fac4864 2021 tl 102 0 b - unisafac4864/102 nfa4864/102 zfa4864/102 mjm 5 3. issues that are...

FAC4864/102/0/2021 NFA4864/102/0/2021 ZFA4864/102/0/2021

Tutorial letter 102/0/2021

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

SAICA’s Principles of Examination 4

Exam technique 5

United Nations Global Compact Principles 8

Learning unit 1 Consolidated and separate financial statements 9

2 Business combinations 31

3 Investments in associates and joint ventures 56

4 Disclosure of interests in other entities 69

Self assessment questions and suggested solutions 78

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DUE DATE DUE DATE FOR THIS TUTORIAL LETTER: 19 FEBRUARY 2021 TEST 1 ON TUTORIAL 102: 23 MARCH 2021

PERSONNEL AND CONTACT DETAILS Personnel Telephone

NumberLecturers Ms T van Mourik (Course leader) Ms S Aboobaker Mr H Combrink Mr M Hlongwane Ms T Mahuma Mr P Masha Ms A Oosthuizen Ms C Wright

012 429-3549 012 429-4373 012 429-4792 012 429-4511 012 429-4669

012 429-8971 012 429-2004

Please send all technical e-mail queries to: [email protected] Please use the module telephone number to contact the lecturers: 012 429-4720

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.

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SUGGESTED WORKING PROGRAMME

FEBRUARY 2021THURSDAY FRIDAY SATURDAY SUNDAY MONDAY TUESDAY WEDNESDAY

4 Consolidated and separate

financial statements

5 Consolidated and separate


6Consolidated and separate


7Consolidated and separate


8Business

combinations

9 Business

combinations

10Business

combinations

11 Investments in associates and joint ventures

12 Investments in

associates and joint ventures

13Investments in

associates and joint ventures

14Disclosure of interests in

other entities

15Do self

assessment questions

16 Do self


17Do self


SAICA’S PRINCIPLES OF EXAMINATION The SAICA principles of examination levels provide guidance on how the standards (or topics within a standard) will be examined. Throughout the study material, we will refer you to the following principles of examination levels: 1. Issues that are at a core level: An issue is at core level if: • It is based on a significant conceptual underpinning/foundation of current financial

accounting (i.e. based on identification, recognition, measurement and presentation and disclosure of elements); or

• It is prevalent (i.e. issues and industries that would be commonly encountered in practice in the course of an entry-level Chartered Accountant’s work). Here, the emphasis is on issues that are of a more general nature.

2. Issues that are at an awareness level: Awareness means that the issue is not core but it is important for an entry-level. Chartered

Accountant to know about the issue. It is important for them to be able to identify that it is an issue that potentially has significant accounting implications and requires additional or specialist IFRS knowledge.

They would need to be able to identify and describe what the accounting issue is and read

up on it futher. Students would also be expected to perform basic processing of the transaction when the numbers are given (e.g. obtained from an expert).

A good example might be borrowing costs i.e. students should be able to do the journal to

capitalise any qualifying borrowing costs to Property, Plant and Equipment when the borrowing cost amount has been supplied.

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3. Issues that are excluded. The following standards are excluded from the syllabus: • IFRS 1, First-time Adoption of International Financial Reporting Standards • IFRS 4, Insurance contracts • IFRS 6, Exploration for and Evaluation of Mineral Resources • IFRS 8, Operating Segments • IFRS 14, Regulatory Deferral Accounts • IAS 20, Government Grants • IAS 26, Accounting and Reporting by Retirement Benefit Plans • IAS 29, Financial Reporting in Hyperinflationary Economics • IAS 33, Earnings per Share • IAS 34, Interim Financial Reporting • IAS 41, Agriculture Please note the scope of all standards is at an awareness level, even if the standard is

excluded. Exclusions within any standard will be specifically identified in your study material. The treatment of any Interpetation Note will follow the principle of examination level of the related standard.

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 applying the relevant 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.

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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 a 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.

The SAICA has adopted a Competency Framework that defines pervasive and technical

competencies that entry-level Chartered Accountants (CAs) must be able to demonstrate. These competencies include a number of professional skills, one of which is the ability to communicate effectively and efficiently. Refer to SAICA’s Guidelines for candidates relating to the assessment of Communication Skills in the Initial Test of Competency.

EXAM TECHNIQUE Please note that NO marks will be awarded for theory in a discussion question. The suggested solutions for discussion questions will however include the theory for completeness purposes, and to assist students with the application of the theory. Students should not waste time by stating the theory in the tests or the exam as no marks are awarded for theory.

• 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. Narrations to journals should always be provided, except for when it is stated in a question that it is not required.

• Layout and presentation

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.

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• 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.

• 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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THE UNITED NATIONS GLOBAL COMPACT PRINCIPLES

INTRODUCTION The United Nations Global Compact (UNGC) is underpinned on the principle of corporate sustainability which emphasises on the value and principles-based approach to doing business. It established the ten principles based on the four main values: human rights, labour practices, environmental concerns and anti-corruption. The summary of the principles is provided on the table below.

OBJECTIVES/OUTCOMES After you have engaged this topic, you should be able to demonstate an awareness of the importance of the UNGC principles. This topic is not examinable but it is important that you should have a sufficient awareness of these principle as they are applicable in practice.

The summary of the 10 UNGC princinciples

UNGC

Ten

Principles

Human

rights

1. Businesses should support and respect the protection of

internationally proclaimed human rights and;

2. Make sure that they are not complicit in human rights abuses

Labour 3. Businesses should uphold the freedom of association and the

effective recognition of the right to collective bargaining

4. The elimination of all forms of forced and compulsory labour

5. The effective abolition of child labour

6. The elimination of discrimination in respect of employment and

occupation

Environment 7. Businesses should support a precautionary approach to

environmental challenges

8. Undertake initiatives to promote greater environmental

responsibility

9. Encourage the development and diffusion of environmentally

friendly technologies

Anti-

Corruption

10.Businesses should work against corruption in all its forms,

including extortion and bribery Source: Greenstone, 2014

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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. 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 At the end of this learning unit, you should be able to: 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).

Assessed in Learning unit 7. 5. Account for changes in ownership interest. Assessed in Learning unit 7. 6. Account for the cost of investments in subsidiaries, joint ventures and associates

in the separate financial statements of the investor (IAS 27.9, .10, .13 and .14) at cost (IAS 27.10(a)).

7. Account for dividends from subsidiaries, joint ventures and associates (IAS 27.12). 8. Disclosures in separate financial statements (IAS 27.15 - 17).

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PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. Group Statements, 17th edition, Volume 1, ALL chapters 2. Group Statements, 17th edition, Volume 2, Chapter 10. 3. IAS 27 Separate Financial Statements. 4. IFRS 10 Consolidated Financial Statements.

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 PRESCRIBED STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLES OF EXAMINATION LEVELS The SAICA principles of examination levels provide guidance on how the standards (or topics within a standard) will be examined. The principles of examination levels for IAS 27 are as follows: Description Paragraph Level Notes Objective 1 CoreScope 2 – 3 AwarenessDefinitions 4 – 8 Core 8A Excluded Investment entity matters Preparation of separate financial

9 Core Separate financial statements

statements 10(a) Core Cost measurement 10(b) Excluded Fair value in separate AFS 10(c) Excluded Equity method in separate AFS 10E1 Core Cost measurement principles 11 – 11B Excluded Investment entity matters 12 Core Dividends received 13 – 14 Excluded Group reorganisations Disclosure 15 – 17 Core Refer to learning unit 4 16A Excluded Investment entity matters Effective date and transition 18 – 20 Excluded

The principles of examination levels for IFRS 10 are as follows: Description Paragraph Level Notes Objective 1 Core 2 – 3 Core Meeting the objective Scope 4 Awareness 4A – 4B Excluded Control 5 – 9 Core 10 – 14 Core Power 15 – 16 Core Returns 17 – 18 Core Link between power and returnsAccounting requirements 19 – 21 Core 22 – 24 Core Non-controlling interests 25 – 26 Core Loss of control – refer to learning

unit 7 Vertical

groups Awareness I.e. The parent’s subsidiary has an

investment in a subsidiary/ associate

Change in ownership

Depends Refer to learning unit 7

IFRS 5 – Groups

Excluded Subsidiaries acquired with a view to resale and subsidiaries classified as held for sale

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Description Paragraph Level Notes Determining whether an entity is an investment entity

27 – 30 Excluded Investment entity

Investment entities: exception to consolidation

31 – 33 Excluded Investment entity

Defined terms A Core Application guidance B1 Core B2 – B8 Core Assessing control B9 – B10 Core Power B11 – B13 Core Relevant activities B14 – B28 Core Rights that give power B29 – B33 Core Franchises B34 – B50 Core Voting rights B51 – B54 Core Power when voting or similar

rights do not have a significant effect

B55 – B57 Core Exposure to variable returns B58 – B72 Excluded Link between power and returns –

Delegated power B73 – B75 Excluded Relationship with other parties B76 – B79 Excluded Control of specified assets B80 – B83 Core Continuous assessment B84 Excluded Principle/ agent B85 Core Market conditions B85A – B85W Excluded Investment entity B86 – B88 Core Accounting requirements B89 – B91 Core Potential voting rights B92 – B95 Core Reporting date B96 Core Changes in proportion held by

NCI B97 – B99 Core Loss of control – refer to learning

unit 7 B99A Excluded Loss of control – not a business B100 – B101 Excluded Investment entity

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EXAMPLE

The following example illustrates the basic consolidation process: 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’000Assets 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. 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 each line-item of the subsidiary is added to each line-item 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) 200At acquisition elimination journal

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SECTION B – QUESTIONS ON CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

QUESTION 1.1 (45 marks - 68 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 Finance costs 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

1 375 000 254 320

14 000 239 260

-

- 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 399Credits 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 obliged to pay a preference dividend for a financial year if an ordinary dividend is declared during the financial year. 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 acquisition of Minnie Ltd also met the definition of acquiring a business, as defined in IFRS 3 Business Combinations.

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2. The details of acquisition of the interest in the ordinary shares in Minnie Ltd were as follows:

• 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. • 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. A market-related pre-tax discount rate is 10%, compounded annually. 9. Assume a normal income 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.

22

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

at 31 December 20.12.

Communication skills: presentation and layout

22

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

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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)

(4)(4)

Gross profit Other income [C9] Other expenses [C10] Finance costs (given)

1 907 501-

(633 820) (14 000)

(4) (4) (1)

Profit before tax Income tax expense [C11]

1 259 681(289 180) (5)

PROFIT FOR THE YEAR 970 501Other 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 400TOTAL 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

(1) (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

(1) 1 086 901 Total (26) Maximum (22)

Communication skills: presentation and layout (1)

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 (IAS 40.15). 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 assetsProperty, plant and equipment* Goodwill [C1]

2 253 000 6 730

(3)(10)

2 259 730Current 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

(1)(1)(1)

348 953Total 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)(1)(1)

1 945 117Non-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 149Current liabilities Bank overdraft Trade payables (61 593 + 122 000 + 9 000[C6] (J2 Mickey)) Dividends payable [C3]

25 000192 593

960

(1)(1)(1)

218 553Total liabilities 468 702Total equity and liabilities 2 608 683

TotalMaximum

(25)(22)

* 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] [1] [1] [3]

Equity at acquisition: 336 270 - Share capital - Retained earnings

160 000 176 270

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

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

[1] [1] [1]

Non-controlling interests (100 000) [1]Goodwill 6 730 [10]

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

Consideration and NCI 44 800 26 880 17 920 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. 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.

C4. Equipment sold by Mickey Ltd to Minnie Ltd

MinnieLtd 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.

COMMENT Transaction costs should be carefully analysed as the accounting treatment for transaction costs are not all the same. Acquisition-related costs (finder’s fees, advisory, legal, valuation, professional fees, and administration fees) should be expensed in profit or loss in the consolidated financial statements of the acquirer in accordance with IFRS 3.53. Costs to issue debt or equity are not acquisition-related costs as defined in accordance with IFRS 3. 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. The parent will measure its investments in subsidiaries at cost in accordance with IAS 27.10(a) in its separate financial statements. Acquisition-related costs in the separate financial statements of the parent should thus also be expensed. Students should read carefully how the parent treated the transaction costs in its separate financial statements. In this question, acquisition-related costs of R10 000 will be paid by the seller of the shares (Minnie Ltd) and is included in the purchase price to be paid by Mickey Ltd. In accordance with IFRS 3.53, these costs should however be expensed.

C7. Revenue

Mickey 2 700 000 [1]Minnie 1 200 000 [1]Total intragroup sales (80 000) [1]Intragroup equipment sold [C4] (50 000) [1] 3 770 000 [4]

C8. Cost of sales

Mickey (1 375 000)Minnie (591 499)Total intragroup sales 80 000Intragroup equipment sold [C4] 40 000 [1]Depreciation on intragroup equipment [C4] 2 000 [1]Unrealised profit – closing inventory [C5] (2 000) [1]Reversal of at acquisition inventory adjustment [C2] (16 000) [1] (1 862 499) [4]

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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 320Minnie 180 000Intragroup rent paid (30 000) [1]Reversal of fair value adjustment on investment property (150 000) [1]Ordinary dividend elimination [C2] (14 000) [1]Preference dividend elimination [C3] (4 320) [1] - [4]

C10. Other expenses

Mickey (254 320)Minnie (406 000)Fair value adjustment on contingent consideration [C6] (1 000) [1]Acquisition cost [C6] (10 000) [1]Reversal of at acquisition debtors adjustment [C2] 7 500 [1]Intragroup rent paid 30 000 [1] (633 820) [4]

C11. Income tax expenses

Mickey (239 260)Minnie (88 700)Deferred tax on unrealised profit [C4] 2 800 [1]Deferred tax on depreciation [C4] (560) [1]Deferred tax on unrealised profit [C5] 560Deferred tax on reversal of at acquisition inventory adjustment [C2] 4 480 [1]Deferred tax on reversal of at acquisition debtors adjustment [C2] (2 100) [1]Reversal of deferred tax on fair value adjustment on investment property (150 000 x 80% x 28%) 33 600 [1] (289 180) [5]

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C12. Pro forma consolidation journals

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

Dr R

CrR

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 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 Income tax expense (P/L) 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

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Dr R

Cr R

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 Income tax expense (P/L) 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 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 (31 marks – 47 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 Hlongwane, the managing director of the company. Mr Hlongwane is a meteorologist and an expert in predicting weather patterns. According to a contractual agreement, Mr Hlongwane 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 Nkwane, 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 Mrs Nkwane has the rights to decide which suppliers are used for the purchase of boats. REQUIRED MarksDiscuss, 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: • Your answer must comply with International Financial Reporting Standards (IFRS).

12 9

10

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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). 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).

(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 (IFRS 10.10). 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 Hlongwane 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 Hlongwane 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 Hlongwane not exercise his rights.

(1)

(1)

The rights that Mr Hlongwane has are deemed to be protective rights, as it is rights designed to protect the interest of Mr Hlongwane 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.

(2)

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)(12)

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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.

(2)

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)

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

(2)

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)

Rent-a-Boat Ltd is a structured entity as defined and a subsidiary of Great White Ltd. (1)(10)

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QUESTION 1.3 (11 marks – 17 minutes) Luke Ltd Luke Ltd is primarily involved in astrological observation and research, from its base at the South African Large Telescope in Sutherland in the Western Cape. Luke Ltd tenders for various contracts and is commissioned for international astrological projects. The majority of Luke Ltd's funding for projects is provided by a consortium of international investors from South Africa, the United States, Germany, Poland and India. Luke Ltd is busy expanding its operations and has identified Leia Ltd as a perfect synergistic investment. Luke Ltd and its subsidiaries have a February year end. Leia Ltd Leia Ltd is a company started by three Unisa computer engineering students with exceptional data processing skills and registered patents. The company’s relevant activities are the development of data processing and analysis software, which will come in very handy with the amount of data streams that the scientists at Luke Ltd are creating. Leia Ltd’s share capital consists of 100 issued ordinary shares. Each share carries one voting right. Luke Ltd acquired 49 of the ordinary shares of Leia Ltd on 1 January 20.16. The StarCon Consortium holds the remainder of the voting rights. An extract of the shareholders’ agreement between Luke Ltd and the StarCon Consortium is as follows: (a) Luke Ltd and the StarCon Consortium each have the right to appoint two of the four directors. (b) Luke Ltd has the right to establish Leia Ltd’s operating and capital decisions and policies. (c) The StarCon Consortium has the right, as a lender and provider of funds, to seize Leia Ltd’s

assets if Leia Ltd fails to meet the specified loan repayment conditions. REQUIRED MarksDiscuss, in terms of IFRS 10 Consolidated Financial Statements, whether Leia Ltd should be consolidated in the consolidated financial statements of Luke Ltd for the year ended 29 February 20.16.

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

10

1

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QUESTION 1.3 - Suggested solution Discussion whether Leia Ltd should be consolidated Required to consolidate? A subsidiary is an entity that is controlled by another entity (known as the parent). Luke Ltd will need to consolidate Leia Ltd if control exists (IFRS 10 Appendix A).

(1)

Control 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 10.6-7). Power over the investee (IFRS 10.7(a)) To have power over an investee, an investor must have existing rights that gives it the current ability to direct relevant activities (IFRS 10.B9).

Direct relevant activities Establishing operating and capital decisions of the investee (IFRS 10.B12(a)). According to the shareholders’ agreement, Luke Ltd can establish the operating and capital policies of Leia Ltd. This indicates that Luke Ltd has the ability to direct relevant activities.

(1)

Appointing and remunerating an investee’s key management personnel (IFRS 10.B12(b)). According to the shareholders’ agreement, Luke Ltd and the StarCon Consortium can each appoint two members of the Leia Ltd’s key management. This indicates that Luke Ltd and the StarCon Consortium have the ability to direct relevant activities.

(1)

(1)

An investor can have power over an investee even if other entities have existing rights that give them the current ability to participate in the direction of the relevant activities. However, an investor that holds only protective rights does not have power over an investee and consequently does not control the investee. (IFRS 10.14) According to the shareholders’ agreement, The StarCon Consortium can seize Leia Ltd’s assets if Leia Ltd fails to meet the specified loan repayment conditions. This indicates that The StarCon Consortium has a protective right but not power over Leia Ltd.

(1)

(1)

1B. Exposure/rights to variable returns (IFRS 10.7(b))Luke Ltd and the StarCon Consortium have rights to variable returns in the form of dividends due to its 49% and 51% shareholding in Leia Ltd respectively.

(1)

1C. Link between power and returns (IFRS 10.7(c))…but also has the ability to use its power to affect the investor’s returns from its involvement with the investee By establishing the operating and capital decisions of Leia Ltd, the StarCon Consortium can use its power to affect its returns from Leia Ltd.

(1)

By appointing Leia Ltd’s key management personnel, Luke Ltd can use its power to affect its returns from Leia Ltd. (1)

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Conclusion • Both entities have the right to direct the relevant activities of Leia Ltd but Luke Ltd has the

right to establish the operating and capital policies of Leia Ltd as well. • The StarCon Consortium holds the majority of the shares. • The StarCon Consortium doesn’t have power over Leia Ltd because it has protective and

not substantive rights. • Both entities have exposure/rights to variable returns. • Both entities have the power to affect its returns from its involvement with Leia Ltd. • StarCon Consortium is the majority shareholder but Luke has control over Leia Ltd. • Luke will be required to consolidate Leia Ltd.

(1) (1)

Total (11)Maximum (10)

Communication skills: conclusion and logical flow (1)


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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 At the end of this learning unit, you should be able to: 1. Identify a business combination. 2. Account for business combinations by applying the acquisition method. 3. Account for a business combination in which control is achieved in stages. 4. Account for measurement period adjustments. 5. Determine what forms part of a business combination. 6. Recognition and subsequent measurement of particular assets acquired in terms

of IFRS 3. 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).

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. IFRS 3 Business Combinations. 2. Group Statements, 17th edition, Volume 1, Chapter 2. 3. Group Statements, 17th edition, Volume 2, Chapter 9.

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SECTION A - SAICA’S PRINCIPLES OF EXAMINATION LEVELS The SAICA principles of examination levels provide guidance on how the standards (or topics within a standard) will be examined. The principles of examination levels for IFRS 3 are as follows: Description Paragraph Level Notes Objective 1 CoreScope 2(a) – 2(b) Core 2(c) Awareness 2A Excluded Identifying a business combination

3 Core

The acquisition method 4 – 5 Core 6 – 7 Core Identify the acquirer 8 – 9 Core Determine the acquisition date 10 – 28 Core Recognise and measure assets,

liabilities and NCI 28A – 28B Core Leases in which the acquiree is

the lessee 29 Excluded Reacquired rights 30 Excluded Share-based payment trans-

actions 31 Core Assets held for sale 32 Core Goodwill or gain from bargain

purchase 33 Excluded Exchange of only equity interests 34 – 36 Core Bargain purchases 37 – 40 Core Consideration transferred 41 – 44 Core Particular types of combinations 45 – 50 Core Measurement period 51 Core What is included in transaction 52(a) Excluded Pre-existing relationships 52(b) – 52(c) Core Separate transactions 53 Core Transaction costs Subsequent measurement and 54 Coreaccounting 55 Excluded Reacquired rights 56 Core Contingent liabilities 57 Core Indemnification assets 58 Core Contingent consideration Disclosures 59 – 63 Core Refer to learning unit 4 Effective date and transition 64 – 67 Excluded Reference to IFRS 9 67A Excluded Withdrawal of IFRS 3 (2004) 68 Excluded Defined terms Core

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Description Paragraph Level Notes Application guidance B1 – B4 Excluded Entities under common control B5 – B6 Awareness Identify a business combination B7 – B12 Awareness Definition of a business B13 – B18 Excluded Identifying the acquirer B19 – B27 Excluded Reverse acquisitions B28 – B30 Deleted B31 – B34 Core Intangible assets B35 – B36 Excluded Reacquired rights B37 – B40 Core Assembled workforce and other

items that are not identifiable E5 (B38) Excluded Put options to NCI B41 – B45 Core Fair value of particular assets and

NCI B46 Core Goodwill or gain from bargain

purchase B47 – B49 Excluded Combinations of mutual entities B50 Core What is included in transaction B51 – B53 Excluded Pre-existing relationship

settlement B54 – B55 Core Contingent payments to

employees or selling shareholders B56 – B62 Excluded Share-based payment awards

exchanged for acquiree’s awards B62A –

B62B Excluded Equity-settled share-based

payment transactions of acquiree B63 Core Other IFRSs that provide

guidance B64 – B67 Core Disclosure - refer to learning unit 4 B68 – B69 Excluded Transitional provisions

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IDENTIFY A BUSINESS COMBINATION In order to identify a business combination, the definition of a business as stated in IFRS 3 should be considered and applied. The definition had been amended in July 2019. The amendment is effective from 1 January 2020 with an option to pre-adopt. It is important that you first work through IE74 to IE123 in your IFRS textbook as the IFRS is what you have in the exam/test and it is for your benefit to familiarise yourself with it. To enhance your understanding of the relevant illustrative examples of the IFRS 3 amendment, please refer to the following screencasts that may be found on MyUnisa under the lessons tab for tutorial letter 102. - Part 1 – Overview - Part 2 – Concentration test (numeric application) - Part 3 – Similar Assets - Part 4 – Further criteria assessed The amended definition of a business that is found in IFRS 3 is as follows: An integrated set of activities and assets that is capable of being conducted and managed for the purposes of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities. The application of the guidance layed out in paragraphs B7 to B12D is summarised into a mindmap found below. Please note you are still required to go to these paragraphs in IFRS and read them and familiarise yourself with them. The mindmap summary below is merely an illustration to enhance your understanding of these paragraphs. The question 2.1 below highlights the major changes in the application of the definition, and may be used as practice questions once you have already studied the IFRS application paragraphs, illustrative examples and the screencasts indicated above.

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APPLICATION GUIDANCE TO DETERMINE ACQUISITION OF A BUSINESS

(SAICA – adapted)

Is the process critical to the ability to develop or convert the inputs into outputs?

Do the acquired assets and liabilities meet the definition of a business?

Have you met the criteria for the concentration test?

Do you want to apply the concentration test?

Yes No

No

No Business = inputs + a substantive process + the ability to contribute to the ability to create outputs. Do the activities and assets have outputs at acquisition date?

Yes

Yes

Does the process significantly contribute to the ability to continue producing output and is considered unique/scarce; or cannot be replaced without significant impact on the ability to continue producing outputs?

Is the process critical when applied to the inputs to continue producing outputs, AND there is a skilled, knowledgeable or experienced organised workforce to perform the process?

No

Do the inputs include a skilled, knowledgeable or experienced organized workforce to perform the process AND other inputs the workforce could develop or convert into outputs?

No

No

Yes

Yes

Yes

Purchased assets: Apply IFRS 3 Business combinations

Acquisition is a business

Acquisition is NOT a business

Yes No

Purchased assets: Apply asset standards (i.e IAS 16,38,40; etc.)

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ACQUISITION METHOD (Applying IFRS 3 Business Combinations)

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).

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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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

Step 5

Step 6

Step 7

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SECTION B - QUESTION ON BUSINESS COMBINATIONS QUESTION 2.1A (10 marks – 15 minutes) Designa Cars Ltd is a motor car dealer and purchased a portfolio of cars for resale. Within this portfolio are 19 different cars. The fair value of the price paid for the portfolio of cars is equal to the aggregate fair value of the 19 cars acquired. The vehicles are of different makes and models specifically five BMW’s of different models, five Mercedes Benz of different models, seven Toyota’s of different models and two Fords of different models. Two of the BMW’s and two of the Mercedes Bens were made as a customised order per specific customer requirements. These changes are cosmetic and do not change the risks associated with these vehicles. Due to the wide range of cars in the portfolio the class of customers would not be similar. The risks associated with operation in the motor vehicle industry for the vehicles acquired is not significantly different. No employees, other assets other processes and other activities are transferred. REQUIRED

Marks

Designa Cars Ltd opted to apply the concentration test to the purchase of the portfolio in terms of IFRS 3.B7A. Discuss if the concentration test is met or not in terms of IFRS3. B7B. Conclude if this acquisition results in acquisition of a business or not.

10

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 2.1A - Suggested solution Designa Cars Ltd opted to apply the concentration test to the purchase of the portfolio in terms of IFRS 3.B7A. Discuss if the concentration test is met or not in terms of IFRS3. B7B. Conclude if this acquisition results in acquisition of a business or not.

Single identifiable asset/group: Each vehicle is an individual asset and can be used separately from another tangible asset. (1)

The assets acquired are all motor vehicles and are therefore the same in nature. (1)

They are all purchased for the same purpose of resale by Designa Cars Ltd and are therefore all of the same class of assets namely; inventory (IFRS 3. B7B (e)) Consequently, they share the same risks. (1)

It does not matter that some of the vehicles have come with some changes to customise to customer needs as it is still one asset. The customisation has not changed the risks attached to the assets. Therefore, these vehicles still all share similar risks. (IFRS 3. B7B (e)) (1)

Therefore the group of assets are of the same nature and share similar risks. (1)

Therefore the portfolio of vehicles are considered a single identifiable asset group and recognised and measured as such in a business combination. (IFRS 3. B7B (c)) (1)

Fair value: The fair value of the price paid for the portfolio of cars is equal to the aggregate fair value of the 19 cars acquired. (1)

This indicates that substantially all of the fair value of the assets acquired are concentrated in the group of vehicles purchased (IFRS 3. B7B (b)). (1)

Concentration test: Therefore we can confirm that the concentration test is met.

(1)

Conclusion: We can conclude that the acquisition of the portfolio is not a business. (IFRS 3. B7A (a)). (1) (10)

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QUESTION 2.1B (15 marks – 23 minutes) Designa Cars Ltd is a motor car dealer and purchased a portfolio of cars. This portfolio of cars consisted of are 22 different vehicles. 19 of these motor vehicles are luxury vehicles purchased for resale while three of them are large delivery trucks used to deliver motor vehicles to other car dealers and bulk buyers. The three large delivery trucks purchased includes contracts for outsourced trained drivers to drive these specialised trucks as well as a specialised motor plan to maintain and service these trucks regularly as well as outsourced security needed whilst transporting deliveries. The processes and services performed through these outsource contract are minor in considering all the processes involved in generating the required income (output). No employees, other assets, other processes and other activities are transferred. The aggregate fair value of the 19 luxury cars is similar to the aggregate fair value of the three delivery trucks acquired. The 19 cars are all of different makes and models specifically five BMW’s of different models, five Mercedes Benz of different models, seven Toyota’s of different models and two Fords of different models. Two of the BMW’s and two of the Mercedes Benz were made as a customised order per specific customer requirements. These changes are cosmetic and do not change the risks associated with these vehicles. Due to the wide range of cars in the portfolio the class of customers would not be similar. The risks associated with operation in the motor vehicle industry for the vehicles acquired for resale is not significantly different. REQUIRED

Marks

(a) Designa Cars Ltd opted to apply the concentration test to the purchase of the portfolio in terms of IFRS 3.B7A. Discuss in terms of IFRS3. B7B if the concentration test is met or not. Conclude if this acquisition results in acquisition of a business or not.

8

(b) Designa Cars Ltd did not opt to apply the concentration test to the purchase of the portfolio in terms of IFRS 3.B7A. Discuss in terms of IFRS3. B8 – B12D if the results in acquisition of a business or not.

7


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QUESTION 2.1B - Suggested solution (a) Designa Cars Ltd opted to apply the concentration test to the purchase of the portfolio

in terms of IFRS 3.B7A. Discuss in terms of IFRS3. B7B if the concentration test is met or not. Conclude if this acquisition results in acquisition of a business or not.

Single identifiable asset/group: Each vehicle is an individual asset and can be used separately from another tangible asset. (1)

The assets acquired are all motor vehicles, so they are of the same in nature. (1)

However, they are all not purchased for the same purpose by Designa Cars Ltd and are therefore all not of the same class of assets. (1)

The 19 luxury cars are purchased for the purpose of resale by Designa Cars Ltd and are classified as inventory. While the three delivery trucks will be used by Designa Cars Ltd for other activities and are classified as property plant and equipment.

(1)

Therefore, they and are not of the same class of assets and not considered similar (IFRS 3. B7B (f(ii))). (1)

Consequently, the portfolio of assets purchased do not share the same risk associated with managing and creating output and may not be grouped as a singles identifiable asset group (IFRS 3. B7B (e)). (1)

They may not be recognised and measured as a single identifiable asset in a business combination (IFRS 3. B7B (c)). (1)

Fair value: There substantially two groups of assets (i.e the luxury cars and delivery trucks). (1)

This indicates that substantially all of the fair value of the assets acquired are not concentrated in just one group of vehicles purchased [IFRS 3. B7B (b)]. (1)

Concentration test: Therefore we can confirm that the concentration test is not met. (1)

Conclusion: Designa Cars Ltd shall further assess in terms of IFRS3.B8 – B12D to determine if the portfolio of vehicles acquired is a business or not. [IFRS 3. B7A (b)]. (1)


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(b) Designa Cars Ltd did not opt to apply the concentration test to the purchase of the

portfolio in terms of IFRS 3.B7A. Discuss in terms of IFRS3. B8 – B12D if the results in acquisition of a business or not.

IFRS 3.B12C The purchasing the portfolio of vehicles activity generates revenue from the resale of the luxury cars. This revenue output from the activity of purchasing the portfolio of vehicles. Therefore, we apply IFRS3.B12C to assess if the acquired process is substantive.

(1)

The outsource services provided by outsourced personnel are not critical to the ability to continue producing outputs. (1)

They are minor/ancillary in the context of all processes involved in generation the required output (IFRS 3. B12C (a)). (1)

The relevant inputs do not include an organised workforce with the necessary skills, knowledge or experience to perform the process and do not include other inputs the workforce could develop or convert into outputs (IFRS 3.B12C (a)). (1)

The process of purchasing vehicles for resale and delivering such vehicles is a process that is readily accessible in the marketplace. They are not unique or scarce and can be replaced without significant cost [IFRS 3. B12C (b)). (2)

Therefore, the process acquired is not substantive and the acquisition of the portfolio of vehicles is not a business. (1)

(7)

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QUESTION 2.1C (11 marks – 17 minutes) Designa Cars Ltd is a motor car dealer and owns a 10% interest in Car Security Ltd. Car Security Ltd specialises in the installation of car security such as gearlocks and anti-hijack systems into all types of motor cars. At 31 March 20.20 Designa Cars Ltd purchased a further 75% interest in Car Security Ltd for cash consideration of R3 000 000. On this date Designa Cars Ltd obtained control over Car Security Ltd in accordance with IFRS 10 Consolidated Financial Statements. The fair value of Car Security Ltd shares is R60 per share on 31 March 20.20 with a total of 200 000 shares in issue. Both companies have a 31 December year end. The extracted trial balance of Car Security Ltd are shown in the table below at their fair values on the relevant dates: 31 March 20.20

Dr/(Cr) R

30 June 20.20

Dr/(Cr) R

Retained earnings (10 000 000) (14 000 000)Long-term liabilities (9 700 000) (9 600 000)Property, plant and equipment 9 500 000 10 300 000Financial asset 600 000 670 000Intangible assets 3 000 000 3 000 000Cash and cash equivalents 1 500 000 1 800 000Trade and other receivables 400 000 530 000Trade and other payables (800 000) (840 000)Deferred tax liability (840 000) (920 000) REQUIRED

Marks

Calculate the fair value of gross assets acquired i.t.o IFRS3.B7B (a) and (b) and conclude if the concentration test has been met.

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QUESTION 2.1C - Suggested solution The concentration test is met if substantially all of the fair value of the gross assets acquired is concentrated in the groups of similar identifiable assets. The group of assets acquired of R13 500 000 [C3] is substantially all of the fair value of gross assets R15 000 000 [C3] in terms of IFRS 3.B7B.

(10)

Therefore, the concentration test is met for the purchase of the interest in Car Security Ltd. (1) (11)

CALCULATIONS C1. Fair value of net identifiable assets acquired [IFRS3.B7B (b)]

R

Property, plant and equipment 9 500 000 [½]Intangible asset 3 000 000 [½]Financial asset 600 000 [½]Cash and cash equivalents 1 500 000 [½]Trade and other receivables 400 000 [½]Long-term liabilities (9 700 000) [½]Trade and other payables (800 000) [½]Deferred tax liability - [1]

4 500 000

[4½] C2. Fair value of gross assets acquired i.t.o IFRS 3.B7B (b)

Consideration paid 3 000 000 [½]NCI at fair value ((200 000 x R60) x 15%) 1 800 000 [1]Fair value of remaining interest ((200 000 x R60) x 10%) 1 200 000 [1]

6 000 000Net identifiable assets acquired [C1] (4 500 000)Excess i.t.o IFRS3.B7B(a) 1 500 000

C3. Assets acquired excluding IFRS3. B7B (a) assets

Property, plant and equipment 9 500 000Intangible asset 3 000 000Financial asset 600 000Trade and other receivables 400 000Cash and cash equivalents (excluded) - (1)

13 500 000 (1)Plus: Excess [C2] 1 500 000 (7)Fair value of gross assets acquired 15 000 000

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R OR IFRS 3.B7B (b) check: Consideration paid 3 000 000 NCI at fair value ((200 000 x R60) x 15%) 1 800 000 Fair value of remaining interest ((200 000 x R60) x 10%) 1 200 000 Cash and cash equivalents (1 500 000)payables 800 000 Long-term liabilities 9 700 000

15 000 000

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QUESTION 2.2 (45 marks – 68 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 Italia 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. Colour Ltd has a licensed customer list on 1 January 20.11. The agreements relating to the

customer list does not prohibit the selling or leasing thereof. The useful life of the customer list is four years on 1 January 20.11 and the fair value is R175 794. Colour Ltd has not recognised an asset in this regard.

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 normal income 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. • The acquisition of Colour Ltd also met the definition of acquiring a business, as defined in

IFRS 3 Business Combinations.

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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.

12

(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.


32

1


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QUESTION 2.2 - 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]) 1 206 000 (1) Acquisition cost (P/L) (given) 120 000 (1) Share capital (SCE) (1 000 x R460) 460 000 (2) Contingent consideration (SFP) (given)

60 000 (1)

Deferred consideration (SFP) [C6]

186 000 (3) Bank (SFP)

620 000 (1)

Accounting for the investment in Colour Ltd

COMMENT Transaction costs should be carefully analysed as the accounting treatment for transaction costs are not all the same. Acquisition-related costs (finder’s fees, advisory, legal, valuation, professional fees, and administration fees) should be expensed in profit or loss in the consolidated financial statements of the acquirer in accordance with IFRS 3.53. Costs to issue debt or equity are not acquisition-related costs as defined in accordance with IFRS 3. 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. The parent will measure its investments in subsidiaries at cost in accordance with IAS 27.10(a) in its separate financial statements. Acquisition-related costs in the separate financial statements of the parent should thus also be expensed. Students should read carefully how the parent treated the transaction costs in its separate financial statements. In this question, acquisition-related costs of R120 000 was paid by the acquirer and included in the cash payment of R620 000 that was paid on 1 January 20.11. The acquisition-related costs should thus be expensed in accordance with IFRS 3.53.

31 December 20.11

J2 Fair value adjustment (P/L) (85 000 - 60 000) 25 000 (1) Contingent consideration (SFP) 25 000 (1)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.

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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 (1)

Interest on the deferred payment

J4 Bank (SFP) (150 000 x 60%) 90 000 (1) Other income (P/L) 90 000 (1) Dividends received from Colour Ltd

Total (15)

Maximu

m

(12)

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 Retained earnings (SCE) (given) 1 050 000 Machinery (SFP) (given) 300 000 (1) Land (SFP) (400 000 – 300 000) 100 000 (1) Intangible asset – customer list [C2] (SFP) 175 794 (1)Goodwill (SFP) [C3] or (balancing) 10 828 (1)Indemnification asset (SFP) (450 000 x 40%) 180 000 (2) Non-controlling interests (SFP/SCE) (given) 805 000 (1) Recognised contingent liability (SFP) (given) 450 000 (1) Deferred tax (SFP) [C4] 155 622 (3) Investment in Colour Ltd (SFP) (part (a)) 1 206 000 (1)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).

COMMENT Deferred tax on contingent liability The tax base of a liability is the carrying amount, less any amount that would be deductible for tax purposes in future periods. The question states that the claim will not be deductible for taxation purposes should it succeed. This will result in the tax base being the carrying amount. There is thus no temporary difference and deferred tax will not be provided.

Dr Cr R R

31 December 20.11

J2 Depreciation (P/L) (300 000 x ¼) 75 000 (1) Accumulated depreciation (SFP)

75 000 (1)

Provision for depreciation on machinery revaluedJ3 Deferred tax (SFP) (75 000 x 28%) 21 000 (1) Income tax expense (P/L) 21 000 (1) 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 (1) Indemnification asset (SFP) 180 000 (1)

Legal expense (P/L) 270 000Reversal 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 – customer list (P/L) (175 794 [C2] / 4) 43 949 (1) Intangible asset – customer list (SFP)

43 949 (1)

Amortisation of customer listJ6 Deferred tax (SFP) (43 949 x 28%) 12 306 (1)

Income tax expense (P/L) 12 306 (1)Taxation on amortisation

COMMENT The customer list 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.

J7 Land (SFP) (450 000 - 400 000) 50 000 (1)

Fair value remeasurement (P/L) 50 000 (1)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 (1) 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 80% 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 (1)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 (1) Non-controlling interests (SFP/SCE) (150 000 x 40%) 60 000 (1) Dividends paid (SCE) (given) 150 000 (1) Elimination of intragroup dividends

Total (35)

Maximum (32) Communication skills: presentation and layout (1)

CALCULATIONS C1. Consideration transferred

Cash (given) 620 000Shares (1 000 x R460) 460 000Deferred consideration [C6] 186 000Contingent consideration (given) 60 000Acquisition costs paid (given) (120 000) 1 206 000 [1]

C2. Customer list

Intangible asset – customer list (given) 175 795 [1] C3. Calculation of goodwill (IFRS 3.32)

+ Consideration transferred [C1] 1 206 000+ Non-controlling interests (given) 805 000 2 011 000-Net identifiable assets acquired 2 000 172

Share capital (given) 800 000 Retained earnings (given) 1 050 000Adjustments to the net assets (J1) Contingent liability recognised (J1) (450 000)Machinery – revaluation surplus (J1) 300 000Land – fair value adjustment (J1) 100 000Indemnification asset raised recognised (J1) 180 000Intangible asset (customer list) (J1) 175 794Deferred tax [C4] (155 622)

Goodwill 10 828 C4. Deferred tax

Machinery (300 000 x 28%) 84 000 [1]Land (100 000 x 28% x 80%) 22 400 [1]Intangible asset – customer list (175 794 x 28%) 49 222 [1]Indemnification asset - Recognised contingent liability (indemnified item) - 155 622

[3]

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COMMENT A deferred tax liability is recognised on the customer list (intangible asset) since the carrying amount of the customer list exceeds its tax base (the tax base of the customer list 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. 2ndF MODE (Clear All)

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

3. 10 I/YR 3. 10 i 3. 10 I/Y [1]

4. 2 N 4. 2 n 3. 2 N [1]

5. 225 060 FV 5. 225 060 FV 5. 225 060 FV [1]

6. PV 186 000 6. Comp PV 186 000 6. Comp PV 186 000

[3]

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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 (customer list) 175 794 Deferred tax (49 222) 2 000 172 1 200 103 800 069Equity represented by goodwill 10 828 5 897 4 931Consideration and NCI 2 011 000 1 206 000 805 000 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) 2 686 033 405 020 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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LEARNING UNIT 3 – INVESTMENTS IN ASSOCIATES AND JOINT

VENTURES

INTRODUCTION IAS 28 deals with the accounting for investments in associates and joint ventures and specifies the use of the equity method. The accounting treatment of the investments in associates and joint ventures in the separate financial statements of an investor is prescribed in IAS 27. The method to follow in determining whether a joint arrangement must be classified as a joint venture is discussed in IFRS 11 and will be covered in learning unit 5.

OBJECTIVES/OUTCOMES At the end of this learning unit, you should be able to: 1. Define an associate in accordance with IAS 28. 2. Discuss the existence or absence of significant influence in an investment held

and the appropriate accounting treatment of the investment. 3. Identify evidence of existence of significant influence in cases where an investor

holds directly or indirectly less than 20% of the voting power of the investee. 4. Apply the equity method in accounting for investments in associates and joint

ventures in the consolidated or group financial statements of the investor. 5. Account for the investment in associate or joint venture in the separate financial

statements of the investor at cost (IAS 27.10(a)).

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. Group Statements, 17th edition, Volume 2, Chapter 11. 2. IAS 28 Investments in Associates and Joint Ventures.

COMMENT The disposal of interests in investees and piecemeal acquisition of interests in investees will only be covered and assessed in tutorial letter 104 and test 3.

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SECTION A – SAICA’S PRINCIPLES OF EXAMINATION LEVELS The SAICA principles of examination levels provide guidance on how the standards (or topics within a standard) will be examined. The principles of examination levels for IAS 28 are as follows: Description Paragraph Level Notes Objective 1 Core Scope 2 Awareness Definitions 3 – 4 Core Significant influence 5 – 7 Core Equity method 10 – 15 Core Application of equity method 16 – 17 Core 18 – 19 Excluded Venture capital organisation or

similar 20 – 21 Excluded Classifications as held for sale 22 – 24 Core Discontinuing the use of equity

method 25 Excluded Change in ownership – Interest

remains an associate or joint venture IFRS 5 –

Groups Excluded Classification as held for sale

26 – 36 Core Equity method procedures 36A Excluded Investment entity matters 37 – 39 Core Equity method procedures 40 – 43 Core Impairment losses Separate financial statements 44 Core Effective date and transition 45 – 46 Excluded Withdrawal of IAS 28 (2003) 47 Excluded

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EXAMPLE

The following example illustrates the basic equity accounting procedures: Investment in associate accounted for at cost On 1 January 20.17 I Ltd acquired a 30% interest in A Ltd for R200 000 and exercised significant influence over the financial and operating policy decisions of A Ltd from that date. I Ltd accounts for investments in associates at cost in terms of IAS 27.10(a). A Ltd recorded profit after tax of R500 000 and other comprehensive income after tax (revaluation surplus) of R100 000 for the year ended 31 December 20.17.

Investor (I) Separate financial statements

Pro forma

journals Group financial statements

R’000 R’000 R’000Assets Assets Investment in A Ltd (cost) 200 180 Investment in A Ltd 380Trade debtors 100 Trade debtors 100 Equity Equity Share capital (50) Share capital (50)Retained earnings (120) (150) Retained earnings (270)Revaluation surplus (30) (30) Revaluation surplus (60) Liabilities Liabilities Long-term loan (100) Long-term loan (100)

Note 1 Note 2 Notes 1. When an investor prepares separate financial statements, it shall account for investments in

associates at cost (IAS 27.10). 2. Pro forma journals are prepared in order to equity account for the investment in associate in

the group financial statements. I Ltd’s share of A Ltd’s profits and other comprehensive income for the current and prior years must thus be recognised in the group financial statements. The pro forma journal will be as follows:

Dr Cr R’000 R’000

Investment in A Ltd (SFP) 180 Share of profit of associate (P/L) (500 000 x 30%) 150 Share of other comprehensive income of associate (OCI) (100 000 x 30%)

30

Equity accounting of investment in associate for the current year

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SECTION B – QUESTION ON INVESTMENTS IN ASSOCIATES AND JOINT VENTURES

QUESTION 3.1 (40 marks – 60 minutes) Furnit-Your-World Ltd is a retailer of office and household furniture and was established in 19.9 by Mr Brian Pillay. The company has a number of high-profile customers, such as hotels and banks. On 1 March 20.4 Furnit-Your-World Ltd acquired 120 000 shares of Urban Drapes Ltd, a company that manufactures and retails drapes, curtains and bedding, for an amount of R3 766 000 which was paid in cash. Furnit-Your-World Ltd obtained control of Urban Drapes Ltd in accordance with IFRS 10 Consolidated Financial Statements. The assets and liabilities were fairly valued on the date of acquisition. No additional assets, liabilities or contingent liabilities were identified at that date. Furnit-Your-World Ltd has been making every effort to expand their customer base during the last year. The company aims to be a "one-stop shop" for large corporate companies by supplying them with all their furniture, curtains and electronic appliances. As a result of this objective, the company purchased 75 000 shares in Digital Décor Ltd, a company that retails electronic equipment, on 1 August 20.11 for an amount of R485 000 which was settled in cash. Since the need for electronic equipment in buildings such as hotels and banks are immense, Furnit-Your-World Ltd identified this as a gap in their market. From 1 August 20.11 Furnit-Your-World Ltd exercised significant influence over the financial and operating policy decisions of Digital Décor Ltd. The assets and liabilities of Digital Décor Ltd were deemed to be fairly valued on 1 August 20.11. No additional assets or liabilities were identified at that date. You may assume that no excess arose on the acquisition of Digital Décor Ltd. The following was extracted from the trial balances of Furnit-Your-World Ltd, Urban Drapes Ltd and Digital Décor Ltd for the year ended 31 March 20.12:

Furnit-Your-World

Ltd R

Urban Drapes Ltd

R

Digital Decor Ltd

R

Debits Cost of sales 12 865 000 5 450 000 8 721 000 Other expenses 1 289 000 412 000 571 000 Finance costs 104 500 31 600 58 200 Income tax expense 631 058 246 954 230 196 Credits Ordinary share capital - 500 000 shares 1 300 000 - 200 000 shares 450 000 - 300 000 shares 300 000 Revenue 16 081 250 6 812 500 10 203 570 Other income 514 500 13 000 32 000 Mark-to-market reserve - 31 March 20.12 333 500 16 000 12 200 Mark-to-market reserve - 1 April 20.11 213 600 14 800 10 700

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Furnit-Your-World Ltd has other equity investments (apart from its investments in Urban Drapes Ltd and Digital Décor Ltd), but does not hold a shareholding of more than 5% in each of those investments. Additional information 1. Relevant accounting policies Furnit-Your-World Ltd has the following relevant accounting policies: • Investments in subsidiaries and associates are measured at cost in the separate

financial statements.

• Equity investments are accounted for in accordance with IFRS 9 Financial Instruments in its separate financial statements. Furnit-Your-World Ltd irrevocably elected to present subsequent changes in the fair value of its equity investments in other comprehensive income in a mark-to-market reserve.

• Other comprehensive income is disclosed net of tax in the statement of profit or loss and

other comprehensive income. • Furnit-Your-World Ltd elected to measure non-controlling interests at the proportionate

share of the acquiree’s identifiable net assets at the acquisition date. 2. Dividends Urban Drapes Ltd declared and paid a dividend on 31 May 20.11 amounting to R40 000. Digital Décor Ltd declared and paid a dividend on 28 February 20.12 amounting to R44 000. 3. Group transactions

During June 20.11 Furnit-Your-World Ltd redecorated their office and purchased curtains from Urban Drapes Ltd to the amount of R54 000 on 30 June 20.11. This was sold at a gross profit percentage of 15% to Furnit-Your-World Ltd. Furnit-Your-World Ltd depreciates the curtains over the useful life of six years on a straight-line basis. During February 20.12 Urban Drapes Ltd received a large order from a customer in Swaziland. The customer has been dealing with Urban Drapes Ltd for a number of years and prefers to deal with this company rather than any other South African company. The customer requested Urban Drapes Ltd to sell beds to him, in addition to the bedding required. In order to accommodate this established customer, Urban Drapes Ltd purchased several beds from Furnit-Your-World Ltd for an amount of R89 000 in February 20.12, at a mark-up of 20% on cost. At year end, not all the beds have been delivered to Swaziland and beds to the value of R23 000 were still on hand. From the date of acquisition, Urban Drapes Ltd purchased inventory from Furnit-Your-World Ltd. Furnit-Your-World Ltd sold the inventory to Urban Drapes Ltd at a mark-up of 25% on cost. Total sales amounted to R620 000 for the current financial year. Inventory of R130 000 was still on hand in the records of Urban Drapes Ltd at year end.

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4. Redeemable preference shares

Furnit-Your-World Ltd issued compulsory redeemable preference shares amounting to R100 000 to Urban Drapes Ltd on 1 November 20.11 at a premium of 8%. It is redeemable on 31 October 20.14 at the nominal value. A payment of R9 000 is made annually on 31 October. Furnit-Your-World Ltd classified the redeemable preference shares as debt and both companies accounted for the dividends as interest (you may assume that this classification is correct).

5. Digital Decor Ltd

The retained earnings of Digital Décor Ltd amounted to R1 620 000 on 1 August 20.11. Digital Décor Ltd earned its profits evenly throughout the year, with the exception of machinery with a carrying amount of R90 000 that was sold on 1 August 20.11. The machinery was sold for R93 500 to an employee. The employee settled the purchase price on 31 January 20.12 in terms of an arrangement that he had with the company. Digital Décor Ltd recognised a profit on sale of machinery of R3 500 which was included in other income. You must assume that 6 months is a significant amount of time.

All Digital Décor Ltd s other comprehensive income for the 20.12 financial year was earned after the acquisition by Furnit-Your-World Ltd.

6. Taxation

Assume an income tax rate of 28% and a Capital Gains Tax inclusion rate of 80%. Ignore Value Added Tax (VAT) and Dividend Tax. You may assume that the income tax expense given is correctly calculated before any adjustments related to the above information are made. The income tax expense of Digital Decor Ltd attributable to the first four months was R80 320 and the remaining balance is attributable to the last eight months. You may assume that this is correct and that no adjustments are necessary.

7. General All the companies in the group have a year end of 31 March 20.12. A market-related pre-tax discount rate is 9% per annum compounded annually. There have been no changes in the issued ordinary share capital of any of the companies in

the group since incorporation.

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REQUIRED Marks

(a) Prepare the correcting and/or additional journal(s) required to account for the profit or loss on sale of machinery to the employee in the separate financial statements of Digital Decor Ltd for the year ended 31 March 20.12. Journal narrations are not required.

5

(b) Prepare the consolidated statement of profit or loss and other comprehensive income of the Furnit-Your-World Ltd Group for the year ended 31 March 20.12. Income and expenditure should be presented in terms of their function.


33

2

Please note: • Comparative figures are not required. • The allocation of profit attributable to owners of the parent and non-controlling

interests is not required. • Round off all amounts to the nearest Rand and percentages to two decimal points. • Notes to the consolidated financial statements are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3.1 – Suggested solution (a) Correcting journal entry

Dr R

Cr R

Profit on sale of equipment (other income) (P/L) (given) 3 500 (1)Loss on sale of equipment (other expenses) (P/L) [C7] 443 (3) Interest received (P/L) [C7] 3 943 (1)Correction of sale of equipment to include interest effect (5)

(b) FURNIT-YOUR-WORLD LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 MARCH 20.12

20.12 R

Revenue (16 081 250 + 6 812 500 - 54 000 [C4] - 89 000 [C1] – 32 500 [C5]) 22 718 250 (5)Cost of sales (12 865 000 + 5 450 000 - 89 000 [C1] + 3 833 [C1] - 45 900 [C4] – 26 000 [C5]) (18 157 933) (3)Gross profit 4 560 317Other income (514 500 + 13 000 - 24 000 [C2] - 11 000 [C2] - 2 705 [C3]) 489 795 (7)Other expenses (1 289 000 + 412 000 - 1 013 [C4]) (1 699 987) (1)Finance costs (104 500 + 31 600 - 2 705 [C3]) (133 395) (1)Share of profit of associate [C6] 110 384 (12)Profit before tax 3 327 114Income tax expense (631 058 + 246 954 - 1 073 [C1] - 2 268 [C4] + 284 [C4] – 1 820 [C5]) (873 135) (3)PROFIT FOR THE YEAR 2 453 979Other comprehensive income: Items that will not be reclassified to profit or loss: Mark-to-market reserve [(333 500 – 213 600) + (16 000 - 14 800)] Share of other comprehensive income of associate [(12 200 - 10 700) x 25%]

121 100

375

(4)

(1)Other comprehensive income for the year, net of tax 121 475TOTAL COMPREHENSIVE INCOME FOR THE YEAR 2 575 454

Total (37) Maximum (33)


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COMMENT

Furnit-Your-World Ltd has two main equity investments during the current financial year, an investment in a subsidiary, Urban Drapes Ltd, and an investment in an associate, Digital Decor Ltd. In accordance with IFRS 10.B86 Furnit-Your-World Ltd will combine its trial balance with the trial balance of Urban Drapes Ltd by combining all like items (i.e. add the revenue of Furnit-Your-World Ltd of R16 081 250 to the revenue of Urban Drapes Ltd of R6 812 500 etc.). In accordance with IAS 28.10 Furnit-Your-World Ltd will apply the equity method to account for Digital Decor Ltd by recognising its share of the profits of Digital Decor Ltd in the line item “share of profit of associate” and the share of other comprehensive income in “share of other comprehensive income of associate”.

CALCULATIONS

C1. Calculation of unrealised profit in inventory

Sales price of inventory on hand at year end (given) 23 000Unrealised profit (23 000 x 20/120) 3 833 [1]Decrease in deferred tax expense / increase in deferred tax asset (3 833 x 28%) 1 073

[1]

[2] Pro forma journals (for completeness purposes only)

Dr R

Cr R

J1 Revenue (P/L) (Furnit-Your-World) Cost of sales (P/L) (Urban Drapes) Elimination of intragroup sales

89 000 89 000

J2 Cost of sales (P/L) (Furnit-Your-World) (23 000 x 20/120) Inventory (SFP) (Urban Drapes) Elimination of unrealised profit in closing inventory of Urban Drapes Ltd

3 833

3 833

J3 Deferred tax (SFP) (3 833 x 28%) Income tax expense (P/L) (Furnit-Your-World) Tax implication of unrealised profit in closing inventory of Urban Drapes Ltd

1 073 1 073

C2. Calculation of elimination of dividends

Dividend declared by Urban Drapes Ltd (given) 40 000 Dividend attributable to Furnit-Your-World Ltd (40 000 x 60%) 24 000 [1]Dividend declared by Digital Decor Ltd (given) 44 000 Dividend attributable to Furnit-Your-World Ltd (44 000 x 25%) 11 000 [1] [2]

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Pro forma journals (for completeness purposes only)

Dr R

Cr R

J1 Other income (P/L) (40 000 x 60%)Non-controlling interests (SFP/SCE) Dividends paid (SCE) Elimination of intragroup dividends (Urban Drapes)

24 000 16 000

40 000

J2 Other income (P/L) (44 000 x 25%) Investment in associate (SFP) Elimination of intragroup dividends (Digital Decor)

11 000 11 000

C3. Calculation of elimination of intragroup preference dividends

HP 10 B11 Sharp EL 733A Sharp EL 738

• 2ndF C (Clear All) • 2ndF C.CE (Clear All) • 2ndF MODE (Clear All) • 3 N • 3 n • 3 N [1]• -9 000 PMT • -9 000 PMT • -9 000 PMT [1]• -100 000 FV • -100 000 FV • -100 000 FV [1]• 108 000 PV • 108 000 PV • 108 000 PV [1]• I/YR ⇒ 6,01% • COMP i ⇒ 6,01% • COMP I/Y ⇒ 6,01% [4]

COMMENT Furnit-Your-World Ltd issued compulsory redeemable preference shares amounting to R100 000 at a premium of 8%. The present value is thus R108 000 (R100 000 x 1,08).

1 November 20.11 Capital Interest Payment Closing balance

Interest 31 March 20.12 (108 000 x 6,01% x 5/12) 108 000 2 705

- 110 705 [1]

Payment 31 October 20.12 110 705 3 786 (9 000) 105 491Interest 31 March 20.13 105 491 2 642 - 108 132Payment 31 October 20.13 108 132 3 698 (9 000) 102 831Interest 31 March 20.14 102 831 2 575 - 105 406Payment 31 October 20.14 105 406 3 605 (9 000) 100 011

The rounding difference of R11 is due to the rounding of the interest rate to two decimal points.

[5] Pro forma journal (for completeness purposes only)

Dr R

Cr R

J1 Interest received (P/L) Finance costs (P/L) Elimination of intragroup preference dividends classified as a liability

2 705 2 705

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C4. Calculation of unrealised profit in curtains (property, plant and equipment)

Sales price (given) 54 000Gross profit / unrealised profit [54 000 x 15% (gross profit %)] 8 100 [1]Cost price (54 000 - 8 100) 45 900 [1] Decrease in deferred tax expense / increase in deferred tax asset (8 100 x 28%) 2 268 [1] Depreciation on unrealised profit [(8 100 / 6) x 9/12] 1 013 [1] Increase in deferred tax expense / increase in deferred tax liability (1 013 x 28%) 284

[1]

[5]


Dr R

Cr R

J1 Revenue (P/L) (Urban Drapes) Cost of sales (P/L) (Urban Drapes) (54 000 x 85%) Property, plant and equipment (SFP) (54 000 x 15%) Elimination of unrealised profit in closing PPE of Furnit-Your-World Ltd

54 000

45 9008 100

J2 Deferred tax (SFP) (8 100 x 28%) Income tax expense (P/L) (Urban Drapes) Tax implication of unrealised profit in closing PPE of Furnit-Your-World Ltd

2 268 2 268

J3 Accumulated depreciation (SFP) (8 100/6 x 9/12) Depreciation (P/L) (Urban Drapes) Realisation of unrealised profit

1 013 1 013

J4 Income tax expense (P/L) (Urban Drapes) (1 013 x 28%) Deferred tax (SFP) Tax implication of realisation of unrealised profit

284 284

C5. Calculation of unrealised profit on inventory

Inventory in the records of Digital Decor Ltd 130 000Unrealised profit (130 000 x 25/125) 26 000 Furnit-Your-World Ltd has a 25% interest in the associate: Revenue (130 000 x 25%) 32 500 [1]Cost of sales (130 000 x 100/125 x 25%) (26 000) [1]Unrealised profit (OR 26 000 x 25%) 6 500 Income tax expense (6 500 x 28%) 1 820 [1] [3]

COMMENT Note that the curtains will form part of Urban Drapes Ltd’s inventory, as the company sells curtains. However, in the records of Furnit-Your-World Ltd, the curtains will be property, plant and equipment, as they will be used in the company’s office.

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Dr R

Cr R

J1 Revenue (P/L) (130 000 x 25%) Cost of sales (P/L) (130 000 x 100/125 x 25%) Investment in associate (SFP) (130 000 x 25/125 x 25%) Elimination of unrealised profit in closing inventories of Digital Decor Ltd

32 500

26 0006 500

J2 Deferred tax (SFP) (6 500 x 28%) Income tax expense (P/L) Tax implication of unrealised profit in closing inventories of Digital Decor Ltd

1 820 1 820

C6. Calculation of share of profit of associate

8 months from

1 August 20.11

Profit before tax excluding profit on sale of equipment [(10 203 570 + 32 000 - 8 721 000 - 571 000 - 58 200 - 3 500) x 8/12] 587 913 [7]Other income - interest received on sale of machinery [C7] 3 943 [2]Other expenses - loss on sale of machinery [C7] (443) [1]Income tax expense (230 196 (year) - 80 320 (four months given on p 14)) (149 876) [1]Profit after tax 441 537Share of profit of associate (441 537 x 25%) 110 384 [1] [12]

OR

Profit before tax excluding profit on sale of equipment 587 913Profit on sale of machinery not apportioned 3 500Income tax expense (230 196 (year) – 80 320 (four months)) (149 876)Profit after tax 441 537Share of profit of associate (441 537 x 25%) 110 384

COMMENT The investor sold inventory to the associate (downstream transaction). The investor thus made the unrealised profit in P/L and the unrealised profit is included in the inventory of the associate. The unrealised profit thus has to be eliminated against revenue and cost of sales of the parent, as well as the investment in associate (SFP) account. The share of profit of associate (P/L) is thus not affected. Should the associate sell to the investor, then the unrealised profit will affect the share of profit of associate (P/L). Also note that the total sales and cost of sales of R620 000 related to the intragroup sales for the year are not eliminated when an associate is involved, as only unrealised profit is eliminated (IAS 28.28).

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C7. Calculation of sale of machinery

HP 10 B11 Sharp EL 733A Sharp EL 738

• 2ndF C (Clear all) • 2ndF C.CE (Clear all) • 2ndF MODE (Clear all) • 1 2ndF PMT (1 P/YR) • 93 500 FV • 93 500 FV [1]• 93 500 FV • 0,5 n • 0,5 N [1]• 0,5 N • 9% I/YR • 9% i • 9% I/YR [1]• PV ⇒ 89 557 • COMP PV ⇒ 89 557 • COMP PV ⇒ 89 557 [1]

Discounted proceeds 89 557Carrying amount of machinery 90 000 [1]

Loss on sale of machinery (443) [5]

Undiscounted proceeds 93 500 [1]Discounted proceeds 89 557 [1]

Interest received on sale of machinery 3 943 [2]

COMMENT The profit or loss on sale of equipment was recorded after the acquisition by Furnit-Your-World Ltd. It must thus be subtracted when calculating the apportioned profit for the eight months, as it has to be included in full, and not only apportioned for eight months.

COMMENT For this question, the present value of the proceeds must be calculated, as it will only be settled in six months, which is considered to be a significant period that affects the time value of money. If a question is silent in this regard, the default time to be considered significant is 12 months and longer.

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LEARNING UNIT 4 - DISCLOSURE OF INTERESTS IN OTHER ENTITIES

INTRODUCTION IFRS 12 deals with the disclosure requirements to enable users of financial statements to evaluate its interest in other entities.

OBJECTIVES/OUTCOMES At the end of this learning unit, you should be able to: 1. Disclosures in the consolidated or group financial statements: 1.1 Disclose significant judgements and assumptions that an entity made in

determining that it has control of another entity, joint control of an arrangement or significant influence over another entity.

1.2 Disclose significant judgements and assumptions that an entity made in determining the type of joint arrangement (i.e. joint operation or joint venture).

1.3 Disclose an entity’s interests in subsidiaries, interests in joint arrangements and associates and interests in unconsolidated structured entities.

2. Disclose the following for an interest in a subsidiary: 2.1 The interest that non-controlling interests have in the group’s activities and

cash flows. 2.2 The nature and extent of significant restrictions. 2.3 Nature of the risks associated with an entity’s interests in consolidated

structured entities. 2.4 Consequences of changes in a parent’s ownership interest in a subsidiary

that do not result in a loss of control. 2.5 Consequences of losing control of a subsidiary during the reporting period. 3. Disclose the following for interests in joint arrangements and associates: 3.1 Nature, extent and financial effects of an entity’s interests in joint

arrangements and associates. 3.2 Risks associated with an entity’s interests in joint ventures and associates. 4. Disclose the following for interests in unconsolidated structured entities: 4.1 Nature of interests. 4.2 Nature of risks.

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. IFRS 12 Disclosure of Interests in Other Entities.

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SECTION A - SAICA’S PRINCIPLES OF EXAMINATION LEVELS The SAICA principles of examination levels provide guidance on how the standards (or topics within a standard) will be examined. The principles of examination levels for IFRS 12 are as follows: Description Paragraph Level Notes Objective 1 Core 2 – 4 Core Meeting the objective 2(a)(iii) Excluded Investment entity Scope 5 – 6 Core 6(b)(ii) Excluded Investment entity Significant judgements and 7 – 9 Coreassumptions 9A – 9B Excluded Investment entity status Interests in subsidiaries 10 – 11 Core 12 Core The interest of NCI 13 Core Significant restrictions 14 – 17 Core Nature of the risks 18 Core Changes in ownership interest that do

not result in a loss of control 19 Core Losing control of a subsidiary Interests in unconsolidated subsidiaries

19A – 19G Excluded Investment entities

Interests in joint arrangements

20 Core

and associates 21 - 22 Core Nature, extent and financial effects 21A Excluded Investment entity 23 Core Risks associated with the interestsInterests in unconsolidated 24 – 25 Corestructured entities 25A Excluded Investment entity 26 – 28 Core Nature of interests 29 Core Nature of risksDefined terms A CoreApplication guidance B1 Core B2 – B6 Core Aggregation B7 – B9 Core Interests in other entities B10 – B17 Core Summarised financial information B18 – B20 Core Commitments for joint ventures B21 – B26 Core Unconsolidated structured entities

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SECTION B – QUESTIONS ON DISCLOSURE OF INTERESTS IN OTHER

ENTITIES QUESTION 4.1 (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 4.1 - 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 amountR’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 4.2 (18 marks – 27 minutes) Olympian Ltd was incorporated in 19.0 and provides training to a wide range of athletes intending to compete in the Olympic Summer and Winter Games. Olympian Ltd acquired an interest in Dive Ltd. Olympian Ltd has a 31 December financial year end. The following information is provided for Dive Ltd: At the start of the new millennium, Olympian Ltd noted that it cannot meet all the requirements of all the athletes anymore, due to an increase in the number and variety of sports events. In 20.0, four additional synchronised diving events were introduced, resulting in Olympian Ltd purchasing 40% of the share capital and voting rights of Dive Ltd on 1 January 20.0. From this date Olympian Ltd had control of Dive Ltd. All the diving training will transfer to Dive Ltd. Olympian Ltd concluded a contractual arrangement with Dive Ltd, stipulating that Dive Ltd is prohibited from providing training to athletes other than those of Olympian Ltd. According to the contractual arrangements, Olympian Ltd will also receive an amount from Dive Ltd per athlete trained. Dive Ltd has a financial year end of 28 February, due to the change in season from March, which affects the type of swimming pools used. It is more practical for Dive Ltd to have a financial year end of 29 February 20.12, as it coincides with all of the yearly maintenance contracts, the largest expense of Dive Ltd. Dive Ltd is located and operates in Durban. The following trial balance of Dive Ltd is presented as at 31 December 20.11, adjustments have been made to align with the financial year end of Olympian Ltd and no additional adjustments are required: R

Profit for the period 1 January 20.11 to 31 December 20.11 (850 400)Gain on revaluation of land (10 800)Revaluation surplus - 1 January 20.11 (43 200)Dividend paid on 31 December 20.11 100 000Property, plant and equipment 1 200 000Trade and other receivables 550 000Cash and cash equivalents 300 000Long-term loan (750 000)Deferred tax liability (21 000)Trade and other payables (474 600)

The accumulated non-controlling interests of Dive Ltd in the consolidated financial statements of Olympian Ltd amounted to R960 300 at 1 January 20.11. Revenue amounting to R1 520 000 was recorded for the current financial year.

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REQUIRED Marks

Prepare the investment in Dive Ltd note to the consolidated financial statements of the Olympian Ltd Group for the year ended 31 December 20.11. Please note: • Ignore the disclosure requirements in terms of IFRS 3.B64-.B67.

Communication skills: Presentation and layout

17

1 Please note: • Comparative amounts are not required. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4.2 – Suggested solution OLYMPIAN LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.11 1. Investment in Dive Ltd

Name of subsidiary: Dive Ltd (1)Principal place of business: Durban (1)Proportion of ownership interests and voting rights held by non-controlling interests:

60% (1)

Profit allocated to non-controlling interests of the subsidiary during the reporting period: (850 400 x 60%)

R510 240 (1)

Accumulated non-controlling interests of the subsidiary at the end of the reporting period: [960 300 (given) + 510 240 + (10 800 x 60%) - (100 000 x 60%)]

R1 417 020 (3)

Dividend paid to non-controlling interests: (100 000 x 60%) R60 000 (1)

A contractual arrangement stipulates that all diving training provided to Olympian Ltd's athletes will transfer to Dive Ltd. Dive Ltd is prohibited from providing training to athletes other than those of Olympian Ltd according to the contractual arrangement. Olympian Ltd receives an amount from Dive Ltd for every athlete trained. Due to these conditions, Olympian Ltd is deemed to have control of Dive Ltd, even though it holds only 40% of the voting rights of Dive Ltd.

(1)

(1)

(1)

Dive Ltd has a financial year end of 29 February. The reason for the different financial year end is due to the change in season from March, which affects the type of swimming pools used. It is more practical for Dive Ltd to have a financial year end of 29 February, as it coincides with all of the yearly maintenance contracts, the largest expense for Dive Ltd (IFRS12.11)

(1)

(1)

Summarised financial information of Dive Ltd for the year ended 31 December 20.11:

R

Current assets (330 000 + 550 000) 850 000 (1) Non-current assets 1 200 000 (½)Current liabilities (474 600) (½)Non-current liabilities (750 000 + 21 000) (771 000) (1)Revenue (1 520 000) (½)Profit for the period (850 400) (½)Total comprehensive income (850 400 + 10 800) (861 200) (1) Total (18) Maximum (17)

Communications skills: presentation and layout (1)

COMMENT All of the above information is disclosed in terms of IFRS 12.7(a), IFRS 12.9(b) and IFRS 12.11 -12.

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SELF ASSESSMENT QUESTIONS AND SUGGESTED SOLUTIONS

Question Question name Source Marks Topics covered Page

1 Rich DotCom Ltd FAC4864Test 1 of 2016

40 • Pro forma journal entries –subsidiary

• Discussion on control (share trust) (IFRS 10)

• Discussion on what forms part of a business combination (IFRS 3)

78

2 Chevy Ltd FAC4864Test 1 of 2017

40 • Presentation of consolidated statement of profit or loss and other comprehensive income

• Discussion on a business combination in the separate accounting records (IFRS 3)

86

3 Iphepha SA Ltd FAC4864Test 2 of 2017

40 • Pro forma journal entries –intragroup transactions

• Prepare a reconciliation between the net asset value and the carrying amount of a joint venture (IFRS 12)

• Pro forma journal entries – joint venture

• Calculation of the carrying amount of an investment in an associate

• Discussion on acquisition-related costs (IFRS 3 and IAS 28)

• Discussion on losses of an associate (IAS 28)

96

4 Mouth Watering Meats Ltd

FAC4864Test 1 of 2018

40 • Pro forma journal entries –subsidiary and associate

• Discussion on power (IFRS 10)

• Discussion on control (IFRS 10)

106

5 Top Blinds Ltd FAC4864Test 1 of 2019

40 • Presentation of consolidated statement of financial position

• Discussion on accounting of customers list (IFRS 3)

• Discussion on power (IFRS 10)

115

6 Oneity Ltd SAICA 2019(adapted)

40 • Discussion on assets and liabilities acquired – recog-nition and measurement (IFRS 3)

125

7 Massmark Ltd FAC4864Test 1 of 2020

40 • Discussion on assets and liabilities acquired – recog-nition and measurement (IFRS 3)

• Disclosure of investment in associate note (IFRS 12)

134

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QUESTION 1 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

Rich Dotcom Ltd operates in various industries and is listed on the Johannesburg Stock Exchange. 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 000Property, plant and equipment 2 000 000Investment in RichDad Ltd 500 000Financial assets 300 000Inventory 250 000Trade receivables 165 000Cash and cash equivalents 654 000Cost of sales 1 350 000Other expenses 655 000Income tax expense 256 000

6 530 000Credits Issued ordinary share capital Rich Dotcom Ltd - 100 000 shares 750 000 RichDad Ltd - 10 000 shares 150 000Retained earnings (1 January 20.15) Rich Dotcom Ltd 1 600 000 RichDad Ltd 480 000Long-term loan - Deferred tax 485 000Trade payables 365 000Revenue 2 250 000Other 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 acquisition of RichDad Ltd also met the definition of acquiring a business, as defined in IFRS 3 Business Combinations.

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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: • 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.

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The RDEST has been set up to operate the share option plan for the employees and is not a long-term employee benefit plan. 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.

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REQUIRED

YOU HAVE 60 MINUTES TO ANSWER THIS QUESTION

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

9

1

4

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 1 - 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

Retained earnings (SCE) (given) 300 000

Intangible asset (SFP) (given) 30 000

(1)

Office building (SFP) (500 000 - 350 000) 150 000

(1) Goodwill (SFP) (balancing) 64 040

(1)

Deferred tax (SFP) ((150 000 x 28%) + (30 000 x 28% x 80%))

48 720 (2) Non-controlling interests (SCE/SFP) [C1]

145 320 (1)

Investment in RichDad Ltd (SFP) (given) 500 000 (1)Elimination of at acquisition equity

J2 Deferred tax (SFP) (26 250 x 28%) 7 350 (1)Retained earnings (SCE) (balancing) 18 900 (1) Accumulated depreciation (SFP) (150 000/20 x 3,5) 26 250 (2)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

Accumulated depreciation (SFP) [J2] 26 250 (1) Office building (SFP) [J1] 150 000 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 (1)Non-controlling interests' share of since acquisition reserves

J5 Revenue (P/L) (given) 300 000 (1) Cost of sales (P/L) (balancing) OR (300 000 x 100/150) 200 000 Equipment (SFP) (300 000 x 50/150) OR (balancing)

100 000 (2)

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 (1)Tax implication of the depreciation on equipment

J7 Accumulated depreciation (SFP) (100 000/5) 20 000 (1) Depreciation (P/L) 20 000 (1)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 (1)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 (3)

Non-controlling interests (SFP/SCE) 60 600 (1)Non-controlling interests' share of current year's profit

Total (30) 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 320Equity represented by goodwill (balancing) 64 040 64 040 - Consideration and NCI 645 320 500 000 145 320 Since acquisition until beginning of year 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 Deferred tax on intangible asset (technical expertise) The tax base of an asset is any amount that would be deductible for tax against future economic benefits. The question states that SARS does not allow any deductions against taxable income in respect of the technical expertise. This will result in the tax base being zero which will give rise to a temporary difference. Deferred tax should thus be provided using the appropriate tax rate. The tax rate used will be based on the manner of recovery of the carrying amount of the intangible asset. In this question, the technical expertise has an indefinite useful life, it can thus only be recovered through sale and the CGT rate is used. 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]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]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)).

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).

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)

(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)

(1)

Therefore, Rich Dotcom Ltd limits the exposure to variability of returns from RDEST indicating that it has power over the RDEST.

(1)

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(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)

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.

(1)


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] 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] 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)


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QUESTION 2 40 marks


This question consists of two independent parts. PART I 28 marks Chevy Ltd (Chevy) is a South African company listed on the Johannesburg Stock Exchange. Chevy specialises in the restoration and sale of classic motor vehicles. All the companies in the Chevy Group have a February year end. Chevy acquired 70% of the ordinary share capital of Apache Ltd (Apache) on 30 June 20.15 for a cash consideration of R885 000. Apache’s retained earnings amounted to R1 085 000 on the date of acquisition. The fair value of the non-controlling interests on that date amounted to R365 000. Apache’s assets and liabilities were deemed to be fairly valued on the acquisition date and no additional assets, liabilities or contingent liabilities were identified. From 30 June 20.15, Chevy exercised control over Apache as per the definition of control in accordance with IFRS 10 Consolidated Financial Statements. The acquisition of Apache also met the definition of acquiring a business, as defined in IFRS 3 Business Combinations. Chevy acquired 65% of the ordinary share capital of Chevelle Ltd (Chevelle) on 30 April 20.16 for a cash consideration of R1 060 000. The fair value of the non-controlling interests on that date amounted to R570 000. The acquisition of Chevelle resulted in the recognition of goodwill in the consolidated financial statements of Chevy. From 30 April 20.16, Apache exercised control over Chevelle as per the definition of control in accordance with IFRS 10 Consolidated Financial Statements. The acquisition of Chevelle also met the definition of acquiring a business, as defined in IFRS 3 Business Combinations. Chevelle’s assets and liabilities were deemed to be fairly valued on 30 April 20.16, with the exception of the following: • Equipment was revalued with R134 000 more than the carrying amount. The remaining useful

life of the equipment on 30 April 20.16 was three years. The equipment is used in the production of income.

No additional assets, liabilities or contingent liabilities were identified on 30 April 20.16. The following intragroup transactions took place within the group during the year ended 28 February 20.17: • From 30 June 20.15 Apache has been selling inventory to Chevy at cost price plus 20%.

Included in the closing inventory of Chevy on 28 February 20.17 was inventory amounting to R132 500 (20.16: R87 400) that was purchased from Apache.

• During the 20.17 financial year, sales from Apache to Chevy amounted to R335 200. • Apache acquired land to the value of R700 000 on 1 August 20.16 for investment purposes.

The land is currently used by Chevy as a scrap yard. Based on the valuation performed on 28 February 20.17 the investment property’s value increased with R100 000.

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• Chevy sold office furniture to Chevelle on 1 November 20.16 for R14 000. The original cost

price of the furniture was R15 700. The furniture was originally purchased on 1 September 20.15 and had a useful life of five years on that date.

The separate trial balances of the various companies as at 28 February 20.17 are as follows: Chevy

Ltd R

Apache Ltd R

ChevelleLtd R

Ordinary share capital (100 000 ordinary shares each) (100 000) (100 000) (100 000)Retained earnings (1 March 20.16) (7 522 300) (2 172 000) (1 273 820)Revaluation surplus (200 000) - -Gain on property valuation (other comprehensive income) (54 320)

- -

Deferred tax (276 800) (138 400) (20 000)Trade and other payables (110 000) (88 000) (66 000)Profit before tax (2 561 822) (1 152 200) (793 600)Land 4 000 400 - -Investment property - 800 000 -Equipment (carrying amount) 1 400 000 264 000 694 420Office furniture (carrying amount) 967 360 22 000 31 000Investment in Apache 885 000 - -Investment in Chevelle 1 060 000 - -Inventory 801 982 786 800 630 000Trade and other receivables 450 000 260 000 320 000Cash and cash equivalents 400 500 1 137 800 290 000Income tax expense 760 000 320 000 238 000Dividends paid (paid on 28 February 20.17) 100 000 60 000 50 000

Additional information 1. The Chevy Group apply the following accounting policies:

• Equipment and office furniture are accounted for according to the cost model in accordance with IAS 16 Property, Plant and Equipment.

• Land is accounted for according to the revaluation model in accordance with IAS 16 Property, Plant and Equipment.

• Depreciation on equipment and furniture items are provided on the straight-line method over the asset’s remaining useful life.

• Investment property is accounted for according to the fair value model in accordance with IAS 40 Investment Property.

• Non-controlling interests are measured at fair value at the acquisition date, for all acquisitions.

2. It is the accounting policy of Chevy and Apache to account for investments in subsidiaries at

cost in accordance with IAS 27.10(a) in its separate financial statements. 3. Chevelle’s income and expenses accrued evenly throughout the financial year. 4. 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. 5. There were no changes in the issued ordinary share capital of any of the companies in the

group.

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PART II 12 marks Potato Ltd is a Johannesburg Stock Exchange listed company that grows and distributes vegetables. On 1 January 20.17 Potato Ltd acquired the tomato division of ZZ4 Ltd. The main reason for this acquisition was so that Potato Ltd could get access to a supply contract between the tomato division and Veg & Fruit Ltd, a national greengrocer. The purchase consideration consisted of an immediate cash payment of R260 000 and an additional cash payment of R150 000 payable on 1 January 20.18. The tomato division constitutes a business and Potato Ltd obtained control over the business from 1 January 20.17 in terms of IFRS 10 Consolidated Financial Statements. The assets and liabilities of the tomato division on the acquisition date were as follows: Carrying amount

Dr/(Cr) R

Fair value Dr/(Cr)

R

Assets 380 000 400 000 Liabilities (110 000) (130 000)

The supply contract between the tomato division and Veg & Fruit Ltd had a fair value of R80 000 on 1 January 20.17 and the contract will expire on 1 March 20.19. The tomato division did not recognise an asset in its accounting records in respect of the contract. Additional information 1. Assume a market related pre-tax interest rate of 12% per annum, compounded annually. 2. Assume a normal income tax rate of 28% and a Capital Gains Tax inclusion rate of 80%.


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REQUIRED

YOU HAVE 60 MINUTES TO ANSWER THIS QUESTION

Marks PART I Prepare the consolidated statement of profit or loss and other comprehensive income of the Chevy Ltd Group for the year ended 28 February 20.17, starting with the profit before tax. Other comprehensive income should be presented net of tax.

27


PART II Discuss, with reference to amounts, how the purchase transaction of the tomato division should be accounted for on 1 January 20.17 in the separate accounting records of Potato Ltd. Please note: • Round off all amounts to the nearest Rand. • Show all your calculations. • Comparative figures are not required. • Notes to the consolidated statement of profit or loss and other comprehensive

income are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

1

12

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QUESTION 2 - Suggested solution PART I CHEVY LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.17 R

Profit before tax [C1] 4 154 325 (14)Income tax expense [C6] (1 242 905) (6)PROFIT FOR THE YEAR 2 911 420 Other comprehensive income: Items that will not be reclassified to profit or loss: Gains on property (54 320 + (100 000 – (100 000 x 28% x 80%))) 131 920 (1)TOTAL COMPREHENSIVE INCOME FOR THE YEAR 3 043 340 Profit attributable to: Owners of the parent (balancing) 2 533 994 (1) Non-controlling interests (244 756 [C7] + 152 670 [C7]) 377 426 (6) 2 911 420 Total comprehensive income attributable to: Owners of the parent (balancing) 2 642 634 (1) Non-controlling interests [377 426 (above) + (77 600 x 30%)] 400 706 (2) 3 043 340



COMMENT As the solution starts with profit before tax, adjustments affecting only the statement of profit or loss and other comprehensive income are not required. An example is the elimination of the intragroup sales between Apache and Chevy amounting to R335 200. The pro forma journal entry required is debit revenue (P/L) and credit cost of sales (P/L) of R335 200. However, the net effect on profit before tax is zero and this adjustment is therefore not required in [C1].

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CALCULATIONS C1. Profit before tax

Chevy Ltd 2 561 822 [1]Apache Ltd 1 152 200 [1]Chevelle Ltd (793 600 x 10/12) 661 333 [1]Realisation of unrealised intragroup profit for 20.16 [C2] or (20/120 x 87 400) 14 567 [2]Elimination of unrealised intragroup profit for 20.17 [C3] or (20/120 x 132 500) (22 083) [2]Depreciation on revalued equipment [C4] or (134 000/3 x 10/12) (37 222) [1]Elimination of intragroup gain on disposal of office furniture [C5] or (14 000 – (15 700 – (15 700/60 x 14))) (1 963) [2]Elimination of intragroup depreciation on office furniture [C5] or (1 963/46 x 4) 171 [1]Elimination of intragroup dividends received from Apache Ltd (60 000 x 70%) (42 000) [1]Elimination of intragroup dividends received from Chevelle Ltd(50 000 x 65%) (32 500) [1]Fair value adjustment on investment property (100 000) [1] 4 154 325 [14]

COMMENT The land will be recognised as investment property in the separate financial statements of Apache Ltd, as it was acquired for investment purposes. The fair value adjustment and the deferred tax adjustment was thus recognised in profit or loss in Apache’s separate financial statements. Since the land is rented by Chevy (the parent), it now becomes owner-occupied property, plant and equipment in the consolidated financial statements (IAS 40.15). The fair value adjustment of R100 000 and deferred tax adjustment of R22 400 (refer to C6) recognised in profit or loss by Apache must thus be reversed in the consolidated financial statements. It is the group’s accounting policy to measure land in accordance with the revaluation model. The increase in fair value of R100 000 must thus be recognised in the consolidated financial statements in other comprehensive income, net of deferred tax (refer to C8).

C2. Unrealised profit in inventory – 20.16

Inventory - opening balance 1 March 20.16 87 400 Unrealised profit (20/120 x 87 400) 14 567Deferred tax expense (14 567 x 28%) (4 079)Adjustment for 20.17 10 488

C3. Unrealised profit in inventory – 20.17

Inventory - closing balance 28 February 20.17 132 500 Unrealised profit (20/120 x 132 500) 22 083Deferred tax expense (22 083 x 28%) (6 183)Adjustment for 20.17 15 900

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C4. Depreciation on revalued equipment

Remaining useful life 3Revaluation at acquisition date 134 000 Additional depreciation for 20.17 (134 000/3 x 10/12) 37 222Deferred tax expense (37 222 x 28%) (10 422)Adjustment for 20.17 26 800

C5. Intragroup gain on disposal of office furniture and depreciation

Cost price 15 700Accumulated depreciation up to 1 November 20.16 (15 700/60 x 14) (3 663)Carrying amount on 1 November 20.16 12 037Selling price (14 000)Unrealised profit on disposal of furniture (1 963)Deferred tax on gain (1 963 x 28%) 550 Depreciation on furniture (1 963/(60 – 14) x 4) (171)Deferred tax (171 x 28%) 48

C6. Income tax expense

Chevy Ltd (760 000)Apache Ltd (320 000)Chevelle Ltd (238 000 x 10/12) (198 333) [1]Tax implication of intragroup profit for 20.16 [C2] or (14 567 x 28%) (4 079)Tax implication of intragroup profit for 20.17 [C3] or (22 083 x 28%) 6 183 [1]Tax implication of additional depreciation [C4] or (37 222 x 28%) 10 422 [1]Tax implication of gain on disposal of furniture [C5] or (1 963 x 28%) 550 [1]Tax implication of depreciation on furniture sold [C5] or (171 x 28%) (48) [1]Tax implication of fair value adjustment on investment property 22 400 [1] (1 242 905) [6]

C7. Non-controlling interests

Apache Ltd Profit before tax 1 152 200 [½]Income tax expense (320 000) [½]Profit after tax 832 200After tax effect of realisation of intragroup profit 20.16 [C2] 10 488 [½]After tax effect of elimination of intragroup profit 20.17 [C3] (15 900) [½]After tax effect of fair value adjustment on investment property (100 000 – (100 000 x 28% x 80%)) (77 600) [1] 749 188 Profit or loss attributable to non-controlling interests (749 188 x 30%) 224 756 [½] Chevelle Ltd Profit before tax 793 600 [½]Income tax expense (238 000) [½]Profit for full year 555 600Profit for 10 months (555 600 x 10/12) 463 000 [½]After tax effect of additional depreciation [C4] (26 800) [½] 436 200 Profit or loss attributable to non-controlling interests (436 200 x 35%) 152 670 [½] [6]

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C8. Analysis of owners' equity of Apache Ltd (for completeness)

Chevy Ltd 70%

Total At Since NCI At acquisition Share capital 100 000 Retained earnings 1 085 000 1 185 000 829 500 355 500Equity represented by goodwill (balancing) 65 000 55 500 9 500Consideration and NCI 1 250 000 885 000 365 000

Since acquisition Beginning of the year

Retained earnings (2 172 000 – 1 085 000 – 10 488) 1 076 512 753 558 322 954 Current year Profit for the year [C7] 749 188 524 432 224 756Other comprehensive income: Revaluation (100 000 – (100 000 x 28% x 80%)) 77 600 54 320 23 280

Dividends (60 000) (42 000) (18 000) 3 093 300 1 290 310 917 990

C9. Analysis of owners' equity of Chevelle Ltd (for completeness)

Chevy Ltd 65% Total At Since NCI At acquisition Share capital 100 000 Retained earnings 1 273 820 Profit for 2 months (463 000 [C7] x 2/12) 92 600 Revaluation of equipment 134 000 Deferred tax (37 520) 1 562 900 1 015 885 547 015Equity represented by goodwill (balancing) 67 100 44 115 22 985Consideration and NCI 1 630 000 1 060 000 570 000

Current year Profit for the year [C7] 436 200 283 530 152 670Dividends (50 000) (32 500) (17 500) 2 016 200 251 030 705 170

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PART II Discuss how the purchase transaction of the tomato division should be accounted for

According to IFRS 3.3 an entity shall determine whether a transaction or other event is a business combination by applying the definition in IFRS 3, which requires that the asset acquired, and liabilities assumed constitute a business. The tomato division constitutes a business.

(1)

A business combination is defined in IFRS 3 as a transaction or other event in which an acquirer obtains control of one or more businesses (Appendix A). On 1 January 20.17 Potato Ltd acquired the tomato division (business) and obtained control thereof.

(1)

Therefore, the principles of IFRS 3 will be applied in accounting for the purchase transaction of the tomato division on 1 January 20.17 as the transaction meets the definition of a business combination.

(1)

According to IFRS 3.4 an entity shall account for each business combination by applying the acquisition method. Applying the acquisition method requires: (a) identifying the acquirer; (b) determining the acquisition date; (c) recognising and measuring the identifiable assets acquired, the liabilities assumed and

any non-controlling interest in the acquiree; and (d) recognising and measuring goodwill or a gain from a bargain purchase. Application of acquisition method Potato Ltd will apply the acquisition method to account for the transaction.

(1)

The acquirer will be Potato Ltd, and the acquisition date will be 1 January 20.17.

(1)

The acquirer shall recognise identifiable assets acquired and the liabilities assumed if they meet the definitions of assets and liabilities in the Framework. The identifiable assets acquired, and the liabilities assumed will be measured at their acquisition-date fair values. Therefore, the previously recognised assets will be recognised at the fair value of R400 000 and the liabilities at the fair value of R130 000.

(1)

No deferred tax will be recognised on the recognition of the previous assets and liabilities as the SARS will deem the tax base on initial recognition to be the same as the fair value of the assets and liabilities acquired.

(1)

The acquirer’s application of the recognition principle and conditions may result in recognising some assets and liabilities that the acquiree had not previously recognised as assets and liabilities in its financial statements (IFRS 3.13). An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal criterion (IFRS 3.B31).

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As the supply contract is a contract, it will be considered identifiable and should be recognised on acquisition date at fair value being R80 000 as it meets the contractual-legal criterion.

(1)

A deferred tax liability will be created at 28% of R80 000 (R22 400). The reason being that the supply contract was not acquired by means of a purchase transaction. The SARS will not recognise the supply contract and thus the base cost will be equal to Rnil.

(1)

The consideration transferred in a business combination shall be measured at fair value (IFRS 3.37) The consideration consists of a cash payment of R260 000 and a deferred payment of R150 000. The deferred payment (current liability) will be discounted to a present value. Therefore the consideration will amount to R260 000 + R133 929 (R150 000/1, 12 = R393 929).

(2)

The last step is to recognise goodwill or a gain on bargain purchase. Goodwill is calculated as the excess of the consideration transferred over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed.

(1)

The goodwill recognised for the business combination of the tomato division will be R66 329. The amount is calculated as follows: R Consideration transferred: - Cash 260 000 - Deferred payment 133 929 393 929 Minus net identifiable assets acquired 327 600 - Previous assets 400 000 - Supply contract 80 000 - Deferred tax on supply contract (22 400)- Previous liabilities (130 000)Goodwill 66 329

(1)

Total

Maximum(13)(12)

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QUESTION 3 40 marks


Iphepha SA Ltd is a company listed on the Johannesburg Stock Exchange with a February year end. Iphepha SA Ltd owns several paper mills across South Africa. These paper mills manufacture paper from wood pulp and other specialised ingredients. Iphepha SA Ltd has various investments in subsidiaries as well as another investment that they acquired in the previous financial year. Imithi Ltd On 1 September 20.15, Iphepha SA Ltd acquired 30 000 ordinary shares in Imithi Ltd for a cash consideration of R80 000 as well as the transfer of machinery. At the date of acquisition, the machinery transferred to Imithi Ltd had a carrying amount of R22 500, a fair value of R30 000 and a remaining useful life of four years. You may assume that this transfer has commercial substance. From 1 September 20.15, Iphepha SA Ltd has been exercising significant influence over the financial and operating policy decisions of Imithi Ltd. The equity of Imithi Ltd consisted of the following at the acquisition date:

R

Ordinary share capital (100 000 shares) Retained earnings

100 000 275 200

375 200 All the assets and liabilities of Imithi Ltd were deemed to be fairly valued at the acquisition date and no additional assets or liabilities were identified. Iphepha SA Ltd has been purchasing wood pulp from Imithi Ltd since 1 September 20.15 at a mark-up of 20% on cost. Iphepha SA Ltd uses this wood pulp in the paper manufacturing process. The following information relates to these sale transactions: Year ended

28 February 20.17 R

Year ended 29 February 20.16

R

Included in Iphepha SA Ltd’s inventory on hand in respect of inventory purchased from Imithi Ltd

85 000

38 500

Sales from Imithi Ltd to Iphepha SA Ltd

280 000

130 000

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RecycleLab Ltd On 1 March 20.16, Iphepa SA Ltd acquired a 60% controlling interest in RecycleLab Ltd for a cash consideration. The acquisition of RecycleLab Ltd also met the definition of acquiring a business, as defined in IFRS 3 Business Combinations. RecycleLab Ltd is a company that buys wood waste from timber companies, recycles it and sells it to furniture manufacturing companies. At the acquisition date, the fairly valued equity of RecycleLab Ltd consisted of ordinary share capital and retained earnings. You may assume that goodwill arose with the acquisition. All the assets and liabilities of RecycleLab Ltd were deemed to be fairly valued at the acquisition date and no additional assets, liabilities or contingent liabilities were identified. On 1 April 20.16, Iphepa SA Ltd entered into a joint arrangement with three other companies and acquired a 25% interest in the ordinary share capital of FineWoods Ltd for a cash consideration. Iphepa SA Ltd exercises joint control over the relevant activities of FineWoods Ltd in terms of the joint arrangement. FineWoods Ltd was correctly classified as a joint venture in accordance with IFRS 11 Joint Arrangements and is material to the group. You may assume that no goodwill or excess arose with this acquisition. All the assets and liabilities of FineWoods Ltd were deemed to be fairly valued at the acquisition date with the exception of equipment. On 1 April 20.16 the equipment of FineWoods Ltd had a carrying amount and fair value of R70 000 and R85 000 respectively. This equipment had a remaining useful life of four years on 1 April 20.16 and is depreciated on the straight-line method. No additional assets or liabilities were identified at the acquisition date. On 1 August 20.16, Iphepa SA Ltd sold equipment with a carrying amount of R120 800 to FineWoods Ltd for R140 000. The equipment is still included in the equipment of FineWoods Ltd on 28 February 20.17. This equipment had a remaining useful life of three years on 1 August 20.16 and is depreciated on the straight-line method. The separate trial balances of the various companies as at 28 February 20.17 are as follows: Imithi

Ltd

Dr/(Cr) R

RecycleLab Ltd

Dr/(Cr)

R

FineWoods Ltd

Dr/(Cr)

R

Property, plant and equipment 510 435 398 740 755 630Trade receivables 158 750 87 750 220 150Inventory 101 770 77 640 120 900Cash and cash equivalents 20 500 10 220 35 700Ordinary dividends (paid on 28 February 20.17) 50 000

20 000 25 000

Ordinary share capital - 100 000 shares - 150 000 shares - 150 000 shares - 50 000 shares

(100 000) - - -

-

(150 000) - -

- -

(150 000) -

7% Preference share capital - - (240 000)Retained earnings (1 March 20.16) (350 410) (180 000) (270 350)Trade payables (130 005) (74 610) (200 810)Long-term liabilities (105 220) (98 890) (190 500)Loan from Iphepha SA Ltd (25 000) - -Profit for the year (130 820) (90 850) (105 720) - - -

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Additional information 1. It is the accounting policy of all the companies in the Iphepha SA Ltd Group to account for

investments in subsidiaries, investments in associates and investments in joint ventures at cost in accordance with IAS 27.10(a) in their separate financial statements.

2. The non-redeemable preference shares of FineWoods Ltd are cumulative and are correctly

classified as an equity instrument in accordance with IAS 32 Financial Instruments: Presentation. FineWoods Ltd paid preference dividends up until 29 February 20.16. Iphepa SA Ltd does not have an interest in the preference share capital of FineWoods Ltd.

3. Profits for all the companies accrued evenly throughout the year. 4. There were no changes in the issued ordinary or preference share capital of any of the

companies in the group. 5. The loan to Imithi Ltd amounting to R25 000 was granted by Iphepha SA Ltd on

1 February 20.16. There are no indications that the loan to Imithi Ltd will be repaid in the foreseeable future.

6. The net asset value of FineWoods Ltd on 28 February 20.17 amounted to R741 070. 7. It is the accounting policy of all the companies in the Iphepha SA Ltd Group to account for

property, plant and equipment in accordance with the cost model in terms of IAS 16 Property, Plant and Equipment.

8. Iphepa SA Ltd elected to measure non-controlling interests at the proportionate share of the

acquiree’s net identifiable assets at the acquisition date for all acquisitions. 9. Assume a normal income tax rate of 28% and a Capital Gains Tax inclusion rate of 80%.


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REQUIRED

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

Marks

(a) Provide the pro forma journal entries to account for the intragroup sale transaction

of inventory between Iphepha SA Ltd and Imithi Ltd in the consolidated financial statements of the Iphepha SA Ltd Group for the year ended 28 February 20.17. Journals relating to deferred taxation and journal narrations are required.


(b) Prepare a reconciliation between the net asset value of FineWoods Ltd and the

carrying amount of the investment in FineWoods Ltd in the consolidated financial statements of the Iphepha SA Ltd Group for the year ended 28 February 20.17.

(c) Provide the pro forma journal entries to account for the investment in

FineWoods Ltd in the consolidated financial statements of the Iphepha SA Ltd Group for the year ended 28 February 20.17. Journals relating to deferred taxation are also required.

(d) Calculate the carrying amount of the investment in Imithi Ltd that should be

disclosed in the consolidated statement of financial position of the Iphepha SA Ltd Group as at 28 February 20.17.

(e) Discuss, with reasons, the difference in the accounting treatment of acquisition-

related costs between investments in associates and investments in subsidiaries. (f) Assume that Imithi Ltd made a loss amounting to R465 500 for the previous year

ended 29 February 20.16.

Discuss, with reasons and reference to calculations, how this loss of Imithi Ltd would have been treated in the consolidated financial statements of the Iphepha SA Ltd Group for the previous year ended 29 February 20.16.

Communication skills: logical flow and conclusion Please note: • Round off all amounts to the nearest Rand. • Comparative figures are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

7

1

6

11

6

2

6

1

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QUESTION 3 - Suggested solution (a) Pro forma journals for the intragroup sale of inventory

Dr R

Cr R

J1 Retained earnings (SCE) (38 500 x 30% x 20/120) Share of profit of associate (P/L) Elimination of unrealised profit in opening inventory of Iphepha SA Ltd

1 925 1 925

(2)(1)

J2 Share of profit of associate (P/L) (1 925 x 28%) Retained earnings (SCE) Tax implication of unrealised profit in opening inventory

539 539

(1)(1)

J3 Share of profit of associate (P/L) (85 000 x 30% x 20/120) Inventory (SFP) Elimination of unrealised profit in closing inventory of Iphepha SA Ltd

4 250 4 250

(2)(1)

J4 Deferred tax (SFP) (4 250 x 28%) Share of profit of associate (P/L) Tax implication of unrealised profit in closing inventory

1 190 1 190

(1)(1)

TotalMaximum

(10)(7)

Communication skills: presentation and layout (narrations) (1) (b) Reconciliation between the net asset value of FineWoods Ltd to the investment in

FineWoods Ltd in the financial statements of the Iphepha SA Ltd Group [IFRS 12.B14(b)]

Dr/(Cr) R

Net assets of joint venture (741 070 (given) – 240 000 (preference shares)) 501 070 (1) 25% interest in net asset value of joint venture (501 070 x 25%) 125 268 (1)Unrealised profit on intragroup sales [(140 000 – 120 800) x 25%] (4 800) (1)Realisation of unrealised profit (4 800/3 x 7/12) 933 (1)Fair value adjustment on equipment at acquisition [(85 000 – 70 000) x 72% x 25%] 2 700 (3)Depreciation on fair value adjustment at acquisition (2 700/4 x 11/12) (619) (1)Preference dividends in arrears (240 000 x 7% x 25%) (4 200) (1)Carrying amount of investment in FineWoods Ltd on 28 February 20.17 119 282


OR

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Dr/(Cr)

R

Net assets of joint venture (given) 741 070 (1) Reconciling items: Unrealised profit on intragroup sales (140 000 – 120 800) (19 200) (1)Realisation of unrealised profit (19 200/3 x 7/12) 3 733 (1)Fair value adjustment on equipment at acquisition [(85 000 – 70 000) x 72%] 10 800 (2)Depreciation on fair value adjustment at acquisition (10 800/4 x 11/12) (2 475) (1)Preference dividends in arrears (240 000 x 7%) (16 800) (1)Preference share capital (0% interest) (240 000) (1) 477 128 25% interest in net asset value of joint venture (477 128 x 25%) 119 282 (1) Carrying amount of investment in FineWoods Ltd on 28 February 20.17 119 282


(c) Pro forma journals for investment in FineWoods Ltd in group financial statements of

the Iphepha SA Ltd Group

Dr R

Cr R

J1 Investment in FineWoods Ltd (SFP) Other income (P/L) [C4]

Share of profit of joint venture (P/L) [C4] Equity account joint venture

13 509 6 250

19 759

(1)(1)(3)

J2 Other income (P/L) [(140 000 - 120 800) x 25%] Investment in joint venture (SFP)

Elimination of unrealised profit

4 800 4 800

(2)

J3 Deferred tax (SFP) (4 800 x 28%) Income tax expense (P/L)

Tax implication on elimination of unrealised profit

1 344 1 344

(1)(1)

J4 Investment in joint venture (SFP) (4 800/3 x 7/12) Depreciation (P/L)

Realisation of unrealised profit

933 933

(2)(1)

J5 Income tax expense (P/L) (933 x 28%) Deferred tax (SFP)

Tax implication on realisation of unrealised profits

261 261

(1)(1)

Total

Maximum(14)

(11)

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COMMENT The elimination of the unrealised profit on the intragroup sale of inventory is an adjustment in accordance with IAS 28 while applying the equity method in the group financial statements. It is therefore important to note that these elimination journals are therefore not recorded in the separate accounting records of either the investor or the associate. By eliminating the unrealised profit on inventory, the carrying amount of the investment in associate is reduced. However, the tax base of the investment in associate in the group financial statements will stay the same (the original cost paid by the investor which will be used for CGT purposes). This difference between the carrying amount and the tax base gives rise to deferred tax which is recognised in the group financial statements in the deferred tax line-item. If the associate is the seller, the carrying amount of inventory in the group is adjusted with the unrealised profit. As the tax base stays the same, the elimination gives rise to a temporary difference which is recognised in the group financial statements in the deferred tax line-item.

(d) Carrying amount of investment in Imithi Ltd to be disclosed in the consolidated

statement of financial position of the Iphepha SA Ltd Group as at 28 February 20.17

Dr/(Cr)R

Cost of investment (80 000 (cash) + 30 000 (machinery)) 110 000 (1)Excess at acquisition [(375 200 x 30%) – 110 000] 2 560 (1) Equity accounting of Imithi Ltd (156 030 x 30%)

156 030 46 809 (1)

Share of retained earnings (350 410 – 275 200) 75 210 (1)Profit for the year (given) 130 820 (1)Elimination of intragroup dividends (given) (50 000) (1) Unrealised profit on intragroup transfer of machinery – to beginning of year [[(30 000 - 22 500) x 30%] - (2 250/4 x 6/12)]

(1 969) (2)

Realisation of unrealised profit – current year (2 250/4) 563 (1)Carrying amount of investment in Imithi Ltd on 28 February 20.17

157 963

Total (10) Maximum (6)

(e) Different treatment of acquisition-related costs

Subsidiaries The acquirer shall account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received [IFRS 3.53]. The acquisition-related costs will thus not form part of the cost of the investment.

(1)

Associates The cost for an associate includes the purchase price and other costs directly attributable to the acquisition or issue of the asset such as professional fees for legal services, transfer taxes and other transaction costs [IAS 28.10 (E1 footnote)]. The acquisition-related costs will thus form part of the cost of the investment. (1) (2)

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(f) Discussion regarding loss of associate

If an entity’s share of losses of an associate or a joint venture equals or exceeds its interest in the associate or joint venture, the entity discontinues recognising its share of further losses [IAS 28.38]. The interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture determined using the equity method together with any long-term interests that, in substance, form part of the entity’s net investment in the associate or joint venture [IAS 28.38]. An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, an extension of the entity’s investment in associate or joint venture [IAS 28.38]. As there are no indications that the loan from Iphepha SA Ltd to Imithi Ltd will be repaid in the foreseeable future, the loan forms part of the net investment in the associate.

(1)

The interest in the associate thus amounts to R135 591 (R110 000 + R25 000 + R2 560 – R1 969).

(2)

The loss of Imithi Ltd attributable to Iphepha SA Ltd amounts to R69 825 (R465 500 x 6/12 x 30%). This loss is limited to the interest in Imithi Ltd of R135 591. The loss of R69 825 is less than the interest in Imithi Ltd and therefore the total loss of R69 825 will be recognised.

(2)

Losses recognised using the equity method in excess of the entity’s investment in ordinary shares are applied to the other components of the entity’s interest in an associate or a joint venture in the reverse order of their seniority (i.e. priority in liquidation) [IAS 28.38]. The total loss of R69 825 will be applied to the investment in the ordinary shares. (1)

(6)Communication skills: logical flow and layout (1)

CALCULATIONS C1. Analysis of owners’ equity of RecycleLab Ltd

Total Iphepha SA Ltd

(60%) NCI At Since At acquisition Share capital 150 000 Retained earnings 180 000 330 000 198 000 132 000 Equity represented by goodwill 2 000 2 000 - Consideration and NCI 332 000 200 000 132 000 Current year Profit for the year 90 850 54 510 36 340 Dividends paid (20 000) (12 000) (8 000) 402 850 42 510 160 340

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C2. Pro forma journals for investment in RecycleLab Ltd in consolidated financial

statements of the Iphepha SA Ltd Group (for completeness purposes only)

Dr R

Cr R

J1 Ordinary share capital (SCE)Retained earnings (SCE) Goodwill (SFP)

Investment in RecycleLab Ltd (SFP) Non-controlling interests (SFP/SCE) [C1]

Elimination of at acquisition equity

150 000 180 000

2 000

200 000132 000

J2 Non-controlling interests (P/L) [C1]

Non-controlling interests (SFP) Recognition of NCI’s interest in profit for the year

36 340 36 340

J3 Other income (P/L) [C1] Non-controlling interests (SFP/SCE)

Dividends paid (SCE) Elimination of intragroup dividends

12 000 8 000

20 000

C3. Total profit of joint venture (FineWoods Ltd)

Profit from 1/4/20.16 – 28/2/20.17 (105 720 x 11/12) (96 910) [1]Preference dividend (240 000 x 7% x 11/12) 15 400 [1]Elimination of intragroup dividends (given) 25 000 [1] (56 510) Equity account FineWoods Ltd (56 510 x 25%) (14 128) [1]Depreciation on fair value adjustment at acquisition (from part (b)) 619 [1]Unrealised profit on intragroup sales [4 800 (from part (b)) x 72%] 3 456 [1]Realisation of unrealised profit [933 (from part (b)) x 72%] (672) [1] (10 725) [7]

C4. Analysis of owners’ equity of FineWoods Ltd (ordinary share capital)


(25%) At Since At acquisition Ordinary share capital 150 000 Retained earnings 270 350 Profit (1/3/20.16 – 1/4/20.16) (105 720 x 1/12) 8 810 Preference dividends in arrears (240 000 x 7% x 1/12) (1 400) Equipment [(85 000 – 70 000) x 72%] 10 800 438 560 109 640 Goodwill/Excess (given) - Consideration 109 640 Current year Profit (1/4/20.16 – 28/2/20.17) (105 720 x 11/12) 96 910 Depreciation on equipment (10 800/4 x 11/12) (2 475) Preference dividends (240 000 x 7% x 11/12) (15 400) Total current year profit 79 035 19 759 Dividends paid (25 000) (6 250) 492 595 13 509

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C5. Analysis of owners’ equity of Imithi Ltd


(30%)

At Since

At acquisition Share capital 100 000 Retained earnings 275 200

375 200 112 560 Excess (2 560)

Consideration (80 000 + 30 000) 110 000 Since acquisition Retained earnings (350 410 – 275 200) 75 210 22 563 Current year Profit of Imithi Ltd 130 820 39 246 Dividends paid (50 000) (15 000)

531 230 46 809

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QUESTION 4 40 marks


This question consists of two independent parts. PART I 30 marks Mouth Watering Meats Ltd is a South African company that specialises in the processing and packaging of a variety of meat products. The company is listed on the Johannesburg Stock Exchange. One of Mouth Watering Meats Ltd’s key suppliers filed for liquidation in 20.16 and as a result, the management of Mouth Watering Meats Ltd agreed to acquire strategic shareholdings in certain of its other key suppliers. These shareholdings will ensure stability and sustainability in the company’s procurement process. The details of these acquisitions are listed below: Boasting Beef Ltd Mouth Watering Meats Ltd acquired 45 000 ordinary shares in Boasting Beef Ltd on 1 May 20.17 for a share consideration of 10 000 ordinary shares and a cash consideration of R200 000. Boasting Beef Ltd is also listed on the Johannesburg Stock Exchange and its main business is the sourcing and distribution of beef to an extensive retail client base. Mouth Watering Meats Ltd exercises significant influence over the financial and operating policy decisions of Boasting Beef Ltd from the acquisition date. The equity of Boasting Beef Ltd consisted of the following on 1 March 20.17: R

Ordinary share capital (100 000 shares) Retained earnings

100 000 552 800

652 800 The equity of Boasting Beef Ltd consisted only of ordinary share capital and retained earnings at the acquisition date. All the assets and liabilities of Boasting Beef Ltd were deemed to be fairly valued at the acquisition date, except for the company’s warehouses which had a carrying amount of R590 000 and a fair value of R750 000 on 1 May 20.17. The warehouses had a remaining useful life of six years at the acquisition date. The aforementioned warehouses have been correctly classified as owner-occupied property by Boasting Beef Ltd. On 1 September 20.17, Mouth Watering Meats Ltd sold one of its machines used in its meat packaging process, to Boasting Beef Ltd for R145 000. The carrying amount of this machine was R120 000 and its remaining useful life was 4 years at the date of sale. This machine have been used in the beef packaging process of Boasting Beef Ltd from 1 September 20.17. Boasting Beef Ltd paid a management fee of R50 000 to Mouth Watering Meats Ltd during the 20.18 financial year.

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As part of the year end audit procedures performed by the external auditors of Boasting Beef Ltd, it was identified that financial assets acquired by the company on 22 June 20.17 for an amount of R300 000, had a fair value of R370 000 on 28 February 20.18. This fair value adjustment has not yet been recognised in the separate accounting records of Boasting Beef Ltd. Boasting Beef Ltd’s profit for the year ended 28 February 20.18 amounted to R551 700. Cheeky Chickens Ltd Mouth Watering Meats Ltd is the controlling shareholder of Cheeky Chickens Ltd, a company that specialises in the production of chicken livestock. This controlling interest was acquired on 1 January 20.17 when Mouth Watering Meats Ltd acquired 65% of the ordinary share capital of Cheeky Chickens Ltd for a cash consideration of R810 000. At the acquisition date, the fairly valued equity of Cheeky Chickens Ltd consisted only of ordinary share capital and retained earnings which amounted to R225 000 and R927 800 respectively. On 1 January 20.17, Cheeky Chickens Ltd had a non-cancellable order backlog for 60 ton chicken feed. Chicken feed is sold at R6 000 per ton at a profit mark-up of 20% on cost. This order backlog will be cleared in 2 months’ time (30 ton per month). All the assets and liabilities of Cheeky Chickens Ltd were deemed to be fairly valued and no additional assets, liabilities or contingent liabilities were identified at the acquisition date. From 12 June 20.17, Cheeky Chickens Ltd has been selling chicken feed to Boasting Beef Ltd on a monthly basis at a profit mark-up of 40% on cost. Boasting Beef Ltd then uses the purchased chicken feed to supplement its feed to newly born calves. Cheeky Chickens Ltd’s total sales to Boasting Beef Ltd for the 20.18 financial year amounted to R458 000. A total inventory value of R94 000 was still on hand in the records of Boasting Beef Ltd at 28 February 20.18. Cheeky Chickens Ltd’s profit for the current financial year amounted to R430 900 (20.17: R371 900). Additional information 1. All the companies in the Mouth Watering Meats Ltd Group have a 28 February year end. 2. The quoted closing share price for the ordinary shares of Mouth Watering Meats Ltd was

R12,20 per share on 1 May 20.17. 3. It is the accounting policy of Mouth Watering Meats Ltd to account for investments in

subsidiaries and investments in associates at cost in accordance with IAS 27.10(a) in its separate financial statements.

4. It is the accounting policy of all the companies in the Mouth Watering Meats Ltd Group to

account for all other investments in financial assets in accordance with IFRS 9 Financial Instruments. All the companies in the Mouth Watering Meats Ltd Group irrevocably elected to present subsequent changes in the fair value of these investments in other comprehensive income in a mark-to-market reserve.

5. Assume that the profits of each of the companies in the Mouth Watering Meats Ltd Group

accrued evenly throughout the respective years. 6. An appropriate pre-tax discount rate is 9% per annum, compounded monthly.

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7. There were no changes in the issued ordinary share capital of any of the companies in the

group during the past two years. 8. It is the accounting policy of all the companies in the Mouth Watering Meats Ltd Group to

account for property, plant and equipment in accordance with the cost model in terms of IAS 16 Property, Plant and Equipment and to provide depreciation by applying the straight-line method.

9. Mouth Watering Meats Ltd elected to measure non-controlling interests at the proportionate

share of the acquiree’s net identifiable assets at the acquisition date for all acquisitions. 10. Assume an income tax rate of 28% and a Capital Gains Tax inclusion rate of 80%.

Ignore Value Added Tax (VAT) and Dividend Tax. 11. The acquisition of the subsidiary also met the definition of acquiring a business, as defined in

IFRS 3 Business Combinations. PART II 10 marks Edcor Ltd is a company listed on the Johannesburg Stock Exchange in the retail sector. Edcor Ltd intends to increase its market capitalisation and is in the process of acquiring a few companies that will help increase profits, which will increase share price and therefore increase its market capitalisation. Esquare Ltd Esquare Ltd is a small retail company started by three enterprising recently qualified students. The company’s business processes are expertly managed and therefore show great potential for scalability. Edcor Ltd is a party to a forward contract to acquire the majority of the shares in Esquare Ltd. One share equals one voting right. The forward contract's settlement date is in 25 days. Esquare 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. OneShop Ltd Edcor Ltd intends to acquire a 55% interest in OneShop Ltd. Edcor Ltd will have the right to restrict OneShop Ltd from undertaking activities that could significantly change the credit risk of OneShop Ltd to the detriment of Edcor Ltd. Another entity, Dido Ltd, will have existing rights that will provide them with the right to direct the relevant activities of OneShop Ltd. All the companies have a 28 February year end.

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REQUIRED


Marks

PART I Provide the pro forma consolidation journal entries of the Mouth Watering Meats Ltd Group for the year ended 28 February 20.18. Journal entries relating to deferred taxation are also required.


Please note: • The at acquisition elimination journal is not required. • Round off all amounts to the nearest Rand. • Journal narrations are required. • Show all your calculations. • Your answer must comply with International Financial Reporting Standards (IFRS). PART II (a) Discuss, with reasons, whether Edcor Ltd has power over Esquare Ltd. (b) Discuss, with reasons, whether Edcor Ltd will have control over OneShop Ltd.

Communication skills: logical flow and conclusion Please note: • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4 - Suggested solution PART I Pro forma consolidation journal entries for the year ended 28 February 20.18 BOASTING BEEF LTD Dr

R

Cr R

J1 Investment in associate (SFP) [C1] Share of profit of associate (P/L) Recognition of excess at acquisition

64 978 64 978

(5)(1)

J2 Investment in associate (SFP) Share of profit of associate (P/L) [C1] Share of other comprehensive income of associate (OCI) (((370 000 – 300 000) x (1 – (28% x 80%))) x 45) Recognition of share of profit and share of OCI of associate for the year

224 132 199 688

24 444

(2)

(2)

J3 Other income (profit on sale of machinery) (P/L) ((145 000 – 120 000) x 45%) Investment in associate (SFP) Elimination of unrealised profit in machinery

11 250

11 250(2)(1)

J4 Deferred tax (SFP) (11 250 x 28%) Income tax expense (P/L) Tax effect of elimination of unrealised profit in machinery

3 150 3 150

(1)(1)

J5 Investment in associate (SFP) (11 250 / 4 x 6/12) Cost of sales (P/L) Realisation of intragroup profit on machinery

1 406 1 406

(2)(1)

J6 Income tax expense (P/L) (1 406 x 28%) Deferred tax (SFP) Tax effect of realisation of intragroup profit on machinery

394 394

(1)

CHEEKY CHICKENS LTD J7 Retained earnings (SCE)

Deferred tax (SFP) (59 332 x 28%) Accumulated amortisation (SFP) (59 332 [C3] x 2/2) Amortisation on intangible asset (order backlog) for previous year

42 719 16 613

59 332

(1)(1)(3)

J8 Retained earnings (SCE) [[(371 900 x 2/12) – 42 719 (J7)] x 35%] Non-controlling interests (SFP) Non-controlling interests’ share of since acquisition reserves

6 743

6 743(2)(1)

J9 Revenue (P/L) (94 000 x 45%) Cost of sales (P/L) (94 000 x 100/140 x 45%) Investment in associate (SFP) (balancing) Elimination of unrealised profit in closing inventories of Boasting Beef Ltd

42 300 30 21412 086

(1)(1)(1)

J10 Deferred tax (SFP) [(42 300 – 30 214) x 28%] Income tax expense (P/L) Tax effect of elimination of unrealised profit in closing inventories

3 384 3 384

(1)(1)

J11 Non-controlling interests (P/L) [C2] Non-controlling interests (SFP) Non-controlling interests’ share of current year profit

147 769 147 769

(2)(1)

Total (36) Maximum (29) Communication skills: presentation and layout (1)

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COMMENT You will notice that the NCI is shown for Cheeky Chickens Ltd, but it is not shown for Boasting Beef Ltd. This is because the investment in Boasting Beef Ltd is an investment in associate and the investment in Cheeky Chickens Ltd an investment in subsidiary. Remember that the starting point for a consolidation is 100% the trial balance of the parent plus 100% the trial balance of the subsidiary (Cheeky Chickens Ltd). If the subsidiary is not wholly owned, then the parent will still add 100% but allocate the non-controlling interests their share through three line-items namely NCI (P/L), NCI (OCI) and NCI (SCE/SFP). However, for an associate, the starting point is only the trial balance of the parent. The equity method is then applied to recognise the investor’s share of the P/L and OCI using three line-items namely Share of P/L of associate, share of OCI of associate and Investment in associate (SFP). There is therefore no NCI to recognise for an investment in associate.

EXAM TECHNIQUE Students must remember to classify their journals (i.e. SFP, OCI, SCE, SFP, P/L) in order to earn the available marks. The at acquisition elimination journal was not required. Students must read carefully to ensure they don’t waste valuable time by providing information that was not required.

PART II (a) Discuss whether Edcor Ltd has power over Esquare Ltd Definition of power 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). OR To have power over an investee, an investor must have existing rights that gives it the current ability to direct relevant activities. For the purpose of assessing power, only substantive rights and rights that are not protective shall be considered (IFRS 10.B9). Existing rights For a right to be substantive, the holder must have the practical ability to exercise that right (IFRS 10.B22). 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). The fact that it takes 25 days before Edcor Ltd can exercise its voting rights does not stop Edcor Ltd from having the current ability to direct the relevant activities from the moment Edcor Ltd acquires the forward contract.

(1)

(1)

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Edcor 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 Edcor Ltd can settle the forward contract in 25 days. (1)

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.

(1)

Conclusion An investor that holds more than half of the voting rights of an investee has power unless another entity has existing rights that provide that entity with the right to direct the relevant activities (IFRS 10.B35 -. B37). Edcor Ltd will have the majority shares and one share equals one voting right. (1)

Edcor Ltd has power over Esquare Ltd because it holds substantive potential voting rights that give them the current ability to direct the relevant activities. (1)


(b) Discuss whether Edcor Ltd will have control over OneShop Ltd Definition of control 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). Existing rights For an investor that 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). Edcor Ltd will hold 55% of OneShop Ltd and thus have a majority of the voting rights, but Edcor Ltd's voting rights are not substantive.

(1)(1)

However, an investor that holds only protective rights does not have power over an investee, and consequently does not control the investee (IFRS 10.14). Protective rights relate to fundamental changes to the activities of an investee (IFRS 10.B26). 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). Conclusion Edcor Ltd only has rights that restrict OneShop Ltd from undertaking activities that could change the credit risk of OneShop Ltd to the detriment (disadvantage) of Edcor Ltd. Although Edcor Ltd will hold the majority of the voting rights, they will only hold protective rights and thus do not have control over OneShop Ltd.

(1)

(2)Total (5)

Maximum (4)Communication skills: logical flow and conclusion (1)

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CALCULATIONS C1. Analysis of owners’ equity of Boasting Beef Ltd

Total

Mouth Watering Meats Ltd

45% [1] At Since At acquisition – 1 May 20.17 Share capital 100 000 Retained earnings (1 March 20.17) 552 800

Profit up to acquisition date (2 months)(551 700 x 2/12) 91 950 [1]

Revaluation surplus (750 000 – 590 000) 160 000 [1] Deferred tax (160 000 x 28%) (44 800) [1] 859 950 386 978 Excess (64 978) Consideration [R200 000 + (10 000 x 12,20)] 322 000 [1] [5] Since acquisition - current year

Profit since acquisition (10 months)(551 700 x 10/12) 459 750 [1]

Additional depreciation of revaluation[((160 000 – 44 800) / 6) x 10/12] (16 000) [1]

Total current year profit 443 750 199 688 [2]

Current year OCI: Mark-to-market reserve[(370 000 – 300 000) x (1 – (28% x 80%))] 54 320 24 444

1 358 020 224 132 C2. Analysis of owners’ equity of Cheeky Chickens Ltd

Total

Mouth Watering Meats Ltd

65% NCI 35%

At Since At acquisition – 1 January 20.17 Share capital 225 000 Retained earnings 927 800

Intangible asset (order backlog) (59 332 [C3] x 72%) 42 719

1 195 519 777 087 418 432 Goodwill 32 913 32 913 - Consideration and NCI 1 228 432 810 000 418 432 Since acquisition Retained earnings (371 900 x 2/12) 61 983 Amortisation (42 719 x 2/2) (42 719) Total retained earnings 19 264 12 522 6 742 Current year

Profit for the year (430 900 – 42 300 (J9) + 30 214 (J9) + 3 384 (J10)) 422 198 274 429 147 769 [2]

1 669 894 286 951 572 943

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C3. Order backlog at acquisition

HP 10BII SHARP EL-733A SHARP EL-738 1. 2nd F C (Clear All) 1. 2nd FC (Clear All) 1. 2ndF MODE (Clear All) 2. 12 2nd F PMT 2. - 2. - 3. 6 000 x 20/120 x 30 PMT 3. 6 000 x 20/120 x 30 PMT 3. 6 000 x 20/120 x 30 PMT [1]4. 9 I/YR 4. 9/12 i 4. 9/12 I/Y [1]5. 2 N 5. 2 n 5. 2 N [1]6. PV = 59 332 6. 0 FV 6. 0 FV 7. Comp PV = 59 332 7. Comp PV = 59 332 [3]

COMMENT Order backlog The acquiree had an order backlog that, in accordance with IFRS 3.IE25, meets the contractual-legal criterion even if the purchase or sales orders can be cancelled. The order backlog therefore had to be recognised as an intangible asset.

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QUESTION 5 40 marks


Top Blinds Ltd is a company that specialises in the manufacturing and installation of blinds and security shutters. Top Blinds Ltd is listed on the Johannesburg Stock Exchange and has a 31 December year end. On 1 March 20.18, Top Blinds Ltd acquired a 55% controlling interest in Bamboo Ltd. Bamboo Ltd supplies eco-friendly and sustainable products to manufacture bamboo blinds. Top Blinds Ltd will be settling the purchase price at the dates as specified below: On 1 March 20.18 • R750 000 in cash.

• Issue of 25 000 ordinary shares in Top Blinds Ltd to the shareholders of Bamboo Ltd.

• Issue of 70 000 mandatory redeemable, 8% cumulative R2 preference shares in Top Blinds Ltd. The preference shares are redeemable three years after the acquisition date, at a premium of 5% on the face value.

• Financial assets owned by Top Blinds Ltd, with a carrying amount of R350 000 and a fair value of R420 000, transferred to the shareholders of Bamboo Ltd.

• Included in the R750 000 cash payment is R18 500 share issue costs related to the 25 000 issued ordinary shares and R22 300 acquisition-related costs in respect of valuations and lawyers’ fees. Top Blinds Ltd expensed these amounts in its separate financial statements.

On 28 February 20.20

• R300 000 cash depending on the following: • The profit before tax of Bamboo Ltd for the year ended

28 February 20.20 increases by at least 5%. The fair value of this obligation was deemed to be R165 000 on 1 March 20.18 and R185 000 on 31 December 20.18.

All the assets and liabilities of Bamboo Ltd were deemed to be fairly valued at the acquisition date with the exception of the following: • Inventory was overvalued with R72 000. At 31 December 20.18, 70% of the inventory was

sold to unrelated third parties. • Bamboo Ltd has a unique customer list that consists of detailed information about customers.

The customer list’s terms of confidentiality prohibits Bamboo Ltd from selling this list. The fair value of the customer list on 1 March 20.18 amounted to R330 000. The customer list has an indefinite useful life.

• Bamboo Ltd manufactures bamboo blinds that have a unique shape. Before the date of acquisition, Bamboo Ltd incurred development costs of R220 000 concerning the development of a trade dress (unique colour, shape and package design) for these blinds. Bamboo Ltd expensed these development costs when incurred. The registration of the trade dress was not finalised at the date of acquisition and the fair value was therefore estimated as R245 000 on 1 March 20.18. On 1 March 20.18, it is expected that this trade dress will have a useful life of five years. The trade dress was registered on 31 May 20.18. Bamboo Ltd obtained the official valuation report on this day which indicated that the fair value of the trade dress amounted to R280 000.

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• On 1 March 2018, a liability with a fair value of R195 000 was correctly recognised in the

consolidated financial statements of the Top Blinds Ltd Group in accordance with IFRS 3. This liability relates to a legal claim instituted against Bamboo Ltd. The previous shareholders agreed to reimburse Top Blinds Ltd for 45% of the damages payable if the legal claim against Bamboo Ltd is successful. The claim will not be deductible for taxation purposes should it be successful. The fair value of the contingent liability remained unchanged at year end.

No additional assets, liabilities or contingent liabilities were identified at the acquisition date. Bamboo Ltd revalued their investments in equity instruments on 28 February 20.18. This was the only revaluation on investments in equity instruments that Bamboo Ltd performed during the current financial year. Since the date of acquisition, Top Blinds Ltd has been selling inventory to Bamboo Ltd at a profit of 20% on cost. Inventory purchased from Top Blinds Ltd, still on hand at year end amounted to R185 700. Total sales from Top Blinds Ltd to Bamboo Ltd for the current financial year amounted to R320 000. Included in the separate records of both Top Blinds Ltd and Bamboo Ltd on 31 December 20.18 is an amount of R77 800 that Bamboo Ltd still owes Top Blinds Ltd for inventory purchased on 31 December 20.18. On 1 August 20.18, Top Blinds Ltd sold equipment with a carrying amount of R110 500 to Bamboo Ltd for R150 000. The equipment had a remaining useful life of three years on that date. Safe Shutters Ltd Safe Shutters Ltd is a well-established company that manufactures quality security shutters. On 1 July 20.17, Top Blinds Ltd acquired a 30% interest in Safe Shutters Ltd for a cash consideration of R200 000 as well as the transfer of equipment. The equipment transferred to Safe Shutters Ltd at the date of acquisition had a carrying amount of R90 000 and a fair value of R115 000 on 1 July 20.17. This equipment had a remaining useful life of three years on 1 July 20.17. In addition to the cash payment of R200 000, Top Blinds Ltd also paid lawyers’ fees of R10 000 on 1 July 20.17. From 1 July 20.17, Top Blinds Ltd exercised significant influence over the financial and operating policy decisions of Safe Shutters Ltd. Safe Shutters Ltd’s equity consisted of the following on 1 July 2017: R

Ordinary share capital (100 000 shares) Retained earnings Revaluation surplus

100 000 783 160 250 400

1 133 560 All the assets and liabilities of Safe Shutters Ltd were deemed to be fairly valued at the acquisition date and no additional assets or liabilities were identified. During the current financial year, Safe Shutters Ltd sold inventory to Top Blinds Ltd at a gross profit percentage of 25%. Included in Top Blinds Ltd’s inventory on hand on 31 December 20.18 is inventory amounting to R130 000 in respect of purchases from Safe Shutters Ltd.

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ABC Logistics Ltd Top Blinds Ltd is in the process of incorporating a new company, ABC Logistics Ltd. In accordance with its proposed Memorandum of Incorporation, ABC Logistics Ltd’s agreed purpose will be to perform administrative and operational activities necessary to run a delivery scheme for Top Blinds Ltd. In accordance with this scheme, 100 employees who had been employed by Top Blinds Ltd, will become shareholders and employees of ABC Logistics Ltd. Top Blinds Ltd plans to acquire 40% of the ordinary share capital and voting rights of ABC Logistics Ltd. The remaining 60% of the ordinary share capital will be allocated equally between the 100 employees. Each ordinary share confers one voting right to the shareholder. The 100 employees have an agreement to vote in unison. The relevant activities of ABC Logistics Ltd will include the following: • Arranging financing in order to purchase 50 delivery vehicles to be used; • Purchase of the delivery vehicles to be used by the employees; and • Insurance for and maintenance of the delivery vehicles. As per the Memorandum of Incorporation of ABC Logistics Ltd, the Managing Director can make all decisions relating to the operations of the company (including those relating to the activities described above), except for the selection of insurance and maintenance companies that should be used by ABC Logistics Ltd. Top Blinds Ltd will have the right to select the insurance and maintenance companies which ABC Logistics Ltd should use. Mr J Jonas, one of the employees, was elected Managing Director by a majority vote by the other employees. Other financial information The following is an extract from the separate trial balances of the different companies as at 31 December 20.18: Top Blinds

Ltd R

Dr/(Cr)

Bamboo Ltd R

Dr/(Cr)

Safe Shutters Ltd R

Dr/(Cr) Ordinary share capital (631 500) (200 000) (100 000)Preference share capital (252 500) - -Retained earnings (1 January 20.18) (2 842 900) (2 397 746) (940 610)Mark-to-market reserve (1 January 20.18) (589 420) (333 060) -Revaluation surplus (1 January 20.18) (384 100) - (250 400)Property, plant and equipment 3 000 580 2 391 790 1 219 810Investments in equity instruments 672 950 765 800 -Inventory 944 550 880 600 645 700Cash and cash equivalents 286 340 158 530 80 690Trade receivables 899 450 410 285 280 440Trade payables (746 020) (389 650) (200 900)Long-term borrowings (684 651) (100 540) (133 130)Deferred tax (87 530) (120 485) (50 800)Profit after tax for the year (1 800 710) (1 234 824) (445 800)Fair value adjustments on investments in equity instruments

(240 600)

(150 700)

-

Gain on revaluation of land (170 000) - (280 000)Dividends paid on 31 December 20.18 500 000 320 000 175 000

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Additional information 1. It is the accounting policy of Top Blinds Ltd to account for investments in subsidiaries and

investments in associates at cost in accordance with IAS 27.10(a) in its separate financial statements.

2. It is the accounting policy of all the companies in the Top Blinds Ltd Group to account for all

other investments in equity instruments in accordance with IFRS 9 Financial Instruments. All the companies in the Top Blinds Ltd Group irrevocably elected to present subsequent changes in the fair value of these investments in other comprehensive income in a mark-to-market reserve.

3. All the companies in the Top Blinds Ltd Group have a 31 December year end. 4. The fair value of the ordinary shares of Top Blinds Ltd was R22 per share on 1 March 20.18. 5. Assume that the profits of all the companies in the Top Blinds Ltd Group accrued evenly

throughout the respective years. 6. An appropriate pre-tax discount rate is 9% per annum, compounded annually. 7. You can correctly assume that a consolidated deferred tax liability was recognised in the

consolidated financial statements of the Top Blinds Ltd Group for the year ended 31 December 20.18.

8. There were no changes in the issued ordinary share capital of Bamboo Ltd or

Safe Shutters Ltd. 9. It is the accounting policy of all the companies in the Top Blinds Ltd Group to account for plant

and equipment according to the cost model and land according to the revaluation model in terms of IAS 16 Property, Plant and Equipment.

10. Top Blinds Ltd elected to measure non-controlling interests at the proportionate share of the

acquiree’s net identifiable assets at the acquisition date for all acquisitions. 11. Assume an income tax rate of 28% and a Capital Gains Tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. 12. The acquisitions of the subsidiaries also met the definition of acquiring a business, as defined

in IFRS 3 Business Combinations.

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REQUIRED


Marks

(a) Prepare only the assets section of the consolidated statement of financial position of the Top Blinds Ltd Group as at 31 December 20.18.


(b) Discuss, with reasons, how the customer list of Bamboo Ltd should be accounted

for in the consolidated financial statements of the Top Blinds Ltd Group. (c) Discuss, with reasons, whether Top Blinds Ltd will have power over

ABC Logistics Ltd.

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

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6

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QUESTION 5 - Suggested solution (a) Prepare only the asset section of the consolidated statement of financial position TOP BLINDS LTD GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.18 R

ASSETS Non-current assets Property, plant and equipment [C1] 5 358 356 (3)Investments in equity instruments (672 950 + 765 800) 1 438 750 (1)Intangible assets [C2] 233 333 (2)Investment in associate [C3] 548 793 (10)Goodwill [C4] 154 660 (15) 7 733 892Current assets Trade receivables [C7] 1 231 935 (1)Inventory [C8] 1 762 850 (3)Cash and cash equivalents (286 340 + 158 530) 444 870Indemnification asset (195 000 x 45%) 87 750 (1) 3 527 405Total assets 11 261 297



EXAM TECHNIQUE It is important to remember to transfer the answer you get in the calculations to your solution. Marks were not allocated in this question to students who calculated goodwill but did not reflect it in the solution. Furthermore, only the asset section was required therefore do not waste time completing other sections.

(b) Discuss, with reasons, how the customer list of Bamboo Ltd should be accounted for

in the consolidated financial statements of the Top Blinds Ltd Group Customer lists Top Blinds Ltd shall recognise, separately from goodwill, the identifiable intangible assets acquired in a business combination (IFRS 3.B31).

(1)

Top Blinds Ltd has a unique customer list and as customer lists are frequently licensed, it meets the separability criterion. It is also standard practice in the industry to license customer lists.

(1) The customer list of Bamboo Ltd’s terms of confidentiality prohibits Bamboo Ltd from selling this list. This customer list would thus not meet the separability criterion, as the list cannot be sold (IFRS 3.B33). (1)Top Blinds Ltd will thus not account for this list in its consolidated financial statements, as it is not identifiable and does not meet the separability or contractual-legal criterion.

(1)


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(c) Discuss, with reasons, whether Top Blinds Ltd will have power over ABC Logistics Ltd Power over the investeeTop Blinds Ltd will have power over ABC Logistics Ltd when they have existing rights that give them the current ability to direct the relevant activities, i.e. the activities that significantly affect ABC Logistics Ltd’ returns.

(1)

Relevant activities ABC Logistics Ltd will be incorporated with the ability to conduct the following relevant activities: • Arranging financing to fund the purchase of operating assets • Acquisition of operating assets to be used by the employees • Insurance for and maintenance of the operating assets

(1)

Existing rights Although Top Blinds Ltd has voting rights, it does not possess a majority of voting rights as they plan to only acquire 40% of the ordinary share capital and voting rights. Top Blinds Ltd can however have power even if it holds less than a majority of the voting rights.

(1)

As per the Memorandum of Incorporation of ABC Logistics Ltd, Mr J Jonas, the Managing Director, can make all decisions relating to the operations of the company except for the selection of insurance and maintenance companies that should be used by ABC Logistics Ltd, which resides with Top Blinds Ltd.

(1)

The design of ABC Logistics Ltd therefore confers the significant decision-making rights over the majority of relevant activities to the managing director and not to Top Blinds Ltd. The managing director is appointed by the employees and not by Top Blinds Ltd.

(1)

The rights held by Top Blinds Ltd in respect of insurance and maintenance service providers is not seen as key in comparison to the other relevant activities and appears to be a protective right in order to ensure that the operating assets of ABC Logistics Ltd are properly maintained. (1)Conclusion Top Blinds Ltd will not have power over ABC Logistics Ltd as they will not have existing rights to direct the relevant activities of ABC Logistics Ltd. (1)


Communication skills: logical flow and conclusion (1) CALCULATIONS C1. Property, plant and equipment

Top Blinds Ltd plus Bamboo Ltd (3 000 580 + 2 391 790) 5 392 370 [1]Unrealised profit in closing equipment of Bamboo Ltd (150 000 – 110 500) (39 500) [1]Realisation of unrealised profit in equipment (39 500/3 x 5/12) 5 486 [1] 5 358 356 [3]

C2. Intangible assets

Trade dress (IFRS 3 recognition at acquisition of Bamboo Ltd) 280 000 [1]Customer list (cannot be sold) (see part (b)) - Amortisation of trade dress (280 000/5 x 10/12) (46 667) [1] 233 333 [2]

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C3. Investment in associate (Safe Shutters Ltd)

Cost of investment (200 000 + 10 000 (IAS 28.10 E2) + 115 000) 325 000 [1]Excess at acquisition ((1 133 560 x 30%) – 325 000) 15 068 [1] Recognition of opening equity [(940 610 – 783 160) x 30%] 47 235 [1] Equity accounting in current year 165 240 [2]Share of profit or loss of associate (445 800 x 30%) 133 740Share of OCI of associate (280 000 x 30%) 84 000Dividend received (175 000 x 30%) (52 500) Unrealised profit included in opening equipment of Safe Shutters Ltd ((115 000 – 90 000) x 30% = 7 500 - (7 500/3 x 6/12))

(6 250) [2]

Realisation of unrealised profit in current year (7 500/3) 2 500 [1] 548 793 [10]

C4. Goodwill

Acquisition of Bamboo Ltd Share capital 200 000Retained earnings (1 January 20.18) 2 397 746Profit (1/1/20.18 – 1/3/20.18) (1 234 824 x 2/12) 205 804 [1]Mark-to-market reserve (1 January 20.18) 333 060Mark-to-market reserve (OCI) 150 700 [1]Inventory (72 000 x 72%) (51 840) [1]Intangible asset (trade dress) (280 000 x 72%) 201 600 [1]Contingent liability (195 000) [1]Indemnification asset (195 000 x 45%) 87 750 [1]Identifiable net assets 3 329 820Non-controlling interests (3 329 820 x 45%) (1 498 419) [1]Consideration transferred [C5] (1 986 061) [8] (154 660) [15]

C5. Consideration transferred for the acquisition of Bamboo Ltd

Cash payment 750 000 [1]Issue of ordinary shares (25 000 x R22) 550 000 [1]Share issue costs (18 500) [1]Acquisition-related costs (IFRS 3.53) (22 300) [1]Issue of preference shares [C6] 141 861 [2]IFRS 9 investment at fair value 420 000 [1]Contingent consideration 165 000 [1] 1 986 061 [8]

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C6. Issue of preference shares as consideration

HP 10BII SHARP EL-733A SHARP EL-738 1. 2nd F C (Clear All) 1. 2nd FC (Clear All) 1. 2ndF MODE (Clear All) 2. 1 2nd F PMT 2. - 2. -3. 70 000 x 2 x 8% PMT 3. 70 000 x 2 x 8% PMT 3. 70 000 x 2 x 8% PMT [1]4. 9 I/YR 4. 9 i 4. 9 I/Y [1]5. 3 N 5. 3 n 5. 3 N [1]6. 70 000 x 2 x 1,05 FV 6. 70 000 x 2 x 1,05 FV 6. 70 000 x 2 x 1,05 FV [1]7. PV = 141 861 7. Comp PV = 141 861 7. Comp PV = 141 861 Total [3] Maximum [2]

C7. Trade receivables

Top Blinds Ltd plus Bamboo Ltd (899 450 + 410 285) 1 309 735Elimination of intragroup trade receivables (77 800) 1 231 935 [1]

C8. Inventory

Top Blinds Ltd plus Bamboo Ltd (944 550 + 880 600) 1 825 150IFRS 3 adjustment (acquisition of Bamboo Ltd) (72 000)70% of inventory above sold at year end (72 000 x 70%) 50 400 [1]Unrealised profit in closing inventory of Bamboo Ltd (Top Blinds Ltd sold to Bamboo Ltd) (185 700 x 20/120)

(30 950)

[1]

Unrealised profit in closing inventory of Top Blinds Ltd (Safe Shutters Ltd sold to Top Blinds Ltd) (130 000 x 25% x 30%)

(9 750)

[1] 1 762 850 [3]

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C9. Analysis of owners’ equity of Bamboo Ltd (for completeness)

Total

Top Blinds Ltd: 55% NCI

At Since

At acquisition (1 March 20.18) Share capital Retained earnings Mark-to-market reserve Profit for 2 months (1 234 824 x 2/12) Mark-to-market reserve (OCI) Inventory (72 000 x 72%) Intangible asset (trade dress) (245 000 x 72%) Contingent liability Indemnification asset (195 000 x 45%)

200 0002 397 746

333 060205 804150 700(51 840)

176 400(195 000)

87 750

3 304 620 1 817 541 1 487 079 Goodwill 168 520 168 520 -

Consideration [C5] and NCI 3 473 140 1 986 061 1 487 079 Measurement period adjustment:

Intangible asset (trade dress) [(280 000 x 72%) – 176 400] 25 200

Adjusted net assets (3 304 620 + 25 200) 3 329 820 1 831 401 1 498 419

Adjusted goodwill 154 660 154 660 - Consideration [C5] and NCI 3 484 480 1 986 061 1 498 419

Current year Profit (1 234 824 x 10/12) Amortisation (280 000/5 x 10/12)

1 029 020 (46 667)

Tax (46 667 x 28%) Inventory sold (51 840 x 70%)

13 067 36 288

Total current year profit 1 031 708 567 439 464 269

Dividend (320 000) (176 000) (144 000)

4 196 188 391 439 1 818 688

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QUESTION 6 40 marks


Oneity Ltd (Oneity) is a South African based retail holding company listed on the Johannesburg Stock Exchange (JSE). The Oneity group has an extensive global footprint comprising 400 stores in 10 countries and specialises in retail sectors such as household appliances, furniture and fashion apparel. Key information pertaining to all companies within the Oneity group: • TheOneity group prepares its financial statements in accordance with International Financial

Reporting Standards (IFRSs). • The Oneity group early adopted IFRS 16 Leases for the financial year ended

28 February 20.19. • All companies have a 28 February year end. Acquisition of assets and liabilities of UB Appliances On 8 November 20.17 the Oneity Board unanimously decided to propose a take-over of UB Appliances (UBA), South Africa’s biggest appliance retailer. This would further diversify the Oneity product offerings and leverage off several synergies that could be derived from Oneity’s well-established supply chain. Oneity and UBA entered into a sale of business agreement on 19 December 20.17. Ownership of UBA was made up as follows prior to this take-over: Shareholders ShareholdingVestBid Ltd is a private equity firm with a diversified investment portfolio 30%Mr Lace (COO of UBA) and Mr Trainer (CEO of Oneity), each held a 35% equity interest in UBA

70%

100% Accounting for the acquisition of the assets and liabilities of UBA The purchase agreement stipulated that specified assets and liabilities of UBA were to be transferred to Oneity on 1 March 20.18. Oneity therefore obtained control, as defined in IFRS 10 Consolidated Financial Statements, over these assets and liabilities on this date. The take-over also met the definition of acquiring a business, as defined in IFRS 3 Business Combinations. The financial accountant of Oneity, on instruction of Mr Trainer, processed journal entry JNL: NR 458 for 20.19 to account for the acquisition of the specified assets and liabilities of UBA.

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JNL:NR-458

Notes Dr Cr Account description

Financial statement

R’000

R’000

Property, plant and equipment SFP 1 10 000 Investment property SFP 2 6 550 Intangible assets: Goodwill SFP 3 4 500 Non-current assets held for sale SFP 4 7 500 Inventory SFP 5 29 700 Bank and cash (R14 800 000 – R325 000 – R900 000 – R5 500 000)

SFP

6; 8; 9; 12

8 075

Right-of-use asset SFP 7 1 650 Intangible assets: Workforce (R3 500 000 + R5 500 000)

SFP

8

9 000

Share issue costs P/L 9 900 Intangible assets: Legal fees incurred SFP 12 325 Gain on bargain purchase (balancing figure) P/L 9 160

Lease liability SFP 7 1 760Share capital (300 000 x R253 (25 300 cents))

SCE

9

75 900

Provision: Earn-out bonus SFP 10 3 100Provision: Contingent payment SFP 11 5 000Provision: Claim from customer SFP 13 1 600

Acquisition of UBA 87 360* 87 360* * The casting of the journal entry is correct. 1. UBA’s property, plant and equipment consist of several buildings and equipment and a piece

of owner-occupied land. All of these assets were considered to be fairly valued in terms of IFRS 3 at the acquisition date, except for the owner-occupied land. This land is currently held for industrial use as a site for one of UBA’s factories. Similar sites have recently been developed into office buildings. On the acquisition date the land in question had no restrictions to prevent it from being developed into office buildings. The fair value of all UBA’s property, plant and equipment amounted to R10 million (if the site were held for industrial use) and R12 million (if the site were developed into office buildings) on the acquisition date.

2. The investment property is an office building which was subject to a market-related lease

agreement between Oneity and UBA. The lease came to an end on 28 February 20.18. Oneity leased the building from UBA for office space and will continue to use it for this purpose. The carrying amount of this building in the separate financial statements of UBA on the acquisition date did not materially differ from its fair value.

3. The goodwill recognised is a result of a previous business combination between UBA and

an unrelated third party a number of years ago. The goodwill has never been impaired. 4. The non-current assets held for sale consist of a factory building that was correctly classified

as a non-current asset held for sale in terms of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. The estimated costs to sell are R250 000 and the fair value of the factory building was R7 500 000 on the acquisition date. Oneity intends to sell the building within 12 months.

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5. The inventory balance is correctly reflected at the lower of cost and net realisable value in

accordance with IAS 2 Inventories and this value approximates the fair value of the inventory on the acquisition date.

6. The bank and cash of UBA at the acquisition date was R14 800 000 (favourable balance). 7. The right-of-use asset and corresponding lease liability are a result of a lease agreement

between UBA and an unrelated third party and the amounts reflected are based on the original contract. Per the lease agreement, UBA leases a number of specialised machines that are used in the supply chain process. The lease agreement does not qualify for the recognition exceptions stipulated in IFRS 16 par. 5. On the acquisition date, the remaining lease term amounted to four years and the correctly calculated present value of the remaining lease payments, as if this lease were a new lease on the acquisition date, amounted to R1 850 000. UBA’s lease payments are higher than what market participants are currently paying. On the acquisition date, the fair value of this ‘off-market’ component amounted to R292 000.

8. The purchase agreement stipulates that UBA’s key personnel and executives (an assembled

workforce) would be employed by Oneity subsequent to the take-over. Mr Trainer valued this workforce at R3 500 000 on the acquisition date. Oneity was required to pay retrenchment packages of R5 500 000 in cash on 1 March 20.18 to the employees not employed by Oneity after the take-over.

9. The purchase consideration was settled by Oneity with an immediate cash payment of

R32 400 000 to UBA on 1 March 20.18. In addition Oneity issued 300 000 ordinary shares on 8 March 20.18. Oneity incurred share issue costs amounting to R900 000 on the issue date. Oneity’s share price was as follows on the relevant dates:

Date Quoted on the JSE 1 March 2018 25 200 cents per share 8 March 2018 25 300 cents per share

10. An earn-out bonus of R3 500 000 will be payable to Mr Lace on 28 February 20.21 if he

remains in the employ of Oneity until that date. If he resigns before that date, the bonus will be forfeited. The fair value of the earn-out bonus was reliably determined to be R3 100 000 on the acquisition date.

11. Cash payments of R2 500 000 each are payable to Messrs Lace and Trainer, in the event

of Oneity’s price-earnings multiple (PE ratio) exceeding 18 by 28 February 20.21. The fair value of these further payments was reliably determined as being R4 600 000 in total on the acquisition date.

12. Oneity incurred legal fees amounting to R325 000 in drafting the purchase agreement, which

was paid in cash on the acquisition date. 13. On the acquisition date, the following facts were identified from the draft separate financial

statements of UBA for 20.18: • UBA expensed an amount of R1 900 000 incurred with the development and registration

of a patent for a specific appliance developed and manufactured by the company during 20.18 as it did not meet the requirements for recognition as an intangible asset per IAS 38 Intangible Assets. Oneity’s management decided not to continue using the patent. A fair value could reliably be placed on the patent and amounted to R1 200 000 on the acquisition date.

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• An amount of R1 800 000 was correctly disclosed as a contingent liability in terms of

IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The contingent liability is a result of a claim from a customer who was allegedly injured using an UBA appliance. The classification as a contingent liability was based on the fact that only a possible obligation, as defined in terms of IAS 37 par.10, existed at the end of 20.18. This conclusion was still applicable and correct at the acquisition date as none of the circumstances which resulted in the conclusion had changed. The fair value of this contingent liability was reliably determined to amount to R1 600 000 on the acquisition date.

Additional information • All items of property, plant and equipment are accounted for on the cost model in terms of

IAS 16 Property, Plant and Equipment. • All intangible assets are accounted for on the cost model in terms of IAS 38. • All items of investment property are accounted for on the fair value model in terms of IAS 40

Investment Property. • Assume a normal income tax rate at 28% and a Capital Gains Tax inclusion rate of 80%.


(SAICA – adapted)

COMMENT This question is an opportunity to analyse and illustrate an understanding and insight into IFRS 3. You should be able to formulate your concerns about the given information and provide adequate responses supported by reasons in line with IFRS.

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REQUIRED


Marks

Discuss any concerns relating to the recognition and measurement of the various elements that you have regarding the accounting entry (JNL: NR-458). Provide reasons to support your concerns as well as recommendations on how to correctly account for the matter.

Communication skills: clarity of expression; appropriate style

Please note: • Round off all amounts to the nearest Rand. • Ignore taxation. • You are not required to refer to the Conceptual Framwork. • You are not required to re-calculatie the goodwill or gaim from bargain purchase • You are not required to provide any correcting journal entries.. • Discussions regarding disclosure are not required. • Support your discussion with calculations where appropriate. • Your answer must comply with International Financial Reporting Standards (IFRS).

39

1

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QUESTION 6 – Suggested solution Discuss any concerns relating to the recognition and measurement of the various elements that you have regarding the accounting entry (JNL: NR-458). Provide reasons to support your concerns as well as recommendations on how to correctly account for the matter.

1 Property, plant and equipment The property, plant and equipment was measured at the incorrect fair value because,

in terms of IFRS 13.27, the fair value of a non-financial asset takes into account the market participants’ ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use.

(1)

As there are no restrictions in developing the land for a site of office buildings, this would be its highest and best use.

(1)

The property, plant and equipment should therefore be measured at the fair value of R12 000 000 on acquisition date and not R10 000 000.

(1)

2. Investment property The recognition of the office building as investment property is incorrect because, in

terms of IFRS 3.15, at the acquisition date the acquirer should classify or designate the identifiable assets acquired and the liabilities assumed as necessary to apply other IFRSs.

(1)

Since the building will be used by Oneity for office space (administrative purposes), it becomes owner-occupied in terms of IAS 40.5.

(1)

The building should therefore be recognised as property, plant and equipment in terms of IAS 16 on acquisition date and should not be recognised as investment property in terms of IAS 40.

(1)

3. Goodwill recognised as an intangible asset The goodwill was incorrectly recognised as an intangible asset on acquisition date

because, in terms of IFRS 3.10, only identifiable assets acquired should be recognised separately from goodwill on the acquisition date.

(1)

The goodwill is not identifiable since it is not separable, nor does it arise from contractual or other legal rights.

(1)

The goodwill should therefore not be recognised as an intangible asset on acquisition date but should rather be subsumed into the goodwill recognised as a result of the business combination.

(1)

4. Non-current assets held for sale The non-current assets held for sale were incorrectly measured at fair value on the

acquisition date because, in terms of IFRS 3.31, the acquirer should measure non-current assets held for sale at fair value less costs to sell, as determined in terms of IFRS 5.

(1)

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The non-current assets held for sale should therefore be measured at fair value less costs

to sell of R7 250 000 [R7 500 000 – R250 000] on acquisition date and not the fair value of R7 500 000.

(1)

5. Right-of-use asset and lease liability The right-of-use asset and lease liability were measured at the incorrect amounts

because, in terms of IFRS 3.28B, the acquirer should measure the lease liability at the present value of the remaining lease payments as if the lease was a new lease at the acquisition date. Furthermore, the right-of-use asset should be measured at the same amount as the lease liability, adjusted to reflect favourable or unfavourable terms of the lease when compared to market terms.

(1)

The lease liability should therefore be measured at R1 850 000 on acquisition date and not R1 760 000.

(1)

As UBA’s lease payments are more than what market participants are currently paying, the ‘off-market’ component of R292 000 is unfavourable.

(1)

The right-of-use asset should therefore be measured at R1 558 000 (R1 850 000 – R292 000) on acquisition date and not R1 650 000.

(1)

6. Workforce recognised as an intangible asset The workforce was incorrectly recognised as an intangible asset separately from goodwill

on the acquisition date because, in terms of IFRS 3.B37, an assembled workforce is not an identifiable asset at the acquisition date / in terms of IAS 38.15, an entity has insufficient control over the expected future economic benefits arising from a team of skilled staff to meet the definition of an intangible asset.

(1)

The assembled workforce should therefore not be recognised as an intangible asset separately from goodwill on the acquisition date but should rather be subsumedinto goodwill recognised as a result of the business combination on acquisition date. (1)

7. Retrenchment packages recognised as an intangible asset The retrenchment packages were incorrectly recognised as an intangible asset

separately from goodwill on the acquisition date because, in terms of IFRS 3.51, amounts that are not part of the exchange for the acquiree shall be accounted for as separate transactions / the retrenchment packages were not primarily paid for the benefit of the acquiree (or its former owners) and should therefore not form part of the business combination.

(1)

The amount paid should therefore be recognised as an expense in profit or loss when it is incurred and should not be recognised as an intangible asset on acquisition date.

(1)

8. Immediate cash payment The immediate cash payment was not included as part of the consideration paid, although

IFRS 3.37 requires the consideration transferred in a business combination to be measured at fair value, which includes the fair value of assets such as cash transferred by the acquirer.

(1)

The immediate cash payment should therefore be recognised at fair value of R32 400 000 as part of the consideration transferred and credited to bank.

(1)

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9.

Issue of ordinary shares: Acquisition date

The incorrect price was used to measure the ordinary shares issued as part of the consideration transferred because, in terms of IFRS 3.37, the acquirer should measure the consideration transferred at the acquisition date fair value – this includes equity instruments issued by the acquirer. (1)

The issue of the share capital should therefore be measured at R252 (25 200 cents)

per share (that is, the unadjusted quoted price on the JSE) on the acquisition date and not R253 (25 300 cents) per share / The issue of the share capital should therefore be measured at R75 600 000 (300 000 x R252) and not R75 900 000. This is because control in terms of IFRS 10, was obtained on 1 March 20.18, irrespective of the fact that Oneity issued the shares on 8 March 20.18.

(1)

10. Issue of ordinary shares: Share issue costs The share issue costs have incorrectly been expensed because, in terms of IFRS 3,

transaction costs should be accounted for in terms of other IFRSs and in terms of IAS 32.35, transaction costs on the issue of the shares should be debited to the share capital (that is, accounted for as a deduction from equity).

(1)

The share issue costs of R900 000 should therefore be recognised directly in equity (debited to share capital) and should not be expensed in profit or loss.

(1)

11. Earn out bonus The earn-out bonus was incorrectly included as part of the consideration transferred

because, in terms of IFRS 3.B55(a), when contingent payments to employees or selling shareholders are automatically forfeited if employment terminates, this payment is remuneration for post-combination services.

(1)

Since the earn-out bonus is dependent on Mr Lace still being in the employ of Oneity on 28 February 20.21, the earn-out bonus should be recognised as a separate expense as the services are being rendered by Mr Lace and should not be recognised as a provision on acquisition date.

(1)

12. Further cash payment (contingent payment) The further cash payment (contingent payment) of R5 000 000 (R2 500 000 to each of

Mr Lace and Mr Trainer) was measured at the incorrect amount because, in terms of IFRS 3.37, the consideration transferred in a business combination should be measured at fair value.

(1)

The additional payment should therefore be measured at its fair value of R4 600 000 on acquisition date and not an amount of R5 000 000.

(1)

13. Legal fees incurred The legal fees incurred by Oneity in drafting the purchase agreement was incorrectly

recognised as an intangible asset on acquisition date because, in terms of IFRS 3.53, acquisition-related costs incurred to effect the business combination should be recognised as an expense in the period it is incurred.

(1)

The legal fees should therefore be recognised as an expense in profit or loss when it is incurred and should not be recognised as an intangible asset on acquisition date.

(1)

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14.

Registered patent expensed in previous years

The registered patent was incorrectly not recognised as an identifiable asset separately from goodwill on the acquisition date because, in terms of IFRS 3.10 / IFRS 3.B31, all identifiable intangible assets acquired on the acquisition date should be recognised separately from goodwill on the acquisition date.

(1)

The patent is identifiable since it is registered, that is, it arises from a contractual right.

(1)

The fact that Oneity does not intend to use the patent going forward is irrelevant. The fair value is determined on what market participants are willing to pay to transfer the asset (IFRS 13.9).

(1)

The patent should therefore be recognised as a separate intangible asset on the acquisition date at its fair value of R1 200 000. (1)

15. Contingent liability recognised The contingent liability in connection with the claim from the customer was incorrectly

recognised separately from goodwill on the acquisition date because, in terms of IFRS 3.23, the acquirer should only recognise contingent liabilities assumed in a business combination separately from goodwill on the acquisition date if it is a present obligation that arises from past events and its fair value can be determined reliably.

(1)

Although the fair value of the contingent liability could be determined reliably at R1 600 000, no present obligation existed at the acquisition date and the contingent liability should therefore not be recognised as a provision on acquisition date.

(1)

16. Gain from a bargain purchase recognised The recognition of a gain from a bargain purchase as a debit entry is incorrect because,

in terms of IFRS 3.32, the acquirer shall only recognise a gain from a bargain purchase if the consideration transferred is less than the fairly valued net identifiable assets at the acquisition date.

(1)

Based on the entry provided, goodwill should have been recognised and not a gain from a bargain purchase.

(1)

The amount is also incorrect as a result of the errors and concerns noted above. (1) Total (42) Maximum (39) Communication skills: clarity of expression; appropriate style (1)

EXAM TECHNIQUE The recalculation of goodwill or gain on bargain purchase and correction journal entries where not required. Do not provide the solution that was not required. Providing a theory reference without application and highlighting concerns without supporting reasons does not earn marks.

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QUESTION 7 40 marks


Massmark Ltd is a South African-based globally competitive regional management group that is listed on the Johannesburg Stock Exchange. Massmark Ltd invested in a portfolio of diversified, complementary, focused wholesale and retail businesses. Massmark Ltd is the second-largest distributor of consumer goods in Africa, the leading retailer of general merchandise, liquor and home improvement equipment and supplies, and the leading wholesaler of basic foods. The financial year end of the Massmark Ltd Group and all the companies in the group is 31 December. DionLink Ltd On 1 August 20.19 Massmar Ltd acquired a 60% interest in the ordinary share capital of DionLink Ltd, a retailer of electronics and appliances. As a result of this acquisition, Massmark Ltd obtained control over DionLink Ltd as from 1 August 20.19 as defined in IFRS 10 Consolidated Financial Statements. Ojewa Keng, the group accountant, has prepared the analysis of equity of DionLink Ltd at the acquisition date in preparation for the consolidation procedures for the year ended 31 December 20.19. You may assume that all amounts are correct, except as stated otherwise. Analysis of owners' equity of DionLink Ltd at acquisition date 60% 40% Notes Total

R At R

NCI R

At acquisition Net asset value as at 1 August 20.19 1 1 209 500 725 700 483 800Inventory 2 95 000 57 000 38 000Deferred tax adjustment 2 (26 600) (15 960) (10 640)Land fair value adjustment 3 23 000 13 800 9 200Deferred tax adjustment 3 (5 152) (3 091) (2 061) 1 295 748 777 449 518 299Equity represented by goodwill 9 169 98 801 (89 632)Consideration and NCI 4; 4.7 1 304 917 876 250 428 667 Measurement period adjustments Net asset value (above) 1 295 748 777 449 518 299Land adjustment 3 27 000 16 200 10 800Deferred tax adjustment 3 (6 048) (3 629) (2 419)Net asset value – measurement period 1 316 700 790 020 526 680Equity represented by goodwill (97 783) 230 (98 013)Consideration and NCI 4 1 218 917 790 250 428 667 All the assets and liabilities of DionLink Ltd were deemed to be fairly valued, except where advised otherwise in the notes below. Furthermore, no additional assets, liabilities or contingent liabilities were identified on the acquisition date, except as provided for in the notes below.

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Notes 1. Ojewa Keng calculated the net asset value of DionLink Ltd as at 1 August 20.19 as follows:

Sub notes R

Ordinary share capital (10 000 issued ordinary shares) 1.1 800 000Retained earnings 1.2 220 000Revaluation surplus 62 000Preference share capital 1.3 127 500 1 209 500

1.1 There were no changes to the ordinary share capital of DionLink Ltd for the year ended

31 December 20.19. 1.2 The balance of the retained earnings amounting to R220 000 was as reported in the

interim financial statements of DionLink Ltd for the interim period ended 30 June 20.19. The retained earnings balance was correctly calculated in the interim financial statements. Due to the negative impact of the international trade war on the sale of electronic consumer goods, DionLink Ltd had a loss of R38 000 for the period 1 July 20.19 to 31 December 20.19. DionLink Ltd declared an interim dividend of R27 000 on 25 July 20.19. The interim dividend was paid on 15 August 20.19.

1.3 The equity of DionLink Ltd as at 1 August 20.19 consisted of 11% 1 500 issued

preference shares at a nominal value of R85 per share. The preference shares give their holders a right to a preferential dividend in priority to the payment of any dividend to the holders of ordinary shares. The preference shareholders are only entitled to receive a repayment of the nominal value of the preference share upon liquidation of DionLink Ltd and do not have any further rights on liquidation. Preference shareholders do not have any voting rights. The fair value of the preference shares amounted to R105 per share on 1 August 20.19.

2. Included in the inventory balance of DionLink Ltd as at 1 August 20.19 was a net realisable

value of R95 000 relating to mobile devices manufactured by a well-known international manufacturer and distributor of mobile devices, Heiwau. The ongoing international trade war raised an expectation that there would be a trade ban on the trade of an Andrios operating system that are used by the Heiwau mobile devices with effect from 31 December 20.19, thus rendering the mobile devices obsolete. As a result, Massmark Ltd could not reliably determine the fair value of this inventory as at 1 August 20.19.

On 15 January 2020 an independent market expert reliably measured the fair value of the

Heiwau mobile devices as at 1 August 20.19 at R58 634. DionLink Ltd did not remeasure the inventory in its separate financial statements.

3. The property, plant and equipment balance of DionLink Ltd reflected in the interim financial

statements for the interim period ended 30 June 20.19 included land with a carrying amount of R150 000. The fair value of this land was R173 000 as at 1 August 20.19 and DionLink Ltd remeasured the land in its separate financial statements on that date.

On 15 November 20.19, DionLink Ltd entered into discussions with an unrelated third-party

entity for the disposal of the land. An agreement was reached on 1 December 20.19 to dispose of the land to the unrelated third-party entity for a fair valued consideration of R200 000.

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4. The consideration and costs relating to the acquisition of the investment in DionLink Ltd were

calculated as follows by Ojewa Keng:

Sub notes

R

Cash amount paid on 1 August 20.19 4.1 300 000Debentures 4.2 131 750Carrying amount of office furniture transferred 4.3 65 000Issue of shares 4.4 200 000Contingent consideration asset 4.5 (43 000)Fair value of the preference shares at acquisition (1 500 x 105) 1.4 157 500Payment to the CEO 4.6 65 000 876 250Measurement period adjustment Contingent consideration (64 000 – 43 000) 4.5 (21 000) Payment to CEO (resigned 15 December 20.19) 4.6 (65 000)Total consideration transferred 790 250

4.1 A cash payment of R300 000 was made on 1 August 20.19 to the transacting attorneys.

Massmark Ltd appointed KPG Services Ltd, a company that specialises in business combinations to assist with the structuring of the arrangement. The costs related to the services provided by KPG Services Ltd amounted to R25 400 and were included in the cash payment made to the transacting attorneys.

4.2 On 1 August 20.19, Massmark Ltd issued 1 550 R85 debentures. The interest on the

debentures is payable annually in arears at a nominal interest rate of 8,25% per annum. A fair discount rate on similar debentures amount to 10,75% per annum on the date of issue. The debentures will be settled in cash on 30 July 2024.

4.3 Massmark Ltd transferred office furniture with a carrying amount of R65 000 and a fair

value of R85 000 to DionLink Ltd to be used in the office of the Chief Executive Officer (CEO) on 1 August 20.19. The office furniture was correctly recorded in the asset register of DionLink Ltd on 1 August 20.19.

4.4 Massmark Ltd issued 800 of its ordinary shares to the shareholders of DionLink Ltd on

1 August 20.19 when the share price of each share was R250. The ordinary shares were registered on 11 August 20.19 when the shares were valued at R275 each. Massmark Ltd incurred share issue costs amounting to R22 390 with regards to the issue of the 800 ordinary shares. The share issue costs of R22 390 were included in the cash payment made to the transacting attorneys on 1 August 20.19.

4.5 DionLink Ltd has committed to refund Massmark Ltd R64 000 on 31 Decembe 20.19

should the operating profit for the four months ending 30 November 20.19 not increase by 11%. The fair value of this consideration amounted to R43 000 on 1 August 20.19 taking into account all possible outcomes. During the four months ended 30 November 20.19, there was a lot of uncertainty in the worldwide economic environment particularly with regards to the electronic consumer goods, thus the operating profit only increased by 7,5%.

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4.6 On 1 August 20.19, Massmark Ltd entered into an agreement with Dion Linker, CEO,

founder and majority shareholder of DionLink Ltd. Massmark Ltd views Dion Linker as key to the value of DionLink Ltd. The agreement sought to incentivise Dion Linker to remain with DionLink Ltd after the acquisition by Massmark Ltd for at least six months. Massmark Ltd paid Dion Linker R65 000 on 1 August 20.19 in line with this agreement, further agreeing that Dion Linker does not have to repay this amount should he resign at any time after 1 August 20.19. Dion Linker resigned as CEO of DionLink Ltd on 15 December 20.19 with immediate effect. Ojewa Keng accounted for this as a measurement period adjustment.

4.7 The fair value of non-controlling interests of the ordinary share capital amounted to

R428 667 as at 1 August 20.19. Marko Ltd Marko Ltd is an upcoming retail store that offers consumer foods, latest electronics, houseware, outdoor equipment and liquor in its stores in Johannesburg, Bloemfontein and Durban, with its head office of Marko Ltd in Johannesburg. The extract of the preliminary trial balance of Marko Ltd as at 31 December 20.19 contained the following balances, which may be accepted as correct, except where stated otherwise. Dr/(Cr)

R

Non-current assets 782 767Current assets 584 410Ordinary share capital (100 000 shares) (200 000)Retained earnings (1 January 20.19) (126 874)Revaluation surplus (77 600)Profit after tax for the year (106 382)Revenue (575 541)Non-current liabilities (511 915)Current liabilities (344 406) Massmark Ltd acquired 25 000 ordinary shares in Marko Ltd on 1 August 20.19 and exercised significant influence over the operating and financial policy decisions of Marko Ltd from that date. The purchase consideration amounted to R120 000. You may assume that an excess arose on the acquisition of Marko Ltd. All the assets and liabilities of Marko Ltd were deemed to be fairly valued on the date of acquisition except for land and trade receivables which was undervalued by R81 500 and R57 500 respectively. No additional assets or liabilities were identified at the acquisition date. The trade receivables were still outstanding at year end. An independent sworn appraiser valued the land upwards by R100 000 on 31 December 20.19. Marko Ltd accounted for this revaluation in its separate financial statements for the year ended 31 December 20.19. The fair value of the shares of Marko Ltd amounted to R7,45 per share on 31 December 20.19. The investment in Marko Ltd is material to Massmark Ltd. No dividends were declared by Marko Ltd during the current financial year.

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Additional information 1. Income and expenses accrued evenly throughout the 20.19 financial year. 2. It is the accounting policy of Massmark Ltd to account for investments in subsidiaries and

investments in associates at cost in its separate financial statements. 3. Massmark Ltd elected to measure non-controlling interests at fair value on acquisition date for

all acquisitions. 4. 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).

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REQUIRED


Marks

(a) Discuss all considerations relating to the recognition and measurement of the

various elements of the acquisition of DionLink Ltd in the preparation of the consolidated financial statements of the Massmark Ltd Group for the year ended 31 December 20.19.

Communication skills: clarity of expression

Please note: • You are required to provide reasons to support your cconsiderations as well

as recommendations on how to correctly account for the matter. • You are only required to discuss the acquisition method and measurement

period adjustments. • Show all calculations. • You are not required to refer to the Conceptual Framework. • You are not required to re-calculate goodwill or gain from a bargain purchase. • You are not required to discuss subsequent measurement. (b) Prepare the investment in associate note to the consolidated financial statements

of the Massmark Ltd Group for the year ended 31 December 20.19.

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

26

1

12

1

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QUESTION 7 - Suggested solution (a) Discuss all considerations relating to the recognition and measurement of the various

elements of the acquisition of DionLink Ltd in the preparation of the consolidated financial statements of the Massmark Ltd Group for the year ended 31 December 20.19.

1. General On 1 August 20.19 Massmark Ltd acquired 60% of the ordinary shares of DionLink Ltd

and obtained control thereof.

(1)

The principles of IFRS 3 will be applied in accounting for the purchase transaction of DionLink Ltd on 1 August 20.19 as the transaction meets the definition of a business combination. (1)

Massmark Ltd will apply the acquisition method at the acquisition date on 1 August 20.19 as detailed in the paragraphs below.

(1)

Massmark Ltd should recognise and measure all identifiable assets acquired and the liabilities assumed in the business combination at their acquisition date fair values. (1)

2. Net asset value as at 1 August 20.19 The ordinary share capital was adequately valued at R800 000 on the acquisition date

for the 10 000 issued ordinary shares.

(1)

The retained earnings balance was incorrectly included at R220 000 as this was the balance as at 30 June 20.19.

(1)

The loss for the period 1 July 20.19 to 31 July 20.19 must be accounted for in the balance of retained earnings. The loss for the period is R38 000 x 1/6 = R6 333. (1)

The preference shares give their holders a right to a preferential dividend in priority to the payment of any dividend to the holders of ordinary shares. Therefore, the preference dividend should also be taken into account when calculating the retained earnings as at 1 August 20.19. The accrual amount that should be deducted from retained earnings is R1 169 [(1 500 x 85) x 11% x 1/12]

(1)

DionLink Ltd declared an interim dividend of R27 000 on 25 July 20.19, this amount should be deducted from retained earnings to calculate the retained earnings as at 1 August 20.19. The correct retained earnings balance should be R185 498 [C1] as at the acquisition date.

(1)

The revaluation surplus was correctly included in the net asset value as at 1 August 20.19 as R62 000. (1)

COMMENT It is important to note the date at which the retained earnings balance was given (i.e 30 June 2019) and therefore does not include the profit/loss for July. The loss for July needs to be included in the retained earnings balance to attain the correct retained earnings balance at acquisition date. To do this correctly you should note that the loss given is for 6 months. You should then calculate the portion of 1 month of the 6 months and not 12 months.

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3. Preference share capital The share capital of DionLink Ltd consists of two classes of shares being ordinary shares

and preference shares.

(1)

The total owner's equity must be allocated between the different classes of capital in accordance with the particular rights attached to each in order to: (1)

• identify the equity of the subsidiary attributable to the total investment of the parent; and

• determine the total interest of the non-controlling interests (where applicable). The preference share capital of R127 500 (1 500 x 85) should not be included in the

calculation of the goodwill or gain on bargain purchase of DionLink Ltd as at 1 August 20.19 but should be analysed in a separate calculation in line with the particular rights attached to it. (1)

Massmark Ltd did not acquire any preference shares as at 1 August 20.19, thus the allocation of 60% to Massmark Ltd and 40% to NCI in the calculation performed is incorrect. The preference share capital should be measured at fair value of R157 500 and be allocated to NCI only.

(1)

4. Inventory The calculation of goodwill or gain on bargain purchase of DionLink Ltd as at

1 August 20.19 will not reflect any adjustment to inventory as it is already measured at fairvalue i.e. net realisable value in DionLink Ltd’s financials. (1)

On 15 January 2020, the fair value of the Heiwau mobile devices was reliably calculated to have been R58 634 as at 1 August 20.19. This qualifies as a measurement period adjustment as the fair value of the inventory was reliably determined by an independent valuator. Furthermore, the period within which the fair value was confirmed was in less than 12 months, which was four months after acquisition date. (1)

The measurement period adjustment of fair value of inventory that will have an impact on the calculation of goodwill or gain on bargain purchase is calculated as an overvaluation of the carrying amount of inventory as at 1 August 20.19 of R36 366 (R95 000 – R58 634), with a deferred tax consequence of R10 182 (R36 366 x 28%). (1)

COMMENT Please note that since the information indicates that the inventory had already been measured at net realisable value in DionLink’s separate financial statements, the inventory adjustment of R95 000 is not needed and results in a double counting. Remember that a measurement period adjustment is an adjustment of an item within the measurement period (12 months since acquisition date) of which the value at acquisition could not be attained at that date. When the value for the relevant item can be determined later on for the acquisition date, it is considered as an adjustment to at acquisition equity and consequently goodwill only if it falls within the measurement period of 12 months since acquisition date. Therefore, the inventory at the fair value of R58 634 is a measurement period adjustment.

5. Land

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The adjustment to the fair value of land at acquisition date of R23 000 and the related deferred tax consequence was incorrectly included in the calculation of the fair value of the net asset of DionLink Ltd as at 1 August 20.19 as the fair value was already adjusted in the separate financial statements of DionLink Ltd as at that date. (1)

An adjustment of R27 000 on the land, together with the related deferred tax consequence, were incorrectly included as a measurement period adjustment. This is because at acquisition date, there was no uncertainty with regards to the fair value of the land. The disposal of the land was only considered after the acquisition date (on 15 November 20.19) and should therefore not be included as a measurement period adjustment. (1)

6. Acquisition related costs and share issue costs Acquisition related costs should be expensed in profit or loss in the consolidated financial

statements of the acquirer in accordance with IFRS 3.53, thus the R25 400 must be deducted from the cash payment made to the transacting attorneys in the calculation of the consideration transferred for the acquisition of DionLink Ltd (IAS 32; IFRS 9). (1)

Share issue costs of R22 390 relating to the issue of 800 ordinary shares of Massmark Ltd are not acquisition-related costs as defined in terms of IFRS 3. The share issue costs must be accounted for as a deduction from equity in terms of IAS 32.35 in the separate and consolidated financial statements of Massmark Ltd. (1)

COMMENT Transaction costs should be carefully analysed as the accounting treatment for transaction costs are not all the same. Note that the parent will measure its investments in subsidiaries at cost in accordance with IAS 27.10(a) in its separate financial statements. Acquisition-related costs in the separate financial statements of the parent should thus also be expensed. Students should read carefully how the parent treated the transaction costs in its separate financial statements.

7. Debentures The debentures were incorrectly calculated at R131 750. (1)

The fair value of the debentures that should be included in the consideration paid is the present value of the debentures for a cash settlement on 30 July 20.24, calculated as follows: (1)

2ndF Mode Clear All N 5 (1) PMT 10 869 (131 750 x 8,25%) (1) FV 131 750 (1) I 10,75% (1) COMP PV 119 500 Max (2)

8. Office furniture

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The transfer of the office furniture was correctly recorded at the carrying amount in the calculation of the consideration transferred as the office furniture will be used within the group. Massmark Ltd thus retains control of the office furniture. (1)

9. Issue of 800 shares of Massmark Ltd The consideration for the shares issued was correctly calculated using the acquisition

date fair value R250 per share as at 1 August 20.19 in terms of IFRS 3.37. Control in terms of IFRS 10 was obtained on 1 August 20.19 irrespective of the fact that the issued shares were registered on 11 August 20.19. (1)

10. Contingent consideration As part of the acquisition of DionLink Ltd, DionLink Ltd has committed to repay

Massmark Ltd R64 000 on 31 December 20.19 should the operating profit for the four months ending 30 November 20.19 not increase by 11%. The contingent asset was therefore correctly recognised as part of the consideration transferred at the acquisition date fair value of R43 000 in terms of IFRS 3.39. (1)

The fair value of the contingent asset takes into account all possible outcomes with regards to the commitment. The contingent asset will subsequently be measured at fair value, with the gains or losses recognised in profit or loss. Therefore, the adjustment to the fair value of the contingent asset as a measurement period adjustment was incorrect.

(1)

11. Non-controlling interests The fair value of the preference shares at acquisition amounting to R157 500 should not be included in the consideration transferred relating to the acquisition of the issued ordinary shares of the DionLink Ltd. The full balance forms part of NCI.

(1)

12. Non-controlling interests Massmark Ltd elected to measure non-controlling interests at fair value on acquisition

date for all acquisitions. The non-controlling interests on the issued ordinary shares was correctly valued at fair value at acquisition date. (1)

13. Consideration paid to the CEO of DionLink Ltd The amount paid to Dion Linker is correctly included as consideration transferred for

the acquisition of DionLink Ltd, as in terms of IFRS 3.B55(a), when the contingent payments are not affected by employment termination, it is an indication that the contingent payments are additional consideration rather than remuneration. (1)

As a result, when Dion Linker resigned from DionLinks Ltd with immediate effect from 15 December 20.19, it was incorrect for Ojewa Keng to process a measurement period adjustment of R65 000, as this amount is considered to be part of the consideration transferred. (1)


Communication: clarity of expression (1)

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COMMENT Please note that you should read the information in the question carefully. The question specifically states that Massmark did obtain control over DionLink, therefore a discussion regarding control in terms of IFRS 10 should not be given. Remember that a discussion regarding the accounting for the acquisition in terms of IFRS 3 was required and not a discussion of consolidation procedures after acquisition date. Since a discussion/consideration are required, do not merely show the calculations and amounts for the net asset value on 1 August 20.19 but rather give the relevant discussion surrounding these calculations in terms of IFRS 3.

EXAM TECHNIQUE Remember to discuss items that are correct as well to earn the easy marks and not just the incorrect items, unless the required states that you specifically should not.

CALCULATIONS C1. Retained earnings

Opening balance 220 000 Loss for period (38 000 x 1/6) (6 333) Dividends declared (27 000) Preference dividend accrual [(1 500 x 85) x 11% x 1/12] (1 169) 185 498

C2. Analysis of equity of DionLink Ltd (for completeness)

Total

At

60% NCI 40%

At acquisition Share capital 800 000 Retained earnings [C2] 185 498 Revaluation surplus 62 000 1 047 498 628 499 418 999Equity represented by goodwill 39 879 30 211 9 668Consideration and NCI (C3) 1 087 377 658 710 428 667

Measurement period adjustment Net asset value 1 047 498 628 499 418 999Inventory [(95 000 – 58 634) x 72%] (26 183) (15 710) (10 473) 1 021 315 612 789 408 526Equity represented by goodwill 50 352 30 211 20 141Consideration and NCI 1 071 667 658 710 428 667

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C3. Consideration transferred (for completeness)

Cash amount paid 300 000Costs directly related to issue of shares (22 390)Debentures 119 500Carrying amount of vehicle transferred 65 000Cost related to KPG Services (Pty) Ltd (25 400)Issue of shares 200 000Contingent consideration asset (43 000)Payment to the CEO 65 000 658 710

C4. Analysis of preference share capital of DionLink Ltd at acquisition (for completeness)

Total

R At

NCI 100%

At acquisition Share capital Preference dividend accrual

127 5001 169

127 5001 169

128 669 128 669Equity represented by goodwill 28 831 28 831Consideration and NCI 157 500 157 500

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(b) Prepare the investment in associate note to the consolidated financial statements of

the Massmark Ltd Group for the year ended 31 December 20.19. MASSMARK LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED

31 DECEMBER 20.19

1. Investment in associate Massmark Ltd owns a 25% interest in the wholesale and retail company, Marko Ltd.

Marko Ltd is incorporated in South Africa where it conducts its principal business. The associate is measured using the equity method. (2)

Summarised financial information of associate for the year ended 31 December 20.19:

R

Non-current assets 782 767 (1) Current assets 584 410 (1) Non-current liabilities (511 915) (1) Current liabilities (344 406) (1) Revenue (575 541) (1) Profit for the year (106 382) (1) Other comprehensive income for the year (77 600) (1) Total comprehensive income (106 382 + 77 600) (183 982) Reconciliation of the summarised information Net asset value (782 767 + 584 410 – 511 915 – 344 406) or (200 000 + 126 874 + 106 382 + 71 600) 510 856 Fair value adjustments – Trade receivables (57 500 x 72%) 41 400 (1) Net asset of associate 552 256 25% interest in net assets of associate 138 064 (1) Carrying amount of investment in associate at 31 December 20.19 138 064 No dividends were declared during the year.

(1)

Fair value of investment in associate The fair value of the investment in the associate is R186 250 (R7,45 x 25 000) (1)



EXAM TECHNIQUE Please read the required carefully. The investment in associate note was asked and NOT the investment in subsidiary note. Remember to state that no dividends were declared during the year.

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