
Plus Ringo NCI share of post acquisition profits
(100 - 60) x 34%
13.6
153.6
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
Add: Parent % of Paul’s post acquisition profits
Add: Parent % of Ringo’s post acquisition profits
700
150 x 60%
90
40 x 66%
26.4
816.4
125
Strategic Business Reporting
Statement of financial position for John Group
John
Paul
Ringo
Goodwill
Assets
900
700
400
Group
W3 (95 +
250)
345
900 + 700 +
400
2,000
2,345
Share Capital
300
200
100
Parent
300
Accumulated
Profits
700
400
100
W5
816
W4
154
NCI
Equity
Liabilities
1,270
575
300
200
500 + 300
+200
1,075
2,345
126
Strategic Business Reporting
Changes in Mixed Groups
127
Strategic Business Reporting
Solutions to Lecture Illustrations
Working
Total
A’s direct interest in C
A’s indirect interest (via B)
25%
(90% x 70%)
63%
A’s effective interest in C
Non Controlling Interest in C
0.88
(Balancing figure)
12%
100%
Working
Total
D’s direct interest in F
D’s indirect interest (via E)
30%
(70% x 40%)
28%
D’s effective interest in F
Non Controlling Interest in F
0.58
(Balancing figure)
0.42
100%
Action
Result
D invests in E in 2008
D owns 70% of E making it a subsidiary
D invests in F in 2009
D owns 30% of F making it an associate
E invests in F in the current year
This makes D’s effective interest in F
58% as per our working.
F has gone from an associate to a subsidiary.
This is a step-acquisition so we need to revalue the current investment in F and
take the gain or loss to the income statement.
128
Strategic Business Reporting
Action
Result
D invests in E in 2008
D owns 70% of E making it a subsidiary
E invests in F in 2009
E owns 40% of F making it an associate
as E has significant influence and D
controls that influence.
D invests in F in the current year
This makes D’s effective interest in F
58% as per our working.
F has gone from an associate to a subsidiary.
This is a step-acquisition so we need to revalue the current investment in F and
take the gain or loss to the income statement.
Working
Total
G’s direct interest in I
G’s indirect interest (via H)
80%
(90% x 10%)
9%
G’s effective interest in I
Non Controlling Interest in I
0.89
(Balancing figure)
0.11
100%
Action
Result
G invests in H in 2008
G owns 90% of H making it a subsidiary
G invests in I in 2009
G owns 80% of I making it a subsidiary
H invests in I in the current year
This makes G’s effective interest in I
89% as per our working.
I was a subsidiary before with an 80% holding.
It is now still a subsidiary with an 89% holding.
This is a decrease in the NCI of 9% and will be a transaction within equity.
129
Strategic Business Reporting
Action
Result
G invests in H in 2008
G owns 90% of H making it a subsidiary
H invests in I in 2009
I is a simple investment of 10%
G invests in I in the current year
This makes G’s effective interest in I
89% as per our working.
I was an investment before.
It is now a subsidiary with an 89% holding.
This is a step acquisition.
130
Strategic Business Reporting
IAS 21
Foreign Currency I & II
131
Strategic Business Reporting
Illustration 1
Which of the following statements relating to IAS 21 The effects of changes in foreign
exchange rates is correct?
A. The functional currency of a foreign subsidiary is the currency that the group financial
statements are presented in.
B. A foreign subsidiary must present it’s financial statements in the presentational currency
of the parent.
C. Consideration will be given to the currency of the costs and sales of the entity when
determining it’s functional currency.
D. The more autonomous a subsidiary, the more likely it’s functional currency is that of the
parent entity.
Answer C
Illustration 2
Bulldog Ltd has a year end of 31 January.
On 13th October Bulldog Ltd buys goods from Eagle Inc. a US supplier for $250,000.
On 24th November Bulldog settles the transaction in full.
Exchange rates
13th October £1 : $1.45
24th November £1 : $1.55
Show the accounting entries for these transactions.
132
Strategic Business Reporting
Illustration 2 Solution
Agreeing Transaction
On date of agreeing the transaction use the spot
rate to record it
Working
£
250,000 /
1.45
172,414
DR Purchases
172,414
CR Payables
172,414
On Settlement
On date of agreeing the transaction use the spot
rate to record it
Working
£
250,000 /
1.55
161,290
DR Payables
172,414
CR Cash with amount actually paid
161,414
CR FX Gain with the difference
11,000
133
Strategic Business Reporting
Illustration 3
Jeff Ltd. purchases an item of plant on 1st June from a foreign supplier on one month’s
credit for €100,000. Jeff is a US company.
Exchange rates
1st June
$ = €1.50
21st June
$ = €1.40
How will this transaction be dealt with in the accounts for the year to 21st June?
134
Strategic Business Reporting
Solution to Illustration 3
At Purchase Date
Working
$
The rate at the time of purchase is $ : €1.50
€100,000 / 1.50
66,666
DR Asset
66,666
CR Payables
66,666
At 21st June
The rate at this time is $ : €1.40
Working
$
€100,000 / 1.40
71,429
The payable must be retranslated at the year end as it is a monetary balance.
So........
DR FX Loss
(71,429 - 66,666)
4,763
CR Payables
(71,429 - 66,666)
4,763
The $4,763 is unrealised so is included in Other Comprehensive Income.
135
Strategic Business Reporting
Illustration 4
Big Ltd. acquired 80% of Cahoona Inc. on 1st July 20X1.Cahoona Inc are based in
Burgerland where the functional currency is Francs (Fr). The financial statements for the
year to 30 June 20X2 are below.
SFP
Investment in Cahoona
Non Current Assets
Big
$
Cahoona
Fr
5000
10,000
3,000
5,000
2,000
20000
5,000
Share Capital
6,000
1,500
Retained Earnings
4,000
2,500
10,000
1,000
20,000
5,000
Big
$
Cahoona
Fr
Revenue
25,000
35,000
Operating Costs
-15,000
-26,250
Profit Before Tax
10,000
8,750
Tax
-5,000
-7,450
Profit for the Year
5,000
1,300
Current Assets
Liabilities
Income Statement
136
Strategic Business Reporting
There was no other comprehensive income for either entity in the period.
Other information:
I. The fair value of the net assets of Cahoona was Fr6,000 on the date of acquisition with
any increase being attributable to land held at historic cost.
II. Big sold goods to Cahoona during the year for $1,000 cash.
III.The NCI is valued using the Fair Value method at FR 2000 at acquisition.
IV. The Goodwill in Cahoona was impairment tested at the year end and was impaired by
FR200. The impairment was deemed to have accrued evenly over the year so the
average rate should be used to treat it.
Exchange rates to $1:
1 July 2001
Average rate
1 June
30 June
Fr
1.5
1.75
1.9
2
Prepare the group statement of financial position and statement of other comprehensive
income.
137
Strategic Business Reporting
Illustration 4 Solution
Working 1- Group Structure
Big
↓
80%
Cahoona
Date Acquired
1 Year Ago
Parent Share
80%
NCI
20%
100%
Working 2 - Equity Table in Functional Currency
At Acquisition
Fr
At Year End
Fr
Share Capital
1,500
1,500
Accumulated Profits
1,200
2,500
Fair Value Adjustment on land (Balancing
figure)
3,300
3,300
6,000
7,300
1.5
2
4000
3650
Translate at
Total Net Assets in $
Post acquisition Loss including FX movements
-350
138
Strategic Business Reporting
Working 3 - Goodwill in Functional Currency
Fr
Cost of Parent Investment
(5,000 @ 1.5)
Fr
7,500
Fair Value NCI
2,000
Less net assets at acquisition (W2)
-6,000
Goodwill
3,500
Translated at closing rate
(3500 / 2)
Impairment
$1,750
-$114
Remaining Goodwill
To SFP
$1,636
Add Back Impairment
(200 / 1.75)
$114
Goodwill at Opening Rate
(3500 / 1.5)
-$2,333
FX Loss on Goodwill for Year
-$583
Working 4 - NCI
$
Fair Value of NCI at Acquisition Rate
(2000 / 1.5)
1,333
NCI% Post Acquisition Loss (W2)
(20% x -350)
-70
NCI % Goodwill Impairment in Year
(20% x -114)
-22.8
NCI% Goodwill FX Loss
(20% x -583)
-117
1,124
139
Strategic Business Reporting
Working 5 - Group Accumulated Profit
$
Parent’s Accumulated Profits
4,000
Share of Sub Post-Acq Loss
(80% x -350)
-280
Parent% Goodwill Impairment in Year
(80% x -114)
-91
Parent% Goodwill FX loss
(80% x -583)
-466
3,162
Statement of Financial Position
SFP
Non Current Assets
Big
Cahoona
$
10,000
((3,000 + 3,300) / 2) =
3,150
13,150
Goodwill (W3)
Current Assets
1636
5,000
(2000 / 2)
6000
20786
Share Capital
6,000
Parent
6,000
Retained Earnings
4,000
W5
3162
W4
1124
10,000
((1,000 / 2)
10500
20,000
0
20786
NCI
Liabilities
140
Strategic Business Reporting
FX Gains/Losses for year
Closing Net Assets at Cl. Rate (W2)
Comprehensive Income for Year at Ave. Rate
Opening Net Assets at Op. Rate
(7300 / 2)
3650
(1300 /
1.75)
-743
(6000 / 1.5)
-4000
FX Loss for Year on Net Assets
-1,093
FX Loss for Year on Goodwill (W3)
-583
Total FX Loss for the year
-1,676
NCI Share Profit/Loss for Period
NCI Share Profit in Period
20% x 1300
260
NCI Share Goodwill Impairment
20% x 200
-40
Share of Profit in FR
Translate at Ave. Rate
220
(220 / 1.75)
126
141
Strategic Business Reporting
Statement of Comprehensive Income
Big
Cahoonas
Adjustment
$
Revenue
25,000
(35,000 / 1.75)
Inter Co
-1,000
44,000
Operating Costs
-15,000
(26,250 / 1.75
Inter Co
-1,000
-29,000
Profit Before Tax
Tax
15,000
-5000
(7,450 / 1.75)
-9,257
Profit for the Year
5,743
Profit Attributable to:
Parent
Non Controlling Interest
(Balance)
5,617
126
5,743
Comprehensive Income
Profit for the Year
5,743
FX differences on translation of foreign operations (W6)
-1,676
4,067
142
Strategic Business Reporting
Ethics
143
Strategic Business Reporting
Illustration 1
Jocatt operates in the energy industry and undertakes complex natural gas trading
arrangements, which involve exchanges in resources with other companies in the industry.
Jocatt is entering into a long-term contract for the supply of gas and is raising a loan on the
strength of this contract. The proceeds of the loan are to be received over the year to 30
November 2011 and are to be repaid over four years to 30 November 2015. Jocatt wishes
to report the proceeds as operating cash flow because it is related to a long-term purchase
contract. The directors of Jocatt receive extra income if the operating cash flow exceeds a
predetermined target for the year and feel that the indirect method is more useful and
informative to users of financial statements than the direct method.
(i) Comment on the directors’ view that the indirect method of preparing statements of
cash flow is more useful and informative to users than the direct method.
(7 marks)
(ii) Discuss the reasons why the directors may wish to report the loan proceeds as an
operating cash flow rather than a financing cash flow and whether there are any ethical
implications of adopting this treatment.
(6 marks)
Professional marks will be awarded in part (b) for the clarity and quality of discussion.
(2 marks)
Solution to Illustration 1
144
Strategic Business Reporting
i.
Many companies use the indirect method for preparing the statement of cash flow on the
grounds of cost.
The indirect method is essentially a reconciliation of the net income reported in the
statement of financial position with the cash flow from operations whereas the direct
method shows the inflows and outflows of cash under different categories.
The method of reconciliation in the indirect method is confusing to users and not easy to
match to the rest of the financial statements with the only real information being the
difference between net profit before tax and cash from operations.
The direct method allows for reporting operating cash flows by understandable categories
as they can see the amount of cash collected from customers, cash paid to suppliers, cash
paid to employees and cash paid for other operating expenses. Users can gain a better
understanding of the major trends in cash flows and can compare these cash flows with
those of the entity’s competitors.
An issue in the use of the indirect method for users is the abuse of the classifications of
specific cash flows such as cash outflows which should have been reported in the
operating section being classified as investing cash outflows with the result that companies
enhance operating cash flows.
A problem for users is the fact that entities can choose the method used and there is not
enough guidance on the classification of cash flows in the operating, investing and
financing sections of the indirect method used in IAS 7.
145
Strategic Business Reporting
ii.
The directors main reason for wishing to do this is to manipulate the income of the firm.
The complex nature of the indirect method as discussed previously means that the
directors are attempting to confuse users who do not have a detailed understanding of
cash flow accounting.
The information provided by directors should be a faithful representation which is unbiased
so that information disclosed is truthful and neutral. They have a responsibility to perform
in an ethical manner.
The reliance of users on the information provided for investment decisions means that the
directors must put aside their own self interest to provide information that is true and fair.
They may be tempted to manipulate the income of the firm for several reasons:
i. To gain performance related bonuses.
ii.To protect the share price of the firm.
iii.To ensure that their jobs are safe and reputations enhanced.
Regardless of the personal impact on the directors they must act independently and
objectively in the application of the accounting standards reporting the loan as cash flows
from financing activities.
146
Strategic Business Reporting
IFRS 8 & IAS 33
Operating Segments & EPS
147
Strategic Business Reporting
Illustration 1
Norman, a public limited company, has three business segments which are currently
reported in its financial statements. Norman is an international hotel group which reports to
management on the basis of region. It does not currently report segmental information
under IFRS8 ‘Operating Segments’. The results of the regional segments for the year
ended 31 May 20X8 are as follows:
Revenue
External
Internal
Segmental
Profit/Loss
$m
$m
$m
$m
$m
European
200
3
-10
300
200
South East Asia
300
2
60
800
300
Other
500
5
105
2,000
1,400
Region
Segmental
Assets
Segmental
Liabilities
There were no significant inter company balances in the segment assets and liabilities.
The hotels are located in capital cities in the various regions, and the company sets
individual performance indicators for each hotel based on its city location.
Required:
Discuss the principles in IFRS8 ‘Operating Segments’ for the determination of a
company’s reportable operating segments and how these principles would be
applied for Norman plc using the information given above.
148
Strategic Business Reporting
Solution
Requirements of IFRS 8
IFRS 8 requires operating segments to be identified based on the management structure
and reporting system in the entity. The components that are reviewed regularly by the
CEO in order to allocate resources and assess performance will form the segments.
The standard seeks to enable users to view information on the business operations which
fully discloses the financial effects of the different areas and types of operations
undertaken.
Under the standard an operating segment is defined as a component:
I.
That engages in business activities from which it may earn revenues and incur
expenses (even if the revenues & expenses are with other components in the entity).
II.
Whose operating results are reviewed regularly by the entity’s chief operating decision
makers to make decisions about resources to be allocated to the segment and assess
its performance; and for which discrete financial information is available
An operating segment will be a reportable segment if it meets the following criteria:
I.
Revenues (internal & external) are more than 10% of combined revenue.
II.
Profit or loss is more than 10% of combined total.
III. Assets are more than 10% of combined total.
75% or more of the entities external revenue must be reported by operating segments. If
not then, other segments must be identified even if they do not meet the criteria for
reportable segments until 75% is reported.
Application to Norman
The KPIs used by the management of Norman are based on city so it may well be that the
operating segments of Norman could be split further on a city basis.
Norman should investigate their reporting structure to evaluate whether decisions about
allocation and performance are made within the entity on a city basis and consider splitting
the segments further.
Regarding the current segments, only the South East Asia segment passes all 3 tests for a
reportable segment. The European segment meets only the criteria for 10% + of reported
revenue and fails on the others.
149
Strategic Business Reporting
The current reported segments report only 50% of the entity’s total external revenue so
they will have to identify further operating segments regardless of whether they meet the
criteria until the reach 75%.
By examining the internal reports of Norman the entity can determine whether the
operating segments should be further split based on the information used by management.
150
Strategic Business Reporting
Illustration 2
An entity issued 300,000 shares at full market price on 1st July 2009. The year end of the
entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st
December 2009 was $1,000,000.
Calculate the EPS at 31st December 2009.
Solution
Date
Shares
Months
Fraction
Ave
1/01/09
900,000
6/12
-
450,000
1/07/09
1,200,000
6/12
-
600,000
1,050,000
EPS = 1,000,000 / 1,050,000 = 95.24c
151
Strategic Business Reporting
Illustration 3
ABC Ltd. makes a bonus issue of 1 for 6 on 1st July 2009. The year end of the entity is
31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st
December 2009 was $1,000,000.
Calculate the EPS at 31st December 2009.
Solution
Date
Shares
Months
Fraction
Ave
1/01/09
900,000
6/12
7/6
525,000
1/07/09
1,050,000
6/12
525,000
1,050,000
EPS = 1,000,000 / 1,050,000 = 95.24c
152
Strategic Business Reporting
Illustration 4
ABC Ltd. makes a rights issue of 1 for 3 on 1st July 2009. The current share price is $4
and the rights issue is at a price of $3 The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st
December 2009 was $1,000,000.
Last year’s earnings were $900,000
Calculate the EPS at 31st December 2009 and the new EPS for 2008.
Solution
No. Shares
Price
Total
3
4
12
1
3
3
4
15
THERP = (15 / 4) = $3.75 so rights fraction is: 4/3.75
Date
Shares
Months
Fraction
Ave
1/01/09
900,000
6/12
4/3.75
480,000
1/07/09
1,200,000
6/12
600,000
1,080,000
December 2009 EPS = 1,000,000 / 1,080,000 = 92.59c
c
December 2008 EPS (900,000 / 900,000)
100
Inverted Bonus Fraction
3.75/4
Comparable EPS
93.75
153
Strategic Business Reporting
IAS 19 - Pensions
154
Strategic Business Reporting
Illustration 1
A company maintains a defined benefit pension scheme for it’s employees. The following
information is relevant:
The pension assets brought forward in 20X0 $1,000 with a closing balance of $2,000.
The Discount Rate is 11%.
Calculate the expected return on Pension Assets.
Solution
Pension Assets Brought Forward
1,000
Expected Return %
11%
Expected Return on Plan Assets
110
155
Strategic Business Reporting
Illustration 2
A company maintains a defined benefit pension scheme for it’s employees. The following
information is relevant:
The liabilities of the scheme were $1,400 at the start of the period and $2,600 at the end.
The discount rate is 12%.
Calculate the Interest Cost for the period.
Solution
Pension Liabilities Brought Forward
1,400
Discount Rate
12%
Interest Cost
168
156
Strategic Business Reporting
Illustration 3 - Try this yourself!
The following details refer to Company A’s pension scheme.
B/F
C/F
Pension Assets
1,000
2,000
Pension Liabilities
1,400
2,600
The discount rate is 11%
Calculate the return on assets and the interest cost.
Solution
Pension Assets Brought Forward
1,000
Expected Return %
11%
Expected Return on Plan Assets
110
Pension Liabilities Brought Forward
1,400
Discount Rate
11%
Interest Cost
154
157
Strategic Business Reporting
Illustration 4
A company maintains a defined benefit pension scheme for it’s employees. The following
information is relevant:
The pension assets brought forward in 20X0 $1,800 with a closing balance of $2,700.
The company contributes $90 per year into the scheme.
Benefits paid out in the period were $100.
The liabilities of the scheme were $1,600 at the start of the period and $2,100 at the end.
The discount rate is 12%.
The terms of the scheme have changed meaning that past service costs have arisen of
$35 and the current service costs for the period are $70.
Required:
Show the treatment for the pension scheme in the financial statements of the
company.
(See Video)
158
Strategic Business Reporting
IFRS 2
Share Based Payments
159
Strategic Business Reporting
Illustration 1
An entity grants 1 share option to each of its 100 employees on 1 January Year 1. Each
grant is conditional upon the employee working for the entity over the next three years.
The fair value of each share option as at 1 January Year 1 is $8
At the end of each year the number of employees expected to take up the options are:
Year 1:
Year 2:
95
97
When the rights are taken up in year 3, 98 employees actually receive the options.
Show the treatment for the employee benefits over the three years.
Solution
Year
Total
Employees
expected to
qualify
Value of
option
Proportion
of vesting
period
Total
cumulative
charge
Cost for each period
Dr Wages
Cr equity
1
95
8
1/3
253
253
2
97
8
2/3
517
517 - 253 = 264
3
98
8
3/3
784
784 - 253 - 264 = 267
160
Strategic Business Reporting
Illustration 2
An entity grants 1 share option to each of its 500 employees on 1 January Year 1. Each
grant is conditional upon the employee working for the entity over the next three years.
The fair value of each share option as at 1 January Year 1 is $10
On the basis of a weighted average probability, the entity estimates on 1 January that 100
employees will leave during the three-year period and therefore forfeit their rights to share
options.
The following actually occurs:
– 20 employees leave during Year 1 and the estimate of total employee departures over
the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures over
the three-year period is revised to 60 employees
– 10 employees leave during Year 3
Solution
Year
Employee
Departures
Total EXPECTED to
leave
TOTAL EXPECTED
TO VEST AT YEAR
END
1
20
70
430
2
25
60
440
3
10
20 + 25 + 10 (Actual)
445
Year
Total
Employees
expected to
qualify
Value of
option
Proportion
of vesting
period
Total
cumulative
cost
Cost for each period
Dr Expense
Cr equity
1
430
10
1/3
1433
1433
2
440
10
2/3
2933
2,933 - 1,433 = 1,500
3
445
10
3/3
4450
4,450 - 2933 = 1,517
161
Strategic Business Reporting
Illustration 3
Same question with additional information of share option price at the end of each year:
Year 1
Year 2
Year 3
10
12
14
Solution
Year
Total
Employees
expected to
qualify
Share
Option
Price
Proportion
of vesting
period
Total
cumulative
cost
Cost for each period
Dr Expense
Cr Liability
1
430
10
1/3
1433
1433
2
440
12
2/3
3520
3,520 - 1,433 = 2,087
3
445
14
3/3
6230
6,230 - 3,520 = 2,710
162
Strategic Business Reporting
Illustration 4
At the beginning of year 1, an entity grants 1 share options to each of its 500 employees
over a vesting period of 3 years at a fair value of $15
Year 1
40 leave, further 70 expected to leave;
Share options now repriced (as market value of shares has fallen) as the Fair Value of the
options had fallen to $5. After the repricing they are now worth $8. The modification has
therefore increased the Fair Value from $5 to $8.
Year 2
35 leave, further 30 expected to leave
Year 3
28 leave
Hint!
The repricing has increased the Fair Value of the Option by $3.
This amount is recognised over the remaining two years of the vesting period, along with
remuneration expense based on the original option value of $15
Solution
Year
Total
Employees
expected to
qualify
Option
Value
Proportion
of vesting
period
Total
cumulative
cost
Cost for each period
Dr Expense
Cr Equity
1
390
15
1/3
1950
1950
2
395
15
2/3
3950
3,950 - 1,950 = 2,000
3
397
15
3/3
5955
5,955 - 3,950 = 2,005
Year
Total
Employees
expected to
qualify
Option
Value
Proportion
of vesting
period
Total
cumulative
cost
Cost for each period
Dr Expense
Cr Equity
2
395
3
1/2
593
593
3
397
3
2/2
1191
1191 - 593 = 598
163
Strategic Business Reporting
Year
Original Charge
Additional Charge
Total Charge in Year
1
1950
1950
2
2000
593
2593
3
2005
598
2603
Total
5955
1191
7146
164
Strategic Business Reporting
IAS 16 & 36
Non Current Assets and
Impairment
165
Strategic Business Reporting
Illustration 1
A company purchases a crane with a useful economic life of 15 years for $200m with an
obligation to decommission at a cost of $50m. The applicable discount rate is 8%.
Show the recognition of the asset in the financial statements and the treatment over the
first accounting period.
Solution
Initial Recognition
Asset (200 + (50 x 1/1.0815)
DR
215.75
Cash
200
Liability
15.75
Year 1 Treatment
Depreciation Charge (215.75 / 15)
DR
Finance Cost to I/S (15.75 x 8%)
CR
14.38
Accumulated Depreciation
Dismantling Liability
CR
14.38
1.26
1.26
166
Strategic Business Reporting
Illustration 2
Ashanti owned a piece of property, plant and equipment (PPE) which cost $12 million and
was purchased on 1 May 2008. It is being depreciated over 10 years on the straight-line
basis with zero residual value. On 30 April 2009, it was revalued to $13 million and on 30
April 2010, the PPE was revalued to $8 million. The whole of the revaluation loss had been
posted to the statement of comprehensive income and depreciation has been charged for
the year. It is Ashanti’s company policy to make all necessary transfers for excess
depreciation following revaluation.
Solution
Balance
BF
Dep’n (12/10)
B/F
0.00
Initial Revaluation
2.20
Transfer to Equity
-0.24
C/F
1.96
Historic Cost
Revalued Am’t
Revaluation
Reserve
12
12
0.0
-1.2
-1.2
0.0
2.2
2.2
Revaluation
CF
10.8
13
2.2
Dep’n
-1.2
-1.44
-0.24
NBV
9.6
11.56
1.96
New Valuation
8
Total Impairment
3.56
Remove revaluation less dep’n
1.96
Income Statement
1.6
167
Strategic Business Reporting
Illustration 3
Property, plant & equipment with a total cost of $1m has components of a structure valued
at $700,000 with a useful economic life of 20 years and plant worth $300,000 with a useful
economic life of 10 years.
Show the depreciation charges in the financial statements in year 1.
Solution
Cost
Depreciation
NBV
Structure
Plant
Total
700,000
300,000
1,000,000
(700,000 / 20) = 35,000 (300,000 /10) = 30,000
665,000
270,000
65,000
935,000
168
Strategic Business Reporting
Illustration 4
The carrying value of an item of plant in the financial statements is $400,000. By operating
the plant the business expects to earn discounted cash-flows of $350,000 over the rest of
it’s useful life. The could sell the plant now for $300,000 with costs to sell of $25,000.
What is the recoverable amount?
Solution
$m
Value in Use
350,000
Fair Value less cost to sell (300,000 - 25,000)
275,000
Recoverable amount is the higher of these two which is the Value in Use of $350,000.
169
Strategic Business Reporting
Illustration 5
A company has an asset for which the following information is relevant:
$‘000
Carrying amount
400
Fair Value
350
Cost to sell
25
Cash flows expected in each of the next 5 years
90
Discount rate
10%
Annuity rate for 10% over 5 years
3.791
Carry out the impairment review for the asset.
Solution
$‘000
Value in Use (90 x 3.791)
Fair Value less cost to sell (350,000 - 25,000)
341.19
325
Recoverable amount is the higher of these two which is the Value in Use of $341,190.
Carrying Value
400
Recoverable Amount
341.19
Impairment
58.81
170
Strategic Business Reporting
Illustration 6
A cash generating unit has the assets outlined below. It’s recoverable amount has been
assessed as $1,000. Show the treatment for any impairment.
Assets
Carrying Value
Goodwill
100
PPE
800
Intangible
400
1300
Solution
Impairment Test
Carrying Value of Assets
1,300
Recoverable Amount
1,000
Impairment
Assets
300
Carrying Value
Impairment
Post
Impairment
Goodwill
100
-100
Nil
PPE
800
(200 x 800/1,200) = -133
667
Intangible
400
(200 x 400/1,200) = -67
333
1300
1000
171
Strategic Business Reporting
IFRS 5 - Assets Held For Sale
and Discontinued Operations
172
Strategic Business Reporting
Illustration 1
Archie Co. committed itself at the beginning of the financial year to selling a property that
is being under-utilised following the economic downturn. As a result of the economic
downturn, the property was not sold by the end of the year. The asset was actively
marketed but there were no reasonable offers to purchase the asset. Archie is hoping that
the economic downturn will change in the future and therefore has not reduced the price of
the asset.
Can Archie Co. classify the property as available for sale under IFRS 5?
Solution
Although Archie has a plan to sell, it is available immediately and they are trying to locate a
buyer it would appear that they are not marketing the property at a reasonable price.
They have not reduced the price even though there has been a downturn that has
presumably reduced prices in general so cannot classify the property under IFRS 5.
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Strategic Business Reporting
Illustration 2
A company has a machine that cost $300,000 to buy two years ago. At the time of
purchase the machine had a useful economic life of 30 years and they apply the
revaluation model under IAS 16 (Revaluation less depreciation).
The company has decided to sell the machine and it’s fair value at this time is $290,000
with additional costs to sell being estimated at $5,000. The value in use of the machine
has been determined as $300,000.
Although the machine has not been sold at the year end as the decision was taken that
day the company is confident that it will be sold quickly and is committed to selling it
having begun to market the machine to potential purchasers.
How should the machine be treated at the year end in the financial statements and
at what value will it be included?
174
Strategic Business Reporting
Solution
Cost
300,000
Depreciation Year 1
(300,000 / 30)
10,000
Depreciation Year 2
(300,000 / 30)
10,000
(No revaluations Yet)
280,000
Carrying Value of Machine
IFRS 5 says to apply the appropriate standard immediately prior to classification.
The machine is held under the revaluation model so revalue it before classification.
Carrying Value of Machine
280,000
Fair Value
290,000
Revaluation Reserve
10,000
This revaluation is treated under IAS 16 and creates a revaluation reserve with the movement shown in
OCI.
We then need to impairment test the Asset under IAS 36.
New Carrying value
290,000
F.V. Less Costs (290,000 - 5,000)
Recoverable Amount = Higher of
Value In Use (300,000)
so......
300,000
No Impairment as recoverable amount is higher than carrying value.
Lastly we must revalue Asset to the lower of Fair Value Less costs or Carrying Value under IFRS 5
Carrying Value of Machine
Fair Value Less Costs
IFRS 5 Impairment to P/L
290,000
(290,000 - 5,000)
285,000
5,000
The impairment will reduce the carrying value of the machine to $285,000 and the charge will be written
off to the income statement.
The machine will no longer be depreciated.
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Strategic Business Reporting
Illustration 3
A company has two divisions each of which form a major line of business, Division A and
Division B.
Mid way through the current period Division A was shut down with losses of $50,000 on
the sale of the fixed assets of the business and redundancy costs of $100,000.
Division B was restructured incurring losses of $85,000.
Results in the period included the following information:
Div A
Div B
$‘000
$‘000
1,000
2,000
Cost of Sales
750
1,250
Distribution
250
300
Administration
100
50
Revenue
Finance costs for the business were $40,000 in the period and the tax charge was
$32,000.
Prepare a note to the accounts showing the analysis of the discontinued operation
and draft the income statement for the company for the period.
176
Strategic Business Reporting
Solution
Discontinued Operations Analysis
$‘000
Revenue
1,000
Cost of Sales
750
Gross Profit
250
Admin Expenses
100
Distribution Costs
250
Operating Loss
-100
Loss on Disposal of Fixed Assets
-50
Redundancy Costs
-100
Total Loss
-250
177
Strategic Business Reporting
IAS 40 - Investment Property
178
Strategic Business Reporting
Illustration 1
Which of the following are Investment Property?
• Building used as accommodation for staff.
• Land purchased as an investment. No planning consent yet.
• New office building purchased for capital appreciation.
Solution
Building used as accommodation for staff.
NO
Land purchased as an investment. No planning consent yet.
YES
New office building purchased for capital appreciation.
YES
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Strategic Business Reporting
Illustration 2
A company has purchased a building for investment purposes on 1st Jan 20X0. The
building cost a total of $1.5m with the land element being estimated at $500,000.
The building has a useful life of 30 years. At the 31st December 20X0 the fair value of the
building (including the land) was $2m.
Show the treatment of the property for the two methods possible under IAS 40.
Solution
Cost Model
Cost of the Property
$1,500,000
Depreciation in Period
(1,500,000 - 500,000) / 30
Carrying Value at 31 December 20X0
$33,333
$1,466,667
Fair Value Model
Cost of the Property
Depreciation in Period
Fair Value Adjustment to Income
Carrying Value at 31 December 20X0
$1,500,000
Not Depreciated
$0
($2m - $1.5m)
$500,000
$2,000,000
180
Strategic Business Reporting
IAS 38 - Intangible Assets
181
Strategic Business Reporting
Illustration 1
Which of the following should be classified as development?
1. Lion Ltd has spent $200,000 investigating whether a particular substance, drefite, found
in the Arctic Circle is resistant to heat.
2. Hoey Ltd has incurred $250,000 expenses in the course of making new material for skiequipment which will be more durable.
3. Ryan Ltd has found that a chemical compound, mallerite, is harmful to the human body.
4. Lion Ltd has incurred a further $300,000 using drefite in creating prototypes of a new
heat-resistant body-suit for humans.
Solution
2 & 4 are development
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Strategic Business Reporting
Illustration 2
Coddy Ltd is developing a new product, the fold-up bicycle. Forecasts are as follows:
Expense Costs
20X5
20X6
20X7
20X8
$
$
$
$
500
700
800
800
500
700
900
Revenue from other activities
Revenue from Fold-up Bicycle
Development costs
-600
Show how the development costs should be treated if:
1. the costs do not qualify for capitalisation
2. the costs do qualify for capitalisation.
Solution
1. Expense Costs
Revenue from other
activities
20X5
20X6
20X7
20X8
Total
500
700
800
800
2800
500
700
900
2100
Revenue from other widgets
Development costs
-600
Net Profit/Loss
-100
-600
1200
1500
1700
4300
2. Amortise Development Costs
Revenue from other
activities
20X5
20X6
20X7
20X8
Total
500
700
800
800
2800
500
700
900
2100
0
-143
-200
-257
-600
500
1057
1300
1443
4300
600 x
500/2100
600 x
700/2100
600 x
900/2100
Revenue from other widgets
Development costs
Net Profit/Loss
Working for Costs
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Strategic Business Reporting
Illustration 3
A company has 3 projects in development:
Project A is in development and testing of the product has proved successful. Production
has begun and some sales have been made to date. The costs have been measured
accurately and the project looks likely to be profitable. All costs incurred so far meet the
criteria to be capitalised under IAS 38.
Project B is also in development and testing of the product has proved successful. The
costs have been measured accurately and the company expects to begin production and
sales next year. All costs incurred so far meet the criteria to be capitalised under IAS 38.
Project C was begun in the current period and to date there has been a feasibility study
carried out which was inconclusive.
Other Information:
A
B
C
Total Costs to the start of the year
600
500
Costs incurred in the period
200
100
150
Total Anticipated Revenues
20,000
30,000
Unknown
Revenue in Period
5,000
0
0
Show how the above will be treated in the current period accounts discussing each project
individually.
184
Strategic Business Reporting
Solution
Project A
Project A is in production and meets the criteria for capitalisation. All costs to date will
be capitalised and amortisation based on sales during the period will be charged
Costs Capitalised to Date
600
Costs in the period
200
Total costs to be capitalised
800
Ammortisation in Period
(800 x 5,000/20,000)
Intangible Asset Carried Forward
200
600
Project B
Project B meets the criteria for capitalisation. All costs to date will be capitalised but
production has not begun meaning that no amortisation will occur.
Costs Capitalised to Date
500
Costs in the period
100
Total costs to be capitalised
600
Intangible Asset Carried Forward
600
Project C
Project C does not meet the criteria for capitalisation as it is purely research into the
feasibility of the project and the outcome was uncertain. All costs to date will be
written off to the income statement in the period incurred.
Costs in the period
150
185
Strategic Business Reporting
IAS 20 - Government Grants
186
Strategic Business Reporting
Illustration 1
A company purchases an item of plant on which it receives a government grant of 30% of
the purchase price. The plant cost $2m and has no residual value.
The plant is to be depreciated on a straight line basis over it’s 10 year life.
Show the possible accounting treatments for the government grant in the first year.
Solution
DR
Plant at Cost
2,000,000
Cash
Income Statement Depreciation
2,000,000
200,000
Accumulated Depreciation
Cash for Government Grant
200,000
600,000
Deferred Income
Deferred Income Recognition in Year (600,000 / 10)
CR
600,000
60,000
Income Statement
60,000
Total charge to Income Statement (200,000 - 60,000) = $140,000
DR
Plant at Cost
2,000,000
Cash
Cash
2,000,000
600,000
Plant at Cost
Income Statement Depreciation ((2m - 600k) /10)
Accumulated Depreciation
CR
600,000
140,000
140,000
Total Charge to Income Statement = $140,000
187
Strategic Business Reporting
IAS 23 - Borrowing Costs
188
Strategic Business Reporting
Illustration 1
A company is building a qualifying asset worth $2.5m and has issued a bond of the same
value to do so with an effective interest rate of 6%.
The asset will take 9 months to build and for the first 3 months the company invests the
proceeds of the bond and earns interest at 3%.
What borrowing costs should be capitalised?
Solution
$
Total Interest for the Year
For 9 months
Temporary Investment Income
(2.5m x 6%)
150,000
x 9/12
112,500
(2.5m x 3%) x 3/12
-18,750
93,750
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Strategic Business Reporting
Illustration 2
A company has a £1m 6% loan and a £2m 8% loan. It builds a building costing £600,000
and it takes 8 months.
What borrowing costs should be capitalised?
Solution
Total Borrowing
Cost
Total Cost
$1m
6%
6
$2m
8%
16
$3m
At total cost
22
Average Rate therefore is (22/3) = 7.33%
We can capitalise 600,000 x 7.33% x 8/12 = $29,320
Illustration 3
Company buys land on 1/12, a planning application is prepared during December and
January. Permission is obtained at the end of January. Payment for the land is made on
1/2. On this date a loan is taken out to pay for the land and building construction
Adverse weather conditions meant a delay in the commencement of work until 15/3.
When should interest be capitalised from?
Solution
Expenses start being incurred
1 December
Borrowing costs incurred
1 February
Activities started
15 March
Start Capitalising on 15 March
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Strategic Business Reporting
Illustration 4
Davos is building an office block and issued a $10 million unsecured loan with a coupon
(nominal) interest rate of 6% on 1 April 20X9. The loan is redeemable at a premium which
means the loan has an effective finance cost of 7·5% per annum.
The loan was specifically issued to finance the building of the new block which meets the
definition of a qualifying asset in IAS 23. Construction of the block commenced on 1 May
20X9 and it was completed and ready for use on 28 February 2010, but did not open for
trading until 1 April 20X0.
During the year trading at Davos’ was below expectations so they suspended the
construction of the new block for a two-month period during July and August 20X9. The
proceeds of the loan were temporarily invested for the month of May 20X9 and earned
interest of $40,000.
Calculate the borrowing costs that can be capitalised under IAS 23
Solution
The effective interest rate is 7.5% which should be used to capitalise the interest as this is
a qualifying asset.
The interest cost for the year to 31/03/20X0 would therefore be ($10m x 7.5%) =
$750,000.
However the building only began on 1/05/20X9 and was completed on 28/02/20X0 so one
month at the start and one month at the end can’t be capitalised.
In addition there were 2 months during which construction was suspended.
8 months interest ($750,000 x 8/12) = $500,000 less the temporary investment income of
$40,000 should be caplitalised.
Total = $460,000
The rest of the cost should be written off to the Income statement.
191
Strategic Business Reporting
IAS 12
Deferred Tax
192
Strategic Business Reporting
Illustration 1
An entity has the following assets & liabilities recorded in it’s balance sheet at 31
December 2008:
Carrying Value
$m
Tax Base
$m
Property
20
14
Plant & Equipment
10
8
Inventory
8
12
Trade Receivables
6
8
Trade Payables
12
12
Cash
4
4
The entity had made a provision for inventory obsolescence of $4m that is not allowable
for tax purposes until the inventory is sold and an impairment charge against trade
receivables of $2m that will not be allowed in the current year for tax purposes but will be
in the future. Income tax paid is at 30%.
Required:
Calculate the deferred tax provision at 31 December 20X8.
Solution
Carrying Value
$m
Tax Base
$m
Temporary
Difference
Asset/
Liability?
Property
20
14
6
Liability
Plant &
Equipment
10
8
2
Liability
Inventory
8
12
-4
Asset
Trade
Receivables
6
8
-2
Asset
Trade Payables
12
12
0
-
Cash
4
4
0
-
2
Liability
Total
The deferred tax liability will be $2,000,000 x 30% = $600,000
193
Strategic Business Reporting
Illustration 2
Show the accounting treatment in the following situations:
(i) A company treats royalties as income when receivable in accordance with IFRS. The
tax regime taxes royalties when they are received. The Income Statement of the
company shows $1m of royalties in the period of which $500,000 have been received.
(ii)In accordance with IFRS a company has deferred $2m of income on a long term
contract. The tax rules state that the income should be recognised immediately.
(iii)Depreciation on Plant & Equipment in the period under IFRS is $4m where the tax
allowable depreciation is $2m.
(iv)Depreciation on Buildings in the period under IFRS is $3m where the tax allowable
depreciation is $4m.
The tax rate is 30%
Solution
Financial
Statements
Tax Effect
Deferred Tax
Royalties
More Income
More Tax
Liability
Deferred Income
Less Income
Less Tax
Asset
Plant & Equipment
More Expense
Less Tax
Asset
Buildings
Less Expense
More Tax
Liability
Working
Tax
Situation
Situation
DR
Royalties
Deferred Income
(1m - 500k) x 30%
Deferred Tax
CR
DR
150
150
(2m x 30%)
600
600
Plant & Equipment
(4m - 2m) x 30%
600
600
Buildings
(4m - 3m) x 30%
300
CR
300
194
Strategic Business Reporting
Illustration 3
An entity granted 1,000 share options to an employee vesting 3 years later. The fair value
of at the grant date was $3
Tax law allows a tax deduction of the intrinsic value at the end of the vesting period.
The intrinsic value is $1.20 at the end of year 1 and $3.40 at the end of year 2
Assume a tax rate of 30%.
Solution
Step 1 - Calculate the Options Expense.
Year
No.
Options
Value of
option
Proportion
Dr Expense
Cr equity
Period
Expense
1
1000
3
1/3
1000
1000
2
1000
3
2/3
2000
1000
Step 2 - Calculate the Tax Allowable Deduction
Year
No.
Options
Intrinsic Value of
option
Proportion
Total Tax
Allowable
Period
Expense
1
1000
1.2
1/3
400
400
2
1000
3.4
2/3
2267
1867
Step 3 - Treatment
Share
Expense
Tax Allowable
(At Exercise Date)
SFP
Asset
I/S
CR
SCI
CR
Year 1
1,000
400
(400 x 30%)
=120
120
Nil
Year 2
1000
1,867
(1,867) x 30%
= 560
480
80
Total
2000
2267
680
600
80
The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30%
= 80) goes to equity rather than the income statement.
195
Strategic Business Reporting
IAS 37
Provisions
196
Strategic Business Reporting
Illustration 1
Greenie, a public limited company, builds, develops and operates airports. During the
financial year to 30 November 2010, a section of an airport collapsed and as a result
several people were hurt. The accident resulted in the closure of the terminal and legal
action against Greenie. When the financial statements for the year ended 30 November
2010 were being prepared, the investigation into the accident and the reconstruction of the
section of the airport damaged were still in progress and no legal action had yet been
brought in connection with the accident. The expert report that was to be presented to the
civil courts in order to determine the cause of the accident and to assess the respective
responsibilities of the various parties involved, was expected in 2011.
Financial damages arising related to the additional costs and operating losses relating to
the unavailability of the building. The nature and extent of the damages, and the details of
any compensation payments had yet to be established. The directors of Greenie felt that at
present, there was no requirement to record the impact of the accident in the financial
statements.
Compensation agreements had been arranged with the victims, and these claims were all
covered by Greenie’s insurance policy. In each case, compensation paid by the insurance
company was subject to a waiver of any judicial proceedings against Greenie and its
insurers. If any compensation is eventually payable to third parties, this is expected to be
covered by the insurance policies.
The directors of Greenie felt that the conditions for recognising a provision or disclosing a
contingent liability had not been met. Therefore, Greenie did not recognise a provision in
respect of the accident nor did it disclose any related contingent liability or a note setting
out the nature of the accident and potential claims in its financial statements for the year
ended 30 November 2010.
(6 marks)
Solution
IAS 37 paragraph 14, states that an entity must recognise a provision if, and only if:
(i) a present obligation (legal or constructive) has arisen as a result of a past event (the
obligating event),
(ii)payment to settle the obligation is probable (‘more likely than not’),
(iii)and the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and,
therefore, results in an enterprise having no realistic alternative but to settle the obligation
[IAS 37.10].
At the date of the financial statements, there was no current obligation for Greenie. In
particular, no action had been brought in connection with the accident. It was not yet
probable that an outflow of resources would be required to settle the obligation. Thus no
provision is required.
Greenie may need to disclose a contingent liability. IAS 37 defines a contingent liability as:
197
Strategic Business Reporting
(a) a possible obligation that has arisen from past events and whose existence will be
confirmed by the occurrence or not of uncertain future events; or
(b) a present obligation that has arisen from past events but is not recognised because:
(i) it is not probable that an outflow of resources will occur to settle the obligation; or
(ii)the amount of the obligation cannot be measured with sufficient reliability.
IAS 37 requires that entities should not recognise contingent liabilities but should disclose
them, unless the possibility of an outflow of economic resources is remote. It appears that
Greenie should disclose a contingent liability. The fact that the real nature and extent of
the damages, including whether they qualify for compensation and details of any
compensation payments remained to be established all indicated the level of uncertainty
attaching to the case. The degree of uncertainty is not such that the possibility of an
outflow of resource could be considered remote. Had this been the case, no disclosure
under IAS 37 would have been required.
Thus the conditions for establishing a liability are not fulfilled. However, a contingent
liability should be disclosed as required by IAS 37.
The possible recovery of these costs from the insurer give rise to consideration of whether
a contingent asset should be disclosed. Given the status of the expert report, any
information as to whether judicial involvement is likely will not be available until 2011. Thus
this contingent asset is more possible than probable. As such no disclosure of the
contingent asset should be included.
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Strategic Business Reporting
Illustration 2
Grange has prepared a plan for reorganising the parent company’s own operations. The
board of directors has discussed the plan but further work has to be carried out before they
can approve it. However, Grange has made a public announcement as regards the
reorganisation and wishes to make a reorganisation provision at 30 November 2009 of
$30 million. The plan will generate cost savings. The directors have calculated the value in
use of the net assets (total equity) of the parent company as being $870 million if the
reorganisation takes place and $830 million if the reorganisation does not take place.
Grange is concerned that the parent company’s property, plant and equipment have lost
value during the period because of a decline in property prices in the region and feel that
any impairment charge would relate to these assets. There is no reserve within other
equity relating to prior revaluation of these non-current assets.
Solution
A provision for restructuring should not be recognised, as a constructive obligation does
not exist. A constructive obligation arises when an entity both has a detailed formal plan
and makes an announcement of the plan to those affected. The events to date do not
provide sufficient detail that would permit recognition of a constructive obligation.
Therefore no provision for reorganisation should be made and the costs and benefits of
the plan should not be taken into account when determining the impairment loss. Any
impairment loss can be allocated to non-current assets, as this is the area in which the
directors feel that loss has occurred.
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Strategic Business Reporting
IAS 10 - Subsequent Events
200
Strategic Business Reporting
Illustration 1
Which of the following are adjusting events for Fishcakes Ltd? The year end is 30 June
20X1 and the accounts are approved on 20 August 20X1.
1. Sales of year-end inventory on 4 July 2011 at less than cost
2. Issue of new ordinary shares on 10 July 2011.
3. A fire in the warehouse occurred on 16 July 2011. All stock was destroyed.
4. A major credit customer was declared bankrupt on 20 July 2011.
5. All of the share capital of a rival, Haggis Ltd was acquired on 22 July 2011.
6. On 4 August, $700,000 was received in respect of an insurance claim dated 13
February 2011.
Which of the following are adjusting events for Fishcakes Ltd?
Solution
1, 4 and 6.
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Strategic Business Reporting
Interim Reporting (IAS 34) &
First Time Adoption (IFRS 1)
202
Strategic Business Reporting
Illustration 1
In the IFRS opening statement of financial position at 1 May 2009, Lockfine elected to
measure its fishing fleet at fair value and use that fair value as deemed cost in accordance
with IFRS 1 First Time Adoption of International Financial Reporting Standards. The fair
value was an estimate based on valuations provided by two independent selling agents,
both of whom provided a range of values within which the valuation might be considered
acceptable. Lockfine calculated fair value at the average of the highest amounts in the two
ranges provided. One of the agents’ valuations was not supported by any description of
the method adopted or the assumptions underlying the calculation. Valuations were
principally based on discussions with various potential buyers. Lockfine wished to know
the principles behind the use of deemed cost and whether agents’ estimates were a
reliable form of evidence on which to base the fair value calculation of tangible assets to
be then adopted as deemed cost.
Lockfine was unsure as to whether it could elect to apply IFRS 3 Business Combinations
retrospectively to past business combinations on a selective basis, because there was no
purchase price allocation available for certain business combinations in its opening IFRS
statement of financial position.
Solution
The question arises as to whether the selling agents’ estimates can be used to calculate
fair value in accordance with IFRS 1 First Time Adoption of International Financial
Reporting Standards. Assets carried at cost (e.g. property, plant and equipment) may be
measured at their fair value at the date of the opening IFRS statement of financial position.
Fair value becomes the ‘deemed cost’ going forward under the IFRS cost model.
Deemed cost is an amount used as a surrogate for cost or depreciated cost at a given
date. If, before the date of its first IFRS statement of financial position, the entity had
revalued any of these assets under its previous GAAP either to fair value or to a priceindex-adjusted cost, that previous GAAP revalued amount at the date of the revaluation
can become the deemed cost of the asset under IFRS 1. It is generally advantageous to
use independent estimates when determining fair value, but Lockfine should ensure that
the valuation is prepared in accordance with the requirements of the relevant IFRS
standard.
An independent valuation should generally, as a minimum, include enough information for
Lockfine to assess whether or not this is the case. The selling agents’ estimates provided
very little information about the valuation methods and underlying assumptions that they
could not, in themselves, be relied upon for determining fair value in accordance with IAS
16 Property, Plant and Equipment. Furthermore it would not be prudent to value the boats
at the average of the higher end of the range of values.
IFRS 1, however, does not set out detailed requirements under which fair value should be
determined. Issuers who adopt fair value as deemed cost have only to provide the limited
disclosures, and methods and assumptions for determining the fair value do not have to
be disclosed. The revaluation has to be broadly comparable to fair value. The use of fair
value as deemed cost is a cost effective alternative approach for entities which do not
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Strategic Business Reporting
perform a full retrospective application of the requirements to IAS 16. Thus Lockfine was
not in breach of IFRS 1 and can determine fair value on the basis of selling agent
estimates.
In accordance with IFRS 1, an entity which, during the transition process to IFRS, decides
to retrospectively apply IFRS 3 to a certain business combination must apply that decision
consistently to all business combinations occurring between the date on which it decides
to adopt IFRS 3 and the date of transition. The decision to apply IFRS 3 cannot be made
selectively. The entity must consider all similar transactions carried out in that period; and
when allocating values to the various assets (including intangibles) and liabilities of the
entity acquired in a business combination to which IFRS 3 is applied, an entity must
necessarily have documentation to support its purchase price allocation, extended or
applied to other similar situations.
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Strategic Business Reporting
Financial Instruments I
205
Strategic Business Reporting
Illustration 1
Aron held 3% holding of the shares in Smart, a public limited company. The investment
was classified as available-for-sale and at 31 May 2009 was fair valued at $5 million. The
cumulative gain recognised in equity relating to the available-for-sale investment was
$400,000.
On the same day, the whole of the share capital of Smart was acquired by Given, a public
limited company, and as a result, Aron received shares in Given with a fair value of $5·5
million in exchange for its holding in Smart.
Show the treatment for the transaction in the accounts to the 31 May 2009:
i) Under IAS 39
ii)If the asset was classified as FVOCI under IFRS 9
Solution
i)
IAS 39
Proceeds of Share exchange
$m
5.5
Carrying amount of Shares
5
Gain on de-recognition
0.5
Recycle gain previously recognised in Equity
0.4
Gain to Income Statement
0.9
IFRS 9
Proceeds of Share exchange
Carrying amount of Shares
$m
5.5
5
Gain on de-recognition
0.5
Gain to Income Statement
0.5
Previous gain transferred from other reserves to retained earnings
0.4
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Strategic Business Reporting
Illustration 2
The publication of IFRS 9, Financial Instruments, represents the completion of the first
stage of a three-part project to replace IAS 39 Financial Instruments: Recognition and
Measurement with a new standard. The new standard purports to enhance the ability of
investors and other users of financial information to understand the accounting of financial
assets and reduces complexity.
Required:
Discuss the approach taken by IFRS 9 in measuring and classifying financial assets and
the main effect that IFRS 9 will have on accounting for financial assets. (11 marks)
Solution
IFRS 9 Financial instruments retains a mixed measurement model with some assets
measured at amortised cost and others at fair value. The distinction between the two
models is based on the business model of each entity and a requirement to assess
whether the cash flows of the instrument are only principal and interest. The business
model approach is fundamental to the standard and is an attempt to align the accounting
with the way in which management uses its assets in its business whilst also looking at the
characteristics of the business. A debt instrument generally must be measured at
amortised cost if both the ‘business model test’ and the ‘contractual cash flow
characteristics test’ are satisfied. The business model test is whether the objective of the
entity’s business model is to hold the financial asset to collect the contractual cash flows
rather than have the objective to sell the instrument prior to its contractual maturity to
realise its fair value changes.
The contractual cash flow characteristics test is whether the contractual terms of the
financial asset give rise, on specified dates, to cash flows that are solely payments of
principal and interest on the principal amount outstanding.
All recognised financial assets that are currently in the scope of IAS 39 will be measured at
either amortised cost or fair value. The standard contains only the two primary
measurement categories for financial assets unlike IAS 39 where there were multiple
measurement categories. Thus the existing IAS 39 categories of held to maturity, loans
and receivables and available-for-sale are eliminated along with the tainting provisions of
the standard.
A debt instrument (e.g. loan receivable) that is held within a business model whose
objective is to collect the contractual cash flows and has contractual cash flows that are
solely payments of principal and interest generally must be measured at amortised cost.
All other debt instruments must be measured at fair value through profit or loss (FVTPL).
An investment in a convertible loan note would not qualify for measurement at amortised
cost because of the inclusion of the conversion option, which is not deemed to represent
payments of principal and interest. This criterion will permit amortised cost measurement
when the cash flows on a loan are entirely fixed such as a fixed interest rate loan or where
interest is floating or a combination of fixed and floating interest rates.
207
Strategic Business Reporting
IFRS 9 contains an option to classify financial assets that meet the amortised cost criteria
as at FVTPL if doing so eliminates or reduces an accounting mismatch. An example of this
may be where an entity holds a fixed rate loan receivable that it hedges with an interest
rate swap that swaps the fixed rates for floating rates. Measuring the loan asset at
amortised cost would create a measurement mismatch, as the interest rate swap would be
held at FVTPL. In this case the loan receivable could be designated at FVTPL under the
fair value option to reduce the accounting mismatch that arises from measuring the loan at
amortised cost.
All equity investments within the scope of IFRS 9 are to be measured in the statement of
financial position at fair value with the default recognition of gains and losses in profit or
loss. Only if the equity investment is not held for trading can an irrevocable election be
made at initial recognition to measure it at fair value through other comprehensive income
(FVTOCI) with only dividend income recognised in profit or loss. The amounts recognised
in OCI are not recycled to profit or loss on disposal of the investment although they may be
reclassified in equity.
The standard eliminates the exemption allowing some unquoted equity instruments and
related derivative assets to be measured at cost. However, it includes guidance on the rare
circumstances where the cost of such an instrument may be appropriate estimate of fair
value.
The classification of an instrument is determined on initial recognition and reclassifications
are only permitted on the change of an entity’s business model and are expected to occur
only infrequently. An example of where reclassification from amortised cost to fair value
might be required would be when an entity decides to close its mortgage business, no
longer accepting new business, and is actively marketing its mortgage portfolio for sale.
When a reclassification is required it is applied from the first day of the first reporting
period following the change in business model.
All derivatives within the scope of IFRS 9 are required to be measured at fair value. IFRS 9
does not retain IAS 39’s approach to accounting for embedded derivatives. Consequently,
embedded derivatives that would have been separately accounted for at FVTPL under IAS
39 because they were not closely related to the financial asset host will no longer be
separated. Instead, the contractual cash flows of the financial asset are assessed as a
whole and are measured at FVTPL if any of its cash flows do not represent payments of
principal and interest.
One of the most significant changes will be the ability to measure some debt instruments,
for example investments in government and corporate bonds at amortised cost. Many
available-for-sale debt instruments currently measured at fair value will qualify for
amortised cost accounting.
Many loans and receivables and held-to-maturity investments will continue to be measured
at amortised cost but some will have to be measured instead at FVTPL. For example
some instruments, such as cash-collateralised debt obligations, that may under IAS 39
have been measured entirely at amortised cost or as available-for-sale will more likely be
measured at FVTPL. Some financial assets that are currently disaggregated into host
financial assets that are not at FVTPL will instead by measured at FVTPL in their entirety.
208
Strategic Business Reporting
IFRS 9 may result in more financial assets being measured at fair value. It will depend on
the circumstances of each entity in terms of the way it manages the instruments it holds,
the nature of those instruments and the classification elections it makes.
Assets that are currently classified as held-to-maturity are likely to continue to be
measured at amortised cost as they are held to collect the contractual cash flows and
often give rise to only payments of principal and interest.
IFRS 9 does not directly address impairment. However, as IFRS 9 eliminates the
available-for-sale (AFS) category, it also eliminates the AFS impairment rules. Under IAS
39 measuring impairment losses on debt securities in illiquid markets based on fair value
often led to reporting an impairment loss that exceeded the credit loss that management
expected. Additionally, impairment losses on AFS equity investments cannot be reversed
within the income statement section of the statement of comprehensive income under IAS
39 if the fair value of the investment increases. Under IFRS 9, debt securities that qualify
for the amortised cost model are measured under that model and declines in equity
investments measured at FVTPL are recognised in profit or loss and reversed through
profit or loss if the fair value increases.
209
Strategic Business Reporting
Financial Instruments II
210
Strategic Business Reporting
Illustration 1
A company invests $100,000 in a 3 year redeemable 12% bond.
The bond consists of interest payments and principle only and the company intends to
hold it until it is redeemed.
Show the treatment for the bond over the 3 year period.
Solution
O’Bal
Interest (12%)
DR Financial Asset
CR Income Statement
Cash Rec’d
(12% x 100,000)
DR Cash
CR Financial Asset
Cl’bal
100,000
12,000
-12,000
100,000
100,000
12,000
-12,000
100,000
100,000
12,000
-12,000
100,000
At the end of the term the bond is repaid and the company receives $100,000.
211
Strategic Business Reporting
Illustration 2
A company invests $10,000 in a 3 year redeemable 10% bond which is redeemable at a
premium of $675.
The bond consists of interest payments and principle only and the company intends to
hold it until it is redeemed.
The effective interest rate on the bond is 12%.
Show the treatment for the bond over the 3 year period.
Solution
O’Bal
Interest (12%)
DR Financial Asset
CR Income Statement
Cash Rec’d
(10% x 10,000)
DR Cash
CR Financial Asset
Cl’bal
10,000
1,200
-1,000
10,200
10,200
1,224
-1,000
10,424
10,424
1,251
-1,000
10,675
The Premium payable at the end of the term means that the company receives $10,675.
212
Strategic Business Reporting
Illustration 3
A company issues a $30,000 3 year 7% redeemable bond at a discount of 10% with issue
costs of $1,000.
The bond is redeemable at a premium of $1,297.
The effective interest rate is 14%.
Show the treatment for the bond over the 3 year period.
$
Issue Proceeds
30,000
Discount
-3,000
Issue Costs
-1,000
Net Proceeds
26,000
O’Bal
Interest (14%)
DR Income Statement
CR Financial Liability
Cash Paid (7% x 30,000)
DR Financial Liability
CR Cash
Cl’bal
26,000
3,640
-2,100
27,540
27,540
3,856
-2,100
29,296
29,296
4,101
-2,100
31,297
213
Strategic Business Reporting
Illustration 4
VB acquired 40,000 shares in another entity, JK, in March 2012 for $2.68 per share. The
investment was held for trading purposes on initial recognition. The shares were trading at
$2.96 per share on 31 July 2012.
Show the treatment to record the initial recognition of this financial asset and its
subsequent measurement at 31 July 2012
Solution
$
As the shares are held for trading they will be classified as Fair Value through Profit &
Loss
Recognition of Financial Asset
(40,000 x $2.68)
107200
Fair Value on 31 July 2012
(40,000 x $2.96)
118400
Movement to Income Statement (Gain)
11200
214
Strategic Business Reporting
Illustration 5
QWE issued 10 million 5% convertible $1 bonds 2015 on 1 January 2010. The proceeds of
$10 million were credited to non-current liabilities and debited to bank. The 5% interest
paid has been charged to finance costs in the year to 31 December 2010.
The market rate of interest for a similar bond with a five year term but no conversion
terms is 7%. (The annuity rate for 5 years at 7% is 4.100 with the discount rate in
year 5 being 0.713).
Show the split of the compound instrument between debt and equity and the
treatment of the debt portion in the first year.
Solution
$
First Step is to calculate debt value (Present Value of interest & Capital)
Interest for 5 Years at 5%
($10m x 5%)
500,000
(500,000 x 4.100)
2,050,000
($10m x 0.713)
7130000
Discounted Cash Flows
Discount Interest Payment at effective rate
Discount Capital Repayment
Total Debt Portion
9180000
The difference between the issued value of the convertible debt and the present value
of the interest and capital is the EQUITY portion of the debt
Total Convertible Debt
10,000,000
Present Value of Interest and capital from above
9180000
Total Equity Portion
820000
O’Bal
Interest (7%)
DR Income Statement
CR Financial Liability
Cash Paid
(5% x 10m)
DR Financial Liability
CR Cash
Cl’bal
9,180,000
642,600
-500,000
9,322,600
215
Strategic Business Reporting
Illustration 6
Aron issued one million convertible bonds on 1 June 2006. The bonds had a term of three
years and were issued with a total fair value of $100 million which is also the par value.
Interest is paid annually in arrears at a rate of 6% per annum and bonds, without the
conversion option, attracted an interest rate of 9% per annum on 1 June 2006. The
company incurred issue costs of $1 million. If the investor did not convert to shares they
would have been redeemed at par. At maturity all of the bonds were converted into 25
million ordinary shares of $1 of Aron. No bonds could be converted before that date. The
directors are uncertain how the bonds should have been accounted for up to the date of
the conversion on 31 May 2009 and have been told that the impact of the issue costs is to
increase the effective interest rate to 9·38%.
Solution
Debt & Equity Split
Year
Cash Flows
DR 9%
PV
1
6
0.917
5.50
2
6
0.841
5.05
3
6
0.772
4.63
3
100
0.772
77.20
Debt Total
92.38
Total Value
100.00
Equity Total (Bal)
Issue Costs
7.62
$
Debt
($1m x 92.38/100)
923,800
Equity
($1m x 7.62/100)
76,200
Pre- Issue Costs
Issue Costs
Net Value
Debt
Equity
Total
92.38
7.62
100
0.92
0.08
1
91.46
7.54
99
216
Strategic Business Reporting
Year
O’bal
Interest
(9.38%)
Cash Paid
Cl’bal
1
91.46
8.58
6.00
94.04
2
94.04
8.82
6.00
96.86
3
96.86
9.09
6.00
99.95
This is the $100m conversion value of the bond with slight rounding difference
217
Strategic Business Reporting
Hedge Accounting
218
Strategic Business Reporting
Illustration 1
In June 20X5 ABC Co. (a jewellery manufacturer) is worried about the price of gold
increasing. ABC intends to buy 1,000 ounces of gold on 31st Dec 20X5 so enters into a
futures contract to buy 1,000 ounces of gold at $1,235 per ounce on 31 June 20X5.
The year end of ABC Co. is 31 October 20X5 and on that date the futures price for delivery
on 31 Dec 20X5 is $1,300 per ounce.
Show the accounting entries to record the futures contract in the financial
statements at the year end 31 October 20X5.
Solution
The initial cost of the futures contract is zero (one of the characteristics of a derivative).
By the year end it has moved in value creating a gain as ABC has a contract to buy at
$1,235 whereas it would now have cost $1,300 so they could sell it at that price if they
wanted to.
so...
DR Financial Asset (1,000 x (1,300 - 1,235)) =
CR Gain in P/L
$65,000
$65,000
219
Strategic Business Reporting
Illustration 2
NMN is a UK based company and is receiving $400,000 from a US customer in 6 months.
NMN takes out a forward contract at a rate of £1:$1.40 and by it’s year end in 3 months
the spot rate is £1:$1.45.
At what value should the contract be included in the financial statements at the year end?
Solution
Forward contract amount expected (400,000 / 1.4) £285,714
Spot rate value (400,000 / 1.45) £275,862
Initial Valuation on inception = 0 (No Cost)
Increase in value of Forward (285,714 - 275,862) = £9,852 Asset
220
Strategic Business Reporting
Illustration 3
A company purchases a $2 million bond that has a fixed interest rate of 6% per year . The
instrument is classed as a FVPL financial asset. The fair value is $2 million.
The company enters into an interest rate swap (fair value zero) to offset the risk of a
decline in fair value. If the derivative hedging instrument is effective, any decline in the fair
value of the bond should be offset by opposite increases in the fair value of the derivative
instrument. The swap is expected to be 100% effective.
The company designates and documents the swap as a hedging instrument.
Market interest rates increase to 7% and the fair value of the bond decreases to
$1,920,000.
Show the double entry to record the hedge in the financial statements
Solution
The instrument is a hedged item in a fair value hedge, this change in fair value of the
instrument is recognised in profit or loss, as follows:
Dr Income statement 80,000
Cr Bond 80,000
The fair value of the swap has increased by $80,000. Since the swap is a derivative, it is
measured at fair value with changes in fair value recognised in profit or loss.
Dr Swap 80,000
Cr Income statement 80,000
The changes in fair value of the hedged item and the hedging instrument exactly offset,
the hedge is 100% effective and, the net effect on profit or loss is zero.
221
Strategic Business Reporting
Illustration 4
ABC intends to buy 1,000 ounces of gold on 31st Jan 20X6 at the prevailing market price
on that date. The current price of gold is $1,200.
ABC is concerned that the price of gold may rise, so enters into a futures contract to buy
1,000 ounces of gold at $1,300 per ounce on 31 March 20X5.
The company designates and documents the futures contract as a hedging instrument.
The year end of ABC Co. is 31 October 20X5 and on that date the futures price for delivery
on 31 March 20X6 is $1,400 per ounce. The market price of gold on that date is $1,325.
On 31 Jan 20X6 the futures contract is settled at $1,450 and the contract for the gold
purchase is completed at a price of $1,350.
Show the impact of this cash flow hedge on the financial statements of ABC Co. at:
(i) 31 Oct 20X5
(ii) 31 Jan 20X6
Solution
31 Oct 20X5
The gain on the futures contract of (1,000 x (1,400 - 1,300)) $100,000 will initially be
recognised in reserves:
DR Financial Asset
CR Reserves (OCI)
$100,000
$100,000
31 Jan 20X6
Now that the transaction has taken place both parts can be taken to Profit or Loss
DR Purchase of Gold (1,000 x 1,350)
$1,350,000
CR Cash
$1,350,000
CR Gain on futures contract (1,000 x (1,450 - 1,300) $150,000
DR Cash
$150,000
The net effect is that the cost of the gold was (1,350,000 - 150,000) $1,200,000 - which
was the prevailing price when the futures contract was entered into to hedge price
fluctuations.
222
Strategic Business Reporting
Illustration 5
P intends to buy 1000 barrels of oil, the current price is $95 per barrel. They hedge the risk
of a rise in prices by taking out a futures contract to secure the price at $100 per barrel. By
the year end the oil price is $150 per barrel and the futures price is $160.
How should the hedge be treated in the financial statements?
Solution
Movement on cashflow (150 - 95) x 1000 = $55,000 (Loss)
Gain on future (160 - 100) x 1000 = $60,000 (Gain)
The effective portion of the hedging instrument of $55,000 should go to OCI with the
$5,000 remaining to P/L
so…
DR Derivative $60,000
CR OCI
$50,000
CR P/L
$5,000
223
Strategic Business Reporting
Financial Instrument
Disclosures
224
Strategic Business Reporting
No Illustrations, Just Objective Test Questions
1. IFRS 7 splits financial instrument disclosures into 2 categories. Which of the following is
a category of disclosure under IFRS 7?
A. Information about strategies.
B. Information about significance.
C. Information about hedging.
D. Information about risks.
E. Information about reclassification.
Answer B and D
2. Which of the following is not a required disclosure under the ‘Information about risks’
category of IFRS 7?
A. Qualitative disclosures
B. Quantitative disclosures
C. Market Risk disclosures
D. Cash flow disclosures
Answer D
225
Strategic Business Reporting
Financial Asset Impairments
226
Strategic Business Reporting
Illustration 1
On 01 January 20X4 Satchel purchased a $10m 5 year 8% bond which is redeemable at a
premium of $1.22m. The effective interest rate on the bond is 10%.
It is estimated on initial recognition of the asset that there is a 0.25% risk of default in the
next 12 months and that if this does occur there would be no more further payments of
interest and only 60% of the capital would be repaid.
How should the bond be treated in the financial statements of Satchel?
227
Strategic Business Reporting
Solution
We need to create a 12 month allowance for expected credit losses which has 3 steps:
1. What is the cash shortfall between what was expected and what will now be received.
2. Discount this shortfall at effective interest rate.
3. Probability weight it.
In each year there will be (10m x 8%) $800,000 less interest received and (($10m +
$1.22m) x 40%) $4.488m not returned at the end if the default occurs so…
Year
Shortfall
Discount Rate
Present Value
1
800
1/1.1
727
2
800
1/1.12
661
3
800
1/1.13
601
4
800
1/1.14
546
5
800 + 4,488
1/1.15
3,283
Present Value of Shortfall
5,819
Probability of Default in 12 months
0.25%
15
Loss Allowance
The loss allowance of $15,000 should be set-off against the carrying value of the bond.
The interest on the bond should continue to be calculated on the gross amount i.e. not net
of the loss allowance.
Year
O’Bal
Effective
interest
Interest
Received
C’Bal
Loss
Allowance
Carrying
Amount
1
10,000
1,000
800
10,200
-15
10,185
2
10,200
1,020
800
10,420
-15
10,405
228
Strategic Business Reporting
Illustration 2
On 01 January 20X4 Satchel purchased a $10m 5 year 8% bond which is redeemable at a
premium. The effective interest rate on the bond is 10%.
It is estimated on initial recognition of the asset that there is a 0.25% risk of default in the
next 12 months and that if this does occur there would be no more further payments of
interest and only 60% of the capital would be repaid.
On 31 December 20X4 the interest for the year has been paid but it is estimated that there
has been a significant increase in the risk of default on the bond. There is now a 10%
likelihood that default will occur over the life of the bond and if so no further interest will be
received and only 30% of the capital would be repaid.
How should the bond be treated in the financial statements of Satchel?
229
Strategic Business Reporting
Solution
We now need to create a lifetime allowance for expected credit losses over the life of the
bond which has 3 steps:
1. What is the cash shortfall between what was expected and what will now be received.
2. Discount this shortfall at effective interest rate.
3. Probability weight it.
In each year there will be (10m x 8%) $800,000 less interest received and (($10m +
$1.22m) x 70%) $7.845m not returned at the end if the default occurs so…
Year
Shortfall
Discount Rate
Present Value
1
PAID
-
-
2
800
1/1.1
727
3
800
1/1.12
661
4
800
1/1.13
601
5
800 + 7,845
1/1.14
5,905
Present Value of Shortfall
7,894
Probability of Default
10%
Loss Allowance
789
The loss allowance of $14,000 should be increased to $789,000 and again set-off against
the carrying value of the bond.
The interest on the bond should continue to be calculated on the gross amount i.e. not net
of the loss allowance.
Year
O’Bal
Effective
interest
Interest
Received
C’Bal
Loss
Allowance
Carrying
Amount
1
10,000
1,000
800
10,200
-789
9,411
230
Strategic Business Reporting
Illustration 3
On 01 January 20X4 Satchel purchased a $10m 5 year 8% bond which is redeemable at a
premium. The effective interest rate on the bond is 10%.
It is estimated on initial recognition of the asset that there is a 0.25% risk of default in the
next 12 months and that if this does occur there would be no more further payments of
interest and only 60% of the capital would be repaid.
On 31 December 20X4 the interest for the year was been paid but it was estimated that
there has been a significant increase in the risk of default on the bond. There is now a
10% likelihood that default will occur over the life of the bond and if so no further interest
will be received and only 30% of the capital would be repaid.
On 31 December 20X5 only interest of $400,000 was received due to financial difficulties
suffered by the bond issuer. Satchel do not expect to recover any further interest but do
expect to recover 50% of the capital expected at the end of the 5 years.
How should the bond be treated in the financial statements of Satchel?
231
Strategic Business Reporting
Solution
There has now been evidence that the bond is credit impaired which means it needs to be
written down to the present value of the expected cash flows on the bond.
The carrying value of the bond at this point will be
Year
O’Bal
Effective
interest
Interest
Received
C’Bal
Loss
Allowance
Carrying
Amount
1
10,000
1,000
800
10,200
-15
10,185
2
10,200
1,020
400
10,820
-789
10,031
Satchel now only expects (($10m + $1.22m) x 50%) $5.61m to be returned at the end if
the default occurs so…
Year
Shortfall
Discount Rate
Present Value
5
5,610
1/1.13
4,215
10,031
Current Carrying Value of Bond
5816
Impairment
The interest on the bond will now be calculated on the impaired value…
Year
O’Bal
Effective
interest
Interest
Received
C’Bal
Loss
Allowance
Carrying
Amount
3
4,215
422
0
4,637
0
4,637
4
4,637
464
0
5,100
0
5,100
5
5,100
510
0
5,610
0
5,610
Leaving the balance due to be received at the end as the $5.61m expected.
232
Strategic Business Reporting
Illustration 4
On 01 January 20X4 Navel purchased a $2m 5 year 10% bond. The effective interest rate
on the bond is also 10%. The bond is designated as FVOCI.
On 31 December 20X4 the interest for the year was been paid and it was estimated that
there has not been a significant increase in the risk of default on the bond. The fair value
of the bond on that date was $1.9m.
Therefore only a 12 month expected credit loss allowance should be made which has
been determined as $40,000.
How should the bond be treated in the financial statements of Navel?
Solution
On 31 December 20X4 the bond should be revalued through OCI to it’s new fair value of
$1.9m by entries…
DR OCI
CR Bond
$100,000
$100,000
In addition a loss allowance of $40,000 should be recognised, however as the bond is
classified as FVOCI the entries to do this are…
DR P/L
CR OCI
$40,000
$40,000
The net effect is a (100,000 - 40,000) $60,000 charge to OCI.
233
Strategic Business Reporting
IFRS 16 - Leases I
(Lessee)
234
Strategic Business Reporting
Illustration 1
An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay 3 annual
payments of $25,000, the first of which is payable on 31/12/X0. In addition they have an
option to extend the lease which they are reasonably certain to do for 1 additional year at
a cost of $2,0000.
Direct costs of $2000 were incurred in obtaining the lease and $500 of these were
reimbursed by the lessor.
The interest rate implicit in the lease is 12%
Show the treatment in the lessees financial statements over the life of the asset.
Solution
Present Value of minimum lease payments
$
Discount Rate
1
Payment
25,000
1/1.12
22,321
2
Payment
25,000
1/1.122
19,930
3
Payment
25,000
1/1.123
17,795
4
Payment
20,000
1/1.124
12,710
Lessees Liability
72,756
Lease Liability on SFP
Period
Opening
Bal
Interest Charge(12%)
DR Income Statement
CR Lease Liability
Lease Payment
DR Lease Liability
CR Cash
Closing Bal
1
72,756
8,731
-25,000
56,487
2
56,487
6,778
-25,000
38,265
3
38,265
4,592
-25,000
17,857
4
17,857
2,143
-20,000
-0
235
Strategic Business Reporting
Right of Use Asset
Present value of minimum lease payments
72,756
Direct Costs
2,000
Reimbursement
-500
Right of Use asset
74,256
The asset will be depreciated over the 4 year lease term at (74,256 / 4) $18,689 per yr.
236
Strategic Business Reporting
Illustration 2
A company takes out a 5 year lease on a ship on 01/01/X0 the useful life of the ship is 20
years. $5.5m is to be paid in arrears each year. The lessor has agreed to maintain the ship
for the duration of the contract
The interest rate is 6% and the standalone price of the lease on the ship is $25m of the
$27.5m total payments.
Explain the treatment in the income statement and the statement of financial position for
the lease contract.
Solution
Total Lease
Standalone Price of Ship
Maintenance cost (Bal) TO P/L EACH YEAR
($5.5m x 5)
27.5
($5m x 5)
25
($0.5m x 5)
2.5
Present Value of minimum lease payments
$
Discount Rate
1
Payment
5
1/1.06
4.72
2
Payment
5
1/1.062
4.45
3
Payment
5
1/1.063
4.20
4
Payment
5
1/1.064
3.96
5
Payment
5
1/1.065
3.74
Lessees Liability
21.06
237
Strategic Business Reporting
Lease Liability on SFP
Period
Opening
Bal
Interest Charge(6%)
DR Income Statement
CR Lease Liability
Lease Payment
DR Lease Liability
CR Cash
Closing Bal
1
21.06
1.26
-5.00
17.32
2
17.32
1.04
-5.00
13.36
3
13.36
0.80
-5.00
9.16
4
9.16
0.55
-5.00
4.71
5
4.71
0.28
-5.00
-0.00
Right of Use Asset
Present value of minimum lease payments
21.06
The asset will be depreciated over the 5 year lease term at (21.06 / 5) $4.21m per yr.
238
Strategic Business Reporting
Illustration 3
An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay $50,000
up front then 3 annual payments of $100,000, the first of which is payable on 31/12/X0.
The lease payments are indexed to the Consumer Price Index (CPI) for the previous 12
months.
At the start of the lease the CPI is 110 and by the beginning of the second year it is 120.
The interest rate implicit in the lease is 5%
Show the treatment in the lessees financial statements over the first 2 years of the lease.
Solution
Year 1
Present Value of minimum lease payments
$
Discount Rate
Up front payments are not added to the lease liability but are added to the right of use
asset.
1
Payment
100,000
1/1.05
95,238
2
Payment
100,000
1/1.052
90,703
3
Payment
100,000
1/1.053
86,384
Lessees Liability
272,325
Lease Liability on SFP
Period
Opening
Bal
Interest Charge(5%)
DR Income Statement
CR Lease Liability
Lease Payment
DR Lease Liability
CR Cash
Closing Bal
1
272,375
13,619
-100,000
185,994
239
Strategic Business Reporting
Right of Use Asset
Present value of minimum lease payments
272,325
Up front payment
50,000
Right of Use asset
322,325
The asset will be depreciated over the 3 yr lease term at (322,325 / 4) $107,441 per yr.
Year 2
Present Value of minimum lease payments
$
Discount Rate
The remaining payments will increase to (100,000 x 120/110) = $109,091
1
Payment
109,091
1/1.05
103,896
2
Payment
109,091
1/1.052
98,949
Lessees Liability
202,845
Lease Liability on SFP
Period
Opening
Bal
Interest Charge(5%)
DR Income Statement
CR Lease Liability
Lease Payment
DR Lease Liability
CR Cash
Closing Bal
1
272,375
13,619
-100,000
185,994
Adjust liability up to $202,845 (202845 - 185,994)
16,851
New Liability
2
202,845
202,845
10,142
-109,091
103,896
103,896
5,195
-109,091
0
240
Strategic Business Reporting
Right of Use Asset
Opening Balance
322,325
Depreciation Year 1
-107,442
Carrying Value
214,883
Lease Adjustment
16,851
New Carrying Value
231,734
Depreciation Year 2
-115,867
Carrying Value Year 2
115,867
241
Strategic Business Reporting
IFRS 16 - Leases II
(Lessor)
242
Strategic Business Reporting
Illustration 1
ABC Co. leases an asset to CD Co. for a term of 4 years from 1/1/2010. Annual
instalments are payable in arrears of $2m. At the end of the term CD Co. can lease the
asset for a secondary term of 10 years at a rent of $50,000 per year.
The expected residual value at end of the initial lease is $1m .
Interest rate implicit in the lease 6%.
Show the treatment for the lease in the financial statements of the lessor.
Solution
Present Value of minimum lease payments
$
Discount Rate
1
Payment
2
1/1.06
1.89
2
Payment
2
1/1.062
1.78
3
Payment
2
1/1.063
1.68
4
Payment
2
1/1.064
1.58
4
Residual Value
1
1/1.064
0.79
Net Investment in Lease (Receivable)
7.72
Receivable on SFP
Period
Opening
Bal
Interest Charge(6%)
DR Receivable
CR P/L Finance Income
Lease Payment
DR Cash
CR Receivable
Closing Bal
1
7.72
0.46
-2.00
6.18
2
6.18
0.37
-2.00
4.55
3
4.55
0.27
-2.00
2.83
4
2.83
0.17
-2.00
1.00
1.00
Remaining balance is the residual value
243
Strategic Business Reporting
Illustration 2
A company hires out plant to other businesses on long term operating leases.
On 01/04/X0 it hires out an item of plant on a 6 year lease with an amount payable on that
date of $200,000 followed by 5 payments of $100,000 on 01/04/X1 - 01/04/X5.
The plant will be returned to the company on 31/03/X6.
The cost of the plant to the company was $1,100,000 and it has a 30 year useful economic
life with no residual value.
i. What is the annual rental income recognised by the company?
ii.Show the treatment in the income statement and the statement of financial position for
the years 20X0 and 20X1.
Solution
i.
Total Rental Income over the lease
200,000 + (100,000 x 5)
700,000
700,000 / 6
116,667
Rental Income to be recognised in Income Statement each period
116,667
Recognise on Straight Line Basis
ii.
Period
Rental Received
Rental
Recognised
Difference to
Deferred Income
Total Deferred
Income
20X0
200,000
116,667
83,333
83,333
20X1
100,000
116,667
-16,667
66,666
244
Strategic Business Reporting
Income Statement
20X0
20X1
Rental Income Receivable
116,667
116,667
Depreciation ($1.1m / 30 yrs.)
-36,667
-36,667
20X0
20X1
Plant at Cost
1,100,000
1,100,000
Depreciation
-36,667
-73,334
1,063,333
1,026,666
Non Current Liabilities Deferred Income
66,666
49,999
Current Liabilities Deferred Income
16,667
16,667
83,333
66,666
SFP
Carrying Value
245
Strategic Business Reporting
Illustration 3
A company enters into a sale and finance agreement on 1/1/X1 when the Carrying Value
of the asset was $70,000. The sale proceeds were $120,000, which was the fair value of
the asset, with the remaining useful economic life of the asset being 5 years.
The lease was for 5 annual rentals of $20,000 in arrears. Implicit interest rate of 8% (5
year annuity 3.99).
How should the lease be recognised in the financial statements of each party. Assume the
lease is an operating lease from the perspective of the lessor.
Solution
Right of use Asset
PV Minimum Payments
(20,000 x 3.99)
79,800
Fair Value on Sale
120,000
Carrying Value before Sale
70,000
Right of Use Asset
(79,800 / 120,000) x 70,000
46,550
Gain on Sale
Total Gain
(120,000 - 70,000)
50,000
Fair Value of Machine
120,000
Liability remaining
79,800
Rights Transferred to Lessor
Gain to P/L
(120,000 - 79,800)
40,200
50,000 x (40,200 / 120,000)
16,750
246
Strategic Business Reporting
Entries
DR Cash
Amount Received
120,000
DR Right of Use Asset
W1
46,550
CR Machine
W1
70,000
CR Lease Liability
W1
79,800
(120,000 - 70,000) / 120,000)
16,750
CR P/L
Lessor Treatment
DR Machine
120,000
CR Cash
120,000
The rental income will then be recognised straight line
247
Strategic Business Reporting
Illustration 4
A company enters into a sale and finance agreement on 1/1/X1 when the Carrying Value
of the asset was $8m. The sale proceeds were $10m and the fair value of the asset was
$9.7m.
The lease was for 5 annual rentals of $1.5m in arrears. Implicit interest rate of 4%.
How should the lease be recognised in the financial statements of each party. Assume the
lease is an operating lease from the perspective of the lessor.
Solution
W1 - Present Value of minimum lease payments
$
Discount Rate
1
Payment
1.5
1/1.04
1.44
2
Payment
1.5
1/1.042
1.39
3
Payment
1.5
1/1.043
1.33
4
Payment
1.5
1/1.044
1.28
5
Payment
1.5
1/1.045
1.23
Lessees Liability
6.68
W2 - Right of use Asset
PV Minimum Payments
Difference in FV & Sale Price
6.68
($10m - $9.7m)
-0.3
Liability Created
6.38
Fair Value on Sale
9.7
Carrying Value before Sale
Right of Use Asset
8
(6.38 / 9.7) x 8
5.26
248
Strategic Business Reporting
W3 - Gain on Sale
Total Gain
(9.7 - 8)
1.7
Fair Value of Machine
9.7
Liability remaining
6.38
Rights Transferred to Lessor
Gain to P/L
(9.7 - 6.38)
3.32
1.7 x (3.32 / 9.7)
0.58
Entries
DR Cash
DR Right of Use Asset
Amount Received
10
W2
5.26
CR Machine (CV)
CR Financial Liability
8
(10 - 9.7)
0.3
CR Lease Liability
W2
6.38
CR P/L
W3
0.58
Lessor Treatment
DR Machine
9.7
DR Financial Asset
0.3
CR Cash
10
The rental income will then be recognised straight line.
The lease payments will be allocated to the lease and the financial asset proportionally.
249
Strategic Business Reporting
IFRS 15 - Revenue I
250
Strategic Business Reporting
Illustration 1
Fresco sells an IT system to Dining on the first day of a new accounting period.
The package includes hardware delivered immediately and a contract for support over the
next 3 years with that support worth $50,000 p/a.
The total cost of the contract is paid up front and is $300,000.
How much should Fresco recognise as revenue from the transaction in the current year?
Solution
Step 1 - Identify the Contract
Fresco has agreed to supply Dining with goods and services.
Step 2 - Identify the performance obligations
Fresco has promised to do two things:
- Supply the hardware
- Supply the support
Step 3 - Determine the transaction price
The total price is $300,000
Step 4 - Allocate price to obligations
Based on the individual prices the support is worth (50,000 x 3) $150,000 leaving the rest
of the $300,000 to be for the hardware (300,000 - 150,000) = $150,000.
Step 5 - Recognise the revenue when (or as) the performance obligation is satisfied
The supply of the hardware happens immediately so the revenue for it should be
recognised now.
The support is provided over time so should be recognised on that basis i.e. $50,000 per
year over the 3 years.
251
Strategic Business Reporting
Illustration 2
Jumbo has agreed to sell a piece of complex machinery with two years free servicing to
Jet for $441,000. The machine usually sells for $420,000.
The servicing will cost Jumbo $50,000 to provide and they generally include a mark-up of
40% when setting the price to charge customers for servicing.
The two year servicing contract is not available as a stand-alone product.
How should the transaction price be allocated to the machine and servicing?
Solution
We can see that the machine generally sells for $420,000 but there is no comparable price
for the servicing contract.
Based on the cost + mark-up the servicing would be worth (50,000 x 140%) $70,000.
Therefore the total value of the performance obligations is (420,000 + 70,000) $490,000.
The fact that Jumbo is selling these for $441,000 would imply that a 10% discount has
been applied.
This should be allocated proportionally to the machine and servicing so the amounts
recognised should be:
Goods (420,000 x 90%) $378,000
Services (70,000 x 90%) $63,000 (Recognised over 2 years)
Total (378,000 + 63,000) $441,000
252
Strategic Business Reporting
Illustration 3
Jumbo has agreed to sell a piece of complex machinery with two years free servicing to
Jet for $700,000. The machine usually sells for $600,000 although a 5% discount is often
applied to machines of this specification.
The servicing will cost Jumbo $100,000 to provide and they generally include a mark-up of
30% when setting the price to charge customers for servicing.
The two year servicing contract is not available as a stand-alone product but Jumbo has a
policy of not offering discounts on servicing contracts.
How should the transaction price be allocated to the machine and servicing?
Solution
We can see that the machine generally sells for $600,000 but there is no comparable price
for the servicing contract.
Based on the cost + mark-up the servicing would be worth (100,000 x 130%) $130,000.
Therefore the total value of the performance obligations is (600,000 + 130,000) $730,000.
The fact that Jumbo is selling these for $700,000 would imply that a $30,000 discount has
been applied.
However rather than be allocated proportionally to the machine and servicing the discount
should be applied to the machine only because:
- The discount amounts to 5% of the $600,000 for the machine which is the standard
discount for this item given generally.
- There is not generally a discount on servicing.
…so the amounts recognised should be:
Goods (600,000 x 95%) $570,000
Services (130,000 x 100%) $130,000 (Recognised over 2 years)
Total (570,000 + 130,000) $700,000
253
Strategic Business Reporting
Illustration 4
Placo obtained a contract to sell Davo $3m worth of services over a 3 year period. Specific
costs that would not have been incurred otherwise amounted to $120,000.
How should the revenue and costs be recognised?
Solution
The revenue should be recognised in line with the contract terms over 3 years so ($3m / 3)
$1m per year.
The costs should be capitalised as they are specific to the contract so…
DR Asset (Costs)
CR Cash
$120,000
$120,000
…then recognised in line with the revenue over 3 years
DR Profit/Loss (120,000 / 3)
CR Asset (Costs)
$40,000
$40,000
254
Strategic Business Reporting
IFRS 15 - Revenue II
255
Strategic Business Reporting
Illustration 1
Badger Co. manufactures smart phones and sells them through a contractual relationship
with Bodger Co. Badger provides Bodger with the phones for a price of $150 payable once
the phone is sold on to a customer.
Bodger has also agreed to a clause in the contract of sale that they cannot sell the phone
for less than $200.
How should the goods and revenue be treated in the financial statements of Badger and
Bodger?
Solution
When the goods are provided to Bodger initially they still remain the property of Badger as
they have retained control of them by stipulating the price at which they should be soldr
They will stay as part of Badger’s inventory and no revenue recognised until it is sold to an
end customer.
Once the goods are sold to the customer for $200 Bodger should only recognise the
commission they have received on selling the goods i.e. $50.
The other $150 is paid to Badger and should be recognised as their revenue on the sale.
256
Strategic Business Reporting
Illustration 2
Johnston enters into a contract to sell a piece of plant to Paints on 01 Jan 20X6 and
delivers the plant on that date for Paints to begin to use. The price agreed in the contract is
$400,000 to be paid on 01 Jan 20X8.
The market rate of interest available to this customer is 10%.
How should this transaction be accounted for in the accounts of Johnston?
Solution
Discount the Revenue and recognise a receivable on the discounted amount
($400,000 x 1 / 1.12)
DR Receivable
CR Revenue
330,578
330,578
Unwind the discount over the two years
Year 1
DR Receivable
(330,578 x 10%)
CR Finance Income
33,058
33,058
Year 2
DR Receivable
((330,578 + 33,058) x 10%)
CR Finance Income
Final Receivable
36,364
36,364
(330,578 + 33,058 + 36,364)
400,000
257
Strategic Business Reporting
Illustration 3
Gerry has just completed a contract to supply Roses with 200 pineapple trees over the
next 2 years for a set price of $40,000.
As part of the contract Gerry agreed to pay $2,000 to increase the height of the doors at
Roses in order to get the trees into the store.
How much revenue should be recognised in year 1 of the contract?
Solution
The consideration paid to Roses should be treated as a reduction in the transaction price.
The price therefore will be reduced to (40,000 - 2,000) $38,000.
This will be recognised over the term of the contract so in year 1 ($38,000 / 2) $19,000 will
be recognised.
258
Strategic Business Reporting
Illustration 4
Avon has sold goods to 1000 customers at a price of $400 each. The goods are delivered
and control passed to the customer immediately and they are paid for up front. Each good
is currently in inventory at a value of $200.
The customers have the option to return the goods to Avon if they are not sold in the next
60 days for a full refund at which stage Avon will be able to sell them on at a profit.
Based on prior experience Avon estimates that 95% of the goods will not be returned.
Solution
Based on the amount of expected revenue Avon should recognise ((1000 x $400) x 95%)
$380,000.
A refund liability for the rest ((1000 x $400) x 5%) $20,000 should be created.
The entries for this will be:
DR Cash
CR Revenue
CR Liability
$400,000
$380,000
$20,000
The inventory will have been derecognised when transferred to customers but an asset
should be created for the goods expected to be returned
DR Asset ((1000 x $200) x 5%)
CR COS
$10,000
$10,000
259
Strategic Business Reporting
Construction Contracts Under
IFRS 15
260
Strategic Business Reporting
Illustration 1
ABC Co. is building a football stadium under a construction contract.
The estimated costs to complete the stadium are $400,000.
The costs to date have been $350,000.
The total estimated revenue is $1,000,000.
It is estimated that the contract is 50% complete.
(i) What amounts of revenue, costs and profit will be recognised in the income
statement?
(ii) If the expected revenue from the contract was $500,000 show the amounts of
revenue, costs and profit that would be recognised in the income statement?
Solution
Expected Profit
$
Total Expected Revenue
Total Expected Costs
1,000,000
(400,000 + 350,000)
Total Expected Profit
Recognised this year
Revenue
Costs
750,000
250,000
(250,000 x 50%)
125,000
(1,000,000 x 50%)
500,000
(750,000 x 50%)
375,000
125,000
Total Loss expected to be recognised immediately
$
Total Expected Revenue
500,000
261
Strategic Business Reporting
Total Loss expected to be recognised immediately
$
Costs
(400,000 + 350,000)
Loss
750,000
-250,000
Revenue
(500,000 x 50%)
250,000
Costs
(750,000 x 50%)
375,000
Provision for loss
-125,000
-250,000
262
Strategic Business Reporting
Illustration 2
ABC Co. is building a football stadium under a construction contract.
The estimated costs to complete the stadium are $400,000.
The costs to date have been $350,000.
It is estimated that the contract is 50% complete.
The company is not able to reliably estimate the outcome of the contract but believes it will
recover all costs from the customer.
What amounts of revenue, costs and profit will be recognised in the income
statement?
Solution
$
Costs to date
Revenue
350,000
(Costs to be recovered)
Profit
350,000
0
263
Strategic Business Reporting
Illustration 3
A construction company has the following contracts in progress:
X
Y
Z
Costs Incurred to Date
350
200
600
Costs to complete
50
800
900
Work Certified to date
400
300
1000
Contract Price
500
600
2000
Cash Received on Contract
300
200
1200
Profit is accrued on the contracts as a percentage of completion derived by comparing
work certified to the total sales value.
Contracts X and Z have been in progress for several years and the following amounts
have been recognised to date:
X
Z
Revenue
100
300
Costs
80
250
Calculate the figures to be included in the financial statements in relation to the
above contracts.
264
Strategic Business Reporting
Solution
Step 1 - Calculate the expected profit on each contract
X
Y
Z
Costs Incurred to Date
350
200
600
Costs to complete
50
800
900
Total Costs Expected
400
1000
1500
Contract Price
500
600
2000
Profit Expected
100
-400
500
X
Y
Z
Work Certified to date
400
300
1000
Contract Price
500
600
2000
Percentage complete
80%
50%
50%
X
Y
Z
Profit Expected
100
-400
500
Percentage Completion
80%
50%
50%
80
-400
250
Step 2 - Percentage completion
Step 3 - Profit to be recognised
Profit/Loss
265
Strategic Business Reporting
Step 4 - Income Statement Figures
X
Y
Z
Total
Sales by %
400
300
1000
1700
Recognised to Date
-100
0
-300
-400
Recognise this Year
300
300
700
1300
Costs by %
320
500
750
1570
Recognised to Date
-80
0
-250
Recognise this Year
240
500
500
Provision For Loss
Profit/Loss
200
60
-400
200
-70
Step 5 - Bal. Sheet Figures
X
Y
Z
Revenue Recognised to Date
400
300
1000
Cash Received
300
200
1200
Receivable/(Payable)
100
100
-200
Costs Recognised to Date (COS)
320
500
750
Costs Incurred to Date
350
200
600
Balance (WIP if Incurred Greater)
30
-
-
266
Strategic Business Reporting
Illustration 4
On 1 October 20X9 Mocca entered into a construction contract that was expected to take
27 months and therefore be completed on 31 December 20X1.
Details of the contract are:
Agreed contract price
Estimated total cost of contract (excluding plant)
$’000
12,500
5,500
Plant for use on the contract was purchased on 1 January 20X0 (three months into the
contract as it was not required at the start) at a cost of $8 million. The plant has a four-year
life and after two years, when the contract is complete, it will be transferred to another
contract at its carrying amount. Annual depreciation is calculated using the straight-line
method (assuming a nil residual value) and charged to the contract on a monthly basis at
1/12 of the annual charge.
The correctly reported income statement results for the contract for the year ended 31
March 20X0 were:
Revenue recognised
Contract expenses recognised
Profit recognised
$‘000
3,500
(2,660)
840
Details of the progress of the contract at 31 March 20X1 are:
Contract costs incurred to date (excluding depreciation)
Agreed value of work completed and billed to date
Total cash received to date (payments on account)
$’000
4,800
8,125
7,725
The percentage of completion is calculated as the agreed value of work completed as a
percentage of the agreed contract price.
Required:
Calculate the amounts which would appear in the income statement and statement
of financial position of Mocca for the year ended/as at 31 March 20X1 in respect of
the above contract.
(10 marks)
267
Strategic Business Reporting
Solution
Percentage Completion
Value of Work Completed to date
8,125
Contract Value
12,500
Percentage Completion
(8,125 / 12,500)
65%
Expected Total Profit
Total Costs Expected
5,500
Depreciation
(8/48 x 24)
4000
Total Costs
9,500
Total Revenue
12,500
Expected Total Profit
Recognise to date
(12,500 - 9,500)
3,000
(3,000 x 65%)
1,950
Recognised Last Year
840
Recognise this year
(1,950 - 840)
1,110
Income Statement Extracts
Revenue
(12,500 x 65%) - 3,500
4,625
Costs
(9,500 x 65%) - 2,660
3,515
Gross Profit Recognised
1,110
SFP Amounts
Revenue Recognised to Date
Cash Received to Date
Receivable due from customers
(12,500 x 65%)
8,125
7,725
400
268
Strategic Business Reporting
SFP Amounts
Costs Recognised to Date
Costs Incurred to Date
(9500 x 65%)
6,175
(8000/48 x 15) + 4800
7,300
Work In Progress
1,125
SFP Extracts
Non Current Asset
(8,000 - 2,500)
5500
Receivables
(8,125 - 7,725)
400
Work In Progress
1,125
269
Strategic Business Reporting
Entity Reconstructions
270
Strategic Business Reporting
Illustration 1
$‘000
Assets
500
500
Equity & Liabilities
Issued Equity Shares @ $1 each
600
Share Premium
100
Retained Earnings
-300
Liabilities
100
500
Dividends cannot be paid while accumulated losses exist.
Equity of $600,000 is only backed by assets of $500,000.
Loan finance cannot be raised due to the current financial position.
Required
Apply a capital reduction and restate the statement of financial position.
271
Strategic Business Reporting
Solution
DR
Share Premium
100
Equity Share Capital
200
Retained Earnings
CR
300
$‘000
Assets
500
500
Equity & Liabilities
Issued Equity Shares
400
Share Premium
0
Retained Earnings
0
Liabilities
100
500
272
Strategic Business Reporting
Illustration 2
$‘000
Intangible Asset (Brand)
50,000
Non Current Assets
220,000
270,000
Inventory
20,000
Receivables
30,000
320,000
Equity & Liabilities
Issued Equity Shares @ $1 each
100,000
Share Premium
75,000
Retained Earnings
-100,000
75,000
Debenture Loan
125,000
Overdraft
20,000
Payables
100,000
320,000
A reconstruction scheme is to take place under the following conditions:
(i) The equity shares of $1 nominal currently in issue will be written off and will be replaced
on a one-for-one basis by new equity shares with nominal value of $0.25.
(ii)The debenture loan will be replaced by the issue of new equity shares - four new shares
with nominal value of $0.25 each for every $1 debenture loan converted.
(iii)New shares with a nominal value of $0.25 will be offered to the existing equity holders
in the ratio of three new shares for every one currently held. All current equity holders
are expected to take this up.
(iv)Share premium account to be eliminated.
(v)Brand to be written off as it is impaired.
(vi)Deficit on the retained earnings to be eliminated.
Prepare the revised SFP and show any workings undertaken to achieve this.
273
Strategic Business Reporting
Solution
Reconstruction Account
DR
CR
New Equity Shares
(100,000 x 0.25) Note (i)
25,000
Remove Equity Shares
Note (i)
100,000
Conversion of Debenture
(125,000 x 4 x 0.25) Note (ii)
125,000
Remove Debenture Loan
Note (ii)
125,000
Brand Impairment
Note (v)
50,000
Share Premium Removed
Note (iv)
75,000
Retained Earnings
Note (vi)
100,000
300,000
300,000
$‘000
Intangible Asset (Brand)
Non Current Assets
0
220,000
220000
Bank (-20,000 + 75,000) Note (iii)
55,000
Inventory
20,000
Receivables
30,000
325000
Equity & Liabilities
Issued Equity Shares (125,000 + 25,000 + 75,000)
225,000
Share Premium
0
Retained Earnings
0
225,000
Debenture Loan
0
Overdraft
0
Payables
100,000
325,000
274
Strategic Business Reporting
Agriculture (IAS 41)
275
Strategic Business Reporting
Illustration 1
A farmer purchased a flock of 50 5 year old sheep on 1 February 20X4 and on 31 July
20X4 purchased another flock of 20 5.5 year old sheep.
The following fair values less estimated ‘point of sale’ costs were applicable:
- 5 year old sheep at 1 February 20X4 $70.
- 5.5 year old sheep at 31 July 20X4 $77.
- 6 year old sheep at 31 January 20X5 $80.
Required:
Calculate the amount that will be taken to the statement of profit or loss for the year
ended 31 January 20X5.
Solution
$
Purchase of 50 sheep on 1 Feb 20X4
(50 x $70)
3500
Purchase of 20 sheep on 31 July 20X4
(20 x $77)
1540
Total Purchased Value
Value at 31 January 20X5
Increase in FV to P/L
5040
(70 x $80)
5600
(5,600 - 5,040)
560
276
Strategic Business Reporting
Illustration 2
Jimmy owns a farm with a herd of 300 goats worth $40 each on 1 January 20X4. At 31
December 20X4 the goats have reproduced and he has 345 goats worth $42 each. At the
local market the goats are sold with a commission of 3% on each sale. In addition Jimmy
sold 3000 litres of goats milk at an average selling price of $1.20 per litre.
Required:
Calculate the amounts that will be taken to the statement of profit or loss for the
year ended 31 December 20X4 and extracts from the Statement of Financial
position.
Solution
$
Value of Goats at 1 Jan 20X4
(300 x $40)
12000
Estimated ‘point of sale’ costs
(12,000 x 3%)
-360
11640
Value of Goats at 31 Dec 20X4
(345 x $42)
14490
Estimated ‘point of sale’ costs
(14,490 x 3%)
-435
14,055
Increase in FV to P/L
Sale of Milk
Total to P/L
(14,055 - 11,640)
2,415
(3,000 x $1.20)
3,600
6,015
Non Current Assets
Herd of Goats
14,055
277
Strategic Business Reporting
Cash Flow Statements
278
Strategic Business Reporting
Illustration 1
The group financial statements for Nasser Ltd. show the following information:
X1
X0
NCI on Statement of Financial Position
820
700
NCI share of Profit after Tax
220
130
What was the dividend paid to the NCI in the year X1?
Solution
NCI
Opening Balance
700
Closing Balance
-820
Share of Profit
220
Total
100
Dividend to NCI was $100 = CASH OUTFLOW
279
Strategic Business Reporting
Illustration 2
Indigo Ltd, took up a 40% holding in Violet Ltg. for consideration of $120 in 20X1. The
group financial statements for Indigo Ltd. show the following information:
X1
X0
Post tax Income from Associate (Income
Statement)
50
0
Investment in Associate (SFP)
150
0
Loan to Associate
20
0
What amounts will be included in the group cash flow statement in the year X1?
Solution
Associate
Opening Balance
0
Closing Balance
-150
Purchase of Associate
120
Share of Profit
50
Total
20
Dividend Received from Associate was 20
Amounts for cash flow statement
$
Income from Associate (Remove from profit before tax)
-50
Consideration Paid (Cash paid out)
-120
Dividend Received from associate
20
Loan to Associate
0 - 20
-20
280
Strategic Business Reporting
Illustration 3
Extracts from the group SFP of Express Ltd are outlined below:
X1
X0
Property Plant & Equipment
50,600
44,050
Inventory
33,500
28,700
Receivables
27,130
26,300
Trade Payables
33,340
32,810
During the period Express Ltd purchased 75% of Delivery Ltd. At the date of acquisition
the fair value of the following assets and liabilities were determined:
Property Plant & Equipment
4,200
Inventory
1,650
Receivables
1,300
Payables
1,950
Show the movements in cash for the 4 items outlined above.
Solution
PPE
INV
REC
PAY
Opening Balance
44,050
28,700
26,300
32,810
Closing Balance
-50,600
-33,500
-27,130
-33,340
Purchase sub
4,200
1,650
1,300
1,950
Total
-2,350
-3,150
470
1,420
OUT
OUT
IN
OUT
281
Strategic Business Reporting
Illustration 4
Using the information in illustration 3 show the movements in cash if Express Ltd. Had
already owned the subsidiary and sold it during the period.
Solution
PPE
INV
REC
PAY
Opening Balance
44,050
28,700
26,300
32,810
Closing Balance
-50,600
-33,500
-27,130
-33,340
Sale sub
-4,200
-1,650
-1,300
-1,950
Total
-10,750
-6,450
-2,130
-2,480
OUT
OUT
OUT
IN
282
Strategic Business Reporting
Illustration 5
A Group has a foreign subsidiary which had the following FX Gains & Losses on
translation into the Group presentational currency:
$m
PPE
30
Inventory
5
Receivables
18
Payables
(7)
The Balances on these accounts in the Group Financial Statements were:
2011
2010
335
240
Inventory
70
50
Receivables
72
40
Payables
-35
-25
PPE
Depreciation in the period was $25m.
Show the cash flows arising from the above information to be included in the Group
Statement of Cash-flows.
Solution
PPE
INV
REC
PAY
Opening Balance
240
50
40
25
Closing Balance
-335
-70
-72
-35
FX Differences
30
5
18
7
Dep’n
-25
Total
-90
-15
-14
-3
OUT
OUT
OUT
IN
283
Strategic Business Reporting
Illustration 6
Consolidated Financial Statements for Group.
Group Income Statement
$m
Revenue
4,000
COS
-2,200
Gross Profit
1,800
Other Expenses
-789
Profit from operations
1011
Gain on sale of sub (Note i)
50
Finance cost (Note ii)
-200
PBT
861
Tax
-180
Profit after tax
681
Foreign Currency Translations
62
Total Comprehensive Income
743
Attributable to Parent
600
Attributable to NCI
143
Group Statement of Changes in Equity
Balance B/F
$m
3,307
Profit Attributable to Parent
600
Dividends Paid
-240
Issue of Shares
1000
Balance C/F
4667
284
Strategic Business Reporting
20X2
20X1
52
72
5,900
4,100
Inventories
950
800
Receivables
1,000
900
80
98
7982
5970
Share Capital
3,500
2,500
Retained Earnings
1,167
807
543
500
225
140
1,554
1,200
278
218
Trade Payables
450
400
Accrued Interest
25
20
Income Tax
130
120
Obligations under Finance
Leases
45
25
Overdraft
65
40
7982
5970
Goodwill
Property Plant & Equipment
Cash
NCI
Non-Current Liabilities
Obligations under Finance
Leases
Long term borrowings
Deferred Tax
Current Liabilities
(i) On 1 April 20X2 the parent disposed of a 75% subsidiary for $250m in cash which had
the following net assets at the time:
$m
Property Plant & Equipment
200
Inventory
100
Receivables
110
285
Strategic Business Reporting
Cash
Payables
Income Tax
Interest bearing borrowings
10
(80)
(25)
(75)
240
The subsidiary had been purchased several years ago for a cash payment of $110m when
it’s net assets had been $120m.
(ii) Goodwill is measured using the proportionate method
(iii)The following currency differences occurred
Total
$m
Parent Share
$m
Property Plant & Equipment
25
20
Inventories
20
15
Receivables
20
16
Payables
-9
-6
56
45
Retranslation of Profit for period
16
12
Offset exchange losses on borrowings (see
below)
-10
-10
62
47
On retranslation of net assets:
The exchange losses on borrowings relate to foreign loans taken out to finance
investments in subsidiaries. The accounts assistant has offset these against the
retranslation of the net investments in the subsidiaries. The exchange gain on retranslation
of the income statement (from average rate for the year to the closing rate) relates to
operating profit excluding depreciation.
(iv) Depreciation for the year was $320m and the group disposed of PPE with a net book
value of $190m for cash of $198m. the profit on this disposal has been credited to ‘Other
operating expenses’.
The group entered into a significant number of new finance leases in the period of which
$250m related to additions to property, plant & equipment.
Prepare the consolidated cash flow statement for the period.
286
Strategic Business Reporting
Solution
W1 - Goodwill
Goodwill in Disposal Subsidiary
$m
Cost of Investment
110
Net assets acquired
120 x 75%
Goodwill
-90
20
Goodwill
Opening Balance
72
Closing Balance
-52
Disposal
-20
Total
0
W2 - PPE
PPE
Opening Balance
4,100
Closing Balance
-5,900
Disposal of Sub
-200
Other Disposals (Note iv)
-190
Exchange Differences (Note iii)
25
Additions on Finance Leases (Note iv)
250
Depreciation
-320
Total
-2235
Difference is Additions - CASH OUT
287
Strategic Business Reporting
W3 - Working Capital Movements
Inventories
Receivables
Payables
O’Bal
800
900
400
Cl’Bal
-950
-1,000
-450
Sub
-100
-110
-80
FX
20
20
9
Movement
-230
-190
-121
CASH
OUT
OUT
IN
Net Movement OUT
299
W4 - Share Capital
Opening Balance
2,500
Closing Balance
-3,500
Total
-1,000
Shares of 1,000 issued = CASH IN
288
Strategic Business Reporting
W5 - NCI
Opening Balance
500
Closing Balance
-543
Share of Profit
143
Disposal of Sub
(240 x 25%)
Total
-60
40
Dividend to NCI was 40 = CASH OUTFLOW
W6 - Finance Leases
Opening Balance (Current Leases)
25
Opening Balance (Non Current Leases)
140
Closing Balance (Current Leases)
-45
Closing Balance (Non Current Leases)
-225
New Leases in Year
250
Balance
145
The difference is the leases REPAID in the year which is a cash flow
289
Strategic Business Reporting
W7 - Long Term Borrowings
Opening Balance
1,200
Closing Balance
-1,554
Disposal of Sub
-75
Exchange Loss
10
Total
-419
New Borrowings therefore of 419 - CASH IN
W8 - Income Tax
Opening Balance (Income Tax)
120
Opening Balance (Deferred Tax)
218
Closing Balance (Income Tax)
-130
Closing Balance (Deferred Tax)
-278
Disposal of Sub
-25
Income Statement Charge (Increase tax due)
180
Balance
85
The difference is the tax PAID in the year which is a cash flow
290
Strategic Business Reporting
W9 - Interest Payable
Opening Balance
20
Closing Balance
-25
Income Statement Charge
200
Total
195
This is interest paid - CASH OUT
291
Strategic Business Reporting
Cash Flow Statement
$m
Profit Before Tax
861
Depreciation
320
FX Differences on Profit
16
Profit on sale of PPE
Gain on Sale of Subsidiary
(198 - 190)
-8
250 - ((240 x 75%)+
20)
-50
Finance Expense
Working Capital Movements
200
W3
Cash Generated from Operations
-299
1040
Interest Paid
W9
-195
Income Taxes Paid
W8
-85
Net Cash from Operating activities
760
Cash Flow from Investing Activities
Receipts from the sale of PPE
Purchases of PPE (W2)
Sale of Subsidiary Less cash sold (250 - 10)
198
-2,235
240
-1797
Cash Flow from Financing Activities
Issue of Shares (W4)
1,000
New Long Term Borrowings (W7)
419
Finance Leases Repaid (W6)
-145
Dividends Paid
-240
Dividend Paid to NCI (W5)
-40
994
Net Decrease in Cash & Cash equivalents
-43
Cash b/f
(98 - 40)
58
Cash c/f
(80 - 65)
15
43
292
Strategic Business Reporting
$m
Profit Before Tax
861
Depreciation
320
FX Differences on Profit
16
Profit on sale of PPE
Gain on Sale of Subsidiary
(198 - 190)
-8
250 - ((240 x 75%)+
20)
-50
Finance Expense
200
Working Capital Movements
-299
Cash Generated from Operations
1040
Interest Paid
-195
Income Taxes Paid
-85
Net Cash from Operating activities
760
Cash Flow from Investing Activities
Receipts from the sale of PPE
Purchases of PPE (W4)
Sale of Subsidiary Less cash sold
198
-2,235
240
-1797
Cash Flow from Financing Activities
Issue of Shares
1,000
New Long Term Borrowings (W6)
419
Finance Leases Repaid (W5)
-145
Dividends Paid
-240
Dividend Paid to NCI (W3)
-40
994
Net Decrease in Cash & Cash equivalents
-43
Cash b/f
(98 - 40)
58
Cash c/f
(80 - 65)
15
293