SCHOOL OF ACCOUNTING SCIENCES - University of … 10 also sets out how to apply the principle of control and sets out the accounting requirements for preparation of consolidated financial

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Tutorial letter 102/0/2017

APPLIED FINANCIAL ACCOUNTING II

FAC4864/NFA4864/ZFA4864

Year Module

Department of Financial Governance

IMPORTANT INFORMATION:

This tutorial letter contains important information about your module.

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INDEX Page Due date 3

Personnel and contact details 3

Prescribed method of study 3

Suggested working programme 4

Exam technique 4

Learning unit 1 Consolidated and separate financial statements 7

2 Business combinations 36

Self assessment questions and suggested solutions 52

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DUE DATE

DUE DATE FOR THIS TUTORIAL LETTER: 14 FEBRUARY 2017 TEST 1 ON TUTORIAL 102: 14 MARCH 2017

PERSONNEL AND CONTACT DETAILS

Personnel Telephone Number

Lecturers Prof ZR Koppeschaar (CTA coordinator) Ms A de Wet (Course leader) Ms C Wright (Course leader) Mr HA Combrink Ms T Deysel Mr T Nkwane Ms A Oosthuizen Ms S Riekert Ms T van Mourik Secretary Ms MJ Marais

012 429-4717 012 429-6124 012 429-2004 012 429-4792 012 429-4713 012 429-6346 012 429-8971 012 429-4669 012 429-3549

012 429-4720

Please send all e-mail queries to: [email protected] Please use the module telephone number to contact the lecturers: 012 429-4185

PRESCRIBED METHOD OF STUDY 1. Firstly study the relevant chapter(s) in your prescribed textbook so that you master the basic principles

and supplement this with the additional information in the learning unit (where applicable). 2. Read the standards and interpretation(s) covered by the learning unit. 3. Do the questions in the study material and make sure you understand the principles contained in the

questions. 4. Consider whether you have achieved the specific outcomes of the learning unit. 5. After completion of all the learning units - attempt the self assessment questions (open book, but within

the time constraint) to test whether you have mastered the contents of this tutorial letter.

mailto:[email protected]

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SUGGESTED WORKING PROGRAMME

FEBRUARY 2017

WEDNESDAY THURSDAY FRIDAY SATURDAY SUNDAY MONDAY TUESDAY

1 Consolidated and separate

financial statements









6 Business

combinations

7 Business

combinations

8 Business

combinations

9 Business

combinations

10 Business

combinations

11 Business

combinations

12 Do self

assessment questions

13 Do self


14 Do self


EXAM TECHNIQUE 1. Introduction

Examination technique remains the key distinguishing feature between candidates who pass and those that fail. Practice by answering questions under exam conditions by preparing the solution within the time limits and then by marking your solution. By marking your solution you will learn from your mistakes.

2. Examination technique From a review of candidates’ answers to past examination questions, the general examination

technique issues were identified. These problems affected the overall performance of candidates. Although these aspects seem like common sense, candidates who pay attention to them are likely to obtain better marks.

To improve your overall examination technique and performance take note of the following: • Discussion questions Lay the foundation of your answer by stating the relevant theory first. Stating the theory

provides perspective from which the question is answered. Then proceed to apply the theory and to demonstrate insight into the question.

Identify all the issues and address all considerations in your application. Remember to

conclude at the end. In addition markers found that candidates used their own abbreviations (sms messaging

style) in their answers. Marks could not be awarded here as it is not up to the markers to interpret abbreviations that are not commonly used. The increased use of an sms style of writing in a professional examination is a major concern. Candidates should pay specific attention to the way in which they write their answers, and bear in mind that this is a professional examination for which presentation marks are awarded.

• Journal entries Describe the specific accounts affected by the journals and clearly convey the

classification of the account (e.g. P/L; OCI; SFP; SCE). Ensure that the journal entries are processed the correct way around. Indicate the debit and credit of accounts clearly.

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• Layout and presentation

Narrations to journals should always be provided, except for when it is stated in a question that it is not required. Candidates should allocate time to planning the layout and presentation of their answers before committing thought to paper. Very often, candidates start to write without having read the question properly, which invariably leads to, for example, parts of the same question being answered in several places or restatement of facts in different parts. Marks are awarded for appropriate presentation and candidates should answer questions in the required format, that is, in the form of a letter, memorandum or a report, if this is what is required.

The quality of handwriting is also an ongoing problem. The onus is on the candidate to

produce legible answers. • Irrelevancy Marks are awarded for quality, not quantity. Long-windedness is no substitute for clear,

concise, logical thinking and good presentation. Candidates should bear in mind that a display of irrelevant knowledge, however sound, will gain no marks.

• Calculations Always show all your calculations. Remember that your calculations should contain a

reference when used in a solution. Calculations done in pencil will NOT be marked. • Time management Use the reading time allocated to a question wisely, by highlighting important issues by

trying to envisage the required. Candidates are advised to use their time wisely and budget time for each question. The

marks allocated to each question are an indication of the relevant importance the examiners attach to that question and thus the time that should be spent on it. Candidates should beware of the tendency to spend too much time on the first question attempted and too little time on the last. They should never overrun on time on any question, but rather return to it after attempting all other questions.

• Recommendations / interpretations Responses to these requirements are generally poor, either because candidates are

unable to explain principles that they can apply numerically or because they are reluctant to commit themselves to one course of action. It is essential to make a recommendation when a question calls for it, and to support it with reasons. Not only the direction of the recommendation (i.e. to do or not to do something) is important, but particularly the quality of the arguments – in other words, whether they are relevant to the actual case and whether the final recommendation is consistent with those arguments. Unnecessary time is wasted by stating all the alternatives.

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• Open-book examination Candidates are reminded that they MUST familiarise themselves with the open book

policy. To this end candidates are advised of the following: • No loose pages (of any kind) may be brought into the exam. • Writing on flags – Candidates are only allowed to highlight, underline, sideline and

flag in the permitted texts. Writing on flags is permitted for reference and cross-referencing purposes only, that is, writing may only refer to the name or number of the relevant discipline, standard, statement or section in the legislation.

Any contravention of this regulation will be considered to be misconduct.

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LEARNING UNIT 1 - CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

INTRODUCTION IAS 27 prescribes accounting and disclosure requirements on how to account for the cost of an investment in the separate records of the investor for investments in subsidiaries, joint ventures and associates. This includes use of IFRS 9 where the entity exercises the policy choice. IFRS 10 deals with the definition of control and establishes control as the basis for consolidation. IFRS 10 also sets out how to apply the principle of control and sets out the accounting requirements for preparation of consolidated financial statements. IFRS 10 deals with the principles that should be applied to a business combination (including the elimination of intragroup transactions, consolidation procedures, etc.) from the date of acquisition until date of loss of control.

OBJECTIVES/OUTCOMES After you have studied this learning unit, you should be able to demonstate knowledge of: 1. Define control (IFRS 10 Appendix A and IFRS 10.5-.18). 2. Identify situations in which consolidated financial statements should be presented

and the scope of consolidated financial statements (IFRS 10.4). 3. Apply the consolidation procedure (IFRS 10.19-.24 and IFRS 10.B86-.B96)

including: 3.1 Elimination of the parent’s investment in the subsidiary; 3.2 Account for non-controlling interests in the profit or loss of consolidated

subsidiaries; 3.3 Account for non-controlling interests in the net assets of consolidated

subsidiaries; 3.4 Elimination of intragroup balances, transactions, income and expenses; 3.5 Use of uniform accounting policies; 3.6 Use of the same end of reporting period date; and 3.7 Presentation of non-controlling interests in the statement of financial position. 4. Account for a loss of control transaction (IFRS 10.25 and IFRS 10.B97-.B99) –

Details in Tutorial Letter 104/2016. 5. Account for changes in ownership interest – Details in Tutorial Letter 104/2016. 6. Account for the cost of investments in subsidiaries, joint ventures and associates in

the separate financial statements of the investor (IAS 27.9-.14) either: 6.1 At cost; 6.2 In accordance with IFRS 9; or 6.3 Using the equity method as described in IAS 28. 7. Account for dividends from subsidiaries, joint ventures and associates (IAS 27.12).

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OBJECTIVES/OUTCOMES 8. Disclosures in separate financial statements (IAS 27.15-.17). 9. Disclosures in consolidated financial statements (IFRS 12). 9.1 Disclose significant judgements and assumptions that an entity made in

determining that it has control of another entity; 9.2 Disclose interests in subsidiaries. 9.3 Disclose interest in unconsolidated subsidiaries held by an investment entity. 9.4 Disclose interest in unconsolidated structured entities. 10. Accounting for investment entities (IFRS 10, IFRS 12 and IAS 27): 10.1 Define an investment entity; 10.2 Account for an investment entity; and 10.3 Disclose an investment entity.

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. Group Statements, 16th edition, Volume 1 Chapter 1 A group of entities and its financial statements: theory and background 3 Consolidation at acquisition date 4 Consolidation after acquisition date 5 Intragroup transactions 6 Adjustments and sundry aspects of group statements 7 Consolidation of complex group 8 Interim acquisition of an interest in a subsidiary 2. Group Statements, 16th edition, Volume 2, Chapter 10. 3. IAS 27 Separate Financial Statements. 4. IFRS 10 Consolidated Financial Statements. 5. IFRS 12 Disclosure of Interests in Other Entities. 6. Understanding of IFRS 9 Financial Instruments.

COMMENT Please note that Group Statements, Volume 1, was covered thoroughly in your undergraduate studies and therefore this tutorial letter is only a revision of the basic consolidation principles. It is very important that you spend enough time to revise these principles.

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THE REST OF LEARNING UNIT 1 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED TEXTBOOK.

SECTION A - ADDITIONAL INFORMATION 1. Overview - IAS 27 Separate Financial Statements

IAS

Defi

nit

ion

s

• Consolidated financial statements 27.4

• Separate financial statements 27.4

Reco

gn

itio

n

Dividends received from a subsidiary, joint venture or associate 27.12

Measu

rem

en

t

When an entity prepares separate financial statements, it shall account for investments in subsidiaries, joint ventures and associates either: (a) at cost, (b) in accordance with IFRS 9, or (c) using the equity method as described in IAS 28.

27.10

• When an investment is accounted for at cost or using the equity method in terms of IAS 27.10 and it’s classified as held for sale – account for in accordance with IFRS 5.

• When an investment is accounted for in accordance with IFRS 9 in terms of IAS 27.10 and it’s classified as held for sale – continue to account for investments in terms of IFRS 9.

Dis

clo

su

re

Refer to IAS 27.15-.17

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2. Overview - IFRS 10 Consolidated Financial Statements

IFRS

• Consolidated financial statements 10 App A

Defi

nit

ion

s

• Decision maker 10 App A

• Group 10 App A

• Parent 10 App A

• Relevant activities 10 App A

• Removal rights 10 App A

• Subsidiary 10 App A

• Control of an investee 10 App A; 10.5-.9

• Power 10 App A; 10.10-.14

• Returns 10.15-.16

• Link between power and returns 10 App A; 10.17-.18

• Non-controlling interests 10 App A; 10.22-.24

• Substantive voting rights 10.B22-.B25

• Protective rights 10 App A;10.B26-.B28

• Potential voting rights 10.B47-.B50

• Variable returns 10.B55-.B57 • Investment entity 10 App A

Co

nso

lid

ati

on

pro

ced

ure

s

10.B86

(a) Combine like items of assets, liabilities, equity, income, expenses and cash flows of parent with those of subsidiary.

(b) Eliminate the carrying amount of the parent’s investment in subsidiary and the parent’s portion of equity of the subsidiary.

(c) Eliminate intragroup transactions and balances.

Dere

co

gn

itio

n

If a parent loses control of a subsidiary, the parent

10.25-.26 10.B97-.B99

(a) Derecognise assets (including goodwill) and liabilities of subsidiary;

(b) Derecognise the carrying amount of any non-controlling interests;

(c) Recognise the fair value of the consideration received; (d) Recognise the retained investment at fair value; (e) Reclassify to P/L or transfer directly to retained earnings

the amounts recognised in OCI;

(f) Recognise any resulting difference as a gain/loss in profit/loss.

Dis

clo

su

re

Refer to IFRS 12 Disclosure of Interests in Other Entities

12.10-.19

Fra

mew

ork

• Definition of liability: Paragraphs 4.15-4.19 and 4.46 • Definition of equity: Paragraphs 4.20-4.23

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3. Overview - IFRS 12 Disclosure of Interests in Other Entities – Sections relating to disclosure of interests in subsidiaries

IFRS / IAS

Defi

nit

ion

s

• Income from a structured entity 12 App A

• Interest in another entity 12 App A

• Structured entity 12 App A

• Consolidated financial statements 27.4

• Control of an entity 10 App A

• Group 10 App A

• Non-controlling interests 10 App A

• Parent 10 App A

• Protective rights 10 App A

• Relevant activities 10 App A

• Separate financial statements 27.4

• Subsidiary 10 App A • Investment entity 10 App A

Ob

jecti

ve

Objective of the standard is to disclose significant judgements and assumptions made in determining:

12.1-.4

• the nature of an interest in an entity or arrangement; and 12.2(a)(i)

• that it meets the definition of an investment entity, if applicable 12.2(a)(iii)

Sco

pe

This IFRS shall be applied by an entity that has an interest in any of the

following:

• subsidiaries 12.5(a) • unconsolidated structured entities 12.5(d) • disclose information about unconsolidated structured entities in the

separate financial statements of the entity if consolidated financial statements are not prepared

12.6(b)

Dis

clo

su

re

Significant judgements and assumptions • Disclose information about significant judgements and assumptions

it has made (and changes to those judgements and assumptions) in determining:

12.7-.9

- that it has control of another entity - that the parent is an investment entity

12.7(a) 9A

• Examples of disclosure of significant judgements and assumptions made in determining that:

12.9

- it does not control another entity even though it holds more than half of the voting rights of the other entity

12.9(a)

- it controls another entity even though it holds less than half of the voting rights of the other entity

12.9(b)

- it is an agent or a principal 12.9(c); 10.58-.72

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Dis

clo

su

re

Interests in subsidiaries • Disclose information about interests in subsidiaries to understand: 12.10-.19 - the composition of the group 12.10(a)(i) - the interest that non-controlling interests have in the group’s

activities and cash flows 12.10(a)(ii) &

12.12 • Disclose information about interests in subsidiaries to evaluate: - the nature and extent of significant restrictions on its ability to

access or use assets, and settle liabilities, of the group 12.10(b)(i) &

12.13 - the nature of, and changes in, the risks associated with its

interests in consolidated structured entities 12.10(b)(ii) &

12.14-.17 - the consequences of changes in its ownership interest that do

not result in a loss of control 12.10(b)(iii) &

12.18 - the consequences of losing control during the reporting period 12.10(b)(iv) &

12.19

• If date or reporting period of subsidiary’s financial statements differ with the consolidated financial statements, disclose the date of the end of the reporting period and the reason for using a different date or period

12.11

Non-controlling interests • Disclose for each of an entity’s subsidiaries that have non-

controlling interests that are material to the reporting entity: 12.12

- the name of the subsidiary 12.12(a) - the principal place of business (and country of incorporation if

different from the principal place of business) 12.12(b)

- the proportion of ownership interests held by non-controlling interests

12.12(c)

- the proportion of voting rights held by non-controlling interests, if different from the proportion of ownership interests held

12.12(d)

- the profit or loss allocated to non-controlling interests of the subsidiary during the reporting period

12.12(e)

- accumulated non-controlling interests of the subsidiary at the end of the reporting period

12.12(f)

- summarised financial information about the subsidiary 12.12(g) Restrictions and changes in ownership • Disclose significant restrictions on the entity’s ability to access or

use the assets and settle the liabilities of the group 12.13

• Disclose the terms of any contractual arrangements that could require the parent or its subsidiaries to provide financial support to a consolidated structured entity, including events or circumstances that could expose the reporting entity to a loss

12.14-.17

• Present a schedule that shows the effects on the equity attributable to owners of the parent of any changes in its ownership interest in a subsidiary that do not result in a loss of control

12.18

• If control of a subsidiary is lost, disclose the gain or loss, if any, calculated in accordance with IFRS 10.25

12.19

• When an entity becomes, or ceases to be, an investment entity, it shall disclose the change of investment entity status and the reasons for the change

12.9B

Interests in unconsolidated subsidiaries (investment entities) 12.19A-.19G

Interests in unconsolidated structured entities 12.24-.31

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EXAMPLES

The following examples illustrates the basic consolidation process: 1. Investment in subsidiary accounted for at cost

P Ltd acquired a 100% interest in S Ltd for R200 000 on 1 January 20.13 when S Ltd’s share capital and retained earnings amounted to R80 000 and R120 000 respectively. Investments in subsidiaries are accounted for at cost in terms of IAS 27.10(a).

Parent (P) Separate Financial

Statements

Subsidiary (S) Financial Statements

Total

Pro forma

journals

Consolidated Financial Statements

(P + S)

R’000 R’000 R’000 R’000 R’000 Assets Assets Assets Investment in S Ltd (cost)

200

Investments

-

200

(200)

Investment in S Ltd (cost)

-

Trade debtors 100 Trade debtors 280 380 Trade debtors 380 Equity Equity Equity Share capital (50) Share capital (80) (130) 80 Share capital (50) Retained earnings (150) Retained earnings (150) (300) 120 Retained earnings (180) Liabilities Liabilities Liabilities Long-term loan (100) Long-term loan (50) (150) Long-term loan (150)

Note 1 Note 2 Note 3

Notes

1. When a parent prepares separate financial statements, it shall account for investments in subsidiaries at cost, in accordance with IFRS 9 at fair value or using the equity method as described in IAS 28. In this case P Ltd accounted for the investment in S Ltd at cost in its separate financial statements. Separate financial statements are prepared by the parent and are presented in addition to the consolidated financial statements.

2. Broadly speaking, the first step in preparing consolidated financial statements is to combine

the financial statements of the parent and the subsidiaries (i.e. 100% of the net of the subsidiary is added to the net of the parent).

3. Pro forma journals are prepared for consolidation purposes only and are not recognised in

the individual records of either the parent or the subsidiary. The pro forma journals eliminate common balances. The only two common items in this case is the investment in the subsidiary on the statement of financial position in the parent (P) and the portion of the equity of the subsidiary (S) held by the parent. The investment held by the parent in the subsidiary is therefore set off against the equity of the subsidiary as follows:

Dr Cr R’000 R’000

Share capital (SCE) 80 Retained earnings (SCE) 120 Investment in S Ltd (SFP) 200 At acquisition elimination journal

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2. Investment in subsidiary accounted for at fair value P Ltd acquired a 100% interest in S Ltd for R200 000 on 1 January 20.13 when S Ltd’s share capital and retained earnings amounted to R80 000 and R120 000 respectively. Investments in subsidiaries are accounted for at fair value through other comprehensive income (OCI) in terms of IAS 27.10(b). At 31 December 20.13 the fair value of the investment in S Ltd amounted to R220 000. Ignore the effects of tax.


Statements


Total

Pro forma

journals


(P + S)

R’000 R’000 R’000 R’000 R’000 Assets Assets Assets Investment in S Ltd (200 + 20)

220

Investments

-

220

(220)

Investment in S Ltd

-

Trade debtors 100 Trade debtors 280 380 Trade debtors 380 Equity Equity Equity Share capital (50) Share capital (80) (130) 80 Share capital (50) Retained earnings (150) Retained earnings (150) (300) 120 Retained earnings (180) Mark-to-market (20) Mark-to-market - (20) 20 Mark-to-market - Liabilities Liabilities Liabilities Long-term loan (100) Long-term loan (50) (150) Long-term loan (150)

Note 1 Note 2

Notes 1. P Ltd elected to measure its investment in S Ltd in terms of IFRS 9 i.e. at fair value through

other comprehensive income. Therefore at initial recognition P Ltd measures the investment in S Ltd at its fair value of R200 000 (generally being the consideration given). P Ltd subsequently measures the investment in S Ltd at fair value (R220 000). The fair value adjustment of R20 000 (R220 000 – R200 000) is recognised in OCI and accumulated in equity through the mark-to-market reserve.

2. On consolidation, any fair value adjustments recognised in the separate financial statements of

the parent (P Ltd) on its investment in the subsidiary (S Ltd) since acquisition must be reversed to start at cost. The pro forma journals will be as follows:

Dr Cr R’000 R’000

Mark-to-market reserve (OCI) 20 Investment in S Ltd (SFP) 20 Reversal of fair value adjustment on investment in S Ltd


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3. Investment in subsidiary accounted for using the equity method P Ltd acquired a 100% interest in S Ltd for R200 000 on 1 January 20.13 when S Ltd’s share capital and retained earnings amounted to R80 000 and R120 000 respectively. Investments in subsidiaries are accounted for using the equity method in terms of IAS 27.10(c). Ignore the effects of tax.


Statements


Total

Pro forma

journals


(P + S)

R’000 R’000 R’000 R’000 R’000 Assets Assets Assets Investment in S Ltd (200 + (100% x 30))

230

Investments

-

220

(230)

Investment in S Ltd

- Trade debtors 100 Trade debtors 280 380 Trade debtors 380 Equity Equity Equity Share capital (50) Share capital (80) (130) 80 Share capital (50) Retained earnings (180) Retained earnings (150) (330) 150 Retained earnings (180) Liabilities Liabilities Liabilities Long-term loan (100) Long-term loan (50) (150) Long-term loan (150)

Note 1 Note 2

Notes 1. P Ltd elected to measure its investment in S Ltd by using the equity method. Therefore at

initial recognition P Ltd measures the investment in S Ltd at cost of R200 000 (generally being the consideration given). P Ltd subsequently equity accounts for its share in S Ltd’s post-acquisition net assets. P Ltd’s profit or loss will include R30 000 (R150 000 – R120 000) as its share of profit of subsidiary.

2. On consolidation, any equity accounting adjustments recognised in the separate financial

statements of the parent (P Ltd) on its investment in the subsidiary (S Ltd) since acquisition must be reversed to start at cost. The pro forma journals will be as follows:

Dr Cr R’000 R’000

Share of profit of subsidiary (P/L) 30 Investment in S Ltd (SFP) 30 Reversal of equity accounting of investment in S Ltd


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COMMENT If the investor’s accounting policy is to account for investments in subsidiaries using the equity method in terms of IAS 27.10(c), the accounting implication will be as follows: In the separate financial statements of the investor: - The investment in subsidiary is initially recognised at cost and adjusted thereafter for

the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income.

- Dividends received from the subsidiary shall be recognised as a reduction from the carrying amount of the investment.

In the consolidated financial statements of the group: - The post-acquisition change in the investor’s share of the investee’s net assets will be

reversed so that the investment is again stated at cost before the at acquisition elimination journal entry is processed.

- The intragroup dividend paid by the subsidiary will be eliminated against the investment (instead of other income) and non-controlling interests.

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SECTION B - QUESTIONS ON CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

QUESTION 1.1 (47 marks - 71 minutes) The following trial balances at 31 December 20.12 are presented to you: Mickey

Ltd R

Minnie Ltd R

Debits Investment property - Land Factory buildings Equipment Investment in Minnie Ltd - 112 000 Ordinary shares at cost - 12 000 12% Preference shares at cost Inventory Trade receivables Bank Cost of sales Other expenses Income tax expense Preference dividends paid (up to 30 June 20.12) Ordinary dividends - Final dividend for the year ended 31 December 20.11 (declared and paid on 29 February 20.12) - Interim dividend for 20.12: paid 30 September 20.12

-

1 200 000 236 000

140 000 26 880 80 000

114 953 90 000

1 375 000 268 320 239 260

-

- 60 000

700 000

- 125 000

- -

26 000 40 000

- 591 499 406 000 88 700 7 200

20 000 -

3 830 413 2 004 399

Credits Issued ordinary shares (640 000 shares; 160 000 shares) Issued 12% Preference shares (20 000 shares) Retained earnings (1 January 20.12) Deferred tax Trade payables Bank overdraft Revenue Other income

640 000

- 260 000 150 500 61 593

- 2 700 000

18 320

160 000 40 000

174 950 102 449 122 000 25 000

1 200 000 180 000

3 830 413 2 004 399

Additional information 1. Mickey Ltd obtained its interest in the non-redeemable cumulative preference shares of

Minnie Ltd on 1 January 20.12 at a cost of R26 880. Minnie Ltd is contractually obliged to make preference dividend payments. You may assume that the preference shares were correctly classified as equity. The interest in the ordinary shares was also acquired on 1 January 20.12. From this date Mickey Ltd had control over Minnie Ltd as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. The details of acquisition of the interest in the ordinary shares in Minnie Ltd were as follows:

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• The purchase price agreed on, was payable in cash and a portion in shares. • A cash amount of R154 000 was payable by Mickey Ltd on 31 December 20.12 in order

for them to avoid using an overdraft facility at 10% per annum. • The share portion was settled by the issue of 1 000 ordinary shares of Mickey Ltd worth

R105 000 on 1 January 20.12 and R110 000 on 31 December 20.12. • A contingent consideration of R10 000 was also payable on 30 June 20.13 if certain

profits were met. The fair value of the contingent consideration was R8 000 on 1 January 20.12 and R9 000 on 31 December 20.12.

• The agreement determined that the seller of the shares will pay the costs relating to the

agreement and valuation expenses. The amount is R10 000 and is included in the purchase price. You may assume that the tax effect of the R10 000 is correctly accounted for.

• With the exception of the items listed below, all assets and liabilities of Minnie Ltd were

deemed to be fairly valued on acquisition date:

Carrying amount R

Fair value R

Inventory Trade receivables

20 000 27 000

36 000 19 500

The fair value of inventory represents the value at which it can be purchased. 2. Mickey Ltd, a manufacturer of equipment, sold equipment to Minnie Ltd to the value of

R50 000 on 1 January 20.12. Mickey Ltd sells equipment at cost plus 25%. Minnie Ltd uses the equipment in the production of inventory and depreciates equipment at 20% per annum according to the straight-line method.

3. Minnie Ltd purchases all its inventory from Mickey Ltd at a gross profit percentage of 20%.

Inventory purchased from Mickey Ltd still on hand at year end was as follows: 31 December 20.12 - R30 000 The inventory on hand at 31 December 20.12 was written down to net realisable value by

Minnie Ltd. Total sales of Mickey Ltd to Minnie Ltd for the year ended 31 December 20.12 amounted to

R80 000. 4. Minnie Ltd acquired the land on 30 June 20.12 at R550 000 for investment purposes. The land

is rented by Mickey Ltd at R5 000 per month and used as a storage facility for its inventory. Rent paid and received are included in other expenses and other income respectively. No rent was in arrears at 31 December 20.12. Minnie Ltd elected the fair value model to measure the investment property. The investment property value increased with R150 000 for the year ended 31 December 20.12.

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5. It is the group accounting policy to disclose land at revalued amounts. 6. It is the policy of Mickey Ltd to account for investments in subsidiaries at cost in accordance

with IAS 27.10(a) in its separate financial statements. 7. Mickey Ltd elected to measure non-controlling interests at fair value at acquisition for all

acquisitions. The fair value of the non-controlling interests was R100 000 on 1 January 20.12. 8. Mickey Ltd is not considered a share trader for income tax purposes or an investment entity as

defined in IFRS 10 Consolidated Financial Statements. 9. A market-related pre-tax discount rate is 10%, compounded annually. 10. Assume a tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore tax on financial

instruments. Ignore the effects of Dividend Tax and Value Added Tax (VAT). REQUIRED

Marks

1. Prepare the consolidated statement of profit or loss and other comprehensive income of the Mickey Ltd Group for the year ended 31 December 20.12. Income and expenditure should be indicated in terms of their function.

21½

2. Prepare the consolidated statement of financial position of the Mickey Ltd Group as

at 31 December 20.12.

Communication skills: Presentation and layout

22½

2

Please note: • Comparative figures are not required. • Notes are not required. • Show all your calculations. • Round all calculated amounts off to the nearest R1. • Your answer must comply with International Financial Reporting Standards (IFRS). • IAS 33 disclosure is not required.

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QUESTION 1.1 - Suggested solution 1. MICKEY LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 DECEMBER 20.12 R

Revenue [C7] Cost of sales [C8]

3 770 000 (1 862 499)

(2) (5)

Gross profit Other income [C9] Other expenses [C10]

1 907 501 -

(647 820)

(3)

(3½) Profit before tax Income tax expense [C11]

1 259 681 (289 180)

(4)

PROFIT FOR THE YEAR 970 501

Other comprehensive income: Items that will not be reclassified to profit or loss: Gains on property revaluation [150 000 – (150 000 x 28% x 80%)] 116 400 (1) Other comprehensive income for the year, net of tax 116 400 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 1 086 901

Profit attributable to: Owners of the parent (balancing) Non-controlling interests (49 944[C2] + 1 920[C3])

918 637 51 864

(½) (1)

970 501

Total comprehensive income attributable to: Owners of the parent (balancing) Non-controlling interests (51 864 + 34 920 [C2])

1 000 117 86 784

(½) (1)

1 086 901

(21½)

COMMENT The land will be recognised as investment property in the separate financial statements of Minnie Ltd, as it was acquired for investment purposes. The fair value adjustment and the deferred tax adjustment was thus recognised in profit or loss. Since the land is rented by Mickey Ltd (parent), it now becomes owner occupied property, plant and equipment in the group financial statements. The fair value adjustment and deferred tax adjustment recognised in profit or loss by Minnie Ltd must thus be reversed. It is the group accounting policy to measure land in accordance with the revaluation model. The increase in fair value of R150 000 must thus be recognised in other comprehensive income, net of deferred tax.

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2. MICKEY LTD GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.12

R ASSETS Non-current assets

Property, plant and equipment* Goodwill [C1]

2 253 000 6 730

(3½) (7)

2 259 730

Current assets Inventory (80 000 + 26 000 - 2 000[C5]) Trade receivables (114 953 + 40 000) Cash and cash equivalents

104 000 154 953

90 000

(1½) (1)

(½)

348 953

Total assets 2 608 683

EQUITY AND LIABILITIES

Equity attributable to owners of the parent Share capital (640 000 + 105 000[C6]) Retained earnings (260 000 + 918 637 (from 1 above) – 60 000 (div)) Other components of equity [C2]

745 000 1 118 637

81 480

(1) (1½) (½)

1 945 117 Non-controlling interests (178 864[C2] + 16 000[C3]) 194 864 (1)

Total equity 2 139 981

Non-current liabilities Deferred tax (150 500 + 102 449 - 2 240[C4] - 560[C5])

250 149

(2)

250 149

Current liabilities Bank overdraft Trade payables (61 593 + 122 000 + 9 000[C6] (J2 Mickey)) Dividends payable [C3]

25 000 192 593

960

(½) (1½) (½)

218 553

Total liabilities 468 702

Total equity and liabilities 2 608 683

Communication skills: Presentation and layout (22½) (2)

* Land (550 000 + 150 000)

Factory buildings Equipment (236 000 + 125 000 – 8 000 [C4])

700 000

1 200 000 353 000

2 253 000

COMMENT

Note that the investment in Minnie Ltd was only carried at R140 000 in the trial balance of Mickey Ltd, which thus indicates that the share issue, the contingent consideration and the acquisition costs have not yet been recorded in the records of Mickey Ltd.

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CALCULATIONS C1. Goodwill

Purchase price (243 000)

Share issued (1 000 x 105) Fair value of contingent consideration Acquisition costs Cash (FV = 154 000; n = 1; I = 10%; PV = 140 000)

105 000 8 000

(10 000) 140 000

[1] [½] [½]

[1½]

Equity at acquisition: 336 270

- Share capital - Retained earnings

160 000 176 270

[½]

- Given - Preference dividend - Inventory (16 000 x 72%) - Trade debtors (7 500 x 72%)

174 950 (4 800) 11 520 (5 400)

[½] [1] [½] [½]

Non-controlling interests (100 000) [½]

Goodwill 6 730

[7]

COMMENT Preference dividend The preference dividend paid of R7 200 up to 30 June 20.12 relates to a dividend for the year ended 31 December 20.11 amounting to R4 800 (R40 000 x 12%). This amount has to be accrued for at acquisition, since the preference shares are cumulative. The remaining R2 400 (R7 200 – R4 800 or R40 000 x 12% x 6/12) relates to the six month period ended 30 June 20.12. An amount of R2 400 must thus still be accrued for the last six months, refer to [C3]. Inventory and trade debtors The IFRS 3 fair value adjustments made to trade debtors and inventory at acquisition must again be reversed when the underlying assets are derecognised. Since trade receivables and inventory are current assets, they are expected to realise within 12 months if no other information is provided. These fair value adjustments are therefore reversed at year end.

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C2. Analysis of owners’ equity of Minnie Ltd – ordinary shares

Total

Mickey Ltd (70%) NCI

At Since

At acquisition Share capital Retained earnings:

160 000

Balance given Debtors (7 500 x 72%) Inventory (16 000 x 72%) Preference dividend in arrears

174 950 (5 400) 11 520 (4 800)

Equity represented by goodwill

336 270 6 730

235 389 7 611

100 881 (881)

Consideration and NCI 343 000 243 000 100 000

Since acquisition Current year

Profit (1 200 000 – 591 499 – 406 000 + 180 000 – 150 000 [J13] – 88 700 + 33 600 [J14]) Profit attributable to PSH Debtors Inventory

177 401 (4 800) 5 400

(11 520)

Total current year profit Revaluation – land [150 000 x (100% - (80% x 28%))] Dividend

166 481

116 400 (20 000)

116 537

81 480 (14 000)

49 944

34 920 (6 000)

605 881 184 017 178 864

C3. Analysis of owners’ equity of Minnie Ltd – preference shares

Total

Mickey Ltd (60%) NCI

At Since

At acquisition Share capital Dividend in arrears

40 000 4 800

24 000 2 880

16 000 1 920


Since acquisition Current year Profit attributable to PSH (40 000 x 12%) Dividend Dividend accrued

4 800 (7 200) (2 400)

2 880 (4 320) (1 440)

1 920 (2 880)

(960)

40 000 (2 880) 16 000

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COMMENT Preference shares have a preference to dividends over ordinary shares, and if the preference shares are cumulative, preference dividends have to be accrued for even if the dividends have not been declared. The profit attributable to preference shareholders of R4 800 is the preference dividend for the current year. Please note that this profit attributable to preference shareholders is deducted in the analysis of ordinary shares to ensure we don’t double account. The preference dividend that was paid of R7 200 (as per the trial balance) is preference dividends up to 30 June 20.12 only. The preference dividend for the period 1/7/20.12 – 31/12/20.12 is R2 400 which is calculated as R4 800 x 6/12. The parent thus has to accrue for this as preference dividends as the amount is owed to the preference shareholders at year end. For further guidance on the treatment of preference share capital refer to: Group Statements Vol 1 Par 6.19-6.20 Work through these examples: Group Statements Vol 1 Example 6.18 Group Statements Vol 1 Example 6.12

C4. Equipment sold by Mickey Ltd to Minnie Ltd

Minnie Ltd

Group

Dif- ference

Tax

Unrealised profit (50 000 x 25/125) Depreciation (10 000 x 20%) Deferred taxation at 28% Net

50 000

40 000

10 000

2 000 8 000

2 240 5 760

2 800

(560) 2 240

C5. Unrealised profit in inventory Closing balance: (30 000 x 20%) = R6 000 limited to R2 000* Taxation effect: (2 000 x 28%) = R560 * The inventory was already written-off from R30 000 to R26 000 (per trial balance) by

Minnie Ltd, an adjustment of R4 000. Therefore the remaining unrealised profit for group statement purposes is R2 000 (R6 000 – R4 000).

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C6. Journals in the records of Mickey Ltd

Dr R

Cr R

J1 Investment in Minnie Ltd (SFP) Share capital (SCE)

105 000 105 000

J2 Investment in Minnie Ltd (SFP) Contingent consideration liability (SFP) Fair value adjustment (P/L)

8 000

1 000*

9 000

J3 Acquisition costs (P/L) Investment in Minnie Ltd (SFP)

10 000# 10 000

* Not tax deductible. # The given information states that you may assume that the tax effect of the R10 000 is

correctly accounted for. C7. Revenue

Mickey 2 700 000 [½] Minnie 1 200 000 [½] Total intragroup sales (80 000) [½] Intragroup equipment sold [C4] (50 000) [½] 3 770 000

[2] C8. Cost of sales

Mickey (1 375 000) [½] Minnie (591 499) [½] Total intragroup sales 80 000 [½] Intragroup equipment sold [C4] 40 000 [½] Depreciation on intragroup equipment [C4] 2 000 [1] Unrealised profit – closing inventory [C5] (2 000) [1½] Reversal of at acquisition inventory adjustment [C2] (16 000) [½] (1 862 499)

[5]

COMMENT The depreciation on the intragroup equipment will be included in cost of sales instead of operating expenses as the specific machine is used in the production of inventory.

C9. Other income

Mickey 18 320 [½] Minnie 180 000 [½] Intragroup rent paid (30 000) [½] Reversal of fair value adjustment on investment property (150 000) [½] Ordinary dividend elimination [C2] (14 000) [½] Preference dividend elimination [C3] (4 320) [½] -

[3]

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C10. Other expenses

Mickey (268 320) [½] Minnie (406 000) [½] Fair value adjustment on contingent consideration [C6] (1 000) [1] Acquisition cost [C6] (10 000) [½] Reversal of at acquisition debtors adjustment [C2] 7 500 [½] Intragroup rent paid 30 000 [½]

(647 820)

[3½] C11. Income tax expenses

Mickey (239 260) [½] Minnie (88 700) [½] Deferred tax on unrealised profit [C4] 2 800 [½] Deferred tax on depreciation [C4] (560) [½] Deferred tax on unrealised profit [C5] 560 [½] Deferred tax on reversal of at acquisition inventory adjustment [C2] 4 480 [½] Deferred tax on reversal of at acquisition debtors adjustment [C2] (2 100) [½] Reversal of deferred tax on fair value adjustment on investment property 150 000 x 80% x 28%

33 600

[½]

(289 180)

[4] C12. Pro forma consolidation journals

The pro forma journals are provided for completeness only and should explain the adjustments made to the statement of profit or loss and other comprehensive income.

Dr R

Cr R

Investment in ordinary shares J1 Share capital (SCE) 160 000

Retained earnings (SCE) (174 950 – 4 800) 170 150 Inventory (SFP) 16 000 Debtors (SFP)

7 500

Deferred tax (SFP) [(16 000 - 7 500) x 28%]

2 380 Investment in Minnie (SFP)

243 000

Non-controlling interests (SCE/SFP)

100 000 Goodwill (SFP) (balancing) 6 730

At acquisition elimination journals J2 Cost of sales (P/L) 16 000

Inventory (SFP)

16 000 Reversal of fair value adjustment at acquisition

J3 Debtors (SFP) 7 500 Other expenses (P/L) 7 500 Reversal of fair value adjustment at acquisition

J4 Deferred tax (SFP) [(16 000 - 7 500) x 28%] 2 380 Income tax expense (P/L) 2 380 Reversal of deferred tax on fair value adjustments at

acquisition

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Dr R

Cr R

J5 Revenue (Mickey) (P/L) (50 000 x 25/125) 50 000 Cost of sales (Mickey) (P/L) (50 000 x 100/125)

40 000

Equipment (Minnie) (SFP)

10 000 Elimination of unrealised profit on intragroup equipment

sale J6 Deferred tax (SFP) (10 000 x 28%) 2 800

Income tax expense (P/L)

2 800 Deferred tax on intragroup sales

J7 Accumulated depreciation (Minnie) (SFP) (10 000 x 20%) 2 000

Cost of sales (Depreciation) (Mickey) (P/L)

2 000 Elimination of intragroup depreciation

J8 Income tax expense (P/L) (2 000 x 28%) 560 Deferred tax (SFP)

560

Deferred tax on intragroup depreciation J9 Sales (Mickey) (P/L) 80 000

Cost of sales (Minnie) (P/L)

80 000 Elimination of intragroup sales

J10 Cost of sales (Mickey) [(30 000 x 20%) - 4 000] 2 000 Inventory (Minnie) (SFP)

2 000

Elimination of unrealised profit on intragroup sales J11 Deferred tax (SFP) (2 000 x 28%) 560


560 Deferred tax on intragroup unrealised profit

J12 Other income (rental income) (Minnie) (P/L) (5 000 x 6) 30 000 Other expenses (rental expense) (Mickey) (P/L)

30 000

Elimination of intragroup rental income and expense J13 Other income (fair value adjustment) (P/L) 150 000

Investment property (SFP)

150 000 Reversal of the fair value adjustment on land included

in P/L J14 Deferred tax (SFP) (150 000 X 28% X 80%) 33 600


33 600 Reversal of deferred tax raised on the fair value

adjustment J15 Property, plant and equipment (SFP) 550 000

Investment property (SFP)

550 000 Reclassification of the land to owner occupied PPE

J16 Property, plant and equipment (SFP) 150 000 Revaluation surplus (OCI)

150 000

Recognising the increase in the fair value of the owner occupied land

J17 Deferred tax (OCI) (150 000 x 28% x 80%) 33 600 Deferred tax (SFP)

33 600

Deferred tax on the revaluation surplus

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Dr R

Cr R

J18 Non-controlling interests (P/L) 49 944 Non-controlling interests (SCE/SFP)

49 944

NCI's share of profit for the year J19 Non-controlling interests (OCI) 34 920

Non-controlling interests (SCE/SFP)

34 920 NCI's share of other comprehensive income for the year

J20 Other income (dividend received) (P/L) 14 000 Non-controlling interests (SCE/SFP) 6 000 Dividends paid (SCE)

20 000

Elimination of dividends paid

Investment in preference shares J21 Share capital (SCE) 40 000

Retained earnings (SCE) 4 800 Non-controlling interests (SCE/SFP)

17 920

Investment in Minnie (SFP)

26 880 At acquisition elimination journals

J22 Non-controlling interests (P/L) 1 920 Non-controlling interests (SCE/SFP)

1 920

NCI's share of profit for the year J23 Other income (dividend received) (P/L) 4 320

Non-controlling interests (SCE/SFP) 2 880 Dividends paid (SCE)

7 200

Elimination of dividends paid J24 Non-controlling interests (SCE/SFP) 960

Dividends payable (SFP)

960 Reclassification of dividends payable

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QUESTION 1.2 (35 marks – 53 minutes) Great White Ltd was established in 20.3 and their main business is to take tourists on shark cage diving expeditions in Gansbaai. Great White Ltd has several investments as indicated below: Whales Ltd On 1 March 20.10 Great White Ltd acquired 60% of the issued share capital of Whales Ltd, a company that is in the industry of arranging whale watching expeditions in the Hermanus area. One voting right is attached to each share. The remaining 40% of the issued share capital is owned by Mr Lombard, the managing director of the company. Mr Lombard is a meteorologist and an expert in predicting weather patterns. According to a contractual agreement, Mr Lombard has rights to refuse the boats of Whales Ltd to go out onto the sea when he expects severe weather conditions that may damage the boats and/or place the lives of the crew and tourists in danger. Great White Ltd has the rights to make all other decisions regarding operating activities. Dolphins Ltd Great White Ltd acquired 50% of the issued share capital of Dolphins Ltd on 1 September 20.12, a company situated in Ballito. Dolphins Ltd organises dolphin watching expeditions on the North Coast. One voting right is attached to each share. Mrs Yen, a retired widow, acquired the remaining 50% interest. Mrs Yen lives in Japan along with her children and rarely visits South Africa and Dolphin Ltd. Mrs Yen has the rights to make decisions regarding the investment of surplus funds. Great White Ltd has the rights to make decisions regarding the purchase and disposal of boats, organising expeditions and appointing staff. Rent-a-Boat Ltd On 1 November 20.12, a new company was formed in Gansbaai, namely Rent-a-Boat Ltd, which rents out charter boats. Hundred percent (100%) of the issued share capital is held by Mrs van Riebeeck, a local business woman in the Gansbaai area. In terms of a contractual agreement, Rent-a-Boat Ltd must have boats available for Great White Ltd at any given period. Great White Ltd also has the rights to determine the accounting policies and to appoint the directors in terms of the contractual agreement.The customers of Rent-a-Boat Ltd other than Great White Ltd contribute a very small fraction of the revenue. Mrs van Riebeeck has the rights to decide which suppliers are used for the purchase of boats. REQUIRED

Marks

Discuss, with reasons, whether or not each of the companies indicated above is a subsidiary of Great White Ltd for the year ended 31 December 20.12. Your answer should address: (a) Whales Ltd (b) Dolphins Ltd (c) Rent-a-Boat Ltd Please note: • Marks for theory will only be awarded once. • Your answer must comply with International Financial Reporting Standards

(IFRS).

14 9 12

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QUESTION 1.2 – Suggested solution General theory Great White Ltd as the investor has to determine whether it is a parent by assessing whether it controls the investee, Whales Ltd (IFRS 10.5).

(½)

An investor controls an investee when it 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 (IFRS 10.6).

(1)

(a) Whales Ltd

An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, thus the activities that significantly affect the investee’s returns.

(1)

The power that Great White Ltd has over Whales Ltd results from the voting rights of 60%, which are the majority voting rights.

(1)

Mr Lombard has the rights to refuse the boats to go out to sea when he suspects adverse weather conditions, due to his technical expertise as a meteorologist.

(1)

Mr Lombard can only protect the company and its assets and thus his own interest in the company by refusing boats to go out in severe weather conditions, as boats might be damaged and crew and tourists’ lives may be in danger should Mr Lombard not exercise his rights.

(1)

(1)

The rights that Mr Lombard has are deemed to be protective rights, as it is rights designed to protect the interest of Mr Lombard without giving him power over Whales Ltd (IFRS 10 Appendix A).

(1) (1)

Great White Ltd has the rights to make decisions regarding all other operating activities, which is thus seen as the relevant activities, as it is the activities of Whales Ltd that significantly affect the returns (IFRS 10 Appendix A).

(1)

Great White Ltd has, in terms of the 60% voting rights together with the rights to make decisions regarding relevant activities of Whales Ltd, power over Whales Ltd.

(1) (½)

Great White Ltd has rights to variable returns in the form of dividends due to its involvement with Whales Ltd as a shareholder.

(1)

The power, together with the exposure to variable returns and the ability to affect the amount of the returns, results in Great White Ltd having control over Whales Ltd.

(1)

Whales Ltd is thus a subsidiary of Great White Ltd. (1) (14)

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(b) Dolphins Ltd

Great White Ltd owns 50% of the voting rights of Dolphins Ltd, which does not constitute the majority voting rights.

(1)

Great White Ltd has the rights to make decisions regarding the purchase and disposal of boats, organising expeditions and appointing staff.

(1)

These activities are deemed to be relevant activities, as it significantly affects the returns of Dolphins Ltd. This results in Great White Ltd having power over Dolphins Ltd.

(1) (½)

Mrs Yen has the rights to make decisions regarding the investment of surplus funds, which is not deemed to be relevant activities.

(1)

Mrs Yen does thus not have power over Dolphins Ltd.

(1)

Great White Ltd has exposure, or rights, to variable returns from its involvement with the investee by means of the dividends received from the shares owned.

(1)

The power, together with the exposure to variable returns and the ability to affect the amount of the returns, results in Great White Ltd having control over Dolphins Ltd.

(1) (½)

Dolphins Ltd is thus a subsidiary of Great White Ltd. (1) Total (9)

(c) Rent-a-Boat Ltd

Great White Ltd does not own any voting rights from shares in Rent-a-Boat Ltd and does not have power in terms of voting rights.

(1)

Great White Ltd has the rights, in terms of a contractual agreement, to make decisions regarding the accounting policies and appointment of directors of Rent-a-Boat Ltd, which is deemed to be relevant activities as it significantly affects the returns of Rent-a-Boat Ltd.

(1)

(1)

Mrs van Riebeeck has the rights to decide which suppliers are used for the purchase of boats, which also constitutes relevant activities.

(1)

If two or more investors each have existing rights that give them the unilateral ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee, has power over the investee (IFRS 10.13).

(1)

(1)

The rights that Great White Ltd has regarding the relevant activities together with the contractual agreement that grants them almost exclusive use of Rent-a-Boat Ltd’s boats, constitutes power over Rent-a-Boat Ltd.

(1)

(1)

Great White Ltd has exposure, or rights, to variable returns from its involvement with the investee by means of the contractual agreement stating that Rent-a-Boat Ltd must supply boats to Great White Ltd (ifrs 10.B57(c)).

(1)

(½)

The power, together with the exposure to variable returns and the ability to affect the amount of the returns by means of the contract, results in Great White Ltd having control over Rent-a-Boat Ltd.

(1)

(½)

Rent-a-Boat Ltd is a structured entity as defined and a subsidiary of Great White Ltd. (1) (12)

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QUESTION 1.3 (11 marks - 17 minutes) Energise Ltd was formed in Johannesburg in 20.1 and its purpose is to sell pre-paid electricity, both locally and internationally. Energise Ltd has acquired many interests in foreign entities and concluded many contractual arrangements with foreign entities, due to the increasing demand for pre-paid electricity in foreign countries. Energise Ltd has a financial year end of 31 March. The following information is available relating to Energise Ltd’s foreign interest: Power LLC On 1 April 20.4, Energise Ltd formed Power LLC, a company that is located and operated in Iran. Energise Ltd did not acquire any of the share capital of Power LLC. A contractual arrangement was entered into between Energise Ltd and the shareholders of Power LLC, stating that voting rights relate to administrative tasks only and the relevant activities are directed by means of the contractual arrangement. Power LLC was formed in order to construct power plants in Iran. All the electricity generated will be sold to Energise Ltd, which will sell and distribute it throughout Iran. The construction of power plants is expected to continue until 20.24. As a result of the current ongoing sanctions against Iran, Power LLC have been experiencing difficulties in acquiring parts required in the construction of the power plants that has to be imported. This resulted in a delay in the construction of several power plants. As Power LLC cannot sell the unfinished power plants to Energise Ltd but is still incurring operating expenses, Power LLC has almost depleted their funds. The initial contractual arrangement between Energise Ltd and Power LLC did not make any provision for financial support, as it was not deemed necessary at that stage. However, Energise Ltd has noted that Power LLC requires drastic intervention. Energise Ltd provided a loan to Power LLC amounting to R1,2 billion on 1 January 20.12. A portion of the loan is secured by the power plants which amounted to R500 million. The remainder of the loan is unsecured. No repayments have yet been arranged. The entire loan carries interest at 10% per annum. Energise Ltd did not consolidate Power LLC in its consolidated financial statements for the year ended 31 March 20.12. There are currently no indications that the sanctions against Iran will be lifted. You may assume that the terms of the contractual agreement did not meet the criteria for control in accordance with IFRS 10, joint control in accordance with IFRS 11 or significant influence in accordance with IAS 28. REQUIRED Marks

Prepare the unconsolidated structured entity note to the consolidated financial statements of the Energise Ltd Group for the year ended 31 March 20.12.

Communication skills: Presentation and layout Please note: • Accounting policies are not required. • Comparative figures are not required. • Your answer must comply with International Financial Reporting Standards

(IFRS).

10

1

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QUESTION 1.3 - Suggested solution ENERGISE LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 MARCH 20.12 1. Unconsolidated structured entity

IFRS 12.26 Energise Ltd is involved with an unconsolidated structured entity through a contractual arrangement with the shareholders of Power LLC. Energise Ltd does not own any of the share capital of Power LLC. Energise Ltd entered into a contractual arrangement with the shareholders of Power LLC, stating that voting rights relate to administrative tasks only and the relevant activities are directed by means of the contractual arrangement. Power LLC was set up to construct power plants in Iran, which will generate electricity that will be sold to Energise Ltd.

(3) IFRS 12. B26(f)

As a result of the current ongoing sanctions against Iran, Power LLC have been experiencing difficulties in acquiring parts required in the construction of the power plants that has to be imported. This resulted in a delay in the construction of several power plants and in Power LLC's funds being depleted.

(1) IFRS 12.30

Energise Ltd granted a loan of R1,2 billion to Power LLC as a result of the delay. The loan provided to Power LLC has no fixed repayment terms and carries interest at 10% per annum. The capital portion of the loan was secured by Power LLC’s power plants to the value of R500 million.

(2) IFRS 12. B26(c)

Energise Ltd earned interest income (included in other income) from its involvement with Power LLC during the financial year.

(1) The following table summarises the carrying values recognised in the statement of financial position and maximum exposure to loss from its involvement at 31 March 20.12 with the structured entity:

Description Carrying amount R’000

Maximum exposure to loss

R’000

Line item in the statement of

financial position

Long term loan to Power LLC

* 1 230 000

1 230 000

Financial investments

(3)

* (1 200 + 30 interest) IFRS 12.29(a) IFRS 12.29(c) IFRS 12.29(b) (10)

Communication skills: Presentation and layout (1)

EXAM TECHNIQUE Please note that you do not have to show the references to the standard in your suggested solution.

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QUESTION 1.4 (10 marks – 15 minutes) Pensions Investment Group Ltd (PIG) is a public company established with a sole purpose of managing funds of various public and private sector pension funds with a view to provide the investors with a decent return on their investments. The company has three main investors being the Public Pension Fund, Telecoms Pension Fund and Unions SA Pension Fund. Quarterly reports with fair values of the investments are sent to investors and used as a yard stick for performance. The returns earned by PIG are based on the movements in the fair value of the investments. PIG’s investments consist mainly of equity investments of various companies listed on the JSE Limited but the company also has a 20% exposure to the bond markets on the Bond Exchange of South Africa Limited (BESA Limited). The following represents PIG’s investments, which are subsidiaries, for the year ended 28 February 20.13:

Date of acquisition

Fair value on date of

acquisition

Fair value on 28 February 20.13

R R

BrutiCell Ltd (55% controlling interest) 1 January 20.13 500 000 642 000 SenFin Ltd (60% controlling interest) 1 February 20.13 750 000 720 000 Barley Ltd (50,1% controlling interest) 1 January 20.13 425 000 820 000 The net assets of the above subsidiaries, fairly valued at the respective dates of acquisition, were as follows:

BrutiCell Ltd R

SenFin Ltd R

Barley Ltd R

Share capital (400 000 shares; 200 000 shares; 150 000 shares) 400 000 200 000 150 000 Retained earnings 600 000 450 000 320 000 Net profit (since acquisition to 28 February 20.13) 50 000 100 000 30 000 It is the policy of PIG to account for its investments in subsidiaries in accordance with IFRS 9 Financial Instruments in its separate financial statements. REQUIRED

Marks

Discuss, with reasons and illustrative journals, how PIG Ltd should account for its investments in subsidiaries for the year ended 28 February 20.13.

Communication skills: Logical flow, layout and conclusion

9

1

Please note: • Your discussion only needs to focus on Investment Entities in accordance with

IFRS 10. • You can ignore any discussions relating to taxation. • Discussions on the requirements at acquisition date is not required. • Discussion regarding disclosure requirements is not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 1.4 - Suggested solution In order for an entity to be classified as an investment entity it should meet the following definition as outlined below: (a) Obtains funds from one or more investors for the purpose of providing those investor(s) with

investment management services (IFRS 10.27(a)). (½) PIG Ltd secures investment from three pension funds currently and promises them a decent

return for managing these investments (½) (b) Commits to its investor(s) that its business purpose is to invest funds solely for returns from

capital appreciation, investment income, or both (IFRS 10.27(b)). (½) It is indicated that PIG Ltd has been established with a sole purpose of managing funds to earn

returns for the pension funds. (½) (c) Measures and evaluates the performance of substantially all of its investments on a fair value

basis. (½) PIG Ltd uses fair value as a yard stick and therefore a measure of its performance. (½) PIG Ltd also displays characteristics of an investment entity in that (IFRS 10.28): • it has more than one investor (three investors) (½) • these investors do not appear to be related parties (½) • it currently has investments in three different entities (½) PIG Ltd therefore meets the definition of an investment entity. (½) An investment entity shall not consolidate its subsidiaries or apply IFRS 3 Business Combinations, but will instead measure the investment in a subsidiary at fair value through profit or loss in accordance with IFRS 9 Financial Instruments (IFRS 10.31). (1) PIG Ltd will therefore have to process the following entries relating to the subsidiaries for the year ended 28 February 20.13 in the separate financial statements as there is no consolidated financial statements. (1) Dr

R Cr R

Investment in BrutiCell (SFP) (642’-500’) 142 000 (1) Investment in Barley (SFP) (820’-425’) 395 000 (1) Investment in SenFin (SFP)(720’-750’) 30 000 (1) Fair value adjustments (P/L) 507 000 (1) Accounting for subsidiaries at fair value

Total (11) Maximum (9) Communication skills: Logical flow and layout (1)

EXAM TECHNIQUE Please note that you do not have to show the references to the standard in your suggested solution.

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LEARNING UNIT 2 - BUSINESS COMBINATIONS

INTRODUCTION IFRS 3 deals with accounting for a business combination on date of acquisition and outlines the principles on how to account for identifiable assets acquired and liabilities assumed, non-controlling interests and goodwill or gain from a bargain purchase taking into account certain exceptions to recognition, measurement and classification principles as established in other IFRS standards.

OBJECTIVES/OUTCOMES After you have studied this unit, you should be able to demonstrate knowledge of: 1. Identify a business combination [IFRS 3.3]. 2. Account for business combinations by applying the acquisition method

[IFRS 3.4-.53]. 3. Account for a business combination in which control is achieved in stages

[IFRS 3.41-.42]. 4. Account for measurement period adjustments [IFRS 3.45-.50]. 5. Determine what forms part of a business combination [IFRS 3.51-.52]. 6. Recognition and subsequent measurement of particular assets acquired in terms of

IFRS 3 [IFRS 3.54-.58 and IFRS 3.B31-.B40]. 7. Test goodwill for impairment annually, or more frequently if events or changes in

circumstances indicate that the asset might be impaired in accordance with IAS 36.10(b).

8. Disclose information that enable users of an entity’s financial statements to

evaluate the nature and financial effect of a business combination that occurs either:

• during the current reporting period; or • after the end of the reporting period but before the financial statements are

authorised for issue [IFRS 3.59-.60]. 9. Disclose information that enables users of an entity’s financial statements to

evaluate the financial effects of adjustments recognised in the current reporting period that relate to business combinations that occurred in the period or previous reporting periods [IFRS 3.61-.63].

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PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. IFRS 3 Business Combinations. • Reverse acquisitions (IFRS 3.B19-.B27) are excluded from the SAICA syllabus. • Acquirer share-based payment awards exchanged for awards held by the

acquiree’s employees (IFRS 3.52(b) and IFRS 3.B56-B62) are excluded from the SAICA syllabus.

2. Group Statements, 16th edition, Volume 1 - chapter 2 and Volume 2 - chapter 9.

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THE REST OF LEARNING UNIT 2 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED TEXTBOOK.

SECTION A - ADDITIONAL INFORMATION 1. Overview - IFRS 3 Business Combinations

IFRS 3

Defi

nit

ion

s

Important definitions to know:

• Acquirer and acquiree Appendix

• Acquisition date A

• Business combination

• Business

• Contingent consideration

• Equity interests

• Fair value

• Goodwill

• Identifiable

• Intangible asset

• Non-controlling interests

• Owners

Sco

pe

IFRS 3 applies to all business combinations.

IFRS 3 does not apply to: 3.2-.3

• Joint ventures;

• Acquisition of assets that does not constitute a business; and

• Combination of businesses under common control.

Acq

uis

itio

n

meth

od

An entity shall account for each business combination by applying the acquisition method.

3.4-.53

(see the summary of the acquisition method below)

Su

bseq

uen

t

measu

rem

en

t an

d

acco

un

tin

g

Assets acquired, liabilities assumed and equity instruments issued in a business combination are subsequently measured in accordance with the applicable IFRSs for those items.

3.54-.58

IFRS 3 provides specific guidance on the subsequent measurement of:

• Reacquired rights

• Contingent liabilities

• Indemnification assets

• Contingent consideration

Dis

clo

su

re

The acquirer shall disclose information specified in B64-B67. 3.59-.63

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2. Acquisition method

Who is the acquirer?

The entity that obtains control of the acquiree (IFRS 3.6-.7). See control as defined in IFRS 10.5-.18

When did the acquisition

occur?

The date on which the acquirer obtains control of the acquiree (IFRS 3.8-.9).

Recognise the

identifiable assets and liabilities acquired in the business combination

Recognition criteria: To qualify for recognition the: • Assets and liabilities should meet the definitions of the

Conceptual Framework. • Assets and liabilities must be part of what is exchanged in the

business combination (not a separate transaction) Exceptions:

• Contingent liabilities should be recognised if there is a present

obligation and its fair value can be measured reliably (IFRS 3.22-.23).

• Recognise indemnification asset (debtor) only if indemnifi-cation item (liability) is recognised on acquisition date (IFRS 3.27-.28).

Note that the acquiree may not have recognised certain assets and

liabilities in its own financial statements that do qualify for recognition in the group financial statements. Examples are: • Identifiable intangible assets not recognised by the acquiree

(IFRS 3.13). • Restructuring provisions (meeting the liability definition). • Reacquired right (intangible asset) of the acquirer (IFRS 3.29).

Measure the assets and liabilities acquired in the business combination

Measurement criteria: Assets and liabilities acquired should be measured at their fair values at acquisition date. Remember: • Restatement of assets and liabilities to fair value has deferred

tax implications for the business combination. • The restatement of assets to fair value may also result in an

additional depreciation/amortisation charge in the consolidated financial statements (and again deferred tax implications)

Step 1

Step 2

Step 3

Step 4

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Exceptions:

• Reacquired right is measured based on the remaining

contractual term of the contract (excluding renewal periods) (IFRS 3.29).

• Share based payment awards should be measured in terms of IFRS 2 (IFRS 3.30).

• Assets held for sale should be measured in terms of IFRS 5 (fair value less cost to sell) (IFRS 3.31).

Recognise and measure NCI

Measure NCI at (IFRS 3.19): • Fair value or • The proportionate share of the acquiree’s identifiable net

assets.

Measure consideration transferred

Consideration is measured at fair value on acquisition date (except for share based payments) Consideration includes: • Assets transferred • Liabilities incurred • Equity interests issued

Recognise and measure goodwill

Goodwill = Consideration transferred + NCI - net assets acquired Goodwill is recognised as an asset and tested annually for impairment. Gain on bargain purchase is recognised as a gain in profit or loss on acquisition date.

Note: If the transferred asset remains within the group, the asset should be measured at its carrying amount at acquisition date.

Step 5

Step 6

Step 7

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SECTION B - QUESTION ON BUSINESS COMBINATIONS

QUESTION 2.1 (52 marks – 78 minutes) Italia Ltd is a glass manufacturing company operating in Johannesburg. The management of Italia Ltd has identified external acquisition as an area of expansion. As a result, Italia Ltd purchased a 60% interest in Colour Ltd on 1 January 20.11. On this date Italia Ltd obtained control over Colour Ltd when the share capital and retained earnings of Colour Ltd amounted to R800 000 and R1 050 000 respectively. All the companies in the group have a 31 December year end. The following matters were identified to be taken into account in calculating the identifiable assets and liabilities of Colour Ltd at fair value at the acquisition date: 1. The fair value of the non-controlling interests was R805 000 on 1 January 20.11. 2. Machinery was valued at R300 000 more than the carrying amount. The remaining useful life

from the date of acquisition is four years. Colour Ltd continued to account for machinery in accordance with the cost model as per IAS 16.

3. Land with a cost price of R300 000 had a fair value of R400 000 on 1 January 20.11. The

value of the land has increased to R450 000 at 31 December 20.11. It is the policy of Colour Ltd to account for land in accordance with the cost model as per IAS 40 Investment Property.

4. Colour Ltd disclosed a contingent liability of R450 000 in their financial statements on

1 January 20.11 relating to a court case involving a patent right not meeting industry standards. The claim represents a present obligation but at this point in time the attorneys of Colour Ltd are of the opinion that it is unlikely to lead to an outflow of economic benefits due to a lack of evidence to support the claim. The R450 000 is the fair value of the claim taking into account all possible outcomes on 1 January 20.11.

As part of the purchase agreement by Italia Ltd, the shareholders have guaranteed to

reimburse Colour Ltd 40% of the claim, should it be successful. On 31 December 20.11 the court case has progressed to such an extent that it is virtually

certain that Colour Ltd will have to pay R550 000. Colour Ltd recognised a provision of R550 000 in its financial statements on 31 December 20.11. The related transaction have been recorded correctly in Colour Ltd’s financial statements.

The claim will not be deductible for taxation purposes should it succeed.

5. Details of the consideration transferred to the shareholders of Colour Ltd are as follows: • Cash consideration of R620 000 was paid on 1 January 20.11 into the lawyer’s trust

account. • Italia Ltd will make a cash payment of R225 060 on 31 December 20.12. The

South African Revenue Services agrees with the accounting treatment and will allow the tax deduction for interest expense.

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• Italia Ltd issued 1 000 ordinary shares to the shareholders of Colour Ltd. The fair value

of the shares was R460 each on 1 January 20.11. On registration date of the shares on 22 January 20.11, the shares were valued at R465 each. The total number of shares in issue by Italia Ltd was 1 000 000 at 1 January 20.11.

• Italia Ltd is required to make an additional cash payment of R150 000 on 30 June 20.13 if the share price of Colour Ltd increases by more than 20%. The fair value of the contingent consideration was estimated to be R60 000 on 1 January 20.11 and R85 000 on 31 December 20.11. The share price of Colour Ltd had increased by 32% by 31 December 20.11. The changes in fair values on the contingent consideration is as a result of after acquisition date events.

Included in the cash consideration paid is acquisition related costs in respect of valuations and

lawyer’s fees of R120 000 which was paid by Italia Ltd. 6. On 1 January 20.10 Italia Ltd granted Colour Ltd the right to use its trademark for a period of

five years with the option to renew it for four years. Colour Ltd pays an annual fee of R50 458 for this right (a market-related fee for similar contracts is R35 000 per annum). It is expected that Colour Ltd will generate annual benefits of R125 000 through the use of the trademark, while incurring expenses of R34 542 per annum, excluding the annual fee. Neither Italia Ltd nor Colour Ltd recognised an asset or liability in respect of the right granted. The agreement may be terminated at a penalty of R70 000.

7. The abridged statement of profit or loss and other comprehensive income of Italia Ltd and

Colour Ltd for the year ended 31 December 20.11 is as follows (before taking the above information into account):

Italia Ltd

R Colour Ltd

R Statement of profit or loss and other comprehensive income

Profit for the year after tax

2 600 000

601 876

Dividends paid on 31 December 20.11 150 000

Additional information • It is the group’s policy to measure investment property using the fair value model as per IAS 40

Investment Property. • Intangible assets are accounted for using the cost model as per IAS 38 Intangible Assets. • Italia Ltd elected to measure the non-controlling interests in Colour Ltd at fair value. • Investments in subsidiaries are accounted for at cost in terms of IAS 27.10(a). • The company tax rate is 28% and the capital gains tax inclusion rate is 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. • A market-related interest rate (before tax) is 10%, compounded annually. • None of the companies are considered a share trader for income tax purposes or an

investment entity as defined in IFRS 10 Consolidated Financial Statements.

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REQUIRED

Marks

(a) Prepare the journal entries in the separate records of Italia Ltd for the year ended 31 December 20.11, relating to the information in the question. Journal entries relating to deferred taxation are also required.

16

(b) Prepare the pro forma journal entries for the Italia Ltd Group for the year ended 31 December 20.11. Journal entries relating to deferred taxation are also required.


35

1

Please note: • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 2.1 - Suggested solution (a) Journal entries in the accounting records of Italia Ltd

Dr Cr R R 1 January 20.11 J1 Investment in Colour Ltd (SFP) (balancing or [C1]) 1 255 000 (½) Acquisition cost (P/L) (given) 120 000 (1) Settlement gain reacquired right [C2] (P/L)

49 000 (5)

Share capital (SCE)(1 000 x R460)

460 000 (1½) Contingent consideration (SFP) (given) 60 000 (1) Deferred consideration (SFP) [C6] 186 000 (2½) Bank (SFP) 620 000 (1) Accounting for the investment in Colour Ltd

COMMENT Acquisition costs Acquisition costs are incurred by the acquirer to effect a business combination. These costs should not be included when measuring the consideration transferred. Instead those costs should be expensed by the acquirer when incurred (IFRS 3.53). Cost to issue debt or equity These costs should be accounted for in terms of IAS 32 as a deduction from the fair value of a debt instrument or as a deduction from equity in respect of an equity instrument.

31 December 20.11 J2 Fair value adjustment (P/L) (85 000 - 60 000) 25 000 (1½) Contingent consideration (SFP) 25 000 (½) Fair value adjustment on contingent consideration payable

COMMENT

As part of the acquisition of the subsidiary, a contingent consideration is due if the share price of the subsidiary, Colour Ltd, increase by more than 20% at 30 June 20.13. In terms of IFRS 3.39 this contingent consideration is recognised at the acquisition date fair value of R60 000. Subsequently, the contingent consideration is measured at fair value and the liability needs to be remeasured to fair value at year end, R85 000. For further guidance on contingent consideration refer to: Group Statements Vol 1 Par 2.11 Vol 2 Par 9.6 Work through these examples: Group Statements Vol 1 Example 2.14 Group Statements Vol 2 Example 9.18

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Dr Cr R R

J3 Finance costs (P/L) (10% x R186 000 (J1)) 18 600 (1) Deferred consideration (SFP) 18 600 (½) Interest on the deferred payment

(16)

COMMENT

The carrying amount and the tax base of the liability are equal since the interest on the liability is deductible for tax purposes. There are therefore no deferred tax implications on journals 2 and 3. No journals are necessary in the records of Colour Ltd as the transaction by Italia Ltd to acquire the shareholding involves the previous shareholders of Colour Ltd. It therefore does not have an impact on the issued share capital of Colour Ltd.

(b) Pro forma journal entries in the group’s accounting records

Dr Cr

1 January 20.11 R R

J1 Share capital (SCE) (given) 800 000 (½) Retained earnings (SCE) (given) 1 050 000 (½) Machinery (SFP) (given) 300 000 (1) Land (SFP) (400 000 – 300 000) 100 000 (1) Intangible asset – reacquired rights [C2] (SFP) 175 794 (4) Goodwill (SFP) [C3] or (balancing) 59 828 (½) Indemnification asset (SFP) (450 000 x 40%) 180 000 (1½) Non-controlling interests (SFP/SCE) (given) 805 000 (½) Recognised contingent liability (SFP) (given) 450 000 (1) Deferred tax (SFP) [C4] 155 622 (3½) Investment in Colour Ltd (SFP) (part (a)) 1 255 000 (½) Elimination of investment – at acquisition journal

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COMMENT Italia Ltd recognises and measures all identifiable assets acquired and the liabilities assumed in the business combination at their acquisition date fair values. Take note of the group’s policy in terms of the measurement of non-controlling interests (NCI). In this case, it is mentioned in the information that the NCI is measured at fair value and it is given as R805 000 at acquisition date. The contingent liability in respect of the legal claim is recognised as a liability assumed in a business combination since it is a present obligation resulting from past events and its fair value can be measured reliably (IFRS 3.23). Also take note that the indemnification asset (debtor) may only be recognised if the indemnification item (in this case the contingent liability) was recognised on acquisition date (IFRS 3.27). The indemnification asset should be measured on the same basis as the indemnification item (fair value in this case). For further guidance on contingent liabilities and indemnification assets refer to: Group Statements Vol 1 Par 2.12 and 2.13 Group Statements Vol 2 Par 9.4 Work through this example: Group Statements Vol 2 Example 9.9 and 9.11

Dr Cr R R 31 December 20.11 J2 Depreciation (P/L) (300 000 x ¼) 75 000 (1½) Accumulated depreciation (SFP) 75 000 (½) Provision for depreciation on machinery revalued

J3 Deferred tax (SFP) (75 000 x 28%) 21 000

(1)


21 000 (½)

Taxation on depreciation adjustment

COMMENT

At acquisition, the fair value of machinery was R300 000 higher than the carrying amount in the separate records of Colour Ltd. Colour Ltd recognised depreciation in its separate financial statements on the cost price of the machinery (this is in terms of its accounting policy). At consolidation however, the value of the machinery is R300 000 higher resulting in an additional depreciation charge that is calculated over the remaining useful life (four years) of the machinery.

J4 Contingent liability (SFP) (given) 450 000 (½) Indemnification asset (SFP) 180 000 (½) Legal expense (P/L) 270 000 (½) Reversal of contingent liability raised at acquisition

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COMMENT Colour Ltd raised a provision in its own accounting records of R550 000 at 31 December 20.11 relating to the legal claim. A contingent liability was also recognised as a liability (in respect of the legal claim) in the consolidated financial statements at acquisition date (R450 000). This contingent liability and indemnification asset previously recognised in the group’s financial statements (J1) on acquisition date must now be reversed in order to avoid “double accounting” for this liability.

Dr Cr R R

J5 Amortisation – reacquired right (P/L) (175 794 [C2] / 4) 43 949 (1) Intangible asset - reacquired right (SFP) 43 949 (½) Amortisation of reacquired right J6 Deferred tax (SFP) (43 949 x 28%) 12 306

(1)


12 306 (½) Taxation on amortisation

COMMENT The reacquired right is recognised as an intangible asset and is accounted for in accordance with IAS 38. We therefore amortise the intangible asset over the useful life of the asset which is the remaining period of the use of the trademark.

J7 Land (SFP) (450 000 - 400 000) 50 000 (1) Fair value remeasurement (P/L) 50 000 (½) Remeasurement in terms of IAS 40 J8 Income tax expense (P/L) (50 000 x 28% x 80%) 11 200

(1)

Deferred tax (SFP)

11 200 (½)

Taxation on fair value adjustment

COMMENT

Land is carried at cost in the separate records of Colour Ltd. However, it is the group’s policy to account for investment property (which includes land) in accordance with the fair value model as per IAS 40. We therefore need to account for the fair value movement in the value of land at year end. In this case we use the CGT inclusion rate of 66,6% as the fair value adjustment is higher than the original cost price.

J9 Non-controlling interests (P/L) [C5] 330 013 (5) Non-controlling interests (SFP/SCE) 330 013 (½) NCI share of profits

COMMENT

At consolidation, we add 100% of the line items of the statement of profit or loss and other comprehensive income of the subsidiary to the statement of profit or loss and other comprehensive income of the parent to calculate the consolidated figures. However, we are only entitled to 60% of the line items of the statement of profit or loss and other comprehensive income of the subsidiary. We therefore allocate the 40% share of the non-controlling interests via one line item: non-controlling interests (P/L).

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Dr Cr R R

J10 Other income - dividends received (P/L) (150 000 x 60%) 90 000

(1½)

Non-controlling interests (SFP/SCE) (150 000 x 40%) 60 000

(1½)

Dividends paid (SCE) (given)

150 000 (1)

Elimination of intragroup dividends J11 Other income – license fee received – parent (P/L)

(given) 50 458

(½) Other expenses – license fee paid – subsidiary (P/L) 50 458 (½) Elimination of intragroup license fee

Total (36)

Maximum (35) Communication skills: Presentation and layout (1)

COMMENT The fee paid and received for the use of the trademark is an intragroup transaction, irrespective of the fact that it is treated as a reacquired right in accordance with IFRS 3, and must therefore be eliminated at consolidation.

CALCULATIONS C1. Consideration transferred

Cash (given) 620 000 Shares (1 000 x R460) 460 000 Settlement gain [C2] 49 000 Deferred consideration [C6] 186 000 Contingent consideration (given) 60 000 Acquisition costs paid (given) (120 000)

1 255 000 [½]

C2. Reacquired right

COMMENT Impact of reacquired right on the consolidated financial statements: Neither Italia nor Colour recognised an intangible asset in their separate financial statements for the right granted. The reacquired right represents an identifiable intangible asset for the group and should be recognised as part of the business combination. The value of the intangible asset to be recognised is based on the remaining contractual term of the contract, regardless of renewal options. Impact of reacquired right on the separate financial statements: If the terms of the contract giving rise to the reacquired right are not in line with current market transactions, the contract will have a favourable or unfavourable component. The contract is favourable to Italia as Italia receives an annual fee of R50 458 in terms of the current agreement whilst Italia would have received an annual fee of R35 000 in the market. The contract is effectively settled due to the business combination (the group is viewed as a single entity and cannot have a contract with itself). IFRS 3 requires that Italia recognise a gain or loss on this settlement of favourable/unfavourable component of the reacquired right at acquisition date (in Italia’s separate financial statements).

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COMMENT The gain/loss to be recognised is measured at the lower of: - the amount the contract is favourable/unfavourable from the acquirer’s perspective;

and - the amount of any settlement provision to the counterparty to whom the contract is

unfavourable. For further guidance on reacquired rights refer to: Group Statements Vol 1 Par 2.11 Group Statements Vol 2 Par 9.4 Work through this example: Group Statements Vol 2 Example 9.9

Existing

contract On market

contract

Annual fee (payable to Italia) 50 458 [½] 35 000 [½] Other costs 34 542 [½] 34 542 [½]

Total cost of the contract for Colour 85 000

69 542

Income (125 000) [½] (125 000) [½]

Annual net income (40 000)

(55 458)

Discounted value: On-market present value (fair value in terms of IFRS 3) (PMT = 55 458; n = 4; i = 10%; COMP PV =)

175 795

[2]

Existing contract present value (PMT = 40 000; n = 4; i = 10%; COMP PV =)

126 795

[2]

Favourable component from Italia Ltd’s perspective 49 000

Provide a gain on the reacquired right of the lesser of R49 000 or R70 000 penalty in the accounting records of Italia Ltd. [1]

C3. Calculation of goodwill (IFRS 3.32)

+ Consideration transferred [C1] 1 255 000 + Non-controlling interests (given) 805 000

2 060 000 -Net identifiable assets acquired 2 000 172

Share capital (given) 800 000 Retained earnings (given) 1 050 000 Adjustments to the net assets (J1)

Contingent liability recognised (J1) (450 000)

Machinery – revaluation surplus (J1) 300 000 Land – fair value adjustment (J1) 100 000 Indemnification asset raised recognised (J1) 180 000 Intangible asset (Reacquired right) (J1) 175 794 Deferred tax [C4] (155 622)

Goodwill 59 828

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C4. Deferred tax

Machinery (300 000 x 28%) 84 000 [1] Land (100 000 x 28% x 80%) 22 400 [1] Intangible asset - reacquired right (175 794 x 28%) 49 222 [1] Indemnification asset - Recognised contingent liability (indemnified item) -

155 622

[3]

COMMENT A deferred tax liability is recognised on the reacquired right (intangible asset) since the carrying amount of the reacquired right exceeds its tax base (the tax base of the reacquired right is nil as no amounts in respect of this asset will be deductible for tax purposes in the future against any taxable economic benefits) (IAS 12.7). Deferred tax is not recognised on the indemnification asset since the carrying amount and tax base of the indemnification asset is equal (the economic benefits from the indemnification asset will not be taxable in the future) (IAS 12.7). Deferred tax is not recognised on the recognised contingent liability (indemnification item) since the carrying amount and tax base of the liability is equal. The tax base of the contingent liability is its carrying amount minus amounts that will be tax deductible in the future. In this case no amounts will be deductible in the future in respect of this liability, therefore the carrying amount and tax base is equal (IAS 12.8).

C5. Non-controlling interests

Profit for the year (given) 601 876 [½] Depreciation on machinery (J2) (75 000) [½] Income tax on depreciation (J3) 21 000 [½] Legal expense (J4) 270 000 [½] Amortisation (J5) (43 949) [½] Income tax on amortisation (J6) 12 306 [½] Fair value remeasurement on land (J7) 50 000 [½] Income tax on fair value remeasurement (J8) (11 200) [½]

825 033

NCI for the year = 825 033 x 40% = 330 013 [½] [4½] C6. Deferred consideration

HP 10BII SHARP EL-733A SHARP EL-738

1. 2nd

F C (Clear All) 1. 2nd

FC (Clear All) 1. 2nd

F MODE (Clear All)

2. 0 PMT 2. 0 PMT 2. 0 PMT

3. 10 I/YR 3. 10 i 3. 10 I/Y [½]

4. 2 N 4. 2 n 3. 2 N [½]

5. 225 060 FV 5. 225 060 FV 5. 225 060 FV [½]

6. PV 186 000 6. Comp PV 186 000 6. Comp PV 186 000 [½]

[2]

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C7. Analysis of owners’ equity of Colour Ltd

Total

Italia Ltd 60% NCI

At Since

At acquisition Share capital 800 000

Retained earnings 1 050 000 Equity (Contingent liability) (450 000) Equity (Machinery) 300 000 Deferred tax (84 000) Equity (Land) 100 000 Deferred tax (22 400) Equity (Indemnification asset) 180 000 Intangible asset (Reacquired right) 175 794 Deferred tax (49 222)

2 000 172 1 200 103

800 069

Equity represented by goodwill 59 828 54 897 4 931


805 000

Since acquisition

Current year

Comprehensive income for the year 601 876

Depreciation on machinery (75 000)

Income tax on depreciation 21 000

Legal expense 270 000 Amortisation (43 949) Income tax on amortisation 12 306 Fair value adjustment on land 50 000 Income tax on fair value adjustment (11 200)

Total current year profit 825 033 495 020 330 013 Dividends (150 000) (90 000) (60 000)

2 735 033 405 020 1 075 013

EXAM TECHNIQUE It was not necessary to make use of an owners’ equity analysis in this question. Nonetheless, one is provided for those students who make use of the analysis method.

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SELF ASSESSMENT QUESTIONS AND SUGGESTED SOLUTIONS

Question Question name Source Marks Topics covered Page

1 Smart Ltd FAC4864 Test 1 of 2012

50 • IFRS 3 acquisition date discussion

• IFRS 10 control discussion • Business combination jour-

nal entries when acquiring assets and liabilities

• Contingent liability and indemnification asset discus-sion in terms of IFRS 3

53

2 Pepadew Ltd FAC4864 Test 1 of 2013

40 • Calculation of goodwill • Journal entries in the

separate accounting records of the parent

• IFRS 10 control discussion • Impairment of investment in

subsidiary journals in the separate accounting records of the parent

62

3 Trading Auto Ltd FAC4864 Test 1 of 2014

40 • Consolidation journal entries at year end

• IFRS 10 control discussion

71

4 Amalgamated Fast Foods Ltd

FAC4864 Test 1 of 2015

40 • IFRS 10 discussion on NCI • Consolidated statement of

profit or loss and other comprehensive income

• IFRS 12 disclosure

82

5 Rich DotCom Ltd FAC4864 Test 1 of 2016

40 • Consolidation journal entries at year end

• IFRS 10 control discussion (Share Trust)

• IFRS 3 discussion on what forms part of a business combination

94

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QUESTION 1 50 marks

YOU HAVE 19 MINUTES TO READ THIS QUESTION

PART A 34 marks

Smart Ltd (Smart) is an independent supplier of furniture with various manufacturing operations throughout South Africa. Smart Ltd’s most recent financial reporting date was 30 June 20.10. Background

Smart recently established that they are underperforming in the Western Cape. The management of Smart established that the reason for the poor performance is due to the lack of labour and frequent labour disputes. The management of Smart decided to increase their performance by means of corporate activity and entered into an agreement with Doors Ltd (Doors) to purchase their Western Cape division. The transaction between Doors and Smart constitutes a “business combination” as defined in IFRS 3 Business Combinations. Western Cape division

The purchase agreement between Smart and Doors was signed and finalised by management on 1 January 20.10. Smart, in accordance with the agreement, is liable to transfer the purchase consideration on 1 January 20.10 and will therefore in turn acquire the assets and assume the liabilities on this date. The agreement however stipulates that there will be a transition phase for 12 months. The purpose of this phase is to carry over knowledge and expertise from Doors’ management to Smart’s management. The management of Doors will still be responsible for the implementation of the financial and operating policies during the transition phase. The Western Cape division will unconditionally be handed over to Smart’s management on 1 January 20.11 and from this date Smart will have control over the Western Cape division as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. Consideration transferred

Smart transferred R2 million in cash to the sellers, Doors, on 1 January 20.10. Assets acquired and liabilities assumed of the Western Cape division The following assets were acquired and liabilities assumed of the Western Cape division:

Notes Carrying Amount

01/01/20.11 R

Carrying amount

01/01/20.10 R

Fair value 01/01/20.10

R

Fair value 01/01/20.11

R

Machinery 770 000 800 000 850 000 820 000 Plant 1 000 000 1 200 000 990 000 1 200 000 Creditors (290 000) (300 000) (280 000) (300 000) Work force 1 - - 300 000 450 000 Labour dispute (fair value of claims)

2

-

-

‘80 000)

(100 000)

Net assets and liabilities 1 480 000 1 700 000 1 780 000 2 070 000

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Notes to the assets acquired and liabilities assumed 1. One of the main reasons why Smart purchased the Western Cape division from Doors was

attributable to the effective work force already established by Doors in their Western Cape division. The fair values were determined by an independent consultant. Management of Smart is of the opinion that the work force will add a lot of value to their existing division in the Western Cape.

2. Labour unrest increased after the recent dismissal of a number of Doors’ employees in the

Western Cape division. The trade unions to which these employees belong have instituted a legal claim against Doors on behalf of the employees. The financial manager of Doors did not include any amount relating to the legal claim in the net assets. Should such a claim be successful, any amount paid by Doors will not be deductible for tax purposes. The fair value of the claims as above was reliably determined by an independent actuary.

3. Doors contractually agreed to reimburse the Western Cape division for 75% of the damages

payable relating to the legal claim against Doors as a result of the dismissal. 4. Doors’ Western Cape division incurred research and development costs during the periods

20.10 and 20.9 aimed at reducing redundant manufacturing costs. The financial manager of Doors expects an annual cost saving of R250 000 per annum from 1 January 20.11 to 31 December 20.14. It is the opinion of the financial manager that the cost saving will only be 50% probable. Doors did not recognise an intangible asset in terms of IAS 38 Intangible Assets. The development cost was expensed when incurred.

Additional information 1. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. Where appropriate and unless stated otherwise, the South African Revenue Service (SARS) accepts the acquisition date fair values of assets and liabilities for taxation purposes.

2. Assume a market related pre-tax interest rate of 12% per annum, compounded annually. 3. The remaining useful life of the machinery and plant was three years on 1 January 20.10. 4. Smart Ltd is not considered a share trader for income tax purposes or an investment entity as

defined in IFRS 10 Consolidated Financial Statements. PART B 16 marks SECTION 1 9 marks Jetta Ltd has annual shareholder meetings at which decisions are made to direct the relevant activities. The next scheduled shareholders’ meeting is in nine months. However, shareholders that individually or collectively hold at least 10% of the voting rights can call a special meeting to change the existing policies over the relevant activities, but a requirement to give notice to the other shareholders means that such a meeting cannot be held for at least 30 days. Policies over the relevant activities can be changed only at special or scheduled shareholders' meetings. This includes the approval of material disposal of fixed assets as well as acquiring or disposing of significant investments. Golf Ltd is a party to a forward contract to acquire the majority of shares in Jetta Ltd. The forward contract's settlement date is in 25 days.

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SECTION 2 7 marks Uno Ltd holds a 55% interest in Corolla Ltd. Uno Ltd has the right to restrict Corolla Ltd from undertaking activities that could significantly change the credit risk of Corolla Ltd to the detriment of Uno Ltd. Another entity, Ford Ltd, has existing rights that provide them with the right to direct the relevant activities of Corolla Ltd (Ford Ltd is not an agent of Uno Ltd). REQUIRED

YOU HAVE 75 MINUTES TO ANSWER THIS QUESTION

Marks

PART A (a) Prepare a report to the management of Smart Ltd in which you discuss, with

reasons, the following items with regard to the acquisition of the Western Cape division of Doors Ltd:

(i) The appropriate acquisition date; (ii) The recognition of the legal claim againsts Doors Ltd and possible

reimbursement of the damages. You do not have to address subsequent measurement in your report.

Communication skills: Conclusion, logical flow and format

(b) Prepare all the journal entries that should be processed by Smart Ltd for the year

ended 30 June 20.11 in respect of the acquisition of the Western Cape division. Your solution must include the calculations of the deferred tax consequences of all

assets and liabilities recognised.

3 7

1

23

PART B SECTION 1 Discuss, with reasons, whether Golf Ltd has power over Jetta Ltd in terms of IFRS 10 Consolidated Financial Statements.

9

SECTION 2 Discuss, with reasons, whether Uno Ltd has control over Corolla Ltd in terms of IFRS 10 Consolidated Financial Statements.

7

Please note: • Journal narrations are not required • Your answer must comply with the requirements of International Financial Reporting

Standards (IFRS).

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QUESTION 1 – Suggested solution PART A (a) REPORT FORMAT

DATE: 10 March 20.12 TO: The Chief Financial Officer of Smart Ltd FROM: CTA Student RE: Acquisition of Western Cape Division

(i) Appropriate acquisition date

• The date of acquisition is the date on which the acquirer, Smart Ltd, obtains control of the acquiree's business, which is in this case the Western Cape Division (IFRS 3.8).

(1) • The date the acquirer obtains control of the acquirer’s business is generally

when the acquirer transfers the consideration, acquires the assets and assumes the liabilities – closing date, which in this case is on 1 January 20.10. However, the acquirer might obtain control on a date that is either earlier or later than the closing date (IFRS 3.9).

(1) • Smart Ltd will have control of the Western Cape Division from

1 January 20.11. Doors Ltd’s management therefore have power over the relevant activities as they govern the operating and financial policies from 1 January 20.10 to 31 December 20.10.

(1) • The date of acquisition is 1 January 20.11 as this is the date when control

is obtained by Smart Ltd over the Western Cape Division.

(1) Total (4)

Maximum (3)

(ii) Reimbursement of Doors

• The acquirer shall recognise as of the acquisition date a contingent liability assumed in a business combination if it is a present obligation that arises from past events and the fair value can be measured reliably (IFRS 3.23).

An acquirer recognises a contingent liability at fair value at the date of acquisition.

(1)

(½) • Based on the above a contingent liability for the labour dispute should be

recognised as there is a present obligation (damages payable) as a result of past event (unfair dismissals).

The fair value was determined by an independent actuary on the date of acquisition, 1 January 20.11. A contingent liability needs to be recognised of R100 000.

(1)

(½) • The seller in a business combination may contractually indemnify the

acquirer for the outcome of a contingency related to all or part of a specific asset or liability (IFRS 3.27).

The acquirer shall recognise an indemnification asset at the same time that it recognises the indemnified item measured on the same basis as the indemnified item (IFRS 3.27).

(½)

(½)

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(b) Journal entries for the year ended 30 June 20.11 Dr

R Cr R

1 January 20.11 J1 Machinery (SFP) (given) 820 000 (1) Plant (SFP) (given) 1 200 000 (1) Indemnification asset (SFP) (R100 000 x 75%) 75 000 (1½) Intangible asset (SFP) [C2] 379 669 (2½) Investment/Receivable (SFP) [C1] 2 240 000 (2) Contingent liability (SFP) (given) 100 000 (1) Deferred tax (SFP) [C3] 106 307 (4) Creditors (SFP) (given) 300 000 (1) Goodwill (SFP) (balancing) 271 638 (½) At acquisition recognition of assets acquired and

liabilities assumed

J2 Unearned finance income (SFP) ((2 240 000 – 2 00 000) x 6/12)

120 000

(2)

Interest received (P/L) 120 000 (½) Recognition of unearned finance income to profit or

loss

30 June 20.11 J3 Amortisation: Intangible asset (P/L)

(R379 669/4 x 6/12)

47 459

(2) Accumulated amortisation: Intangible asset (SFP) 47 459 (½) Recognition of amortisation on intangible asset J4 Deferred tax (SFP) (R47 459 x 28%) 13 289 (1) Income tax expense (P/L) 13 289 (½) Recognition of deferred tax on amortisation J5 Depreciation (P/L) ((R820 000 + R1 200 000) x 6/24)

Accumulated depreciation: Machinery (SFP) Accumulated depreciation: Plant (SFP) Recognition of depreciation on PPE

505 000 205 000 300 000

(2) (½) (½)

Total (24) Maximum (23)

• The reimbursement that Doors Ltd contractually agreed to relates to a liability, labour disputes (R100 000), recognised at the acquisition date which was measured at acquisition date fair value.

Smart Ltd shall therefore recognise an indemnification asset at the acquisition date measured at fair value for the reimbursement payable by Doors Ltd.

(½)

(½)

• The fair value of the indemnification asset to be recognised at acquisition date by Smart Ltd will be R75 000 (75% x R100 000).

(1)

• There will be no deferred tax implications on contingent liability as the South African Revenue Service (SARS) will not allow any deductions on the liability, therefore it is exempt at initial recognition.

• The indemnification asset should be recognised using the same basis of measurement. Therefore the indemnification asset will also have no deferred tax as the contingent liability does not have deferred tax (IFRS 3.57).

(1)

(1) Total (8)

Maximum (7) Communication skills: Conclusion, logical flow and format (1)

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COMMENT Why was the work force of R450 000 not included as an intangible asset at acquisition as part of identified assets acquired and liabilities assumed in the business combination? Intangible assets shall be recognised separately from goodwill, if they are identifiable. In terms of IAS 38, an intangible asset is identifiable if it meets either the separability criteria or the contractual/legal criteria. The workforce does not meet the above criteria as: • It is not controlled by a legal contract (the Western Cape Division does not have a

contract with the collection of employees as a whole); and • The workforce cannot be sold separately and does not meet the separability

criteria. Therefore, the workforce is not separately recognised as an intangible asset. Also refer to IFRS 3.B37-.B40.

CALCULATIONS C1. Amount of cash paid on 1 January 20.10, determining fair value


1. 2nd

F C (Clear All) 2. 1 2

nd F PMT/YR

3. 0 PMT 4. 12 I/YR 5. 1 N 6. 2 000 000 PV 7. FV 2 240 000

1. 2nd

FC (Clear All) 2. 0 PMT 3. 12 i 4. 1 n 5. 2 000 000 PV 6. Comp FV 2 240 000

1. 2nd

F MODE (Clear All) 2. 0 PMT 3. 12 I/Y 3. 1 N 4. 2 000 000 PV 5. COMP FV 2 240 000

[1½]

COMMENT

Consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values. The R2 000 000 was paid in cash on 1 January 20.10. The acquisition date is only on 1 January 20.11, therefore the FV (future value) needs to be calculated in order to determine the fair value of consideration transferred at acquisition date. On 1 January 20.10 the following journal would have been processed in the accounting records of Smart Ltd: Dr

R Cr R

Investment in Western Cape Division (SFP) (2 000 000 + 240 000)

2 240 000

Bank (SFP) 2 000 000 Unearned finance income (SFP) 240 000

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C2. Development costs


1. 2nd

F C (Clear All) 2. 125 000 PMT 3. 12 I/YR 4. 4 N 5. 0 FV 6. PV 379 669

1. 2nd

FC (Clear All) 2. 125 000 PMT 3. 12 i 4. 4 n 5. 0 FV 6. Comp PV 379 669

1. 2nd

F MODE (Clear All) 2. 125 000 PMT 3. 12 I/Y 3. 4 N 4. 0 FV 5. COMP PV 379 669

[2]

C3. Deferred tax

Carrying amount

Tax base Temporary differences

Machinery 820 000 820 000 - [½] Intangible asset: Development costs 379 669 - 379 669 [½] Plant 1 200 000 1 200 000 - [½] Indemnification asset 75 000 75 000 - [½] Creditors (300 000) (300 000) - [½] Contingent liability (100 000) (100 000) - [½] Total temporary differences 379 669 Deferred tax at 28% 106 307 [½]

[3½]

COMMENT Why is it that machinery, plant and creditors have a tax base equal to the carrying amount for the deferred tax calculation if there is a difference between the fair value and carrying amount? A business combination that involves the purchase of the net assets (as in Western Cape Division that was purchased as a going concern) of another entity rather than the purchase of the shares in the other entity, does not result in a parent-subsidiary relationship. In such circumstances, the acquirer applies IFRS 3 in its separate or individual financial statements by including the assets/liabilities purchased instead of recognising an equity share investment in Doors Ltd. Due to the above, the SARS will deem the tax base on initial recognition to be the same as the fair value of the assets and liabilities acquired. However the development cost (intangible asset) is an asset that was created at acquisition date as a result of IFRS 3. The intangible assets were not acquired by means of a purchase transaction. The SARS will not recognise these assets (no future deduction against taxable income) and thus the tax base will be equal to zero. Therefore all these items will result in temporary differences. Note that if shares in Doors Ltd was acquired instead of the net assets then the deferred tax calculation and adjustment on group level for deferred tax would have included the existing assets and liabilities which had a fair value adjustment as a result of applying IFRS 3 and new assets and liabilities recognised on group level as a result of IFRS 3.

PMT calculated as follows: R250 000 x 50% = R125 000 [1]

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PART B SECTION 1

• To have power over an investee, an investor must have existing rights that give it the current ability to direct the relevant activities [IFRS 10.B9].

(1)

• For the purpose of assessing power, only substantive rights and rights that are not protective shall be considered [IFRS 10.B9].

(1)

• For a right to be substantive, the holder must have the practical ability to exercise that right [IFRS 10.B22].

(1)

• When assessing control, an investor considers its potential voting rights as well as potential voting rights held by other parties to determine whether it has power [IFRS 10.B47].

(1)

• The fact that it takes 25 days before Golf Ltd can exercise its voting rights does not stop Golf Ltd from having the current ability to direct the relevant activities from the moment Golf Ltd acquires the forward contract.

(1)

• Golf Ltd's forward contract is a substantive right that gives them the current ability to direct the relevant activities because a special meeting cannot be held for at least 30 days, but Golf Ltd can settle the forward contract in 25 days.

(1½)

• The existing shareholders are unable to change the existing policies over the relevant activities because a special meeting cannot be held for at least 30 days, at which point the forward contract will have been settled.

(1½)

• Golf Ltd has power over Jetta Ltd because it holds substantive potential voting rights that give them the current ability to direct the relevant activities.

(1)

(9)

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SECTION 2 • An investor controls an investee if the investor has: (a) power over 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 [IFRS 10.7].

(½) (½)

(½)

• If an investor holds more than half of the voting rights of an investee, to have power over an investee, the investor's voting rights must be substantive [IFRS 10.B36].

(½)

• Uno Ltd hold 55% of Corolla Ltd and thus have a majority of the voting rights, but Uno Ltd's voting rights are not substantive.

(1)

• In terms of IFRS 10.14, an investor that holds only protective rights does not have power over an investee and consequently does not control the investee.

(1½)

• Protective rights relate to fundamental changes to the activities of an investee [IFRS 10.B26].

(½)

• Protective rights are designed to protect the interests of their holder without giving that party power over the investee to which those rights relate [IFRS 10.B27].

(1)

• Uno Ltd only has rights that restrict Corolla Ltd from undertaking activities that could

change the credit risk of Corolla Ltd to the detriment (disadvantage) of Uno Ltd.

(½)

• Although Uno Ltd holds the majority of the voting rights, they only hold protective rights

and thus do not have control over Corolla Ltd.

(1½) Total

Maximum (8) (7)

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QUESTION 2 40 marks


Pepadew Ltd (Pepadew) is a company founded in South Africa with a 30 September 20.12 current financial year end. Pepadew's main business is to export high-quality South African fruit to South East Asia. The company is listed on the JSE Limited. You are the senior group accountant of Pepadew and responsible for the year end consolidation. The financial director, Mr Clueless, approached you to assist with the finalisation of certain aspects and transactions about which he is uncertain. The information that follows relates to these outstanding items. Transaction 1: Broccoli Ltd (Broccoli) In order to further diversify their business, Pepadew acquired 80% of the ordinary shares in Broccoli on 30 April 20.12. From this date Pepadew had control over Broccoli as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. Broccoli distributes vegetables locally as well as internationally. On 30 April 20.12, the issued share capital of Broccoli was R400 000 (200 000 ordinary shares), while the retained earnings amounted to R1 500 000. The fair value of the net identifiable assets was equal to the carrying amount thereof at the acquisition date, except as differently indicated in the information below. The following three items were not recorded in the records of Broccoli: Fair value

R • Customer contracts - renewable, not separable (manner of recovery of

carrying amount– through use)

140 000 • Internally generated client lists - contingent on a privacy agreement and cannot

be sold (manner of recovery of carrying amount– through use)

210 000 • Internally generated trademark – separable (manner of recovery of carrying

amount– through use)

90 000 The net identifiable assets at 30 April 20.12 include land that is carried at R500 000, which represents the original cost. The land was valued by an independent valuer on 30 April 20.12. The valuation report which was received on 15 June 20.12, shows that the land had a fair value of R430 000 at the date of valuation. On 1 April 20.12 Broccoli offered packages to their employees who do not wish to be employed by the Pepadew Group. By 30 April 20.12 it was estimated that five of the employees of Broccoli will accept the package and will receive a cash payment of R15 000 each on 30 September 20.12. The transaction has not been recorded in the records of Broccoli. The package payments will not be deductible for tax. The former shareholders of Broccoli were Veggie Ltd and Mr Green, an employee of Broccoli. Pepadew settled the purchase price of the interest as follows:

• Issued 60 000 and 40 000 Pepadew ordinary shares respectively to Veggie Ltd and Mr Green

on 30 September 20.12.

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• A cash payment of R600 000 to Veggie Ltd on 30 April 20.12. • During February 20.12 Pepadew was sued for an amount of R100 000 by Veggie Ltd (in

respect of the infringement of a patent). The claim was settled as part of the consideration to buy the shares in Broccoli. The fair value of the claim was R80 000 on 30 April 20.12.

• A cash payment of R600 000 to Mr Green to be made on 30 April 20.13. Under the acquisition

agreement, 10% of this payment will be refunded to Pepadew by Mr Green if the profits of Broccoli decline to less than R450 000 per year in the 20.13 or 20.14 financial years. On 30 April 20.12, the fair value of the amount receivable by Pepadew is estimated at R15 000.

• An amount of R5 000 per month will be paid to Mr Green for a period of 24 months

(commencing 1 May 20.12), when and if the monthly income of Broccoli exceeds R85 000 per month during this period. Mr Green will act as the financial manager of Broccoli during this period, at a lower than market related salary.

Transaction 2: Mango Ltd (Mango) Pepadew purchased a 15% interest in Mango on 1 July 20.8 (the date of incorporation of Mango) for R3 500 000. Pepadew acquired a further 55% interest in Mango for R9 270 000 on 30 June 20.12. From this date, Pepadew had control over Mango as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. The carrying amount of the previously held investment on 30 June 20.12 was R3 900 000, which is the fair value. The statement of financial position of Mango as at 30 June 20.12 was as follows: Dr

R’000

Cr R’000

Share capital (500 000 shares) Retained earnings Net assets

- -

24 000 24 000

14 000 10 000 - 24 000

On 30 June 20.12 the following matters were identified to be taken into account in calculating the purchase consideration: • Included in the purchase price of R9 270 000 is acquisition related costs in respect of

valuations and agreements of R100 000 which was paid by Pepadew. • On 1 January 20.10 Pepadew granted Mango the right to use its trademark for a period of five

years with the option to renew it for four years. Mango pays an annual fee of R40 000 for this right (a market-related fee for similar contracts is R50 000 per annum). It is expected that Mango will generate annual benefits of R120 000 through the use of the trademark, while incurring expenses of R20 000 per annum, excluding the annual fee. Neither Pepadew nor Mango recognised an asset or liability in respect of the right granted. The agreement may be terminated at a penalty of R80 000.

• Pepadew settled the purchase price of R9 270 000 by issuing 100 000 ordinary shares at fair

value and R8 500 000 cash payable on 30 June 20.13. A contingent consideration of R500 000 was also payable on 30 June 20.13 if certain profit targets were met. The fair value of the contingent consideration was R320 000 on 30 June 20.12 and R350 000 on 30 September 20.12.

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Transaction 3: Strategic investment in Litchi Ltd (Litchi) Some years ago Pepadew made a strategic investment in Litchi. The objective of Litchi’s incorporation was to transfer ownership of agricultural land to previously disadvantaged farm workers on litchi farms. Pepadew paid R500 000 for 15% voting rights in the company as well as an option that, if exercised, will entitle Pepadew to an additional 40% of the voting rights in Litchi. The relevant activities of Litchi are directed solely by means of voting rights. The option is currently exercisable and there are no barriers to the exercise of the option. Mr Clueless initially expensed the R500 000 paid as Black Economic Empowerment cost. However the external auditors are questioning whether this was the correct accounting treatment in terms of IFRS 10 Consolidated Financial Statements. Transaction 4: Dividend received from Apple Ltd (Apple) Pepadew acquired the 60% interest in the share capital and voting rights of Apple on 1 September 20.11 at a cost of R780 000. From this date, Pepadew had control over Apple as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. On 30 September 20.12 (date dividends were declared and paid) Pepadew received a dividend payment from Apple of R30 000. Apple’s equity consisted of the following reserves on the specific dates: At

acquisition R

30 Sept 20.11

R

30 Sept 20.12

R

Share capital (500 000 shares) Retained earnings Net assets

500 000 800 000 1 300 000

500 000 810 000 1 310 000

500 000 730 000 1 230 000

Mr Clueless processed only the following journal with regard to the dividend received from Apple: Dr

R Cr R

30 September 20.12 Bank (SFP) 30 000 Investment in Apple (SFP) 30 000 Recognition of dividend received

Additional information • The fair value of the Group’s shares were as follows on the respective dates:

Pepadew

R Broccoli

R Apple

R

30 April 20.12 5,90 7,35 - 30 June 20.12 6,70 7,60 - 30 September 20.12 6,00 7,95 1,48

• It is the accounting policy of Pepadew Ltd to account for all investments in subsidiaries at cost

in accordance with IAS 27 Separate Financial Statements and all other equity investments at fair value through profit or loss in terms of IFRS 9 Financial Instruments.

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• Assume that the ruling tax rate is 28% and that the capital gains tax inclusion rate is 80%.

Ignore Dividend Tax and Value Added Tax (VAT). • Assume that a market related pre-tax interest rate of 9% per annum is applicable. • Pepadew Ltd is not considered a share trader for income tax purposes or an investment entity

in terms of IFRS 10 Consolidated Financial Statements.

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REQUIRED


Marks

Prepare a memorandum to Mr Clueless to assist with the finalisation of certain aspects and transactions relating to the Pepadew Ltd Group, as listed below, for the year ended 30 September 20.12: (a) Mr Clueless is uncertain if the Pepadew Ltd Group should measure non-controlling

interests in Broccoli Ltd at fair value or at the proportionate share of net assets of Broccoli Ltd and what the effect thereof on goodwill will be. Calculate the goodwill on the purchase of Broccoli Ltd as at 30 April 20.12 based on non-controlling interests in Broccoli Ltd being measured at fair value (transaction 1).

(b) Calculate the goodwill on the purchase of Broccoli Ltd as at 30 April 20.12 based on

non-controlling interests in Broccoli Ltd being measured at the proportionate share of net assets of Broccoli Ltd (transaction 1).

(c) Prepare the journal entries in order to account for the further investment made in

Mango Ltd in the separate accounting records of Pepadew Ltd for the year ended 30 September 20.12 (transaction 2).

(d) Advise Mr Clueless if the investment in Litchi Ltd should be consolidated in the

financial statements of the Pepadew Ltd Group for the year ended 30 September 20.12 in terms of IFRS 10 Consolidated Financial Statements (transaction 3).

(e) Prepare the correcting journal entries relating to the dividends received from

Apple Ltd in the separate accounting records of Pepadew Ltd for the year ended 30 September 20.12 (transaction 4).

Please note: • Ignore any taxation effects for part (e) of this question.

Communication skills: Presentation and layout Please note: • No discussion of the measurement of non-controlling interests is required for part a

and part b, only calculations. • Journal narrations are not required. • Round off all amounts to the nearest Rand. • Show all calculations. • Your answer must comply with International Financial Reporting Standards (IFRS).

10½

1½

14

6

6

2

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QUESTION 2 - Suggested solution

MEMORANDUM TO: Mr Clueless FROM: CTA Student DATE: 9 March 20.13 SUBJECT: Finalisation of outstanding transactions relating to the Pepadew Ltd Group (2) Attached please find my comments regarding each transaction as requested. (a) Goodwill/Gain from bargain purchase if non-controlling interests are measured at fair

value R

Consideration transferred [C1] 1 645 459 (4) Plus: Non-controlling interests (20% x 200 000 x R7,35) 294 000 (1½) Minus: Net asset value [C2] (1 936 280) (5) Goodwill 3 179

(10½) (b) Goodwill/Gain from bargain purchase if non-controlling interests are measured at the

proportionate share of net assets R Consideration transferred (above) 1 645 459 (½) Plus: Non-controlling interests (20% x 1 936 280) 387 256 (½) Minus: Net asset value (above) (1 936 280) (½) Goodwill 96 435

(1½)

EXAM TECHNIQUE Goodwill could also have been calculated as follows: Consideration transferred (above) R1 645 459 Minus: 80% of net asset value (1 936 280 x 80%) (R1 549 024) R96 435

(c) Journal entries in the separate accounting records of Pepadew Ltd

Dr R

Cr R

J1

30 June 20.12 Capital/Equity (SCE) (100 000 x 6,70) Loan (SFP) (8 500 000/1,09) Contingent consideration (SFP) Investment in Mango Ltd (SFP) Acquisition cost (P/L) Settlement loss reacquired right (P/L) [C3] Investment in Mango Ltd (SFP) (balancing) Accounting for the investment in Mango Ltd

100 000 21 535

12 566 630

670 000

7 798 165 320 000

3 900 000

(1½) (1½)

(1) (½) (1) (4)

(½)

J2

30 September 20.12 Fair value adjustment (P/L) (350 000 – 320 000) Contingent consideration (SFP) FV adjustment on contingent consideration payable

30 000

30 000

(1½) (½)

J3 Interest on loan (P/L) (9% x 3/12 x 7 798 165 (J1)) Loan (SFP) Interest on the deferred payment

175 459 17 459

(1½) (½)

(14)

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(d) Discussion whether Litchi Ltd should be consolidated

• An entity that is a parent shall present consolidated financial statements. • In terms of IFRS 10.5 an investor shall determine whether it's a parent by assessing

whether it controls the investee.

(½)

(½) • An investor controls an investee when it 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 [IFRS 10.6].

(½) • Pepadew Ltd has rights to variable returns in the form of dividends due to its

involvement with Litchi Ltd as a 15% shareholder.

(½) • To have power over an investee, an investor must have existing rights that give it the

current ability to direct the relevant activities [IFRS 10.B9]. (½)

• When assessing control, an investor considers its potential voting rights as well as potential voting rights held by other parties to determine whether it has power [IFRS 10.B47].

(½) • Potential voting rights are considered only if the rights are substantive

[IFRS 10.B47].

(½) • For a right to be substantive, the holder must have the practical ability to exercise

that right [IFRS 10.B22].

(½) • The options are currently exercisable and there are no barriers to the exercise of the

option, therefore the rights are substantive. Therefore the option should be taken into account when assessing control.

(½)

(½) • Pepadew Ltd has the option to acquire an additional 40% of the voting rights, which

will result in Pepadew Ltd having the majority of the shares and thus majority of the voting rights.

(1) • Based on the inclusion of the option which is currently exercisable, Pepadew Ltd

controls Litchi Ltd. Litchi Ltd is thus a subsidiary of Pepadew Ltd and therefore Pepadew Ltd should consolidate Litchi Ltd.

(2) Total

Maximum (8) (6)

(e) Correcting journal entries in the separate accounting records of Pepadew Ltd

Dr R

Cr R

30 September 20.12 J1 Investment in Apple (SFP) (given) 30 000 (1) Dividends received/Other income (P/L) 30 000 (½) Recognise dividend received

J2 Impairment loss (P/L) [C4] 336 000 (4) Investment in Apple (SFP) 336 000 (½) Impairment of investment in Apple

(6)

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CALCULATIONS C1. Consideration transferred - Share capital (100 000 x R5,90) 590 000 [1]

- Cash to Veggie Ltd 600 000 [½] - Veggie Ltd claim (100 000 – 20 000) (80 000) [1] - Cash to Mr Green (600 000/1,09) 550 459 [1] - Financial asset (15 000) [½] - Salary of Mr Green -

1 645 459

[4]

COMMENT The journal entry for the consideration paid in the separate accounting records of Pepadew Ltd would have been as follows:

Notes Dr R

Cr R

J1 Investment in subsidiary (SFP) 1 1 645 459 Veggie Ltd claim liability (SFP) 2 80 000 Contingent consideration - asset (SFP) 3 15 000 Bank (SFP) 600 000 Share capital (SCE) 4 590 000 Deferred payment (SFP) 5 550 459 Salary payable to Mr Green (SFP) 6 -

Notes: 1 Balancing amount. 2 This is a transaction that does not relate to the business combination, it is a liability

that existed before the business combination and was only settled during the business combination accounting. The acquirer owed money to the previous shareholder Veggie Ltd as a result of a prior claim. IFRS 3.51 indicates that items that do not form part of the business combination (such as this prior claim) must be excluded from the business combination accounting. Therefore the payment of R80 000 to the prior owner Veggie Ltd should be deducted from the consideration, in order to only result in consideration that directly relates to the business combination.

3 Note the contingent consideration is an asset and not a liability in this scenario. The question states that the amount will be refunded to Pepadew Ltd should certain targets not be met.

4 Although the shares were only issued on 30 September 20.12, the share price as at 30 April 20.12 (acquisition date) will be used to calculate the consideration paid. IFRS 3.37 states that the consideration transferred shall include the acquisition date fair values of equity interests issued by the acquirer.

5 The deferred payment will be discounted to a present value as at the acquisition date to calculate the fair value of the consideration transferred.

6 Mr Green will act as financial manager of Broccoli Ltd in exchange for a salary that is low in comparison to the market. This indicates that the additional amount of R5 000 per month (payable to him if the monthly earnings exceed R85 000) represents remuneration for services and not consideration transferred (IFRS 3.B55(c)).

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C2. Net asset value

- Share capital 400 000 [½] - Retained earnings 1 500 000 [½] - Customer contracts (140 000 x 72%) 100 800 [1] - Client lists (not separable) - - Internally generated trademarks (90 000 x 72%) 64 800 [1] - Land [500 000 - 430 000 x (100% - (80% x 28%))] (54 320) [1] - Provision for packages (15 000 x 5) (75 000) [1]

1 936 280 [5]

COMMENT The payment of packages to employees will occur within 12 months from acquisition date, therefore the amount of R75 000 does not need to be discounted to a present value.

C3. Reacquired right

Off market

rate

On market

rate

Annual fee Other costs Income Annual income Difference market component Unfavourable component from Pepadew Ltd’s perspective (PMT = 10 000; n = 2,5; i = 9%; PV =)

40 000 20 000 60 000

(120 000) (60 000)

50 000 20 000

70 000 (120 000) (50 000)

(10 000)

21 535

[½] [½]

[½]

[1½]

Provide loss of the lesser of R21 535 or R80 000 penalty in the accounting records of Pepadew Ltd.

[½]

[3½] C4. Possible impairment of investment of Apple

Impairment indicator? Perform IAS 36.12 (h) test:

Carrying amount in separate > Carrying amount in Group 780 000 (given) > 738 000 (1 230 000 x 60%) [1½] Carrying amount in group

Cost Since reserves (800 000 – 730 000) x 60%

780 000 (42 000)

738 000

OR

Dividend received > Total comprehensive income for the year 100%: R50 000 (30 000 / 60%) > (R30 000) (810 000 – 50 000 - 730 000) [1½] 60%: R30 000 (given) > (R18 000) (30 000 x 60%) Impairment indicator = Yes

[½]

Recoverable amount (1,48 x 500 000 x 60%) Carrying amount in separate (given)

444 000 (780 000)

[1] [½]

Impairment (336 000) [3½]

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QUESTION 3 40 marks


This question consists of two independent parts. PART A 32 marks Trading Auto Ltd is a retailer of new and previously owned vehicles. Trading Auto Ltd owned shares in Cars Ltd at 31 December 20.13, the financial year end of the group. Cars Ltd Trading Auto Ltd acquired a 60% interest in the share capital and voting rights of Cars Ltd, a retailer of previously owned vehicles, on 1 August 20.12. From that date Trading Auto Ltd is exposed to variable returns from its involvement with Cars Ltd and has the ability to affect those returns through its power over Cars Ltd. The shares purchased in Cars Ltd were newly issued ordinary shares. Cars Ltd had the following equity balances in its accounting records on the relevant dates:

01/08/20.12 31/12/20.12 31/12/20.13

R R R

Ordinary share capital (10 000 shares) 750 000 750 000 750 000 Retained earnings 20 000 180 000 320 000 Revaluation surplus 32 000 32 000 18 000

802 000 962 000 1 088 000

All the assets and liabilities of Cars Ltd were deemed to be fairly valued, with the exception of the following: • In 20.10, Cars Ltd internally developed a new design used to produce paint for spray painting

the body work of slightly damaged vehicles. Cars Ltd has not yet patented this design and has never recognised an asset related to this design. The fair value of this design amounted to R420 000 on 1 August 20.12, based on similar market conditions, and is expected to have an indefinite useful life. The South African Revenue Service (SARS) does not allow any deductions against taxable income in respect of this design.

• Land with a carrying amount of R130 000 on 1 August 20.12 had a fair value of R143 000 on

the same date. Land is disclosed as part of property, plant and equipment. Cars Ltd did not remeasure the land in its separate financial statements. This land was sold on 1 December 20.12 for an amount of R150 000, which equalled the fair value on that date.

No additional assets, liabilities or contingent liabilities were identified on the acquisition date. The consideration and other costs relating to the acquisition of the investment in Cars Ltd consisted of the following: • A cash amount of R210 500 paid on 1 August 20.12 to the transacting attorneys. • A liability amounting to R45 500 payable to the SARS by Cars Ltd was settled by

Trading Auto Ltd on 1 August 20.12.

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• The transfer of a previously owned vehicle to Cars Ltd to be used for business purposes by the

Chief Executive Officer (CEO) of Cars Ltd, with a carrying amount of R275 000 and a fair value of R247 000 on 1 August 20.12.

• Costs directly related to the internal division of Trading Auto Ltd that specialises in business combinations amounted to R34 000 and was included in the cash payment on 1 August 20.12.

• 500 Ordinary shares of Trading Auto Ltd were issued to Cars Ltd. • Included in the cash amount paid on 1 August 20.12 were R13 000 share issue costs related

to the 500 issued ordinary shares. • An amount of R53 000 to be refunded to Trading Auto Ltd by Cars Ltd should the operating

profit for the four months ended 30 November 20.12 not increase by 13%. This amount must then be refunded to Trading Auto Ltd on 31 December 20.12 if the target was not met. The fair value of this consideration amounted to R36 000 on 1 August 20.12 taking into account all possible outcomes. The operating profit increased by 11% for the four months ended 30 November 20.12.

The contract for this acquisition was drafted on 15 July 20.12. Due to an administrative delay, the 500 ordinary shares were only issued to Cars Ltd on 5 August 20.12. The change in the share price over this period was as a result of normal market fluctuations. On 1 February 20.13 the accountant of Trading Auto Ltd confirmed that the following item relating to the business combination is yet to be finalised in the accounting records: • A lump sum of R90 000 was paid to the CEO in a separate transaction on 1 August 20.12 as

an incentive for the CEO to remain with the company after the acquisition by Trading Auto Ltd. On 1 August 20.12 the contract with the CEO was signed, but it was not made available to the accountant. This lump sum was provisionally included in the payroll of Trading Auto Ltd as an incentive bonus to a future employee, since the intention of this payment was not clear due to the absence of the contract. The contract was made available to the accountant on 1 February 20.13; when he noted that the CEO does not need to repay this amount should he resign at any time after 1 August 20.12. You may assume that this is material and has been corrected in the separate financial statements on 1 February 20.13. This matter will also conclude the accounting of the acquisition.

On 1 November 20.12 Cars Ltd sold a previously owned vehicle to Trading Auto Ltd for an amount of R62 000. The vehicle will be used for company purposes by the financial manager of Trading Auto Ltd. Cars Ltd charges a gross profit percentage of 30% on sales. The vehicle had an estimated remaining useful life of four years on 1 November 20.12, which corresponded to the wear and tear allowance claimable as a taxation deduction. A dividend amounting to R50 000 was declared by Cars Ltd on 31 December 20.13. This dividend was paid on 31 January 20.14. The share prices of the two companies' shares amounted to the following on the various dates:

15/07/20.12 01/08/20.12 05/08/20.12

R R R

Share price of one Trading Auto Ltd share 560 530 590 Share price of one Cars Ltd share 123 119 115 Additional information 1. It is the accounting policy of Trading Auto Ltd to account for investments in subsidiaries at cost

in its separate financial statements.

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2. Trading Auto Ltd elected to measure non-controlling interests at fair value on acquisition date

for all acquisitions. 3. It is the accounting policy of Trading Auto Ltd and Cars Ltd to measure land and buildings in

accordance with the revaluation model. 4. It is the accounting policy of Trading Auto Ltd and Cars Ltd to measure vehicles in accordance

with the cost model. 5. Trading Auto Ltd is not considered a share trader for income tax purposes or an investment

entity as defined in IFRS 10 Consolidated Financial Statements. 6. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

the effects of Dividend Tax and Value Added Tax (VAT). PART B 8 marks Samoosas Ltd is a franchisor of Indian cuisine take-away restaurants and is located in Umhlanga. Samoosas Ltd sold an existing franchise, Samoosas Ltd Greytown (Greytown), to equal owners Tandoori Ltd and Naan Ltd. Tandoori Ltd has the rights to prepare the budgets and to appoint all employees of Greytown and Naan Ltd has the rights to direct the petty cash and the sanitation of the restaurant. Samoosas Ltd has the right to make changes to the trademark of the franchise and force Greytown to adapt to such changes. Samoosas Ltd also stipulates in the franchise agreement that the spices used in the production processes must be purchased from Samoosas Ltd in order to protect the image of Samoosas Ltd's franchises.

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REQUIRED


Marks

PART A Prepare the pro forma journal entries for the Trading Auto Ltd Group for the year ended 31 December 20.13. Journal entries related to deferred taxation are also required.


31

1

Please note: • Journal narrations are required. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

PART B Discuss, with reasons, which entity exercises control over Samoosas Ltd Greytown.

Communication skills: Logical flow and conclusion

7

1

Please note: • Discussions regarding appropriate accounting treatment is not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3 – Suggested solution PART A

Pro forma consolidation journal entries Dr Cr R R

J1 Share capital (SCE) (given) 750 000

(½) Retained earnings (SCE) (given) 20 000

(½)

Revaluation surplus (SCE) (given) 32 000

(½) Intangible asset (SFP) (given) 420 000

(1)

Land (SFP) (143 000 - 130 000) 13 000

(1½) Goodwill (SFP) (balancing) 140 992

(½)

Deferred tax (SFP) [(420 000 + 13 000) x 28% x 80%]

96 992 (1½) Non-controlling interests (SCE/SFP) (10 000 x 40% x R119)

476 000 (2)

Investment in Cars Ltd (SFP) [C1]

803 000 (5) Elimination of at acquisition equity

J2 Retained earnings (Cars Ltd) (SCE) ([C2] or balancing) 12 834

(½) Deferred tax (SFP) (5 208 [C2] - 217 [C2]) 4 991

(1½)

Accumulated depreciation (Trading Auto Ltd) (SFP) [C2] 775

(1½) Motor vehicle (Trading Auto Ltd) (SFP) [C2]

18 600 (1½)

Reversal of intragroup unrealised profit and depreciation in 20.12

J3 Deferred tax (SFP) (13 000 x 28% x 80%) 2 912 (½) Retained earnings (SCE) (balancing) 10 088 (½) Land (SFP) (J1) 13 000 (½) Reversal of fair value adjustment on land upon disposal J4 Retained earnings (SCE)

[(180 000 - 20 000 - 10 088 [C3] - 12 834 (J2)) x 40%] 54 831

(2½) Non-controlling interests (SFP/SCE)

54 831 (½)

Accounting for non-controlling interests' share of since acquisition reserves

J5 Accumulated depreciation (Trading Auto Ltd) (SFP) [C4] 4 650

(1) Other expenses (depreciation) (Cars Ltd) (P/L)

4 650 (½)

Realisation of unrealised profit included in equipment

EXAM TECHNIQUE

Journal 1 could also have been prepared as follows:

Alternative: Dr

R Cr R

J1.1 Share capital (SCE) (given) 750 000 (½) Retained earnings (SCE) (given) 20 000 (½) Revaluation surplus (SCE) (given) 32 000 (½) Intangible asset (SFP) (given) 420 000 (1) Land (SFP) (143 000 - 130 000) 13 000 (1½) Goodwill (SFP) (balancing) 50 992 (½) Deferred tax (SFP)

[(420 000 + 13 000) x 28% x 80%] 96 992 (1½) Non-controlling interests (SFP)

(10 000 x 40% x R119) 476 000 (2) Investment in Cars Ltd (SFP) [C1] 713 000 (4½) Elimination of at acquisition equity

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EXAM TECHNIQUE Dr

R Cr R

J1.2 Goodwill (SFP) (given) 90 000 Investment in Cars Ltd (SFP) 90 000 (½) Accounting for lump sum payment as part of

consideration

Dr R

Cr R

J6 Income tax expense (Cars Ltd) (P/L) [C4] 1 302

(1) Deferred tax (SFP)

1 302 (½)

Tax implication of the realisation of the unrealised profit included in equipment

J7 Non-controlling interests (P/L) [(320 000 - 180 000 + 50 000 dividend + 4 650 (J5) - 1 302 (J6)) x 40%] 77 339

(3)

Non-controlling interests (OCI) [(18 000 - 32 000) x 40%] 5 600 (1½) Non-controlling interests (SFP/SCE)

71 739 (½)

Accounting of non-controlling interests' share of the current year's profit

J8 Other income (P/L) (50 000 x 60%) 30 000

(1½) Non-controlling interests (SFP/SCE) (50 000 x 40%) 20 000

(1)

Dividend declared (SCE) (given)

50 000 (½)

Elimination of dividend declared by subsidiary

J9 Shareholders for dividends (SFP) (J8) 30 000

(1)

Dividend receivable (SFP)

30 000 (½)

Elimination of intragroup dividend receivable and payable at year end

Total (35) Maximum (31) Communication skills: Presentation and layout (1) CALCULATIONS C1. Consideration transferred

Cash amount paid (given) 210 500 [½] Costs directly related to issue of shares (given) (13 000) [½] Settlement of liability payable by Cars Ltd (given) 45 500 [½] Carrying amount of vehicle transferred (given)(remains within the group) 275 000 [½] Costs directly related to maintenance of internal acquisitions department

(given) (34 000) [½] Issue of shares (500 x R530) 265 000 [1] Contingent consideration asset (given) (36 000) [½] 713 000

[4]

Measurement period adjustment - lump sum payment to CEO, part of consideration (given) 90 000 [½]

Total consideration paid 803 000

[4½]

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COMMENT The journal entry for the consideration paid in the separate accounting records of Trading Auto Ltd would have been as follows:

Notes Dr R

Cr R

J1 Investment in subsidiary (SFP) 1 803 000 Share capital/Retained earnings (SCE) 2 13 000 Acquisition costs (P/L) 2 34 000 Contingent consideration - asset (SFP) 3 36 000 Bank (SFP) 210 500 Share capital (SCE) 265 000 SARS liability/Bank (SFP) 45 500 Lump sum payable/Bank (SFP) 4 90 000 Vehicles (SFP) 5 275 000

Notes: 1 Balancing amount. 2 In this question the cash amount paid included acquisition related costs and share

issue costs. As explained in question 4 acquisition related costs should be expensed in profit or loss and share issue costs shall be accounted for as a deduction from equity.

3 Note the contingent consideration is an asset and not a liability in this scenario. The question states that the amount will be refunded to Trading Auto Ltd should certain targets not be met.

4 The lump sum payment to the CEO is included in the consideration transferred as the payment is not affected by employment termination (IFRS 3.B55(a)).

5 The consideration transferred may include assets of the acquirer that have carrying amounts that differ from their fair values at the acquisition date. If so, the acquirer shall remeasure the transferred assets or liabilities to their fair values and recognise the resulting gains or losses in profit or loss. However, sometimes the transferred assets remain within the combined entity after the business combination and the acquirer therefore retains control of them. In this situation the acquirer shall measure those assets at their carrying amounts immediately before the acquisition date and shall not recognise a gain or loss.

C2. Unrealised profit and depreciation - 20.12

Revenue (given) 62 000 [½] Cost of sales (62 000 x 70%) (43 400) [½] Unrealised profit in motor vehicle (alternative: 62 000 x 30%) 18 600

Depreciation (18 600 / 4 x 2/12) (775) [1] Deferred tax expense (18 600 x 28%) (5 208) [½] Deferred tax expense (775 x 28%) 217 [½] Decrease in retained earnings - 20.12 12 834

[3]

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C3. Land Carrying amount on 1 August 20.12 (given) 130 000

Fair value on 1 August 20.12 (given) 143 000 Revaluation surplus movement in consolidated financial statements 13 000 [½]

Reconciliation Profit on sale in separate financial statements Carrying amount (given) 130 000 Proceeds (given) 150 000

20 000

Profit on sale in consolidated financial statements Carrying amount (given) 143 000 Proceeds (given) 150 000

7 000

Difference to be reversed (20 000 - 7 000) 13 000 Deferred tax effect (13 000 x 28% x 80%) (2 912) [½]

10 088

[1] C4. Unrealised profit and depreciation - 20.13 Unrealised profit in motor vehicle [C2] 18 600 Depreciation (18 600 / 4) 4 650 [½] Deferred tax expense (4 650 x 28%) (1 302) [½]

Increase in profit for the year – 20.13 3 348

[1]

C5.

Analysis of owners’ equity of Cars Ltd

Total

Trading Auto Ltd (60%) NCI

At Since

At acquisition

Share capital (given) 750 000

Retained earnings (given) 20 000

Revaluation surplus (given) 32 000

Intangible asset adjustment 420 000

Deferred tax adjustment (420 000 x 28% x 80%) (94 080)

Land adjustment (143 000 - 130 000) 13 000

Deferred tax adjustment (13 000 x 28% x 80%) (2 912)

1 138 008 682 805

455 203

Equity represented by goodwill 50 992 30 195

20 797

Consideration and NCI [C1]; (10 000 x 40% x 119) 1 189 000 713 000

476 000

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Total

Trading Auto Ltd (60%) NCI

At Since

Measurement period adjustment

Net asset value (from above) 1 138 008 682 805

455 203

Equity represented by goodwill 140 992 120 195

20 797

Consideration and NCI [713 000 [C1] + 90 000 (given)] 1 279 000 803 000

476 000

Since acquisition until beginning of year

Retained earnings (180 000 - 20 000 - 10 088 [C3] - 12 834 [C2]) 137 078

82 247 54 831

Current year

Profit for the year (320 000 - 180 000 + 50 000 dividend + 3 348 [C4]) 193 348

116 009 77 339

Revaluation surplus (18 000 - 32 000) (14 000)

(8 400) (5 600)

Dividend (given) (50 000)

(30 000) (20 000)

1 545 426 159 856 582 570

COMMENT Tax rate used for deferred tax The tax rate used for the calculation of deferred tax is in accordance with the manner in which the asset’s carrying amount will be recovered. If the carrying amount is recovered through depreciation (plant, equipment, etc.) or amortisation (intangible asset with definite useful life) the rate used will be 28%. If the carrying amount of the asset is recovered through sale (land, intangible asset with indefinite useful life) then the rate will be the capital gains tax rate. In this question, the intangible asset has an indefinite useful life and therefore the capital gains tax rate is used. Calculating profit for the year The information given did not provide the profit for the current year, therefore it should be calculated by reconciling the retained earnings general ledger account: Retained

earnings R

Opening balance 1 January 20.12 180 000 Plus profit for the year x Minus dividends paid (50 000)

Closing balance 31 December 20.13 320 000

x = R190 000

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PART B Control definition An investor controls an investee when it 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 [IFRS 10.6]. (½) Both companies are exposed to variable returns of the entity in the form of dividends, due to their capacity as shareholders.

(½)

Power and rights An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, ie the activities that significantly affect the investee’s returns [IFRS 10.10]. (½) Power arises from rights [IFRS 10.11]. (½) Tandoori Ltd and Naan Ltd are equal shareholders. (½) Relevant activities If two or more investors each have existing rights that give them the unilateral ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee [IFRS10.13]. (½) Tandoori Ltd has the rights to prepare the budgets and to appoint all employees of Greytown and Naan Ltd has the rights to direct the petty cash and the sanitation of the restaurant. (½) The preparation of the budgets and the appointment of employees will be the relevant activities, as it will significantly affect the returns. (½) The direction of the petty cash and the sanitation of the restaurant will not be deemed to be relevant activities. (½) Protective rights An investor that holds only protective rights does not have power over an investee, and consequently does not control the investee [IFRS 10.14]. (½) Protective rights are rights that are designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate [IFRS 10 Appendix A]. (½) Samoosas Ltd has the rights to make changes to the logo of the franchise and force Greytown to adapt to such changes. (½) Samoosas Ltd also stipulates that the spices used in the production processes must be purchased from Samoosas Ltd in order to protect the image of Samoosas Ltd's franchises. (½)

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These rights are considered to be protective rights as it was only designed to protect the interest of Samoosas Ltd and does not give Samoosas Ltd power. (½) Conclusion Tandoori Ltd thus has the power to direct the relevant activities. (½) Tandoori Ltd thus controls Greytown. (1)

Total (8½) Maximum (7)

Communication skills: Logical flow and conclusion (1)

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QUESTION 4 40 marks


Amalgamated Fast Foods Ltd (AFF) is a public company listed on the JSE Limited in South Africa. The company is Africa's leading fast food restaurant franchisor. In order to expand their business, AFF purchased an 85% shareholding in Shisa Nyama Ltd (Shisa Nyama) on 1 March 20.14. Each share entitles the shareholder to one vote. Shisa Nyama is a franchise fast food restaurant specialising in flamed-grilled meals. Shisa Nyama’s restaurants are located all over South Africa. From 1 March 20.14, AFF had control of Shisa Nyama in accordance with IFRS 10 Consolidated Financial Statements. Both companies have a 28 February year end. The following trial balances as at 28 February 20.15 are presented to you (you may assume that the amounts are correct, except where otherwise indicated in the information below): AFF Shisa

Nyama R R Debits Other investments 6 014 679 - Equipment 672 021 1 436 994 Investment in Shisa Nyama 300 000 - Inventory 254 481 241 976 Trade receivables 667 933 - Cash and cash equivalents 234 791 214 000 Cost of sales 2 187 948 555 104 Other expenses 1 041 169 587 032 Income tax expense 664 249 66 714 Finance costs - 54 688 Dividend paid (paid on 28 February 20.15) 81 000 35 000

12 118 271 3 191 508

Credits Issued ordinary share capital 500 000 250 000 Retained earnings – 1 March 20.14 5 255 028 345 871 Long-term loan - 546 880 Deferred tax 321 864 132 479 Trade payables 479 877 428 517 Revenue 5 469 871 1 487 761 Other income 91 631 -

12 118 271 3 191 508

Investment in Shisa Nyama The purchase agreement stipulated that the consideration for the 85% interest in Shisa Nyama consisted of the following: • A cash amount of R250 000 which was paid on 1 March 20.14.

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• 500 ordinary shares issued by AFF. The market price of AFF’s shares was R800 per share on

1 March 20.14, and R850 per share on 28 February 20.15. The share issue costs amounted to R50 000. AFF’s accountant, Mr Clueless, debited the investment in Shisa Nyama account with the R50 000 share issue costs.

• A further R300 000 will be paid to the former shareholders on 1 March 20.18. • The consideration also includes an amount of R375 000 to be paid in cash to the former

shareholders on 1 March 20.17, if the profits generated by Shisa Nyama during the period 1 March 20.14 to 28 February 20.17 increase by 120% above the current level. The fair value of this obligation on acquisition date, taking into account the probability and time value of money, was R285 620. At 28 February 20.15, the sales of Shisa Nyama declined slightly and the fair value was re-estimated at R275 654.

• An amount of R35 620 was paid to an attorney to draw up the purchase agreement as well as the valuation of the shares. These costs were already included in the cash amount of R250 000 paid by AFF on 1 March 20.14.

Mr Clueless was unsure how to account for the acquisition of Shisa Nyama and consequently only accounted for the cash payment of R250 000 and share issue costs in the separate financial statements of AFF. All the assets and liabilities of Shisa Nyama were deemed to be fairly valued on acquisition date, with the exception of the following: • Braai equipment with a carrying amount of R761 626 had a fair value of R850 000 on

1 March 20.14. AFF however indicated that after the acquisition they intend to stop the use of this specific braai equipment due to the equipment’s carbon emissions, and subsequently valued the braai equipment only at R800 000 on 1 March 20.14. The equipment was originally purchased on 1 September 20.12 and had a useful life of five years on this date. This estimate has not changed since the acquisition of the braai equipment.

• Shisa Nyama also distributes bottles of their braai sauce to retailers. Due to a nationwide shortage of the braai sauce’s secret ingredient, Shisa Nyama had a contractual order backlog for 60 boxes of sauce on 1 March 20.14. A box of sauce is sold at R1 500 per box at a profit mark-up of 50% on sales. The order backlog was completed and distributed by the end of November 20.14. The price for a box of sauce remained unchanged at R1 500 per box for the duration of the current financial year.

• No additional assets, liabilities or contingent liabilities were identified at the acquisition date. On 1 March 20.13, AFF granted Shisa Nyama the right to use its recipe for potato mash for a period of six years and an option to renew the right for two additional years. Shisa Nyama pays an annual fee of R55 755 for this right (a market-related fee for similar recipes is R50 755 per annum). The fair value of the right, correctly calculated on 1 March 20.14, was R403 169. Neither of the two companies has recognised an asset or liability in respect of this right in their separate accounting records. The agreement may be terminated by paying a penalty of R25 000. The following intragroup transactions took place within the group during the year ended 28 February 20.15: • From 1 July 20.14, AFF purchased braai sauce from Shisa Nyama at cost plus 33,33%.

Included in the closing inventory of AFF on 28 February 20.15 was inventory amounting to R89 657 that was purchased from Shisa Nyama. At the AFF stock count on 28 February 20.15 the auditors identified three boxes of sauce that has already reached their expiry date and therefore cannot be sold. The inventory balance in the separate accounting records of AFF was adjusted with the write-off of the sauce.

• Total intragroup sales for the 20.15 financial year amounted to R120 000.

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Investment in Pop Tart Ltd (Pop Tart) On 1 December 20.14, AFF entered into negotiations to acquire the controlling interest in Pop Tart, a South African company specialising in the importation and distribution of popular American treats. The current offer on the table would require AFF to acquire 7 000 ordinary shares from the current shareholders. Pop Tart’s shares consist of 10 000 issued ordinary shares and 1 000 issued preference shares. The preference shares have a nominal value of R100 each. The preference shares give their holders the right to a preferential dividend before the payment of any dividend to the ordinary shareholders. On liquidation of Pop Tart, the preference shareholders are entitled to receive R100 per share before the remainder of the net assets are distributed to the ordinary shareholders. The preference shareholders do not have any further rights on liquidation. Each ordinary share entitles the shareholder to one vote and the preference shareholders do not have any voting rights. The purchase agreement was signed and finalised by management on 28 February 20.15. AFF, in accordance with the agreement, purchased the ordinary shares on 28 February 20.15 and therefore obtained control of Pop Tart in accordance with IFRS 10 Consolidated Financial Statements. The fair value of Pop Tart’s shares was as follows on 28 February 20.15: Ordinary

shares Preference

shares R R

Last traded share price 210 162 Price agreed upon in the purchase agreement 221 - Additional information 1. Investments in subsidiaries are accounted for at fair value in accordance with IAS 27.10(b).

However, Mr Clueless has not processed any fair value adjustments for the investment in Shisa Nyama for the 20.15 financial year.

2. The acquisition of Shisa Nyama and Pop Tart resulted in the recognition of goodwill in the consolidated financial statements of the group.

3. It is the accounting policy of AFF to account for property, plant and equipment using the cost model in accordance with IAS 16 Property, Plant and Equipment.

4. The AFF Group provides depreciation on property, plant and equipment items using the straight-line method over the asset’s remaining useful life.

5. There was no change in the issued ordinary share capital of Shisa Nyama during the 20.15 financial year.

6. You may assume that all income tax related entries have been correctly accounted for in the separate accounting records of AFF.

7. Unless stated otherwise, assume a market related after-tax discount rate of 6,84% per annum, compounded annually.

8. AFF has elected to measure the non-controlling interests of Shisa Nyama at fair value on acquisition date. The fair value of the non-controlling interests of Shisa Nyama amounted to R200 000 on 1 March 20.14.

9. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore Value Added Tax (VAT) and Dividend Tax.

10. None of the companies are considered a share trader for income tax purposes or an investment entity as defined in IFRS 10 Consolidated Financial Statements.

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REQUIRED


Marks

(a) Advise Mr Clueless on the correct measurement of the non-controlling interests in Pop Tart Ltd at the acquisition date in the consolidated financial statements of the Amalgamated Fast Foods Ltd Group.

(b) Prepare the consolidated statement of profit or loss and other comprehensive

income of the Amalgamated Fast Foods Ltd Group for the year ended 28 February 20.15. Income and expenditure should be presented in terms of their function.


(c) Prepare the investment in Shisa Nyama Ltd note, in terms of IFRS 12 Disclosure of

Interests in Other Entities, to the consolidated financial statements of the Amalgamated Fast Foods Ltd Group for the year ended 28 February 20.15.

You may assume that the non-controlling interests of Shisa Nyama Ltd are material

to Amalgamated Fast Foods Ltd. For the summarised financial information you only have to disclose the following line-items:

• Current assets • Current liabilities • Revenue • Profit for the year

10

22

1

7

Please note:

• Comparative figures are not required.

• Notes to the consolidated statement of profit or loss and other comprehensive income are not required.

• Show all your calculations.

• The allocation of total comprehensive income for the period attributable to owners of the parent and non-controlling interests as per IAS 1.81B are not required.

• Round off all amounts to the nearest Rand.

• Round off all percentages to the nearest two decimals.

• IAS 33 Earnings Per Share disclosure is not required.

• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4 - Suggested solution (a) Measurement of the non-controlling interests in Pop Tart Ltd at the acquisition

date Theory IFRS 3.19 states that for each business combination, the acquirer shall measure at the acquisition date components of non-controlling interests in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation at either: (a) fair value; or (b) the present ownership instruments’ proportionate share in the recognised

amounts of the acquiree’s identifiable net assets. All other components of non-controlling interests shall be measured at their acquisition-date fair values, unless another measurement basis is required by IFRSs.

(2)

(1)

Application The non-controlling interests in Pop Tart Ltd should be separated into two components namely ordinary share capital and preference share capital and measured separately. Both components will however be recognised in one line-item in equity namely non-controlling interests. The non-controlling interests in Pop Tart Ltd also do not have to be measured at fair value merely because the non-controlling interests in Shisa Nyama Ltd are measured at fair value. The measurement choice can be applied on a subsidiary by subsidiary basis, thus for each business combination. Conclusion Amalgamated Fast Foods Ltd will take up 7 000 of the 10 000 shares, thus the remaining 3 000 shares (30%) will be allocated to NCI. Amalgamated Fast Foods Ltd will not take up any of the preference shares, therefore the entire preference share capital will be allocated to NCI. Measurement of ordinary share capital Pop Tart Ltd’s ordinary share capital presents an ownership interest as each share entitles a shareholder to one vote. Amalgamated Fast Foods Ltd will also receive a proportionate share of Pop Tart Ltd’s net assets in the event of liquidation.

(1)

(1)

(½)

(½)

(1)

Therefore Mr Clueless will have a choice to measure the 30% non-controlling interests in ordinary share capital at the proportionate share of Pop Tart Ltd’s identifiable net assets or at fair value at acquisition date.

(2)

The fair values of the acquirer’s interest in the acquiree and the non-controlling interests on a per-share basis might differ. The main difference is likely to be the inclusion of a control premium in the per-share fair value of the acquirer’s interest in the acquiree (IFRS 3.B45).

(1)

If Mr Clueless chooses to measure the non-controlling interests in ordinary share capital at fair value, the last traded share price of R210 should be used, resulting in non- controlling interests of R630 000 (10 000 x 30% x R210) for the ordinary shares.

(1)

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Measurement of preference share capital

The non-controlling interests that relate to Pop Tart Ltd’s preference shares do not qualify for the measurement choice in paragraph 19 because they do not entitle their holders to a proportionate share of Pop Tart Ltd’s net assets in the event of liquidation. The preference shareholder also do not have any voting rights and therefore do not have a present ownership interest.

(2)

Therefore Mr Clueless will have to measure the 100% non-controlling interests in the preference shares at their acquisition-date fair value of R162, resulting in non- controlling interests of R162 000 (1 000 x R162) for the preference shares.

(1) Total (14) Maximum (10) (b) AMALGAMATED FAST FOODS LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.15

R Revenue (5 469 871(AFF) [½] + 1 487 761(SN) [½] –

120 000 (intragroup sales) [½])

6 837 632

(1½) Cost of sales [C1] (2 666 215) (4)

Gross profit 4 171 417 Other income [C4] 35 291 (5½) Other expenses [C6] (1 733 700) (4) Finance costs (54 688 (SN) [½] + 19 824 [C8] [2]) (74 512) (2½)

Profit before tax 2 398 496 Income tax expense [C9] (683 699) (3)

PROFIT FOR THE YEAR 1 714 797 Other comprehensive income for the year, net of tax -

TOTAL COMPREHENSIVE INCOME FOR THE YEAR 1 714 797

Profit attributable to: Owners of the parent (balancing) 1 699 393 (½) Non-controlling interests [C10] 15 404 (3½)

1 714 797

Total (24½) Maximum (22) Communication skills: Presentation and layout (1) (c) AMALGAMATED FAST FOODS LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR

ENDED 28 FEBRUARY 20.15

Investment in subsidiary Subsidiary name: Shisa Nyama Ltd (½) Principal place of business: South Africa (½) Proportion of ownership interest held by

non-controlling interests:

15%

(½)

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20.14

R

Profit allocated to non-controlling interests of the subsidiary during the reporting period (from part b)

15 404

(½)

Accumulated non-controlling interests of the subsidiary at the end of the reporting period (200 000 + 15 404 – 5 250)

210 154

(1½)

Dividends paid to non-controlling interests 5 250 (½) Summarised financial information about the subsidiary The following is summarised financial information for Shisa Nyama Ltd,

prepared in accordance with IFRS, modified for fair value adjustments on acquisition. The information is before intragroup eliminations.

Current assets (241 976 + 214 000) 455 976 (1) Current liabilities (given) (428 517) (½) Revenue (given) (1 487 761) (½) Profit for the year (224 223 [C10] – 18 180 [C10] – 58 056 [C10] –

32 400 [C10]) or (102 690 [C10] + 12 897 [C10])

(115 587)

(2) Total (8) Maximum (7) CALCULATIONS C1. Cost of sales

Amalgamated Fast Foods Ltd (given) 2 187 948 [½] Shisa Nyama Ltd (given) 555 104 [½] Elimination of intragroup sales for 20.15 (120 000) [½] Elimination of unrealised intragroup profit [C2] 17 913 [1½] Depreciation on the revalued equipment [C3] 25 250 [1]

2 666 215

[4]

COMMENT The additional depreciation on the “braai equipment” is included in cost of sales as the equipment is used in the production of “inventory”. If it was office equipment the additional depreciation would have been included in other expenses.

C2. Unrealised profit in inventory

Inventory on hand at 28 February 20.15 89 657 Unrealised profit (33,33 / 133,33 x 89 657) 22 413 [1] Inventory written down to net realisable value (1 500 x 3) (4 500) [½]

17 913 [1½] Deferred tax expense – 20.15 (17 913 x 28%) (5 016)

Adjustment for 20.15 12 897

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C3. Depreciation on the revalued equipment

Fair value on 1 March 20.14 (given) 850 000 Carrying amount on 1 March 20.14 (given) (761 626)

Revaluation at acquisition date 88 374 Remaining useful life 3,5 years Depreciation for 20.15 (88 374 / 3,5) or (88 374 / 42 x 12) 25 250 [1] Deferred tax expense – 20.15 (25 250 x 28%) (7 070)


C4. Other income

Amalgamated Fast Foods Ltd (given) 91 631 [½] Fair value adjustment of contingent consideration (285 620 – 275 654) 9 966 [1] Settlement gain on reacquired right [C5] 19 199 [3] Elimination of intragroup dividends (35 000 x 85%) (29 750) [½] Elimination of potato mash recipe fee received (55 755) [½] 35 291

[5½] C5. Reacquired right – settlement gain

Difference between annual fee for existing contract and on-market contract (55 755 – 50 755)

5 000

[1]

Favourable component from Amalgamated Fast Foods Ltd’s perspective (discounted to present value): (FV=0; N=5; I=9,5%(6,84%/0,72); PMT=5 000; COMP PV)

19 199

[1½] Provide a settlement gain on the reacquired right of the lesser of R19 199 or R25 000

penalty in the accounting records of Amalgamated Fast Foods Ltd. [½]

[3] C6. Other expenses

Amalgamated Fast Foods Ltd (given) 1 041 169 [½] Shisa Nyama Ltd (given) 587 032 [½] Acquisition related costs not correctly processed in separate records 35 620 [½] Reversal of order backlog (60 x 1 500 x 50/100) 45 000 [1] Amortisation of intangible asset (reacquired right) (403 169 / 5) or [C7] 80 634 [1] Elimination of potato mash recipe fee paid (55 755) [½] 1 733 700

[4]

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COMMENT At acquisition the order back log will be recognised as an intangible asset in terms of IFRS 3.13. Also refer to IFRS 3.IE25 for further guidance on the recognition of intangible assets not previously recognised by the acquiree. The gross profit on the sale of the boxes is used to calculate the fair value of the order backlog of R45 000 (R1 500 x 50% x 60 boxes). Note the journal entries relating to the order backlog included in the at acquisition journal: Dr

R

Cr R

Share capital (SCE) 250 000 Retained earnings (SCE) 345 871 Intangible asset (Reacquired right) (SFP) 403 169 Intangible asset (Order backlog) (SFP) 45 000 Equipment 88 374 Deferred tax (Order backlog) (SFP) 12 600 Deferred tax (Other assets) (SFP) 137 632 Goodwill (SFP) (balancing) 345 689 Non-controlling interests (SFP/SCE) 200 000 Investment in Shisa Nyama (SFP) 1 127 871

The intangible asset (order backlog) will subsequently be amortised over its useful life (time to complete the order backlog) and the following journal will be processed after acquisition, when the backlog is completed: Dr

R

Cr R

Amortisation (P/L) 45 000 Accumulated amortisation (SFP) 45 000 Deferred tax (SFP) 12 600 Income tax expense (P/L) 12 600

C7. Amortisation of intangible asset (reacquired right)

Present value of intangible asset on 1 March 20.14 (given) 403 169 Amortisation 20.15 (403 169 / 5) 80 634 [1] Deferred tax expense – 20.15 (80 634 x 28%) (22 578)


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C8. Deferred consideration


1. 2nd F C (clear all) 1. 2nd FC (clear all) 1. 2nd F MODE (clear all) 2. 0 PMT 2. 0 PMT 2. 0 PMT 3. 6,84%/72% 4. =9,5

I/YR

3. 6,84%/72% 4. =9,5

i

3. 6,84%/72% 4. =9,5

I/YR

[½]

5. 4 N 5. 4 n 5. 4 N [½] 6. 300 000 FV 6. 300 000 FV 6. 300 000 FV [½] 7. PV 208 672 7. Comp PV 208 672 7. Comp PV 208 672

8. 8. 8. Interest accrued for 20.15 (208 672 x 9,5%) 19 824 [½] [2] C9. Income tax expense

Amalgamated Fast Foods Ltd (given) 664 249 [½] Shisa Nyama Ltd (given) 66 714 [½] Tax implication of elimination of intragroup profit (17 913 [C2] x 28%) (5 016) [½] Tax implication of reversal of order backlog (45 000 [C6] x 28%) (12 600) [½] Tax implication of depreciation on revalued equipment at acquisition

(25 250 [C3] x 28%)

(7 070)

[½] Tax implication of amortisation of intangible asset (80 634 [C7] x 28%) (22 578) [½]

683 699

[3] C10. Non-controlling interests

Revenue 1 487 761 Cost of sales (555 104) Other expenses (587 032) Finance costs (54 688) Income tax expense (66 714)

Profit of Shisa Nyama Ltd 224 223 [1] Elimination of unrealised intragroup profit [C2] (12 897) [½] Depreciation on the revalued equipment [C3] (18 180) [½] Amortisation of intangible asset (reacquired right) [C7] (58 056) [½] Reversal of order backlog (45 000 [C6] – 12 600 [C9]) (32 400) [½]

102 690

Non-controlling interests (102 690 x 15%) 15 404 [½]

[3½]

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C11.

Analysis of owners’ equity of Shisa Nyama Ltd (for completeness)

Total

Amalgamated Fast Foods Ltd (85%) NCI

At Since

At acquisition

Share capital (given) 250 000

Retained earnings (given) 345 871

Reacquired right (403 169 x 72%) 290 282

Intangible asset (order backlog) (45 000 x 72%) 32 400

Revaluation of equipment [(850 000 – 761 626) x 72%] 63 629

982 182 834 855

147 327

Equity represented by goodwill (balancing) 345 689 293 016

52 673

Consideration [C12] and NCI 1 327 871 1 127 871

200 000


Current year

Profit for the year [C10] 102 690

87 286 15 404

Dividend paid (given) (35 000)

(29 750) (5 250)

1 395 561

57 536 210 154

C12.

Consideration transferred

Cash payment (250 000 – 35 620 (legal fees)) 214 380 Shares (500 x R800) 400 000 Deferred consideration [C8] 208 672 Contingent consideration (given) 285 620 Settlement gain (reacquired right) [C5] 19 199

1 127 871

COMMENT Transaction costs should be carefully analised as the accounting treatment for transaction costs are not all the same. Share issue costs are not acquisition related costs as defined in terms of IFRS 3. Acquisition related costs (finder’s fees, advisory, legal, valuation, professional fees, administration fees) should be expensed in profit or loss in the consolidated financials of the acquirer. Some of these costs can however, in terms of IFRS 9, be capitalised to the investment in the separate accounting records of the acquirer. Any acquisition related costs capitalised in the separate accounting records of the acquirer will have to be expensed upon consolidation. Share issue costs shall be accounted for as a deduction from equity in terms of IAS 32.35 in the separate and consolidated financials of the acquirer. In this question the accountant was unsure how to account for the acquisition in the separate accounting records of AFF and consequently only accounted for the cash amount paid and share issue costs.

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COMMENT Therefore, the accountant did the following: Dr

R

Cr R

J1 Investment in subsidiary (SFP) 300 000 Bank (SFP) 250 000 Bank (SFP) (Share issue cost paid) 50 000

The correct journal entries for the consideration paid in the separate accounting records of AFF Ltd should have been as follows: Dr

R

Cr R

J1 Investment in subsidiary (SFP) 1 127 871 Acquisition costs (P/L) 35 620 Bank (SFP) 250 000 Share capital (SCE) 400 000 Deferred consideration (SFP) 208 672 Contingent consideration (SFP) 285 620 Settlement gain – reacquired right (P/L) 19 199

J2 Share capital/Retained earnings (SCE) 50 000 Bank (SFP) 50 000

Therefore the correcting journal entry, relating to the share issue cost, in the separate accounting records of AFF Ltd would have been as follows: Dr

R

Cr R

J1 Share capital/Retained earnings (SCE) 50 000 Investment in subsidiary (SFP) 50 000

From the above it’s clear that the share issue costs will have no effect on the consideration paid in terms of IFRS 3.

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QUESTION 5 40 marks


Rich Dotcom Ltd operates in various industries and is listed on the JSE Limited. The company has several investments in other companies. You have recently been appointed as the Financial Manager: Group Reporting and has received the following consolidated trial balance of the group for the year ended 31 December 20.15 (you may assume that the amounts are correct, except where otherwise indicated in the information below): R Debits Intangible assets 400 000 Property, plant and equipment 2 000 000 Investment in RichDad Ltd 500 000 Financial assets 300 000 Inventory 250 000 Trade receivables 165 000 Cash and cash equivalents 654 000 Cost of sales 1 350 000 Other expenses 655 000 Income tax expense 256 000

6 530 000

Credits Issued ordinary share capital Rich Dotcom Ltd - 100 000 shares 750 000 RichDad Ltd - 10 000 shares 150 000 Retained earnings (1 January 20.15) Rich Dotcom Ltd 1 600 000 RichDad Ltd 480 000 Long-term loan - Deferred tax 485 000 Trade payables 365 000 Revenue 2 250 000 Other income 450 000

6 530 000

Upon further inspection of the consolidated trial balance, you noticed that the only consolidation procedures performed by the previous Financial Manager were the combining of the like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its only subsidiary. You subsequently obtained the following information relating the investment in the subsidiary: Investment in RichDad Ltd Rich Dotcom Ltd acquired a 75% controlling shareholding in RichDad Ltd on 1 July 20.11. The retained earnings amounted to R300 000 at that date. All the assets and liabilities of RichDad Ltd were fairly valued at that date except for the following:

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• An office building with a carrying amount of R350 000 had a fair value of R500 000. The

remaining useful life and residual value remained unchanged at 20 years and Rnil respectively at that date. RichDad Ltd sold its office building on 31 December 20.14 for an amount of R300 000 to a property developer.

• RichDad Ltd owns a registered trademark which was designed during 20.10 at a cost of

R200 000. The trademark was correctly recognised as an intangible asset by RichDad Ltd. The original cost represents the fair value on 1 July 20.11. In order to manufacture the trademarked product, RichDad Ltd also documented the required technical expertise used which is unpatented. The fair value of the technical expertise was valued at R30 000 on 1 July 20.11. The trademark and technical expertise are both expected to have an indefinite useful life. The South African Revenue Service (SARS) does not allow any deductions against taxable income in respect of the technical expertise.

RichDad Ltd was also in negotiation with new clients regarding potential contracts worth R300 000 at the acquisition date. No additional assets, liabilities or contingent liabilities were identified at the acquisition date. The current year’s profit after tax for RichDad Ltd was R300 000. Intragroup transactions RichDad Ltd sold three of its products to Rich Dotcom Ltd on 1 January 20.15. The total sales amounted to R300 000. These products are classified as equipment as part of property, plant and equipment by Rich Dotcom Ltd. The useful life and residual value of the equipment was five years and Rnil respectively at that date. RichDad Ltd charges a gross profit percentage of 50% on cost price. Email from the Chief Executive Officer On your second day in the new position, you received the following email: Financial Manager: Group Reporting

From: Chief Executive Officer <[email protected]> Sent: 11 March 20.16 21:40 To: Financial Manager: Group Reporting Subject: Share option plan Attachments: Trust deed.docx Dear You There are two issues that require your urgent attention: Rich Dotcom Employee Share Trust Before your appointment, the board of directors of Rich Dotcom Ltd took a decision to set up the Rich Dotcom Employee Share Trust (RDEST) for the benefit of its employees. The employees of Rich Dotcom Ltd are entitled to a share option plan as part of their remuneration. The RDEST has been set up to operate the share option plan for the employees and is not a long-term employee benefit plan.

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Attached please find the trust deed for your perusal. The trust deed contains, inter alia, the following provisions: • All the elected trustees of RDEST must be employees of Rich Dotcom Ltd; • Rich Dotcom Ltd will provide the funding to RDEST and guarantee its obligations in order to

operate the share option plan; • The trust will buy Rich Dotcom Ltd’s shares; and • The trust will hold the shares for the duration of the vesting period in accordance with the share

option plan. Acquisition of SuperMom Ltd Rich Dotcom Ltd is in the process of acquiring a controlling shareholding in SuperMom Ltd. Their current Chief Executive Officer is a close friend of mine and she has brought the following to my attention: She was appointed six months ago by SuperMon Ltd on a three year contract. Included in her contract is a provision that if SuperMom Ltd is acquired by Rich Dotcom Ltd within the period of three years after her appointment, that she will be entitled to a once-off payment of R1 000 000 after the successful completion of the acquisition. Kind regards CEO Additional information 1. Investments in subsidiaries are accounted for at cost in accordance with IAS 27.10(a). 2. It is the accounting policy of Rich Dotcom Ltd to account for property, plant and equipment

using the cost model in accordance with IAS 16 Property, Plant and Equipment. 3. The Rich Dotcom Ltd Group provides depreciation on property, plant and equipment items

using the straight-line method over the asset’s remaining useful life. 4. There was no change in the issued ordinary share capital of any companies in the group since

1 July 20.11. 5. You may assume that all income tax related entries have been correctly accounted for in the

separate accounting records of Rich Dotcom Ltd. 6. Rich Dotcom Ltd has elected to measure the non-controlling interests of RichDad Ltd at its

proportionate share of the acquiree’s identifiable net assets at acquisition date. 7. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. 8. None of the companies are considered a share trader for income tax purposes or an

investment entity as defined in IFRS 10 Consolidated Financial Statements.

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REQUIRED


Marks

(a) Provide the pro forma journal entries for the Rich Dotcom Ltd Group for the year ended 31 December 20.15. Journal entries relating to deferred taxation are also required.


(b) Discuss, with reasons, whether Rich Dotcom Ltd controls the Rich Dotcom

Employee Share Trust.

Communication skills: Logical flow and conclusion (c) Discuss, with reasons, how the payment to the Chief Executive Officer of

SuperMom Ltd will be treated at the acquisition date if Rich Dotcom Ltd successfully completes the acquisition.

25

1

8

1

5

Please note: • Show all your calculations. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 5 - Suggested solution (a) Provide the pro forma journal entries for the Rich Dotcom Ltd Group for the year ended

31 December 20.15. Dr Cr R R J1 Share capital (SCE) (given) 150 000 (½) Retained earnings (SCE) (given) 300 000 (½) Intangible asset (SFP) (given) 30 000 (½) Office building (SFP) (500 000 - 350 000) 150 000 (1) Goodwill (SFP) (balancing) 64 040 (½) Deferred tax (SFP) [(150 000 x 28%) + (30 000 x 28% x 80%)] 48 720 (1½) Non-controlling interests (SCE/SFP) [C1] 145 320 (1) Investment in RichDad Ltd (SFP) (given) 500 000 (½) Elimination of at acquisition equity

J2 Deferred tax (SFP) (26 250 x 28%) 7 350 (1) Retained earnings (SCE) (balancing) 18 900 (½) Accumulated depreciation (SFP) (150 000/20 x 3,5) 26 250 (1½) Depreciation on office building up to end of prior year

J3 Deferred tax (SFP) (123 750 x 28%) 34 650 (1) Retained earnings (SCE) (balancing) 89 100 (½) Office building (SFP) (150 000 [J1] - 26 250 [J2]) 123 750 (1½) Reversal of fair value adjustment on office building upon disposal

J4 Retained earnings (SCE) [(480 000 - 300 000 - 18 900 [J2] – 89 100 [J3]) x 25%]

18 000

(3)

Non-controlling interests (SFP/SCE) 18 000 (½) Non-controlling interests' share of since acquisition reserves

J5 Revenue (P/L) (given) 300 000 (½) Cost of sales (P/L) (balancing) OR (300 000 x 100/150) 200 000 (½) Equipment (SFP) (300 000 x 50/150) OR (balancing) 100 000 (1½) Elimination of unrealised profit on the sale of equipment

J6 Deferred tax (SFP) (100 000 x 28%) 28 000 (1) Income tax expense (P/L) 28 000 (½) Tax implication of the depreciation on equipment

J7 Accumulated depreciation (SFP) (100 000/5) 20 000 (1½) Depreciation (P/L) 20 000 (½) Realisation of unrealised profit on sale of equipment

J8 Income tax expense (P/L) (20 000 x 28%) 5 600 (1) Deferred tax (SFP) 5 600 (½) Tax implication of the depreciation on the equipment

J9 Non-controlling interests (P/L) [(300 000 - 100 000 [J5] + 28 000 [J6] + 20 000 [J7] - 5 600 [J8]) x 25%]

60 600 (3½)

Non-controlling interests (SFP/SCE) 60 600 (½) Non-controlling interests' share of current year's profit

Total (27) Maximum (25) Communication skills: Presentation and layout (1)

EXAM TECHNIQUE It is good exam technique to always provide journal narrations, even when it is not explicitly required.

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CALCULATIONS C1. Analysis of owners’ equity of RichDad Ltd

Total

Rich Dotcom Ltd (75%) NCI

At Since

At acquisition

Share capital (given) 150 000 Retained earnings (given) 300 000 Intangible asset (technical expertise) (30 000 x (1- (28% x 80%))

23 280

Revaluation of office building [(500 000 – 350 000) x 72%]

108 000

581 280 435 960 145 320

Equity represented by goodwill (balancing)

64 040

64 040

-



Retained earnings [(480 000 – 300 000 -108 000]

72 000

54 000

18 000

Current year Profit for the year [(300 000 -100 000 [J5] + 28 000 [J6] + 20 000 [J7] – 5 600 [J8])

242 400

181 800

60 600

959 720 235 800 223 920

COMMENT Sale of office building Upon the sale of the office building, the subsidiary has correctly accounted for the sale in its separate records. However, remember that as a result of the IFRS 3 adjustment to fair value (R150 000), there is still an amount recognised in the consolidated records for the office building (the R150 000 less accumulated depreciation). This amount, including the tax consequences, must therefore be eliminated (J3). Intragroup transaction The intragroup transaction was “upstream”, the subsidiary selling to the parent. Therefore, any unrealised profit will also affect non-controlling interests which must be adjusted accordingly.

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(b) Discuss, with reasons, whether Rich Dotcom Ltd controls the Rich Dotcom Employee

Share Trust

Theory An investor controls an investee when it 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 [IFRS 10.6]

(½)

An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, i.e. the activities that significantly affect the investee’s returns [IFRS 10.10]

(½)

Consideration of the following factors may assist in determining whether an entity controls an investee [IFRS 10.B3]:

Application

(a) The purpose and design of the investee; RDEST was established by Rich Dotcom Ltd to operate a share option plan for

the benefit of its employees and Rich Dotcom Ltd is therefore involved in the decisions of RDEST.

(1)

(b) What the relevant activities are and how decisions about those activities are made;

Rich Dotcom Ltd will provide the finances to RDEST to enable the trust to purchase the shares and hold it till the vesting dates. The trustees who operate the trust are all employees of RDEST.

(1)

(c) Whether the rights of the investor give it the current ability to direct the relevant activities;

An investor has power when it has the rights to appoint, reassign or remove members of an investee’s key management personnel who have the ability to direct the relevant activities [IFRS 10.B15(b)].

(½)

All the elected trustees of RDEST must be employees of Rich Dotcom Ltd and Rich Dotcom Ltd can therefore appoint, reassign or remove trustees and therefore have power over RDEST.

(1)

Rich Dotcom Ltd has no voting rights in RDEST and evidence of whether it has the practical ability to direct the relevant activities unilaterally must be considered.

(1)

Sometimes there will be indications that the investor has a special relationship with the investee, which suggests that the investor has more than a passive interest in the investee [IFRS 10.B19].

(½)

Rich Dotcom Ltd will provide the finances to RDEST to enable the trust to purchase the shares and will provide guarantees for its obligations. This indicates more than just a passive relationship and that it therefore has the practical ability to direct the relevant activities of RDEST.

(1)

(d) Whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; and

RDEST is established to purchase the shares of Rich Dotcom Ltd and hold them during the vesting period of the share option plan. The Rich Dotcom Ltd’s shares that RDEST purchases and hold during the vesting period hedges Rich Dotcom Ltd’s exposure to changes in its share price by limiting the variability in the cost of the employee share scheme.

(1)

Therefore, Rich Dotcom Ltd limits the exposure to variability of returns from RDEST indicating that it has power over the RDEST.

(1)

(e) Whether the investor has the ability to use its power over the investee to affect the amount of the investor’s returns.

Rich Dotcom Ltd established RDEST to operate a share option plan for the benefit of Rich Dotcom Ltd’s employees and therefore had the opportunity and incentive to obtain rights that result in Rich Dotcom Ltd having the ability to direct the relevant activities.

(1)

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Conclusion Rich Dotcom Ltd therefore controls RDEST as it is exposed, or has rights, to variable returns from its involvement with the RDEST and has the ability to affect those returns through its power over the RDEST.

Total (10)

Maximum (8) Communication skills: Logical flow and conclusion (1)

(c) Discuss, with reasons, how the payment to the Chief Executive Officer of SuperMom Ltd

will be treated at the acquisition date if Rich Dotcom Ltd successfully completes the acquisition

Theory The acquirer and the acquiree may have a pre-existing relationship or other arrangement before negotiations for the business combination began, or they may enter into an arrangement during the negotiations that is separate from the business combination. The acquirer shall identify any amounts that are not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination, ie amounts that are not part of the exchange for the acquiree. [IFRS 3.51]

(½)

The acquirer should consider the reasons for the transaction, who initiated the transaction and the timing of the transaction, which are neither mutually exclusive nor individually conclusive, to determine whether a transaction is part of the exchange for the acquiree or whether the transaction is separate from the business combination [IFRS3.B50]

(½)

Application

The reasons for the transaction: SuperMom Ltd appointed their CEO on a three year contract to obtain her services and included the provision for the once-off payment if SuperMom Ltd is successfully acquired by another entity within that period.

(1)

Who initiated the transaction: SuperMom Ltd initiated the transaction by entering into a contract with their CEO.

(1)

The timing of the transaction: The contract with the CEO was entered into before the negotiations for the acquisition of SuperMom Ltd by Rich Dotcom Ltd began.

(1)

There is no evidence that the agreement was arranged primarily to provide benefits to Rich Dotcom Ltd or the Rich Dotcom Ltd Group.

(1)

Conclusion

Therefore, the liability to pay R1 000 000 to the CEO is included in the application of the acquisition method and a liability is recognised as part of the liabilities assumed by Rich Dotcom Ltd on the acquisition date.

(1)

Total (6)

Maximum (5)

Documents

SCHOOL OF ACCOUNTING SCIENCES - University of … 10 also sets out how to apply the principle of control and sets out the accounting requirements for preparation of consolidated financial