QUESTION 90: BASIC CONSOLIDATION

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1 QUETION 90: BAIC CONOLIDATION In recent years Hillusion has acquired a reputation for buying modestly performing businesses and selling them at a substantial profit within a period of two to three years of their acquisition. On 1 July 2002 Hillusion acquired 80% of the ordinary share capital of keptik at a cost of $10,280,000. On the same date it also acquired 50% of keptik s 10% loan notes at par. The market price of each keptik share at the date of acquisition was $6.00. The summarized draft financial statements of both companies are: tatements of profit or loss and other comprehensive income: Year to 31 March 2003 Hillusion keptik $000 $000 ales revenue 60,000 24,000 Cost of sales (42,000) (20,000) Gross profit 18,000 4,000 Operating expenses (6,000) (200) Loan interest received (paid) 75 (200) Operating profit 12,075 3,600 Taxation (3,000) (600) Profit after tax for the year 9,075 3,000 tatements of financial position: as at 31 March 2003 Tangible non-current assets 19,320 8,000 Investments 11,280 Nil 30,600 8,000 Current assets 15,000 8,000 Total assets 45,600 16,000 Equity and liabilities Ordinary shares of $1 each 10,000 2,000 Accumulated profits 25,600 8,400 35,600 10,400 Non-current liabilities 10% Loan notes nil 2,000 Current liabilities 10,000 3,600 Total equity and liabilities 45,600 16,000 The following information is relevant: (i) The fair values of keptik s assets were equal to their book values with the exception of its plant, which had a fair value of $3 2 million in excess of its book value at the date of acquisition. The remaining life of all of keptik s plant at the date of its acquisition was four years and this period has not changed as a result of the acquisition. Depreciation of plant is on a straight-line basis and charged to cost of sales. keptik has not adjusted the value of its plant as a result of the fair value exercise. Page 1 of 5 (kashifadeel.com)

2 (ii) (iii) (iv) (v) (vi) (vii) In the post acquisition period Hillusion sold goods to keptik at a price of $12 million. These goods had cost Hillusion $9 million. During the year keptik had sold $10 million (at cost to keptik) of these goods for $15 million. Hillusion bears almost all of the administration costs incurred on behalf of the group (invoicing, credit control etc.). It does not charge keptik for this service as to do so would not have a material effect on the group profit. Revenues and profits should be deemed to accrue evenly throughout the year. The current accounts of the two companies were reconciled at the year-end with keptik owing Hillusion $750,000. Hillusion has a policy of valuing non-controlling interests at fair value at the date of acquisition. For this purpose, the share price of keptik should be used. An impairment test on 31 March 2003 showed that consolidated (full) goodwill should be written down by $400,000. Required: (a) Prepare a consolidated statement of profit or loss and other comprehensive income and statement of financial position for Hillusion for the year to 31 March 2003 (20 marks) (b) Explain why it is necessary to eliminate unrealized profits when preparing group financial statements; and how reliance on the entity financial statements of keptik may mislead a potential purchaser of the company. (5 marks) (25 marks) Note: your answer should refer to the circumstances described in the question. ACCA F7 June 2003 Q1 Page 2 of 5 (kashifadeel.com)

3 ANWER TO QUETION 90: BAIC CONOLIDATION Part (a) Hillusion Group Consolidated tatement of profit or loss For the year ended 31 March 2003 Hillusion keptic x 9/12 Adj. Group $000 $000 $000 $000 Revenue 60,000 18,000 (12,000 J6) 66,000 Cost of sales (42, J4) (15, J3) 12,000 J6 (46,100) Gross profit 17,500 2,400 19,900 Operating expenses (6,000) ( J7) (6,550) Interest (exp)/inc. 75 (150) (75) Profit before tax 11,575 1,700 13,275 Taxation (3,000) (450) (3,450) Profit after tax 8,575 1,250 9,825 Non controlling interest ($1,250 x 20%) (250) Profit for group owners 9,575 Hillusion Group Consolidated FP as at 31 March 2003 Assets $000 $000 Non current assets Goodwill W3 930 Investments $11,280 11,280 J1 - Tangible assets$19,320+8,000+3,200j2 600J3 29,920 30,850 Current assets $15,000+8, J4 750J5 21,750 Total assets 52,600 Equity and liabilities Equity: Equity shares of $1 each 10,000 Retained earnings W6 26,100 36,100 Non Controlling interest W5 2,650 38,750 Non - current liabilities 10% loan notes $2,000-1,000J1 1,000 Current Liabilities $10,000+3, J5 12,850 Total equity and liabilities 52,600 W1 GROUP TRUCTURE keptic ubsidiary Acquisition date:1 Jul 2002 Group = 80% NCI 20% $000 Page 3 of 5 (kashifadeel.com)

4 W2 NET AET (of subsidiary) AT ACQUIITION Equity share capital 2,000 Retained earnings (pre) 6,150 J2 3,200 11,350 W3 GOODWILL InvestmentJ1 10,280 Less: 11,350 W2 x 80%W1 (9,080) 1,200 Fair value of NCI (2,000 x 20% x $6) 2,400 Less: 7,000 W2 x 20%W1 (2,270) 130 1,330 J7 (400) 930 W4 POT ACQUIITION REERVE (of subsidiary) RE Balance 2,250 J3 (600) J7 (400) 1,250 W5 NON CONTROLLING INTERET 11,350 W2 x 20%W1 2,270 NCI goodwill W ,250 W4 x 20% W ,650 W6 GROUP REERVE RE Parent reserves 25,600 J4 (500) 25,100 1,250W4 x 80% W1 1,000 26,100 JOURNAL ENTRIE WITH WORKING Dr. $ 000 Cr. Investment in subsidiary 10, % loan notes 1,000 Investments 11,280 As given in question. Tangible assets 3,200 (i) 2 Reserves () 3,200 Recording of fair value in excess of book value Page 4 of 5 (kashifadeel.com)

5 CO / RE () 600 (i) 3 Tangible assets 600 Depreciation effect on fair value adjustment $ 3,200/4 years x 9/12 = $600 CO / RE (P) 500 (ii) 4 Inventory 500 Unrealized profit in inventory $12,000-10,000=2,000x3/12 (margin ratio) = $500 Payables 750 (v) 5 Receivables 750 Cancellation of intra group balances Revenue 12,000 (ii) 6 CO 12,000 Cancellation of intra group sales and purchases RE ()/ Operating expenses 400 (vii) 7 Goodwill 400 Impairment of goodwill Page 5 of 5 (kashifadeel.com)