Solutions Manual For Company Accounting 10th Edition By Leo Knapp McGowan Sweeting by StudyGuide

Solutions Manual For Company Accounting 10th Edition By Leo Knapp McGowan Sweeting

Chapter 1: Nature and regulation of companies

Chapter 1 – Nature and regulation of companies REVIEW QUESTIONS 1.

Outline the advantages of incorporation over other forms of organisation such as partnerships.

The corporate form of organisation permits individuals to have "limited liability". This confers on shareholders a limit on their liability in the event of a winding up of the company to the amount (if any) unpaid on their shares. (S516). In the case of a partnership no such limitation applies (unless the partnership specifically adopts limited liability) and the insolvency of one or more partners can result in other solvent partners having to contribute any losses and debts out of their own private assets.

Distinguish between a proprietary company and a public company.

A public company is one in which there is usually a substantial public interest in that the ownership of the company's share capital is widely spread. Public companies are entitled to raise capital through a share issue by issuing a disclosure document which entitles them to have their shares or debentures etc. listed on a stock exchange, such as the Australian Securities Exchange, to facilitate transferability. Proprietary companies on the other hand have specific limitations in terms of the amount and restrictions on its fundraising activities. Specific features of a proprietary company include the need to have a share capital (unlike a public company which may be limited by guarantee and not merely shares): • a requirement to have at least one shareholder and only one director (three directors for a public company) and not more than 50 shareholders (not including employee shareholders) • not required to restrict the transfer of its shares (however it may elect to do so) • the use of the designation "Pty" or “Proprietary” in its name • a requirement not to engage in any fundraising activity which would require it to lodge a disclosure document with ASIC.

1.1

Solutions Manual to accompany Company Accounting 10e

Distinguish between a large and a small proprietary company. What are the implications of being classified large rather than small?

A small proprietary company is defined in Section 45A of Corporations Act 2001, as amended, as one which meets 2 of the following three criteria: - consolidated annual revenue less than $25 million# - consolidated gross assets at the end of the financial year is less than $12.5 million# - the companies and the entities it controls have fewer than 50 employees^ at the end of the financial year. #These figures must be determined in accordance with accounting standards ^ Part-time employees measured at appropriate fraction of full-time If these criteria are not met the company will be a large proprietary company. Small proprietary companies do not have to prepare formal financial statements or have them audited. However, they must keep sufficient accounting records to allow preparation and audit of accounts if either 5% of their voting shareholders or ASIC request this to be done. Large proprietary companies, must prepare financial reports in accordance with accounting standards, have them audited, send them to shareholders and lodge them with ASIC (Section 292)

Outline the special features of a no liability company.

Companies engaged in the more speculative area of mining exploration are most often registered as no liability. Such companies have NL at the end of the company name and have the advantage of being more attractive to potential investors as unlike companies limited by the unpaid amount on their shares; there is no such liability on the part of shareholders to contribute to the debts and liabilities of the companies.

What is the purpose of a certificate of registration?

A certificate of registration is issued by ASIC as a part of the registration procedure. Provided the company complies with S117 of the Corporations Act, ASIC will: • give the company an ACN Number • register the company • issue a certificate that states the company's name, ACN No. etc. Once registered, the company is capable of performing all the functions of a corporate body.

What are replaceable rules and how do they differ from a constitution?

Replaceable rules are the set of internal rules (contained in the Corporations Act) governing the conduct of its operations between the company and its member directors and between members themselves [see example of such rules in ch 1 Section 1.3.3]. If the rules are not adopted by the company then they must draw up a constitution which will cover much of the same issues covered by the replacement rules but may be extended or modified by the promoters of the company.

1.2

Chapter 1: Nature and regulation of companies

Outline the main features and purpose of a disclosure document.

A disclosure document, particularly the prospectus, contains all the information necessary for investors to make an informed assessment of the company's future prospects and other relevant matters including: • rights and liabilities attaching to securities • financial position, performance and prospects of the body issuing the securities • interests of each director, proposed director, promoter, stockbroker and their professional advisers in any property acquired or proposed to be acquired with the funds derived from the securities issue. • whether the securities issued will be quoted on a Stock Exchange.

In administering a company, the Corporations Act requires the keeping of various books, registers and records. Outline these and briefly discuss their content.

There are a range of records required to be maintained by a company including: • Minute books of the proceedings and decisions made at all directors’ and shareholders’ meetings as well as all resolutions passed without a meeting (s. 251A). If the company is a proprietary company with only one director, any declarations by this director must be minuted. • Financial records that will enable financial statements to be prepared and audited from time to time in accordance with the Act (ss. 286, 292, 302 and 303). • Register of members, or share register, giving each member’s name and address, and the date on which the entry of the member’s name is made on the register. If the company has a share capital, the register must also show the date on which an allotment of shares takes place, the number of shares in each allotment, the shares held by each member, the class of shares held, the share numbers (if any), the amount paid on the shares, and whether or not the shares are fully paid (s. 169). • Register of option holders to record the names and addresses of the holders of options over the shares of a company. The register must include the number and description of the shares over which options were granted, details of any event that must happen before the options can be exercised, and any consideration for the grant of the options and for the exercise of the options (s. 170). Copies of documents which grant an option over shares must be kept with this register. • Register of debenture holders to record each debenture holder’s name and address, and the amount of the debentures held (s. 171).

Outline the differences between shares and debentures.

Ordinary shares attract no fixed rate of dividend, carry voting rights and may participate in surplus assets and profits of the company – they represent ownership of x% of the company. Ordinary shares are classified as equity. The company may issue shares either fully paid or partly paid (s. 254A). If partly paid shares are issued, the shareholder is liable to pay calls on the shares (except in the case of no liability companies). A company also has the right to issue preference shares, but may only do so either if there is a statement in its constitution setting out the rights of these shareholders or if these rights have been approved by a special resolution of the company. © John Wiley and Sons Australia, Ltd 2015

1.3

Solutions Manual to accompany Company Accounting 10e

Not all preference shares are the same. Classification of preference shares as equity or liabilities depends on the rights and features of the shares – judgment is required re which classification is appropriate. For example, redeemable, cumulative 10% preference shares, which are to be redeemed on a set date, are definitely liabilities. Preference shares redeemable at the option of the company may or may not be liabilities, depending on the probability of the company redeeming them. Debentures are issued by the company raise funds but are borrowings, not equity. Debentures may be secured. A trust deed/trustee must be established to protect the rights of debenture holders.

10. What are the main reasons for the development of accounting regulations? The history of accounting regulation had its origins in the industrialised European settlement of the late 18th century. The social, political and economic changes which occurred saw the gradual decline of the importance of family enterprises and the separation of ownership from control as the control of entities was delegated by owners to agents. The growth in the number and size of 'joint stock companies in the late nineteenth century prompted the rise of disclosure although, initially, this focused on stewardship. The greater complexity of organisations in the mid to late twentieth century and twenty-first century gradually resulted in disclosure requirements developing into a more sophisticated form of financial reporting, which remains an ongoing process.

11. Explain the difference between accounting standards, interpretations and accounting framework.

the

Accounting conceptual framework Provide broad/general principles that provide guidance in preparation of general purpose financial reports. These are not mandatory. For example: The Framework (para.7) provides general information about what is included in a financial report/ a complete set of financial statements: 7. Financial statements form part of the process of financial reporting. A complete set of financial statements normally includes a balance sheet, an income statement, a statement of cash flows and a statement of changes in equity, and those notes and other statements and explanatory material that are an integral part of the financial statements. They may also include supplementary schedules and information based on or derived from, and expected to be read with, such statements. Such schedules and supplementary information may deal, for example, with financial information about industrial and geographical segments and disclosures about the effects of changing prices. Financial statements do not, however, include such items as reports by directors, statements by the chairman, discussion and analysis by management and similar items that may be included in an annual or interim report. The Framework (para. 49) provides definitions of basic elements to be included in measuring the financial position such as:

1.4

Chapter 1: Nature and regulation of companies

(a) An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Accounting standards can be defined as: ‘a technical pronouncement that sets out the required accounting for particular types of transactions and events’ (AASB, 2014). Hence these provide specific requirements for a particular area of financial reporting. These are required to be complied with via corporations law. For example: AASB 101 Presentation of Financial Statements specifies that particular assets or liabilities must be included on the face of the statement of financial position itself (such as intangibles). AASB 102 Inventories (para 9) specifies thatNinventories shall be measured at the lower of cost and net realisable value. Interpretations provide guidance on urgent financial reporting issues. These are required to be complied with via AASB 1048. The AASB is responsible for developing both Australian equivalents of IFRIC Interpretations and domestic Interpretations, thereby replacing the former Urgent Issues Group (UIG). As stated by AASB (2014): AASB and UIG Interpretations are listed in Accounting Standard AASB 1048 Interpretation of Standards, giving them authority under the Corporations Act 2001 alongside the Standards. Interpretations are mandatory for members of CPA Australia, The Institute of Chartered Accountants in Australia and the Institute of Public Accountants, and as such must be consistently applied in the preparation and presentation of general purpose financial statements. Interpretations may also be given authority by other legislative or regulatory bodies. For example: Interpretation 132 specifies the treatment of costs incurred in building Internet web sites. Interpretation 1031 relates to issues re GST and, for example, specifies that (in general) “Revenues, expenses and assets shall be recognised net of the amount of goods and services tax (GST)” (para 6)

1.5

Solutions Manual to accompany Company Accounting 10e

12. Does a company have to comply with accounting standards in order to show a ‘true and fair view’ of its financial affairs? Discuss. Before the early 1990s, the directors of a company could elect not to comply with an accounting standard issued by the AASB if they believed the particular standards would cause the accounts not to present a true and fair view. This 'true and fair override' no longer exists and directors must now comply with applicable accounting standards and add any additional information in the notes to the financial statements if they believe adherence to the standards does not present a true and fair view. Compliance with standards therefore has become the norm, resulting in an increased interest, both positive and negative, in the requirements of accounting standards by different lobby groups, particularly among those required to prepare financial statements. As noted above, in Australia due to Corporations law requirements for the companies we are considering, the accounting standards must be complied with, even if the resulting financial statements and notes do not provide a true and fair view. Additional information is required if compliance does not result in a true and fair view. The requirements for this additional information are in AASB 101. You should note that the current international accounting standards (in limited circumstances and with extensive disclosure provisions) do provide for a true and fair ‘override’ (i.e. a true and fair override allows companies to depart from accounting standards where compliance with these would not provide a true and fair view). Although the Australian equivalent, AASB 101, includes this override provision ( in para 19) this is in effect negated for Australian companies as Aus19.1 states: Aus19.1 In relation to paragraph 19, the following shall not depart from a requirement in an Australian Accounting Standard: a) entities required to prepare financial reports under Part 2M.3 of the Corporations Act; b) private and public sector not-for-profit entities; and c) entities applying Australian Accounting Standards – Reduced Disclosure Requirements.

13. What are the current arrangements for setting accounting standards in Australia? The AASB under the auspices of the Financial Reporting Council is entrusted with the task of making accounting standards both for the purposes of the Corporations Act and for the public and not-for-profit sectors in Australia. [See Figure 1.1 in section 1.7.4].

14. Distinguish between the following organisations and their roles in the regulation of financial reporting in Australia: • the Financial Reporting Council (FRC) • the Australian Accounting Standards Board (AASB) • the International Accounting Standards Board (IASB) • the IFRS Interpretations Committee • the Australian Securities and Investments Commission (ASIC) • the Australian Securities Exchange (ASX)

1.6

Chapter 1: Nature and regulation of companies

•

the Asian-Oceanic Standard Setters Group (AOSSG).

Financial Reporting Council (FRC) The main role of the FRC is to act as an overseer and advisory body to the standard setter, the AASB. The main functions of the FRC under the ASIC Act 2001, s. 225, are to: • oversee the process for setting accounting standards and give the Minister reports and advice on that process • appoint AASB and AUASB members (other than the chair) • approve and monitor the AASB’s and AUASB’s priorities, business plan, budget and staffing arrangements • determine the AASB’s and AUASB’s broad strategic direction • give the AASB and AUASB directions, advice or feedback on matters of general policy and procedures • monitor the development of international accounting and auditing standards and the standards that apply in major international financial centres, and – further the development of a single set of accounting standards and auditing standards for worldwide use with appropriate regard to international developments – promote the adoption of international best practice accounting standards and auditing standards in the Australian standard-setting process if this is in the best interests of both the private and public sectors of the Australian economy • monitor the operation of accounting and auditing standards to ensure their continued relevance and their effectiveness in achieving their objectives in respect of both the private and public sectors of the Australian economy, as well as the effectiveness of the AASB’s consultative arrangements • seek contributions towards the costs of the Australian accounting and auditing standard-setting process • monitor and periodically review the level of funding and funding arrangements for the AASB and AUASB • establish appropriate consultative mechanisms • advance and promote the objectives of standard setting as specified in the Act • perform any other functions that the Minister confers on the FRC by written notice to the chair. A major policy direction of the FRC that has affected the agenda of the AASB is the formalisation of a policy of adopting the accounting standards of the International Accounting Standards Board (IASB) for application to reporting periods beginning on or after 1 January 2005. (This includes also the adoption of Interpretations issued by the IFRS Interpretations Committee for use in the Australian context.) Australian Accounting Standards Board (AASB) The functions of the AASB, according to s. 227(1) of the ASIC Act 2001, are to: • develop a conceptual framework (not having the force of an accounting standard) for the purpose of evaluating proposed accounting standards and international standards • make accounting standards for the purpose of the Corporations Act • formulate accounting standards for other purposes, e.g. for non-companies, the public sector and the not-for-profit sector • participate in and contribute to the development of a single set of accounting standards for worldwide use

1.7

Solutions Manual to accompany Company Accounting 10e

• advance and promote the main objectives of developing accounting standards. The AASB must develop accounting standards not only for the corporate sector but also for other sectors, such as the public sector and the not-for-profit sector. The objectives of developing accounting standards are: (1) to facilitate the development of accounting standards that require the provision of financial information that: • allows users to make and evaluate decisions about allocating scarce resources • helps directors to discharge their obligations in relation to financial reporting • is relevant to assessing performance, financial position, financing and investment • is relevant and reliable • facilitates comparability • is readily understandable. (2) to facilitate the Australian economy by: • reducing the cost of capital • enabling Australian entities to compete effectively overseas • having accounting standards that are clearly stated and easy to understand. (3) to maintain investor confidence in the Australian economy (including its capital markets). In performing its functions, the AASB is required to follow the broad strategic directions determined by the FRC. The AASB may formulate accounting standards which are of general or limited application, in that the Board may specify the entities, time, place or circumstance to which the standard applies. Furthermore, as long as it is practicable to do so, the AASB is required to conduct a cost–benefit analysis of the impact of a proposed accounting standard before making or formulating the standard. However, the cost–benefit analysis is not necessary where the standard is being made or formulated by issuing the text of an international standard. The AASB conducts its meetings in a forum open to the public, which (hopefully) increases faith in the due process system of standard setting. In line with the FRC’s main function of overseeing the process of setting accounting standards, the AASB is required to adopt international financial reporting standards (IFRSs) as issued by the IASB. Besides issuing accounting standards that are equivalent to the IASB’s standards, the AASB has continued to issue accounting standards relevant to the public sector, as well as accounting standards that relate solely to the Australian legal environment. International Accounting Standards Board (IASB) On its website, the IASB states that it is an: … independent standard-setting body of the IFRS Foundation. Its members … are responsible for the development and publication of IFRSs, including the IFRS for SMEs and for approving Interpretations of IFRSs as developed by the IFRS Interpretations Committee... All meetings of the IASB are held in public and webcast. In fulfilling its standard-setting duties the IASB follows a thorough, open and transparent due process of which the publication of consultative documents, such as discussion papers and exposure drafts, for public comment is an important component. The IASB engages closely with stakeholders around the world, including investors, analysts, regulators, business leaders, accounting standard-setters and the accountancy profession

1.8

Chapter 1: Nature and regulation of companies

In 2013 the constitution of the IFRS foundation and IASB was revised to include the following primary objectives: (a) to develop, in the public interest, a single set of high quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles. These standards should require high quality, transparent and comparable information in financial statements and other financial reporting to help investors, other participants in the world’s capital markets and other users of financial information make economic decisions. (b) to promote the use and rigorous application of those standards. (c) in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings. (d) to promote and facilitate adoption of International Financial Reporting Standards (IFRSs), being the standards and interpretations issued by the IASB, through the convergence of national accounting standards and IFRSs. (IFRS Foundation Constitution, para 2)

Following the direction given by the FRC in 2002, the AASB has adopted the IFRSs issued by the IASB as from 1 January 2005. Hence, the financial statements prepared by Australian companies are comparable with those prepared by entities in other countries which also have adopted IASB standards. This should allow for greater understanding of financial statements worldwide, and lead to a more efficient flow of capital across national boundaries. The IASB has signed an agreement with the Financial Accounting Standards Board (FASB), the body responsible for issuing accounting standards in the United States. The agreement requires both bodies to work together towards convergence of global accounting standards. The aim is to agree on high-quality solutions to existing and future accounting issues. If such agreement could be reached, potentially there would be one set of global accounting standards. The Securities and Exchange Commission (SEC) in the United States, despite proposing a ‘roadmap’ to consider whether and how US companies could begin using the IFRSs by 2014, has yet to make a final decision. IFRS Interpretations Committee The IFRS Interpretations Committee has the task of reviewing on a timely basis, within the context of existing international accounting standards and the IASB framework, accounting issues that are likely to receive divergent or unacceptable treatment in the absence of authoritative guidance, with a view to reaching consensus as to the appropriate accounting treatment. The Interpretations Committee considers issues of reasonably widespread importance, and not issues of concern to only a small set of enterprises. The interpretations cover: • newly identified financial reporting issues not specifically dealt with in IFRSs • issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop in the absence of authoritative guidance, with a view to reaching a consensus on the appropriate treatment. The AASB has adopted the Interpretations issued by the IFRS Interpretations Committee for use by Australian companies as from 1 January 2005, and modifies them if necessary for the not-for-profit sector in Australia. Australian Securities and Investments Commission (ASIC) The ASIC is an independent government body set up to enforce and administer the Corporations Act and financial services laws to protect consumers, investors and creditors.

1.9

Solutions Manual to accompany Company Accounting 10e

ASIC regulates and informs the public about Australian companies, financial markets, financial services organisations and professionals who deal and advise in investments, superannuation, insurance, deposit taking and credit. The Australian Securities and Investments Commission Act 2001 requires ASIC to: • uphold the law uniformly, effectively and quickly • promote confident and informed participation by investors and consumers in the financial system • make information about companies and other bodies available to the public • improve the performance of the financial system and the entities within it. One of the roles of ASIC is to reduce fraud and unfair practices in financial markets and financial products so that consumers can use them confidently and companies and markets can operate effectively. In an accounting context, as part of its role, ASIC also attempts to ensure that a company’s financial statements lodged with it under the requirements of the Corporations Act comply with accounting standards, if applicable. Australian Securities Exchange (ASX). The ASX is a public company operating Australia’s share markets. It oversees both the shares and future exchanges. In an accounting context, it is particularly concerned with improving the disclosure of information in the financial reports of companies listed with it on the various stock exchanges throughout Australia. It exercises its influence by way of the Listing Rules — a set of rules with which companies must comply if they wish to be listed, and remain listed, on the stock exchange. Asian-Oceanic Standard Setters Group (AOSSG) The AOSSG is an interest group of several standard setters, based in Asian and Oceanic countries, for the purpose of commenting (lobbying) on accounting standards set by the IASB. Its Memorandum of Understanding specified the following objectives: • Promoting the adoption of and convergence with IFRS by jurisdictions in the region • Promoting consistent application of IFRS in the region • Coordinating input from the region to the technical activities of the IASB • Cooperating with governments and regulators and other regional and international organisations to improve the quality of financial reporting.

15. To which entities do accounting standards apply? Discuss the nature of a reporting entity, and consider reasons for the concept being replaced. Accounting standards apply to the general-purpose financial statements/reports of entities which are “reporting entities” and also to those entities which decide to prepare generalpurpose financial statements even if they are not reporting entities. The AASB, in SAC 1, provided the following definition of a reporting entity: Reporting entities are all entities (including economic entities) in respect of which it is reasonable to expect the existence of users who rely on the entity’s general purpose financial report for information that will be useful to them for making and evaluating decisions about the allocation of scarce resources.

1.10

Chapter 1: Nature and regulation of companies

All reporting entities are subject to accounting standards when preparing their generalpurpose financial statements. Entities such as small proprietary companies, family trusts, partnerships, sole traders and wholly owned subsidiaries of Australian reporting entities will normally not be required to prepare general purpose statements in accordance with accounting standards. The introduction of the IASB’s differential reporting requirements for Small and MediumSized Entities shifted the focus from whether an entity is/is not a reporting entity to whether the entity is required to prepare a general-purpose financial statement/report and is publicly accountable. However as noted in the text the Australian differential reporting requirements for Small and Medium-Sized Entities have retained the primacy of the reporting entity concept in determining which entities are required to prepare GPFRs. Public accountability is used to determine which entities are permitted to use the Reduced Disclosure Regime. The RDR involves recognition and measurement requirements of full IFRSs (Tier 1), as already adopted in Australia, but with disclosures substantially reduced (Tier 2) in comparison with those required under full IFRSs. As noted in the text the introduction of the RDR in Australia represents only the first stage in considering differential reporting and rationalization of reporting requirements in Australia and in the next stage the AASB is expected to consider a shift from the reporting entity concept to GPFRs as: • the IFRSs which Australia has adopted apply to GPFRs rather than reporting entities, and, • internationally the reporting entity concept is used to determine the boundaries of the entity being reported on rather than the entity required to provide GPFRs. The nature of the reporting entity is that the question to be asked by preparers of financial reports in deciding whether they are a reporting entity (and hence need to prepare a GPFR) is: Is it reasonable to expect the existence of users who depend on GPFRs for making and evaluating economic decisions? This will also be impacted by who are considered ‘users’. As the text notes the reporting entity concept in SAC1, and in the Framework, was very broad. In 2010 the IASB and the FASB issued Exposure Draft ED193 Conceptual Framework for Financial Reporting: The Reporting Entity which redefined ‘reporting entity’ to include a more restricted set of users (namely existing and potential investors, lenders and other creditors).The text also discusses the three main features of a reporting entity as per ED 193. However, it is important to note these features and not always sufficient when identifying a reporting entity.

16. Investigate the nature of the Reduced Disclosure Regime (RDR), and outline the implications of applying the RDR in Australia. The RDR has been established in Australia since the release of AASB 1053 in June 2010. This has resulted in a two-tier reporting system in Australia, as outlined in table 1.1 on p. 29 of the text. Hence, all entities which prepare general-purpose financial statements are required to comply fully with IFRSs issued by the IASB; however, only those entities on Tier 2 have reduced disclosure requirements. The implications are:

1.11

Solutions Manual to accompany Company Accounting 10e

•

that more entities will be required to comply with full IFRSs, than would be required under the SME arrangements developed by the IASB which has issued a stand-alone accounting standard, IFRS for SMEs, that ‘replaces’ the full suite of IFRSs for such entities. The GPFRs of any Australian company will need to apply the same recognition and measurement principles and options.

17. Would compliance with IFRS’s ensure compliance with Australian Accounting Standards? Give reasons for your answer. Whilst Australia has largely adopted the IFRS’s, compliance with IFRSs alone would not ensure compliance with Australian Accounting Standards as: 1. As noted above for SMEs the IASB have issued a separate standard that includes changes to recognition and measurement requirements for some items. The Australian Reduced Disclosures Regime does not alter these recognition and measurement requirements. Hence entities complying with IFRS for SMEs would not comply with Australian Accounting Standards. 2. There are some Australian accounting standards (and interpretations) where there is no IFRS equivalent (for example, AASB 1054 Australian Additional Disclosures).

1.12

Chapter 1: Nature and regulation of companies

CASE STUDIES Case study 1

Legal rights and obligations of a small business

Visit the website of the Australian Government’s Attorney-General’s Department dealing with the law (www.comlaw.gov.au) and find the Corporations Act 2001. Assuming that you are the director of a small proprietary company, find the ‘small business guide’ and learn of your rights and obligations under the Act for managing your business. Prepare a brief report for the tutorial class. The Small Business Guide in the Corporations Act can be found following Section 111J. The guide summarises the main rules in the Corporations Act (the Corporations Act 2001) that apply to proprietary companies limited by shares—the most common type of company used by small business. The guide gives a general overview of the Corporations Act as it applies to those companies and directs readers to the operative provisions in the Corporations Act. Students, in their capacity as would-be directors, are required to present a report to the class, summarising the requirements of the Guide. Such topics to be covered include: • The meaning of registration, including shareholders’ and directors’ liabilities • Rules for internal management of a company • Company structure and setting up a new company • Continuing obligations once the company is set up • Company directors, secretaries and shareholders • Who can sign company documents • Funding the company’s operations • Returns to shareholders • Annual financial reports and audit • Disagreements within the company • Companies in financial trouble

Case study 2

The AASB

Visit the AASB website (www.aasb.gov.au) and find out the following items: • Who is the Chair of the AASB? • Who are the members, and which organisations do they represent? • Which accounting standards have been issued in the past year? • Why are there differences in the numbering systems for current accounting standards (e.g. AASB x, AASB xxx and AASB xxxx)? • What current projects (if any) is the AASB working on in cooperation with the IASB?

Assuming that you already have access to the AASB website: Chairman of the AASB Go to AASB Board, then Current Board Members .Current chair is Kevin Stevenson Members of the AASB and organisations represented

1.13

Solutions Manual to accompany Company Accounting 10e

Stay in the same location and the names and organisations represented on the AASB are all shown. Don’t forget to include the observers as well. Comment: too many men?? Any academics on the board? Accounting standards issued in the past year: On the AASB website, go to Quick Links, then Table of Standards. Read from Table 1 all of the standards issued in the last year. Different numbering systems for standards See Pronouncements for information, plus section 1.7.4 in the text. AASB x represent those standards adopted by the AASB from the IFRSs of the IASB AASB xxx represent those standards adopted by the AASB from the IASs of the IASB and its predecessor the IASC AASB xxxx represent those standards issued exclusively by the AASB for companies in the Australian context In addition, the AAS standards consist of standards issued by the AASB for special organisations e.g. superannuation plans, government (The numbering system is also set out in tabular format at the For Students link; go to About the AASB then For Students). Current projects On the AASB website, go to Work in Progress, then Projects. It would appear that there are no specific projects at the moment being worked on by the AASB in cooperation with the IASB. The AASB is one of several standard setting boards that liaise with the IASB and merely provide submissions to the IASB on various topics. See also AASB Submissions to the IASB on the website. Also check the News section and Latest News on the website.

Case study 3

Setting up a company

Visit the website of the Australian Securities and Investments Commission (www.asic.gov.au) and find the form(s) that you must complete to start a company, assuming that you wish to set up a small proprietary company to take over your current successful business, which has been operating as a partnership (with three partners) in the past. On the website of the ASIC, go to Download forms, select the form 201 for Registering a company. Students should print the form and fill it out as if they wish to set up a proprietary company, with more than one owner shareholder.

Case study 4

The IASB

Visit the website of the International Accounting Standards Board (www.ifrs.org) or the Financial Accounting Standards Board (www.fasb.org) and find and report to the class on the following pieces of information: • Joint Update Note from the IASB and FASB on Accounting Convergence July 2012 • the accounting standards being changed as a result of the international convergence moves • the membership of the IASB and which countries the members come from

1.14

Chapter 1: Nature and regulation of companies

• the goals of the IASB. 1. Joint Update Note from the IASB and FASB on Accounting Convergence July 2012 On the IASB website, go to IFRS, then Use around the world, then Jurisdictional and International MoUs, and finally click on United States in the Jurisdiction table to gain access to “Convergence with US GAAP”. Alternatively visit the website of the FASB, go to Quicklinks, and then International Convergence. Report on the latest information available from these sites, which are updated regularly. 2.

Which accounting standards have or are being changed as a result of international convergence moves

The update report contains 3 tables that provide status and changes as a result of short term, long term and longer term priority convergence projects. These are replicated below.

1.15

Solutions Manual to accompany Company Accounting 10e

Short Term Convergence Projects

Source: Hoogervorst, Hans, and Seidman, Leslie F., IASB-FASB Update Report to the FSB Plenary on Accounting Convergence, 5 April 2012, p.3

1.16

Chapter 1: Nature and regulation of companies

Long Term Convergence Projects

Source: Hoogervorst, Hans, and Seidman, Leslie F., IASB-FASB Update Report to the FSB Plenary on Accounting Convergence, 5 April 2012, p.4

1.17

Solutions Manual to accompany Company Accounting 10e

Longer Term Priority Convergence Projects

Source: Hoogervorst, Hans, and Seidman, Leslie F., IASB-FASB Update Report to the FSB Plenary on Accounting Convergence, 5 April 2012, p.5

Membership of IASB and member countries

Go to the IASB website and see, About us. Click on About the organisation and there you will find the information about the Chairman, the Vice-Chairman and all members of the IASB, and the countries from which they came by reading each person’s information sheet. 4.

Goals of the IASB

Go to the IASB website and see About us. Click on About the organisation and there you will find the IASB objectives. On this page you can also access a 7 page guide ‘Who we are and what we do’ from the Related Information link.

Case study 5

ASIC

Visit the website of the Australian Securities and Investments Commission (www.asic.gov.au) and find out and report to the class on the following: • what ASIC is and its role • the tips given to prospective shareholders regarding the reading of a company’s prospectus • a list of the policy statements and practice notes issued by ASIC • ‘What’s new’ on the website.

1.18

Chapter 1: Nature and regulation of companies

1. ASIC and its role On the ASIC website, go to About ASIC and look up Our Role 2. Tips to prospective shareholders re prospectuses From within the About ASIC menu, go to ASIC and consumers. From there, access Go to MoneySmart, then Tools & Resources, and Check ASIC lists, then Check a Prospectus. The ASIC has information about prospectuses which changes quite regularly. See what tips you can find about prospectuses, assuming that you are a prospective investor. 3. Regulatory guides issued From ASIC’s home page, go to Publications and then to Regulatory Documents. regulatory guides are accessible here.

The

4. What’s new See ASIC’s home page, and What’s New features on the home page.

Case study 6

FRC

Visit the website of the Financial Reporting Council (www.frc.gov.au) and locate its strategic plan and report to the class on the following: •

What is the key purpose of the strategic plan?

There is a separate link on the FRC homepage to information about the strategic plan. Click on this and open the strategic plan for 2013-16. As this document notes, the FRC’s objectives are to facilitate the development of high quality accounting standards, auditing and assurance standards, and related guidance. The FRC aims to achieve these objectives by developing task forces for specific areas of interest. •

Identify and outline the four sources of complexity in financial reporting that the Managing Complexity in Financial Reporting Task Force outlined in its report to the FRC in May 2012. 1) Increasingly complex business operations 2) Complexities in the regulatory framework 3) Changing attitudes of businesses and stakeholders 4) Developments in Integrated Reporting

You should also outline the nature of and purpose of the project, any recommendations or progress made. This report can be found on the website by going to the Reports section, then Other Reports.

1.19

Chapter 2: Financing company operations

Chapter 2 – Financing company operations REVIEW QUESTIONS 1.

Explain the nature of a share. Distinguish between an ordinary share and a preference share.

Basically, a share represents ownership of a portion of the share capital of a company. Also note the discussion in Chapter 1 of the text concerning the relationship between limited liability and the amount paid up on a share. The differences between ordinary and preference shares are determined by the terms of issue. A company has the right to issue preference shares, but may only do so either if there is a statement in its constitution setting out the rights of these share or if these rights have been approved by a special resolution of the company. Not all preference shares are the same. However common differences between ordinary and preference shares are: ▪ Ordinary shares represent ordinary ownership interest and therefore have right to participate in profits, voting rights and rights to receive return of capital if the company is wound up and after that of all other claimants (i.e. creditors). ▪ Preference shares are distinguished as normally having a set rate of ‘dividend’ (e.g. 5%) that is paid prior to any dividend to ordinary shareholders and have preference (before ordinary shareholders) to return of capital if the company is wound up. Also may be: ▪ Cumulative – i.e. if dividends are not paid in one period, they accumulate and are paid in the future when profits and funds are available; ▪ Participating- may receive an ‘extra’ dividend and participate in surplus assets or profits; ▪ May have voting rights (often only in specific circumstances; e.g. if dividends are not paid) ▪ Redeemable – may be able to be bought back either at a fixed time or at the option of either party (shareholder or company) Note: Classification of preference shares as equity or liabilities depends on the rights and features of the shares – judgment is required re which classification is appropriate. For example, redeemable, cumulative 10% preference shares, which are to be redeemed on a set date, are definitely liabilities. Preference shares redeemable at the option of the company may or may not be liabilities. If the preference shares are classified as liabilities, any dividend paid on those shares must be treated as interest expense (not as a dividend).

2.1

Solution Manual to accompany Company Accounting 10e

2. Describe the purpose of each of the ledger accounts used to record the issue of shares. Cash Trust: used to record money received from applicants subscribing for shares. These amounts remain in the trust account until the shares have been allotted to applicants. The balance will then be transferred to the company’s general bank account. Application: used to record the amount of money received from applicants subscribing for shares. Once the directors decide to allot the shares to the applicants, then this account is cleared out and transferred to the Share Capital Account or to Allotment, Calls in Advance and refunds from Cash Trust if appropriate. Share Capital: used to record the amount called up from successful applicants who have now been allotted shares in the company. The amount is transferred in from the Application Account or the Allotment and Call accounts. Other accounts that may be used depending on the details of the share issue will be the Allotment Account and the Call Account. These accounts are used if shares are payable by instalments.

3. Explain what can happen if a share issue is ‘underwritten’ and the effect that underwriting can have on achieving a minimum subscription. If a share issue is underwritten, this means that the underwriter, if a share issue is not fully subscribed by the public, guarantees to either purchase the remaining unsubscribed shares or arrange for others to subscribe to the issue. Underwriters are usually financial institutions or brokers, and they will charge the company a commission for their services. If the share issue is fully subscribed, the underwriter will collect the commission and not have to do anything.

4. If a share issue is oversubscribed, what action can be taken in relation to excess money received on application? Excess monies received on application for shares will be refunded to the applicant. However where shares are issued on a partly paid basis, the excess can be used as an offset in reducing allotment money due and in payment of any future calls, provided the company’s constitution and the terms of the prospectus allow for this treatment.

5. When can a company forfeit its shares? What happens to money already paid by the holder of those shares? A company can forfeit its shares provided the rules for forfeiture are in the company’s constitution. The rules usually specify that shares would be forfeited for non-payment of calls. Where shares are forfeited, the company can, depending on the constitution, retain the funds already paid on the forfeited shares in which case the Forfeited Shares account will be considered a reserve and part of equity. Alternatively, the forfeited shares can be reissued and the amount received, less the costs of forfeiture and reissue of shares, may then be refunded to the former shareholders. In this case, the Forfeited Shares account is a liability.

2.2

Chapter 2: Financing company operations

6. How should a company account for the legal costs of formation? Should the accounting treatment be the same as that for underwriting and other share issue costs? Legal costs of formation were traditionally treated as an asset and then systematically amortised over an arbitrary period. However there are no future economic benefits to be gained from these costs and they should be written off to expense, as per AASB 138 Intangible Assets. Underwriting and other share issue costs are discussed in AASB 132 Financial Instruments: Presentation, paras. 35 and 37, and the appropriate treatment is to regard these costs as a reduction of the share capital being raised (if the share issue occurs). The rationale for the different treatment is that share issue costs and the raising of capital is viewed as a single transaction and as such, the increase in equity is the net amount the company receives from the issue of shares (after considering any tax effect on the share issue costs). However, if no capital is issued (i.e. the share issue is not successful) then such costs are expensed.

7. What is a rights issue? Distinguish between a renounceable and a non-renounceable rights issue. How would a company account for such issues? A rights issue is an issue of new shares to existing shareholders whereby they are given the right to purchase additional shares in proportion to their current shareholdings. Usually the issue price is set below the current market price of the company’s shares. A renounceable rights issue allows the shareholder to take up the rights issue, let it lapse or sell their rights on the securities market. A non-renounceable rights issue only allows the shareholder to either take up the rights by subscribing for more shares, or reject the rights, which mean that they lapse. The shareholders cannot sell the rights. Accounting for a rights issue is discussed in the chapter at section 2.5.1 and practical aspects are shown in illustrative example 2.6.

8. What is private placement of shares? What are the advantages and disadvantages of a private placement? A private placement is an issue of shares to a large institutional investor. The main advantages are speed, price and direction. The disadvantage is that existing shareholders experience a dilution of their ownership as well as an ability to make a profit if there had been a rights issue instead of a private placement.

9. What is a share option? How does a company account for share options that lapse? A share option is an instrument giving the holder the right to buy or sell a set number of shares in the company by a set date at a set price. Options can be issued for a price or at no cost to the recipient. If issued for a price, an options ledger account is used. On expiry of the exercise date, this account balance is transferred to share capital (for the number of options exercised x the

2.3

Solution Manual to accompany Company Accounting 10e

options price) and to lapsed options reserve (for the number of options lapsed x the options price). Where options are issued at a cost, then the amount received for options not yet exercised is disclosed in the statement of financial position as an increase in equity and shown below the company’s share capital.

10. Detail the characteristics of redeemable preference shares recognised as liabilities rather than equity. Redeemable preference shares recognised as liabilities rather than equity normally would be redeemable in cash on a specified date or at the option of the holder, be cumulative in regard to the payment of dividends, non-participating in further dividends and have priority rights to return of capital over ordinary shares. The accounting treatments of such preference shares when they are redeemed are shown the text in illustrative examples 2.9 and 2.10.

11. What are share consolidations and share splits? How are they accounted for? Share consolidations involve packaging the existing capital into a smaller number of shares. This doesn’t affect the balance in the Share Capital account and therefore there is no journal entry required, but only an adjustment to the share register in regard to the number of shares. Share splits are the opposite to share consolidations. They involve packaging the existing capital into a larger number of shares. For example when BHP merged with Billiton and became BHP Billiton it split its shares on the basis of two shares for every one share. A share split also doesn’t affect the balance in the Share Capital account and therefore there is no journal entry required, but only an adjustment to the share register in regard to the number of shares.

12. What restrictions exist under the Corporations Act 2001 on the conversion of ordinary shares to preference shares? Conversion of ordinary shares to preference shares is permitted provided the shareholders’ rights in regard to the conversion have been set out in the company’s constitution or approved by a special resolution of the company. These rights will detail the shareholders’ rights in regard to repayment of capital, participation in surplus assets and profits, whether the dividends will be cumulative or non-cumulative, voting rights and priority payment of dividends and capital in relation to other shares.

13. Why would a company wish to buy back its own shares? What conditions must be fulfilled before the company can do so? What types of share buy-backs are permissible under the Corporations Act 2001? A company may wish to buy back its own shares in order to change its financial leverage. Alternatively it may be cashed up with no suitable profitable investments, so rather than keep the cash idle it may be beneficial to buy back its shares. Share buy-backs can also help in

2.4

Chapter 2: Financing company operations

cleaning up small lots of shares that are held. A company can only buy back its own shares if the buy back does not materially prejudice the company’s ability to pay its creditors. The five types of share buy backs permissible under the Corporations Act are discussed in section 2.9 of the chapter. See especially Table 2.1, page 55.

14. How should a company account for a share buy-back? How does it account for a buy-back premium? A buy-back discount? Discuss. Where the amount paid for a buy back share exceeds the initial issue price, then a buy back premium arises. If the amount paid for the buy back is less than the issue price, then a buy back discount arises. The accounting for a buy back of shares was discussed by the Urgent Issues Group in Abstract 22, issued in 1998. Even though the document no longer exists, it is used here in the absence of additional guidance. It states in paragraphs 4 and 5 that where shares are bought back, the equity of the entity must be directly reduced by the cost of acquisition of the shares bought back. Abstract 22 does not however prescribe which equity accounts are to be adjusted as a result of the buy back. Section 2.9.2 of the text outlines common treatments in practice. An example of the accounting for a share buy back is given in illustrative example 2.12.

15. What is a debenture? Briefly outline the different types of debentures permitted under the Corporations Act 2001 and outline the procedures which must be followed to issue debentures. A debenture is a chose in action whereby a company undertakes to repay money borrowed by it. The chose in action may include a charge over company property to secure repayment. The different types of debentures under the Corporations Act are a mortgage debenture where the security is a first mortgage on land; a debenture where the security is over sufficient tangible property; and an unsecured note or unsecured deposit note where the first two names cannot apply.

2.5

Solution Manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Public floats

Torque Mining Ltd issued a prospectus on 25 January 2013 inviting applications for up to 20 000 000 ordinary shares at an issue price of 20c each, payable in full on application. A minimum subscription of $3 000 000 was specified, with share issue costs of $376 350 expected to be incurred. The expected closing date for the offer was 15 March 2013. On 27 March 2013, the company advised that the Initial Public Offering had been withdrawn as the minimum subscription had not been reached. (Based on information from Torque Mining Ltd, www.torquemining.com.au/news.) Required A. What is the rationale behind specifying a minimum subscription to be reached before a share issue can be made? B. Assume that the minimum subscription was reached, the offer closed on 15 March 2013, and that 3,000,000 shares were issued on 27 March 2013 with share issue costs paid on that day. Prepare the journal entries required to be processed from the 25 January to the 27 March inclusive. C. Given that the share issue was not completed, explain how any costs associated with the offer would be accounted for?

A. A company is required to specify in the disclosure document what it intends to do with the funds expected to be raised. If the minimum subscription specified in the document is not met, no shares can be issued and all application money must be refunded. This is to protect investors as, if the minimum subscription is not reached, the company would not have adequate funds to achieve the objectives as stated in the disclosure document. This would place any investment at risk. B. The entries required given these assumptions are: To 15 Mar. Cash Trust Application (Money received on application) 27 Mar. Application Share Capital (Issue of 15m shares fully

Dr Cr

3 000 000 3 000 000

Dr 3 000 000 Cr paid to 20c)

Cash Cash Trust (Transfer on allotment of shares)

Dr Cr

3 000 000

Share Issue Costs/Share Capital Cash (Costs of issuing the shares)

Dr Cr

376 350

3 000 000

376 350

2.6

Chapter 2: Financing company operations

C. If the share issue was not completed the costs associated with the offer would be expensed to the profit/loss (AASB 132, para 37).

Case Study 2

Private placement

On 13 March 2013, Mining company Aeon Metals Ltd announced plans to raise $1 150 000 through a placement of 5 227 273 ordinary fully paid shares at $0.22 per share to institutional investors to fund new surveys and drilling campaigns for its copper project. Prior to this announcement the shares of Aeon Metals Ltd were trading at around $0.26. (Based on information from Aeon Metals, www.aeonmetals.com.au.) Required A. Distinguish between a public share float and a private placement. B. Assuming that the placement above proceeded, what journal entries would be required to account for it? A. The main differences between a public share float (share capital raised by a public company by way of advertisements and disclosure documents to encourage public subscription for shares) and a private placement (shares issued privately to institutional investors) are: • Time - a public share float is much slower to achieve than a private placement • Expenditure - Public share floats require greater costs through publication of disclosure documents, advertisement, appointment of underwriters • Total cash raised – public share floats usually raise more capital as there are restrictions by the ASX on the amount raised through private placements. • Share price and direction – a private placement may be made close to the current price if it is made to existing shareholders, and a private placement may be made with “friendly” institutions B. Cash Dr 1 150 000 Share Capital Cr (Private placement of 5,227,273 shares at $0.22 per share)

Case Study 3

1 150 000

Prospectus and share issue

From the website of the Australian Securities and Investments Commission (ASIC) (www.asic.gov.au), find a company which has issued a prospectus for the purpose of raising additional funds (shares or debentures) from the public in the current year (calendar or financial). Find a copy of that prospectus online (they are usually on the company’s website, linked via ASIC’s website). Required Report to the class on the nature and details of the prospective fundraising, and the reasons why such funds are being raised.

2.7

Solution Manual to accompany Company Accounting 10e

This answer belongs to the students, depending on the current prospectus selected from the ASIC website.

Case Study 4

Share buy-backs

Read the article on pages 76–79 by Kim Wyatt and Jarrod McDonald, ‘Who really wins from an off-market share buyback?’ (In the Black, October 2004, pp. 54–7). Required Considering the given examples of Telstra, Foster’s, IAG, Woolworths, Channel Seven and the Commonwealth Bank, discuss in groups of three or four whether you believe off-market buy-backs are worthwhile from an individual shareholder’s point of view. Present your findings to the class. Students should firstly establish the model adopted by Wyatt and McDonald for measuring the gains and losses from share buybacks. The question that needs to be answered is whether share buy-backs are beneficial to an individual shareholder. From Wyatt and McDonald’s research, the answer varies from one buy-back to another depending on an individual’s marginal tax bracket. Some buy-backs seem to benefit the company rather than the individual shareholders. Students should read the article and present their findings to the class for each different buyback scheme examined by Wyatt and McDonald. Question to consider: Can we generalise from their research that buy-backs are worthwhile, or not?

Case Study 5

Rights issues vs. private placements

Read the following newspaper article: Investor prepares for fight as Transurban issues shares Transurban’s largest shareholder has failed in an eleventh-hour appeal to halt an allotment of newly-issued shares to institutional investors but will get a chance to air its grievances before the takeover’s umpire. The Takeovers Panel yesterday rejected a request by the Sydney fund manager CP2 for interim orders — similar to a temporary injunction — seeking to halt the $542 million share issue. However, a panel will be appointed to consider the shareholder’s application for final orders against the raising, which Transurban wants to use to pay for its $630 million purchase of Lane Cove Tunnel. The latest dispute between Transurban and its largest shareholder creates further instability for the toll-road company, and raises fears of a protracted stand-off. A day after Transurban’s embattled chairman, David Ryan, attempted to quell a push for board scalps, CP2 went to the takeovers umpire saying the company’s rights issue ‘constitutes frustrating actions’.

2.8

Chapter 2: Financing company operations

The fund manager, which owned just under 15 per cent of Transurban before the capital raising, joined two Canadian pension funds in unsuccessfully trying a $7.2 billion takeover offer for the toll-road group two weeks ago. CP2’s stake will be diluted because it did not participate in the share issue. Yesterday CP2 said Transurban had conducted the rights issue in a ‘misinformed market’ and the timing of the sale precluded the Canadian-led consortium and overseas investors from participating. It wanted shareholders to be able to vote on the capital raising and, if it went ahead, the institutional entitlement offer to be reopened. However, this appears impractical given the new shares can be traded from today. Andrew Chambers, an Austock analyst, said there had been mixed messages from CP2 because it wanted the rights issue stopped while it was also seeking to reopen the institutional offer. ‘There seems to be mixed objectives, which always create uncertainty for the stock’, he said. Transurban and CP2 declined to comment yesterday because the matter was before the Takeovers Panel. However, Transurban said its capital raising was proceeding as planned. Shares in Transurban closed down 11c, at a seven-month low of $4.30. Source: Matt O’Sullivan, Sydney Morning Herald, 26 May 2010. Required A. Distinguish between a rights issue and a private placement. B. From the above article, what appears to be the problem voiced by Transurban’s largest shareholder against the share issue? A. A rights issue is an issue of new shares to existing shareholders, based on their proportionate holdings of existing shares. Only if the terms of the rights issue are renounceable will new shareholders be able to acquire shares in Transurban. A private placement is an arrangement whereby shares are sold to new or existing institutional shareholders who have negotiated to buy a block of newly-issued shares in the company. There is no requirement for the placement to be proportional among existing shareholders. B. The issue is one of control. In a rights issue, shareholders normally hold the same proportion of shares after the issue as before. Not so in a private placement. New or existing institutional investors may privaely acquire enough shares to reduce the control of other existing shareholders and therefore increase their own control. It appears from the article that CP2 was more interested in being part of a private placement with Canadian pension funds so that its influence over Transurban would rise, rather than being part of a rights issue where its influence would remain at approximately 15%..

Case Study 6

Share market floats

Read the following article: Companies cautious on floats Low business confidence and sentiment will continue to cloud the IPO market in Australia next year, but with a backlog of potential market listings and record amounts of cash on the sidelines, activity could pick up in the later part of the year.

2.9

Solution Manual to accompany Company Accounting 10e

Ernst & Young’s year-end global IPO update, released yesterday, shows that while the global outlook next year is more positive than this year, a tough 2012 is still weighing on activity. In Australia this year there have been 36 IPOs to the end of last month, with total capital raised of $US865 million ($821m) — down 63 per cent in volume and 29 per cent in value compared with last year. More than half the 36 capital raisings were small resource companies with average capital raised less than $US10m and a single IPO — Woolworths’ spin-off of retail properties into the Shopping Centres Australasia Property Group — accounted for more than half the total capital raised for the year. Anne-Maree Keane, Ernst & Young Australia transactions partner, said the Australian equity market was in ‘relatively good shape’ and was ‘on the up’, but broader business confidence and sentiment continued to cloud the outlook for increased activity. ‘There are companies in the background, potentially waiting to go (to IPO) but in the meantime they tick along, business as usual, Ms Keane said. ‘There is a backlog but people are reluctant to embark on an IPO process because of the time, cost and risk. ‘People do need to exit some of these businesses. If you’re a large, family-owned operation, succession planning is starting to become a real issue for some because it’s been potentially five years waiting for things to get better.’ Ms Keane said this year was driven by sentiment and that, while there were record amounts of cash looking for a home, investors were concerned that IPOs resulted in an immediate drop in the value of their investment. A lack of confidence to invest for the long term was seeing people focus on short-term fundamentals and what their return would be in six months, rather than three to 10 years, she added. ‘Retails investors and institutions have seen that immediate decline in their investments, so they are keeping their money in cash,’ she said. While historically there was a strong uptick with IPOs following a quiet period, Ms Keane said the volatility in global markets made it difficult to predict what the future held for new listings. ‘Historically, when we’ve had a quiet period of IPOs and the window opens, there is a rush and that creates some competition,’ she said. While sentiment remains cautious, the global report is tipping a pick-up in the second half of next year, a trend that is also expected to be seen in Australia. Ms Keane said the company was getting more inquiries and, while there had previously been a few false starts on activity picking up, plans that had been deferred were being revisited. ‘We are getting an increased level of inquiries where people are starting to tentatively think about putting it back on the board agenda for next year and that is something that we haven’t seen for a few years,’ she said. Source: Tasker, S 2012, ‘Companies cautious on floats’, The Australian, 19 December, p. 18. Required A. What reasons are provided for investors being cautious about participating in public share floats in 2013? B. Using the Internet, investigate the success or otherwise of IPOs made in 2013 (e.g. Austral Resources and IPB Petroleum made IPOs in 2013). A. The article suggests a range of factors (interrelated) that will impact. These include:

2.10

Chapter 2: Financing company operations

• Low business confidence • Concern over global outlook • Focus on short term returns B. The success or otherwise will depend on the choice made by students.

2.11

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 2.1

Oversubscription on share issue, payable in full on application

Maple Ltd was registered on 1 March 2017. Directors decided to issue 500 000 ordinary shares on 31 March 2017, payable in full on application at an issue price of $2.The company received applications for 560 000 shares, sent letters of regret to applicants for 10 000 shares and the remaining applicants received partial allotments by issue of 10 shares for every 11 shares applied for, making the total allotment 500 000 shares. Legal costs of issuing the shares, $12 000, were paid. Required Prepare journal entries and ledger accounts to record the above transactions. MAPLE LTD General Journal 2017 Mar 31 Cash Trust Dr Application Cr (Money received on application 560 000 x $2)

1 120 000 1 120 000

Application Cash Trust (Refund to unsuccessful applicants for 10 000 shares)

Dr Cr

20 000

Application Share Capital (Issue of 500 000 shares fully paid to applicants for 550 000 shares)

Dr Cr

1 000 000

Application Cash Trust (Refunds of excess application money to successful applicants)

Dr Cr

100 000

Cash Cash Trust (Transfer on allotment of shares)

Dr Cr

1 000 000

Share Issue Costs/Share Capital Cash (Costs of issuing the shares)

Dr Cr

12 000

20 000

1 000 000

100 000

1 000 000

12 000

2.12

Chapter 2: Financing company operations

MAPLE LTD GENERAL LEDGER Cash Trust 31/03/17

Application

1 120 000 31/03/17

Application

20 000

Application

100 000

Cash 1 120 000

1 000 000 1 120 000

Application 31/03/17

Cash Trust

20 000 31/03/17

Share Capital

1 000 000

Cash Trust

100 000

Cash Trust

1 120 000

Share Capital 31/03/17

Application

1 000 000

Share Issue Costs

12 000

Balance c/d

988 000

Share Issue Costs 31/03/17

Cash

12 000 Cash

31/03/17

Cash Trust

1 000 000 31/03/17

1 000 000 Balance b/d

1 000 000

988 000

2.13

Solution Manual to accompany Company Accounting 10e

Question 2.2

Undersubscription on share issue, money due on allotment

On 1 January 2017, Elm Ltd issued a prospectus inviting applications for 300 000 ordinary shares, at an issue price of $6, payable $4 on application, $2 on allotment. By 30 April, applications were received for 290 000 shares with $4 paid. As the minimum required subscription had been reached, on 1 May the directors allotted 290 000 shares. Share issue costs of $1200 were also paid on the same date. All of the allotment money was received by 1 June. Required Prepare journal entries to record the above transactions. ELM LTD General Journal 2017 To 30 April

Cash Trust Application

Dr Cr

1 160 000

Application

1 160 000

Allotment

580 000

1 160 000

(being receipt of applications)

1 May

Share Capital

1 740 000

(being issue of shares)

Share Capital/Share Issue Costs Cash/Payables

1 200

(being payment of share issue costs) Cash

Cash Trust

1 160 000

(transfer of application money) To 1 June

Cash Allotment

Dr Cr

580 000 580 000

(being receipt of allotment money due)

2.14

Chapter 2: Financing company operations

Question 2.3

Share issue, payment by instalments

On 1 July 2017, Pine Ltd issued a prospectus inviting applications for 600 000 ordinary shares, at an issue price of $7, payable $2.50 on application, $1.50 on allotment, and $3 on future call(s), dates to be determined by the directors. By 1 September, applications were received for 620 000 shares with $2.50 paid per share. On 6 September, the directors allotted 600 000 shares. Refunds were made to applicants for 20 000 shares. Share issue costs of $12 400 were also paid on the same date. All of the allotment money was received by 1 October. On 1 February 2018, a first and final call for $3 was made. All of the call money was received by 1 March 2018. Required Prepare journal entries to record the above transactions. PINE LTD General Journal 2017 To 1 Sept

Cash Trust Application

Dr Cr

1 550 000 1 550 000

(being receipt of applications for 620,000 shares at $2.50 per share)

6 Sept

Application

1 500 000

Allotment

900 000

Share Capital

2 400 000

(being issue of 600,000 shares)

Application

Cash Trust

50 000 50 000

(being refund to unsuccessful applicants) Share Capital/Share Issue Costs Cash/Payables

12 400

(being payment of share issue costs) Cash

Cash Trust

1 500 000

(transfer of application money) To 1 October

Cash

900 000

2.15

Solution Manual to accompany Company Accounting 10e

Allotment

900 000

(being receipt of allotment money due) 1 Feb 2018

Call Share Capital

Dr Cr

1 800 000

Dr Cr

1 800 000

1 800 0000

(being first and final call for $3) To 1 March

Cash Call

1 800 000

(being receipt of call money)

2.16

Chapter 2: Financing company operations

Question 2.4

Calls on different classes of shares, forfeiture and reissue

Share capital of Oak Ltd at 31 March 2017 was as follows: 300 000 ordinary shares at an issue price of $4 each paid to $2.50, and 100 000 preference shares at an issue price of $4 each paid to $2. At that date, a further call of $1.50 on ordinary shares and $2 on preference shares was made. During the 3 months to 30 June 2017, all calls were duly received except those on 5000 preference shares which were forfeited as at 30 June 2017. To bring capital back to the original amount of issued capital, the forfeited shares were offered to an investment company at a price of $3.50 per share paid to $4 and the transfer was completed on 30 September 2017. According to the company’s constitution, shareholders’ equity in forfeited shares must be refunded to them. On 31 October, the previous owner of forfeited shares received a refund cheque for the amount due, less selling costs of $720. Required Show journal entries to implement the above transactions. OAK LTD General Journal 2017 March 31

June 30

Sept 30

Call - Ordinary Call - Preference Share Capital - Ordinary Share Capital - Preference (Call of $1.50 on ordinary shares and $2 on preference shares)

Dr Dr Cr Cr

450 000 200 000

Cash Dr Call - Ordinary Cr Call - Preference Cr (Receipt of $1.50 call on 300 000 ordinary shares and $2 call on 95 000 preference shares)

640 000

Share Capital - Preference Call - Preference Forfeited Shares Liability (Forfeiture of 5 000 preference shares for non-payment of $2 per share call)

Dr Cr Cr

20 000

Cash Forfeited Shares Liability Share Capital - Preference (Reissue of 5 000 preference

Dr Dr Cr

17 500 2 500

450 000 200 000

450 000 190 000

10 000 10 000

20 000

2.17

Solution Manual to accompany Company Accounting 10e

shares for $3.50, paid to $4)

Oct 31

Forfeited Shares Liability Cash (Expenses of reissue)

Dr Cr

720

Forfeited Shares Liability Cash (Refund to former shareholders)

Dr Cr

6 780

720

6 780

2.18

Chapter 2: Financing company operations

Question 2.5

Issue of shares by instalment; ledger accounts

On 30 September 2016, Jacaranda Ltd issued a prospectus calling for applications for 600 000 ordinary shares at an issue price of $3, payable $1.50 on application and $1.50 on allotment. By the closing date of 31 October 2016, the company had received the following application money: From applicants for 500 000 shares From applicants for 120 000 shares

750 000 360 000

On 15 November, it was decided to allot to applicants who paid more than the application money the number of shares applied for, and to applicants who paid only the application money 480 000 shares. Application money was refunded to 20 000 unsuccessful applicants. The constitution gives the directors the power to apply excess application money to allotment. All other allotment money was received by 31 December 2016. Required Prepare the necessary ledger accounts to record the above transactions. JACARANDA LTD General Ledger Cash Trust 31/10/16

Application

1 110 000 15/11/16 15/11/16

Application Cash

1 110 000

30 000 1 080 000 1 110 000

Application 15/11/16

Share Capital

900 000 31/10/16

15/11/16

Allotment

180 000

15/11/16

Cash Trust

30 000

Cash – Trust

1 110 000

Share Capital 15/11/16

Appl’n & Allot.

1 800 000

Application

180 000

Allotment 15/11/16

Share Capital

900 000 15/11/16

2.19

Solution Manual to accompany Company Accounting 10e

31/12/16

Cash

900 000

720 000 900 000

Cash 15/11/16

Cash Trust

31/12/16

Allotment

1 080 000 31/12/16

Balance c/d

720 000 1 800 000

31/12/16

Balance b/d

1 800 000 1 800 000

1 800 000

2.20

Chapter 2: Financing company operations

Question 2.6

Rights issues and private placements

The equity of Ash Ltd on 30 June 2017 was: Share capital (issued at $4, fully paid) Asset revaluation surplus Retained earnings

1 200 000 700 000 400 000

The following transactions occurred during the year ended 30 June 2018. 1. On 1 August 2017, a 1-for-4 rights offer was made to existing shareholders. The issue price was $4 per share payable in full on allotment, and rights were transferable. Shares issued under the offer were to rank equally with existing shares as from 1 August 2017. The issue was underwritten for a commission of $8000. The issue closed fully subscribed on 31 August, the holders of 50 000 shares having transferred their rights. Directors proceeded to allotment. The underwriting commission was paid on 7 September. 2. On 1 March 2018, 220 000 shares were privately placed with Blossom Investments Ltd at $4 per share. Required A. Prepare general journal entries to record the above transactions. B. Prepare the equity section of the statement of financial position as it would appear at 30 June 2018, assuming a profit for the year of $50 000. ASH LTD General Ledger A. (1) 2017 Aug 31

Cash

Dr Cr

300 000

Share Issue Costs/Share Capital Cash (Payment of underwriting commission)

Dr Cr

8 000

Cash

Dr Cr

880 000

Share Capital (Rights issue for 75 000 shares issued for $4) Sept 7

(2) 2018 March 1

Share Capital (Private placement of 220 000 shares at $4 each with Blossom Investments Ltd)

300 000

8 000

880 000

2.21

Solution Manual to accompany Company Accounting 10e

B. ASH LTD EQUITY (as at 30 June 2018) Contributed equity: 595 000 ordinary shares issued for $4 less Share issue costs (underwriting) Revaluation Reserve/Surplus Retained Earnings

$2 380 000 8 000

$2 372 000 700 000 450 000 $3 522 000

2.22

Chapter 2: Financing company operations

Question 2.7

Unsecured notes, issue and redemption

On 1 July 2016, Beech Ltd issued a prospectus inviting applications for 1000 7.5% unsecured notes of $200 each, payable in full on application. By 31 August, the company received applications for 920 of the notes and they were subsequently allotted. The notes were classified as a liability in the financial statements. On 30 June 2019, the company decided to redeem the notes in cash on the open market, at a premium of $4 per note. Required Ignoring interest, prepare the ledger accounts to record the above transactions. BEECH LTD A. Cash Trust 31/8/16

Application – Notes

184 000 31/8/16

Cash

184 000

Cash (extract) 31/8/16

Cash Trust

184 000 30/6/19

Unsecured notes and redemption expense

187 680

Application - Notes 31/8/16

Unsecured Notes

184 000 31/8/16

Cash Trust

184 000

Unsecured Notes 30/6/19

Cash

184 000 31/8/16

Application

184 000

Expense on Redemption 30/6/19

Cash

3 680

2.23

Solution Manual to accompany Company Accounting 10e

Question 2.8

Forfeiture of shares

The notice shown below appeared in the Financial News on 1 October 2017. ARGAN NL Notice of Sale of Forfeited Shares

All shares on which the call of fifty cents per share, due for payment on 1 September 2017, remains unpaid, will be sold by public auction on 1 November 2017, at 11 a.m. at the Australian Securities Exchange, Sydney, NSW. Assume the following: • 1 000 000 shares were forfeited • the forfeited shares were all paid to $1.50 per share • all the shares were sold at the auction for $1.80 per share and will be credited to $2.00 • costs of forfeiture and reissue amounted to $4000 • the balance of the Forfeited Shares account will be refunded to the former shareholders. Required Discuss the benefits to a company from forfeiting and reissuing shares, and prepare journal entries to record the forfeiture and reissue above. The main benefit to a company for forfeiting and reissuing shares is to tidy up the share capital account and the share register. Shares are usually forfeited for non-payment of calls; hence, by forfeiting and reissuing these shares, the company can ensure that all shareholders are paid up to the same amount on their shares. This makes it easier in the future when dividends are declared on a per share basis in that all shareholders are paid up to the same amount and no proportionate dividends need to be calculated. ARGAN NL General Journal 2017

1 Nov

Share Capital Dr Call Cr Forfeited Shares Liability Cr (Forfeiture of 1 000 000 shares called to $2 for non-payment of 50c call)

2 000 000

Cash Dr Forfeited Shares Liability Dr Share Capital Cr (Reissue of forfeited shares at public auction for $1.80, paid to $2)

1 800 000 200 000

Forfeited Shares Liability Dr Cash Cr (Expenses of forfeiture and reissue)

4 000

500 000 1 500 000

2 000 000

4 000

2.24

Chapter 2: Financing company operations

Forfeited Shares Liability Cash (Refund to former shareholders)

Dr Cr

1 296 000 1 296 000

2.25

Solution Manual to accompany Company Accounting 10e

Question 2.9

Oversubscription and payment by instalments

The equity balances for Acacia Ltd at the 1 July 2018 comprised the following: Share capital (All ordinary shares, issued and paid to $5, less issue costs of $12 000) Retained earnings

$2 988 000 $7 600 400 $10 588 400

On 1 October 2018, Acacia Ltd issued a prospectus for applications for 200 000 ordinary shares to the public at an issue price of $7, payable $2.50 on application, $1.50 on allotment and the remaining $3 in future call(s) as determined by the directors. By 1 December applications had been received for 240 000 ordinary shares with $2.50 attached. At a directors’ meeting on 5 December, it was decided to reject applications for 40 000 shares and issue shares to the remaining applicants. Share issue costs of $4000 were paid on 5 December. All outstanding allotment money was received by the 1 January 2019. The first call for $2 was made on 1 February 2019 with all money received by 20 February. The final call for $1 was made on 20 June 2019. At 30 June 2019 this call money had not been received in relation to 25 000 shares. Required A. Prepare the journal entries to record the transactions of Acacia Ltd as outlined above. (Show all workings.) B. Calculate the amount of share capital in the statement of financial position of Acacia Ltd as at 30 June 2019 (Show all workings.) C. How would your answers to requirements A and B change if: By 1 December applications had been received for 240 000 ordinary shares of which applicants for 80 000 shares forwarded $4 per share, and the remainder paying only the application money. At a directors’ meeting on 5 December, it was decided to allot shares applicants who had paid $4, and to reject applications for 40 000 shares where applicants had only forwarded $2.50 on application. According to the company’s constitution, all surplus money from application can be transferred to Allotment and/or Call accounts.

ACACIA LTD (i)

2018 To 1 Dec

Cash Trust Application

Dr Cr

600 000

Application

500 000

Allotment

300 000

600 000

(being receipt of applications)

5 Dec

Share Capital

800 000

2.26

Chapter 2: Financing company operations

(being issue of shares)

Application

Cash Trust

100 000 100 000

(being refund to unsuccessful applicants) Share Capital/Share Issue Costs Cash/Payables

4 000

(being payment of share issue costs) Cash

Cash Trust

500 000

(transfer of application money) 2019 To 1 Jan

1 Feb

Cash Allotment

Dr Cr

(being receipt of allotment money due) Call Dr Share Capital Cr

300 000 300 000

400 000 400 000

(being first call for $2)

To 20 Feb

Cash Call

Dr Cr

400 000

Dr Cr

200 000

Dr Cr

175 000

400 000

(being receipt of call money)

20 June

Second (or Final) Call Share Capital

200 000

(being final call for $1)

To 30 June

Cash Second (or Final) Call

175 000

(being receipt of call money)

2.27

Solution Manual to accompany Company Accounting 10e

(ii) The amount of share capital in the statement of financial position of Acacia Ltd as at 30 June 2019 is $4,659,000. Beg balance $2,988,000 + new share issue 1,400,000 (200,000 * $7) -less costs (4,000) -less calls in arrears (25,000) Total $4,359,000 (iii) Entries changed as below. (Note: the entries for calls would not change; nor would the total amount of share capital at 30 June 2019). 2018 To 1 Dec

Cash Trust Application

Dr Cr

720 000

Application

500 000

Allotment

300 000

Share Capital

720 000

(being receipt of applications 80,000 * $4 + 160,000* 2.50) 5 Dec

800 000

(being issue of shares)

Application

Allotment

120 000 120 000

(transfer of allotment monies received on application) Application

Cash Trust

100 000 100 000

(being refund to unsuccessful applicants) Share Capital/Share Issue Costs Cash/Payables

4 000

(being payment of share issue costs) Cash

620 000

2.28

Chapter 2: Financing company operations

Cash Trust

620 000

(transfer of application money) 2019 To 1 Jan

Cash Allotment

Dr Cr

180 000 180 000

(being receipt of allotment money due)

2.29

Solution Manual to accompany Company Accounting 10e

Question 2.10

Issue by instalments, oversubscription, forfeiture and reissue

On 1 April 2016, Magnolia Ltd was incorporated and a prospectus was issued inviting applications for 100 000 shares, at an issue price of $10, payable $5 on application, $2.50 on allotment and $1.25 on each of two calls to be made at intervals of 4 months after the date of allotment. By 30 April, applications were received for 120 000 shares. On 3 May, the directors allotted 100 000 ordinary shares to the applicants in proportion to the number of shares for which applications had been made. The surplus application money was offset against the amount payable on allotment. The balance of the allotment money was received by 10 May. Legal costs of forming the company were $1300 and were paid on 11 May. Share issue costs of $800 were also paid on the same date. The two calls were made on the dates stated in the prospectus, but the holders of 10 000 shares did not pay either call. In addition, a holder of another 5000 shares did not pay the second call. On 10 March 2017, as provided by the company’s constitution, the directors forfeited the 15 000 shares on which calls were unpaid. On 25 March 2017, the forfeited shares were reissued as fully paid for a consideration of $9 per share. Costs of forfeiture and reissue amounted to $250. The constitution does not provide for refund of any balance in the forfeited shares account after reissue to former shareholders. Required A. Prepare ledger accounts to record the above transactions. B. Prepare the equity section of Magnolia’s statement of financial position on completion of the transactions. MAGNOLIA LTD General Ledger

30/4/16

3/5/16 3/5/16

3/5/16

10/3/17

Cash Trust 600 000 3/5/16

Application

Share capital Allotment

Share capital

Calls & Forfeited Shares Reserve

Application 500 000 30/4/16 100 000 600 000

Allotment 250 000 3/5/16 10/5/16 250 000

Share Capital 3/5/16 150 000 3/9/16

Cash

600 000

Cash Trust

600 000 600 000

Application Cash

100 000 150 000 250 000

Applic. & allot First call

750 000 125 000

2.30

Chapter 2: Financing company operations

25/3/17

Balance c/d

1 000 000 3/1/17 25/3/17

Second call Cash & Forfeited Shares Reserve

1 150 000 25/3/17

3/5/16

Cash Trust

Cash 600 000 11/5/16

10/5/16 --/9/16

Allotment First Call

150 000 11/5/16 112 500 25/3/17

25/1/17 25/3/17

Second Call Share Capital

106 250 25/3/17 135 000 1 103 750 1 101 400

25/3/17

11/5/16

Balance b/d

Formation Costs Exp Share Issue Costs Forfeited Shares Reserve Balance c/d

Cash

1 150 000 1 000 000

1 300 800 250 1 101 400 1 103 750

Formation Costs Expense 1 300 P&L

1 300

Share Issue Costs 800

Cash

3/9/16

Share Capital

3/1/17

Share Capital

25/3/17 25/3/17 25/3/17

Balance b/d

125 000 150 000

Share Capital Cash (costs) Balance c/d

First Call 125 000 --/9/16 10/3/16 125 000

Cash Share Capital

112 500 12 500 125 000

Second Call 125 000 --/1/17 10/3/17 125 000

Cash Share Capital

106 250 18 750 125 000

Forfeited Shares Reserve 15 000 10/3/17 Share Capital 250 103 500 118 750 25/3/17 Balance b/d

118 750

118 750 103 500

2.31

Solution Manual to accompany Company Accounting 10e

B. MAGNOLIA LTD Equity (as at 25 March 2017) Contributed equity: (100 000 shares paid to $10) Less Share issue costs Reserves [Forfeited shares] Retained earnings [formation costs] Total Equity

$1 000 000 800

$999 200 103 500 (1 300) $1 101 400

2.32

Chapter 2: Financing company operations

Question 2.11

Oversubscription, with excess money received on application

On 1 August 2018, Prunus Ltd issued a prospectus inviting applications for 800 000 ordinary shares to the public at an issue price of $12, payable as follows: $4 on application (due by closing date of 1 November) $5 on allotment (due 1 December) $3 on future call/calls to be determined by the directors By 1 November, applications had been received for 860 000 ordinary shares of which applicants for 100 000 shares forwarded the full $12 per share, applicants for 300 000 shares forwarded $9 per share and the remainder forwarded only the application money. At a directors’ meeting on 7 November, it was decided to allot shares in full to applicants who had paid the either $12 or $9 on application, to reject applications for 20 000 shares and to proportionally allocate shares to all remaining applicants. According to the company’s constitution, all surplus money from application can be transferred to Allotment and/or Call accounts. Share issue costs of $11 000 were also paid on 7 November. All outstanding allotment money was received by the due date. A first call for $1.60 was made on 1 February 2019 with money due by 1 March. All money was received by the due date. A second and final call for $1.40 was made on 1 June with money due by 18 June. All money was received by the due date. Required Prepare the journal entries to record these transactions of Prunus Ltd. (Show all workings.) PRUNUS LTD General Journal 2018 To 1 November 15

Cash Trust Application

5 740 000

(Cash received on application) November 7

Application Cash Trust

80 000

(Refund to 20 000 applicants) Application

3 200 000

Allotment

4 000 000

Share Capital

7 200 000

(Allotment of 800 000 shares) © John Wiley and Sons Australia, Ltd 2015

2.33

Solution Manual to accompany Company Accounting 10e

Cash

Cash Trust

5 660 000

(Transfer of trust funds) Application *

2 460 000

Allotment

2 160 000

Calls in Advance

300 000

(Allocation of application across allotment and calls in advance) * refer to workings table at end of solution Share Issue Costs/Share Capital Dr Cash

11 000

(Payment of share issue costs $11 000) December 1

Cash

Allotment

1 840 000

(Cash received on allotment) 2019 February 1

Call 1

Share Capital

1 280 000

(Call of $1.60 per share) Calls in Advance Call 1

160 000

(Transfer of calls received in advance) March 1

Cash

Call 1

1 120 000

(Cash received on 700 000 shares) June 1

Call 2

1 120 000

2.34

Chapter 2: Financing company operations

Share Capital

1 120 000

(Call of $1.40 per share) Calls in Advance Call 2

140 000

(Transfer of calls received in advance) June 28

Cash

Call 2

980 000

(Cash received on 700 000 shares) Workings Allocation of money received on application No. of Shares applied for 100 000 300 000 440 000 20 000 860 000

No. of Shares Allotted 100 000 300 000 400 000 0 800 000

Money Received

Application $4

Allotment $5

Call 1 $1.60

Call 2 $1.40

1 200 000 2 700 000 1 760 000 80 000 $5 740 000

400000 1 200 000 1 600 000

500 000 1 500 000 160 000

160 000 -

140 000

$3 200 000

$2 160 000

$160 000

$140 000

2.35

Solution Manual to accompany Company Accounting 10e

Question 2.12

Oversubscription with pro rata allotment, and forfeiture

On 1 July 2017, Gum Ltd was registered and offered 1 000 000 ordinary shares to the public at an issue price of $6, payable as follows: $3 on application (due 15 August) $2 on allotment (due 15 September) $1 on final call The issue was underwritten at a commission of $8000. By 15 August, applications had been received for 1 200 000 ordinary shares of which applicants for 200 000 shares forwarded the full $6 per share, the remainder paying only the application money. At a directors’ meeting on 16 August, it was decided to allot shares in full to applicants who had paid the full amount and proportionally to all remaining applicants. According to the company’s constitution, all surplus money from application can be transferred to Allotment and/or Call accounts. The underwriting commission was paid on 28 August. Other share issue costs of $6000 were also paid on this date. All outstanding allotment money was received by the due date. The final call was made on 1 November with money due by 30 November. All money was received on the due date except for the holder of 30 000 shares who failed to meet the final call. On 7 December, as provided for in the constitution, the directors decided to forfeit these shares. They were reissued, on 15 December, as paid to $6 for $5.60 cash. The balance of the Forfeited Shares account was returned to the former shareholder on 16 December. Required Prepare the journal entries to record the transactions of Gum Ltd up to and including that which took place on 16 December 2017. (Show all workings.) GUM LTD General Journal 2017 August 15

Cash Trust Application

4 200 000

(Cash received on application) August 16

Application

3 000 000

Allotment

2 000 000

Share Capital

5 000 000

(Allotment of 1 000 000 shares) Cash

Cash Trust

4 200 000 4 200 000

2.36

Chapter 2: Financing company operations

(Transfer of trust funds) Application *

1 200 000

Allotment

1 000 000

Calls in Advance

200 000

(Allocation of application across allotment and calls in advance) August 28

Share Issue Costs/Share Capital Dr Cash

14 000

(Payment of underwriting commission and other share issue costs [$8 000 + $6 000]) September 15

Cash

Allotment

1 000 000

(Cash received on allotment) 2017 November 1

Call

Share Capital

1 000 000

(Call of $1 per share) Calls in Advance Call

200 000

(Transfer of calls received in advance) November 30

Cash

Call

770 000

(Cash received on 770 000 shares) December 7

Share Capital

180 000

Call

30 000

Forfeited Shares Liability

150 000

(Forfeiture of 30 000 shares)

2.37

Solution Manual to accompany Company Accounting 10e

December 15

Cash

168 000

Forfeited Shares Liability

12 000

Share Capital

180 000

(Reissue of shares forfeited) December 16

Forfeited Shares Liability

Cash

138 000

(Refund to former shareholders)

Workings Allocation of money received on application No. of Shares applied for 200 000 1 000 000 1 200 000

No. of Shares Allotted 200 000 800 000 1 000 000

Money Received

Application

Allotment

Call

1 200 000 3 000 000 $4 200 000

600 000 2 400 000 $3 000 000

400 000 600 000 $1 000 000

200 000 $200 000

2.38

Chapter 2: Financing company operations

Question 2.13

Ordinary shares, redeemable preference shares and options

Prepare ledger accounts to record the following transactions for Poplar Ltd, ignoring preference share interest payments: 2015 July

21 31 Aug. Dec.

14 1

2018 March

March

April

May

A disclosure document was issued inviting applications for 100 000 ordinary shares at an issue price of $3, payable in full on application. The disclosure document also offered 50 000 10% redeemable preference shares at $2, fully payable on application. The issue was underwritten at a commission of $6500. Applications closed with the ordinary issue oversubscribed by 20 000 and the preference shares undersubscribed by 15 000. All shares were allotted with application money being refunded to unsuccessful applicants for ordinary shares. The underwriter paid amounts due less commission. The directors resolved to give each ordinary shareholder, free of charge, one option for every two shares held. The options are exercisable on 1 May 2018 and allow each holder to acquire one ordinary share at an exercise price of $2.70. Options not exercised on that date will lapse. A disclosure document was issued inviting applications for 100 000 ordinary shares at an issue price of $2.50, payable in full on application. The main purpose of the issue was to fund the redemption of the preference shares. The issue was fully subscribed and all money due was received. The shares were then allotted. The preference shares were redeemed at a price of $2.10 per share. The shares had been classified as equity in the financial statements. The holders of 35 000 options elected to exercise those options and 35 000 ordinary shares were issued and cash received. All other options lapsed. POPLAR LTD

31/5/18

Share Capital - Ordinary 644 500 31/7/15 Application - ord 31/3/18 Application -ord

Balance c/d

1/5/18

Cash - ord

31/5/18

Balance b/d

644 500

10/4/18

Shareholders’ redemption

Share Capital - Preference 100 000 31/7/15 Application - pref

300 000 250 000 94 500 644 500 644 500

100 000

2.39

Solution Manual to accompany Company Accounting 10e

21/7/15 21/7/15

Application - ord Application - pref

31/3/18

Application - ord

31/7/15 31/7/15 31/3/18

31/7/15

Share capital - ord Cash trust (refund) Share capital - ord

Share capital - pref

31/7/15

Cash trust

14/8/15 31/3/18 1/5/18

Application - pref Cash trust Share Capital - ord

14/8/15

10/4/18

Application - pref

Cash

Cash Trust 360 000 31/7/15 Application - ord 70 000 31/7/15 Cash 430 000

60 000 370 000 430 000

250 000 31/3/18 250 000

250 000 250 000

Cash

Application – Ordinary 300 000 21/7/15 Cash trust 60 000 360 000 250 000 31/3/18 Cash trust

Application - Preference 100 000 21/7/15 Cash Trust 14/8/15 Cash and share issue costs 100 000

Cash (extract) 370 000 10/4/18 Shareholders’ redemption 23 500 250 000 94 500

360 000 360 000 250 000

70 000 30 000 100 000

105 000

Share Issue Costs 6 500

Shareholders’ Redemption 105 000 10/4/18 Share capital -pref and retained earns.

105 000

2.40

Chapter 2: Financing company operations

10/4/18

Shareholders’ redemption

Retained Earnings (extract) 5 000

2.41

Solution Manual to accompany Company Accounting 10e

Question 2.14

Debentures issue and redemption

A prospectus was issued by Birch Ltd on 1 November 2016, inviting applications for 5000 9% $200 debentures, payable $150 on application and $50 on allotment. The terms of the prospectus were such as to give the company the option to redeem the debentures at 1 month’s notice, providing a 12% premium was paid. If the company chose not to exercise this option for a period of 5 years, then the company could redeem them at nominal value. The market interest rate for debentures of similar risk was 9%. Applications for 5300 debentures were received by 24 November. The debentures were allotted on 30 November, with excess application money being refunded to the unsuccessful applicants. All allotment money was received on 31 December. Interest was payable half-yearly on 30 June and 31 December. On 1 November 2018, the company purchased 800 of the debentures on the open market for $180 each. Brokerage and stamp duty amounted to $210. On 1 September 2019, the company gave notice to the holders of 3000 debentures of redemption on 31 October 2019. These were subsequently redeemed on 31 October, and appropriate interest was paid. The balance of debentures was redeemed in due course on 30 November 2021. Required Provide general journal entries for the above transactions. Include entries for halfyearly interest payments. Assume the end of the reporting period is 30 June. BIRCH LTD 2016 to Nov 24 Cash Trust Dr Application - Debentures Cr (Cash received on 5 300 $200 debentures payable $150 on application) Nov 30

Nov 30

Dec 31

795 000 795 000

Application - Debentures Debenture Holders Debentures (Allotment of debentures)

Dr Dr Cr

750 000 250 000

Application - Debentures Cash Trust (Refund to unsuccessful applicants)

Dr Cr

45 000

Cash Cash Trust (Transfer from trust account)

Dr Cr

750 000

Cash Debenture Holders (Cash received on allotment)

Dr Cr

250 000

Interest Expense Cash

Dr Cr

5 625

1 000 000

45 000

750 000

250 000

5 625

2.42

Chapter 2: Financing company operations

(Interest paid on debentures: $750 000 x 0.09 x 1/12) 2017 June 30 & Interest Expense Dr Dec 31 Cash Cr (Interest on $1 000 000 @ 9% for each ½ year) 2018 June 30

Nov 1

Dec 31

2019 June 30

Oct 31

Dec 31

45 000 45 000

Interest Expense Dr Cash Cr (Interest on $1 000 000 @ 9% for ½ year)

45 000

Debentures Interest Expense Income on Redemption of Debs. Cash (Redemption of 800 debentures on the open market for $180 each, and interest expense for four months)

Dr Dr Cr Cr

160 000 4 800

Brokerage and Stamp Duty Expense Cash (Brokerage and stamp duty on open market redemption)

Dr Cr

210

45 000

20 800 144 000

210

Interest Expense Dr Cash Cr (Interest on 4,200 debentures @ 9% for ½ year)

37 800

Interest Expense Dr Cash Cr (Interest on 4,200 debentures @ 9% for ½ year)

37 800

Debentures Interest Expense Expense on Redemption of Debs. Debenture Holders (Redemption of 3 000 $200 debentures for $224 each, and interest expense for four months)

Dr Dr Dr Cr

600 000 18 000 54 000

Debenture Holders Cash (Cash paid)

Dr Cr

672 000

Interest Expense

10 800

37 800

672 000

2.43

Solution Manual to accompany Company Accounting 10e

Cash (Interest on 1 200 $200 debentures for six months at 9%)

2020 June 30 & Interest Expense Dec 31 Cash (Interest on 1 200 $200 debentures for ½ year at 9%) 2021 June 30

Nov 30

10 800

Dr Cr

10 800

Dr Cr

10 800

Debentures Dr Interest Expense Dr Debenture Holders Cr (Redemption of 1 200 $200 debentures at nominal value, and interest expense for five months)

240 000 9 000

Debenture Holders Cash (Cash paid)

249 000

Interest Expense Cash (Interest on 1 200 $200 debentures for 2/1 year at 9%)

Dr Cr

10 800

249 000

2.44

Chapter 2: Financing company operations

Question 2.15

Shares, debentures and options

At 30 June 2016, the trial balance of Evergreen Ltd contained the following. EVERGREEN LTD Trial Balance as at 30 June 2016 Current assets Plant and equipment (net) Goodwill Retained earnings Accounts payable 10% unsecured notes Share capital 80 000 preference shares issued at $10, paid to $5 1 100 000 ordinary shares issued at $2, paid to $1

300 000 820 000 320 000 900 000 $

2 340 000

340 000 500 000 400 000 1 100 000 2 340 000

After a number of years of unprofitable trading, the company underwent the following restructure to improve its financial position: 1. A call of $5 per share was made on the issued preference capital and a call of $1 on each of the ordinary shares. All call money was duly received. 2. The ordinary shareholders were given the following options: • A rights issue of 1 ordinary share, at an issue price of $2, payable in full on application, for every 10 shares held. • To apply for one $50 7% debenture for every 100 shares held. These were payable in full on application. Holders of 600 000 shares chose the first option and holders of 500 000 shares chose the second option. All money was received when due. Required Prepare general journal entries to record the above events. EVERGREEN LTD General Journal 1.

Call - Preference Call - Ordinary Share Capital - Preference Share capital - Ordinary (Call of $5 on 80 000 preference shares and $1 call on 1 100 000 ordinary shares)

Dr Dr Cr Cr

400 000 1 100 000

Cash Call - Preference Call - Ordinary (Receipt of calls)

Dr Cr Cr

1 500 000

Cash Share Capital - Ordinary

Dr Cr

120 000

400 000 1 100 000

120 000

2.45

Solution Manual to accompany Company Accounting 10e

(Cash on 60 000 shares under rights issue) Cash Trust Application - Debentures (Cash on 5 000 $50 debentures payable in full on application)

Dr Cr

250 000

Application - Debentures Debentures (Issue of 5 000 $50 debentures)

Dr Cr

250 000

Cash Cash Trust (Transfer from trust account)

Dr Cr

250 000

2.46

Chapter 2: Financing company operations

Question 2.16

Share buy-back

Wattle Ltd decided to repurchase 250 000 of its ordinary shares under a buy-back scheme for $5.70 per share. At the date of the buy-back, the equity of Wattle Ltd consisted of: Share capital (3 000 000 shares fully $ paid) General reserve Retained earnings

6 000 000 680 000 1 230 000

The costs of the buy-back scheme amounted to $3800. Required A. Prepare the journal entries to account for the buy-back, assuming: (i) that the original amount of the shares is eliminated from Share Capital, and then any remaining buy-back price adjusted equally against the General Reserve and Retained Earnings accounts. (ii) that the buy-back is not adjusted against share capital, but is adjusted firstly against the General Reserve account, then any remaining against the Retained Earnings account. B. Assume now that the buy-back price per share was equal to $2.60 and that the company had no General Reserve account, and retained earnings of only $520 000. Further, assume that the company accounts for share buy-backs against retained earnings first. Prepare journal entries to record the share buy-back. WATTLE LTD General Journal A. (i)

(ii)

General Reserve Retained Earnings Share Capital Cash (Repurchase of 250 000 ordinary shares under a buy-back scheme plus costs)

Dr Dr Dr Cr

464 400 464 400 500 000

General Reserve Retained Earnings Cash (Repurchase of 250 000 ordinary shares under a buy-back scheme plus costs)

Dr Dr Cr

680 000 748 800

Retained Earnings Dr Share Capital Dr Cash Cr (Repurchase of 250 000 ordinary shares under a buy-back scheme plus costs)

520 000 133 800

1 428 800

653 800

2.47

Solution Manual to accompany Company Accounting 10e

Question 2.17

Series of independent situations

Prepare journal entries to implement the following independent decisions: 1. To redeem out of retained earnings 150 000 preference shares, issued and paid to $2.50, at a price of $2.60. The preference shares had been treated as equity. 2. To redeem 150 000 preference shares, recorded as liabilities, fully paid at $1.50 each, for $1.60, this being funded by the issue of 240 000 ordinary shares at an issued price of $1 payable in full on application. Assume all shares were applied for and allotted. 3. To redeem 20 000 $50 debentures by purchasing them on the open market for $48 each. They were previously issued by the company at nominal value. 4. To issue 50 000 options, at an issue price of 75c per option. Each option allows the holder to subscribe for one ordinary share at an exercise price of $3.60 per share on or before 1 July 2017. 5. By 1 July 2017, 40 000 of the options issued in (4) above were exercised and shares were issued. The remaining options lapsed. 6. To issue 150 000 $25 debentures, payable in full on application. Applications were received for 180 000 debentures. Allocation was done on a first-come first-served basis and excess application money was refunded to unsuccessful applicants. 7. To convert $25 000 of 9% convertible notes. Holders of $20 000 of the notes do not wish to exercise their rights and request payment in cash, and holders of the remaining $5000 decide to convert on the basis of one ordinary share paid to 75c for each $1 note held. The company has recognised all of the notes as a liability. 8. To make a 1-for-4 rights issue at an issue price of $1.60 per share. Share capital before the issue consisted of 100 000 ordinary shares issued and paid to $1. All rights are exercised by the expiry date.

Share Capital - Preference Retained Earnings Shareholders’ Redemption (Redemption of 150 000 shares at price of $2.60)

Dr Dr Cr

375 000 15 000

Shareholders’ Redemption Cash (Payment on redemption)

Dr Cr

390 000

Retained Earnings Share Capital - Ordinary (Transfer against retained earnings)

Dr Cr

375 000

Cash Trust Application - Ordinary (Money received on application)

Dr Cr

240 000

Application - Ordinary Share Capital - Ordinary (Allotment of 240 000 shares)

Dr Cr

240 000

390 000

375 000

240 000

2.48

Chapter 2: Financing company operations

Cash Cash Trust (Transfer on allotment)

Dr Cr

240 000

Preference Share Liability Redemption Premium Expense Shareholders’ Redemption (Redemption of 150 000 shares at a price of $1.60)

Dr Dr Cr

225 000 15 000

Shareholders’ Redemption Cash (Payment on redemption)

Dr Cr

240 000

Debentures Cash Income on Redemption of Debentures (Purchase of 20,000 $50 debentures for $48 each on stock exchange)

Dr Cr Cr

1 000 000

Cash Share Options (Issue of 50 000 share options at 75c each)

Dr Cr

37 500

Cash Share Capital – Ordinary (Issue of 40 000 ordinary shares as a result of 40 000 options exercised)

Dr Cr

144 000

Share Options Dr Share Capital – Ordinary Cr Lapsed Options Reserve Cr (Write-off of options exercised, and lapsed)

37 500

Cash Trust Dr Application - Debentures Cr (Cash received as $25 per debenture Application money on 180 000 debentures)

4 500 000

Application - Debentures Debentures (Issue of 150 000 $25 debentures)

Dr Cr

3 750 000

Cash Application - Debentures Cash Trust (Transfer on allotment and refund to unsuccessful applicants)

Dr Dr Cr

3 750 000 750 000

240 000

960 000 40 000

37 500

144 000

30 000 7 500

4 500 000

3 750 000

4 500 000

2.49

Solution Manual to accompany Company Accounting 10e

Convertible Note Liability Convertible Noteholders (Transfer to noteholders account)

Dr Cr

25 000

Convertible Noteholders Cash Share Capital (Conversion of 5,000 of convertible notes by cash payment and issue of 5 000 shares issued for $1 and paid to 75c each: fair value of notes redeemed)

Dr Cr Cr

25 000

Cash Share Capital (1 for 4 rights issue of 25 000 shares at $1.60)

Dr Cr

40 000

25 000

20 000 5 000

40 000

2.50

Chapter 2: Financing company operations

Question 2.18

Shares, options and debentures

The share capital of Cedar Ltd on 30 June 2015 was: Share capital: 140 000 ‘A’ ordinary shares issued at $4, paid to $2.50 60 000 ‘B’ ordinary shares issued at $3, fully paid

$ 350 000 180 000 $ 530 000

Required Prepare journal entries to record the following transactions in the records of Cedar Ltd. 2015 Nov.

2016 Jan.

Feb.

Mar.

The company makes a 1-for-4 rights offer to its ‘B’ ordinary shareholders. The rights are renounceable and allow holders to obtain ‘B’ ordinary shares for $3.20 per share, payable in full on application. The holders of 44 000 ‘B’ ordinary shares accept the rights offer by the expiry date. The shares are duly allotted and all money is received. A call of $1.50 per share is made on all ‘A’ ordinary shares. All call money except that owing by the holder of 8000 shares is received by 31 January. Shares on which calls are unpaid are forfeited and cancelled, as per the company’s constitution. To assist with cash flow difficulties, the company issued a prospectus inviting offers for 80 000 options to acquire ‘A’ ordinary shares at an issue price of $1.20 per option, payable in full on application. Each option, exercisable on 31 December 2017, allows the holder to acquire one ‘A’ ordinary share for $3.60. Offers had been received for 60 000 options and these were duly allotted.

2017 Dec.

The holders of 45 000 options exercised their options and 45 000 ‘A’ ordinary shares were allotted. The remaining options lapsed. All money was received. Costs of issuing the shares, $3400, were paid on 31 January 2018.

2019 June

June

The company issued a disclosure document inviting applications for 1000 7% $100 debentures, payable in full on application. The debentures are redeemable at nominal value on 1 June 2022. Applications were received for all debentures which were duly allotted. Costs of debenture issue, $2100, were paid on 15 July.

2.51

Solution Manual to accompany Company Accounting 10e

CEDAR LTD General Journal 2015 Nov 30

2015 Jan 16

Jan 31

Feb 5

Mar 31

2017 Dec 31

Cash Share Capital - B Ordinary (Issue of 11 000 B ordinary shares at a price of $3.20 under a 1 for 4 rights issue)

Dr Cr

35 200

Call -A Ordinary Share Capital - A Ordinary (Call of $1.50 per share on 140 000 A Ordinary shares)

Dr Cr

210 000

Cash Call - A Ordinary (Cash received on call)

Dr Cr

198 000

Share Capital - A Ordinary Call - A Ordinary Forfeited Shares Reserve (Forfeiture and cancellation of 8 000 A ordinary shares)

Dr Cr Cr

32 000

Cash Share Options (Issue of 60 000 options exercisable on 31 December 2007)

Dr Cr

72 000

Cash Share Capital - A Ordinary (Issue of 45 000 A ordinary shares at $3.60 on exercise of 45 000 options)

Dr Cr

162 000

Share Options Share Capital – A Ordinary Lapsed Options Reserve (Write-off of options exercised and lapsed)

Dr Cr Cr

72 000

35 200

210 000

198 000

12 000 20 000

72 000

162 000

54 000 18 000

2.52

Chapter 2: Financing company operations

2018 Jan 31

2019 June 30

July 15

Share Issue Costs/Share Capital Cash (Payment of share issue costs)

Dr Cr

3 400

Cash Trust Application - Debentures (Cash on 1000 $100 debentures payable in full on application)

Dr Cr

100 000

Application - Debentures Debentures (Issue of 1000 $100 debentures)

Dr Cr

100 000

Cash Cash Trust (Transfer from trust account)

Dr Cr

100 000

Debenture Issue Expenses Cash (Costs of debenture issue)

Dr Cr

2 100

3 400

100 000

2 100

2.53

Solution Manual to accompany Company Accounting 10e

Question 2.19

Calls on shares, forfeiture, issue and exercise of options, redemption of preference shares

Olive Ltd’s equity at 30 June 2016 was as follows: 400 000 ordinary shares, issued at $1.60, fully paid 500 000 ordinary shares, issued at $2, called to $1.20 180 000 redeemable preference shares, issued at $1, fully paid Calls in advance (10 000 ordinary shares) Share issue costs General reserve Retained earnings

$ 640 000 600 000 180 000 8 000 (7 000) 60 000 310 000

The following events occurred during the year ended 30 June 2017: 2016 July

Aug.

Sept.

Oct.

31 2017 Jan.

31 Feb.

5 18

April

26 15

The final call, due 31 August, was made on the partly paid shares. All call money was received, except for that due on 24 000 shares. In accordance with the constitution, the shares on which the call was unpaid were forfeited. The company is entitled to keep any balance from forfeiture of shares. The company offered ordinary shareholders 1 option (at a price of 80 cents per option) for every 5 shares held. Each option entitled the holder to buy 1 ordinary share at a price of $1.50 per share, exercisable on or before 15 April 2017. 70 000 options were taken up by shareholders, for which all money due was received. A prospectus was issued, inviting applications for 100 000 ordinary shares at an issue price of $2, payable in full on application. The purpose of the issue was to fund the redemption of the preference shares. The issue was underwritten at a commission of $6700. The issue closed fully subscribed, with all money due having been received. The 100 000 shares were allotted, and the underwriting commission was paid. The directors resolved to redeem the preference shares out of the proceeds of the January share issue for $1.06 per share. Cheques were issued to the preference shareholders. 52 000 shares were issued as a result of 52 000 options having been exercised, for which money had been received. The unexercised options lapsed.

2.54

Chapter 2: Financing company operations

Required Prepare general journal entries to record the above transactions.

OLIVE LTD General Journal 2016 Jul 15

Aug 31

Sep 10

Oct 31

2017 Jan 31

Call - Ordinary Share Capital - Ordinary (Final call of 80c per share on 500 000 ordinary shares)

Dr Cr

400 000

Calls in Advance Call –Ordinary (Calls already received in advance cancelled against the call due)

Dr Cr

8 000

Cash Call – Ordinary (Cash received on 466 000 ordinary shares)

Dr Cr

372 800

Share Capital - Ordinary Call – Ordinary Forfeited Shares Reserve (Forfeiture of 24 000 ordinary shares for non-payment of 80c call, with the capital already paid in held as a reserve)

Dr Cr Cr

48 000

Cash Share Options (Issue of 70 000 options purchased at 80c each)

Dr Cr

56 000

Cash Trust Application – Ordinary (Cash trust money held on application for 100 000 ordinary shares @ $2 each)

Dr Cr

200 000

400 000

8 000

372 800

19 200 28 800

56 000

200 000

2.55

Solution Manual to accompany Company Accounting 10e

Feb 5

Feb 18

Feb 26

Apr 15

Application – Ordinary Share Capital – Ordinary (Issue of 100 000 ordinary shares)

Dr Cr

200 000

Cash Cash Trust (Transfer of cash)

Dr Cr

200 000

Share Issue Costs/Share Capital Cash (Underwriting commission paid)

Dr Cr

6 700

Share Capital – Preference Retained Earnings Shareholders Redemption (Redemption of 180 000 preference shares at $1.06 per share, out of the proceeds received from issue of ordinary shares)

Dr Dr Cr

180 000 10 800

Shareholders’ Redemption Dr Cash Cr (Payment to redeem preference shares)

190 800

Cash Share Capital – Ordinary (Issue of 52 000 ordinary shares @ $1.50 as a result of options exercised)

Dr Cr

78 000

Share Options Share Capital – Ordinary Lapsed Options Reserve (Write-off of share options @ 80c, with 52 000 being exercised and 18 000 lapsing)

Dr Cr Cr

56 000

200 000

6 700

190 800

78 000

41 600 14 400

2.56

Chapter 3: Company operations

Chapter 3: Company operations REVIEW QUESTIONS EW QUESTIONS 1. Discuss the definition and essential characteristics of an asset. When should an asset be recognised? How should assets be measured? Three essential characteristics can be derived from the definition of assets in paragraphs 4.84.14 (53-59) of the Conceptual Framework. (i) A resource controlled by the entity, (ii) future economic benefits, (iii) past events. Refer section 3.1.1 of the chapter and these are discussed further below: Future economic benefit. (refer paragraphs 4.8- 4.11/53- 56) Possession of a right, or of a physical object, does not constitute an asset in the absence of future economic benefits (business entities—generation of cash flow, non-business— providing goods or services which satisfy the organisation's objectives). A machine that produces unwanted output and has no resale value is not an asset. Control (refer paragraphs 4.12- 4.13/57-58) Ownership or title to a physical item is not necessary for that item to qualify as an asset (for example, a leased asset). The issue is whether the entity can secure the benefits and deny access to others. Past transaction or event (refer paragraphs 4.13- 4.14/58- 59) A past transaction or event ensures that we count as assets only present capacity to obtain future benefits. Therefore, we exclude items that may provide future benefits because we have budgeted their acquisition but which are not presently controlled because acquisition has not yet occurred. Also note the fact in paragraph 59 of the Framework that incurring a cost is not a requirement for an asset. To be recognised (included in the financial statements) an item must meet the definition and recognition criteria. Paragraph 4.44/83 of the Conceptual Framework states that an asset should only be recognised when it is probable that any future economic benefit associated with the item will eventuate and that the asset possesses a cost or other value that can be reliably measured. It is expected that the notion of “a reliable measure” will be replaced by a “faithfully representative and verifiable measure” in the conceptual framework. Section 3.3.1 notes various measurement bases for assets. It is important to understand that the criteria requires a ‘cost or other value’, so do not need to be able to measure the value of the actual benefits to be received. Initially many assets are measured at cost, however subsequent to this different rules may apply depending on the nature of the asset. For example, inventory must be measured at lower of cost or net realisable value; certain non-current assets may remain measured at cost (subject to depreciation) or measured at fair value. Accounting standards may specify the measurement required for particular assets. If a choice of measurement is allowed this would © John Wiley and Sons Australia, Ltd 2015

3.1

Solution Manual to accompany Company Accounting 10e

be an accounting policy choice and hence the measurement chosen should be one that provides relevant and reliable (representationally faithful) information (refer section 3.6). Section 3.1.2 of the chapter, discusses a proposed asset definition as outlined in the discussion paper, A Review of the Conceptual Framework for Financial Reporting. A new definition has been developed because of perceived shortcomings of the existing definition. The definition proposed is: a present economic resource controlled by the entity as a result of past events (para 2.11)

2. Ottowa Ltd was going through some difficult trading times and was barely breaking even. In attempting to improve sales, the company spent $500 000 on an advertising campaign during the current year in the hope that sales would improve in the new year. Management decided that the cost of this campaign should be recorded as an asset in order that the small current profit for the firm would not become a loss. Discuss whether management’s decision is justified. Advertising costs may be treated as an asset only if they satisfy the definition of an asset. Do they have the essential characteristics of an asset? Do they provide controlled future economic benefits flowing to the entity from a past event or events? Do they satisfy the proposed definition of an asset put forward by the IASB and as discussed in section 3.1.2 of the chapter? It is not sufficient to treat them as an asset merely to show a better profit figure. If advertising costs are not assets, then management’s decision is not justified. If they are assets, then the decision to treat them as an asset in the records will only be justified if the advertising costs satisfy the recognition criteria, i.e. is it probable that the advertising expenditure will lead to future economic benefits flowing to the entity, and can the costs be measured reliably? Discuss the meaning of “probable”. Note that in this case, there is a cost which can be reliably measured (i.e. a faithfully representative and verifiable cost).

3. What are the essential characteristics of a liability? When should liabilities be recognised in the accounting records, and what techniques should be used to measure them? The Conceptual Framework (4.4.b/49.b) defines a liability as: a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Three essential characteristics can be derived from the definition of liabilities in the Conceptual Framework, paragraphs (4.15-4.19/60-64). (a) present obligation to make an outflow of resources, (b) future outflows of economic benefits, (c) past transactions or other past events. See section 3.1.3 of the chapter. Discussed further as below: Essential characteristics of liability are: 1. Future outflows of economic benefits

3.2

Chapter 3: Company operations

Note: Liabilities can be settled by transfer of assets of any type (cash not the only asset—say deliver goods that have been pre-paid) or by provision of services and the fact that the amount of the liability is not certain (for example, warranty obligations, long service leave) does not preclude recognition as a liability. This actually falls under the reliability of measurement rule. 2. Present obligation to make an outflow of resources Essential notion is that the entity is presently obligated and cannot avoid settling the obligation—there is no reasonable alternative other than to settle. The obligation may be enforceable from legal sources such as contract or legislation administrative regulation, or it may be constructive. Also note: This must involve an external party as cannot be ‘obligated’ to one-self. Hence setting aside reserves (for example, for major overhauls, renewals of plant, etc) does not constitute a liability. Further, decisions to acquire assets in the future do not give rise to liabilities unless there is an irrevocable agreement. 3. Past event This is required to ensure that only present obligations to make future outflows of economic resources are included as liabilities. The Conceptual Framework (4.38/91) specifies two criteria which must be satisfied before an item that meets the definition (such as a liability) can be recognised – (a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and (b) the item has a cost or value that can be measured with reliability. “Probable” in this context means that the future outflow of economic benefits is more likely than less likely, i.e. a greater than 50% probability. It is expected that the notion of “a reliable measure” will be replaced by a “faithfully representative and verifiable measure” in the conceptual framework. Most liabilities are measured at nominal value, however for particular liabilities like long service leave entitlements for employees and certain lease liabilities, the discounted present value method is used. Other possible measurement suggestions are “value to the entity” and “discharge price”. Note measurement may involve the use of estimates. See section 3.3.2 of the chapter for further discussion of measurement methods. See also section 3.1.4 of the chapter which discusses possible changes to the definition of a liability.

4. What are the essential characteristics of equity? Equity is defined in the Conceptual Framework (paragraph 4.4/49(c)), as ‘the residual interest in the assets of the entity after deducting all its liabilities’. Equity as such is not a stand-alone concept but a ‘residual’, determined by subtracting recognised liabilities from recognised assets.

3.3

Solution Manual to accompany Company Accounting 10e

5. Explain what is meant by the term recognition. Are all items that meet the definition of an element of the financial statement always recognised? Discuss how the proposed changes to the recognition criteria in the 2013 Discussion Paper, A Review of the Conceptual Framework for Financial Reporting, could impact on recognition of items. Recognition is outlined in the Conceptual Framework (4.37/ 82): Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the criteria for recognition set out in paragraph 83. It involves the depiction of the item in words and by a monetary amount and the inclusion of that amount in the balance sheet or income statement totals. Items that satisfy the recognition criteria should be recognised in the balance sheet or income statement. The failure to recognise such items is not rectified by disclosure of the accounting policies used nor by notes or explanatory material.

Hence recognition is inclusion of an item in a financial statement. This can be contrasted with disclosure which normally means that information is included (disclosed) either in the statements or in the notes to the accounts. Not all items that meet the definition will be recognised as the Conceptual Framework (4.38/ 83) requires that the following criteria be met before an element can be recognised: An item that meets the definition of an element should be recognised if: (a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and (b) the item has a cost or value that can be measured with reliability.

For example, a company may have an item that meets the definition of a liability but not the recognition criteria (for example, has been found liable in a court case but the amount to be paid has not yet been determined and cannot be estimated). In such cases the relevant standard (AASB 137) requires disclosure of the item. As this does not meet both the definition and recognition criteria it cannot be included on the face of the financial statements. However information about this item would be disclosed separately in the notes Section 3.2.1 discusses the recognition criteria proposed in the 2013 discussion paper. The significant change proposed is to abolish probability as recognition criteria. The existing recognition criteria of probability means that any elements where there is less than 50% likelihood of outflows being required to be made/or economic benefits being received are excluded from recognition (subject to the requirements of specific standards). The abolition of the probability threshold could result in such items being included and probability of inflows/outflows would be reflected in the measurement. Recognition would be subject to the cost constraint and considerations of relevance and faithful representation.

6. As maintenance costs on equipment have been steadily rising every year, Brasilia Ltd has been setting aside regularly a provision for plant maintenance at an increasing amount. The provision has been recorded as a liability, and as an expense. Discuss whether Brasilia Ltd’s treatment is correct. The Conceptual Framework definition of a liability requires that there must be a present obligation. Furthermore, a provision must firstly be a liability for it to exist. See Section 3.1.3 of the chapter. © John Wiley and Sons Australia, Ltd 2015

3.4

Chapter 3: Company operations

The recording of future maintenance costs is merely a book entry involving a future sacrifice by Brasilia Ltd itself to any external party. There is no present obligation that exists separate from the company’s own actions and so no liability for maintenance costs exists under the Framework’s definition of liabilities. Nor can there be an expense as there has been no outflow or depletion of assets or incurrence of a liability in Brasilia Ltd. It may be more appropriate for Brasilia Ltd to ensure that the depreciation charged takes into account accurately the consummation of economic benefits over time.

7. Distinguish between current and non-current assets. Can property, plant and equipment be reported as a current asset? If so, when? The distinction between a current and a non-current asset can be found in paragraph 66 of AASB 101. Here a current asset is defined as an asset that (a) is expected to be realised in, or is intended to be sold or consumed in the entity’s normal operating cycle (usually twelve months); or (b) is held primarily for trading purposes, or (c) is expected to be realised within twelve months after the reporting period; or (d) the asset is cash or a cash equivalent which is not restricted in its use beyond twelve months. If an asset doesn’t satisfy this definition, then it will be classified as a non-current asset. See section 3.3.1 of the chapter. An example of an item of property, plant and equipment being reported as a current asset may be where a particular machine or group of such assets is no longer being used by the entity in its factory and is being held for sale, which is expected to take place in the next twelve months. For such non-current assets to be reclassified as current, it must satisfy the requirements of paragraph 3 of AASB5, Non-current Assets Held for Sale and Discontinued Operations, which states: Assets classified as non-current in accordance with AASB 101 Presentation of Financial Statements shall not be reclassified as current assets until they meet the criteria to be classified as held for sale in accordance with this Standard. Assets of a class that an entity would normally regard as non-current that are acquired exclusively with a view to resale shall not be classified as current unless they meet the criteria to be classified as held for sale in accordance with this Standard.

8. Distinguish between current and non-current liabilities. Can a liability, which satisfies the definition of a current liability, be reported, internally and/or externally, as a non-current liability? Explain. The distinction between a current and a non-current liability can be found in paragraph 69 of AASB 101. Here a current liability is defined as a liability that is (a) expected to be settled in the entity’s normal operating cycle or (b) is held primarily for trading purposes, or (c) it is due to be settled within twelve months after the reporting period, or (d) the entity does not have an unconditional right to defer the settlement of the liability for at least twelve months after the reporting period. If a liability doesn’t satisfy this definition, then it will be classified as a non-current liability. See section 3.3.2 of the chapter. A long-term interest bearing liability that is due to be settled within twelve months would satisfy the definition of a current liability. However paragraph 73 of AASB 101 states that such liabilities must continue to be reported as a non-current liability where the entity has

3.5

Solution Manual to accompany Company Accounting 10e

discretion to refinance or roll over its obligations for at least twelve months after the reporting date. In many cases an entity may report both non-current and current liabilities for an item. For example, a loan for $100 000 for 5 years with $20 000 of the principal to be paid annually, would, at inception, be presented as a $20 000 current liability and $80 000 as a non-current liability.

9. Discuss the nature of income and revenue. When can revenue be recognised? Income is defined at paragraph 4.25/70 of the Conceptual Framework as meaning increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. Income is sub-classified into revenue and gains. The Conceptual Framework (paragraph 4.29/74) states that ‘revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent.’ It notes (paragraph 4.30/75) that gains can arise either from ordinary activities or from other activities/sources and are no different in nature, although presentation may vary. Gains are usually reported on a net basis, unlike revenue. Revenue is defined in AASB 118 Revenue as the gross inflow of economic benefits during the period arising in the course of ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. Paragraph 4.38/83 of the Conceptual Framework states that income should only be recognised when it is probable these inflows or savings in outflows will occur and the amount can be reliably measured (to be replaced by a faithfully representative and verifiable measure). Specific standards provide guidance or place restrictions on the recognition of revenues. For example, AASB 118 Revenue places further restrictions on the recognition of the types of revenue within its scope in that it requires a control test and a cost test to be applied. The control test requires the entity to transfer the significant risks and rewards of ownership of the goods, and not to retain continuing management involvement associated with effective control over the goods. The cost test requires that all costs incurred or to be incurred in respect of the sale to be measured reliably. For revenue from services, a stage of completion test is also required. Principles have been established for an entity to apply in order to report useful information about the revenue and cash flows arising from its contracts to provide goods or services to customers, especially contracts which require performance over time. See section 3.2.2 of the chapter for further details. The standard also provides requirements for the recognition of revenue from dividends and interest. See section 3.2.2 for further discussion, and AASB 118 paragraphs 14-34. Section 3.2.2 of the text also discusses the revised AASB 118 Revenue from Contracts with Customers expected to apply from 2017.

3.6

Chapter 3: Company operations

10. What is the nature of an expense, and when are expenses to be recognised? How can expenses be classified in the preparation of financial statements for internal reporting purposes? Expenses are defined at paragraph 4.25/70(b) of the Conceptual Framework as decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Paragraph 4.38/83 states that expenses should only be recognised when it is probable that the future economic benefits will flow from the entity and the amount can be reliably measured (to be replaced by a faithfully representative, verifiable measure). See section 3.2.3 of the chapter for a brief discussion of the recognition of different types of expenses. Expenses are usually classified in general-purpose financial statements by their nature such as employee expenses or depreciation, or their function such as distribution and administrative expenses. However, for internal reporting purposes, expenses can be classified in a way that best suits the user of the financial statement e.g. variable v fixed, controllable v non-controllable. See also Section 3.3.5 of the chapter.

11. How are income and expenses classified in the preparation of a statement of profit or loss and other comprehensive income? Can income and expenses appear directly in the Retained Earnings account, without appearing in the current period’s profit? Explain. As discussed in question 10, expenses are classified according to their nature or their function. For income items, AASB 118 classifies revenue into different categories. Paragraph 88 of AASB 101 states that all income and expense items must be included in the current period’s profit and loss, unless an Australian standard requires or permits otherwise. The most common occurrence of this would be when an initial adjustment is made due to a new or revised standard requiring an alternative application, or a change in accounting policy or adjustment for a prior period error, usually requiring an adjustment to retained earnings opening balance. Chapter 14 discusses accounting for changes in accounting policies and prior period errors. Note therefore that, apart from specified exceptions, income and expenses are to be included in the profit or loss for the reporting period, and not as part of “other comprehensive income” or adjusted from retained earnings directly.

12. When do dividends become a legal debt of the company? When are they to be recognised as liabilities? Where a company has a constitution that provides for directors to declare a dividend, then a dividend becomes a debt of the company once the dividend is declared. Where no such statement exists in a company’s constitution, then the debt will only arise when the time for payment of the dividend arrives. If a dividend has been declared (or paid) by the time of completion of the financial report but not on or before the reporting date it must not be recognised as a liability as at the reporting © John Wiley and Sons Australia, Ltd 2015

3.7

Solution Manual to accompany Company Accounting 10e

date. Instead such a dividend must be disclosed in notes as an event after reporting date. See sections 3.4.1 and 3.4.2 of the chapter.

13. What factors determine the selection of accounting policies? The overriding factor in the selection of an accounting policy is to determine whether the policy provides users with information useful for making economic decisions. In selecting accounting policies, AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors establishes a hierarchy for entities to follow in preparing generalpurpose financial statements. Firstly, paragraph 7 of AASB 108 states that, when an Australian accounting standard specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item shall be determined by applying the Standard. Secondly, in the absence of an Australian accounting standard that specifically applies to a transaction, other event or condition, paragraph 10 requires management to use its judgement in developing and applying an accounting policy that results in information that is: (a) relevant to the economic decision-making needs of users; and (b) reliable, in that the financial statements: (i) represent faithfully the financial position, financial performance and cash flows of the entity; (ii) reflect the economic substance of transactions, other events and conditions, and not merely the legal form; (iii) are neutral, that is, free from bias; (iv) are prudent; and (v) are complete in all material respects. (For further discussion of relevance, faithful representation, neutrality and completeness, see section 3.6.1 of the text.) Thirdly, in making the judgement described in paragraph 10, paragraph 11 requires management to refer to the following sources in descending order: (a) the requirements in Australian Accounting Standards dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework. Fourthly, in making the judgement described in paragraph 10, paragraph 12 then suggests that management may also consider the most recent pronouncements of other standard setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources mentioned in paragraph 11. Finally, AASB 108 paragraph 13 requires that the accounting policies selected are applied consistently for similar transactions, other events and conditions, unless an Australian accounting standard specifically requires or permits categorisation of items for which different policies may be appropriate. If an accounting standard permits such categorisation, then the accounting policy selected shall be applied consistently to each category.

3.8

Chapter 3: Company operations

14. Under what circumstances can an accounting policy be changed? How is the change to be accounted for? See section 3.6.2 of the text. AASB 108 paragraph 14 states that changes in accounting policies can be made only in the following circumstances: • •

the change is required by an accounting standard the change results in the financial statements providing reliable and more relevant information about the effect of transactions , other events and conditions on the entity’s financial position, financial performance or cash flows.

Thus, unless a change is prescribed or will result in improved financial reporting, the same accounting policies should be adopted each year. Where a new accounting policy is adopted other than as a result of the issue of a new standard, AASB 108 paragraph 19(b) prescribes that the change arising on adoption is to be applied retrospectively. Retrospective application is described in paragraph 22 thus: the entity shall adjust the opening balance of each affected component of equity for the earliest prior period and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied.

Thus, the company will need to consider the impact of the change of accounting policy not only on current and future financial periods but also on past financial periods. Asset or liability accounts may need to be amended. For example, assets raised under a previous policy of capitalisation must be written off as if the costs included in those assets had been expensed when incurred.

15. Discuss the nature of a reserve. What reasons may there be for no definitions being given for a reserve in the legislation, accounting standards and the Conceptual Framework? AASB 101 para 54 describes the equity of a company as consisting of share capital and reserves (retained earnings and other reserves).The term reserve is not defined in any accounting standard or the Corporations Act. Guidance on the nature of a reserve can be found by looking at what companies include as ‘reserves’ in their annual reports and what accounting standards refer to as reserves. In addition to retained earnings, the most common type of reserves are general, revaluation and foreign currency translation reserves. ‘Retained earnings’ is one category of reserves, according to AASB 101. Retained earnings represent the balances of the profit and losses (before items of other comprehensive income) which the company has made since incorporation, which have not been paid as dividends or bonus share issues to shareholders, transferred to reserves, or used to buy back shares (Henderson and Pierson, 2000, p 534). Some ‘other’ reserves arise as the result of accounting standards requiring amounts of other comprehensive income to be accumulated in equity (eg. revaluation surplus) and others arise from transfers from retained earnings (often known as general reserves) due to generally accepted accounting principles. Some have arisen from dubious accounting practices, now banned.

3.9

Solution Manual to accompany Company Accounting 10e

Students should realise that reserves do not represent ‘cash’ balances. Reserves are ‘book’ entries and no cash is physically transferred or created by these entries. Students should recognise that for example, the creation of a general reserve is a transfer from profit, and profit does not necessarily represent cash. What reasons may there be for no definitions being given for a reserve in the legislation, accounting standards, and the conceptual framework ? I would say that the reason there is no definition given for a reserve in the legislation, accounting standards and conceptual framework is because it is not possible to categorise reserves according to a homogeneous definition. Reserves may be created in a number of different ways (accounting standards, GAAP, other dubious accounting practices). It therefore would appear to be a very difficult task to establish a general definition to include all ‘reserves’. Any definition may be too restrictive. 16. In preparing financial statements for internal management purposes, discuss the benefits and disadvantages of complying with the requirements of accounting standards. The benefit of complying with the requirements of accounting standards when preparing financial statements for internal management is the cost savings. This is especially the case for reporting entities required to prepare general-purpose financial statements for external users. Rather than having an accounting system that is set up to prepare financial statements for internal users and another set of financial statements for external users, costs would be minimised if only the one set of financial statements was prepared. The disadvantage is that management may feel that a certain number of accounting standards do not depict the company’s overall profit performance and financial position from which key performance indicators are being used to assess management. Furthermore, different expense classifications would be more helpful for management control purposes than are the classifications by nature or function.

3.10

Chapter 3: Company operations

CASE STUDIES Case Study 1

Footballers as assets

One of the well-known soccer clubs in Britain, Liverchester, has made a decision to include its players on the club’s statement of financial position as assets. These players are signed to the club every 3 years and are paid large amounts of money by the club each year under various contracts. The club also insists on a transfer fee being paid if a player wishes to go to another club while under contract. Required Discuss whether the Liverchester club is justified in its action of treating players as assets, by reference to appropriate accounting regulations. Assets are defined in the Conceptual Framework, (para. 4.4/49(a)) as ‘a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’. According to paras 4.8-4.14/53-59 of the Framework, an asset has three essential characteristics: 1. An asset contains future economic benefits in the form of a potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. 2. The future benefits must be controlled by the entity. This means that an asset does not have to be legally owned. Control is not defined in the Framework; nevertheless, in para. 4.12/57, an ability of the entity to deny or regulate access to those benefits is implied. 3. Assets must have come into existence as a result of past events. Future economic benefits which are not currently controlled by the entity are not assets. A past event must have occurred. Hence, inventories expected to be acquired by the company next month are not assets to the entity at present. Once these three essential characteristics are satisfied, an asset exists. Under the Conceptual Framework the existence of an asset is not dependent on factors such as whether it has been purchased at a cost, is ‘tangible’ or has a physical existence, has a legally enforceable claim over it, or is exchangeable in the marketplace for cash or other assets. Does the Liverchester club have future economic benefits? Yes. In the form of ticket sales, promotional and sponsorship benefits. Does Liverchester control the future economic benefits? As control means the capacity to deny or regulate the access of others to those benefits, Liverchester would appear to have control. Substantial transfer fees are required if a player wants to go to another club. Has there been a past event? Yes, there is a contract signed with each player. Can the players be recognised as assets? Recognition criteria could be discussed if it is agreed that the players are assets. But how do you obtain a reliable measure of your asset? And what about other officials e.g. coaching staff, management? Are they not assets as well?

3.11

Solution Manual to accompany Company Accounting 10e

Case Study 2

Liabilities and recognition

SuperBags Ltd is being sued for breach of patent. The company suing is claiming that a range of handbags that SuperBags Ltd has manufactured and subsequently sold are copies of their own designs. SuperBags Ltd has admitted that there are some similarities between the designs and that their designs were based on the other company’s handbags. However, SuperBags Ltd lawyers are arguing that the differences between the handbag designs may be sufficient to avoid a finding of breach of patent. Legal advice has suggested that there is a 40% probability that SuperBags Ltd will be found guilty for breach of patent and has estimated that, if found guilty, Superbags Ltd will be required to pay $980 000 to the other company. Required Discuss fully how SuperBags Ltd should account for this event by: A. applying the requirements of AASB 137; B. applying the definitions and recognition criteria as proposed in the July 2013 Discussion Paper, A Review of the Conceptual Framework for Financial Reporting. A. AASB 137 defines a provision as: a liability of uncertain timing or amount (para. 10) To be recognised as a provision the item must: • meet the definition of a provision, and • meet the recognition criteria (i.e. can be measured reliably and it is probable the outflow will be required. These recognition criteria are consistent with the Conceptual Framework and are also specified in AASB 137 for provisions). It would be argued that the item meets the definition of a provision. The past event is the manufacture and sale of the handbags which are based on designs of the other company and so have similarities to those of the other company. This has led to the SuperBags Ltd having a present obligation (would be considered constructive due to sale of handbags which potentially breach copyright of the other company and not a legal obligation as this time) to make an outflow (this is potential payment of cash via damages). There is clearly uncertainty about the timing and (possibly) the amount of any potential payment. However at this time the recognition criteria are not met as the potential outflow (i.e. payment of cash damages) is not probable (ie is less than 50%). Hence this would be a contingent liability. As the possibility of an outflow is 40% this is not remote and hence would need to be disclosed in the notes in accordance with AASB 137, para 86. B. In the 2013 IASB discussion paper, A Review of the Conceptual Framework for Financial Reporting, the proposed definition of a liability is: a present obligation of the entity to transfer an economic resource as a result of past events (2.11).

For the same reasons as outlined above in this case the item would meet the proposed definition of a liability as there is a present obligation to transfer economic resources as a result of past events (in this case actions of copying bags has given rise to an obligation to potentially pay damages).

3.12

Chapter 3: Company operations

This discussion paper proposes that the only recognition criteria be that there be a faithful representation. The discussion paper argues that probability would be reflected in measurement (see section 3.2.1 of the text). Given this it would appear under the proposed definition and recognition criteria this item would be recognised as a liability (presumably, ignoring the time value of money, at $392 000 being 40% of $980 000). The uncertainly associated with the item would also need to be disclosed if this was to be a faithful representation.

Case Study 3

Reserves

Obtain the annual reports of a number of companies (these are usually available from the company website). Required From the statement of changes in equity (and associated notes): A. Identify the number and different types of reserves. B. Check if the company explains the nature of these reserves (this will be in the notes if these are explained). C. Report to the class on the reserves common across the companies you have considered and why there may be differences between the type and number of reserves reported across these companies. The discussion will vary depending on the companies that students consider. For example, • Woolworths’ 2013, annual report includes hedging reserve, foreign currency translation reserve, remuneration reserve, asset revaluation reserve, equity instrument reserve and retained earnings, and the nature of these is explained in note 18 of the financial report. • Telstra’s 2013 annual report includes reserves titled foreign currency translation, cash flow hedging, consolidation fair value, general reserve and retained profits. • Qantas’s 2013, annual report includes employee compensation reserve, hedging reserve, foreign currency translation reserve and retained earnings, and the nature of these is explained in note 23 of the financial report. Many of these reserves (e.g. revaluation, hedging) are due to requirements of accounting standards. Hence differences will occur due to different transactions/events that relate to the entity and also through management choices/decisions (e.g. Telstra has a general reserve).

3.13

Solution Manual to accompany Company Accounting 10e

Case Study 4

Reserves and cash

Havana Ltd Has the following balances at 1 August 2017: $ ASSETS Cash Accounts receivable Inventory Property, plant and equipment Total assets

4 000 14 000 11 000 37 000 66 000

LIABILITIES Accounts payable Loan Total liabilities Net assets

4 000 19 000 23 000 43 000

EQUITY Share capital Retained earnings Total equity

25 000 18 000 43 000

During the month ending 31 August 2017 the following occurred: (a) Inventory that had cost $7000 was sold for $13 000 ($9000 on credit and $4000 cash sales). (b) $8000 in cash was received from customers for credit sales (i.e. accounts receivables). (c) Inventory was purchased for $10 000 ($2000 on credit and $8000 for cash). (d) A payment of $1100 was made on the loan: being $1000 principle and $100 interest for August. (e) $4000 was paid to creditors (accounts payable) (f) Depreciation of $350 was charged on the property, plant and equipment. (g) On 31 August 2017, the directors decided to transfer $11 000 from retained earnings to a general reserve. They did this as they wished to ensure enough cash was available to purchase more property, plant and equipment and this reserve is intended to indicate cash available for such purchases. Required A. Calculate the profit for the month of August 2017 (ignore taxation). B. Calculate the balances in the retained earnings and general reserve accounts at the end of the period. C. Calculate the amount of cash at the end of the period. D. Use this case to illustrate/explain why a general reserve created does not represent cash available for future purchases. A. Profit for the month is: Sales Revenue Less Expenses of: Cost of sales Interest

13 000 (7 000) (100)

3.14

Chapter 3: Company operations

Depreciation Profit

(350) 5 550

B. The balances are: Retained earnings Beginning balance Plus profit Less transfer to reserve End balance

18 000 5 550 (11 000) 12 550

General reserve Beginning balance Plus transfer from RE End balance

0 11 000 11 000

C. The balance of cash is: Beginning balance Plus cash sales Plus payments from customers Less cash for inventory Less payment on loan Less payment to creditors End balance

4 000 4 000 8 000 (8 000) (1 100) (4 000) 2 900

D. This case shows: • Although profit of $5,550 this is not represented by cash increases. Cash in fact has decreased. The profit is reflected in the increase in net assets overall (for example, increase in inventory and accounts receivable, and decrease in accounts payable and loan). • The general reserve of $11 000 represents an appropriation of profit – not cash. In fact, despite the balance of $11 000 in this reserve, the company has only $2 900 in cash. Hence a reserve does not ‘create’ or represent a pool of cash available for any purpose.

3.15

Solution Manual to accompany Company Accounting 10e

Case Study 5

Accounting policies

Toyko Ltd has incurred advertising expenditure, the treatment of which is not prescribed by any existing accounting standard. The board of directors has requested the financial accountant record the expenditure as an asset so as not to impact the current year’s profit. The accountant is concerned with the request and requires your assistance in determining an accounting policy for this expenditure. Required A. Provide the accountant with two accounting policies or treatments that the company could adopt to account for this expenditure. B. What assistance does AASB 108 provide to help the accountant choose between the policies provided in requirement A? C. Which of your policies would best meet the requirements of AASB 108? Why? A.

Currently, there is no Australian accounting standard to provide accounting policies or guidance specifically to deal with accounting for advertising expenditure of this kind. Two potential accounting policies are: (a) expense all advertising expenditure as incurred, or (b) capitalise all advertising expenditure (i.e. treat the costs as an asset).

AASB 108, paragraph 10 states that, in the absence of an Australian accounting standard, management shall use its judgement in developing and applying an accounting policy that results in information that is both relevant to the economic decision making needs of users and is reliable, i.e. provides a faithful representation of the entity’s financial position and performance, as well as being free from bias and complete. Paragraph 11 requires management to refer to the accounting standards of other bodies dealing with similar and related issues and the definitions, recognition criteria and measurement concepts contained in the conceptual framework when choosing between competing accounting policies.

Students could select either policy – the key issue is whether or not such expenditure results in the creation of an asset as per the Conceptual Framework’s definition. If so, the expenditure should be capitalised. If not, the expenditure should be expensed. Students should provide valid arguments to support their choice of accounting policy. In this case, we would argue against capitalisation as the main purpose of the board is to show a higher profit in the current year, i.e. this is not a faithful representation of the entity’s financial position or performance.

3.16

Chapter 3: Company operations

Case Study 6

Accounting policies

Nassau Boats Ltd builds luxury ocean-going yachts which generally take up to 3 years to construct and are worth $50 million each. The company normally takes out a loan to finance the initial construction phase for each yacht. Interest on these loans has been treated as an expense with $750 000 written off over the last 5 years. In the current year ended 30 June 2017, the company changed its accounting policy with respect to interest and now capitalises the interest against the cost of each yacht as allowed by AASB 123 Borrowing Costs. Amounts of $40 000 and $22 000 were capitalised against two yachts on which construction started this year but no adjustments have been made for yachts under construction at the beginning of the year. The new accounting policy and its impact have been disclosed in the notes to the financial statements for the year ended 30 June 2017. Required Critically evaluate the company’s adoption of the new accounting policy with respect to the requirements of AASB 108. AASB 108 requires that when a company voluntarily changes an accounting policy it shall apply the change retrospectively (p19(b)). Retrospective application means that, where practicable, the entity shall adjust the opening balance of each affected component of equity for the earliest period presented, and the other comparative amounts disclosed for each prior period presented as if the new policy had always been applied. Nassau Boats changed its accounting policy with respect to the capitalisation of interest during the year but no retrospective adjustment was made to the value of yachts constructed or commenced in prior periods. Retrospective adjustment requires adjustments to show opening balances and comparative figures as if interest had always been capitalised rather than expensed therefore prior year expenses amounting to $750 000 need to be reclassified. To do this the company will need to go back and calculate the amount of interest for each yacht constructed or commenced over the last five years. Cost of goods sold figures would need to be restated for yachts completed and sold, and inventory costs would need to be amended for yachts on hand or in progress that beginning of the current year. Prior year adjustments to interest and cost of goods sold expenses would be made against the opening balance of retained earnings.

3.17

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS RACTICE QUEST IONS

Question 3.1

Dividends and reserve transfers

Prepare general journal entries to record the following unrelated transactions of a limited company: 1. Payment of an interim dividend of $200 000 (in cash). 2. Declaration of a final dividend of $420 000. 3. Transfer of $65 000 from the revaluation surplus to a general reserve. 4. Transfer of $120 000 to the general reserve from retained earnings. 5. Payment of 300 000 bonus shares, fully paid at $1 per share from a general reserve.

Retained Earnings/Interim Dividend Cash (Payment of interim dividend)

Dr Cr

200 000

Retained Earnings/ Dividend Declared Dividend Payable (Declaration of final dividend)

Dr Cr

420 000

Revaluation Surplus General Reserve (Transfer from revaluation surplus to general reserve)

Dr Cr

65 000

Retained Earnings/ T’fer to Reserve General Reserve (Transfer to general reserve)

Dr Cr

120 000

General Reserve Share Capital (Being bonus dividend out of general reserve)

Dr Cr

300 000

200 000

420 000

65 000

120 000

300 000

3.18

Chapter 3: Company operations

Question 3.2

Dividends

The constitution of Beijing Ltd requires approval of final dividends by shareholders at the Annual General Meeting (AGM) before these can be declared or paid. 1. On 27 September 2014, following approval and declaration at the AGM a final dividend of $142 000 was paid. This dividend had been recommended on 29 June 2013 from retained earnings. 2. On 6 January 2015, the directors declared and paid an interim dividend of $98 000 from retained earnings. 3. On 2 July 2015, the directors recommended a final dividend of $180 000 from retained earnings. 4. On 24 September 2015, the final dividend of $180 000 was approved and declared at the AGM. This was paid later on 24 September after the AGM. Required A. Prepare general journal entries to account for the above events/transactions. B. What is the total amount of dividends recognised for the year ending 30 June 2015? C. Would your answers to A and B change if in relation to 3 above the directors had recommended this dividend on the 28 June 2015 instead of the 2 July 2015?

A. 2014 27 Sept.

Retained Earnings/Final Dividend Dr Cash Cr (Recognition and payment of final dividend)

142 000

Retained Earnings/ Interim Dividend Dr Cash Cr (Recognition and payment of interim dividend)

98 000

142 000

2015 6 Jan.

98 000

2 July

There is no entry as the dividend has not been declared (only recommended).

24 Sept

Retained Earnings/Final Dividend Dr Cash Cr (Recognition and payment of final dividend)

180 000 180 000

B. The total amount of dividends recognised for the year ending 30 June 2015 is $240 000 being: • Final dividend from 2014 of $142 000, and • Interim dividend of $98 000.

C. There would be no changes as the dividend has not been declared, and so is not recognised at the date of recommendation.

3.19

Solution Manual to accompany Company Accounting 10e

Question 3.3

Dividends

The constitution of Hanoi Ltd allows directors to declare a final dividend at any time and this is not subject to any further approval, authorisation or discretion. 1. On 27 September 2015, following the AGM a final dividend of $42 000 was paid. This dividend had been declared on 29 June 2015 from retained earnings. 2. On 1 February 2016, the directors declared and paid an interim dividend of $24 000 from the general reserve. 3 On 2 July 2016, the directors declared a final dividend of $41 000 from retained earnings. 4. On 24 September 2016, following the AGM the final dividend of $41 000 was paid. Required A. Prepare general journal entries to account for the above events/transactions. You need to include a date for each entry. B. What is the total amount of dividends recognised for the year ending 30 June 2016? C. Would your answers to A and B change if in relation to 3 above the directors had declared this dividend on the 28 June 2016 instead of the 2 July 2016?

A. 2015 27 Sept.

Dividend Payable Dr 42 000 Cash Cr (Payment of final dividend recognised on 29 June 2015)

42 000

General Reserve Dr Cash Cr (Recognition and payment of interim dividend)

24 000 24 000

Retained Earnings/Final Dividend Declared Dr Dividend Payable Cr (Recognition of declaration final dividend)

41 000

Dividend Payable Cash (Payment of final dividend)

41 000

2016 1 Feb.

2 July

24 Sept

Dr Cr

41 000

B. The total amount of dividends recognised for the year ending 30 June 2016 is $24 000 being the interim dividend. C. If the dividend had been declared on 28 June 2016 then it would be recognised at that date and the total amount of dividends recognised for the year ending 30 June 2016 would be $65 000 being: • Interim dividend of $24 000 and. • Final dividend from 2016 of $41 000.

3.20

Chapter 3: Company operations

Question 3.4

Dividends

The constitution of Oslo Ltd states that directors can only determine a final dividend and that any dividends determined can be revoked prior to time of payment. 1. On 5 August 2015, following the AGM a final dividend of $306 000 was paid from retained earnings. This dividend had been determined on 29 June 2015. 2. On 11 January 2016, the directors declared and paid an interim dividend of $224 000 from the general reserve. 3. On 28 June 2016, the directors determined that a final dividend of $320 000 from retained earnings would be paid following the AGM. 4. On 12 September 2016, following the AGM the final dividend of $320 000 was paid. Required A. Prepare general journal entries to account for the above events/transactions. You need to include a date for each entry. B. What is the total amount of dividends recognised for the year ending 30 June 2016? C. Would your answers to A and B change if in relation to 3 above the directors had determined this dividend on the 1 July 2016 instead of the 28 June 2016?

A. 2015 5 Aug.

Retained Earnings/Final Dividend Dr Cash Cr (Recognition and payment of final dividend)

306 000

General Reserve Dr Cash Cr (Recognition and payment of interim dividend)

224 000

306 000

2016 11 Jan.

224 000

28 June

There is no entry as the dividend has not been declared (only determined).

12 Sept

Retained Earnings/Final Dividend Dr Cash Cr (Recognition and payment of final dividend)

320 000 320 000

B. The total amount of dividends recognised for the year ending 30 June 2016 is $530 000 being: • Final dividend from 2015 of $306 000, and • Interim dividend of $224000. C. There would be no changes as the dividend has not been declared, and so is not recognised at the date it is determined. Further the 1 July 2016 is not within the current reporting period.

3.21

Solution Manual to accompany Company Accounting 10e

Question 3.5

Retained earnings

At 1 July 2016, the balance in the Retained Earnings account of Canberra Ltd was $3 500 000. The company’s share capital at the 1 July 2016 comprises 400 000 6% preference shares issued for $2.00 per share and 1 400 000 ordinary shares fully paid at $1 per share. During the year ended 30 June 2017, the following events occurred: 1. On 1 February 2017, the directors declared and paid an interim ordinary dividend of $224 000 from retained earnings. 2. On 14 March 2017, the directors issued 40 000 ordinary bonus shares fully paid at $1.40 per share from retained earnings. 3. Profit for the year was $4 300 000. 4. On 30 June 2017, the directors declared a final ordinary dividend of $680 000. A dividend was also declared on the preference shares. 5. On 30 June 2017, the directors resolved to transfer $1 500 000 to a general reserve from retained earnings, and to transfer $4 000 000 from a previously created plant maintenance reserve back to retained earnings. Required Prepare journal entries for the above transactions, and the Retained Earnings account at 30 June 2017.

CANBERRA LTD General Journal 2017 1 Feb

14 Mar

June 30

Retained Earnings/Interim Dividend Cash (Payment of interim dividend)

Dr Cr

224 000

Retained Earnings Share Capital (ordinary) (Issue of bonus Shares)

Dr Cr

56 000

Profit or Loss Summary Retained Earnings (Transfer of profit closing entry)

Dr Cr

4 300 000

Retained Earnings/Dividend Declared Dr Dividend Payable - Ord Cr Dividend Payable - Pref Cr (Declaration of final ordinary dividend and 6% dividend on preference shares)

728 000

Retained Earnings/Transfer to Gen. Res. Dr General Reserve Cr (Transfer to general reserve)

1 500 000

224 000

56 000

4 300 000

680 000 48 000

1 500 000

3.22

Chapter 3: Company operations

Plant Maintenance Reserve Dr Ret. Earnings/T’fer from P M Res. Cr (Transfer from plant maintenance reserve)

4 000 000 4 000 000

Other closing entries will be required if the solution uses Interim Dividend, Dividend Declared, and transfers to/from reserve accounts to close these accounts to Retained Earnings.

Retained Earnings 1 /2/17

Ord Div. – interim

224 000 1/07/16

14/3/17

Share Capital

56 000 30/06/17 P or L Summary

30/6/17

Ord Div. Payable

680 000

Pref. Dividend Payable Transfer to general reserve

48 000

Open bal.

3 500 000 4 300 000

1 500 000 30/06/17 Transfer from Plant

30/06/17 Balance c/d

9 292 000

Maint. Reserve

11 800 000 30/06/17 Balance b/d

4 000 000 11 800 000 9 292 000

3.23

Solution Manual to accompany Company Accounting 10e

Question 3.6

Dividends and share issues

The share capital of Kathmandu Ltd as at 1 July 2016 comprised 1 400 000 ordinary shares issued and paid to $3.00 less share issue costs of $41 000. Information about some events/transactions relating to Kathmandu Ltd is below: 1. On 21 August 2016, a dividend of $440 000 was paid in cash. This dividend had been determined (proposed) on 29 June 2016 from retained earnings. 2. On 1 October 2016, Kathmandu Ltd issued a prospectus calling for applications for 1 600 000 ordinary shares from the public at an issue price of $4.20, payable $2.50 on application and $1.70 on allotment. By 25 November 2016, it had received 1 800 000 applications with $2.50 paid. On 1 December 2016 the company issued the shares and made refunds to 200 000 applicants. Costs incurred in the share issue totalled $52 000. All allotment monies were received by 24 December 2016. 3. On 28 June 2017, the directors determined a final dividend of $0.18 per share from retained earnings. This is to be paid on 20 August 2017 following the annual general meeting. At 30 June 2017, the directors transferred $350 000 to retained earnings from the general reserve. Required A. Prepare the general journal entries required in the year ended 30 June 2017 to reflect the events/transactions above. B. How would your entries above change if the final dividends had not been determined (at 29 June 2016 and 28 June 2017), but had been declared at these dates? A. 2016 21 Aug

Retained Earnings/Dividend paid Dr Cash/Bank Cr (Recognition and payment of dividend)

To 25 Nov Cash Trust Dr Application Cr (Receipt of monies with applications) 1 Dec

Application Dr Cash Trust Cr (Refund to unsuccessful applicants)

440 000 440 000

4 500 000 4 500 000

500 000 500 000

Application Dr 4 000 000 Allotment Dr 2 720 000 Share Capital Cr 6 720 000 (Recognition of issues of shares and share capital due on allotment and application) Cash/Bank Dr Cash Trust Cr (T/f of monies received on application) Share Issue Costs/Share Capital

4 000 000 4 000 000

52 000 3.24

Chapter 3: Company operations

Cash/Creditors/Payables (Costs of share issue)

24 Dec

Cash Allotment (Receipt of allotment money)

2017 28 June

30 June

Dr Cr

52 000

2 720 000 2 720 000

There is no entry as the dividend has only been determined, not declared.

General reserve Dr 350 000 Retained earnings (or T’fer from Gen.Res.) Cr (Transfer from general reserve)

350 000

B. If the final dividends had been declared then the following entries would be processed: 2016 21 Aug Dividend Payable Dr 440 000 Cash/Bank Cr 440 000 (Payment of dividend recognised on 29 June 2016) 2017 28 June

Retained earnings/Dividend Declared Dr 540 000 Dividend Payable Cr (Recognition of final dividend declared: 3 million shares @18c)

540 000

3.25

Solution Manual to accompany Company Accounting 10e

Question 3.7

Equity movements and statement of changes in equity

The following is the equity of Paris Ltd on 30 June 2016: Share capital (fully paid ordinary shares at $3.50) General reserve Revaluation surplus Retained earnings

2 100 000 640 000 160 000 310 000 3 210 000

The following transactions occurred during the year ended 30 June 2017: 1. At the annual general meeting on 1 September 2016, the directors confirmed a final dividend of 20c per share for the year ended 30 June 2016. The dividend had been proposed (determined) on the 28 June 2016 and had not been provided for in the annual financial statements. Dividends were paid by direct debit at the close of the meeting. 2. On 31 December 2016, the directors, who were keen to keep cash resources in the business for further expansion of plant facilities, made a bonus share issue of 1 share for every 12 shares held valued at $3.80 per share from the general reserve. 3. On 30 June 2017, the directors decided to transfer $50 000 from the revaluation surplus to the general reserve. This portion of the surplus related to an asset that had been sold in May 2016. 4. The profit for the year after charging income tax expense of $140 000 was $690 000. 5. On 30 June 2017, the directors recommended a final dividend of 10c per share out of retained earnings. This was expected to be ratified and paid at the annual general meeting on 28 August 2017. Required A. Prepare journal entries to record the transactions. B. Prepare a statement of changes in equity for the year ended 30 June 2017. A. 2016 Sept 1

Dec 31

2017 June 30

Retained Earnings/Dividend Paid Cash (Payment of dividend confirmed at the AGM)

Dr Cr

120 000

General Reserve Share Capital (Payment of 1 for 12 bonus issue @$3.80 out of general reserve)

Dr Cr

190 000

Revaluation Surplus Dr General Reserve Cr (Transfer from revaluation surplus to general reserve)

120 000

190 000

50 000 50 000

3.26

Chapter 3: Company operations

Profit or Loss Summary Retained Earnings (Profit for the year closing entry)

Dr Cr

690 000 690 000

No entry for dividends on 30 June 2017 as these have not been declared. B. PARIS LTD Statement of Changes in Equity for the year ended 30 June 2017 Total comprehensive income for the year*

$690 000

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend paid during year Balance at 30 June 2017

$310 000 690 000 (120 000) $880 000

Share capital: Balance at 1 July 2016 Bonus share issue during the period Balance at 30 June 2017

$ 2 100 000 190 000 $ 2 290 000

Other reserves: General Balance at 1 July 2016 Bonus share issue during the period Transfer from revaluation surplus Balance at 1 July 2017

$640 000 (190 000) 50 000 $500 000

Revaluation surplus Balance at 1 July 2016 Transfer to general reserve Balance at 30 June 2017

$160 000 (50 000) $110 000

* Comprehensive income = $690 000 profit. There were no items of other comprehensive income

3.27

Solution Manual to accompany Company Accounting 10e

Question 3.8

Adjustments and preparation of financial statements

The following details are taken from the accounting records of Aster Ltd at 30 June 2017: Debit Sales revenue Cost of sales Selling expenses Administrative and general expenses Financial expenses (including borrowing costs of $7000) Dividend revenue Interest revenue Plant and machinery (cost) Accumulated depreciation – plant and machinery Freehold land Buildings (cost) Accumulated depreciation – buildings 6% government bonds (face value $20 000) Shares in other companies Bank loan (due 2020) Accounts receivable Allowance for doubtful debts Inventories (at lower of cost and market) Mortgage payable (secured over land and buildings) Accounts payable Goodwill Share capital (120 000 ordinary shares issued for $2) General reserve Retained earnings 1/7/16

Credit 882 680

694 000 82 000 51 000 17 000 10 000 1 320 150 000 70 000 40 000 80 000 30 000 22 000 75 000 24 000 54 000 8 000 46 000 16 000 30 000 30 000 240 000 16 000 13 000

$ 1 341 000

The following items, not yet recorded, must be adjusted before completion of the company’s financial statements: 1. Depreciation to be recorded as follows: plant and machinery at 20% of cost; buildings at 5% of cost. Goodwill has not been impaired. 2. Income tax to be provided at 30% of profit before tax. 3. Dividends of 8c per share were declared on 30 June 2017. 4. Transfer $10 000 of the general reserve back to retained earnings. Required A. Prepare general journal entries to record the adjustments necessary. B. Prepare the statement of profit or loss and other comprehensive income for Aster Ltd for the year ended 30 June 2017. C. Prepare the statement of changes in equity for Aster Ltd for the year ended 30 June © John Wiley and Sons Australia, Ltd 2015

3.28

Chapter 3: Company operations

2017. D. Prepare the statement of financial position for Aster Ltd as at 30 June 2017. A. 2017 June 30

Depreciation - Plant & Machinery Accum. Depn - Plant & Mach (Depreciation at 20% per annum)

Dr Cr

30 000

Depreciation - Buildings Accum. Depn - Bldgs (Depreciation at 5% per annum)

Dr Cr

4 000

Income Tax Expense Current Lax Liability (Tax of 30% on profit of $16 000 as calculated below)

Dr Cr

4 800

Retained Earnings/Dividend Declared Dividend Payable (Final dividend of 8c per share on 120 000 shares declared)

Dr Cr

9 600

General Reserve Retained Earnings/Transfer from reserve (Being transfer from this reserve)

10 000

30 000

4 000

4 800

9 600

10 000

ASTER LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Income: Sales $882 680 Dividend revenue 10 000 Interest revenue 1 320 Total revenues 894 000 Expenses: Selling expenses Cost of sales $694 000 Other selling expenses 82 000 Total selling expenses 776 000 Administrative expenses Administrative expenses 51 000 Depreciation of plant & machinery 30 000 Depreciation of buildings 4 000 Total administrative expenses 85 000 Financial expenses Financial expenses 17 000 © John Wiley and Sons Australia, Ltd 2015

3.29

Solution Manual to accompany Company Accounting 10e

Total financial expenses Total expenses Profit before income tax Income tax expense (30%) Profit for the year Other comprehensive income Total comprehensive income for the year

17 000 878 000 16 000 4 800 $11 200 0 $11 200

ASTER LTD Statement of Changes in Equity for the year ended 30 June 2017

Total comprehensive income for the year Retained earnings: Balance at 1 July 2016 Profit for the period Dividend declared Transfer from general reserve Balance at 30 June 2017 Share capital: Balance at 1 July 2016 Balance at 30 June 2017 Other reserves: General Balance at 1 July 2016 Transfer to retained earnings Balance at 30 June 2017

$11 200 $13 000 11 200 (9 600) 10 000 $24 600 $240 000 $240 000

$16 000 (10 000) $6 000

D. ASTER LTD Statement of Financial Position as at 30 June 2017 Current assets Accounts receivable Allowance for doubtful debts Inventories Total current assets Non-current assets Government bonds Shares in other companies Freehold land Buildings Accumulated depreciation Plant and machinery Accumulated depreciation Goodwill Total non-current assets

$54 000 8 000

$46 000 46 000 92 000 22 000 75 000 40 000

80 000 (34 000) 150 000 (100 000)

46 000 50 000 30 000 263 000 3.30

Chapter 3: Company operations

Total assets Current liabilities Accounts payable Current tax liability Dividend payable Total current liabilities Non-current liabilities Bank loan payable Mortgage payable Total non-current liabilities Total liabilities Net assets Equity Share capital 120 000 ordinary shares issued and paid to $2 General reserve Retained earnings Total equity

355 000 30 000 4 800 9 600 44 400 24 000 16 000 40 000 84 400 $270 600

240 000 6 000 24 600 $270 600

3.31

Solution Manual to accompany Company Accounting 10e

Question 3.9

Ledger accounts for equity adjustments

The equity of Oslo Ltd at 30 June 2016 consisted of: Share capital: 200 000 10% cumulative pref. shares issued at $2, fully paid 100 000 ordinary shares issued at $1, paid to 50c General reserve Retained earnings

$400 000 50 000 40 000 860 000

The following transactions occurred during the year ended 30 June 2017: 2016 June 30

July 9 Sept. 19 Oct. 5 21 22

2017 Jan. 10 June 30

Already deducted from the retained earnings balance of $860 000 were final ordinary dividends of $7000 and preference dividends of $40 000 that had been declared at 30 June 2016. These dividends were expected to be paid later in 2016. Final call made on 100 000 partly paid ordinary shares. Call money received. Final dividends paid. Revaluation of an item of land upwards by $50 000. (This is the initial revaluation of land. Ignore taxation.) With the surplus created from the revaluation of land, the directors made a bonus issue of ordinary shares to existing ordinary shareholders, on the basis of 3 shares for every 10 shares, valued at $1.08 per share. Interim dividend of 6c per ordinary share paid out of retained earnings. Preference dividend for the year and final ordinary dividend of 6c per share were declared.. Transfer of $3000 to the general reserve from retained earnings.

Required Prepare ledger accounts to reflect the above transactions. OSLO LTD

General Ledger

30/6/17

Balance

Share Capital - Ordinary 132 400 30/6/16 Balance 9/9/16 Final call 22/10/16 Reval surplus 132 400 30/6/17 Balance

50 000 50 000 32 400 132 400 132 400

3.32

Chapter 3: Company operations

Share Capital – Preference 30/6/16 Balance

30/6/17

10/1/17 30/6/17 30/6/17 30/6/17

9/7/16

19/9/16

General Reserve 43 000 30/6/16 Balance 30/6/17 Retained earnings 43 000 30/6/17 Balance

Balance

Int ord div Pref div payable Ord div payable General reserve

Retained Earnings (extract) 7 800 30/6/16 Balance 40 000 7 800 3 000

Ord share capital

Final Call 50 000 19/9/16 Cash

Final call

Cash (extract) 50 000 5/10/16 Ord div payable 5/10/16 Pref div payable 10/1/17 Retained earnings (int ord div)

400 000

40 000 3 000 43 000 43 000

860 000

50 000

7 000 40 000 7 800

3.33

Solution Manual to accompany Company Accounting 10e

Cash

Ordinary Dividend Payable 7 000 30/6/16 Balance 30/6/16 Retained earnings

7 000 7 800

5/10/16

Cash

Preference Dividend Payable 40 000 30/6/16 Balance 30/6/16 Retained earnings

40 000 40 000

22/10/16

Share capital

30/6/17

Balance

5/10/16

21/10/16

Gain on Revaluation (OCI)

Revaluation Surplus

Revaluation Surplus 32 400 21/10/16 Gain on Revaluation (OCI) 17 600 50 000 30/6/17 Balance

50 000

50 000 17 600

Land (extract) 50 000

Other Comprehensive Income * 50 000 21/10/16 Land

50 000

*Entries for revaluations in this chapter are simplified and do not consider taxation. Revaluations of such items are considered in Chapter 9.

3.34

Chapter 3: Company operations

Question 3.10

Adjustments and financial statements

The trial balance of Madrid Ltd as at 30 June 2016 is given below: MADRID LTD Trial Balance as at 30 June 2016 Debit Share capital Second call (3 000 000 shares at 25c each) Calls in advance Retained earnings (1/7/15) Mortgage payable on land and buildings Bank overdraft Accounts payable Land Buildings Vehicles Accumulated depreciation — buildings Accumulated depreciation — vehicles Financial investments Goodwill Accounts receivable Inventory Sales revenue Interest on financial investments Cost of sales Commission expense Delivery expense Salaries — administrative Salaries — travellers Directors’ fees Interest on mortgage General expenses

Credit $ 101 250 000

750 000 3 000 000 3 900 000 30 000 000 11 250 000 3 000 000 15 300 000 60 000 000 3 750 000 6 000 000 750 000 52 500 000 8 250 000 8 240 000 24 000 000 36 000 000 2 625 000

16 500 000 150 000 300 000 3 000 000 1 035 000 300 000 1 500 000 2 200 000 $ 197 775 000 $ 197 775 000

Additional information A.The share capital at 1 July 2015 consisted of 45 000 000 shares fully paid at $1 and 75 000 000 shares issued for $1 and called to 75c per share. B. The following adjustments have to be made to the trial balance prior to the preparation of the financial statements: (i) doubtful debts at 30 June 2016 are estimated to be $230 000 (ii) unrecorded and unpaid travellers’ salaries amount to $170 000 (iii) prepaid general expenses amount to $23 000 (iv) income tax expense to be recognised of $3 758 000 (v) a final dividend is to be recommended for $2 250 000. The company’s constitution requires shareholders to ratify final dividends. (vi) $1 300 000 is to be transferred to a general reserve (vii) depreciation on vehicles at the rate of 20% p.a. and on buildings at the rate of 5% p.a. for the whole year © John Wiley and Sons Australia, Ltd 2015

3.35

Solution Manual to accompany Company Accounting 10e

Required A. Prepare a statement of profit or loss and other comprehensive income for Madrid Ltd for the year ended 30 June 2016 for internal purposes. B. Prepare a statement of financial position for Madrid Ltd as at 30 June 2016 for internal purposes. Workings 2016 June 30 (i)

Bad Debts Expense Allowance for Doubtful Debts* *or Allowance for Impairment of receivables

(ii)

(iii)

(v)

Dr Cr

$’000 230

Salaries: Travellers Salaries Payable

Dr Cr

170

Prepaid Expenses General Expenses

Dr Cr

Income Tax Expense Current Lax Liability

Dr Cr

3 758

Dr Cr

1 300

170

3 758

(vi) No entry (vi)

(vii)

Transfer to General Reserve General Reserve

1 300

Depreciation – Vehicles Dr 750 Depreciation - Buildings Dr 3 000 Accum. Depn – Vehicles Cr 750 Accum. Depn - Bldgs Cr 3 000 (Depreciation at 20% per annum on vehicles and 5% per annum on buildings)

3.36

Chapter 3: Company operations

The trial balance of Madrid Ltd as at 30 June 2016 after the above adjustments is therefore: MADRID LTD TRIAL BALANCE (as at 30 June 2016) Debit $’000 Share Capital Second Call (3 000 000 shares at 25c each) Calls in Advance Retained Earnings (1/7/15) Transfer to General Reserve General Reserve Mortgage Payable on Land and Buildings Bank Overdraft Accounts Payable Salaries Payable Current Tax Liability Land Buildings Vehicles Accumulated Depreciation - Buildings Accumulated Depreciation - Vehicles Financial Investments Goodwill Accounts Receivable Allowance for Doubtul Debts Inventory Prepaid Expenses Sales Revenue Interest on Financial Investments Cost of Sales Commission Expense Delivery Expense Salaries: Administrative Salaries: Travellers Directors’ Fees Interest on Mortgage Bad Debt Expense Income Tax Expense Depreciation – Vehicles Depreciation – Buildings General Expenses

Credit $’000 101 250

750 3 000 3 900 1 300 1 300 30 000 11 250 3 000 170 3 758 15 300 60 000 3 750 9 000 1 500 52 500 8 250 8 240 230 24 000 23 36 000 2 625 16 500 150 300 3 000 1 205 300 1 500 230 3 758 750 3 000 2 177 206 983

______ 206 983

3.37

Solution Manual to accompany Company Accounting 10e

MADRID LTD Statement of Profit or Loss and Other Comprehensive Income For year ended 30 June 2016 Income: Sales Interest on financial investments Total income Expenses: Selling expenses Cost of sales Commission expense Delivery expense Depreciation – vehicles Salaries: travellers Total selling expenses Administrative expenses Salaries: administrative Depreciation – buildings Directors’ fees General expenses Total administrative expenses Financial expenses Bad debt expense Interest on mortgage Total financial expenses Total expenses Profit before income tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

($’000)

($’000) 36 000 2 625 38 625

16 500 150 300 750 1 205

18 905 3 000 3 000 300 2 177 8 477 230 1 500 1 730 29 112 9 513 3 758 5 755 0 $5 755

3.38

Chapter 3: Company operations

2. MADRID LTD Statement of Financial Position as at 30 June 2016 Current assets Inventory Accounts receivable Less Allowance for doubtful debts Prepaid expenses Total current assets Non-current assets Land Buildings Less Accumulated depreciation Vehicles Less Accumulated depreciation Financial investments Goodwill Total non-current assets Total assets Current liabilities Bank overdraft Accounts payable Salaries payable Current tax liability Total current liabilities Non-current Liabilities Mortgage payable on land and buildings Total non-current liabilities Total liabilities Net assets

($’000) 8 240 230

(4’000) 24 000 8 010 23 32 033 15 300

60 000 (9 000) 3 750 (1 500)

51 000 2 250 52 500 8 250 129 300 161 333 11 250 3 000 170 3 758 18 178 30 000 30 000 48 178 $113 155

Equity Share capital Less second call Calls in advance General reserve Retained earnings* Total equity

101 250 (750)

100 500 3 000 1 300 8 355 $113 155

*Retained earnings = 3 900 + 5 755 – 1 300

3.39

Solution Manual to accompany Company Accounting 10e

Question 3.11

Equity transactions and retained earnings account

The equity of Washington Ltd at 1 July 2017 consisted of: Share capital 500 000 ‘A’ ordinary shares — fully paid 400 000 ‘B’ ordinary shares issued for $2 and paid to $1.50 General reserve Retained earnings

$1 500 000 600 000 930 000 1 780 200

The following events occurred during the financial year 1 July 2017 to 30 June 2018: 2017 Aug. Oct.

Dec.

15 20 21

2018 March

June

The final dividend of $96 000 was paid. This had been declared on 29 June 2017 from retained earnings. The first and final call was made on the ‘B’ ordinary shares. All call money was received. The directors allotted a 1-for-10 bonus issue on all ‘A’ ordinary shares, valued at $3, to be paid out of the general reserve. An interim dividend of 9c per fully paid share was paid on all ordinary shares out of retained earnings. The directors declared a final dividend of 11c per fully paid share on all ordinary shares out of retained earnings. Half of the remaining balance in the general reserve was transferred back to retained earnings.

Required A. Prepare journal entries to record the above transactions. B. Assuming that the company made an after-tax profit of $1 400 000 for the year, prepare the retained earnings ledger account for the year ended 30 June 2018. A. 2017 Aug 10 Dividend Payable Cash (Payment of final dividend)

Dr Cr

96 000

Oct 15 Final Call – B Ordinary Share Capital – B Ordinary (Call of 50c on 400 000 shares)

Dr Cr

200 000

Oct 20 Cash Final Call – B Ordinary

Dr Cr

200 000

Dec 21 General Reserve Share Capital – A Ordinary (Bonus issue out of general reserve)

Dr Cr

150 000

96 000

200 000

150 000 3.40

Chapter 3: Company operations

2018 Mar 1 Retained Earnings/Interim Dividend Paid Dr Cash Cr (Interim dividend of 9c per ord. share paid)

81 000 81 000

June 30 Retained Earnings/Dividend Declared Dr Dividend Payable Cr (Declaration of final dividend: 11c * 900 000 shares)

99 000

Jun 30 General Reserve Dr Retained Earnings/T’fer from Gen. Res. Cr (General reserve transferred to retained earnings)

390 000

99 000

390 000

Workings: Calculation of general reserve Balance 1/7/2017 930 000 Less bonus issue (150 000) Less transfer to retained earnings (390 000) Balance 30 June 2018 $390 000 B.

Retained Earnings 1/3/18 Interim dividend paid 81 000 1/7/17 Balance 30/6/18 Final Dividend 99 000 30/6/18 P or L Summary Declared 30/6/18 Balance c/d 3 390 200 30/6/18 General Reserve t’fer 3 570 200 1/7/18 Balance b/d

1 780 200 1 400 000 390 000 3 570 200 3 390 200

3.41

Solution Manual to accompany Company Accounting 10e

Question 3.12

Equity adjustments, and statement of changes in equity

Equity of Santiago Ltd at 1 July 2016 consisted of: Share capital General reserve Plant replacement reserve Retained earnings

1 764 000 600 000 550 000 980 000

Additional information (a) Santiago Ltd had made two previous share issues. In 2012, it issued 400 000 ordinary shares issued and paid to $2.00. Costs incurred in this share issue totalled $12 000. In December 2015, it issued 500 000 ordinary shares at an issue price of $2.40. At 30 June 2016, these were paid to $2.00. Costs incurred in this share issue totalled $24 000. The following events occurred during the year ending 30 June 2017: 2016 July Aug.

5 10

Final dividend of $81 000 was declared. Final dividend declared on 5 July was paid

Sept. Sept. 2017 Jan.

2 30

First and final call made on the 500 000 partly paid shares. All call money received.

March

June

July

Interim dividend of 10c per share declared and paid out of retained earnings. The directors made a 1-for-8 bonus issue of shares from the general reserve. Shares are issued at $2.20 each. Profit before tax for the year was $760 000 out of which the following appropriations were made: (a) Income tax expense $220 000 (b) Transfers to reserves from retained earnings General reserve 100 000 Plant replacement reserve 30 000 The final dividend of 10c per share on all issued shares was declared.

Required A. Prepare the journal entries (in general journal format) required in the year ending 30 June 2017. B. Prepare the statement of changes in equity up to 30 June 2017. A. 2016 July 5 Retained Earnings/Final Div Declared Dividend Payable (Final dividend declared)

Dr Cr

81 000 81 000

3.42

Chapter 3: Company operations

Aug 10 Dividend Payable Cash (Final dividend paid)

Dr Cr

81 000

Sept 2 Final Call Share Capital (Final call on 500 000 shares at 40c)

Dr Cr

200 000

Sept 30 Cash Final Call (Cash received on call) 2017 Jan 30 Retained Earnings/Interim Div Paid Cash (Interim dividend paid; 900 000*10c)

Dr Cr

200 000

Dr Cr

90 000

Mar 10 General Reserve Share Capital (Bonus share issue; 900 000/8*$2.20)

Dr Cr

247 500

Jun 30 Income Tax Expense Current Tax Liability (Income tax expense for the year)

Dr Cr

220 000

Retained Earnings/T’fers to Reserves General Reserve Plant Replacement Reserve (Transfers to reserves)

Dr Cr Cr

130 000

Revenues Expenses (excl. tax) Profit or Loss Summary (Closing entry)

Dr Cr Cr

Profit or Loss Summary Income Tax Expense (Tax expense closing entry)

Dr Cr

220 000

Profit or Loss Summary Retained Earnings (Closing entry to transfer profit)

Dr Cr

540 000

81 000

200 000

90 000

247 500

220 000

100 000 30 000

x 760 000

220 000

540 000

The entry for the final dividend declared on the 2 July is not included as only required to prepare entries for the year ending 30 June 2017.

3.43

Solution Manual to accompany Company Accounting 10e

B. SANTIAGO LTD Statement of Changes in Equity for the year ended 30 June 2017 Total comprehensive income for the period*

$540 000

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend declared – final 2016 Interim dividend paid Transfer to plant replacement reserve Transfer to general reserve Balance at 30 June 2017

$980 000 540 000 (81 000) (90 000) (30 000) (100 000) $1 219 000

Share capital: Balance at 1 July 2016 Call on shares Issue of bonus shares Balance at 30 June 2017

$1 764 000 200 000 247 500 $2 211 500

Other reserves: General reserve Balance at 1 July 2016 Transfer from retained earnings Issue of bonus shares Balance at 30 June 2017

$600 000 100 000 (247 500) $452 500

Plant replacement reserve Balance at 1 July 2016 Transfer from retained earnings Balance at 30 June 2017

$550 000 30 000 $580 000

* Comprehensive income = Profit $540 000 (there are no items of other comprehensive income)

3.44

Chapter 3: Company operations

Question 3.13

Equity adjustments and statement of changes in equity

The equity of London Ltd at 30 June 2016 was: Share capital 50 000 10% cumulative preference shares — fully paid 100 000 ordinary shares — fully paid Revaluation surplus Development reserve Retained earnings Total equity

50 000 200 000 250 000 50 000 20 000 (30 000 ) 290 000

During the year ended 30 June 2017, the following transactions occurred: 2016 Sept.

In 2015, the directors had authorised the development reserve as they were considering developing a new product. In anticipation of this, the directors had authorised the appropriation for developments last year. The board now directs that the reserve be discontinued and transferred back to retained earnings.

2017 March

The profits for the half-year were such that the directors declared dividends of 10% on the preference shares. The directors also declared an interim dividend of 10c per share on ordinary shares. Preference dividends have not been paid for 2015 or 2016. Dividends declared on 1 March were paid.

April

12 1

June

The directors authorised the issue to ordinary shareholders of a bonus share issue of 1 share for every 5 held, valued at $2.20. The shares do not rank for dividend until 2018. The issue is out of the revaluation surplus. The profit before tax for the year was $300 000. The directors recommended a final dividend of 18c per share on ordinary shares out of retained earnings. The company’s constitution requires approval of final dividends on ordinary shares by shareholders at the annual general meeting. Assume the taxation rate is 30%.

Required A. Prepare general journal entries to record all transactions for the year. B. Prepare a statement of changes in equity for the year ended 30 June 2017.

3.45

Solution Manual to accompany Company Accounting 10e

A. 2016 Sept 1

2017 Mar 1

Mar 12

April 1

June 30

Damages Expense Cash (Payment of damages from lawsuit)

Dr Cr

15 000

Development Reserve Retained Earnings/Transfer from Reserve (Reserve transfer to retained earnings)

20 000

15 000

20 000

Retained Earnings/Dividends Declared Dr Dividend Payable – Pref Cr Interim Dividend Payable-Ord Cr (Declaration of 10% preference dividend for three years on cumulative shares, and ordinary interim dividend of 10c per share)

25 000

Dividend Payable - Preference Interim Dividend Payable – Ord Cash (Payment of dividends)

Dr Dr Cr

15 000 10 000

Revaluation Surplus Dr Share Capital - Ordinary Cr (Issue of 1 for 5 bonus shares valued at $2.20 out of revaluation surplus)

44 000

Revenue and Expenses Profit or Loss Summary (Profit before tax for the year)

Dr Cr

300 000

Income Tax Expense Current Tax Liability (Tax expense)

Dr Cr

90 000

Profit or Loss Summary Income Tax Expense (Being closing entry)

Dr Cr

90 000

Profit or Loss Summary Retained Earnings (Transfer of profit)

Dr Cr

210 000

15 000 10 000

25 000

44 000

300 000

90 000

210 000

No entry for dividends as not yet approved.

3.46

Chapter 3: Company operations

B. LONDON LTD Statement of Changes in Equity for the year ended 30 June 2017 Total comprehensive income for the year

$210 000

Retained earnings: Balance at 1 July 2016 Profit Preference dividend paid Ordinary interim dividend paid Transfer from development reserve Balance at 30 June 2017

$(30 000) 210 000 (15 000) (10 000) 20 000 $175 000

Share capital: Balance at 1 July 2016 Issue of bonus shares Balance at 30 June 2017

$250 000 44 000 $294 000

Other reserves: Revaluation surplus Balance at 1 July 2016 Issue of bonus shares Balance at 30 June 2017 Development reserve Balance at 1 July 2016 Transfer to retained earnings Balance at 30 June 2017

50 000 (44 000) (6 000) $20 000 (20 000) $ 0

3.47

Solution Manual to accompany Company Accounting 10e

Question 3.14

Share issues, options, dividends and reserves

The equity of Cairo Ltd at 30 June 2016 consisted of: 400 000 ordinary ‘A’ shares, issued at $2, fully paid 300 000 ordinary ‘B’ shares, issued at $2, called to $1.20 50 000 6% redeemable preference shares, issued at $1.50, fully paid Share issue costs Calls in advance (at 80c) Share options (issued at 60c, fully paid) Retained earnings

$800 000 360 000 75 000 (2 670) 16 000 24 000 318 000

The options were exercisable by 28 February 2017. Each option entitled the holder to acquire two ordinary ‘C’ shares at a price of $1.80 per share, payable by 28 February 2017. The following transactions occurred during the year ended 30 June 2017: 2016 Sept.

Oct.

Nov.

25 1

Dec.

2017 Jan.

Feb.

April 30 May 31 June

18 26 27

The preference dividend and the final ordinary dividend of 16c per share were paid. These dividends had both been determined (i.e. proposed but not declared) on 30 June 2016 from retained earnings. The preference shares were redeemed out of retained earnings at a 5% premium. Cheques were issued to the preference shareholders. A 1-for-5 renounceable rights offer was made to ordinary ‘A’ shareholders at an issue price of $1.90 per share. The offer’s expiry date was 30 November 2016. The issue was underwritten at a commission of $3000. Holders of 320 000 shares accepted the rights offer, with other rights being renounced to the underwriter. Ordinary ‘A’ shares were issued and money received. The underwriting commission was paid.

The directors transferred $35 000 from retained earnings to a general reserve. As a result of options being exercised, 70 000 ordinary ‘C’ shares were issued. Unexercised options lapsed. The final call, due by 31 May 2017, was made on the partly paid shares. All call money was received by this date, except for that due on 15 000 shares. The shares on which the final call was unpaid were forfeited. The forfeited shares were reissued, credited as paid to $2, for $1.80 cash per share. The balance of the Forfeited Shares account will be refunded to the former shareholders on 27 June. Paid refund to former holders of forfeited shares. The directors determined a 20c per share final dividend out of © John Wiley and Sons Australia, Ltd 2015

3.48

Chapter 3: Company operations

Sept.

retained earnings to be payable on 15 September 2017. Final dividend paid.

Required Prepare general journal entries to record the above transactions. 2016 Sept 15 Retained Earnings/Dividend Paid– Ordinary Retained Earnings/Dividend Paid– Preference Cash (Recognition and payment of ordinary dividend [400 000 x 16c +300 000 x 16c x 3/5 = $92 800] and preference dividend [$75 000 x 6%]) Oct 20 Share Capital – Preference Retained Earnings/Redemption Premium (75 000 x 5%) Shareholders’ Redemption (Redemption of preference shares out of profits) Note: dividends do not accrue on the preference shares

Retained Earnings/Transfer to Share Capital Share Capital – Ordinary (Retained earnings transferred to capital. NOTE: no dividends will be paid on this share capital)

Dr Dr

92 800 4 500 97 300

Dr Dr

75 000 3 750

78 750

Dr Cr

75 000

Oct 25 Shareholders’ Redemption Cash (Payment of cash to redeem preference shares)

Dr Cr

78 750

Nov 30 Cash Share Capital – Ordinary ‘A’ (Renounceable rights issue) [400 000/5 = 80 000 x 1.90]

Dr Cr

152 000

75 000

78,750

152 000

3.49

Solution Manual to accompany Company Accounting 10e

Dec 20 Share Issue Costs (Share Capital) Cash (Payment of share issue costs)

Dr Cr

3 000

Dr Cr

35 000

Feb 28 Cash Share Capital – Ordinary ‘C’ (Issue of shares to options holders) [70 000 x $1.80]

Dr Cr

126 000

Share Options Share Capital – Ord ‘C’ Lapsed Options Reserve (Transfer of options account, 35 000 exercised and 5 000 lapsed) [70 000/2 = 35 000 x 60c = 21 000]

Dr Cr Cr

24 000

April 30 Call – Ordinary ‘B’ Share Capital – Ordinary ‘B’ Call of 80c per share on Ordinary B shares)

Dr Cr

240 000

Calls in Advance (20 000 x 80c) Call – Ord ‘B’ (Transfer of calls in advance)

Dr Cr

16 000

May 31 Cash Call – Ord ‘B’ (Cash received on call) [(300 000 – 20 000 – 15 000) x 80c]

Dr Cr

212 000

June 18 Share Capital – Ordinary ‘B’ Call – Ordinary ‘B’ Forfeited Shares Liability (Forfeiture of 15 000 Ordinary B shares)

Dr Cr Cr

30 000

2017 Jan 10 Retained Earnings/Transfer to reserve General Reserve (Transfer to general reserve)

3 000

35 000

126 000

21 000 3 000

240 000

16 000

212 000

12 000 18 000

3.50

Chapter 3: Company operations

26 Cash Forfeited Shares Liability Share Capital – Ordinary ‘B’ (Reissue of 15 000 shares paid to $2 for payment of $1.80)

Dr Dr Cr

27 000 3 000

27 Forfeited Shares Liability Cash (Refund to former shareholders)

Dr Cr

15 000

Dr Cr

170 000

Sept 15

Retained Earnings/Dividend Paid Cash (Dividend recognised and paid) [Workings from the entries above: 400 000 + 300 000 + 80 000 + 70 000 – 15 000 + 15 000= 850 000 x 20c] Note: No entry for dividend on 28 June as not declared (only determined).

30 000

15 000

170 000

3.51

Solution Manual to accompany Company Accounting 10e

Question 3.15

Financial statements

At 30 June 2017, the trial balance of Budapest Ltd was: BUDAPEST LTD Trial Balance as at 30 June 2017 Debit $ Accounts payable Current tax liability Dividend payable Bank loan Interest revenue Consulting revenue Cash Accounts receivable Allowance for doubtful debts Inventory Buildings

52 100 241 500 7 500 300 000 915 000

Accumulated depreciation – buildings Equipment

Credit $ 65 000 84 500 195 000 180 000 6 000 20 000

55 000 425 000

Accumulated depreciation – equipment Cost of sales Administrative expenses Advertising expenses Income tax expense Interest expense Salaries and wages Sales returns Sales revenue Other selling expenses Doubtful debts expense General reserve Retained earnings Revaluation surplus Share capital

48 100 1 294 500 340 600 57 050 84 500 16 400 255 000 79 000 3 080 000 152 500 9 000

$4 222 150

45 000 150 050 46 000 240 000 $4 222 150

Additional information (a) The bank loan is to be repaid in three equal instalments payable on 1 July each year commencing 1 July 2017. There is no intention of refinancing the loan. (b) An interim dividend of $165 000 was paid during the year out of retained earnings. (c) $75 000 was transferred from the revaluation surplus to retained earnings. (d) A bonus share issue of 10 000 shares issued and paid to $4.00 was made in October 2017 from the general reserve. (e) A final dividend of $195 000 has been declared at the end of the year (30 June 2017) © John Wiley and Sons Australia, Ltd 2015

3.52

Chapter 3: Company operations

out of retained earnings. Note (b) to (e) are already adjusted in the trial balance. Required A. Prepare the statement of profit or loss and other comprehensive income for Budapest Ltd for the year ended 30 June 2017, with expenses classified by function. B. Prepare the statement of changes in equity for the year ended 30 June 2017. C. Prepare the statement of financial position for Budapest Ltd at 30 June 2017, classifying assets and liabilities clearly into current and non-current categories. A. BUDAPEST LTD Statement of Profit or Loss and Other Comprehensive Income For year ended 30 June 2017 Income: Sales Less sales returns Interest revenue Consulting revenue Total revenues Expenses: Selling expenses Cost of sales Advertising expenses Other selling expenses Salaries and wages Total selling expenses Administrative expenses Financial expenses Doubtful debts Interest expense

$3 080 000 79 000

$3 001 000 6 000 20 000 3 027 000

1 294 500 57 050 152 500 255 000 1 759 050 340 600 9 000 16 400 25 400

Total expenses Profit before income tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

2 125 050 901 950 84 500 $817 450 0 $817 450

3.53

Solution Manual to accompany Company Accounting 10e

B. BUDAPEST LTD Statement of Changes in Equity for the year ended 30 June 2017 Total comprehensive income for the year

$817 450

Retained earnings: Balance at 1 July 2016 Profit for the period Transfer from revaluation surplus Interim dividend paid Final dividend declared Balance at 30 June 2017

$435 050 817 450 75 000 (165 000) (195 000) $967 500

Share capital: Balance at 1 July 2016 Bonus share issue Balance at 30 June 2017

$200 000 40 000 $240 000

Other reserves: Revaluation surplus Balance at 1 July 2016 Transfer to retained earnings Balance at 30 June 2017 General reserve Balance at 1 July 2017 Bonus share issue Balance at 30 June 2017

121 000 (75 000) $46 000 $ 85 000 (40 000) $45 000

3.54

Chapter 3: Company operations

C. BUDAPEST LTD Statement of Financial Position as at 30 June 2017 Current assets Cash Inventory Accounts receivable Less allowance doubtful debts Total current assets Non-current assets Buildings Accumulated depreciation Equipment Accumulated depreciation Total non-current assets Total assets Current liabilities Accounts payable Dividend payable Bank loan Current tax liability Total current liabilities Non-current Liabilities Bank loan Total non-current liabilities Total liabilities Net assets

$52 100 300 000 241 500 (7 500)

915 000 (55 000) 425 000 (48 100)

234 000 586 100

860 000 376 900 1 236 900 1 823 000 65 000 195 000 60 000 84 500 404 500 120 000 120 000 524 500 $1 298 500

Equity Share capital Revaluation surplus General reserve Retained earnings Total equity

$240 000 46 000 45 000 967 500 $1 298 500

3.55

Solution Manual to accompany Company Accounting 10e

Question 3.16

Equity transactions and adjustments, statement of changes in equity

On 30 June 2016, the equity of Vienna Ltd consisted of: 25 000 ordinary shares, issued at $3, called to $2.50 1500 ordinary shares, issued at $1.50, fully paid Calls in arrears (1000 shares at 50c) General reserve Retained earnings Total equity

62 500 2 250 (500 ) 12 500 39 500 116 250

The company has recognised a liability of $10 000 in relation to 5000 8% redeemable preference shares, issued at $2 each and fully paid. These preference shares must be redeemed at a 5% premium by 31 March 2017. During the year ended 30 June 2017, the following events occurred: 1. By 31 July 2016, $300 of outstanding call money had been received. 2. On 7 August 2016 the directors forfeited those ordinary shares with calls still outstanding. The company’s constitution provides that no refund is made to the former shareholders. 3. On 17 September 2016, the final dividends (40c per share on ordinary shares and 8% on preference shares) declared on 30 June 2016 were paid. 4. On 31 December 2016, an ordinary interim cash dividend of 30c per share was declared and paid. 5. To fund the redemption of preference shares, on 16 January 2017 the directors issued a prospectus offering 12 000 ordinary shares at an issue price of $2.80, payable 70c on application, $1.40 on allotment, and 70c on a future call. The closing date for applications was 15 February 2017. The issue was underwritten by UBeaut Ltd for a fee of $1600, payable on 23 February 2017. 6. By 15 February 2017, applications had been received for 15 000 shares, with applicants for 3000 shares having paid the full issue price. 7. On 25 February 2017, the directors allotted 3000 shares to those applicants who had paid the full issue price per share, and 9000 shares to other applicants on a first-come first-served basis. The company’s constitution allows excess application money to be retained and used to offset other money payable. By 15 March 2017, all allotment money had been received. 8. On 31 March 2017, the preference shares were redeemed, and cheques were sent to preference shareholders on 4 April 2017. 9. Profit for the year was $3625. On 30 June 2017, the directors decided to: • transfer the general reserve balance to retained earnings • make a 1-for-6 bonus issue in lieu of a final cash dividend; the bonus shares were issued on 30 June 2017, valued at $2.70 each. Required A. Prepare general journal entries (including any closing entries) to record the above events. B. Prepare a statement of changes in equity as at 30 June 2017.

3.56

Chapter 3: Company operations

A. VIENNA LTD General journal 2016 July 31 Cash Call (Receipt of call monies)

Dr Cr

300

Dr Cr Cr

1 000

Sept 17 Preference Dividend Payable Ordinary Dividend Payable Cash (Payment of final ordinary and preference dividend)

Dr Dr Cr

800 10 600

Dec 31 Retained Earnings /Dividend Paid Cash (Ordinary interim dividend paid [26 500 – 400 = 26 100] x 30c)

Dr Cr

7 830

Dr Cr

16 800

Feb 23 Share Issue Costs (Share Capital) Cash (Payment of underwriting commission)

Dr Cr

1 600

Feb 25 Application Allotment Share Capital (Issue of 12 000 ordinary shares with $1.40 due on allotment) Application Cash Cash Trust

Dr Dr Cr

8 400 16 800

Dr Dr Cr

2 100 14 700

Aug 7

Share Capital Call Forfeited Shares Reserve (Forfeiture of 400 shares)

2017 Feb 15 Cash Trust Application (Application monies received) [3 000 x $2.80] + [12 000 x 70c]

300

200 800

11 400

7 830

16 800

1 600

25 200

16 800 3.57

Solution Manual to accompany Company Accounting 10e

(Refund to unsuccessful applicants [3000 x 70c] and transfer of balance of cash)

Application Allotment Calls in Advance (Transfer of excess application monies)

Dr Cr Cr

6 300

Mar 15 Cash Allotment (Receipt of balance of allotment monies)

Dr Cr

12 600

4 200 2 100

12 600

Mar 31 Preference Share Liability Dr 10 000 Redemption Premium Exp. (10 000 x 5%) Dr 500 Shareholders’ Redemption Cr 10 500 (Redemption of preference shares liability at a 5% premium out of profits) Note: Interest up to 31 March has not been recognised on these preference shares. It could be assumed that the premium on redemption is effectively interest expense. Alternatively, interest of 8% for 9 months (= $600) could be recognised separately from the redemption expense. Mar 31 Retained Earnings/T’fer to Share Capital Share Capital (Transfer to share capital as required by ASIC Regulatory Guide 68)

Dr Cr

10 000

April 4 Shareholders’ Redemption Cash (Payment to preference shareholders)

Dr Cr

10 500

June 30 Profit or Loss Summary General Reserve Retained Earnings (Transfer of profit and transfer from general reserve)

Dr Dr Cr

3 625 12 500

Retained Earnings/Bonus Issue Share Capital (Issue of 6 350 ordinary shares under a 1-for-6 bonus issue) [38 100 shares/6 x $2.70]

Dr Cr

17 145

10 000

10 500

16 125

17 145

3.58

Chapter 3: Company operations

B. VIENNA LTD Statement of Changes in Equity for the year ended 30 June 2017 Total comprehensive income for the year Retained earnings: Balance at 1 July 2016 Profit for the period Ordinary dividend paid Bonus share issue Transfer to share capital Transfer from general reserve Balance at 30 June 2017 Share capital: Balance at 1 July 2016 Receipt of calls in arrears Forfeiture of shares [1000 – 200] Share issue costs Issue of ordinary shares Calls in advance Transfer from retained earnings (redemption of pref. share liability) Issue of bonus shares Balance at 30 June 2017 Other reserves: Forfeited shares Balance at 1 July 2016 Forfeiture of shares Balance at 30 June 2017 General Balance at 1 July 2016 Transfer to retained earnings Balance at 30 June 2017

$3 625 $39 500 3 625 (7 830) (17 145) (10 000) 12 500 $20 650 $64 250 300 (800) (1 600) 25 200 2 100 10 000 17 145 $116 595

0 800 800 $12 500 (12 500) $ 0

3.59

Solution Manual to accompany Company Accounting 10e

Question 3.17

Adjustments and financial statements

The unadjusted trial balance of Pretoria Ltd at 30 June 2016 contained the following information: PRETORIA LTD Unadjusted Trial Balance as at 30 June 2016 Debit Sales Sales returns Cost of sales Advertising expense Sales salaries Administrative salaries Office expenses Rent expense Vehicle running expenses Debenture interest expense Bad debt expense Motor vehicles Accumulated depreciation – motor vehicles Fixtures and fittings (cost) Accumulated depreciation – fixtures and fittings Allowance for doubtful debts Debenture interest received Retained earnings Share capital (80 000 shares issued at $2 each) 7% debentures Trade creditors Loan payable to bank Patents 8% debentures in Prague Ltd Trade debtors Bills receivable Cash at bank Share issue costs

Credit $ 624 000

1 080 265 320 18 000 72 000 75 000 15 900 19 600 2 000 1 170 2 340 70 000 20 000 26 000 12 000 1 650 360 18 600 160 000 18 000 22 000 14 000

30 000 9 000 71 000 5 400 203 200 3 600 $ 890 610

$ 890 610

Additional information (Unless otherwise indicated you will need to make adjustments for the following events/transactions). (a) The 8% debentures in Prague Ltd were held throughout the year, and the full interest entitlement for the year has not been received. Likewise, there is interest to be accrued on the debenture liability for the year. (b) An interim dividend of $16 000 has been paid during the year out of retained earnings. (Hint: This is already adjusted in the trial balance). (c) Depreciation of motor vehicles and fixtures and fittings is to be provided at the rates © John Wiley and Sons Australia, Ltd 2015

3.60

Chapter 3: Company operations

of 20% and 15% straight-line respectively for the year. Patents were not amortised by the company. (d) The allowance for doubtful debts is to be increased to $3600. (e) ON 30 June 2016, a final dividend of 10c per share has been declared from retained earnings. (f) Income tax expense for the year is estimated to be $72 000. (g) On 30 June 2016, the directors decided to set aside (i) $10 000 to provide for the enhanced cost of replacing fixtures and fittings and (ii) $5000 for the redemption of debentures. (h) The debentures are due for redemption in 3 years. Required A. Prepare a statement of profit or loss and other comprehensive income for the year ended 30 June 2016. B. Prepare the Retained Earnings account for the year ended 30 June 2016. C. Prepare a statement of financial position for the company as at 30 June 2016.

A. Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2016 Income: Sales $624 000 Less sales returns 1 080 $622 920 Debenture interest revenue* 720 Total revenues 623 640 Expenses: Selling expenses Cost of sales 265 320 Advertising 18 000 Sales salaries 72 000 Total selling expenses 355 320 Administrative expenses Administrative salaries 75 000 Office expenses 15 900 Vehicle running expenses 2 000 Depreciation of furniture & fittings* 3 900 Depreciation of motor vehicles* 14 000 Total administrative expenses 110 800 Financial expenses Interest expense on debentures* 1 260 Rent expense 19 600 Bad debts* 4 290 Total financial expenses 25 150 Total expenses 491 270 Net profit before income tax 132 370 Income tax expense 72 000 Profit for the year 60 370 Other comprehensive income 0 Total comprehensive income for the year $60 370 © John Wiley and Sons Australia, Ltd 2015

3.61

Solution Manual to accompany Company Accounting 10e

*Workings for parts A and B (in general journal format) (a) Interest Receivable Dr Debenture Interest Received (revenue) Cr (8% of $9 000 = $720 – 360) Debenture Interest Expense Interest Payable (7% of $18 000 = $1 260 – 1 170 = 90)

Dr Cr

360 360

90 90

(b) Interim dividend paid has already been debited to retained earnings as there is no separate account in the trial balance; hence, the beginning balance of retained earnings = $18 600 + $16 000 = $34 600 (c)

(d)

(e)

(f)

(g)

Depreciation Expense – Motor Vehicles Depreciation Expense – Furniture & Fitts. Accumulated Depreciation – Vehicles Accumulated Depreciation – F & E (20% of $70 000 and 15% of $26 000)

Dr Dr Cr Cr

14 000 3 900

Bad Debts Expense Allowance for Doubtful Debts ($3 600 - $1 650)

Dr Cr

1 950

Retained Earnings/Dividend Declared Dividend Payable

Dr Cr

8 000

Income Tax Expense Current Tax Liability

Dr Cr

72 000

Retained Earnings/Transfer to reserves Plant Replacement Reserve Debenture Redemption Reserve

Dr Cr Cr

15 000

14 000 3 900

1 950

8 000

72 000

10 000 5 000

3.62

Chapter 3: Company operations

B. Retained Earnings -/-/16

Dividend – interim

16 000 1/07/15

Opening balance

34 600

8 000 30/06/16 P or L Summary

60 370

30/6/16 Dividend payable– final Transfer to plant replacement reserve Transfer to deb. redemption reserve 30/06/16 Balance c/d

10 000

5 000 55 970 94 970

94 970 1/7/16

Balance b/d

55 970

3.63

Solution Manual to accompany Company Accounting 10e

C. PRETORIA LTD Statement of Financial Position as at 30 June 2016 Current assets Cash Trade debtors Allowance for doubtful debts Interest receivable Bills receivable Total current assets Non-current assets 8% debentures in Prague Ltd Motor vehicles Accumulated depreciation Furniture and fittings Accumulated depreciation Patents Total non-current assets Total assets

$203 200 $71 000 3 600

9 000 70 000 (34 000) 26 000 (15 900)

Current liabilities Trade creditors Debenture interest payable Current tax liability Dividend payable Total current liabilities Non-current liabilities 7% debentures Loan payable to bank Total non-current liabilities Total liabilities Net assets Equity Share capital 80 000 ordinary shares issued at $2 Less, Share issue costs Other reserves: Plant replacement reserve Debenture redemption reserve Retained earnings Total equity

67 400 360 5 400 276 360

36 000 10 100 30 000 85 100 361 460

22 000 90 72 000 8 000 102 090 18 000 14 000 32 000 134 090 $227 370

160 000 3 600 10 000 5 000

156 400

15 000 55 970 $227 370

3.64

Chapter 3: Company operations

Question 3.18

Adjustments and financial statements

The following unadjusted trial balance is for the year ended 30 June 2017: SINGAPORE LTD Unadjusted Trial Balance as at 30 June 2017 Debit Bank overdraft Vehicle rental expenses Cash at bank Investment in government bonds Goodwill Interest revenue Insurance expense Land Buildings Office furniture and equipment Retained earnings (1/7/16) Revaluation surplus Accumulated depreciation – office furniture and equipment Accumulated depreciation – buildings Allowance for doubtful debts Cost of sales Advertising expense Sales returns and allowances Sales Mortgage payable Inventory Share capital (called to $1 per share) General reserve Interest expense on overdraft Discount received Discount allowed Fees revenue Proceeds on sale of furniture Carrying amount of furniture sold Accounts payable Accounts receivable Salaries of sales staff Administrative wages Calls in arrears (25c per share) Calls in advance (25c per share) Interest expense on mortgage

Credit $ 178 050

72 000 7 500 150 000 24 000 4 800 3 000 230 000 1 000 000 127 000 83 000 15 000 23 000 100 000 14 700 197 400 12 300 8 700 478 120 90 000 106 000 1 140 000 18 000 11 300 11 250 12 000 17 900 13 000 5 000 133 900 225 400 60 000 68 620 2 000 6 000

4 500 $ 2 326 720

$ 2 326 720

Additional information (a) Singapore Ltd is involved in the computer services industry. Leased vehicles are used mainly for delivery and service of computers. The company’s head office, which © John Wiley and Sons Australia, Ltd 2015

3.65

Solution Manual to accompany Company Accounting 10e

houses its administrative staff, is located on a prime piece of real estate in the local township. (b) The following adjustments are required before preparation of Singapore Ltd’s financial statements for the year: (i) Depreciation to be provided on a straight-line basis on buildings at 5% p.a. and on office furniture and equipment at 10% p.a. The sale of office furniture occurred at the beginning of the current financial year. (ii) Goodwill is considered not to be impaired. (iii) Management was informed that a particular debtor had become bankrupt and the full account of $12 000 needs to be written off. (iv) The Allowance for Doubtful Debts account needs to be adjusted to 8% of accounts receivable, after considering the adjustment in item iii above. (v) Current income tax expense (and tax liability) for the year is estimated to be $8000. (vi) Accrued wages to staff: sales $1500, administrative $2000. (vii) Vehicle rental paid in advance at 30 June 2017 amounted to $30 000. (viii) Shares with calls in arrears are to be forfeited, any reserve being retained by the company. (ix) A dividend of 3c per share is declared on shares remaining after considering item viii. (x) Land is to be revalued upwards to its fair value of $250 000. (xi) Transfer $10 000 from the general reserve to retained earnings. Required A. Prepare the journal entries (in general journal form) required by items i to xi above. B. Prepare the adjusted trial balance as at 30 June 2017. C. Prepare the statement of profit or loss and other comprehensive income with expenses classified by function for Singapore Ltd for the year ended 30 June 2017. D. Prepare the statement of changes in equity for the year. E. Prepare the company’s statement of financial position as at 30 June 2017. A. General Journal 2017 June 30 Depreciation Expense – Buildings Dr Accumulated Depreciation – Buildings Cr (Depreciation at 5% per annum)

50 000 50 000

30 Depreciation Expense – Furniture & Equip. Accumulated Depreciation – F & E (Depreciation at 10% per annum)

Dr Cr

12 700

30 Allowance for Doubtful Debts Accounts Receivable (Bad debts written off)

Dr Cr

12 000

30 Bad Debts Expense

14 372

12 700

12 000

3.66

Chapter 3: Company operations

June

Allowance for Doubtful Debts (Recognition of allowance at 8% of receivables) 8% x (225 400 – 12 000) – (14 700 – 12 000)

14 372

30 Income Tax Expense Current Tax Liability (Income tax expense)

Dr Cr

8 000

30 Salaries Expense – Sales Staff Wages & Salaries Payable (Accrued salaries of sales staff)

Dr Cr

1 500

30 Administrative Wages Expense Wages & Salaries Payable (Accrued wages of admin. staff)

Dr Cr

2 000

30 Prepaid Rent Vehicle Rental Expense (Rent prepaid)

Dr Cr

30 000

30 Share Capital Call Forfeited Shares Reserve (Forfeiture of 8 000 shares)

Dr Cr Cr

8 000

30 Retained Earnings/Dividend Declared Dividend Payable (Dividend of 3c on 1 132 000 shares)

Dr Cr

33 960

8 000

1 500

2 000

30 000

2 000 6 000

33 960

30 Land Dr 20 000 Gain on revaluation of land (OCI) Cr (Recognition of other comprehensive income on revaluation of land)

20 000

30 Gain on revaluation of land (OCI) Revaluation Surplus (Transfer to revaluation surplus)

20 000

Dr Cr

20 000

30 General Reserve Dr Retained Earnings/Transfer from Reserve Cr (Transfer from general reserve)

10 000

3.67

Solution Manual to accompany Company Accounting 10e

B. SINGAPORE LTD Adjusted Trial Balance as at 30 June 2017 DEBIT $ Bank overdraft Vehicle rental expenses Cash at bank Investment in government bonds Goodwill Interest revenue Insurance expense Land Buildings Office furniture & equipment Retained earnings Revaluation surplus Accumulated depreciation – office furn & equip Accumulated depreciation- buildings Allowance for doubtful debts Cost of sales Advertising expense Sales returns and allowances Sales Mortgage payable Inventory Share capital (called to $1 per share) General reserve Interest expense on overdraft Discount received Discount allowed Fees revenue Proceeds on sale of furniture Carrying amount of furniture sold Accounts payable Accounts receivable Salaries of sales staff Administrative wages Calls in advance (25 cents per share) Interest expense on mortgage Depreciation expense – buildings Depreciation expense - furniture & equipment Bad debts expense Income tax expense Current tax liability Wages & salaries payable Prepaid rent Forfeited shares reserve Dividend payable

CREDIT $ 178 050

42 000 7 500 150 000 24 000 4 800 3 000 250 000 1 000 000 127 000 59 040 35 000 35 700 150 000 17 072 197 400 12 300 8 700 478 120 90 000 106 000 1 132 000 8 000 11 300 11 250 12 000 17 900 13 000 5 000 133 900 213 400 61 500 70 620 6 000 4 500 50 000 12 700 14 372 8 000 8 000 3 500 30 000

2 421 292 © John Wiley and Sons Australia, Ltd 2015

6 000 33 960 2 421 292 3.68

Chapter 3: Company operations

C. SINGAPORE LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Income: Sales $478 120 Less sales returns 8 700 $469 420 Fees revenue 17 900 Proceeds on sale of furniture 13 000 Discount received 11 250 Interest revenue 4 800 Total income 516 370 Expenses: Selling expenses Cost of sales 197 400 Advertising 12 300 Vehicle rent 42 000 Sales staff salaries 61 500 Total selling expenses 313 200 Administrative expenses Insurance expense 3 000 Carrying amount of furniture sold 5 000 Administrative wages 70 620 Depreciation of furniture & equipment 12 700 Depreciation of buildings 50 000 Total administrative expenses 141 320 Financial expenses Interest expense on overdraft 11 300 Interest expense on mortgage 4 500 Discount allowed 12 000 Bad debts 14 372 Total financial expenses 42 172 Total expenses 496 692 Net profit before income tax 19 678 Income tax expense 8 000 Profit for the year $11 678 Other comprehensive income 20 000 Total comprehensive income for the year $31 678

3.69

Solution Manual to accompany Company Accounting 10e

D. SINGAPORE LTD Statement of Changes in Equity for the year ended 30 June 2017 Total comprehensive income for the year

$31 678

Retained earnings: Balance at 1 July 2016 Profit Dividend declared - final Transfer from general reserve Balance at 30 June 2017

$83 000 11 678 (33 960) 10 000 $70 718

Share capital: Balance at 1 July 2016 Shares forfeited Balance at 30 June 2017 Other reserves: General reserve Balance at 1 July 2016 Transfer to retained earnings Balance at 30 June 2017 Revaluation surplus Balance at 1 July 2016 Revaluation of land Balance at 30 June 2017 Forfeited shares reserve Balance at 1 July 2016 Forfeiture of shares Balance at 30 June 2017

$1 144 000 (6 000) $1 138 000

$18 000 (10 000) $8 000 $ 15 000 20 000 $35 000 $

0 6 000 $6 000

3.70

Chapter 3: Company operations

E. SINGAPORE LTD Statement of Financial Position as at 30 June 2017 Current assets Cash at bank $7 500 Accounts receivable $213 400 Allowance for doubtful debts (17 072) 196 328 Inventory 106 000 Prepaid rent 30 000 Total current assets 339 828 Non-current assets Government bonds 150 000 Land 250 000 Buildings 1 000 000 Accumulated depreciation (150 000) 850 000 Office furniture and equipment 127 000 Accumulated depreciation (35 700) 91 300 Goodwill 24 000 Total non-current assets 1 365 300 Total assets 1 705 128 Current liabilities Bank overdraft 178 050 Accounts payable 133 900 Wages and salaries payable 3 500 Current tax liability 8 000 Dividend payable 33 960 Total current liabilities 357 410 Non-current liabilities Mortgage payable 90 000 Total non-current liabilities 90 000 Total liabilities 447 410 Net assets $1 257 718 Equity Share capital 1 132 000 ordinary shares issued and paid to $1 1 132 000 Plus, calls in advance 6 000 1 138 000 General reserve 8 000 Revaluation surplus 35 000 Forfeited shares reserve 6 000 Retained earnings 70 718 Total equity $1 257 718

3.71

Chapter 4: Fundamental concepts of corporate governance

Chapter 4 - Fundamental concepts of corporate governance REVIEW QUESTIONS 1. What is corporate governance? Corporate governance is the system by which companies are directed and managed. It influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and how performance is optimised.

Outline four key theories of corporate governance. What are their similarities and what are their differences?

Agency theory The separate legal status of the corporation means that the control of the corporation is detached from the equity investment where we witness a separation of ownership from control. This theory relates to the importance of the board remaining independent of management so that they can exercise control on behalf of the owners. Stakeholder theory Stakeholder theory focuses less on maintaining and enhancing shareholder value and more on providing value to all the company’s stakeholders. Many would argue that these are not mutually exclusive because shareholders, as the residual claimants of free cash flows, have a vested interest in ensuring the company uses its resources for maximum effect. Team production theory Team production theory proposes that corporations provide value by combining the key factors of production (i.e. labour or employees, capital or investors, debt or lenders and suppliers) in a manner that markets cannot. This theory sees the board as the ultimate power in the firm in contrast to both agency theory (which would portray the shareholders as holding that position) and stewardship theory (which would see various combinations of stakeholders as holding that position). Resource dependence theory This theory posits that boards (and corporate governance) exist to provide companies with the access to resources that they could not gain through market or management links. Thus, boards exist to provide access to capital, information, power and other important inputs that can assist the company to control its environment Managerial and class hegemony theory Both managerial and class hegemony theory are allied to resource dependence theory in the sense that all three share the concept of people providing access to resources. In contrast to resource dependence theory’s focus on the company, however, class hegemony theory is a

4.1

Solution Manual to accompany Company Accounting 10e

Marxist-based concept that conceptualises the upper class or business elite as a group manipulating the governance of corporations to perpetuate its power base. Managerial hegemony theory is similar to class hegemony theory in that the governance system and board is seen as the tool of management. It argues that the real power in corporate governance lies with management and that they can take advantage of shareholder weakness to pursue self-interest.

3. What are the three main fiduciary duties of directors and why are they necessary? ▪ ▪ ▪

Act in good faith for a proper purpose Not misuse the position or information (ie. Avoid a conflict of interest) Act with due care and diligence

These duties are necessary because of the fiduciary relationship that forms the basis of the relationship between a director and the company.

What are the similarities and differences between a director’s duties under sections 180 and 588G of the Corporations Act.

Both duties are derived from the common law duty of care and diligence. The duty of care in section 180(1) provides that directors must apply a reasonable degree of care and skill. Section 588G provides that if a director allows a firm to trade while insolvent, they will become personally liable for the debts incurred after the point of insolvency is reached. The duty extends to prevent a company from trading so as to become insolvent. One difference between the 2 sections is that s558G applies to directors only and not to officers.

How are continuous disclosure and insider trading requirements similar, and how are they different?

Continuous disclosure represents the obligation of listed companies to ensure the market is notified of information that a reasonable person would expect to have a material effect on the price or value of the firm’s securities. Insider trading is the offence, which arises when anyone possessing information about a listed company not generally available to the market trades in securities from that firm or “tips off” others to trade in the relevant securities. One similarity between them is that they are both elements of market based regulation for listed companies, given legislative force via the Corporations Act. Another similarity is that there are a number of defences to insider trading and to continuous disclosure requirements for directors.

4.2

Chapter 4: Fundamental concepts of corporate governance

One key difference between them is that continuous disclosure is a disclosure requirement of people within the company while insider trading is an offence that outsiders can breach. 6. How can accountants contribute to effective governance? Accountants must produce timely, accurate and reliable reports of the true position of the company. The accounting function will need to provide directors (as well as senior managers) with insights into the strategic factors at play in their organisations. Auditors play a key role in the external flow of information that they provide and the expectation that they will be independent and report breaches.

What are the different types of regulation and how are they related?

“Hard” regulation is also known as black letter law and comprises the legally binding obligations (such as directors’ and officers’ duties under the Corporations Act, 2001). In contrast, “soft regulation” are non-binding obligations and would include items such as non-mandated industry codes of conduct, societal expectations and expert opinion on corporate governance practice. Finally, there are various forms of “hybrid regulation” which are not strictly binding but generally entail some form of sanction if they are not followed. Examples of hybrid regulations would include the ASX Corporate governance principles and recommendations or industry regulations where the self-regulation could involve some form of penalty such as a fine or suspension administered by a professional body. These various forms of regulation are interrelated and vary from legal regulation with penalties to self-regulation with no penalties.

What is ‘soft’ regulation and what are its advantages and disadvantages when compared with ‘hard’ regulation?

“Soft regulation” is non-binding obligations and would include items such as non-mandated industry codes of conduct, societal expectations and expert opinion on corporate governance practice. “Hard” regulation is also known as black letter law and comprises the legally binding obligations (such as directors’ and officers’ duties under the Corporations Act, 2001). The advantage of “soft regulation’ is that it encourages self-regulation of companies to implement certain codes of conduct which can encourage social pressure and an application of the spirit of the regulation rather than strict adherence to the letter of the regulation. It is also less costly for society to implement. The disadvantage is that there are no penalties with “soft regulation” and so it may lack impact.

4.3

Solution Manual to accompany Company Accounting 10e

The advantages of the “hard regulation” approach are: • It provides at least a set of minimum corporate governance practices that must be followed

by all corporations, and • There are no uncertainties as to which practices are required. This also assists with

enforcement and with potential liability in terms of litigation. The disadvantages of this approach are: • While this provides a minimum set of practices, it is likely that good corporate governance

requires practices beyond the minimum prescribed. • It also can encourage a ‘check list’ (form over substance) approach to corporate

governance. • Legislative backing of rules can result in the view that corporate governance is about

dealing with legal liability rather than about promoting the interests of shareholders and stakeholders. • It is generally accepted that there is no ‘one’ model of corporate governance. A rules-based

approach is essentially a ‘one size fits all’ approach and does not take into account the specific circumstances of the particular entity (e.g. such as distribution of shareholders, nature of environment).

9. Explain how the regulation pyramid is used by regulators to enforce regulation. Regulations are interrelated – the various forms of regulation overlap and reinforce. Regulators can use a series of measures to enforce regulations ranging from encouraging selfregulation through to enforcement with mandatory penalties with no discretion. Good answers would outline all the components of the pyramid and would also provide examples of the escalation of application. Australia has numerous regulators including ASIC, ACCC, APRA, ASX and EPA

10.

What is an independent director and how does this differ from a non-executive director? What are the advantages and disadvantages of independent directors?

Independent directors are those with no relationship with the firm that would, or could be perceived to, materially affect their decision making. Independent directors are in fact a sub-set of non-executive directors. Non-executive directors are either independent or “grey” directors. Grey directors are those that may, at times, experience a conflict of interest due to their positions with other organisations. The ASX Corporate Governance Principles and Recommendations set out a number defining characteristics of independent directors under 2.1 (text Figure 4.5), and identifies examples of interests or relationships where independence could be compromised and would need to be assessed.

4.4

Chapter 4: Fundamental concepts of corporate governance

The ASX Corporate Governance Principles and Recommendations set out a number of advantages of having independent directors; the key ones being aims to ensure judgments made by board are in best interests of the entity and not biased towards interest of management. Disadvantages could include: • Lack of detailed knowledge of specific company and its operations • May not be as ‘invested’ in the specific company as executive directors • Potential conflicts of interests • Lack of skills or knowledge in particular areas

11.

Why is s. 588G of the Corporations Act 2001 of major importance to directors?

In essence, this section provides that if a director allows a firm to trade while insolvent, they will become personally liable for the debts incurred after the point of insolvency is reached. It is intended to engender in directors of companies experiencing financial stress a proper sense of attentiveness and responsible conduct directed towards the avoidance of any increase in the company’s debt burden. This duty is different from other director duties as courts will use an objective test in its application. This means that it is not a defence to show your background or circumstances meant you did not know the company was trading insolvently (with some rare exceptions provided for in the defence outlined in s588H); you are deemed to have the knowledge to understand the financial circumstances of the company.

12.

What are the ASX Corporate Governance Council’s Corporate governance principles and recommendations and how do they operate?

On 31 March, 2003 the ASX Corporate Governance Council released its first Principles of good corporate governance and best practice recommendations. This has been subsequently revised a number of times in 2007, 2010 and 2014 and is now known as the ASX Corporate Governance Principles and Recommendations. Details of the Principles and Recommendations are http://www.asx.com.au/regulation/corporate-governance-council.htm

available

from:

The role of the principles is to provide guidance to companies and investors on best practice corporate governance and to increase the transparency of a listed company’s corporate governance practices. These include recommendations to guide companies in how to meet the principles. As such, the recommendations for each Principle are not mandatory; rather, the approach of the ASX is an ‘if not, why not’ approach where companies are asked to (1) detail whether they comply with each best practice recommendation and (2) explain why they do not comply if this is the case. The principles are examples of “hybrid regulation” which are not strictly binding but generally entail some form of sanction if they are not followed.

4.5

Solution Manual to accompany Company Accounting 10e

13.

What are the similarities and differences between the two major types of international systems of corporate governance?

The similarities between the Anglo and Pluralist systems are that both systems require robust societal legal structures and transparency. The differences between them arise as a result of what is emphasised: Anglo systems (the basis of Australia’s system) emphasise markets and shareholder rights as important legal requirements. Pluralist systems (which form the basis of many Asian and continental European systems) place a greater emphasis on stakeholders.

4.6

Chapter 4: Fundamental concepts of corporate governance

CASE STUDIES Case Study 1

Director’s duties and insider trading

Read the extracts from newspaper articles by Blair Speedy (p.188 in the textbook). Required A. What is insider trading? As noted in the text, according to Farrar (2005, p. 272), insider trading refers to ‘improper trading in securities on the basis of price-sensitive information that is not available to the public in order to make a profit or avoid a loss’. B. The articles state that Mr Mason (the Chairman of David Jones) said that sales figures were not price sensitive information. Do you agree? What information is there to refute this statement. As noted in the articles the test of price sensitivity of information is whether a reasonable person would expect the information to have a material effect on the share price. Given that sales are linked to profitability and particularly here where it is stated ‘the first-quarter result marked a return to sales growth from existing stores after three straight quarters of decline’. Hence this suggests that the information was price sensitive which in fact was evidenced by the 6.6 per cent rise in the share price when the information was released (as the article notes, ‘its biggest one-day gain since June last year’). Clearly if the information caused analysts to revise their outlook it was price sensitive. Further, the fact that the “company brought forward the release to November 1 to calm market speculation” suggests that the price sensitivity of the information was anticipated. C. ASX Listing Rule 12.8 requires a listed entity to have a trading policy. This specifies restrictions in relation to trading of the company’s shares by directors and other key management personnel. Guidance Note 27 suggests that part of this can be met by specifying either prescribed periods for trading or 'black out' periods when trading is not allowed. It also suggests the trading policy include procedures for given written clearance for directors to trade outside 'allowed' periods (often expected to be given by the Chair). The share purchases discussed appear to have met the trading policy of David Jones. Does this mean that the trades are acceptable? As the article notes the compliance with the company’s trading policy does not negate the requirement to comply with the law and the corporations law is clear that insider trading is illegal and so, if deemed as insider trading, are not acceptable. The Guidance note itself suggests that the trading policy note that: Under insider trading laws, a person who possesses inside information may be prohibited from trading even where the trading occurs within a permitted trading window, or outside a black-out or other prohibited period, specified in the entity’s trading policy (Guidance Note 27, p. 3).

Whether these trades are ultimately determined to be insider trading will be a matter for the ASIC (and possibly the courts). Further, although there are no specific recommendations regarding trading in shares in the ASX corporate governance guidelines, under principle 3 it is recommended that the company

4.7

Solution Manual to accompany Company Accounting 10e

should have a code of conduct and suggestions for content include statements that directors etc will: • not take advantage of the property or information of the entity or its customers for personal gain or to cause detriment to the entity or its customers; • not take advantage of their position or the opportunities arising therefrom for personal gain. D. It is claimed by Dean Paatsch, that “there is no way directors can ever trade without being aware of market-sensitive information that is not known by the wider market”. Do you agree with this statement? If so, how can the potential problem of insider trading by directors be prevented? Students may agree or disagree with this statement, but given Directors position in a company in most circumstances it could be argued this statement would be true. As noted at 3, the ASX listing rules require a company to have a trading policy and this would restrict trading by directors. However, as is evident from this case, simply having specified trading ‘windows’ or’ blackouts’ does not always prevent opportune trading, as it cannot necessarily be foreseen when price sensitive information is available. However companies could restrict trading at ad hoc times, given expectation or existence of price sensitive information. A number of suggestions to avoid problems are made in the articles. These include: • •

Paying directors in cash rather than shares/stock (although instance here is about purchase of shares not sale of shares). However this is inconsistent with aligning directors and owner interests via remunerating at least partly in shares. Allowing directors to buy (or sell) shares under a pre-set program. This would mean that timing of such trades was not at the discretion of the director and therefore they could not undertake opportunistic trading on the basis of insider information.

It could be argued that given the substantial part of remuneration is often paid in shares or the like (to align interests with owners) that trading itself should not be prevented but that deterrents, via corporations law, need to be adequate to discourage insider trading.

4.8

Chapter 4: Fundamental concepts of corporate governance

Case Study 2

Independent directors

Read the following newspaper article by Adam Creighton (p.190 in the text book). Required A. What are problems associated with independent directors (actual or perceived) in this example. The article has identified that more independent directors on a board are associated with poorer performance. This is attributed to two factors: lack of skills, expertise and experience (or ‘ignorance’ as the article states); and lack of incentive or motivation (which it argues is associated with lack of monitoring). This latter factor could be attributed to the requirement for independence per se; if ‘independent’ of company could be argued less ‘bound’ to its success (or failure). Students may identify other problems (such as association with increased remuneration). B. Outline the requirements and the rationale for the independent directors in the ASX’s principles and recommendations for corporate governance. Do you think these are reasonable? The ASX Corporate Governance Principles and Recommendations sets out a number of advantages of having independent directors; the key ones being aims to ensure judgments made by board are in best interests of the entity and not biased towards interest of management. Further, it argues that ‘having a majority of independent directors makes it harder for any individual or small group of individuals to dominate the board’s decisionmaking’ (ASX CGC, 2013 p. 15). It considers a director as independent only if he or she is free of any interest, position, association or relationship that might influence, or reasonably be perceived to influence, his or her capacity to bring an independent judgement to bear on issues before the board and to act in the best interests of the entity and its security holders generally (p.15). A list of factors is provided that could indicate that independence may be comprised (these include serving on the board for more than 9 years, and having material contractual or other relationships with the entity). Whether this is reasonable is a matter of opinion but could note the following: • The recommendations for independent directors are only one within the principle of structuring the board to add value (Structure the board to add value: A listed entity should have a board of an appropriate size, composition, skills and commitment to enable it to discharge its duties effectively). Hence would also need to consider skill sets etc - not independence on its own. • These recommendations of the ASX are not required to be complied with, although listed companies need to explain why they have not complied. This allows flexibility where it is considered that other factors would provide benefits rather than complying with independence recommendations. It could be argued that given the requirement to explain where recommendations have not been followed that this may provide a strong incentive to be seen as following the ‘rules’ and perhaps encourage a form over substance approach. However a number of companies do not comply with the independence recommendations (for example, the Chair of the Board for Harvey Norman Ltd is not an independent director).

4.9

Solution Manual to accompany Company Accounting 10e

• •

Some of the guidance could be argued as arbitrary. For example, the guidance suggests that being a director of the entity for more than 9 years could indicate independence is compromised. Why is 9 years proposed? This seems arbitrary. Given the principal- agent relationship and the fact that a key role of the board is to monitor management (on behalf of shareholders) some independence from management is required on the Board.

C. The article states that the recommendations for independent directors ‘solved the “principle agent problem by destroying the principle”’. What is the rationale for this statement? As noted previously the principle agent problem derives from the separate legal status of the corporation which means that the control of the corporation is detached from the equity investment where we witness a separation of ownership from control. This theory relates to the importance of the board remaining independent of management so that they can exercise control on behalf of the owners (so that management cannot act in their own self-interest at the expense of shareholders). Hence the recommendation for independent directors as in principle they should act in the best interests of shareholders (owners) and maximise wealth for shareholders. The article argues that independent directors are not in fact acting in the best interests of shareholders (as evidenced by poor performance) due to problems identified in answer to 1 above.

4.10

Chapter 4: Fundamental concepts of corporate governance

Case Study 3

Executive remuneration and regulation

Read the extract from an article by Terry McCrann (p.191 in the textbook). Required A. What have been the consequences of the introduction of the two-strike rule? Do you think this has improved corporate governance? The articles identify the following consequences: • Has encouraged boards to be more responsive to shareholder concerns in relation to remuneration (and other issues in general) and has seen a substantial reform in pay structures. • Boards required to provide information and hence held more accountable. Would argue has improved governance due to: • Boards more responsive to shareholder concerns (noted in article that ‘has ushered in a new era of engagement with shareholders, who were often dismissed as a necessary nuisance by company directors in the past’). • Reform of pay structure reduced excesses and has potential to better align directors with shareholder interests and curb excessive pay. • Increased transparency by requiring specific details of remuneration. • Provides an ‘easier’ mechanism for shareholders (especially minority) to protest or question as requires only 25% of votes cast.

B. What are the criticisms of the two strike rule? Do you think these are valid? Possible criticisms are: • Undemocratic: this argument is based on the fact that the ‘strike’ vote only requires 25% of the votes cast at the AGM. Given that in many instances relatively few votes are actually cast at the AGM as many shareholders are passive investors, this means that a small minority (which may not reflect the opinion of the majority) can result in ‘strikes’. • Unnecessary: if minority shareholders dissatisfied only need 5% to call an extraordinary general meeting and to spill the board still requires a majority of over 50% of all votes. Hence provisions already existed for shareholders to act if dissatisfied. • Ineffective: This relates to the point above, that although only need 25% of votes cast to spill board, still require 50% of all votes. • Costly: as could require extraordinary general meeting and result in spill of board (and re-elections etc). • Misused: intention was as a mechanism for shareholders to express dissatisfaction for remuneration, but may be used where dissatisfied with other aspects (eg. company performance). Validity of these criticisms: This will depend on personal position. However could argue:

4.11

Solution Manual to accompany Company Accounting 10e

•

• • •

It would appear on the face undemocratic in terms of overall % required, particularly due to the count of only those votes actually cast at the AGM. This could be countered by arguments that: o Provides a mechanism for minority but active investor’s views to be considered. As noted in extracts, strikes can be viewed as advisory as they still require majority for spill of board. If unnecessary, why has it had a positive impact on remuneration packages and engagement with shareholders? Also, even though 5% of shareholders can call an EGM, this is a significant action, whereas the two strikes rule allows shareholders to express concern without taking such action as a first step. Again, if ineffective, why has it had a positive impact on remuneration packages and engagement with shareholders? As extracts state, in most cases a second strike has not occurred and so minimal costs involved for most companies. It can be argued that shareholders are using this mechanism to complain or bring notice to issues apart from remuneration. However the extracts suggest that the ‘shareholder community is using the weapon responsibly in a targeted way’.

4.12

Chapter 4: Fundamental concepts of corporate governance

PRACTICE QUESTIONS 1.

Do you agree that a majority of directors of listed companies should be independent? Justify your argument, paying particular attention to the implications for the skills base of the board and the ability of the board to monitor management appropriately.

It is not necessary that a majority of directors of listed companies are independent. The more important factor is that the board members have a great understanding of the underlying business as well as being capable of ‘independent thinking’ particularly in relation to the responsibility to control agency costs associated with managers. (Academic studies have failed to find any consistent evidence of a relationship between firm performance and the independence of directors.) Good answers will note the ASX principles are “comply or explain” in approach and the soon-to-be-implemented changes to their Principles of Good Governance have moved away from definitions of independence to “indicators” of governance strengthening this view.

If you believe that agency theory appropriately describes the corporate governance dilemma, what are the implications for what boards should do? How would this differ if you thought resource dependence theory was a more appropriate explanation? Do you think it is one theory or the other? Justify your response and discuss the implications for board structure.

If agency theory is a key factor for corporate governance, boards should consider steps that can be taken to ensure board members remain independent of management so that they can exercise the control on behalf of the company’s owners. One area that this would impact would be the structuring of the board in terms of the number of independent directors. If resource dependence is a key factor for corporate governance, boards should consider what additional resources they require that they could not gain through market or management links. Thus, boards exist to provide access to capital, information, power and other important inputs that can assist the company to control its environment. In practice, both theories play an important role in the area of corporate governance. Two of the key functions that a board must fulfil are monitoring and control and access to resources. Thus boards should consider these factors when appointing board members and ensure that there is an adequate ‘independent’ component as well as a broad knowledge base of the members that includes a good understanding of the central business involved.

Why are continuous disclosure and insider trading provisions important to modern economies? What are the implications of these requirements for a board of directors of a listed company? What are some practical steps a board can take to ensure compliance with these provisions?

The central idea behind both continuous disclosure and the prohibition on insider trading is to build a robust and efficient equities market in Australia because they allow the market to be

4.13

Solution Manual to accompany Company Accounting 10e

as fully informed as possible when making investment decisions and provide the ability to rely on efficient provision of information. Continuous disclosure is the specific requirement of listed entities under Listing Rule 3.1 (and given legislative force via section 674(1) of the Corporations Act) to keep the market informed of information likely to affect the price of its shares. If the information is confidential (i.e. not known outside the company) then a company may choose not to disclose if a reasonable person would not think it necessary to disclose and the information is insufficiently clear. Obviously, this is a very wide obligation of disclosure and this requires considerable judgment from directors as to when to disclose and when not to disclose as virtually every decision made by a board of directors has the potential to affect the price of its securities. Therefore, listed companies must develop key information management systems that seek to manage the flow of information to the market.

Compare and contrast typical Anglo systems of governance with Pluralistic forms of governance. Which do you think is more effective and why? What are the implications of your choice for the legal system and capital markets?

The Anglo system of corporate governance is based on a well-developed legal system, a mature market economy and the philosophy (or national culture) that the most important role of the board is to supervise management and reduce the agency costs associated with the separation of ownership from control. This protection of shareholder rights (particularly minority rights) is embedded in the legal system (e.g. directors’ duties), capital markets (e.g. continuous disclosure requirements) and corporate and community culture (e.g. the predominance of shareholder value as the ultimate goal of the for-profit company). The Pluralist system of corporate governance is based on a civil law system, a more stakeholder orientated relationship between shareholders, banks and the community, and a more public benefit or communal philosophy or culture. Under this system, a key role of the Board can be to ensure appropriate representation of stakeholders in the direction and control of the corporation. For instance in Germany, which operates a pluralist system, employees often have a right to have representatives sit on the supervisory board. In relation to which is more effective, it is largely dependent on the legal system and cultural backgrounds as to which is more suitable.

‘Any corporate governance system is only as good as the people involved in it.’ Discuss.

As the text notes decisions in, and about, corporations are made by people. The quality of any corporate governance is ultimately affected by the people involved in it. The following points could be discussed: • Competence — clearly, if individuals do not have the requisite expertise or experience

then this will adversely impact on decisions they make and reduce the quality of corporate governance.

4.14

Chapter 4: Fundamental concepts of corporate governance

• Integrity (ethics) of individuals. Whether or not individuals will act ethically is affected by

a number of factors. These include: – the individual’s own moral code – the culture of the corporation and of peers. This is particularly important in relation to top management. In a number of corporations it is argued that either ethical or unethical behaviour permeates due to the stance taken by the ‘leaders’. – the consequences of the decision. For example, if asked to do something that is not ‘right’ by a manager and refusing could impact on employment/future promotion; how ‘wrong’ is the decision and will it have a significant impact on others; what is the likelihood of being caught and what are the consequences if found to be acting unethically).

Obtain the annual reports of a range of companies in the same industry and search for any disclosures in relation to corporate governance principles and practices. In relation to these disclosures: (a) Identify the key areas considered by these companies. (b) Are there any differences or similarities in corporate governance practices? (c) Do you believe you could judge or rank the relative standard of corporate governance of these companies based on the information provided? If not, what other information would you need to do so? (d) Which company would you rank as having the best (or worst) corporate governance from these disclosures? Explain how you have arrived at this decision. (e) Compare your rankings with those of other students. Identify and discuss the reason for any discrepancies between rankings No specific answers can be provided as this will depend on the companies considered. Go online and download a couple of annual reports in the same industry, from 2012 to 2015 and see the differences. Discuss the following in class: (a)

What have you found out about the key areas?

(b)

Explain the differences and similarities in class, on your Blackboard or WebCT.

(c)

Discuss how and what you would use to judge or rank the companies and what further information you would need.

(d)

Discuss the judgment you have made.

(e)

Did you identify the best and worst cases or corporate governance?

Obtain the annual reports of a range of companies in the same industry in different countries and search for any disclosures in relation to corporate governance principles and practices. In relation to these disclosures: (a) Identify any differences or similarities in corporate governance practices. (b) Can you provide any reasons from the business and regulatory environments in the countries that would explain these differences?

4.15

Solution Manual to accompany Company Accounting 10e

No specific answers can be provided as this will depend on the companies considered. Again go online and download annual reports from various countries to discuss in class. It may also be useful to consider, identify and compare: •

country economic and business environmental factors

•

any specific corporate governance guidelines or requirements issued for companies in the specific countries considered, for example by local stock exchanges, as well as considering enforcement mechanisms.

•

Which of their governance practices reflect the Anglo versus Pluralist system

In class, explain the differences or similarities in corporate governance practices.

Obtain the annual report for a listed company and examine the remuneration packages provided for executives.

(a) Identify the key components of the remuneration packages for directors and executives. Note: these are disclosed in annual reports (or available on the company’s web page as a separate remuneration report) and see how these principles are reflected in the packages. A suggested example is the 2013 annual report for AMP — this includes details of the remuneration package and related benchmarks. You can access this from links from http://www.amp.com.au/ or the 2013 annual report for Crown Ltd which includes details of the amounts of potential cash bonuses. You can access this from links from http://www.crownlimited.com. These will normally include fixed components and also components related to short and long term hurdles. (b) Do you think these packages are appropriate to provide incentives for these executives to work in the interests of shareholders? As fixed components are not related to performance then these would only provide limited incentives to act in shareholder interests. Short term incentives are normally aimed at maximizing profit in the short term. These may also be linked to dividends. Long term incentives are aimed at maximizing value and are normally reflected in share price. Maximizing profit, paying and maintaining dividends and maximizing share value are all in the interests of shareholders (although relative importance on each of these will vary across companies/shareholders). You may also wish to consider the following: • Are the benchmarks/targets for obtaining any bonuses clear? • Are these reasonable for rewarding performance? For example, if linked to the share price

of the company do they take into account general share price movements for similar companies? If they do not, then they may be penalising or rewarding managers for market factors rather than their own performance.

4.16

Chapter 4: Fundamental concepts of corporate governance

• Are there any components that do not seem ‘fit’ with shareholder interests? If so, why do

you think these components are included? (c) How much information is provided about any bonuses paid? Is this information sufficient to allow shareholders to determine if these packages are reasonable? This will depend on the reports that you have found. You will probably find that in many cases there is limited information (in particular about benchmarks — often generic information about benchmarks is included rather than specifics). This makes it difficult for shareholders to consider, however, there could be legitimate competitive reasons for not disclosing this information.

Each year various bodies give corporate governance awards. The Australasian Reporting Awards (Inc.), an independent not-for-profit organisation makes annual awards for corporate governance reporting.

(a) Locate the criteria on which this award is based. The Australasian Reporting Awards and criteria for corporate governance awards states that “These Awards seek to recognise the quality and completeness of disclosure and reporting of corporate governance practices in the annual reports of business entities in the public and private sectors.” http://www.arawards.com.au/ The corporate governance reporting awards are one of the Special awards for excellence and “use the Principles of Good Corporate Governance and Best Practice Recommendations of the ASX Corporate Governance Council as the guiding criteria for the private sector Awards. The adjudication panel will follow the “if not why not” philosophy of the guidelines and look for reports that provide quality disclosures and clear explanations of how and why certain paths were followed.” http://www.arawards.com.au/ (b) In what areas of corporate governance reporting did winning companies outperform other companies? The Australasian Reporting Awards identifies companies that have been ranked as gold, silver or bronze (for example, one difference between gold and silver is that gold requires ‘full’ disclosure whereas silver requires ‘adequate’ disclosure). It may be useful to look at reports for companies in these different rankings to identify any differences. (c) Does the winning of an award for reporting necessarily mean that these companies have best corporate governance practices? Students should consider: • How would you tell if a company did not follow these practices that they have claimed? • How likely it is that companies who do not have good corporate governance practices

would disclose this fact? It may be what is not disclosed that is important. (Remember: Enron was perceived as one of the best but fell short in practice)

4.17

Solution Manual to accompany Company Accounting 10e

10. Australian companies listed on the ASX must report on their corporate governance practices on the basis of ‘comply or explain’. That is, they are not required to comply with all of the specific corporate governance practices recommended by the ASX but if they choose not to comply, they must identify which guidelines have not been ignored and provide a reason for their lack of compliance. (a) Examine the corporate governance disclosures of some Australian listed companies and identify any instances where best practice recommendations of the ASX have not been met. Examples are: • As discussed in the text Harvey Norman’s 2013 annual report it is disclosed that the

recommendations relating to independence of board members and the Chairman are not met. You can access this report from http://www.harveynormanholdings.com.au/ • Kresta Holdings Ltd 2013 annual report discloses that they are compliant except that there is no separate nomination committee. https://www.kresta.com.au/ • Students should be able to find own examples. (b) Do you believe that the noncompliance in these instances is justified? Responses will depend on the nature of non-compliance and also circumstances and reasons given by particular company for non-compliance. (c) What are the advantages of having a ‘comply or explain’ requirement rather than requiring all companies to comply with all best practice recommendations? The advantages are that this allows specific circumstances of a company to be considered when determining appropriate corporate governance practices (so for example, does not impose a ‘one size fits all’ approach regardless of the size of the company). This is consistent with the principles-based approach to corporate governance. While this allows flexibility, the fact that the need to disclose and justify non-compliance also allows shareholders and other stakeholders to clearly identify any instances of non-compliance and also requires management to consider this (it could be argued that as they need to disclose if they do not comply then management need to explicitly consider whether or not non-compliance is justified as they will be open to scrutiny).

11. At any time there are problems (and subsequent investigations) with corporate governance, which include deficiencies in financial reporting. (a) Search the website of regulatory authorities (such as the Australian Securities and Investments Commission or the Securities and Exchange Commission in the United States) and identify a case that has been investigated that involves issues of corporate governance. The ASIC annual report provides a summary of major cases and the media centre (under the Publications link) often provides summaries of cases considered or investigated (access from http://www.asic.gov.au). The ‘key matters’ section at

4.18

Chapter 4: Fundamental concepts of corporate governance

http://www.asic.gov.au/asic/ASIC.NSF/byHeadline/Media%20centre has information on major investigations/cases. (b) Briefly discuss the corporate governance issues and what part financial reporting played in these. This will depend on the cases found by students. It may be useful to look at the annual reports of companies involved in investigations and consider their corporate governance disclosures (and practices). (c) Suggest what procedures or practices would prevent these abuses occurring. Again, this will depend on the cases found by students. It may be useful to consider the nature of cases and problems: e.g. did these require collusion (i.e. involvement of more than one person); how were problems detected (this may give a hint of how problems could be prevented and whether corporate governance processes could have assisted); what corporate governance disclosures did these entities make (do these indicate that the systems are acceptable).

4.19

Chapter 5: Fair value measurement

Chapter 5 – Fair value measurement REVIEW QUESTIONS 1.

Name three current accounting standards that permit or require the use of fair values.

AASB 3 Business combinations para 32 AASB 9 Financial instruments para 4.1 AASB 116 Property, plant and equipment, para 31 AASB 138 Intangibles para 33, 75 AASB 140 Investment property para 30 AASB 141 Agriculture para 13

What are the main objectives of AASB 13?

The main objectives are: - to define fair value - to establish a framework for measuring fair value - to require disclosures about fair value measurement (AASB 13, para 1) 3. What are the key elements of the definition of “fair value”? -

current exit price: to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date

How does the proposed definition of fair value differ from that used in current accounting standards?

The definitions are the same in terms of: - assumes an hypothetical transaction - the transaction is orderly - market participants is the same as knowledgeable willing parties in an arm’s length transaction The new definition: - specifies that an entity is selling the asset, not buying - clarifies that a liability is to be transferred - specifies the need for a measurement date

5.1

Solution Manual to accompany Company Accounting 10e

How does entry price differ from exit price?

An entry price is one that would be paid to buy an asset or received to incur a liability. An exit price is one that would be received to sell an asset or paid to transfer a liability. They are expected to be the same IF they relate to the same asset or liability on the same date in the same form in the same market. This is probably only true in an active market.

6. Is the reporting entity a market participant? No. Assumptions made by market participants are not those made by the entity itself. The fair value is not entity-specific.

Does the measurement of fair value take into account transport costs and transaction costs? Explain.

Transaction costs are the incremental direct costs to sell an asset or transfer a liability, while transport costs are the costs necessarily incurred to transfer an asset to its most advantageous market. The measurement of fair value requires both costs to be taken into consideration in the determination of the most advantageous market. However, only transport costs are used in the calculation of the fair value number. Transaction costs are entity-specific, transport costs are not; they relate to the asset itself. See Illustrative example 5.1.

What are the key steps in determining a fair value measure?

An entity has to determine: 1. the particular asset or liability that is the subject of the measurement (consistent with its unit of account). 2. for a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its highest and best use). 3. the principal (or most advantageous market) for the asset or liability. 4. the valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use in pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorised.

5.2

Chapter 5: Fair value measurement

Explain the difference between the current use of an asset and the highest and best use of that asset.

The current use is how the reporting entity is currently using an asset. The highest and best use is based on how market participants will use the asset. An example of where the two may differ is where land is currently used as a site for a factory, but the land could be used for residential purposes. The current use is industrial while the highest and best use could be either industrial or residential.

10. Explain the difference between the in-combination valuation premise and the standalone valuation premise. The valuation premise is established by the highest and best use of the asset. In-combination valuation premise is discussed in AASB 13, para 31(a) which states that the highest value of an asset may be: “through its use in combination with other assets as a group (as installed or otherwise configured for use) or in combination with other assets and liabilities (e.g. a business)”. In these circumstances, the fair value will be the price received in a current sales transaction, assuming the asset will be used with other assets and/or liabilities that are also available to market participants. If the asset is to be used with a business and include liabilities, the nature of the associated liabilities are only those used to fund working capital, not liabilities used to fund assets that are outside the group of assets in the current transaction. Stand-alone valuation premise is essentially when the asset is being considered as a single (stand-alone) asset, and not in combination with other assets or liabilities. In these circumstances, “the fair value of the asset is the price that would be received in a current transaction to sell the asset to market participants that would use the asset on a stand-alone basis”. (AASB 13 para. 31(b)) 11. What is the difference between an entity’s principal market and its most advantageous market? Appendix A to AASB 13 contains the following definitions: Most advantageous market: The market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after considering transaction costs and transport costs. Principal market: The market with the greatest volume and level of activity for the asset or liability.

5.3

Solution Manual to accompany Company Accounting 10e

Because there may be buyers and sellers who are willing to pay high prices and deal outside the principal market, the most advantageous market may not be the principal market. However, an entity may assume that the principal market is the most advantageous market provided that the entity can access the principal market.

5.4

Chapter 5: Fair value measurement

12. What valuation techniques are available to measure fair value? -

the market approach: prices generated by market transaction the cost approach: prices based on amounts required to replace the service capacity of an asset. the income approach: prices generated by considering future cash flows or future income and expenses

13. Explain the fair value hierarchy. The fair value hierarchy is a hierarchy of inputs into the fair value measurement. The inputs are the assumptions that market participants make when using a valuation technique in pricing an asset or liability. The inputs are classified as observable or unobservable. The fair value hierarchy gives the highest priority to observable inputs and the lowest to unobservable inputs. The hierarchy does NOT prioritise the valuation techniques, just the inputs to those techniques. The fair value hierarchy prioritises inputs into 3 levels – Level 1, 2 and 3 – see the answer to RQ 14 for information on these levels. The hierarchy is also used in the disclosure process as a fair value measure is classified in its entirety based on the lowest level input that is significant to the entire measurement.

14. Explain the different levels of fair value inputs. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. The inputs are observable. The markets must be active. The assets/liabilities must be identical. Level 2 inputs are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly as prices or indirectly as derived from prices. The inputs are observable. The inputs are based on market prices or other market data such as interest rate curves. Level 3 inputs are inputs for the asset or liability that are not based on observable market data. The inputs are unobservable. The information may include entity-specific data.

5.5

Solution Manual to accompany Company Accounting 10e

15. How does the measurement of the fair value of a liability differ from that of an asset? The highest and best use does not apply to liabilities. There will generally be no observable price for the transfer of a liability. The measurement of the liability is based on the same methodology that the counterparty would use to measure the fair value of the corresponding asset. Non-performance risk is taken into consideration in the measurement of the fair value of a liability.

5.6

Chapter 5: Fair value measurement

CASE STUDIES Case Study 1

Valuation premise for measurement of fair value

Snapper Ltd conducts a business that makes women’s shoes. It operates a factory in an inner suburb of Perth. The factory contains a large amount of equipment that is used in the manufacture of shoes. Snapper Ltd owns both the factory and the land on which the factory stands. The land was acquired in 2007 for $200 000 and the factory was built in that year at a cost of $520 000. Both assets are recorded at cost, with the factory having a carrying amount at 30 June 2016 of $260 000. In recent years there has been a property boom in Perth with residential house prices doubling such that the average price of a house is approximately $500 000. A recent valuation of the land on which the factory stands as performed by a property valuation group and based on recent sales of land in the area has the land at a value of $1 000 000. The land is now considered prime residential property given its closeness to the city and, with its superb river views, its suitability for building executive apartments. It would cost $100 000 to demolish the factory to make way for these apartments to be built. It is estimated that to build a new factory on the current site would cost around $780 000. The directors of Snapper Ltd want to measure both the factory and the land at fair value as at 30 June 2016. Required Discuss how you would measure these fair values. 1. Determine the asset or liability that is the subject of measurement: In this case, there are 2 assets that could be measured at fair value, namely land and factory. An alternative would be to consider the land and the factory as a single asset. 2. Determine the valuation premise consistent with the highest and best use The land could be sold for residential purposes for an estimated $1m. Given the cost to demolish the existing factory of $100 000, the land could be sold for residential purposes for $900 000. Measuring fair value in this fashion assumes a specific use and is based on an in-exchange valuation premise as the land is considered on a stand-alone basis. The land and factory could also be sold as a package for use by market participants in conjunction with other assets. The factory has been depreciated by the reporting entity to half its original cost. Given the cost to build a new factory is $780 000, a depreciated replacement cost of the existing factory could be said to be $390 000. However as the factory could presumably be viably built on a cheaper block of land ie one not usable for residential purposes, it is unlikely that there is a market for the land and the factory on an in-use basis. A market participant would be forced to pay the $900 000 for the factory and the land given the alternative use of the land for residential purposes. 3. Determine the most advantageous market for the assets The most advantageous market would appear to be the selling of the property for residential purposes. 4. Determine the valuation technique

5.7

Solution Manual to accompany Company Accounting 10e

The market approach would be the appropriate valuation technique given that there are observable market inputs in relation to the selling prices of similar properties. The land has a fair value based on market prices for similar properties of $900 000. The factory has a zero fair value as a separate asset. Example 2 of the Illustrative Examples considers a similar situation to this case. The highest and best use of the land is determined by comparing: (i) the value of the land as a vacant block for residential purposes which would include the factory at a zero fair value, and (ii) the value of the land as currently developed for industrial use which would include the factory as an ongoing asset. The highest and best use is the higher of these two values. If (i) is chosen, then the factory has a zero fair value and no subsequent depreciation would be determined. If (ii) is chosen, then it would be necessary to determine the fair value of the land separate from the fair value of the factory in order to depreciate the factory. It could be argued that that the fair value of the factory equals the difference between the fair value of the land for residential purposes and the fair value of the combined assets.

5.8

Chapter 5: Fair value measurement

Case Study 2

Highest and best use

Bream Ltd is in the business of bottling wine, particularly for small wineries that cannot afford sophisticated technical equipment and want to concentrate on the growing of the grapes themselves. One of the key features of the bottles that are used by Bream Ltd is that, for the bottles used for white wine and champagne, they have an in-built insulation device that is successful in keeping the contents of the bottle cold, with the temperature being unaffected by the bottle being held in the hand. In January 2016, Solar-Blue, a company experimenting with energy sources useful in combating climate change, produced a device which, when attached to the outside of a container, could display the actual temperature of the liquid inside. The temperature was displayed by the highlighting of certain colours on the device. Exactly how this device could be attached to wine bottles had yet to be specifically determined. However, Bream Ltd believed that its employees had the skills that would enable the company to determine the feasibility of such a project. Whether the costs of attaching the device to wine bottles would be prohibitive was also unknown. As Bream Ltd was concerned that competing wine bottling companies may acquire the device from Solar-Blue, it paid $100 000 for the exclusive rights to use the device with bottles. The accountant wants to measure the fair value of the asset acquired. Required Discuss the process of determining this fair value. 1.

Determine the asset or liability that is the subject of measurement: In this case, the asset is the right to use the temperature-revealing device.

Determine the valuation premise consistent with the highest and best use To measure the fair value of the asset at initial recognition, the highest and best use of the asset is determined on the basis of its use by market participants. There are a number of possible uses for the asset: (a) Bream Ltd could continue to develop the device for use with bottles - how the device could be used with wine bottles has yet to be specifically determined. Bream Ltd believes its employees have the skills to be able to investigate this possibility. The fair value measured would then be based on an in-use valuation premise and would be based on the price that would be received in a current transaction to sell the device to market participants, assuming that there are other wine makers, or even soft drink companies that would be able to use the device in conjunction with their bottling activities. (b) Bream Ltd could decide to cease development of the device in relation to its applicability to use with bottles. In valuing the asset, the assumption is then that other market participants would also lock up the device based upon a defensive competitive strategy, reducing the risk that competitors could achieve a significant marketing edge and so substantially increase market share. The appropriate assumption is then an inuse valuation premise. (c) Bream Ltd could consider that the highest and best use of the asset is to cease development of the project as other market participants would also cease development if they acquired the asset. This may be the case where market participants do not consider that the device will eventually be able to be used with bottles and so the device will not provide a market rate of return if completed. The fair value would be

5.9

Solution Manual to accompany Company Accounting 10e

measured using an in-exchange valuation premise in this scenario. The fair value would be determined by considering what market participants would pay for the rights to use the device for bottles if Bream Ltd sold this asset to them. 3. Determine the principal (or most advantageous market) for the assets The most advantageous market would be determined by considering the three scenarios in part 2 above, and taking into account the transport and transaction costs. 4. Determine the valuation technique This asset is a unique asset. There are no similar assets on the market. Hence a market valuation approach is not applicable. An income valuation approach could be used based on the expected extra cash flows that could be derived from sales once the device has proved to be successful. Given that the device still has to be proved to be useful in relation to bottles, this requires a great deal of judgement. The cost approach would require the determination of the costs required to develop a similar device and have the rights to its use. This would be difficult for Bream Ltd to be able to calculate with any reliability. It is expected that the income valuation approach would be the most applicable method. In deciding to pay Solar-Blue $100 000 for the rights to use the device, it is assumed that Bream Ltd would have investigated the possible effects on its profits and market share if its competitors had acquired the device from Solar-Blue.

5.10

Chapter 5: Fair value measurement

Case Study 3

‘In-combination’ valuation premise

Herring Ltd acquired a business that used a large number of assets that worked in combination to produce a product saleable in offshore markets. One feature of the assets of the business is that it includes a computer program that enables the inputs to the manufacturing process to be transferred in a predetermined routine to the assets that work together to produce the output. In measuring the fair value of the computer program, management of Herring Ltd determined that the valuation premise was ‘in-combination’ as the program worked together with other assets in the business. Required Discuss how the various valuation approaches may be applied in the determination of the fair value of the computer program. The computer program would provide the best value to market participants through its use with other assets as the program works with other assets in the manufacturing process. Hence, the in-use valuation premise is appropriate for this asset while the highest and best use for the asset is its current use within the manufacturing process. The market valuation approach would not be applicable if the software program is unique. Use of the market valuation approach would require the existence of comparable software assets. The income approach could be applied with a present value technique being used. The cash flows used in this technique would be based on the income stream expected to result from the use of the computer program over its economic life. This may be determined by considering what market participants would pay as a licence fee to be able to use the computer program in their businesses. The cost approach could also be used. This approach would require the estimation of what it would cost currently to construct a substitute computer program that would perform the same tasks as the program being valued. A difficulty in this process could arise if some of the components of the program are unique and difficult to replicate by another market participant.

5.11

Solution Manual to accompany Company Accounting 10e

Case Study 4

Characteristics of an asset

Mr Merman owned a large house on a sizeable piece of land in Brisbane. The property had been in his family since around 1889. Mr Merman was 92 years old and was incapable of taking care of the large property. He wanted to move into a retirement village and so sold his property to the MedSea Group which was an association of doctors. The doctors wanted to use the house for their medical practice as it was centrally situated, had many rooms and had an ‘old-world’ atmosphere that would make patients feel comfortable. The house was surrounded by a large group of trees that had been planted by the Merman family over the years. The trees covered a large portion of the land. MedSea did not want to make large alterations to the house as it was suitable for a doctors’ surgery. Only minor alterations to the inside of the house and some maintenance to the exterior were required. However, MedSea wanted to divide the land and sell the portion adjacent to the house; this portion currently being covered in trees. The property sold would be very suitable for up-market apartment blocks. One of the conditions of the sale of the property to MedSea was that, while Mr Merman remained alive, the trees on the property could not be cut down as it would have caused him great distress to see such alterations to the family home. This clause in the contract would restrict the building of the apartment blocks. However, this restriction would not be enforceable on subsequent buyers of the property if MedSea wanted to sell the property in the future. A further issue affecting the building of the apartment blocks was that across one corner of the block there was a gas pipeline that was a part of the city infrastructure for the supply of gas facilities to Brisbane residents. Required Outline any provisions in AASB 13 that relate to consideration of restrictions on the measurement of fair values of assets, and how in the situation described above the restrictions would affect the measurement of the fair value of the property by MedSea. The relevant paragraphs of AASB 13 are: -

Para 11: Fair value measurement shall consider the characteristics of an asset or liability eg condition, location and restrictions on sale or use. Para 20: although an entity must have access to the market at the measurement date, it does not need to be able to sell the particular asset or transfer the liability on that date if there are restrictions on the sale of the asset. Para 28(b): Highest and best use must be a legally permissable use, taking into account any legal restrictions on the use of the asset.

Para BC46 states that restrictions on the sale or use of an asset affect its fair value if market participants would take the restrictions into account when pricing the asset at the measurement date. Para BC100 states that restrictions on the transfer of an asset relate to the marketability of an asset. The inclusion of a restriction preventing the sale of an asset typically results in a lower fair value for the restricted asset than for the non-restricted asset, all other factors being equal.

5.12

Chapter 5: Fair value measurement

Note that the adjustment for a restriction is not a level 1 input, and if the adjustment is significant, the fair value measure would be categorised at a lower level of the fair value hierarchy. The asset considered in this case is the house and the land. There are no restrictions on the house but there are restrictions on the land. There are 2 restrictions on the land: - the trees cannot be cut down until Mr Merman dies; and - there is a gas pipeline across one corner of the land. The restriction on the cutting down of the trees is enforceable on MedSea but not on any subsequent buyers of the property. Because the restriction is specific to MedSea and not to other market participants the restriction is not considered in measuring the fair value of the property – fair value measurement is not entity-specific. Therefore the fair value of the land is based on the higher of its fair value as the grounds of the current property, ie on an in-use valuation premise – and its fair value in exchange to market participants ie on an in-exchange valuation premise, considering the use of the property as a residential building site. The restriction on the property in relation to the felling of the trees is not a consideration in this measurement process. The restriction in relation to the gas pipeline is a condition specific to the asset itself in the same way as the condition or location of an asset is specific to an asset. This restriction is transferred to subsequent buyers of the property, the market participants. Measurement of the fair value of the property must then take into consideration the existence of the restriction and the effect on the valuation of the property. For example, if a building cannot be built over the pipeline as the gas authorities may need access to the pipeline, then this restricts the size of any building that could be built on the property. This affects the value of the land regardless of whether an in-use or an in-exchange valuation premise is applied.

5.13

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 5.1

Requirement for a standard

Measurement at fair value has been available in accounting standards for a long period of time. However, it was only in 2011 that the AASB issued AASB 13 Fair Value Measurement, providing an accounting standard in relation to fair value measurement. Required Discuss why such a standard was considered necessary. The definition of fair value prior to the issue of AASB 13 was as follows: Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable willing parties in an arm’s length transaction. Paragraph BC30 provides three reasons for the change in the definition: 1. the current definition does not specify whether an entity is buying or selling the asset. It is then uncertain whether fair value is an exit [selling] price or an entry [buying] price. The proposed definition requires the use of an exit price. 2. in the current definition, it is unclear what is meant by “settling” a liability. Who are the knowledgeable parties? Does this mean the creditor, or other parties? The proposed definition requires measurement by reference to the transfer of a liability to a party who may not be the creditor. 3. there is no explicit statement in the current definition whether the exchange or settlement takes place at the measurement date or at some other date. The proposed definition specifies that the fair value is the price at the measurement date.

Question 5.2

Definition of fair value

AASB 13 provides a definition of ‘fair value’. Required Outline the key characteristics of this definition and explain the effects of the inclusion of each characteristic in the definition. The key characteristics are: 1. a current exit price: The price is based on expectations about the future cash flows to be generated by an asset or used to pay or transfer a liability. The cash flows for an asset can be generated from use of the asset or sale of the asset. The price may be different from an entry price.

5.14

Chapter 5: Fair value measurement

The effect of this characteristic, for an asset, is that the price is a selling price not a buying price. 2. an orderly transaction: An orderly transaction is defined in Appendix A as: A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (eg a forced liquidation or distress sale).

The transaction is a hypothetical one. The transaction occurs in current markets, in particular in markets where orderly transactions occur. Market transactions in cases of liquidation sales or fire sales are not relevant markets. This characteristic affects the choice of markets to be observed. 3. between market participants: A definition of market participants is given in Appendix A: Buyers and sellers in the principal (or most advantageous market) for the asset or liability that have all the following characteristics: a) They are independent of each other, ie they are not related parties as defined in AASB 124 Related Party Disclosures …. b) They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary; c) They are able to enter into a transaction for the asset or liability; d) They are willing to enter into a transaction for the asset or liability, ie they are motivated but not forced or otherwise compelled to do so.

The phrase “knowledgeable, willing parties in an arm’s length transaction” has the same meaning. The assumptions made in the valuation process are those made by the market participants, not those made by the reporting entity. There is no need to identify specific market participants – the emphasis is on the characteristics of the participants. The fair value measure is not entity-specific. The market participants are assumed to have the other assets to combine with the asset being valued where an in-use valuation premise is applied. 4. at the measurement date: Fair value is measured at a specific point of time taking into consideration the conditions and restrictions in relation to an asset and a liability at that date.

5.15

Solution Manual to accompany Company Accounting 10e

Question 5.3

Assets without an active market

Emily Chasan (2008) reported: ‘It’s ridiculous to apply fair value accounting to assets that have no market,’ said Christopher Whalen, managing director of risk research firm Institutional Risk Analytics. ‘All this volatility we now have in financial reporting and disclosure, it’s just absolute madness.’ ‘Investors as a group have to get a better understanding of what the volatility means,’ said Ed Nusbaum, chief executive of accounting firm Grant Thornton. ‘They want to live in a perfect world. They’d like complete transparency and no surprises. But I think it’s unlikely that the big write-downs that we’ve seen will reverse.’

Required Discuss the issues associated with fair value accounting for assets without an active market. Paragraph 62 of AASB 13 proposes 3 possible valuation techniques: - the market approach - the cost approach, and - the income approach In using these techniques the reporting entity will make assumptions or provide inputs into the valuation model. The inputs are classified as being one of two types: - observable, and - unobservable These inputs are prioritised into 3 levels: Levels 1, 2 and 3. Only Level 1 and level 2 inputs relate to information obtained from markets. Level 3 inputs are not based on observable market data. In the quotation from Chasan the question is whether fair values based on unobservable inputs should be allowed. Questions relate to: - the reliability of the fair value numbers - the cost of generating such numbers - the relevance and understandability of these numbers: will users of financial reports treat all fair values the same regardless of the level of inputs? Past experience with entities such as Enron do not inspire confidence in the use of fair value numbers based on unobservable inputs. The quotation from Nusbaum states that investors have to get used to an imperfect world. The standard-setters have tried to get users used to such a world by requiring entities to disclose the assumptions underlying the fair values disclosed. Whether this will allow users to be able to deal with volatility and to assess the effects of unobservable inputs is yet unknown.

5.16

Chapter 5: Fair value measurement

Question 5.4

Unit of account

Recognition and disclosure of assets and liabilities depends on determining the ‘unit of account’. Required A. What is meant by ‘unit of account’? B. Provide some examples of the application of unit of account in Australian Accounting Standards. C. What unit of account is adopted in AASB 13 for fair value measurement and disclosure? (A) The phrase “unit of account” refers to the level at which the accounting for an asset or a liability occurs. For example, with a vehicle, is the unit of account the whole car or parts of the car? Appendix A defines “unit of account” as: “The level at which an asset or a liability is aggregated or disaggregated in a Standard for recognition purposes”. (B)

AASB 116 para 44: depreciation of PPE is often calculated on the parts of a larger asset, for example, an aeroplane may be broken down into parts such as seating, engine, electronics etc. for depreciation purposes. AASB 136 para 80 requires goodwill to be allocated to individual CGUs, if possible, for purposes of impairment testing. The allowance for doubtful debts may be determined for each customer or be based on a grouping of customers perhaps classified on risk levels.

(C)

According to para 14 of AASB 13, whether the asset or liability is a stand-alone asset or liability, a group of assets or a group of liabilities, or a group of assets and liabilities, recognition and disclosure depends on a determination of the unit of account. The unit of account for an asset or a liability is determined in accordance with the Standard that requires or permits the fair value measurement, unless AASB 13 determines otherwise. In other words, reference must be made back to other AASBs such as AASB 116 and AASB 136. If another AASB requires that a single asset be used then this is the unit of account for fair value measurement. If another AASB requires a grouping of assets to be used, then fair value is applied to such a group. Note para 32 of AASB 13: the fair value measurement of a non-financial asset assumes that the asset is sold consistently with the unit of account. So for example, in relation to the aeroplane example, the fittings of an aeroplane would be replaced in a stand-alone transaction as would the engines, giving rise to different assets for depreciation purposes. Note para 39(b) of AASB 13: The unit of account for the asset is not the same as for the liability or equity instrument.

5.17

Solution Manual to accompany Company Accounting 10e

Question 5.5

Exit prices as fair value

Benston (2008) issued the following statement: Although the FASB has specified that fair values should be exit prices, many of the illustrative examples involve calculations of value-in-use or entrance values. This inconsistent application of the prescription of FAS 157 appears due to two factors. One is that the price another firm might pay for an asset depends on the value of the asset to that firm, its value in use. The other is perhaps the realization that when there is no potential purchaser, exit values would be zero or even negative if the firm would have to pay to dispose of an asset. The balance sheet would be decimated.

Required Discuss whether Benston’s criticisms of FAS 157 are applicable to AASB 13. Benston raises 2 issues: 1. Although fair value is defined as an exit price, use of entry prices in level 2 inputs and determination of values using level 3 inputs will mean that fair values are not always really exit prices. Where the valuation relies on an in-use valuation premise, the fair value may be determined by calculating the cost of constructing an item of plant and equipment. Also if an income valuation approach is used, there may be no market measures at all as the NPV calculation could be based on unobservable market data. This also raises questions in terms of the fair value being entity-specific versus that of market participants. Where unobservable data such as income stream is used, the numbers used in that calculation will generally be based on those coming from an entity’s own data. This is firstly because a reporting entity has no access to other entity’s internal data, and secondly because the asset being valued may not currently be being used by other entities. 2. In some cases, the exit price will be zero. Does this affect relevance of information? A classic case of this is the land on which there is currently a factory but, because of rising residential prices, the highest and best use of the land is for residential purposes. For unique assets, those that are special tools for the entity, are there circumstances where there are no other market participants. Or must the valuer assume that other market participants have the relevant other assets to use with the asset being valued? This seems to stretch the hypothetical transaction very thinly,

5.18

Chapter 5: Fair value measurement

Question 5.6

Orderly transactions

The definition of fair value requires that an asset or a liability be transferred in an ‘orderly transaction’. Required A. What is an orderly transaction? B. In order to be classified as an orderly transaction, how long must a transaction be exposed to a market? C. Can orderly transactions occur in a distressed market? (A) What is an orderly transaction? Appendix A defines an “orderly transaction” as follows: “A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (e.g. a forced liquidation or distress sale). Note the words: exposure to the market before measurement date; usual and customary; not forced. Some examples of transactions being potentially non-orderly include: - The seller focussed on a single market participant during the marketing period. - The seller has filed for bankruptcy or has been placed in receivership. - Regulatory or legal requirements forced a sales transaction. - The selling price falls outside the normal range for similar transactions. (B)

In order to be classified as an orderly transaction, how long must a transaction be exposed to a market? There is no specific period set in AASB 116. Obviously, the longer the period that a transaction is exposed to the market, the better for categorising as an orderly transaction. In determining whether a transaction is orderly, observation must be made of the market in which the transaction occurred to determine relative lengths of exposure. For example, in relation to equity instruments which are sold on a stock exchange such as the ASX, the time period may be measured in minutes if trading via electronic means is considered a normal transaction. Transactions involving specific forms of real estate such as port facilities may require exposure to a market for several months.

(C)

Can orderly transactions occur in a distressed market? It may be necessary to distinguish between a distressed market and a distressed sale. In current economic times where there seems to be a constant global financial crisis, certain markets may be generally regarded as distressed. eg properties in Greece. Determination of whether a market is stressed requires judgement. A sale in a distressed market is not necessarily a distressed sale.

5.19

Solution Manual to accompany Company Accounting 10e

Question 5.7

Exit prices as fair value for classes of assets

In its response to the IASB Exposure Draft, the G100 stated: The G100 does not believe that an exit price based measure of fair value is appropriate for all classes of assets. While such a measure may be appropriate for financial instruments we do not believe that an exit price based measure provides useful information for certain classes of non-financial assets such as property, plant and equipment where an entity-specific measure may be more appropriate.

Required Discuss the use of entity-specific information in the generation of fair value numbers under AASB 13. The measurement of fair values under AASB 13 is based on a hypothetical transaction between the reporting entity and market participants. The assumptions used as inputs into the valuation process are those made by the market participants, not those made by the entity itself. Hence the fair value under AASB 13 is not an entity-specific measure. However, even though this is the intent of the standard-setters, the question is whether in practice fair value measures will not be based on entity-specific information: - a reporting entity is not required to identify specific market participants, so any assumptions made will not relate to the circumstances facing any entity currently operating in practice. - In an endeavour to make the inputs more reliable, an entity may rely on information generated within itself rather than less reliable, hypothetical information concerning some non-existent market participant. - If the market participant buyer steps into the shoes of the entity that holds those specialised assets, then potentially the market participant is assumed to be the same as the reporting entity and entity-specific factors are used in the valuation. - Where an income valuation approach is used, and a net present value method applied, it is hard to see that entities will not insert the entity-specific information into the present value calculations. - Similarly where level 3 unobservable inputs are used, non-market data is not readily available for in-use assets carried by other entities. - Simple cost-benefit considerations will encourage an entity to use in-house data rather than model what a market participant might hypothetically do.

5.20

Chapter 5: Fair value measurement

Question 5.8

Entry and exit values

The accounting literature contains many debates over whether fair value should be based on what the owner would receive upon selling an asset or what it would pay to acquire a new one. The oft quoted example is that of a specialised machine such as a large blast furnace operated by a large mining company that once installed would never be removed except for scrap. This asset is purchased at a high price but once installed can be sold for scrap value only. The argument by the opponents of exit values is that the acquisition of such an asset would require the buyer to record an immediate loss. The argument of the opponents of replacement cost or entry price is that use of such a measure conceals the risk inherent in the specialisation strategy adopted by the company on acquisition of such an asset. Required Discuss how AASB 13 resolves this debate. The definition of “fair value” in AASB 13 requires that an exit price be used in the measurement of fair value – fair value is the price that would be received to sell an asset. However note paragraph 27: “A fair value measurement of a non-financial asset takes into account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use.” The highest and best use establishes the valuation premise which may use the asset in combination with other assets as a group. In such a case the fair value is the price received in a current transaction to sell the asset assuming that the asset would be used with other assets and that those other assets would be available to market participants. (Alternatively of course, the highest and best use could be to sell the asset on a stand-alone basis.) Applying this to the situation of the mining company’s blast furnace this blast furnace is not used as a stand-alone asset. It is used in conjunction with the whole process of melting ore to produce, for example, iron and steel products. Traditional arguments about measurement were based on either a replacement cost approach or an exit (selling) amount approach: - AASB 13 does not use an entry price approach, rather it uses an exit price approach. This is because the market that the entity faces is the exit market. Replacement costs only apply when the entity enters into a replacement of asset transaction. - AASB 13, although it applies an exit value approach, it adopts a different exit value approach from that argued for in the traditional accounting literature. In that literature the exit price was purely considered in selling the asset as a stand-alone asset. In such a case, upon acquisition of the blast furnace, the entity would experience a loss equal to the difference between the cost price of the furnace and the scrap value of the furnace. Under AASB 13, the exit price would be measured using the highest and best use approach and be measured using the assumption that the furnace is used in combination with the other assets of the mining company. Note that this approach by AASB 13 solves similar debates involving assets such as specialised tools where an entity may make its own tools to be used in its manufacturing

5.21

Solution Manual to accompany Company Accounting 10e

process. There is then no organised market for such tools. Under AASB 13 it is assumed that other market participants would have such tools available.

Question 5.9

Measurement of fair value

Ernst & Young (2005, p. 8) made the following statement: Nevertheless, the path the standard-setters have chosen is one where big swings in balance sheet and income statement numbers are inevitable. As a consequence, users of financial reports will need clear distinctions to be made between objective and subjective figures, between realised gains and losses, gains and losses based on real market process, and gains and losses based on hypothetical calculations.

Required Discuss how AASB 13 attempts to overcome these issues when providing information to users of financial reports. Paragraph 91 of AASB 13 states that the key principle of disclosure is that an entity will disclose information that enables users of the financial statements to assess the methods and inputs to develop these measurements as well as to enable users to see the effect on profit or loss or other comprehensive income where unobservable inputs are used. If fair values are only used in a small number of cases, then it is possible that users of financial statements may be able to see what is occurring. However if a large number of an entity’s assets are measured at fair value, the extent of the detail may be such as to make the information not understandable. Para 93(e) specifically addresses disclosures where level 3 inputs are used in the measurement of fair value. In particular the effects on comprehensive income are addressed. Disclosure of information concerning valuation methods and inputs – such as required by paragraph 93(d) should assist in understanding the level of objective and subjective information. As the measurement of fair value is based on a hypothetical transaction, there is always going to be information based on “hypothetical calculations”. What are “real” market processes? As the measures of fair value are based on hypothetical transactions, no measures of fair value are based on real market transactions. However, the methods used and the inputs used have differing market measures in them. By disclosing the methods and inputs used, users of financial reports are made aware of these differences and can then assess for themselves the reliability and relevance of the information to them in making their decisions. The distinction between realised and unrealised gains is not based on AASB 13 but rather on the underlying standard that is applied in the measurement of specific assets. For example, with property, plant and equipment, under the valuation model where fair value is measured, the application of AASB 116 requires the valuation increment to be recognised in other comprehensive income (an unrealised gain) rather than in profit or loss (only for realised

5.22

Chapter 5: Fair value measurement

gains). However for financial assets, some movements in fair value, although unrealised, may be recognised in profit or loss.

Question 5.10

Determination of fair value

Trout Ltd holds an asset that is traded in three different markets, namely Market A, Market B, and Market C. Trout Ltd normally trades in Market C. Some information gathered in relation to these three markets is as follows: Market A Annual volume

Market b

Market C

60 000

24 000

12 000

100

106

Transport costs

Possible fair value

Transaction costs

Net proceeds

Price

Required Using the above information, explain how Trout Ltd should measure the fair value of the asset it holds. The principal market in this example is Market A as it has the highest volume and level of activity. The most advantageous market in this example is Market C as it has the highest net proceeds. Note that both transaction and transport costs are considered in determining which market is the most advantageous market. However transaction costs are not used in the measurement of the fair value. Paragraph 16 of AASB 13 requires that a fair value measurement assumes that the transaction to sell an asset takes place in either: (a) the principal market or (b) in the absence of a principal market, the most advantageous market. In determining the fair value of this asset held by Trout Ltd: IF the information about volume and activity in each market is available to Trout Ltd then the fair value must be measured using the principal market. In this case, the fair value is $92. IF the information about all the markets is not reasonably available or if Trout Ltd does not have access to all markets, then Trout Ltd would use Market C to measure fair value. The fair value is then $94. © John Wiley and Sons Australia, Ltd 2015

5.23

Solution Manual to accompany Company Accounting 10e

Question 5.11

Fair value of work-in-progress

In relation to fair value measurement, the following statement was made by Benston (2008): Since the exit price of raw materials will almost always be less than the price at which they were purchased and the exit value of partially finished goods probably is zero or negative, companies using the . . . definition of fair value would have to record a substantial expense . . . The situation is likely to be more drastic for fixed assets, particularly for special-purpose assets that have no value to other parties.

Required Discuss the statement made by Benston. The comment that “the exit price of raw materials will almost always be less than the price at which they were purchased and the exit value of partially finished goods probably is zero or negative” is not true. This comment assumes that an in-exchange valuation premise is used. If that were the case then the current selling price of such items may be small. However, where an in-use valuation premise is used, the exit value is determined based on what a market participant would pay for these items assuming the items are used by that participant in conjunction with other assets held by the market participant. The exit price for raw material would then not be significantly different from what the reporting entity paid, assuming no market changes in the short term. Similarly with the special purpose non-current assets such as a large blast furnace used by a smelting company. This asset may not be able to be removed once placed into the reporting entity’s factory. As such its disposable – or in-exchange – value would be scrap value only. However, assuming a market participant had the same combination of other assets and requires a blast furnace to complete the grouping of assets to get a factory into operation, the fair value is not zero. The fair value would be based on the cost of obtaining such a blast furnace for incorporation into the factory’s operations.

5.24

Chapter 5: Fair value measurement

Question 5.12

Management bias on fair value measurement

One of the concerns associated with fair value measurement is that management bias may affect the reliability of the information. AASB 13 requires that fair values be based on market-based assumptions rather than entity-specific assumptions in order to overcome this issue. Required Compare the potential for management bias when making market-based or entityspecific assumptions. The measurement of fair values under AASB 13 is based on a hypothetical transaction between the reporting entity and market participants. Being hypothetical this allows management to decide the constraints and the determinants of that transaction. The assumptions used as inputs into the valuation process are those made by the market participants, not those made by the entity itself. Hence the fair value under AASB 13 is not supposed to be an entity-specific measure. However, even though this is the intent of the standard-setters, the question is whether in practice fair value measures will not be based on entity-specific information: - a reporting entity is not required to identify specific market participants, so any assumptions made will not relate to the circumstances facing any entity currently operating in practice. - In an endeavour to make the inputs more reliable, an entity may rely on information generated within itself rather than less reliable, hypothetical information concerning some non-existent market participant. - If the market participant buyer steps into the shoes of the entity that holds those specialised assets, then potentially the market participant is assumed to be the same as the reporting entity and entity-specific factors are used in the valuation. - Where an income valuation approach is used, and a net present value method applied, it is hard to see that entities will not insert the entity-specific information into the present value calculations. - Similarly where level 3 unobservable inputs are used, non-market data is not readily available for in-use assets carried by other entities. - Simple cost-benefit considerations will encourage an entity to use in-house data rather than model what a market participant might hypothetically do. Under these circumstances, management bias could potentially enter into the determination of the fair value.

5.25

Solution Manual to accompany Company Accounting 10e

Question 5.13

Liabilities

Cod Ltd holds a number of liabilities that it wants to measure at fair value. The accountant of Cod Ltd is unsure of how to apply AASB 13 in relation to liabilities. Required A. Under what circumstances are liabilities measured at fair value? B. When measuring the fair value of a liability, is it true that the price to transfer the liability is the same as the price to settle the liability? C. Should the credit risk of an entity be taken into account in measuring the fair value of a liability? (A) Under AASB 137 para 36, when measuring a provision, the amount recognised should be the best estimate of the consideration required to settle the present obligation at the end of the reporting period. This is often expressed as the amount an entity would pay to settle the present obligation or to provide consideration to a third party to assume it. Under AASB 13, for a liability, fair value is the amount paid to transfer a liability rather than the amount to settle a liability. Note para 34(a) of AASB 13: a liability would remain outstanding and the market participant transferee would be required to fulfil the obligation. The liability would not be settled with the counterparty or otherwise extinguished on the measurement date. However, the IASB in para BC 82 of the Basis for Conclusions to IAS 13 argued that the fair value of a liability from the perspective of market participants who owe the liability is the same regardless of whether it is settled or transferred. This is because both settlement and transfer of a liability reflect all costs incurred, whether direct or indirect, and the entity faces the same risks as a market participant transferee. Similar thought processes are used in estimating both the amount to settle a liability and to transfer a liability. Hence many provisions may be measured at fair value under AASB 137. Other circumstances where a liability is measured initially at fair value are: • Recognition of an asset retirement obligation; • Recognition of a restructuring liability; • Recognition of liabilities assumed in a business combination; and • In applying an impairment test to goodwill when it is necessary to measure the fair value of the entity itself. • In measuring the fair value of the non-controlling interest in a subsidiary when the full goodwill method is used. • Under AASB 139, on initial recognition, financial liabilities must be measured at fair value as per AASB 13. Subsequent measurement may also be at fair value. (B) No. The price to transfer a liability assumes that the liability continues whereas the price to settle a liability assumes the liability is extinguished – see (a) above. The result may however be the same. (C) According to para 42 of AASB 13 the fair value of a liability reflects the effect of nonperformance risk- defined in Appendix A as “the risk that an entity will not fulfil an obligation. Non-performance risk includes, but may not be limited to, the entity’s own credit risk.”

5.26

Chapter 5: Fair value measurement

Note Illustrative example 5.10 in the text to the different measures of fair value when two entities have different credit ratings. The use of fair values may also result in an entity recording a gain when there is a decline in the credit rating of an entity. In such a case the decline in credit rating causes an increase in the interest rate at which an entity can borrow. Question 5.14

Fair value hierarchy

AASB 13 proposes a fair value hierarchy. Required Discuss the differences between the various levels in the hierarchy and whether prices produced under all levels should be described as ‘fair values’. There are 3 valuation approaches into which inputs or assumptions are made. The inputs are classified as observable and unobservable. The inputs are placed in a fair value hierarchy [note that the valuation techniques are not put into a hierarchy, just the inputs to those techniques]. Note: 1. The inputs are prioritised into 3 levels – Levels 1,2 and 3. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Note the references to active markets and the need for identical items. Level 2 inputs are inputs other than quoted market prices in level 1 that are observable for the asset or liability, either directly as prices or indirectly being derived from prices. These inputs are observable and may be inputs from information other than prices such as interest rate curves. Adjustments may have to be made to these prices based on condition of the assets. Level 3 inputs are not based on observable market data. These are unobservable inputs. This information may sometimes be based on entity-specific data adjusted for factors concerning market participants. 2. The fair value hierarchy gives the highest priority to quoted market prices in active markets for identical assets and liabilities [level 1] and lowest priority to unobservable inputs [level 3]. 3. The availability of inputs and their relative subjectivity affect the selection of the valuation technique. 4. The fair value measure is categorised in its entirety at the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement.

5.27

Solution Manual to accompany Company Accounting 10e

Questions about whether prices determined using level 3 inputs should be called fair values are based on issues about - the reliability of the fair value numbers - the cost of generating such numbers - the relevance and understandability of these numbers: will users of financial reports treat all fair values the same regardless of the level of inputs? Past experience with entities such as Enron do not inspire confidence in the use of fair value numbers based on unobservable inputs. Whether disclosure will assist in overcoming these problems is an issue on which there is still on-going debate. The standard-setters believe that disclosure will assist in the interpretation of the fair value numbers. Question 5.15

Disclosures relating to fair values

Disclosures in relation to fair value measurement depend on whether the fair value measurement is recurring or nonrecurring. Explain the difference between these terms and give examples of differences in the disclosures required under the two circumstances. Recurring and non-recurring bases Note para 91 of AASB 13 for use of the terms “recurring” and “non-recurring”. Note para 93 (a) for definitions of these terms. “Recurring” fair value measures are those that other AASB accounting standards require or permit in the statement of financial position at balance date. “Non-recurring” fair value measures are those that some AASB accounting standards require or permit in specific circumstances eg in relation to non-current assets held for sale. Disclosures required Para 91 sets out the objective of the disclosures required under AASB13. In para 91 (a) for both measurement on a recurring and non-recurring basis, the valuation techniques and inputs to develop those measurements must be disclosed. In para 91 (b), for recurring measurements only, where Level 3 inputs are used, the effect of the measurement on profit or loss or other comprehensive income must be disclosed. Note para 93: (a) for recurring and non-recurring (b) for recurring and non-recurring (c) for recurring only: the amounts of any transfers between level 1 and level 2 of the fair value hierarchy, the reasons for the transfers and the entity’s policy for determining when transfers between levels are deemed to have occurred. (d) for recurring and non-recurring

5.28

Chapter 5: Fair value measurement

(e) for recurring only when the measures are categorised within Level 3 of the fair value hierarchy – a reconciliation between opening and closing balances disclosing also certain specified changes during the period (f) for recurring only where fair value measures are categorised within Level 3 of the hierarchy (g) for recurring and non-recurring (h) for recurring only where measures are categorised within Level 3 (i) for recurring and non-recurring measures

Question 5.16

Highest and best use

Royal Dutch Shell (2009) stated: 5.2 In practical terms, however, we doubt that an asset measured on any other basis than its intended use will provide more useful information to readers . . . the fact that, say, a site used for production would have a higher market value if it were redeveloped for retail purposes, is not relevant if the entity is not engaged in retail or, more obviously, needs the site in order to carry out its production operations. 5.3 The risk here is that the fair value measure, as redefined, results in irrelevant information.

Required Discuss the issues associated with measuring the fair value of a site currently used for production but which also can be redeveloped for retail purposes. This quotation raises questions about the utility of fair value information about assets that are held for use rather than exchange. With AASB 13 the standard-setters have been concerned with how to measure fair value rather than when to require fair value measures. As noted in section 5.8.5 of the text, a number of respondents to the IASB questioned whether the measurement of fair value should be prescribed before the measurement section of the Framework has been determined. Potentially the way in which users want to use fair values to make decisions may have an effect on how fair value is determined. The analysis in the section 5.8.5 referring to Whittington’s two schools of thought in relation to measurement shows large differences in the purpose of information and its determination. In the example of the land on which a factory is built but for which there is a higher and better use in terms of residential property, the question of whether the factory should have a fair value of zero may be of concern. It could be argued that measuring the factory at zero would not provide decision-useful information when an entity is using that factory in its operations. In particular users may want to see a depreciation component determined so that they could assess the economic resources consumed in the generation of cash flows process. In other words, it could be argued that the use of fair value in this circumstance does not provide the most decision-useful information. However on the other hand, recording the factory at a zero amount alerts the users of the report that there are alternative uses for the land and factory.

5.29

Solution Manual to accompany Company Accounting 10e

Question 5.17

Disclosure: issues associated with measurement and use of fair value

‘The term “fair value” should be restricted to measures based on market values and not applied to measures that are based on management conjectures. Users of financial statements will expect that where fair values are used there is less subjectivity associated with those measures.’ Required Discuss the above statement. Note section 5.8.4 of the text: In 2005, Ernst & Young noted the practical reality that a Level 3 subjective assessment will be necessary for many assets and liabilities required to be measured at fair value. This will include intangible assets, assets acquired in a business combination, unquoted equity securities, pension costs, and biological assets during the growth phase. In all these cases, many hypotheses will have to be made in determining a market price for the asset or liability. Ernst & Young argued that it would be inappropriate to refer to such calculated values as ‘fair value’. This was not seen as just a matter of semantics but rather that the term ‘fair value’ implies to a reader active and liquid markets with knowledgeable and willing buyers and sellers and observable arm’s length transactions — not values calculated on the basis of hypothetical markets, with hypothetical buyers and sellers. Ernst & Young queried whether these hypothetical amounts are sufficiently understandable, reliable, relevant and comparable to be suitable for financial reporting. In AASB 13, the standard setters have attempted to allay some of these concerns by requiring extensive disclosures about the measurement of fair values and the level of inputs used. Whether this will be sufficient to overcome the concerns raised in 2005 by Ernst & Young is a key question. Consider also whether the disclosures required by such paras. as 93 (d) – (h), which all relate to fair value measurements categorised within Level 3 of the fair value hierarchy, are sufficient to alert users of the financial statements about the subjectivity of certain fair value measures and the potential for movements in these measures (see for example the information re sensitivity to changes in inputs required under para 93 (h) (i).

5.30

Chapter 6: Accounting for company income tax

Chapter 6: Accounting for company income tax REVIEW QUESTIONS 1.

A fellow student comments: “The taxes payable method makes sense because income tax expense is based on the income tax return. I don’t understand why we bother with deferred tax liabilities and deferred tax assets.” Present arguments to convince the student why accounting for income tax should consider both current tax and deferred tax.

The fellow student has a point because the current tax liability is an obligation to the Tax Office that is near-term and easily calculated. The Company has to pay tax based on its taxable profit for the year. The current tax liability meets the criteria of being probable and reliable. In contrast, deferred tax balances seem to require some imagination about the income taxes a company will have to pay well into the future. Refer back to chapter 3 to the definitions of an asset and a liability in the Conceptual Framework 2010. An asset is defined as a “resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”. A liability is defined as a “present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”. Deferred tax liabilities and assets do not seem to satisfy the definitions of liabilities and assets. The key question regarding deferred tax liabilities is whether one believes that they are “present obligations”. They are not legal obligations (only current tax liabilities are legal), and it is arguable whether deferred tax liabilities are “constructive obligations”. Regarding assets, the key question is whether deferred tax assets are “resources controlled by the entity”. There is no doubt that future tax consequences of a positive nature do lead to future economic benefits in the form of tax savings. But are they “controlled by the entity”? One strong argument for deferred tax is that the assets and liabilities shown in the statement of financial position may give rise to future tax consequences when the benefits of the assets are recovered or the liabilities are settled. If we ignore those future tax consequences, the financial statements include incomplete or limited information. Assume that land is sold in the future at its carrying amount of $500 million and capital gains tax of $140 million results. Surely, the future liability for capital gains tax is relevant information to the users of the financial report? If a deferred tax liability is not recognised in such a case, then it can be argued that the company’s liabilities are understated or unreported. Another argument for deferred tax is that we consider future consequences beyond 12 months when estimating other liabilities such as provision for long service leave or provision for warranty. These provisions are measured as a “deferred liability” using best estimates including various assumptions about what will happen in the future. Why should income tax be any different?

6.1

Solution Manual to accompany Company Accounting 10e

Explain why income tax expense is usually not equal to accounting profit multiplied by the corporate tax rate. Your answer should refer to the main principles of accounting for income tax.

In accrual accounting, an expense that arises from the recognition of a liability must be measured by reference to what the expected cash flow will be on settlement of the liability. Rent expense that arises from rent payable is ultimately paid in cash. Similarly, income tax expense should reflect income taxes to be paid in cash whether for the current period or in a future period. Prima facie income tax calculated as accounting profit multiplied by the corporate tax rate does not connect with the income tax that a company expects to pay because income tax is levied on taxable profit not accounting profit. The main principles of accounting for income tax are that a company should recognise both: • the current tax consequences of the transactions and events of the period as reflected in the calculation of taxable profit • the future or deferred tax consequences that will arise from the recovery of assets and settlement of liabilities Accordingly, income tax expense includes a current tax component based on the transactions and events of the current period and deferred tax component that is attributable to changes in asset and liability balances during the current period. The required note disclosure for income tax expense makes this clear as shown in the textbook. The components of income taxation expense are as follows: Current tax expense

$78 000

Deferred tax expense from origination and reversal of temporary differences

54 000

Total income tax expense

$ 132 000

The main principles of accounting for income tax consider not only the current tax consequences, but place special emphasis on the future tax consequences arising as a result of differences between the carrying amounts of an entity’s assets and liabilities determined under accounting standards and the tax bases of those assets and liabilities determined under income tax legislation.

Accounting profit is based on a full accrual model whereas taxable profit is based on a partial accrual model. Explain this comment by reference to the following items: long service leave, doubtful debts, prepayments, warranty costs, interest costs, development costs and rent received in advance.

In accordance with paragraph 27 of AASB 101 Presentation of Financial Statements, the financial statements other than the statement of cash flows must be prepared using the accrual basis of accounting. In contrast, taxable profit uses a partial accrual model because some items must be recognised on a cash basis.

6.2

Chapter 6: Accounting for company income tax

Long service leave is accrued for accounting purposes resulting in the provision for employee benefits, however, for tax purposes it is only recognised as an allowable deduction when the leave is actually taken by an employee and paid in cash. Doubtful debts are accrued as an accounting expense resulting in the contra-asset Allowance for Doubtful Debts. In contrast, the deduction is only allowed for tax purposes when the debt is written off accounts receivable as bad indicating that the cash from the customer is not going to be collected. Prepaid insurance is recognised as an asset for accounting purposes and then charged to expense over time as the benefits of the asset are consumed. The tax treatment is to record the amount prepaid as an allowable deduction immediately (at the time of payment). Warranty expenses are recognised on the sale of goods for accounting purposes resulting in the provision for warranty, whereas for tax purposes the deduction is not allowed until the goods are fixed under warranty and the entity has effectively paid for the warranty. Interest expense is accrued for accounting purposes resulting in Interest Payable however, for tax purposes only interest paid is deductible. Development costs may be recognised as an asset for accounting purposes and then expensed as the benefits are consumed. In contrast, development costs are allowed as a deduction for tax purposes when paid. Rent received in advance is regarded as the liability Unearned Revenue for accounting purposes and then recorded as income (revenue) over time as the service is provided. The common tax treatment is to record the amount received in advance as taxable income immediately.

In contrast to accounting profit, taxable profit is based on rules that create economic incentives and disincentives. Explain this comment by reference to the following items: depreciation of non-current assets, exempt income, fines and penalties, and entertainment costs.

Depreciation expense recognised in accordance with AASB 116 Property, plant and equipment allocates the depreciable amount of the asset on a systematic basis over the asset’s useful life. The tax treatment is based on a set of rates provided by the tax office. Tax depreciation is usually accelerated when compared to accounting depreciation because the government wants to encourage capital expenditures in the economy. Exempt income may be recognised as revenue in accounting profit but does not enter the calculation of taxable profit. A good example is a government grant to a company for hiring apprentices. The government wants to encourage employers to give jobs to young people so they do not give money to a company and then take it away as a tax. The grant for apprentices is exempt from tax. Fines and penalties are recognised as expenses in accounting profit but do not enter the calculation of taxable profit. The government does not want to encourage pollution, anticompetitive behaviour or traffic violations by giving those responsible a tax break for it.

6.3

Solution Manual to accompany Company Accounting 10e

Entertainment costs are recognised as expenses in accounting profit, but for tax purposes may not be allowed as deductions. The idea here is not to encourage hard drinking in the workplace by providing tax deductions for it.

In contrast to accounting profit, taxable profit does not include the effects of valuation adjustments. Explain this comment by reference to the following items: goodwill, revalued property or plant and inventory.

Purchased goodwill is recognised as an asset for accounting purposes. Purchased goodwill is expensed based on annual impairment testing. An impairment loss is, in effect, a valuation adjustment that reflects a diminishment in recoverability of the asset. For tax purposes, writedowns of goodwill are not allowed as a deduction. Revalued land that is sold will give rise to a gain or loss for accounting purposes that is calculated using the revalued amount of the land, that is, the carrying amount of the land at fair value. In contrast, the gain or loss included in taxable profit is based on the land’s original cost. Revalued plant is depreciated for accounting purposes based on revalued amount of plant rather than its original cost. In contrast, tax depreciation is based on the original cost of plant. Inventory is valued at the lower of cost and net realisable value for accounting purposes. The valuation adjustment that arises from the use of net realisable value is recognised as an expense in accounting profit. For tax purposes, inventory is only deductible when sold based on its original cost.

Describe how to prepare a current tax worksheet to determine the current tax for the period. What items are typically added back to accounting profit and what items are deducted?

The current tax worksheet uses an indirect approach to determine taxable profit. It begins with accounting profit, that is, profit before tax. Adjustments are then made to: • remove items included in profit before tax that do not enter into the calculation of taxable profit • add in other items that do enter into the calculation of taxable profit Figure 6.8 in the textbook shows how the adjustments are made. •

(Revenues or gains that are not equal to assessable incomes in the period - subtract Interest revenue Dividend revenue Gain on sale of plant for accounting purposes Unearned revenue at the beginning of the year.

•

Expenses or losses that are not equal to deductions in the period - add back Non-deductible expenses, for example, entertainment Impairment loss on goodwill or other assets

6.4

Chapter 6: Accounting for company income tax

Warranty expense Bad and doubtful debts expense, Depreciation expense Development expense. •

Assessable incomes that are not equal to revenues or gains in the period - add in Interest received Dividends received Gain on sale of plant for tax purposes Unearned revenue at the end of the year.

•

Deductions that are not equal to expenses or losses in the period - subtract Long service leave paid Warranty paid Bad debts written off Tax depreciation Development costs paid.

Explain why the current tax liability at the end of the reporting period may not equal the income tax expense for the period.

The current tax liability represents the amount of tax expected to be paid to the Australian Tax Office by the company on assessment for the current year using the current tax rates and tax law. Current tax liability = tax on taxable income less any instalments of tax paid for the year Tax on taxable income = taxable income x corporate tax rate In contrast, income tax expense relates to income tax that is expected to be paid or refunded in the future because of current tax and deferred tax. Income tax expense includes a component for the current tax liability but also includes a component for any deferred tax liabilities and assets. As shown in the textbook, the current tax included in profit or loss for the year is recognised as follows: 30.6.17

Income Tax Expense Current Tax Liability

Dr Cr

78 000 78 000

(Step 1: The journal entries to recognise the current tax for the year based on taxable income)

Income tax expense also includes the deferred tax that is included in the profit or loss for the year because of changes to assets and liabilities as follows:

6.5

Solution Manual to accompany Company Accounting 10e

30.6.17

Income Tax Expense

54 000

Deferred Tax Asset

6 000

Deferred Tax Liability

60 000

(Step 2: The journal entries to recognise the deferred tax included in the profit or loss for the year)

Income tax expense does not include the deferred tax that is attributable to changes in assets and liabilities that are recognised in other comprehensive income as follows: 30.6.17

Tax on revaluation increase (OCI)

Deferred Tax Liability

30 000

(Step 3: The journal entries to recognise the deferred tax

30 000

included in other comprehensive income for the year)

Describe how to prepare a deferred tax worksheet to determine the deferred tax for the period.

(1)

(2)

(3)

(4)

(5)

(6)

Asset/Liability

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diff

Deductible Temp Diff

Total

Total Total x tax rate

Deferred Tax Asset Deferred Tax Liability

Total x tax rate

The first column in the worksheet lists the names of each asset and liability of the company. The second column of the worksheet sets out the carrying amount (book value) of each asset and liability. The third column of the worksheet records the deductible amount for income tax purposes when an asset is recovered or liability settled. The fourth column shows the tax base of an asset or liability. The tax base of an asset of liability is the amount implied by income tax legislation.

6.6

Chapter 6: Accounting for company income tax

The fifth and sixth columns of the worksheet record the taxable and deductible temporary differences of the assets and liabilities respectively. If the carrying amount of an asset or liability is equal to its tax base, then there is no temporary difference to record. The taxable temporary differences are totalled and multiplied by the corporate tax rate to determine the deferred tax liability balance at the end of the period. The deductible differences are totalled and multiplied by the corporate tax rate to determine the deferred tax asset balance at the end of the period.

What is the tax base of an asset or liability and how is it determined? Are there any similarities in the approach to measuring the tax base of an asset compared to a liability?

AASB 112 defines the tax base as the amount that is attributed to an asset or a liability for tax purposes (para 5). Tax base of an asset: Taxable economic benefits expected from recovery of the asset Tax base of asset = Deductible amount in future

[1]

No taxable economic benefits expected from recovery of the asset Tax base of asset = Carrying amount

[2]

Tax base of a liability General rule: Tax base of liability = Carrying amount − Deductible amount in future

[1]

Unearned revenue Tax base of liability = Carrying amount – Untaxed future revenue

[2]

As shown above, the definitions for the tax base of an asset or liability are similar to some extent because they depend on the “deductible amount in future” when the asset is recovered or the liability is settled.

10. Which items in the statement of financial position typically give rise to: (a) taxable temporary differences and deferred tax liabilities; and (b) deductible temporary differences and deferred tax assets? As shown in Figure 6.14, differences between the carrying amount and tax base of an asset or liability are known as temporary differences. They are temporary because once the asset is realised/recovered or the liability is settled the difference will no longer exist. The recovery

6.7

Solution Manual to accompany Company Accounting 10e

of the asset or settlement of the liability will have a future tax consequence as there will either be an increase or a decrease in the tax due in the future period. Taxable temporary differences give rise to an increase in future tax payments whereas deductible temporary differences give rise to a decrease in future tax payments. For example, when interest is received for interest receivable in a future period there is an increase in taxable income and tax due in that future period. For example, when long service leave is paid out of the provision for employee benefits in a future period, there is a decrease in taxable income and tax due in that future period. Figure 6.14 of the text and section 6.6.3 highlight the following temporary differences: (a) Deductible temporary differences {Deductible temporary difference x tax rate = Deferred tax asset} Asset carrying amount less than tax base Accounts receivable Depreciable plant (depreciation faster for accounting purposes) Liability carrying amount greater than tax base Provision for employee benefits (e.g. long service leave) Provision for warranty Interest payable Unearned revenue (b) Taxable temporary differences {Taxable temporary difference x tax rate = Deferred tax asset} Asset carrying amount greater than tax base Depreciable plant (depreciation faster for tax purposes) Revalued land Dividend receivable Interest receivable Prepaid insurance Development asset It is apparent that the two main categories involve assets or liabilities with carrying amounts greater than tax bases.

11. According to AASB 112, certain temporary differences are to be excluded from the calculation of deferred tax liabilities and assets. Identify the items excluded and discuss reasons for their exclusion. The temporary difference for goodwill is excluded from the calculation of deferred tax liabilities. The exclusion of goodwill avoids the need to gross up goodwill to an amount greater than the amount at which it is initially recognised.

6.8

Chapter 6: Accounting for company income tax

Using a simple example: Cost of business acquired Plant Inventory Goodwill

100 50 20 30

If taxable temporary difference on goodwill, deferred tax liability is 30 x 30% = 9 Cost of business acquired Plant Inventory Deferred tax liability Goodwill

100 50 20 (9) 39

The temporary difference on initial recognition of an asset or liability that, at the time of the transaction, does not affect accounting or taxable profit is also excluded. Recall that the deferred tax balances relate to future tax consequences. A purchased building has no future tax consequences if depreciation is not deductible or capital gains tax is not payable. The recognition of a deferred tax liability in this case would be inconsistent with the main principles of AASB 112.

12. Discuss when a deferred tax asset or deferred tax liability must be recognised. Are there any similarities in the recognition approach? The recognition of deferred tax liabilities is dissimilar to the recognition of deferred tax assets. There are no recognition criteria for a deferred tax liability (DTL) because paras. 15 and 16 of AASB112, indicate that a DTL must be recognised for all taxable temporary differences. This is because it is always probable that future sacrifices of economic benefits will flow from the entity in the form of settling tax liabilities and the amount can be reliably measured. In contrast, there are recognition criteria for a deferred tax asset (DTA). Para 24 of AASB 112 states that a deferred tax asset must be recognised for all deductible temporary differences. However, unlike the criteria for a DTL, the paragraph puts in the following proviso: “to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilised” That is, economic benefits in the form of reductions in tax payments will only flow to a company if it is probable that it will have a taxable profit in future against which deductions can be offset.

6.9

Solution Manual to accompany Company Accounting 10e

13. Deferred tax liabilities and assets may reverse over time. Explain this comment by reference to depreciation of plant and provision for warranty. Assume an item of plant is acquired at the beginning of Year 1 and depreciated using the rate of 25% for accounting purposes ($2 500 by 4 years) but 50% for taxation purposes ($5 000 by 2 years). The following table is in relation to the plant over the four years that it is depreciated for accounting purposes: • the carrying amount • tax base • taxable temporary difference • deferred tax liability Year 1

Year 2

Year 3

Year 4

Account

Tax

Account

Tax

Account

Tax

Account

Tax

Plant - cost

10 000

Accum Depn

2 500

5 000

10 000

7 500

10 000

Carrying amount

7 500

5 000

Tax base

—

2 500 —

5 000

—

Temp Diff

2 500

5 000

2 500

—

DTL (30%)

750

1 500

750

—

The taxable temporary difference and deferred tax liability for the plant increase in Year1 and Year 2 when tax depreciation ($5 000) is greater than accounting depreciation ($2, 500). The taxable temporary difference and deferred tax liability for the plant reverse (decrease) in Year 3 and Year 4 when accounting depreciation ($2 500) is greater than tax depreciation ($Nil). Assume that warranty expense of $5 000 is provided at the end of Year 1 and Year 2 and that warranty costs of $2 500 are paid in Year 3 and Year 4. The provision for warranty at the end of each year is as follows: Year 1 Account

Year 2 Tax

Account

Year 3 Tax

Account

Year 4 Tax

Account

Tax

Provison for Warranty

5 000

10 000

7 500

5 000

Temp Diff

5 000

10 000

7 500

5 000

DTA (30%)

1 500

3 000

2 250

1 500

The deductible temporary difference and deferred tax asset for the provision increase in Year1 and Year 2 when the amount of warranty expense ($5 000) is greater than warranty paid ($Nil). The deductible temporary difference and deferred tax asset for the provision

6.10

Chapter 6: Accounting for company income tax

reverse (decrease) in Year 3 and Year 4 when warranty paid ($2 500) is greater than warranty expense ($Nil).

14. According to AASB 112, a deferred tax asset may be offset against a deferred tax liability in certain circumstances. Identify those circumstances. Para 74 of AASB 112 requires deferred tax assets and deferred tax liabilities to be offset against each other if: • the entity has a legally enforceable right to set off current tax liabilities with current tax assets • The deferred tax assets and deferred tax liabilities relate to income taxes levied by the same taxation authority on: o the same taxable entity o different taxable entities that intend to settle current tax liabilities and assets on a net basis or realise assets and settle liabilities simultaneously in future periods The taxation authority in Australia is the Australian Taxation Office (ATO). A company will ordinarily meet the requirements for offset in relation to Australian income tax and only show a net amount in the statement of financial position for either deferred tax asset or deferred tax liability. In the text, offsetting is ignored to focus on how the balances of deferred tax assets and deferred tax liabilities are determined.

15. Why are tax adjustments for prior periods sometimes necessary? How are such adjustments brought to account? Tax adjustments for prior periods arise because of an underprovision or overprovision of tax at the time the financial statements are completed. The current and deferred tax balances are determined for accounting purposes using the best information available at the time. However, these balances are subject to any further adjustments that may be made for the period when the income tax return is finally lodged with the ATO. The income tax return may be lodged some months after the financial statements are completed. The tax adjustments for prior periods that relate to current and deferred tax recognised in the profit or loss are brought to account in the profit or loss of the current period.

16. Explain the significance of a change in the corporate tax rate when accounting for income tax. Para 51 of AASB 112 states that the measurement of deferred tax liabilities and deferred tax assets must reflect the tax consequences that would flow from the manner in which the entity expects, at the end of the reporting period to recover or settle the carrying amounts of its assets and liabilities.

6.11

Solution Manual to accompany Company Accounting 10e

Para 52 indicates that the tax rate applicable that an entity expects when it recovers or settles the carrying amounts of its assets and liabilities is relevant to the measurement of deferred tax liabilities and deferred tax assets. Accordingly, a change in the corporate tax rates necessitates the restatement of the balances of Deferred Tax Assets and Deferred Tax Liabilities that have been calculated using a previous tax rate. The beginning balances of DTA and DTL need to be adjusted to reflect the new tax rate that will be used in regard to the amount of tax now expected to be settled or recovered. The change in the tax rate will also affect the current tax and deferred tax recognised in the current period, for example, the current tax liability will be determined using taxable income multiplied by the new tax rate.

17. Describe how income tax losses can provide a future tax benefit. What is criterion for the recognition of income tax losses as a deferred tax asset and in what circumstances is it likely to be satisfied? How does exempt income impact on tax losses? Income tax losses can provide a future tax benefit because the losses can be carried forward and utilised to reduce the taxable income of a future period. Paragraph 34 of AASB 112 sets out the recognition criteria in relation to raising a deferred tax asset from tax losses. A deferred tax asset is recognised for tax losses if it is probable that future taxable profit will be available against which the carried forward losses can be utilised. The recognition of tax losses as a deferred tax asset is consistent with the recognition of deductible temporary differences as deferred tax assets. Paragraph 36 of AASB 112 requires close consideration of whether future taxable profits will be available for tax losses and points to the following factors: • taxable temporary differences that result in taxable amounts in the future • the expiry date for tax losses, if any • whether the cause of the tax losses is likely to reoccur • tax planning opportunities Exempt income earned in the current year reduces the amount of that year’s tax loss. That is, where an entity has a tax loss of say $15 000 and the entity earned $3 000 in exempt income in that year, then the tax loss that can be carried forward to later years is reduced to $12 000. In the case of recovering a tax loss from a previous year, the entity must first of all reduce the carry forward tax loss by the amount of exempt income earned in the current period. This situation results in the ATO collecting additional tax from the entity because of the exempt income. For example, assume that an entity has a carry forward tax loss of $18 000, exempt income for the current period is $5 000 and the current year’s taxable income is $25 000. Instead of reducing the taxable income down by $18 000 to $7 000, the entity must first reduce the carry forward tax loss by the $5 000 exempt income. This will now result in the entity’s taxable income being reduced down by only $13 000, being ($18 000 - $5 000) to $12 000. Thus the ATO will collect an additional ($5 000 x Tax Rate) because of the exempt income.

6.12

Chapter 6: Accounting for company income tax

CASE STUDIES Case Study 1

Tax bases and deferred tax adjustments over time

Aidan Ltd, a profitable company, purchased a machine on 1 July 2014 at a cost of $120 000. The machine had a useful life of 5 years and the company adopts the straightline basis of depreciation. On 1 July 2015, the company reassessed the useful life of the machine down from the remaining 4 years to an expected 3 years. The accounting depreciation charge was adjusted accordingly. Because of a change in economic conditions, the machine was sold for $55 000 on 30 June 2017. The tax depreciation rate for this type of machine was 15% p.a. The company tax rate is 30%. Required For each of the 3 years ended 30 June 2015, 2016 and 2017, calculate the carrying amount and tax base of the asset, and determine the deferred tax entry in relation to the machine. Explain your answer. 1. Year ended 30 June 2015 Cost Accumulated depn

Carrying amount $120 000 (24 000 96 000

)

Temporary difference

Tax base $120 000 (18 000 ) 102 000

$6 000

The temporary difference of $6000 is deductible, as the future taxable amount ($96 000) is less than the future deductible amount ($102 000), leading to the recognition of a deferred tax asset of 30% of $6000 = $1800: Deferred Tax Asset (6 000 x 30%) Income Tax Expense

Dr Cr

1 800 1 800

2. Year ended 30 June 2016 Cost Accumulated depn

Carrying Tax amount base $120 000 $120 000 (56 000 ) (36 000 64 000 84 000

Previous temp difference Increase

Temporary difference ) $ 20 000 (6 000 ) 14 000

The reassessment of useful life down to 3 years increased the depreciation charge from $24 000 p.a. (i.e. $120 000 + 5) to $32 000 p.a. (i.e. $96 000  3). The temporary difference in the second year increases the deductible difference, leading to an increased deferred tax asset of 30% of $14 000 = $4200. Deferred Tax Asset (14 000 x 30%) Income Tax Expense

Dr 4 200 Cr

4 200

3. Year ended 30 June 2017

6.13

Solution Manual to accompany Company Accounting 10e

Cost Accumulated depn Previous temp difference Increase

Carrying Temporary amount Tax base difference $120 000 $120 000 (88 000 ) (54 000 ) $ 32 000 66 000 34 000 (20 000 ) 14 000

Hence the adjustment is: Deferred Tax Asset (14 000 x 30%) Income Tax Expense

Dr 4 200 Cr

4 200

4. On sale of the machine On sale of the machine when the asset is deleted from the accounting records, the total temporary difference of $34 000, leading to a total deferred tax asset of $10 200, is reversed as the tax benefit will be received in the current year. This is because the gain on sale recognised for accounting purposes will far exceed the loss on sale for tax purposes. Carrying amount Tax base Proceeds Gain (loss) Difference

$32 000 55 000 23 000

$66 000 55 000 (11 000 ) 34 000

Hence, the adjustment is: Income Tax Expense Deferred Tax Asset (34 000 x 30%)

Dr 10 200 Cr

10 200

Further explanation of adjustments Owing to differing rates of depreciation for accounting and tax causing a difference between the carrying amount and tax base for the machine, a deferred tax asset has been raised in the years 2015 to 2017. The difference in depreciation rates causes the carrying amount and tax base to differ at the date of sale and thus the gain (loss) on sale also differs. The deductible temporary difference will be reversed via the difference between the gain for accounting and the loss for tax purposes. The deferred tax asset is effectively received in the final year.

6.14

Chapter 6: Accounting for company income tax

Case Study 2

Deferred tax asset of a loss making company

Isa Ltd is a gold exploration company. Isa Ltd has recognised a deferred tax asset balance for tax losses in its statement of financial position for each of the past four years as follows: Isa Ltd ($000s)

Deferred tax asset

2014

2015

2016

2017

24 200

133 200

197 000

300 800

At 30 June 2017, Isa Ltd is in financial distress due to a cash shortage and bank restrictions on providing any further funds. Required The auditors of Isa Ltd have asked for your advice on whether a deferred tax asset should be recognised for carried forward tax losses at 30 June 2017. Discuss with reference to AASB 112. Isa Ltd is in financial distress at 30 June 2017 and the recognition of tax losses is inappropriate in these circumstances because it is not probable that future taxable profit will be available against which the tax losses can be utilised. Paragraph 56 of AASB 112 requires that a deferred tax asset be reviewed each year and reduced if it is no longer probable that it will be utilised. Pargaraph 25 of AASB 101 indicates that if going concern assumption is not appropriate, then the financial statements should not be prepared on a going concern basis. A deferred tax asset should not be recognised for tax losses if a company is on the verge of liquidation and it is likely the tax losses will not be utilised. In Isa’s case, the recognition of the tax losses as a deferred tax asset in previous years (20142016) should also be called into question. The fact that the company has consistently made a tax loss over the three years indicates that a future taxable profit is not around the corner. Deferred Tax Asset

24 200

133 200

197 000

300 800

Based on the year-on-year balances of the deferred tax asset, the tax loss for each year is at least the following: 2014: $24 200 2015: $109 000 2016: $63 800 2017: $103 800 The tax loss for 2017 and 2015 appears to have increased significantly relative to the applicable prior year.

6.15

Solution Manual to accompany Company Accounting 10e

One reason that the management of Isa may have recognised the tax losses as a deferred tax asset is to reduce the loss for the year shown in the statements of profit or loss. As an example, the year to 30 June 2017, could be as follows: Loss before tax Add: Income Tax Income Loss for the year

($200 000) 103 800 (96 200)

All available evidence, both positive and negative, must be evaluated before determining whether to recognise a deferred tax asset for a tax loss. Paragraph 35 of AASB 112 notes that the existence of unused tax losses provides strong evidence that future taxable profit may not be available. This evidence has great weight in Isa’s case because there is no other evidence that would suggest a future taxable profit is probable. Isa Ltd could be a company with high risk such as a junior mining company that spends large amounts on exploration and development activities, which are treated as an asset in the accounting records, but are claimable immediately as tax deductions. These companies often have no or small revenues because they have not reached the stage of having a mine with economic production. In light of the risk associated with taxable profits in future, a deferred tax asset for tax losses should not be recognised.

6.16

Chapter 6: Accounting for company income tax

Case Study 3

Deferred tax balances and discounting

Your fellow student was playing ‘Angry Birds’ on a mobile phone in the lecture theatre when they suddenly stopped, looked up at you and said, ‘Deferred tax liabilities and assets should be measured using a discounted cash flow model. The deferred tax is paid or refunded in the future — that could be years away — so the time value of money should be taken into account.’ Required Refer to AASB 112 and comment on your fellow student’s argument. Identify other assets and liabilities where discounting is required in the measurement approach. Paragraph 53 states that deferred tax assets and liabilities shall not be discounted. The expected increase (decrease) in tax to be paid in future periods is recognised on a gross basis. Land revalued from its cost of $100 000 to its fair value of $1 100 000 gives rise to a taxable temporary difference of $1 000 000 and a deferred tax liability of $300 000. The tax will not be paid until the land is actually sold for $1 100 000 and such a sale may not happen for 5 or 10 years. The statement of financial position may show a deferred tax liability of $300 000 for tax that is not due for 10 years. Based on a discount rate of 5%, the present value of the liability would be $300 000/(1.05)^10 equal to $184 174. It is clear that there is a material difference between the gross amount of the liability and its present value. There is a good argument that the disclosure of the gross amount for deferred tax assets and liabilities may be misleading. Other liabilities and assets subject to measurement using a present value approach include the following: AASB 137 Provisions, Contingent Liabilities and Contingent Assets Liabilities such as the provision for employee benefits and provision for warranty are measured using discounting. Paragraph 45 of AASB 137 states that “where the effect of the time value of money is material, the provision shall be the present value of the expenditures expected to be required to settle the obligation”. AASB 117 Leases Lessees initially recognise finance leases as assets and liabilities using the fair value of the lease property or, if lower, the “present value of the minimum lease payments”. AASB 1023 General Insurance Contracts and AASB 1038 Life Insurance Contracts Paragraph 5.1 of AASB 1023 requires that the liability of outstanding claims for a general insurance company is measured using estimates discounted to present value. In AASB 1038, life insurance contracts are measured on a “net present value” basis. © John Wiley and Sons Australia, Ltd 2015

6.17

Solution Manual to accompany Company Accounting 10e

AASB 13 Fair Value Measurement AASB 13 includes the valuation technique of “the income approach” where future amounts (eg cash flows or income or expenses) are converted to a single discounted amount. Fair values based on the income approach may be used in the subsequent measurement of assets in AASB 116 Property, Plant and Equipment, AASB 138 Intangible Assets, AASB 139 Financial Instruments, AASB 140 Investment Property and AASB 141 Agriculture.

6.18

Chapter 6: Accounting for company income tax

Case Study 4

Recognition of deferred tax assets

Shady Sheds Ltd manufactures prefabricated sheds, ranging from industrial sheds and garden sheds down to small items such as dog kennels. In recent years, Shady Sheds Ltd has recorded accounting losses. The company has retrenched several of its staff after struggling to find new markets for its products. In the prior year, the company recognised expenses and liabilities for long-service leave and potential redundancy payouts. Redundancy costs and long-service leave are not deductible for income tax until paid. The company recognised deferred tax assets as a result of these liabilities. With the long-service leave and redundancy entitlements being paid out to the retrenched employees in the current year, the company has now been able to claim large tax deductions for the cash payments made. The effect of these deductions is that the company has recorded a significant tax loss in the current year. Required A. Outline the requirements of AASB 112 in relation to the recognition of deferred tax assets from long-service leave and retrenchment liabilities. How do these requirements differ (if at all) from the recognition requirements for deferred tax assets from tax losses? B. Discuss whether the deferred tax asset from the employee benefits liabilities in the prior year should have been recognised. Should the tax loss in the current year be recognised as a deferred tax asset? PART A Long service leave liabilities and retrenchment liabilities provide tax deductions on the payment of cash to employees. For accounting purposes, an expense is recognised on an accrual basis. Hence, there is a difference between the carrying amount of the liability for accounting purposes and the tax base of zero, caused by the existence of a future deductible amount when cash is paid. The resulting deductible temporary difference leads to the existence of a deferred tax asset. Paragraph 24 of AASB 112 specifies that a deferred tax asset can be recognised ‘to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised’. Para. 28 states: It is probable that taxable profit will be available against which a deductible temporary difference can be utilised when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse: (a) in the same period as the expected reversal of the deductible temporary difference; or (b) in periods into which a tax loss arising from the deferred tax asset can be carried back or forward. When there are insufficient taxable temporary differences for the entity to use against the deductible temporary differences, a deferred tax asset can be recognised only to the extent that it is probable that the entity will have enough taxable income in the same period as the reversal of the deductible temporary difference or recovery of a tax loss, or tax planning opportunities are available to the entity that will create taxable income in appropriate periods (para. 29). All available evidence, both positive and negative, must be evaluated before

6.19

Solution Manual to accompany Company Accounting 10e

determining whether to recognise a deferred tax asset. In evaluating whether the entity will have sufficient taxable income in future periods, paragraph 29 states that the entity must ignore the taxable amounts arising from deductible temporary differences expected to originate in future periods, because the deferred tax asset from future deductible temporary differences will itself require future taxable income in order to be used. In relation to tax losses, the recognition criteria are discussed in paragraph 34. A deferred tax asset arising from the carry forward of an unused tax loss must be recognised to the extent that it is probable that future taxable profits will be available against which the unused tax loss can be used. It appears, therefore, that the recognition criteria for deferred tax assets from tax losses are the same as the recognition criteria for other deferred tax assets, described above. AASB 112 also points out, however, that the mere existence of a tax loss provides strong evidence that future taxable income may not be available to ensure that the deferred tax asset from the tax loss is recognisable. Para. 35 states that when an entity has a history of recent losses, it can recognise a deferred tax asset from tax losses only to the extent that it has sufficient taxable temporary differences, or there is other convincing evidence that sufficient taxable profits will be available in the future against which the unused tax losses can be used. Para. 36 specifies a number of factors which the entity must consider in assessing the probability that a deferred tax asset from a tax loss can be recognised: • whether the entity has sufficient taxable temporary differences which will result in taxable amounts in future so that the tax losses can be used • whether it is probable that the entity will have future taxable profits before the tax losses expire (this is not an issue in Australia as tax losses can be carried forward indefinitely) • whether the unused tax losses result from identifiable causes which are unlikely to recur • whether tax planning opportunities are available to the entity that will create sufficient future taxable profits to recover the tax losses. If, based on an assessment of the evidence, it is not probable that sufficient future taxable income will exist, then a deferred tax asset can be recognised only to the extent that it can be recovered against the future taxable income available.

PART B Looking at the requirements of AASB 112 concerning the recognition of deferred tax assets from temporary differences and tax losses, there is little evidence in Shady Sheds Ltd to support the recognition of any deferred tax assets. Shady Sheds Ltd is struggling after losing market share and has recorded accounting losses over an extended period of time. To convince the auditors, Shady Sheds Ltd will have to show clearly the basis for the expectation of returning to profitability and future taxable profits so that it can claim the benefits of the tax loss and of the deferred tax assets from long service leave and retrenchments. Relevant evidence would be: • recent operating performance in markets including in any significant new markets • budgets for operating performance in markets in the next 12 months and any other evidence that supports the reliability of the budgets

6.20

Chapter 6: Accounting for company income tax

Case Study 5

Company tax instalment system

The current system for paying company tax was introduced by the Australian Government on 1 July 2000 as part of its legislation introducing the goods and services tax (GST). The effect of this system for most companies is that income tax is paid, under the PAYG (pay as you go) system, in regular quarterly instalments, thereby smoothing out the cash flow requirements for tax payments throughout the year. Basic details for determining tax payments by companies are available on the Australian Taxation Office (ATO) website at www.ato.gov.au. Assume that Chelsey Ltd, for the year ended 30 June 2017, pays quarterly PAYG tax instalments as follows: $8000 on 28 July 2016 (final payment for 30 June 2016) $4000 on 28 October 2016 (1st payment for 30 June 2017) $11 000 on 28 February 2017 (2nd payment for 30th June 2017) $12 000 on 28 April 2017 (3rd payment for 30 June 2017) Chelsey Ltd determines its annual tax for the year to 30 June 2017 is to be $33 000 on an estimated taxable income of $110 000. An increase to the deferred tax liability and deferred tax asset of $3000 and $6600 was also recognised. As a result of determining the annual tax to be an amount of $33 000, the company pays a final tax payment for the year on 28 July 2017 as follows: Final tax instalment = $33 000 – $4000 – $11 000 – $12 000 = $6000 On 1 October 2017, the ATO notified Chelsey Ltd that its taxable income for the year ended 30 June 2017 was assessed as $115 000, requiring a total tax payment for that year of $34 500. This difference was due to the ATO disallowing: • a depreciation claim of $3000 made by the company at a depreciation rate higher than that used in the accounting records • a claim for entertainment expenses of $2000. In other words, the underprovision for tax of $1500 ($34 500 − $33 000) was caused by an expected temporary difference between accounting depreciation and tax depreciation ($3000) that did not eventuate, and a disallowed deduction of $2000. Hence, an entry must be made, in respect of the depreciation, to reduce the deferred tax liability established at the end of the reporting period (30 June 2017) by $900 to take into account the taxable temporary difference that did not arise, and to recognise an additional expense of $600 to record the additional income tax payable. Chelsey Ltd paid the additional tax on 20 October 2017. Required Prepare the journal entries to record all payments of tax and the adjustments from the underprovision for tax of Chelsey Ltd in respect of the year ended 30 June 2017. Journal entries to record all payments of tax and the adjustments from the underprovision for tax in Chelsey Ltd are shown below. 2016 July

Oct.

Current Tax Liability Cash (Final payment of tax for year ended 30 June 2016)

Dr Cr

8 000

Income Tax Expense Cash

Dr Cr

4 000

8 000

4 000

6.21

Solution Manual to accompany Company Accounting 10e

(Payment of first PAYG instalment for year ended 30 June 2017) 2017 Feb.

April

June

July

Oct.

Income Tax Expense Cash (Payment of second PAYG instalment for year ended 30 June 2017)

Dr Cr

11 000

Income Tax Expense Cash (Payment of third PAYG instalment for year ended 30 June 2017)

Dr Cr

12 000

Income Tax Expense Current Tax Liability (Recognition of final instalment payable for current tax)

Dr Cr

6 000

Deferred Tax Asset Deferred Tax Liability Income Tax Expense (End-of-period adjustment determined on the basis of tax-effect accounting recording adjustments to deferred tax asset and liability (ignoring offsets) and tax expense)

Dr Cr Cr

6 600

Current Tax Liability Cash (Final PAYG instalment for year ended 30 June 2017)

Dr Cr

6 000

Deferred Tax Liability Underprovision for Tax (expense) Current Tax Liability (Adjustment for income tax underprovided)

Dr Dr Cr

900 600

Current Tax Liability Cash (Additional tax paid after assessment by ATO)

Dr Cr

1 500

11 000

12 000

6 000

3 000 3 600

6 000

1 500

6.22

Chapter 6: Accounting for company income tax

Case Study 6

Income tax disclosures of top Australian companies

Select three companies listed on the ASX from different industries; for example, Telstra Corporation, Woolworths, and Fortescue Metals. Go to www.asx.com.au and find the most recent annual financial report of the three companies. Compare the information relating to income tax in the financial statements and report your findings to class. The presentation should address the following:  the income tax expense included in the profit or loss for the year  any income tax included in other comprehensive income  the current and deferred tax components of income tax expense  whether a deferred tax asset or deferred tax liability or both is disclosed in the statement of financial position and the magnitude of these balances. This is an open-ended case for student presentation. Students should use the ASX website by clicking on “Prices and Research” and then use the drop down menu for “Company Information” and follow the link for the “Listed Companies Directory”. You will find the companies in each industry as per the “GICS Industry Group”. Select three companies from three different industries and go from there to the annual reports of each company in the “Announcements” section to view the income tax disclosures in the financial statements and notes. Alternatively students can use a search engine, such as Google, to find the financial statements and notes of three appropriate companies. The presentation should consider if deferred tax liabilities or deferred tax assets are expected based on what the company’s operations are. For example, Telstra has large capital expenditure commitments that involving property, plant and equipment at accelerated tax depreciation rates and should be expected to have a large deferred tax liability.

6.23

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 6.1

Calculation of current and deferred tax

The following data applies to the two unrelated companies Lloyd Ltd and Cole Ltd: Lloyd Ltd

Cole Ltd

Profit before tax for the year to 30 June 2017

$1 300 000

$136 000

Taxable income for the year to 30 June 2017

340 000

150 000

Deferred tax liability 1 July 2016

—

90 000

Deferred tax asset 1 July 2016

—

15 000

960 000

306 000

—

70 000

Taxable temporary differences at 30 June 2017 Deductible temporary differences at 30 June 2017

All taxable and deductible temporary differences relate to the profit or loss. Assume a corporate tax rate of 30%. Required A. For each company, prepare the journal entries to record the current and deferred tax for 30 June 2017. B. For each company, prepare the income tax section of the statement of profit or loss and other comprehensive income for the year ended 30 June 2017, and show the note disclosure for the current and deferred components of income tax expense. PART A LLOYD LTD Taxable income ` Corporate tax rate Current tax liability at 30 June 2017

Journal entry for current tax: Income Tax Expense Current Tax Liability

$340 000 30% $102 000

Dr Cr

102 000 102 000

Taxable temporary differences Corporate tax rate Deferred tax liability at 30 June 2017

Journal entry for deferred tax: Income Tax Expense

$960 000 30% $288 000

288 000

6.24

Chapter 6: Accounting for company income tax

Deferred Tax Liability

288 000

PART B LLOYD LTD Statement of Profit or Loss and Other Comprehensive Income (EXTRACT) for the year ended 30 June 2017 Profit before income tax Income tax expense Profit for the year

$1 300 000 (390 000) 910 000

Note: Income tax (a) Major components of income tax expense Current tax Deferred tax from origination of temporary differences Income Tax expense

$102 000 288 000 390 000

COLE LTD PART A Taxable income ` Corporate tax rate Current tax liability at 30 June 2017

Journal entry for current tax: Income Tax Expense Current Tax Liability

$150 000 30% $45 000

Dr Cr

45 000 45 000

Taxable temporary differences at 30 June 2017 Corporate tax rate Deferred tax liability at 30 June 2017 Deferred tax liability at 30 June 2016 Increase in Deferred tax liability for the year

$306 000 30% $91 800 90 000 $ 1 800

Deductible temporary differences at 30 June 2017 Corporate tax rate Deferred tax asset at 30 June 2017 Deferred tax asset at 30 June 2016 Increase in Deferred tax asset for the year

$70 000 30% $21 000 15 000 $ 6 000

6.25

Solution Manual to accompany Company Accounting 10e

Journal entry for deferred tax: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

6 000 1 800 4 200

PART B COLE LTD Statement of Profit or Loss and Other Comprehensive Income (EXTRACT) for the year ended 30 June 2017 Profit before income tax Income tax expense Profit for the year

$136 000 (40 800) 95 200

Note: Income tax (a) Major components of income tax expense Current tax Deferred tax from origination and reversal of temporary differences Income Tax expense

$45 000 (4 200) 40 800

6.26

Chapter 6: Accounting for company income tax

Question 6.2

Current tax liability in four cases

The chief financial officer of Lost Weekend Ltd has asked you to calculate the taxable income and prepare the journal entry for the current tax liability in each of the following four cases. Case 1 Case 2 Case 3 Case 4 Accounting profit (loss) After debiting as expense: Goodwill impairment loss* Entertainment costs* Donation to political party* Depreciation expense – plant Long-service leave expense For tax purposes: Tax depreciation for plant Long-service leave paid

$40 000

$20 000

$5 000

$(10 000 )

6 000 — 1 000 4 000 600

— 6 000 3 000 2 000 600

— 7 000 — 10 000 600

8 000 — — 2 000 1 200

8 000

4 000 —

20 000 —

4 000 2 400

—

*These items are non-deductible for tax purposes.

Assume a tax rate of 30%.

Case 1 Current Tax Worksheet $ Profit before income tax Add: Goodwill impairment loss Donation to political party Depreciation expense Long service leave expense

$ 40 000 6 000 1 000 4 000 600

Deduct: Long service leave paid Tax depreciation Taxable income Current tax liability @ 30%

8 000

11 600 51 600

(8 000) 43 600 $13 080

The journal entry is: Income Tax Expense Current Tax Liability

Dr Cr

13 080 13 080

6.27

Solution Manual to accompany Company Accounting 10e

Case 2 Current Tax Worksheet $

Profit before income tax Add: Entertainment costs Donation to political party Depreciation expense Long service leave expense

20 000 6 000 3 000 2 000 600

Deduct: Long service leave paid Tax depreciation Taxable income Current tax liability @ 30%

11 600 31 600

4 000

(4 000) 27 600 $8 280

The journal entry is: Income Tax Expense Current Tax Liability

Dr Cr

8 280 8 280

Case 3 Current Tax Worksheet $ Profit before income tax Add: Entertainment costs Depreciation expense Long service leave expense

$ 5 000 7 000 10 000 600

Deduct: Long service leave paid Tax depreciation Taxable income Current tax liability @ 30%

17 600 22 600

20 000

(20 000) 2 600 $ 780

The journal entry is: Income Tax Expense Current Tax Liability

Dr Cr

780 780

6.28

Chapter 6: Accounting for company income tax

Case 4 Current Tax Worksheet $ Loss before income tax Add: Goodwill impairment loss Depreciation expense Long service leave expense

$ (10 000) 8 000 2 000 1 200

Deduct: Long service leave paid Tax depreciation Tax loss Current tax liability @ 30%

2 400 4 000

11 200 1 200

(6 400) (5 200) $0

Assuming that recognition criteria for a tax loss are satisfied, the journal entry is: Deferred Tax Asset Income Tax Income

Dr Cr

1 560 1 560

6.29

Solution Manual to accompany Company Accounting 10e

Question 6.3

Current tax worksheet and entries for current and deferred tax

At 30 June 2016, Grace Ltd had the following deferred tax balances: Deferred tax liability $18 000 Deferred tax asset 15 000 Grace Ltd recorded a profit before tax of $80 000 for the year to 30 June 2017, which included the following items: Depreciation expense – plant $7 000 Doubtful debts expense 3 000 Long-service leave expense 4 000 For taxation purposes the following amounts are allowable deductions for the year to 30 June 2017: Tax depreciation – plant $8 000 Bad debts written off 2 000 Depreciation rates for taxation purposes are higher than for accounting purposes. A corporate tax rate of 30% applies. Required A. Prepare a current tax worksheet to determine the taxable income for the year to 30 June 2017. B. Determine by what amount the balances of the deferred liability and deferred tax asset will increase or decrease for the year to 30 June 2017 because of depreciation, doubtful debts and long-service leave. C. Prepare all journal entries to account for income tax assuming recognition criteria are satisfied. D. What are the balances of the deferred tax liability and deferred tax asset at 30 June 2017? A. Current Tax Worksheet for year ended 30 June 2017 Profit before income tax Add: Doubtful debts expense Depreciation expense - plant Long service leave expense Deduct: Bad debts written off Long service leave paid Tax depreciation - plant Tax loss Current tax liability @ 30%

$ 80 000 3 000 7 000 4 000

2 000 8 000

14 000 94 000

(10 000) 84 000 $25 200

B. Deferred Tax for the Year Tax depreciation greater than depreciation expense

6.30

Chapter 6: Accounting for company income tax

 Accumulated depreciation for tax purposes greater than for accounting purposes  The carrying amount of the depreciable asset is greater than the tax base  Deferred tax liability Increase in deferred tax liability = ($8 000 – $7 000) x 30% = $300 Doubtful debts expense greater than bad debts written off  Allowance for doubtful debts for accounting purposes but not tax purposes  The carrying amount of accounts receivable is less than the tax base  Deferred tax asset Increase in deferred tax asset = ($3 000 – $2 000) x 30% = $300 Long service leave expense greater than long service leave paid  provision for long service leave for accounting purposes but not tax purposes  The carrying amount of the liability is greater than the tax base  Deferred tax asset Increase in deferred tax asset = ($4 000 – $0) x 30% = $1 200 C. Tax entries for 30 June 2017 The journal entry for current tax is: Income Tax Expense Current Tax Liability

Dr Cr

25 200

Dr Cr Cr

1 500

25 200

The journal entry for deferred tax is: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Current tax Deferred tax from origination and reversal of temporary differences Income Tax expense

300 1 200

$25 200 (1 200) 24 000

D. Deferred tax balances at 30 June 2017

30/06/17

Ending balance

Deferred Tax Liability $ 1/07/16 Beginning balance 18 300 Income tax expense

$ 18 000 300

6.31

Solution Manual to accompany Company Accounting 10e

18 300

1/07/16

Beginning balance Income tax expense

18 300

Deferred Tax Asset $ 15 000 1 500 30/06/17 Ending balance 16 500

$ 16 500 16 500

The balance of the deferred tax liability at 30 June 2017 indicates that the taxable temporary difference for depreciable assets is $61 000 at 30 June 2017, that is, the carrying amount of the depreciable assets is $61 000 greater than the tax base at 30 June 2017. Taxable temporary difference 30/6/2017 x tax rate = deferred tax liability 30/6/2017 $61 000 x 30% = $18 300 The balance of the deferred tax asset at 30 June 2017 indicates that the deductible temporary differences for accounts receivable and the provision for long service leave are $55 000 at 30 June 2017. Deductible temporary differences 30/6/2017 x tax rate = deferred tax asset 30/6/2017 $55 000 x 30% = $16 500

Question 6.4

Current and deferred tax over three years

On 1 July 2014, Rich Ltd was incorporated. The accounting profit and other relevant information of Rich Ltd for the three years to 2017 are as follows: 2017

2016

2015

$1 800 000

$1 500 000

$1 200 000

—

500 000

Depreciation expense – plant

20 000

Gain on sale of plant for accounting

22 000

—

Warranty paid

250 000

—

Tax depreciation – plant

30 000

Gain on sale of plant for tax

52 000

—

Provision for warranty – carrying amount Provision for warranty – tax base

—

250 000

500 000

—

Plant – carrying amount

—

60 000

80 000

Profit before tax Warranty expense

6.32

Chapter 6: Accounting for company income tax

Plant – tax base

—

40 000

70 000

The company tax rate is 30%. Required Calculate the current and deferred tax of Rich Ltd for each year, 2015, 2016 and 2017, and prepare the required tax journal entries for each year. Current Tax Worksheet for the year ended 30 June 2015 Accounting profit Add: Warranty expense Depreciation expense - plant

$1 200 000 500 000 20 000

Deduct: Warranty paid Tax depreciation - plant Taxable profit Current tax liability @ 30%

0 30 000

520 000 1 720 000

(30 000) 1 690 000 $507 000

Deferred Tax Worksheet as at 30 June 2015

Asset Plant Liability Provn for warranty

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diff

80 000

70 000

10 000

500 000

0 10 000 3 000

DTL (30%) DTA (30%) Beginning balance Increase

0 $ 3 000

Deductible Temp Diff

500 000 500 000 150 000 0 $ 150 000

The journal entry for current tax for the year to 30 June 2015 is: Income Tax Expense Current Tax Liability

Dr Cr

507 000 507 000

The journal entry for deferred tax for the year to 30 June 2015 is: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

150 000 3 000 147 000

In the 30 June 2015 financial statements:

6.33

Solution Manual to accompany Company Accounting 10e

 Income tax expense for the year $360 000 ($507 000 – $147 000)  Current tax liability $507 000  Deferred tax liability $3 000  Deferred tax asset $150 000 Current Tax Worksheet for the year ended 30 June 2016 Accounting profit Add: Warranty expense Depreciation expense - plant

$1 500 000 0 20 000

Deduct: Warranty paid Tax depreciation - plant Taxable profit Current tax liability @ 30%

250 000 30 000

20 000 1 520 000

(280 000) 1 240 000 $ 372 000

Deferred Tax Worksheet as at 30 June 2016

Asset Plant Liability Provn for warranty

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diff

60 000

40 000

20 000

250 000

0 20 000 6 000

DTL (30%) DTA (30%) Beginning balance Increase/(Decrease)

3 000 $ 3 000

Deductible Temp Diff

250 000 250 000 75 000 150 000 $ (75 000)

The journal entry for current tax for the year to 30 June 2016 is: Income Tax Expense Current Tax Liability

Dr Cr

372 000 372 000

The journal entry for deferred tax for the year to 30 June 2016 is: Income Tax Expense Deferred Tax Liability Deferred Tax Asset

Dr Cr Cr

78 000 3 000 75 000

In the 30 June 2016 financial statements:  Income tax expense $450 000 ($372 000 + $78 000)  Current tax liability $372 000

6.34

Chapter 6: Accounting for company income tax

 Deferred tax liability $6 000 ($3 000 + $3 000)  Deferred tax asset $75 000 ($150 000 – $75 000)

Current Tax Worksheet For the year ended 30 June 2017 Accounting profit Add: Warranty expense Depreciation expense - plant Gain on sale for tax

$1 800 000 0 20 000 52 000

Deduct: Warranty paid Tax depreciation - plant Gain on sale for accounting Taxable profit Current tax liability @ 30%

72 000 1 872 000

250 000 30 000 22 000

302 000 1 570 000 $ 471 000

Deferred Tax Worksheet as at 30 June 2017 Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diff

Asset Plant Liability Provn for warranty

0 0

DTL (30%) DTA (30%) Beginning balance Increase/(Decrease)

6 000 $(6 000)

Deductible Temp Diff

0 0 0 75 000 $ (75 000)

The journal entry for current tax for the year to 30 June 2017 is: Income Tax Expense Current Tax Liability

Dr Cr

471 000 471 000

The journal entry for deferred tax for the year to 30 June 2017 is: Income Tax Expense Deferred Tax Liability Deferred Tax Asset

Dr Dr Cr

69 000 6 000 75 000

In the 30 June 2017 financial statements:  Income tax expense $540 000 ($471 000 + $69 000)

6.35

Solution Manual to accompany Company Accounting 10e

 Current tax liability $471 000  Deferred tax liability $0 ($6 000 – $6 000)  Deferred tax asset $0 ($75 000 – $75 000) The total of the income tax expense and income tax paid for the three years is as follows: Income tax expense 30 June 2015 30 June 2016 30 June 2017

360 000 450 000 540 000 $1 350 000

Current tax liability (Tax paid for year) 507 000 372 000 471 000 $1 350 000

In aggregate the income tax expense and income tax paid across the three years is equal because by the end of 30 June 2017, there are no outstanding temporary differences, that is, the temporary differences for plant and the provision for warranty have reversed in full. Note how the origination of the deductible temporary difference for the provision reduces income tax expense for 30 June 2015. Then note how the reversal the deductible temporary difference for the provision increases income tax expense for 30 June 2016 and 30 June 2017. The totals for income tax expense and income tax paid highlight how accounting for income tax is itself an application of accrual accounting. The expense is not based on the income tax to be paid for the period but the current and deferred tax that arises in the period.

6.36

Chapter 6: Accounting for company income tax

Question 6.5

Tax bases and adjusting entries for deferred tax

Rattlesnakes Ltd is reviewing its deferred tax for the year. In each of the following situations prepare the end-of-period adjustment journal entries to account for income tax on the initial appearance or reversal of any temporary differences. Explain in each case why particular accounts are affected. 1. The company purchased a depreciable asset at the beginning of the year for $100 000. For accounting purposes, an annual depreciation rate of 20% straight-line is used, whereas for taxation the rate is 30% straight-line. 2. The company’s provision for long-service leave at the beginning and end of the year are $160 000 and $155 000 respectively. In the current year, $20 000 in long-service leave was paid to a long-standing employee. 3. In calculating taxable income, the company has deducted $50 000 of development expenditure incurred at the beginning of the year. For accounting purposes, the $50 000 has been capitalised as an asset and is amortised on a straight-line basis over 5 years. The company is not entitled to any additional deduction above the 100% of costs incurred. 4. The company has an allowance for doubtful debts of $8000 at the end of the year. The balance of the allowance account at the beginning of the year was $5000. In the current period, $10 000 was written off as being uncollectable. The gross amount of accounts receivable at the beginning and end of the year are $62 000 and $60 000 respectively. 5. The company has interest receivable of $10 000 at the end of the year. No interest was receivable at the beginning of the year. Interest income is included in taxable profit only when received. 6. The company has revalued land at the end of the year. The land was revalued during the year from its original cost of $90 000 to a fair value of $150 000. 7. The company revalued plant at the beginning of the year from $400 000 to $500 000. The plant is being depreciated at the rate of 10% per year for accounting purposes and 5% per year for tax purposes. 8. The company has goodwill of $200 000 at the end of the year. The goodwill has a tax base of $Nil. 1. Depreciable asset  Carrying amount is $80 000 (Cost $100 000 – Accum Depn $20 000)  Tax base $70 000 (Cost $100 000 – Accum Depn $30 000) The tax base is the future deductible amount for the asset.  Carrying amount > Tax base  Taxable temporary diff  Deferred tax liability The carrying amount ($80 000) exceeds the tax base ($70 000) resulting in a taxable temporary difference of $10 000. A deferred tax liability of $3 000 must be recognised as follows: Income Tax Expense Deferred Tax Liability

Dr Cr

3 000 3 000

The company has claimed a tax deduction for depreciation of $30 000 in the current year but the depreciation expense is only $20 000. As the deduction exceeds the expense, taxable profit of the current year is reduced and tax is deferred to a future period.

6.37

Solution Manual to accompany Company Accounting 10e

Tax depreciation is usually greater than depreciation expense in the early years of an asset’s life because of accelerated depreciation rates for tax. This results in the origination of a taxable temporary difference and deferred tax liability. However, after the asset is fully depreciated for tax purposes the depreciation expense will be greater than tax depreciation. This results in the reversal of the taxable temporary difference and deferred tax liability. 2. Provision for long service leave  Carrying amount is $155 000  Tax base is $0 The tax base is the carrying amount less future deductible amount of the liability.  Carrying amount > Tax base  Deductible temporary diff  Deferred tax asset At the beginning of the current year, a balance in the provision for long service leave account is $160 000 and the deductible temporary difference is $160 000. Therefore the deferred tax asset account has a balance of $48 000 at the beginning of the year ($160 000 x 30%) At the end of the current year, the provision account and deductible temporary difference amount to $155 000 and the deferred tax asset balance must be $46 500 ($155 000 x 30%) Hence, the deferred tax asset account decreases by $1 500 in the current year. The entry to record the decrease is: Income Tax Expense Deferred Tax Asset

Dr Cr

1 500 1 500

The company has claimed a tax deduction for LSL paid of $20 000 in the current year but the LSL expense is only $15 000. As the deduction exceeds the expense, taxable profit of the current year is reduced and the deferred tax asset at the beginning of the year has been partially realised. Long service leave is usually accrued in the accounting records before any tax deduction can be claimed. Tax deductions are available on payment of long service leave to particular employees. Hence prior to any payment for long serve leave, the company would have established a deferred tax asset for deductible temporary differences, representing future tax deductions available to the company. 3. Development asset  Carrying amount is $40 000 (Cost $50 000 – Accum Amortisation $10 000)  Tax base is $0 The tax base is the future deductible amount for the asset.  Carrying amount > Tax base  Taxable temporary diff  Deferred tax liability At the end of the year, the asset carrying amount ($40 000) and its tax base ($0) result in a taxable temporary difference of $40 000, and a deferred tax liability of $12 000 ($40 000 x 30%), which is recognised in the following entry: Income Tax Expense Deferred Tax Liability

Dr Cr

12 000 12 000

6.38

Chapter 6: Accounting for company income tax

The company has claimed the development expenditure of $50 000 as a tax deduction when paid, but it has been treated as an asset for accounting purposes under AASB 138 and amortised over time. Hence, tax deductions exceed the accounting expense for the development costs in the current year. In future years, it is anticipated that future taxable amounts will emanate from the development asset and result in additional tax to be paid. 4. Accounts receivable  Carrying amount is $52 000 (Gross $60 000 – Allowance $8 000)  Tax base is $60 000 The tax base is the gross amount of the asset as it does not generate future taxable amounts  Tax base > Carrying amount  Deductible temporary diff  Deferred tax asset The carrying amount of accounts receivables at the beginning of the year is $57 000 ($62 000 − $5 000) and the tax base is $62 000 resulting in a deductible temporary difference of $5 000 and deferred tax asset of $1 500 ($5 000 x 30%). At the end of the year, the carrying amount of accounts receivable is $52 000 and the tax base is $60 000 resulting in a deductible temporary difference of $8 000 and deferred tax asset of $2 400 ($8 000 x 30%). Hence, the deferred tax asset must be increased from $1 500 to $2 400 as follows: Deferred Tax Asset Income Tax Expense

Dr Cr

900 900

The allowance is the source of the deductible temporary difference for accounts receivable. Doubtful debts expense and the allowance are recognised for accounting purposes but not tax purposes. Only debts written off accounts receivable are deductible. The allowable tax deduction for bad debts written off in the current period is equal to $10 000, and the expense for accounting is the total amount credited to the allowance account for doubtful debts, $13 000, an increase in the allowance account of $3 000. 5. Interest receivable  Carrying amount is $10 000  Tax base is $0 The tax base is the future deductible amount for the asset  Carrying amount > Tax base  Taxable temporary diff  Deferred tax liability At the end of the year, the asset carrying amount ($10 000) and its tax base ($0) result in a taxable temporary difference of $10 000, and a deferred tax liability of $3 000 ($10 000 x 30%), which is recognised in the following entry: Income Tax Expense Deferred Tax Liability

Dr Cr

3 000 3 000

Interest received rather than interest revenue is subject to tax. Interest receivable indicates that in a future period interest will be received and increase the taxable profit and tax paid. Hence, interest receivable results in the recognition of a deferred tax liability.

6.39

Solution Manual to accompany Company Accounting 10e

6. Revalued land  Carrying amount is $150 000  Tax base is $90 000 The tax base is the future deductible amount for the asset based on cost.  Carrying amount > Tax base  Taxable temporary diff  Deferred tax liability At the end of the year, the asset carrying amount ($150 000) and its tax base ($90 000) result in a taxable temporary difference of $60 000 and a deferred tax liability of $18 000 ($60 000 x 30%), which is recognised in the following entry: Tax on revaluation increment (OCI) Deferred Tax Liability

Dr Cr

18 000 18 000

The tax on the revaluation of the land is recognised in other comprehensive income consistent with the recognition of the $60 000 revaluation increment on the land. In a future period, if the land was sold for its carrying amount of $150 000 this would give rise to a capital gain of $60 000 for taxation purposes and increase the taxable profit and tax paid. Hence, the revaluation of the land above its original cost results in the recognition of a deferred tax liability. 7. Revalued plant  Carrying amount is $450 000 (Fair value $500 000 – Accum Depn $50 000)  Tax base is $380 000 (Cost $400 000 – Accum Depn $20 000) The tax base is the future deductible amount for the asset based on cost.  Carrying amount > Tax base  Taxable temporary diff  Deferred tax liability At the end of the year, the asset carrying amount ($450 000) and its tax base ($380 000) result in a taxable temporary difference of $70 000 and a deferred tax liability of $21 000 ($70 000 x 30%), which is recognised in the following entry: Tax on revaluation increment (OCI) Income tax expense Deferred Tax Liability

Dr Cr Cr

30 000 9 000 21 000

The tax on the revaluation increment for the plant is $30 000 ($100 000 x 30%) and must be recognised in other comprehensive income. However, the tax on depreciation effect on the carrying amount and tax base of the asset is recognised in the profit or loss. The tax depreciation is $20 000 whereas the depreciation expense is $50 000. This reduces the taxable temporary difference for the plant by $30 000 and the deferred tax liability by $9 000 ($30 000 x 30%) 8. Goodwill  Carrying amount is $200 000  Tax base is $0 The tax base is the future deductible amount for the asset  Carrying amount > Tax base  Taxable temporary diff  Deferred tax liability Goodwill is an excluded taxable temporary difference by virtue of paragraph 15 of AASB 112 otherwise it would result in the recognition of a deferred tax liability.

6.40

Chapter 6: Accounting for company income tax

Question 6.6

Current and deferred tax worksheets and tax entries

You have been asked by the management of My Bag Ltd to assist with the preparation of the income tax entries for the year ended 30 June 2017. The company reported a profit before tax for the year to 30 June 2017 of $900 000. The company’s statements of financial position include assets and liabilities as follows:

Accounts receivable Allowance for doubtful debts Plant – at cost Accumulated depreciation Development asset – at cost Accumulated amortisation Interest receivable Provision for long-service leave Deferred tax asset Deferred tax liability

2017 $ 245 000 (20 000) 600 000 (190 000) 360 000 (130 000) 10 000 48 000 ? ?

2016 $ 200 000 (10 000) 600 000 (120 000) 200 000 (80 000) 20 000 62 000 21 600 60 000

(a) The company is entitled to claim a tax deduction of 125% on development costs when incurred. (b)Interest revenue of $10 000 is included in the profit for the year to 30 June 2017. (c) Expenses included in profit for the year to 30 June 2017 are as follows:  parking and other fines $10 000  depreciation expense for plant $70 000  doubtful debts expense $25 000  amortisation of development asset $50 000  long-service leave expense $36 000. (d)Accumulated depreciation on plant for tax purposes is $280 000 on 30 June 2017 and $180 000 on 30 June 2016. There have been no acquisitions or disposals of plant during the current year. (e) The corporate tax rate is 30%. Required Complete the current tax and deferred tax worksheets of My Bag Ltd and prepare the tax entries for 30 June 2017. Current Tax Worksheet for the year ended 30 June 2017 Accounting profit

$900 000

Add: Parking and other fines

$10 000

Depreciation expense - plant

70 000

Doubtful debts expense

25 000

6.41

Solution Manual to accompany Company Accounting 10e

Amortisation – development asset

50 000

Long service leave expense

36 000

Interest received

20 000

211 000

Less: Tax depreciation - plant

100 000

Bad debts written off

15 000

Development costs paid

160 000

Additional deduction for development costs

40 000

Long service leave paid

50 000

Interest revenue

10 000

375 000

Taxable profit

736 000

Current tax liability @ 30%

$220 800

The journal entry for current tax for the year to 30 June 2017 is as follows: Income Tax Expense Current Tax Liability

Dr Cr

220 800 220 800

Workings

1/07/16

Beginning balance Interest revenue

Interest receivable $ 20 000 Interest received 10 000 30/06/17 Ending balance 30 000

Development asset - at cost $ Beginning balance 200 000 Develop costs paid 160 000 30/06/17 Ending balance 360 000

$ 20 000 10 000 30 000

$ 360 000 360 000

6.42

Chapter 6: Accounting for company income tax

Additional deduction for development costs = 25% x $160 000 = $40 000

30/06/17

Allowance for doubtful debts $ Bad debts write off 15 000 1/07/16 Beginning balance Ending balance 20 000 Doubt debts expense 35 000

$ 10 000 25 000 35 000

Provision for long service leave $ LSL paid 50 000 1/07/16 Beginning balance Ending balance 48 000 LSL expense 98 000

$ 62 000 36 000 98 000

Accumulated depreciation – for tax purposes $ 1/07/16 Beginning balance Ending balance 280 000 Tax depreciation 280 000

$ 180 000 100 000 280 000

6.43

Solution Manual to accompany Company Accounting 10e

Deferred tax worksheet as at 30 June 2017 Carrying Amount

Future Deductible Amount

Tax Base

Taxable Temporary Differences

Accounts receivable (net)

225 000

245 000

[2]

Plant (net)

410 000

320 000

[1]

90 000

Development asset (net)

230 000

[1]

230 000

Interest receivable

10 000

[1]

10 000

48 000

[1]

Deductible Temporary Differences

Assets 20 000

Liabilities Provision for LSL

48 000

Total Temporary Diffs

330 000

Deferred tax liability 30%

99 000

68 000

20 400

Deferred tax asset 30% Beginning balances

60 000

21 600

Increase/(Decrease)

39 000

(1 200)

Tax Bases Assets that generate future taxable economic benefits: [1] Tax Base = Future deductible amount Assets that do not generate future taxable economic benefits: [2] Tax Base = Carrying amount Liabilities except unearned revenue: [1] Tax Base = Carrying amount less Future deductible amount Liability of unearned revenue: [2] Tax Base = Carrying amount – Untaxed future revenue

The journal entry for the deferred tax for the year to 30 June 2017 is as follows: Income Tax Expense Deferred Tax Liability Deferred Tax Asset

Dr Cr Cr

40 200 39 000 1 200

6.44

Chapter 6: Accounting for company income tax

Question 6.7

Current and deferred tax worksheets and tax entries

You are the accountant of Brand New Friend Ltd, a reporting entity with a year end of 30 June 2017. You are currently preparing the tax information for inclusion in the financial statements. An extract from the statement of profit or loss and other comprehensive income is as follows: Profit before tax Included in the profit: Employee expenses Legal expenses Exempt income Interest revenue Audit fees expense Rent revenue Interest expense Bad debts expense Depreciation expense – plant and equipment Depreciation expense – buildings Entertainment expenses

$ 500 000 550 000 125 000 75 000 30 000 80 000 20 000 20 000 30 000 52 500 10 000 5 000

Additional information (a) Exempt income is not subject to tax. (b)Interest is assessable on receipt and deductible when paid. Interest receivable at 30 June 2017 is $25 000 (2016: $30 000). Interest payable at 30 June 2017 is $1000 (2016: $6000). (c) The company raised an accrual liability of $35 000 for work not performed by 30 June 2017 (2016: $30 000). Fees for audit work are not deductible unless the audit work has been performed. (d)Rent revenue relates to a contract where the annual rent is received in advance. The unearned revenue liability at 30 June 2017 is $20 000 (2016: $15 000). Rent is assessable when received. (e) The bad debts expense relates to an account that has been written off. (f) Property, plant and equipment is as follows: Property, plant and equipment Buildings at cost Accumulated depreciation – buildings Plant and equipment at cost Accumulated depreciation – plant and equipment

30 June 2017 $ 500 000 (50 000) 450 000 350 000 (97 500)

30 June 2016 $ 500 000 (40 000) 460 000 150 000 (45 000)

252 500 $ 702 500

105 000 $ 565 000

The company’s buildings do not qualify for tax deductions and are not subject to capital gains tax. Tax depreciation for 30 June 2017 is $70 000. The tax written down value of plant and equipment at 30 June 2017 is $220 000 (2016: $90 000).

6.45

Solution Manual to accompany Company Accounting 10e

(g) Entertainment expenses are not deductible. (g) Legal expenses include $50 000 related to capital transactions that are not deductible. (h)Employee expenses for the year include $50 000 for annual leave and $10 000 for long-service leave. The provision for employee benefits at 30 June 2017 is $180 000 (2016: $170 000). (i) The deferred tax balances at 30 June 2016 are: deferred tax liability $13 500 and deferred tax asset $66 300. (j) The company tax rate is 30%. Required Complete the current and deferred tax worksheets of Brand New Friend Ltd for 30 June 2017 and use the worksheets to prepare the tax entries for the year. Current Tax Worksheet for the year ended 30 June 2017 Accounting profit

$500,000

Add: Legal expenses (non-deductible)

$50 000

Entertainment expenses

5 000

Depreciation expense - buildings

10 000

Depreciation expense – plant and equip

52 500

Interest expense

20 000

Audit fees expense

80 000

Employee leave expenses (A/L & LSL)

60 000

Rent received

25 000

Interest received

35 000

337 500

Less: Exempt income

75 000

Rent revenue

20 000

Interest revenue

30 000

Interest paid

25 000

Tax depreciation – plant & equip

70 000

Audit fees deduction

75 000

Leave paid to employees

50 000

345 000

6.46

Chapter 6: Accounting for company income tax

Taxable profit

492 500

Current tax liability @ 30%

$147 750

The journal entry for current tax for the year to 30 June 2017 is as follows: Income Tax Expense Current Tax Liability

Dr Cr

147 750 147 750

Workings

1/07/16

30/06/17

Beginning balance Interest revenue

Interest paid Ending balance

Interest receivable $ 30 000 Interest received 30 000 30/06/17 Ending balance 60 000

$ 35 000 25 000 60 000

Interest payable $ 25 000 1/07/16 1 000 20 000

$ 6 000 20 000 26 000

Beginning balance Interest expense

Unearned rent revenue $ 20 000 1/07/16 Beginning balance 20 000 Rent received 40 000

$ 15 000 25 000 40 000

Provision for employee benefits $ LSL paid 50 000 1/07/16 Beginning balance Ending balance 180 000 Leave expenses 230 000

$ 170 000 60 000 230 000

Rent revenue Ending balance

6.47

Solution Manual to accompany Company Accounting 10e

Deferred tax worksheet as at 30 June 2017 Carrying Amount

Future Deductible Amount

Tax Base

Taxable Temporary Differences

Deductible Temporary Differences

Interest receivable

25 000

[1]

25 000

Plant and equip (net)

252 500

220 000

[1]

32 500

Accrued audit fees

35 000

[1]

35 000

Interest payable

1 000

[1]

1 000

Provision emp benefits

180 000

[1]

180 000

Unearned rent revenue

20 000

[2]

20 000

Assets

Liabilities

Total Temporary Diffs

57 500

Deferred tax liability 30%

17 250

236 000

70 800

Deferred tax asset 30% Beginning balances

13 500

66 300

Increase for the year

3 750

4 500

The journal entry for deferred tax for the year to 30 June 2017 is as follows: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

4 500 3 750 750

6.48

Chapter 6: Accounting for company income tax

Proof of the opening deferred tax balances at 1 July 2016 Deferred tax worksheet as at 30 June 2016 Carrying Amount

Future Deductible Amount

Tax Base

Taxable Temporary Differences

Deductible Temporary Differences

Interest receivable

30 000

[1]

30 000

Plant and equip (net)

105 000

90 000

[1]

15 000

Accrued audit fees

30 000

[1]

30 000

Interest payable

6 000

[1]

6 000

Provision emp benefits

170 000

[1]

170 000

Unearned rent revenue

15 000

[2]

15 000

Assets

Liabilities

Total Temporary Diffs

45 000

Deferred tax liability 30%

13 500

221 000

66 300

Deferred tax asset 30%

The increase in the deferred tax asset for 2016-2017 is attributable to the following Increase in accrued audit fees 5 000 Increase in provision for employee benefits 10 000 Increase in unearned rent revenue 5 000 Decrease in interest payable (5 000) 15 000 x 30% = $4 500

The increase in the deferred tax liability for 2016-2017 is attributable to the following: Increase in the difference between tax and accounting written down value of plant 17 500 Decrease in interest receivable (5 000) 12 500 x 30% = $3 750

6.49

Solution Manual to accompany Company Accounting 10e

Question 6.8

Deferred tax worksheets and tax entries

Pretty Gone Ltd commenced operations on 1 July 2015. Extracts from the statements of financial position of Pretty Gone Ltd as at 30 June 2017 and 30 June 2016 are as follows: PRETTY GONE LTD Statement of Financial Position as at 30 June 2017 Assets Cash Accounts receivable Allowance for doubtful debts Inventory Prepaid insurance Dividends receivable Plant and equipment – at cost Accumulated depreciation – plant equipment Goodwill Shares in listed companies at cost Deferred tax asset Liabilities Bank overdraft Accounts payable Current tax liability Provision for employee benefits Provision for dividend Borrowings Deferred tax liability

and

65 000 885 000 (80 000 ) 640 000 40 000 36 000 1 240 000 (380 000 )

2016 $

52 000 858 000 (70 000 ) 749 000 30 000 21 000 918 000 (315 000 )

78 000 140 000 ?

78 000 110 000 60 000

209 300 191 100 50 985 137 800 65 000 — ?

175 500 156 000 46 270 130 000 52 000 260 000 28 800

Additional information (a) Accumulated depreciation based on tax depreciation is $485 000 at 30 June 2017and $360 000 at 30 June 2016. There have been no disposals of plant during the year to 30 June 2017. (b)Deferred tax liabilities and assets are not netted off in the statement of financial position. (c) The corporate tax rate is 30%. Required A. Prepare the deferred tax worksheet at 30 June 2016 to prove that the deferred tax liability and asset balances are $28 800 and $60 000 respectively. B. Prepare the deferred tax worksheet at 30 June 2017 to determine the deferred tax entries for the year. C. Assume that the company made a profit before tax of $700 000 for the year to 30 June 2017 and that the differences between accounting profit and taxable profit are apparent from items shown in the statement of financial position and its comparative. Prepare the condensed current tax worksheet for the year to 30 June 2017 and the current tax entries for the year. © John Wiley and Sons Australia, Ltd 2015

6.50

Chapter 6: Accounting for company income tax

Part A Deferred Tax Worksheet as at 30 June 2016

Assets Cash A/cs Receivable Inventory Prepaid insurance Dividend receivable Plant & equip Goodwill Shares in other companies Liabilities Bank overdraft A/cs payable Current tax liability Provision for employee benefits Provision for dividend Borrowings Total temporary differences Excluded differences Temp differences for deferred tax Deferred tax liability (30%) Deferred tax asset (30%)

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diffs $

Deductible Temp Diffs $

52 000 788 000 749 000 30 000 21 000

0 0 749 000 0 0

52 000 858 000 749 000 0 0

[2] [2] [1] [1] [1]

0 0 0 30 000 21 000

0 70 000 0 0 0

603 000 78 000 110 000

558 000 0 110 000

[1] [1] [1]

45 000 78 000 0

0 0 0

175 500 156 000 46 270

0 0 0

175 500 156 000 46 270

[1] [1] [1]

0 0 0

130 000

[1]

130 000

52 000

[1]

260 000

[1]

0 174 000

0 200 000

78 000

96 000

200 000

28 800 60 000

6.51

Solution Manual to accompany Company Accounting 10e

Part B Deferred Tax Worksheet as at 30 June 2017 Carrying Deductible Tax Base Amount Amount $ Assets Cash A/cs Receivable Inventory Prepaid insurance Dividend receivable Plant & equip Goodwill Shares in other companies Liabilities Bank overdraft A/cs payable Current tax liability Provision for employee benefits Provision for dividend Total temporary differences Excluded differences Temp differences for deferred tax Deferred tax liability (30%) Deferred tax asset (30%) Begin Balances Increase for year

Taxable Temp Diffs $

Deductible Temp Diffs $

65 000 805 000 640 000 40 000 36 000

0 0 64 000 0 0

65 000 885 000 640 000 0 0

[2] [2] [1] [1] [1]

0 0 0 40 000 36 000

0 80 000 0 0 0

860 000 78 000 140 000

755 000 0 140 000

[1] [1] [1]

105 000 78 000 0

0 0 0

209 300 191 100 50 985

0 0 0

209 300 191 100 50 985

[1] [1] [1]

0 0 0

137 800

[1]

137 800

65 000

[1]

259 000

217 800

78 000

181 000

217 800

54 300 65 340 28 800 25 500

60 000 5 340

The entries to record the deferred tax for the year ended 30 June 2017 are: Income Tax Expense Deferred Tax Asset Deferred Tax Liability

Dr Dr Cr

20 160 5 340

25 500

6.52

Chapter 6: Accounting for company income tax

Part C Current Tax Worksheet (Condensed) for the year ended 30 June 2017 Accounting profit

$700,000

Add: Depreciation expense – plant & equip

65 000

[380 000 – 315 000]

Increase in allowance for doubtful debts

10 000

Increase in provision for employee benefits

7 800

82 800

Less: Tax depreciation – plant & equip

125 000

[485 000 – 360 000]

Increase in prepaid insurance

10 000

Increase in dividends receivable

15 000

150 000

Taxable profit

632 800

Current tax liability @ 30%

$189 840

The entries to record the current tax for the year ended 30 June 2017 are: Income Tax Expense Current Tax Liability

Dr Cr

189 840 189 840

Additional Explanations for Current Tax Worksheet Increase in allowance for doubtful debts  Doubtful debts expense > Bad debts w/o  Add back the increase Increase in provision for employee benefits  Benefits expense > Benefits paid  Add back the increase Increase in prepaid insurance  Insurance paid > Insurance expense  Deduct the increase Increase in dividends receivable  Dividend revenue > Dividend received  Deduct the increase

6.53

Solution Manual to accompany Company Accounting 10e

Additional Explanations for Deferred Tax Worksheet The deferred tax worksheets shown in the solution for this question are comprehensive because all assets and liabilities are included. But we would still get the same answer if we ignored the assets and liabilities that do not have any future tax consequences as follows: • Cash • Inventory • Goodwill (an excluded temporary difference) • Shares in listed companies • Bank overdraft • Accounts payable • Current tax liability • Provision for dividend • Borrowings

The increase in the deferred tax asset for 2016-2017 is attributable to the following Increase in provision for employee benefits 7 800 Increase in allowance for doubtful debts 10 000 17 800 x 30% = $5 340 The increase in the deferred tax liability for 2016-2017 is attributable to the following: Increase in prepaid insurance 10 000 Increase in dividends receivable 15 000 Increase in the difference between tax and accounting written down value of plant 60 000 85 000 x 30% = $25 500

Plant (net) 2017 Plant (net) 2016 Increase in Difference

Accounting 860 000 603 000

Tax 755 000 558 000

Difference 105 000 45 000 60 000

6.54

Chapter 6: Accounting for company income tax

Question 6.9

Deferred tax worksheets and tax entries

The financial statements of Forest Fire Ltd for the year ended 30 June 2017 showed a profit before tax of $480 000. The profit includes non-deductible expenses of $20 000. Extracts from the statements of financial position of the company as at 30 June 2017 and 30 June 2016 are as follows: FOREST FIRE LTD Statement of Financial Position (Extract) as at 30 June 2017 Assets Cash Inventories Allowance for obsolescence Prepaid rent Plant Accumulated depreciation – plant Land Deferred tax asset Liabilities Trade payables Unearned service revenue Provision for annual leave Deferred tax liability

2016

150 000 96 000 (7 000 ) 50 000 140 000 (32 000 ) 200 000 ?

$ 180 000 85 000 (5 200 ) 56 000 170 000 (28 000 ) 100 000 19 470

68 000 60 000 15 200 ?

76 000 50 000 9 700 18 900

Additional information (a) The accumulated depreciation on plant for tax purposes was $47 000 at 30 June 2017 (2016: $35 000). (b)On 30 June 2017, the company’s land was revalued from the historical cost of $100 000 to its fair value of $200 000. (c) The corporate tax rate is 30%. Required A. Prepare the condensed current tax worksheet for the year to 30 June 2017 and the current tax entries for the year. B. Prepare the deferred tax worksheet at 30 June 2016 to prove that the deferred tax liability and asset balances are $18 900 and $19 470 respectively. C. Prepare the deferred tax worksheet at 30 June 2017 and the deferred tax entries for the year. D. Prepare the statement of profit or loss and other comprehensive income for the year ended 30 June 2017. Part A Current Tax Worksheet (Condensed) for the year ended 30 June 2017 Accounting profit

$480 000

6.55

Solution Manual to accompany Company Accounting 10e

Add: Non-deductible expenses

20 000

Depreciation expense – plant & equip

4 000

[32 000 – 28 000]

Increase in allowance for obsolescence

1 800

Decrease in prepaid rent

6 000

Increase in unearned service revenue

10 000

Increase in provision for annual leave

5 500

47 300

12 000

Less: Tax depreciation – plant & equip [47 000 – 35 000]

Taxable profit

515 300

Current tax liability @ 30%

$154 590

The entries to record the current tax for the year ended 30 June 2017 are: Income Tax Expense Current Tax Liability

Dr Cr

154 590 154 590

Additional Explanations for Current Tax Worksheet Increase in allowance for obsolescence  Inventory expense > Inventory written off  Add back the increase Decrease in prepaid rent  Rent expense > Rent paid  Add back the increase Increase in unearned revenue  Cash received for services > Service revenue  Add back the increase Increase in provision for annual leave  Leave expense > Leave paid  Add back the increase

6.56

Chapter 6: Accounting for company income tax

Part B Deferred Tax Worksheet as at 30 June 2016 Carrying Deductible Tax Base Amount Amount

Assets Cash Inventories Prepaid rent Plant Land Liabilities Trade payables Unearned revenue Provision for annual leave Total Temporary Differences Deferred tax liability (30%) Deferred tax asset (30%)

Taxable Temp Diffs $

Deductible Temp Diffs $

180 000 79 800 56 000 142 000 100 000

0 85 000 0 135 000 100 000

180 000 85 000 0 135 000 100 000

[2] [1] [1] [1] [1]

0 0 56 000 7 000 0

0 5 200 0 0 0

76 000 50 000 9 700

0 50 000 9 700

76 000 0 0

[1] [2] [1]

0 0 0

0 50 000 9 700

63 000

64 900

18 900 19 470

Tax Bases Assets that generate future taxable economic benefits: [1] Tax Base = Future deductible amount Inventories deductible amount is at cost = 85 000 Prepaid rent deduction already claimed so deductible amount = $0 Plant and equipment deductible amount at tax written down value = 170 000 – 35 000 = 135 000 Land deductible amount at cost = 100 000 Assets that do not generate future taxable economic benefits: [2] Tax Base = Carrying amount Cash = 180 000 Liabilities except unearned revenue: [1] Tax Base = Carrying amount less Future deductible amount Trade payables = 76 000 – 0 = 76 000 Provision for annual leave = 9 700 – 9 700 = 0 Liability of unearned revenue: [2] Tax Base = Carrying amount – Untaxed future revenue Unearned service revenue = 50 000 – 50 000 = 0

Part C © John Wiley and Sons Australia, Ltd 2015

6.57

Solution Manual to accompany Company Accounting 10e

Deferred Tax Worksheet as at 30 June 2017 Carrying Deductible Tax Base Amount Amount

Taxable Temp Diffs $

Deductible Temp Diffs $

150 000 89 000 50 000 108 000 200 000

0 96 000 0 93 000 100 000

150 000 96 000 0 93 000 100 000

[2] [1] [1] [1] [1]

0 0 50 000 15 000 100 000

0 7 000 0 0 0

68 000 60 000 15 200

0 60 000 15 200

68 000 0 0

[1] [2] [1]

0 0 0

0 60 000 15 200

165 000

82 200

49 500 24 660 18 900 30 600 30 000 600 30 600

Profit or loss

19 470 5 190 0 5 190 5 190

* Deferred tax included in other comprehensive income Revaluation increment on land for the period $100 000 x 30% = $30 000

The entries to record the deferred tax in profit or loss for the year ended 30 June 2017 are: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

5 190 600 4 590

The entries to record the deferred tax in other comprehensive income for the year ended 30 June 2017 are: Tax on revaluation (OCI) Deferred Tax Liability

Dr Cr

30 000

6.58

Chapter 6: Accounting for company income tax

Additional Explanations for Deferred Tax Worksheet The increase in the deferred tax asset for 2016-2017 is attributable to the following: Increase in allowance for obsolescence 1 800 Increase in provision for annual leave 5 500 Increase in unearned service revenue 10 000 17 300 x 30% = $5 190 The increase in the deferred tax liability for 2016-2017 is attributable to the following: Decrease in prepaid rent (6 000) Increase in the difference between tax and accounting written down value of plant 8 000 2 000 x 30% = $ 600 Increase in land

Plant (net) 2017 Plant (net) 2016 Increase in Difference

100 000 x 30% =$ 30 000

Accounting 142 000 108 000

Tax 135 000 93 000

Difference 7 000 15 000 8 000

Part D FOREST FIRE LTD Statement of Comprehensive Income for the year ended 30 June 2017 Profit for the year Other comprehensive income: Revaluation of land Tax on revaluation of land Comprehensive income for the year

Working Profit before income tax Less: Income tax expense current tax journal deferred tax journal Profit for the year

$330 000 $100 000 (30 000)

70 000 $400 000

$480 000 154 590 (4 590)

150 000 $330 000

6.59

Solution Manual to accompany Company Accounting 10e

Question 6.10

Current and deferred tax worksheets and tax entries

Fromthehip Ltd’s statement of profit or loss for the year ended 30 June 2007 and extracts from its statements of financial position as at 30 June 2017 and 30 June 2016 are shown below. The statements for the current year are yet to be finalised by accounting for income tax. FROMTHEHIP LTD Statement of Profit or Loss for the year ending 30 June Income Service revenue Rent revenue Insurance claim for loss of profits Less: Expenses Employee expenses Insurance expense Accounting fees Bad and doubtful debts Cleaning and maintenance Depreciation of equipment Entertainment expenses Interest on borrowings Legal fees Motor vehicle expenses Other Restructuring costs Profit before tax

$ 900 000 50 000 41 200 660 000 50 000 5 500 19 500 3 250 5 500 4 000 75 000 3 800 6 000 3 750 23 000

FROMTHEHIP LTD Statement of Financial Position (Extract) as at 30 June 2017 Assets Cash at bank Trade debtors Allowance for doubtful debts Prepaid insurance Land – at fair value Equipment – at cost Accumulated depreciation Other debtors Deferred tax asset Liabilities Trade creditors Borrowings Unearned rent revenue Provision for employee benefits Provision for restructuring Other creditors

991 200

859 300 $ 131 900

2016

$ 900 100 240 550 (38 000) 10 950 450 000 58 000 (24 500) 142 400 ?

$ 800 100 200 000 ( 20 000) 5 000 300,000 58 000 (19 000) — 18 000

239 000 543 800 50 000 49 500 23 000 10 000

245 000 438 500 — 40 000 — —

6.60

Chapter 6: Accounting for company income tax

— ?

Current tax liability Deferred tax liability

13 300 32 700

Additional information (a) The original cost of the land is $200 000. (b)The tax written down value of equipment at 30 June 2017 is $28 000 (2016: $35 000). During the 2017 year, there were no additions or disposals of equipment. (c) Legal fees of $3800 are capital in nature and non-deductible for tax purposes. (d)Other creditors at 30 June 2017 include an accrual for accounting fees of $4500 for work not yet performed (2016: $Nil). For tax purposes, the accounting fees are deductible only if work has been performed. (e) For tax purposes, restructuring costs are deductible only when paid. (f) Other debtors at 30 June 2017 include $41 200 relating to an insurance claim that is in-process. Insurance income is only assessable for tax purposes after the insurance proceeds have been received. (g) The corporate tax rate is 30%. Required A. Prepare the current tax worksheet for the year to 30 June 2017 and the current tax entries for the year. B. Prepare the deferred tax worksheet at 30 June 2016 to prove that the deferred tax liability and asset balances are $18 000 and $32 700 respectively. C. Prepare the deferred tax worksheet at 30 June 2017 and the deferred tax entries for the year. D. Prepare the statement of profit or loss and other comprehensive income for the year ended 30 June 2017. Part A Current Tax Worksheet for the year ended 30 June 2017 Accounting profit before income tax

$131 900

Add: Entertainment expense (non-deductible)

$4 000

Legal expenses (non-deductible)

3 800

Insurance expense

50 000

Accounting fees expense

5 500

Bad and doubtful debts expense

19 500

Depreciation expense - equipment

5 500

Restructuring expense

23 000

Employee expenses

660 000

Rent received

100 000

871 300

6.61

Solution Manual to accompany Company Accounting 10e

Deduct: Insurance income

41 200

Insurance paid

55 950

Accounting fees (for tax)

1 000

Bad debts written off

1 500

Tax depreciation - equipment

7 000

Restructuring costs paid

Employee costs paid

650 500

Rent revenue

50 000

807 150

Taxable income

196 050

Current tax liability @ 30%

58 815

Income tax expense Current tax liability (Recognition of current tax liability at 30 June 2017)

Dr Cr

58 815 58 815

Workings for current tax worksheet •

Tax depreciation charge = $35 000 – $28 000 = $7 000

•

Accounting fees for tax = $5 500 - $4 500 = $1 000

•

Bad debts written off Allowance for Doubtful Debts Debts written off 1 500 Beginning balance Ending balance 38 000 Expense 39 500

•

Rent received

Rent revenue Ending balance

•

20 000 19 500 39 500

Unearned rent revenue 50 000 Beginning balance 50 000 Rent received 100 000

0 100 000 100 000

Insurance paid

Beginning balance Insurance paid

Prepaid Insurance 5 000 55 950

Expense Ending balance

50 000 10 950 6.62

Chapter 6: Accounting for company income tax

•

60 950

Provision for Employee Benefits Leave paid 650 500 Beginning balance Ending balance 49 500 Expense 700 000

40 000 660 000 700 000

Employee costs paid

Restructuring costs paid

Costs paid Ending balance

•

Provision for Restructuring 0 Beginning balance 23 000 Expense 23 000

0 23 000 23 000

Other Debtors – Insurance 0 Cash proceeds 41 200 Ending balance 41 200

0 41 200 41 000

Insurance proceeds

Beginning balance Insurance revenue

6.63

Solution Manual to accompany Company Accounting 10e

Current Tax Worksheet (Condensed) for the year ended 30 June 2017 Accounting profit before income tax

$131 900

Add: Entertainment expense (non-deductible)

$4 000

Legal expenses (non-deductible)

3 800

Increase in accrued accounting fees

4 500

Increase in allowance for doubtful debts

18 000

Depreciation expense - equipment

5 500

Increase in provision for restructuring

23 000

Increase in provision for employee benefits

9 500

Increase in unearned rent revenue

50 000

118 300

Deduct: Increase in insurance receivable

41 200

Increase in prepaid insurance

5 950

Tax depreciation - equipment

7 000

54 150

Taxable income

196 050

Current tax liability @ 30%

58 815

6.64

Chapter 6: Accounting for company income tax

Part B Deferred Tax Worksheet as at 30 June 2016 Carrying Deductible Tax Base Amount Amount

Assets Cash at bank Trade debtors Prepaid insurance Land Equipment Other debtors Liabilities Trade creditors Borrowings Unearned revenue Provision for employee benefits Provision for restructuring Other creditors Total Temporary Differences Deferred tax liability (30%) Deferred tax asset (30%)

Taxable Temp Diffs $

Deductible Temp Diffs $

800 100 180 000 5 000 300 000 39 000 0

0 0 0 200 000 35 000

800 100 200 000 0 100 000 35 000

[2] [2] [1] [1] [1]

0 0 5 000 100 000 4 000

0 20 000 0 0 0

245 000 438 500 0 40 000

0 0

245 000 438 500

[1] [1]

40 000

[1]

40 000

109 000

60 000

0 0

32 700 18 000

6.65

Solution Manual to accompany Company Accounting 10e

Part C Deferred Tax Worksheet as at 30 June 2017

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diffs $

Deductible Temp Diffs $

900 100 202 550 10 950 450 000 33 500 41 200

0 0 0 200 000 28 000 0

900 100 240 550 0 250 000 28 000 0

[2] [2] [1] [1] [1] [1]

0 0 10 950 250 000 5 500 41 200

0 38 000 0 0 0

239 000 543 800 50 000 49 500

0 0 50 000 49 500

239 000 543 800 0 0

[1] [1] [2] [1]

50 000 49 500

23 000

[1]

4 500

[1]

23 000

307 650

4 500 165 000

92 295 49 500 32 700 59 595 45 000 14 595 59 595

Profit or loss

18 000 31 500 0 31 500 31 500

* Deferred tax included in other comprehensive income Revaluation increment on land for the period $150 000 x 30% = $45 000

The entries to record the deferred tax in profit or loss for the year ended 30 June 2017 are: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

31 500

14 595 16 905

6.66

Chapter 6: Accounting for company income tax

The entries to record the deferred tax in other comprehensive income for the year ended 30 June 2017 are: Tax on revaluation (OCI) Deferred Tax Liability

Dr Cr

45 000 45 000

Part D FROMTHEHIP LTD Statement of Comprehensive Income for the year ended 30 June 2017 Profit for the year Other comprehensive income: Revaluation of land Tax on revaluation of land Comprehensive income for the year

Working Profit before income tax Less: Income tax expense current tax journal deferred tax journal Profit for the year

$89 990 $150 000 (45 000)

105 000 $194 990

$131 900 58 815 (16 905)

41 910 $89 990

Check Net assets (Equity) at 30 June 2016 Add comprehensive income for the year Net assets (Equity) at 30 June 2017

$527 600 194 990 $ 722 590

6.67

Solution Manual to accompany Company Accounting 10e

Question 6.11

Current and deferred tax worksheets and tax entries

The following information has been provided in relation to Jennifer Ltd: 1. The company recorded a profit before tax for the 2016–17 period of $120 000. 2. At 30 June 2017, the company’s plant is carried at cost of $200 000, with accumulated depreciation of $80 000. Depreciation of $40 000 was recognised as an expense in the 2016–17 period. The tax deduction allowed in that year is $50 000, resulting in a carrying amount of plant for tax purposes at 30 June 2017 of $90 000. No acquisitions or disposals of plant occurred during the 2016–17 period. 3. At 30 June 2016, the company reported an accounts receivable balance of $140 000, with a balance in the allowance for doubtful debts of $20 000. In December 2016, the company wrote $15 000 of the accounts receivable off as bad debts, adjusting the allowance for doubtful debts. In the statement of financial position at 30 June 2017, the company reported an accounts receivable balance of $160 000 with a related allowance for doubtful debts of $12 000. 4. As a part of its sales strategy, the company offers a 2-year warranty on its products. At 30 June 2016, the balance in the provision for warranty was $40 000. In the 2016– 17 period, because of a fault in the materials supplied, there was an unusual number of claims under the warranty, these amounting to $30 000. In anticipation of future claims, the company reported a provision for warranty payable of $60 000 at 30 June 2017. 5. The company pays its insurance for the following 12 months in May each year. On 1 May 2017, the amount paid was $21 000, compared with $18 000 in the previous year. Tax deductions for insurance occur with the cash payment. 6. The company buys inventory on a 30-day credit arrangement. The accounts payable of $30 000 at 30 June 2017 was only marginally higher than the $28 000 balance one year earlier. 7. During the 2016–17 period, the company incurred $20 000 worth of entertainment expenses, which was higher than the previous year expense of $15 000. These expenses are non-deductible for tax purposes. 8. No other assets and liabilities have tax consequences. The tax rate is 30%. Required A. Prepare the current tax worksheet for the year ended 30 June 2017 and the entries to record the current tax. B. Prepare the deferred tax worksheet as at 30 June 2016 to determine the beginning balances for deferred tax liability and deferred tax asset. C. Prepare the deferred tax worksheet as at 30 June 2017 and the entries to record the deferred tax for the year.

6.68

Chapter 6: Accounting for company income tax

Part A Current Tax Worksheet for the year ended 30 June 2017 Profit before tax

$120 000

Add: Entertainment expenses

$20 000

Depreciation expense - plant

40 000

Doubtful debts expense

7 000

Warranty expense

50 000

Insurance expense

18 500

135 500

Less: Tax depreciation - plant

50 000

Bad debts written off

15 000

Warranty paid

30 000

Insurance paid

21 000

116 000

Taxable profit

139 500

Current tax liability @ 30%

$41 850

The journal entry for current tax for the year to 30 June 2017 is as follows: Income Tax Expense Current Tax Liability

Dr Cr

41 850 41 850

Current Tax Worksheet Explanations Doubtful debts expense = 15 000 – 20 000 + 12 000 = 7 000 Insurance expense = (10/12 x 18 000) + (2/12 x 21 000) = 18 500 Warranty expense = 30 000 – 40 000 + 60 000 = 50 000

6.69

Solution Manual to accompany Company Accounting 10e

Part B Deferred Tax Worksheet as at 30 June 2016 Carrying Deductible Tax Base Amount Amount

Assets Plant A/cs receivable Prepaid insurance Liabilities A/cs payables Provision for warranty

Taxable Temp Diffs $

Deductible Temp Diffs $

160 000 120 000 15 000

140 000 0 0

140 000 140 000 0

[1] [2] [1]

20 000 0 15 000

0 20 000 0

28 000 40 000

0 40 000

28 000 0

[1] [1]

0 0

0 40 000

35 000

60 000

Total Temporary Differences Deferred tax liability (30%) Deferred tax asset (30%)

10 500 18 000

Assets that generate future taxable economic benefits: [1] Tax Base = Future deductible amount Assets that do not generate future taxable economic benefits: [2] Tax Base = Carrying amount Liabilities except unearned revenue: [1] Tax Base = Carrying amount less Future deductible amount Liability of unearned revenue: [2] Tax Base = Carrying amount – Untaxed future revenue

PLANT: 2016:

Accounting Tax $200 000 $200 000 40 000 60 000 160 000 140 000* * Carrying amount at 6/16 ($90 000) plus depreciation for tax purposes in current year ($50 000) = $140 000 Taxable temporary difference $20 000 and Deferred tax liability of $6 000 Cost Accum Depreciation

ACCOUNTS RECEIVABLE 2016: Accounts receivable Allowance

$140 000 20 000 120 000 Deductible temporary difference $20 000 and Deferred tax asset $6 000 WARRANTY PAYABLE 2016: Balance of $40 000 Deductible temporary difference $40 000 and Deferred tax asset $12 000 PREPAID INSURANCE 2016: Balance of $15 000 [$18 000 – 2 x $1 500 expired] Taxable temporary difference $15 000 and Deferred tax liability of $4 500

6.70

Chapter 6: Accounting for company income tax

Part C Deferred Tax Worksheet as at 30 June 2017 Carrying Deductible Tax Base Amount Amount $ Assets Plant A/cs receivable Prepaid insurance Liabilities A/cs payable Provision for warranty

Taxable Temp Diffs $

Deductible Temp Diffs $

120 000 148 000 17 500

90 000 0 0

90 000 160 000 0

[1] [2] [1]

30 000 0 17 500

0 12 000 0

30 000 60 000

0 60 000

30 000 0

[1] [1]

0 0

0 60 000

47 500

72 000

Total Temporary Differences Deferred tax liability (30%) Deferred tax asset (30%) Begin Balances Increase for year

14 250 21 600 10 500 3 750

18 000 3 600

The entries to record the deferred tax for the year ended 30 June 2017 are: Income Tax Expense Deferred Tax Asset Deferred Tax Liability

Dr Dr Cr

150 3 600 3 750

The increase in the deferred tax asset for 2016-2017 is attributable to the following Decrease in allowance for doubtful debts (8 000) Increase in provision for warranty 20 000 12 000 x 30% = $3 600 The increase in the deferred tax liability for 2016-2017 is attributable to the following: Increase in prepaid insurance 2 500 Increase in the difference between tax and accounting written down value of plant 10 000 12 500 x 30% = $3 750

Plant (net) 2017 Plant (net) 2016 Increase in Difference

Accounting 120 000 160 000

Tax 90 000 140 000

Difference 30 000 20 000 10 000

6.71

Solution Manual to accompany Company Accounting 10e

Question 6.12

Current and deferred assessment and tax entries

tax

worksheets,

amended

The accounting profit before tax of She Said Ltd for the year ended 30 June 2017 was $24 000 and included the income and expense items shown below. Government grant (exempt from tax) Proceeds on sale of plant Carrying amount of plant sold Entertainment expense Bad debts expense Depreciation expense – plant Insurance expense Annual leave expense

5 360 33 000 30 000 12 100 5 200 24 000 11 900 15 400

The statements of financial position of She Said Ltd as at 30 June 2017 and 2016 included the following assets and liabilities: SHE SAID LTD Statement of Financial Position (Extract) as at 30 June 2017 Accounts receivable $ 156 000 Allowance for doubtful debts (6 800 ) Prepaid insurance 3 400 Plant – at cost 240 000 Accumulated depreciation – plant (134 400 ) Deferred tax asset ? Provision for annual leave 14 100 Deferred tax liability ?

2016 $ 147 500 (5 200 ) 5 600 290 000 (130 400 ) 4 470 9 700 9 504

Additional information (a) In March 2017, the company received an amended assessment from the ATO for the year ended 30 June 2016 indicating that an amount of $4500 claimed as a deduction for legal expenses had been disallowed. The company has not yet adjusted its accounts to reflect the amendment. (b)For tax purposes the carrying amount of plant sold was $26 000. There were no other disposals or acquisitions of plant during the year. (c) The tax deduction for plant depreciation was $28 800. Accumulated depreciation at 30 June 2016 for taxation purposes was $156 480. (d)The tax rate is 30%. Required A. Prepare the journal entry necessary to record the amended assessment of the company for 30 June 2016. B. Prepare the current tax worksheet for the year ended 30 June 2017and the entries to record the current tax. C. Explain your treatment of annual leave expense in the current tax worksheet. D. Prepare the deferred tax worksheet as at 30 June 2017 and the entries to record the deferred tax. © John Wiley and Sons Australia, Ltd 2015

6.72

Chapter 6: Accounting for company income tax

E. What would be the journal entry for current tax for the year ended 30 June 2017 if company had previously recognised a deferred tax asset for carried forward tax losses of $18 400. Part A Journal entry to record 2016 amendment assessment March 2017 Income tax expense Current tax liability

Dr Cr

1 350 1 350

Note: the disallowed expense item increases the tax due for the year to 30 June 2016 but it is brought to account in the current period Part B Current Tax Worksheet for the year ended 30 June 2017

Profit before income tax Add: Entertainment expense (non-deductible) Carrying amount of plant sold (accounts) Depreciation expense – plant Bad debts expense Insurance expense Annual leave expense Deduct: Government grant (exempt) Carrying amount of plant sold (tax) Depreciation – taxation Bad debts written off Insurance paid Annual leave paid Taxable income Current tax liability @ 30% Journal entry Income tax expense Current tax liability

$24 000 $12 100 30 000 24 000 5 200 11 900 15 400

5 360 26 000 28 800 3 600 9 700 11 000

Dr Cr

98 600 122 600

(84 460) 38 140 $11 442

11 442 11 442

Explanations for current tax worksheet Adjusting for carrying amount sold Adjusting for the carrying amount of plant sold in the current tax worksheet has the same effect as adjusting for any gain/loss on sale. The net adjustment in the worksheet is add $4 000 (add $30 000 deduct $26 000)

6.73

Solution Manual to accompany Company Accounting 10e

Gain on sale for accounting is $33 000 – $30 000 = $3 000 Gain on sale for tax is $33 000 - $26 000 = $7000  Add $4 000

Allowance for Doubtful Debts $ Ending balance 6 800 Beginning balance Debts written off 3 600 Expense 10 400

$ 5 200 5 200 10 400

Provision for Annual Leave $ 11 000 Beginning balance 14 100 Expense 25 100

$ 9 700 15 400 25 100

Leave paid Ending balance

Beginning balance Insurance paid

Prepaid Insurance $ 5 600 9 700 15 300

Ending balance Expense

$ 3 400 11 900 15 300

Part C Annual leave in the current tax worksheet Income tax laws and accounting standards regard annual leave as relevant to the calculation of taxable income and profit before tax however, tax laws use the “cash basis” and accounting standards use the accrual basis. In the current year, the company recorded an expense of $15 400 relating to leave that accrues in the period. But the tax deduction allowed is the amount paid of $11 000. Accordingly, the leave expense of $15 400 is added back to accounting profit to remove it from the calculation of taxable income. And then leave paid is deducted from accounting profit to include it into the calculation of taxable income. The net effect of the two adjustments equals the increase in the provision for the year and results in the taxable income being $4 400 more than the accounting profit for the year ended 30 June 2017. The company has a higher taxable income and pays more tax in the current period but it will have lower taxable income and pay less tax in a future period when leave paid is greater than leave expense.

6.74

Chapter 6: Accounting for company income tax

Part D Deferred Tax Worksheet as at 30 June 2017 Carrying Deductible Tax Base Amount Amount $ Assets A/cs receivable Prepaid insurance Plant Liabilities Provision for annual leave

Taxable Temp Diffs $

Deductible Temp Diffs $

149 200 3 400 105 600

0 0 78 720

156 000 0 78 720

[2] [1] [1]

0 3 400 26 880

6 800 0 0

14 100

[1]

14 100

30 280

20 900

Total Temporary Differences Deferred tax liability (30%) Deferred tax asset (30%) Begin Balances Increase/ (Decrease)

9 084 6 270 9 504 (420)

4 470 1 800

Deferred Tax Liability Deferred Tax Asset Income Tax Expense

Dr Dr Cr

420 1 800 2 220

Explanations for deferred tax worksheet Plant for tax purposes Cost 240 000 Accumulated depreciation (156 480 + 28 800 – **24 000) 161 280 Tax base 78 720 **$24 000 = $50 000 (cost of plant sold) - $26 000 (tax carrying amount of plant sold) Allowance for doubtful debts In the current year, the allowance for doubtful debts increases by $1 600 resulting in the deferred tax asset increasing by $480.

6.75

Solution Manual to accompany Company Accounting 10e

Provision for annual leave In the current year, the provision for annual leave increases by $4 400 resulting in the deferred tax asset increasing by $1 320. Prepaid insurance In the current year, prepaid insurance decreases by $2 200 resulting in the deferred tax liability decreasing by $660. Plant Plant is being depreciated faster for taxation purposes than for accounting purposes. The carrying amount and tax base of plant at 30 June 2017 and 30 June 2016 is as follows:

Plant (net) 2017 Plant (net) 2016 Increase in Difference

Accounting 105 600 159 600

Tax 78 720 133 520

Difference 26 880 26 080 800

In the current year, the difference between the carrying amount and tax base of plant increases by $800 resulting in the deferred tax liability increasing by $240. Part E Tax Losses Carried Forward Deferred tax asset for tax losses at1 July 2016 = 18 400 x 30% = $5 520 Tax losses must be offset against exempt income first before reducing the taxable income of a period. Accordingly, the tax losses that are available to offset the taxable income of $38 140 are $13 040 ($18 400 – $5 360) resulting in a final taxable income of $25 100. Current Tax Worksheet (Extract) for the year ended 30 June 2017

Taxable income Add back exempt income

38 140 5 360 43 500 (18 400) 25 100 $7 530

Less recoupment of tax loss Taxable income after recoupment of tax loss Current tax liability @ 30% Journal entry: Income tax expense Deferred tax asset Current tax liability

Dr Cr Cr

13 050

5 520 7 530

6.76

Chapter 6: Accounting for company income tax

Question 6.13

Current and deferred tax worksheets, carried forward tax loss and tax entries

The draft statement of profit or loss of That’s Alright Ltd for the year ended 30 June 2017 showed a profit before tax of $22 240, included the following items of income and expense: Government grant (exempt from tax) $ 5 000 Proceeds on sale of plant 23 000 Carrying amount of plant sold 20 000 Impairment of goodwill 11 100 Bad debts expense 8 100 Depreciation expense – plant 14 000 Insurance expense 12 900 Long-service leave expense 14 500 The statements of financial position of That’s Alright Ltd at 30 June 2017 and 30 June 2016 include the following assets and liabilities: THAT’S ALRIGHT LTD Statement of Financial Position (Extract) as at 30 June 2017 Assets Cash Accounts receivable Allowance for doubtful debts Prepaid insurance Plant Accumulated depreciation – plant Goodwill Accumulated impairment losses Deferred tax asset Liabilities Accounts payable Provision for long-service leave Current tax liability Deferred tax liability

6 000 96 000 (6 800 ) 3 400 140 000 (32 000 ) 22 200 (11 100 ) ? 78 000 13 200 ? ?

2016 $

18 000 85 000 (5 200 ) 5 600 170 000 (28 000 ) 22 200 — 9 540 76 000 9 700 — 3780

Additional information (a) For tax purposes the carrying amount of plant sold was $15 000. (b)The tax deduction for plant depreciation was $20 250. The accumulated depreciation on plant for tax purposes at 30 June 2017 is $40 250 (2016: $35 000). (c) In the year ended 30 June 2016, the company recorded a tax loss. At 1 July 2016 carry forward tax losses amounted to $16 900. The company recognised a deferred tax asset in respect of these tax losses at 30 June 2016. (d)Tax losses carried forward must be offset against any exempt income before being used to reduce taxable income. (e) The company does not set off deferred tax liabilities and assets and the corporate tax rate is 30%.

6.77

Solution Manual to accompany Company Accounting 10e

Required A. Prepare the current tax worksheet for the year ended 30 June 2017 and the applicable tax entries. B. Discuss the factors the company should have considered before recognising a deferred tax asset with respect to the tax loss incurred in the year ended 30 June 2016? C. Prepare the deferred tax worksheet as at 30 June 2017 and the applicable tax entries. D. Discuss whether the company should set off deferred tax liabilities and assets based on the requirements of AASB 112.

Part A Current Tax Worksheet for the year ended 30 June 2017 Profit before income tax Add: Impairment of goodwill (non-deductible) Depreciation expense – plant Carrying amount of plant sold for accounts Bad debts expense Long service leave expense Insurance expense Deduct: Grant revenue (exempt) Tax depreciation Bad debts written off Long service leave paid Insurance paid Carrying amount of plant sold for tax Taxable income Add back exempt income

$22 240 $11 100 14 000 20 000 8 100 14 500 12 900

5 000 20 250 6 500 11 000 10 700 15 000

Tax losses recouped Taxable income Current tax liability @ 30%

80 600 102 840

(68 450) 34 390 5 000 39 390 (16 900) 22 490 $6 747

The journal entry to record the current tax adjustments are: Income Tax Expense Current Tax Liability Deferred Tax Asset

Dr Cr Cr

11 817 6 747 5 070

Explanations for the current tax worksheet

6.78

Chapter 6: Accounting for company income tax

•

Reduction in deferred tax asset = Tax losses used $16 900 x 30% = $5 070

•

Gain/loss on sale of equipment: Proceeds on sale Carrying amount Gain (loss)

Accounting $23 000 20 000 3 000

Taxation $23 000 15 000 8 000

Net adjustment in the current tax worksheet is to add $5 000 •

Long service leave paid

30/06/17

•

$ 9 700 14 500 24 200

Bad Debts written off

30/6/17

•

Provision for Long Service Leave $ Leave paid 11 000 1/07/16 Beginning balance Ending balance 13 200 Leave Expense 24 200

Allowance for Doubtful Debts $ Bad debts write off 6 500 1/07/16 Beginning balance Ending balance 6 800 Bad Debt Expense 13 300

$ 5 200 8 100 13 300

Insurance Paid

1/07/16

Beginning balance Insurance paid

Prepaid Insurance $ 5 600 10 700 30/6/17 16 300

Insurance expense Ending balance

$ 12 900 3 400 16 300

Part B Recognition of deferred tax asset for tax losses Deferred tax assets arising from the carry forward of unused tax losses must be recognised to the extent, and only to the extent, that it is probable that future taxable amounts within the entity will be available against which the unused tax losses can be utilised In completing the financial statements for 30 June 2016, the company and its auditors should have considered whether there were sufficient grounds to form the view that company would probably earn taxable profits of at least $16 900 in future financial years.

6.79

Solution Manual to accompany Company Accounting 10e

Part C. Deferred Tax Worksheet as at 30 June 2017

Assets Cash A/cs Receivable Prepaid insurance Plant Goodwill Liabilities A/cs payable Provision for LSL Total temporary differences Excluded differences Temp differences for deferred tax Deferred tax liability (30%) Deferred tax asset (30%) Begin Balances Adjustments Increase/ Decrease for year

Carrying Amount

Deductible Amount

Tax Base

6 000 89 200 3 400 108 000 11 100

0 0 0 99 750 0

6 000 96 000 0 99 750 0

78 000 13 200

0 137 800

78 000 0

Taxable Temp Diffs $

Deductible Temp Diffs $

[2] [2] [1] [1] [1]

0 0 3 400 8 250 11 100

0 6 800 0 0 0

[1] [1]

0 0 22 750

0 13 200 20 000

11 100

11 650

20 000

3 495 6 000 3 780

9 540 (5 070) 1 530

(285)

Tax bases Assets that generate future taxable economic benefits: [1] Tax Base = Future deductible amount Assets that do not generate future taxable economic benefits: [2] Tax Base = Carrying amount Liabilities except unearned revenue: [1] Tax Base = Carrying amount less Future deductible amount Liability of unearned revenue: [2] Tax Base = Carrying amount – Untaxed future revenue

The journal entry required to record movements in the deferred tax accounts for the year ended 30 June 2017 is as follows: Deferred Tax Liability Deferred Tax Asset Income Tax Income

Dr Dr Cr

285 1 530

1 815

6.80

Chapter 6: Accounting for company income tax

Explanations for the deferred tax worksheet *Plant for tax purposes Cost Accumulated depreciation (35 000 + 20 250 – 15 000) Tax base

140 000 40 250 99 750

Allowance for doubtful debts In the current year, the allowance for doubtful debts increases by $1 600 resulting in the deferred tax asset increasing by $480. Provision for long service leave In the current year, the provision for annual leave increases by $3 500 resulting in the deferred tax asset increasing by $1 050. Prepaid insurance In the current year, prepaid insurance decreases by $2 200 resulting in the deferred tax liability decreasing by $660. Plant Plant is being depreciated faster for taxation purposes than for accounting purposes. The carrying amount and tax base of plant at 30 June 2017 and 30 June 2016 is as follows:

Plant (net) 2017 Plant (net) 2016 Increase in Difference

Accounting 108 000 142 000

Tax 99 750 135 000

Difference 8 250 7 000 1 250

In the current year, the difference between the carrying amount and tax base of plant increases by $1 250 resulting in the deferred tax liability increasing by $375. Part D Offset of deferred tax asset and deferred tax liability The company meets the requirements of paragraph 74 of AASB 112 as follows: • It has a legally enforceable right to set off current tax liabilities with current tax assets from the Australian Tax Office • The deferred tax assets and deferred tax liabilities relate to income taxes levied by the same taxation authority, that is the ATO, and the same taxable entity. The additional journal entry to offset the closing balances is as follows: Deferred Tax Liability Deferred Tax Asset

Dr Cr

3 495 3 495

The statement of financial position at 30 June 2017 would show a deferred tax asset of $2 505.

6.81

Solution Manual to accompany Company Accounting 10e

Question 6.14

Current and deferred tax worksheets, change in tax rate and tax entries

The profit before tax of Perfect Skin Ltd for the year ended 30 June 2017 is $600 000 and includes the following revenue and expense items: Rent revenue Government grant received (exempt from tax) Bad debts expense Depreciation expense – plant Long-service leave expense Annual leave expense Office supplies expense Entertainment expenses Depreciation expense – buildings

30 000 10 000 60 000 50 000 45 000 30 000 15 000 18 000 8 000

Extracts from the statements of financial position of the company at 30 June 2017 and 30 June 2016 showed the following assets and liabilities: PERFECT SKIN LTD Statement of Financial Position (Extract) as at 30 June 2017 Assets Cash Inventory Accounts receivable Allowance for doubtful debts Office supplies Plant Accumulated depreciation Buildings Accumulated depreciation Goodwill Deferred tax asset Liabilities Accounts payable Provision for employee benefits Rent received in advance Deferred tax liability

80 000 170 000 500 000 (55 000) 25 000 500 000 (260 000) 300 000 (148 000) 70 000 ? 290 000 100 000 25 000 ?

2016 $

85 000 155 000 480 000 (40 000) 22 000 500 000 (210 000) 300 000 (140 000) 70 000 40 500 260 000 75 000 20 000 38 100

Additional information (a) Entertainment costs and depreciation of buildings are not allowed as tax deductions. The buildings are also not subject to capital gains tax. The government grant revenue is not assessable for tax purposes. (b)Accumulated depreciation of plant for tax purposes was $315 000 at 30 June 2016, and depreciation for tax purposes for the year ended 30 June 2017 amounted to $75 000. (c) Office supplies are claimed as a tax deduction when purchased. Rent is taxed when received. © John Wiley and Sons Australia, Ltd 2015

6.82

Chapter 6: Accounting for company income tax

(d)Assume a tax rate of 30% for the year ended 30 June 2017. Required A. Prepare a current tax worksheet for the year ended 30 June 2017 to calculate taxable income and the company’s current tax liability, and then record the entries for current tax. B. Prepare a deferred tax worksheet as at 30 June 2017 to calculate the end-of-period adjustments required for the deferred tax asset and liability accounts, and then record the entries for deferred tax. C. Assume that the government decided, after the election in August 2016, to change the income tax rate for the year ended 30 June 2017 from 30% to 35%. Show the impact of the change in the tax rate on the journal entries prepared under requirements A and B, and prepare any additional entries that may be required. Part A Current Tax Worksheet for the year ended 30 June 2017 Accounting profit before tax

$600 000

Add Entertainment expenses

18 000

Depreciation expense – buildings

8 000

Bad debts expense

60 000

Depreciation expense – plant

50 000

Long service leave expense

45 000

Annual leave expense

30 000

Office supplies expense

15 000

Rent received

35 000 861 000

Deduct Rent revenue

30 000

Government grant received

10 000

Tax depreciation

75 000

Bad debts written off

45 000

Long service leave and Annual leave paid

50 000

Office supplies paid for

18 000 228 000

Taxable income

633 000

6.83

Solution Manual to accompany Company Accounting 10e

Current tax liability = 30% x $633 000

$189 900

The appropriate journal entry for current tax is: Income Tax Expense Current Tax Liability

Dr Cr

189 900 189 900

Workings: •

Bad Debts written off

Accs Receivable Ending balance

•

40 000 60 000 100 000

Rent Received in Advance 30 000 Beginning balance 25 000 Cash 55 000

20 000 35 000 55 000

Rent received

Revenue Ending balance

•

Allowance for Doubtful Debts 45 000 Beginning balance 55 000 Expense 100 000

Long service leave and Annual leave paid

Cash Ending balance

Provision for Employee Benefits 50 000 Beginning balance LSL Expense 100 000 A/L Expense 150 000

75 000 45 000 30 000 150 000

6.84

Chapter 6: Accounting for company income tax

Part B Deferred Tax Worksheet as at 30 June 2017

Assets Cash Inventory A/cs receivable Office supplies Plant Buildings Goodwill Liabilities A/cs payable Provision for employee benefits Rent received in advance Total temporary differences Excluded differences Temporary Diffs for deferred tax Deferred tax liability (30%) Deferred tax asset (30%) Beginning balances Adjustments Increase for year

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diffs $

Deductible Temp Diffs $

80 000 170 000 445 000 25 000 240 000 152 000 70 000

0 170 000 0 0 110 000 0 0

80 000 170 000 500 000 0 110 000 0 0

[2] [1] [2] [1] [1] [1] [1]

290 000 100 000

0 100 000

290 000 0

[1] [1]

100 000

25 000

[2]

25 000

55 000

25 000 130 000 152 000 70 000

377 000 222 000

180 000

155 000

180 000

46 500 54 000 38 100 0 8 400

40 500 0 13 500

The journal entry required for the year ended 30 June 2017 is as follows: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

13 500

8 400 5 100

6.85

Solution Manual to accompany Company Accounting 10e

Explanations for the deferred tax worksheet Plant for tax purposes Carrying amount at 1 July 2016 Tax Depreciation Tax base at 30 June 2017

($500 000 – 315 000)

$185 000 (75 000) 110 000

Allowance for doubtful debts In the current year, the allowance for doubtful debts increases by $15 000 resulting in the deferred tax asset increasing by $4 500. Provision for employee benefits In the current year, the provision for employee benefits increases by $25 000 resulting in the deferred tax asset increasing by $7 500. Rent received in advance In the current year, rent received in advance increases by $5 000 resulting in the deferred tax asset increasing by $1 500. Office supplies In the current year, office supplies increase by $3 000 resulting in the deferred tax liability increasing by $900. Plant Plant is being depreciated faster for taxation purposes than for accounting purposes. The carrying amount and tax base of plant at 30 June 2017 and 30 June 2016 is as follows:

Plant (net) 2017 Plant (net) 2016 Increase in Difference

Accounting 240 000 290 000

Tax 110 000 185 000

Difference 130 000 105 000 25 000

In the current year, the difference between the carrying amount and tax base of plant increases by $25 000 resulting in the deferred tax liability increasing by $7 500.

6.86

Chapter 6: Accounting for company income tax

Part C As a result of a change in the tax rate, the current tax would be based on 35% instead of 30% as follows: Taxable income Current tax liability = 35% x $633 000

633 000 $221 550

The journal entry for current tax becomes: Income Tax Expense Current Tax Liability

Dr Cr

221 550 221 550

As a result of a change in the tax rate, the company must also restate the beginning balances of the deferred tax asset and liability as follows: Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Dr Cr Cr

6 750 6 350 400

Deferred tax asset beginning balance at 35% = $40 500 x 0.35/0.30 = $47 250  Increase by $6 750 from $40 500 to $47 250 Deferred tax liability beginning balance at 35% = $38 100 x 0.35/0.30 = $44 450  Increase by $6 350 from $38 100 to $44 450

The deferred tax worksheet would change as follows: Taxable Temp Diffs 155 000

Temporary Diffs for deferred tax Deferred tax liability (35%) Deferred tax asset (35%) Beginning balances Adjustments Increase for year

Deferred Tax Asset Deferred Tax Liability Income Tax Expense

Deductible Temp Diffs 180 000

54 250 38 100 6 350 9 800

Dr Cr Cr

63 000 40 500 6 750 15 750

15 750

9 800 5 950

6.87

Solution Manual to accompany Company Accounting 10e

Question 6.15

Current and deferred tax worksheets, change in tax rate, tax entries and note disclosures

Mister Malcontent Ltd’s profit before tax for the year ended 30 June 2017 was $252 450. Included in this profit are the following items of income and expense: Amortisation of development costs Depreciation expense – equipment (15%) Entertainment expense Insurance expense Doubtful debts expense Proceeds on sale of equipment Carrying amount of equipment sold Rent revenue Annual leave expense Royalty revenue (non-assessable)

$30 000 40 000 12 450 24 000 14 000 30 000 36 667 25 000 54 000 2 000

At 30 June, the company’s draft statements of financial position showed the following balances: MISTER MALCONTENT LTD Statement of Financial Position (Extract) as at 30 June 2017 Assets Cash Accounts receivable Allowance for doubtful debts Inventories Prepaid insurance Rent receivable Development costs Accumulated amortisation Equipment Accumulated depreciation Deferred tax asset Liabilities Accounts payable Provision for annual leave Mortgage loan Deferred tax liability Current tax liability

55 000 295 000 (16 000) 162 000 30 000 3 500 120 000 (30 000) 200 000 (90 000) ? 310 500 61 000 100 000 ? ?

2016 $

65 000 277 000 (18 000) 185 000 25 000 5 500 — — 266 667 (80 000) 28 220 294 000 65 000 150 000 19 437 12 500

Additional information (a) A tax deduction for development expenditure of 125% of the $120 000 spent during the year is available under income tax legislation. The profit before tax reflects the amount of development costs amortised in the current period. (b)All equipment was purchased on 1 July 2014. The tax depreciation rate for equipment is 20%. The equipment sold on 30 June 2017 cost $66 667. (c) Rent is assessed for tax when received in cash. © John Wiley and Sons Australia, Ltd 2015

6.88

Chapter 6: Accounting for company income tax

(d)The company pays tax in quarterly instalments. The following payments were made during the year ended 30 June 2017. 28 July 2016 (Final payment for 30 June 2016) 28 October 2016 (1st payment for 30 June 2017) 28 February 2017 (2nd payment for 30 June 2017) 28 April 2017 (3rd payment for 30 June 2017)

$12 500 8 420 9 380 9 750

(e) The company tax rate applicable for the year ended 30 June 2016 was 34%, but as a result of the government’s taxation reform package the company tax rate dropped to 30% effective from 1 July 2016. No entry has yet been made in the current period for the change in tax rates. Required A. Prepare the current tax worksheet to determine taxable income and calculate the current tax liability for the year ended 30 June 2017 (show all workings). B. Prepare the journal entries relevant to current tax for the year. C. Explain the rationale behind your treatment of the following items in the current tax worksheet: • insurance costs • rent income • entertainment costs Do future tax consequences arise from these items? Explain. D. Prepare the deferred tax worksheet to calculate the deferred tax asset and liability balances as at 30 June 2017. E. Prepare the journal entries relevant to deferred tax for the year. F. Prepare the income tax note disclosures of the financial statements for 30 June 2017 in accordance with the requirements of AASB 112. Part A Current Tax Worksheet for year ended 30 June 2017 Accounting profit before income tax

$252 450

Add: Entertainment expense (non-deductible)

$12 450

Amortisation of development costs

30 000

Insurance expense

24 000

Depreciation expense - equipment

40 000

Carrying amount of equip sold (accounts)

36 667

Doubtful debts expense

14 000

Annual leave expense

54 000

Rent received

27 000

238 117 490 567

6.89

Solution Manual to accompany Company Accounting 10e

Deduct: Royalty revenue (exempt)

2 000

Rent revenue

25 000

Carrying amount of equip sold (for tax)

26 667

Tax depreciation - equipment

53 333

Bad debts written off

16 000

Insurance paid

29 000

Development costs paid

120 000

Additional deduction 25% of devp’t costs

30 000

Annual leave paid

58 000

(360 000)

Taxable income

130 567

Tax on taxable income @ 30%

39 170

Less tax paid during the year

(27 550)

Current tax liability

$11 620

Workings for current tax worksheet •

Tax depreciation charge = $266 667 x 20% = $53 333

•

Gain/loss on sale of equipment at end of year: Accounting Cost $66 667 Accum dep’n 30 000 Carrying amt/tax base 36 667 Proceeds 30 000 Gain (loss) (6 667)

Tax $66 667 40 000 26 667 30 000 3 333

Accumulated depreciation for tax = $66 667 x 20% x 3 years = $40 000 Accumulated depreciation for accounts = $66 667 x 15% x 3 years = $30 000 •

Bad debts written off Allowance for Doubtful Debts Ending balance 16 000 Beginning balance Debts written off 16 000 Expense 32 000

•

18 000 14 000 32 000

Rent received

Beginning balance

Rent Receivable 5 500

Ending balance

3 500

6.90

Chapter 6: Accounting for company income tax

Revenue

•

25 000 30 500

Prepaid Insurance 25 000 29 000 54 000

Ending balance Expense

30 000 24 000 54 000

Annual leave paid

Leave paid Ending balance

•

27 000 30 500

Insurance paid

Beginning balance Insurance paid

•

Rent received

Provision for Annual Leave 58 000 Beginning balance 61 000 Expense 119 000

65 000 54 000 119 000

Development costs paid

Beginning balance Costs paid

Development Costs 0 120 000 120 000

Ending balance

120 000 120 000

Current Tax Worksheet (Condensed) for the year ended 30 June 2017 Accounting profit before income tax

$252 450

Add: Entertainment expense (non-deductible)

$12 450

Depreciation expense - equipment

40 000

Gain on sale of plant (for tax)

3 333

Loss on sale of plant (accounts)

6 667

Decrease in rent receivable

2 000 64 450

Deduct: Royalty revenue (exempt)

2 000

Tax depreciation - equipment

53 333

Increase in development asset (net)

90 000

Additional deduction 25% of devp’t costs

30 000

6.91

Solution Manual to accompany Company Accounting 10e

Decrease in allowance for doubtful debts

2 000

Increase in prepaid insurance

5 000

Decrease in provision for annual leave

4 000

186 333

Taxable income

130 567

Tax on taxable income @ 30%

39 170

Less tax paid during the year

(27 550)

Current tax liability

$11 620

Part B Journal entry for current tax liability Income tax expense Current tax liability (Recognition of current tax liability at 30 June 2017)

Dr Cr

11 620 11 620

Journal entry/ies for current tax paid Income tax expense Cash

Dr Cr

27 550

6.92

Chapter 6: Accounting for company income tax

Part C Rationale for treatment Insurance costs Income tax legislation includes insurance costs as an item in taxable profit using the cash basis whereas accounting standards recognise insurance expense using the accrual basis. As $29 000 was spent in cash in the current year, the ATO allows this as a tax deduction; however, for accounting purposes, under the accrual system, the company capitalises this cost as an asset until the insurance is used up, $24 000 being regarded as insurance services used up in the current year. As the allowable deduction is $5 000 greater than the accounting expense, the company’s taxable income will be less than its accounting profit for the year. Accordingly, the company will pay less tax this year but more in a future year when the accounting expense is greater than the amount paid. At the end of the current year, the company will also record a deferred tax liability for a taxable temporary difference arising from the prepaid insurance asset recorded by the company. Rent income Income tax legislation includes rent income as an item in taxable profit using the cash basis whereas accounting standards recognise rent revenue using the accrual basis. In this question, $3 500 of revenue has not yet been received and has been recorded in the company’s statement of financial position as a receivable. Rent receivable at 30 June 2016 of $5 500 together with the rent received that relates to the current year of $21 500 ($25 000 - $3 500) equals rent income of $27 000 for tax purposes. As the company has recorded rent revenue of $25 000, an adjustment is made in the worksheet to deduct the accounting figure and replace with the tax figure. The company still has rent receivable at the end of the current year and it will be subject to tax when received. At the end of the current year, the company records a deferred tax liability for a taxable temporary difference arising from rent receivable. Entertainment costs Income tax legislation does not allow a deduction for entertainment costs unless the costs relate to employee costs, that is, the costs are part of an employment package. Accordingly there are no current or future tax consequences for these entertainment costs. In contrast, the employment costs are recognised as an accounting expense as incurred and must be added back to accounting profit in the current tax worksheet.

6.93

Solution Manual to accompany Company Accounting 10e

Part D Deferred Tax Worksheet as at 30 June 2017

Assets Cash A/cs receivable Inventories Prepaid insurance Rent receivable Develop’t costs Equipment Liabilities A/cs payable Provision for annual leave Mortgage loan Total temporary differences Excluded differences Temp differences for deferred tax Deferred tax liability (30%) Deferred tax asset (30%) Beginning balances Adjustments Increase/ (Decrease)

Carrying Amount

Deductible Amount

Tax Base

Taxable Temp Diffs

55 000 279 000 162 000 30 000 3 500 90 000 110 000

0 0 162 000 0 0 0 80 000

55 000 295 000 162 000 0 0 0 80 000

[2] [2] [1] [1] [1] [1] [1]

310 510 61 000

0 61 000

310 510 0

[1] [1]

100 000

[1]

Deductible Temp Diffs

16 000 30 000 3 500 90 000 30 000

61 000

153 500

77 000

153 500

77 000

46 050 23 100 19 437 (2 287) 28 900

28 220 (3 320) (1 800)

Tax base for equipment = cost $200 000 less accum depn $120 000 = $80 000 Accum depn for tax = (266 667 x 20% x 3 years) – (66 667 x 20% x 3 years) = $120 000

6.94

Chapter 6: Accounting for company income tax

Part E Journal entries for deferred tax The tax rate has changed from 34% to 30%, which means the opening balances for the deferred tax asset and deferred tax liability at 1 July 2016 must be adjusted downwards. Deferred tax asset opening balance at 30% ($28 220 x 0.30/0.34 ) Deferred tax asset opening balance at 34% Adjustment required (reduction)

$ 24 900 28 220 $ (3 320)

Deferred tax liability opening balance at 30% ($19 437 x 0.30/0.34) Deferred tax liability opening balance at 34% Adjustment required (reduction)

$ 17 150 19 437 $ (2 287)

The change of tax rate requires the following entry to be made: Deferred Tax Liability Income Tax Expense Deferred Tax Asset

Dr Dr Cr

2 287 1 033 3 320

In accordance with the deferred tax worksheet, the journal entry required to record movements in the deferred tax accounts for the year ended 30 June 2017 is as follows: Income Tax Expense Deferred Tax Asset Deferred Tax Liability

Dr Cr Cr

30 700

1 800 28 900

6.95

Solution Manual to accompany Company Accounting 10e

Additional explanations for deferred tax worksheet The decrease in the deferred tax asset for 2016-2017 is attributable to the following Decrease in allowance for doubtful debts (2 000) Decrease in provision for annual leave (4 000) (6 000) x 30% = $(1 800)

The increase in the deferred tax liability for 2016-2017 is attributable to the following: Increase in prepaid insurance 5 000 Decrease in rent receivable (2 000) Increase in development asset (net) 90 000 Increase in the difference between tax and accounting written down value of plant 3 333 96 333 x 30% = $28 900

Plant (net) 2017 Plant (net) 2016 Increase in Difference

Accounting 110 000 186 667

Tax 80 000 160 000

Difference 30 000 26 667 3 333

Part F Notes to the financial statements for the year ended 30 June 2017: Note X Income tax (a) Major components of income tax expense Current tax Deferred tax from origination and reversal of temporary differences Deferred tax resulting from change in the tax rate Tax expense

$39 170 30 700 1 033 $70 903

(b) Reconciliation of income tax expense with pre-tax accounting profit, multiplied by the tax rate Income tax expense on the accounting profit for the company is reconciled to the tax as follows: Pre-tax accounting profit Tax at the Australian tax rate of 30% Tax effect of expenses not deductible in calculating taxable income (entertainment) Tax effect of non-taxable revenue (royalty) Tax- effect of additional tax deductions (development) Tax effect of net movements in items giving rise to:

$252 450 75 735 3 735 (600) (9 000)

6.96

Chapter 6: Accounting for company income tax

Deferred tax assets Deferred tax liabilities Current tax expense

(1 800) (28 900) 39 170

The tax rate is the national income tax rate. (c) Change in tax rate As from 1 July the company tax rate changed from 34% to 30%. (d) Deferred tax assets and liabilities for each type of temporary difference The following items have given rise to deferred tax assets: Allowance for doubtful debts $4 800 Employee benefits 18 300 Total deferred tax assets $23 100 The following items have given rise to deferred tax liabilities: Prepayments $ 9 000 Development costs 27 000 Rent receivable 1 050 Plant and equipment 9 000 Total deferred tax liability $46 050

(e) Deferred tax expenses and revenues recognised in profit for each type of temporary difference:)* Deferred tax expense in relation to: Prepayments Development costs Plant and equipment Rent receivable Total deferred tax expense Deferred tax income in relation to: Accounts receivable Employee benefits Total deferred tax income

$1 500 27 000 1 000 (600) 28 900 (600) (1 200) (1 800)

* This disclosure item is only required if the movements in deferred items cannot be readily ascertained from other disclosures made with respect to deferred assets and liabilities.

6.97

Solutions manual to accompany Company Accounting 10e

Chapter 7 – Financial Instruments REVIEW QUESTIONS 1.

Define financial instrument and identify transactions that give rise to financial instruments and those that do not.

Paragraph 11 of AASB 132 defines a financial instrument as: any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

Transactions that do give rise to financial instruments • • • • • • •

Sale or purchase of goods or services on credit terms Deposit of cash with a financial institution Taking out a bank loan Buying or selling derivatives such as options Issue or purchase of ordinary shares Issue or purchase of debt securities Issue or purchase of convertible notes

Transactions that do NOT give rise to financial instruments • • • • • • • •

Sale or purchase of goods or services for cash Prepayments Unearned revenue Commodity contracts Employee benefits Leases Warranty Insurance

7.2

Chapter 7: Financial instruments

Define financial asset and list some common examples

A financial asset is defined in paragraph 11 of AASB 132 as any asset that is: (a)

Cash

(b) an equity instrument of another entity

(c)

a contractual right: (i) to receive cash or another financial asset from another entity or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity

(d) a contract that will or may be settled in the entity’s own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include puttable financial instruments classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

7.3

Solutions manual to accompany Company Accounting 10e

Examples of financial assets (Figure 7.3 from the textbook) Definition

Examples

Para.11(a)

Cash on hand Deposit of cash with a bank or similar financial institution

Para.11(b)

Shares held in another entity other than a subsidiary, joint venture entity or associate

Para.11(c)(i)

Trade receivables Loans or advances to other entities Bills of exchange held Promissory notes held Secured, unsecured or convertible notes held Debentures held Bonds held Right to cash from a guarantor

Para.11(c)(ii)

Purchased call or put options for shares in another entity Interest rate or currency rate swap agreements Forward exchange contracts Forward rate agreements Futures contracts

Para.11(d)(i)

A contract to receive at a future date as many of the entity’s own equity instruments as are equal in value to $100 million

Para.11(d)(ii)

A contract to receive at a future date a variable number of the entity’s own equity instruments as are equal in value to 100 ounces of gold at that date

7.4

Chapter 7: Financial instruments

Define financial liability and list some common examples.

A financial liability is defined in paragraph 11 of AASB 132 as any liability that is: (a)

a contractual obligation: (i)

to deliver cash or another financial asset to another entity or

(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity (b) a contract that will or may be settled in the entity’s own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own nonderivative equity instruments. Also, for these purposes the entity’s own equity instruments do not include puttable financial instruments classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

7.5

Solutions manual to accompany Company Accounting 10e

Examples of financial liabilities (Figure 7.4 from the textbook) Definition

Examples

Para.11(a)(i)

Bank overdraft Trade payables Loans or advances from other entities Bills of exchange issued Promissory notes issued Secured, unsecured or convertible notes issued Debentures issued Redeemable preference shares Obligation to pay cash as a guarantor

Para.11(a)(ii)

Sold call or put options for shares in another entity Interest rate or currency rate swap agreements Forward exchange contracts Forward rate agreements

Para.11(b)(i)

A contract to deliver at a future date as many of the entity’s own equity instruments as are equal in value to $100 million

Para.11(b)(ii)

A contract to deliver at a future date as many of the entity’s own equity instruments as are equal in value to 100 ounces of gold at that date

7.6

Chapter 7: Financial instruments

Define derivative and explain how a hybrid contract can have an embedded derivate. List some common examples of derivatives and embedded derivatives.

Appendix A of AASB 9 defines a derivative as a contract with three characteristics: (I)

the value of the contract changes in response to an underlying — that is, a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable that is not specific to a party to the contract.

(II)

no initial net investment is required or it is smaller than for other types of contracts expected to have a similar response to changes in market factors.

(III)

settlement is at a future date.

Paragraph 4.3.1 of AASB 9 describes an embedded derivative as follows: An embedded derivative is a component of a hybrid contract that also includes a nonderivative host – with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable independently of that instrument, or has a different counterparty, is not an embedded derivative, but a separate financial instrument. Examples of derivatives • • • • •

Futures contract – a standardized contract written by an exchange clearing house that can be traded and where settlement occurs at a specific time in the future based on a predetermined price without physical delivery Forward contract – a non-standardized contract written between two parties where settlement occurs at a specific time in the future based on a pre-determined price Option contract – a contract that gives the holder the right but not the obligation to buy or sell an underlying asset at a pre-determined price on or before a specific date. Exchange traded options do not require physical delivery Warrants – long dated option contracts that are exchange traded Swap contract – a contract to exchange cash on or before a specified time based on an underlying that is usually interest rates or exchange rates for currencies

7.7

Solutions manual to accompany Company Accounting 10e

Examples of embedded derivatives • • •

Convertible notes – a security that has a face value and coupon rate but that entitles the holder to convert the note into a fixed number of ordinary shares Debt instrument with embedded option – there is an option to extend the term to maturity of a debt instrument without a concurrent interest rate adjustment Debt instrument with embedded futures – debt contract that pays interest based on the price of gold

Define an equity instrument and explain how it differs to a financial liability.

An equity instrument is defined in paragraph 11 of AASB 132 as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. An equity instrument is effectively the default category for an instrument that does not meet the definition of either financial asset or financial liability. Ordinary shares issued that cannot be put back to the company – non-puttable ordinary shares – are the most common example of an equity instrument. In accordance with paragraph 16 of AASB 132, the key difference between an equity instrument and a financial liability is that for an equity instrument there are:  no contractual obligations to deliver cash or another financial asset to another entity  no contractual obligations to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable  no contractual obligations to deliver a variable number of the entity’s own equity instruments AASB 132 does not contain a clear hierarchy to be used in determining whether a financial instrument is a financial liability or an equity instrument of the issuer. Paragraph 15 of AASB 132 sets out the general principle: The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument. Interpreting the substance of contractual arrangements is the key. Consider the case of preference shares that have escalating ‘dividend’ payments if certain events occur, such that one would always expect the issuer to pay the dividend even if it is not strictly legally required to do so.

7.8

Chapter 7: Financial instruments

Other guidance that assists in the classification for the issuer is: Paragraph AG25 of AASB 132 explains that the classification of preference shares issued depends on the various rights that attach to the issue. Paragraphs 21-24 of AASB 132 deals with contracts that involve settlement in the entity’s own equity instruments – if the contract allows for net cash settlement or net share settlement, then the instrument is a financial asset or financial liability – if the contract requires gross physical settlement in a fixed number of shares, then there is an equity instrument only Paragraph 25 of AASB 132 deals with contingent settlement provisions – if the contractual arrangements require an entity to deliver cash or another financial asset based on uncertain future events, then the instrument is regarded as a financial liability except in limited circumstances Paragraph 26 of AASB 132 deals with settlement options for derivative financial instruments – if the derivative allows for settlement other than by the issue of an equity instrument, then the instrument is a financial asset or financial liability

Explain why some preference shares are recognised as financial liabilities by the issuer whilst others are recognised as equity instruments.

The substance of contractual arrangements must govern whether preference share issues are treated as equity instruments or equity issues. Preference shares take the legal form of an equity issue but may in substance be financial liabilities to the issuer. Consider the example of an issue of 10% redeemable preference shares that must be mandatorily redeemed after three years. In substance, the issue of these preference shares achieves the same result as agreeing to a three year bank loan at the fixed interest rate of 10%. Financial Liability v Equity Classification (From Figure 7.6 of the Textbook) From Perspective of the Issuer

Equity

Financial Liability

√

1. Ordinary shares

2. Preference Shares •

Non-redeemable

•

Discretionary distributions

√

3. Preference Shares

7.9

Solutions manual to accompany Company Accounting 10e

•

Mandatorily redeemable

•

Non-discretionary distributions

√

4. Preference Shares •

Redeemable at option of holder

•

Conditional distributions

√

5. Preference Shares

•

Redeemable at option of issuer

•

Conditional distributions

√

What is a convertible note? How does the issuer of convertible notes initially recognise the notes in its financial statements?

A convertible note is a debt security with an embedded conversion option that makes the security convertible into ordinary shares of the issuer. A convertible note is an example of a compound financial instrument that contains both a liability and an equity component Paragraph 28 of AASB 132 requires the issuer of a convertible note to present the liability component and the equity component separately in the statement of financial position as follows: (a) The issuer’s obligation to make scheduled payments of interest and principal is a financial liability that exists as long as the instrument is not converted. On initial recognition, the fair value of the liability component is the present value of the contractually determined stream of future cash flows discounted at the rate of interest applied at that time by the market to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but without the conversion option. (b) The equity instrument is an embedded option to convert the liability into equity of the issuer. This option has value on initial recognition even when it is out of the money. On conversion of a convertible instrument at maturity, the entity derecognises the liability component and recognises it as equity. The original equity component remains as equity (although it may be transferred from one line item within equity to another). There is no gain or loss on conversion at maturity. Figure 7.8 of the textbook illustrates. Convertible notes with a face value of $2 million pay interest annually in arrears at 6% p.a. The fair value of these obligations is the financial liability component and is calculated as $1 848 156 based on a discount rate of 9% p.a. The difference between the face value of the notes and the fair value of the debt obligations is $151 844. This difference is attributable to the conversion option and is the equity component.

7.10

Chapter 7: Financial instruments

8. Should the dividends on preference shares be recognised directly in equity or as an expense in profit or loss? Paragraph 35 of AASB 132 states that: Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial instrument shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be debited by the entity directly to equity, net of any related tax benefit. Accordingly if preference shares are classified as a financial liability, then the dividend distributions on the shares must be recognised as an expense in the profit or loss. In effect, the dividends are treated as if interest. In contrast, if preference shares are classified as an equity instrument, then the dividend distributions on the shares must be debited directly in equity. The debit will usually be against retained profits. It is also worth noting that in the calculation of basic earnings per share – a summary financial performance measure widely used by financial analysts when evaluating a company – preference share distributions are deducted in the calculation of earnings (i.e. profit) irrespective of whether the preference shares are classified as financial liabilities or equity instruments. Examples (a) Dividends paid on non-redeemable preference shares Dividends paid on non-redeemable preference shares – preference shares will be classified as equity instruments therefore dividends will be classified as a distribution to equity holders and included in the statement of changes in equity. (b) Dividends paid on preference shares redeemable at the holder’s option Dividends paid on preference shares redeemable at the holder’s option – preference shares will be classified as financial liabilities therefore the “dividends” will be classified as interest expense and included in the determination of profit or loss. (c) Interest paid on a five-year, fixed interest note Interest paid on a 5 year, fixed interest note – the notes will be classified as a financial liability therefore interest will be classified as interest expense and included in the determination of profit or loss. (d) Interest paid on a convertible note classified as a compound instrument Interest expense is included in the determination of profit and loss and is calculated using the debt component (financial liability component) of the convertible note and the market interest rate for similar debt with no conversion option. The difference between the interest paid on the convertible notes and the interest expense represents the unwinding of the discount on the debt component and is adjusted against the debt component.

7.11

Solutions manual to accompany Company Accounting 10e

The initial recognition of a financial asset or financial liability is based on a ‘rights and obligations approach’. Discuss.

The principle for initial recognition of a financial asset or financial liability is set out at paragraph 3.1.1 of AASB 9: An entity shall recognise a financial asset or financial liability in its statement of financial position when, and only when, the entity becomes a party to the contractual provisions of the instrument When an entity becomes subject to contractual rights and obligations, then it must recognise any financial asset or financial liability that arises from those rights and obligations. Examples at paragraph B3.1.2 of AASB 9: •

Unconditional receivables and payables are recognised as financial assets or liabilities when the entity becomes a party to the contract and, as a consequence, has a legal right to receive or a legal obligation to pay cash. Normal trade accounts receivable and trade accounts payable would fall into this category.

•

Assets to be acquired and liabilities to be incurred under a firm commitment to purchase or sell goods or services are generally not recognised until at least one of the parties has performed under the agreement. An entity that receives a firm order for the supply of goods does not recognise a financial asset at the date of the commitment but delays recognition until the ordered goods have been shipped or delivered.

•

Forward contracts within the scope of the standard are recognised as a financial asset or liability on the commitment date rather than on the date that settlement takes place

•

Option contracts within the scope of the standard are recognised as financial assets or liabilities when the holder or writer becomes a party to the contract

•

Planned future transaction, no matter how likely to occur, are not recognised as financial assets or financial liabilities because the entity is not party to a contract

10.

What is a regular way purchase or sale of a financial asset and what is the difference between trade date accounting and settlement date accounting?

Appendix A of AASB 9 states that a regular way purchase or sale is: A purchase or sale of a financial asset under a contract whose terms require delivery of the asset within the time frame established generally by regulation or convention in the marketplace concerned. In accordance with paragraph B3.1.5 of AASB 9: The trade date is the date an entity commits itself to purchase or sell an asset. Trade date accounting refers to:

7.12

Chapter 7: Financial instruments

(a) the recognition of an asset to be received and the liability to pay for it on the trade date (b) the derecognition of an asset that is sold, recognition of any gain or loss on disposal and the recognition of a receivable from the buyer for payment on the trade date In accordance with paragraph B3.1.6 of AASB 9: The settlement date is the date that an asset is delivered to or by an entity. Settlement date accounting refers to: (a) the recognition of an asset on the day it is received by the entity (b) the derecognition of an asset that is sold and recognition of any gain or loss on disposal on the day that it is delivered by the entity Refer Figure 7.9 of the textbook for an example of trade date and settlement date accounting

11.

When does an entity set off a financial asset and financial liability for presentation in its statement of financial position?

According to paragraph 42 of AASB 132: A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an entity: (a) currently has a legally enforceable right to set off the recognised amounts; and (b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously Paragraph 49 of AASB 132 sets out examples where the conditions for set off are NOT met as follows: (a) Several different financial instruments used to emulate the features of a single financial instrument, for example, a group of option contracts that is used to create a synthetic futures position. (b) Financial assets and financial liabilities that arise from financial instruments having the same primary risk exposure but that involve different counterparties (e.g. a portfolio of derivatives). (c) Financial or other assets pledged as collateral for non-recourse financial liabilities. (d) Financial assets set aside in a trust by a debtor for the purpose of discharging an obligation where those assets have not been accepted by the creditor in settlement of the obligation (a sinking fund arrangement) (e) Losses expected to be recovered from a third party by virtue of a claim under and insurance contract.

7.13

Solutions manual to accompany Company Accounting 10e

12.

When does an entity derecognise a financial asset or financial liability from its statement of financial position?

Financial asset derecognition - Refer Figure 7.10 of the textbook.

Financial liability derecognition – paragraph 3.3.1 of AASB 9: An entity shall remove a financial liability (or part of a financial liability) from its statement of financial position when, and only when, it is extinguished – ie when the obligation specified in the contract is discharged or cancelled or expires.

7.14

Chapter 7: Financial instruments

13.

How is the initial measurement of a financial asset determined? Is it possible for a gain or loss to arise on initial measurement of a financial asset? Explain.

Initial measurement: the general principal Paragraph 5.1.1 of AASB 9: At initial recognition, an entity shall measure a financial asset as: (a) The fair value of the financial asset PLUS (b) Transaction costs that are directly attributable to the acquisition of the financial asset except if the financial asset is classified as fair value through profit or loss

Paragraph B5.1.2A of AASB 9: The best evidence of the fair value of a financial instrument at initial recognition is normally the transaction price (i.e. the fair value of the consideration given or received)

Difference between initial measurement at fair value and transaction price If an entity determines that the fair value of a financial asset at initial recognition differs from the transaction price, then a difference arises. Accounting for the difference depends on how the fair value of the financial asset has been determined. Fair value determined by: • a quoted price in an active market for identical asset (Level 1 input) • a valuation technique that uses only data from observable markets (almost the same thing as Level 2 input) In this case, the difference between fair value and the transaction price is recorded as a gain or loss. Fair value determined by other means (Level 3 input): In this case, the difference between fair value and transaction price is deferred and included in the initial measurement of the financial asset.

7.15

Solutions manual to accompany Company Accounting 10e

14.

How is the initial measurement of a financial liability determined and how does it differ to the initial measurement of a financial asset?

Paragraph 5.1.1 of AASB 9: At initial recognition, an entity shall measure a financial liability as: (a) The fair value of the financial liability LESS (b) Transaction costs that are directly attributable to the acquisition or issue of the financial liability except if the financial liability is classified as fair value through profit or loss In effect there is no difference between the initial measurement of a financial liability and a financial. It should be noted that transaction costs are deducted instead of added in the measurement of a financial liability. The transactions costs incurred are by nature a debit, which means they are added in the initial measurement of a financial asset but deducted in the initial measurement of a financial liability.

15.

Describe the subsequent measurement of financial assets. What is the default category for subsequent measurement of a financial asset?

Paragraph 4.1.1 of AASB 9 requires that an entity must classify financial assets as either subsequently measured at amortised cost or subsequently measured at fair value Amortised cost Paragraph 4.1.2 states that a financial asset can only be subsequently measured at amortised cost if it meets two strict conditions as follows: (a) The asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows (b) The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding Purchased debt securities or purchased and originated loans are examples of financial assets that may meet these two conditions. In accordance with Appendix A of AASB 9, the amortised cost of a financial asset is the amount recognised at initial recognition less principal repayments add/less cumulative amortisation using the effective interest method less any reduction for impairment or uncollectibility.

7.16

Chapter 7: Financial instruments

Fair Value Paragraph 4.1.1 of AASB 9 makes it clear that a financial asset is subsequently measured at fair value if subsequent measurement at amortised cost does not apply. Trading portfolios of equity instruments, debt securities held short term and derivatives are examples of financial assets that are subsequently measured at fair value. In accordance with Appendix A of AASB 9, fair value of a financial asset is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date (refer AASB 13 requirements covered at chapter 5 of the textbook) Fair value measurement of a financial asset ordinarily means fair value through profit or loss such that gains or losses on remeasurement at reporting date are recognised in the profit or loss. Paragraph 5.7.5 of AASB 9 allows subsequent measurement at fair value other than through profit or loss in one circumstance. An entity can make an irrevocable election at initial recognition to use fair value through other comprehensive income for investments in equity instruments not held for trading. If a financial asset qualifies for subsequent measurement at amortised cost, then paragraph 4.1.5 of AASB 9 still allows an entity to make an irrevocable election to use fair value through profit or loss if doing so eliminates or significantly reduces an accounting mismatch – that is inconsistency between measurement approach and how gains and losses on the asset are treated. The Default Classification Subsequent measurement at fair value is the default classification because a financial asset can only be subsequently measured at amortised cost if it meets the two conditions for a business model and contractual cash flows that are principal and interest. In the majority of cases, the roads will lead to subsequent measurement at fair value. Paragraph 4.4.1 of AASB 9 explains how an entity may change its business model and this, and only this, can result in reclassifications of financial assets between the categories of subsequent measurement at amortised cost and subsequent measurement at fair value.

16.

Explain how financial assets that are debt instruments, equity instruments or derivatives are subsequently measured.

Figure 7.14 of the textbook illustrates three financial asset categories: (1) Holdings of debt instruments — classified and measured at either amortised cost or fair value through profit or loss; (2) Holdings of equity instruments — classified and measured at either fair value through profit or loss or fair value through other comprehensive income; and (3) Holdings of derivatives — classified and measured at fair value through profit or loss.

Illustration of subsequent measurement of financial assets (from Figure 7.14 of the textbook)

Financial asset (1) Debt instruments (includes hybrids)

Financial asset (3) Derivative instruments © John Wiley and Sons Australia, Ltd 2015

Financial asset (2) Equity instruments 7.17

Solutions manual to accompany Company Accounting 10e

Fail

Business model test

Yes

Held for trading

paragraph 4.1.2(a)

Pass No Cash flows characteristics test

Fail

paragraph 4.1.2(b)

Pass

Yes

Fair value option elected? paragraph 5.7.5

Yes

Fair value through other comprehensive income (FVOCI)

7.18

Chapter 7: Financial instruments

17.

Describe the subsequent measurement of financial liabilities. What is the default category for subsequent measurement of a financial liability?

Paragraph 4.2.1 of AASB 9 requires an entity to classify all financial liabilities as subsequently measured at amortised cost using the effective interest rate except: (a)

financial liabilities subsequently measured at fair value through the profit or loss including derivatives

(b)

financial liabilities that arise when the transfer of a financial assets does not qualify for derecognition or when the continuing involvement in a financial asset approach applies

(c)

financial guarantee contracts as defined in Appendix A

(d)

commitments to provide a loan at a below-market interest rate

In accordance with Appendix A of AASB 9, the amortised cost of a financial liability is the amount recognised at initial recognition less principal repayments add/less cumulative amortisation using the effective interest method. The effective interest method uses the effective interest rate to allocate interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments through the expected life of the financial liability to the net carrying amount of the liability. The Default Classification Subsequent measurement at amortised cost is the default classification because it applies in the absence of any other measurement being applicable. In contrast to financial assets, paragraph 4.4.2 of AASB 9 prohibits financial liabilities from being reclassified for subsequent measurement. Figure 7.19 of the textbook illustrates the subsequent measurement of financial liabilities.

7.19

Solutions manual to accompany Company Accounting 10e

Illustration of subsequent measurement of financial liabilities from Figure 7.19 of the textbook)

Financial liability (1)

Financial liability (2)

Debt instruments

Derivative instruments

Held for trading

Financial liability (3)

Financial liability (4)

Financial guarantee contracts

Commitments to provide loans at a below-market interest rate

Yes

Conditional fair value option elected?

Yes

paragraph 4.2.2

Amortised cost using effective interest rate method

Fair value through profit or loss (FVTPL)

Higher of: – AASB 137 amount – AASB 9 initial amount less AASB 118 amortisation

7.20

Chapter 7: Financial instruments

18.

Disclosures are required in respect of the nature and extent of risks arising from financial instruments. What are the usual risks and what details must be included in the disclosures?

From Figure 7.23 of the textbook

Type of risk

Description

Market risk

• Currency risk — the risk that the value of a financial instrument will fluctuate because of changes in foreign exchange rates • Interest rate risk — the risk that the value of a financial instrument will fluctuate because of changes in market interest rates. For example, the issuer of a financial liability that carries a fixed rate of interest is exposed to decreases in market interest rates, such that the issuer of the liability is paying a higher rate of interest than the market rate. • Other price risk — the risk that the value of a financial instrument will fluctuate as a result of changes in market prices (other than those arising from interest rate risk or currency risk) Market risk embodies the potential for both loss and gain.

Credit risk

The risk that one party to a financial instrument will fail to discharge an obligation and cause the other party to incur a financial loss

Liquidity risk

The risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities. This is also known as funding risk. For example, as a financial liability approaches its redemption date, the issuer may experience liquidity risk if its available financial assets are insufficient to meet its obligations.

7.21

Solutions manual to accompany Company Accounting 10e

From Figure 7.24 of the textbook Item

Summary of details required

Qualitative

• For each type of risk:

disclosures

–

exposures to risk and how they arise.

(paragraph 33)

–

the entity’s objectives, policies and processes for managing the risk and the methods used to measure the risk.

– Quantitative disclosures

any changes in exposures or managing the risk from the previous period.

• For each type of risk: –

(paragraph 34)

summary quantitative data about exposure to that risk at the end of the reporting period based on the information provided internally to key management personnel of the entity.

–

summary data for any concentration of risk — that is, financial instruments that have similar characteristics and are affected similarly by changes in economic or other conditions. For example, a risk concentration may be geographic area, by industry or by currency.

Credit risk — general (paragraph

• By class of financial instrument: –

36)

the amount that best represents maximum exposure to credit risk at the end of the reporting period without taking into account any collateral held or other credit enhancements (e.g. guarantees).

–

a description of any collateral held as security and other credit enhancements and their financial effect.

–

information about the credit quality of financial assets that are neither past due or impaired.

Credit risk — financial assets that

• By class of financial asset: –

are either past due or impaired (paragraph 37)

an analysis of the age of financial assets that are past due as at the end of the reporting period but not impaired.

–

an analysis of financial assets that are individually determined to be impaired as at the end of the reporting period.

7.22

Chapter 7: Financial instruments

Credit risk —

• Financial or non-financial assets obtained during the period by taking possession of

collateral and other

collateral held as security or other credit enhancements:

credit enhancements

–

The nature and amount of the assets.

obtained (paragraph

–

Policies for disposing of or use of assets which are not readily convertible to

38) Liquidity risk (paragraph 39)

cash. • Maturity analysis for non-derivative financial liabilities showing the remaining contractual undiscounted cash flows by contractual maturities • Maturity analysis derivative financial liabilities showing the remaining contractual undiscounted cash flows by contractual maturities that are essential for understanding the timing of cash flows. • Description of how liquidity risk is managed — for example: –

having access to undrawn loan commitments.

–

holding readily liquid financial assets than can be sold to meet liquidity needs.

– Market risk

having diverse funding sources.

• Sensitivity analysis for each type of market risk (i.e. currency risk, interest rate risk

(paragraphs 40 to

and other price risk) showing:

and 42)

–

how profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at the end of the reporting period — for example, the effect on interest expense for the current year if interest rates had varied between 0.25–0.5%.

–

methods and assumptions used in preparing the analysis.

–

any changes from the previous period in the methods and assumptions used and the reasons for such changes.

• Alternative sensitivity analysis, such as value at risk, that reflects interdependencies between market risk variables (e.g. between interest rate risk and currency risk): –

explanation of method used including main parameters and assumptions.

–

objective of method used and limitations.

7.23

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Financial instruments in the global financial crisis

Read the following extract from the Report of the Financial Crisis Advisory Group (2009). Discuss the controversy and complexity surrounding the accounting for financial instruments at the time of the 2008 financial crisis. Extract from Report of Financial Crisis Advisory Group While the post-mortems are still being written, it seems clear that accounting standards were not a root cause of the financial crisis. At the same time, it is clear that the crisis has exposed weaknesses in accounting standards and their application. These weaknesses reduced the credibility of financial reporting, which in part contributed to the general loss of confidence in the financial system. The weaknesses primarily involved (1) the difficulty of applying fair value (‘mark-to-market’) accounting in illiquid markets; (2) the delayed recognition of losses associated with loans, structured credit products, and other financial instruments by banks, insurance companies and other financial institutions; (3) issues surrounding the broad range of off-balance-sheet financing structures, especially in the US; and (4) the extraordinary complexity of accounting standards for financial instruments, including multiple approaches to recognizing asset impairment. Some of these weaknesses also highlighted areas in which International Financial Reporting Standards (‘IFRS’) and US generally accepted accounting principles (‘US GAAP’) diverged. In the early part of the crisis, the principal criticism of financial reporting focused on fair value accounting. This criticism contended that fair value accounting contributed to the pro-cyclicality of the financial system. Prior to the crisis, it is argued, fair value accounting led to significant overstatement of profits; however, during the crisis, it was supposed to have led to a severe overstatement of losses and the consequent ‘destruction of capital’. Thus, the argument went, a vicious cycle ensued: falling asset prices led to accounting write-downs; the write-downs led to forced asset sales by institutions needing to meet capital adequacy requirements; and the forced sales exacerbated the fall in asset prices. In the US, moreover, critics singled out the other-thantemporary impairment standards for available-for-sale and held-to-maturity securities as being particularly ‘destructive’ because institutions were forced to take charges against earnings as a consequence of what they believed to be temporary ‘market irrationality’. Proponents of fair value accounting do not deny that indeed mark-to-market accounting shows the fluctuations of the market, but they maintain that these cycles are a fact of life and that the use of fair value accounting does not exacerbate these cycles. Moreover, they argue that fair value accounting standards provided ‘early warning’ signals by revealing the market’s discomfort with inflated asset values. In their view, this contributed to a more timely recognition of problems and mitigation of the crisis. Whatever the final outcome of the debate over fair-value accounting, it is unlikely that, on balance, accounting standards led to an understatement of the value of financial assets. While the crisis may have led to some understatement of the value of mark-to-market assets, it is important to recognize that, in most countries, a majority of bank assets are still valued at historic cost using the amortized cost basis. Those assets are not marked to market and are not adjusted for market liquidity. By now it seems clear that the overall value of these assets has not been understated — but overstated. The incurred loss model for loan loss provisioning and difficulties in applying the model — in particular, identifying appropriate trigger points for loss recognition — in many instances has delayed the recognition of losses on loan portfolios. (The results of the US stress tests seem to bear this out.) Moreover, the off-balance-sheet standards, and the way they were applied, may have obscured losses associated with securitizations and other complex structured products. Thus, the overall effect of the current mixed attribute model by which assets of financial institutions have been measured, coupled with the obscurity of off-balance-sheet exposures, has probably been to understate the losses that were embedded in the system. Even if the overall effect of accounting standards may not have been pro-cyclical, we consider it imperative that the weaknesses in the current standards be addressed as a matter of urgency. Improvements in accounting standards cannot ‘cure’ the financial crisis by resolving underlying economic and governance issues (for example, the massive overleveraging of the global economy, excessive risk taking, and the undercapitalization of the banking sector). However, as demonstrated by the positive market reaction to disclosure of the results of the US stress tests, improvements in standards that enhance transparency and reduce complexity can help restore the confidence of financial market participants and thereby serve as a catalyst for increased financial stability and sound economic growth. Conversely, any changes in financial reporting that reduce transparency and allow the impact of the crisis to be obscured would likely have the opposite effect, by further reducing the confidence of market participants and thereby prolonging the crisis or by laying the foundation for future problems.

7.24

Chapter 7: Financial instruments

Source: Financial Crisis Advisory Group (2009).

The Report suggests that weaknesses in accounting for financial instruments contributed to the general loss of confidence during the Global Financial Crisis (GFC). The weaknesses identified are: 1. The difficulty of applying fair value (‘mark to market’) accounting in illiquid markets 2. The delayed recognition of losses associated with loans, structured credit products, and other financial instruments by banks, insurance companies and other financial institutions 3. Issues surrounding off-balance sheet financing 4. The complexity of the accounting standards for financial instruments The difficulty of applying fair value accounting Fair value accounting overstated gains in a rising market and then losses when the market headed downwards. Falling asset prices necessitated write-downs that led to forced sales and then more falling prices. The recognition of losses affected capital adequacy requirements and led to fire sales and more losses with earnings numbers affected and market confidence drained. The delayed recognition of losses The majority of bank assets – for example, loan portfolios – were still valued on an amortised cost basis. The recognition of losses on these assets was not timely. The market did not have timely information on the true financial position of various significant financial institutions and panic and a flight to cash was the result. Off balance sheet financing Again the issue is that obscurity of financial affairs can mean panic and confusion if events occur that are likely to cause financial stress to a financial institution. Complexity There is complexity in the range and nature of financial instruments but also in the accounting standards that describe how these instruments should be recognised and measured. If you read AASB 9, then you will find that it is very challenging document and not easily translated into simple descriptions about what accounting is required. The standard is full of cross-referencing and long worded paragraphs. It also raises fair value accounting as one of the issues.

7.25

Solutions manual to accompany Company Accounting 10e

Wikipedia: The Role Fair-Value Accounting Played in the Subprime Mortgage Crisis One of the causes: Brian S. Wesbury, Chief Economist, and Robert Stein, Senior Economist at First Trust Advisors in their “Economic Commentary” claimed that “It is true that the root of this crisis is bad mortgage loans, but probably 70% of the real crisis that we face today is caused by mark-to-market accounting in an illiquid market.” Critics have blamed fair-value accounting for the subprime crisis, pointing out that fair-value accounting created difficulties measuring the value of subprime positions. They claim that fair-value accounting contributed to excessive leverage used by banks during boom period, and led to a downward spiral during bust period, forcing banks to value assets at “fire-sale” prices, creating a much lower than necessary valuation of subprime assets, which caused contagion and engendered the tightened lending. Just a messenger: “Fair value accounting…is a fundamental mechanism to provide investors with important transparency…. The roots of today’s crisis have many causes, but fair value accounting is not one of them.” --Scott Evans, Executive Vice President, Asset Management at TIAA-CREF at October 2008 SEC roundtable on mark-to-market accounting (pg. 17) Proponents argue that fair value accounting provides a clear measurement of the underlying value of assets. They state that the subprime crisis was not caused by accounting, but by bad operating of firms, investors and sometimes by fraud. It is unfair to blame the fair value accounting that is merely a reflection of the actual problem. “Death spiral”, contagion and systemic risk Banks are required to maintain “adequate capital” to comply with regulatory requirements. The capital ratio is the percentage of bank’s capital to its risk-weighted assets. Weights are defined by Basel Accords. Adequately capitalized banks are required to have a no lower than 4% Tier 1 capital ratio and a no lower than 8% total capital ratio. At the beginning of the crisis, the values of mortgage-backed assets started to fall, and firms holding mortgagebacked assets had to write those assets down to market value, the bank’s regulatory capital went down. Under certain loan covenants and regulatory capital requirements, banks were forced to sell mortgage-backed assets for cash to reduce “risk adjusted assets”. Some firms were also selling because of a fear that the prices will decline further. The fire sale created an excessive supply which further drove down the market price of mortgage-backed assets and the regulatory capital of banks continued to decline. This phenomenon is referred to as the “death spiral”. Moreover, death spiral can lead to “financial contagion”. If fire-sale prices from a distressed bank become relevant marks for other banks, mark-to-market accounting can cause writedowns and regulatory capital problems for otherwise sound banks (Cifuentes, Ferrucci, and Shin, 2005; Allen and Carletti, 2008; Heaton, Lucas, and McDonald, 2009). This is considered to be systemic risk in the banking industry.

7.26

Chapter 7: Financial instruments

Case Study 2

Financial instruments and performance reporting

Find and read the following article: • Horton, J & Macve, R 2008, ‘“Fair value” for financial instruments: how erasing theory is leading to unworkable global accounting standards for performance reporting’, Australian Accounting Review, vol. 10, no. 21, May, pp. 26–39. Required Provide a brief summary of the authors’ main criticisms. The article by Horton and Macve raises the following criticisms: 1. Changes in interest rates The authors disagree with recognition of gains or losses in financial performance arising from financial liabilities being remeasured because of changes in interest rates. The authors reject the notion of maintaining a capital value in this case. The authors argue that when interest rates change the relevant concept for capital maintenance is the capacity to maintain the level of cash flows in the future to meet interest commitments. The fall in value of fixed interest investments does not reduce a company’s ability to continue to meet its interest obligations on its issued debentures and to pay dividends to shareholders out of the unchanged cash flows it is still receiving 2. Changes in creditworthiness The authors point to the classic case of a downgrade in a company’s creditworthiness leading to the recognition of a gain because its borrowings have a lower value. The authors argue that there is a fundamental inconsistency in the accounting treatment for loan capital and equity capital because there is no recognition in the current value of the equity ownership interest. The authors argue that changing valuation should take account of the changing valuation of all expected future cash flows: But there would be an equal if not greater “loss” to equity from the downgrading of the expected value, first of any “goodwill”, then of the value of assets, and finally of any expectation of receiving a residual payout given the priority of debtholders. 3. Hedges The authors point to the mismatch that arises when financial instruments are hedging operating assets and activities that are not reported at current value or are hedging transactions that are yet to occur.

7.27

Solutions manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 7.1

Identification of financial assets, financial liabilities and equity instruments

Which of the following items qualify as a financial asset, financial liability or equity instrument? Give reasons for your answers. This solution is based on AASB 132 Financial Instruments: Presentation. Refer to paragraph 4 for the scope of the Standard. Refer to paragraph 11 for the definitions of financial asset, financial liability and equity instrument. Item

Financial

Equity

Asset

Liability

Instrument

Definition

a. Cash held

Para 11(a)

b. Investment in debt

Para 11(c)(i)

security j. Fwd exchange contract

Gaining:

Losing:

Para 11(c)(ii)

Para 11(a)(ii)

k. Investment in private coy

Para 11(b)

r. Finance leases

Lessor:

Lessee:

Para 11(c)(i)

Para 11(a)(i)

s. Trade receivables

Para 11(c)(i)

t. Loan receivables

Para 11(c)(i)

u. Debentures issued

Para 11(a)(i)

v. Bank borrowings

Para 11(a)(i)

w. Ordinary shares issued x. Call options held

Para 11 Para 11(c)(ii)

y. Call options written

Para 11(a)(ii)

z. Convertible notes issued

Debt comp.

Option comp.

Para 11(a)(i)

Para 11

7.28

Chapter 7: Financial instruments

Item

Does not meet definitions or excluded

c. Investment in subsidiary

Excluded by Para 4(a)

d. Provision for restoration

Does not relate to exchange with another entity

e. Buildings owned

Physical asset

f. Income tax payable

Income taxes are levied not contractual

g. Provision for emp. benefits

Excluded by Para 4(b)

h. Deferred revenue

Obligation to provide goods or services

i. Prepayments

Right to goods or services

l. Interest in joint venture

Excluded by Para 4(a)

m. Interest in a partnership

Excluded by Para 4(a)

n. Interest in a disc. trust

Contractual rights are not held until discretion used

o. Investment in associate

Excluded by Para 4(a)

p. Fwd contract for wheat

Contract for the exchange of physical commodity

q. Fwd contract for gold

Contract for the exchange of physical commodity

r. Operating lease

Exchange is for use of asset in the period. Only amounts receivable of payable at end of period would qualify as financial assets and liabilities

7.29

Solutions manual to accompany Company Accounting 10e

Question 7.2

Subsequent measurement of financial assets and financial liabilities

The trainee accountant at Halloween Ltd is unsure how to measure a number of items included in its financial records and has asked for your advice. Identify whether each of the following is a financial asset or financial liability and explain on what basis it must be subsequently measured. Trade receivables Primary borrowings of $1 million carrying a variable interest rate 5-year government bonds held paying interest of 5% p.a. Investment in a long-term portfolio of shares listed on the ASX Investment in a trading portfolio of shares listed on the ASX Purchased loans held for short periods before being on-sold Mandatorily converting notes held paying coupon interest of 6% p.a. — the notes must convert to a variable number of ordinary shares at the expiration of their term. Mandatorily redeemable preference shares held at a cumulative dividend rate of 6% p.a. — the preference shares must be redeemed for cash at the expiration five years. Call or put options held on shares in Telstra Corporation Ltd Call or put options written on shares in Telstra Corporation Ltd (a) ASX SPI 200 Futures contract with a negative fair value (b) ASX SPI 200 Futures contract with a positive fair value

Item

Classification

Subsequent Measurement

(a) Trade receivables

Financial Asset

Amortised cost

(b) Primary borrowings

Financial Liability Amortised cost

Financial Asset

Amortised Cost

(d) Investment in long-term share portfolio

Financial Asset

FVTPL or FVOCI

(e) Investment in trading portfolio

Financial Asset

FVTPL

(f) Purchased loans held for on-sale

Financial Asset

FVTPL

(g) Convertible notes held having

Financial Asset

FVTPL or

mandatory conversion option (h) Preference shares held having

FVOIC Financial Asset

FVTPL or

7.30

Chapter 7: Financial instruments

mandatory redemption

FVOCI

(i) Call/Put options held on Telstra

Financial Asset

FVTPL

(j) Call/Put options written on Telstra

Financial Liability FVTPL

(k) Futures contract ASX Index (negative)

Financial Liability FVTPL

(l) Futures contract ASX Index (positive)

Financial Asset

FVTPL

Index FVTPL = Fair value through profit or loss FVOIC = Fair value through other comprehensive income

7.31

Solutions manual to accompany Company Accounting 10e

Question 7.3

Distinguishing financial liabilities from equity instruments

Determine whether Satellite Ltd has a financial liability or equity instrument resulting from the issue of securities in each situation below. Give reasons for your answer. A. Satellite Ltd issues 100 000 $1 convertible notes. The notes pay interest at 7% p.a. The market rate for similar debt without the conversion option is 9%. Each note is not redeemable, but it converts at the option of the holder into however many shares that will have a value of exactly $1. B. Satellite Ltd issues 100 000 $1 redeemable convertible notes. The notes pay interest at 5% p.a. Each note converts at any time at the option of the holder into one ordinary share. The notes are redeemable at the option of the holders for cash after 5 years. Market rates for similar notes without the conversion option are 7% p.a. C. Satellite issues 100 000 $1 redeemable convertible notes. The notes pay interest at 5% p.a. Each note converts at any time at the option of the holder into one ordinary share. The notes are redeemable at the option of the issuer for cash after 5 years. If after 5 years the notes have not been redeemed or converted, they cease to carry interest. Market rates for similar notes without the conversion option are 7% p.a. D. Satellite issues 100 000 $1 redeemable convertible notes. The notes pay interest at 5% p.a. The notes are redeemable after 5 years at the option of the issuer for cash or for a variable number of shares (calculated according to a formula). If after 5 years the notes have not been redeemed or converted, they continue to carry interest at a new market rate to be determined at the expiration of the 5 years. E. Satellite Ltd issues redeemable preference shares with a fixed maturity date. The shares are redeemable only on maturity at the option of the holder. The shares carry a cumulative 6% dividend. F. Satellite Ltd issues redeemable preference shares. The shares carry a cumulative 6% dividend. The shares are redeemable for cash if the company makes an accounting loss in any year. Satellite Ltd is highly profitable and has a history profits and paying ordinary dividends at a yield of about 4% annually without fail for the past 25 years. The market interest rate for long-term debt at the time the preference shares were issued was 7% p.a. Paragraph 16 of AASB 132: When an issuer applies the definitions in paragraph 11 to determine whether a financial instrument is an equity instrument rather than a financial liability, the instrument is an equity instrument if, and only if, both conditions (a) and (b) below are met. (a) The instrument includes no contractual obligation: (i) to deliver cash or another financial asset to another entity or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the issuer (b) If the instrument will or may be settled in the issuer’s own equity instruments, it is: (i) a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments or

7.32

Chapter 7: Financial instruments

(ii) a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments SATELLITE LTD A. 100 000, $1, 7% convertible notes – non-redeemable, convertible at the option of

holder, convertible into variable number of ordinary shares Equity Instrument

Financial Liability Contractual obligation to deliver variable number of own equity instruments means there is no equity risk. A financial liability in full: refer para 16(b) Initial measurement at fair value should be based perpetuity of annual interest at 9% market rate PV = $7 000 ÷ 9% = $77 778

B. 100 000, $1, 5% convertible notes – redeemable for cash at the option of the holder

after 5 years, convertible at the option of the holder at any time, convertible for a fixed number of ordinary shares Equity Instrument

Financial Liability

Equity component for the conversion option as it relates to a fixed number of own equity instruments: refer para 16(b). The equity component is initially measured as the difference between issue proceeds and financial liability component.

Contractual obligation to pay annual interest and principal at the end of 5 years. Financial liability component is initially measured as the present value of the interest and principal discounted at equivalent rate of 7% p.a. for pure play debt security.

Option to convert = $100 000 – $91 801 = $8 199

PV = $100 000 x 0.7130 + $5 000 x 4.1002 = $91 801

C. 100 000, $1, 5% convertible notes – redeemable for cash at the option of the issuer

after 5 years, convertible at the option of the holder, convertible for a fixed number of ordinary shares, interest ceases after 5 years if redemption or conversion not completed Equity Instrument

Financial Liability

Contractual obligation for annual interest only. The issuer does not have a contractual obligation to repay principal at redemption since redemption is at the issuer’s option. Financial liability component is initially measured as the present value of the interest discounted at equivalent rate of 7% p.a. for

7.33

Solutions manual to accompany Company Accounting 10e

Option to convert = $100 000 – $20 501 = $79 499

pure play debt security. PV = $5 000 x 4.1002 = $20 501

D. 100 000, $1, 5% convertible notes – redeemable for cash or a variable number of

own equity instruments at the option of the issuer after 5 years, interest adjusted to new market rate after 5 years Equity Instrument

Financial Liability Contractual obligation for annual interest only. The issuer does not have a contractual obligation to repay principal because any redemption is at the issuer’s option. Variable number of own equity instruments means there is no equity risk. In substance, a perpetuity to annual interest at market rate PV = $5 000 ÷ 5% = $100 000

E. 6% preference shares – redeemable for cash on maturity date at the option of the

holder, cumulative dividend distributions Equity Instrument

Financial Liability Contractual obligation for annual dividends and to repay principal if demanded by the holder at maturity. A financial liability classification is appropriate here

Figure 7.6 of the textbook sets out five examples for the classification of preference share from the perspective of the issuer. In these five examples, there are no preference shares that qualify as compound financial instruments. Paragraph AG 37 of AASB 132 however does provide such an example: Assume that a non-cumulative preference share is mandatorily redeemable for cash in five years, but that dividends are payable at the discretion of the entity before the redemption date. Such an instrument is a compound financial instrument, with the liability component being the present value of the redemption amount. The unwinding of the discount on this component is recognised is profit or loss and classified as interest expense. Any dividends paid relate to the equity component and, accordingly, are recognised as a distribution of profit or loss.

7.34

Chapter 7: Financial instruments

Question 7.4

Netting off a financial asset and financial liability

In each of the situations below, state whether the financial asset and financial liability must be offset in the books of Company A as at 30 June 2015, and explain why. A. Company A owes Company B $500 000, due on 30 June 2018. Company B owes Company A $300 000, due on 30 June 2018. A legal right of set-off between the two companies is documented in writing, and the parties have indicated their intent to settle the amounts on a net basis. B. Company A owes Company B $500 000, due on 30 June 2016. Company B owes Company A $300 000, due on 31 March 2016. A legal right of set-off between the two companies is documented in writing, and the parties have indicated their intent to settle the amounts on a net basis whenever possible. C. Company A owes Company B $500 000, due on 30 June 2016. Company C owes Company A $300 000, due on 30 June 2016. D. Company A owes Company B $500 000, due on 30 June 2016. Company C owes Company A $500 000, due on 30 June 2016. A legal right of set-off between the three companies is documented in writing, and the parties have indicated their intent to settle the amounts on a net basis. E. Company A owes Company B $500 000, due on 30 June 2017. Company A has plant and equipment with a fair value of $500 000 that it pledges to Company B as collateral for the debt. COMPANY A Paragraph 42 of AASB 132: A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an entity: (a) currently has a legally enforceable right to set off the recognised amounts; and (b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. Scenario A. A owes B $500 000 due on 30 June 2018. B owes A $300 000 due on 30 June 2018. Legal right of set-off exists and parties intend to settle net. Amounts can be settled net as they are due on the same dates. B. A owes B $500 000 due on 30 June 2016. B owes A $300 000 due on 31 March 2016. Although a legal right of set-off exists and parties intend to settle net, the amounts cannot be settled net as they are not due on the same dates. C. A owes B $500 000 due on 30 June 2016. C owes A $300 000 due on 30 June 2016. The amounts relate to different counterparties and

Para 42(a)

Para 42(b)

Offset

√

Yes

7.35

Solutions manual to accompany Company Accounting 10e

there is no indication of any agreement between them – refer para 49(b) of AASB 132. D. A owes B $500 000 due on 30 June 2016. C owes A $500 000 due on 30 June 2016. Legal right of set-off exists between the three parties, amounts due on the same dates, intent and ability to settle on a net basis. E. A owes B $500 000 due on 30 June 2017. A has plant and equipment with a fair value of $500 000 that it pledges to B as collateral for the debt. Plant and equipment is not a financial asset – refer para 49(c) of AASB 132.

√

Yes

7.36

Chapter 7: Financial instruments

Question 7.5

Convertible notes issue including financial liability at amortised cost

1 July 2015, Parade Ltd issues 2000 convertible notes. The notes have a three year term and are issued at par with a face value of $1000 per note, giving total proceeds at the date of issue of $2 million. The notes pay interest at 4% p.a. annually in arrears. The holder of each note is entitled to convert the note into 250 ordinary shares of Parade Ltd at contract maturity. When the notes are issued, the prevailing market interest rate for similar debt (similar term, similar credit status of issuer and similar cash flows) without conversion options is 8% p.a. Hence at the date of issue: Present value of the principal: $2 million payable in 3 years’ time: Present value of the interest: $80 000 ($2 million × 4%) payable annually in arrears for 3 years Total contractual cash flows

$1 587 664 206 168 $1 793 832

Required Prepare the journal entries of Parade Ltd to account for the convertible notes for each year ending 30 June under the following circumstances. A. The holders do not exercise their option and the note is repaid at the end of its term. B. The holders exercise their conversion option at the expiration of the contract term.

PARADE LTD

Amortised cost of convertible note liability Interest Paid

Interest Exp

(4% x $2m)

(8% x Liab)

Difference

Liability

1 July 2015

1 793 832

30 June 2016

80 000

143 507

63 507

1 857 339

30 June 2017

80 000

148 587

68 587

1 925 926

30 June 2018

80 000

154 074

74 074

2 000 000

240 000

446 168

206 168

7.37

Solutions manual to accompany Company Accounting 10e

PART A Journal entries 1/7/2015

30/6/2016

30/6/2017

30/6/2018

Cash Convertible Note Liability Option to Convert Notes** (Issue of 2000 convertible notes for cash)

Dr Cr Cr

2 000 000

Interest Expense Convertible Note Liability Cash (Interest expense/paid for 2016)

Dr Cr Cr

143 507

Interest Expense Convertible Note Liability Cash (Interest expense/paid for 2017)

Dr Cr Cr

148 587

Interest Expense Convertible Note Liability Cash (Interest expense/paid for 2018)

Dr Cr Cr

154 074

Convertible Note Liability Cash (Redemption of 2000 convertible notes for cash)

Dr Cr

2 000 000

1 793 832 206 168

63 507 80 000

68 587 80 000

74 074 80 000

2 000 000

** Option to Convert Notes is an equity account. It is initially measured as the difference between the proceeds from the note issue ($2 000 000) and the present value of the note liability based on the market rate for equivalent debt ($1 793 832).

7.38

Chapter 7: Financial instruments

PART B Journal entries 1/7/2015

30/6/2016

30/6/2017

30/6/2018

Cash Convertible Note Liability Option to Convert Notes (Issue of 2000 convertible notes for cash)

Dr Cr Cr

2 000 000

Interest Expense Convertible Note Liability Cash (Interest expense/paid for 2016)

Dr Cr Cr

143 507

Interest Expense Convertible Note Liability Cash (Interest expense/paid for 2017)

Dr Cr Cr

148 587

Interest Expense Convertible Note Liability Cash (Interest expense/paid for 2018)

Dr Cr Cr

154 074

Convertible Note Liability Option to Convert Notes Ordinary Share Capital (Conversion of 2000 convertible notes into 500 000 ordinary shares)

Dr Dr Cr

2 000 000 206 168

1 793 832 206 168

63 507 80 000

68 587 80 000

74 074 80 000

2 206 168

7.39

Solutions manual to accompany Company Accounting 10e

Question 7.6

Convertible notes issue including financial liability at amortised cost

On 1 July 2014 Strawman Ltd issues convertible notes with a face value of $12 million. The convertible notes have a 20 year term and mature on 30 June 2034. Interest is payable semiannually in arrears, i.e. on 31 December and 30 June each year, and the coupon rate of interest is 7.5% p.a. At around the same point in time, companies with a similar credit rating issue debt securities without a conversion option with a coupon rate of 8% p.a., payable semiannually. Required A. Explain why the coupon rate to holders of the convertible notes is less than the rate of return offered to investors in the debt securities of other similar companies. B. Determine the debt and equity components of the convertible notes issued using the residual valuation method. C. Prepare the entries of Strawman Ltd to account for the convertible notes over the period 1 July 2014 to 30 June 2017. D. Prepare the entries of Strawman Ltd to account for the convertible notes up until 30 June 2017 if the issue occurred on 2 July 2014 and interest was payable semiannually in arrears on 1 January and 1 July each year. STRAWMAN LTD A. The issuer of the convertible notes has contractual obligations to make semi-annual

interest payments and return principal at the end of the 20 year term. The issuer is also giving the holder of the notes an option to acquire ordinary shares at some point in the future. If the option is for a fixed number of ordinary shares, then the attached option has the character of a valuable call option. In exchange for giving the holder of the convertible note a valuable option, the issuer requires the holder to accept a lower interest rate than would be the case for a pure debt security. B. In the residual method, an amount is assigned to the financial liability component of the

compound financial instrument. The amount assigned to the equity component is the residual, that is the difference between the proceeds of the issue and the amount assigned to the financial liability component. The advantage of the residual method is the simplicity with which the equity component is determined using the implied value from the issue price for the security. The alternative of separately valuing the conversion option could be complicated especially if the ordinary shares of the entity are not listed on a securities exchange. The disadvantage of the residual approach is that it may be difficult to identify a pure debt security that is comparable to convertible note with no conversion option, that is, debt securities with similar terms to maturity and risk. Financial Liability Component = $2 499 469 + $8 906 748 = $11 406 217 Equity Component = $12 000 000 – $11 406 217 = $593 783 Workings

7.40

Chapter 7: Financial instruments

The discount rate is 8% p.a. paid semi-annually or 4% per half year whilst the interest coupon is 7.5% p.a. paid semi-annually or 3.75% per half year Present Value of Principal = $12 000 000 x 0.208289 = $2 499 469 Working for present value factor: Solve for rate paid annually equivalent to 8% p.a. paid semi-annually (1+r)^1 = (1.04)^2 r = (1.04)^2 – 1 = 0.0816 PV Factor = 1/(1.0816)^20 = 0.208289 Present Value of Interest Stream = $12 000 000 x 0.0375 x 19.79277 = $8 906 748 Working for annuity factor Annuity Factor = [1 – (1+r)^-n]/r = 1 – (1.04)^-40 = 19.79277 C. Entries for Strawman 1 July 2014 to 30 June 2017 Convertible notes – financial liability component schedule Period #

Opening Balance

Interest Rate

Interest Exp

Payment 3.75%

Amortisation

Closing Balance

Period End

11 406 217

0.04

456 249

450 000

6,249

11 412 466 Dec-14

11 412 466

0.04

456 499

450 000

6,499

11 418 965 Jun-15

11 418 965

0.04

456 759

450 000

6,759

11 425 724 Dec-15

11 425 724

0.04

457 029

450 000

7,029

11 432 753 Jun-16

11 432 753

0.04

457 310

450 000

7,310

11 440 063 Dec-16

11 440 063

0.04

457 602

450 000

7,602

11 447 665 Jun-17

Journal entries

7.41

Solutions manual to accompany Company Accounting 10e

1/7/2014

31/12/2014

30/6/2015

31/12/2015

30/6/2016

31/12/2016

30/6/2017

Cash Convertible Note Liability Option to Convert Notes (Issue of convertible notes)

Dr Cr Cr

12 000 000

Interest Expense Convertible Note Liability Cash (First interest payment)

Dr Cr Cr

456 249

Interest Expense Convertible Note Liability Cash (Second interest payment)

Dr Cr Cr

456 499

Interest Expense Convertible Note Liability Cash (Third interest payment)

Dr Cr Cr

456 759

Interest Expense Convertible Note Liability Cash (Fourth interest payment)

Dr Cr Cr

457 029

Interest Expense Convertible Note Liability Cash (Fifth interest payment)

Dr Cr Cr

457 310

Interest Expense Convertible Note Liability Cash (Sixth interest payment)

Dr Cr Cr

457 602

11 406 217 593 783

6 249 450 000

6 499 450 000

6 759 450 000

7 029 450 000

7 310 450 000

7 602 450 000

D. Entries for Strawman if interest payments after end of reporting period

Journal entries

7.42

Chapter 7: Financial instruments

1/7/2014

31/12/2014

1/1/2015

30/6/2015

1/7/2015

31/12/2015

1/1/2016

30/6/2016

1/7/2016

31/12/2016

1/1/2017

30/6/2017

Cash Convertible Note Liability Option to Convert Notes (Issue of convertible notes)

Dr Cr Cr

12 000 000

Interest Expense Convertible Note Liability (Accrual of interest to 31 Dec 14)

Dr Cr

456 249

Convertible Note Liability Cash (First interest payment)

Dr Cr

450 000

Interest Expense Convertible Note Liability (Accrual of interest to 30 June 15)

Dr Cr

456 499

Convertible Note Liability Cash (Second interest payment)

Dr Cr

450 000

Interest Expense Convertible Note Liability (Accrual of interest to 31 Dec 15)

Dr Cr

456 759

Convertible Note Liability Cash (Third interest payment)

Dr Cr

450 000

Interest Expense Convertible Note Liability (Accrual of interest to 30 June 16)

Dr Cr

457 029

Convertible Note Liability Cash (Fourth interest payment)

Dr Cr

450 000

Interest Expense Convertible Note Liability (Accrual of interest to 31 Dec 16)

Dr Cr

457 310

Convertible Note Liability Cash (Fifth interest payment)

Dr Cr

450 000

Interest Expense Convertible Note Liability (Accrual of interest to 30 June 17)

Dr Cr

457 602

11 406 217 593 783

456 249

450 000

456 499

450 000

456 759

450 000

457 029

450 000

457 310

450 000

457 602

7.43

Solutions manual to accompany Company Accounting 10e

Question 7.7

Accounting for loan assets at amortised cost

Last Ltd is a manufacturing company that makes loans to other parties from time to time. The loan assets are classified by Last Ltd as subsequently measured at amortised cost. On 1 July 2015, Last Ltd made the following loans: (a) A 3-year loan of $1 million to Grate Ltd at an interest rate of 15% p.a. due annually in arrears on 30 June each year. Grate Ltd incurred transaction costs of $97 749 in respect of this loan to arrange charges for security. (b) A 3-year loan of $1 million to American Ltd at an interest rate of 10% p.a. with interest due only on settlement at 30 June 2018. (c) A 3-year loan of $1 million to an employee, Mr Whale. The loan is interest free in recognition of his loyalty to the company. Required Prepare the entries of Last Ltd to account for the three loans from initial recognition on 1 July 2015 to derecognition on 30 June 2018.

(a) Loan to Grate Ltd, $1m, 3 years, interest due each year 15% p.a. Initial measurement = fair value + transn costs = $1 000 000 + $97 749 = $1 097 749 Annual interest received = 15% x $1 000 000 = $150 000 Effective interest rate: Solve equation by trial and error 1 097 749 = 150 000/(1+r) + 150 000/(1+r)^2 + 150 000/(1+r)^3 + 1 000 000/(1+r)^3 r = 11% Amortised Cost of Loan Receivable Period #

Opening Balance

Interest Rate

Interest Income

Interest Received

Amortisation

Closing Balance

Period End

1 097 749

0.11

120 752

150 000

29 248

1 068 501

Jun-16

1 068 501

0.11

117 535

150 000

32 465

1 036 036

Jun-17

1 036 036

0.11

113 964

150 000

36 036

1 000 000

Jun-18

Journal entries

7.44

Chapter 7: Financial instruments

1/7/2015

30/6/2016

30/6/2017

30/6/2018

Loan Receivable – Grate Ltd Cash (Initial measurement of loan asset)

Dr Cr

1 097 749

Cash Loan Receivable – Grate Ltd Interest Income (First interest receipt)

Dr Cr Cr

150 000

Cash Loan Receivable – Grate Ltd Interest Income (Second interest receipt)

Dr Cr Cr

150 000

Cash Loan Receivable – Grate Ltd Interest Income (Third interest receipt)

Dr Cr Cr

150 000

Cash Loan Receivable – Grate Ltd (Return of principal for loan asset)

Dr Cr

1 000 000

1 097 749

29 248 120 752

32 465 117 535

113 964 36 036

1 000 000

7.45

Solutions manual to accompany Company Accounting 10e

(b) Loan to American Ltd, $1m, 3 years, interest due on settlement 10% p.a. Initial measurement = fair value = $1 000 000 Interest received on settlement = 10% x $1 000 000 x 3 = $300 000 Effective interest rate: Solve equation by trial and error 1 000 000 = 1 300 000/(1+r)^3 r = 9.1393% Amortised Cost of Loan Receivable Period #

Opening Balance

Interest Rate

Interest Income

Interest Received

Amortis-

Closing Balance

Period End

1 000 000

0.091393

91 393

1 091 393

Jun-16

1 091 393

0.091393

99 746

1 191 139

Jun-17

1 191 139

0.091393

108 861

300 000

(191 139)

1 000 000

Jun-18

ation

Rounding the effective interest rate to say 9.14% would result in a rounding difference of $25 in the final period but this would still give an acceptable answer to the question. Journal entries 1/7/2015

30/6/2016

30/6/2017

30/6/2018

Loan Receivable – American Ltd Cash (Initial measurement of loan asset)

Dr Cr

1 000 000

Loan Receivable – American Ltd Interest Income (Accrual of interest for 2016 year)

Dr Cr

91 393

Loan Receivable – American Ltd Interest Income (Accrual of interest for 2017 year)

Dr Cr

99 746

Cash Loan Receivable – American Ltd Interest Income (Interest receipt on settlement)

Dr Cr Cr

300 000

Cash Loan Receivable – American Ltd (Principal returned on settlement)

Dr Cr

1 000 000

91 393

99 746

191 139 108 861

1 000 000

7.46

Chapter 7: Financial instruments

(c) Loan to Mr Whale, $1m, 3 years, interest-free Initial measurement = fair value = $1 000 000 /(1+r)^3 Where: r is the market rate of interest for a similar loan. Assume r = 10% p.a. for zero coupon debt instruments with 3 year term Fair Value = $1 000 000/(1.10)^3 = $751 315 Paragraph B5.1.1 of AASB 9: The fair value of a financial instrument at initial recognition is normally the transaction price (i.e. the fair value of the consideration given or received). However, if part of the consideration given is for something other than the financial instrument, an entity shall measure the fair value of the financial instrument. For example, the fair value of a long-term loan or receivable that carries no interest can be measured as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument (similar as to currency, term, type of interest rate and other factors) with a similar credit rating. Any additional amount lent is an expense or a reduction of income unless it qualifies for recognition as some other type of asset. In this case, the extra amount lent is to reward Mr Whale for his employee loyalty. Consideration given for loan = $1 000 0000 Fair value of loan receivable = $751 315 Employee Expense = $248 685

Amortised Cost of Loan Receivable Period #

Opening Balance

Interest Rate

Interest Income

Interest Received

Amortis-

Closing Balance

Period End

751 315

0.10

75 131

826 446

Jun-16

826 446

0.10

82 645

909 091

Jun-17

909 091

0.10

90 909

1 000 000

Jun-18

ation

7.47

Solutions manual to accompany Company Accounting 10e

Journal entries 1/7/2015

30/6/2016

30/6/2017

30/6/2018

Loan Receivable –Mr Whale Employee Expenses Cash (Initial measurement of loan asset)

Dr Dr Cr

751 315 248 685

Loan Receivable – Mr Whale Interest Income (Unwinding of discount for 2016)

Dr Cr

75 131

Loan Receivable – Mr Whale Interest Income (Unwinding of discount for 2017)

Dr Cr

82 645

Loan Receivable – Mr Whale Interest Income (Unwinding of discount for 2018)

Dr Cr

90 909

Cash Loan Receivable – Mr Whale (Principal returned on settlement)

Dr Cr

1 000 000

75 131

82 645

90 909

1 000 000

7.48

Chapter 7: Financial instruments

Question 7.8

Trading in shares

Pedro Ltd is an investment company that trades in shares on the Australian Securities Exchange. Pedro Ltd measures the shares at fair value through the profit or loss. Pedro Ltd makes the following trades in Telstra Corporation Ltd. Trade date 8 June 2015

Quantity 10 000

Price $5.00

Buy/Sell Buy

Brokerage $500

15 June 2015

40 000

$5.20

Buy

$800

30 June 2015

20 000

$4.50

Sell

$400

Settlement date is T+3 meaning that settlement of trades occurs three business days after trade date. The closing market price for shares in Telstra at 30 June 2015 is $4.60. Required Prepare the entries of Pedro Ltd on the basis of: A. Trade date accounting B. Settlement date accounting. Extract from the accounting policy note of an Australian investment company: Valuation of Trading Portfolio Securities, including listed and unlisted shares and options, are initially brought to account at market value, which is the cost of acquisition, or proceeds in the case of options written, and are revalued to market values continuously

‘Continuously’ means revalue every time there is a sale and also at the end of the period. The result is the net gain/loss on trading. A. Trade date accounting for shares classified as a financial asset at fair value through

profit or loss Journal entries

7.49

Solutions manual to accompany Company Accounting 10e

8/6/2015

11/6/2015

15/6/2015

18/6/2015

30/6/2015

Shares in Telstra Brokerage Expense Payable to Broker (Acquisition,10 000 x $5.00)

Dr Dr Cr

50 000 500

Payable to Broker Cash at Bank (Settlement of 8 June buy trade)

Dr Cr

50 500

Shares in Telstra Brokerage Expense Payable to Broker (Acquisition, 40 000 x $5.20)

Dr Dr Cr

208 000 800

Payable to Broker Cash at Bank (Settlement of 15 June buy trade)

Dr Cr

208 800

Loss on Shares in Telstra (P/L) Shares in Telstra (Loss, 50 000 x $4.50 – $258 000)

Dr Cr

33 000

Receivable from Broker Brokerage Expense Shares in Telstra (Sale, 20 000 x $4.50)

Dr Dr Cr

89 600 400

Shares in Telstra Gain on Shares in Telstra (P/L) (Gain, 30 000 x [$4.60 – $4.50])

Dr Cr

3 000

50 500

208 800

33 000

90 000

3 000

Check for 30 June 2015 -

Shares on hand = 30 000 x $4.60 = $138 000 Shares (journals) = $50 000 + $208 000 – $33 000 – $90 000 + $3 000 = $138 000 Net loss on shares = $33 000 – $3 000 = $30 000 Journal entries

3/7/2015

Cash at Bank Receivable from Broker (Settlement of 30 June sell trade)

Dr Cr

89 600 89 600

Assume the Telstra share price at 3 July is $4.80. Revaluing the shares to 3 July would give: Journal entries 3/7/2015

Shares in Telstra Gain on Shares in Telstra (P/L) (Gain, 30 000 x [$4.80 – $4.60])

Dr Cr

6 000 6 000

Check for 3 July 2015 -

Shares on hand = 30 000 x $4.80 = $144 000

7.50

Chapter 7: Financial instruments

Shares (journals) = $138 000 + $6 000 = $144 000 Gain on shares = $6 000

B. Settlement date accounting for shares classified as a financial asset at fair value

through profit or loss Journal entries 11/6/2015

15/6/2015

30/6/2015

Shares in Telstra Brokerage Expense Cash at Bank (Acquisition,10 000 x $5.00)

Dr Dr Cr

50 000 500

Shares in Telstra Brokerage Expense Cash at Bank (Acquisition, 40 000 x $5.20)

Dr Dr Cr

208 000 800

Loss on Shares in Telstra (P/L) Shares in Telstra (Loss, 50 000 x $4.60 – $258 000)

Dr Cr

28 000

50 500

208 800

28 000

Check for 30 June 2015 -

Shares on hand = 50 000 x $4.60 = $230 000 Shares (journals) = $50 000 + $208 000 – $28 000 = $230 000 Loss on shares = $28 000

In contrast to the solution for trade date accounting, the sell trade on 30 June 2015 is not brought to account at year end because the settlement date occurs on 3 July 2015.

Paragraph B3.1.6 of AASB 9: When settlement date accounting is applied an entity accounts for any change in the fair value of the asset to be received during the period between the trade date and the settlement date in the same way as it accounts for the acquired asset. In other words, the change in value is not recognised for assets measured at amortised cost; it is recognised in profit or loss for assets classified as financial assets measured at amortised cost Assume the Telstra share price at 3 July is $4.80. Revaluing the shares to 3 July would give: Journal entries

7.51

Solutions manual to accompany Company Accounting 10e

3/7/2015

Shares in Telstra Gain on Shares in Telstra (P/L) (Loss,50 000 x [$4.80 – $4.60])

Dr Dr Cr

10 000

Cash at Bank Brokerage Expense Loss on Shares in Telstra (P/L) Shares in Telstra (Sale, 20 000 x $4.80)

Dr Dr Dr Cr

89 600 400 *6 000

10 000

96 000

*20 000 x [$4.80 - $4.50] Check for 3 July 2015 -

Shares on hand = 30 000 x $4.80 = $144 000 Shares (journals) = $230 000 + $10 000 – $96 000 = $144 000 Net gain on shares = $10 000 – $6 000 = $4 000

7.52

Chapter 7: Financial instruments

Question 7.9

Various financial assets and financial liabilities

Great Adventure Ltd has entered into a number of contracts that are financial instruments as follows. (a) On 1 July 2014, the company acquired 100 000 shares in Telstra Corporation Ltd as a longterm investment at a cost of $500 000. The year-end market prices of Telstra shares were $6.50 on 30 June 2015 and $5.50 on 30 June 2016. (b) On 1 April 2015, the company acquired 100 000 exchange traded call options in Westpac Banking Corporation Ltd at a cost of $3.00 per option. The options have an exercise price of $38.00 and mature on 22 November 2015. The options have a fair value to the holder of $4.00 each on 30 June 2015 and $5.20 each on 22 November 2015. (c) On 1 October 2014, the company sold 100 000 exchange traded call options in Woolworths Ltd at a premium of $2.50 per option. The options have an exercise price of $40.00 and mature on 20 July 2015. Woolworths share price is $39.00 on 20 July 2015. The options have a fair value to the holder of $1.50 each on 30 June 205 and $Nil each on 20 July 2015. (d) On 1 March 2015, the company sells 50 units of ASX SPI 200 Futures. Each contract unit is valued at $25 per index point. The ASX SPI Futures Index is 5800 on 1 March 2015, 6500 on 30 June 2015 and 5500 on 22 September 2015 when the company closes out its position. Required Prepare the entries of Great Adventure Ltd for any financial assets or financial liabilities that arise in each case. (a) Shares in Telstra as long term investor – investment in equity instrument Paragraph 5.7.5 of AASB 9: At initial recognition, an entity may make an irrevocable election to present in other comprehensive income subsequent changes in the fair value of an investment in an equity instrument within the scope of this Standard that is not held for trading. If election made – gains and losses recognised in other comprehensive income Journal entries

7.53

Solutions manual to accompany Company Accounting 10e

1/7/2014

30/6/2015

30/6/2016

Shares in Telstra Cash at Bank (Initial measurement, 100 000 x $5.00)

Dr Cr

500 000

Shares in Telstra Gain on Shares in Telstra (OCI) (Subsequent measurement, 100 000 x [$6.50 – $5.00])

Dr Cr

150 000

Loss on Shares in Telstra (OCI) Shares in Telstra (Subsequent measurement, 100 000 x [$5.50 – $6.50])

Dr Cr

100 000

500 000

150 000

100 000

If election NOT made – gains and losses recognised in profit or loss Journal entries 1/7/2014

30/6/2015

30/6/2016

Shares in Telstra Cash at Bank (Initial measurement, 100 000 x $5.00)

Dr Cr

500 000

Shares in Telstra Gain on Shares in Telstra (P/L) (Subsequent measurement, 100 000 x [$6.50 – $5.00])

Dr Cr

150 000

Loss on Shares in Telstra (P/L) Shares in Telstra (Subsequent measurement, 100 000 x [$5.50 – $6.50])

Dr Cr

100 000

500 000

150 000

100 000

7.54

Chapter 7: Financial instruments

(b) Bought call options in Westpac are a financial asset that is a derivative Financial assets that are investments in derivatives are accounted for at fair value through profit or loss except if certain hedging rules apply Journal entries 1/4/2015

30/6/2015

22/11/2015

Bought Call Options – Westpac Cash at Bank (Initial measurement, 100 000 x $3.00)

Dr Cr

300 000

Bought Call Options – Westpac Gain on Call Options (P/L) (Subsequent measurement, 100 000 x [$4.00 – $3.00])

Dr Cr

100 000

Bought Call Options – Westpac Gain on Call Options (P/L) (Subsequent measurement, 100 000 x [$5.20 – $4.00])

Dr Cr

120 000

Cash at Bank Bought Call Options – Westpac (Exchange settlement, 100 000 x $5.20)

Dr Cr

520 000

300 000

100 000

120 000

520 000

(c) Written call options in Woolworths are a financial liability that is a derivative Financial liabilities for written call options are derivatives and accounted for at fair value through the profit or loss except if certain hedging rules apply Journal entries 1/10/2014

30/6/2015

20/7/2015

Cash at Bank Written Call Options – Woolies (Initial measurement, 100 000 x $2.50)

Dr Cr

250 000

Written Call Options – Woolies Gain on Call Options (P/L) (Subsequent measurement, 100 000 x [$1.50 - $2.50])

Dr Cr

100 000

Written Call Options – Woolies Gain on Call Options (P/L) (Exchange settlement 100 000 x [$0 – $1.50])

Dr Cr

150 000

250 000

100 000

150 000

7.55

Solutions manual to accompany Company Accounting 10e

(d) Sold 50 units of ASX SPI Futures is a derivative that may be a financial asset or financial liability Futures contracts are accounted for at fair value through the profit or loss except if certain hedging rules apply Date

ASX SPI 200

Fair value of contract

Gain/(Loss) on

Futures Index

(50  25  Index)

Sell Contract

1 March 2015

5 800

$7 250 000

30 June 2015

6 500

$8 125 000

($875 000)

22 Sept 2015

5 500

$6 875 000

$1 250 000

Realised gain

375 000

Journal entries 1/3/2015

No entry

30/6/2015

Loss on ASX SPI 200 Futures SPI Futures Contract Liability (Subsequent measurement at reporting date)

Dr Cr

875 000

SPI Futures Contract Liability SPI Futures Contract Asset Gain on ASX SPI 200 Futures (Subsequent measurement at settlement)

Dr Dr Cr

875 000 375 000

Cash at Bank SPI Futures Contract Asset (Settlement of Futures Contract)

Dr Cr

375 000

22/9/2015

875 000

1 250 000

375 000

7.56

Chapter 7: Financial instruments

Question 7.10

Forward to buy shares

Wilshere Ltd enters a forward contract to buy its own ordinary shares after 12 months at a fixed forward price. Wilshere Ltd has a contractual obligation based on the forward price and it has a contractual right based on the market price at the maturity date. Wilshere Ltd is considering a range of different alternatives for the settlement of the contract. Details of the contract are: Contract date Maturity date Market price per share on 1 February 2016 Market price per share on 31 December 2016 Market price per share on 31 January 2017 Fixed forward price per share on 31 January 2017 Present value of forward price on 1 February 2016 Number of shares under the forward contract Fair value of forward contract on 1 February 2016 Fair value of forward contract on 31 December 2016 Fair value of forward contract on 31 January 2017

1 February 2016 31 January 2017 $1.00 $1.10 $1.06 $1.04 $1.00 1 000 000 $Nil $630 000 $200 000

Required Prepare the entries of Wilshere Ltd for the forward purchase contract on its own shares assuming the company has a year end of 31 December and that the contract will be settled: A. Cash for cash (net cash settlement) B. Shares for shares (net share settlement) C. Cash for shares (gross physical settlement). A. Cash for cash (net cash settlement) In this case the contract gives rise to either a financial asset or financial liability because there is:  a contractual right to receive cash from another entity (financial asset)  a contractual obligation to deliver cash to another entity (financial liability)

Journal entries

7.57

Solutions manual to accompany Company Accounting 10e

1/2/2016

No entry, fair value = $Nil

31/12/2016

Forward Contract Gain on Forward Contract (P/L) (Subsequent measurement at fair value, $630 000 - $Nil)

Dr Cr

630 000

Loss on Forward Contract (P/L) Forward Contract (Subsequent measurement at fair value, $200 000 - $630 000)

Dr Cr Cr

430 000

Cash Forward Contract (Settlement of contract, realised gain of $200 000)

Dr Cr

200 000

31/1/2017

630 000

430 000

200 000

The question and solution assume that Wilshere Ltd has an annual reporting date of 31 December. If Wilshere Ltd has a half year reporting date of 30 June, then the contract would also have to be remeasured to fair value on that date.

7.58

Chapter 7: Financial instruments

B. Shares for shares (net share settlement) Net share settlement means the contract is settled by a variable number of the entity’s own equity instruments dependent on the price at settlement date. In this case the contract gives rise to either a financial asset or financial liability because there is:  a contract that will be settled in the entity’s own equity instruments  a derivative that will be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments Paragraph AG36 of AASB 132: An entity’s own equity instruments are not recognised as a financial asset regardless of the reason for which they are reacquired. Paragraph 33 requires an entity that reacquires its own equity instruments to deduct those equity instruments from equity. Journal entries 1/2/2016

No entry, fair value = $Nil

31/12/2016

Forward Contract Gain on Forward Contract (P/L) (Subsequent measurement at fair value, $630 000 - $Nil)

Dr Cr

630 000

Loss on Forward Contract (P/L) Forward Contract (Subsequent measurement at fair value, $200 000 - $630 000)

Dr Cr Cr

430 000

Share Capital Forward Contract (Settlement of contract, realised gain of $200 000)

Dr Cr

200 000

31/1/2017

630 000

430 000

200 000

The final entry must be debited against equity. Share capital is the equity account shown in the solution but another equity account could be used, for example, ‘Share Repurchase Reserve’ Section 259A of the Corporations Act, 2001 generally prohibits a company from acquiring shares in itself unless for the purpose of an authorised buy back, employee share scheme or financing arrangement of a financial institution. If a company acquires shares in itself, then subsequently the company should cancel the shares or transfer the shares to a third party.

7.59

Solutions manual to accompany Company Accounting 10e

C. Shares for cash (gross physical settlement) Gross physical settlement means the contract is settled by the exchange of a fixed amount of cash for a fixed number of shares. In this case the contract gives rise to an equity instrument because there is:  a contract that will be settled in the entity’s own equity instruments  a derivative that will be settled only by the issuer exchanging a fixed amount of cash for a fixed number of its own equity instruments

Journal entries 1/2/2016

No entry as an equity instrument

31/12/2016

No entry as an equity instrument

31/1/2017

Share Capital Cash (Settlement of contract, 1m x $1.04)

Dr Cr

1 040 000 1 040 000

The final entry must be debited against equity. Share capital is the equity account shown in the solution but another equity account could be used, for example, ‘Share Repurchase Reserve’

7.60

Chapter 7: Financial instruments

Question 7.11

Purchased debt instrument with impairment

On 1 January 2015, Sikofu Banking Ltd purchases a debt instrument with a 5-year term for its fair value of $1000 million (including transaction costs). The instrument has a principal amount of $1250 million (the amount payable on redemption) and carries fixed interest of 4.7% paid annually in arrears on 31 December. The annual cash interest income is thus $59 million ($1250 million × 0.047 rounded to nearest million). Using a financial calculator, the effective interest rate is calculated as 10%. The debt instrument is classified as subsequently measured at amortised cost. During 2017, the issuer of the instrument is in financial difficulties and it becomes probable that the issuer will be put into receivership. The fair value of the instrument is estimated to be $636 million on 31 December 2017, calculated by discounting the expected future cash flows at 10%. No cash flows are received during 2017. At the end of 2018, Sikofu Banking Ltd receives a letter stating that the issuer will be able to meet all of its remaining obligations, including interest and repayment of principal. Required Prepare the entries of Sikofu Banking Ltd for all years from initial recognition to derecognition of the financial asset. Amortised Cost of Purchased Debt Instrument (no impairment) B. Amortised cost at

C. Interest inc.

D. Interest

E. Amortised cost at

beginning of year

(B  10%)

Cash flows

end (B + C − D)

2015

1 000

100

1 041

2016

1 041

104

1 086

2017

1 086

109

1 136

2018

1 136

113

1 190

2019

1 190

119

59 + 1 250

A. Year

Journal entries if there is no impairment

7.61

Solutions manual to accompany Company Accounting 10e

1/1/2015

31/12/2015

31/12/2016

31/12/2017

30/6/2018

30/6/2019

$m 1 000

Investment in Debt Security Cash (Acquisition of debt instrument)

Dr Cr

Cash Investment in Debt Security Interest Income (Interest for 2015)

Dr Dr Cr

59 41

Cash Investment in Debt Security Interest Income (Interest for 2016)

Dr Dr Cr

59 45

Cash Investment in Debt Security Interest Income (Interest for 2017)

Dr Dr Cr

59 50

Cash Investment in Debt Security Interest Income (Interest for 2018)

Dr Dr Cr

59 54

Cash Investment in Debt Security Interest Income (Interest and principal for 2019)

Dr Cr Cr

1 309

1 000

100

104

109

113

1 190 119

Amortised Cost of Purchased Debt Instrument (with impairment) C. Interest

D. Interest

E. Impairment

F. Ending

B. Beginning

(B x 10%)

Cash flow

Loss/(Reversal)

(B+C-D-E)

2015

1 000

100

1 041

2016

1 041

104

1 086

2017

1 086

109

559

636

2018

636

(490)

1 190

2019

1 190

119

A. Year

59 + 1 250

At the end of 31 December 2017, the asset carrying amount must be adjusted to the recoverable amount of $636m through an impairment loss of $559m. At the end of 31 December 2018, the asset carrying amount must be adjusted to $1190m through an impairment reversal of $490m. Journal entries with impairment for 2017-2018

7.62

Chapter 7: Financial instruments

1/1/2015

31/12/2015

31/12/2016

31/12/2017

30/6/2018

30/6/2019

$m 1 000

Investment in Debt Security Cash (Acquisition of debt instrument)

Dr Cr

Cash Investment in Debt Security Interest Income (Interest for 2015)

Dr Dr Cr

59 41

Cash Investment in Debt Security Interest Income (Interest for 2016)

Dr Dr Cr

59 45

Impairment Loss Investment in Debt Security Interest Income (Impairment loss for 2017)

Dr Cr Cr

559

Investment in Debt Security Reversal of Impairment Loss Interest Income (Reversal of impairment for 2018)

Dr Cr Cr

554

Cash Investment in Debt Security Interest Income (Interest and principal for 2019)

Dr Cr Cr

1 309

$m 1 000

100

104

450 109

490 64

1 190 119

7.63

Chapter 8: Foreign currency transactions and forward exchange contracts

Chapter 8 - Foreign currency transactions and forward exchange contracts REVIEW QUESTIONS 1.

Explain the financial reporting issue that arises when a company enters into foreign currency transactions. Provide examples of various foreign currency transactions and indicate whether each transaction involves the initial recognition of a monetary item or non-monetary item or both. (LO 1)

Company financial statements presented in Australian dollars must include the financial effects of all transactions during the reporting period including the financial effects of foreign currency transactions. The foreign currency transactions have to be recognised using accrual accounting. Accordingly, monetary assets and monetary liabilities may be recognised before there is a cash receipt or cash payment that concludes or settles the transaction. Pursuant to accrual accounting, monetary assets and monetary liabilities are translated into $A on the date of initial recognition and then subsequently at the end of a reporting period and on cash settlement. The need for the re-translation of monetary items creates the financial reporting issue of exchange differences and how such differences should be recognised in the financial statements. Examples of foreign currency transactions that result in the initial recognition and measurement of a monetary item are as follows: Transaction

Initial recognition and measurement Monetary item Non-monetary item

Purchase of inventory on account

Trade creditor

Purchase of plant on account

Payable to supplier

Plant

Purchase of services on account

Payable to supplier

Issue of debentures for cash

Debentures liability

Issue of debentures for land

Debentures liability

Land

Loan funds arranged from a bank

Loan payable

Sale of inventory on account

Trade receivable

Right to receive dividend

Dividend receivable

Loan funds provided to another entity

Loan receivable

Inventory

8.2

Solution Manual to accompany Company Accounting 10e

Explain what is meant by a spot exchange rate, closing exchange rate and forward exchange rate. (LO 2)

A spot exchange rate is the exchange rate for immediate delivery at a particular point in time. (AASB 121, para 8), for example, on 1 January 2017 at 4.59 pm, $A1 = $U.S.0.85. A closing exchange rate is the spot exchange rate at the end of the reporting period (AASB 121, para 8), for example, on 30 June 2017 at close of business $A1 = $U.S.0.90 A forward exchange rate is the exchange rate specified for currency exchange at a specified future date, for example, a 3 month forward exchange contract entered into on 1 July 2017 specifies a currency exchange on 30 September 2017 at the a forward rate of $A1 = $U.S.87. 3.

Illustrate the direct method and indirect methods of quoting exchange rates. Assume an Australian company has a deposit with a financial institution at year end amounting to $U.S.100 000 and the closing exchange rate is $A1 = $U.S.0.90. Calculate the $A amount of the deposit to be included in the statement of financial position (LO 2)

Direct method

Indirect method

One unit of foreign currency expressed in Australian currency

One unit of Australian currency expressed in foreign currency

$U.S.1 = $A1.11’

A$1 = $U.S.$0.90

Translation process

multiplication

division

Example of translation

$U.S.100 000 x 1.11’ = $A111 111

$U.S.100 000 0.90 =A$111 111

How currencies are expressed

Example of quoted rates

A deposit at call denominated in foreign currency with a financial institution is a 'monetary item' being an asset to be received in a fixed or determinable number of units of currency refer definition at paragraph 8 of AASB 121. In this example, the amount of currency to be received is US$100 000. Any monetary item outstanding at year-end, which is at reporting date, must be translated using the closing exchange rate. Therefore, the balance of cash and cash equivalents on the face of the statement of financial position will include $A111 111 in respect of the $U.S.100 000 deposit with a financial institution. As an aside, it is worth noting that an investment in foreign shares is not a monetary item because it is not an asset to be received in fixed or determinable amounts of money. For example, shares with a cost of $U.S.100 000 would be translated into $A when acquired but © John Wiley and Sons Australia, Ltd 2015

8.3

Chapter 8: Foreign currency transactions and forward exchange contracts

would NOT be remeasured at the closing rate at the end of the reporting period. 4.

Explain how the items that arise from foreign currency transactions are translated into Australian dollars when initially recognised in the accounting records. What sort of items must subsequently be re-measured under AASB 121? At what dates does the re-measurement occur? (LO 4)

Initial measurement Each asset, liability, item of equity, revenue or expense that arises from entering a foreign currency transaction must initially be recognised using the spot rate at the date of the transaction between the functional currency and the foreign currency (paragraph 21). Subsequent measurement Foreign currency monetary items that are outstanding at reporting date must be subsequently measured (i.e. retranslated) at the spot rate at the reporting date, for example, at the end of the financial year. Foreign currency monetary items must also be remeasured at the date of settlement in order that their balances accord with the cash flow that occurs on the date of settlement (paragraph 23) In contrast, non-monetary items measured in terms of historic cost are translated using the applicable historic exchange rate. Non-monetary items that are revalued (e.g. an asset measured at fair value) are retranslated using the exchange rate at the date of the revaluation (paragraph 23). Monetary items denominated in foreign currency Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency (AASB 121 para. 8). Examples include: • Borrowings in $U.S. • Cash deposit in Pounds Sterling • Trade creditor in Euros • Trade debtor in Yen

8.4

Solution Manual to accompany Company Accounting 10e

Illustration Initial recognition and subsequent measurement of foreign currency monetary items can be depicted as follows: Date of transaction

Reporting date

Settlement date

Record the transaction at the

Re-measure monetary asset or

spot rate (initial recognition of

liability at the closing rate.

liability at the spot rate.

monetary asset or liability). Record cash settlement of monetary asset or liability at spot rate.

Explain what is meant by the term ‘exchange difference’. Distinguish between an unrealised exchange loss and a realised exchange loss. Provide an overview of the accounting requirements of AASB 121 in relation to foreign currency transactions and exchange differences. (LO 3, LO 4 and LO 5)

Definition of exchange difference Paragraph 8 of AASB 121 defines an exchange difference to mean: “the difference resulting from translating a given number of units of one currency into another currency at different exchange rates” Therefore, an exchange difference arises when a balance denominated in foreign currency is re-measured and there has been a movement in exchange rates between two dates. AASB 121 recognises exchange differences on the foreign currency monetary items. Exchange differences on foreign currency monetary items are determined by comparing the foreign currency amount translated at the applicable exchange rate at the reporting date (or, where the monetary item is settled during the reporting period, at the date of settlement) with that same foreign currency amount translated at the date on which the original transaction took place (or, if later, the last reporting date). Exchange differences: realised versus unrealised A realised exchange difference arises on the cash realisation of a recognised asset or cash settlement of a recognised liability. In the case of a monetary item (e.g. a trade payable), the realised exchange difference equals the difference between the translated amount at the date of initial recognition and translated amount at the date of cash settlement.

8.5

Chapter 8: Foreign currency transactions and forward exchange contracts

Date of transaction

Settlement date Realised Exchange Difference

Record the transaction at the

Re-measure monetary asset or

spot rate (initial recognition of

liability at the spot rate for cash

monetary asset or liability).

settlement

In contrast, an unrealised exchange difference arises whenever a recognised asset or recognised liability continues to be recognised in the financial statements but is re-measured using an exchange rate that is different to the historic exchange rate. Monetary items that are re-measured at the end of the financial reporting period give result in unrealised exchange differences. Date of transaction

Reporting Date Unrealised Exchange Difference

Record the transaction at the

Re-measure monetary asset or

spot rate (initial recognition of

liability at the closing rate for

monetary asset or liability).

inclusion in the statement of financial position

Another exchange difference arises if a monetary item is remeasured at settlement date after having been included in the statement of financial position at the end of a previous reporting period. In effect, this is an adjustment of the exchange difference. The adjustment ensures that the total exchange difference recognised for the monetary item in the current and prior periods equals the realised exchange difference.

Reporting Date

Settlement Date Adjustment Exchange Difference

Re-measure monetary asset or

liability at the closing rate for

liability at the spot rate for cash

inclusion in the statement of

settlement

financial position

8.6

Solution Manual to accompany Company Accounting 10e

Accounting treatment of exchange differences The accounting treatment of exchange differences for monetary items is set out at paragraph 28 of AASB 121 as follows: Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition during the period or in previous financial statements, shall be recognised in profit or loss in the period in which they arise

The accounting treatment of exchange differences for non-monetary items is set out at paragraph 30 of AASB 121 as follows: When a gain or loss on a non-monetary item is recognised in other comprehensive income, any exchange component of that gain or loss shall be recognised in other comprehensive income. Conversely, when a gain of loss on a non-monetary item is recognised in profit or loss, any exchange component of that gain or loss shall be recognised in profit or loss.

The following table summarises the required approach. Item

Recognition of exchange differences

Monetary items •

Trade payable

In profit or loss as exchange rates change

•

Trade receivable

In profit or loss as exchange rates change

Non-monetary items •

Land at cost

None

•

Land at fair value > cost

In other comprehensive income as part of revaluation gain to reserve

•

Land at fair value < cost

In profit or loss as part of revaluation loss

•

Inventory at NRV

In profit or loss as part of inventory expense

•

Impaired asset at recoverable

In profit or loss as part of impairment loss

amount

8.7

Chapter 8: Foreign currency transactions and forward exchange contracts

AASB 121 mandates the immediate recognition method where exchange differences on monetary items are recognised in the profit and loss in the period of exchange rate movement. Other methods, such as the ‘defer and amortise’, or 'recognition on realisation' are not permitted. Has the correct decision been made from the point of view of the conceptual framework? Are there other reasons to prefer the immediate recognition method? (LO 3)

AASB 121 requires the immediate recognition of exchange gains and losses on foreign currency monetary items. The application of the immediate recognition method to non-current monetary items is problematic because by definition the life of the non-current monetary item will span several accounting periods during which significant movements in exchange rates may occur. In accounting for unrealised exchange gains and losses on non-current monetary items, the three main methods that have been considered by standard setters are as follows: i. ii. iii.

recognise the exchange difference in the profit or loss only when the settlement of the monetary item occurs recognise the exchange difference as an asset or liability and then amortise it to the profit and loss over the term or life of the monetary item immediately recognise the exchange difference in the profit and loss

In addition, some combination of these three methods is possible, for example, immediate recognition of exchange losses but deferral of exchange gains. All the above approaches had been used in practice in years prior to the first release of an Australian Accounting Standard (AAS 20) in October 1985. Recognition on settlement only Recognition of exchange differences only on settlement of monetary items is conceptually the weakest approach because it defies the basic tenets of accrual accounting. In the ordinary course, the recognition of revenues and expenses does not depend on a cash transaction. Deferred into the statement of financial position and then amortised to profit or loss In the first version of AAS 20, the required accounting treatment for non-current monetary items was that exchange differences be deferred (initially recognised as an asset or liability balance) and then systematically amortised or allocated to the profit and loss over the term of the monetary item. The matching principle was used as the justification for this approach. The implicit assumption adopted was that an exchange difference on a non-current foreign currency borrowing represented an adjustment to the effective interest rate on that borrowing and therefore formed part of the cost of borrowing in a foreign currency. Therefore, these exchange differences ought to be matched against the revenue over the period during which the funds were available to the borrower. This issue was debated at length by the (then) Accounting Standards Review Board prior to the re-release of AAS 20 in December 1987. At this point, the matching argument lost out and the ‘defer and amortise’ method for unrealised exchange differences on non-current monetary items was dropped in favour of the immediate

8.8

Solution Manual to accompany Company Accounting 10e

recognition method. Immediate recognition There were several reasons why the Australian standards setters decided to change from defer and amortise to immediate recognition. First, it was argued that an accounting treatment should not depend upon an arbitrary balance sheet classification between current and non-current items. Second, amortisation allocated the effect of an economic event (an exchange rate change) to periods other than the period in which the event occurred. Third, from a balance sheet perspective, deferred foreign exchange differences do not fall into the definition of an asset or liability. For example, ‘assets’ had been tentatively defined by the Accounting Standards Review Board in its original (February 1985) Release 100 (paragraph 35) as: . . . probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events

Arguably, a deferred exchange loss cannot be carried forward as an asset because it conveys no future economic benefit. Similarly, a deferred exchange gain did not satisfy the ASRB's definition (paragraph 43) of liabilities, which was as follows: . . . probable future sacrifices of economic benefits . . .

In accordance with the definitions of assets and liabilities, the immediate recognition method should be used for all foreign currency monetary items including forward exchange contracts. Another reason to prefer the immediate recognition method is that it makes the effects of foreign exchange risk on a company for the period transparent in its financial report. The standard setters believe that managers will be more likely to manage foreign exchange risk if it is regularly brought to account in the financial statements. This is an example of how the how the accounting approach used can have real economic consequences through affecting management behaviour. 7.

You are the technical accounting consultant of a Big 4 accounting firm. One of your clients is an Australian travel company that arranges package tours in overseas destinations. The client states as follows: “When we arrange accommodation in foreign hotels we recognise a liability at the spot rate. Then when we pay for the accommodation any exchange gain or loss is included in the profit or loss. We believe that we are complying with AASB 121”. Do you agree? Explain (LO 4)

A travel agent is likely to make foreign exchange gains or losses on foreign currency transactions because of fluctuations in exchange rates. In the case of the Australian travel company, an expense and liability are recognised when a firm booking is made with an overseas hotel. The Australian dollars needed to settle the foreign currency obligation (the recorded liability) however, might vary from the date of the booking because of fluctuations in the exchange rate.

8.9

Chapter 8: Foreign currency transactions and forward exchange contracts

The difference in exchange rates between the date of the transaction and the date of settlement result in a realised exchange gain or loss. The accounting policy suggested by the Australian travel agent is to recognise exchange gains and losses in the reporting periods that they are realised. In contrast, AASB 121 generally requires that exchange gains and losses are recognised in the profit or loss in the reporting period in which the exchange rates change. Realisation of exchange gains and losses is NOT the criteria for recognition of exchange gains and losses. The recognition of exchange differences based on realisation fails the requirements of AASB 121 when the date of the foreign currency transaction and settlement of a related foreign currency monetary item straddle the end of reporting period: This can be illustrated as follows: Date of Transaction

End of Reporting Period 2016

Date of Settlement

FC obligation at spot rate

FC obligation at closing exchange rate

FC cash payment at spot exchange rate

Unrealised exchange difference recognised in profit or loss for 2016

Exchange difference to date of settlement recognised in profit or loss for 2017

Realised exchange difference recognised in profit or loss for 2017

End of Reporting Period 2017

 AASB 121  Travel agent

Explain what is meant by the term ‘qualifying asset’. Describe the accounting treatment for exchange differences that relate to qualifying assets. (LO 5)

Definition of qualifying asset Paragraph 5 of AASB 123 ‘Borrowing costs’ defines a qualifying asset as follows: A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale

Examples of qualifying assets In accordance with paragraph 7 of AASB 123 examples of qualifying assets include the following: (a) (b) (c) (d) (e)

inventories that require a substantial period of time to bring them to saleable condition manufacturing plants power generation facilities intangible assets investment properties

8.10

Solution Manual to accompany Company Accounting 10e

Another example found in practice would be the construction of a cable network or mobile phone network for a telecommunications company. Qualifying assets do NOT include: • Financial assets such as investments in shares • Inventories manufactured over a short period of time • Assets ready for use or sale when acquired Definition of borrowing costs Paragraph 5 of AASB 123 defines borrowing costs as follows: Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds

Borrowing costs include exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. Capitalisation of borrowing costs including exchange differences. Paragraph 8 of AASB 123 sets out the accounting treatment for borrowing costs as follows: An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognise other borrowing costs as an expense in the period in which it incurs them.

If land or inventory can only be realised in foreign currency, then how should the recoverable amount of the land or realisable value of the inventory be measured? (LO 5)

Non-monetary assets such as land or inventory that are subsequently measured at historic cost are translated using the historic exchange rate at the date of the acquisition of the asset. In contrast, land subsequently measured at recoverable amount is translated using the spot exchange rate at the date of valuation. Similarly, inventory that is subsequently measured at net realisable value is translated at the date of valuation. An example can be used to demonstrate the required approach. Land acquired for $U.S.500 000 when $U.S.1 = $A1.30 Land recoverable amount $U.S.510 000 when $U.S.1 = $A1.20 Translated cost is $A650 000 ($U.S.500 000 x 1.3) Translated recoverable amount is $A612 000 ($U.S.510 000 x 1.2) Impairment loss is $38 000 including foreign exchange difference

8.11

Chapter 8: Foreign currency transactions and forward exchange contracts

10. What is meant by foreign exchange risk? How can forward exchange contracts be used to manage foreign exchange risk? (LO 6 and LO 7) From section 8.6 of the chapter Foreign exchange risk is the risk that an entity’s financial position, financial performance or cash flows will be affected by fluctuations in exchange rates, that is, fluctuations between the $A and other currencies such as the $U.S. In an accounting context, foreign exchange risk may relate to the following: 1. recognised assets and liabilities 2. unrecognised firm commitments to buy or sell an asset 3. a forecasted or planned transaction to buy or sell an asset From section 8.7 of the chapter A forward exchange contract is an agreement between two parties to exchange a specified quantity of one currency for another at a specified exchange rate (the forward rate) on a specified future date. The advantage of using a forward exchange contract for hedging is the ease of acquisition and its flexibility. Contracts are readily available from financial institutions and can be arranged for settlement at specific dates and for specific amounts of foreign currency. An Australian company may enter a forward exchange contract to buy foreign currency or sell foreign currency. A forward contract that buys foreign currency fixes the amount to be paid in $A for a specified quantity of foreign currency. For example, a forward contract to buy $U.S.100 000 at the forward rate of $A1=$U.S.0.80 ensures that a company receives $U.S.100 000 in exchange for $A125 000. Hence, a forward contract that buys $U.S. manages the foreign exchange risk associated with recognised liabilities or recognised firm commitments and planned transactions to buy assets. In effect, the forward contract to buy $U.S. locks in the $A cost of the foreign currency needed for a future outflow of economic resources (e.g. a future cash payment to settle a payable in $U.S.). A forward contract that sells foreign currency fixes the amount to be received in $A for specified quantity of foreign currency. . For example, a forward contract to sell $U.S.100 000 at the forward rate of $A1=$U.S.0.80 ensures that a company receives $A125 000 in exchange for $U.S.100 000. Hence a forward contract that sells $U.S. manages the foreign exchange risk associated with recognised assets or recognised firm commitments and planned transactions to sell assets.. In effect, the forward contract to sell $U.S. locks in $A amount to be received for the foreign currency arising from a future inflow of economic resources (e.g. a future cash receipt for a receivable in $U.S.)

8.12

Solution Manual to accompany Company Accounting 10e

11. Explain how the fair value of a forward contract is measured at inception date, at reporting date and at settlement date. (LO 7) The fair value of a forward contract is the net discounted cash flow that would result if the financial effects of the original forward contract were offset by taking out another forward contract. For example, a forward contract to buy $U.S.100 000 on 1 August 2017 can be offset by entering into another forward contract to sell $U.S.100 000 on the same date. At inception date, the fair value of a forward contract is $Nil on the basis that the opposing position could be entered into on the same date at the same forward rate. At a reporting date or settlement date however, the forward rate for the opposing position has usually changed from the date of inception and the forward contract will have a positive or negative fair value. The diagram below illustrates the measurement at fair value of a forward contract to buy $US.100 000 ignoring discounting. 1 June 2017

30 June 2017

31 July 2017

Date of entering fwd

Reporting date

Settlement date

Contract to buy $U.S.100 000 Right at fwd rate of 0.80 = $125 000 Obligation at fwd rate of 0.80 = $125 000 Fair value = $Nil

Contract to buy $U.S.100 000 Right at fwd rate of 0.50 = $200 000 Obligation at fwd rate of 0.80 = $125 000 Fair value = $75 000

Contract to buy $U.S.100 000 Right at fwd rate of 0.67 = $149 254 Obligation at fwd rate of 0.80 = $125 000 Fair value = $24 254

Gain on fwd contract $75 000

Loss on fwd contract $50 746

Realised gain on fwd contract $24 254

12. Distinguish between a fair value hedge and a cash flow hedge that uses a forward exchange contract as the hedging instrument. Describe the accounting treatment of any gains or losses on a forward contract that qualifies for hedge accounting. (LO 8) From the summary section of the chapter A forward contract designated as a hedging instrument for a hedged item that is a recognised asset or liability is referred to as a fair value hedge. The gain or loss on a forward contract in a fair value hedge is immediately recognised to the profit or loss. A forward contract designated as a hedging instrument for a hedged item that is a highly probable forecast transaction is referred to as a cash flow hedge. The gain or loss on a forward contract that is a cash flow hedge is recognised in other comprehensive income and a cash flow hedge reserve. When the forecast transaction occurs, the gain or loss in the cash flow reserve is transferred into the amount of a recognised asset or liability or reclassified in other comprehensive income and recognised to the profit or loss. A forward contract designated as a hedging instrument for a firm commitment may be recognised as fair value hedge or a cash flow hedge. The gain or loss on the unrecognised firm commitment is recognised consistently

8.13

Chapter 8: Foreign currency transactions and forward exchange contracts

with the gain or loss on the forward contract, that is, in the profit or loss or in other comprehensive income.

8.14

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 8.1

Translation of various foreign currency transactions and balances

On 1 June 2017, Laurie Ltd entered into various transactions in NZ$ when the exchange rate was A$1.00 = NZ$1.40. Any assets arising from the NZ$ transactions are still on hand and any liabilities remain unsettled. On 30 June 2017, the exchange rate is A$1.00 = NZ$1.20. Translate each of following items for initial and subsequent measurement as appropriate: (a) Sale revenue and trade receivable of NZ$15 000

Date of transaction 1.6.17

Reporting date 30.6.17

Record the sales at spot rate

Restate the monetary item to closing rate

Trade receivable $N.Z.15 000  1.4 = $A10 714

Trade receivable $N.Z.15 000  1.2 = $A12 500

Exchange gain of $A1 786

Journal entries 1.6.17

30.6. 17

Trade receivables Sales

10 714 Cr

Trade receivables Foreign exchange gain

Dr Cr

10 714

1 786

8.15

Chapter 8: Foreign currency transactions and forward exchange contracts

(b) Inventory and trade payable of NZ$20 000

Date of transaction 1.6.17

Reporting date 30.6.17

Record inventory purchase at spot rate

Restate the monetary item to closing rate

Trade payable $N.Z.20 000  1.4 = $ A14 286

Trade payable $N.Z.20 000  1.2 = $A16 667

Exchange loss of $A2 381

Journal entries 1.6.17

Inventory Trade creditors

30.6. 17

14 286 Cr

Foreign exchange loss Trade creditors

Dr Cr

14 286

2 381 2 381

Date of transaction 1.6.17

Reporting date 30.6.17

Record acquisition at spot rate

Plant at cost is a non-monetary item that is NOT restated.

Plant $N.Z.30 000  1.4 = $A21 429

Journal entry 1.6.17

Plant

Dr Cash

21 429 Cr

21 429

8.16

Solution Manual to accompany Company Accounting 10e

(d) Interest free borrowings of NZ$100 000. Date of transaction 1.6.17

Reporting date 30.6.17

Record the borrowings at spot rate

Restate the monetary item to closing rate

Borrowings $N.Z.100 000  1.4 = $A71 429

Borrowings $N.Z..100 000  1.2 =$A83 333

Exchange loss of $A11 904

Journal entries 1.6.17

Cash

Dr Borrowings

30.6. 17

Foreign exchange loss Borrowings

71 429 Cr

Dr Cr

71 429

11 904

8.17

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.2

Translation of various foreign currency transactions and balances

Know Your Product Ltd is an Australian company with a functional currency of A$. The company has entered into a number of transactions denominated in US$ during the year ended 30 June 2017. If the closing exchange rate is A$1.00 = US$0.77, then determine the translated amount that will be included in the financial statements for each of the following balances: (a) Land at cost US$400 0000 acquired on 1 February 2017 when the exchange rate is A$1.00 = US$0.67. Date of transaction 1.2.17

Reporting date 30.6.17

Record acquisition at spot rate

Land at cost is a non-monetary item that is NOT restated.

Land $U.S.400 000  0.67 = $A597 015

Journal entry 1.2.17

Land

Dr Cash

597 015 Cr

597 015

(b) Land revalued to US$600 000 on 30 June 2017 that had cost US$400 000 on 1 February 2017 when the exchange rate was A$1.00 = US$0.67. Date of transaction 1.2.17

Reporting date 30.6.17

Record acquisition at spot rate

Land restated to fair value at spot rate

Land $U.S.400 000  0.67 = $A597 015

Land $U.S.600 000  0.77 = $A779 221

Gain on revaluation of $A182 206

Journal entries

8.18

Solution Manual to accompany Company Accounting 10e

1.2.17

Land

Dr Cash

30.6. 17

Land Gain (OCI)

597 015 Cr

revaluation

Dr Cr

597 015

182 206

8.19

Chapter 8: Foreign currency transactions and forward exchange contracts

(c) Credit sale of US$80 000 on 12 March 2017 when the exchange rate is A$1.00 = US$0.69. Received cash from debtor of US$40 000 on 30 June 2017. Date of transaction 12.3.17

Reporting date and Settlement date 30.6.17

Record the sales at spot rate

Restate the monetary item to closing rate

Trade receivable $U.S.80 000  0.69 = $A115 942

Trade receivable $U.S.80 000  0.77 = $A103 896

Exchange loss of $A12 046

Record cash receipt at spot rate $U.S.40 000  0.77 = $A51 948

Journal entries 12.3.17

30.6. 17

Trade receivables Sales

115 942 Cr

115 942

Foreign exchange loss Trade receivables

Dr Cr

12 046

Cash Trade receivables

Dr Cr

51 948

12 046

51 948

8.20

Solution Manual to accompany Company Accounting 10e

(d) Credit purchase of inventory of US$250 000 on 15 June 2017 when the exchange rate is A$1.00 = US$0.62. The creditor remains unpaid at 30 June 2017.

Date of transaction 15.6.17

Reporting date 30.6.17

Record inventory purchase at spot rate

Restate the monetary item to closing rate

Trade payable $U.S.250 000  0.62 = $A403 226

Trade payable $U.S.250 000  0.77 =$A324 675

Exchange gain of $A78 551

Journal entries 15.6.17

30.6. 17

Inventory Trade creditors

Trade creditors Foreign exchange gain

403 226 Cr

Dr Cr

403 226

78 551

8.21

Chapter 8: Foreign currency transactions and forward exchange contracts

(e) A loan payable of US$800 000 arranged on 1 January 2017 when the exchange rate is A$1.00 = US$0.60. On 30 June 2017, the outstanding interest on the loan is US$20 000. Date of transaction 1.1.17

Reporting date 30.6.17

Record the loan transaction at spot rate

Restate the monetary item to closing rate

Loan payable $U.S.800 000  0.60 = $A1 333 333

Loan payable $U.S.800 000  0.77 =$A1 038 961

Exchange gain of $A294 372 Recognise interest for the period Interest payable $U.S.20 000  0.77 =$A25 974

Journal entries 1.1.17

Cash

Dr Loan payable

30.6. 17

1 333 333 Cr

1 333 333

Loan payable Foreign exchange gain

Dr Cr

294 372

Borrowing costs expense* Interest payable

Dr Cr

25 974

294 372

25 974

*Borrowing costs include interest expense and foreign exchange differences in the nature of adjustments to interest costs.

8.22

Solution Manual to accompany Company Accounting 10e

(f) A six month forward contract to buy US$3 000 000 entered into on 1 April 2017 at the forward rate of A$1.00 = US$0.72. On 30 June 2017, the forward rate for a 3month forward to buy US$3 000 000 is A$1.00 = US$0.70. Assume a 3-month discount rate of 2% applies at 30 June 2017.

Date of transaction 1.4.17

Reporting date 30.6.17

Initial recognition of forward contract

Subsequent measurement of forward contract

Contract right to receive $U.S. $U.S.3 000 000  0.72 = $A4 166 667

Contract right to receive $U.S. $U.S.3 000 000  0.70 = $A4 285 714

Contract obligation fixed in $A $U.S.3 000 000  0.72 = $A4 166 667

Fair value = $A0

Net contract position = receivable $A119 047 Fair value =$A119 047  1.02 = $A116 713

Gain in fair value of contract $A116 713

Journal entry 30.6.17

Forward contract Gain on contract*

Dr forward

116 713 Cr

116 713

*The gain on the fair value of the forward contract is recognised in the profit or loss.

8.23

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.3

Translation of consulting service expense

Orstralia Ltd is an Australian company that receives management consulting services from Spin Incorporated. On 15 June 2017, Orstralia received an invoice from Spin amounting to US$5 million for services provided over the period 1 January 2017 to 31 May 2017. On 15 July 2017, Orstralia paid the invoice. The functional currency of Orstralia Ltd is A$ and its financial year ends on 30 June. Applicable exchange rates are as follows: 01/01/2017 31/05/2017 Average 01/01/2017 to 31/05/2017 15/06/2017 30/06/2017 15/07/2017

A$1 = US$0.70 A$1 = US$0.64 A$1 = US$0.65 A$1 = US$0.62 A$1 = US$0.60 A$1 = US$0.58

Required In accordance with AASB 121, prepare the entries of Orstralia Ltd to record the management fee transaction.

Date of transaction 15 June 2017

Reporting date 30 June 2017

Initial measurement Payable $U.S.5m  0.62 = $A8 064 516

Subsequent measurement Payable $U.S.5m  0.60 = $A8 333 333 .

Exchange loss $A268 817

Settlement Date 15 July 2017 Subsequent measurement Payable $U.S.5m  0.58 = $A8 620 690

Exchange loss $A287 357

Expense $U.S.5m  0.65 = $A7 692 308

Cash payment $U.S.5m  0.58 = $A8 620 690

Exchange loss $372 208

Journal entries

8.24

Solution Manual to accompany Company Accounting 10e

15.6.17

30.6. 17

15.7.

Management services expense Foreign exchange loss Payable to supplier

Dr Dr Cr

7 692 308 372 208 8 064 516

Foreign exchange loss Payable to supplier

Dr Cr

268 817

Foreign exchange loss Payable to supplier

Dr Cr

287 357

Payable to supplier Cash

Dr Cr

8 620 690

268 817

287 357

17 8 620 690

In contrast to a sales transaction or purchase transaction for inventory, the management expense is incurred over a period of time rather than at a point in time. Accordingly, the expense should be translated using an average exchange rate for the relevant period.

8.25

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.4

Translation of purchase of inventory on credit terms

Stranded Ltd is an Australian company that purchases inventory from Hammers plc, which is an English company. The following information is relevant to a recent acquisition of inventory for £300 000 pursuant to a contract with terms including FOB shipping. Date 11-5-2017 22-6-2017 30-6-2017 31-7-2017

Event Inventory shipped Inventory delivered End of reporting period Cash payment of £300 000 to Hammers plc

Exchange rate A$1 = £0.41 A$1 = £0.42 A$1 = £0.43 A$1 = £0.39

Required In accordance with AASB 121, prepare all of the entries of Stranded Ltd that relate to the foreign currency purchase of inventory. How would your answer change if the inventory acquired had a net realisable value of £270 000 at 30 June 2017?

Journal entries 11.5.1 7

30.6.1 7

Inventory Trade creditors (Inventory purchase £300 000  0.41)

Trade creditors Foreign exchange gain (Re-measurement of trade payable £300 000  0.43 less £300 000  0.41)

Dr Cr

731 70 731 70

7 7

Dr Cr

34 033 34 033

Dr Cr

71 556 71 556

31.7.1 7

Foreign exchange loss Trade creditors (Re-measurement of trade payable £300 000  0.39 less £300 000  0.43)

Dr Cr

769 23 769 23

0 0

Trade creditors Cash (Cash payment £300 000  0.39)

Additional explanations •

The date of the transaction for inventory purchased FOB shipping is the date of shipping, that is, 11 May 2017.

8.26

Solution Manual to accompany Company Accounting 10e

•

Stranded Ltd’s statement of financial position as at 30 June 2017 will include a trade payable balance of $697 674, that is, £300 000 translated at the closing rate of 0.43. Stranded Ltd’s statement of profit or loss for the year ending 30 June 2017 will include a foreign exchange gain of $34 033 whilst its statement of profit or loss for the year ending 30 June 2018 will include a foreign exchange loss of $71 556

•

The realised exchange difference is a foreign exchange loss of $37 523, that is, $769 230 less $731 707 OR $71 566 less $34 033.

What if the net realisable value of the inventory is £270 000 at 30 June 2017? The translated net realisable value of the inventory at 30 June 2017 would be $627 907 (i.e. £270 000  0.43). Inventory must be measured at the lower of cost and net realisable value at reporting date. Hence, an inventory expense of $103 800 (i.e. $731 707 less $627 907) would have to be recognised for the year to 30 June 2017.

8.27

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.5

Translation of foreign currency borrowings and interest costs

On 1 October 2016, the Australian company Run Down Ltd enters a loan agreement with the Bank of Scotland to borrow £2 000 000 for a period of 5 years. The interest on the borrowings is payable half-yearly in arrears at the fixed interest rate of 10% p.a. with interest payments of £100 000 (i.e. £2 000 000 × 10% × ½ year) due on 31 March and 30 September each year. The functional currency of Run Down is A$. It has reporting periods ending on 31 December and 30 June. Applicable exchange rates during the financial period ending 30 June 2017 are as follows: 1 October 2016 31 December 2016 31 March 2017 30 June 2017

A$1 = £0.42 A$1 = £0.40 A$1 = £0.38 A$1 = £0.36

Required In accordance with AASB 121, prepare the entries of Run Down Ltd to record the borrowing transaction, the borrowing costs expense, the borrowings costs paid and the remeasurement of the borrowings at the end of the reporting period.

8.28

Solution Manual to accompany Company Accounting 10e

Journal entries

1.10.16

Cash

Non-current borrowings (Initial recognition and measurement of borrowings £2m  0.42) 31.12. 16

Foreign exchange loss Non-current borrowings (Subsequent measurement of borrowings £2m 0.40 – £2m  0.42)

Borrowing costs expense Interest payable (Recognition of interest payable £2m x ¼ year x 10%  0.40) 31.3.1 7

30.6.1 7

Interest payable Borrowing costs expense Cash (Cash payment of interest £2m x 1/2 year x 10%  0.38)

Foreign exchange loss Non-current borrowings (Subsequent measurement of borrowings £2m 0.36 – £2m  0.40)

Borrowing costs expense Interest payable (Recognition of interest payable £2m x ¼ year x 10%  0.36)

4 761 905 4 761

Cr 905

Dr Cr

238 09 5 238 09 5

Dr Cr

125 00 0 125 00 0

Dr Dr Cr

125 00 0 138 15 263 15

8 8 Dr Cr

555 55 555 55

6 6

Dr Cr

138 88 138 88

9 9

Additional explanations •

The carrying amount of the borrowings at 30 June 2017 is $5 555 556, that is £2m 0.36.

•

The recording of interest based on ½ year or ¼ year is a simplification as interest is usually determined on a daily basis. For example, interest payable at 30 June 2017 is more accurately calculated as $138 508, that is, £2m x 91/365 days x 10%  0.36.

8.29

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.6

Translation of purchase of plant, sale of inventory and interest free loan

Just Like Ltd is an Australian company. The functional currency of Just Like is A$. It has reporting periods ending on 31 December and 30 June. During the year ended 30 June 2017, Just Like entered into various foreign currency transactions in Euros (€) as follows: (a) On 15 November 2016 Just Like Ltd ordered plant costing €800 000 from an Italian company under a FOB destination contract. On 30 November 2016, the plant was delivered. On 25 January 2017, the invoice for the plant purchase was paid. (b) On 30 November 2016 Just Like Ltd sold inventory to a German customer for the agreed price of €500 000. The inventory had a cost of $350 000. On 31 January 2017, the sales invoice was paid by the customer. (c) On 1 July 2016, Just Like Ltd made an interest free loan to a related French company, Attitude Cavaliere, for €1 000 000. The term of the loan is set at 5 years at which time Attitude Cavaliere will be required to arrange its debt finances independently. Applicable exchange rates are as follows: 1 July 2016 15 November 2016 30 November 2016 31 December 2016 25 January 2017 31 January 2017 30 June 2017

€1 = A$1.22 €1 = A$1.15 €1 = A$1.25 €1 = A$1.20 €1 = A$1.18 €1 = A$1.16 €1 = A$1.30

Required In accordance with AASB 121, prepare the entries of Just Like Ltd for the half year to 31 December 2016 and the full year to 30 June 2016. (a) Purchase of plant from Italian supplier for €800 000

15 November 2016

31 December 2016

Date of purchase

Reporting date

Settlement date

Plant and Payable initially measured at spot rate

Re-measure Payable at closing rate

€800 000 x 1.15 = $920 000

€800 000 x 1.2 = $960 000

Re-measure Payable Record cash settlement at spot rate €800 000 x 1.18 = $944 000

Exchange loss $40 000

25 January 2017

Exchange gain $16 000

8.30

Solution Manual to accompany Company Accounting 10e

Journal entries 15.11. 16

31.12. 16

Plant Payable to supplier (Plant purchase €800 000 x 1.15)

Dr Cr

920 000

Foreign exchange loss Payable to supplier (Re-measurement of Payable €800 000 x 1.2 - €800 000 x 1.15)

Dr Cr

40 000

Dr Cr

16 000

Dr Cr

944 000

Payable to supplier Foreign exchange gain (Re-measurement of Payable €800 000 x 1.18 - €800 000 x

25.1.1 7

920 000

40 000

16 000

1.2) 944 000

Payable to supplier Cash (Cash payment €800 000 x 1.18)

8.31

Chapter 8: Foreign currency transactions and forward exchange contracts

(b) Sale of inventory to German customer for €500 000

30 November 2016

31 December 2016

Date of sale

Reporting date

Settlement date

Sale and Receivable recognised at spot rate

Re-measure Receivable at closing rate

€500 000 x 1.25 = $625 000

€500 000 x 1.20 = $600 000

Re-measure Receivable Record cash settlement at spot rate €500,000 x 1.16 = $580 000

Exchange loss $25 000

31 January 2017

Exchange loss A$20 000

Journal entries 30.11. 16

Accounts receivable Sales (Sale €500 000 x 1.25)

Dr Cr

Cost of sales Inventory

Dr Cr

625 00 625 00

0 0

350 00 350 00

0 0 31.12. 16

Foreign exchange loss Accounts receivable (Re-measurement of Receivable €500 000 x 1.2 - €500 000 x 1.25)

Foreign exchange loss Accounts receivable (Re-measurement of Receivable €500 000 x 1.16 - €500 000 x

31.1.1 7

Dr Cr 25 000 25 000

Dr Cr 20 000 20 000

1.2) Dr Cr Cash Accounts receivable (Cash receipt €500 000 x 1.16)

580 00 580 00

8.32

Solution Manual to accompany Company Accounting 10e

31 December 2016

30 June 2017

Date of loan transaction

Reporting date

Receivable initially measured at spot rate

Receivable re-measured at closing rate

€1 000 000 x 1.22 =$1 220 000

€1 000 000 x 1.20 = $1 200 000

€1 000 000 x 1.30 =$1 300 000

Exchange loss $20 000

Exchange gain $100 000

Journal entries 1.7.16

31.12. 16

Loan receivable Cash (Receivable €1 000 000 x 1.22)

Dr Cr

Foreign exchange loss Loan receivable (Re-measurement of Receivable €1 000 000 x 1.2 - €1 000 000 x 1.22)

Dr Cr

30.6.1

Loan receivable Foreign exchange gain (Re-measurement of Receivable €1 000 000 x 1.3 - €1 000 000 x

1 220 1 220

000 000

20 000 20 000

Dr Cr

100 00 100 00

0 0

1.2)

8.33

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.7

Translation of purchases of inventory on credit terms

You are the financial controller of Yummy Limited an Australian company listed on the ASX that distributes imported food products in the local market. The functional currency of Yummy Ltd is A$. Yummy Ltd’s purchases of inventory in foreign currency during the year ended 30 June 2017 are set out below. Exchange rates at delivery date, shipment date, the end of the reporting period and payment date are expressed to A$1. Supplier

Madras Curry Monster Foreign Currency Indian Rupee (IR) Invoice amount 3 000 000 Contract basis FOB Shipping Shipment date 20 Jul 2016 Delivery date 31 Jul 2016 Payment date 30 Sep 2016 Delivery date IR 10 Shipment date IR 12 End of the reporting IR 18 period Payment date IR 15

Thai Satay Saucy Thai Baht (THB) 900 000 FOB Destination 31 Jul 2016 30 Aug 2016 31 Oct 2016 THB 2 THB 3 THB 10

Russian Caviary Russian Rouble (RR) 40 000 000 FOB Shipping 1 Nov 2016 31 Dec 2016 31 Jan 2017 RR 1 000 RR 2 000 RR 1 800

Turkish Delightful Turkish Lire (TL) 80 000 000 FOB Shipping 31 Mar 2017 30 Apr 2017 31 Jul 2017 TL 10 000 TL 10 500 TL 10 750

German Sausagez Euros (€) 500 000 FOB Destination 30 Apr 2017 30 Jun 2017 31 Aug 2017 €0.80 €0.78 €0.70

THB 4

RR 500

TL 11 000

€0.75

Required In accordance with AASB 121, prepare the necessary entries in relation to the inventory purchase transactions up until and including 31 August 2017. YUMMY LIMITED FOB Shipping Ownership passes to purchaser upon goods being loaded onto shipping vessel, that is, the date of transaction is the shipping date. FOB Destination Ownership passes to purchaser upon goods being delivered to purchaser, that is, the date of transaction is the delivery date. Madras Curry Monster Journal entries

8.34

Solution Manual to accompany Company Accounting 10e

20.7.1

Inventory Accounts payable (Purchase IR3 000 000  12)

Dr Cr

250 000

Accounts payable Foreign exchange gain (Re-measurement of payable IR3 000 000  15 – IR3 000 000  12)

Dr Cr

50 000

Dr Cr

200 000

30.9.1 6

Accounts payable Cash (Cash payment IR3 000 000 

250 000

50 000

200 000

15)

Thai Satay Saucy Journal entries 30.8.1 6

31.10. 16

 4)

Inventory Accounts payable (Purchase THB900 000  2)

Dr Cr

450 000

Accounts payable Foreign exchange gain (Re-measurement of payable THB900 000  2 – THB900 000

Dr Cr

225 000

Dr Cr

225 000

Accounts payable Cash (Cash payment THB900 000  4)

450 000

225 000

8.35

Chapter 8: Foreign currency transactions and forward exchange contracts

Russian Caviary Journal entries 1.11.1 6

Inventory Accounts payable (Purchase RR40m  2 000)

Foreign exchange loss Accounts payable (Re-measurement of payable RR40m  500 – RR40m  2 000)

Dr Cr

20 000 20 000

60 000 60 000

31.1.1 7 Accounts payable Cash (Cash payment RR40m  500)

Dr Cr

80 000 80 000

Turkish Delightful Journal entries 31.3.1 7

30.6.1 7

31.7.1 7

Inventory Accounts payable (Purchase TL80m  10 500)

Dr Cr

7 619

Accounts Payable

Dr Cr

177

Dr Cr

169

Dr Cr

7 273

Foreign exchange gain (Re-measurement of payable TL80m  10 750 – TL80m  10 500)

Accounts payable Foreign exchange gain (Re-measurement of payable TL80m  11 000 – TL80m  10 750)

7 619

177

169

7 273

Accounts payable Cash (Cash payment TL80m  11 000)

8.36

Solution Manual to accompany Company Accounting 10e

German Sausagez Journal entries 30.6.1 7

31.8.1 7

Inventory Accounts payable (Purchase €500 000  0.80)

Dr Cr

625 000

Foreign exchange loss Accounts payable (Re-measurement of payable €500 000  0.75 – €500 000  0.80)

Dr Cr

41 667

Dr Cr

666 667

Accounts payable Cash (Cash payment €500 000  0.75)

625 000

41 667

666 667

8.37

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.8

Translation of sales of inventory on credit terms

You are the financial controller of Clare Valley Limited an Australian company listed on the ASX that sells premium Australian wines into overseas markets. Clare Valley’s sales of inventory in foreign currency during the year ended 30 June 2017 are set out below. Exchange rates at delivery date, shipment date, the end of the reporting period and payment date are expressed to A$1. Customer Foreign currency

Israel #3 Israeli Shekel (NIS) Invoice amount 1 500 000 Contract basis FOB Shipping Delivery date 30 Aug 2016 Shipment date 31 Jul 2016 Cash receipt date 31 Oct 2016 Delivery date NIS 1.5 Shipment date NIS 1.4 End of the reporting NIS 1.1 period Cash receipt date NIS 1.3

Dubai #6 Dubai Dirham (AED) 10 000 000 FOB Shipping 31 Oct 2016 30 Sep 2016 5 Feb 2017 AED 3.5 AED 4 AED 3.8

Turkey #4 Turkish Lire (TL) 10 000 000 000 FOB Destination 31 Jan 2017 30 Nov 2016 31 Mar 2017 TL 9 500 TL 9 000 TL 10 750

Egypt #8 Egyptian Dinar (ED) 250 000 000 FOB Destination 31 Mar 2017 28 Feb 2017 31 Jul 2017 ED 5 000 ED 5 500 ED 5 750

United States #9 US Dollar (US$) 1 000 000 FOB Shipping 30 Apr 2017 15 Apr 2017 31 Aug 2017 US$0.65 US$0.70 US$0.78

AED 4.2

TL 10 500

ED 6 000

US$0.76

Required In accordance with AASB 121, prepare the necessary entries in relation to the sale transactions up until and including 31 August 2017. CLARE VALLEY LIMITED FOB Shipping Ownership passes to customer upon goods being loaded onto shipping vessel, that is, the date of transaction is the shipping date. FOB Destination Ownership passes to customer upon goods being delivered to customer, that is, the date of transaction is the delivery date.

8.38

Solution Manual to accompany Company Accounting 10e

Customer # 3 in Israel Journal entries 31.7.1 6

31.10. 16

Accounts receivable Sales (Sale NIS1.5m  1.4)

Dr Cr

1 071 429

Accounts receivable Foreign exchange gain (Re-measurement of Receivable NIS1.5m  1.3 – NIS1.5m  1.4)

Dr Cr

82 417

Cash Accounts receivable (Cash receipt NIS1.5m  1.3)

Dr Cr

1 153 846

1071 429

82 417

1 153 846

Customer # 6 in Dubai Journal entries 30.9.1 6

Accounts receivable Sales (Sale AED10m  4)

Foreign exchange loss Accounts receivable (Re-measurement of Receivable AED10m  4.2 – AED10m  4)

Dr Cr

2 500 000 2 500 000

119 048 119 048

5.2.17 Cash Accounts receivable (Cash receipt AED10m  4.2)

Dr Cr

2 380 952 2 380 952

8.39

Chapter 8: Foreign currency transactions and forward exchange contracts

Customer # 4 in Turkey Journal entries 31.1.1 7

31.3.1 7

Accounts receivable Sales (Sale TL10bn  9 500)

Dr Cr

1 052 632

Foreign exchange loss Accounts receivable (Re-measurement of Receivable TL10bn  10 500 – TL10bn  9 500)

Dr Cr

100 251

Dr Cr

952 381

Cash Accounts receivable (Cash receipt TL10bn  10 500)

1 052 632

100 251

952 381

Customer # 8 in Egypt Journal entries 31.3.1 7

30.6.1 7

31.7.1 7

Accounts receivable Sales (Sale ED250m  5 000)

Dr Cr

50 000

Foreign exchange loss Accounts receivable (Re-measurement of Receivable ED250m  5 750 – ED250m  5 000)

Dr Cr

6 522

Dr Cr

1 811

Dr Cr

41 667

Foreign exchange loss Accounts receivable (Re-measurement of Receivable ED250m  6 000 – ED250m  5 750)

50 000

6 522

1 811

41 667

Cash Accounts receivable (Cash receipt ED250m  6 000)

8.40

Solution Manual to accompany Company Accounting 10e

Customer # 9 in United States Journal entries 15.4.1 7

30.6.1 7

31.8.1 7

Accounts receivable Sales (Sale $U.S.1m  0.70)

Dr Cr

1 428 571

Foreign exchange loss Accounts receivable (Re-measurement of Receivable $U.S.1m  0.78 – $U.S.1m  0.70)

Dr Cr

146 520

Dr Cr

33 738

Dr Cr

1 315 789

Accounts receivable Foreign exchange gain (Re-measurement of Receivable $U.S.1m  0.76 – $U.S.1m  0.78)

1 428 571

146 520

33 738

1 315 789

Cash Accounts receivable (Cash receipt $U.S.1m  0.76)

8.41

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.9

Translation of purchase of inventory paid in instalments and translation of borrowing hedged by forward contract

You are the finance director of the Australian listed company, Fire Would Ltd that has a functional currency in A$. Fire Would purchases goods from Hong Kong and has borrowings from a US bank. The company’s financial year ends on 30 June 2017. Fire Would entered the following transactions during the year. (a) Fire Would purchased inventories from a Hong Kong supplier for HK$2 700 000 on 15 April 2017. The purchase contract is settled in three equal instalments of HK$900 000. The following exchange rates apply. 15 April 2017 31 May 2017 30 June 2017 31 August 2017 30 September 2017

Date of purchase HK$2 700 000 1st payment of HK$900 000 End of the reporting period 2nd payment of HK$900 000 3rd payment of HK$900 000

A$1 = HK$5.99 A$1 = HK$6.01 A$1 = HK$6.21 A$1 = HK$6.18 A$1 = HK$6.24

(b) On 1 January 2017, Fire Would borrowed US$6 000 000 from an investment bank in the United States for a 12-month period. The borrowing has a fixed rate of interest at 10% p.a. payable at six monthly intervals. On 1 April 2017, Fire Would entered a nine month forward contract to buy US$5 000 000 in order to hedge against the foreign exchange risk on the US$ loan principal. The following exchange rates apply. Date

Spot Rate

1 January 2017 1 April 2017 30 June 2017 31 December 2017

A$1 = US$0.89 A$1 = US$0.86 A$1 = US$0.85 A$1 = US$0.80

Forward Rate 31/12/2017) A$1 = US$0.84 A$1 = US$0.82 A$1 = US$0.79 A$1 = US$0.80

(for

Required In accordance with AASB 121, prepare the entries of Fire Would to account for its foreign currency transactions. Assume a 0% discount rate for fair value calculations. (a) Purchase of inventory from Hong Kong supplier with three repayments

8.42

Solution Manual to accompany Company Accounting 10e

Journal entries Inventory Accounts payable (Purchase $HK2.7m  5.99)

Dr Cr

450 751

15.4.1

Dr Cr

1 500

Accounts payable Foreign exchange gain (Re-measurement of payable $HK2.7m  6.01 – $HK2.7m  5.99)

Dr Cr

149 750

Dr Cr

9 646

Dr Cr

1 407

Dr Cr

145 631

Accounts payable Cash nd (2 cash payment $HK0.9m  6.18)

Dr Cr

1 400

Accounts payable Foreign exchange gain (Re-measurement of payable $HK0.9m  6.24 – $HK0.9m  6.18)

Dr Cr

144 231

31.5.1

31.5.1 7

30.6.1 7

31.8.1 7

30.9.1 7

Accounts payable Cash (1st cash payment $HK0.9m  6.01) Accounts payable Foreign exchange gain (Re-measurement of payable $HK1.8m  6.21 – $HK1.8m  6.01) Foreign exchange loss Accounts payable (Re-measurement of payable $HK1.8m  6.18 – $HK1.8m  6.21)

450 751

1 500

149 750

9 646

1 407

145 631

1 400

144 231

Accounts payable Cash (3rd cash payment $HK0.9m  6.24)

Workings

Date 15/04/2017

HK$ Purchase

Exchange Rate (HK$) 5.99

Exchange Gain (Loss) -

Less Payment (A$) see table below -

Net Exchange Gain (Loss) -

8.43

Chapter 8: Foreign currency transactions and forward exchange contracts

2,700,000

450,751

31/05/2027

Remeasure

2,700,000

6.01

449,251

1,500

30/06/2017

Remeasure

1,800,000

6.21

289,855

159,396

149,750

31/08/2017

Remeasure

900,000

6.18

145,631

144,224

145,631

9,646 (1,407)

30/09/2017

Remeasure

6.24

check

145,631 -

144,231 439,612

1,400 11,139 450,751

Date

HK$

Exchange Rate (HK$)

Payment in A$

15/04/2017

Purchase

2,700,000

5.99

31/05/2027 30/06/2017

1st Pymt

900,000

6.01 6.21

149,750

31/08/2017

2nd Pymt

900,000

6.18

145,631

30/09/2017

3rd Pymt

900,000

6.24 Total Pymts

144,231 439,612

(b) Borrowings of $U.S.6 000 000 at interest of 10% p.a and forward contract to hedge principal repayment due Journal entries

8.44

Solution Manual to accompany Company Accounting 10e

1.1.17

Cash Borrowings (Initial borrowings $U.S.6m  0.89)

30.6.1 7

Foreign exchange loss Borrowings (Re-measurement of borrowings $U.S.6m  0.85 – $U.S.6m  0.89) 30.6.1

Borrowing costs expense Cash ($U.S.6m x 10% x 181/365  0.85)

Dr Cr

6 741 573

Dr Cr

317 251

Dr Cr

350 040

Dr Cr

231 553

Dr Cr

441 176

Dr Cr

7 500 000

Dr Cr

378 082

Dr Cr

79 114

Dr Cr

152 439

6 741 573

317 251

350 040

231 553

30.6.1 7

31.12.

Forward contract to buy $U.S.5m Gain on forward contract (Re-measurement of fwd contract $U.S.5m  0.79 – $U.S.5m  0.82)

31.12.

Foreign exchange loss Borrowings (Re-measurement of borrowings $U.S.6m  0.80 – $U.S.6m  0.85)

31.12. 17

Borrowings Cash (Borrowings repaid $U.S.6m  0.80) Borrowing costs expense Cash ($.U.S.6m x 10% x 184/365  0.80)

441 176

7 500 000

378 082

79 114

152 439

Loss on forward contract Forward contract to buy $U.S.5m (Re-measurement of fwd contract $U.S.5m  0.80 – $U.S.5m  0.79) Cash Forward contract to buy $U.S.5m (Settlement of fwd contract $U.S.5m  0.80 – $U.S.5m  0.82

8.45

Chapter 8: Foreign currency transactions and forward exchange contracts

In this case, the hedged item is a recognised liability therefore, it is a fair value hedge with gains and losses on the hedging instrument (the forward contract) recognised to profit or loss as incurred.

Workings

Date

Exchange Rate (US$)

US$

1/01/2017 1/04/2017

Borrowings Remeasure

6,000,000

0.89 0.86

6,741,573 -

30/06/2017

Remeasure

6,000,000

0.85

7,058,824

31/12/2017

Payment

6,000,000

0.80

7,500,000

check

Borrowing Costs

Exchange Gain (Loss) 317,250 441,176 758,427 758,427

30/06/2017

Interest

297,534

0.85

350,040

31/12/2017

Interest

302,466

0.80

378,082

1/04/2017

Contract Date

5,000,000

0.82

6,097,561

30/06/2017

Remeasure

5,000,000

0.79

6,329,114

31/12/2017

Remeasure

5,000,000

0.80

6,250,000

Forward contract

231,553 (79,114) 152,439

check

152,439

8.46

Solution Manual to accompany Company Accounting 10e

Question 8.10

Translation of purchase of inventory paid in instalments, translation of borrowing with hedged interest commitment, and translation of purchase of inventory with hedged liability to supplier

You are the finance director of Gripweed Ltd an Australian company listed on the ASX. The company is an importer of goods from overseas markets. The company’s financial year ends on 30 June 2017. The company entered the following transactions during the year. (a) Gripweed purchased inventories from a Hong Kong supplier for HK$300 000. The title to the goods passes to the company on delivery. The payment for the inventories is due in equal instalments. The following exchange rates are applicable: 22 April 2017 30 April 2017 31 May 2017 30 June 2017 31 July 2017

Date of order for inventory Date of delivery for inventory 1st payment of HK$100 000 2nd payment of HK$100 000 3rd payment of HK$100 000

A$1 = HK$8.00 A$1 = HK$8.50 A$1 = HK$8.56 A$1 = HK$8.59 A$1 = HK$8.94

(b) Gripweed purchased land in Japan on 1 July 2016for ¥50 000 000. The land is subsequently revalued on 30 June 2017 to its fair value of ¥80 000 000. The following exchange rates are applicable: 1 July 2016 30 June 2017

Date of acquisition of land Date of revaluation of land

A$1 = ¥160 A$1 = ¥245

(c) Gripweed arranged interest-only borrowings on 1 January 2017 for US$20 000 000. The borrowings have a ten-year term and interest is paid half-yearly at the rate of 7.6% p.a. Gripweed took out a six month forward exchange contract on 1 January 2017 as a hedge against the initial interest payment due. The following exchange rates are applicable: 1 January 2017 30 June 2017

Spot Rate A$1 = US$0.80 A$1 = US$0.65

Forward rate for 30/6/2017 A$1 = US$0.75 A$1 = US$0.65

(d) Gripweed purchases inventories on 1 May 2017 from an English supplier for £350 000. On the same date, Gripweed enters a three month forward exchange contract to buy £350 000 to hedge its liability to the supplier. On 31 July 2017, the supplier is paid and the forward contract is settled. The following exchange rates are applicable: 1 May 2017 30 June 2017 31 July 2017

Spot Rate A$1 = £0.67 A$1 = £0.55 A$1 = £0.40

Forward rate for 31/7/2017 A$1 = £0.65 A$1 = £0.50 A$1 = £0.40

(e) Assume the same facts as part (d) except that the date of the purchase of inventory is 31 July 2017 and at 1 May 2017 it is a highly probable forecast transaction.

8.47

Chapter 8: Foreign currency transactions and forward exchange contracts

Required In accordance with AASB 121, prepare the entries of Gripweed Ltd to account for its foreign currency transactions. Assume a 0% discount rate for fair value calculations. Explain the techniques applied in respect of each transaction. (a) Purchase of inventory from Hong Kong supplier with three repayments Journal entries 30/04/17

31/05/17

30/06/17

31/07/17

Inventory Accounts payable (Purchase HK$300 000/8.5)

Dr Cr

35 294

Accounts payable Foreign exchange gain (Payable re-measured HK$300 000/8.56 – HK$300 000/8.5)

Dr Cr

247

Accounts payable Cash (1st repayment HK$100 000/8.56)

Dr Cr

11 682

Accounts payable Foreign exchange gain (Payable re-measured HK$200 000/8.59 – HK$200 000/8.56)

Dr Cr

Accounts payable Cash (2nd repayment HK$100 000/8.59)

Dr Cr

11 641

Accounts payable Foreign exchange gain (Payable re-measured HK$100 000/8.94 – HK$100 000/8.59)

Dr Cr

456

Accounts payable Cash (3rd repayment HK$100 000/8.94)

Dr Cr

11 186

35 294

247

11 682

11 641

456

11 186

8.48

Solution Manual to accompany Company Accounting 10e

Workings

Date

Exchange Rate (HK$)

HK$

Exchange Gain (Loss)

Less Payment (A$) see table below

Net Exchange Gain (Loss)

30/04/2017

Purchase

300,000

8.50

35,294

31/05/2017

Remeasure

200,000

8.56

23,364

11,930

11,682

247

30/06/2017

Remeasure

100,000

8.59

11,641

11,723

11,641

31/07/2017

Remeasure

8.94

check

11,641 -

11,186 34,509

456 785 35,294

Date

HK$

Exchange Rate (HK$)

Payment in A$

30/04/2017

Purchase

300,000

8.00

31/05/2017

1st Pymt

100,000

8.56

11,682

30/06/2017

2nd Pymt

100,000

8.59

11,641

31/07/2017

3rd Pymt

100,000

8.94 Total Pymts

11,186 34,509

8.49

Chapter 8: Foreign currency transactions and forward exchange contracts

(b) Purchase of land in Japan subsequently revalued to fair value Journal entries 1.1.17

30.6.1 7

Land – at cost Cash (Land acquired ¥50m  160) Land – at fair value Land – at cost Gain on revaluation (OCI) (Land revalued to fair value ¥80m  245 – ¥50m  160

312 500 312 500

Dr Cr

326 531 312 500 14 031

The gain on revaluation includes a foreign exchange loss because the translated amount of the revaluation increment by itself is a gain of $122 449 (i.e. ¥30m  245)

8.50

Solution Manual to accompany Company Accounting 10e

Cash Borrowings (Initial borrowings $U.S.20m  0.80)

30.6.1 7

Foreign exchange loss Borrowings (Re-measurement of borrowings $U.S.20m  0.65 – $U.S.20m  0.80) 30.6.1

Borrowing costs expense Cash ($U.S.20m x 7.6% x 181/365  0.65)

Dr Cr

25 000 000

Dr Cr

5 769 231

Dr Cr

1 159 621

Dr Cr

154 616

Dr Cr

154 616

Dr Cr

154 616

25 000 000

5 769 231

1 159 621

154 616

30.6.1 7

Forward contract to buy $U.S. Gain to hedge reserve (OCI) (Contract fair value $U.S.753 753  0.65 - $U.S.753 753  0.75) Cash Forward contract to buy $U.S. (Settlement of contract $U.S.753 753  0.65 – $U.S.753 753  0.75)

154 616

Reclassification from reserve (OCI) Borrowing costs expense (Reclassification from cash flow hedge reserve to profit or loss)

In this case, the hedged item is the initial interest due on 30 June 2017 equal to $U.S.753 753 (i.e. $U.S.20m x 7.6% x 181/365 days), therefore it is a cash flow hedge. Gains or losses on the forward contract are recognised to other comprehensive income and a cash flow hedge reserve. When the borrowing costs expense is recognised the amount in the cash flow hedge reserve is reclassified to the profit or loss. The borrowing costs expense for the period net of the gain on the forward contract is $1 005 005 (i.e. $1 159 621 – 154 616), which is the same as the interest commitment at the forward rate on the inception of the contract (i.e. $U.S.753 753  0.75)

8.51

Chapter 8: Foreign currency transactions and forward exchange contracts

(d) Purchase of inventory from England and forward contract on same date Journal entries 1.5.17

30.6.1 7

31.7.1 7

Inventory Accounts payable (Purchase £350 000  0.67)

Dr Cr

522 388

Foreign exchange loss Accounts payable (Re-measurement of payable £350 000  0.55 – £350 000  0.67)

Dr Cr

113 976

Dr Cr

161 538

Dr Cr

238 636

Dr Cr

875 000

Dr Cr

175 000

Dr Cr

336 538

Forward contract to buy £’s Gain on forward contract (Re-measurement of fwd contract £350 000  0.50 – £350 000  0.65)

Foreign exchange loss Accounts payable (Re-measurement of payable £350 000  0.40 – £350 000  0.55) Accounts payable Cash

Forward contract to buy £’s Gain on forward contract (Re-measurement of fwd contract £350 000  0.40 – £350 000  0.50)

522 388

113 976

161 538

238 636

875 000

175 000

336 538

Cash Forward contract to buy £’s (Settlement of contract £350 000 0.40 – £350 000  0.65)

In this case, the hedged item is a recognised liability (i.e. accounts payable of £350 000 and there is a fair value hedge. Gains or losses on the fair value of the hedging instrument must be recognised to the profit or loss as incurred. The final amount paid to the English supplier is $875 000 however, the hedging instrument contributes cash of $336 538. The net cash outflow for the hedged item and hedging instrument is $538 462 (i.e. $875 000 – $336 538). Given a discount rate of 0%, the amount

8.52

Solution Manual to accompany Company Accounting 10e

paid for the recognised liability is effectively £350 000 at the forward rate of $A1 = £0.65. (e) Purchase of inventory from England and forward contract in anticipation Journal entries 1.5.17

30.6.1 7

31.7.1 7

No entry Forward contract to buy £’s Gain to hedge reserve (OCI) (Re-measurement of fwd contract £350 000  0.50 – £350 000  0.65) Forward contract to buy £’s Gain to hedge reserve (OCI) (Re-measurement of fwd contract £350 000  0.40 – £350 000  0.50) Inventory Transfer from hedge reserve Accounts payable (Payable £350 000  0.40 and transfer of gain from hedge reserve)

Dr Cr

161 538

Dr Cr

175 000

Dr Dr Cr

538 462 336 538

Dr Cr

336 538

161 538

175 000

875 000

336 538

Cash Forward contract to buy £’s (Settlement of contract £350 000 0.40 – £350 000  0.65)

In this case, the hedged item is a highly probable forecasted purchase of inventory transaction and there is a cash flow hedge. Gains or losses on the fair value of the hedging instrument must be recognised in other comprehensive income and the cash flow hedge reserve. When the forecasted purchase transaction occurs, the net amount of the gains or losses recognised to the cash flow hedge reserve are transferred out of the reserve and form part of the cost of the inventory recognised. The cost of the inventory is $538 642 after the gains on the hedging instrument. Given a discount rate of 0%, the cost of the inventory is effectively £350 000 at the forward rate of $A1 = £0.65.

8.53

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.11

Translation of sale of inventory with no hedge, fair value hedge and cash flow hedge

Cool World Ltd is an Australian mining company listed on the ASX. The company is an exporter of iron ore to overseas steel mills. The company’s functional currency is A$ and its financial year ends on 30 June 2017. The company entered various sale transactions during the year. Assume a discount rate of 0% for fair value calculations. Relevant exchange rates are as follows: Spot Rate A$1 = US$0.78 A$1 = US$0.76 A$1 = US$0.78 A$1 = US$0.80

1April 2017 1 June 2017 30 June 2017 31 July 2017

Forward rate for 31/7/2017 A$1 = US$0.75 A$1 = US$0.72 A$1 = US$0.74 A$1 = US$0.80

(a) On 1 April 2017, Cool World sold iron ore to a Japanese customer for US$1 250 000. On 31 July 2017, the customer paid for the iron ore. (b) On 1 June 2017, Cool World sold iron ore to a Chinese customer for US$2 250 000. On 31 July 2017, the customer paid for the iron ore. On 1 June 2017, the company entered into a forward exchange contract to sell US$2 250 000, which it designated as a hedge of the customer account. (c) On 1 June 2017, Cool World sold iron ore to a Korean customer for US$3 500 000. On 31 July 2017, the customer paid for the iron ore. On 1 April 2017, in anticipation of a highly probable transaction with its Korean customer, Cool World entered into a forward exchange contract to sell US$3 500 000 as hedging instrument. The forward contract has a settlement date of 31 July 2017. Required In accordance with AASB 121, prepare the entries of Cool World Ltd to account for its foreign currency transactions. Assume a 0% discount rate for fair value calculations. (a) Japanese customer 1 April 2017

30 June 2017

Date of sale Initial recognition of receivable $U.S.1.25m  0.78 = $1 602 564

Reporting date Restate receivable $U.S.1.25m  0.78 = $1 602 564

Exchange loss on debtor nil

31 July 2017 Settlement date Restate receivable &cash receipt $U.S.1.25m  0.80 = $1 562 500

Exchange loss on debtor $40 064

Journal entries

8.54

Solution Manual to accompany Company Accounting 10e

1.4.17

Accounts receivable Sales

30.6.1 7

Dr Cr

1 602 564 1 602 564

Foreign exchange gain/loss is NIL Spot rate is same

Dr Dr Cr

40 064 1 562 500 1 602 564

31.7.1 7

Foreign exchange loss Cash Accounts receivable

Cool World makes a realised exchange loss of $40 064 from date of sale to date of cash receipt.

8.55

Chapter 8: Foreign currency transactions and forward exchange contracts

(b) Chinese Customer 1 June 2017

30 June 2017

Date of sale Initial recognition of receivable $U.S.2.25m  0.76 = $2 960 526

Reporting date Restate receivable $U.S.2.25m  0.78 = $2 884 615

Exchange loss on debtor $75 911 Fwd contract to sell $U.S. Right $U.S.2 25m  0.72 = $3 125 000 Obligation $U.S.2.25m  0.72 = $3 125 000 Fair value = $0

31 July 2017 Settlement date Restate receivable &cash receipt $U.S.2.25m  0.80 = $2 812 500

Exchange loss on debtor $72 115

Fwd contract to sell $U.S. Right $U.S.2 25m  0.72 = $3 125 000 Obligation $U.S.2.25m  0.74 = $3 040 541 Fair value = $84 459

Gain on fwd contract $84 459

Fwd contract to sell $U.S. Right $U.S.2 25m  0.72 = $3 125 000 Obligation $U.S.2.25m  0.80 = $2 812 500 Fair value = 312 500

Gain on fwd contract $228 041

Journal entries 1.6.17

Accounts receivable Sales

Dr Cr

2 960 526

Foreign exchange loss Accounts receivable

Dr Cr

75 911

Forward contract to sell $U.S Gain on forward contract

Dr Cr

84 459

30.6.1

Dr Dr Cr

72 115 2 812 500

31.7.1

Foreign exchange loss Cash Accounts receivable

Cash Gain on forward contract Forward contract to sell $U.S

Dr Cr Cr

312 500

30.6.1 7

2 960 526

75 911

84 459

2 884 615

228 041 84 459

31.7.1 7

Cool World’s fair value hedge ensures that $3 125 000 is collected after the date of sale.

8.56

Solution Manual to accompany Company Accounting 10e

30 June 2017

Date of sale Initial recognition of receivable $U.S.3.5m  0.76 = $4 605 263

Reporting date Restate receivable $U.S.3.5m  0.78 = $4 487 179

Exchange loss on debtor $118 084 Fwd contract to sell $U.S. Right $U.S.3.5m  0.75 = $4 666 667 Obligation $U.S.3.5m  0.72 = $4 861 111 Fair value = ($194 444)

31 July 2017 Settlement date Restate receivable &cash receipt $U.S.3.5m  0.80 = $4 375 000

Exchange loss on debtor $112 179

Fwd contract to sell $U.S. Right $U.S.3.5m  0.75 = $4 666 667 Obligation $U.S.3.5m  0.74 = $4 729 730 Fair value = ($63 063)

Gain on fwd contract $131 381

Fwd contract to sell $U.S. Right $U.S.3.5m  0.75 = $4 666 667 Obligation $U.S.3.5m  0.80 = $4 375 000 Fair value = $291 667

Gain on fwd contract $354 730

Journal entries 1.6.17

Loss to hedge reserve (OCI) Forward contract to sell $U.S.

1.6.17 Accounts receivable Reclassification from reserve

Dr Cr

194 444

Dr Cr Cr

4 605 263

Dr Cr

118 084

Dr Cr

131 318

Dr Cr Cr

112 179 4 375 000

Dr Dr Cr

291 667 63 063

194 444

194 444 4 410 819

(OCI)

Sales 30.6.1 7

118 084

Foreign exchange loss Accounts receivable 30.6.1

31.7.1 7

131 318

Forward contract to sell $U.S Gain on forward contract

Foreign exchange loss Cash Accounts receivable

Cash Forward contract to sell $U.S Gain on forward contract

4 487 179

354 730

8.57

Chapter 8: Foreign currency transactions and forward exchange contracts

Question 8.12

Translation of hedged firm commitment, hedged highly probable forecast transaction, hedged recognised liability and borrowings and interest attributable to a qualifying asset.

Aloha Ltd is an Australian company that purchases inventory and specialised equipment from US suppliers. The company’s functional currency is A$ and its financial year ends on 30 June 2017. The company entered various transactions denominated in US$ during the year. Assume a discount rate of 0% for fair value calculations. Relevant exchange rates are as follows:

1 January 2017 1 March 2017 1 May 2017 30 June 2017 31 August 2017

Spot Rate A$1 = US$0.90 A$1 = US$0.84 A$1 = US$0.80 A$1 = US$0.75 A$1 = US$0.82

Forward rate for 31/8/2017 A$1 = US$0.88 A$1 = US$0.81 A$1 = US$0.78 A$1 = US$0.72 A$1 = US$0.82

(a) On 1 March 2017, Aloha entered into a firm commitment with a US company to build a new equipment item for US$1 800 000. On 31 August 2017, the item of equipment is delivered and installed and recognised as an asset in Aloha’s accounting records. On 1 March 2017, Aloha entered a six month forward contract to buy US$1 800 000 for settlement on 31 August 2017. The forward contract is designated as a hedging instrument for an unrecognised firm commitment. (b) On 31 August 2017, Aloha acquired inventory, as normal around this time of year, from a US supplier for US$5 000 000. On 1 January 2017, Aloha entered an eight month forward contract to buy US$5 000 000 for settlement on 31 August 2017. The forward contract is designated as a hedging instrument for a highly probable forecast inventory purchase transaction. (c) On 1 May 2017, Aloha acquired inventory from a US supplier for US$500 000. The invoice is paid in full on 31 August 2017. On 1 May 2017, Omega Ltd entered a four month forward exchange contract to buy US$500 000 for settlement on 31 August 2017. The forward contract is designated as a hedging instrument for a recognised liability. (d) On 1 January 2017 Aloha commenced the construction of an item of specialised plant. The estimated construction period for the plant is 18 months. On 1 January 2017, Aloha borrowed US$18 000 000 to finance the construction of the plant. The interest on the borrowings is 10% interest p.a. paid at the end of each year. The average exchange rate for the period 1 January 2017 to 30 June 2017 is A$1.00 = US$0.825. (a) Hedge of firm commitment Journal entries

8.58

Solution Manual to accompany Company Accounting 10e

1.3.17

30.6.1 7

No entries

Forward contract to buy $U.S. Gain on forward contract (Forward contract $U.S.1.8m  0.72 – $U.S.1.8m  0.81)

Dr Cr

277 778

Loss on firm commitment Firm commitment to buy

Dr Cr

277 778

Dr Cr

304 878

Dr Cr

27 100

Dr Cr

304 878

Dr Cr Cr

2 222 222

30.6.1 7

277 778

asset

(Firm commitment $U.S.1.8m  0.72 – $U.S.1.8m  0.81)

31.8.1 7

Loss on forward contract Forward contract to buy $U.S (Forward contract $U.S.1.8m  0.82 – $U.S.1.8m  0.72)

Forward contract to buy $U.S. Cash (Settlement of contract $U.S.1.8m  0.82 – $U.S.1.8m  0.81)

Firm commitment to buy asset Gain on firm commitment (Firm commitment $U.S.1.8m  0.82 – $U.S.1.8m  0.72)

Equipment Firm commitment to buy

304 878

27 100

304 878

27 100 2 195 122

asset 31.8.1

Payable to supplier

Equipment cost of $U.S.1.8m at the forward rate of 0.81 is $2 222 222

8.59

Chapter 8: Foreign currency transactions and forward exchange contracts

(b) Hedge of highly probable forecasted inventory purchase Journal entries 1.1.17

30.6.1 7

31.8.1 7

No entry

Forward contract to buy $U.S. Gain to hedge reserve (OCI) (Re-measurement of fwd contract $U.S.5m  0.72 – $U.S.5m  0.88)

Dr Cr

1 262 626

Loss to hedge reserve (OCI) Forward contract to buy $U.S. (Re-measurement of fwd contract $U.S.5m  0.82 – $U.S.5m  0.72)

Dr Cr

846 883

Dr Dr Cr

5 681 818 415 743

Dr Cr

415 743

Inventory Transfer from hedge reserve Accounts payable (Payable $U.S.5m  0.82 and transfer or net gain from hedge reserve)

1 262 626

846 883

6 097 561

415 743

Cash Forward contract to buy $U.S. (Settlement of contract $U.S.5m 0.82 – $U.S.5m  0.88)

Inventory of $U.S.5m at the forward rate of 0.88 is $5 681 818

8.60

Solution Manual to accompany Company Accounting 10e

30.6.1 7

31.8.1 7

Inventory Accounts payable (Purchase $U.S.0.5m  0.80)

Dr Cr

625 000

Foreign exchange loss Accounts payable (Re-measure payable $U.S.0.5m  0.75 – $U.S.0.5m  0.80)

Dr Cr

41 667

Forward contract to buy $U.S. Gain on forward contract (Re-measure fwd contract $U.S.0.5m  0.72 – $U.S.0.5m  0.78)

Dr Cr

53 419

Accounts payable Foreign exchange gain Cash (Re-measure payable settlement at $U.S.0.5m  0.82)

Dr Cr Cr

666 667

625 000

41 667

53 419

56 911 609 756

and

Loss on forward contract Forward contract to buy $U.S. Cash (Re-measure and settle fwd contract $U.S.0.5m 0.82 – $U.S.0.5m  0.78)

84 688 53 419 31 269

Cash payment made to supplier for inventory purchase of $U.S.0.5m at the forward rate of 0.78 is $641 025

8.61

Chapter 8: Foreign currency transactions and forward exchange contracts

(d) Borrowings for qualifying asset Journal entries 1.1.17

30.6.1 7

Cash Borrowings (Initial measurement borrowings $U.S.18m  0.90)

Dr Cr

20 000 000

Foreign exchange loss Borrowings (Re-measure borrowings $U.S.18m  0.75 – $U.S.18m  0.90)

Dr Cr

4 000 000

Plant under construction Interest payable (Borrowing costs accrued and capitalised $U.S.18m x 10% x 181/365 day  0.75)

Dr Cr

1 190 137

20 000 000

4 000 000

1 190 137

Interest expense of $U.S.18m x 10% x 181/365 day is $U.S.892 603 Interest payable of $U.S.892 603 at the closing rate of 0.75 is $1 190 137 Interest expense of $U.S.892 603 at the average rate of 0.825 is $1 081 943 The difference between interest expense and interest payable is the foreign exchange loss on interest equal to $108 194. Both the interest expense and the foreign exchange loss on interest are capitalised into the cost of the qualifying asset.

8.62

Solution Manual to accompany Company Accounting 10e

Chapter 9 - Property, plant and equipment REVIEW QUESTIONS 1.

What assets constitute property, plant and equipment? Para 6 of AASB 116 defines PPE as follows: Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period.

What are the recognition criteria for property, plant and equipment? Para 7 of AASB 116 contains the following recognition criteria: The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if: (a) it is probable that future economic benefits associated with the item will flow to the entity; and (b) the cost of the item can be measured reliably.

How should items of property, plant and equipment be measured at point of initial recognition, and would gifts be treated differently from acquisitions? Para 15 of AASB 116 requires the initial measurement to be at cost. The measurement rule applies regardless of how the entity obtains the asset. A gift has a zero cost.

How is cost determined? Para 16 states: The cost of an item of property, plant and equipment comprises: (a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates. (b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. (c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when

9.1

Chapter 9: Property, plant and equipment

the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. 5.

What choices of measurement model exist subsequent to assets being initially recognised? Para 29 of AASB 116 states: An entity shall choose either the cost model in paragraph 30 or the revaluation model in paragraph 31 as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.1

What factors should entities consider in choosing alternative measurement models? Relevance of information provided: generally current information is preferred to past information. Reliability of the information: cost measures are generally more reliable than valuation measures. Cost of providing the information: Adoption of the valuation model entails costs of valuation and audit.

What is meant by ‘depreciation expense’? Para 6 of AASB 116 defines depreciation as: Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life

How is useful life determined? Para 6 of AASB 116 states: Useful life is: (a) the period over which an asset is expected to be available for use by an entity; or (b) the number of production or similar units expected to be obtained from the asset by an entity Paras 56-57 state:

9.2

Solution Manual to accompany Company Accounting 10e

56.

The future economic benefits embodied in an asset are consumed by an entity principally through its use. However, other factors, such as technical or commercial obsolescence and wear and tear while an asset remains idle, often result in the diminution of the economic benefits that might have been obtained from the asset. Consequently, all the following factors are considered in determining the useful life of an asset: (a) expected usage of the asset. Usage is assessed by reference to the asset's expected capacity or physical output. (b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle. (c) technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. (d) legal or similar limits on the use of the asset, such as the expiry dates of related leases.

57.

The useful life of an asset is defined in terms of the asset's expected utility to the entity. The asset management policy of the entity may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets.

What is meant by ‘residual value’ of an asset? Para 6 of AASB 116 states: The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

10.

How does an entity choose between depreciation methods, for example, straightline versus reducing-balance models? Para 60 of AASB 116 states: The depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity. Choice is based on which method best reflects the pattern of benefits expected to be consumed by a specific asset given its use in a specific entity.

9.3

Chapter 9: Property, plant and equipment

11.

What is meant by ‘components depreciation’?

Note paras 43-47 of AASB 116: 43.

Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.

44.

An entity allocates the amount initially recognised in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part. For example, it may be appropriate to depreciate separately the airframe and engines of an aircraft, whether owned or subject to a finance lease.

45.

A significant part of an item of property, plant and equipment may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item. Such parts may be grouped in determining the depreciation charge.

46.

To the extent that an entity depreciates separately some parts of an item of property, plant and equipment, it also depreciates separately the remainder of the item. The remainder consists of the parts of the item that are individually not significant. If an entity has varying expectations for these parts, approximation techniques may be necessary to depreciate the remainder in a manner that faithfully represents the consumption pattern and/or useful life of its parts.

47.

An entity may choose to depreciate separately the parts of an item that do not have a cost that is significant in relation to the total cost of the item.

Components depreciation means breaking an asset down into its component parts for separate depreciation of those parts.

12.

Under the revaluation model, how is a revaluation increase accounted for? Para 39 of AASB 116 states: If an asset's carrying amount is increased as a result of a revaluation, the increase shall be recognized in other comprehensive income and accumulated equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss.

13.

Under the revaluation model, how is a revaluation decrease accounted for? Para 40 of AASB 116 states: If an asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognized in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus.

9.4

Solution Manual to accompany Company Accounting 10e

14.

When, and why, must tax-effect be considered in accounting for revaluation increases and decreases? Para 42 of AASB 116 states: The effects of taxes on income, if any, resulting from the revaluation of property, plant and equipment are recognised and disclosed in accordance with AASB 112 Income Taxes. Tax-effects are accounting at the point of revaluation only when there is an effect on the asset revaluation surplus. This is because of the recognition of equity at that point. Where revaluation decrements occur, any tax-effect is calculated at the end of the period when the balance day adjustment for tax is determined.

15.

Should accounting for revaluation increases and decreases be done on an asset-byasset basis or on a class-of-assets basis? Paras 36-38 of AASB 116 state:

16.

36.

If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued.

37.

A class of property, plant and equipment is a grouping of assets of a similar nature and use in an entity's operations. The following are examples of separate classes: (a) land; (b) land and buildings; (c) machinery; (d) ships; (e) aircraft; (f) motor vehicles; (g) furniture and fixtures; and (h) office equipment.

38.

The items within a class of property, plant and equipment are revalued simultaneously to avoid selective revaluation of assets and the reporting of amounts in the financial statements that are a mixture of costs and values as at different dates. However, a class of assets may be revalued on a rolling basis provided revaluation of the class of assets is completed within a short period and provided the revaluations are kept up to date.

What differences occur between asset-by-asset or class-of-asset bases in accounting for revaluation increases and decreases? Using an asset-by asset basis means that decrements affect the profit or loss for the period while increments are taken directly to equity.

9.5

Chapter 9: Property, plant and equipment

With a class basis, by netting off increments and decrements within a class, there will be a net effect, affecting either profit or loss or equity depending on whether decrements are greater than or less than increments.

17.

When should property, plant and equipment be derecognised? Para 67 of AASB 116 states: The carrying amount of an item of property, plant and equipment shall be derecognised: (a) on disposal; or (b) when no future economic benefits are expected from its use or disposal.

9.6

Solution Manual to accompany Company Accounting 10e

CASE STUDY QUESTIONS Case study 1

Fair value basis for measurement

The management of Ransom Ltd has decided to use the fair value basis for the measurement of its equipment. Some of this equipment is very hard to obtain and has in fact increased in value over the current period. Management is arguing that, as there has been no decline in fair value, no depreciation should be charged on these pieces of equipment. Discuss. Para 50 of AASB 116 notes that depreciation is a process of allocation. Depreciation is not a change in value. Depreciation is measuring the change in value due to the use of an asset over the period, and not changes in value due to other factors such as changes in customer tastes. The consumption of benefits is considered to be separate from changes in the fair value of an asset. Consider the example [in section 7.5.1 of the text] used by the Accounting Standards Board in the UK in its 1996 Discussion Paper concerning the drop in value of a new car during its first year.

Case study 2

Straight-line vs diminishing balance depreciation

Silence Ltd uses tractors as a part of its operating equipment, and it applies the straight-line depreciation method to depreciate these assets. Silence Ltd has just taken over Lambs Ltd, which uses similar tractors in its operations. However, Lambs Ltd has been using a diminishing balance method of depreciation for these tractors. The accountant in Silence Ltd is arguing that for both entities the same depreciation method should be used for tractors. Provide arguments for and against this proposal. The arguments for and against must be based on the pattern in which the assets’ future economic benefits are expected to be consumed by the entities. If both entities use the assets such that the pattern of consumption of benefits is the same, then the same depreciation method should be used. If the entities use the tractors in ways such that the pattern of consumption of benefits is different then different methods of depreciation can be used. The method chosen must be applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits.

Case study 3

Annual depreciation charge

A company is in the movie rental business. Movies are generally kept for 2 years and then either sold or destroyed. However, management wants to show increased profits, and believes that the annual depreciation charge can be lowered by keeping the movies for 3 years. Discuss.

9.7

Chapter 9: Property, plant and equipment

Changing the number of years does not necessarily change the annual depreciation charge. If after 2 years the movies are worth nothing – hence they are normally destroyed at this point – then to keep the movies for another year simply means that there is no depreciation charge in the 3rd year as all the benefits have been received by the end of the 2nd year and there are none received in the third year. If the movies could be still rented in a 3rd period, again there may be no change in the depreciation in the first two years. The depreciation charge is also a function of the residual value of the asset. Consider the following case: Scenario 1: Movie cost $30 and has a residual value at the end of year 2 of $15. Assuming equal benefits over the 2 years [unlikely], the annual depreciation charge is $7.50. Scenario 2: Movie cost $30 and has a residual value at end of year 3 of $5. Assuming equal benefits [very unlikely], the annual depreciation charge is $8.33.

Case study 4

Decline in value of assets

A new accountant has been appointed to the firm of Simpsons Ltd, which owns a large number of depreciable assets. Upon analysing the entity’s depreciation policy, the accountant has implemented a new policy based on the principle that the depreciation rate for particular assets should measure the decline in the value of the assets. Discuss this policy change. It could be argued that there are 2 concepts of depreciation, namely: -

a process of allocation, and a change in the value of an asset.

There are at least 3 variables that cause a change in value of an asset over the period: -

a reduction in value due to the use of the asset over the period, an increase/decrease in the value due to a change in the general price level, a change in the specific price level for this type of asset

Where depreciation is calculated as an allocation of the cost of the asset, what is being measured is variable (1) above. If depreciation is measured as a change in the value of an asset, the depreciation charge is a mixture of all the above variables. AASB 116 para. 6 describes depreciation as a systematic allocation, hence adopting the process of allocation approach. Hence if the accountant wants to adopt accounting policies that are compliant with international accounting standards, then he/she will need to change the depreciation policy to one of allocation rather than change in value. To discuss the differences in approach, consider the example [in section 7.5.1 of the text] used by the Accounting Standards Board in the UK in its 1996 Discussion Paper concerning the drop in value of a new car during its first year.

9.8

Solution Manual to accompany Company Accounting 10e

Case study 5

Depreciation charges

A new accountant has been appointed to Outlander Ltd and has implemented major changes in the calculation of depreciation. As a result, some parts of the factory have much larger depreciation charges. This has incensed some operations managers who believe that, as they take particular care with the maintenance of their machines, their machines should not attract large depreciation charges that reduce the profitability of their operations and reflect badly on their management skills. The operations managers plan to meet the accountant and ask for change. How should the new accountant respond? The determination of the depreciation charge relies on the consideration of a large number of factors such as useful life, residual value, and consumption of benefits. Some parts of the factory may have: -

assets with high initial costs low residual values high patterns of use on initial acquisition

These parts of the factory will attract high depreciation charges. However, careful maintenance may lead to: -

higher residual values longer useful lives

The depreciation charge per annum can then be reduced. Good management will not judge performance on factors outside the control of the employees. Cost savings may be a better measure of performance than profitability.

Case study 6

Depreciation charges

The management of Predator Ltd has been analysing the financial reports provided by the accountant, who has been with the firm for a number of years. Management has expressed its concern over depreciation charges being made in relation to the company’s equipment. In particular, it believes that the depreciation charges are not high enough in relation to the factory machines because new technology applied in that area is rapidly making the machines obsolete. Management’s concern is that the machines will have to be replaced in the near future and, with the low depreciation charges, the fund will not be sufficient to pay for the replacement machines. Discuss. Two key mistakes are being made by management: (i) (ii)

the depreciation charge relates to the replacement cost of the asset, and charging depreciation results in the creation of a fund for the replacement of assets.

Re (i): depreciation is an allocation of the depreciable amount of an asset. The depreciable amount is the cost or other amount substitute for cost. Under AASB 116, there are two measurement models available namely the cost model and the revaluation model. Under the

9.9

Chapter 9: Property, plant and equipment

revaluation model, an asset can be carried at fair value. Neither of these models result in a depreciation charge that measures the replacement cost of the asset. However, note para. 33 of AASB 116: where there is no market-based evidence of fair value, an entity may use, as an estimate of fair value, a depreciated replacement cost approach. AASB 116 does not give any information as to how this method works, for example whether it is based on the replacement cost of a similar asset or the replacement cost of a new asset. Given that replacement cost is used as an estimate of fair value, it is more likely that a replacement cost of used assets would be used. Again, the depreciation charge is not related to the cost of new replacement assets. Re (ii):Depreciation is a book entry. It does not reflect cash flows. There are no monies deposited in a sinking fund to replace the assets being depreciated. Even if the entity creates an asset replacement reserve as an appropriation of retained earnings, there is no cash fund as this is also a book entry.

Case study 7

Building costs

Tourist Ltd has acquired a new building. Which of the following items should be included in the cost of the building? (a) Stamp duty (b) Real estate agent’s fees (c) Architect’s fees for drawings for internal adjustments to the building to be made before use (d) Interest on the bank loan to acquire the building, and an application fee to the bank to get the loan, which is secured on the building (e) Cost of changing the name on the building (f) Cost of changing the parking bays (g) Cost of refurbishing the lobby to the building to attract customers and make it more user friendly See paragraph 16 of AASB 116 Include: (a) stamp duty (b) real estate agent’s fees (c) architect’s fees (d) interest [ may be expensed or capitalised – see AASB Borrowing Costs] (e) costs of changing name on building (g) costs of refurbishing lobby Exclude: (f) these may be considered as a separate asset, depends for example whether the parking bays are an integral part of the building or external to the building

9.10

Solution Manual to accompany Company Accounting 10e

Case study 8

Capitalisation

Transporter Ltd has acquired a new machine, which it has had installed in its factory. Which of the following items should be capitalised into the cost of the building? (a) Labour and travel costs for managers to inspect possible new machines and for negotiating for a new machine (b) Freight costs and insurance to get the new machine to the factory (c) Costs for renovating a section of the factory, in anticipation of the new machine’s arrival, to ensure that all the other parts of the factory will have easy access to the new machine (d) Cost of cooling equipment to assist in the efficient operation of the new machine (e) Costs of repairing the factory door, which was damaged by the installation of the new machine (f) Training costs of workers who will use the machine See paragraph 16 of AASB 116. Include: (a) labour and travel costs (b) freight costs (c) costs of renovating (d) cost of cooling equipment Exclude: (e) costs of repair – these are not directly attributable to bringing the asset to its location & condition for operation. These costs should be expensed. (f) training costs – these benefits cannot be controlled

Case study 9

Expensing of costs

Blitz Ltd has acquired a new building for $500 000. It has incurred incidental costs of $10 000 in the acquisition process for legal fees, real estate agent’s fees and stamp duties. Management believes that these costs should be expensed because they have not increased the value of the building and, if the building was immediately resold, these amounts would not be recouped. In other words, the fair value of the building is considered to still be $500 000. Discuss how these costs should be accounted for. According to para 16 of AASB 116, the cost of an asset includes any directly attributable costs. The $10 000 incidental costs should therefore be include in the cost of the asset. The cost is then $510 000. Paragraph 15 of AASB 116 requires an asset to be recognised initially at cost – in this case $510 000. If the asset is subsequently measured under the cost model: Whether or not the asset should be written down depends on whether the asset is impaired. Paragraph 63 of AASB 116 requires an entity to apply AASB 136 Impairment of Assets. If the asset is a part of a cash generating unit, and the recoverable amount of the CGU is greater than the carrying amount of the assets of the CGU then the building will not be written down.

9.11

Chapter 9: Property, plant and equipment

If the asset is subsequently measured under the revaluation model: As the fair value is only $500 000, a revaluation decrement would be determined and an expense recognised.

9.12

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 9.1

Initial recognition of an asset

Miami Ltd recently acquired a second-hand machine for installation in its factory. The machine was acquired from Vice Ltd, with Miami Ltd giving a block of land plus $5 000 cash in exchange for the machine. The land had been acquired by Miami Ltd for $200 000 three years ago, but was considered to have a fair value of $300 000 at the date of exchange. The machine had a carrying amount in the records of Vice Ltd of $310 000 at this date. Miami Ltd planned to use the machine in its main factory. The installation of the machine would require that it be cemented into the factory floor in order to achieve sufficient stability for the machine to operate. The cost is expected to be $550. However, when the machine is replaced in three years’ time, the costs of removal of the machine are expected to be $250. As the operation of the machine requires some technical knowledge, current staff will need to be trained for its use. As it has supplied the machine, Vice Ltd has agreed to supply training at a cost of $250. Required The accountant of Miami Ltd is unsure of how to account for the acquisition of the machine and has asked for your advice. Prepare a report providing detailed advice to the accountant. 1. The appropriate accounting standard to apply is AASB 116 Property, Plant and Equipment as the machine meets the definition of property, plant and equipment. 2. Under AASB116, the machine must initially be measured at cost. 3. Cost is defined as having 3 components, purchase price, directly attributable costs and dismantling costs. 4. Purchase price is based on the fair value of what is given up by the acquirer. In this case, the purchase price is the fair value of the land plus the cash, namely $305 000. 5. Costs directly attributable to the acquisition and necessary to get the machine into the condition and location for management to use the machine can be capitalised into the cost of the machine. In this case, the $550 cost for the cementing of the machine into the factory floor meets this criterion, but the training of the staff does not. 6. The dismantling costs can only be capitalised if there is an obligation at the time of acquisition of the asset for such dismantling. Such an obligation does not exist in this case. Therefore the dismantling costs on replacement of the machine cannot be capitalised into the cost of the machine. 7. The machine must initially be recognised at a cost of $305 550.

9.13

Chapter 9: Property, plant and equipment

Question 9.2

Application of revaluation model

At 1 July 2014, Twister Ltd acquired the following non-current assets: Equipment Vehicles

$100 000 80 000

They are in different classes of non-current assets and are to be measured at fair value. The expected useful lives of vehicles and equipment are 5 years and 10 years, respectively. At 30 June 2015, the fair values of both assets were assessed. The equipment had a fair value of $82 000, and the vehicles, $70 000. The remaining useful lives were assessed to be 8 years for equipment and 7 years for vehicles. At 30 June 2016, the fair value of equipment was assessed to be $81 750 and the fair value of vehicles was $55 000. Required Prepare the journal entries for Twister Ltd for the years ending 30 June 2015 and 2016. Twister Ltd General Journal 30 June 2015 Depreciation expense – equipment Dr Accumulated depreciation – equipment Cr (Depreciation – $100 000 / 10 years)

10 000 10 000

Accumulated depreciation - equipment Dr 10 000 Equipment Cr (Write down of equipment to carrying amount: $90 000)

Expense- write-down of equipment Dr Equipment Cr (Revaluation from carrying amount to fair value: $90 000 to $82 000)

8 000

Depreciation expense – vehicles Accumulated depreciation – vehicles (Depreciation – 20% x $80 000)

Dr Cr

16 000

Accumulated depreciation – vehicles Dr Vehicles Cr (Write-down to carrying amount: $64 000)

16 000

Vehicles Dr Gain on revaluation of vehicles (OCI) Cr (Revaluation increment: $64 000 to $70 000)

6 000

Income tax expense (OCI)

1 800

10 000

8 000

16 000

6 000

9.14

Solution Manual to accompany Company Accounting 10e

Deferred tax liability (Tax effect of revaluation increment)

1 800

Gain on revaluation of vehicles (OCI) Dr Income tax expense (OCI) Cr Asset revaluation surplus - vehicles Cr (Accumulation of net revaluation gain in equity)

6 000 1 800 4 200

30 June 2016 Depreciation Expense – Equipment Dr Accumulated depreciation – Equipment Cr (Depreciation – $82 000 / 8years)

10 250

Accumulated depreciation - Equipment Dr Equipment Cr (Write down from previous FV $82 000 to carrying amount $71 750)

10 250

Equipment Dr 10 000 Gain on revaluation of equipment (P/L) Cr Gain on revaluation of equipment (OCI) Cr (Revaluation of equipment from $71 750 to $81 750, with prior revaluation write-down of $8 000) Income tax expense (OCI) Deferred tax liability (Tax effect of revaluation gain)

Dr Cr

600

Gain on revaluation of equipment (OCI) Dr Income tax expense (OCI) Cr Asset revaluation surplus Cr (Accumulation of revaluation gain in equity)

2 000

Depreciation expense – vehicles Accumulated Depreciation – vehicles (Being depreciation – $70 000 / 7 years)

Dr Cr

10 000

Accumulated depreciation – vehicles Dr Vehicles Cr (Write down of vehicles to carrying amount of $60 000)

10 000

Loss on revaluation of vehicles (OCI) Dr Vehicles Cr (Write down to fair value: $60 000 to $55 000)

5 000

Deferred tax liability Income tax expense (OCI) (Tax effect of write down to fair value)

1 500

8 000 2 000

600

600 1 400

10 000

Dr Cr

10 000

5 000

1 500

9.15

Chapter 9: Property, plant and equipment

Asset revaluation surplus Income tax expense (OCI) Loss on revaluation of vehicles (OCI) (Reduction in accumulated equity due to revaluation decrement on vehicles)

Dr Dr Cr

3 500 1 500 5 000

9.16

Solution Manual to accompany Company Accounting 10e

Question 9.3

Initial recognition of an asset, depreciation

Mongol Trading operates in a very competitive field. To maintain its market position, it purchased two new machines for cash on 1 January 2016. It previously rented machines. Machine A cost $40 000, and machine B cost $100 000. Each machine was expected to have a useful life of 10 years, and residual values were estimated at $2000 for machine A and $5000 for machine B. Due to technological advances, Mongol Trading decided to replace machine A. It traded in machine A on 31 March 2018 for machine C, which cost $64 000. A trade-in of $28 000 was allowed for machine A, and the balance of machine C’s cost was paid in cash. Machine C was expected to have a useful life of 8 years and a residual value of $8000. On 2 July 2018, extensive repairs were carried out on machine B at a cash cost of $66 000. Mongol Trading expected these repairs to extend machine B’s useful life by 4 years and to increase machine B’s estimated residual value to $13 450. Machine B was eventually sold for cash on 1 April 2020 for $115 000. Mongol Trading uses the straight-line depreciation method, recording depreciation to the nearest month. The end of the reporting period is 30 June. Required Prepare general journal entries to record the above transactions and depreciation journal entries required at the end of each reporting period up to and including 30 June 2020. 1. GENERAL JOURNAL ENTRIES 01/01/16 Machinery Cash (Machines A & B purchased) 30/06/16

30/06/17

31/03/18

Dr Cr

140 000

Depreciation - machinery Dr Accumulated depreciation - machinery Cr (Depreciation at year end: [A: (40 000–2 000)/10 x ½ = 1 900] [B: (100 000-5 000)/10 x ½ = 4 750]

6 650

Depreciation - machinery Dr Accumulated depreciation - machinery Cr (Depreciation at year end: [A: (40 000–2 000)/10 = 3 800] [B: (100 000-5 000)/10 = 9 500])

13 300

Depreciation - Machinery Dr Accumulated Depreciation - Machinery Cr (Depreciation up to point of sale: A: (40 000–2 000)/10 x 9/12)

2 850

Accumulated depreciation – machinery (1900 + 3800 + 2850) Carrying amount of machinery sold (40 000 – 8 550) Machinery

140 000

6 650

13 300

2 850

8 550

Dr Cr

31 450

40 000

9.17

Chapter 9: Property, plant and equipment

(De-recognition of asset sold - Machine A) 31/03/18

30/06/18

02/07/18

Machinery Dr Proceeds – Machine A Cr Cash Cr (Purchase of Machine C and trade-in of Machine A)

64 000

Depreciation - Machinery Dr Accumulated Depreciation - Machinery Cr (Depreciation at year end: [B: 9 500] + [C: (64 000-8 000)/8 x 3/12 = 1 750])

11 250

Machinery Cash (Cost of extensive repairs on machine B)

66 000

Cost of Machine B Depreciation up to repair date Residual value Depreciable amount Useful life remaining Depreciation p.a.

30/06/19

01/04/20

30/06/20

= = = = = = = = = = =

Dr Cr

28 000 36 000

11 250

66 000

100 000 + 66 000 166 000 4 750 + 9500 +9500 23 750 13 450 166 000 – 23 750 – 13 450 128 800 10 – 2.5 + 4 11.5 years 128 800/11.5 11 200

Depreciation – machinery Dr Accumulated depreciation - machinery Cr Depreciation at year end: (C: (64 000–8 000)/8 = 7 000) (B: 128 800/11.5 = 11 200)

18 200

Depreciation - machinery Dr Accumulated depreciation - machinery Cr (Depreciation up to point of sale: B: 11 200 x 9/12)

8 400

Cash Proceeds – sale of machine B (Sale of machine B)

18 200

8 400

Dr Cr

115 000

Accumulated depreciation – machinery (23 750 + 11 200 + 8 400) Carrying amount of machinery sold Machinery (De-recognition of Machine B on sale)

Dr Dr Cr

43 350 122 650

Depreciation - machinery

7 000

115 000

166 000

9.18

Solution Manual to accompany Company Accounting 10e

Accumulated depreciation - machinery Cr (Depreciation at year end: machine C)

7 000

9.19

Chapter 9: Property, plant and equipment

Question 9.4

Revaluation of assets

On 30 June 2016, the statement of financial position of Miss Congeniality Ltd showed the following non-current assets after charging depreciation: Building Accumulated Depreciation Motor Vehicle Accumulated Depreciation

300 000 (100 000)

$200 00 0

120 000 (40 000)

80 000

The company has adopted fair value for the valuation of non-current assets. This has resulted in the recognition in previous periods of an asset revaluation surplus for the building of $14 000. On 30 June 2016, an independent valuer assessed the fair value of the building to be $160 000 and the vehicle to be $90 000. The income tax rate is 30%. Required A. Prepare any necessary entries to revalue the building and the vehicle as at 30 June 2016. B. Assume that the building and vehicle had remaining useful lives of 25 years and 4 years respectively, with zero residual value. Prepare entries to record depreciation expense for the year ended 30 June 2017 using the straight-line method. A. *NOTE: there is an amount of $14 000 in the asset revaluation surplus (ARS) account for building from previous periods. This would have been recognised from net revaluation gains to the building and can therefore be decreased with any revaluation losses on building before those losses are required to be recognised directly in the P&L. The amount in the ARS account is net of tax. Therefore, the full amount of previous revaluation gains for the buildings would have been $20 000 ($14 000 / 0.7). The tax amount would be recognised in the Deferred Tax Liability account for $6 000. 30 June 2016 Accumulated depreciation – Building Building (Writing down to carrying amount)

Dr Cr

100 000

Loss on revaluation of building (P&L) Dr Loss on revaluation of building (OCI) Dr Building Cr (Revaluation downwards of building - *Note)

20 000 20 000

Deferred tax liability Income tax expense (OCI) (Tax-effect of revaluation decrement on previously revalued asset - *Note)

Dr Cr

6 000

Asset revaluation surplus - Building Dr Income tax expense (OCI) Dr Loss on revaluation of building (OCI) Cr

14 000 6 000

100 000

40 000

6 000

20 000

9.20

Solution Manual to accompany Company Accounting 10e

(Reduction in accumulated equity due to revaluation decrement on building - *Note) Accumulated depreciation – Vehicle Vehicle (Writing down to carrying amount)

Dr Cr

40 000

Vehicle Dr Gain on revaluation of vehicle (OCI) Cr (Revaluation to fair value)

10 000

Income tax expense (OCI) Deferred tax liability (Tax-effect of revaluation increment)

Dr Cr

3 000

Gain on revaluation of vehicle (OCI) Income tax expense (OCI) Asset revaluation surplus - vehicle

Dr Cr Cr

10 000

B. 30 June 2017 Depreciation expense – Building Dr Accumulated depreciation – Building Cr ($160 000/25) Depreciation expense – Vehicle Dr Accumulated depreciation – Vehicle Cr ($90 000/ 4)

40 000

10 000

3 000

3 000 7 000

6 400 6 400

22 500

9.21

Chapter 9: Property, plant and equipment

Question 9.5

Revaluation of assets

In the 30 June 2016 annual report of Payback Ltd, the equipment was reported as follows: Equipment (at cost) Accumulated Depreciation

500 000 (150 000) 350 000

The equipment consisted of two machines, Machine A and Machine B. Machine A had cost $300 000 and had a carrying amount of $180 000 at 30 June 2016, and Machine B had cost $200 000 and was carried at $170 000. Both machines are measured using the cost model, and depreciated on a straight-line basis over a 10-year period. On 31 December 2016, the directors of Payback Ltd decided to change the basis of measuring the equipment from the cost model to the revaluation model. Machine A was revalued to $180 000 with an expected useful life of 6 years, and Machine B was revalued to $155 000 with an expected useful life of 5 years. At 30 June 2017, Machine A was assessed to have a fair value of $163 000 with an expected useful life of 5 years, and Machine B’s fair value was $136 500 with an expected useful life of 4 years. The tax rate is 30%. Required A. Prepare the journal entries during the period 1 July 2016 to 30 June 2017 in relation to the equipment. B. According to accounting standards, on what basis may management change the method of asset measurement, for example from cost to fair value? PAYBACK LTD 31 December 2016 – Change from cost model to revaluation model Depreciation expense – Machine A Accumulated depreciation (1/2 x 10% x $300 000)

Dr Cr

15 000

Depreciation expense – Machine B Accumulated depreciation (1/2 x 10% x $200 000)

Dr Cr

10 000

Machine A

Machine B

Cost Accum depn Fair value Increment

300 000 135 000 165 000 180 000 15 000

Accumulated depreciation – Machine A Machine A

15 000

10 000

Cost Accum depn

200 000 40 000 160 000 155 000 5 000

Fair value Decrement Dr Cr

135 000 135 000 9.22

Solution Manual to accompany Company Accounting 10e

(Writing the asset down to carrying amount) Machine A Gain on revaluation of machinery (OCI) (Revaluation of asset)

Dr Cr

15 000

Dr Cr

4 500

Gain on revaluation of machinery (OCI) Dr Income tax expense (OCI) Cr Asset revaluation surplus – Machine A Cr (Accumulation of net revaluation gain in equity)

15 000

Accumulated depreciation – Machine B Machine B (Writing the asset down to carrying amount)

Dr Cr

40 000

Loss – revaluation decrement (P/L) Machine B (Revaluation of machine from $200 000 to $155 000)

Dr Cr

5 000

Income tax expense – gain on revaluation of asset (OCI) Deferred tax liability (Tax-effect of revaluation)

15 000

4 500

4 500 10 500

40 000

5 000

30 June 2017 Depreciation expense – Machine A Accumulated depreciation (1/6 x ½ x $180 000)

Dr Cr

15 000

Depreciation expense – Machine B Accumulated depreciation (1/5 x ½ x $155 000)

Dr Cr

15 500

Machine A Carrying amount Fair value Decrement

Machine B Carrying amount Fair value Decrement

$ 139 500 136 500 3 000

Accumulated depreciation – Machine A Machine A (Writing down to carrying amount)

Dr Cr

15 000 15 000

Loss on revaluation of machinery (OCI) Machine A (Revaluation downwards)

Dr Cr

2 000

$ 165 000 163 000 2 000

15 000

15 500

2 000

9.23

Chapter 9: Property, plant and equipment

Deferred tax liability Dr Income tax expense (OCI) Cr (Tax-effect of revaluation decrement on asset previously revalued upwards)

600

Asset revaluation surplus – Machine A Dr Income tax expense (OCI) Dr Loss on revaluation of machinery (OCI) Cr (Reduction in accumulated equity due to revaluation decrement)

1 400 600

Accumulated depreciation – Machine B Machine B (Writing down to carrying amount)

Dr Cr

15 500

Loss – revaluation decrement Machine B (Writing down to fair value)

Dr Cr

3 000

600

2 000

15 500

3 000

B: Basis for change in accounting policy Refer to AASB 8 paragraph 9. Discuss the cost basis method and the fair value method in relation to the relevance and reliability of information. Current information is generally more relevant than past information. Determination of cost is generally more reliable than determination of fair value. Discuss the trade-off between relevance and reliability, that is, as information becomes less reliable it also loses its relevance. A fair value measure may, because of its timeliness, be more relevant but if the measure becomes more unreliable, the relevance of the information decreases.

9.24

Solution Manual to accompany Company Accounting 10e

Question 9.6 Acquisition of assets, depreciation and change to revaluation model Robert Niro commenced operations on 30 March 2012 in the rubbish and recycling industry, trading as Midnight Run Services Ltd. The end of the reporting period is 31 December, and the company depreciates all depreciable assets using the straight-line method. The following events occurred during 2015 and 2016: 2015 April

June

Aug. Dec.

31 31

2016 March 13 Aug. 01

Dec.

Paid $140 000 cash for a second-hand truck (Truck A). Robert estimated the truck’s useful life and residual value at 5 years and $20 000. Paid $1500 cash to recondition Truck A’s engine. Paid $32 000 cash for equipment. Robert estimated the equipment’s useful life and residual value at 10 years and $1500. Paid $600 cash for Truck A’s transmission repairs and oil change. Recorded depreciation on Truck A and equipment.

Paid $290 cash to replace a damaged bumper bar on Truck A. Traded in Truck A for a new truck (Truck B) that cost $240 000. The dealer granted a trade-in allowance of $90 000 on the Truck A, and the balance was paid in cash. Robert estimated Truck B’s useful life and residual value at 7 years and $30 000. Recorded depreciation on Truck B and the equipment. Robert decided to change the basis of measuring equipment to the revaluation model. He assessed the equipment’s fair value at 31 December 2016 at $29 000.

Required Prepare general journal entries to record the above events. MIDNIGHT RUN SERVICES 01/04/15 Truck A Cash (Acquisition of Truck A)

Dr Cr

140 000

Dr Cr

1 500

30/06/15 Equipment Cash

Dr Cr

32 000

31/08/15 Repairs & maintenance expense

600

Truck A Cash (Reconditioning of Truck A’s engine)

140 000

1 500

32 000

9.25

Chapter 9: Property, plant and equipment

Cash (Repairs and maintenance on Truck A) 31/12/15 Depreciation – Truck A Accumulated depreciation – Truck A (Depreciation of Truck A: 9/12 x 1/5[141 500 – 20 000)

600

Dr Cr

18 225

Dr Cr

1 525

Dr Cr

290

Dr Cr

14 175

Dr Dr Cr

32 400 109 100

Dr Proceeds on sale of Truck A Cr Cash Cr (Acquisition of Truck B and trade-in of Truck A)

240 000

Depreciation – equipment Accumulated depreciation – equipment (Depreciation of equipment: 6/12 x 1/10[32 000 – 1 500) 13/03/16 Repairs & maintenance expense Cash 01/08/16 Depreciation – Truck A Accumulated depreciation – Truck A (Depreciation for year to date of sale: 7/12 x 1/5[141 500 – 20000]) 01/08/16 Accumulated depreciation – Truck A (18 225 + 14 175) Carrying amount on sale – Truck A Truck A (Carrying amount of asset sold) 01/08/16 Truck B

31/12/16 Depreciation – Truck B Accumulated depreciation – Truck B (Depreciation of Truck B: 5/12 x 1/7[240 000 – 30 000]) Depreciation – equipment Accumulated depreciation – equipment (Depreciation of equipment: 1/10[32 000 – 1 500)

18 225

1 525

290

14 175

141 500

90 000 150 000

Dr Cr

12 500

Dr Cr

3 050

12,500

3 050

31/12/16 Accumulated depreciation – equipment

9.26

Solution Manual to accompany Company Accounting 10e

(1 525 + 3 050) Equipment (Write down to carrying amount of $27 425)

Dr Cr

4 575

Equipment Gain on revaluation of equipment (OCI) (Recognition of revaluation increment: 27 425 to 29 000)

Dr Cr

1 575

Income tax expense (OCI) Dr Deferred tax liability Cr (Tax-effect of revaluation of equipment: 30% x 1575)

473

Gain on revaluation of equipment (OCI) Dr Income tax expense (OCI) Cr Asset revaluation surplus Cr (Accumulation of revaluation surplus in equity)

1 575

4 575

1 575

473

473 1 102

9.27

Chapter 9: Property, plant and equipment

Question 9.7

Depreciation calculation

On 1 July 2016, Salt Airlines Ltd acquired a new aeroplane for a total cost of $10 million. A breakdown of the costs to build the aeroplane was given by the manufacturers as follows: Aircraft body Engines (2) Fitting out of aircraft: Seats Carpets Electrical equipment — passenger seats — cockpit Food preparation equipment

3 000 000 4 000 000 1 000 000 50 000 200 000 1 500 000 250 000

All costs include installation and labour costs associated with the relevant part. It is expected that the aircraft will be kept for 10 years and then sold. The main value of the aircraft at that stage is the body and the engines. The expected selling price is $2.1 million, with the body and engines retaining proportionate value. Costs in relation to the aircraft over the next 10 years are expected to be as follows: • Aircraft body. This requires an inspection every 2 years for cracks and wear and tear, at a cost of $10 000. • Engines. Each engine has an expected life of 4 years before being sold for scrap. It is expected that the engines will be replaced in 2020 for $4.5 million and again in 2024 for $6 million. These engines are expected to incur annual maintenance costs of $300 000. The manufacturer has informed Salt Airlines Ltd that a new prototype engine with an extra 10% capacity should be on the market in 2022, and that existing engines could be upgraded at a cost of $1 million. • Fittings. Seats are replaced every 3 years. Expected replacement costs are $1.2 million in 2019 and $1.5 million in 2025. The repair of torn seats and faulty mechanisms is expected to cost $100 000 p.a. Carpets are replaced every 5 years. They will be replaced in 2021 at an expected cost of $65 000, but will not be replaced again before the aircraft is sold in 2026. Cleaning costs amount to $10 000 p.a. The electrical equipment (such as the TV) for each seat has an annual repair cost of $15 000. It is expected that, with the improvements in technology, the equipment will be totally replaced in 2022 by substantially better equipment at a cost of $350 000. The electrical equipment in the cockpit is tested frequently at an expected annual cost of $250 000. Major upgrades to the equipment are expected every 2 years at expected costs of $250 000 (in 2015), $300 000 (in 2017), $345 000 (in 2019) and $410 000 (in 2024). The upgrades will take into effect the expected changes in technology. • Food preparation equipment. This incurs annual costs for repair and maintenance of $20 000. The equipment is expected to be totally replaced in 2022. Required A. Discuss how the costs relating to the aircraft should be accounted for. B. Determine the expenses recognised for the 2016–17 financial year.

A. Discuss:

9.28

Solution Manual to accompany Company Accounting 10e

- the advantages of a components approach versus a simple depreciation of the $10 million dollars over the 10-year period. - the treatment of the upgrades of cockpit equipment - accounting for inspections

B: Expenses for the 2016-17 year: Aircraft body: Annual expense of $5 000 ($10 000 / 2years) for inspection for cracks Depreciation expense = 1/10 (3 000 000 – 3/7 x $2 100 000) = $210 000 It is explained that the main value of the aircraft is the body ($3m) and engines ($4m), a total of $7m. These two components are expected to retain their proportionate values for when the aircraft is sold in 10 years’ time for $2.1m Therefore, the depreciable amount for the aircraft body is adjusted by its proportionate residual value. That is, $3m/$7m x $2.1m selling price. Engines: Depreciation expense = 4 000 000/4 = $1 000 000 Maintenance expense = $300 000 The depreciation calculation does not take into account the proportionate value of the engines compared to the aircraft body. Why? The aircraft body is kept until it is expected to be sold in 10 years’ time, whereas the engines are replaced every 4 years. Fittings Seats: Depreciation = 1/3 x $1 000 000 = $333 333 Annual expense = $100 000 Carpets: Depreciation = 1/5 x 50 000 = $10 000 Cleaning = $10 000 Electrical: Passenger Annual expense = $15 000 Depreciation = 1/6 x $200 000 = $33 333 (expected to be replaced in 2020 – 6 years from date of purchase) Electrical: Cockpit Annual expense = $250 000 Depreciation = 1/10 x $1 500 000 = $150 000 Food preparation equipment: Annual expense = $20 000 Depreciation = 250 000/6 = $41 667

9.29

Chapter 9: Property, plant and equipment

Total other expenses = $ 700 000 Annual depreciation = $1 778 333

9.30

Solution Manual to accompany Company Accounting 10e

Question 9.8

Depreciation

Max Ltd was formed on 1 July 2014 to provide delivery services for packages to be taken between the city and the airport. On this date, the company acquired a delivery truck from Payne Trucks. The company paid cash of $50 000 to Payne Trucks, which included government charges of $600 and registration of $400. Insurance costs for the first year amounted to $1200. The truck is expected to have a useful life of 5 years. At the end of the useful life, the asset is expected to be sold for $24 000, with costs relating to the sale amounting to $400. The company went extremely well in its first year, and the management of Max Ltd decided at 1 July 2015 to add another vehicle, a flat-top, to the fleet. This vehicle was acquired from a liquidation auction at a cash price of $30 000. The vehicle needed some repairs for the elimination of rust (cost $2300), major servicing to the engine (cost $480) and the replacement of all tyres (cost $620). The company believed it would use the flattop for another 2 years and then sell it. Expected selling price was $15 000, with selling costs estimated to be $400. On 1 July 2015, both vehicles were fitted out with a radio communication system at a cost per vehicle of $300. This was not expected to have any material effect on the future selling price of either vehicle. Insurance costs for the 2015– 16 period were $1200 for the first vehicle and $900 for the newly acquired vehicle. All went well for the company except that, on 1 August 2016, the flat-top that had been acquired at auction broke down. Max Ltd thought about acquiring a new vehicle to replace this one but, after considering the costs, decided to repair the flat-top instead. The vehicle was given a major overhaul at a cost of $6500. Although this was a major expense, management believed that the company would keep the vehicle for another 2 years. The estimated selling price in 3 years’ time is $12 000, with selling costs estimated at $300. Insurance costs for the 2016–17 period were the same as for the previous year. Required Prepare the journal entries for the recording of the vehicles and the depreciation of the vehicles for each of the 3 years. The financial year ends on 30 June. MAX LTD 2014 1/7

2015 30/6

Vehicles Cash (Acquisition of delivery truck)

Dr Cr

50 000

Insurance expense Cash (Truck insurance)

Dr Cr

1 200

Depreciation expense - Vehicles Accumulated depreciation (Annual depreciation: 1/5 x $50 000 - $23 600)

Dr Cr

5 280

50 000

1 200

5 280

9.31

Chapter 9: Property, plant and equipment

1/7

2016 30/6

1/7

1/8

Vehicles Cash (Acquisition of flat-top truck)

Dr Cr

30 000

Vehicles Cash (Amounts paid on flat-top truck: $2 300 + $620)

Dr Cr

2 920

Servicing expense Cash (Service of flat-top truck)

Dr Cr

480

Vehicles Cash (Installation of radios to trucks)

Dr Cr

600

Insurance expense Cash (Insurance on trucks)

Dr Cr

2 100

Depreciation expense - Vehicles Dr Accumulated depreciation Cr (Depreciation of vehicles: 1/5 ($50 000 - $23 600) + ¼ x $300= $5 355 ½ ($32 920 + $300 – $14 600 = $9 310

14 665

Insurance expense Cash (Insurance on trucks)

Dr Cr

2 100

Depreciation expense – Vehicles Accumulated depreciation (Depreciation on flat-top: 1/12 x ½ ($32 920 + $300 - $14 600)

Dr Cr

776

Accumulated depreciation – Vehicles Dr Vehicles Cr (Write-down of flat-top truck to carrying amount: $9 310 + $776)

10 086

30 000

2 920

480

600

2 100

14 665

2 100

776

10 086

9.32

Solution Manual to accompany Company Accounting 10e

Vehicles Cash (Overhaul of flat-top truck)

Dr Cr

6 500 6 500

2017 30/6

Depreciation expense – Vehicles Dr 5 480 Accumulated depreciation Cr 5 480 (Depreciation on vehicles: delivery truck: $5 355 as per previous year flat-top truck: 11/12[1/3 ($32 920 + $300 - $9 310 - $776 +$ 6 500 – ($12 000 - $300)] = $5 480)

9.33

Chapter 9: Property, plant and equipment

Question 9.9

Depreciation

Sting Ltd constructed a building for use by the administration section of the company. The completion date was 1 July 2010, and the construction cost was $840 000. The company expected to remain in the building for the next 20 years, at which time the building would probably have no real salvage value and have to be demolished. It is expected that demolition costs will amount to $15 000. In December 2016, following some severe weather in the city, the roof of the administration building was considered to be in poor shape so the company decided to replace it. On 1 July 2017, a new roof was installed at a cost of $220 000. The new roof was of a different material to the old roof, which was estimated to have cost only $140 000 in the original construction, although at the time of construction it was thought that the roof would last for the 20 years that the company expected to use the building. Because the company had spent the money replacing the roof, it thought that it would delay construction of a new building, thereby extending the original life of the building from 20 years to 25 years. Required Discuss how you would account for the depreciation of the building and how the replacement of the roof would affect the depreciation calculations. If the roof were treated as a separate component of the building: Roof: depreciation p.a. = $140 000 x 1/20 = $7 000 Rest of building: depreciation p.a. = $700 000 x 1/20 = $35 000 At 1 July 2017, the roof would have been depreciated to $91 000 (being $140,000 less 7 x $7 000). This would then be written off on replacement of the roof. The new roof would be depreciated at $12 222, being 1/18 x $220,000 p.a. (18 years depn = 207+5) Further, the rest of the building would have a carrying amount of $455 000, being $700 000 less 7 x $35 000. Depreciation p.a. for the next 18 years would be $25 278. Total depreciation is then $37 500. If the roof were not treated as a separate component: Depreciation p.a. = 1/20 x $840 000 = $42 000 At 1 July 2017, the building would have been depreciated to a carrying amount of $546 000, being $840 000 – 7 x $42 000. On replacement of the roof, the total depreciable cost is $766 000, being $546 000 + $220 000. Depreciation p.a. for the next 18 years is $42 556.

9.34

Solution Manual to accompany Company Accounting 10e

Question 9.10

Acquisition, disposal and depreciation of non-current assets

Avatar Bricklaying Ltd commenced trading on 1 July 2015. On 8 July 2015, a brickcutting machine was purchased for $3500, payable in two equal instalments due on 1 August and 1 October 2015. Transport costs of $120 were paid in cash to deliver the machine to Avatar Bricklaying Ltd’s premises. Machinery is depreciated at 20% p.a. on the diminishing balance. On 25 September 2015, the business purchased a second-hand truck, Truck X, for $26 000. Stamp duty amounted to $700. The truck dealer also fitted four new tyres at a cost of $1200 and spray painted the business logo onto the truck doors at a cost of $500. All amounts were paid in cash. The truck was expected to have a useful life of 3 years and a residual value of $5000. On 1 March 2017, major repairs were carried out on the brick-cutting machine, which affected its productive capacity at a cost of $1820, paid in cash. Avatar Bricklaying Ltd made no change to the depreciation rate. On 23 April 2017, Truck X was traded in on a new truck, Truck Y, costing $56 000. An amount of $17 000 was allowed for the trade-in of Truck X and the balance paid in cash. Truck Y was expected to have a useful life of 7 years and a residual value of $7000. Avatar Bricklaying Ltd depreciates trucks using the straight-line method and records depreciation to the nearest month. The end of the reporting period is 30 June. On 30 June 2017, the business changed the basis of measuring trucks to the revaluation model. The fair value of Truck Y at that date was $58 000. Required A. Prepare general journal entries (round all amounts to the nearest dollar) to record the above transactions and to record depreciation necessary for the years ended 30 June 2016 and 2017. B. Justify the value you recognised as the cost of the second-hand truck, Truck X, purchased on 25 September 2015 by reference to the requirements of AASB 116. C. Assume that on 30 June 2018 the carrying amount of the truck was $49 500 and its fair value was $46 000. Prepare the general journal entry/entries to revalue the truck to fair value on that date in accordance with the requirements of AASB 116.

General journal entries

08/07/15

01/08/15

25/09/15

Machinery (3500 + 120) Payable Cash (Acquisition of brick-cutting machine, including transport costs)

Dr Cr Cr

3 620

Payable Cash (Payment of instalment of machine)

Dr Cr

1 750

Truck X

28 400

3 500 120

1 750

9.35

Chapter 9: Property, plant and equipment

01/10/15

30/06/16

Cash (Acquisition of Truck X: 26 000 + 700 + 1200 + 500)

28 400

Payable Cash (Payment of 2nd instalment on machine)

Dr Cr

1 750

Depreciation – machinery Dr Accumulated depreciation – machinery Cr (Depreciation of machinery: 20% x 3620)

724

1 750

724

Depreciation – Truck X Dr 5 850 Accumulated depreciation – Truck X Cr (Depreciation of Truck X: 9/12 x 1/3[28 400 – 5 000]) 01/03/17

Depreciation – machinery Dr Accumulated depreciation – machinery Cr (Depreciation of machinery up to date of major repairs: 8/12 x 20% x 2 896. CA = 2 510 = 3 620 – 724 - 386) Machinery Cash (Repairs on machinery: Revised CA = 2 510 + 1 820 = 4 330)

23/04/17

386

1,820

Depreciation – Truck X Dr Accumulated depreciation – Truck X Cr (Depreciation of Truck X up to time of trade-in: 10/12 x 1/3[28 400 – 5000]

6 500

Truck Y Proceeds on sale of Truck X Cash (Acquisition of Truck Y) 30/06/17

386

Dr Cr

Accumulated depreciation – Truck X (5 850 + 6 500) Carrying amount of Truck X on sale Truck X (De-recognition of Truck X on sale)

Depreciation – Truck Y Accumulated depreciation – Truck Y (Depreciation of Truck Y:

1,820

6 500

Dr Dr Cr

12 350 16 050

Dr Cr Cr

56 000

Depreciation – machinery Dr Accumulated depreciation – machinery Cr (Depreciation of machinery: 4/12 x 20% x 4330) Dr Cr

5 850

28 400

17 000 39 000

289 289

1 167 1 167

9.36

Solution Manual to accompany Company Accounting 10e

2/12 x 1/7[56 000 – 7 000 CA = 54 833) Truck Y Dr Gain on revaluation of Truck Y (OCI) Cr (Revaluation of Truck Y from 54 833 to 58 000)

3 167 3 167

Income tax expense (OCI) Deferred tax liability (Tax effect of revaluation gain on truck) 30% x 3 167)

Dr Cr

950

Gain on revaluation of Truck Y (OCI) Income tax expense (OCI) Asset revaluation surplus

Dr Cr Cr

3 167

950

950 2 217

Justify the value recognised as the truck cost on 25/09/15

AASB 116 requires items of property, plant and equipment that quality for recognition as an asset to be recognised at their cost. Cost is defined as the amount of cash paid or the fair value of other consideration given to acquire an asset at the time of its acquisition. This includes its purchase price and any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. In the case of the truck the purchase price was $26 000 and attributable costs included the stamp duty, new tyres and sign writing (total of $2 400). All these costs were necessary to get the truck into the location and condition that was required for management to use the asset. Thus, the total cost of the truck is $28 400. C.

General journal entry required on 30/06/18 to revalue the truck from ca of $49 500 to fv of $46 000

30/06/18

Accumulated depreciation – Truck Y Truck Y (Write down asset from former FV of 58 000 to its carrying amount of 49 500)

Dr Cr

8 500 8 500

Loss on revaluation of Truck Y (OCI) Dr 3 167 Loss on revaluation of Truck Y (P/L) Dr 333 Truck Y Cr (Revaluation downwards of truck from CA of 49 500 to FV of 46 000) Deferred tax liability Income tax expense (OCI) (Tax effect of revaluation decrement)

Dr Cr

950

Asset revaluation surplus Income tax expense (OCI)

Dr Dr

2 217 950

3 500

950

9.37

Chapter 9: Property, plant and equipment

Loss on revaluation of Truck Y (OCI) Cr (Reduction in equity due to revaluation decrement)

3 167

9.38

Solution Manual to accompany Company Accounting 10e

Question 9.11

Revaluation of assets

On 1 July 2016, Kingdom Ltd acquired two assets within the same class of plant and equipment. Information on these assets is as follows:

Machine A Machine B

Cost $100 000 60 000

Expected useful life 5 years 3 years

The machines are expected to generate benefits evenly over their useful lives. The class of plant and equipment is measured using fair value. At 30 June 2017, information about the assets is as follows:

Machine A Machine B

Fair value $84 000 38 000

Expected useful life 4 years 2 years

On 1 January 2018, Machine B was sold for $29 000 cash. On the same day, Kingdom Ltd acquired Machine C for $80 000 cash. Machine C has an expected useful life of 4 years. Kingdom Ltd also made a bonus issue of 10 000 shares at $1 per share, using $8000 from the general reserve and $2000 from the asset revaluation surplus created as a result of measuring Machine A at fair value. At 30 June 2018, information on the machines is as follows:

Machine A Machine C

Fair value $61 000 68 500

Expected useful life 3 years 1.5 years

The income tax rate is 30%. Required Prepare the journal entries in the records of Kingdom Ltd to record the described events over the period 1 July 2016 to 30 June 2018, assuming the ends of the reporting periods are 30 June 2017 and 30 June 2018. 1 July 2016 Machine A Machine B Cash

Dr Dr Cr

100 000 60 000

Dr Cr

20 000

160 000

30 June 2017 Depreciation expense – Machine A Accumulated depreciation (1/5 x $100 000)

20 000

9.39

Chapter 9: Property, plant and equipment

Depreciation expense – Machine B Accumulated depreciation (1/3 x $60 000)

Dr Cr

20 000

Accumulated depreciation- Machine A Machine A (Writing down to carrying amount)

Dr Cr

20 000

Machine A Dr Gain on revaluation of Machine A (OCI) Cr (Revaluation increment: $80 000 to $84 000)

4 000

Income tax expense (OCI) Deferred tax liability (Tax effect of revaluation increment)

Dr Cr

1 200

Gain on revaluation of Machine A (OCI) Dr Income tax expense (OCI) Cr Asset revaluation surplus – Machine A Cr (Accumulation of net revaluation gain in equity))

4 000

Accumulated depreciation – Machine B Machine B (Writing down to carrying amount)

Dr Cr

20 000

Expense – revaluation decrement (P&L) Machine B (Revaluation to fair value at 30/6/17)

Dr Cr

2 000

Machine C Cash (Acquisition of machine C)

Dr Cr

80 000

Depreciation expense – Machine B Accumulated depreciation (($38 000 / 2years) x 1/2 year depn)

Dr Cr

9 500

Cash

Dr Cr

29 000

Carrying amount of Machine B Sold Accumulated depreciation Machine B (Carrying amount of machine sold)

Dr Dr Cr

28 500 9 500

General reserve Asset revaluation surplus – Machine A

Dr Dr

8 000 2 000

20 000

4 000

1 200

1 200 2 800

20 000

2 000

1 January 2018

Proceeds on sale of Machine B (Sale of Machine B)

80 000

9 500

29 000

38 000

9.40

Solution Manual to accompany Company Accounting 10e

Share Capital

10 000

30 June 2018 Depreciation expense – Machine A Accumulated depreciation (1/4 x $84 000)

Dr Cr

21 000

Depreciation expense – Machine C Accumulated depreciation (1/4 x ½ x $80 000)

Dr Cr

10 000

Accumulated depreciation – Machine A Machine A (Writing down to carrying amount)

Dr Cr

21 000

Loss on revaluation of Machine A (OCI) Machine A (Write down of plant from $63000 to $61000)

Dr Cr

2 000

Deferred tax liability Income tax expense (OCI) (Tax-effect on downward revaluation subsequent to upward revaluation)

Dr Cr

600

21 000

10 000

21 000

2 000

600

*Asset revaluation surplus – Machine A Dr 800 Income tax expense (OCI) Dr 600 Loss on revaluation of Machine A(P&L) Dr 600 Loss on revaluation of Machine A (OCI) Cr 2 000 (Accumulation of revaluation loss to equity) *Note: in the previous year the value of the ARS account from a revaluation increment for Machine A was $2 800. However, the entity used $2 000 of this surplus for a bonus share issue, leaving $800 balance in this account. Therefore, when recognising a revaluation decrement for Machine A the ARS account can only be reduced by the $800 remaining. The balance of the loss on revaluation must now be recognised directly in P&L. Accumulated depreciation – Machine C Machine C (Writing down to carrying amount)

Dr Cr

10 000

Loss on revaluation (P&L) Machine C (Revaluation to fair value at 30/6/18)

Dr Cr

1 500

10 000

1 500

9.41

Chapter 9: Property, plant and equipment

Question 9.12

Acquisition and sale of assets, depreciation

Jeremiah’s Turf Farm owned the following items of property, plant and equipment as at 30 June 2015: Land (at cost) Office building (at cost) Accumulated depreciation Turf cutter (at cost) Accumulated depreciation Water desalinator (at fair value)

150 000 (23 375 ) 65 000 (42 367)

$120 000 126 625

22 633 189 000

Additional information (at 30 June 2015) (a) The straight-line method of depreciation is used for all depreciable items of property, plant and equipment. Depreciation is charged to the nearest month and all figures are rounded to the nearest dollar. (b) The office building was constructed on 1 April 2011. Its estimated useful life is 20 years and it has an estimated residual value of $40 000. (c) The turf cutter was purchased on 21 January 2012, at which date it had an estimated useful life of 5 years and an estimated residual value of $3200. (d) The water desalinator was purchased and installed on 2 July 2014 at a cost of $200 000. On 30 June 2015, the plant was revalued upwards by $7000 to its fair value on that day. Additionally, its useful life and residual value were re-estimated to 9 years and $18 000 respectively. The following transactions occurred during the year ended 30 June 2016: (Note: All payments are made in cash.) (e) On 10 August 2015, new irrigation equipment was purchased from Johnson Supplies for $37 000. On 16 August 2015, the business paid $500 to have the equipment delivered to the turf farm. Bob Redford was contracted to install and test the new system. In the course of installation, pipes worth $800 were damaged and subsequently replaced on 3 September. The irrigation system was fully operational by 19 September and Bob Redford was paid $9600 for his services. The system has an estimated useful life of 4 years and a residual value of $0. (f) On 1 December 2015, the turf cutter was traded in on a new model worth $80 000. A trade-in allowance of $19 000 was received and the balance paid in cash. The new machine’s useful life and residual value were estimated at 6 years and $5000 respectively. (g) On 1 January 2016, the turf farm’s owner decided to extend the office building by adding three new offices and a meeting room. The extension work started on 2 February and was completed by 28 March at a cost of $49 000. The extension is expected to increase the useful life of the building by 4 years and increase its residual value by $5000. (h) On 30 June 2016, depreciation expense for the year was recorded. The fair value of the water desalination plant was $165 000. Required (Show all workings and round amounts to the nearest dollar.) Prepare general journal entries to record the transactions and events for the reporting period ended 30 June 2016 (narrations are not required).

9.42

Solution Manual to accompany Company Accounting 10e

General Journal Entries

DATE

DETAILS

10/08/15 Irrigation equipment Cash

37 000

16/08/15 Irrigation equipment Cash

500

03/09/15 Repairs and maintenance expense Cash

800

37 000

500

8 00

19/09/15 Irrigation equipment Cash

9 600

01/12/15 Depreciation – Turf cutter Accumulated depreciation – Turf cutter (($65 000 – $3 200)/5 x 5/12 = $5 150))

5 150

01/12/15 Carrying amount – Turf cutter ($65 000 – $47 517) Accumulated depreciation – Turf cutter ($42 367 + $5 150) Turf Cutter

17 483 47 517

01/12/15 Turf cutter Cash Proceeds on sale – Turf cutter

80 000

28/03/16 Depreciation - Building Accumulated depreciation - Building ($150 000 – $40 000/20 x 9/12 = $4 125)

4 125

28/03/16 Accumulated depreciation – Building ($23 375 + $4 125) Office building

27 500

28/03/16 Office building Cash

49 000

30/06/16 Depreciation expense – Turf cutter Accumulated depreciation – Turf cutter ($80 000 – $5 000/6 x 7/12 = $7 292)

7 292

9 600

5 150

65 000

61 000 19 000

4 125

27 500

49 000

7 292

9.43

Chapter 9: Property, plant and equipment

30/06/16 Depreciation expense – Water desalinator Accumulated depreciation – Water desalinator ($189 000 – $18 000/9 = $19 000)

19 000 19 000

30/06/16 Depreciation expense – Irrigation equipment Accumulated depreciation – Irrigation equipment ($47 100 – 0/4 x 9/12 = $8 831)

8 831

30/06/16 Depreciation expense – Building Accumulated depreciation - Building ($150 000 – $27 500 + $49 000 = $171 500 $171 500 – [$40 000 + $5 000)/{20 -5 + 4} = $6 658 p.a. $6 658 x 3/12 = $1 665)

1 665

30/06/16 Accumulated depreciation – Water desalinator Water desalinator (Writing down to carrying amount)

19 000

8 831

1 665

19 000

Loss on revaluation of desalinator (OCI) Water desalinator (Revaluation downwards from carrying amount of $170 000 (being $189 000 - $19 000) to fair value of $165 000)

5000

Deferred tax liability Income tax expense (OCI) (Tax-effect of revaluation decrement subsequent to previous increment)

1500

Asset revaluation surplus Income tax expense (OCI) Loss on revaluation of desalinator (OCI) (Reduction in accumulated equity due to revaluation decrement on land)

5 000

1500

3500 1 500 5000

9.44

Solution Manual to accompany Company Accounting 10e

Question 9.13

Acquisitions, disposals, depreciation

Jumper Ltd purchased equipment on 1 July 2016 for $39 800 cash. Transport and installation costs of $4200 were paid on 5 July 2016. Useful life and residual value were estimated to be 10 years and $1800 respectively. Mandurah Ltd depreciates equipment using the straight-line method to the nearest month, and reports annually on 30 June. The company tax rate is 30%. In June 2018, changes in technology caused the company to revise the estimated total life from 10 years to 5 years, and the residual value from $1800 to $1200. This revised estimate was made before recording the depreciation for the financial year ended 30 June 2018. On 30 June 2018, the company adopted the revaluation model to account for equipment. An expert valuation was obtained showing that the equipment had a fair value of $30 000 at that date. On 30 June 2019, depreciation for the year was charged and the equipment’s carrying amount was remeasured to its fair value of $16 000. On 30 September 2019, the equipment was sold for $8400 cash. Required (Show all workings and round amounts to the nearest dollar.) Prepare general journal entries to record the transactions and events for the period 1 July 2016 to 30 September 2019. General journal entries DATE

DETAILS 2016 1 July

5 July

2017 30 June

2018 30 June

30 June

Equipment Cash

39 800

Equipment Cash

4 200

Depreciation – Equipment Accumulated depreciation - Equipment ($44 000 – $1 800/10 = $4 220)

4 220

Depreciation – Equipment Accumulated depreciation - Equipment ($44 000 – $1 200/4 = $8 560 + prospective adjustment for change in estimates [$8 560 – 4 220] = $4 340)

12 900

Accumulated depreciation – Equipment Equipment (Write down to carrying amount)

17 120

Equipment Gain on revaluation of equipment (OCI)

3 120

39 800

4 200

4 220

12 900

17 120

3 120 9.45

Chapter 9: Property, plant and equipment

(Fair value $30 000; Carrying amount $26 880; Revaluation increase $3 120) Income tax expense (OCI) Deferred tax liability (Tax-effect of revaluation increment)

2019 30 June

30 June

2019 30 Sept

936 936

Gain on revaluation of equipment (OCI) Income tax expense (OCI) Asset revaluation surplus (Transfer to accumulated equity subsequent to revaluation of asset)

3 120

Depreciation – Equipment Accumulated depreciation – Equipment ($30 000 – $1 200/3 = $9 600)

9 600

Accumulated depreciation – Equipment Equipment (Write down to carrying amount)

9 600

Loss on revaluation of plant (OCI) Loss on revaluation of plant (P&L) Equipment (Fair value $16 000; Carrying amount $20 400; Revaluation decrease $4 400)

3 120 1 280

936 2184

9 600

4 400

Deferred tax liability Income tax expense (OCI) (Tax effect on decrement relating to prior increment)

936

Asset revaluation surplus Income tax expense (OCI) Loss on revaluation of plant (OCI) (Reduction in accumulated equity due to devaluation of plant)

2 184 936

Depreciation expense – Equipment Accumulated depreciation - Equipment (3/12[$16 000 – $1 200/2])

1 850

Accumulated depreciation – Equipment Carrying amount of Equipment Equipment

1 850 14 150

Cash

8 400

936

3 120

1 850

16 000

9.46

Solution Manual to accompany Company Accounting 10e

Proceeds on sale – Equipment

8 400

9.47

Chapter 9: Property, plant and equipment

Question 9.14

Acquisitions, disposals, trade-ins, overhauls, depreciation

Matty Damon is the owner of Bourne’s Beaut Boats. The company’s final trial balance on 30 June 2017 (end of the reporting period) included the following balances: Processing Plant (at cost, purchased 4 April 2015) Accumulated Depreciation – Processing Plant

$148 650 (81 274)

Charter Boats Accumulated Depreciation – Boats

291 200 (188 330)

The following boats were owned at 30 June 2017: Boat 1 2 3 4

Purchase date 23 February 2013 9 September 2013 6 February 2014 20 April 2015

Cost $62 000 $66 400 $78 600 $84 200

Estimated useful life 5 years 5 years 4 years 6 years

Estimated residual value $3 000 $3 400 $3 600 $3 800

Additional information Bourne’s Beaut Boats calculates depreciation to the nearest month using straight-line depreciation for all assets except the processing plant, which is depreciated at 30% on the diminishing balance method. Amounts are recorded to the nearest dollar. Part A The following transactions and events occurred during the year ended 30 June 2018: 2017 July 26

Dec.

2018 Feb. 6 June 30

Traded in Boat 1 for a new boat (Boat 5) which cost $84 100. A tradein allowance of $8900 was received and the balance was paid in cash. Registration and stamp duty costs of $1500 were also paid in cash. Matty Damon estimated Boat 5’s useful life and residual value at 6 years and $4120 respectively. Overhauled the processing plant at a cash cost of $62 660. As the modernisation significantly expanded the plant’s operating capacity and efficiency, Matty Damon decided to revise the depreciation rate to 25%. Boat 3 reached the end of its useful life but no buyer could be found, so the boat was scrapped. Recorded depreciation.

Required Prepare general journal entries (narrations are required) to record the transactions and events for the year ended 30 June 2018. Part B On 26 March, Matty Damon was offered fish-finding equipment with a fair value of $9500 in exchange for Boat 2. The fish-finding equipment originally cost its owner $26 600 and had a carrying value of $9350 at the date of offer. The fair value of Boat 2

9.48

Solution Manual to accompany Company Accounting 10e

was $9100. Required If Matty Damon accepts the exchange offer, what amount would the business use to record the acquisition of the fish-finding equipment? Why? Justify your answer by reference to the requirements of AASB 116 relating to the initial recognition of a property, plant and equipment item.

Part A. DATE

General journal entries DETAILS

26/07/17 Depreciation – boats Accumulated depreciation – boats (Depreciation of boat 1 to date of sale: 1/12 x 1/5 [$62 000 – 3000])

Cr 983 983

Accumulated depreciation - boats Carrying amount of boat sold Charter Boats (Derecognition of boat 1 on sale: $11 800 x 53/12 = $52 117)

52 117 9 883

Charter Boats Proceeds on sale of boat Cash (Purchase of boat 5 and trade in of boat 1)

85 600

04/12/17 Depreciation – processing plant Accumulated depreciation – processing plant (Depreciation to date of overhaul: [$148 650 – 81 274] x 30% x 5/12)

62 000

8 900 76 700

8 422 8 422

Accumulated depreciation – processing plant Processing plant (Write down to carrying amount prior to overhaul)

89 696

Processing plant Cash (Overhaul of plant) (New depreciable amount : = $148 650 + $62 660 – $89 696 = $121 614)

62 660

06/02/18 Depreciation - boats Accumulated depreciation – boats (Depreciation to date of scrapping: $78 600 – $3 600/4 x 7/12 = $10 937)

89 696

62 660

10 937 10 937

9.49

Chapter 9: Property, plant and equipment

Accumulated depreciation – boats Carrying amount of boat scrapped Charter Boats (Derecognition of boat 3 at the end of its useful life: ($78 600 - $3 600)/4 x 48/12

DATE

DETAILS

75 000 3 600 78 600

30/06/18 Depreciation – boats Accumulated depreciation – boats (Depreciation charge for the year: Boat 2: ($66 400 – $3 400)/ 5 = $12 600 Boat 4: ($84 200 – $3 800)/6 = $13 400 Boat 5: ($85 600 – $4 120)/6 x 11/12 = $12 448)

38 448

Depreciation – processing plant Accumulated depreciation – processing plant (Depreciation charge for the year: $121 614 x 25% x 7/12)

17 735

38 448

17 735

Part B AASB 116 requires property, plant and equipment items to be initially recognised at cost. Cost is further defined as the ‘amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction’. In this situation, the fish finder is acquired by exchange – no cash is paid – hence, the ‘cost’ of the asset will be measured by reference to the fair value of the consideration given in exchange, that is, boat 2. Thus, the fish finder would be recognised at a cost of $9 100 this being the fair value of boat 2.

9.50

Solution Manual to accompany Company Accounting 10e

Question 9.15

Classification of acquisition costs

Nikita Ltd began operations on 1 July 2016. During the following year, the company acquired a tract of land, demolished the building on the land and built a new factory. Equipment was acquired for the factory and, in March 2017, the factory was ready. A gala opening was held on 18 March, with the local parliamentarian opening the factory. The first items were ready for sale on 25 March. During this period, the following inflows and outflows occurred: 1.

While searching for a suitable block of land, Nikita Ltd placed an option to buy with three real estate agents at a cost of $100 each. One of these blocks of land was later acquired. 2. Payment of option fees $300 3. Receipt of loan from bank 400 000 4. Payment to settlement agent for title search, stamp duties and 10 000 settlement fees 5. Payment of arrears in rates on building on land 5 000 6. Payment for land 100 000 7. Payment for demolition of current building on land 12 000 8. Proceeds from sale of material from old building 5 500 9. Payment to architect 23 000 10. Payment to council for approval of building construction 12 000 11. Payment for safety fence around construction site 3 400 12. Payment to construction contractor for factory building 240 000 13. Payment for external driveways, parking bays and safety lighting 54 000 14. Payment of interest on loan 40 000 15. Payment for safety inspection on building 3 000 16. Payment for equipment 64 000 17. Payment of freight and insurance costs on delivery of equipment 5 600 18. Payment of installation costs on equipment 12 000 19. Payment for safety fence surrounding equipment 11 000 20. Payment for removal of safety fence 2 000 21. Payment for new fence surrounding the factory 8 000 22. Payment for advertisements in the local paper about the forthcoming factory and its benefits to the local community 500 23. Payment for opening ceremony 6 000 24. Payments to adjust equipment to more efficient operating levels subsequent to initial operation 3 300 Required Using the information provided, determine what assets Nikita Ltd should recognise and the amounts at which they would be recorded.

Land:

Option cost Settlement agent Rates Land Demolition of old building Proceeds on sale of material

$100 10 000 5 000 100 000 12 000 (5 500) $121 600

9.51

Chapter 9: Property, plant and equipment

Building

Architects Council Fence Building Safety inspection Removal of safety fence

$23 000 12 000 3 400 240 000 3 000 2 000 $283 400

Improvements: Driveway et al New fence

$54 000 8 000 $62 000

Equipment:

$64 000 5 600 12 000 11 000 3 300 $95 900

Cost Freight & Insurance Installation Safety equipment Adjustments

Options on land not acquired: expense $200 Interest: $40 000 must be capitalised if relates to a qualifying asset; otherwise it is expensed. The only possible qualifying asset is the factory. In this example, it may be necessary to apportion the interest, depending on what loan was used for – see AASB 123 Borrowing Costs. Advertising: expense $500 Opening ceremony: expense $6 000

9.52

Solution Manual to accompany Company Accounting 10e

Question 9.16

Cost of acquisition

Bad Boys Ltd started business early in 2015. During its first 9 months, Bad Boys Ltd acquired real estate for the construction of a building and other facilities. Operating equipment was purchased and installed, and the company began operating activities in October 2015. The company’s accountant, who was not sure how to record some of the transactions, opened a Property ledger account and recorded debits and (credits) to this account as follows. 1. 2. 3. 4. 5. 6. 7. 8.

Cost of real estate purchased as a building site Paid architect’s fee for design of new building Paid for demolition of old building on building site purchased in (1) Paid land tax on the real estate purchased as a building site in (1) Paid excavation costs for the new building Made the first payment to the building contractor Paid for equipment to be installed in the new building Received from sale of salvaged materials from demolishing the old building 9. Made final payment to the building contractor 10. Paid interest on building loan during construction 11. Paid freight on equipment purchased 12. Paid installation costs of equipment 13. Paid for repair of equipment damaged during installation Property ledger account balance

170 000 23 000 28 000 1 700 15 000 250 000 148 000 (6 800) 350 000 22 000 1 900 4 200 2 700 1 009 700

Required A. Prepare a schedule with the following column headings. Analyse each transaction, enter the payment or receipt in the appropriate column, and total each column. Land Item no.

Land

improvements

Manufacturing Building

equipment

Other

B. Prepare the journal entry to close the $1 009 700 balance of the Property ledger account. A. Item

Land

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

170 000

Land Improvements

Building

Manufacturing Equipment

Other

23 000 28 000 1 700 15 000 250 000 148 000 (6 800) 350 000 22 000 1 900 4 200 2 700

9.53

Chapter 9: Property, plant and equipment

TOTAL

192 900

660 000

154 100

Land Buildings Manufacturing equipment Repairs expense Property (Cost of acquisition reallocated)

Dr Dr Dr Dr Cr

192 900 660 000 154 100 2 700

2 700

Journal entry:

1 009 700

9.54

Solution Manual to accompany Company Accounting 10e

Question 9.17

Acquisition, disposal and depreciation of assets

Robot Manufacturing Ltd’s post-closing trial balance at 30 June 2016 included the following balances: Machinery Control (at cost) Accumulated Depreciation – Machinery Control Fixtures (at cost) Accumulated Depreciation – Fixtures

$244 480 113 800 308 600 134 138

The Machinery Control and Accumulated Depreciation – Machinery Control accounts are supported by subsidiary ledgers. Details of machines owned at 30 June 2016 are as follows: Machine 1 2 3

Purchase date 28 Apr 2012 04 Feb 2014 26 Mar 2015

Cost $74 600 $82 400 $87 480

Estimated useful Life 5 years 5 years 6 years

Estimated residual value $3 800 $4 400 $5 400

Additional information  Robot Manufacturing Ltd uses the general journal for all journal entries, records depreciation to the nearest month, balances its accounts 6-monthly, and records amounts to the nearest dollar.  Robot Manufacturing Ltd uses straight-line depreciation for machinery and diminishing balance depreciation at 20% p.a. for fixtures. The following transactions and events occurred from 1 July 2016 onwards: 2016 03 July Exchanged items of fixtures (cost: $100 600; carrying amount at exchange date: $56 872; fair value at exchange date: $57 140) for a used machine (Machine 4). Machine 4’s fair value at exchange date was $58 000. Machine 4 originally cost $92 660 and had been depreciated by $31 790 to exchange date in the previous owner’s accounts. Robot Manufacturing Ltd estimated Machine 4’s useful life and residual value at 3 years and $4580. 10 Oct Traded in Machine 2 for a new machine (Machine 5), that cost $90 740. A trade-in allowance of $40 200 was received and the balance was paid in cash. Freight charges of $280 and installation costs of $1600 were also paid in cash. Robot Manufacturing Ltd estimated Machine 5’s useful life and residual value at 6 years and $5500. 2017 24 Apr Overhauled Machine 3 at a cash cost of $16 910, after which Robot Manufacturing Ltd revised its residual value to $5600 and extended its estimated useful life by 2 years. 16 May Paid for scheduled repairs and maintenance on the machines of $2 370. 30 June Recorded depreciation and scrapped Machine 1. Required A. Prepare journal entries to record the above transactions and events. (Narrations are not required.)

9.55

Chapter 9: Property, plant and equipment

B. Prepare the Accumulated Depreciation Control – Machinery and Accumulated Depreciation – Fixtures ledger accounts for the period 1 July 2016 to 30 June 2017. 1.

JOURNAL ENTRIES

• • •

M1 depreciation = [74 600 – 3 800]/60 = 1 180 per month M2 depreciation = [82 400 – 4 400]/60 = 1 300 per month M3 depreciation = [87 480 – 5 400]/72 = 1 140 per month

03/07/16

Accumulated depreciation – fixtures (100 600 – 56 872) Carrying amount of asset sold – fixtures Fixtures (De-recognition of asset sold)

Dr Dr Cr

43 728 56 872

Machinery (M4) Dr Proceeds on sale of asset – fixtures Cr (Sale of asset and recognition of asset acquired)

57 140

100 600

57 140

M4 depreciation = [57 140 – 4 580]/36 = 1 460 per month 10/10/16

Depreciation – machinery (M2) Dr Accumulated depreciation – machinery (M2) Cr (Depreciation of M2 up to date of trade-in: 3 months x 1300) Accumulated depreciation – Machinery (M2) (1 300 x 32 months) Carrying amount of machinery sold (M2) (82 400 – 41 600) Machinery (M2) (De-recognition of asset sold) Machinery (M5) Proceeds on sale of machinery – (M2) Cash (Acquisition of new machinery (M5): 90 740 + 280 + 1600)

3 900 3 900

41 600

Dr Cr

40 800

Dr Cr Cr

92 620

82 400

40 200 52 420

M5 depreciation = [92 620 – 5 500]/72 = 1 210 per month 24/04/17

Depreciation – Machinery (M3) Dr Accumulated depreciation – Machinery (M3) Cr (Depreciation on M3 up to point of overhaul: 1 140 x 10 months)

11 400

Accumulated Depreciation - machinery (M3) Dr Machinery (M3) Cr (write down to carrying amount prior to overhaul) [$1 140 x 25 months]

28 500

11 400

28 500

9.56

Solution Manual to accompany Company Accounting 10e

Machinery (M3) Cash (Cost of overhaul)

Dr Cr

16 910 16 910

M3: new depreciable amount = 87 480 – (1 140 x 25mths) + 16 910 – 5,600 = 70 290 new useful life = 72–25+24 = 71 months revised depreciation = 70 290/71 = 990 per month 16/05/17

30/06/17

Repairs and maintenance expense Cash (Repairs and maintenance expense)

Dr Cr

2 370

Depreciation expense– machinery Accumulated depreciation – machinery (Depreciation charge up to end of year: M1: 1 180 x 10 months = 11 800 M3: 990 x 2 months = 1 980 M4: 1 460 x 12 months = 17 520 M5: 1 210 x 9 months = 10 890)

Dr Cr

42 190

Depreciation – fixtures Dr Accumulated depreciation – fixtures Cr (Depreciation charge up to year end: Cost: 308 600 – 100 600 = 208,000) Accumulated depreciation = 134 138 – 43 728 = 90 410 Depreciable amount = 117,590 Depreciation charge = 117 590 x 20% = 23 518)

23 518

Accumulated depreciation – machinery (M1) (1 180 x 60 months) Carrying amount of machinery scrapped (M1) (74 600 – 70 800) Machinery (M1) (De-recognition of machinery scrapped – M1)

2 370

42 190

23 518

70 800

Dr Cr

3 800 74 600

9.57

Chapter 9: Property, plant and equipment

LEDGER ACCOUNTS

10/10/16 31/12/16 24/04/17 30/06/17

ACCUMULATED DEPRECIATION CONTROL - MACHINERY Machinery (M2) 41 600 30/06/16 Balance b/d Balance c/d 76 100 10/10/16 Depreciation (M2) 117 700 Machinery (M3) 28 500 31/12/16 Balance b/d Machinery (M1) 70 800 24/04/17 Depreciation (M3) Balance c/d

30 390 129 690

30/06/17

Depreciation

ACCUMULATED DEPRECIATION - FIXTURES 03/07/016 Fixtures 43 728 30/06/16 Balance b/d 31/12/16 Balance c/d 90 410 134 138 31/12/16 Balance b/d 30/06/17 Fixtures 113 928 30/06/17 Depreciation 113 928

113 800 3 900 117 700 76 100 11 400 42 190 129 690

134 138 ______ 134 138 90 410 23 518 113 928

9.58

Solution Manual to accompany Company Accounting 10e

Question 9.18

Acquisition, disposal and depreciation of non-current assets

Bruce is the owner of Willis Meat Supplies. Willis Meat Supplies’ adjusted trial balance at 31 December 2016 (end of the reporting period) included the following balances: Processing Plant (at cost; purchased 10 April 2013) Accumulated Depreciation – Processing Plant Trucks Control (at cost) Accumulated Depreciation Control – Trucks

$148 650 109 135 291 400 174 200

The Trucks Control and Accumulated Depreciation Control – Trucks accounts are supported by subsidiary ledgers. Details of trucks owned at 31 December 2016 are as follows: Truck 1 2 3 4

Purchase Date 25 August 2013 05 March 2014 02 August 2014 23 October 2014

Cost $61 000 $70 600 $75 600 $84 200

Estimated Useful Life 4 years 4 years 4 years 5 years

Estimated Residual Value $3 400 $3 400 $3 600 $3 200

Additional information  Bruce uses the general journal for all entries, calculates depreciation to the nearest month, balances his accounts 6-monthly, and records amounts to the nearest dollar.  Bruce uses straight-line depreciation for all depreciable assets except the processing plant, which is depreciated at 30% p.a. on the diminishing balance. The following transactions and events occurred during 2017: January 27

June 02

July 24 September 28

Traded-in Truck 1 for a new truck (Truck 1A) which cost $84 100. A trade-in allowance of $10 200 was received and the balance was paid in cash. Registration and painting costs of $1500 were also paid in cash. Bruce estimated Truck 1A’s useful life and residual value at 5 years and $4600. Modernised the processing plant at a cash cost of $61 574. Although the modernisation significantly expanded the plant’s operating capability and efficiency, Bruce decided that no revision to the depreciation rate was warranted. Sold Truck 3 for $25 000 in cash. Exchanged Truck 2 (fair value at exchange date: $10 640) for computer equipment. The computer equipment’s fair value was $10 550 at exchange date. The computer equipment originally cost $26 600 and had been depreciated in the previous owner’s accounts by $15 850 to date of exchange. Bruce estimated the computer equipment’s useful life and residual value at 4 years and $320. Recorded depreciation.

December 31 Required A. Prepare journal entries to record the above transactions and events. (Narrations are not required.) B. Prepare the Processing Plant and Accumulated Depreciation Control – Trucks

9.59

Chapter 9: Property, plant and equipment

general ledger accounts for the period 1 January 2017 to 31 December 2017: 1.

JOURNAL ENTRIES

Depreciation of trucks: • Truck 1: [61 000 – 3 400]/4y = 14 400 p.a. or 1 200/m • Truck 2: [70 600 – 3 400]/4y = 16 800 p.a. or 1 400/m • Truck 3: [75 600 – 3 600]/4y = 18 000 p.a. or 1 500/m • Truck 4: [84 200 – 3 200]/5y = 16 200 p.a. or 1 350/m

27/01/17

Depreciation – trucks (T1) Accumulated depreciation – trucks (T1) (Depreciation up to point of trade-in: 1 200 x 1 month) Accumulated depreciation – trucks (T1) (1 200 x 41 months) Carrying amount of truck sold – trucks (T1) (61 000 – 49 200) Trucks (T1) (De-recognition of Truck T1 on sale) Trucks (T1A) (84 100 + 1 500) Proceeds on sale– Trucks (T1) Cash (Purchase of truck T1A)

Dr Cr

1 200

49 200

Dr Cr

11 800

Dr Cr Cr

85 600

1 200

61 000

10 200 75 400

Depreciation of T1A = [85 600 – 4 600]/60 = 1 350 per month 02/06/17

Depreciation – processing plant Dr Accumulated depreciation – processing plant Cr (Depreciation up to point of modernisation: ([148 650 – 109 135] x 30% x 5/12)

4 939

Accumulated depreciation – processing plant Dr Processing Plant Cr (writedown to carrying amount prior to modernisation: [109 135 + 4 939])

114 074

Processing plant Cash (Cost of modernisation of processing plant)

61 574

Dr Cr

4 939

114 074

61 574

Carrying amount of processing plant = 148 650 – (109 135 + 4 939) + 61 574 = 96 150 24/07/17

Depreciation – trucks (T3) Accumulated depreciation – trucks

Dr Cr

10 500 10 500

9.60

Solution Manual to accompany Company Accounting 10e

(Depreciation of T3 up to sale: 1 500 x 7 months) Accumulated depreciation – trucks (T3) (1 500 x 36 months) Carrying amount of truck sold – trucks (T3) (75 600 – 54 000) Trucks (T3) De-recognition of truck (T3) sold)

54 000

Dr Cr

21 600

Dr Cr

25 000

Depreciation – trucks (T2) Dr Accumulated depreciation – trucks (T2) Cr (Depreciation up to point of exchange: 1 400 x 9m)

12 600

Cash Proceeds on sale of trucks (T3) (Proceeds on sale of truck T3) 28/09/17

Accumulated depreciation – trucks (T2) (1 400 x 43m) Carrying amount of truck sold – (T2) (70 600 – 60 200) Trucks (T2) (De-recognition of truck sold - T2) 28/09/17

Computer equipment Proceeds on sale of trucks (T2) (Acquisition of computer equipment at cost)

75 600

25 000

12 600

60 200

Dr Cr

10 400

Dr Cr

10 640

70,600

10 640

Computer equipment depreciation = [10,640 – 320]/48 = 215 per month) 31/12/17

Depreciation – trucks (T1A = 1 350 x 11m) + (T4 = 1 350 x 12m) Depreciation – processing plant (96 150 x 30% x 7/12) Depreciation – computer equipment (215 x 3m) Accumulated depreciation – trucks Accumulated depreciation – processing plant Accumulated depreciation – computer equipment (Depreciation of non-current assets at year end)

31 050

Dr Dr Cr Cr

16 826 645

31,050 16,826 645

LEDGER ACCOUNTS

31/12/16 02/06/17

Balance b/d Cash

30/06/17

Balance b/d

PROCESSING PLANT 148 650 02/06/17 Acc. depreciation 61 574 30/06/17 Balance c/d 210 224 96 150

114 074 96 150 210 224

9.61

Chapter 9: Property, plant and equipment

31/12/17

22/01/17 30/06/17 24/07/17 21/09/17 31/12/17

Balance b/d

______ 96 150 96 150

31/12/17

Balance c/d

ACCUMULATED DEPRECIATION CONTROL - TRUCKS Trucks (T1) 49 200 31/12/016 Balance b/d Balance c/d 126 200 22/01/17 Depreciation (T1) 175 400 Trucks (T3) 54 000 30/06/17 Balance b/d Trucks (T2) 60 200 24/07/17 Depreciation (T3) Balance c/d 66 150 21/09/17 Depreciation (T2) ______ 31/12/17 Depreciation 180 350 31/12/17 Balance b/d

96 150 96 150

174 200 1 200 175 400 126 200 10 500 12 600 31 050 180 350 66 150

9.62

Chapter 10: Leases

Chapter 10: Leases REVIEW QUESTIONS 1. Define each of the following: (a) lease (b) non-cancellable lease (c) executory costs (d) guaranteed residual value (e) minimum lease payments (f) initial indirect costs (g) interest rate implicit in the lease. lease – an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time (para 4) non-cancellable lease – a lease that is cancellable only: (a) upon the occurrence of some remote contingency; (b) with the permission of the lessor; (c) if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or (d) upon the payment by the lessee of such an additional amount that, at the inception of the lease, continuation of the lease is reasonably certain. (para 4) executory costs – costs for services and taxes to be paid by and reimbursed to the lessor, e.g. maintenance and insurance costs guaranteed residual value (a) For lessees: that part of the residual value that is guaranteed by the lessee or by a party related to the lesee; (b) For lessors: that part of the residual value that is guaranteed by the lessee or by a third party unrelated to the lessor. (para 4) The guaranteed residual value is that part of the residual value of the leased asset guaranteed by the lessee or a third party related to the lessee (AASB 117, paragraph 4). The lessor will estimate the residual value of the leased asset at the end of the lease term based on market conditions at the inception of the lease and the lessee will guarantee that, when the asset is returned to the lessor, it will realise at least that amount. The guarantee may range from 1% to 100% of the residual value and is a matter for negotiation between lessor and lessee. Where a lessee guarantees some or all of the residual value of the asset, the lessor has transferred risks associated with movements in the residual value to the lessee. minimum lease payments – the payments over the lease term that the lessee is or can be required to make for the use of the asset See AASB 117, paragraph 4, the definition can be expressed as follows: Minimum lease payments

= +

(i) (ii)

Payments over the lease term Guaranteed residual value

10.2

Solution Manual to accompany Company Accounting 10e

+ -

(iii) (iv) (v)

Bargain purchase option Contingent rent Reimbursement of costs paid by the lessor

Discuss each component in full. initial indirect costs – are incremental costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred by a manufacturer or dealer lessors (para 4). Examples include commission, legal fees and internal costs, but exclude general overheads such as those incurred by a sale and marketing team (para 38). interest rate implicit in the lease – this is defined in AASB 117, paragraph 4 as the discount rate that at the inception of the lease causes the aggregate present value of: (a) the minimum lease payments; and (b) the unguaranteed residual value to be equal to the sum of: (i) the fair value of the leased asset, and (ii) any initial direct costs of the lessor. This interest rate is used to discount the minimum lease payments to their present value for recognition purposes. This discount rate is implicit in the lease because it is the terms of the lease (number, timing and quantum of repayments, guaranteed residual values or bargain purchase options) that determine its value. Any change to the terms or to the fair value will change the interest rate.

Leases are classified on the basis of ‘substance over form’. What does this criterion mean and how does it relate to the capitalisation of finance leases?

The AASB Framework in paragraph 35 states that ‘if information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form’. Thus, all aspects and implications of an arrangement or transaction should be evaluated to determine its substance, with weight given to those aspects and implications that have an economic effect, prior to accounting for that event or transaction. Whether a lease is classified as a finance lease or an operating lease depends on the substance of the lease arrangement rather than the form of the contract. Thus, if ‘in substance’ substantially all of the risks and rewards incident with ownership are transferred from the lessor to the lessee the arrangement giving rise to a finance lease. Substance over form is particularly relevant to leases because company management may be motivated to structure arrangements to avoid finance lease classifications in order to keep the arrangements “off balance sheet”. That is, finance leases require the initial recognition of an asset and a liability. The asset is then depreciated and the liability is reduced by the lease payments. In contrast, an operating lease only requires the recognition of expenses at the time of the lease payments. The inclusion of the additional asset and liability can have a

10.3

Chapter 10: Leases

substantial negative impact on the financial statements or on decisions based on those statements. (refer section 10.4 for examples)

Describe the classification guidance that can be used to distinguish between a finance lease and an operating lease.

The classification guidance is relevant to making a judgment about whether a lease is a finance lease because it transfers substantially all the risks and rewards incidental to ownership of an asset irrespective of whether title for the asset is eventually transferred. Refer to Figure 10.2 in the text which illustrates the classification guidance and is reproduced below.

10.4

Solution Manual to accompany Company Accounting 10e

The meaning of ‘major part’ of the economic life of the leased asset is not defined in the standard but historically 75% or more has been used in Australia. Similarly, the meaning of “substantially all” of the fair value of the leased asset is not defined but historically 90% or more has been used in Australia. 4.

Explain why the management of a lessee company may be motivated to avoid the classification of a lease arrangement as a finance lease by referring to possible adverse effects on the financial statements.

The main motivation is to avoid the financial statement effects of a finance lease, in particular, the recognition of a lease liability in respect of the future obligation to make lease payments. Lease arrangements classified as finance leases are recognised in the statement of financial position whereas operating leases are not. The recognition of finance lease assets and finance lease liabilities has a negative impact on common accounting ratios that are used to assess a company as follows: (a) The recognition of the finance lease asset has a negative effect on users’ perceptions of the company’s financial performance by reducing the return on assets ratio. (b) The recognition of the finance lease liability has a negative effect on users’ perceptions of the company’s leverage by increasing the debt to equity or debt to assets ratio. (c) The recognition of a finance lease liability has a negative effect on users’ perceptions of the company’s liquidity by reducing the current ratio, that is, current assets to current liabilities. (d) In the early years of the lease, the recognition of a finance lease asset and finance lease liability gives rise to expenses for interest and depreciation that typically exceed the expense that would be recognised if an operating lease. Accordingly, a finance lease has a negative effect on users’ perceptions of the company’s financial performance in the early years of the lease. Illustration using Boral Limited’s 2013 annual report Recall the financial information about leases in Figure 10.1 of the text relating to Boral Limited for 30 June 2013. Finance lease liabilities recognised in the statement of financial position are as follows: Current $1.8 million Non-current $7.1 million Total $8.9 million However, there are also operating leases that involve future commitments of $285.1 million. The future commitments include $84.6 million due within 12 months. Assume that all of Boral’s operating leases were classified as finance leases starting from 30 June 2013 and ignore discounting. The table below illustrates what the effect would be on the financial ratios of Boral for 30 June 2013:

10.5

Chapter 10: Leases

Boral 2013

Finance leases $8.9m

Finance leases $285.1m

Net Operating Cash Flow

$294.0m

Total Assets

$6316.4m

$6601.5m

4.65%

4.45%

Current Assets

$1842.7m

Current Liabilities

$1174.3m

$1258.9m

Current Ratio

1.57

1.46

Total Liabilities

$2922.9m

$3208.0m

Total Assets

$6316.4m

$6601.5m

Debt to Assets

0.46

0.49

Cash Return on Assets

Source for above figures is same as that for Fig.10.1 – Boral Limited annual financial report 2013 (pp.58 & 60)

Briefly outline the AASB 117 requirements applicable to a lessee accounting for a finance lease.

Initial Recognition and Measurement of Finance Lease Asset and Finance Lease Liability Paragraph 20 of AASB 117 requires recognition of an asset and a liability, each determined at the inception of the lease, equal in amount to the fair value of the leased property or, if lower, the present value of the minimum lease payments (PV of MLP). Assuming the PV of MLP is lower the entry is: Lease Asset Lease Liability

Dr Cr

PV of MLP PV of MLP

Any initial direct costs incurred by the lessee are added to initial measurement of the lease asset and lease liability. Subsequent Measurement of Finance Lease Asset Paragraph 27 of AASB 117 requires the lessee to depreciate a leased depreciable asset over its useful life to the lessee in a pattern reflecting the consumption or loss of the rewards embodied in the asset. The length of a leased asset’s useful life to the lessee depends on whether or not ownership of the asset will transfer at the end of the lease term. If ownership of the asset is reasonably certain to transfer to the lessee, then the useful life to the lessee is the same as the useful life of the asset at the commencement of the lease term. If the asset is to be returned to the lessor, then the useful life to the lessee is the shorter of the lease term and the useful life of the asset. Subsequent Measurement of Finance Lease Liability

10.6

Solution Manual to accompany Company Accounting 10e

The lease liability recognised at the commencement of the lease term represents the present value of future lease payments relating to the use of the asset. This present value is determined by applying the interest rate implicit in the lease Paragraph 25 of AASB 117 explains that during the lease term the discount for the present value unwinds and is recognised as interest expense. The difference between the lease payments relating to the use of the asset and the unwinding of the discount for the period is the reduction in the lease liability for the period. The reduction in the lease liability for the period is found using a lease payments schedule as shown in illustrative example 10.2. The subsequent measurement of the lease liability at a point in time therefore, represents the present value of the remaining minimum lease payments. Note that it is the lease payments relevant to the use of the asset that are included in the minimum lease payments. Reimbursement of executory costs and contingent rent are not included in the minimum lease payments. De-recognition of Finance Lease Asset At the conclusion of the lease term, the lease liability is settled by either returning the lease asset to the lessor or making a final payment to acquire the asset. If the leased asset is returned to the lessor, then the gross amount of the asset and any accumulated depreciation must be de-recognised from the lessee’s statement of financial position. If the leased asset is purchased by the lessee, then the leased asset is reclassified into an owned asset.

Briefly outline the AASB 117 requirements applicable to a lessee accounting for an operating lease.

Paragraph 33 of AASB 117 requires the lessee to recognise lease payments as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefits. In accordance with the accrual basis of accounting: (a) payments made that relate to the current accounting period are recognised as an expense (b) payments made that relate to a future accounting period are recognised as a prepaid asset (c) payments to be made in a future accounting period that relate to the current accounting period are recognised as an expense and liability

Do you agree that the note disclosures made by a lessee in respect of noncancellable operating leases provide relevant information to the users of the financial report? Give reasons for your answer.

Lease accounting is a good example of where referring only to the information disclosed in the financial statements has the potential to mislead users. Only finance leases are recognised

10.7

Chapter 10: Leases

in a lessee’s statement of financial position, which means that the obligations or future contractual commitments that relate to finance leases are apparent but those for operating leases are not. In order to understand the full extent of a lessee’s obligations for leases, it is necessary to refer to the note disclosure on future commitments for non-cancellable operating leases. Consider the example of the Boral Limited disclosures shown at Figure 10.1 in the text. A user that referred only to the statement of financial position would be aware of future lease obligations at the discounted amount of approximately $8.9 million ($1.8million current and $7.1million non-current). The user could be misled into thinking that Boral only needed future cash of around $8.9 million to cover the principal for its lease obligations. The true state of affairs is that Boral has additional commitments for leases not disclosed in the statement of financial position amounting to $285.1 million with$84.6 million due in the next 12 months. The true state of affairs is only apparent from the note disclosures for operating leases. Current proposals in ED 242 would require a lessee to recognise assets and liabilities for all leases with a maximum possible term that is more than 12 months. These proposals would overcome the differential approach to lease obligations that exist in AASB 117. It would ensure that users had prominent, consistent and comparable financial information about all of the lessee’s lease obligations.

Compare and contrast the AASB 117 requirements applicable to a lessor that is a manufacturer/dealer accounting for a finance lease with those for a nonmanufacturer/non-dealer.

Initial recognition measurement of receivable

Initial direct costs

and lease

Non-Manufacturer/Dealer Lessor (Financier) Net investment in the lease = Minimum lease payments + Initial Direct Costs + Unguaranteed residual value

Manufacturer/Dealer Lessor Net investment in the lease = Minimum lease payments +

Unguaranteed residual value

(discounted using the interest rate implicit in the lease) Included in lease receivable

(discounted using the interest rate implicit in the lease) Expense

Interest rate implicit in the Calculation includes the Calculation excludes the lease effect of initial direct costs effect of initial direct costs (lower discount rate applies) (higher discount rate applies) Recognition of selling profit There is no selling profit for A selling profit is recognised at commencement of lease a financier lessor as follows: Sales revenue = present value of minimum lease payments

10.8

Solution Manual to accompany Company Accounting 10e

Cost of sales = cost of leased asset less present value of unguaranteed residual Subsequent measurement of Lease receipts (excluding lease receivable contingent rent and reimbursements) are separated into interest revenue and reduction of lease receivable using the interest rate implicit in the lease.

Lease receipts (excluding contingent rent and reimbursements) are separated into interest revenue and reduction of lease receivable using the interest rate implicit in the lease.

If the lessor is a manufacturer/dealer, the lessor in a finance lease makes two profits, namely gross profit on sale and interest on the receivable over time. See AASB 117 para.43. Initial costs to establish a lease agreement do not satisfy the definition of initial direct costs in the standard, para. 4. Instead these initial establishment costs must be treated as an expense when the selling profit is recorded (para. 46). As a consequence of the definition of the interest rate implicit in the lease, these costs are not included in the formula, unlike the initial direct costs incurred by a lessor as financier. Hence, the calculation of the interest rate implicit in the lease for a manufacturer/dealer lessor is different from the calculation for a financier lessor. The establishment costs of a manufacturer/dealer lessor are to be treated as an expense (see AASB 117 paras. 42 and 46). The manufacturer dealer lessor recognises sales revenue at the commencement of the lease equal to the present value of the minimum lease payments, (which equals fair value minus the present value of any unguaranteed residual value). Cost of sales is recorded as the cost minus the present value of any unguaranteed residual value, which the lessor may have to recover by a future sale after the end of the lease agreement. See especially AASB 117 paras. 42 and 44.

Briefly outline the AASB 117 requirements applicable to a lessor accounting for an operating lease.

Para 49: Assets subject to lease are to be presented in the statement of financial position according to their nature. Para 50: Lease income to be recognised on a straight-line basis over the lease term unless another systematic basis is more appropriate. Para 52: Initial direct costs shall be added to the carrying amount of the leased asset and recognised as an expense over the lease term on the same basis as the lease income. Para 53: Depreciation of the lease asset (if appropriate) shall be consistent with the lessor’s normal depreciation policy for similar assets.

10.9

Chapter 10: Leases

Para 56: Disclose information regarding future minimum lease payments for non-cancellable operating leases; contingent rents and a general description of leasing arrangements.

10.

Describe how a lessee accounts for a cash incentive received from the lessor to enter into a non-cancellable operating lease.

In order to induce prospective lessees to enter into non-cancellable operating leases, lessors may offer lease incentives, such as rent-free periods, up-front cash payments or contributions towards lessee expenses such as fit-out or removal costs. However attractive these incentives appear, it is unlikely that they are ‘free’ and the lessor will structure the rental payments so as to recover the costs of the incentives over the lease term. Thus, rental payments will be higher for leases with incentives than for leases that do not offer incentives. AASB 117 is silent with respect to incentives and deals only with accounting for the rental payments made under the operating lease agreement. In June 2004, Interpretation 115 Operating leases - incentives was issued to provide guidance on accounting for incentives by both lessors and lessees. UIG Interpretation 115, paragraph 3, requires that all incentives associated with an operating lease should be regarded as part of the net consideration agreed for the use of the leased asset irrespective of the nature or form of the incentive or the timing of the lease payments. Lessees The aggregate benefit of incentives is treated as a reduction in rental expense over the lease term on a straight-line basis. Another systematic basis other than straight-line can be used if it better represents the diminishment of the benefits of the leased asset to the lessee. Assume a lessee received an upfront cash incentive of $20 000 to enter into a ten-year noncancellable operating lease for office space at $50 000 p.a. The lessee will recognise an annual lease rental expense of $48 000, that is, $50 000 less $2,000 per year. This can be illustrated by journal entries as follows: Cash Liability to lessor

Dr Cr

20 000

Lease expense Liability to lessor Cash

Dr Dr Cr

48 000 2 000

20 000

50 000

Lessors The aggregate cost of the incentives is treated as a reduction in rental income over the lease term on a straight-line basis. 11.

Explain how a profit made by a lessee on a sale and leaseback transaction is to be accounted for.

10.10

Solution Manual to accompany Company Accounting 10e

Accounting for any profit made on the sale in a ‘sale and leaseback transaction’ depends on two factors as follows: (1)

The classification of the leaseback arrangement.

(2)

The relationship of the sales price to the fair value of the asset at the date of sale

If the leaseback is classified as a finance lease then all profit is deferred and amortised over the lease term. If the leaseback is classified as an operating lease and: • Sales price equals fair value – the profit is recognised immediately • Sales price is less than fair value – the profit is recognised immediately unless any loss is compensated for via lower than market lease payments. If this is the case the loss is deferred and amortised. • Sales price is greater than fair value – the ‘normal’ profit is recognised immediately but the excess profit is deferred and amortised over the lease term.

12.

‘The accounting treatment required by AASB 117 (paragraph 59) is not in accordance with the Conceptual Framework.’ Discuss.

AASB 117, paragraph 59 requires that any profit on sale of an asset which is subsequently leased back under a finance lease agreement be deferred and amortised over the lease term. This deferral means that the profit on sale is recognised in the statement of financial position as a liability and then subsequently allocated to income across the lease term. The recognition of deferred profit or gains as a liability in the statement of financial position is not in accordance with the Conceptual Framework. The Conceptual Framework at paragraph 4.4(b) defines a liability as: a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A deferred gain certainly arises from a past transaction – the sale of the asset – but, as there is no future sacrifice in respect of this amount, conceptually it should not be classified and reported as a liability. The definition of income at paragraph 4.4(b) in the Conceptual Framework is: income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

10.11

Chapter 10: Leases

The sale of an asset provides a net cash inflow resulting in an increase in equity during the accounting period thus, clearly giving rise to income. The accounting treatment prescribed by AASB 117, paragraph 59 effectively requires an entity to report income as a liability.

13.

What is the major change to accounting for leases proposed in ED 242 Leases?

In accordance with the proposals in ED 242 Leases: •

The two-way classification of finance and operating leases is no longer going to be used.

•

The new standard is to be a principle-based standard based on definitions of assets and liabilities. A lessee would recognise assets and liabilities for all leases with a maximum possible term of more than 12 months.

•

Both lessees and lessor are to apply a right-of-use model: a lessee recognises a right to use a leased asset and a lease liability for the obligation to pay for that right while a lessor recognises a right to receive lease payments.

•

Whereas many current leases are recognised as operating leases by lessees with no leased asset or obligation being recognised, under the new proposals lease assets and liabilities would be recognised for many current operating leases.

•

Accounting for lease options and contingent rentals will now be treated as part of the lease contract and accounted for as such.

•

Leases are to be classified into Type A (broadly property) and Type B (broadly nonproperty). This classification is relevant to how the lease asset is amortised and how expenses related to the lease are presented.

10.12

Solution Manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Identification of leases

For the following arrangements, discuss whether they are ‘in substance’ lease transactions, and thus fall under the ambit of AASB 117. 1. Entity A leases an asset to Entity B, and obtains a non-recourse loan from a financial institution using the lease rentals and asset as collateral. Entity A sells the asset subject to the lease and the loan to a trustee, and leases the same asset back. 2. Entity A enters into an arrangement to buy petroleum products from Entity B. The products are produced in a refinery built and operated by Entity B on a site owned by Entity A. Although Entity B could provide the products from other refineries which it owns, it is not practical to do so. Entity B retains the right to sell products produced by the refinery to other customers but there is only a remote possibility that it will do so. The arrangement requires Entity A to make both fixed unavoidable payments and variable payments based on input costs at a target level of efficiency to Entity B. 3. Entity A leases an asset to Entity B for its entire economic life and leases the same asset back under the same terms and conditions as the original lease. The two entities have a legally enforceable right to set off the amounts owing to one another, and an intention to settle these amounts on a net basis. 4. Entity A enters into a non-cancellable 4-year lease with Entity B for an asset with an expected economic life of 10 years. Entity A has an option to renew the lease for a further 4 years at the end of the lease term. At the conclusion of the lease arrangement, the asset will revert back to Entity B. In a separate agreement, Entity B is granted a put option to sell the asset to Entity A should its market value at the end of the lease be less than the residual value. Scenario 1 The substance of this arrangement is that Entity A has effectively sub-leased the asset to Entity B and has used the lease income stream to borrow cash. Scenario 2 This arrangement contains a lease in that: • It relates to a specific item – the refinery built on the purchaser’s site • The arrangement conveys the right to use the refinery for an agreed period of time given that there is only a remote possibility that the refinery’s output will be sold to other customers • The purchaser must make fixed unavoidable payments irrespective of whether or not it takes the refinery output. Thus, in substance, the purchaser is leasing the refinery from the seller. Scenario 3 In this example, the terms and conditions and period of each of the leases are the same. Therefore, the risks and rewards incident to ownership of the underlying asset are the same as before the arrangement. Further, the amounts owing are offset against one another, and so there is no retained credit risk. The substance of the arrangement is that no transaction has occurred.

10.13

Chapter 10: Leases

Scenario 4 The existence of the option to lease the asset for another four years, and the put option arrangement which effectively guarantees the residual value of the asset at the end of the lease mean that this is an ‘in substance’ finance lease as substantially all of the risks and rewards associated with the asset are transferred to Entity A.

10.14

Solution Manual to accompany Company Accounting 10e

Case Study 2

Sale and leaseback arrangements

Kapiti Ltd is a company involved in a diverse range of activities involving power generation, machinery retailing and agriculture. The accounting policy note attached to the 2016 financial statements included the following under the heading ‘Leases’: During the year the company entered into a refinancing arrangement which involved the sale of the Lilac Mountain power station under a sale and leaseback arrangement. The difference between the carrying amount of the power station and its original cost has been included in profit and disclosed as a gain on sale of a non-current asset. Sales proceeds in excess of the original cost have been treated as deferred income in the statement of financial position. The amount of deferred income will be systematically amortised over the term of the lease. The power station is a unique asset in that the licence to generate power from that station is held by Kapiti Ltd and cannot be transferred. The leaseback period is for the remaining 20 years economic life of the power station and Kapiti Ltd has guaranteed its expected residual value at that time of $55 000. Required A. Does the Kapiti Ltd sale and leaseback arrangement involve a finance lease or an operating lease? Justify your choice. B. Critically evaluate the accounting treatment adopted by Kapiti Ltd with respect to the sale and leaseback agreement. Refer, where necessary, to relevant sections of AASB 117. C. Compare the resulting deferred income account with the Conceptual Framework/Framework’s definitions of and recognition criteria for the elements of financial statements. A.

AASB 117 defines a finance lease as one which ‘transfers substantially all the risks and rewards incidental to ownership of an asset’. Given that: • Kapiti Ltd is the only entity which can legally operate the power station and obtain the benefits; • the lease term is for the remaining economic life of the power station; and • Kapiti Ltd has guaranteed the expected residual value; The arrangement is a finance lease as all the risks and rewards are transferred from the owner to the lessee.

AASB 117, paragraph 59 states: “If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over carrying amount shall not be immediately recognised as income by a seller-lessee. Instead it shall be deferred and amortised over the lease term.” What Kapiti Ltd has done is to recognise as a gain the difference between the power station’s carrying amount, at the date of sale, and its original cost. All other proceeds have been deferred. This accounting treatment is not in accordance with the standard which requires the entire gain (proceeds – carrying amount) to be deferred and amortised over the lease term. The treatment adopted by Kapiti Ltd is that mandated by AASB 117, paragraph 61 for a gain on sale arising from a sale and leaseback

10.15

Chapter 10: Leases

arrangement which involves an operating lease. As demonstrated in part (a) above this transaction is not an operating lease. C.

Deferral of all or some of the gain results in the creation of a ‘deferred income’ account which is reported on the statement of financial position. This account does not meet the Conceptual Framework’s definition of either an asset or a liability as there are no ‘future economic benefits’ or any ‘present obligation to make a future sacrifice of benefits’ arising from the sale transaction. The transaction gives rise to income in that there has been an increase in economic benefits during the accounting period in the form of cash received from the sale of the power station resulting in a net increase in equity. Accordingly, the ‘gain on sale’ should be recognised immediately in the statement of profit or loss and other comprehensive income as the net increase in equity has occurred and can be reliably measured. Deferral of the gain creates a balance which does not comply with the Conceptual Framework’s definitions.

10.16

Solution Manual to accompany Company Accounting 10e

Case Study 3

Finance leases vs operating leases

Timaru Ltd runs a successful chain of fashion boutiques, but has been experiencing significant cash flow problems. The directors are examining a proposal made by an accounting consultant that all the shops currently owned by the company be sold and either leased back or the businesses moved to alternative leased shops. The directors are keen on the plan but are puzzled by the consultant’s insistence that all lease agreements for the shops be ‘operating’ rather than ‘finance’ leases. Required A. Explain the difference between a finance lease and an operating lease. B. Explain, by reference to the requirements of AASB 117, why the consultant prefers operating to finance leases. C. Describe three disadvantages to the company of entering into finance lease agreements.

AASB 117, paragraph 4 defines a finance lease as ‘an agreement which transfers substantially all the risks and rewards incidental to ownership of an asset.’ An operating lease any lease other than a finance lease.

The differential accounting treatment prescribed by AASB 117 is the reason for advice given by the consultant that all leases are operating. For finance leases, the standard requires the company to recognise a lease asset (the shop) and a lease liability (the present value of the lease payments) at the inception of the lease. Subsequently, the asset is depreciated and interest expense recognised as the liability is reduced by the lease payments. This accounting treatment impacts on both the statement of financial position and statement of profit or loss and other comprehensive income. On the other hand, operating leases are treated as ‘rental arrangements’ with the lease payment recognised as an expense when paid. There is no impact on the statement of financial position.

Disadvantages of entering into finance lease agreements include: • Capitalisation of the leased asset increases non-current asset values and reduces return on asset ratios • Recognition of lease liabilities increases reported liability values adversely affecting the debt/equity ratio and liquidity/solvency ratios such as the current ratio • Reporting additional liabilities may cause a breach of debt covenants meaning that debts become due and payable immediately • Reporting additional liabilities may increase the cost of future borrowings or even adversely affect the company’s capacity to borrow further funds. • Depreciation and interest expense may result in lower reported profits • Depreciation and interest expenses are non tax deductible leading to the recognition of additional deferred tax liabilities • Disclosure requirements are significantly more onerous.

10.17

Chapter 10: Leases

Case Study 4

Sale and leaseback issues

Read the following article written by Cathy Bolt that appeared in The West Australian, 17 February 2007. Bunnings to sell, lease back $200m of stores Buoyed by the strength of the retail property market, Wesfarmers yesterday put a package of 11 of its Bunnings hardware warehouse stores on the block on a sale-and-leaseback basis in a move expected to raise more than $200 million. Over the past decade, it has become standard practice for Bunnings to offload its retail warehouses to external landlords once they are fully developed but the latest sales campaign puts an unprecedented number on the market at once. Bunnings Warehouse Property Trust, set up by Wesfarmers in 1998 to remove the real estate underlying its expanding hardware empire from its balance sheet, confirmed yesterday it would be among the bidders for the portfolio, which would deliver a big step-up in its existing portfolio of 51 Bunnings warehouses, around a third of the retailer’s Australasian big-box network. But investment bank Grant Samuel, appointed to manage the sale process, said it expected competition to be very high. The portfolio is six properties in Australia — Belconnen in the ACT, Penrith and Nowra in NSW, Nerang and Stafford in Queensland and Box Hill in Victoria — and five in New Zealand at Whangarei, Rotorua, Palmerston North, Hamilton and Nae Nae. The initial lease terms are for 12 years followed by two five-year options. Bunnings managing director John Gillam said it had been encouraged by a trend over the past 18 months for investment grade properties bundled together to be keenly sought. Since the initial 20 properties were put into the Bunnings Warehouse Property Trust, the biggest number sold at once was three to Valad Property in 2005. The most recent was a property in North Belmont, NSW, bought by BWPT for $10.85 million on an initial yield of 6.95 per cent rising to 7.2 per cent in March.

Required A. Discuss whether the setup of the Bunning Warehouse Property Trust would achieve the stated aim of removing the real estate from Wesfarmer’s balance sheet (statement of financial position). B. Outline how the trust should account for the leaseback given the lease terms outlined in the article. Support your answer by reference to the requirements of AASB 117. The question of whether or not the setting up of the Property Trust would remove the real estate from the statement of financial position of Wesfarmers depends on nature of the ongoing relationship between the two entities. If Wesfarmers retains control of the Trust then the Trust’s assets (including the real estate) would be included in Wesfarmers consolidated financial statements each year. If control if not retained then the assets would not be reported by Wesfarmers. Given that the lease back arrangements are for a total of 22 years (an initial term of 12 years with options to renew for a further two periods of 5 years) it is likely that this would represent a major part of the economic life of the Bunnings stores and should be accounted for as finance leases by the Trust.

10.18

Solution Manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 10.1

Lease classification

Mansion Ltd manufactures specialised moulding machinery for both sale and lease. On 1 July 2015 Mansion Ltd leased a machine to On The Hill Ltd. The machine being leased cost Mansion Ltd $195 000 to make and its fair value at 1 July 2015 is considered to be $212 515. The terms of the lease are as follows: The lease term is for 5 years, starting on Annual lease payment, payable on 30 June each year Estimated useful life of machine (scrap value $2500) Estimated residual value of machine at end of lease term Residual value guaranteed by On The Hill Ltd Interest rate implicit in the lease The annual lease payment includes an amount of $7500 to cover annual maintenance and insurance costs. On The Hill Ltd may cancel the lease only with the consent of Mansion Ltd On The Hill Ltd intends to lease a new machine at the end of the lease term.

1 July 2015 $57 500 8 years $37 000 $25 000 10%

Required Classify the lease for both Mansion Ltd and On The Hill Ltd. Justify your answer. Both companies will classify the transaction as a finance lease because under the terms of the agreement, substantially all of the risks and rewards incidental to ownership of the machine have been transferred from the lessor to the lessee. This conclusion can be supported by the fact that: • the lease is non-cancellable (by definition), • the machine is to be returned at the end of the lease term with a guaranteed value of $25 000, • the PV of MLP is, at 96.5%, substantially all of the fair value of the machine at the inception of the lease. PV of MLP = $50 000 x 3.7908 [T2 5y 10%] + $25 000 x 0.6209 [T1 5y 10%] = $189 540 + $15 523 = $205 063/212 515 = 96.5%

10.19

Chapter 10: Leases

Question 10.2

Accounting for a finance lease and operating lease by the lessee

On 30 June 2015, Jersey Line Ltd entered into a 10 year finance lease for the right to use equipment. The fair value of the equipment at that inception of the lease is $1 200 000. Lease payments are made in advance on 30 June each year. An extract of the lease repayments schedule is as follows: JERSEY LINE LTD Extract of Lease Payments Schedule Minimum lease Interest Reduction in payments expense liability 30 June 2015 30 June 2015 30 June 2016 30 June 2017

$ 160 000 160 000 160 000

— 98 313 92 144

160 000 61 687 67 856

Balance of liability $ 1 143 131 983 131 921 444 853 588

Required A. Based on the lease repayment schedule, prepare the journal entries of the Jersey Line Ltd to account for the finance lease from 30 June 2015 to 30 June 2017. B. Assume that the agreement is an operating lease and prepare the journal entries of Jersey Line Ltd on that basis. C. Compare the effect of whether the lease is classified as a finance lease or operating lease on the statement of profit or loss and other comprehensive income of Jersey Line Ltd for 30 June 2016 and 30 June 2017. D. Identify two circumstances that can cause the lessor’s lease receivable to differ from the lessee’s lease liability. In this example, will the lease receivable raised by the lessor differ from the lease liability raised by Jersey Line Ltd? PART A – FINANCE LEASE Journal entries 30 June 2015 Leased Equipment Lease Liability (Initial recognition of finance lease) Lease Liability Cash (First lease payment in advance)

Dr Cr

1 143 131

Dr Cr

160 000

Dr Dr Cr

61 687 98 313

1 143 131

160 000

30 June 2016 Lease Liability Interest Expense Cash (Second lease payment in advance)

160 000

10.20

Solution Manual to accompany Company Accounting 10e

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 1, $1 143 131 ÷ 10)

114 313 114 313

30 June 2017 Lease Liability Interest Expense Cash (Third lease payment in advance)

Dr Dr Cr

67 856 92 144

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 2, $1 143 131 ÷ 10)

114 313

160 000

114 313

PART B – OPERATING LEASE Year ended 30 June 2015 30 June 2015 Prepaid Rental Costs Cash (First lease payment)

Dr Cr

160 000

Dr Cr

160 000

Dr Cr

160 000

Dr Cr

160 000

Year ended 30 June 2016 1 July 2015 Rental Expense - Equipment Prepaid Rental Costs (Reversal of prepayment)

160 000

30 June 2016 Prepaid Rental Costs Cash (Second lease payment)

160 000

Year ended 30 June 2017 1 July 2016 Rental Expense - Equipment Prepaid Rental Costs (Reversal of prepayment)

160 000

30 June 2017

10.21

Chapter 10: Leases

Prepaid Rental Costs Cash (Third lease payment)

Dr Cr

160 000 160 000

PART C – EFFECT ON PROFIT OF THE LESSEE Classification as a finance lease results in the lessee recording higher expenses (lower profit) in the earlier years of the lease and lower expenses (higher profit) in the later years of the lease. Finance Lease

Operating Lease

30 June 2016: Rent Expense

$160 000

Interest Expense

$98 313

Depreciation Expense

$114 313 $212 626

$160 000

30 June 2017: Rent Expense

$160 000

Interest Expense

$92 144

Depreciation Expense

$114 313 $206 457

$160 000

PART D One circumstance is where there is an unguaranteed residual value in the lease contract. The lessee will value the leased asset and liability at the present value of the minimum lease payments, as defined in paragraph 4 of the standard, whereas the lease receivable will be valued at the net investment in the lease, which is the present value of the minimum lease payments plus the present value of the unguaranteed residual value, all discounted at the interest rate implicit in the lease (see. para.36 and para. 4 of the standard). A second circumstance is where the lessor is a financier who has incurred initial direct costs. In this case the lessee will value the asset at the lesser amount between fair value and the present value of minimum lease payments. The lessor will value the receivable at fair value plus initial direct costs (see para. 38 of the standard). Neither of the above circumstances are applicable to this example. Therefore, the lease receivable of the lessor should equal the lease liability of the lessee.

10.22

Solution Manual to accompany Company Accounting 10e

Question 10.3

Accounting for a finance lease and operating lease by the lessee

On 1 July 2015, Highway 99 Ltd entered into a finance lease for a motor vehicle. The lease term is for 5 years, at the end of which Highway 99 Ltd pays the guaranteed residual value of $7000 for ownership of the vehicle. Lease payments of $13 000 are paid annually in advance, while the residual is paid at the end of the lease. Highway Ltd is separately responsible for maintenance of the vehicle, and for registration and all insurance costs. Highway 99 Ltd has a year end of 30 June. The lease repayments schedule is as follows: HIGHWAY 99 LTD Extract of Lease Payments Schedule Minimum lease Interest Reduction in payments expense liability 1 July 2015 1 July 2015 1 July 2016 1 July 2017 1 July 2018 1 July 2019 30 June 2020

13 000 13 000 13 000 13 000 13 000 7 000

— 5 668 4 678 3 555 2 280 833

13 000 7 332 8 322 9 445 10 720 6 167

Balance of liability $ 54 986 41 986 34 654 26 332 16 887 6 167

Required A. Based on the lease repayment schedule, prepare the journal entries of Highway 99 Ltd to account for the finance lease from 1 July 2015 to 30 June 2020. B. Assume that lease is classified as an operating lease and prepare the journal entries of Highway 99 Ltd on that basis. C. Compare the financial statement effects of your answers to Part A and Part B for 30 June 2016 PART A – FINANCE LEASE

Year ended 30 June 2016 1 July 2015 Leased Motor Vehicle Lease Liability (Initial recognition of finance lease)

Dr Cr

54 986

Lease Liability Cash (First lease payment)

Dr Cr

13 000

Dr Cr

5 668

54 986

13 000

30 June 2016 Interest Expense Interest Payable (Accrual of interest expense)

5 668

10.23

Chapter 10: Leases

Depreciation Expense Dr 9 597 Accumulated Depreciation Cr (Depreciation for first year, [$54 986 – $7 000] ÷ 5)

9 597

Year ended 30 June 2017 1 July 2016 Lease Liability Interest Payable Cash (Second lease payment)

Dr Dr Cr

7 332 5 668

Dr Cr

4 678

13 000

30 June 2017 Interest Expense Interest Payable (Accrual of interest expense)

4 678

Depreciation Expense Dr 9 597 Accumulated Depreciation Cr (Depreciation for second year, [$54 986 – $7 000] ÷ 5)

9 597

Year ended 30 June 2018 1 July 2017 Lease Liability Interest Payable Cash (Third lease payment)

Dr Dr Cr

8 322 4 678

Dr Cr

3 555

13 000

30 June 2018 Interest Expense Interest Payable (Accrual of interest expense)

Depreciation Expense Dr 9 597 Accumulated Depreciation Cr (Depreciation for third year, [$54 986 – $7 000] ÷ 5)

3 555

9 597

Year ended 30 June 2019 1 July 2018

10.24

Solution Manual to accompany Company Accounting 10e

Lease Liability Interest Payable Cash (Fourth lease payment)

Dr Dr Cr

9 445 3 555

Dr Cr

2 280

13 000

30 June 2019 Interest Expense Interest Payable (Accrual of interest expense)

2 280

Depreciation Expense Dr 9 597 Accumulated Depreciation Cr (Depreciation for fourth year, [$54 986 – $7 000] ÷ 5)

9 597

Year ended 30 June 2020 1 July 2019 Lease Liability Interest Payable Cash (Fifth and final lease payment)

Dr Dr Cr

10 720 2 280

Dr Dr Cr

6 167 833

13 000

30 June 2020 Lease Liability Interest Expense Cash (Payment of guaranteed residual)

7 000

Depreciation Expense Dr 9 598 Accumulated Depreciation Cr (Depreciation for fifth year, [$54 986 – $7 000] ÷ 5) Motor vehicle Accumulated depreciation Leased Motor Vehicle (Leased vehicle => Owned vehicle)

Dr Dr Cr

7 000 47 986

13 000

9 598

54 986

PART B – OPERATING LEASE

Year ended 30 June 2016 1 July 2015 Prepaid Rental Costs

10.25

Chapter 10: Leases

Cash (First lease payment)

13 000

30 June 2016 Rental Expense - Vehicle Prepaid Rental Costs (Adjusting entry for prepayment)

Dr Cr

13 000

Dr Cr

13 000

Dr Cr

13 000

Dr Cr

13 000

Dr Cr

13 000

Dr Cr

13 000

Year ended 30 June 2017 1 July 2016 Prepaid Rental Costs Cash (Second lease payment)

13 000

30 June 2017 Rental Expense - Vehicle Prepaid Rental Costs (Adjusting entry for prepayment)

13 000

Year ended 30 June 2018 1 July 2017 Prepaid Rental Costs Cash (Third lease payment)

13 000

30 June 2018 Rental Expense - Vehicle Prepaid Rental Costs (Adjusting entry for prepayment)

13 000

Year ended 30 June 2019 1 July 2018 Prepaid Rental Costs Cash (Fourth lease payment)

13 000

30 June 2019

10.26

Solution Manual to accompany Company Accounting 10e

Rental Expense - Vehicle Prepaid Rental Costs (Adjusting entry for prepayment)

Dr Cr

13 000

Dr Cr

13 000

Rental Expense - Vehicle Prepaid Rental Costs (Adjusting entry for prepayment)

Dr Cr

13 000

Motor Vehicle Cash (Payment of guaranteed residual)

Dr Cr

7 000

13 000

Year ended 30 June 2020 1 July 2019 Prepaid Rental Costs Cash (Fifth lease payment)

13 000

30 June 2020

13 000

7 000

PART C – FINANCIAL STATEMENT EFFECTS FOR LESSEE

Finance Lease

Operating Lease

30 June 2016: Statement of Financial Position Assets Leased Motor Vehicle (Net)

$45 389

(54 986 less depn 9 597)

Liabilities Lease Liability

41 986

Interest Payable

5 668

Statement of Profit or Loss and Other Comprehensive Income Rent Expense

$13 000

Interest Expense

5 668

Depreciation Expense

9 597

10.27

Chapter 10: Leases

Question 10.4

Accounting for a finance lease by the lessee

On 30 June 2015, Rahway Prison Ltd arranged to lease equipment from Cheapa Finance Co. Limited. At the inception of the lease, the equipment had a fair value of $1 100 000, an estimated useful economic life of 10 years and an estimated scrap value of $Nil. Rahway Prison Ltd intends to purchase the equipment at the end of the lease term for its guaranteed residual value. The lease term is 7 years and payments of $237 692 are due in advance on 30 June each year. The guaranteed residual value of the equipment at the end of the lease term is $200 000. If the lease is cancelled by Rahway Prison Ltd a cancellation payment of $500 000 applies. The interest rate implicit in the lease is 24% p.a. Required A. Explain whether Rahway Prison Ltd should classify the lease as finance lease or an operating lease. B. Prepare the lease repayment schedule. C. On the basis that the lease is a finance lease, prepare the journal entries of Rahway Prison in respect of all years. PART A The lease would be classified by both lessee and lessor as a finance lease as substantially all of the risks and rewards incidental with ownership have been transferred as a result of the lease arrangement. This is evidenced by the fact that: • • •

the lease is non-cancellable because a significant penalty applies the lease term, at 70%, could be argued to represent a major part of the economic life of the machine, and the present value of the minimum lease payments is substantially all of the fair value of the machine at the inception of the lease:

PV of MLP = 237 692 + 237 692 x 3.0205 [T2 24% 6 yrs] + 200 000 x 0.2218 [T1 24% 7 yrs] = 237 692 + 717 948 + 44 360 =1 000 000 PV of MLP ÷ FV= 1 000 000 ÷ 1 100 000 = 91%

PART B – LEASE PAYMENT SCHEDULE Rahway Prison Ltd (Lessee) Schedule of lease payments MLP

Interest

Liability

expense

reduction

balance

10.28

Solution Manual to accompany Company Accounting 10e

30 June 2015

1 000 000

30 June 2015

237 692

762 308

30 June 2016

237 692

182 954

54 738

707 570

30 June 2017

237 692

169 817

67 875

639 695

30 June 2018

237 692

153 527

84 165

555 530

30 June 2019

237 692

133 327

104 365

451 165

30 June 2020

237 692

108 280

129 412

321 753

30 June 2021

237 692

77 221

160 471

161 282

30 June 2022

200 000

38 718*

161 282

–

*includes adjustment for the effect of rounding PART C – JOURNAL ENTRIES 30 June 2015 Leased Equipment Lease Liability (Initial recognition of finance lease)

Dr Cr

1 000 000

Lease Liability Cash (First lease payment in advance)

Dr Cr

237 692

Dr Dr Cr

54 738 182 954

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 1, $1 000 000 ÷ 10)

100 000

30 June 2016 Lease Liability Interest Expense Cash (Second lease payment in advance)

1 000 000

237 692

100 000

30 June 2017 Lease Liability Interest Expense Cash (Third lease payment in advance)

Dr Dr Cr

67 875 169 817

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 2, $1 000 000 ÷ 10)

100 000

237 692

100 000

30 June 2018

10.29

Chapter 10: Leases

Lease Liability Interest Expense Cash (Fourth lease payment in advance)

Dr Dr Cr

84 165 153 527

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 3, $1 000 000 ÷ 10)

100 000

237 692

100 000

30 June 2019 Lease Liability Interest Expense Cash (Fifth lease payment in advance)

Dr Dr Cr

104 365 133 327

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 4, $1 000 000 ÷ 10)

100 000

237 692

100 000

30 June 2020 Lease Liability Interest Expense Cash (Sixth lease payment in advance)

Dr Dr Cr

129 412 108 280

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 5, $1 000 000 ÷ 10)

100 000

237 692

100 000

30 June 2021 Lease Liability Interest Expense Cash (Seventh lease payment in advance)

Dr Dr Cr

160 471 77 221

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 6, $1 000 000 ÷ 10)

100 000

237 692

100 000

30 June 2022 Lease Liability Dr Interest Expense Dr Cash Cr (Payment of guaranteed residual value)

161 282 38 718

Depreciation Expense

100 000

200 000

10.30

Solution Manual to accompany Company Accounting 10e

Accumulated Depreciation Cr (Depreciation for year 7, $1 000 000 ÷ 10) Equipment Dr 300 000 Accumulated depreciation Dr 700 000 Leased Equipment Cr (Leased equipment reclassified to owned equipment)

100 000

1 000 000

10.31

Chapter 10: Leases

Question 10.5

Accounting for a finance lease by the lessee

Florida Sun Ltd has entered into a lease arrangement to acquire the right to use an item of equipment. The terms of the lease are as follows: Inception of the lease and the beginning of the lease term Termination date of the lease Period of the lease Guaranteed residual value at end of the lease term Interest rate implicit in the lease Lease rental amount payable annually in advance Fair value of leased asset

31 December 2015 31 December 2020 5 years $2 715 15% $30 000 $125 000

The lease is non-cancellable. Florida Sun Ltd is responsible for maintaining and insuring the equipment. Florida Sun Ltd returns the equipment to the lessor at the end of the five year lease period. The economic life of the equipment is six years at which time it will have no scrap value. Florida Sun Ltd has a financial year ending 31 December. Required A. Explain whether Florid Sun Ltd should classify the lease as finance lease or an operating lease. B. Prepare the lease repayment schedule. C. Prepare the journal entries of Florida Sun Ltd in respect for the lease for all years assuming it is a finance lease. PART A – LEASE CLASSIFICATION Florida Sun Ltd should classify the lease as a finance lease based on the following: (i) The lease is not cancellable by the lessee (ii) The present value of the minimum lease payments is substantially all of the economic life of the leased asset PV of MLP = 30 000 + 30 000 x 2.8550 [T2 15% 4 yrs] + 2 715 x 0.4972 [T1 15% 5 yrs] = 30 000 + 85 650+ 1 350 =117 000 PV of MLP ÷ FV= 117 000 ÷ 125 000 = 93.6%

(iii) The lease term of 5 years is for a major part of the economic life of the asset (i.e. 5/6 = 83.3%) (iv) The lessee bears all maintenance and insurance costs consistent with ownership Hence it appears from these guidelines that substantially all the risks and benefits incidental to ownership are transferred to the lessee and so the lease is a finance lease.

10.32

Solution Manual to accompany Company Accounting 10e

PART B – LEASE PAYMENT SCHEDULE Florida Sun Ltd (Lessee) Schedule of lease payments MLP

Interest

Liability

expense

reduction

balance

31 Dec 2015

117 000

31 Dec 2015

30 000

87 000

31 Dec 2016

30 000

13 050

16 950

70 050

31 Dec 2017

30 000

10 508

19 492

50 558

31 Dec 2018

30 000

7 584

22 416

28 142

31 Dec 2019

30 000

4 221

25 779

2 363

31 Dec 2020

2 715

352*

2 363

*Includes adjustment for the effect of rounding PART C – JOURNAL ENTRIES

31 December 2015 Leased Equipment Lease Liability (Initial recognition of finance lease)

Dr Cr

117 000

Lease Liability Cash (First lease payment in advance)

Dr Cr

30 000

Dr Dr Cr

16 950 13 050

117 000

30 000

31 December 2016 Lease Liability Interest Expense Cash (Second lease payment in advance)

Depreciation Expense Dr 22 857 Accumulated Depreciation Cr (Depreciation for year 1, [$117 000 – 2 725] ÷ 5)

30 000

22 857

10.33

Chapter 10: Leases

31 December 2017 Lease Liability Interest Expense Cash (Third lease payment in advance)

Dr Dr Cr

19 492 10 508 30 000

Depreciation Expense Dr 22 857 Accumulated Depreciation Cr (Depreciation for year 2, [$117 000 – 2 725] ÷ 5)

22 857

31 December 2018 Lease Liability Interest Expense Cash (Fourth lease payment in advance)

Dr Dr Cr

22 416 7 584 30 000

Depreciation Expense Dr 22 857 Accumulated Depreciation Cr (Depreciation for year 3, [$117 000 – 2 725] ÷ 5)

22 857

31 December 2019 Lease Liability Interest Expense Cash (Fifth lease payment in advance)

Dr Dr Cr

22 416 7 584

Depreciation Expense Dr 22 857 Accumulated Depreciation Cr (Depreciation for year 4, [$117 000 – 2 725] ÷ 5)

30 000

22 857

31 December 2020 Depreciation Expense Dr 22 857 Accumulated Depreciation Cr (Depreciation for year 5, [$117 000 – 2 725] ÷ 5)

Lease Liability Dr 2 363 Interest Expense Dr 352 Leased Equipment Cr (Return of leased asset at guaranteed residual value)

22 857

2 715

10.34

Solution Manual to accompany Company Accounting 10e

Accumulated Depreciation Leased Equipment (De-recognition of leased asset)

Dr Cr

114 285

10.35

Chapter 10: Leases

Question 10.6

Accounting for a finance lease by the lessor

On 1 July 2015, Jane Plum went to the local car yard, North Ltd, and agreed to lease a new Ford Mustang based on an agreed price of $37 000. South Ltd, a local finance company, set up the lease agreement. North Ltd had acquired the car from the manufacturer for $30 000 and transferred the car to South Ltd for $37 000. South Ltd — the lessor — wrote a lease agreement, incurring initial direct costs of $1410 as a result. The lease agreement contained the following provisions:

Initial payment on 1 July 2015 Payments on 1 July 2016 and 1 July 2017 Guaranteed residual value at 30 June 2018 Implicit interest rate in the lease The lease is non-cancellable.

$13 000 $13 000 $10 000 6%

South Ltd agreed to pay for the insurance and maintenance of the vehicle, the latter to be carried out by North Ltd at regular intervals. The required lease payments included the costs for these services at $3000 p.a. The vehicle had an expected useful life of 4 years. The expected residual value of the vehicle at 30 June 2018 was $12 000. Costs of maintenance and insurance incurred by South Ltd over the years ended 30 June 2016 to 30 June 2018 were $2810, $3020 and $2750 respectively. On 30 June 2018, Jane returned the vehicle to South Ltd. On 5 July 2018, South Ltd sold the car to a third party for $9000 and Jane agreed to pay the balance of the guaranteed residual. The lease is classified as a finance lease by South Ltd. Required A. Calculate the net investment in the lease for South Ltd B. Prepare a lease receipts schedule for South Ltd. C. Prepare the journal entries of South Ltd in relation to the lease from 1 July 2015 to 5 July 2018. D. In relation to finance leases, explain why the balance of the lease receivable asset raised by the lessor at the inception of the lease may differ from the balance of the lease liability raised by the lessee. SOUTH LTD (LESSOR) South Ltd is a financier lessor rather than a manufacturer/dealer lessor. The significance of this classification is that: • there is no selling profit to South Ltd on entering into the lease arrangement • initial indirect costs are included the initial recognition of the lease receivable PART A The annual lease receipts that relate to the use of the asset amount to $10 000, that is, the full amount of $13 000 less reimbursement for executory costs $3 000. The guaranteed residual at

10.36

Solution Manual to accompany Company Accounting 10e

the end of the lease is $10 000 and the unguaranteed is $2 000 giving a total of $12 000 at the end of the lease. The lease receivable is initially measured at $38 410 calculated as follows: (1) Fair Value + Initial Direct Costs = $37 000 + $1 410 (2) Net investment in lease = PV of MLP + PV of Unguaranteed Residual Value (UGRV) PV of MLP = 10 000 + 10 000 x 1.8334 [T2 6% 2 yrs] + 10 000 x 0.8396 [T1 6% 3 yrs] = 10 000 + 18 334+ 8 396 =36 730 PV of UGRV = 2 000 x 0.8396 [T1 6% 3 yrs]

= 1 679 Net investment in lease = 36 730 + 1 679 = $38 409 (difference due to rounding) PART B – LEASE RECEIPTS SCHEDULE South Ltd (lessor) Schedule of lease receipts MLR

1 July 2015 1 July 2015 1 July 2016 1 July 2017 30 June 2018

Interest revenue

10 000 10 000 10 000 12 000 42 000

1 705 1 207 678* 3 590

Receivable reduction $ 10 000 8 295 8 793 11 322 38 410

Receivable balance $ 38 410 28 410 20 115 11 322 --

*Includes adjustment for the effect of rounding PART C – JOURNAL ENTRIES

South Ltd (lessor) Journal entries 1 July 2015 Vehicle Cash (Purchase of vehicle by lessor)

Dr Cr

37 000

Lease Receivable

38 410

37 000

10.37

Chapter 10: Leases

Cash Cr Vehicle Cr (Lease of vehicle and payment of initial direct costs) Cash

1 410 37 000

Dr Cr Cr

13 000

Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

3 000

Insurance and Maintenance Expense Cash (Executory costs incurred for the year)

Dr Cr

2 810

Interest Receivable Interest Revenue (Accrual of interest for the year)

Dr Cr

1 705

Dr Cr Cr Cr

13 000

Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

3 000

Insurance and Maintenance Expense Cash (Executory costs incurred for the year)

Dr Cr

3 020

Interest Receivable Interest Revenue (Accrual of interest for the year)

Dr Cr

1 207

Dr Cr

13 000

Unearned Revenue Lease Receivable (First lease receipt in advance)

3 000 10 000

30 June 2016

3 000

2 810

1 705

1 July 2016 Cash Unearned Revenue Interest Receivable Lease Receivable (Second lease receipt in advance)

3 000 1 705 8 295

30 June 2017

3 000

3 020

1 207

1 July 2017 Cash Reimbursement Revenue

3 000

10.38

Solution Manual to accompany Company Accounting 10e

Interest Receivable Lease Receivable (Third lease receipt in advance)

Cr Cr

1 207 8 793

30 June 2018 Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

3 000

Insurance and Maintenance Expense Cash (Executory costs incurred for the year)

Dr Cr

2 750

Vehicle Interest Revenue Lease Receivable (Return of vehicle at end of lease)

Dr Cr Cr

12 000

Cash Accounts Receivable/J Plum Proceeds on Sale of Vehicle (Revenue from sale of vehicle)

Dr Dr Cr

9 000 1 000

Carrying Amount of Vehicle Sold Vehicle (Expense from sale of vehicle)

Dr Cr

12 000

3 000

2 750

678 11 322

5 July 2018

10 000

12 000

PART D – FINANCE LEASE RECEIVABLE V FINANCE LEASE LIABILITY

Two situations in which the lease receivable recorded by lessor is not the same as lease asset recorded by lessee are: 1.

There is an unguaranteed residual value. The lessor records as a lease receivable its net investment in the lease (present value of the minimum lease payments receivable and the present value of any unguaranteed residual value). The lessee, however, records as a leased asset (and lease liability) the present value of the minimum lease payments. The amount recorded by the lessee does not include any unguaranteed residual value.

and/or 2.

If the lessor or lessee has incurred initial direct costs. If lessor (other than a manufacturer/dealer lessor) has incurred initial direct costs then its lease receivable balance is equal to the fair value of the asset plus costs. If the lessee has incurred initial direct costs they are added to the value of the leased asset.

10.39

Chapter 10: Leases

Question 10.7

Accounting for a finance lease by the lessee and lessor

On 1 July 2015, Lions Den Ltd leased a plastic-moulding machine from Jersey City Ltd. The machine cost Jersey City Ltd $130 000 to manufacture and had a fair value of $154 109 on 1 July 2015. The lease agreement contained the following provisions:

Lease term Annual rental payment, in advance on 1 July each year Residual value at end of the lease term Residual guaranteed by lessee Interest rate implicit in lease The lease is cancellable only with the permission of the lessor.

4 years $41 500 $15 000 nil 8%

The expected useful life of the machine is 6 years. Lions Den Ltd intends to return the machine to the lessor at the end of the lease term. Included in the annual rental payment is an amount of $1500 to cover the costs of maintenance and insurance paid for by the lessor. Required A. Explain why the lease should be classified as a finance lease by both lessee and lessor based on the guidance provided in AASB 117. B. Prepare (1) the lease payment schedule for the lessee (show all workings); and (2) the journal entries in the accounting records of the lessee for all years of the lease. C. Prepare (1) the lease receipt schedule for the lessor (show all workings); and (2) the journal entries in the accounting records of the lessor for all years of the lease. PART A – CLASSIFICATION OF LEASE The lease would be classified by both lessee and lessor as a finance lease as substantially all of the risks and rewards incidental with ownership have been transferred as a result of the lease arrangement. This is evidenced by the fact that: • the lease is non-cancellable (by definition), • the lease term, at 67%, could be argued to represent a major part of the economic life of the machine, and • the present value of the minimum lease payments is substantially all of the fair value of the machine at the inception of the lease: PV of MLP = 40 000 + 40 000 x 2.5771 [T2 8% 3 yrs] = 40 000 + 103 084 = 143 084/154 109 = 93% The lease payments for the use of the asset are $40 000 per annum, that is, $41 500 total less $1 500 for reimbursement of executory costs.

PART B – ACCOUNTING BY LESSEE

10.40

Solution Manual to accompany Company Accounting 10e

(1)

Lease payment schedule Lions Den Ltd (Lessee) Schedule of lease payments\ MLP

1 July 2015 1 July 2015 1 July 2016 1 July 2017 1 July 2018

(2).

Interest expense $

Liability reduction $

40 000 40 000 40 000 40 000 160 000

8 247 5 706 2 963 16 916

40 000 31 753 34 294 37 037 143 084

Liability balance $ 143 084 103 084 71 331 37 037 -

Journal entries Lions Den Ltd (Lessee)

1 July 2015 Leased Machine Lease Liability (Inception of lease)

Dr Cr

143 084

Lease Liability Prepaid Ins & Maintenance Cash (First lease payment in advance)

Dr Dr Cr

40 000 1 500

Ins & Maintenance Expense Prepaid Ins & Maintenance (Adjusting entry for prepayment)

Dr Cr

1 500

Interest Expense Interest Payable (Interest accrued at year end)

Dr Cr

8 247

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 1, $143 084 ÷ 4)

35 771

143 084

41 500

30 June 2016

1 500

8 247

35 771

1 July 2016 Lease Liability Interest Payable Prepaid Ins & Maintenance

Dr Dr Dr

31 753 8 247 1 500

10.41

Chapter 10: Leases

Cash (Second lease payment in advance)

41 500

30 June 2017 Ins & Maintenance Expense Prepaid Ins & Maintenance (Adjusting entry for prepayment)

Dr Cr

1 500

Interest Expense Interest Payable (Interest accrued at year end)

Dr Cr

5 706

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 2, $143 084 ÷ 4)

35 771

1 500

5 706

35 771

1 July 2017 Lease Liability Interest Payable Prepaid Ins & Maintenance Cash (Third lease payment in advance)

Dr Dr Dr Cr

34 294 5 706 1 500

Ins & Maintenance Expense Prepaid Ins & Maintenance (Adjusting entry for prepayment)

Dr Cr

1 500

Interest Expense Interest Payable (Interest accrued at year end)

Dr Cr

2 963

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 3, $143 084 ÷ 4)

35 771

41 500

30 June 2018

1 500

2 963

35 771

1 July 2018 Lease Liability Interest Payable Prepaid Ins & Maintenance Cash (Fourth lease payment in advance)

Dr Dr Dr Cr

37 037 2 963 1 500

1 500

41 500

30 June 2019 Ins & Maintenance Expense

10.42

Solution Manual to accompany Company Accounting 10e

Prepaid Ins & Maintenance (Adjusting entry for prepayment)

1 500

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation for year 4, $143 084 ÷ 4)

35 771

Accumulated Depreciation Leased Machine (De-recognition of lease asset)

143 084

Dr Cr

35 771

143 084

PART C – ACCOUNTING BY LESSOR Jersey City Ltd is a manufacturer/dealer lessor. The significance of this classification is that: • there is a selling profit to Jersey City Ltd on entering into the lease arrangement • initial indirect costs are not included the initial recognition of the lease receivable but treated as part of the sale transaction The lease receivable is initially measured at the fair value of $154 109 calculated as follows: Net investment in lease = PV of MLP + PV of Unguaranteed Residual Value (UGRV) PV of MLP = 40 000 + 40 000 x 2.5771 [T2 8% 3 yrs] = 40 000 + 103 084 =143 084 PV of UGRV = 15 000 x 0.7350 [T1 8% 4 yrs]

= 11 025 Net investment in lease = 143 084 + 11 025 = $154 109 (1)

Lease receipts schedule

Jersey City Ltd (Lessor) Lease receipts schedule MLR $ 1 July 2015 1 July 2015 1 July 2016 1 July 2017 1 July 2018 30 June 2019

40 000 40 000 40 000 40 000 15 000

Interest revenue $

9 129 6 659 3 992 1 111

Receivable reduction $

Receivable balance $

40 000 30 871 33 341 36 008 13 889

154 109 114 109 83 238 49 897 13 889 -

10.43

Chapter 10: Leases

175 000

20 891

154 109

10.44

Solution Manual to accompany Company Accounting 10e

(1)

Journal Entries

Jersey City Ltd (Lessor) 1 July 2015 Lease Receivable Dr 154 109 Inventory Cr Cost of Sales Dr *118 975 Sales Revenue Cr (Inception of lease) (* Cost less PV of UGRV [15 000 x 0.735]) (** PV of MLP) Cash

Dr Cr Cr

41 500

Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

1 500

Interest Receivable Dr Interest Revenue Cr (Interest revenue accrued at year end)

9 129

Unearned Revenue Lease receivable (First lease receipt in advance)

130 000 **143 084

1 500 40 000

30 June 2016

1 500

9 129

1 July 2016 Cash

Dr Cr Cr Cr

41 500

Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

1 500

Interest Receivable Dr Interest Revenue Cr (Interest revenue accrued at year end)

6 659

Interest Receivable Unearned Revenue Lease receivable (Second lease receipt in advance)

9 129 1 500 30 871

30 June 2017

1 500

6 659

10.45

Chapter 10: Leases

1 July 2017 Cash

Dr Cr Cr Cr

41 500

Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

1 500

Interest Receivable Dr Interest Revenue Cr (Interest revenue accrued at year end)

3 992

Interest Receivable Unearned Revenue Lease receivable (Third lease receipt in advance)

6 659 1 500 33 341

30 June 2018

1 500

3 992

1 July 2018 Cash

Dr Cr Cr Cr

41 500

Unearned Revenue Dr Reimbursement Revenue Cr (Adjusting entry for unearned revenue)

1 500

Inventory Interest Revenue Lease Receivable (Return of equipment at lease end)

15 000

Interest Receivable Unearned Revenue Lease receivable (Fourth lease receipt in advance)

3 992 1 500 36 008

30 June 2019

Dr Cr Cr

1 500

1 111 13 889

The lessor would also record insurance and maintenance expenses during the lease term for the insurance and maintenance costs it incurs in relation to the plastic moulding machine.

10.46

Solution Manual to accompany Company Accounting 10e

Question 10.8

Accounting for a finance lease by the lessee and the lessor

On 1 July 2015, Standing Ltd leased a processing plant to Fell Ltd. The plant was purchased by Standing Ltd on 1 July 2015 for its fair value of $467 112. The lease agreement contained the following provisions: Lease term Economic life of plant Annual rental payment, in arrears (commencing 30/6/2016) Residual value at end of the lease term Residual guaranteed by lessee Interest rate implicit in lease The lease is cancellable only with the permission of the lessor.

3 years 5 years $150 000 $90 000 $60 000 7%

Fell Ltd intends to return the processing plant to the lessor at the end of the lease term. The lease has been classified as a finance lease by both the lessee and the lessor. Required A. Prepare (1) the lease payment schedule for the lessee (show all workings); and (2) the journal entries in the records of the lessee for all years of the lease. B. Prepare (1) the lease receipt schedule for the lessor (show all workings); and (2) the journal entries in the records of the lessor for all years of the lease. PART A – ACCOUNTING BY THE LESSEE

FELL LTD 1.

Lease payment schedule Fell Ltd (Lessee) Schedule of lease payments MLP $

1 July 2015 30 June 2016 30 June 2017 30 June 2018 30 June 2018

150 000 150 000 150 000 60 000 510 000

Interest expense $

30 984 22 652 13 741 67 377

Liability reduction $

119 016 127 348 136 259 60 000 442 623

Liability balance $ *442 623 323 607 196 259 60 000 -

Workings

10.47

Chapter 10: Leases

PV of MLP

= $150 000 x 2.6243 [T2 7% 3y] + $60 000 x 0.8163 [T1 7% 3y] = $393 645 + $48 978 = $442 623*

Journal entries

Fell Ltd (Lessee) 1 July 2015 Leased Processing Plant Dr Lease Liability Cr (Initial recognition of finance lease)

442 623 442 623

30 June 2016 Lease Liability Interest Expense Cash (First lease payment in arrears)

Dr Dr Cr

119 016 30 984

Depreciation Expense Accumulated Depreciation (Depreciation for year 1) [(442 623 – 60 000)/3]

Dr Cr

127 541

Lease Liability Interest Expense Cash (Second lease payment in arrears)

Dr Dr Cr

127 348 22 652

Depreciation Expense Accumulated Depreciation (Depreciation for year 2) [(442 623 – 60 000)/3]

Dr Cr

127 541

Dr Dr Cr

136 259 13 741

Depreciation Expense Accumulated Depreciation (Depreciation for year 3) [(442 623 – 60 000)/3]

Dr Cr

127 541

Lease Liability

60 000

150 000

127 541

30 June 2017

30 June 2018 Lease Liability Interest Expense Cash (Third lease payment in arrears)

150 000

127 541

150 000

127 541

10.48

Solution Manual to accompany Company Accounting 10e

Leased Processing Plant (Return of plant to lessor)

Accumulated Depreciation Leased Processing Plant (De-recognition of leased asset)

Dr Cr

60 000

382 623 382 623

PART B – ACCOUNTING BY THE LESSOR

STANDING LTD 1. Lease receipts schedule Standing Ltd (Lessor) Lease receipts schedule MLR $ 1 July 2015 30 June 2016 30 June 2017 30 June 2018 30 June 2018

150 000 150 000 150 000 90 000 540 000

Interest revenue $

Receivable reduction $

32 698 24 487 15 703 72 888

117 302 125 513 134 297 90 000 467 112

Receivable balance $ 467 112 349 810 224 297 90 000 -

Net investment in lease = P.V. of MLP + P.V of unguaranteed residual value (UGRV) = $442 623 + 30 000 x 0.8163 [T1 7% 3y] = $467 112

2. Journal entries Christchurch Ltd (Lessor) Journal entries 1 July 2015 Processing Plant Cash (Acquisition of plant)

Dr Cr

467 112

Lease Receivable Dr Plant Cr (Initial recognition of finance lease)

467 112

10.49

Chapter 10: Leases

30 June 2016 Cash Interest revenue Lease receivable (First lease receipt in arrears)

Dr Cr Cr

150 000

Dr Cr Cr

150 000

Dr Cr Cr

150 000

Dr Cr

90 000

32 698 117 302

30 June 2017 Cash Interest Revenue Lease Receivable (Second lease receipt in arrears)

24 487 125 513

30 June 2018 Cash Interest Revenue Lease Receivable (Third lease receipt in arrears) Processing Plant Lease Receivable (Return of plant at end of lease)

15 703 134 297

90 000

10.50

Solution Manual to accompany Company Accounting 10e

Question 10.9

Accounting for a finance lease by the lessee and lessor

On 1 July 2015, River Bridge Ltd leased a crane from Shield Ltd. The crane cost Shield Ltd $120 307, considered to be its fair value on that same day. The finance lease agreement contained the following provisions: The lease term is for 3 years, starting on The lease is non-cancellable Annual lease payment, payable on 30 June each year Estimated useful life of crane Estimated residual value of crane at end of lease term Residual value guaranteed by River Bridge Ltd Interest rate implicit in the lease The lease was classified as a finance lease by both River Bridge Ltd and Shield Ltd at 1 July 2015. The crane is returned to Shield Ltd at the end of the lease.

1 July 2015 $39 000 4 years $22 000 $16 000 7%

Required A. Prepare (1) the lease payment schedule for the lessee (show all workings); and (2) the lease receipt schedule for the lessor (show all workings). B. Prepare the journal entries in the records of the lessee for all years of the lease. C. Prepare the journal entries in the records of the lessor for all years of the lease. PART A – LEASE SCHEDULES 1. lease repayment schedule River Bridge Ltd (lessee) Schedule of lease payments MLP $ 1 July 2015 30 June 2016 30 June 2017 30 June 2018 30 June 2018

Interest expense $

Liability reduction $

Liability balance $ 115 409 84 488 51 402 16 000 -

39 000 39 000 39 000 16 000

8 079 5 914 3 598 -

30 921 33 086 35 402 16 000

133 000

17 591

115 409

PV of MLP = (39 000 x 2.6243 [T2 7% 3y]) + (16 000 x 0.8163 [T1 7% 3y]) = 102 348 + 13 061 = 115 409 2. lease receipts schedule

10.51

Chapter 10: Leases

Shield Ltd (lessor) Schedule of lease receipts MLR $ 1 July 2015 30 June 2016 30 June 2017 30 June 2018 30 June 2018

Interest Revenue $

Receivable reduction $

Receivable balance $ 120 307 89 728 57 009 22 000 -

39 000 39 000 39 000 22 000

8 421 6 281 3 991 -

30 579 32 719 35 009 22 000

139 000

18 693

120 307

Net investment in lease = PV of MLP + PV of Unguaranteed residual value (UGRV) = 115 409 + 6 000 x 0.8163 [T1 7% 3y]) = 120 307 PART B – JOURNALS OF THE RIVER BRIDGE LTD (LESSEE) 1 July 2015 Leased Crane Dr 115 409 Lease Liability Cr (Recognition of lease asset and lease liability at the inception of the lease).

115 409

30 June 2016 Lease Liability Interest Expense Cash (First lease payment in arrears)

Dr Dr Cr

30 921 8 079 39 000

Depreciation Expense Dr 33 136 Accumulated depreciation Cr (Depreciation = ($115 409 - $16 000)/3 years)

33 136

30 June 2017 Lease Liability Interest Expense Cash (Second lease payment in arrears)

Dr Dr Cr

33 086 5 914

Depreciation Expense Dr 33 136 Accumulated depreciation Cr (Depreciation = ($115 409 - $16 000)/3 years)

39 000

33 136

10.52

Solution Manual to accompany Company Accounting 10e

30 June 2018 Lease Liability Interest Expense Cash (Third lease payment in arrears)

Dr Dr Cr

35 402 3 598 39 000

Depreciation Expense Dr 33 137 Accumulated depreciation Cr (Depreciation = ($115 409 - $16 000)/3 years)

33 137

Lease Liability Leased Crane (Return of leased asset)

Dr Cr

16 000 16 000

Accumulated Depreciation Leased Crane (De-recognition of leased asset)

Dr Cr

99 409 99 409

PART C – JOURNALS OF THE SHIELD LTD (LESSOR) 1 July 2015 Crane Machine Cash (Purchase of crane).

Dr Cr

120 307

Lease Receivable Crane Asset (Recognition of lease receivable at the inception of the lease).

Dr Cr

120 307

Dr Cr Cr

39 000

Dr Cr Cr

39 000

120 307

30 June 2016 Cash Interest Revenue Lease Receivable (First lease receipt in arrears)

8 421 30 579

30 June 2017 Cash Interest Revenue Lease Receivable (Second lease receipt in arrears)

6 281 32 719

30 June 2018 Cash

10.53

Chapter 10: Leases

Interest Revenue Lease Receivable (Third lease receipt in arrears)

Cr Cr

Crane Machine Lease Receivable (Return of crane at end of lease)

Dr Cr

3 991 35 009

22 000

10.54

Solution Manual to accompany Company Accounting 10e

Question 10.10 Accounting for a finance lease by the lessee Hardup Ltd agreed to lease a motor vehicle from Forcash Ltd that had a fair value at 30 June 2015 of $38 960. The lease agreement contained the following provisions: Lease term (non-cancellable) Annual rental payments (commencing 30/6/15) Guaranteed residual value (expected fair value at end of lease term) Extra rental per annum if the car is used outside the metropolitan area

3 years $11 200 $12 000 $1 000

The expected useful life of the vehicle is 5 years. At the end of the 3-year lease term, the car was returned to the lessor, which sold it for $10 000. The annual rental payments include an amount of $1200 to cover the cost of maintenance and insurance arranged and paid for by the lessor. The car was used outside the metropolitan area in the year to 30 June 2017. The lease is considered to be a finance lease. Required A. Determine the interest rate implicit in the lease. B. Prepare the lease payments schedule of Hardup Ltd. C. Prepare the journal entries of Hardup Ltd for the whole of the lease period. D. Prepare the relevant disclosures of Hardup Ltd required by AASB 117 for the year ending 30 June 2017 including comparatives. E. How would the initial measurement of the lease liability change if the guaranteed residual value was only $10 000, and the expected fair value at the end of the lease term was $12 000? PART A – INTEREST RATE IMPLICIT IN THE LEASE MLP = the minimum lease payments UGRV = the unguaranteed residual value FV = the fair value of the leased asset IDC = initial direct costs of the lessor. The interest rate implicit in the lease is the discount rate that makes: PV of MLP + PV of UGRV = FV + IDC

By trial and error, or a financial calculator, determine the interest rate of 5%: 10 000 now 10 000 x 1.8594 (annuity for 2 years at 5%) 12 000 x 0.8638 (PV of sum in 3 years at 5%) Total

= = = =

$10 000 $18 594 $10 366 $38 960

The minimum lease payments do not include the costs of maintenance and insurance (executory costs) hence, lease payments relevant to MLP = 11 200 – 1 200 = $10 000 each year.

10.55

Chapter 10: Leases

PART B – LEASE PAYMENTS SCHEDULE Hardup Ltd Lease payments schedule MLP $ 30 June 2015 30 June 2015 30 June 2016 30 June 2017 30 June 2018

Interest expense $

10 000 10 000 10 000 12 000 42 000

Liability reduction $

Liability balance $

10 000 8 552 8 980 11 428 38 960

1 448 1 020 572 3 040

38 960 28 960 20 408 11 428 --

PART C – JOURNAL ENTRIES OF HARDUP LTD (LESSEE) Journal entries 30 June 2015 Leased Vehicle Dr Lease Liability Cr (Recognition of lease asset and liability)

38 960

Lease Liability Prepaid Executory Costs Cash (1st lease payment in advance)

10 000 1 200

Dr Dr Cr

1 July 2015 Executory Costs Expense Dr Prepaid Executory Costs Cr (Executory costs expense for 2015-2016)

38 960

11 200

1 200 1 200

30 June 2016 Lease Liability Interest Expense Prepaid Executory Costs Cash (2nd lease payment in advance)

Dr Dr Dr Cr

8 552 1 448 1 200

Depreciation Expense Accumulated Depreciation

Dr Cr

8 987

11 200

8 987

10.56

Solution Manual to accompany Company Accounting 10e

(Depreciation year 1 = 1/3($38 960 - $12 000))

1 July 2016 Executory Costs Expense Dr Prepaid Executory Costs Cr (Executory costs expense for 2016-2017)

1 200 1 200

30 June 2017 Lease Liability Interest Expense Prepaid Executory Costs Cash (3rd lease payment in advance)

Dr Dr Dr Cr

8 980 1 020 1 200

Contingent Rental Expense Cash (Contingent rental paid for the year)

Dr Cr

1 000

Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation year 2 = 1/3($38 960 - $12 000))

1 July 2017 Executory Costs Expense Dr Prepaid Executory Costs Cr (Executory costs expense for 2017-2018)

11 200

1 000

8 987 8 987

1 200 1 200

30 June 2018 Depreciation Expense Dr Accumulated Depreciation Cr (Depreciation year 3 = 1/3($38 960 - $12 000))

8 987

Lease Liability Interest Expense Leased Vehicle (Return of vehicle to lessor)

Dr Dr Cr

11 428 572

Accumulated Depreciation Leased Vehicle (De-recognition of leased asset)

Dr Cr

26 960

Loss on Guaranteed Residual Value Cash

Dr Cr

2 000

8 987

12 000

26 960

2 000

10.57

Chapter 10: Leases

(Payment required under guarantee)

10.58

Solution Manual to accompany Company Accounting 10e

PART D – NOTE DISCLOURES OF HARDUP LTD 30 JUNE 2017 (LESSEE) Accounting policies Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases The entity as a lessee Assets held under finance leases are recognised as assets of the entity at their fair value at the date of acquisition or, if lower, at the present value of the minimum lease payments. The corresponding liability to the lessor is included in the statement of financial position as a finance lease liability. Lease payments are apportioned between finance charges and reduction of the lease liability to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income, unless they are directly attributable to qualifying assets, in which case they are capitalised in accordance with the entity’s general policy on borrowing costs. Property plant and equipment

Leased Motor Vehicles at cost Accumulated Depreciation

2017

2016

38 960 (17 974) 20 986

38 960 (8 987) 29 973

Finance Lease Liabilities Minimum Lease Payments 2017 2016 Amounts payable under finance leases: Within one year 12 000 After one year but not more than five years Total minimum lease payments 12 000 Less finance charges ( 572) Present value of minimum lease payments 11 428

10 000 12 000 22 000 (1 592) 20 408

Present Value of Payments 2017 2016 Amounts payable under finance leases: Within one year 11 428 After one year but not more than five years Present value of minimum lease payments 11 428

9 524 10 884 20 408

In respect of finance leases the following item has been recognised as an expense during the period: 2017 2016 Contingent rent 1 000 0 Contingent rent is payable if the lease vehicle is driven outside of the metropolitan area.

10.59

Chapter 10: Leases

PART E – LEASE LIABILITY

If the guaranteed residual value were $10 000, then, although the interest rate implicit in the lease stays at 5%, the lessee must record the leased asset and liability at the PV of the MLP, namely $37 232, calculated as follows: $10 000 deposit $10 000 x 1.8594 (PV of annuity for 2 years at 5%) $10 000 x 0.8638 (PV of future sum in 3 years at 5%)

10 000 18 594 8 638 37 232

The lease schedule would then be as follows: MLP $ 30 June 2015 30 June 2015 30 June 2016 30 June 2017 30 June 2018

10 000 10 000 10 000 10 000 40 000

Interest expense $

Liability reduction $

1 362 930 476 2 768

10 000 8 638 9 070 9 524 37 232

Liability balance $ 37 232 27 232 18 594 9 524 --

All payment journals would change to reflect the new interest expense and reduction in liability amounts. Depreciation expense per annum will change to 1/3($37 232 - $10 000) = $9 077. No payment would be required under the guarantee.

10.60

Solution Manual to accompany Company Accounting 10e

Question 10.11

Accounting for a sale and leaseback transaction by the lessee and lessor

Squeal Ltd is asset rich but cash poor. In an attempt to alleviate its liquidity problems, it entered into an agreement on 1 July 2015 to sell its processing plant to Tyres Ltd for $467 100. At the date of sale, the plant had a carrying amount of $400 000 and a future useful life of 5 years. Tyres Ltd immediately leased the processing plant back to Squeal Ltd. The terms of the lease agreement were: Lease term Economic life of plant Annual rental payment, in arrears (commencing 30/6/16) Residual value of plant at end of lease term Residual value guaranteed by Squeal Ltd Interest rate implicit in the lease The lease is cancellable, but only with the permission of the lessor.

3 years 5 years $165 000 $90 000 $60 000 6%

At the end of the lease term, the plant is to be returned to Tyres Ltd. In setting up the lease agreement Tyres Ltd incurred $9414 in legal fees and stamp duty costs. The annual rental payment includes $15 000 to reimburse the lessor for maintenance costs incurred on behalf of the lessee. Required A. Explain why the lease should be classified as a finance lease by both the lessor and lessee. B. Prepare a lease payments schedule and the journal entries in the records of Squeal Ltd for the lease. Show all workings. C. Prepare a lease receipts schedule and the journal entries in the records of Tyres Ltd for the lease. Show all workings. D. Explain how and why your answers to requirements A and B would change if the lease agreement could be cancelled at any time without penalty. E. Explain how and why your answer to requirements A, B and C would change if the processing plant had been manufactured by Tyres Ltd at a cost of $400 000. SALE AND LEASEBACK TRANSACTION Squeal Ltd (Seller) Squeal Ltd (Lessee) and Tyres Ltd (Lessor) If a sale and leaseback transaction results in a finance lease any excess of proceeds over the carrying amount shall not be immediately recognised as income by a seller-lessee. Instead, it shall be deferred and amortised over the lease term.

10.61

Chapter 10: Leases

PART A - CLASSIFICATION OF THE LEASE Both the lessor and the lessee must determine whether the lease agreement effectively transfers substantially all of the risks and rewards from the owner to the lessee. In this case, based on the following evidence, both parties should conclude that such a transfer is achieved and the lease should be classified as a finance lease: •

the lease is non-cancellable (by definition)

•

the lease term at 60% which, arguably, is for a major part of the asset’s economic life, and

•

the PV of the MLP at 96.6% represents substantially all of the asset’s fair value (see calculation below)

PV of MLP Minimum Lease Payments = ($165 000 – $15 000) x 3 [rentals net of executory costs] + $60 000 [GRV] Interest Rate 6% Pattern of Payments - Arrears PV of MLP = $150 000 x 2.6730 [T2 6% 3 years] + $60 000 x 0.8396 [T1 6% 3 years] = $400 950 + $50 376 = $451 326 PV/FV

= $451 326/$467 100 = 96.6%

10.62

Solution Manual to accompany Company Accounting 10e

PART B – LEASE PAYMENTS SCHEDULE AND JOURNALS 1. Lease repayment schedule Squeal Ltd (Lessee) Lease Payments Schedule Date

MLP $

1 July 2015 30 June 2016 30 June 2017 30 June 2018 30 June 2018

Interest Expense $

150 000 150 000 150 000 60 000 510 000

Reduction of liability $

27 080 19 704 11 890 58 674

122 920 130 296 138 110 60 000 451 326

Balance of lease liability $ 451 326 328 406 198 110 60 000 -

2. Accounting for the lease in the books of Squeal Ltd (lessee)

Journal Entries 1 July 2015 Cash Deferred gain on sale Processing plant (Sale of plant under sale and leaseback agreement)

Dr Cr Cr

467 100

Leased plant Dr Lease liability Cr (Recognition of lease agreement)

451 326

Lease liability Dr Interest expense Dr Executory costs expense Dr Cash Cr (First lease payment in arrears)

122 920 27 080 15 000

Depreciation expense Dr Accumulated depreciation Cr (Depreciation of leased asset [($451 326 – 60 000)/3]

130 442

Deferred gain on sale

22 367

67 100 400 000

451 326

30 June 2016

165 000

130 442

10.63

Chapter 10: Leases

Revenue on sale Cr (Amortisation of deferred gain - $67 100/3)

22 367

30 June 2017 Lease liability Dr Interest expense Dr Executory costs expense Dr Cash Cr (Second lease payment in arrears)

130 296 19 704 15 000

Depreciation expense Dr Accumulated depreciation Cr (Depreciation of leased asset [($451 326 – 60 000)/3]

130 442

165 000

130 442

Deferred gain on sale Dr 22 367 Revenue on sale Cr (Amortisation of deferred gain - $67 100/3)

22 367

30 June 2018 Lease liability Dr Interest expense Dr Executory costs expense Dr Cash Cr (Third lease payment in arrears)

138 110 11 890 15 000

Depreciation expense Dr Accumulated depreciation Cr (Depreciation of leased asset [($451 326 – 60 000)/3]

130 442

165 000

130 442

Deferred gain on sale Dr 22 367 Revenue on sale Cr (Amortisation of deferred gain - $67 100/3)

22 367

Lease liability Dr Leased plant Cr (Return of leased asset to lessor)

60 000 60 000

Leased plant Dr Accumulated depreciation Cr (De-recognition of leased asset)

391 326 391 326

PART C – LEASE RECEIPTS SCHEDULE AND JOURNALS © John Wiley and Sons Australia, Ltd 2015

10.64

Solution Manual to accompany Company Accounting 10e

Lessor is a financier lessor (i.e. non-maufacturer/non-dealer) therefore: Net investment in the lease = fair value of leased asset + initial indirect costs = 467 100 + 9 414 = $476 514 Net investment in the lease = PV of MLP + PV of UGRV = 451 326 + 30 000 x 0.8396 [T1 6% 3 years] = $476 514 1. Lease receipts schedule Tyres Ltd (Lessor) Lease Receipts Schedule Date

MLR $

1 July 2015 30 June 2016 30 June 2017 30 June 2018 30 June 2018

150 000 150 000 150 000 90 000 540 000

Interest Revenue $

Reduction in Receivable $

28 591 21 306 13 589 63 486

121 409 128 694 136 411 90 000 476 514

Balance of lease Receivable $ 476 514 355 105 226 411 90 000 -

2. Accounting for the lease in the books of Tyres Ltd (lessor) Journal Entries 1 July 2015 Processing plant Dr Cash Cr (Purchase of plant from Squeal Ltd)

467 100

Lease receivable Dr Processing plant Cr (Recognition of lease agreement)

467 100

Lease receivable Dr Cash Cr (Payment of initial direct costs)

9 414

467 100

9 414

10.65

Chapter 10: Leases

30 June 2016 Cash Dr Lease receivable Cr Interest revenue Cr Reimbursement revenue Cr (First lease receipt in arrears)

165 000

Maintenance expense Dr Cash/Payable Cr (Maintenance costs incurred)

15 000

Cash Dr Lease receivable Cr Interest revenue Cr Reimbursement revenue Cr (Second lease receipt in arrears)

165 000

Maintenance expense Dr Cash/Payable Cr (Maintenance costs incurred)

15 000

Cash Dr Lease receivable Cr Interest revenue Cr Reimbursement revenue Cr (Third lease receipt in arrears)

165 000

Maintenance expense Dr Cash/Payable Cr (Maintenance costs incurred)

15 000

Processing plant Dr Lease receivable Cr (Return of processing plant)

90 000

121 409 28 591 15 000

15 000

30 June 2017

128 694 21 306 15 000

15 000

30 June 2018

136 411 13 589 15 000

15 000

90 000

10.66

Solution Manual to accompany Company Accounting 10e

PART D – LEASE CANCELLABLE WITHOUT PENALTY As the lease is now cancellable without penalty the lease can no longer be classified as a finance lease and thus should be treated as an operating lease. The consequences are: From Squeal Ltd’s perspective 1. 2. 3. 4.

the leased asset is not capitalised – no asset/liability is raised on 1 July 2015 the profit on the sale of the processing plant can be recognised immediately in the statement of profit or loss and other comprehensive income the lease payment is treated as an expense item when paid. no depreciation expense is recorded Journal Entries

1 July 2015 Cash Gain on sale Processing plant (Sale of plant under sale and leaseback agreement)

Dr Cr Cr

467 100

Rental expense Dr Executory costs expense Dr Cash Cr (First lease payment in arrears)

150 000 15 000

Rental expense Dr Executory costs expense Dr Cash Cr (Second lease payment in arrears)

150 000 15 000

Rental expense Dr Executory costs expense Dr Cash Cr (Third lease payment in arrears)

150 000 15 000

67 100 400 000

30 June 2016

165 000

30 June 2017

165 000

30 June 2018

165 000

10.67

Chapter 10: Leases

PART E – LESSOR A MANUFACTURER/DEALER If Tyres Ltd had manufactured the plant at cost of $400 000 then this would not be a sale and leaseback transaction. Accordingly, the following changes to the answer would occur: • •

Tyres Ltd (lessor) would record the initial direct costs as an expense The lease receivable recorded by Tyres Ltd would revert back to the fair value of $467 100 and the interest rate implicit in the lease would change to approx. 7%*. * $150 000 x 2.6243 + $90 000 x 0.8163 = $393 645 + $73 467 = $467 112

•

The initial entry to record the lease in Tyres Ltd’s books would change to: Lease receivable Dr 467 100 Sales revenue Cr Cost of sales Dr **375 523 Processing plant Cr (Initial recognition of lease and recording sale of plant)

*442 623 400 000

* Using 7%, PV of MLP = $150 000 x 2.6243 + $60 000 x 0.8163 **[$400 000 (cost of plant) less $24 489 (PV of unguaranteed residual value) = $30 000 x 0.8163]

Lease establishment expense Dr Cash Cr (Payment of establishment costs)

9 414 9 414

Thus, a profit on ‘sale’ of $67 100 (net of initial direct costs) would be recorded. •

Squeal Ltd (lessee) would have no ‘sale’ of plant entries and would simply record the leased asset/lease liability. As a result there would be no amortisation of the gain over the lease term.

10.68

Solution Manual to accompany Company Accounting 10e

Question 10.12 Accounting for a finance lease by the lessee and lessor Paradise Ltd has entered into an agreement to lease a D9 bulldozer to Thunder Road Ltd. The lease agreement details are as follows: Length of lease Commencement date Annual lease payment, payable 30 June each year commencing 30 June 2016 Fair value of the bulldozer at 1 July 2015 Estimated economic life of the bulldozer Estimated residual value of the plant at the end of its economic life Residual value at the end of the lease term, of which 50% is guaranteed by Thunder Road Ltd Interest rate implicit in the lease

5 years 1 July 2015 $8 000 $34 797 8 years $2 000 $7 200 9%

The lease is cancellable, but a penalty equal to 50% of the total lease payments is payable on cancellation. Thunder Road Ltd does not intend to buy the bulldozer at the end of the lease term. Paradise Ltd incurred $1000 to negotiate and execute the lease agreement. Paradise Ltd purchased the bulldozer for $34 797 just before the inception of the lease. Required A. Explain why the lease should be classified as a finance lease by both the lessor and lessee. B. Prepare a schedule of lease payments and the journal entries for Thunder Road Ltd in respect of the lease for the lease term. C. Prepare a schedule of lease receipts and the journal entries for Paradise Ltd in respect of the lease for the lease term. D. Prepare an appropriate note to the financial statements for both companies as at 30 June 2016. PART A – LEASE CLASSIFICATION The lease should be classified by both parties as a finance lease as substantially all of the risks and rewards incidental with ownership of the bulldozer have been transferred from the lessor to the lessee as indicated by the following: • • •

the lease is non-cancellable (by definition), the lease term, at 62.5%, which is, arguably, a major part of the bulldozer’s economic life, but the present value of the minimum lease payments is substantially all of the fair value of the asset at the lease inception, as calculated below: PV of MLP = $8 000 x 3.8897 [T2 9% 5 yrs] + $3 600 x 0.649931 [T1 9% 5yrs] = $33 457 this is equal to 96.1% of fair value at lease inception

PART B – ACCOUNTING BY THE LESSEE

10.69

Chapter 10: Leases

The lease is initially measured at the lower of fair value of the leased asset and the present value of the minimum lease payments. Fair value of leased asset = $34 797 PV of MLP = $33 457 Thunder Road Ltd (Lessee) Lease payment schedule Date

MLP

Interest

Liability

Balance of

expense

reduction

liability

1 July 2015

33 457

30 June 2016

8 000

3 011

4 989

28 468

30 June 2017

8 000

2 562

5 438

23 030

30 June 2018

8 000

2 073

5 927

17 103

30 June 2019

8 000

1 539

6 461

10 642

30 June 2020

8 000

958

7 042

3 600

30 June 2020

3 600

43 600

10 143

33 457

Journal entries for Thunder Road Ltd (lessee) 1 July 2015 Leased bulldozer Dr Lease liability Cr (Recognition of leased asset and lease liability)

33 457 33 457

30 June 2016 Lease liability Interest expense Cash (First lease payment in arrears)

Dr Dr Cr

4 989 3 011

Depreciation expense Accumulated depreciation (Depreciation of leased asset [(33 457 – 3 600) 5]

Dr Cr

5 971

8 000

5 971

30 June 2017

10.70

Solution Manual to accompany Company Accounting 10e

Lease liability Dr Interest expense Dr Cash Cr (Second lease payment in arrears)

5 438 2 562

Depreciation expense Accumulated depreciation (Depreciation of leased asset [(33 457 – 3 600) 5]

Dr Cr

5 971

Lease liability Interest expense Cash (Third lease payment in arrears)

Dr Dr Cr

5 927 2 073

Depreciation expense Accumulated depreciation (Depreciation of leased asset [(33 457 – 3 600) 5]

Dr Cr

5 971

Lease liability Dr Interest expense Dr Cash Cr (Fourth lease payment in arrears)

6 461 1 539

Depreciation expense Accumulated depreciation (Depreciation of leased asset [(33 457 – 3 600) 5]

Dr Cr

5 971

Lease liability Interest expense Cash (Fifth lease payment in arrears)

Dr Dr Cr

7 042 958

Depreciation expense Accumulated depreciation (Depreciation of leased asset [(33 457 – 3 600) 5]

Dr Cr

5 973

Lease liability Leased bulldozer

Dr Cr

3 600

8 000

5 971

30 June 2018

8 000

5 971

30 June 2019

8 000

5 971

30 June 2020

8 000

5 973

3 600

10.71

Chapter 10: Leases

(Return of bulldozer to lessor) Lease liability Leased bulldozer (De-recognition of leased asset)

Dr Cr

29 857 29 857

PART C – ACCOUNTING BY THE LESSOR The lease is initially measured at the net investment in the lease. Lessor is a financier lessor (i.e. non-maufacturer/non-dealer) therefore: Net investment in the lease = fair value of leased asset + initial indirect costs = 34 797 + 1 000 = $35 797 Net investment in the lease = PV of MLP + PV of UGRV = 33 457 + 3 600 x 0.6499 [T1 9% 5yrs] = $35 797

Paradise Ltd (Lessor) Lease receipts schedule Year ended

Receivable

Interest

Receivable

Balance of

revenue

reduction

receivable

1 July 2015

35 797

30 June 2016

8 000

3 222

4 778

31 019

30 June 2017

8 000

2 792

5 208

25 811

30 June 2018

8 000

2 323

5 677

20 134

30 June 2019

8 000

1 812

6 188

13 946

30 June 2020

8 000

1 254

6 746

7 200

30 June 2020

7 200

47 200

11 403

35 797

Journal entries for Paradise Ltd (lessor) 1 July 2015 Bulldozer Cash (Purchase of bulldozer)

Dr Cr

34 797 34 797

10.72

Solution Manual to accompany Company Accounting 10e

Lease receivable Dr Bulldozer Cr Cash Cr (Recognition of lease receivable and payment of initial direct costs)

35 797 34 797 1 000

30 June 2016 Cash Dr Lease receivable Cr Interest revenue Cr (Receipt of first lease payment in arrears)

8 000 4 778 3 222

30 June 2017 Cash Dr Lease receivable Cr Interest revenue Cr (Receipt of second lease payment in arrears)

8 000 5 208 2 792

30 June 2018 Cash Dr Lease receivable Cr Interest revenue Cr (Receipt of third lease payment in arrears)

8 000 5 677 2 323

30 June 2019 Cash Dr Lease receivable Cr Interest revenue Cr (Receipt of fourth lease payment in arrears)

8 000 6 188 1 812

30 June 2020 Cash Dr Lease receivable Cr Interest revenue Cr (Receipt of fifth lease payment in arrears) 30 June 2020 Bulldozer Dr Lease receivable Cr (Return of bulldozer from lessee)

8 000 6 746 1 254

7 200 7 200

10.73

Chapter 10: Leases

PART D – NOTE DISCLOSURES Paradise Ltd (lessor) Disclosure notes for year ended 30 June 2015 Accounting policies Leasing Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases The entity as a lessor Amounts due from lessees under finance leases are recorded as receivable at the amount of the entity’s net investment in the leases. Finance lease income is allocated to accounting periods so as to reflect a constant periodic rate of return on the entity’s net investment outstanding in respect of the leases. Finance Lease Receivables PV of Investment

PV of Investment

in lease receivable

2016

2015

8 000

5 208

After one year but not more than five years 31 200

25 811

Total minimum lease payments receivable 39 200

31 019

Amounts receivable under finance leases: Within one year

Less unearned finance income

( 8 181)

Present value of minimum lease payments 31 019 Unguaranteed residual values of assets leased under finance leases at the reporting date are estimated at $3 600 (2015 $nil)

10.74

Solution Manual to accompany Company Accounting 10e

Thunder Road Ltd (lessee) Accounting policies Leasing Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases The entity as a lessee Assets held under finance leases are recognised as assets of the entity at their fair value at the date of acquisition or, if lower, at the present value of the minimum lease payments. The corresponding liability to the lessor is included in the statement of financial position as a finance lease liability. Lease payments are apportioned between finance charges and reduction of the lease liability to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income, unless they are directly attributable to qualifying assets, in which case they are capitalised in accordance with the entity’s general policy on borrowing costs. Leased asset – net carrying amount The carrying amount of the entity’s plant and equipment includes an amount of $27 486 (2015 $nil) Finance Lease Liabilities PV of Minimum

PV of Minimum

Lease Payments

2016

2015

8 000

5 438

After one year but not more than five years 27 600

23 030

Total minimum lease payments

35 600

28 468

Less finance charges

( 7 132)

Amounts payable under finance leases: Within one year

Present value of minimum lease payments 28 468

10.75

Chapter 10: Leases

Question 10.13 Accounting for a finance lease with leaseback variations by the lessee and lessor On 1 July 2015, Foundout Ltd acquired an item of plant for $31 864. On the same date, Foundout Ltd entered into a lease agreement with Hardway Ltd in relation to the asset. According to the lease agreement, Hardway Ltd agreed to pay $12 000 immediately, with a further two payments of $12 000 on 1 July 2016 and 1 July 2017. At 30 June 2018, the asset is to be returned to the lessor and its residual value is expected to be $6000. Hardway Ltd has agreed to guarantee the expected residual value at 30 June 2018. The payments by Hardway Ltd include insurance and maintenance costs of $2000 p.a. The costs of preparing the lease agreement amounted to $360. The interest rate implicit in the lease is 9%. The lease is classified as a finance lease. Plant is depreciable on a straight-line basis. Required A. Prepare a schedule of lease receipts for Foundout Ltd and the journal entries from 1 July 2015 to 30 June 2018. B. Prepare a schedule of lease payments for Hardway Ltd and the journal entries from 1 July 2015 to 30 June 2018. C. Assume that Hardway Ltd guaranteed a residual value of only $4000. Prepare the lease schedules of Foundout Ltd and Hardway Ltd if this is the case. D. Instead of acquiring the plant for $31 864, assume that Foundout Ltd manufactured the plant at a cost of $29 500 before entering into the lease agreement with Hardway Ltd. Prepare a schedule of lease receipts for Foundout Ltd and the journal entries for the year ended 30 June 2016. E. Assume that Hardway Ltd manufactured the plant itself at a cost of $29 500 and sold the plant to Foundout Ltd for $31 864. Hardway Ltd then leased it back under the original terms of the finance lease, with Hardway Ltd guaranteeing a residual value of $4000. Prepare a lease schedule and journal entries for both Foundout Ltd and Hardway Ltd for the year ended 30 June 2016. PART A – ACCOUNTING BY THE LESSOR

Lease receipts schedule of Foundout Ltd (lessor) Workings: • Annual payment of $12 000 includes $2 000 executory cost reimbursement • Lessor incurred $360 initial direct costs (costs of preparing lease agreement). AASB 117, paragraph 38 requires that initial direct costs must be included as part of the lease receivable (unless the lessor is a manufacturer/dealer). The interest rate implicit in the lease is defined in such a way that the initial direct costs are automatically included in the finance lease receivable. • AASB 117, paragraph 36 requires the lessors to recognise a receivable equal to the net investment of the lease (PV of MLP receivable and PV of UGRV) Calculations Present value of the initial lease payment on 1 July 2015 Present value of two lease payments ($10 000 x 1.7591*)

$10 000 17 591

10.76

Solution Manual to accompany Company Accounting 10e

Present value of the guaranteed residual value ($6 000 x 0.7722**) 4 633 Present Value of Minimum Lease Payments: 32 224 This figure is equal to the fair value of the asset $31 864 plus the lessor’s initial direct costs $360. * **

based on an annuity rate on 2 years at 9% based on a single payment at the end of year 3 at 9%

Foundout Ltd (lessor) Schedule of lease receipts MLR

Interest

Receivable

Revenue

reduction

balance

9% 1 July 2015

32 224

1 July 2015

10 000

22 224

1 July 2016

10 000

2 000

8 000

14 224

1 July 2017

10 000

1 280

8 720

5 504

30 June 2018

6 000

496

5 504

NIL

36 000

3 776

32 224

10.77

Chapter 10: Leases

Journal entries of Foundout Ltd (lessor) 1 July 2015 Plant

Dr Cr

31 864

Lease receivable Plant Cash (Recognition of receivable for leased asset & payment of initial direct costs)

Dr Cr Cr

32 224

Cash

Dr Cr Cr

12 000

Unearned revenue Reimbursement revenue (Reimbursement revenue recognition)

Dr Cr

2 000

Ins. & maintenance expense Cash/Payable (Executory costs incurred during the year)

Dr Cr

2 000

Interest receivable Interest revenue (Accrual for interest revenue at year end)

Dr Cr

2 000

Dr Cr Cr Cr

12 000

Unearned revenue Reimbursement revenue (Reimbursement revenue recognition)

Dr Cr

2 000

Ins. & maintenance expense Cash/Payable (Executory costs incurred during the year)

Dr Cr

2 000

Cash (Acquisition of plant)

Lease receivable Unearned revenue (Receipt of 1st payment in advance)

31 864

31 864 360

10 000 2 000

30 June 2016

2 000

1 July 2016 Cash Interest receivable Lease receivable Unearned revenue (Receipt of 2nd payment in advance)

2 000 8 000 2 000

30 June 2017

2 000

10.78

Solution Manual to accompany Company Accounting 10e

Interest receivable Interest revenue (Accrual for interest revenue at year end)

Dr Cr

1 280

Dr Cr Cr Cr

12 000

Unearned revenue Reimbursement revenue (Reimbursement revenue recognition)

Dr Cr

2 000

Ins. & maintenance expense Cash/Payable (Executory costs incurred during the year)

Dr Cr

2 000

Plant

Dr Cr Cr

6 000

1 280

1 July 2017 Cash Interest receivable Lease receivable Unearned revenue (Receipt of 3rd payment in advance)

1 280 8 720 2 000

30 June 2018

Interest revenue Lease receivable (Return of leased asset from lessee)

2 000

496 5 504

10.79

Chapter 10: Leases

PART B – ACCOUNTING BY THE LESSEE

Lease payments schedule of Hardway Ltd (lessee) AASB 117 requires the lessee to recognise finance lease assets/liabilities at ‘amounts equal to fair value of leased property or, if lower, the present value of minimum lease payments’ (paragraph 20). In this case, using an interest rate of 9%, the PV of MLP ($32 224) is higher than fair value ($31 864) due to the existence of the lessor’s initial direct costs of $360 being included in the implicit rate of 9%, as well as a 100% guaranteed residual value. As the value of the lessee’s asset/liability is restricted to a maximum of fair value, the interest implicit in the lease must be recalculated for the lessee as follows: Using a 10% rate: $10 000 + $10 000 x 1.7355 [T2 10% 2y] + $6 000 x 0.7513 [T1 10% 3y] = $10 000 + $17 355 + $4 508 = $31 864 (fair value) Hardway Ltd (lessee) Schedule of lease payments MLP

Interest

Liability

Expense

reduction

balance

10% 1 July 2015

31 864

1 July 2015

10 000

21 864

1 July 2016

10 000

2 186

7 814

14 050

I July 2017

10 000

1 405

8 595

5 455

1 July 2018

6 000

545

5 455

36 000

4 136

31 864

Nil

10.80

Solution Manual to accompany Company Accounting 10e

Journal entries of Hardway Ltd (lessee) 1 July 2015 Leased equipment Dr Lease liability Cr (Recognition of lease asset and lease liability at the inception of the lease).

31 864

Lease liability Prepaid executory costs Cash st (1 lease payment in advance)

Dr Dr Cr

10 000 2 000

Executory costs expense Prepaid executory costs (Adjusting entry for prepayment)

Dr Cr

2 000

Interest expense Interest payable (Accrual of interest at year end)

Dr Cr

2 186

Depreciation expense Accumulated depreciation (Depreciation of the leased asset*)

Dr Cr

8 621

31 864

12 000

30 June 2016

2 000

2 186

8 621

As ownership is not expected to be transferred to the lessee at the end of the lease term, the asset should be depreciated over the lease term (i.e. over 3 years). Depreciation of $8 621 is calculated as follows: $8 621 = ($31 864 - $6 000)/3 years

1 July 2016 Interest payable Lease liability Prepaid executory costs Cash (2nd lease payment in advance)

Dr Dr Dr Cr

2 186 7 814 2 000

Executory costs expense Prepaid executory costs (Adjusting entry for prepayment)

Dr Cr

2 000

Interest expense Interest payable (Accrual of interest at year end)

Dr Cr

1 405

12 000

30 June 2017

12 000

1 405

10.81

Chapter 10: Leases

Depreciation expense Accumulated depreciation (Depreciation of the leased asset)

Dr Cr

8 621

Dr Dr Dr Cr

1 405 8 595 2 000

Executory costs expense Prepaid executory costs (Adjusting entry for prepayment)

Dr Cr

2 000

Depreciation expense Accumulated depreciation (Depreciation of the leased asset)

Dr Cr

8 622

Lease liability Interest expense Leased equipment (Return of leased asset to lessor)

Dr Dr Cr

5 455 545

Accumulated depreciation Leased equipment (De-recognition of leased asset)

Dr Cr

25 864

8 621

1 July 2017 Interest payable Lease liability Prepaid executory costs Cash (3rd lease payment in advance)

12 000

30 June 2018

12 000

8 622

6 000

25 864

10.82

Solution Manual to accompany Company Accounting 10e

PART C – CHANGE IN GUARANTEED RESIDUAL VALUE If the guaranteed residual value is $4 000, then an unguaranteed residual value of $2 000 arises, that is, $6 000 - $4 000. Foundout Ltd (lessor) For Foundout Ltd, as the total residual value is unchanged the receipts schedule is identical to part A. Both the guaranteed and unguaranteed residual are included in the calculation of the net investment in the lease. HardwayLtd (lessee) For Hardway Ltd, as the guaranteed residual value has changed the present value of the minimum lease payments will need to be recalculated as follows, using the implicit rate of 9% PV of MLP Present value of the initial lease payment on 1 July 2014 Present value of two lease payments ($10 000 x 1.7591*) Present value of the guaranteed residual value ($4 000 x 0.7722**) Present Value of Minimum Lease Payments: * based on an annuity rate on 2 years at 9% ** based on a single payment at the end of year 3 at 9% •

$10 000 17 591 3 089 30 680

the payments schedule must now start with a liability of $30 680:

Hardway Ltd (lessee) Schedule of lease payments MLP

Interest expense 9%

Liability reduction

1 July 2015

Liability balance 30 680

1 July 2015

10 000

20 680

1 July 2016

10 000

1 861

8 139

12 541

1 July 2017

10 000

1 129

8 871

3 670

30 June 2018

4 000

330

3 670

NIL

34 000

3 320

30 680

10.83

Chapter 10: Leases

PART D – MANUFACTURER/DEALER LESSOR As Foundout Ltd is now a manufacturer lessor, AASB 117 paragraph 42 requires a profit or loss to be recorded with respect to the plant at the commencement of the lease and the establishment costs to be recognised as an expense when the selling profit is recognised. Foundout Ltd’s net investment in the lease is now equal to $31 864 and the interest rate implicit in the lease is 10%. The initial direct costs of $360 are not included in the lease receivable. Foundout Ltd (lessor) Schedule of lease receipts MLR Interest Receivable Revenue reduction 10% 1/7/2015

Receivable balance 31 864

1/7/2015

10 000

21 864

1/7/2016

10 000

2 186

7 814

14 050

1/7/2017

10 000

1 405

8 595

5 455

30/6/2018

6 000

545

5 455

NIL

36 000

4 136

31 864

Journal entries of Foundout Ltd (lessor) 1 July 2015 Lease receivable Sales revenue* Cost of sales** Inventory (Initial recognition of lease receivable and recording sale of plant)

Dr Cr Dr Cr

31 864 31 864 29 500 29 500

*Sales revenue = fair value as there is a 100% guaranteed residual value **Cost of sales = carrying amount as there is a 100% guaranteed residual value Lease establishment expenses Cash (Payment of establishment costs)

Dr Cr

360

Cash

Dr Cr Cr

12 000

Lease receivable Unearned revenue (Receipt of 1st payment in advance)

360

10 000 2 000

10.84

Solution Manual to accompany Company Accounting 10e

30 June 2016 Unearned revenue Reimbursement revenue (Reimbursement revenue recognition)

Dr Cr

2 000

Executory costs expense Cash (Executory costs incurred for the year)

Dr Cr

2 000

Interest receivable Interest revenue (Accrual for interest at year end)

Dr Cr

2 186

2 000

2 186

PART E – SALE AND LEASEBACK The schedules are the same as for Part C.

Foundout Ltd (lessor) Schedule of lease receipts MLR Interest Receivable Revenue reduction 9% 1 July 2015 1 July 2015 1 July 2016 1 July 2017 30 June 2018

10 000 10 000 10 000 6 000 36 000

2 000 1 280 496 3 776

10 000 8 000 8 720 5 504 32 224

Hardway Ltd (lessee) Schedule of lease payments MLP Interest Liability expense reduction 9% 1 July 2015 1 July 2015 1 July 2016 1 July 2017 30 June 201

10 000 10 000 10 000 4 000 34 000

1 861 1 129 330 3 320

10 000 8 139 8 871 3 670 30 680

Receivable balance 32 224 22 224 14 224 5 504 NIL

Liability balance 30 680 20 680 12 541 3 670 NIL

Hastings Ltd has entered into a sale & leaseback transaction. As the lease is a finance lease AASB 117, paragraph 59, requires that any excess of sales proceeds over the carrying amount of the plant be deferred and amortised over the lease term.

10.85

Chapter 10: Leases

Journal entries of Hardway Ltd (seller and lessee)

1 July 2015 Cash

Dr Inventory Cr Deferred gain on sale Cr (Sale of plant and recognition of excess proceeds as a deferred gain)

31 864 29 500 2 364

Leased equipment Dr Lease liability Cr (Recognition of lease asset and lease liability at the inception of the lease).

30 680

Lease liability Prepaid executory costs Cash (First lease payment in advance)

Dr Dr Cr

10 000 2 000

Executory costs expense Prepaid executory costs (Adjusting entry for prepayment)

Dr Cr

2 000

Interest expense Interest payable (Accrual of interest for the year)

Dr Cr

1 861

Depreciation expense Accumulated depreciation (Depreciation of the leased asset (30 680 – 4,000)/3 = 8 893))

Dr Cr

8 893

30 680

12 000

30 June 2016

12 000

1 861

Deferred gain on sale Dr 788 Gain on sale of leased plant Cr (Amortisation of deferred gain over lease term: $2 364/3 = $788)

8 893

788

Journal entries of Foundout Ltd (buyer and lessor)

The journal entries for Foundout Ltd are the same as Part A.

10.86

Solution Manual to accompany Company Accounting 10e

Question 10.14 Accounting for a finance lease by manufacturer lessor Loot Ltd manufactures specialised moulding machinery for both sale and lease. On 1 July 2015, Loot Ltd leased a machine to Hotinpursuit Ltd, incurring $1500 in costs to prepare and execute the lease document. The machine being leased cost Loot Ltd $195 000 to make and its fair value at 1 July 2015 is considered to be $212 515. The terms of the lease agreement are as follows: Lease term commencing on 1 July 2015 Annual lease payment commencing on 1 July 2016 Estimated useful life of machine (scrap value $2500) Estimated residual value of machine at end of lease term Residual value guaranteed by Hotinpursuit Ltd Interest rate implicit in the lease The lease is classified as a finance lease.

5 years $57 500 8 years $37 000 $25 000 10%

The annual lease payment includes an amount of $7500 to cover annual maintenance and insurance costs. Actual executory costs incurred for each of the 5 years were: 2015–16 $ 7 200 2016–17 7 700 2017–18 7 800 2018–19 7 100 2019–20 7 000 Hotinpursuit Ltd may cancel the lease but will incur a penalty equivalent to 2 years payments if it does so. Hotinpursuit Ltd intends to lease a new machine at the end of the lease term. The end of the reporting period for both companies is 30 June. Required A. Prepare a schedule of lease receipts for Loot Ltd. B. Prepare the journal entries of Loot Ltd in respect of the finance lease. C. Assume the lease is classified as an operating lease and Loot Ltd paid Hotinpursuit Ltd $50 000 on 1 July 2015 to enter into the agreement. Prepare the journal entries of Loot Ltd in respect of the operating lease from 1 July 2015 to 1 July 2017. Loot Ltd is a manufacturer/dealer lessor. Hence its initial direct costs for the lease are treated as part of the sale transaction rather than part of the lease transaction. PART A – SCHEDULE OF LEASE RECEIPTS PV of MLP = 96.5% of FV at the date of the lease inception [$50 000 (3.7908) + $25 000(.6209)

= =

$189 540 + $15 523 $205 063

PV/FV

$205 063/$212 515

10.87

Chapter 10: Leases

PV of UGRV

96.5%

= =

$12 000 x 0.6209 $7 450

Loot Ltd (Lessor) Schedule of Lease Receipts Year ending

1/7/15 1/7/16 1/7/17 1/7/18 1/7/19 1/7/20 1/7/20

MLR

50 000 50 000 50 000 50 000 50 000 37 000 287 000

Interest revenue (10%)

Reduction of receivable

21 252 18 377 15 214 11 736 7 906 74 485

28 748 31 623 34 786 38 264 42 094 37 000 212 515

Balance of receivable 212 515 183 767 152 144 117 358 79 094 37 000 -

PART B – JOURNAL ENTRIES OF LESSOR FOR FINANCE LEASE 1 July 2015 Lease receivable Cost of sales Inventory Sales revenue

Dr Dr Cr Cr

212 515 187 550

Lease arrangement expense Cash

Dr Cr

1 500

195 000 205 065

1 500

10.88

Solution Manual to accompany Company Accounting 10e

30 June 2016 Executory costs expense Cash/Payable

Dr Cr

7 200

Interest receivable Interest revenue

Dr Cr

21 252

Receivable for executory costs Reimbursement revenue

Dr Cr

7 500

Dr Cr Cr Cr

57 500

Executory costs expense Cash/Payable

Dr Cr

7 700

Interest receivable Interest revenue

Dr Cr

18 377

Receivable for executory costs Reimbursement revenue

Dr Cr

7 500

Dr Cr Cr Cr

57 500

Executory costs expense Cash/Payable

Dr Cr

7 800

Interest receivable Interest revenue

Dr Cr

15 214

Receivable for executory costs Reimbursement revenue

Dr Cr

7 500

7 200

21 252

7 500

1 July 2016 Cash Interest receivable Lease receivable Receivable for executory costs

21 252 28 748 7 500

30 June 2017

7 700

18 377

7 500

1 July 2017 Cash Interest receivable Lease receivable Receivable for executory costs

18 377 31 623 7 500

30 June 2018

7 800

15 214

7 500

10.89

Chapter 10: Leases

1 July 2018 Cash Interest receivable Lease receivable Receivable for executory costs

Dr Cr Cr Cr

57 500

Executory costs expense Cash/Payable

Dr Cr

7 100

Interest receivable Interest revenue

Dr Cr

11 736

Receivable for executory costs Reimbursement revenue

Dr Cr

7 500

Dr Cr Cr Cr

57 500

Executory costs expense Cash/Payable

Dr Cr

7 000

Interest receivable Interest revenue

Dr Cr

7 906

Receivable for executory costs Rimbursement revenue

Dr Cr

7 500

Cash Interest receivable Lease receivable Receivable for executory costs

Dr Cr Cr Cr

57 500

Inventory Lease receivable

Dr Cr

37 000

15 214 34 786 7 500

30 June 2019

7 100

11 736

7 500

1 July 2019 Cash Interest receivable Lease receivable Receivable for executory costs

11 736 38 264 7 500

30 June 2020

7 000

7 906

7 500

1 July 2020

7 906 42 094 7 500

37 000

10.90

Solution Manual to accompany Company Accounting 10e

PART C – JOURNAL ENTRIES OF LESSOR FOR OPERATING LEASE 1 July 2015 Lease arrangement expense Cash

Dr Cr

1 500

Lease incentive asset Cash

Dr Cr

50 000

Rent and other receivable Rent revenue Reimbursement revenue Lease incentive asset

Dr Cr Cr Cr

57 500

Executory costs expense Cash/Payable

Dr Cr

7 200

Depreciation expense Accumulated depreciation [(195 000 – 2 500) ÷ 8]

Dr Cr

24 062

Dr Cr

57 500

Rent and other receivable Rent revenue Reimbursement revenue Lease incentive asset

Dr Cr Cr Cr

57 500

Executory costs expense Cash/Payable

Dr Cr

7 700

Depreciation expense Accumulated depreciation [(195 000 – 2 500) ÷ 8]

Dr Cr

24 062

Dr Cr

57 500

1 500

50 000

30 June 2016

40 000 7 500 10 000

7 200

24 062

1 July 2016 Cash Rent and other receivable

57 500

30 June 2017

40 000 7 500 10 000

7 700

24 062

1 July 2017 Cash Rent and other receivable

57 500

10.91

Chapter 10: Leases

Question 10.15 Accounting for a finance lease by the lessee and lessor On 1 July 2015, Wellington Ltd acquired a new car. The manager of Wellington Ltd, Jack Wellington, went to the local car yard, Hamilton Autos, and discussed the price of a new Racer Special with John Hamilton. Jack and John agreed on a price of $37 876. As Hamilton Autos had acquired the vehicle from the manufacturer for $32 000, John was pleased with the deal. On discussing the financial arrangements in relation to the car, Jack decided that a lease arrangement was the most suitable. John agreed to arrange for Dunedin Ltd, a local finance company, to set up the lease agreement. Hamilton Autos then sold the car to Dunedin Ltd for $37 876. Dunedin Ltd wrote a lease agreement, incurring initial direct costs of $534 in the process. The lease agreement contained the following clauses: Initial payment on 1 July 2015 Payments on 1 July 2016 and 1 July 2017 Interest rate implicit in the lease

$13 000 $13 000 6%

The lease agreement also specified for Dunedin Ltd to pay for the insurance and maintenance of the vehicle, the latter to be carried out by Hamilton Autos at regular intervals. A cost of $3000 p.a. was included in the lease payments to cover these services. Jack wanted the lease to be considered an operating lease for accounting purposes. To achieve this, the lease agreement was worded as follows: • The lease is cancellable by Wellington Ltd at any stage. However, if the lease is cancelled, Wellington Ltd agrees to lease, on similar terms, another car from Dunedin Ltd. • Wellington Ltd is not required to guarantee the payment of any residual value. At the end of the lease term, 30 June 2018, or if cancelled earlier, the car automatically reverts to the lessor with no payments being required from Wellington Ltd. The vehicle had an expected economic life of 6 years. The expected fair value of the vehicle at 30 June 2018 was $12 000. Because of concern over the residual value, Dunedin Ltd required Jack to sign another contractual arrangement separate from the lease agreement which gave Dunedin Ltd the right to sell the car to Wellington Ltd if the fair value of the car at the end of the lease term was less than $10 000. Costs of maintenance and insurance paid by Dunedin Ltd to Hamilton Autos over the years ended 30 June 2016 to 30 June 2018 were $2810, $3020 and $2750. At 30 June 2018, Jack returned the vehicle to Dunedin Ltd. The fair value of the car was determined by to be $9000. Dunedin Ltd invoked the second agreement. With the consent of Wellington Ltd, Dunedin Ltd sold the car to Hamilton Autos for a price of $9000 on 5 July 2018, and invoiced Wellington Ltd for $1000. Wellington Ltd subsequently paid this amount on 13 July 2018. Required Assuming the lease is classified as a finance lease, prepare the following: A. Schedule of lease payments for Wellington Ltd. B. Journal entries of Wellington Ltd for the lease from 1 July 2015 to 13 July 2018. C. Schedule of lease receipts for Dunedin Ltd. D. Journal entries of Dunedin Ltd for the lease from 1 July 2015 to 13 July 2018. PART A - Schedule of lease payments for lessee, Wellington Ltd

10.92

Solution Manual to accompany Company Accounting 10e

PV of MLP = $10 000 + ($10 000 x 1.8334) + ($10 000 x 0.8396) = $36 730 Date

Payment $

1 July 2015 1 July 2015 1 July 2016 1 July 2017 30 June 2018

10 000 10 000 10 000 10 000

Interest 6% $

Reduction in Liability $

1 604 1 100 566 3 270

10 000 8 396 8 900 9 434 36 730

Liability $ 36 730 26 730 18 334 9 434 -

Part B - Journal entries for lessee, Wellington Ltd 1 July 2015 Leased Vehicle Lease Liability

Dr Cr

36 730

Lease Liability Executory Costs Expense Cash

Dr Dr Cr

10 000 3 000

Interest Expense Interest Payable

Dr Cr

1 604

Depreciation Expense Accumulated Depreciation (1/3 ($36 730 - $10 000))

Dr Cr

8 910

Dr Dr Dr Cr

8 396 1 604 3 000

36 730

13 000

30 June 2016

1 604

8 910

1 July 2016 Lease Liability Interest Payable Executory Costs Expense Cash

13 000

10.93

Chapter 10: Leases

30 June 2017 Interest Expense Interest Payable

Dr Cr

1 100

Depreciation Expense Accumulated Depreciation (1/3 ($36 730 - $10 000)

Dr Cr

8 910

Dr Dr Dr Cr

8 900 1 100 3 000

Dr Dr Dr Cr

9 434 566 26 730

Dr Cr

1 000

Dr Cr

1 000

1 100

8 910

1 July 2017 Lease Liability Interest Payable Executory Costs Expense Cash

13 000

30 June 2018 Lease Liability Interest Expense Accumulated Depreciation Leased Vehicle

36 730

5 July 2018 Loss on Lease Payable to Lessor

1 000

13 July 2018 Payable to Lessor Cash

1 000

10.94

Solution Manual to accompany Company Accounting 10e

PART C -Schedule of lease receipts for lessor, Dunedin Ltd PV = $37 876 (FV) + $534 (initial direct costs) = $38 410

Date

Payment

1 July 2015 1 July 2015 1 July 2016 1 July 2017 30 June 2018

10 000 10 000 10 000 12 000

Interest 6%

Reduction in Receivable

1 705 1 207 678 3 590

10 000 8 295 8 793 11 322 38 410

Receivable 38 410 28 410 20 115 11 322 --

Part D - Journal entries for lessor, Dunedin Ltd

1 July 2015 Vehicle Cash

Dr Cr

37 876

Lease Receivable Cash Vehicle

Dr Cr Cr

38 410

Cash

13 000

37 876

534 37 876

Revenue - Reimbursement of Executory Costs Cr Lease Receivable Cr

3 000 10 000

30 June 2016 Executory Costs Expense Cash/Payable

Dr Cr

2 810

Interest Receivable Interest Revenue

Dr Cr

1 705

2 810

1 705

10.95

Chapter 10: Leases

1 July 2016 Cash

Dr Revenue – Reimbursement of Executory Costs Cr Interest Receivable Cr Lease Receivable Cr

$ 13 000

3 000 1 705 8 295

30 June 2017 Executory Costs Expense Cash/Payable

Dr Cr

3 020

Interest Receivable Interest Revenue

Dr Cr

1 207

3 020

1 207

1 July 2017 Cash

Dr Revenue – Reimbursement of Executory Costs Cr Interest Receivable Cr Lease Receivable Cr

$ 13 000

3 000 1 207 8 793

30 June 2018 Executory Costs Expense Cash/Payable

Dr Cr

2 750

Vehicle Interest Revenue Lease Receivable

Dr Cr Cr

12 000

Cash Dr Receivable from Lessee Dr Proceeds on Sale of Vehicle Cr

9 000 1 000

Carrying Amount of Vehicle Sold Dr Vehicle Cr

12 000

2 750

678 11 322

5 July 2018

10 000

12 000

13 July 2018 Cash Receivable from Lessee

Dr Cr

1 000

10.96

Chapter 11: Intangible assets

Chapter 11 – Intangible assets REVIEW QUESTIONS 1. What are the key characteristics of an intangible asset? Para 8 of AASB 138 defines an intangible asset as: An identifiable non-monetary asset without physical substance. Key characteristics are: ▪ Identifiable [see 2 below]: because of its emphasis on markets is inserted to exclude many possible intangibles that are difficult to measure eg staff morale, good customer relations ▪ Non-monetary: this characteristic excludes financial assets such as receivables from being classified as intangibles ▪ Without physical substance: excludes items of PP&E covered by AASB 116 2. Explain what is meant by ‘identifiability’. Para 12 of AASB 138 states: An asset meets the identifiability criterion in the definition of an intangible asset when it: (a) is separable, ie is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or (b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. (c) excludes goodwill, and other possible assets such as staff morale (d) is included to allow such assets as water rights, where these were allocated by a government but if not used were unable to be on-sold and so were not separable, to be classified as intangible assets

3. How do the principles for amortisation of intangible assets differ from those for depreciation of property, plant and equipment? ▪ ▪ ▪ ▪

Basic principle of allocation of the depreciable amount on a systematic basis over useful life is the same. With intangibles, straight-line method is the default method where the pattern of receipt of benefits cannot be reliably determined. Not so for PPE. With intangibles can have indefinite lives, not so for PPE With intangibles with finite lives, residual value is assumed to be zero unless para 100 criteria are met. Not so for PPE.

11.1

Solutions manual to accompany Company Accounting 10e

4. Explain what is meant by an ‘active market’.

AASB 13, Appendix A, defines an active market as: “a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.” Consider markets such as property and used cars compared with brand names.

5. How is the useful life of an intangible asset determined? Useful life must be assessed as finite or indefinite. Note para 90 in relation to assessment of whether an indefinite useful life exists: Many factors are considered in determining the useful life of an intangible asset, including: (a) the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team; (b) typical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way; (c) technical, technological, commercial or other types of obsolescence; (d) the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset; (e) expected actions by competitors or potential competitors; (f) the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity's ability and intention to reach such a level; (g) the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases; and (h) whether the useful life of the asset is dependent on the useful life of other assets of the entity.

6. What intangibles can never be recognised if internally generated? Why? Para 63 states: Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets Para 64 gives the reason: Expenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognised as intangible assets.

11.2

Chapter 11: Intangible assets

Explain the difference between ‘research’ and ‘development’. Para 8 contains the following definitions: Research: is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development: is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Para 56 gives examples of research activities: (a) activities aimed at obtaining new knowledge; (b) the search for, evaluation and final selection of, applications of research findings or other knowledge; (c) the search for alternatives for materials, devices, products, processes, systems or services; and (d) the formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services. Para 59 gives examples of development activities: (a) the design, construction and testing of pre-production or pre-use prototypes and models; (b) the design of tools, jigs, moulds and dies involving new technology; (c) the design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production; and (d) the design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services

Explain when development outlays can be capitalised. Para 57 states that when all the following criteria are met, development outlays can be capitalised: (a) the technical feasibility of completing the intangible asset so that it will be available for use or sale. (b) its intention to complete the intangible asset and use or sell it. (c) its ability to use or sell the intangible asset. (d) how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the

11.3

Solutions manual to accompany Company Accounting 10e

intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset. (e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. (f) its ability to measure reliably the expenditure attributable to the intangible asset during its development. 9. Explain how intangible assets are initially measured, and whether the measurement differs dependent on whether the assets are acquired in a business combination or internally generated by an entity. Para 24 states that an intangible asset must be initially measured at cost. When internally generated cost is based upon capitalisation of development costs. When acquired in a business combination cost is measured as the fair value of the asset at acquisition date, and a hierarchy of measures of fair value is available – see paras 39-41.

10. Give two ways in which it is easier to recognise intangibles that are acquired in a business combination than those that are internally generated. 1. Reliable measurement: For internally generated assets, the criteria in para 57 must be met. With assets acquired in a business combination, valuations including those given by valuers can be used. 2. Banned assets: Para 63 bans the recognition of certain intangibles. These can be recognised when acquired in a business combination. 3. Research: When internally generated outlays on research are expensed. In-process research can be capitalised on a business combination.

11. What are the recognition criteria for intangible assets? Para 21 states: An intangible asset shall be recognised if, and only if: (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and (b) the cost of the asset can be measured reliably.

12. Explain why managers may prefer to expense outlays on intangibles rather than capitalise them. See section 9.2.7 of the text. Some reasons are: 1. Managers prefer to inflate future profits 2. Investors generally consider write-offs as one-time items, of no consequence for

11.4

Chapter 11: Intangible assets

3. 4. 5. 6.

valuation. Immediate expensing obviates the need to provide explanations in case of failure. Cost and benefit Lack of relevance of capitalised numbers Volatility

13. Explain why capitalisation of outlays may not provide relevant information about the intangible assets held by an entity. ▪ ▪ ▪

There is no necessary link between capitalised costs and expected future benefits Time gap: the gap between outlay and the determination of outcome Correlation gap: there level of expenditure is not necessarily proportional to eventual worth of the outcome.

14. Explain the application of the revaluation model for intangible assets. Relevant paras are: 75. After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be determined by reference to an active market. Revaluations shall be made with such regularity that at the balance sheet date the carrying amount of the asset does not differ materially from its fair value. 81.

If an intangible asset in a class of revalued intangible assets cannot be revalued because there is no active market for this asset, the asset shall be carried at its cost less any accumulated amortisation and impairment losses.

82.

If the fair value of a revalued intangible asset can no longer be determined by reference to an active market, the carrying amount of the asset shall be its revalued amount at the date of the last revaluation by reference to the active market less any subsequent accumulated amortisation and any subsequent accumulated impairment losses.

85.

If an intangible asset's carrying amount is increased as a result of a revaluation, the increase shall be credited directly to equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss.

86.

If an intangible asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be debited directly to equity under the heading of revaluation surplus to the extent of any credit balance in the revaluation surplus in respect of that asset.

Method is basically the same as that under AASB 116 for PP&E. AASB 138 has a restriction on use of fair value in that it must be measured by reference to an active market.

11.5

Solutions manual to accompany Company Accounting 10e

15. Explain the use of fair values in the accounting for intangible assets. 1. Initial recognition: Fair values are used to measure cost when intangibles are acquired in a business combination. Fair values may be measured in a variety of ways – see paras 39-41. 2. Subsequent to initial recognition: After initial recognition, all intangibles may be measured under the cost model or the revaluation model. However, to use the revaluation model, fair value can only be measured by reference to an active market.

11.6

Chapter 11: Intangible assets

CASE STUDY QUESTIONS Case Study 1

Characteristics of intangible assets

David James (2001b) stated: The Australian company Health Communications Network (HCN), for example, has most of its balance sheet assets in the form of either cash or intangible assets. In its 2000–01 annual report, out of combined assets of $49.7 million, cash assets were $20.4 million and intangible assets were $22.2 million. Plant and equipment were only $1.47 million. This is characteristic of the shift to intangible assets, but the recent fate of HCN demonstrates some of the difficulties of ownership in the post-industrial environment. The company was the subject of a public furore when it was alleged it had plans to sell prescription information, collected from general practitioners, to undisclosed third parties, possibly pharmaceutical companies. The matter has been referred to the privacy commissioner, but the message is clear: just because a company possesses information, does not mean it can always do with it as it wishes. HCN ‘owns’ the information, but this does not give it the same rights of ownership as, say, ownership of plant and equipment. Required Using the information in the above quotation, discuss the characteristics of intangible assets. The characteristics of intangibles should be discussed at 2 levels: 1. the definition of an asset; 2. the definition of an intangible asset – noting the characteristics specific to intangibles, particularly identifiability. Ownership is not a characteristic of either tangible or intangible assets. Compare plant and equipment with prescription information as assets in terms of the definition of an asset and the definition of an intangible asset.

11.7

Solutions manual to accompany Company Accounting 10e

Case Study 2

Non-recognition of intangible assets

David James (2001b) stated: According to its 1999–2000 annual report, Qantas had total assets of $12 billion. Intangible assets were only $25 million, around 2% of the asset base. Yet Stuckey believes the airline’s intangibles are of far greater importance to the company. ‘Qantas is interesting because it combines a fantastic brand — an intangible asset — with a heap of capital-intensive tangible assets — the planes they have tried to keep well utilised. They have done very well in an industry that has been a real financial under-performer internationally. They stand out as one of the best performers in that sector.’ Required In relation to a major airline such as Qantas, discuss what intangible assets are probably not on the statement of financial position, and possible reasons for their nonrecognition. Possible assets for an airline that are not on the balance sheet: Brand name Safety record Customer service Computer systems for reservations, seating arrangements, customer profiles In-flight entertainment Monopoly protection by Government – e.g. Australian 2 airline policy restricts competition Some of the above are not intangible assets as they are not identifiable eg safety record Some intangibles that could be on the balance sheet are: Patents Trade names Question: Is the brand name “Qantas” inclusive of many of the assets listed above? Could the brand name be valued separately from these assets?

11.8

Chapter 11: Intangible assets

Case Study 3

Non-amortisation of assets

Nick Tabakoff (1999) stated: ASIC (Australian Securities and Investments Commission) may have plans to change the treatment of television licences in company accounts, as a precursor to the possible introduction of IAS 38. The commission is seeking the views of the main television networks regarding a change to the accounting rules that apply to their licences which, as intangibles, may be amortised. They have not been amortised in the past because of the view held by leading media companies that licences have an ongoing life. Some ASIC officials beg to differ — because licences need to be reapplied for and renewed every five years, they should be amortised on the grounds that they could be taken away by the Government at any time. The Seven and Nine television networks have been steadily increasing the value placed on their television licences in recent years, a practice that would almost certainly be prevented if IAS 38 was introduced. Required Obtain access to the most recent financial statements of your local television stations, and review their policies and accounting for television licences. Critically analyse the arguments for and against the non-amortisation of these assets. The licences only last for 5 years. The TV company may expect to have the licence renewed, but does the company have an asset beyond the 5 years: - are there expected future benefits? - Can the entity control those benefits [are they controlled by the government that issues the licence? Compare with the employee who may leave] - What is the past transaction given the licence for any subsequent term has not yet been issued? Does it depend on the rules for issuing the licence? For example, if the legislation states that the company will have its licence renewed if it meets certain tests such as: no offending material presented to the public 25% local content shown provides for local sporting events These events are then within the control of the company to achieve, in comparison to the licence renewal being at the “pleasure of the government minister in the best interests of the Australian public” which is beyond the company to control. In other words, what grounds are there for nonrenewal occurring and what control does the company have over renewal.

11.9

Solutions manual to accompany Company Accounting 10e

Case Study 4

Amortisation of intangibles

Nick Tabakoff (1999) stated: News Corporation is far from convinced of the merits of the standard [IAS 38]. At the Australian division, News Limited, finance director and deputy chief executive Peter McCourt says: ‘The reason you get standards like that is that they are prepared by people who are not really responsible to anybody. The business community gains nothing from writing off the value of intangibles over a limited time frame. If the standard comes in, the market will simply add back the amortisation.’ McCourt believes the standard penalises companies that are acquisitive when it comes to intangible assets. He can see no reason for the existence of the standard. ‘Who is it aimed at, who is being better informed by taking that charge? I don’t think it gets you anywhere.’ He is not alone in getting worked up about preventing accountants from minimising the values placed on intangibles. Even the legendary Berkshire Hathaway chief Warren Buffett has strong views on the issue. He has been quoted as saying: ‘Amortisation of intangibles is rubbish. It distorts true cashflows and thus economic reality. For example, the economic earnings of Disney are much greater than reported earnings. Accounting is pushing people to do things that are nuts.’ These comments were made before the latest revisions to AASB 138. Required Comment on whether the current AASB 138 has resolved the issues raised in this article. 4 key issues: 1. Amortisation: should intangibles be amortised? Argument for: the benefits are consumed; need to allocate the cost of past, consumed benefits. Assets should not be overstated. Argument against: The benefits have not declined. Also, AASB 138 does not allow the recognition of new internally generated benefits, so to write off old benefits but not allow the recognition of new benefits means a double hit to income – eg consider depreciation of a brand as well as expensing the costs of advertising to maintain the brand. AASB 138 allows non-amortisation under certain conditions. Is there any distortion of cash flows? No. 2. Are acquisitive companies penalised under AASB 138? Advantages to acquirers: • Easier to recognise intangibles • Can use fair value to measure compared with measurement of cost • Can recognise assets listed in para 63. Disadvantages to acquirers: • Recognition leads to amortisation expenses on recognised intangibles; affects profits. • See arguments in text as to why managers may prefer current non-recognition rules

11.10

Chapter 11: Intangible assets

3. Do annual reports show economic reality? This is based on the comment re economic earnings of Disney being greater than reported earnings. See the Zeff graph in the chapter comparing reported assets and market capitalisation of entities. Many internally generated assets are not recognised under AASB 138. See figure 7.1 from Jenkins and Upton again comparing the difference between market capitalisation & reported assets. 4. Is there a need for a separate standard on intangibles? The argument for a separate standard for intangibles is related to the unique measurement and relevance issues relating to intangibles. For example with measurement: Cost model: hard to isolate costs, hard to determine depreciation Revaluation model: lack of markets

11.11

Solutions manual to accompany Company Accounting 10e

Case Study 5

Human resource accounting

In the following article, Whiting and Chapman (2003) consider whether the value of rugby players, being a team’s most valuable asset, should be placed on the balance sheet (statement of financial position). Sporting glory — the great intangible While rugby stars are heroes to many, when checking the books they become a complex intangible. Rosalind Whiting and Kyla Chapman investigate the merits of Human Resource Accounting in professional sport. Australia, New Zealand and rugby union – a combination guaranteed to stir patriotic feelings across the Tasman! But what if we add accounting to this equation? Rugby players are the teams’ most valuable assets, so should we be placing their value on the balance sheet? And if so, does it make any difference to the decisions that users of financial statements make? Human resource accounting in professional sport Professional sport has been prevalent in the United Kingdom and the United States for nearly 200 years. However, professional sport arrived later to Australia and New Zealand. In particular, the Kiwis only entered this arena in 1995 when the New Zealand Rugby Football Union (NZRFU) signed the Tri Nations sponsorship deal and removed all barriers preventing rugby union players being paid for their services. Player contract expenses in New Zealand now amount to over NZ$20 million annually, according to the NZRFU. In the United Kingdom and the United States, the professional teams’ financial accounts quite often incorporate human resource accounting (HRA). HRA is basically an addition to traditional accounting, in which a value for the employees is placed on the balance sheet and is amortised over a period of time, instead of expensing costs such as professional development. There is debate about the merits of this process and the arguments are in line with those we have been hearing about intangibles in general. More recently, there has been worldwide movement towards recognising acquired identifiable intangible assets at fair value in the financial statements. So why not include an organisation’s human resources? While (thankfully) most people agree that employees are valuable, there are accounting difficulties with the concept of ownership or control of the employees (asset definition) and the reliability of measurement. Despite these concerns, one area where HRA does have some international acceptability is in accounting for professional sport, mainly because of the measurable player transfer costs. But there is still some variability in the reporting of human resource value, ranging from the capitalisation of signing and transfer fees through to player development costs or valuations. To the authors’ knowledge, HRA is not currently practised with Australia and New Zealand’s professional sports teams. The absence of transfer fees between clubs when trading players may explain this. Decision making Accountants are required to provide information that assists users in assessing an organisation’s financial and service performance and in making decisions about providing resources to, or doing business with the firm. The big question is whether HRA information is more useful to the decision maker than the alternative expensing treatment. Supporters of HRA argue that capitalised information is useful for strategic planning and management of employees, and provides a more accurate measure of the firm’s status and total performance. Those against HRA say it is too subjective to be useful and that it just imposes another cost on the organisation. Some detractors argue that it makes unprofitable organisations appear © John Wiley and Sons Australia, Ltd 2015

11.12

Chapter 11: Intangible assets

profitable simply because smart people work there. But those who believe in the efficiency of the market would argue that investors are not naive, and decisions would be unaffected by the way in which human resource information is presented. Past research has shown that sophisticated users of financial information do make significantly different decisions with the different presentations. With this in mind we decided to test this outcome in New Zealand. The New Zealand study In June 2001, 64 members of the New Zealand professional body, the Institute of Chartered Accountants of New Zealand (ICANZ) responded to our postal questionnaire. This constituted a 20 per cent response rate from the 300 randomly selected ICANZ members. All respondents were provided with the CEO’s report, and the financial statements and notes of the fictitious Gladiator Super Twelve rugby franchise. Half of the respondents were sent financial statements in which player training and development costs were expensed in the year that they were incurred. The other half received an identical set of statements; however, the team was capitalised on the balance sheet. It was stated in the notes to the accounts that the team was periodically revalued every five years, and then annual player training and development costs were capitalised and added to the valuation and subsequently amortised over a period of three years (average contract length). Respondents were asked a series of decision making questions and then the answers from the two groups (expensing and capitalising) were statistically compared. Generally, the presentation of the human resource information made no difference to the assessments and decisions made by our respondents. They assessed financial position and performance, risk and future financial performance to be at the same level regardless of the presentation. And even when presented with an investment decision where they had to divide $100,000 between the franchise and a fixed term New Zealand bank investment, there was no difference in the levels of investment between the two groups. In most cases respondents in the two groups gave similar reasons for their assessments. However, when assessing current performance, the group with the expensed player development costs mainly used statement of financial performance information, whereas the group with the capitalised statements also used the statement of financial position. This suggests that they understood the nature of the information with which they were provided. Differences in opinion Women and men showed no overall differences in their responses. However, it was with investment experience that we uncovered some contrasting results. Most of our respondents fell into two groups, those with limited investment experience (less than one year) and those having extensive experience (five or more years). We felt that the experienced group would more closely represent the sophisticated users as studied in previous research. We found some differences in assessments between the experienced and the limited experience group. The groups rated financial performance and risk of the franchise differently and invested significantly different amounts in the franchise. Interestingly, members of the limited experience group rated growth as a more important reason for their investment decisions — whereas the experienced group said net profit levels were more important. Of greater interest was whether experience level affected respondents’ ability to cope with the different presentations of human resource information. In most cases it did not. However, limited experience investors did make significantly different assessments of the risk and future performance of the franchise according to the presentation of the human resource information. In these situations the limited experience expensing group acted like the

11.13

Solutions manual to accompany Company Accounting 10e

experienced group of investors, whereas the limited experience capitalising group did not. The capitalised information may have confused the less experienced investors. In general, the users (sophisticated and unsophisticated) were unaffected in their assessments and decisions by the presentation of the human resource information. This conflicts with prior studies, which found that HRA did make a difference to decision making. This variation could be due to accountants now having a better understanding of the issues surrounding intangibles recognition and the effect of accounting method choice on financial statement numbers and ratios. Also accountants are spending less time in accounting number preparation and more time in interpretation and business advice. However, our exercise only explored one type of decision-making process, that of an investment. Prior studies may have been of a wider nature, which could explain the differing result. Overall, our study shows that generally accountants will make the same investment decisions regardless of whether human resource information is expensed or capitalised. If HRA is to follow the international trends emerging in intangibles reporting, then capitalised human resource information may become more prevalent. This study suggests that this won’t negatively affect those accountants who provide interpretative and investment advice. Required Critically analyse the arguments made in the article and assess whether there should be any changes made to AASB 138 as a result.

The key question relates to what information about human resources in a football team where players are contracted is useful to readers of financial accounts. Are players intangible assets? They are assets in that being under contract the company/sporting entity can control them in terms of the players’ ability to move clubs. In relation to the criterion of identifiability, the club has the legal right to trade the players, and the players are separable from the club. However players are physical assets and as such are not intangible assets. Accounting for the players must be accounted for under AASB 116 Property, plant & equipment. However, the existence of great players can add intangible assets to an entity such as increasing the brand worth of the name of the club, which assists in increasing sales of club merchandise, membership and gate takings. Other intangibles associated with sporting clubs relate to training, and attitude. Clubs can generate pride because of past and current performance, which increases the value of the club. Many supporters follow a club through good times and bad times, regardless of the worth of current players. Whiting and Chapman discuss two forms of measurement in relation to players, namely expensing of costs relating to the players and capitalisation of those costs. An alternative, being valuation of the player is not discussed. The authors endeavoured to assess whether different decisions would be made if capitalised outlays were included in the balance sheet. In general users weer unaffected in their assessments. AASB 138 considers whether a well trained work force is an asset – see para. 15. In the ED for that standard, the IASB signalled an intention that an assembled workforce [compare with a team of players] would not be considered an intangible asset.

11.14

Chapter 11: Intangible assets

Case Study 6

Accounting for brands

In the following article by Peacock (2004), it was reported that the clothing and footwear giant Pacific Brands was set to list on the stockmarket with a $1 billion + initial public offering (IPO). Patersons Securities analyst, Rob Brierley, was quoted as saying, ‘The high brand awareness will certainly be its [Pacific Brand’s] marketing strength.’

A history of most popular brands Pacific Brands can trace its history back to 1893 when it began making Dunlop bicycle tyres. Along the way, it has collected an astonishing array of brands, many remarkable stories in their own right. Bonds, one of the company’s flagship brands, was founded in 1915 by American immigrant George A. Bond who started out making hosiery and gloves in Sydney. In 1928, Bonds underwear and hosiery secured Charles Kingsford-Smith and Charles Ulm on their historic first flight across the Pacific. King Gee workwear has been with Australians for more than 75 years, with the first overalls produced in tiny rented premises in Sydney. Its name is derived from a colloquial expression popular during the reign of King George V. According to PacBrands’ website ‘King Gee’ became Australian slang for a show-off. ‘For example, in the 1920s someone who had a high opinion of themselves might have attracted the comment, “he’s so good he thinks he’s King G”,’ it said. Holeproof was first made in Australia in the late 1920s when a hosiery manufacturer started turning out ladieswear under licence from the Holeproof Hosiery Company in the US. The company opened its first Australian mill in Melbourne in 1930, becoming the first manufacturer to make and market Australian-made, self-supporting socks. Unique Corsets, later better known as bra maker Berlei, was already nearly 20 years old by then. Founded by Fred R. Burley with a nominal capital of £10 000 in Sydney, the company set out ‘to design, manufacture and sell corsets and brassieres of such perfect fit, quality and workmanship as will bring pleasure and profit to all concerned’. Clarks shoes go back even further, to 1825, and a small sheepskin slipper business founded by Cyrus and James Clark in the small English village of Street. Sixty years later, the company was credited with creating the first shoe to follow the natural shape of the foot — ‘a revolutionary concept in its time’.

Required Given the perceived importance of the brands to the success of the IPO, discuss whether the AASB in AASB 138 has adopted too conservative an approach to the accounting for brands. Accounting for brands under AASB 138: (a) internally generated - internally generated intangibles must meet the recognition criteria in para 57 - para 63 specifically excludes the recognition of internally generated brands (b) acquired brands: - Recognised at cost - If acquired as part of a business combination must meet the recognition criteria of AASB 3, para 37 (c) , namely that fair value can be measured reliably [ see also paras 45-46 of AASB 3] - Initially measured at cost = fair value.

11.15

Solutions manual to accompany Company Accounting 10e

Subsequently can be measured at cost or revalued amount, but use of the latter requires the existence of an active market. Amortisation based on useful life, or non-amortisation on indefinite life

Pacific Brands has a history back to 1893, the history including the internal generation of brands as well as the acquisition of brands such as Bonds Two key questions are: - whether there should be different treatment within the one company for internally generated and acquired brands - whether old acquired brands such as Bonds and King Gee cannot be revalued due to no active market being available

11.16

Chapter 11: Intangible assets

Case Study 7

Accounting for brands

Jon West Ltd is a leading company in the sale of frozen and canned fish produce. These products are sold under two brand names. Fish caught in southern Australian waters are sold under the brand ‘Artic Fresh’, which is the brand the company developed when it commenced operations and which is still used today. Fish caught in the northern oceans are sold under the brand name ‘Tropical Taste’, the brand developed by Fishy Tales Ltd. Jon West Ltd acquired all the assets and liabilities of Fishy Tales Ltd a number of years ago when it took over that company’s operations. Jon West Ltd has always marketed itself as operating in an environmentally responsible manner, and is an advocate of sustainable fishing. The public regards it as a dolphin-friendly company as a result of its previous campaigns to ensure dolphins are not affected by tuna fishing. The marketing manager of Jon West Ltd has noted the efforts of the ship, the Steve Irwin, to disrupt and hopefully stop the efforts of Japanese whalers in the southern oceans and the publicity that this has received. He has recommended to the board of directors that Jon West Ltd strengthen its environmentally responsible image by guaranteeing to repair any damage caused to the Steve Irwin as a result of attempts to disrupt the Japanese whalers. He believes that this action will increase Jon West Ltd’s environmental reputation, adding to the company’s goodwill. He has told the board that such a guarantee will have no effect on Jon West Ltd’s reported profitability. He has explained that, if any damage to the Steve Irwin occurs, Jon West Ltd can capitalise the resulting repair costs to the carrying amounts of its brands, as such costs will have been incurred basically for marketing purposes. Accordingly, as the company’s net asset position will increase, and there will be no effect on the statement of profit or loss and other comprehensive income, this will be a win–win situation for everyone. Required The chairman of the board knows that the marketing manager is very effective at selling ideas but knows very little about accounting. The chairman has, therefore, asked you to provide him with a report advising the board on how the proposal should be accounted for under International Financial Reporting Standards and how such a proposal would affect Jon West Ltd’s financial statements. 1. Accounting for the Guarantee •

Is there a liability? Legal or constructive? What is the past event? What obligation exists?

•

Should it be recognised?

•

How is it to be measured?

•

Contingent liability?

Expect that a provision/contingent liability would need to be raised in relation to the guarantee. Measurement issues may lead to the need for a contingent liability. 2. Can costs be capitalised into brands?

11.17

Solutions manual to accompany Company Accounting 10e

•

Note one brand is internally generated and one is acquired. The internally generated brand “Artic Fresh” will not be recognised while “Tropical Taste” was acquired in a business combination. Accounting for internally generated brands differs from that for brands acquired in a business combination - explain

•

Extra outlays on the brand cannot be capitalised into an already existing brand as the outlays are generally to maintain the existing asset rather than increase the asset. Also, hard to distinguish the expenditure from that spent to develop the business as a whole.

•

AASB 138 says that brands cannot be revalued as no active market exists.

•

Can the outlay be related to the brand or is it internally generated goodwill: does it relate to the entity as a whole rather than a single asset? Cannot recognise internally generated goodwill.

•

Expected result is that any outlays would need to be expensed

3. Effects on financial statements • • • •

Liability? Provision? Contingent liability – notes only Asset? No Profit: expense relating to the guarantee provision?

11.18

Chapter 11: Intangible assets

Case Study 8

Accounting for intangible assets

Pics Ltd is an Australian mail-order film developer. Although the photo developing business in Australia is growing slowly, Pics Ltd has reported significant increases in sales and net income in recent years. While sales increased from $50 million in 2009 to $120 million in 2015, profit increased from $3 million to $12 million over the same period. The stock market and analysts believe that the company’s future is very promising. In early 2016, the company was valued at $350 million, which was three times 2015 sales and 26 times estimated 2016 profit. What is the secret of Pics Ltd’s success? Company management and many investors attribute the company’s success to its marketing flair and expertise. Instead of competing on price, Pics Ltd prefers to focus on service and innovation, including: • Customers are offered a CD and a set of prints from the same roll of film for a set price. • Customers are given, at no extra charge, a ‘picture index’ of mini-photos of the roll. • A replacement roll is given to every customer (at no extra charge) with every development order. As a result of such innovations, customers accept prices that are 60% above those of competitor discount film developers, and Pics Ltd maintains a gross profit margin of around 40%. Nevertheless, some investors have doubts about the company as they are uneasy about certain accounting policies the company has adopted. For example, Pics Ltd capitalises the costs of its direct mailings to prospective customers ($4.2 million at 30 June 2015) and amortises them on a straight-line basis over 3 years. This practice is considered to be questionable as there is no guarantee that customers will be obtained and retained from direct mailings. In addition to the mailing lists developed by in-house marketing staff, Pics Ltd purchased a customer list from a competitor for $800 000 on 4 July 2016. This list is also recognised as a non-current asset. Pics Ltd estimates that this list will generate sales for at least another 2 years, more likely another 3 years. The company also plans to add names, obtained from a phone survey conducted in August 2016, to the list. These extra names are expected to extend the list’s useful life by another year. Pics Ltd’s 2015 statement of financial position also reported $7.5 million of marketing costs as non-current assets. If the company had expensed marketing costs as incurred, 2015 net income would have been $10 million instead of the reported $12 million. The concerned investors are uneasy about this capitalisation of marketing costs, as they believe that Pics Ltd’s marketing practices are relatively easy to replicate. However, Pics Ltd argues that its accounting is appropriate. Marketing costs are amortised at an accelerated rate (55% in year 1, 29% in year 2, and 16% in year 3), based on 25 years’ knowledge and experience of customer purchasing behaviour. Required Explain how Pics Ltd’s costs should be accounted for under AASB 138 Intangible Assets, giving reasons for your answer.

AASB 138 definitions •

Asset: A resource:

11.19

Solutions manual to accompany Company Accounting 10e

• •

(a) controlled by an entity as a result of past events; and (b) from which future economic benefits are expected to flow to the entity. Intangible asset: An identifiable non-monetary asset without physical substance. Identifiable: An asset is identifiable when it: (a) is separable – ie can be separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or (b) arises from contractual or other legal rights.

Costs of direct mailings to prospective customers (capitalised and amortised) • •

Under AASB 138 internally generated customer lists and items similar in substance shall not be recognised as intangible assets. Accordingly, Pics Ltd should: - Write off all costs capitalised to date; and - Expense all such costs as incurred from now on.

Purchased customer list (capitalised and amortised) • • •

It meets the asset definition. Pics Ltd has control as it has the power to obtain the future economic benefits flowing from it and can restrict the access of others to it. Future economic benefits exist in the form of potential sales. It also meets the intangible asset definition, as it is non-monetary, has no physical substance, and is identifiable as it can be sold. Assuming that it is probable that future economic benefits will be obtained from this list, Pics Ltd’s treatment is correct – ie recognise it as an intangible asset at cost and then, as the question indicates that Pics Ltd has chosen the cost model, amortise it.

Cost of phone survey conducted after customer list purchased (to be capitalised) • •

Under AASB 138 subsequent expenditure on customer lists and items similar in substance (whether externally acquired or internally generated) is always expensed as incurred. Hence, Pics Ltd should expense the cost of the phone survey.

Marketing costs (capitalised and amortised) •

• •

They do not meet the asset definition. Pics Ltd cannot demonstrate control over he future economic benefits flowing from them, as it cannot restrict the access of others to those benefits. AASB 138 states that control normally arises fron legal rights (eg. restraint of trade agreements). Without such rights it is difficult to demonstrate control. Pics Ltd’s marketing practices and flair are known to competitors and accordingly could be replicated. Hence, Pics Ltd should: - Write off all costs capitalised to date; and - Expense all such costs as incurred from now on.

11.20

Chapter 11: Intangible assets

Case Study 9

Patents

Song Ltd has recently obtained some patents considered useful in its manufacture of men’s shoes. The patents consist of: • Patent XC456, acquired from a leather manufacturing firm for $425 000. • Patent CU254, obtained as part of a bundle of assets acquired from the conglomerate U-Beaut Fashions. Song Ltd is also in the process of preparing an application for a patent for a new process of softening leather. It has spent a number of years refining this process. The accountant for Song Ltd is unsure how to account for patents under IFRSs. He has asked you to prepare a detailed report for him on the principles of how to account for patents, using the examples above to illustrate the appropriate accounting procedures. Required Prepare a report for Song Ltd’s accountant. 1. Which accounting standard should be applied to determine the appropriate accounting principles? Patents are an intangible asset as per AASB 138: - non-monetary - identifiable - lacking physical substance AASB 138 Intangibles is therefore the relevant accounting standard to apply for patents. 2. How should the various patents be accounted for at initial recognition? • Patent XC456: This is an asset acquired as a single acquisition. The probable flow recognition criterion is always met. The recognition criterion that needs to be met is the reliable measurement criterion. The asset must be measured at cost, being purchase price plus any directly attributable costs. • Patent CU254: This asset was acquired as part of a bundle of assets. The accounting will depend on whether the bundle of assets constituted a business: (a) if the bundle of assets does not constitute a business, then the patent must be recognised at cost. The cost will be determined by allocating the cost for the bundle of assets across the assets acquired on a pro rata basis, that is, using the fair value of the asset in proportion to the fair values of the total assets acquired. This means that it is necessary to determine the fair value of the patent. The hierarchy of measures of fair value will be used: - quoted market prices in an active market: this will not be applicable for patents; - prices in recent transactions of the same or similar assets: unlikely to be available for patents; - measurement techniques such as present value calculations, multiples using royalty rates etc (b) if the bundle of assets does constitute a business using the definition of “business” in AASB 3 Business Combinations – an integrated set of activities and assets capable of being conducted and managed for the purpose of providing a return

11.21

Solutions manual to accompany Company Accounting 10e

•

[inputs, processes and outputs] - then there are no recognition to be applied as all recognition are assumed to be met. The asset is initially measured at cost which is the fair value of the asset, determined as described in (a) above. Internally generated patent: Amounts spent on internally generating a patent must be classified into research and development. If classified as research, then the outlays must be expensed. If classified as development, then para 57 is applied and when all six of the criteria are met, subsequent outlays are capitalised as an asset. Examples of these criteria are: the technical feasibility of completing the asset, and an intention to complete the asset and use or sell it. Para 63 does exclude some assets from recognition, but patents are not in this list.

3. How should patents be accounted for subsequent to initial measurement? Under AASB 138, subsequent to initial recognition, an entity may choose to use the revaluation model or the cost model. However the use of the revaluation model requires the existence of an active market in order to measure the fair value. Given the unique nature of patents, an active market is unlikely to exist. Therefore the cost model must be used. Under the cost model there is the question of subsequent depreciation/amortisation of the asset. The first question will be that of the useful life of the asset. IF the asset is considered to have an indefinite useful life no amortisation is required. If the expected useful life is finite, depreciation must be charged. The determination of useful life will require an analysis of a number of factors (as per para 90) such as expected actions by competitors and the stability of the industry and changes in market demand. If an indefinite useful life is selected for a patent, then an annual impairment test is required under AASB 136 Impairment of Assets. IF a finite useful life is determined, the depreciable amount of the asset will be written off over the useful life on a systematic basis, with the method chosen reflecting the pattern in which the expected benefits are expected to be consumed by the entity. Where the pattern of flow of benefits cannot be determined reliably, the straight-line method must be used. Further, the residual value is assumed to be zero, unless there is a commitment by a third party to acquire the asset in the future or there exists an active market. The latter will not exist for patents.

11.22

Chapter 11: Intangible assets

PRACTICE QUESTIONS Question 11.1

Recognition of intangibles

A list of items that could be accounted for as intangible assets by Dory Ltd is as follows: 1. Cost of purchasing a trademark 2. Unrecovered costs of a successful lawsuit to protect a patent 3. Goodwill acquired in the purchase of a business 4. Costs of developing a patent 5. Cost of engineering activity to advance the design of a product to the manufacturing stage 6. Deposits with an advertising agency for advertisements to increase the goodwill of the company Required Discuss which of these should be included as an intangible asset in the accounts of Dory Ltd. Give reasons for your answers. The key characteristics are: - identifiable - non-monetary - lack of physical substance 1. Cost of purchasing a trademark A trademark meets each of the above characteristics of an intangible asset. Hence acquisition of a trademark would mean that an intangible asset could be recognised. Initially intangible assets are measured at cost. 2. Unrecovered costs of a successful law suit to protect a patent These cannot be recognised as an asset as they are not separable. Can they be capitalised into the cost of the patent? As they do not add to the benefits of the patent no extra asset is acquired. The costs are of the same nature as “repairs and maintenance costs” for PPE and should be expensed. In the late 1990s Walt Disney Company faced the loss of its copyright on “Mickey Mouse” which could have led to the loss of millions of dollars of sales. It went to the Supreme Court and won an extension of copyright lives from 50 to 70 years. These court costs could be capitalised into the copyright on Mickey Mouse as there was an extension to the useful life of the copyright. 3. Goodwill acquired in the purchase of a business This can be recognised as an asset under AASB 3. However goodwill is not an intangible asset as it is not separable. 4. Costs of developing a patent The costs of developing a patent must be assessed under the accounting for research and development principles. Any research costs must be expensed. Development costs can only be capitalised after the criteria in para 57 are all met.

11.23

Solutions manual to accompany Company Accounting 10e

5. Costs of engineering activity to advance the design of a product to the manufacturing stage. If the para 57 criteria are all met then these costs can be capitalised into an intangible asset, being the design of the product. 6. Deposits with an advertising agency for advertisements to increase the goodwill of the company. Internally generated goodwill cannot be recognised. Only acquired goodwill can be recognised as an asset – but not as an intangible asset. These costs are not costs of acquiring goodwill – goodwill cannot be acquired as a separate asset. The costs must be expensed.

11.24

Chapter 11: Intangible assets

Question 11.2

Recognition of intangibles

A list of some of items that could be accounted for as intangible assets by Flathead Ltd is as follows: 1. Investment in a subsidiary company 2. Training costs associated with a new product 3. Cost of testing in search for product alternatives 4. Legal costs incurred in securing a patent 5. Long-term receivables Required Discuss which of these should be included as an intangible asset in the accounts of Flathead Ltd. Give reasons for your answers. The key characteristics are: - identifiable - non-monetary - lack of physical substance 1. Investment in a subsidiary company Paragraph 2 excludes financial assets from AASB 138 as these are accounted for under AASB 132 2. Training costs These are not separable; hence training costs are not identifiable as an asset. Para 29(b) also excludes costs of staff training as part of the cost of an intangible asset as it is not a directly attributable cost. 3. Cost of testing in search of product alternatives Paragraph 56(c) gives as an example of research “the search for alternatives for materials, devices, products, processes, systems or services;” Being research these costs are expensed. 4. Legal costs incurred in securing a patent These would be costs that are directly attributable to preparing the asset for its intended use and would be capitalised into the cost of the patent as an intangible asset. 5. Long-term receivables Monetary items are money held and assets to be received in fixed or determinable amounts of money. Receivables – short or long term – are monetary assets. Hence they are not intangible assets.

11.25

Solutions manual to accompany Company Accounting 10e

Question 11.3

Amortisation of brands

In its 2012 annual report (Note 16, p. 125) Wesfarmers Ltd made the following statement: Trade names: the brand names included above have been assessed as having indefinite lives on the basis of strong brand strength, ongoing expected profitability and continuing support. The brand name incorporates complementary assets such as store formats, networks and products offerings. Gaming and liquor licences: gaming and liquor licences have been assessed as having indefinite lives on the basis that the licences are expected to be renewed in line with business continuity requirements. Required What are the amortisation policies set down in AASB 138, and how have they been applied by Wesfarmers Ltd? In determining the amortisation the first step is to determine whether the life of the asset is indefinite or definite (AASB 138:88). Indefinite does not mean infinite – an indefinite life means that with the proper maintenance there is no foreseeable end to the life of the asset. AASB 138:90 lists factors that should be considered to determine the life of the asset. If indefinite life then there is no need to amortise the asset (AASB 138: 107). However indefinite life assets are subject to annual impairment tests under AASB 136 Impairment of Assets. If definite life, the asset is depreciated in a similar fashion to that of PPE. The depreciable amount of the asset is allocated on a systematic basis over the useful life with the method chosen reflecting the pattern in which the benefits are received - see AASB 138:97 AASB 138:98 notes that the method used will rarely result in an amortisation charge that is lower than that that would be calculated under a straight-line basis. Where the pattern of benefits cannot be reliably determined then the straight-line method should be used – AASB 138:97 The residual value of the asset is assumed to be zero unless there is a commitment by a third party to purchase the asset at the end of its useful life. Or there is an active market for the asset - AASB 138: 100. For intangibles with both definite and indefinite lives the useful life must be reviewed every year – AASB 138:109.

11.26

Chapter 11: Intangible assets

Question 11.4

Brands and formulas

Wayne Upton (2001, p. 71) in his discussion of the lives of intangible assets noted that the formula for Coca-Cola has grown more valuable over time, not less, and that Sir David Tweedie, then chairman of the IASB, jokes that the brand name of his favourite Scotch whisky is older than the United States of America — and, in Sir David’s view, the formula for Scotch whisky has contributed more to the sum of human happiness. Required Outline the accounting for brands under AASB 138, and discuss the difficulties for standard setters in allowing the recognition of all brands and formulas on statements of financial position. Accounting for brands under AASB 138: (a) internally generated - internally generated intangibles must meet the recognition criteria in para 57 - para 63 specifically excludes the recognition of internally generated brands (b) acquired brands: - Recognised at cost - If acquired as part of a business, AASB 3 states that no recognition criteria need be applied. Provided the asset meets the definition of an intangible asset, it must be recognised as a separate asset. As with separately acquired intangible assets, para 33 of AASB 3 provides that, where intangible assets are acquired as part of a business combination, the effect of probability is reflected in the measurement of the asset. Hence the probability recognition criterion is automatically met. – see also paras 11-12 of AASB 3. - Initially measured at cost = fair value. - Subsequently can be measured at cost or revalued amount, but use of the latter requires the existence of an active market. - Amortisation based on useful life, or non-amortisation on indefinite life Consider a major brand of whisky – Chivas Regal, Johnny Walker etc – and debate the argument that the brand name is worthless if separated from the company, for example, could Chivas Regal sell the brand name to another company making whisky that tastes different from the Chivas Regal whisky? Or is the brand an integral part of the whole company? Compare with Coca-Cola – would a lemonade company buy the brand name Coca Cola or is the brand an integral part of the whole product of the company?

11.27

Solutions manual to accompany Company Accounting 10e

Question 11.5

Financial statements and intangibles

Upton (2001, p. 50) notes: There is a popular view of financial statements that underlies and motivates many discussions of intangible assets. That popular view often sounds something like this: If accountants got all the assets and liabilities into financial statements, and they measured all those assets and liabilities at the right amounts, stockholders’ equity would equal market capitalization. Right? Required Comment on the truth of this ‘popular view’. Upton argues that ensuring all the assets and liabilities are in the statement of financial position has never been an objective of accounting. He argues that financial reporting tries to provide information about economic resources and the two groups that hold claims against those resources. It helps to correct or confirm expectations. He provides an example of the mild climate at the entity’s home office. This is not an asset of the entity but it may affect the value of things that are economic resources such as the value of the home office building. Four criteria must be met before including items in a statement of financial position: - definitions - measurability of a relevant attribute - relevance, and - reliability: representationally faithful, verifiable & neutral Information about some intangibles may be relevant, but many items are not measurable. Some assets may be measurable, but the measurement attribute may not be relevant, for example capitalisation of research costs. Recognition of expenditure for which economic benefits are not probable as assets does not provide relevant information. In outlaying the funds, management’s intention was to generate future benefits. However, the degree of certainty that economic benefits will flow to the entity beyond the current period is insufficient to warrant the recognition of an asset.

11.28

Chapter 11: Intangible assets

Question 11.6

Useful life of trademark

Snapper Ltd holds a trademark that is well known within consumer circles and has enabled the company to be a market leader in its area. The trademark has been held by the company for 9 years. The legal life of the trademark is 5 years, but is renewable by the company at little cost to it. Required Discuss how the company should determine the useful life of the trademark, noting in particular what form of evidence it should collect to justify its selection of useful life. 1. Does the company have an asset beyond the 5 years: - are there expected future benefits? -

Can the entity control those benefits [are they controlled by the government that issues the licence? Compare with the employee who may leave]

What is the past transaction given the renewal of the trademark for any subsequent term has not yet been granted?

2. Evidence of control is the crucial element. In particular evidence relating to whether the company controls the variables that determine renewal of the trademark. For example, does renewal depend on the company meeting certain criteria which it can control, such as having good business practices, or does it depend on the whim of a government bureaucrat, which the entity cannot control. 3. Note para 90 of AASB 138: Many factors are considered in determining the useful life of an intangible asset, including: (a) the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team; (b) typical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way; (c) technical, technological, commercial or other types of obsolescence; (d) the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset; (e) expected actions by competitors or potential competitors; (f) the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity's ability and intention to reach such a level; (g) the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases; and (h) whether the useful life of the asset is dependent on the useful life of other assets of the entity.

11.29

Solutions manual to accompany Company Accounting 10e

Question 11.7

Recognition of copyright

Whiting Ltd acquired two copyrights during 2016. One copyright related to a textbook that was developed internally at a cost of $10 500. This book is estimated to have a useful life of 5 years from 1 September 2016, the date it was published. The second copyright was purchased from the King George University Press on 1 December 2016 for $12 000. This book which analyses aboriginal history in Western Australia prior to 2000 is considered to have an indefinite useful life. Required Discuss how these two copyrights should be reported in the statement of financial position of Whiting Ltd at 30 June 2017. Internally developed copyright It is unlikely that any asset is recognised with this copyright. Being internally developed no costs can be capitalised until all the criteria in para 57 are met. Also under para 63, publishing titles can never be recognised as intangible assets. Acquired intangible This copyright will be recognised as an intangible asset. In terms of recognition criteria, the probability recognition criterion is always met. Further, the cost can usually be measured reliably. Intangible assets are measured initially at cost. In this case the asset will be measured at cost of $12,000. Having an indefinite life there will be no amortisation charge per annum.

11.30

Chapter 11: Intangible assets

Question 11.8

Research and development

Salmon Ltd’s research and development section has come up with an idea for a project on using cane toad poison for medicinal purposes. The board of directors of Salmon Ltd believes that the project has promise and could lead to future profits for the company. The project is, however, very expensive and needs approval from the board. The company’s chief financial officer, Mr Pink, has expressed concern that the profits of the company have not been strong in recent years and he does not want to see research and development costs charged as expenses to the profit or loss. Mr Pink has proposed that Salmon Ltd should hire an outside firm, Tuna Ltd, to undertake the work and obtain the patent. Salmon Ltd could then acquire the patent from Tuna Ltd, with no effect on the profit or loss of Salmon Ltd. Required Discuss whether Mr Pink’s proposal is a sound idea, particularly in relation to the effect on the profit or loss of Salmon Ltd. Mr Pink’s proposal is sound. If Salmon Ltd undertakes the research and development of the patent for the medicine itself then the accounting for the outlays will be based on AASB 138. In particular, any outlays spent on research will be expensed as incurred, lowering the profit for the period. Any outlays classified as development can only be capitalised once the six tests in AASB 138:57 are met. Until this occurs, any development costs must be expensed, again reducing profit. If Salmon Ltd assigns the task to an outside company and pays for the work done then the inprocess research and eventually the patent can be recognised as an asset at cost. Provided the asset can be reliably measured then an intangible asset can be recognised. There will be no effect on the profit of the company until the asset is derecognised if failure to create a useful product occurs, or if it is necessary to amortise the asset once successfully generated – also at that stage the asset may be considered to have an indefinite life which means no amortisation will be required.

11.31

Solutions manual to accompany Company Accounting 10e

Question 11.9

Recognition of brands

In its 2012 annual report (Note 17, p.16) Australian Pharmaceutical Industries (API) Ltd provided the following information: Brand names In thousands of AUD Australian pharmaceutical distribution — Soul Pattinson brand name Australian retailing — Priceline brand name

31 August 2012

31 August 2011

37 500

61 500 61 500 99 000 99 000 The valuation of Soul Pattinson (SP) brand has been completed as part of Australian Pharmacy Distribution CGU as predominant economic benefits of the SP brand have been realised in Pharmacy Distribution business. Additionally, the cash flows derived from the SP brand cannot be separated from the cash flows derived from the wholesale distribution business and banner group operations. Required Explain the recognition and measurement of the Soul Pattinson brand by API. API has recognised the Soul Pattinson brand in its records. In relation to brands, AASB 138 specifies: •

Internally generated brands cannot be recognised – para 63

Hence the Soul Pattinson brand must have been acquired either as a separate asset or as part of a business combination. If acquired as a single asset it would have been recognised at cost, being purchase price plus incidental acquisition costs. The probability recognition criteria in AASB 138:21(a) is always considered to be satisfied for separately acquired intangible assets – AASB 138:25. Further, according to AASB 138:26, the cost of a separately acquired intangible asset can usually be measured reliably. If acquired as part of a business combination it would have been recognised at fair value. No recognition criteria need be applied for assets acquired in a business combination Once recognised the asset does not have to be revalued as the asset is initially recognised at “cost” not as a part of adoption of the revaluation model. Note that the brand has the same amount, namely $99m in both 2011 and 2012. Hence the asset is not being amortised. The asset must then be presumed to have an indefinite life. Hence the asset’s useful life would need to be reviewed every year, and an impairment test conducted every year. Note the last sentence in the quotation from the Annual Report: “the cash flows derived from the SP brand cannot be separated from the cash flows derived from the wholesale distribution business and banner group operations”. This statement is similar to that in para 64 of AASB 138 where it explains why internally generated brands cannot be recognised as intangible assets – expenditure “cannot be distinguished from the cost of developing the business as a whole”. For API, the company cannot distinguish the cash flows attributable to the CGU that contains the brand from the cash flows of the brand. Hence the recoverable amount of the brand is determined by observing the recoverable amount of the CGU.

11.32

Chapter 11: Intangible assets

Question 11.10 Acquired vs internally generated intangibles In their article entitled ‘U.S. firms challenged to get “intangibles” on the books’ Byrnes and Aubin (2011) noted that in the United States ‘intangible assets such as brands, customer relationships, patents and other information technology are accounted for in one if created in-house and another if acquired’. They noted the following comments made concerning this accounting practice: The different treatment means a patent that was developed by one company and then sold to another can go from valued at next to nothing, to being worth millions — or even billions — of dollars, almost overnight, said Esther Mills, president of Accounting Policy Plus, a New York-based adviser specializing in complex accounting issues. . . The accounting difference could result in distorted behaviour, warns Abraham Briloff, a professor emeritus of accountancy at Baruch College, tempting companies to buy intellectual property rather than doing research themselves. . . Robert Herz, former chairman of the US Financial Accounting Standards Board, said in 2006 and 2007, when his group and the International Standards Board consulted with investors, managers and auditors about what the two standard setters should focus on, accounting for intangibles did not rank as highly as did a number of other subjects. Required A. Explain the accounting for internally generated intangibles in AASB 138. B. Discuss any differences between accounting for internally generated intangibles and acquired intangibles in AASB 138. C. Discuss why companies may be reluctant to press for changes in AASB 138 to require more recognition of internally generated intangibles. A.

Where there is no related expenditure on the existence of an internally generated asset it cannot be recognised as under AASB 138:24, intangible assets are initially measured at cost. Expenditure on the development of internally generated intangibles may be capitalised dependent on whether the expenditure is classified as research or development. Research is original and planned investigation with the prospect of new knowledge – see AASB 138:56 for examples. Development is the application of research findings - see AASB 138:59 for examples. Research expenditure is expensed as incurred – AASB 138:54. Development expenditure may be capitalised if all the six criteria in para 57 of AASB 138 are met. AASB 138:63 states that certain internally generated intangibles such as brands and mastheads “shall not” be recognised. This list does not include patents. Note that “customer relationships” are mentioned in the beginning of the quoted article. This should never be recognised as an intangible asset as it does not meet the definition of an asset as the company has no control over that asset. Even it were regarded as an

11.33

Solutions manual to accompany Company Accounting 10e

asset it does not meet the criterion of identifiability – as it cannot be sold or exchanged – in the definition of an intangible asset. If recognised, internally generated intangibles must be amortised unless they have indefinite lives. B.

It is easier to recognise intangibles when they are acquired in comparison to when they are internally generated. For acquired intangibles there is a market transaction and the acquired assets are measured at cost – measured at fair value for business combinations. For assets acquired in a business combination fair values may be used compared with having to determine a cost. With acquired assets, the assets prohibited in para 63 for recognition as internally generated intangibles, may be recognised. Once recognised, all intangible assets are subsequently treated the same.

See section 11.2.7 of the text. •

•

• •

Managers prefer to inflate future profits. Where major investments in research and development are written off, this is a guarantee that future revenues and earnings derived from these acquisitions will be reported unencumbered by the major expense item, the amortisation of the intangible asset. The effects on ratios such as rates of return on assets and equity are better in the future if write-offs occur now rather than periodic amortisations later. Investors generally consider write-offs as one-time items, of no consequence for valuation. A number of large hits is considered better than periodic amortisation. Investors discount the effect of one-time write-offs and cheer the improved profitability of subsequent years. Immediate expensing obviates the need to provide explanations in case of failure. Writing off assets denotes failure, and managers prefer to avoid questions and lawsuits. Further failure always attracts more attention than success. Cost and benefit. Accounting rules involve entities in incurring costs, such as those for running analytical models, measuring fair values, and paying auditors to review the measures. Lack of relevance of capitalised numbers. Is there a sufficient link between the capitalised costs and the expected future benefits? For knowledge-based assets, the measurement of the benefits may be impossible.

11.34

Chapter 11: Intangible assets

Question 11.11 Recognition of patents in a business acquisition In their article ‘Motorola deal offers Google tax, patent benefits’ Browning and Byrnes (2011) noted the following: Google Inc’s blockbuster acquisition of Motorola Mobility Holdings Inc will bring an unusual stable of tax and accounting benefits to the search-engine giant, already one of Corporate America’s most savvy users of such perks. . . By agreeing on August 15 to pay $12.5 billion in cash for struggling Motorola Mobility’s vast portfolio of 17 000 patents and 7500 pending patent applications on top of its handset business and television set-top boxes, Google is building a defensive bulwark for its Android phone software, already available on Motorola phones among others. . . The acquisition further highlights the lack of transparency in accounting rules on how intangibles such as patents, brand names and the like are valued and their worth to investors. Google has yet to announce the value it will give Motorola’s intangibles, but experts agree it will be far more than what is currently on the cell phone maker’s books. In a recent filing, Motorola Mobility reported an amortized value of $176 million for its intangible assets as of July 2, 2011. Valuing patents may be more an art than a science. Kevin Smithen, an analyst at Macquarie Capital, an investment firm in New York, estimated the $12.5 billion purchase price represented a $4.5 billion value for Motorola Mobility’s portfolio, $3.2 billion in cash the company holds, a $3 billion handset and TV set-top business, and $1.7 billion in net operating loss tax benefits it has been unable to use. Willens [a New York accounting and tax expert] estimated the $12.5 billion deal will include $3 billion in goodwill, or the value Google expects to generate from Motorola Mobility’s brand, know-how and other intangibles, not including the patents. Required A.Outline the accounting for identifiable intangible assets at acquisition date when there is a business combination. B. Explain the difference in the accounting for patents by Google in comparison to that of Motorola. A. The assets are measured at cost which is also equal to their fair value at acquisition date. Fair value is measured in accordance with AASB 13. When assets are acquired as part of a business combination there are no recognition criteria to be applied. Provided they meet the definition of an asset, they must be recognised as separate assets. AASB 138:33 states that the effect of probability of the existence of future economic benefits is reflected in the measurement of the asset at fair value, hence any probability recognition criteria is automatically met. AASB 138:33 also states that the reliability of measurement recognition test is always met as sufficient information is always available in a business combination to reliably measure intangible assets.

11.35

Solutions manual to accompany Company Accounting 10e

B. Google will account for the patents as per A. above. In essence all patents will be recognised and will be measured at fair value. In contrast with Motorola, not all patents are recognised as assets and most likely will be measured at cost rather than fair value. If the patents were acquired by Motorola as separate assets, then they will be recognised only if they meet the asset recognition tests. AASB 138:25 states that the probability recognition test is always satisfied for separately acquired intangible assets. These assets can usually be measured reliably. Hence some separately acquired asset may not have been recognised by Motorola because they were not able to be measured reliably. Further, if acquired as separate assets they would be measured initially at cost, being the sum of the purchase price and directly attributable costs. Hence whereas Google will measure these assets at fair value, Motorola will have measured them at cost. If the patents had been internally generated by Motorola, in order to be recognised the costs incurred would have had to meet all the six tests given in AASB 138:57. If these tests were not met then no asset would have been recognised and the costs outlaid would have been expensed. Motorola may have applied the revaluation model subsequent to initial recognition, meaning that Motorola may have measured some patents at fair value. This would not have allowed Motorola to recognise any more assets as the assets have firstly to be initially measured at cost before the revaluation model can be applied. However in order to apply the revaluation model the fair value must be able to be measured by reference to an active market – AASB 138:75. An active market is defined in AASB 13 as a market in which transactions for an asset take place with sufficient frequency and volume to provide pricing information on an ongoing basis.

11.36

Chapter 11: Intangible assets

Question 11.12 position

Recognition of intangibles in statements of financial

In the article ‘Why are intangibles not on the balance sheet?’ reported on 19 November 2010 at www.i-capitaladvisors.com, Mary Adams provided a number of reasons why intangibles are not shown on balance sheets in the United States:  Many intangibles are not owned by the company.  The value of intangibles is closely linked with related assets.  The dollar value of intangibles can be difficult to identify since there is no financial transaction creating them. Required Discuss whether these reasons prevent intangibles from being recognised in Australia under AASB 138. Many intangibles are not owned by the company The definition of an asset does not rely on ownership. Assets are recognised based on the control of future economic benefits rather than ownership. Potentially Mary Adams was considering such potential assets as good staff relationships, customer satisfaction and good union-management relationships. These items would not be owned by a company. Also they probably are not under the control of a company as well. Even if there were some debate about an entity being able to control such items, these items could never be recognised as an intangible asset because they fail the identifiability test. In order to be identifiable an asset must be either: - Separable ie capable of being separate or divided from an entity and sold, transferred, licensed, rented or exchanged; or - Arise from contractual or other legal rights regardless of whether those rights are transferable or separable. Hence ownership is not the issue. Control and identifiability are the key issues. Note however that items such as good customer relationships may lead to the recognition of goodwill in a business combination. Goodwill is probably neither controllable nor identifiable. The value of intangibles is closely linked with related assets Expenditure by a company may benefit many parts of the company. For example, advertising by Microsoft may have an effect on the trademarks of Microsoft Word, Excel, Outlook or other aspects of the Microsoft brand. Potentially advertising expenditure cannot be linked to specific intangible assets held by an entity. The reason given for the para 63 exclusion on certain internally generated assets such as brands, mastheads and publishing titles was that the standard-setters did not believe that the costs associated with developing the listed assets can be distinguished from the cost of developing the business as a whole.

11.37

Solutions manual to accompany Company Accounting 10e

The dollar value of intangibles can be difficult to identify since there is no financial transaction creating them. This may be the case in such companies as Apple and Microsoft where the level of computer sophistication by the staff is what creates value for the company. As employees become more skilled the value of the company increases but there is no financial transaction creating this increase in value – except for salaries and training costs. The value of brands such as Billabong and Roxy may become more valuable purely because of teenage trends rather than any outlays by the companies involved. Note that the initial measure of an intangible asset is at cost rather than value, except in a business combination where the cost is considered to be the fair value. Measurement of cost is generally more critical than measuring the dollar value. Hence many intangibles are not recognised because the cost to create those intangibles cannot be identified. With internally developed intangibles, this problem is recognised by the need to meet the six para 57 criteria before any intangible development asset can be recognised. With separately acquired intangibles, AASB 138:26 states that the cost can usually be determined reliably. With intangibles acquired in a business combination, AASB 138:33 argues that there will always be sufficient information available to ensure that the fair value can always be reliably measured.

11.38

Chapter 11: Intangible assets

Question 11.13

Research and development

Because of the low level of rainfall in Simonstown, householders find it difficult to keep their gardens and lawns sufficiently watered. As a result, many householders have installed bores that allow them to access underground water suitable for using on the garden. This is a cheaper option than incurring excess water bills by using the government-provided water system. One of the problems with much of the bore water is that its heavy iron content leaves a brown stain on paths and garden edges. This can make homes look unsightly and lower their value. Noting this problem, Strand Laboratories believed that it should research the problem with the goal of developing a filter system that could be attached to a bore and remove the effects of the iron content in the water. This process, if developed, could be patented and filters sold through local reticulation shops. In 2011, Strand commenced its work on the problem, resulting in August 2015 in a patent for the NoMoreIron filter process. Costs incurred in this process were as shown below. 2011–12 Research conducted to develop filter $125 000 2012–13 Research conducted to develop filter 132 000 2013–14 Design and construction of prototype 152 000 2014–15 Testing of models 51 000 2015–16 Fees for preparing patent application 12 000 2016–17 Research to modify design 34 000 2017–18 Legal fees to protect patent against cheap copies 15 000 Required Discuss how the company should account for each of these outlays. The outlays must be analysed using para 57 of AASB 138: Technical feasibility: At the end of the 2014-15 period, the company has completed the testing of the models and planned to prepare a patent application believing the product was technically feasible. Intention to complete and sell: The company always had the belief that the product would be saleable but it was not until the product was tested and found to be feasible that the company could commence plans to sell. Ability to use or sell: Because of problems with the design, it had to be modified to make the product saleable and lessen returns or warranty claims. This was completed at the end of the 2016-17 period. Existence of a market: The market was always open to such a product. However, the existence of a market requires the product to be available at a price that customers would be prepared to pay. This may have been part of the reason for modifying the design in the 2016-17 period. Availability of resources: The company was not short of resources to develop this product. Ability to measure costs reliably: Cost of the product was readily available after the modifications to the design in the 2016-17 period.

11.39

Solutions manual to accompany Company Accounting 10e

All costs incurred up to the end of the 2016-17 period must be expensed. The only costs available for capitalisation are the $15 000 costs incurred in the 2017-18 period.

11.40

Chapter 11: Intangible assets

Question 11.14

Research and development

Stellenbosch Laboratories Ltd manufactures and distributes a wide range of general pharmaceutical products. Selected audited data for the reporting period ended 31 December 2014 are as follows: Gross profit Profit before income tax Income tax expense Profit for the period Total assets: Current Non-current

$ 17 600 000 1 700 000 500 000 1 200 000 7 300 000 11 500 000

The company uses a standard mark-up on cost. From your audit files, you ascertain that total research and development expenditure for the year amounted to $4 700 000. This amount is substantially higher than in previous years and has eroded the profitability of the company. Mr Bosch, the company’s finance director, has asked for your firm’s advice on whether it is acceptable accounting practice for the company to carry forward any of this expenditure to a future accounting period. Your audit files disclose that the main reason for the significant increase in research and development costs was the introduction of a planned 5-year laboratory program to attempt to find an antidote for the common cold. Salaries and identifiable equipment costs associated with this program amounted to $2 350 000 for the current year. The following additional items were included in research and development costs for the year: (a) Costs to test a new tamper-proof dispenser pack for the company’s major selling line (20% of sales) of antibiotic capsules — $760 000. The new packs are to be introduced in the 2015 financial year. (b) Experimental costs to convert a line of headache powders to liquid form — $590 000. The company hopes to phase out the powder form if the tests to convert to the stronger and better handling liquid form prove successful. (c) Quality control required by stringent company policy and by law on all items of production for the year — $750 000. (d) Costs of a time and motion study aimed at improving production efficiency by redesigning plant layout of existing equipment — $50 000. (e) Construction and testing of a new prototype machine for producing hypodermic needles — $200 000. Testing has been successful to date and is nearing completion. Hypodermic needles accounted for 1% of the company’s sales in the current year, but it is expected that the company’s market share will increase following introduction of this new machine. Required Respond to Mr Bosch’s question for each of these items. The outlays must be analysed using para 57 of AASB 138: Technical feasibility: Intention to complete and sell:

11.41

Solutions manual to accompany Company Accounting 10e

Ability to use or sell: Existence of a market: Availability of resources: Ability to measure costs reliably:

(a)

Dispenser pack: As the dispenser pack was a new product, costs incurred until the pack developed met the para 57 tests are expensed. In this case, determining the technical feasibility of the pack and developing a cost effective product would have been two key issues.

(b)

Converting powders to liquid form: The tests have not yet proven successful, therefore the technical feasibility test would not be met and the $590 000 must be expensed.

(c)

Costs of quality control: These costs relate to products being produced and hence can be capitalised into the products produced. No separate intangible such as “Superior Quality” could be raised as such an asset is not identifiable.

(d)

Costs of time and motion study: As the equipment is being used in current production, the costs could be capitalised into the cost of the equipment.

(e)

New prototype machine: This is a difficult one to classify. The question hinges on the “nearing completion” statement. It is a question of what has yet to be done. Questions relating to the para 57 criteria need to be asked. For example: has technical feasibility been established, and is it only minor adjustments that are being made? Do any minor adjustments have a material effect on the determination of the costs of the machine?

11.42

Chapter 11: Intangible assets

Question 11.15

Recognition of intangibles

Ladysmith Ltd has recently diversified by taking over the operations of Kimberley Ltd at a cost of $10 million. Kimberley Ltd manufactures and sells a cleaning cloth called the ‘Supaswipe’, which was developed by Kimberley Ltd’s highly trained and innovative research staff. The unique nature of the coating used on the ‘Supaswipe’ has resulted in Kimberley Ltd acquiring a significant share of the South African market. A recent expansion into the Equatorial African market has proved successful. As a result of the takeover, Ladysmith Ltd acquired the following assets: Fair value (at date of acquisition) Land and buildings $ 3 200 000 Production machinery 2 000 000 Inventory 1 800 000 Accounts receivable 700 000 $ 7 700 000 In addition to the above, Kimberley Ltd owned, but had not recognised, the following: • trademark — ‘Supaswipe’ • patent — formula for the special coating. The research staff of Kimberley Ltd have agreed to join the staff of Ladysmith Ltd and will continue to work on a number of projects aimed at producing specialised versions of the ‘Supaswipe’. The directors have requested your assistance in accounting for the acquisition of Kimberley Ltd. In particular, they are uncertain as to the treatment of the $2.3 million discrepancy between the assets recorded by Kimberley Ltd and the price paid for the company. Required Write to the directors outlining the alternative courses of action available in relation to the $2.3 million discrepancy. Your reply should cover the issues of asset recognition, measurement, classification and subsequent accounting treatment. Asset recognition: The trademark and the patent are intangible assets, meeting the definition in relation to identifiability as the company has legal rights to both. As the assets are acquired as part of a business combination, recognition of the assets comes under AASB 3, in particular paras 11-12 and AASB 138 para 33 which state that no recognition criteria need be applied. Provided the assets meet the definition of an intangible asset, they must be recognise as separate assets based on their fair values at acquisition date., Initial Measurement: Measurement of the fair value of the assets is based on paras. 39-41 of AASB 138, and may be determined by: - quoted market prices in an active market – unlikely in this case; - recent transactions: unlikely in this case; or - measurement techniques, using valuers to measure the fair values of the assets. As the worth of the trademark is related to the owner of the trademark also having the patent to be able to use the formula for the special coating, it is doubtful whether the two assets can be separately valued. However, the value of the trademark may relate to the customer awareness and appeal of the current product in comparison to having to sell a new brand name.

11.43

Solutions manual to accompany Company Accounting 10e

Classification The assets when recognised are classified as non-current intangible assets. Subsequent measurement Having initially recognised the assets, the company can choose to use the cost or the revaluation models. However, use of the revaluation model is subject to their being an active market to determine subsequent fair values of the assets. Any subsequent outlays in relation to the assets are subject to the criteria in relation to para 57 of AASB 138 prior to capitalisation of the outlays. The useful lives of the assets need to be determined to see whether they need to be amortised. If an asset has an indefinite life no amortisation is required. However, an annual impairment test in relation to such an asset is necessary. Other assets: goodwill If the fair values of the patent and the trademark are less than the $2.3 million, then goodwill is recognised. This is also subject to an impairment test annually, but is not required to be amortised. If other intangible assets exist they should also be separated out of goodwill.

11.44

Chapter 11: Intangible assets

Question 11.16

Accounting for research and development

Read the following article from the website of the Australian Trade Commission. Business spending on research and development hits A17.9 billion Latest data from the Australian Bureau of statistics reveals business spending on research and development (R&D) grew to $17.9 billion in 2010–11, an increase of seven per cent over the previous financial year. Businesses in the manufacturing industry registered the largest growth in R&D expenditure, increasing by $499 million or 12 per cent over the past year. Next best was the professional, scientific and technical services industry which recorded increased spending by $140 million. While all states and territories reported higher spending on R&D, the strongest growth since 2009–10 was in Queensland (up $322 million), followed by Western Australia (up $265 million), and New South wales (up $255 million). The Minister for Industry and Innovation, Greg Combet, welcomed the ABS findings that small firms with up to four employees had increased their R&D spending by 28 per cent to more than $800 million.

Source: Austrade (2012). Required One of the small companies that has been increasing its expenditure on R&D has contacted you. You are required to provide advice on how R&D expenditure should be accounted for under AASB 138 (disregard any discussion on amortisation of intangibles). Accounting for research and development expenditure will depend on whether the R&D is acquired as a separate asset, acquired as part of a business combination or whether the company has spent money on developing its own intangible assets. Separately acquired assets If the company acquired in-process research from another company it would be recognised as an asset if the cost could be reliably measured, which is usually the case – AASB 138:26. There is no need to apply any probability recognition test – AASB 138:25. Assets meeting the recognition tests are measured at cost, being the sum of purchase price and directly attributable costs. Assets acquired in a business combination If R&D assets are acquired as part of a business combination there are no recognition tests to be met. Provided the assets meet the definition of an asset they must be recognised as separate assets. The initial measurement of the asset is at cost, being its fair value at acquisition date – AASB 138:33. Internally generated intangible assets Where expenditure is made in relation to research and development, the expenditure must be categorised into whether the expenditure was for research or for development. These terms are defined in AASB 138:8.

11.45

Solutions manual to accompany Company Accounting 10e

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Expenditure on research activities is expensed when incurred: AASB 138:54 Expenditure on development is capitalised as an intangible asset if all the six criteria in AASB 138:57 are met. If the criteria are not met the expenditure is expensed as incurred. If the criteria are met, the amount to be capitalised is the expenditure incurred from the date when the intangible asset first meets the para 57 tests. There can be no reinstatement of amounts previously expensed. AASB 138:63 provides an exclusion in relation to recognising some internally generated assets even if the para 57 tests are met: Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets. Subsequent expenditure AASB 138:20 discusses subsequent expenditure on intangible assets. In general it is expected that subsequent expenditure will be expensed rather than capitalised as it generally maintains currently recognised benefits rather than adds to them. Subsequent expenditure on para 63 assets is always expensed. Note AASB 138:42 in relation to subsequent expenditures relating to acquired in-process research and development expenditure. Effectively the same criteria for initially recognising an asset and expensing are applied to account for subsequent expenditure, namely: - Research outlays are expensed - Development outlays are only capitalised in the para 57 criteria are all met, otherwise they are expensed.

11.46

Chapter 11: Intangible assets

Question 11.17

Amortisation of intangibles

Read the following article from www.crikey.com.au. With $5b of intangibles, will new Fairfax director wield the axe? With its share price sliding to record lows, Fairfax Media is now in the invidious position of having the most widely optimistic balance sheet of any ASX 200 company. When its latest statutory earnings were released on February 23, page 9 revealed that the dominant item on the balance sheet was $$5.1 billion worth of intangibles. Note 7 on page 20 of the interim report provided the following breakdown of those intangibles:  Mastheads and trademarks: $3.21 billion  Goodwill: $1.8 billion  Radio licence: $121 million  Software: $64.5 million  Customer relationships: $9.5 million Unfortunately, Australia’s accounting regulations don’t require any specific disclosure or breakdowns within an asset class. . . With newspapers in structural and precipitous decline courtesy of the internet, Fairfax Media is now only capitalised at $1.53 billion, based on a share price of 65 cents. So how on earth can the Fairfax directors along with the auditor, Douglas Bain from Ernst & Young, continue to claim the company has net assets of $4.735 billion? The discrepancy has now blown out to a record $3.2 billion. . . For mine, it is pretty clear that Fairfax should clear the decks by writing down its intangibles by at least $2 billion. . .

Source: Mayne, S (2012). Required A.Outline the accounting principles on amortisation of intangibles in AASB 138. B. Discuss what actions should be taken by Fairfax. A.

The accounting principles for intangibles are much the same as those for PPE ie allocation of the depreciable amount on a systematic basis over the useful life of the asset.

Method of allocation

Any method that allocates benefits on a systematic basis is allowed. However with intangibles, straight-line method is the default method where the pattern of receipt of benefits cannot be reliably determined. This is not the case with PPE. Useful life IF the asset is considered to have an indefinite useful life no amortisation is required. If the expected useful life is finite, depreciation must be charged. The determination of useful life will require an analysis of a number of factors (as per AASB 138:90) such as expected actions by competitors and the stability of the industry and changes in market demand. If an indefinite useful life is selected for a patent, then an annual impairment test is required under AASB 136 Impairment of Assets. IF a finite useful life is determined, the depreciable amount of the asset will be written off over the useful life on a systematic basis, with the method chosen reflecting the pattern in

11.47

Solutions manual to accompany Company Accounting 10e

which the expected benefits are expected to be consumed by the entity. Where the pattern of flow of benefits cannot be determined reliably, the straight-line method must be used. Further, the residual value is assumed to be zero, unless there is a commitment by a third party to acquire the asset in the future or there exists an active market. Useful life must be assessed as finite or indefinite. Note AASB 138: 90 in relation to assessment of whether an indefinite useful life exists. Many factors are considered in determining the useful life of an intangible asset, including: (a) the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team; (b) typical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way; (c) technical, technological, commercial or other types of obsolescence; (d) the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset; (e) expected actions by competitors or potential competitors; (f) the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity's ability and intention to reach such a level; (g) the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases; and (h) whether the useful life of the asset is dependent on the useful life of other assets of the entity. Residual Value With intangibles with finite lives, residual value is assumed to be zero unless para 100 criteria are met – existence of a commitment of a third party to acquire the asset at the end of the useful life or there is an active market for the asset, and residual value can be determined by reference to the market and it is probable that the market will exist at the end of the asset’s useful life (AASB 138:100) B.

If the market capitalisation of Fairfax Media is only $1.53 billion and its assets exceed that then the best action that should be undertaken by Fairfax is to conduct an impairment test. The recoverable amount of the assets is potentially lower than the carrying amount of the assets. There seem to be a number of external indicators namely the existence of new markets such as competition from internet news with the lowered demand for print media that would require an impairment test to be undertaken.

Subject to the impairment test the assets may be written down and new depreciation variables such as useful lives determined. With any intangibles that are being considered by Fairfax to have indefinite lives, there should be an annual impairment test of those assets anyway.

11.48

Chapter 12: Business combinations

Chapter 12 – Business Combinations REVIEW QUESTIONS 1.

What is meant by a “business combination”?

AASB 3 Appendix A: Business: “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants” Business combination: A transaction or other event in which an acquirer obtains control of one or more businesses” Consider inputs, processes and outputs Only in a business combination can goodwill be present.

Discuss the importance of identifying the acquisition date.

Acquisition date is the date on which the acquirer obtains control of the acquiree. Important because on this date: • the fair values of the identifiable assets acquired and liabilities assumed are measured. • the fair value of the consideration transferred is measured • the goodwill or gain on bargain purchase is calculated.

What is meant by “contingent consideration” and how is it accounted for?

Appendix A: Contingent consideration: Usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met. See AASB 3 paras. 39-40

12.1

Solutions manual to accompany Company Accounting 10e

Para 39: The consideration transferred includes any asset or liability resulting from a contingent consideration arrangement. This is measured at fair value at acquisition date. Para 40: The acquirer shall classify the obligation to pay contingent consideration as a liability or equity. Para 58: Changes in the measurement of the obligation subsequent to acquisition date resulting from events after the acquisition date are accounted for differently depending on whether the obligation was classified as equity or debt. If classified as equity, the equity shall not be remeasured. If classified as liability, it is accounted under AASB 139 of AASB 137 as appropriate. 4.

Explain the key components of “core” goodwill.

Core goodwill has two main components: (i) Going concern goodwill: relates to the net assets of the acquiree, in that the acquiree’s net assets together are worth more than the net assets separately, caused by the synergy created by the acquiree’s net assets within the acquiree as a going concern. (ii) Combination goodwill: relates to the extra benefits accruing because of the synergy created by the acquirer and the acquiree combining together eg if the raw materials available to the acquiree are of particular use to the acquirer. These benefits could affect the recorded earnings of the acquirer or the acquiree [or both] depending on the nature of the benefits. 5.

What recognition criteria are applied to assets and liabilities acquired in a business combination?

See pages 354-5 of the text.

Para 10 of AASB 3 states that the identifiable assets acquired and liabilities assumed shall be recognised separately from goodwill. Because the assets and liabilities are measured at fair value, the assets and liabilities are recognised regardless of the degree of probability of inflow/outflow of economic benefits. The fair value reflects expectations in its measurement. The assets and liabilities recognised must meet the definitions of assets and liabilities in the Framework. [Para 11] The assets and liabilities recognised must also be part of the exchange transaction rather than resulting from separate transactions [para 12].

12.2

Chapter 12: Business combinations

How is an acquirer identified?

Para 6: For each business combination, one of the combining entities shall be identified as the acquirer. Appendix A: The acquirer is the entity that obtains control of the acquiree. Appendix A: Control is the power to govern the financial and operating policies of the acquiree so as to obtain benefits from its activities. Determination of the acquirer requires judgement. Paragraphs B13-B18 of AASB 3 provides indicators/guidelines to assist in this judgement: -

form of consideration: did one entity transfer cash or other assets for the shares of the other? [para B14]; did one entity issue its own equity interests in exchange for another entity’s equity interests? [para B15] Was there a premium paid by one of the entities? [para B16(e)] subsequent management: which entity’s management subsequently controls the business combination? What are the relative voting rights after the business combination? [para B15(a)] What is the composition of the senior management of the combined entity? [para B15(d)] large minority voting interest: The acquirer normally holds the largest minority voting interest in the combined entity. [para B15(b)] predator or target: which entity initiated the combination? [B17]. relative size of the businesses: is the fair value of one entity significantly greater than another? [para B16]]. Large entities normally takeover small entities;

Explain the key steps in the acquisition method.

AASB 3 para 5: 1. 2. 3. 4.

identify the acquirer determine the acquisition date recognise and measure the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree recognise and measure goodwill or a gain from a bargain purchase.

How is the consideration transferred calculated?

AASB 3 para 37 states that the consideration transferred shall be - measured at fair value, determined at acquisition date, and - calculated as the sum of the fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer, and the equity interests issued by the acquirer.

12.3

Solutions manual to accompany Company Accounting 10e

If an acquiree liquidates, what are the key accounts raised by the acquiree and what accounts are transferred to these accounts? LIQUIDATION ACCOUNT Assets taken over Liabilities arising during the liquidation process Liquidation expenses Balance to Shareholders Distribution

Contra assets Liabilities assumed Reserves Consideration received

SHAREHOLDERS’ EQUITY ACCOUNT Consideration paid to shareholders

10.

Share capital Balance Liquidation Account

How is a gain on bargain purchase accounted for?

AASB 3 para 34 specifies the measurement of the gain. Para 36 requires an acquirer to: reassess the identification and measurement of the identifiable assets acquired and liabilities assumed, and measurement of the consideration transferred. This review is to ensure that the measurements are appropriate. Para 34 requires an acquirer, subsequent to para 36 procedures, recognise any remaining gain on bargain purchase immediately in profit or loss.

12.4

Chapter 12: Business combinations

11.

Why is it important to identify an acquirer in a business combination?

Consider the example in para B18 in Appendix B to AASB 3. Assume A Ltd and B Ltd combine together by creating C Ltd which acquires all the shares in A Ltd and B Ltd and issues its own shares in exchange. As noted in para B18, C Ltd is not necessarily the acquirer. What differences occur if either A Ltd or B Ltd is identified as the acquirer? 2 effects: (i) the consideration transferred is based on what the acquirer gives up; and (ii) the acquiree’s net assets are measured at fair value. In relation to point (ii), if A Ltd is the acquirer then in the consolidated financial statements B Ltd’s net assets are adjusted to fair value while A Ltd’s net assets are at the carrying amounts in A Ltd. If B Ltd is the acquirer, A Ltd’s net assets are adjusted to fair value while B Ltd’s net assets are at the carrying amounts in B Ltd.

12.5

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Applying AASB 3

Bass Ltd has recently undertaken a business combination with Bream Ltd. At the start of negotiations, Bass Ltd owned 30% of the shares of Bream Ltd. The current discussions between the two entities concerned Bass Ltd’s acquisition of the remaining 70% of shares of Bream Ltd. The negotiations began on 1 January 2016 and enough shareholders in Bream Ltd agreed to the deal by 30 September 2016. The purchase agreement was for shareholders in Bream Ltd to receive in exchange shares in Bass Ltd. Over the negotiation period, the share price of Bass Ltd shares reached a low of $5.40 and a high of $6.20. The accountant for Bass Ltd, Mr Spencer, knows that AASB 3 has to be applied in accounting for business combinations. However, he is confused as to how to account for the original 30% investment in Bream Ltd, what share price to use to account for the issue of Bass Ltd’s shares, and how the varying dates such as the date of exchange and acquisition date will affect the accounting for the business combination. Required Provide Mr Spencer with advice on the issues that are confusing him. Issue 1: How to account for the original 30% investment in Bream Ltd -

initially recorded at fair value plus transactions cost, based on para 43 of AASB 139 subsequently accounted for under IAS 39 eg could be measured at fair value with changes in value included in profit or loss or changes recognised directly in equity. On formation of the business combination, para. 42 of AASB 3 requires that the acquirer remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognise the resultant gain/loss in profit or loss. Where the investment had been measured at fair value with increments recognised directly in equity, these amounts are transferred at acquisition date to profit or loss as well, and disclosed as reclassification adjustments.

Issue 2: What share price to use Para 27 of AASB 3 requires the use of the fair value at the date of acquisition. This price will include all expectations of the takeover, including any premium for control. Some argue this does not reflect the cost to Bassl Ltd. See pp 458-459 for the debate on use of agreement date model and the acquisition date model. Issue 3: Effects of different dates AASB 3 refers to acquisition date only. All measures of fair value are made on acquisition date, for both the consideration transferred and the assets acquired and liabilities assumed. As noted under Issue 1, the 30% investment, originally recognised at the date of exchange, the date the acquirer initially acquired that investment, must at acquisition date be remeasured to fair value.

12.6

Chapter 12: Business combinations

Case Study 2

Accounting for goodwill

Silver Ltd has acquired a major manufacturing division from Fern Ltd. The accountant, Ms Ball, has shown the board of directors of Silver Ltd the financial information regarding the acquisition. Ms Ball calculated a residual amount of $45 000 to be reported as goodwill in the accounts. The directors are not sure whether they want to record goodwill on Silver Ltd’s statement of financial position. Some directors are not sure what goodwill is or why the company has bought it. Other directors even query whether goodwill is an asset, with some being concerned with future effects on the statement of profit or loss and other comprehensive income. Required Prepare a report for Ms Ball to present to the directors to help them understand the nature of goodwill and how to account for it. Nature of goodwill • • • • •

Is it an asset? 2 types: Internal vs external/acquired goodwill Nature of internal goodwill: undervalued/unrecorded assets, core goodwill Nature of acquired goodwill? Core goodwill: going concern & combination Why did acquirer pay for goodwill? Synergy – extra benefits

How to account for it • •

•

Internal goodwill IAS 38: not recognised as cannot determine a cost Acquired goodwill • Recognised only in a business combination • Measured as a residual under para 32 • Subject to annual impairment test • If allocated to CGU, write off first if impairment loss • If reversal of impairment loss, no reinstatement of goodwill Future effects on Statement of Comprehensive Income • No cause for concern • No annual amortisation • Only expense if impairment loss • Impairment loss cushioned by various accounting treatments such as use of cost method for PPE, non-recognition of internally generated goodwill & internally generated intangibles

12.7

Solutions manual to accompany Company Accounting 10e

Case Study 3

Identifying the acquirer

White Ltd has been negotiating with Cloud Ltd for several months, and agreements have finally been reached for the two companies to combine. In considering the accounting for the combined entities, management realises that, in applying AASB 3, an acquirer must be identified. However, there is debate among the accounting staff as to which entity is the acquirer. Required A. What factors/indicators should management consider in determining which entity is the acquirer? B. Why is it necessary to identify an acquirer? In particular, what differences in accounting would arise if White Ltd or Cloud Ltd were identified as the acquirer? Part 1: The acquirer is the combining entity that obtains control of the other combining entities. [Appendix A, AASB 3]

Determination of the acquirer requires judgement. Paragraphs B13-B18 of AASB 3 provides indicators/guidelines to assist in this judgement: -

Part 2: Why identify an acquirer? The consideration transferred is measured on the basis of the consideration given by the acquirer, while the identifiable assets and liabilities of the acquiree are measured at fair value. In relation to White Ltd – Cloud Ltd, the main effect then would be: If White Ltd is the acquirer, the identifiable assets, liabilities and contingent liabilities of Cloud Ltd would be measured at fair value while White Ltd assets and liabilities remain at their original carrying amounts. If Cloud Ltd were the acquirer, it would be White Ltd’s assets and liabilities that would be at fair value.

12.8

Chapter 12: Business combinations

Case Study 4

Accounting for research

Tall Ltd has acquired all the net assets of Blacks Ltd with the latter going into liquidation. Both companies operate in the area of testing and manufacturing pharmaceutical products. One of the main reasons that Tall Ltd sought to acquire Blacks Ltd was that the latter company had an impressive record in the development of drugs for the cure of some mosquito-related diseases. Blacks Ltd employed a number of scientists who were considered to be international experts in their area and at the leading edge of research in their field. Much of the recent work undertaken by these scientists was classified for accounting purposes as research, and as per AASB 138 Intangible Assets was expensed by Blacks Ltd. However, in deciding what it would pay to take over Blacks Ltd, Tall Ltd had paid a sizeable amount of money for the ongoing research being undertaken by Blacks Ltd as it was expected that it would be successful eventually. The accountant for Tall Ltd, Mr Basket, has suggested that the amount paid by Tall Ltd for this research should be shown as goodwill in the company’s statement of financial position. However, the directors of the company do not believe that this faithfully represents the true nature of the assets acquired in the business combination, and want to recognise this as an asset separately from goodwill. Mr Basket believes that this will not be in accordance with AASB 138. Required Provide the directors with advice on the accounting for the aforementioned transaction. Principles in AASB 138: • • • •

Definitions of research vs development Para 57 criteria to determine what is research & development: note 2 or 3 examples of these criteria Expense research outlays, capitalise development using para 57 Never recognise certain internally generated intangibles para 63 examples to be given

How to account for the acquired research: • • •

AASB 3 is the relevant accounting standard, not AASB 138 Measure at FV using hierarchy: active market, similar transactions & valuation techniques Intangibles that meet the recognition criteria must be accounted for separately from goodwill. Directors may prefer a classification of goodwill as the latter is not amortised, whereas intangibles generally have a finite life.

12.9

Solutions manual to accompany Company Accounting 10e

Case Study 5

Accounting for acquisition-related costs

One of the responsibilities of the Group Accountant for Southland Ltd, Ms Bluff, is to explain the accounting principles applied by the company in preparing the annual report to the company’s Board of Directors. Having analysed AASB 3, Ms Bluff is puzzled by the requirement in paragraph 53 of AASB 3 that any acquisition-related costs such as fees for lawyers and valuers should be expensed. Ms Bluff has analysed other accounting standards such as AASB 116 Property, Plant and Equipment and notes that under this standard such costs are capitalised into the cost of any property, plant and equipment acquired. She therefore believes that to expense such costs in accounting for a business combination would not be consistent with accounting for acquisitions of other assets. Further, Ms Bluff believes that to expense such costs would result in a loss being reported in the statement of profit or loss and other comprehensive income in the period the business combination occurs. She is not sure how she will explain to the board of directors that the company makes a loss every time it enters a business combination. She believes the directors will wonder why the company enters into business combinations if immediate losses occur — surely losses indicate that bad decisions have been made by the company. Required Prepare a report for Ms Bluff on how she should explain the accounting for acquisitionrelated costs to the board of directors. Arguments in favour of expensing: - These costs are not part of the fair value exchange between the buyer and the seller. - The services received from the outlays have been consumed, and so do not give rise to assets. Arguments against expensing: - Inconsistent with other accounting standards such as AASB 116 Property, Plant and Equipment. - The costs are an integral part of the acquisition price, with the outlays being incurred in order to generate future benefits. Under AASB 3, a fair value model is adopted so consistency with AASB 116 is not a strong argument. The acquirer is prepared to incur the costs at acquisition. Hence there must be an expectation on the acquirer’s part that these will be recouped via future benefits from the business combination. As noted by Ms New, business combinations do not result in immediate losses. However, because the fair value model is used, the assets acquired cannot be stated in excess of fair value – compare the initial measurement of financial instruments acquired under para 43 of AASB 139. If goodwill reflects expected future benefits and is measured as a residual, then it may be argued the total benefits acquired by the acquirer are reflected in the cost of the combination being the sum of the consideration transferred and the directly attributable costs. Under this view there would be a larger goodwill measured than currently recognised under AASB 3, but no expense for the acquisitionrelated costs. Note para BC366 of the Basis for Conclusions for AASB 3, the IASB argues:

12.10

Chapter 12: Business combinations

1. Acquisition-related costs are not part of the fair value exchange between the buyer and the seller. 2. They are separate transactions for which the buyer pays the fair value for the services received. 3. These amounts do not generally represent assets of the acquirer at acquisition date because the benefits obtained are consumed as the services are received.

12.11

Solutions manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 12.1

Accounting by the acquirer

The trial balance of Jackman Ltd at 1 January 2016 was as follows: Debit Credit Share capital Preference – 12 000 fully paid shares $12 000 Ordinary – 60 000 fully paid shares 60 000 Retained earnings 43 000 Equipment $84 000 Accumulated depreciation – equipment 20 000 Inventory 36 000 Accounts receivable 20 000 Investments 12 000 Patents 7 000 Debentures 8 000 Accounts payable _____ 16 000 $159 000 $159 000 At this date, all the assets and liabilities of Jackman Ltd are sold to Hugh Ltd, with Jackman Ltd going into voluntary liquidation. The terms of acquisition are: (a) Hugh Ltd is to take over all the assets of Jackman Ltd, as well as the accounts payable of Jackman Ltd. (b) Costs of liquidation of $700 are to be paid by Jackman Ltd with funds supplied by Hugh Ltd. (c) Preference shares in Jackman Ltd are to receive two fully paid shares in Hugh Ltd for every three shares held, or alternatively, $0.80 per share in cash payable at the acquisition date. (d) Ordinary shareholders of Jackman Ltd are to receive two fully paid ordinary shares in Hugh Ltd for every share held or, alternatively, $2.50 in cash payable half at the acquisition date and half in one year’s time. (e) Debenture holders of Jackman Ltd are to be paid in cash out of funds provided by Hugh Ltd. The debentures have a fair value of $102 per $100 debenture. (f) All shares issued by Hugh Ltd have a fair value of $1.20 per share. (g) Costs of issuing and registering the shares issued by Hugh Ltd amount to $80 for the preference shares and $200 for the ordinary shares. (h) Legal and accounting costs associated with the acquisition of Jackman Ltd amount to $2000. The two parties agree on the terms of the arrangement, and holders of 6 000 preference shares and 10 000 ordinary shares elect to receive cash. Hugh Ltd assesses the fair values of the identifiable assets and liabilities of Jackman Ltd to be as follows: Equipment Inventory Accounts receivable Patents Investments

$72 000 40 000 18 000 8 000 12 000

12.12

Chapter 12: Business combinations

Accounts payable

16 000

Hugh Ltd has an incremental borrowing rate of 10%. Required A. Prepare the acquisition analysis in relation to the above acquisition by Hugh Ltd. B. Prepare the journal entries in the records of Hugh Ltd at the date of acquisition. C. Prepare the journal entry for the payment of the deferred consideration in one year’s time. Net fair value of identifiable assets and liabilities acquired: Equipment Inventory Accounts receivable Patents Investments

$72 000 40 000 18 000 8 000 12 000 150 000 (16 000) $134 000

Accounts payable

Consideration transferred: Cash: Costs of liquidation Preference shareholders – 6000 x $0.80 Ordinary shareholders: Payable now ½ x 10 000 x $2.50 Payable later ½ x 10 000 x $2.50 x 0.909091 Debentures including premium - $8 000 x 1.02 Shares: *Preference shareholders – 4 000 x $1.20 **Ordinary shareholders – 100 000 x $1.20 Consideration ransferred

$700 4 800 12 500 11 364 8 160 4 800 120 000

Goodwill = $162 324 - $134 000 =

$37 524

124 800 $162 324 $28 324

*Preference shares: (12 000 – 6 000) x 2/3 = 4 000 pref. shares **Ordinary shares: (60 000 – 10 000) x 2 = 100 000 ord. shares

12.13

Solutions manual to accompany Company Accounting 10e

QUESTION 12.1 (cont’d) B. Journal entries in Hugh Ltd at acquisition date, 1 January 2016, are: Equipment Dr Inventory Dr Accounts receivable Dr Patents Dr Investments Dr Goodwill Dr Accounts payable Cr Consideration payable Cr Share capital – Ordinary Cr Share capital – Preference Cr (Acquisition of assets and liabilities of Jackman Ltd)

72 000 40 000 18 000 8 000 12 000 28 324

Consideration payable Dr Cash Cr (Payment of cash to shareholders of Jackman Ltd) * $37 524 - $11 364 to be paid in 1 year’s time

*26 160

Incidental costs expense Dr Cash Cr Incidental costs of acquiring Jackman Ltd)

2 000

Share Capital – Ordinary Share Capital – Preference Cash (Cost of issue of shares on acquisition of Jackman Ltd)

16 000 37 524 120 000 4 800

26 160

2 000

Dr Dr Cr

200 80

Dr Dr Cr

11 364 1 136

280

C: Journal entry in one year’s time, 1 January 2017: Consideration payable Interest expense Cash (Payment of deferred consideration)

12 500

12.14

Chapter 12: Business combinations

Question 12.2

Accounting at acquisition date by the acquirer

On 1 July 2016, Brad Ltd acquired all of the assets and liabilities of Pitt Ltd. In exchange for these assets and liabilities, Brad Ltd issued 100 000 shares that at date of issue had a fair value of $5.20 per share. Costs of issuing these shares amounted to $1000. Legal costs associated with the acquisition of Pitt Ltd amounted to $1200. The asset and liabilities of Pitt Ltd at 1 July 2016 were as follows: Carrying amount Assets Cash Accounts receivable Inventory Equipment Accumulated depreciation – equipment Patents Liabilities Accounts payable Debentures

Fair value

$2 000 10 000 64 000 320 000 (96 000) 240 000

$2 000 10 000 68 000 232 000 — 280 000

(16 000) (64 000)

Required A. Prepare the acquisition analysis at 1 July 2016 for the acquisition of Pitt Ltd by Brad Ltd. B. Prepare the journal entries in the records of Brad Ltd at 1 July 2016. C. Prepare the journal entries in the records of Brad Ltd assuming that the shares issued by Brad Ltd had a fair value of $4.80. A. Acquisition analysis: Net fair value of identifiable assets and liabilities acquired: Patents Equipment Inventory Cash Accounts receivable Accounts payable Debentures Net assets Consideration transferred: 100 000 shares at $5.20 each Goodwill = $520 000 - $512 000 =

$280 000 232 000 68 000 2 000 10 000 592 000 (16 000) (64 000) (80 000) $512 000 $520 000 $8 000

B. Journal entries in records of Brad Ltd at 1 July 2016: Patents Dr 280 000 Equipment Dr 232 000 Inventory Dr 68 000 Cash Dr 2 000 Accounts receivable Dr 10 000 Goodwill Dr 8 000 Accounts payable Cr

16 000

12.15

Solutions manual to accompany Company Accounting 10e

Debentures Cr Share capital Cr (Acquisition of the assets and liabilities of Pitt Ltd) Share capital Cash (Costs of share issue)

Dr Cr

Acquisition expenses Dr Cash Cr (Costs associated with the acquisition of Pitt Ltd)

64 000 520 000

1 000 1 000

1 200

C. Journal entries in records of Pitt Ltd if FV of shares = $4.80 Fair value of acquiree’s net assets $512 000 Consideration transferred: 100 000 x $4.80 $480 000 Gain on bargain purchase $32 000 The only entry that changes from Part B is: Patents Dr 280 000 Equipment Dr 232 000 Inventory Dr 68 000 Cash Dr 2 000 Accounts receivable Dr 10 000 Accounts payable Cr Loans Cr Share capital Cr Gain on bargain purchase Cr

1 200

16 000 64 000 480 000 32 000

12.16

Chapter 12: Business combinations

Question 12.3

Accounting by acquirer

On 1 July 2016, Angelina Ltd took control of the assets and liabilities of Jolie Ltd. At this date the statement of financial position of Jolie Ltd was as follows: Carrying amount Machinery $40 000 Fixtures & fittings 60 000 Vehicles 35 000 Current assets 10 000 Current liabilities (16 000) Total net assets $129 000 Share capital (80 000 shares at $1.00 per share) 80 000 General reserve 20 000 Retained earnings 29 000 Total equity $129 000

Fair value $67 000 68 000 35 000 12 000 (18 000)

Required Prepare the journal entries in the records of Angelina Ltd at 1 July 2016 in each of the following situations, assuming the costs of issuing the shares by Angelina Ltd cost $1600: A. Angelina Ltd issued 80 000 shares having a fair value of $2.40 per share in exchange for the net assets of Jolie Ltd B. Angelina Ltd issued 80 000 shares having a fair value of $2.00 per share in exchange for the net assets of Jolie Ltd. C. Angelina Ltd acquired the shares of Jolie Ltd. The agreement was that Angelina Ltd would pay the shareholders of Jolie Ltd one share in Angelina Ltd for every two shares held in Jolie Ltd plus $1 in cash for each share held in Jolie Ltd. Shares in Angelina Ltd have a fair value of $1.80 per share. A. Acquisition of net assets of Jolie Ltd: FV of an Angelina Ltd shares is $2.40 Net fair value of identifiable assets and liabilities acquired: Machinery $67 000 Fixctures & fittings 68 000 Vehicles 35 000 Current assets 12 000 182 000 Current liabilities (18 000) $164 000 Consideration transferred Shares: 80 000 x $2.40 $192 000 Goodwill = $192 000 - $164 000 $28 000 Journal entries: Angelina Ltd Machinery Fixtures & fittings Vehicles Current assets Goodwill

Dr Dr Dr Dr Dr

67 000 68 000 35 000 12 000 28 000

12.17

Solutions manual to accompany Company Accounting 10e

Current liabilities Cr Share capital Cr (Acquisition of assets and liabilities of Jolie Ltd) Share capital Cash (Share issue costs)

Dr Cr

18 000 192 000

1 600 1 600

B. Acquisition of net assets of Jolie Ltd: FV of an Angelina Ltd shares is $2.00 Net fair value of net assets acquired $164 000 Consideration transferred Shares: 80 000 x $2.00 $160 000 Gain on bargain purchase = $164 000 - $160 000 $4 000 Journal entries: Jolie Ltd Machinery Dr Fixtures & fittings Dr Vehicles Dr Current assets Dr Current liabilities Cr Gain on bargain purchase Cr Share capital Cr (Acquisition of assets & liabilities of Higher Ltd) Share capital Cash (Share issue costs)

Dr Cr

67 000 68 000 35 000 12 000 18 000 4 000 160 000

1 600 1 600

C. Acquisition of shares in Jolie Ltd Consideration transferred: Shares: 1/2 x 80 000 x $1.80 Cash: $1.00 x 80 000

$72 000 80 000 $152 000

Journal entries in Angelina Ltd: Shares in Jolie Ltd Share capital Cash (Acquisition of shares in Jolie Ltd)

Dr Cr Cr

152 000

Share capital Cash (Share issue costs)

Dr Cr

1 600

72 000 80 000

1 600

12.18

Chapter 12: Business combinations

Question 12.4

Accounting by acquirer

On 1 July 2016, the financial position of Thurman Ltd was as follows: Carrying amount Assets Cash $200 000 Accounts receivable 800 000 Plant 2 100 000 Accumulated depreciation – plant (600 000) Fixtures & fittings 900 000 Accumulated depreciation – fixtures & fittings 100 000 Land 1 100 000 Vehicles 800 000 Accumulated depreciation – vehicles (200 000) Total assets $5 000 000 Equity Share capital – 100 000 shares 2 500 000 Retained earnings 2 000 000 Total equity 4 500 000 Liabilities Accounts payable 100 000 Loans 400 000 Total liabilities 500 000 Total equity and liabilities $5 000 000

Fair value 200 000 800 000 1 600 000 850 000 1 500 000 610 000

100 000 400 000

Uma Ltd acquired all the assets and assumed all the liabilities of Thurman Ltd on 1 July 2016. In exchange, Uma Ltd agreed to:  issue 5 Uma Ltd shares for every Thurman Ltd share held. Uma Ltd shares were assessed to have a fair value of $8 per share. Costs of share issue were $600.  transfer a patent to the former shareholders of Thurman Ltd; the patent had been internally generated by Uma Ltd and was carried at $400 000. It was considered to have a fair value of $1 200 000.  pay cash of $2.00 per share to the former shareholders of Thurman Ltd for each share held in Thurman Ltd. At 30 June 2016, Thurman Ltd had reported a contingent liability relating to a guarantee given by that company to another entity. Thurman Ltd did not record the guarantee as a liability because of the difficulty of measuring the liability. The fair value of this contingent liability was assessed as $20 000. Uma Ltd incurred $9000 in costs in relation to accounting and legal fees in relation to its acquisition of Thurman Ltd. Required Prepare the journal entries in the records of Uma Ltd in relation to its acquisition of Thurman Ltd at 1 July 2016. Acquisition analysis: Net fair value of identifiable assets and liabilities acquired: Cash $200 000 Accounts receivable 800 000 Plant 1 600 000

12.19

Solutions manual to accompany Company Accounting 10e

Fixtures and fittings Land Vehicles Accounts payable Loans Guarantee (contingent)

850 000 1 500 000 610 000 (100 000) (400 000) (20 000) $5 040 000

Consideration transferred: Shares: 100 000 x 5 x $8 Patent Cash: 100 000 x $2.00

$4 000 000 1 200 000 200 000 $5 400 000 $360 000

Goodwill = $5 400 000 - $5 040 000 = Journal entries in Uma Ltd Patent Dr Gain Cr (Re-measurement as part of consideration transferred in a business combination) Cash Accounts receivable Plant Fixtures & fittings Land Vehicles Goodwill Accounts payable Loans Guarantee payable Share capital Patent Cash (Acquisition of Thurman Ltd)

800 000 800 000

Dr Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr Cr Cr

200 000 800 000 1 600 000 850 000 1 500 000 610 000 360 000

Acquisition-related expenses Dr Cash Cr (Payment of directly attributable costs)

9 000

Share capital Cash (Costs of issuing shares)

100 000 400 000 20 000 4 000 000 1 200 000 200 000

Dr Cr

9 000

600 600

12.20

Chapter 12: Business combinations

Question 12.5

Acquiring the shares of an acquire

Bruce Ltd considered the takeover of Willis Ltd. Both companies operated in the mining industry, but Willis Ltd had access to some infrastructure assets that would be useful to the operations of Bruce Ltd, in particular, both railroad and port facilities. After due consideration including an in-depth financial analysis of the project, on 1 January 2016, Bruce Ltd made an offer to the shareholders of Willis Ltd:  Bruce Ltd would pay two fully paid ordinary shares in Bruce Ltd plus $3.20 cash for every preference share in Willis Ltd, payable at acquisition date.  Bruce Ltd would pay three fully paid ordinary shares in Bruce Ltd plus $1.50 in cash for every ordinary share in Willis Ltd. Half the cash is payable at acquisition, and the other half is payable in one year’s time. However, part of the deal was that 80% of the shareholders of Willis Ltd had to accept the deal by the closing date of the offer, 30 March 2016. The shareholders of Willis Ltd took financial advice and the majority decided that this was a worthwhile offer. Of the ordinary shareholders, 90% accepted the offer while of the preference shareholders, all accepted the offer. At 30 March 2016, the share capital of Willis Ltd consisted of 100 000 fully paid ordinary shares at $2 per share, while the preference share capital consisted of 50 000 5% preference shares issued at $2 per share. The contract was agreed to on 1 April 2016. At that date, the fair value of each Bruce Ltd share, based on recent market transactions, was $3.80. Bruce Ltd’s borrowing rate on current debt was 8% p.a. The cost of issuing the ordinary shares in Bruce Ltd was $1500 for the shares issued to the former Willis Ltd preference shareholders and $2400 for the shares issued to the former ordinary shareholders in Willis Ltd. Required Prepare the journal entries in Bruce Ltd to record the acquisition of the shares of Willis Ltd at 1 April 2016 and the deferred payment on 1 April 2017. Acquisition analysis To Preference Shareholders: Cash Shares Total To Ordinary Shareholders: Cash

= = = = =

$3.20 x 50 000 $160 000 (2 x 50 000) x $3.80 $380 000 $540 000

($1.50 x ½ x 90 000) + ($1.50 x ½ x 90 000 x 0.9259 $67 500 + $62 500 $130 000 (3 x 90 000) x $3.80 $1 026 000 $1 156 000

= = = = =

Shares Total

Journal entries: Bruce Ltd

12.21

Solutions manual to accompany Company Accounting 10e

01/04/16 Preference shares in Willis Ltd Dr Cash Cr Share capital Cr (Acquisition of all preference shares in Willis Ltd) Ordinary shares in Willis Ltd Cash Payable to ex-Willis shareholders Share capital (Acquisition of ordinary shares in Willis Ltd)

160 000 380 000

Dr 1 156 000 Cr 67 500 Cr 62 500 Cr 1 026 000

Share capital Dr Cash Cr (Cost of issuing shares for acquisition of shares in Willis Ltd) 01/04/17 Payable (to ex-Willis shareholders) Interest expense Cash (Payment of deferred amount)

540 000

Dr Dr Cr

3 900 3 900

62 500 5 000 67 500

12.22

Chapter 12: Business combinations

Question 12.6

Accounting by the acquirer, provisional accounting, disclosures by the acquirer

Matt Ltd was a pharmaceutical company operating in Brisbane while Damon Ltd operated a number of research laboratories on the Gold Coast, being particularly concerned with producing products that were related to the effects of mosquito bites. Matt Ltd believed that the acquisition of Damon Ltd would be of significant benefit to it as Damon Ltd had an excellent research facility that would add value to the products manufactured by Matt Ltd. It was prepared to pay a premium for the assets of Damon Ltd because of the high quality of the research staff of Damon Ltd and their ability to provide synergies between the two companies. On 1 June 2016, Matt Ltd acquired all the assets and liabilities of Damon Ltd. In exchange for these, Matt Ltd issued 50 000 shares. Based on recent market transactions, it was determined that these shares had a fair value at acquisition date of $3.04. At this date, Matt Ltd could only determine a provisional fair value for the machinery. Matt Ltd also recognised an intangible asset relating to research and development undertaken by Damon Ltd, but it was not recognised by that entity as it did not meet the recognition criteria under AASB 138 Intangible Assets. This asset was considered to have a fair value of $4000. Subsequent to the end of the reporting period of 30 June 2016, the final fair value was determined on 2 September 2016 to be $104 800. Depreciation on machinery was charged at 20% p.a. The assets and liabilities of Damon Ltd at 1 June 2016 were as follows: Carrying amount Fair value Machinery $98 000 $100 000 Fixtures 15 000 16 000 Accounts receivable 20 000 20 000 Cash 24 000 24 000 Accounts payable (6 400) (6 400) Loans (13 600) (13 600) Required A. Prepare the journal entries at 1 June 2016 in the accounting records of Matt Ltd to record the acquisition of Damon Ltd as well as any disclosures regarding the acquisition in the notes to the accounts at 30 June 2016. B. Prepare any journal entries at 2 September 2016 in relation to the provisional measurement of the machine. A: At 1 June 2016: Net fair value of identifiable assets and liabilities of Damon Ltd

Consideration transferred Goodwill

= = = = =

$100 000 + $16 000 + $20 000 + $24 000 +$4 000 - $6 400 - $13 600 $144 000 50 000 shares x $3.04 $152 000 $152 000 - $144 000 $8 000

12.23

Solutions manual to accompany Company Accounting 10e

The journal entries at acquisition date, 1 June 2016 are: Machinery Dr 100 000 Fixtures Dr 16 000 In-process research and development Dr 4 000 Accounts receivable Dr 20 000 Cash Cr 24 000 Goodwill Dr 8 000 Accounts payable Cr Loans Cr Share capital Cr (Acquisition of assets and liabilities of Damon Ltd)

6 400 13 600 152 000

Check disclosures against the following paragraphs from AASB 3 Appendix B: Paragraph B64 (a) B64 (b) B64 (d) B64 (e) B64 (f)

B64 (i)

the names and descriptions of the combining businesses [Matt Ltd is a pharmaceutical company; Damon Ltd is a company involved in research] the acquisition date: 1 June 2016 primary reasons for the business combination [ R&D] a qualitative description of the factors making up goodwill [excellent work force and synergies] the consideration transferred: $152 000 Fair value of each major class of consideration, including for equity instruments issued: - the number [50 000] - the method of determining fair value [recent market transactions] amounts recognised for each major class of assets acquired and liabilities assumed [see journal entry]

12.24

Chapter 12: Business combinations

QUESTION 12.6 (cont’d) B. See paragraphs 45-50 of AASB 3 in relation to initial accounting determined provisionally. At 1 June 2016, the provisional amounts must be used as per journal entries in (A.) on the previous page. Note the disclosure required by paragraph B67 of AASB 3. In 2016, as per paragraph 45, the carrying amount of the machinery must be calculated as if its fair value at the acquisition date had been recognised from that date, with an adjustment to goodwill. If the machinery had a 5-year life from acquisition date, Damon Ltd would have charged depreciation for 1 month in 2016. Extra depreciation of $80 is required, being 1/5 x 1/12 x $4 800. The adjusting entry at 2 September 2016 is: Machinery Goodwill (Adjustment for provisional accounting)

Dr Cr

4 800

Retained earnings (1/7/16) Accumulated depreciation (Adjustment to depreciation due to provisional accounting)

Dr Cr

4 800

If depreciation has been calculated monthly for 2016, further adjustments would be required.

12.25

Solutions manual to accompany Company Accounting 10e

Question 12.7

Accounting for an acquirer, liquidation of acquiree

The financial statements of Clint Ltd and Eastwood Ltd at 1 July 2016 were as follows:

Plant Accumulated depreciation Inventory Accounts receivable Cash Goodwill Total assets Accounts payable Net assets Share capital Retained earnings General reserve Total equity

Clint Ltd $60 000 (15 000) 12 600 20 000 25 000 — 102 600 1 800 100 800 90 000 8 800 2 000 100 800

Eastwood Ltd $58 000 (13 000) 23 000 35 000 — 9 000 112 000 18 000 94 000 81 000 3 000 10 000 94 000

At this date all the identifiable assets and liabilities of Eastwood Ltd were recorded at fair value except for the following assets: Fair value Plant $48 000 Inventory 25 000 Clint Ltd agreed to pay Eastwood Ltd $5000 in cash plus 15 000 fully paid shares in Clint Ltd, these shares having a fair value of $6 per share. The business combination was completed and Eastwood Ltd went into liquidation. Costs of liquidation amounted to $1000. Clint Ltd incurred accounting and legal costs amounting to $400 in relation to the business combination. Costs of issuing the Clint Ltd shares were $300. Required A. Prepare the journal entries in Clint Ltd to record the business combination. B. Prepare the statement of financial position of Clint Ltd immediately after the business combination. C. Prepare the Liquidation Account and the Shareholders Distribution Account in Eastwood Ltd. A. Journal entries: Clint Ltd Net fair value of identifiable assets and liabilities acquired: Plant Inventory Accounts receivable Accounts payable

$48 000 25 000 35 000 108 000 (18 000) 90 000

12.26

Chapter 12: Business combinations

Net fair value of identifiable assets and liabilities acquired = Consideration transferred = = Goodwill =

$90 000 $5 000 + (15 000 x $6) $95 000 $5 000

The journal entries are: Plant Dr Inventory Dr Accounts receivable Dr Goodwill Dr Accounts payable Cr Payable to Eastwood Ltd Cr Share capital Cr (Acquisition of Eastwood Ltd and issue of shares)

Payable to Eastwood Ltd Cash (Payment of cash consideration)

48 000 25 000 35 000 5 000 18 000 5 000 90 000

Dr Cr

5 000

Acquisition-related expenses Dr Cash Cr (Payment of acquisition-related costs)

400

Share capital Cash (Share issue costs)

300

Dr Cr

5 000

400

300

12.27

Solutions manual to accompany Company Accounting 10e

Question 12.7 (cont’d) B.

CLINT LTD Statement of Financial Position Current Assets Cash Accounts receivable Inventories Total Current Assets

$19 300 55 000 37 600 $111 900

Non-current Assets Plant Accumulated depreciation Goodwill Total Non-current Assets Total Assets

108 000 (15 000) 5 000 98 000 209 900

Current Liabilities Accounts payable Net Assets

19 800 $190 100

Equity Share capital Retained earnings General reserve Total Equity

$179 700 8 400 2 000 $190 100

C. Ledger Accounts – Eastwood Ltd Liquidation Plant Inventory Accounts receivable Goodwill Cost of liquidation Balance b/d Shareholders Distribution

$ $ 58 000 Accumulated depreciation - plant 13 000 23 000 Accounts payable 18 000 35 000 Retained earnings 3 000 9 000 General reserve 10 000 1 000 Clint Ltd 95 000 13 000 139 000 139 000 13 000 Balance c/d 13 000 13 000

Shareholders’ Distribution $ Distribution: Share capital Cash *4 000 Liquidation Shares in Clint Ltd 90 000 94 000 *$5000 cash paid by Clint Ltd less $1000 liquidation costs © John Wiley and Sons Australia Ltd 2015

13 000

$ 81 000 13 000 94 000

12.28

Chapter 12: Business combinations

Question 12.8

Accounting for an acquirer, liquidation of acquire

The statement of financial position of Biel Ltd at 1 July 2016 was as follows: Cash $9 000 Accounts receivable 27 760 Inventory 22 680 Buildings 100 000 Accumulated depreciation (20 000) Fixtures 40 000 Accumulated depreciation (16 000) Plant and equipment 50 000 Accumulated depreciation (13 200) Goodwill 1 600 Total assets $201 840

Share capital (48 000 shares) Retained earnings

$48 000 47 040 95 040

Accounts payable Guarantees Loans

34 800 32 000 40 000 106 800

Total equity and liabilities

$201 840

Jessica Ltd acquired all the assets except cash of Biel Ltd on 1 July 2016. Jessica Ltd determined the fair values of all the identifiable assets and liabilities at acquisition date and determined that the only identifiable items that were not recorded at amounts equal to fair values were: Fair value Inventory $30 000 Buildings 100 000 Fixtures 25 000 Plant and equipment 38 000 Guarantees (33 000) Jessica Ltd also determined that Biel Ltd had not recorded the accrued interest on the loans, amounting to $2200. In exchange for the assets of Biel Ltd, Jessica Ltd agreed to provide sufficient additional cash to enable Biel Ltd to pay off its debts as well as liquidation costs of $2000. In addition, Jessica Ltd would pay two fully paid shares in Jessica Ltd for every three shares held in Biel Ltd. The fair value of each Jessica Ltd share was agreed to be $2.50. Costs of issuing the shares amounted to $1000. Required A. Prepare the journal entries in the records of Jessica Ltd to record its acquisition of the assets of Biel Ltd at 1 July 2016. B. Prepare the Liquidation, Liquidator’s Cash and Shareholders’ Distribution accounts of Biel Ltd. A. Acquisition analysis Net fair value of assets acquired: Accounts receivable Inventory Buildings Fixtures Plant and equipment

$27 760 30 000 100 000 25 000 38 000 $220 760

12.29

Solutions manual to accompany Company Accounting 10e

Consideration transferred Shares: 2/3 x 48 000 x $2.50 Cash Accounts payable Guarantees Loans Interest on loans Liquidation expenses

$80 000 $34 800 33 000 40 000 2 200 2 000 112 000 (9 000)

Cash held Gain on bargain purchase

= =

103 000 $183 000 $183 000 - $220 760 $37 760

General Journal Accounts receivable Dr Inventory Dr Buildings Dr Fixtures Dr Plant and equipment Dr Gain on bargain purchase Cr Payable to Biel Ltd Cr Share capital Cr (Acquisition of assets of Biel Ltd and shares issued)

27 760 30 000 100 000 25 000 38 000

Payable to Biel Ltd Cash (Payment of cash consideration)

Dr Cr

103 000

Share capital Cash (Costs of issuing shares)

Dr Cr

1 000

37 760 103 000 80 000

103 000

1 000

12.30

Chapter 12: Business combinations

QUESTION 12.8 (cont’d) B. BIEL LTD Liquidation $ 27 760

Accounts receivable

Accum. depreciation buildings Accum. Depreciation - fixtures Accum. Depreciation - PPE Retained earnings Receivable from Jessica Ltd

$ 20 000

Inventory Buildings Fixtures Plant and equipment Goodwill Interest payable on loans Liquidation expenses Guarantees

22 680 100 000 40 000 50 000 1 600 2 200 2 000 1 000

Shareholders’ distribution

32 000 279 240

279 240

Liquidator’s Cash $ 9 000 Liquidation expenses 103 000 Loans and interest Guarantees Accounts payable 112 000

$ 2 000 42 200 33 000 34 800 112 000

Opening balance Receivable from Jessica Ltd

Shares in Jessica Ltd

Shareholders’ Distribution $ 80 000 Share capital Liquidation 80 000

16 000 13 200 47 040 183 000

$ 48 000 32 000 80 000

12.31

Solutions manual to accompany Company Accounting 10e

Question 12.9

Accounting by acquirer, liquidation journal entries by acquiree

The financial statements of Pacino Ltd at 1 August 2016 contained the following information: Assets Vehicles $30 000 Accumulated depreciation (4 400) Delivery trucks 35 000 Accumulated depreciation (6 200) Machinery 19 800 Accumulated depreciation (3 000) Buildings 48 000 Accumulated depreciation (4 000) Land 80 000 Cash 2 000 Accounts receivable 12 000 Inventory 17 200 Total assets $226 400

Equity Share capital: 50 000 shares Retained earnings Total equity

48 000 25 600 73 600

Liabilities Loans Provisions Payables Accounts payable Total liabilities

64 000 28 000 42 000 18 800 152 800

Total equity and liabilities

$226 400

Pacino Ltd is involved in the manufacture of fine Italian leather shoes. The company was established by the de Niro brothers over 100 years ago. The family became very wealthy as their shoes were prized by the fashion conscious in the community. However, the current manager, Roberto de Niro, wants to retire and leave the business to the family. The two boys who are the sons of Roberto do not want to continue in the family business. Roberto then offers to sell the business to his main rival, Al Ltd, which is headed up by the manager and owner, Vito Corleone. Vito and Roberto come to an agreement by which Al Ltd will take over Pacino Ltd. Al Ltd will acquire all the assets of Pacino Ltd except for the cash and the motor vehicles. In exchange, Al Ltd will give the shareholders of Pacino Ltd a block of land valued at $96 000 and a motor vehicle valued at $20 400. These assets are currently held by Al Ltd. The land is carried at cost of $40 000 while the motor vehicle is carried at $20 000, being cost of $21 000 and accumulated depreciation of $1000. Al Ltd will also provide sufficient additional cash to enable Pacino Ltd to pay off the accounts payable and the liquidation expenses of $1200. On liquidation of Pacino Ltd, the land and the motor vehicles will be distributed to the sons of Roberto de Niro. Al Ltd incurred legal and valuation costs of $2000 in undertaking the business combination. The assets and liabilities of Pacino Ltd are recorded at amounts equal to fair value except for the following: Fair value Land $100 000 Buildings 56 000 Machinery 20 000 Delivery trucks 30 000 Inventory 20 000 Al Ltd also recognised the brand ‘Pacino’ that was not recognised in the records of Pacino Ltd as it was an internally developed brand. It was calculated that this brand

12.32

Chapter 12: Business combinations

had a fair value of $26 000. Required A. Prepare the journal entries in Al Ltd to record the acquisition of the assets and liabilities of Pacino Ltd. B. Prepare the journal entries to record the liquidation of Pacino Ltd A. Acquisition analysis Fair value of identifiable assets and liabilities acquired: Accounts receivable Land Buildings Machinery Delivery trucks Brand “Pacino” Inventory

$12 000 100 000 56 000 20 000 30 000 26 000 20 000

Loans Provisions Payables

(64 000) (28 000) (42 000)

$264 000

134 000 $130 000

Consideration transferred Land Motor vehicles Cash: Accounts payable Liquidation expenses Cash held

Goodwill Goodwill

= =

$96 000 20 400 $18 800 1 200

$20 000 (2 000)

18 000 $134 400

$134 400 - $130 000 $4 400

12.33

Solutions manual to accompany Company Accounting 10e

QUESTION 12.9 (cont’d) AL LTD General Journal Land Dr Gain Cr (Re-measurement as part of consideration transferred in a business combination)

56 000

Accumulated depreciation - vehicles Dr Motor vehicles Cr Gain Cr (Re-measurement as part of consideration transferred in a business combination)

1 000

56 000

600 400

Accounts receivable Land Buildings Machinery Delivery trucks Brand “Pacino” Inventory Goodwill Loans Provisions Payables Land Motor vehicles Payable to Pacino Ltd (Acquisition of net assets of Pacino Ltd)

Dr Dr Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr Cr Cr

12 000 100 000 56 000 20 000 30 000 26 000 20 000 4 400

Payable to Pacino Ltd Cash (Payment of the consideration transferred)

Dr Cr

18 000

Acquisition expenses Dr Cash Cr (Costs associated with the business combination)

2 000

64 000 28 000 42 000 96 000 20 400 18 000

18 000

2 000

12.34

Chapter 12: Business combinations

QUESTION 12.9 (cont’d) B. Liquidation of Pacino Ltd PACINO LTD

Liquidation Inventory Accounts receivable Land Buildings Machinery Delivery trucks (Transfer of assets)

General Journal Dr 212 000 Cr Cr Cr Cr Cr Cr

Accumulated depreciation – trucks Accumulated depreciation – machinery Accumulated depreciation – buildings Liquidation

Dr Dr Dr Cr

6 200 3 000 4 000

Payables Loans Provisions Liquidation (Transfer of liabilities)

Dr Dr Dr Cr

42 000 64 000 28 000

Retained earnings Liquidation (Transfer of retained earnings)

Dr Cr

25 600

Receivable from Al Ltd Liquidation (Consideration transferred)

Dr Cr

134 400

Land Vehicles Cash Receivable from Al Ltd (Receipt of purchase consideration)

Dr Dr Dr Cr

96 000 20 400 18 000

Liquidation Liquidation expenses payable (Expense payable)

Dr Cr

1 200

Liquidation Shareholders’ distribution (Transfer of surplus on liquidation)

Dr Cr

94 000

17 200 12 000 80 000 48 000 19 800 35 000

13 200

134 000

25 600

134 400

1 200

94 000

12.35

Solutions manual to accompany Company Accounting 10e

QUESTION 12.9 (cont’d)

Liquidation expenses payable Accounts payable Cash (Payment of outstanding debts)

Dr Dr Cr

1 200 18 800

Shareholders distribution Dr Accumulated depreciation – vehicles Dr Vehicles Cr (Transfer of vehicles held by Pacino Ltd to shareholders

25 600 4 400

Share capital Shareholders’ distribution (Transfer of share capital)

Dr Cr

48 000

Shareholders’ distribution Land Motor vehicles (Transfer of assets to shareholders)

Dr Cr Cr

116 400

20 000

30 000

48 000

96 000 20 400

12.36

Chapter 12: Business combinations

Question 12.10

Accounting by the acquirer, liquidation of the acquiree

Edward Ltd is a manufacturer of frozen foods in Geelong. His products include many forms of vegetables and meats but one item lacking in its product range is frozen fish. The board of Edward Ltd decided to investigate a takeover of a Tasmanian company, Norton Ltd, whose prime product was the packaging of frozen Huon salmon. The reason this company was of particular interest was that Edward Ltd already owned a number of factories in Hobart some of which were under-utilized. If Norton were acquired, then Edward Ltd would liquidate the company and transfer all the processing work to its other Hobart factories. The financial statements of Norton Ltd at 1 December 2016 showed the following information: Plant Accumulated depreciation – plant Land Cash Accounts receivable Inventory Total assets Accounts payable Provisions Loans Total liabilities Share capital – 60 000 A ordinary shares – 40 000 B ordinary shares Retained earnings Total equity

$133 600 (32 000) 20 800 16 000 44 800 23 200 206 400 24 800 24 000 17 200 66 000 48 000 32 000 60 400 140 400

All the assets and liabilities of Norton Ltd were recorded at amounts equal to fair value except for: Fair value Plant 112 000 Land 35 800 Inventory 28 000 Norton Ltd also had a brand ‘Jon West’ that was not recorded by the company because it had been internally generated. It was valued at $10 000. Norton Ltd had not recorded both the interest accrued on the loans amounting to $22 800 and annual leave entitlements of $13 000. Edward Ltd decided to acquire all the assets of Norton Ltd except for the cash. In exchange for these assets, Edward Ltd agreed to provide:  Two shares in Edward Ltd for every three A ordinary shares held in Norton Ltd. The fair value of each Edward Ltd share was agreed to be $2.16.  Artworks to the owners of the B ordinary shares held in Norton Ltd. (These artworks were held in the records of Edward Ltd at $40 000 and valued at $58 000.)  Sufficient additional cash to enable Norton Ltd to pay off its liabilities including the expected liquidation costs of $4000. The business combination occurred on 1 December 2016. Legal and accounting costs incurred by Edward Ltd in undertaking this business combination amounted to $1300.

12.37

Solutions manual to accompany Company Accounting 10e

Costs to issue the shares to the A ordinary shareholders of Norton Ltd were $700. Required A. Prepare the journal entries in the records of Edward Ltd at 1 December 2016 to record the business combination. B. Prepare the following accounts for Norton Ltd: Liquidation, Liquidator’s Cash, and Shareholders’ Distribution. A. Acquisition Analysis – Edward Ltd – Norton Ltd Net fair value of identifiable assets and liabilities acquired Accounts receivable Inventory Plant Land Brand “Jon West”

$44 800 28 000 112 000 35 800 10 000 $230 600

Consideration transferred Shareholders Shares Artworks Creditors Cash:

Goodwill

‘A’ shares of Norton Ltd Shares in Edward (2/3) to B ordinary shareholders

60 000 40 000 x $2.16

Accounts payable Provisions Loans Liquidation costs Interest on loans Annual leave Total cash required Less cash already held

24 800 24 000 17 200 4 000 22 800 13 000 105 800 (16 000)

[$234 200 – $230 600]

$86 400 58 000 144 400

89 800 $234 200

$3 600

12.38

Chapter 12: Business combinations

QUESTION 12.10 (cont’d)

EDWARD LTD General Journal Artworks Gain (Gain on re-measurement of asset used as part of consideration in acquisition of Norton Ltd)

Dr Cr

18 000

Accounts receivable Inventory Plant Land Brand Goodwill Payable to Norton Ltd Share capital Artworks (Acquisition of Norton Ltd)

Dr Dr Dr Dr Dr Dr Cr Cr Cr

44 800 28 000 112 000 35 800 10 000 3 600

Payable to Norton Ltd Cash (Payment of consideration)

Dr Cr

89 800

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

1 300

Share capital Cash (Payment of share issue costs)

Dr Cr

700

18 000

89 800 86 400 58 000

89 800

1 300

700

12.39

Solutions manual to accompany Company Accounting 10e

QUESTION 12.10 (cont’d) B. NORTON LTD General Ledger

Receivables Inventory Plant Land Interest on loans Annual leave payable Liquidation costs Shareholders’ distribution

Opening balance Edward Ltd

Shares in Edward Ltd Artworks

LIQUIDATION ACCOUNT 44 800 Retained earnings 23 200 Accumulated depreciation 133 600 Receivable from Edward Ltd 20 800 22 800 13 000 4 000 64 400 326 600

60 400 32 000 234 200

326 600

LIQUIDATOR’S CASH ACCOUNT 16 000 Accounts payable 89 800 Provisions Loans Liquidation costs Interest payable ______ Annual leave 105 800

24 800 24 000 17 200 4 000 22 800 13 000 105 800

SHAREHOLDERS’ DISTRIBUTION 86 400 Share capital – ‘A’ shares 58 000 Shares capital – ‘B’ Shares ______ Liquidation 144 400

48 000 32 000 64 400 144 400

12.40

Chapter 12: Business combinations

Question 12.11

Accounting by an acquirer

Denzel Ltd and Washington Ltd are family-owned ginger producing companies operating in Buderim in Queensland. Denzel Ltd is owned by the Lewis family while the Meninga family owns Washington Ltd. The Lewis family has only one son, Wally, and he is engaged to the daughter of the Meninga family. Because the son is currently managing Denzel Ltd, it is proposed that, after the wedding, Washington Ltd be liquidated and Wally would manage the whole of the two companies’ assets. Information about the assets and liabilities of Washington Ltd at 1 January 2017 is as follows: Carrying Fair amount value Buildings $540 000 $495 000 Accumulated depreciation (63 000) Land 558 000 756 000 Machinery 350 000 327 600 Accumulated depreciation (26 000) Irrigation equipment 218 000 202 500 Accumulated depreciation (20 000) Vehicles 162 000 154 800 Accumulated depreciation (18 000) Cash 18 000 18 000 Accounts receivable 126 000 112 500 Payables 72 000 72 000 Loan from Broncos bank 432 000 432 000 Denzel Ltd valued a brand at $40 000 that was used by Washington Ltd but had not been recognised by Washington Ltd as it was internally generated. The brand was considered to have an indefinite life. The accounting records of Washington Ltd at 1 January 2017 did not include accrued interest on the loan of $12 000. The Lewis and Meninga families agreed to the following terms in relation to the joining together of the two companies:  Denzel Ltd is to acquire all the assets of Washington Ltd except for cash and one of the vehicles (having a carrying amount of $40 500, and a fair value of $43 200) and assume all the liabilities except for the loan from the Broncos bank and any accrued interest. The vehicle will be given to Mr and Mrs Meninga. Washington Ltd will go into liquidation.  Denzel Ltd is to supply sufficient additional cash to enable the loan from the Broncos Bank to be paid off and to cover the liquidation expenses of $4950. It will also give $135 000 to be distributed to the Meninga family to help pay for the cost of the wedding.  Denzel Ltd is to give a piece of its land in the Buderim Hills overlooking the Maroochydore coastline to Washington Ltd to be distributed to the Meninga family to build a retirement home. The land is recorded in the records of Denzel Ltd at $72 000 and has a fair value of $198 000.  Denzel Ltd is to issue 100 000 shares these having a fair value of $12.60 per share. These are to be distributed via Washington Ltd to the daughter of Mr and Mrs Meninga to give her a continuing interest in the family business.  The business combination occurred on 1 January 2017 as per the agreement with Denzel Ltd incurring legal and accounting costs of $22 500 and share issue costs of

12.41

Solutions manual to accompany Company Accounting 10e

$16 000. Required Prepare the journal entries in the records of Denzel Ltd to account for the business combination. Acquisition Analysis Net fair value of identifiable assets and liabilities acquired: Accounts receivable Land Buildings Machinery Irrigation equipment Vehicles ($154 800 - $43 200) Brand Accounts payable

$112 500 756 000 495 000 327 600 202 500 111 600 40 000 2 045 200 72 000 $1 973 200

Consideration transferred:

Goodwill

Shares: 100 000 x $12.60 per share Cash: [$432 000 + $12 000 +$4 950 +$135 000 - $18 000] Land:

$1 260 000

$2 023 950 - $1 973 200 =

$50 750

565 950 198 000 $2 023 950

12.42

Chapter 12: Business combinations

QUESTION 12.11 (cont’d)

The journal entries in Denzel Ltd are: Land

Dr Gain Cr (Re-measurement as part of consideration transferred in a business combination)

126 000 126 000

Accounts receivable Dr Land Dr Buildings Dr Machinery Dr Irrigation equipment Dr Vehicles Dr Brand Dr Goodwill Dr Payables Cr Share capital Cr Payable to Washington Ltd Cr Land Cr (Acquisition of net assets of Washington Ltd)

112 500 756 000 495 000 327 600 202 500 111 600 40 000 50 750

Payable to Washington Ltd Cash (Payment of purchase consideration)

Dr Cr

565 950

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

22 500

Share capital Cash (Share issue costs)

Dr Cr

16 000

72 000 1 260 000 565 950 198 000

565 950

22 500

16 000

12.43

Solutions manual to accompany Company Accounting 10e

Question 12.12

Accounting by acquirer

On 1 July 2016, three companies — Radcliffe Ltd, Grint Ltd and Watson Ltd — sign an agreement whereby the operations of Grint Ltd and Watson Ltd are to be taken over by Radcliffe Ltd. Grint Ltd is to liquidate after the transfer is complete, but Watson Ltd will continue to operate after the takeover. The financial statements of the three companies on that day showed the following information:

Cash Accounts receivable Inventory Property, plant & equipment (net) Shares in listed companies Loan receivable – Potter Ltd Accounts payable Mortgage loan 7% Debentures – nominal value Share capital – issued at $1 each Retained earnings

Radcliffe Ltd $50 000 75 000 56 000 120 000 22 500 — 323 500 62 000 25 000 100 000 120 000 16 500 323 500

Grint Ltd $8 000 50 000 32 000 75 000 6 000 25 000 196 000 13 000 10 000 — 100 000 73 000 196 000

Watson Ltd $20 000 46 000 29 000 127 000 37 000 — 259 000 31 000 — 80 000 90 000 58 000 259 000

The details of the acquisition agreements are as follows: Grint Ltd Radcliffe Ltd is to acquire all of the assets (except for cash) and all of the liabilities of Grint Ltd. In exchange, the shareholders of Grint Ltd are to receive three (3) shares in Radcliffe Ltd and $1 in cash for every five (5) shares held in Grint Ltd. The agreed value of each Radcliffe Ltd share is $3.20. The cash retained by Grint Ltd is to be used as part of the purchase consideration. The assets of Grint Ltd are recorded at their fair values except for: Carrying Fair amount value Inventory $32 000 $36 000 Property, plant & equipment 75 000 85 000 Shares in listed companies 6 000 6 600 Watson Ltd Radcliffe Ltd is to acquire the issued shares of Watson Ltd. In exchange, the shareholders of Watson Ltd are to receive 35 000 7% $5.00 debentures in Radcliffe Ltd, redeemable at nominal value on 1 July 2020. Additional information Radcliffe Ltd is to pay expenses of $7000 to transfer the assets of Grint Ltd to its premises. Costs to issue shares to Grint Ltd are $800. Costs of issuing debentures to the shareholders of Watson Ltd are $700. Required Prepare the acquisition analyses and journal entries in the records of Radcliffe Ltd to record the acquisition agreements.

12.44

Chapter 12: Business combinations

Acquisition analysis : Radcliffe Ltd - Grint Ltd Fair value of identifiable assets and liabilities acquired Accounts receivable Inventory Property, plant and equipment Shares in listed companies Loan receivable – Potter Ltd

$50 000 36 000 85 000 6 600 25 000 202 600 (13 000) (10 000) $179 600

Accounts payable Mortgage loan

Consideration transferred Shareholders: Shares: Number issued by Grint Ltd 100 000 Shares in Radcliffe (3/5) 60 000 Cash: 100 000/5 x $1.00 20 000 less held by Grint (8 000)

Goodwill

x $3.20 $192 000

[204 000 – 179 600]

12 000 204 000

$24 400

Acquisition Analysis: Radcliffe Ltd – shareholders of Watson Ltd Cost of acquisition of shares = Fair value of debentures issued Debentures issued 35 000 x $5 = $175 000

12.45

Solutions manual to accompany Company Accounting 10e

QUESTION 12.12 (cont’d) RADCLIFFE LTD General Journal Accounts receivable Inventory Property, plant and equipment Shares in listed companies Loan receivable – Potter Ltd Goodwill Accounts payable Mortgage loan Share capital Payable to Grint Ltd (Acquisition of net assets of Grint Ltd)

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

50 000 36 000 85 000 6 600 25 000 24 400

Payable to Grint Ltd Cash (Payment of purchase consideration)

Dr Cr

12 000

Share capital Cash (Share issue costs)

Dr Cr

800

Acquisition related expenses Cash (Payment of transfer costs)

Dr Cr

7 000

Shares in Watson Ltd 7% Debentures (Acquisition of shares in Watson Ltd)

Dr Cr

175 000

7% Debentures Cash (Debenture issue expenses)

Dr Cr

700

13 000 10 000 192 000 12 000

12 000

800

7 000

175 000

700

12.46

Chapter 12: Business combinations

Question 12.13

Accounting by acquirer of acquisition of net assets as well as shares in other companies

Sean Ltd has established a successful security business, providing both personnel and technical equipment to safeguard the security of its customers. Because of major terrorist threats throughout the world, the business is expanding. Sean Ltd has noted that a number of other companies have been making some interesting advances in the security business and so Sean Ltd undertook an aggressive takeover strategy to expand its business. In particular, it has investigated two companies; Connery Ltd, which has made advances in the area of security cameras by improving the image quality of the cameras; and Bond Ltd, which has improved the security of alarm systems. Both have developed their own products over the years and gained significant reputations. At 1 September 2016, Sean Ltd obtained the following financial information about the two companies it wants to takeover:

Land and buildings $ Plant and equipment Accumulated depreciation – PPE Shares in James Ltd Goodwill Cash Accounts receivable Inventory $ Provisions Accounts payable Loans Share capital: 150 000 shares 60 000 shares General reserves Retained earnings

Connery Ltd 32 000 100 000 (16 000) 17 600 4 000 4 160 17 040 24 000 182 800

22 000 10 000 24 000

Bond Ltd 28 800 24 000 (4 000) 5 600 4 480 67 200 9 600 20 320 156 000 16 400 8 000 80 000

120 000

5 000 1 800 182 800

48 000 1 000 2 600 156 000

ean Ltd decided to go ahead with the acquisition of Connery Ltd. It decided to acquire all the assets of Connery Ltd except for cash and shares in James Ltd. Acquisition-related costs are expected to be $5200. All the assets of Connery Ltd are recorded at fair value except for the following: Fair value Land & buildings $ 64 000 Shares -James Ltd 14 400 Inventory 20 800 Connery Ltd had not recorded its major brand Golden Eye Cameras which have a fair value of $14 000. In exchange, the shareholders of Connery Ltd are to receive, for every three Connery Ltd shares held, one Sean Ltd share worth $2.00 each. Costs to issue these shares are © John Wiley and Sons Australia Ltd 2015

12.47

Solutions manual to accompany Company Accounting 10e

$840. Additionally, Sean Ltd will transfer to Connery Ltd its ‘Shares in James’ asset, currently recorded at $12 800 which has a fair value of $12 000. These shares, together with those already owned by Connery Ltd, will be sold and the proceeds distributed to the Connery Ltd shareholders. Assume that the shares were sold for their fair values. Sean Ltd will also give Connery Ltd sufficient additional cash to enable Connery Ltd to pay all its creditors. All the liabilities recorded by Connery Ltd are at fair value; however, Connery Ltd has not recorded $7280 of accounts payable or accrued expenses of $23 760. Connery Ltd will then liquidate. Liquidation costs are estimated to be $6960. Sean Ltd also decided to acquire all the issued shares of Bond Ltd. In exchange, the shareholders of Bond Ltd are to receive one Sean Ltd share, worth $2.00, and $1.20 cash for every two Bond Ltd shares held. Bond Ltd also had some unrecorded intangibles which had a fair value of $12 000. Required A. Prepare the acquisition analysis and journal entries to record the acquisitions in the records of Sean Ltd. B. Prepare the Liquidation account and Shareholders’ Distribution account for Connery Ltd. C. Explain in detail why, if Connery Ltd has recorded a goodwill asset of $4000, Sean Ltd calculates the goodwill acquired via an acquisition analysis. Why does Sean Ltd not determine a fair value for the goodwill asset and record that figure as it has done for other assets acquired from Connery Ltd? D. If Sean Ltd subsequently receives a dividend cheque for $1000 from Bond Ltd, paid from retained earnings earned before its acquisition of the shares in Bond Ltd, how should Sean Ltd account for that cheque? Why? E. Shortly after the business combination, the liquidator of Connery Ltd receives a valid claim of $800 from a creditor. As Sean Ltd has agreed to provide sufficient cash to pay all the liabilities of Connery Ltd at acquisition date, the liquidator requests and receives a cheque for $800 from Sean Ltd. How should Sean Ltd record this payment? Why? A. Acquisition Analysis – Sean Ltd - Connery Ltd Fair value of identifiable assets and liabilities acquired Accounts receivable Inventory Land and buildings Plant and equipment Brand Golden Eye

$17 040 20 800 64 000 84 000 14 000 $199 840

Consideration transferred Shareholders Shares

Shares of Connery Ltd Shares in Sean Ltd (1/3) Shares in James Ltd

150 000 50 000

Provisions

$22 000

x $2.00

$100 000 12 000

Creditors Cash

12.48

Chapter 12: Business combinations

Accounts payable Loans Liquidation costs Accrued expenses Total cash required Less cash already held

Goodwill

17 280 24 000 6 960 23 760 94 000 (4 160)

89 840 $201 840

$201 840 – $199 840

$2 000

Acquisition Analysis – Sean Ltd - Bond Ltd Consideration transferred To Shareholders: Shares Shares of Bond Ltd Shares in Sean Ltd (1/2) Cash 60 000/2 x $1.20

60 000 30 000

x $2.00

$60 000 36 000 $96 000

12.49

Solutions manual to accompany Company Accounting 10e

QUESTION 12.13 (cont’d) SEAN LTD General Journal Loss

Dr Cr

800

Accounts receivable Inventory Land and buildings Plant and equipment Brand Goodwill Payable to Connery Ltd Shares in James Ltd Share capital (Acquisition of Connery Ltd’s assets)

Dr Dr Dr Dr Dr Dr Cr Cr Cr

17 040 20 800 64 000 84 000 14 000 2 000

Payable to Connery Ltd Cash (Payment of consideration)

Dr Cr

89 840

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

5 200

Share capital Cash (Payment of share issue costs)

Dr Cr

840

Shares in Bond Ltd Share capital Cash (Acquisition of shares in Bond Ltd)

Dr Cr Cr

96 000

Shares in James Ltd (Re-measurement as part of consideration transferred in a business combination)

800

89 840 12 000 100 000

89 840

5 200

840

60 000 36 000

12.50

Chapter 12: Business combinations

QUESTION 12.13 (cont’d) B. CONNERY LTD General Ledger

Accounts receivable Inventory Land and buildings Plant & equipment Goodwill Accounts payable Accrued expenses Liquidation costs payable Shareholders’ distribution Loss on sale of shares

LIQUIDATION ACCOUNT 17 040 Retained earnings 24 000 General reserve 32 000 Consideration transferred 100 000 Accumulated depreciation - PPE 4 000 7 280 23 760 6 960 6 400 3 200 224 640

1 800 5 000 201 840 16 000

______ 224 640

SHAREHOLDERS’ DISTRIBUTION ACCOUNT Cash (from sale of shares) 26 400 Share capital Shares in Sean Ltd 100 000 Liquidation 126 400

120 000 6 400 126 400

SHARES IN JAMES LTD 17 600 Cash – sale of shares 12 000 Liquidation – loss on sale 29 600

26 400 3 200 29 600

CASH ACCOUNT 4 160 Provisions 89 840 Accounts payable 26 400 Loans Accrued expenses payable Liquidation costs payable ______ Shareholders distribution 120 400

22 000 17 280 24 000 23 760 6 960 26 400 120 400

Opening balance Consideration transferred

Opening balance Consideration transferred Shares in James Ltd

12.51

Solutions manual to accompany Company Accounting 10e

QUESTION 12.13 (cont’d) C. Goodwill is measured differently for two reasons: a)

AASB 3 prohibits the recognition of internally generated goodwill so the figure recorded in the books of Connery Ltd does not represent the total goodwill of the company at acquisition date. Goodwill cannot be separated from the company and sold separately so no fair value is available. The only way goodwill can be measured is to compare the total value of the company against the fair values of its identifiable net assets, any surplus is deemed to represent the value of the net unidentifiable assets or goodwill.

D. The journal entry to record the dividend cheque is: Cash

Dr Dividend revenue

1 000

(Dividend received from Bond Ltd) All dividends are treated as revenue by the acquirer regardless out of which equity the dividend is paid.

E. Sean Ltd should post the following journal: Goodwill Cash (Payment to Connery Ltd)

Dr Cr

800 800

If the liability had been identified at acquisition date then Sean Ltd would have paid an extra $800 cash to acquire the assets of Connery Ltd. As the consideration transferred has increased (from $201 840 to $202 640) but there has been no change in the fair values of identifiable assets and liabilities, then the value of goodwill acquired must increase (from $2000 to $2800).

12.52

Chapter 12: Business combinations

Question 12.14

Accounting for net assets and shares acquired by acquirer

On 1 January 2016, Jason Ltd concluded agreements to take over the operations of Stratham Ltd and to acquire the rest of the shares of Mechanic Ltd. The statements of financial position of the three companies as at that date were: Jason Ltd Stratham Ltd Cash $20 000 $1 000 Accounts receivable 35 000 19 000 Inventory 52 000 26 500 Property, plant & equipment (net) 280 500 149 500 Shares in Mechanic Ltd (15 000 shares) 19 000 — Debentures in Blitz Ltd 45 000 18 000 451 500 214 000 Accounts payable Loan payable $10 Debentures – nominal value Share capital – issued at $1 Retained earnings

78 000 — — 300 000 73 500 451 500

76 000 40 000 — 80 000 18 000 214 000

Mechanic Ltd $12 500 30 000 40 000 107 500 — — 190 000 27 500 — 50 000 70 000 42 500 190 000

The details of the acquisition agreements are as follows: Stratham Ltd Jason Ltd is to acquire all of the assets, except cash, and all of the liabilities of Stratham Ltd. In exchange, for every four shares in Stratham Ltd shareholders are to receive three shares in Jason Ltd and $1.00 in cash. Each share in Jason Ltd has a fair value of $1.80. Jason Ltd is to pay additional cash to Stratham Ltd to cover the total liquidation expenses of Stratham Ltd which are expected to amount to $6000. The cash already held by Stratham Ltd is to go towards the liquidation costs. The assets of Stratham Ltd are all recorded in Stratham Ltd’s records at cost (depreciated if applicable). The fair values of Stratham Ltd’s assets are: Fair value Receivables $ $17 500 Inventory 32 000 Property, plant and equipment 165 500 Debentures in Transporter Ltd 19 000 Two items not appearing in the records of Stratham Ltd were a liability for accrued expenses of $4000 and in-process research and development outlays which had a fair value of $6000. Mechanic Ltd Jason Ltd is to acquire the remaining issued capital of Mechanic Ltd. In exchange, the shareholders in Mechanic Ltd are to receive four shares in Jason Ltd for every five shares held in Mechanic Ltd. The legal costs incurred by Jason Ltd in issuing its shares to Stratham Ltd and Mechanic Ltd amounted to $1300 and $800 respectively. Accounting and legal costs associated with the acquisitions amounted to $4200 of which $500 relation to the

12.53

Solutions manual to accompany Company Accounting 10e

acquisition of the shares in Mechanic Ltd. Required Prepare the acquisition analyses and journal entries necessary to record the acquisition of both Stratham Ltd and Mechanic Ltd in the records of Jason Ltd. Acquisition Analysis: Jason Ltd – Stratham Ltd Fair value of identifiable assets and liabilities acquired: Accounts receivable Inventory Property, plant and equipment Debentures in Blitz Ltd In-process R&D

$17 500 32 000 165 500 19 000 6 000 240 000 40 000 76 000 4 000 120 000 $120 000

Loan payable Accounts payable Accrued expenses Net assets

Consideration transferred Shares

No. of shares issued Stratham Ltd Shares issued by Jason Ltd (3/4)

80 000 60 000 x $1.80

Cash 80 000/4 x $1.00 Additional cash: $6000 less $1000 held by Stratham Total consideration transferred Goodwill

$108 000 20 000 5 000 $133 000

[$133 000 – $120 000]

$13 000

Acquisition Analysis - Jason Ltd – Mechanic Ltd

Consideration transferred No. of shares issued by Mechanic Ltd Already held by Jason Ltd To acquire

70 000 15 000 55 000

Jason Ltd to issue 55 000 x 4/5 x $1.80

$79 200

12.54

Chapter 12: Business combinations

QUESTION 12.14 (cont’d) JASON LTD General Journal Accounts receivable Dr Inventory Dr Property, plant and equipment Dr Debentures in Blitz Ltd Dr In-process R&D Dr Goodwill Dr Accounts payable Cr Loan payable Cr Accrued expenses Cr Share capital Cr Payable to Stratham Ltd Cr (Acquisition of net assets of Stratham Ltd)

17 500 32 000 165 500 19 000 6 000 13 000

Payable to Stratham Ltd Cash (Payment of consideration)

25 000

Dr Cr

76 000 40 000 4 000 108 000 25 000

25 000

Shares in Mechanic Ltd Dr Share capital Cr (Purchase of remaining shares in Mechanic Ltd)

79 200

Share capital Cash (Share issue costs incurred)

Dr Cr

2 100

Acquisition expenses Cash (Acquisition expenses)

Dr Cr

4 200

79 200

2 100

4 200

12.55

Solutions manual to accompany Company Accounting 10e

Question 12.15

Accounting by acquirer

Catherine Ltd is a company that is involved in nurseries, providing fresh flowers as well as many varieties of plants to many large retail businesses that sell tools, garden furniture and plants. The company has been doing well, but is deficient in a couple of areas. To become more diverse as well as to increase efficiencies, Catherine Ltd decided to acquire a couple of businesses that were both competitors as well as having products that fitted into Catherine Ltd’s expansion plans. The first company under consideration was Zeta Ltd. Zeta Ltd was a long-time competitor with Catherine Ltd and produced many fine varieties of trees that would provide Catherine Ltd with an expanded range of products to offer its customers. On 1 July 2016, Catherine Ltd obtained the following information about Zeta Ltd: Assets Buildings Accumulated depreciation Gardening equipment Accumulated depreciation Tools Office equipment Accumulated depreciation Cash Accounts receivable Allowance for doubtful debts Inventory Goodwill Total assets

$60 000 (10 000) 84 000 (12 000) 18 000 28 000 (8 000) 22 000 59 000 (7 000) 108 000 14 000 $356 000

Equity Share capital: 60 000 $2 shares 120 000 Retained earnings 44 000 Total equity 164 000 Liabilities Accounts payable Other payables Accrued expenses Loans Mortgage on buildings Total liabilities Total equity and liabilities

28 000 12 000 20 000 32 000 100 000 192 000 $356 000

Catherine Ltd decided to acquire Zeta Ltd and then liquidate the company. It agreed to acquire all the assets, other than cash, and all the liabilities, other than the mortgage on the buildings, the accrued expenses and the other payables. The acquisition date was 1 July 2016. In exchange for these assets and liabilities, Catherine Ltd agreed to provide the following:  Three shares in Catherine Ltd for every four shares held in Zeta Ltd. The fair value of each Catherine Ltd share was agreed to be $6.00.  Sufficient additional cash to allow Zeta Ltd to pay off the mortgage, the accrued expenses and the other payables as well as pay the expected liquidation expenses of $5000. Catherine Ltd analysed the assets and liabilities of Zeta Ltd and determined that the only assets for which the fair value was different from the current recorded amount were: Fair value Buildings $ 90 000 Gardening equipment 100 000 Inventory 138 000 It is expected that the amount collectible on the accounts receivable is the net amount recorded. Catherine Ltd also determined that Zeta Ltd had a number of trademarks that were not recorded but had a fair value of $10 000. Further, there was interest

12.56

Chapter 12: Business combinations

accruing on the mortgage of $5000 that had not been recorded. It was calculated that the cost of issuing the shares to the former shareholders of Zeta Ltd would be $4500 and the legal and accounting costs associated with the acquisition would be $5000. The other company that had attracted the attention of Catherine Ltd was Jones Ltd. Jones Ltd was a diversified organisation of which there were many divisions that were effectively profit centres of Jones Ltd. One such division was the Douglas Division. Catherine Ltd was impressed with the look of the Douglas Division even though it had been established a lot longer than Catherine Ltd and had been reorganised a number of times. Catherine Ltd decided to acquire the Douglas Division from Jones Ltd. The Douglas Division reported the following assets and liabilities with related fair values: Carrying Fair amount value Buildings $ 45 000 $ 60 000 Accumulated depreciation – (5 000) buildings Equipment 72 000 69 000 Accumulated depreciation – (8 000) equipment Inventory 28 000 29 000 Accounts receivable 42 000 40 000 Accounts payable 32 000 32 000 Accrued expenses 10 000 10 000 In exchange for the assets and liabilities of the Douglas Division, Catherine Ltd agreed to provide Jones Ltd with the following:  Cash of $86 000.  Buildings, which had a fair value of $120 000 but were recorded in Catherine Ltd at $80 000 net of accumulated depreciation of $20 000. Accounting and legal outlays associated with the acquisition amounted to $2500. Required A. Prepare the journal entries in the records of Catherine Ltd for the acquisitions of Zeta Ltd and the Douglas Division of Jones Ltd. B. Prepare the liquidation account for Zeta Ltd. C. Prepare the journal entries in Jones Ltd for the sale of the Douglas Division to Catherine Ltd. A. Acquisition Analysis: Catherine Ltd – Zeta Ltd Net fair value of identifiable assets and liabilities acquired: Buildings Gardening equipment Tools Office equipment Accounts receivable Inventory Trademarks Accounts payable Loans © John Wiley and Sons Australia Ltd 2015

$90 000 100 000 18 000 20 000 52 000 138 000 10 000 428 000 28 000 32 000 12.57

Solutions manual to accompany Company Accounting 10e

60 000 Net fair value of identifiable assets and liabilities acquired $368 000 Consideration transferred: Shares in Catherine Ltd No. of shares issued by Zeta Ltd 60 000 Shares in Catherine Ltd to issue: (3/4 x 60 000) 45 000 x $6.00 $270 000 Cash Other payables $12 000 Accrued expenses 20 000 Mortgage 100 000 Interest on mortgage 5 000 Liquidation costs 5 000 142 000 Less cash held 22 000 120 000 Total consideration $390 000 Goodwill [$390 000 - $368 000] $22 000 Acquisition Analysis: Catherine Ltd – Jones Ltd’s Douglas Division Net fair value of identifiable assets and liabilities acquired Buildings Equipment Inventory Accounts receivable

$60 000 69 000 29 000 40 000 198 000

Accounts payable Accrued expenses

$32 000 10 000

Consideration transferred: Cash Buildings Goodwill

[$206 000 - $156 000]

42 000 $156 000 $86 000 120 000 $206 000 $50 000

12.58

Chapter 12: Business combinations

QUESTION 12.15 (cont’d) JOURNAL ENTRIES ACQUISITION OF ZETA LTD CATHERINE LTD General Journal Buildings Gardening equipment Tools Office equipment Trademarks Inventory Accounts receivable Goodwill Accounts payable Loans Payable to Zeta Ltd Share capital (Acquisition of assets and liabilities of Zeta Ltd and issue of shares)

Dr Dr Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

90 000 100 000 18 000 20 000 10 000 138 000 52 000 22 000

Payable to Zeta Ltd Cash (Payment of cash)

Dr Cr

120 000

Share capital Cash (Payment of costs of issuing shares)

Dr Cr

4 500

Acquisition-related expenses Cash (Costs related to acquisition)

Dr Cr

5 000

28 000 32 000 120 000 270 000

120 000

4 500

5 000

12.59

Solutions manual to accompany Company Accounting 10e

QUESTION 12.15 (cont’d) JOURNAL ENTRIES ACQUISITION OF DOUGLAS DIVISION

CATHERINE LTD General Journal Accumulated depreciation – buildings Dr Buildings Dr Gain Cr (Re-measurement of asset given as part consideration in acquisition of Douglas Division of Jones Ltd)

20 000 20 000

Buildings Dr Equipment Dr Inventory Dr Accounts receivable Dr Goodwill Dr Accounts payable Cr Accrued expenses Cr Payable to Jones Ltd Cr Buildings Cr (Acquisition of the Douglas Division of Jones Ltd)

60 000 69 000 29 000 40 000 50 000

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

2 500

Payable to Jones Ltd Cash (Payment of consideration)

Dr Cr

86 000

40 000

32 000 10 000 86 000 120 000

2 500

86 000

12.60

Chapter 12: Business combinations

QUESTION 12.15 (cont’d) B. Liquidation of Zeta Ltd ZETA LTD General Ledger

Buildings Gardening equipment Tools Office equipment Inventory Accounts receivable Goodwill Liquidation expenses Interest on mortgage Shareholders distribution

LIQUIDATION A/C Allowance DD 7 000 $60 000 Accum. depreciation - Bldgs $10 000 84 000 Accum. depreciation - GE 12 000 18 000 Acum. depreciation - OE 8 000 28 000 Accounts payable 28 000 108 000 Loans 32 000 59 000 Retained earnings 44 000 14 000 Receivable from Catherine Ltd 390 000 5 000 5 000 150 000 . $531 000 $531 000

C. Sale of Douglas Division to Catherine Ltd

JONES LTD General Journal Carrying amount of division sold Accounts payable Accrued expenses Accumulated depreciation – buildings Accumulated depreciation – equipment Buildings Equipment Inventory Accounts receivable (Carrying amount of net assets sold)

Dr Dr Dr Dr Dr Cr Cr Cr Cr

132 000 32 000 10 000 5 000 8 000

Receivable from Catherine Ltd Revenue on sale of division (Consideration for net assets of division sold)

Dr Cr

206 000

Cash Buildings Receivable from Catherine Ltd (Receipt of consideration)

Dr Dr Cr

86 000 120 000

45 000 72 000 28 000 42 000

206 000

12.61

Chapter 13: Impairment of assets

Chapter 13 – Impairment of assets REVIEW QUESTIONS 1.

What is an impairment test? It is a test to determine if an entity’s assets are overstated, that is, whether the carrying amount of the assets is greater than their recoverable amount.

Why is an impairment test considered necessary? An entity’s balance sheet may overstate the assets, either because the assets’ fair values are lower than the carrying amounts, or because the accountant’s estimates are wrong eg the calculation of depreciation requires estimates of residual value, useful life, pattern of benefits.

When should an entity conduct an impairment test? At each reporting date, an entity must assess whether there is any indication of impairment. If such an indication exists, the entity shall estimate the recoverable amount of the asset [AASB 136 para 9]

What are some external indicators of impairment? AASB 136 para 12: (a) significant decline in market value (b) significant changes in the technological, market, economic or legal environment in which the entity operates (c) increases in market interest rates (d) the carrying amount of the entity’s assets exceeds the entity’s market capitalisation

What are some internal indicators of impairment? AASB 136 para 12: (a) evidence of obsolescence or physical damage (b) assets becoming idle, plans to discontinue operations, plans to dispose of assets (c) economic performance is worse than expected

What is meant by recoverable amount? Recoverable amount is the higher of an asset’s value in use and fair value less costs of disposal.

13.1

Solutions manual to accompany Company Accounting 10e

How is an impairment loss calculated in relation to a single asset accounted for? AASB 136 para 60 Under cost model: - Recognise loss immediately in profit or loss - Write down asset – if depreciable, increase accumulated depreciation and impairment losses account Under revaluation model: as for a revaluation decrease under that model, the effect being dependent on whether there have been past revaluation increments.

What are the limits to which an asset can be written down in relation to impairment losses? An asset must be reduced to its recoverable amount.

What is a cash generating unit? The smallest identifiable group of assets that generates cash inflows largely independent of the cash flows from other assets or groups of assets.

10. How are impairment losses accounted for in relation to cash generating units? AASB 136 para 104: - Reduce the carrying amount of any goodwill allocated to the CGU - Allocate any balance of loss to the other assets of the CGU pro rata on the basis of their carrying amounts

11. Are there limits in adjusting assets within a cash generating unit when impairment losses occur? AASB 136 para 105: - An entity shall not reduce the carrying amount of the asset in a CGU below the highest of: - Its fair value less costs of disposal; - Its value in use; and - Zero.

12. How is goodwill tested for impairment? AASB 136 para 80: - Allocate the goodwill to each of the acquirer’s CGUs if possible - If it cannot be allocated, treat as a corporate asset - Test goodwill annually, but note para 99 may allow use of a preceding period’s information.

13. What is a corporate asset? An asset other than goodwill that contributes to the future cash flows of both the CGU under review and other CGUs.

13.2

Chapter 13: Impairment of assets

14. How are corporate assets tested for impairment? AASB 136 para 102: - Allocate if possible to CGUs - If it cannot be allocated on a reasonable and consistent basis, after testing the separate CGUs, identify the smallest group of CGUs that includes the CGU under review and to which the corporate asset can be allocated and test the group of CGUs for impairment.

15. When can an entity reverse past impairment losses? AASB 136 para 110: At each reporting date, an entity shall assess whether there is any indication that past impairment losses – other than for goodwill – may no longer exist or have decreased. If such an indication exists, the recoverable amount is determined. If the recoverable amount exceeds the carrying amount, reversal may occur, subject to the para 117 limitations.

16. What are the steps involved in reversing an impairment loss? 1. Test for indication that past losses may no longer exist or have decreased. Testing involves analysing external and internal sources of information as per para 111. 2. If test is positive, determine the recoverable amount of the asset [or CGU] 3. If the recoverable amount is greater than the carrying amount, determine the carrying amount that would have been determined had no impairment loss been recognised in prior years. 4. Subject to the limit in 3. above, if testing an individual asset, write the asset up recognising income in current period’s profit or loss. Accounting for asset depends on whether the cost model or the revaluation model is used. 5. If testing a CGU, allocate the reversal amount to the assets of the CGU – except goodwill – pro rata to carrying amounts, but ensuring that the carrying amounts of the CGU’s assets are not increased above the lower of: - Recoverable amount; and - Carrying amount had no impairment occurred. 6. Adjust depreciation/amortisation charges of assets [para 121]

13.3

Solutions manual to accompany Company Accounting 10e

CASE STUDY QUESTIONS Case Study 1

Cash – generating units

Fresh Milk Ltd owns a large number of dairy farms in Queensland. It has a number of factories that are used to produce milk products that are then sent to other factories to be converted into milk-based products such as yoghurt and custard. In applying AASB 136 Impairment of Assets, the accountant for Fresh Milk Ltd is concerned about correctly identifying the cash-generating units (CGUs) for the company, and has sought your advice on such questions as to whether the milk production section is a separate CGU even though the company does not sell milk directly to other parties, or whether it should be included in the milk-based products CGU. Required Write a report to the accountant of Fresh Milk Ltd, including the following: 1. Define a CGU. 2. Explain why impairment testing requires the use of CGUs, rather than being based on single assets. 3. Explain the factors that the accountant should consider in determining the CGUs for Fresh Milk Ltd. 1. Define a CGU A cash-generating unit is the smallest identifiable group of assets that generates cash flows that are largely independent of the cash inflows from other assets or groups of assets. 2. Explain why impairment testing requires the use of CGUs The impairment test requires a comparison of the recoverable amount of an asset with the higher of the asset’s value in use and fair value less costs of disposal. Value in use requires: - an estimate of the future cash flows the entity expects to derive from the asset - expectations about variety in timing of cash flows - the price for bearing the uncertainty inherent in the asset These cash flows are based upon data such as financial budgets and forecasts. For some assets, there are no cash flows that are generated independently from those of other assets e.g. the milking machines or the machines used to separate cream from milk etc do not generate independent cash flows. The eventual cash flows come from the sale of the milk products. These machines could be sold separately, giving a fair value less costs of disposal. However, as management have decided to use the machines rather than sell them, management have made the decision that the value in use is greater than the value via sale. 3. Explain the factors that the accountant should consider in determining the CGUs for Fresh Milk Ltd Cash flows must be independent of other cash flows A CGU must be the lowest aggregation of assets independently generating cash flows. Factors include (see paras 69-71 of AASB 136):

13.4

Chapter 13: Impairment of assets

how management monitors the entity’s operations: such as product lines, businesses, individual locations, districts or regional areas. How does management break down Fresh Milk Ltd – by factory? By dairy district? By product? how management makes decisions about continuing or disposing of the entity’s assets and operations. If management wanted to sell off part of the business but still keep a viable business remaining, how could the business be broken down into parts that could be sold off? the existence of an active market for the output produced even if some or all of the output is used internally. In this case, the milk produced is not sold to the public or other entities but is used to make further milk products. However, as there is an active market for milk, the milk production section is potentially a separate CGU. This is because the assets in that section could generate cash flows independently of the rest of the entity. Internal transfer prices should not be used to determine recoverable amount unless these reflect the best estimate of prices that could be achieved in arm’s length transactions.

13.5

Solutions manual to accompany Company Accounting 10e

Case Study 2

Understanding impairment testing

Read the following information reported by Pacific Brands Ltd on page 65 of its 2010 annual report. Recoverability of brand names The carrying amount of intangible assets representing brand names was impaired during the prior year. The impairment test was triggered by the Consolidated Entity’s brand rationalisation as part of its ‘Pacific Brands 2010’ transformation plan and certain brand names have become redundant, been discontinued or identified for retirement. The recoverable amount was calculated using value in use calculations. The carrying amount of the brand names was determined to be higher than their recoverable amount and an impairment loss was recognised against Brand names in the following units; Underwear and Hosiery $0.4 million, Homewares $24.9 million and Footwear, Outerwear & Sport $27.3 million.

Required An investor in the company has approached you to explain the meaning of the note as he does not understand the meaning of impairment tests. Write a note to him to assist him in understanding this part of the annual report. Purpose of the impairment test - to ensure assets are not overstated. - carrying amounts (CA) must not exceed recoverable amounts - recoverable amount (RA) is higher of FV less costs of disposal & value in use Basic steps for individual asset 1. check for indication of impairment: external and internal sources 2. if positive indicator, undertake test; if not no test required 3. determine existence of individual asset 4. measure recoverable amount: FV less costs of disposal and/or PV of future cash flows 5. if asset impaired, write asset down to recoverable amount 6. testing of indicators may indicate ability to reverse prior impairment loss Pacific Brands Ltd The assets in question here are brands. The brands would be carried at cost if acquired separately or fair value if acquired as part of a business combination. There is no indication as to whether the brands are amortised or whether they are expected to have indefinite useful lives. If the brands are not amortised then they need to be tested annually for impairment. It appears that Pacific Brands undertook a brand rationalisation scheme – this may have involved looking for indicators of impairment. Note some of the reasons for impairment: redundancy, discontinued and identified for retirement. The company has used a value in use method to measure recoverable amount. Individual brands have been written down, with an impairment loss recorded (the credit would be to “Accumulated amortisation and impairment losses” or just “Accumulated impairment losses” if the brand was not amortised.

13.6

Chapter 13: Impairment of assets

Case Study 3

Impairment testing and goodwill

At 30 June 2014, Longreach Ltd is considering undertaking an impairment test. Having only recently adopted the international accounting standards, the management of Longreach Ltd seeks your advice in relation to this test under AASB 136 Impairment of Assets. Required Write a report to management, specifically explaining: 1. the purpose of the impairment test 2. how the existence of goodwill will affect the impairment test 3. the basic steps to be followed in applying the impairment test. Purpose of the impairment test -

to ensure assets are not overstated. carrying amounts (CA) must not exceed recoverable amounts recoverable amount (RA) is higher of FV less costs of disposal & value in use

Effect of goodwill on impairment test -

goodwill should be allocated to each CGU based on internal management monitoring of goodwill if unallocated must be tested at smallest CGU containing the goodwill in testing a CGU containing goodwill, if an impairment loss occurs, goodwill is to be written off first once written off, goodwill cannot be written back under a reversal of impairment process CGUs containing goodwill must be tested annually, although some relief is available As internally generated goodwill cannot be recognised, any such goodwill will cushion the impairment of an impairment loss

Basic steps 1. 2. 3. 4. 5. 6.

check for indication of impairment: external and internal sources if positive indicator, undertake test; if not no test required determine existence of CGUs [define] allocate corporate assets and goodwill measure recoverable amount: FV less costs of disposal PV of future cash flows if CGU impaired, allocate loss firstly to goodwill and then to other assets on a pro rata basis; cannot reduce CA of an asset below highest of FV less costs of disposal, value in use & zero. Assets may have been measured on cost model or revaluation model 7. testing of indicators may indicate ability to reverse prior impairment loss

13.7

Solutions manual to accompany Company Accounting 10e

Case Study 4

Frequency of impairment test

In setting up its systems to apply AASB 136 Impairment of Assets, management of Mildura Ltd wants to know how often the company needs to apply an impairment test on its assets, and what information it needs to generate to determine whether a test is needed. Required Prepare a response to management. Frequency of test: For most assets, there is no specific timing for the conducting of impairment tests. Para 9 of AASB 136 states that an entity shall at each reporting date assess whether there is any indication that an asset may be impaired. Para 16 notes that irrespective of any indication of impairment, for - intangible assets with an indefinite useful life - intangible assets not yet available for use - goodwill annual impairment tests are required. But see paras 24 and 99 for relief clauses. Information needed to be generated: Para 12 outlines sources of information to indicate impairment, both internal and external. Discuss the need for an entity to install systems to generate this information, specific to that entity, so that the information is available at balance date for assessment of the need for an impairment test.

13.8

Chapter 13: Impairment of assets

Case Study 5

Impairment losses

Read the following article by Leonora Walet, which was published on 14 December 2011 and reported on www.businessspectator.com.au. CLP expects $A245m carbon-related impairment loss Regional power utility CLP Holdings Ltd said it will write down the value of carbonemitting assets in Australia, resulting in an expected impairment loss of $A245 million ($US247.13 million) due to a new carbon tax law. Australia’s parliament last month passed landmark legislation to impose a A$23 per tonne tax on carbon emissions for 500 of the nation’s biggest polluters across mining, energy and heavy manufacturing from mid-2012. Hong Kong-based CLP said in a statement on Tuesday that it had completed a study on the impact of the legislation on its Australian unit TRUenergy, and would have to write down the value of the unit’s coal facility in Yallourn, Victoria, by A$350 million, the company said in a statement. The writedown would result in a loss that would be recognised in its books this year, it said. ‘No further writedowns within the TRUenergy portfolio are required as a result of the passing of the Clean Energy legislation,’ the company said. Analysts had expected a writedown of as much as $772 million because of the new law. ‘The new carbon tax in Australia will significantly impact the long-term profitability of this plant,’ said CLSA analyst Rajesh Panjwani in a report released on Monday, adding that the coal facility accounted for 17 percent of the power utility’s net worth. TRUenergy is one of Australia’s largest integrated energy companies, providing gas and electricity to more than 2.5 million households and business customers. TRUenergy owns and operates a 5469 megawatt (MW) portfolio of electricity generation facilities. Analysts expect the Australian carbon legislation to have a limited impact on the company in the near term, as the new law allows CLP to claim up to A$1.5 billion in cash compensation and free carbon permits, which could boost earnings at TRUenergy by 15 percent yearly before interest, taxes, depreciation and amortisation (EBITDA) from 2013 to 2015. But there would be less predictability after the first three years as Australia ended the cash incentive and introduced a carbon-trading scheme under which the market would determine the price of carbon, said analysts.

Required Explain what is meant by an ‘impairment loss’ and whether a carbon tax in Australia could result in companies reporting impairment losses. An impairment loss arises when the carrying amount of an asset is greater than its recoverable amount. The argument in this article is that when a carbon tax is imposed, this decreases the value of assets associated with carbon emission. Hence the assets may have to be written down. Note that legislative change is an external indicator of impairment. The assets in this example relate to assets in the coal industry. Note the comments re long-term profitability – a reduction in long-term profitability means that the recoverable amount of assets will decline as the PV of future cash flows declines. Profitability may not decline if there are still major markets overseas willing to pay suitable prices for coal.

13.9

Solutions manual to accompany Company Accounting 10e

Case Study 6

Determination of CGUs

The Rennes City Council contracts out the bus routes in Rennes to various subcontractors based on a tender arrangement. Some routes, such as the Express to City routes, are profitable, while others, such as those collecting schoolchildren from remote areas, are unprofitable. As a result, the city council requires tenderers to take a package of routes, some profitable, some less so. The Le Bon Bus Company has won the contract to operate its buses with a package of five separate routes, one of which operates at a significant loss. Specific buses are allocated by the Le Bon Bus Company to each route, and cash flows can be isolated to each route because drivers and takings are specific to each route. Required Discuss the determination of cash-generating units for the Le Bon Bus Company. Note definition of “cash-generating unit” in AASB 136. It is possible to determine the profitability of each route as costs and revenues can be isolated to each route. However, as the council contracts for a package of routes, it is not possible to stop operating a single route in the package. Hence, the tender for the package is based on the group of routes as a package. The lowest level of identifiable cash flows that are largely independent of the cash flows from other assets is the cash flows of the package of routes. The cash-generating unit is then the package of routes.

13.10

Chapter 13: Impairment of assets

Case Study 7

Impairment of goodwill

As reported by Jennifer Saba on www.reuters.com on 9 February 2012, Thomson Reuters Corp reported a fourth quarter loss of $2.57 billion after taking a one-time $3 billion goodwill impairment charge to account for the decline in its financial services business. Ms Saba reported that ‘Thomson Reuters’ business has suffered in the wake of the financial crisis, with customers in banking and finance laying off tens of thousands of employees and slashing costs. The global news and information provider's next generation flagship desktop product, Eikon, has also posted disappointing sales.’ Required Explain why the impairment loss was charged to goodwill and not to other assets in the company. Goodwill must be assessed annually for impairment. Hence it may be measured for impairment sooner than other assets that have to rely on an assessment of indicators for impairment before an impairment test is undertaken. With a CGU, if an impairment loss occurs, the impairment loss is written off firstly against any goodwill allocated to the CGU.

13.11

Solutions manual to accompany Company Accounting 10e

Case Study 8

Identification of CGUs

Burger Queen is a chain of fast-food restaurants — most reasonably sized towns in the country have a Burger Queen outlet. The key claim to fame of the Burger Queen restaurants is that their fried chips are extra crunchy. Also, to ensure that there is a consistent standard of food and service across the country, the management of the chain of restaurants conducts spot checks on restaurants. Failure to provide the high standard expected by Burger Queen management can mean that the franchise to a particular location can be taken away from the franchisee. Burger Queen management is responsible for the television advertising across the country as well as the marketing program, including the special deals that may be available at any particular time. Each restaurant is responsible for its own sales, cooking of food, training of staff, and general matters such as cleanliness of the store. However, all material used in the making of the burgers and other items sold are provided at a given cost from the central management, which can thereby control the quality and the price. Required Identify the cash-generating unit(s) in this scenario. Give reasons for your conclusions. Each Burger Queen restaurant should be treated as a separate CGU as the cash flows are largely independent of the other stores. The only exception to this is advertising. Although the ingredients for making the burgers are supplied at a set cost, the amount of materials used is specific to an individual restaurant. Whether a specific restaurant remains in existence is based on an analysis of the performance of that restaurant – an analysis that is independent of the other restaurants. Internal management reporting would be organized to measure performance on a restaurantby-restaurant basis. The restaurants are in different neighbourhoods and probably have different customer bases.

13.12

Chapter 13: Impairment of assets

Case Study 9

Identification of CGUs

Marla Macalister is in the business of making rubber tubing that comes in all sorts of sizes and shapes. Marla has established three factories in the north, south and east parts of the city. Each factory has a large machine that can be adjusted to produce all the varieties of tubing that Marla sells. Each machine is capable of producing around 100 000 metres of tubing a week, depending on diameter and shape. Marla’s current sales amount to about 250 000 metres a week. Each factory is never worked to full capacity. However, sales are sufficiently high that Marla cannot afford to shut one of the factories. In order to satisfy customer demand as quickly as possible, all orders are directed to Marla, who allocates the jobs to the various factories depending on the current workload of each factory. This also ensures that efficient runs of particular types of tubing can be done at the same time. Each factory is managed individually in terms of maintenance of the machines, the hiring of labour and the packaging and delivery of the finished product. Required Identify the cash-generating unit(s) in this scenario. Give reasons for your conclusions. The CGU is the business as a whole. All three factories are needed to run the business. The jobs are allocated to a specific factory dependent on Louis’ assessment of efficiencies and current workload of each factory. The factories are not run independently

13.13

Solutions manual to accompany Company Accounting 10e

Case Study 10

Identification of CGUs

Fad Furniture Ltd has three separate operating divisions. The first, the timber division, is in charge of producing milled timber. This division manages a number of timber plantations and timber mills from which the finished timber is produced. The majority of the timber is sold, at an internal transfer price, to the second area of operations in Fad Furniture, the parts division. Any excess timber is sold to external parties. The parts division is responsible for turning the timber into parts for the making of timber furniture, both indoor and outdoor. These parts are suitable only for the manufacture of the furniture produced by Fad Furniture. The parts are then transferred at internal transfer prices to the third area of operations, the furniture division. This division assembles the furniture and delivers it to the various outlets that retail Fad Furniture’s products. Required A. Identify the cash-generating unit(s) in this scenario, giving reasons for your conclusions. B. Would the determination of the cash-generating units be affected if the parts division was also responsible for kit furniture, where the parts are made available to customers for self-assembly? A.

There are two CGUs, namely the timber division and the combination of the parts division and the furniture division. The parts division is not a separate CGU as it cannot sell its products in an external market – the parts are only suitable for the manufacture of the furniture produced by Fad Furniture. Its cash flows are then dependent on the furniture division. Internal transfer prices do not reflect market prices for outputs. In undertaking an impairment test for the timber division, arm’s length prices should be used. In determining whether the timber division is a separate CGU the question is whether the timber is saleable externally i.e. an ability to generate independent cash flows. Even if all the timber were used internally, if it could all be sold externally, the timber division would be a separate CGU.

An assessment would have to be made on the viability of the kit furniture industry. If the kit furniture industry is purely an offshoot of the furniture industry, and is viable only because it relies on cost savings on manufacturing the parts for the furniture industry, then there is no change in the CGUs from (A). If the kit furniture industry was independently viable, then it is possible that the parts division could be broken down into two parts, one part is combined with the furniture division while the other is that dedicated to the kit furniture industry. The key question is whether the kit furniture section is the smallest identifiable group of assets that generates cash inflows that are largely independent.

13.14

Chapter 13: Impairment of assets

Case Study 11

Value in use

Management is assessing the future cash flows in relation to an entity’s assets, and considers that there are two possible scenarios for future cash flows. The first, for which there is a 70% probability of occurrence, would provide future cash flows of $5 million. The second, which has a probability of occurrence of 30%, would provide future cash flows of $8 million. Management has decided that the calculation of value in use should be based on the most likely scenario, namely the one that will produce cash flows of $5 million. Required Evaluate management’s decision. Note Appendix A to AASB 136 – an integral part of the Standard. The Appendix reviews the traditional approach and the expected cash flow approach. The traditional approach would calculate a present value based on the most likely scenario using a cash flow of $5m whereas the expected cash flow approach would be based on the expected cash flow of $5.9m [being 70% x $5m plus 30% x $8m] Note para A10: The application of the traditional approach requires the same estimates and subjectivity without providing the computational transparency of the expected cash flow approach. Note para A12: the expected cash flow approach is subject to a cost-benefit constraint. Consider the example in paras A13 and A14.

13.15

Solutions manual to accompany Company Accounting 10e

Case Study 12

Write-down

Mildura Enterprises Ltd acquired a building in which to conduct its operations at a cost of $10 million. The building generates no cash flows on its own and is considered a part of the cash-generating unit, which is the firm as a whole. Since the building was acquired, the value of inner-city properties has declined owing to an overabundance of office space and the downturn in the economy. The company would receive only $8 million dollars if it decided to sell the building now. However, the company believes the building is serving its purpose and the profits are high, so there is no current intention of selling the building. Required Discuss whether the building should be written down to $8 million. Provide any journal entries necessary. As the building generates no cash flows of its own it is not a separate CGU but is a part of the CGU being the entity as a whole. Providing the recoverable amount of the CGU exceeds the carrying amount of the CGU, there is no impairment in relation to the CGU. There is therefore no need to write the building down. The recoverable amount of individual assets is not important. The entity’s expected cash flows are not from the sale of the building. They are from the operation of the CGU.

13.16

Chapter 13: Impairment of assets

Case Study 13

Asset impairment

Parkes Ltd acquired a network facility for its administration section on 1 July 2012. The network facility cost $550 000 and was depreciated using a straight-line method over a 5-year period, with a residual value of $50 000. On 30 June 2014, the company assessed the current market value of the facility given that there was an active market for such facilities as many companies used a similar network. The value was determined to be $300 000. Required Discuss whether the network facility asset is impaired and whether it should be written down to $300 000. Provide any journal entries necessary. The carrying amount of the asset at 30 June 2010 is $350 000. Whether the asset should be written down depends on whether the asset is a part of a cashgenerating unit. In this example, it appears that the network facility does not independently generate cash flows from the network. Instead the network is used as a part of the administration section, itself being a corporate asset. If the network is a part of a CGU, then there is no need to write individual assets down outside the CGU incurring an impairment loss.

13.17

Solutions manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 13.1

Impairment loss of individual asset

Arrow Ltd acquired a machine for $250 000 on 1 July 2013. It depreciated the asset at 10% p.a. on a straight-line basis. On 30 June 2015, Arrow Ltd conducted an impairment test on the asset. It determined that the asset could be sold to other entities for $154 000 with costs of disposal of $2000. Management expect to use the machine for the next four years with expected cash flows from use of the machine being as follows: 2016 $80 000 2017 60 000 2018 50 000 2019 40 000 The rate of return expected by the market on this machine is 8%. Required Assess whether the machine is impaired. If necessary, provide the appropriate journal entry to recognise any impairment loss. At 30 June 2015: Machine at cost Accumulated depreciation (10% x 2 yrs) Carrying amount = Recoverable amount is fair value less costs of disposal

= =

Value in use is calculated at the present value of future cash flows = = =

$250 000 50 000 $200 000

$154 000 - $2000 $152 000

$80 000 x 0.9259 + $60 000 x 0.8673 + $50 000 x 0.7938 + $ 40 000 x 0.7350 $74 072 + $52 038 + $39 690 + $29 400 $195 200

The higher of the value in use ($195 200) and the fair value less the costs of disposal ($152 000) is the value in use. As the value in use of $195 200 is less than the carrying amount of the asset of $200 000, the asset is considered to be impaired. The impairment loss is $4 800. The appropriate journal entry is as follows: Impairment loss - machine Dr Accumulated depreciation and impairment losses – machine Cr (Impairment loss on machine)

4 800 4 800

13.18

Chapter 13: Impairment of assets

Question 13.2

Cash-generating unit

Spear Ltd reported the following information in its statement of financial position at 30 June 2015: Plant $650 000 Accumulated depreciation – plant (150 000) Intangible assets 300 000 Accumulated amortisation (100 000) Land 300 000 Total non-current assets 1 000 000 Cash 50 000 Inventory 180 000 Total current assets 230 000 Total assets $1 230 000 Liabilities 150 000 Net assets $1 080 000 At 30 June 2015, Spear Ltd analysed the internal and external sources of information that would indicate deterioration in the worth of its assets. It determined that there were indications of impairment. Spear Ltd calculated the recoverable amount of the assets to be $980 000. Required Provide the journal entry for any impairment loss at 30 June 2015.

Carrying amount of assets Recoverable amount Impairment loss

= = =

$1 230 000 $980 000 $250 000

Assuming the inventory is carried at the lower of cost and net realisable value, the allocation of the impairment loss will not involve both cash and inventory. The allocation of the impairment loss is as follows:

Plant Intangibles Land

Carrying Amount

Proportion

Allocation of Loss

Net Carrying Amount

$500 000 200 000 300 000 $1 000 000

5/10 2/10 3/10

125 000 50 000 75 000 250 000

375 000 150 000 225 000

The journal entry to record the impairment loss is:

Impairment loss Accumulated depreciation and impairment losses –plant

250 000

125 000

13.19

Solutions manual to accompany Company Accounting 10e

Accumulated amortisation and impairment losses –intangibles Land (Allocation of impairment loss)

Cr Cr

150 000 75 000

13.20

Chapter 13: Impairment of assets

Question 13.3

Cash-generating unit

Bow Ltd reported the following assets in its statement of financial position at 30 June 2015: Plant $800 000 Accumulated depreciation (240 000) Land 300 000 Patent 240 000 Office equipment 620 000 Accumulated depreciation (340 000) Inventory 220 000 Cash and cash equivalents 180 000 $1 780 000 The recoverable amount of the entity was calculated to be $1 660 000. The fair value less costs of disposal of the land was $280 913. Required Prepare the journal entry for any impairment loss at 30 June 2015. Carrying amount of assets Recoverable amount Impairment loss

= = =

$1 780 000 $1 660 000 $120 000

Proportion

Allocation of Loss

Net Carrying Amount

Plant $560 000 Land 300 000 Patent 240 000 Office equipment 280 000 $1 380 000

56/138 30/138 24/138 28/138

48 696 26 087 20 870 24 347 120 000

511 304 273 913 219 130 255 653

If the fair value less costs of disposal of the land is $280 913, then the land cannot be written down to an amount below that figure. Hence the maximum impairment loss allocable to land is $19 087. The extra $7000 must be allocated to the other assets. Carrying Amount Plant $511 304 Patent 219 130 Office equipment 255 653 $986 087

Proportion

Allocation of Loss

511 304/986 087 219 130/986 087 255 653/986 087

3 630 1 555 1 815 7 000

Net Carrying Amount 507 674 217 575 253 838

13.21

Solutions manual to accompany Company Accounting 10e

The journal entry to record the impairment loss is: Impairment loss Accumulated depreciation and impairment losses –plant Land Accumulated amortisation and impairment losses – patent Accumulated depreciation and impairment losses –office equipment (Allocation of impairment loss)

120 000

Cr Cr

52 326 19 087

22 425

26 162

13.22

Chapter 13: Impairment of assets

Question 13.4

Cash-generating unit, goodwill

Crossbow Ltd is an entity that specialises in the manufacture of leather footwear for women. It has aggressively undertaken a strategy of buying out other companies that had competing products. These companies were liquidated and the assets and liabilities brought into Crossbow Ltd. At 30 June 2015, Crossbow Ltd reported the following assets in its statement of financial position: Cash $20 000 Leather and other inventory products 180 000 Brand ‘Crossbow Shoes’ 160 000 Shoe factory at cost 820 000 Accumulated depreciation – factory (120 000) Machinery for manufacturing shoes 640 000 Accumulated depreciation – machinery (240 000) Goodwill on acquisition of competing companies 40 000 $1 500 000 Because of the competition from overseas as customers pursue a strategy of buying online rather than visit Crossbow Ltd’s stores, Crossbow Ltd assessed its impairment position at 30 June 2015. The indicators suggested that an impairment loss was probable. Crossbow Ltd calculated a recoverable amount of its company of $1 420 000. Required Prepare the journal entry(ies) for any impairment loss occurring at 30 June 2015. Carrying amount of assets Recoverable amount Impairment loss

= = =

$1 500 000 $1 420 000 $80 000

The impairment loss is firstly used to write off the goodwill of $40 000. The balance of the loss, $40 000, is allocated across the other assets, except for cash and inventory, assuming it is recorded at the lower of cost and net realisable value:

Brand Factory Machinery

Carrying Amount

Proportion

Allocation of Loss

Net Carrying Amount

160 000 700 000 400 000 1 260 000

16/126 70/126 40/126

5 079 22 222 12 699 40 000

154 921 677 778 387 301

The journal entry to record the impairment loss is: Impairment loss Goodwill Accumulated amortisation and impairment losses – brand Accumulated depreciation and

Dr Cr Cr

80 000 40 000 5 079

13.23

Solutions manual to accompany Company Accounting 10e

impairment losses –factory Accumulated depreciation and impairment losses –machinery (Allocation of impairment loss)

22 222

12 699

13.24

Chapter 13: Impairment of assets

Question 13.5

Impairment loss, goodwill, partly owned subsidiary

Round Ltd acquired 60% of the issued shares of Shield Ltd on 1 January 2015 for $426 000. At this date, the net fair value of the identifiable assets and liabilities of Shield Ltd was $660 000. At 31 December 2015, the tangible assets and liabilities of Shield Ltd as included in the consolidated financial statements of Round Ltd were as follows: Property, plant and equipment Accumulated depreciation Inventory Cash

Liabilities

$863 000 (120 000) 743 000 55 000 22 000 820 000 (50 000) $770 000

Goodwill had not been written down over the year. In conducting an impairment test on Shield Ltd as a cash-generating unit, Round Ltd assessed the recoverable amount of Shield Ltd to be $800 000. Required A. Explain how the impairment loss in relation to Shield Ltd should be allocated. Prepare journal entry(ies) in relation to the assets of Shield Ltd at 31 December 2015 as a result of the impairment test. B. Explain the accounting for the impairment (if any) if the recoverable amount was $860 000. A. Acquisition analysis: Fair value of identifiable net assets Net fair value acquired Consideration transferred Goodwill Goodwill for entity Goodwill to NCI

= = = = = = = =

$660 000 60% x $660 000 $396 000 $426 000 $30 000 $30 000/60% $50 000 $20 000

At 31 December 2015, the carrying amount of the assets is $820 000 plus goodwill of $50,000, namely $870 000. If the recoverable amount is $800 000, then there is an impairment loss of $70 000 The goodwill of $50 000 is then written off, and the remaining $20 000 impairment loss is allocated across the other assets of Shield Ltd, excluding inventory.

13.25

Solutions manual to accompany Company Accounting 10e

Carrying Amount

Proportion

Property, plant & equipment 743 000

100%

Allocation of Loss

Net Carrying Amount

20 000

723 000

The journal entry to record the impairment is: Impairment loss Goodwill Accumulated depreciation and impairment losses - PPE (Allocation of impairment loss)

Dr Cr

70 000 50 000

20 000

B. If the recoverable amount was $860 000, then the impairment loss is $10 000. Goodwill is reduced from $50 000 to $40 000, of which 60% (ie $24 000) is attributable to the parent entity. The parent entity’s goodwill is then reduced by $6,000, ie, from $30 000 to $24 000. The journal entry is: Impairment loss Accumulated impairment losses – Goodwill (Allocation of impairment loss)

Dr Cr

6 000 6 000

13.26

Chapter 13: Impairment of assets

Question 13.6

Cash-generating unit, reversal of impairment loss

Mace Ltd manufactures glass and glass products. Mace Ltd has organised itself into a number of divisions each of which has a different function. For example, one division deals with the manufacture of glass bottles for containing various drinks such as water and wine while another division produces bottles associated with the perfume industry. Each of these divisions is regarded as a separate cash-generating unit (CGU) for accounting purposes. One of the divisions of Mace Ltd is associated with the production of glass used for the bottling of fruit products. At 30 June 2015, the carrying amounts of the assets of this division were as follows: Non-current assets Glass bottling factory Accumulated depreciation — buildings Equipment Accumulated depreciation — equipment Goodwill Current assets Inventory Receivables Cash

$336 000 (144 000) 176 000 (32 000) 12 000 64 000 28 000 16 000

At 30 June 2015, Mace Ltd was concerned that the assets of this division were impaired. Many fruit products were now being bottled in plastic rather than glass meaning that the demand for glass bottles for bottling fruit had suffered a decline. Subsequent to assessing the indicators of impairment, Mace Ltd believed that the assets of the division were impaired. Mace Ltd calculated the recoverable amount of the fruitbottling division to be $428 000. In preparing the financial statements at 30 June 2015 Mace Ltd allocated the impaired loss to the relevant assets, assuming the receivables were collectable. Mace Ltd also changed its method of measuring the depreciation of the factory and equipment for the 2015–16 period, increasing the depreciation charge on the factory from $48 000 to $52 000 p.a., and from $36 000 to $40 000 p.a. for equipment. During the 2015–16 period, the market experienced dissatisfaction with the use of plastic for the bottling of fruit as users were worried about contamination if held for long periods. As a result the market demand for glass bottles increased. Mace Ltd believed that it could reverse the previous impairment and assessed the recoverable amount of the division at $24 000 greater than the carrying amount of the assets of the unit. For the 2015–16 financial statements, Mace Ltd accounted for a reversal of the previous impairment loss. Required A. Prepare the journal entry(ies) for Mace Ltd at 30 June 2015 for the impairment of the assets. B. (i) Prepare the journal entry(ies) for Mace Ltd at 30 June 2016 for reversal of the prior impairment loss. (ii) What differences would occur in this entry(ies) if the recoverable amount at 30 June 2016 was $16 000 greater than the carrying amount of assets of the division? (iii) If the recoverable amount of the factory at 30 June 2016 was $140 000, how

13.27

Solutions manual to accompany Company Accounting 10e

would this change the entry(ies) in B(ii)?

A. Carrying amount of assets: Factory Equipment Goodwill Inventory Receivables Cash

$192 000 144 000 12 000 64 000 28 000 16 000 456 000 428 000 $28 000

Recoverable amount Impairment loss

Goodwill is written down by $12 000, and the balance of the impairment loss, namely $16,000 is written off across the other relevant assets:

Factory Equipment

Carrying Amount

Proportion

Allocation of Loss

Net Carrying Amount

192 000 144 000 336 000

192/336 144/336

9 143 6 857 16 000

182 857 137 143

The impairment journal entry at 30 June 2015 is: Impairment loss Goodwill Accumulated depreciation and impairment losses – factory Accumulated depreciation and impairment losses – equipment (Allocation of impairment loss)

Dr Cr

28 000 12 000

9 143

6 857

13.28

Chapter 13: Impairment of assets

B (i) At 30 June 2016, the two assets are reported as follows: Factory Accumulated depreciation and impairment losses

$336 000

Equipment Accumulated depreciation and impairment losses

$176 000

205 143 130 857

[144 000 + 9 143 + 52 000]

78 857 97 143

[32 000 + 6 857 + 40 000]

The carrying amounts of these assets if no impairment loss had occurred would have been: Factory Accumulated depreciation and impairment losses

$336 000

Equipment Accumulated depreciation and impairment losses

$176 000

192 000 144 000

[144 000 + 48 000]

68 000 108 000

[32 000 + 36 000]

The differences between the carrying amounts recorded at 30 June 2016 and the carrying amounts if no impairment losses had been recorded are: Factory Equipment

[144 000 – 130 857] [108 000 – 97 143]

$13 143 $10 857 $24 000

As the recoverable amount at 30 June 2016 exceeds the carrying amount by $24 000, then the total differences can be recognised as: Accumulated depreciation and impairment losses – factory Accumulated depreciation and impairment losses – equipment Income: reversal of impairment loss (Reversal of impairment loss)

13 143

Dr Cr

10 857

24 000

13.29

Solutions manual to accompany Company Accounting 10e

B (ii) If the excess of the recoverable amount over carrying amounts at 30 June 2016 was only $16,000, then the reversal would be based on a pro rata allocation based on carrying amounts at time of reversal:

Factory Equipment

Carrying Amount

Proportion

Allocation Net Carrying of Excess Amount

130 857 97 143 228 000

130 857/228000 97 143/228000

9 183 6 817 16 000

140 040 103 960

The entry would be: Accumulated depreciation and impairment losses – factory Accumulated depreciation and Impairment losses – equipment Income: reversal of impairment loss (Reversal of impairment loss)

9 183

Dr Cr

6 817 16 000

B (iii) If the recoverable amount of the factory at 30 June 2016 was only $140 000, then the reversal of the impairment for the factory could only be $9 143(i.e. $140 000 less $130 857). Hence the balance of $40 (i.e. $9 183 - $9 143) could be allocated to equipment. The journal entry is: Accumulated depreciation and impairment losses – factory Accumulated depreciation and impairment losses – equipment Income: reversal of impairment loss (Reversal of impairment loss)

9 143

Dr Cr

6 857 16 000

The $6 857 allocated to equipment still does not exceed the carrying amount if the asset had never been impaired. The equipment will now be shown as: Equipment Accumulated depreciation and impairment losses

$176 000 72 000 [32 000 + 6 857 +40 000 – 6 857] $104 000

13.30

Chapter 13: Impairment of assets

Question 13.7

Reversal of impairment losses

Saxon Ltd conducted an impairment test at 30 June 2015. As a part of that exercise, it measured the recoverable amount of the entity, considered to be a single cashgenerating unit, to be $217 600. The carrying amounts of the assets of the entity at 30 June 2015 were: Equipment 200 000 Accumulated depreciation (40 000) Patent 40 000 Goodwill 6 400 Inventory 32 000 Receivables 1 600 The receivables held by Saxon Ltd were all considered to be collectable. The inventory was measured in accordance with AASB 102 Inventories. For the period ending 30 June 2016, the depreciation charge on equipment was $14 720. If the equipment had not been impaired the charge would have been $20 000. At 30 June 2016, the recoverable amount of the entity was calculated to be $10 400 greater than the carrying amount of the assets of the entity. As a result, Saxon Ltd recognised a reversal of the previous year’s impairment loss. Required Prepare the journal entry(ies) accounting for the impairment loss at 30 June 2015 and the reversal of the impairment loss at 30 June 2016.

Impairment loss is $22 400 i.e. $240 000 less $217 600. The goodwill of $6 400 is written off. The remaining $16 000 impairment loss is allocated as follows:

Patent Equipment

Carrying Amount 40 000 160 000 200 000

Allocation 3 200 12 800 16 000

Net Amount 36 800 147 200 184 000

At 30 June 2015, the journal entry to record the impairment is: Impairment loss Patent Goodwill Accumulated depreciation & impairment losses – equipment

Dr Cr Cr Cr

22 400 3 200 6 400 12 800

At 30 June 2016, in relation to the assets previously adjusted for impairment:

Patent

CA at 30/6/15 36 800

CA – if no impairment Difference 40 000 3 200

13.31

Solutions manual to accompany Company Accounting 10e

Equipment Accumulated depreciation & impairment losses

200 000

(67 520*)

(60 000)

7 520 10 720

*Accum depn & impairment losses – Equip: $40,000 + 12 800 + 14 720 As the recoverable amount at 30 June 2016 is only $10 400 greater than the carrying amount of the entity, this is the maximum reversal amount. The $10 400 reversal is allocated as follows:

Patent Equipment

CA at 30/6/15 36 800 132 480 169 280

Allocation 2 261 8 139 10 400

However, the equipment can only be revalued upwards by $7 520. The balance of $619 is allocated to the patent which increases its allocation to $2 880 which is still less than $3 200. The reversal is then accounted for as follows: Accumulated amortisation and impairment losses - patent Dr Accumulated depreciation & impairment losses - equipment Dr Income – reversal of impairment loss Cr

2 880 7 520 10 400

13.32

Chapter 13: Impairment of assets

Question 13.8

Cash-generating units, goodwill, corporate assets

One of the largest companies operating in the fashion industry in Australia is Lancelot Ltd. For accounting purposes, it operates through two cash-generating units referred to as Holy Division and Grail Division. At 30 June 2015, information was gathered that suggested that the company’s assets had suffered impairment losses. Lancelot Ltd conducted an impairment test, calculating the carrying amounts of the assets of each of the cash-generating units and the head office as well the recoverable amounts of the two cash-generating units and the entity as a whole. The assets of the Head office could not be allocated to the two cash-generating units. This information is shown in the following table: Grail Head Holy Division Division Office Buildings $117 000 $72 000 $135 000 Accumulated depreciation (27 000) (14 400) (45 000) Fittings 252 000 130 500 Accumulated depreciation (54 000) (27 000) Plant 144 000 198 000 Accumulated depreciation (36 000) (18 000) Inventory 54 000 32 400 Goodwill 18 000 13 500 $468 000 $387 000 Recoverable amount of each CGU Recoverable amount of Lancelot

$430 200

$378 000 $875 700

The buildings held by Holy Ltd, located in the central business district, had a fair value less costs of disposal of $87 300. Required Prepare the journal entry(ies) at 30 June 2015 to record the accounting for the impairment losses.

Holy Unit: Impairment loss is $37 800, being $468 000 less $430 200. Write-off goodwill of $18 000 Allocation of $19 800 impairment loss:

Buildings Fittings Plant

90 000 198 000 108 000 396 000

Allocation of loss 4 500 9 900 5 400 19 800

85 500 188 100 102 600 376 200

As buildings has fair value less costs of disposal of $87 300, the $1 800 extra impairment loss for the land must be allocated to the other two assets:

13.33

Solutions manual to accompany Company Accounting 10e

Fittings Plant

188 100 102 600 290 700

1 165 635 1 800

186 935 101 965 288 900

Grail Unit: Impairment loss is $9 000, being $387 000 less $378 000 Write-off $9 000 of goodwill Corporate Asset - Head Office: Holy 468 000 37 800

Carrying amount Impairment loss

Grail 387 000 9 000

Head Office 90 000

Recoverable amount of entity Impairment loss

Entity 945 000 46 800 898 200 875 700 $22 500

This impairment loss is then firstly used to eliminate the goodwill in the Grail Unit of $4 500 (13 500 – 9 000). The balance of $18 000 is then used to write-down the other assets of the entity: Holy Unit:

Fittings Plant

186 935 101 965

4 674 2 549

182 261 99 416

Grail Unit:

Buildings Fittings Plant

57 600 103 500 180 000

1 440 2 587 4 500

56 160 100 913 175 500

Headquarters Buildings

90 000 $720 000

2 250 18 000

87 750 702 000

The journal entries to record the impairment are: Impairment loss Accumulated depreciation & impairment losses – head office buildings

Impairment loss – Holy unit Goodwill Accumulated depreciation and impairment losses - buildings Accumulated depreciation & impairment losses – fittings

Dr Cr

2 250

2250

45 023 18 000

2 700

15 739

13.34

Chapter 13: Impairment of assets

Accumulated depreciation & impairment losses – plant Impairment loss – Grail unit Goodwill Accumulated depreciation and impairment losses- buildings Accumulated depreciation & impairment losses – fittings Accumulated depreciation & impairment losses – plant

Dr Cr

8 584

22 117 13 500

1 440

2 587

4 500

13.35

Solutions manual to accompany Company Accounting 10e

Question 13.9

Cash-generating units, reversal of impairment losses

The two cash-generating units of Dark Forest Ltd are referred to as the Lady CGU and the Lake CGU. At 31 July 2015, the carrying amounts of the assets of the two divisions were: Lady CGU Lake CGU Equipment $9000 $7 200 Accumulated depreciation (3900) (2 250) Brand 1440 — Inventory 324 450 Receivables 450 492 Goodwill 150 120 The receivables were regarded as collectable, and the inventory was measured according to AASB 102 Inventories. The brand had a fair value less costs of disposal of $1320. The equipment held by the Lady CGU was depreciated at $1800 p.a., and the equipment of Lake CGU was depreciated at $1500 p.a. Dark Forest Ltd undertook impairment testing in July 2015, and determined the recoverable amounts of the two CGUs at 31 July 2015 to be: Lady CGU Lake CGU

$6264 5940

The relevant assets were written down as a result of the impairment testing affecting the financial statements of Dark Forest Ltd at 31 July 2015. As a result of the impairment testing management re-assessed the factors affecting the depreciation of its non-current asset. The depreciation of the equipment held by the Lady CGU was increased from $1800 p.a. to $2100 p.a. for the year 2015–16. By 31 July 2016, the performance in both divisions had improved, and the carrying amounts of the assets of both divisions and their recoverable amounts were as follows:

Carrying amounts of assets Recoverable amount of CGU

Lady CGU $7932 9012

Lake CGU $8598 9120

Required Determine how Dark Forest Ltd should account for the results of the impairment tests at both 31 July 2015 and 31 July 2016.

Equipment Brand Inventory Receivables Goodwill Recoverable amount Impairment loss

Lady CGU $5100 1440 324 450 150 7464 6264 (1200)

Lake CGU 4950 0 450 492 120 6012 5940 (72)

In relation to the Lake CGU, write goodwill down by $72:

13.36

Chapter 13: Impairment of assets

Impairment loss Accumulated impairment losses - goodwill

In relation to the Lady CGU, reduce goodwill by $150 and allocate the remaining $1050 impairment loss to applicable assets:

Equipment Brand

Carrying Amount 5100 1440 6540

Proportion 510/654 144/654

Allocation of Excess 816 234 1050

Net Carrying Amount 4284 1206

As the brand has a fair value less costs of disposal of $1320, only $120 of the impairment loss can be allocated to it, so the equipment must be reduced by a further $114, to $4170. The journal entry to record the impairment loss at 31 July 2015 is: Impairment loss Dr Goodwill Cr Accumulated depreciation and impairment losses – equipment Cr Accumulated impairment losses – brand Cr (Allocation of impairment loss)

1200 150 930 120

At 31 July 2016, the equipment and brand are recorded as follows: Equipment Accumulated depreciation and impairment losses

Brand Accumulated impairment losses

$9000 (6930) 2070

[3900 +930 +2100]

$1440 (120) 1320

13.37

Solutions manual to accompany Company Accounting 10e

At 31 July 2016: In relation to the Lake CGU, there can be no reversal of the prior goodwill impairment. In relation to the Lady CGU, the equipment would have had the following carrying amount if the impairment loss had not occurred: Equipment Accumulated depreciation and impairment losses

$9000 (5700) 3300

[3900 + 1800]

Hence, the maximum reversal of impairment in relation to equipment is $1230 (ie $3300 $2070). The maximum reversal for the brand is $120. As the recoverable amount for the Lady CGU’s assets exceed the carrying amount by $1080 [ie $9012 – 7932], the whole of this amount can be allocated on a pro rata basis as a reversal of impairment losses:

Equipment Brand

Carrying Amount

Proportion

Allocation of Excess

2070 1320 3390

207/339 132/339

660 420 1080

Net Carrying Amount 1410 900

As the brand can only be reversed to the extent of $120, then $300 can be allocated to equipment. The adjusted allocation for equipment is now $960 which is less than the maximum adjustment amount of $1230. The entry for the reversal of the impairment loss is: Accumulated depreciation and impairment losses – equipment Accumulated impairment losses – brand Income: reversal of impairment loss (Reversal of impairment loss)

Dr Dr Cr

960 120 1080

13.38

Chapter 13: Impairment of assets

Question 13.10

Cash-generating units, corporate assets, goodwill

Camelot Ltd is in the business of manufacturing children’s toys. Its operations are carried out through three operating divisions, namely the Merlin Division, the Hollow Division and the Hills Division. These divisions are separate cash-generating units. In accounting for any impairment losses, all central management assets are allocated to each of these divisions. At 31 July 2016, the assets allocated to each division were as follows: Merlin Hollow Hills CGU CGU CGU Buildings $656 $600 $368 Accumulated depreciation (336) (304) (272) Land 160 240 120 Machinery 240 328 448 Accumulated depreciation (48) (256) (248) Inventory 96 64 80 Goodwill 32 40 24 Head Office assets 160 120 96 In relation to land values, the land relating to the Merlin and Hills Divisions have carrying amounts less than their fair values as stand-alone assets. The land held by the Hollow Division has a fair value less costs of disposal of $234. Camelot Ltd determined the recoverable amount of each of the cash-generating units at 31 July 2016 as follows: Merlin $936 Hollow 720 Hills 640 Required Prepare the journal entry(ies) for Camelot Ltd to record any impairment loss at 31 July 2016.

Merlin $320 160 192 96 32 160 960 936 (24)

Buildings Land Machinery Inventory Goodwill Head office assets Recoverable amount Impairment loss

Hollow $296 240 72 64 40 120 832 720 (112)

Hills $96 120 200 80 24 96 616 800 0

Merlin CGU Write down the goodwill by $24: Impairment loss Accumulated impairment losses

13.39

Solutions manual to accompany Company Accounting 10e

- goodwill (Allocation of impairment loss)

Hollow UCGU Write off goodwill of $40 and allocate the $72 balance of impairment loss:

Buildings Land Machinery Head Office assets

Carrying Amount

Proportion

Allocation of Excess

296 240 72 120 728

296/728 240/728 72/728 120/728

29 24 7 12 72

Net Carrying Amount 267 216 65 108

As the land has a fair value less costs of disposal of $234, only $6 of the impairment loss can be allocated to it. Hence, the remaining $18 must be allocated to the other assets: Carrying Amount Buildings 267 Machinery 65 Head Office assets 108 440

Proportion 267/440 65/440 108/440

Allocation of Excess 11 2 _5 18

Net Carrying Amount 256 63 103

The entry is: Impairment loss Goodwill Accumulated depreciation and impairment losses – buildings Land Accumulated depreciation and impairment losses – machinery Accumulated depreciation and impairment losses – head office assets (Allocation of impairment loss)

Dr Cr

112 40

Cr Cr

40 6

13.40

Chapter 13: Impairment of assets

Question 13.11

Cash-generating units, corporate assets

Arthur Ltd is a large manufacturing company. Its main operations are concerned with the production of paper products ranging from the production of paper suitable for high quality printing for computing purposes to the production of cardboard suitable for packing many types of products. It has three cash-generating units, Knights Division, Round Division and Table Division. At 30 June 2016, the net assets relating to each of the divisions were as follows: Round Knights CGU CGU Table CGU Property, plant and equipment $294 000 $217 000 $189 000 Accumulated depreciation (84 000) (70 000) (56 000) Patents and trademarks 84 000 98 000 56 000 Inventories 105 000 77 000 70 000 Cash 63 000 56 000 35 000 462 000 378 000 294 000 Liabilities 42 000 35 000 35 000 Net assets $420 000 $443 000 $259 000 Arthur Ltd has its head office in the centre of Perth while its divisions are located in factories built in Fremantle as the products then have access to both rail and port facilities. The management of Arthur Ltd believes that the company’s head office supplies approximately equal service to the three divisions. In recent years the political climate in Australia has placed more emphasis on global climate change and the use of factories that are more attune to limiting the effects of global warming. To assist Arthur Ltd to limit its carbon emissions the company has built a research centre — the Climate Action Centre (CAC) — to provide information on how the factories can reduce the emission of carbon gasses. The CAC is also located in Fremantle. The CAC does not produce any cash flows and the head office supplies an immaterial amount of service to the CAC. It is not possible to allocate the assets of the CAC to the three producing CGUs. At 30 June 2016 the Head Office and the CAC had the following assets:

Land Plant and equipment Accumulated depreciation

Head Office $7 000 28 000 (3 500)

CAC $3 500 10 500 (2 800)

In the months prior to the end of the 2016 financial year economic indicators have suggested that the company’s assets may have been impaired, so management has determined the recoverable amount of each of the producing CGUs. The recoverable amounts were calculated to be: Knights Division Round Division Table Division

$504 000 350 000 280 000

Required Prepare the journal entry(ies) for Arthur Ltd to record any impairment loss at 30 June 2016.

13.41

Solutions manual to accompany Company Accounting 10e

Recoverable amount Impairment loss

Knights $462 000 10 500 472 500 504 000 _____0

Round $378 000 10 500 388 500 350 000 (38 500)

Table $294 000 10 500 304 500 280 000 (24 500)

Total carrying amounts after adjusting for impairment loss

472 500

350 000

280 000

Carrying amount of assets Allocation of Head Office assets

The carrying amounts of the CGUs after adjusting for the impairment loss add to $1 102 500. Together with the CAC ($11 200), the total is $1 113 700. This is less than the total recoverable amount of $1 134 000. Hence there is no need to write down the assets of the CAC. However, the assets of the Round and Table CGUs must be written down: Round CGU: Carrying Amount Head Office 10 500 Patents/trademarks 98 000 PPE 147 000 255 500

Proportion 10.5/255.5 98/255.5 147/255.5

Allocation of Excess 1 582 14 767 22 151 38 500

Net Carrying Amount 83 233 124 849

The journal entry is: Impairment loss Patents and trademarks Accumulated depreciation and impairment losses – PPE (Allocation of impairment loss)

Dr Cr

36 918 14 767

22 151

Table Division: Carrying Amount Head Office 10 500 Patents/trademarks 56 000 PPE 133 000 199 500

Proportion 10.5/199.5 56/199.5 133/199.5

Allocation of Excess 1 289 6 878 16 333 24 500

Net Carrying Amount 49 122 116 667

The journal entry is: Impairment loss Patents and trademarks Accumulated depreciation and impairment losses – plant (Allocation of impairment loss)

Dr Cr

23 211

6 878 16 333

13.42

Chapter 13: Impairment of assets

The total impairment loss allocated to the head office is $2 871 (i.e. $1 582 + $1 289). This is allocated across the assets of the head office: Head Office Carrying Amount Land 7 000 Plant and equipment 24 500 31 500

Proportion 7/31.5 24.5/31.5

Allocation of Excess 638 2 233 2 871

Net Carrying Amount 6 362 22 267

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Allocation of impairment loss)

Dr Cr Cr

2 871 638 2 233

13.43

Solutions manual to accompany Company Accounting 10e

Question 13.12

Goodwill, corporate assets

A large manufacturing company, St. George Ltd, has its operations in Newcastle. It has two cash-generating units, Red Unit and Dragon Unit. At 30 June 2015, the management of the company decided to conduct impairment testing. It calculated that the recoverable amounts of the two divisions were $1 245 000 (Red Unit) and $930 000 (Dragon Unit). In considering the assets of the cash-generating units the company allocated the assets of the corporate area equally to the units. The carrying amounts of the assets and liabilities of the two cash-generating units and the corporate assets at 30 June 2015 were as follows: Dragon Red Unit Unit Corporate Equipment 960 000 — Accumulated depreciation (Equipment) (360 000) — Land 270 000 450 000 Buildings 330 000 420 000 630 000 Accumulated depreciation (Buildings) (120 000) (180 000) (150 000) Furniture & fittings — 90 000 Accumulated depreciation (Furniture & — (30 000) fittings) Goodwill — — 42 000 Cash 36 000 24 000 Inventory 90 000 120 000 Receivables 60 000 24 000 ______ Total assets 1 266 000 918 000 522 000 Provisions 60 000 120 000 Debentures 90 000 198 000 Total liabilities 150 000 318 000 Net assets $1 016 000 $600 000 In relation to these assets: • the receivables of both units were considered to be collectable • the land held by the Dragon Unit had a fair value less costs of disposal of $405 000. Required Prepare the journal entry(ies) required at 30 June 2015 to account for any impairment losses. Red Unit: Total assets

= $1 266 000 + $21 000 goodwill + $240 000 buildings = $1 527 000 Recoverable amount = $1 245 000 Impairment loss = $282 000

Dragon Unit: Total assets

= $918 000 + $21 000 + $240 000 = $1 179 000 Recoverable amount = $930 000 Impairment loss = $249 000

13.44

Chapter 13: Impairment of assets

RED UNIT: ALLOCATION OF IMPAIRMENT LOSS Write-off goodwill of $21 000 Allocate $261 000 to all assets except cash, inventory and receivables. Equipment $600 000 Land 270 000 Buildings 210 000 Corporate Building 240 000 1 320 000

118 636 53 386 41 523 47 455 261 000

DRAGON UNIT: ALLOCATION OF IMPAIRMENT LOSS Write off goodwill of $21 000 Allocate $228 000 to relevant assets Land 450 000 Buildings 240 000 Furniture 60 000 Corporate Building 240 000 990 000

103 636 55 273 13 818 55 273 228 000

184 727 46 182 184 727

However land can only be written down by $45 000, hence need to allocate $58 636 to other assets: Buildings 184 727 Furniture 46 182 Corporate Building 184 727 415 636

26 060 6 515 26 061 (rounded) 58 636

Journal entries are: Impairment loss Goodwill

Dr Cr

42 000

Impairment loss Dr Accumulated depreciation and impairment losses: corporate building Cr (47 455 + 55 273 + 26 061)

128 789

Impairment loss (Red Unit) Dr Land Cr Accumulated depreciation and impairment losses: equipment Cr Accumulated depreciation and impairment losses: buildings Cr

213 545

Impairment loss (Dragon Unit) Land

146 666

Dr Cr

42 000

128 789

53 386 118 636 41 523

45 000

13.45

Solutions manual to accompany Company Accounting 10e

Accumulated depreciation and impairment losses: buildings * Cr Accumulated depreciation and impairment losses: furniture ** Cr * $55 273 + $26 060 ** $13 818 + $6 515

81 333 20 333

13.46

Chapter 13: Impairment of assets

Question 13.13

Corporate assets

At 31 July 2015, Enchantment Ltd conducted an impairment test of its two cashgenerating units, referred to as Crystal CGU and Cave CGU. In conducting this impairment review the goodwill that was recorded by Enchantment Ltd was allocated to each of the cash-generating units as well as to the Head Office. The assets of the Head Office were not allocated to the individual cash-generating units. As a result of the impairment review it was determined that both cash-generating units had suffered impairment losses and relevant assets were written off or had their carrying amounts reduced. The carrying amounts of the assets of the cash-generating units and the Head Office after the allocation of the impairment losses to the two cashgenerating units were as follows: Head Crystal CGU Cave CGU Office Equipment $256 000 $240 000 — Accumulated depreciation (96 000) (96 000) — Land 64 000 40 000 — Buildings 88 000 80 000 $160 000 Accumulated depreciation (32 000) (48 000) (40 000) Furniture & fittings 32 000 24 000 80 000 Accumulated depreciation (12 000) (8 000) (16 000) Goodwill — — 20 800 Accumulated impairment — — (9 600) losses Cash 4 000 6 400 — Inventory 24 000 32 000 — Receivables 16 000 6 400 — Total assets 344 000 276 800 195 200 Provisions 16 000 32 000 Borrowings 24 000 52 800 Total liabilities 40 000 84 800 Net assets $304 000 $192 000 As the final step in the impairment process, Enchantment Ltd conducted an impairment test of the entity as a whole. It calculated the recoverable amount of that entity to be $760 000. Required A. Calculate any impairment loss for Enchantment Ltd B. Prepare the journal entry(ies) to record the adjustments made for this impairment loss. A. Determination of impairment loss Assets: Crystal CGU Assets: Cave CGU Corporate including goodwill of $11 200

$344 000 276 800 195 200 $816 000

Recoverable amount

$760 000

13.47

Solutions manual to accompany Company Accounting 10e

Impairment loss

$56 000

Goodwill written off

$11 200

Amount to be allocated

$44 800

B. Preparation of journal entry for impairment loss Allocation: Carrying amount Crystal CGU: Equipment Land Buildings Furniture & fittings Cave CGU: Equipment Land Buildings Furniture & fittings Head Office: Building Furniture & fittings

Allocation

$160 000 64 000 56 000 20 000

$10 011 4 005 3 504 1 251

144 000 40 000 32 000 16 000

9 010 2 503 2 002 1 001

120 000 64 000 $716 000

7 508 4 005 $44 800

The required journal entry is: Impairment loss Dr Accumulated impairment losses – goodwill Dr Goodwill Cr Accumulated depreciation and impairment losses – equipment Crystal CGU Cr Land – Crystal CGU Cr Accumulated depreciation and impairment losses – buildings Crystal CGU Cr Accumulated depreciation and impairment losses – F&F Crystal CGU Cr Accumulated depreciation and impairment losses – equipment Cave CGU Cr Land – Cave CGU Cr Accumulated depreciation and impairment losses – buildings Cave CGU Cr Accumulated depreciation and impairment losses – F&F Cave CGU Cr Accumulated depreciation and impairment losses – buildings Head Office Cr Accumulated depreciation and impairment losses – F&F Head Office Cr

56 000 9 600

20 800 10 011 4 005 3 504 1 251 9 010 2 503 2 002 1 001 7 508 4 005

13.48

Chapter 13: Impairment of assets

Question 13.14

Impairment loss

Excalibur Ltd operates in the Swan Valley in Western Australia where it is involved in the growing of grapes and the production of wine. In June 2015, it anticipated that its assets may be impaired due to a glut on the market for grapes and an impending tax from the Australian government seeking to reduce binge drinking of alcohol by teenage Australians. Land is measured by Excalibur Ltd at fair value. At 30 June 2015, the entity revalued the land to its fair value of $120 000. The land had previously been revalued upwards by $20 000. The tax rate is 30%. As a result of its impairment testing, Excalibur Ltd calculated that the recoverable amount of the entity’s assets was $1 456 000. The carrying amounts of the assets of Excalibur Ltd prior to adjusting for the impairment test and the revaluation of the land were as follows: Non-current assets Buildings Accumulated depreciation Land (at fair value 1/7/14) Plant and equipment Accumulated depreciation Goodwill Accumulated impairment losses Trademarks – wine labels Current assets Cash Receivables

850 000 (194 000) 128 000 1 454 000 (750 000) 60 000 (44 000) 80 000 7 000 9 000

Required A. Prepare the journal entries required on 30 June 2015 in relation to the measurement of the assets of Excalibur Ltd. B. Assume that, as the result of the allocation of the impairment loss, the plant and equipment was written down to $640 000. If the fair value less costs of disposal of the plant and equipment was determined to be $600 000, outline the adjustments, if any, that would need to be made to the journal entries you prepared in part A of this question, and explain why adjustments are or are not required.

A. Assets Recoverable amount Impairment loss

$1 592 000 1 456 000 136 000

Goodwill written off Balance to be allocated

16 000 120 000

Buildings Plant and equipment Trademarks

656 000 704 000 80 000

[$1 600 000 - $8 000 write-down of land]

54 667 58 667 6 666

601 333 645 333 73 334

13.49

Solutions manual to accompany Company Accounting 10e

1 440 000

120 000

Asset revaluation surplus Deferred tax liability Land

Dr Dr Cr

5 600 2 400

Accumulated impairment losses Impairment loss Goodwill

Dr Dr Cr

44 000 16 000

Impairment loss Dr Accumulated depreciation and impairment losses – buildings Cr Accumulated depreciation and impairment losses - plant and equipment Cr Accumulated amortisation and impairment losses - trademarks Cr

120 000

8 000

60 000

54 667 58 667 6 666

B. P&E written down to $640 000 FV less costs of disposal $600 000 No adjustment required. Cannot write down below fair value but can be carried at an amount greater than fair value. The impairment is calculated on the CGU not on individual assets. As P&E are included in the CGU, they do not independently generate cash flows. Therefore it is impossible to determine value in use for P&E. Hence cannot determine the recoverable amount. So cannot conduct an impairment test on P&E as an asset. Hence use a CGU in relation to the P&E No need to write down.

13.50

Chapter 13: Impairment of assets

Question 13.15

Corporate assets

One of the largest companies in Australia involved in the growing and processing of apples is Uther Ltd, located in Stanthorpe, Queensland. Uther Ltd is organised into three divisions which are regarded as separate cash-generating units of the company. Information on the carrying amounts of the cash-generating units at 30 June 2015 is as follows: Cador CGU Duke Cornwall CGU CGU Land $352 000 $224 000 $128 000 Plant & equipment 672 000 496 000 432 000 Accumulated depreciation (192 000) (160 000) (128 000 Inventories 192 000 144 000 112 000 Accounts receivable 96 000 80 000 48 000 1 120 000 784 000 592 000 Liabilities 96 000 80 000 80 000 Net assets 1 024 000 704 000 512 000 Uther Ltd also had a head office and a research centre, also located in Stanthorpe. The research centre is used by all the cash-generating units to improve the quality of the handling and processing of the apples and related products. The assets of these operations at 30 June 2015 were as follows: Head Office Research Centre Land $88 000 53 600 Fixtures and fittings 64 000 36 000 Accumulated depreciation (8 000) (9 600) 144 000 80 000 In June 2015 the management of Uther Ltd undertook an impairment test of the assets of the entity. Some of the information used in that process was as follows:  As the Head Office interacts equally with the three cash-generating units, the assets of the Head Office were allocated equally to the three units, but not to the research centre. In relation to the research centre, there was no reasonable way to allocate its assets to the cash-generating units. Only cash-generating units produce cash flows.  The recoverable amounts of the cash-generating units were assessed to be: Cador CGU $1 240 000 Duke CGU 800 000 Cornwall CGU 600 000  The land held by Cador Ltd was measured at fair value under AASB 116 Property, Plant and Equipment. At 30 June 2015, the fair value was $352 000.  The land held by Duke Ltd was measured at cost. At 30 June 2015, it had a fair value less costs of disposal of $216 211. Required Prepare the journal entry(ies) for accounting for any impairment loss incurred by Uther Ltd at 30 June 2015. 3 divisions are CGUs Head office and research centre are not CGUs

13.51

Solutions manual to accompany Company Accounting 10e

Allocate head office assets to each division Determine impairment of research centre with entity as a whole Step 1: Calculate impairment loss Adjust the carrying amounts of the CGUs for the allocable corporate asset (head office) and compare with recoverable amounts to determine impairment loss. Cador 1 120 000 48 000 1 168 000 1 240 000 ______0

Duke 784 000 48 000 832 000 800 000 (32 000)

Carrying Amount

Proportion

Allocation of loss

48 000 224 000 336 000 608 000

48/608 224/608 336/608

2 526 11 789 17 685 32 000

Carrying amounts of assets Allocation of head office assets Recoverable amount Impairment loss

Cornwall 592 000 48 000 640 000 600 000 (40 000)

Step 2: Allocate impairment loss Duke Division

Head office Land Plant

Adjusted carrying Amount 212 211 318 315

As the fair value less costs of disposal of the land is $216 211, then only $7 789 can be allocated to this asset. The other $4 000 must be allocated across the other assets:

Head office * Plant

Carrying Amount

Proportion

45 474 318 315 $363 789

45474/363789 318315/363789

Allocation of loss 500 3 500 $4 000

Adjusted carrying Amount 314 815

* $48 000 - $2 526 The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant ** (Impairment loss – Duke division: ** $17 685+ $3 500)

Dr Cr Cr

28 974 7 789 21 185

13.52

Chapter 13: Impairment of assets

Cornwall Division

Head office Land Plant

Carrying Amount

Proportion

Allocation of loss

48 000 128 000 304 000 480 000

48/480 128/480 304/480

4 000 10 667 25 333 40 000

Dr Cr

36 000

Adjusted carrying Amount 117 333 278 667

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Impairment loss – Cornwall division)

10 667

25 333

Step 4: Impairment losses for head office assets Total loss is $7 026, being $2 526 + $500 + $4 000

Land Fixtures and fittings

Carrying Amount

Proportion

Allocation of loss

88 000 56 000 $144 000

88/144 56/144

4 294 2 732 $7 026

Dr Cr

7 026

Adjusted carrying Amount 83 706 53 268

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – F&F (Impairment loss – head office)

4 294 2 732

Step 5: Research centre assets are $80 000 Carrying amount (after allocation of impairment loss): Cador CGU $1 168 000 Duke CGU 800 000 Cornwall CGU 600 000 Research centre 80 000 2 648 000 Recoverable amount of entity 2 640 000 Impairment loss _(8 000)

13.53

Solutions manual to accompany Company Accounting 10e

Carrying Amount

Proportion

Allocation of loss

480 000

480000/1407789

Adjusted carrying Amount

Cador: Plant

2 727

477 273

314 815

1 789

313 026

117 333 278 667

667 1 583

116 666 277 084

83 706 53 268

476 303

83 230 52 965

53 600 26 400 $1 407 789

305 150 $8 000

53 295 26 250

Duke: Plant Cornwall: Land Plant Head office: Land F&F Research Centre Land F&F

Impairment loss Accumulated depreciation and impairment losses – plant [Cador] Accumulated depreciation and impairment losses – plant [Duke] Land: Cornwall Accumulated depreciation and impairment losses – plant [Cornwall] Land: head office Accumulated depreciation and impairment losses – F&F [HO] Land: research centre Accumulated depreciation and impairment losses: F&F [RC]

8 000

2 727

Cr Cr

1 789 667

Cr Cr

1 583 476

Cr Cr

303 305

150

13.54

Chapter 14: Disclosure: legal requirements and accounting policies

Chapter 14 – Disclosure: Legal requirements and accounting policies REVIEW QUESTIONS 1.

What do the terms ‘financial performance’ and ‘financial position’ mean and how do they relate to the objective of general-purpose financial reporting?

Financial performance is discussed in the Conceptual Framework, paragraph OB16 as relating to the return that the entity has produced on its economic resources. Profit is frequently used as a measure of financial performance (Conceptual Framework paragraph 4.24). Information about income and expenses during a financial period plus changes in assets, liabilities and equities will enable users to assess past performance and make reasonable predictions about the ability of a company to continue to generate profits from its operating activities. Information about financial performance is largely contained in the statement of profit or loss and other comprehensive income and notes thereto. Its content is regulated by AASB 101 Presentation of Financial Statements. Financial position is discussed in paragraph OB12 of the Conceptual Framework as relating to the entity’s economic resources, the claims against the entity and the effects of transactions and other events that change an entity’s economic resources and claims. Information about financial position is largely contained in the statement of financial position (or balance sheet) and notes thereto. Its content is also regulated by AASB 101 and provides information concerning: ➢

Resources controlled. Predictions about the ability of an entity to continue to operate and generate positive cash flows are enhanced by information about assets.

➢

Financial structure. Details of how the entity is financed – through debt or equity – help users determine future distributions of cash flows and the capacity of the entity to attract resources in the future. A debt-laden company has more of its future cash flows committed to interest and principal repayment than does a company largely financed by its shareholders. Such an entity will also have a more limited capacity to borrow additional funds should this become necessary.

➢

Capacity to adapt. Information about the realisable value, current state of repair and any restrictions on use of assets enables users to assess the capacity of the entity to adapt to economic or environmental change.

➢

Liquidity The availability of cash in the near future after taking into account any financial commitments due over this period.

14.2

Solutions manual to accompany Company Accounting 10e

➢

Solvency. Availability of cash over the longer term in order to meet debts when they fall due.

The Corporations Act requires directors to ensure that financial reports give a true and fair view. What does the term ‘true and fair view’ mean?

The requirement for a 'true and fair' disclosure of the financial position and performance of the company (and the consolidated financial position and performance if consolidated accounts are required) is a controversial one. A ‘true and fair’ view, according to s.297 and s.295(3)(c) of the Corporations Act, requires compliance with accounting standards and the provision of additional information in the notes to the financial statements where compliance with accounting standards does not give a ‘true and fair view. Notwithstanding secs. 297 and 295(3)(c), the term 'true and fair' is not defined in the Corporations Act and its precise meaning in the context of published financial statements is not stated, there have been calls for its abolishment and the substitution of 'present fairly' in accordance with accounting standards. However, it is generally agreed that 'true and fair' has a more philosophical connotation as it endeavours to place the requirement for truth and fairness in reporting on a higher, more ethical level than mere conformity with accounting standards. Presently, if there is any reason that the directors believe that the financial statements prepared in accordance with accounting standards do not present a 'true and fair' view, they are required to add such information in the notes in order to present such a view. The substitution of 'true and fair' with 'presently fairly' would enable directors to relinquish their responsibilities of determining this overriding requirement that financial reports be assessed for truth and fairness, which itself provides a greater credibility for users of reports. Following the postEnron era and sub-prime mortgage crisis in the US, the need to retain ‘true and fair’ is undoubtedly even more important as it underscores an ethical dimension of external reporting.

What is comparative information and why must it be disclosed in financial statements?

Comparative information is the presentation of data relating to the previous financial year (for all financial statements and notes thereto) alongside that of the current year's information. The main purpose of its disclosure is to enable users to analyse and compare the company's previous results with current results. Analysis of trends in historical results over several years is of benefit to many members and analysts wishing to assess the company’s likely future prospects. Comparability of information is considered in paragraphs QC20QC25 of the Conceptual Framework to be a necessary qualitative characteristic that enhances the usefulness of information that is relevant and faithfully represented in general purpose financial statements.

14.3

Chapter 14: Disclosure: legal requirements and accounting policies

4. (a)

What should be included in the directors’ report and the auditor’s report? Director's Reports.

Under the Corporations Act, the annual financial report for a company, registered scheme or disclosing entity must be accompanied by a directors' report (s.298). Minimum requirements for the annual directors' report are set down in ss.298-300A. The amount of detail necessary in the report depends on the nature of the company or registered scheme. The content of the report consists of two main parts – general information about operations and activities (required by s.299), and specific information (required by s.300).

(b)

Auditor's Report

According to s.307, the auditor who conducts an audit of the financial report must form an opinion about the following matters: ➢ whether the financial report is in accordance with the Corporations Act ➢ whether the financial report is in accordance with accounting standards ➢ whether the financial report gives a true and fair view ➢ if additional information was included to give a true and fair view, whether that additional information was necessary ➢ whether the auditor has been given all information, explanation and assistance necessary for the conduct of the audit ➢ whether the company has kept financial records sufficient to enable the financial report to be prepared and audited ➢ whether the company has kept other records and registers as required by the Act. The auditor's report must express the opinion of the auditor as to whether the financial report is in accord with the Act, specifically s.296 (compliance with accounting standards) and s.297 (true and fair view). If the auditor is of the opinion that the financial report does not give a true and fair view, and is not in accord with the Act or with accounting standards, the auditor must state the reasons for that opinion in the report. Furthermore, if the financial report does not comply with an accounting standard, the auditor’s report must quantify the effect that non-compliance has on the financial report.

What is concise reporting? Of what benefit is this form of reporting?

Under S314(1) of the Corporations Act, directors may send to members a concise report in lieu of the full set of financial statements and notes covering the financial year's performance. The principal beneficiary of the concise report is the company who saves on printing and postage costs (assuming that members in the main do not exercise their right to receive the full set of accounts) and secondly, the members who are more likely to be able to digest a simplified set of accounts designed to be user friendly.

14.4

Solutions manual to accompany Company Accounting 10e

Which entities are required to provide a half-year financial report?

If any entity is a disclosing entity as defined under the Corporations Act, it is required to provide, in addition to the annual financial report, a half-year financial report. A disclosing entity is defined in s.111AC of the Corporations Act as an entity that issued ‘enhanced disclosure’ securities (e.g. has its shares listed on the ASX, or, is a borrower, which has issued debentures and appointed a trustee for the debenture holders).

What information is required by the Corporations Act to be included in the halfyear financial report?

Under the Corporations Act, the half-year report must include a set of financial statements (as required by accounting standards) as well as the notes to the financial statements and the directors’ declaration about the statements and notes. Attached to the half-year financial report must be a half-year directors’ report and an auditor’s report.

What disclosures are required by AASB 101 regarding accounting policies?

The contents of the summary of significant accounting policies note are broadly outlined in paragraph 117 of AASB 101. However, the details may be prescribed by other accounting standards or be a matter for management judgement. The accounting policies note will usually disclose the following information, usually in note 1 or 2. First, the note usually states that the financial statements are GPFS. The note also discloses the statutory basis or other reporting framework, if any, under which the financial statements are prepared and whether the entity is a for-profit or not-for-profit entity. Second, the note should disclose the measurement basis or bases used in preparing the financial statements. Third, the note should provide a description of accounting policies. AASB 101 paragraph 119 states that the information provided should allow users to understand how transactions and other events are reflected in the reported financial performance and position, but leaves the detail to management judgement. Finally, the note should disclose information about the assumptions made concerning the future, and other major sources of estimation uncertainty at the end of the reporting period that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In respect of those assets and liabilities, the note should include details of their nature and carrying amount at the end of the reporting period (AASB 101 paragraph 125).

14.5

Chapter 14: Disclosure: legal requirements and accounting policies

Why would an accounting estimate change and how is the change accounted for?

An accounting estimate may need revision if changes occur in the circumstances on which the estimate was based or as a result of new information or more experience. For example, technological changes may require the estimate of an asset’s useful life to be downgraded, or new information received about the financial status of a customer may require an increase in the estimate of bad debts. According to AASB 108, paragraph 36 the change in an accounting estimate must be applied prospectively by including it in profit or loss in the reporting period of the change. The change may affect only the current period’s profit or loss (e.g. bad debts) or profit or loss of both the current period and future periods (e.g. depreciation due to the change in the useful life of a non-current asset). Additionally, the nature and amount of the change shall be disclosed for the current, and if practicable, for future financial periods.

10. What is a prior period error? How and when is it corrected? Prior period errors are omissions from, and other misstatements in, the entity’s financial statements for one or more previous reporting periods that are discovered in the current period. Errors can occur for a number of reasons, including mathematical mistakes, misinterpretation of information, mistakes in applying accounting policies, oversight or misinterpretation of facts, and fraud. If the error is material then AASB 108 requires that it be corrected in the period in which it was discovered by retrospective restatement of the financial statements affected by the error. In other words, the entity must change the prior year figures to reflect the figures that would have been reported had the error not occurred. This restatement may involve changing prior year comparative figures or restating the opening amounts of comparative figures depending on whether the error was in the prior year or further back. The aim is to present financial statements (restated) as if the error had never occurred by correcting the error in the comparative information for the previous period(s) in which it occurred. Extensive disclosures of the line by line effect of the error are also required in the year of correction. 11. What is the difference between ‘retrospective application’ and ‘retrospective restatement’? Retrospective application is used in the context of accounting policy changes (either when a new or revised accounting standard does not include any specific transitional provisions relating to the change, or, when an entity changes an accounting policy voluntarily), and refers to the application of a new accounting policy to transactions, other events and conditions as if that policy had always been applied. Retrospective restatement is used in the context of errors and refers to a correction of the recognition, measurement and disclosure of elements of financial statements as if a prior period error had never occurred.

14.6

Solutions manual to accompany Company Accounting 10e

12. When is it impractible to make a retrospective change in an accounting policy or a retrospective restatement to correct an error? According to AASB 108 paragraph 5, applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so. For a particular prior period, it is impracticable to apply a change in an accounting policy retrospectively or to make a retrospective restatement to correct an error if: •the effects are not determinable; • it requires assumptions about what management’s intent would have been in that period; or • it requires significant estimates of amounts and it is impossible to distinguish objectively information about those estimates.

13. Outline the concept of materiality as it applies to financial reporting. Materiality is a concept essential to the preparation and presentation of general purpose financial statements. The Corporations Act's requirement that financial statements present a 'true and fair' view does not mean that the financial statements must be absolutely accurate to the last cent or absolutely complete in terms of the information disclosed. Rather, the notion of 'true and fair' is one of reasonableness, whereby the user can assume that the financial statements contain no material errors or omissions. The notion of materiality guides the margin of error acceptable, the degree of precision required and the extent of disclosure required. Materiality is defined in paragraph 9 of AASB 1031 as: Information is material if its omission, misstatement or non-disclosure has the potential, individually or collectively to: (a) (b)

influence the economic decisions of users taken on the basis of the financial statements; or affect the discharge of accountability by the management or governing body of the entity.

Accounting standards apply only where information resulting from their application is material. Thus, preparers need to make judgements as to whether the information provided by the application of a standard such as AASB 117 Leases is material to report users. If a company's sole lease arrangement is deemed to be immaterial in respect of either its financial performance or financial position, the requirements of AASB 117 need not be applied.

14. What is the difference between the two types of events occurring after the end of the reporting period? Is their accounting treatment identical? Events occurring after the end of the reporting period are defined in AASB 110 as those events, both favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are authorised for issue. There are two types of events described in AASB 110:

14.7

Chapter 14: Disclosure: legal requirements and accounting policies

•

adjusting events after the end of the reporting period which provide evidence of conditions that existed at end of the reporting period (e.g. the settlement of a court case after the end of the reporting period that confirms the company had a present obligation at the end of the reporting period) non-adjusting events after the end of the reporting period are events that are indicative of conditions that arose after the end of the reporting period (e.g. a flood or fire after the end of the reporting period that destroys a company’s building and plant).

The treatment in the financial statements is different in both cases. Paragraph 8 of AASB 110 requires the financial effect of the adjusting events to be reflected in the financial statements prepared at the end of the reporting period, i.e. an adjustment must be made to the financial statements before publication. AASB 110, paragraph 21 requires material non-adjusting events to be disclosed by way of note to the financial statements.

14.8

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Accounting policies

The board of directors has resolved to change the accounting policy for treatment of advertising expenditure. Previously, advertising expenditure had been expensed as incurred. Following extensive market research, the board has taken the view that benefits from advertising expenditure in the form of product awareness and increased sales will be received by the company over a 3-year period following the expenditure. Due to a recent fire and water damage to the company’s accounting records, details of advertising expenditure in prior years have been destroyed. Required The board of directors has approached you for advice regarding the disclosures, if any, which are required for this change in accounting policy. As the change in accounting policy was voluntary, the provisions of paragraph 29 of AASB 108 are applicable as follows: • the nature of the change • the reasons that applying the new accounting policy provides reliable and more relevant information • to the extent practicable, the amount of the adjustment for the current and previous periods to each financial statement line item affected and, if applicable, the basic and diluted earnings per share • the amount of the adjustment relating to periods prior to those presented to the extent practicable • if retrospective application is impracticable, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy was applied. To comply with paragraph 29, the change in accounting policy note may be worded as follows (other variations are possible): The board of directors has resolved to change the accounting policy for treatment of advertising expenditure. Previously, advertising expenditure had been expensed as incurred. However, following extensive market research, the board has taken the view that benefits from advertising expenditure in the form of product awareness and increased sales and will be received by the company over a 3 year period following the expenditure. Accordingly, the board believes the new accounting policy will provide reliable and more relevant information. Retrospective application of this change in accounting policy is impractible following a recent fire and water damage which has destroyed the company’s accounting records. Note, insufficient information was provided in the case study to determine: the amount of the adjustments for the current period to each financial statement line item affected; calculation of basic and diluted earnings per share; and how and from when the change in accounting policy was applied.

14.9

Chapter 14: Disclosure: legal requirements and accounting policies

Case Study 2

Accounting policies

Refer to case study 1. Assume the change in the accounting policy for advertising expenditure was due to the issue of a new accounting standard which requires advertising expenditure to be capitalised and then written off over a period not exceeding 5 years. Required Advise the company of the disclosures, if any, which are required by this change in accounting policy. As the change in accounting policy was due to the issue of a new accounting standard, the provisions of paragraph 28 of AASB 108 are applicable as follows: • • • • • •

the title of the standard when applicable, that the change is made in accordance with the transitional provisions of the standard, a description of those provisions and provisions that might have an effect on future periods the nature of the change in accounting policy to the extent practicable, the amount of the adjustment for the current and previous periods to each financial statement line item affected and, if applicable, the basic and diluted earnings per share the amount of any adjustment to periods prior to those presented to the extent practicable if comparative information has not been restated because it is impracticable to do so, the circumstances that prevented retrospective application and a description of how and from when the change in accounting policy has been applied.

To comply with paragraph 28, the change in accounting policy note may be worded as follows in the absence of any transitional provisions of the new accounting standard (other variations are possible): The board of directors has resolved to change the accounting policy for treatment of advertising expenditure. Previously, advertising expenditure had been expensed as incurred. However, following extensive market research, the board has taken the view that benefits from advertising expenditure in the form of product awareness and increased sales and will be received by the company over a 3 year period following the expenditure. Retrospective application of this change in accounting policy is impractible following a recent fire and water damage which has destroyed the company’s accounting records. Note, insufficient information was provided in the case study in relation to: the title of the accounting standard; transitional provisions of the standard; the amount of the adjustments for the current period to each financial statement line item affected; calculation of basic and diluted earnings per share; and how and from when the change in accounting policy was applied.

14.10

Solutions manual to accompany Company Accounting 10e

Case Study 3

Materiality

Antelope Ltd is a catering company specialising in providing catering services to remote area mine sites. The company has operations in Australia but during the current year it acquired significant long-term contracts in Pakistan and Nigeria. AASB 8 Operating Segments requires entities to disclose material segment information but Antelope Ltd has failed to comply with this requirement. Required Discuss whether the non-disclosure by Antelope Ltd of information about operations in Pakistan and Nigeria would be material. Information is material if its omission or misstatement would influence the economic decisions of users taken on the basis of the financial report (the Conceptual Framework, paragraph QC11). The non-disclosure of information relating the existence of long-term contracts in both Pakistan and Nigeria would be material to the users of Antelope’s financial statement. Both countries are politically and economically unstable so there is a significant risk that these operations could be disrupted exposing Antelope Ltd to potential losses on the contracts and other losses if corporate employees are harmed or property is destroyed. Disclosing the information allows users to factor in such risks into their predictions about the company’s future performance and position and ensures an informed decision is made. Furthermore, paragraph 12 of AASB 1031 notes: In deciding whether an item or an aggregate of items is material, the size and nature of the omission or misstatement of the items usually need to be evaluated together. In particular circumstances, either the nature or the amount of an item or an aggregate of items could be the determining factor. For example: • an entity expands its operations into a new segment which affects the assessment of the risks and opportunities facing the entity (paragraph 12(b)(iii)).

14.11

Chapter 14: Disclosure: legal requirements and accounting policies

Case Study 4

Events occurring after the end of the reporting period

The statement of financial position of Waterbuck Ltd as at 30 June 2014 includes an asset ‘Debenture money receivable $500 000’ and a liability ‘Debentures $500 000’. Note 12 to the accounts reveals that the issue of the debentures to a private investor was approved by the board of directors on 28 June 2014 but the debenture issue did not take place until 17 July 2014. Required Comment on the accounting treatment of the debenture issue in accordance with the requirements of AASB 110. The issue of the debentures on 17 July 2014 is a non-adjusting event after the end of the reporting period as it is indicative of conditions that arose after the end of the reporting period. Approval by a Board of Directors does not create a present obligation to repay debentures hence no liability existed as at 30 June 2014 and the debenture asset and liability should not have been recognised. The end of the reporting period adjusting journal should be reversed and the debenture issue disclosed in a note to the financial statements accounts as required by AASB 110, paragraph 21.

14.12

Solutions manual to accompany Company Accounting 10e

Case Study 5

Compliance with accounting policy disclosure requirements

The accounting policy note from the Amcor Ltd 2012 annual report was provided in figure 14.1 (pp. 000–00). Required Using the disclosures required in relation to accounting policies discussed in section 14.4.1 as a reference point, critically evaluate the compliance with these disclosures by Amcor Ltd in the company’s accounting policy note. Students should be encouraged to review the overall content of the CSR Ltd accounting policy note, but are not expected to have a detailed knowledge of all of the individual CSR Ltd accounting policies. Items included in CSR Ltd accounting policy note that students may comment on and discuss include: • • • • •

whether the statements are GPFS financial reporting conceptual framework measurement basis description of accounting policies management judgements.

Students are encouraged to offer an opinion as to the usefulness to users of accounting policies disclosure required by AASB 101.

14.13

Chapter 14: Disclosure: legal requirements and accounting policies

PRACTICE QUESTIONS Question 14.1

Annual reporting requirements, true and fair view

The directors of an Australian company, Mango Ltd, have formed a view that compliance with a particular AASB standard will mean the company’s financial statements will not provide a true and fair view which is contrary to the Corporations Act. Required Advise the directors how this problem can be resolved when preparing the company’s financial statements in accordance with AASB 101. The Corporations Act 2001 (s295(3)(c) and s297) specifies that a ‘true and fair’ view of an entity’s financial statements requires compliance with accounting standards AND the provision of additional information in the notes to the financial statements when compliance does not provide a ‘true and fair’ view. s297 True and fair view The financial statements and notes for a financial year must give a true and fair view of: (a) the financial position and performance of the company, registered scheme or disclosing entity; and (b) if consolidated financial statements are required—the financial position and performance of the consolidated entity. This section does not affect the obligation under section 296 for a financial report to comply with accounting standards. Note:

If the financial statements and notes prepared in compliance with the accounting standards would not give a true and fair view, additional information must be included in the notes to the financial statements under paragraph 295(3)(c).

AASB101 Presentation of Financial Statements states that, in most circumstances, a fair presentation is achieved by compliance with accounting standards (paragraph 15). However, paragraph 17, states that a fair presentation also requires an entity to: (a) select and apply accounting policies in accordance with AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors…. (b) present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; and (c) provide additional disclosures when compliance with the specific requirements in Australian Accounting Standards is insufficient to enable users to understand the impact or particular transactions, other events and conditions on the entity’s financial position and financial performance. The directors of Mango Ltd can resolve the problem by ensuring that additional information is disclosed in the notes to its financial statements explaining its compliance with the relevant accounting standard and how such compliance impacts on the entity’s financial performance and position.

14.14

Solutions manual to accompany Company Accounting 10e

Question 14.2

Accounting policies

Wombat Ltd has provided the following information to help with the preparation of the accounting policy note to the financial statements for the year ended 30 June 2018. Wombat Ltd values its inventory at the lower of cost and net realisable value. Costs are assigned to inventory as follows: 1. Raw materials: purchase cost on a first-in-first-out basis. 2. Work in progress: cost of direct material and labour and a proportion of manufacturing overheads based on normal operating capacity. 3. Finished goods: same as work in progress. Items of plant and equipment are measured using the cost basis. Land and buildings are measured using the fair value basis. Independent valuations of land and buildings are obtained every year unless circumstances indicate that an earlier valuation is required. The valuations are based on the amount that could be exchanged between a knowledgeable willing buyer and a knowledgeable willing seller in an arm’s-length transaction on the valuation date. Where the carrying amount of land and buildings is materially different from its fair value, valuation adjustments are made. Valuation increases are credited to an asset revaluation surplus unless they are reversed against a previous valuation decrease. Valuation decreases are expensed unless they are reversed against a previous valuation increase. Buildings, plant and equipment are depreciated on a straight-line basis so as to write off the cost or other value of each asset less estimated residual value at the end of the life of the asset over its expected useful life. Depreciation of assets starts when they are installed and ready for use. Depreciation rates used by the company are: Buildings 5% Plant and equipment 15-25% Receivables are carried at nominal amounts less any allowance for doubtful debts. An estimate of doubtful debts is recognised when collection of the full nominal amount is no longer probable. Bad debts are written off as incurred. Credit sales are on 30-day terms. In determining cash flows for the year, the company includes in the cash balance all cash on hand and in banks net of any outstanding bank overdrafts. Long-term cash deposits are not part of the daily cash management function and are regarded as investments. The company recognises liabilities for the following employee entitlements accrued as at the end of the reporting period — wages and salaries, annual leave and long-service leave. Such liabilities are measured as required by AASB 119 Employee Benefits. Required Prepare the accounting policy note for inclusion in the financial statements of Wombat Ltd as at 30 June 2018. This task may require you to research the accounting policy disclosure requirements of applicable accounting standards. Read the disclosure requirements of AASB 101 Presentation of Financial Statements. As there is no indication in the question that there have been any changes to accounting policies during the year we can assume that the policies are consistent with those adopted in prior periods. AASB 101 paragraph 117(b) requires disclosure of ‘the other accounting policies used that are relevant to an understanding of the financial statements’. To comply with this requirement it will also be necessary to check other standards to determine if additional or specific disclosures are required about policies adopted with respect to individual classes of

14.15

Chapter 14: Disclosure: legal requirements and accounting policies

assets, liabilities, income and expenses. For example, AASB 102, paragraph 36(a) requires accounting policies adopted for measuring inventories to be disclosed. Note, there is no specific wording or order required for disclosures under AASB 101 - this is a matter for management discretion. Wombat Ltd Notes to the financial statements 30 June 2018

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of accounting The financial report is a general-purpose financial report prepared in accordance with applicable accounting standards and interpretations, and the requirements of the Corporations Act 2001. The financial statements have been prepared in accordance with the historical cost convention except for land and buildings, which are measured at fair value. Judgements, estimates and assumptions In order for financial statements to comply with AASB standards, management is required to make judgements, estimates and assumptions when applying the company’s accounting policies. All judgements, estimates and assumptions are believed to be reasonable under the circumstances. Actual results may differ from these judgements, estimates and assumptions. Changes to Accounting Policies There have been no changes to accounting policies during the year. Receivables Receivables are carried at nominal amounts less any allowance for doubtful debts. An estimate of doubtful debts is recognised when collection of the full nominal amount is no longer probable. Bad debts are written off as incurred. Credit sales are on 30 day terms. Inventories Inventories are valued at the lower of cost and net realisable value. Costs incurred in bringing each inventory item to its present location and conditions are allocated as follows: • Raw materials – purchase cost on a first-in-first-out basis • Work in progress and finished goods – direct material and labour cost and a proportion of manufacturing overheads based on normal operating capacity. Property, plant and equipment Measurement Land and buildings are measured on a fair value basis. At each reporting date, the value of each asset in these classes is reviewed to ensure that it does not differ materially from the asset’s fair value at that date. Where necessary, the asset is revalued to reflect its fair value. All other classes of plant and equipment are measured at cost.

14.16

Solutions manual to accompany Company Accounting 10e

Depreciation Buildings, plant and equipment are depreciated on a straight-line basis so as to write off the cost or other value of each asset less estimated residual value at the end of the life of the asset over its expected useful life. Depreciation of assets commences when they are installed and ready for use.

Major depreciation rates are: • •

Buildings Plant and equipment

2018 5% 15% – 25%

2017 5% 15% - 25%

Employee entitlements Provision is made for employee entitlement benefits accumulated as a result of employees rendering services up to the reporting date. These benefits include wages and salaries, annual leave and long service leave. Provisions made in respect of employee entitlement benefits expected to be settled within 12 months are measured at their nominal amounts. Provisions made in respect of employee entitlement benefits not expected to be settled within 12 months are measured at the present value of the estimated future cash outflow to be made in respect of benefits accrued up to the reporting date. Cash and Cash equivalents For the purposes of the Statement of Cash Flows, cash includes cash on hand and in banks net of outstanding bank overdrafts.

14.17

Chapter 14: Disclosure: legal requirements and accounting policies

Question 14.3

Accounting estimates and errors

Young Ltd estimates its future liability for repairs to products sold with a 12-month warranty as a percentage of its net credit sales. Warranty expense and actual repair costs for the last 2 years ending 30 June were: Expenses Actual costs 2016–17 2017–18

$40 000 44 000

$64 000 72 000

Required Comment on Young Ltd’s accounting method for warranty liabilities. What action should be taken with respect to the accounting estimates? If an investigation during 2018–19 finds that the figure for warranty expense was incorrectly calculated for 2017– 18 and should have been $60 000, what action is required under AASB 108?

The significant variances between the provision for warranty and the actual repairs in the two years indicate that either the policy of using a percentage of net credit sales as a means of estimating warranty costs is not appropriate, or the percentage used is not adequate. The company needs to look at changing either its policy or perhaps simply increasing the percentage used. Past claims as a percentage of past net credit sales should provide a reliable measure. If a new percentage is adopted it will be applied prospectively (from 2018-19 on) according to AASB 108 paragraph 36. If the variance for 2017-18 was due to an error in calculation then, providing it is material, the figures for 2017-18 should be retrospectively corrected (according to AASB 108 paragraph 42) by the following entry: $ $ Retained earnings (1 July 2018) Dr 16 000 Provision for Warranty Cr 16 000 Additionally, this would indicate that the variance in 2016-17 may be a one-off aberration.

14.18

Solutions manual to accompany Company Accounting 10e

Question 14.4

Events occurring after the end of the reporting period

In relation to the operations of Cat Ltd, the following events took place after the 30 June 2016 reporting period end: • On 17 July 2016 Cat Ltd’s main fishing fleet was sunk during a freak storm. Insurance will cover the replacement of the vessels but lost sales representing $550 000 in profits are not covered. • On 19 July 2016 Cat Ltd took delivery of a fishing net for its prawn trawler. The net was purchased from a UK manufacturer on delivered duty paid shipping terms and was in transit at the end of the reporting period. An inspection of the net revealed significant structural flaws and the net was returned to the supplier on 28 July 2016. Cat Ltd is to receive a full refund of the $650 000 purchase price which had been paid in advance on 29 June 2016. • On 29 August 2016 a lawsuit was lodged against the company by the families of crew members drowned in the 17 July storm, alleging negligence, and claiming $4 million in damages. No date has as yet been set for the court hearing. • On 1 September 2016 the directors resolved to issue to the public 10 000 5% debentures of $10 each, payable $5 on application and $5 on allotment. Required Classify the above events into adjusting and non-adjusting events after the end of the reporting period, justifying your choice.

Classification of after reporting period events Assuming all events are material by reason of size and nature: Date 17 July 2016

Classification Non-Adjusting

Justification The storm which caused the loss of the fishing fleet and the uninsured loss of profits occurred after the end of the reporting period and impacts on future conditions.

19 July 2016

Adjusting

The receipt and subsequent return of the fishing net provides new information about the assets owned by Camel Ltd as at the end of the reporting period.

29 August 2016

Non-Adjusting

The lawsuit arose as a consequence of an after the end of the reporting period event (the storm on 17 July) and it may have material effects on future cash flows or operations if the company has to pay the $4 million damages claim.

1 September 2016

Non-Adjusting

The issue of $100 000 5% debentures to the public does not relate to conditions existing at the end of the reporting period but will have a material impact on future cash flows.

14.19

Chapter 14: Disclosure: legal requirements and accounting policies

Question 14.5

Accounting policies and accounting estimates

For Dog Ltd, determine whether each of the following is an accounting policy or an accounting estimate: 1. The useful life of depreciable plant is determined as being 5 years. 2. Dog Ltd depreciates non-current assets. 3. Dog Ltd uses straight-line depreciation. 4. Dog Ltd determines that it will calculate its warranty provision using past experience of products returned for repair under warranty. 5. The current year’s warranty provision is calculated by providing for 1% of current year sales, based on last year’s warranty claimed amounting to 1% of sales. (a) accounting estimate (b) accounting policy (c) accounting estimate (the policy is to depreciate non-current assets – see (b) – estimates are then required regarding: useful life; residual value; and pattern of benefits) (d) accounting policy (e) accounting estimate (i.e., an accounting estimate that is determined by applying a policy of estimating warranty provisions as a % of sales based on the prior period %)

14.20

Solutions manual to accompany Company Accounting 10e

Question 14.6

Materiality and events occurring after the end of the reporting period

The following information has been made available to you to assist in the preparation of the financial statements of Ant Ltd for the year ended 30 June 2018: 1. The company has been involved in a dispute with a government environment agency relating to the release of noxious gases from its manufacturing plant in early June 2018. An expert investigation was conducted to determine if the company was at fault. The investigator’s report released on 1 August 2018 found Ant Ltd to be responsible for the release and damages amounting to $1 500 000 were payable by the company. 2. On 9 July 2018, the sales manager raised credit notes worth $30 000 relating to sales of faulty goods in the last 2 weeks of June 2018. 3. On 25 September 2018, the company received notification that a customer owing $130 000 had gone into liquidation. The liquidator advised that unsecured creditors are likely to receive a distribution of only 20c in the dollar. The liquidation was caused by a flood in July 2018 which destroyed the customer’s operating plant and warehouse. The damage was not covered by insurance. Assume all events or transactions are material. Required In relation to the above events or transactions, prepare the necessary notes or general journal entries to comply with applicable accounting standards.

Release of investigator’s report on 1 August 2018

The release of the report and the decision that damages were payable by Ant Ltd provide new information about conditions existing at the end of the reporting period given that the release of the noxious gases occurred in June 2018. Assuming a profit before tax of $720 000, at the amount of $1 500 000 is clearly material and the following adjustment should be made: June 30

Damages expense Dr 1 500 000 Damages payable Cr (Recognition of damages liability)

1 500 000

Credit notes raised on 9 July 2018

As these credit notes relate to sales which occurred prior to the end of the reporting period this provides more information about conditions existing at 30 June 2018 and will (or may, depending on materiality) require adjustment by journal entry. However, as the credit notes represent only approximately 4% of profit before tax ($30 000/$720 000), it could be argued that no adjustment is necessary on the grounds of immateriality. The journal entry (ignoring materiality considerations) is shown below: June 30

Sales returns and allowances Dr Accounts receivable Cr (Credit notes relating to June sales)

30 000 30 000

Liquidation of debtor

14.21

Chapter 14: Disclosure: legal requirements and accounting policies

As the liquidation was caused by an event after the end of the reporting period no adjustment will be made as this information does not change the situation that existed at 30 June 2018. However, the $104 000 loss (80 cents in the dollar x $130 000) will be material to next year’s profits based on the current year’s profit before tax ($104 000/$720 000 = 14%), and must be disclosed by note. Ant Ltd Notes to the financial statements year ended 30 June 2018 Note X: Events occurring after the end of the reporting period In September 2018, a debtor owing $130 000 went into liquidation. The company expects to recover only 20% of the amount owing.

14.22

Solutions manual to accompany Company Accounting 10e

Question 14.7

Events occurring after the end of the reporting period

Sable Ltd has provided the following information concerning events occurring after the end of the reporting period. This information is to be used for the preparation of the financial statements for the year ended 30 June 2017. On 17 July 2017, a firebomb destroyed four of the company’s transport vehicles resulting in damages of $400 000. Insurance will cover $300 000 of the damages but payment of the insurance claim has been delayed by a police investigation. As a result of the loss of these vehicles, the company’s delivery schedules have been severely disrupted. On 18 July 2017, the release of a far superior and cheaper product by a competitor caused a major decline in demand for product X made by Sable Ltd. In an effort to sell remaining stock of the product Sable Ltd has reduced its selling price to 50% of cost. Inventory on hand at 30 June 2017 was recorded at its cost of $153 000. On 15 August 2017, the Department of Occupational Health and Safety charged the company over unsafe storage practices that resulted in the leakage of toxic materials into a local creek. The leakage occurred on 3 July 2017. If found to be negligent by the court, the company will have to pay a fine of $350 000 plus legal and clean-up costs in excess of $250 000. On 21 August 2017, the purchasing manager discovered that a batch of invoices relating to June inventory purchases had not been processed. The invoices totalled $37 650. On 30 August 2017, the company issued a prospectus offering 3000 10% debentures of $100 each for public subscription. The debentures are redeemable on 1 October 2020. Interest is payable annually in arrears. The debentures are secured by a floating charge over the company’s assets. Assume all events and transactions are material. Required A. Classify the above events as either adjusting or non-adjusting events after the end of the reporting period. Justify your classification. B. Based on your answer to requirement A, prepare the necessary journal entries or note disclosures to comply with the requirements of AASB 110.

A. Classification of events Date

Event

17 July

Firebombing of vehicles

Condition at 30 June 2017 None as vehicles destroyed after 30 June 2017

18 July

Selling price reduction for product X

Inventory on hand at cost of $153 000

New information Future losses

Net realisable value of inventory only $76 500 (50% x

Classification Non-adjusting

Adjusting

14.23

Chapter 14: Disclosure: legal requirements and accounting policies

$153 000) 15 August

Charge of environmental damage lodged

None as leak occurred after 30 June 2017

Future fines ($350 000) plus legal costs and clean-up costs (> $250 000)

Non-Adjusting

21 August

Unrecorded purchase invoices

Accounts payable and inventory

Understatement of both items by $37 650

Adjusting

30 August

Debenture offer

None as debentures issued after 30 June 2017

Future cash flow effects and increase of liabilities

Non-Adjusting

B. Adjusting journal entries 2017 30 June

30 June

Inventory write-down expense Dr Inventory – product X Cr (Write-down to net realisable value)

76 500

Inventory Dr Accounts payable Cr (Recognition of unrecorded invoices)

37 650

76 500

37 650

Note Disclosures Note X:

Events occurring after the end of the reporting period

On 17 July 2017, a firebomb destroyed a number of transport vehicles resulting in disruption of delivery schedules and an uninsured loss of $100 000. On 15 August 2017, the company was charged with environmental damages arising from a leakage of toxic materials from the storage tanks on 3 July 2017. Possible losses from fines, legal and clean-up costs could be in excess of $600 000. The directors will vigorously defend the claim of negligence. On 30 August 2017, the company offered 3000 10% $100 debentures for public subscription. The debentures are secured by floating charge over the company’s assets and are redeemable on 1 October 2020.

14.24

Solutions manual to accompany Company Accounting 10e

Question 14.8

Materiality

The annual audit of the accounting records and draft financial statements of Koala Ltd as at 30 June 2017 revealed the following errors and omissions: 1. Credit notes totalling $33 000 relating to June sales were posted against sales made in July. 2. The purchase price of $71 200 for a new vehicle on 1 January 2017 was posted to the vehicle maintenance expense account. Motor vehicles are depreciated at 25% p.a. straight-line. 3. A manufacturing assembly line has been taken out of operation pending its sale. The asset had a carrying amount of $50 000 as at 30 June 2017. 4. No disclosure has been made about a fire in the warehouse during May that caused damage worth $10 000. The warehouse and its contents are fully insured. 5. No adjustment to the allowance for doubtful debts has been made to reflect the fact that a major debtor owing $20 000 went into liquidation after the end of the reporting period. Correspondence with the liquidator indicates that the expected payout will be no more than 10c in the dollar. Assume all errors and omissions are material. Required Prepare the necessary adjustments (if any) for all items.

KOALA LTD General Journal 2017 30 June

Sales revenue Accounts receivable (July credit notes raised in respect of June sales)

Dr Cr

33 000

Motor vehicles Vehicle maintenance expense (Correction of misposting)

Dr Cr

71 200

Depreciation – Motor vehicles Accumulated depreciation (Depreciation expense for the year; $71 200 x 25% x ½)

Dr Cr

8 900

Allowance for doubtful debts Accounts receivable (Debt written off as uncollectible)

Dr Cr

18 000

33 000

71 200

8 900

18 000

Note: No journal entry is required for the reclassification of the manufacturing assembly line as ‘non-current asset held for sale’ in the statement of financial position, unless the carrying amount is greater than its fair value less costs to sell.

14.25

Chapter 14: Disclosure: legal requirements and accounting policies

Question 14.9

Materiality and events occurring after the end of the reporting period

You are currently auditing the financial statements and records of Buffalo Ltd for the year ended 30 June 2018. In the course of your investigations you uncover the following transactions that occurred after the end of the reporting period but which appear to relate to the financial year ended 30 June 2018: 1. Sales return notes raised for goods returned in the final 2 weeks of June 2018 were posted as July 2018 sales returns. The goods returned were worth $16 500. 2. On 16 September 2018 there was a fire in the company’s main warehouse. Loss of inventory was covered by insurance but there was significant disruption to the flow of production output. The financial effects of the disruption are estimated to be $150 000, and are not covered by insurance. 3. Buffalo Ltd manufactures textiles and purchases raw cotton from overseas. A shipment of cotton was in transit at the end of the reporting period and, given that the price per bale is determined by quality, an estimated cost of $125 000 was recognised. The cotton duly arrived on 18 July 2018 and after examination it was determined that the cost will be $163 000. 4. On 23 July 2018 a favourable judgement was handed down in a lawsuit lodged by Buffalo Ltd against a major supplier for damages arising from poor-quality materials delivered in April 2017. The damages and costs awarded to Buffalo Ltd totalled $1 500 000. Assume all items are material. Required Classify each item as either an adjusting or non-adjusting event after the end of the reporting period. Justify your answer. A. 1.

Misposting of sales returns notes

These incorrectly posted transactions overstate Sales Revenue and Accounts Receivable by $16 500. Base Amount Profit before tax Sales Revenue Receivables (Current assets)

$218 000 10 000 000 431 000

Error as % of base 7.6% 0.2% 3.8%

The error is not greater than 10% for any of the relevant base amounts. However, it is between 5-10% of profit and thus its materiality is a matter of judgement. 2.

Uninsured disruption to production output

This disruption (financial effects estimated to be $150 000) will have an overall decreasing effect on future profits. As future profits are concerned average base amounts will be used. Base Amount Average profit before tax

$266 500

Error as % of base 56.3%

14.26

Solutions manual to accompany Company Accounting 10e

Average equity

228 000

65.8%

This event is material. 3.

Increased cost of raw cotton inventory

The increase in cost affects Inventory and Accounts Payable by $38 000 ($163 000 - $125 000). Base Amount Inventory (Current assets) Accounts payable (Current liabilities)

$431 000

Error as % of base 8.8%

396 000

9.6%

Given that the understatement is close to 10% of both base amounts it is likely to be regarded as material. 4.

Receipt of damages

The damages award will increase Revenue and Cash by $1.5 million. Base Amount Profit before tax Cash (Current assets)

$218 000 431 000

Error as % of base >100% > 100%

The item is clearly material. B. The following events provide more information about conditions existing at the end of the reporting period and are adjusting events: Misposting of sales returns notes Increase in cost of raw cotton inventory Receipt of damages The following events do not relate to conditions existing at the end of the reporting period but do provide material information with respect to future financial performance or financial position and are non-adjusting events: Uninsured disruption to production output

14.27

Chapter 14: Disclosure: legal requirements and accounting policies

Question 14.10

Accounting policies, accounting estimates and errors

In order to comply with AASB 108, determine whether the following changes should be accounted for prospectively or retrospectively: (a) A change in accounting estimate. (b) A voluntary change in an accounting policy. (c) A change in accounting policy required by a new or revised accounting standard. (d) An immaterial error discovered in the current year, relating to a transaction recorded three years ago. (e) In the current year, a material error was discovered relating to a transaction recorded three years ago. Management determines that retrospective application would cause undue cost and effort. (a) prospective (b) retrospective (c) as required by the transitional provisions of that Standard; if not specified then retrospective (d) the amount is immaterial and so may be ignored or corrected in the current year. (e) retrospective application is required unless impracticable to do so, but the definition of impracticable does not include undue cost and effort (AASB 108 paragraph 5).

14.28

Solutions manual to accompany Company Accounting 10e

Question 14.11

Changes in accounting estimates

On 1 July 2010, Bird Ltd acquired a building for $2 500 000 with an estimated life of 25 years and a residual value of nil. Bird Ltd uses the straight-line method of depreciation. Based on expert advice provided to Bird Ltd in 2016, it was decided the building should be depreciated over a total period of 20 years. At 1 July 2015, details for the building were as follows: Cost Accumulated depreciation

$ 2 500 000 (500 000) 2 000 000

Required Prepare the accounting policy note required by AASB 108 for this change in an accounting estimate by Bird Ltd for the year ended 30 June 2016. Show all workings. Bird Ltd Extract from Notes Year ended 30 June 2016 Note xx At the beginning of the financial year, the total useful life to the company of the building was revised downwards from 25 to 20 years. For each of the remaining 15 years of the asset’s life, including the current financial year, depreciation expense will be increased by $33 333, from the original estimate of $100 000, to $133 333. Workings Depreciation over useful life of 25 years = $2 500 000/25 years = $100 000 Remaining useful life from 1 July 2015 after revised estimate: 15 years Depreciation of remaining carrying amount over a useful life of 15 years = $2 000 000/15 years = $133 333 Increase in depreciation expense $133 333 - $100 000 = $33 333

14.29

Chapter 14: Disclosure: legal requirements and accounting policies

Question 14.12

Accounting estimates and policies

Mouse Ltd traditionally estimated its allowance for doubtful debts as a percentage of net credit sales for the year. An analysis of the variance between the allowance amount and the actual bad debts written off for the past 5 years has shown significant unfavourable discrepancies. In the previous year (ended 30 June 2017) the allowance was estimated at $24 000 but bad debts written off during the current year were $11 200 more than allowed for. Consequently, the accountant has decided to change the method of estimation from a percentage of net credit sales to an analysis of the accounts receivable balances. This analysis estimated that the allowance for doubtful debts should be $35 600 as at 30 June 2018 (the current year). Required A. Show the following for the year ended 30 June 2018: 1. the ledger account for the allowance for doubtful debts 2. the end of the reporting period adjusting journal entry. B. Justify your accounting treatment in requirement A by reference to the requirements of AASB 108. C. Explain how and why the change in method of estimation should be disclosed by Mouse Ltd. A.

Date 30/6/18 30/6/18

ALLOWANCE FOR DOUBTFUL DEBTS Details $ Date Details Accounts receivable* 35 200 1/7/17 Balance b/d Balance c/d 35 600 30/6/18 Bad debts expense** 70 800 1/7/18 Balance b/d

$ 24 000 46 800 70 800 35 600

*$35 200 bad debts written off ($24 000 + $11 200) **$46 800 = $35 600 + $11 200

Balance date adjustment entry DATE DETAILS 30/6/18 Bad debts expense Allowance for doubtful debts (Balance date adjustment)

Dr 46 800

Cr 46 800

B. AASB 108, paragraph 36 requires that the effect of a change in an accounting estimate shall be recognised prospectively by including it in profit or loss in the period of the change. New information in the form of debts which actually went bad during the year ended 30 June 2018 proved that the estimate of doubtful debts as at 30 June 2017 (last year) was inadequate and should have been $35 200 rather than $24 000. The amount of $11 200 ($35 200 - $24 000) in bad debts written off that was more than © John Wiley and Sons Australia, Ltd 2015

14.30

Solutions manual to accompany Company Accounting 10e

allowed for last year has been added to bad debts expense for the current year (i.e. prospectively) in accordance with paragraph 36. The balance of the bad debts expense for the current year, $46 800, is comprised of $35 600 (allowance for doubtful debts as at 30 June 2018 based on an analysis of outstanding account receivable balances) plus $11 200 (adjustment for underestimation of allowance for doubtful debts as at 30 June 2017). C. The key issue here is whether or not the change in the way Mouse Ltd estimates its doubtful debts is a change in an accounting policy. AASB 108, paragraph 35 states ‘A change in the measurement basis applied is a change in an accounting policy, and is not a change in an accounting estimate. When it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate.’ The asset here is Accounts Receivable, a financial asset which is measured at the lower of nominal value and recoverable amount. Where a debt is not expected to be collected in full it is disclosed in the financial statements at its expected amount via the allowance for doubtful debt adjustment. The change in the way this ‘recoverable amount’ is estimated does not change the measurement basis and is therefore not a change in accounting policy. Mouse Ltd should disclose the nature and amount of any change in an accounting estimate (according to AASB 108 paragraph 39), usually in its accounting policy note.

14.31

Chapter 14: Disclosure: legal requirements and accounting policies

Question 14.13

Accounting policies

At a meeting held on 16 June 2016, the directors of Alpaca Ltd decided to change the company’s accounting policy in regard to research and development expenditure. In previous years, research and development expenditure has been capitalised and amortised over 3 years. In line with this policy, $75 000 was capitalised on 1 January 2015. The new policy is to write off all research and development to expense when incurred. During the year ended 30 June 2016, the company spent a further $62 000 on research and development which was capitalised on 1 January 2016. Research and development expenditure is allowable as a deduction for tax purposes when incurred. Required Prepare any note disclosures required by AASB 108 in respect of the change in accounting policy. Show all workings. Workings: To comply with AASB 108, paragraphs 19(b) and 22, the change of accounting policy in regard to research and development expenditure needs to be applied retrospectively, i.e. Alpaca Ltd has to calculate the effect of the change on the opening balance of retained earnings and both current year profit and non-current asset figures. The capitalisation policy adopted in the prior year would have resulted in the following figures being reported in the financial statements for the year ended 30 June 2015: Statement of Financial Position 2015 Other Non-Current Assets Research and development Accumulated Amortisation

$75 000 *12 500 62 500

Statement of Profit or Loss and Other Comprehensive Income 2015 Expenses Amortisation - Research & Development

*$12 500

*$12 500 = $75 000/3 x ½ year Income Tax Effect As the total amount spent on research and development is tax deductible in the year of expenditure, a taxable temporary difference would have existed at 30 June 2015 as shown below: Asset

Carrying amount

Research and

$62 500

Future taxable amount (62 500)

Future deductible amount 0

Tax base

Taxable temporary difference 62 500

14.32

Solutions manual to accompany Company Accounting 10e

development

A deferred tax liability of $18 750 ($62 500 x 30%) would have been recognised as a result of the taxable temporary difference. To adopt the new accounting policy the following journal entries would be posted: 2016 16 June

16 June

Accumulated amortisation Dr 12 500 Retained earnings (1/7/15) Dr 62 500 Research and development Cr (Derecognition of research and development asset) Deferred tax liability* Dr Retained earnings (1/7/15) Cr (Derecognition of deferred tax liability) * $18 750 = 30% x $62 500

75 000

18 750 18 750

Note: AASB 108, paragraph 29 also requires comparative figures to be restated. If the new accounting policy had always been in place the financial statements at 30 June 2016 would include the following figures assuming a tax rate of 30%: Statement of Financial Position No asset would be recorded. The comparative amounts for retained earnings (1/7/15) and deferred tax liability would both be lower by $43 750 ($62 500 - $18 750) and $18 750 (respectively). Statement of Profit or Loss and Other Comprehensive Income 2016 Expenses Research & Development expense $62 000

2015 $75 000

Disclosure of Accounting Policy Change Alpaca Ltd Notes to the financial statements 30 June 2016 Summary of Significant Accounting Policies Changes in Accounting Policies An adjustment of $(43 750) has been made to the opening balance of retained earnings representing the effect of a change in accounting policy for the recognition of research and development costs. As these costs are not considered to represent future economic benefits they are now expensed when they are incurred rather than being capitalised and amortised over 3 years. Accordingly, the research and development asset has been derecognised and an

14.33

Chapter 14: Disclosure: legal requirements and accounting policies

adjustment made to the balance of deferred tax liability. Comparative information has been restated to reflect the change in accounting policy.

14.34

Solutions manual to accompany Company Accounting 10e

Question 14.14 (adapted from IAS 8 Implementation Guidance) Accounting policies During the year ended 30 June 2015, David Ltd changed its accounting policy for depreciating property, plant and equipment, so as to apply much more fully a components approach — that is, various components of each asset with different useful lives or patterns of benefits will be depreciated separately and thus it deals more accurately with the components of property, plant and equipment, while at the same time adopting the revaluation model. In the years before 2015, David’s asset records were not sufficiently detailed to apply a components approach fully. In June 2014, management commissioned an engineering survey, which provided information on the components held and their fair values, useful lives, estimated residual values and depreciable amounts at 1 July 2014. However, the survey did not provide a sufficient basis for reliably estimating the cost of those components that had not previously been accounted for separately, and the existing records before the survey did not permit this information to be reconstructed. David Ltd’s management considered how to account for each of the two aspects of the accounting change. They determined that it was not practicable to account for the change to a fuller components approach retrospectively, or to account for that change prospectively from any earlier date than 1 July 2014. Also, the change from a cost model to a revaluation model will be accounted for prospectively due to lack of information from prior years. Therefore, management concluded that it should apply David Ltd’s new policy prospectively from 1 July 2014. Additional information (a) Property, plant and equipment at 30 June 2014: Cost $25 000 Accumulated depreciation 14 000 Carrying amount 11 000 (b) Prospective depreciation expense for the year ended 2015 (old basis) $1500. (c) Some results of the engineering survey: Valuation Estimated residual value Average remaining asset life (years)

$17 000 3 000 7

(d) David Ltd’s tax rate is 30 per cent. Required A. Calculate depreciation expense under the new policy (new basis) for the year ended 30 June 2015. B. Prepare the accounting policy note required by AASB 108 for this change in accounting policy by David Ltd for the year ended 30 June 2015.

1. Depreciation expense under the new policy for the year ended 30 June 2015 (new basis) = ($17 000 - $3 000)/7 = $2 000.

2. © John Wiley and Sons Australia, Ltd 2015

14.35

Chapter 14: Disclosure: legal requirements and accounting policies

David Ltd Extract from Notes Year ended 30 June 2015 Note xx From 1 July 2014, David Ltd changed its accounting policy for depreciating property, plant and equipment, so as to apply much more fully a components approach, whilst at the same time adopting the revaluation model. Management takes the view that this policy provides reliable and more relevant information because it deals more accurately with the components of property, plant and equipment and is based on up-to-date values. The policy has been applied prospectively from 1 July 2014 because it was not practicable to estimate the effects of applying the policy either retrospectively, or prospectively from any earlier date. Accordingly, the adoption of the new policy has no effect on prior years. The effect on the current year is to: • increase the carrying amount of property, plant and equipment at the start of the year by $6,000; • increase the opening deferred tax liability by $1,800; • create an asset revaluation surplus at the start of the year of $4,200; • increase depreciation expense by $500; and • reduce tax expense by $150. Workings: Carrying amount of property, plant and equipment: $17 000 [valuation] - $11 000 [carrying amount] = $6 000 Deferred tax liability: 30% x $6 000 = $1 800 Asset revaluation surplus: $6 000 x (1 – 30%) = $4 200 Depreciation expense: $2 000 (new basis) - $1 500 (old basis) = $500 Tax expense: 30% x $500 [increase in depreciation expense] = $150

14.36

Chapter 15 – Disclosure: presentation of financial statements REVIEW QUESTIONS 1. What constitutes a complete set of financial statements? According to paragraph 10 of AASB 101, a complete set of financial statements comprises: (a) a statement of financial position as at the end of the period; (b) a statement of profit or loss and other comprehensive income for the period; (c) a statement of changes in equity for the period; (d ) a statement of cash flows for the period; (e) notes, comprising a summary of significant accounting policies and other explanatory information; (ea) comparative information in respect of the preceding period as specified in paragraphs 38 and 38A; and (f) a statement of financial position as at the beginning of the preceding period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements in accordance with paragraphs 40A-40D. AASB 101 also provides that that an entity may use titles for the statements other than those specified in paragraph 10, e. g. the statement of financial position may be referred to as the balance sheet and the statement of profit or loss and other comprehensive income may be referred to as the statement of comprehensive income.

What are the eight general features of a complete set of financial statements?

AASB 101 (paragraphs 15 – 46) outlines eight general features of a complete set of financial statements: 1. fair presentation and compliance with Standards 2. going concern 3. accrual basis of accounting 4. materiality and aggregation 5. offsetting 6. frequency of reporting 7. comparative information 8. consistency of presentation.

3. Financial statements must include ‘comparative figures’. What does this mean, and can a company change these comparative figures in the following year? Discuss fully. Paragraph 38 of AASB 101 requires disclosure of comparative financial information in respect of the preceding period’ (i.e. the previous reporting period) for all amounts required to be reported in the current period’s financial statements. Comparative information for narrative and descriptive information is also to be included if it is relevant to understanding the current period’s financial statements. According to paragraph 38A of AASB 101: An entity shall present, as a minimum, two statements of financial position, two statements of profit or loss and other comprehensive income, two separate statements of profit or loss (if presented), two statements of cash flows and two statements of changes in equity, and related notes.

If the presentation or classification of items in the financial statements is changed, comparative information must also be reclassified and the nature, amount of and reason for the reclassification must be disclosed (AASB 101 paragraph 41). Reclassification is not necessary if this is ‘impracticable’; for example, an entity may not have collected data in previous periods in a way that allows reclassification. In this case, the reason for not reclassifying the comparative amounts and the nature of the adjustments that would have been made if the amounts were reclassified must be disclosed (AASB 101 paragraph 42). Comparative information must also be adjusted for changes in accounting policy or corrections of errors in accordance with AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors. AASB 108 is covered in chapter 14. According to AASB 101 paragraphs 40A and 40B, three statements of financial position (and two each of the other statements and related notes) must be presented when: • a company applies an accounting policy retrospectively, or • makes a retrospective restatement of items in its financial statements, or • reclassifies items in its financial statements. These three statements of financial position must be presented at: • the end of the current period • the end of the preceding period • the beginning of the preceding period. Thus, if the reporting period ends on 30 June 2018, the three statements of financial position must be presented at 30 June 2018, 30 June 2017 and 1 July 2016. However, related notes are not required for this third statement of financial position — that is, 1 July 2016 (AASB 101 paragraph 40C). As noted in section 15.1, the third statement of financial position (the beginning of the preceding period) forms part of a complete set of financial statements.

Is there a required or fixed format for the presentation of the statement of financial position?

No. AASB 101 does not prescribe a required order or format for the statement of financial position (paragraph 57). Paragraph 54 of AASB simply lists items that are sufficiently different in nature or function to warrant separate presentation in the statement of financial position. However, reference is made in AASB 101 to the Implementation Guidance on IAS 1 Presentation of Financial Statements which accompanies, but is not part of, IAS 1. The Implementation Guidance provides guidance as to how a company may present a statement of financial position distinguishing between current and non-current items.

All assets and liabilities are normally classified either as current or non-current in the statement of financial position. What other method of classification is permitted by AASB 101 and when should this other method be used?

AASB 101 paragraph 60 requires all assets and liabilities to be classified either as current or non-current, unless a liquidity presentation is appropriate to provide more relevant and reliable information. For some entities, such as financial institutions, assets and liabilities may be presented in increasing or decreasing order of liquidity if this provides information that is reliable and more relevant than a current/non-current presentation, because these entities do not supply goods and services within a clearly defined operating cycle (AASB 101 paragraph 63).

A current asset is an asset expected to be realised within an entity’s normal operating cycle. What is an operating cycle and can the cycle extend beyond 12 months?

Paragraph 68 of AASB 101 defines the operating cycle as the time between the acquisition of assets for processing and their realisation into cash or cash equivalents (i.e. short-term, highly liquid investments readily convertible to known amounts of cash and subject to an insignificant risk of changes in value). The operating cycle is usually 12 months but it may be longer than 12 months after the reporting period.

Is there a required or fixed format for the presentation of the statement of profit or loss and other comprehensive income?

No. AASB 101 does not prescribe a required order or format for the statement of profit or loss and other comprehensive income. However, a company must chose 1 of 2 presentations. According to paragraph 10A of AASB 101, a company may present either: 1. a single statement of profit or loss and other comprehensive income with profit or loss and other comprehensive income presented in two sections (the two sections are to be presented together with the profit or loss section presented first followed directly by the other comprehensive income section); or 2. a separate statement of profit or loss immediately followed by a statement of comprehensive income.

Entities are required by AASB 101 to present an analysis of expenses using a classification based on either their nature or their function. What is meant by this requirement and where is the classification disclosed?

Although details of expenses are not included as a line item on the statement of profit or loss and other comprehensive income (except finance costs) according to AASB 101 paragraph 82, entities are required by paragraph 99 to present an analysis of expenses recognised in profit or loss using a classification based on either: • the nature of expense method, e.g. depreciation, purchases of materials, transport costs, employee benefits and advertising costs (AASB 101 paragraph 102), or • the function of expense (or ‘cost of sales’) method, e.g. expenses classified according to their function as part of cost of sales or, for example, as distribution costs or administrative expenses (AASB 101 paragraph 103). Furthermore, entities are encouraged by paragraph 100 of AASB 101 to present the expense analysis required by AASB 101 paragraph 99 in the statement of profit or loss and other comprehensive income. The standard notes that the function of expenses or ‘cost of sales’ method can provide more relevant information to users than the nature of expense method, but may require the arbitrary allocation of costs to functions and involve considerable judgement (AASB 101 paragraph 103). Entities classifying expenses by function are also required to disclose additional information on the nature of expenses, including depreciation and amortisation expense and employee benefits expenses (AASB 101 paragraph 104). This additional disclosure of expenses by nature is usually provided in the notes that accompany the financial statements.

What items comprise other comprehensive income?

Other comprehensive income comprises items of income and expense (including reclassification adjustments) that are not recognised in profit or loss as required or permitted by other accounting standards (AASB 101 paragraph 7). According to AASB 101 paragraph 7, the items of other comprehensive income include: (a) changes in a revaluation surplus (see AASB 116 Property, Plant and Equipment and AASB 138 Intangible Assets ; (b) measurements of defined benefit plans (see AASB 119 Employee Benefits); (c) gains and losses arising from translating the financial statements of a foreign operation (see AASB 121 The Effects of Changes in Foreign Exchange Rates); (d) gains and losses from investments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph 5.7.5 of AASB 9 Financial Instruments; (e) the effective portion of gains and losses on hedging instruments in a cash flow hedge (see AASB 139 Financial Instruments: Recognition and Measurement); and (f) for particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liability’s credit risk (see paragraph 5.7.7 of AASB 9).

10. What are reclassification adjustments? Reclassification adjustments are amounts that were recognised in other comprehensive income in previous years (or the current year) but are reclassified (or ‘recycled’) to the current period’s profit or loss when the relevant item is derecognised (usually sold). Paragraph 93 of AASB 101 explains reclassification adjustments as follows: Other Australian Accounting Standards specify whether and when amounts previously recognised in other comprehensive income are reclassified to profit or loss. Such reclassifications are referred to in this Standard as reclassification adjustments. A reclassification adjustment is included with the related component of other comprehensive income in the period that the adjustment is reclassified to profit or loss. These amounts may have been recognised in other comprehensive income as unrealised gains in the current or previous periods. Those unrealised gains must be deducted from other comprehensive income in the period in which the realised gains are reclassified to profit or loss to avoid including them in total comprehensive income twice.

11. How is total comprehensive income determined? The aggregation of profit or loss and other comprehensive income is referred to as total comprehensive income and represents the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners or shareholders (AASB 101 paragraph 7). In summary this may be expressed as follows: Total comprehensive income (changes in equity other than transactions with shareholders) = profit or loss (income – expenses) + other comprehensive income (income and expense items not recognised in profit or loss). Components of other comprehensive income include: (a) changes in a revaluation surplus (see AASB 116 Property, Plant and Equipment and AASB 138 Intangible Assets ; (b) measurements of defined benefit plans (see AASB 119 Employee Benefits); (c) gains and losses arising from translating the financial statements of a foreign operation (see AASB 121 The Effects of Changes in Foreign Exchange Rates); (d) gains and losses from investments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph 5.7.5 of AASB 9 Financial Instruments; (e) the effective portion of gains and losses on hedging instruments in a cash flow hedge (see AASB 139 Financial Instruments: Recognition and Measurement); and (f) for particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liability’s credit risk (see paragraph 5.7.7 of AASB 9).

12. The statement of changes in equity is the link between the statement of profit or loss and other comprehensive income and the statement of financial position. Explain. The statement of changes in equity discloses total comprehensive income for the period (which is equal to the aggregation of profit or loss and other comprehensive income), the amounts of transactions with equity holders, and a reconciliation of movements during the period for each component of equity. This represents the changes in the entity’s net assets during the period. Transactions involving the entity and shareholders (e.g. dividends, share issues) must be disclosed in the statement of changes in equity, while other non-owner changes in equity (e.g. revaluations of property, plant and equipment) can only be disclosed in the statement of profit or loss and other comprehensive income. 13. What are ‘notes’ and what is the purpose of providing notes? Notes are provided to help users understand the information provided in financial statements, i.e. the statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows. The notes that accompany the financial statements must be presented in a systematic manner, with appropriate cross-referencing to each related item in the financial statements (AASB 101 paragraph 113). According to paragraph 112(a) and (b) of AASB 101, the notes must present information about the basis of preparation of the financial statements, the specific accounting policies used and disclose information required by Australian accounting standards that is not presented elsewhere in the financial statements. For example, disclosure of ‘non-adjusting’ events in accordance with AASB 110 Events after the Reporting Period relates to information not presented elsewhere in the financial statements. The notes must also disclose information not presented in the financial statements but which is relevant to an understanding of the financial statements (AASB 101 paragraph 112(c)).

14. According to AASB 101 in what order are notes normally presented? According to paragraph 114 of AASB 101, notes are normally presented in the following order: • a statement of compliance with Australian accounting standards (see also AASB 101 paragraph 16) • a summary of significant accounting policies applied • supporting information for items presented in the financial statements in the order in which each financial statement and each line item is presented • other disclosures (such as contingencies), commitments and non-financial disclosures. The summary of significant accounting policies applied in the preparation of the financial statements is usually presented as note 1 to the financial statements, including the statement of compliance with Australian accounting standards.

15. AASB 101 now requires forecast information to be disclosed. Discuss. AASB 101 does not require forecast financial information to be disclosed. Rather, paragraph 125 of AASB 101 requires a company to disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. The assumptions about the future and other sources of measurement uncertainty relate to estimates that require management’s most difficult, subjective or complex judgements, e.g. future interest rates, future changes in prices affecting costs and useful lives. These judgements become more subjective and complex as the number of variables and assumptions affecting the possible future resolution of the uncertainties increases (AASB 101 paragraph 127). It is suggested that disclosure of assumptions regarding the future should relate to the impact of those assumptions on the existing position of the company, rather than on forecast information.

16. AASB 101 requires certain information to be disclosed in financial statements. In respect of the following items, specify where the information would be included in the statement of profit or loss and other comprehensive income, the statement of financial position or the statement of changes in equity: (a) transfer from retained earnings to general reserve (b) profit for the period (c) income tax expense (d) interest revenue and interest expense (e) dividends (f) depreciation expense (g) auditor remuneration (h) share capital. Note: assets/liabilities may be disclosed under the sub-headings of current/non-current assets/liabilities or assets/liabilities in order of liquidity depending on which statement of financial position format is chosen – current/non-current or liquidity. (a)

Changes in retained earnings and each reserve during the period are disclosed in the statement of changes in equity.

(b)

Profit for the period is disclosed as a line item in the statement of profit or loss and other comprehensive income.

(c)

Income tax expense is disclosed as a line item in the statement of profit or loss and other comprehensive income.

(d)

Interest revenue would be disclosed as a part of the line item ‘revenue’ in the statement of profit or loss and other comprehensive income. If significant, interest

revenue would be disclosed as a separate category of revenue, usually in the notes. Interest expense is disclosed as a line item in the statement of profit or loss and other comprehensive income as ‘finance costs’. (e)

According to paragraph 107 of AASB 101, an entity must disclose both the amount of dividends recognised as distributions to owners (shareholders) during the period and the related amount per share either: • in the statement of changes in equity, or • in the notes.

(f)

Depreciation expense may be disclosed as a line item in the statement of profit or loss and other comprehensive income if expenses are classified by nature. Alternatively, depreciation may form part of various line items in the statement of profit or loss and other comprehensive income (e.g. distribution costs, administrative costs, etc.) if expenses are classified by function.

(g)

In accordance with AASB 1054 Australian Additional Disclosure paragraphs 10-11, an entity must disclose fees to each auditor or reviewer — that is, auditor remuneration being the amounts paid or payable to the auditor in relation to: • an audit or review of the financial statements of the entity • all other services performed during the reporting period, disclosing separately the nature of other services.

(h)

Share capital is disclosed as a line item in the statement of financial position as part of equity. In addition, various details relating to each class of share capital, such as number of shares authorised, number of shares issued and fully paid, etc. are disclosed in the notes in accordance with AASB 101 paragraph 79(a). Details of changes (if any) in share capital, e.g. share issues, will be disclosed in the statement of changes in equity.

17. AASB 101 requires certain line items to be disclosed in the statement of financial position and the statement of profit or loss and other comprehensive income. Can additional line items be disclosed? Explain. In the statement of financial position, AASB 101 paragraph 55 requires the presentation of additional items, headings and subtotals when it is considered relevant to an understanding of the company’s financial position. Furthermore, additional line items, headings and subtotals can be included in the statement of profit or loss and other comprehensive income when it is considered relevant to an understanding of the company’s financial performance (AASB 101 paragraph 85).

CASE STUDIES Case study 1

Analysis of expenses

Entities are required by AASB 101 to present an analysis of expenses using a classification based on either their nature or their function. Which classification should an entity use? Entities are required by AASB 101 paragraph 99 to present an analysis of expenses within profit or loss using a classification based on either: • the nature of expense method, e.g. depreciation, purchases of materials, transport costs, employee benefits and advertising costs or • the function of expense (or ‘cost of sales’) method, e.g. expenses classified according to their function as part of cost of sales, or, for example, as distribution costs or administrative expenses. According to AASB 101 paragraph 99, the classification should be based on “whichever provides information that is reliable and more relevant”. The classification method selected may depend on historical and industry factors, and the nature of the entity (AASB 101 paragraph 105). Also note that entities are encouraged to present the analysis of expenses in the statement of profit or loss and other comprehensive income (AASB 101 paragraph 100). Expenses classified according to their nature (e.g. depreciation, transport costs, etc.) are not reallocated among various functions within the entity. As no allocations of expenses to functional classifications, this method may be simple for entities to apply (AASB 101 paragraph 102). The function method can provide more relevant information to users, but may require the arbitrary allocation of costs to functions and involve considerable judgement (AASB 101 paragraph 103). Entities classifying expenses by function are also required to disclose additional information on the nature of expenses, including depreciation and amortisation expense and employee benefits expenses (AASB 101 paragraph 104). This additional disclosure of expenses by nature is usually provided in the notes that accompany the financial statements. Interestingly, in support of this additional disclosure when the function of classification is used, AASB 101 notes it is required “because information on the nature of expenses is useful in predicting future cash flows” (AASB 101 paragraph 105). As both expense classification methods have merit for different types of entities, AASB 101 does not prescribe a particular method. Rather, AASB 101 requires management to select the classification method that is reliable and more relevant (AASB 101 paragraph 105).

Case study 2

Classification of expenses

Examples provided in the chapter indicate that Tabcorp Holdings Ltd (figure 15.10, p. 000) classified expenses by nature, whereas Sigma Pharmaceuticals Ltd (figure 15.11, p. 000) classified expenses by function. Give some possible reasons for the different methods of classification of expenses used by these two companies. Tabcorp Ltd and Sigma Pharmaceuticals Ltd presumably selected their respective expense classification methods due to considerations of reliable and relevance for users of financial statements. Some companies may regard the disclosure of cost of sales (and gross margin) as providing important and sensitive information to competitors; hence these companies will be reluctant to use the function of expense method. The expense classification method selected for financial reporting may also be in accordance with how internal reports are prepared and presented to management within the company.

Case Study 3

Measurement basis used

A first-time shareholder has approached you requesting some advice. The shareholder has received the company’s annual report and noticed the following statement in the summary of significant accounting policies: The financial report has been prepared on the basis of historical cost, except for the revaluation of certain non-current assets which is explained in the notes. Explain to the shareholder why this statement is included in the accounting policy note.

It is important for companies to disclose the measurement basis (or bases) used in preparing the financial statements because AASB standards permit alternatives, e.g. cost or revaluation basis for property, plant and equipment under AASB 116 Property, Plant and Equipment. Therefore users of financial statements need to understand which basis (or bases) the company has chosen in order to facilitate comparisons with other companies as revaluations may have an impact on both financial performance (in the form of higher depreciation expense and thus lower profit) and financial position of the company (higher asset and equity values).

Case Study 4

Management judgements

Any judgements made by management when applying the entity’s accounting policies that have significant effect on amounts recognised in the financial statements must also be disclosed. What judgements do you think are made by management? According to paragraph 122 of AASB 101, an entity must disclose in the notes the judgements, apart from those involving estimates, made by management when applying the entity’s accounting policies that have the most significant effect on the amounts recognised in the financial statements. These judgements (as outlined in AASB 101 paragraph 123) may include: a) whether financial assets are held-to-maturity investments; b) whether substantially all the risks and rewards of ownership of an asset are transferred (a finance lease) or whether the lease is an operating lease; and c) whether, in substance, particular sales of goods are financing arrangements and therefore do not give rise to revenue.

Case Study 5

Formats for statement of profit or loss and other comprehensive income

The accountant for Moonshine Ltd has heard that following recent changes to accounting standards, the income statement now has a new title and companies now have a choice regarding the presentation of income and expense items recognised in a period. However, the accountant is unsure of the exact requirements following changes to accounting standards. As you are a recent university accounting graduate, the accountant seeks your assistance and requests that you provide information to Moonshine Ltd about this apparent presentation choice and whether the income statement now has a new title. The statement of profit or loss and other comprehensive income provides information regarding the financial performance of the entity for the reporting period. Income, expenses and other comprehensive income (e.g. movements in asset revaluation reserve) are summarised in the statement of profit or loss and other comprehensive income to determine an entity’s total comprehensive income, the usual measure of an entity’s financial performance. According to paragraph 10A of AASB 101, an entity may present: • a single statement of profit or loss and other comprehensive income with profit or loss and other comprehensive income presented in two sections (the two sections are to be presented together with the profit or loss section presented first followed directly by the other comprehensive income section), or • a separate statement of profit or loss immediately followed by a statement of comprehensive income, which shall begin with profit or loss. There appears to be no clear principles as to why income and expenses can be separated into two statements. While the income statement is now referred to as the statement of profit or loss and other comprehensive income by AASB 101, according to paragraph 10 an entity may use another title for the statement of profit or loss and other comprehensive income , e.g. statement of comprehensive income .

PRACTICE QUESTIONS Question 15.1

Statement of profit or loss and other comprehensive income (classify expenses by function)

The following information relates to Final Frontier Ltd. Profit before tax for the year ended 30 June 2017 was $388 000. The following items were used in determining that profit: Sales revenue $1 116 000 Cost of sales 468 000 Selling expenses 120 000 Administrative expenses 72 000 Other expenses 44 000 Interest expense 24 000 During the year, land was revalued and a gain of $20 000 was recorded. Assume the company’s taxation rate is 30c in the dollar. Required Prepare a statement of profit or loss and other comprehensive income for Final Frontier Ltd for the year ended 30 June 2017, in accordance with the requirements of AASB 101 (classify expenses by function). [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question].

FINAL FRONTIER LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Revenue Cost of sales Gross profit Selling expenses Administrative expenses Other expenses Finance costs Profit before income tax Income tax expense Profit for the year Other comprehensive income Items that will not be reclassified to profit or loss Gain on revaluation of land Income tax relating to items not reclassified Other comprehensive income for the year, net of tax Total comprehensive income for the year

$ 1 116 000 (468 000) 648 000 (120 000) (72 000) (44 000) (24 000) 388 000 (116 400) 271 600

20 000 (6 000) 14 000 $ 285 600

Question 15.2

Disclosure of items in the financial statements

AASB 101 requires certain information to be disclosed in statement of financial position. In respect of each of the following items, specify (i) the name of the line where the item would appear on the statement of financial position, and (ii) classification (current/non-current) on the statement of financial position: (a) goodwill (b) share capital (c) cash at bank (d) dividend payable (e) accounts receivable (f) machinery (g) debentures payable (due in 10 years) (h) provision for long service leave (due in 8 years) (i) accounts payable (j) asset revaluation surplus.

Item (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Name of line item in the statement of financial position Intangible assets Share capital Cash and cash equivalents Trade and other payables Trade and other receivables Property, plant and equipment Long-term borrowings Employee benefits Trade and other payables Reserves

Classification Non-current assets Equity Current assets Current liabilities Current assets Non-current assets Non-current liabilities Non-current liabilities Current liabilities Equity

Question 15.3

Disclosure of items in the financial statements

AASB 101 requires certain information to be disclosed in financial statements. In respect of each of the following items, specify (i) whether the item would be disclosed in the statement of profit or loss and other comprehensive income, the statement of financial position or the statement of changes in equity, and (ii) the name of the line where the item would appear on that particular financial statement: (a) transfer to retained earnings from general reserve (b) prepaid insurance expense (c) short-term, highly liquid investments (d) borrowing costs (e) change in equity due to recorded increase in value of property (f) brand names (g) issue of redeemable preference shares (classified as equity) during the year (h) estimated future obligations to repair or replace faulty goods previously sold by the company (i) proceeds from sale of finished goods (j) distribution of profits to shareholders during the year.

Item (a)

Title of financial statement on which item disclosed Statement of changes in equity

(b) (c)

Statement of financial position Statement of financial position

(d)

Statement of profit or loss and other comprehensive income Statement of profit or loss and other comprehensive income; and statement of changes in equity

(e)

(f) (g)

(h) (i) (j)

Statement of financial position Statement of financial position; and statement of changes in equity Statement of financial position Statement of profit or loss and other comprehensive income Statement of changes in equity

Name of line item in the financial statement ‘Transfer to retained earnings’, part of the reconciliation for changes in retained earnings and general reserve during the year ‘Trade and other receivables’ ‘Cash and cash equivalents’. This particular asset because of its apparent high liquidity status would be regarded as a ‘cash equivalents’ asset. If it does not fit the definition of ‘cash equivalents’ (see AASB 107 paragraph 6), then it would be disclosed as a ‘trade and other receivables’ ‘Finance costs’ ‘Gain on revaluation’, part of other comprehensive income for the year; and ‘total comprehensive income for the year’, part of the reconciliation for changes in the revaluation surplus during the year ‘Other intangible assets’ ‘Share capital’; and ‘issue of share capital’, part of the reconciliation for changes in share capital during the year ‘Provisions’ ‘Revenue’ ‘Dividends’, part of the reconciliation for changes in retained earnings during the year and disclosure of the related amount per share

Question 15.4

Disclosure of items in the financial statements

AASB 101 requires certain information to be disclosed in financial statements and in the notes. In respect of each of the following items, specify the name of the financial statements where the item would appear, or whether disclosure would be found in the notes to the financial statements: (a) provision for warranty repairs (b) allowance for depreciation (c) issue of ordinary shares (d) finance expenses (e) contingent liabilities (f) deferred tax asset (g) gain on revaluation of land (not reversing any previous devaluation) (h) audit fees (i) change to the opening balance of retained earnings due to a correction of a prior period error (j) dividends paid and declared.

Item (a) (b) (c) (d)

provision for warranty repairs allowance for depreciation issue of ordinary shares finance expenses

(e) (f) (g)

contingent liabilities deferred tax asset gain on revaluation of land (not reversing any previous devaluation)

(h)

audit fees

(i)

change to the opening balance of retained earnings due to a correction of a prior period error dividends paid and declared

(j)

Name of financial statement or notes Statement of financial position Notes Statement of changes in equity Statement of profit or loss and other comprehensive income (profit or loss section) Notes Statement of financial position Statement of profit or loss and other comprehensive income (other comprehensive income section) Notes (showing split between audit fees and other fees including the nature of other fees) Statement of changes in equity

Statement of changes in equity

Question 15.5

Statement of profit or loss and other comprehensive income (classify expenses by nature)

The following information was obtained for Neptune Ltd for the year ended 30 June 2017: Net sales revenue $1 800 000 Gain on sale of equipment 60 000 Increase in inventories of finished goods and work in progress 50 000 Depreciation and amortisation expense 280 000 Employee benefits expense 400 000 Interest expense 8 000 Retained earnings (1/7/16) 120 000 Dividends paid 100 000 Transfer from general reserve 40 000 Raw materials used 600 000 Land 200 000 During the year land was revalued from $180 000 to $200 000. Income tax rate is 30%. Required Prepare a statement of profit or loss and other comprehensive income for Neptune Ltd for the year ended 30 June 2017 so as to comply with the requirements of AASB 101 (classify expenses by nature). [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question].

NEPTUNE LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Revenue Other income Changes in inventories of finished goods and work in progress Raw material used Depreciation and amortisation expense Employee benefits expense Finance costs Profit before income tax Income tax expense Profit for the year Other comprehensive income Items that will not be reclassified to profit or loss Gain on revaluation of land Income tax relating to items not reclassified Other comprehensive income for the year, net of tax Total comprehensive income for the year

$1800 000 60 000 50 000 (600 000) (280 000) (400 000) (8 000) 622 000 (186 600) 435 400

20 000 (6 000) 14 000 $ 449 400

Note: The amount of dividends paid ($100 000) and the related amount per share must also be disclosed either in the statement of changes in equity or in the notes (AASB 101, paragraph 107).

Question 15.6

Statement of profit or loss and other comprehensive income (classify expenses by nature)

The accountant at Venus Ltd has asked you to prepare the statement of profit or loss and other comprehensive income for the year ended 30 June 2017 in accordance with AASB 101 (classify expenses by nature). To assist, the following trial balance extract has been provided: Debit Credit Sales revenue $5 725 000 Sales returns and allowances $ 56 100 72 500 Changes in inventories of finished goods and work in 390 500 23 000 progress 4 000 000 300 000 Raw materials used 675 000 1 500 Salaries and wages expense 125 000 Other employee benefits expenses 228 700 Other expenses 82 400 Interest paid 185 000 Interest received 343 500 Dividends received Proceeds from sale of land Cost of land sold Sundry revenue Depreciation and amortisation expense The company tax rate is 30%. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. VENUS LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Revenue* $ 5 765 900 Other income** 115 000 Changes in inventories of finished goods and work in progress (390 500) Raw materials used (4 000 000) Employee benefits expense*** (800 000) Depreciation and amortisation expense (343 500) Other expenses (228 700) Finance costs (82 400) Profit before income tax 35 800 Income tax expense (10 740) Profit for the year 25 060 Other comprehensive income nil Total comprehensive income for the year $ 25 060

Workings: *Revenue: Sales Sales returns and allowances Interest Dividends Sundry **Other income Proceeds on sale of land Cost of land sold

***Employee benefits expense Salaries and wages Other employee benefits

$ 5 725 000 (56 100) 72 500 23 000 1 500 5 765 900 $ 300 000 (185 000) 115 000

$ (675 000) (125 000) (800 000)

Question 15.7

Statement of profit or loss and other comprehensive income (classify expenses by function)

The following information has been extracted from the accounting records of Pluto Ltd for the year ended 30 June 2017: Debit Credit Sales Dividends paid Cost of sales Finance costs Distribution costs Transfer from general reserve Marketing costs Administrative costs Proceeds from sale of plant and machinery Carrying amount of plant and machinery

$1 800 000 $ 10 000 1 072 000 40 000 116 000 16 000 54 000 104 000 60 000 40 000

Tax rate is 30%. Required Prepare a statement of profit or loss and other comprehensive income for Pluto Ltd, for the year ended 30 June 2017, to comply with AASB 101 (classify expenses by function). [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. PLUTO LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Revenue Other income* Cost of sales Distribution costs Marketing costs Administrative costs Finance costs Profit before income tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

$ 1800 000 20 000 (1072 000) (116 000) (54 000) (104 000) (40 000) 434 000 (130 200) 303 800 nil $ 303 800

Note: The amount of dividends paid ($10 000) and the related amount per share must also be disclosed either in the statement of changes in equity or in the notes (AASB 101, paragraph 107).

Workings: *Other income: Proceeds from sale of plant and machinery Carrying amount of plant and machinery

$ 60 000 (40 000) 20 000

Question 15.8

Statement of financial position

The trial balance of Asteroid Ltd as at 30 June 2018 is as follows: Debit ($000) Share capital Calls in arrears 250 Calls in advance Retained earnings Mortgage payable on land and buildings Accrued expenses Land 5 100 Buildings 20 000 Fixtures and fittings 1 250 Accumulated depreciation: Buildings Fixtures and fittings Goodwill 20 000 Current tax payable Accounts receivable 3 185 Inventory 8 000 Bank overdraft Accounts payable Allowance for doubtful debts Dividend payable General reserve Prepayments 215 $ 58 000

Credit ($000) 33 750 1 000 1 600 10 000 50

3 000 375 395

5 500 1 000 80 750 500 $ 58 000

Required Prepare the statement of financial position for Asteroid Ltd in accordance with AASB 101 as at 30 June 2018. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. ASTEROID LTD Statement of Financial Position as at 30 June 2018 $'000 ASSETS Current assets Trade and other receivables* Inventories Total current assets

3 320 8 000 11 320

Non-current assets Property, plant and equipment**

22 975

Goodwill Total non-current assets Total assets

20 000 42 975 54 295

LIABILITIES Current liabilities Trade and other payables*** Short-term borrowings Current tax payable Total current liabilities

1 800 5 500 395 7 695

Non-current liabilities Long-term borrowings Total non-current liabilities Total liabilities

10 000 10 000 17 695

Net assets

36 600

EQUITY Share capital**** Reserves Retained earnings Total equity

34 500 500 1 600 36 600

Workings: $'000 *Trade and other receivables Accounts receivable Allowance for doubtful debts

3 185 (80) 3 105 215 3 320

Prepayments

**Property, plant and equipment: Land Buildings Accumulated depreciation Fixtures and fittings Accumulated depreciation *** Trade and other payables Accrued expenses Accounts payable Dividend payable

****Share capital Share capital Calls in advance Calls in arrears

5 100 20 000 (3 000) 1 250 (375)

17 000 875 22 975 50 1 000 750 1 800

33 750 1 000 (250)

34 500

Question 15.9

Statement of changes in equity

The equity section of the statement of financial position of Comet Ltd at 30 June 2016 discloses: 2016 2015 Share capital

$3 700 000

$3 600 000

General reserve

500 000

100 000

Revaluation surplus

800 000

240 000

Retained earnings

500 000

680 000

$5 500 000

$4 620 000

Additional information (a) Comet Ltd issued 100 000 shares at $1 each during the year. (b) Profit for the year was $300 000. (c) Dividends paid during the year were $80 000. (d) A transfer of $400 000 was made from retained earnings to general reserve during the year. (e) Land was revalued by $800 000 during the year. (f) Tax rate is 30%. Required Prepare the statement of changes in equity for Comet Ltd for the year ended 30 June 2016. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question].

COMET LTD Statement of Changes in Equity for the year ended 30 June 2016 Share General Reval. Retained Total capital reserve surplus earnings Balance at 1 July 2015 $3 600 000 $ 100 000 $ 240 000 $ 680 000 $ 4 620 000 Total comprehensive income for the year - 560 000 300 000 860 000 Dividend paid - (80 000) (80 000) Issue of share capital 100 000 100 000 Transfer to general reserve - 400 000 - (400 000) Balance at 30 June 2016 $3 700 000 $ 500 000 $ 800 000 $ 500 000 $ 5 500 000 Note: Insufficient information was provided in the question to determine dividend per share.

Question 15.10

Non-compliance with AASB 101

Moon Ltd is the parent company of two subsidiaries, Luna Ltd and Apollo Ltd, in Australia. The financial statements of Moon Ltd have been prepared by a trainee accountant and are shown below. Profit or Loss Statement for the year ended 30 June 2018 Profit from operations $ 500 000 Income from government bonds 12 500 Dividends from subsidiaries 7 500 520 000 Income tax expense (250 000) Profit for year 270 000 Retained profits at 1 July 2017 67 000 337 000 Interim dividends paid — preference $ (6 000) shares (100 000) — ordinary (6 000) shares (125 000) $(237 000) Final dividends declared — preference shares — ordinary shares Transfer to general reserve (50 000) (287 000) Retained profits at 30 June 2018 $ 50 000

Shareholders’ equity 100 000 redeemable preference shares, fully paid 2 000 000 ordinary shares, fully paid Share capital Revaluation surplus

Statement of Assets, Liabilities and Equity as at 30 June 2018 Long-term assets

General reserve Retained profits Total equity Non-current liabilities 12% debentures Deferred tax liability Current liabilities Trade creditors Dividends payable Current tax liability Provision for employee benefits

$ 470 000 30 000 119 000 131 000 250 000 300 000

$ 200 000 Plant

$2 300 000

200 000 Accumulated depreciation 2 200 000 Freehold land and buildings 100 000 Accumulated depreciation Investment property and 150 000 intangible assets 50 000 Short-term assets 2 500 000 Inventory

(530 000) $ 1 770 000 1 000 000 (180 000) 820 000

Debtors (less allowance for impairment $20 000) Cash at bank

770 000 2 000 000

3 360 000

140 000 100 000

440 000

500 000

800 000 $3 800 000

$3 800 000

Additional information relevant to the presentation of these financial statements, but not included as part of them, is as follows: (a) Profit from operations is after charging: Depreciation $ 300 000 Debenture interest 40 000 Employee benefits 50 000 Impairment of receivables 10 000 Audit and tax 20 000 (b) Freehold land was revalued by directors at the end of the current year at $600 000, an increase of $100 000. Buildings on the land were valued at cost $400 000 less accumulated depreciation $180 000. Required Indicate items in the financial statements of Moon Ltd that do not comply with the disclosure requirements of AASB 101. For each item, state your reason(s) for identifying it as not complying with AASB 101.

In order to comply with the disclosure requirements of AASB 101, many amendments are necessary including: 1. Profit and loss statement is to be referred to as statement of profit or loss and other comprehensive income, as per AASB 101. 2. Format and headings for the statement of profit or loss and other comprehensive income should be as per the Implementation Guidance that accompanies IAS 1, to disclose information contained in AASB 101 paragraphs 82, 82A and 85 as necessary. Also see figure 15.9 of the text. 3. Separate headings for revenue, other income and expenses must be shown in the statement of profit or loss and other comprehensive income, and the term “profit from operations” is no longer suitable. 4. Expenses, classified according to nature or function should be disclosed in the statement of profit or loss and other comprehensive income (AASB 101 paragraphs 99 – 105). 5. ‘Debenture interest’ expense ($40 000) must be included in the statement of profit or loss and other comprehensive income under ‘finance costs’, and any interest payable included under ‘trade and other payables’ in the statement of financial position. 6. ‘Retained profits’ is now referred to as ‘retained earnings’ in AASB 101 (paragraphs 96, 108 and 110). 7. Statement of assets, liabilities and equity should be referred to as the statement of financial position, as per AASB 101. 8. Format and headings of the statement of financial position to be as per the Implementation Guidance that accompanies IAS 1, to disclose items required by AASB 101 paragraphs 54 and 55 as appropriate (see figure 15.2 of the text). Details of information included under these headings are then to be provided in notes to the financial statements. 9. AASB 101 paragraph 60, requires all assets and liabilities to be classified either as current or non-current, unless a liquidity presentation is more appropriate to provide relevant and reliable information. 10. ‘Investment property’ and ‘intangible assets’ must be disclosed as separate items in the statement of financial position (AASB 101 paragraph 54).

Chapter 15: Disclosure: presentation of financial statements

11. A statement of changes in equity must be presented in accordance with AASB 101 paragraphs 106 and 107. 12. Various details of shares on issue at beginning and end of year, shares issued and redeemed during year as per AASB 101 paragraph 79(a). 13. Disclose details of nature and purpose of each reserve (AASB 101 paragraph 79(b)). 14. Corresponding figures (including narrative and descriptive information) for the preceding period (AASB 101 paragraph 38). 15. In the summary of significant accounting polices note, the measurement basis (bases) used in the preparation of the financial statements and other accounting policies used that are relevant to an understanding of the financial statements (AASB 101 paragraph 117). 16. Sources of estimation uncertainty should be disclosed in accordance with AASB 101 paragraph 125. 17. Audit fees paid or payable to the auditor for an audit or review of the financial statements must be disclosed. Amounts for all other services must be disclosed separately (including the nature and amount of the other services) as required by AASB 1054 paragraph 10 and 11. 18. Company details (county of incorporation, description of the nature of the company’s operations and its principal activities, etc.), if not provided elsewhere in the financial report, must be disclosed (AASB 101 paragraph 138). 19. Details regarding the amount of dividends distributed to shareholders and the related amount per share must be disclosed in the statement of changes in equity or in the notes (AASB 101 paragraph 107). 20. A note disclosing those judgements, apart from those involving estimations, that management has made in the process of applying the entity’s accounting policies that have the most significant effect on the amounts recognised in the financial statements (AASB 101 paragraph 122). 21. A company whose financial statements comply with International Financial Reporting Standards shall make an explicit and unreserved statement of such compliance in the notes (AASB 101 paragraph 16).

15.1

Solutions manual to accompany Company Accounting 10e

Question 15.11

Non-compliance with AASB 101

Saturn Ltd’s financial statements for the year ended 30 June 2017 have been drafted by the assistant accountant, who is not fully aware of the current disclosure requirements of AASB 101. As a result, there are errors in the drafting. Saturn Ltd is a listed public company. Income tax payable by the company is at the rate of 30c in the dollar. The company’s draft financial statements appear below. Required From the draft financial statements of Saturn Ltd, identify ten items which have not been disclosed or accounted for in accordance with AASB 101. The financial statements are required to meet only the minimum disclosure requirements. For each item, state your reason(s) for identifying it as being incorrectly disclosed in accordance with AASB 101. SATURN LTD Profit or Loss Statement for the year ended 30 June 2017 Note 2017 2016 Operating profit before income tax 1 $ 95 000 $ 81 000 Income tax attributable to operating profit (44 000) (34 300) Operating profit after income tax 51 000 46 700 Profit on extraordinary items 2 16 000 4 400 Income tax attributable to profit on (7 000) (2 200) extraordinary items Profit on extraordinary items after income 9 000 2 200 tax Operating profit and extraordinary items 60 000 48 900 after income tax 52 900 28 000 Retained earnings at the beginning of the 8 500 1 000 financial year Aggregate of amounts transferred from reserves Total available for appropriation 121 400 77 900 Dividends provided for or paid (30 000) (20 000) Aggregate of amounts transferred to reserves (12 000) (5 000) Retained profits at the end of the financial $ 79 400 $ 52 900 year The attached notes elaborate on these financial statements. SATURN LTD Statement of Net Equity as at 30 June 2017 Note Current assets Cash Inventories Receivables Total current assets Non-current assets

2017

2016

$ 55 000 175 000 185 000 415 000

$ 50 000 160 000 170 000 380 000

15.2

Chapter 15: Disclosure: presentation of financial statements

Investments Property, plant and equipment Intangibles Other Total non-current assets Liabilities Creditors and borrowings Provisions Total liabilities Net assets Shareholders’ equity Paid-up capital Reserves Total equity The attached notes elaborate on these financial statements.

80 000 365 000 90 000 40 000 575 000

75 000 245 000 90 000 35 000 445 000

5 6

510 100 85 000 595 100 $394 900

480 100 80 000 560 100 $264 900

7 8

$300 000 94 900 $394 900

$200 000 64 900 $264 900

Notes to the financial statements (for the year ended 30 June) 2017 1. Operating profit before income tax Operating profit before income tax has been determined after: Crediting as revenue: $ 13 000 interest (received or receivable from other persons) 18 000 dividends (received or receivable from other persons) 7 000 Debiting as expense: 3 500 annual leave (transfer to provision) 5 000 impairment of receivables 11 500 long-service leave (transfer to provision) 7 000 depreciation – property, plant and equipment 15 000 interest (paid or payable to other persons) audit and tax 2. Profit on extraordinary items The total shown comprises: 16 000 Profit on sale of segment of the business (7 000) Income tax applicable thereto 9 000 3. Investments Shares and investment properties 80 000 4. Other non-current assets Deferred tax asset 40 000 5. Creditors and borrowings Bank overdraft – secured 120 600 Trade creditors 389 500 510 100 6. Provisions Income tax 32 000 Dividends 20 000 Employee benefits 15 000

2016

$ 12 000 15 000 5 000 3 000 4 000 12 000 7 000 10 000

4 400 (2 200) 2 200 75 000 35 000 125 100 355 000 480 100 31 000 20 000 13 000

15.3

Solutions manual to accompany Company Accounting 10e

Deferred tax 7. Paid-up capital 300 000 ordinary shares, fully paid 8. Reserves General reserve Retained profits

18 000 85 000

16 000 80 000

300 000

200 000

15 500 79 400 94 900

12 000 52 900 64 900

Answer for each item should identify the error and state the reason for it being incorrectly disclosed in accordance with AASB 101. Incorrect items in terms of minimum disclosure include: 1. Profit and loss statement should be referred to as the statement of profit or loss and other comprehensive income, as per AASB 101. 2. Format and headings for the statement of profit or loss and other comprehensive income should be as per the Implementation Guidance that accompanies IAS 1, to disclose information contained in AASB 101 paragraphs 82, 82A and 85 as necessary. Also see figure 15.9 of the text. 3. Expenses can be disclosed in the statement of profit or loss and other comprehensive income. Interest expense to be shown in the statement of profit or loss and other comprehensive income under the heading ‘finance costs’ (AASB 101 paragraph 82(b)). 4. ‘Extraordinary items’ (income or expense) are not to be presented either in the statement of profit or loss and other comprehensive income or in the notes (AASB 101 paragraph 87). 5. Statement of net equity should be referred to statement of financial position, as per AASB 101. 6. ‘Retained profits’ is now referred to as ‘retained earnings’ in AASB 101 (paragraphs 96, 108 and 110). 7. Format and headings of the statement of financial position to be as per the Implementation Guidance that accompanies IAS 1, to disclose items required by AASB 101 paragraphs 54 and 55 as appropriate (see figure 15.2 of the text). Details of information included under these headings are then to be provided in notes to the financial statements. 8. A statement of changes in equity must be presented in accordance with AASB 101 paragraphs 106 and 107. 9. There is no disclosure in relation to the shares issued during the period as required by AASB 101 paragraph 79(a). 10. Disclose details of nature and purpose of each reserve (AASB 101 paragraph 79(b)). 11. ‘Creditors and borrowings’ should be separately disclosed in the statement of financial position under the headings ‘trade and other payables’ and ‘borrowings’ or financial liabilities as required by AASB 101 paragraph 54 and the Implementation Guidance. 12. The reserves note is incorrect, as retained earnings (profits) are included in the reserves figure. AASB 101 (paragraphs 106(d) and 108) and the Implementation Guidance require retained earnings to be shown separately from other components of equity in the statement of financial position.

15.4

Chapter 15: Disclosure: presentation of financial statements

13. ‘Deferred tax asset’ to be disclosed as a separate heading in the statement of financial position according to AASB 101 paragraph 54(o) and the Implementation Guidance, not under ‘other non-current assets’. 14. ‘Deferred tax liability’ to be disclosed as a separate heading in the statement of financial position according to AASB 101 paragraph 54(o) and the Implementation Guidance, not under ‘Provisions’. 15. ‘Provision for dividend’ is not a provision as there is no uncertainty as to timing or amount. Dividends should be treated as part of ‘trade and other payables’ (see chapter 3). 16. In the summary of significant accounting polices note, the measurement basis (bases) used in the preparation of the financial statements and other accounting policies used that are relevant to an understanding of the financial statements (AASB 101 paragraph 117). 17. Sources of estimation uncertainty should be disclosed in accordance with AASB 101 paragraph 125. 18. Audit fees paid or payable to the auditor for an audit or review of the financial statements must be disclosed. Amounts for all other services must be disclosed separately (including the nature and amount of the other services) as required by AASB 1054 paragraphs 10 and 11. 19. Company details (county of incorporation, description of the nature of the company’s operations and its principal activities, etc.), if not provided elsewhere in the financial report, must be disclosed (AASB 101 paragraph 138). 20. Details regarding the amount of dividends distributed to shareholders and the related amount per share must be disclosed in the statement of changes in equity or in the notes (AASB 101 paragraph 107). 21. A note disclosing those judgements, apart from those involving estimations, that management has made in the process of applying the entity’s accounting policies that have the most significant effect on the amounts recognised in the financial statements (AASB 101 paragraph 122). 22. A company whose financial statements comply with International Financial Reporting Standards shall make an explicit and unreserved statement of such compliance in the notes (AASB 101 paragraph 16).

15.5

Solutions manual to accompany Company Accounting 10e

Question 15.12

Statement of financial position, statement of changes in equity and notes

A junior accounts clerk has prepared the following summarised information as at 30 June 2016 for Earth Ltd: Assets Inventories (at lower of cost and net realisable value) $ 970 000 Accounts receivable 651 020 Cash 1 598 080 Land and buildings 1 750 000 Plant and equipment 1 716 000 Prepayments 3 400 Calls in arrears (2500 shares at 20c) 500 Patents — cost 100 000 $6 789 000 Liabilities and equity Retained earnings (30/6/16) 575 480 Liabilities 1 038 520 Share capital (5 000 000 shares) 4 086 000 Reserves and provisions 1 089 000 $6 789 000 Upon further investigation, you have discovered the following additional information: (a) Liabilities of $1 038 520 comprise: Accounts payable $790 000 Accrued expenses 8 520 Mortgage loans 240 000 (b) Reserves and provisions of $1 089 000 include: Employee benefits (payable after 1 July 2023) Current tax liability Dividends Allowance for impairment of receivables Accumulated depreciation – plant and equipment Accumulated depreciation – buildings Accumulated amortisation – patents (c) Cash of $1 598 080 consists of: Cash at bank 10% Telstra bonds (regarded as long-term investments)

$400 000 160 000 200 000 10 000 72 000 207 000 40 000

$ 298 080 1 300 000

(d) Retained earnings balance as at 1 July 2015 was $275 000. (e) Profit for the period was $500 480. (f) Shareholder approval is not required for final dividends declared by directors. (g) During the year, Earth Ltd paid $75 000 to its auditor, of which $19 000 related to services other than the annual audit and half-yearly review.

15.6

Chapter 15: Disclosure: presentation of financial statements

Required Prepare, for Earth Ltd, the statement of financial position, statement of changes in equity and notes thereto at 30 June 2016 in accordance with the requirements of AASB 101. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. EARTH LTD Statement of Financial Position as at 30 June 2016 Note ASSETS Current assets Cash and cash equivalents Trade and other receivables Inventories Total current assets Non-current assets Property, plant and equipment Intangible assets Investments Total non-current assets Total assets LIABILITIES Current liabilities Trade and other payables Current tax payable Total current liabilities Non-current liabilities Long-term borrowings Long-term provisions Total non-current liabilities Total liabilities

2 3

4 5 6

3 187 000 60 000 1 300 000 4 547 000 $ 6 459 500

998 520 160 000 1 158 520

8 9

240 000 400 000 640 000 $1 798 520

Net assets EQUITY Share capital Retained earnings Total equity

$ 298 080 644 420 970 000 1 912 500

$ 4 660 980

4 085 500 575 480 $ 4 660 980

15.7

Solutions manual to accompany Company Accounting 10e

EARTH LTD Statement of Changes in Equity for the year ended 30 June 2016

Balance at 1 July 2015 Total comprehensive income for the year Dividend payable – ordinary Balance at 30 June 2016

Share capital $ 4 085 500

Retained earnings $ 275 000

Total $ 4 360 500

$ 4 085 500

500 480 (200 000) $ 575 480

500 480 (200 000) $ 4 660 980

Dividends: 4 cents per share

EARTH LTD Notes to and forming part of the financial statements for the year ending 30 June 2016 Note 1. Summary of significant accounting policies Statement of compliance The financial statements are general purpose financial statements which have been prepared in accordance with the requirements of the Corporations Act 2001, Australian Accounting Standards which include Australian equivalents to International Financial Reporting Standards (AIFRSs) and AASB Interpretations. Compliance with AIFRSs ensures the financial statements and notes comply with International Financial Reporting Standards. Basis of preparation The financial statements have been prepared on the historical cost basis, except where stated otherwise. Various accounting policies details need to be provided, including details required by AASB 101 paragraph 122 (management judgements made in applying accounting polices) and paragraph 125 (sources of estimation uncertainty). Note 2. Trade and other receivables Accounts receivable Allowance for impairment of receivables Prepaid expenses

Note 3. Inventories Raw materials Work in progress Finished goods

$ 651 020 (10 000) 641 020 3 400 644 420

$x x x 970 000

15.8

Chapter 15: Disclosure: presentation of financial statements

Note 4. Property, plant and equipment

Balance Accumulated depreciation

Land & buildings

Plant & equipment

Total

$ 1 750 000 (207 000) 1 543 000

$ 1 716 000 (72 000) 1 644 000

$ 3 466 000 (279 000) 3 187 000

Note 5. Intangible assets Patents Balance Accumulated amortisation

Note 6. Investments 10% Telstra bonds - at cost Note 7. Trade and other payables Accounts payable Accrued expenses Dividends

$ 100 000 (40 000) 60 000

$1 300 000

$ 790 000 8 520 200 000 998 520

Note 8. Long-term borrowings Mortgage loans

$ 240 000

Note 9. Long-term provisions Employee benefits

$ 400 000

Note 10. Share capital Share capital Calls in arrears (2 500 shares at 20 cents per share) Note 11. Audit fees Amounts paid or payable to the auditor for: - audit or review of the financial reports of the entity - other services: • (details not provided in question)

$ 4 086 000 (500) 4 085 500

$ 56 000 19 000 75 000

15.9

Solutions manual to accompany Company Accounting 10e

Question 15.13

Statement of financial position, statement of changes in equity and notes

Mercury Ltd has suffered losses consistently during recent years, and after preparation of the statement of profit or loss and other comprehensive income for the year ended 30 June 2018 the ledger balances were: Share capital (1 250 000 shares at $1) Accounts payable Easy Finance Company — loan Accounts receivable Allowance for impairment of receivables Inventories (work in progress and finished goods) Plant and equipment Accumulated depreciation – plant Accumulated losses Current tax liability ABC Bank Limited — overdraft (short-term) — long-term loan Goodwill

$ 625 000 245 000 125 000 $ 340 000 100 000 347 500 240 000 112 500 186 000 6 000 50 000 100 000 250 000 $1 363 500

$1 363 500

Additional information (a) The loan from Easy Finance matures on 31 December 2018. (b) The auditing firm was paid a total of $30 000, comprising $22 500 for the annual audit, $2500 for taxation advice, and $5000 for consulting advice paid to a related practice of the auditor. (c) On 1 March 2018, 125 000 ordinary shares were issued at a price of $1 payable in full. (d) Balance of retained earnings at 1 July 2017 was $139 370 Dr and loss for the current year was $46 630. Required Prepare the statement of financial position and statement of changes in equity as at 30 June 2018, and notes to comply with AASB 101. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. MERCURY LTD Statement of Financial Position as at 30 June 2018 Note ASSETS Current assets Trade and other receivables Inventories Total current assets

2 3

$ 240 000 347 500 587 500

15.10

Chapter 15: Disclosure: presentation of financial statements

Non-current assets Property, plant and equipment Goodwill Total non-current assets Total assets LIABILITIES Current liabilities Trade and other payables Short-term borrowings Current tax payable Total current liabilities Non-current liabilities Long-term borrowings Total non-current liabilities Total liabilities

127 500 250 000 377 500 $ 965 000

5 6

$ 245 000 175 000 6 000 426 000

100 000 100 000 $ 526 000

Net assets

$ 439 000

EQUITY Share capital Retained earnings Total equity

$ 625 000 (186 000) $ 439 000

MERCURY LTD Statement of Changes in Equity for the year ended 30 June 2018

Balance at 1 July 2017 Total comprehensive income for the year Issue of ordinary shares Balance at 30 June 2018

Share capital $ 500 000

Retained earnings $ (139 370)

Total $ 360 630

125 000 $ 625 000

(46 630) $ (186 000)

(46 630) 125 000 $ 439 000

MERCURY LTD Notes to and forming part of the financial statements for the year ending 30 June 2018 Note 1. Summary of significant accounting policies Statement of compliance The financial statements are general purpose financial statements which have been prepared in accordance with the requirements of the Corporations Act 2001, Australian Accounting Standards which include Australian equivalents to International Financial Reporting Standards (AIFRSs) and AASB Interpretations. Compliance with AIFRSs ensures the financial statements and notes comply with International Financial Reporting Standards.

15.11

Solutions manual to accompany Company Accounting 10e

Basis of preparation The financial statements have been prepared on the historical cost basis, except where stated otherwise. Various accounting policies details need to be provided, including details required by AASB 101 paragraph 122 (management judgements made in applying accounting polices) and paragraph 125 (sources of estimation uncertainty). Note 2. Trade and other receivables Accounts receivable Allowance for impairment of receivables

$ 340 000 (100 000) 240 000

Note 3. Inventories Work in progress Finished goods

$x x 347 500

Note 4. Property, plant and equipment

Balance Accumulated depreciation

Plant & equipment $ 240 000 (112 500) 127 500

Note 5. Trade and other payables Accounts payable Note 6. Short-term borrowings Bank overdraft Loan Note 7. Long-term borrowings Bank term loan Note 8. Audit fees Amounts paid or payable to the auditor for: - audit or review of the financial reports of the entity - other services: • taxation advice consulting advice

Total $ 240 000 (112 500) 127 500 $ 245 000

$ 50 000 125 000 175 000 $ 100 000

$ 22 500 2 500 5 000 30 000

15.12

Chapter 15: Disclosure: presentation of financial statements

Question 15.14 The following details are taken from the accounting records of Mars Ltd as at 30 June 2016: Debit Credit Plant and equipment (net of depreciation) $ 800 000 Land 600 000 Buildings (net of depreciation) 900 000 Investments (long-term) 460 000 Accounts receivable 600 000 Allowance for impairment of receivables $ 60 000 Inventory 520 000 Bank overdraft 200 000 Accounts payable 400 000 Dividend payable 256 000 Goodwill (net of impairment) Share capital (3 200 000 shares) 300 000 2 400 000 General reserve 290 000 Retained earnings 375 000 Income tax payable 249 000 Other debtors 50 000 $4 230 000 $4 230 000 Additional information (a) Profit for the year was $581 000. (b) Balance of retained earnings at 1 July 2015 was $80 000. (c) During the year $30 000 was transferred from retained earnings to general reserve. (d) A final dividend of 8c per share has been declared by directors and is not subject to shareholders’ approval. Required Prepare the statement of financial position and statement of changes in equity to comply with AASB 101. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. MARS LTD Statement of Financial Position as at 30 June 2016 ASSETS Current assets Trade and other receivables* Inventories Total current assets

$ 590 000 520 000 1 110 000

Non-current assets Property, plant and equipment** Goodwill

2 300 000 300 000

15.13

Solutions manual to accompany Company Accounting 10e

Investments Total non-current assets Total assets

460 000 3 060 000 $ 4 170 000

LIABILITIES Current liabilities Trade and other payables*** Short-term borrowings Current tax payable Total current liabilities Total liabilities

$ 656 000 200 000 249 000 1 105 000 $ 1 105 000

Net assets

$ 3 065 000

EQUITY Share capital Reserves Retained earnings Total equity

$ 2 400 000 290 000 375 000 $ 3 065 000

15.14

Chapter 15: Disclosure: presentation of financial statements

MARS LTD Statement of Changes in Equity for the year ended 30 June 2016 Share capital $ 2 400 000

Balance at 1 July 2015 Total comprehensive income for the year Dividend payable – ordinary Transfer to general reserve Balance at 30 June 2016 $ 2 400 000

General reserve $ 260 000

Retained earnings $ 80 000

Total $ 2 740 000

30 000 $ 290 000

581 000 (256 000) (30 000) $ 375 000

581 000 (256 000) $ 3 065 000

Dividends: 8 cents per share Workings: *Trade and other receivables Accounts receivable Allowance for doubtful debts Other debtors

**Property, plant and equipment Land & buildings Plant & machinery

***Trade and other payables Accounts payable Dividend payable [3 200 000 shares x 8 cents per share]

$ 600 000 (60 000) 540 000 50 000 590 000

$ 1 500 000 800 000 2 300 000

$ 400 000 256 000 656 000

15.15

Solutions manual to accompany Company Accounting 10e

Question 15.15

Statement of profit or loss and other comprehensive income (classify expenses by function), statement of financial position and statement of changes in equity

Refer to the information in practice question 3.8 for Aster Ltd on page 145. Required A.

Prepare a statement of profit or loss and other comprehensive income for Aster Ltd in accordance with the requirements of AASB 101 (classify expenses by function).

Prepare a statement of financial position for Aster Ltd in accordance with AASB 101. Use the current/non-current presentation format. Prepare a statement of changes in equity for Aster Ltd in accordance with the requirements of AASB 101.

[Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. A. ASTER LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Sales revenue Cost of goods sold Gross profit Other income* Selling expenses Administrative and general expenses Depreciation** Financial expenses*** Finance costs Profit before income tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

$ 882 680 (694 000) 188 680 11 320 (82 000) (51 000) (34 000) (10 000) (7 000) 16 000 (4 800) 11 200 nil $ 11 200

Workings: *Other income: Dividends Interest

$ 10 000 1 320 11 320

**Depreciation: Plant and machinery Buildings

$ 30 000 4 000

15.16

Chapter 15: Disclosure: presentation of financial statements

34 000 ***Financial expenses: Financial expenses Less Finance costs

$ 17 000 (7 000) 10 000

B. ASTER LTD Statement of Financial Position as at 30 June 2017 ASSETS Current assets Trade and other receivables* Inventories Total current assets

$ 46 000 46 000 92 000

Non-current assets Property, plant and equipment** Goodwill Investments*** Total non-current assets Total assets

136 000 30 000 97 000 263 000 $ 355 000

LIABILITIES Current liabilities Trade and other payables**** Current tax payable Total current liabilities

$ 39 600 4 800 44 400

Non-current liabilities Long-term borrowings***** Total non-current liabilities Total liabilities

40 000 40 000 $ 84 400

Net assets

$ 270 600

EQUITY Share capital Reserves Retained earnings Total equity

$ 240 000 6 000 24 600 $ 270 600

Workings: *Trade and other receivables: Accounts receivable Allowance for doubtful debts

$ 54 000 (8 000) 46 000

15.17

Solutions manual to accompany Company Accounting 10e

**Property, plant and equipment: Freehold land Buildings Accumulated depreciation [30 000 + 4 000] Plant and machinery Accumulated depreciation [70 000 + 30 000]

$ 40 000 80 000 (34 000) 150 000 (100 000)

***Investments: 6% Government bonds Shares in other companies

46 000 50 000 136 000

$ 22 000 75 000 97 000

****Trade and other payables: Accounts payable Dividend payable (120 000 shares x 8 cents per share)

$ 30 000 9 600 39 600

*****Long-term borrowings: Bank loan (due 2020) Mortgage payable

$ 24 000 16 000 40 000

C. ASTER LTD Statement of Changes in Equity for the year ended 30 June 2017

Balance at 1 July 2016 Total comprehensive income for the year Dividend declared Transfer to retained earnings Balance at 30 June 2017

Share capital $ 240 000

Conting. reserve $ 16 000

Retained Total earnings $ 13 000 $ 269 000

$ 240 000

(10 000) $ 6 000

11 200 11 200 (9 600) (9 600) 10 000 $ 24 600 $ 270 600

Dividends: 8 cents per share

15.18

Chapter 15: Disclosure: presentation of financial statements

Question 15.16

Statement of profit or loss and other comprehensive income (classify expenses by function), statement of financial position and statement of changes in equity

The trial balance of Black Hole Ltd at 30 June 2018 was as follows: Debit Share capital (ordinary shares issued at $2, fully paid) General reserve Retained earnings (1/7/17) Revaluation surplus Mortgage loan Bank overdraft (at call) 7% debentures Interest payable Accounts payable Dividend payable Current tax liability Provision for employee benefits Deferred tax liability Allowance for doubtful debts Accumulated depreciation – plant and equipment $ 500 Accumulated impairment – goodwill 58 000 Cash 87 700 Accounts receivable 7 000 Inventory Prepaid insurance Plant and equipment 222 500 Land 220 000 Buildings 380 000 Goodwill 105 000 Deferred tax asset 9 800 Sales revenue Cost of sales 450 000 Administrative expenses 265 000 Other expenses 10 000 Interest revenue Dividends revenue Income tax expense 50 400 Dividends paid 20 000 Dividends declared 10 000 Transfer to general reserve 25 000 $1 920 900

Credit $ 200 000 25 000 128 400 85 000 250 000 69 200 80 000 2 800 69 500 10 000 52 100 34 200 18 400 12 800 42 500 10 000

825 000

2 500 3 500

$1 920 900

Additional information (a) Administrative expenses for the year include interest expense of $28 700. (b) All assets are carried at cost, except for land and buildings which are carried at valuation. (c) During the year, 50 000 shares were issued at an issue price of $2 each, payable in © John Wiley and Sons Australia, Ltd 2015

15.19

Solutions manual to accompany Company Accounting 10e

full on application. (d) On 30 June 2018, the directors revalued land and buildings. The revaluation was based on an independent valuation received from FJ Holden, Registered Valuer. The valuation was based on fair values. The carrying amounts of land and buildings before the revaluation were $195 000 and $350 000 respectively. (e) The mortgage loan is repayable in annual instalments of $50 000 due on 1 March each year. (f) The 7% debentures are to be redeemed on 31 March 2019. There is no plan to refinance these debentures in the future. (g) The provision for employee benefits consists of: Annual leave $18 000 Long-service leave 16 200 (h) No employee is eligible for long-service leave until 2022. (i) The company tax rate is 30%. Required A. Prepare a statement of profit or loss and other comprehensive income for Black Hole Ltd for the year ended 30 June 2018, according to the requirements of AASB 101 (classify expenses by function). B. Prepare a statement of financial position for Black Hole Ltd as at 30 June 2018 to comply with AASB 101. C. Prepare a statement of changes in equity for Black Hole Ltd for the year ended 30 June 2018, according to the requirements of AASB 101. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. A. BLACK HOLE LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2018 Sales revenue Cost of sales Gross profit Other income* Administrative expenses** Other expenses Finance costs Profit before income tax Income tax expense Profit for the year Other comprehensive income Items that will not be reclassified to profit or loss Gain on revaluation of land Gain on revaluation of buildings Income tax relating to items not reclassified Other comprehensive income for the year, net of tax Total comprehensive income for the year

$ 825 000 (450 000) 375 000 6 000 (236 300) (10 000) (28 700) 106 000 (50 400) 55 600

25 000 30 000 (16 500) 38 500 $ 94 100

15.20

Chapter 15: Disclosure: presentation of financial statements

Workings: *Other income: Interest Dividends

$ 2 500 3 500 6 000

** Administrative expenses: Administrative expenses Less Interest expense

$ 265 000 (28 700) 236 300

B. BLACK HOLE LTD Statement of Financial Position as at 30 June 2018 ASSETS Current asets Cash and cash equivalents Trade and other receivables* Inventories Total current assets Non-current assets Deferred tax asset Property, plant and equipment** Goodwill*** Total non-current assets Total assets

$ 500 52 200 87 700 140 400 9 800 780 000 95 000 884 800 $ 1 025 200

LIABILITIES Current liabilities Trade and other payables**** Short-term borrowings***** Current portion of long-term borrowings Current tax payable Short-term provisions Total current liabilities

$ 82 300 149 200 50 000 52 100 18 000 351 600

Non-current liabilities Long-term borrowings****** Deferred tax liability Long-term provisions Total non-current liabilities Total liabilities

200 000 18 400 16 200 234 600 $ 586 200

Net assets

$ 439 000

15.21

Solutions manual to accompany Company Accounting 10e

EQUITY Share capital Reserves Retained earnings Total equity

$ 200 000 110 000 129 000 $ 439 000

Workings: *Trade and other receivables: Accounts receivable Allowance for doubtful debts Prepaid insurance **Property, plant and equipment: Land Buildings Plant and equipment Accumulated depreciation

$ 58 000 (12 800) 7 000 52 200 $ 220 000 380 000 $ 222 500 (42 500)

***Goodwill: Goodwill Accumulated impairment

180 000 780 000

$ 105 000 (10 000) 95 000

****Trade and other payables: Interest payable Accounts payable Dividend payable

$ 2 800 69 500 10 000 82 300

***** Short-term borrowings: Bank overdraft (at call) 7% Debentures

$ 69 200 80 000 149 200

******Long-term borrowings: Mortgage loan Less instalment payable 1 March 2019

$ 250 000 (50 000) 200 000

C. BLACK HOLE LTD Statement of Changes in Equity for the year ended 30 June 2018

Balance at 1 July 2017 Total comprehensive income

Share capital $ 100 000

General Reval. Retained Total reserve surplus earnings - $ 46 500 $ 128 400 $ 274 900

15.22

Chapter 15: Disclosure: presentation of financial statements

for the year Issue of share capital Dividend paid – ordinary Dividend declared – ordinary Transfer to general reserve Balance at 30 June 2018

100 000 $ 200 000

- 38 500 55 600 94 100 - 100 000 - (20 000) (20 000) - (10 000) (10 000) 25 000 - (25 000) $ 25 000 $ 85 000 $ 129 000 $ 439 000

Dividends: 30 cents per share (assuming shares issued during the year entitled to dividends paid and declared).

15.23

Solutions manual to accompany Company Accounting 10e

Question 15.17

Statement of profit or loss and other comprehensive income (classify expenses by nature), statement of financial position and statement of changes in equity

The summarised trial balance of Star Ltd as at 30 June 2017 is shown below. Debit Credit Ordinary share capital (1 500 000 shares) $1 062 500 General reserve (1/7/16) 175 000 Revaluation surplus (1/7/16) 60 000 Retained earnings (1/7/16) 104 500 Bank loan (long-term) 43 500 Deferred tax liability (1/7/16) 3 000 Mortgage (long-term) 50 000 Accounts payable 132 000 Provision for employee benefits (long-term) 75 000 Allowance for doubtful debts 37 500 Accumulated depreciation: Plant 9 500 Office furniture 850 Buildings 2 500 Land (at cost) $ 211 500 Factory buildings (at cost) 250 000 Accounts receivable 542 950 Plant (at cost) 90 000 Inventory 651 100 Office furniture (at cost) 6 000 Goodwill 200 000 Cash at bank 278 800 Employee benefits expense 12 500 Sales 1 730 500 Raw materials and consumables used 1 083 100 Changes in inventories of finished goods and 3 100 work in progress Other expenses (excluding depreciation but including interest expense $31 000 on bank 163 500 loan and mortgage) $3 489 450 $3 489 450 The accountant for the company seeks your assistance in preparing the financial statements for external reporting purposes and advises you of the following information that needs to be taken into account before finalising the financial statements. Additional information (a) Depreciation is to be provided for: Plant $9 000 Office furniture 800 Buildings 2 500 (b) The estimated total income tax expense relating to profit or loss items only for 2017 is $200 000, consisting of $150 000 for the current liability and $50 000 as a deferred tax liability. (c) Final dividends of 2 cents per share were declared by directors. (d) Directors decided to transfer $10 000 from retained earnings to general reserve. © John Wiley and Sons Australia, Ltd 2015

15.24

Chapter 15: Disclosure: presentation of financial statements

(e) Following expert advice, the directors decided on 30 June 2017 to revalue the land and factory buildings to reflect current fair values. Consequently, directors placed a value of $300 000 on land and $350 000 on the buildings. (f) Company tax rate is 30%. Required Based on the ledger balances and the additional information provided, prepare a statement of profit or loss and other comprehensive income (classify expenses by nature), a statement of financial position and a statement of changes in equity for Star Ltd for the year ended 30 June 2017, to comply with AASB 101. [Comparative information must be disclosed in respect of the preceding period for all amounts reported in the current period's financial statements in accordance with AASB 101 paragraph 38. However this information is not provided in the question]. STAR LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Revenue $ 1 730 500 Changes in inventories of finished goods and work in progress 3 100 Raw materials and consumables used (1 083 100) Employee benefits expense (12 500) Depreciation* (12 300) Other expenses** (132 500) Finance costs (31 000) Profit before income tax 462 200 Income tax expense (200 000) Profit for the period 262 200 Other comprehensive income Items that will not be reclassified to profit or loss Gain on revaluation of land*** 88 500 Gain on revaluation of buildings*** 105 000 Income tax relating to items not reclassified (58 050) Other comprehensive income for the year, net of tax 135 450 Total comprehensive income for the year $ 397 650 Workings: *Depreciation: Plant Office furniture Buildings

$ 9 000 800 2 500 12 300

**Other expenses: Other expenses Less interest expense

$ 163 500 (31 000) 132 500

***Gain arising during the year on revaluation of: Land (300 000 –211 500) $ 88 500 Buildings (350 000 – (250 000 – (2 500 acc. dep. + 2 500 dep.))) 105 000

15.25

Solutions manual to accompany Company Accounting 10e

STAR LTD Statement of Financial Position as at 30 June 2017 ASSETS Current assets Cash and cash equivalents Trade and other receivables* Inventories Total current assets Non-current assets Property, plant and equipment** Goodwill Total non-current assets Total assets

$ 278 800 505 450 651 100 1 435 350

725 850 200 000 925 850 $ 2 361 200

LIABILITIES Current liabilities Trade and other payables*** Current tax payable Total current liabilities

$ 162 000 150 000 312 000

Non-current liabilities Long-term borrowings**** Deferred tax liabilities***** Long-term provisions Total non-current liabilities Total liabilities

93 500 111 050 75 000 279 550 $ 591 550

Net assets

$ 1 769 650

EQUITY Share capital Reserves Retained earnings Total equity

$ 1 062 500 380 450 326 700 $ 1 769 650

Workings: *Trade and other receivables: Accounts receivable Allowance for doubtful debts

$ 542 950 (37 500) 505 450

15.26

Chapter 15: Disclosure: presentation of financial statements

**Property, plant and equipment: Freehold land Factory buildings

$300 000 350 000 650 000

Plant Accumulated depreciation [9 500 + 9 000] Office furniture Accumulated depreciation [850 + 800]

90 000 (18 500) 6 000 (1 650)

***Trade and other payables: Accounts payable Dividend payable (1 500 000 shares x 2 cents per share)

71 500 4 350 725 850

$ 132 000 30 000 162 000

****Long-term borrowings: Bank loan Mortgage

$ 43 500 50 000 93 500

***** Deferred tax liabilities: Balance 1/7/2016 Deferred tax portion of income tax expense Revaluation of: Land (30% x [300 000 – 211 500]) Buildings (30% x [350 000 – (250 000 – (2 500 + 2 500)])

$ 3 000 50 000 26 550 )31 500

58 050 111 050

STAR LTD Statement of Changes in Equity for the year ended 30 June 2017 Share General capital reserve Balance at 1 July 2016 $ 1 062 500 $ 175 000 Total comprehensive income for the year -

Reval. Retained Total surplus earnings $ 60 000 $ 104 500 $ 1 402 000 135 450

262 200

397 650

Dividend declared – ordinary - (30 000) (30 000) Transfer to general reserve 10 000 - (10 000) Balance at 30 June 2017 $ 1 062 500 $ 185 000 $ 195 450 $ 326 700 $ 1 769 650 Dividends: 2 cents per share

15.27

Chapter 16: Disclosure: statement of cash flows

Chapter 16 – Disclosure: statement of cash flows REVIEW QUESTIONS 1.

What is the purpose of the statement of cash flows? In what ways may the information in the statement be of benefit to users?

The purpose of a statement of cash flows is to provide information about the historical changes to an entity’s cash and cash equivalents. It is designed to provide users with information to assess the ability of the entity to generate cash and the needs of the entity to use cash. According to paragraphs 4-5 of the standard AASB 107, the statement of cash flows, when used in conjunction with the other financial statements will benefit users in that it will enable them to: • Evaluate the changes in net assets of the entity • Evaluate the entity’s financial structure, including its liquidity and solvency • Evaluate the entity’s ability to adapt to changing circumstances and opportunities • Assess the entity’s ability to generate cash in the future and enable predictions of future cash flows to be made • Compare the performance of this entity with other entities because it eliminates the effects of using different accounting treatments (for example depreciation methods) for the same transactions and events • Check the accuracy of past assessments of future cash flows • Examine the relationship between profitability and net cash flow. The statement of cash flows may also provide useful information to internal users such as managers in their planning and controlling operations.

What is the concept of cash used in the preparation of the statement of cash flows? Why is defining cash important?

The concept of cash adopted by AASB 107 covers both cash and cash equivalents. Note the definitions of “cash” and “cash equivalents” shown in the chapter. Note also from paragraph 8 of the standard that certain borrowings (e.g. bank overdrafts) may be included in the definition of cash equivalents if they are repayable on demand and form an integral part of the entity’s cash management function. The definitions of “cash” and “cash equivalents” are important because, in effect, they determine what items are included in the cash pool and what transactions represent an inflow to the pool or outflow from the pool. Items included in these definitions cannot create cash flows by themselves. That is, increasing a bank balance with funds from a short-term bank bill doesn’t generate a cash flow, whereas decreasing a bank account to purchase machinery is a cash flow.

16.1

Chapter 16: Disclosure: statement of cash flows

Distinguish between cash flows from operating activities, investing activities and financing activities. Explain the importance of cash flows from operating activities.

From the definitions in the standard in paragraph 6: Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities are activities that result in changes in the size and composition of the contributed capital equity and borrowings of the entity. Section 16.4 of the text provides a detailed discussion of these three activities. Cash flows from operating activities are important to users of a statement of cash flows because they represent cash flows generated by the entity’s business operations. A high and constant stream of these cash flows would generally indicate an entity’s capacity to generate cash to carry on as a going concern, and an entity’s flexibility to change the nature of its activities. As stated in paragraph 13 of AASB 107, the amount of cash flows from operating activities is a key indicator of the extent to which the operations of the entity have generated sufficient cash flows to repay loans, maintain the operating capability of the entity, pay dividends and make new investments without recourse to external sources of finance. Cash flows from operating activities can be used to assess the quality of the entity’s profits. A company that makes profits but keeps on losing cash or needing more cash from its stakeholders does not have a sustainable future.

4. Describe how the cash purchase of land and buildings would be classified in the statement of cash flows by each of the following: (a) a property development company that purchases land and buildings in the ordinary course of business to redevelop and sell (b) an investment property company that holds land and buildings for the purpose of earning rental income or for capital appreciation This question highlights how the classification of cash flows can vary across entities. a) property developer A property development company purchases land and building as part of its principal revenue producing activities in a manner similar to the purchase of inventory by a retailer. It should classify the purchase as a cash flow from operating activities. b) property investment company A property investment company that holds land and buildings for the purpose of earning rental income or for capital appreciation is acquiring the assets for the long term. It should classify the purchase as a cash flow from investing activities. The rent income received will be classified in operating activities.

16.2

Chapter 16: Disclosure: statement of cash flows

5. Are the following items cash flows pursuant to AASB 107? If so, indicate which classification from operating, investing or financing activities is appropriate. (a) increase in bank overdraft (b) cash loans made to employees (c) proceeds from sale of investments (d) depreciation of plant (e) income tax paid (f) sale of motor vehicle for cash (g) issue of ordinary shares in exchange for convertible notes (h) bad debts written off (i) bad debts recovered (j) revaluation increase for land (k) transfer from general reserve to retained earnings (l) dividends declared and paid (m) share buyback (n) acquisition of a motor vehicle by way of a finance lease Item (a) will only be a cash flow if the bank overdraft is not included as a component of cash and cash equivalents. If so, it would be classified in financing activities. Item (b) is a cash flow. It is classified in investing activities. Item (c) is a cash flow. It is classified in investing activities for entities other than financial institutions. Item (d) is an expense but not a cash flow. It would only be included in the statement if the indirect method of presenting cash flows from operating activities is used. Item (e) is a cash flow. It is classified in operating activities. However, some component of income tax, such as capital gains tax, could be classified in investing activities because it relates to the sale of non-current assets. Item (f) gives rise to a cash flow. The cash proceeds on sale is classified in investing activities. The gain/loss on sale would only be included in the statement if the indirect method of presenting cash flows from operating activities is used. Item (g) is not a cash flow. It is included in the statement of changes in equity but not the statement of cash flows. Item (h) is not a cash flow. Bad debts expense would only be included in the statement if the indirect method of presenting cash flows from operating activities is used. Item (i) is a cash flow. It is classified in operating activities as part of cash receipts from customers. Item (j) is not cash flow. The revaluation increment is included in the statement of profit or loss and other comprehensive income but not the statement of cash flows. Item (k) is not cash flow. It is included in the statement of changes in equity but not the statement of cash flows.

16.3

Chapter 16: Disclosure: statement of cash flows

Item (l) is a cash flow – for dividends paid during the period. It can be classified in operating activities, investing activities or financing activities but consistency in classification is required. Item (m) is a cash flow. It is classified in financing activities. Item (n) is not a cash flow. The acquisition of the motor vehicles under finance lease does not, of itself, give rise to any cash inflows or outflows. The finance lease will give rise to cash flows during the financial year in the form of lease repayments. The amount of the lease payments relating to the repayment of the finance lease liability would be classified in financing activities. The amount of the lease payments relating to the payment of the financing charges under the lease (the interest) could be classified in operating cash flows or financing cash flows.

6. Explain the differences between the direct and indirect methods of presenting cash flows from operating activities. Which method is more informative? The direct method of presenting cash flow from operating activities shows the details of cash receipts and cash payments, e.g. the cash flows from receipts from customers and for payments to suppliers and employees. In contrast, the indirect method of presenting cash flow from operating activities begins with the profit for the year and makes adjustments in order to arrive at the net cash flow figure. The adjustments are for non-cash based expenses (e.g. depreciation), any item included in the profit or loss that is not classified as operating (e.g. proceeds from sale of plant), and accrual balances (e.g. the increase in accounts payable). Under either method of presentation, the final figure for net cash flows from operating activities is the same. The fact that the standard AASB 107 allows either method suggests that both provide useful information to the users of the financial reports. The direct method is relatively more informative about cash flows from operating activities because it shows the gross cash inflows and outflows rather than a net cash flow amount. In order to answer certain questions – e.g. “is the company collecting more or less cash from customers than in previous years?”- the information presented by the direct method is needed. The AASB/IASB permits either method to be used, but encourages the use of the direct method (paragraph 19). The direct method also appears to be favoured by the Australian Securities Exchange as Appendix 4E to the ASX listing rules states as follows: The statement of cash flows may be condensed but must report as line items each significant form of cash flow and comply with the disclosure requirements of AASB 107 Statement of Cash Flows, or for foreign entities, the equivalent foreign accounting standard. The indirect method does not show the sources of the cash flows but provides a calculation reconciling the entity’s profit with operating cash flows. The indirect method explains why profit is different to operating cash flow thereby providing important information on the extent to which profit is cash-based and accrual based. Many of the top Australian companies

16.4

Chapter 16: Disclosure: statement of cash flows

prepare a note disclosure for the reconciliation of profit and cash flows from operations and this indicates that the reconciliation has information value to shareholders and analysts.

7. Why does AASB 107 require gross cash flows to be reported in the statement of cash flows? In what limited circumstances can net cash flows be reported? Gross cash flows are required to be reported under AASB 107 for investing and financing activities (paragraph 21) and gross cash flows are also required if the direct method of reporting operating cash flows is used (paragraph 18). As a general principle, netting off financial statement items results in loss of information whether it is netting off cash inflows against cash outflows, netting off revenues against expenses or netting off assets against liabilities. Paragraph 13 states that reporting specific components of historical cash flows provides a useful basis for forecasting future cash flows. It is considered that the gross flows approach is a more informative method of presentation than that which discloses only the net amount of cash flows with no indication of inflows/outflows of individual items of operating activities. Net cash flows can be reported for operating, investing and financing activities in limited circumstances as discussed in paragraphs 22 to 24. A travel agency is a good example of whether netting of operating cash flows is appropriate. The travel agency introduces consumers to service providers of accommodation, flights and car rental. The customer pays the travel agency and the agency remits cash to the service providers. The travel agency receives commissions from the suppliers and the suppliers are responsible for settling any claims by the customer. In substance, the cash flow that relates to the accommodation, flights and car rental is not cash flow of the travel agency. Rather, the travel agency is just an intermediary providing a service to connect consumers and service providers for a fee.

8. What are the limitations of a statement of cash flows? Give examples of transactions that may have significant consequences on the future cash position of a company which are not reported in the statement? Limitations of the statement of cash flows are: • •

•

The statement is based on past cash flows and not future cash flows. However by producing comparative figure for previous periods, trends in cash flows can then be examined as an aid to predicting future cash flow position. Non-cash transactions such as the purchase of a non-current asset by long-term debt do not affect the current statement of cash flows, but may have an impact in later periods in regard to interest and principal repayments. Such non-cash transactions are required to be disclosed in a note; however entities are not required to also disclose the impact this transaction will have on future cash flows. Other important information such as credit standby arrangements and unused loan facilities do not appear in the statement of cash flows although it might be included in the disclosure notes. AASB 107 at paragraph 50 merely encourages, rather than requires, disclosure of information about credit standby arrangements and unused loan

16.5

Chapter 16: Disclosure: statement of cash flows

•

facilities as at the end of the financial year. This information is relevant to assessing whether the entity has any “head room” for cash resources in the future. Users of the statement of cash flows should always pay close attention to the disclosure notes that accompany the statement. The statement of cash flows does not enable the user to totally assess the liquidity/solvency position of an entity as the standard doesn’t require entities to state that if the assets of the entity were realised, then there would be sufficient cash to pay off all debts as they fall due. Management can manipulate cash flows by prepaying or delaying cash payments that will affect cash flows for that particular reporting period. Comparative figures would tend to eliminate this limitation, as the cash flows have to eventually occur. Therefore the statement of cash flows should not be evaluated for one period only, but rather over a number of periods. Comparability of cash flow information across companies may be affected by differences in the way companies apply the definition of cash equivalents or classify cash flows such as interest paid.

Examples of transactions are: • • • • •

Purchase of investments in shares in exchange for the issue of shares. The investments may give rise to dividends received in the future. Purchase of a new business in exchange for the issue of shares. The new business may significantly affect the cash flows from operating activities in the future. Sale of non-current assets in exchange for non-cash consideration. Sale of an existing business in exchange for shares in another company. The operating cash flows of the sold business will not be included in future statements. Purchase of a major item of plant by way of a finance lease. The finance lease will give rise to cash payments for interest and principal repayments in the future.

9. A fellow student explained: ‘Profit is the premier measure of financial performance. You can think of profit as cash flows from operating activities adjusted for the effects of accrual accounting. Do you agree? Give reasons. Profit (earnings) is the key measure. Turn on the television to a business show or read the business section of a newspaper. When a top company’s recent performance is being discussed, earnings is usually at the forefront of the analysis. The discussion will normally address whether earnings for the quarter or half year or full year has increased or decreased relative to a prior period? The discussion may also address whether earnings for the quarter or half year or full year exceeded or failed to meet the expectations of analysts (the market). Why is profit the key measure? Why not discuss net cash from operating activities instead? The answer is because accrual accounting profit is a more complete measure of financial performance. It includes the financial effects of all transactions and events that affect net assets (excluding transactions with owners as owners and items of other comprehensive income) rather than just those transactions that affect cash and cash equivalents. The indirect method of presenting cash flows from operating activities makes it clear that profit is composed of cash flows and accrual accounting adjustments. Therefore, the analysis of a company’s profits should consider both the cash flow component and the accruals © John Wiley and Sons Australia, Ltd 2015

16.6

Chapter 16: Disclosure: statement of cash flows

adjustments component. Dissecting profit into cash and accrual components is one way to think about earnings quality. Profits that are well-backed by cash flow are superior to profits that rely more on accrual adjustments. In practice, it has been found that operating cash flow is more persistent than the accrual component of earnings, i.e., it does not change as much year on year. This means that an increase in profit is likely to be more reliable if it is supported by an increase in operating cash flow rather than just some temporary accrual adjustments. 10. A fellow student explained: ‘The easiest way for managers to manage earnings or manipulate profits is to manipulate the accrual accounting adjustments’ Do you agree? Provide examples of management decisions that may increase profit but have no impact on cash flows from operating activities. Because profit is the key financial measure, managers of top companies tend to be under pressure to manipulate it to meet market expectations. Profit is composed of operating cash flows and accruals adjustments. Therefore, management can manipulate either or both components in order to manipulate profits. The manipulation of cash flows normally requires the manipulation of real transactions such as the following: • cut discretionary spending on advertising or research • offer discounts to boost customer receipts before year end and delay restocking until after year-end • delay payments to suppliers. But manipulating accruals is easier because the company doesn’t have to change any of its real activities. This makes manipulating accruals a lower cost option that manipulating cash flows. Examples of manipulating accruals to increase profits are as follows: • record revenues in the current period for services to be performed in future • reduce the allowance for bad and doubtful debts using new management forecasts • reduce the provision for warranty based on new management forecasts • reduce the provision for employee benefits based on new estimates of employee retention and long service leave commitments • increase deferred tax asset by recognising tax losses not previously brought to account based on new management expectations of future profits • allocate additional costs to inventory that were previously recognised as periodic expenses • adjust the accounting policy in relation to the depreciation of non-current assets resulting in lower depreciation charges in the short-term • reverse prior period impairment losses based on new management forecasts.

11. The statement of cash flows is based on the idea that there is a pool of funds which increases and decreases as a result of transactions that occur during the reporting period. The statement uses cash and cash equivalents as the concept for the pool of funds. Prior to 1992, Australian companies prepared ‘funds statements’ with a broader concept of funds similar to working capital. However, the best concept of

16.7

Chapter 16: Disclosure: statement of cash flows

funds is cash and cash equivalents because it is easy to understand, and with broader concepts, less is disclosed. Discuss these assertions. A statement using cash and cash equivalents as the concept of funds makes it easier for users to understand the statement compared to a broader concept of funds incorporating say working capital. A company’s obligations and commitments are usually settled in cash and so cash flow data is relevant to assess a firm’s ability to sustain operations and meet its commitments as and when they fall due. Statements based on other concepts of funds do not provide information that is as relevant to solvency. As “cash and cash equivalents” is a narrow concept, there is also less chance of any manipulation occurring to produce a desired result. Also, the broader the concept, the more likely that differing interpretations will occur. The arguments in favour of a wider concept of funds is that it would be more consistent with the accrual accounting techniques that are used in the preparation of the other financial statements and the movement of accounts in the statement of financial position would be more fully explained. For example, land purchased by issue of debentures might be included in a funds flow statement whereas it would not be included in a statement of cash flows. Conversely, a statement using working capital as the funds concept may result in the loss of information in other circumstances. For example, inventory, receivables and cash would all fit into the concept of working capital and sales of inventory on credit or for cash would result in these items being netted off.

12. A recently graduated accountant made the following observation: For the purposes of preparing a statement of cash flows, the concept of cash includes ‘cash equivalents’. It is therefore difficult to see why accounts receivable is not included in the concept of cash. After all, money owed to the business by the short-term money market (a receivable) is included in the definition of cash. So let us be consistent and include all receivables.’ Discuss. Paragraph 6 of AASB 107 defines cash equivalents as short-term highly liquid investments that are readily convertible into known amounts of cash, and which are subject to an insignificant risk of changes in value. In contrast to deposits in the short term money market, an account receivable is not readily convertible into known amounts of cash on hand. Customers with accounts often have terms of 30 days or more and may not pay on time. Risk may also play part with an account receivable if the customer becomes bankrupt and cannot pay their account. The standard does not explicitly address if receivables should be included in cash equivalents, however paragraph 14 clearly indicates that cash received from customer accounts is included in cash flows from operating activities.

13. A student of accounting, after studying the illustrative examples of AASB 107, was confused. Long-term borrowings are recognised as a financing activity of an entity,

16.8

Chapter 16: Disclosure: statement of cash flows

yet interest paid is included in cash flow from operations. After some consideration the student concluded, ‘since interest expense is regarded as a financial cost, interest paid should be treated as part of the financing activities of an entity, and be classified in the statement of cash flows accordingly.’ Would you support the conclusion reached by the student? Explain. It is true that interest expense is classified as a financing cost in the statement of profit or loss (refer para. 82 of AASB 101) however, revenue and expense classifications do not necessarily determine classifications of cash flows. It is also true that interest expense enters into the determination of profit or loss but this fact is not determinative either, e.g. proceeds from sale of plant as a revenue enters into the profit or loss but is classified in investing activities. Since interest is being paid on long-term borrowings that were initially reported as a financing cash inflow, then the conclusion reached by the student is logical. The standard itself is unclear on the reporting of interest paid. See paragraph 31 of the standard that seems to allow a choice of classification provided it is applied consistently. Paragraphs 32-33 indicate that the classification of interest paid should be in either operating or financing activities. Classification in financing activities would also probably assist users for financial analysis purposes. The vexed issue of whether interest paid should be classified in operating or financing activities has a long history. In the context of the United States – refer Nurnberg, H., 1993, Inconsistencies and ambiguities in cash flow statements under FASB Statement No. 95, Accounting Horizons, Vol 7, No. 2, June 1993, pp. 60-75. Nurnberg suggests that companies should not have a choice to report similar cash flows differently. A similar analysis applies to the treatment of dividends paid on shares. Are they to be regarded as operating activities or financing activities? The standard permits either treatment (para. 34).

16.9

Chapter 16: Disclosure: statement of cash flows

CASE STUDIES Case Study 1

Increasing cash flow decreasing profit

Lana Ferdinand, the owner-manager of a small proprietary company, had carefully monitored the cash position over the past financial year, and was pleased to note at the end of the year that the cash position was strong, and had shown a healthy 50% increase over the year. When presented with the statement of profit or loss for the year, she was dismayed to note that profit had deteriorated significantly. In her anger, she accuses you of having made errors in the accounting since ‘such a silly situation could not possibly exist’. How would you respond to Lana Ferdinand? You need to explain the difference between cash accounting and accrual accounting to Lana Ferdinand. Accrual accounting is not limited to those transactions that have an effect on cash and cash equivalents. It recognises the financial effects of all transactions and events of the period that affect the elements of the financial statements – assets, liabilities, equity, revenues and expenses. Possible causes of having an improved cash position with a deteriorating profit could be: a. Receiving cash for revenue in advance. b. Receipt of cash for a large one off customer account that was recorded as revenue in the previous period. c. Cash proceeds from sale of a non-current asset where a significant loss on sale is recognised in expenses d. Cash proceeds from the sale of a significant business at the beginning of the year that no longer contributes to the bottom line profit of the entity e. Additional cash from new borrowings with interest costs that are payable at year end f. Recording of significant new non-cash expenses – depreciation and amortisation, writing off inventory and impairment losses g. Recording an expense that was prepaid last year, ie. a significant decrease in prepayments

16.10

Chapter 16: Disclosure: statement of cash flows

Case Study 2

Direct vs indirect method of presentation

Find and read the following article: • Bradbury, M 2011, ‘Direct or Indirect Cash Flow Statements?’ Australian Accounting Review, vol. 21, no. 2, June, pp. 124–30. Present arguments as to why the direct method is superior to the indirect method of presenting cash flows from operating activities. Bradbury asks three questions to examine the matter of whether the direct method of presentation is superior as follows: 1) Can the additional information provided by the direct method of presentation be otherwise estimated by analysts? 2) Does the direct method of presentation provide more useful information? 3) Is the direct method more costly to prepare? For the first question, Bradbury reviews the research evidence that compares estimates of cash flow data with reported cash flows. Bradbury concludes that net cash flows from operating activities and individual line items, such as cash receipts from customers, cannot be reliably estimated by analysts using mechanical accruals reversals procedures. The calculation of cash flows by company outsiders using indirect means is confounded because of business acquisitions, discontinued operations and asset growth. For the second question, Bradbury reviews the research evidence of the predictive ability of the cash flow data disclosed by the direct method of presentation. The direct method is encouraged at paragraph 19 of AASB 107 on the basis that it provides information that may be useful to estimate/predict future cash flows. Bradbury concludes that the operating cash flows reported by the direct method perform better at predicting future net cash flows from operating activities than cash flows reported by the indirect method or other alternatives such as earnings. Bradbury also points to capital market research and concludes that the direct method of presentation provides information that is value relevant or incremental to that provided by the indirect method based on its association with share prices or share returns. For the third question, Bradbury concludes that there is little evidence on the cost of preparing the statement of cash flows using the direct method of presentation relative to the indirect method. Bradbury does note however, that if the direct method is not used there are significant costs to the market (analysts) from estimating the detailed operating cash flow information from the outside.

16.11

Chapter 16: Disclosure: statement of cash flows

Case Study 3

Cash flows and financial distress

Find and read the following article: • Flanagan, J & Whittred, G 1992, ‘Hooker Corporation: A Case Study for Cashflow Reporting’, Australian Accounting Review, vol. 1, no. 3, May, pp. 48–52. Provide a brief summary of the authors’ main points. Flanagan and Whittred make the case for cash flow information by discussing the failure of Hooker Corporation. They demonstrate how traditional accrual accounting measures (for example return on assets and equity, quick ratio, current ratio, leverage ratio and interest cover) did not provide sufficient warning signals that the company was in serious trouble. They also note that “funds from operations” – the concept of funds that was used before cash and cash equivalents – was highly correlated with profits and did not indicate that the company would have trouble meeting its debts as and when they fell due. They also illustrate how the company’s share price was a comparatively good indicator of the “bad news” of the company. Changes in share price may be a good red flag of financial distress for companies listed on the ASX.

16.12

Chapter 16: Disclosure: statement of cash flows

Case Study 4

Cash flows and ratio analysis

Find and read the following article: • Carslaw, C & Mills, J 1991, ‘Developing Ratios for Effective Cash Flow Statement Analysis’, Journal of Accountancy, vol. 172, no. 5, November, pp. 63–70. Provide a brief summary of how information in the statement of cash flows may be used in ratio analysis. Carslaw and Mills group cash flow ratios into the four categories as follows: (1) cash return (2) quality of earnings (3) solvency (4) capital expenditure commitments. (1) Cash return ratios Cash return on assets

Cash generated from operations Total assets

Cash return on equity

Net cash from operating activities Total shareholders’ equity

Cash flow per ordinary share

Net cash from operating activities less preference dividends Weighted average number of ordinary shares

Cash return on assets shows the cash productivity of assets and excludes interest paid which goes to how the assets are financed. It is different from the usual profit-based return on assets because it does not include the effects of accruals and asset allocations such as depreciation and amortisation. Cash return on equity shows the return made by the providers of share capital in terms of cash. This ratio can be refined even further to calculate cash flow per ordinary share. (2) Quality of earnings ratios Quality of sales

Quality of net income

Cash receipts from customers Sales revenue Net cash from operating activities Operating profit after tax Cash generated from operations Operating profit before interest, taxes and depreciation

The quality of sales ratio indicates the extent to which sales revenue is being received in cash. A low ratio could indicate that there is a lag in cash collections or that there is a high level of uncollectible customer debts. The quality of net income ratios indicates the extent to which profit is being received in cash. A low ratio would indicate that a significant proportion of profits is not being realised into cash during the reporting period. If the ratio were

16.13

Chapter 16: Disclosure: statement of cash flows

consistently low over a number of years, then this could indicate that the company had created profits that are not supported by cash flow. (3) Solvency based ratios Cash debt coverage

Net cash from operating activities less total dividends Debt

Cash interest coverage

Cash generated from operations Interest expense

Cash dividend coverage

Net cash from operating activities Total dividends Net cash from operating activities less preferred dividends Ordinary dividends

The cash debt coverage ratio is often a good predictor of financial distress because a company needs cash inflow to meet its debt commitments. Cash interest cover is a complement to the interest cover ratio that is calculated using net profit. A ratio greater than one indicates sufficient cash is being generated from operations to meet interest commitments. In most cases, it would be desirable or prudent for the ratio to be well in excess of one so that the company has a margin of safety in respect of its interest commitments. Cash dividend coverage shows the extent to which the current level of dividends can be maintained using internally generated cash sources. (4) Capital expenditure ratios Capital acquisitions

Investment/Finance

Net cash from operating activities less total dividends Cash payments for capital acquisitions Net cash flows from investing activities Net cash flows from financing activities Net cash flows from investing activities Net cash flows from operating and financing activities

The capital acquisitions ratio shows the extent to which current capital expenditure commitments are covered by cash flows from operations. One difficulty with using this ratio is that, unlike dividends, capital expenditures may vary considerably from one year to the next. The investment to finance ratio measures the extent to which funds for investment are being generated from financing sources. A low ratio would indicate that cash flows from operating activities are being utilised to fund investing activities.

16.14

Chapter 16: Disclosure: statement of cash flows

Case Study 5

Earnings quality, cash flows and accruals

Find and read the following article: • Schipper, K & Vincent, L 2003, ‘Earnings Quality’, Accounting Horizons, vol. 17 (supplement), pp. 97–110. Provide a brief summary of how cash flows from operating activities and accruals can be used to measure earnings quality. Schipper and Vincent discuss four earnings quality measures derived from the relations between profit accruals and cash flow as follows: 1) Ratio of cash from operations to profit 2) Changes in total accruals 3) Abnormal (discretionary) accruals estimated from accounting fundamentals 4) Direct estimation of accruals-to-cash relations The first measure of earnings quality based on the ratio of cash from operations to profit presumes that higher quality earnings means closeness to operating cash flow. For example, a ratio of one would indicate higher quality earnings than a ratio 0.5. The second measure of changes in total accruals presumes that some portion of accruals is constant over time. Therefore, the change in total accruals is a measure of manager’s manipulation of profit. The higher the percentages change in total accruals the lower earnings quality. The third measure is estimated abnormal accruals. This measure presumes that there is some expected, normal or unmanipulated level of accruals based on the accounting fundamentals of the company. For example, a company with $100 million of plant and equipment might be expected to have $14 million of depreciation charges for the year based on an average useful life. It is possible to develop a statistical model for expected accruals based on accounting fundamentals. What is unexplained by the model – the error terms - represents abnormal accruals. Alternatively, the expected accruals can be compared to actual accruals and the difference is unexpected or abnormal accruals. Higher abnormal accruals indicate more management manipulation of accruals and lower earnings quality. The fourth measure is also based on a statistical model but the model uses working capital as the sole accounting fundamental. Changes in working capital are regressed on current, prior period and next period cash flows. The error terms of the model arise because management misestimate accruals (whether intentionally or otherwise). Higher errors indicate lower earnings quality.

16.15

Chapter 16: Disclosure: statement of cash flows

Case Study 6

Earnings quality, cash flows and accruals

Compare and contrast the financial information in the following table in respect of a failed company and surviving company from the same industry. One.Tel ($000) 1997

1998

1999

2000

Profit (Loss) for the year

3 723

5 910

6 965

–291 100

Net cash flow from operating activities (CFO) Total accruals (TAcc)

13 402

–8 000

–28 945

–168 900

–9 679

13 910

35 910

–122 200

TAcc/CFO

–0.72

–1.74

–1.24

0.72

Telstra ($m) 1997 1 609

1998 3 000

1999 3 488

2000 3 673

Profit (Loss) for the year

Net cash flow from operating activities (CFO) Total accruals (TAcc)

5 254

5 635

6 574

6 547

–3 636

–2 635

-3 086

-2 874

TAcc/CFO

–0.69

–0.47

-0.47

-0.44

Source: Based on information from Associate Professor Richard Morris, University of New South Wales. It is interesting to compare One.Tel with Telstra because One.Tel failed in 2001 but Telstra is a survivor. They are both telecommunication companies and should face similar accounting issues. However, in terms of size One.Tel was small when compared to Telstra. Notice from 1997-2000 Telstra has increasing profits and increasing positive cash flows from operations. In contrast, One.Tel’s profit rises from 1997 to 1999 but then declines spectacularly to a huge loss in 2000; while at the same time its CFO is positive in 1997 but negative thereafter. Comparing the accruals of both companies provides an insight into the creative accounting at One.Tel that occurred prior to its collapse. Notice how Telstra’s total accruals, calculated as profit less operating cash flow, are negative each year. This is what you would expect for a telecommunications company because, on average, accounting accruals for non-cash expenses like depreciation and amortisation should be very significant. In contrast, One.Tel’s total accruals were positive in years 1998 and 1999 and increasing year on year. Large positive total accruals and increasing positive total accruals are a warning sign that managers may be manipulating earnings. One.Tel’s total accruals scaled by operating cash flows Tacc/CFO are also larger in each year in absolute terms than Telstra’s. This indicates that the accrual process is relatively more important to One.Tel’s profit than Teltra’s, i.e. Telstra’s profit is of higher quality.

16.16

Chapter 16: Disclosure: statement of cash flows

The following extract from an article by Paul Barry in the Sydney Morning Herald published on 1 August 2002 discusses some of the creative accounting of One.Tel in the 1999 year. One.Tel's cash SOS, then it all fell apart By Paul Barry August 1 2002 Mr Hodgson's second day in the witness box produced more startling evidence of One.Tel's accounting practices, which allowed the company to turn a $7 million loss into a $25 million profit in 1999 and to conceal expenses of at least $173 million up to April 2000. Mr Hodgson revealed that the $14.2 million bonuses paid to Jodee Rich and Brad Keeling between July 1999 and February 2000 were not debited to the profit-and-loss account at the time they were paid. Instead, they were treated as assets of the company - like property and equipment - so the cost could be spread. Mr Hodgson agreed that this device boosted One.Tel's profit in 1999 by $3 million and reduced the company's loss for the first half of 2000 by about $8 million. Deferring the expense gave One.Tel an excuse for not disclosing the bonuses to shareholders until 15 months after the first tranche was paid. Asked whose idea it was to handle the payments in this way, Mr Hodgson said that instructions came from Mr Silbermann and Mr Rich. Mr Hodgson said he and Mr Silbermann devised an argument that the bonuses were "set-up costs" of One.Tel's European businesses (which the company was already deferring). "You agree, don't you, that it's not a persuasive argument?" retorted Michael Slattery, QC, counsel for One.Tel's liquidators. "I believed it was a bit of a stretch and a bit of a grey area, absolutely," Mr Hodgson replied. "It was a very big stretch, wasn't it?" asked Mr Slattery. "It was a stretch." One.Tel's auditor, Steven La Greca, of BDO Nelson Parkhill, also thought it was a bit of a stretch, but gave it the thumbs up all the same. But by the end of December 1999 he was raising doubts in writing. By this time, One.Tel was being investigated by the Australian Securities and Investments Commission for deferring many millions of dollars of other expenses that would have plunged the company deep into the red. And Mr La Greca was also under pressure. He and BDO were ultimately reprimanded and fined $10,000 each by the Institute of Chartered Accountants of Australia. After a six-month battle, ASIC insisted that One.Tel's accounting policies be changed. This ultimately led in August 2000 to the company declaring $245 million of costs that would otherwise have been hidden.

16.17

Chapter 16: Disclosure: statement of cash flows

Case Study 7

Cash flows of top Australian companies

Select three companies listed on the ASX from different industries; for example, metals and mining, telecommunication services, consumer staples. Go to www.asx.com.au and find the most recent annual financial statements of the three companies. Compare their statements of cash flows and report your findings to the class, especially with respect to the major categories of operating activities, investing activities and financing activities. This is an open-ended case for student presentation. Students should use the ASX website by clicking on “Prices and Research” and then use the drop down menu for “Company information” then click on “view complete list” from the Listed Companies Directory. Select three companies from three different industries and go from there to the annual reports of each company in the “Company Announcements” section to view the statements of cash flows. Alternatively students can use a search engine, such as Google, to find the statements of cash flows of three appropriate companies.

16.18

Chapter 16: Disclosure: statement of cash flows

PRACTICE QUESTIONS Question 16.1

The cash records approach

Wilko Ltd had cash and cash equivalents at 1 July 2016 of $100 000. The transactions of Wilko Ltd for the year to 30 June 2017 are as follows: 1. 2. 3. 4. 5.

Borrowed $30 000 with a 6-month loan payable Received $380 000 cash for customer accounts Sold for $40 000 cash a plant asset with a carrying amount of $30 000 Issued ordinary shares for $120 000 cash Purchased a plant asset for $87 000; $27 000 in cash and $60 000 vendor loan 6. Exchanged 10 000 shares for land with a fair value of $100 000 7. Received a $40 000 dividend in cash 8. Invested $100 000 cash on the short-term money market 9. Paid fixed-term loan principal of $80 000 and interest of $8000 10. Cash payments for suppliers accounts $250 000 Required Prepare the statement of cash flows of Wilko Ltd for the year to 30 June 2017.

WILKO LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers Cash generated from operations Interest paid Net cash from operating activities Cash flows from investing activities Proceeds from sale of plant Purchase of plant Dividends received Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital Proceeds from short-term borrowings Repayments of borrowings Net cash used in financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

$380 000 (250 000) 130 000 (8 000) 122 000 40 000 (27 000) 40 000 53 000 120 000 30 000 (80 000) 70 000 245 000 100 000 $345 000

16.19

Chapter 16: Disclosure: statement of cash flows

Explanations *The purchase of plant using finance from the vendor is not a cash flow * The exchange of shares for land is not a cash flow * Investing on the short term money market results in the exchange of cash for a cash equivalent * Interest paid and dividends received are classified in operating activities and investing activities respectively in this example.

16.20

Chapter 16: Disclosure: statement of cash flows

Question 16.2

The reconstruction of accounts (formulae) approach

Below are the statements of financial position of Brilleaux Ltd as at 30 June 2016 and 2017, and its statement of profit or loss and statement of changes in equity for the year ended 30 June 2017: BRILLEAUX LTD Statements of Financial Position as at 30 June 2017 2016 Assets Cash at bank $ 23 000 $ 6 500 Accounts receivable 33 500 37 500 Inventory 82 000 66 000 Prepaid insurance 2 500 3 500 Land 40 000 44 800 Machinery 360 000 300 000 Accumulated depreciation: machinery (81 000 ) (67 000 ) Total assets $ 460 000 $ 391 300 Liabilities Accounts payable $ 25 000 $ 22 000 Interest payable 3 000 3 400 Other accrued expenses 7 000 4 500 Long-term borrowings 145 000 120 000 Equity Share capital 170 000 100 000 Retained earnings 110 000 141 400 Total liabilities and equity $ 460 000 $ 391 300

BRILLEAUX LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales $ 420 000 Lease income received 7 500 Gain on the sale of machinery 9 000 Less: Expenses Cost of sales $ 281 000 Interest expense 11 500 Loss on the sale of land 10 000 Depreciation expense 22 000 Insurance expense 3 500 Other operating expenses 81 500 Profit for the year

$ 436 500

409 500 $ 27 000

16.21

Chapter 16: Disclosure: statement of cash flows

BRILLEAUX LTD Statement of Changes in Equity for the year ended 30 June 2017 Share Other Retained capital reserves earnings $100 000 $ 141 400 27 000 (58 400 ) 70 000 $170 000 $ 110 000

Balance at 1/7/16 Profit the period Dividends paid Issue of share capital Balance at 30/6/17

Total $ 241 400 27 000 (58 400 ) 70 000 $ 280 000

Additional information (a) Land with an original cost of $44 800 was sold for cash of $34 800 during the year. (b) Machinery with a carrying amount of $25 000 (cost $33 000 and accumulated depreciation $8000) was sold for cash of $34 000. (c) Lease income is earned from leasing part of the land holdings that are in excess to operating needs. Required Prepare the statement of cash flows of Brilleaux Ltd for the year ended 30 June 2017 based on the direct method of presentation. Include a note disclosure to reconcile the net cash flows from operating activities with the profit for the year.

BRILLEAUX LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers

$424 000

Cash paid to suppliers, employees and other

(375 500)

Cash generated from operations

48 500

Interest paid

(11 900)

Net cash from operating activities

36 600

Cash flows from investing activities Proceeds from sale of land

34 800

Proceeds from sale of machinery

34 000

16.22

Chapter 16: Disclosure: statement of cash flows

Purchase of land

(40 000)

Purchase of machinery

(93 000)

Lease income received

7 500

Net cash used in investing activities

(56 700)

Cash flows from financing activities Proceeds from issue of share capital

70 000

Proceeds from borrowings

25 000

Dividends paid

(58 400)

Net cash used in financing activities

36 600

Net increase (decrease) in cash and cash equivalents

16 500

Cash and cash equivalents at beginning of period

6 500

Cash and cash equivalents at end of period

$23 000

Workings: Cash receipts from customers Accounts Receivable 37 500 Cash (from customers) 420 000 Balance c/d 457 500

Balance b/d Sales

424 000 33 500 457 500

Cash receipts = Sales + Decrease in Accounts Receivable = 420 000 +4 000 = 424 000

Cash payments to suppliers, employees and other

Balance b/d A/c Payable (purchases)*

Inventory 66 000 Cost of sales 297 000 Balance c/d 363 000

281 000 82 000 363 000

Accounts Payable 294 000 Balance b/d

22 000

*balancing item for reconstruction

Cash (paid to suppliers)

16.23

Chapter 16: Disclosure: statement of cash flows

Balance c/d

25 000 319 000

Cash (paid to employees etc) Balance c/d

Balance b/d Cash (insurance paid)

Inventory (purchases)

297 000 319 000

Other Accrued Expenses 79 000 Balance b/d 7 000 Other expenses 86 000

4 500 81 500 86 000

Prepaid Insurance 3 500 Insurance expense 2 500 Balance c/d 6 000

3 500 2 500 6 000

Cash paid = Cost of sales + Other expenses + Insurance expense + Increase in Inventory – Increase in Accounts Payable – Increase in Other Accrued Expenses – Decrease in Prepaid Insurance = 281 000 + 81 500 + 3 500 + 16 000 – 3 000 – 2 500 – 1 000 = 375 500

Interest paid Interest Payable 11 900 Balance b/d 3 000 Interest Expense 14 900

Cash (interest paid) Balance c/d

3 400 11 500 14 900

Interest paid = Interest Expense + Decrease in Interest Payable = 11 500 + 400 = 11 900

Land purchased for cash

Balance b/d Cash (purchase)

Land 44 800 Sale of land 40 000 Balance c/d 84 800

44 800 40 000 84 800

Machinery – at cost 300 000 Sale of machinery 93 000 Balance c/d

33 000 360 000

Machinery purchased for cash

Balance b/d Cash (purchase)

16.24

Chapter 16: Disclosure: statement of cash flows

Balance b/d Cash (purchase)

393 000

Machinery – net 233 000 Carrying amount sold 93 000 Depreciation expense Balance c/d 326 000

25 000 22 000 279 000 326 000

Other Explanations: • Proceeds from sale of land – refer additional information • Proceeds from sale of machinery – refer additional information • Dividends paid – refer the statement of changes in equity • Shares issued for cash – refer the statement of changes in equity • Lease income received as a result of investing activity– refer the statement of profit or loss • Proceeds from borrowings – refer the statements of financial position for the increase in the account

BRILLEAUX LTD Reconciliation for note disclosure 2017 Profit for the period

27 000

Add: Non-cash expenses: Depreciation expense

22 000

Add/(Less): Non-operating items Loss on sale of land

10 000

Gain on sale of machinery

(9 000)

Lease income

(7 500)

Add/(Less): Changes in accrual assets and liabilities Decrease in accounts receivable Increase in inventory

4 000 (16 000)

16.25

Chapter 16: Disclosure: statement of cash flows

Decrease in prepaid insurance

1 000

Increase in accounts payable

3 000

Decrease in interest payable

(400)

Increase in other accrued expenses

2 500

Net cash from operating activities

36 600

16.26

Chapter 16: Disclosure: statement of cash flows

Question 16.3

The reconstruction of accounts (formulae) approach

Selected financial statements of Sparko Ltd are shown below. SPARKO LTD Statements of Financial Position as at 30 June 2017 Assets Cash at bank $ 18 000 Accounts receivable 34 000 Inventory 112 000 Equipment 72 000 Accumulated depreciation – equipment (30 000 ) Land 40 000 Buildings 120 000 Accumulated depreciation – buildings (10 000 ) Total assets $ 356 000 Liabilities Accounts payable $ 52 000 Bank overdraft — Equity Share capital 214 000 Retained earnings 90 000 Total liabilities and equity $ 356 000

2016 $

— 28 000 96 000 60 000 (18 000 ) 80 000 120 000 (6 000 ) 360 000

48 000 20 000 200 000 92 000 360 000

SPARKO LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales revenue Less: Expenses: Cost of sales: Beginning inventory Add: Purchases Less: Ending inventory Depreciation – equipment Depreciation – buildings Interest expense Other expenses Loss on sale of land Loss on sale of equipment Profit for the year

96 000 112 000 (112 000 )

180 000

168 000 12 000

$ 96 000 14 000 4 000 2 000 38 000 8 000 6 000

Additional information (a) On 1 July 2016, the shareholders injected a capital contribution of $14 000 cash into the business. (b) During the year, equipment costing $12 000 and written down to a carrying amount of $10 000 was sold for $4000 cash. (c) Half of the land on hand at the beginning of the year was sold for $32 000 cash. (d) During the year, dividends to shareholders were declared and paid. © John Wiley and Sons Australia, Ltd 2015

16.27

Chapter 16: Disclosure: statement of cash flows

(e) The bank overdraft is considered to be an integral part of the company’s cash management arrangements. (f) Ignore income tax. Required Prepare the statement of cash flows of Sparko Ltd for the year ended 30 June 2017 based on the direct method of presentation. Include a note disclosure to reconcile the profit for the year with net cash flows from operating activities. SPARKO LTD Statement of Cash Flows For year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Net cash from operating activities

$174 000 (146 000) $28 000

Cash flows from investing activities Proceeds from sale of land Proceeds from sale of equipment Payment for equipment Net cash from investing activities

32 000 4 000 (24 000)

Cash flows from financing activities Proceeds from issue of shares Interest paid Dividends paid Net cash from financing activities

14 000 (2 000) (14 000)

12 000

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of the period Cash and cash equivalents at end of the period

(2 000) 38 000 (20 000) $18 000

16.28

Chapter 16: Disclosure: statement of cash flows

WORKINGS:

Receipts from customers Accounts Receivable 28 000 Cash (from customers) 180 000 Balance c/d 208 000

Balance b/d Sales revenue

174 000 34 000 208 000

Cash receipts = Sales – Increase in Accounts Receivable = 180 000 – 6 000 = 174 000

Payments to suppliers, employees and other

Cash (paid to suppliers) Balance c/d

Accounts Payable 108 000 Balance b/d 52 000 Purchases 160 000

48 000 112 000 160 000

Payments to suppliers and employees = $108 000 + $38 000 = $146 000 Cash paid = Cost of sales + Other expenses + Increase in Inventory – Increase in Accounts Payable = 96 000 + 38 000+ 16 000 – 4 000 = 146 000

Purchase of equipment

Balance b/d Purchase of equipment

Equipment - at cost 60 000 Cost of equipment sold 24 000 Balance c/d 84 000

12 000 72 000 84 000

Land 80 000 Cost of land sold 0 Balance c/d 80 000

40 000 40 000 80 000

Purchase of land

Balance b/d Purchase of land

16.29

Chapter 16: Disclosure: statement of cash flows

Dividend paid

Dividends paid Balance c/d

Retained Earnings 14 000 Balance b/d 90 000 Profit 104 000

92 000 12 000 104 000

Other Explanations: • Proceeds from issue of shares – refer increase in share capital in statement of financial position • Interest paid classified in financing activities is the same as interest expense as there is no interest payable or accrued interest • Proceeds from sale of land – refer additional information • Proceeds from sale of equipment – refer additional information

SPARKO LTD Reconciliation for note disclosure Profit for the year Add: Non-cash expenses: Depreciation – equipment Depreciation – buildings Add/(Less): Non-operating items Loss on sale of land Loss on sale of equipment Add/(Less): Changes in accrual assets and liabilities Increase in accounts receivable Increase in inventory Increase in accounts payable Net cash from operating activities

2017 12 000 14 000 4 000 8 000 6 000

(6 000) (16 000) 6 000 $ 28 000

16.30

Chapter 16: Disclosure: statement of cash flows

Question 16.4

The reconstruction of accounts (formulae) approach

Selected financial statements of The Big Figure Ltd are shown below. THE BIG FIGURE LTD Statements of Financial Position as at 30 June 2017 Assets Cash at bank Accounts receivable Inventory Land Buildings Accumulated depreciation – buildings Plant and equipment Accumulated depreciation – plant and equipment Total assets Liabilities Accounts payable Interest payable Provision for employee benefits Long-term loan Equity Share capital Retained earnings Total liabilities and equity

2016

43 000 84 500 113 500 25 000 265 000 (100 000 ) 40 000 (10 000 ) 461 000

67 000 250 3 000 66 250

125 000 199 500 461 000

62 000 76 000 124 000 62 500 137 500 (85 000 ) 40 000 (5 000 ) 412 000

60 500 750 8 750 45 000 125 000 172 000 412 000

THE BIG FIGURE LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales $ 443 500 Less: Expenses: Cost of sales $ 283 000 Employee expenses 98 000 Interest expense 5 000 Loss on the sale of land 6 250 Depreciation expense – buildings 15 000 Depreciation expense - plant and equipment 5 000 412 250 Profit for the year $ 31 250 Additional information (a) During the year ended 30 June 2017, cash dividends were paid to shareholders. (b) Building extensions were paid for during the year, and a block of land, costing $37 500 was sold for $31 250 cash. (c) No plant was purchased or sold during the year. Required A. Prepare the statement of cash flows of The Big Figure Ltd for the year ended 30 June © John Wiley and Sons Australia, Ltd 2015

16.31

Chapter 16: Disclosure: statement of cash flows

2017 based on the direct method of presentation. B. Show how cash flows from operating activities would be presented in the statement if the indirect method of presentation were used.

PART A. THE DIRECT METHOD OF PRESENTATION THE BIG FIGURE LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers $435 000 Cash paid to suppliers & employees (369 750) Cash generated from operations 65 250 Interest paid (5 500) Net cash from operating activities Cash flows from investing activities Proceeds on sale of land 31 250 Payment for buildings (127 500) Net cash used in investing activities Cash flows from financing activities Proceeds from borrowings 21 250 Dividends paid (3 750) Net cash from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

$59 750

(96 250)

17 500 (19 000) 62 000 $43 000

PART B. THE INDIRECT METHOD OF PRESENTATION THE BIG FIGURE LTD Cash Flows from Operating Activities for the year ended 30 June 2017 Cash from operating activities Profit Adjustments for: Depreciation – plant and equipment Depreciation – buildings Loss on sale of land Interest expense Increase in accounts receivable Decrease in inventories Increase in accounts payable Decrease in accrued expenses Cash generated from operations Interest paid Net cash from operating activities

$31 250 5 000 15 000 6 250 5 000 (8 500) 10 500 6 500 (5 750) 65 250 (5 500) $59 750

16.32

Chapter 16: Disclosure: statement of cash flows

WORKINGS Receipts from customers Accounts Receivable 76 000 Cash from customers 443 500 Balance c/d 519 500

Balance b/d Sales

435 000 84 500 519 500

Cash receipts = Sales – Increase in Accounts Receivable = 443 500 – 8 500 = 435 000

Payments to suppliers Inventory 124 000 Cost of sales 272 500 Balance c/d 396 500

283 000 113 500 396 500

Accounts Payable 266 000 Balance b/d 67 000 Inventory (purchases) 333 000

60 500 272 500 333 000

Provision for employee benefits 103 750 Balance b/d 3 000 Employee expenses 106 750

8 750 98 000 106 750

Balance b/d A/c Payable (purchases)* *balancing item for reconstruction

Cash (paid to suppliers) Balance c/d

Payments to employees

Cash (paid to employees) Balance c/d

Payments to suppliers and employees = $266 000 + $103 750 = $369 750 Cash paid = Cost of sales + Employee expenses – Decrease in Inventory – Increase in Accounts Payable + Decrease in Provision = 283 000 + 98 000 – 10 500 – 6 500 + 5 750 = 369 750

Interest paid Cash (interest paid) Balance c/d

Interest Payable 5 500 Balance b/d 250 Interest expense 5 750

750 5 000 5 750

16.33

Chapter 16: Disclosure: statement of cash flows

Dividends paid Dividends paid Balance c/d

Retained Earnings 3 750 Balance b/d 199 500 Profit 203 250

172 000 31 250 203 250

Buildings- at cost 137 500 127 500 Balance c/d 84 000

265 000 265 000

Land 62 500 Cost of land sold 0 Balance c/d 62 500

37 500 25 000 62 500

Long term loan Balance b/d 66 250 Cash (proceeds) 66 250

45 000 21 250 66 250

Purchase of buildings

Balance b/d Purchase of buildings

Purchase of land

Balance b/d Purchase of land

Proceeds from borrowings

Balance c/d

16.34

Chapter 16: Disclosure: statement of cash flows

Question 16.5

The reconstruction of accounts (formulae) approach

Keepit Ltd is seeking additional finance from its bank and the bank manager has asked for a statement of cash flows for the six months to 30 June 2017. From the data presented below, prepare the statement of cash flows based on the direct method of presentation. Also prepare a note reconciling net cash flow from operating activities to the profit for the year. KEEPIT LTD Statements of Financial Position as at 30 June 2017 Assets Cash at bank $ Trade debtors Inventory Equipment $ 75 000 Acc. depn – equipment (20 000 ) Buildings 430 000 Acc. depn – buildings (110 000 ) Total assets $ Liabilities Trade creditors $ Current tax liability Provision for dividend Loan due 2020 Equity Share capital Retained earnings Total liabilities and $ equity

2016

39 500 120 000 150 000

$ 55 000 320 000 684 500 120 000 17 000 30 000 80 000 420 000 17 500 684 500

110 000 (30 000 ) 330 000 (80 000 )

20 000 77 000 80 000 80 000

$ $

250 000 507 000 60 000 7 500 20 000 — 400 000 19 500 507 000

KEEPIT LTD Statement of Profit or Loss for six months to 30 June 2017

16.35

Chapter 16: Disclosure: statement of cash flows

Income Sales revenue Rent revenue Discount received Less: Expenses Cost of sales Discount allowed Bad debts Salaries and wages Loss on sale of equipment Depreciation – buildings Depreciation – equipment Profit before tax Less: Income tax expense Profit after tax

$ 485 000 14 000 1 000 365 000 1 500 4 500 39 000 5 000 30 000 10 000

$ 500 000

455 000 45 000 17 000 $ 28 000

Additional information (a) New demountable buildings were purchased for cash. (b) During the quarter, a dividend to shareholders was declared. (c) A loan was raised during the year to provide cash for working capital needs. (d) Equipment that had cost $35 000 and been depreciated by $20 000 was sold for cash of $10 000. KEEPIT LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated from operations Rent received Income tax paid Net cash from operating activities Cash flows from investing activities Payment for demountable buildings Proceeds from sale of equipment

$436 000 (413 000) 23 000 14 000 (7 500) $29 500

(100 000) 10 000

16.36

Chapter 16: Disclosure: statement of cash flows

Net cash used in investing activities

(90 000)

Cash flows from financing activities Proceeds from issue of shares Proceeds from borrowings Dividends paid Net cash provided by financing activities

20 000 80 000 (20 000) 80 000

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

19 500 20 000 $39 500

Reconciliation of Net Cash from Operating Activities with Profit Profit Depreciation Loss on sale of equipment Increase in current tax liability Increased in trade debtors Increase in inventories Increase in trade creditors Net cash from operating activities

$28 000 40 000 5 000 9 500 (43 000) (70 000) 60 000 $29 500

WORKINGS Receipts from customers Trade debtors 77 000 Discount allowed 485 000 Bad debts expense Cash (from customers) Balance c/d 562 000

Balance b/d Sales

Received From Customers $436 000

= Sales = $485 000

Begin accounts + rec'able + $77 000

Ending accounts - rec'able - $120 000

Discount + allowed - $1500

1 500 4 500 436 000 120 000 562 000

Bad - debts - $4500

Payments to suppliers and employees

Balance b/d Trade creditors (purchases)*

Inventory 80 000 Cost of sales 435 000 Balance c/d 515 000

365 000 150 000 515 000

*balancing item for reconstruction

16.37

Chapter 16: Disclosure: statement of cash flows

Trade Creditors 1 000 Balance b/d 374 000 Inventory (purchases) 120 000 495 000

Discount received Cash (paid to suppliers) Balance c/d

Cost of Sales

60 000 435 000 495 000

Paid to suppliers of goods $374 000

Begin = - invent. = $365 000 - $80 000

Ending + invent. + $150 000

Begin Ending trade trade + creditors - creditors + $60 000$120-0$120 000

Paid to employee other $39 000

Salaries Wages = Expense = $39 000

Ending accrued - expenses 0

Begin. prepaid - expenses 0

Begin accrued + expenses + 0

Disc - recd. - $1 000

Ending prepaid + expenses + 0

Payments to suppliers, employees and other = $374 000 + $39 000 = $413 000 Income tax paid Current Tax Liability 7 500 Balance b/d 17 000 Income tax expense 24 500

Cash (income tax paid) Balance c/d

Income tax paid $7 500

Income tax = expense = $17 000

Begin tax + payable + 7 500

7 500 17 000 24 500

Ending tax - payable 17 000

Demountable Buildings Balance b/d Payment for demountables

Buildings- at cost 330 000 100 000 Balance c/d 430 000

430 000 430 000

Retained Earnings 30 000 Balance b/d 17 500 Profit 47 500

19 500 28 000 47 500

Dividends paid Dividends declared* Balance c/d

16.38

Chapter 16: Disclosure: statement of cash flows

Cash (dividends paid) Balance c/d

Provision for dividend 20 000 Balance b/d 30 000 Dividend declared 50 000

20 000 30 000 50 000

Other Explanations: • Rent received – refer rent revenue in the statement of profit or loss (there are no accruals for rent apparent in the statements of financial position) • Proceeds from issue of shares – refer change in share capital in the statement of financial position • Proceeds from borrowings – refer change in loan due 2020 in the statement of financial position • Proceeds from sale of land – refer additional information

16.39

Chapter 16: Disclosure: statement of cash flows

Question 16.6

The reconstruction of accounts (formulae) approach

From the following information of Outofsight Ltd, prepare a statement of cash flows for the year ended 30 June 2017 based on the direct method of presentation. Include any appropriate notes. OUTOFSIGHT LTD Statements of Financial Position as at 30 June 2017 2016 Assets Petty cash $ 400 $ 200 Cash at bank 30 600 24 200 Bank bills 12 000 10 000 Accounts receivable $ 127 400 $ 102 960 Allowance for doubtful debts (11 400 ) 116 000 (6 960 ) 96 000 Inventory 70 800 74 600 Motor vehicles 50 400 42 000 Acc. depn – motor vehicles (12 800 ) 37 600 (10 000 ) 32 000 Office furniture 18 400 16 000 Acc. depn – office furniture (8 400 ) 10 000 (7 600 ) 8 400 Total assets $ 277 400 $ 245 400 Liabilities Accounts payable $ 47 200 $ 45 000 Current tax liability 4 200 3 200 Equity Share capital 196 000 165 000 Retained earnings 30 000 32 200 Total liabilities and equity $ 277 400 $ 245 400 OUTOFSIGHT LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales revenue Proceeds from sale of vehicle Less: Expenses Cost of sales Salaries and wages Doubtful debts Depreciation – motor vehicles Depreciation – office equipment Carrying amount of vehicle sold Profit before tax Less: Income tax expense Profit after tax

750 000 3 000

753 00 0

603 000 116 360 14 440 6 000 800 2 400

743 00 0 10 000 4 20 0 5 80 0

Additional information © John Wiley and Sons Australia, Ltd 2015

16.40

Chapter 16: Disclosure: statement of cash flows

(a) A dividend was paid during the year. (b) The terms of the bank bills do not exceed 90 days.

OUTOFSIGHT LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated from operations Income tax paid Net cash from operating activities Cash flows from investing activities Payment for vehicle Payment for office furniture Proceeds from sale of vehicle Net cash used in investing activities Cash flows from financing activities Proceeds from issue of shares Dividends paid Net cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period* Cash and cash equivalents at end of period**

$715 560 (713 360) 2 200 (3 200) $(1 000) (14 000) (2 400) 3 000 (13 400) 31 000 (8 000) 23 000 8 600 34 400 $43 000

Note 1: Cash and cash equivalents consist of cash on hand, balances with banks, and investments in money market instruments. Cash and cash equivalents included in the statement of cash flows comprise the following amounts included in the statement of financial position: 2017 2016 Cash on hand $ 400 $ 200 Cash balances with banks $30 600 $24 200 Short-term investments – bank bills 12 000 10 000 Cash and cash equivalents $43 000 $34 400

Note 2: Reconciliation of Net Cash from Operating Activities with Profit Profit Depreciation Allowance for doubtful debts Gain on sale of vehicle Current tax liability Change in assets and liabilities Increase in trade debtors Decrease in inventories Increase in trade creditors

$5 800 6 800 4 440 (600) 1 000 (24 440) 3 800 2 200

16.41

Chapter 16: Disclosure: statement of cash flows

Net cash from operating activities

$(1 000)

Workings Receipts from customers Allowance for Doubtful Debts 10 000 Balance b/d

Accounts receivable* (bad debts written off) Balance c/d

11 400 495 000

6 960

Doubtful debts expense

14 440 21 400

*balancing item for reconstruction

Accounts Receivable 102 960 Allowance for doubt debts 750 000 (bad debts written off) Cash (from customers) Balance c/d 852 960

Balance b/d Sales

Received From Customers $715 560

= Sales = $750 000

Begin. accounts + rec'able + $102 960

Ending Accounts Rec'able $127 400

10 000 715 560 127 400 852 960

Bad debts Written Off $10 000

Payments to suppliers and employees

Balance b/d A/c Payable (purchases)*

Inventory 74 600 Cost of sales 599 200 Balance c/d 673 800

603 000 70 800 673 800

Accounts Payable 597 000 Balance b/d 47 200 Inventory (purchases) 644 200

45 000 599 200 644 200

*balancing item for reconstruction

Cash (paid to suppliers) Balance c/d

Payments suppliers of goods $597 000

Cost of Begin = Sales - invent. = $603 000 - $74 600

Ending + invent. + $70 800

Begin Ending accounts accounts + payable - Payable + $45 000$120-$ $47 200

Disc - recd. - $0

Payments to employees = Salaries and wages expense = $116 360

16.42

Chapter 16: Disclosure: statement of cash flows

Cash payments to suppliers and employees = $597 000 + $116 360 = $713 360 Income tax paid Current Tax Liability 3 200 Balance b/d 4 200 Income tax expense 7 400

Cash (income tax paid) Balance c/d

Income tax paid $3 200

Income tax = expense = $4 200

Begin tax + payable + 3 200

3 200 4 200 7 400

Ending tax - payable 4 200

Purchase of vehicles for cash Vehicles - Net (Cost less Accumulated Depreciation) Balance b/d 32 000 Carrying amount of vehicle sold Depreciation expense Cash (purchase) 14 000 Balance c/d 46 000

2 400 6 000 37 600 46 000

Dividends paid Dividends paid Balance c/d

Retained Earnings 8 000 Balance b/d 30 000 Profit 38 000

32 200 5 800 38 000

Other Explanations: • Payment for office furniture – refer change in the asset account at cost in the statement of financial position • Proceeds from issue of shares – refer change in share capital in the statement of financial position • Proceeds from sale of vehicle – refer statement of profit or loss

16.43

Chapter 16: Disclosure: statement of cash flows

Question 16.7

The reconstruction of accounts (formulae) approach

The trial balances of Cheque Book Ltd for 30 June 2016 and 30 June 2017 are shown below. CHEQUE BOOK LTD Trial Balances as at 30 June 2016 2017 Debit Credit Debit Credit Accounts payable $ 6 253 $ 5 916 Bank overdraft 1 390 8 432 Current tax liability 3 000 4 000 Share capital 30 000 45 000 General reserve 5 000 7 500 Retained earnings (opening) 3 573 4 382 Petty cash $ 25 $ 25 Accounts receivable 6 537 10 975 Allowance for doubtful debts 500 1 000 Inventory 18 258 30 289 Machinery 24 900 39 200 Accumulated depn – mach. 2 745 5 750 Office furniture 5 000 3 900 Accumulated depn – furn. 1 450 1 500 Sales revenue 85 000 100 000 Gain on sale of machinery — 50 Cost of sales 30 000 35 000 Employee expenses 47 321 49 943 Doubtful debts expense 1 500 1 700 Depreciation expense 2 550 3 075 Income tax expense 2 820 2 743 Dividend declared and paid — 4 000 Transfer to general reserve — 2 500 $ 138 911 $ 138 911 $ 183 350 $ 183 350 Additional information (a) Office furniture that had originally cost $1100 and had accumulated depreciation of $200 was sold during the year for cash. (b) A machine costing $5000 was acquired in exchange for the issue of 5000 shares at a price of $1 each. (c) The bank overdraft facility is considered part of the day-to-day cash management of the company. Required A. Prepare the statement of cash flows of Cheque Book Ltd for 30 June 2017 based on the direct method of presentation. B. Prepare the required notes to the statement. Also prepare a note that explains the difference between the net cash from operating activities and profit after tax for the year.

16.44

Chapter 16: Disclosure: statement of cash flows

CHEQUE BOOK LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash used in operations Income taxes paid Net cash from operating activities

$94 362 (97 311) (2 949) (1 743)

Cash flows from investing activities Purchase of machinery Proceeds from sale of office equipment Net cash used in investing activities

(9 300) 950

Cash flows from financing activities Proceeds from issue of shares Dividends paid Net cash provided by financing activities

10 000 (4 000)

$(4 692)

(8 350)

6 000

Net decrease in cash and cash equivalents

(7 042)

Cash and cash equivalents at beginning of period

(1 365)

Cash and cash equivalents at end of period

$(8 407)

16.45

Chapter 16: Disclosure: statement of cash flows

Note 1: Cash and cash equivalents Cash and cash equivalents included in the statement of cash flows are comprised of the following amounts included in the statement of financial position: 2017 $ 25 (8 432) $ (8 407)

Cash on hand Bank Overdraft Cash and cash equivalents

2016 $ 25 (1 390) $ (1 365)

The bank overdraft is integral to the company’s cash management function.

Note 2: Non-cash Financing and Investing Activities During the reporting period, machinery of $5 000 was acquired in exchange for the issue of 5 000 shares.

Note 3: Reconciliation of Net Cash from Operating Activities with Profit Profit for the year Depreciation Allowance for doubtful debts Gain on sale of furniture Change in assets and liabilities Increase in accounts receivable Increase in inventory Decrease in accounts payable Increase in current tax liability Net cash from operating activities

$7 589 3 075 500 (50) (4 438) (12 031) (337) 1 000 $(4 692)

Workings Receipts from customers

Accounts receivable* (bad debts written off) Balance c/d

Allowance for Doubtful Debts 1 200 Balance b/d 1 000 2 200

Doubtful debts expense

500 1 700 2 200

*balancing item for reconstruction

Balance b/d Sales revenue

Accounts Receivable 6 537 Allowance for doubt debts 100 000 (bad debts written off) Cash (from customers) Balance c/d 106 537

1 200 94 362 10 975 106 537

16.46

Chapter 16: Disclosure: statement of cash flows

Received From customers = Sales $94 362 = $100 000

Begin Accnts + rec'able + $6 537

Ending Accnts - rec'able - $10 975

Bad debts - w/o - $1 200

Payments to suppliers

Balance b/d A/c Payable (purchases)*

Inventory 18 258 Cost of sales 47 031 Balance c/d 65 289

35 000 30 289 65 289

Accounts Payable 47 368 Balance b/d 5 916 Inventory (purchases) 53 284

6 253 47 031 53 284

*balancing item for reconstruction

Cash (paid to suppliers) Balance c/d

Payments to suppliers of goods $47 368

Cost of sales

Begin = - invent = $35 000 - $18 258

Payments to Employee $49 943

Begin. accrued + expenses + 0

= Expense = $49 943

Ending + invent. + $30 289

Begin accts + payable + $6 253

Ending accts - payable - $5 916

Ending Begin Ending accrued prepaid prepaid expenses - expenses + expenses 0 0 + 0

Cash payments to suppliers and employees = $47 368 + $49 943 = $97 311

Income tax paid

Cash (income tax paid) Balance c/d

Income tax paid $1 743

Income tax = expense = $2 743

Current Tax Liability 1 743 Balance b/d 4 000 Income tax expense 5 743

Begin tax + payable + 3 000

3 000 2 743 5 743

Ending tax - payable 4 000

16.47

Chapter 16: Disclosure: statement of cash flows

Purchase of machinery Machinery - at cost 24 900 5 000 9 300 Balance c/d 39 200

Balance b/d Share capital Cash (purchase)

39 200 39 200

Purchase of office furniture Office Furniture – at cost 5 000 Sale of office furniture (Cost of furn. sold) 0 Balance c/d 5 000

Balance b/d Cash (purchase)

1 100 3 900 5 000

Proceeds from sale of office furniture Sale of Office Furniture 1 100 Accumulated depn (Accum depn of furn. sold) 50 Proceeds from sale

Office furniture (Cost of furn. sold) Gain on sale of furn.

1 150

200 950 1 150

Gain on sale = Proceeds less Carrying amount of equip sold Proceeds = Gain on sale + Carrying amount of equip sold = $50 + $900 = $950 Accum. Depreciation – Office Furniture Sale of equipment 200 Balance b/d Balance c/d 1 500 Depreciation expense – office furniture* 1 700 *balancing item for reconstruction

1 450 250 1 700

Proceeds from issue of shares

Balance c/d

Share Capital Balance b/d Machinery 45 000 Cash (proceeds) 45 000

30 000 5 000 10 000 45 000

Dividends paid

16.48

Chapter 16: Disclosure: statement of cash flows

Cost of sales Employee expenses Doubtful debts Depreciation expense Income tax expense Profit for the year*

Profit or Loss Summary 35 000 Sales revenue 49 943 Gain on sale of machinery 1 700 3 075 2 743 7 589 100 050

100 000 50

100 050

*balancing item for reconstruction

Dividends declared and paid Transfer to general reserve Balance c/d*

Retained Earnings 4 000 Balance b/d 2 500 Profit for the year 5 471 11 971

4 382 7 589 11 971

*balancing item for reconstruction

Other Explanations: • Dividends paid refer the trial balance

16.49

Chapter 16: Disclosure: statement of cash flows

Question 16.8

The reconstruction of accounts (formulae) approach

The statements of financial position of Allthrough Ltd as at 30 June 2017 and 30 June 2016 are presented below. ALLTHROUGH LTD Statements of Financial Position as at 30 June 2017 2016 Current assets Cash at bank $ $ 74 600 — Accounts receivable 127 200 111 300 Inventory 275 000 221 200 Prepayments 22 800 23 000 Non-current assets Buildings 639 000 339 000 Accumulated depreciation – buildings (111 400 ) (97 600 ) Equipment 361 200 331 200 Accumulated depreciation – equipment (89 900 ) (67 000 ) Land 168 000 39 000 Long-term investments 70 000 160 000 Total assets 1 461 900 $ 1 134 700 Current liabilities Bank overdraft $ 16 700 $ — Accounts payable 215 000 218 000 Accrued expenses 10 500 14 000 Current tax liability 26 000 24 000 Non-current liabilities Loan payable $ 240 000 $ 150 000 Debentures due 1/9/21 300 000 200 000 Total liabilities 808 200 606 000 Net assets 653 700 528 700 Equity Share capital $ 502 100 $ 388 100 Retained earnings 151 600 140 600 Total equity $ 653 700 $ 528 700 Examination of the company’s general ledger accounts revealed the following: (a) Depreciation expense was recorded during the year as follows: buildings $13 800; and equipment $22 900. (b) An extension was added to the building at a cost of $300 000 cash. (c) Long-term investments with a cost of $90 000 were sold for $125 000. (d) Vacant land next to the company’s plant was purchased for $129 000 with payment consisting of $39 000 cash and a loan payable for $90 000 due on 31 July 2018. (e) Debentures of $100 000 were issued for cash at nominal value. (f) Thirty thousand shares were issued at $3.80 per share. (g) Equipment was purchased for cash. (h) Sales for the period were $875 600; cost of sales amounted to $525 300; other expenses (excluding depreciation, carrying amount of investments sold, interest, and bad debts) amounted to $149 400. (i) Bad debts of $3500 were written off. (j) Income tax paid during the year amounted to $73 700.

16.50

Chapter 16: Disclosure: statement of cash flows

(k) Interest expense and interest paid amounted to $40 000. (l) The bank overdraft is integral part of the company’s cash management function. Required A. Prepare the statement of cash flows of Allthrough Ltd for the year ended 30 June 2017 using the direct method of presentation. B. Prepare a note disclosure to reconcile net cash flows from operating activities with the profit for the year and also prepare any other notes required by AASB 107. A. ALLTHROUGH LTD Statement of Cash Flows for the year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers, employees and other Cash generated from operations Interest paid Income taxes paid Net cash from operating activities

$856 200 (734 800) 121 400 (40 000) (73 700)

Cash flows from investing activities Payment for equipment Payments for property Proceeds from sale of investments Net cash used in investing activities

(30 000) (339 000) 125 000

Cash flows from financing activities Proceeds from issue of shares Proceeds from issue of debentures Dividends paid Net cash provided by financing activities

114 000 100 000 (69 000)

$7 700

(244 000)

145 000

Net decrease in cash and cash equivalents

(91 300)

Cash and cash equivalents at beginning of period

74 600

Cash and cash equivalents at end of period

$(16 700)

16.51

Chapter 16: Disclosure: statement of cash flows

B. Note 1: Cash and cash equivalents Cash and cash equivalents included in the statement of cash flows are comprised of the following amounts included in the statement of financial position:

Cash at bank Bank Overdraft Cash and cash equivalents

2017 $ – (16 700) $(16 700)

2016 $ 74 600 – $ 74 600

The bank overdraft is integral to the company’s cash management function.

Note 2: Non-cash Financing and Investing Activities During the period, property was acquired for $129 000, part of the purchase consideration amounting to $90 000 is deferred until July 2018

Note 3: Reconciliation of Net Cash from Operating Activities with Profit Profit for the year Depreciation Gain on sale of investments Change in assets and liabilities Increase in accounts receivable Increase in inventory Decrease in prepayments Decrease in accounts payable Decrease in accrued expenses Increase in current tax liability Net cash from operating activities

$80 000 36 700 (35 000) (15 900) (53 800) 200 (3 000) (3 500) 2 000 $7 700

16.52

Chapter 16: Disclosure: statement of cash flows

Workings Receipts from customers Accounts Receivable 111 300 Bad debts expense 875 600 Cash (from customers) Balance c/d 986 900

Balance b/d Sales

Received From Customers $856 200

= Sales = $875 600

+ +

Begin Accounts rec'able $111 300

Ending accounts - Rec'able - $127 200

3 500 856 200 127 200 986 900

Bad debts $3 500

Payments to suppliers, employees and other

Balance b/d A/c Payable (purchases)*

Inventory 221 200 Cost of sales 579 100 Balance c/d 800 300

525 300 275 000 800 300

Accounts Payable 582 100 Balance b/d 215 000 Inventory (purchases) 797 100

218 000 579 100 797 100

*balancing item for reconstruction

Cash (paid to suppliers) Balance c/d

Payments suppliers of goods $582 100

Cost of = sales = $525 300

Begin - invent - $221 200

Ending + invent. + $275 000

Begin Accts + payable + $218 000

Prepayments and Accrued Expenses Liability (Net) Balance b/d 9 000 Other operating expenses Cash (paid employees/other) 152 700 Balance c/d 161 700

Payments Employees Other $152 700

= Expense = $149 400

Begin. accrued + expenses + $14 000

Ending accrued - expenses - $10 500

Begin prepaid - expenses - $23 000

Ending Accts - Payable - $215 000

149 400 12 300 161 700

Ending prepaid + expenses + $22 800

16.53

Chapter 16: Disclosure: statement of cash flows

Cash payments to suppliers and employees = $582 100 + $152 700 = $734 800

Income tax paid Current Tax Liability 73 700 Balance b/d 26 000 Income tax expense* 99 700

Cash (income tax paid) Balance c/d

24 000 75 700 99 700

*balancing item for reconstruction

Dividends paid Profit or Loss Summary Cost of sales 525 300 Sales revenue 875 600 Other operating expenses 149 400 Proceeds from sale of invest 125 000 Depn expense - buildings 13 800 Depn expense - equipment 22 900 Cost of investments sold 90 000 Bad debts expense 3 500 Interest expense 40 000 Income tax expense 75 700 Profit for the year* 80 000 1 000 600 1 000 600 *balancing item for reconstruction

Dividends paid Balance c/d

Retained Earnings 69 000 Balance b/d 151 600 Profit 220 600

140 600 80 000 220 600

Other Explanations: Interest paid – additional info item (k) Income taxes paid – additional info item (j) Purchase of equipment – additional info item (g) ($361 200 – $331 200 = $30 000) Purchase of property – additional info items (b) and (d) ($300 000 + 39 000 = $339 000) Proceeds from sale of investments – additional info item (c ) Proceeds from issue of shares – additional info item (f) (30 000 x $3.80= $114 000) Proceeds from long term borrowings – additional info item (e)

16.54

Chapter 16: Disclosure: statement of cash flows

Question 16.9

The reconstruction of accounts (formulae) approach

The draft statements of financial position of Thecity Ltd as at 30 June 2017 and 30 June 2016 are presented below. THECITY LTD Statements of Financial Position as at 30 June 2017 2016 Assets Cash at bank $ 54 800 $ 42 000 Bank bills 10 000 8 600 Deposits at call 6 400 5 000 Accounts receivable 49 300 37 800 Allowance for doubtful debts (2 500 ) (1 900 ) Inventory 94 200 96 600 Prepaid expenses 10 800 4 200 Interest receivable 1 600 1 800 Share investments 35 600 67 800 Land 70 000 70 000 Buildings 360 000 240 000 Accumulated depreciation – buildings ( 104 400 ) (94 500 ) Equipment 180 000 154 800 Accumulated depreciation – equipment (57 900 ) (69 600 ) Deferred tax asset 14 400 12 200 Total assets $ 722 300 $ 574 800 Liabilities Accounts payable $ 120 520 $ 93 960 Accrued expenses 9 780 8 340 Interest payable 4 000 3 000 Current tax liability 13 600 15 000 Bank overdraft 34 800 32 000 Finance lease 50 000 — Debentures (10%) 180 000 150 000 Deferred tax liability 23 000 20 000 Equity Share capital (ordinary shares, issued at $1) 206 240 184 900 Retained earnings 80 360 67 600 Total liabilities and equity $ 722 300 $ 574 800 THECITY LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales Interest income Dividend income Discount received Gain on sale of share investments

$ 1 386 000 4 360 7 200 2 100 22 600 1 422 260

Less: Expenses © John Wiley and Sons Australia, Ltd 2015

16.55

Chapter 16: Disclosure: statement of cash flows

Cost of sales $ 932 000 Bad debts expense 2 800 Loss on sale of equipment 1 600 Depreciation – equipment 10 500 Depreciation – buildings 9 900 Discount allowed 950 Interest expense 18 400 Employee and other expenses 418 950 1 395 100 Profit before tax 27 160 Less: Income tax expense (14 400 ) Profit after tax $ 12 760 Additional information in relation to the year ended 30 June 2017 (a) New equipment was purchased at a cost of $67 400 of which $17 400 was paid in cash. The balance was covered by taking out a finance lease. (b) Equipment, which cost $42 200 and had a carrying amount of $20 000 was sold for cash. (c) Debentures were issued at nominal value ($100 each) for cash. (d) Share investments with an original cost of $32 200 were sold for cash. (e) Bank bills held and bank overdraft form part of cash and cash equivalents. Required Prepare the statement of cash flows of Thecity Ltd for the year ended 30 June 2017 in accordance with AASB 107 using either of the direct method or indirect method of presentation.

A. Direct method THECITY LTD Statement of Cash Flows For year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers, employees and other Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Cash flows from investing activities Interest received Dividends received Purchase of equipment Purchase of buildings Proceeds from sale of investments Proceeds from sale of equipment Net cash used in investing activities Cash flows from financing activities Proceeds from issue of shares Proceeds from issue of debentures

$1 371 350 (1 325 050) 46 300 (17 400) (15 000) $13 900 4 560 7 200 (17 400) (120 000) 54 800 18 400 (52 440) 21 340 30 000

16.56

Chapter 16: Disclosure: statement of cash flows

Net cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

51 340 12 800 23 600 $36 400

Cash at bank Bank bills held Deposits at call Bank Overdraft Cash and cash equivalents

2016 $ 42 000 8 600 5 000 (32 000) $ 23 600

Note 2: Non-cash Financing and Investing Activities During the period, new equipment was acquired for $67 400, part of the purchase consideration amounting to $50 000 is subject to a finance lease.

Workings Receipts from customers

Accounts receivable* (bad debts written off) Balance c/d

Allowance for Doubtful Debts 2 200 Balance b/d 2 500 4 700

Bad debts expense

1 900 2 800 4 700

*balancing item for reconstruction

Balance b/d Sales revenue

Accounts Receivable 37 800 Allowance for doubt debts 1 386 000 (bad debts written off) Discount allowed Cash (from customers) Balance c/d 1 423 800

2 200 950 1 371 350 49 300 1 423 800

Cash receipts = Sales – Increase in Accounts Receivable – Bad debts written off – Discount allowed = 1 386 000 – 11 500 – 2 200 – 950 = 1 371 350

Payments to suppliers, employees and other

16.57

Chapter 16: Disclosure: statement of cash flows

Inventory 96 600 Cost of sales 929 600 Balance c/d 1 026 200 *balancing item for reconstruction Balance b/d A/c Payable (purchases)*

Discount received Cash (paid to suppliers) Balance c/d

Accounts Payable 2 100 Balance b/d 900 940 Inventory (purchases) 120 520 1 023 560

Prepaid Expenses / Accrued Expenses Liability (Net) Balance b/d (Prepaid exp) 4 200 Balance b/d (Accrued exp) Cash (paid employees/other) 424 110 Employee other expenses Balance c/d (Accrued exp) 9 780 Balance c/d (Prepaid exp) 438 090

932 000 94 200 1 026 200

93 960 929 600 1 023 560

8 340 418 950 10 800 438 090

Cash paid to suppliers & employees = $900 940 + $424 110 = $1 325 050 Cash paid = Cost of sales + Employee/Other expenses – Discount received – Decrease in Inventory – Increase in Accounts Payable + Increase in Prepaid expenses – Increase in Accrued Expenses = 932 000 + 418 950 – 2 100 – 2 400 – 26 560 + 6 600 – 1 440 = 1 325 050

Interest paid Cash (interest paid) Balance c/d

Interest Payable 17 400 Balance b/d 4 000 Interest expense 21 400

3 000 18 400 21 400

Interest paid = Interest Expense – Increase in Interest Payable = 18 400 – 1 000 = 17 400

Income taxes paid Journal entry: Income Tax Expense Deferred Tax Asset Current Tax Liability Deferred Tax Liability

Dr Dr Cr Cr

14 400 2 200 13 600 3 000

16.58

Chapter 16: Disclosure: statement of cash flows

Current Tax Liability 15 000 Balance b/d 13 600 ITE/DTA/DTL 28 600

Cash (income tax paid) Balance c/d

15 000 13 600 28 600

Income tax paid = Income tax expense + Decrease in Current tax liability + Increase in Deferred tax asset – Increase in Deferred tax liability = 14 400 + 2 200 + 1 400 – 3 000 = 15 000

Interest received Interest Receivable 1 800 Cash (interest received) 4 360 Balance c/d 6 160

Balance b/d Interest income

4 560 1 600 6 160

Interest received = Interest Income + Decrease in Interest Receivable = 4 360 + 200 = 4 560

Proceeds from sale of investments

Share investments (cost of investments sold) Gain on sale

Sale of Investments 32 200 Proceeds from sale

54 800

22 600 54 800

54 800

Gain on sale = Proceeds – Carrying amount of asset sold Proceeds= Gain on sale + Carrying amount of asset sold = 22 600 + 32 200 = 54 800

Proceeds from sale of equipment

Loss on sale Proceeds from sale

Sale of Equipment Equipment 1 600 (carrying amount sold) 18 400 20 000

20 000

Loss on sale = Proceeds – Carrying amount of asset sold Proceeds= Loss on sale + Carrying amount of asset sold

16.59

Chapter 16: Disclosure: statement of cash flows

– 1 600 + 20 000 = 18 400

Purchase of equipment

Balance b/d Finance lease liability Cash (purchase)

Equipment – at cost 154 800 Sale of equipment (Cost of equip sold) 50 000 17 400 Balance c/d 222 200

180 000 222 200

Retained Earnings 0 Balance b/d 80 360 Profit 80 360

67 600 12 760 80 360

42 200

Dividends paid

Dividends paid Balance c/d

B. Indirect method THECITY LTD Statement of Cash Flows (extract) For year ended 30 June 2017 Cash flows from operating activities Profit before tax Depreciation – equipment Depreciation – buildings Loss on sale of equipment Interest expense Gain on sale of share investments Interest income Dividend income Increase in accounts receivable Increase in allowance for doubtful debts Decrease in inventory Increase in prepaid expenses Increase in accounts payable Increase in accrued expenses Cash generated from operations Interest paid Income tax paid Net cash from operating activities

$27 160 10 500 9 900 1 600 18 400 (22 600) (4 360) (7 200) (11 500) 600 2 400 (6 600) 26 560 1 440 46 300 (17 400) (15 000) $13 900

16.60

Chapter 16: Disclosure: statement of cash flows

Question 16.10

The reconstruction of accounts (formulae) approach

Selected financial statements of Imahog Ltd are shown below. IMAHOG LTD Statements of Financial Position as at 30 June 2017 Assets Cash at bank $ 82 000 Accounts receivable 121 600 Allowance for doubtful debts (10 100 ) Inventory 132 000 Interest receivable 860 Prepaid insurance 960 Marketable securities 35 000 Plant and equipment 416 000 Accumulated depreciation – plant and (74 600 ) equipment 8 200 Deferred tax asset Total assets $ 711 920 Liabilities Bank overdraft $ 7 600 Accounts payable 69 000 Provision for employee benefits 11 620 Accrued interest 2 680 Unearned revenue 1 100 Current tax liability 6 800 Final dividend payable 40 000 Convertible notes 80 000 Deferred tax liability 6 400 Total liabilities 225 200 Net assets $ 486 720 Equity Share capital (ordinary shares) 400 000 General reserve 40 000 Retained earnings 46 720 Total equity $ 486 720

2016 $

78 000 112 800 (8 900 ) 123 200 940 810 30 000 342 000 (62 300 ) 7 720

624 270

9 430 57 400 9 340 2 500 410 6 400 17 500 60 000 6 040 169 020 455 250

350 000 40 000 65 250 455 250

IMAHOG LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales Interest revenue Dividend revenue Discount received Proceeds — sale of plant Less: Expenses Cost of sales Carrying amount of plant sold

$ 432 000 1 200 1 500 680 12 000

$ 447 380

$ 261 840 10 500

16.61

Chapter 16: Disclosure: statement of cash flows

Depreciation – plant 31 800 Discount allowed 1 410 Bad debts expense 11 200 Insurance expense 1 200 Interest expense 2 120 Long-service leave expense 1 560 Wages expense 97 600 419 230 Profit before tax 28 150 Less: Income tax expense (6 680 ) Profit after tax $ 21 470 Additional information (a) The plant sold during the year originally cost $30 000. (b) 20 000 ordinary shares were issued for cash at a price of $2.50 per share. (c) 1250 ordinary shares in a company listed on the ASX were acquired for cash at a price of $4 per share. (d) The overdraft facility extends to a limit of $15 000 payable on demand. This facility is regarded as part of the overall cash management of the company. Required A. Prepare the statement of cash flows of Imahog Ltd for the year ended 30 June 2017 in accordance with AASB 107 either the direct method or indirect method of presentation. B. Prepare an appropriate note to the financial statement to justify the definition of cash and cash equivalents used. A. Direct Method IMAHOG LTD Statement of Cash Flows For year ended 30 June 2017 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers & employees Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Cash flows from investing activities Proceeds on sale of plant Purchase of plant Purchase of marketable securities (shares) Dividends received Interest received Net cash used in investing activities Cash flows from financing activities Proceeds from issue of shares Proceeds from long-term borrowings Dividends paid Net cash provided by financing activities

$412 480 (356 590) 55 890 (1 940) (6 400) $47 550 12 000 (104 000) (5 000) 1 500 1 280 (94 220) 50 000 20 000 (17 500)

52 500

16.62

Chapter 16: Disclosure: statement of cash flows

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

5 830 68 570 $74 400

Note 1: Cash and cash equivalents consist of cash on hand and balances with banks, investments in money market instruments (if any) and bank overdrafts used as an integral part of the cash management function. Cash and cash equivalents included in the statement of cash flows comprise the following balance sheet amounts: 2017 2016 Cash on hand and balances with banks $82 000 $78 000 Bank overdraft (7 600) (9 430) Cash and cash equivalents $74 400 $68 570

16.63

Chapter 16: Disclosure: statement of cash flows

Workings using ledger accounts

Cash receipts from customers

Allowance for Doubtful Debts ___________________________________________________________________ A/c receivable (written off) 10 000 Balance b/d 8 900 Balance c/d 10 100 Bad debts expense 11 200 20 100 20 100

Accounts Receivable/Unearned Revenue (Net) ___________________________________________________________________ Balance (A/c rec) b/d 112 800 Balance (A/c rec) c/d 121 600 Balance (Unearned rev) c/d 1 100 Balance (Unearned rev) b/d 410 Sales 432 000 Total written off 10 000 Discount allowed 1 410 ______ Cash (from customers) 412 480 545 900 545 900

Cash paid to suppliers, employees and other

Inventory ___________________________________________________________________ Balance b/d 123 200 Balance c/d 132 000 A/C payable (Purchases) 270 640 Cost of sales 261 840 393 840 393 840 Accounts Payable ___________________________________________________________________ Balance c/d 69 000 Balance b/d 57 400 Discount received 680 Cash (to suppliers) 258 360 Inventory (Purchases) 270 640 328 040 328 040 Provision for Employee Benefits ___________________________________________________________________ Balance c/d 11 620 Balance b/d 9 340 Cash (to employees) 96 880 Expenses* 99 160 108 500 108 500 *Expenses = LSL $1 560 + wages $97 600 = $99 160 Prepaid Insurance ___________________________________________________________________ Balance (prepaid insur) b/d 810 Balance (prepaid insur) c/d 960

16.64

Chapter 16: Disclosure: statement of cash flows

Cash (insurance paid)

1 350 2 160

Insurance Expenses

1 200 2 160

Paid to suppliers employees and other = $258 360 + $96 880 + $1 350= $356 590

Interest paid

Accrued Interest ___________________________________________________________________ Balance c/d 2 680 Balance b/d 2 500 Cash (interest paid) 1 940 Expense 2 120 4 620 4 620

Income taxes paid

Current Tax Liability ___________________________________________________________________ Cash (income tax paid) 6 400 Balance b/d 6 400 Balance c/d 6 800 ITE/DTA/DTL 6 800 13 080 13 080 Journal entries for income tax: Income Tax Expense (current) Deferred Tax Asset Deferred Tax Liability Current Tax Liability

Dr Dr Cr Cr

6 680 480 360 6 800

Cash paid for plant and equipment

Plant and Equipment at cost ___________________________________________________________________ Balance b/d 342 000 Balance c/d 416 000 Plant acquired 104 000 Cost of plant sold 30 000 446 000 446 000

Interest received

Interest Receivable ___________________________________________________________________ Balance b/d 940 Balance c/d 860 Interest revenue 1 200 Cash (interest received) 1 280 2 140 2 140

16.65

Chapter 16: Disclosure: statement of cash flows

Dividends paid = last year’s liability. There are no interim dividends.

Retained earnings ___________________________________________________________________ Balance c/d 46 720 Balance b/d 65 250 Dividends declared 40 000 Profit for the year 21 470 86 720 86 720 Final Dividend Payable ___________________________________________________________________ Balance c/d 40 000 Balance b/d 17 500 Cash (dividend paid) 17 500 Dividends declared 40 000 57 500 57 500

B. Indirect method IMAHOG LTD Statement of Cash Flows (extract) For year ended 30 June 2017 Cash flows from operating activities Profit before tax Depreciation – plant Proceeds on sale of plant Carrying amount of plant sold Interest revenue Dividend revenue Interest expense Increase in accounts receivable Allowance for doubtful debts Increase in inventory Increase in prepaid insurance Increase in accounts payable Increase in provision for employee benefits Increase in unearned revenue Cash generated from operations Interest paid Income tax paid Net cash from operating activities

$28 150 31 800 (12 000) 10 500 (1 200) (1 500) 2 120 (8 800) 1 200 (8 800) (150) 11 600 2 280 690 55 890 (1 940) (6 400) $47 550

16.66

Chapter 16: Disclosure: statement of cash flows

Question 16.11

The reconstruction of accounts (formulae) approach

Foryoubaby manufactures and distributes a range of educational products for babies and toddlers. Selected financial statements of Foryoubaby Ltd prepared for internal management purposes are provided below. FORYOUBABY LTD Statements of Financial Position as at 30 June 2017 2016 Changes Current assets Bank bills (due 31 July) $ 15 000 $ — $ 15 000 Deposits at call 83 000 41 000 42 000 Accounts receivable 277 000 220 000 57 000 Allowance for doubtful (14 500 ) (11 500 ) (3 000 ) debts 503 000 477 600 25 400 Inventory 40 000 45 000 (5 000 ) Prepaid expenses Total current assets 903 500 772 100 131 400 Non-current assets Deferred tax asset 2 200 2 000 200 Shares in Neerbub Ltd 225 000 375 000 (150 000 ) Buildings (cost) 1 950 000 1 350 000 600 000 Accumulated depreciation – (505 000 ) (469 000 ) (36 000 ) buildings 890 500 760 500 130 000 Equipment (cost) (289 500 ) (348 000 ) (58 500 ) Accumulated depreciation – 500 000 500 000 0 equipment Land (cost) Total non-current assets 2 773 200 2 170 500 602 700 Total assets 3 676 700 2 942 600 734 100 Current liabilities Bank overdraft $ 63 000 $ 107 000 $ (44 000 ) Accounts payable 433 500 457 600 (24 100 ) Provision for employee 33 750 29 500 4 250 benefits 25 000 22 500 2 500 Interest payable 180 000 195 000 (15 000 ) Dividend payable 72 000 60 000 12 000 Current tax liability Total current liabilities 807 250 871 600 (64 350 ) Non-current liabilities Deferred tax liability 7 500 6 500 1 000 Bank loan (secured) 180 000 100 000 80 000 Debentures 800 000 600 000 200 000 Total non-current 987 500 706 500 281 000 liabilities Total liabilities 1 794 750 1 578 100 216 650 Net assets $ 1 881 950 $ 1 364 500 $ 517 450 Equity Share capital $ 1 129 500 $ 889 500 $ 240 000

16.67

Chapter 16: Disclosure: statement of cash flows

Retained earnings Total equity

752 450 $ 1 881 950

475 000 $ 1 364 500

277 450 517 450

FORYOUBABY LTD Statement of Profit or Loss for the year ended 30 June 2017 Income Sales revenue Dividends received Proceeds from sale of share investment Proceeds from sale of equipment Discount received Total income Expenses Cost of sales Carrying amount of shares sold Carrying amount of equipment sold Depreciation expense – equipment Depreciation expense – buildings Interest expense Bad debts expense Discount allowed Employee and other expenses Profit before tax Income tax expense Profit after tax

$ 6 580 000 43 000 245 000 94 000 12 750 $ 6 974 750 3 475 000 150 000 15 000 46 500 36 000 73 000 14 650 5 250 2 411 100

FORYOUBABY LTD Statement of Changes in Equity for the year ended 30 June 2017 Share capital Other Retained reserves earnings $ 889 500 $ 475 000

6 226 500 748 250 (290 800 ) $ 457 450

Total

Balance at $ 1 364 500 1/7/16 Comprehensive 457 450 457 450 income for the (180 000 ) (180 000 ) period 240 000 240 000 Dividends $ 1 129 500 $ 752 450 $ 1 881 950 declared Issue of share capital Balance at 30/6/17 Additional information During the year, Foryoubaby Ltd entered into the following transactions relevant to the preparation of the statement of cash flows: (a) New equipment was purchased at a cost of $250 000; $150 000 was paid in cash and the balance covered using the company’s existing debt facilities. (b) Equipment with a cost of $120 000 and accumulated depreciation of $105 000 was sold for $94 000 cash.

16.68

Chapter 16: Disclosure: statement of cash flows

(c) Shares in Neerabup Ltd were sold for $245 000 cash. (d) Debentures (9%) were issued at nominal value for cash, $200 000. (e) An additional 40 000 ordinary shares were issued for cash at $6 per share. (f) The bank overdraft facility is used as part of the company’s everyday cash management facilities. (g) Repayments of loan principal amounting to $20 000 were made during the year. Required A. Prepare a statement of cash flows in accordance with AASB 107 using the direct method of presentation. B. Prepare notes as follows: (a) explain the composition of cash and cash equivalents using relevant accounts included in the statement of financial position; and (b) reconcile the net cash from operating activities to profit after tax. C. Comment on the company’s cash flows during the year ended 30 June 2017 and cash position at 30 June 2017. A. FORYOUBABY LTD Statement of Cash Flows for the year ended 30 June 2017

Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated from operations Interest paid Income taxes paid Net cash from operating activities

$6 506 100 (5 913 600) 592 500 (70 500) (278 000) $244 000

Cash flows from investing activities Payment for building additions Payment for equipment Dividends received Proceeds from sale of equipment Proceeds from sale of shares Net cash used in investing activities

(600 000) (250 000) 43 000 94 000 245 000

Cash flows from financing activities Proceeds from issue of shares Proceeds from issue of debentures Proceeds from bank borrowings Repayment of bank borrowings Dividends paid Net cash provided by financing activities

240 000 200 000 100 000 (20 000) (195 000)

(468 000)

325 000

Net increase in cash in cash and cash equivalents

101 000

Cash and cash equivalents at beginning of period

(66 000)

16.69

Chapter 16: Disclosure: statement of cash flows

Cash and cash equivalents at end of period

$ 35 000

B. Note 1: Cash and cash equivalents consist of cash on hand and balances with banks, investments in money market instruments (if any) and bank overdrafts used as an integral part of the cash management function. Cash and cash equivalents included in the statement of cash flows comprise the following statement of financial position amounts: 2017 2016 Bank bills (due 31 July) $ 15 000 Deposits at call 83 000 $ 41 000 Bank overdraft (63 000) (107 000) Cash and cash equivalents $ 35 000 $ (66 000)

Note 2: Reconciliation of Net Cash from Operating Activities with Profit Profit for the year Depreciation - equipment Depreciation – buildings Dividends received Gain on sale of equipment Gain on sale of share investment Change in assets and liabilities Increase in accounts receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Increase in accrued expenses Increase in interest payable Increase in allowance for doubtful debts Increase in current tax liability Increase in deferred tax liability Increase in deferred tax asset Net cash from operating activities

$457 450 46 500 36 000 (43 000) (79 000) (95 000) (57 000) (25 400) 5 000 (24 100) 4 250 2 500 3 000 12 000 1 000 (200) $244 000

The reporting period saw an increase in the cash position of the company of $101 000. Net cash from operating activities showed a strong result to the extent of $244 000. Considerable funds were provided by financing activities with share and debenture issues resulting in cash inflows of $440 000. The positive net cash inflows from operations and financing enabled considerable net spending of $468 000 on non current assets and the payment of a cash dividend. The net cash flow during the period was strong and resulted in an improved cash position at the end of the year, compared with the previous year.

16.70

Chapter 16: Disclosure: statement of cash flows

Workings Receipts from customers Allowance for Doubtful Debts 11 650 Balance b/d

Accounts receivable* (bad debts written off) Balance c/d

14 500 26 150

11 500

Bad debts expense

14 650 26 150

*balancing item for reconstruction Accounts Receivable 220 000 Allowance for doubt debts 6 580 000 (bad debts written off) Discount allowed Cash (from customers) Balance c/d 6 800 000

Balance b/d Sales revenue

Received From custom's 6 506 100

Begin accts = Sales + rec'able = 6 580 000 + 220 000

Ending accts - rec'able - 277 000

Disc - all - 5250

11 650 5 250 6 506 100 277 000 6 800 000

Bad debts - 11 650

Payments to suppliers, employees and other Inventory Balance b/d 477 600 Cost of sales A/c Payable (purchases)* 3 500 400 Balance c/d 3 978 000 *balancing item for reconstruction Accounts Payable 12 750 Balance b/d 3 511 750 Inventory (purchases) 433 500 3 958 000

Discount received Cash (paid to suppliers) Balance c/d

Payments suppliers of goods 3 511 750

Cost of sales = = 3 475 000

Begin invent 477 600

Ending + invent. + 503 000

3 475 000 503 000 3 978 000

457 600 3 500 400 3 958 000

Begin Ending accts accts + pay - pay + 457 600 - 433 500

Disc Recd 12 750

16.71

Chapter 16: Disclosure: statement of cash flows

Prepaid Expenses / Provision for Employee Benefits (Net) Balance b/d (Prepaid exp) 45 000 Balance b/d (Provision) 29 500 Cash (paid employees/other) 2 401 850 Employee other expenses 2 411 100 Balance c/d (Provision) 33 750 Balance c/d (Prepaid exp) 40 000 2 480 600 2 480 600

Payments For Services 2 401 850

= Expense = 2 411 100

Begin. accrued + expenses + 29 500

Ending accrued - expenses 33 750

Begin prepaid expenses 45 000

Ending prepaid + expenses + 40 000

Cash paid to suppliers, employees & other = $3 511 750 + $2 401 850 = $5 913 600

Interest paid Interest Payable 70 500 Balance b/d 25 000 Interest expense 95 500

Cash (interest paid) Balance c/d

Payment For Interest 70 500

= Expense = 73 000

Begin + accrued + interest + 22 500

22 500 73 000 95 500

Ending accrued interest 25 000

Income taxes paid Current Tax Liability 278 000 Balance b/d 72 000 ITE/DTA/DTL 350 000

Cash (income tax paid) Balance c/d

The entry for income tax is as follows Income Tax Expense Deferred Tax Asset Deferred Tax Liability Current Tax Liability

Dr Dr Cr Cr

290 800 200

Income Tax Paid 278

Begin DTL 6.5

End - DTL - 7.5

= =

ITE 290.8

Begin + CTL + 60

End - CTL - 72

+ +

60 000 290 000 350 000

1 000 290 000

Begin DTA 2

+ +

End DTA 2.2

16.72

Chapter 16: Disclosure: statement of cash flows

Purchase of equipment

Balance b/d Cash (purchase)

Sale of equipment Balance c/d

Equipment – at cost 760 500 Sale of equipment 250 000 Balance c/d 1 010 500

Accumulated Depreciation - Equipment 105 000 Balance b/d 289 500 Dep’n expense 394 500

120 000 890 500 1 010 500

348 000 46 500 394 500

Dividend paid

Cash (dividends paid) Balance c/d

Dividend Payable 195 000 Balance b/d 180 000 Dividends declared 375 000

195 000 180 000 375 000

Other explanations • Purchase of buildings – refer change in asset account in statement of financial position • Dividends received – refer statement of profit or loss (no dividends are receivable) • Proceeds from sale of equipment – refer statement of profit or loss • Proceeds from sale of investments – refer statement of profit or loss • Proceeds from issue of shares – refer change in share capital account in statement of financial position • Proceeds from bank borrowings – refer additional info item (a) • Repayment of bank borrowings – refer additional info item ((g)

16.73

Chapter 16: Disclosure: statement of cash flows

Question 16.12

The reconstruction of accounts (formulae) approach with a business acquisition

Selected financial statements of Oyeh Ltd are shown below. OYEH LTD Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2017 $000 $000 Income Sales revenue 25 745 Interest received 1 358 Proceeds on sale of equipment 113 27 216 Expenses Cost of sales 16 410 Employee expenses 4 248 Amortisation of licences 295 Depreciation 780 Doubtful debts 50 Carrying amount of equipment sold 80 Warranty expenses 1 210 Interest expense 291 Other operating expenses 3 133 26 497 Profit before tax 719 Income tax expense (384) Profit after tax 335 Other Comprehensive Income Revaluation increase on land 736 Income tax on revaluation increase (221) 515 Comprehensive income 850 OYEH LTD Statements of Financial Position as at 31 December 2017 $000 Current assets Cash at bank 4 961 Accounts receivable 6 924 Allowance for doubtful debts (144) Inventories 2 263 Prepayments 759 Non-current assets Marketable securities – at cost 1 700 Land - at fair value 1 336 Plant and equipment – at cost 5 327 Less: Accumulated depreciation (2 646) Deferred tax asset 451 Licences – at cost 5 398 Less: Accumulated amortisation (1 186)

2016 $000 4 667 4 973 (110) 1 779 601 60 400 5 104 (2 038) 323 3 811 (891)

16.74

Chapter 16: Disclosure: statement of cash flows

Total assets Current liabilities Accounts payable Bank loans Interest payable Provision for dividends Current tax liability Provision for employee benefits Provision for warranty Non-current liabilities Bank loans Deferred tax liability Shareholders’ equity Share capital General reserve Asset revaluation surplus Retained earnings Total liabilities and shareholders’ equity

Balance at 1/1/17 Comprehensive income Dividends declared Transfer to reserve Shares issued Shares bought back Balance at 31/12/17

25 143

18 679

4 527 3 055 31 340 345 570 255

2 416 1 816 20 260 135 392 —

5 000 785

6 000 665

4 750 803 515 4 167 25 143

2 000 770 — 4 205 18 679

OYEH LTD Statement of Changes in Equity for the year ended 31 December 2017 Share Retained Asset General Capital Earnings Revaluation Reserve Surplus $000 $000 $000 $000 2 000 4 205 — 770 335

515

$000 18 679 850

(340)

(33)

3 000 (250) 4 750

Total

— 3 000 (250)

4 167

515

803

25 143

Additional information During the year, Oyeh Ltd entered into the following transactions relevant to the preparation of the statement of cash flows: (a) On 15 July 2017, the company acquired the Woohoo business from a competitor. The details of the business acquisition were as follows: $000 Cash used to acquire Woohoo business 1 892 Fair value of the assets acquired and liabilities assumed © John Wiley and Sons Australia, Ltd 2015

16.75

Chapter 16: Disclosure: statement of cash flows

Accounts receivable

1 243

Inventories

284

Plant and equipment

182

Marketable securities

637

Licences Provision for employee benefits Accounts payable Bank loans – current

1 000 (154) (1 023) (277) 1 892

(b) Shares were issued and bought back during the period for cash. (c) The primary bank loan is a revolving credit facility with a limit of $10 000 000. Required A. Prepare the statement of cash flows of Oyeh Ltd for the year ended 31 December 2017 using the direct method of presentation. B. Prepare a note disclosure to reconcile net cash flows from operating activities with the profit for the year. A. OYEH LTD Statement of Cash Flows for the year ended 31 December 2017 $000 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers, employees and other Cash generated from operations Interest paid Income taxes paid Net cash from operating activities

25,021 (23,992) 1,029 (280) (403)

Cash flows from investing activities Interest received Proceeds from sale of equipment Purchase of plant and equipment Purchase of land Purchase of marketable securities Purchase of licences Purchase of Woohoo business Net cash from investing activities

1,358 113 (293) (200) (1,003) (587) (1,892)

$000

346

(2,504)

16.76

Chapter 16: Disclosure: statement of cash flows

Cash flows from financing activities Proceeds from share issue Payments for shares bought back Repayment of bank loans Dividends paid Net cash from financing activities

3,000 (250) (38) (260) 2,452

Net increase in cash and cash equivalents

294

Cash and cash equivalents at 1 January 2017

4,667

Cash and cash equivalents at 31 December 2017

4,961

16.77

Chapter 16: Disclosure: statement of cash flows

LEDGER RECONSTRUCTIONS Allowance doubtful debts ($000) Dr Opening balance Doubtful debts expense A/c receivable (bad debts w/o) * Closing balance

Bal 110

144

Bal 4,973

6,924

Bal 392

570

Bal 601

759

Bal 1,779

2,263

Bal 2,416

4,527

50 16

Accounts receivable ($000) Dr Opening balance Acquisition of Woohoo business Sales revenue Allowance (bad debts w/o) Cash (receipts from customers) Closing balance

1,243 25,745 16 25,021

Provision for employee benefits ($000) Dr Opening balance Acquisition of Woohoo business Employee entitlements expense Cash (paid to employees) Closing balance

Cr 154 4,248

4,224

Prepayments ($000) Dr Opening balance Other operating expenses Cash (paid other expenses) Closing balance

Cr 3,133

3,291

Inventories ($000) Dr Opening balance Cost of sales Acquisition of Woohoo business Accounts payable (purchases) Closing balance

Cr 16,410

284 16,610

Accounts payable ($000) Dr Opening balance Inventory (purchases) Acquisition of Woohoo business Cash (paid to suppliers) Closing balance

Cr 16,610 1,023

15,522

16.78

Chapter 16: Disclosure: statement of cash flows

Interest payable ($000) Dr Opening balance Interest expense Cash (interest paid) Closing balance

Bal 20

Bal -

255

Bal 135

345

Bal 400

1,336

Bal 3,066

2,681

Bal 3,811

5,398

291 280

Provision for warranty ($000) Dr Opening balance Warranty expense Cash (warranty paid) Closing balance

Cr 1,210

955

Current tax liability ('$000) Dr Opening balance ARR/ITE/DTA/DTL Cash (income tax paid) Closing balance Income tax journal entry Dr Asset revaluation reserve Dr Income tax expense Dr Deferred tax asset Cr Deferred tax liability Cr Current tax liability

Cr 613

403

221 384 128 120 613

Land - at fair value ( $000) Dr Opening balance Revaluation increment on land Cash (purchase) Closing balance

736 200

Plant and equipment - net ( $000) Dr Opening balance Depreciation expense Carrying amount of equipment sold Acquisition of Woohoo business Cash (purchase) Closing balance

Cr 780 80

182 293

Licences at cost ($000) Dr Opening balance Acquisition of Woohoo business Cash (purchase) Closing balance

1,000 587

16.79

Chapter 16: Disclosure: statement of cash flows

Provision for dividends ($000) Dr Opening balance Dividends declared Cash (dividends paid) Closing balance

Bal 260

340

Bal 2,000

4,750

Bal 60

1,700

Bal 7,816

8,055

340 260

Share capital ( $000) Dr Opening balance Cash (proceeds from issue) Cash (paid for buyback) Closing balance

Cr 3,000

250

Marketable securities ('$000) Dr Opening balance Acquisition of Woohoo business Cash (purchase) Closing balance

637 1,003

Bank loans - current and non-current ('$000) Dr Opening balance Acquisition of Woohoo business Cash (repayment) Closing balance

Cr 277

16.80

Chapter 16: Disclosure: statement of cash flows

B Note Disclosure Profit after tax

$000 335

Depreciation expense Amortisation of licences Carrying amount of equipment sold Proceeds from equipment sold Interest received

780 295 80 (113) (1,358)

Increase in asset and liability accounts: Increase in accounts payable Increase in interest payable Increase in current tax liability Increase in provision for employee benefits Increase in allowance for doubtful debts Increase in provision for warranty Increase in accounts receivable Increase in inventories Increase in prepayments Decrease in deferred tax liability Increase in deferred tax asset

1,088 11 210 24 34 255 (708) (200) (158) (101) (128)

Net cash from operating activities

346

Additional explanations of the note • The increase/decrease in the asset and liability accounts does not include any amount attributable to the acquisition of the Woohoo business, i.e., the increase in accounts payable of $1,088,000 is calculated as follows: $4,527,000 – 1,023,000 – 2,416,000. • There is a decrease in the deferred tax liability account because the amount relating to the deferred tax on the revaluation of land is not included, i.e., the decrease in the DTL of $101,000 is calculated as follows: $785,000 – 221,000 – $665,000

16.81

Chapter 16: Disclosure: statement of cash flows

Question 16.13

Statement of financial position approach

Selected financial statements of Roxette Ltd are shown below. ROXETTE LTD Statements of Financial Position as at 31 December 2017 $000 Current assets Cash at bank 1 722 Inventories 720 Trade receivables 2 016 Allowance for doubtful debts (288 ) Non-current assets Land 1 800 Buildings 2 880 Accumulated depreciation – buildings (432 ) Plant and equipment 3 024 Accumulated depreciation – plant and (288 ) equipment 30 Deferred tax asset 11 184 Total assets Current liabilities Trade payables 504 Interest payable 90 Current tax payable 654 Non-current liabilities Borrowings 1 152 Equity Share capital 3 600 Retained earnings 5 184 Total liabilities and equity 11 184

2016 $000 1 266 648 1 584 (216 ) 720 2 880 (288 ) 2 880 (288 ) 9 186

576 72 546 720 2 880 4 392 9 186

ROXETTE LTD Statement of Profit or Loss for the year ended 31 December 2017 Income Sales revenue Proceeds from sale of plant Less: Expenses Cost of sales Salaries and wages Doubtful debts Depreciation – buildings Depreciation – plant and equipment Carrying amount of plant sold Interest Rent and utilities Profit before tax

$000

6 372 216

6 588

1 728 1 440 288 144 504 216 78 774

5 172 1 416

16.82

Chapter 16: Disclosure: statement of cash flows

Less: Income tax expense 624 Profit after tax 792 Additional information (a) Plant that had cost $720 000 was sold during the year for $216 000. At the date of sale, the plant had accumulated depreciation of $504 000. (a) Land was acquired in exchange for 100 000 shares issued at $2.40 each. Required A. Apply the statement of financial position approach to prepare the statement of cash flows of Roxette Ltd for the year ended 31 December 2017. B. Prove your answer to part A using the accounts reconstruction (formulae) approach. C. Prepare a note that reconciles net cash flow from operating activities with the profit after tax. A. ROXETTE LTD Statement of Cash Flows for the year ended 31 December 2017 $000

$000

Cash flows from operating activities Cash receipts from customers

5,724

Cash paid to suppliers, employees and other

(4,086)

Cash generated from operations

1,638

Interest paid

(60)

Income tax paid

(546)

Net cash from opeating activities

1,032

Cash flows from investing activities Purchase of plant & equipment

(864)

Proceeds on sale of plant

216

Purchase of land

(840)

Net cash from investing activities

(1,488)

Cash flows from financing activities Proceeds from borrowing

432

Proceeds from share issue

480

Net cash from financing activities

912

16.83

Chapter 16: Disclosure: statement of cash flows

Net increase in cash and cash equivalents

456

Cash and cash equivalents at 1 January 2017

1,266

Cash and cash equivalents at 31 December 2017

1,722

16.84

Workings - Spreadsheet

Cash at bank Inventories Trade receivables Allowance for doubtful debts Land Buildings Accumulated depreciation Plant and equipment Accumulated depreciation Deferred tax asset

Balance Sheets 2017 2016 $000 $000 1,722 1,266 720 648 2,016 1,584 (288) (216) 1,800 720 2,880 2,880 (432) (288) 3,024 2,880 (288) (288) 30 11,184 9,186

Total Change $000 456 72 432 (72) 1,080 (144) 144 30 1,998

Adjustment Entries Dr. Cr. $000 Ref $000

i f j k

Trade payables Interest payable Current tax payable

504 90 654

576 72 546

(72) 18 108

Borrowings Share capital Retained earnings

1,152 3,600 5,184

720 2,880 4,392

432 720 792

216 288

144 720 504

78 624 30 240 6,372 72 72

Cash proceeds from sale of plant 11,184

9,186

1,998

9,360

h b/c a/b l

72 6,372 216 240

d g e/g k

504 30

l c/a h/d i/e f j g

288 144 504 78 624 216 9,360

Cash Operate(In)/Out ing $000 $000 (5,724) 840 864 60 546 (432) (480) 4,086

(216) (456)

Investing $000

Financing $000

(5,724) 840

864

60 546 (432) (480) 4,086

(1,032)

(216) 1,488

(912)

Adjustments to reverse non-cash $000 a) Reverse doubtful debts expense Dr. Allowance for doubtful debts Cr. Retained earnings

288

b) Reverse bad debts written off the allowance account Dr. Trade receivables Cr. Allowance for doubtful debts

216

288

216

c) Reverse sales revenue Dr. Retained earnings Cr. Accounts receivable

6,372

d) Reverse depreciation of building Dr. Accumulated depreciation - Building Cr. Retained earnings

144

e) Reverse depreciation of plant and equipment Dr. Accumulated depreciation - P&E Cr. Retained earnings

504

f) Reverse interest expense Dr. Interest payable Cr. Retained earnings

g) Reverse sale of plant and equipment Dr. Plant and equipment Cr. Accumulated depreciation Cr. Retained earnings (Gain/loss on sale) Cr. Cash proceeds on sale

$000

6,372

144

504

78 720 504 216

h) Reverse increase in inventories Dr. Retained earnings Cr. Inventories

i) Reverse decrease in accounts payable Dr. Retained earnings Cr. Accounts payable

j) Reverse income tax expense Dr. Current tax payable Cr. Retained earnings

624

k) Reverse increase in deferred tax asset Dr. Current tax payable Cr. Deferred tax asset

l) Reverse shares issued in exchange for land Dr. Share capital Cr. Land

240

624

240

Chapter 16: Disclosure: statement of cash flows

B. Workings – Account Reconstructions

Allowance for doubtful debts ($000) Dr Opening balance Doubtful debts expense Trade receivables. (write/off) * Closing balance

Bal 216

288

Bal 1,584

2,016

Bal 648

720

Bal 576

504

Bal 72

Bal 546

654

288 216

Trade receivables ($000) Dr Opening balance Sales revenue Allowance (write/off) Cash (receipts from customers) Closing balance

6,372 216 5,724

Inventories ($000) Dr Opening balance Cost of sales Trade Payables (Purchases) Closing balance

Cr 1,728

1,800

Trade payables ($000) Dr Opening balance Inventories (Purchases) Cash (paid to suppliers) Closing balance

Cr 1,800

1,872

Interest payable ($000) Dr Opening balance Interest expense Cash (interest paid) Closing balance

Cr 78

Current Tax Payable ( $000) Dr Opening balance Income tax expense Deferred tax asset Cash (income taxes paid) Closing balance

Cr 624 30

546

16.1

Chapter 16: Disclosure: statement of cash flows

Plant and equipment - at cost ($000) Dr Opening balance Sale of plant Cash (purchases) Closing balance

Bal 2,880

3,024

Bal 720

1,152

Bal 720

1,800

Bal 2,880

3,600

720 864

Borrowings ($000) Dr Opening balance Cash (proceeds) Closing balance

Cr 432

Land - at cost ($000) Dr Opening balance Share capital Cash (purchases) Closing balance

240 840

Share capital ($000) Dr Opening balance Land Cash (proceeds) Closing balance

Cr 240 480

C. Reconciliation Profit after tax Add back expenses not derived from external transaction Depreciation - buildings Depreciation - plant and equipment Doubtful debts Add/Deduct effects of accruals balances Increase in trade receivables Increase in inventories Decrease in trade payables Increase in current tax payable Increase in interest payable Increase in deferred tax asset Net cash from operating activities

$000 792 144 504 288 (648) (72) (72) 108 18 (30) 1,032

16.2

Chapter 16: Disclosure: statement of cash flows

Question 16.14

Statement of financial position accounts approach

Riotincell Ltd sells premium fashion wear made in Australia. The statement of profit or loss of Riotincell Ltd for 31 December 2017 and its statements of financial position as at 31 December 2017 and 31 December 2016 are shown below. RIOTINCELL LTD Statement of Profit or Loss for the year ended 31 December 2017 $ Income Sales 12 140 364 Dividends received 22 918 Interest received 2 625 Proceeds from sale of plant and equipment 464 420 12 630 327 Expenses Cost of sales

(5 186 695)

Employee expenses Depreciation – plant and equipment

(3 033 562)

Depreciation – buildings

(205 000)

Carrying amount of plant and equipment sold

(706 993)

(516 757)

Amortisation of intangibles

(10 310)

Bad debts

(36 850)

Audit and accounting fees

(32 694)

Other operating expenses

(510 000)

Interest expense

(126 546)

Profit before tax

(10 365 407) 2 264 920

Income tax expense Profit after tax

(932 530) 1 332 390

16.3

Chapter 16: Disclosure: statement of cash flows

RIOTINCELL LTD Statements of Financial Position as at 31 December 2017 $ Non-current assets

2016 $

Land and buildings (net)

6 991 800

6 450 000

Plant and equipment (net)

4 571 450

2 200 600

Investments at cost

783 361

743 282

Intangibles (net) Current assets

112 650

122 960

Cash on hand

12 624

25 895

Deposits at call

150 000

100 000

Accounts receivable

2 047 613

1 700 685

Inventories

1 838 295

1 065 040

Prepayments

165 697

97 468

Total assets Non-current liabilities

16 673 490

12 505 930

Bank loans-secured

1 068 250

1 200 000

Provision for employee benefits

1 470 568

1 268 245

Provision for warranty Current liabilities

642 000

411 600

Bank loans – secured

100 000

50 000

Bank overdraft – secured

566 723

494 553

Accounts payable

3 022 306

2 110 240

Accrued interest

13 500

9 400

Other accrued expenses

640 070

423 050

Current tax liability

898 635

312 698

Provision for warranty

182 612

98 008

16.4

Chapter 16: Disclosure: statement of cash flows

Provision for employee benefits Equity

15 000

21 500

Share capital

3 314 800

2 058 000

Retained earnings

4 739 026

4 048 636

Total liabilities and equity

16 673 490

12 505 930

Additional information (a) The bank overdraft is considered to be an integral part of the company’s cash management function. (b) Dividends of $642 000 were declared and paid during the period. (c) A new bank loan of $500 000 was arranged during the year to provide additional funds for working capital. (d) Interest and dividends paid are classified in cash flows from financing activities. Required A. Apply the statement of financial position approach to prepare the statement of cash flows of Riotincell Ltd for the year ended 31 December 2017. B. Prove your answer to part A using the accounts reconstruction (formulae) approach. C. Prepare note disclosures to explain the following: (1) the balance of cash and cash equivalents; and (2) the difference between net cash from operating activities and profit after tax for the year.

A. STATEMENT OF CASH FLOWS FULL BALANCE SHEET APPROACH

RIOTINCELL LTD Statement of Cash Flows for the year ended 31 December 2017 $

Cash flows from operating activities Receipts from customers

11,756,586

Payments to suppliers, employees and other

(7,964,522)

Cash generated from operations

3,792,064

Income tax paid

(346,593)

Net cash from operating activities

3,445,471

Cash flows from investing activities Interest received

2,625

Dividends from investments

22,918

Proceeds from sale of plant

464,420

16.5

Chapter 16: Disclosure: statement of cash flows

Purchase of plant and equipment

(3,594,600)

Purchase of land and building

(746,800)

Purchase of investments

(40,079)

Net cash from investing activities

(3,891,516)

Cash flows from financing activities Proceeds from share issue

1,256,800

Proceeds from bank loans

500,000

Repayment of bank loans

(581,750)

Interest paid

(122,446)

Dividends paid

(642,000)

Net cash from financing activities

410,604

Net decrease in cash and cash equivalents

(35,441)

Cash and cash equivalents at 1 January 2017

(368,658)

Cash and cash equivalents at 31 December 2017

(404,099)

16.6

WORKINGS WITH A SPREADSHEET

2017 $ 6,991,800 4,571,450

Balance Sheets 2016 $ 6,450,000 2,200,600

Total Change $ 541,800 2,370,850

Investments Intangibles (net) Cash on hand Deposits at call Accounts receivable Inventories Prepayments

783,361 112,650 12,624 150,000 2,047,613 1,838,295 165,697 16,673,490

743,282 122,960 25,895 100,000 1,700,685 1,065,040 97,468 12,505,930

40,079 (10,310) (13,271) 50,000 346,928 773,255 68,229 4,167,560

Bank loan (non-current) Provn employee (non-current) Provision for warranty Bank loan (current) Bank overdraft Accounts payable Accrued interest Other accrued expenses Current tax liability Provision for warranty Provn employee (current) Share capital Retained profits

(1,068,250) (1,470,568) (642,000) (100,000) (566,723) (3,022,306) (13,500) (640,070) (898,635) (182,612) (15,000) (3,314,800) (4,739,026)

(1,200,000) (1,268,245) (411,600) (50,000) (494,553) (2,110,240) (9,400) (423,050) (312,698) (98,008) (21,500) (2,058,000) (4,048,636)

131,750 (202,323) (230,400) (50,000) (72,170) (912,066) (4,100) (217,020) (585,937) (84,604) 6,500 (1,256,800) (690,390)

Land and buildings (net) Plant and equipment (net)

Adjustment Entries DR CR $ Ref $ 205,000 m 706,993 l 516,757 o 10,310

36,850

a/b c r

202,323 230,400

e g

912,066 126,546 217,020 932,530 84,604

12,140,364 773,255 6,500 22,918 2,625

d j i k h f b/a c/d f/e p/h

Cash (In)/Out $ 746,800 3,594,600

Operating Cashflow $

40,079 -

12,140,364 773,255 68,229

(11,756,586) -

6,500 36,850 912,066 202,323 84,604 230,400

Financing Cashflow $

40,079

(11,756,586)

131,750 (50,000) 122,446 346,593 (1,256,800) 7,964,522

Investing Cashflow $ 746,800 3,594,600

131,750

(50,000)

122,446 346,593

(1,256,800) 7,964,522

Chapter 16: Disclosure: statement of cash flows

68,229

Cash proceeds on sale of plant & equip Dividends received Interest received Dividends paid (16,673,490)

(12,505,930)

(4,167,560)

642,000 17,837,290

q/g r/i j k l m n o s o p q s

217,020 126,546 932,530 706,993 205,000 10,310 52,337 642,000 464,420 22,918 2,625 17,837,290

(464,420) (22,918) (2,625) 642,000 35,441

(464,420) (22,918) (2,625) (3,445,471)

3,891,516

642,000 (410,604)

16.1

Adjustments made in the spreadsheet to reverse non-cash account movements $ $ a) Reverse bad debts expense DR Accounts receivable 36,850 CR Retained profits 36,850 b) Reverse sales revenue DR Retained profits CR Accounts receivable

12,140,364

c) Reverse increase in inventories DR Retained profits CR Inventories

773,255

d) Reverse increase in accounts payable DR Accounts payable CR Retained profits

912,066

12,140,364

773,255

912,066

e) Reverse increase in non-current provision for employee benefits DR Provision for employee benefits 202,323 CR Retained profits 202,323 f) Reverse decrease in current provision for employee benefits DR Retained profits 6,500 CR Provision for employee benefits

6,500

g) Reverse increase in non-current provision for warranty DR Provision for warranty 230,400 CR Retained profits

230,400

h) Reverse increase in current provision for warranty DR Provision for warranty 84,604 CR Retained profits

84,604

i) Reverse increase in other accrued expenses DR Other accrued expenses CR Retained profits

217,020

j) Reverse interest expense DR Accrued interest CR Retained profits

126,546

k) Reverse income tax expense DR Current tax liability CR Retained profits

932,530

217,020

126,546

932,530

Chapter 16: Disclosure: statement of cash flows

l) Reverse depreciation of plant and equipment DR Plant and equipment (net) CR Retained profits

706,993

m) Reverse depreciation of building DR Land and buildings (net) CR Retained profits

205,000

n) Reverse amortisation DR Licences (net) CR Retained profits

10,310

o) Reverse sale of plant and equipment DR Plant and equipment (net) CR Retained profits (loss on sale) CR Cash proceeds on sale

706,993

205,000

10,310

516,757 52,337 464,420

p) Dividends received DR Retained profits CR Dividends received

22,918

q) Interest received DR Retained profits CR Interest received

2,625

r) Reverse increase in prepayments DR Retained profits CR Prepayments

68,229

s) Dividends paid DR Dividends paid CR Retained profits

642,000

22,918

2,625

68,229

642,000

16.1

Chapter 16: Disclosure: statement of cash flows

B. RECONSTRUCTED LEDGERS Accounts receivable ( $) Dr Opening balance Bad debts expense Sales Cash (receipts from cust) Closing balance

Bal 1,700,685

2,047,613

Bal 1,065,040

1,838,295

Bal 2,110,240

3,022,306

36,850 12,140,364 11,756,586

Inventories ($) Dr Opening balance Cost of sales Accounts payable (purchases) Closing balance

Cr 5,186,695

5,959,950

Accounts Payable ($) Dr Opening balance Inventory Cash (paid to suppliers) Closing balance

Cr 5,959,950

5,047,884

Provision for employee benefits - current and non current ($) Dr Cr Bal Opening balance 1,289,745 Employee expenses 3,033,562 Cash (paid to employees) 2,837,739 Closing balance 1,485,568

Prepayments, provision for warranty and other accrued expenses - net ($) Dr Cr Bal Opening balance 835,190 CR Audit and accounting fees 32,694 Other operating expenses 510,000 Cash (paid other) 78,899 Closing balance 1,298,985 CR Accrued interest($) Dr Opening balance Interest expense Cash (interest paid) Closing balance

Bal 9,400

13,500

Bal 312,698

898,635

126,546 122,446

Current tax liability ($) Dr Opening balance Income tax expense Cash (income tax paid) Closing balance

Cr 932,530

346,593

16.2

Chapter 16: Disclosure: statement of cash flows

Land and building - net ( $) Dr Opening balance Depreciation expense Cash (purchases) Closing balance

Bal 6,450,000

6,991,800

Bal 2,200,600

4,571,450

Bal 743,282

783,361

Bal 2,058,000

3,314,800

Bal 1,250,000

1,168,250

205,000 746,800

Plant and equipment - net ( $) Dr Opening balance Depreciation expense Carrying amount of plant sold Cash (purchases) Closing balance

Cr 706,993 516,757

3,594,600

Investments ( $) Dr Opening balance Cash (purchases) Closing balance

40,079

Share capital ( $) Dr Opening balance Cash (proceeds from issue) Closing balance Bank loans - current and non current ($) Dr Opening balance Cash (new bank loan) Cash (repayments of loans) 581,750 Closing balance

Cr 1,256,800

Cr 500,000

16.3

Chapter 16: Disclosure: statement of cash flows

C. NOTES

Note 1: Cash and cash equivalents Cash and cash equivalents consist of cash on hand and balances with banks, investments in money market instruments (if any) and bank overdrafts used as an integral part of the cash management function. Cash and cash equivalents included in the statement of cash flows comprise the following statement of financial position amounts: 2017 2016 Cash on hand $ 12 624 $ 25,895 Deposits at call 150 000 100 000 Bank overdraft (566 723) (494 553) Cash and cash equivalents $(404 099) $(368 658)

Note 2: Reconciliation of profit and net cash from operating activities $ 1,332,390

Profit after income tax Add back non-cash expenses Depreciation expense Amortisation of intanigibles Carrying amount of plant sold Add/Deduct items classified as non-operating Proceeds from sale of plant Interest expense Dividends received Interest received Add/Deduct effects of accrual balances Increase in accounts payable Increase in current tax liability Increase in provision for employee benefits Increase in account receivables Increase in inventories Increase in prepayments Increase in provision for non-current warranty Increase in other accrued expenses Net cash from operating activities

911,993 10,310 516,757

(464,420) 126,546 (22,918) (2,625)

912,066 585,937 195,823 (346,928) (773,255) (68,229) 315,004 217,020 3,445,471

16.4

Chapter 16: Disclosure: statement of cash flows

Question 16.15

Statement of financial position approach

Block No. 9 Ltd is a manufacturer of tennis racquets and fashion wear. Selected financial statements of Block No. 9 Ltd are shown below. BLOCK NO. 9 LTD Statements of Financial Position as at 31 December 2017 2016 $000 $000 Current assets Cash at bank

135

274

Inventories

2 774

2 486

Prepaid rent

115

—

Accounts receivable

2 897

2 654

Allowance for doubtful debts Non-current assets

(150)

(120)

Investments

2 478

1 250

Land

2 000

1 750

Buildings

800

Less: Accumulated depreciation

(200)

(160)

Plant and equipment

1 125

768

Less: Accumulated depreciation

(600)

(548)

Total assets Current liabilities

11 374

9 154

Accounts payable

3 200

2 583

Accrued interest

Current tax liability

243

Provision for employee benefits

205

298

Payable to EO Ltd

—

Provision for warranty Non-current liabilities

314

—

16.5

Chapter 16: Disclosure: statement of cash flows

Bank borrowings

3 515

3 800

Total Liabilities

7 544

6 774

Net assets Shareholders’ equity

3 830

2 380

Share capital

2 750

2 000

Retained earnings

1 080

380

Total Shareholders’ Equity

3 830

2 380

BLOCK NO. 9 LTD Statements of Profit or Loss for the year ended 31 December 2017 $000 Income Sales Dividends from investments Proceeds on sale of plant Expenses

2016 $000

31 944

27 346

Cost of sales

(28 205)

(24 611)

Bad and doubtful debts

(125)

Inventory written off

(50)

—

Warranty expense

(314)

—

Depreciation – building Depreciation – plant and equipment

(40)

(100)

(60)

Rent expense

(600)

(680)

Salaries and wages

(1 324)

(1 231)

Carrying amount of plant sold Interest expense Profit before tax

(20) (322)

(428)

915

218

16.6

Chapter 16: Disclosure: statement of cash flows

Income tax expense

(215)

(90)

Profit after tax 700 128 Additional information (a) In March 2017, the company sold tennis racquets in exchange for investments having a fair value of $80 000. (b) In December 2017, the company acquired investments from EO Ltd at the agreed value of $805 000. The consideration for the acquisition is comprised of 500 000 shares issued at $1.50 each and $55 000 in cash to be paid in January 2018. (c) In December 2017, plant was sold for cash of $20 000. The plant had originally cost $68 000 and had accumulated depreciation of $48 000 at the date of sale. (d)The bank borrowings relate to a revolving credit facility having a limit of $5 000 000. Required A. Apply the statement of financial position approach to prepare the statement of cash flows of Block No. 9 Ltd for the year ended 31 December 2017. B. Prove your answer to part A using the accounts reconstruction (formulae) approach. C. Prepare a note disclosure to explain the difference between net cash from operating activities and profit after tax for the year. PART A BLOCK NO. 9 LTD Statement of Cash Flows for the year ended 31 December 2017 $000

$000

Cash flows from operating activities Receipts from customers

31,606

Payments to suppliers, employees and other

(30,138)

Interest paid

(320)

Income taxes paid

(55)

Net cash from operating activities

1,093

Cash flows from investing activities Dividends received

Proceeds from sale of plant and equipment

Purchase of plant and equipment

(425)

Purchase of land

(250)

Purchase of investments

(343)

16.7

Chapter 16: Disclosure: statement of cash flows

Net cash from investing activities

(947)

Cash flows from financing activities Repayment of borrowings

(285)

Net cash from financing activities

(285)

Net decrease in cash and cash equivalents

(139)

Cash and cash equivalents at 1 January 2017

274

Cash and cash equivalents at 31 December 2017

135

16.8

WORKINGS WITH A SPREADSHEET Cash at bank Inventories

Balance Sheets 2,017 2,016 $000 $000 135 274 2,774 2,486

Total Change $000 (139) 288

Prepaid rent Accounts receivable

115 2,897

2,654

115 243

Allowance for doubtful debts Investments

(150) 2,478

(120) 1,250

(30) 1,228

Land Buildings Less: Accumulated depreciation Plant and equipment Less: Accumulated depreciation

2,000 800 (200) 1,125 (600) 11,374

1,750 800 (160) 768 (548) 9,154

250 (40) 357 (52) 2,220

Accounts payable Accrued interest Current tax liability Provision for employee benefits Payable to EO Provision for warranty Borrowings Share capital Retained profits

(3,200) (12) (243) (205) (55) (314) (3,515) (2,750) (1,080)

(2,583) (10) (83) (298) (3,800) (2,000) (380)

(617) (2) (160) 93 (55) (314) 285 (750) (700)

Adjustment Entries DR CR $000 Ref $000 50 80 90 5 35

e f/g p b/d c a/c f o

40 68 100

k n l/n

617 322 215 55 314

h m q i o j

750 31,944 418 93 115 51

o d/a g/b i/e p/h r/j

Cash (In)/Out $000

Operating Cashflow $000

Investing Cashflow $000

Financing Cashflow $000

418 115 31,944 5 80 805

35 90 50 617 314

(31,606)

343

250 425 -

320 55 285 30,138

250

425

320 55

285 30,138

Chapter 16: Disclosure: statement of cash flows

Retained profits (continued)

k l m q

40 100 322 215

Cash proceeds on sale of plant & equip Dividends received

n r

20 51 35,362

(11,374)

(9,154)

(2,220)

35,362

(20) (51) 139

(1,093)

(20) (51) 947

285

16.1

Adjustments made in the spreadsheet to reverse non-cash account movements $000 $000 a) Reverse doubtful debts expense DR Allowance for doubtful debts 35 CR Retained profits 35 b) Reverse bad debts expense DR Accounts receivable CR Retained profits

c) Bad debts written off allowance DR Accounts receivable CR Allowance for doubtful debts

d) Reverse sales revenue DR Retained profits CR Accounts receivable

5 31,944 31,944

e) Reverse inventory written off DR Inventories CR Retained profits

f) Reverse acquisition of investments using inventory DR Inventories CR Investments

g) Reverse increase in inventory DR Retained profits CR Inventories

418

h) Reverse increase in accounts payable DR Accounts payable CR Retained profits

617

i) Reverse decrease in provision for employee benefits DR Retained profits CR Provision for employee benefits

j) Reverse increase in provision for warranty DR Provision for warranty CR Retained profits

314

k) Reverse depreciation of building DR Accumulated depreciation CR Retained profits

l) Reverse depreciation of plant and equipment DR Accumulated depreciation CR Retained profits

100

m) Reverse interest expense DR Accrued interest CR Retained profits

322

418

617

314

100

322

Chapter 16: Disclosure: statement of cash flows

n) Reverse sale of plant and equipment DR Plant and equipment CR Accumulated depreciation CR Cash proceeds on sale

68 48 20

o) Reverse acquisition of investments for issue of shares and deferred payment DR Share capital 750 DR Payable to EO Ltd 55 CR Investments 805 p) Reverse increase prepaid rent DR Retained profits CR Prepaid rent

115

q) Reverse income tax expense DR Current tax liability CR Retained profits

215

r) Dividends received DR Retained profits CR Dividends received

115

215

16.1

Chapter 16: Disclosure: statement of cash flows

PART B RECONSTRUCTED LEDGER ACCOUNTS Allowance doubtful debts ($000) Dr Opening balance Doubtful debts expense Accounts receivable (debts w/o) Closing balance

Bal 120

150

Bal 2,654

2,897

Bal 2,486

2,774

Bal 2,583

3,200

Bal 298

205

Bal -

115

35 5

Accounts receivable ($000) Dr Opening balance Bad debts written off ( P&L) Provision for doubtful debts Sales revenue Cash (receipts from customers) Closing balance

Cr 90 5

31,944 31,606

Inventories ($000) Dr Opening balance Cost of sales Inventory written off Investments (exchange) Purchases (accounts payable) * Closing balance

Cr 28,205 50 80

28,623

Accounts Payable ($000) Dr Opening balance Inventory purchases Cash (paid to suppliers) Closing balance

Cr 28,623

28,006

Provision for employee benefits ($000) Dr Opening balance Salary and wages expense Cash (paid to employees) Closing balance

Cr 1,324

1,417

Prepaid rent ($000) Dr Opening balance Rent expense Cash (rent paid) Closing balance

Cr 600

715

Cash paid to suppliers, employees & other, 28,006 + 1,417 + 715 = 30,138

16.2

Chapter 16: Disclosure: statement of cash flows

Accrued Interest ($000) Dr Opening balance Interest expense Cash (interest paid) Closing balance

Bal 10

Bal 83

243

Bal 768

1,125

Bal 220

525

Bal 1,250

2,478

Bal 1,750

2,000

Bal 3,800

3,515

322 320

Current tax liability ('$000) Dr Opening balance Income tax expense Cash (income taxes paid) Closing balance

Cr 215

Plant and equipment - cost ( $000) Dr Opening balance Sale of plant and equipment Cash (purchase) Closing balance

Cr 68

425

Plant and equipment - Net ( $000) Dr Opening balance Carrying amount of plant sold Depreciation expense Cash (purchase) Closing balance

Cr 20 100

425

Investments ( $000) Dr Opening balance Share capital Payable to EO Ltd Inventories Cash (purchase) Closing balance

750 55 80 343

Land ( $000) Dr Opening balance Cash (purchase) Closing balance

250

Borrowings ( $000) Dr Opening balance Cash (proceeds) Closing balance

285

16.3

Chapter 16: Disclosure: statement of cash flows

PART C Reconciliation Note Profit after tax

$000 700

Add back expenses not derived from external transactions Depreciation expense - building Depreciation expense - plant and equipment

40 100

Add/Deduct items classified as non-operating items Dividends received

(51)

Add/Deduct effects of accrual balances Deduct: Increase in current assets Increase in accounts receivable Increase in prepaid rent Increase in inventories

(243) (115) (368)

Add: Increase in current liabilities Increase in accounts payable Increase in accrued interest Increase in current tax liability Increase in provision for warranty Increase in allowance for doubtful debts

617 2 160 314 30

Deduct: Decrease in current liabilities Decrease in provision for employee benefits

(93)

Net cash flows operating activities

1,093

16.4

Solutions manual to accompany Company Accounting 10e

Chapter 17 – Disclosure: translation of financial statements REVIEW QUESTIONS 1.

What is the purpose of translating financial statements from one currency to another? Para 3 of AASB 121 notes 2 areas of application: • Translation of results and financial position of foreign operations for the purpose of including those results in the consolidated financial statements of a group, or to allow an investor to equity account for these results. • Translation of an entity’s results and financial position into another currency for presentation purposes

What is meant by ‘functional currency’?

Para 8 of AASB 121 defines functional currency as “the currency of the primary economic environment in which the entity operates”.

What is the rationale behind the choice of an exchange rate as an entity’s functional currency?

One of the objectives of the translation process is to provide information that is generally compatible with the expected economic effects of an exchange rate change on an entity’s cash flows and equity. A parent entity that has an investment in a foreign subsidiary has assets under its control that are exposed to a change in the exchange rate. Capturing the extent of this exposure should be reflected in the choice of exchange rate. Where a subsidiary acts simply as a conduit for the parent’s transactions, then the consolidation approach must treat the foreign currency statements of the subsidiary as artefacts that must be translated into the currency of the parent. Where the subsidiary is not just a conduit for the parent, but the latter is dependent on its own economic environment then the choice of exchange rate must reflect the fact that the functional currency is that of the subsidiary not the parent.

What guidelines are used to determine the functional currency of an entity?

See paragraphs 9-12 of AASB 121 and section 17.2.3 of the text, particularly Tables 2-4.

17.2

Chapter 17: Disclosure: translation of financial statements

How are statement of profit or loss and other comprehensive income items translated from the local currency into the functional currency?

Income and expenses: these are translated at the rate current at the date the transaction occurred. Dividends paid: these are translated at the rate current at the date of payment. Dividends declared: these are translated at the rate current at the date of declaration Transfers to/from reserves: for internal transfers, the rates applicable are those existing when the amounts transferred were originally recognised in equity.

How are statement of financial position items translated from the local currency into the functional currency?

Para 23 of AASB 121: -

foreign currency monetary items are translated using the closing rate non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction non-monetary items that are measured at fair value in a foreign currency are translated using the exchange rates at the date when the value was determined.

Assets: Classify as monetary or non-monetary. Translate monetary assets at the current rate existing at end of reporting period. For non-monetary assets, use the rate current at the date at which the recorded amount for the asset was entered into the accounts. Liabilities: Classify liabilities into monetary and non-monetary. Use the same principles as for assets. Share capital: if on hand at acquisition, use the rate at acquisition date. If arising subsequent to acquisition, use the rate at date of issue. Other reserves: If on hand at acquisition date, use the rate at that date. For reserves created by internal transfer, use the rate at date the amounts transferred were originally recognised in equity. Retained earnings: If on hand at acquisition date, use the rate at that date. Post-acquisition profits are carried forward balances.

How are foreign exchange gains and losses calculated when translating from local currency to functional currency?

Exchange differences arise from translating the foreign operation’s monetary items at current rates while the non-monetary items are translated using an historical rate. For non-monetary items exchange differences arise only when they are sold or exchanged. Hence, exchange differences are calculated by examining movements in the monetary items over the period.

What is meant by ‘presentation currency’?

Paragraph 8 of AASB 121 states that presentation currency is the currency in which the financial statements are presented.

17.3

Solutions manual to accompany Company Accounting 10e

How are statement of profit and loss and other comprehensive income items translated from functional currency to presentation currency?

Income and expenses: These are translated at the rates current at the applicable transaction dates. Dividends paid: These are translated at the rates current when the dividends were paid. Dividends declared: These are translated at the rates current when the dividends are declared.

10.

How are statement of financial position items translated from functional currency to presentation currency?

Assets: Current rates at the end of the reporting period are used Liabilities: Current rates at the end of the reporting period are used Share capital: If on hand at acquisition date, the rate at acquisition date is used Other reserves: If on hand at acquisition date, use the rate at that date. For reserves created by internal transfer, use the rate at date the amounts transferred were originally recognised in equity. Retained earnings: If on hand at acquisition date, use the rate at that date. Post-acquisition profits are carried forward balances

11.

What causes a foreign currency translation reserve to arise?

A foreign currency translation reserve will arise when the financial statements are translated into the presentation currency. It arises because income and expense items are translated at dates of the transactions and not the closing rate, and in the case of a net investment in a foreign operation where the opening net assets are translated at an exchange rate different from the closing rate.

12.

Why are gains/losses on translation taken to a foreign currency translation reserve rather than to profit and loss for the period?

According to paragraph 41 of AASB 121, these exchange differences have little or no direct effect on the present and future cash flows from operations. Movements in the foreign currency translation reserve are, however, shown as part of other comprehensive income for the period.

13.

The accounts listed below are for a wholly owned foreign subsidiary. In the space provided indicate the exchange rate that would be used to translate the accounts into Australian dollars. Use the following letters to indicate the appropriate exchange rate: H — historical exchange rate C — current exchange rate at the end of the current period A — average exchange rate for the current period.

17.4

Chapter 17: Disclosure: translation of financial statements

Cash Prepaid expenses Equipment Goodwill Accounts payable Inventory – cost Inventory – NRV Capital Sales Depreciation expense

14.

A$ is functional currency C H H H C H C H A H

Foreign currency is functional currency C C C C C C C H A C

Discuss the differences in the translation process when translating from a local currency to a functional currency compared with translating from a functional currency to a presentation currency.

Note para 23 for functional currency translation Note para 39 for presentation translation In relation to the income statement, there is little difference in that in both cases, most revenues and expenses are translated at the average rate for the period. Differences will occur in relation to depreciation. In relation to share capital, no differences occur in translation. In relation to the statement of financial position, there is no difference in translation of the monetary items as current rates are always used. With non-monetary items, functional currency translation for items measured in terms of historical cost are translated at historical rates, while for presentation translation current rates are used. For non-monetary items measured at fair value, current rates are always used. Note that for a functional currency translation, exchange differences on monetary items are recognised in profit or loss [para 28] while presentation translation results in exchange differences being recognised in other comprehensive income [para 39]

17.5

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Financial reporting

In Note 1 (p. 72) of the 2012 annual report of the Qantas Group, the following information is provided: Translation of Foreign Operations Assets and liabilities of foreign operations, including controlled entities and investments in associates and jointly controlled entities, are translated to the functional currency at the rates of exchange prevailing at balance date. The income statements of foreign operations are translated to the functional currency at rates approximating the foreign exchange rates prevailing at the dates of the transactions. Exchange differences arising on translation are recognised in other comprehensive income and are presented within equity in the foreign currency translation reserve.

Required Explain this note to a reader of the Qantas report. This note is concerned with the financial statements of foreign entities controlled by Qantas. These financial statements have probably been prepared in a currency other than the A$. The note does not tell us anything about the functional currencies of the overseas operations but is concerned with the translation of the foreign operations’ financial statements into A$s so they can be included in the consolidated financial statements of the Qantas Group. The method used to translate a functional currency into a presentation currency involves the following translation process: Assets: Rates of exchange at balance date (current rates) are used Liabilities: Rates of exchange at balance date (current rates) are used Share capital: If on hand at acquisition date, the rate at acquisition date is used Other reserves: If on hand at acquisition date, the rate at that date is used. For reserves created by internal transfer, the rate at the date the amounts transferred were originally recognised in equity is used. Retained earnings: If on hand at acquisition date, the rate at that date is used. Post-acquisition profits are carried forward balances. Revenues/expenses: Rates approximating the foreign exchange rates at the dates of the transactions are used – probably an average rate is used. Under this translation method, exchange differences arise because the opening net assets are translated at a rate different from the closing rate while revenues/expenses are translated at rates different from the closing rate. These exchange differences are not recognised in profit or loss. They are recognised in other comprehensive income and transferred to a foreign currency translation reserve account.

17.6

Chapter 17: Disclosure: translation of financial statements

Case Study 2

Financial reporting

In its 2011 annual report (p. 98) Wesfarmers notes that the functional currency and presentation currency of Wesfarmers Ltd and its Australian subsidiaries are the Australian dollar. In Note 32 it lists its overseas subsidiaries and their functional currencies. These include Bunnings (NZ) Ltd for which the functional currency is the New Zealand dollar (NZD), and Wesfarmers Kleenheat Elpiji Ltd for which the functional currency is the Bangladesh taka (BDT). Required Discuss the translation process that will occur so that these subsidiaries can be included in the consolidated financial statements of Wesfarmers Ltd. The foreign operations are being prepared in their functional currencies, generally the currency of the country in which the country operates e.g. NZ or Bangladesh. In order to include the financial statements prepared in a functional currency other than the A$, they must be translated into the presentation currency of A$. This process involves the following translation process: Assets: Rates of exchange at balance date (current rates) are used Liabilities: Rates of exchange at balance date (current rates) are used Share capital: If on hand at acquisition date, the rate at acquisition date is used Other reserves: If on hand at acquisition date, the rate at that date is used. For reserves created by internal transfer, the rate at the date the amounts transferred were originally recognised in equity is used. Retained earnings: If on hand at acquisition date, the rate at that date is used. Post-acquisition profits are carried forward balances. Revenues/expenses: Rates approximating the foreign exchange rates at the dates of the transactions are used – probably an average rate is used. Under this translation method, exchange differences arise because the opening net assets are translated at a rate different from the closing rate while revenues/expenses are translated at rates different from the closing rate. These exchange differences are not recognised in profit or loss. They are recognised in other comprehensive income and transferred to a foreign currency translation reserve account.

17.7

Solutions manual to accompany Company Accounting 10e

Case Study 3

Determination of functional currency

In relation to the following case situations, discuss the choice of a functional currency. Case A A Malaysian operation manufactures a product using Malaysian materials and labour. Specialised equipment and senior operations staff are supplied by its Australian parent. Reimbursement invoices for these services are denominated in the Malaysian ringgit. The product is sold in the Malaysian market at a price, denominated in Malaysian ringgit, which is determined by competition with similar locally produced products. The foreign operation retains sufficient cash to meet wages and day-to-day operating costs with the remainder being remitted to the Australian parent. The receipt of dividends from the foreign operation is important to the parent’s cash management function. Long-term financing is arranged and serviced by the parent. Case B A Korean operation is a wholly-owned subsidiary of an Australian company which regards the operation as a long-term investment, and thus takes no part in the day today decision making of the operation. The operation purchases parts from various nonrelated Australian manufacturers for assembly by Korean labour. The finished product is exported to a number of countries but Australia is the major market. Consequently, sales prices are determined by competition within Australia. In answering this question reference must be made to: - the definition of functional currency in para 8, particularly noting the need to identify the “primary economic environment” - the factors in pars 9 -11 if AASB 121, with para 9 containing the primary indicators Case A The choice for functional currency is the Australian $ or the Malaysian Ringgit Note: - Malaysian materials and labour are used - Specialised equipment & senior op. staff are supplied by Australia but invoices denominated in ringgit - selling prices are determined by local competition - dividends are paid to Australian parent - parent arranges long-term finance Relating this to AASB 121: Para 9(a)(i): the ringgit influences sales prices, and is the currency in which goods and services are settled Para 9(a)(ii): the ringgit is the currency whose competitive forces and regulations mainly determine sales prices para 9(b) the ringgit is the currency that mainly influences labour, material and other costs Para 10 Para 11

financing is provided in A$ the activities are not an extension of the parent The cash flows from the activities of the foreign operation do affect © John Wiley and Sons Australia Ltd 2015

17.8

Chapter 17: Disclosure: translation of financial statements

the cash flows of the reporting entity The primary indicators are those in para 9. Even though some of the indicators noted in para 11 relate to the A$, it is concluded here that the functional currency is the Malaysian ringgit. Case B Note:

Para 9(a)(i) Para 9(a)(ii) Para 9(b)

- the operation is a long-term investment of the parent - parent does not participate in daily management decisions of the subsidiary - inputs are from Australia and based on $A - labour costs are Korean currency - sales revenue is denominated in A$ A$ mainly influences sales prices Australian competitive forces & regulations affect sales prices A$ influences material inputs while Korean currency influences labour costs

based on para 9, the functional currency is the Korean currency.

17.9

Solutions manual to accompany Company Accounting 10e

Case Study 4

Determination of functional currency

In relation to the following case situations, discuss whether you regard the reporting entity as exposed to foreign exchange gains and losses in relation to the foreign entity. Case A A foreign operation extracts mineral ores that are shipped to Australia for processing at the parent entity’s smelters. All senior personnel at the foreign operation are parent entity employees. Monthly invoices for ore supplied to the parent are denominated in US dollars. The parent entity pays these invoices with US dollars obtained by selling its finished product to US customers, thus taking advantage of a natural hedge. Payments to the foreign operation cover all running costs but long-term financing is provided by the parent entity. Case B A foreign operation extracts a mineral product that it exports worldwide. The sales price is subject to daily fluctuations. The Australian parent regards the operation as an investment only but the extreme volatility of the foreign operation’s sales prices impacts on the price of the parent’s shares on the Australian stock exchange because the investment in the foreign operation is one of the parent’s significant assets. Exposure to gains and losses relates to the potential losses an entity could incur in relation to its holding of net assets in a foreign location if there were a change in the exchange rate. Case A the foreign operation holds net assets namely extractive net assets offshore ore supplied is denominated in US$ senior personnel probably paid in A$ processing occurs in Australia customers are resident in US long-term financing is provided from Australia The functional currency is the US$. In relation to exposure to foreign exchange gains and losses, by holding net assets offshore, the Australian parent is exposed to foreign exchange gains and losses on the worth of that investment in A$. The exposure is lessened by the loan to the subsidiary Case B The parent has an offshore investment. The parent is then exposed to foreign exchange gains and losses in relation to the relative worth of the net assets held offshore. The worth of the shares held by the parent will be affected by any change in the foreign exchange rate between the two countries. In general, regardless of whether the functional currency is the parent or the foreign subsidiary, provided there are assets held offshore, the wealth of the parent is affected by movements in exchange rates when it holds assets offshore. Where the functional currency is that of the parent, accounting under AASB 121 does not report changes in the worth of the non-monetary assets.

17.10

Chapter 17: Disclosure: translation of financial statements

Case Study 5

Determination of functional currency

In relation to the following case situations, discuss which currency is the functional currency of the foreign entity. Case A An Indonesian operation manufactures a product using Indonesian materials and labour. Patented processes and senior operations staff are supplied by its Australian parent. Reimbursement invoices for these services are denominated in Indonesian rupiah. The product is sold in the Indonesian market at a price, denominated in rupiah, that is determined by competition with similar locally produced products. The Indonesian operation remits all revenue to the Australian parent, retaining only sufficient cash to meet wages and day-to-day operating costs. The receipt of cash from the Indonesian operation is important to the parent’s cash management function. Longterm financing is arranged and serviced by the parent. Case B A New Zealand operation is a wholly-owned subsidiary of an Australian company. The parent regards the operation as a long-term investment and all financial and operational decisions are made by New Zealand management. The New Zealand operation purchases parts from various non-related Australian manufacturers for assembly in New Zealand. The finished product is exported to a number of countries with Australia as the major market. Consequently, sales prices are determined by competition within Australia. In answering this question reference must be made to: • the definition of functional currency in para 8, particularly noting the need to identify the “primary economic environment” • the factors in pars 9 -11 if AASB 121, with para 9 containing the primary indicators Case A The functional currency is either Indonesian rupiah or Australian dollars Note: Indonesian materials and labour are used Processes & staff supplied from Australia but denominated in A$ Product is sold in rupiah determined by local competition All profits remitted to Australia Financing provided by parent Para 9(a) Para 9(b) Para 10(a) Para 10(b) Para 11

Rupiah influences sales prices Indonesian competitive forces & regulations affect sales prices some costs are denominated in A$ and others in rupiah financing is in A$ operating activities usually retained in rupiah Activities have a significant degree of autonomy Transactions not a high proportion of foreign operations activities Cash flows do affect Australian parent

17.11

Solutions manual to accompany Company Accounting 10e

In general expect functional currency to be Indonesian rupiah, particularly given influence of para 9. Case B The functional currency is either the NZ$ of the A$ Note: Managed from NZ Parts are supplied from Australia Assembly is in NZ Australia is major market Sales prices determined by Australian market forces Para 9(a) Para 9(b) Para 11

A$ influences sales prices Australian competitive forces & regulations affect sales prices Input costs are mixed A$ and NZ$ Not much autonomy for NZ operation

Expect functional currency is the Australian dollar.

17.12

Chapter 17: Disclosure: translation of financial statements

Case Study 6

Determination of functional currency

Foreign Ltd is a Queensland software developer that specialises in software that controls the operations of open cut mining. To exploit opportunities in the US market, the firm has established a wholly-owned subsidiary operating in Atlanta, Georgia. The operations of the subsidiary (Opencut Inc.) essentially involve the marketing of software initially developed in Australia but which is further developed by the US subsidiary to suit the special requirements of particular US customers. Foreign Ltd does not charge Opencut Inc. for the software successfully amended and marketed in the United States. At this stage no dividends have been paid by Opencut Inc; however, it is expected that dividends will commence within 12 months. With respect to working capital, Opencut Inc. has a ‘revolving credit’ agreement (overdraft facility) with the Bank of Georgia, which has been guaranteed by the Australian parent. Required Discuss the process of translating the financial statements of Opencut Inc. for consolidation with Foreign Ltd. Step 1 is to determine the functional currency which is either the A$ of the US$ Note: product is developed in Australia Further costs of development and marketing occur in the US Sales are to US customers Finance is provided in US dollars Para 9(a)

Para 9(b) Para 10 Para 11

the US$ influences sales prices The US is the country whose regulations and competitive forces determine the sales price the main input costs are in A$ finances are in US$ Receipts from operating activities are retained in US$ Not a great deal of autonomy

The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash. In this example, the country in which the cash is generated is the US, while the country in which it expends the most cash for developing the product is Australia. Given that further costs are incurred in the US (and proportion is unknown), and the fact that financing is based on US$, the functional currency is probably the US dollar.

17.13

Solutions manual to accompany Company Accounting 10e

Case Study 7

Determination of functional currency

Victory Ltd is an Australian company with two overseas subsidiaries, one in Indonesia and the other in South Korea. The Indonesian subsidiary has as its major activity the distribution in Indonesia of Victory Ltd’s products. It has been agreed that the subsidiary will, for a period of time, retain all profits in order to expand its distribution network in Indonesia. In the past it has remitted most of its profits to the Australian parent company. The South Korean subsidiary has been established to manufacture a range of products for the South-East Asian market. There is also an expectation that it could in the future become the major manufacturing plant for Victory Ltd and provide a supply of products for the Australian market. Required Based on the above, determine the functional currency of the foreign subsidiaries. Explain your choice. In answering this question reference must be made to: • the definition of functional currency in para 8, particularly noting the need to identify the “primary economic environment” • the factors in pars 9 -11 if AASB 121, with para 9 containing the primary indicators In relation to the Indonesian subsidiary: • products are supplied from Australia • profits may be retained in Indonesia • sales are made in Indonesia Note: Para 9

Para 10 Para 11

the Indonesian currency influences sales prices and Indonesia is the country whose competitive forces and regulations mainly determine sales prices. The Australian dollar mainly influences input costs the Indonesian rupiah is the currency in which receipts from operating activities are usually retained the activities of the foreign operation are carried out as an extension of the reporting entity

It is concluded that the functional currency is the Australian dollar. In relation to the South Korean subsidiary: • products are manufactured in South Korea • sales are made in south-east Asia, maybe including Korea • plant could supply products for sale in Australia in future Note: Para 9:

Para 10 Para 11

Not sufficient information is given to determine where major sales occur, but indications are that sales are made in many Asian countries The South Korean currency influences input costs receipts from operating activities are kept in South Korean currency Subsidiary is not just an extension of parent

17.14

Chapter 17: Disclosure: translation of financial statements

Functional currency is South Korean currency. It’s unlikely that this would change even if eventually sales of products are made in Australia, as the latter would be only one of the markets serviced by the subsidiary.

17.15

Solutions manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 17.1

Translation into functional currency

Sydney Ltd is a manufacturer of sheepskin products in Australia. It is a wholly-owned subsidiary of a Hong Kong company, Wan Chai Ltd. The following assets are held by Sydney Ltd at 30 June 2017: Exchange rate on acquisition Cost Useful life Acquisition date Plant A$ (years) date (A$1 HK$) Tanner 40 000 5 10/8/13 5.4 Benches 20 000 8 8/3/15 5.8 Presses 70 000 7 6/10/16 6.2 Plant is depreciated on a straight-line basis, with zero residual values. All assets acquired in the first half of a month are allocated a full month’s depreciation. Inventory: • At 1 July 2016, the inventory on hand of $25 000 was acquired during the last month of the 2015–16 period. • Inventory acquired during the 2016–17 period was acquired evenly throughout the period. Total purchases of $420 000 were acquired during that period. • The inventory of $30 000 on hand at 30 June 2017 was acquired during June 2017. Relevant exchange rates (quoted as A$1 HK$) are as follows: Average for June 2016 1 July 2016 Average for 2016–17 Average for June 2017 30 June 2017

7.2 7.0 7.5 7.7 7.8

Required 1. Assuming the functional currency for Sydney Ltd is the A$, calculate: (a) the balances for the plant items and inventory in HK$ at 30 June 2017 (b) the depreciation and cost of sales amounts in the statement of profit or loss and other comprehensive income for 2016–17. 2. Assuming the functional currency is the HK$, calculate: (a) the balances for the plant items and inventory in HK$ at 30 June 2017 (b) the depreciation and cost of sales amounts in the statement of profit or loss and other comprehensive income for 2016–17. 1. The functional currency for Sydney Ltd is the A$ a). Plant: A$ Tanner 40 000 Accumulated depreciation (40 000 x 1/5 x 47/12) 31 333 Benches Accumulated depreciation

20 000

Rate 7.8

HK$ 312 000

HK$

7.8

244 400

67 600

7.8

156 000

17.16

Chapter 17: Disclosure: translation of financial statements

(20 000 x 1/8 x 28/12)

5 833

7.8

45 500

Presses Accumulated depreciation (70 000 x 1/7 x ¾)

70 000

7.8

546 000

7 500

7.8

58 500

30 000

7.8

8 000 2 500 7 500

7.5 7.5 7.5

60 000 18 750 56 250

25 000 420 000 445 000 30 000 415 000

7.2 7.5

180 000 3 150 000 3 330 000 231 000 3 099 000

Inventory

110 500

487 500 665 600 234 000

b). Depreciation: Tanner: 1/5 x 40 000 Benches: 1/8 x 20 000 Presses: Cost of sales: Opening stock Purchases Closing stock

2. The functional currency for Sydney Ltd is the HK$ a). Plant: A$ Tanner 40 000 Accumulated depreciation (40 000 x 1/5 x 47/12) 31 333

7.7

Rate 5.4

HK$ 216 000

HK$

5.4

169 200

46 800

Benches Accumulated depreciation (20 000 x 1/8 x 28/12)

20 000

5.8

116 000

5 833

5.8

33 832

Presses Accumulated depreciation (70 000 x 1/7 x ¾)

70 000

6.2

434 000

7 500

6.2

46 500

30 000

7.7

8 000 2 500 7 500

5.4 5.8 6.2

43 200 14 500 46 500

25 000 420 000 445 000 30 000 415 000

7.2 7.5

180 000 3 150 000 3 330 000 231 000 3 099 000

Inventory

135 000

82 168

387 500 516 468 231 000

b). Depreciation: Tanner: 1/5 x 40 000 Benches: 1/8 x 20 000 Presses: Cost of sales: Opening stock Purchases Closing stock

7.7

104 200

17.17

Solutions manual to accompany Company Accounting 10e

Question 17.2

Translation into presentation currency

Canberra Ltd, an Australian company, acquired all the issued shares of Washington Ltd, a US company, on 1 January 2016. At this date, the net assets of Washington Ltd are shown below. US$ Property, plant and equipment 155 000 Accumulated depreciation (30 000) 125 000 Cash 10 000 Inventory 20 000 Accounts receivable 10 000 Total assets 165 000 Accounts payable 15 000 Net assets 150 000 The trial balance of Washington Ltd at 31 December 2016 was: US$ US$ Dr Cr Share capital 100 000 Retained earnings 50 000 Accounts payable 42 000 Sales 90 000 Accumulated depreciation – plant and 45 000 equipment 155 000 Property, plant and equipment 40 000 Accounts receivable 45 000 Inventory 12 000 Cash Cost of sales Depreciation Other expenses

30 000 15 000 30 000 327 000

______ 327 000

Additional information 1. No property, plant and equipment were acquired in the 2016 period. 2. All sales and expenses were acquired evenly throughout the period. The inventory on hand at the end of the year was acquired during December 2016. 3. Exchange rates were (A$1 US$): 1 January 2016 0.52 31 December 2016 0.60 Average for December 0.58 2016 0.56 Average for 2016 4. The functional currency for Washington Ltd is the US dollar. Required 1. Prepare the financial statements of Washington Ltd at 31 December 2016 in the presentation currency of Australian dollars. 2. Verify the translation adjustment.

17.18

Chapter 17: Disclosure: translation of financial statements

3. Discuss the differences that would occur if the functional currency of Washington Ltd were the Australian dollar. 4. If the functional currency were the Australian dollar, calculate the translation adjustment. 1. Functional currency is the US$ - Presentation currency is the A$

Sales Cost of sales: Opening stock Purchases Closing stock Cost of sales Gross profit Expenses: Depreciation Other Profit for the period Retained earnings at 1/1/16 Retained earnings at 31/12/16 Share capital Foreign currency translation reserve Total equity Property, plant & equipment Accumulated depreciation Accounts receivable Inventory Cash Accounts payable Net assets

US$ 90 000

rate 1/0.56

A$ 160 714

20 000 55 000 75 000 45 000 30 000 60 000

1/0.52 1/0.56

38 462 98 214 136 676 80 357 56 319 104 395

15 000 30 000 45 000 15 000 50 000 65 000 100 000 ______ 165 000 155 000 45 000 110 000 40 000 45 000 12 000 207 000 42 000 165 000

1/0.56 1/0.56

1/0.56

1/0.52 1/0.52

1/0.60 1/0.60 1/0.60 1/0.60 1/0.60 1/0.60

26 786 53 571 80 357 24 038 96 154 120 192 192 308 (37 500) 275 000 258 333 75 000 183 333 66 667 75 000 20 000 345 000 70 000 275 000

2. Verifying the foreign currency translation reserve Profit as translated Profit x closing rate: 15 000 x 1/0.60 Translation gain Opening net assets Opening net assets x opening rate (150 000 x 1/0.52) Opening net assets x closing rate (150 000 x 1/0.6) Translation loss

24 038 25 000 962 150 000 288 462 250 000

Total foreign currency translation reserve

(38 462) (37 500)

17.19

Solutions manual to accompany Company Accounting 10e

Question 17.2 (Cont’d) 3. Functional currency is the A$

Sales Cost of sales: Opening stock Purchases Closing stock Cost of sales Gross profit Expenses: Depreciation Other Profit Foreign currency translation loss Profit Retained earnings at 1/1/16 Retained earnings at 31/12/16 Share capital Total equity Property, plant & equipment Accumulated depreciation Accounts receivable Inventory Cash Accounts payable Net assets

US$ 90 000

rate 1/0.56

A$ 160 714

20 000 55 000 75 000 45 000 30 000 60 000

1/0.52 1/0.56

38 462 98 214 136 676 77 586 59 090 101 624

15 000 30 000 45 000 15 000

1/0.52 1/0.56

50 000 65 000 100 000 165 000

1/0.52

155 000 45 000 110 000 40 000 45 000 12 000 207 000 42 000 165 000

1/0.52 1/0.52

1/0.58

1/0.52

1/0.60 1/0.58 1/0.60 1/0.60

28 846 53 571 82 417 19 207 (1 877) 17 330 96 154 113 484 192 308 305 792 298 077 86 538 211 539 66 667 77 586 20 000 375 792 70 000 305 792

Differences in calculations when functional currency is A$ not US$: • closing stock / inventory: this is to be translated using the average rate for the period during which it was purchased, that is, average rate for December 2016. • Recognition of FCT Gain or Loss: o when translating the financial reports into functional currency, this is to be recognised in profit or loss as a FCT Gain or Loss; o when translating the financial reports into presentation currency this is to be recognised in other comprehensive income and shown as a FCT Reserve in Equity. 4. Verification of translation adjustment Net monetary assets at 1 January 2016 Increases: sales Decreases: Purchases Expenses Net monetary assets at 31 December 2016

US$ 5 000 90 000 95 000

rate change gain/(loss) (1/0.6 – 1/0.52) (1 282) (1/0.6 – 1/0.56) (10 714) (11 996)

55 000 30 000 85 000 10 000

(1/0.6 – 1/0.56) (1/0.6 – 1/0.56)

6 548 3 571 10 119 (1 877)

17.20

Chapter 17: Disclosure: translation of financial statements

Question 17.3

Translation of financial statements into functional currency

Perth Ltd, a company incorporated in Australia, acquired all the issued shares of Victoria Peak Ltd, a Hong Kong company, on 1 July 2016. The trial balance of Victoria Peak Ltd at 30 June 2017 was: HK$ HK$ Dr Cr Share capital 800 000 Retained earnings (1/7/16) 240 000 General reserve 100 000 Payables 160 000 Deferred tax liability 120 000 Current tax liability 20 000 Provisions 80 000 Sales 610 000 Proceeds on sale of land 250 000 Accumulated depreciation – plant 340 000 Plant 920 000 Land 400 000 Cash 240 000 Accounts receivable 300 000 Inventory at 1 July 2016 60 000 Purchases 260 000 Depreciation – plant 156 000 Carrying amount of land sold 200 000 Income tax expense 50 000 Other expenses 134 000 ________ 2 720 000 2 720 000 Additional information 1. Exchange rates based on equivalence to HK$1 were: A$ 1 July 2016 0.20 8 October 2016 0.25 1 December 2016 0.28 1 January 2017 0.30 2 April 2017 0.27 30 June 2017 0.22 Average during last quarter 2016– 0.24 17 0.26 Average 2016–17 2. Inventory was acquired evenly throughout the year. The closing inventory of HK$60 000 was acquired during the last quarter of the year. 3. Sales and other expenses occurred evenly throughout the year. 4. The Hong Kong tax rate is 20%. 5. The land on hand at the beginning of the year was sold on 8 October 2016. The land on hand at the end of the year was acquired on 1 December 2016. 6. Movements in plant over 2016–17 were: Plant at 1 July 2016 HK$ 600 000 Acquisitions – 8 October 2016 200 000 – 2 April 2017 120 000

17.21

Solutions manual to accompany Company Accounting 10e

Plant at 30 June 2017 920 000 Depreciation on plant is measured at 20% per annum on cost. Where assets are acquired during a month, a full month’s depreciation is charged. The functional currency of the Victoria Peak Ltd is the Australian dollar.

Required 1. Prepare the financial statements of Victoria Peak Ltd in Australian dollars at 30 June 2017. 2. Verify the translation adjustment.

1. Sales Cost of sales: Opening inventory Purchases Closing inventory Gross profit Proceeds of land sold Carrying amount of land sold Gain on sale

HK$ 610 000

Rate 0.26

A$ 158 600

60 000 260 000 320 000 60 000 260 000 350 000

0.20 0.26

12 000 67 600 79 600 14 400 65 200 93 400

250 000 200 000 50 000 400 000

0.25 0.20

62 500 40 000 22 500 115 900

0.20 0.25 0.27 0.26

24 000 7 500 1 620 34 840 67 960 47 940 31 140 79 080 13 000 66 080 48 000 114 080 160 000 20 000 294 080

Expenses: Depreciation: Full year: (600 000x0.2) 120 000 8/10: (200 000 x 0.2) x 9/12 30 000 2/4: (120 000 x 0.2) x 3/12 6 000 Other 134 000 290 000 110 000 FC translation gain/(loss) Profit before income tax Income tax expense 50 000 Profit 60 000 Retained earnings (op) 240 000 Retained earnings (cl) 300 000 Share capital 800 000 General reserve 100 000 1 200 000 Plant: Held for full year Purchased 8/10 Purchased 2/4 Accumulated depreciation

Land Inventory Cash

600 000 200 000 120 000 (184 000) (120 000) (30 000) (6 000) 400 000 60 000 240 000

0.24

0.26 0.20 0.20 0.20

0.20 0.25 0.27 0.20 0.20 0.25 0.27 0.28 0.24 0.22

120 000 50 000 32 400 (36 800) (24 000) (7 500) (1 620) 112 000 14 400 52 800

17.22

Chapter 17: Disclosure: translation of financial statements

Accounts receivable Total assets Payables Deferred tax liability Current tax liability Provisions Total liabilities Net assets

300 000 1 580 000 160 000 120 000 20 000 80 000 380 000 1 200 000

0.22 0.22 0.22 0.22 0.22 0.22

66 000 377 680 35 200 26 400 4 400 17 600 83 600 294 080

2. Verification of translation adjustment Net monetary assets at 1/7/16 Increases: Sales Proceeds – land Decreases: Purchases Land Plant Expenses Tax Net monetary assets at 30/6/17

464 000 *

0.22 – 0.20

9 280

610 000 250 000 1 324 000

0.22 – 0.26 0.22 – 0.25

(24 400) (7 500) (22 620)

260 000 400 000 200 000 120 000 134 000 50 000 1 164 000 160 000

0.22 – 0.26 0.22 – 0.28 0.22 – 0.25 0.22 – 0.27 0.22 – 0.26 0.22 – 0.26

10 400 24 000 6 000 6 000 5 360 2 000 53 760 31 140

The verification process requires the calculation of the difference between the closing rate and the applied or opening rate.

* opening balance sheet was: Capital Retained earnings General reserve Plant Accumulated depreciation Land Inventory Net monetary assets

800 000 240 000 100 000 1 140 000 600 000 **(184 000) 200 000 60 000 464 000 1 140 000

** = Accumulated depreciation at the end of the financial period Add back the Depreciation for the current financial period = Accumulated depreciation at the beginning of the financial period

$(340 000) 156 000 $(184 000)

17.23

Solutions manual to accompany Company Accounting 10e

Question 17.4

Translation into presentation currency

On 1 July 2015, Adelaide Ltd, an Australian company, acquired shares in Mong Kok Ltd, a company based in Hong Kong. At this date, the equity of Mong Kok Ltd was:

Share capital General reserve Retained earnings

HK$ 200 000 100 000 300 000

At 30 June 2016 and 2017 respectively, the retained earnings balances of Mong Kok Ltd were HK$400 000 and HK$450 000 respectively. All transactions occurred evenly throughout these years. The internal financial statements of the two companies at 30 June 2017 were as follows: Statements of Profit or Loss and Other Comprehensive Income Adelaide Ltd A$ Sales Cost of sales Expenses Dividend revenue Profit before income tax Tax expense Profit Retained earnings as at 1/7/17 Dividend paid Retained earnings as at 30/6/18

700 000 300 000 400 000 210 200 189 800 12 000 201 800 51 800 150 000 750 000 900 000 100 000 800 000

Mong Kok Ltd HK$ 595 000 400 000 195 000 100 000 95 000 — 95 000 20 000 75 000 450 000 525 000 25 000 500 000

Statements of Financial Position Adelaide Ltd A$ Current assets Shares in Cantonese Ltd Property, plant and equipment (net) Patents and trademarks Total assets Liabilities Net assets Equity: Share capital General reserve Retained earnings Total equity Additional information

311 520 288 480 700 000 100 000 1 400 000 100 000 1 300 000

Mong Kok Ltd HK$ 250 000 — 500 000 150 000 900 000 100 000 800 000

500 000 — 800 000 1 300 000

200 000 100 000 500 000 800 000

17.24

Chapter 17: Disclosure: translation of financial statements

1. 2.

The dividend paid by Mong Kok Ltd was paid on 1 May 2018. Some relevant exchange rates are: 1 July 2015 Average 2015–16 1 July 2016 Average 2016–17 1 July 2017 Average 2017–18 1 May 2018 30 June 2018

HK$1 0.82 0.85 0.88 0.90 0.85 0.80 0.78

$A0.80

Required Translate the financial statements of Mong Kok Ltd as at 30 June 2018 into the presentation currency of Australian dollars, assuming that the functional currency is the Hong Kong dollar. Translated accounts of Mong Kok Ltd as at 30 June 2018 HK$

Sales Cost of sales Expenses Tax expense Profit for the period Retained earnings (1/7/17) Dividend paid Retained earnings (30/6/18) Share capital General reserve FCTR

Current assets Property, plant & equipment (net) Patents and trademarks Liabilities

Exchange Rate

595 000 400 000 195 000 100 000 95 000 20 000 75 00 450 000 525 000 25 000 500 000 200 000 100 000 _______ 800 000

0.85 0.85

250 000 500 000 150 000 900 000 100 000 800 000

0.78 0.78 0.78

0.85 0.85

0.8 0.8 0.8

0.78

505 750 340 000 165 750 85 000 80 750 17 000 63 750 366 000 429 750 20 000 409 750 160 000 80 000 (25 750) 624 000 195 000 390 000 117 000 702 000 78 000 624 000

17.25

Solutions manual to accompany Company Accounting 10e

Question 17.4 (Cont’d) Foreign Currency Translation Reserve (FCTR) at 30 June 2018 2015-16 Opening net investment Profit for the period FCTR at 30 June 2016

= HK$(200 000 + 100 000 + 300 000) = HK$600 000 = R.E.30/6/16 HK$400 000 - R.E.1/7/15 HK$300 000 = HK$100 000 = 600 000(0.85 - 0.8) + 100 000 (0.85 - 0.82) = A$33 000 (credit)

2016-17 Opening net investment

= HK$(200 000 + 100 000 + 400 000) = HK$700 000 Profit for the period = R.E.30/6/17 HK$450 000 - R.E.30/6/16 HK$400 000 = HK$50 000 FCTR change = 700 000(0.9 - 0.85) + 50 000 (0.9 - 0.88) = $36 000 (credit) Hence at 30 June 2017, the FCTR has a credit balance of $69 000.

2017-18 Opening net investment Profit for the period Dividend FCTR change

= = = = = =

HK$(200 000 + 100 000 + 450 000) HK$750 000 HK$75 000 HK$25 000 750 000(0.78 - 0.9) + 75 000 (0.78 - 0.85) – 25 000 (0.78 - 0.8) $(94 750) (debit)

The balance of the FCTR at 30 June 2018 is then $(25 750).

Retained earnings balance at 1 July 2017 Retained earnings (1/7/15) Profit 2015-16 Profit 2016-17 Retained earnings (1/7/17)

= = = = = = =

HK$300 000 x 0.8 A$240 000 HK$100 000 x 0.82 A$82 000 HK$50 000 x 0.88 A$44 000 A$366 000

17.26

Chapter 17: Disclosure: translation of financial statements

Question 17.5

Translation into presentation currency

Lion Ltd is an international company resident in Singapore. It acquired the issued shares of an Australian company, Brisbane Ltd, on 1 July 2016 for A$700 000. At 30 June 2017, the following information was available about the two companies:

Share capital Retained earnings as at 1/7/16 Provisions Payables Sales Dividend revenue Accumulated depreciation – plant Cash Accounts receivable Inventory Shares in Brisbane Ltd Buildings (net) Plant Cost of sales Depreciation – plant Tax expense Other expenses Dividend paid Dividend provided

Lion Ltd S$ 560 000 330 000 45 000 14 000 620 000 6 400 210 000 1 785 400 92 100 145 300 110 000 336 000 84 000 420 000 390 000

Koala Ltd A$ 350 000 170 000 30 000 40 000 310 000 0 160 000 1 060 000 30 000 115 000 80 000 0 220 000 400 000 120 000

85 000 23 000 50 000 20 000 30 000 1 785 400

40 000 15 000 10 000 10 000 20 000 1 060 000

Additional information 1. Sales, purchases and other expenses were incurred evenly throughout the 2016– 17 period. The dividend was paid by Brisbane Ltd on 1 January 2017, while the dividend was declared on 30 June 2017. 2. Brisbane Ltd acquired A$100 000 additional new plant on 1 January 2017. Of the depreciation charged in the 2016–17 period, A$8000 related to the new plant. 3. The rates of exchange between the Australian dollar and the Singapore dollar were (expressed as A$1 S$0.6):

1 July 2016 0.60 1 December 2016 0.64 1 January 2017 0.68 30 June 2017 0.70 Average for the 2016–17 period 0.65 The functional currency of Brisbane Ltd is the Australian dollar.

Required 1. Translate the financial statements of Brisbane Ltd into Singapore dollars for inclusion in the consolidated financial statements of Lion Ltd. 2. Verify the translation adjustment. © John Wiley and Sons Australia Ltd 2015

17.27

Solutions manual to accompany Company Accounting 10e

1. Translation of subsidiary’s accounts into S$ A$ Sales 310 000 Cost of sales 120 000 Gross profit 190 000 Depreciation – plant 40 000 Other expenses 10 000 50 000 Profit before tax 140 000 Tax expense 15 000 Profit 125 000 Retained earnings 1/7/16 170 000 295 000 Dividend paid 10 000 Dividend provided 20 000 30 000 Retained earnings 30/6/17 265 000 Share capital 350 000 Foreign currency translation reserve -Provisions 30 000 Payables 40 000 685 000 Cash 30 000 Accounts receivable 115 000 Inventory 80 000 Buildings (net) 220 000 Plant 400 000 Accumulated depreciation (160 000) 685 000

Rate 0.65 0.65 0.65 0.65

0.65 0.6 0.68 0.7

0.6

0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7

S$ 201 500 78 000 123 500 26 000 6 500 32 500 91 000 9 750 81 250 102 000 183 250 6 800 14 000 20 800 162 450 210 000 58 050 21 000 28 000 479 500 21 000 80 500 56 000 154 000 280 000 (112 000) 479 500

2. Verification of FCTR Opening net investment = A$520 000 (SC 350 000 + RE 170 000) Opening net investment x opening rate = 520 000 x 0.6 = S$312 000 Opening net investment x closing rate = 520 000 x 0.7 = S$364 000 Exchange gain = S$52 000 Change in equity of subsidiary Change in equity as translated Change in equity x closing rate Exchange gain Net FCTR

= = = = = = = = =

A$125 000 – (10 000 + 20 000) A$95 000 81 250 – (6 800 + 14 000) S$60 450 95 000 x 0.7 S$66 500 S$6 050 S$52 000 + S$6 050 S$58 050

17.28

Chapter 17: Disclosure: translation of financial statements

Question 17.6

Different functional currencies

On 1 July 2016, an Australian company, Toowoomba Ltd, acquired all the issued capital of a Swedish company, Stockholm Ltd, for $997 400. At the date of acquisition, the equity of Stockholm Ltd consisted of: Krona (K) Share capital 800 000 General reserve 200 000 Retained earnings 635 000 The internal financial statements of Stockholm Ltd at 30 June 2017 are shown below. Statement of Profit or Loss and Other Comprehensive Income K K Revenues 2 585 000 Cost of sales: Opening stock 600 000 Purchases 1 800 000 2 400 000 Closing stock 580 000 1 820 000 Gross profit 765 000 Expenses: Depreciation 125 000 Other 270 000 395 000 Profit before income tax 370 000 Income tax expense 200 000 Profit for the period 170 000 Retained earnings as at 1 July 2016 635 000 805 000 Dividend paid 100 000 Retained earnings as at 30 June 2017 705 000 Statement of Financial Position 1/7/16 K 500 000 600 000 1 100 000 300 000 700 000 (100 000) 800 000 (235 000) 1 465 000 2 565 000 350 000 580 000 930 000

30/6/17 K Current assets Cash and receivables 500 000 Inventory 580 000 Total current assets 1 080 000 Non-current assets Land 300 000 Buildings 700 000 Accumulated depreciation (130 000) Plant 900 000 Accumulated depreciation (330 000) Total non-current assets 1 440 000 Total assets 2 520 000 Current liabilities 235 000 Non-current liabilities Notes – issued September 2016 580 000 Total liabilities 815 000

17.29

Solutions manual to accompany Company Accounting 10e

1 635 000 800 000 200 000 635 000 1 635 000

Net assets Equity Share capital General reserve Retained earnings Total equity

1 705 000 800 000 200 000 705 000 1 705 000

Additional information 1. Exchange rates for the Swedish krona were as follows: 1 krona = $A 0.54 0.52 0.52 0.50 0.51

1 July 2016 Average 2016–17 January 2017 30 June 2017 Average for the last 4 months of the 2016– 17 period 2. Stockholm Ltd acquired additional plant for K100 000 on 1 January 2017 by issuing a note for K80 000 and paying the balance in cash. 3. Sales, purchases and other expenses were incurred evenly through the year. 4. Depreciation for the period in krona was as follows: Buildings $30 000 Plant – acquired before 1 July 2016 85 000 – acquired 1 January 2017 10 000 5. The inventory is valued on a FIFO basis. The opening stock was acquired when the exchange rate was 0.54, and the closing stock was acquired during the last 4 months of the 2016–17 period. 6. Dividends of K50 000 were paid on 2 July 2016 and 1 January 2017. 7. The tax rate for Stockholm Ltd is 25%. Required 1. Translate the accounts of the foreign subsidiary, Stockholm Ltd, into Australian dollars at 30 June 2017, assuming: (a) the functional currency is the Swedish krona, and the presentation currency is the Australian dollar (b) the functional currency is the Australian dollar, as is the presentation currency. 2. Verify the translation adjustments in requirement 1. 1. Translation of accounts (a) Translation from functional currency (K) to presentation currency ($A) K'000 Revenue Cost of sales: Opening stock Purchases

K'000 2 585

600 1 800

K'000 0.52

$'000 1 344

0.54 0.52

324 936

17.30

Chapter 17: Disclosure: translation of financial statements

2 400 580

Closing stock Cost of sales Gross profit Depreciation Other expenses

125 270

Dividend paid

50 50

Retained earnings as at 30/6/17 Share capital General reserve Foreign Currency Translation Reserve

Cash & receivables Inventory Land Buildings Accumulated depreciation Plant Accumulated depreciation

Net assets

0.52 0.52 395 370 200 170 635 805

Income tax expense Profit for the period Retained earnings as at 1/7/016

Current liabilities Notes

0.51 1 820 765

100 705 800 200

0.52 0.54 0.54 0.52 0.54 0.54

____ $1 705

1 260 296 964 380 65 140 205 175 104 71 343 414 53 361 432 108 (48) $853

500 580 300 700 (130) 900 (330) 2 520

0.5 0.5 0.5 0.5 0.5 0.5 0.5

250 290 150 350 (65) 450 (165) 1 260

235 580 815

0.5 0.5

117 290 407

$1 705

$853

17.31

Solutions manual to accompany Company Accounting 10e

Question 17.6 (Cont’d) 2 (a) Proof of Foreign Currency Translation Reserve Change in net investment Opening net assets Opening net assets x ending exchange rate Opening net assets x beginning exchange rate Translation loss Income statement items Change in retained earnings Change x ending exchange rate Change as translated Translation gain Balance of FCTR

= = = = = =

K1 635 1 635 x 0.5 $818 1 635 x 0.54 $883 $(65)

= = = = = = =

K705 - K635 K70 K70 x 0.5 $35 $361 - $343 $18 $17

= =

$(65) + $17 $(48)

17.32

Chapter 17: Disclosure: translation of financial statements

Question 17.6 (Cont’d) 1. (b) Translation from local currency (K) to functional currency (A$A) K'000 K'000 Revenue 2 585 0.52 Cost of sales: Opening stock 600 0.54 Purchases 1 800 0.52 2 400 Closing stock 580 0.51 Cost of sales 1 820 Gross profit 765 Depreciation 115 0.54 10 0.52 Other expenses 270 0.52 395 370 Foreign Exchange Gain Income tax expense Profit for the period Retained earnings as at 1/7/16 Dividend paid

Retained earnings as at 30/6/17 Share capital General reserve

Cash & receivables Inventory Land Buildings Accumulated depreciation Plant Accumulated depreciation

Current liabilities Notes

Net Assets

$'000 1 344 324 936 1 260 296 964 380 62 5 140 207 173 15 188 104 84 343 427 27 26 53 374 432 108 914

200 170 635 805 50 50 100 705 800 200 1 705

0.52

500 580 300 700 (130) 800 100 (320) (10) 2 520

0.50 0.51 0.54 0.54 0.54 0.54 0.52 0.54 0.52

250 296 162 378 (70) 432 52 (173) (5) 1 322

235 580 815

0.5 0.5

118 290 408

$1 705

0.54 0.54 0.52

0.54 0.54

$914

17.33

Solutions manual to accompany Company Accounting 10e

Question 17.6 (Cont’d) 2. (b) Proof of exchange gain K'000 Net Monetary Assets at 1/7/16 Increases: Sales Decreases: Purchases Other expenses Income tax expense Dividends Acquisition of plant

Net Monetary Assets at 30/6/17

*(430) 2 585 2155

(0.54 - 0.5) (0.52 - 0.5)

1 800 270 200 50 50 100 $2 470

(0.52 - 0.5) (0.52 - 0.5) (0.52 - 0.5) (0.54 - 0.5) (0.52 - 0.5) (0.52 - 0.5)

K'000 Gain/(loss) 17 (52) (35) 36 5 4 2 1 2 $50

(315)

Foreign Exchange Gain (Any difference is due to rounding)

*Opening statement of financial position: Share Capital General Reserve Retained Earnings

800 000 200 000 635 000 1 635 000

Inventory Land Building (net) Plant (net) Net Monetary Assets

600 000 300 000 600 000 565 000 *430 000 1 635 000

17.34

Chapter 17: Disclosure: translation of financial statements

Question 17.7

Translation into functional currency

On 1 January 2016, an Australian company, Darwin Ltd, formed a company, New York Ltd, in the United States to sell Australian products such as boomerangs and cuddly koalas and kangaroos. The initial capital was US$500 000. On 1 February 2017, a lease was signed on a shop for US$20 000, payable on the first day of each month. On 15 February, store furnishings were acquired for $448 000; these were expected to have a useful life of 4 years. On 10 June 2016, more fittings were acquired at a cost of $124 000, again with an expected life of 4 years. Additional information 1. Where non-current assets are acquired during a month, a full month’s depreciation is applied. 2. The tax rate in the United States is 20%, while the tax rate in Australia is 30%. 3. The functional currency for New York Ltd is the Australian dollar. 4. Exchange rates for the financial year were (A$1 US$): 1 January 2016 0.60 1 February 0.63 15 February 0.64 10 June 0.66 30 June 0.65 Average for first half year 0.63 30 September 0.66 1 December 0.69 Average for second half year 0.65 31 December 2016 0.70 5. Sales in the first half of the year amounted to $210 000. 6. Expenses, other than depreciation, leases costs, and purchases, in the first half of the year amounted to $60 000. 8. Financial information relating to New York Ltd for the year ending 31 December 2016 is:

Sales revenue Closing inventory Accumulated depreciation – furniture and fittings Accounts payable Share capital Lease expenses Purchases Inventory Other expenses Depreciation – furniture and fittings Furniture and fittings Cash Accounts receivable

US$ 680 000 20 000 120 750 40 000 500 000 1 360 750 220 000 230 000 20 000 150 000 120 750 572 000 14 600 33 400 1 360 750

17.35

Solutions manual to accompany Company Accounting 10e

Required Translate the financial statements of New York Ltd into Australian dollars for inclusion in the consolidated financial statements of Southern Ltd at 31 December 2016. 1. Translation into A$ US$ Sales First half Second half

rate

210 000 470 000 680 000

1/0.63 1/0.65

333 333 723 077 1 056 410

60 000 170 000 230 000 20 000 210 000 470 000

1/0.63 1/0.65

95 238 261 538 356 776 30 769 326 007 730 403

102 667 18 083 Other expenses 60 000 90 000 Leases expenses (20000x5mths) 100 000 (20000x6mths) 120 000 490 750 Trading loss (20 750 Foreign currency translation loss Loss for the period (20 750)

1/0.64 1/0.66 1/0.63 1/0.65 1/0.63 1/0.65

160 417 27 398 95 238 138 462 158 730 184 615 764 860 (34 457) (656 615) (91 072)

Share capital Retained earnings

500 000 (20 750) 479 250

1/0.60

833 333 (91 072) 742 261

Cash Accounts receivable Fittings

14 600 33 400 448 000 124 000 (102 667) (18 083) 20 000 519 250 40 000 479 250

1/0.7 1/0.7 1/0.64 1/0.66 1/0.64 1/0.66 1/0.65

20 857 47 714 700 000 187 879 (160 417) (27 398) 30 769 799 404 57 143 742 261

Cost of sales: Purchases First half Second half Closing inventory Gross profit Expenses: Depreciation: fittings

Accumulated depreciation Inventory Total assets Accounts payable Net assets

1/0.65

1/0.7

17.36

Chapter 17: Disclosure: translation of financial statements

Question 17.7 (cont’d) Verification of translation loss Net monetary assets at 1/1/16 Increases: sales-

Decreases: Acquisition of furniture Purchases Lease expenses Other expenses

Net monetary assets at 31/12/16

US$ 500 000 210 000 470 000 1 180 000

rate change gain/(loss) 1/0.7 – 1/0.6 (119 047) 1/0.7 – 1/0.63 (33 333) 1/0.7 – 1/0.65 (51 648) (204 028)

448 000 124 000 60 000 170 000 100 000 120 000 60 000 90 000 1 172 000 8 000

1/0.7 – 1/0.64 1/0.7 – 1/0.66 1/0.7 – 1/0.63 1/0.7 – 1/0.65 1/0.7 – 1/0.63 1/0.7 – 1/0.65 1/0.7 – 1/0.63 1/0.7 – 1/0.65

60 000 10 736 9 523 18 683 15 873 13 186 9 524 9 891 147 416 (56 612) (rounded)

17.37

Solutions manual to accompany Company Accounting 10e

Question 17.8

Translation to presentation currency

On 1 July 2017, Melbourne Ltd, an Australian company, acquired the issued shares of Memphis Ltd, a company incorporated in the United States. The draft statement of profit or loss and other comprehensive income and statement of financial position of Memphis Ltd at 30 June 2018 was as follows: US$ US$ Sales revenues 1 600 000 Cost of sales: Opening inventory 140 000 Purchases 840 000 980 000 Closing inventory 280 000 700 000 Gross profit 900 000 Expenses: Depreciation 90 000 Other 270 000 360 000 Profit before income tax 540 000 Income tax expense 200 000 Profit 340 000 Retained earnings as at 1 July 2017 200 000 540 000 Dividend paid 120 000 Dividend declared 200 000 320 000 Retained earnings as at 30 June 2018 220 000

Current assets: Inventory Accounts receivable Cash Total current assets Non-current assets: Patent Plant Accumulated depreciation Land Buildings Accumulated depreciation Total non-current assets Total assets Current liabilities: Provisions Accounts payable Total current liabilities Non-current liabilities: Loan from Echidna Ltd Total liabilities Net assets

2018 US$

2017 US$

280 000 20 000 20 000 320 000

140 000 130 000 570 000 840 000

80 000 720 000 (130 000) 500 000 920 000 (120 000) 1 970 000 2 290 000

80 000 600 000 (80 000 300 000 820 000 (80 000) 1 640 000 2 480 000

500 000 320 000 820 000

620 000 940 000 1 560 000

530 000 1 350 000 940 000

— 1 560 000 920 000

17.38

Chapter 17: Disclosure: translation of financial statements

Equity: Share capital 720 000 720 000 Retained earnings 220 000 200 000 Total equity 940 000 920 000 Additional information On 1 January 2018, Memphis Ltd acquired new plant for US$120 000. This plant is depreciated over a 5-year period. On 1 April 2018, Memphis Ltd acquired US$200 000 worth of land. On 1 October 2017, Memphis Ltd acquired US$100 000 worth of new buildings. These buildings are depreciated evenly over a 10-year period. The interim dividend was paid on 1 January 2018 while the dividend payable was declared on 30 June 2018. Sales, purchases and expenses occurred evenly throughout the period. The inventory on hand at 30 June 2018 was acquired during June 2018. The loan of US$530 000 from Melbourne Ltd was granted on 1 July 2017. The interest rate is 8% per annum. Interest is paid on 30 June and 1 January each year. On consolidation, the partial goodwill method is used. The exchange rates for the financial year were as follows: US$1 A$ 1 July 2017 2.00 1 October 2017 1.80 1 January 2018 1.70 1 April 2018 1.60 30 June 2018 1.50 Average June 2018 1.52 Average for 2017–18 1.75 Required 1. If the functional currency for Memphis Ltd is the US dollar, prepare the financial statements of Memphis Ltd at 30 June 2018 in the presentation currency of the Australian dollar. 2. Verify the foreign currency translation adjustment.

1. Translation to presentation currency US$ Sales Cost of sales: Opening stock Purchases Closing inventory Gross profit Depreciation: Plant -Old Plant -New Buildings - Old

1 600 000

Exchange rate 1.75

140 000 840 000 980 000 280 000 700 000 900 000

2.00 1.75

38 000 12 000 32 500

1.75 1.60 1.75

1.52

A$ 2 800 000 280 000 1 470 000 1 750 000 425 600 1 324 400 1 475 600 66 500 19 200 56 875

17.39

Solutions manual to accompany Company Accounting 10e

Buildings -New Interest

7 500 21 200 21 200 Other expenses 227 600 360 000 Profit before income tax 540 000 Income tax expense 200 000 Profit for the period 340 000 Retained earnings at 1 July 2017 200 000 540 000 Dividend paid 120 000 Dividend declared 200 000 320 000 Retained earnings at 30 June 2018 220 000 Share capital 720 000 Foreign Currency Translation Reserve Loan from Melbourne Ltd 530 000 Provisions 500 000 Accounts payable 320 000 2 290 000 Inventory 280 000 Accounts receivable 100 000 Cash 20 000 Plant 720 000 Accumulated depreciation (130 000) Land 500 000 Buildings 920 000 Accumulated depreciation (120 000) 2 290 000

1.75 1.70 1.50 1.75

1.75 2.00 1.70 1.50 2.00 2.00 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

13 125 36 040 31 800 398 300 621 840 853 760 350 000 503 760 400 000 903 760 204 000 300 000 504 000 399 760 1 440 000 (429 760) 795 000 750 000 480 000 3 435 000 420 000 150 000 30 000 1 080 000 (195 000) 750 000 1 380 000 (180 000) 3 435 000

17.40

Chapter 17: Disclosure: translation of financial statements

Question 17.8 (cont’d) 2. Verification of translation adjustment: = = = = = = =

US$220 000 – US$200 000 US$20 000 20 000 x 1.50 A$30 000 A$399 760 – A$400 000 A$(240) A$30 240

Translation loss

= = = = = =

US$920 000 920 000 x 2.00 A$1 840 000 920 000 x 1.50 A$1 380 000 A$(460 000)

Total translation loss

= A$(429 760)

Movement in retained earnings Movement x closing rate Movement as translated Translation gain Net investment at 1 July 2017 Net investment x opening rate Net investment x closing rate

17.41

Solutions manual to accompany Company Accounting 10e

Question 17.9

Translation into functional currency

Use the information in question 17.8. Required 1. If the functional currency for Memphis Ltd is the Australian dollar, prepare the financial statements of Memphis Ltd at 30 June 2018 in the functional currency. 2. Verify the foreign currency translation adjustment.

1. Translation into functional currency of A$ US$ Sales Cost of sales: Opening stock Purchases

1 600 000

Closing inventory Gross profit Depreciation: Plant -Old Plant -New Buildings - Old Buildings -New Interest Other expenses

Foreign Exchange Gain/(Loss) Profit before income tax Income tax expense Profit for the period Retained earnings at 1 July 2017 Dividend paid Dividend declared Retained earnings at 30 June 2018 Share capital Loan from Melbourne Ltd Provisions Accounts payable

Exchange rate 1.75

140 000 840 000 980 000 280 000 700 000 900 000

2.00 1.75

38 000 12 000 32 500 7 500 21 200 21 200 227 600 360 000

2.00 1.70 2.00 1.80 1.70 1.50 1.75

540 000 200 000 340 000 200 000 540 000 120 000 200 000 320 000 220 000 720 000 530 000 500 000 320 000 2 290 000

1.52

1.75 2.00 1.70 1.50 2.00 2.00 1.50 1.50 1.50

A$ 2 800 000 280 000 1 470 000 1 750 000 425 600 1 324 400 1 475 600 76 000 20 400 65 000 13 500 36 040 31 800 398 300 641 040 834 560 449 140 1 283 700 350 000 933 700 400 000 1 333 700 204 000 300 000 504 000 829 700 1 440 000 795 000 750 000 480 000 4 294 700

17.42

Chapter 17: Disclosure: translation of financial statements

Question 17.9 (Cont’d) Inventory Accounts receivable Cash Patent Plant Accumulated depreciation Land Buildings Accumulated depreciation

280 000 20 000 20 000 80 000 600 000 120 000 (118 000) (12 000) 300 000 200 000 820 000 100 000 (112 500) (7 500) 2 290 000

1.52 1.50 1.50 2.00 2.00 1.70 2.00 1.70 2.00 1.60 2.00 1.80 2.00 1.80

425 600 30 000 30 000 160 000 1 200 000 204 000 (236 000) (20 400) 600 000 320 000 1 640 000 180 000 (225 000) (13 500) 4 294 700

2. Verification of Translation Adjustment Net monetary assets at 1 July 2017 Increases: Sales - inventory Decreases: Plant Land Buildings Purchases Other expenses Interest Income tax expense Dividend paid Dividend declared Net monetary assets at end

US$ (860 000)

1.50 – 2.00

Gain/(loss) 430 000

1 600 000 740 000

1.50 – 1.75

(400 000) 30 000

120 000 200 000 100 000 840 000 227 600 21 200 21 200 200 000 120 000 200 000 2 050 000 (1 310 000)

1.50 – 1.70 1.50 – 1.60 1.50 – 1.80 1.50 – 1.75 1.50 – 1.75 1.50 – 1.70 1.50 – 1.50 1.50 – 1.75 1.50 – 1.70 1.50 – 1.50

24 000 20 000 30 000 210 000 56 900 4 240 50 000 24 000 ____419 140 449 140

17.43

Solutions manual to accompany Company Accounting 10e

Chapter 18 – Consolidation: controlled entities REVIEW QUESTIONS 1.

What is a subsidiary?

A subsidiary is an entity that is controlled by another entity, a parent.

What is meant by the term “control”?

An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. 3.

For what purposes are the consolidated financial statements prepared?

Possible objectives are: - Supply of relevant information - Supply of comparable information - Accountability of management - Reporting of risks and benefits 4.

What are the key elements of control?

There are 3 key elements: -

Power over the investee Exposure or rights to variable returns from the parent’s involvement with the subsidiary The ability to use the power over the subsidiary to affect the amount of the parent’s returns. When does an investor have power over an investee?

Power is defined as “existing rights that give the current ability to direct the relevant activities” An investor has power over an investor when it has the current right to direct the relevant activities of the investee. 6.

What are “relevant” activities?

Relevant activities are activities of the subsidiary that significantly affect the investee’s returns. Examples are: (a) selling and purchasing of goods or services;

18.1

Chapter 18: Consolidation: controlled entities

(b) managing financial assets during their life (including upon default); (c) selecting, acquiring or disposing of assets; (d) researching and developing new products or processes; and (e) determining a funding structure or obtaining funding. 7.

Explain the link between power and returns

A parent must have the ability to use its power over the investee to affect the returns received from the investee. The parent must be able to use its power to increase the benefits and limit its losses from the subsidiary’s activities. If the investor has power in that it has the majority voting power in the investee, but all the operating decisions have already been established in the constitution of the investee, then the investor does not have control over the investee.

When are potential voting rights considered when deciding if one entity controls another?

Potential voting rights are rights to obtain voting rights of an investee, such as within an option or convertible instrument. Potential voting rights are only considered if the rights are substantive ie practical or utilitarian. This depends on the terms and conditions associated with the options. If an investor holds options that are deeply out of the money – such that the investee would never exercise those options – the options would not be considered to be substantive.

Is the non-controlling interest classified as a liability or equity?

It is classified as equity as the group does not have a present obligation to outflow funds to those shareholders.

10.

Are only those entities in which another entity owns more than 50% of the issued shares classified as subsidiaries?

No. The criterion for consolidation is not based on percentage ownership, but rather it is based on the concept of control. However, when the percentage interest is below 50%, judgement on the existence of control is required. In forming this judgement, the accountant has to rely on evidence to form an opinion.

11.

What benefits could be sought by an entity that obtains control over another entity?

Consider: - Dividends

18.2

Solutions manual to accompany Company Accounting 10e

Returns from structuring activities with the investee eg obtaining a supply of raw material, access to a port facility Returns from denying or regulating access to a subsidiary’s assets eg a patent for a competing product Returns from economies of scale Remuneration from provision of services such as servicing of assets, and management

18.3

Chapter 18: Consolidation: controlled entities

CASE STUDIES Case Study 1

Nature of control

The following comment was made by the Swedish Financial Reporting Board to the IASB in response to the issue of ED 10 Consolidated Financial Statements, and received by the IASB on 6 April 2009: We agree that consolidated financial statements would be improved, if they include entities under ‘de facto’ control. However, the problem is to establish which entities are really under ‘de facto’ control. There are situations where it is very clear that the dominant shareholder de facto controls another entity, but there are also lots of situations, where it is not clear that the dominant shareholder de facto controls the other entity. We suggest that the requirement for consolidation based on ‘de facto’ control is restricted to situations, where it is beyond reasonable doubt that control really exists.

Required Discuss whether AASB 10 meets the problem raised by the Swedish Financial Reporting Board. De facto control Paragraphs B73 to B75 of AASB 10 discuss an investor’s relationship with other parties. Paragraph B73: When assessing control, an investor shall consider the nature of its relationship with other parties and whether those other parties are acting on the investor’s behalf (ie they are ‘de facto agents’). The determination of whether other parties are acting as de facto agents requires judgement, considering not only the nature of the relationship but also how those parties interact with each other and the investor. Paragraph B74: Such a relationship need not involve a contractual arrangement. A party is a de facto agent when the investor has, or those that direct the activities of the investor have, the ability to direct that party to act on the investor’s behalf. Paragraph B75: Examples of other parties that might act as de facto agents for the investor: a) the investor’s related parties b) a party that received its interest in the investee as a contribution or loan from the investor c) a party that has agreed not to sell, transfer or encumber its interests in the investee without the investor’s prior approval d) a party that cannot finance its operations without subordinated financial support from the investor

18.4

Solutions manual to accompany Company Accounting 10e

e) an investee for which the majority of the members of its governing body or for which its key management personnel are the same as those of the investor f) a party that has a close business relationship with the investor, such as the relationship between a professional service provider and one of its significant clients. Reasonable doubt AASB 10 requires: -

an investor to consider all facts and circumstances when assessing control (AASB 10, para.8) an investor to consider factors in determining control (eg AASB 10, para.B3) the application of judgement (eg AASB 10: paras. B23 and B73)

To introduce a “beyond reasonable doubt” test may not necessarily help the judgement process. There presumably would be a need to determine how this test would be applied as well as determining what is reasonable and who assesses what is reasonable. This may raise just another level of problems and points of view.

18.5

Chapter 18: Consolidation: controlled entities

Case Study 2

Convertible debentures

Peter Ltd establishes Pan Ltd for the sole purpose of developing a new product to be manufactured and marketed by Peter Ltd. Peter Ltd engages Mr Hook to lead the team to develop the new product. Mr Hook is named Managing Director of Pan Ltd at an annual salary of $100 000, $10 000 of which is advanced to Mr Hook by Pan Ltd at the time Pan Ltd is established. Mr Hook invests $10 000 in the project and receives all of Pan Ltd’s initial issue of 10 shares of voting ordinary shares. Peter Ltd transfers $500 000 to Pan Ltd in exchange for 7%, 10-year debentures convertible at any time into 500 shares of Pan Ltd voting ordinary shares. Pan Ltd has enough shares authorised to fulfil its obligation if Peter Ltd converts its debentures into voting ordinary shares. The constitution of Pan Ltd provides certain powers for the holders of voting common shares and the holders of securities convertible into voting ordinary shares that require a majority of each class voting separately. These include: (a) the power to amend the corporate purpose of Pan Ltd, and (b) the power to authorise and issue voting shares of securities convertible into voting shares. At the time Pan Ltd is established, there are no known economic legal impediments to Peter Ltd converting the debt. Required Discuss whether Pan Ltd is a subsidiary of Peter Ltd. Source: Adapted from Case V issued by the Financial Accounting Standards Board (FASB) as a part of its Consolidations project.

Peter Ltd Convertible debentures

Pan Ltd Mr Hook owns 100% of shares

The question is whether Peter Ltd is a parent of Pan Ltd. This depends on whether Peter Ltd controls Pan Ltd. Consider the definition of control as per Appendix A of AASB 10. Key question: As Peter Ltd holds convertible debentures, does this give it control over Pan Ltd? Mr Hook actually controls Pan Ltd but the AASB 10 concept of control is a capacity to control, a power to govern concept rather than an actual control concept. Peter Ltd can be considered a passive controller. The holder of a presently exercisable instrument has the capacity to control. It has the unilateral ability to exercise the instrument and thus obtain the power to determine financial and operating policy. By not exercising the conversion option, Peter Ltd is implicitly accepting the policy determinations of Pan Ltd. An analogy can be drawn with delegated authority. Mr Hook knows that if he fails to gain the approval of Peter Ltd for his actions, then the latter can exercise control by converting the debentures. © John Wiley and Sons Australia, Ltd 2015

18.6

Solutions manual to accompany Company Accounting 10e

The instrument must be currently exercisable. An alternative position is that Mr Hook controls until Peter Ltd actually chooses to exercise the conversion option. Peter Ltd cannot actually make any policy decisions in relation to Pan Ltd. It must first exercise the conversion option. It may never exercise that option. In that case, Mr Hook determines all policies in relation to Pan Ltd. Mr Hook has current capacity to control; this would change if Peter Ltd exercised its options. But until it takes that step, it does not have the current capacity to control. Given that Peter Ltd has not exercised the option, do the shareholders in Peter Ltd want or need information about the combined entity of the two companies? A further point of discussion is whether the likelihood of exercise of the conversion option should be part of the decision process. Under AASB 10, the rights must be substantive in order for control to exist. For example, because of economic conditions, Peter Ltd may not want to exercise the options. If it is detrimental to the holder of the options to exercise the options, the holder does not have control over the other entity. Review illustrative examples 18.1 and 18.2 in the text.

18.7

Chapter 18: Consolidation: controlled entities

Case Study 3

Power and relevant activities

According to paragraph BC43 of the Basis for Conclusions on IFRS 10 Consolidated Financial Statements: Respondents to ED 10 did not object to changing the definition of control to power to direct the activities of an investee. Many were confused, however, about what the Board meant by ‘power to direct’ and which ‘activities’ the Board had in mind. They asked for a clear articulation of the principle behind the term ‘power to direct’. They also expressed the view that power should relate to significant activities of an investee, and not those activities that have little effect on the investee’s returns.

Required Discuss what AASB 10 has done, if anything, to meet the comments made by the respondents to ED 10. Power to direct Some aspects of power raised in AASB 10 include: • Power needs to be absolute (AASB 10:9) • Power need not have been exercised. (AASB 10:12) • Power precludes others from controlling an investee. • Power is not defined just as the legal or contractual right to direct the activities of an investee, even though this would require less judgement. Instead power is defined in terms of the current ability to direct the activities. (AASB 10 Appendix A) • Power exists even if the investor does not actively direct the activities of an investee eg if one investee held 70% of the voting power but did not exercise its voting power while another investee held 30% of the voting power and actively exercised its voting power, the former entity would still be the parent. • Power does not require the investor to be able to act today ie it may be necessary for the investor to undertake steps in order to act, such as call a meeting before it can exercise its voting or other rights. (AASB 10, B24) Activities In order to control an investee an investor must have the current ability to direct the activities of the investee that significantly affect the investee’s returns – the relevant activities. (AASB 10:10, 13 and Appendix A) The activities would not just be the administrative activities of an investee. In general the relevant activities would be those that relate to the operating and financing activities of an investee – such as • selling goods or services, • purchasing inventory, • making capital expenditure, • obtaining finance. (AASB 10:B11, B12)

18.8

Solutions manual to accompany Company Accounting 10e

Case Study 4

Voting interest widely held

Mickey Ltd is a production company that produces movies and television shows. It also owns cable television systems that broadcast its movies and television shows. Mickey Ltd transferred to Mouse Ltd its cable assets and the shares in its previously owned and recently acquired cable television systems, which broadcast Mickey Ltd’s movies. Mouse Ltd assumed approximately $200 million in debt related to companies it acquired in the transaction. After the transfer date, Mouse Ltd acquired additional cable television systems, incurring approximately $2 billion of debt, none of which was guaranteed by Mickey Ltd. Mouse Ltd was initially established as a wholly-owned subsidiary of Mickey Ltd. Several months after the transfer, Mouse Ltd issued ordinary shares in an initial public offering, raising nearly $1 billion in cash and reducing Mickey Ltd’s interest in Mouse Ltd to 41%. The remaining 59% of Mouse Ltd’s voting interest is widely held. The managing director of Mouse Ltd was formerly the manager of broadcast operations for Mickey Ltd. Half the directors of Mouse Ltd are or were executive officers of Mickey Ltd. Mouse Ltd and its subsidiaries have entered individually into broadcast contracts with Mickey Ltd, pursuant to which Mouse Ltd and its cable system subsidiaries must purchase 90% of their television shows from Mickey Ltd at payment terms, and other terms and conditions of supply as determined from time to time by Mickey Ltd. That agreement gives Mouse Ltd and its cable television system subsidiaries the exclusive right to broadcast Mickey Ltd’s movies and television shows in specific geographic areas containing approximately 45% of the country’s population. Mouse Ltd and its cable television subsidiaries determine the advertising rates charged to their broadcast advertisers. Under its agreement with Mickey Ltd, Mouse Ltd has limited rights to engage in businesses other than the sale of Mickey Ltd’s movies and television shows. In its most recent financial year, approximately 90% of Mouse Ltd’s sales were Mickey Ltd movies and television shows. Mickey Ltd provides promotional and marketing services and consultation to the cable television systems that broadcast its movies and television shows. Mouse Ltd rents office space from Mickey Ltd in its headquarters facility through a renewable lease agreement, which will expire in 5 years’ time. Required A. Should Mickey Ltd consolidate Mouse Ltd? Why? B. If Mickey Ltd had not established Mouse Ltd but had instead purchased 41% of Mouse Ltd’s voting shares on the open market, does this change your answer to requirement A? Why? Source: Adapted from Case III issued by the FASB as a part of its Consolidations project.

41% Mickey Ltd

Mouse Ltd Mickey Ltd NCI

41% 59% - widely held

18.9

Chapter 18: Consolidation: controlled entities

If the NCI is widely held then it may be argued that Mickey Ltd has the capacity to control Mouse Ltd based on the potential for the NCI to outvote Mickey Ltd in determining the directors of Mouse Ltd. However, other factors should also be considered, such as: - historical attendance at AGMs of Mouse Ltd - interest groups such as Green groups within the NCI - geographical distribution of NCI If the NCI were tightly held would the decision be any different? The other key factor in the definition is the returns criterion. A parent must have the rights to variable returns from the control exercised as well as the ability to use power to affect returns. In this case, many of the key policy decisions seem to have been set by contract: - must purchase 90% of TV shows from Mickey Ltd - terms & conditions of supply determined by Mickey Ltd - limited rights to engage in other businesses - provision of marketing services - lease of rental space. Hence even if the NCI could dominate the Board of Mouse Ltd, there is not much they can change to increase or modify their benefits. Mickey Ltd is therefore running the business. The NCI are simply investors. B) Whether the ownership of Mouse Ltd’s shares comes from acquisition on the open market or acquisition at incorporation of the company is not of interest as it has no effect on the determination of control.

18.10

Solutions manual to accompany Company Accounting 10e

Case Study 5

Business combinations

Popeye Ltd has recently acquired all the issued shares of Bluto Ltd and will be required to prepare consolidated financial statements at the end of the next financial year. The accountant for Popeye Ltd, Ms Olive Oyl, has been informed that she will need to consider applying AASB 3 Business Combinations in preparing these statements. Unfortunately, this has caused Olive some confusion as she is not aware of any links between AASB 3 and AASB 10. She has asked for your advice. Required Discuss why AASB 3 may be related to the application of AASB 10.

A business combination is defined as “a transaction or other event in which an acquirer obtains control of one or more businesses”. Control is defined in AASB 3 in the same way as it is in AASB 10. When an entity becomes a parent of another entity, its subsidiary, because of the relationship between the two entities, a business combination occurs. In most cases, the acquirer is the parent while the subsidiary is an acquiree. The date on which a parent-subsidiary relationship occurs is the acquisition date as defined in AASB 3. This relationship will have an effect on the preparation of consolidated financial statements as AASB 3 will need to be applied in accounting for the consideration transferred by the acquirer, the accounting for the identifiable assets and liabilities of the acquiree and the determination of goodwill/gain on bargain purchase arising in the business combination. Note that there are a number of situations where, in a business combination, the parent entity is not the acquirer. Section 18.4 of the text illustrates two such situations: - 18.4.1: the formation of a new entity which owns the shares of two other entities that are combining. Application of the factors in AASB 3 is necessary to determine which of the two joining entities – not the legal parent – is the acquirer for consolidation purposes. - 18.4.2: reverse acquisitions where there is a share for share exchange such that the former shareholders of the subsidiary now are the majority shareholder in the parent. The subsidiary is then the acquirer.

18.11

Chapter 18: Consolidation: controlled entities

Case Study 6

Options

Donald Ltd and Daisy Ltd own 80% and 20% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Disneyland Ltd. Donald Ltd sells half of its interest to Goofy Ltd and buys call options from Goofy Ltd that are exercisable at any time at a premium to the market price when issued and, if exercised, would give Donald Ltd its original 80% ownership interest and voting rights. At 30 June 2015, the options are out of the money. Required Discuss whether Donald Ltd is the parent of Disneyland Ltd.

Donald Ltd

40% 40% Disneyland Ltd

Daisy Ltd

Goofy Ltd

20%

As Donald Ltd holds options in Disneyland Ltd, it has the potential to control that entity. However, including the options when determining control depends on whether the options are substantive ie whether it is in the interest of Donald Ltd to exercise the options. The options are currently out of the money. Hence the options should not be included in the determination of control. However, if there are other reasons why Donald may be able to increase its returns from Disneyland Ltd such as access to facilities/scarce resources then even if the options are out of the money, Donald Ltd may still consider that it is worthwhile to exercise the options. In such cases, the options would be included in the decision on who controls Disneyland Ltd.

18.12

Solutions manual to accompany Company Accounting 10e

Case Study 7

Relevant activities

Caspar Ltd and Spooky Ltd decide to establish a new entity, Ghosts Ltd. The purpose of Ghosts Ltd is to develop and market a new car seat designed for use by babies when travelling in a car. Caspar Ltd and Spooky Ltd have specific roles in the new company and have unilateral ability to make all decisions in relation to their specified roles. Caspar Ltd has agreed that it will be responsible for developing the new car seat and obtaining all the approvals from the relevant safety bodies in Australia. Once the seat has been designed and all safety approvals have been received, Spooky Ltd will manufacture and market the product. Required Discuss the activities undertaken by the Caspar Ltd and Spooky Ltd in relation to the determination of which entity controls Ghosts Ltd. Power is defined as “existing rights that give the current ability to direct the relevant activities. Relevant activities are “activities of the investee that significantly affect the investee’s returns”. Discuss whether either or both activities affect the returns of Ghost Ltd. If the activities of Caspar Ltd and Spooky Ltd both affect the investee’s returns then it is necessary to determine which activities – developing and obtaining regulatory approval or manufacturing and marketing – MOST significantly affect the investee's returns. In determining this, it would be necessary to consider: • • • •

the purpose and design of the investee; the factors that determine the profit margin, revenue and value of the investee as well as the value of the car seat product; the effect on the investee’s returns resulting from each investor’s decision-making authority with respect to the factors in the dot point above; and the investors’ exposure to variability of returns.

In this particular example, the investors would also consider: • •

the uncertainty of, and effort required in, obtaining regulatory approval (considering the investor’s record of successfully developing and obtaining regulatory approval of car seat products); and which investor controls the car seat product once the development phase is successful.

18.13

Chapter 18: Consolidation: controlled entities

Case Study 8

Options

Hewey Ltd, Dewey Ltd and Louie Ltd each own one-third of the ordinary shares that carry voting rights at a general meeting of shareholders of Woodchuck Ltd. Hewey Ltd, Dewey Ltd and Louie Ltd each have the right to appoint two directors to the board of Woodchuck Ltd. Hewey Ltd also owns call options that are exercisable at a fixed price at any time and, if exercised, would give it all the voting rights in Woodchuck Ltd. The management of Hewey Ltd does not intend to exercise the call options, even if Dewey Ltd and Louie Ltd do not vote in the same manner as Hewey Ltd. Required Discuss whether Woodchuck Ltd is a subsidiary of any of the other entities. Facts: Hewey Ltd Dewey Ltd Louie Ltd

each have 1/3 of ordinary shares of Woodchuck Ltd

Hewey Ltd owns call options that would give it 100% of the voting rights of Woodchuck Ltd. Management do not intend to exercise the options, presumably because it is not in their economic interest to do so. As the options are not substantive, they should not be considered in determining control. Woodchuck Ltd is not a subsidiary of any of the three companies.

18.14

Solutions manual to accompany Company Accounting 10e

Case Study 9

Convertible debt

Scrooge Ltd and McDuck Ltd own 55% and 45% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Beagle Boys Ltd. McDuck Ltd also holds debt instruments that are convertible into ordinary shares of Beagle Boys Ltd. The debt can be converted at a substantial price, in comparison with McDuck Ltd’s net assets, at any time, and if converted would require McDuck Ltd to borrow additional funds to make the payment. If the debt were to be converted, McDuck Ltd would hold 70% of the voting rights and Scrooge Ltd’s interest would reduce to 30%. Given the effect of increasing its debt on its debt–equity ratio, McDuck Ltd does not believe that it has the financial ability to enter into conversion of the debt. Required Discuss whether McDuck Ltd is a parent of Beagle Boys Ltd. Scrooge Ltd

55% Beagle Boys Ltd

McDuck Ltd 45% McDuck Ltd holds convertible debt in Beagle Boys Ltd that would, on exercise, give it 70% of Beagle Boys Ltd. However, this would result in a substantial increase in McDuck Ltd’s debt-equity ratio raising doubts about the company’s capacity to exercise the options. When considering potential voting rights, an investor shall consider the purpose and design of the instrument, as well as the purpose and design of any other involvement the investor has with the investee. This includes an assessment of the various terms and conditions of the instrument as well as the investor’s apparent expectations, motives and reasons for agreeing to those terms and conditions. If the investor also has voting or other decision-making rights relating to the investee’s activities, the investor assesses whether those rights, in combination with potential voting rights, give the investor power. In this situation, although the debt instruments are convertible at a substantial price, they are currently convertible and the conversion feature gives McDuck Ltd the power to affect the returns from Beagle Boys Ltd. The existence of the potential voting rights are considered and it is determined that McDuck Ltd not Scrooge Ltd controls Beagle Boys Ltd. The financial ability of McDuck Ltd to pay the conversion price does not influence the assessment. An investor, in assessing whether it has power, considers only substantive rights relating to an investee (held by the investor and others). For a right to be substantive, the holder must have the practical ability to exercise that right. It is necessary to consider any barriers that might prevent the holder from exercising the rights. Examples of such barriers include: (i) financial penalties and incentives that would prevent (or deter) the holder from exercising its rights. (ii) an exercise or conversion price that creates a financial barrier that would prevent (or deter) the holder from exercising its rights.

18.15

Chapter 18: Consolidation: controlled entities

(iii) terms and conditions that make it unlikely that the rights would be exercised, for example, conditions that narrowly limit the timing of their exercise. (iv) the absence of an explicit, reasonable mechanism in the founding documents of an investee or in applicable laws or regulations that would allow the holder to exercise its rights. (v) the inability of the holder of the rights to obtain the information necessary to exercise its rights. (vi) operational barriers or incentives that would prevent (or deter) the holder from exercising its rights (eg the absence of other managers willing or able to provide specialised services or provide the services and take on other interests held by the incumbent manager). (vii) legal or regulatory requirements that prevent the holder from exercising its rights (eg where a foreign investor is prohibited from exercising its rights). If McDuck Ltd does not have the financial ability to enter into the conversion of the debt, then it does not have the practical ability to exercise those rights. Hence, the existence of the convertible debt cannot affect the determination of control. Scrooge Ltd would then be the parent of Beagle Boys Ltd

18.16

Solutions manual to accompany Company Accounting 10e

Case Study 10

Control

Daffy Duck Ltd has acquired, during the current year, the following investments in the shares issued by other companies: Elmer Ltd $120 000 (40% of issued capital) Fudd Ltd $117 000 (35% of issued capital) Daffy Duck Ltd is unsure how to account for these investments and has asked you, as the auditor, for some professional advice. Specifically, Daffy Duck Ltd is concerned that it may need to prepare consolidated financial statements under AASB 10. To help you, the company has provided the following information about the two investee companies. Elmer Ltd • The remaining shares in Elmer Ltd are owned by a diverse group of investors who each hold a small parcel of shares. • Historically, only a small number of the shareholders attend the general meetings or question the actions of the directors. • Daffy Duck Ltd has nominated three new directors and expects that they will be appointed at the next annual general meeting. The current board of directors has five members. Fudd Ltd • The remaining shares in Fudd Ltd are owned by a small group of investors who each own approximately 15% of the issued shares. One of these shareholders is Elmer Ltd, which owns 17%. • The shareholders take a keen interest in the running of the company and attend all meetings. • Two of the shareholders, including Elmer Ltd, already have representatives on the board of directors who have indicated their intention of nominating for re-election. Required A. Advise Daffy Duck Ltd as to whether, under AASB 10, it controls Elmer Ltd and/or Fudd Ltd. Support your conclusion. B. Would your conclusion be different if the remaining shares in Elmer Ltd were owned by three institutional investors each holding 20%? If so, why?

A. Daffy Duck Ltd 40%

35%

Elmer Ltd

Fudd Ltd 17%

- NCI is a diverse group - low attendance at AGM - Daffy Duck Ltd expects to appoint 3/5 directors

- NCI is small group - keen interest - interested in directors

18.17

Chapter 18: Consolidation: controlled entities

Consider the definition of control. Power to govern or capacity to control depends on an entity having the ability to direct the policies of another entity so as to affect the returns of that entity and to be able to use that power to increase those returns. Determination of control is a judgement. Ability to exert control depends on such factors as: - size of the voting interest - the dispersion of other shareholdings - level of disorganisation or apathy of the NCI shareholders - attendance at AGMs - contractual arrangements - arrangements between friendly parties Applying these to the above example, it is expected that Elmer Ltd is a subsidiary. If Elmer Ltd is a subsidiary, then Fudd Ltd is also a subsidiary as Daffy Duck Ltd would control 52% of the vote. B. A change in the relative ownerships within Elmer Ltd would suggest that, dependent on other factors, it would lose its subsidiary status. Fudd Ltd would also then lose its subsidiary status

18.18

Solutions manual to accompany Company Accounting 10e

Case Study 11

Subsidiary status

Sylvester Ltd owns 40% of the shares of Tweety Pie Ltd, and holds the only substantial block of shares in that entity; no other party owns more than 3% of the shares. The annual general meeting of Tweety Pie Ltd is to be held in one month’s time. Two situations may arise. • Sylvester Ltd will be able to elect a majority of Tweety Pie Ltd’s board of directors as a result of exercising its votes as the largest holder of shares. As only 75% of shareholders voted in the previous year’s annual meeting, Sylvester Ltd may have the majority of the votes that are cast at the meeting. • By obtaining the proxies of other shareholders and, after meeting with other shareholders who normally attend general meetings of Tweety Pie Ltd and convincing these shareholders to vote with it, Sylvester Ltd may obtain the necessary votes to have its nominees elected as directors of the board of Tweety Pie Ltd, regardless of the attendance at the general meeting. Required Discuss the potential for Tweety Pie Ltd being classified as a subsidiary of Sylvester Ltd. Sylvester Ltd

Tweety Pie Ltd 40% -

Situation 1 Discuss: -

the concept of control the need for judgement factors to consider when determining the existence of control: - NCI = 60% - no other party > 3% interest - only 75% attendance at AGM last year apply to above situation

It will probably be concluded that Sylvester Ltd is the parent of Tweety Pie Ltd. Situation 2 Consider: - The difference between actual control and capacity to control: the party actually controlling the other entity may not have the capacity to control. Just because Sylvester Ltd’s nominees are elected as Board members does not automatically mean that it becomes the parent of Tweety Pie Ltd. It simply means that it actually controls that entity. The question is whether it has the capacity to control. - Attendance at AGMs: If holders of 90% of the voting shares attended the AGM, then holders of 50% of the shares could have outvoted Sylvester Ltd. They may allow Sylvester Ltd to manage Tweety Pie Ltd because of the great managerial skills or

18.19

Chapter 18: Consolidation: controlled entities

business connections of Sylvester Ltd. In this case, Sylvester Ltd is not the parent of Tweety Pie Ltd. The purpose of consolidation: If Sylvester Ltd is actually controlling Tweety Pie Ltd, even though it does not have the capacity to control, would the shareholders of Sylvester Ltd be interested in a set of consolidated financial statements for the combined group? Does the issue of accountability provide sufficient grounds for the consolidation of the two entities?

18.20

Solutions manual to accompany Company Accounting 10e

Case Study 12

Determining subsidiary status

Required In the following independent situations, determine whether a parent–subsidiary relationship exists, and which entity, if any, is a parent required to prepare consolidated financial statements under AASB 10. A. Road Ltd is a company that was hurt by a recent global financial crisis. As a result, it experienced major trading difficulties. It previously obtained a significant loan from Wile E. Bank, and when Road Ltd was unable to make its loan repayments, the bank made an agreement with Road Ltd to become involved in the management of that company. Under the agreement between the two entities, the bank had authority for spending within Road Ltd. Road Ltd’s managers had to obtain authority from the bank for acquisitions over $10 000, and was required to have bank approval for its budgets. B. Runner Ltd owns 80% of the equity shares of Beep Beep Ltd, which owns 100% of the shares of Looney Ltd. All companies prepare reports under Australian accounting standards. Although the shares of Beep Beep Ltd are not traded on any stock exchange, its debt instruments are publicly traded. C. Coyote Ltd is a major financing company whose interest in investing is return on the investment. Coyote Ltd does not get involved in the management of its investments. If the investees are not managed properly, Coyote Ltd sells its shares in that investee and selects a more profitable investee to invest in. It previously held a 35% interest in Tunes Ltd as well as providing substantial convertible debt finance to that entity. Recently, Tunes Ltd was having cash flow difficulties and persuaded Coyote Ltd to convert some of the convertible debt into equity so as to ease the effects of interest payments on cash flow. As a result, Coyote Ltd’s equity interest in Tunes Ltd increased to 52%. Coyote Ltd still wanted to remain as a passive investor, with no changes in the directors on the board of Tunes Ltd. These directors were appointed by the holders of the 48% of shares not held by Coyote Ltd. In each of these circumstances the following principles from the Basis of Conclusions to AASB 10 should be used: B2

To determine whether it controls an investee an investor shall assess whether it has all the following: (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee; and (c) the ability to use its power over the investee to affect the amount of the investor’s returns.

This question will be looked at under two scenarios: (i) Road Ltd is not a subsidiary of any other entity.

18.21

Chapter 18: Consolidation: controlled entities

The key issue is whether the fact that the bank has authority in relation to acquisitions and approval of budgets is sufficient to give the bank the status of a parent. The bank will receive a return from Road Ltd in the form of interest on the loan. Wile E. Bank Has: - Power over Road Ltd, as it has rights arising from the legal contract - It can affect some of the relevant activities eg acquisitions, but not others such as appointment of key management personnel. Road Ltd will not be a subsidiary of Wile E. Bank because: The bank is not exposed to variable returns from its involvement with Road Ltd. The interest payments are not affected by the profitability of Road Ltd. - It cannot use its power over Road Ltd to affect the amount of its returns, as the returns are fixed interest payments. -

(ii) Road Ltd is a wholly owned subsidiary of another entity, Chuck Jones Ltd. The key issue in this scenario is whether the authority given to the bank in relation to acquisitions and budget approval is sufficient to state that Chuck Jones Ltd does not control Road Ltd. The key issue is whether Chuck Jones Ltd still has power over Road Ltd given the arrangements with the bank. Relevant activities over which a parent should have power include: (a) selling and purchasing of goods or services; (b) managing financial assets during their life (including upon default); (c) selecting, acquiring or disposing of assets; (d) researching and developing new products or processes; and (e) determining a funding structure or obtaining funding. Decisions about relevant activities include: (a) establishing operating and capital decisions of the investee, including budgets; and (b) appointing and remunerating an investee’s key management personnel or service providers and terminating their services or employment. The key issue then is whether Chuck Jones Ltd has the ability to direct the relevant activities ie those activities that most significantly affect the investee’s returns. It is probable that Chuck Jones Ltd no longer controls Road Ltd as the bank can:veto any changes to significant transactions for the benefit of Chuck Jones Ltd. It can deny the company its ability to make acquisitions, and it can reject moves within a budget to undertake changes in inventory production. B. Runner Ltd

80%

Beep Beep Ltd

100%

Looney Ltd

The issue is whether Beep Beep Ltd needs to prepare a set of consolidated financial statements for itself and Looney Ltd.

18.22

Solutions manual to accompany Company Accounting 10e

Note that paragraph 4 of AASB 10 states that an entity that is a parent shall present consolidated financial statements except: (a) a parent need not present consolidated financial statements if it meets all the following conditions: (i) it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all 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; (ii) its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets); (iii) 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; and (iv) its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with International Financial Reporting Standards (IFRSs). Note all criteria are required to be met. In this example: (i) Looney Ltd is a wholly owned subsidiary of Beep Beep Ltd (ii) The ultimate parent, Runner Ltd, prepares reports under AASs, which comply with IFRSs However, the debt instruments of Beep Beep Ltd are traded publicly which means that it breaches 4(a)(iii) above. Hence Beep Beep Ltd is not exempt from preparing consolidated financial statements. Both Runner Ltd and Beep Beep Ltd would be required to prepare consolidated financial statements. C. Coyote Ltd currently holds 52% of the shares of Tunes Ltd. It does not want to become involved in the management of Tunes Ltd, and the directors are appointed by the noncontrolling interest (NCI). Control is not based on actual control but on the capacity to control. Coyote Ltd - has power over the investee via its share ownership - is exposed to variable returns via dividends arising from its share ownership - has the ability to affect those returns as it can become involved in management whenever it wishes, given its superior voting power. Coyote Ltd is a parent of Tunes Ltd and hence must prepare consolidated financial statements. Further, when Coyote Ltd held a 35% interest in Tunes Ltd it also held convertible debt in that entity which could, if converted, give it an equity interest of 52%. In this situation, Coyote Ltd was a parent of Tunes Ltd and should have prepared consolidated financial statements. It would appear under the circumstances that the conversion was substantive ie economically feasible, and currently exercisable.

18.23

Chapter 18: Consolidation: controlled entities

Case Study 13

Determining subsidiary status

Required In the following independent situations, determine whether a parent–subsidiary relationship exists and which entity, if any, is a parent required to prepare consolidated financial statements under AASB 10. A. Tom Ltd and Toots Ltd each hold 50% of the shares in Jerry Ltd, all companies being involved in the computer software industry. Tom Ltd agrees that Toots Ltd should provide the management of Jerry Ltd because of the expertise provided by its managing director, Bob Gates. Toots Ltd receives a management fee for providing its expertise. B. Spike Ltd has recently acquired a 35% interest in Tyke Ltd, a company that has discovered large deposits of iron ore. Spike Ltd has extensive experience in the mining industry and, as a result, has been able to have four of its directors elected to the board of Tyke Ltd, which has six directors in total. C. Butch Ltd holds 30% of the shares issued by Toodles Ltd. The other shareholders come from mixed backgrounds, but each holds on average 10% of shares in Butch Ltd. There are seven directors of Toodles Ltd. Four of these are appointed by Butch Ltd. The other three directors are appointed by three of the other shareholders who have an interest in the management of the company. Most of the remaining shareholders live outside Australia and rarely attend board meetings of Butch Ltd unless they have other business to attend to in Australia around the same time as the board meetings are held. In each of these circumstances the following principles from the Basis of Conclusions to AASB 10 should be used: B2

B3 Consideration of the following factors may assist in making that determination: (a) the purpose and design of the investee; (b) what the relevant activities are and how decisions about those activities are made; (c) whether the rights of the investor give it the current ability to direct the relevant activities; (d) whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; and (e) whether the investor has the ability to use its power over the investee to affect the amount of the investor’s returns A. Both Tom Ltd and Toots Ltd hold 50% of the shares in Jerry Ltd, with Toots Ltd actually directing Jerry Ltd because of its management expertise. In this circumstance, Jerry Ltd is not a subsidiary of either company. Neither investor has the power over Jerry Ltd, as neither investor holds existing rights to enable it to direct the relevant activities of Jerry Ltd. Although Tom Ltd allows Toots Ltd

18.24

Solutions manual to accompany Company Accounting 10e

to currently manage the investee, it can step in at any time and challenge the management arrangements. As neither investor holds more than 50% of the shares, neither has power. Hence there is no need for any consolidated financial statements to be prepared. B. Spike Ltd currently has the ability to elect a majority of directors of Tyke Ltd. This has occurred potentially just because of its expertise in the mining industry. As in (a) above, this does not give it power over Tyke Ltd. There is no information to suggest that the other 65% of shareholders in Tyke Ltd could not get together and change the management of Tyke Ltd. Spike Ltd does not have power over Tyke Ltd. Spike Ltd does not have to prepare consolidated financial statements. C. Currently Butch Ltd holds 30% of the shares of Toodles Ltd. The remaining shareholders consist of 7 shareholders having on average 10% of Toodles Ltd’s shares. In relation to these investors: - most live outside Australia - most do not attend AGMs Where an investor has less than a 50% holding of shares in the investee, judgement is required to determine whether control exists. It is necessary to examine the potential actions of the holders of the other shares in Toodles Ltd. In this case, it is difficult to make a decision as: - The fact that there are only 7 others shareholders with 10% each, only 3 of these need to get together to have the same voting capacity as Butch Ltd. This lessens the likelihood of Butch Ltd having control. - The fact that most live outside Australia lessens the probability of these shareholders getting together to take control. However, they could give their proxies to each other. - The attendance at AGMs is low by the other shareholders. This however can change if these shareholders become dissatisfied with Butch Ltd as a manager. - The other shareholders have an interest in management shown by their appointing 3 of the directors – only 1 less than Butch’s 4 directors. As the shareholders have an interest – as opposed to being apathetic – the probability of becoming involved if they become dissatisfied with Butch Ltd is higher. On balance, Butch Ltd is probably not a parent of Toodles Ltd as it does not have sufficient power to continue to direct the relevant activities of Toodles Ltd.

18.25

Chapter 18: Consolidation: controlled entities

Case Study 14

Less than majority ownership

On 1 March 2016, Heckle Ltd acquired 40% of the voting shares of Jeckle Ltd. Under the company’s constitution, each share is entitled to one vote. On the basis of past experience, only 65% of the eligible votes are typically cast at the annual general meetings of Jeckle Ltd. No other shareholder holds a major block of shares in Jeckle Ltd. The financial year of Jeckle Ltd ends on 30 June each year. The directors of Heckle Ltd argue that they are not required under AASB 10 to include Jeckle Ltd as a subsidiary in Heckle Ltd’s consolidated financial statements at 30 June 2016 as there is no conclusive evidence that Heckle Ltd can control the financial and operating policies of Jeckle Ltd. The auditors of Heckle Ltd disagree, referring specifically to past years voting figures. Required Provide a report to Heckle Ltd on whether it should regard Jeckle Ltd as a subsidiary in its preparation of consolidated financial statements at 30 June 2016. 40% Heckle Ltd Discuss: -

Jeckle Ltd

the concept of control the need for judgement factors to consider when determining the existence of control, such as: - NCI is 60% - 65% of voters attended AGM - no block holdings of shares apply to above situation

It is expected that Heckle Ltd is the parent of Jeckle Ltd. Do all parent entities have to prepare consolidated financial statements? Paragraph 4 of AASB 10 establishes which entities must prepare consolidated financial statements.

18.26

Solutions manual to accompany Company Accounting 10e

Case Study 15

Determining parent status

Chip Ltd has 37% of the voting interest in Dale Ltd. An investment bank with which Chip has business relationships holds a 15% voting interest. Because of the closeness of the business relationship with the bank, Chip Ltd believes it can rely on the bank’s support to ensure it cannot be outvoted at general meetings of Dale Ltd. Required Given that there is no guarantee that the bank will always support Chip Ltd, particularly if there is a potential for economic loss, discuss whether Chip Ltd is a parent of Dale Ltd. -

Discuss: the concept of control the need to apply judgement these situations are often referred to “strawmen” – other parties that act as agents or in conjunction with the NCI. In the example in this question, the NCI has an assurance that the voting of the investment bank will always be aligned with its own, ensuring that it cannot be outvoted. If control is the basis for consolidation, a factor to consider is the influence available through a friendly party. Note however, that there is no guarantee that the investment bank will always vote with the NCI – the relationship may change over time. However, many of the other factors considered in relation to an NCI and control, such as the attendance at the AGM and the size of blocks of shareholdings may also change over time.

18.27

Chapter 18: Consolidation: controlled entities

Case Study 16

Rights to variable returns

Some have argued that the criteria for consolidation should be control plus significant risks and rewards of ownership or economic benefits. These parties argue that the consolidated financial statements are not meaningful if they include subsidiaries in which the parent’s level of returns is less than 50% or is not significant. Required Discuss: 1. the place of a returns criterion in the definition of control 2. possible returns that could occur as a result of obtaining control of another entity 3. the need to place a specified level of returns in the definition of control. The concept of control has basically 3 tests: - power over the investee - exposure, or rights, to variable returns from its involvement with the investee; and - the ability to use its power over the investee to affect the amount of the investor’s returns (a) Place of a returns criterion: The objective is to identify entities that are effectively able to use the assets and direct the activities of another and to benefit from such use as if those assets were held and those activities were undertaken on their behalf. It is doubtful that an entity would control another if there were no benefits in doing so. Assets are repositories of benefits. One holds assets in order to receive the benefits. (b) Possible returns: - cash distribution via dividends or residual interest - production of product or service complementary to the operation of the parent e.g. guaranteed source of raw material such as sand useful to the parent’s manufacture of glass. - the subsidiary has assets of use to the parent e.g. a patent that it may use or may control the production of competing products by others (c) Need for a specified level of returns: For example, must the parent be entitled to at least 50% of the returns from the subsidiary? If the returns were purely dividends/residual interest, this may be of interest. Given the variety of possible returns as noted above, the concept of a majority of returns seems both unnecessary and unworkable as the measurement of the relative returns would be very difficult. Measurement of the relative worth of different types of returns could be difficult. The ability to control is not dependent on the level of returns to be received. If the need for consolidation is based on concepts such as accountability, then the level of returns is not important. It is more crucial to determine whether management can affect the returns from another entity.

18.28

Solutions manual to accompany Company Accounting 10e

Chapter 19 – Consolidation: wholly owned subsidiaries REVIEW QUESTIONS 1. Explain the purpose of the pre-acquisition entries in the preparation of consolidated financial statements. The purpose of the pre-acquisition entry is to: - prevent double counting of the assets of the economic entity - prevent double counting of the equity of the economic entity - recognise any gain on bargain purchase A simple example such as that below could be used to illustrate these points: A Ltd has acquired all the issued shares of B Ltd. The balance sheets of both companies immediately after acquisition are as follows: Share capital Reserves

$200 100 300

Shares in B Ltd Cash

150 150 300

Share capital Reserves

Cash

$100 50 150 -150 150

The balance of the “Shares in B Ltd” account can be changed to introduce goodwill/ gain on bargain purchase amounts.

2. When there is a dividend payable by the subsidiary at acquisition date, under what conditions should the existence of this dividend be taken into consideration in preparing the pre-acquisition entries? Discuss: - the difference between ex div and cum div acquisitions - the effects on the acquisition journal entry in the records of the parent under each circumstance. Assume for example that A Ltd acquires all the issued shares of B Ltd for $500 000 when at acquisition date B Ltd has recorded a dividend payable of $10,000. - the effects on the acquisition analysis - the differences in the pre-acquisition entries at acquisition date if the acquisition is cum div versus ex div. [ the cum div entry will need to eliminate the dividend receivable raised by the parent and the dividend payable raised by the subsidiary]

19.1

Chapter 19: Consolidation: wholly owned subsidiaries

3. Is it necessary to distinguish pre-acquisition dividends from post-acquisition dividends? Discuss: -

the definition of acquisition date the meaning of pre-acquisition and post-acquisition equity according to para 38A of AASB 127 an entity shall recognise a dividend from a subsidiary in profit or loss ie as revenue – regardless of whether it is paid from pre- or post-acquisition equity

4. If the subsidiary has recorded goodwill in its records at acquisition date, how does this affect the preparation of the pre-acquisition entries? Discuss: - the difference between internally generated and acquired goodwill, and how the goodwill can be internally generated to the subsidiary but acquired by the parent - the effects on the worksheet in relation to the goodwill eg if the subsidiary has recorded goodwill of $50 and the parent acquires all the shares in a subsidiary for $4,050 when the equity of the subsidiary is $3 950 Parent Goodwill

Subsidiary 50

Cr 100

Group 150

In calculating the net fair value of the identifiable assets and liabilities acquired, there must be an adjustment for the unidentifiable asset, goodwill, to calculate the goodwill acquired by the group. The goodwill acquired, but not recorded, is recognised in the business combination valuation entries. The pre-acquisition entries will eliminate the BCVR as pre-acquisition equity. On consolidation, the adjustment columns in the worksheet contain the adjustment necessary so that the group goodwill is shown in the consolidated balance sheet. This amount is the total of the goodwill recognised by the subsidiary at acquisition date and the goodwill recognised on consolidation. This equals the total goodwill acquired by the parent in its acquisition of the subsidiary.

5. Explain how the existence of an excess affects the pre-acquisition entries, both in the year of acquisition and in subsequent years. Explain the meaning of and accounting for an excess as per AASB 3 Year of acquisition: Excess is shown in the pre-acquisition entry as a gain. Subsequent years: The excess is subsumed into the opening balance of retained earnings. It reduces the balance recorded by the subsidiary as the parent paid less for the subsidiary than the fair value of the identifiable assets and liabilities of the subsidiary.

19.2

Solutions manual to accompany Company Accounting 10e

6. At the date the parent acquires a controlling interest in a subsidiary, if the carrying amounts of the subsidiary’s assets are not equal to fair value, explain why adjustments to these assets are required in the preparation of the consolidated financial statements. AASB 3, paragraph 18, requires that identifiable assets and liabilities of the subsidiary be shown at fair value. The standard-setters believe that the fair value of the assets and liabilities provides the most relevant information to users. Even though the standard refers to an allocation of the cost of a business combination, the standard does not require the identifiable assets and liabilities acquired to be recorded at cost. The only asset acquired that is not measured at fair value is goodwill. The fair value approach is emphasised by the required accounting for any bargain purchase on combination. It is not accounted for as a reduction in the fair values of the identifiable assets and liabilities acquired such that these items are recorded at cost. Instead, the fair values are unchanged and the excess is recognised as a gain.

7. How does AASB 3 Business Combinations affect the acquisition analysis? The formation of a parent–subsidiary relationship by the parent obtaining control over the subsidiary is a business combination. The parent, being the controlling entity is an acquirer, with the subsidiary being the acquiree. The acquisition analysis is then totally based on AASB 3. The acquisition analysis reflects the application of the acquisition method: Step 1: Identify the acquirer – in this case, it is the parent. Step 2: Determine the acquisition date Step 3: Recognise and measure the identifiable assets acquired and the liabilities assumed at fair value. The differences between the carrying amounts and fair values of the identifiable assets, liabilities and contingent liabilities of the subsidiary are recognised via business combination valuation reserves. The effect is to recognise the assets and liabilities of the subsidiary at fair value. Step 4: Recognise and measure goodwill or a gain from a bargain purchase. The goodwill is recognised in the BCVR entries while the gain is recognised in the pre-acquisition entries.

8. What is the purpose of the business combination valuation entries? The purpose of these entries is to make consolidation adjustments so that in the consolidate balance sheet the identifiable assets, liabilities and contingent liabilities of the subsidiary are reported at fair value. This is to fulfil step 3 of the acquisition method required to account for business combinations by AASB 3.

9. Using an example, explain how the business combination valuation entries affect the preacquisition entries. Assume at acquisition date, the subsidiary has land recorded at a carrying amount of $10 000 and having a fair value of $15 000. The tax rate is 30%. At acquisition date, the BCVR entries will recognise an increment to land of $5 000, a deferred tax liability of $1 500 and a BCVR of $3 500. This BCVR is pre-acquisition equity. Hence in the preacquisition entry, if prepared at acquisition date, there would be a debit adjustment to BCVR to eliminate the balance of pre-acquisition equity.

19.3

Chapter 19: Consolidation: wholly owned subsidiaries

In subsequent periods, if the land is sold, in the BCVR entries, on sale of the land, there would be a credit adjustment to “Transfer from BCVR”, as the reserve is transferred to retained earnings. In preparing the pre-acquisition entries in the year of sale, the initial entry carried forward from the previous period will still include the BCVR relating to land. A further entry is then required debiting the “Transfer from BCVR” account – hence eliminating pre-acquisition equity – and crediting the BCVR account as this account no longer exists. 10. Why are some adjustment entries in the previous period’s consolidation worksheet also made in the current period’s worksheet? The consolidation worksheet is just a worksheet. The consolidation worksheet entries do not affect the underlying financial statements or the accounts of the parent or the subsidiary. Hence, if last year’s profits required to be adjusted on consolidation, then potentially retained earnings needs to be adjusted in the current period. Similarly, a BCVR entry to recognise the land on hand at acquisition at fair value is made in the consolidation worksheet for each year that the land remains in the subsidiary. The entry does not change from year to year. Again the reason is that the adjustment to the carrying amount of the land is only made in a worksheet and not in the actual records of the subsidiary itself.

19.4

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Handling research outlays

Lynx Ltd has just acquired all the issued shares of Indus Ltd. The accounting staff at Lynx Ltd has been analysing the assets and liabilities acquired in Indus Ltd. As a result of this analysis, it was found that Indus Ltd had been expensing its research outlays in accordance with AASB 138 Intangible Assets. Over the past 3 years, the company has expensed a total of $20 000, including $8000 immediately before the acquisition date. One of the reasons that Lynx Ltd acquired control of Indus Ltd was its promising research findings in an area that could benefit the products being produced by Lynx Ltd. There is disagreement among the accounting staff as to how to account for the research abilities of Indus Ltd. Some of the staff argue that, since it is research, the correct accounting is to expense it, and so it has no effect on accounting for the group. Other members of the accounting staff believe that it should be recognised on consolidation, but are unsure of the accounting entries to use, and are concerned about the future effects of recognition of an asset, particularly as no tax advantage remains in relation to the asset. Required Advise the group accountant of Lynx Ltd on what accounting is most appropriate for these circumstances. Accounting for research and development in the subsidiary itself is governed by AASB 138 Intangible Assets. Research outlays are expensed under AASB 138 para 54. Recognition of intangibles acquired in a business combination is discussed in paras 33-41 of AASB 138. Para 13 of AASB 3 recognises that some intangible assets not recognised by an acquiree may be recognisable by the acquirer. In a business combination the intangible asset is measured at its fair value, using the hierarchy in AASB 138. In order to recognise an intangible asset, it must meet the definition of an asset. In preparing the consolidated financial statements, Lynx Ltd will recognise the in-process research asset in its business combination valuation entries, for example: In-Process Research Deferred Tax Liability Business Combination Valuation Reserve

Dr Cr Cr

x x x

The tax-effect, in this case a liability relating to the expected tax to be paid on the earnings from the research asset, is recognised. In future periods, the in-process research will be subject to the amortisation procedures in AASB 138, resulting in further BCVR entries such as: Amortisation Expense Accumulated Amortisation

Dr Cr

Deferred Tax Liability Income Tax Expense

Dr Cr

When the In-Process research is fully amortised, the BCVR will be transferred to retained earnings, and no future consolidation adjustments will be necessary.

19.5

Chapter 19: Consolidation: wholly owned subsidiaries

Case Study 2

Unrecorded liability

Scorpio Ltd has finally concluded its negotiations to take over Norma Ltd, and has secured ownership of all the shares of Norma Ltd. One of the areas of discussion during the negotiation process was the current court case that Norma Ltd was involved in. The company was being sued by some former employees who were retrenched, but are now claiming damages for unfair dismissal. The company did not believe that it owed these employees anything. However, realising that industrial relations was an uncertain area, particularly given the country’s current confusing industrial relations laws, it had raised a note to the accounts issued before the takeover by Scorpio Ltd reporting the existence of the court case as a contingent liability. No monetary amount was disclosed, but the company’s lawyers had placed a $56 700 amount on the probable payout to settle the case. The accounting staff of Scorpio Ltd is unsure of the effect of this contingent liability on the accounting for the consolidated group after the takeover. Some argue that it is not a liability of the group and so should not be recognised on consolidation, but are willing to accept some form of note disclosure. A further concern being raised is the effects on the accounts, depending on whether Norma Ltd wins or loses the case. If Norma Ltd wins the court case, it will not have to pay out any damages and could get reimbursement of its court costs, estimated to be around $40 000. Required Give the group accountant your opinion on the accounting at acquisition date for consolidation purposes, as well as any subsequent effects when the entity either wins or loses the case. Under para 27 of AASB 137 Provisions, Contingent Liabilities and Contingent Assets, an entity’s contingent liabilities are not recognised in the accounts of the entity but are reported by way of note to the accounts. Under AASB 3 para 36, an acquirer must recognise at the acquisition date the acquiree’s identifiable assets and liabilities that satisfy the recognition criteria at their fair values at that date. Para 23 of AASB 3 state that the requirements of AASB 137 do not apply in determining which contingent liabilities to recognise as of acquisition date. However, the liability recognised must be a present obligation – not a possible obligation. Also, contrary to AASB 137, the acquirer recognises contingent liability even if it not probable that an outflow of resources will be required. The fair value measurement takes into account the probability of outflows occurring. Scorpio Ltd must then recognise the liability in its consolidated financial statements at fair value. This is done using the BCVR entries, assuming a fair value of $40 000: Business Combination Valuation Reserve Deferred Tax Asset Provision for Damages

Dr Dr Cr

28 000 12 000 40 000

If Norma Ltd wins the court case and no damages have to be paid, the consolidation worksheet entry changes to: Transfer from BCVR Income Tax Expense Gain from Court Case

Dr Dr Cr

28 000 12 000 40 000

If Norma Ltd loses the court case and pays damages of an amount less than $40 000, say $30 000, then the worksheet entry is:

19.6

Solutions manual to accompany Company Accounting 10e

Transfer from BCVR Income Tax Expense Gain from Court Case Damages Expense

Dr Dr Cr Cr

28 000 12 000 10 000 30 000

If Norma Ltd loses the court case and pays damages of an amount equal to or greater than $40 000, say $50 000, then the worksheet entry is: Transfer from BCVR Income Tax Expense Damages Expense

Dr Dr Cr

28 000 12 000 40 000

In relation to the court costs, assume that Norma Ltd has at the date of acquisition already incurred court costs of, say, $10 000 and expects to win the case and get these costs reimbursed. Under AASB 137, Norma Ltd does not itself recognise a contingent asset in its records. Further under AASB 3, contingent assets are not recognised by the acquirer as a part of step 3 of the acquisition method. They therefore do not affect the consolidation process. If the $10 000 were received by Norma Ltd in a later period upon winning the court case, it would be recognised as a gain by both Norma Ltd and the group.

19.7

Chapter 19: Consolidation: wholly owned subsidiaries

Case Study 3

Accounting for assets and liabilities

Mensa Ltd has acquired all the shares of Cancer Ltd. The accountant for Mensa Ltd, having studied the requirements of AASB 3 Business Combinations, realises that all the identifiable assets and liabilities of Cancer Ltd must be recognised in the consolidated financial statements at fair value. Although he is happy about the valuation of these items, he is unsure of a number of other matters associated with accounting for these assets and liabilities. He has approached you and asked for your advice. Required Write a report for the accountant at Mensa Ltd advising on the following issues: 1. Should the adjustments to fair value be made in the consolidation worksheet or in the accounts of Cancer Ltd? 2. What equity accounts should be used when revaluing the assets, and should different equity accounts such as income (similar to recognition of an excess) be used in relation to recognition of liabilities? 3. Do these equity accounts remain in existence indefinitely, since they do not seem to be related to the equity accounts recognised by Cancer Ltd itself? 1. From the point of view of AASB 3 and AASB 127, there is no specification on where the adjustments are made. However if the assets of the subsidiary are adjusted to fair value in the accounts of the subsidiary itself then this amounts to adoption of the revaluation model by the subsidiary and all the regulations in AASB 116 and AASB 138 apply. In particular, the assets must be continuously adjusted to reflect current fair values. If, on the other hand, the adjustments are made in the consolidation worksheet, this is a recognition on consolidation of the cost of the assets to the group entity rather than an adoption of the revaluation model. Hence the recognition of the subsidiary’s assets at fair value is to measure cost to the acquirer. There is then no need to make subsequent adjustments to the assets when the fair values change. Because of the costs associated with using the revaluation model, it is expected that most entities will make the adjustments in the consolidation worksheet rather than in the accounts of the subsidiary itself. 2. The accounting standards do not specify the name of the equity account raised on valuation of the assets and liabilities of the subsidiary. Hence, an asset revaluation reserve account could be used for the assets. Leo et al uses a BCVR because adjustments are made to both assets and liabilities and the BCVR is then a generic account for all adjustments arising as a result of the business combination. It is not appropriate to use income for liabilities as the recognition of equity for both assets and liabilities does not affect current period profit or loss. There is no gain by the acquirer on recognition of assets or liabilities not recognised by the subsidiary. 3. The BCVR remains in existence while the underlying assets and liabilities remain unsold, unconsumed or unsettled. With asset revaluation reserves under the revaluation model there is no requirement that it ever be transferred to retained earnings, although this is normal practice and is allowed under AASB 116. Similarly, the BCV reserves could remain indefinitely. However, the extra benefits/expenses resulting from using the assets or settling the liabilities will flow into the subsidiary’s retained earnings account. Hence the group recognises the net benefits in the BCVR while the subsidiary recognises them in retained earnings. This situation requires an adjustment in the consolidation worksheet every year while such a difference in equity classification occurs. If on consolidation as the assets are used up or sold and the liabilities settled the BCVR is transferred to retained earnings, no subsequent consolidation adjustment is required.

19.8

Solutions manual to accompany Company Accounting 10e

Case Study 4

Goodwill

When Hydra Ltd acquired the shares of Draco Ltd, one of the assets in the statement of financial position of Draco Ltd was $15 000 goodwill, which had been recognised by Draco Ltd upon its acquisition of a business from Valhalla Ltd. Having prepared the acquisition analysis as part of the process of preparing the consolidated financial statements for Hydra Ltd, the group accountant, Asmund Asmundson, has asked for your opinion. Required Provide advice on the following issues: 1. How does the recording of goodwill by the subsidiary affect the accounting for the group’s goodwill? 2. If, in subsequent years, goodwill is impaired, for example by $10 000, should the impairment loss be recognised in the records of Hydra Ltd or as a consolidation adjustment? 1.

The goodwill recorded by the subsidiary affects the adjustment to goodwill on consolidation. If the acquisition analysis results in the calculation of a group goodwill of, say, $20 000, then as the subsidiary has already recorded $15 000, a debit adjustment of $5 000 is required in the consolidation worksheet. If the acquisition analysis results in the calculation of a group goodwill of, say, $12 000, then as the subsidiary has already recorded $15 000, a credit adjustment of $3 000 is required in the consolidation worksheet. If the acquisition analysis determines an excess of, say, $2 000, then the whole $15 000 goodwill is eliminated on consolidation. Any accumulated impairment losses recorded by the subsidiary at acquisition date must be adjusted for in the consolidation worksheet.

The determination of the impairment loss would be based on the subsidiary as a CGU with the consolidated numbers representing the carrying amounts of the CGU. In writing off goodwill as the result of an impairment loss, the goodwill written off could be either that recognised by the subsidiary or that recognised on consolidation. If the goodwill on consolidation is written off this is done via the pre-acquisition entries. If the subsidiary writes off its recorded goodwill, no adjustment is required on consolidation for the impairment write-down. If the consolidated goodwill was $20 000, then if an impairment loss of $10 000 occurred, an amount of at least $5 000 would have to be written off in the subsidiary’s accounts.

19.9

Chapter 19: Consolidation: wholly owned subsidiaries

Case Study 5

Bargain purchase

The accountant for Carina Ltd, Ms Finn, has sought your advice on an accounting issue that has been puzzling her. When preparing the acquisition analysis relating to Carina Ltd’s acquisition of Lyra Ltd, she calculated that there was a gain on bargain purchase of $10 000. Being unsure of how to account for this, she was informed by accounting acquaintances that this should be recognised as income. However, she reasoned that this would have an effect on the consolidated profit in the first year after acquisition date. For example, if Lyra Ltd reported a profit of $50 000, then consolidated profit would be $60 000. She is unsure of whether this profit is all post-acquisition profit or a mixture of pre-acquisition profit and post-acquisition profit. Required Compile a detailed report on the nature of an excess, how it should be accounted for and the effects of its recognition on subsequent consolidated financial statements. 1. 2.

The gain arises as a result of a bargain purchase. AASB 3 requires that, on calculation of a gain on bargain purchase, the acquirer reassess the identification and measurement of the identifiable assets and liabilities. After this reassessment, any remaining excess is recognised as current period income. The gain on bargain purchase is all post-acquisition as it is in excess of the pre-acquisition equity equal to the net fair value of the identifiable assets and liabilities of the subsidiary. In subsequent periods, it is included in retained earnings (opening balance) – it reduces the adjustment to the opening balance of retained earnings. Example: Assume at acquisition date the recorded retained earnings was $10 000 and a gain on bargain purchase of $1 000 arose. In the first period subsequent to acquisition date, the subsidiary recorded a profit of $5 000. In the first period subsequent to acquisition the group would recognise a zero balance in retained earnings and a profit of $6 000, being the recorded $5 000 plus the $1 000 gain on bargain purchase [all post-acquisition]. In the following period, the subsidiary would report an opening balance of $15 000 and the pre-acquisition entry would show a debit adjustment to retained earnings (opening balance) of $9 000, thus showing a post-acquisition balance of $6 000.

19.10

Solutions manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 19.1

Pre-acquisition entries at acquisition date and one year later, no fair value/carrying amount differences at acquisition date

On 1 July 2016, Max Ltd acquired all the issued shares of Rodney Ltd for $200 000. The financial statements of Rodney Ltd showed the equity of Rodney Ltd at that date to be: Share capital — 20 000 $5 shares General reserve Retained earnings

$100 000 40 000 60 000

All the assets and liabilities of Rodney Ltd were recorded at amounts equal to their fair values at that date. During the year ending 30 June 2017, Rodney Ltd undertook the following actions. • On 10 September 2016, paid a dividend of $20 000 from the profits earned prior to 1 July 2016. • On 28 June 2017, declared a dividend of $20 000 to be paid on 15 August 2017. • On 1 January 2017, transferred $15 000 from the general reserve existing at 1 July 2016 to retained earnings. Required A. Prepare the pre-acquisition entries at 1 July 2016. B. Prepare the pre-acquisition entries at 30 June 2017. Acquisition analysis: At 1 July 2016: Net fair value of identifiable assets and liabilities acquired Consideration transferred Goodwill

= = = =

$100 000 + $40 000 + $60 000 (equity) $200 000 $200 000 $0

A. Pre-acquisition entries at 1 July 2016: Retained earnings (1/7/16) Share capital General reserve Shares in Rodney Ltd

Dr Dr Dr Cr

60 000 100 000 40 000

Retained earnings (1/7/16) Share capital General reserve Shares in Rodney Ltd

Dr Dr Dr Cr

60 000 100 000 40 000

Retained earnings (1/7/16) General reserve

Dr Cr

15 000

200 000

B. Pre-acquisition entries at 30 June 2017

200 000

15 000

Note that neither of the dividend transactions have any effect on the pre-acquisition entries regardless of whether the dividends are paid/declared from pre- or post-acquisition equity.

19.11

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.2

Consolidation worksheet entries at acquisition date and one year later, no fair value/carrying amount differences at acquisition date

On 1 July 2016, Jackson Ltd acquired all the issued shares (cum div.) of Laurie Ltd for $240 000. At that date the financial statements of Laurie Ltd showed the following information: Share capital General reserve Retained earnings Dividend payable

$100 000 50 000 70 000 20 000

All the assets and liabilities of Jackson Ltd were recorded at amounts equal to their fair values at that date. The dividend payable reported at 1 July 2016 by Laurie Ltd was paid on 15 August 2016. Laurie Ltd paid a $25 000 dividend on 2 February 2017. Required A. Prepare the consolidation worksheet entries at 1 July 2016. B. Prepare the consolidation worksheet entries at 30 June 2017. C. What differences would occur in the entries in A and B above if the shares were bought on an ex div. basis?

Acquisition analysis: At 1 July 2016: Net fair value of identifiable assets and liabilities acquired Consideration transferred Goodwill

= = = = =

$100 000 + $50 000 + $70 000 (equity) $220 000 $240 000 - $20 000 (dividend receivable) $220 000 $0

A: Worksheet entries at 1 July 2016 Retained earnings (1/7/16) Share capital General reserve Shares in Laurie Ltd

Dr Dr Dr Cr

70 000 100 000 50 000

Dividend payable Dividend receivable

Dr Cr

20 000

Dr Dr Dr Cr

70 000 100 000 50 000

220 000

20 000

B: Worksheet entries at 30 June 2017 Retained earnings (1/7/16) Share capital General reserve Shares in Laurie Ltd

220 000

C: Differences if shares issued on an ex div basis Acquisition analysis: At 1 July 2016: Net fair value of identifiable assets

19.12

Solutions manual to accompany Company Accounting 10e

and liabilities acquired Consideration transferred Goodwill

= = = =

$100 000 + $50 000 + $70 000 (equity) $220 000 $240 000 $20 000

The worksheet entries at 1 July 2016 and 30 June 2017 are the same: 1. Business combination valuation entries Goodwill Business combination valuation reserve 2. Pre-acquisition entries Retained earnings (1/7/16) Share capital General reserve Business combination valuation reserve Shares in Laurie Ltd

Dr Cr

20 000

Dr Dr Dr Cr Cr

70 000 100 000 50 000 20 000

20 000

240 000

19.13

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.3

Worksheet entries at acquisition date and at subsequent year end, no fair value/carrying amount differences at acquisition date, existing goodwill at acquisition date

On 1 January 2017, Graham Ltd acquired all the issued shares (cum div.) of Leslie Ltd for $263 000. At that date the equity of Leslie Ltd was recorded at: Share capital Reserves Retained earnings

$150 000 40 000 60 000

On 1 January 2017, the records of Leslie Ltd also showed that the company had recorded the asset goodwill at cost of $5000. Further Leslie Ltd had a dividend payable liability of $10 000, the dividend to be paid in March 2017. All other assets and liabilities were carried at amounts equal to their fair values. Required A. Prepare the consolidation worksheet entries on 1 January 2017, immediately after combination. B. Prepare the consolidation worksheet entries at 30 June 2017. C. Prepare the consolidation worksheet entries at 1 January 2017 assuming the consideration transferred was $259 000.

A: Consolidation worksheet entries at 1 January 2017 At 1 January 2017: Net fair value of identifiable assets and liabilities of Leslie Ltd =

Consideration transferred Goodwill acquired Non-recorded goodwill

= = = = = = =

($150 000 + $40 000 + $60 000) (equity) - $5 000 (goodwill) $245 000 $263 000 - $10 000 (dividend receivable) $253 000 $253 000 – 245 000 $8 000 $8 000 - $5 000 $3 000

Business combination valuation entries Goodwill Business combination valuation reserve

Dr Cr

3 000

Retained earnings (1/1/17) Share capital General reserve Business combination valuation reserve Shares in Leslie Ltd

Dr Dr Dr Dr Cr

60 000 150 000 40 000 3 000

Dividend payable Dividend receivable

Dr Cr

10 000

3 000

Pre-acquisition entries

253 000

10 000

19.14

Solutions manual to accompany Company Accounting 10e

B: Consolidation worksheet entries at 30 June 2017 The entries are the same as in A. above except that the dividend payable/receivable entry will no longer be required as the dividend has been paid by Leslie Ltd. C. Worksheet entries assuming the recorded goodwill is At 1 January 2017: Net fair value of identifiable assets and liabilities of Leslie Ltd =

Consideration transferred Goodwill acquired Over statement of goodwill

= = = = = = =

($150 000 + $40 000 + $60 000) (equity) - $5 000 (goodwill) $245 000 $259 000 - $10 000 (dividend receivable) $249 000 $249 000 – 245 000 $4 000 $4 000 - $5 000 $(1 000)

Business combination valuation entries Business combination valuation reserve Goodwill

Dr Cr

1 000 1 000

Pre-acquisition entries Retained earnings (1/1/17) Share capital General reserve Business combination valuation reserve Shares in Leslie Ltd

Dr Dr Dr Cr Cr

60 000 150 000 40 000

Dividend payable Dividend receivable

Dr Cr

10 000

1 000 249 000

10 000

Note: this situation would occur where the parent pays less than the full fair value of the subsidiary. If the real goodwill of the subsidiary was only $4000 then there should be an impairment adjustment of $1000 to goodwill in the subsidiary prior to preparing the consolidation entries. In this case the following adjustment entry would be required: Accumulated impairment losses – goodwill Goodwill The pre-acquisition entry would be:

Dr Cr

Impairment loss – goodwill Retained earnings (1/1/17) Share capital General reserve Shares in Leslie Ltd

Cr Dr Dr Dr Cr

1000 1000

1 000 60 000 150 000 40 000 249 000

Goodwill is then shown in the CFS at $4000 and no impairment loss is shown.

19.15

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.4

Worksheet entries at acquisition date and in subsequent year, no fair value/carrying amount differences at acquisition date, bargain purchase

On 1 July 2016, John Ltd acquired all the issued shares of Robert Ltd for $153 000. At this date the equity of Robert Ltd was recorded as follows: Share capital General reserve Retained earnings

$80 000 30 000 40 000

All the identifiable assets and liabilities were recorded at amounts equal to their fair values. Required A. Prepare the consolidation worksheet entries at 1 July 2016 and 1 July 2017 assuming John Ltd paid $153 000 for the shares in Robert Ltd. B. Prepare the consolidation worksheet entries at 1 July 2016 and 1 July 2017 assuming John Ltd paid $148 000 for the shares in Robert Ltd. C. Prepare the consolidation worksheet entries at 1 July 2016 assuming John Ltd paid $145 000 for the shares in Robert Ltd and at that date Robert Ltd had recorded goodwill of $4000. A: Consideration of $153 000 Acquisition analysis: At 1 July 2016: Net fair value of identifiable assets and liabilities of Robert Ltd = Consideration transferred Goodwill acquired

= = = =

($80 000 + $30 000 + $40 000) (equity) $150 000 $153 000 $153 000 – $150 000 $3 000

Worksheet entries at 1 July 2016: Business combination valuation entries Goodwill Business combination valuation reserve

Dr Cr

3 000

Dr Dr Dr Dr Cr

40 000 80 000 30 000 3 000

3 000

Pre-acquisition entries Retained earnings (1/7/16) Share capital General reserve Business combination valuation reserve Shares in Robert Ltd

153 000

Worksheet entries at 1 July 2017 The entries are the same as those above.

19.16

Solutions manual to accompany Company Accounting 10e

B: Consideration of $148 000 Acquisition analysis: At 1 July 2016: Net fair value of identifiable assets and liabilities of Robert Ltd = Consideration transferred Gain on bargain purchase

= = = =

($80 000 + $30 000 + $40 000) (equity) $150 000 $148 000 $148 000 – $150 000 $2 000

Worksheet entries at 1 July 2016: Pre-acquisition entries Retained earnings (1/7/16) Share capital General reserve Gain on bargain purchase Shares in Robert Ltd

Dr Dr Dr Cr Cr

40 000 80 000 30 000

Dr Dr Dr Cr

38 000 80 000 30 000

2 000 148 000

Worksheet entries at 1 July 2017 Retained earnings (1/7/17) Share capital General reserve Shares in Robert Ltd

148 000

C: Consideration of $145 000 and recorded goodwill of $4000 Acquisition analysis: At 1 July 2016: Net fair value of identifiable assets and liabilities of Robert Ltd

Consideration transferred Gain on bargain purchase

= = = = =

($80 000 + $30 000 + $40 000) (equity) - $4 000 (goodwill) $146 000 $145 000 $145 000 – $146 000 $1 000

Worksheet entries at 1 July 2016: 1. Business combination valuation reserve entries Business combination valuation reserve Goodwill

Dr Cr

4 000

Dr Dr Dr Cr Cr Cr

40 000 80 000 30 000

4 000

2. Pre-acquisition entries Retained earnings (1/7/16) Share capital General reserve Business combination valuation reserve Gain on bargain purchase Shares in Robert Ltd

4 000 1 000 145 000

19.17

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.5

Preparation of worksheet subsequent to acquisition, no fair value/carrying amount differences at acquisition date

On 1 July 2015, Adam Ltd acquired all the issued shares (ex div.) of Luke Ltd. At this date the financial statements of Luke Ltd showed the following balances in its accounts: Share capital General reserve Retained earnings Dividend payable Goodwill

$150 000 40 000 80 000 20 000 10 000

At 1 July 2015, all the identifiable assets and liabilities of Luke Ltd were recorded at amounts equal to their fair values. The financial statements of Adam Ltd and Luke Ltd at 30 June 2016 contained the following information:

Required Prepare the consolidated financial statements at 30 June 2016. Acquisition analysis At 1 July 2015:

19.18

Solutions manual to accompany Company Accounting 10e

Net fair value of identifiable assets and liabilities of Luke Ltd

Consideration transferred Goodwill acquired Unrecorded goodwill

= = = = = = = =

($150 000 + $40 000 + $80 000) (equity) - $10 000 (goodwill) $260 000 $292 000 - $20 000 (dividend receivable) $272 000 $272 000 – $260 000 $12 000 $12 000 - $10 000 $2 000

The consolidation worksheet entries at 30 June 2016 are: 1. Business combination valuation entries Goodwill Business combination valuation reserve

Dr Cr

2 000

Retained earnings (1/7/15) Share capital General reserve Business combination valuation reserve Shares in Luke Ltd

Dr Dr Dr Dr Cr

80 000 150 000 40 000 2 000

Transfer from general reserve General reserve

Dr Cr

10 000

2 000

2. Pre-acquisition entries

The consolidation worksheet at 30 June 2016 is: Adam Luke Ltd Ltd Profit for the period 35 000 25 000 Retained earnings 90 000 80 000 2 (1/7/15) Transfer from general 0 10 000 2 reserve Retained earnings 125 000 115 000 (30/6/16) Share capital 700 000 150 000 2 General reserve 92 000 30 000 2 Business combination 0 0 2 valuation reserve Provisions 30 000 20 000 Payables 15 000 25 000 Loans 50 000 110 000 1 012 000 450 000 Plant 600 000 820 000 Accum. Depreciation (295 000) (650 000) Fixtures 300 000 120 000 Accum depreciation (180 000) (80 000) Land 200 000 140 000 Brands 50 000 30 000 Shares in Luke Ltd 272 000 0

272 000

10 000

Adjustments Dr Cr

Group

80 000

60 000 90 000

10 000

0 150 000

150 000 40 000 2 000

10 000 2 000

272 000

2 1

700 000 92 000 0

50 000 40 000 160 000 1 192 000 1 420 000 (945 000) 420 000 (260 000) 340 000 80 000 0

19.19

Chapter 19: Consolidation: wholly owned subsidiaries

Inventory Cash Receivables Goodwill

45 000 5 000 15 000 0 1 012 000

40 000 7 000 13 000 10 000 450 000

2 000 284 000

85 000 12 000 28 000 12 000 1 192 000

284 000

ADAM LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2016 Profit for the period Other comprehensive income Comprehensive income

$60 000 _____0 $60 000

ADAM LTD Consolidated Statement of Financial Position as at 30 June 2016 Current assets: Cash Receivables Inventories Total current assets Non-current assets: Plant Accumulated depreciation Fixtures Accumulated depreciation Land Brands Goodwill Total non-current assets Total assets Equity Share capital General reserve Retained earnings Total equity Current liabilities: Provisions Payables Total current liabilities Non-current liabilities: Loans Total liabilities Total equity and liabilities

$12 000 28 000 85 000 125 000 1 420 000 (945 000) 420 000 (260 000) 340 000 80 000 12 000 1 067 000 $1 192 000

700 000 92 000 150 000 942 000 50 000 40 000 90 000 160 000 250 000 $1 192 000

19.20

Solutions manual to accompany Company Accounting 10e

Question 19.6

Business combination valuation entries, pre-acquisition entries

On 1 July 2016, Mutt Ltd acquired all the issued shares of Jeff Ltd for $174 800. At this date the equity of Jeff Ltd consisted of share capital of $80 000 and retained earnings of $68 800. All the identifiable assets and liabilities of Jeff Ltd were recorded at amounts equal to fair value except for:

Patent Plant (net of $40 000 depreciation) Inventory

Carrying amount $60 000 40 000 21 600

Fair value $72 000 48 000 28 000

The patent was considered to have an indefinite life. It was calculated that the plant had a further life of 10 years, and was depreciated on a straight-line basis. All the inventory was sold by 30 June 2017. In June 2017, Jeff Ltd conducted an impairment test on the patent, as it was considered to have an indefinite life, and the goodwill. As a result, the goodwill was considered to be impaired by $1200. In May 2017, Jeff Ltd transferred $20 000 from the retained earnings on hand at 1 July 2016 to a general reserve. The tax rate is 30%. Required Prepare the consolidation worksheet adjustments entries at 1 July 2016 and 30 June 2017.

At 1 July 2016: Net fair value of identifiable assets and liabilities of Jeff Ltd

Consideration transferred Goodwill

= = =

($80 000 + $68 800) (equity) +$6 400 (1 – 30%) (inventory) + $12 000 (1 – 30%) (patent) + $8 000 (1 – 30%) (plant) $167 280 $174 800 $7 520

Worksheet entries at 1 July 2016 Business combination valuation entries Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

6 400

Patent Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

*Accumulated depreciation - equipment Dr Equipment Cr Deferred tax liability Cr Business combination valuation reserve Cr *refer to end of solution for an alternative to this journal entry

40 000

1 920 4 480

3 600 8 400

32 000 2 400 5 600

19.21

Chapter 19: Consolidation: wholly owned subsidiaries

Goodwill Business combination valuation reserve

Dr Cr

7 520

Dr Dr Dr Cr

68 800 80 000 26 000

7 520

2. Pre-acquisition entries Retained earnings (1/7/16) Share capital Business combination valuation reserve Shares in Jeff Ltd

174 800

Worksheet entries at 30 June 2017 Business combination valuation entries The entries at 1 July 2013 are affected by: - the sale of the inventory - the depreciation of the plant - the impairment of the goodwill Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

6 400

Patent Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Accumulated depreciation - equipment Equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

40 000

Depreciation expense Accumulated depreciation (10% x $8 000)

Dr Cr

800

Deferred tax liability Income tax expense (30% x $1 000)

Dr Cr

240

Goodwill Business combination valuation reserve

Dr Cr

7 520

Impairment loss – goodwill Accum. impairment losses – goodwill

Dr Cr

1 200

1 920

4 480

3 600 8 400

32 000 2 400 5 600

800

240

7 520

1 200

Pre-acquisition entries The pre-acquisition entries are affected by: - transfer from business combination valuation reserve Retained earnings (1/7/16) Share capital Business combination valuation reserve Shares in Jeff Ltd

Dr Dr Dr Cr

68 800 80 000 26 000 174 800

19.22

Solutions manual to accompany Company Accounting 10e

General reserve Transfer to general reserve

Dr Cr

12 000

Transfer from business comb. valuation reserve Business combination valuation reserve

Dr Cr

4 480

12 000

4 480

*Alternative BCVR entry for Equipment Accumulated depreciation - equipment Dr 40 000 Equipment Cr 40 000 Equipment Dr 8 000 Deferred tax liability Cr 2 400 Business combination valuation reserve Cr 5 600 The above BCVR entry demonstrates the 2 steps for the recognition of a change in fair value on consolidation.

1. Write back all of the accumulated depreciation for the asset at date of aqusition. 2. Recognise the increase/decrease to the asset’s fair value with the tax effect. NB: From these 2 journal entries it is easier to see that the depreciation adjustments then required at the end of each year for consolidation purposes are based on the $8 000 increase to fair value. That is, the additional amount of the asset that needs to be depreciated. In this question….$8,000 / 10years = $800 per year.

19.23

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.7 Business combination valuation entries and preacquisition entries at acquisition date, previously held shares In 2012, Stan Ltd acquired 40% of the issued shares for $72 000. This acquisition did not give Stan Ltd control of Lee Ltd as the ownership of Lee Ltd was held by a small number of shareholders as Lee Ltd was developed as a family company in 2001. On 1 July 2016, Stan Ltd approached these family members following a death in the family and persuaded them to sell the remainder of the shares in Lee Ltd to Stan Ltd for $137 700 on a cum div. basis. Information about the two companies at 1 July 2016 included the following. • Stan Ltd recorded its original investment in Lee Ltd at fair value, with changes in fair value being recognised in profit or loss. At 1 July 2016, the asset was recorded at $91 800. • The equity of Lee Ltd at 1 July 2016 consisted of $144 000 capital and $36 000 retained earnings. • Included in the assets and liabilities recorded by Lee Ltd at 1 July 2016 were goodwill of $5400 (net of accumulated impairment losses of $3600) and dividend payable of $4500. • On the acquisition date all the identifiable assets and liabilities of Lee Ltd were recorded at carrying amounts equal to their fair values except for inventory for which the fair value of $39 600 was $3600 greater than its carrying amount, and equipment for which the fair value of $94 500 was greater than the carrying amount, this being cost of $108 000 less accumulated depreciation of $18 000. • Besides determining the fair values of the recorded assets and liabilities of Lee Ltd, Stan Ltd discovered that Lee Ltd had two assets that had not been recorded by Lee Ltd. These were internally generated patents that had a fair value of $45 000 and in-process research and development for which Lee Ltd had expensed $90 000, but which Stan Ltd valued at $18 000. Further in the financial statements of Lee Ltd at 30 June 2016 Lee Ltd had reported the existence of a contingent liability relating to guarantees for loans. Stan Ltd determined that this liability had a fair value of $9000. • The tax rate is 30%. Required Prepare the consolidation worksheet entries for consolidated financial statements prepared by Stan Ltd at 1 July 2016.

Acquisition analysis: 1 July 2016 Net fair value of identifiable assets and liabilities of Lee Ltd

Consideration transferred Previously held equity interest Goodwill acquired Unrecorded goodwill

= = = = = = = =

$144 000 + $36 000 + $3 600 (1– 30%) (BCVR – inventory) + $4 500 (1 – 30%) (BCVR – plant) - $5 400 (goodwill) + $45 000 (1 – 30%) (BCVR - patents) + $18 000 (1 – 30%) (BCVR – research) - $9 000 (1 – 30%) (BCVR – liability) $218 070 $137 700 - $4 500 (dividend receivable) $133 200 $91 800 (fair value) ($133 200 + $91 800) - $218 070 $6 930 $6 930 - $5 400 $1 530

Business combination valuation entries at 1 July 2016

19.24

Solutions manual to accompany Company Accounting 10e

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

3 600

Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

18 000

Patents Deferred tax liability Business combination valuation reserve

Dr Cr Cr

45 000

In-process research Deferred tax liability Business combination valuation reserve

Dr Cr Cr

18 000

Business combination valuation reserve Deferred tax asset Guarantee payable

Dr Dr Cr

6 300 2 700

Accumulated impairment losses – goodwill Goodwill

Dr Cr

3 600

Goodwill Business combination valuation reserve

Dr Cr

1 530

Retained earnings (1/7/16) Share capital Business combination valuation reserve Shares in Lee Ltd

Dr Dr Dr Cr

36 000 144 000 45 000

Dividend payable Dividend receivable

Dr Cr

4 500

1 080 2 520

13 500 1 350 3 150

13 500 31 500

5 400 12 600

9 000

3 600

1 530

Pre-acquisition entries at 1 July 2016

225 000

4 500

19.25

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.8

Business combination valuation entries, pre-acquisition entries subsequent to acquisition

Robert Ltd acquired all the issued shares (cum div.) of Matt Ltd on 1 July 2015. At this date the financial position of Matt Ltd was as follows:

The assets of Matt Ltd did not include a patent that was valued by Robert Ltd at $10 000. Its useful life was considered to be 5 years, with benefits being received equally over that period. The plant was considered to have a further 10-year life and is depreciated on a straight-line basis. All the inventory was sold by 30 June 2016. The goodwill on hand at 1 July 2015 was written off as the result of an impairment test conducted in June 2017. The dividend on hand at 1 July 2015 was paid in August 2015. In exchange for the shares in Matt Ltd, Robert Ltd gave the following consideration: • 50 000 shares in Robert Ltd, each share having a fair value of $2.00 per share. • Cash of $40 000. • Artworks having a fair value of $60 000. Robert Ltd incurred legal and accounting costs of $5000 and share issue costs of $4000. In January 2019, Matt Ltd paid a bonus dividend of $40 000, being one share for every three shares held, the dividend being paid from retained earnings on hand at 1 July 2015. The tax rate is 30%. Required Prepare the consolidation worksheet entries for consolidated financial statements prepared by Robert Ltd at 30 June 2020. At 1 July 2015: Net fair value of identifiable assets and liabilities of Matt Ltd

Consideration transferred

= = =

($120 000 + $23 200 + $44 000) (equity) - $4 800 (goodwill) + $2 000 (1 – 30%) (plant) + $4 000 (1 – 30%) (inventory) + $10 000 (1 -30%) (patents) $193 600 (50 000 x $2) + $40 000 + $60 000 - $8 000 (dividend receivable) $192 000

19.26

Solutions manual to accompany Company Accounting 10e

Gain on bargain purchase Goodwill adjustment

= =

$1 600 ($4 800)

1. Business combination valuation entries at 30 June 2020 Amortisation expense - patents Income tax expense Retained earnings (1/7/19) Transfer from business combination valuation reserve (1/5 x $10 000 p.a.)

Dr Cr Dr

2 000

Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

25 600

Depreciation expense - plant Retained earnings (1/7/19) Accumulated depreciation – plant (1/10 x $2000 p.a.)

Dr Dr Cr

200 800

Deferred tax liability Income tax expense Retained earnings (1/7/19)

Dr Cr Cr

300

Retained earnings (1/7/15) Share capital General reserve Business combination valuation reserve Gain on bargain purchase Shares in Matt Ltd

Dr Dr Dr Dr Cr Cr

44 000 120 000 23 200 6 400

Dividend payable Dividend receivable

Dr Cr

8 000

600 5 600

7 000

23 600 600 1 400

1 000

60 240

2. Pre-acquisition entries At 1 July 2015:

1 600 192 000

8 000

At 30 June 2020 This entry is affected by: - payment of dividend on hand at acquisition date - $8 000 - payment of bonus dividend of $40 000 in 2019 – prior period - in relation to the BCVR: the inventory was sold in a prior period 2015-6, the goodwill was impaired in 2017, a prior period, while in the current period, the trademark was written off. Retained earnings (1/7/19)*

400

19.27

Chapter 19: Consolidation: wholly owned subsidiaries

Share capital General reserve Business combination valuation reserve ** Shares in Matt Ltd

Dr Dr Dr Cr

160 000 23 200 8 400 192 000

* $44 000 - $1 600 gain on bargain purchase - $40 000 bonus dividend + $2 800 (transfer of BCVR – inventory) - $4 800 (transfer of BCVR on goodwill) ** $1 200 (plant) + $7 000 (patents)

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

7 000 7 000

19.28

Solutions manual to accompany Company Accounting 10e

Question 19.9

Business combination valuation entries, pre-acquisition entries for multiple years

Barry Ltd acquired all the issued shares of Colin Ltd on 1 January 2016 for $72 000. At this date the equity of Colin Ltd consisted of: Share capital General reserve Retained earnings

$ 50 000 12 500 5 000

All the identifiable assets and liabilities of Colin Ltd were recorded at amounts equal to their fair values except for: Carrying amount $50 000 12 000

Plant (cost $70 000) Inventory

Fair value $52 000 16 000

Of the inventory on hand at 1 January 2016, 90% was sold by 30 June 2016. The remainder was all sold by 30 June 2017. The plant was considered to have a further 2-year life with benefits to be received equally in each of those years. The tax rate is 30%. Required Prepare the consolidated worksheet entries for the consolidated financial statements prepared by Barry Ltd at 30 June 2016, 30 June 2017, and 30 June 2018.

Acquisition analysis at 1 January 2016: Fair value of identifiable assets and liabilities of Colin Ltd =

Consideration transferred Goodwill

= = =

$50 000 + $12 500 + $5 000 + $4 000 (1 – 30%) (BCVR – inventory) + $2 000 (1 – 30%) BCVR – plant) $71 700 $72 000 $300

1. Worksheet entries at 30 June 2016 Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Accumulated depreciation (1/2 x $1 000 p.a.)

Dr Cr

500

Deferred tax liability Income tax expense (30% x $500)

Dr Cr

150

Cost of sales Income tax expense Transfer from business combination

Dr Cr

3 600

18 000 600 1 400

500

150

1 080

19.29

Chapter 19: Consolidation: wholly owned subsidiaries

valuation reserve Cr This entry relates to the 90% of the inventory that has been sold by 30 June 2016. Inventory Dr 400 Deferred tax liability Cr Business combination valuation reserve Cr This entry relates to the 10% of the inventory still on hand at 30 June 2016. Goodwill Business combination valuation entry

Dr Cr

300

Retained earnings (1/1/16) Share capital Reserves Business combination valuation reserve Shares in Colin Ltd

Dr Dr Dr Dr Cr

5 000 50 000 12 500 4 500

Transfer from business combination val’n reserve Business combination valuation reserve

Dr Cr

2 520

Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation

Dr Dr Cr

1 000 500

Deferred tax liability Income tax expense Retained earnings (1/7/16) (30% x amounts in above depreciation entry)

Dr Cr Cr

450

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

400

Goodwill Business combination valuation entry

Dr Cr

300

Dr Dr Dr Dr Cr

7 520 50 000 12 500 1 980

2 520

120 280

300

Pre-acquisition entries

72 000

2 520

2. Worksheet entries at 30 June 2017 Business combination valuation entries

18 000 600 1 400

1 500

300 150

120

280

300

Pre-acquisition entries Retained earnings (1/7/16) Share capital Reserves Business combination valuation reserve Shares in Colin Ltd

72 000

19.30

Solutions manual to accompany Company Accounting 10e

Transfer from business combination val’n reserve Business combination valuation reserve

Dr Cr

280

Depreciation expense Income tax expense Retained earnings (1/7/17) Transfer from business combination valuation reserve

Dr Cr Dr

500

Goodwill Business combination valuation entry

Dr Cr

1 300

Retained earnings (1/7/17) * Share capital Reserves Business combination valuation reserve Shares in Colin Ltd * 5 000 + $4 000(1 -30%)

Dr Dr Dr Dr Cr

7 800 50 000 12 500 1 700

Transfer from business combination val’n reserve Business combination valuation reserve

Dr Cr

1 400

280

3. Worksheet entries at 30 June 2018 Business combination valuation entries

150 1 050

1 400

1 300

Pre-acquisition entries

72 000

1 400

19.31

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.10

Consolidation worksheet, previously held investment in subsidiary

On 1 August 2012, Erik Ltd acquired 10% of the shares in Finn Ltd for $8000. Erik Ltd used the fair value method to measure this investment with movements in fair value being recognised in profit or loss. At 1 July 2014, the fair value of this investment was $15 400. The original investment in Finn Ltd was due to the fact that Finn Ltd was undertaking research into particular microbiological elements that could influence the profitability of Erik Ltd. With the continuing success of this research, Erik Ltd decided to acquire the remaining shares (cum div.) in Finn Ltd. On 1 July 2014, Erik Ltd made an offer to buy the remaining shares in Finn Ltd for $151 000 cash. This offer was accepted by the shareholders of Finn Ltd. On 1 July 2014, immediately after the business combination, the statement of financial position of Finn Ltd was as follows:

On analysing the financial statements of Finn Ltd, Erik Ltd determined that all the assets and liabilities recorded by Finn Ltd were shown at amounts equal to their fair values except for:

Plant and equipment (cost $46 000) Inventory

Carrying amount $35 000 42 000

Fair value $43 000 46 000

The plant and equipment is expected to have a further 4-year life and is depreciated on a straight-line basis. The inventory was all sold by 30 June 2015. Finn Ltd had expensed all the outlays on research and development. Erik Ltd placed a fair value of $12 000 on this asset. Finn Ltd also had reported a contingent liability at 30 June 2014 in relation to claims by customers for damaged goods. Erik Ltd placed a fair value of $3000 on these claims. The research and development is amortised evenly over a 10-year period. The claims by customers were settled in May 2015 for $2800. The company tax rate is 30%.

19.32

Solutions manual to accompany Company Accounting 10e

Required A. Prepare the consolidated financial statements of Erik Ltd at 1 July 2014, immediately after the business combination. B. Prepare the consolidation worksheet entries at 30 June 2015. At 1 July 2014: Net fair value of identifiable assets and liabilities of Finn Ltd

Consideration transferred Previously acquired equity interest Goodwill

= = = = = =

($90 000 + $12 000 + $36 000) (equity) + $4 000 (1 – 30%) (inventory) + $8 000 (1 – 30%) (plant) + $12 000 (1 – 30%) (R&D) - $3 000 (1 – 30% (claims) $152 700 $151 000 - $12 600 (dividend receivable) $138 400 $15 400 ($138 400 + $15 400) - $152 700 $1 100

A. WORKSHEET ENTRIES AT 1 JULY 2014 1. Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

11 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

4 000

Deferred research and development Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Business combination valuation reserve Deferred tax asset Provision for customer claims

Dr Dr Cr

2 100 900

Goodwill Business combination valuation reserve

Dr Cr

1 100

Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Shares in Finn Ltd

Dr Dr Dr Dr Cr

36 000 90 000 12 000 15 800

Dividend payable Dividend receivable

Dr Cr

12 600

3 000 2 400 5 600

1 200 2 800

3 600 8 400

3 000

1 100

2. Pre-acquisition entries

153 800

12 600

19.33

Chapter 19: Consolidation: wholly owned subsidiaries

Erik Ltd 11 000 25 200 10 000

Finn Ltd 20 600 20 000 8 000

Inventory Shares in Finn Ltd Plant Accum depreciation

55 000 153 800 210 000 (85 000) 380 000

42 000 0 107 000 (22 000) 175 600

Dividend payable Other liabilities

25 000 75 000

12 600 25 000

Share capital Retained earnings General reserve Business combination valuation reserve

130 000 93 500 56 500 -

90 000 36 000 12 000 -

380 000

175 600

Cash Receivables Other assets

Adjustments Dr Cr

1 1 1 1

Group

12 600

153 800 3 000

2 1

12 000 900 1 100 4 000

11 000

12 600 3 000 2 400 1 200 3 600

1 2

90 000 36 000 12 000 2 100 15 800

197 500

5 600 2 800 8 400 1 100 197 500

1 1 1 1

31 600 32 600 32 000

101 000 0 314 000 (96 000) 415 200 25 000 110 200

130 000 93 500 56 500 0

415 200

FINN LTD Consolidated Statement of Financial Position as at 1 July 2014 Current assets: Cash and equivalents Receivables Inventories Total current assets Non-current assets: Plant and equipment Accumulated depreciation Other assets Total non-current assets Total assets Equity Share capital Retained earnings General reserve Total equity Current liabilities: Dividend payable Other liabilities Total liabilities

$31 600 32 600 101 000 165 200 314 000 (96 000) 218 000 32 000 250 000 $415 200 130 000 93 500 56 500 280 000 25 000 110 200 135 200

19.34

Solutions manual to accompany Company Accounting 10e

Total equity and liabilities

$415 200

B. WORKSHEET ENTRIES AT 30 JUNE 2015 1. Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

11 000

Depreciation expense Accumulated depreciation (1/4 x $8 000)

Dr Cr

2 000

Deferred tax liability Income tax expense

Dr Cr

600

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

4 000

Deferred research and development Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Amortisation expense Accumulated amortisation

Dr Cr

1 200

Deferred tax liability Income tax expense

Dr Cr

360

Transfer from business combination valuation reserve Income tax expense Damages expense Gain on claims settlement

Dr Dr Cr Cr

2 100 900

Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Goodwill Shares in Finn Ltd

Dr Dr Dr Dr Dr Cr

36 000 90 000 12 000 14 000 1 800

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

700

3 000 2 400 5 600

2 000

600

1 200

2 800

3 600 8 400

1 200

360

2 800 200

2. Pre-acquisition entries

153 800

700

19.35

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.11 Consolidation worksheet Ethan Ltd acquired all the issued shares (ex div.) of Darren Ltd on 1 July 2014 for $110 000. At this date Darren Ltd recorded a dividend payable of $10 000 and equity of: Share capital Retained earnings Asset revaluation surplus

$ 54 000 36 000 18 000

All the identifiable assets and liabilities of Darren Ltd were recorded at amounts equal to their fair values at acquisition date except for:

Inventory Machinery (cost $100 000)

Carrying amount $ 14 000 92 500

Fair value $ 16 000 94 000

The machinery was considered to have a further 5-year life. Of the inventory, 90% was sold by 30 June 2015. The remainder was sold by 30 June 2016. Both Darren Ltd and Ethan Ltd use the valuation method to measure the land. At 1 July 2014, the balance of Ethan Ltd’s asset revaluation surplus was $13 500. In May 2015, Darren Ltd transferred $3600 from the retained earnings at 1 July 2014 to a general reserve. The tax rate is 30%. The following information was provided by the two companies at 30 June 2015.

Required Prepare the consolidated financial statements of Ethan Ltd at 30 June 2015.

19.36

Solutions manual to accompany Company Accounting 10e

Acquisition analysis At 1 June 2014:

Net fair value of identifiable assets and liabilities of Darren Ltd

Consideration transferred Gain on bargain purchase

= = =

($54 000 + $36 000 + $18 000) (equity) + $1 500 (1 – 30%) (plant) + $2 000 (1 – 30%) (inventory) $110 450 $110 000 $450

THE WORKSHEET ENTRIES AT 1 JULY 2014 ARE:

1. Business combination valuation entries Accumulated depreciation Plant & machinery Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

7 500

Depreciation expense Accumulated depreciation (1/5 x $1 500)

Dr Cr

300

Deferred tax liability Income tax expense (30% x $300)

Dr Cr

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr Cr

1 800

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

6 000 450 1 050

300

540 1 260 200 60 140

2. Pre-acquisition entries At 1 July 2014: Retained earnings (1/714) Share capital Asset revaluation surplus Business combination valuation reserve Gain on bargain purchase Shares in Darren Ltd

Dr Dr Dr Dr Cr Cr

36 000 54 000 18 000 2 450 450 110 000

The entry at 30 June 2015 is affected by: - sale of inventory

19.37

Chapter 19: Consolidation: wholly owned subsidiaries

transfer to general reserve of $3 600

Retained earnings (1/7/14) Share capital Asset revaluation surplus Business combination valuation reserve Gain on bargain purchase Shares in Darren Ltd

Dr Dr Dr Dr Cr Cr

36 000 54 000 18 000 2 450

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

1 260

General reserve Transfer to general reserve

Dr Cr

3 600

450 110 000

1 260

3 600

Ethan Ltd 120 000

Darren Ltd 12 500

Income tax expense

56 000

4 200

Profit Retained earnings (1/7/14) Transfer from BCVR

64 000 80 000

8 300 36 000

144 000 0

44 300 3 000

144 000

41 300

360 000 -

54 000 -

2 2

54 000 2 450

10 000 514 000 13 500

3 000 98 300 18 000

3 000

18 000

5 000 18 500

2 000 20 000

7 000 20 500

532 500 42 500

118 300 13 000

541 780 55 920

575 000

131 300

160 000 360 000 (110 000)

20 000 125 600 (33 000)

Profit before tax

Transfer to general reserve Retained earnings (30/6/15) Share capital BCVR

General reserve Asset revaluation surplus (1/7/14) Gains Asset revaluation surplus (30/6/15) Liabilities

Land Plant & machinery Accum depreciation

1 1

Adjustments Dr Cr 300 450 1 800 90 540

36 000

1 260

Group 2

130 850

1 1

59 570 71 280 80 000

1 260

3 000

0 151 280 0 151 280

1 050 140 1 260

1 1 2

360 000 0

10 000 521 280 13 500

450 60

1 1

597 700

7 500

6 000 300

1 1

180 000 479 600 (135 800)

19.38

Solutions manual to accompany Company Accounting 10e

Inventory Shares in Darren

55 000 110 000 575 000

18 700 131 300

200 124 600

110 000 124 600

73 900 0 597 700

ETHAN LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2015 Profit before income tax Income tax expense Profit for the period Other comprehensive income Gains on revaluation of assets Comprehensive income

$130 850 59 570 $71 280 7 000 $78 280

ETHAN LTD Consolidated Statement of Changes in Equity for financial period ending 30 June 2015 Comprehensive income for the period

$78 280

Retained earnings at 1 July 2014 Profit for the period Retained earnings at 30 June 2015

$80 000 71 280 $151 280

Share capital at 1 July2014 Share capital at 30 June 2015

$360 000 $360 000

Asset revaluation surplus at 1 July 2014 Increments Asset revaluation surplus at 30 June 2015

$13 500 7 000 $20 500

General reserve at 1 July 2014 General reserve at 30 June 2015

$10 000 $10 000

ETHAN LTD Consolidated Statement of Financial Position as at 30 June 2015 Current Assets Inventories Non-current Assets Property, plant and equipment: Land Plant & machinery Accumulated depreciation Total Non-current Assets Total Assets

$73 900

180 000 $479 600 (135 800)

343 800 523 800 $597 700

19.39

Chapter 19: Consolidation: wholly owned subsidiaries

Equity Share capital Retained earnings General reserve Asset revaluation surplus Total Equity Liabilities Total Equity and Liabilities

$360 000 151 280 10 000 20 500 541 780 55 920 $597 700

19.40

Solutions manual to accompany Company Accounting 10e

Question 19.12 Consolidation worksheet, previously held investment in subsidiary On 1 July 2015, Jason Ltd held shares in Bruce Ltd measured at $18 600. Jason Ltd uses the fair value method to measure these shares with movements in fair value being recognised in profit or loss. Jason Ltd had acquired these shares 2 years earlier for $12 300. The shares had a fair value at 1 July 2015 of $20 000. On 1 July 2015, Jason Ltd acquired the remaining 80% of the shares (cum div.) in Bruce Ltd. The consideration for these shares consisted of 30 000 shares in Jason Ltd valued at $2.00 per share plus a brand that was carried in the records of Jason Ltd at $20 000 (net of accumulated amortisation of $3000) but was valued at $24 800. On 1 July 2015 the equity of Bruce Ltd consisted of: Share capital Retained earnings

$ 50 000 32 000

At this date, Bruce Ltd had recorded a dividend payable of $6000, which was paid on 15 August 2015. Bruce Ltd had also recorded goodwill of $5000, net of accumulated impairment losses of $7000. Bruce Ltd had an unrecorded asset relating to internally generated trademarks that had a fair value of $8000. These had a future expected useful life of 8 years. All identifiable assets and liabilities of Bruce Ltd were recorded at amounts equal to fair value except for the following:

Plant (cost $90 000) Inventory

Carrying amount $74 000 18 000

Fair value $80 000 23 000

The plant was expected to have a further 6-year life. In relation to the inventory held at 1 July 2015, 90% was sold by 30 June 2016 and the rest before 30 June 2017. The tax rate is 30%. In June 2016, Bruce Ltd transferred $2000 from retained earnings on hand at 1 July 2015 to general reserve, and a further $3000 in June 2017.

19.41

Chapter 19: Consolidation: wholly owned subsidiaries

Required A. Prepare the journal entries in Jason Ltd at 1 July 2015 in relation to the business combination with Bruce Ltd and for the receipt of the dividend in August 2015 B. Prepare the consolidation worksheet at 30 June 2017 for the preparation of the consolidated financial statements of Jason Ltd. A. ENTRIES IN JASON LTD 1 July 2015 Accumulated amortisation - brand Brand (Writing down to carrying amount)

Dr Cr

3 000

Brand Gain (Revaluation prior to sale)

Dr Cr

4 800

Shares in Bruce Ltd Dividend receivable Brand Share capital (Acquisition of additional shares in Bruce Ltd)

Dr Dr Cr Cr

80 000 4 800

3 000

4 800

24 800 60 000

19.42

Solutions manual to accompany Company Accounting 10e

Shares in Bruce Ltd Gain (Revaluation of investment in Bruce Ltd from $18 600 to $20 000)

Dr Cr

1 400

Dr Cr

6 000

1 400

15 August 2015 Cash Dividend receivable B.

6 000

CONSOLIDATION OF BRUCE LTD AT 30 JUNE 2017

At 1 July 2015: Net fair value of identifiable assets and liabilities of Dorado Ltd

Consideration transferred Previously held equity interest Goodwill Goodwill recorded Unrecorded goodwill

= = = = = = =

($50 000 + $32 000) (equity) + $6 000 (1 – 30%) (plant) + $5 000 (1 – 30%) (inventory) + $8 000 (1 – 30%) ( trademarks) - $5 000 (goodwill) $90 300 $80 000 $20 000 ($80 000 + $20 000) - $90 300 $9 700 $5 000 $4 700

Consolidation worksheet entries at 30 June 2017 1. Business combination valuation entries Accumulated depreciation – plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

16 000

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation (1/6 x $6000 p.a. for 2 years)

Dr Dr Cr

1 000 1 000

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

600

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

500

Trademark Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000 1 800 4 200

2 000

300 300

150

350 8 000 2 400 5 600

19.43

Chapter 19: Consolidation: wholly owned subsidiaries

Amortisation expense Retained earnings (1/7/16) Accumulated depreciation (1/8 x $8000 p.a. for 2 years)

Dr Dr Cr

1 000 1 000

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

600

Accumulated impairment losses Goodwill [7 000 – 4 700] Business combination valuation reserve

Dr Cr Cr

7 000

2 000

300 300

2 300 4 700

2. Pre-acquisition entries Retained earnings (1/7/16) * Dr 33 150 Share capital Dr 50 000 General reserve Dr 2 000 Business combination valuation reserve ** Dr 14 850 Shares in Bruce Ltd Cr 100 000 * 32 000 + (90% x $3 500 BCVR inventory) - $2000 transfer to general reserve ** $4 200 + $350 + $ 5600 + $4 700 Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr (10% x $3 500 BCVR inventory) General reserve Transfer to general reserve

Dr Cr

350 350

3 000 3 000

19.44

Solutions manual to accompany Company Accounting 10e

QUESTION 19.12 (cont’d)

Jason Ltd 60 000

Bruce Ltd 55 000

Income tax expense Profit Retained earnings (1/7/16)

22 000 38 000 44 000

18 000 37 000 38 000

Transfer from BCVR

0 82 000 24 000

0 75 000 5 000

58 000

70 000

42 000

7 000

Share capital Provisions Deferred tax liability

150 000 55 000 0

50 000 12 000 0

Payables

35 000 340 000

8 000 147 000

43 000 401 700

Cash Accounts receivable Inventory Shares in Bruce Ltd Plant Accumulated depreciation Trademark Accum. amortisation Goodwill Accumulated impairment losses

25 000 50 000 40 000 100 000 210 000 (85 000)

14 000 25 000 37 000 0 90 000 (24 000)

39 000 75 000 77 000 0 290 000 (95 000)

0 0 0 0

0 0 12 000 (7 000)

340 000

147 000

Profit before tax

Transfer to general reserve Retained earnings (30/6/17) General reserve BCVR

1 1 1

1 1 2 2

Adjustments Dr Cr 1 000 300 500 300 1 000 150 1 000 1 000 33 150 350

Group 1 1

113 100

39 850 73 250 47 450

300 300

1 1

350

3 000

0 120 700 26 000 94 700

2 2 2

2 000 3 000 14 850

50 000

1 1

600 600

16 000

8 000

44 000 4 200 5 600 4 700 350

1 800 2 400

1 1

100 000 10 000 2 000

2 1 1

2 000 2 300

1 1

7 000 140 050

1 1 1 2

140 050

150 000 67 000 3 000

8 000 (2 000) 9 700 0 401 700

19.45

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.13

Consolidation worksheet, consolidated financial statements

Griffin Ltd is a major Australian company operating in the manufacture of women’s clothing. One of its major competitors was Frank Ltd whose business was established by a French family over 30 years ago. It had won numerous awards for its designs and has established a number of brands that have been successful, especially with the teenage market. In order to expand its business as well as to reduce the number of players in the market, on 1 July 2013 Griffin Ltd acquired all the issued shares (cum div.) of Frank Ltd for $330 000. At this date the equity of Frank Ltd was as follows: Share capital General reserve Retained earnings

$200 000 20 000 50 000

All the identifiable assets and liabilities of Frank Ltd were recorded at amounts equal to their fair values except for the following:

Plant (cost $220 000) Land Inventory

Carrying amount $180 000 190 000 20 000

Fair value $186 000 210 000 28 000

The plant’s expected remaining useful life was 5 years with benefits being expected evenly over that period. The plant was sold on 1 January 2016 for $87 000. The land was sold in February 2015 for $250 000. Of the inventory, 90% was sold by 30 June 2014 and the rest by 30 June 2015. At 1 July 2013, Frank Ltd had recorded a dividend payable of $10 000 that was paid in September 2013. Frank Ltd also had some unrecorded assets, in particular the brands relating to the successful clothing sold in the teenage market. Griffin Ltd valued these brands at $12 000 and assessed them to have an indefinite life. In its financial statements at 30 June 2013, Frank Ltd raised a contingent liability relating to a guarantee it had made to one of its related companies. Griffin Ltd assessed the fair value of the guarantee payable at $10 000. In August 2015, Frank Ltd was required to pay $2500 in relation to the guarantee. All transfers to the general reserve made by Frank Ltd have been from retained earnings earned prior to 1 July 2013. The tax rate is 30%. The financial information provided by the two companies at 30 June 2016 is as follows:

19.46

Solutions manual to accompany Company Accounting 10e

Required Prepare the consolidated financial statements of Griffin Ltd at 30 June 2016.

19.47

Chapter 19: Consolidation: wholly owned subsidiaries

At 1 July 2013: Net fair value of identifiable assets and liabilities of Frank Ltd

Consideration transferred Goodwill

= = = =

$200 000 + $20 000 + $50 000 (equity) + $8 000 (1 – 30%) (inventory) + $20 000 (1 – 30%) (land) + $6 000 (1 – 30%) (plant) - $10 000 (1 – 30%) (guarantee liability) + $12 000 (1 – 30%) (brands) $295 200 $330 000 - $10 000 (divs. receivable) $320 000 $24 800

1. Business combination valuation entries at 30 June 2016 Depreciation expense Gain on sale of plant Income tax expense Retained earnings (1/7/15) Transfer from business combination valuation reserve (Final adjustment for Plant & Depn to date of sale)

Dr Dr Cr Dr

600 3 000

Brands Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Transfer from business combination valuation reserve Income tax expense Gain on guarantee Guarantee expense

Dr Dr Cr Cr

7 000 3 000

Goodwill Business combination valuation reserve

Dr Cr

24 800

1 080 1 680

4 200

3 600 8 400

7 500 2 500

24 800

19.48

Solutions manual to accompany Company Accounting 10e

QUESTION 19.13 (cont’d) 2. Pre-acquisition entries At 1/7/2013: Retained earnings (1/7/13) Share capital General reserve Business combination valuation reserve Shares in Frank Ltd

Dr Dr Dr Dr Cr

50 000 200 000 20 000 50 000 320 000

At 30 June 2016: This entries are affected by: - sale of land in February 2015 – prior period - sale of inventory by 30 June 2015 – prior period - sale of plant in January in current period - settlement of guaranteed loan in current period - transfer to general reserve of $15 000 in current period. - transfer to general reserve of $13 000 in prior period Retained earnings (1/7/15) * Share capital General reserve Business combination valuation reserve Shares in Perseus Ltd

Dr Dr Dr Dr Cr

56 600 200 000 33 000 30 400 320 000

* $50 000 + $14 000 (BCVR land) + $5 600 (BCVR inventory) - $13 000 gen reserve Business combination valuation reserve Transfer from business combination valuation reserve (Settlement of loan)

7 000

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of plant)

Dr Cr

4 200

General reserve Transfer to general reserve

Dr Cr

15 000

4 200

15 000

19.49

Chapter 19: Consolidation: wholly owned subsidiaries

QUESTION 19.13 (cont’d) Griffin Ltd Revenues 190 000 Expenses 80 000 110 000 Gains on sale of non5 000 current assets Profit before tax 115 000 Tax expense 40 000 Profit 75 000 Retained earnings 80 000 (1/7/15) Transfer from BCVR 0

Dividend paid T’fer to gen reserve Ret earn. (30/6/16) Share capital General reserve Business comb. valuation reserve

Asset reval surplus (1/7/15) Increment Asset reval surplus (30/6/16) Provisions Payables Defer. tax liability Shares in Frank Ltd Cash Accounts receivable Inventory Plant Accum depreciation Goodwill Brands

Frank Ltd 110 000 76 000 34 000 4 000 38 000 6 000 32 000 88 000 0

Adjustments Dr Cr 7 500 600 2 500

Group

3 000

1 080

1 2 1 2

1 680 56 600 7 000 4 200

4 200 7 000

1 2

1 1

307 500 154 100 153 400 6 000 159 400 47 920 111 480 109 720 0

155 000 34 000 0 34 000 121 000 280 000 20 000

120 000 0 15 000 15 000 105 000 200 000 48 000

421 000 12 000

353 000 0

487 200 12 000

12 000 24 000

0 0

12 000 24 000

445 000 15 000 40 000 0 500 000

353 000 12 000 8 000 0 373 000

511 200 27 000 48 000 3 600 589 800

320 000 12 000 28 000 30 000 230 000 (120 000) 0 0 500 000

0 30 000 12 000 51 000 320 000 (40 000) 0 0 373 000

2 2 2 2 2

1 1

200 000 33 000 15 000 30 400 7 000

24 800 12 000 398 280

15 000

8 400 24 800 4 200

1 1 2

3 600

320 000

398 280

221 200 34 000 0 34 000 187 200 280 000 20 000 0

0 42 000 40 000 81 000 550 000 (160 000) 24 800 12 000 589 800

19.50

Solutions manual to accompany Company Accounting 10e

QUESTION 19.13 (cont’d) GRIFFIN LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for year ended 30 June 2016 Revenues Expenses

$307 500 154 100 153 400 6 000 159 400 47 920 111 480

Gains on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income: Gains on revaluation of assets Comprehensive income for the period

12 000 $123 480

GRIFFIN LTD Consolidated Statement of Changes in Equity for year ended 30 June 2016

Comprehensive income for the period

$123 480

Retained earnings balance at 1 July 2015 Profit for the period Dividend paid Retained earnings balance at 30 June 2016

$109 720 111 480 (34 000) $187 200

Share capital balance at 1 July 2015 Share capital balance at 30 June 2016

$280 000 $280 000

General reserve balance at 1 July 2015 General reserve balance at 30 June 2016

$20 000 $20 000

Asset revaluation surplus at 1 July 2015 Gains Asset revaluation surplus at 30 June 2016

$12 000 12 000 $24 000

19.51

Chapter 19: Consolidation: wholly owned subsidiaries

QUESTION 19.13 (cont’d)

GRIFFIN LTD Consolidated Statement of Financial Position as at 30 June 2016 Current Assets Cash Accounts receivable Inventory Total Current Assets

$42 000 40 000 81 000 163 000

Non-current Assets Property, plant, and equipment Accumulated depreciation Goodwill Intangibles: Brands Total Non-current Assets Total Assets

$550 000 (160 000)

390 000 24 800 12 000 426 800 $589 800

Equity Share capital Reserves: General reserve Asset revaluation surplus Retained earnings Total Equity Current Liabilities Payables Provisions Total Current Liabilities Non-current Liabilities Deferred tax liability Total Liabilities Total Equity and Liabilities

$280 000 20 000 24 000 187 200 511 200 48 000 27 000 75 000 __3 600 78 600 $589 800

19.52

Solutions manual to accompany Company Accounting 10e

Question 19.14 Consolidation worksheet entries On 1 July 2015, Zack Ltd acquired all the issued shares (ex div.) of William Ltd for $227 500. At this date the equity of William Ltd consisted of: Share capital General reserve Retained earnings

$ 150 000 34 000 20 000

At acquisition date, William Ltd reported a dividend payable of $8000. All the identifiable assets and liabilities of William Ltd were recorded at amounts equal to their fair values except for: Carrying amount $175 000 150 000 32 000

Plant (cost $200 000) Land Inventory

Fair value $190 000 155 000 40 000

The plant was considered to have a further 3-year life. Of the inventory, 90% was sold by 30 June 2016 and the remainder was sold by 30 June 2017. The land was sold in January 2016 for $170 000. William Ltd had recorded goodwill of $2000 (net of accumulated impairment losses of $12 000).William Ltd was involved in a court case that could potentially result in the company paying damages to customers. Zack Ltd calculated the fair value of this liability to be $8000, even though William Ltd had not recorded any liability. The following events occurred in the year ending 30 June 2016. • On 12 August 2015 William Ltd paid the dividend that existed at 1 July 2015. • On 1 December 2015 William Ltd transferred $17 000 from the general reserve existing at 1 July 2015 to retained earnings. • On 1 January 2016 William Ltd made a call of 10c per share on its issued shares. William Ltd had 100 000 shares on issue. All call money was received by 31 January 2016. • On 29 June 2016 William Ltd reassessed the liability in relation to the court case as the chances of winning the case had improved. The fair value was now considered to be $2000. Required Prepare the consolidation worksheet entries for the preparation by Zack Ltd of its consolidated financial statements at 30 June 2016.

Acquisition analysis at 1 July 2015: Net fair value of identifiable assets and liabilities of William Ltd

Consideration transferred Goodwill Goodwill recorded Unrecorded goodwill

= = = = =

($150 000 + $34 000 + $20 000) (equity) + $8 000 (1 – 30%) (inventory) + $15 000 (1 – 30%) (plant) + $5 000 (1 – 30%) (land) - $8 000 (1 – 30%) (provision for damages) - $2 000 (goodwill) $216 000 $227 500 $11 500 $2 000 $9 500

19.53

Chapter 19: Consolidation: wholly owned subsidiaries

Worksheet entries at 30 June 2016 1. Business combination valuation entries Accumulated depreciation – plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

25 000

Depreciation expense Accumulated depreciation (1/3 x $15 000)

Dr Cr

5 000

Deferred tax liability Income tax expense

Dr Cr

1 500

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

5 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

800

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

7 200

Accumulated impairment losses Goodwill Business combination valuation reserve

Dr Cr Cr

10 000 4 500 10 500

5 000

1 500

1 500 3 500

240 560

2 160

5 040 12 000 2 500 9 500

19.54

Solutions manual to accompany Company Accounting 10e

QUESTION 19.14 (cont’d) Business combination valuation reserve Deferred tax asset Provision for damages

Dr Dr Cr

1 400 600

Transfer from business combination valuation reserve Income tax expense Gain

Dr Dr Cr

4 200 1 800

Dr Dr Dr Dr Cr

20 000 150 000 34 000 23 500

2 000

6 000

2. Pre-acquisition entries At 1/7/15: Retained earnings (1/7/15) Share capital General reserve Business combination valuation reserve Shares in William Ltd

227 500

The entry at 30/06/2016 is affected by: - 90% of inventory sold, 10% on hand - re-measurement of liability from $8000 to $2000 - $17 000 transfer from pre-acquisition general reserve - call of 10c per share on 100 000 shares ‘ Transfer from business combination valuation reserve Business combination valuation reserve (Sale of inventory)

Dr Cr

5 040

Business combination valuation reserve Transfer from business combination valuation reserve (Re-measurement of liability)

4 200

Transfer from general reserve General reserve

Dr Cr

17 000

Share capital Shares in William Ltd

Dr Cr

10 000

5 040

4 200

17 000

10 000

19.55

Chapter 19: Consolidation: wholly owned subsidiaries

Question 19.15 Consolidation worksheet entries Ron Ltd operates a number of supermarkets with an emphasis on the supply of quality produce. The operations of Sam Ltd are primarily in the fine fruit market. Believing that the acquisition of Sam Ltd would enable Ron Ltd to expand its supply of quality produce to its customers, Ron Ltd commenced actions to acquire the shares of Sam Ltd. On 1 July 2013, Ron Ltd acquired all the issued shares (cum div.) of Sam Ltd for $123 500. At this date the equity of Sam Ltd consisted of: Share capital Reserves Retained earnings

$100 000 5 000 10 000

On 1 July 2013, Sam Ltd had recorded a dividend payable of $6000 and goodwill of $5000 (net of accumulated impairment losses of $7000). The dividend was paid in August 2013. In the previous year’s annual report Sam Ltd had reported the existence of a contingent liability for damages based upon a lawsuit by a customer who had slipped on some fallen fruit in one of the stores operated by Sam Ltd. Ron Ltd calculated that this liability had a fair value of $10 000. Sam Ltd also had some customer databases that were not recorded as assets but Ron Ltd placed affair value of $6000 on these items. Sam Ltd believed that the databases had a future life of 4 years. All of the identifiable assets and liabilities of Sam Ltd were recorded at amounts equal to their fair values except for the following: Carrying amount $94 000 80 000 20 000

Plant (cost $120 000) Land Inventory

Fair value $96 000 85 000 24 000

The plant had an expected remaining useful life of 10 years. The land was sold by Sam Ltd in February 2015. The inventory was all sold by 30 June 2014. In February 2016, Sam Ltd transferred $3000 of the reserves on hand at 1 July 2013 to retained earnings. The remaining $2000 was transferred in February 2017. The court case involving the damages sought by the customer was settled in May 2017. Sam Ltd was required to pay $7500 to the customer. Required Prepare the consolidation worksheet entries for the preparation by Sam Ltd of its consolidated financial statements at 30 June 2017. At 1 July 2013: Net fair value of identifiable assets and liabilities of Sam Ltd

Consideration transferred Goodwill Recorded goodwill

= = = = =

($100 000 + $5 000 + 10 000) (equity) + $2 000 (1 – 30%) (plant) + $5 000 (1 – 30%) (land) + $4 000 (1 – 30%) (inventory) + $6 000 (1 – 30%) (data bases) - $10 000 (1 -30%) (damages payable) - $5 000 (goodwill) $114 900 $123 500 - $6 000 (dividend receivable) $117 500 $2 600 $5 000

19.56

Solutions manual to accompany Company Accounting 10e

Unrecorded goodwill

$(2 400)

A. Worksheet entries at 30 June 2017: 1. Business combination valuation entries

Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

26 000

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation (1/10 x $2 000 p.a. for 4 years)

Dr Dr Cr

200 600

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

240

Amortisation expense – data bases Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve

Dr Cr Dr

1 500

24 000 600 1 400

800

60 180

450 3 150

4 200

Transfer from business combination valuation reserve Income tax expense Damages expense Gain

Dr Cr Cr Cr

7 000

Accumulated impairment losses - goodwill Business combination valuation reserve Goodwill

Dr Dr Cr

7 000 2 400

Retained earnings (1/7/13) Share capital Reserves Business combination valuation reserve Shares in Sam Ltd

Dr Dr Dr Dr Cr

10 000 100 000 5 000 2 500

Dividend payable Dividend receivable

Dr Cr

6 000

3 000 7 500 2 500

9 400

Pre-acquisition entries At 1/7/13:

117 500

6 000

At 30/6/17, the entry at acquisition date is affected by: - sale of inventory in prior period - payment of dividend: $6 000 in prior period - sale of land in prior period - transfer from reserves - $3 000 - in prior period

19.57

Chapter 19: Consolidation: wholly owned subsidiaries

- transfer from reserve - $2 000 – in current period - settlement of court case in current period - de-recognition of data bases in current period Retained earnings (1/7/16) * Share capital Reserves Business combination valuation reserve Shares in Sam Ltd

Dr Dr Dr Cr Cr

19 300 100 000 2 000 3 800 117 500

* = $10 000 + $2 800 (BCVR - inventory) + $3 500 (BCVR – land) + $3 000 (reserve transfer) Transfer from reserves Reserves

Dr Cr

2 000

Business combination valuation reserve Transfer from business combination valuation reserve (Court case settled)

7 000

Transfer from business combination valuation reserve Business combination valuation reserve (Data bases de-recognised)

2 000

Dr Cr

7 000

4 200 4 200

19.58

Solutions manual to accompany Company Accounting 10e

Question 19.16 Consolidation worksheet entries, consolidated financial statements George Ltd acquired all the issued shares (ex div.) of Francis Ltd on 1 July 2014 for $246 000. At this date the equity of Francis Ltd consisted of: Share capital General reserve Retained earnings

$ 130 000 50 000 40 500

At the acquisition date all the identifiable assets and liabilities of Francis Ltd consisted of:

Plant (cost $230 000) Land Inventory

Carrying amount $200 000 100 000 30 000

Fair value $210 000 120 000 38 000

The inventory was all sold by 30 June 2015. The land was sold on 1 February 2015 for $150 000. The plant was considered to have a further 5-year life. The plant was sold for $155 000 on 1 January 2016. Also at acquisition date Francis Ltd had recorded a dividend payable of $7000 and goodwill (net of accumulated impairment losses of $13 000) of $5000. Francis Ltd had not recorded some internally generated brands that George Ltd considered to have a fair value of $12 000. The brand was considered to have an indefinite life. Also not recorded by Francis Ltd was a contingent liability relating to a current court case in which Francis Ltd was involved and a supplier was seeking compensation. George Ltd placed a fair value of $15 000 on this liability. This court case was settled in May 2016 at which time Francis Ltd was required to pay damages of $16 000. In February 2015, Francis Ltd transferred $20 000 from the general reserve on hand at 1 July 2014 to retained earnings. A further $15 000 was transferred in February 2016. Both companies have an equity account entitled ‘Other components of equity’ to which certain gains and losses from financial assets are taken. At 1 July 2014, the balances of these accounts were $30 000 (George Ltd) and $15 000 (Francis Ltd). The financial statements of the two companies at 30 June 2016 contained the following information: PLEASE NOTE THAT THE BELOW CHANGES DETAILED IN THE WHITE BOXES WILL BE TAKEN INTO AFFECT IN THE 1 ST REPRINT OF THE TEXT.

19.59

Chapter 19: Consolidation: wholly owned subsidiaries

Total Equity and Liabilities for George should show as $658 000

The amount for “Shares in Francis” of $246 000 should be shown in George’s column.

Required Prepare the consolidated financial statements for George Ltd at 30 June 2016. At 1 July 2014: Net fair value of identifiable assets and liabilities of Francis Ltd

($130 000 + $50 000 + $40 500) (equity) + $20 000 (1 – 30%) (land) + $10 000 (1 – 30%) (plant) + $8 000 (1 – 30%) (inventory) + $12 000 (1 – 30%) (brands) - $15 000 (1 -30%) (liability) - $5 000 (goodwill)

19.60

Solutions manual to accompany Company Accounting 10e

Consideration transferred Goodwill acquired Goodwill recorded Unrecorded goodwill

= = = = =

$240 000 $246 000 $6 000 $5 000 $1 000

Worksheet entries at 30 June 2016 1. Business combination valuation entries Depreciation expense – plant Gain/(loss) on sale of non-current assets Income tax expense Retained earnings (1/7/15) Transfer from business combination reserve (1/5 x $10 000 p.a for 1½ years.)

Dr Dr Cr Dr Cr

1 000 7 000

Brands Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Transfer from business combination valuation reserve Income tax expense Damages expense

Dr Dr Cr

10 500 4 500

Accumulated impairment losses – goodwill Goodwill Business combination valuation reserve

Dr Cr Cr

13 000

2 400 1 400 7 000

3 600 8 400

15 000

12 000 1 000

19.61

Chapter 19: Consolidation: wholly owned subsidiaries

QUESTION 19.16 (cont’d) 2. Pre-acquisition entries At 1 July 2014: Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Shares in Francis Ltd

Dr Dr Dr Dr Cr

40 500 130 000 50 000 25 500

Dr Dr Dr Dr Cr

80 100 130 000 30 000 5 900

246 000

At 30 June 2016: The above entry is affected by: - sale of inventory in prior period - sale of land in prior period - settlement of court case in current period - sale of plant in current period

Retained earnings (1/7/15) * Share capital General reserve Business combination valuation reserve Shares in Francis Ltd

246 000

* = $40 500 + $20 000 (general reserve transfer) + $5 600 (BCVR – inventory) + $14 000 (BCVR – land)) Transfer from business combination valuation reserve Business combination valuation reserve (Sale of plant)

Dr Cr

7 000

Business combination valuation reserve Transfer from business combination valuation reserve (Settlement of court case)

10 500

Transfer from general reserve General reserve

Dr Cr

7 000

10 500

15 000 15 000

19.62

Solutions manual to accompany Company Accounting 10e

QUESTION 19.16 (cont’d) George Ltd Revenues 90 000 Expenses 34 000 Trading profit 56 000 Gains (losses) on sale 8 000 of non-current assets Profit before tax 64 000 Income tax expense 12 000 Profit 52 000 Retained earnings 103 000 (1/7/15) Transfer from BCVR 0 Transfer from general reserve Dividend paid Retained earnings (30/6/16) Share capital General reserve BCVR

Other components of equity (1/7/15) Increases/Decreases Other components of equity (30/6/16) Total equity Accounts payable Deferred tax liability Other liabilities Goodwill Accumulated impairment losses Inventory Cash Financial assets Shares in Francis Ltd Land Brands Plant Accum depreciation

Francis Ltd 64 000 42 000 22 000 8 000 30 000 5 000 25 000 55 000 0

Adjustments Dr Cr 1 000 15 000

7 000

4 500

1 2 1 2

1 400 80 100 10 500 7 000 15 000

2 400

Group

153 000 61 000 92 000 9 000 101 000 19 100 76 500

7 000 10 500

1 2

30 000

15 000

30 000

185 000 20 000 165 000

95 000 0 95 000

150 000 10 000 0

130 000 20 000 0

325 000 30 000

245 000 15 000

333 400 45 000

5 000 35 000

3 000 18 000

8 000 53 000

360 000 30 000 18 000 250 000 658 000

263 000 10 000 10 000 230 000 513 000

386 400 40 000 31 600 480 000 938 000

20 000 0

18 000 (13 000)

40 000 10 000 110 000 246 000 20 000 80 000 314 000 (182 000) 658 000

30 000 5 000 207 000 0 20 000 0 466 000 (220 000) 513 000

188 400 20 000 168 400 2 2 2 2

130 000 30 000 5 900 10 500

15 000 8 400 1 000 7 000

3 600

12 000

13 000

246 000 1

2 1 1 2

12 000

327 900

150 000 15 000 0

26 000 0 70 000 15 000 317 000 0 40 000 92 000 780 000 (402 000) 938 000

19.63

Chapter 19: Consolidation: wholly owned subsidiaries

QUESTION 19.16 (cont’d) GEORGE LTD Consolidated Statement of profit or Loss and Other Comprehensive Income for financial year ended 30 June 2016 Revenues Expenses Trading profit Gains (losses) on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: Gains Comprehensive income for the period

$153 000 61 000 92 000 9 000 101 000 19 100 $81 900 800 $82 700

GEORGE LTD Consolidated Statement of Changes in Equity for financial year ended 30 June 2016 Comprehensive income for the period

$82 700

Retained earnings balance at 1 July 2015 Profit for the period Transfer from general reserve Dividend paid Retained earnings balance at 30 June 2016

$76 500 81 900 30 000 (20 000) $168 400

Share capital balance at 1 July 2015 Share capital balance at 30 June 2016

$150 000 $150 000

General reserve balance at 1 July 2015 Transfers from general reserve General reserve balance at 30 June 2016

$45 000 (30 000 $15 000

Other components of equity at 1 July 2015 Gains Other components of equity at 30 June 2016

$45 000 8 000 $53 000

19.64

Solutions manual to accompany Company Accounting 10e

QUESTION 19.16 (cont’d) GEORGE LTD Consolidated Statement of Financial Position as at 30 June 2016 Current Assets Inventory Financial assets Cash Total Current Assets Non-current Assets Property, plant and equipment: Land Plant Accumulated depreciation – Plant Brands Goodwill Total Non-current Assets Total Assets Equity Share capital Reserves: General reserve Other components of equity Retained earnings Total Equity Liabilities Current liabilities Accounts payable Non-current liabilities Deferred tax liabilities Other Total non-current liabilities Total liabilities Total Equity and Liabilities

$70 000 317 000 15 000 402 000

40 000 780 000 (402 000) 92 000 26 000 536 000 $938 000

$150 000 15 000 53 000 168 400 386 400

40 000 31 600 480 000 511 600 551 600 $938 000

19.65

Chapter 20: Consolidation: intragroup transactions

Chapter 20 – Consolidated financial statements: intragroup transactions REVIEW QUESTIONS 1. Why is it necessary to make adjustments for intragroup transactions? The consolidated financial statements are the statements of the group, an economic entity consisting of the parent and its subsidiaries. The consolidated financial statements then can only contain profits, assets and liabilities that relate to parties external to the group. Adjustments must then be made for intragroup transactions as these are internal to the economic entity, and do not reflect the effects of transactions with external parties. This is also consistent with the entity concept of consolidation, which defines the group as the net assets of the parent and the net assets of the subsidiary. Transactions between these parties must then be adjusted in full as both parties are within the economic entity.

2. In making consolidation worksheet adjustments, sometimes tax-effect entries are made. Why? Accounting for tax is governed by AASB 112 Income Tax. Deferred tax accounts are raised when a temporary difference arises because the tax base of an asset or liability differs from the carrying amount. Some consolidation adjustments result in changing the carrying amounts of assets and liabilities. Where this occurs a temporary difference arises as there is no change to the tax base. In these situations, tax-effect entries, require the raising of deferred tax assets and liabilities, are necessary. Consider an example of an item of inventory carried at cost of $10 000 being sold by a parent to a subsidiary for $12 000, the inventory still being on hand at the end of the period. The tax rate is 30%. In the consolidation worksheet there is a credit adjustment to inventory of $2 000 as the cost to the economic entity differs from that to the subsidiary. In the subsidiary’s accounts, the inventory is carried at $12 000 and has a tax base of $12 000, giving rise to no temporary differences. From the group’s point of view, the asset has a carrying amount of $10 000, giving a temporary difference of $2 000. As the expected future deduction is greater than the assessable amount, a deferred tax asset exists for the group. This has no effect on the amount of tax payable in the current period.

20.1

Solutions manual to accompany Company Accounting 10e

3. Why is it important to identify transactions as current or prior period transactions? Current period transactions affect different accounts than prior period transactions. For example, current period sales of inventory affect sales and cost of sales accounts, whereas prior period sales of inventory affect retained earnings. If the transactions are not correctly placed into a time context, then the adjustments used for those transactions may be inappropriate.

4. Where an intragroup transaction involves a depreciable asset, why is depreciation expense adjusted? The cost of the asset to the group is different from that recorded by the acquirer of the depreciable asset within an intragroup transaction. The acquirer records depreciation on the cost to the acquirer while in the consolidated financial statements, the group wants to show depreciation calculated on cost to the group. Hence an adjustment is necessary. If a profit is made on an intragroup sale of a depreciable asset, then the cost of the asset to the group is less than the cost recorded by the acquirer of the asset. Hence an adjustment is necessary to reduce the depreciation expense and accumulated depreciation in relation to the asset.

5. How are adjustments for post-acquisition dividends different from those for pre-acquisition dividends? Explain. There is no difference in the accounting for pre-acquisition or post-acquisition dividends. They are all accounted for as post-acquisition dividends. The adjustment is to dividend revenue recorded by the parent and dividends paid recorded by the subsidiary. The treatment of all dividends as post-acquisition dividends is hard to justify conceptually and this decision was made by the standard-setters on pragmatic grounds. Refer to AASB 127 and AASB 9 (para 5.7.6). 6. What is meant by “realisation of profits”? Profit is realised when an entity or an economic entity transacts with another external entity. For a group or economic entity this is consistent with the concept that the consolidated financial statements show only the results of transactions with external entities. The consolidated statement of profit or loss and other comprehensive income will thus show only realised profits. Profits recognised by group members on sale of assets within the group are unrealised profits. With transferred inventory involvement of an external party, or realisation, occurs when the inventory is on-sold to an external entity. With transferred depreciable assets, realisation occurs as the asset is used up, as the benefits are received by the group as a result of use of the asset. The proportion of profits realised in any one period is measured by reference to the depreciation charged on the transferred asset. Profits recorded from intragroup services are considered to be immediately realised.

7. When are profits realised in relation to inventory transfers within the group? Realisation occurs on involvement of an external entity, namely when the inventory is on-sold to an entity that is not a member of the group.

20.2

Chapter 20: Consolidation: intragroup transactions

8. When are profits realised on transfers of depreciable assets within the group? As the asset is never on-sold by a member of the group, remaining instead within the group and being consumed by use within the group, the point of realisation cannot be directly determined by reference to involvement of an external entity. Realisation is then indirectly determined by usage of the asset within the group, that is, in proportion to the consumption of the benefits from the asset within the group. Realisation of the profit/loss on sale within the group is then measured in the same proportion to the depreciation of the asset. For example, if the transferred asset is being depreciation on a straight line basis over a 10-year period, that is, at 10% per annum, then the profit on sale is realised at 10% per annum.

20.3

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Consolidation adjustments

Jessica Ltd sold inventory during the current period to its wholly owned subsidiary, Amelie Ltd, for $15 000. These items previously cost Jessica Ltd $12 000. Amelie Ltd subsequently sold half the items to Ningbo Ltd for $8000. The tax rate is 30%. The group accountant for Jessica Ltd, Li Chen, maintains that the appropriate consolidation adjustment entries are as follows: Sales Cost of Sales Inventory Deferred Tax Asset Income Tax Expense

Dr Cr Cr Dr Cr

15 000 13 000 2 000 300 300

Required A. Discuss whether the entries suggested by Li Chen are correct, explaining on a line-by-line basis the correct adjustment entries. B. Determine the consolidation worksheet entries in the following year, assuming the inventory is on-sold, and explain the adjustments on a line-by-line basis. A. The correct entry is: Sales Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr Cr Dr Cr

15 000 13 500 1 500 450 450

Sales:

Recorded sales = $15 000 + $8 000 = $23 000 Group sales = $8 000 [external entity sales only] Adjustment = $15 000 Cost of sales: Recorded = $12 000 + ½ x $15 000 = $19 500 Group = ½ x $12 000 = $6 000 Adjustment = $13 500 Inventory: Recorded = ½ x $15 000 = $7 500 Group = ½ x $12 000 = $6 000 Adjustment = $1 500 DTA:

As inventory in the first adjustment is reduced by $1 500, this changes the carrying amount of the asset. A change in the carrying amount creates a temporary difference between it and the tax base giving rise to a deferred tax benefit which will be reversed on sale of the asset to an external entity.

20.4

Chapter 20: Consolidation: intragroup transactions

Assuming the inventory is on-sold, the entry in the following year is: Retained earnings (op bal) Income tax expense Cost of sales

Dr Dr Cr

1 050 450 1 500

Retained earnings (op bal): In the prior period, Jessica Ltd recorded an after tax profit of $2 100 on sale of inventory to Amelie Ltd. Half of this inventory was on-sold to an external entity, leaving half the profit, $1 050, unrealised. Hence prior period profit is reduced by $1 050. Income tax expense: In the prior period, the group raised a deferred tax asset of $450. When the inventory is on-sold this year the account is reversed effectively crediting the deferred tax asset account and debiting the income tax expense. Cost of sales: Recorded = ½ x $15 000 = $7 500 Group = ½ x $12 000 = $6 000 Adjustment = $1 500

20.5

Solutions manual to accompany Company Accounting 10e

Case Study 2

Depreciation expense

At the beginning of the current period, Jessica Ltd sold a used depreciable asset to its wholly owned subsidiary, Amelie Ltd, for $80 000. Jessica Ltd had originally paid $200 000 for this asset, and at time of sale to Amelie Ltd had charged depreciation of $150 000. This asset is used differently in Amelie Ltd from how it was used in Jessica Ltd; thus, whereas Jessica Ltd used a 10% p.a. straight-line depreciation method, Amelie Ltd uses a 20% straight-line depreciation method. In calculating the depreciation expense for the consolidated group (as opposed to that recorded by Amelie Ltd), the group accountant, RuiFen Xue, is unsure of which amount the depreciation rate should be applied to ($200 000, $50 000 or $80 000) and which depreciation rate to use (10% or 20%). Required Provide a detailed response, explaining which depreciation rate should be used and to what amount it should be applied. For the group, depreciation is based on the cost of the asset to the group and the depreciation rate is that applied by the entity using the asset. The asset has been transferred within the group. Note that consolidation adjustments are not based on reversing intragroup transactions. The purpose of the adjustments made is to remove the effects of the transactions so that the group position in relation to external entities is reported. As the usage of the asset in the group has changed as a result of transfer within the group, then the depreciation rate used by the group must reflect the actual consumption of benefits within the group. In this example, the cost of the asset to the group is the carrying amount at time of transfer, namely $50 000. The asset is being used by Amelie Ltd which applies a 20% depreciation rate. This is then the rate used by the group.

20.6

Chapter 20: Consolidation: intragroup transactions

Case Study 3

Income on redemption

The parent entity, Leah Ltd, has purchased on the open market, for an amount less than nominal value, some debentures previously issued by its wholly owned subsidiary, Natalie Ltd. The group accountant for Leah Ltd, James Cong, has stated that the adjustment in the consolidation worksheet includes the raising of an account Income on Redemption. He is unsure whether this is correct. Required What does this account represent? Would an adjustment to income, or subsequently to retained earnings, have to be made for the rest of the life of the group? If not, what event would cause the discontinuation of this adjustment entry?

Assume debentures have a nominal value of $100 and are acquired on the open market for $90. The consolidation adjustment entry is: Debentures Income on redemption Debentures in Subsidiary

Dr Cr Cr

100 10 90

The economic entity has made a gain on buying its own debentures. Effectively, the group has derecognised a liability at a gain. While the debentures remain unredeemed, a similar entry is made every year, with a credit to retained earnings instead of income on redemption. When the debentures are eventually redeemed [assume a subsequent period], the subsidiary will pay the nominal amount to the debenture holders. Hence the parent will receive $100 on redemption, passing the entry: Cash Debentures in Subsidiary Income on redemption

Dr Cr Cr

100 90 10

From the economic entity’s point of view the gain/income was made when the group derecognised the liability on the parent acquiring the subsidiary’s debentures. Hence, in the year of redemption, the group will not recognise a gain. The consolidation adjustment is: Income on redemption Retained earnings (op bal)

Dr Cr

10 10

No consolidation adjustments are required in future periods.

20.7

Solutions manual to accompany Company Accounting 10e

Case Study 4

Bonus dividend

The parent entity, Olivia Ltd, has received a bonus dividend paid from its subsidiary’s postacquisition profits. The accountant for Olivia Ltd, Lu Rong, is concerned that if on consolidation the total effects of this transaction have to be eliminated, then this will show a misleading financial position for the group. Her concern is that the subsidiary, by making a bonus dividend, has reduced the ability of the group to pay cash dividends. The consolidation adjustments will result in this fact not being made known to the users of the consolidated financial statements. Required Discuss whether Lu Rong has cause for concern, and what options are available for her in accounting for the bonus dividend.

When a parent receives a bonus dividend from a subsidiary, no journal entries are passed in the parent’s records as the parent’s wealth in the subsidiary has not changed – there has simply been a movement within equity with no change in total equity. However, one result of the bonus dividend is that equity previously available for dividend has now been classed as share capital, and no longer available for dividend. If the following consolidation worksheet adjustment were made: Share capital Bonus dividend paid

Dr Cr

x x

The effect of the reduction in equity available for dividend would not be obvious to shareholders. Hence, the following consolidation worksheet adjustment is preferred: Share capital Capitalised profits reserve

Dr Cr

x x

The consolidated accounts then show that a bonus dividend has been paid and that there has been a reduction in profits available for dividend distribution. This fact would be disclosed by way of note.

20.8

Chapter 20: Consolidation: intragroup transactions

PRACTICE QUESTIONS Question 20.1

Intragroup transactions

Koala Ltd owns all of the shares of Kangaroo Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) In April 2016, Koala Ltd sells inventory to Kangaroo Ltd for $12 000. This inventory had previously cost Koala Ltd $8000, and it remains unsold by Kangaroo Ltd at the end of the period. (b) All the inventory in (a) is sold to Cockatoo Ltd, an external party, for $16 500 on 19 June 2016. (c) Half the inventory in (a) is sold to Galah Ltd, an external party, for $7200 on 20 June 2016. The remainder is still unsold at the end of the period. (d) Koala Ltd, in January 2016, sold inventory for $8000. This inventory had been sold to it by Kangaroo Ltd in the previous year. It had originally cost Kangaroo Ltd $4800, and was sold to Koala Ltd for $9600.

(a)

(b)

(c)

(d)

Sales revenue Cost of sales Inventory

Dr Cr Cr

12 000

Deferred tax asset Income tax expense (30% x $4 000)

Dr Cr

1 200

Sales revenue Cost of sales

Dr Cr

12 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

12 000

Deferred tax asset Income tax expense (30% x $2 000)

Dr Cr

600

Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

3 360 1 440

8 000 4 000

1 200

12 000

10 000 2 000

600

4 800

20.9

Solutions manual to accompany Company Accounting 10e

Question 20.2

Intragroup transactions

Numbat Ltd owns all of the shares of Goanna Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) On 1 July 2015, Numbat Ltd sold an item of plant costing $15 000 to Goanna Ltd for $18 000. Numbat Ltd had not charged any depreciation on the plant before the sale. Both entities depreciate assets at 10% p.a. on cost. (b) On 1 January 2014, Goanna Ltd sold a new tractor to Numbat Ltd for $30 000. This had cost Goanna Ltd $24 000 on that day. Both entities charged depreciation at the rate of 10% p.a. on cost. (c) On 1 July 2015, Numbat Ltd sold an item of machinery to Goanna Ltd for $9000. This item had cost Numbat Ltd $6000. Numbat Ltd regarded this item as inventory whereas Goanna Ltd intended to use it as a non-current asset. Goanna Ltd charges depreciation at the rate of 10% p.a. on cost. (d) In February 2015, Numbat Ltd sold inventory to Goanna Ltd for $9000, at a mark-up of 20% on cost. One-quarter of this inventory was unsold by Goanna Ltd at 30 June 2015. (e) Goanna Ltd sold land to Numbat Ltd in December 2015. The land had originally cost Goanna Ltd $20 000, but was sold to Numbat Ltd for only $16 000. To help Numbat Ltd pay for the land, Goanna Ltd gave Numbat Ltd an interest-free loan of $9000, and the balance was paid in cash. Numbat Ltd has as yet made no repayments on the loan. (f) On 1 July 2014, Goanna Ltd rented a spare warehouse to be used jointly by Numbat Ltd and Galah Ltd with each company paying half the agreed rent to Goanna Ltd. The rent paid to Goanna Ltd in the 2014–15 year was $300 while the rent paid in the 2015–16 year was $350.

(a)

Proceeds on sale of plant Carrying amount of asset sold Asset

Dr Cr Cr

18 000

Gain on sale of plant Asset

Dr Cr

3 000

Deferred tax asset Income tax expense

Dr Cr

900

Accumulated depreciation Depreciation expense (10% x $3000 p.a.)

Dr Cr

300

Income tax expense Deferred tax asset

Dr Cr

Retained earnings (1/7/15) Deferred tax asset Tractors

Dr Dr Cr

4 200 1 800

Accumulated depreciation Depreciation expense Retained earnings (1/7/15)

Dr Cr Cr

1 500

15 000 3 000

(b)

3000

900

300

6 000

600 900

20.10

Chapter 20: Consolidation: intragroup transactions

(10% x $6000 p.a. for 2.5 years)

(c)

(d)

(e)

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

180 270

Sales revenue Cost of sales Machinery

Dr Cr Cr

9 000

Deferred tax asset Income tax expense

Dr Cr

900

Accumulated depreciation Depreciation expense (10% x $3000 p.a.)

Dr Cr

300

Income tax expense Deferred tax asset

Dr Cr

Retained earnings (1/7/12) Income tax expense Cost of sales

Dr Dr Cr

262.5 112.5

Proceeds on sale of land Land Carrying amount of land sold

Dr Dr Cr

16 000 4 000

Land

Dr Cr

4 000

Income tax expense Deferred tax liability (30% x $4 000)

Dr Cr

1 200

Loan from Goanna Ltd Loan to Numbat Ltd

Dr Cr

9 000

Rent revenue Rent expense

Dr Cr

175

450

6 000 3 000

900

300

375

20 000

OR Loss on sale of land

(f)

4 000

1 200

9 000

175

20.11

Solutions manual to accompany Company Accounting 10e

Question 20.3

Intragroup transactions

Dingo Ltd owns all of the shares of Bilby Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) On 1 January 2015, Dingo Ltd sold inventory costing $6000 to Bilby Ltd at a transfer price of $8000. On 1 September 2015, Bilby Ltd sold half these items of inventory back to Dingo Ltd, receiving $3000 from Dingo Ltd. Of the remaining inventory kept by Bilby Ltd, half was sold in January 2016 to Goanna Ltd at a loss of $200. (b) On 1 January 2016, Bilby Ltd sold an item of plant to Dingo Ltd for $2000. Immediately before the sale, Bilby Ltd had the item of plant on its accounts for $3000. Bilby Ltd depreciated items at 5% p.a. on the diminishing balance and Dingo Ltd used the straightline method over 10 years. (c) On 1 July 2015, Dingo Ltd sold a motor vehicle to Bilby Ltd for $12 000. This had a carrying amount to Dingo Ltd of $9600. Both entities depreciate motor vehicles at a rate of 10% p.a. on cost. (d) During the 2014–15 period, Dingo Ltd sold inventory to Bilby Ltd for $9000, recording a before-tax profit of $1800. Half this inventory was unsold by Bilby Ltd at 30 June 2015. (e) Bilby Ltd sells second-hand machinery. Dingo Ltd sold one of its depreciable assets (original cost $80 000, accumulated depreciation $64 000) to Bilby Ltd for $10 000 on 1 January 2016. Bilby Ltd had not resold the item by 30 June 2016. (f) On 1 May 2016, Bilby Ltd sold inventory costing $300 to Dingo Ltd for $360 on credit. On 30 June 2016, only half of these goods had been sold by Dingo Ltd, but Dingo Ltd had paid $280 back to Bilby Ltd.

(a)

(b)

Retained earnings (1/7/15) Income tax expense Sales revenue Cost of sales (4000 + 500) Inventory (1/4 x 2000)

Dr Dr Dr Cr Cr

1 400 600 3 000

Deferred tax asset Income tax expense

Dr Cr

150

Plant Proceeds on sale of plant Carrying amount of plant sold

Dr Dr Cr

1 000 2 000

Plant

Dr Cr

1 000

Loss on sale of plant Income tax expense Deferred tax liability

Dr Cr

300

Depreciation expense Accumulated depreciation (10% x $1000 x ½ year)

Dr Cr

Deferred tax liability

4 500 500

150

3 000

1 000

300

20.12

Chapter 20: Consolidation: intragroup transactions

Income tax expense

(c)

Proceeds on sale of motor vehicle Carrying amount of motor vehicle sold Motor vehicles

Dr Cr Cr

12 000

Gain on sale of vehicles Motor vehicles

Dr Cr

2 400

Deferred tax asset Income tax expense

Dr Cr

720

Accumulated depreciation Depreciation expense (10% x 2 400 p.a.)

Dr Cr

240

Income tax expense Deferred tax asset

Dr Cr

Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

630 270

Inventory Proceeds on sale of machinery Carrying amount of machinery sold

Dr Dr Cr

6 000 10 000

Inventory Loss on sale of machinery

Dr Cr

6 000

Income tax expense Deferred tax liability

Dr Cr

1 800

Sales revenue Cost of sales Inventory

Dr Cr Cr

360

Deferred tax asset Income tax expense

Dr Cr

Accounts payable Accounts receivable

Dr Cr

9 600 2 400

(d)

(e)

2 400

720

240

900

16 000

(f)

6 000

1 800

330 30

20.13

Solutions manual to accompany Company Accounting 10e

Question 20.4

Intragroup transactions

Emu Ltd owns all of the shares of Cassowary Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) Emu Ltd sold inventory to Cassowary Ltd on 1 September 2015 for $27 000. This inventory had cost Emu Ltd $18 000. One-third of the inventory was sold by Cassowary Ltd to Goanna Ltd for $13 000 and one-third to Galah Ltd for $13 200. (b) Emu Ltd manufactures certain items which it then markets through Cassowary Ltd. During the current period, Emu Ltd sold items for $18 000 to Cassowary Ltd at cost plus 20%. Cassowary Ltd has sold 75% of these transferred items at 30 June 2016. (c) During June 2016, Cassowary Ltd declared a $2000 dividend. The dividend was paid in August 2017. (d) In January 2016, Cassowary Ltd paid a $4500 interim dividend. (e) Emu Ltd sold a warehouse to Cassowary Ltd for $150 000. This had originally cost Emu Ltd $123 000. The transaction took place on 1 January 2015. Cassowary Ltd charges depreciation at 5% p.a. on a straight-line basis.

(a)

(b)

(c)

(d)

(e)

Sales revenue Cost of sales Inventory

Dr Cr Cr

27 000

Deferred tax asset Income tax expense

Dr Cr

900

Sales revenue Cost of sales Inventory

Dr Cr Cr

18 000

Deferred tax asset Income tax expense

Dr Cr

225

Dividend payable Dividend declared

Dr Cr

2 000

Dividend revenue Dividend receivable

Dr Cr

2 000

Dividend revenue Dividend paid

Dr Cr

4 500

Retained earnings (1/7/15) Deferred tax asset Warehouse

Dr Dr Cr

18 900 8 100

Accumulated depreciation Depreciation expense

Dr Cr

2025

24 000 3 000

900

17 250 750

225

2 000

4 500

27 000

1350

20.14

Chapter 20: Consolidation: intragroup transactions

Retained earnings (1/7/12) (5% x $27 000 p.a. for 1.5 yrs)

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

675

405.0 202.5 607.5

20.15

Solutions manual to accompany Company Accounting 10e

Question 20.5

Intragroup transactions

Platypus Ltd owns all of the share capital of Wallaby Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) During the year ending 30 June 2016, Wallaby Ltd sold $55 000 worth of inventory to Platypus Ltd. Wallaby Ltd recorded an $8000 profit before tax on these transactions. At 30 June 2016, Platypus Ltd has one-quarter of these goods still on hand. (b) Platypus Ltd manufactures items of machinery which are used as property, plant and equipment by other companies, including Wallaby Ltd. On 1 January 2016, Platypus Ltd sold such an item to Wallaby Ltd for $52 000, its cost to Platypus Ltd being only $45 000 to manufacture. Wallaby Ltd charges depreciation on these machines at 20% p.a. on the diminishing balance. (c) A non-current asset with a carrying amount of $1200 was sold by Wallaby Ltd to Platypus Ltd for $900 on 1 January 2016. Platypus Ltd intended to use this item as inventory, being a seller of second-hand goods. Both entities charged depreciation at the rate of 10% p.a. on the diminishing balance on non-current assets. The item was still on hand at 30 June 2016. (d) Platypus Ltd issued 1000 10% debentures of $100 at nominal value on 1 October 2015. Wallaby Ltd acquired 300 of these. Interest is payable half-yearly on 31 March and 30 September. Accruals have been recognised in the legal entities’ accounts. (e) On 25 June 2016, Platypus Ltd declared a dividend of $8000. On the same day, Wallaby Ltd declared a $4000 dividend.

(a)

(b)

(c)

Sales revenue Cost of sales Inventory

Dr Cr Cr

55 000

Deferred tax asset Income tax expense

Dr Cr

600

Sales revenue Cost of sales Machinery

Dr Cr Cr

52 000

Deferred tax asset Income tax expense

Dr Cr

2 100

Accumulated depreciation Depreciation expense (20% x ½ x $7000)

Dr Cr

700

Income tax expense Deferred tax asset

Dr Cr

210

Inventory Dr Proceeds on sale of non-current asset Dr Carrying amount of non-current asset sold Cr

300 900

Inventory Loss on sale of non-current asset

Dr Cr

300

Income tax expense

53 000 2 000

600

45 000 7 000

2 100

700

210

1 200

300

20.16

Chapter 20: Consolidation: intragroup transactions

(d)

(e)

Deferred tax liability

Debentures Debentures in Platypus Ltd

Dr Cr

30 000

Interest revenue Interest expense (10% x $30 000 x ¾)

Dr Cr

2 250

Interest payable Interest receivable (10% x $30 000 x ¼)

Dr Cr

750

Dividend payable Dividend declared

Dr Cr

4 000

Dividend revenue Dividend receivable

Dr Cr

4 000

30 000

2 250

750

4 000

20.17

Solutions manual to accompany Company Accounting 10e

Question 20.6

Consolidated worksheet entries, rationale for adjustments

Tasmanian Ltd owns all the issued shares of Tiger Ltd, having acquired its ownership interest on 1 August 2010. The accountant, Ms Echidna, is preparing the consolidated financial statements at 30 June 2016, and, as a part of preparing the consolidation worksheet for Tasmanian Ltd, is analysing the intragroup transactions between the parent and its subsidiary. The intragroup transactions under analysis are as follows (assume a tax rate of 30%): (a) On 1 February 2016, Tiger Ltd sold inventory to Tasmanian Ltd for $15 000, recording a before-tax profit of $3000. By 30 June 2016, Tasmanian Ltd has sold one-third of these to other entities for $6000. (b) On 1 January 2015, Tasmanian Ltd sold an item of machinery to Tiger Ltd that Tiger Ltd classified as inventory. At the date of sale, Tasmanian Ltd had recorded the asset at a carrying amount of $150 000 (net of $20 000 depreciation, calculated using a 10% p.a. straight-line method). Tiger Ltd recorded the asset at $160 000. Tiger Ltd sold it to Oz Animals Ltd on 15 August 2016 for $100 000. (c) Tasmanian Ltd supplies motor vehicles to its executives, and the managing director is supplied with a new Ferrari every 2 years. On 1 January 2014, as the managing director of Tasmanian Ltd wanted a new car, the company sold the Ferrari to Tiger Ltd to be used by the newly appointed accounting graduate. At the date of sale, the car had a carrying amount of $240 000, and was sold to Tiger Ltd for $260 000. The vehicle is depreciated at 20% p.a. straight-line by Tiger Ltd, and is still being used by the accounting graduate. (d) Tasmanian Ltd installed new computing systems at a cost of $825 000 on 1 September 2015. These are depreciated evenly over a 5-year period. To assist in the installation and training, Tiger Ltd sent one of its young computer experts to Tasmanian Ltd for a 6-month period, charging the company $100 000 for the services provided. Required A. Prepare the consolidation worksheet entries at 30 June 2016 to adjust for the effects of the above inter-entity transactions. B. Ms Echidna is concerned that the auditors may require her to explain the adjustments she has made. Provide suitable explanations for transactions (a) and (b) above.

A. (a) Sales

15 000

Cost of sales Inventory

Dr Cr Cr

Deferred tax asset Income tax expense

Dr Cr

600

Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

7 000 3 000

Retained earnings (1/7/15) Deferred tax asset Vehicles

Dr Dr Cr

14 000 6 000

Accumulated depreciation

10 000

13 000 2 000

600

(b)

(c)

10 000

20 000

20.18

Chapter 20: Consolidation: intragroup transactions

(d)

Retained earnings (1/7/15) Depreciation expense (20% x $20 000 for 1.5 yrs)

Cr Cr

6 000 4 000

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

1 200 1 800

Other revenue Other expenses

Dr Cr

100 000

3 000

100 000

B. (a) Sales: Tiger recorded sales of $15 000 while Tasmanian Ltd recorded sales of $6000. Total recorded sales are $21 000. Sales to the group – those to external entities – are $6 000. Therefore adjustment of $15 000 is necessary. Cost of sales: Tiger Ltd recorded cost of sales of $12 000 while Tasmanian Ltd recorded cost of sales of $5 000 (being 1/3 x $15 000). Total recorded cost of sales is $17 000. Cost of sales to the group is $4 000 (being 1/3 x $12 000). Cost of sales therefore needs to be reduced by $13 000. Inventory: Recorded inventory held by Tasmanian Ltd is $10 000 (being 2/3 x $15,000). Cost of inventory to the group is $8000 (being 2/3 x $12 000). Inventory therefore has to be reduced by $2000 to show cost to the group in the CFS. Deferred tax asset/income tax expense: The reduction of $2000 to the carrying amount of the inventory creates a temporary difference between carrying amount of the asset and its tax base. A deferred tax asset is raised to reflect the future tax benefits when the asset is sold. (b) Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

7 000 3 000 10 000

Retained earnings: In the prior period Tasmanian Ltd recorded an after-tax profit of $7000 on sale of the machine to Tiger Ltd. No external entities were involved in this sale. The group therefore does not want to recognise any such sale. Hence prior period’s profits - reflected in Retained Earnings – are reduced by $7000. Cost of sales: Tiger Ltd regards the asset as inventory. It recorded a cost of sales of $160 000 on sale of the asset to Oz Animals Ltd. The cost of the asset to the group is $150 000. Hence cost of sales is reduced by $10 000. Income tax expense: In the consolidated financial statements at 30 June 2015, a deferred tax asset of $3000 was raised as the carrying amount to the group of the inventory on hand ($150 000) was different from its tax base ($160 000). On sale of the asset to Oz Animals Ltd in the current period that deferred tax asset is reversed giving rise to a debit to the income tax expense of $3000 (being 30% x $10 000).

20.19

Solutions manual to accompany Company Accounting 10e

Question 20.7

Consolidation worksheet

On 1 July 2015, Fluffy Ltd acquired all the issued shares of Glider Ltd. Fluffy Ltd paid $30 000 in cash and 20 000 shares in Fluffy Ltd valued at $3 per share. At this date, the equity of Glider Ltd consisted of $66 000 share capital and $6000 retained earnings. At 1 July 2015, all the identifiable assets and liabilities of Glider Ltd were recorded at amounts equal to their fair values except for:

Plant (cost $150 000) Patents Inventory

Carrying amount $120 000 90 000 18 000

Fair value $123 000 105 000 22 500

The plant was considered to have a further 5-year life. The patents were sold for $120 000 to an external entity on 18 August 2015. The inventory was all sold by 30 June 2016. Additional information (a) Fluffy Ltd sells certain raw materials to Glider Ltd to be used in its manufacturing process. At 1 July 2016, Glider Ltd held inventory sold to it by Fluffy Ltd in the previous year at a profit of $600. During the 2016–17 year, Fluffy Ltd sold inventory to Glider Ltd for $21 000. None of this was on hand at 30 June 2017. (b) Glider Ltd also sells items of inventory to Fluffy Ltd. During the 2016–17 year, Glider Ltd sold goods to Fluffy Ltd for $4500. At 30 June 2017, inventory which had been sold to Fluffy Ltd at a profit of $300 was still on hand in Fluffy Ltd’s inventory. (c) On 1 July 2016, Glider Ltd sold an item of plant to Fluffy Ltd for $15 000. This plant had a carrying amount in the records of Glider Ltd of $14 000 at time of sale. This type of plant is depreciated at 10% p.a. on cost. (d) On 1 January 2015, Fluffy Ltd sold an item of inventory to Glider Ltd for $18 000. The inventory had cost Fluffy Ltd $16 000. This item was classified by Glider Ltd as plant. Plant of this type is depreciated by Glider Ltd at 20% p.a. (e) On 1 March 2017, Glider Ltd sold an item of plant to Fluffy Ltd. Whereas Glider Ltd classified this as plant, Fluffy Ltd classified it as inventory. The sales price was $9000 which included a profit to Glider Ltd of $1500. Fluffy Ltd sold this to another entity on 31 March for $9900. (f) The tax rate is 30%. At 30 June 2017, the following financial information was provided by the two companies:

20.20

Chapter 20: Consolidation: intragroup transactions

Fluffy Ltd Dr Sales revenue Cost of sales Trading expenses Office expenses Depreciation expenses Proceeds on sale of plant Carrying amount of plant sold Income tax expense Share capital Retained earnings (1/7/16) Current liabilities Deferred tax liability Plant Accumulated depreciation – plant Intangibles Deferred tax assets Shares in Glider Ltd Inventory Receivables

Glider Ltd Cr 64 500

30 900 4 800 7 950 1 800

Dr 46 350 9 000 4 050 3 900

9 000 7 500 11 100

15 000 14 000 7 300

96 000 48 000 21 100 11 000 57 000

66 000 31 500 10 500 15 000 107 250

18 300 12 000 8 100 90 000 28 500 8 250 267 900

Cr 78 000

267 900

33 450 11 100 9 450 0 24 600 12 450 249 450

249 450

Required Prepare a consolidation worksheet for the preparation of the consolidated financial statements of Fluffy Ltd at 30 June 2017.

At 1 July 2015: Net fair value of identifiable assets and liabilities of Glider Ltd

Consideration transferred Goodwill

= = =

$66 000 + $6 000 (equity) + $4 500 (1 – 30%) (inventory) + $15 000 (1 – 30%) (patents) + $3 000 (1 – 30%) (plant) $87 750 $90 000 $2 250

1. Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

30 000

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation (1/5 x $3000 p.a. for 2 years)

Dr Dr Cr

600 600

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

360

27 000 900 2 100

1 200

180 180

20.21

Solutions manual to accompany Company Accounting 10e

Goodwill Business combination valuation reserve

Dr Cr

2 250

Dr Dr Dr Cr

6 000 66 000 18 000

Dr Dr Dr Cr

19 650 66 000 4 350

2 250

2. Pre-acquisition entries At 1/7/15: Retained earnings (1/7/15) Share capital Business combination valuation reserve Shares in Glider Ltd

90 000

At 30/6/17: Retained earnings (1/7/16)* Share capital Business combination valuation reserve Shares in Glider Ltd

90 000

(* = $6000 + $3 150 + $10 500)

3. Sales and profit in closing inventory Sales revenue Cost of sales

Dr Cr

21 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

4 500

Deferred tax asset Income tax expense

Dr Cr

Dr Dr Cr

420 180

Proceeds on sale of plant Carrying amount of plant sold Plant

Dr Cr Cr

15 000

Deferred tax asset Income tax expense

Dr Cr

300

Accumulated depreciation - plant Depreciation expense (10% x $1000)

Dr Cr

100

Income tax expense

21 000

4 200 300

4. Profit in opening inventory of Glider Ltd Retained earnings (1/7/16) Income tax expense Cost of sales

600

5. Sale of Plant - current period

14 000 1 000

300

100

20.22

Chapter 20: Consolidation: intragroup transactions

Deferred tax asset

6. Sale of Inventory classified as Plant : prior period Retained earnings (1/7/16) Deferred tax asset Plant

Dr Dr Cr

1 400 600

Accumulated depreciation Depreciation expense Retained earnings (1/7/16) (20% x $2000 p.a. for 1.5 years)

Dr Cr Cr

600

Income tax expense Retained earnings (1/7/16) Deferred tax asset

Dr Dr Cr

120 60

2 000 400 200

180

7. Sale of Plant classified as Inventory: current period Proceeds on sale of plant Carrying amount of plant sold Cost of sales

Dr Cr Cr

9 000 7 500 1 500

20.23

Solutions manual to accompany Company Accounting 10e

QUESTION 20.7 (cont’d) Fluffy Ltd 64 500

Glider Ltd 78 000

Cost of sales

30 900

46 350

Gross profit Trading expenses Office expenses Depreciation

33 600 4 800 7 950 1 800

31 650 9 000 4 050 3 900

14 550 19 050 9 000

16 950 14 700 15 000

7 500

14 000

1 500

1 000

20 550 11 100

15 700 7 300

Profit Retained earnings (1/7/16)

9 450 48 000

8 400 31 500

Retained earnings (30/6/17) Share capital BCVR

57 450

39 900

96 000 --

66 000 --

Total equity

153 450

105 900

Current liabilities Deferred tax liability Total liabilities Total equity and liabilities

21 100 11 000 32 100 185 550

10 500 15 000 25 500 131 400

Sales revenue

Profit from trading Proceeds from sale of plant Carrying amount of plant sold Gain/loss on sale of machinery Profit before tax Tax expense

3 3

5 7

Adjustments Dr Cr 21 000 4 500 21 000 4 200 600 1 500

600

100 400

Group 117 000 3 3 4 7

5 6

49 950

67 050 13 800 12 000 5 800 31 600 35 450 0

15 000 9 000 14 000 7 500

5 7

0 0

4 5 6

1 2 4 6 6

180 30 120

600 19 650 420 1 400 60

180 90 300

180 200

1 3 5

1 6

35 450 18 160

17 290 57 750

75 040 2 2

66 000 4 350

2 100 2 250

1 1

96 000 0 171 040

360

900

31 600 26 540 58 140 229 180

20.24

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.7 (cont’d)

Fluffy Ltd 57 000

Glider Ltd 107 250

Accumulated depreciation

(18 300)

(33 450)

Intangibles Shares in Glider Ltd Deferred tax asset

12 000 90 000 8 100

11 100 9 450

Inventory Receivables Goodwill Total assets

28 500 8 250 0 185 550

24 600 12 450 0 131 400

Plant

1 5 6

3 5 6

Adjustments Dr Cr 27 000 1 000 2 000 30 000 1 200 100 600

1 5 6 1

90 000 30 180

2 5 6

300

90 300 600

2 250 177 210

177 210

Group 134 250

(22 250)

23 100 0 18 330

52 800 20 700 2 250 229 180

20.25

Solutions manual to accompany Company Accounting 10e

Question 20.8

Intragroup transactions rationale for transactions

Mallee Ltd owns 100% of the shares of Fowl Ltd. The following events occurred during the 2016–17 period: (a) Fowl Ltd sold inventory for $15 000 in August 2016. This inventory had been sold to it by Mallee Ltd in June 2016 for $13 500. The inventory had originally cost Mallee Ltd $9000. (b) On 1 January 2016, Fowl Ltd sold machinery to Mallee Ltd for $150 000. The carrying amount of the machinery at time of sale was $120 000. The machinery is depreciated at 10% p.a. on cost. Required A. Prepare the consolidation worksheet entries for the above two transactions for the preparation of consolidated financial statements at 30 June 2017. B. Provide an explanation for the worksheet entries made in A above.

A. (a)

(b)

Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

3 150 1 350

Retained earnings (1/7/16) Deferred tax asset Machinery

Dr Dr Cr

21 000 9 000

Accumulated depreciation Depreciation expense Retained earnings (1/7/16)

Dr Cr Cr

4 500

Dr Dr Cr

900 450

4 500

30 000

3 000 1 500

(10% x $30 000 p.a. for 1.5 years) Income tax expense Retained earnings (1/7/16) Deferred tax asset

1 350

B. (a) Retained earnings: In the previous period, Mallee Ltd recorded a $4500 before-tax profit, or a $3150 after-tax profit on sale of inventory within the group. Because the sale did not involve external entities, the profit must be eliminated on consolidation. Cost of sales: In the current period, the transferred inventory is sold to external entities. Fowl Ltd records cost of sales of $13 500 which is $4500 greater than the cost of sales to the group, namely $9000. Hence, cost of sales is reduced by $4500. Note that this increases group profit by $4500, reflecting the realisation of the profit to the group in the current period (due to the sale to an external party), when it was recognised by the legal entity in the previous period. Income tax expense: At the end of the previous period, in the consolidated statement of financial position a deferred tax asset of $1350 (30% x $4500) was raised because of the difference in cost of the inventory recorded by the legal entity and that recognised by the group. This deferred tax asset is reversed when the asset is sold. The adjustment to income tax expense reflects the reversal of the deferred tax asset raised at the end of the previous period. (b)

20.26

Chapter 20: Consolidation: intragroup transactions

Retained earnings: In the prior period, Fowl Ltd sold machinery to Mallee Ltd at an after-tax profit of $21 000, being $30 000(1 – 30%). As there were no external parties to the group involved in this transaction, the profit is unrealised to the group. Hence, retained earnings (1/7/16) must be reduced by $21 000. Machinery: The machinery is still held by Mallee Ltd at 30 June 2017, and recorded at $150 000 cost. The cost to the group is $120 000. As the asset must be reported in the consolidated financial statements at cost to the group, machinery must be reduced by $30 000. Deferred tax asset: A change in the carrying amount of the asset causes a temporary difference between the carrying amount and the tax base of the asset. As the carrying amount is reduced by $30 000, a deferred tax asset of $9 000 (30% x $30 000) is raised. Depreciation expense and accumulated depreciation: The asset is depreciated by the Mallee Ltd at $15 000 p.a. (being 10% x $150 000) while the depreciation to the group is $12 000 (being 10% x $120 000). Hence depreciation p.a. must be reduced by $3 000. As the transfer occurred on 1 January 2016, this means a reduction to prior period depreciation, via retained earnings of half a year’s depreciation, $1 500, and a reduction in current depreciation expense of $3000. This means a reduction to accumulated depreciation of $4 500. Deferred tax asset and income tax expense: As changes to accumulated depreciation change the carrying amount of the asset, there is a tax-effect to be considered. The deferred tax asset raised in relation to the sale of the asset within the group is reversed as the asset is depreciated. Hence, there is an overall reversal of $1350, being 30% x $4500, being the change to accumulated depreciation with resultant effects on tax expense both in the current period of $900 (30% x $3 000) and the prior period of $450 (30% x $1 500).

20.27

Solutions manual to accompany Company Accounting 10e

Question 20.9

Consolidation worksheet, concept of realisation

On 1 July 2016, Gilberts Ltd acquired all the issued shares (cum div.) of Potoroo Ltd for $50 000. At this date the equity of Potoroo Ltd consisted of: Share capital Retained earnings

$ 25 000 7 500

At this date, Potoroo Ltd had recorded a dividend payable of $7500 which was paid in August 2016. All the identifiable assets and liabilities of Potoroo Ltd were recorded at amounts equal to fair values except for inventory for which the fair value was $1000 greater than carrying amount. Only 10% of the inventory on hand at 1 July 2016 remained unsold by 30 June 2017. The tax rate is 30%. During the 2016–17 period, the following transactions occurred. (a) Gilberts Ltd sold inventory to Potoroo Ltd for $30 000 at a profit before tax of $6000. At 30 June 2017, inventory which was sold to Potoroo Ltd for $12 500 at a profit before tax of $2500 was still on hand in the records of Potoroo Ltd. (b) On 1 January 2017, Gilberts Ltd sold machinery to Potoroo Ltd at a gain of $5000. The machinery was considered to have a further 5-year life. (c) During the period Potoroo Ltd rented a warehouse from Gilberts Ltd, paying $1250 in rent to Gilberts Ltd. (d) During the period Gilberts Ltd recorded gains from revaluation of land, which is measured using the fair value method. These gains increased the asset revaluation surplus by $2000 to give a balance of $14 000 at 30 June 2017. (e) In June 2017, an impairment test was conducted on Potoroo Ltd and resulted in the recognition of impairment losses on goodwill of $8000 (recognised in other expenses) The following financial information was provided by the companies at 30 June 2017:

Sales revenue Dividend revenue Other income Gains on sale of non-current assets Total income Cost of sales Other expenses Total expenses Profit before income tax Income tax expense Profit for the year Retained earnings (1/7/16) Dividend paid Retained earnings (30/6/17)

Gilberts Ltd $62 500 2 500 2 500 2 500

Potoroo Ltd $59 000 — 5 000 5 000

70 000 (52 500) (7 500) (60 000) 10 000 (3 375) 6 625 15 000 21 625 (6 250) $15 375

69 000 (45 000) (2 500) (47 500) 21 500 (4 875) 16 625 7 500 24 125 (2 500) $21 625

Required A. Prepare the consolidated statement of profit or loss and other comprehensive income and the consolidated statement of changes in equity for Gilberts Ltd at 30 June 2017. B. Discuss the concept of realisation using the intragroup transactions in this question to illustrate your answer.

20.28

Chapter 20: Consolidation: intragroup transactions

At 1 July 2016: Net fair value of identifiable assets and liabilities of Potoroo Ltd

Consideration transferred Goodwill

= = = = =

$25 000 + $7 500 (equity) + $1000 (1 – 30%) (inventory) $33 200 $50 000 - $7 500 dividend $42 500 $9 300

A. Worksheet entries 1. Business combination valuation entries Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

900

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

100

Goodwill Business combination valuation reserve

Dr Cr

9 300

Retained earnings (1/7/16) Share capital Business combination valuation reserve Shares in Potoroo Ltd

Dr Dr Dr Cr

7 500 25 000 10 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

630

Impairment loss - goodwill Accumulated impairment losses

Dr Cr

8 000

270

630

30 70

9 300

2. Pre-acquisition entries

42 500

630

8 000

20.29

Solutions manual to accompany Company Accounting 10e

QUESTION 20.9 (cont’d) 3. Dividend paid Dividend revenue Interim dividend paid

Dr Cr

2 500

Sales revenue Cost of sales Inventory

Dr Cr Cr

30 000

Deferred tax asset Income tax expense

Dr Cr

750

Dr Cr

1 250

Gain on sale of PPE Machinery

Dr Cr

5 000

Deferred tax asset Income tax expense

Dr Cr

1 500

Accumulated depreciation Depreciation expense (20% x $5000 x 1/2)

Dr Cr

500

Income tax expense Deferred tax asset

Dr Cr

150

2 500

4. Sales

27 500 2 500

750

5. Rental of warehouse Other income Other expenses

1 250

6. Sale of machinery

5 000

1 500

7. Depreciation

500

150

20.30

Chapter 20: Consolidation: intragroup transactions

Sales revenue Dividend revenue Other income Cost of sales Other expenses

Profit from trading Gain/loss on sale of PPE Profit before tax Tax expense

Profit Retained earnings (1//7/16) Transfer from BCV reserve Dividend paid Retained earnings (30/6/17)

Gilberts Potoroo Ltd Ltd 62 500 59 000 2 500 0 2 500 5 000 67 500 64 000 52 500 45 000 7 500 2 500 60 000 7 500 2 500 10 000 3 375

47 500 16 500 5 000 21 500 4 875

6 625 15 000

4 3 5

Adjustments Dr Cr 30 000 2 500 1 250

1 2

900 8 000

5 000

150

16 625 7 500

7 500

630

21 625 6 250 15 375

24 125 2 500 21 625

27 500 1 250 500

270 750 1 500

Group

4 5 7

1 4 6

91 500 0 6 250 97 750 70 900 16 250 87 150 10 600 2 500 13 100 5 880

7 220 15 000 630

2 500

22 220 6 250 15 970

20.31

Solutions manual to accompany Company Accounting 10e

QUESTION 20.9 (cont’d)

GILBERTS LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June, 2017 Revenue: sales Other income

$91 500 6 250 $97 750

Expenses: Cost of sales Other

70 900 16 250

Gain on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income: Gains on revaluation of assets Comprehensive income for the period

87 150 10 600 2 500 13 100 5 880 $7 220 2 000 $9 220

GILBERTS LTD Consolidated Statement of Changes in Equity For the financial year ended 30 June 2017 Comprehensive income for the year

$9 220

Retained earnings balance at 1 July 2016 Profit for the year Dividend paid Retained earnings balance at 30 June 2017

$15 000 7 220 (6 250) $15 970

Share capital balance at 1 July 2016 Share capital balance at 30 June 2017

$25 000 $25 000

Asset revaluation surplus balance at 1 July 2016 Gains on revaluation of assets Asset revaluation surplus at 30 June 2017

$12 000 2 000 $14 000

B. Concept of realisation ▪ ▪ ▪

▪

Realisation occurs on involvement of an external entity Sale of inventory: realisation occurs when inventory is on-sold to external party – see worksheet adjustment (4) where adjustment is made for unrealised profits Sale of machinery: realisation occurs as plant is used up and benefits received – see worksheet adjustments (6) and (7). Note that the gain on sale is considered to be fully unrealised but as the asset is depreciated, profit is realised; the credit to depreciation expense in adjustment (7) means an increase in group profit. Services: Profits/losses on services are realised immediately; see adjustment (5)

20.32

Chapter 20: Consolidation: intragroup transactions

Question 20.10 Consolidated financial statements, rationale for adjustments Leadbeaters Ltd acquired all the issued shares (cum div.) of Possum Ltd on 1 July 2014. At this date the shareholders’ equity of Possum Ltd was: Share capital – 100 000 shares General reserve Asset revaluation surplus Retained earnings

450 000 45 000 45 000 15 000

At 1 July 2014, the accounting records of Possum Ltd contained a dividend payable of $30 000. This dividend was paid in August 2014. All the identifiable assets and liabilities at acquisition date were recorded at amounts equal to their fair values except for:

Plant (cost $290 000) Inventory

Carrying amount $220 000 160 000

Fair value $227 500 175 000

The plant was considered to have a further 5-year life. It was sold on 1 January 2017 for $118 000. The inventory was all sold by 30 June 2015. Possum Ltd did not record a contingent liability relating to a lawsuit by a customer for faulty goods. Possum Ltd considered this liability had a fair value of $18 000. The lawsuit was settled in May 2015 when Possum Ltd was required to pay damages of $20 000. Additional information (a) On 1 July 2015, Leadbeaters Ltd sold plant to Possum Ltd at a before-tax profit of $6000. This class of non-current asset is depreciated at 20% p.a. on cost by Leadbeaters Ltd while Possum Ltd uses a rate of 10% p.a. on cost. (b) In June 2016 Possum Ltd sold $50 000 worth of inventory to Leadbeaters Ltd at a beforetax profit of $5400. At 30 June 2017, inventory on which Possum Ltd had made a profit of $750 on sale to Leadbeaters Ltd was still on hand. (c) On 10 February 2017, Possum Ltd used the whole of the general reserve existing at 1 July 2014 to pay a bonus dividend of three shares for every ten held. (d) Both Leadbeaters Ltd and Possum Ltd use the valuation method to measure land. In June 2017, Leadbeaters Ltd recorded revaluation increases of $15 000 while Possum Ltd recorded increases of $12 000. (e) The tax rate is 30%. Financial information provided by the companies at 30 June 2017 was as follows:

20.33

Solutions manual to accompany Company Accounting 10e

Possum Ltd

Plant Accumulated depreciation – plant Land Shares in Possum Ltd Inventory Receivables Cash Total assets

Leadbeaters Ltd $ 558 750 (318 000) 531 300 594 000 270 000 43 500 37 500 $1 717 050

Dividend payable Other current liabilities Loans Total liabilities

15 000 52 050 150 000 $ 217 050

6 000 60 000 60 000 $ 126 000

Share capital Asset revaluation surplus Retained earnings (1/7/16) Revenues Expenses Gains/(losses) on sale of non-current assets Tax expense Dividend declared Total equity

$1 200 000 225 000 22 500 162 000 (48 000) 6 000

$495 000 120 000 18 000 210 000 (80 000) 5 000

(52 500) (15 000) $1 500 000

(60 000) (6 000) $ 702 000

$ 318 000 (165 000) 397 500 — 240 000 22 500 15 000 $ 828 000

Required A. Prepare the consolidated financial statements of Leadbeaters Ltd at 30 June 2017. B. Explain the consolidation worksheet entries made for the intragroup transactions in (a) and (b) in the additional information. At 1 July 2014: Net fair value of identifiable assets and liabilities of Possum Ltd

Consideration transferred Goodwill A. 1. Business combination valuation entries

= = =

Depreciation expense Gain on sale of non-current assets Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve (Depreciation is charged at $1500 p.a.)

$450 000 + $45 000 + $45 000 + $15 000 (equity) + $15 000 (1 – 30%) (inventory) + $7 500 (1 – 30%) (machinery) - $18 000 (1 – 30%) (liability) $558 150 $594 000 $35 850

Dr Dr Cr Dr Cr

750 3 750 1 350 2 100 5 250

20.34

Chapter 20: Consolidation: intragroup transactions

Goodwill Business combination valuation reserve

Dr Cr

35 850 35 850

2. Pre-acquisition entries at 30 June 2017 Retained earnings (1/7/16) * Share capital General reserve Asset revaluation surplus (1/7/16) Business combination valuation reserve Shares in Possum Ltd * = $15 000 +$10 500 - $12 600

Dr Dr Dr Dr Dr Cr

12 900 450 000 45 000 45 000 41 100

Share capital General reserve

Dr Cr

45 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

5 250

Dr Dr Cr

4 200 1 800

Accumulated depreciation Retained earnings (1/7/16) Depreciation expense (10% x $6000 p.a.)

Dr Cr Cr

1 200

Retained earnings (1/7/16) Income tax expense Deferred tax asset

Dr Dr Cr

180 180

Dr Dr Cr

525 225

Dr Cr

6 000

594 000

45 000

5 250

3. Sale of Plant Retained earnings (1/7/16) Deferred tax asset Plant

6 000

4. Depreciation of Plant

600 600

360

5. Profit in Opening/Closing Inventory Retained earnings (1/7/16) Deferred tax asset Inventory

750

6. Dividend payable Dividend payable Dividend declared

6 000

20.35

Solutions manual to accompany Company Accounting 10e

Dividend revenue Dividend receivable

Dr Cr

6 000 6 000

20.36

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.10 (cont’d) Leadbeaters Possum Ltd Ltd Revenues 162 000 210 000 Expenses 48 000 80 000 Trading profit 114 000 130 000 Gains/losses on sale of 6 000 5 000 non-current assets Profit before tax 120 000 135 000 Tax expense 52 500 60 000 Profit 67 500 75 000 Retained earnings 22 500 18 000 (1/7/16)

Transfer from BCVR Dividend declared Ret. Earnings (30/6/17) Share capital BCVR

Asset revaluation surplus (1/7/16) Gains/losses Asset revaluation surplus (30/6/17) Total equity Loans Other current liabilities Dividend payable Total liabilities Total equity and liabilities Shares in Possum Ltd Inventory Receivables Cash Plant Accum. depreciation Land Deferred tax asset Goodwill Total assets

0 90 000 15 000 75 000 1 200 000

93 000 6 000 87 000 495 000

6 1

Adjustments Dr Cr 6 000 750 600

Group

3 750

180

1 350

1 2 3 4 5 2

2 100 12 900 4 200 180 525 5 250

600

5 250

6 000

35 850 5 250

1 2

366 000 128 150 237 850 7 250 245 100 111 330 133 770 21 195

0 154 965 15 000 139 965 1 200 000

2 2 2

450 000 45 000 41 100

1 275 000 210 000

582 000 108 000

45 000

15 000 225 000

12 000 120 000

27 000 300 000

1 500 000 150 000 52 050 15 000 217 050 1 717 050

702 000 60 000 60 000 6 000 126 000 828 000

1 639 965 210 000 112 050 15 000 337 050 1 977 015

594 000 0 270 000 240 000 43 500 22 500 37 500 15 000 558 750 318 000 (318 000) (165 000) 531 300 397 500 0 0 0 1 717 050

0 828 000

1 339 965 273 000

6 000

1 200

3 5 1

1 800 225 35 850 662 010

594 000 750 6 000

2 5 6

6 000

360

662 010

0 509 250 60 000 52 500 870 750 (481 800) 928 800 1 665 35 850 1 977 015

20.37

Solutions manual to accompany Company Accounting 10e

QUESTION 20.10 (cont’d) LEADBEATERS LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2017 Revenues Expenses Trading profit Gains/(losses) on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: gains on revaluation of assets Comprehensive income for the period

$366 000 128 150 237 850 7 250 245 100 111 330 $133 770 27 000 $160 770

LEADBEATERS LTD Consolidated Statement of Changes in Equity for financial year ended 30 June 2017 Comprehensive income for the period

$160 770

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend declared Balance at 30 June 2017

$21 195 133 770 (15 000) $139 965

Share capital: Balance at 1 July 2016 Balance at 30 June 2017

$1 200 000 $1 200 000

Asset revaluation surplus: Balance at 1 July 2016 Gains Balance at 30 June 2017

$273 000 27 000 $300 000

20.38

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.10 (cont’d) LEADBEATERS LTD Consolidated Statement of Financial Position as at 30 June 2017 ASSETS Current Assets Inventories Receivables Cash Total Current Assets Non-current Assets Property, plant and equipment: Plant Accumulated depreciation Land Deferred tax assets Goodwill Total Non-current Assets Total Assets

$509 250 60 000 52 500 621 750

$870 750 (481 800

EQUITY AND LIABILITIES Equity Share capital Asset revaluation surplus Retained earnings Total Equity Current Liabilities Dividend payable Other Non-current Liabilities: Interest-bearing liabilities: Loans Total Liabilities Total Equity and Liabilities

388 950 928 800 1 665 35 850 1 355 265 $1 977 015

$1 200 000 300 000 __139 965 1 639 965

$15 000 112 050

127 050 210 000 _337 050 $1 977 015

20.39

Solutions manual to accompany Company Accounting 10e

QUESTION 20.10 (cont’d) B. (a) Retained earnings: This is a prior period transaction. As there were no external parties to the group involved in this transaction, the prior period profit is unrealised to the group. Hence, retained earnings (1/7/16) must be reduced by $4 200 (profit after tax). Plant: The plant is still held by Possum Ltd at 30 June 2017 and recorded at $6 000 more than the cost to the group. As the asset is reported in the consolidated financial statements at cost to the group, plant must be reduced by $6 000. Deferred tax asset: A change in the carrying amount of the asset causes a temporary difference between the carrying amount and the tax base of the asset. As the carrying amount is reduced, a deferred tax asset of $1 800 (30% x $6 000) is raised. Depreciation expense and accumulated depreciation: The asset is depreciated by Possum Ltd based on the price paid to Leadbeaters Ltd which includes the unrealised profit of $6 000. Depreciation for the group should be based on cost to the group which means depreciation p.a. must be reduced by $600 (10% x $6 000). A reduction to prior period depreciation, via retained earnings of $600, and a reduction in current depreciation expense of $600. This means a reduction to accumulated depreciation of $1200. Deferred tax asset and income tax expense: As changes to accumulated depreciation change the carrying amount of the asset, there is a tax-effect to be considered. The deferred tax asset raised in relation to the sale of the asset within the group is reversed as the asset is depreciated. Hence, there is an overall reversal of $360, being 30% x $1200, being the change to accumulated depreciation with resultant effects on tax expense both in the current period and prior period of $180 (30% x $600). (b) Retained earnings: This is a prior period transaction. In the previous period, Possum Ltd recorded a $750 before-tax profit, or a $525 after-tax profit on sale of inventory still held within the group at 30/6/16. Because the sale did not involve external entities, the profit must be eliminated on consolidation. Any profit on sale of other inventory now sold to external entities does not require any adjustment on consolidation as the profits on the sale are realised by the group. Inventory: At 30 June 2017, Leadbeaters Ltd still has the inventory on hand from intragroup transactions in the prior period and records them at cost which includes an unrealised profit of $750. The cost of this inventory to the group is $750 less than the amount recorded by the legal entity; hence inventory is then reduced by $750. Deferred tax asset/income tax expense: A change in the carrying amount of the asset inventory causes a temporary difference between the carrying amount and the tax base of the asset. As the carrying amount is reduced, a deferred tax asset of $225 (30% x $750) is raised.

20.40

Chapter 20: Consolidation: intragroup transactions

Question 20.11 Consolidation worksheet Golden Ltd acquired all the issued shares of Bandicoot Ltd on 1 July 2016. Golden Ltd paid $40 000 cash plus 100 000 shares in Golden Ltd which had a fair value of $2 per share. At the acquisition date all the identifiable assets and liabilities of Bandicoot Ltd were recorded at amounts equal to their fair values, except inventory, which had a fair value $1500 greater than its carrying amount. All this inventory was sold by Bandicoot Ltd prior to 30 June 2017. Bandicoot Ltd conducts a strong research and development division. It has expensed all past outlays. Golden Ltd has assessed that on-process research and development has a fair value of $12 000. It assessed this asset at 30 June 2017 and decided that $3000 of this asset should be written off as amortisation expense. In the 2016 annual report Bandicoot Ltd reported in the notes the existence of a contingent liability relating to damages being sought by a supplier. Golden Ltd assessed the liability to have a fair value at 1 July 2016 of $10 500. Bandicoot Ltd made an out-of-court settlement with the supplier in August 2016, paying $10 000 to the supplier. The income tax rate is 30%. Intragroup transactions occurring in the 2016–17 period were as follows. (a) During the course of the year, Bandicoot Ltd sold inventory to Golden Ltd. Total sales were $60 000, these being sold at cost plus 25%. At 30 June 2017, Golden Ltd still held inventory that it had bought from Bandicoot Ltd for $15 000. (b) On 1 January 2017, Golden Ltd acquired $90 000 of debentures previously issued by Bandicoot Ltd. These were acquired on the open market for $85 500. Interest on debentures is paid half-yearly. Interest due on 30 June 2017 has been paid by Bandicoot Ltd. (c) On 1 April 2017, Golden Ltd sold an item of inventory to Bandicoot Ltd for $45 000. This asset had cost Bandicoot Ltd $36 000 to manufacture. The asset is to be used by Bandicoot Ltd as part of its plant and machinery. The depreciation rate used by Bandicoot Ltd for this type of asset is 20% p.a. on cost. The financial information provided by the two entities at 30 June 2017 was as follows:

20.41

Solutions manual to accompany Company Accounting 10e

Golden Ltd $352 100 25 500 10 000 387 600 (184 500) (51 900) (236 400) 151 200 (48 000) 103 200 36 000 139 200 (27 000)

Bandicoot Ltd $272 000 5 000 23 000 300 000 (180 000) (33 000) (213 000) 87 000 (30 000) 57 000 18 000 75 000 (7 500)

(24 000)

(7 200)

(36 000)

(10 800)

Retained earnings (30/6/17) Share capital General reserve Total equity

(87 000) 52 200 480 000 102 000 $634 200

(25 500) 49 500 180 000 36 000 $265 500

Deferred tax liabilities 8% debentures Dividend payable Provisions Payables Total liabilities Total equity and liabilities

19 500 0 24 000 18 000 16 500 $78 000 $712 200

7 500 120 000 10 800 35 460 15 000 $188 760 $454 260

Plant and machinery Accumulated depreciation Land Debentures in Bandicoot Ltd Shares in Bandicoot Ltd Cash Receivables Inventory Total assets

$160 000 (60 000) 143 450 85 500 240 000 8 500 31 750 103 000 $712 200

165 000 (39 000) 225 000 — — 5 260 15 500 82 500 $454 260

Sales Dividend revenue Other income/gains Cost of sales Other expenses Profit before income tax Income tax expense Profit for the year Retained earnings (1/7/16) Dividend paid from 2015–16 profit Dividend paid from 2016–17 profit Dividend declared from 2016–17 profit

Required Prepare the consolidation worksheet for the preparation of the consolidated financial statements of Golden Ltd at 30 June 2017.

At 1 July 2016: Net fair value of identifiable assets and liabilities of Bandicoot Ltd

$180 000 + $18 000 + $36 000 + $1 500 (1 – 30%) (inventory) + $12 000 (1 – 30%) (R&D)

20.42

Chapter 20: Consolidation: intragroup transactions

Consideration transferred Goodwill

= = =

- $10 500 (1 -30%) (liability) $236 100 $240 000 $3 900

1. Business combination valuation entries Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

1 500

Research & development Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Amortisation expense Accumulated amortisation

Dr Cr

3 000

Deferred tax liability Income tax expense

Dr Cr

900

Transfer from business combination valuation reserve Deferred tax asset Damages expense Gain on settlement of liability

Dr Dr Cr Cr

7 350 3 150

Goodwill Business combination valuation reserve

Dr Cr

3 900

Retained earnings (1/7/16) Share capital Business combination valuation reserve General reserve Shares in Bandicoot Ltd

Dr Dr Dr Dr Cr

18 000 180 000 6 000 36 000

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of inventory)

Dr Cr

1 050

7 350

450

1 050

3 600 8 400

3 000

900

10 000 500

3 900

2. Pre-acquisition entries

Business combination valuation reserve Transfer from business combination valuation reserve

240 000

1 050

7 350

(Settlement of court case)

20.43

Solutions manual to accompany Company Accounting 10e

QUESTION 20.11 (cont’d) 3. Dividend declared Dividend payable Dividend declared

Dr Cr

10 800

Dividend revenue Dividend receivable

Dr Cr

10 800

Dividend revenue Interim dividend paid - 2015-16 profits

Dr Cr

7 500

Dividend revenue Interim dividend paid: 2016-17 profits

Dr Cr

7 200

Debentures Debentures in Bandicoot Ltd Income on redemption of debentures

Dr Cr Cr

90 000

Interest revenue Interest expense (8% x ½ x $90 000)

Dr Cr

3 600

Sales revenue Cost of sales Inventory

Dr Cr Cr

60 000

Deferred tax asset Income tax expense

Dr Cr

900

Sales revenue Cost of sales Plant and machinery

Dr Cr Cr

45 000

Deferred tax asset Income tax expense

Dr Cr

2 700

Accumulated depreciation Depreciation expense (1/4 x 20% x $9 000)

Dr Cr

450

Income tax expense Deferred tax asset

Dr Cr

135

10 800

4. Dividend paid

7 500

7 200

5. Debentures

85 500 4 500

3 600

6. Unrealised profit in closing inventory

57 000 3 000

900

7. Sale of inventory for use as non-current asset

36 000 9 000

2 700

8. Depreciation on plant and machinery

450

135

20.44

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.11 (cont’d) Sales revenue

Golden Bandicoot Ltd Ltd 352 100 272 000

6 7 5

Adjustments Dr Cr 60 000 45 000 3 600 500 4 500 10 800 7 500 7 200

Other income

10 000

5 000

Dividend revenue

25 500

23 000

Cost of sales

387 600 184 500

300 000 180 000

1 500

Other expenses

51 900

33 000

3 000

Profit before tax Tax expense

236 400 151 200 48 000

213 000 87 000 30 000

103 200 36 000

57 000 18 000

139 200 27 000

75 000 7 500

24 000 36 000 87 000 52 200

7 200 10 800 25 500 49 500

480 000 102 000 0

180 000 36 000 0

634 200 19 500

265 500 7 500

0 24 000 18 000 16 500 78 000 712 200

120 0000 10 800 35 460 15 000 188 760 454 260

Profit Retained earnings (1/7/16) Transfer from BCVR

Dividend paid: 2015/16 profits 2016/17 profits Dividend declared Retained earnings (30/6/17) Share capital General reserve BCVR

Total equity Deferred tax liabilities 8% debentures Dividend payable Provisions Payables Total liabilities Total equity and liabilities

3 4 4

1 8

3 150 135

18 000

1 2

7 350 1 050

2 2 2 2

180 000 36 000 6 000 7 350

57 000 36 000 10 000 3 600 450

450 900 2 700

90 000 10 800

519 100 1 5

16 400 23 000

6 7 1 5 8

1 6 7

558 500 273 000 73 850

346 850 211 650 77 235

134 415 36 000 1 050 7 350

1 2

7 500

7 200 10 800

4 3

8 400 3 900 1 050 3 600

5 3

Group

1 1 2 1

0 170 415 27 000 24 000 36 000 87 000 83 415 480 000 102 000 0

665 415 30 600 30 000 24 000 53 460 31 500 169 560 834 975

20.45

Solutions manual to accompany Company Accounting 10e

QUESTION 20.11 (cont’d) Golden Ltd

Bandicoot Ltd

Adjustments Dr Cr 9 000

Group

Plant & machinery Accumulated depreciation Land Debentures in Bandicoot Ltd Shares in Bandicoot Ltd Deferred tax assets

160 000 (60 000)

165 000 (39 000)

143 450 85 500

225 000 0

85 500

368 450 0

240 000

135

3 465

Cash Receivables Inventory R&D in-process Accumulated amortisation R&D Goodwill Total assets

8 500 31 750 103 000 0 0

5 260 15 500 82 500 0 0

10 800 3 000

3 6

3 000

712 200

454 260

6 7

450

900 2 700

12 000

3 900 518 385

518 385

316 000 (98 550)

13 760 36 450 182 500 12 000 (3 000) 3 900 834 975

20.46

Chapter 20: Consolidation: intragroup transactions

Question 20.12 Consolidated worksheet journal entries On 1 July 2013, Rock Ltd acquired (ex div.) all of the issued capital of Wallaby Ltd. The recorded equity of Wallaby Ltd at this date consisted of: Share capital General reserve Retained earnings

$120 000 25 000 55 000

At 1 July 2013, all the identifiable assets and liabilities of Wallaby Ltd were recorded at fair value except for the following assets:

Land Inventory Machinery (cost $86 000) Vehicles (cost $58 000)

Carrying amount $100 000 78 500 52 000 47 000

Fair value $130 000 86 100 56 000 53 000

Additionally, Wallaby Ltd’s records showed a dividend payable at 1 July 2013 of $8000. This dividend was paid on 31 October 2013. The assets of Wallaby Ltd at acquisition date included goodwill recorded at $15 000 arising from a business combination transaction in 2009. At 1 July 2013, Wallaby Ltd owned but had not recorded an internally generated brand name. This brand name was considered by Rock Ltd to have a fair value of $29 000 and an indefinite useful life. An impairment test conducted with respect to the brand name on 30 June 2016 concluded that its recoverable amount at that date was $2000 less than its carrying amount. The vehicles and machinery were expected to have a further useful life of 6 and 8 years respectively, with benefits to be received evenly over those periods. Inventory on hand at 1 July 2013 was all sold by 31 January 2014. The land owned at 1 July 2013 was sold in September 2014 for $150 000. The machinery on hand at 1 July 2013 was sold on 1 January 2016 for $38 000. Adjustments for the differences between carrying amounts and fair values of assets and liabilities on hand at acquisition date are recognised on consolidation. When assets are sold or derecognised, any related valuation reserves are transferred to retained earnings. In June 2015, Wallaby Ltd paid a share dividend worth $20 000 from the general reserve on hand at 1 July 2013. The trial balances of both companies at 30 June 2016 showed the following balances:

20.47

Solutions manual to accompany Company Accounting 10e

Debit balances Cash Receivables Inventory Other current assets Deferred tax assets Vehicles Equipment Land Financial assets Goodwill Shares in Wallaby Ltd Debentures in Rock Ltd Dividend paid Dividend declared Transfer to general reserve Cost of sales Income tax expense Depreciation and other expenses Carrying amount of machinery sold Carrying amount of equipment sold

Rock Ltd $ 2 500 27 000 39 700 15 200 7 500 88 000 — 140 000 68 000 28 000 250 000 — 10 000 20 000 10 000 210 000 30 000 39 000 — 21 000 $1 005 900

Wallaby Ltd $ 1 250 13 000 24 500 8 200 3 500 158 000 42 000 180 000 14 800 15 000 — 25 000 5 000 12 000 5 000 192 550 32 000 36 000 30 500 — $798 300

Credit balances Share capital General reserve Retained earnings (1/7/15) Accounts payable Loan payable (due 30/6/20) Dividend payable Provisions Current tax liability Deferred tax liability Accumulated depreciation – vehicles Accumulated depreciation – equipment 8% Debentures (matures 30/6/19) Sales revenue Dividend revenue Other income Proceeds on sale of equipment Proceeds on sale of machinery

Rock Ltd $ 200 000 35 000 51 300 69 500 25 000 20 000 12 500 43 000 11 800 16 400 — 25 000 450 000 17 000 11 400 18 000 — $1 005 900

Wallaby Ltd $ 140 000 10 000 67 500 36 000 15 000 12 000 9 300 34 000 5 000 60 000 34 500 — 320 000 — 17 000 — 38 000 $798 300

Additional information (a) Dividends may be declared by either company without shareholder approval. (b) The tax rate is 30%. (c) On 1 January 2016, Rock Ltd sold an item of equipment to Wallaby Ltd for $18 000. The equipment had a carrying amount at the date of sale of $21 000. Both companies depreciate equipment at 20% p.a. on a straight-line basis. (d) On 1 May 2015, Wallaby Ltd sold a machine to Rock Ltd for $7800. The machine had a carrying amount of $7000 at the date of sale. Rock Ltd recorded the machine as inventory. The inventory item was sold to an external party in November 2015 for $8200.

20.48

Chapter 20: Consolidation: intragroup transactions

(e) All interest on the 8% debentures has been paid and brought to account in the records of both companies. (f) During the 2015–16 financial year, Rock Ltd sold inventory to Wallaby Ltd for $75 000. The cost of this inventory to Wallaby Ltd was $70 000. Of this inventory, 25% is still on hand at 30 June 2016. (g) The transfer to general reserve recorded by Wallaby Ltd in the current year was from retained earnings recorded at 1 July 2013. Required Prepare the consolidation worksheet journal entries for the preparation of the consolidated financial statements of Rock Ltd at 30 June 2016.

Acquisition analysis

At 1 July 2013: Net fair value of identifiable assets, liabilities and contingent liabilities of Wallaby Ltd =

Net fair value acquired Consideration transferred Goodwill Recorded goodwill Adjustment required

= = = = =

$120 000 + $25 000 +$55 000 (equity) + $6 000 (1 – 30%) (BCVR - vehicles) + $4 000 (1 – 30%) (BCVR – machinery) + $30 000 (1 – 30%) (BCVR - land) + $7 600 (1 – 30%) (BCVR - inventory) + $29 000 (1 – 30%) (BCVR – brand name) - $15 000 (goodwill) $238 620 $250 000 $11 380 $11 380 - $15 000 $(3 620)

CONSOLIDATION WORKSHEET ENTRIES YEAR AT -30 JUNE 2016 1. Business combination valuation entries Accumulated depreciation - vehicles Vehicles Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

11 000

Depreciation expense Retained earnings (1/7/15) Accumulated depreciation - Vehicles (1/6 x $6000 p.a for 3 years)

Dr Dr Cr

1 000 2 000

Deferred tax liability Income tax expense Retained earnings (1/7/15)

Dr Cr Cr

900

5 000 1 800 4 200

3 000

300 600

20.49

Solutions manual to accompany Company Accounting 10e

Depreciation expense Carrying amount of machinery sold * Income tax expense Retained earnings (1/7/15) Transfer from BCVR (1/8 x $4000 p.a. for 2.5 yrs prior to sale) * 5.5 yrs x $500 p.a.

Dr Dr Cr Dr Cr

250 2 750

Brand name Deferred tax liability Business combination valuation reserve

Dr Cr Cr

29 000

Impairment loss Accumulated impairment losses - brand

Dr Cr

2 000

Deferred tax liability Income tax expense

Dr Cr

600

Business combination valuation reserve Goodwill

Dr Cr

3 620

900 700 2 800

8 700 20 300

2 000

600

3 620

2. Pre-acquisition entries Retained earnings (1/7/15)* Dr 81 320 Share capital ** Dr 140 000 General reserve Dr 5 000 Business combination valuation reserve Dr 23 680 Shares in Wallaby Ltd Cr * ($55 000 + $5 320 (BCVR – inventory)+ $21 000 (BCVR - land) ** $120 000 + $20 000 Transfer from business combination valuation reserve Business combination valuation reserve (Transfer on sale of machinery)

Dr Cr

2 800

General reserve Transfer to general reserve

Dr Cr

5 000

Dr Cr

5 000

12 000

250 000

2 800

5 000

3. Dividend paid Dividend revenue Dividend paid

5 000

4. Dividend declared Dividend payable

20.50

Chapter 20: Consolidation: intragroup transactions

Dividend declared Dividend revenue Dividend receivable

12 000

Dr Cr

12 000

Dr Cr

2 000

Dr Cr

25 000

Proceeds on sale of equipment Equipment Carrying amount of equipment sold

Dr Dr Cr

18 000 3 000

Income tax expense Deferred tax liability

Dr Cr

900

Depreciation expense – equipment Accumulated depreciation (1/2 x 20% x $3 000)

Dr Cr

300

Deferred tax liability Income tax expense

Dr Cr

12 000

5. Interest on debentures Interest revenue Interest expense (8% x $25 000)

2 000

6. Debentures 8% Debentures Debentures in Rock Ltd

25 000

7. Sale of equipment: Rock Ltd to Wallaby Ltd

21 000

900

8. Depreciation of equipment

300

9. Prior year sale of machine classified as inventory – Wallaby Ltd to Rock Ltd Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

560 240 800

10. Current year sale of inventory – Rock Ltd to Wallaby Ltd Sales revenue Cost of sales

Dr Cr

75 000 73 750

20.51

Solutions manual to accompany Company Accounting 10e

Inventory

Deferred tax asset Income tax expense

Dr Cr

1 250 375 375

20.52

Chapter 20: Consolidation: intragroup transactions

Question 20.13 Consolidation worksheet, consolidated financial statements On 1 July 2015, Ghost Ltd acquired all the shares of Bat Ltd for $330 000 on an ex-div. basis. On this date, the equity and liabilities of Bat Ltd included the following balances: Share capital General reserve Retained earnings Dividend payable Provisions

200 000 25 000 45 000 10 000 169 500

At acquisition date, all the identifiable assets and liabilities of Bat Ltd were recorded at amounts equal to fair value except for:

Plant and equipment (cost $300 000) Trademark Inventory Land Goodwill Machinery (cost $18 000)

Carrying amount $186 000 100 000 70 000 50 000 25 000 15 000

Fair value $190 000 110 000 80 000 70 000 55 000 16 000

Goodwill was not impaired in any period. The plant and equipment had a further 5-year life at acquisition date and was expected to be used evenly over that time. The trademark was considered to have an indefinite life. The machinery, which was estimated to have a further 4year life at acquisition date, was sold on 1 January 2017. Any adjustments for differences between carrying amounts at acquisition date and fair values are made on consolidation. During the year ended 30 June 2016, all inventories on hand at acquisition date were sold, and the land was sold on 1 June 2017. Any valuation reserves created are transferred on consolidation to retained earnings when assets are sold or fully consumed. Additional information (a) Of the interim dividend paid by Bat Ltd in the current year, $5000 was from profits before acquisition date. All other dividends were from current year profits. Shareholder approval is not required in relation to dividends. (b) On 1 July 2016, Bat Ltd has on hand inventory worth $12 000, being transferred from Ghost Ltd in June 2016. The inventory had previously cost Ghost Ltd $8000. On 31 March 2017, Bat Ltd transferred an item of plant with a carrying amount of $10 000 to Ghost Ltd for $15 000. Ghost Ltd treated this item as inventory. The item was still on hand at the end of the year. Bat Ltd applied a 20% depreciation rate to this plant. (c) On 1 January 2017, Bat Ltd acquired $8000 inventory from Ghost Ltd. This inventory originally cost Ghost Ltd $5000. The profit in inventory on hand at 30 June 2017 was $1000. (d) During the year ending 30 June 2017, Bat Ltd sold inventory costing $12 000 to Ghost Ltd for $18 000. Two-thirds of this was sold to external parties for $9000. (e) On 1 January 2016, Ghost Ltd sold furniture to Bat Ltd for $8000. This had originally cost Ghost Ltd $12 000 and had a carrying amount at the time of sale of $7000. Both entities charge depreciation at a rate of 10% p.a. (f) Ghost Ltd sold some land to Bat Ltd in December 2016. The land had originally cost Ghost Ltd $25 000, but was sold to Bat Ltd for only $20 000. To help Bat Ltd pay for the land, Ghost Ltd gave Bat Ltd an interest-free loan of $12 000. Bat Ltd has as yet made no repayments on the loan. (g) The tax rate is 30%.

20.53

Solutions manual to accompany Company Accounting 10e

On 30 June 2017 the trial balances of Ghost Ltd and Bat Ltd were as follows: Debit balances Shares in Bat Ltd Cash Receivables Inventory Deferred tax assets Machinery Plant and equipment Land Furniture Trademark Goodwill Cost of sales Other expenses Income tax expense Interim dividend paid Final dividend declared Loan to Bat Ltd Credit balances Share capital General reserve Retained earnings (1/7/16) Final dividend payable Current tax liabilities Provisions Loan from Ghost Ltd Sales Other income Gains(losses) on sale of non-current assets Accumulated depreciation – plant and equipment Accumulated depreciation – machinery Accumulated depreciation – furniture

Ghost Ltd $325 000 7 800 6 000 20 000 10 200 15 000 113 000 25 000 7 000 — — 162 000 53 000 20 000 12 000 6 000 12 000 $794 000

Bat Ltd — $35 000 20 000 50 000 — 15 000 300 000 50 000 8 000 100 000 25 000 128 000 41 000 18 000 10 000 4 000 — $804 000

$312 000 20 000 30 000 6 000 8 000 78 000 — 220 000 62 000 22 000 34 000

$200 000 25 000 45 000 4 000 2 500 169 500 12 000 182 000 20 000 25 000 114 000

1 000 1 000 $794 000

3 000 2 000 $804 000

Required Prepare the consolidation worksheet for Ghost Ltd for the preparation of consolidated financial statements at 30 June 2017. At 1 July 2015: Net fair value of identifiable assets, liabilities and contingent liabilities of Bat Ltd

Net fair value acquired Cost of combination

= =

($200 000 + $25 000 + $45 000) (equity) + $10 000 (1 – 30%) (inventory) + $20 000 (1 –30%) (land) + $4 000 (1 – 30%) (plant & equipment) + $1 000 (1 – 30%) (machinery) + $10 000 (1 – 30%) (trademark) - $25 000 (goodwill) $276 500 $330 000

20.54

Chapter 20: Consolidation: intragroup transactions

Goodwill acquired Unrecorded goodwill acquired

= = =

$53 500 $53 500 – $25 000 $28 500

Business combination valuation entries at 30 June 2017 Gain (loss) on sale of non-current assets Income tax expense Transfer from business combination valuation reserve

Dr Cr

20 000

Trademark Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000

Accumulated depreciation - P&E Plant and equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

114 000

Depreciation expense - P&E Retained earnings (1/7/16) Accumulated depreciation - P&E ($4 000 /5)

Dr Dr Cr

800 800

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

480

Depreciation expense – machinery Gain (loss) on sale of non-current assets Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve

Dr Dr Cr Dr

125 625

6 000

14 000

3 000 7 000

110 000 1 200 2 800

1 600

240 240

225 175

700

Pre-acquisition entry 30/6/15 Retained earnings Share capital General reserve Business combination valuation reserve Goodwill Shares in Bat Ltd

Dr Dr Dr Dr Dr Cr

45 000 200 000 25 000 31 500 28 500

Dr Dr Dr Dr Dr Cr

52 000 200 000 25 000 24 500 28 500

330 000

Pre-acquisition entry 30/6/17 Retained earnings* (1/7/16) Share capital General reserve Business combination valuation reserve Goodwill Shares in Bat Ltd * $45 000 + $7000 BCVR - Inventory

330 000

20.55

Solutions manual to accompany Company Accounting 10e

Transfer from business combination valuation reserve Business combination valuation reserve Cr

14 000 14 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

700

Shares in Bat Ltd Interim dividend paid

Dr Cr

5 000

Dr Cr

5 000

Dividend payable Final dividend declared

Dr Cr

4 000

Dividend revenue Dividend receivable

Dr Cr

4 000

700

5 000

3. Interim dividend paid Dividend revenue Interim dividend paid

5 000

4. Final dividend declared

4 000

20.56

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.13 (cont’d) 5. Inter-entity sales of inventory: Profit in opening inventory Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

2 800 1 200

Gain (loss) on sale of non-current assets Inventory

Dr Cr

5 000

Deferred tax asset Income tax expense

Dr Cr

1 500

4 000

6. Transfer of plant to inventory: Ghost Ltd – Bat Ltd

5 000

1 500

7. Intragroup sales of inventory: Profit in ending inventory Sales Cost of sales Inventory

Dr Cr Cr

8 000

Deferred tax asset Income tax expense

Dr Cr

300

7 000 1 000

300

8. Intragroup sales of inventory: Profit in ending inventory Sales Cost of sales Inventory

Dr Cr Cr

18 000

Deferred tax asset Income tax expense

Dr Cr

600

Dr Dr Cr

700 300

Dr Cr Cr

150

Dr Dr Cr

30 15

16 000 2 000

600

9. Sale of Furniture Retained earnings (1/7/16) Deferred tax asset Furniture

1 000

10. Depreciation Accumulated depreciation - furniture Depreciation expense Retained earnings (1/7/16) Income tax expense Retained earnings (1/7/16) Deferred tax asset QUESTION 20.13 (cont’d)

100 50

11. Sale of land: Ghost Ltd to Bat Ltd

20.57

Solutions manual to accompany Company Accounting 10e

Land Gain (loss) on sale of non-current assets

Dr Cr

5 000

Income tax expense Deferred tax liability

Dr Cr

1 500

Dr Cr

12 000

Loan from Ghost Ltd Loan to Bat Ltd

Financial Statements Sales revenue

Ghost Bat Ltd Ltd 220 000 182 000

Other income

62 000

Cost of sales

282 000 202 000 162 000 128 000

Other expenses

53 000

Trading profit Gains/losses on sale of noncurrent assets

20 000

41 000

215 000 169 000 67 000 33 000 22 000 25 000

Profit before tax Tax expense

89 000

58 000

20 000

18 000

Profit Retained earnings (1/7/16)

69 000 30 000

40 000 45 000

99 000 12 000

85 000 10 000

6 000

4 000

Transfer from BCV reserve Dividend paid Dividend declared

7 8 3 4

1 1 1

1 1 6

5 000

1 500

12 000

Adjustments Dr Cr 8 000 18 000 5 000 4 000

800 125

20 000 625 5 000

4 000 7 000 16 000 100

5 000

Group 376 000 73 000

5 7 8 10

449 000 263 000

94 825

357 825 81 175 26 375

117 550 5 10 11

1 200 30 1 500

6 000 240 225 1 500 300 600

1 1 1 6 7 8

1 1 2 5 9 10 2

800 175 52 000 2 800 700 15 14 700

240 50

1 10

14 000 700

1 1

5 000 5 000 4 000

2 3 4

31 865

85 685 18 800

0104 485 12 000 6 000

20.58

Chapter 20: Consolidation: intragroup transactions

Retained earnings (30/6/17) Share capital General reserve BCVR Total Equity Deferred tax liabilities Dividend payable Current tax liability Loan from Ghost Ltd Provisions Total Liabilities Total Liabilities + Equity

18 000 81 000

14 000 71 000

18 000 86 485

312 000 200 000 20 000 25 000 -

2 2 2

200 000 25 000 9 800

413 000 296 000 -

480

4 000

6 000

4 000

8 000

2 500

12 000

7 000 2 800

1 1

3 000 1 200 1 500

1 1 11

312 000 20 000 418 485 5 220

6 000 10 500

12 000

78 000 169 500 92 000 188 000

247 500 269 220

505 000 484 000

687 705

20.59

Solutions manual to accompany Company Accounting 10e

QUESTION 20.13 (cont’d)

Ghost Ltd

Bat Ltd

Group

Shares in Bat Ltd Cash Inventory

325 000 7 800 20 000

-35 000 50 000

Receivables Land Plant & equipment Accumulated depreciation – P & E Machinery Accumulated depreciation – Mach. Furniture Accumulated depreciation – Furn. Trademark Goodwill Deferred tax assets

6 000 25 000 113 000 (34 000)

20 000 50 000 300 000 (114 000)

15 000 (1 000)

15 000 (3 000)

7 000 (1 000)

8 000 (2 000)

10 200

100 000 25 000 -

Loan to Bat Ltd

12 000

Total assets

505 000

484 000

11 1

Adjustments Dr Cr 325 000

5 000 1 000 2 000 4 000

6 7 8 4

110 000 1 600

1 1

5 000 114 000

-42 800 62 000

22 000 80 000 303 000 (35 600) 30 000 (4 000)

1 000 10

150

1 2 6 7 8 9

10 000 28 500 1 500 300 600 300

12 000

14 000 (2 850) 110 000 53 500 12 855

687 705

20.60

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.13 (cont’d) GHOST LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2017 Income: Sales revenue Other income

$376 000 73 000 449 000

Expenses: Cost of sales Other Trading profit Gains/(losses) on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other items of comprehensive income Comprehensive income

263 000 94 825 333 800 81 175 26 375 117 550 31 865 $85 685 0 $85 685

GHOST LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2017 Comprehensive income for the period

$85 685

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend paid Dividend declared Balance at 30 June 2017

$18 800 85 685 (12 000) (6 000) $86 485

General reserve: Balance at 1 July 2016 Balance at 30 June 2017

$20 000 $20 000

Share capital: Balance at 1 July 2016 Balance at 30 June 2017

$312 000 $312 000

20.61

Solutions manual to accompany Company Accounting 10e

QUESTION 20.13 (cont’d) GHOST LTD Consolidated Statement of Financial Position as at 30 June 2017 ASSETS Current Assets Cash Inventories Receivables Total Current Assets Non-current Assets Property, plant and equipment Land Plant & Equipment Accumulated depreciation Machinery Accumulated depreciation Furniture Accumulated depreciation Trademark Goodwill Tax assets: Deferred tax asset Total Non-current Assets Total Assets EQUITY AND LIABILITIES Equity Share capital General reserve Retained earnings Total Equity Current Liabilities Dividend payable Current tax liabilities Provisions Total Current Liabilities Non-current Liabilities: Deferred tax liabilities Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

$42 800 62 000 22 000 126 800

$80 000 $303 000 (35 600) $30 000 (4 000) $14 000 (2 850)

267 400 26 000 11 150 110 000

53 500 12 855 560 905 $687 705

$312 000 20 000 86 485 $418 485 6 000 10 500 247 500 264 000 5 220 5 220 $269 220 $687 705

20.62

Chapter 20: Consolidation: intragroup transactions

Question 20.14 Consolidation worksheet, consolidated financial statements On 1 July 2016, King Ltd acquired all the shares of Parrot Ltd on a cum-div. basis. At this date, the equity and liability sections of Parrot Ltd’s statement of financial position showed the following balances: Share capital – 60 000 shares General reserve Retained earnings Other reserves Dividend payable

$ 60 000 30 000 21 000 6 000 5 000

The dividend payable at acquisition date was subsequently paid in September 2016. At acquisition date, all the identifiable assets and liabilities of Parrot Ltd were recorded at amounts equal to fair value except for:

Inventory Equipment (cost $30 000) Machinery (cost $17 000) Land

Carrying amount $50 000 24 000 15 000 18 480

Fair value $56 000 32 000 16 000 24 480

A bonus dividend, on the basis of 6 ordinary shares for every 60 ordinary shares held, was paid in January 2018 out of Other Reserves existing at acquisition date. The inventory on hand in Parrot Ltd at 1 July 2016 was sold during the following 12 months. The machinery which had a further 5-year life on acquisition date was sold on 1 January 2018. The land on hand at acquisition date was sold by 1 March 2017. The equipment was estimated to have a further 8-year life. At 1 July 2016, Parrot Ltd had not recorded any goodwill. Valuation adjustments are made on consolidation and, on realisation of a business combination valuation reserve, a transfer is made to retained earnings on consolidation. Additional information (a) On 1 July 2017, Parrot Ltd has on hand inventory worth $12 000 transferred from King Ltd in June 2017. The inventory had previously cost King Ltd $11 800. Profit in inventory on hand at 30 June 2017 is $200. By 30 June 2018, Parrot Ltd had sold all $12 000 of the inventory to external parties. (b) On 1 January 2018, King Ltd acquired $15 000 worth of inventory for cash from Parrot Ltd. The inventory had previously cost Parrot Ltd $11 000. By 30 June 2018, King Ltd had sold $11 250 of the transferred inventory for $16 000 to external entities. (c) On 1 January 2017, Parrot Ltd sold equipment to King Ltd for $8000. This had originally cost Parrot Ltd $12 000 and had a carrying amount at the time of sale of $7000. Both entities charge depreciation at a rate of 10% p.a. straight-line. (d) King Ltd sold an item of inventory to Parrot Ltd on 1 January 2018 for use as machinery. This item cost King Ltd $4000 and was sold to Parrot Ltd for $6000. Parrot Ltd depreciated the item at 10% p.a. straight-line. (e) On 30 June 2018, half of the goodwill was written off as a result of an impairment test. (f) The tax rate is 30%. (g) All dividends declared by Parrot Ltd have been from post-acquisition profits. Shareholder approval is not required in relation to dividends. On 30 June 2018, the trial balances of King Ltd and Parrot Ltd were as follows:

20.63

Solutions manual to accompany Company Accounting 10e

Debit balances Shares in Parrot Ltd Inventory Other current assets Deferred tax assets Machinery Land Equipment Cost of sales Other expenses Income tax expense Interim dividend paid Final dividend declared Advance to Parrot Ltd

King Ltd $137 200 171 580 8 620 16 200 28 000 — 34 000 65 000 22 000 7 200 4 000 10 000 10 000 $513 800

Parrot Ltd — $70 320 3 100 7 400 22 000 24 480 37 300 53 500 27 000 2 000 2 000 3 000 — $252 100

$170 000 41 000 16 000 120 000 10 000 8 000 34 800 — 85 000 19 000 4 000 4 000 2 000 $513 800

$66 000 30 000 35 500 — 3 000 2 500 10 100 10 000 65 000 21 000 1 000 2 000 6 000 $252 100

Credit balances Share capital General reserve Retained earnings (1/7/17) Debentures Final dividend payable Current tax liabilities Other payables Advance from King Ltd Sales Other revenue Gains/(losses) on sale of non-current assets Accumulated depreciation – machinery Accumulated depreciation – equipment

Required Prepare the consolidated financial statements for King Ltd at 30 June 2018.

At 1 July 2016: Net fair value of identifiable assets and liabilities of Parrot Ltd

Consideration transferred Goodwill

= $60 000 + $30 000 + $21 000 + $6 000 (equity) + $1 000 (1 – 30%) (machinery) + $8 000 (1 – 30%) (equipment) + $6 000 (1 – 30%) (land) + $6 000 (1 – 30%) (inventory) = $131 700 = $137 200 = $5 500

Business combination valuation entries Depreciation expense – machinery Gains/(losses on non-current assets sold

Dr Dr

100 700

20.64

Chapter 20: Consolidation: intragroup transactions

Income tax expense Retained earnings (1/7/17) Transfer from business combination valuation reserve

Cr Dr

240 140

700

Accumulated depreciation – equipment Dr Equipment Dr Deferred tax liability Cr Business combination valuation reserve Cr

6 000 2 000

Depreciation expense Retained earnings (1/7/17) Accumulated depreciation

Dr Dr Cr

1 000 1 000

Deferred tax liability Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

600

Goodwill Dr Business combination valuation reserve Cr

5 500

2 400 5 600

2 000

300 300

5 500

20.65

Solutions manual to accompany Company Accounting 10e

QUESTION 20.14 (cont’d) 2. Pre-acquisition entries At 1 July 2016: Retained earnings (1/7/16) Share capital General reserve Other reserves Business combination valuation reserve Shares in Parrot Ltd

Dr Dr Dr Dr Dr Cr

21 000 60 000 30 000 6 000 20 200 137 200

At 30 June 2018: Retained earnings (1/7/17)* Dr 29 400 Share capital Dr 60 000 General reserve Dr 30 000 Other reserves Dr 6 000 Business combination valuation reserve Dr 11 800 Shares in Parrot Ltd Cr 137 200 * $21 000 + ($6 000 - $1 800) (inventory) + ($6 000 - $1 800) (land) Share capital Other reserves

Dr Cr

Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr Impairment loss - goodwill Accumulated impairment losses

6 000 6 000

700 700

Dr Cr

2 750

Dr Cr

2 000

Dividend payable Final dividend declared

Dr Cr

3 000

Dividend revenue Dividend receivable

Dr Cr

3 000

Dr Dr Cr

140 60

2 750

3. Current dividend paid Dividend revenue Interim dividend paid

2 000

4. Dividend declared

3 000

5. Profit in opening inventory Retained earnings (1/7/17) Income tax expense Cost of sales

200

20.66

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.14 (cont’d) 6. Profit in ending inventory Sales revenue Cost of sales Inventory

Dr Cr Cr

15 000

Deferred tax asset Income tax expense

Dr Cr

300

Dr Dr Cr

700 300

Accumulated depreciation Depreciation expense Retained earnings (1/7/17)

Dr Cr Cr

150

Income tax expense Retained earnings (1/7/17) Deferred tax asset

Dr Dr Cr

30 15

Sales revenue Cost of sales Machinery

Dr Cr Cr

6 000

Deferred tax asset Income tax expense

Dr Cr

600

Accumulated depreciation Depreciation expense (10% x 1/2 x $2 000)

Dr Cr

100

Income tax expense Deferred tax asset

Dr Cr

10 000

14 000 1 000

300

7. Sale of Equipment Retained earnings (1/7/17) Deferred tax asset Equipment

1 000

8. Depreciation

100 50

9. Inventory sale and depreciation of machinery

4 000 2 000

600

100

10. Advances Advance from King Ltd Advance to Parrot Ltd

10 000

20.67

Solutions manual to accompany Company Accounting 10e

QUESTION 20.14 (cont’d) King Ltd Sales revenue 85 000

Parrot Ltd 65 000

Other revenue

19 000

21 000

Cost of sales

104 000 65 000

86 000 53 500

Other expenses

22 000

27 000

87 000 17 000 4 000

80 500 5 500 1 000

21 000 7 200

6 500 2 000

Profit Retained earnings (1/7/17)

13 800 16 000

4 500 35 500

Transfer from BCV reserve

29 800 4 000 10 000 14 000 15 800

40 000 2 000 3 000 5 000 35 000

170 000

66 000

41 000

30 000

226 800

131 000

Trading profit Gains/(losses on sale of non-current assets Profit before tax Tax expense

Dividend paid Dividend declared Retained earnings (30/6/18) Share capital General reserve Other Reserves Business combination valuation reserve Total equity

6 9 3 4

1 1 2

5 8 9

1 1 2 5 7 8 2

Adjustments Dr Cr 15 000 6 000 2 000 3 000

100 1 000 2 750

200 14 000 4 000 100 100

129 000 35 000

5 6 9 8 9

700

60 30 30

140 1 000 29 400 140 700 15 700

60 000 6 000 30 000 6 000 11 800

164 000 100 300

52 650

152 950 11 050 4 300

240 300 300 600

1 1 6 9

300 50

1 8

700

2 000 3 000

2 2 2 2 2

Group

3 4

15 350 7 880

7 470 20 455

-27 925 4 000 10 000 14 000 13 925 170 000

6 000 5 600 5 500 700

1 1 2

41 000 ---

224 925

20.68

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.14 (cont’d) Debentures Deferred tax liability Dividend payable Current tax liability Other payables Advance from King Ltd Total liabilities Total equity and liabilities

Shares in Parrot Land Machinery Accumulated depreciation Equipment Accumulated depreciation Inventory Deferred tax asset

Advance to Parrot Ltd Other assets Goodwill Accumulated impairment loss Total assets

120 000

10 000 8 000 34 800 --

3 000 2 500 10 100 10 000

172 800 399 600

25 600 156 600

King Ltd 137 200 -28 000 (4 000)

600

3 000

10 000

10 000 10 500 44 900 -187 200 412 125

Parrot Ltd -24 480 22 000 (2 000)

2 400

120 000 1 800

Adjustments Dr Cr 137 200

2 000

1 000 2 000

7 1

72 300 (3 850)

1 000 45 30

6 8 9

240 900 24 725

100

1 1 8

2 000 6 000 150

Group -24 480 48 000 (5 900)

34 000 (2 000)

37 300 (6 000)

171 580 16 200

70 320 7 400

10 000

8 620 --

3 100 --

3 000

2 750

8 720 5 500 (2 750)

399 600

156 600

6 7 9

300 300 600

5 500

183 820

184 120

412 125

20.69

Solutions manual to accompany Company Accounting 10e

QUESTION 20.14 (cont’d) KING LTD Consolidated Statement of profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2018 Revenues: Sales revenue Other Expenses: Cost of sales Other Trading profit Gains/(losses on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive Comprehensive income for the period

$129 000 35 000 100 300 52 650

$164 000

152 950 11 050 4 300 15 350 7 880 $7 470 0 $7 470

KING LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2018 Comprehensive income for the period

$7 470

Retained earnings: Balance at 1 July 2017 Profit for the period Dividend paid Dividend declared Balance at 30 June 2018

$20 455 7 470 (4 000) (10 000) $13 925

Share capital: Balance at 1 July 2017 Balance at 30 June 2018

$170 000 $170 000

General reserve: Balance at 1 July 2017 Balance at 30 June 2018

$41 000 $41 000

20.70

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.14 (cont’d) KING LTD Consolidated Statement of Financial Position as at 30 June 2018 ASSETS Current Assets Inventories Non-current Assets Property, plant and equipment Land Equipment Accumulated depreciation Machinery Accumulated depreciation Other assets Goodwill Accumulated Impairment Loss Tax assets: Deferred tax asset Total Non-current Assets Total Assets

$240 900

$24 480 $72 300 (3 850) 48 000 (5 900)

EQUITY AND LIABILITIES Equity Share capital General reserve Retained earnings Total Equity Current Liabilities Dividendpayable Current tax liabilities Other payables Total Current Liabilities Non-current Liabilities: Deferred tax liabilities Interest-bearing liabilities: Debentures Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

68 450 42 100

135 030 8 720 5 500 (2 750) 24 725 171 225 $412 125

$170 000 41 000 13 925 $224 925 10 000 10 500 44 900 65 400 1 800 120 000 121 800 $187 200 $412 125

20.71

Solutions manual to accompany Company Accounting 10e

Question 20.15

Consolidation worksheet, consolidated financial statements

On 1 July 2015, Wolf Ltd acquired all the shares of Spider Ltd on an ex-div. basis. Acquisition related expenses were $5000. On this date, the equity and liabilities of Spider Ltd included the following balances: Share capital General reserve Retained earnings Dividend payable Provisions

200 000 25 000 45 000 10 000 206 500

At acquisition date, all the identifiable assets and liabilities of Spider Ltd were recorded at amounts equal to fair value except for:

Plant (cost $300 000) Trademark Inventory Equipment (cost $80 000) Land Machinery (cost $18 000) Fittings (cost $15 000) Goodwill

Carrying amount $186 000 100 000 70 000 50 000 50 000 15 000 10 000 25 000

Fair value $190 000 110 000 80 000 53 000 70 000 16 000 10 000

Goodwill was written down by $5000 at 30 June 2016 by Wolf Ltd as a result of an annual impairment test. The plant had a further 5-year life at acquisition date and was expected to be used on a straight-line basis over that time. The trademark was considered to have an indefinite life. The machinery, which was estimated to have a further 4-year life at acquisition date, was sold on 1 January 2017. At 1 July 2015, Spider Ltd had not recorded a liability relating to a guarantee that was considered to have a fair value of $10 000. An amount of $6000 was paid by Spider Ltd in June 2017 in part payment of this liability. The balance of this liability was still considered to be $4000 at 30 June 2017. Immediately after acquisition of its shares by Wolf Ltd, Spider Ltd revalued the equipment to fair value. The equipment was expected to have a further 5-year useful life. Spider Ltd registered a patent on 28 June 2015 but has not yet recognised it as an asset. Wolf Ltd believes the fair value of the patent was $30 000. The patent is legally enforceable for a period of 10 years. On 30 June 2016, Spider Ltd determined that the patent was impaired by $9000. On 1 January 2017, Spider Ltd sold the patent for $17 000. During the year ended 30 June 2016, all inventory on hand at acquisition date was sold, and the land was sold on 1 June 2017. Any adjustments for differences between carrying amounts at acquisition date and fair values are made on consolidation. Any valuation reserves created are transferred on consolidation to retained earnings when assets are sold or fully consumed. Additional information (a) The interim dividend of $5000 was paid by Spider Ltd in the current year. Shareholder approval is not required in relation to payment of dividends. (b) On 1 July 2016, Spider Ltd has on hand inventory worth $12 000, being transferred from Wolf Ltd in June 2008. The inventory had previously cost Wolf Ltd $8000. All the inventory is sold to external parties in the year ending 30 June 2017.

20.72

Chapter 20: Consolidation: intragroup transactions

(c)

On 31 March 2017, Spider Ltd transferred an item of plant with a carrying amount of $10 000 to Wolf Ltd for $15 000. Wolf Ltd treated this item as inventory. The item was still on hand at the end of the year. Spider Ltd applied a 20% depreciation rate to this plant. (d) During the 2017 year, Wolf Ltd sold inventory to Spider Ltd for $9000, this being at cost plus 20% mark-up. Of this inventory, $1800 remained on hand at 30 June 2017. (e) During the 2017 year, Spider Ltd sold inventory costing $12 000 to Wolf Ltd for $18 000. One-third of this was sold to external parties for $9000. (f) On 1 January 2016, Wolf Ltd sold furniture to Spider Ltd for $8000. This had originally cost Wolf Ltd $12 000 and had a carrying amount at the time of sale of $7000. Both entities charge depreciation at a rate of 10% p.a. (g) Wolf Ltd purchased a new block of land for $25 000 in August 2016. This block of land was sold to Spider Ltd in December 2016 for $50 000. To help Spider Ltd pay for the land, Wolf Ltd gave Spider Ltd an interest-free loan of $12 000. Spider Ltd has not as yet made any repayments on the loan. (h) On 1 January 2017, Spider Ltd sold an item of inventory to Wolf Ltd who regarded the item as plant and equipment. The inventory cost Spider Ltd $9000 to manufacture and was sold for $12 000. Wolf Ltd assesses the plant and equipment’s useful life to be 5 years. (i) On 1 January 2016, Spider Ltd sold a motor vehicle to Wolf Ltd. On this date, the motor vehicle had a carrying amount of $240 000 and was sold to Wolf Ltd for $260 000. The motor vehicle is depreciated at 20% p.a. on a straight-line basis by Wolf Ltd. (j) The tax rate is 30%. On 30 June 2017, the trial balances of Wolf Ltd and Spider Ltd were as follows: Debit balances Shares in Spider Ltd Cash Receivables Inventory Deferred tax assets Motor vehicle Fittings Machinery Plant Equipment Land Furniture Trademark Goodwill Cost of sales Other expenses Income tax expense Interim dividend paid Final dividend declared Loan to Spider Ltd

Wolf Ltd $330 000 2 800 6 000 20 000 10 200 10 000 — 15 000 203 000 53 000 25 000 7 000 — — 162 000 53 000 20 000 12 000 6 000 12 000 $947 000

Spider Ltd — $40 000 5 000 50 000 20 000 20 000 15 000 15 000 324 000 53 000 50 000 8 000 80 000 25 000 128 000 31 000 18 000 5 000 4 000 — $891 000

Credit balances

20.73

Solutions manual to accompany Company Accounting 10e

Share capital General reserve Asset revaluation surplus Retained earnings (1/7/16) Final dividend payable Current tax liabilities Provisions Deferred tax liabilities Loan from Wolf Ltd Sales Other income Gains/(losses) on sale of non-current assets Accumulated depreciation – plant Accumulated depreciation – Machinery Accumulated depreciation – furniture Accumulated depreciation – fittings Accumulated depreciation – equipment Accumulated depreciation – vehicles

$312 000 20 000 — 30 000 6 000 8 000 50 000 20 000 — 220 000 84 000 50 000 114 000 1 000 1 000 — 30 000 1 000 $947 000

$200 000 25 000 5 000 45 000 4 000 2 500 110 500 11 000 12 000 182 000 30 000 80 000 138 000 3 000 2 000 5 000 30 000 6 000 $891 000

Required Prepare the consolidated financial statements for Wolf Ltd at 30 June 2017.

At 1 July 2015: Net fair value of identifiable assets and liabilities of Spider Ltd =

Net fair value acquired Consideration transferred Goodwill acquired Unrecorded goodwill acquired

= = = = =

($200 000 + $25 000 + $45 000) (equity) + $10 000 (1 – 30%) (inventory) + $20 000 (1 –30%) (land) + $4 000 (1 – 30%) (plant) + $1 000 (1 – 30%) (machinery) + $10 000 (1 – 30%) (trademark) + $30 000 (1 – 30%) (patent) + $3 000 (1 – 30%) (equipment) - $10 000 (1 – 30%) (loan guarantee) - $25 000 (goodwill) $292 600 $330 000 $37 400 $37 400 – $25 000 $12 400

Business combination valuation entries at 30 June 2017 Gain/(loss) on sale of non-current assets Income tax expense Transfer from business combination valuation reserve (Sale of land)

Dr Cr

Trademark

20 000 6 000

14 000

10 000

20.74

Chapter 20: Consolidation: intragroup transactions

Deferred tax liability Cr Business combination valuation reserve Cr Accumulated depreciation - plant Dr Plant and equipment Cr Deferred tax liability Cr Business combination valuation reserve Cr

3 000 7 000 114 000 110 000 1 200 2 800

Depreciation expense - plant Retained earnings (1/7/16) Accumulated depreciation - plant ($4 000 /5)

Dr Dr Cr

800 800

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

480

1 600

240 240

20.75

Solutions manual to accompany Company Accounting 10e

QUESTION 20.15 (cont’d) Depreciation expense – machinery Gain/(loss) on sale of non-current assets Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve (Sale of machinery)

Dr Dr Cr Dr

Business combination valuation reserve Deferred tax asset Loan guarantee

Dr Dr Cr

2 800 1 200

Dr Dr Cr

4 200 1 800

Dr Dr Cr Dr

1 000 17 000

Transfer from business combination valuation reserve Income tax expense Guarantee expense (Payment of guarantee) Amortisation expense Gain/(loss) on sale of non-current assets Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve (Sale of patent) Accumulated depreciation - fittings Fittings

125 625 225 175

700

4 000

6 000

5 400 8 400

21 000

Dr Cr

5 000

Goodwill Dr Business combination valuation reserve Cr

12 400

Retained earnings (1/7/16) Accumulated impairment losses

5 000

Dr Cr

5 000

12 400

5 000

20.76

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.15 (cont’d) 2.

Pre-acquisition entry 01/07/15 Retained earnings Share capital General reserve Asset revaluation surplus Business combination valuation reserve Shares in Spider Ltd

Dr Dr Dr Dr Dr Cr

45 000 200 000 25 000 2 100 57 900

Dr Dr Dr Dr Dr Cr

52 000 200 000 25 000 50 900 2 100

330 000

Pre-acquisition entry 30/6/17 Retained earnings* (1/7/17) Share capital General reserve Business combination valuation reserve** Asset revaluation surplus Shares in Spider Ltd * 45 000 + 10 000 (1 – 0.3) inventory ** 57 900 – 7000 BCVR - inventory

Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr (Sale of land) Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr (Sale of machinery) Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr (Sale of patent) Business combination valuation reserve Transfer from business combination valuation reserve (Payment of guarantee)

Dr Cr

330 000

14 000 14 000

700 700

21 000 21 000

4 200 4 200

20.77

Solutions manual to accompany Company Accounting 10e

QUESTION 20.15 (cont’d) 3. Interim dividend paid Dividend revenue Interim dividend paid

Dr Cr

5 000

Dividend payable Final dividend declared

Dr Cr

4 000

Dividend revenue Dividend receivable

Dr Cr

4 000

5 000

4. Final dividend declared

4 000

5. Inter-entity sales of inventory: Profit in opening inventory Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

2 800 1 200 4 000

6. Transfer of plant to inventory: Wolf Ltd – Spider Ltd Gain/(loss) on sale of non-current assets Inventory

Dr Cr

5 000

Deferred tax asset Income tax expense

Dr Cr

1 500

5 000

1 500

7. Intragroup sales of inventory: Profit in ending inventory Sales Cost of sales Inventory

Dr Cr Cr

9 000

Deferred tax asset Income tax expense

Dr Cr

8 700 300

8. Intragroup sales of inventory: Profit in ending inventory Sales Cost of sales Inventory

Dr Cr Cr

18 000

Deferred Tax Asset Income Tax Expense

Dr Cr

1 200

14 000 4 000

1 200

20.78

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.15 (cont’d) 9. Sale of Furniture Retained earnings (1/7/17) Deferred tax asset Furniture

Dr Dr Cr

700 300

Accumulated depreciation - furniture Depreciation expense Retained earnings (1/7/16)

Dr Cr Cr

150

Income tax expense Retained earnings (1/7/16) Deferred tax asset

Dr Dr Cr

30 15

Gain/(loss) on sale of non-current assets Land

Dr Cr

25 000

Deferred tax asset Income tax expense

Dr Cr

7 500

Loan from Wolf Ltd Loan to Spider Ltd

Dr Cr

12 000

1 000

10. Depreciation

100 50

11. Sale of Land

25 000

7 500

12 000

12. Transfer of inventory to plant: Wolf Ltd – Spider Ltd Sales Cost of sales Inventory

Dr Cr Cr

12 000

Deferred tax asset Income tax expense

Dr Cr

900

Accumulated depreciation – P & E Depreciation expense

Dr Cr

300

Income Tax expense Deferred tax asset

Dr Cr

9 000 3 000

900

300

20.79

Solutions manual to accompany Company Accounting 10e

QUESTION 20.15 (cont’d) 13. Transfer of MV in prior period Retained earnings (1/7/16) Deferred tax asset Motor vehicle

Dr Dr Cr

14 000 6 000

Accumulated depreciation-MV Retained earnings (1/7/16) Depreciation expense

Dr Cr Cr

6 000

Income tax expense Retained earnings (1/716) Deferred tax asset

Dr Dr Cr

1 200 600

20 000

2 000 4 000

1 800

20.80

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.15 (cont’d) Financial Wolf Spider Statements Ltd Ltd Sales revenue 220 000 182 000

Other income

84 000

Cost of sales

304 000 162 000

7 8 12 30 000 3 4 212 000 128 000

53 000

31 000

215 000 89 000 50 000

159 000 53 000 80 000

Profit before tax Tax expense

139 000

123 000

20 000

18 000

Profit Retained earnings (1/7/16)

119 000 30 000

115 000 45 000

Other expenses

Trading profit Gains/(losses)

1 1 1

1 1 1 6 11

Adjustments Dr Cr 9 000 18 000 12 000 5 000 4 000

800 125 1 000

4 000 8 700 14 000 9 000 6 000 100 300 4 000

Group 363 000

105 000

5 7 8 12 1 10 12 13

468 000 254 300

75 525

329 825 138 175 62 375

20 000 625 17 000 5 000 25 000

200 550 1 5 10 12 13

1 1 1 1 2 5 9 10 13 13

1 800 1 200 30 90 1 200

800 175 8 400 5 000 52 000 2 800 700 15 14 000 600

6 000 225 240 5 400 1 500 90 1 200 7 500 900 240 50 2 000

1 1 1 1 6 7 8 11 12 1 10 13

19 265

181 285 (7 200)

20.81

Solutions manual to accompany Company Accounting 10e

Transfer from BCV reserve

Dividend paid Dividend declared Retained earnings (30/6/17) Share capital General Reserve BCVR

Asset reval’n surplus Total Equity Deferred tax liabilities Dividend payable Current tax liability Loan from Wolf Ltd Provisions Loan guarantee Total Liabilities Total Liabilities + Equity

149 000 12 000 6 000

160 000 5 000 4 000

18 000 131 000

9 000 151 000

312 000 20 000

200 000 25 000

2 2

200 000 25 000

1 2 2

2 800 50 900 4 200

5 000

2 100

2 900

463 000 20 000

381 000 11 000

480

490 985 34 720

6 000

4 000

8 000

2 500

1 2 2 2

4 200 14 000 700 21 000

14 000 700 21 000 4 200

1 1 1 2

5 000 4 000

3 4

174 085 12 000 6 000 18 000 156 085

12 000 11

312 000 20 000 7 000 2 800 12 400 14 000 700 21 000

3 000 1 200

1 1 1 2 2 2

1 1

6 000 10 500

12 000

50 000 0

110 500 0

84 000

140 000

215 720

547 000

521 000

706 705

4 000

160 500 4 000

20.82

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.15 (cont’d) Wolf Ltd

Spider Ltd

Group

Shares in Spider Ltd Cash Inventory

330 000 2 800 20 000

0 40 000 50 000

Receivables Land Vehicle Accumulated depreciation – Veh. Equipment Accumulated depreciation –Equip. Plant

6 000 25 000 10 000 (1 000)

5 000 50 000 20 000 (6 000)

53 000 (30 000)

203 000

324 000

Accumulated depreciation – Plant Machinery Accumulated depreciation – Mach. Furniture Accumulated depreciation – Furn. Fittings Accumulated depreciation – Fit. Trademark Goodwill Accumulated impairment losses Deferred tax assets

(114 000)

(138 000)

15 000 (1 000)

15 000 (3 000)

7 000 (1 000)

8 000 (2 000)

0 0

15 000 (5 000)

Adjustments Dr Cr 330 000

5 000 300 4 000 4 000 25 000 20 000

6 7 8 4 11 13

6 000

0 42 800 60 700

7 000 50 000 10 000 (1000) 106 000 (60 000)

1 12

114 000 300

110 000 3 000 1 600

1 12 1

414 000 (139 300) 30 000 (4 000)

1 000

14 000 (2 850)

5 000

10 000 0

150

5 000

0 0

80 000 25 000 -

1 1

10 000 12 400

10 200

20 000

1 6 7 8 9 11 12 13

Loan to Spider Ltd

12 000

Total assets

547 000

521 000

1 200 1 500 90 1 200 300 7 500 900 6 000

714 280

90 000 37 400 (5 000)

5 000

45 90 1 800

10 12 13

46 955

12 000

714 280

706 705

20.83

Solutions manual to accompany Company Accounting 10e

QUESTION 20.15 (cont’d) WOLF LTD Consolidated Statement of profit or Loss and Other Comprehensive Income for financial year ended 30 June 2017 Income: Sales revenue Other income Expenses: Cost of sales Other Trading profit Gains/(losses) on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income Comprehensive income for the period

$363 000 105 000 468 000 254 300 75 525 329 825 62 375 200 550 19 265 $181 285 $0 $181 285

WOLF LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2017 Total comprehensive income for the period

$181 285

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend paid Dividend declared Balance at 30 June 2017

$(7 200) 181 285 (12 000) (6 000) $156 085

General reserve: Balance at 1 July 2016 Balance at 30 June 2017

$20 000 $20 000

Share capital: Balance at 1 July 2016 Balance at 30 June 2017

$312 000 $312 000

Asset revaluation surplus: Balance at 1 July 2016 Balance at 30 June 2017

$2 900 $2 900

20.84

Chapter 20: Consolidation: intragroup transactions

QUESTION 20.15 (cont’d) WOLF LTD Consolidated Statement of Financial Position as at 30 June 2017 ASSETS Current Assets Cash Inventories Receivables Total Current Assets Non-current Assets Property, plant and equipment Land Plant Accumulated depreciation Machinery Accumulated depreciation Furniture Accumulated depreciation Fittings Accumulated depreciation Vehicles Accumulated depreciation Equipment Accumulated depreciation Trademark Goodwill Accumulated impair. Tax assets: Deferred tax asset Total Non-current Assets Total Assets EQUITY AND LIABILITIES Equity Share capital General reserve Asset revaluation surplus Retained earnings Total Equity Current Liabilities Dividend payable Current tax liabilities Provisions Total Current Liabilities Non-current Liabilities: Deferred tax liabilities Loan Guarantee Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

$42 800 60 700 7 000 110 500

$50 000 $414 000 (139 300) $30 000 (4 000) $14 000 (2 850) $10 000 (0) 10 000 (1 000) 106 000 (60 000) $37 400 (5 000)

274 700 26 000 11 150 10 000 9 000 46 000 90 000 32 400 46 255 596 205 $706 705

$312 000 20 000 2 900 156 085 $490 985 6 000 10 500 160 500 177 000 34 720 4 000 38 720 $215 720 $706 705

20.85

Chapter 21: Consolidation: non-controlling interest

Chapter 21 – Consolidation: non-controlling interest REVIEW QUESTIONS 1.

What is meant by the term “non-controlling interest” (NCI)? NCI is the term used for the ownership interest in a subsidiary other than the parent. It is defined in AASB 127 as: The equity in a subsidiary not attributable, directly or indirectly, to a parent.

Explain whether the NCI is better classified as debt or equity. The main argument for the NCI being classified as equity is that it better fits the definition of equity. The subsidiary has no present obligation in relation the NCI so the NCI does not meet the definition of a liability. Some writers argue that NCI should be disclosed separately from equity an liabilities – the “mezzanine” treatment. This argument relates to the utility of financial statements in relation to the user group, the parent shareholders. It is argued that this form of presentation provides more relevant information to the parent shareholders.

Explain whether the NCI is entitled to a share of subsidiary equity or some other amount. If the NCI is classified as equity, it is entitled to a share of consolidated equity. Note that consolidated equity is basically subsidiary equity adjusted for the effects of intragroup transactions – that is, realised subsidiary equity. If it were classified as a liability of the subsidiary then the calculation of the NCI would be based on the obligation held by the subsidiary.

How does the existence of an NCI affect the business combination valuation entries? There is no effect. However if the full goodwill method is used, the recognition of the subsidiary’s goodwill is made via a BCVR entry. In contrast, where the partial goodwill method is used, goodwill is recognised in the pre-acquisition entry. Why? The BCVR entries, apart from that for goodwill, are prepared because of the requirement of AASB 3 to show the identifiable assets and liabilities of the acquiree at fair value. The determination of fair value is not affected by the parent’s ownership in the subsidiary.

21.1

Solutions manual to accompany Company Accounting 10e

How does the existence of an NCI affect the pre-acquisition entries? The pre-acquisition entry eliminates the investment account recorded by the parent and the preacquisition equity of the subsidiary, as well as recognising any gain on bargain purchase. The consideration transferred reflects the amount paid by the parent for its share of the equity of the subsidiary. The first effect then on the pre-acquisition entry is that the equity eliminated is only the parent’s share. The second effect is that the gain on bargain purchase recognised is only that relating to the parent’s share of the equity of the subsidiary.

Why is it necessary to change the format of the worksheet where a NCI exists in the group? The AASB require the disclosure of the equity of the group, as well as the relative proportions of the parent and the subsidiary. For a wholly owned subsidiary situation, the final column in the worksheet represents the group position which is also the parent’s position, as there is no NCI. Where an NCI exists, having determined the group position, the equity must be divided into parent share and the NCI share. Hence, the worksheet must have additional columns to divide the group equity into the relative shares of the parent and the NCI. This is done by calculating the NCI share and subtracting it from the group equity so that the final column is then the parent entity’s share.

Explain how the adjustment for intragroup transactions affects the calculation of the NCI share of equity. The NCI does not affect the adjustment itself, as the full effects of the intragroup transaction are adjusted for on consolidation. However, where the subsidiary records profit which is unrealised to the group, this affects the calculation of the NCI. The NCI is entitled only to a share of consolidated equity rather than subsidiary equity. Hence, where the subsidiary has recorded unrealised profit, the NCI share of the recorded profit of the group must be adjusted for any of that profit which is unrealised. In the Step 2 & Step 3 calculations of the NCI share of equity, this is a share of recorded equity. As adjustments are made for intragroup transactions, where these transactions reflect adjustments for unrealised subsidiary profit, an adjustment is also made to the NCI share of profit. The net result is then that the NCI gets a share of realised subsidiary equity.

Explain whether an NCI adjustment needs to be made for all intragroup transactions. An NCI adjustment does NOT need to be made for all intragroup transactions. An NCI adjustment only needs to be made where the adjustment is for unrealised profit recorded by the subsidiary. Hence the transaction must be an upstream – subsidiary to parent – transaction in order for an NCI adjustment to be made. Further the upstream transaction must relate to unrealised subsidiary profit.

What is meant by ‘realisation of profit’? Profit is realised when the group transacts with an entity external to the group. The point of realisation depends then on identifying when the external entity is involved. With inventory (and other sale) transactions the point of realisation is easily identified as it is the point of sale when the external entity is involved. It is at this point that the group recognises

21.2

Chapter 21: Consolidation: non-controlling interest

profit on sale, being the excess of the sale proceeds over the cost to the group of the item being sold. With assets not sold but used by the group – see 10. below. With intragroup services, see the answer to 11. below.

10.

When is profit realised on an intragroup transaction involving a depreciable asset? See the answer to 9. above. With assets used by the group such as depreciable assets, the group does not interact with an external entity. It is then impossible to determine a point of realisation based on direct involvement of the group with an external entity. The point of realisation is then based on indirect involvement. The depreciable asset is used by the group to assist in its interaction with external entities eg by making inventories for sale to external entities. The depreciation charge measures the extent of that involvement in any one year as the depreciation charge is based on para 60 of AASB 116 which notes that the depreciation charge reflects the pattern of benefits consumed by the entity. Realisation of profit then occurs as the asset is used up or consumed by the entity. Realisation is then in proportion to the depreciation charge made on the asset.

11.

When is profit realised on an intragroup transaction involving the parent renting a warehouse from the subsidiary? With such a transaction, the subsidiary records revenue, which increases subsidiary profit. This profit is not recognised by the group. However, no adjustment is made to the NCI share of equity as a result of this transaction. This is because of the difficulty of determining a point of realisation as no external entity is ever involved in this transaction.

12.

If a step approach is used in the calculation of the NCI share of equity, what are the steps involved? There are 3 steps: 1. Share of equity at acquisition date. 2. Share of change in equity between the acquisition date and the beginning of the current period. 3. Share of change in equity in the current period.

13.

What are two events that could occur between the acquisition date and the beginning of the current period that could affect the calculation of the NCI share of retained earnings? • •

14.

Changes in the assets & liabilities recognised via the BCVR entries eg sale of the inventory on hand in the subsidiary at the acquisition date. Movements in equity eg transfers to/from general reserve, prior period dividends

For what line items in the financial statements is it necessary to provide a break-down into parent entity share and NCI share?

21.3

Solutions manual to accompany Company Accounting 10e

Statement of Profit or Loss and Other Comprehensive Income: AASB 101 para 83: Disclose both NCI and parent share of profit/loss for the period AND share of total comprehensive income for the period Statement of Financial Position: AASB 101 para 54 (q) and (r): NCI share of equity, and share capital and reserves attributable to parent Statement of Changes in Equity: AASB 101 para 106 (a): total comprehensive income for the period, showing that attributable to the parent and that attributable to the NCI.

21.4

Chapter 21: Consolidation: non-controlling interest

CASE STUDY QUESTIONS Case Study 1

Equity classification

Len Inn is the accountant for Wallaby Trucks Ltd. This entity has an 80% holding in the entity Tyres-R-Us Ltd. Len is concerned that the consolidated financial statements prepared under AASB 10 may be misleading. He believes that the main users of the consolidated financial statements are the shareholders of Wallaby Trucks Ltd. The key performance indicators are then the profit numbers relating to the interests of those shareholders. He therefore wants to prepare the consolidated financial statements showing the non-controlling interest in Tyres-RUs Ltd in a category other than equity in the statement of financial performance, and for the statement of changes in equity to show the profit numbers relating to the parent shareholders only. Required Discuss the differences that would arise in the consolidated financial statements if the noncontrolling interests were classified as debt rather than equity, and the reasons the standard setters have chosen the equity classification in AASB 10.

Prime users: There is nothing in either AASB 101 or AASB 127 that indicates who the prime users of the consolidated financial statements are. In the income statement there is no preference given to the parent over the NCI, although in the balance sheet, the NCI is limited to a one-line disclosure. The Framework also gives no preference to either the parent or the NCI.

NCI as equity or liability: The main argument for the NCI being classified as equity is that it better fits the definition of equity. The subsidiary has no present obligation in relation to the NCI so the NCI does not meet the definition of a liability. Some people argue that the NCI should be disclosed separately from equity and liabilities – the “mezzanine” treatment. This argument relates to the utility of financial statements in relation to the user group, the parent shareholders. It is argued that this form of presentation provides more relevant information to the parent shareholders.

Disclosure requirements: Statement of Profit or Loss and Other Comprehensive Income: AASB 101 para 83: Disclose both NCI and parent share of profit/loss for the period AND share of total comprehensive income for the period Statement of Financial Position: AASB 101 para 54 (q) and (r): NCI share of equity, and share capital and reserves attributable to parent Statement of Changes in Equity: AASB 101 para 106 (a): total comprehensive income for the period, showing that attributable to the parent and that attributable to the NCI.

21.5

Solutions manual to accompany Company Accounting 10e

If the NCI were classified as debt, any dividends would be disclosed as an expense, while the NCI would not receive a share of profit. In the statement of financial position the NCI would be shown under liabilities, while in the statement of changes in equity there would be no NCI information.

21.6

Chapter 21: Consolidation: non-controlling interest

Case Study 2

Adjustment for the NCI share of equity

The consolidated financial statements of Whale Submarine Works Ltd are being prepared by the group accountant, Raz Putin. He is currently in dispute with the auditors over the need to adjust for the NCI share of equity in relation to intragroup transactions. He understands the need to adjust for the effects of the intragroup transactions, but believes that it is unnecessary to adjust for the NCI share of equity. He argues that the NCI group of shareholders has its interest in the subsidiary and as a result is entitled to a share of what the subsidiary records as equity. He also disputes with the auditors about the notion of ‘realisation’ of profit in relation to the NCI. If realisation requires the involvement of an external entity in a transaction, then in relation to transactions such as intragroup transfers of vehicles and services such as interest payments, there is never any external party involved. Those transactions are totally within the group and never involve external entities. As a result, the more appropriate accounting is to give the NCI a share of subsidiary equity and not be concerned with the fictitious involvement of external entities. Required Write a report to Raz convincing him that his argument is fallacious. 1. The need to adjust for the NCI share of equity in relation to intragroup transactions: If the NCI is classified as equity, it is entitled to consolidated equity. Note that consolidated equity is basically subsidiary equity adjusted for the effects of intragroup transactions – that is, realised subsidiary equity. If it were classified as a liability of the subsidiary then the calculation of the NCI would be based on the obligation held by the subsidiary. 2. Vehicles & services: Profit is realised when the group transacts with an entity external to the group. The point of realisation depends then on identifying when the external entity is involved. With inventory (and other sales) transactions the point of realisation is easily identified as it is the point of sale when the external entity is involved. It is at this point that the group recognises profit on sale, being the excess of the sale proceeds over the cost to the group of the item being sold. With assets used by the group such as depreciable assets, the group does not interact with an external entity. It is then impossible to determine a point of realisation based on direct involvement of the group with an external entity. The point of realisation is then based on indirect involvement. The depreciable asset is used by the group to assist in its interaction with external entities eg by making inventories for sale to external entities. The depreciation charge measures the extent of that involvement in any one year as the depreciation charge is based on para 60 of AASB 116 which notes that the depreciation charge reflects the pattern of benefits consumed by the entity. Realisation of profit then occurs as the asset is used up or consumed by the entity. Realisation is then achieved in proportion to the depreciation charge made on the asset. With transactions such as services, the subsidiary records revenue, which increases subsidiary profit. This profit is not recognised by the group. However, no adjustment is made to the NCI share of equity as a result of this transaction. This is because of the difficulty of determining a point of realisation as no external entity is ever involved in this transaction.

21.7

Solutions manual to accompany Company Accounting 10e

Case Study 3

The step approach

In December 2016, Frog Ltd acquired 60% of the shares of Kovrov Ltd. The accountant for Frog Ltd, Nikki Romanov, is concerned about the approach she should take in preparing the consolidated financial statements for the newly established group. In particular, she is concerned about the calculation of the NCI share of equity, particularly in the years after acquisition date. She has heard accountants in other companies talking about a ‘step’ approach, and in particular how this makes accounting in periods after the acquisition date very easy as it is then necessary to prepare only one step. Required Prepare a report for Nikki, explaining the step approach to the calculation of NCI and the effects of this approach in the years after acquisition date.

The 3 steps are: 1. Share of equity at acquisition date. 2. Share of the change in equity between the acquisition date and the beginning of the current period. 3. Share of change in equity in the current period. In preparing the consolidated financial statements at, say, 30 June 2018, the consolidation worksheet prepared at 30 June 2017 will contain Steps 1 and 2 for the 2018 worksheet: - Step 1 journal entry never changes - Step 2 for 2008 is the combination of Steps 2 and 3 for 2017. Hence in 2018, the only new calculations relate to Step 3, namely the share of changes in equity for the 2017-18 period.

21.8

Chapter 21: Consolidation: non-controlling interest

Case Study 4

Effects of intragroup transactions

Because the Moth Cement Works Ltd has a number of subsidiaries, Star Lin is required to prepare a set of consolidated financial statements for the group. She is concerned about the calculation of the NCI share of equity particularly where there are intragroup transactions. The auditors require that when adjustments are made for intragroup transactions the effects of these transactions on the NCI should also be adjusted for. Star has two concerns. First, why is it necessary to adjust the NCI share of equity for the effects of intragroup transactions? Second, is it necessary to make NCI adjustments in relation to all intragroup transactions? Required Prepare a report for Star, explaining these two areas of concern.

Why is it necessary? Under Australian accounting standards, the NCI is classified as equity, mainly because the NCI does not fit the definition of a liability. If the NCI is classified as equity, it is entitled to a share of consolidated equity. Consolidated equity is determined after adjusting for the effects of intragroup transactions. Consolidated equity for the NCI is then subsidiary equity adjusted for the effects of those intragroup transactions affecting subsidiary equity– that is, realised subsidiary equity. Is it necessary to make NCI adjustments in relation to all intragroup transactions? The NCI does not affect the adjustment itself, as the full effects of the intragroup transaction are adjusted for on consolidation. However, where the subsidiary records profit which is unrealised to the group, this affects the calculation of the NCI. The NCI is entitled only to a share of consolidated equity rather than subsidiary equity. Hence, where the subsidiary has recorded unrealised profit, the NCI share of the recorded profit of the group must be adjusted for any of that profit which is unrealised. In the Step 2 & Step 3 calculations of the NCI share of equity, this is a share of recorded equity. As adjustments are made for intragroup transactions, where these transactions reflect adjustments for unrealised subsidiary profit, an adjustment is also made to the NCI share of profit. The net result is then that the NCI gets a share of realised subsidiary equity. However, an NCI adjustment does NOT need to be made for all intragroup transactions. An NCI adjustment only needs to be made where the adjustment is for unrealised profit recorded by the subsidiary. Hence the transaction must be an upstream – subsidiary to parent – transaction in order for an NCI adjustment to be made. Further the upstream transaction must relate to unrealised subsidiary profit.

21.9

Solutions manual to accompany Company Accounting 10e

PRACTICE QUESTIONS Question 21.1

Full and partial goodwill methods

On 1 July 2016, Rainbow Ltd acquired 80% of the issued shares of Lorikeet Ltd for $165 000. At this date, the equity of Lorikeet Ltd was: Share capital General reserve Retained earnings

$ 100 000 40 000 50 000

At acquisition date all the identifiable assets and liabilities of Lorikeet Ltd were recorded at amounts equal to fair value. At 30 June 2018, the equity of Lorikeet Ltd consisted of: Share capital General reserve Retained earnings

$ 100 000 50 000 80 000

During the 2017–18 year Lorikeet Ltd recorded a profit of $15 000. Required Prepare the consolidated worksheet entries at 30 June 2018 for Rainbow Ltd assuming: A. At 1 July 2016, the fair value of the non-controlling interest was $40 000 and Rainbow Ltd adopts the full goodwill method. B. Rainbow Ltd adopts the partial goodwill method.

A. Full Goodwill Method At 1 July 2016: Fair value of identifiable assets and liabilities of Lorikeet Ltd (a) Consideration transferred (b) NCI in Lorikeet Ltd Aggregate of (a) and (b) Goodwill Goodwill of Lorikeet Ltd Fair value of Lorikeet Ltd Fair value of INA of Lorikeet Ltd Goodwill of Lorikeet Ltd Goodwill of Rainbow Ltd Goodwill acquired Goodwill of Lorikeet Ltd Control premium – parent

= = = = = = =

$100 000 + $40 000 + $50 000 $190 000 $165 000 $40 000 $205 000 $205 000 - $190 000 $15 000

= = = =

$40 000/0.2 $200 000 $190 000 $10 000

= = =

$15 000 $10 000 $5 000

Consolidation worksheet entries at 30 June 2018: 1. Business combination valuation entries

21.10

Chapter 21: Consolidation: non-controlling interest

Goodwill Business combination valuation reserve (Goodwill of subsidiary)

Dr Cr

10 000

Dr Dr Dr Dr Dr Cr

40 000 80 000 32 000 8 000 5 000

Dr Dr Dr Dr Cr

10 000 20 000 8 000 2 000

Dr Dr Cr

6 000 2 000

Dr Cr

3 000

10 000

2. Pre-acquisition entries Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve Goodwill Shares in Lorikeet Ltd

165 000

3. NCI share of equity 1/7/16 Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve NCI (20% of equity at 1/7/16)

40 000

4. NCI share of equity from 1/7/16 – 30/6/17 Retained earnings (1/7/17)* General reserve** NCI * 20% of change in RE of $30 000 ** 20% of change in GR of $10 000

8 000

5. NCI share of equity 1/7/17- 30/6/18 NCI share of profit NCI (20% x $15 000)

3 000

B. Partial Goodwill Method At 1 July 2016: Fair value of identifiable assets and liabilities of Lorikeet Ltd (a) Consideration transferred (b) NCI in Lorikeet Ltd Aggregate of (a) and (b) Goodwill of Rainbow Ltd

= = = = = = = =

$100 000 + $40 000 + $50 000 $190 000 $165 000 20% x $190 000 $38 000 $203 000 $203 000 - $190 000 $13 000

21.11

Solutions manual to accompany Company Accounting 10e

1. Business combination valuation entries There is no BCVR entry as only parent goodwill is recognised 2. Pre-acquisition entries Retained earnings (1/7/17) Share capital General reserve Goodwill Shares in Lorikeet Ltd

Dr Dr Dr Dr Cr

40 000 80 000 32 000 13 000

Dr Dr Dr Cr

10 000 20 000 8 000

165 000

3. NCI share of equity 1/7/16 Retained earnings (1/7/17) Share capital General reserve NCI (20% of equity at 1/7/16)

38 000

Entries 4-5 are the same as for the full goodwill method

21.12

Chapter 21: Consolidation: non-controlling interest

Question 21.2

Full goodwill and partial goodwill methods

Swamp Ltd acquired 90% of the shares (cum div.) of Tortoise Ltd on 1 July 2015 for $237 000. At this date, the equity of Tortoise Ltd consisted of: Share capital Asset revaluation surplus Retained earnings

$ 125 000 30 000 80 000

At acquisition date all the identifiable assets and liabilities of Tortoise Ltd were recorded at amounts equal to fair value. Tortoise Ltd had recorded a dividend payable of $10 000, which was paid in August 2015, and goodwill of $5000. At 30 June 2017, the equity of Tortoise Ltd consisted of: Share capital Asset revaluation surplus Retained earnings

$ 100 000 40 000 110 000

During the 2016–17 year Tortoise Ltd recorded a profit of $20 000. Required Prepare the consolidated worksheet entries at 30 June 2017 for Swamp Ltd assuming: A. At 1 July 2015, the fair value of the non-controlling interest was $25 000 and Swamp Ltd adopts the full goodwill method. B. Swamp Ltd adopts the partial goodwill method.

A. Full Goodwill Method At 1 July 2015: Fair value of identifiable assets and liabilities of Tortoise Ltd

(a) Consideration transferred (b) NCI in Tortoise Ltd Aggregate of (a) and (b) Goodwill Goodwill of Tortoise Ltd Fair value of Tortoise Ltd Fair value of INA of Tortoise Ltd Goodwill of Tortoise Ltd Goodwill recorded Non-recorded goodwill Goodwill of Swamp Ltd Goodwill acquired Goodwill of Tortoise Ltd Control premium – parent

= = = = = = = =

$125 000 + $30 000 + $80 000 (equity) - $5 000 (goodwill) $230 000 $237 000 – 90% x $10 000 (div. payable) $228 000 $25 000 $253 000 $253 000 - $230 000 $23 000

= = = = = =

$25 000/0.1 $250 000 $230 000 $20 000 $5 000 $15 000

= = =

$23 000 $20 000 $3 000

21.13

Solutions manual to accompany Company Accounting 10e

Consolidation worksheet entries at 30 June 2017: 1. Business combination valuation entries Goodwill Business combination valuation reserve (Unrecorded goodwill of subsidiary)

Dr Cr

15 000

Dr Dr Dr Dr Dr Cr

72 000 112 500 27 000 13 500 3 000

Dr Dr Dr Dr Cr

8 000 12 500 3 000 1 500

Dr Dr Cr

3 000 1 000

Dr Cr

2 000

15 000

2. Pre-acquisition entries Retained earnings (1/7/16) Share capital Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Tortoise Ltd

228 000

3. NCI share of equity 1/7/15 Retained earnings (1/7/16) Share capital Asset revaluation surplus Business combination valuation reserve NCI (10% of equity at 1/7/15)

25 000

4. NCI share of equity from 1/7/15 – 30/6/16 Retained earnings (1/7/16) Asset revaluation surplus NCI

4 000

5. NCI share of equity 1/7/16- 30/6/17 NCI share of profit NCI (10% x $20 000)

2 000

B. Partial Goodwill Method At 1 July 2015: Fair value of identifiable assets and liabilities of Tortoise Ltd

(a) Consideration transferred (b) NCI in Tortoise Ltd

= = = = = =

$125 000 + $30 000 + $80 000 - $5 000 (goodwill) $230 000 $237 000 – 90% x $10 000 (div. payable) $228 000 10% x $230 000 $23 000

21.14

Chapter 21: Consolidation: non-controlling interest

Aggregate of (a) and (b) Goodwill of Swamp Ltd

= = = Goodwill recorded – parent share = = Unrecorded goodwill – parent share =

$251 000 $251 000 - $230 000 $21 000 90% x $5 000 $4 500 $16 500

1. Business combination valuation entries There are no BCVR entries for goodwill. Under the partial goodwill method only the parent’s share of goodwill is recognised. This is done in the pre-acquisition entry.

2. Pre-acquisition entries Retained earnings (1/7/17) Share capital Asset revaluation surplus Goodwill Shares in Tortoise Ltd

Dr Dr Dr Dr Cr

72 000 112 500 27 000 16 500

Dr Dr Dr Cr

8 000 12 500 3 000

228 000

3. NCI share of equity 1/7/15 Retained earnings (1/7/16) Share capital Asset revaluation surplus NCI (10% of equity at 1/7/15)

23 500

Entries (4) and (5) are the same as in Part A.

21.15

Solutions manual to accompany Company Accounting 10e

Question 21.3

Partial goodwill method, gain on bargain purchase

Black Ltd acquired 90% of the shares of Swan Ltd for $107 600 on 1 July 2016. At this date the equity of Swan Ltd consisted of: Share capital Retained earnings

$ 80 000 40 000

At acquisition date all the identifiable assets and liabilities of Swan Ltd were recorded at amounts equal to fair value. At 30 June 2017, the equity of Swan Ltd consisted of: Share capital General reserve Retained earnings

$ 80 000 10 000 60 000

During the 2016–17 year Swan Ltd recorded a profit of $15 000. The transfer to general reserve was from retained earnings existing at 1 July 2016. Required Prepare the consolidated worksheet entries at 30 June 2017 for Black Ltd assuming Black Ltd adopts the partial goodwill method.

Partial Goodwill Method At 1 July 2016: Fair value of identifiable assets and liabilities of Swan Ltd (a) Consideration transferred (b) NCI in Swan Ltd Aggregate of (a) and (b) Gain on bargain purchase

= = = = = = = =

$80 000 + $40 000 $120 000 $107 600 10% x $120 000 $12 000 $119 600 $120 000 - $119 600 $400

1. Business combination valuation entries There is no BCVR entry as a gain on bargain purchase occurred. 2. Pre-acquisition entries Retained earnings (1/7/16) Share capital Gain on bargain purchase Shares in Swan Ltd * 90% x $40 000

Dr Dr Cr Cr

36 000 72 000

General reserve Transfer to general reserve (90% x $10 000)

Dr Cr

9 000

400 107 600

9 000

21.16

Chapter 21: Consolidation: non-controlling interest

3. NCI share of equity 1/7/16 Retained earnings (1/7/16) Share capital NCI (10% of equity at 1/7/16)

Dr Dr Cr

4 000 8 000

NCI share of profit NCI (10% x $15 000)

Dr Cr

1 500

General reserve Transfer to general reserve (10% x $10 000)

Dr Cr

1000

12 000

4. NCI share of equity from 1/7/16 – 30/6/17

1 500

1 000

21.17

Solutions manual to accompany Company Accounting 10e

Question 21.4

Full goodwill method, multiple years

On 1 July 2016, Huntsman Ltd acquired 90% the issued shares of Spider Ltd for $140 300. At this date the equity of Spider Ltd consisted of $100 000 share capital and $50 000 retained earnings. All the identifiable assets and liabilities of Spider Ltd were recorded at amounts equal to fair value except for plant for which the carrying amount of $80 000 (net of accumulated depreciation of $40 000) was $3000 less than the fair value. The plant was estimated to have a further 3-year life. The fair value of the non-controlling interest was $15 500. Huntsman Ltd uses the full goodwill method. The following annual results were recorded by Spider Ltd following the business combination: Year ended

30 June 2017 30 June 2018 30 June 2019 30 June 2020

Profit/(loss)

$8 000 9 000 10 000 11 000

Other items of comprehensive income $2 000 3 000 4 000 5 000

The other items of comprehensive income relate to the gains on land of Spider Ltd that are recorded at fair value under the revaluation method of measurement. The group transfers the revaluation reserves to retained earnings when an asset is sold or fully consumed. The tax rate is 30%. Required Prepare the consolidation worksheet entries for the preparation of consolidated financial statements of Huntsman Ltd for each of the years ending 30 June 2017–20.

90% Huntsman Ltd

Spider Ltd Huntsman Ltd 90% NCI 10%

Acquisition analysis 1 July 2016 Net fair value of identifiable assets and liabilities of Spider Ltd = ($100 000 + $50 000) (equity) + $3 000 (1 – 30%) (plant) = $152 100 (a) Consideration transferred = $140 300 (b) Non-controlling interest = $15 500 Aggregate of (a) and (b) = $155 800 Goodwill = $155 800 – $152 100 = $3 700 Goodwill of Spider Ltd Fair value of Spider Ltd = $15 500/0.1 = $155 000 Fair value of INA of Spider Ltd = $152 100 Goodwill of Spider Ltd = $2 900 Goodwill of Huntsman Ltd

21.18

Chapter 21: Consolidation: non-controlling interest

Goodwill acquired Goodwill of Spider Ltd Control premium

= = =

$3 700 $2 900 $800

1. Consolidation Worksheet Entries - 1 July 2016 1. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

40 000

Goodwill Business combination valuation reserve

Dr Cr

2 900

Dr Dr Dr Dr Cr

45 000 90 000 4 500 800

Dr Dr Dr Cr

5 000 10 000 500

37 000 900 2 100

2 900

2. Pre-acquisition entries Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in Spider Ltd

140 300

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/16) Share capital Business combination valuation reserve NCI (10% of balances at 1 July 2016)

15 500

Consolidation Worksheet Entries - 30 June 2017

1. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

40 000

Depreciation expense Accumulated depreciation - plant (1/3 x $3 000 p.a.)

Dr Cr

1 000

Deferred tax liability Income tax expense

Dr Cr

300

2 900

Goodwill

37 000 900 2 100

1 000

300

21.19

Solutions manual to accompany Company Accounting 10e

Business combination valuation reserve

2 900

2. Pre-acquisition entry Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in Spider Ltd

Dr Dr Dr Dr Cr

45 000 90 000 4 500 800

Dr Dr Dr Cr

5 000 10 000 500

Dr Cr

730

Dr Cr

200

140 300

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/16) Share capital Business combination valuation reserve NCI

15 500

4. NCI share of equity: 1 July 2016 - 30 June 2017 NCI share of profit NCI (10% [$8000 – ($1 000 - $300)) Asset revaluation surplus NCI (10% x $2 000)

730

200

Consolidation Worksheet Entries - 30 June 2018 Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

40 000

Depreciation expense Retained earnings (1/7/17) Accumulated depreciation - plant (1/3 x $3 000 p.a. for 2 years)

Dr Dr Cr

1 000 1 000

Deferred tax liability Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

600

Dr Cr

2 900

45 000

Goodwill Business combination valuation reserve

37 000 900 2 100

2 000

300 300

2 900

2. Pre-acquisition entry Retained earnings (1/7/17)

21.20

Chapter 21: Consolidation: non-controlling interest

Share capital Business combination valuation reserve Goodwill Shares in Spider Ltd

Dr Dr Dr Cr

90 000 4 500 800

Dr Dr Dr Cr

5 000 10 000 500

Dr Dr Cr

730 200

140 300

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/17) Share capital Business combination valuation reserve NCI

15 500

4. NCI share of equity: 1 July 2016 - 30 June 2017 Retained earnings (1/7/17) Asset revaluation surplus NCI (RE: 10% ($8 000 – [$1 000 - $300]) ARS: 10% x $2 000

930

This entry is the combination of the previous year’s entries for NCI for 1/7/16 – 30/6/17

5. NCI share of equity: 1 July 2017 - 30 June 2018

NCI share of profit NCI (10% ($9 000 – [$1 000 - $300])

Dr Cr

830

Asset revaluation surplus NCI (10% x $3000)

Dr Cr

300

Depreciation expense - plant Income tax expense Retained earnings (1/7/18) Transfer from business combination valuation reserve

Dr Cr Dr

1 000

Goodwill Business combination valuation reserve

Dr Cr

2 900

Dr Dr Dr Dr

45 000 90 000 4 500 800

830

300

Consolidation Journal entries - 30 June 2019

1. Business combination valuation entries

300 1 400

2 100

2 900

2. Pre-acquisition entry Retained earnings (1/7/18) Share capital Business combination valuation reserve Goodwill

21.21

Solutions manual to accompany Company Accounting 10e

Shares in Spider Ltd Transfer from business combination reserve Business combination valuation reserve

140 300

Dr Cr

1 890

Dr Dr Dr Cr

5 000 10 000 500

Dr Cr Cr

1 560 500

1 890

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/17) Share capital Business combination valuation reserve NCI

15 500

4. NCI share of equity: 1 July 2016 - 30 June 2018 Retained earnings (1/7/17) Asset revaluation surplus NCI RE: 10% ($8 000 + $9 000 – $1 400 plant) ARS: 10% ($2 000 + $3 000)

2 060

This entry is the combination of the previous year’s entries (no. 4 & 5) for NCI for 1/7/16 – 30/6/18

5. NCI share of equity: 1 July 2018 - 30 June 2019 NCI share of profit NCI (10% [10 000– ($1000 - $300)]) Transfer from business combination valuation reserve Business combination valuation reserve (10% x $2 100 plant) Asset revaluation surplus NCI (10% x $4 000) 5.

Dr Cr

930

Dr Cr

210

Dr Cr

400

Dr Cr

2 900

Dr Dr Dr Dr Cr

46 890 90 000 2 610 800

930

210

400

Consolidation Journal entries - 30 June 2020

1. Business combination valuation entries Goodwill Business combination valuation reserve

2 900

2. Pre-acquisition entry Retained earnings (1/7/19) Share capital Business combination valuation reserve Goodwill Shares in Spider Ltd

140 300

21.22

Chapter 21: Consolidation: non-controlling interest

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/19) Share capital Business combination valuation reserve NCI

Dr Dr Dr Cr

5 000 10 000 500

Dr Cr Cr

2 700 900

15 500

4. NCI share of equity: 1 July 2016 - 30 June 2019 Retained earnings (1/7/19) Asset revaluation surplus NCI RE: 10% ($8 000 + $9 000 + $10 000) ARS: 10% ($2 000 + $3 000 + $4000)

3 600

This entry is the combination of the previous year’s entries (no. 4 & 5) for NCI for 1/7/16 – 30/6/19

5. NCI share of equity: 1 July 2019 - 30 June 2020 NCI share of profit NCI (10% x $11 000)

Dr Cr

1 100

Asset revaluation surplus NCI (10% x $5 000)

Dr Cr

500

1 100

500

21.23

Solutions manual to accompany Company Accounting 10e

Question 21.5

Partial and full goodwill methods

On 1 July 2016 Sugar Ltd acquired 90% of the shares of Glider Ltd for $435 240. At this date the equity of Glider Ltd consisted of share capital of $300 000 and retained earnings of $120 000. All the identifiable asset and liabilities of Glider Ltd were recorded at amounts equal to fair value except for: Carrying Fair value amount $ 80 000 $ 95 000 300 000 330 000 15 000 18 000

Land Plant (cost $380 000) Inventory

The plant was considered to have a further 10-year life. All the inventory was sold by 30 June 2017. The tax rate is 30%. Sugar Ltd uses the partial goodwill method. During the 2016–17 period Glider Ltd recorded a profit of $30 000. Required A. Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Sugar Ltd at 30 June 2017. B. Prepare the consolidation worksheet entries if Sugar Ltd used the full goodwill method, assuming the fair value of the non-controlling interest at 1 July 2016 was $47 700.

90% Sugar Ltd

Glider Ltd Sugar Ltd 90% NCI 10%

At 1 July 2016: Net fair value of identifiable assets and liabilities of Glider Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill of the parent

= = = = = = =

$300 000 + $120 000 (equity) + $15 000 (1 – 30%) (land) + $3 000 (1 – 30%) (inventory) + $30 000 (1 – 30%) (plant) $453 600 $435 240 10% x $453 600 $45 360 $480 600 $480 600 - $453 600 $27 000

A. Worksheet entries at 1 July 2016 1. Business combination valuation entries Land

Dr Cr Cr

15 000

Deferred tax liability Business combination valuation reserve Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

80 000

4 500 10 500

50 000 9 000 21 000

21.24

Chapter 21: Consolidation: non-controlling interest

Depreciation expense Accumulated depreciation (1/10 x $30 000)

Dr Cr

3 000

Deferred tax liability Income tax expense

Dr Cr

900

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

3 000

900

2 100

2. Pre-acquisition entries Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in Glider Ltd

Dr Dr Dr Dr Cr

108 000 270 000 30 240 27 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

1 890

Dr Dr Dr Cr

30 000 3 360 12 000

NCI share of profit Dr NCI Cr (10% ($30 000 – ($3 000 - $900) – ($3 000 – $900)))

2 580

435 240

1 890

3. NCI share of equity at 1 July 2016 Share capital Business combination valuation reserve Retained earnings (1/7/16) NCI

45 360

4. NCI share of equity: 1/7/16 - 30/6/17

Transfer from business combination valuation reserve Business combination valuation reserve (10% x $2 100)

Dr Cr

2 580

210 210

B. FULL GOODWILL METHOD NCI has a fair value of $47 700 At 1 July 2016: Net fair value of identifiable assets and liabilities of Glider Ltd =

$300 000 + $120 000 (equity) + $15 000 (1 – 30%) (land) + $3 000 (1 – 30%) (inventory) + $30 000 (1 – 30%) (plant)

21.25

Solutions manual to accompany Company Accounting 10e

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

Goodwill of Subsidiary Fair value of Glider Ltd

$453 600 $435 240 $47 700 $482 940 $482 940 - $453 600 $29 340 = =

$47 700/10% $477 000

Net fair value of identifiable assets and liabilities Goodwill of subsidiary

= =

$453 600 $23 400

Goodwill of parent Goodwill acquired Goodwill of subsidiary Goodwill of parent (control premium)

= = =

$29 340 $23 400 $5 940

There will need to be an additional BCVR entry: Goodwill Business combination valuation entry

Dr Cr

23 400

Dr Dr Dr Dr Cr

270 000 108 000 51 300 5 940

Dr Dr Dr Cr

30 000 5 700 12 000

23 400

The pre-acquisition entry at 1 July 2016 would change to: Share capital Retained earnings (1/7/16) Business combination valuation reserve * Goodwill Shares in Glider Ltd * $30 240 (see A. entry) + (90% x $23 400)

435 240

The Step 1 NCI entry changes to: Share capital Business combination valuation reserve * Retained earnings (1/7/16) NCI * $3 360 (see A. entry)+ 10% x $23 400]

47 700

All other entries under part A are the same for Part B.

21.26

Chapter 21: Consolidation: non-controlling interest

Question 21.6

Partial goodwill method, consolidation worksheet

Barren Ltd acquired 75% of the shares of Goose Ltd for $191 000 on 1 July 2016. At this date the equity of Goose Ltd consisted of: Share capital General reserve Retained earnings

$ 80 000 48 000 32 000

At this date all the identifiable assets and liabilities of Goose Ltd were recorded at amounts equal to their fair values except for: Carrying Fair value amount $130 000 $140 000 100 000 130 000 40 000 120 000

Plant (cost $156 000) Inventory Brands

The plant was considered to have a further useful life of 10 years. The brands have an indefinite life. The inventory was all sold by 30 June 2017. The tax rate is 30%. Barren Ltd uses the partial goodwill method. An impairment test was conducted in June 2017 resulting in the write off of all the goodwill of Goose Ltd and $20 000 from the brands. Financial information provided by the two companies at 30 June 2019 was as follows:

Sales Cost of sales Gross profit Expenses Profit before income tax Income tax expense Profit for the year Retained earnings (1/7/18) Retained earnings (30/6/19) Share capital General reserve Total equity Current liabilities Deferred tax liabilities Total liabilities Total equity and liabilities Plant Accumulated depreciation – plant Brands Shares in Goose Ltd Inventory Total assets

Barren Ltd Goose Ltd $400 000 $64 000 (170 000) (28 000) 230 000 36 000 (60 000) (5 600) 170 000 30 400 (40 000) (4 000) 130 000 26 400 95 000 60 000 225 000 86 400 300 000 80 000 50 000 64 000 575 000 230 400 $ 40 000 $ 3 600 20 000 6 000 60 000 9 600 $635 000 $240 000 $340 000 (100 000)

$152 000 (19 200)

80 000 191 000 124 000 $635 000

40 000 0 67 200 $240 000

Required Prepare the consolidated financial statements of Barren Ltd at 30 June 2019.

21.27

Solutions manual to accompany Company Accounting 10e

75% Barren Ltd

Goose Ltd Barren Ltd 75% NCI 25%

Pre-acquisition analysis At 1 July 2016: Net fair value of identifiable assets and liabilities of Goose Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill: parent only

= = = = = = =

($80 000 + $48 000 + $32 000) (equity) + $10 000 (1 – 30%) (plant) + $80 000 (1 – 30%) (brands) + $30 000 (1 – 30%) (inventory) $244 000 $191 000 25% x $244 000 $61 000 $252 000 $252 000 - $244 000 $8 000

A. Consolidation worksheet entries at 30 June 2019 1. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

26 000

Depreciation expense Retained earnings (1/7/18) Accumulated depreciation (1/10 x $10 000 p.a. for 3 years)

Dr Dr Cr

1 000 2 000

Deferred tax liability Income tax expense Retained earnings (1/7/18)

Dr Cr Cr

900

Brands Deferred tax liability Business combination valuation reserve

Dr Cr Cr

80 000

Retained earnings (1/7/18) Accumulated impairment losses – brands

Dr Cr

20 000

Deferred tax liability Retained earnings (1/7/18)

Dr Cr

6 000

16 000 3 000 7000

3 000

300 600

24 000 56 000

20 000

6 000

21.28

Chapter 21: Consolidation: non-controlling interest

2. Pre-acquisition entries Retained earnings (1/7/18) * Share capital General reserve Business combination valuation reserve Shares in Goose Ltd

Dr Dr Dr Dr Cr

47 750 60 000 36 000 47 250 191 000

* = $24 000 + $8 000 goodwill + 75% x $21 000 (BCVR – inventory) 3. NCI in equity at 1/7/16 Retained earnings (1/7/18) Share capital General reserve Business combination valuation reserve NCI (25% of balances at 1/7/16)

Dr Dr Dr Dr Cr

8 000 20 000 12 000 21 000

Dr Dr Cr Cr

3 150 4 000

61 000

4. NCI in equity: 1/7/16 - 30/6/18 Retained earnings (1/7/18) General reserve Business combination valuation reserve NCI

5 250 1 900

RE: 25% ($60 000 - $32 000 – ($2 000 - $600) – ($20 000 - $6 000)) GR: 25% ($64 000 - $48 000) BCVR: 25% x $21 000 (BCVR inventory) 5. NCI in equity: 1/7/18 - 30/6/19 NCI share of profit NCI (25% ($26 400– ($1 000 - $300)))

Dr Cr

6 425 6 425

21.29

Solutions manual to accompany Company Accounting 10e

Financial Statements Sales revenue Cost of sales Other expenses Profit before tax Tax expense Profit for the period Retained earnings (1/7/18) Retained earnings (30/6/19) Capital General reserve BCVR

Barren Ltd 400 000 170 000 230 000 60 000 170 000

Goose Ltd 64 000 28 000 36 000 5 600 1 30 400

Adjustments Dr Cr

40 000 130 000

4 000 26 400

95 000

2 000 20 000 47 750

225 000

60 000 1 1 2 86 400

300 000 50 000

80 000 2 64 000 2

60 000 36 000

0 2

47 250

Group

NCI Dr

Parent Cr

464 000 198 000 266 000 66 600 199 400

1 000

300

600 6 000

1 1

43 700 155 700 91 850

6 425

149 275

3 4

8 000 3 150

80 700

247 550

320 000 78 000 7 000 56 000

1 1

15 750

229 975

3 3 4 3

20 000 12 000 4 000 21 000

Total equity: parent Total equity: NCI

300 000 62 000 5 250

0 591 975

Total equity

575 000 230 400

661 300

Current liabilities Deferred tax liabilities Total liabilities

40 000

3 600

43 600

20 000 60 000

6 000 1 1 9 600

Shares in Goose Ltd Plant Accum. depreciation Brands Accumulated impairment losses Inventory Goodwill Total assets

191 000

340 000 152 000 (100 000) (19 200) 1 80 000

124 000

40 000 1

900 6 000

3 000 24 000

3 4 5

46 100

26 000

191 000

16 000 3 000

1 1

476 000 (96 200)

20 000

200 000 (20 000)

80 000

326 900 326 900

191 200 751 000

69 325

661 300

89 700

67 200

635 000 240 000

1 1

74 575

61 000 1 900 6 425 74 575

21.30

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.6 (cont’d) BARREN LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2019 Revenues: Sales revenue Expenses: Cost of sales Other expenses

$464 000 198 000 66 600 264 600 199 400 43 700 155 700

Profit before income tax Income tax expense Profit for the period Attributable to: Parent shareholders Non-controlling interest

149 275 6 425 $155 700

BARREN LTD Consolidated Statement of Changes in Equity for the year ended 30 June 2019 Comprehensive income for the period Non-controlling interest Parent shareholders

$155 700 $6 425 $149 275 Group

Parent

Retained earnings: Balance at 1 July 2018 Profit for the period Balance at 30 June 2019

$91 850 155 700 $247 550

$80 700 149 275 $229 975

Business combination valuation reserve: Balance at 1 July 2018 Balance at 30 June 2019

$15 750 $15 750

0 0

Share capital: Balance at 1 July 2018 Balance at 30 June 2019

$320 000 $320 000

$300 000 $300 000

General reserve: Balance at 1 July 2018 Balance at 30 June 2019

$78 000 $78 000

$62 000 $62 000

21.31

Solutions manual to accompany Company Accounting 10e

QUESTION 21.6 (cont’d)

BARREN LTD Consolidated Statement of Financial Position as at 30 June 2019 ASSETS Current Assets Inventory Non-current Assets: Property, plant and equipment Plant Accumulated depreciation Brands Accumulated impairment losses Total Non-current Assets Total Assets EQUITY AND LIABILITIES Equity attributable to owners of the parent: Share capital Other reserves: General reserve Retained earnings Parent Interest Non-controlling Interest Total Equity Current Liabilities Non-current Liabilities Deferred tax liabilities Total Liabilities Total Equity and Liabilities

$191 200

$476 000 (96 200) 200 000 (20 000)

379 800 180 000 559 800 $751 000

$300 000 62 000 229 925 591 925 69 375 661 300 43 600 46 100 89 700 $751 000

21.32

Chapter 21: Consolidation: non-controlling interest

Question 21.7

Full goodwill method, multiple years

On 1 July 2016, Fur Ltd acquired 75% of the shares of Seal Ltd for $191 000 when the equity of Seal Ltd consisted of $120 000 share capital and $90 000 retained earnings. At this date, all the identifiable assets and liabilities of Seal Ltd were recorded at amounts equal to their fair values except for:

Inventory Land Machinery (cost $68 000)

Carrying amount $20 000 80 000 48 000

Fair value $26 000 110 000 57 000

Note the following in relation to these assets: All the inventory was sold by 30 June 2017. The land was revalued in the records of Seal Ltd immediately after the business combination. It was subsequently sold by Seal Ltd on 1 June 2018 for $113 000. At this date, the recorded gains on this land taken to other comprehensive income were $3000, the land being revalued to fair value by Seal Ltd immediately prior to sale.  The machinery was considered to have a further useful life of 3 years. The fair value of the non-controlling interest in Seal Ltd at 1 July 2016 was $63 000. Fur Ltd uses the full goodwill method. The following annual results were recorded by Seal Ltd following the business combination:  

Year ended

Profit/(loss)

30 June 2017 30 June 2018 30 June 2019 30 June 2020

$15 000 34 500 (9000) 33 000

Other items of comprehensive income $ 3 000 7 500 10 500 4 000

The other items of comprehensive income relate to gains/(losses) on the revaluation of land which is measured at fair value in the records of Seal Ltd. The group transfers the valuation reserves to retained earnings when an asset is sold or fully consumed. The tax rate is 30%. Required Prepare the consolidation worksheet entries for the preparation of consolidated financial statements of Fur Ltd for each of the years ending 30 June 2016–20.

75% Fur Ltd

Seal Ltd Fur Ltd 75% NCI 25%

Acquisition analysis 1 July 2016 Net fair value of identifiable assets and liabilities of Seal Ltd = ($120 000 + $90 000) (equity) + $30 000 (1 – 30%) (land) + $9 000 (1 – 30%) (plant)

21.33

Solutions manual to accompany Company Accounting 10e

= = = = = =

+ $6 000 (1 – 30%) (inventory) $241 500 $191 000 $63 000 $254 000 $254 000 – $241 500 $12 500

Goodwill of Seal Ltd Fair value of Seal Ltd Fair value of INA of Seal Ltd Goodwill of Seal Ltd Goodwill of Fur Ltd Goodwill acquired Goodwill of Seal Ltd Control premium – parent

= = = =

$63 000/0.25 $252 000 $241 500 $10 500

= = =

$12 500 $10 500 $2 000

1. Consolidation Worksheet Entries - 1 July 2016 1. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

6 000

Goodwill Business combination valuation reserve

Dr Cr

10 500

Dr Dr Dr Dr Dr Cr

67 500 90 000 15 750 15 750 2 000

Dr Dr Dr

22 500 30 000 5 250

9 000 2 700 6 300

1 800 4 200

10 500

QUESTION 21.7 (cont’d) 2. Pre-acquisition entries Retained earnings (1/7/16) Share capital Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Seal Ltd

191 000

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/16) Share capital Asset revaluation surplus

21.34

Chapter 21: Consolidation: non-controlling interest

Business combination valuation reserve NCI (25% of balances at 1 July 2016)

Dr Cr

5 250 63 000

Consolidation Worksheet Entries - 30 June 2017

1. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Accumulated depreciation - plant (1/3 x $9 000 p.a.)

Dr Cr

3 000

Deferred tax liability Income tax expense

Dr Cr

900

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

6 000

Goodwill Business combination valuation reserve

Dr Cr

9 000 2 700 6 300

3 000

900

1 800

4 200 10 500 10 500

21.35

Solutions manual to accompany Company Accounting 10e

QUESTION 21.7 (cont’d) 2. Pre-acquisition entry Retained earnings (1/7/16) Share capital Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Seal Ltd

Dr Dr Dr Dr Dr Cr

67 500 90 000 15 750 15 750 2 000

Transfer from business combination valuation reserve Business combination valuation reserve (75% x 70% x $6 000)

Dr Cr

3 150

Dr Dr Dr Dr Cr

22 500 30 000 5 250 5 250

191 000

3 150

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/16) Share capital Asset revaluation surplus Business combination valuation reserve NCI

63 000

4. NCI share of equity: 1 July 2016 - 30 June 2017 NCI share of profit Dr NCI Cr (25% [$15000 – ($3 000 - $900) – ($6 000 - $1 800)]) Transfer from business combination valuation reserve Business combination valuation reserve (25% x 70% x $6 000) Asset revaluation surplus NCI (25% x $3 000)

2 175 2 175

Dr Cr

1 050

Dr Cr

750

1 050

750

21.36

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.7 (cont’d) 3.

Consolidation Worksheet Entries - 30 June 2018

1. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Retained earnings (1/7/17) Accumulated depreciation - plant

Dr Dr Cr

3 000 3 000

Deferred tax liability Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

1 800

Dr Cr

10 500

Retained earnings (1/7/17) Share capital Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Seal Ltd *RE: [$67 500 + $3 150 BCVR - inventory]

Dr Dr Dr Dr Dr Cr

70 650 90 000 15 750 12 650 2 000

Transfer from asset revaluation surplus Asset revaluation surplus (75% x 70% x $30 000)

Dr Cr

15 750

Dr Dr Dr Dr Cr

22 500 30 000 5 250 5 250

Goodwill Business combination valuation reserve

9 000 2 700 6 300

6 000

900 900

10 500

2. Pre-acquisition entries

191 000

15 750

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/17) Share capital Asset revaluation surplus Business combination valuation reserve NCI

63 000

21.37

Solutions manual to accompany Company Accounting 10e

QUESTION 21.7 (cont’d) 4. NCI share of equity: 1 July 2016 - 30 June 2017 Retained earnings (1/7/17) Asset revaluation surplus Business combination valuation reserve NCI (RE: 25% ($15 000 – [$3 000 - $900]) ARS: 25% x $3 000 BCVR: 25% x 70% x $6 000 inventory

Dr Dr Cr Cr

3 225 750

NCI share of profit NCI (25% ($34 500 – [$3 000 - $900])

Dr Cr

8 100

Transfer from asset revaluation surplus Asset revaluation surplus (25% x 70% x $30 000 plus 25% x $3000)

Dr Cr

6 000

Asset revaluation surplus NCI (25% x $7 500)

Dr Cr

1 875

Depreciation expense - plant Income tax expense Retained earnings (1/7/18) Transfer from business combination valuation reserve

Dr Cr Dr

3 000

Goodwill Business combination valuation reserve

Dr Cr

1 050 2 925

5. NCI share of equity: 1 July 2017 - 30 June 2018

8 100

6 000

1 875

Consolidation Journal entries - 30 June 2019

1. Business combination valuation entries

900 4 200

6 300 10 500 10 500

21.38

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.7 (cont’d) 2. Pre-acquisition entries Retained earnings (1/7/18) * Dr 86 400 Share capital Dr 90 000 Business combination valuation reserve Dr 12 600 Goodwill Dr 2 000 Shares in Seal Ltd Cr 191 000 * (75% x $90 000) + 75% x 70% ($6 000 inventory + $30 000 land) Transfer from business combination valuation reserve Business combination valuation reserve (75% x $6 300 machinery)

Dr Cr

4 725

Dr Dr Dr Dr Cr

22 500 30 000 5 250 5 250

Dr Cr Cr Cr

17 325

4 725

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/18) Share capital Asset revaluation surplus Business combination valuation reserve NCI

63 000

4. NCI share of equity: 1 July 2016 - 30 June 2018 Retained earnings (1/7/18) Asset revaluation surplus Business combination valuation reserve NCI

3 375 1 050 12 900

RE: 25% ($15 000 + $34 500 – $4 200 machinery + $24 000 transfer from ARS) BCVR: 25% (70% x $6 000) ARS: 25% ($3 000 + $7 500 – [$3000 + (70% x $30 000)transfer]) 5. NCI share of equity: 1 July 2018 - 30 June 2019 NCI NCI share of profit/loss (25% [(9 000) – ($3000 - $900)]) Transfer from business combination valuation reserve Business combination valuation reserve (25% x $6 300 machinery) Asset revaluation surplus NCI (25% x $10 500)

Dr Cr

2 775

Dr Cr

1 575

Dr Cr

2 625

2 775

1 575

2 625

21.39

Solutions manual to accompany Company Accounting 10e

QUESTION 21.7 (cont’d) 5.

Consolidation Journal Entries - 30 June 2020

1. Business combination valuation entries Goodwill Business combination valuation reserve

Dr Cr

10 500 10 500

2. Pre-acquisition entry Retained earnings (1/7/19) * Dr 91 125 Share capital Dr 90 000 Business combination valuation reserve ** Dr 7 875 Goodwill Dr 2 000 Shares in Seal Ltd Cr 191 000 * [75% x $90 000 + 75% x 70%($30 000 land + $6 000 inv + $9 000 mach)] ** 75% x $10 500 3. NCI share of equity at 1 July 2016 Retained earnings (1/7/19) Share capital Asset revaluation surplus Business combination valuation reserve NCI

Dr Dr Dr Dr Cr

22 500 30 000 5 250 5 250 63 000

4. NCI share of equity: 1 July 2019 - 30 June 2020 Retained earnings (1/7/19) Dr 16 125 Business combination valuation reserve Cr 2 625 Asset revaluation surplus Cr 750 NCI Cr 12 750 (RE: [25% ($15 000 + $34 500 - $9 000 + ($21 000 + $3 000) t’fer from ARS)] ARS: 25% ($3 000 + $7 500 + $10 500 – [$21 000 +$3 000] t’fer) BCVR: 25% x 70% x ($6 000 + $9 000)

5. NCI share of equity: 1 July 2019 - 30 June 2020 NCI share of profit NCI (25% x $33 000])

Dr Cr

8 250

Asset revaluation surplus NCI (25% x $4 000)

Dr Cr

1 000

8 250

1 000

21.40

Chapter 21: Consolidation: non-controlling interest

Question 21.8

Partial and full goodwill methods, dividends

Thorny Ltd acquired 80% of the shares (cum div.) of Devil Ltd on 1 July 2016 for $303 000. At this date the shareholders’ equity of Devil Ltd consisted of: Share capital General reserve Retained earnings

$ 150 000 60 000 75 000

At this date all the identifiable assets and liabilities of Devil Ltd were recorded at amounts equal to their fair values except for the following:

Patents Machinery (cost $140 000) Buildings (cost $32 000) Inventory

Carrying Fair value amount $100 000 $130 000 110 000 117 500 25 000 25 000 60 000 70 000

Information about the assets and liabilities of Devil Ltd at 1 July 2016 included: The patents were considered to have an indefinite useful life. It was estimated that the machinery had a remaining useful life of 5 years. The machinery was sold on 1 January 2019.  At 1 July 2016, Devil Ltd had not recorded an internally developed brand. The fair value placed on the brand was $65 000. It was considered to have an indefinite useful life.  Devil Ltd had recorded goodwill of $7500 from a business combination undertaken in 2014.  One of the liabilities existing at 1 July 2016 was dividends payable of $7500. The following events were recorded by Devil Ltd in the years subsequent to the acquisition date:  

2016 Aug. 2017 June Aug. 2018 June

Aug. Dec. 2019 June

Paid the $7500 dividend on hand at 1 July 2016.

28 30 16

Declared a dividend of $12 000. Reported a profit of $30 000. Paid the $12 000 dividend declared in June.

28 29 30 15 29

Transferred half the general reserve existing at 1 July 2016 to retained earnings. Declared a dividend of $9000. Reported a profit of $37 500. Paid the $9000 dividend declared in June. Paid an interim dividend of $7500.

26 28 30

Transferred $9000 from retained earnings to general reserve. Declared a dividend of $12 000. Reported a profit of $45 000.

Required A. Prepare the consolidated worksheet entries for the preparation of the consolidated financial statements of Thorny Ltd at 30 June 2019. Assume Thorny Ltd uses the partial goodwill method.

21.41

Solutions manual to accompany Company Accounting 10e

As for A except that Thorny Ltd uses the full goodwill method. At 1 July 2016, Thorny Ltd valued the non-controlling interest in Devil Ltd at $73 870.

80% Thorny Ltd

Devil Ltd Thorny Ltd 80% NCI 20%

A: PARTIAL GOODWILL METHOD At 1 July 2016: Net fair value of identifiable assets and liabilities of Devil Ltd =

= (a) Consideration transferred = = (b) Non-controlling interest = = Aggregate of (a) and (b) = Goodwill acquired – parent only = = Unrecorded goodwill acquired = =

($150 000 +$60 000 + $75 000) (equity) + $30 000 (1 – 30%) (patents) + $7 500 (1 – 30%) (machinery) + $10 000 (1 – 30%) (inventory) + $65 000 (1 – 30%) (brand) - $7 500 (goodwill) $356 250 $303 000 – (80% x $7 500) (divs rec) $297 000 20% x $356 250 $71 250 $368 250 $368 250- $356 250 $12 000 $12 000 - (80% x $7 500) $6 000

Working: Retained earnings (1/7/16) Profit 2016-17 Dividend declared Retained earnings (30/6/17) Transfer from general reserve Dividend declared Profit 2017-18 Retained earnings (30/6/18) Interim dividend paid Transfer to general reserve Dividend declared Profit 2018-19 Retained earnings (30/6/19)

Devil Ltd $75 000 30 000 (12 000) 93 000 30 000 (9 000) 37 500 151 500 (7 500) (9 000) (12 000) 45 000 $168 000

21.42

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.8 (cont’d) A. CONSOLIDATION WORKSHEET ENTRIES AT 30 JUNE 2019 1. Business combination valuation entries Patents Deferred tax liability Business combination valuation reserve

Dr Cr Cr

30 000

Depreciation expense Gain on machinery sold * Income tax expense Retained earnings (1/7/12) Transfer from business combination valuation reserve * $1500 x 2.5 yrs

Dr Dr Cr Dr

750 3 750

Accumulated depreciation –buildings Buildings

Dr Cr

7 000

Brand Deferred tax liability Business combination valuation reserve

Dr Cr Cr

65 000

9 000 21 000

1 350 2 100

5 250

7 000

19 500 45 500

2. Pre-acquisition entries Retained earnings (1/7/18) * Dr 89 600 Share capital Dr 120 000 General reserve Dr 24 000 Business combination valuation reserve Dr 57 400 Goodwill Dr 6 000 Shares in Devil Ltd Cr 297 000 * (80% x $75 000) + (80% x $30 000) (GR transfer) + 80%(70% x $10000) (BCVR inv) Transfer from business combination valuation reserve Business combination valuation reserve (80% x 70% x $7 500)

Dr Cr

4 200

Dr Dr Dr Dr Cr

15 000 30 000 12 000 15 750

4 200

3. NCI share of equity at 1/7/16 Retained earnings (1/7/18) Share capital General reserve Business combination valuation reserve NCI (20% of balances)

72 750

21.43

Solutions manual to accompany Company Accounting 10e

QUESTION 21.8 (cont’d) 4.

NCI share of equity: 1/7/16 - 30/6/18 Retained earnings (1/7/18) * Dr Business combination valuation reserve ** Cr General reserve Cr NCI Cr *20%[$151 500 - $75 000] - $2 100 machinery) ** 20% x 70% x $10 000 inventory

14 880 1 400 6 000 7 480

5. NCI share of equity: 1/7/18 - 30/6/19 NCI share of profit NCI (20%($45 000 - ($750 + $3750 - $1 350))

Dr Cr

8 370

General reserve Transfer to general reserve (20% x $9 000)

Dr Cr

1 800

Dr Cr

1 050

NCI Dividend paid (20% x $7 500)

Dr Cr

1 500

NCI Dividend declared (20% x $12 000)

Dr Cr

2 400

Dr Cr

6 000

Dividend payable Dividend declared (80% x $12 000)

Dr Cr

9 600

Dividend revenue Dividend receivable

Dr Cr

9 600

Transfer from business combination valuation reserve Business combination valuation reserve (20% x 70% x $7 500)

8 370

1 800

1 050

1 500

2 400

7. Dividend paid Dividend revenue Dividend paid (80% x $7 500)

6 000

8. Dividend declared

9 600

21.44

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.8 (cont’d) B: FULL GOODWILL METHOD At 1 July 2016: Net fair value of identifiable assets and liabilities of Devil Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Recorded goodwill Unrecorded goodwill Goodwill of Devil Ltd: Fair value of Devil Ltd

= = = = = = = =

= = Net fair value of identifiable assets and liabilities of Devil Ltd = Goodwill of Devil Ltd = Recorded goodwill = Unrecorded goodwill =

Goodwill of Thorny Ltd: Goodwill acquired Goodwill of Devil Ltd Goodwill of Thorny Ltd – control premium

($150 000 +$60 000 + $75 000) (equity) + $30 000 (1 – 30%) (patents) + $7 500 (1 – 30%) (machinery) + $10 000 (1 – 30%) (inventory) + $65 000 (1 – 30%) (brand) - $7 500 (goodwill) $356 250 $303 000 – (80% x $7 500) (divs rec) $297 000 $73 870 $370 870 $14 620 $7 500 $7 120 $73 870/0.2 $369 350 $356 250 $13 100 $7 500 $5 600

= =

$14 620 $13 100

$1 520

DIFFERENT ENTRIES: Business combination valuation entries There is an extra BCVR entry under the full goodwill method: Goodwill Business combination valuation reserve

Dr Cr

5 600 5 600

Pre-acquisition entry The pre-acquisition changes under the full goodwill method: Retained earnings (1/7/18) * Dr 89 600 Share capital Dr 120 000 General reserve Dr 24 000 Business combination valuation reserve Dr 61 880 Goodwill Dr 1 520 Shares in Devil Ltd Cr 297 000 * (80% x $75 000) + (80% x $30 000) (GR transfer) + 80%(70% x $10000) (BCVR inv)

21.45

Solutions manual to accompany Company Accounting 10e

QUESTION 21.8 (cont’d) The first step in the calculation of the NCI changes to be: NCI share of equity at 1/7/16 Retained earnings (1/7/18) Dr 15 000 Share capital Dr 30 000 General reserve Dr 12 000 Business combination valuation reserve * Dr 16 870 NCI Cr * now includes 20% x $5 600 of BCVR – goodwill = $1 120

73 870

21.46

Chapter 21: Consolidation: non-controlling interest

Question 21.9

Partial goodwill method, gain on bargain purchase, intragroup transactions

On 1 July 2015, Water Ltd paid $236 400 for 75% of the share capital of Rat Ltd. At this date, the equity of Rat Ltd consisted of: Share capital (200 000 shares) General reserve Retained earnings

$ 200 000 80 000 40 000

A comparison of the carrying amounts and fair values of Rat Ltd’s assets at the acquisition date showed the following:

Land Plant (cost $150 000) Inventory Accounts receivable Goodwill

Carrying Fair value amount $184 000 $200 000 100 000 120 000 65 000 90 000 40 000 35 000 4 000

In relation to these assets, the following information is available:  The plant had a further 5-year life but was sold on 1 January 2017.  All the inventory was sold by 30 June 2016.  All the accounts receivable were collected by 30 June 2016. Any valuation reserves arising on consolidation are transferred on realisation of the asset to retained earnings. Water Ltd uses the partial goodwill method. The following transactions occurred between 1 July 2015 and 30 June 2017: 2016 Jan. Feb.

1 11

March 21 June

25 30

Aug. Sept.

14 21

2017 Jan. June

1 30

Rat Ltd transferred $20 000 from general reserve to retained earnings. Rat Ltd paid an $8000 dividend, half being from profits earned prior to 1 July 2015. Rat Ltd sold inventory to Water Ltd for $50 000 recording a before-tax profit of $10 000. Both companies use a perpetual inventory system. The tax rate is 30%. Rat Ltd declared a $15 000 dividend. Rat Ltd recorded a profit of $130 000. One-quarter of the inventory sold by Rat Ltd to Water Ltd on 21 March 2016 is still on hand in Water Ltd. The $15 000 dividend declared by Rat Ltd was paid. The remaining inventory in Water Ltd sold to it by Rat Ltd was sold outside the group. Rat Ltd paid a $16 000 dividend. Rat Ltd recorded a profit of $150 000.

Required Prepare the consolidation worksheet entries for the preparation of consolidated financial statements by Water Ltd at 30 June 2017

75% Water Ltd

Rat Ltd Water Ltd 75% NCI 25%

21.47

Solutions manual to accompany Company Accounting 10e

Acquisition analysis At 1 July 2015: Net fair value of identifiable assets and liabilities of Rat Ltd = ($200 000 + $80 000 + $40 000) (equity) + $16 000 (1 – 30%) (BCVR - land) + $20 000 (1 – 30%) (BCVR - plant) + $25 000 (1 – 30%) (BCVR - inventory) - $4 000 (goodwill) - $5 000 (1 – 30%) (BCVR - accs rec) = $355 200 (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Gain on bargain purchase

= = = = =

$236 400 25% x $355 200 $88 800 $325 200 $30 000

WORKSHEET ENTRIES AT 30 JUNE 2017 1. Business combination valuation entries Land Deferred tax liability Business combination valuation reserve Gain on sale/carrying amount of plant sold Depreciation expense Retained earnings (1/7/16) Income tax expense Transfer from business combination valuation reserve (Sale of plant)

Dr Cr Cr

16 000

Dr Dr Dr Cr

14 000 2 000 2 800

4 800 11 200

4 800 14 000

21.48

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.9 (cont’d)

2. Pre-acquisition entries Retained earnings (1/7/16) * Share capital General reserve ** Business combination valuation reserve Goodwill Shares in Rat Ltd

Dr Dr Dr Dr Cr Cr

25 500 150 000 45 000 18 900 3 000 236 400

* 75%($40 000 + $17 500 BCVR transfer inventory - $3 500 BCVR transfer accs. receivable + $20 000 general reserve transfer) - $30 000 gain on bargain purchase **75% ($80 000 - $20 000) Transfer from business combination valuation reserve Business combination valuation reserve (75% x $14 000 – sale of plant)

Dr Cr

10 500

Dr Dr Dr Dr Cr

10 000 50 000 9 800 20 000

10 500

3. NCI share of equity at 1/7/15 Retained earnings (1/7/16) Share capital Business combination valuation reserve General reserve NCI (25% of balances)

89 800

4. NCI share of equity from 1/7/15 – 30/6/16 Retained earnings (1/7/16) Dr 31 050 General reserve Cr Business combination valuation reserve Cr NCI Cr (RE: 25%($167 000 - $40 000 – ($4 000 - $1 200 depn on plant)) GR: 25% x $20 000)

5 000 3 500 22 550

Note: RE of $167 000 = $40 000 + $20 000 GR -$8 000 div - $15 000 div +$130 000 profit

21.49

Solutions manual to accompany Company Accounting 10e

QUESTION 21.9 (cont’d) 5. NCI share of equity from 1/7/16 – 30/6/17 NCI share of profit Dr NCI Cr (25%($150 000 – ($14 000 + $2 000 - $4 800) plant) Transfer from business combination valuation reserve Business combination valuation reserve (25% x $14 000 plant) NCI Dividend paid (25% x $16 000)

34 700 34 700

Dr Cr

3 500

Dr Cr

4 000

Dr Cr

12 000

3 500

4 000

6. Dividend paid Dividend revenue Dividend paid (75% x $16 000)

12 000

7. Unrealised profit in beginning inventory: Rat Ltd – Water Ltd Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

1 750 750

Dr Cr

437.50

2 500

8. NCI adjustment NCI share of profit Retained earnings (1/7/16) (25% x $1 750)

437.50

21.50

Chapter 21: Consolidation: non-controlling interest

Question 21.10

Full goodwill method, consolidation worksheet, consolidated financial statements

Western Ltd acquired 75% of the shares of Quoll Ltd on 1 July 2012. In exchange for these share Western Ltd gave a consideration of $26 000 cash and 10 000 shares in Western Ltd, these having a fair value of $2 each. At this date the shareholders’ equity of Quoll Ltd consisted of: Share capital (15 000 shares) Retained earnings

$ 45 000 9 000

At this date all the identifiable assets and liabilities of Quoll Ltd were recorded at amounts equal to their fair values except for plant for which the fair value was $2000 greater than the carrying amount of $25 000 (original cost was $35 000). The plant was expected to have a further 5-year life. The fair value of the non-controlling interest at 1 July 2012 was $15 000. Western Ltd uses the full goodwill method. The tax rate is 30%. Assets held by Quoll Ltd at 30 June 2017 include financial assets. Gains and losses on these assets are recognised in other comprehensive income. During the 2016–17 year Quoll Ltd recorded gains of $1500 on these assets. Financial information supplied by the two companies at 30 June 2017 was as follows:

Sales revenue Interest revenue Dividend revenue Cost of sales Financial expenses Selling expenses Other expenses Profit before tax Income tax expense Profit for the year Retained earnings (1/7/16) Dividend paid Retained earnings (30/6/17) Share capital Other components of equity Total equity Current liabilities Non-current liabilities: Loans Total liabilities Total equity and liabilities

Western Quoll Ltd Ltd $75 000 $118 000 375 1 000 2 700 1 000 78 075 120 000 (51 000) (87 750) (2 250) (3 000) (6 000) (9 000) (2 250) (2 250) (61 500) (102 000) 16 575 18 000 (7 500) (8 200) 9 075 9 800 28 900 21 700 37 975 31 500 (4 000) (3 600) 33 975 27 900 60 000 45 000 — 7 500 93 975 80 400 12 750 4 350 — 7 500 12 750 11 850 $106 725 $92 250

Plant Accumulated depreciation Shares in Quoll Ltd Loans from Quoll Ltd Inventory Cash Financial assets

45 000 (25 500) 46 000 3 750 13 400 21 075 0

90 000 (45 750) 0 0 23 250 750 16 500

21.51

Solutions manual to accompany Company Accounting 10e

Deferred tax assets Total assets

3 000 $106 725

7 500 $92 250

Additional information (a) At 1 July 2017, Western Ltd held inventory that had been sold to it by Quoll Ltd in the previous year at a profit of $1200. (b) During the 2016–17 year, Quoll Ltd sold inventory to Western Ltd for $28 500. At 30 June 2017, Western Ltd still had on hand inventory that had been sold to it by Quoll Ltd for a profit of $1800 before tax. (c) Interest of $375 was paid by Western Ltd to Quoll Ltd on both 30 June 2016 and 30 June 2017. Required Prepare the consolidated financial statements of Western Ltd for the year ended 30 June 2017.

75% Western Ltd

Quoll Ltd Western Ltd 75% NCI 25%

Acquisition analysis At 1 July 2012: Net fair value of identifiable assets and liabilities of Quoll Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = =

$45 000 + $9 000 (equity) + $2 000 (1 – 30%) (BCVR – plant) $55 400 $46 000 $15 000 $61 000 $5 600

= =

$15 000/25% $60 000

Goodwill of Quoll Ltd: Fair value of Quoll Ltd

Net fair value of identifiable assets and liabilities of Quoll Ltd = Goodwill of Quoll Ltd =

$55 400 $4 600

Goodwill of Western Ltd: Goodwill acquired = $5 600 Goodwill of Quoll Ltd = $4 600 Goodwill of Western Ltd – control premium = $1000

1. Business combination valuation entry Depreciation expense Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve

Dr Cr Dr Cr

400 120 1 120 1 400

21.52

Chapter 21: Consolidation: non-controlling interest

(1/5 x $2000 p.a. for 5 years) Goodwill Dr Business combination valuation reserve Cr

4 600 4 600

2. Pre-acquisition entry At 30 June 2017 (same as at 1/7/12): Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in Quoll Ltd

Dr Dr Dr Dr Cr

6 750 33 750 4 500 1 000 46 000

Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr (75% x $1 400)

1 050 1 050

3 NCI share of equity at 1/7/12 Retained earnings (1/7/16) Share capital Business combination valuation reserve NCI

Dr Dr Cr Cr

2 250 11 250 1 500

Dr Dr Cr

2 895 1 500

15 000

4. NCI share of equity: 1/7/12 - 30/6/16 Retained earnings (1/7/16) Other components of equity (1/7/16) NCI RE: 25% ($21 700 - $9 000 - $1 120) OCE: 25% x $6 000

4 395

5. NCI share of equity: 1/7/16- 30/6/17 NCI share of profit NCI (25% x $9 800)

Dr Cr

Transfer from business combination valuation reserve Dr Business combination valuation reserve Cr (25% x $1 400) Gain/(losses): other components of equity NCI (25% x $1500)

Dr Cr

2 450 2 450

350 350

375 375

21.53

Solutions manual to accompany Company Accounting 10e

NCI Dividend paid (25% x $3 600)

Dr Cr

900 900

6. Profit in opening inventory: Quoll Ltd - Western Ltd Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

840 360

Dr Cr

210

1 200

7. NCI adjustment NCI share of profit Retained earnings (1/7/16) (25% x $840)

210

8. Profit in ending inventory: Quoll Ltd - Western Ltd Sales

28 500

Cost of sales Inventory

Dr Cr Cr

Deferred tax asset Income tax expense

Dr Cr

540

Dr Cr

315

Dr Cr

3 750

Dr Cr

375

26 700 1 800

540

9. NCI adjustment NCI NCI share of profit (25% x $1260)

315

10. Loans Loans Loans from Quoll Ltd

3 750

11. Interest on loans Interest revenue Financial expenses

375

12. Dividend paid

21.54

Chapter 21: Consolidation: non-controlling interest

Dividend revenue Dividend paid (75% x $3 600)

Dr Cr

2 700 2 700

21.55

Solutions manual to accompany Company Accounting 10e

QUESTION 21.10 (cont’d) Financial Statements Sales revenue Interest rev. Dividend rev. Cost of sales Financial exp. Selling exp. Other exp. incl depreciation Profit before tax Tax expense

Western Quoll Ltd Ltd 75 000 118 000 375 1 000 2 700 1 000 78 075 120 000 51 000 87 750 2 250 6 000 2 250

3 000 9 000 2 250

8 200

Profit

9 075

9 800

Retained earnings (1/7/16) Transfer from BCVR

28 900

21 700

Other comp (op) Gains/losses Other comp (cl) Total equity: parent Total equity: NCI

1 200 26 700 375 1

Group

6 8 11

400

61 500 102 000 16 575 18 000 7 500

Dividend paid Retained earnings (30 /6/17) Share capital BCVR

8 11 12

Adjustments Dr Cr 28 500 375 2 700

37 975 4 000 33 975

31 500 3 600 27 900

60 000 0

45 000 0

93 975 0 0 0

72 900 6 000 1 500 7 500

NCI

Parent

15 475 5 7 41 890 3 4

2 450 210 2 250 2 895

315

13 130

210

36 955

350 5

350

164 500 1 000 1 000 166 500 110 850 4 875 15 000 4 900 135 625 30 875

1 2 6 2

2 2

360

1 120 6 750 840 1 050

33 750 4 500

120 540

1 8

1 400

2 700

4 600 1 050

1 2

15 400

57 715 4 900 52 815

900

71 250 3 1 150 3 125 215 6 000 4 1 500 5 7 500 132 715 5 9

Total equity

93 975

80 400

132 715

Current liabilities Loans Total liabilities Total equity and liabilities

12 750

4 350

17 100

0 12 750 106 725

7 500 11 850 92 250

3 750

11 250 1 500

350

15 000 4 395 2 450 375

3 4 5 5

21 005

132 715

3 750 20 850 153 565

60 000 0 106 085 4 500 1 125 5 625 111 710

1 500 375

900 315

50 085 4 000 46 085

21.56

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.10 (cont’d) Plant Accumulated depreciation Shares in Quoll Ltd Loans from Quoll Ltd Inventory Cash Financial assets Deferred tax assets Goodwill Total assets

45 000 90 000 (25500) (45750)

135 000 (71 250)

46 000

3 750

13 400 21 075 0 3 000

23 250 750 16 500 7 500

1 800

34 850 21 825 16 500 11 040

106 725

92 250

540

1 2

4 600 1 000 90 235

5 600 90 235

153 565

WESTERN LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2017 Revenue Sales revenue Interest revenue Dividend revenue Total revenue Expenses: Cost of sales Financial Expenses Selling Other Total expenses Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: gains Comprehensive income for the period Profit for the period attributable to: Parent interest Non-controlling interest Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$164 500 1 000 1 000 166 500 110 850 4 875 15 000 4 900 135 625 30 875 15 400 $15 475 1 500 $16 975

$13 130 2 345 $15 475 $14 255 2 720 $16 975

21.57

Solutions manual to accompany Company Accounting 10e

QUESTION 21.10 (cont’d) WESTERN LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2017

Comprehensive income for the period

Group $14 255

Parent $2 720

Retained earnings: Balance at 1 July 2016 Profit for the period Transfer from BCVR Dividend paid Balance at 30 June 2017

$41 890 15 475 350 (4 900) $52 815

$36 955 13 130 0 (4 000) $46 085

Other components of equity: Balance at 1 July 2016 Gains/losses Balance at 30 June 2017

$6 000 1 500 $7 500

$4 500 1 125 $5 625

Business combination valuation reserve at 1 July 2016 Transfer to retained earnings Business combination valuation reserve at 30 June 2017

$1 500 350 $1 150

0 0 0

Share capital: Balance at 1 July 2016 Balance at 30 June 2017

$71 250 $71 250

$60 000 $60 000

21.58

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.10 (cont’d) WESTERN LTD Consolidated Statement of Financial Position as at 30 June 2017 ASSETS Current Assets Inventories Cash Financial assets Total Current Assets Non-current Assets Property, plant and equipment Plant Accumulated depreciation Tax assets: Deferred tax assets Goodwill Total Non-current Assets Total Assets

EQUITY AND LIABILITIES Equity attributable to equity holders of the parent Share capital Reserves: Other components of equity Retained earnings Parent Entity Interest Non-controlling Interest Total Equity Current Liabilities: Non-current Liabilities: Interest-bearing liabilities: Loans Total Liabilities Total Equity and Liabilities

$34 850 21 825 16 500 73 175

$135 000 (71 250)

63 750 11 040 5 600 80 390 $153 565

$60 000 5 625 46 085 111 710 21 005 $132 715 17 100 3 750 $20 850 $153 565

21.59

Solutions manual to accompany Company Accounting 10e

Question 21.11

Partial goodwill method, consolidation worksheet.

Northern Ltd acquired 80% of the shares (cum div.) of Bettong Ltd on 1 July 2016 for $399 600. At this date, the shareholders’ equity of Bettong Ltd consisted of: Share capital General reserve Asset revaluation surplus Retained earnings

$ 375 000 15 000 22 500 15 000

At this date, Bettong Ltd’s liabilities included a dividend payable of $3000 while the assets included goodwill of $37 500. The dividend was paid on 15 August 2016. All the identifiable assets and liabilities of Bettong Ltd at 1 July 2016 had carrying amounts equal to their fair values except for:

Plant (cost $280 000) Brands Land Inventory

Carrying amount Fair value $100 000 $130 000 150 000 165 000 90 000 120 000 100 000 115 000

Note the following in relation to these assets:  Plant had an estimated useful life of 5 years.  Brands were assessed to have an indefinite useful life.  Land was sold on 1 January 2017 for $130 000.  Inventory was all sold outside the group by 30 June 2017. Northern Ltd uses the partial goodwill method. During the year ending 30 June 2017, the following events occurred: (a) Bettong Ltd sold inventory to Northern Ltd for $12 000. This inventory had cost Bettong Ltd $8000. At 30 June 2017, one-fifth of this inventory still remained in Northern Ltd. (b) On 1 April 2017, Bettong Ltd sold plant to Northern Ltd for $22 500. The plant had a carrying amount of $15 000 in the records of Bettong Ltd at time of sale to Northern Ltd. The asset was classified as inventory by Northern Ltd. It remained unsold at 30 June 2017. (c) Bettong Ltd recorded, as part of other comprehensive income, gains on revaluation of specialised plant of $7500. The tax rate is 30%. Financial information provided by the two companies at 30 June 2017 is as follows: Northern Ltd Sales Other income Total income Cost of sales Other expenses Total expenses Trading profit Gains/(losses) on sale of non-current assets Profit before tax Tax expense Profit for the year Retained earnings at 1 July 2016 Transfer from general reserve

$300 000 110 000 410 000 (220 000) (106 000) (326 000) 84 000 15 000 99 000 (34 000) 65 000 50 000 — 115 000

Bettong Ltd $240 000 50 000 290 000 (184 000) (51 000) (235 000) 55 000 30 000 85 000 (28 000) 57 000 15 000 12 000 84 000

21.60

Chapter 21: Consolidation: non-controlling interest

Dividend paid Dividend declared Retained earnings at 30 June 2017 Share capital General reserve Asset revaluation surplus Provisions Payables Deferred tax liabilities Non-current liabilities Total equity and liabilities

(20 000) (10 000) (30 000) 85 000 500 000 20 000 — 15 000 20 000 5 000 120 000 $765 000

(15 000) (6 000) (21 000) 63 000 375 000 3 000 30 000 10 000 8 000 2 000 50 000 $541 000

Shares in Bettong Ltd Plant Accumulated depreciation – plant Land Brands Deferred tax assets Goodwill Cash Receivables Inventory Total assets

$397 200 460 000 (370 000) 80 000 100 000 8 000 — 5 800 2 000 82 000 $765 000

— $410 000 (250 000) 120 000 170 000 8 500 37 500 5 000 5 000 35 000 $541 000

Required Prepare the consolidation worksheet for the preparation of consolidated financial statements by Northern Ltd at 30 June 2017.

80% Northern Ltd

Bettong Ltd Northern Ltd 80% NCI 20%

A. Consolidation worksheet entries Acquisition analysis At 1 July 2016: Net fair value of identifiable assets and liabilities of Bettong Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill acquired: parent only

= = = = = = =

($375 000 + $15 000 + $22 500 + $15 000) (equity) + $15 000 (1 – 30%) (inventory) + $30 000 (1 –30%) (land) + $30 000 (1 – 30%) (plant) + $15 000 (1 – 30%) (brands) - $37 500 (goodwill) $453 000 $399 600 – (80% x $3 000) div. $397 200 20% x $453 000 $90 600 $487 800 $487 800 - $453 000

21.61

Solutions manual to accompany Company Accounting 10e

Unrecorded goodwill

= = =

$34 800 $34 800 – (80% x $37 500) $4 800

1. Business combination valuation entries at 30 June 2017 Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

15 000

Gain on sale of land Income tax expense Transfer from business combination valuation reserve

Dr Cr

Brands Deferred tax liability Business combination valuation reserve

Dr Cr Cr

15 000

Accumulated depreciation - Plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

180 000

4 500

10 500 30 000 9 000

21 000

4 500 10 500

150 000 9 000 21 000

21.62

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.11 (cont’d) Depreciation expense - Plant Accumulated depreciation - Plant ($30 000/5)

Dr Cr

6 000

Deferred tax liability Income tax expense

Dr Cr

1 800

Retained earnings (1/7/16) Share capital General reserve Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Bettong Ltd

Dr Dr Dr Dr Dr Dr Cr

12 000 300 000 12 000 18 000 50 400 4 800

Transfer from general reserve General reserve (80% x $12 000)

Dr Cr

9 600

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of inventory: 80% x $10 500)

Dr Cr

8 400

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of land: 80% x $21 000)

Dr Cr

16 800

Dr Dr Dr Dr Dr Cr

3 000 75 000 3 000 4 500 12 600

6 000

1 800

2. Pre-acquisition entry 30/6/17

397 200

9 600

8 400

16 800

3. NCI share of equity at 1 July 2016 Retained earnings (1/7/16) Share capital General reserve Asset revaluation surplus Business combination valuation reserve NCI (20% of balances)

98 100

21.63

Solutions manual to accompany Company Accounting 10e

QUESTION 21.11 (cont’d) 4. NCI share of equity: 1/7/16 – 30/6/17 NCI share of profit Dr 1 860 NCI Cr 1 860 (20% ($45 000 – ($15 000 - $4 500) – ($30 000 - $9 000) –($6 000 – $1 800))) Transfer from general reserve Dr General reserve Cr (NCI share of reserve transfer: 20% x $12 000) Transfer from business combination valuation reserve Business combination valuation reserve (20% ($10 500 + $21 000))

2 400 2 400

Dr Cr

6 300

Gains/Losses: asset revaluation surplus NCI (20% x $7 500)

Dr Cr

1 500

NCI Interim dividend paid (20% x $15 000)

Dr Cr

3 000

NCI Final dividend declared (20% x $6 000)

Dr Cr

1 200

Dr Cr

12 000

Dividend payable Dividend declared (80% x $6 000)

Dr Cr

4 800

Dividend revenue Dividend receivable

Dr Cr

4 800

6 300

1 500

3 000

1 200

5. Interim dividend paid Dividend revenue Dividend paid (80% x $15 000)

12 000

6. Final dividend declared

4 800

21.64

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.11 (cont’d) 7. Intragroup sales of inventory: Bettong Ltd – Northern Ltd Sales Cost of goods sold Inventory

Dr Cr Cr

12 000

Deferred tax asset Income tax expense

Dr Cr

240

Dr Cr

112

11 200 800

240

8. NCI adjustment NCI NCI share of profit (20% x $560)

112

9. Transfer of plant to inventory: Bettong Ltd – Northern Ltd Gain on sale of plant Inventory

Dr Cr

7 500

Deferred tax asset Income tax expense

Dr Cr

2 250

Dr Cr

1 050

7 500

2 250

10. NCI adjustment NCI NCI share of profit (20%($7 500 - $2 250))

1 050

21.65

Solutions manual to accompany Company Accounting 10e

QUESTION 21.11 (cont’d) Financial Northern Bettong Statements Ltd Ltd Sales revenue 300 000 240 000 Other income 110 000 50 000

Cost of sales Other expenses Trading profit Gains on noncurrent assets Profit before tax Tax expense

410 000 290 000 220 000 184 000 106 000 51 000 326 000 235 000 84 000 55 000 15 000 30 000

7 5 6

Adjustments Dr Cr 12 000 12 000 4 800

1 1

15 000 6 000

1 9

30 000 7 500

99 000

85 000

34 000

28 000

Profit

65 000

57 000

Ret. earnings (1/7/16) Transfer from BCV reserve Transfer from general reserve

50 000

15 000

12 000

2 2 2

8 400 16 800 9 600

115 000 20 000 10 000 30 000 85 000

84 000 15 000 6 000 21 000 63 000

Dividend paid Div. declared

Ret. earnings (30/6/17) Share capital 500 000 375 000 General reserve 20 000 3 000 BCVR 0 0

ARS (1/7/16) Gains/Losses ARS (30/6/17) Total equity: parent Total equity: NCI

Total equity

605 000 441 000 0 22 500 0 7 500 0 30 000

605 000 471 000

11 200

Group

NCI

Parent

63 690 4

1 860

112 1 050

53 000 3

3 000

50 000

6 300 4

6 300

2 400 4

2 400

528 000 143 200

671 200 407 800 163 000 570 800 100 400 7 500 107 900

4 500 9 000 1 800 240 2 250

2 2 2

300 000 12 000 50 400

18 000

10 500 21 000

1 1 1 7 9

1 1

12 000 4 800

5 6

9 600 10 500 21 000 8 400 16 800

2 1 1 2 2

44 210

125 390 23 000 11 200 34 200 91 190 575 000 3 20 600 3 6 300 3

75 000 3 000 12 600

693 090 4 500 3 7 500 4 12 000

4 500 1 500

4 4 8 10

3 000 1 200 112 1 050

8 10

3 000 1 200

4 4

2 400 6 300

4 4

112 992 20 000 10 000 30 000 82 992 500 000 20 000 0

602 992 0 6 000 6 000 608 992 98 100 1 860 1 500

3 4 4

705 090

62 992

96 098

705 090

21.66

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.11 (cont’d)

Provisions Payables Deferred tax liabilities Non-current liabilities Total liabilities Total equity and liabilities

15 000 20 000 5 000

10 000 8 000 2 000

120 000

50 000

170 000

160 000 70 000 765 000 541 000

236 900 941 990

Shares in Bettong Ltd Plant Accumulated depreciation Land Brands Deferred tax assets Cash Receivables Inventory

397 200

Goodwill Total assets

0 37 500 765 000 541 000

6 1

460 000 410 000 (370 000)(250 000) 1 80 000 120 000 100 000 170 000 8 000 8 500 5 800 2 000 82 000

4 800 1 800

1 7 9

5 000 5 000 35 000

180 000

4 500 9 000

397 200

150 000 6 000

1 1

720 000 (446 000) 200 000 285 000 18 990

15 000 240 2 250 4 800 800 7 500

1 1

25 000 23 200 18 700

4 800 723 390 723 390

6 7 9

10 800 2 200 108 700 42 300 941 990

21.67

Solutions manual to accompany Company Accounting 10e

Question 21.12

Partial goodwill, consolidation worksheet

On 1 July 2015, Mallee Ltd acquired 80% of the issued shares (cum div.) of Fowl Ltd for $166 400. At this date, the equity of Fowl Ltd consisted of: Share capital General reserve Retained earnings

$ 120 000 24 000 16 000

At 1 July 2015, one of the liabilities of Fowl Ltd was a dividend payable of $10 000. This was paid on 1 September 2015. One of the assets recorded by Fowl Ltd was goodwill of $5000. Mallee Ltd uses the partial goodwill method. At 1 July 2015, all the identifiable assets and liabilities of Fowl Ltd were recorded at amounts equal to their fair values except for: Carrying amount Fair value $80 000 $88 000 60 000 80 000 40 000 52 000

Plant (cost $100 000) Land Inventory

In relation to these assets:  The plant had an expected useful life of 4 years.  Land is measured in the records of Mallee Ltd at fair value. The land on hand at 1 July 2015 was sold by Mallee Ltd on 8 February 2017. On sale any related asset revaluation surplus is transferred to retained earnings.  The inventory was all sold by 30 June 2016. Additional information (a) In June 2016, Fowl Ltd transferred $8000 from the general reserve existing at 1 July 2015 to retained earnings. There were no other transfers relating to the general reserve in 2015– 16. (b) At 30 June 2016, Fowl Ltd recognised gains on revaluation of land of $6000 in other comprehensive income for the period. (c) In June 2016, Fowl Ltd sold inventory to Mallee Ltd for $7000. This had originally cost Fowl Ltd $5000. 20% of this inventory remained unsold by Mallee Ltd at 30 June 2016. (d) During the 2016–17 period, Fowl Ltd inventory to Mallee Ltd for $120 000. At 30 June 2017, Mallee Ltd holds inventory sold to it by Fowl Ltd for $20 000 which had cost Fowl Ltd $15 000. (e) On 1 January 2016, Fowl Ltd sold an item of inventory to Mallee Ltd at a before tax profit of $5000. This asset was classified as plant by Mallee Ltd and depreciated over a 5-year period. (f) The tax rate is 30%. (g) Financial information provided by the companies at 30 June 2017 was as follows:

Sales revenue Other revenue Total revenue Cost of sales Other expenses Total expenses Profit before tax Tax expense Profit for the period

Mallee Ltd Fowl Ltd $910 000 $624 000 60 000 65 600 970 000 896 600 (625 000) (464 000) (225 000) (129 600) 850 000 573 600 120 000 96 000 (30 000) (32 000) 90 000 64 000

21.68

Chapter 21: Consolidation: non-controlling interest

Retained earnings at 1 July 2016 Transfer from asset revaluation surplus Transfer to general reserve Dividend paid Dividend declared Retained earnings at 30 June 2017 Share capital General reserve Asset revaluation surplus Total equity Provisions Payables Deferred tax liabilities Non-current liabilities Total liabilities Total equity and liabilities

100 000 — — (20 000) (30 000) 140 000 400 000 — — 540 000 40 000 30 000 12 000 78 000 160 000 $700 000

48 000 14 000 (12 000) (12 000) (16 000) 86 000 120 000 28 000 10 000 254 000 30 000 40 000 15 000 65 000 150 000 $404 000

Shares in Fowl Ltd Plant Accumulated depreciation – plant Land Intangibles Deferred tax assets Cash Receivables Inventory Goodwill Total assets

$153 400 800 000 (544 000) 60 000 75 000 15 000 20 000 40 600 80 000 4 000 $700 000

— $320 000 (120 000) 90 000 60 000 8 000 5 000 6 000 30 000 5 000 $404 000

Required Prepare the consolidation worksheet for the preparation of consolidated financial statements by Mallee Ltd at 30 June 2017.

80% Mallee Ltd

Acquisition analysis At 1 July 2015: Net fair value of assets and liabilities of Fowl Ltd

(a) Consideration transferred i. = (b) Non-controlling interest Aggregate of (a) and (b) Goodwill: parent only Unrecorded goodwill

Fowl Ltd Mallee Ltd 80% NCI 20%

($120 000 + $24 000 + $16 000) (equity) + $8 000 (1 – 30%) plant + $20 000 (1 – 30%) land + $12 000 (1 – 30%) inventory - $5 000 (goodwill) = $183 000 = $161 400 – (80% x $10 000) div receivable $153 400 = 20% x $183 000 = $36 600 = $190 000 = $7 000 = $7 000 – (80% x $5000)

21.69

Solutions manual to accompany Company Accounting 10e

$3 000

1. BCVR entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation (1/4 x $8 000 p.a. for 2 years)

Dr Dr Cr

2 000 2 000

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

1 200

12 000 2 400 5 600

4 000

600 600

2. Pre-acquisition entries at 30/6/17 Retained earnings (1/7/16) * Dr 25 920 Share capital Dr 96 000 Asset revaluation surplus Dr 11 200 General reserve Dr 12 800 Business combination valuation reserve Dr 4 480 Goodwill Dr 3 000 Shares in Fowl Ltd Cr 153 400 * = 80% ($16 000 + $8 000 transfer from general reserve + $8 400 BCVR inventory) Transfer from asset revaluation surplus Transfer to retained earnings (Transfer on sale of land in current period)

Dr Cr

11 200

21.70

Chapter 21: Consolidation: non-controlling interest

QUESTION 21 12 (cont’d) 3. NCI share of equity at 1/7/15 Retained earnings (1/7/16) Share capital Asset revaluation surplus General reserve Business combination valuation reserve NCI

Dr Dr Dr Dr Dr Cr

3 200 24 000 2 800 4 800 2 800 37 600

4. NCI share of equity: 1/7/15-30/6/16 Retained earnings (1/7/16) Dr 7 800 Asset revaluation surplus Dr 1 200 General reserve Cr 1 600 BCVR Cr 1 680 NCI Cr 5 720 (RE: 20% ($48 000 - $16 000 – ($2 000 - $600) +$8 400 t’fer BCVR inventory) BCVR: 20% x $8 400 sale of inventory GR: 20% x $8 000 ARS: 20% [$20 000 - $14 000]) 5. NCI share of equity: 1/7/16-30/6/17 NCI share of profit NCI (20% ($64 000 – ($2 000 - $600))

Dr Cr

12 520

Transfer from asset revaluation surplus Transfer to retained earnings (20% x $14 000)

Dr Cr

2 800

Gains on revaluation of land NCI (20% x $4 000)

Dr Cr

800

General reserve Transfer to general reserve (20% x $12 000)

Dr Cr

2 400

NCI

Dr Cr

2 400

Dr Cr

3 200

Dr Cr

9 600

Dividend paid (20% x $12 000) NCI Dividend declared (20% x $16 000) 6.

12 520

2 800

800

2 400

3 200

Dividend paid this period Dividend revenue Dividend paid (80% x $12 000)

9 600

21.71

Solutions manual to accompany Company Accounting 10e

QUESTION 21.12 (cont’d) 7.

Dividend declared this period Dividend payable Dividend declared (80% x $16 000)

Dr Cr

12 800

Dividend revenue Dividend receivable

Dr Cr

12 800

8. Unrealised profit in opening inventory: Fowl Ltd to Mallee Ltd Retained earnings (1/7/16) Income tax expense Cost of sales (Unrealised profit is 20% x $2 000)

Dr Dr Cr

280 120 400

9. NCI adjustment NCI share of profit Retained earnings (1/7/16) (20% x $280)

Dr Cr

56 56

10. Unrealised profit in closing inventory: Fowl Ltd to Mallee Ltd Sales revenue Cost of sales Inventory

Dr Cr Cr

120 000

Deferred tax asset Income tax expense

Dr Cr

1 500

Dr Cr

700

115 000 5 000

1 500

11. NCI adjustment NCI NCI share of profit (20% x $3500)

700

12. Sale of inventory to non-current asset: Fowl Ltd to Mallee Ltd Retained earnings (1/7/16) Deferred tax asset Plant

Dr Dr Cr

3 500 1 500

Dr Cr

700

5 000

13. NCI adjustment NCI Retained earnings (1/7/16) (20% x $3 500)

700

21.72

Chapter 21: Consolidation: non-controlling interest

QUESTION 21 12 (cont’d) 14. Depreciation on plant Accumulated depreciation Dr Depreciation expense Cr Retained earnings (1/7/16) Cr (Depreciation of 20% x $5 000 p.a. for 1.5 years) Income tax expense Retained earnings (1/7/16) Deferred tax asset

1 500 1 000 500

Dr Dr Cr

300 150

Dr Dr Cr

140 70

450

15. NCI adjustment NCI share of profit Retained earnings (1/7/16) NCI (20% x ($1 000 - $300) p.a.)

210

21.73

Solutions manual to accompany Company Accounting 10e

QUESTION 21 12 (cont’d) Financial Statements Sales revenue Other revenue

Mallee Fowl Ltd Ltd 910 000 624 000 60 000 65 600

Cost of sales

970 000 869 600 625 000 464 000

Other expenses

10 6 7

225 000 129 600 850 000 573 600 120 000 96 000

30 000

32 000

8 14

Profit

90 000

64 000

Retained earnings (1/7/16)

100 000

48 000

14 000

Profit before tax Tax expense

Transfer from ARS Transfer to general reserve Dividend paid Dividend declared

ARS (1/7/16) Transfer to RE Gains/losses ARS (30/6/17) Total equity: parent Total equity: NCI

Total equity

400 115 000 2 000 1 000

120 300

2 000 25 920 280 3 500 150 11 200

600 1 500

600 500

Group

20 000 30 000

12 000 16 000

0 0 540 000 234 000 0 20 000

0 0

(14 000) 4 000 10 000

540 000 254 000

9 600 12 800

NCI

Parent

127 680 5 9 15 117 250 3 4 15

12 520 56 140 3 200 7 800 70

700 11

115 664

56 700

106 936

2 800 5

2 800

1 414 000 103 200

8 10 14

1 10

1 14

190 000 126 000 0 12 000

50 000 40 000 Ret. earnings 140 000 86 000 (30/6/16) Share capital 400 000 120 000 General reserve 0 28 000 BCVR

1 2 8 12 14 2

Adjustments Dr Cr 120 000 9 600 12 800

6 7

1 517 200 973 600 355 600 1 329 200 188 000 60 320

9 13

247 730 12 000

2 400

222 600 9 600

22 400 33 200

2 400 3 200

5 5

20 000 30 000

67 600 180 130 2 2

96 000 12 800

4 480

11 200

5 600

11 200

59 600 163 000

424 000 3 15 200 3 5 1 120 3 620 450 8 800 3 4 (2 800) 4 000 5 10 000

24 000 4 800 2 400 2 800

5 5 11 13

2 400 3 200 700 700

630 450

1 680

0 572 600 4 800

2 800

0 3 200 8 000 580 600

37 600 5 720 12 520 800 210 72 386

3 4 5 5 15

49 850

2 800 1 200 800

72 386

400 000 9 600

1 600

630 450

21.74

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.11 (cont’d)

Financial Statements Provisions Payables Deferred tax liabilities Non-current liabilities Total liabilities Total equity and liabilities

Mallee Ltd 40 000 30 000 12 000

Fowl Ltd 30 000 40 000 15 000

78 000

65 000

143 000

160 000 150 000 700 000 404 000

308 400 938 850

7 1

Shares in Fowl Ltd Plant

153 400

Accumulated depreciation Land Intangibles Deferred tax assets Cash Receivables Inventory Goodwill Total assets

(544 000)(120 000) 1 14 60 000 90 000 75 000 60 000 15 000 8 000 10 12 20 000 5 000 40 600 6 000 76 000 30 000 4 000 5 000 2 700 000 404 000

Adjustments

Group

12 800 1 200

80 000 57 200 28 200

2 400

153 400

800 000 320 000

12 000 5 000 4 000

1 1103 000 12 1 (646 500)

450

150 000 135 000 25 550

12 800 5 000

7 10

20 000 1 500

1 500 1 500

3 000 353 850 353 850

NCI

Parent

25 000 33 800 101 000 12 000 938 850

21.75

Solutions manual to accompany Company Accounting 10e

Question 21.13

Full goodwill method, consolidation worksheet, consolidated financial statements

King Ltd acquired 80% of the shares of Parrot Ltd on 1 July 2013 for $115 000. At this date the equity of Parrot Ltd consisted of: Share capital (100 000 shares) General reserve Retained earnings

$ 80 000 2 400 29 600

All the identifiable assets and liabilities of Parrot Ltd were recorded at amounts equal to their fair values except for:

Plant (cost $65 000) Land Inventory

Carrying Fair value amount $52 000 $56 000 40 000 45 000 25 000 28 000

The plant was expected to have a further useful life of 10 years. The land was sold on 1 January 2016. The inventory was all sold by 30 June 2014. King Ltd uses the full goodwill method. The fair value of the non-controlling interest at 1 July 2013 was $28 000. At 1 July 2013, Parrot Ltd had unrecorded brands that had a fair value of $18 000. These had an indefinite life. Additional information (a) Parrot Ltd had inventory on hand at 30 June 2015 that included inventory at cost of $8000 that had been sold to it by King Ltd. This inventory had cost King Ltd $6000. It was all sold by Parrot Ltd by 30 June 2016. (b) During the 2015–16 year, Parrot Ltd sold inventory to King Ltd for $48 000. At 30 June 2016, King Ltd still had some of this inventory on hand. This inventory had been sold to it by Parrot Ltd at a profit of $4000. (c) On 1 January 2015, Parrot Ltd sold plant to King Ltd for $16 000. This had a carrying amount in Parrot Ltd at time of sale of $12 000. Plant of this class is depreciated at 20% p.a. (d) Management and consultation fees derived by King Ltd are all from Parrot Ltd and represent charges for administration $1760 and technical services for the manufacturing section $2240. (e) All debentures issued by Parrot Ltd are held by King Ltd. (f) Other components of equity relate to movements in the fair values of financial assets held by the entities. Gains and losses on these financial assets are recognised in other comprehensive income. The balance of the other components of equity account at 1 July 2015 was $8000 (King Ltd) and $6400 (Parrot Ltd). (g) Financial information provided by the two companies at 30 June 2016 was:

Sales revenue Debenture interest Management and consultation fees Dividends Total revenue Cost of sales Manufacturing expenses Depreciation on plant

King Ltd Parrot Ltd $252 800 $176 000 4 000 — 4 000 — 9 600 — 270 400 176 000 (104 000) (68 000) (82 000) (53 000) (12 000) (12 000)

21.76

Chapter 21: Consolidation: non-controlling interest

Administrative expenses Financial expenses Other expenses Total expenses Profit from trading Gains on sale of non-current assets Profit before income tax Income tax expense Profit for the year Retained earnings at 1 July 2015

Retained earnings at 30 June 2016 Share capital General reserve Other components of equity Debentures Current tax liability Dividend payable Deferred tax liabilities Other current liabilities Total equity and liabilities

(12 000) (8 800) (11 200) 230 000 40 400 10 000 50 400 (20 000) 30 400 40 000 70 400 (8 000) (8 000) (16 000) 54 400 240 000 37 600 10 400 160 000 20 000 8 000 12 000 60 000 $602 400

(6 400) (4 000) (9 600) 153 000 23 000 5 000 28 000 (13 600) 14 400 36 000 50 400 (8 000) (4 000) (12 000) 38 400 80 000 8 000 8 000 80 000 13 600 4 000 5 600 9 600 $247 200

Shares in Parrot Ltd Debentures in Parrot Ltd Plant Accumulated depreciation Intangibles Accumulated amortisation Deferred tax assets Financial assets Land Inventory Receivables Total assets

$115 000 80 000 96 000 (52 000) 60 800 (32 000) 58 600 40 000 120 000 72 000 44 000 $602 400

— — $81 600 (44 000) 44 000 (20 000) 24 000 48 000 45 600 44 000 24 000 $247 200

Dividend paid Dividend declared

Required Prepare the consolidated financial statements of King Ltd at 30 June 2016.

80% King Ltd

Parrot Ltd King Ltd 80% NCI 20%

Acquisition analysis At 1 July 2013: Net fair value of assets and liabilities of Parrot Ltd =

$80 000 + $2 400 + $29 600 (equity) + $4 000 (1 – 30%) (plant) + $5 000 (1 – 30%) (land) + $3 000 (1 – 30%) (inventory) + $18 000 ( 1- 30%) (brands(

21.77

Solutions manual to accompany Company Accounting 10e

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Goodwill of Parrot Ltd: Fair value of Parrot Ltd Net fair value of identifiable assets and liabilities of Parrot Ltd Goodwill of Parrot Ltd Goodwill of King Ltd: Goodwill acquired Goodwill of Parrot Ltd Goodwill of King Ltd: control premium

= = = = =

$133 000 $115 000 $28 000 $143 000 $10 000

= =

$28 000/20% $140 000

= =

$133 000 $7 000

= =

$10 000 $7 000

$3 000

1. Business combination valuation entries At 30 June 2016: Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

13 000

Depreciation expense Retained earnings (1/7/15) Accumulated depreciation ($4 000/10 = $400 p.a.)

Dr Dr Cr

400 800

Deferred tax liability Income tax expense Retained earnings (1/7/15)

Dr Cr Cr

360

9 000 1 200 2 800

1 200

120 240

21.78

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.13 (cont’d) Gain/loss on sale of land Income tax expense Transfer from business combination valuation reserve

Dr Cr

5 000

Brands Deferred tax liability Business combination valuation reserve

Dr Cr Cr

18 000

Goodwill Business combination valuation reserve

Dr Cr

7 000

Retained earnings (1/7/15)* Share capital General reserve Business combination valuation reserve ** Goodwill Shares in Parrot Ltd * 80% ($29 600 + $2 100 BCVR inventory) ** 80% x ($2 800 + $3 500 + $12 600 + $7 000)

Dr Dr Dr Dr Dr Cr

25 360 64 000 1 920 20 720 3 000

Transfer from business combination valuation reserve Business combination valuation reserve (80% x $3 500 BCVR land)

Dr Cr

2 800

Retained earnings (1/7/15) Dr Share capital Dr General reserve Dr Business combination valuation reserve * Dr NCI Cr * 20% x ($2 800 + $3 500 + $2 100 + $12 600 + $7 000)

5 920 16 000 480 5 600

1 500

3 500

5 400 12 600

7 000

2. Pre-acquisition entries

115 000

2 800

NCI share of equity at 1/7/13

28 000

NCI share of equity: 1/7/13 - 30/6/15 Retained earnings (1/7/15) Dr 1 588 General reserve Dr 1 120 Other components of equity (1/7/15) Dr 1 120 Business combination valuation reserve Cr NCI Cr (RE: 20% ($36 000 - $29 600 + $2 100 BCVR inventory – ($800 - $240)) GR: 20% ($8 000 - $2 400) BCVR: 20% x $2 100 OCE: 20% x $6 400)

420 3 408

21.79

Solutions manual to accompany Company Accounting 10e

QUESTION 21.13 (cont’d) 5.

NCI share of equity: 1/7/15 - 30/6/16 NCI share of profit NCI (20% ($14 400 – ($400 - $120)))

Dr Cr

3 530

Transfer from business combination valuation reserve Business combination valuation reserve (20% x $3 500)

Dr Cr

700

3 530

700

Gains/Losses: other components of equity NCI (20%[$8 000 - $6 400])

Dr Cr

320

NCI

Dr Cr

1 600

Dr Cr

800

Interim dividend paid (20% x $8 000) NCI Final dividend declared (20% x $4 000)

320

2 000

800

6. Unrealised profit in opening inventory: King Ltd to Parrot Ltd Retained earnings (1/7//15) Income tax expense Cost of sales

Dr Dr Cr

1 400 600 2 000

7. Unrealised profit in closing inventory: Parrot Ltd to King Ltd Sales

Dr Cr Cr

48 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

1 200

Dr Cr

560

44 000 4 000

1 200

8. NCI adjustment NCI NCI share of profit (20% x $2 800)

560

9. Transfer of plant in prior period: Parrot Ltd – King Ltd

Retained earnings (1/7/15) Deferred tax asset Plant

Dr Dr Cr

2 800 1 200 4 000

21.80

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.13 (cont’d) 10. NCI adjustment NCI Retained earnings (1/7/15) (20% x $2 800) 11.

Dr Cr

560 560

Depreciation on plant transfer Accumulated depreciation Depreciation expense Retained earnings (1/7/15) (20% x $4000 p.a. for 1.5 years)

Dr Cr Cr

1 200

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

240 120

Dr Dr Cr

112 56

Dr Cr Cr

4 000

Debentures Debentures in Parrot Ltd

Dr Cr

80 000

Debenture interest revenue Financial expenses

Dr Cr

4 000

Dr Cr

6 400

Dividend payable Dividend declared (80% x $4 000)

Dr Cr

3 200

Dividend revenue Dividend receivable

Dr Cr

3 200

800 400

360

12. NCI adjustment NCI share of profit Retained earnings (1/7/15) NCI

168

13. Intragroup services Management and consulting fees Administrative expenses Manufacturing expenses

1 760 2 240

14. Debentures

80 000

4 000

15. Dividend paid Dividend revenue Dividend paid (80% x $8 000)

6 400

16. Dividend declared

3 200

21.81

Solutions manual to accompany Company Accounting 10e

QUESTION 21.13 (cont’d) Financial Statements Sales revenue Interest revenue Management fees Dividend revenue Total revenues Cost of sales

King Parrot Ltd Ltd 252 800 176 000 4 000 0

4 000

9 600

15 16

6 400 3 200

270 400 176 000 104 000 68 000

30 400

14 400

Retained earnings (1/7/15)

40 000

36 000

70 400 8 000 8 000 16 000 54 400

50 400 8 000 4 000 12 000 38 400

Retained earnings (30/6/16) Share capital 240 000 General reserve 37 600

80 000 8 000

332 000 126 400 Other comp (op) 8 000 6 400 Gains/losses 2 400 1 600 Other comp (cl) 10 400 8 000 342 400 134 400

400

5 000

6 11

600 240

2 2

800 25 360 1 400 2 800 120 2 800

64 000 1 920

Parent Cr

2 000 44 000 2 240

6 7 13

800 1 760 4 000

11 13 14

3 530 112 5 920 1 588 56

560

27 498

560

39 156

700

380 800 126 000 131 760 24 600 16 640 8 800 20 800 328 600 52 200 10 000 62 200

120 1 500 1 200

1 1 7

31 620

30 580 1 2 6 9 11 2

NCI Dr

380 800 0

Profit for year

Dividend paid Div. declared

Group

4 000

Manufacturing 81 000 53 000 expenses Depreciation 13 000 12 000 Administrative 12 000 6 400 Financial 8 800 4 000 Other 11 200 9 600 Total expenses 230 000 153 000 Profit from 40 400 23 000 trading Gains on sale 10 000 5 000 Profit before 50 400 28 000 tax Tax expense 20 000 13 600

Transfer from BCVR

7 14

Adjustments Dr Cr 48 000 4 000

240 400

1 11

46 160

5 12 3 4 12

3 500

700

6 400 3 200

15 16

77 440 9 600 8 800 18 400 59 040

256 000 43 680 358 720 14 400 4 000 18 400 377 120

1 600 800

3 3 4 4 5

16 000 480 1 120 1 120 320

5 5

66 654 8 000 8 000 16 000 50 654

240 000 42 080 332 734 13 280 3 680 16 960 349 694

21.82

Chapter 21: Consolidation: non-controlling interest

BCVR

20 720

2 800 12 600 7 000 2 800

1 1 1 2

4 480

Parent interest NCI

Total equity 342 400 134 400 Current tax 20 000 13 600 liability Deferred tax 12 000 5 600 liability Dividend 8 000 4 000 payable Debentures 160 000 80 000 Other liabilities 60 000 9 600 260 000 112 800 Total equity 602 400 247 200 and liabilities Shares in Parrot Ltd Debentures in Parrot Ltd Plant

360

1 200 5 400

1 1

3 200

8 800

80 000

160 000 69 600 295 840 677 440

115 000

80 000

96 000

81 600

9 000 4 000 1 200

1 9 1

164 600

602 400 247 200

1 11 1

13 000 1 200 18 000

7 9

1 200 1 200

420 700

4 5

5 5 8 10

1 600 800 560 560

28 000 3 408 3 530 320 168 40 066

3 4 5 5 12

40 066

349 694 31 906

381 600

(83 000) 122 800 (52 000)

360

4 000 3 200 1 2

5 600

23 840

115 000

Accumulated (52 000) (44 000) depreciation Intangibles 60 800 44 000 Accumulated (32 000) (20 000) amortisation Deferred tax 58 600 24 000 assets Financial assets 40 000 48 000 Land 120 000 45 600 Inventory 72 000 44 000 Receivables 44 000 24 000 Goodwill 0 0 Total assets

381 600 33 600

7 000 3 000 319 920 319 920

7 16

84 640 88 000 165 600 112 000 64 800 10 000 677 440

21.83

Solutions manual to accompany Company Accounting 10e

QUESTION 21.13 (cont’d) KING LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2016 Revenue: Sales Expenses: Cost of sales Manufacturing Depreciation Administrative Financial Other

$380 800

Profit from trading Gains from sale of non-current assets Profit before tax Income tax expense Profit for the period

126 000 131 760 24 600 16 640 8 800 20 800 328 600 52 200 10 000 62 200 31 620 $30 580

Other comprehensive income: Other components of equity: gains Comprehensive income for the period

4 000 $ 34 580

Profit for the period attributable to: Parent entity interest Non-controlling interest

$27 498 $3 082

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$31 178 $3 402

21.84

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.13 (cont’d) KING LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2016

Comprehensive income for the period

Group $34 580

Parent $31 178

Retained earnings: Balance at 1 July 2015 Profit for the period Dividend paid Dividend declared Balance at 30 June 2016

$46 160 30 580 (9 600) (8 800) $59 040

$39 156 27 498 (8 000) (8 000) $50 654

General reserve: Balance at 1 July 2015 Balance at 30 June 2016

$43 680 $43 680

$42 080 $42 080

Business combination valuation reserve Balance at 1 July 2015 Balance at 30 June 2016

$5 180 $4 480

---

Other components of equity: Balance at 1 July 2015 Gains/Losses Balance at 30 June 2016

$14 400 4 000 $18 400

$13 280 $3 680 $16 960

21.85

Solutions manual to accompany Company Accounting 10e

QUESTION 21.13 (cont’d) KING LTD Consolidated Statement of Financial Position as at 30 June 2016 Current Assets Inventories Receivables Financial assets

$112 000 64 800 88 000 264 800

Non-current Assets Property, plant and equipment Plant Accumulated depreciation Land Intangibles Accumulated amortisation Tax assets: Deferred tax asset Goodwill Total Non-current Assets Total Assets

164 600 (83 000) 165 600 247 200 122 800 (52 000) 84 640 10 000 412 640 $677 440

Equity and liabilities Equity attributable to equity holders of the parent Share capital Reserves: General reserve Other components of equity Retained earnings Parent Entity Interest Non-controlling Interest Total Equity Current Liabilities Tax liabilities: Current tax liability Payables: Dividend payable Other Total Current Liabilities Non-current Liabilities Interest-bearing liabilities: Debentures Tax liabilities: Deferred tax liability Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

$240 000 42 080 16 960 50 654 349 694 31 906 381 600

33 600 8 800 69 600 112 000 160 000 23 840 183 840 295 840 $677 440

21.86

Chapter 21: Consolidation: non-controlling interest

Question 21.14

Partial and full goodwill methods, consolidation worksheet entries

On 1 July 2012, Fin Ltd acquired 75% of the shares (cum div.) of Whale Ltd for $67 500. At this date the equity of Whale Ltd consisted of: Share capital General reserve Retained earnings

$ 30 000 3 000 15 000

At the date of the business combination, all the identifiable assets and liabilities of Whale Ltd had carrying amounts equal to their fair values except for: Carrying amount Plant (cost $60 000) Inventory Receivables

Fair value $40 000 25 000 33 000

$55 000 31 000 30 000

The plant had a further useful life of 5 years. It was sold by Whale Ltd on 1 April 2017 for $3000. At 30 June 2013, all the inventory was sold to entities outside the group. Also, by 30 June 2013, receivables of $33 000 had been collected. One of the liabilities of Whale Ltd at 1 July 2012 was dividend payable of $10 000. The tax rate is 30%. Fin Ltd uses the partial goodwill method. Additional information (a) At 30 June 2016, inventory of Fin Ltd included assets sold to it by Whale Ltd for a beforetax profit of $300. These items were sold to external entities during the 2016–17 year. (b) During the 2016–17 year, Whale Ltd had sold inventory to Fin Ltd for $60 000. The mark-up on sales was 25% on cost. At 30 June 2017, Fin Ltd still had some of this inventory on hand, amounting to items acquired from Whale Ltd for $3000. (c) On 1 January 2017, Whale Ltd sold plant to Fin Ltd for a before-tax profit of $1200. This plant was carried at $3000 (original cost $20 000) in the records of Whale Ltd at time of sale. Depreciation on this type of plant is calculated using a 20% p.a. straight-line method. (d) Financial information provided by Whale Ltd concerning events affecting it during the 2016–17 year was as follows: Profit for the year Retained earnings at 1 July 2016 Dividend paid Dividend declared Transfer to general reserve Retained earnings at 30 June 2017

$23 400 30 000 53 400 (12 000) (6 000) (1 500) 19 500 $33 900

Whale Ltd also reported a comprehensive income for the year of $34 650, which included gains on revaluation of land of $750 as the asset revaluation surplus in relation to the land had increased from $3000 to $3750 over the year. Required A. Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Fin Ltd at 30 June 2017.

21.87

Solutions manual to accompany Company Accounting 10e

Prepare the consolidation worksheet entries that would be used at 30 June 2017 if Fin Ltd had used the full goodwill method and the fair value of the non-controlling interest at 1 July 2012 was $19 500. 75% Fin Ltd

Whale Ltd Fin Ltd NCI

75% 25%

A: PARTIAL GOODWILL METHOD Acquisition analysis At 1 July 2012: Net fair value of identifiable assets and liabilities of Whale Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = = =

($30 000 + $3 000 + $15 000) (equity) + $15 000 (1 – 30%)(plant) + $6 000 (1 – 30%) (inventory) - $3 000 (1 – 30%) (receivables) $60 600 $67 500 – (75% x $10 000) (div) $60 000 25% x $60 600 $15 150 $75 150 $75 150 - $60 600 $14 550

1. Business combination valuation entries at 30/6/17 Depreciation expense Gain/(loss) on sale of plant Income tax expense Retained earnings (1/7/12) Transfer from business combination valuation reserve (Depreciation is 20% x $15 000 per annum)

Dr Dr Cr Dr

2 250 750 900 8 400

10 500

2. Pre-acquisition entries at 30/6/17 Pre-acquisition entries at 1/7/12 Retained earnings (1/7/12) Share capital Business combination valuation reserve General reserve Goodwill Shares in Whale Ltd

Dr Dr Dr Dr Dr Cr

11 250 22 500 9 450 2 250 14 550

60 000

21.88

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.14 (cont’d) Pre-acquisition entry at 30/6/17 Retained earnings (1/7/16) * Share capital Business combination valuation reserve ** General reserve Goodwill Shares in Whale Ltd

Dr Dr Dr Dr Dr Cr

12 825 22 500 7 875 2 250 14 550 60 000

* 75%[$15 000 + $4 200 (inventory) – $2 100 (receivables)] ** 75% x $10 500 plant

Transfer from business combination valuation reserve Business combination valuation reserve (75% x $10 500)

Dr Cr

7 875

Dr Dr Dr Dr Cr

3 750 7 500 3 150 750

Dr Dr Cr Cr

1 650 750

7 875

3. NCI share of equity at 1/7/12 Retained earnings (1/7/16) Share capital Business combination valuation reserve General reserve NCI (25% of balances)

15 150

4. NCI share of equity: 1/7/12 - 30/6/16 Retained earnings (1/7/15) Asset revaluation surplus (1/7/15) Business combination valuation reserve NCI RE: 25% ($30 000 - $15 000 - $8 400) BCVR: 25% (70% [$6 000 - $3 000]) ARS: 25% x $3 000

525 1 875

21.89

Solutions manual to accompany Company Accounting 10e

QUESTION 21.14 (cont’d) 5. NCI share of equity: 1/7/16 - 30/6/17 NCI share of profit NCI (25%($23 400 – ($2 250 + $750 - $900)))

Dr Cr

5 325

General reserve Transfer to general reserve (25% x $1 500)

Dr Cr

375

Gains/Losses on revaluation of land NCI (25% x $750)

Dr Cr

187.50

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of plant: 25% x $10 500) NCI Dividend paid (25% x $12 000) NCI Dividend declared (25% x $6 000)

5 325

375

187.50

Dr Cr

2 625

Dr Cr

3 000

Dr Cr

1 500

2 625

3 000

1 500

6. Dividend paid Dividend revenue Dividend paid (75% x $12 000)

Dr Cr

9 000

Dividend payable Dividend declared (75% x $6 000)

Dr Cr

4 500

Dividend revenue Dividend receivable

Dr Cr

4 500

9 000

7. Dividend declared

4 500

21.90

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.14 (cont’d) 8 Sale of inventory in prior period: Fin Ltd– Whale Ltd Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

210 90

Dr Cr

52.50

300

9. NCI adjustment NCI share of profit Retained earnings (1/7/16) (25% x $210)

52.50

10. Profit in closing inventory: Fin Ltd – Whale Ltd Sales

Dr Cr Cr

60 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

180

Dr Cr

105

59 400 600

180

11. NCI adjustment NCI NCI share of profit (25% x $420)

105

12. Sale of non-current asset: Fin Ltd – Whale Ltd Gain on sale of non-current assets Plant

Dr Cr

1 200

Deferred tax asset Income tax expense

Dr Cr

360

Dr Cr

210

1 200

360

13. NCI adjustment NCI NCI share of profit (25% x $840)

210

21.91

Solutions manual to accompany Company Accounting 10e

QUESTION 21.14 (cont’d)

14. Depreciation Accumulated depreciation Depreciation expense (1/2 x 20% x $1200)

Dr Cr

120

Income tax expense Deferred tax asset

Dr Cr

120

15. NCI adjustment NCI share of profit NCI (25% x $84)

21.92

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.14 (cont’d) B: FULL GOODWILL METHOD Acquisition analysis At 1 July 2012 Net fair value of identifiable assets and liabilities of Whale Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

($30 000 + $3 000 + $15 000) (equity) + $15 000 (1 – 30%)(plant) + $6 000 (1 – 30%) (inventory) - $3 000 (1 – 30%) (receivables) $60 600 $67 500 – (75% x $10 000) dividend $60 000 $19 500 $79 500 $18 900

Goodwill of Whale Ltd: Fair value of Whale Ltd

= =

$19 500/25% $78 000

Net fair value of identifiable assets and liabilities of Whale Ltd Goodwill of Whale Ltd

= =

$60 600 $17 400

Goodwill of Fin Ltd: Goodwill acquired Goodwill of Whale Ltd Goodwill of Fin Ltd – control premium

= = =

$18 900 $17 400 $1 500

DIFFERENT ENTRIES 1. Business combination valuation entries at 30/6/17 An additional entry is required: Goodwill Business combination valuation reserve 2.

Dr Cr

17 400 17 400

Pre-acquisition entry at 30/6/13: Retained earnings (1/7/16) * Dr 12 825 Share capital Dr 22 500 Business combination valuation reserve ** Dr 20 925 General reserve Dr 2 250 Goodwill Dr 1 500 Shares in Whale Ltd Cr * 75%[$15 000 + $4 200 (inventory) – $2 100 (receivables)] ** 75% ($10 500 plant + $17 400 goodwill)

60 000

3. NCI share of equity at 1/7/12 Retained earnings (1/7/16) Share capital Business combination valuation reserve General reserve NCI * 25% x ($10 500 + $4 200 - $2 100 + $17 400)

Dr Dr Dr Dr Cr

3 750 7 500 7 500 750 19 500

21.93

Solutions manual to accompany Company Accounting 10e

Question 21.15

Full goodwill method, consolidated financial statements

On 1 July 2014, Mudlark Ltd acquired 80% of the shares of Peewee Ltd on an ex div basis for $305 600. At this date, all the identifiable assets and liabilities of Peewee Ltd were recorded at amounts equal to fair value except for:

Inventory Machinery (cost $200 000)

Carrying amount Fair value $120 000 $130 000 160 000 165 000

At 30 June 2014, Peewee Ltd had recorded a dividend payable of $10 000. The inventory on hand at 1 July 2014 was all sold by 30 November 2014. The machinery had a further 5-year life, but was sold on 1 April 2017. At acquisition date, Peewee Ltd reported a contingent liability of $15 000 that Mudlark Ltd considered to have a fair value of $7000. This liability was settled in June 2015 for $10 000. At acquisition date, Peewee Ltd had not recorded an asset relating to equipment design as the asset was still in the research phase. Mudlark Ltd placed a fair value on the asset of $12 000, reflecting expected benefits existing at acquisition date. The asset was considered to have a further 10-year life. On 1 January 2016, the asset met the requirements of IAS 38 Intangible Assets and subsequent expenditure by Peewee Ltd on the asset was capitalised. Mudlark Ltd uses the full goodwill method. At 1 July 2014, the fair value of the noncontrolling interest was $75 000. Additional information (a) On 1 July 2015, Peewee Ltd sold an item of plant to Mudlark Ltd at a profit before tax of $4000. Mudlark Ltd depreciates this class of plant at a rate of 10% p.a. on cost while Peewee Ltd applies a rate of 20% p.a. on cost. (b) At 30 June 2016, Mudlark Ltd had on hand some items of inventory purchased from Peewee Ltd in June 2015 at a profit before tax of $500. These were all sold by 30 June 2017. (c) During the 2016–17 period Mudlark Ltd sold $12 000 inventory to Peewee Ltd at a markup of 20% on cost. $3000 of this inventory remains unsold by 30 June 2017. (d) The other components of equity relate to financial assets. These assets are measured at fair value with movements in fair value being recognised in other comprehensive income. (e) The parent and the subsidiary are considered to be separate cash generating units. Management have analysed the impairment indicators on an annual basis and conducted an impairment test on the subsidiary cash generating unit in the 2015–16 year, which resulted in the writing down of goodwill in the records of the subsidiary by $4000. There have been no other business combinations involving these entities since 1 July 2014. (f) The tax rate is 30%. (g) Shareholder approval is not required in relation to dividends. (h) On 30 June 2017 the trial balances of Mudlark Ltd and Peewee Ltd were as follows: Debit balances Shares in Peewee Ltd Inventory Financial assets Other current assets Deferred tax assets Plant Land Equipment design Goodwill

Mudlark Peewee Ltd Ltd $305 600 — 180 000 $60 000 229 000 215 000 10 000 2 000 15 800 8 000 452 100 303 000 144 200 42 000 — 18 000 20 000 22 000

21.94

Chapter 21: Consolidation: non-controlling interest

Cost of sales Other expenses Income tax expense Dividend paid Dividend declared Credit balances Share capital Other components of equity Other reserves Retained earnings (1/7/16) Transfer from other reserves Sales Other revenue Gains/losses on sale of non-current assets Debentures Deferred tax liability Other current liabilities Dividend payable Accumulated amortisation – equipment design Accumulated impairment losses – goodwill Accumulated depreciation – plant

120 000 50 000 35 000 14 000 20 000 $1 595 700

70 000 10 000 40 000 6 000 4 000 $800 000

$800 000 100 000 50 000 45 000 — 200 000 40 000 10 000 70 000 20 000 38 700 10 000 — — 212 000 $1 595 700

$330 000 80 000 1 000 16 000 2 000 140 000 25 000 5 000 20 000 12 000 35 000 4 000 4 000 16 000 110 000 $800 000

(i) Extracts from the statement of changes in equity for Peewee Ltd were as follows: 2014–15 2015–16 2016–17 Retained earnings (opening balance) $20 000 $19 000 $16 000 Profit for the year 20 000 20 000 50 000 Dividends paid (3 000) (6 000) (6 000) Dividends declared (15 000) (17 000) (4 000) Transfers to/from other reserves* (3 000) — 2 000 Retained earnings (closing balance) $19 000 $16 000 $58 000 Other reserves (opening balance) $30 000 $33 000 $33 000 Transfers to/from retained earnings* 3 000 — (2 000) Bonus issue* — — (30 000) Other reserves (closing balance) $33 000 $33 000 $1 000 Other components of equity (op. bal.) $10 000 $42 000 $72 000 Movements in fair value 32 000 30 000 8 000 Other components of equity (cl. bal.) $42 000 $72 000 $80 000 Share capital (opening balance) $300 000 $300 000 $300 000 Bonus issue* — — 30 000 Share capital (closing balance) $300 000 $300 000 $330 000 * These items were from equity earned prior to 1 July 2014. Required Prepare the consolidated financial statements of Mudlark Ltd at 30 June 2017.

At 1 July 2014: Peewee Ltd: Goodwill Accum. impairment losses ($16 000 - $4 000)

$22 000 12 000 10 000

21.95

Solutions manual to accompany Company Accounting 10e

Net fair value of identifiable assets, liabilities and contingent liabilities of Peewee Ltd = $300 000 + $30 000 + $10 000 + $20 000 + $10 000 (1 – 30%) (BCVR – inventory) + $5 000 (1 – 30%) (BCVR – machine) - $7 000 (1 – 30%) (BCVR – provision) + $12 000 (1 – 30%) (BCVR – equip. design) - $10 000 (goodwill) = $364 000 (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = =

$305 600 $75 000 $380 600 $16 600

Goodwill of Peewee Ltd: Fair value of Peewee Ltd

= =

$75 000/20% $375 000

Net fair value of identifiable assets and liabilities of Peewee Ltd Goodwill of Peewee Ltd Recorded goodwill Unrecorded goodwill

= = = =

$364 000 $11 000 $10 000 $1 000

Goodwill of Mudlark Ltd: Goodwill acquired Goodwill of Peewee Ltd Goodwill of Mudlark Ltd – control premium

= = =

$16 600 $11 000 $5 600

21.96

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.15 (cont’d) CONSOLIDATION WORKSHEET ENTRIES 1. Business combination entries Equipment design Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Amortisation expense Retained earnings (1/7/16) Accumulated amortisation (1/10 x $12 000 p.a. for 3 years)

Dr Dr Cr

1 200 2 400

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

1 080

Depreciation expense Gain on sale of machinery Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve (Depreciation is 1/5 x $5 000 p.a.)

Dr Dr Cr Dr

750 2 250

Accumulated impairment losses – goodwill Goodwill

Dr Cr

12 000

Goodwill Business combination valuation reserve

Dr Cr

1 000

3 600 8 400

3 600

360 720

900 1 400

3 500

12 000

1 000

21.97

Solutions manual to accompany Company Accounting 10e

QUESTION 21.15 (cont’d) 2. Pre-acquisition entries At 1 July 2014: Retained earnings (1/7/14) Share capital Other reserves (1/7/14) Other components of equity (1/7/14) Business combination valuation reserve Goodwill Shares in Peewee Ltd

Dr Dr Dr Dr Dr Dr Cr

16 000 240 000 24 000 8 000 12 000 5 600

Dr Dr Dr Dr Dr Dr Cr

15 280 240 000 26 400 8 000 10 320 5 600

305 600

At 30 June 2017: Retained earnings (1/7/16) Share capital Other reserves (1/7/16) Other components of equity (1/7/16) Business combination valuation reserve Goodwill Shares in Peewee Ltd

305 600

RE: 80%[$20 000 + $7 000 (BCVR – inv) - $4 900 (BCVR –prov) - $3 000 (transfer to other reserves)] Other reserves: 80% ($30 000 + $3 000) BCVR: 80%($3 500 + $8 400 + $1 000)

Share capital Other reserves: bonus issue (Bonus issue: 80% x $30 000)

Dr Cr

24 000

Transfer from other reserves [RE] Transfer to retained earnings [OR] (80% x $2 000)

Dr Cr

1 600

Dr Cr

2 800

Transfer from business combination valuation reserve Business combination valuation reserve (80% x $3500)

24 000

1 600

2 800

21.98

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.15 (cont’d) 3. NCI share of equity at acquisition date 1/7/14 Retained earnings (1/7/16) Dr 4 000 Share capital Dr 60 000 Other reserves (1/7/09) Dr 6 000 Other components of equity (1/7/16) Dr 2 000 Business combination valuation reserve * Dr 3 000 NCI Cr 75 000 (20% of balances) * 20% x ($7 000 inv + $3 500 mach - $4 900 liab. + $8 400 eq design + $1000 g’will) 4. NCI share of changes in equity from 1/7/14 to 30/6/16 Other reserves (1/7/16) Dr Other components of equity (1/7/16) Dr Retained earnings (1/7/16) Cr Business combination valuation reserve Cr NCI Cr RE: 20% [$16 000 - $20 000 - $1 400 – ($2 400 - $720)] BCVR: 20% ($7 000 - $4 900) Other reserves: 20% ($33 000 - $30 000) Other components: 20% ($72 000 - $10 000)

600 12 400 1 416 420 11 164

5. NCI share of changes in equity from 1/7/16 to 30/6/17 NCI share of profit Dr 9 412 NCI Cr (20% [$50 000 – ($1 200 - $360) – ($750 + $2 250 - $900)] NCI

Dr Cr

1 200

Dr Cr

800

Transfer from other reserves [RE] Transfer to retained earnings [OR] (20% x $2 000)

Dr Cr

400

Share capital Other reserves: bonus issue (20% x $30 000)

Dr Cr

6 000

Movements in fair value [OCE] NCI (20% x $8 000)

Dr Cr

1 600

Dividend paid (20% x $6 000) NCI Dividend declared (20% x $4 000)

9 412

1 200

800

400

6 000

1 600

21.99

Solutions manual to accompany Company Accounting 10e

QUESTION 21.15 (cont’d) Transfer from business combination valuation reserve Business combination valuation reserve (20% x $3 500)

Dr Cr

700

Dr Cr

4 800

Dividend revenue Dividend declared (80% x $4 000)

Dr Cr

3 200

Dividend payable Dividend receivable

Dr Cr

3 200

Dr Dr Cr

2 800 1 200

Dr Cr

560

Accumulated depreciation Retained earnings (1/7/16) Depreciation expense (10% x $4 000 p.a.)

Dr Cr Cr

800

Income tax expense Retained earnings (1/7/16) Deferred tax asset

Dr Dr Cr

120 120

Dr Dr Cr

56 56

700

6. Dividend paid Dividend revenue Dividend paid (80% x $6 000)

4 800

7. Dividend declared

3 200

8. Sale of plant: Peewee Ltd to Mudlark Ltd Retained earnings (1/7/16) Deferred tax asset Plant

4 000

9. NCI effect NCI Retained earnings (1/7/16) (20% x $2 800

560

10. Depreciation

400 400

240

11. NCI effect NCI share of profit Retained earnings (1/7/16) NCI

112

21.100

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.15 (cont’d) 12. Profit in opening inventory Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

350 150

Dr Cr

500

13 NCI effect NCI share of profit Retained earnings (1/7/16)

14. Sales of inventory: current period Mudlark Ltd to Peewee Ltd Sales

12 000

Cost of sales Inventory

Dr Cr Cr

Deferred tax asset Income tax expense

Dr Cr

150

11 500 500

150

21.101

Solutions manual to accompany Company Accounting 10e

QUESTION 21.15 (cont’d) Financial Mudlark Peewee Statements Ltd Ltd Sales revenue 200 000 140 000 Other revenue 40 000 25 000

Cost of sales

240 000 165 000 120 000 70 000

Other expenses

50 000

10 000

170 000 70 000 10 000

80 000 85 000 5 000

80 000

90 000

35 000

40 000

Profit

45 000

50 000

Ret. earnings (1/7/16)

45 000

16 000

Transfer from BCVR Transfer from other reserves

Trading profit Gains on noncurrent assets Profit before tax Tax expense

Dividend paid Div. declared

14 6 7

1 1

12 000 4 800 3 200

1 200 750

10 12

120 150

2 000

1 600

90 000 14 000 20 000 34 000 56 000

68 000 6 000 4 000 10 000 58 000

856 000 388 000 35 000 33 000 15 000

12 14 10

61 550 239 550 145 450 12 750

360 900 150

1 1 14

73 860

84 340

500 11 500 400

385 000 178 000

158 200

BCVR

Parent Cr

328 000 57 000

2 250

2 400 1 400 15 280 2 800 120 350 2 800

800 000 330 000

NCI Dr

1 1 2 8 10 12 2

Ret. earnings (30/6/17) Share capital

Other reserves (1/7/16) Transfer to/from RE Bonus issue Other reserves (30/6/17)

Group

240 000 24 000 10 320

9 412 56 70 4 000 56

74 802

720 400

1 10

39 770

3 500

700

400

4 800 3 200

2 2 2

5 11 13 3 11

8 400 1 000 2 800

6 7

1 1 2

125 210 15 200 20 800 36 000 89 210

26 400

1 200 800

866 000

1 880

957 090 41 600

1 416 560 70

3 4

60 000 6 000 3 000

5 5

37 760

112 562 14 000 20 000 34 000 78 562 800 000

420 700

4 5

878 562 35 000

6 000 600

(2 000)

1 600

14 600

400

0 (30 000) 50 000 1 000

24 000

(6 000) 50 200

6 000

4 9 13

15 000 0 50 000

21.102

Chapter 21: Consolidation: non-controlling interest

OCE (1/7/16)

90 000

72 000

Movements OCE (30/6/17) Total equity: parent Total equity: NCI

10 000 100 000

8 000 80 000

Total equity

1006000 469 000

Dividend 10 000 4 000 payable Other current 38 700 35 000 Deferred tax 20 000 12 000 liabilities Debentures 70 000 20 000 Total liabilities 138 700 71 000 Total equity 1144700 540 000 and liabilities Shares in Peewee Ltd Plant Accumulated depreciation Equipment design Accumulated amortisation Land Deferred tax assets Inventory Financial assets Receivables Goodwill Accumulated impairment losses Total assets

305 600

8 000

18 000 172 000

1179290 7

3 200

1 080

452 100 303 000 (212 000)(110 000) 10 18 000

(4 000)

144 200 15 800

42 000 8 000

180 000 60 000 229 000 215 000 10 000 2 000 20 000 22 000 0 (16 000)

1144700 540 000

3 4 5

2 000 12 400 1 600

5 5 9

1 200 800 560

75 000 11 164 9 412 1 600 112 108 854 108 854

139 600 16 400 156 000 1 084 562 3 4 5 5 11

94 728

1 179 290

10 800

3 600

73 700 34 520 90 000 209 020 1388310

154 000

8 14

1 2 1

305 600

4 000

800

751 100 (321 200)

12 000

30 000

1 200 150

1 000 5 600 12 000

3 600

(7 600)

240

186 200 24 910

500

3 200 12 000

7 1

396 970 396 970

239 500 444 000 8 800 36 600 (4 000)

1388310

21.103

Solutions manual to accompany Company Accounting 10e

QUESTION 21.15 (cont’d)

MUDLARK LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2017 Revenue: Sales Other Total revenue Expenses: Cost of sales Other

$328 000 57 000 385 000

Profit from trading Gains from sale of non-current assets Profit before tax Income tax expense Profit for the period

178 000 61 550 239 550 145 450 12 750 158 200 73 860 $84 340

Other comprehensive income: Movements in fair value of financial assets Comprehensive income for the period

18 000 $102 340

Profit for the period attributable to: Parent entity interest Non-controlling interest

$74 802 $9 538

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$91 202 $11 138

21.104

Chapter 21: Consolidation: non-controlling interest

QUESTION 21.15 (cont’d)

MUDLARK LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2017

Comprehensive income for the period

Group $102 340

Parent $91 202

Retained earnings: Balance at 1 July 2016 Profit for the period Transfer from BCVR Transfer from other reserves Dividend paid Dividend declared Balance at 30 June 2017

$39 770 84 340 700 400 (15 200) (20 800) $89 210

$37 760 74 802 0 0 (14 000) (20 000) $78 562

Other reserves: Balance at 1 July 2016 Transfers to/from retained earnings Bonus issue of shares Balance at 30 June 2017

$41 600 14 600 (6 000) $50 200

$35 000 15 000 ____0 $50 000

Business combination valuation reserve Balance at 1 July 2016 Balance at 30 June 2017

$2 550 $1 880

0 0

$154 000 18 000 $172 000

$139 600 $16 400 $156 000

Other components of equity: Balance at 1 July 2016 Gains/Losses Balance at 30 June 2017

21.105

Solutions manual to accompany Company Accounting 10e

QUESTION 21.15 (cont’d)

MUDLARK LTD Consolidated Statement of Financial Position as at 30 June 2017 Current Assets Inventories Receivables Financial assets

$239 500 8 800 444 000 692 300

Non-current Assets Property, plant and equipment Plant Accumulated depreciation Equipment design Accumulated amortisation Land Tax assets: Deferred tax asset Goodwill Accumulated impairment losses Total Non-current Assets Total Assets

751 100 (321 200) 30 000 (7 600) 186 200 24 910 36 600 (4 000) 696 010 $1 388 310

Equity and liabilities Equity attributable to equity holders of the parent Share capital Reserves: Other reserves Other components of equity Retained earnings Parent Entity Interest Non-controlling Interest Total Equity Current Liabilities Payables: Dividend payable Other Total Current Liabilities Non-current Liabilities Interest-bearing liabilities: Debentures Tax liabilities: Deferred tax liability Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

$800 000 50 000 156 000 78 562 1 084 562 94 728 1 179 290

10 800 73 700 84 500 90 000 34 520 124 520 209 020 $1 388 310

21.106

Chapter 22: Consolidation: other issues

Chapter 22 – Consolidation: other issues REVIEW QUESTIONS 1.

What is the difference between direct and indirect NCI? Direct NCI (DNCI) own shares directly in an entity. Indirect NCI are DNCI shareholders in an entity which is a parent of another entity. These DNCI are then the INCI in the subsidiary. Example: 80% A Ltd

60% B Ltd

C Ltd

A Ltd 80% DNCI 20%

A Ltd 48% DNCI 40% INCI 12%

Explain the difference in the calculation of the direct and indirect NCI. Direct NCI receive a share of all equity of the subsidiary while indirect NCI receive a share of only post-acquisition equity. In adjusting the NCI for the effects of intragroup transactions, generally there is no difference between INCI and DNCI. However where dividends are paid/payable by a subsidiary containing an INCI, adjustments are necessary to ensure no double counting occurs.

Why does the indirect NCI receive a share of only post-acquisition equity? Assume: 80% A Ltd

60% B Ltd

C Ltd

A Ltd 80% DNCI 20%

A Ltd 48% DNCI 40% INCI 12%

The DNCI in B Ltd receives a share of the whole of the equity of B Ltd which includes equity relating to the asset “Shares in C Ltd”. This asset reflects the assets of C Ltd that were on hand in C Ltd at the date B Ltd acquired its shares in C Ltd. The pre-acquisition equity of C Ltd also relates to these assets. As the DNCI receives a share of the equity of B Ltd relating to these assets, and as the DNCI in B Ltd is the same party as the INCI in C Ltd, to give the DNCI a share of all the equity of B Ltd as well as the INCI in C Ltd getting a share of the preacquisition equity of C Ltd would double-count the share of equity to the NCI. As the investment account “Shares in C Ltd” only relates to the pre-acquisition equity of C Ltd, the INCI is then entitled to a share of the post-acquisition equity of C Ltd.

22.1

Solutions manual to accompany Company Accounting 10e

What effect does the existence of an indirect NCI have on the adjustments for intragroup transactions? The effect is the same as that for DNCI except in the case of dividends – see 5. below.

What effect does the existence of an indirect NCI have on the adjustments for dividends paid within a group? Assume: 80% A Ltd

60% B Ltd

C Ltd

A Ltd 80% DNCI 20%

A Ltd 48% DNCI 40% INCI 12%

If C Ltd pays/declares a dividend and dividend revenue is recognised by B Ltd, then the share of equity attributed to the DNCI in B Ltd must be adjusted for the dividend revenue recognised by B Ltd using an entry of the order: NCI NCI Share of Profit/Loss

Dr Cr

x x

The INCI in C Ltd is given a share of the post-acquisition profits of C Ltd prior to the appropriation of any dividend. The INCI in C Ltd is unaffected by any NCI adjustments for dividends paid/declared by C Ltd – only DNCI in C is affected. The profits of C Ltd are then used to pay dividends to B Ltd and recognised as revenue by B Ltd. Hence the profits of C Ltd are now also being shown in B Ltd as dividend revenue. To give the INCI in C Ltd a share of the profits of C Ltd as well as give the DNCI in B Ltd a share of the profits of B Ltd including the dividend revenue from C Ltd would double count the NCI share of equity. Hence the above adjustment is required, reducing the NCI share in total as well as the NCI share of current period profit/loss.

In the pre-acquisition entry, why are only partial eliminations made when a NCI exists? Consider the following group: 80% A Ltd

60% B Ltd

C Ltd

A Ltd 80% DNCI 20%

A Ltd 48% DNCI 40% INCI 12%

When B Ltd acquires its shares in C Ltd, the investment in B Ltd relates to the 60% of the equity/net assets acquired in C Ltd. The cost of the combination paid by B Ltd then relates to the proportional share of equity/net assets acquired in C Ltd. Hence, in the pre-acquisition entry, only a proportional share of C Ltd’s equity is eliminated. At acquisition date, all the equity of C Ltd is pre-acquisition equity. As the INCI is entitled to a share of post-acquisition equity only [see DQ 2 above], the INCI is not entitled to a share of

22.2

Chapter 22: Consolidation: other issues

C Ltd’s equity when preparing the consolidated financial statements immediately after the combination.

Why is no adjustment made for an indirect NCI when preparing consolidated financial statements immediately after acquisition? INCI receive a share of post-acquisition equity only. The only equity on hand at acquisition or immediately after acquisition is pre-acquisition equity. Hence there is no need to make any calculations for the INCI share of equity.

Explain the effects on the consolidation process when the acquisition is non-sequential. Assume: 80% A Ltd

60% B Ltd

C Ltd

A Ltd 80% DNCI 20%

A Ltd 48% DNCI 40% INCI 12%

A sequential acquisition occurs when A Ltd acquires its shares in B Ltd prior to or at the same time as B Ltd acquires its shares in C Ltd. A non-sequential acquisition occurs when B Ltd acquires its shares in C Ltd prior to A Ltd acquiring its shares in B Ltd. The complicating factor with such an acquisition is that when A Ltd acquires its shares in B Ltd one of the assets of B Ltd is “Shares in C Ltd”, and its carrying amount may be different from its fair value due to an increase in the net assets of C Ltd subsequent to B Ltd’s acquisition of shares in C Ltd. As a result, in preparing the acquisition analysis of A Ltd – B Ltd the post-acquisition equity recognised by C Ltd and any differences between carrying amounts and fair values of C Ltd’s assets and liabilities must be taken into account.

What are reciprocal ownership interests? Reciprocal ownership interests arise when two entities within a group each own shares in each other: 40% A Ltd

B Ltd 20%

22.3

Solutions manual to accompany Company Accounting 10e

10.

Explain how reciprocal ownership interests are accounted for on consolidation. Reciprocal ownership interests arise when two entities within a group each own shares in each other: 40% A Ltd

B Ltd 20%

The problem on consolidation is to determine the NCI share of equity given the reciprocal relationship. Assuming A Ltd is the parent, there is a DNCI in B Ltd of 60%. The determination of the INCI share of equity, given that the NCI has an interest in both A Ltd and B Ltd is more difficult. Techniques such as simultaneous equations can be used to assist in determining the relative shares of equity.

22.4

Chapter 22: Consolidation: other issues

CASE STUDY QUESTIONS Case Study 1

Non-controlling interest

P Ltd owns 20% of B Ltd. In recent months it has been in takeover discussions with A Ltd, and agreement has finally been reached between the different parties on the acquisition by P Ltd of 60% of the issued shares of A Ltd. One of the assets of A Ltd is a 70% holding in B Ltd. The group accountant of P Ltd has been examining the new group under the control of P Ltd and considering the implications for the preparation of consolidated financial statements. One of the members of the accounting team, Mei Fen, has raised the issue of accounting for indirect non-controlling interests. According to Mei Fen, with the new group structure there are both direct and indirect non-controlling interests, and she argues that different measurements are then required. The group accountant has asked you to determine the non-controlling interests in the new group, differentiating between different non-controlling interest groups, and to explain the difference, if any, in the calculation of their interests in group equity. Prepare a report for the group accountant. The ownership interests are as follows: P Ltd 20% 60% A Ltd

70%

A Ltd:

DNCI = 40% P Ltd = 60%

B Ltd:

DNCI = 10% INCI = 28% P Ltd = 62%

B Ltd

Direct NCI receives a share of all equity of the subsidiary while indirect NCI receive a share of only post-acquisition equity. In adjusting the NCI for the effects of intragroup transactions, generally there is no difference between INCI and DNCI. However where dividends are paid/payable by a subsidiary containing an INCI, adjustments are necessary to ensure no double counting occurs. The DNCI in A Ltd receives a share of the whole of the equity of A Ltd which includes equity relating to the asset “Shares in B Ltd”. This asset reflects the assets of B Ltd that were on hand in B Ltd at the date A Ltd acquired its shares in B Ltd. The pre-acquisition equity of B Ltd also relates to these assets. As the DNCI receives a share of the equity of A Ltd relating to these assets, and as the DNCI in A Ltd is the same party as the INCI in B Ltd, to give the DNCI a share of all the equity of A Ltd as well as the INCI in B Ltd getting a share of the pre-acquisition equity of B Ltd would doublecount the share of equity to the NCI. As the investment account “Shares in B Ltd” only relates to the pre-acquisition equity of B Ltd, the INCI is then entitled to a share of the post-acquisition equity of B Ltd.

22.5

Solutions manual to accompany Company Accounting 10e

Case Study 2

Dividends and non-controlling interests

Andrew Brown is the group accountant for P Ltd. P Ltd owns 60% of A Ltd which owns 70% of B Ltd. He has just completed the preparation of the consolidated financial statements of the group, and is discussing issues raised by the auditors. The auditors have raised concerns about the accounting for a dividend paid by B Ltd to A Ltd in the current period. They argue that further consolidation adjustments are necessary to avoid double-counting the non-controlling interest’s share of equity. Andrew has asked for your advice concerning the effect of the payment of such a dividend on the determination of the non-controlling interest share of equity. Write a report to Andrew explaining the non-controlling interests that exist within the group, and how the calculation of their interests is affected by payment of dividends within the group. 60% P Ltd

70% A Ltd P Ltd 60% DNCI 40%

B Ltd P Ltd 42% DNCI 30% INCI 28%

If B Ltd pays/declares a dividend and dividend revenue is recognised by A Ltd, then the share of equity attributed to the DNCI in A Ltd must be adjusted for the dividend revenue recognised by A Ltd using an entry of the order: NCI NCI Share of Profit/Loss

Dr Cr

x x

The INCI in B Ltd is given a share of the post-acquisition profits of B Ltd prior to the appropriation of any dividend. The INCI in B Ltd is unaffected by any NCI adjustments for dividends paid/declared by B Ltd – only DNCI in B is affected. The profits of B Ltd are then used to pay dividends to A Ltd and recognised as revenue by A Ltd. Hence the profits of B Ltd are now also being shown in A Ltd as dividend revenue. To give the INCI in B Ltd a share of the profits of B Ltd as well as give the DNCI in A Ltd a share of the profits of A Ltd including the dividend revenue from B Ltd would double count the NCI share of equity. Hence the above adjustment is required, reducing the NCI share in total as well as the NCI share of current period profit/loss.

22.6

Chapter 22: Consolidation: other issues

PRACTICE QUESTIONS Note: In Questions 22.1 – 22.6, at the acquisition date the identifiable assets and liabilities of the subsidiary are recorded at amounts equal to fair values. In Questions 22.7 – 22.16, these have carrying amounts different from fair values.

Question 22.1

Consolidation worksheet entries, three companies

On 1 July 2015, Canada Ltd acquired 80% of the shares of China Ltd and China Ltd acquired 75% of the shares of Chile Ltd. All shares were acquired cum div. Equity of the companies at 1 July 2015 was as follows: China Ltd $ 80 000 5 000 1 000 8 000

Share capital Asset revaluation surplus Retained earnings Dividend payable

Chile Ltd $ 60 000 — 4 000 5 000

At 1 July 2015, all identifiable assets and liabilities of China Ltd and Chile Ltd were recorded at fair value. No goodwill or gain on bargain purchase arose in any of the share acquisitions. The financial statements of the three companies at 30 June 2017 contained the following information:

Share capital Asset revaluation surplus Retained earnings (1/7/16) Dividend payable Profit

Canada Ltd $ 130 000 — 10 000 13 000 4 000

China Ltd $ 80 000 5 000 10 500 8 000 2 000

Chile Ltd $ 60 000 — 13 000 6 000 1 500

The final dividends were declared out of profits for the year ended 30 June 2017. Since 1 July 2015, the following intragroup transactions have occurred: (a) China Ltd sold to Chile Ltd an item of machinery for $12 000 on 31 December 2015. The machinery had originally cost China Ltd $14 000 and at the time of sale had been depreciated to $11 200. The group charges depreciation at 10% straight-line. (b) During the year ended 30 June 2017, inventory was transferred by Chile Ltd to China Ltd at 25% on cost to Chile Ltd. $4000 of this inventory is included in the inventory of China Ltd as at 30 June 2017. The tax rate is 30%. Required Prepare the consolidation worksheet entries for the year ended 30 June 2017.

80% Canada Ltd

75% China Ltd

Chile Ltd Canada

Ltd 80%

Canada Ltd 60% DNCI 20%

DNCI INCI

25% 15%

Pre-acquisition analysis: Canada Ltd – China Ltd At 1 July 2015:

22.7

Solutions manual to accompany Company Accounting 10e

Net fair value of identifiable assets and liabilities of China Ltd = = Net fair value acquired = = =

($80 000 + $5 000 + $1 000) (equity) $86 000 80% x $86 000 $68 800 Consideration transferred

1. Pre-acquisition entry Canada Ltd – China Ltd At 30 June 2017: Retained earnings (1/7/16) Share capital Asset revaluation surplus Shares in China Ltd

Dr Dr Dr Cr

800 64 000 4 000

Dr Dr Dr Cr

200 16 000 1 000

68 800

2. NCI share of equity of China Ltd at 1/7/15 Retained earnings (1/7/16) Share capital Asset revaluation surplus NCI

17 200

3. NCI share of equity of China Ltd: 1/7/15to 30/6/16 Retained earnings (1/7/16) NCI (20% ($10 500 - $1 000))

Dr Cr

1 900 1 900

4. NCI share of equity of China Ltd: 1/7/16 to 30/6/17 NCI Share of profit NCI (20% x $2 000)

Dr Cr

400

NCI

Dr Cr

1 600

Dr Cr

900

Dividend declared (20% x $8 000 NCI NCI Share of profit (20% x 75% x $6000)

400

1 600

900

Pre-acquisition analysis: China Ltd to Chile Ltd At 1 July 2015: Net fair value of identifiable assets and liabilities of Chile Ltd = ($60 000 + $4 000) (equity) = $64 000 (a) Consideration transferred = $48 000 (b) Non-controlling interest = 25% x $64 000 = $16 000 Aggregate of (a) and (b) = $64 000 Goodwill = zero

22.8

Chapter 22: Consolidation: other issues

5. Pre-acquisition entry – China Ltd to Chile Ltd At 30 June 2015: Retained earnings (1/7/16) Share capital Shares in Chile Ltd

Dr Dr Cr

3 000 45 000

Dr Dr Cr

1 000 15 000

48 000

6. DNCI share of equity of Chile Ltd at 1/7/15 Retained earnings (1/7/16) Share capital NCI

16 000

7. NCI share of equity of Chile Ltd: 1/7/15 to 30/6/16 DNCI share Retained earnings (1/7/16) NCI (25% ($13 000 - $4 000))

Dr Cr

2 250

Dr Cr

1 350

2 250

INCI share Retained earnings (1/7/16) NCI (15% ($13 000 - $4 000))

1 350

8. NCI share of equity of Chile Ltd: 1/7/16 to 30/6/17 DNCI share NCI share of profit NCI (25% x $1 500)

Dr Cr

375

NCI share of profit NCI (15% x $1 500)

Dr Cr

225

NCI

Dr Cr

1 500

Dividend payable Final dividend declared (80% x $8 000)

Dr Cr

6 400

Dividend revenue Dividend receivable

Dr Cr

6 400

375

INCI share

Dividend declared (25% x $6 000)

225

1 500

9. Final dividend declared: China Ltd

6 400

22.9

Solutions manual to accompany Company Accounting 10e

10. Final dividend declared: Chile Ltd Dividend payable Final dividend declared (75% x $6 000)

Dr Cr

4 500

Dividend revenue Dividend receivable

Dr Cr

4 500

Retained earnings 1/7/16) Machinery

Dr Cr

800

Deferred tax asset Retained earnings (1/7/16)

Dr Cr

240

Dr Cr

112

Accumulated depreciation Depreciation expense Retained earnings (1/7/16)

Dr Cr Cr

120

Income tax expense Retained earnings (1/7/16) Deferred tax asset

Dr Dr Cr

24 12

Dr Dr Cr

5.6 11.2

Sales revenue Cost of sales Inventory

Dr Cr Cr

4 000

Deferred tax asset Income tax expense

Dr Cr

240

4 500

11. Sale of machinery: China Ltd – Chile Ltd

800

240

12. NCI adjustment NCI Retained earnings (1/7/16) (20% ($800 - $240))

112

13. Depreciation

80 40

14. NCI adjustment Retained earnings (1/7/16) NCI share of profit NCI (20% ($80 - $24) pa)

16.8

15. Inventory transfer: Chile Ltd – China Ltd

3 200 800

240

22.10

Chapter 22: Consolidation: other issues

16. NCI adjustment NCI NCI share of profit (25% + 15%) ($800 - $240)

Dr Cr

224

22.11

Solutions manual to accompany Company Accounting 10e

Question 22.2

Calculation of the non-controlling interest

On 1 July 2014, Fiji Ltd acquired 75% of the shares of India Ltd at a cost of $280 000 and India Ltd acquired 80% of the shares of Japan Ltd at a cost of $135 000. At acquisition date, the equity of India Ltd and Japan Ltd was as follows and represented the fair values of identifiable assets and liabilities at that date: India Ltd $ 150 000 20 000 50 000

Share capital General reserve Retained earnings

Japan Ltd $ 140 000 — 20 000

On 30 June 2016, India Ltd transferred the general reserve back to retained earnings and declared a dividend of $20 000 which was paid on 1 November 2016. On 30 June 2018, the companies provided the following information. India Ltd 48 000 20 000 28 000 75 000 103 000 — 10 000 15 000 25 000 $ 78 000

Profit before income tax Income tax expense Profit Retained earnings (1/7/17) Transfer to general reserve Dividend paid Dividend declared Retained earnings (30/6/18)

Japan Ltd $ 32 000 15 000 17 000 42 000 59 000 20 000 — 10 000 30 000 $ 29 000

Required Calculate the non-controlling interest share of retained earnings (30/6/18) for India Ltd and Japan Ltd.

75% Fiji Ltd

80% India Ltd Fiji Ltd 75% DNCI 25%

Japan Ltd Fiji Ltd 60% DNCI 20% INCI 20%

1. NCI share of equity in India Ltd at 1/7/14 Retained earnings (1/7/17) Share capital General reserve NCI

Dr Dr Dr Cr

12 500 37 500 5 000 55 000

2. NCI share of equity in India Ltd: 1/7/14 – 30/6/17 Retained earnings (1/7/17) General reserve NCI (RE: 25% ($75 000 - $50 000))

Dr Cr Cr

6 250

5 000 1 250

22.12

Chapter 22: Consolidation: other issues

3. NCI share of equity in India Ltd: 1/7/17 – 30/6/18 NCI share of profit NCI (25% x $28 000)

Dr Cr

7 000

NCI

Dr Cr

2 500

Dr Cr

3 750

Dr Cr

2 000

Dividend paid (25% x $10 000) NCI Dividend declared (25% x $15 000) NCI NCI Share of profit (25% x 80% x $10 000)

7 000

2 500

3 750

2 000

Acquisition analysis: India Ltd – Japan Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Japan Ltd = $160 000 (a) Consideration transferred = $135 000 (b) Non-controlling interest = 20% x $160 000 = $32 000 Aggregate of (a) and (b) = $167 000 Goodwill = $7 000 In the pre-acquisition entry at 30/6/15, the following adjustment would be made: Retained earnings (1/7/14)* *(80% x $20 000)

16 000

Dr Dr Cr

4 000 28 000

1. DNCI share of equity in Japan Ltd at 1/7/14 Retained earnings (1/7/17) Share capital NCI

32 000

2. NCI share of equity of Japan Ltd: 1/7/14 – 30/6/17 Retained earnings (1/7/17) NCI (20% ($42 000 - $20 000))

Dr Cr

4 400

Retained earnings (1/7/17) NCI (20% ($42 000 - $16 00/0.8))

Dr Cr

4 400

3. NCI share of equity in Japan Ltd from 1/7/17 – 30/6/18 NCI share of profit NCI (DNCI: 20% x $17 000)

Dr Cr

3 400

22.13

Solutions manual to accompany Company Accounting 10e

NCI share of profit NCI (INCI: 20% x $17 000)

Dr Cr

3 400

NCI

Dr Cr

2 000

Dr Cr

8 000

Dividend declared (20% x $10 000) General reserve Transfer to general reserve ((20% + 20%) x $20 000)

3 400

2 000

8 000

The total NCI share of Retained Earnings at 30 June 2018 of India Ltd is $17 500 ($12 500 + $6 250 + $7 000 - $2 500 - $3 750 - $2 000). The total NCI share of Retained Earnings at 30 June 2018 of China Ltd is $9 600 ($4 000 + $4 400 + $4 400 + $3 400 + $3 400 - $2 000 - $8 000). The total NCI share of Retained Earnings at 30 June 2018 is $27 100.

22.14

Chapter 22: Consolidation: other issues

Question 22.3

Consolidation worksheet entries, multiple subsidiaries

On 1 July 2014, Laos Ltd acquired 70% of the shares of Maldives Ltd for $100 000 and Maldives Ltd acquired 60% of Malaysia Ltd for $70 000. The equity of the companies at 1 July 2014 was: Maldives Ltd $ 100 000 40 000

Share capital Retained earnings

Malaysia Ltd $ 80 000 30 000

At 1 July 2014, all the identifiable assets and liabilities of both Maldives Ltd and Malaysia Ltd were recorded at fair value. At 30 June 2017, the financial data of the three companies were as follows:

Sales revenue Other revenue Total revenues Cost of sales Other expenses Total expenses Profit before income tax Income tax expense Profit for the period Retained earnings (1/7/16) Total available for appropriation Dividend paid Retained earnings (30/6/17) Share capital Net assets

Laos Ltd $ 120 000 60 000 180 000 90 000 60 000 150 000 30 000 8 000 22 000 55 000 77 000 15 000 62 000 148 000 $ 210 000

Maldives Ltd $ 102 000 44 000 146 000 80 000 41 000 121 000 25 000 8 000 17 000 46 000 63 000 10 000 53 000 100 000 $ 153 000

Malaysia Ltd $ 84 000 36 000 120 000 72 000 26 000 98 000 22 000 5 000 17 000 25 000 42 000 5 000 37 000 80 000 $ 117 000

Since 1 July 2014, the following transactions have occurred between the three companies: • During the current year, Maldives Ltd sold inventory valued at $20 000 to Laos Ltd, this having cost Maldives Ltd $15 000. Half of this inventory is still on hand at 30 June 2017. • On 1 July 2016, Malaysia Ltd sold a motor vehicle to Maldives Ltd for $25 000. The carrying amount of the vehicle at the date of sale was $23 000. Vehicles are depreciated at 30% p.a. on a straight-line basis. The company tax rate is 30%. Required Prepare the consolidation worksheet journal entries for the year ended 30 June 2017.

70% Laos Ltd

60% Maldives Ltd DNCI 30%

Malaysia Ltd DNCI 40% INCI 18%

Acquisition analysis: Laos Ltd – Maldives Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Maldives Ltd

= =

$100 000 + $40 000 $140 000

22.15

Solutions manual to accompany Company Accounting 10e

(a) Consideration transferred (b) Non-controlling interest

= = = = =

Aggregate of (a) and (b) Goodwill

$100 000 30% x $140 000 $42 000 $142 000 $2 000

1. Pre-acquisition entry – 30 June 2017 Retained earnings (1/7/16) Share capital Goodwill Shares in Maldives Ltd

Dr Dr Dr Cr

28 000 70 000 2 000

Dr Dr Cr

12 000 30 000

100 000

2. NCI share of equity in Maldives Ltd at 1/7/14 Retained earnings (1/7/16) Share capital NCI

42 000

3. NCI share of equity in Maldives Ltd: 1/7/14 – 30/6/16 Retained earnings (1/7/16) NCI (30% ($46 000 - $40 000))

Dr Cr

1 800 1 800

4. NCI share of equity in Maldives Ltd: 1/7/16 – 30/6/17 NCI share of profit NCI (30% x $17 000)

Dr Cr

5 100

NCI

Dr Cr

3 000

Dr Cr

900

Dividend paid (30% x $10 000) NCI NCI share of profit (30% x 60% x $5 000)

5 100

3 000

900

Acquisition analysis: Maldives Ltd – Malaysia Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Malaysia Ltd (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill =

= $80 000 + $30 000 = $110 000 = $70 000 = 40% x $110 000 = $44 000 = $114 000 $4 000

22.16

Chapter 22: Consolidation: other issues

5. Pre-acquisition entry – 30 June 2017 Retained earnings (1/7/16) Share capital Goodwill Shares in Malaysia Ltd

Dr Dr Dr Cr

18 000 48 000 4 000

Dr Dr Cr

12 000 32 000

70 000

6. NCI share of equity in Malaysia Ltd at 1/7/14 Retained earnings (1/7/16) Share capital NCI

44 000

7. NCI share of equity in Malaysia Ltd: 1/7/14 – 30/6/16 NCI Retained earnings (1/7/16) (40% ($25 000 - $30 000)) NCI Retained earnings (1/7/16) (18% ($25 000 - $18 000/0.6))

Dr Cr

2 000

Dr Cr

900

2 000

900

8. NCI share of equity in Malaysia Ltd: 1/7/16 – 30/6/17 NCI share of profit NCI (40% x $17 000)

Dr Cr

6 800

NCI share of profit NCI (18% x $17 000)

Dr Cr

3 060

NCI

Dr Cr

2 000

Dividend paid (40% x $5 000)

6 800

3 060

2 000

9. Dividend paid Maldives Ltd: Malaysia Ltd:

70% x $10 000 = $7 000 60% x $5 000 = $3 000

Dividend revenue Dividend paid

Dr Cr

10 000

Dr Cr Cr

20 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

750

10 000

10. Sale of inventory: Maldives Ltd – Laos Ltd Sales

17 500 2 500

750

22.17

Solutions manual to accompany Company Accounting 10e

11. NCI adjustment NCI NCI share of profit (30% x $1 750)

Dr Cr

525 525

12. Sale of motor vehicle: Malaysia Ltd – Maldives Ltd Proceeds on sale of motor vehicle Carrying amount of vehicle Motor vehicle

Dr Cr Cr

25 000

Deferred tax asset Income tax expense

Dr Cr

600

Dr Cr

812

Accumulated depreciation Depreciation expense (30% x $2 000)

Dr Cr

600

Income tax expense Deferred tax asset

Dr Cr

180

Dr Cr

244

23 000 2 000

600

13. NCI adjustment NCI NCI share of profit ((40% + 18%) ($2 000 – $600))

812

14. Depreciation

600

180

15. NCI adjustment NCI share of profit NCI ((40% + 18%) ($600-$180))

244

22.18

Chapter 22: Consolidation: other issues

Question 22.4

Calculation of the non-controlling interest share of retained earnings

On 1 July 2016, Nauru Ltd acquired 60% of the shares of Nepal Ltd for $300 000, and Nepal Ltd acquired 80% of the shares of New Zealand Ltd for $190 000. It was considered that Nauru Ltd exercised control over Nepal Ltd and New Zealand Ltd. At acquisition date, the equity for Nepal Ltd and New Zealand Ltd was as follows, and represented the fair values of identifiable assets and liabilities at that date: Nepal Ltd Share capital General reserve Retained earnings

$ 200 000 130 000 80 000

New Zealand Ltd $ 140 000 70 000 20 000

Three years later, the companies provided the following information: Nepal Ltd Profit before income tax Income tax expense Profit Retained earnings (1/7/18) Dividend declared Retained earnings (30/6/19)

24 000 10 000 14 000 88 000 102 000 10 000 $ 92 000

New Zealand Ltd $ 18 000 7 500 10 500 27 500 38 000 8 000 $ 30 000

There was a transfer to reserves of $4000 from pre-acquisition profits in the period ended 30 June 2018 by New Zealand Ltd. Required Calculate the non-controlling interest’s share of retained earnings (30/6/19) of Nepal Ltd and New Zealand Ltd.

60% Nauru Ltd

Nepal Ltd DNCI 40%

80% New Zealand Ltd DNCI INCI

20% 32%

1. NCI share of equity of Nepal Ltd at 1/7/16 Retained earnings (1/7/18) Share capital General reserve NCI

Dr Dr Dr Cr

32 000 80 000 52 000 164 000

2. NCI share of equity of Nepal Ltd: 1/7/16 – 30/6/18 Retained earnings (1/7/18) NCI (40% ($88 000 - $80 000))

Dr Cr

3 200

22.19

Solutions manual to accompany Company Accounting 10e

3. NCI share of equity of Nepal Ltd from 1/7/18 – 30/6/19 NCI share of profit NCI (40% x $14 000)

Dr Cr

5 600

Dr Cr

4 000

Dr Cr

2 560

5 600

4. Dividend declared – Nepal Ltd NCI Dividend declared (40% x $10 000) NCI NCI share of profit (40% x 80% x $8 000)

4 000

2 560

The NCI share of Retained Earnings (30/6/19) of Nepal Ltd is $34 240 (= $32 000 + $3 200 + $56 000 - $4 000 - $2 560) Acquisition analysis: Nepal Ltd – New Zealand Ltd At 1 July 2016: Net fair value of identifiable assets and contingent of New Zealand Ltd (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = =

$140 000 + $170 000 + $20 000 (equity) $230 000 $190 000 $20% x $230 000 $46 000 $236 000 $6 000

The pre-acquisition entry at 30 June 2019 is: Retained earnings (1/7/18)* Share capital General reserve Goodwill Shares in New Zealand Ltd *(80% x $20 000) – (80% x $4 000)

Dr Dr Dr Dr Cr

12 800 112 000 59 200 6 000 190 000

The NCI share of New Zealand Ltd’s equity is then:

5. NCI share of equity of New Zealand Ltd at 1/7/16 Retained earnings (1/7/18) Share capital General reserve NCI

Dr Dr Dr Cr

4 000 28 000

14 000 46 000

22.20

Chapter 22: Consolidation: other issues

6. NCI share of New Zealand Ltd from 1/7/16– 30/6/18 General reserve Retained earnings (1/7/18) NCI (GR: 20% x $4 000 RP: 20% ($27 500 - $20 000))

Dr Dr Cr

800 1 500

Retained earnings (1/7/18) NCI (32% ($27 500 - $12 800/0.8))

Dr Cr

3 680

2 300

3 680

7. NCI share of equity of New Zealand Ltd: 1/7/18 – 30/6/19 NCI share of profit NCI (20% x $10 500)

Dr Cr

2 100

NCI share of profit NCI (32% x $10 500)

Dr Cr

3 360

Dr Cr

1 600

2 100

3360

8. Dividend declared NCI Dividend declared (20% x $8 000)

1 600

The NCI share of Retained Earnings (30/6/19) of New Zealand Ltd is $13 040 (= $4 000 + $1 500 + $3 680 + $ 2100 + $3 360 - $1 600). The total NCI share of Retained Earnings at 30/6/19 is $47 280.

22.21

Solutions manual to accompany Company Accounting 10e

Question 22.5

Consolidation worksheet, consolidated statement of profit or loss and other comprehensive income

Pakistan Ltd acquired 75% of the shares of Peru Ltd on 1 July 2013 for $1 900 000. The identifiable assets and liabilities of Peru Ltd at fair value on the acquisition date were represented by: Share capital $ 500 000 General reserve 800 000 Retained earnings 1 200 000 $ 2 500 000 On the same date, Peru Ltd acquired 60% of Philippines Ltd for $1 100 000. The identifiable assets and liabilities of Philippines Ltd at the acquisition date at fair value were represented by: Share capital General reserve Retained earnings

660 000 500 000 500 000 1 660 000

The financial information provided by the three companies for the year ended 30 June 2018 is shown below. The following additional information was obtained: (a) All transfers to general reserve were from post-acquisition profits. (b) Included in the plant and machinery of Philippines Ltd was a machine sold by Peru Ltd on 30 June 2015 for $75 000. The asset had originally cost $130 000 and it had been written down to $60 000. Philippines Ltd had depreciated the machine on a straight-line basis over 5 years, with no residual value. (c) Philippines Ltd had transferred one of its motor vehicles (carrying amount of $15 000) to Pakistan Ltd on 31 March 2017 for $12 000. Pakistan Ltd regarded this vehicle as part of its inventory. The vehicle was sold by Pakistan Ltd on 31 July 2017 for $17 000. (d) The tax rate is 30%. Pakistan Ltd Sales revenue $ 2 850 000 Other revenue 420 000 Total revenues 3 270 000 Cost of sales 1 410 000 Other expenses 200 000 Total expenses 1 610 000 Profit before income tax 1 660 000 Income tax expense 580 000 Profit 1 080 000 Retained earnings (1/7/17) 4 070 000 Total available for 5 150 000 appropriation 400 000 Dividend paid 400 000 Dividend declared 100 000 Transfer to general reserve 900 000 $ 4 250 000 Retained earnings (30/6/18)

Peru Ltd $ 1 100 000 200 000 1 300 000 520 000 80 000 600 000 700 000 160 000 540 000 2 300 000 2 840 000 160 000 200 000 50 000 410 000 $ 2 430 000

Philippines Ltd $ 880 000 60 000 940 000 380 000 110 000 490 000 450 000 140 000 310 000 1 120 000 1 430 000 80 000 90 000 40 000 210 000 $ 1 220 000

Required Prepare the consolidated statement of profit or loss and other comprehensive income and statement of changes in equity (not including movements in the general reserve and share

22.22

Chapter 22: Consolidation: other issues

capital) for the group for the year ended 30 June 2018. 75% Pakistan Ltd

60% Peru Ltd Pakistan Ltd 75% DNCI 25%

Philippines Ltd Pakistan Ltd 45% DNCI 40% INCI 15%

Pre-acquisition analysis: Pakistan Ltd – Peru Ltd At 1 July 2013: Net fair value of identifiable assets and liabilities of Peru Ltd (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = =

$500 000 + $800 000 + $1 200 000 (equity) $2 500 000 $1 900 000 25% x $2 500 000 $625 000 $2 525 000 $25 000

1. Pre-acquisition entry Pakistan Ltd – Peru Ltd At 30 June 2018: Retained earnings (1/7/17)* Share capital General reserve Goodwill Shares in Peru Ltd * (75% x $1 200 000)

Dr Dr Dr Dr Cr

900 000 375 000 600 000 25 000

Dr Dr Dr Cr

300 000 125 000 200 000

1 900 000

2. DNCI share of equity of Peru Ltd at 1/7/13 Retained earnings (1/7/17) Share capital General reserve NCI (25% of balances)

625 000

3. DNCI share of equity of Peru Ltd: 1/7/13 – 30/6/17 Retained earnings (1/7/17) NCI (25% ($2 300 000 - $1 200 000))

Dr Cr

275 000

22.23

Solutions manual to accompany Company Accounting 10e

4. DNCI share of equity of Peru Ltd: 1/7/17 – 30/6/18 NCI share of profit NCI (25% x $540 000)

Dr Cr

135 000

General reserve Transfer to general reserve (25% x $50 000)

Dr Cr

12 500

NCI

Dr Cr

40 000

Dr Cr

50 000

Dr Cr

13 500

Dr Cr

12 000

Dividend paid (25% x $160 000) NCI Dividend declared (25% x $200 000)

NCI NCI share of profit (25% x 60% x $90 000 – Dividend declared by Philippines Ltd, in current period) NCI NCI share of profit (25% x 60% x $80 000 – Dividend paid by Philippines Ltd, in current period)

135 000

12 500

40 000

50 000

13 500

12 000

Pre-acquisition analysis: Peru Ltd – Philippines Ltd At 1 July 2013: Net fair value of identifiable assets and liabilities of Philippines Ltd (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

$1 660 000 $1 100 000 40% x $1 660 000 $664 000 $1 764 000 $104 000

5. Pre-acquisition entry: Peru Ltd – Philippines Ltd Retained earnings (1/7/17) Share capital General reserve Goodwill Shares in Philippines Ltd

Dr Dr Dr Dr Cr

300 000 396 000 300 000 104 000 1 100 000

6. DNCI share of equity of Philippines Ltd at 1/7/13

22.24

Chapter 22: Consolidation: other issues

Retained earnings (1/7/17) Share capital General reserve NCI (40% of balances)

Dr Dr Dr Cr

200 000 264 000 200 000 664 000

7. NCI share of equity of Philippines Ltd: 1/7/13 – 30/6/17 Retained earnings (1/7/17) NCI (40% ($1 120 000 - $500 000))

Dr Cr

248 000

Retained earnings (1/7/17) NCI (15% ($1 120 000 - $300 000/0.6))

Dr Cr

93 000

248 000

93 000

8. NCI share of equity of Philippines Ltd: 1/7/17 – 30/6/18 NCI Share of profit NCI (40% x $310 000)

Dr Cr

124 000

NCI Share of profit NCI (15% x $310 000)

Dr Cr

46 500

General reserve Transfer to general reserve (55% x $40 000)

Dr Cr

22 000

NCI

Dr Cr

32 000

Dr Cr

36 000

Dr Cr

120 000

Dr Cr

48 000

Dividend paid (40% x $80 000) NCI Dividend declared (40% x $90 000)

124 000

46 500

22 000

32 000

36 000

9. Dividend paid: Peru Ltd Dividend revenue Dividend paid (75% x $160 000)

120 000

10. Dividend paid: Philippines Ltd Dividend revenue Dividend paid (60% x $80 000)

48 000

22.25

Solutions manual to accompany Company Accounting 10e

11. Dividend declared: Peru Ltd Dividend payable Dividend declared (75% x $200 000)

Dr Cr

150 000

Dividend revenue Dividend receivable

Dr Cr

150 000

Dividend payable Dividend declared (60% x $90 000)

Dr Cr

54 000

Dividend revenue Dividend receivable

Dr Cr

54 000

150 000

12. Dividend declared: Philippines Ltd

54 000

13. Plant and machinery transfer: Peru Ltd – Philippines Ltd Retained earnings (1/7/17) Deferred tax asset Plant and machinery

Dr Dr Cr

10 500 4 500

Dr Cr

2 625

Accumulated depreciation Retained earnings (1/7/17) Depreciation expense

Dr Cr Cr

9 000

Income tax expense Retained earnings (1/7/17) Deferred tax asset

Dr Dr Cr

900 1 800

Dr Dr Cr

525 1 050

15 000

14. NCI adjustment NCI Retained earnings (1/7/17) (25% x $10 500)

2 625

15. Depreciation

6 000 3 000

2 700

16. NCI adjustment NCI share of profit * Retained earnings (1/7/17) NCI (* 25% x $2 100)

1 575

17. Transfer of non-current assets to inventory in prior period: Philippines Ltd – Pakistan Ltd

22.26

Chapter 22: Consolidation: other issues

Cost of sales Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

3 000

Dr Cr

1 155

900 2 100

18. NCI adjustment Retained earnings (1/7/17) NCI share of profit (55% x $2 100)

1 155

22.27

Solutions manual to accompany Company Accounting 10e

Question 22.5 (cont’d) Financial Pakistan Statements Ltd Sales revenue 2 850 000 Other revenue 420 000

Total revenue Cost of sales Other expenses Total expenses Profit before tax Tax expense Profit

3 270 000 1 410 000 200 000 1 610 000 1 660 000 580 000 1 080 000

Peru Philippines Ltd Ltd 1 100 000 880 000 200 000 60 000 9 10 11 12 1 300 000 940 000 520 000 380 000 17 80 000 110 000 600 000 490 000 700 000 450 000 160 000 140 000 15 540 000 310 000

Retained earnings (1/7/17)

4 070 000

2 300 000

1 120 000 1 5 13 15

5 150 000

2 840 000

1 430 000

400 000

160 000

80 000

Dividend paid

Adjustments Dr Cr

Group

3 000

900 000 300 000 10 500 1 800

Parent Cr

135 000 124 000 46 500 525 300 000 275 000 200 000 248 000 93 000 1 050 1 155

13 500 12 000 1 155

4 4 18

1 278 630

2 625

5 170 220

4 830 000 308 000

120 000 48 000 150 000 54 000

900

NCI Dr

3 000

900

6 000 2 100

15 17

5 138 000 2 313 000 387 000 2 700 000 2 438 000 880 000 1 558 000

6 285 800

4 8 8 16 2 3 6 7 7 16 18

7 843 800

48 000 120 000

10 9

472 000

6 448 850

40 000 32 000

4 8

400 000

22.28

Chapter 22: Consolidation: other issues

Dividend declared

400 000

200 000

90 000

Transfer to general reserve

100 000

50 000

40 000

190 000

900 000 4 250 000

310 000 2 430 000

210 000 1 220 000

1 148 000 6 695 800

Retained earnings (30/6/18)

150 000 54 000

11 12

486 000

50 000 36 000 12 500 22 000

4 8 4 8

400 000 155 500 955 500 5 493 350

22.29

Solutions manual to accompany Company Accounting 10e

PAKISTAN LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2018 Revenue: Sales revenue Other revenue

$4 830 000 308 000 5 138 000

Expenses: Cost of sales Other expenses

2 313 000 387 000 2 700 000 2 438 000 880 000 $1 558 000 $1 558 000

Profit before income tax Income tax expense Profit for the period Comprehensive Income for the period Attributable to: Parent interest Non-controlling interest

$1 278 630 279 370 $1 558 000

PAKISTAN LTD Consolidated Statement of Changes in Equity (extract) for the year ended 30 June 2018 Consolidated

Parent

Comprehensive income for the period

$1 558 000

$1 278 630

Retained earnings at 1 July 2017 Profit for the period Dividend paid Dividend declared Transfer to general reserve Retained earnings at 30 June 2018

$6 285 800 1 558 000 (472 000) (486 000) (190 000) $6 695 800

$5 170 220 1 278 630 (400 000) (400 000) (155 500) $5 493 350

22.30

Solution Manual to accompany Company Accounting 10e

Question 22.6

Consolidated financial statements

On 1 July 2013, the following balances appeared in the ledgers of the following three companies:

Retained earnings General reserve Dividend payable Share capital

Russia Ltd

Samoa Ltd

$ 20 000 8 000 4 000 80 000

$ 10 000 2 000 2 000 60 000

Singapore Ltd $ 5 000 1 000 — 20 000

The dividend payable on 1 July 2013 was paid in October 2013. For the year ended 30 June 2018, the following information is available: • Inter-company sales were: Samoa Ltd to Russia Ltd — $20 000 Singapore Ltd to Russia Ltd — $15 000 The mark-up on cost on all sales was 25%. • At 30 June 2018, inventory of Russia Ltd included: $1000 of goods purchased from Samoa Ltd $1800 of goods purchased from Singapore Ltd. • The current income tax rate is 30%. • Russia Ltd paid $67 200 for 80% of the shares of Samoa Ltd at 1 July 2013 when all identifiable assets and liabilities of Samoa Ltd were recorded at fair value. • Samoa Ltd paid $18 750 for 75% of the shares of Singapore Ltd at 1 July 2013 when all identifiable assets and liabilities of Singapore Ltd were recorded at fair value as below. Receivables $ 9 000 Inventory 10 000 Plant 20 000 Total assets 39 000 Liabilities 13 000 Net assets $ 26 000 • The plant has an expected remaining useful life of 5 years. By 30 June 2014, all receivables had been collected and inventory sold. The financial information for the year ended 30 June 2018 for all three companies was as follows: Russia Ltd Sales revenue $ Cost of sales Gross profit Expenses: Selling and administrative (inc. depn) Financial

Dividend revenue Profit before income tax Income tax expense Profit Retained earnings (1/7/17)

98 400 61 000 37 400 10 000 3 000 13 000 24 400 3 200 27 600 12 000 15 600 40 000 55 600

Samoa Ltd $

48 500 29 000 19 500

Singapore Ltd $ 30 000 13 000 17 000

5 000 1 000 6 000 13 500 4 500 18 000 8 100 9 900 20 000 29 900

3 000 1 000 4 000 13 000 — 13 000 5 200 7 800 10 000 17 800

22.31

Solutions manual to accompany Company Accounting 10e

Total available for appropriation Transfer to general reserve Dividend paid Dividend declared

4 000 5 000 5 000 14 000

1 900 2 000 2 000 5 900

— 4 000 2 000 6 000

Retained earnings (30/6/18) General reserve Share capital Equity Receivables Inventory Shares in Samoa Ltd Shares in Singapore Ltd Plant Total assets Provisions Dividend payable Total liabilities Net assets

41 600 12 000 80 000 133 600 18 000 25 000 65 600 — 50 000 158 600 20 000 5 000 25 000 133 600

24 000 3 900 60 000 $ 87 900 $ 25 000 26 400 — 18 750 39 750 109 900 20 000 2 000 22 000 $ 87 900

11 800 1 000 20 000 $ 32 800 $ 11 000 13 800 — — 20 000 44 800 10 000 2 000 12 000 $ 32 800

$ $

Required Prepare the consolidated financial statements of Russia Ltd at 30 June 2018.

80% Russia Ltd

75% Samoa Ltd DNCI 20%

Singapore Ltd DNCI 25% INCI 15%

Pre-acquisition analysis: Russia Ltd – Samoa Ltd At 1 July 2013: Net fair value of the identifiable assets and liabilities of Samoa Ltd = = (a) Consideration transferred = = (b) Non-controlling interest = = Aggregate of (a) and (b) = Goodwill =

($60 000 + $10 000 + $2 000) (equity) $72 000 $67 200 – (80% x $2 000) $65 600 20% x $72 000 $14 400 $80 000 $8 000

1. Pre-acquisition entry

Retained earnings (1/7/17)* Share capital General reserve Goodwill Shares in Samoa Ltd

Dr Dr Dr Dr Cr

8 000 48 000 1 600 8 000

65 600

22.32

Solution Manual to accompany Company Accounting 10e

2. NCI share of equity in Samoa Ltd at 1/7/13 Retained earnings (1/7/17) Share capital General reserve NCI

Dr Dr Dr Cr

2 000 12 000 400 14 400

3. NCI share of equity in Samoa Ltd: 1/7/13 – 30/6/17 Retained earnings (1/7/17) NCI (20% ($20 000 - $10 000))

Dr Cr

2 000 2 000

4. NCI share of equity in Samoa Ltd: 1/7/17 – 30/6/18 NCI share of profit NCI (20% x $9 900)

Dr Cr

1 980

General reserve Transfer to general reserve (20% x $1 900)

Dr Cr

380

NCI

Dr Cr

400

Dr Cr

400

Dr Cr

900

Dividend paid (20% x $2 000) NCI Dividend declared (20% x $2 000) NCI NCI share of profit (20% x 75% x ($2 000 + $4 000))

1 980

380

400

900

Acquisition analysis: Samoa Ltd – Singapore Ltd At 1/7/13: Net fair value of identifiable assets and liabilities of Singapore Ltd (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Gain on bargain purchase

= = = = = = =

$20 000 + $1 000 + $5 000 (equity) $26 000 $18 750 25% x $26 000 $6 500 $25 250 $750

22.33

Solutions manual to accompany Company Accounting 10e

5. Pre-acquisition entry At 1/7/13: Retained earnings (1/7/13) Share capital General reserve Gain on bargain purchase Shares in Singapore Ltd

Dr Dr Dr Cr Cr

3 750 15 000 750 750 18 750

At 30/6/13: Retained earnings (1/7/17)* Dr 3 000 Share capital Dr 15 000 General reserve Dr 750 Shares in Singapore Ltd Cr * $3000 = (75% x $5000) - $750 (gain on bargain purchase)

18 750

6. NCI share of equity in Singapore Ltd at 1/7/13 Retained earnings (1/7/17) Share capital General reserve NCI

Dr Dr Dr Cr

1 250 5 000 250 6 500

7. NCI share of equity in Singapore Ltd: 1/7/13 – 30/6/17 Retained earnings (1/7/17) NCI (25% ($10 000 - $5 000))

Dr Cr

1 250

Retained earnings (1/7/17) NCI (15% ($10 000 - $3 000/0.75))

Dr Cr

900

1 250

900

8. NCI share of equity in Singapore Ltd: 1/7/17 – 30/6/18 NCI share of profit NCI (25% x $7 800)

Dr Cr

1 950

NCI share of profit NCI (15% x $7 800)

Dr Cr

1 170

NCI

Dr Cr

1 000

Dr Cr

500

Dividend paid (25% x $4 000) NCI Dividend declared (25% x $2 000)

1 950

1 170

1 000

500

22.34

Solution Manual to accompany Company Accounting 10e

9. Interim dividend paid Singapore Ltd: Samoa Ltd:

Dividend revenue Interim dividend paid

75% x $4 000 80% x $2 000

Dr Cr

= =

$3 000 $1 600 $4 600

4 600 4 600

10. Dividend declared Singapore Ltd: Samoa Ltd

75% x $2 000 80% x $2 000

= =

Dividend payable Dividend declared

Dr Cr

3 100

Dividend revenue Receivables

Dr Cr

3 100

Dr Cr Cr

20 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

$1 500 $1 600 $3 100

3 100

11. Sale of inventory: Samoa Ltd – Russia Ltd Sales

19 800 200

12. NCI adjustment NCI NCI share of profit (20% x $140)

13. Sale of inventory: Singapore Ltd – Russia Ltd Sales

Dr Cr Cr

15 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

108

Dr Cr

101

14 640 360

108

14. NCI adjustment NCI NCI share of profit ((25% + 15%) ($360 - $108))

101

22.35

Solutions manual to accompany Company Accounting 10e

Question 22.6 (cont’d) Financial Russia Statements Ltd Sales revenue 98 400

Samoa Ltd 48 500

Singapore Ltd 30 000

11 13

Adjustments Dr Cr 20 000 15 000 19 800 14 640

Group

61 000

29 000

13 000

Gross profit Selling & admin expenses Financial expenses Total expenses

37 400 10 000

19 500 5 000

17 000 3 000

73 340 18 000

Dividend revenue

3 000 13 000 24 400 3 200

1 000 6 000 13 500 4 500

1 000 4 000 13 000 -

5 000 23 000 50 340 -

Profit before tax Tax expense

27 600 12 000

18 000 8 100

13 000 5 200

Profit

15 600

9 900

7 800

Retained earnings (1/7/17)

40 000

20 000

10 000

55 600 4 000

29 900 1 900

17 800 -

5 000

2 000

4 000

Transfer to general reserve Dividend paid

11 13

4 600 3 100 60 108

11 13

8 000 3 000

900 28 101

50 340 25 132

59 000

84 208 5 900 4 600

1 980 1 950 1 170 2 000 2 000 1 250 1 250 900

68 560

25 208

1 5

Parent Cr

141 900

Cost of sales

9 10

NCI Dr

6 400

4 8 8 2 3 6 7 7

4 12 14

21 137

51 600

380

400 1 000

4 8

72 737 5 520 5 000

22.36

Solution Manual to accompany Company Accounting 10e

Dividend declared

Retained earnings (30/6/18) General reserve

Share capital

5 000

2 000

3 100

5 900

14 000 41 600

5 900 24 000

6 000 11 800

12 000

3 900

1 000

1 5

1 600 750

14 550

80 000

60 000

20 000

1 5

48 000 15 000

97 000

4 8

18 200 66 008

Total equity: parent Total equity: NCI

Total equity

133 600

87 900

32 800

177 558

Provisions Dividend payable Total liabilities Total equity and liabilities

20 000 5 000 25 000 158 600

20 000 2 000 22 000 109 900

10 000 2 000 12 000 44 800

50 000 5 900 55 900 233 458

Deferred tax asset

18 000 25 000

25 000 26 400

11 000 13 800

Receivables Inventory

400 500

3 100

11 13

60 108

5 000 15 520 57 217

2 4 6 2 6

400 380 250 12 000 5 000

4 4 4 8 8 12 14

400 400 900 1 000 500 28 101 33 859

13 520

80 000

14 400 2 000 1 980 6 500 1 250 900 1 950 1 170 33 859

2 3 4 6 7 7 8 8

150 737 26 821

177 558

168 3 100 200 360

10 11 13

50 900 64 640

22.37

Solutions manual to accompany Company Accounting 10e

Shares in Samoa Shares in Singapore Ltd Plant Goodwill Total assets

65 600 -

18 750

50 000 158 600

39 750 109 900

20 000 44 800

65 600 18 750

8 000 130 318

130 318

1 5

109 750 8 000 233 458

22.38

Solution Manual to accompany Company Accounting 10e

Question 22.6 (cont’d) RUSSIA LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2018 Revenue: Sales revenue Expenses: Cost of sales Selling administrative expenses Financial expenses

$141 900 68 560 18 000 5 000 91 560 50 340 25 132 $25 208 $25 208

Profit before income tax Income tax expense Profit for the period Comprehensive income for the period Attributable to: Parent entity Non-controlling interest

$21 137 4 071 $25 208

RUSSIA LTD Consolidated Statement of Changes in Equity (extract) for the year ended 30 June 2018 Consolidated $25 208

Parent $21 137

Retained earnings at 1 July 2017 Profit for the period Dividend paid Dividend declared Transfer to general reserve Retained earnings at 30 June 2018

$59 000 25 208 (6 400) (5 900) (5 900) $66 008

$51 600 21 137 (5 000) (5 000) (5 520) $57 217

General reserve at 1 July 2017 Transfer from retained earnings General reserve at 30 June 2018

$8 650 5 900 $14 550

$8 000 5 520 $13 520

Share capital at 1 July 2017 Share capital at 30 June 2018

$97 000 $97 000

$80 000 $80 000

Comprehensive income for the period

22.39

Solutions manual to accompany Company Accounting 10e

RUSSIA LTD Consolidated Statement of Financial Position as at 30 June 2018 Current Assets Receivables Inventories Total Current Assets Non-current Assets Tax assets: Deferred tax asset Property, plant and equipment (net) Goodwill Total Non-current Assets Total Assets Current Liabilities: Payables: Accounts payable Provisions: Dividend payable Total Liabilities Net Assets

50 000 5 900 55 900 $177 558

Equity Share capital Other reserves: General reserve Retained earnings Parent Interest Non-controlling Interest Total Equity

$80 000 13 520 57 217 150 737 26 821 $177 558

$50 900 64 640 115 540 168 109 750 __8 000 117 918 233 458

22.40

Solution Manual to accompany Company Accounting 10e

Question 22.7

Consolidation worksheet entries

The statements of financial position of Tonga Ltd, Thailand Ltd and Tuvalu Ltd for the year ended 30 June 2017 are shown below. Tonga Ltd Share capital Retained earnings Dividend payable Non-current assets Shares in Thailand Ltd Shares in Tuvalu Ltd Inventory Receivables

$ 150 000 60 000 30 000 $ 240 000 $ 120 000 55 800 — 10 000 54 200 $ 240 000

Thailand Ltd $ 50 000 18 000 10 000 $ 78 000 $ 20 000 — 21 000 25 000 12 000 $ 78 000

Tuvalu Ltd $ 21 000 4 000 6 000 $ 31 000 $ 10 000 — — 20 000 1 000 $ 31 000

For the year ended 30 June 2017, Thailand Ltd and Tuvalu Ltd recorded a profit of $2000 and $1000 respectively. Thailand Ltd acquired 90% of the ordinary shares of Tuvalu Ltd for a total consideration of $20 730. At the acquisition date, 1 July 2014, Tuvalu Ltd’s equity comprised: Share capital (21 000 shares) $ 21 000 Retained earnings 1 000 At this date, all identifiable assets and liabilities of Tuvalu Ltd were recorded at fair value except for some plant for which the fair value of $8000 was $1000 greater than the carrying amount of $7000 (i.e. original cost of $8500 less accumulated depreciation of $1500). The plant is expected to last a further 5 years. On the same day, the directors of Tonga Ltd made a successful offer for 45 000 of Thailand Ltd’s fully paid shares. The consideration was $54 990 and, at the acquisition date, Thailand Ltd’s equity comprised: Share capital (50 000 shares) Retained earnings

$ 50 000 4 000

At this date, all identifiable assets and liabilities of Tonga Ltd were recorded at fair value except for some machinery whose fair value was $3000 greater than its recorded amount of $6000, the latter being $10 000 cost less accumulated depreciation of $4000. The machinery is expected to have a further useful life of 3 years. When assets are sold or fully consumed, any related valuation surpluses are transferred to retained earnings. Required Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Tonga Ltd at 30 June 2017.

90% Tonga Ltd

90% Thailand Ltd DNCI 10%

Tuvalu Ltd DNCI 10% INCI 9%

22.41

Solutions manual to accompany Company Accounting 10e

Pre-acquisition analysis: Thailand Ltd to Tuvalu Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Tuvalu Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) = Goodwill

($21 000 + $1 000) (equity) + $1 000 (1 – 30%) (BCVR - plant) = $22 700 = $20 730 = 10% x $22 700 = $2 270 $23 000 = $300

1. Business combination valuation entries: Tuvalu Ltd Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

1 500

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation

Dr Dr Cr

200 400

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

180

Dr Dr Dr Dr Cr

900 18 900 630 300

Dr Dr Dr Cr

100 2 100 70

Retained earnings (1/7/16) NCI (10% ($9 000 - $1 000 – ($400 - $120)))

Dr Cr

772

Retained earnings (1/7/16)

695

500 300 700

600

60 120

2. Pre-acquisition entry: Thailand Ltd – Tuvalu Ltd Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in Tuvalu Ltd

20 730

3. DNCI share of equity in Tuvalu Ltd at 1/7/14 Retained earnings (1/7/16) Share capital Business combination valuation reserve NCI (10% of balances at 1/7/14)

2 270

4. NCI share of equity in Tuvalu Ltd: 1/7/14 – 30/6/16

772

22.42

Solution Manual to accompany Company Accounting 10e

NCI (9% ($9 000 - $900/.9 – ($400 - $120))

695

5. NCI share of equity in Tuvalu Ltd: 1/7/16 – 30/6/17 NCI share of profit NCI (10% ($1 000 – ($200 -- $60)))

Dr Cr

NCI share of profit NCI (9% ($1 000 – ($200 - $60)))

Dr Cr

NCI

Dr Cr

600

Dividend declared (10% x $6 000)

600

Pre-acquisition analysis: Tonga Ltd – Thailand Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Thailand Ltd

(a) Consideration transferred (b) Non-controlling interest = Aggregate of (a) and (b) Goodwill

$50 000 + $4 000) (equity) + $3 000 (1 – 30%) (BCVR - machinery) = $56 100 = $54 990 $10% x $56 100 = $5 610 = $60 600 = $4 500

6. Business combination valuation entries: Thailand Ltd Depreciation expense Retained earnings (1/7/16) Income tax expense Transfer from business combination valuation reserve

Dr Dr Cr

1 000 1 400 300

2 100

7. Pre-acquisition entry: Tonga Ltd – Thailand Ltd Retained earnings (1/7/16) Transfer from business combination valuation reserve Share capital Goodwill Shares in Thailand Ltd

3 600

Dr Dr Dr Cr

1 890 45 000 4 500

54 990

22.43

Solutions manual to accompany Company Accounting 10e

8. NCI share of equity in Thailand Ltd at 1/7/14 Retained earnings (1/7/16) Share capital Business combination valuation reserve NCI

Dr Dr Dr Cr

400 5 000 210

Dr Cr

2 060

Dr Cr

130

Dr Cr

210

Dr Cr

1 000

Dr Cr

540

5 610

9. NCI share of equity in Thailand Ltd: 1/7/14 – 30/6/16 Retained earnings (1/7/16) NCI (10% ($26 000 - $4 000 – $1 400))

2 060

10. NCI share of equity in Thailand Ltd: 1/7/16 - 30/6/17 NCI share of profit NCI (10% ($2 000 – [$1 000 - $300])) Transfer from business combination valuation reserve Business combination valuation reserve (10% x $2 100) NCI Dividend declared (10% x $10 000) NCI NCI share of profit (10% x 90% x $6 000)

130

210

1 000

540

11. Dividend declared: Thailand Ltd Dividend payable Dividend declared (90% x $10 000)

Dr Cr

9 000

Dividend revenue Dividend receivable

Dr Cr

9 000

Dividend payable Dividend declared (90% x $6 000)

Dr Cr

5 400

Dividend revenue Dividend receivable

Dr Cr

5 400

9 000

12. Dividend declared: Tuvalu Ltd

5 400

22.44

Solution Manual to accompany Company Accounting 10e

Question 22.8

Consolidation worksheet, consolidated statement of profit or loss and other comprehensive income and statement of changes in equity

On 1 July 2017, Vanuatu Ltd acquired 80% of the shares in Vietnam Ltd (cum div.) for $44 760. At this date, Vietnam Ltd had not recorded any goodwill and all its identifiable net assets were recorded at fair value except for land and inventory. Carrying amount $ 8 000 12 000

Land Inventory

Fair value $ 10 000 15 000

Half of this inventory still remained on hand at 30 June 2018. Immediately after the acquisition date, Vietnam Ltd revalued the land to fair value. The land was still on hand at 30 June 2018. At 1 July 2017, Vietnam Ltd acquired 75% of the shares in Brunei Ltd for $15 300. Brunei Ltd had not recorded any goodwill and all its identifiable assets and liabilities were recorded at fair value except for the following: Carrying amount $ 10 000

Inventory

Fair value $ 14 000

All the inventory was sold by 30 June 2018. When assets are sold or fully consumed, any related valuation surpluses are transferred to retained earnings. At the acquisition date, the financial statements of the three companies showed the following: Vanuatu Ltd $ 80 000 20 000 16 000 6 400 12 000

Share capital General reserve Asset revaluation surplus Retained earnings Dividend payable

Vietnam Ltd $ 32 000 3 200 6 400 4 800 3 200

Brunei Ltd $ 20 000 — — (3 200 ) —

The following information was provided for the year ended 30 June 2018: Vanuatu Ltd Sales revenue Cost of sales Gross profit Less: Distribution administrative expenses

$ 108 000 72 000 36 000

Vietnam Ltd $ 72 000 61 200 10 800

9 000 27 000 1 280 28 280 8 480 19 800 6 400 26 200

2 700 8 100 1 500 9 600 1 920 7 680 4 800 12 480

Brunei Ltd $ 54 000 40 500 13 500

and

Plus: Interim dividend revenue Profit before income tax Income tax expense Profit Retained earnings (1/7/17)

2 880 10 620 — 10 620 2 400 8 220 (3 200 ) 5 020 22.45

Solutions manual to accompany Company Accounting 10e

4 000 4 000 8 000 18 200

Less: Dividend paid Dividend declared $

— 1 600 1 600 $ 10 880

1 000 1 000 2 000 3 020

Retained earnings (30/6/18) Additional information (a) Dividends declared for the year ended 30 June 2017 were duly paid. (b) Intragroup purchases (at cost plus 331/3%) were: Vanuatu Ltd from Vietnam Ltd — $43 200; Vietnam Ltd from Brunei Ltd — $37 800. (c) Intragroup purchases valued at cost to the purchasing company were included in inventory at 30 June 2018, as follows: Vanuatu Ltd — $5400; Vietnam Ltd — $4500. (d) The tax rate is 30%. Required A. Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Vanuatu Ltd at 30 June 2018. B. Prepare the consolidated statement of profit or loss and other comprehensive income and statement of changes in equity (not including movements in share capital and other reserves) at 30 June 2018.

80% Vanuatu Ltd

75% Vietnam Ltd Vanuatu Ltd 80% DNCI 20%

Brunei Ltd Vanuatu Ltd 60% DNCI 25% INCI 15%

Acquisition analysis: Vanuatu Ltd – Vietnam Ltd At 1 July 2017: Net fair value of identifiable assets and liabilities of Vietnam Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = =

($32 000 + $3 200 + $6 400 + $4 800) (equity) + $2 000 (1 – 30%) (ARS - land) + $3 000 (1 – 30%) (BCVR - inventory) $ 49 900 $44 760 – (80% x $3 200) (div. receivable) $42 200 20% x $49 900 $9 980 $52 180 $ 2 280

22.46

Solution Manual to accompany Company Accounting 10e

1. Business combination valuation entries The land is revalued in the records of Vietnam Ltd. Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Dr

1 500

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

1 500

Dr Dr Dr Dr Dr Dr Cr

3 840 25 600 2 560 6 240 1 680 2 280

Dr Cr

840

Dr Dr Dr Dr Dr Cr

960 6 400 640 1 560 420

450

1 050

450 1 050

2. Pre-acquisition entry: Vanuatu Ltd – Vietnam Ltd Retained earnings (1/7/17) Share capital General reserve Asset revaluation surplus * Business combination valuation reserve Goodwill Shares in Vietnam Ltd * 80%($6 400 + $1 400) Transfer from business combination valuation reserve Business combination valuation reserve

42 200

840

3. NCI share of equity in Vietnam Ltd at 1/7/17 Retained earnings (1/7/17) Share capital General reserve Asset revaluation surplus Business combination valuation reserve NCI (20% of balances)

9 980

4. NCI share of equity in Vietnam Ltd: 1/7/17 – 30/6/18 NCI share of profit NCI (20% x [$7 680 – ($1 500 - $450)]) Transfer from business combination valuation reserve Business combination valuation reserve (20% x $1 050) NCI NCI share of profit (20% x 75% x $2 000, being

Dr Cr

1 326

Dr Cr

210

Dr Cr

300

1 326

210

300

22.47

Solutions manual to accompany Company Accounting 10e

dividend revenue from Brunei Ltd) NCI

Dr Cr

Dividend declared (20% x $1 600)

320 320

Acquisition analysis: Vietnam Ltd – Brunei Ltd At 1 July 2017: Net fair value of identifiable assets and liabilities of Brunei Ltd:

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = =

($20 000 - $3 200) (equity) + $4 000 (1 – 30%) (BCVR - inventory) $19 600 $15 300 25% x $19 600 $4 900 $20 200 $600

5. Business combination valuation entries Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

4 000 1 200

2 800

Retained earnings (1/7/17) Business combination valuation reserve Share capital Goodwill Shares in Brunei Ltd

Cr Dr Dr Dr Cr

2 400

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

2 100

Dr Dr Cr Cr

5 000 700

6. Pre-acquisition entry: Vietnam Ltd – Brunei Ltd The entry at 30 June 2018 is:

2 100 15 000 600 15 300

2 100

7. 25% DNCI share of equity in Brunei Ltd at 1/7/17 Share capital Business combination valuation reserve Retained earnings (1/7/17) NCI

800 4 900

22.48

Solution Manual to accompany Company Accounting 10e

8. NCI share of equity in Brunei Ltd: 1/7/17 – 30/6/18 NCI share of profit NCI (25% x [$8 220 – ($4 000 - $1 200)])

Dr Cr

1 355

NCI share of profit NCI (15% ($8 220 – ($4 000 - $1 200)))

Dr Cr

813

Transfer from BCVR Business combination valuation reserve (25% x $2 800) NCI Dividend paid (25% x $1 000) NCI Dividend declared (25% x $1 000)

9. Dividend paid Brunei Ltd: 75% x $1 000

1 355

813

Dr Cr

700 700

Dr Cr

250

Dr Cr

250

Dr Cr

750

250

$750

Dividend revenue Dividend paid

750

10. Dividend declared Vietnam Ltd: 80% x $1 600 Brunei Ltd: 75% x $1 000

= =

$1 280 $ 750 $2 030

Dividend payable Dividend declared

Dr Cr

2 030

Dividend revenue Dividend receivable

Dr Cr

2 030

2030

2 030

11. Intragroup sales: Vietnam Ltd – Vanuatu Ltd Sales revenue Cost of sales Inventory

Dr Cr Cr

43 200

Deferred tax asset Income tax expense

Dr Cr

405

41 850 1 350

405

22.49

Solutions manual to accompany Company Accounting 10e

NCI NCI share of profit (20% x ($1 350 - $405)

Dr Cr

189 189

13. Intragroup sales: Brunei Ltd – Vietnam Ltd Sales

Dr Cr Cr

37 800

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

338

Dr Cr

315

36 675 1 125

338

14. NCI adjustment NCI NCI share of profit ((25% + 15%) ($1 125 - $338))

315

22.50

Solution Manual to accompany Company Accounting 10e

Financial Statements Sales revenue

Vanuatu Ltd 108 000

Vietnam Ltd 72 000

Brunei Ltd 54 000

Cost of sales

72 000

61 200

40 500

Dividend revenue

36 000 9 000 27 000 1 280

10 800 2 700 8 100 1 500

13 500 2 880 10 620 -

Income tax expense

28 280 8 480

9 600 1 920

10 620 2 400

Profit

19 800

7 680

8 220

Retained earnings (1/7/17) Transfer from BCVR

6 400

4 800

(3 200)

3 840

2 400

6 560

2 6

840 2 100

1 050 2 800

1 5

910

26 200 4 000 4 000

12 480 1 600

5 020 1 000 1 000

8 000 18 200

1 600 10 880

2 000 3 020

D&A expenses

Dividend paid Dividend declared

Retained earnings (30/6/18)

11 13 1 5

9 10

Adjustments Dr Cr 43 200 37 800 1 500 41 850 4 000 36 675

Group

Parent Cr

4 8 8 3

1 326 1 335 813 960

300 189 315 800

4 8

210 700

153 000 11 13

100 675 52 325 14 580 37 745 --

750 2 030 450 1 200 405 338

1 5 11 13

37 745 10 407

27 338

NCI Dr

750 2 030

9 10

34 808 4 250 4 570 8 820 25 988

4 12 14 7

24 668

6 400 0

250 320 250

8 4 8

31 068 4 000 4 000 8 000 23 068

22.51

Solutions manual to accompany Company Accounting 10e

Question 22.8 (cont’d)

VANUATU LTD Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2018 Sales revenue Expenses: Cost of sales Other

$153 000 100 675 14 580 115 255 37 745 10 407 $27 338 $27 338

Profit before income tax Income tax expense Profit for the period Comprehensive Income for the period Attributable to: Parent interest Non-controlling interest

$24 668 $2 670

VANUATU LTD Consolidated Statement of Changes in Equity (extract) for the year ended 30 June 2018 Consolidated

Parent

Comprehensive income for the period

$27 338

$24 668

Retained earnings at 1 July 2017 Profit for the period Transfer from business combination valuation reserve Dividend paid Dividend declared Retained earnings at 30 June 2018

$6 560 27 338 910 (4 250) (4 570) $25 988

$6 400 24 668 0 (4 000) (4 000) $23 068

22.52

Solution Manual to accompany Company Accounting 10e

Question 22.9

Consolidation worksheet entries

On 1 July 2016, Brunei Ltd acquired (ex div.) 80% of the shares of Bhutan Ltd for $146 400. At this date, the equity of Bhutan Ltd consisted of: Share capital General reserve Retained earnings

100 000 50 000 20 000

In the accounts at this date, Bhutan Ltd had recorded a dividend payable of $5000, goodwill of $13 000, and furniture at cost of $80 000 less accumulated depreciation of $10 000. All the identifiable assets and liabilities of Bhutan Ltd were recorded at fair value except for the following:

Plant (cost $120 000) Inventory

Carrying amount $ 90 000 40 000

Fair value $ 100 000 45 000

The plant has a further 5-year life, and is depreciated using the straight-line method. Of the inventory, 90% was sold by 30 June 2017, the remaining 10% being sold by 30 June 2018. During the 2016–17 period, Bhutan Ltd recorded a profit of $40 000. There were no changes in reserves. During the 2017–18 period, Bhutan Ltd recorded a profit of $36 000, and recorded a transfer to general reserve of $6000. On 1 January 2017, Bhutan Ltd acquired a 50% interest in Burma Ltd for $57 000, giving it a capacity to control that entity. At this date, the equity of Burma Ltd consisted of: Share capital $ 80 000 General reserve 40 000 Retained earnings (10 000 ) The identifiable assets and liabilities of Burma Ltd consisted of:

Land Plant (cost $110 000) Inventory

Carrying amount $ 50 000 80 000 10 000

Fair value $ 56 000 82 000 12 000

All the inventory on hand at 1 January 2017 was sold by 30 June 2017. The plant had a further 10-year life, and was depreciated using the straight-line method. The land was sold by Burma Ltd in the 2017–18 period. The profit of Burma Ltd for the period from 1 January 2017 to 30 June 2017 was $8000. There were no movements in the general reserve during this period. During the 2017–18 period, Burma Ltd earned a $20 000 profit. Burma Ltd also transferred $20 000 from general reserve to retained earnings during the 2017–18 period. Assume an income tax rate of 30%. When assets are sold or fully consumed, any related valuation surpluses are transferred to retained earnings. Required Prepare, in general journal entry format, the consolidation worksheet entries for the preparation of the consolidated financial statements of Brunei Ltd at 30 June 2018.

22.53

Solutions manual to accompany Company Accounting 10e

80% Brunei Ltd

50% Bhutan Ltd DNCI 20%

Burma Ltd DNCI 50% INCI 10%

Acquisition analysis: Brunei Ltd – Bhutan Ltd At 1/7/16: Net fair value of identifiable assets and liabilities of Bhutan Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill acquired Goodwill recorded Adjustment to goodwill

= = = = = = = = =

($100 000 + $50 000 + $20 000) (equity) - $13 000 (goodwill) + $10 000 (1 – 30%) (BCVR - plant) + $5 000 (1 – 30%) (BCVR - inventory) $167 500 $146 400 20% x $167 500 $33 500 $179 900 $12 400 80% x $13 000 $10 400 $2 000

1. Business combination valuation entries Accumulated depreciation – furniture Furniture

Dr Cr

10 000

Accumulated depreciation – plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

30 000

Depreciation expense Retained earnings (1/7/17) Accumulated depreciation (20% x $10 000 per annum)

Dr Dr Cr

2 000 2 000

Deferred tax liability Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

1 200

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

500

10 000

20 000 3 000 7 000

4 000

600 600

150

350

2 Pre-acquisition entries Entry at 30/6/18: Retained earnings (1/7/17) * Share capital General reserve

Dr Dr Dr

18 520 80 000 40 000

22.54

Solution Manual to accompany Company Accounting 10e

Business combination valuation reserve ** Goodwill Shares in Bhutan Ltd *$16 000 + 80% x 90% x $3 500 ** 80% x $7 000 + 80% x 10% x $3 500

Dr Dr Cr

5 880 2 000

Transfer from BCVR BCVR

Dr Cr

280

Dr Dr Dr Dr Cr

4 000 20 000 10 000 2 100

Dr Cr Cr

7 720

NCI share of profit Dr NCI Cr (20% [$36 000 – [$2 000 - $600] – [$500 - $150]])

6 850

146 400

280

3. NCI share of equity in Bhutan Ltd at 1/7/16 Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve NCI (20% of balances at 1/7/16)

36 100

4. NCI share of equity in Bhutan: 1/7/16 – 30/6/17 Retained earnings Business combination valuation reserve NCI (RE: 20% [$40 000 – [$2 000 - $600] BCVR: 20% x 90% x $3 500)

630 7 090

5. NCI share of equity in Bhutan Ltd: 1/7/17 – 30/6/18

Transfer from business combination valuation reserve Business combination valuation reserve (20% x 10% x $3 500) General reserve Transfer to general reserve (20% x $6 000)

6 850

Dr Cr

1 200

Acquisition analysis: Bhutan Ltd – Burma Ltd At January 2017: Net fair value of identifiable assets and liabilities of Burma Ltd

= ($80 000 + $40 000 - $10 000) (equity) + $6 000 (1 – 30%) (BCVR - land) + $2 000 (1 – 30%) (BCVR - plant) + $2 000 (1 – 30%) (BCVR - inventory) = $117 000

22.55

Solutions manual to accompany Company Accounting 10e

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Gain on bargain purchase

= = = = =

$57 000 50% x $117 000 $58 500 $115 500 $1 500

6. Business combination valuation entries Gain on sale of land/Carrying amount of land sold Income tax expense Transfer from business combination valuation reserve

Dr Cr

6 000 1 800

4 200

Accumulated depreciation – plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

30 000

Depreciation expense – plant Retained earnings (1/7/17) Accumulated depreciation (10% x $2 000 per annum)

Dr Dr Cr

200 100

Deferred tax liability Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

28 000 600 1 400

300

60 30

7. Pre-acquisition entries Entry at 30/6/13: Retained earnings (1/7/17) * Transfer from business combination valuation reserve Transfer from general reserve Share capital General reserve Business combination valuation reserve Shares in Burma Ltd

Cr Dr Dr Dr Dr Dr Cr

5 800 2 100 10 000 40 000 10 000 700 57 000

* $(5 000) +50% x $1 400 BCVR inventory - $1 500 gain

8. NCI share of equity in Burma Ltd at 1/1/17 Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve NCI (50% share of balances – direct NCI only)

Cr Dr Dr Dr Cr

5 000 40 000 20 000 3 500 58 500

22.56

Solution Manual to accompany Company Accounting 10e

9. NCI share of equity in Burma Ltd: 1/1/17 – 30/6/17 Retained earnings (1/7/17) Dr Business combination valuation reserve Cr NCI Cr (RE: 50% x ($(2 000) – $(10 000) – [$100 - $30])) Retained earnings (1/7/17) NCI (10% ($(2 000) – [$100 - $30] – $(5 800)/50%]))

3 965 700 3 265

Dr Cr

953 953

10. NCI share of equity in Burma Ltd: 1/7/12 – 30/6/13 NCI share of profit Dr NCI Cr (50% x ($20 000 – [$200 - $60] – [$6 000 - $1 800]))

7 830 7 830

NCI share of profit Dr NCI Cr (10% x ($20 000 – [$200 - $60] – [$6 000 - $1 800]))

1 566

Transfer from general reserve General reserve (50% x $20 000)

10 000

Dr Cr

1 566

10 000

22.57

Solutions manual to accompany Company Accounting 10e

Question 22.10

Consolidation worksheet entries

On 1 July 2016, Indonesia Ltd acquired 75% of the issued shares of India Ltd for $320 000. At this date the statement of financial position of India Ltd was as follows: Current assets Non-current assets Liabilities Net assets Share capital General reserve Retained earnings Total equity

20 000 500 000 520 000 (120 000 ) $ 400 000 $ 100 000 100 000 200 000 $ 400 000

All the identifiable assets and liabilities of India Ltd were recorded at fair value except for some land for which the fair value was $10 000 greater than the carrying amount and some depreciable assets with a further 5-year life for which the fair value was $12 000 greater than the carrying amount. The tax rate is 30%. On 1 July 2018, Palau Ltd acquired 60% of the issued shares of Indonesia Ltd for $350 000. At this date, the statement of financial position of Indonesia Ltd was as follows: Current assets $ 120 000 Non-current assets Investment in India Ltd $ 320 000 Other 280 000 600 000 720 000 Liabilities (220 000 ) Net assets $ 500 000 Share capital $ 200 000 Retained earnings 300 000 $ 500 000 All the identifiable assets and liabilities of Indonesia Ltd were recorded at fair value except for the investment in India Ltd which had a fair value of $400 000. The statement of financial position of India Ltd at 1 July 2018 was as follows: Current assets Non-current assets

Liabilities Share capital General reserve Retained earnings

$ $

30 000 600 000 630 000 (130 000 ) 500 000 100 000 120 000 280 000 500 000

All the identifiable assets and liabilities of India Ltd at this date were recorded at fair value except for the land held at 1 July 2016 which, at 1 July 2018, had a fair value of $20 000 greater than carrying amount, and the depreciable assets which have a further 3-year life have a fair value of $8000 greater than carrying amount. Financial information about Palau Ltd, Indonesia Ltd and India Ltd at 30 June 2019 is shown below:

22.58

Solution Manual to accompany Company Accounting 10e

Palau Ltd Current assets $ 200 000 Non-current assets 350 000 Investment in Indonesia — Ltd 100 000 Investment in India Ltd 500 000 Land (80 000 ) Depreciable assets 1 070 000 Accumulated depreciation 250 000 $ 820 000 Liabilities $ 300 000 Net assets 200 000 Share capital 150 000 General reserve 170 000 Retained earnings (1/7/18) $ 820 000 Profit for the period

Indonesia Ltd $ 150 000 — 320 000 50 000 400 000 (80 000 ) 840 000 260 000 $ 580 000 $ 200 000 — 300 000 80 000 $ 580 000

India Ltd 35 000 — — 40 000 620 000 (40 000 ) 655 000 120 000 $ 535 000 $ 100 000 120 000 280 000 35 000 $ 535 000 $

Required Prepare the worksheet entries for the consolidated financial statements at 30 June 2019.

75% Indonesia Ltd At 1 July 2016: Net fair value of identifiable assets and liabilities of India Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

India Ltd

= = = = = =

$100 000 + $100 000 +$200 000 + $10 000 (1 – 30%) (BCVR – land) + $12 000 (1 – 30%) (BCVR – N/C assets) $415 400 $320 000 25% x $415 400 $103 850 $423 850 $8 450

Business combination valuation entries at 30/6/18: Indonesia Ltd – India Ltd Land

Dr Cr Cr

10 000

Deferred tax liability Business combination valuation reserve Depreciable assets Deferred tax liability Business combination valuation reserve

Dr Cr Cr

12 000

Retained earnings (1/7/17) Deferred tax liability Accumulated depreciation ($12 000/5 years = $2 400 p a for 2 years)

Dr Dr Cr

3 360 1 440

150 000

3 000 7 000

3 600 8 400

4 800

Pre-acquisition entry at 1/7/16: Indonesia Ltd -India Ltd Retained earnings (1/7/16)

22.59

Solutions manual to accompany Company Accounting 10e

Share capital General reserve Business combination valuation reserve Goodwill Shares in India Ltd

Dr Dr Dr Dr Cr

75 000 75 000 11 550 8 450 320 000

60% Palau Ltd ---------------------------- Indonesia Ltd At 1 July 2018: Net fair value of identifiable assets and liabilities of Indonesia Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = =

$200 000 + $300 000 + $80 000 (BCVR – Shares in India) $580 000 $350 000 40% x $580 000 $232 000 $582 000 $2 000

(1) Business combination valuation entry - India Ltd at 30 June 2019 Land

Dr Cr Cr

10 000

Deferred tax liability Business combination valuation reserve

10 000

Deferred tax liability Business combination valuation reserve

Dr Cr Cr

Retained earnings (1/7/18) Depreciable assets Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

4 800 8 000

Depreciation expense Accumulated depreciation (1/3 x $8 000)

Dr Cr

2 667

Deferred tax liability Income tax expense

Dr Cr

800

Dr Cr

80 000

Land

3 000 7 000

3 840 8 960

2 667

800

(2) Business combination valuation entry - Indonesia Ltd Shares in India Ltd Business combination valuation reserve

80 000

Using the pre-acquisition entry for Indonesia Ltd - India Ltd at 1/7/16: Retained Earnings: 75% ($280 000 - $3 360) - $150 000 General Reserve: (75% x $120 000) - $75 000 Business Combination Valuation Reserve: (75% x $22 960) - $11 550 Goodwill * : $10 300 - $8 450 Total

= = = = =

$57 480 $15 000 $5 670 $1 850 $80 000

22.60

Solution Manual to accompany Company Accounting 10e

* $10 300 = $400 000 - 75%($500 000 + $14 000 + $5 600) The further entry at 30/6/19 is: Retained earnings (1/7/18) General reserve Business combination valuation reserve Goodwill Shares in India Ltd

Dr Dr Dr Dr Cr

57 480 15 000 5 670 1 850

Dr Dr Dr Dr Cr

180 000 120 000 48 000 2 000

Dr Dr Dr Cr

120 000 80 000 32 000

Dr Cr

32 000

Dr Dr Dr Dr Dr Cr

150 000 75 000 75 000 11 550 8 450

Dr Dr Dr Dr Cr

50 000 25 000 25 000 3 850

80 000

(3) Pre-acquisition entry: Palau Ltd - Indonesia Ltd Retained earnings (1/7/18) Share capital Business combination valuation reserve Goodwill Shares in Indonesia Ltd

350 000

(4) DNCI in Indonesia Ltd at 1/7/18 Retained earnings (1/7/18) Share capital Business combination valuation reserve NCI (RE: 40% x $300 000 SC: 40% x $200 000 BCVR: 40% x $80 000)

232 000

(5) DNCI in Indonesia Ltd from 1/7/18 to 30/6/19 NCI share of profit NCI (40% x $80 000)

32 000

(6) Pre-acquisition entry: Indonesia Ltd - India Ltd Retained earnings (1/7/18) Share capital General reserve Business combination valuation reserve Goodwill Shares in India Ltd

320 000

(7) DNCI in equity of India Ltd at 1/7/16 Retained earnings (1/7/18) Share capital General reserve Business combination valuation reserve* NCI (* 25% x $15 400)

103 850

22.61

Solutions manual to accompany Company Accounting 10e

(8) DNCI in equity of India Ltd from 1/7/16 to 30/6/18 General reserve Dr Retained earnings (1/7/18) Dr NCI Cr (GR: 25%($120 000 - $100 000) RE: 25%($280 000 - $200 000 - $4 800))

5 000 18 800 23 800

(9) DNCI in India Ltd from 1/7/18 to 30/6/19 Business combination valuation reserve NCI (25% ($22 960 - $15 400))

Dr Cr

1 890

NCI share of profit NCI (25% ($35 000 – [$2 667 - $800]))

Dr Cr

8 283

Dr Cr

9 940

1 890

8 283

(10) INCI in India Ltd from 1/7/18 to 30/6/19 NCI share of profit NCI (30%($35 000 – [$2 667 - $800])

9 940

22.62

Solution Manual to accompany Company Accounting 10e

Question 22.11

Consolidation worksheet entries, analysis of noncontrolling interest

A client of yours is the chief accountant of Comoros Ltd which, at 30 June 2017, has two subsidiaries, Cook Islands Ltd and Chile Ltd. He is unsure how to prepare the consolidated financial statements and has asked for your help. He has provided you with the information below concerning the group, and has determined a series of questions for which he wants clear, well-written answers. Provide the answers to these questions. Assume an income tax rate of 30%. Part A Comoros Ltd acquired 40% of the capital of Cook Islands Ltd on 1 July 2014 for $79 400, consisting of $9400 cash and 14 000 Comoros Ltd shares having an estimated fair value of $5 per share. The equity of Cook Islands Ltd at this date is shown below. Share capital General reserve Retained earnings

$ 100 000 50 000 40 000

All the identifiable assets and liabilities of Cook Islands Ltd were recorded at fair value except for plant (carrying amount $60 000, net of $10 000 depreciation) for which the fair value was $65 000. The plant has a further 5-year life. During January 2015, Cook Islands Ltd paid a dividend of $5000. Further, in January 2015, a transfer to retained earnings of $4000 was made from the general reserve established before 1 July 2014. Required A. Prepare the business combination valuation and pre-acquisition entries in relation to Comoros Ltd’s acquisition of Cook Islands Ltd at 30 June 2015, assuming Cook Islands Ltd is a subsidiary of Comoros Ltd at this date. B. Explain how the calculations used in requirement A meet the requirements of AASB 3 Business Combinations. C. If Comoros Ltd acquired its shares in Cook Islands Ltd at 1 July 2014, but did not achieve control until 1 July 2015 when the retained earnings of Cook Islands Ltd were $60 000 and the fair value of plant was $30 000 greater than the carrying amount, should the fair values be measured at 1 July 2014, or at 1 July 2015 when Comoros Ltd obtained control of Cook Islands Ltd? Explain your answer, referring to requirements of appropriate accounting standards to justify your answer. D. If Cook Islands Ltd earned a $10 000 profit between 1 July 2014 and 30 June 2015, determine the non-controlling interest share of Cook Islands Ltd’s equity at 30 June 2015. E. Explain your calculation of the non-controlling interest share of profit in requirement D. Part B Cook Islands Ltd acquired 75% of the issued shares of Chile Ltd at 1 January 2015 for $137 000 when the equity of Chile Ltd consisted of $100 000 capital and $62 000 retained earnings which included profit of $12 000, earned from 1 July 2014. At acquisition date, all the identifiable assets and liabilities of Chile Ltd were recorded at fair value except for the following assets:

22.63

Solutions manual to accompany Company Accounting 10e

Carrying amount Land $ 80 000 Plant (net of accumulated depreciation of 60 000 $15 000) 20 000 Inventory

Fair value $ 90 000 65 000 25 000

Of the inventory, 90% was sold by 30 June 2015 and the remainder by 30 June 2016. The land was sold in January 2017 for $120 000. The plant has a further 5-year life. When assets are sold or fully consumed, any related valuation surpluses are transferred to retained earnings. Required Prepare the business combination valuation and pre-acquisition entries at 30 June 2015 and 30 June 2017. Part C The following transactions affect the preparation of consolidated financial statements at 30 June 2017: (a) Sale of inventory in June 2016 from Chile Ltd to Comoros Ltd — the inventory cost Chile Ltd $2000, and was sold to Comoros Ltd for $3000. At 30 June 2017, the inventory was all sold by Comoros Ltd. (b) Sale of plant on 1 January 2016 from Chile Ltd to Comoros Ltd — the plant had a carrying amount in Chile Ltd of $12 000 at time of sale, and was sold for $15 000. The plant had a further 5-year life. (c) Dividend of $10 000 declared in June 2017 by Chile Ltd to be paid in August 2017. (d) Payment of a $4500 management fee from Chile Ltd to Comoros Ltd in February 2017. Required In relation to the preparation of the consolidated financial statements at 30 June 2017: A. Provide consolidation worksheet journal entries for the above transactions, including related non-controlling interest adjustments. B. If the retained earnings (1/7/16) of Chile Ltd was $80 000 and the profit for the 2016– 17 period was $10 000, calculate the non-controlling interests share of Chile Ltd’s equity at 30 June 2017, assuming no changes in reserves. C. The calculation of non-controlling interest is based on the concept of sharing only those profits that are realised to the group. Explain this concept, showing how it is implemented using transactions (a), (b) and (d) in part C. D. Explain the non-controlling interest adjustment entry in relation to transaction (c). E. Explain the adjustment entry for transaction (a).

Part A Business combination valuation and pre-acquisition entries: Comoros Ltd – Cook Islands Ltd At 1 July 2014 Net fair value of identifiable assets, and liabilities of Cook Islands Ltd

$100 000 + $50 000 + $40 000) (equity) + $5 000 (1 – 30%) (BCVR - plant)

22.64

Solution Manual to accompany Company Accounting 10e

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

$193 500 $79 400 60% x $193 500 $116 100 $195 500 $2 000

A(A). The worksheet entries at 30 June 2015 are: Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

10 000

Depreciation expense Accumulated depreciation

Dr Cr

1 000

Deferred tax liability Income tax expense

Dr Cr

300

Dr Dr Dr Dr Dr Dr Cr

16 000 1 600 40 000 18 400 1 400 2 000

5 000 1 500 3 500

1 000

300

Pre-acquisition entry Retained earnings (1/7/14) Transfer from general reserve Share capital General reserve Business combination valuation reserve Goodwill Shares in Cook Islands Ltd

79 400

A(B). • • • • • •

Consideration transferred is based on the fair value of what is given up by Comoros Ltd. Identifiable assets and liabilities acquired are measured at fair value Goodwill is calculated as a residual under the partial goodwill method Goodwill is not amortised, but is subject to an impairment test Fair values are measured at acquisition date Use of acquisition method

A(C). The appropriate date for determination of the fair values of identifiable assets and liabilities acquired is the acquisition date, 1 July 2015, being the date of control. It would be necessary for Comoros Ltd to revalue the investment in Cook Islands Ltd to its fair value at 1 July 2015 according to paragraph 42 of AASB 3 Business Combinations.

22.65

Solutions manual to accompany Company Accounting 10e

A(D). NCI share of equity of Cook Islands Ltd at 30 June 2015 NCI share of equity at 1/7/14 Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve NCI

Dr Dr Dr Dr Cr

24 000 60 000 30 000 2 100 116 100

NCI share of equity: 1/7/14 – 30/6/15 Share of profit NCI (60% x ($10 000 – [$1 000 - $300]))

Dr Cr

5 580

Transfer from general reserve General reserve

Dr Cr

2 400

NCI

Dr Cr

3 000

Dividend paid (60% x $5 000)

5 580

2 400

3 000

A(E). Need to adjust for the depreciation on revalued plant to avoid double counting. The NCI has a share of the Business Combination Valuation Reserve. Cook Islands Ltd’s current period recorded profit includes the benefits in relation to the revalued plant. Not to reduce the recorded profit by the amounts already recognised in the BCVR, would be to double count the NCI share of equity.

Part B Valuation and pre-acquisition entries at 30 June 2015 and 30 June 2017: Cook Islands Ltd – Chile Ltd At 1 January 2015: Net fair value of identifiable assets and liabilities of Chile Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

($100 000 + $62 000) (equity) + $10 000 (1 – 30%) (BCVR - land) + $5 000 (1 – 30%) (BCVR - plant) + $5 000 (1 – 30%) (BCVR - inventory) $176 000 $137 000 25% x $176 000 $44 000 $181 000 $5 000

Worksheet entries at 30 June 2015

22.66

Solution Manual to accompany Company Accounting 10e

Business combination valuation entries Land

10 000

Deferred tax liability Business combination valuation reserve

Dr Cr Cr

Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Depreciation expense – plant Accumulated depreciation (1/2 x 1/5 x $5 000)

Dr Cr

500

Deferred tax liability Income tax expense

Dr Cr

150

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

4 500

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

500

Retained earnings (1/1/15) Share capital Business combination valuation reserve Goodwill Shares in Chile Ltd

Dr Dr Dr Dr Cr

46 500 75 000 10 500 5 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

2 363

Dr Cr

10 000

3 000 7 000

10 000 1 500 3 500

500

150

1 350

3 150

150 350

Pre-acquisition entries

137 000

2 363

Worksheet entries at 30 June 2017 Business combination valuation entries Gain on sale of land/carrying amount of land sold Income tax expense Transfer from business combination valuation reserve

3 000

7 000

Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Depreciation expense – plant

1 000

10 000 1 500 3 500

22.67

Solutions manual to accompany Company Accounting 10e

Retained earnings (1/7/16) Accumulated depreciation (1/5 x $5 000 per annum)

Dr Cr

1 500

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

750

Dr Dr Dr Dr Cr

49 125 75 000 7 875 5 000

Dr Cr

5 250

2 500

300 450

Pre-acquisition entries Retained earnings (1/1/16)* Share capital Business combination valuation reserve Goodwill Shares in Chile Ltd * (75% x $62 000) + (75% x ($5 000 (1 – 30%)) Transfer from business combination valuation reserve Business combination valuation reserve (75% x $7 000)

137 000

5 250

Part C C(A) (i) Sale of inventory in prior period, from Chile Ltd to Comoros Ltd Retained earnings (1/7/16) Income tax expense Cost of sales (ii).

490 490

Dr Dr Cr

2 100 900

Dr Cr

1 470

Dr Cr

900

3 000

NCI adjustment NCI Retained earnings (1/7/16) ((25% + 45%) x $2 100))

(v)

Dr Cr

1 000

Sale of plant in prior period, from Chile Ltd to Comoros Ltd Retained earnings (1/7/16) Deferred tax asset Plant

(iv)

700 300

NCI adjustment NCI share of profit Retained earnings (1/7/16) ((25% + 45%) x $700))

(iii)

Dr Dr Cr

1 470

Depreciation on plant Accumulated depreciation Depreciation expense

600

22.68

Solution Manual to accompany Company Accounting 10e

Retained earnings (1/7/16) Income tax expense Retained earnings (1/7/11) Deferred tax asset (vi)

300

Dr Dr Cr

180 90

Dr Dr Cr

294 147

Dividend payable Dividend declared

Dr Cr

7 500

Dividend revenue Dividend receivable

Dr Cr

7 500

Dr Cr

4 500

Dr Dr Dr Cr

15 500 25 000 3 500

Dr Cr Cr

4 238

Retained earnings (1/7/16) Dr NCI Cr * (45% ($80 000 - $49 125/0.75 – [$1 500 - $450]))

6 053

270

NCI adjustment NCI share of profit Retained earnings (1/7/16) NCI ((25% + 45%) x ($600 - $180) p.a.))

441

(vii) Dividend declared

7 500

(viii) Management fee Management fee revenue Management fee expense

4 500

C(B). Calculation of NCI NCI share of equity at 1 January 2015 Retained earnings (1/7/16) Share capital Business combination valuation reserve NCI (25% of balances)

44 000

NCI share of equity from 1/1/15 – 30/6/16 Retained earnings (1/7/16) * Business combination valuation reserve NCI * (25% ($80 000 - $62 000 – [$1 500 - $450]))

875 3 363

6 053

NCI share of equity from 1/7/16 – 30/6/17 NCI share of profit Dr NCI Cr (25% ($10 000 – [$1 000 - $300] – [$10 000 - $3 000]))

575 575

22.69

Solutions manual to accompany Company Accounting 10e

NCI share of profit Dr NCI Cr (45% ($10 000 – [$1 000 – $300] – [$10 000 - $3 000] )

1 035

NCI

2 500

Dividend declared (25% x $10 000)

Dr Cr

1 035

2 500

C(C). Realisation relates to involvement of an external party. In relation to (a): realisation occurs at point of sale to external party In relation to (b): no direct external party. Assume realisation occurs in proportion to consumption of benefits as asset is used. That is, in proportion to depreciation. In relation to (d): assume instant realisation

C(D). The INCI receives a share of profit of Chile Ltd. The DNCI in Cook Islands Ltd receives a share of profit of Cook Islands Ltd which includes the dividend revenue from Chile Ltd. There is a problem of double counting the NCI share of Chile Ltd’s profits. It will be necessary in calculating the NCI share of Cook Islands Ltd’s equity to reduce the NCI share of equity, and NCI Share of Profit by $4 500 (i.e. 60% x 75% x $10 000).

C(E). See Chapter 21. Explain:

effect on profit effect on cost of sales tax effect

22.70

Solution Manual to accompany Company Accounting 10e

Question 22.12

Consolidated financial statements

On 1 July 2017, United States Ltd acquired 60% of the shares of Peru Ltd for $108 000. On the same day, Peru Ltd acquired 80% of the shares (cum div.) of Canada Ltd for $71 600. At the acquisition date, Peru Ltd’s and Canada Ltd’s financial statements showed the following balances: Peru Ltd $ 100 000 30 000 15 000 —

Share capital General reserve Retained earnings Dividend payable

Canada Ltd $ 60 000 20 000 8 000 5 000

The dividend of Canada Ltd was paid later in 2017. On 1 July 2017, all identifiable assets and liabilities of Peru Ltd and Canada Ltd were recorded at fair values except for the following: Peru Ltd

Canada Ltd

Carrying amount

Fair value

Carrying amount

Fair value

Plant and machinery $ 60 000 (cost $80 000) Inventory 40 000 Vehicles (cost $80 000) —

$ 80 000

—

50 000 —

$ 30 000 50 000

$ 40 000 55 000

The vehicles have an expected useful life of 4 years and the plant is expected to last a further 10 years. Benefits are expected to be received evenly over these periods. All inventory on hand at 1 July 2017 was sold by 30 June 2018. When assets are sold or fully consumed, any related valuation surpluses are transferred to retained earnings. The financial statements of the three companies at 30 June 2018 are as follows. United States Ltd Sales revenue $ 520 000 Other revenue 160 000 680 000 Cost of sales 410 000 Other expenses 146 000 556 000 Profit before income tax 124 000 Income tax expense 51 000 Profit 73 000 Retained earnings (1/7/17) 24 000 97 000 Interim dividend paid 10 000 Final dividend declared 16 000 Transfer to general 25 000 reserve 51 000 46 000 Retained earnings 250 000 (30/6/18) 145 000 Share capital 21 000 General reserve 41 000

Peru Ltd

Canada Ltd

$ 365 000 105 000 470 000 190 000 180 000 370 000 100 000 40 000 60 000 15 000 75 000 15 000 8 000 6 000 29 000 46 000 100 000 36 000 6 000 30 000

$ 115 000 58 000 173 000 86 000 42 000 128 000 45 000 20 000 25 000 8 000 33 000 3 000 4 000 4 000 11 000 22 000 60 000 24 000 20 000 20 000

22.71

Solutions manual to accompany Company Accounting 10e

Bank overdraft Provisions Current tax liability Deferred tax liability Dividend payable Bank Receivables Inventory Dividend receivable Shares in Peru Ltd Shares in Canada Ltd Deferred tax asset Plant Accumulated depreciation Vehicles Accumulated depreciation

55 000 25 000 16 000 $ 599 000 $ 49 000 61 200 103 000 4 800 108 000 — 21 000 200 000 (48 000 ) 130 000 (30 000 ) $ 599 000

42 000 12 000 8 000 $ 280 000 $ 25 000 17 000 41 800 3 200 — 67 600 15 400 180 000 (70 000 ) — — $ 280 000

26 000 8 000 4 000 $ 184 000 $ 32 000 16 000 68 000 — — — 8 000 — — 100 000 (40 000 ) $ 184 000

Additional information (a) Included in the ending inventory of Peru Ltd was inventory purchased from Canada Ltd for $10 000. This had originally cost Canada Ltd $8000. (b) United States Ltd had sold inventory to Canada Ltd during the period for $25 000. This had cost United States Ltd $20 000. Half of this has been sold to external parties by Canada Ltd during the year for $15 000. (c) The tax rate is 30%. Required Prepare the consolidated financial statements for United States Ltd and its subsidiaries, Peru Ltd and Canada Ltd, for the period ending 30 June 2018.

60% United States Ltd

80% Peru Ltd Canada Ltd United States Ltd 60% United States Ltd 48% DNCI 40% DNCI 20% INCI 32%

Pre-acquisition analysis: United States Ltd – Peru Ltd At 1 July 2017: Net fair value of identifiable assets and liabilities of Peru Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

($100 000 + $30 000 + $15 000) (equity) + $20 000 (1 – 30%) (BCVR - plant) + $10 000 (1 – 30%) (BCVR - inventory) $166 000 $108 000 40% x $166 000 $66 400 174 400 $8 400

1. Business combination valuation entries

22.72

Solution Manual to accompany Company Accounting 10e

Accumulated depreciation P & M Deferred tax liability Business combination valuation reserve

Dr Cr Cr

20 000

Depreciation expense – P & M Accum depreciation – P & M (1/10 x $20 000 p.a.)

Dr Cr

2 000

Deferred tax liability Income tax expense

Dr Cr

600

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

10 000

6 000 14 000

2 000

600

3 000

7 000

2. Pre-acquisition entries : United States Ltd – Peru Ltd The entry at 30/6/18 is: Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve Goodwill Shares in Peru Ltd

Dr Dr Dr Dr Dr Cr

9 000 60 000 18 000 12 600 8 400

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

4 200

Dr Dr Dr Dr Cr

6 000 40 000 12 000 8 400

NCI share of profit Dr NCI Cr (40% ($60 000 – [$2 000 - $600]) – [$10 000 - $3000])

20 640

General reserve Transfer to general reserve (40% ($36 000 - $30 000))

2 400

108 000

4 200

3. NCI share of equity in Peru Ltd at 1/7/17 Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve NCI (40% of balances)

66 400

4. NCI share of equity in Peru Ltd: 1/7/17 – 30/6/18

Dr Cr

20 640

2 400

22.73

Solutions manual to accompany Company Accounting 10e

valuation reserve Business combination valuation reserve (40% x $7 000)

Dr Cr

2 800

NCI

Dr Cr

6 000

Dr Cr

2 240

Interim dividend paid (40% x $15 000) NCI

2 800

6 000

NCI share of profit (40% x 80% x $7 000, being dividend revenue, paid & provided from Canada Ltd) NCI

Dr Cr

Final dividend declared (40% x $8 000)

2 240

3 200 3 200

Pre-acquisition analysis: Peru Ltd – Canada Ltd At 1 July 2017: Net fair value of identifiable assets and liabilities of Canada Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Gain on bargain purchase

= = = = = = =

($60 000 + $20 000 + $8 000) (equity) + $5 000 (1 – 30%) (BCVR - vehicles) + $10 000 (1 – 30%) (BCVR - inventory) $98 500 $71 600 – (80% x $5 000) (dividend) $67 600 20% x $98 500 $19 700 $87 300 $11 200

5. Business combination valuation entries - Peru Ltd – Canada Ltd Accumulated depreciation – vehicles Vehicles Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

30 000

Depreciation expense – vehicles Accumulated depreciation - vehicles (1/4 x $5 000 p.a.)

Dr Cr

1 250

Deferred tax liability Income tax expense

Dr Cr

375

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

10 000

25 000 1 500 3 500

1 250

375

3 000 7 000

22.74

Solution Manual to accompany Company Accounting 10e

6. Pre-acquisition entries: Peru Ltd – Canada Ltd Retained earnings 1/7/17) Share capital General reserve Business combination valuation reserve Gain – other income Shares in Canada Ltd

Dr Dr Dr Dr Cr Cr

6 400 48 000 16 000 8 400

Transfer from business combination valuation reserve Business combination valuation reserve (80% x $7 000)

Dr Cr

5 600

Dr Dr Dr Dr Cr

1 600 12 000 4 000 2 100

11 200 67 600

5 600

7. DNCI share of equity in Canada Ltd at 1/7/17 Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve NCI (20% of balances)

19 700

8. NCI share of equity in Canada Ltd from 1/7/17 – 30/6/18 NCI share of profit Dr NCI Cr (20% ($25 000 – [$1 250 - $375] – [$10 000 - $3 000))

3 425 3 425

NCI share of profit Dr 9 960 NCI Cr (32% ($25 000 – [$1 250 - $375] – [$10 000 - $3 000] + $11 200/0.8))

9 960

General reserve Transfer to general reserve ((20% + 32%) ($24 000 - $20 000))

2 080

Transfer from business combination valuation reserve Business combination valuation reserve (20% x $7 000) NCI Interim dividend paid (20% x $3 000) NCI Final dividend declared (20% x $4 000) 9. Interim dividend paid

Dr Cr

2 080

Dr Cr

1 400

Dr Cr

600

Dr Cr

800

1 400

600

800

22.75

Solutions manual to accompany Company Accounting 10e

Peru Ltd: Canada Ltd:

60% x $15 000 80% x $3 000

= =

Dividend revenue Interim dividend paid

$9 000 $2 400 $11 400 Dr Cr

11 400 11 400

10. Dividend declared Peru Ltd: Canada Ltd:

60% x $8 000 80% x $4 000

= =

$4 800 $3 200 $8 000

Dividend payable Final dividend declared

Dr Cr

8 000

Dividend revenue Dividend receivable

Dr Cr

8 000

Dr Cr Cr

10 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

600

Dr Cr

728

8 000

11. Inventory transfer: Peru Ltd – Canada Ltd Sales

8 000 2 000

600

12. NCI adjustment NCI NCI share of profit ((20% + 32%) ($ 2000 - $600))

728

13. Inventory transfer: United States Ltd to Canada Ltd Sales

Dr Cr Cr

25 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

750

22 500 2 500

750

22.76

Solution Manual to accompany Company Accounting 10e

Financial Statements Sales revenue

Pattini Ltd 520 000

Kantang Ltd 365 000

Phenom Ltd 115 000

Other income

160 000

105 000

58 000

Cost of sales

680 000 410 000

470 000 190 000

173 000 86 000

Other expenses

146 000

180 000

42 000

Profit before tax Tax expense

556 000 124 000 51 000

370 000 100 000 40 000

128 000 45 000 20 000

Profit

73 000

60 000

25 000

24 000

15 000

8 000

97 000

75 000

33 000 -

Transfer from BCVR Retained earnings (1/7/17)

11 13 9 10

Adjustments Dr Cr 10 000 25 000 11 400 11 200 8 000

1 5 1 5

10 000 10 000 2 000 1 250

8 000 22 500

Group

20 640 3 425 9 960 2 800 1 400 6 000 1 600

2 240 728

965 000 6

11 13

314 800 1 279 800 675 500

1 1 5 5 11 13

1 046 750 233 050 102 675

130 375

4 200 5 600 9 000 6 400

Parent Cr

371 250

600 3 000 375 3 000 600 750

2 6 2 6

NCI Dr

7 000 7 000

1 5

4 200 31 600 166 175

4 8 8 4 8 3 7

4 12

99 318

24 000 123 318

22.77

Solutions manual to accompany Company Accounting 10e

Interim dividend paid Final dividend declared Transfer to general reserve

10 000

15 000

3 000

11 400

16 600

16 000

8 000

4 000

8 000

20 000

25 000

6 000

4 000

35 000

Retained earnings (30/6/18) Share capital

51 000 46 000

29 000 46 000

11 000 22 000

71 600 94 575

250 000

100 000

60 000

General reserve

145 000

36 000

24 000

BCVR

2 6 2 6

60 000 48 000 18 000 16 000

2 6

12 600 8 400

302 000 171 000

14 000 4 200 3 500 5 600

1 2 5 6

6 300

Total equity: Parent Total equity: NCI

Bank overdraft Provisions Current tax liability

6 000 600 3 200 800 2 400 2 080

182 000

106 000

573 875

21 000 41 000 55 000

6 000 30 000 42 000

20 000 20 000 26 000

47 000 91 000 123 000

10 000 16 000 30 520 56 520 66 798

3 7 3 4 7 8 3 7

4 4 4 8 8 12 441 000

4 8 4 8 4 8

40 000 12 000 12 000 2 400 4 000 2 080 8 400 2 100

250 000 150 520

2 800 1 400

6 000 66 400 2 240 20 640 3 200 19 700 600 3 425 800 9 960 728 142 373 142 373

4 8

3 4 7 8 8

467 318 106 557

573 875

22.78

Solution Manual to accompany Company Accounting 10e

Deferred tax liability Dividend payable Total liabilities Total equity & liabilities

25 000

12 000

8 000

16 000 158 000 599 000

8 000 98 000 280 000

4 000 78 000 184 000

Bank Receivables Inventory

49 000 61 200 103 000

25 000 17 000 41 800

32 000 16 000 68 000

Div. receivable Shares in Peru Shares in Canada Deferred tax asset

4 800 108 000 21 000

3 200 67 600 15 400

8 000

Plant Accum deprec. Vehicles Accum deprec. Goodwill

200 000 (48 000) 130 000 (30 000) -

180 000 (70 000) -

100 000 (40 000) -

599 000

280 000

184 000

1 5 10

600 375 8 000

6 000 1 500

11 13 10 2 6

600 750

20 000

5 2

30 000 8 400 334 575

51 525 20 000 332 525 906 400

2 000 2 500 8 000 108 000 67 600 11 13

1 5

2 000 25 000 1 250

334 575

1 5 5

106 000 94 200 208 300 45 750 380 000 (100 000) 205 000 (41 250) 8 400 906 400

22.79

Question 22.12 (cont’d) UNITED STATES LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2018 Sales revenue Other income

$965 000 314 800 1 279 800 675 500 371 250 1 046 750 233 050 102 675 $130 375 $130 375

Cost of sales Other expenses Profit before income tax Income tax expense Profit for the period Comprehensive Income for the period Attributed to: Parent interest Non-controlling interest

$99 318 $31 057

UNITED STATES LTD Consolidated Statement of Changes in Equity for the year ended 30 June 2018 Consolidated Comprehensive income for the period $130 375

Parent $99 318

Retained earnings at 1 July 2017 Profit for the period Transfer from business combination valuation reserve Transfer to general reserve Interim dividend paid Dividend declared Retained earnings at 30 June 2018

$31 600 130 375 4 200 (35 000) (16 600) (20 000) $94 575

$24 000 99 318 0 (30 520) (10 000) (16 000) $66 798

General reserve at 1 July 2017 Transfer from retained earnings General reserve at 30 June 2018

136 000 35 000 $171 000

120 000 30 520 $150 520

Business combination valuation reserve at 1 July 2017 Transfer to retained earnings Business combination valuation reserve at 30 June 2018

$10 500 4 200 $6 300

Share capital at 1 July 2017 Share capital at 30 June 2018

$302 000 $302 000

$250 000 $250 000

Solution Manual to accompany Company Accounting 10e

UNITED STATES LTD Consolidated Statement of Financial Position as at 30 June 2018

Current Assets Cash assets: Bank Receivables Inventories Total Current Assets Non-Current Assets Property, plant and equipment: Plant Accumulated depreciation Vehicles Accumulated depreciation Tax assets: Deferred tax asset Goodwill Total Non-Current Assets Total Assets Equity Share capital Reserves: General reserve Retained earnings Parent Interest Non-controlling Interest Total Equity Current Liabilities Interest-bearing liabilities: Bank overdraft Provisions Tax liabilities: Current Payables: Dividend Payable Total Current Liabilities Non-current Liabilities Tax liabilities: Deferred tax liability Total Liabilities Total Equity and Liabilities

$106 000 94 200 208 300 408 500

$380 000 (100 000) 205 000 (41 250)

280 000 163 750 45 750 __8 400 497 900 $906 400

$250 000 150 520 66 798 467 318 106 557 $573 875 47 000 91 000 123 000 20 000 281 000 51 525 332 525 $906 400

22.77

Solutions manual to accompany Company Accounting 10e

Question 22.13

Sale of shares with no loss of control

Note: The consolidation worksheet entries are prepared at 1 July 2019 after the sale of shares in B Ltd by A Ltd On 1 July 2017, A Ltd acquired 80% of the shares issued by B Ltd for $85 000. At this date, the shareholders’ equity of B Ltd consisted of share capital of $80 000 and retained earnings of $20 000. All identifiable assets were recorded at amounts equal to fair value except for plant for which the fair value was $4000 greater than the carrying amount. The plant had a further 4-year life. Goodwill is calculated on a partial basis. On 1 July 2018, A Ltd sold a quarter of its shareholding in B Ltd for $48 000 cash. The financial statements of A Ltd and B Ltd at this date prior to the sale were as follows: A Ltd B Ltd Share capital $ 100 000 $ 80 000 General reserve 20 000 10 000 Retained earnings 100 000 70 000 Liabilities 20 000 12 000 240 000 172 000 Shares in B Ltd $ 85 000 Other assets 155 000 172 000 240 000 172 000 Required Prepare the consolidation worksheet at 1 July 2018 after the sale of shares by A Ltd, assuming that the sale did not result in A Ltd losing control of B Ltd.

Acquisition analysis at 1 July 2017: Fair value of identifiable net assets of B Ltd

(a) Consideration transferred (a) NCI share of B Ltd Aggregate of (a) and (b) Goodwill

= = = = = = =

$80 000 + $20 000 + $4 000 (1 – 30%) (BCVR – plant) $102 800 $85 000 20% x $102 800 $20 560 $105 560 $2 760

Entry in A Ltd on sale of shares in B Ltd Cash Shares in B Ltd Gain on sale

Dr Cr Cr

48 000

Dr Cr Cr

4 000

21 250 26 750

Consolidation worksheet entries at 1 July 2019 1. Business combination valuation entries Plant Deferred tax liability BCVR

1 200 2 800

22.78

Solution Manual to accompany Company Accounting 10e

Retained earnings (1/7/18) Accumulated depreciation ( 2 yrs x ¼ x $4 000)

Dr Cr

2 000

Deferred tax liability Retained earnings (1/7/18)

Dr Cr

600

Dr Dr Dr Dr Cr

12 000 48 000 1 680 2 070

Dr Dr Dr Cr

4 000 16 000 560

Dr Dr Cr

9 720 2 000

Dr Cr Cr Cr

26 750

Dr Dr Dr Dr Cr

13 720 16 000 560 2 000

2 000

600

2. Pre-acquisition entry Retained earnings (1/7/18) Share capital BCVR Goodwill Shares in B Ltd (60% of balances at acquisition date)

63 750

3. NCI at 1/7/17 Retained earnings (1/7/19) Share capital BCVR NCI (20% of balances)

20 560

4. NCI share of changes in equity from 1/7/17 to 30/6/18 Retained earnings (1/7/19) General reserve NCI (RE: 20% ($70 000 - $20 000 – ($2 000 - $600) GR: 20% x $10 000)

11 720

5. Adjustment to gain on sale of shares Gain on sale Retained earnings (1/7/19) Transfer from general reserve Other reserves (RE: 20% ($70 000 - $20 000 – ($2 000 - $600)) GR: 20% x $10 000)

9 720 2 000 15 030

6. NCI changes as a result of sale of shares by parent Retained earnings (1/7/19) Share capital BCVR General reserve NCI (RE: 20% ($70 000 – ($2000 - $600)) Cap: 20% x $80 000 BCVR: 20% x $2 800 GR: 20% x $10 000)

32 280

22.79

Solutions manual to accompany Company Accounting 10e

QUESTION 22.13 (cont’d) The consolidation worksheet at 1/7/19 is as follows:

A Ltd Gain on sale Retained earnings (1/7/18) Transfer from general reserve Share capital General reserve BCVR Other reserves NCI

B Ltd

26 750

26 750 (5)

100 000

70 000

2 000(1) 12 000(2)

100 000

80 000

20 000

10 000

NCI Dr

600(1) 9 720 (5)

48 000(2)

1 680(2)

4 000(3) 9 720(4) 13 720 (6)

138 880

2 800(1)

2 000

16 000(3) 16 000(6) 2 000(4) 2 000(6) 560(3) 560(6)

100 000 26 000 0

15 030 (5)

15 030 20 560(3) 11 720(4) 32 280(6)

20 000 266 750

12 000 172 000

600(1)

Shares in B Ltd Other assets Goodwill

63 750

203 000

172 000

4 000(1)

0 266 750

0 172 000

2 070(2)

70 000

2 000(1) 16 000(2)

64 560

1 200(1)

32 600 379 070

63 750(2)

2 000(1)

377 000 2 070 379 070

Note the retained earnings closing balance at 30 June 2019: A Ltd B Ltd Dr Cr NCI Dr 100 000

Parent 0

2 000(5)

Liabilities

Retained earnings (30/6/19)

NCI Cr

600(1)

4 000(3) 9 720(4)

NCI Cr

Parent 138 880

22.80

Solution Manual to accompany Company Accounting 10e

Question 22.14

Sale of shares with loss of control

X Ltd acquired 80% of the issued shares of Y Ltd for $700 000 on 1 July 2017 when the equity of Y Ltd consisted of $400 000 capital and $300 000 retained earnings. At this date the carrying amounts of Y Ltd’s identifiable assets and liabilities were not different from fair value except for plant for which the fair value was $10 000 greater than carrying amount. The plant had a further 5-year life. On 30 June 2018, X Ltd sold all its interest in Y Ltd for $1 200 000 when the financial statements of Y Ltd showed: Sales revenue Expenses Profit Retained earnings (1/7/18) Retained earnings (30/6/19) Share capital Total equity Net assets

900 000 775 000 125 000 500 000 625 000 400 000 $ 1 025 000 $ 1 025 000

Required Prepare the consolidation worksheet entries for X Ltd at 30 June 2019. Acquisition analysis at 1 July 2017: Fair value of identifiable assets and liabilities of Y Ltd

(a) Consideration transferred (b) NCI in Y Ltd Aggregate of (a) and (b) Goodwill – parent share

= = = = = = =

$400 000 + $300 000 + $10 000 (1 – 30%) (BCVR plant) $707 000 $700 000 20% x $707 000 $141 400 $841 400 $134 400

If there had been no sale of shares, the business combination valuation entries at 30 June 2019 would have been: Plant

Dr Cr Cr

10 000

Depreciation expense Retained earnings (1/7/18) Accumulated depreciation

Dr Dr Cr

2 000 2 000

Deferred tax liability Income tax expense Retained earnings (1/7/18)

Dr Cr Cr

1 200

Deferred tax liability Business combination valuation entry

3 000 7 000

4 000

600 600

X Ltd would pass the following journal entry on sale of its investment in Y Ltd: Cash Shares in Y Ltd Gain

Dr Cr Cr

1 200 000 700 000 500 000 22.81

Solutions manual to accompany Company Accounting 10e

The real gain to the group is calculated as follows – note there is no remaining investment: Gain = =

$1 200 000 (proceeds on sale) - $957 760 (X Ltd’s share of Y Ltd’s net assets) * $242 240

* = 80% ($1 025 000 (recorded net assets) + ($10 000 - $4000) plant – ($3000 - $1200) (deferred tax liability)) + $134 400 goodwill to parent The adjustment to the gain on sale on consolidation is then $257 760 (= $500 000 - $242 240). The consolidation worksheet entries at 30 June 2019 are then:

1. Adjustment to gain on sale of shares and reinstatement of equity earned by the group up to point of sale Gain on sale of shares Sales Expenses ($775 000 + ($2000 - $600)) Retained earnings (1/7/18) ($500 000 - $300 000 – ($2000 - $600)) Transfer from BCVR ($7 000 – 80% x $7000) Reduction in equity

Dr Cr Dr

257 760 900 000 776 400

198 600

Cr Dr

65 840

1 400

24 720

Dr Dr Cr

39 720 1 400

2. NCI reduction Share of profit (20% x $125 000 – ($2000 - $600) Retained earnings (1/7/18) (20% x $500 000 - $300 000 – ($2000 - $600) Transfer from BCVR (20% x $7000) Reduction in equity

65 840

22.82

Solution Manual to accompany Company Accounting 10e

Question 22.15

Acquisition of additional shares in subsidiary

On 1 July 2017, K Ltd acquired 60% of the issued capital of L Ltd for $66 000 cash when the equity of L Ltd consisted of share capital of $80 000 and retained earnings of $20 000. All the identifiable assets and liabilities of L Ltd were recorded at amounts equal to fair value except for plant for which the fair value was $4000 greater than carrying amount. The plant had a further 4-year life. On consolidation goodwill is calculated on a partial basis. On 1 July 2019, K Ltd acquired a further 20% interest in Ltd for $26 000. At this date, the shareholders’ equity of L Ltd consisted of $80 000 share capital and $40 000 retained earnings. Required Prepare the consolidation worksheet entries for the year ended 30 June 2020. Acquisition analysis at 1 July 2017: Fair value of identifiable net assets of L Ltd

(a) Consideration transferred (b) Carrying amount of NCI Aggregate of (a) and (b) Goodwill

= = = = = = =

$80 000 + $20 000 + $4 000 (1 – 30%) (BCVR – plant) $102 800 $66 000 40% x $102 800 $41 120 $107 120 $4 320

On acquisition of the additional shares, K Ltd records the following: Shares in Ltd Cash

Dr Cr

66 000 66 000

Consolidation worksheet entries prior to acquisition of additional shares: 1. Business combination valuation entries Plant

Dr Cr Cr

4 000

Deferred tax liability BCVR Retained earnings (1/7/19) Accumulated depreciation

Dr Cr

2 000

Deferred tax liability Retained earnings (1/7/19)

Dr Cr

600

Dr Dr Dr Dr Cr

12 000 48 000 1 680 4 320

1 200 2 800

2 000

600

2. Pre-acquisition entries Retained earnings (1/7/19) Share capital BCVR Goodwill Shares in L Ltd

66 000 22.83

Solutions manual to accompany Company Accounting 10e

3. NCI at 1/7/17 Retained earnings (1/7/19) Share capital BCVR NCI (40% of equity balances of L Ltd)

Dr Dr Dr Cr

8 000 32 000 1 120

Retained earnings (1/7/19) NCI (40% ($40 000 - $20 000 – ($2000 - $600)))

Dr Cr

7 440

Dr Dr Dr

7 720 16 000 560

Dr Cr

1 720

Dr Cr Cr Cr

24 280

41 120

7 440

4. Acquisition of additional shares by K Ltd Retained earnings (1/7/19) Share capital BCVR Retained earnings: Decrease due to acquisition of additional shares in L Ltd Shares in L Ltd

26 000

5. Reduction in NCI due to acquisition of shares by K Ltd NCI Retained earnings (1/7/19) Share capital BCVR (Half of NCI share prior to sale of shares)

7 720 16 000 560

22.84

Solution Manual to accompany Company Accounting 10e

Question 22.16

Acquisition of additional shares in a subsidiary

Peter Ltd acquired an 80% interest in Sam Ltd on 1 July 2015 for $32 000 when equity of Sam Ltd consisted of: Share capital Retained earnings

$20 000 16 000

All the identifiable assets and liabilities of Sam Ltd were recorded at amounts equal to their fair values at this date except for plant for which the fair value was $2000 greater than the carrying amount. The remaining economic life of the plant was 5 years. The fair value of the non-controlling interest was $8000. The full goodwill method was used on consolidation. On 1 July 2017, Peter Ltd acquired a further 20% of Sam Ltd for $10 000 when the shareholders’ equity of Sam Ltd was: Share capital Retained earnings

$20 000 20 000

Required Prepare the consolidation worksheet entries at 1 July 2017 immediately after Peter Ltd’s acquisition of further shares in Sam Ltd.

At 1 July 2015 Net FV of INA of Sam Ltd

(a) Consideration transferred (b) NCI in Sam Ltd Aggregate of (a) and (b) Goodwill

Goodwill attributed to Peter Ltd: Net FV acquired Consideration transferred Goodwill – Peter Ltd Goodwill attributed to NCI

= = = = = = =

$20 000 + $16 000 + $2 000(1 -30%) (BCVR – plant) $37 400 $32 000 $8 000 $40 000 $40 000 - $37 400 $2 600

= = = = = =

80% x $37 400 $29 920 $32 000 $2 080 $2 600 – $2 080 $520

Note: Peter Ltd paid $32 000 for 80%. FV of Sam Ltd was $40 000 (NCI FV $8000/0.2) Therefore, as $32 000 = 80% of $40 000, there is no control premium in this question. WORKSHEET ENTRIES At 1 July 2017 – prior to acquisition of further 20% of shares in Sam Ltd: 1. BCVR Plant Deferred tax liability BCVR Retained earnings (1/7/17)

Dr Cr Cr

2 000

800

600 1 400

22.85

Solutions manual to accompany Company Accounting 10e

Accumulated depreciation

800

Deferred tax liability Retained earnings 91/7/17)

Dr Cr

240

Goodwill BCVR

Dr Cr

2 600

Dr Dr Dr Cr

12 800 16 000 3 200

Retained earnings (1/7/17) Share capital BCVR NCI

Dr Dr Dr Cr

3 200 4 000 800

Retained earnings (1/7/17) NCI (20%[20 000 – 16 000 – (800 – 240)])

Dr Cr

688

240

2 600

2. Pre-acquisition entry Retained earnings (1/7/17) Share capital BCVR Shares in Sam Ltd

32 000

3. NCI

8 000

688

CONSOLIDATION WORKSHEET ENTRIES at 1/7/17 AFTER FURTHER ACQUISITION OF SHARES IN SAM LTD Use entries (1) – (3) above 4. Reduction in NCI as result of acquisition of further shares NCI Retained earnings (1/7/17) Share capital BCVR (Write-down the whole of the NCI interest as subsidiary is now wholly owned)

Dr Cr Cr Cr

8 688

Dr Dr Dr

4 000 3 888 800

Dr Cr

1 312

3 888 4 000 800

5. Elimination of additional interest in Sam Ltd Share capital Retained earnings (1/7/17) BCVR Retained earnings (1/7/17): decrease due to acquisition of shares in Sam Ltd from NCI Shares in Sam Ltd

10 000

22.86

Solution Manual to accompany Company Accounting 10e

Question 22.17

Sale of shares in subsidiary by parent without loss of control

Pretty Ltd acquired an 80% interest in Smart Ltd on 1 July 2015 for $20 375 when the shareholders’ equity of Smart Ltd consisted of: Share capital Retained earnings

$12 500 10 000

All the identifiable assets and liabilities of Smart Ltd were recorded at amounts equal to their fair values except for plant for which the fair value was $1250 greater than carrying amount. The remaining economic life of the plant was 5 years. The fair value of the non-controlling interest was $5000. The full goodwill method was used on consolidation. On 1 July 2017, Pretty Ltd sold a 16% interest in Smart Ltd (i.e. 1/5 of its holdings) for $5000. Shareholders’ equity of Smart Ltd at this date consisted of share capital of $12 500 and retained earnings of $12 500. Required Prepare the consolidation worksheet entries at 1 July 2017 immediately after Pretty Ltd sold its shares in Smart Ltd.

At 1 July 2015: Net FV of INA

(a) Consideration transferred (b) NCI in Smart Ltd Aggregate of (a) and (b) Goodwill Goodwill of Smart Ltd: FV of Smart Ltd Net FV of INA of Smart Ltd Goodwill of Smart Ltd Goodwill of Pretty Ltd: Goodwill acquired Goodwill of Smart Ltd Goodwill of Pretty Ltd: control premium

= $12 500 + $10 000 + $1 250 (1 – 30%) (BCVR – plant) = $23 375 = $20 375 = $5 000 = $25 375 = $2 000

= = = = =

$5000/20% $25 000 $23 375 $25 000 - $23 375 $1 625

= $2 000 = $1 625 = $375

CONSOLIDATION WORKSHEET ENTRIES at 1/7/17 PRIOR TO SALE OF SHARES BY PARENT 1. BCVR Plant

Dr Cr Cr

1 250

Deferred tax liability BCVR Retained earnings (1/7/17) Accumulated depreciation

Dr Cr

500

375 875

500 22.87

Solutions manual to accompany Company Accounting 10e

Deferred tax liability Retained earnings (1/7/17)

Dr Cr

150

Goodwill BCVR

Dr Cr

1 625

Dr Dr Dr Dr Cr

8 000 10 000 2 000 375

Retained earnings (1/7/17) Share capital BCVR NCI

Dr Dr Dr Cr

2 000 2 500 500

Retained earnings (1/7/17) NCI (20%(12 500 – 10 000 – (500 – 150)))

Dr Cr

430

150

1 625

2. Pre-acquisition entry Retained earnings (1/7/17) Share capital BCVR Goodwill – control premium Shares in Smart Ltd

20 375

3. NCI

5 000

430

CONSOLIDATION WORKSHEET ENTRIES at 1/7/17 AFTER SALE OF SHARES BY PARENT 1. BCVR No change – as above 2. Pre-acquisition entry Now use only 64% of pre-acquisition equity Retained earnings (1/7/17) Dr 6 400 Share capital Dr 8 000 BCVR Dr 1 600 Goodwill – control premium* Dr 300 Shares in Smart Ltd ** Cr Note: Pretty Ltd sold 1/5 of its holding in Smart Ltd. *Goodwill is therefore reduced by 1/5. ($375 – [1/5 x $375]) **Shares in Smart Ltd is reduced by 1/5. ($20 375 – [1/5 x $20 375])

16 300

3. NCI Use entry as at top of page plus the following entry for the extra 16% interest: Retained earnings 91/7/17) * Share capital BCVR NCI

Dr Dr Dr Cr

1 944 2 000 400

4 344

22.88

Solution Manual to accompany Company Accounting 10e

(* RE = 16%(12 500 – (500 – 150))

4. Elimination of gain recorded by Pretty Ltd Pretty Ltd records a gain

= $5 000 – 1/5 x $20 375 = $925

Gain on sale Retained earnings (1/7/17) * Other reserves (*RE: 16%[(12 500 – 10 000) – (500 – 150)])

Dr Cr Cr

925

344 581

22.89

Solutions manual to accompany Company Accounting 10e

Question 22.18

Sale of shares in subsidiary by parent resulting in loss of control

Use the information in question 22.17 but assume that Pretty Ltd sold half of its shares in Smart Ltd (leaving it with a 40% interest in Smart Ltd) for $12 500. As a result of this sale, Pretty Ltd lost control of Smart Ltd. Required A. Prepare the journal entries in Pretty Ltd to record the sale of shares in Smart Ltd and the recording of any gain/loss on sale. B. Prepare the consolidation worksheet entries at 1 July 2017 immediately after Pretty Ltd sold its shares in Smart Ltd. A. On sale of shares in Smart Ltd by Pretty Ltd, Pretty Ltd passes the following entry: Cash

Dr 12 500 Shares in Smart Ltd Cr 10 187.5 Shares in Smart Ltd Dr 2 312.5 Gain [recorded] Cr 4 625 Note: Pretty Ltdf sold ½ its holding in Smart Ltd. Therefore, its investment in Smart Ltd is reduced by 1/2 . Original investment amount $20 375 x ½ = $10 187.50 If Pretty Ltd sold ½ its holding for $12 500 then it’s assumed the FV of its holding was $25 000. Therefore, the recorded gain on sale is $4 625 ($25 000 - $20 375) The real gain to the group is calculated as follows: Real gain to group

= $12 500 proceeds of sale + $12 500 FV of remaining investment - $21 720 Pretty Ltd’s share of net assets * - $375 goodwill recognised by Pretty Ltd (control premium) = $2 905

* Pretty Ltd’s share of net assets

= =

80% [$25 000 recoded by Smart Ltd + $1 625 goodwill + ($1 250 - $500) unrecorded plant - ($375 - $150) unrecorded DTL 80% x $27 150 $21 720

B. CONSOLIDATION ADJUSTMENT Gain on sale Retained earnings (1/7/17) ($4 625 – $2 905) BEFORE SALE Pretty Ltd Retained 0 earnings (1/7/17)

Smart Ltd 12 500

Dr Cr

Dr 500 8 000

Cr 150

1 720 1 720

NCI Dr 2 000 430

NCI Cr

Group 1 720

22.90

Solution Manual to accompany Company Accounting 10e

AFTER SALE Pretty Ltd Retained 0 earnings (1/7/17) Gain on 4 625 sale

Smart Ltd

Dr 0

NCI Dr

1 720

NCI Cr

Group 1 720

2 905

22.91

Solutions manual to accompany Company Accounting 10e

Question 22.19

Consolidated financial statements, reciprocal shareholdings

On 1 July 2014, Singapore Ltd acquired 10% of the issued capital of New Caledonia Ltd for $60 000. At this date the equity of New Caledonia Ltd consisted of: Share capital Retained earnings

$ 100 000 450 000

All the identifiable assets and liabilities of New Caledonia Ltd were recorded at fair value except for some machinery for which the fair value was $20 000 greater than carrying amount. The machinery had a further 5-year life, with benefits expected to be received evenly over this period. On 1 January 2017, New Caledonia Ltd acquired 60% of the issued capital of Singapore Ltd for $132 000, obtaining control over the financial and operating policies of Singapore Ltd. At this date the equity of Singapore Ltd consisted of: Share capital Retained earnings (1/7/16) Profit to 1/1/17

$ 100 000 50 000 50 000

All the identifiable assets and liabilities of Singapore Ltd were recorded at fair value except for plant and machinery (expected life of 5 years) whose fair value was $5000 greater than carrying amount, and the investment account Shares in New Caledonia Ltd which had a fair value of $70 000. The financial statements of New Caledonia Ltd at 1 January 2017 contained the following information: Carrying Fair value amount Current assets $ 120 000 $ 120 000 Non-current assets Plant and machinery 470 000 490 000 Other 200 000 200 000 790 000 810 000 Liabilities (160 000 ) (160 000 ) Net assets $ 630 000 $ 650 000 Share capital $ 100 000 Retained earnings (1/7/16) 500 000 Profit to 1/1/17 30 000 Equity $ 630 000 The plant and machinery of New Caledonia Ltd whose fair value was greater than carrying amount had a further 4-year life. At 30 June 2017 Singapore Ltd had not disposed of its shares in New Caledonia Ltd. At 30 June 2017, the financial statements of New Caledonia Ltd and its subsidiary Singapore Ltd included the following:

Profit before income tax Income tax expense Profit Retained earnings at 1/7/16 Dividends paid at 28/6/17

New Caledonia Ltd $ 50 000 (10 000 ) 40 000 500 000 540 000 (20 000 )

Singapore Ltd $ 80 000 (20 000 ) 60 000 ) 50 000 ) 110 000 ) (10 000

22.92

Solution Manual to accompany Company Accounting 10e

Retained earnings at 30/6/17

520 000

100 000

Current assets Non-current assets Shares in Singapore Ltd Shares in New Caledonia Ltd Plant and machinery Accumulated depreciation Other Total assets Liabilities Net assets

80 000

30 000

132 000 — 600 000 (72 000 ) 80 000 820 000 (200 000 ) $ 620 000

— 60 000 140 000 (20 000 50 000 260 000 (60 000 200 000

Equity Share capital Retained earnings Total equity

100 000 520 000 620 000

100 000 100 000 200 000

Required Prepare the consolidated financial statements at 30 June 2017. Where necessary, make calculations to the nearest dollar.

60% New Caledonia Ltd

Singapore Ltd DNCI 40%

10% At 1 July 2014: Net fair value of INA of New Caledonia Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = = =

$100 000+ $450 000 + $20 000 (1 – 30%) (BCVR - machinery $564 000 $60 000 90% x $564 000 $507 600 $567 600 $3 600

Business combination valuation entries, New Caledonia Ltd, at 1 January 2017 Machinery Deferred tax liability Business combination valuation reserve

Dr Cr

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation (1/5 x $20 000 per annum)

Dr Dr Cr

20 000 6 000

14 000 2 000 8 000

10 000

22.93

Solutions manual to accompany Company Accounting 10e

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

3 000 600 2 400

Pre-acquisition entries, Singapore Ltd to New Caledonia Ltd, at 1 January 2014 Retained earnings (1/7/11) Share capital Business combination valuation reserve Goodwill Shares in New Caledonia Ltd (10% of balances) At 1 January 2017 Net fair value of INA of Singapore Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

Dr Dr Dr Dr Cr

= = = = = =

45 000 10 000 1 400 3 600 60 000

$100 000+ $50 000 + $50 000 + $5 000 (1 – 30%) (BCVR – P&M) + $10 000 (1 – 30%) (BCVR – shares) $210 500 $132 000 40% x $210 500 $84 200 $216 200 $5 700

Business combination valuation entries, Singapore Ltd, at 1/1/17 Machinery Deferred tax liability Business combination valuation reserve

Dr Cr

Shares in New Caledonia Ltd Deferred tax liability Business combination valuation reserve

Dr Cr

5 000 1 500

3 500 10 000 3 000

7 000

Business combination valuation entry, New Caledonia Ltd Machinery Deferred tax liability Business combination valuation reserve

Dr Cr

Depreciation expense Retained earnings (1/7/16) Deferred tax liability Business combination valuation reserve (1/5 x $20 000 per annum)

Dr Dr Cr

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

20 000 6 000

14 000 2 000 8 000 3 000

7 000

3 000

600 2 400

22.94

Solution Manual to accompany Company Accounting 10e

The $10 000 increase in the worth of "Shares in New Caledonia Ltd" is attributable to: Retained Earnings (1/7/16): 10%($500 000 – [$8 000 - $2 400]) - $45 000 = $4 440 Profit after tax: 10%($30 000 – [$2 000 - $600]) = $2 860 Business Combination Valuation Reserve:(10% x $7 000) = $700 Goodwill:(10% x $56 000 *) - $3 600 = $2 000 *$56 000 = $70 000/10% less [$650 000 – [6 000 + 3 000 – 3000]DTL]

The consolidation worksheet entries at 30 June 2017 are: 1. Business combination valuation entries, New Caledonia Ltd Machinery Deferred tax liability Business combination valuation reserve

Dr Cr

20 000

Depreciation expense Retained earnings (1/7/16) Deferred tax liability Accumulated depreciation (1/5 x $20 000 per annum)

Dr Dr Cr Cr

2 000 8 000

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

3 000

Depreciation expense Accumulated depreciation (1/2 x 1/4 x $20 000)

Dr Cr

2 500

Deferred tax liability Income tax expense

Dr Cr

750

6 000

14 000

3 000 7 000

600 2 400

2 500

750

2. Pre-acquisition entries, Singapore Ltd to New Caledonia Ltd Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in New Caledonia Ltd

Dr Dr Dr Dr Cr

45 000 10 000 1 400 3 600 60 000

3. Business combination valuation entries, Singapore Ltd Machinery Deferred tax liability Business combination valuation reserve

Dr Cr

Depreciation expense Accumulated depreciation (1/2 x 1/5 x $5 000)

Dr Cr

5 000 1 500

3 500 500

500

22.95

Solutions manual to accompany Company Accounting 10e

Deferred tax liability Income tax expense

Dr Cr

150

Shares in New Caledonia Ltd Deferred tax liability Business combination valuation reserve

Dr Cr

10 000

Profit before income tax Retained earnings (1/7/16) Business combination valuation reserve Goodwill Shares in New Caledonia Ltd

Dr Dr Dr Dr Cr

150

3 000

7 000

2 860 4 440 700 2 000 10 000

4. Pre-acquisition entry, New Caledonia Ltd to Singapore Ltd Profit before income tax * Retained earnings (1/1/16) Share capital Business combination valuation reserve Goodwill Shares in Singapore Ltd * 60% x $50 000

Dr Dr Dr Dr Dr Cr

30 000 30 000 60 000 6 300 5 700

Dr Dr Dr Dr Cr

20 000 20 000 40 000 4 200

132 000

5. NCI in Singapore Ltd at 1/1/17 NCI share of profit (to 1/1/17) * Retained earnings (1/7/16)* Share capital Business combination valuation reserve** NCI (* 40% x $50 000) ** 40% x $10 500 (= $3 500 + $7 000))

84 200

6. NCI in equity from1/1/17 to 30/6/17 Let

K S k s

= recorded profits of New Caledonia Ltd after reciprocal dividend revenue = recorded profits of Singapore Ltd after reciprocal dividend revenue = real profits of New Caledonia Ltd = real profits of Singapore Ltd

k s k

= K + 0.6s = S + 0.1k = K + 0.6(S + 0.1k) = K + 0.6S + 0.06k 0.94k = K + 0.6S k = 1/0.94 K + 0.6/0.94 S k

= 1/0.94($40 000 - $6 000 div- [$2 000 - $600] depn – [$2 500 - $750] depn - $2 860/10% pre-acq) + 0.6/0.94($60 000 - $2 000 div – [$500 - $150] depn - ($30 000)/0.6) pre-acq) = $2 394 + $4 883

22.96

Solution Manual to accompany Company Accounting 10e

= $7 277 = S + 0.1k = $7 650 + (0.1 x $7 277) = $8 378 = 40% s = 40% x $8 378 = $3 352

NCI

NCI Share of Profit NCI

Dr Cr

3 352 3 352

7. Dividends paid New Caledonia Ltd: 10% x $20 000 = $2 000 Singapore Ltd: 60% x $10 000 = $6 000 Dividend revenue Dividend paid

Dr Cr

8 000

Dr Cr

4 000

8 000

8. NCI adjustment NCI Dividend paid (40% x $10 000)

4 000

Note in relation to balance of Retained Earnings (1/7/16), there are no post-acquisition profits:

also, S s

= = = = = = =

1/0.94 K + 0.6/0.94 S 1/0.94($500 000 – [$8 000 - $2 400] - $4 440/0.1 - $45 000/0.1) + 0.6/0.94($50 000 - $30 000/0.6) 1/0.94( zero) + 0.6/0.94( zero) zero zero S + 0.1k zero

22.97

Solutions manual to accompany Company Accounting 10e

Question 22.19 (cont’d) New Singap Caledo ore nia Ltd Ltd Profit before tax 50 000 80 000 1 1 3 3 4 7 Tax expense 10 000 20 000 Financial Statements

Profit for the 40 000 period Retained earnings 500 000 (1/7/16)

50 000

1 2 3 4

2 4 2 3 4

10 000 60 000 1 400 700 6 300

Parent Cr

84 140

600 750 150

8 000 45 000 4 440 30 000

NCI Dr

2 000 2 500 500 2 860 30 000 8 000 1 1 3

2 400

8 000

14 000 3 500 7 000

1 3 3

28 500

55 640 5 6 464 960 5

20 000 3 352 20 000

520 600 22 000 498 600

32 288 444 960

4 000

477 248 18 000 459 248

130 000 5

40 000

90 000

16 100 5

4 200

11 900

561 148 8

Total equity Liabilities

620 000 200 000 200 000 60 000

Total equity and liabilities

820 000 260 000

Current assets Shares in Singapore Shares in New Caledonia Plant & machinery Accumulated depreciation

80 000 132 000

30 000 --

60 000

10 000

600 000 140 000

1 3

20 000 5 000

Other assets

Group

60 000

540 000 110 000 Dividends paid 20 000 10 000 Retained earnings 520 000 100 000 (30/6/17) Share capital 100 000 100 000 Business combination valuation reserve Total equity: parent Total equity: NCI

Adjustments Dr Cr

(72 000) (20 000)

80 000

50 000

1 1 3

3 000 750 150

6 000 3 000 1 500 3 000

1 1 3 3

644 700 269 600

4 000 91 552

84 200 3 352 91 552

914 300

132 000 60 000 10 000

4 2 3

110 000 --765 000

7 000 2 500 500

1 1 3

(102 000)

130 000

22.98

5 6

83 552 644 700

Solution Manual to accompany Company Accounting 10e

Goodwill

Total assets

2 3 4

3 600 2 000 5 700 261 900

820 000 260 000

11 300

261 900

914 300

New Caledonia Ltd Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017 Profit before income tax Income tax expense Profit for the period Comprehensive Income for the period Attributable to: Parent interest Non-controlling interest

$84 140 28 500 $55 640 $55 640 $32 288 $23 352

New Caledonia Ltd Consolidated Statement of Changes in Equity for the year ended 30 June 2017 Consolidated Total comprehensive income for the period $55 640

Parent $32 288

Retained earnings at 1/7/16 Profit for the period Dividend paid Retained earnings at 30/6/17

$464 960 55 640 (22 000) $498 600

$444 960 32 288 (18 000) $459 248

Business combination valuation reserve at 1/7/16 Business combination valuation reserve at 30/6/17

-$16 100

-$11 900

Share capital at 1/7/16 Share capital at 30/6/17

$130 000 $130 000

$90 000 $90 000

22.99

Solutions manual to accompany Company Accounting 10e

New Caledonia Ltd Consolidated Statement of Financial Position as at 30 June 2017 Assets: Current Assets Non-current Assets Plant & machinery Accumulated depreciation Goodwill Other Total Non-current Assets Total Assets Equity and Liabilities: Equity attributable to equity holders of the parent Share capital Business combination valuation reserve Retained earnings Non-controlling interest Total equity Liabilities Total equity and liabilities

$110 000 765 000 (102 000) 11 300 130 000 804 300 $914 300

$90 000 11 900 459 248 561 148 83 552 644 700 269 600 $914 300

22.100

Solutions manual to accompany Company Accounting 10e

Chapter 23 – Associates and joint ventures REVIEW QUESTIONS 1. What is an associate entity? Paragraph 2 of AASB 128 defines an associate as: An entity, including an unincorporated entity such as a partnership, over which the investor has significant influence, and that is neither a subsidiary nor an interest in a joint venture. The key criterion is the existence of significant influence, also defined in para. 2. Note that an investor does not have to hold shares in an associate – yet the application of the equity method depends on such a shareholding. However, see the presumptions in para 6 of AASB 128.

2. Why are associates distinguished from other investments held by the investor? The suite of accounting standards provides different levels of disclosure dependent on the relationship between the investor and the investee: Subsidiaries: a control relationship Joint ventures: a joint control relationship Associates: a significant influence relationship Other investments: no relationship Where there is a relationship, it relates to the ability of the investor to influence the direction of the investee, in comparison to a simple holding of shares as an investment. Where such a relationship exists, it is argued that the investor is affected, from an accountability perspective as well as a potential receipt of benefits perspective [why get involved if there are no benefits to doing so?]. These effects result in the need for additional disclosure about the relationship.

3. Discuss the similarities and differences between the criteria used to identify subsidiaries and that used to identify associates. A subsidiary is identified where another entity controls that entity. Control is defined in para 2 of AASB 128. An associate is identified where another entity has significant influence over that entity. Control Power over the investee

Significant influence Power to participate

Exposure or rights to variable returns From involvement in investee

To participate in the financial and operating policy decisions

Ability to affect returns through power

-----------

No ownership interest is necessary

23.2

Chapter 23: Associates and joint ventures

4. What is meant by “significant influence”? Para 2 of AASB 128 states: Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies Note:

power to participate financial and operating policy decisions

5. What factors could be used to indicate the existence of significant influence? Note paras 6 and 7 of AASB 128: 6.

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. Conversely, 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. A substantial or majority ownership by another investor does not necessarily preclude an investor from having 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.

What is a joint venture?

A joint arrangement is an arrangement between two or more entities so that two or more entities have joint control of another entity. Where a joint arrangement exists, the arrangement must be classified as either a joint operation or a joint venture. The classification depends on the rights and obligations of the parties to the arrangement. Joint ventures are accounted for under AASB 128 while joint operations are accounted for under AASB 11. A joint venture is described as an arrangement where the investor has a right to an investment in the investee. The investee will have the following features: - the legal form of the investee and the contractual arrangements are such that the investor does not have rights to the assets and obligations for the liabilities of the investee; and - the investee has been designed to have a trade of its own and as such must directly face the risks arising from the activities it undertakes, such as demand, credit or inventory risks.

23.3

Chapter 23: Associates and joint ventures

What is meant by joint control?

Joint control is 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. The key element of joint control is the sharing of control. In other words, there must be at least two investors who have shared control of the investee (AASB 128, para. 3)

How does joint control differ from control as applied on consolidation?

Under AASB 10: An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. There are three investor-investee relationships which are based on different levels of control: Relationship Parent - subsidiary Investor-associate Joint arrangement - investee

Level of control Dominant control Significant influence Joint control

With a subsidiary there can be only one parent. With joint control there needs to be at least 2 entities that share control.

Discuss the relative merits of accounting for investments by the cost method, the fair value method and the equity method.

Cost method: Advantages:

Disadvantages:

Fair value method: Advantages:

Disadvantages:

Simplicity Reliable measure No indication of changes in value since acquisition Revenue recognised only on dividend receipt

Up-to-date value, present information compared with past Information Revenue recognised as value changes rather than waiting for dividends Reliability a function of how active the market is Costs associated with regular updating, extra costs for audit and valuation fees

Equity method: Advantages: Disadvantages:

Carrying amount related to change in wealth of the investee Revenue recognised prior to dividend receipt Carrying amount reliant on validity of investee information Carrying amount not based on market value Recognition of revenue prior to associate declaring dividend; no transaction has yet occurred

23.4

Chapter 23: Associates and joint ventures

10. Outline the accounting adjustments required in relation to transactions between the investor and an associate/joint venture. Explain the rationale for these adjustments. Note paragraph 22: - adjust for profits and losses on upstream/downstream transactions - adjust to the extent of investor’s interest i.e. proportionate adjustment - adjust investor’s share in associate’s profits and losses Rationale AASB 128 provides no rationale. A key question is whether the equity method is used as a measurement technique to approximate fair value, or as a consolidation technique. If it is a measurement technique, then why adjust for inter-entity transactions? If it is a consolidation technique, then adjustments can be justified – however, does the method of adjustment proposed in para 22 conform with consolidation techniques? Debate: - why should investor’s share of associate’s profits be adjusted if investor sells to associate as associate’s profits are unaffected by this transaction? - Should individual accounts such as “sales”, “cost of sales” and “inventories” be adjusted? - Should downstream transactions affect different accounts than upstream transactions?

11. Compare the accounting for the effects of inter-entity transactions for transactions between parent entities and subsidiaries and between investors and associates/joint ventures. See para 22 of AASB 128 Consolidation Adjust for upstream & downstream Adjust for unrealised profits/losses Adjust for inter-entity balances Adjust for 100% of effect Adjust individual accounts such as sales investment account Transactions are within group

Equity method Adjust for upstream & downstream Adjust for unrealised profits/losses No adjustment for inter-entity balances Proportionate adjustment Adjust share of profits/losses & No economic entity/group structure

12. Discuss whether the equity method should be viewed as a form of consolidation or a valuation technique. AASB 128 does not give a clear indication whether the equity method is a consolidation technique or a measurement technique similar to fair value. Note para 20: “Many of the procedures appropriate for the application of the equity method are similar to the consolidation procedures described in AASB 127.” If a measurement method, the equity method is an extension of the accrual process within the historical cost system. Revenue is recognised in relation to the investee as the investor records profits/losses, instead of merely when the investor pays dividends. The balance sheet is a one-line figure, being an alternative to fair value. If it is a measurement technique, why adjust for the effects of inter-entity transactions?

23.5

Chapter 23: Associates and joint ventures

Further, why not just use fair value if available, or reliably measurable, and equity method as a default? Why use a criterion such as significant influence to determine associates – why not apply to all material investments? If a consolidation technique, there is an expansion of the group to include the investor’s share of the associate. The group then is more than just controlled entities. Why not use proportionate consolidation? Why not properly adjust for inter-entity transactions? Why expand the group beyond controlled entities? Unfortunately, it appears that equity accounting is a hybrid between a measurement technique and consolidation. Standard-setters need to determine a conceptual basis for accounting for associates and apply an appropriate method. 13. Explain why equity accounting is sometimes referred to as “one-line consolidation”. Equity accounting is similar to consolidation in that: - both recognise the investor’s share of post-acquisition equity in the income statement. The consolidation method recognises the MI share as well, but divides equity into parent and MI share. - both adjust for the effects of inter-entity transactions - in the income statement, the share of profits/losses of an associate is similar to the parent’s share of the post-acquisition equity of a subsidiary – however, under the equity method this is not taken against individual accounts but there is a one-line total. - in the balance sheet, the investment in the associate is adjusted for the increase in the investor’s share of the net assets of the associate – similar to the parent’s share of the net assets of a subsidiary. However, under equity accounting, there is no recognition of the individual assets and liabilities of the associate, rather, there is a one-line recognition.

14. Explain the differences in application of the equity method of accounting where the method is applied in the records of the investor compared with the application in the consolidation worksheet of the investor. There are 2 major differences when equity accounting is applied in the consolidation worksheet rather than in the accounts of the investor. First, in relation to past periods: If the adjustments are made in the records of the investor, then in any period, there is only a need to recognise the effects of the current period changes in share of the profit/losses of the associate. If the adjustments are made on consolidation, as the worksheet is only a temporary document and has no affect on the actual accounts, in periods subsequent to the date of acquisition, there needs to be a recognition, via retained earnings, of the investor’s share of prior period profits/losses of associate. Second, in relation to dividend revenue: If the adjustments are made in the accounts of the investor, then on payment of a dividend by the associate, the adjustment is:

23.6

Chapter 23: Associates and joint ventures

Cash Investment in associate

Dr Cr

x x

If the adjustments are made on consolidation, the worksheet adjustment is: Dividend revenue Investment in associate

Dr Cr

x x

15. Explain the treatment of dividends from the associate under the equity method of accounting. The treatment of dividends differs dependent on whether the equity method is applied in the accounts of the investor or applied on consolidation in the consolidation worksheet. Dividends paid In the accounts of the investor: On payment of the dividend by the associate, in the accounts of the investor, the following entry is made: Cash Investment in associate

Dr Cr

x x

As the investor recognises its share of the profits/losses of the associate as income, and this profit/loss is prior to the appropriation of dividends, then to recognise dividend revenue would double count the income recognised by the investor. The dividend is simply a receipt of equity already recognised via application of the equity method. Consolidation worksheet: In the year of payment of the dividend the consolidation adjustment entry is: Dividend revenue Investment in associate

Dr Cr

x x

When the dividend is paid the investor records the receipt of cash and recognises dividend revenue. The effect of the above entry is to eliminate the dividend revenue previously recognised by the investor. Because the investor recognises a share of the whole of the profit of the associate, the dividend revenue cannot also be recognised as income by the investor. Dividends declared Where revenue is recognised on declaration of the dividend, the effect is the same as for dividends paid. Where the investor does not recognise dividend revenue, then there is no entry in the investor’s accounts, nor is there any adjustment in the consolidation worksheet. In using the consolidation worksheet method, care must be taken in calculating the investor’s share of post-acquisition retained earnings where a dividend was declared at the end of the previous period. This must be added back to the closing balance of retained earnings, as the investor has not yet recognised the appropriation of profits.

23.7

Chapter 23: Associates and joint ventures

CASE STUDIES Case Study 1

Significant influence

The accountant of Cornett Chocolates Ltd, Ms Fraulein, has been advised by her auditors that the entity’s investment in Concertina’s Milk Ltd should be accounted for using the equity method of accounting. Cornett Chocolates Ltd holds only 20.2% of the voting shares currently issued by Concertina’s Milk Ltd. Since the investment was undertaken purely for cash flow reasons based on the potential dividend stream from the investment, Ms Fraulein does not believe that Cornett Chocolates Ltd exerts significant influence over the investee. Required Discuss the factors that Ms Fraulein should investigate in determining whether an investor– associate relationship exists, and what avenues are available so that the equity method of accounting does not have to be applied.

The relevant paragraphs from AASB 128 are: Paragraph 2: Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies

Paragraphs 6 and 7: 6.

Points to discuss: 1. Why the investment is undertaken by Swiss Chocolates is irrelevant. The definition of significant influence is based on the capacity to participate, not the actual or intention to participate. 2. Whether Swiss Chocolates actually exerts influence is irrelevant. 3. The 20% is a guideline only. 4. Factors will include those in paragraph 7. Further an analysis of the 80% holding by other parties is very important. If it is closely held, then the ability for Swiss Chocolates to participate is limited.

23.8

Chapter 23: Associates and joint ventures

Case study 2

Nature of a joint venture

Billabong International Ltd acquired Nixon Inc in 2006 for approximately US$55 million and a deferred payment of US$76 million in 2012. However, in 2012, along with many other retailers, Billabong was having difficulty with its debt. In February 2012, it undertook a major restructure shedding 400 jobs and selling off some of its accessories brands. On 17 February 2012, the following news was reported by AAP (Australian Associated Press Pty Ltd) on http://news.smh.com.au: Billabong said it had entered into an agreement with Trilantic Capital Partners (TCP) to establish a joint venture for Nixon. Under the joint venture, Billabong will retain 48.5 per cent of Nixon, while TCP will purchase 48.5 per cent and Nixon’s management will purchase 3.0 per cent,’ Billabong said in a statement.

Required Discuss what arrangements would have to exist between Billabong, TCP and Nixon’s management in order for a joint venture to exist. There are three entities that have an interest in Nixon. In particular Billabong has 48.5% and TCP holds 48.5% while Nixon’s management hold 3%. In order for a joint venture to exist there must be an agreement between 2 or more parties to have joint control. Joint control is 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. The key element of joint control is the sharing of control. In other words, there must be at least two investors who have shared control of the investee. It is most likely that Nixon’s management (holding 3%) will not be a party to the joint venture. Instead Billabong and TCP will jointly control Nixon. The key arrangement for a joint venture to exist between Billabong and TCP must be an agreement to have joint control of Nixon.

Case study 3

Nature of a joint venture

On 8 November 2011, flight CZ319 of China Southern Airlines took off from Beijing to Perth, the capital of Western Australia, symbolising the maiden voyage from China’s mainland to Western Australia. China Southern Airlines flies to many countries in the world. On 21 September 2010, it was reported via www.csair.com that the Air France KLM Group and China Southern Airways had signed a joint venture agreement based on sharing revenues on the Paris–Guangzhou route. It was stated that: Air France and China Southern will have joint governance of the joint venture. A management committee will be implemented, with five working groups in charge of implementing the joint venture agreements in the fields of network management, revenue management, sales, products and finance.

Required Discuss what would be necessary for there to be a joint venture between China Southern Airlines and Air France, and whether the description given above signifies the existence of a joint venture in accordance with AASB 128. Associates An associate is defined as an entity over which the investor has significant influence.

23.9

128:3

Chapter 23: Associates and joint ventures

The key characteristic determining the existence of an associate is that of significant influence. This is defined as the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies. The key features of this definition are: • The investor has the power or the capacity to affect the decisions made in relation to the investee. As with the concept of control used in determining the parent-subsidiary relationship, an investor is not required to actually exercise the power to influence. It is only necessary that an investor has the ability to do so. • The specific power is that of being able to participate in the financial and operating policy decisions of the investee. Note that the investor cannot control the investee, just significantly influence the investee. • There is no requirement that the investor holds any shares, or has any beneficial interest in the associate. However as discussed later, the application of the equity method is only possible where the investor holds shares in the associate. In other cases, the investor is required to make specific disclosures in its financial statements. Joint ventures A joint arrangement is an arrangement between two or more entities so that two or more entities have joint control of another entity. Where a joint arrangement exists, the arrangement must be classified as either a joint operation or a joint venture. The classification depends on the rights and obligations of the parties to the arrangement. Joint ventures are accounted for under AASB 128 while joint operations are accounted for under AASB 11. A joint venture is described as an arrangement where the investor has a right to an investment in the investee. The investee will have the following features: - the legal form of the investee and the contractual arrangements are such that the investor does not have rights to the assets and obligations for the liabilities of the investee; and - the investee has been designed to have a trade of its own and as such must directly face the risks arising from the activities it undertakes, such as demand, credit or inventory risks. Differences The major differences lie in the level of control that exists between the entities and the interrelationship between the investors. With an associate, an investor only has significant influence. There may be only one investor that has significant influence over an associate. However, there may be a number of investors that have significant influence over an associate – but there will not be any agreement between these investors in relation to control of the associate. With a joint venture, each joint venturer has joint control over the joint venture. This will be established by an agreement between the venturers themselves. In the quotation it is noted that Air France and China Southern will have “joint governance” of the project. Unless this term means joint control – requiring unanimous agreement of the two venturers – then there is no joint venture as defined in AASB 128. An agreement that just involves a sharing of revenues does not constitute a joint venture. There does not seem to be a separate joint venture which has rights to assets and obligations of the joint venture in which each venturer has an investment. If the joint arrangement is not structured through a separate vehicle then the arrangement is a joint operation rather than a joint venture.

23.10

Chapter 23: Associates and joint ventures

Case study 4

Equity accounting

Amalgamated Holdings Ltd (www.ahl.com.au) provided the following information in Note 1 of its 2012 annual report (p. 44): (iii) Associates and jointly controlled entities (‘equity accounted investees’) Associates are those entities for which the Group has significant influence, but not control, over the financial and operating policies. Significant influence is presumed to exist when the Group holds between 20% and 50% of the voting power of another entity. Jointly controlled entities are those entities over whose activities the Group has joint control, established by contractual agreement and requiring unanimous consent for strategic financial and operating decisions. The consolidated financial statements include the Group’s share of the profit or loss and other comprehensive income of associates and jointly controlled entities from the date that significant influence or joint control commences until the date that significant influence or joint control ceases. The Group’s share of movements in reserves is recognised directly in consolidated equity. When the Group’s share of losses exceeds its interest in an equity accounted investee, the Group’s carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has legal or constructive obligations to make payments on behalf of the investee. (iv) Transactions eliminated on consolidation Intra-Group balances and transactions, and any unrealised gains and losses or income and expenses arising from intra-Group transactions, are eliminated in preparing the consolidated financial report. Unrealised gains arising from transactions with associates and jointly controlled entities are eliminated to the extent of the Group’s interest in the entity. Unrealised losses are eliminated in the same way as unrealised gains but only to the extent there is no evidence of impairment. Required Some investors in Amalgamated Holdings Ltd who have limited accounting knowledge, particularly about equity accounting, have asked you to provide a report to them commenting on: • the differences between associates and partnerships • the determination of the date of significant influence • realisation of profits/losses on inter-entity transactions • recognition of losses of an associate.

1. Differences between associates and partnerships There are no differences. Paragraph 3 of AASB 128 defines an associate as follows: An associate is an entity over which the investor has significant influence. An associate therefore includes a partnership. 2. Determination of the date of significant influence AASB 128 does not define the date of significant influence, unlike AASB 3 Business Combinations which contains a definition of date of acquisition. However, in line with the latter definition, the date of significant influence would be the date that the investor obtains significant influence in relation to the associate. It is not necessarily the date the investor acquires its investment in the associate. 3. Realisation of profits/losses on inter-entity transactions

23.11

Chapter 23: Associates and joint ventures

The realisation of profits/losses is the same as that for gains/losses on intragroup transactions within a consolidated group. Realisation occurs when a party external to the investor-associate is involved in the transaction. Hence, profits made by an associate selling inventory to its investor are realised when the investor on-sells the inventory to an external party. With transfer of depreciable assets, realisation occurs as the asset is consumed or used up, with the proportion of profit/loss realised being measured in proportion to the depreciation of the transferred asset. 4. Recognition of losses of an associate Note the following paragraphs from AASB 128: 38.

If an entity's share of losses of an associate or a joint venture equals or exceeds its interest in the associate or joint venture, the entity discontinues recognising its share of further losses. The interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture determined using the equity method together with any long-term interests that, in substance, form part of the entity's net investment in the associate or joint venture. For example, an item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, an extension of the entity's investment in that associate or joint venture. Such items 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. Losses recognised using the equity method in excess of the entity's investment in ordinary shares are applied to the other components of the entity's interest in an associate or a joint venture in the reverse order of their seniority (ie priority in liquidation).

39.

After the entity's interest is reduced to zero, additional losses are provided for, and a liability is recognised, only to the extent that the entity has incurred legal or constructive obligations or made payments on behalf of the associate or joint venture. If the associate or joint venture subsequently reports profits, the entity resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised.

23.12

Chapter 23: Associates and joint ventures

PRACTICE QUESTIONS Question 23.1

Adjustments where investor prepares and does not prepare consolidated financial statements

Piano Ltd has a 30% interest in a joint venture, Mandolin Ltd, in which it invested $50 000 on 1 July 2014. The equity of Mandolin Ltd at the acquisition date was: Share capital Retained earnings

$ 30 000 120 000

All the identifiable assets and liabilities of Mandolin Ltd were recorded at amounts equal to their fair values. Profits and dividends for the years ended 30 June 2015 to 2017 were as follows:

2015 2016 2017

Profit before tax $80 000 70 000 60 000

Income tax expense $30 000 25 000 20 000

Dividends paid $80 000 * 15 000 10 000

Required A. Prepare journal entries in the records of Piano Ltd for each of the years ended 30 June 2015 to 2017 in relation to its investment in the joint venture, Mandolin Ltd. (Assume Piano Ltd does not prepare consolidated financial statements.) B. Prepare the consolidation worksheet entries to account for Piano Ltd’s interest in the joint venture, Mandolin Ltd. (Assume Piano Ltd does prepare consolidated financial statements.) 30% Piano Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Mandolin Ltd Net fair value acquired Cost of investment Goodwill

Mandolin Ltd

= = = = =

$150 000 30% x $150 000 $45 000 $50 000 $5 000

1. Journal entries in the accounts of Piano Ltd 1 July 2014

2014 – 2015

Investment in Mandolin Ltd Cash/Payable (Acquisition of shares in Mandolin Ltd)

Dr Cr

50 000

Cash

Dr Cr

24 000

Dr Cr

15 000

Investment in Mandolin Ltd (Dividend received from Mandolin Ltd: 30% x $80 000) 30 June 2015

Investment in Mandolin Ltd Share of profit or loss of associates and joint ventures (Recognition of profit in Mandolin Ltd: 30% x $50 000)

50 000

24 000

15 000

23.13

Chapter 23: Associates and joint ventures

2015 – 2016

Cash

Dr Cr

Investment in Mandolin Ltd (Dividend received: 30% x $15 000) 30 June 2016

2016– 2017

4 500

Investment in Mandolin Ltd Share of profit or loss of associates and joint ventures (Recognition of profit in Mandolin Ltd: 30% x $45 000)

Dr Cr

13 500

Cash

Dr Cr

3 000

Dr Cr

12 000

Investment in Mandolin Ltd (Dividend from joint venture: 30% x $10 000) Investment in Mandolin Ltd * Share of profit or loss of associates and joint ventures (Recognition of profit in Mandolin Ltd: 30% x $40 000) 2.

4 500

13 500

3 000

12 000

Consolidation Worksheet Entries

30 June 2013: Investment in Mandolin Ltd Share of profit or loss of associates and joint ventures (30% x $50 000

15 000

Dividend revenue Investment in Mandolin Ltd (30% x $80 000

Dr Cr

24 000

Retained earnings (1/7/15) Investment in Mandolin Ltd (30% x $(30 000))

Dr Cr

9 000

Investment in Mandolin Ltd Share of profits or losses of associates and joint ventures (30% x $45 000)

13 500

Dividend revenue Investment in Mandolin Ltd (30% x $15 000)

Dr Cr

4 500

15 000

24 000

30 June 2014:

9 000

13 500

4 500

30 June 2015: Investment in Mandolin Ltd

23.14

Chapter 23: Associates and joint ventures

Retained earnings (1/7/16) (30% [$30 000 + $(30 000)])

Investment in Mandolin Ltd Share of profit or loss of associates and joint ventures (30% x $40 000)

Dividend revenue Investment in Mandolin Ltd (30% x $10 000)

Dr Cr

12 000

3 000

23.15

Chapter 23: Associates and joint ventures

Question 23.2

Accounting for associate/joint venture by an investor

Violin Ltd acquired a 40% interest in Drum Ltd in which it invested $170 000 on 1 July 2015. Violin Ltd has signed a joint venture agreement with the other investors in Drum Ltd providing joint control to all investors. The share capital, reserves and retained earnings of Drum Ltd at the investment date and at 30 June 2016 were as follows: 1 July 2015 $300 000 — — 100 000

Share capital Asset revaluation surplus General reserve Retained earnings

30 June 2016 $300 000 100 000 15 000 109 000

At 1 July 2015, all the identifiable assets and liabilities of Drum Ltd were recorded at amounts equal to their fair values. The following is applicable to Drum Ltd for the year to 30 June 2016: (a) Profit (after income tax expense of $11 000): $39 000 (b) Increase in reserves • General (transferred from retained earnings): $15 000 • Asset revaluation (revaluation of freehold land and buildings at 30 June 2016): $100 000 (c) Dividends paid to shareholders: $15 000. Violin Ltd does not prepare consolidated financial statements. Required Prepare the journal entries in the records of Violin Ltd for the year ended 30 June 2016 in relation to its investment in the joint venture, Drum Ltd.

40% Violin Ltd

Drum Ltd

At 1 July 2015: Net fair value of identifiable assets and liabilities of Drum Ltd Net fair value acquired Cost of investment Goodwill

= = = = =

$400 000 40% x $400 000 $160 000 $170 000 $10 000

Recorded profit – Drum Ltd Investor’s Share – 40%

$39 000 15 600

Increment in Asset Revaluation Surplus (40% x $100 000)

$40 000

Note: As the general reserve is created as an appropriation from Retained Earnings, then there is no need to adjust for movements in general reserve. The journal entries in the records of Violin Ltd for the year ended 30 June 2016 are:

23.16

Chapter 23: Associates and joint ventures

1 July 2015

Investment in Drum Ltd

D r

Cash/Share capital

170 0 0 0

170 00 0

2015– 2016

Cash

6 000 r

Investment in Drum Ltd

6 000 r

(Dividend from joint venture: 40% x $15 000) 30 June 2016

Investment in Drum Ltd

D r

Share of profit or loss of associates and joint ventures

15 6 0 0

15 60 0

(40% x $39 000) Investment in Drum Ltd Share of other comprehensive income of associates and joint ventures

D r

40 0 0 0

40 000

Cr (40% x $100 000) Share of other comprehensive income of associates and joint ventures Asset revaluation surplus

Dr Cr

40 000 40 000

23.17

Chapter 23: Associates and joint ventures

Question 23.3

Inter-entity transactions where investor has no subsidiaries

Lute Ltd acquired 20% of the ordinary shares of Sitar Ltd on 1 July 2014. At this date, all the identifiable assets and liabilities of Lute Ltd were recorded at amounts equal to their fair values. An analysis of the acquisition showed that $2000 of goodwill was acquired. Sitar Ltd was judged to be an associate of Lute Ltd. Lute Ltd has no subsidiaries, and records its investment in the associate, Sitar Ltd, in accordance with AASB 128. In the 2015–16 period, Sitar Ltd recorded a profit of $100 000, paid an interim dividend of $10 000 and, in June 2016, declared a further dividend of $15 000. In June 2015, Sitar Ltd had declared a $20 000 dividend, which was paid in August 2015, at which date it was recognised by Lute Ltd. The following transactions have occurred between the two entities (all transactions are independent unless specified). (a) In January 2016, Sitar Ltd sold inventory to Lute Ltd for $15 000. This inventory had previously cost Sitar Ltd $10 000, and remains unsold by Lute Ltd at the end of the period. (b) In February 2016, Lute Ltd sold inventory to Sitar Ltd at a before-tax profit of $5000. Half of this was sold by Sitar Ltd before 30 June 2016. (c) In June 2015, Sitar Ltd sold inventory to Lute Ltd for $18 000. This inventory had cost Sitar Ltd $12 000. At 30 June 2015, this inventory remained unsold by Lute Ltd. However, it was all sold by Lute Ltd before 30 June 2016. The tax rate is 30%. Required Prepare the journal entries in the records of Lute Ltd in relation to its investment in Sitar Ltd for the year ended 30 June 2016. Profit for the period Adjustments for inter-entity transactions: Unrealised after tax profit in ending inventory (a) [$5 000 (1 – 30%)] Unrealised after tax profit in ending inventory (b) [$2 500 (1 – 30%)] Unrealised profit in opening inventory (c) [$6 000 (1 – 30%)

$100 000

(3 500) (1 750) 4 200 98 950 $19 790

Investor’s share – 20% Journal entries in records of Lute Ltd: 1.

Cash Investment in Sitar Ltd (20% ($10 000 + $20 000))

Investment in Sitar Ltd Share of profit or loss of associates and joint ventures

Dr Cr

6 000

19 790

6 000

19 790

23.18

Chapter 23: Associates and joint ventures

Question 23.4

Accounting for an associate across two years

On 1 July 2015, Key Ltd acquired 25% of the shares of Board Ltd for $400 000. The acquisition of these shares gave Key Ltd significant influence over Board Ltd. At this date, the equity of Board Ltd consisted of: Share capital $660 000 General reserve 100 000 Retained earnings 440 000 At 1 July 2015, all the identifiable assets and liabilities of Board Ltd were recorded at amounts equal to their fair values except for:

Land Plant (cost $1 200 000)

Carrying amount $1 200 000 1 000 000

Fair value $1 600 000 1 100 000

The plant was considered to have a further useful life of 5 years. The land was revalued in the records of Board Ltd and the revaluation model applied in the measurement of the land. The tax rate is 30%. At 30 June 2017, Board Ltd reported the following information: Profit before tax Income tax expense Profit after tax

$720 000 (300 000) 420 000

Retained earnings at 1 July 2016

$820 000 1 240 000 (40 000) (50 000) (30 000) (120 000) $1 120 000 640 000 150 000 310 000 $$2 220 000

Dividends paid Dividends declared Transfer to general reserve Retained earnings at 30 June 2017 Share capital General reserve Asset revaluation surplus Total equity

Board Ltd also reported other comprehensive income relating to gains on revaluation of land of $10 000. Required Prepare the journal entries for inclusion in the consolidation worksheet of Key Ltd at 30 June 2017 for the equity accounting of Board Ltd. 25% Key Ltd

Board Ltd

At 1 July 2015: Net fair value of identifiable assets and liabilities of Board Ltd

Net fair value acquired Cost of investment

= = = = =

$1 200 000 (equity) + $400 000 (1 – 30%) (land) + $100 000 (1 –30%) (plant) $1 550 000 25% x $1 550 000 $387 500 $400 000

23.19

Chapter 23: Associates and joint ventures

Goodwill

$12 500

Depreciation of plant p.a. after tax

= =

1/5 x $70 000 $14 000

Consolidation Worksheet Entries Retained earnings Movement in retained earnings: $820 000 -$440 000 Increase in general reserve ($120 000* - $100 000) Pre-acquisition adjustments: Depreciation of plant

$380 000 20 000

(14 000) 386 000 Investor’s share – 25% $96 500 *GR balance at 30/6/17 is $150 000. During that reporting period there was a Transfer to GR of $30 000. Therefore, at 30/6/16, the balance of GR was $120 000. The consolidation worksheet entry at 30 June 2017 is: Investment in Board Ltd Retained earnings (1/7/16)

Dr Cr

96 500 96 500

Asset revaluation surplus Prior period: Movement in asset revaluation surplus: $300 000 – $280 000 Investor’s share – 25% Current period Movement in asset revaluation surplus: $310 000 – $300 000 Investor’s share – 25%

$20 000 $5 000 $10 000 $2 500

The consolidation worksheet entries are: Investment in Board Ltd Asset revaluation surplus

Dr Cr

5 000

Investment in Board Ltd Share of other comprehensive income of associates and joint ventures

2 500

Share of other comprehensive income of associates and joint ventures Asset revaluation surplus

5 000

Dr Cr

2 500

2 500 2 500

Current period profit: 2016 – 2017 Profit for the period Pre-acquisition adjustment: Depreciation of plant

$420 000 (14 000) $406 000 $101 500

Investor’s share – 25% The consolidation worksheet entries at 30 June 2017 are:

23.20

Chapter 23: Associates and joint ventures

Investment in Board Ltd Share of profit or loss of associates and joint ventures

Dividend revenue Investment in Board Ltd (25% ($40 000 + $50 000))

Dr Cr

101 500

101 500 22 500

22 500

23.21

Chapter 23: Associates and joint ventures

Question 23.5

Accounting for an associate across two years with interentity transactions

Use the information in question 23.4, and assume also that the following inter-entity transactions occurred. (a) On 1 July 2016, Key Ltd holds inventory sold to it by Board Ltd at an after-tax profit of $20 000. This inventory was all sold to external entities by 30 June 2017. (b) During the 2016–17 period, Board Ltd sold inventory to Key Ltd for $100 000 recording an after-tax profit of $15 000. One-third of this inventory is still held by Key Ltd at 30 June 2017. (c) On 1 January 2016, Board Ltd sold a vehicle to Key Ltd for $40 000. The vehicle was recorded at a carrying amount of $38 000 by Board Ltd at the date of sale. The vehicle is estimated to have a further 2-year life. (d) From 1 July 2015, Key Ltd rented a warehouse from Board Ltd and paid rent of $15 000 p.a., the rent being paid in advance each year. Required Prepare the journal entries for inclusion in the consolidation worksheet of Key Ltd at 30 June 2017 for the equity accounting of Board Ltd. 25% Key Ltd

Board Ltd

At 1 July 2015: Net fair value of identifiable assets and liabilities of Board Ltd

Net fair value acquired Cost of investment Goodwill Depreciation of plant p.a. after tax

= = = = =

$1 200 000 (equity) + $400 000 (1 – 30%) (land) + $100 000 (1 –30%) (plant) $1 550 000 25% x $1 550 000 $387 500 $400 000 $12 500

= =

1/5 x $70 000 $14 000

Consolidation Worksheet Entries Retained earnings (prior period: 1/7/15 to 30/6/16) Movement in retained earnings: $820 000 -$440 000 Increase in general reserve ($120 000 - $100 000) Pre-acquisition adjustments: Depreciation of plant Adjustments for inter-entity transactions: Inventory on hand at 1July 2016: $20 000(1 – 30%) Unrealised profit on sale of vehicle: Gain $2000(1 -30%) less depreciation ($1 400/2 x ½ year) Investor’s share – 25%

$380 000 20 000 (14 000) $386 000 (14 000) (350) $371 650 $92 913 (rounded)

The consolidation worksheet entry at 30 June 2017 is:

23.22

Chapter 23: Associates and joint ventures

Investment in Board Ltd Retained earnings (1/7/16)

Dr Cr

92 913 92 913

$20 000 $5 000 $10 000 $2 500

The consolidation worksheet entries are: Investment in Board Ltd Asset revaluation surplus

Dr Cr

5 000

Investment in Board Ltd Share of other comprehensive income of associates and joint ventures

2 500

Share of other comprehensive income of associates and joint ventures Asset revaluation surplus

5 000

Dr Cr

2 500

2 500 2 500

Current period profit: 2016 – 2017 Profit for the period Pre-acquisition adjustment: Depreciation of plant

$420 000 (14 000) $406 000

Adjustments for inter-entity transactions: Realised profit in opening inventory Unrealised profit in ending inventory: 1/3 x $15 000 Realised profit on vehicle: $1 400/2

14 000 (5 000) 700 $415 700 $103 925

Investor’s share – 25% The consolidation worksheet entries at 30 June 2017 are:

Investment in Board Ltd Share of profit or loss of associates and joint ventures

Dividend revenue Investment in Board Ltd (25% ($40 000 + $50 000))

Dr Cr

103 925

103 925 22 500

22 500

23.23

Chapter 23: Associates and joint ventures

Question 23.6

Inter-entity transactions where investor does not prepare consolidated financial statements

Acoustic Ltd owns 25% of the shares of its joint venture, Bass Ltd. At the acquisition date, there were no differences between the fair values and the carrying amounts of the identifiable assets and liabilities of Bass Ltd. For 2015–16, Bass Ltd recorded a profit of $100 000. During this period, Bass Ltd paid a $10 000 dividend, declared in June 2015, and an interim dividend of $8000. The tax rate is 30%. The following transactions have occurred between Acoustic Ltd and Bass Ltd: (a) On 1 July 2014, Bass Ltd sold a non-current asset costing $10 000 to Acoustic Ltd for $12 000. Acoustic Ltd applies a 10% p.a. on cost straight-line method of depreciation. (b) On 1 January 2016, Bass Ltd sold an item of plant to Acoustic Ltd for $15 000. The carrying amount of the asset to Bass Ltd at time of sale was $12 000. Acoustic Ltd applies a 15% p.a. straight-line method of depreciation. (c) A non-current asset with a carrying amount of $20 000 was sold by Bass Ltd to Acoustic Ltd for $28 000 on 1 June 2016. Acoustic Ltd regarded the item as inventory and still had the item on hand at 30 June 2016. (d) On 1 July 2014, Acoustic Ltd sold an item of machinery to Bass Ltd for $6000. This item had cost Acoustic Ltd $4000. Acoustic Ltd regarded this item as inventory whereas Bass Ltd intended to use the item as a non-current asset. Bass Ltd applied a 10% p.a. on cost straight-line depreciation method. Required Acoustic Ltd applies AASB 128 in accounting for its investment in Bass Ltd. Assuming Acoustic Ltd does not prepare consolidated financial statements, prepare the journal entries in the records of Acoustic Ltd for the year ended 30 June 2016 in relation to its investment in Bass Ltd.

Profit for the period Adjustments for inter-entity transactions: Realised profit on equipment sold on 1/7/16 (a) 10% x $2 000 (1 - 30%) Unrealised profit on sale of plant on 1/1/16 (b) original profit $3 000 (1 – 30%) less depreciation of 15% x ½ x $2 100 Unrealised profit in ending inventory (c) $8 000 (1 – 30%) Realised profit on inventory to non-current asset sale: 10% x $2 000 (1 – 30%)

$100 000

Investor’s share – 25% (approx.)

$23 185

140

(1 942) (5 600) 140 92 738

Journal entries in Acoustic Ltd: Cash Investment in Bass Ltd (Dividend received from joint venture: 25% x $10 000) Cash Investment in Bass Ltd

Dr Cr

2 500

Dr Cr

2 000

2 500

2 000

23.24

Chapter 23: Associates and joint ventures

(25% x $8 000) Investment in Bass Ltd Share of profit or loss of associates and joint ventures

23 185

23.25

Chapter 23: Associates and joint ventures

Question 23.7

Associate incurs losses

On 1 July 2014, Ukulele Ltd acquired 40% of the shares of Bongo Ltd for $100 000. At this date, all the identifiable assets and liabilities of Bongo Ltd were recorded at amounts equal to fair value except for inventory which had a fair value $10 000 greater than the carrying amount. All inventory was sold by 30 June 2015. The tax rate is 30%. Bongo Ltd was classified as an associate of Ukulele Ltd. The profits and losses recorded by Bongo Ltd from the next 6 years were as follows: 2014–15 2015–16 2016– 1 7 2017– 1 8 2018– 1 9 2019– 2 0

$30 000 5 000 (250 000)

(50 000)

15 000

20 000

Required Prepare the journal entries for the consolidation worksheet of Ukulele Ltd for the equity accounting of Bongo Ltd in each of the years from 2014–20. Table of workings Year

Post-acquisition Profit/(Loss)

2014-15 * 2015-16 2016-17 2017-18 2018-19 2019-20

$23 000 5 000 (250 000) (50 000) 15 000 20 000

Share of Profit/(Loss) 40%

Cumulative share

$9 200 2 000 (100 000) (20 000) 6 000 8 000

$9 200 11 200 (88 800) (108 800) (102 800) (94 800

Equityaccounted balance of investment $109 200 111 200 11 200 0 0 5 200

*In the 2014-15 year it is necessary to calculate the share of post-acquisition profits of Bongo Ltd: Recorded profits of Bongo Ltd = $30 000 Pre-acquisition profits = $10 000 (1 - 30%) (inventory sale) = $7 000 Post-acquisition profits = $23 000 40% share = $9 200 The journal entries are: 30/6/15 Investment in associates and joint ventures Share of profit or loss of associates and joint ventures

30/6/16 Investment in associates and joint ventures

9 200

9 200 11 200

23.26

Chapter 23: Associates and joint ventures

Retained earnings (1/7/15) Share of profit or loss of associates and joint ventures

9 200

2 000

30/6/17 Share of profit or loss of associates and joint ventures Retained earnings (1/7/16) Investment in associates and joint ventures

Dr Cr Cr

100 000

30/6/18 Share of profit or loss of associates and joint ventures Retained earnings (1/7/17) Investment in associates and joint ventures

Dr Dr Cr

11 200 88 800

30/6/19 Retained earnings (1/7/18) Investment in associates and joint ventures

Dr Cr

100 000

30/6/20 Retained earnings (1/7/19) Investment in associates and joint ventures Share of profit or loss of associates and joint ventures

Dr Cr

100 000

11 200 88 800

100 000

94 800 5 200

23.27

Chapter 23: Associates and joint ventures

Question 23.8

Disclosure of movements in asset revaluation surplus in associate

Maracas Ltd entered into a joint venture agreement with another company to each buy 50% of Tuba Ltd on 1 July 2015 and to operate Tuba Ltd on a joint control basis. Maracas Ltd acquired its shares in Tuba Ltd for $110 000. The equity of Tuba Ltd consisted of $100 000 share capital and $80 000 retained earnings. At 1 July 2015, all the identifiable assets and liabilities of Tuba Ltd were recorded at amounts equal to their fair values except for:  Land: this had a fair value of $110 000 which was $20 000 greater than the carrying amount in Tuba Ltd. After 1 July 2015, Tuba Ltd revalued the land to fair value in its own records and continued to measure it using the revaluation model. The fair value of the land at 30 June 2016 was $140 000 and at 30 June 2017 was $160 000.  Plant: At 1 July 2015, the plant had a fair value of $240 000 which was $10 000 greater than the carrying amount in Tuba Ltd. The plant was estimated to have a further 5-year life.  Inventory: At 1 July 2015, the inventory held by Tuba Ltd had a fair value of $85 000 which was $15 000 greater than its cost to Tuba Ltd. The inventory was all sold by 30 June 2017. Transactions between Maracas Ltd and Tuba Ltd consisted of:  During the 2015–16 period, Tuba Ltd sold inventory to Maracas Ltd at a before-tax profit of $6000. Half of this inventory was still on hand at 30 June 2016.  During the 2016–17 period, Tuba Ltd sold inventory to Maracas Ltd for $70 000 at a beforetax profit of $8000. Of this inventory, 10% was still on hand in Maracas Ltd at 30 June 2017.  On 1 January 2016, Maracas Ltd sold a vehicle to Tuba Ltd at a before-tax profit of $3000. The vehicle had a further 3-year life; The retained earnings balance of Tuba Ltd at 30 June 2016 was $170 000. The tax rate is 30%. The consolidated statements of profit or loss and other comprehensive income of Maracas Ltd at 30 June 2017 — not including the equity-accounted results of Tuba Ltd — and of Tuba Ltd were as follows: Maracas Ltd (Consolidated) $500 000

Revenues Expenses Profit before income tax

280 000 220 000

Income tax expense

(80 000)

Profit for the year

$140 000

Other comprehensive income: Gains on revaluation of non-current assets Comprehensive income

Tuba Ltd 240 00 0 80 000 160 00 0 (50 000 ) 110 00 0

30 000

14 000

$170 000

$124 0 00

Required A. Prepare the journal entries for inclusion in the consolidation worksheet of Maracas Ltd for the application of the equity method to Tuba Ltd at 30 June 2017. B. Prepare the consolidated statement of profit or loss and other comprehensive income of Maracas Ltd at 30 June 2017 including the equity-accounted results of Tuba Ltd. At 1 July 2015:

23.28

Chapter 23: Associates and joint ventures

Net fair value of identifiable assets and liabilities of Tuba Ltd

= = = = =

Net fair value acquired Cost of investment Goodwill

$100 000 + $80 000 + $20 000 (1 – 30%) (land) + $10 000 (1 –30%) (plant) + $15 000 (1 – 30%) (inventory) $211 500 50% x $211 500 $105 750 $110 000 $4 250

A. Consolidation Worksheet Entries Retained earnings Movement in retained earnings: $170 000 -$80 000 Pre-acquisition adjustments: Inventory: $15 000 (1 – 30%) Depreciation of plant: 1/5 x $10 000 (1 – 30%)

$90 000 (10 500) (1 400) $78 100

Adjustments for inter-entity transactions: Inventory on hand at 30 June 2016: ½ x $6 000(1 – 30%) Unrealised profit on sale of vehicle: Gain $3000(1 -30%) less depreciation (1/3 x ½ x$2 100)

(2 100) (1 750) $74 250 $37 125

Investor’s share – 50% The consolidation worksheet entry at 30 June 2017 is: Investment in Tuba Ltd Retained earnings (1/7/16)

Dr Cr

37 125 37 125

Asset revaluation surplus (re: Land revaluations) Prior period Movement in asset revaluation surplus: $35 000 - $14 000 Investor’s share – 50% Current period Movement in asset revaluation surplus: $49 000 - $35 000 Investor’s share – 50%

$21 000 $10 500 $14 000 $7 000

The consolidation worksheet entries are: Investment in Tuba Ltd Asset revaluation surplus

Dr Cr

21 000

Investment in Tuba Ltd Share of other comprehensive income of associates and joint ventures

7 000

Share of other comprehensive income of associates and joint ventures Asset revaluation surplus

21 000

Dr Cr

7 000

23.29

Chapter 23: Associates and joint ventures

Current period profit: 2016 – 2017 Profit for the period Pre-acquisition adjustment: Depreciation of plant

$110 000 (1 400) $108 600

Adjustments for inter-entity transactions: Realised profit in opening inventory Unrealised profit in ending inventory: 10% x $8 000 (1 – 30%) Realised profit on vehicle: 1/3 x $2 100 Investor’s share – 50%

2 100 (560) 700 $110 840 $55 420

The consolidation worksheet entries at 30 June 2017 are:

Investment in Tuba Ltd Share of profit or loss of associates and joint ventures

55 420

B. Consolidated Statement of Profit or Loss and Other Comprehensive Income Maracas Ltd Consolidated Statement of Profit or Loss and Other Comprehensive Income at 30 June 2017 Revenues Expenses Trading profit Share of profit or loss of associates and joint ventures accounted for using the equity method Profit before tax Income tax expense Profit for the year Other comprehensive income: Gains on revaluation of non-current assets Share of other comprehensive income of associates and joint ventures accounted for using the equity method Other comprehensive income Comprehensive income for the year

$500 000 280 000 220 000 55 420 275 420 80 000 $195 420 30 000 7 000 $37 000 $232 420

23.30

Chapter 23: Associates and joint ventures

Question 23.9

Investor prepares consolidated financial statements, multiple periods

On 1 July 2014, Harp Ltd purchased 30% of the shares of Lyre Ltd for $60 050. At this date, the ledger balances of Lyre Ltd were: Capital Other reserves Retained earnings

$150 000 30 000 15 000 $195 000

Assets Less: Liabilities

$225 000 (30 000) $195 000

At 1 July 2014, all the identifiable assets and liabilities of Lyre Ltd were recorded at fair value except for plant whose fair value was $5000 greater than carrying amount. This plant has an expected future life of 5 years, the benefits being received evenly over this period. Dividend revenue is recognised when dividends are declared. The tax rate is 30%. The results of Lyre Ltd for the next 3 years were:

Profit/(loss) before income tax Income tax expense Profit/(loss) Dividend paid Dividend declared

30 June 2015 $ 50 000 (20 000) 30 000 15 000 10 000

30 June 2016 $ 40 000 (20 000) 20 000 5 000 5 000

30 June 2017 $(5 000) — (5 000) 2 000 1 000

Required Prepare, in journal entry format, for the years ending 30 June 2015, 2016 and 2017, the consolidation worksheet adjustments to include the equity-accounted results for the associate, Lyre Ltd, in the consolidated financial statements of Harp Ltd. 30% Harp Ltd

Lyre Ltd

At 1 July 2014: Net fair value of identifiable assets and liabilities of Lyre Ltd Net fair value acquired Cost of investment Goodwill Depreciation of plant p.a. after tax

= = = = = =

$195 000 (equity) + $5 000 (1 –30%) (plant) $198 500 30% x $198 500 $59 550 $60 050 $500

= =

1/5 x $3 500 $700

1. Consolidation Worksheet Entries 2014 – 2015 Recorded profit for the period Pre-acquisition adjustments: Depreciation of plant Investor’s share – 30%

$30 000 700 29 300 $8 790

23.31

Chapter 23: Associates and joint ventures

The consolidation worksheet entries at 30 June 2015 are: Investment in Lyre Ltd Share of profit or loss of associates and joint ventures

Dividend revenue Investment in Lyre Ltd (30% [$15 000 + $10 000])

Dr Cr

8 790

8 790 7 500 7 500

2015 – 2016 Profit for the period Pre-acquisition adjustment: Depreciation of plant

$20 000 700 $19 300 $5 790

Investor’s share – 30% The consolidation worksheet entries at 30 June 2016 are: Investment in Lyre Ltd Retained earnings (1/7/15) (30%[$20 000 - $15 000 - $700])

Dr Cr

1 290

Investment in Lyre Ltd Share of profit or loss of associates and joint ventures

5 790

Dividend revenue Investment in Lyre Ltd (30% ($5 000 + $5 000))

Dr Cr

1 290

5 790 3 000 3 000

2016 – 2017 Profit (loss) for the period Pre-acquisition adjustment: Depreciation of plant

$ (5 000) 700 $(5 700) $(1 710)

Investor’s share – 30%

The consolidation worksheet entries at 30 June 2017 are: Investment in Lyre Ltd Retained earnings (1/7/16) (30%[$30 000 – $15 000 – (2 x $700)] ) Share of profit or loss of associates and joint ventures Investment in Lyre Ltd Dividend revenue Investment in Lyre Ltd (30% [$2 000 + $1 000])

Dr Cr

4 080

Dr Cr

1 710

Dr Cr

900

4 080

1 710

900

23.32

Chapter 23: Associates and joint ventures

Question 23.10

Consolidated worksheet entries to include investment in associate

On 1 July 2013, Bongo Ltd acquired 30% of the shares of Tom-Tom Ltd for $60 000. At this date, the equity of Tom-Tom Ltd consisted of: Share capital (100 000 shares) Asset revaluation surplus Retained earnings

$100 000 50 000 20 000

On 1 July 2015, the ownership interest of 30%, together with board representation and a diverse spread of remaining shareholders, was sufficient for the investor to demonstrate significant influence, and accordingly to begin accounting for the investment as an associate. The fair value of the 30% ownership interest in Tom-Tom Ltd at 1 July 2015 was $70 000. At this date, the equity of Tom-Tom Ltd consisted of: Share capital (100 000 shares) Asset revaluation surplus General reserve Retained earnings

$100 000 60 000 10 000 40 000

At this date, all the identifiable assets and liabilities of Tom-Tom Ltd were recorded at fair value except for the following assets:

Machinery Inventory

Carrying amount $20 000 10 000

Fair value $25 000 12 000

The machinery was expected to have a further 5-year life, benefits being received evenly over this period. The inventory was all sold by 30 June 2016. Dividends paid by Tom-Tom Ltd in the 2013–14 period were $10 000, and $12 000 was paid in the 2014–15 period. In June 2015, Tom-Tom Ltd declared a dividend of $10 000. Dividend revenue is recognised when dividends are declared. During the period ending 30 June 2016, the following events occurred: (a) Tom-Tom Ltd sold to Bongo Ltd some inventory, which had previously cost Tom-Tom Ltd $8000, for $10 000. Bongo Ltd still had one-quarter of these items on hand at 30 June 2016. (b) On 1 January 2016, Bongo Ltd sold a non-current asset to Tom-Tom Ltd for $50 000, giving a profit before tax of $10 000 to Bongo Ltd. Tom-Tom Ltd applied a 12% p.a. on cost straight-line depreciation method to this asset. (c) On 31 December 2015, Tom-Tom Ltd paid an interim dividend of $5000. (d) At 30 June 2016, Tom-Tom Ltd calculated that it had earned a profit of $32 000, after an income tax expense of $8000. Tom-Tom Ltd then declared a $5000 dividend, to be paid in September 2016, and transferred $3000 to the general reserve. (e) The tax rate is 30%. Required Prepare the journal entries for the consolidation worksheet of Bongo Ltd at 30 June 2016 for the inclusion of the equity-accounted results of Tom-Tom Ltd. 30% Bongo Ltd

Tom-Tom Ltd

23.33

Chapter 23: Associates and joint ventures

At 1 July 2015: Net fair value of identifiable assets and liabilities of Tom-Tom Ltd

Net fair value acquired Acquisition-date fair value of investment Goodwill Depreciation of machinery p.a. Adjustment for inventory

= = =

$100 000 + $60 000 + $10 000 + $40 000(equity) + $5 000 (1 – 30%)(machinery) + $2 000 (1 – 30%) (inventory)) $214 900 30% x $214 900 $64 470

= =

$70 000 $5 530

= = =

1/5 x $3 500 $700 $1 400

At 1 July 2015, Bongo Ltd would pass the following journal entry to r-measure the investment in Tom-Tom Ltd to fair value: Investment in Tom-Tom Ltd Gain on Investment (Re-measurement of investment to fair value: $70 000 - $60 000)

Dr Cr

10 000 10 000

1 July 2015 – 30 June 2016 Profit for the period Adjustments for inter-entity transactions: Unrealised profit on sale of inventory (1/4 x $2 000) (1 – 30%) Unrealised profit on sale of non-current asset: Profit on sale of $10 000 (1 - 30%) less depreciation of (1/2 x 12% x $7 000)

$32 000

(350)

(6 580) $25 070

Pre-acquisition adjustment: Inventory Depreciation of machinery: 1/5 x $3500

(1 400) (700) $22 970 $6 891

Investor’s share – 30% x $22 970 The entries in the consolidation worksheet at 30 June 2016 are: Dividend revenue Investment in Tom-Tom Ltd (30% [$5 000 + $5 000])

Dr Cr

3 000

Investment in Tom-Tom Ltd Share of profit or loss of associates and joint ventures

6 891

3 000

6 891

23.34

Chapter 23: Associates and joint ventures

Question 23.11

Adjustments where investor does and does not prepare consolidated financial statements

On 1 July 2014, Bell Ltd signed a joint venture agreement with two other investors. They agreed to acquire the shares of Chime Ltd and operate it as a joint venture with the investors having joint control over the company. On 1 July 2014, Bell Ltd acquired a 30% interest in Chime Ltd at a cost of $13 650. The equity of Chime Ltd at acquisition date was: Share capital (20 000 shares) Retained earnings

$20 000 10 000

All the identifiable assets and liabilities of Chime Ltd at 1 July 2014 were recorded at amounts equal to their fair values except for some depreciable non-current assets with a fair value of $15 000 greater than carrying amount. These depreciable assets are expected to have a further 5-year life. Additional information (a) At 30 June 2016, Bell Ltd had inventory costing $100 000 (2015 — $60 000) on hand which had been purchased from Chime Ltd. A profit before tax of $30 000 (2015 — $10 000) had been made on the sale. (b) All companies adopt the recommendations of AASB 112 regarding tax-effect accounting. Assume a tax rate of 30% applies. (c) Information about income and changes in equity of Chime Ltd as at 30 June 2016 is: Profit before tax Income tax expense Profit Retained earnings at 1/7/15 Dividend paid Dividend declared Retained earnings at 30/6/16

$ 360 000 (180 000) 180 000 50 000 230 000 $(50 000) (50 000)

(100 000) $ 130 000

(d) All dividends may be assumed to be out of the profit for the current year. Dividend revenue is recognised when declared by directors. (e) The equity of Chime Ltd at 30 June 2016 was: Share capital Asset revaluation surplus General reserve Retained earnings

$ 20 000 30 000 5 000 130 000

The asset revaluation surplus arose from a revaluation of freehold land made at 30 June 2016. The general reserve arose from a transfer from retained earnings in June 2015. Required A. Assume Bell Ltd does not prepare consolidated financial statements. Prepare the journal entries in the records of Bell Ltd for the year ended 30 June 2016 in relation to the investment in Chime Ltd. B. Assume Bell Ltd does prepare consolidated financial statements. Prepare the consolidated worksheet entries for the year ended 30 June 2016 for inclusion of the equity-accounted results of Chime Ltd.

23.35

Chapter 23: Associates and joint ventures

30% Bell Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Chime Ltd

Chime Ltd

= = = = = =

Net fair value acquired Cost of investment Goodwill

Depreciation: Non-current assets: – 20% x $15 000 (1 -30%)

$20 000 + $10 000 (equity) + $15 000 (1 – 30%) (assets) $40 500 30% x $40 500 $12 150 $13 650 $1 500

$2 100

1. Bell Ltd does not prepare consolidated financial statements

Profit for 2015-2016 period Pre-acquisition adjustments: Depreciation Post-acquisition profit Adjustments for inter-entity transactions: Unrealised after tax profit in ending inventory $30 000 (1 – 30%) Realised profit on opening inventory $10 000 (1 – 30%)

$180 000 2 100 177 900

(21 000)

Investor’s share – 30%

7 000 $163 900 $49 170

Increase in asset revaluation surplus Investor’s share – 30%

$30 000 $9 000

The required entries in Bell Ltd’s accounts for the 2015-2016 year are: Cash

Dr Cr

15 000

Dividend receivable Investment in Chime Ltd (30% x $50 000 – dividend provided)

Dr Cr

15 000

Investment in Chime Ltd Share of other comprehensive income of associates and joint ventures (30% x $30 000)

9 000

Investment in Chime Ltd (30% x $50 000 – dividend paid)

15 000

Share of other comprehensive income of associates and joint ventures Dr Asset revaluation surplus Cr (30% x $30 000)

9 000

23.36

Chapter 23: Associates and joint ventures

Investment in Chime Ltd Share of profits or losses of associates and joint ventures

49 170

Bell Ltd prepares consolidated financial statements Change in retained earnings balance 2014 – 2015 ($50 000 - $10 000) Pre-acquisition adjustments: Depreciation Post-acquisition equity Adjustments: General reserve transfers Unrealised profit in inventory at 30/6/16 ($10 000 (1 - 30%)

$40 000 2 100 37 900 5 000 (7 000) $35 900 $10 770

Investor’s share – 30%

The consolidation worksheet entries at 30/6/16 are: Investment in Chime Ltd Retained earnings (1/7/15)

Dr Cr

10 770

Investment in Chime Ltd Asset revaluation surplus (30% x $30 000)

Dr Cr

9 000

Investment in Chime Ltd Share of profits or losses of associates and joint ventures

49 170

Dividend revenue Investment in Chime Ltd (30% x $50 000 – dividend paid)

Dr Cr

15 000

Dividend revenue Investment in Chime Ltd (30% x $50 000 – dividend declared)

Dr Cr

15 000

10 770

9 000

49 170

15 000

23.37

Chapter 23: Associates and joint ventures

Question 23.12

Accounting for associate joint venture within — and where there are no — consolidated financial statements

On 1 July 2013, Cymbal Ltd purchased 40% of the shares of Gong Ltd for $63 200 and signed a joint venture agreement with the two other shareholders in Gong Ltd. At that date, equity of Gong Ltd consisted of: Share capital $125 000 Retained earnings 11 000 At 1 July 2013, the identifiable assets and liabilities of Gong Ltd were recorded at amounts equal to their fair values. Information about income and changes in equity for both companies for the year ended 30 June 2016 was as shown opposite.

Profit before tax Income tax expense Profit Retained earnings (1/7/15) Dividend paid Dividend declared Retained earnings (30/6/16)

Cymbal Ltd $ 26 000 (10 600) 15 400 18 000 33 400 (5 000) (10 000) (15 000) $ 18 400

Gong Ltd $ 23 500 (5 400) 18 100 16 000 34 100 (4 000) (5 000) (9 000) $ 25 100

Additional information (a) Cymbal Ltd recognised the final dividend revenue from Gong Ltd before receipt of cash. Gong Ltd declared a $6000 dividend in June 2015, this being paid in August 2015. (b) On 31 December 2015, Gong Ltd sold Cymbal Ltd a motor vehicle for $12 000. The vehicle had originally cost Gong Ltd $18 000 and was written down to $9000 for both tax and accounting purposes at time of sale to Cymbal Ltd. Both companies depreciated motor vehicles at the rate of 20% p.a. on cost. (c) The beginning inventory of Gong Ltd included goods at $4000 bought from Cymbal Ltd; their cost to Cymbal Ltd was $3200. (d) The ending inventory of Cymbal Ltd included goods purchased from Gong Ltd at a profit before tax of $1600. (e) The tax rate is 30%. Required A. Prepare the journal entries in the records of Cymbal Ltd to account for the investment in Gong Ltd in accordance with AASB 128 for the year ended 30 June 2016 assuming Cymbal Ltd does not prepare consolidated financial statements. B. Prepare the consolidated worksheet entries in relation to the investment in Gong Ltd, assuming Cymbal Ltd does prepare consolidated financial statements at 30 June 2016. 40% Cymbal Ltd

Gong Ltd

At 1 July 2013: Net fair value of identifiable assets and liabilities of Gong Ltd Net fair value acquired

= = =

$125 000 + $11 000 $136 000 40% x $136 000

23.38

Chapter 23: Associates and joint ventures

= = =

Cost of investment Goodwill

$54 400 $63 200 $8 800

1. Cymbal Ltd does not prepare consolidated financial statements Profit for the period 2015 – 2016 Adjustments for inter-entity transactions: Realised profit on motor vehicle 20% x $3 000 (1 – 30%) Realised profit in opening inventory $800 (1 – 30%) Unrealised profit in ending inventory $1 600 (1 – 30%)

$18 100

420 560 (1 120) $ 17 960

Investor’s share – 40%

$7 184

The entries in the books of Cymbal Ltd at 30 June 2016 are: Cash Investment in Gong Ltd (40% x $4 000 – dividend paid)

Dr Cr

1 600

Dividend receivable Investment in Gong Ltd (40% x $5 000 – dividend declared)

Dr Cr

2 000

Investment in Gong Ltd Share of profits or losses of associates and joint ventures

7 184

1 600

2 000

7 184

2. Cymbal Ltd prepares consolidated financial statements Change in retained earnings 2014 – 2015 ($16 000 – $11 000) Adjustments for inter-entity transactions: Unrealised profit on motor vehicle Profit on sale $3 000 (1 – 30%) less ½ x 20% x $2 100 Unrealised profit in ending inventory $800 (1 – 30%)

$5 000

(1 890) (560) $2 550

Investor’s share – 40%

$1 020

The consolidation worksheet entries at 30 June 2016 are:

Investment in Gong Ltd Retained earnings (1/7/15)

Dr Cr

1 020

23.39

Chapter 23: Associates and joint ventures

Investment in Gong Ltd Share of profits or losses of associates and joint ventures

7 184

Dividend revenue Investment in Gong Ltd (40% x $4 000 – dividend paid)

Dr Cr

1 600

Dividend revenue Investment in Gong Ltd (40% x $5 000 – dividend provided)

Dr Cr

2 000

7 184

1 600

2 000

23.40

Chapter 23: Associates and joint ventures

Question 23.13

Consolidated financial statements including investments in associates

Trombone Ltd acquired 90% of the ordinary shares of Tuba Ltd on 1 July 2012 at a cost of $150 750. At that date the equity of Tuba Ltd was: Share capital (100 000 shares) Reserve Retained earnings

$100 000 8 000 12 000

At 1 July 2012, all the identifiable assets and liabilities of Tuba Ltd were at fair value except for the following assets:

Inventory Depreciable assets

Carrying amount $10 000 25 000

Fair value $15 000 35 000

The inventory was all sold by 30 June 2013. Depreciable assets have an expected further 5year life, with depreciation being calculated on a straight-line basis. Valuation adjustments are made on consolidation. Trombone Ltd uses the partial goodwill method. On 1 July 2015, Trombone Ltd acquired 25% of the capital of Accordion Ltd for $3500. All the identifiable assets and liabilities of Accordion Ltd were recorded at fair value except for the following:

Inventory Depreciable assets

Carrying amount $1 000 6 000

Fair value $1 500 7 000

All this inventory was sold in the 12 months after 1 July 2015. The depreciable assets were considered to have a further 5-year life. Information on Accordion Ltd’s equity position is as follows:

Share capital General reserve Retained earnings

1 July 2015 $10 000 — 2 150

30 June 2016 $10 000 2 000 4 000

For the year ended 30 June 2017, Accordion Ltd recorded a profit before tax of $2600 and an income tax expense of $600. Accordion Ltd paid a dividend of $200 in January 2017. Trombone Ltd regards Accordion Ltd as an associated company. During the year ended 30 June 2017, Accordion Ltd sold inventory to Tuba Ltd for $6000. The cost of this inventory to Accordion Ltd was $4000. Tuba Ltd has resold only 20% of these items. However, Tuba Ltd made a profit before tax of $500 on the resale of these items. On 1 January 2016, Trombone Ltd sold Accordion Ltd a motor vehicle for $4000, at a profit before tax of $800 to Trombone Ltd. Both companies treat motor vehicles as non-current assets. Both companies charge depreciation at 20% p.a. on the reducing balance. Assume a tax rate of 30%. Information about income and changes in equity for Trombone Ltd and its subsidiary, Tuba Ltd, for the year ended 30 June 2017 is as follows:

Sales revenue

Trombone Ltd $200 000

Tuba Ltd $60 000

23.41

Chapter 23: Associates and joint ventures

Less: Cost of sales Gross profit Less: Depreciation Other expenses

Plus: Other revenue Profit before income tax Less: Income tax expense Profit Plus: Retained earnings (1/7/16) Less: Dividend paid Retained earnings (30/6/17)

110 000 90 000 16 000 22 000 38 000 52 000 30 000 82 000 20 000 62 000 120 000 182 000 20 000 $162 000

30 000 30 000 4 000 3 000 7 000 23 000 5 000 28 000 10 000 18 000 80 000 98 000 4 000 $94 000

Required A. Prepare the consolidated statement of profit or loss and other comprehensive income and statement of changes in equity of Trombone Ltd and its subsidiary Tuba Ltd as at 30 June 2017. B. In the consolidated statement of financial position, what would be the balance of the investment account ‘Shares in Accordion Ltd’? 90% Trombone Ltd

Tuba Ltd

25%

Accordion Ltd A: Consolidation worksheet entries – Trombone Ltd – Tuba Ltd At 1 July 2012: Net fair value of identifiable assets and liabilities of Tuba Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

$100 000 + $8 000 + $12 000 (equity) + $5 000 (1 – 30%) (inventory) + $10 000 (1 – 30%)(depreciable assets) $130 500 $150 750 10% x $130 500 $13 050 $163 800 $33 300

1. Business combination valuation entry Depreciation expense Income tax expense Retained earnings (1/7/16) Transfer from business combination valuation reserve

Dr Cr Dr

2 000 600 5 600

7 000

23.42

Chapter 23: Associates and joint ventures

2. Pre-acquisition entries Retained earnings (1/7/16)* Share capital General reserve Business combination valuation reserve Goodwill Shares in Tuba Ltd

Dr Dr Dr Dr Dr Cr

13 950 90 000 7 200 6 300 33 300 150 750

* = (90% x $12 000) + 90% ($5 000 - $1 500) (BCVR - inventory) Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

6 300

Dr Dr Dr Dr Cr

1 200 10 000 800 1 050

Dr Cr Cr

6 240

Dr Cr

1 660

Dr Cr

700

Dr Cr

400

Dr Cr

3 600

6 300

3. NCI in equity of Tuba Ltd at 1/7/12 Retained earnings (1/7/16) Share capital General reserve Business combination valuation reserve NCI

13 050

4. NCI in equity of Tuba Ltd: 1/7/12 – 30/6/16 Retained earnings (1/7/16) Business combination valuation reserve NCI (RE: 10% ($80 000 - $12 000 – $5 600) BCVR: 10% x $3 500 [inventory])

350 5 890

5. NCI in equity of Tuba Ltd: 1/7/16 – 30/6/017 NCI share of profit NCI (10% ($18 000 – [$2 000 - $600])) Transfer from business combination valuation reserve Business combination valuation reserve NCI Dividend paid (10% x $4 000)

1 660

700

400

6. Dividend paid Other revenue Dividend paid (90% x $4 000)

3 600

23.43

Chapter 23: Associates and joint ventures

Equity accounting entries: Trombone Ltd – Accordion Ltd At 1 July 2015: Net fair value of identifiable assets and liabilities of Accordion Ltd

Net fair value acquired Cost of investment Goodwill Inventory adjustment Depreciation p.a.

= = = = =

$10 000 + $2 150 (equity) + $500 (1 – 30%) (inventory) + $1 000 (1 – 30%) (depreciable assets) $13 200 25% x $13 200 $3 300 $3 500 $200

= = =

$350 1/5 x $1000(1 – 30%) $140

Change in Retained Earnings 2015 – 2016 ($4 000 - $2 150) Pre-acquisition adjustments: Inventory Depreciation Post-acquisition equity Adjustments for inter-entity transactions: Unrealised profit on sale of motor vehicle Profit of $800 (1 – 30%) less depreciation of ½ x 20% x $560 Increase in general reserve Investor’s share – 25%

$1 850

(350) (140) $1 360

(504) 2 000 $2 856 $714

Profit for the period 2016-17 Pre-acquisition adjustments: Depreciation Post-acquisition profit Adjustments for inter-entity transactions: Realised profit on motor vehicle 20% ($560 - $56) Unrealised profit on ending inventory (80% x $2 000) (1 – 30%) Investor’s share – 25%

$2 000 (140) 1 860

101 (1 120) $841 $210

23.44

Chapter 23: Associates and joint ventures

The equity accounting entries are: 7. Equity accounting – Accordion Ltd

Financial Statements Sales revenue Other revenue

Cost of sales Depreciation Other expenses

Dividend revenue Investment in Accordion Ltd (25% x $200)

Dr Cr

Investment in Accordion Ltd Retained earnings (1/7/16) Share of profits or losses of associates and joint ventures

Dr Cr

924

Trombo ne Ltd 200 000 30 000

Tuba Ltd

230 000 110 000 16 000 22 000 148 000 82 000 -

65 000 30 000 4 000 3 000 37 000 28 000 -

Share of profits/losses from associates and JVs Profit before tax 82 000 Tax expense 20 000 Profit 62 000 Retained earnings 120 000 (1/7/16) Transfer from BCV reserve 182 000 Dividend paid 20 000 Retained earnings 162 000 (30/6/17)

28 000 10 000 18 000 80 000 98 000 4 000 94 000

6 7

1 2 2

210 Group Dr

NCI Cr

Parent

260 000 31 350

3 600 50

2 000

5 600 13 950 6 300

714

Adjustments Dr Cr

60 000 5 000

210

600

714

7 000

3 600

291 350 140 000 22 000 25 000 187 000 104 350 210

104 560 29 400 75 160 5 181 164 3 4 700 5 257 024 20 400 236 624

1 660 1 200 6 240 700

73 500 173 724 -

400

23.45

247 224 20 000 227 224

Chapter 23: Associates and joint ventures

Question 23.13 (cont’d) TROMBONE LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ending 30 June 2017 Revenues: Sales revenue Other revenue

$260 000 31 350 $291 350

Expenses: Cost of sales Depreciation Other expenses

140 000 22 000 25 000

187 000 104 350 ___210 104 560 29 400 $75 160 $75 160

Share of profits/(losses) of associates and joint ventures Profit before income tax Income tax expense Profit for the period Comprehensive Income for the period Attributable to: Parent interest Non-controlling interest

$73 500 1 660 $75 160

TROMBONE LTD Consolidated Statement of Changes in Equity for the financial year ending 30 June 2017 Group Comprehensive income for the period $75 160

Parent $73 500

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend paid Transfer from business combinations valuation reserve Balance at 30 June 2017

$181 164 75 160 (20 400) ___700 $236 624

$173 724 73 500 (20 000) ______ $227 224

$700 (700) $0

Share capital: Balance at 1 July 2016 Balance at 30 June 2017

unknown unknown

General reserve: Balance at 1 July 2016 Balance at 30 June 2017

unknown unknown

Business combination valuation reserve: Balance at 1 July 2016 Transfer to retained earnings Balance at 30 June 2017

2. Statement of Financial Position Investment in Accordion Ltd ($3 500 + $924 - $50)

$4 374

23.46

Chapter 23: Associates and joint ventures

Question 23.14

Consolidation worksheet entries including investments in associates

You are given the following details for the year ended 30 June 2016:

Profit before tax Income tax expense Profit Retained earnings at 1 July 2015 Dividend paid Dividend declared Transfer to general reserve (from current period’s profit)

Trumpet Ltd $100 000 (31 000) 69 000 20 000 89 000 (14 000) (15 000)

Clarinet Ltd $30 000 (10 000) 20 000 12 000 32 000 (6 000) (4 000)

Cello Ltd $25 000 (6 000) 19 000 11 000 30 000 (2 000) (8 000)

(10 000) (39 000) $ 50 000

(5 000) (15 000) $17 000

(6 000) (16 000) $14 000

Retained earnings at 30 June 2016 Additional information (a) Trumpet Ltd owns 80% of the shares in Clarinet Ltd and 20% of the shares in Cello Ltd. Trumpet Ltd has entered into a contractual agreement with the four other investors in Cello Ltd, and all five investors have a joint control arrangement in relation to Cello Ltd. (b) On 1 July 2014, all identifiable assets and liabilities of Clarinet Ltd were recorded at amounts equal to their fair values. Trumpet Ltd purchased 80% of Clarinet Ltd’s shares on 1 July 2014, and paid $5000 for goodwill, none of which had been recorded on Clarinet Ltd’s records. Trumpet Ltd uses the partial goodwill method. (c) At the date Trumpet Ltd acquired its shares in Cello Ltd, Cello Ltd’s recorded equity was: Share capital $100 000 General reserve 15 000 Retained earnings 5 000 All the identifiable assets and liabilities of Cello Ltd were recorded at amounts equal to their fair values. Trumpet Ltd paid $25 000 for its shares in Cello Ltd on 1 July 2014. Cello Ltd transferred $3000 to general reserve in the year ended 30 June 2015, out of equity earned since 1 July 2014. (d) Included in the beginning inventory of Trumpet Ltd were profits before tax made by Clarinet Ltd: $5000; Cello Ltd: $3000. (e) Included in the ending inventory of Clarinet Ltd were profits before tax made by Cello Ltd: $4000. (f) Cello Ltd had recorded a profit (net of $500 tax) of $2000 in selling certain non-current assets to Trumpet Ltd on 1 January 2016. Trumpet Ltd treats the items as non-current assets and charges depreciation at the rate of 25% p.a. straight-line from that date. (g) Trumpet Ltd purchased for $10 000 an item of plant from Clarinet Ltd on 1 September 2014. The carrying amount of the asset at that date was $7000. The asset was depreciated at the rate of 20% p.a. straight-line from 1 September 2014. (h) During the year ended 30 June 2016, Cello Ltd revalued upwards one of its non-current assets by $8000. There had been no previous downward revaluations. (i) Dividend revenue is recognised when dividends are declared. (j) The tax rate is 30%.

23.47

Chapter 23: Associates and joint ventures

Required Prepare the consolidation worksheet entries (in general journal form) needed for the consolidated statements for the year ended 30 June 2016 for Trumpet Ltd and its subsidiary Clarinet Ltd. Include the equity-accounted results of Cello Ltd.

Trumpet Ltd

80%

20%

Clarinet Ltd

Cello Ltd

NCI 20%

1. Consolidated worksheet entries At 30 June 2014, in relation to Trumpet’s acquisition of Clarinet Ltd: Goodwill acquired

(1)

Pre-acquisition entry Retained earnings (1/7/15) Goodwill Share capital Shares in Clarinet Ltd

(2)

Dr Dr Dr Cr

x 5 000 x

Dr Cr

2 400

NCI share of profit NCI (20% x $20 000)

Dr Cr

4 000

General reserve Transfer to general reserve (20% x $5 000)

Dr Cr

1 000

NCI

Dr Cr

1 200

NCI in equity: 1/7/14 – 30/6/15 Retained earnings (op. bal.) NCI (20% x $12 000)

(3)

$5 000

2 400

NCI in equity from 1/7/15 – 30/6/16

Interim dividend paid (20% x $6 000)

4 000

1 000

1 200

23.48

Chapter 23: Associates and joint ventures

NCI

800

Final dividend declared (20% x $4 000) (4)

(6)

Dr Cr

4 800

Dividend payable Dividend declared (80% x $4 000)

Dr Cr

3 200

Dividend revenue Dividend receivable

Dr Cr

3 200 3 200

Dr Dr Cr

3 500 1 500

Dr Cr

700

5 000

NCI adjustment

700

Sale of plant: Clarinet Ltd – Trumpet Ltd Retained earnings (1/7/15) Deferred tax asset Plant

(9)

3 200

Unrealised profit in beginning inventory: Clarinet Ltd – Trumpet Ltd

NCI share of profit Retained earnings (1/7/15) (20% x $3 500) (8)

4 800

Dividend declared

Retained earnings (1/7/15) Income tax expense Cost of sales (7)

800

Dividend paid Dividend revenue Interim dividend paid (80% x $6 000)

(5)

Dr Dr Cr

2 100 900

Dr Cr

420

3 000

NCI adjustment NCI Retained earnings (1/7/15) (20% x $2 100)

420

23.49

Chapter 23: Associates and joint ventures

(10)

Depreciation Accumulated depreciation Dr Retained earnings (1/7/15) Cr Depreciation expense Cr (20% x 10/12 x $3 000 in previous period and 20% x $3 000 in current period) Income tax expense Retained earnings (1/7/15) Deferred tax asset

1 100 500 600

Dr Dr Cr

180 150

Dr Dr Cr

84 70

330

(11) NCI adjustment NCI share of profit Retained earnings (1/7/15) NCI (12)

154

Equity accounted results of Cello Ltd

Net fair value of identifiable assets and liabilities of Cello Ltd Net fair value acquired Cost of investment Goodwill

= = = = = =

$100 000 + $15 000 + $5 000 (equity) $120 000 20% x $120 000 $24 000 $25 000 $1 000

Change in Retained Earnings 2014 –2015 ($11 000 - $5 000) Adjustments: Increase in general reserve Unrealised profit in closing inventory $3 000 (1 – 30%)

$6 000

3 000 (2 100) 6 900 $1 380

Investor’s share – 20% Recorded profit Adjustments for inter-entity transactions: Realised profit on opening inventory Unrealised profit in ending inventory $4 000 (1 – 30%) Unrealised profit on sale of non-current assets $2 000 (1 – 30%) less depreciation of ½ x 25% x $1 400

$19 000 2 100 (2 800)

Investor’s share – 20%

(1 225) $17 075 $3 415

Increase in asset revaluation surplus [$8 000 x (1 – 30%)] Investor’s share – 20%

$5 600 1 120

The worksheet entries are: Investment in Cello Ltd Retained earnings (1/7/15)

Dr Cr

4 795

1 380

23.50

Chapter 23: Associates and joint ventures

Share of profits or losses of associates and joint ventures

Investment in Cello Ltd Dr Share of other comprehensive income of associates and joint ventures Cr Share of other comprehensive income of associates and joint ventures Asset revaluation surplus Dividend revenue Investment in Cello Ltd (20% x[$2 000 + $8 000])

3 415 1 120 1 120

Dr Cr

1 120

Dr Cr

2 000

1 120

2 000

23.51

Chapter 23: Associates and joint ventures

Question 23.15

Multiple associates, consolidated financial statements

Keyboard Ltd has one subsidiary, Synthesiser Ltd, and two associated companies, Xylophone Ltd and Tambourine Ltd, and Synthesiser Ltd has one associated company, Triangle Ltd. Synthesiser Ltd

Triangle Ltd

Xylophone Ltd

Tambourine Ltd

$1 200 800 $2 000

$ 250 750 $1 000

$200 600 $800

$ 250 750 $1 000

Share capital Ordinary: Held by group Held by other interests

Information about the companies for the year ended 30 June 2017 is as follows:

Trading profit (loss) Dividend revenue Profit before tax Income tax expense Profit Dividend paid Retained earnings (1/7/16) Retained earnings (30/6/17)

Investments Other noncurrent assets (net) Current assets Total assets Share capital Asset revaluation surplus Retained earnings Total equity

Keyboard Ltd

Synthesiser Ltd

Triangle Ltd

Xylophone Ltd

Tambourine Ltd

$ 200

$1 000

$600

$2 400

$1 200

600

400

100

—

800

1 400

700

2 400

1 200

100 700 500 200

500 900 500 400

300 400 200 200

1 200 1 200 1 000 200

600 600 200 400

6 800

3 600

230

2 000

1 210

$7 000

$4 000

$430

$2 200

$1 610

Keyboard Ltd $ 4 008

Synthesis er Ltd $3 000

Triangle Ltd $ 80 0

Xylophon e Ltd —

Tambourin e Ltd —

6 000 1 992 $12 000 $ 1 000

3 000 2 000 $8 000 $2 000

2 000 1 600 $3 60 0 $ 80 0

2 400 1 000 $3 40 0 $1 00 0

1 000

—

7 000 9 000 3 000

4 000 6 000 2 000

—

2 200 3 000

1 610 2 610

400 800 $2 00 0 $1 00 0

200 430

23.52

Chapter 23: Associates and joint ventures

Liabilities Total equity and liabilities

$12 000

$8 000

1 630 370 $2 00 0

600

790

$3 60 0

$3 40 0

Additional information (a) Synthesiser Ltd: Keyboard Ltd acquired a 60% interest on 30 June 2009 for $3008. Shareholders’ equity at 30 June 2009 was: Share capital Retained earnings

$2 000 2 000 $4 000

At the acquisition date, Synthesiser Ltd had not recorded any goodwill. All the identifiable assets and liabilities of Synthesiser Ltd were recorded at amounts equal to their fair values except the following:

Inventory Non-current assets (net)

Carrying amount $ 500 1 200

Fair value $ 600 1 500

By 30 June 2010, all the inventory had been sold by Synthesiser Ltd. The non-current assets had a further expected life of 10 years, with benefits from use being received evenly over these years. The partial goodwill method is used. (b) Triangle Ltd: Synthesiser Ltd acquired, on 1 July 2016, 25% of the share capital for $400. Equity at 30 June 2016 was: Share capital Retained earnings

$1 000 230

At 30 June 2016, Triangle Ltd had not recorded any goodwill. All the identifiable assets and liabilities were recorded at amounts equal to their fair values except for the following:

Inventory Non-current assets (net)

Carrying amount $500 200

Fair value $600 400

By 30 June 2017, half the inventory had been sold to external parties. The non-current assets were revalued in the records of Triangle Ltd on 1 July 2016. (c) Keyboard Ltd: Included in current assets of Keyboard Ltd at 30 June 2017 is inventory that was purchased from Synthesiser Ltd for $900. Synthesiser Ltd sells its goods at cost plus 50% mark-up. (d) Keyboard Ltd: Included in current assets of Keyboard Ltd at 30 June 2016 was inventory that was purchased from Synthesiser Ltd for $600. (e) Synthesiser Ltd: Included in the non-current assets of Synthesiser Ltd at 30 June 2017 is an item of plant that was sold to Synthesiser Ltd by Triangle Ltd on 1 July 2016 for $1200. At the date of sale, this asset had a carrying amount to Triangle Ltd of $1000. It had an expected future useful life of 5 years, with benefits being received evenly over these years. (f) Xylophone Ltd: Keyboard Ltd acquired a 25% interest on 30 June 2014 for $400. Equity at 30 June 2014 was:

23.53

Chapter 23: Associates and joint ventures

Share capital Retained earnings

$800 600

At this date, Xylophone Ltd had not recorded any goodwill. All the identifiable assets and liabilities of Xylophone Ltd were recorded at amounts equal to their fair values except for the following assets:

Inventory Non-current assets (net)

Carrying amount $100 500

Fair value $120 600

The inventory was all sold by 30 June 2015. The non-current assets had a further useful life of 4 years. (g) Tambourine Ltd: Keyboard Ltd acquired a 25% interest on 1 July 2016 for $600. A comparison of carrying amounts and fair values at 30 June 2016 is shown below: Carrying amount $1 000 1 210 790 $3 000 $ 800

Share capital Retained earnings Liabilities Inventory Non-current assets: Plant Equipment

1 000 1 200 $3 000

Fair value

$ 790 1 000 1 200 1 500

The plant had a further 5-year life and the equipment had a further 6-year life. By 30 June 2017, all the undervalued inventory had been sold. (h) Xylophone Ltd: On 1 July 2015, Xylophone Ltd sold a non-current asset to Keyboard Ltd for $500. At the time of sale, this asset had a carrying amount of $450. Keyboard Ltd depreciated this asset evenly over a 5-year period. (i) Tambourine Ltd: At 30 June 2017, Keyboard Ltd held inventory that was sold to it by Tambourine Ltd at a profit before tax of $200 during the previous period. (j) Keyboard Ltd: On 30 June 2017, Keyboard Ltd held inventory that had been sold to it during the previous 6 months by Xylophone Ltd for $1000. Xylophone Ltd made $400 profit before tax on the sale. (k) The tax rate is 30%. Required Prepare the consolidated financial statements of Keyboard Ltd for the year ended 30 June 2017. Include all the associates accounted for under the equity method.

60% Keyboard Ltd

Keyboard Ltd 60% Synthesiser Ltd NCI

25% Xylophone Ltd

25% Tambourine Ltd

40%

25% Triangle Ltd

23.54

Chapter 23: Associates and joint ventures

Pre-acquisition analysis: Keyboard Ltd – Synthesiser Ltd

NOTE: Cost of Keyboard Ltd’s interest in Synthesiser Ltd is $3 008. At 30 June 2009: Net fair value of identifiable assets and liabilities of Synthesiser Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

(1)

(2)

= = = = = =

$2 000 + $2 000 (equity) + $100 (1 – 30%) (BCVR - inventory) + $300 (1 – 30%) (BCVR -non-current assets) $4 280 $3 008 40% x $4 280 $1 712 $4 720 $440

Business combination valuation entries Other non-current assets Deferred tax liability Business combination valuation reserve

Dr Cr Cr

300

Depreciation expense Retained earnings (1/7/16) Accumulated depreciation

Dr Dr Cr

30 210

Deferred tax liability Income tax expense Retained earnings (1/7/16)

Dr Cr Cr

Dr Dr Dr Dr Cr

1 242 1 200 126 440

90 210

240

9 63

Pre-acquisition entry Retained earnings (1/7/16)* Share capital Business combination valuation reserve Goodwill Shares in Synthesiser Ltd

3 008

* (60% x $2 000) + 60% x $70 [BCVR – inventory transfer])

(3)

NCI share of equity of Synthesiser Ltd at 30 June 2009 Retained earnings (30/6/16) Share capital Business combination valuation reserve NCI

Dr Dr Dr Cr

800 800 112 1 712

23.55

Chapter 23: Associates and joint ventures

(4)

NCI share of equity from 1/7/09 – 30/6/16 Retained earnings (30/6/16) Business combination valuation reserve NCI (40% ($3 600 - $2 000 – [$210 - $63]))

(5)

Dr Cr Cr

581

NCI share of profit NCI (40% ($900 – [$30 - $9]))

Dr Cr

352

NCI

Dr Cr

200

Dr Cr

300

NCI share of equity from 1/7/16 – 30/6/17

Dividend paid (40% x $500)

(6)

(8)

200

300

Profit in ending inventory: Synthesiser Ltd – Keyboard Ltd Trading profit Current assets

Dr Cr

300

Deferred tax asset Income tax expense

Dr Cr

300

NCI adjustment NCI NCI share of profit (40% ($300 - $90))

(9)

352

Dividend paid Dividend revenue Dividend paid (60% x $500)

(7)

28 553

Profit in opening inventory: Synthesiser Ltd – Keyboard Ltd Retained earnings (1/7/16) Trading profit

Dr Cr

200

Income tax expense Retained earnings (1/7/16)

Dr Cr

200

23.56

Chapter 23: Associates and joint ventures

(10) NCI adjustment NCI share of profit Retained earnings (1/7/16) (40% ($200 - $60))

Dr Cr

56 56

Accounting for Associates (11) Xylophone Ltd At 30 June 2014: Net fair value of identifiable assets and liabilities of Xylophone Ltd

= = = = =

Net fair value acquired Cost of investment Goodwill

$800 + $600 (equity) + $20 (1 – 30%) (BCVR - inventory) + $100 (1 – 30%)(BCVR non-current assets) $1 484 25% x $1 484 $371 $400 $29

Change in Retained Earnings 2008-2010 ($2 000 - $600) Adjustments for inter-entity transactions: Unrealised profit on sale of non-current asset $50 (1 – 30%) less depreciation of (20% x $35)

$1 400

(28) $1 372

Pre-acquisition adjustments: Inventory ($20 - $6) Depreciation – 2 years x ¼ x $70

(14) (35) $1323 $331

Investor’s share: 25% x $1323 Recorded profit Adjustments for inter-entity transactions: Unrealised profit on ending inventory $400 (1 – 30%) Realised profit on non-current assets (20% x $35)

$1 200

(280) 7 $927

Pre-acquisition adjustments: Depreciation: 25% x $70

(18) $909 $227

Investor’s share: 25% x $912 The consolidated worksheet entries are: Dividend revenue Investment in Xylophone Ltd (25% x $1000)

Dr Cr

250 250

23.57

Chapter 23: Associates and joint ventures

Investment in Xylophone Ltd Retained earnings (1/7/16) Share of profits (losses) in associates and joint ventures

Dr Cr

558 331

227

(12) Tambourine Ltd At 30 June 2016: Net fair value of identifiable assets and liabilities of Tambourine Ltd

= = = = =

Net fair value acquired Cost of investment Gain on bargain purchase

$1 000 + $1 210 (equity) + $200 (1 – 30%)(BCVR - inventory) + $200 (1 – 30%) BCVR - plant) + $300 (1 – 30%) (BCVR - equipment) $2 700 25% x $2 700 $675 $600 $75

Recorded profit Adjustments for inter-entity transactions: Unrealised profit on ending inventory $200 (1 - 30%)

$600

(140) $460

Pre-acquisition adjustments: Inventory Depreciation on plant: 1/5 x $140 Depreciation on equipment: 1/6 x $210

(140) (28) (35) $257 $64

Investor’s share: 25% x $257 The consolidated worksheet entries are:

(13)

Dividend revenue Investment in Tambourine Ltd (25% x $200)

Dr Cr

Investment in Tambourine Ltd Share of profit (losses) of associates and joint ventures

Triangle Ltd

At 1 July 2016: Net fair value of identifiable assets and liabilities of Triangle Ltd

($1 000 + $230) (equity) + $100 (1 – 30%) (inventory) + $200 (1 – 30%) (non-current assets) $1 440

23.58

Chapter 23: Associates and joint ventures

Net fair value acquired Cost of investment Goodwill Inventory adjustment

= = = =

25% x $1 440 $360 $400 $40

= =

50% x 25% x $70 $9

Recorded profit Adjustments for inter-entity transactions: Unrealised profit on sale of plant $200 (1 – 30%) less depreciation of (1/5 x $140)

$400

(112) $288

Pre-acquisition adjustments: Sale of inventory:50% x $70

(35) $253 $63

Investor’s share: 25% x $253

As the balance of the asset revaluation surplus at 30 June 2011 is $200, and the balance at 1 July 2007 was $140 (i.e. 70% x $200), then further revaluations resulting in a $60 increase in the asset revaluation surplus must have occurred in the current period. Hence: Increase in asset revaluation surplus

$60

Investor’s share - 25%

$15

The consolidation worksheet entries are: Dividend revenue Investment in Triangle Ltd (25% x $200)

Dr Cr

Investment in Triangle Ltd Share of profits or losses of associates and joint ventures Asset revaluation surplus

Cr Cr

63 15

As there is a 40% NCI in Synthesiser Ltd, the following entry in the NCI columns is necessary:

NCI share of profit* Dr 5 Asset revaluation surplus** Dr 6 NCI Cr 11 * (40% x ($63 - $50) – note that the NCI already has a share of the dividend revenue in Synthesiser Ltd; hence the share of profit of the associate must be adjusted for the dividend revenue recognised by Synthesiser Ltd to avoid double counting of the NCI share of profit. ** 40% x $15 ** 40% x $15

23.59

Chapter 23: Associates and joint ventures

Financial Statements

Keyboard Ltd 200

Synthesiser Ltd 1 000

600

400

800 -

1 400 -

800 100

1 400 500

Profit for period

700

900

Retained earnings (1/7/16)

6 800

3 600

7 500 500 7 000

4 500 500 4 000

1 000 1 000

2 000 -

Trading profit Dividend revenue

Share of profits/(losses) of associates & JVs Profit before tax Tax expense

Dividend paid Retained earnings (30/6/17) Share capital Asset revaluation surplus BCVR Total equity: parent Total equity: NCI

Total equity

9 000

6 000

Liabilities Total equity and liabilities

3 000 12 000

2 000 8 000

Adjustments Dr Cr 1 7 6 11 12 13

30 300 300 250 50 50

200

1 2 9

210 1 242 200

9 90

11 12 13 1 7

1 070

1 420 354

1 774 561 1 213 5 10 13 9 202 3 4

352 56 5 800 581

884

7 877

200

8 761 500 8 261

1 9 11

300

1 800 3 1 015 13

800 6

210

84 3

112

-10 270

5 8

200 84

1 712 553 352 11 2 996

3 4 5 13

2 344

10 415 700 9 715

12 614 1

Parent Cr

63 60 331

1 200

126

NCI Dr

350

227 64 63 9

Group

2 996

1 000 1 009

12 614

5 018 17 632

23.60

Chapter 23: Associates and joint ventures

Current assets Investments

1 992 4 008

2 000 3 000

Other non-current assets (net) Goodwill Total assets

6 000

3 000

-12 000

-8 000

11 12 13

558 64 78

1 7 2

300 90 440 5 620

300 3008 250 50 50 240

7 2 11 12 13 1

5 620

3 692 4 350

9 150 440 17 632

KEYBOARD LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2017 Revenues Expenses Trading profit Dividend revenue Share of profits (losses) of associates and joint ventures Profit before income tax Income tax expense Profit for the period Asset revaluation surplus: increments Comprehensive income for the period

x x $1 070 350 354 1 774 561 $1 213 15 $1 228

Profit for the period attributable to: Parent interest Non-controlling interest

$884 $329

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$893 $335

KEYBOARD LTD Consolidated Statement of Changes in Equity for the financial year ending 30 June 2017

Comprehensive income for the period

Group $1 228

Parent $893

Retained earnings: Balance at 1 July 2016 Profit for the period Dividend paid Balance at 30 June 2017

$9 202 1 213 (700) $9 715

$7 877 884 (500) $8 261

$84 $84

Business combination valuation reserve: Balance at 1 July 2016 Balance at 30 June 2017

23.61

Chapter 23: Associates and joint ventures

Asset revaluation surplus: Balance at 1 July 2016 Revaluation increment Balance at 30 June 2017

$1 000 ___15 $1 015

$1 000 ____9 $1 009

Share capital: Balance at 1 July 2016 Balance at 30 June 2017

$1 800 $1 800

$1 000 $1 000

KEYBOARD LTD Consolidated Statement of Financial Position as at 30 June 2017 ASSETS Current Assets Non-Current Assets Investments accounted for using the equity method Goodwill (net) Other non-current assets (net) Total Non-current Assets Total Assets

$3 692 4 350 440 9 150 13 940 $17 632

EQUITY AND LIABILITIES Equity attributable to equity holders of the parent Share capital Asset revaluation surplus Retained earnings Parent Interest Non-controlling Interest Total Equity Total Liabilities Total Equity and Liabilities

$1 000 1 009 8 261 10 270 2 344 $12 614 5 018 $17 632

Note: Investments in Associates The group, consisting of Keyboard Ltd and its subsidiary, Synthesiser Ltd, has investments in the following associates: Xylophone Ltd ownership interest is 25%, principal activities are … principal place of business is … Tambourine Ltd ownership interest is 25%, principal activities are … principal place of business is … Triangle Ltd ownership interest is 25%, principal activities are … principal place of business is … The investments in associates are measured using the equity method. The fair values of each of these investments are $.....

23.62

Chapter 23: Associates and joint ventures

Information about the associates extracted from their financial statements at 30 June 2011 is as follows: Xylophone Ltd Tambourine Ltd Triangle Ltd Dividends received $250 $50 $50 Current Assets Non-current Assets Current Liabilities Non-current Liabilities Revenues Other Comprehensive Income Comprehensive Income

1 600 2 000 600 x x x 1 200

1 000 2 400 790 x x x 600

800 1 200 370 x x x 400

23.63

Solutions manual to accompany Company Accounting 10e

Chapter 24 – Joint arrangements REVIEW QUESTIONS 1.

What is a joint arrangement?

AASB 11 states: 4. A joint arrangement is an arrangement of which two or more parties have joint control. 5. A joint arrangement has the following characteristics: (a) The parties are bound by a contractual arrangement (see paragraphs B2–B4). (b) The contractual arrangement gives two or more of those parties joint control of the arrangement (see paragraphs 7–13). 6. A joint arrangement is either a joint operation or a joint venture.

How does a joint arrangement differ from an associate?

An associate exists when an investor has significant influence over another entity. A joint arrangement exists when an investor has joint control over another entity. An investor does not need to have an arrangement with another entity in order to have significant influence whereas to have joint control there must be two or more parties who have joint control.

What is meant by joint control?

See AASB 11 para 7 and Appendix A. Joint control is 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. The key element of joint control is the sharing of control. In other words, there must be at least two investors who have shared control of the investee.

How does joint control differ from control as used in classifying subsidiaries?

There are three investor-investee relationships which are based on different levels of control: Relationship Parent - subsidiary Investor-associate Joint arrangement - investee

Level of control Dominant control Significant influence Joint control

24.2

Chapter 24: Joint arrangements

With a subsidiary there can be only one parent. With joint control there needs to be at least 2 entities that share control.

How does a joint venture differ from a joint operation?

The classification of a joint arrangement into either a joint operation or a joint venture depends on the rights and obligations of the parties to the arrangement. A joint operation is 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. Those parties are called joint operators. A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers. (AASB 11, paragraphs 15 and 16) 6.

What are the key steps in classifying a joint arrangement into joint ventures and joint operations?

The key element in the classification of a joint arrangement is the rights and obligations of the parties to the arrangement. For a joint operation the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint venture, the rights and obligations pertain to the net assets, that is the investment in net assets. See AASB 11 para 14. The assessment of the classification of a joint arrangement requires judgement. The assessment of the rights and obligations in an arrangement involves analysing four factors: 1. the structure of the arrangement 2. the legal form of the arrangement 3. the terms agreed to by the parties in the contractual arrangement, and 4. any other relevant facts and circumstances. See AASB 11 para 17 and figures 24.3 and 24.5 in the text.

How are joint ventures accounted for?

With a joint venture, the joint venturers have an interest in the investment in the joint arrangement. The accounting for this interest is done by application of the equity method in accordance with AASB 128 Investments in Associates and Joint Ventures. 8.

How are joint operations accounted for?

The key feature of a joint operation is that the joint operator has an interest in the individual assets and liabilities of the joint operation. In the situation where the joint operation produces an output which is distributed to the joint operators, the joint operator will receive a share of the output of the joint operation as well as be responsible for a share of the expenses of the operation that are not capitalised into the cost of the output. Hence each joint operator needs to recognise in itsown accounts: (a) its share of any jointly held assets (b) its share of any jointly held liabilities (c) its revenue from the sale of any output received from the joint operation (d) its share of any revenue from the sale of any product that is jointly constructed by the joint operators (e) its share of any expenses incurred by the joint operation (f) its expenses incurred in construction of a joint product

24.3

Chapter 24: Joint arrangements

CASE STUDIES Case study 1

Classification of joint arrangements

In its 2012 annual report (p. 122), Paladin Energy Ltd disclosed the following policy note: (p) Interests in Jointly Controlled Assets The Group has interests in joint ventures that are jointly controlled assets. A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. A jointly controlled asset involves use of assets and other resources of the venturers rather than establishment of a separate entity. The Group recognises its interest in jointly controlled assets by recognising its interest in the assets and the liabilities of the joint venture. The Group also recognises the expenses that it incurs and its share of the income that it earns from the sale of goods or services by jointly controlled assets. Required Discuss whether Paladin is likely to have interests in joint ventures or joint operations. The key phrase in this Note is “rather than establishment of a separate entity”. One of the key elements of classification is whether or not the joint arrangement is structured through a separate vehicle. If a joint arrangement is NOT structured through a separate vehicle then the arrangement is classified as a joint operation. In this example, Paladin is likely to have interests in joint operations. Paladin would recognise its share of any jointly controlled assets, liabilities revenues and expenses. Note that Paladin recognises the expenses it incurs and its share of the income from the sale of goods or services produced from the jointly controlled assets.

Case study 2

Classification of joint arrangements

In Note 1(b) of its annual report for the period ending 31 December 2012 (p. 148), Rio Tinto Ltd reported that it had interests in both jointly controlled entities and jointly controlled assets and that different accounting methods were used for these two items. The Note stated: Jointly controlled entities (JCEs): A JCE is a joint venture that involves the establishment of a corporation, partnership or other entity in which each venturer has a long term interest. JCEs are accounted for using the equity accounting method. Jointly controlled assets (JCAs): JCAs do not involve the establishment of a corporation, partnership or other entity. A JCA is a joint venture in which the venturers have joint control over the assets contributed to or acquired for the purposes of the joint venture. This includes situations where the participants derive benefit from the joint activity through a share of the production, rather than by receiving a share of the results of trading. The Group’s proportionate interest in the assets, liabilities, revenues, expenses and cash flows of JCAs are incorporated into the Group’s financial statements under the appropriate headings. Required Write a report explaining the classification of joint arrangements and the need for different accounting methods. Use the Rio Tinto Note to explain your answer.

24.4

Chapter 24: Joint arrangements

Having determined that a joint arrangement exists it is then necessary to classify it. There are two types of joint arrangements, namely joint ventures and joint operations: - a joint operation: an arrangement in which the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement. These parties are called joint operators. - a joint venture: the parties that have joint control have rights to the net assets of the arrangement. These parties are called joint venturers. The key element in the classification of a joint arrangement is the rights and obligations of the parties to the arrangement. For a joint operation the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint venture, the rights and obligations pertain to the net assets, that is the investment in net assets. The assessment of the classification of a joint arrangement is not straight-forward, it requires judgement. The assessment of the rights and obligations in an arrangement involves analysing four factors: 1. the structure of the arrangement 2. the legal form of the arrangement 3. the terms agreed to by the parties in the contractual arrangement, and 4. any other relevant facts and circumstances. Joint ventures are accounted for by using the equity method while a joint operation is accounted for by the recognition of the joint operator’s share of the assets, liabilities, revenues and expenses of the joint operation. With Rio Tinto, the JCEs involve the establishment of a separate entity i.e. the joint arrangement is structured through a separate vehicle. Note figure 29.2 in the text. The other 3 steps noted above then have to be analysed to see if a joint venture exists. Rio Tinto classifies JCEs as joint ventures and applies the equity method of accounting. With JCAs, there is no separate vehicle established. Hence these are joint operations. These are accounted for by recognition in the financial statements of the Group of the Group’s proportionate share of the assets, liabilities, revenues, expenses and cash flows of the JCAs.

Case study 3

Classification of a joint arrangement

Falls Ltd and Creek Ltd decided to jointly undertake the manufacture of an electric car. They formed Silver Ltd, which will manufacture the car. Falls Ltd and Creek Ltd provide the various parts for the manufacture of the car, which is assembled by Silver Ltd. Falls Ltd and Creek Ltd each hold 50% of the voting rights in Silver Ltd and receive 50% of the cars produced by Silver Ltd. Falls Ltd and Creek Ltd then sell the cars in their own geographic region. The constitution of Silver Ltd requires that the operations of the company must be in accordance with a business plan prepared annually, and to which both Falls Ltd and Creek Ltd both agree. Silver Ltd has six directors, with three being appointed by Falls Ltd and three by Creek Ltd. Required Evaluate whether a joint arrangement exists and how it should be classified. Does a joint arrangement exist? A joint arrangement is an arrangement of which two or more parties have joint control. The two main characteristics are: - the parties are bound by a contractual arrangement, and - the parties have joint control of the arrangement.

24.5

Chapter 24: Joint arrangements

The contractual arrangement in this case would be the constitution of Silver Ltd which would set out the rights and obligations of the owners, namely Falls Ltd and Creek Ltd. Falls Ltd and Creek Ltd each hold 50% of the voting rights in Silver Ltd. In the absence of any other agreement, this would mean that both parties would have to agree before any decision was made. Note the existence of the business plan which requires joint agreement, and note further the structure of the board – 3 directors from each company. Hence it would seem that joint control exists. Hence a joint arrangement exists. How should the joint arrangement be classified? Note firstly that a separate entity, namely Silver Ltd, is established. Hence it could be either a joint operation of a joint venture. However, the other factor to consider is that Silver Ltd produces cars. These cars, as output, are distributed to Falls Ltd and Creek Ltd who sell the cars in their own geographic regions. The profit is then generated by the owners of Silver Ltd subsequent to the receipt of the output from the joint arrangement. Silver Ltd does not make any profit or loss. It just produces output. The parties to the joint arrangement then have a right to substantially all the economic benefits of the assets held by the arrangement. Another feature of such an arrangement is that, as a result of the decision to supply the output of the joint arrangement to the parties themselves, there is no cash inflow to the joint arrangement from the sale of the product. The joint arrangement relies solely on the parties to the arrangement for the supply of cash to continue the operations of the arrangement as well as to pay for the liabilities incurred by the arrangement. The parties themselves are then responsible for the liabilities of the arrangement as the latter has no facility to be able to generate cash for the settlement of liabilities. These forms of arrangement are generally classified as joint operations.

Case study 4

Joint operators as managers

In its 2012 annual report (p. 177) Paladin Energy Ltd supplied the following information: The Angela Joint Venture is involved in the identification of and exploration for uranium resources on tenements to the south of Alice Springs in the Northern Territory, Australia. The joint venture is between Cameco Australia Pty Ltd (Cameco) 50% and Paladin NT Pty Ltd (PNT) 50% (PNT is 100% owned by Paladin) with Paladin as manager and operator of the joint venture. Required Discuss the possible accounting implications of one of the parties to the joint arrangement being appointed as manager of the joint operation, including the situation where that party receives a fee for the provision of such services. The appointment of one of the entities as manager does not affect the classification of the joint arrangement as it does not affect the joint control arrangement. The manager implements the jointly agreed upon decisions. Where one of the entities acts as manger it is common for the joint operation to pay a management fee to the joint operator for its management services.

24.6

Chapter 24: Joint arrangements

In accounting for these payments, the joint operation pays cash to a joint operator, with the cost of the service being capitalised into work in progress and inventory produced by the joint operation. For a joint operator that does not supply the service there are no accounting adjustments necessary because of the transaction. For the joint venturer that does supply the service, normally it would incur a cost to supply the service and earn a profit on the supply of that service. In accounting for its interest in the joint operation, the operator supplying the service has to consider the following: • As with supplying assets other than cash as part of the initial contribution, a joint operator cannot earn a profit on supplying services to itself. • As the joint operation capitalises the amount paid to the operator into the cost of work in progress and inventory, an adjustment is necessary to the inventory related accounts of that operator because the cost of these items to the operator supplying the services is less than that to the other operator(s).

Case study 5

Existence and classification of a joint arrangement

The Chinese mining company Changchun Mining Ltd and the Australian mining company Gold Rush Ltd have agreed to set up a separate company, Dragon Gold Ltd, to mine for gold in Australia. The Australian government has issued permits to the Australian company to mine for gold in specified areas of Australia. The companies have set up a joint operating agreement which contains the following provisions:  The assets and liabilities of Dragon Rush Ltd are those of that company and not of the parties owning shares in Dragon Rush Ltd.  Dragon Rush Ltd has a board of directors that will consist of six persons, three provided by each of Changchun Mining Ltd and Gold Rush Ltd. Each of these companies has a 50% ownership in Dragon Rush Ltd. For any resolution to be passed by the board, there has to be unanimous consent of all directors.  Gold Rush Ltd will provide the management team for Dragon Rush Ltd for which a management fee will be paid by Dragon Rush Ltd. However, all budget matters and work programs have to be approved by the board of Dragon Rush Ltd.  The rights and obligations arising from the exploration development and production activities of Dragon Rush Ltd are to be shared by all parties to the joint arrangement. In particular, the parties will share in the production obtained from the mining activities and all costs associated with the work undertaken.  If cash is required for ongoing mining activities, the board of Dragon Rush Ltd may make calls on the parties owning shares in that company. Required Discuss whether a joint arrangement exists and whether it should be classified as a joint venture or a joint operation. Does a joint arrangement exist? A joint arrangement is an arrangement of which two or more parties have joint control. The two main characteristics are: - the parties are bound by a contractual arrangement, and - the parties have joint control of the arrangement. In this example there is an agreement between Changchun Mining Ltd and Gold Rush Ltd. The Board of Directors has 6 members with 3 from each company. There has to be unanimous consent of all directors. There is then a joint arrangement. How is the joint arrangement classified?

24.7

Chapter 24: Joint arrangements

The parties carry out the joint arrangement through a separate vehicle whose legal form confers separation between the parties and the separate vehicle. However, the parties have been able to reverse the initial assessment of their rights and obligations arising from the legal form of the separate vehicle in which the arrangement is conducted. They have done this by agreeing terms in the joint arrangement agreement that entitle them to rights to the assets (eg exploration and development permits, production, and any other assets arising from the activities) and obligations for the liabilities (eg all costs and obligations arising from the work programmes) that are held in Dragon Gold Ltd. The joint arrangement is thus classified as a joint operation. Both Changchun Mining Ltd and Gold Rush Ltd would recognise in their financial statements their own share of the assets and of any liabilities resulting from the arrangement on the basis of their agreed participating interest. On that basis, each party also recognises its share of the revenue (from the sale of their share of the production) and its share of the expenses.

Case study 6

Classification of a joint arrangement

Two smaller banks that operate in Australia are the Ballarat Bank and the St Martins Bank. These have in the past primarily offered domestic banking services to their customers. However in recent times, these customers have made increasing demands for international currency transactions and access to offshore banking arrangements. As both banks individually are not prepared to undertake the risks associated with international operations on their own, they have decided to join together to provide these services to their customers. To this end, they have formed the Overseas Bank. This bank is regarded as a separate vehicle in its own right, with the assets and liabilities of the Overseas Bank being those of the bank itself. The Ballarat Bank and St Martins bank will each hold a 50% interest in the Overseas Bank. These two banks have signed an agreement such that all major decisions in relation to the Overseas Bank require the unanimous agreement of the two banks. The board of the Overseas Bank will consist of an equal number of representatives of these two banks. The Ballarat Bank and the St Martins bank have agreed to provide initial funding to establish the Overseas Bank and have also agreed on a mechanism for further cash inflows if required. Required Discuss whether a joint arrangement exists and how it should be classified. The joint arrangement is carried out through a separate vehicle – the Overseas Bank - whose legal form confers separation between the parties and the separate vehicle. The terms of the contractual arrangement do not specify that the parties have rights to the assets, or obligations for the liabilities, of the Overseas Bank, but it establishes that the parties have rights to the net assets of the Overseas Bank. The commitment by the parties to provide support if the Overseas Bank is not able to comply with the applicable legislation and banking regulations is not by itself a determinant that the parties have an obligation for the liabilities of the Overseas Bank. There are no other facts and circumstances that indicate that the parties have rights to substantially all the economic benefits of the assets of the Overseas Bank and that the parties have an obligation for the liabilities of the Overseas Bank. The joint arrangement is a joint venture.

24.8

Chapter 24: Joint arrangements

Both the Ballarat Bank and the St Martins Bank recognise their rights to the net assets of the Overseas Bank as investments and account for them using the equity method.

Case study 7

Accounting for an asset used by a number of companies

Raby Ltd and Bay Ltd are companies that have newly discovered oil wells in a Middle-Eastern country. There is some distance to the nearest port and, rather than build separate pipelines, they have agreed to jointly build a pipeline to the port and share the use of the pipeline for transporting oil. The management of the pipeline is conducted in accordance with an agreement between Raby Ltd and Bay Ltd which requires unanimous agreement in relation to such issues as maintenance and future expansion or contraction of the pipeline. Kalgoorlie Ltd also has oil wells in the area and has agreed to use any excess capacity of the pipeline. Required Discuss how you would account for the pipeline. In this circumstance there is a jointly controlled asset, namely the pipeline. As there is no separate vehicle established the joint arrangement is classified as a joint operation. Both Raby Ltd and Bay Ltd will recognise a share of the jointly controlled asset in their records. These two companies will also recognise any expenses associated with the operation of the pipeline such as maintenance costs. If the pipeline is expanded then any costs associated with this would be capitalised equally into the pipeline asset in the records of each of the companies. Any revenues received from Kalgoorlie Ltd would be recognised equally in the records of the two joint operators.

24.9

Chapter 24: Joint arrangements

PRACTICE QUESTIONS Question 24.1

Contributions of cash

On 1 July 2016, Denmark Ltd and Walpole Ltd agreed to a joint operation that would be involved in the production of fertilizer products. The contractual arrangement required both parties to invest $300 000 in the joint operation with each party having a 50% interest in the joint operation. Under the contractual arrangement the joint operation would distribute the output equally to each venturer. At 30 July 2017 the joint operation reported the following information: Statement of Financial Position (partial) Cash $70 000 Accounts payable Raw materials 40 000 Accrued wages Inventory (undistributed) 20 000 Work in progress 40 000 Machinery 250 000 Accumulated depreciation (50 000) $370 000 Cash Receipts and Payments Payments Contributions Purchase of raw materials Wages Purchase of equipment (2 July 2016) Other expenses

$50 000 20 000

$70 000

Receipts $600 000

$ 80 000 120 000 250 000 80 000 $530 000

$600 000

Costs Incurred Wages Raw materials Overheads including depreciation

$140 000 90 000 130 000 360 000 (320 000) $40 000

Cost of inventory Work in progress at 31 July 2017

Required Prepare the journal entries in the records of Denmark Ltd in relation to the joint operation for the year ending 30 June 2017.

1 July 2016 Cash in JO Dr Cash Cr (Investment in JO with Walpole Ltd)

300 000 300 000

30 June 2017 Inventory Raw materials in JO Inventory in JO Work in progress in JO Machinery in JO

Dr Dr Dr Dr Dr

150 000 20 000 10 000 20 000 125 000

(300 000/2) (40 000/2) (20 000/2) (40 000/2) (250 000/2)

24.10

Chapter 24: Joint arrangements

Accumulated depreciation – machinery – JO Accounts payable in JO Accrued wages in JO Cash in JO

Cr Cr Cr Cr

25 000 25 000 10 000 265 000

(50 000/2) (50 000/2) (20 000/2) (300 000 – ½ x 70 000))

24.11

Chapter 24: Joint arrangements

Question 24.2

Contribution of plant

On 1 July 2016, Tully Ltd and Cooktown Ltd signed a contractual agreement to form a joint operation for the manufacture of kitchen products. The agreement provided that Cooktown Ltd would contribute $240 000 in cash while Tully Ltd would provide $40 000 in cash and manufacturing equipment currently held by Tully Ltd that had a fair value of $200 000. The equipment was currently recorded by Tully Ltd at a carrying amount of $180 000, net of accumulated depreciation of $30 000. The agreement provided that each operator would receive half of the output of the joint operation. Depreciation on equipment is charged at 20% p.a. on cost, based on the expected pattern of use in the joint operation. Financial information provided by the joint operation at 30 June 2017 was as follows. Statement of Financial Position (partial) Cash $56 000 Accounts payable Raw materials 32 000 Accrued wages Inventory (undistributed) 16 000 Loan Work in progress 32 000 Equipment 400 000 Accumulated depreciation (80 000) $456 000 Cash Receipts and Payments Payments Contributions Loan Purchase of raw materials Wages Purchase of equipment (2 July 2016) Other expenses

$ 64 000 96 000 200 000 64 000 $424 000

$40 000 16 000 200 000

___ __ $256 000

Receipts $280 000 200 000

$480 000

Costs Incurred Wages Raw materials Overheads including depreciation on equipment Cost of inventory Work in progress at 31 July 2017

$112 000 72 000 144 000 328 000 (296 000) $32 000

Required Prepare the journal entries in the records of Tully Ltd in relation to the joint operation for the year ending 30 June 2017. 1 July 2016 Cash in JO Plant in JO Cash Gain on sale of equipment Plant Accumulated depreciation – plant (Investment in JO with Cooktown Ltd)

Dr Cr Cr Cr Cr Dr

140 000 90 000

(1/2[240 000 + 40 000]) (1/2 x 180 000) 40 000 10 000 210 000

(1/2 x 20 000)

30 000

24.12

Chapter 24: Joint arrangements

30 June 2017 Inventory Raw materials in JO Inventory in JO Work in progress in JO Equipment in JO Accumulated depreciation – equipment – JO Accounts payable in JO Accrued wages in JO Loan Cash in JO

Dr Dr Dr Dr Dr Cr Cr Cr Cr Cr

Working Depreciation charged on contributed asset Depreciation on cost to Tully Ltd Adjustment

Work in progress in JO Inventory in JO Inventory

140 000 16 000 8 000 16 000 100 000

(280 000/2) (32 000/2) (16 000/2) (32 000/2) (200 000/2) 40 000 20 000 8 000 100 000 112 000

$40 000 $36 000 $4 000

20% x $200 000 20% x $180 000

Share of $4000 $390 195 3 415 4 000

$16 000 8 000 140 000 164 000

Accumulated depreciation – equipment – JO Work in progress in JO Inventory in JO Inventory

Dr Cr Cr Cr

(80 000/2) (40 000/2) (16 000/2) (200 000/2) (140 000 – ½ x 56 000))

4 000 390 195 3 415

24.13

Chapter 24: Joint arrangements

Question 24.3

Management fees supplied by one of the joint operators

On 1 July 2016, Broome Ltd and Kalbarri Ltd agreed to a joint operation that would be involved in the production of furniture. The contractual arrangement required both parties to invest $270 000 cash in the joint operation with each party having a 50% interest in the joint operation. Under the contractual arrangement the joint operation would distribute the output equally to each venturer. The joint operation agreed to pay Broome Ltd $30 000 p.a. to supply management services to the joint operation. The cost to Broome Ltd to supply these services is $24 000. At 30 July 2017 the joint operation reported the following information: Statement of Financial Position (partial) Cash $33 000 Accounts payable Raw materials 36 000 Accrued wages Inventory (undistributed) 20 000 Work in progress 54 000 Machinery 225 000 Accumulated depreciation (45 000) $323 000

$45 000 18 000

___ __ $63 000

Cash Receipts and Payments Payments Contributions Purchase of raw materials Wages Purchase of equipment (2 July 2016) Management services (supplied by Broome Ltd) Other expenses

Costs Incurred Wages Raw materials Management services Overheads including depreciation

$ 72 000 108 000 225 000 30 000 72 000 $507 000

Receipts $540 000

$540 000

$126 000 81 000 30 000 117 000 354 000 (300 000) $54 000

Cost of inventory Work in progress at 31 July 2017

Required Prepare the journal entries in the records of Broome Ltd in relation to the joint operation for the year ending 30 June 2017. 1 July 2016 Cash in JO Cash (Investment in JO with Kalbarri Ltd)

Dr Cr

270 000

Dr Dr

140 000 18 000

270 000

30 June 2017 Inventory Raw materials in JO

(280 000/2) (36 000/2)

24.14

Chapter 24: Joint arrangements

Inventory in JO Work in progress in JO Machinery in JO Accumulated depreciation – equipment – JO Accounts payable in JO Accrued wages in JO Cash in JO

Dr Dr Dr

10 000 27 000 112 500

Management services expense Cash (Cost of supplying services to JO)

Dr Cr

24 000

Dr Management services revenue Cr (Receipt from JO for supply of services)

30 000

Management services revenue Management services expense (Elimination of expense of supply of services to self: ½ x $24 000)

12 000

Cr Cr Cr Cr

Cash

Dr Cr

(20 000/2) (54 000/2) (225 000/2) 22 500 22 500 9 000 253 500

(45 000/2) (45 000/2) (18 000/2) (270 000 – ½ x 33 000))

24 000

30 000

12 000

The profit element on supplying services to the JO is $6000 ie $30 000 less $24 000. The profit to itself ie $3000 is proportionately adjusted across inventory-related assets: Share of $3000 Work in progress in JO $27 000 $458 Inventory in JO 10 000 169 Inventory 140 000 2 373 177 000 3 000 Management services revenue Work in progress in JO Inventory in JO Inventory

Dr Cr Cr Cr

3 000 458 169 2 373

24.15

Chapter 24: Joint arrangements

Question 24.4

Sharing of output

On 1 July 2016, Darwin Ltd entered into a joint agreement with Broome Ltd to form an unincorporated entity to produce a new type of widget. It was agreed that each party to the agreement would share the output equally. Darwin Ltd’s initial contribution consisted of $2 000 000 cash and Broome Ltd contributed machinery that was recorded in the records of Broome Ltd at $1 900 000. During the first year of operation both parties contributed a further $3 000 000 each. On 30 June 2017, the venture manager provided the following statements: Costs Incurred For the year ended 30 June 2017 $1 840 000 2 800 000 2 200 000 6 840 000 (4 840 000) $ 2 000 000

Wages Supplies Overheads Cost of inventory Work in progress at 30 June 2017

Receipts and Payments for year ended 30 June 2017 Receipts: Original contributions Additional contributions Payments: Machinery (2/7/16) Wages Supplies Overheads Operating expenses Closing cash balance

800 000 1 800 000 3 000 000 2 100 000 200 000 $

2 000 000 6 000 000 8 000 000

7 900 000 100 000

Assets and Liabilities at 30 June 2017 Assets Cash Machinery Supplies Work in progress Total assets Liabilities Accrued wages Creditors Total liabilities Net assets

100 000 2 800 000 400 000 2 000 000 $ 5 300 000 $

40 000 300 000 $ 340 000 $ 4 960 000

Each joint operator depreciates machinery at 20% p.a. on cost in its own records. Required A. Prepare the journal entries in the records of Darwin Ltd and Broome Ltd in relation to the joint operation. B. Prepare the journal entries in the records of Broome Ltd assuming that the joint operation,

24.16

Chapter 24: Joint arrangements

not the operators, had depreciated the machinery and included that expense in the cost of inventory transferred.

PART A JOURNAL ENTRIES IN RECORDS OF DARWIN LTD $’000 1 July 2016 Cash in J0 Machinery in J0 Cash

Dr Dr Cr

1 000 1 000

Cash in J0 Cash

Dr Cr

3 000

Machinery in J0 Supplies in J0 Work in progress in J0 Inventory Operating expenses Accrued wages in J0 Creditors in J0 Cash in J0

Dr Dr Dr Dr Dr Cr Cr Cr

400 200 1 000 2 420 100

Inventory – depreciation expense Accum. depreciation in JO

Dr Cr

280

$’000

(2 000/2) (2 000/2) 2 000

3 000

30 June 2017

20 150 3 950

(2800/2 – 1 000) (400/2) (2 000/2) (4 840/2) (200/2) (40/2) (300/2) (100/2 – 4 000) (20% x 1 400)

280

JOURNAL ENTRIES IN THE RECORDS OF BROOME LTD $’000

$’000

1 July 2016 Cash in JO Machinery in JO Gain on machinery sold Machinery

Dr Dr Cr Cr

1 000 950

Cash in JO Cash

Dr Cr

3 000

Dr Dr Dr Dr Dr

400 200 1 000 2 420 100

50 1 900

(2 000/2) (1 900/2) (100/2)

3 000

30 June 2017 Machinery in JO Supplies in JO Work in progress in JO Inventory Operating expenses

(2800/2 – 1 000) (400/2) (2 000/2) (4 840/2) (200/2)

24.17

Chapter 24: Joint arrangements

Accrued wages in JO Creditors in JO Cash in JO

Cr Cr Cr

Inventory – depreciation expense Accum. depreciation in JO

Dr Cr

20 150 3 950 270

(40/2) (300/2) (100/2 – 4 000) (20%(400 + 950)

270

PART 2 JOURNAL ENTRIES IN THE RECORDS OF BROOME LTD $’000 $’000 1 July 2016 Cash in JO Machinery in JO Gain on machinery sold Machinery

Dr Dr Cr Cr

1 000 950

Cash in JV Cash

Dr Cr

3 000

Machinery in JO Supplies in JO Work in progress in JO Inventory

Dr Dr Dr Dr

400 200 1 000 2 700

Other expenses Accum depreciation in JO Accrued wages in JO Creditors in JO Cash in JO

Dr Cr Cr Cr Cr

100

50 1 900

(2 000/2) (1 900/2) (100/2)

3 000

30 June 2017

280 20 150 3 950

Accum depreciation in JO Dr 10 Inventory Cr Work in progress in JO Cr (Adjustment for depreciation being based on carrying amount rather than fair value) Working Inventory Work in Progress in JO

2 700 1 000 3 700

73% 27%

(2800/2 – 1 000) (400/2) (2 000/2) (4 840/2) + 280 depn) (200/2) (1/2 x 20% x 2800) (40/2) (300/2) (100/2 – 4 000)

7 3

7 3 10

24.18

Chapter 24: Joint arrangements

Question 24.5

Unincorporated joint operation

On 1 July 2015, Esperance Ltd entered into a joint agreement with Walpole Ltd to establish an unincorporated joint operation to manufacture timber-felling equipment. It was agreed that the output of the operation would be shared: Esperance Ltd 60% and Walpole Ltd 40%. To commence the operations, contributions were as follows: • Esperance Ltd: cash of $1 100 000 and equipment having a carrying amount of $300 000 and a fair value of $400 000 • Walpole Ltd: cash of $600 000 and plant having a carrying amount of $450 000 and a fair value of $400 000. Walpole Ltd revalued the plant it contributed to the joint operation to fair value prior to its transfer to the joint operation. Plant and equipment was depreciated (to the nearest month) in the joint operation’s books at 20% p.a. on cost. During December 2015, an additional $1 000 000 cash was contributed by the operators in the same proportion as their initial contributions. The following information, in relation to the joint operations for the year ended 30 June 2016, was provided by the operation manager: (a)

Costs incurred for the year ended 30 June 2016 Wages Raw materials Overheads Depreciation

$ 400 000 1 200 000 650 000 205 000 2 455 000 2 005 000 $ 450 000

Less: Cost of inventory Work in progress at 30 June 2016 (b)

Receipts and payments for year ended 30 June 2016 Payments Contributions Plant (3 January 2016) Wages Accounts payable Overhead costs Operating expenses

(c)

Receipts $2 700 000

$ 450 000 350 000 980 000 610 000 40 000 $2 430 000 $2 700 000

Assets and liabilities at 30 June 2016.

Cash Raw materials Work in progress Inventory Plant and equipment Accumulated depreciation — plant and equipment Accounts payable Accrued expenses — wages and overheads

Dr Cr $ 270 000 100 000 450 000 255 000 1 250 000 $205 000 320 000 90 000

Required Prepare the journal entries in the records of Esperance Ltd in relation to the joint operation for the year ended 30 June 2016. (Round all amounts to the nearest dollar and show all relevant workings.)

24.19

Chapter 24: Joint arrangements

Journal Entries - Accounts of Esperence Ltd (60% Interest) $'000 $'000 1 July 2015 Cash in JO Plant & equip in JO Gain on equipment sold Equipment Cash

Dr Dr Cr Cr Cr

1 020 420

Dr Cr

600

Dr Dr Dr Dr Dr Dr

60 270 153 1 050 270 24

40 300 1 100

(1700 x .6) ((400 + 300) x .6) (100 x .4)

December 2015 Cash in JO Cash

600

30 June 2016 Raw material in JO Work in progress in JO Inventory in JO Inventory Plant & equipment in JO Other expenses in JO Accum depreciation Plant & equip in JO Accounts payable in JO Accrued expenses in JO Cash in JO Accumulated depreciation Plant & equip in JO Inventory in JO Inventory Work in progress in JO

Cr Cr Cr Cr

Dr Cr Cr Cr

(100 x .6) (450 x .6) (255 x .6) (1 750 x .6) (450 x .6) (40 x .6) 123 192 54 1 458

(205 x .6) (320 x .6) (90 x .6) (1620 - (270 x .6))

12 1 9 2

Depreciation based on 60% ($400 000 - $300 000) requires a $12 000 adjustment to depreciation expense which must be allocated across all forms of inventory which include the depreciation expense:

Work in progress Inventory in JO Inventory

Total Value 270 153 1 050 1 473

% 18 10 71

Allocation 2 1 9

24.20

Chapter 24: Joint arrangements

Question 24.6

Operators share output

Brisbane Ltd enters into an arrangement with another operator, Ipswich Ltd, to establish an unincorporated joint operation to produce a drug that assists both hay fever sufferers and those with sinus problems. To produce the drug requires a combination of the technical and pharmaceutical knowledge of both companies. Each company will receive an equal share of the output of the drug, which they will retail through their own preferred outlets, potentially under different names. Brisbane Ltd agrees to manage the project for a fee of $100 000 p.a. Brisbane Ltd estimates that it will cost $80 000 to provide the service. The management fee is capitalised into the cost of inventory produced. The operation commences on 1 January 2017, with each operator providing $1 million cash. At the end of the first year, the statement of financial position of the joint operation showed: Assets Vehicles Accumulated depreciation Equipment Accumulated depreciation Inventory Work in progress Materials Total assets Liabilities Provisions Payables Total liabilities Net assets Operators’ equity Initial contributions Inventory delivered General administration costs Total equity

200 000 (50 000) 820 000 (60 000) 80 000 320 000 210 000 $ 1 520 000 $

80 000 40 000 $ 120 000 $ 1 400 000 2 000 000 (400 000) (200 000) $ 1 400 000

Required A. Prepare the journal entries in the records of Brisbane Ltd during 2017. B. What differences would occur if the management fee paid to Brisbane Ltd were treated as general administration costs? At 1 January 2017: Cash in JO Cash

Dr Cr

1 000 000 1 000 000

During the period in relation to the supply of management services: Cash

Dr Cr

100 000

Revenue

Dr Cr

80 000

Cash

Dr Cr

100 000

Expenses

At 31 December 2017: Vehicles in JO Accumulated depreciation in JO

100 000

80 000

25 000

24.21

Chapter 24: Joint arrangements

Equipment in JO Accumulated depreciation in JO Inventory in JO Work-in-progress in JO Materials in JO Provisions in JO Payables in JO Inventory Expenses Cash in JO

Dr Cr Dr Dr Dr Cr Cr Dr Dr Cr

410 000

Dr Cr

40 000

Dr Cr Cr Cr

10 000

30 000 40 000 160 000 105 000 40 000 20 000 200 000 100 000 1 000 000

(Share of assets and liabilities of JO) Revenue Expenses (1/2 x cost of providing services) Revenue Inventory Inventory in JO Work-in-progress in JO (Elimination of profit element)

40 000

5 000 1 000 4 000

Workings: Inventory Inventory in JO Work-in-progress in JO

200 000 40 000 160 000 400 000

½ 1/10 2/5

5 000 1 000 4 000 10 000

If the management fee is regarded as general administration expense by the JO instead of being capitalised into inventory, then instead of the two revenue adjustments shown under Part 1 above, the journal entry in the venturer is: Revenue Expense

Dr Cr

50 000 50 000

This eliminates the revenue in relation to itself as well as the expense brought across from the JO.

24.22

Chapter 24: Joint arrangements

Question 24.7

Share of output

During 2016, a group of academics were undertaking a bonding exercise in the Snowy Mountains. While tracking through the hills, they came across a spring of pure sweet water. They formed a company called Albany Ltd and decided to establish the extent of their find. In the process they expended funds, obtained from teaching overseas students, on equipment and employing geologists and mining experts. The general conclusion was that the find was significant and a commercially profitable business selling mineral water was feasible. As they were academics, and had no practical experience in the real world of big business, they decided to establish a joint operation with Denmark Ltd who would establish a factory to produce bottled water. The joint operation agreement was signed on 1 January 2017, with Albany Ltd and Denmark Ltd having a 50% share in the unincorporated joint operation. The initial contributions by the two operators were as follows: Albany Ltd: Capitalised expenses Equipment Cash Denmark Ltd: Cash

$ 800 000 800 000 2 400 000 $4 000 000

The capitalised expenses were recorded in the books of Albany Ltd at $320 000, while the equipment was recorded at a carrying amount of $640 000. In order to supply the cash, Albany Ltd borrowed $800 000 of its required contribution. It is expected that the reserves of water will be depleted within 10 years, and the equipment is expected to have a similar useful life. On 1 June 2017, the joint operation was ready to start producing bottles of water. The joint operation’s accounts at 30 June 2018 contained the following information: Statement of Financial Position (extract) 2017 Work in progress Capitalised costs Plant and equipment Cash Accounts payable – plant Accrued expenses – wages etc.

$ $

800 000 8 160 000 80 000 (240 000) (160 000)

2018 200 000 800 000 7 760 000 240 000 (800 000) (200 000)

Cash Receipts and Payments (extract)

Materials and supplies Administration Wages Accounts payable – plant Contributions from joint operators

2018 Payments $ 480 000 160 000 560 000 960 000

Receipts

$ 2 000 000

The output of the first year’s operations was distributed equally to the joint operators. Production in the first year was estimated to be 15% of the reserves. At 30 June 2018, Albany Ltd held 10% of its share of output in inventory, having sold the rest to its customers for $2 000 000. Expenses of the joint operation incurred up to 30 June 2018 were allocated to the operators. Because of some damage to the environment caused by the establishment of the pumping station to extract the water, there is a potential restoration cost to be incurred at closure of the joint operation. Whether this will be required will depend on the result of current legal inquiries.

24.23

Chapter 24: Joint arrangements

Required Prepare the journal entries in the records of Albany Ltd for the periods ending 30 June 2017 and 2018. Journal entries in the accounts of Albany Ltd Six months ended 30 June 2017 1 January 2017 $'000 Capitalised Expenses in J0 Equipment in JO Cash in JO Gain on equipment sold Gain on capitalised expenses sold Cash Equipment Capitalised expenses

Dr Dr Dr Cr

Cash

Dr Cr

800

Dr Dr Cr Cr Cr

100 3 480

Cash in JO Cash

Dr Cr

1 000

Inventory Plant & equipment in JO Accounts payable in JO Accrued expenses in JO Administration expenses Cash in JO Work-in-progress in JO

Dr Dr Dr Dr Dr Cr Cr

600 200 280 20 80

Inventory Accum amortisation Capitalised expenses in JO Accum depreciation Plant & equipment in JO

624

Bank loan

$'000

160 320 3 200 80

Cr Cr Cr Cr

240 2 400 640 320

(320/2) (640/2) ((2 400 + 4 000)/2) (160/2) (480/2)

800

30 June 2017 Work-in-progress Plant & equipment in JO Cash in JO Accounts payable in JO Accrued expenses in JO

3 080 400 100

(200/2) ((7760 - 800/2) ((240 - 6 400)/2) (800/2) (200/2)

Year ended 30 June 2018 (2 000/2) 1 000

1 080 100

600

((8 160 - 7 760/2) ((800 - 240)/2) ((200- 160)/2) (160/2) (80/2 – 1 120)

Calculations

24.24

Chapter 24: Joint arrangements

Cost of Inventory Work-in-progress Materials and supplies Wages (560 - 200 + 160)

200 480 520 1 200 x 50% = 600

Amortisation of capitalised expenses: Albany Ltd 15% x $160 = $ 24 Depreciation of plant & equipment: Albany Ltd Balance at 1 January 1917 Acquisitions to 30 June 1917 Acquisitions to 30 June 1918

$320 x 15% = $48 $3 480 x 15% = $522 $200 x 15% = $30 Total depreciation = $ 600

Cost of sales Inventory (90% (600 + 624))

Dr Cr

1 101

Cash/receivables Sales revenue

Dr Cr

2 000

1 101

2 000

Note: the balance of inventory in Albany Ltd is 10% (600 + 624) = 122.4 609) = 120.9

24.25

Chapter 24: Joint arrangements

Question 24.8

Operators share output

On 1 July 2017, Toowoomba Ltd entered into a joint operation agreement with Miles Ltd to manufacture stevedoring equipment. It was agreed that each party to the agreement would share the output equally. To commence the operation, contributions were as follows:  Toowoomba Ltd: cash of $2 000 000 and equipment having a $400 000 carrying amount and a fair value of $600 000  Miles Ltd: cash of $1 800 000 and plant having a carrying amount of $900 000 and a fair value of $800 000. Miles Ltd revalued the plant it contributed to the joint operation prior to its transfer to the joint operation. Plant and equipment is depreciated (to the nearest month) in the joint operation’s books at 20% p.a. on cost. During December 2017, both parties contributed an additional $1 500 000 cash. The following information, in relation to the joint operation’s operations for the year ended 30 June 2018, was provided by the operation manager. (a) Costs incurred for the year ended 30 June 2018 $

Wages Raw materials Overheads Depreciation Less: Cost of inventory Work in progress at 30 June 2018

1 200 000 2 150 000 1 860 000 470 000 5 680 000 2 580 000 3 100 000

(b) Receipts and payments for the year ended 30 June 2018

Payments Contributions Plant (10 July 2017) Wages Accounts payable Overhead costs Operating expenses

950 000 1 150 000 1 980 000 1 810 000 440 000 $ 6 330 000

Receipts $ 6 800 000

________ $ 6 800 000

Cash Raw materials Work in progress Inventory Plant and equipment Accumulated depreciation equipment Accounts payable Accrued expenses

–

plant

Dr 470 000 360 000 3 100 000 580 000 2 350 000

and

$ 470 000 530 000 100 000

24.26

Chapter 24: Joint arrangements

Required Prepare the journal entries in the records of Toowoomba Ltd and Miles Ltd in relation to the joint operation for the year ended 30 June 2018.

Journal entries in records of Toowoomba Ltd $'000 1 July 2017 Cash in JO Plant & equipment in JO Gain on plant & equipment sold Plant & equipment Cash

Dr Dr

$'000

1 900 600

Cr Cr Cr

(3 800/2) (800/2 + 400/2) 100 400 2 000

(200/2)

December 2017 Cash in JO Cash

Dr Cr

1 500

Raw material in JO Work-in-progress in JO Inventory in JO Inventory Plant & equipment in JO Other expenses in JO Accum. depreciation in JO Accounts payable in JO Accrued expenses in JO Cash in JO

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

180 1 550 290 1 000 475 220

Accum. depreciation in JO Inventory in JO Work-in-progress in JO Inventory

Dr Cr Cr Cr

1 500

30 June 2018

235 265 50 3 165

(360/2) (3 100/2) (580/2) (2 000/2) (950/2) (440/2) (470/2) (530/2) (100/2) (3 400 – 470/2)

2 11 7

Depreciation based on 50% ($600 000 - $400 000) requires a $20 000 adjustment to depreciation expense which must be allocated across all forms of inventory which include the depreciation cost. Calculation Total Value % Allocation Work-in-progress 1 550 54.6 10 920 Inventory in JO 290 10.2 2 040 Inventory 1 000 35.2 7 040 2 840 20 000

Journal entries in the accounts of Miles Ltd $'000 1 July 2017 Loss on revaluation of plant Plant

Dr Cr

$'000

100 100

24.27

Chapter 24: Joint arrangements

Cash in JO Plant & equipment in JO Plant & equipment Cash

Dr Dr Cr Cr

1 900 700

Dr Cr

1 500

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

180 1 550 290 1 000 475 220

(3 800/2) (800/2 + 600/2) 800 1 800

December 2017 Cash in JO Cash

1 500

30 June 2018 Raw material in JO Work-in-progress in JO Inventory in JO Inventory Plant & equipment in JO Other expenses in JO Accum depreciation in JO Accounts payable in JO Accrued expenses in JO Cash in JO

235 265 50 3 165

(360/2) (3 100/2) (580/2) (2 000/2) (950/2) (440/2) (470/2) (530/2) (100/2) (3 400 – 470/2)

24.28

Chapter 24: Joint arrangements

Question 24.9

Unincorporated joint operation managed by one of the operators

During 2015, discussions took place between Broken Bay Ltd, a company concerned with the design of specialised tools and machines, and two companies, Armidale Ltd and Newcastle Ltd, which could potentially assist in the manufacture of a new tool. The new tool is called SmartTool and is to be used in the making of high grade mining instruments. On 1 July 2016, the three companies agreed to form an unincorporated joint operation to achieve this purpose. It was agreed that the relative interests in the joint operation would be: Broken Bay Ltd Armidale Ltd Newcastle Ltd

50% 25% 25%

It was further agreed that Newcastle Ltd would undertake a management role in relation to the new operation, being responsible for operating decisions and for record keeping. Newcastle Ltd would be paid a management fee by the joint operation of $20 000. In establishing the joint operation, the various parties agreed to provide the following assets as their initial contribution: • Broken Bay Ltd was to provide the patent to SmartTool, which was being recorded by Broken Bay Ltd at a capitalised development cost of $1 400 000. The operators agreed that this asset had a fair value of $2 000 000, with an expected useful life of 10 years. • Armidale Ltd was to provide cash of $1 000 000. • Newcastle Ltd was to provide the basic plant and equipment to manufacture the new tool. The plant and equipment was recorded in the books of Newcastle Ltd at $600 000, but the operators agreed that it had a fair value of $1 000 000. The plant and equipment was estimated to have a further useful life of 5 years. The output of the joint operation was distributed to each of the operators in proportion to their agreed interests during the 2016–17 period. By 30 June 2017, Newcastle Ltd had sold 80% of the output received from the joint operation for $300 000. The joint operation had not paid the management fee to Newcastle Ltd by 30 June 2017. Information from the financial statements of the joint operation as at 30 June 2017 is as follows: Assets Cash Plant and equipment Accumulated depreciation Patent Accumulated depreciation Office equipment Accumulated depreciation Work in progress Liabilities Creditors – for materials Accruals – salaries etc, including the management fee Cash payments Salaries Materials Operating expenses

40 000 1 080 000 (208 000) 2 000 000 (200 000) 88 000 (8 800) 40 000

136 000 112 000

220 000 488 000 84 000

Required A. Prepare the journal entries in the records of Broken Bay Ltd and Armidale Ltd at the commencement of the joint operation.

24.29

Chapter 24: Joint arrangements

Prepare the journal entries in the records of Newcastle Ltd for the financial year ending 30 June 2017.

Journal entries – entries in the accounts of Broken Bay Ltd and Armidale Ltd at 1 July 2016

BROKEN BAY LTD (50%): Patent in JO Cash in JO Plant & equipment in JO Gain on patent sold Capitalised R&D costs

Dr Dr Dr Cr Cr

$'000 700 500 500

$'000

300 1 400

(1400/2) (1 000/2) (1 000/2) (600/2)

ARMIDALE LTD (25%): $'000 Patent in JO Cash in JO Plant & equipment in JO Cash

Dr Dr Dr Cr

500 250 250

Dr Dr Dr

(2 000/4) (1 000/4) (1 000/4) 1 000

B. Journal entries in the accounts of Newcastle Ltd $'000 1 July 2016 Patent in JO Cash in JO Plant & equipment in JO Gain on plant & equipment sold Plant & equipment

$'000

500 250 150

(2 000/4) (1 000/4) (600/4)

Cr Cr

300 600

(3/4 x 400)

30 June 2017 Working: Cost of output Cash expenses Accruals Creditors

792 112 136 1 040 416.8 1 456.8 40.0 1 416.8

Depreciation Work in progress Cost of inventory

Plant & equipment in JO Accum depn - P&E in JO Accum depn - patent in JO Office equipment in JO Accum depn - OE in JO Work in progress in JO

Dr Cr Cr Dr Cr Dr

20 52 50 22 2.2 10

((1 080 - 1 000)/4) (208/4) (200/4) (88/4) (8.8/4) (40/4)

24.30

Chapter 24: Joint arrangements

Inventory Cash in JO Creditors in JO Accruals in JO

Dr Cr Cr Cr

354.2 240 34 28

(1 416.8/4) ((40 - 1 000)/4) (136/4) (112/4)

Accum depn - P&E in JO Dr 20 Inventory Cr 19.5 Work in progress in JO Cr 0.5 (Adjustment in depreciation is $20 = 1/5 x 1/4 x ($1 000 - $600) Allocation to inventory is $19.5 = 354.2/364.2 x $20)

Cash/Accounts receivable Sales Revenue

Dr Cr

300

Cost of sales Inventory (80% (354.2 –19.5 – 5.0))

Dr Cr

263.80

Management fee receivable Fee Revenue

Dr Cr

Cost of supplying service Cash

Dr Cr

Fee revenue Cost of supplying service (1/4 x 20)

Dr Cr

Accruals in JO Management fee receivable

Dr Cr

300

263.80

24.31

Chapter 24: Joint arrangements

Question 24.10

Operators share output

After prospecting unsuccessfully for a number of years for gold, in November 2017 Greens Pool Ltd finally found an economically viable deposit. Realising that it did not have sufficient expertise to operate a gold mine successfully, Greens Pool Ltd formed an unincorporated joint operation with Apollo Bay Ltd, agreeing to share the output of the mine equally. It was agreed that the two operators would initially contribute the following assets: Greens Pool Ltd: Capitalised exploration costs, including permits licences, and mining rights, currently recorded by Greens Pool Ltd at $200 000 Cash Apollo Bay Ltd: Cash

$ 800 000 700 000 1 500 000

The joint operation commenced on 1 January 2018. By 31 December 2018, the mine had been operating successfully. It was reliably estimated at the commencement of the project that the mine had expected reserves of 100 000 tonnes. In the first year following commencement, 5000 tonnes of gold was extracted, while in 2019, 10 000 tonnes was extracted. This output was distributed to the operators equally. All costs except general administration costs were capitalised into the cost of the output, with depreciation of equipment and capitalised exploration costs being written off in proportion to the depletion of the reserves. General administration expenses were allocated to the operators equally. The financial statements of the joint operation over the first 2 years of operation showed the following information: Cash Receipts and Payments Balance at 1 January Contributions from operators Plant and equipment Wages Materials General administration Balance at 31 December

2018 — $ 2 200 000 2 200 000 800 000 600 000 200 000 300 000 1 900 000 $ 300 000

Statement of Financial Position 2018 $ 760 000 Capitalised exploration costs 800 000 Plant and equipment (40 000) Accumulated depreciation 300 000 Cash 50 000 Materials 1 870 000 10 000 Accrued wages 20 000 Accounts payable (materials) 30 000 $ 1 840 000 Net assets Operators’ equity: 3 000 000 Contributions as at 1 January

2019 300 000 1 200 000 1 500 000 190 000 660 000 240 000 300 000 1 390 000 $ 110 000 $

2019 680 000 990 000 (140 000) 110 000 40 000 1 680 000 20 000 30 000 50 000 1 630 000 1 840 000

24.32

Chapter 24: Joint arrangements

Additional contributions 3 000 000 860 000 300 000 1 160 000 $ 1 840 000

Less: Output distributed Allocation: general administration Balance at 31 December

1 200 000 3 040 000 1 110 000 300 000 1 410 000 1 630 000

Required Prepare the journal entries in the records of Greens Pool Ltd to record its interest in the joint operation for the years ending 31 December 2018 and 2019. 2018 Cash in JO Capitalised expenses in JO Capitalised expenses Gain on capitalised expenses sold Cash

Dr Dr Cr

Capitalised expenses in JO Plant & equipment in JO Accum depreciation in JO Cash in JO Materials in JO Accrued wages in JO Accounts payable in JO Inventory General Admin expenses

Cr Dr Cr Cr Dr Cr Cr Dr Dr

1 100 000 100 000

[1/2(700 000 + 1 500 000)] [1/2 x 200 000] 200 000

Cr Cr

300 000 700 000

[1/2 x 600 000]

20 000

[1/2(800 000 – 760 000)] {1/2(800 000 – 0)] [1/2(40 000 – 0)] [1/2(300 000 – 1 100 000)] [1/2(50 000 – 0)] [1/2(10 000 – 0)] [1/2(20 000 – 0)] [1/2 x 860 000] [1/2 x 300 000]

400 000 20 000 950 000 25 000 5 000 10 000 430 000 150 000

As the capitalized expenses are at $100 000 for Greens Pool Ltd, and not $400 000, then the amortisation expense is $5 000, not $20 000. Hence a reduction in the cost of the output is required: Capitalised expenses in JO Inventory

Dr Cr

15 000 15 000

2019 Cash in JO Cash

Dr Cr

Capitalised expenses in JO Plant & equipment in JO Accum depreciation in JO Cash in JO

Cr Dr Cr Cr

Materials in JO Accrued wages in JO Accounts payable in JO Inventory General admin expenses

Cr Cr Cr Dr Dr

600 000

[1/2 x 1 200 000] 600 000 40 000

95 000 50 000 695 000 5 000 5 000 5 000 555 000 150 000

[1/2(680 000 – 760 000)] [1/2(990 000 – 800 000)] [1/2(140 000 – 40 000)] [1/2(110 000 – 300 000 - 1 200 000)] [1/2(40 000 – 50 000)] [1/2(20 000 – 10 000)] [1/2(30 000 – 20 000)] [1/2 x 1 110 000] [1/2 x 300 000]

Capitalised expenses are at $100 000, not $400 000. Therefore, the adjustment should be $10,000 not $40 000.

24.33

Chapter 24: Joint arrangements

Capitalised expenses in JO Inventory

Dr Cr

30 000 30 000

24.34

Chapter 25: Insolvency and liquidation

Chapter 25 – Insolvency and Liquidation REVIEW QUESTIONS 1.

Outline the role of an administrator appointed to a company which is insolvent. Once an administrator is appointed, what roles do the directors of the company have?

If a company is insolvent, the directors can get themselves into serious trouble with the Law if they allow the company to continue to trade. According to s. 436A of the Act, directors are expected to appoint a voluntary administrator to the company even before it becomes insolvent: (1) A company may, by writing, appoint an administrator of the company if the board has resolved to the effect that: (a) in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time; and (b) an administrator of the company should be appointed.

Section 437A(1) spells out the role of an administrator: (1) While a company is under administration, the administrator: (a) has control of the company’s business, property and affairs; and (b) may carry on that business and manage that property and those affairs; and (c) may terminate or dispose of all or part of that business, and may dispose of any of that property; and (d) may perform any function, and exercise any power, that the company or any of its officers could perform or exercise if the company were not under administration.

According to ASIC’s website and s. 438A of the Act, the administrator, after taking control of the company, must investigate and report to creditors information as to the company’s business, property, affairs and financial circumstances, and on the three options available to creditors. These are: 1. End the administration and return the company to the directors’ control 2. Approve a deed of company arrangement through which the company will pay all or part of its debts and then be free of those debts, or 3. Wind up the company and appoint a liquidator. The administrator must give an opinion on each option and recommend which option is in the best interests of creditors (s. 439A). The creditors then make the decision as to which option should be taken (s. 439C). If option 2 is taken, the administrator will continue his or her duties in order to see the deed of arrangement through to its end, if suitable to the creditors. If option 3 is taken, the administrator can become the company’s liquidator and, according to s. 446A, the liquidation process will proceed under the requirements of a creditors’ voluntary winding up. The administrator takes over all the powers of the company and its directors, and the powers of directors are suspended (s. 437C). The administrator has the power to sell or close down the company’s business or sell individual assets in the lead up to the creditors’ decision on the company’s future. The administrator must also report to ASIC on possible offences by people involved with the company, as strict liabilities apply to officers who continue to trade on the company’s behalf. According to s. 437D, only the administrator can deal with company’s property and any such transaction or dealing is void unless: (a) the administrator entered into it on the company’s behalf; or (b) the administrator consented to it in writing before it was entered into; or (c) it was entered into under an order of the Court. (s. 437D(2))

25.1

Solutions manual to accompany Company Accounting 10e

The company’s directors are required under the Act to help the administrator in performing his or her necessary tasks. According to s. 438B, each director must: (1) (a) deliver to the administrator all books in the director’s possession that relate to the company, other than books that the director is entitled, as against the company and the administrator, to retain; and (b) if the director knows where other books relating to the company are—tell the administrator where those books are. (2) Within 5 business days after the administration of a company begins or such longer period as the administrator allows, the directors must give to the administrator a statement about the company’s business, property, affairs and financial circumstances. (3) A director of a company under administration must: (a) attend on the administrator at such times; and (b) give the administrator such information about the company’s business, property, affairs and financial circumstances; as the administrator reasonably requires.

Additional powers are given to the administrator under s. 442A which states: Without limiting section 437A, the administrator of a company under administration has power to do any of the following: (a) remove from office a director of the company; (b) appoint a person as such a director, whether to fill a vacancy or not; (c) execute a document, bring or defend proceedings, or do anything else, in the company’s name and on its behalf; (d) whatever else is necessary for the purposes of this Part.

Even though the administrator is given wide powers under the Act, he or she is also given wide responsibilities. For example, under s.443A, the administrator of a company is liable for debts he or she incurs, in the performance or exercise of any of his or her functions and powers as administrator. According to s. 438E of the Act, an administrator is required to keep proper accounting records and to submit a statement of receipts and payments each six months.

Briefly discuss the ways in which a company may be wound up, indicating in each case the likely circumstances in which each is applicable.

There are two types of "windings-up" of companies: • court ordered; and • voluntary winding up by creditors or members. Court Ordered This type of winding up may proceed on a number of grounds although the most common is the presentation of a statutory demand by a creditor to repay a sum exceeding $2 000 owed by the company (s. 459E). Other than a creditor, the following may make an application to the court for the winding up of a company (s. 459P): • the company itself; • director(s); • ASIC; and a • contributory (present or past shareholder in the company (s. 9). Under s. 459C(2), the Court must presume that a company is insolvent if three months after an application is made (under s. 459A and s. 459B) the company has failed to comply with a statutory

25.2

Chapter 25: Insolvency and liquidation

demand (i.e. repayment of a debt of greater than $2 000). Other circumstances are given in the text in Section 25.2. Other than a statutory demand made by a creditor referred to above, the court may wind up a company if (s. 461): a. b. c. d. e.

the company has by special resolution resolved that it be wound up by the court the company does not commence business within one year from its incorporation the company has no members the directors have acted in their own interests rather than in the interests of members the affairs of the company are being conducted in a manner that is oppressive or unfairly prejudicial to members of the company.

Other less common grounds are dealt with in s. 461(g) to (k) presented in Section 25.2 of the text. Voluntary Winding Up – Members A voluntary winding up by members commences with the passing of a special resolution to wind up the company. The statutory requirement is that the company can pay its debts as and when they fall due. Accordingly the directors will make a written declaration that they believe that the company can pay its debts in full within a period not exceeding twelve months. This is known as a "Declaration of Solvency". Voluntary Winding Up – Creditors There is no declaration of solvency in this case as the company is unable to pay its debts. The winding up proceeds under the control of both members and creditors in separate meetings (see Section 25.3 of the chapter). The members still resolve that the company be wound up but their choice of liquidator is subject to ratification by creditors, at a meeting held immediately after the members meeting which places the company in liquidation.

Outline the powers of a liquidator in winding up a company (a) under a court order and (b) in a voluntary winding up.

The powers of a liquidator in a court ordered winding up are wide reaching but are controlled by the Court. Primarily they allow the liquidators to carry on the business of the company so far as it is necessary for its beneficial winding up. The liquidator is also required to pay any class of creditors in full and make compromises with creditors and agreements regarding calls, liabilities and claims existing between the company and contributories. (Further powers are dealt with in detail in Section 25.4 of the text). The powers of a liquidator under a voluntary winding up are similar to those of a liquidator in a court ordered winding up. In addition, the liquidator may exercise the power under s. 478 of a liquidator appointed by the Court to settle the list of contributories and under s. 483(3) in respect of making calls on contributories. The liquidator also exercises the powers of the Court in fixing a time to have debts and claims proved and convene a general meeting of the company to obtain agreement for matters as the liquidator thinks fit. Finally the liquidator must pay the debts of the company as far as possible and settle the rights of contributories.

25.3

Solutions manual to accompany Company Accounting 10e

What is the purpose of a report as to affairs?

A Report as to Affairs (Form 507) is required under s. 494(2) as an accompanying document to the Declaration of Solvency (Form 520) in a voluntary winding up by members. The Report as to Affairs is also required under s. 475(1) to be submitted by directors of the company to the liquidator not later than 14 days after the making of the winding up order in a court ordered winding up. The purpose of the Report as to Affairs is to provide information concerning the company's estimated realisable value of assets and any expected surplus or deficiency of assets after deducting creditors' claims. It is really a statement of financial position prepared on a realisation basis excluding the usual reporting assumptions of going concern and historical cost.

When is Form 509 used?

Form 509 – Presentation of Summary of Affairs of a Company (Summary of Affairs) is similar to Form 507 except that it is less detailed. It is required to be submitted by the company to the creditors along with a list of creditors. It is only used in a creditors’ voluntary winding up.

When is Form 524 used?

Form 524 is illustrated in the text in figure 25.1. Its purpose is to provide a statement of receipts and payments and is used by an administrator, a provisional liquidator, a liquidator and a receiver. See Form 524 to see its contents.

Who are the contributories of a company? Explain.

The contributories of a company are past or existing members who are likely to contribute to the property of the company in the event of it being wound up. In general terms the liability for existing shareholders only relates to those who have uncalled capital (partly paid shares). In this case their liability only extends to the amount unpaid on their shares. Former shareholders are not liable to contribute where: a. they disposed of their shareholding more than twelve months after the commencement of winding up. b. the debt or liability of the company occurred after they ceased to be members. The liability of such former shareholders will only arise where existing members cannot make the required contribution i.e. the former shareholder will be required to contribute the uncalled part of the share capital that was unable to be recovered from the existing shareholder.

Outline the principles to be followed in apportioning a deficiency among contributories.

Assuming the creditors are to be paid in full but there is insufficient funds to pay out all shareholders, reference will be made to the company's constitution to determine whether there exists a priority as to repayment of capital. If there are different classes of shareholders with different rights in the event of a winding up (i.e. Preference Shares or different categories of Ordinary Capital with different rights enshrined in the

25.4

Chapter 25: Insolvency and liquidation

constitution) calls will be made on the contributing class of ordinary capital in order to satisfy the priority enjoyed by the other classes of share capital. If there is only one class of shareholder, then the deficiency of capital will be borne equally amongst that class.

What must a liquidator do if he or she is unable to collect unpaid call money from shareholders?

If there are insufficient funds to pay creditors requiring a call on contributories and there is no response to that call, the liquidator may take action against that contributory as the requirement to pay the call is a specialty debt permitting the liquidator then to sue the contributory for recovery. The liquidator will in pragmatic terms assess the situation as to whether there is reasonable chance of recovery before proceeding with the action of recovery being conscious of the cost/benefit nature of these actions as liquidator. 10. List the following liabilities in order of priority of payment in the event of winding up a company: • Costs of administration prior to liquidation • Long-service leave payable • Amount payable for research into mining techniques • PAYG income tax instalments • Salary of an employee who is the spouse of a director, $3 000 • Directors’ fees • Liquidation expenses • Telephone bill payable • Audit fees payable for normal audit of company's accounts • Debentures secured by a circulating security interest (floating charge) • Workers’ compensation claim • Accounts payable • Deferred tax liability The order of recovery in terms of s. 556 of the Corporations Act is as follows: a.

Secured Creditor (i) Debentures secured by a floating change

Preferential Unsecured Creditors (i) Liquidation expenses (the liquidator is a relevant authority (ii) Costs of administration prior to liquidation (iii) Other liquidation expenses (iv) Salary (maximum of $2 000) (v) Workers’ compensation (vi) Long service leave

Unsecured Creditors (rank equally). NB No order of listing: ▪ Research costs ▪ PAYG income tax ▪ Salary excess of director’s spouse $1 000 ▪ Directors' fees ▪ Telephone bill payable ▪ Audit fees

25.5

Solutions manual to accompany Company Accounting 10e

▪ Accounts payable/Trade creditors The status of Deferred Tax Liability is unclear. This account normally arises from the application of Accounting Standard AASB 112 Income Taxes and does not represent a legal liability to make payment to a third party. On this basis it would be excluded as it is not a provable debt in terms of the Corporations Act, but the liquidator may be required to lodge an income tax return and taxation consequences from pre-liquidation could be relevant.

11. Arrears of preference dividends are paid in the winding up process in certain circumstances. Outline those circumstances. Reference to the constitution is required to ascertain the degree of preference existing to the preference capital and any arrears of dividend. If the dividend is a legal debt and not yet paid, those shareholders will have a priority over other classes of shares but after payment of unsecured creditors. If there is no substance to the claim of preference, there will be no claim recognised.

12. If there is a surplus on liquidation, discuss how the surplus is to be apportioned among contributories In the case of a surplus of capital, reference will be made to the constitution to assess the rights of shareholders. If, for example, there exists preference shareholders as a class (and that preferential status is recognised in the constitution) then that class will be paid first with ordinary shareholders receiving the balance equally amongst themselves. Also a surplus might attract the interest of the Australian Taxation Office. Companies in liquidation are subject to taxation laws equally with those not in liquidation, and if necessary the liquidator would lodge a tax return.

13. The aim of the Corporations Act is to avoid liquidation if possible. This statement is correct. The main intention of the Corporations Act 2001 is to treat liquidation as a last resort. In an attempt to avoid liquidation, Part 5.3A of the Act deals with the topic of appointing an administrator to a company whenever the directors believe that the company may be insolvent. According to ASIC (on its website), administration is designed to resolve the company’s future direction quickly. The administrator takes full control of the company to try to work out a way to save either the company or the company’s business. If this is not possible, a liquidator will ultimately be appointed to wind up the company. For the role of an administrator, see section 25.1 of the text.

14. Outline the role of a receiver. A receiver or a receiver and manager may be appointed by a court or by creditors, e.g., debenture holders, according to the terms of the agreement, in order to protect the security of those creditors. A receiver must always be a registered liquidator. In general, receivers are appointed at the instigation of a secured creditor who is given such power in his or her trust deed. For example, a receiver may be appointed by a debenture holder as a result of

25.6

Chapter 25: Insolvency and liquidation

failure by the company to abide by the provisions of the trust deed (e.g. failure by the company to pay interest to the debenture holders). The main effect of appointing a receiver (and manager) would be that relevant property can be sold in order to repay the debt of the secured creditor. The receiver is responsible to the secured creditor, not to the company. A court-appointed receiver needs the permission of the court to sell property of the company. In accordance with s. 429(2)(b), when a receiver is appointed, the company is required to submit to him or her a report as to affairs of the company in accordance with Form 507. A receiver is required to open his or her own special bank account (s. 421) and, in accordance with s. 432, to lodge every 6 months an account of the receiver’s receipts and payments. Form 524 (see Figure 25.1) is used for the purpose of submitting this information.

25.7

Solutions manual to accompany Company Accounting 10e

CASE STUDIES Case Study 1

Trading during insolvency

Read the following article: Hewson, Elderslie directors face claim Former Liberal leader John Hewson and other directors of the failed Elderslie Finance Corporation are facing an $18 million claim against them by the company’s liquidator, who claims they must have known the group was trading while insolvent for some time. Dr Hewson was the chairman of Elderslie until shortly before it collapsed in July 2008 owing 4000 noteholders $140 million. The directors are also accused of failing to provide accurate continuous disclosure to investors. Liquidator Nicholas Crouch has instructed lawyer Amanda Banton from Piper Alderman to file proceedings. The claim is expected to be lodged soon in the Federal Court in Sydney. The foreshadowed case was news to Dr Hewson yesterday and he declined to comment on the allegations until he had seen them for himself. Among them is expected to be an assertion that he received preferential payments totalling $270,000 before Elderslie collapsed. ‘That’s ridiculous, I was owed money,’ he said. ‘I was a creditor. I don’t know who’s feeding you this stuff, but I was a creditor.’ In February 2008, in a prospectus for a $60 million raising, Dr Hewson assured investors the company was not directly exposed to the sub-prime meltdown, and claimed that in fact it was able to offer even more attractive interest rates in that sort of climate. ‘I am glad to say that Elderslie has no direct exposure to this market,’ he said. ‘Ironically, much of our leasing business tends to be countercyclical, performing better in more difficult market circumstances, thereby giving us the capacity to offer even more attractive interest rates to our debenture holders.’ Elderslie, which was founded in Perth in 1957 before shifting its head office to Sydney several years ago, is believed by the liquidators to have been trading while insolvent for a year or more, possibly using trust funds to pay day-to-day expenses. Dr Hewson, the former member for the NSW Federal seat of Wentworth, was leader of the Opposition from 1990 to 1994. Mr Crouch said he hoped anything recovered would go some way to recouping the substantial losses of investors and creditors. ‘Our investigations reveal that the Elderslie group was trading while insolvent for a significant period before the receivers and managers were appointed and it was ultimately wound up,’ Mr Crouch said yesterday. ‘It is difficult to see how the directors of the Elderslie group would not have been aware of its financial difficulties during the period in which it continued to issue unsecured notes and debentures to its mums-and-dads investors and incurred debts, which remain unpaid.’ Noteholders have been told they would recover about 10c in the dollar. One of the major assets of the Elderslie group was a related party debt of $69 million to Elderslie Finance Corporation Limited’s holding company, Hotel Nominees. That company is now in receivership. Source: Lahey, K 2010, ‘Hewson, Elderslie directors face claim’, The West Australian, Saturday, 12 June, p. 74. Required A. Consult the ASIC website (www.asic.gov.au) and find out the responsibilities of directors when a company is insolvent. B. What role would have been played by the receivers in Elderslie Finance Corporation before the company was handed over to liquidators?

25.8

Chapter 25: Insolvency and liquidation

A. The responsibilities of directors in an insolvent company is specified on ASIC’s website and is also covered to some extent in Section 25.1 of the text. See also the answer to review question 1 above. B.

The role played by the receivers would be to sell sufficient assets of the company in order to pay the noteholders and debentureholders, as per the trust deeds of the respective securities.

Case Study 2

The rights of shareholders and creditors in liquidation

Read the following news report: Government to reverse rules on shareholders during insolvency The Federal Government is reversing a High Court ruling on how money from failed companies should be distributed. Corporate Law Minister Chris Bowen said that changes to the Corporations Act would ensure that claims by shareholders of insolvent companies ranked after other creditors’ claims. This followed a High Court decision in the Sons of Gwalia case, in which the court found that the claims of some shareholders in the failed gold miner were not subordinate to other claims. Mr Bowen said people invested in a company in the hope of sharing in its profits and, while they were entitled to expect proper disclosure from the company — which was an issue in the Sons of Gwalia case — they must accept they were taking a risk. In contrast, creditors were not gambling on the company’s future profitability. Often they were simply owed money for work they’d done or materials they’d supplied. Mr Bowen said the decision tended to shift the losses suffered by a company’s shareholders to its unsecured creditors. This would have the effect of increasing the cost of unsecured debt and reducing the availability of credit. Source: AAP 2010, ‘Government to reverse rules on shareholders during insolvency’, 2 June, www.heraldsun.com.au. © 2009 AAP. See full copyright notice on the acknowledgements page. Required Via the Internet, find out what had happened to creditors’ rights in the case of the liquidation of the company, Sons of Gwalia. Do you agree with the High court decision and do you support Mr Bowen’s reversal of the decision? Why or why not? Via the internet, you will find those who agree with the government’s decision to reverse the High court’s ruling in favour of shareholders e.g. the Australian Institute of Company Directors (AICD), and those who don’t e.g. legal firms trying to protect shareholders who purchase shares not knowing that a company is on the verge of insolvency. Check it out. There are lots of sites to choose from via Google. What do you think? Should shareholders be the ultimate risk takers, or do they deserve greater protection? Note, in December 2010, the Corporations Amendment (Sons of Gwalia) Act 2010 was passed which amended the Corporations Act 2001 and means that in future all shareholder claims will once again be subordinated, i.e. all claims by creditors must be paid in full before any claims by shareholders. Thus, the Corporations Amendment (Sons of Gwalia) Act effectively reverses the decision by the High Court.

25.9

Solutions manual to accompany Company Accounting 10e

Case Study 3

Rescuing Waterford Crystal in Australia

Read the following article: A crystal clear result For 250 years the fine china, ceramics and crystal produced by Waterford Wedgwood at its Irish and UK operations has graced dining tables the world over. But, by January 2009, the business was insolvent and had been trading at a loss for some time when its banking backers pulled the plug and appointed Deloitte as the global administrator. It could have been the end of an icon. However, the innovative efforts of insolvency experts at the Australian end of the wind-up have saved the profitable sections of the company, retained jobs and secured buy-out funding from the bank that had called in its outstanding debt. It is an inspiring tale of business planning, problem solving, global teamwork and sheer determination. The Waterford Wedgwood Group is headquartered in Ireland, and when the administrators moved in it became apparent the Australian arm, which included the Royal Doulton brand, was well managed and trading profitably but was mired within a group laden with almost A$1 billion in debt. The international group’s banking syndicate, led by the Bank of America and equity providers had reached the limits of their funding appetite and put the entire business up for sale. Almost 200 parties registered interest in buying all or some of the crystal and ceramics maker, but a protracted sales process identified one realistic purchaser — KPS Capital Partners, a private equity fund in the US. Keeping the profitable Australian business alive amid a crumbling empire became the objective, if not obsession, of Tim Norman, a partner with Deloitte and Michael Sloan, a partner in commercial law firm Blake Dawson. Together, they implemented Australia’s first ‘pre-pack’ sale that would ultimately save the local operations and the 450 jobs that went with it. Although the Australian operation was profitable and the cash flow was positive, it was lumbered with a A$300 million bondholder debt after guaranteeing the rest of the group. ‘We had to find a legal mechanism to release that debt so that the Australian business could be sold as a going concern. No one would buy an Australian company with a A$300 million debt. The pre-pack was the legal mechanism we used,’ Sloan says. A pre-packaged insolvency is one where all the work, planning and hard yards are done before the insolvency event. A sale will be structured and worked out ahead of the appointment, but it is implemented immediately following the insolvency appointment. It is orderly, planned, quick and relatively straightforward to execute. It means a lot of uncertainty inherent in the insolvency process is removed. ‘What we did in this case, as part of the international sale to release that high-yield bond debt, was a receiver’s sale. But we needed to keep the business going. To retain consumer confidence in the business, the duration had to be as short as possible. And, in this case, it was one day. So we went in and out very quickly so as not to interrupt the business. We used the pre-pack to do the sale in a day without its guarantee to high-yield bondholders,’ he says. As the pre-pack was an Australian first, there was no blueprint. ‘What we did was examine relevant law, worked out what would comply with the law before obtaining senior legal advice that would, if need be, satisfy a court.’ Sloan and Norman did all the incredibly difficult planning, while managing the people in Australia, managing the suppliers and liaising with the Deloitte team internationally to make it all happen seamlessly. Australia’s legal regulatory regime discourages pre-pack sales by making them much more difficult to implement than in the US and UK. ‘Because of the Australian legal regime and the Corporations Act duties, which focus on process rather than outcome, there’s a degree of risk, indeed a high degree of risk, for conducting a very quick sale. In relation to this one, Deloitte had run a very proper, detailed international sales process, so we felt comfortable that the process had been followed,’ Sloan says. The risks of pre-packs are ‘sweetheart deals’ and ‘phoenix activities’, where people abuse the process and do quick sales to parties who are associated with either the current management or a security holder. Australian law has a lot of protective mechanisms to stop that. ‘But we were

25.10

Chapter 25: Insolvency and liquidation

using a pre-pack to find the most favourable outcome, so we had to jump over high hurdles in Australia,’ Sloan says. Norman and his Deloitte team had to ensure they were complying not only with their legal duties, but were doing the right thing by employees, the company, customers and suppliers. The easy thing for Norman to do would have been to take the appointment and just put the company into receivership. ‘Both our firms would have earned a lot more money if the company had gone into receivership. The hard thing to do was to keep it alive and to find an innovative solution and that’s what we achieved,’ Norman says. He says about 100 pre-pack sales are done in the UK each month amid a more conducive regulatory regime. ‘Here, [in Australia] we are tainted with a history of related-party, nontransparent, behind-the-scenes, director-related phoenixes,’ he says. ‘Combine that with a much tighter and more stringent legal framework, there are more hoops to jump through to do one. But in the right circumstances and with absolute transparency for all stakeholders, pre-packs can make commercial and compelling sense.’ The reason for Waterford Wedgwood’s demise was a combination of a high cost structure, a change in consumer preferences, a lack of synergies and a fall in sales leading to cash flow shortages. Time ran out after it failed to meet debt repayment deadlines. Norman says Waterford Wedgwood’s high-cost production plants in the UK and Ireland proved to be uneconomic on a global scale. He says it cost four times as much to produce a pair of shiraz wine glasses in Ireland as in Czechoslovakia. ‘Thankfully, there were no production plants in Australia,’ he says. ‘Australian operations were very well run, cash flow positive and a profitable venture. All Australia did was take product out of the UK (china and ceramics) and Ireland (crystal) and sell it through 87 retail sites around Australia, principally the major department stores.’ During the sale process, Norman says the eventual buyer KPS Capital Partners ‘cherrypicked the profitable core-income generating assets’, such as plant assets in the UK and Ireland to preserve the china, ceramics and crystal manufacturing businesses. KPS also bought other selected businesses around the globe as part of the package for an undisclosed sum. What made the Australian sale unique was that KPS took on the company’s normal business liabilities. ‘Because the Australian operations were so well run, we encouraged the purchaser to buy the shares, unhitch that carriage and to take the business in full,’ Norman says. ‘It did.’ Norman’s core advice in such a turnaround is that the first move is to establish the facts. ‘The key to any workout or turnaround is understanding the cash flow, the cash position and the immediate cash requirements of the group,’ he says. ‘The more cash you have, the more time you have to implement options. It was Christmas 2008 when we parachuted in on the Australian operations.’ Norman, who met Sloan on new year’s eve in Sydney, devised a plan in January and February 2009 and conducted the pre-pack sale for the entire Australian group in March. Norman and Sloan’s efforts were recently recognised with a Turnaround Management Association (TMA) award. The TMA is a global organisation dedicated to corporate renewal and turnaround management. It has been active in Australia for more than six years and has more than 300 members, including specialist turnaround firms, accounting, legal and private equity firms and financiers. Sloan and Norman say they feel honoured to receive an award that acknowledges their part in saving a business and jobs. ‘We spend our corporate lives involved in distress and failure. When you can help something get off life support, that’s when you do your best work as a practitioner. There’s nothing better than keeping businesses alive and people in jobs,’ Sloan says. It also required tight teamwork involving both firms. ‘It involved a lot of people doing innovative and complex work in very short time periods under considerable pressure.’ Source: Black, A 2010, ‘A crystal clear result’, InTheBlack, February, pp. 42–45. This article was written by the financial journalist, Anthony Black, who has extensive experience writing on corporate and financial matters. For enquiries on past articles refer to anthonyblack3@bigpond.com. Required From the article, describe the actions taken by Tim Norman and Michael Sloan to save the Australian operations of Waterford Wedgwood from liquidation.

25.11

Solutions manual to accompany Company Accounting 10e

Norman and Sloan used a “pre-packaged insolvency plan”. They did all the work, planning and “hard yards” before the insolvency event, so that a sale of the whole Australian business was structured ahead of the appointment of the receiver/liquidator, and implemented immediately following the appointment of the receiver/liquidator. In the Australian case the purchaser of the business, KPS Capital Partners, not only purchased the business assets but also purchased the company’s normal business liabilities. Hence, these liabilities were taken away from the normal task of a liquidator to settle these claims in a business failure. The profitable business in Australia continued with a new owner, and jobs in Australia were saved.

Case Study 4

Liquidation of family company

Assume that you are the managing director of a small, family-owned proprietary company operating in Australia. The members of the company have decided to wind up its operations for family reasons. The company has been trading profitably and has had no problem in paying its accounts when they fall due. Required Investigate what you must do in order to wind up the company properly in accordance with the law. (Hint: Visit the ASIC website.) Report your findings to the class and show details of the forms that must be completed. The winding up procedure will differ depending on whether the company is solvent or insolvent. If insolvent, then a members’ voluntary winding up cannot occur. It will usually be either a creditors’ voluntary wind-up or a wind-up by the court. See Section 25.2 of the chapter for details of forms to be used etc. In a members’ voluntary winding up, directors must provide a declaration of solvency attached to the report as to affairs. A declaration of solvency is not needed in any other winding up. The ASIC website (http://www.asic.gov.au) provides information as to what must be done to wind up a family company. See the section on For companies > Closing down your company, where much information is available, including deregistering a company.

Case Study 5

Current liquidations of previously listed companies

Visit such websites as www.delisted.com.au, and present to the class brief details of three companies which have been listed on the securities exchange, and which are currently going through the process of liquidation. As part of your presentation, provide reasons (if possible) for such liquidations occurring. From the Delisted website (http://www.delisted.com.au/), the home page provides the names of companies who have recently been delisted from the ASX. From this list, identify companies who are in the process of liquidation and select three. From there, access can be found to each of those company news sites or websites, which provide some details of liquidation proceedings. Use the company listings on the Delisted website to search for more data, as well as search engines such as Google.

25.12

Chapter 25: Insolvency and liquidation

PRACTICE QUESTIONS Question 25.1

Three main ledger accounts for liquidation

Insect Ltd went into voluntary liquidation on 30 June 2017, its summarised statement of financial position then being: INSECT LTD Statement of Financial Position as at 30 June 2017 Equity Current assets Share capital: Receivables 160 000 shares issued at a price Inventory of $1, called to 50c $ 80 000 Cash Less: Calls in arrears (40 000 at 25c) (10 000) Non-current assets Land Plant Total assets Current liabilities Payables Total equity $ 70 000 Net assets

$ 10 000 12 000 8 000

$ 30 000

40 000 18 000

58 000 88 000

(18 000) $ 70 000

All assets realised $60 000. Calls in arrears were fully collected. Payables allowed $1000 discount. Costs of liquidation were $5000. Required Record the above in the Liquidation account, the Liquidator’s Cash account and the Shareholders’ Distribution account.

Liquidation Carrying amounts: Land

40 000

Plant

18 000

Receivables

10 000

Inventory Liquidation exps payable

12 000 5 000

Cash (from sale of assets Discount from Creditors Loss (to S/Hs' distribution)

85 000

60 000 1 000 24 000

85 000

Cash Balance

8 000

Liquidation (sale of assets)

60 000

Liquidation exps payable Payables

5 000 17 000

25.13

Solutions manual to accompany Company Accounting 10e

Calls in arrears

10 000

Shareholders’ distribution

78 000

56 000 78 000

Shareholders’ Distribution Liquidation (loss)

24 000

Cash

56 000 80 000

Share capital

80 000

25.14

Chapter 25: Insolvency and liquidation

Question 25.2

Order of priority for paying creditors

Mosquito Ltd, whose capital consisted of $50 000 in fully paid shares, was wound up as a result of a court order. Its liquidator realised $671 650 from the sale of the company’s assets. This amount included $170 000 from the proceeds on sale of the company’s land and buildings. Debts proved and admitted were: Unsecured notes Debentures (secured by circulating security interest) First mortgage on land and buildings Trade accounts payable PAYG tax instalment Fringe benefits tax Directors’ fees GST Employees’ holiday pay Employees’ wages — 5 employees for 2 weeks at $400 per week Secretary’s salary — 3 weeks at $240 per week Managing director’s salary — 4 weeks at $600 per week Sales commission Liquidation expenses Second mortgage on land and buildings Liquidator’s remuneration

$100 000 300 000 100 000 80 000 780 2 000 3 000 1 989 5 000 4 000 720 2 400 500 3 000 80 000 8 000

Required Show the order of priority of payment of debts for Mosquito Ltd and calculate the amount payable to the company’s trade accounts payable.

Proceeds from sale of assets Less payment of debts (in order of priority) 1. Liquidator's expenses 2. Secured debts First mortgage Second mortgage 3. Circulating security interest: Debentures 4. Liquidator’s remuneration 5. Wages: Employees Secretary Managing director Sales commission 6. Employees' holiday pay Amount available for unsecured creditors 7. Ordinary unsecured creditors

$671 650

$3 000 $100 000 70 000

300 000 8 000 4 000 720 2 000 500

Owed Unsecured notes

170 000

100 000

7 220 5 000

Percent dividends 90.04

493 220 178 430

Paid 90 040

25.15

Solutions manual to accompany Company Accounting 10e

Trade accounts payable Fringe benefits tax PAYG tax instalment GST Directors' fees Managing director's salary Second mortgage

80 000 2 000 780 1 989 3 000 400 10 000 198 169

90.04 90.04 90.04 90.04 90.04 90.04 90.04

72 032 1 801 702 1 790 2 701 360 9 004 178 430

Percentage dividend to trade accounts payable = $178 430/198 169 = 90.04c in $

25.16

Chapter 25: Insolvency and liquidation

Question 25.3

Distribution to different classes of shareholders

On 30 April 2017, Moth Ltd went into voluntary liquidation. At that date, equity comprised: Share capital: 100 000 preference shares issued for $1 and fully paid 220 000 ordinary shares issued for $1 and fully paid 160 000 ‘A’ ordinary shares issued for $1 and paid to 60c 20 000 ‘B’ ordinary shares issued for $1, called and paid to 50c Retained earnings Total equity

$ 100 000 220 000 96 000 10 000 426 000 (256 000) $ 170 000

The liquidator proceeded to realise all of the company’s assets. The loss on liquidation amounted to $64 000 and, after paying sundry creditors, there was a cash balance of $106 000 available for distribution to the shareholders. (The constitution gives preference shareholders a prior claim to return of capital, and other shareholders are to rank equally, based on the number of shares held.) Required Prepare a statement of the distribution to shareholders supported by a detailed explanation of the apportionment of any cash among the various classes of shareholders.

Liquidator's Statement of Receipt and Payments Receipts

Balance after paying liabilities. Call on ‘A’ Ordinary Call on ‘B’ Ordinary

Payments

106 000

Distribution to:

32 000 6 000

Preference S/Hs Ordinary S/Hs

144 000

100 000 44 000 144 000

Distribution of cash No of Shares

Ordinary ‘A’ ordinary ‘B’ ordinary Cash available* Deficiency** Total notional cash

220 000 160 000 20 000 400 000

Paid to Notional Call $ 220 000 96 000 10 000 326 000 (6 000) 320 000

$ 64 000 10 000 74 000 6 000 . 80 000

Notional Refund 20c $ 44 000 32 000 4 000 80 000

Actual Deficiency Refund share (Call) $ $ 44 000 176 000 (32 000) 128 000 (6 000) 16 000 6 000 320 000

Total notional cash per share = $80 000 ÷ 400 000 = 20c per share * $6 000 = $106 000 - $100 000 ** Alternatively $320 000 = $64 000 + $256 000

25.17

Solutions manual to accompany Company Accounting 10e

Question 25.4

Receipts and payments with final distribution to shareholders

Butterfly Ltd went into liquidation on 30 June 2018, its equity being as follows: 20 000 10% preference shares each fully paid at $1 10 000 1st issue ordinary shares each fully paid at $1 50 000 2nd issue ordinary shares issued for $1 and paid to 50c Retained earnings (credit balance) $1500 The constitution states that preference shares carry the right to payment of arrears of dividends whether declared or undeclared up to the commencement of the winding up. The last preference dividend was paid to 30 June 2017. To adjust the rights of contributories, the liquidator made a call of 50c per share on the 2nd issue ordinary shares. All call money was received except that in respect of 500 2nd issue ordinary shares. This money proved to be irrecoverable and the shares were subsequently forfeited. Claims admitted for payment amounted to $16 870, assets realised $30 000, and liquidation expenses were $150. Liquidator’s remuneration was fixed at 1% of gross proceeds from sale of assets. Required A. Prepare the liquidator’s final statement of receipts and payments. B. Provide a statement showing the final distribution to shareholders, based on the statement in the constitution that all shares, by number, rank equally on distribution of final cash.

A. Liquidator's Statement of Receipts and Payments Receipts

$'000

Proceeds on sale of assets Call on 2nd issue ordinary

Payments

$'000

30 000

Liquidation expenses

150

24 750

Liquidator's remuneration

300

Other Claims Arrears of preference dividend Payment to: Preference First issue ordinary Second issue ordinary 54 750

16 870 2 000

8 913 4 457 22 060 54 750

B. Share of cash (after forfeiture of 500 2nd issue ordinary shares)

Preference 1st issue ordinary

No of Shares

Paid to Notional Call

20 000 10 000

$ 20 000 10 000

$ -

Notional Refund 44.566c $ 8 913 4 457

Actual Deficiency Refund share (Call) $ $ 8 913 11 087 4 457 5 543

25.18

Chapter 25: Insolvency and liquidation

2nd issue ordinary Cash available Deficiency Total notional cash

49 500 79 500

49 500 79 500 (35 430) 44 070

35 430 . 35 430

22 060 35 430

27 440 44 070

Total notional cash per share = $35 430 ÷ 79 500 = 44.566c per share

25.19

Solutions manual to accompany Company Accounting 10e

Question 25.5

Distribution to different classes of shareholders

On 31 May 2017, Termite Ltd went into liquidation. At that date, the equity of Termite Ltd comprised: 400 000 preference shares issued for $1 paid to 50c 1 000 000 ordinary shares issued for $1 paid to 80c

$ 200 000 800 000 $ 1 000 000

After realising the assets and paying all creditors, the liquidator had $300 000 cash available to distribute to shareholders. Required A. Prepare a statement detailing the distribution of cash to shareholders assuming the company’s constitution was silent regarding the rights of shareholders upon winding up. B. Prepare a statement detailing the distribution of cash to shareholders assuming the company’s constitution provides that upon winding up, preference shareholders are preferential as to return of capital.

A. Share of cash No of Shares

Preference Ordinary Cash available Deficiency Total notional cash

400 000 1 000 000 1 400 000

Paid to

$ 200 000 800 000 1 000 000 (300 000) 700 000

Notional Notional Call Refund 50c $ $ 200 000 200 000 200 000 500 000 400 000 700 000 300 000 . 700 000

Actual Deficiency Refund share $ 300 000 300 000

$ 200 000 500 000 700 000

Total notional cash per share = $700 000 ÷ 1 400 000 = 50c per share

B. Share of cash Preference shareholders receive $200 000. Ordinary shareholders receive $100 000 ($300 000 [cash available] - $200 000 [distribution to preference shareholders]).

25.20

Chapter 25: Insolvency and liquidation

Question 25.6

Order of payment of debt and shareholders’ distributions

Weevil Ltd went into liquidation on 31 March 2017, its equity being as follows: 75 000 ordinary shares issued and fully paid Retained earnings

$ 175 000 (35 600) $ 139 400

Debts proved and admitted for payment by the liquidator were: Debentures (secured by circulating security $ 100 000 interest) Mortgage loan (secured over land and buildings) 240 000 Unpaid annual leave 45 800 Employee retrenchment payments 56 400 Director’s salary 8 400 Directors’ fees 2 400 PAYG tax instalments 6 200 Accounts payable 125 000 Liquidation expenses 1 300 Liquidator’s remuneration 5 000 The land and buildings were seized by the secured creditor and sold to repay the mortgage loan. Surplus funds amounting to $5000 were forwarded to the liquidator. All other assets were sold and realised $230 000. Any calls which the liquidator may need to make are expected to be recoverable. Required Prepare the liquidator’s statement of receipts and payments (show debts in order of priority of payment) and the Shareholders’ Distribution account for Weevil Ltd. (Show all calculations.)

Receipts Proceeds on sale of assets Net proceeds from land & buildings

Liquidator's Statement of Receipts and Payments $ Payments

230 000

Liquidation expenses

1 300

5 000

Director’s salary

2 000

Annual leave Retrenchment payments Debentures Liquidator’s remuneration

45 800 56 400 100 000 5 000 210 500

Unsecured: Director’s salary Directors’ fees

1 120 420

PAYG instalments Accounts payable

1 085 21 875 235 000

235 000

Total debts amount to:

25.21

Solutions manual to accompany Company Accounting 10e

Secured Unsecured

$100 000 250 500 350 500 235 000 115 500

Cash from proceeds of sale of assets Deficiency

As there is a deficiency to pay creditors, and there is no amount to be called up on ordinary shares, the amount available is insufficient to satisfy all creditors’ claims. The deficiency must be borne in reverse order of priority. Section 556 of the Corporations Act provides that certain creditors, namely wages, annual leave and retrenchment payments, will be paid prior to the floating charge security. Cash available for unsecured creditors = $24 500* *$24 500 = $235 000 [receipts] - $210 500 [payments to debenture holders and preferential unsecured creditors] Cash per $1 owed = $24 500 /140 000 = 17.5c per $1 Creditors Total amount Director’s salary $6 400 Directors’ fees 2 400 PAYG instalments 6 200 Accounts payable 125 000 140 000

Payment @ 17.5c $ 1 120 420 1 085 21 875 24 500

Shareholders’ Distribution Deficiency

175 000 175 000

Ord. share capital

175 000 175 000

25.22

Chapter 25: Insolvency and liquidation

Question 25.7

Journal entries and ledger accounts for liquidation

The trial balance of Grasshopper Ltd on 1 June 2017, the date on which the court ordered that the company be wound up, is presented below. GRASSHOPPER LTD Trial Balance as at 1 June 2017 Cash Inventories Plant and machinery Land and buildings Accumulated losses Accounts payable Mortgage (secured over land and buildings) Share capital: 350 000 ordinary shares issued for $1 each, fully paid

Debit $9 000 188 800 211 400 60 000 80 800

Credit

$160 000 40 000 350 000 $550 000

$550 000

Additional information (a) The sale proceeds of assets realised the following amounts in cash: Inventories Plant and machinery

$120 000 140 000

(b) The mortgage holder took possession of the land and buildings and sold them for $90 000 and after settlement of the debt paid any excess funds to the liquidator. (c) Liquidation costs amounted to $19 000. (d) The liquidator paid all liabilities. Required A. Prepare journal entries to wind up the affairs of Grasshopper Ltd. B. Prepare the liquidation account, the cash account and the shareholders’ distribution account. A. Liquidation Inventory Plant & Machinery (Transfer asset carrying amounts to liquidation)

Dr Cr Cr

400 200

Cash

Dr Cr

260 000

Dr Cr

19 000

Cash ($90 000 - $40 000) Dr Mortgage on Land & Buildings Dr Land & Buildings Cr Liquidation (gain on sale: $90 000 - $60 000) Cr

50 000 40 000

Liquidation (Sale of assets) Liquidation Liquidator’s Costs Payable (Recognition of liability to liquidator)

188 800 211 400

260 000

19 000

60 000 30 000

25.23

Solutions manual to accompany Company Accounting 10e

(Gain on sale of land & buildings by mortgage holder) Liquidator’s Costs Payable Accounts payable Cash (Payment of liabilities)

Dr Dr Cr

19 000 160 000

Liquidation Accumulated Losses (Transfer of accumulated losses to liquidation)

Dr Cr

80 800

179 000

80 800

Note: Cash in = $9 000 + $260 000 + $50 000 = $319 000 less cash out $179 000 = $140 000 left Share Capital – Ordinary Shares Shareholders’ Distribution (Transfer share capital account to shareholders’ distribution)

Dr Cr

350 000

Shareholders’ Distribution Cash (Payment to shareholders)

Dr Cr

140 000

Shareholders’ Distribution Liquidation (Transfer of deficiency from liquidation)

Dr Cr

210 000

350 000

140 000

210 000

Carrying amounts of assets: Inventories Plant and machinery Liquidation costs payable Accumulated losses

GRASSHOPPER LTD Liquidation Proceeds on sale of assets: $188 800 Inventories 211 400 Plant and machinery 19 000 Gain on sale of L&B 80 800

Shareholders’ distribution

$500 000

Opening balance

Proceeds on sale of assets: Inventories Plant and machinery Land & buildings

$120 000 140 000 30 000 210 000 $500 000

Cash $9 000 Payments: Liquidation costs payable Accounts payable

$19 000

120 000 140 000 50 000

140 000

Shareholders’ distribution

$319 000

160 000

$319 000

Shareholders’ distribution

25.24

Chapter 25: Insolvency and liquidation

Cash Liquidation

$140 000 Share capital – ordinary shares 210 000 $350 000

$350 000

25.25

Solutions manual to accompany Company Accounting 10e

Question 25.8

Summary of affairs

The trial balance below is of Gnat Ltd’s accounts as at 30 June 2017: GNAT LTD Trial Balance as at 30 June 2017 Debit Share capital Calls in arrears (on 8000 shares) Calls in advance Revaluation surplus Retained earnings Land Buildings Accumulated depreciation – buildings Plant Accumulated depreciation – plant Cash at bank Inventory Accounts receivable Bills receivable Goodwill 12% debentures Mortgage payable Secured creditor (for plant) Unsecured creditors

Credit $ 315 000

$ 2 000 1 500 2 500 72 500 91 000 150 000 36 000 170 000 20 000 15 000 50 000 47 500 40 000 25 000

$663 000

100 000 110 000 25 000 53 000 $663 000

Share capital consisted of 350 000 ordinary shares, issued at a price of $1 and called to 90c. It was decided on 30 June 2017 to wind up Gnat Ltd. Additional information is as follows: (a) Debentures are secured by circulating security interest; mortgage is secured over buildings. (b) Assets are estimated to realise the following amounts: Land Buildings Inventory Plant Bills receivable Accounts receivable Calls in arrears Goodwill

$ 90 000 100 000 35 000 100 000 29 000 43 500 1 500 —

(c) There is an impending lawsuit against the company. Expected damages payout is $15 000. (d) Unsecured creditors comprise: Accounts payable GST Director’s salary Directors’ fees Local government rates

$42 500 2 000 3 500 3 000 2 000 $53 000

Required Present a summary of affairs (as per figure 25.3) for sending to creditors.

25.26

Chapter 25: Insolvency and liquidation

COMPANIES FORM 509 SUMMARY OF AFFAIRS Assets and Liabilities as at 30 June 2017 Valuation

Estimated Realisable Value

$91 000 47 500 40 000 2 000 15 000 50 000 25 000

$90 000 43 500 29 000 1 500 15 000 35 000 -

270 500

214 000

125 000

75 000

4 000

399 500

289 000

1. Assets not specifically charged (a) Interests in land (b) Sundry debtors: Debtors Bill Receivable Calls in Arrears (c) Cash on hand (d) Cash at Bank (e) Stock as detailed in inventory (f) Work in progress (g) Plant and Equipment (h) Other assets: Goodwill 2. Assets subject to specific charges Plant Less Secured Creditor Buildings Less Mortgage Payable

150 000 25 000 114 000 110 000

Total Assets Total estimated realisable value 3. Less preferential creditors entitled to priority over the holders of debentures under floating charge Director's salary

289 000

2 000 287 000

4. Less amounts owing and secured by debenture or floating charge over company's assets 12% debentures

100 000 187 000

25.27

Solutions manual to accompany Company Accounting 10e

Estimated Realisable Value 5. Less Preferential creditors Estimated amount available for unsecured creditors 6. Creditors (unsecured) Trade creditors GST Local government rates Director’s salary Directors’ fees 7. Balances owing to partly secured creditors Mortgages (total claim) Security held (building)

187 000

42 500 2 000 2 000 1 500 3 000

110 000 100 000

10 000

61 000 126 000 126 000

8. Contingent assets 9. Contingent liabilities Estimated surplus (Subject to costs to liquidation) Share capital Issued: 350 000 ordinary shares at $1

350 000

Paid-up: 342 000 shares paid to 90c 8 000 shares paid to 65c

307 800 5 200

313 000

25.28

Chapter 25: Insolvency and liquidation

Question 25.9

Ledger accounts for liquidation

A court order for the winding up of Slater Ltd was made on 31 March 2017. A statement of financial position prepared on that date was as follows: SLATER LTD Statement of Financial Position as at 31 March 2017 Current assets Cash at bank Cash in hand Accounts receivable Inventories Total current assets Non-current assets Plant and equipment (at cost less depreciation) Land and buildings (at cost) Goodwill Total non-current assets Total assets Current liabilities Accounts payable PAYG tax instalments Accrued expenses Total current liabilities Non-current liabilities 2000 $20 10% debentures 11% mortgage on land and buildings Total non-current liabilities Total liabilities Net assets Share capital 20 000 7% cumulative preference shares issued for $2, called to $1.50 each 100 000 ordinary shares issued for $2, called to $1.50 each Less: Calls in arrears: 2000 ordinary shares at 50c

$ 4 000 300 46 500 49 500 $ 100 300 96 200 30 000 39 500 165 700 266 000 29 300 5 700 5 000 40 000 40 000 20 000 60 000 100 000 $ 166 000

$30 000 150 000

Reserves Retained earnings Total equity

$ 180 000 (1000) 179 000 (13 000) $ 166 000

Note: Arrears of preference dividends $4200. Additional information (a) Accrued expenses include: Interest on mortgage Interest on debentures Salary (four employees, $800 each) (b) Assets are expected to realise: Accounts receivable Inventories Plant and equipment Unpaid calls

$ 16 400 10 500 30 000 500

$ 1000 800 3200

(1000 at 50c)

25.29

Solutions manual to accompany Company Accounting 10e

(c) The mortgage holder took possession of the land and buildings and sold them for $60 000, paying any residue to the liquidator. (d) The debentures are secured by a circulating security interest over the assets of Slater Ltd. (e) On 1 May 2017, the liquidator realised the assets in (b) for the above amounts. The balance of the unpaid calls was treated as irrecoverable and the shares were forfeited. (f) On 1 June 2017 the liquidator paid all liabilities and adjusted the rights of shareholders. The constitution, regarding rights of shareholders in a winding up, gives preference shareholders a right to receive arrears of dividend. (g) Uncalled capital (where required to be called up) proved to be recoverable. (h) The winding up of the company was completed on 1 July 2017, costs of liquidation being $3000. Required A. Prepare the Liquidation account and the Shareholders’ Distribution account (show clearly any working in relation to final distribution to shareholders). B. Prepare the liquidator’s statement of receipts and payments.

A. Liquidation Carrying amount of assets: Accounts receivable Inventories Plant and equip. Goodwill

46 500 49 500 96 200 39 500

Liquidation Expenses Arrears of Pref. Div

3 000 4 200

Retained earnings

13 000

Proceeds from Sale of Assets: Accounts receivable Inventories Plant and equipment Gain on disposal of secured asset (L&B)

Forfeited Shares Reserve Share of Deficiency: Preference Ordinary

251 900

16 400 10 500 30 000 30 000

1 000 27 563 136 437 251 900

Shareholders’ Distribution* Share of Deficiency: Preference Ordinary Return of Capital to: Preference Ordinary

27 563 136 437

Share capital: Preference Ordinary

30 000 148 500

2 437 12 063

178 500

25.30

Chapter 25: Insolvency and liquidation

* after forfeiture of 1 000 ordinary shares Share of cash (after forfeiture of 1 000 ordinary shares for not paying calls in arrears) No of Shares

Preference Ordinary

20 000 99 000 119 000

Cash available Deficiency Total notional cash

Paid to Notional Call $ 30 000 148 500 178 500 (14 500) 164 000

$ 10 000 49 500 59 500 14 500 . 74 000

Notional Refund 62.185c $ 12 437 61 563 74 000

Actual Deficiency Refund share (Call) $ $ 2 437 27 563 12 063 136 437 14 500 164 000

Total notional cash per share = $74 000 ÷ 119 000 = 62.185c per share

B. Receipts

Liquidator's Statement of Receipts and Payments $ Payments

Balance of Cash Proceeds on sale of assets: Accounts receivable Inventories Plant and Equipment Net amount received from secured creditors Calls in arrears (ordinary)

4 300

16 400 10 500 30 000

Liquidation expenses Debentures and Interest Salaries Accounts payable PAYG tax instalment Arrears of preference dividend

39 000

$ 3 000 40 800 3 200 29 300 5 700 4 200 86 200

500 Return of Capital: Preference Ordinary 100 700

2 437 12 063 100 700

25.31

Solutions manual to accompany Company Accounting 10e

Question 25.10 Order of payment of debts, journal entries for liquidation surplus Glowworm Ltd went into voluntary liquidation on 30 June 2018. The statement of financial position prepared on that date is as follows: GLOWWORM LTD Statement of Financial Position as at 30 June 2018 Current assets Cash Inventory Accounts receivable Less: Allowance for doubtful debts Non-current assets Plant and equipment Less: Accumulated depreciation Land Shares in listed companies Total assets Current liabilities Accounts payable Other payables Non-current liabilities Mortgage on land Debentures Total liabilities Net assets Equity Share capital: Preference: 20 000 shares, issued at $1, fully paid Ordinary ‘A’ 25 000 shares, issued at $1, fully paid Ordinary ‘B’ 20 000 shares, issued at $1, called to 60c General reserve Retained earnings Total equity

$ 16 000 63 000 $ 36 100 (4 100) 168 000 (35 200)

32 000

132 800 90 600 52 000 386 400 43 200 16 100 85 000 150 000 294 300 $ 92 100

$ 20 000 25 000 12 000

$ 57 000 7 000 28 100 $ 92 100

Additional information (a) Liquidator’s remuneration and expenses amounted to $1800. (b) Other payables of $16 100 comprise: Wages payable — employees Salary payable — managing director Annual leave payable — employees Income tax payable Telephone bill payable

$6 000 2 800 4 400 2 000 900

(c) The debentures are secured by a circulating security interest over the company’s assets. (d) The mortgage holder took possession of the land and sold it for $81 700. (e) Other assets realised: Inventory Accounts receivable Plant and equipment

$54 000 26 000 134 000

25.32

Chapter 25: Insolvency and liquidation

Shares in listed companies

61 000

(f) Uncalled capital (if required to be called up) is recoverable. (g) Preference shareholders are preferential as to dividends and return of capital. The constitution does not provide any further rights for preference shareholders. (h) In relation to return of capital, Ordinary ‘A’ shareholders and Ordinary ‘B’ shareholders rank equally after preference shareholders. Required A. List the debts paid by the liquidator in their order of priority of payment. B. Prepare journal entries to wind up Glowworm Ltd.

Order of priority of payment of debts 1. 2. 3. 4. 5. 6.

Liquidator’s remuneration & expenses Mortgage on land (secured by a non-circulating security interest) Debentures (secured by a circulating security interest)) Salary & wages payable (6 000 + 2 000) Annual leave payable Ordinary unsecured: Mortgage loan – balance $3 300 Director’s salary – balance 800 Accounts payable 43 200 Income Tax payable 2 000 Telephone bill payable 900

$1 800 81 700 150 000 8 000 4 400

50 200

Journal entries Liquidation Inventory Accounts Receivable Plant & Equipment Shares in Listed Companies (Transfer asset carrying amounts to liquidation)

Dr Cr Cr Cr Cr

319 100

Allowance for Doubtful Debts Accumulated Dep’n – Plant & Equip Liquidation (Transfer contra-assets to liquidation)

Dr Dr Cr

4 100 35 200

Liquidation Liquidator’s Remun. & Exps Payable (Recognition of liability to liquidator)

Dr Cr

1 800

63 000 36 100 168 000 52 000

39 300

1 800

25.33

Solutions manual to accompany Company Accounting 10e

Liquidation (loss on sale) Mortgage on Land Land (Loss on sale of land by mortgage holder)

Dr Dr Cr

8 900 81 700

Liquidator’s Cash Liquidation (Sale of assets = 54 + 26 + 134 + 61)

Dr Cr

275 000

General Reserve Retained Earnings Liquidation (Transfer of reserves to liquidation)

Dr Dr Cr

7 000 28 100

Liquidator’s Remun & Exps Payable Mortgage on Land Debentures Accounts payable Other payables Liquidator’s Cash (Payment of liabilities in order of priority)

Dr Dr Dr Dr Dr Cr

1 800 3 300 150 000 43 200 16 100

90 600

275 000

35 100

214 400

Note: Cash in = $16 000 + $275 000 = $291 000 less cash out $214 400 = $76 600 left Share Capital – Preference Share Capital – Ordinary ‘A’ Share Capital – Ordinary ‘B’ Shareholders’ Distribution (Transfer capital accounts to shareholders’ distribution)

Dr Dr Dr Cr

20 000 25 000 12 000

Shareholders’ Distribution Liquidator’s Cash (Payment firstly to preference shareholders)

Dr Cr

20 000

Liquidation Shareholders’ Distribution (Transfer of surplus from liquidation)

Dr Cr

19 600

Shareholders’ Distribution Liquidator’s Cash (Payment of surplus on liquidation to ordinary shareholders) [as per the table below]

Dr Cr

56 600

57 000

20000

19 600

56 600

25.34

Chapter 25: Insolvency and liquidation

Share of cash and surplus No of Shares Ordinary ‘A’ Ordinary ‘B’ Cash available* Surplus Total notional cash

25 000 20 000 45 000

Paid to

$ 25 000 12 000 37 000 (56 600) 19 600

Notional Notional Call Refund $1.43556 $ $ 35 889 8 000 28 711 8 000 64 600 56 600 . 64 600

Actual Refund

Surplus share

$ 35 889 20 711 56 600

$ 10 889 8 711 19 600

Total notional cash per share = $64 600 ÷ 45 000 = $1.43556 per share * $76 600 less payment to preference shareholders $20 000 = $56 600

25.35

Solutions manual to accompany Company Accounting 10e

Question 25.11

Receivership and liquidation

On 31 March 2017, you were appointed receiver, at a remuneration of 5% of the gross proceeds on sale of assets, in respect of Cicada Ltd. Your appointment was made by the ACE Bank, which held an equitable mortgage over the assets of Cicada Ltd, in respect of an advance of $42 000 which was still owing. On 30 April 2017, Cicada Ltd went into voluntary liquidation and you were appointed liquidator for the purposes of the winding up. The trial balance of Cicada Ltd at 31 March 2017 is shown on page 0000. Cicada Ltd Trial Balance as at 31 March 2017 Debits Inventory Plant — subject to hire purchase agreement with Easy Finance Co. Ltd Other plant Work in progress Accounts receivable Retained earnings Credits Share capital (80 000 shares issued for $1 and paid to 60c) ACE Bank Accounts payable Long-service leave payable to retrenched employee Local council rates payable PAYG tax deductions from employees (to be remitted to the Australian Taxation Office) Wages owing to Y. Young (2 weeks to 31 March 2017, at $720 per week) Amount still owing as retrenchment payment

$ 30 000 3 000 24 000 12 240 39 840 23 400 $ 132 480 $48 000 42 000 35 940 2 100 1 800 600 1 440 600 $ 132 480

All assets were sold by you in your capacity as receiver, the proceeds of which amounted to $72 000. To achieve this, you had to spend $1200 to complete the work in progress. Expenses of advertising and stocktaking amounted to $1200. You made the appropriate payments from the receivership funds. After this was completed, you retired from the receivership. You were then appointed liquidator and proceeded with the distribution of funds in hand under the liquidation. Liquidator’s expenses amounted to $600. Required A. Prepare the statement of the receiver’s receipts and payments. B. Prepare the final statement of receipts and payments of the liquidator, showing in detail the order in which the funds in hand are distributed.

A. Receipts Proceeds on sale of assets

Receiver’s Statement of Receipts and Payments $ Payments 72 000

Receiver’s remuneration Receiver’s expenses Mortgage: ACE Bank

$ 3 600 2 400 42 000

25.36

Chapter 25: Insolvency and liquidation

Balance (to Liquidator) 72 000

24 000 72 000

B. Receipts

Liquidator’s Statement of Receipts and Payments $ Payments

Balance from Receiver

24 000

Liquidator’s expenses Wages Long service leave Retrenchment payment

$ 600 1 440 2 100 600 4 740

Accounts payable Rates PAYG tax 24 000

18 054 904 302 24 000

Balance available for unsecured creditors = $24 000 - $4 740 = $19 260 Total owing to unsecured creditors = $35 940 + $1 800 + $600 = $38 340 Proportion paid to unsecured creditors = $19 260 ÷ $38 340 = 50.2347c per $1

25.37

Solutions manual to accompany Company Accounting 10e

Question 25.12

Ledger accounts for liquidation

Hornet Ltd went into voluntary liquidation on 1 January 2018, at which date the statement of financial position was as shown below.

Liabilities and equity Share capital: 400 000 ordinary shares fully paid Retained earnings Mortgage loan Debentures Bank overdraft Accounts payable Other payables

HORNET LTD Statement of Financial Position as at 1 January 2018 Assets Land and buildings (net) Plant (net) $460 000 Fixed deposit 10 000 Accounts receivable 150 000 Investments 100 000 Inventory 80 000 80 000 48 000 $928 000

$250 000 400 000 10 000 98 000 50 000 120 000

$928 000

Additional information (a) Creditors were called on to prove their debts. The liquidator discovered that: • debenture interest of $7500 was due on 1 January 2018 • the Grasshopper Bank holds a mortgage over the plant as security against the overdraft; as the bank has waived its right to seize the plant, the liquidator has undertaken to sell the asset and repay the overdraft • the mortgage loan is secured over land and buildings; the mortgagee has decided to sell the assets to recover the amount owing • the debentures are secured by a circulating security interest over inventory • other payables comprise loans from directors, made on 1 December 2017. (b) Assets realised the following amounts: Land and buildings Less: Rates and selling expenses Less: Mortgage loan Plant and equipment Fixed deposit Accounts receivable Investments Inventory

$ 400 000 (16 000) (150 000)

$234 000 390 000 12 000 90 000 30 000 100 000 $ 856 000

(c) The liquidator made the following payments: Debentures Debenture interest Bank overdraft Accounts payable (in full settlement) Other payables Additional amounts not recorded in the records: Liquidator’s remuneration Liquidation expenses Holiday pay — employee Retrenchment payment — employee Income tax penalty

$100 000 7 500 80 000 76 000 48 000 25 000 11 000 4 000 10 000 3 000 $364 500

25.38

Chapter 25: Insolvency and liquidation

Required A. Prepare the Liquidation account. B. Prepare the liquidator’s statement of receipts and payments. C. Prepare the Shareholders’ Distribution account.

A. Liquidation Carrying amount of assets: Accounts receivable Inventory Plant Fixed deposit Investments Liquidation expenses Liquidator’s remuneration Interest – debentures Retrenchment payment Income tax penalty Holiday pay Shareholders’ distribution (surplus)

Proceeds from sale of assets: 98 000 Accounts receivable 120 000 Inventory 400 000 Plant 10 000 Fixed deposit 50 000 Investments 11 000 Gain on sale of L & B 25 000 Discount – accounts payable 7 500 Retained earnings 10 000 3 000 4 000 738 500 31 500

770 000

90 000 100 000 390 000 12 000 30 000 134 000 4 000 10 000

770 000

B. Receipts Land & buildings Plant Fixed deposit Accounts receivable Investments Inventory

Liquidator's Statement of Receipts and Payments $ Payments 234 000 Liquidation expenses 390 000 Bank overdraft 12 000 Debentures + interest 90 000 Liquidator's remun 30 000 Holiday pay 100 000 Retrench payment Unsecured: Other payables Accounts payable Income tax penalty Shareholders' distribution 856 000

$ 11 000 80 000 107 500 25 000 4 000 10 000 48 000 76 000 3 000 364 500 491 500 856 000

25.39

Solutions manual to accompany Company Accounting 10e

C. Shareholders’ Distribution

Cash

491 500

Share capital Liquidation

491 500

460 000 31 500 491 500

25.40

Chapter 25: Insolvency and liquidation

Question 25.13 Ledger accounts, given a report as to affairs Wasp Ltd went into liquidation on 31 March 2017. The report as to affairs prepared at that date is shown below: Valuation (1)

(2)

(3)

Assets not specifically charged: Calls in arrears (1000 ordinary shares at 25c) Cash on hand Sundry debtors Inventory Assets subject to specific charge Carrying amount Land $40 000 Less: Mortgage and accrued 24 500 interest

Estimated realisable value

250 50 24 400 51 900 76 600

200 50 18 100 17 940 36 290

Estimated realisable value $40 900 24 500

15 500

16 400

$92 100

$52 690 $52 690

Total estimated realisable value Less: Preferential creditors entitled to priority over the holders of a floating charge

(4)

Less: Amount owing under floating charge — bank overdraft

(5)

Less: Other preferential claims

(6)

Less: Unsecured creditors — ordinary Estimated surplus subject to liquidation expenses Share capital Paid-up capital: Issued preference shares: 42 000 shares fully paid at $1 Issued ordinary shares: 60 000 shares called to 60c, issued for $1 Called capital Calls on ordinary shares paid in advance: 4000 shares at 40c each

(600) 52 090 (19 440) 32 650 (1 400) 31 250 (13 450) $ 17 800

$42 000 36 000 78 000 1 600 $79 600 $22 390 Dr

Balance of Retained Earnings account, 31/3/17

Except for the return of capital to shareholders, liquidation of the company was completed at 30 September 2017. The liquidator’s statement of receipts and payments is shown opposite.

Receipts Calls in arrears Cash in hand Receivables Inventory Land (net)

Liquidator’s Statement of Receipts and Payments for 6 months ended 30 September 2017 Payments $ 250 Liquidation expenses 50 Liquidator’s remuneration 17 260 Preferential creditors 34 020 Bank overdraft 24 000 Unsecured creditors less discount Surplus available to shareholders $75 580

1 130 2 400 2 000 19 440 13 410 37 200 $75 580

The mortgage holder had taken possession of the land, sold it for $49 000, and paid the residue to the liquidator after fully satisfying the mortgage claim. Preference shares are preferred to return of capital. All uncalled capital proved recoverable.

25.41

Solutions manual to accompany Company Accounting 10e

Required Prepare the Liquidation account and the Shareholders’ Distribution account as they will appear after repayment of capital. Liquidation Carrying Amount of Assets: Receivables Inventory

24 400 51 900

Liquidator's Expenses & Remuneration Interest on Mortgage

3 530

Retained earnings

22 390

Proceeds on Sale of Assets: Receivables Inventory Creditors (discount) Gain on Disposal of Secured Asset (Land)

17 260 34 020 40 9 000

500 Share of Deficiency Ordinary Preference

102 720

42 400 102 720

Shareholders' Distribution Liquidation (deficiency): Ordinary Cash payments: Ordinary (Calls in Advance refund) Preference

42 400

Share Capital: Preference Ordinary (after final call)*

42 000 41 973

1 173

Calls in Advance - Ordinary

1 600

42 000 85 573

85 573

*$41 973 = $37 600 - $1 600 (calls in advance) + $5 973 (call – see table below)

25.42

Chapter 25: Insolvency and liquidation

Share of cash (showing shares with calls in advance separately) No of Shares

Preference Ordinary Ordinary

42 000 4 000 56 000 60 000 Cash available to ordinary* Deficiency Total notional cash

Paid to Notional Call $ 42 000 4 000 33 600 37 600 4 800 42 400

$ 22 400 22 400 (4 800) . 17 600

Notional Refund 29.333c $ 42 000 1 173 16 427 17 600

Actual Deficiency Refund share (Call) $ $ 42 000 1 173 2 827 (5 973) 39 573 (4 800) 42 400

Total notional cash per share = $17 600 ÷ 60 000 = 29.3333c per share

* After payment to preference shareholders

= $37 200 - $42 000 = ($4 800)

25.43

Solutions manual to accompany Company Accounting 10e

Question 25.14

Journal entries and ledger accounts for liquidation

The trial balance of Locust Ltd on 1 September 2018, the date on which the court ordered that the company be wound up, is presented below. LOCUST LTD Trial Balance as at 1 September 2018 Debit Bank (secured over land and buildings) Accounts payable Accrued expenses Unsecured notes Debentures (secured by a circulating security interest over the company’s assets) Share capital: 7% preference issued at $1 ‘A’ ordinary issued at $1 ‘B’ ordinary issued at $1 ‘C’ ordinary issued at $1 Allowance for doubtful debts Accumulated depreciation: Vehicles Plant and equipment Cash Accounts receivable Inventory Shares in Bee Pty Ltd Vehicles Plant and equipment Land and buildings (net) Goodwill Retained earnings

Credit $ 114 000 91 000 2 000 150 000 200 000 50 000 200 000 40 000 20 000 1 000 17 000 40 000

100 97 000 146 400 17 500 29 000 181 000 250 000 24 000 180 000 $925 000

$925 000

Additional information (a) Share capital consisted of: 50 000 7% preference shares fully paid 200 000 ‘A’ ordinary shares fully paid 100 000 ‘B’ ordinary shares paid to 40c 100 000 ‘C’ ordinary shares paid to 20c The constitution provided that preference shareholders were preferential as to return of capital in a winding up, and ‘C’ ordinary shareholders were deferred as to return of capital until all other classes of shares had been paid in full. (b) Proceeds from sale of assets (the bank agreed to allow the liquidator to sell the land and buildings): Accounts receivable $ 71 000 Inventory 100 000 Shares in Bee Pty Ltd 10 000 Vehicles 10 000 Plant and equipment 116 000 Land and buildings 240 000 (c) Calls on shares: The liquidator called up the uncalled balance on ‘B’ ordinary shares and ‘C’ ordinary shares. Holders of 10 000 ‘C’ ordinary shares and 10 000 ‘B’ ordinary shares failed to pay the call and these shares were subsequently forfeited.

25.44

Chapter 25: Insolvency and liquidation

(d) Payments made by liquidator after negotiation with creditors: Liquidation expenses $ 2 100 Liquidator’s remuneration 4 000 Bank overdraft and interest 116 000 Accounts payable 89 000 Accrued expenses 2 200 Unsecured notes and interest 154 500 Debentures and interest 206 000 Required A. Prepare journal entries to wind up the affairs of Locust Ltd. B. Prepare the Liquidation account, the Cash account and the Shareholders’ Distribution account, clearly showing the share of cash for each class of shares.

A. General Journal Liquidation Accounts Receivable Inventory Shares in Bee Pty Ltd Vehicles Plant & Equipment Land and Buildings Goodwill (Asset accounts transferred to liquidation)

Dr Cr Cr Cr Cr Cr Cr Cr

744 900

17 000

Dr Dr Cr

40 000 1 000

Cash Liquidation (Proceeds on sale of assets)

Dr Cr

547 000

Liquidation Liquidation Expenses Payable Liquidator’s Remun. Payable Bank Overdraft Accrued Expenses Unsecured Notes Debentures (Unrecorded liabilities, debited to liquidation account and representing interest on unsecured notes and debentures, and liquidation expenses)

Dr Cr Cr Cr Cr Cr Cr

18 800

Accumulated Depreciation Vehicles Accumulated Depreciation Plant & Equipment Allowance for Doubtful Debts Liquidation (Contra-assets transferred)

97 000 146 400 17 500 29 000 181 000 250 000 24 000

58 000

547 000

2 100 4 000 2 000 200 4 500 6 000

25.45

Solutions manual to accompany Company Accounting 10e

Accounts Payable Liquidation (Discount given by payables)

Dr Cr

2 000

Call - ‘B’ Ordinary Call - ‘C’ Ordinary Share Capital - ‘B’ Ordinary Share Capital - ‘C’ Ordinary (Call made on ‘B’ ordinary shares (60c) and ‘C’ ordinary shares (80c)

Dr Dr Cr Cr

60 000 80 000

Cash Dr Call - ‘B’ Ordinary Cr Call - ‘C’ Ordinary Cr (Receipt of cash on 90 000 ‘B’ ordinary @ 60c and 90 000 ‘C’ ordinary @ 80c)

126 000

Liquidation Expenses Payable Bank Overdraft Debentures (+ interest) Liquidator’s Remun. Payable Unsecured Notes (+ interest) Accounts Payable Accrued Expenses Cash (Liabilities paid in order of priority)

Dr Dr Dr Dr Dr Dr Dr Cr

2 100 116 000 206 000 4 000 154 500 89 000 2 200

Share Capital - ‘B’ Ordinary Call - ‘B’ Ordinary Forfeited Shares Reserve (Forfeiture of 10 000 ‘B’ Ordinary shares)

Dr Cr Cr

10 000

Share Capital - ‘C’ Ordinary Call - ‘C’ Ordinary Forfeited Shares Reserve (Forfeiture of 10 000 ‘C’ ordinary shares)

Dr Cr Cr

10 000

Share Capital - Preference Share Capital - ‘A’ Ordinary Share Capital - ‘B’ Ordinary Share Capital - ‘C’ Ordinary

Dr Dr Dr Dr

2 000

60 000 80 000

54 000 72 000

573 800

6 000 4 000

8 000 2 000

50 000 200 000 90 000 90 000

25.46

Chapter 25: Insolvency and liquidation

Shareholders' Distribution (Transfer of share capital to shareholders' distribution)

430 000

Liquidation Forfeited Shares Reserve Retained Earnings (Transfer of accumulated losses and forfeited shares reserve to liquidation)

Dr Dr Cr

174 000 6 000

Shareholders' Distribution Liquidation (Deficiency on liquidation transferred)

Dr Cr

330 700

Shareholders' Distribution Cash (Final payment to shareholders as per schedule)

Dr Cr

99 300

180 000

330 700

99 300

B. Liquidation Asset balances transferred Unrecorded liabilities

Accumulated losses and Forfeited Shares Reserve

744 900 Contra-Assets 18 800 Cash (Sale of Assets) Creditors (discount)

58 000 547 000 2 000

Shareholder's Distrib: 174 000 (deficiency) (‘A’ Ord. $166 000) (‘B’ Ord. 74 700) (‘C’ Ord. 90 000)

330 700

937 700

Cash Balance Liquidation (Sale of Assets) Calls on ‘B’ Ordinary and ‘C’ Ordinary shares

100 547 000 126 000

Payment of liabilities Payment to: Preference ‘A’ Ordinary ‘B’ Ordinary

673 100

573 800 50 000 34 000 15 300 673 100

25.47

Solutions manual to accompany Company Accounting 10e

Shareholders' Distribution Liquidation (deficiency) (‘A’ Ord. 166 000) (‘B’ Ord. 74 700) (‘C’ Ord. 90 000) Cash (Preference 50 000) (‘A’ Ord. 34 000) (‘B’ Ord. 15 300)

330 700

Share Capital

430 000

99 300

430 000

Share of cash (after forfeiture of shares and payment to preference shares) No of Shares ‘A’ Ordinary ‘B’ Ordinary ‘C’ Ordinary Cash available Deficiency Total notional cash

200 000 90 000 290 000 90 000 380 000

Paid to Notional Call $ 200 000 90 000 290 000 90 000 380 000 49 300 330 700

$ 49 300 . 49 300

Notional Refund 17c $ 34 000 15 300 49 300 49 300

Actual Deficiency Refund share (Call) $ $ 34 000 166 000 15 300 74 700 49 300 240 700 90 000 49 300 330 700

Total notional cash per ‘A’ and ‘B’ ordinary share = $49 300 ÷ 290 000 = 17c per share * After paying preference shares $50 000

25.48

Chapter 25: Insolvency and liquidation

Question 25.15

Journal entries, given a report as to affairs

At 31 July 2017, the liquidator of Ladybird Ltd, who had been appointed by the court, prepared the report as to affairs shown opposite. Other information (a) Accumulated depreciation on plant and equipment is recorded at $14 000. (b) Arrears of cumulative preference dividend, $12 000. The constitution gives the preference shareholders priority of payment of arrears of preference dividends. All shares rank equally per share as to return of capital. (c) Of the $93 000 trade creditors recognised by the liquidator, Ladybird Ltd had not recorded $3000. Further, Ladybird Ltd had not recorded unpaid salaries and wages amounting to $1400. (d) At the completion of the winding up, the following additional information was available: • interest accrued on mortgage, $2000, and on debentures, $1200 • liquidation expenses, $800, and liquidator’s remuneration, $4000 • no bill receivable was dishonoured • all other creditors were paid the amounts reported in the report as to affairs • land and buildings realised $75 000 • all other assets realised the amounts estimated. (e) In relation to the land and buildings, the mortgagee sold the assets and remitted to the liquidator any amount in excess of the debt due. LADYBIRD LTD Report as to Affairs as at 31 July 2017 Valuation (1) Assets not specifically charged: Interests in land Sundry debtors Cash on hand Cash at bank Inventory Work-in-progress Plant and equipment at cost/value Other assets — Bills receivable (2) Assets subject to specific charge Land and buildings Less: Amounts owing (mortgage)

Total estimated realisable value (3) Less: Preferential creditors entitled to priority over floating charge: claims by employees — salaries and wages (4) Less: Amounts owing and secured by floating (5) charge — debentures Less: Preferential creditors

Estimated realisable value

— $ 58 000 — 1 000 122 000 — 82 000 48 000 311 000

— $ 36 000 — 1 000 94 000 — 44 000 28 000 203 000

91 000 (70 000) 21 000 $332 000

80 000 (70 000) 10 000 $213 000 $213 000

(1 400) 211 600 (30 000) — 181 600

(6) Balances owing to unsecured creditors:

25.49

Solutions manual to accompany Company Accounting 10e

Trade creditors Income tax payable

(93 000) (4 000)

(97 000)

Estimated surplus subject to liquidation $ 84 600 expenses Share capital Issued: 90 000 ordinary shares fully paid $ 125 000 50 000 6% preference shares, fully paid 50 000 Total share capital $ 175 000 Retained earnings $ 19 000 Cr Required Prepare the journal entries in Ladybird Ltd to wind up the company. (Show calculations for the distribution of cash to shareholders.)

Liquidation Sundry Debtors Inventory Plant and Equipment Bills Receivable (Transfer of assets)

Dr Cr Cr Cr Cr

310 000

Accumulated Depreciation Liquidation (Transfer of contra-assets)

Dr Cr

14 000

Liquidation Preference Dividend Payable Trade Creditors Salaries and Wages Payable Mortgage Payable Debentures Liquidation Expenses Payable Liquidator’s Remuneration Payable (Liabilities arising during liquidation)

Dr Cr Cr Cr Cr Cr Cr Cr

24 400

Cash Mortgage Payable Liquidation - loss on disposal Land and Buildings (Sale of land and buildings by mortgagee)

Dr Dr Dr Cr

3 000 72 000 16 000

Cash Liquidation (Proceeds from sale of assets)

Dr Cr

202 000

58 000 122 000 82 000 48 000

14 000

12 000 3 000 1 400 2 000 1 200 800 4 000

91 000

202 000

25.50

Chapter 25: Insolvency and liquidation

Liquidation Expenses Payable Debentures Liquidator’s Remuneration Payable Salaries and Wages Payable Trade Creditors Preference Dividends Payable Cash (Payment of liabilities)

Dr Dr Dr Dr Dr Dr Cr

800 31 200 4 000 1 400 97 000 12 000

Retained Earnings Liquidation (Transfer of reserve accounts)

Dr Cr

19 000

Share Capital - Preference Share Capital - Ordinary Shareholders’ Distribution (Transfer of capital accounts)

Dr Dr Cr

50 000 125 000

Shareholders’ Distribution Liquidation (Transfer of balance representing deficiency on liquidation)

Dr Cr

115 400

Shareholders’ Distribution Cash (Payment of $21 286 to Preference shareholders and $38 314 to Ordinary shareholders)

Dr Cr

59 600

146 400

19 000

175 000

115 400

59 600

WORKINGS: Share of cash No of Shares

Paid to Notional Call

$ Cash available* 59 600 Deficiency . Total notional cash 59 600 *Cash available = $206 000 - $146 400 = $59 600 Preference Ordinary

50 000 90 000 140 000

$ 50 000 125 000 175 000 (59 600) 115 400

Notional Refund 42.5714c $ 21 286 38 314 59 600

Actual Deficiency Refund share (Call) $ $ 21 286 28 714 38 314 86 686 59 600 115 400

Total notional cash per share = $59 600 ÷ 140 000 = 42.5714c per share Liquidation Sundry Debtors Inventory

58 000 122 000

Accumulated Depreciation Proceeds of Sale

14 000 202 000

25.51

Solutions manual to accompany Company Accounting 10e

Plant and Equipment Bills Receivable Arrears – Pref. Dividends Trade Creditors Salaries and Wages Interest – mortgage Interest – Debentures Liquidation Expenses Liquidator’s Remuneration Loss on Disposal - Land & Buildings

82 000 48 000 12 000 3 000 1 400 2 000 1 200 800 4 000 16 000

Retained earnings

19 000

Shareholders’ Distribution

115 400

350 400

Cash Opening Balance: Sundry Debtors Inventory Plant & Equipment Bills Receivable Mortgagee

1 000 36 000 94 000 44 000 28 000 3 000

Liquidation Expenses Salaries and Wages Debentures Liquidator’s Remuneration Trade Creditors Preference Dividends

800 1 400 31 200 4 000 97 000 12 000 146 400

Preference Shareholders Ordinary Shareholders

21 286 38 314 206 000

206 000

Shareholders' Distribution Liquidation (Deficiency) Cash – Preference Cash – Ordinary

115 400 21 286 38 314 175 000

Share Capital – Preference Share Capital – Ordinary

50 000 125 000 175 000

25.52

Chapter 25: Insolvency and liquidation

Question 25.16

Report as to affairs and ledger accounts

The statement of financial position of Snail Ltd on page 0000 was prepared at 30 June 2017, before liquidation proceedings were commenced. SNAIL LTD Statement of Financial Position as at 30 June 2017 Equity Share capital: 30 000 10% preference shares issued at $1, fully paid 20 000 ordinary shares called to 75c, issued at $1 Less: Calls in arrears 25c on 5000 shares Retained earnings Total equity Liabilities Accounts payable GST payable Rent payable Telephone account payable Electricity account payable PAYG tax instalment Wages payable Managing director’s salary payable Fringe benefits tax payable Bank overdraft (secured by circulating security interest) Mortgage payable (secured on freehold) Partly secured creditor (holding $5000 security on plant) Total equity and liabilities Assets Freehold land and buildings (net) Plant (net) Inventory Bills receivable Accounts receivable Cash on hand Total assets

$ 15 000 (1 250)

$ 30 000 13 750

43 750 (6 310) 37 440 19 900 100 90 250 300 420 700 2 350 450 9 000 45 000 8 000

Additional information (a) It is estimated that $1000 of the calls in arrears would be received. (b) The estimated sales values of the assets are as follows: Freehold land and buildings Inventory Accounts receivable Bills receivable Plant (including $5000 on plant over which a security is held)

86 560 $124 000 $ 57 000 12 500 34 000 1 700 15 500 3 300 $124 000

$ 60 000 29 000 11 000 1 700 10 000

Required A. Prepare a report as to affairs as at 30 June 2017. B. Assuming that the liquidator realises all assets (including land and buildings, and plant) and calls in arrears at the amounts estimated, forfeits those shares that do not pay the call, pays the creditors at the amounts as listed in the statement of financial position (except for

25.53

Solutions manual to accompany Company Accounting 10e

accounts payable who settle out at $19 000) and distributes the balance after deducting his expenses of $950 and his remuneration of $2850, prepare the Liquidation account, the Shareholders’ Distribution account, and liquidator’s statement of receipts and payments. The constitution provides that all shares rank equally, per share, as to return of capital.

REPORT AS TO AFFAIRS Assets and liabilities as at 30 June 2017 Valuation

$ 1. Assets not specifically charged (a) Interest in land (b) Sundry debtors: A/cs receivable Sundry debtors: Bills Receivable Sundry debtors: Calls in Arrears (c) Cash on hand (d) Cash at bank (e) Stock as detailed in inventory (f) Work in progress (g) Plant and equipment (Book Value $12 500 - $5 000 partly secured) (Est. realisable value $10 000-$5 000)

Estimated Realisable Value

15 500 1 700

11 000 1 700

1 250 3 300 34 000 7 500

1 000 3 300 29 000 5 000

63 250

51 000

(h) Other assets 2. Assets subject to specific charges Freehold land and buildings Less Mortgage

57 000 45 000

12 000

15 000

Plant Less Secured Creditor

5 000 5 000

75 250

66 000

Total estimated realisable value 3. Less Preferential creditors entitled to priority over the holders of debentures under any floating charge Wages Managing Director's Salary

66 000

700 2 000

2 700 63 300

4. Less Amounts owing and secured by debenture or floating charge over company assets

25.54

Chapter 25: Insolvency and liquidation

Bank overdraft 5. Less Preferential Creditors Estimated amount available for Unsecured creditors 6. Creditors (unsecured) Accounts payable GST payable Rent payable Telephone bill payable Electricity bill payable Managing Director's salary PAYG Tax Instalment Fringe Benefits Tax payable 7. Balances owing to partly secured creditors Total claims Security held

9 000 54 300 54 300 19 900 100 90 250 300 350 420 450 8 000 5 000

8. Contingent assets 9. Contingent liabilities Estimated surplus (Subject to costs of liquidation) Share Capital: Issued: 30 000 10% preference shares issued at $1 20 000 ordinary shares at $1 Paid: 30 000 preference shares 15 000 ordinary shares paid to 75c 5 000 ordinary shares paid to 50c

3 000

24 860 29 440 29 440

30 000 20 000 30 000 11 250 2 500

50 000

43 750

25.55

Solutions manual to accompany Company Accounting 10e

Liquidation Carrying Amount of Assets: Land and Buildings Plant Inventory Bills Receivable Accounts Receivable Liquidation Expenses

57 000 12 500 34 000 1 700 15 500 950

Liquidator's Remuneration

2 850

Retained Earnings

6 310

Proceeds from sale: Land and Buildings Plant Inventory Bills Receivable Accounts Receivable Discount from Accounts Payable Forfeited Shares Deficiency to: Preference Ordinary

130 810

60 000 10 000 29 000 1 700 11 000 900

500* 10 843 6 867 130 810

Shareholders' Distribution * Deficiency: Preference Ordinary Cash Payments: Preference Ordinary

10 843 6 867

Share Capital: Preference Ordinary (19 000 @ 75c)

30 000 14 250

19 157 7 383 44 250

44 250

* After forfeiture of 1 000 ordinary shares.

25.56

Chapter 25: Insolvency and liquidation

Receipts

Liquidator's Statement of Receipts and Payments $ Payments

Cash on Hand Sale of Assets: Land and Buildings Plant Inventory Bills Receivable Accounts Receivable Call on ordinary shares

3 300 Liquidation Expenses Mortgage Payable 60 000 Secured Creditor 10 000 Bank Overdraft 29 000 Liquidator’s remuneration 1 700 Wages 11 000 Managing Director's Salary 1 000 Unsecured Creditors: Accounts Payable PAYG Tax Instalment GST Fringe Benefits Tax Rent Telephone Electricity Managing Director's Salary Partly secured Creditors Payment to: Preference Ordinary 116 000

$ 950 45 000 5 000 9,000 2 850 700 2 000 19 000 420 100 450 90 250 300 350 3 000 89 460 19 157 7 383 116 000

Share of cash (after forfeiture of 1 000 ordinary shares) No of Shares

Preference Ordinary Cash available* Deficiency Total notional cash

30 000 19 000 49 000

Paid to Notional Call $ 30 000 14 250 44 250 (26 540) 17 710

$ 4 750 4 750 26 540 . 31 290

Notional Refund 63.857c $ 19 157 12 133 31 290

Actual Deficiency Refund share (Call) $ $ 19 157 10 843 7 383 6 867 26 540 17 710

* Cash available = $116 000 - $89 460 = $26 540 Total notional cash per share = $31 290 ÷ 49 000 = 63.857c per share

25.57

Solutions manual to accompany Company Accounting 10e

Question 25.17

Sale of assets, final distribution to shareholders

As a result of a court order, Spider Ltd went into liquidation on 30 June 2017. A statement of financial position prepared on that date was as follows: SPIDER LTD Statement of Financial Position as at 30 June 2017 Equity Share capital: 80 000 preference shares, issued at $2 and paid to $1 136 000 ‘A’ ordinary shares, issued for $2, called to $1.50 100 000 ‘B’ ordinary shares, issued for $1, called to 75c

$ 80 000 204 000 75 000 359 000

Less: Calls in arrears: 24 000 ‘A’ ordinary shares 2400 ‘B’ ordinary shares Calls in advance: 4000 ‘A’ ordinary shares at 50c General reserve Retained earnings (losses) Total equity Current assets Cash Accounts receivable Allowance for doubtful debts Inventories Total current assets Non-current assets Land Buildings Less: Accumulated depreciation Plant and equipment Less: Accumulated depreciation Goodwill Less: Accumulated impairment losses Total non-current assets Total assets Current liabilities Loan (unsecured) Creditors and accruals Total current liabilities Non-current liabilities Mortgage (secured on land and buildings) Total non-current liabilities Total liabilities Net assets

$ (6 000) (600)

(6 600) 352 400 2 000 51 600 (26 000) $380 000 $ 1 800

111 000 (2 000)

109 000 39 200 150 000 $ 140 000

$ 432 000 (326 000) 210 000 (160 000) 44 000 (8 000)

106 000 50 000 36 000 332 000 482 000 12 000 50 000 62 000 40 000 40 000 102 000 $380 000

Additional information (a) The company’s constitution was silent as to return of capital in the event of a winding up. (b) The mortgage holder took possession of the land and buildings, sold them for $286 000, paid off the mortgage plus interest owing of $1600 and refunded the difference to the liquidator. (c) The liquidator was able to realise the following amounts for the assets:

25.58

Chapter 25: Insolvency and liquidation

Plant and equipment Inventories Accounts receivable

$49 000 34 000 107 000 $190 000

(d) The ledger account Creditors and Accruals comprises: Workers compensation owing to employee Company income tax owing Annual leave owing to a director’s son Trade creditors

$ 10 000 20 000 4 000 16 000 $50 000

(e) Additional liabilities accepted by the liquidator and not yet recorded were as follows: Interest accrued on mortgage Salaries owing to two directors ($30 000 + $32 000) Retrenchment payments owing to four employees Wages owing to 14 employees

1 600 62 000 40 000 270 000 $373 600

(f) All calls in arrears were received by the liquidator, except from 4000 ‘A’ ordinary shares. These shares were forfeited. (g) Calls in advance were not paid back before the final distribution by the liquidator. Uncalled capital (where required to be called up) on final distribution proved to be recoverable. (h) Liquidation expenses amounted to $7600. Required A. Prepare the journal entry in Spider Ltd’s records to record the sale by the mortgage holder of the land and buildings, and the receipt of any net cash from the mortgage holder. B. Prepare the Liquidation ledger account. C. Prepare the liquidator’s statement of receipts and payments, showing clearly the order of priority of payment of liabilities. D. Show all workings for calculation of the final distribution of deficiency or surplus to shareholders.

A Journal entry for secured creditor: Cash Dr 244 400 Mortgage Payable Dr 40 000 Interest Payable** Dr 1 600 Accum Depn - Bldgs Dr 326 000 Buildings Cr 432 000 Land Cr 140 000 Liquidation Cr 40 000 ** Assumes interest recognised by liquidator. If not, then gain on liquidation is $38 400. B. Accounts receivable Inventories Plant & equipment

Liquidation 111 000 Allow for doubtful debts 39 200 Accum depn – plant & equip 210 000 Accum impairment losses - goodwill Gain - Sale land & buildings

2 000 160 000 8 000 40 000 25.59

Solutions manual to accompany Company Accounting 10e

Goodwill Liquidation expenses Interest on mortgage Directors’ salaries Retrenchment Wages Accumulated losses

44 000 7 600

General reserve Cash: Sale of assets

51 600 190 000

1 600 62 000 40 000 270 000 26 000

Forfeited shares reserve

5 000 456 600 116 616 192 415 45 769

S/H distrib -

Preference ‘A’ Ordinary ‘B’ Ordinary

811 400

Entry to forfeit 4 000 shares Share Capital ‘A’ Ord Call Forfeited Shares Reserve

811 400

Dr Cr Cr

6 000 1 000 5 000

Receipts Balance Cash from mortgage holder Sale of Assets Call on ‘A’ Ord Call on ‘B’ Ord Call on Preference

Liquidator’s Statement of Receipts and Payments Payments 1 800 Liquidation expenses 244 400 Salaries - directors. 190 000 5 000 600 441 800 36 616

Wages – employees Worker’s compensation Annual leave Retrenchment Unsecured Loan Trade creditors Company tax Salaries directors Annual leave Refund: ‘A’ Ordinary ‘B’ Ordinary

478 416

7 600 4 000 270 000 10 000 1 500 40 000 12 000 16 000 20 000 58 000 2 500 441 600 7 585 29 231 478 416

25.60

Chapter 25: Insolvency and liquidation

D. Share of cash (after forfeiture of 4 000 ‘A’ ordinary shares). ‘A’ ordinary shares with calls in advance treated separately below No of Shares

Preference ‘A’ Ord ‘A’ Ord in adv. ‘B’ Ord Cash available* Deficiency Total notional cash

80 000 128 000 4 000 100 000 312 000

Paid to Notional Call $ 80 000 192 000 8 000 75 000 355 000 (200) 354 800

$ 80 000 64 000 25 000 169 000 200 . 169 200

Notional Refund 54.231c $ 43 384 69 416 2 169 54 231 169 200

Actual Deficiency Refund share (Call) $ $ (36 616) 116 616 5 416 186 584 2 169 5 831 29 231 45 769 200 354 800

*Cash available = $441 800 - $441 600 = $200 Total notional cash per share = $169 200 ÷ 312 000 = 54.231c per share No. of ‘A’ Ordinary shares 136 000 - 4 000 (forfeited) - 4 000 (calls in advance) = 128 000

25.61