Other feature HKAS Separate Financial Statements 2.2 Investment Entities

Transcription

1 Key Notes from HKCA Chapter 28: Principles of consolidation HKFRS 10 Consolidated Financial Statements HKAS 28 Investments in Associates and Joint Ventures HKFRS 11 Joint Arrangements HKFRS 12 Disclosure of Interests in Other Entities HKAS 27 Separate Financial Statements Table of Content HKFRS 10, HKAS 28, HKFRS 11, HKFRS Definitions 1.2 Classification 1.3 Control Power Return Ability Accounting treatment: Subsidiary 1.4 Significant influence Accounting treatment: Associate 1.5 Joint control Joint operation Joint venture Accounting treatment: Joint operation and Joint venture 1.6 Accounting treatment: Financial assets 1.7 Disclosure Other feature HKAS Separate Financial Statements 2.2 Investment Entities HKICPA Module A Financial Reporting A Keyword Note Marks are allocated to the correct keyword you write in the answer book. By understanding the keyword in each standard, you can answer the correspondence question in no time. This is the first key for you to pass the examination keyword memorizing technique. HKCA All for you to PASS! 5 page 500

2 Chapter 28 Principal of Consolidation Principles of consolidation HKFRS 10 Consolidated Financial Statements HKAS 28 Investments in Associates and Joint Ventures HKFRS 11 Joint Arrangements HKFRS 12 Disclosure of Interests in Other Entities HKAS 27 Separate Financial Statements Correspondence Question Keyword answer Index Subsidiary -HKFRS 10 Control 1.3 -Power -Return -Ability Associate -HKAS 28 Significant influence 1.4 Joint control -HKFRS 11 Contractual arrangement 1.5 -Joint control -Joint operation All other -HKFRS 9 Financial asset 1.6 Separate Financial -Cost or HKFRS Statements (HKAS 27) Investment Entities No consolidation 2.2 Flow Chart 6 All for you to PASS! HKCA page 501

3 1.1 Definitions Group is a parent and its subsidiaries. (HKFRS 10) Parent is the head of group is to controls one or more entities. (HKFRS 10) Subsidiary is controlled by another entity. (HKFRS 10) Consolidated financial statements are the combined financial statements in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. (HKFRS 10) 1.2 Classification As we have mentioned in Section 1.1, an entity (investee) is treated as another entity s (investor s): Subsidiary if control exists, HKFRS 10 (Section 1.3); Associate if significant influence exists, HKAS 28 (Section 1.4); Joint arrangement if contractual arrangement exists, HKFRS 11 (Section 1.5); or Financial instrument if it does not meet the above criteria, HKFRS 9 (Section 1.6). If an entity acquires ordinary shares of another but does not obtain control or significant influence and no contractual arrangement is made, the investment shall be treated as asset held for accretion of wealth and accounted for under HKAS 39 Financial Instruments: Recognition and Measurement. Ability to govern Control Joint Control Significant influence No Significant influence Subsidiary Joint Arrangement Associate Financial instrument The percentage of shares held by the reporting entities is one of the ways to determine whether control or significant influence exists or not. However, existence of control and significant influence depends on not only percentage of shares owned but also a number of other factors. HKCA All for you to PASS! 7 page 502

4 Chapter 28 Principal of Consolidation 1.3 Control HKFRS 10 requires that an entity (investor) controls another entity (investee) if it has all the following elements: power over the investee (1.3.1) exposure, or rights, to variable returns from its involvement with the investee (1.3.2) the ability to use its power over the investee to affect the amount of the investor s returns (1.3.3) The investor (parent) shall consider all facts and circumstances when assessing whether it controls investee (subsidiary). The parent shall reassess whether it controls the subsidiary if facts and circumstances indicate that there are changes to one or more of the three elements of control. 8 All for you to PASS! HKCA page 503

5 1.3.1 Power An investor (the parent) has power over an investee (the subsidiary) when the investor has existing rights that give it the current ability to direct the relevant activities of investee. Relevant activities are a range of operating and financing activities significantly affect their returns. The following activities, depending on the circumstances, may be relevant activities: selling and purchasing of goods or services; managing financial assets during their life (including upon default); selecting, acquiring or disposing of assets; researching and developing new products or processes; and determining a funding structure or obtaining funding. An investor must have existing rights that give the investor the current ability to direct the relevant activities, but the power can have yet to be exercised. The following are some examples of decisions about relevant activities: establishing operating and capital decisions of the investee, including budgets; appointing and remunerating an investee s key management personnel or service providers and terminating their services or employment. Step 1 The investor considers all facts and circumstances, including: the size of the investor s holding of voting rights relative to the size and dispersion of the holdings of other vote holders; potential voting rights held by the investor, other vote holders or other parties; and rights arising from other contractual arrangement. Where there are no potential voting rights or other contractual arrangements, when the investor holds significantly more voting rights than any other vote holder or organised group of vote holders, and the other shareholdings are widely dispersed, after considering the factors listed above, it may be clear that the investor has power over the investee. However, in other situation, the above factors may provide sufficient evidence that the investor does not have power. In some cases, the above factors may not be conclusive that the investor has power over the investee. Under such a situation, the investor will need to proceed to the second step. HKCA All for you to PASS! 9 page 504

6 Chapter 28 Principal of Consolidation Step 2 If an investor, having considered the above factors, is unclear whether it has power, it should consider additional facts and circumstances, such as: whether other shareholders are passive in nature as demonstrated by voting patterns at previous shareholders meetings; whether the investor has the practical ability to direct the relevant activities unilaterally; whether the investor has a special relationship with the investee, which suggests that the investor may have more than a passive interest in the investee; and whether the investor is exposed to, or has rights to, a large exposure to variability of returns which indicates that the investor may have power. The fewer voting rights the investor holds, and the fewer parties that would need to act together to outvote the investor, the more reliance would be placed on the additional facts and circumstances as in step 2 of the analysis to assess whether the investor s rights are sufficient to give it power Return For the sake of establishment of control, an investor must have expanse or rights to variable returns from its investment. Through the involvement of the investment, investors can have variously potential returns which depend on performance of the investee. Returns may include: dividends remuneration for servicing an investee's assets or liabilities fees and exposure to loss from providing credit support returns as a result of achieving synergies or economies of scale through an investor combining use of their assets with use of the investee's assets 10 All for you to PASS! HKCA page 505

7 1.3.3 Ability Examples of rights that, either individually or in combination, can give an investor power include but are not limited to: rights in the form of voting rights (or potential voting rights) of an investee; rights to appoint, reassign or remove members of an investee s key management personnel who have the ability to direct the relevant activities; rights to appoint or remove another entity that directs the relevant activities; rights to direct the investee to enter into, or veto any changes to, transactions for the benefit of the investor; and other rights (such as decision-making rights specified in a management contract) that give the holder the ability to direct the relevant activities. The following are some examples of rights which can give an investor power: The investor can, without having the contractual right to do so, appoint or approve the investee s key management personnel who have the ability to direct the relevant activities. The investor can, without having the contractual right to do so, direct the investee to enter into, or can veto any changes to, significant transactions for the benefit of the investor. The investor can dominate either the nominations process for electing members of the investee s governing body or the obtaining of proxies from other holders of voting rights. The investee s key management personnel are related parties of the investor (for example, the chief executive officer of the investee and the chief executive officer of the investor are the same person). The majority of the members of the investee s governing body are related parties of the investor. Link between power and returns For the sake of establishment of control, an investor or an agent, who was delegated decision powers by investors, must be able to exercise their power to affect its return from its involvement with its investee Accounting treatment: Subsidiary When an entity controls another entity in accordance with the criteria mention in Section 1.3, a parent subsidiary relationship is established. The investor is the parent company and the investee is the subsidiary. We will discuss the accounting treatments for consolidation of subsidiary in more detail in Chapter 29. HKCA All for you to PASS! 11 page 506

8 Chapter 28 Principal of Consolidation Example 1 (Subsidiary) Ba Ba Ltd ( BBL ) controls over the composition of Board of Directors of Son Ltd ( SL ). BBL owns only 45% shares of SL and is the largest shareholder. Besides, Ma Ma Ltd ( MML ), a wholly-owned subsidiary of BBL, owned 10% shares of SL. Required Please discuss the relationship between BBL and SL. Solution SL is a subsidiary of BBL because BBL can exercise control on SL. BBL controls more than 50% of the voting power (45% direct voting power and 10% indirect voting power through MML). Besides, through the Board of Directors, it can govern the financial and operating policies. 1.4 Significant influence (Associate, HKAS 28) Percentage of share Control Significant influence No significant influence Unless it is shown that there is no significant influence, otherwise it is assumed that the investor has significant influence to investee if it holds directly or indirectly 20% or more of the voting power of the associate. If the holding is less than 20%, the investor will be assumed not to have significant influence unless such influence exists and can be shown. If there is another investor which held a majority of ownership, the investor which held 20% or more of ownership can still have significant influence to the investee. 12 All for you to PASS! HKCA page 507

9 Significant influence is normally created by one of following ways: Representation on the Board of Directors Participation in the policy-making process Material transactions occurring between the two entities The changing over of management The provision of essential technical information While assessing whether an entity has significant the influence of an entity, the existence of potential voting rights. For example, share-warrants and share-call options, must be considered. Where these potential voting rights are not currently exercisable, they will not be taken into consideration. When an investor loses its power of participation in the financial and operating policy decisions of the investee, significant influence is lost. It can occur with or without a loss of voting power or a change in the ownership levels. For example, when an associate becomes subject to the control of a government, court, administrator or regulator, it could also occur as a result of a contractual arrangement. HKCA All for you to PASS! 13 page 508

10 Chapter 28 Principal of Consolidation Accounting treatment: Associate When an entity (investor) has significant influence on another entity (investee) in accordance with the criteria mention in Section 1.4, the investee shall be treated as an associate of investor. We will discuss the accounting treatments for consolidation of associate in more detail in Chapter 30. Example 2 (Associate) Benito Ltd is a manufacturing company of furniture. Anna Ltd owns 70% of the voting rights of Benito Ltd, Chita Ltd owns 15% of the voting rights of Benito Ltd, and the remainder are dispersed among the public. Chita Ltd is also the sole supplier of raw materials to Benito Ltd and has a contract to supply certain expertise regarding the maintenance of Benito Ltd s equipment. Required Please discuss the relationship between Benito Ltd and Chita Ltd. Solution Chita Ltd is the sole supplier of raw materials to Benito Ltd and provides expertise in the form of maintenance of Benito Ltd s equipment. Although Chita Ltd owns only 15% of the voting rights, Chita Ltd may be able to exercise significant influence over Benito Ltd because of the material transactions between Benito Ltd and Chita Ltd. Therefore Benito Ltd may be treated as an associate of Chita Ltd. 1.5 Joint control (HKFRS 11) A joint arrangement is an arrangement of which two or more parties have joint control. A joint arrangement has the following characteristics: The parties are bound by a contractual arrangement. The contractual arrangement gives two or more of those parties joint control of the arrangement. The definition of joint control specifically refers to a contractually agreed sharing of control and states that it only exists when decisions about the relevant activities require the unanimous consent of the parties sharing control. There is no joint control where there is: no contractual arrangement to establish joint control, or a contractual arrangement but unanimous consent is not required to make decisions. 14 All for you to PASS! HKCA page 509

11 The followings are additional points about joint control: No single party controls the arrangement on its own It can prevent any of the other parties from controlling the arrangement, when a party with joint control of an arrangement. An arrangement can be a joint arrangement even though not all of its parties have joint control; some parties to a joint arrangement may participate but not have joint control. Judgment should be applied when assessing whether a party has joint control of an arrangement. Example 3 (Joint control) Xenia, Yvonne and Zach establish an arrangement. Xenia, Yvonne and Zach s share of voting rights are 50%, 30% and 20% respectively. The contractual arrangement between the parties specifies that at least 75% of votes are required to make decisions about relevant activities of the arrangement. Xenia, Yvonne and Zach are not related party to each other. Required Please discuss their power on the arrangement respectively. Solution According to the agreement between the parties, Xenia can block any decision, however does not control the arrangement alone as it does not have 75% of the voting rights alone and it needs the agreement of Yvonne. Since Xenia need the agreement of Yvonne, therefore, the agreement is treated as a joint control arrangement between Xenia and Yvonne since relevant decision about the activities have to be agreed by them. Zach is a participating party to the arrangement, however it does not have joint control. Thus, Zach shall treat the arrangement as associate since it has significant influence. HKCA All for you to PASS! 15 page 510

12 Chapter 28 Principal of Consolidation A joint arrangement is either a joint operation or a joint venture. The classification of joint arrangements requires the parties to assess their rights and obligations arising from the arrangement. When making that assessment, an entity shall consider the following: the structure of the joint arrangement. when the joint arrangement is structured through a separate vehicle: - the legal form of the separate vehicle; - the terms of the contractual arrangement; and - when relevant, other facts and circumstances Joint operation A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Those parties are called joint operators. A joint arrangement which is not structured through a separate entity is always a joint operation Joint venture A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers. The terms of the contractual arrangement Joint operation The contractual arrangement provides the parties to the joint arrangement with rights to the assets, and obligations for the liabilities, relating to the arrangement. Joint venture The contractual arrangement provides the parties to the joint arrangement with rights to the net assets of the arrangement (i.e. it is the separate vehicle, not the parties, that has rights to the assets, and obligations for the liabilities, relating to the arrangement). 16 All for you to PASS! HKCA page 511

13 Rights to assets Obligations for liabilities Joint operation The contractual arrangement establishes that the parties to the joint arrangement share all interests (eg rights, title or ownership) in the assets relating to the arrangement in a specified proportion (eg in proportion to the parties ownership interest in the arrangement or in proportion to the activity carried out through the arrangement that is directly attributed to them). The contractual arrangement establishes that the parties to the joint arrangement share all liabilities, obligations, costs and expenses in a specified proportion (e.g. in proportion to the parties ownership interest in the arrangement or in proportion to the activity carried out through the arrangement that is directly attributed to them). The contractual arrangement establishes that the parties to the joint arrangement are liable for claims raised by third parties. Joint venture The contractual arrangement establishes that the assets brought into the arrangement or subsequently acquired by the joint arrangement are the arrangement s assets. The parties have no interests (ie no rights, title or ownership) in the assets of the arrangement. The contractual arrangement establishes that the joint arrangement is liable for the debts and obligations of the arrangement. The contractual arrangement establishes that the parties to the joint arrangement are liable to the arrangement only to the extent of their respective investments in the arrangement or to their respective obligations to contribute any unpaid or additional capital to the arrangement, or both. The contractual arrangement states that creditors of the joint arrangement do not have rights of recourse against any party with respect to debts or obligations of the arrangement. HKCA All for you to PASS! 17 page 512

14 Chapter 28 Principal of Consolidation Revenues, expenses, profit or loss Guarantees Joint operation The contractual arrangement establishes the allocation of revenues and expenses on the basis of the relative performance of each party to the joint arrangement. For example, the contractual arrangement might establish that revenues and expenses are allocated on the basis of the capacity that each party uses in a plant operated jointly, which could differ from their ownership interest in the joint arrangement. In other instances, the parties might have agreed to share the profit or loss relating to the arrangement on the basis of a specified proportion such as the parties ownership interest in the arrangement. This would not prevent the arrangement from being a joint operation if the parties have rights to the assets, and obligations for the liabilities, relating to the arrangement. The parties to joint arrangement might provide guarantees to third parties. The joint arrangement is a joint operation if the parties have obligations for the liabilities relating to the arrangement. Joint venture The contractual arrangement establishes each party s share in the profit or loss relating to the activities of the arrangement. The parties to joint arrangement might provide guarantees to third parties. The joint arrangement is a joint venture if the parties do not have obligations for the liabilities relating to the arrangement. 18 All for you to PASS! HKCA page 513

15 1.5.3 Accounting treatment: Joint operation and Joint venture When an entity (investor) has joint control with a third party on another entity (investee) in accordance with the criteria mention in Section and 1.5.2, the investee shall be treated as a joint operation and joint venture of the investor respectively. We will discuss the accounting treatments for consolidation of joint operation and joint venture in more detail in Chapter Accounting treatment: Financial assets If an entity (investor) has interests in another entity (investee), but does not obtain control, significant influence or joint control over the investee, the investment shall be treated as financial assets in accordance with HKASs 32&39 and HKFRSs 7&9. We will discuss in more detail in Chapter 9 Financial instruments. 1.7 Disclosure (HKFRS 12) The entity shall disclose: the significant judgments and assumptions made in determining the nature of an interest in another entity or arrangement, and in determining the type of joint arrangement in which an interest is held. information about interests in subsidiaries (including those which are not consolidated as a result of the investment entity exception), associates, joint arrangements and structured entities that are not controlled by an investor. information about significant judgments and assumptions made in determining: - that it has joint control of an arrangement or significant influence over another entity, and - the type of joint arrangement (joint operation or joint venture) when the arrangement is structured through a separate vehicle. information to enable users of the financial statements to evaluate: - the nature, extent and financial effects of its interests in joint arrangements and associates, including the nature and effects of its contractual relationship with other investors. - the nature of, and changes in, risks associated with interests in joint ventures and associates. separated commitments that it has relating to its joint ventures from the amount of other commitments. separated contingent liabilities incurred relating to its interests in joint ventures or associates from the amount of other contingent liabilities. HKCA All for you to PASS! 19 page 514

16 Chapter 28 Principal of Consolidation Additional disclosure Joint arrangement and associate: When a joint arrangement and associate that is material to the reporting entity, the following should be disclosed: - The name of the joint arrangement or associate. - The nature of the entity's relationship with the joint arrangement or associate. - The principal place of business or country of incorporation of the joint arrangement or associate. - The proportion of ownership interest held by the entity or proportion of voting rights held. Joint venture and associate: The following should be disclosed when a joint venture and associate that is material to the reporting entity: - Risks associated with an entity's interests in joint ventures and associates. - Whether the investment in the joint venture or associate is measured using equity method or fair value. Other feature HKAS 27 Separate Financial Statements 2.1 Separate Financial Statements Although HKFRSs do not mandate which entities produce separate financial statements, usually, a holding company will also prepare its own single company financial statement. Separate financial statements shall be prepared in accordance with all applicable HKFRSs, except when an entity prepares separate financial statements. The entity shall account for investments in subsidiaries, joint ventures and associates either: at cost, or in accordance with HKFRS 9. The entity shall apply the same accounting for each category of investments. Investments accounted for at cost shall be accounted for in accordance with HKFRS 5 Non-current Assets Held for Sale and Discontinued Operations when they are classified as held for sale (or included in a disposal group that is classified as held for sale). The measurement of investments accounted for in accordance with HKFRS 9 is not changed in such circumstances. An entity shall recognise a dividend from a subsidiary, a joint venture or an associate in profit or loss in its separate financial statements when its right to receive the dividend is established. 20 All for you to PASS! HKCA page 515

17 2.2 Investment Entities HKFRS 10 was amended in December 2012 to address the issue of investment entities. An investment entity is defined as an entity that: (a) obtains funds from one or more investors for the purpose of providing those investors with investment management services; (b) commits to its investors that its business purpose is to invest funds solelt for returns from capital appreciation, investment income or both; and (c) measures and evaluates the performance of substantially all of its investments on a fair value basis. Investment entities therefore include private equity organisations, venture capital organisations, pension funds and other investment funds. Prior to the amendment, entities such as these were required to apply HKFRS 10 and consolidate all subsidiaries which they control. Investors and other users of the accounts felt, however, that this did not result in useful information; the most useful and relevant information would be to recognise investments at fair value. As a result, HKFRS 10 is amended to require that investment entities measure subsidiaries at fair value through profit or loss rather than consolidate them. This requirement applies only to the subsidiaries of an investment entity which do not provide services which relate to the investment entity s activities. Subsidiaries which provide investment-related services are consolidated as normal. HKCA All for you to PASS! 21 page 516

18 Chapter 29 Accounting for Subsidiaries (HKFRS 3&10) Chapter 29: Accounting for Subsidiaries Pre-acquisition retained earnings of subsidiary In Example 1, we saw that pre-acquisition retained earnings shall be eliminated as this amount is not attributable to the group. If the subsidiary is a wholly-owned subsidiary and set up by the parent company itself, the whole amount of retained earnings are included as group reserves. The following table illustrates the accounting treatments for pre- and post- acquisition retained earnings respectively. Retained earnings of subsidiary Accounting treatment Pre-acquisition Eliminated against parent's investment Post-acquisition Included in group reserves 1.1 Step 2 : Goodwill calculation In the consolidated statement of financial position, goodwill shall be recognised as an asset. The group is required to test for impairment annually. By definition, goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. It is different from the term goodwill used in business. In general sense, goodwill refers to good reputation, customer base, customer loyalty, etc. However, in accounting concept, these items shall be treated and recognised as intangible assets if they fulfilled the criteria of HKAS 38. The goodwill in accounting is likely to arise when a company buys a business such as a subsidiary or an unincorporated business. Goodwill is calculated as the sum of the consideration and the non-controlling interests less the fair value of identifiable net assets acquired. The non-controlling interests can be measured at fair value or as a proportion of the net assets of the acquiree. 22 All for you to PASS! HKCA page 525

19 Therefore, the goodwill is calculated by: Calculation Section Consideration XXX Contingent consideration Acquisition related cost Pre-existing relationship Non-controlling Interests XXX Non-controlling interests Previous Held Interest (FV) XXX 2.1 Step Acquisition XXX Less: Fair Value of Net Assets Share Capital Pre-acquisition Retained Profit Fair Value Adjustment Goodwill (XXX) (XXX) (XXX) (XXX) XXX Contingent liability Indemnification assets Intangible assets Reacquired rights Restructuring and future losses We will discuss the following key elements in more detail in: Consideration transferred: Section Amount of any non-controlling interest: Section Net acquisition-date fair value of identifiable assets acquired and liabilities assumed: Section Consideration transferred Consideration transferred is the total cost of investment in exchange for the acquiree. The consideration transferred in a business combination shall be measured at fair value, which consists of: Acquisition date fair values of the assets transferred; e.g. cash, a business or a subsidiary of the acquirer, member interests of mutual entity, etc Liability incurred by the acquirer to former owners; and e.g. contingent consideration (if any and probable), debt to the former owners, etc Equity interests issued by the acquirer (Share-based transaction shall be measured in accordance with HKFRS 2 instead of fair value) e.g. ordinary or preference equity instruments, options, warrants, etc HKCA All for you to PASS! 23 page 526

20 Chapter 29 Accounting for Subsidiaries (HKFRS 3&10) Example 2 (Goodwill) As at 31 December 2013, Master Ltd acquired all the share capital of Servant Ltd. The statement of financial position of Master Ltd. and Servant Ltd are show as below: Master Ltd Servant Ltd $ $ Non-current assets 10,000 8,000 Investment in Servant Ltd 9,500 - Current assets 6,000 1,250 25,500 9,250 Represented by: Share capital 20,000 7,500 Reserves 4,750 1,250 24,750 8,750 Current liabilities ,500 9,250 The consolidation process involves: Calculating the goodwill in the consolidated statement of financial position Adding the assets and liabilities of Master and Servant together. Eliminating the investment in Servant shown in Master's books against Servant's equity Required Please prepare the consolidated statement of financial position of Master Ltd as at 31 December Solution Goodwill: $ Consideration 9,500 Net assets of Servant Ltd (8,750) All for you to PASS! HKCA page 527

21 Consolidated statement of financial position of Master Ltd as at 31 December 2013 Master Ltd Servant Ltd Consolidated Adjustment Master Ltd $ $ $ $ Non-current assets 10,000 8,000-18,000 Investment in Servant Ltd. 9,500 - (9,500) - Goodwill Current assets 6,000 1,250-7,250 25,500 9,250 26,000 Represented by: Share capital 20,000 7,500 (7,500) 20,000 Reserves 4,750 1,250 (1,250) 4,750 24,750 8,750 24,750 Current liabilities ,250 25,500 9,250 26,000 Note: The adjustments of consolidation are memoranda only. They are not a part of individual company's accounting records. Consolidation adjustment $ $ Dr Share capital 7,500 Pre-acquisition reserves (Servant Ltd) 1,250 Goodwill on consolidation 750 Cr Cost of investment 9,500 HKCA All for you to PASS! 25 page 528

22 Chapter 29 Accounting for Subsidiaries (HKFRS 3&10) Contingent consideration Consideration may be immediate or deferred. Deferred consideration may be contingent upon: an event; or the acquiree attaining certain financial or non-financial goals. Contingent consideration is defined by HKFRS 3 as: Case 1: an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met; or Case 2: a right to the return of previously transferred consideration if specified conditions are met. Therefore, contingent consideration may be a liability or equity (in case 1) or an asset (in case 2) of the acquirer. Since there are substantial uncertainties on the performance of the acquired business, thus the contingent consideration might be a part of many transactions, such as earnings target in an earn-out arrangement. If the acquire fails to meet the targets in the agreements, a contingent consideration asset may arise. HKFRS 3 required the entity to recognise the contingent consideration at acquisition-date using fair value as part of the consideration transferred. As we have mentioned before, contingent consideration may be payable in the form of equity, a financial liability or cash. In the case of equity or financial liability, it is classified in accordance with HKAS 32. The entity shall subsequent account for the consideration in the following ways: When there is change in fair value arising from additional information obtained within the measurement period that affects the position at the acquisition date. - The entity shall remeasure the goodwill; When there is change in fair value due to post-acquisition events, such as meeting earnings targets. The entity shall not remeasure the equity instrument. - If the change is in the form of a financial instrument, for example loan notes, the entity shall account for the change under HKFRS 9. - If the change is in the form of cash, the entity shall account for the change under HKAS 37. page All for you to PASS! HKCA

23 The following table illustrates the accounting treatments: Initial recognition Subsequent measurement Financial liability Dr Investment in subsidiary Cr Liability for contingent consideration Increase in FV: Dr Profit or loss Cr Liability for contingent consideration Equity instrument Dr Investment in subsidiary Cr Equity for contingent consideration No remeasurement Settlement (Paid) Derecognition (No settlement required) Decrease in FV: Dr Liability for contingent consideration Cr Profit or loss Dr Liability for contingent consideration Cr Bank Dr Liability for contingent consideration Cr Profit or loss Dr Equity for contingent consideration Cr Share Capital Dr Equity for contingent consideration Cr Profit or loss Example 3 (Contingent consideration) On 1 January 2013, Predator Ltd acquires all of the share capital of Guardian Ltd for $350m. They agree that a further payment dependent on the earnings of Guardian Ltd post-acquisition will be required. The agreement statues that if Guardian Ltd s earnings exceed $17.5m in each next two year (subject to a maximum of $24.5m), Predator is required to pay 20% of the excess to the previous shareholders. Therefore, the amount of the further payment will be ranged from nil to $1.4m (($24.5m $17.5m) x 20%) The management uses a simulation model and the fair value of the contingent consideration was estimated at $875,000. At the date of acquisition, the fair value of the identifiable net assets of Guardian Ltd was $336m. page 530 HKCA All for you to PASS! 27

24 Chapter 29 Accounting for Subsidiaries (HKFRS 3&10) Required (a) Please calculate: i. Goodwill ii. State how the investment in Guardian Ltd. is recorded in the seperate financial statements of Predator Ltd in the year ended 31 October (b) Under the following two scenarios, please calculate the goodwill and show the journal entries of Predator Ltd. to recognise the investment in Guardian Ltd. i. On 1 June 2013, the fair value of the contingent consideration at acquisition date (1 January 2013) was reassessed to $0.7m. ii. At the end of the first year, Guardian Ltd had earn $28 million. The fair value of contingent consideration in relation to the second year at this stage is estimated to be $0.35m. Solution (a) (i) $'000 Cash consideration 350,000 Fair value of contingent consideration 875 Fair value of identifiable net assets of acquiree (336,000) Goodwill 14,875 (ii) Predator Ltd records the investment in Guardian Ltd $'000 $'000 Dr Investment 350,875 Cr Cash 350,000 Cr Liability for contingent consideration 875 (b) (i) The goodwill will re-measurement period at: $'000 Cash consideration 350,000 Fair value of contingent consideration 700 Fair value of identifiable net assets of acquiree (336,000) Goodwill 14,700 Predator Ltd. should therefore have recorded the investment in Guardian Ltd by: $'000 $'000 Dr Investment 350,700 Cr Cash 350,000 Cr Liability for contingent consideration All for you to PASS! HKCA page 531

25 Adjustment to the original acquisition journal made is therefore required $'000 $'000 Dr Liability for contingent consideration 175 Cr Investment 175 (ii) Goodwill is not remeasured since the change in the estimated fair value of contingent consideration is due to events after the acquisition date, therefore the goodwill shall remain at the acquisition date amount of $14.875m. However, the liability in Predator s financial statements will be adjusted to reflect the new estimate of the amount of contingent consideration payable: Payable in respect of: $'000 Year 1 (($24.5m $17.5m) x 20%) 1,400 Year ,750 The journal entry would be: $'000 $'000 Dr Profit or loss (1, ) 875 Cr Liability for contingent consideration Acquisition related cost Acquisition-related costs are costs the acquirer incurs to effect a business combination. Those costs include finder s fees, advisory, legal, accounting, valuation and other professional or consulting fees, general administrative costs, including the costs of maintaining an internal acquisitions department; and costs of registering and issuing debt and equity securities. The acquirer shall account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities shall be recognised in accordance with HKAS 32 and HKFRS Pre-existing relationship According to HKFRS 3, the acquirer shall account for the pre-existing relationships between the acquirer and acquire separately from the business combination which will not be part of the consideration. 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, i.e. amounts that are not part of the exchange for the acquiree. The acquirer shall recognise as part of applying the acquisition method only the consideration transferred for the acquiree and the assets acquired and liabilities assumed in the exchange for the acquiree. Separate transactions shall be accounted for in accordance with the relevant HKFRSs. For example, the acquirer s settlement of a pre-acquisition payable balance due to the acquiree, the remuneration to employees or former owners of the acquiree for future services and payment of the acquirer s acquisition-related costs should be accounted for as compensation instead of part of the consideration. page 532 HKCA All for you to PASS! 29

26 Chapter 29 Accounting for Subsidiaries (HKFRS 3&10) page All for you to PASS! HKCA

27 Chapter 30: Accounting for Associate and Joint Arrangement Accounting for Associate and Joint Arrangement HKAS 28 Investments in Associates and Joint Ventures HKFRS 11 Joint Arrangements Correspondence Question Keyword answer Index Associate -Significant influence 1.2 Application of the equity method Consideration + post acquisition RE - impairment loss = investment in associate (Consolidation financial position) Inter-companies transactions -Eliminate unrealised profit (% hold only) Joint ventures -Application of equity method Accounting treatment for contribution of nonmonetary assets Joint operations Recognise the following line-by-line in according to its interest in a joint operation: -Its assets (including its share of any jointly held assets) -Its liabilities (including its share of any jointly incurred liabilities) -Its expenses (including its share of any expenses incurred jointly) -Its revenue (from the sale of its share of the output arising from the joint operation) -Its share of the revenue (from the sale of the output by the joint operation) HKCA All for you to PASS! 31 page 589

28 Chapter 30 Accounting for Associate and Joint Arrangement Flow chart 32 All for you to PASS! HKCA page 590

29 1.1 Definitions The equity method is a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor s share of the investee s net assets. The investor s profit or loss includes its share of the investee s profit or loss and the investor s other comprehensive income includes its share of the investee s other comprehensive income. 1.2 Associate An entity uses the equity method to account for its investments in associates in its consolidated financial statements. An entity that does not have any subsidiaries also uses the equity method to account for its investments in associates in its financial statements even though those are not described as consolidated financial statements. The only financial statements to which an entity does not apply the equity method are separate financial statements it presents in accordance with HKAS 27 Separate Financial Statements. As we have mentioned in Chapter 22, if an entity holds, directly or indirectly (e.g. through subsidiaries), more than or equal to 20% but less than 50% of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case Application of the equity method A group s share in an associate is the aggregate of the holdings in that associate or joint venture by the parent and its subsidiaries. The shares held by group s other associates are ignored for this purpose. Since the acquirer does not obtain control over the associate, the associate is not deemed to be part of the single economic entity that is the group. The investment in associate is hence shown in the consolidated financial statements as investment in associate. Any profit or loss and the share of other comprehensive income of the associate shall be recognised as profit or loss in associate and share of other comprehensive income of associates respectively. Consideration XX Add: Post acquisition retained earnings (% of shares) XX Less: Impairment (HKAS 36) (XX) Investment in associate XX HKCA All for you to PASS! 33 page 591

30 Chapter 30 Accounting for Associate and Joint Arrangement Initial recognition On the acquisition date, the acquirer shall recognise its investment in associates at cost. On acquisition date, any difference between the cost of the investment and the entity s share of the net fair value of the investee s identifiable assets and liabilities is accounted for as follows: Goodwill relating to an associate is included in the carrying amount of the investment. Amortisation of that goodwill is not permitted. Therefore, the accounting entries for the investment in associate are as follows. If Cost of investment Fair value of the investee s identifiable assets and liabilities: Dr Investment in associate Cr Bank Any excess of the entity s share of the net fair value of the investee s identifiable assets and liabilities over the cost of the investment is included as income in the determination of the entity s share of the associate s profit or loss in the period in which the investment is acquired. Net assets of associates x % of share XX Add: Goodwill XX Less: Impairment (HKAS 36) (XX) Investment in associate XX If Cost of investment < Fair value of the investee s identifiable assets and liabilities: Dr Investment in associate (Fair value) Cr Bank Cr Share of profit of associate (SOPL) However, if the contribution of a non-monetary asset to an associate is lack of commercial substance, the gain or loss is regarded as unrealised and is not recognised unless it is in addition to receiving an equity interest in an associate or a joint venture. Such unrealised gains and losses shall be eliminated against the investment accounted for using the equity method and shall not be presented as deferred gains or losses in the entity s consolidated statement of financial position or in the entity s statement of financial position in which investments are accounted for using the equity method. 34 All for you to PASS! HKCA page 592

31 Subsequent measurement On the end of reporting period, the acquirer shall recognise the following items: Share of profit or loss of associate Share of other comprehensive income of associate The accounting treatments in the individual account and consolidated accounts of the acquirer may different. Individual accounts Consolidated accounts Dividends declared Dr Bank Cr Dividend income Dr Dividend income Cr Share of profit of associate Share of total comprehensive income retained Share of total comprehensive loss incurred N/A N/A Dr Investment in associate Cr Share of profits of associate Dr Share of loss of associate Cr Investment in 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. The interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture determined using the equity method together with any long-term interests that, in substance, form part of the entity s net investment in the associate or joint venture. For example, an item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, an extension of the entity s investment in that associate or joint venture. Such items may include preference shares and long-term receivables or loans, but do not include trade receivables, trade payables or any long-term receivables for which adequate collateral exists, such as secured loans. Losses recognised using the equity method in excess of the entity s investment in ordinary shares are applied to the other components of the entity s interest in an associate or a joint venture in the reverse order of their seniority (i.e. priority in liquidation). After the entity s interest is reduced to zero, additional losses are provided for, and a liability is recognised, only to the extent that the entity has incurred legal or constructive obligations or made payments on behalf of the associate or joint venture. If the associate or joint venture subsequently reports profits, the entity resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised. If the associate incurred losses after acquisition, the acquirer shall applies HKFRS 9 Financial Instruments: to determine whether it is necessary to recognise any additional impairment loss with respect to its net investment in the associate. HKFRS 9 is also applied to determine whether any additional impairment loss is recognised with respect to its interest in the associate or joint venture that does not constitute part of the net investment and the amount of that impairment loss. HKCA All for you to PASS! 35 page 593

32 Chapter 30 Accounting for Associate and Joint Arrangement Because goodwill that forms part of the carrying amount of an investment in an associate or a joint venture is not separately recognised, it is not tested for impairment separately by applying the requirements for impairment testing goodwill in HKAS 36 Impairment of Assets. Instead, the entire carrying amount of the investment is tested for impairment in accordance with HKAS 36 as a single asset, by comparing its recoverable amount (higher of value in use and fair value less costs to sell) with its carrying amount, whenever application of HKFRS 9 indicates that the investment may be impaired. An impairment loss recognised in those circumstances is not allocated to any asset, including goodwill, that forms part of the carrying amount of the investment in the associate or joint venture. Accordingly, any reversal of that impairment loss is recognised in accordance with HKAS 36 to the extent that the recoverable amount of the investment subsequently increases. In determining the value in use of the investment, an entity estimates: its share of the present value of the estimated future cash flows expected to be generated by the associate or joint venture, including the cash flows from the operations of the associate or joint venture and the proceeds from the ultimate disposal of the investment; or the present value of the estimated future cash flows expected to arise from dividends to be received from the investment and from its ultimate disposal. Using appropriate assumptions, both methods give the same result. For investment in an associate, the investor recognises a dividend from the investment and evidence of impairment is available that: the carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidatedfinancial statements of the investee's net assets, including associated goodwill; or the dividend exceeds the total comprehensive income of the subsidiary, jointly controlled entity or associate in the period the dividend is declared. We will discuss in more detail in impairment of asset. Example 1 (Profit in associate) Amanda Ltd acquires 25% of the 240,000 ordinary shares in Starway on 1 January 2013 for $200,000 cash. Starway earns profits after tax of $160,000 for the year ended of During the year, it declared a dividend of $40,000. There had no other comprehensive income in the financial statements. Required Please advice accounts treatments for Starway s result in the individual accounts and consolidated accounts of Amanda Ltd for the year ended 31 December All for you to PASS! HKCA page 594

33 Solution Individual accounts of Amanda Ltd Record at cost on 1 January 2013 $ $ Dr Investment in associate 200,000 Cr Cash 200,000 Record dividend income $ $ Dr Cash (25% of $40,000) 10,000 Cr Investment income from shares in associates 10,000 However, dividend may be an indicator of impairment of investment in accordance with HKAS 36 since dividend will result in a reduction of net asset in associate. Amanda Ltd is required to carry out impairment test to determine if there is any impairment. Consolidated accounts of Amanda Ltd: Amanda Ltd shall apply equity accounting principles in its consolidated accounts. Therefore, the investment is carried at cost plus Amanda's share of Starway's retained profits in its consolidated statement of financial position. Amanda's share of Starway's profit is included in the consolidated statement of profit or loss and other comprehensive income ($160,000 x 25% = $40,000) Amanda's share of the dividend paid by Starway ($40,000 x 25% = $10,000) is already included in Amanda's profits and therefore only $30,000 is brought in as a consolidation adjustment by: $ $ Dr Investment in associates 30,000 Dr Investment income 10,000 Cr Share of profits of associates 40,000 Since investment in associates shall be stated at cost plus the group share of postacquisition retained profits, being $230,000. HKCA All for you to PASS! 37 page 595

34 Chapter 30 Accounting for Associate and Joint Arrangement Example 2 (Loss in associate) Orange Ltd has acquired 40% of the ordinary shares of Apple Co on 1 January 2013 which cost at $800,000 including goodwill. The results of Apple Co in recent years have been as follows: Year ended 31 December Retained total comprehensive income $ , (1,000,000) 2015 (3,000,000) ,000, ,000,000 Required Calculate the carrying amount of the investment in Apple Co recognised in the consolidated statement of financial position of Orange Ltd for the years ended 31 December Solution Date Carrying amount of investment 31 Dec 2013 $800,000 + ($300,000 x 40%) $920, Dec 2014 $920,000 - ($1,000,000 x 40%) $520, Dec 2015 $520,000 - ($3,000,000 x 40%) Nil ($680,000 losses unrecognized) 31 Dec $680,000 + ($1,000,000 x 40%) Nil ($280,000 losses unrecognized) 31 Dec $280,000 + ($2,000,000 x 40%) $520, Inter-companies transactions HKFRS does not require the acquirer to eliminate Inter-companies transactions between the acquirer (or subsidiaries of the acquirer) with associates. However, unrealised profit, if any, shall be eliminated. The acquirer shall further classify the transactions as: Trading transactions Transfer of non-current assets Trading transactions Trading transactions between the parent company or a subsidiary with the associate may be upstream or downstream. For sale which was made by an associate to the parent company or a group subsidiary, it shall be classified as upstream transaction. For sale which was made by the parent company or a group subsidiary to an associate, it shall be classified as downstream transaction. 38 All for you to PASS! HKCA page 596

35 Classification of Upstream and downstream transactions Asset Parent / subsidiary Downstream Associate Payment Payment Parent / subsidiary Upstream Associate Asset Gains and losses resulting from upstream and downstream transactions between an entity (including its consolidated subsidiaries) and its associate are recognised in the entity s financial statements only to the extent of unrelated investors interests in the associate. Accounting treatments: Upstream transactions (Inventories held by parent) $ $ Dr Cost of sales (Provision for unrealised profit x % of share) Cr Group inventories (Provision for unrealised profit x % of share) Downstream transactions (Inventories held by associate) $ $ Dr Cost of sales (Provision for unrealised profit x % of share) Cr Investment in associate (Provision for unrealised profit x % of share) HKCA All for you to PASS! 39 page 597

36 Chapter 30 Accounting for Associate and Joint Arrangement Example 3 (Upstream and downstream trading transactions) During the year ended 31 December 2013, Cherry Ltd holds 30% of the equity shares of David Ltd. During this year, Cherry had sold $600,000 inventory to David Ltd which cost at $400,000. David also sold $240,000 inventory to Cherry which cost at $200,000. Required Suppose none of the inventory had been sold at year-end, please calculated the intercompany. Solution Cherry Ltd to David Ltd The intergroup profit of Cherry Ltd is ($600,000 - $400,000) $200,000 Reported profit ($200,000 x 70%) $140,000 The remaining profit would be deferred until the sale of the inventory. David Ltd to Cherry Ltd Profit of David Ltd ($240,000 - $200,000) $40,000 The profit earned by David would be eliminated from the carrying value of Cherry s investment ($40,000 x 30%) $12,000. This alternative is to eliminate the profit from David in the reporting period and calculate the profit attributable to the associate Transfer of non-current assets Similar to trading transactions, transfer of non-current assets can be classify as upstream or downstream transactions and gains and losses resulting these transactions are recognised only to the extent of unrelated investors interests in the associate. The acquirer shall eliminate the unrealised profit including any additional depreciation charges related. When downstream transactions provide evidence of a reduction in the net realisable value of the assets to be sold or contributed, or of an impairment loss of those assets, those losses shall be recognised in full by the investor. When upstream transactions provide evidence of a reduction in the net realisable value of the assets to be purchased or of an impairment loss of those assets, the investor shall recognise its share in those losses. 40 All for you to PASS! HKCA page 598

37 Example 4 (Transfer of non-current assets) Ho Co holds 40% of the equity shares of Bobo Co. On 1 January 2012, Ho Co sold a machine to Bobo Co. The details of the transaction are as follows: Transaction price of the machine $10,000 Carrying amount in book of Ho Co $8,000 Expected residual value $nil Expected remaining useful life 4 years On 31 December 2013, Bobo Co determines that the machine shall be impaired to $1,000. Required Prepare the accounting entries for the consolidated statements for Ho Co for the year ended 31 December 2012 and 31 December 2013 related to the transfer of the machine. There is no change in the equity shares of Bobo Co held by Ho Co. Solution $ Cost recognised in Bobo Co 10,000 Carrying amount in Ho Co 8,000 Carrying amount overstated on 1 January ,000 Resulting depreciation per year ($10,000 / 4 years) 2,500 Original depreciation per year ($8,000 / 4 years) 2,000 Depreciation overstated per year 500 For the year ended 31 December 2012 Ho Co shall eliminate its share of the gain or loss arise from the transfer of machine. Dr Gain on disposal ($2,000 x 40%) $800 Cr Investment in associate $800 Dr Investment in associate ($500 x 40%) $200 Cr Share of profit from associate $200 For the year ended 31 December 2013 Dr Impairment loss ($7,500* - $1,000) $6,500 Cr Investment in associate $6,500 *$7,500 = $10,000 (transfer price) - $2,500 (subsequent depreciation) The standard requires the acquirer to recognise any impairment loss in full. HKCA All for you to PASS! 41 page 599

38 Chapter 30 Accounting for Associate and Joint Arrangement Case 7 (Fully disposal): When an associate is fully disposal, any gain or loss is recognised in the consolidated financial statements. The gain or loss of disposal of associate would be calculated as follows: Sale Proceeds Less: Carrying value of investment * Gain / Loss on Disposal $ X (X) X *Carrying value of investment Company Level Cost of investment Accumulated impairment Carrying value of investment X (X) X Consolidation Level Cost of investment Share of post-share acquisition profits Accumulated impairment Carrying value of investment X X (X) X In the year of disposal, the consolidated financial statements: no investment is recognised in the statement of financial position; at the date of disposal, the group share of the associate s results should be included in the statement of comprehensive income Exemptions for excluded associates HKAS 28 applies to all investments in associates unless the investment is classified as "held for sale" which according to HKFRS 5 which case it should be accounted for under HKFRS 5. An investor need not apply the equity method to its investment in an associate or a joint venture if the entity is a parent that is exempt from preparing consolidated financial statements by the scope exception in HKFRS 10 or if all the following apply: The entity is a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the entity not applying the equity method. The entity s debt or equity instruments are not traded in a public market. The entity did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory or other regulatory organization, for the purpose of issuing any class of instruments in a public market, and 42 All for you to PASS! HKCA page 604

39 The ultimate or any intermediate parent of the entity produces consolidated financial statements available for public use that comply with HKFRSs In some cases, the investee may operate under severe long-term restrictions impairing ability to transfer funds to the investor. However, HKFRS does not provide an exemption to this case. Therefore, the requirements of HKAS 28 still apply. When assessing the ability of significant influence over an investee, the investor shall consider restrictions on the transfer of funds from the joint venture or from the associate to the entity. Significant influence must be lost before the equity method ceases to be applicable. 1.3 Joint arrangement In Chapter 22, we have discussed about the classification of joint arrangements. According to HKFRS 11, joint arrangement can be classified as either: Joint operation Joint venture The classification depends upon the rights and obligations of the parties to the arrangements. A joint operation is a joint arrangement which the parties have joint control (joint operators), such as rights to the assets, and obligations for the liabilities of that joint arrangement. A joint arrangement that is not structured through a separate entity is always a joint operation. A joint venture is a joint arrangement which the parties have joint control (joint venturers) of the arrangement have rights to the net assets of the arrangement. A joint arrangement that is structured through a separate entity may be either a joint operation or a joint venture. In order to classify the nature, the parties to the arrangement should assess the terms of the contractual arrangement together with any other facts or circumstances to assess whether they have: rights to the assets and obligations for the liabilities in related to the arrangement (indicating a joint operation) rights to the net assets of the arrangement (indicating a joint venture) HKCA All for you to PASS! 43 page 605

40 Chapter 30 Accounting for Associate and Joint Arrangement As we have defined before, Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. An entity that is a party to an arrangement shall assess whether the contractual arrangement gives all the parties, or a group of the parties, control of the arrangement collectively. All the parties, or a group of the parties, control the arrangement collectively when they must act together to direct the activities that significantly affect the returns of the arrangement (ie the relevant activities HKFRS 10). Once it has been determined that all the parties, or a group of the parties, control the arrangement collectively, joint control exists only when decisions about the relevant activities require the unanimous consent of the parties that control the arrangement collectively. In a joint arrangement, no single party controls the arrangement on its own. A party with joint control of an arrangement can prevent any of the other parties, or a group of the parties, from controlling the arrangement. An arrangement can be a joint arrangement even though not all of its parties have joint control of the arrangement. The following are some examples of relevant activities: Acquisitions and disposals of major operating assets; Researching and developing new products or processes; Determination of a funding structure or obtaining additional funding; Appointing and removing key management personnel; Budgeting; and Declaration of dividends. The following activities are not relevant activities: Amendment to the constitutions; Restrict a borrower from undertaking activities that could significantly change the credit risk of the borrower to the detriment of the lender; The right to seize the assets of a borrower if the borrower fails to meet specified loan repayment conditions; and Issue of equity or debt instrument Joint ventures In the consolidated financial statements, HKAS 28 requires that the joint venturer shall apply equity method to account for transactions related to joint ventures. 44 All for you to PASS! HKCA page 606

41 If the contribution transaction lacks commercial substance, the gain or loss is regarded as unrealised and therefore is not recognised in profit or loss. In the case of Amy Ltd, it is assumed that commercial substance takes place thus the exception shall not be applied. Therefore the gain should be recognised in profit or loss. Therefore, Amy Ltd shall recognise its portion of the gain which is attributable to the interests of the other venturer, such as 50%. In Amy Ltd s separate financial statements, Amy Ltd should record its contribution to the joint venture as below: $ m $ m Dr Interest in JV capital contribution 20 Dr Accumulated depreciation - machinery 8 Cr Interests in JV unrealized gain on contribution of machinery 2 Cr Other income gain on contribution of machinery to B 2 Cr Machinery 24 According to HKAS 28, in the consolidated financial statements of the venturer, any unrealised gains or losses on non-monetary assets contributed to the joint ventures shall be eliminated against the investment using the equity method. Such unrealised gains or losses shall not be presented as deferred gains or losses in the venturer's consolidated statement of financial position. It is because such items do not meet the recognition criteria for assets or liabilities as defined in the Conceptual Framework. Therefore, Amy Ltd shall make the following adjustment under the equity method. In addition to the above adjustment, in its consolidated financial statements: $ m $ m Dr Interest in JV unrealized gain on contribution of machinery 2 Cr Machinery held in JV Joint operations HKFRS 11 requires that a joint operator shall recognise the following line-by-line in according to its interest in a joint operation: Its assets (including its share of any jointly held assets) Its liabilities (including its share of any jointly incurred liabilities) Its expenses (including its share of any expenses incurred jointly) Its revenue (from the sale of its share of the output arising from the joint operation) Its share of the revenue (from the sale of the output by the joint operation) and Its expenses, including its share of any expenses incurred jointly. This treatment is applicable in both of the separate and consolidated financial statements of the joint operator. HKCA All for you to PASS! 45 page 608

42 HKICPA Module A Financial Reporting Summarized Solution (2015) Q & A All for You to PASS! Address 1/F., Yue On Commercial Building, 387 Lockhart Road, Causeway Bay, Hong Kong Hotline (852) Website info@hkcaexam.com Take a shot to Contact us

43 Question (Module A Dec 2012 Q1) HKICPA Module A Financial Reporting TIPS Hotline: info@hkcaexam.com 47 Q&A set pg 210

44 TIPS Hotline: Q&A set pg 211

45 (50 Marks Approximately 90 minutes) TIPS Account for Q -Definition -Apply -Conclusion Discuss + Account for Q -Definition -Apply -Conclusion Consolidation comprehensive income Q -Line by line -Inter-company sale -Unrealized profit -NCI share Consolidated Financial Position Q 1. Line by line 1. Goodwill 2. Fair value adjustment 4. Impairment of goodwill 5. Inter-company transaction 6. NCI Change in equity Q -movement of equity Hotline: info@hkcaexam.com 49 Q&A set pg 212

46 Answer (Module A Dec 2012 Q1) TIPS Memorandum a) Apply Definition Apply Conclusion (Account for) Hotline: info@hkcaexam.com 50 Q&A set pg 213

47 TIPS Definition Apply Conclusion (Account for) Q&A set pg 214 Hotline: