ACCA Paper P2 (HKG) Corporate ReportingHKAS 28(Investments in Associates and Joint
Ventures) ,HKFRS 11 (Joint Arrangements)
and HKFRS 12 (Disclosure of Interests in Other
Entities)
14 Sept. 2012
Gary Leung
www.garyleung.hk
ACCA P2 -Dec 2012
1
HKAS 28 Investments in Associates and
Joint Ventures
•
Introduction
•
Definition
•
Separate financial statement
•
Equity method
•
Transactions between parent and associate
•
Share of losses of the associates
•
Impairments losses
•
Dissimilar accounting policies
•
Different reporting dates
•
Main defects of equity accounting
ACCA P2 -Dec 2012
2
Introduction
• In June 2011, HKICPA issued HKAS 28 (2011) Investments in Associates
and Joint Ventures supersedes HKAS 28 (2003) Investments in
Associates.
• Where one company has a controlling investment in another company,
a parent subsidiary relationship is formed and accounted for as a
group. Companies may also have substantial investments in other
entities without actually having control. Thus, a parent-subsidiary
relationship does not exist between the two.
• If the investing company can exert significant influence over the
financial and operating policies of the investee company, it will have an
active interest in its net assets and results.
• Including the investment at cost in the company's accounts would not
fairly present the investing interest.
• So that the investing entity (which may be a single company or a group)
fairly reflects the nature of the interest in its accounts, the entity’s
interest in the net assets and results of the company, the associate,
needs to be reflected in the entity’s accounts. This is achieved through
the use of equity accounting
ACCA P2 -Dec 2012
3
Introduction
• A third relationship exists where an entity shares
control with one or more other entities. This shared or
joint control, does not give any dominant or significant
influence and all parties that share control must agree
on how the shared entity is to be run.
• Prior to 2011 joint ventures an entity could choose to
use either equity accounting or proportional
consolidation.
• The use of proportional consolidation never had the
support of the accounting profession and in 2011 the
HKICPA withdrew HKAS 31, which allowed its use, and
replaced it with HKFRS 11 Joint Arrangements. This
standard only allows joint ventures to be accounted for
using equity accounting.
ACCA P2 -Dec 2012
4
Definitions of Key Terms
• Associate
– An entity over which the investor has significant influence
• Significant influence
– The power to participate in the financial and operating
policy decisions of the investee but is not control or joint
control of those policies
• Joint arrangement
– An arrangement of which two or more parties have joint
control
• Joint control
– The contractually agreed sharing of control of an
arrangement, which exists only when decisions about the
relevant activities require the unanimous consent of the
parties sharing control
ACCA P2 -Dec 2012
5
Definitions of Key Terms
• Joint venture
– A joint arrangement whereby the parties that have joint
control of the arrangement have rights to the net assets of
the arrangement
• Joint venturer
– A party to a joint venture that has joint control of that joint
venture
• Equity method
– A method of accounting whereby the investment is initially
recognised at cost and adjusted thereafter for the postacquisition change in the investor's share of the investee's
net assets. The investor's profit or loss includes its share of
the investee's profit or loss and the investor's other
comprehensive income includes its share of the investee's
other comprehensive income
ACCA P2 -Dec 2012
6
Significant Influence
• If an investor holds, directly or indirectly (eg through
subsidiaries), 20 per cent or more of the voting power
of the investee, it is presumed that the investor has
significant influence, unless it can be clearly
demonstrated that this is not the case.
• If the investor holds, directly or indirectly (eg through
subsidiaries), less than 20 per cent of the voting power
of the investee, it is presumed that the investor does
not have significant influence, unless such influence can
be clearly demonstrated.
ACCA P2 -Dec 2012
7
Significant Influence
• The existence of significant influence by an investor is usually
evidenced in one or more of the following ways:
– (a) representation on the board of directors or equivalent governing
body of the investee;
– (b) participation in policy-making processes, including participation
in decisions about dividends or other distributions;
– (c) material transactions between the investor and the investee;
– (d) interchange of managerial personnel; or
– (e) provision of essential technical information.
• When significant influence is lost any remaining investment will
be measured at fair value. Any difference between the carrying
amount of the investment in associate and the remeasured
amount will be included within profit or loss. From that point on
the investment will be accounted for in accordance with HKFRS 9.
ACCA P2 -Dec 2012
8
Potential voting rights
• The existence and effect of potential voting rights
that are currently exercisable or convertible,
including potential voting rights held by other
entities, are considered when assessing whether an
entity has significant influence.
• Potential voting rights are not currently exercisable
or convertible when, for example, they cannot be
exercised or converted until a future date or until the
occurrence of a future event.
ACCA P2 -Dec 2012
9
Illustration 1
• X Owns 60% of the voting rights of Y,Z owns 19% of
the voting rights of Y, and the remainder are
dispersed among the public. Z also is the sole
supplier of raw materials to Y and has a contract to
supply certain expertise regarding the maintenance
of Y’s equipment.
• Required:
• What is the relationship between Z and Y ?
ACCA P2 -Dec 2012
10
Illustration 1
• Z may be able significant influence over Y, and
therefore it may have to be treated as an
associate. Although Z owns only 19% of the
voting rights, it is the sole supplier of raw
materials to Y and provides expertise in the
form of maintenance of Y’s equipment.
ACCA P2 -Dec 2012
11
Separate financial statements of the
investor
• In the separate financial statements an
investment in an associate or a joint venture are
to be accounted for in accordance with HKAS 27
Separate Financial Statements.
• In the separate financial statements, the
investment is accounted for:
– Under HKFRS 5 if classified as held for sale;
– At cost or in accordance with HKFRS 9.
• The emphasis in the separate financial
statements will be on the performance of the
assets as investments.
ACCA P2 -Dec 2012
12
Consolidated accounts
• The objective of IAS 28 is to prescribe the
accounting for associates and to describe the
use of the equity method for both associates
and joint ventures.
ACCA P2 -Dec 2012
13
Equity accounting
• The investment in an associate or a joint venture
is initially recognised at cost and the carrying
amount is increased or decreased to recognise
the investor’s share of the profit or loss of the
investee after the date of acquisition.
• Distributions received from the investee reduce
the carrying amount of the investment.
• Adjustments to the carrying amount may also be
necessary for changes in the investor's
proportionate interest in the investee arising
from changes in the investee's other
comprehensive income (e.g. to account for
changes arising from revaluations of property,
plant and equipment and foreign currency
translations.)
ACCA P2 -Dec 2012
14
Equity accounting
• Such changes include those arising from the
revaluation of property, plant and equipment and
from foreign exchange translation differences.
• The investor’s share of the current year’s profit or
loss of the associate is recognised in the
investor’s profit or loss.
• The associate is not consolidated line-by-line.
Instead, the group share of the associate’s net
assets is included in the consolidated statement
of financial position in one line, and share of
profits (after tax) in the consolidated profit or
loss and other comprehensive income in one line.
ACCA P2 -Dec 2012
15
Treatment in a consolidated
statement of financial position
• In group investments, replace the investment as
shown in the individual company statement of
financial position with:
– Either: share of equity at the balance sheet date
(plus fair value adjustments at acquisition) , PLUS
any unimpaired goodwill remaining at the balance
sheet date,
– Or: cost PLUS share of post-acquisition reserves at
the balance sheet date LESS goodwill impaired and
written off since acquisition.
ACCA P2 -Dec 2012
16
Treatment in a consolidated
statement of financial position
• In group reserves, include the parent’s share of the associate’s
(or JV) post-acquisition reserves (the same as for subsidiary).
• Cancel the investment in associate in the individual company’s
books against the share of the associate’s (or JV) net assets
acquired at fair value. The difference is goodwill.
• The fair values of the associate’s (or JV) assets and liabilities
must be used in calculating goodwill. Any change in reserves,
depreciation charges etc due to fair value revaluations must
be taken into account (as they are when dealing with
subsidiaries).
• Where the share of the associate’s net assets acquired at fair
value are in excess of the cost of investment, the difference is
included as income in determining the investor’s share of the
associate’s (JV) profits or losses.
ACCA P2 -Dec 2012
17
Illustration 2
• P owns 80% of S and 40% of A. A statement of financial position of the
three companies at 31December 2011 are:
•
P
S
A
•
$
$
$
• Investment: shares in S
800
–
–
• Investment: shares in A
600
–
–
• Other non-current assets
1,600 800
1,400
• Current assets
2,200 3,300 3,250
•
——— ——— ———
•
5,200 4,100 4,650
•
——— ——— ———
•
• Issued capital – $1 O.S.
1,000 400
800
• Retained earnings
4,000 3,400 3,600
• Liabilities
200
300
250
•
——— ——— ———
•
5,200 4,100 4,650
•
——— ——— ———
ACCA P2 -Dec 2012
18
Illustration 2
• P acquired its shares in S seven years ago when S’s retained
earnings were $520 and P acquired its shares in A on the 1
January 2011 when A’s retained earnings were $400.
• The goodwill in S was fully written off after five years.
• There were no indications during the year that the
investments in A wase impaired.
• Non-controlling interest is valued at the proportionate
share of the subsidiary’s identifiable net assets, it is not
credited with its share of goodwill (i.e. partial goodwill
method).
• Required:
• Prepare the consolidated statement of financial position at
31 December 2011.
ACCA P2 -Dec 2012
19
Illustration 2
•
•
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•
•
•
P Consolidated statement of financial position as at 31 December 2011
$
Investment in associate
1,880
Non-current assets (1,600 + 800)
2,400
Current assets (2,200 + 3,300)
5,500
———
9,780
———
Issued capital
1,000
Retained earnings (W5)
7,520
———
8,520
NCI (W4)
760
Liabilities
500
———
9,780
———
ACCA P2 -Dec 2012
20
Illustration 2
• WORKINGS
•
• (1) Group structure
•
•
P
•
80%
•
S
40%
A
•
ACCA P2 -Dec 2012
21
Illustration 2
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(2)
Net assets working
Issued capital
Retained earnings
A
Issued capital
Retained earnings
Balance
$
400
3,400
———
3,800
———
Balance
sheet
800
3,600
———
4,400
———
Acquisition sheet date
$
400
520
——
920
——
Acquisition
date
800
400
———
1,200
———
(3)
Goodwill
S
$ Cost of investment
800
Net assets acquired (80% X 920 (W2)) (736)
——
64
——
A
$
Cost of investment
600
Net assets acquired (40% × 1,200 (W2))(480)
——
120
——
ACCA P2 -Dec 2012
22
Illustration 2
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
(4) NCI
S only – (20% X 3,800)
$
760
——
(5) Retained earnings
P – from question
Share of S [80% X (3,400 – 520) (W2)]
Share of A [40%X (3,600 – 400) (W2)]
Less Goodwill impaired (W3)
ACCA P2 -Dec 2012
$
4,000
2,304
1,280
(64)
———
7,520
———
23
Illustration 2
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•
•
(6)
Investment in associate
$ Share of net assets (40% × 4,400)
Goodwill
OR
Cost
Share of post acquisition profits
1,760
120
———
1,880
———
600
1,280
———
1,880
———
ACCA P2 -Dec 2012
24
Illustration 3 Dividend paid by an
Associate
• On 1 Jan 2010 entity A acquire 35% interest in
entity B. Entity A paid $475,000 for its interest in
B. At that date the book value of B’s net assets
was $900,000, and their fair value $1,100,000,
the difference of $200,000 relates entirely to an
item of PPE with a remaining useful life of 10
years. During the year B made a profit of $80,000
and paid a dividend of $120,000 on 31 Dec 2010.
•
• Required: How A accounts for its investment in B
under the entity method.
ACCA P2 -Dec 2012
25
Illustration 3- Dividend paid by an
Associate
•
•
•
•
•
•
•
•
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•
•
•
•
EITHER
1)
Cost
Post acq. Profits35% X $80,0000
Adjustment of Fair value (35% X $200,000) /10
Dividend paid (35% X 120,000)
Closing balance of A’s investment in B
OR
2)
Share of FV NAV at 31 Dec 2010
($1,100,000 + 80,000 – 120,000) X 35% – 7,000
Unimpaired Goodwill (475,000 – 315,000-70,000)
ACCA P2 -Dec 2012
475,000
28,000
(7,000)
(42,000)
454,000
364,000
90,000
454,000
26
Treatment in a consolidated profit or loss
and other comprehensive income
• Treatment is consistent with consolidated statement of financial
position :
– Include group share of the associate’s (or JV) profits after tax in the
consolidated statement of comprehensive income. This replaces
dividend income shown in the investing company’s own statement
of comprehensive income.
• Parent’s % the associate ’s (or JV) profit for the year
X
• Less: any impairment loss in the current year
(X)
• Less: the parent’s % of additional depreciation on fair value adjust. (X)
•
X
– Do not add in the associate’s (or JV) revenue and expenses line-byline as this is not a consolidation and the associate is not a subsidiary.
– Time-apportion the associate’s results if acquired mid-year.
• Note that the associate statement of financial position is NOT time
apportioned as the statement of financial position reflects the net
assets at the period end to be
equity accounted.
ACCA P2 -Dec 2012
27
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Illustration 3
P has owned 80% of S and 40% of A for several years. consolidated profit or loss and other
comprehensive income for the year ended 31 December 2011 are:
P
S
A
$
$
$
Revenue
14,000
12,000
10,000
Cost of sales
(9,000)
(4,000)
(3,000)
———
———
———
Gross profit
5,000
8,000
7,000
Administrative expenses
(2,000)
(6,000)
(3,000)
———
———
———
3,000
2,000
4,000
Dividend from associate
400
–
–
———
———
———
Profit from ordinary activities before taxation
3,400
2,000
4,000
Income taxes
(1,000)
(1,200)
(2,000)
———
———
———
Profit from ordinary activities after taxation
2,400
800
2,000
———
———
———
Dividends (paid)
(1,000)
–
(1,000)
Retained earnings for the period
1,400
800
1,000
Goodwill was fully written off three years ago.
Required:
Prepare the consolidated profit or loss and other comprehensive income for the year ended
31 December 2011.
ACCA P2 -Dec 2012
28
•
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•
Illustration 3
P Consolidated profit and loss account for the year ending 31 December 2011
$
Turnover
26,000
Cost of sales
(13,000)
———
Gross profit
13,000
Administrative expenses
(8,000)
———
Operating profit
5,000
Income from associate
800
———
Profit before taxation
5,800
Income taxes
(2,200)
———
Profit after taxation
3,600
———
Profit attributable to:Owner of the parent
3,440
NCI (W3)
160
3,600
Dividends (paid)
(1,000)
ACCA P2 -Dec 2012
29
Illustration 3
•
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•
•
•
•
1) Consolidation schedule
P
Revenue
14,000
Cost of sales
(9,000)
Administration expenses
(2,000)
Income from associate 40% × 2,000
Tax – group
(1,000)
(2)
S
40% A Consolidation
12,000
(4,000)
(6,000)
800
(1,200)
26,000
(13,000)
(8,000)
800
(2,200)
NCI
S only
20% × 800
$160
ACCA P2 -Dec 2012
30
Impairments losses
• After application of the equity method, including recognising the
associate’s losses, the investor applies the requirements of HKAS
36 to determine whether it is necessary to recognise any
additional impairment loss.
• Because goodwill included in the carrying amount of an
investment in an associate is not separately recognised, it is not
tested for impairment separately.
• Instead, the entire carrying amount of the investment is tested for
impairment, by comparing its recoverable amount with its
carrying amount. Accordingly, any reversal of that impairment
loss is recognised in accordance with HKAS 36 to the extent that
the recoverable amount of the investment subsequently increases
ACCA P2 -Dec 2012
31
Impairments losses
• In determining the value in use of the investment, an entity
estimates:
– its share of the present value of the estimated future cash flows
expected to be generated by the associate, including the cash
flows from the operations of the associate and the proceeds on
the ultimate disposal of the investment; or
– the present value of the estimated future cash flows expected to
arise from dividends to be received from the investment and
from its ultimate disposal.
ACCA P2 -Dec 2012
32
Illustration 4
• A acquired 30% of the issued capital of B for $1
million on 31 Dec 2010. The accumulated profit
and the share capital at that date were $2 million
and $ 1 million (share capital @ $1) respectively.
• Financial information of B Ltd at 31 Dec 2008 is
• Share capital $1 million
• Retained profit $3 million
• Recoverable amount is $ 6 million
• Required:
• What amount should be shown in A’s
consolidated balance sheet at 31 Dec 2011, for
the investment in B ?
ACCA P2 -Dec 2012
33
Illustration 4
• Goodwill = 1 million – (30% X 3 million)=0.1
million.
• Interest in associate at 31 Dec 2008
• Cost
1
• Add: profit acq. Profits. ( 3-2)X 30% 0.3
•
1.3
• RA ( 6 X 30%)
1.8
• An impairment test would prove that the
carrying amount of the investment is not
impaired.
ACCA P2 -Dec 2012
34
Illustration 5
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•
•
The following are the summarised accounts of India, New and Delhi for the year
ended 30 June 2011.
Statements of financial position
India
New
Delhi
Tangible assets
90,000 80,000 60,000
Investment in New
92,000
Investment in Delhi
30,000
Current assets
88,000 50,000 10,000
300,000 130,000 70,000
Share capital ($1 share)
175,000 75,000 40,000
Accumulated profits
114,000 51,000 29,000
Equity
289,000 126,000 69,000
Liabilities
11,000 4,000
1,000
300,000 130,000 70,000
ACCA P2 -Dec 2012
35
•
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•
Illustration 5
Profit or loss and other comprehensive income
India
Revenue
500,000
Operating costs
(400,000)
Profit before tax
100,000
Tax
(25,000)
Profit for the year
75,000
Additional information
New
200,000
(140,000)
60,000
(20,000)
40,000
Delhi
100,000
(60,000)
40,000
(14,000)
26,000
i) New
– 1. India acquired 60,000 shares in New three years ago when the accumulated profits were $15,000.
– 2. At the date of acquisition the fair value of New’s non current assets, which at that time had a
remaining useful life of ten years, exceeded their book value by $5,000.
– 3. The group policy is to calculate the goodwill arising on the consolidation of a subsidiary gross with the
NCI at fair value. At acquisition the fair value of the NCI of New was $24,000.
– 4. Impairment reviews reveals that no impairment losses have arisen.
•
ii) Delhi
–
–
–
•
•
5. India acquired 12,000 shares in Delhi three years ago when the accumulated profits were $5,000.
6. At the date of acquisition the fair value of Delhi’s non-current assets, which at that time had a
remaining useful life of four years, exceeded the book value by $20,000.
7. The impairment review reveals the recoverable amount of Delhi at their year-end to be $103,333.
Required:
Prepare the consolidated profit or loss and other comprehensive income and the
consolidated statement of financial position for the India Group 2011.
ACCA P2 -Dec 2012
36
Illustration 5
• W1) Group
•
•
80%
•
New
India
30%
Delhi
ACCA P2 -Dec 2012
37
Illustration 5
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W2 Net Assets
New
DOA
75,000
15,000
Delhi
2009
75,000
51,000
DOA
40,000
5,000
Share Cap.
Acc. Profits
Fair value
adjustment 5,000
5,000
20,000
Less: add.
dep.
(1,500) #
95,000
129,500
65,000
% of Post acq. profits of New 80% (129,500 – 95,000) = $27,600
% of Post acq. Profits of Delhi 30% ( 74,000 – 65,000) = $2,700
# $5,000 X 1/10 X 3 years = $1,500
* $20,000 X ¼ X 3 years = $15,000
ACCA P2 -Dec 2012
2009
40,000
29,000
20,000
(15,000) *
74,000
38
Illustration 5
•
•
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•
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•
W3) Investment in associate
Cost of investment
Plus Post acq. Profits (30% X 9,000)
Less: impairment loss
W4) Impairment review
Carrying value before impairment
Recoverable amount (30% X 103,333)
Impairment loss
ACCA P2 -Dec 2012
30,000
2,700
(1,700)
31,000
32,700
(31,000)
1,700
39
Illustration 5
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W 5) Goodwill
Cost of the New investment
Fair value of the NCI
Net assets
Gross goodwill at acquisition
92,000
24,000
(95,000)
21,000
W6) NCI
Fair value of the NCI at DOA
Plus NCI % of the post acq. Profits
( 20% X 34,500)
OR
NCI % of the net assets at 2009
( 20% X 129,500)
Plus goodwill ( 24,000 – (20% X 95,000))
ACCA P2 -Dec 2012
24,000
6,900
30,900
25,900
5,000
30,900
40
Illustration 5
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W7) Accumulated profits
Parent
New - Post acq. Profits (80% X 34,500)
Delhi-Post acq. Profits ( 30% X 9,000)
Impairment loss on the associate –Delhi
W8) Income from associate
Parent’s % of the associate’s profit for the year (30% X 26,000)
Less: additional deprecation ( 30% X 5,000)
Less: the impairment loss arising in the year
W9) NCI in the subsidiary’s profits for the year
NCI % of the subsidiary’s profits ( 20% X 40,000)
Less: the NCI % of the deprecation of FVA ( 20% X 500)
ACCA P2 -Dec 2012
114,000
27,600
2,700
(1,700)
142,600
7,800
(1,500)
(1,700)
4,600
8,000
(100)
7,900
41
Illustration 5
• India group
• Revenue ( 500,000 + 200,000)
• Operating costs
•
(400,000 + 140,000 + 500 dep. (5,000 X 1/10))
•
•
•
•
•
•
•
•
Operating profit
Income from associate (W8)
Tax ( 25,000 + 20,000)
Profit for the year
Attributable:
Owner
NCI (W9)
ACCA P2 -Dec 2012
700,000
(540,500)
159,500
4,600
(45,000)
119,100
111,200
7,900
119,100
42
Illustration 5
•
•
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•
•
India consolidated profit or loss and other comprehensive income
$
Goodwill
21,000
Tangible ( 90,000 + 80,000 + 5,000- 1,500)
173,500
Investment in associate (w3)
31,000
Current assets
138,000
363,500
•
•
•
•
•
•
Ordinary shares ($1)
Accumulated profits (w7)
NCI (w6)
Equity
Liabilities
175,000
142,600
30,900
348,000
15,000
363,500
ACCA P2 -Dec 2012
43
Inter- company items with associate
and Joint Venture
• Inter-company trading
• Dividends
• Unrealised profit
ACCA P2 -Dec 2012
44
Inter-company trading
• Members of the group can sell to or make purchases
from the associate. This trading will result in the
recognition of receivables and payables in the
individual company accounts.
• Do not cancel inter-company balances on the
statement of financial position and do not adjust sales
and cost of sales for trading with associate.
• In consolidated statement of financial position, show
balances with associate separately from other
receivables and payables.
• The associate is not part of the group. It is therefore
appropriate to show amounts owed to the group by
the associate as assets and amounts owed to the
associate by the group as liabilities.
ACCA P2 -Dec 2012
45
Dividends
• Consolidated statement of financial position:
– Ensure dividends payable/receivable are fully accounted
for in individual companies’ books.
– Include receivable in the consolidated statement of
financial position for dividends due to group from
associates.
– Do not cancel inter-company balance for dividends.
• Consolidated profit or loss and other comprehensive
income:
– Do not include dividends from the associate in the
consolidated statement of P&L and OCI. Parent’s share of
the associate’s profit after tax (hence before dividends) is
included under equity accounting in the income from
associate.
ACCA P2 -Dec 2012
46
Unrealised profit
• If parent sells goods to associate and associate still has these goods in
stock at the year end, their carrying value will include the profit made by
parent and recorded in its books. Hence, profit is included in inventory
value in associate’s net assets (profit is unrealised); and parent’s revenue.
• If associate sells to parent, a similar situation arises, with the profit being
included in associate’s revenue and parent’s inventory.
• To avoid double counting when equity accounting for associate, this
unrealised profit needs to be eliminated.
• Unrealised profits should be eliminated to the extent of the investor’s
interest in the associate.
• To eliminate unrealised profit, deduct the profit from associate’s profit
before tax and retained earnings in the net assets working before equity
accounting for associate, irrespective of whether sale is from associate to
parent or vice versa.
• Unrealised losses should not be eliminated if the transaction provides
evidence of an impairment in value of the asset that has been transferred.
ACCA P2 -Dec 2012
47
Unrealised profit
• Unrealised inter-company profits and losses resulting from
‘upstream’ and ‘downstream’ transactions are to be
eliminated, but on partial rather than full elimination basis, i.e.
only the investor’s proportionate interest in the intercompany profit and losses is adjusted for.
• ‘Upstream’ transactions are, for example, sales of goods from
an associate to the investor.
• Dr. Retained earning
• Cr. Inventory
• ‘Downstream’ transactions are, for example, sales of goods
from the investor to an associate.
• Dr. Retained earning
• Cr. Investment in associate
ACCA P2 -Dec 2012
48
Illustration 6
• Company A sells inventory to its 30% owned
associate, B. The inventory had cost A $200,000 and
was sold for $300,000 to B.
• B also has sold inventory to A. The Cost of this
inventory to B was $100,000, and it was sold for
$120,000.
• Required:
• How would the inter company profit on these
transactions be dealt with in the financial statements
if none of the inventory had been sold at year-end ?
ACCA P2 -Dec 2012
49
Illustration 6
•
•
•
•
•
Solution
Company A to Company B
$000
The inter group profit is $(300 -200)
100
Unrealised Profits would be 100X 30/100 30
The unrealised profit would be deferred until the sale
of the inventory
• Consolidated Journal :
• Dr. Retained profits
30
• Cr. Interest in Associate
30
ACCA P2 -Dec 2012
50
Illustration 6
•
•
•
•
Company B to Company A
$000
The inter group profit is $(120 -100)
20
Unrealised Profit would be (20X 30/100)
6
The unrealised profit would be deferred until the sale
of the inventory .
• Consolidated Journal :
• Dr. Retained profits
6
• Cr. Inventory (B/S)
6
•
ACCA P2 -Dec 2012
51
Shares of losses of the associates
•
•
•
•
•
•
•
•
If an investor’s share of losses of an associate (or JV) equals or exceeds its interest in the
associate, the investor discontinues recognising its share of further losses.
The interest in the associate is its value under the equity method plus any long-term
interest that forms part of the investor’s net investment.
Such interests may include preference shares and long-term receivables or loans but do
not include trade receivables, trade payables or any long-term receivables for which
adequate collateral exists, such as secured loans.
After the investor’s interest is reduced to zero, additional losses are provided for, and a
liability is recognised, only to the extent that the investor has incurred legal or
constructive obligations or made payments on behalf of the associate.
If the associate subsequently reports profits, the investor resumes recognising its share
of those profits only after its share of the profits equals the share of losses not
recognised.
The investment in the associate can be reduced to nil but no further( i.e. the investment
in associate will not be negative, even if there are post acquisition losses of the
associate).
However the investor should continue to recognise losses to the extent of any
guarantees made to satisfy the obligation of the associate (or joint venture). This may
require recognition of a provision in accordance with HKAS 37.
Continuing losses of an associate (or a joint venture) is objective evidence that financial
interests in the associate (or joint venture) other than those included in the carrying
amount may be impaired.
ACCA P2 -Dec 2012
52
Illustration 7
• A parent company has a 40% associate, which was acquired a
number of years ago for $1m. A long-term loan was also made
to the associate of $250,000
• Since the acquisition the associate has made losses totalling
$5m.
• The parent’s share of those losses would be $2m.
• The parent would only be required to recognise the losses to
the extent of the investment of $1m plus $250,000, the
remaining share of losses ($750,000) would not be recognised
unless the parent had a present obligation to make good
those losses.
• If the associate then became profitable, the parent would not
be able to recognise those profits until its share of
unrecognised losses had been eliminated.
ACCA P2 -Dec 2012
53
Dissimilar accounting policies
• Adjustments shall be made to conform the
associate’s accounting policies to those of the
investor when the associate’s financial
statements are used by the investor in
applying the equity method.
ACCA P2 -Dec 2012
54
Different reporting dates
• If the reporting dates of the investor and the
associate are different, the associate
prepares – for the use of the investor –
financial statements as of the same date as
the financial statements of the investor unless
it is impractical to do so. In any case, the
difference between the reporting date of the
associate and that of the investor should be
no more than 3 months.
ACCA P2 -Dec 2012
55
Main defects of equity accounting
• Carrying value in the consolidated balance sheet is based on
share of NET assets
• NET amounts may be immaterial while GROSS assets and
liabilities may be material
• This could give rise to material items of the associate being “off”
the consolidated balance sheet
• The same point applies to the reporting of the associate’s
results in the consolidated income statement
• There is no reporting of the revenue of the associate and no
information as to its separate expenses in the consolidated
income statement
• Ratios could be distorted
• Specifically, gearing and ROCE with the former under-stated and
the latter over-stated
ACCA P2 -Dec 2012
56
HKFRS 11 Joint arrangements
•
•
•
•
•
Introduction
Definition
Joint arrangement
Accounting Treatment
Transactions between a joint operator and joint
operation
ACCA P2 -Dec 2012
57
Introduction
• HKFRS 11 Joint Arrangements provides for a more realistic reflection of
joint arrangements by focusing on the rights and obligations of the
arrangement, rather than its legal form (as is currently the case). The
standard addresses inconsistencies in the reporting of joint arrangements
by requiring a single method to account for interests in jointly controlled
entities.
• HKFRS 11 replaces HKAS 31 Interests in Joint Ventures and SIC-13 Jointlycontrolled Entities — Non-monetary Contributions by Venturers. HKFRS 11
uses some of the same terms as HKAS 31, but with different meanings.
• Thus, there may be some confusion whether HKFRS 11 is a significant
change from HKAS 31. For example, whereas HKAS 31 identified three
forms of joint ventures where there is joint control (i.e., jointly controlled
operations, jointly controlled assets and jointly controlled entities, or
JCEs), HKFRS 11 addresses only two forms of joint arrangements (joint
operations and joint ventures).
• One of the primary reasons for the issuance of HKFRS 11 was to increase
comparability within HKFRS by removing the choice for JCEs to use
proportionate consolidation. Instead, JCEs that meet the definition of a
joint venture (as newly defined) must be accounted for using the equity
method.
ACCA P2 -Dec 2012
58
Definitions
• Joint arrangement
– An arrangement of which two or more
parties have joint control
• Joint control
–The contractually agreed sharing of
control of an arrangement, which exists
only when decisions about the relevant
activities require the unanimous
consent of the parties sharing control
ACCA P2 -Dec 2012
59
Definitions
• Joint venturer
– A party to a joint venture that has joint control
of that joint venture
• Party to a joint arrangement
– An entity that participates in a joint
arrangement, regardless of whether that entity
has joint control of the arrangement
• Separate vehicle
– A separately identifiable financial structure,
including separate legal entities or entities
recognised by statute, regardless of whether
those entities have a legal personality
ACCA P2 -Dec 2012
60
Joint arrangement
• A joint arrangement is an arrangement of which two or more
parties have joint control.
• A joint arrangement has the following characteristics:
– the parties are bound by a contractual arrangement, and
– the contractual arrangement gives two or more of those parties joint
control of the arrangement.
• A joint arrangement is either a joint operation or a joint venture.
• A joint arrangement that is structured through a separate entity
may be either a joint operation or a joint venture. In order to
ascertain the classification, the parties to the arrangement should
assess the terms of the contractual arrangement together with any
other facts or circumstances to assess whether they have:
– Rights to the assets, and obligations for the liabilities, in relation to the
arrangement (i.e. joint operation)
– Rights to the net assets of the arrangement (i.e. joint venture)
ACCA P2 -Dec 2012
61
Joint arrangement
• Contractual arrangements generally specify the
following:
– Purpose, activity and duration of the joint arrangement
– Appointment of members of the board of directors (or
equivalent governing body)
– Decision-making processes:
– Matters requiring decisions from the parties
– Voting rights of the parties
– Required level of agreement for those matters
– Capital or other contributions requirements
• Sharing of assets, liabilities, revenues, expenses or
profit or loss relating to the joint arrangement
ACCA P2 -Dec 2012
62
Types of joint arrangements
• There are two types of joint arrangements. A joint
arrangement is either a joint operation or a joint venture.
• 1) Joint venture
– A joint arrangement whereby the parties that have joint control
of the arrangement have rights to the net assets of the
arrangement
• 2) Joint operation
– A joint arrangement whereby the parties that have joint control
of the arrangement have rights to the assets, and obligations for
the liabilities, relating to the arrangement
• This classification depends on the rights and obligations of
the parties to the arrangement.
• Investors may or may not establish a joint arrangement as a
separate vehicle.
ACCA P2 -Dec 2012
63
Summary of classification
Structure of the joint arrangement
Not structured through a
separate vehicle
Structured through a separate
vehicle
An entity shall consider:
1) The legal form of the separate vehicle
2) The terms of the contractual arrangement; and
3) Where relevant, other facts and circumstances
Joint operation
Joint Venture
ACCA P2 -Dec 2012
64
Illustration 1
• Three parties each have one third of the
voting power in an entity and decisions are
made by a simple majority. In the absence of a
shareholder’s contract, it is clear that joint
control does not exist.
ACCA P2 -Dec 2012
65
Illustration 2
• A and B enter into a contractual arrangement to buy a
building that has 12 floors, which they will lease to other
parties. A and B are responsible for leasing five floors each,
and each can make all decisions related to their respective
floors and keep all of the income with respect to their
floors. The remaining two floors will be joined managed –
all decision with respect to those two floors must be
unanimously agreed between A and B, and they will share
all profits equally.
• Therefore, there are three arrangements:
– Five floors that A control – Accounted for under other HKFRSs.
– Five floors that B control – Accounted for under other HKFRSs.
– Two floors that A and B jointly control – a joint arrangement
(within the scope of HKFRS 11).
ACCA P2 -Dec 2012
66
Joint control
• Joint arrangement characteristics:
– Parities bound by contractual arrangement
• Contractual arrangement gives two or more parties joint control
• Join control exists only when:
– Contractual arrangement gives parties control of arrangement
collectively
– Decisions about relevant activities require unanimous consent of
parties that control arrangement collectively.
• Parties control arrangement collectively when they must act
together to direct activities that significantly affect returns of
arrangement (relevant activities)
• Decision-making process agreed upon in contractual arrangement
implicitly leads to join control.
• Minimum required proportion achieved by more than one
combination is not joint arrangement unless specifies which
combination.
ACCA P2 -Dec 2012
67
Unanimous consent
• The requirement for unanimous consent means that
any party with joint control of the arrangement can
prevent any of the other parties, or a group of the
parties, from making unilateral decisions (about the
relevant activities) without its consent.
• Decision about the relevant activities require the
unanimous consent of all the parities, or a group of the
parties, that collectively control the arrangement.
• Accordingly, it is not necessary for every party to the
arrangement to agree to have unanimous consent.
• To have unanimous consent, only those parities that
collectively control the arrangement must agree.
ACCA P2 -Dec 2012
68
Illustration 3
Minimum
(Case One)
voting
75% vote to direct
requirement relevant activities
s
(Case Two)
75% vote to direct
relevant activities
( (Case Three)
Require the unanimous
consent of A, B and C
Party A
50%
50%
50%
Party B
30%
25%
25%
Party C
20%
25%
25%
Conclusion
Joint control – A and B
collectively control the
arrangement (since
their votes, and only
their votes, together
meet the requirement).
Because they are the
only combination of
parties that collectively
control the
arrangement, it is clear
that A and B must
unanimously agree.
No joint control –
multiple combinations of
parties could collectively
control the arrangement
(that is, A and B or A and
C could vote together to
meet the requirement).
Since there are multiple
combinations, and the
contractual agreement
does not specify which
parties must agree, there
ACCA P2 -Dec 2012
is no unanimous consent.
A, B and C have joint
control of the
arrangement and each
must account for its
investment in according
with HKFRS 11.
69
Accounting Treatment
• Joint operations
– In both its consolidated and separate financial
statements, a joint operator recognize its assets,
liabilities, revenues and expenses (including its shares) in
accordance with HKFRSs
– Party participates but no joint control account for
interest similarly if rights to assets, and obligations for
liabilities. Otherwise, use HKFRs applicable.
• Joint ventures
– Joint venturer account for investment using equity
method unless exempted.
– Party participates but no joint control use HKFRS 9. If
significant influence, use HKAS 28(2011)
ACCA P2 -Dec 2012
70
Illustration 4
• Assume that the joint operator share and
operate an asset together. Joint operator has a
half-share of a jointly controlled gas pipeline
that cost $100,000 to construct. Each joint
operator will pass the following journal entry
in its own book:
• Dr. Pipeline- Property, plant and equipment 50,000
•
Cr. Cash
50,000
ACCA P2 -Dec 2012
71
Illustration 5
• On 1 Jan. 2011, X and Y entered into a joint operation to purchase and
operate and oil pipeline. Both entities contributed equally to the purchase
cost of $20 million and this was financed by a joint loan of $20 million.
• Contract terms
– Y carries out all maintenance work on the pipeline but maintenance expense
are shared between X & Y in the ratio 40%: 60%
– Both entities use the pipelines for their own operations and share any income
from third parties 50%: 50%. Sale to third parties are invoiced by Y.
– The full interest on the loan is initially paid by X but the expense is to be
shared equally.
• During the year ended 31 Dec. 2011
– Y carried out maintenance at a cost of $1.2m
– Income from third parties was $900,000, all paid by Y.
– Interest of $1.5m was paid for the year on 31 Dec. by X.
• Required:
Show the relevant figures that would be recongised in the financial statements of
X and Y for the year ended 31 Dec. 2011.
ACCA P2 -Dec 2012
72
Illustration 5
Total amount
In X
Financial statement
In Y
Financial statement
Statement of financial
statements
JCA – PPE, at cost
$20 m
$10 m
$10 m
Share of loan
$20 m
$0 m
$10 m
Current accounts with Y
(owned by Y) –see working
$720,000
Current accounts with X
(owned to X) –see working
$720,000
Statement of P&L and OCI
Income from third parties
(50:50)
$900,000
$450,000
$450,000
Maintenance cost (40:60)
$1.2 m
$480,000
$720,000
Interest on loan (50:50)
$1.5 m
$750,000
$750,000
ACCA P2 -Dec 2012
73
Illustration 5
•
•
•
•
•
Workings
Income from third parties (50:50)
Maintenance cost (40:60)
Interest on loan (50:50)
Net loss
•
•
•
•
Cash expenses
Cash collected
Net cash expenses
Net cash due to X from Y
Total
$900,000
$1.2 m
$1.5 m
($1.8 m)
X
$450,000
$480,000
$750,000
($780,000)
Y
$450,000
$720,000
$750,000
($1,020,000)
($1.5 m)
($1.2 m)
$900,000
($1.5 m)
($300,000)
$720,000
($720,000)
ACCA P2 -Dec 2012
74
Illustration 6
• D and E establish a joint arrangement (F) using a separate vehicle, but the
legal form of the separate vehicle does not confer separation between the
parties and the separate vehicle itself. That is, D and E have rights to the
assets and obligations for the liabilities of F (F is a joint operation). Neither
the contractual terms, nor the other facts and circumstances indicate
otherwise. Accordingly, D and E account for their rights to assets and their
obligations for liabilities relating to F in accordance with the relevant
HKFRS.
• D and E each own 50% of the equity (e.g., shares) in F. However, the
contractual terms of the joint arrangement state that D has the rights to
all of Building No. 1 and the obligation to pay all the third party debt in F. D
and E have rights to all other assets in F, and obligations for all other
liabilities in F in proportion to their equity interests (i.e., 50%).
ACCA P2 -Dec 2012
75
Illustration 6
•
•
•
•
•
•
•
•
•
•
•
•
•
•
F’s balance sheet is as follows:
Assets
$
Liabilities and equity
$
Cash
20
Debt
120
Building No. 1
120
Employee benefit plan obligation
50
Building No. 2
100
Equity
70
Total assets
240
Total liabilities and equity
240
Under HKFRS 11, D would record the following in its financial statements, to account for its rights to the
assets in F and its obligations for the liabilities in F.
Assets
Liabilities and equity
Cash
10
Debt(2)
120
Building No. 1(1)
120
Employee benefit plan obligation
25
Building No. 2
50
Equity
35
Total assets
180
Total liabilities and equity
180
(1) Since D has the rights to all attached to Building No. 1, it records that amount in its entirety.
(2) D’s obligations are for the third-party debt in its entirety.
ACCA P2 -Dec 2012
76
Transactions between a joint operator
and joint operation
• Sales or contributions of assets to joint operation
– If a joint operator sells goods to the joint operation at
a profit or loss then the joint operator will only
recognise the profit or loss to the extent of the other
parties’ interests in the joint operation.
• Purchases of assets from a joint operation
– If a joint operator purchases goods from a joint
operation, to which it is a party to, it shall not
recognise its share of any gains or losses until it
resells the assets to an external party.
ACCA P2 -Dec 2012
77
Illustration 6
• Entities A, B, C and D each hold a 25% stake in
the joint operation of Z. Entity A sells goods to
Z making a profit of $1,000. Entity A will only
recognises $750 (75%) of profit in its financial
statements.
ACCA P2 -Dec 2012
78
HKFRS 12- Disclosure of interests in
other entities
• Application
• Disclosure
ACCA P2 -Dec 2012
79
Application
• HKFRS 12 shall be applied by an entity if it has an
interest in a subsidiary, an associate or a joint
operation.
• The standard is not applicable to the following:
– post-employment benefit plans (HKAS 19);
– separate financial statements (HKAS 27);
– an interest whereby an entity participates in, but
does not have joint control over a joint arrangement;
– an interest that is accounted for under HKFRS 9.
ACCA P2 -Dec 2012
80
Disclosure
• An entity will disclose information that allows users to
evaluate:
– the nature, extent and financial effects of any interest in an
associate or joint arrangement;
– the nature and effects of any contractual relationship with other
investors who have joint control or significant influence over the
associate or joint arrangement;
– the nature of, and changes in, the risks associated with its joint
ventures and associates.
– The disclosures will include:
•
•
•
•
name of the joint arrangement or associate;
nature of the relationship;
proportion of ownership;
any significant restrictions on the ability of associate or joint venture
to transfer funds to the entity;
• commitments it has relating to its joint ventures;
• unrecognised share of losses of a joint venture or associate.
ACCA P2 -Dec 2012
81
Interaction between HKFRS 9, 10, 11 ,
12 and IAS 28 (2011)
Control alone ?
Yes
No
Consolidation in
accordance with HKFRS 10
Joint control ?
Yes
Disclosures in accordance with HKFRS
12
No
Significant influence ?
Define type of joint arrangement in
accordance with HKFRS 11
Joint operation
Joint Venture
Account for assets,
liabilities, revenues and
expenses
Accounting for an
investment in accordance
with HKAS 28
Disclosures in accordance with HKFRS
12
Disclosures in accordance with HKFRS
12
ACCA P2 -Dec 2012
Yes
No
HKFRS 9
82