Corporate Financial Reporting

ACCT2542 Corporate Financial Reporting & Analysis Semester 2 2009

Version 1.0.3

Corporate Financial Reporting & Analysis

Page 3 Accounting for Income Tax

Page 7 Consolidation Accounting





Page 26 Accounting for Asso

Page 30 Accounting for Interests in Joint Ventures

Page 33 Introduction to Corporate Financial Reporting

Page 36 Presentation of Financial Statements

Page 40 Earnings Per Share

Page 44 Principals of Disclosure

Copyright Ka Hei Yeh 2009

First Edition published October 2009.

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g & Analysis Semester 2 2009

Contents

Accounting for Income Tax

Consolidation Accounting Principles

Consolidation Accounting Wholly Owned Subsidiaries

Consolidation Accounting Intragroup Transactions

Consolidation Accounting Minority Interests

Consolidation Accounting Indirect Ownership

Accounting for Associates The Equity Method

Accounting for Interests in Joint Ventures

Introduction to Corporate Financial Reporting

Presentation of Financial Statements

Earnings Per Share

Principals of Disclosure

published October 2009. (Revised February 2010)

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Corporate Financial Reporting & Analysis Semester 2 2009 3


Background

Accounting for income tax is not as easy as it seems. A businesss accounting profit is rarely

ever the same as its tax profit (or taxable income). This is because they are determined using

different rules. As such, methods must be used to find out a businesss tax profit based on its

accounting profit by using the balance sheet and other accounting information.

Finding Taxable Profit from Accounting Profit

As such, our first step is to define how we get from accounting profit to taxable profit. We

generally take the following steps:

1. Find the accounting profit

2. Add back any expenses that are not tax deductible

3. Deduct away any revenues that are not considered assessable income

4. Add any assessable incomes which are not considered revenue

5. Deduct any tax deductions that are not expenses

Following this, we should get our taxable profit. This is explained later.

Permanent and Temporary Differences

The differences between accounting and tax profit can either be permanent or temporary.

Permanent differences are differences that affect one of either of the profits and will never

affect the other. Such examples include:

Government Grants

Tax Exemptions/Deductions

Tax exemptions and deductions are permanent because both accounting and tax profit take

into account the expenditure from things that cause exemptions and deductions (such as a tax

deduction on purchases of new vehicles) but only tax profit will take into account the

exemption/deduction by further reducing the tax profit whereas it does not further reduce

accounting profit. A permanent difference can affect accounting profit more but not tax profit.

Permanent differences are not explicitly defined in the AASB 112 (Income Tax Standard) but

it does state that any that appear must be disclosed in the financial reports.

Temporary differences are those that occur in both accounting and tax profit but they occur

in different periods. They are defined in the AASB 112 as, differences between the carrying amount

of an asset or liability in the balance sheet and its tax base.

Carrying Amount is the amount at which the asset or liability is recorded on the balance

sheet. Tax Base is the amount which is attributed to the asset or liability for tax purposes. These two

may or may not be the same.



Examples of temporary differences include:

Interest revenue

Instantly recognised by accounting profit, but only recognised in tax profit when actually

cashed out.

Provision for long service leave

Instantly recognised by accounting profit, but only recognised when the long service leave is

actually paid for.

Calculating the Tax Base of an Asset and Liability

The tax base of an asset is calculated by taking the carrying amount and:

Deducting future taxable amounts

Adding future deductible amounts

For a liability, we simply add future taxable amounts and deduct future deductable amounts;

which is the opposite of what is done for assets.

Example:

In our provision for long service leave (a liability), assume we put $1000 in there as our

expense for this year. We know from the above that provision for long service leave is fully tax

deductable only when it is paid out. This is a future deductible amount as it can be deducted in the

future; but not now. As such the tax base of this would be $1,000 + $0 - $1,000 = $0.

Taxable and Deductible Temporary Differences

Temporary differences can be further split into two types based on the asset or liabilitys

carrying amount and tax base.

Taxable temporary differences result in greater taxable income in the future, such as:

An assets carrying value exceeds its tax base, or,

A liabilitys carrying value is exceeded by its tax base.

Since this causes a greater taxable income in the future, this taxable temporary difference,

when multiplied by the tax rate, gives the deferred tax liability. (i.e. the amount of tax that the

business ultimately has to pay in the future because of this temporary difference.)

Examples of a taxable temporary difference include: interest revenue (this is not treated as

assessable income until the actual cash is received), accelerated depreciation (where depreciation is

accelerated for tax purposes) and capitalised costs (as opposed to being expensed).

Deductible temporary differences result in a lower taxable income in the future. This occurs

when:

An assets carrying value is exceeded by its tax base, or,

A liabilitys carrying value exceeds its tax base.



These will result in a lower taxable income in the future and, when multiplied by the tax rate,

gives the deferred tax asset amount. (i.e. the business has already paid for the tax and will not

need to pay any it when the amount is recovered or settled in the future.)

Examples of a deferred tax asset include: provisions (as seen before, all provisions are tax

deductible when paid out) and allowance for doubtful debts (only deductable when it does go bad).

Components in Accounting for Income Tax

From what weve seen above, a companys total tax liability can be split into two parts:

Current Tax

This is the tax that the business has to pay now during the current period.

Deferred Tax

This is the tax that the business will be required to pay when the asset is realised or a

deduction when the liability is expensed.

The Statement of Taxable Income

The Statement of Taxable Income basically shows the tabular process of finding taxable

profit by deduction from the firms accounting profit and other information (as stated on Page 3).

A thorough illustrative example is provided from Slide 39 to Slide 50 of Week 1 lecture notes.

Another example can also be found in Picker et al, Page 189 and Page 207.

Note that in the process of finding the carrying value of items in the statement may require

you to find missing values through the reconstruction of T-Accounts. Refer to ACCT1511 notes if you

have forgotten how to do this.

After finding the current tax liability (say $11,000), we need to do the following journal entry:

Dr Income Tax Expense 11,000

Cr Current Tax Liability 11,000

The Deferred Tax Worksheet

The Deferred Tax Worksheet is simply an extension of the process we use to find taxable or

deductable temporary differences. Although the worksheet looks complex, the process is simple:

1. Take the entire firms assets and liabilities and list out their current carrying value.

2. Deduce the tax bases of all those assets and liabilities.

3. Calculate the difference between the carrying value and the tax value.

4. Based on the kind of asset or liability, place it as a taxable amount or a deductible amount.

5. Add all these taxable and/or deductible temporary differences.

6. Multiply these two figures by the tax rate to find the deferred tax asset and deferred tax

liability respectively.

7. Deduct the respective beginning balances to find the adjustment required.



A thorough illustrative example is provided from Slide 51 to Slide 59 of Week 1 lecture notes.

Another example can also be found in Picker et al, Page 200.

After finding the adjustment values for both Deferred Tax Asset and Deferred Tax Liability,

we will need the following journal entry:

Dr/Cr Deferred Tax Asset [Debit if the adjustment is positive; Credit if negative.]

Dr/Cr Deferred Tax Liability [Credit if the adjustment is positive; Debit if negative.]

Dr/Cr Income Tax Expense [This balances the journal out so it depends on the above two.]

Tax Losses

Sometimes, a business may have more deductions than assessable income (although very

rarely). In this case, the tax office will not reimburse the firm with cash. Instead, they will defer the

deduction until a period where there is no tax loss and the company can then realise the deferred

tax asset.

Asset Revaluation and Tax

Previously, we have learnt that if we revalue an asset, such as a land, we would do the

following:

Dr Land 10,000

Cr Asset Revaluation Reserve 10,000

This is technically correct when there is no tax. However, when we have tax, we also need to

tax the Asset Revaluation Reserve at the current tax rate (30% in Australia). We would need to also

include the following journal entry:

Dr Asset Revaluation Reserve 3,000

Cr Deferred Tax Liability 3,000

We can shorten the above two into a single journal entry to save time.

Dr Land 10,000

Cr Income Tax Expense 7,000


We will also need to reflect this in our deferred tax journal entry by also adding:

Dr Asset Revaluation Reserve 3,000

Consolidation Accounting - Principles


Consolidation Accounting Principles

Background

Consolidation accounting is accounting for business combinations (i.e. more than one entity).

This means things such as creating a balance sheet, income statement etc. for the entire business

group as one whole. Naturally this is similar to normal accounting but there are differences we need

to understand.

Business Combinations

To have a business combination, there must be control. Control is defined as, the power to

govern the financial and operating policies of an entity or business so as to obtain benefits from its

activities. To gain this control, an entity usually needs to have the majority of voting rights in the

entity in question.

It does not matter if a business does not exercise its power over another entity as long as it

holds power.

Example:

Company A has 49% of shares in Company B. Company C has 51% of shares in Company B.

Therefore, Company C has control over Company B.

If Company A has 49%, but the other 51% was owned by many other individuals, then

Company A has control of company B.

In the above example, Company A is the, parent and Company B is the, subsidiary. When

lots of companies are holding shares in each other, it is very hard to determine who has control. As

such, many entities use this as a way to avoid consolidation but still be considered a group.

There are many ways of achieving control over another company. These can be:

Script acquisitions: Company A buys shares in Company B in exchange for shares in

Company A. This means that people who have shares in Company B end up with shares in

Company A.

Purchase method: Directly buying shares in another company to gain control.

At the moment, we will only look at parent-subsidiary relationships where one company

controls another. We will look at other relationships such as joint-ventures later.

Determining the Cost of Acquisition

When a parent acquires control over a subsidiary, it measures the cost of combination as

the fair values of assets, liabilities and equity acquired at the date of exchange. We must note that

this can be different to the carrying amount of the asset on the subsidiarys balance sheet.

Any costs directly associated with the acquisition must also be attributed as a cost of

acquisition.



The acquirer shall only recognise assets and liabilities that can have their fair values

measured reliably; including intangible assets and contingent liabilities.

Recall that fair values can be determined through various methods including:

The current market value of the asset/liability

An estimated value based on comparison with something that has equal or almost equal

features.

The present value of the asset/liability

The net selling value of the asset/liability

The depreciated replacement cost of the asset

Goodwill

Goodwill is the excess that is paid to acquire a business based on its fair value. i.e. If the fair

value of a firms assets and liabilities equals $45,000 but the acquirer paid $50,000 to acquire the

business, then $5,000 can be attributable as goodwill.

Goodwill can only be recognised by the firm being acquired and only purchased goodwill can

be recognised. That is, only an entity which has been purchased before can have goodwill.

Excess

The opposite of goodwill is excess. This is when the acquirer pays less than the fair value of

the assets and liabilities of the entity being acquired. Unlike goodwill, excess is immediately

recognised as a profit or loss.

An excess rarely occurs and if you end up with an excess, you should double check to make

sure you did not make any mistakes. Even the AASB 3 assumes that excesses result from

mathematical calculation errors as this is very rare. If, after recalculation and double checking, an

excess still results, you can then recognise it.

The journal entry to immediately recognise excess as a gain is:

Dr Excess XXXXX

Cr Gain on Acquisition of Subsidiary XXXXX

The Consolidation Method

There are three stages to the consolidation method. These are:

1. Line-by-line aggregation

This is simply adding up the same accounts in the parent and the subsidiary together, such

as adding both entities accounts receivables together etc.

2. Elimination and adjustments for intra-group activities

This is the process of removing any internal activities between the parent and subsidiary. If

the parent sold something to the subsidiary, in terms of the company, nothing has changed,

so we need to eliminate this activity.



A simple example will help clear this up:

Put $4 into your left pocket. Call your left pocket Company A and your right pocket

Company B. Now, take $4 and move it to your right pocket. You have just simulated an inter-group

transaction between Company A and B. But look at yourself, as a person (the entity), you still have $4.

All you did was move the money around. This is exactly what we are trying to eliminate.

3. Allocation to minority interest

This is the allocation that is required when the parent does not own 100% of the subsidiary

and must allocate a portion of the equity to the minority interest.

The Consolidation Worksheet

The Consolidation Worksheet is used to tabulate the above process. It looks like as below:

Parent Ltd Subsidiary Ltd Elimination Entries Consolidated

Balance Dr Cr

Capital

Ret. Earnings

Liabilities

Assets

-Goodwill

-Investment

-Others

Here, we simply add across, taking into account any elimination entries. Elimination entries

are those journal entries that we take the remove intra-group activities such as mention before.

Note that the two Debit and Credit columns must equal each other.

We use the consolidated balance to prepare the consolidated financial statements.

We must also note that these journal entries and the consolidation worksheets are all

temporary; we only use them for one time. The next time we need to do the statements again, we

must go through the entire process again from scratch to produce the consolidated statements.



Consolidation Accounting

Wholly Owned Subsidiaries

Background

Wholly owned subsidiaries are those where a parent has 100% of the shares in the

subsidiary, meaning that they have full control.

Adjustments for Fair Value

When adjusting assets to their fair value, we use the following journal entry:

Dr Asset

Cr Business Combination Valuation Reserve

However, remember that when we increase the value of any asset, there is a tax

consequence that we must also take into account. In this case:

Dr Business Combination Valuation Reserve

Cr Deferred Tax Liability

It must be noted that this is the consolidation entry that is required when an assets fair

value is higher than its carrying amount at the date of acquisition. The same entries can also be used

for recognising an intangible asset at fair value, except here we use the full amount instead of the

difference between fair value and carrying amount.

For recognising contingent liabilities, we use the following:

Dr Business Combination Valuation Reserve

Cr Liability

Dr Deferred Tax Asset

Cr Business Combination Valuation Reserve

Acquisition Analysis

Acquisition analysis is used primarily to find goodwill or excess. We conduct it by:

1. Finding the net fair value of identifiable assets and liabilities. This is the same as taking

equity.

2. Deducting the cost of combination.

Example:

The Parent paid $2 per share for 100,000 of shares in Subsidiary for complete ownership. At

the date of acquisition, the Subsidiary had $120,000 in share capital and $60,000 in retained

earnings.



Additionally, the fair value of land and equipment are $250,000 and $100,000 respectively.

Their carrying amounts are $240,000 and $95,000 respectively.

The acquisition analysis would thus be:

Equity = $120,000 + $60,000

+ ($250,000 - $240,000) x 0.7 [BCVR Land]

+ ($100,000 - $95,000) x 0.7 [BCVR Equipment]

= $190,500

Cost of Combination = 100,000 x $2

= $200,000

Goodwill =$9,500

The journal entries would be:

Dr Retained Earnings 60,000

Dr Share Capital 120,000

Dr Business Combination Valuation Reserve 10,500

Dr Goodwill 9,500

Cr Shares in Subsidiary 200,000

Note that in the example, we have BCVR as a debit figure of $10,500. When we do the

individual journal entries later, we eliminate our equity acquired against this debit figure when we

account for the increase in tax liability due to increase in carrying amount.

Example:

Dr Land 10,000

Cr Business Combination Valuation Reserve 7,000


Dr Equipment 5,000



Notice how we have now eliminated $10,500 from BCVR after the adjustments (the Credits

equal the Debits so it is eliminated) which is exactly the amount we need to eliminate from above.

Dealing with Differences in Depreciation

When assets that depreciate are revalued, their level of depreciation will be different to

what is required for the group as a whole.

Example:

Following on from the previous example if the equipments carrying value in the Subsidiary is

$95,000 and it is depreciated at 20% per year, the subsidiary would record a depreciation expense of

$19,000 per year.



For the group, this equipment is worth $100,000 so the depreciation expense per year should

be $20,000. This is a $1,000 increase over what is actually recorded so we must record the extra

depreciation in the consolidation entries as follows:

Dr Depreciation Expense 1,000

Cr Accumulated Depreciation 1,000

Dr Deferred Tax Asset 300

Cr Income Tax Expense 300

Note that in the example, such an entry can only be made in the year of acquisition because

it directly affects the firms expense accounts. Recall that expense accounts are closed at the end of

each year to retained profits. Thus for the following year, the journal will need to be as follows:

Dr Depreciation Expense1 1,000

Dr Retained Earnings (Opening)2 1,000

Cr Accumulated Depreciation3 2,000

Dr Deferred Tax Asset4 600

Cr Income Tax Expense5 300

Cr Retained Earnings (Opening)6 300

1. This years additional depreciation expense.

2. Last years additional depreciation expense. We cannot directly debit from depreciation

expense from last year as the account has been closed to retained earnings so we debit from

that instead.

3. Total accumulated depreciation. Not an expense account that is closed so we can change it.

4. Deferred Tax Asset results from increase in expense meaning less tax to be paid.

5. This years tax expense should decrease from more expenses. (30% tax rate)

6. Last years tax expense should also be less from more expenses, but cannot be directly

debited from as it has been closed. Credit retained earnings instead. (30% tax rate)

Sale of Assets after Acquisition Date

The Subsidiary owns land of $240,000 in our example previously. If this was sold in the

following year at $275,000 to an external party, the subsidiary would have recorded the following:

Dr Cash 275,000

Cr Land 240,000

Cr Gain on Sale of Land 35,000

However, when we consolidate, we value the land at $250,000 and not $240,000. This

means the gain on sale of the land must be reduced by $10,000. Thus, we would need to adjust it as

follows:

Dr Gain on Sale of Land 10,000


Cr Transfer from BCVR 7,000

Dr Transfer from BCVR 7,000

Cr BCVR 7,000



Note that if this was not in the period where acquisition took place, we would debit

Retained profits (opening) instead of Transfer from BCVR. We would also include this directly in

the pre-acquisition entries.

Recall that the pre-acquisition entries were:




Dr Goodwill 9,500


Add the following journal in:

Dr Retained Earnings (Opening) 7,000


Results in:




Dr Goodwill 9,500


Goodwill Impairment

When goodwill is recorded after acquisition, it is usually amortized/impaired. Goodwill is

only recorded on the consolidation journals.

Example:

Following from our example, our acquisition resulted in $9,500 of recognised goodwill. If

$1,900 was impaired this year, our journal entry would be as follows:

Dr Impairment Loss 1,900

Cr Accumulated Impairment Losses 1,900

In the next year, we would need to put the expense into retained profits since the impairment

loss expense account has been closed to it. That is:

Dr Impairment Loss 1,900

Dr Retained profits (opening) 1,900

Cr Accumulated Impairment Losses 3,800

These two entries in the example are sometimes placed into the pre-acquisition entry.



Excess

Excess is immediately recorded as income in the period of acquisition by crediting the excess

account. In any other period, we put it into the retained profits account.

Dividends

When the subsidiary issues dividends, the parent will be the only entity getting those

dividends as it holds all the shares in that subsidiary. A dividend payout is, as such, treated as a

reduction in the cost of acquiring the subsidiary.

Example:

The subsidiary declared a dividend of $10,000 and the parent bought those shares cum-

dividend, the parent has a right to that dividend. Thus, to the parent, this represents a return of

$10,000 on their investment in the subsidiary. As such, the entry in the parents books would be:

Dr Investment in Subsidiary 190,000

Dr Dividend Receivable 10,000

Cr Cash 200,000

However, when we do consolidation, we need to eliminate the dividend payable from the

subsidiary and the dividend receivable from the parents book. This entry is:

Dr Dividend Payable 10,000

Cr Dividend Receivable 10,000

If a dividend is declared and paid, we use the following:


Cr Dividend Paid 10,000 [If current year]

Cr Retained Profits (opening) 10,000 [If previous year(s)]

If the dividend has been declared, but has not been paid yet, we use the following:


Cr Dividend Declared 10,000

Dr Dividend Payable 10,000

Cr Dividend Receivable 10,000




Background

A large part of doing consolidation is removing transactions between the entities that are

part of the consolidation.

Simple Eliminations

Most elimination entries (journal entries to eliminate intragroup activities) are based very

much on common sense. That means, simply reversing what was done before.

Example:

The parent company provided $10,000 worth of management services to subsidiary. The

subsidiary paid the entire sum in the period it was accrued.

In this case, the parent would have recorded $10,000 of management fee revenue while the

subsidiary would have recorded $10,000 of management fee expense. In this case, we simply reverse

that. i.e.:

Dr Management Fee Revenue $10,000

Cr Management Fee Expense $10,000

If the subsidiary had only paid a fraction (i.e. not the entire sum) we also remove that

because an entity having a payable to and a receivable from itself means it does not owe anything.

Dr Accounts Payable XXXXX

Cr Accounts Receivable XXXXX

This same logic can be applied to many other things such as dividends and borrowings.

Transfer of Inventory

For inventory we only need to eliminate it if inventory has been sold in between the entities.

In these cases, the entity will see the cost of the inventory as the price at which it was originally paid

for when it first entered the entity. The entity will see the sale of the inventory as the revenue

gained when it left the entity.

Example:

The parent bought 200 boxes of apples at $8 per box from a supplier. During the same year,

the parent sold all 200 boxes of apples to the subsidiary at $10 per box. The subsidiary then sold

these boxes to consumers at $12 a box in the same year.

In this case, the parent would have recorded $1,600 in Cost of Goods Sold and $2,000 in Sales

Revenue. Likewise, the subsidiary would have recorded $2,000 in Cost of Goods Sold and $2,400 in

Sales Revenue.



If we add these together, it would mean the entity as a whole had $3,600 in Cost of Goods

Sold and $4,400 in Sales Revenue. As we can see, this is not the case! Thus, we must eliminate the

entry made between the two as it is an intragroup transaction.

Dr Sales Revenue 2,000

Cr Cost of Goods Sold 2,000

The above example only applies when the goods have been bought, transferred and then

sold in the same period. In the case of when inventory has not been entirely sold at the end of the

year but it has been transferred, we must also revalue inventory depending on if it was transferred

at a profit or loss.

Example:

If, in the previous example, only 150 boxes of apples were sold at the end of the year and 50

remained, the journals that the parent and subsidiary have would be as follows:

Parent:

Dr Cost of Goods Sold 1,600

Cr Sales Revenue 2,000

Subsidiary:

Dr Cost of Goods Sold 1,500

Dr Inventory 500

Cr Sales Revenue 1,800

In this case, the remaining inventory is not worth $500 to the entity because it was bought by

the parent for $400 previously. This means we need to eliminate inventory by $100. The true Cost of

Goods Sold is 150x$8=$1,200 meaning we must also eliminate the extra. Sales Revenue must be

written down by $2,000 as well.

Dr Sales Revenue 2,000

Cr Cost of Goods Sold 1900

Cr Inventory 100

Remember! When we change the carrying amount of an asset, we must also include the tax

consequence. In this case it is (assuming a tax rate of 30%):



Transfer of Plant

When plant and is sold by the parent to the subsidiary or vice versa, we need to eliminate

the gain or loss on sale of that plant. We would also need to adjust depreciation because the two

companies would depreciate it at different rates. The consolidated entity as a whole must

depreciate it at the same rate as the company which first bought it does.



Example:

A parent company sells plant to the subsidiary for $90,000 on the 1st January 2009. This plant

was bought on the 1st January 2008 by the subsidiary for $100,000. It is depreciated at 20% over 5

years. The subsidiary

Here we would note that the depreciation should be $20,000 per year and that one year has

already past so the carrying amount would be $80,000. This means the plant was sold at a gain of

$10,000 to the subsidiary.

Also to note that since the subsidiary carries the asset at $90,000 and assuming it will also

depreciate it at the same rate, it will only depreciate $18,000 per year (90,000/5) and not the

$20,000 at which it was previously. Consolidating requires that this be the latter figure.

In this case, we must:

Eliminate the extra $10,000 carrying amount.

Eliminate the extra sale of the plant at $80,000. This is recorded in the parents books.

Add back the extra $2,000 of depreciation.

Eliminate the proceeds of $90,000 for the sold plant recorded on the subsidiarys books.

As such, we use the following journal entry:

Dr Proceeds from plant transfer 90,000

Dr Plant at cost 10,000

Cr Carrying amount of plant sold 80,000


Dr Income Tax Expense 3,000


Note that if the above happened two years later, we would also need to separate each

years depreciation adjustment as depreciation expense is closed off to retained profits at the end of

each year. The proceeds from plant transfer and carrying amount of plant sold account is also

closed off and would need to be referenced to retained profits. For 1st January 2010, the entry would

be:

Dr Opening Retained Earnings 10,000

Dr Plant at Cost 10,000




Dr Opening Retained Earnings 2,000 [For 1st Year Depreciation]

Dr Depreciation Expense 2,000 [For 2nd Year Depreciation]


Dr Deferred Tax Asset 1,200


Cr Opening Retained Earnings 600



Transfer of Land

Unlike plant, land does not depreciate. Thus, we only have to deal with the elimination of

the movement of land around the company.

Example:

The parent bought land on the 1st January 2009 for $100,000. It then sold this land to its

subsidiary for $120,000 one year later. The subsidiary then sold this land for $150,000 to an external

party another two years later.

At the date of sale, the entry required would be:

Dr Proceeds from transfer of land 120,000

Cr Carrying amount of land sold 100,000

Cr Land at cost 20,000



In the next year, the land is not sold so there is unrealised profit:

Dr Opening retained earnings 20,000

Cr Land at cost 20,000


Cr Opening retained earnings 6,000

In the year after when the land is sold, we can finally recognise the profit with:

Dr Opening retained earnings 20,000

Cr Carrying amount of land sold 20,000


Cr Opening retained earnings 6,000

Deagan Chapter 29 provides many more worked examples on intragroup transactions.

Consolidation Accounting Minority Interest



Background

Parents do not always necessarily own 100% of their subsidiaries to have control over them.

They may have control, but have less than complete ownership. The other owners of the subsidiary

are called the minority interest. It is also sometimes known as outside equity interest.

Minority interest is defined as, that portion of profit or loss and net assets of a subsidiary

attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the

parent.

Whats Different?

We still use the same techniques and methods that we used for wholly owned subsidiaries.

That is, we:

Do line-by-line aggregation at 100%.

Eliminate intragroup activities at 100%.

By 100%, we mean that we add the full amounts to each other. Even if the parent (100%)

owns 70% of a subsidiary, we do not add 100% of the parent and 70% of the subsidiaries accounts

together. We add 100% of both the companys accounts together.

There is, however, one intragroup activity that we do not add 100% of and that is dividends.

This is because dividends are paid out according to how much of the subsidiary the parent holds. So

if the parent only holds, say 80% of the company, it is only entitled to 80% of the dividends of which

is intragroup. The remaining 20% is to an external party (the Minority Interest) and thus, is not

intragroup so it does not need to be eliminated.

Methodology in Attributing to Minority Interest

To find who holds what and how much of equity, we first find how much is attributable to

the minority interest. Once we have found this, we know that the residual amount is what is

attributable to the parent company.

We should find minority interest by splitting the whole process into three distinct time

periods.

1. Minority Interest in Pre-Acquisition Equity

2. Minority Interest in Post-Acquisition changes to Equity

3. Minority Interest in Current Period Profit/Loss

Minority Interest in Pre-Acquisition Equity

We need to adjust our pre-acquisition entry to take into account that the parent has only

taken a percentage and not the entire ownership of the subsidiary. We only take a percentage (the

percentage the parent owns) of the net fair value acquired in the subsidiary.



Example:

A parent company has paid $70,000 to obtain 75% of the shares in a subsidiary. At that date,

everything in the subsidiarys books was recorded at fair value except for plant which has a fair value

of $2,000 higher than its carrying amount. The subsidiary had retained earnings of $20,000 and

share capital of $70,000.

Thus, our acquisition entry would be:

Equity = $70,000 + $20,000

+ $2,000 x 0.7 [BCVR Plant]

= $91,400

Net fair value acquired = $91,400 x 75% 1

= $68,550

Cost of Combination = $70,000

Goodwill =$1,450

The journal entries would be:

Dr Retained Earnings 15,000 1

Dr Share Capital 52,500 1

Dr Business Combination Valuation Reserve 1,050 1

Dr Goodwill 1,450 1


1 Note here that we have only acquired 75% ownership.

In the example, the rest of the equity is directly attributable to the minority interest as they

are the holders of that equity. The journal entry is essentially the same except that there is no

goodwill and we credit the minority interest instead.

Example:

Following on from the previous example, 25% of equity is attributable to minority interest:



Dr Business Combination Valuation Reserve 350

Cr Minority Interest 22,850

Minority Interest in Post-Acquisition changes to Equity

When there are changes to equity such as retained earnings, reserve accounts and the

business combination valuation reserve, part of it is attributable to the minority interest.

The most important is recognising retained earnings. We usually do the entry for retained

earnings after all journal entries requiring the use of the retained earnings account are completed.

This is because these accounts all impact on the opening retained earnings account which will affect



how much is attributable to the minority interest. This means you should eliminate intragroup

activities before allocating minority interest here.

Example:

A parent owns 75% of a subsidiary which had $10,000 of retained earnings at acquisition

date. Three years later, that subsidiary now has $60,000 in retained earnings.

Previously, the parent sold plant that that had a carrying amount of $50,000 to the

subsidiary at a profit of $5,000. Both companies depreciate in straight-line over 5 years.

First, we need to adjust for the plant:


Dr Plant at Cost 5,000





Dr Depreciation Expense 1,000




Cr Opening Retained Earnings 300

Notice how there are references to Opening Retained Earnings here.

Aggregating this would give us a debit figure of $7,200 for Opening Retained Earnings.

Moving on to adjusting retained earnings, we note that there is an increase of $50,000 in

retained earnings. This needs to be adjusted lower by $7,200 as seen from above. Thus, the change in

retained profits would be $42,800. We need to attribute 25% of this to minority interest as follows:


Cr Minority Interest 10,700

Basically put, the minority interest is only interested in the profits contributed to the entity

after all adjustments have been made. If there is movement between equity accounts, the minority

interest also has interest in those movements. Thus, a certain percentage (how much is attributable

to the minority) must be allocated to them.

Example:

If $1,000 was moved from retained earnings to the general reserve. (75% ownership)

Dr General Reserve 250

Cr Minority Interest 250



Changes in the Business Combination Valuation Reserve and Minority Interest

During pre-acquisition, we may have assets which have a fair value higher than their carrying

amounts, we have end up with a journal entry as follows:

Dr Inventory 10,000



(Assuming we had Inventory with a fair value $10,000 higher than its carry amount)

When this inventory is sold in the next period (remember we assume that all opening

inventory is sold in the year), we need to reduce Minority Interest because this would have already

been reflected in retained earnings. Not doing this would mean double-counting and getting a

wrong figure. Thus:

Dr Minority Interest 1,750*

Cr Business Combination Valuation Reserve 1,750*

* The firm holds 75% ownership so only 25% of BCVR needs to be eliminated.

Minority Interest in the Current Period

After adjusting for changes in previous periods, we move to the current period. In this period

of time, we are most concerned with:

Dividends

Transfers between equity accounts

Profit or Loss for the period

If $1,000 of dividends were declared in the current period by the subsidiary of which 75% is

owned by the parent, then we would need the following journal entry:

Dr Dividend Payable 750

Cr Dividend Declared 750

Dr Dividend Revenue 750

Cr Dividend Receivable 750

(To eliminate the intragroup dividend of 75%)

Dr Minority Interest 250

Cr Dividend Declared 250

(To attribute 25% of the dividend to the Minority Interest)

If the dividend was paid out in the same period, we simply change a few journals so it

becomes:

Dr Dividend Revenue 750

Cr Dividend Paid 750




Cr Dividend Paid 250

If there were transfers between reserves (such as one in the general reserve), the minority

interest has interest in the movement from these reserves. As such, a $5,000 movement from

general reserve to retained earnings with 75% ownership would take the following form:

Dr Transfer from General Reserve 1,250

Cr General Reserve 1,250

Profit for the Period

If the closing retained earnings are not given in the year, we can figure this out by taking our

adjusted opening balance figure, taking away all expenses and adding revenues. Otherwise, we can

find out profit for the period by taking the retained earnings at the end of the period, adding back

any distributions and deducting the last periods retained earnings away. A portion of this would be

allocated to the minority interest:

Dr Minority Interest Share of Profit XXXXX

Cr Minority Interest XXXXX

Unrealised profits in Upstream Transactions

Upstream transactions are those which are from the subsidiary to the parent. These have an

impact on unrealised profits for the subsidiary which in turn, impacts on minority interest. Since

these profits are unrealised, we need to reverse a portion of these allocations to minority interest

since they have already been put into retained earnings.

Example:

A subsidiary sells $18,000 worth of inventory to the parent at $2,000 profit during the year.

At the end of the year, the parent has not sold any of the inventory in question. The parent holds 75%

of the subsidiary.

Here, we simply take the profit generated ($2,000) which is unrealised in terms of the group.

We then need to tax this since it has not been taxed and then allocate 25% of it to the minority

interest. That is 2000x0.3x0.7 meaning the following:


Cr Minority Interest Share of Profit 350

Note that when this is realised, we will reverse this transaction so that we credit minority

interest and debit its share of the profit instead.

Corporate Financial Reporting & Analysis


Background

Prior to this stage, we have only considered the situations where the subsidiary itself does

not control any other company. However, if the subsidiary has control over another business

it is the parent of a parent-child relationship)

that. We call these parent-child-

The Parent-Child-Grandchild Relationship

In this course, we will only

over a subsidiary that also controls a subsidiary of its own.

many other types of relationships which lead to indirect ownership.

Direct Minority Interest

that has that minority interest. Indirect Minority Interest

interest in another company though the subsi

DMI is actually the minority interest we were dealing with in the previous

notice in this diagram that the 20% DMI in the Child also has an interest in the Grandchild since they

own the Child. Likewise, the Parent has an interest in the Grandchild through the Child.

their interests by multiplying their percentages along the

respective subsidiary.

Example:

In the previous diagram, the parent has 80% of the Child whom has 60% of the Grandchild.

Thus, the Parent has 80% x 60% = 48

20% control of the Child whom has 60% interest in the Grandchild. Thus, there is

12% in the Grandchild.

For the entity as a whole, the 12% IMI and the 40% DMI in the Grandchild totals to 52% that

must be attributable to MI in any of the Grandchilds profits

Parent

Parent80% 60%


g & Analysis Semester 2 2009



not control any other company. However, if the subsidiary has control over another business

child relationship), then the owners of the parent would have interest in

-grandchild relationships.

Grandchild Relationship

only consider the relationship where a parent company has control

over a subsidiary that also controls a subsidiary of its own. However, note that in reality, there are

many other types of relationships which lead to indirect ownership. Graphically this relati

Direct Minority Interest (DMI) is the minority interest that is directly linked to the subsidiary

Indirect Minority Interest (IMI) is the minority interest that has

interest in another company though the subsidiary. Graphically, DMI is shown as

DMI is actually the minority interest we were dealing with in the previous


own the Child. Likewise, the Parent has an interest in the Grandchild through the Child.

eir percentages along the route taken to get from DMI to the


80% x 60% = 48% indirect ownership of the grandchild. The DMI of the child has

20% control of the Child whom has 60% interest in the Grandchild. Thus, there is


in any of the Grandchilds profits.

Child Grandchild

Child Grandchild80% 60%

DMI: 20%


24

Indirect Ownership


not control any other company. However, if the subsidiary has control over another business (that is,

ners of the parent would have interest in

consider the relationship where a parent company has control

However, note that in reality, there are

this relationship is:

is the minority interest that is directly linked to the subsidiary

is the minority interest that has

, DMI is shown as:

DMI is actually the minority interest we were dealing with in the previous section. However,


own the Child. Likewise, the Parent has an interest in the Grandchild through the Child. We calculate

taken to get from DMI to the


ild. The DMI of the child has

20% control of the Child whom has 60% interest in the Grandchild. Thus, there is IMI of 20% x 60% =


Grandchild

Grandchild

: 20% DMI: 40%



Rules for Allocating to Indirect Minority Interest and Direct Minority Interest

DMI is interested in both pre and post acquisition equity of the subsidiary but however, IMI

is only interested in post acquisition equity. Thus, our pre-acquisition entry does not need to take

into account any IMI.

Basically, we follow the same process we outlined to find MI in the previous section. Recall:

1. MI Share of Pre-Acquisition Equity

2. MI Share of Changes in Equity from Acquisition Date to the Beginning of Current Period

3. MI Share of Changes in Equity in the Current Period.

Note that we have already established that IMI does not need to be taken into account in

the pre-acquisition equity, thus, IMI applies to steps 2 and 3 while DMI applies to all steps.

Intragroup Transactions, Indirect Minority Interest and Direct Minority Interest

The required elimination entries for intragroup transactions are generally the same as with

just minority interest. However, we simply need to know which type of minority interest is impacted.

To find this, we simply note which company within the group recorded the profit of the transaction.

The Parent recorded it: No effect on any Minority Interest

The Child recorded it: Impact on Direct Minority Interest only.

The Grandchild recorded it: Impact on both Direct Minority Interest and Indirect Minority

Interest.

Dividends, Indirect Minority Interest and Direct Minority Interest

As a rule of thumb, only Direct Minority Interests gain dividends and Indirect Minority

Interests do not gain any. This is because companies only pay dividends to those who directly hold

their shares. This means that only people who are direct owners (the parent company and the direct

minority interest) gain any dividends. This means that Indirect Minority Interests do not.

However, we must adjust Minority Interests share of profit for the increase in profit as a

result of a grandchild paying dividends to the child company. This is because the Indirect Minority

Interest of the grandchild is the Direct Minority Interest of the child company and thus, has a right to

the increase in profits resulting from a dividend payment. This should be allocated accordingly to

how much Indirect Minority Interest exists.




Background

In Consolidation Accounting, we looked at the case where the parent had control over the

subsidiary. In this part, we look at the case where the company has significant influence, but does

not have control. This means the company has around 20% to 49% of voting rights in the company.

This is where we use the equity method.

Significant Influence

Significant Influence is broadly defined as having 20% to 49% of the voting rights of a

company. However, note that this is a quick guide and a company may have significant influence

even if their level of voting rights is below 20% or exceeds 49%. However in this course, for

simplicitys sake, we consider 20% to 49% of voting rights as having significant influence.

We must also note that the equity method does not apply to:

Venture Capital Organisations

Immaterial Investments

Accounting for Investments

We account for investments at cost at the acquisition date of the investment in question. As

with consolidation, dividends from pre-acquisition profits are seen as a return of investment.

However, as of May 2008, the ASB is now trialling an international standard where all dividends are

realised as just revenue and not a return on investment. For this course however, we will still treat

them as a return on investment.

Dividends from post-acquisition profits are return on investment and are recorded by the

investor as dividend revenue.

Where do we apply the Equity Method?

The Equity Method is applied depending on the situation of the investor. If the investor

already prepares consolidated financial statements, then the equity method is applied in the

consolidated worksheet. The cost method is first applied in the financial statements of the parent

entity before the equity method is applied during consolidation.

Although you do not need to know the exact journals and details of the cost method (since

we are only interested in the equity method), you should have a brief idea of what the cost method

does so that you can

If the investor does not prepare consolidated financial statements, then the equity method

is applied in the accounting records of the investor.



Applying the Equity Method

The investment in an associate is usually recognised at cost at acquisition date with the

carrying amount being varied at later periods to reflect the investees post-acquisition profits. Any

distributions such as dividends from the investee will also reduce the investments carrying amount.

The investors share of the profits or losses in the investee must also be reflected in the

investors profit or loss for the period. We also need to adjust the carrying amount of the investment

for any changes in equity that are not reflected in the profit or loss of the investor. These include

land, plant and equipment revaluations.

Remember, as always, we must not forget the income tax implications of these changes.

Like with consolidation, shares in a company can be acquired with goodwill or at a discount.

We find these in much the same way as we do for normal consolidation; through an acquisition

analysis.

We must also adjust depreciation in the investees profit/loss if the fair value of the asset

differs from the recorded value at acquisition date (We did the same thing with consolidation).

Example:

A Ltd has acquired 25% of B Ltd for $150,000. At acquisition date, all assets of B Ltd in their

books were recorded at their fair values. B Ltd had $300,000 of share capital and retained earnings of

$200,000 at acquisition date. Prepare the acquisition analysis and required journals at the date of

acquisition.

Equity: $300,000 + $200,000 = $500,000

Net fair value acquired: 25% x $500,000 = $125,000

Cost of Combination: $150,000

Goodwill: $25,000

If we assume the investor is a parent:

Dr Investment in B Ltd 150,000

Cr Cash1 150,000

Recording an Associates Profit or Loss and any Dividend Payments

There are slight differences that we need to take into account when recording down an

associates profit/loss and any dividend payments for that period depending on whether the investor

is a parent or not.

The following table on the next page outlines the basic differences between the two in

terms of recording the investors share of profits, losses and dividend payments.

1 Note that this can also be Accounts Payable. It depends on how A Ltd has acquired B Ltd. We assume this to

be cash if it is not mentioned how.



If the Investor is a Parent

All records in the Consolidation Worksheet

If the Investor is not a Parent

All records in the Investors Accounts

Year 1

Acquisition Journal Entry

DR Investment in B Ltd

CR Cash


CR Cash

Recording share of associates profit or loss for the period


DR Share of Income Tax Expense*

CR Share of associates profit or loss*

Note: Flip this journal around to record a loss.





Recording dividends in the current period

DR Dividend Revenue

CR Investment in B Ltd

Note: This is an elimination journal entry that is

required to eliminate the revenue recognised under

the cost method.

DR Dividend Receivable

CR Investment in B Ltd

Note: Dividend Receivable can also be Cash depending

on whether the dividend has been received yet. If

cash, then a journal is needed later to record receipt.

Year 2

Recording share of associates profit or loss for the period and prior periods

To record profits this period.


CR Opening Retained Earnings2

To record profits from last period.




Note: Flip each journal around to record a loss in the

respective period a loss is incurred.




Note: The investor has already recorded last years

share of profit/loss and does not need to record it

again since it is still in the investors books. For a

consolidated entity, the consolidation worksheets are

compiled again at the end of each period. This is not

the case here.


Note that in the above table, we assume that the associate was acquired with all assets

recorded at fair value at acquisition date. If this was not the case, we simply adjust the share of the

associates profit or loss that the investor has. To find out how much we need to adjust by we do a

simple calculation.

Example:

2 Note here that this entry includes Share of Income Tax Expense and Share of associates profit or loss.

The amount we credit to Opening Retained Earnings is the difference between the two. Any dividends can also

be eliminated against here. Example: If the dividend paid in the last period was $5,000, we would reduce both

sides of this journal by $5,000.

*Note that if you are not given the amount of income tax expense, but are given the level of net profit. Then

you may omit Share of Income Tax Expense and simply change the next entry from Share of associates

profit or loss to Share of associates after tax profit or loss.



When A Ltd acquired 25% of B Ltd, B Ltd had recorded a plant at $300,000. However, its fair

value was $350,000. The plant has a useful life of 10 years. Thus, the additional depreciation we need

to recognise each period (assuming one year) is:

[ ($350,000 - $300,000) / 10 ] x 25% = $1,250

However, we need to take into account the tax effect of this. Assuming that the corporate tax

rate is 30% the after tax effect would be: $1,250 x 0.7 = $825. This is the extra amount that we need

to deduct from the amount that is attributable to the investor.

If B Ltd had made a $100,000 profit for the year, of which 25% ($25,000) is attributable to

the investor, we would need to deduct $825 from that so that the investors share of the associates

profit is now $24,175.

Treating Losses that Exceed the Carrying Amount of the Investment

If an associate occurs so many losses that it causes the carrying amount of the investment to

drop below zero, the use of the equity method is to be suspended. The carrying amount of the

investment will never go below zero, and any extra losses from that period and any period later will

be unrecognised. This loss will only be recognised when the associate makes profits that are equal to

the unrecognised losses and at this point, the equity method is to be used again.




Background

Joint Ventures are where two or more companies decide to form a new entity under shared

control. This means that all the assets, liabilities and equity of the new entity are shared between

the controlling companies. This also means that one single company cannot have control over the

entity. All decisions must be made by all the owners of the joint venture.

All Joint Ventures are contractually bound. They cannot be formed without one.

Joint Ventures

Joint Ventures can be split into three different types:

Jointly Controlled Operation (JCO)

Such as manufacturing aircraft where the different components (wings, avionics, tail, interior

etc.) may be constructed by different companies and brought together to make a complete

aircraft. All these companies share risk and return.

Jointly Controlled Asset (JCA)

Such as an oil pipeline, electrical power grid etc. Companies will share in the maintenance

and usage of the asset.

Jointly Controlled Entity (JCE)

A joint venture where a new entity is created and profits are shared.

Methods to Account for Joint Ventures

The AASB 131 currently allows two methods to account for joint ventures:

The One-Line Method

This method is where the venturer simply makes a simple entry into their accounts to note

the investment in the joint venture and the assets given up to do so. This method can only

be used by JCEs but is not preferred.

The Line-by-Line Method (also known as Proportional Consolidation)

This method is where the venturer records its proportionate ownership of the assets,

liabilities, revenues and expenses in its accounts. The AASB 131 requires this method for

JCOs and JCAs. It prefers companies use this method over the one-line method for JCEs.

All the One-Line Method does is recognise the investment in the joint venture with the

following journal:

DR Investment in Joint Venture

CR Cash

Under the Proportional Consolidation method, this is similar for the current period.

DR Cash in Joint Venture

CR Cash



However, in the next period when the venturer knows what the cash has been used on in

the joint venture, it must then reverse the above and allocate the cash to appropriate accounts such

as:

DR Cash

DR Plant

DR Land

Cr Cash in Joint Venture

We take the figures for these from the books of the joint venture. However, we only take

the required percentage. I.e. If we only own 50% of the venture, we will only recognise 50% in this

journal.

Jointly Controlled Operations

In JCOs, each individual venturer:

Recognises assets, liabilities, expenses and revenues in the operation in its own financial

statements.

Uses their own property, plant and equipment. This means that each venturer can use their

own depreciation method and time frame.

Carries their own inventory in the operation.

Capitalises costs in the operation in a work-in-progress account.

JCOs are preferred over JCEs most of the time because they are not considered a separate

economic entity as a JCE is. This means there is no equity, no tax, less regulation and less liability.

Also mentioned is that JCOs allow each venturer to use their own depreciation method, which can

allow for more tax savings.

Jointly Controlled Assets

JCAs are similar to JCOs in how they are recognised. Any jointed held assets are recorded in

the venturers own financial statements. Any liabilities and expenses that are incurred from it are

also split and recorded in their own financial statements.

Jointly Controlled Entities

JCEs are entirely separate economic entities from the venturers. The JCE itself controls all

the ventures assets, liabilities, expenses and revenues. In short, the JCE itself is like any other

business entity in that it prepares its own financial statements and controls itself. The venturers

simply provide cash or any other necessary resources to the JCE for it to function.

JCEs are popular because it allows established firms to undertake higher risk projects. If the

project fails, the liability is only limited to the JCE and not the venturers companies. It also allows

the bypassing of some restrictions such as limitations on foreign ownership. If one company is local

and another international, the international company can bypass this by creating a JCE with the local

company.



Transactions between the Joint Venture and the Venturer

There are a few rules that apply when a venturer purchases or sells an asset to the joint

venture. When the venturer sells an asset to the joint venture, it can only recognise the gain or loss

on the sale of the asset which is attributable to other venturers. Such that if the venturer has a 25%

stake in the joint venture, it can only recognise 75% of the gain or loss.

If a venturer buys an asset from the joint venture, the share of profits from the sale can only

be recognised when the venturer then sells the asset out to another entity other than the joint

venture.

Losses when buying or selling are recognised immediately.

Transferring Assets to a Joint Venture

When transferring assets to a joint venture, we usually use the following entry:

Dr Cash 150,000

Cr Equipment 150,000

Here we are assuming that we put up $300,000 worth of equipment to transfer to the joint

venture. Since we have 50% interest in the joint venture, we only need to credit 50% of the

equipments value since we still own the other 50%. Likewise, we now have 50% of the cash the

other venturer put in ($300,000).

If the fair value of the equipment was different to its carrying amount, then we need to

adjust this. Assuming the carrying amount of the equipment was $200,000 and the fair value of it is

$300,000, the journal entry would be instead be:

Dr Cash 150,000

Cr Equipment 100,000

Cr Profit on Sale of Equipment 50,000

However for the other venturer, the journal entry would be the same either way:

Dr Equipment 150,000

Cr Cash 150,000

In short, we see other venturers contributions as the fair value and not the carrying amount

as recorded by the venturer that contributed the asset.




Background

Financial Accounting is the process of collecting and processing financial information for

users both internal and external to the organisation in question. The objective of financial reporting

is to provide a true, fair (this is disputable), relevant and reliable view of the corporation to its users

to help them make informed decisions.

Types of Reports

Reports can either be general purpose or special purpose. General purpose reports are

those that:

Comply with the AASB Framework

Are tailored to meet needs common to all users

These are usually the regularly yearly financial statements that the corporation is required to

produce. Special purpose reports are those that are designed to meet a specific need required from

a specific group, such as a bank requiring a report on liquidity etc.

Regulation of Financial Reporting

In Australia, five main bodies create or enforce accounting frameworks from the AASB.

These are:

The Financial Reporting Council (FRC)

This body has oversight of the AASB and auditing standards. It monitors the effectiveness of

auditing.

The Australian Accounting Standards Board (AASB)

The neutral standards setter for accounting standards. Currently, however, it relies on the

International Financial Reporting Standards (IRFS) as Australia has adopted these. The AASB

may sometimes change a few things and introduce an Australian version of the equivalent

IFRS.

The Australian Securities and Investment Commission (ASIC)

This body is the corporate watchdog. It monitors corporations in Australia, inspects

auditors and also reviews compliances.

The Financial Reporting Panel

This panel resolves disputes between the ASIC and corporations about treatments of specific

line items in financial reports. This removes the need for court proceedings which can be

costly to the corporation and also removes the need for detailed accounting laws to go

through courts that usually do not understand them enough to make a well informed

decision.



The Australian Stock Exchange (ASX)

The ASX operates the market for financial securities and ensures that they comply with

listing rules and also have continuous disclosure of any information that, in general, will

influence the share price.

Note that Accounting Standards are laws.

Who is Required to Report?

Companies that meet any two of the following three criteria do not have to prepare

accounts, apply standards or be audited.

Consolidated Gross Operating Revenue less than $25 million.

Consolidated Gross Assets less than $12.5 million.

Less than 50 employees.

However, it will have to prepare accounts, apply standards and be audited if it is requested

by ASIC or any shareholder that owns more than 5% of voting rights.

Disclosing Entities

Entities who must report are known as disclosing entities. These companies are required to

file biannual reports. Disclosing entities are those that:

Have securities quoted on the ASX

Have securities issued with a prospectus

Have securities issued during a takeover

Have securities issued with an compromise agreement

Are corporations that take loans

The Annual Report

The annual report is comprised of:

Balance Sheet (also known as the Statement of Financial Position)

Income Statement (also known as the Statement of Financial Performance)

Statement of Cash Flows

Statement of Changes in Equity

Notes to Financial Statements

Directors Declaration

This is a declaration by the director that the accounts are a true and fair view of the business

and that they comply with all accounting standards. It should also state any significant

events after balance date and also state if they believe the firm will be able to pay all

outstanding debts on time. A director can only declare this after a CEO or CFO has declared it.

Directors Report

This report is from the directors of the company. They briefly state what the business has

done during the year, any significant changes in the past or upcoming, significant post-



balance date events and compliances. Most importantly, the report includes a statement of

corporate governance.

Auditors Report

This is the report by the auditors who confirm that the financial statements are a true and

fair representation of the company in question.

Materiality

Materiality is whether the information has the ability to influence decisions or

accountability of managers. For example, a $1 pen in a multi-billion dollar firm would be immaterial

seeing as the purchase of a single $1 pen will not influence decision making. However, the purchase

of company cars is material as it would considerably change the firms accounting figures which

could lead to different decisions being made.

Materiality is normally determined using professional judgement on behalf of management.

Management may also use the AASB 1301 to find arbitrary guidelines to determine materiality.

These guidelines are:

5% - Immaterial

>5% and




Background

The presentation of financial statements is covered by the AASB 101 which is the equivalent

to the IAS 1 with a few minor changes. Financial statements are structured representations of the

financial position and performance of the company.

The AASB 101

Within the AASB 101 are eight different considerations that we must take into account when

applying the standard to financial statements. These are:

1. Fair presentation and compliance with IFRSs

This means fairly representing the effects of all transactions and absolute compliance with

the AASB. Management may state, in the notes, why they believe compliance will be

misleading but they must still apply the standard.

2. Going-concern

Financial statements should be prepared on the grounds that the firm is a going concern

unless management actually intends to liquidate or cease trading. Any uncertainty must be

disclosed.

3. Accrual basis of accounting

Except for the Statement of Cash Flows, all other statements must be prepared on an

accrual basis.

4. Consistency

Financial statements should be in the same format and also consistency between periods for

easy comparison. It is only allowed to change if the firms operations changes significantly or

a newly modified AASB standard requires a different presentation.

5. Materiality and Aggregation

As mentioned previously, all dissimilar material items must be presented individually. They

must not be aggregated.

6. Offsetting

Items in the financial statements should not offset unless it accurately reflects the substance

of transactions or events.

7. Frequency of Reporting

Complete set (Balance Sheet, Income Statement, Statement of Changes in Equity, Statement

of Cash Flows and notes to the financial statements) of financial statements required

annually. Reasons for changing the reporting period must be disclosed.

8. Comparative Information

The financial statements must disclose at least 2 years of data in each statement. If there

has been a change in accounting policy, 3 years is required.

The AASB 101 only applies to general purpose financial statements. That means that

companies which do not have to prepare these or companies that are preparing special purpose

statements do not have to abide by the standard.



The Statement of Financial Position

The Statement of Financial Position (Balance Sheet) measures a businesss assets, liabilities

and equity. Its main use is to provide information on the companys financial position including

capital structure, liquidity, solvency and flexibility. Note that the AASB101 allows you to use either

name for this statement.

This statement is very limited in terms of its usage and interpretability. As such, it is best to

use with the notes to the financial statements. It is also limited by the fact that assets can be

measured at a variety of costs, intangibles are not recognised and the fact that off-balance sheet

items exist.

All assets and liabilities must be classified as current or non-current and they must meet the

criteria to be labelled an asset or liability. Recall the definition of an asset and liability. Line items

should also be listed from the most liquid to the least liquid form.

The standard requires, at a minimum:

Property, Plant and Equipment

Investment Property

Intangible Assets

Financial Assets

Investment accounted for under equity method

Biological assets

Inventories

Trade and other receivables

Cash and cash equivalents

Held for sale assets

Trade and other payables

Provisions

Financial liabilities

Current taxes

Deferred taxes

Non-controlling interested presented within equity

Issued capital and reserves attributable to the owners of the parent

The Statement of Comprehensive Income

The Statement of Comprehensive Income is also known as the Statement of Financial

Performance or more popularly as the Income Statement. Note that the AASB101 allows you to use

either name for this statement. It presents the entire firms revenues and expenses incurred in the

period.

This statement can either be done in one whole statement or split into two statements. One

shows just the components of profit and loss and the other shows components of other

comprehensive income.



The AASB 101 requires all items of revenue and expenses to be listed in the statement and

as such, is a prime source for performance information and also performance prediction. It is limited

by the fact that managers may make biased judgements on the handling of some expenses and/or

revenues which can skew results.

The standard requires, at a minimum:

Revenue

Finance cost

Share of profit and loss of associates/JVs accounted for using the equity method

Tax expense

After-tax profit(loss) of discontinuing operations/assets

Profit or loss

Profit/Loss attributed to non-controlling interests

Profit/Loss attributed to owners of the parent

This is the splitting point if we want to use the two-statement approach. The remaining

points go on the other statement. If we want a one statement approach, combine both

together.

Each component of other comprehensive income classified by nature

Share of other comprehensive income of associates/JVs accounted for using the equity

method

Total comprehensive income

Total comprehensive income attributed to non-controlling interests

Total comprehensive income attributed to owners of the parent

In addition to the above minimum line items, the AASB 101 requires separate disclosures of

certain things to enhance understandability. These include:

Inventory & Property, Plant and Equipment Write-Downs

Restructuring costs

Losses/Gains on Disposals

Profits/Losses on discontinued operations

Litigation settlements

Reversal of provisions

Nature and Function of an Expense

The statement of comprehensive income requires that line items be classified by either their

nature or function. Generally, a function of expense can be broken down into many smaller natures

of expense. If an expenses by function method is used, the breakdown of the nature of expenses

must be disclosed.

For example, cost of sales is a function of expense. However, purchases of materials and

employee costs are the nature of the expense. Both of these are considered part of the cost of sales.



The Statement of Changes in Equity

This statement shows the changes in each component of equity throughout the period. It

puts the opening balances out first, shows all adjustments during the year and then the closing

balance for the period.

The Cash Flow Statement

This statement was studied in depth in ACCT1511: Accounting and Financial Management 1B.

Recall that this is the only statement that does not require the use of accrual basis of accounting.

This statement has already been covered and is not covered in this course.

The Notes to the Financial Statements

These are made to enhance understandability of the financial statements. Typically, the first

note is a summary of all accounting policies the firm uses. This section should also disclose all

contingent liabilities, unrecognised contractual commitments, risk management objectives and

policie

Documents

Corporate Financial Reporting