FINANCIAL ACCOUNTING 3(CUAC 205)

FINANCIAL ACCOUNTING 3(CUAC 205)
PROG: BSCAC LEVEL: YEAR :

PRE-REQUISITE IF YOU HAVE NOT YET PASSED FINANCIAL ACCOUNTING 2(CUAC 110) PLEASE JUST ..GO! AND NEVER COME BACK TO THIS CLASS AGAIN UNTIL YOU HAVE DONE SO!

COURSE OUTLINE AIM To develop knowledge and skills in understanding and applying accounting standards and the regulatory framework in the preparation of Consolidated Financial Statements for groups of companies and assess the earnings of those companies. MAIN CAPABILITIES On successful completion of this paper candidates should be able to: Expain and apply the consolidation procedures in the preparation of financial statements for a group of companies and joint arrangements. Prepare and present financial statements for groups of companies in accordance with International Financial Reporting Standards (IFRS). Calculate and present basic and diluted Earnings Per Share (EPS) for both single companies and groups of companies in accordance with IAS 33 Earnings Per Share.

COURSE OUTLINE continues…
RATIONALE The financial accounting 3 course assumes knowledge acquired in Financial Accounting 1 and Financial Accounting 2; develops and applies this further and in greater depth in consolidated financial statements. The course covers group financial statements in its entirety including simple groups, complex groups, accounting for associates in consolidated financial statements and consolidating foreign subsidiaries. Furthermore, the course also covers joint arrangements. Finally, the course covers the computation and presentation of Earnings per share for both single companies and groups of companies.

8.0 Course Content 8.1 Advanced Corporate Accounts • IAS1 preparation and presentation of financial statements. • Published Financial Statements • Statement of Cash flow IAS # Group Accounts IFRS3/IAS27/IFRS10 • Wholly-owned subsidiary date of acquisition • Partly-owned subsidiary at date of acquisition • Wholly-owned subsidiary after the date of acquisition • Partly-owned subsidiary after the date of acquisition • Inter Company adjustments • Dividend treatment in consolidated financial statements • Consolidation where the capital of the subsidiary includes preference shares

Consolidation of complex groups Vertical groups, horizontal groups • Interim acquisition of interest in a subsidiary • Changes in the degree of control • Associated Companies IAS # 28 • Interest in jointly controlled entities IFRS11 • Consolidation of a foreign subsidiary • Consolidated statement of cash flows IAS7 8.3 Earnings per share IAS # 33 8.4 Business combinations IFRS3

Reference Material(LATEST EDITIONS) GAAP HANDBOOK DESCRIPTIVE ACCOUNTING ACCA, CIMA & CIS STUDY TEXTS OPPERMAN GROUP ACCOUNTING BY CILLIERS

Preliminaries-Revision
A business organisation is an entity that is established in order to achieve specified objectives. For most business organisations, the main objective is to provide goods and/or services at a profit(private sector). However, other business organisations do not intend to make profit, but have the objective to provide goods and services of high quality at the least possible cost(public sector). A business organisation have many stakeholders include; managers,customers,suppliers, investors, bankers etc. These stakeholders need financial information about the business organisation so that they can assess the extent to which it is achieving its set objectives. They also use the financial information to make decisions about the entity.

Activity 1 What form of information is required by the following stakeholders of a business organisation and what type of decisions do they usually make about the entity?. Discuss(5 mins). Managers Investors(potential and existing) Creditors Customers Lendors The financial information about an entity is usually provided in the form of Statements of summaries of business transactions over a given period of time(financial statements). The purpose of accounting standards(IASs and IFRSs) is to stipulate what information is to be presented in the said summaries and how it is to be presented. This helps to ensure that information in the financial statements is adequate, relevant, reliable and comparable.

According to IAS 1 Presentation of Financial Statements a complete set of financial statements comprise of the following; A statement of Financial Position It shows the what the business owns(assets), its obligations(liabilities) and what have been contributed by owners(equity) as at a given date. 2. Either A Statement of Profit or Loss and Other Comprehensive Income, or A statement of Profit or loss Plus a Statement Showing Other Comprehensive income. It shows the revenues, income, expenses, losses and resultant profit of an entity(financial performance) and who owns it for a given period of time. 3.A statement of changes in equity. It shows the transactions between the business and its owners in their capacity as owners e.g introduction of capital or payment of dividends for a given period.

4.Statement of cash flows It shows the cash receipts and payments for a given period of time. 5. Accounting Policies and Explanatory Notes. Other relevant information necessary for the proper understanding of the information provided in the fin. Stats. 6.Comparative figures These are prior year/period figures provided so that they can be compared with the current year/period figures.

INTRODUCTION TO GROUP ACCOUNTS
For a variety of legal, tax and other reasons, undertakings often choose to conduct their activities not through a single legal entity but through several undertakings under the ultimate control of the parent undertaking of the group. Control is the power to govern accounting and financial policies. A parent undertaking is an entity that has one or more subsidiaries, with a subsidiary being an entity that is controlled by another (i.e. the parent). Consolidated financial statements are the financial statements of a group presented as those of a single economic entity.

1.1 Control An investor has control over the investee if it has; The right to variable returns from the investee The power to affect the timing and amounts of those returns through its involvement with the investee. Power is the existing ability to direct the relevant activities of the investee

1.1.1 Group Concept Although from the legal point of view, every company is a separate entity; from the economic point of view the several companies are actually one. In particular, when one company owns enough shares in another company to have a majority of votes at that company’s annual general meeting (AGM), the first company may appoint all the directors of, and decide what dividends should be paid by, the second company. This degree of control enables the first company to manage the trading activities and future plans of the second company as if it were merely a department of the first company. IFRSs recognise that this state of affairs often arises, and require a parent company to produce consolidated financial statements showing the position and results of the whole group.

1.1.2 The single economic unit concept The purpose of consolidated accounts is to: Present financial information about a parent undertaking and its subsidiary undertakings as a single economic unit. Show the economic resources controlled by the group. Show the obligations of the group, and Show the results the group achieves with its resources. Each company in a group prepares its own accounting records and annual financial statements in the usual way. From the individual companies' financial statements, the parent prepares consolidated financial statements.

1.2 Main Consolidation Accounting Standards IAS 27 Separate Financial Statements IFRS 3 Business Combinations IFRS 10 Consolidated Financial Statements IAS 28 Investments in Associates and Joint Ventures IFRS 11 Joint Arrangements. IFRS 12 Disclosure of Interests in Other Entities IAS 7 Statement of Cash Flows. IAS 21 The Effects of Changes in Foreign Exchange Rates

1.3 Respective scope of Consolidation Standards

1.5 Types of interests in other entities Subsidiary Interest Associate Interest Investment Interest Joint arrangement Ownership 50% and above 20%-49% Below 20% Joint Accounting Standards IFRS 10, IFRS 3 IAS 28 IFRS 9 IAS 28, IFRS 11 Accounting treatment Control Consolidation Significant influence Equity method At fair value Separate consolidated financial statements are not required. Joint operation In accordance with relevant IASs/IFRSs; Joint venture = equity method

1.4 Preparation and Presentation of Consolidated Financial Statements IFRS 10 Consolidated Financial Statements IFRS 12 Disclosure of Interests in Other Entities

IFRS 10 Consolidated Financial Statements
A company is a subsidiary of another, if that other company (the ‘parent’) is in a position to exercise control. A parent should prepare and present consolidated financial statements, except if it meets all of the following conditions: it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements. its debt or equity instruments are not traded in a domestic or foreign public market (i.e. stock exchange). it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market. its ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with IFRSs.

Control is Key! Control Parent Subsidiaries Hold 50%+ of votes
Power over 50%+ of votes by virtue of agreement Power to govern financial & operating policies under statute or agreement Power to appoint or remove majority of board Power to cast the majority of votes at board meetings Control Subsidiaries

In summary so far: Consolidated Financial Statements
Parent Company Control Joint Significant Influence Subsidiary Venture Associate Prepare consolidated FS unless: Parent itself is wholly-owned or Parent itself is a partially owned subsidiary of another entity & owners have been informed and do not object, and Parent’s debt or equity is neither traded in a public market nor in the process of being issued, and Ultimate or intermediate parent produces consolidated financial statements that comply with IFRS

Key Consolidation Issues
Date of acquisition – ‘control’ Line by line basis – combine assets, liabilities, income and expenses Intra-group transactions and balances Profits and losses on transactions between group members should be eliminated Profits which are reflected in the value of assets to be included in the consolidation should be eliminated Uniformity of accounting policies Uniform accounting policies should be used for all entities included in the consolidation for like transactions and other events in similar circumstances

Key Consolidation Issues continues…
Non-coterminous year ends As far as possible the financial statements for all entities included in the consolidation should be prepared for the same period and to the same date Appropriate adjustments should be made to information prepared to an earlier date Financial statements over three months before the group’s reporting date should not be used Non-controlling interests should be shown in equity separately from liabilities and parent’s equity De-consolidation on date of ceasing to meet definitions of subsidiary Full disclosure should be given for all departures from IASs / IFRSs

Control intended to be temporary (i.e. sale foreseen within 12 months) = IFRS 5. Control lost = IAS 28 or IFRS 11. Dissimilar activities is not a valid reason for exclusion under any circumstances. If an entity is operating under severe long-term restrictions it is not reason enough to exclude it from consolidation.

IAS 27 Separate Financial Statements
Subsidiaries can be accounted for at cost, or in accordance with IFRS 9 Financial Instruments.

IFRS 3 BUSINESS COMBINATIONS
DEFINITIONS A business combination is the bringing together of separate entities into one reporting entity. Control is the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities. The acquisition date is the date on which the acquirer effectively obtains control of the acquiree.

ACCOUNTING FOR BUSINESS COMBINATIONS
IFRS 3 deals with accounting for business combinations and the ongoing treatment of goodwill Must use acquisition method Thus the acquirer recognises acquiree’s identifiable assets, liabilities and contingent liabilities at their fair values at the acquisition date, and also recognises goodwill, which is subsequently tested for impairment (rather than amortised) The following steps should be undertaken in applying the acquisition method: Identify the acquirer; Determine the acquisition date; Recognise and measure the identifiable net assets acquired; Recognise and measure any non-controlling interest; and Recognise and measure goodwill or gain from a bargain purchase.

1. Identify the acquirer >50% of votes Power to govern by law or agreement Power to appoint or remove majority of board In nearly all business combinations, one entity obtains control over the other Voting control by agreement Power over voting control at board meetings

1. Identify the acquirer continues.. Fair value of one enterprise significantly greater than the other It can sometimes be difficult to identify an acquirer but normally there are indicators that one exists In nearly all business combinations, one entity obtains control over the other Exchange of voting rights for cash Management of one enterprise dominates selection of combined team

2. Determine Acquisition date i.e. the date on which the acquirer obtains control of the acquiree

3. Recognise and measure the identifiable net assets acquired At acquisition date, allocate the cost of a business combination by recognising the acquiree’s identifiable net assets at their acquisition-date fair value Any difference between the cost of the combination and the acquirer’s interest in the fair value of the net assets acquired should be accounted for as goodwill

3. Recognise and measure the identifiable net assets acquired continues… Recognition criteria for assets and liabilities that existed at the acquisition date: Assets other than intangibles – recognise if it is probable that associated future economic benefits will flow to the acquirer, and fair value can be measured reliably. Intangible assets – recognise if fair value can be measured reliably. Liabilities other than contingent liabilities – recognise if it is probable that outflow of economic benefits will occur, and fair value can be measured reliably; NOT future losses or restructuring costs unless previously recognised by acquiree. Contingent liabilities – recognise if fair value can be measured reliably.

3. Recognise and measure the identifiable net assets acquired continues… The fair values at the date of exchange, of assets given, liabilities incurred, and equity instruments issued are to be determined as follows: Deferred amounts for the cost of investment should be discounted to present value. For cost of investment based on share exchange, use published price of shares at date of exchange. There should be no provision for future losses or expected costs. For contingent consideration, provide probable amount Any costs directly attributable to the business combination are excluded from the cost of investment e.g. professional fees, allocation of admin costs, etc.

3. Recognise and measure the identifiable net assets acquired continues… Example: Cost of Investment Jack acquires 24 million $1 shares (80%) of the ordinary shares of Becky by offering a share for share exchange of two shares for every three shares acquired in Becky and a cash payment of $1 per share payable three years later. Jack's shares have a nominal value of $1 and a current market value of $2. The cost of capital is 10% and $1 receivable in 3 years can be taken as $0.75 (i) Calculate the cost of investment and show the journals to record it in Jack's accounts. (ii) Show how the discount would be unwound. (i) Cost of investment

3. Recognise and measure the identifiable net assets acquired continues… Solution $ Deferred cash (at present value) $0.75 × ($1 × 24m) m Shares exchange (24m × 2/3) × $ m –––– 50m $50m is the cost of investment for the purposes of the calculation of Goodwill.

3. Recognise and measure the identifiable net assets acquired continues… Journals in Jack's individual accounts: Dr Cost of investment in subsidiary $50m Cr Noncurrent liabilities deferred consideration $18m Cr Share capital (16 million shares issued × $1 nominal value) $16m Cr Share premium (16 million shares issued × $1 premium element) $16m (ii) Unwinding the discount $18m × 10% = $1.8m Dr Finance cost $1.8m Cr Noncurrent liabilities deferred consideration. $1.8m For the next three years the discount will be unwound, taking the interest to finance cost until the full $24 million payment is made in Year 3.

4. Recognise and measure any non-controlling interest IFRS 3 has an explicit option on a transaction-by-transaction basis to measure NCI at the date of acquisition at either: fair value (new method) e.g. if available, share price of NCI equity shares; or using other valuation techniques if not publicly traded; or NCI’s proportionate share of the net identifiable assets of the entity acquired (old method). The argument against the old method of calculating NCI(partial goodwill method) is that it only recognises the goodwill acquired by the parent i.e. any goodwill attributable to NCI is not recognised. The argument against the new method of calculating NCI(full goodwill method) is that; while NCI is unlikely to benefit from its supposed portion of goodwill since it does not control the subsidiary.

5. Recognise and measure goodwill or gain from a bargain purchase Goodwill is measured as the difference between: the aggregate of: the acquisition-date fair value of the consideration transferred; the amount of any non-controlling interest in the entity acquired (two measurement options); and in a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously-held equity interest in the entity acquired; and the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed, should both be measured in accordance with IFRS 3.

In simple terms, Goodwill = Consideration paid by parent + Non-controlling Interest – Fair Value of subsidiary’s net assets Can be positive or gain on a bargain purchase (i.e. negative)

Positive goodwill Recognise as asset from date of acquisition. Do not amortise. Subject to annual impairment testing or more frequently if events or circumstances dictate.

Gain on a bargain purchase (i.e. negative goodwill) First of all, check the figures used to calculate goodwill to make sure that they are correct. Treated as immediate income i.e. ‘credit Statement of Profit or Loss’ in arriving at profit or loss. Adjustments can be made within 12 months if have used provisional figures, but must account for new values as if recognised at acquisition date.

Goodwill computation Example Daniel acquired 80% of the ordinary share capital of Craig on 31 December for $78,000. At this date the net assets of Craig were $85,000. What goodwill arises on the acquisition; (i) If the NCI is valued using the proportion of net assets method (ii) If the NCI is valued using the fair value method and the fair value of the NCI on the acquisition date is $19,000?

Goodwill computation Proportionate of net assets method(Partial Goodwill method) $ Cost of investment Fair Value of acq.(20%x$85 000) 95 000 Fair value of Net (85 000) Goodwill Goodwill for parent=Cost of investment($78 000)-Proportion of Net Assets Acquired by parent(80% x$ =$68 000)=$ There partial goodwill method therefore calculates goodwill attributable to the parent only. Goodwill attributable to NCI is not calculated because NCI is carried at its proportion of net assets.

Goodwill computation (ii) Fair value method(Full Goodwill method) $ Cost of investment Fair Value of acq 97 000 Fair value of Net (85 000) Goodwill Goodwill for parent=Cost of investment($78 000)-Proportion of Net Assets Acquired by parent(80% x$ =$68 000)=$ Goodwill for NCI =$2 000($ $17 000). This method measures Goodwill attributable to both the parent and NCI. NCI is measured at fair value(proportion on net assets+portion of Goodwill).

Purchased intangibles Intangibles acquired in a business combination must be recognised separately from goodwill if: Separable or arise from contractual or other legal rights; and Fair value can be reliably measured. Normal test for ‘probability of future economic benefits’ deemed to be satisfied for acquired intangibles

2.CONSOLIDATED STATEMENT OF FINANCIAL POSITION
2.1 The mechanics of consolidation A standard group accounting question will provide the accounts of P and the accounts of S and will require the preparation of consolidated accounts. The best approach is to use a set of standard workings. (W1) Establish the group structure Working 1 will show: How much of the subsidiary(S) is owned by Parent(P)? How long has P had control over S? This will be useful for working out the share of S's results since acquisition.

Working 2 shows the value of S's net assets at various points in time, giving an approximation of what the fair value of S is. The first column shows the fair value of S at acquisition, which can be used to calculate goodwill (in working 3). The second column shows the fair value of S's net assets at the year end. The final column shows the post acquisition movement in S's net assets. This increase or decrease will be split between the 2 parties that own S (the parent and the NCI), according to their % ownership.

(W2) Net assets of subsidiary At the date of acquisition At the reporting date Post acquisition $ $ $ Share capital X X – Reserves: Share premium X X – Retained earnings X X X Revaluation surplus X X X X X X

(W3) Goodwill ($) Parent holding (investment) at fair value X NCI value at acquisition (*) X — X Less: Fair value of net assets at acquisition (W2) (X) Goodwill on acquisition X Impairment (X) Carrying Value X

(*) If fair value method adopted: NCI value = fair value of NCI's holding at acquisition (number of shares NCI own × subsidiary share price). (*) If proportion of net assets method adopted: NCI value = NCI % × fair value of net assets at acquisition (from W2). If goodwill is positive, take it as a non current asset to the statement of financial position. If goodwill is negative, it is regarded as a gain on a bargain purchase and is taken as a gain to retained earnings in working 5.

(W4) Non-controlling interest NCI value at acquisition (as in W3) X NCI share of post-acquisition reserves (W2) X NCI share of impairment (fair value method only) (X) — X This shows the value of the subsidiary that is not owned by the parent at year end.

(W5) Group retained earnings $ P's retained earnings (100%) X P's % of sub's post acquisition retained earnings X Less: Parent share of impairment (W3) (X) — X This shows the retained earnings that are attributable to the parent's shareholders.

Example The following SOFPs have been prepared at 31 December 2008. Dickens Jones $ $ Noncurrent assets: Property, plant & equipment 85, ,000 Investments: Shares in Jones ,000 Current assets , ,000 –––––– –––––– 305, ,000

Equity: Ordinary $1 shares , ,000 Share premium , ,000 Retained earnings , ,000 –––––– –––––– 170, ,000 Current liabilities , ,000 –––––– –––––– 305, ,000 Dickens acquired 16,000 ordinary $1 shares in Jones on 1 January 2008, when Jones’ retained earnings stood at $20,000 and share premium was $10,000.On this date, the fair value of the 20% non controlling shareholding in Jones was $12,500. The Dickens Group uses the fair value method to value the non controlling interest. Prepare the consolidated statement of financial position of Dickens as at 31 December 2008.

Dickens Group Workings (w1) Group Structure Dickens /20 000=80% 1 year Jones

Dickens Group Workings (w2) Net Assets of Subsidiary-Jones At Acq.date($) At report. date($) Post-acq($) Share capital Share premium Retained Earnings

Dickens Group Workings (W3) Goodwill $ Parent’s Fair Value(FV) FV of acquisition FV of Net acquisition(W2) (50 000) Goodwill

Dickens Group Workings (W4) Non-Controlling Interest(NCI) $ FV of acquisition(W3) Share of post-acq. Profits-W2(20%X$5000)

Dickens Group Workings (W5) Group Retained Earnings $ 100% of reporting date % of sub’s post-acq. profits-W2(80%X$5000)

Dickens Group Statement of Financial Position as at 31 December 2008 $ Assets Non-current assets Goodwill(W3) Property, Plant & Equipment( ) Current assets( ) Total assets

Dickens Group Statement of Financial Position as at 31 December 2008 $ Equity & Liabilities Equity Ordinary $1 shares Share premium Retained Earnings(W5) Non-Controlling Interest(W4) Current Liabilities( ) Total Equity & Liabilities

Fair Value of Net Assets acquired IFRS 3 revised requires that the subsidiary’s assets and liabilities are recorded at their fair value for the purposes of the calculation of goodwill and production of consolidated accounts. Adjustments will therefore be required where the subsidiary’s accounts themselves do not reflect fair value. How to include fair values in consolidation workings: (1) Adjust (W2) to bring the net assets to fair value at acquisition date, taking into account any subsequent effect this will have on the year end position.

At acquisition At reporting date Post acquisition $ $ $000 SC + reserves X X X Fair value adjustments X X – Fair value depreciation adjustments (X) (X) ––– ––– ––– X X X This will ensure that the fair value of net assets is carried through to the goodwill and non controlling interest calculations.

(2) At the reporting date make the adjustment on the face of the SFP when adding across assets and liabilities. Fair value adjustments could include adjustments to recognised assets, such as property. There may also be intangible assets that are not recognised in the subsidiary's financial statements due to being internally generated. These will be recognised within the consolidated financial statements, as the parent is now purchasing these assets as part of buying the subsidiary.

Example: Fair Value Peppermint acquired 80% of the share capital of Spearmint two years ago, when the reserves of Spearmint stood at $125,000. Peppermint paid initial cash consideration of $1 million. Additionally Peppermint issued 200,000 shares with a nominal value of $1 and a current market value of $1.80. It was also agreed that Peppermint would pay a further $500,000 in three years’ time. Current interest rates are 10% pa. The appropriate discount factor for $1 receivable three years from now is The shares and deferred consideration have not yet been recorded.

Below are the statements of financial position of Peppermint and Spearmint as at 31 December 2004: Peppermint Spearmint $ $000 Noncurrent assets Property, plant & equipment 5, ,500 Investment in Spearmint at cost 1,000 Current assets Inventory Receivables Cash ––––– ––––– 7, ,850

Equity Share capital , Retained earnings 1, ––––– ––––– 3, Noncurrent liabilities 3, Current liabilities , 7, ,850

Further information: (i) At acquisition the fair values of Spearmint’s plant exceeded its book value by $200,000. The plant had a remaining useful life of five years at this date. (ii) For many years Spearmint has been selling some of its products under the brand name of ‘Mintfresh’. At the date of acquisition the directors of Peppermint valued this brand at $250,000 with a remaining life of 10 years. The brand is not included in Spearmint’s statement of financial position. (iii) The consolidated goodwill has been impaired by $258,000. (iv) The Peppermint Group values the non controlling interest using the fair value method. At the date of acquisition the fair value of the 20% non controlling interest was $380,000. Prepare the consolidated statement of financial position as at 31 December

Peppermint Group Workings (W1) Group Structure Peppermint 80% 2 years Spearmint

Peppermint Group Workings (W2) Net Assets of Subsidiary-Spearmint At Acq.date($000) At report. date($000) Post-acq($000) Share capital Reserves FV Adj-Plant FV Depreciation (80) (80) Brand name Brand amortisation 0 (50) (50)

Peppermint Group Workings (W3) Goodwill $000 Parent’s Fair Value(FV)-W FV of acquisition FV of Net acquisition(W2) (1075) Goodwill Impairment (258) Carrying amount 782.5

Peppermint Group Workings (W4) Non-Controlling Interest(NCI) $000 FV of acquisition(W3) 380 Share of post-acq. Profits-W2(20%X$45000) 9 Share of Goodwill impairment(20%X258) (51.6) 337.4

Peppermint Group Workings (W5) Group Retained Earnings $ % of reporting date % of sub’s post-acq. profits-W2(80%X$45000) 36 Unwinding of discount(W6) (78.9) Parent’s share of Goodwill impairment(80%) (206.4)

Peppermint Group Workings (W6) Cost of Investment $000 Immediate cash Shares( X$1.8) 360 Cash-Deferred Consideration( X0.751)

Peppermint Group Workings (W6) Cost of Investment Journal entries Dr($000) Cr($000) Investment in Subsidiary Cash 1000 Share Capital 200 Share premium( ) 160 NCL-Deferred consideration Unwinding of discount Retained Earnings-Finance costs (375.5X1.1^ ) 78.9 NCL-Deferred Consideration 78.9

Peppermint Group Statement of Financial Position as at 31 December 2004 $000 Assets Non-current assets Goodwill(W3) Brand Name(W2)(250-50) 200 Property, Plant & Equipment( ) 7120 Current assets Inventory( ) 650 Receivables( ) 600 Cash(200+50) 250 Total assets

Peppermint Group Statement of Financial Position as at 31 December 2008 $ Equity & Liabilities Equity Ordinary $1 shares ( (W6) Share premium(W6) 160 Retained Earnings(W5) Non-Controlling Interest(W4) NCL( )-W Current Liabilities( ) Total Equity & Liabilities

INTRA-GROUP TRANSACTIONS
P and S may well trade with each other leading to the following potential problem areas: current accounts between P and S loans held by one company in the other dividends and loan interest unrealised profits on sales of inventory Unrealised profits on sales of noncurrent assets. Current Accounts If P and S trade with each other then this will probably be done on credit leading to: a receivables (current) account in one company’s Statement of Financial Position(SFP) a payables (current) account in the other company’s SFP. These are amounts owing within the group rather than outside the group and therefore they must not appear in the consolidated statement of financial position. They are therefore cancelled (contra’d) against each other on consolidation.

Cash/goods in Transit At the year end, current accounts may not agree, owing to the existence of in- transit items such as goods or cash. The usual rules are as follows: If the goods or cash are in transit between P and S, make the adjusting entry to the statement of financial position of the recipient: Cash in transit adjusting entry is: Dr Cash Cr Receivables Goods in transit adjusting entry is: Dr Inventory Cr Payables

This adjustment is for the purpose of consolidation only. Once in agreement, the current accounts may be contra’d and cancelled as part of the process of cross casting the assets and liabilities. This means that reconciled current account balance amounts are removed from both receivables and payables in the consolidated statement of financial position.

Example: Inter Company Current Accounts Current accounts and cash in transit Draft SFPs of Plant and Shrub on 31 March 2007 are as follows. Plant Shrub $ $000 Property, plant & equipment Investment in S at cost Current assets Inventory Trade receivables Cash ––– –––

Example: Inter Company Current Accounts Equity and Liabilities Share capital: Ordinary $1 shares Share premium Retained earnings ––– ––– Non Current liabilities: 10% loan notes – Current liabilities

Example: Inter Company Current Accounts Notes: Plant bought 80,000 shares in Shrub in 2001 when Shrub’s reserves included a share premium of $30,000 and retained earnings of $5,000. Plant's accounts show $6,000 owing to Shrub; Shrub's accounts show $8,000 owed by Plant. The difference is explained as cash in transit. No impairment of goodwill has occurred to date. Plant uses the proportion of net assets method to value the non controlling interest. Prepare a consolidated statement of financial position as at 31 March 2007.

Example: Inter Company Current Accounts Workings Note: Cash in transit The $2,000 cash in transit should be adjusted for in Shrub's accounts prior to consolidation. Assume that the cash has been received and therefore: increase Shrub's cash balance by $2,000 to $7,000. decrease Shrub's receivables balance by $2,000 to $8,000. The outstanding intercompany balance requiring cancelling is therefore $6,000.

Example: Inter Company Current Accounts Workings (W1) Group structure (W2) Net assets of Shrub At the date of acquisition At the reporting date Post acquisition $ $ $000 Share capital – Share premium – Retained earnings –––– –––– ––––

Example: Inter Company Current Accounts Workings (W3) Goodwill $000 Parent holding (investment) at fair value 180 NCI value at acquisition (20% × 135 (W2)) –––– 207 Less: Fair value of net assets at acquisition (135) Goodwill on acquisition

Example: Inter Company Current Accounts Workings (W4) Non controlling interest $000 NCI value at acquisition (as in W3) 27 NCI share of post acquisition reserves (20% × 15 (W2)) 3 ––– 30 ___

Example: Inter Company Current Accounts Workings (W5) Group retained earnings $000 Plant retained earnings 80% of Shrub's post acquisition retained earnings (80% × 15 (W2)) ––– 52

Plant Group Consolidated statement of financial position as at 31 March 2007 Assets $ $000 Noncurrent assets: Intangible assets – goodwill (W3) 72 Property, plant & equipment ( ) 240 ––– 312 Current assets: Inventory ( ) Trade receivables ( – 2 (CIT) – 6 (interco)) 22 Cash ( (CIT)) 416

Plant Group Consolidated statement of financial position as at 31 March 2007 Equity Share capital Share premium Retained earnings (W5) Non controlling interest (W4) ––– Noncurrent liabilities 10% loan notes Current liabilities ( – 6) ––– 416

Intra-group transactions
Unrealised profits on group transfers(PURP) When one group company transfers assets (inventory or property, plant or equipment) to another group company at a profit, the selling company will recognise a profit. If the assets are still held by the group at the year end, their value will include this unrealised profit. The profit is unrealised because the companies in the same group are considered to be a single economic entity. Unrealised profits on such transaction must be eliminated in full on consolidation. If this is not done, a group could artificially increase the value of its assets simply by transferring them at inflated prices between group companies. The consolidation adjustment will depend on which company recorded the profit in its books.

Consolidated Statement of Financial Position Eliminating unrealised profits – consolidation adjustment 1. Where parent transfers asset to subsidiary (parent makes the profit) Dr Retained earnings(W5) Cr Inventory / PPE(reduce value of asset in CSOFP). 2. Where subsidiary transfers asset to parent (subsidiary makes the profit) Dr Retained earnings (group %)-(Reduce Net assets of sub. In W2-at reporting) Dr Non-controlling interests (NCI %)(Reduce Net assets of sub in W2-at reporting) Cr Inventory / PPE(reduce value of asset in CSOFP)

Consolidated Statement of Financial Position Eliminating unrealised profits – consolidation adjustment Example-Eliminating unrealised profits Harry Ltd owns 90% of Shane Ltd. During the year, Shane sold goods to Harry at cost plus 25%. At the year-end, the closing inventory of Harry includes 8,000 of goods, at invoice value, originally acquired from Shane. What adjustments are required on consolidation? Unrealised profit =$8,000 X25/125 =$1,600 Dr Retained earnings (90% X$1,600) =$1,440(Adjust reporting date) Dr Non-controlling interests (10% X$1,600)=$160(Adjust reporting date) Cr Inventory $1,600(CSOFP).

Consolidated Statement of Financial Position Inflated depreciation on transferred property, plant or equipment When property, plant or equipment is transferred between group companies at a profit, the depreciation charge in the buying company’s accounts will be inflated. This additional depreciation must be eliminated on consolidation. Removing inflated depreciation – consolidation adjustment 1.Where parent holds the asset(sub. Is the seller) Dr PPE (reduce accumulated depreciation)-CSOFP. Cr Retained earnings(Adjust W5). 2. Where subsidiary holds the asset(parent is the seller). Dr PPE (reduce accumulated depreciation)-CSOFP Cr Retained earnings (group share of excess depreciation)-Adjust Cr Non-controlling interests (NCI share of excess depreciation)-Adjust

Consolidated Statement of Financial Position Example – inflated depreciation On 1 January 2009, Alison Ltd sold a machine to Billy Ltd for $100,000. The machine cost Alison $50,000 on 1 January Depreciation is charged at 10% per annum on a straight-line basis. The current year-end is 31 December Alison is a 75% subsidiary of Billy. Billy still holds the machine. What adjustments are required on consolidation? Cost to the group $50,000 Depreciation ($50,000 X10% X2yrs) = ($10,000) Carrying amount at the date of transfer (1 Jan 2009) 40,000 Transfer price ,000 Unrealised profit ,000

Consolidated Statement of Financial Position Example – inflated depreciation Dr Retained earnings (75% X$60,000)=$45,000(Adjust W2) Dr Non-controlling interest (25% X60,000)=$15,000(Adjust W2) Cr PPE $60,000(CSOFP). Being elimination of unrealised profit Depreciation based on transferred value ($100,000 X10% X3yrs)=$30,000 Depreciation based on original cost (50,000 X10% X3yrs)= $15,000 Inflated depreciation charged $15,000 Dr PPE (reduce accumulated depreciation) $15,000.(CSOFP) Cr Retained earnings $15,000(Adjust W5). Being elimination of inflated deprecation

Consolidated Statement of Financial Position Example: Inventory Health (H) bought 90% of the equity share capital of Safety (S), two years ago on 1 January 2002 when the retained earnings of Safety stood at $5,000. Statements of financial position at the year end of 31 December 2003 are as follows: Health Safety $000 $000 $000 $000 Noncurrent assets: Property, plant & equipment Investment in Safety at cost 34 –––– ––––

Consolidated Statement of Financial Position Example: Inventory Current assets: Inventory Receivables Bank –––– ––––

Consolidated Statement of Financial Position Equity: Share capital Retained earnings –––– –––– Noncurrent liabilities Current liabilities –––– ––––

Consolidated Statement of Financial Position Safety transferred goods to Health at a transfer price of $18,000 at a markup of 50%. Two thirds remained in inventory at the year end. The current account in Health and Safety stood at $22,000 on that day. Goodwill has suffered an impairment of $10,000. The Health group uses the fair value method to value the non controlling interest. The fair value of the non controlling interest at acquisition was $4,000. Prepare the consolidated statement of financial position at 31/12/03.

Inter-company dividends payable/receivable If the subsidiary company has declared a dividend before the year-end, this will appear in the current liabilities of the subsidiary company and in the current assets of the parent company. These dividends are an intra-group item that must be cancelled before preparing the consolidated statement of financial position. If the subsidiary is wholly owned by the parent the whole amount will be cancelled. If, however, there is a non-controlling interest in the subsidiary, the non-cancelled amount of the dividend payable in the subsidiary’s statement of financial position will be the amount payable to the non-controlling interest. This will be reported as part of the non-controlling interest in the consolidated statement of financial position. Where a dividend has not been declared by the year-end date there is no liability under IAS 10 Events After the Balance Sheet Date and there should, therefore, be no liability reported under International Accounting Standards.

DIVIDENDS PAID OUT OF PRE-ACQUISITION PROFITS When P acquires S, company law dictates that the reserves of S at the date of acquisition are ‘frozen’ (i.e.) if a dividend is paid by S out of pre-acquisition profits, it cannot be recognised as income in the books of P. Traditionally, under accounting standards this was also the case, with P reducing the cost of the investment in S by the dividend received (i.e. the dividend was deemed to be a refund of part of the investment). However, IAS 27 Separate Financial Statements states that an entity shall recognise a dividend from a subsidiary, jointly controlled entity or associate in arriving at profit or loss in its separate FS when its right to receive the dividend is established. Therefore, from an IAS/IFRS perspective, this effectively removes the pre/post- acquisition distinction with respect to dividends paid by a subsidiary as IAS 27 allows an entity to recognise a dividend paid from pre-acquisition profits from a subsidiary in arriving at profit or loss in its separate FS (albeit this is at variance with company law).

DIVIDENDS PAID OUT OF PRE-ACQUISITION PROFITS Example On 3 September 2012 Christy Limited purchased 75% of the ordinary share capital of Voyage Limited for $1,635,000 when the issued ordinary share capital of Voyage Limited was $750,000 and the retained earnings were $1,200,000. At the date of acquisition, the fair value of the net assets of Voyage Limited was the same as their book value. In December 2012, Voyage Limited paid a dividend of $75,000 out of profits in existence at 3 September Requirement Show the calculation of goodwill under company law and IASs/IFRSs.

DIVIDENDS PAID OUT OF PRE-ACQUISITION PROFITS Under Company Law: The dividend is treated as a partial return of the cost of the investment in Voyage Limited. The investment in Voyage Limited is credited with the dividend received and the retained earnings of Voyage Limited at the date of acquisition are reduced by the total dividend paid. Cost of investment ,635,000 Less pre-acquisition dividend received ($75,000 x 75%) (56,250) 1,578,750 FV of net assets at acquisition date: Ordinary share capital 750,000 Retained earnings 1,200,000 Less pre-acquisition dividend (75,000) 1,875,000 Christy Limited’s share at 75% 1,406,250 Goodwill ,500

DIVIDENDS PAID OUT OF PRE-ACQUISITION PROFITS

Consolidated Statement of Financial Position
Preference shares A parent company, in addition to the ordinary shares by which it gained control, may have acquired preferred shares in the subsidiary. If so, any amount paid by the parent company will be included within the investment in subsidiary ﬁgure that appears in the parent company’s statement of ﬁnancial position. Preference shares acquired by the parent are used in the calculation of Goodwill. However the preference shares are usually acquired at par and therefore have no impact on Goodwill calculation. Any preferred shares not held by the parent are part of the non-controlling interest. Where preferred shares are recognised as liabilities of the subsidiary under IAS 32 Financial Instruments: Presentation and Disclosure, they are accounted for in the same way as bonds/debentures/loans. On consolidation, the preferred shares purchased by the parent and included in the cost of investment will be cancelled out against the liability of the subsidiary.

Preference shares The preferred stock of a subsidiary does not appear in a consolidated statement of financial position. If there is a non-controlling interest in the preferred stock, it is reported as a non- controlling interest in the consolidated statement of financial position. Where all the preferred shares are held by the parent, the investment in preferred shares is eliminated against the preferred equity and there is no non- controlling interest in preferred. When 50 percent of the stock is held by the parent, the investment in preferred shares is eliminated against 50 percent of the preferred equity and the other 50 percent is reported as a non-controlling interest. Where all of the preferred stock is held by NCI, it is reported as a non-controlling interest.

Midyear Acquisitions Calculation of reserves at date of acquisition If a parent company acquires a subsidiary midyear, the net assets at the date of acquisition must be calculated based on the net assets at the start of the subsidiary's financial year plus the profits of up to the date of acquisition. To calculate this it is normally assumed that S’s profit after tax accrues evenly over time.

CONSOLIDATED STATEMENT OF PROFIT OR LOSS
Midyear Acquisitions Calculation of reserves at date of acquisition If a parent company acquires a subsidiary midyear, the net assets at the date of acquisition must be calculated based on the net assets at the start of the subsidiary's financial year plus the profits of up to the date of acquisition. To calculate this it is normally assumed that S’s profit after tax accrues evenly over time.

FINANCIAL ACCOUNTING 3(CUAC 205)

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FINANCIAL ACCOUNTING 3(CUAC 205)

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