Voting interest widely held

Transcription

1 Case Study 4 Voting interest widely held Mickey Ltd is a production company that produces movies and television shows. It also owns cable television systems that broadcast its movies and television shows. Mickey Ltd transferred to Mouse Ltd its cable assets and the shares in its previously owned and recently acquired cable television systems, which broadcast Mickey Ltd s movies. Mouse Ltd assumed approximately $200 million in debt related to companies it acquired in the transaction. After the transfer date, Mouse Ltd acquired additional cable television systems, incurring approximately $2 billion of debt, none of which was guaranteed by Mickey Ltd. Mouse Ltd was initially established as a wholly-owned subsidiary of Mickey Ltd. Several months after the transfer, Mouse Ltd issued ordinary shares in an initial public offering, raising nearly $ billion in cash and reducing Mickey Ltd s interest in Mouse Ltd to 4%. The remaining 59% of Mouse Ltd s voting interest is widely held. The managing director of Mouse Ltd was formerly the manager of broadcast operations for Mickey Ltd. Half the directors of Mouse Ltd are or were executive officers of Mickey Ltd. Mouse Ltd and its subsidiaries have entered individually into broadcast contracts with Mickey Ltd, pursuant to which Mouse Ltd and its cable system subsidiaries must purchase 90% of their television shows from Mickey Ltd at payment terms, and other terms and conditions of supply as determined from time to time by Mickey Ltd. That agreement gives Mouse Ltd and its cable television system subsidiaries the exclusive right to broadcast Mickey Ltd s movies and television shows in specific geographic areas containing approximately 45% of the country s population. Mouse Ltd and its cable television subsidiaries determine the advertising rates charged to their broadcast advertisers. Under its agreement with Mickey Ltd, Mouse Ltd has limited rights to engage in businesses other than the sale of Mickey Ltd s movies and television shows. In its most recent financial year, approximately 90% of Mouse Ltd s sales were Mickey Ltd movies and television shows. Mickey Ltd provides promotional and marketing services and consultation to the cable television systems that broadcast its movies and television shows. Mouse Ltd rents office space from Mickey Ltd in its headquarters facility through a renewable lease agreement, which will expire in 5 years time. Required A. Should Mickey Ltd consolidate Mouse Ltd? Why? B. If Mickey Ltd had not established Mouse Ltd but had instead purchased 4% of Mouse Ltd s voting shares on the open market, does this change your answer to requirement A? Why? Source: Adapted from Case III issued by the FASB as a part of its Consolidations project. Mickey Ltd 4% Mouse Ltd Mickey Ltd 4% NCI 59% - widely held

2 A) If the NCI is widely held then it may be argued that Mickey Ltd has the capacity to control Mouse Ltd based on the potential for the NCI to outvote Mickey Ltd in determining the directors of Mouse Ltd. However, other factors should also be considered, such as: - historical attendance at AGMs of Mouse Ltd - interest groups such as Green groups within the NCI - geographical distribution of NCI If the NCI were tightly held would the decision be any different? The other key factor in the definition is the returns criterion. A parent must have the rights to variable returns from the control exercised as well as the ability to use power to affect returns. In this case, many of the key policy decisions seem to have been set by contract: - must purchase 90% of TV shows from Mickey Ltd - terms & conditions of supply determined by Mickey Ltd - limited rights to engage in other businesses - provision of marketing services - lease of rental space. Hence even if the NCI could dominate the Board of Mouse Ltd, there is not much they can change to increase or modify their benefits. Mickey Ltd is therefore running the business. The NCI are simply investors. B) Whether the ownership of Mouse Ltd s shares comes from acquisition on the open market or acquisition at incorporation of the company is not of interest as it has no effect on the determination of control. Case Study Subsidiary status Sylvester Ltd owns 40% of the shares of Tweety Pie Ltd, and holds the only substantial block of shares in that entity; no other party owns more than 3% of the shares. The annual general meeting of Tweety Pie Ltd is to be held in one month s time. Two situations may arise. Sylvester Ltd will be able to elect a majority of Tweety Pie Ltd s board of directors as a result of exercising its votes as the largest holder of shares. As only 75% of shareholders voted in the previous year s annual meeting, Sylvester Ltd may have the majority of the votes that are cast at the meeting. By obtaining the proxies of other shareholders and, after meeting with other shareholders who normally attend general meetings of Tweety Pie Ltd and convincing these shareholders to vote with it, Sylvester Ltd may obtain the necessary votes to have its nominees elected as directors of the board of Tweety Pie Ltd, regardless of the attendance at the general meeting. Required Discuss the potential for Tweety Pie Ltd being classified as a subsidiary of Sylvester Ltd. Sylvester Ltd Tweety Pie Ltd 40%

3 Situation Discuss: - the concept of control - the need for judgement - factors to consider when determining the existence of control: - NCI = 60% - no other party > 3% interest - only 75% attendance at AGM last year - apply to above situation It will probably be concluded that Sylvester Ltd is the parent of Tweety Pie Ltd. Situation 2 Consider: - The difference between actual control and capacity to control: the party actually controlling the other entity may not have the capacity to control. Just because Sylvester Ltd s nominees are elected as Board members does not automatically mean that it becomes the parent of Tweety Pie Ltd. It simply means that it actually controls that entity. The question is whether it has the capacity to control. - Attendance at AGMs: If holders of 90% of the voting shares attended the AGM, then holders of 50% of the shares could have outvoted Sylvester Ltd. They may allow Sylvester Ltd to manage Tweety Pie Ltd because of the great managerial skills or business connections of Sylvester Ltd. In this case, Sylvester Ltd is not the parent of Tweety Pie Ltd. - The purpose of consolidation: If Sylvester Ltd is actually controlling Tweety Pie Ltd, even though it does not have the capacity to control, would the shareholders of Sylvester Ltd be interested in a set of consolidated financial statements for the combined group? Does the issue of accountability provide sufficient grounds for the consolidation of the two entities? Case Study 2 Determining subsidiary status Required In the following independent situations, determine whether a parent subsidiary relationship exists, and which entity, if any, is a parent required to prepare consolidated financial statements under AASB 0. A. Road Ltd is a company that was hurt by a recent global financial crisis. As a result, it experienced major trading difficulties. It previously obtained a significant loan from Wile E. Bank, and when Road Ltd was unable to make its loan repayments, the bank made an agreement with Road Ltd to become involved in the management of that company. Under the agreement between the two entities, the bank had authority for spending within Road Ltd. Road Ltd s managers had to obtain authority from the bank for acquisitions over $0 000, and was required to have bank approval for its budgets. B. Runner Ltd owns 80% of the equity shares of Beep Beep Ltd, which owns 00% of the shares of Looney Ltd. All companies prepare reports under Australian

4 accounting standards. Although the shares of Beep Beep Ltd are not traded on any stock exchange, its debt instruments are publicly traded. C. Coyote Ltd is a major financing company whose interest in investing is return on the investment. Coyote Ltd does not get involved in the management of its investments. If the investees are not managed properly, Coyote Ltd sells its shares in that investee and selects a more profitable investee to invest in. It previously held a 35% interest in Tunes Ltd as well as providing substantial convertible debt finance to that entity. Recently, Tunes Ltd was having cash flow difficulties and persuaded Coyote Ltd to convert some of the convertible debt into equity so as to ease the effects of interest payments on cash flow. As a result, Coyote Ltd s equity interest in Tunes Ltd increased to 52%. Coyote Ltd still wanted to remain as a passive investor, with no changes in the directors on the board of Tunes Ltd. These directors were appointed by the holders of the 48% of shares not held by Coyote Ltd. In each of these circumstances the following principles from the Basis of Conclusions to AASB 0 should be used: B2 To determine whether it controls an investee an investor shall assess whether it has all the following: (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee; and (c) the ability to use its power over the investee to affect the amount of the investor s returns. B3 Consideration of the following factors may assist in making that determination: (a) the purpose and design of the investee; (b) what the relevant activities are and how decisions about those activities are made; (c) whether the rights of the investor give it the current ability to direct the relevant activities; (d) whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; and (e) whether the investor has the ability to use its power over the investee to affect the amount of the investor s returns A. This question will be looked at under two scenarios: (i) Road Ltd is not a subsidiary of any other entity. The key issue is whether the fact that the bank has authority in relation to acquisitions and approval of budgets is sufficient to give the bank the status of a parent. The bank will receive a return from Road Ltd in the form of interest on the loan. Wile E. Bank Has: - Power over Road Ltd, as it has rights arising from the legal contract - It can affect some of the relevant activities eg acquisitions, but not others such as appointment of key management personnel. Road Ltd will not be a subsidiary of Wile E. Bank because: - The bank is not exposed to variable returns from its involvement with Road Ltd. The interest payments are not affected by the profitability of Road Ltd. - It cannot use its power over Road Ltd to affect the amount of its returns, as the returns are fixed interest payments.

5 (ii) Road Ltd is a wholly owned subsidiary of another entity, Chuck Jones Ltd. The key issue in this scenario is whether the authority given to the bank in relation to acquisitions and budget approval is sufficient to state that Chuck Jones Ltd does not control Road Ltd. The key issue is whether Chuck Jones Ltd still has power over Road Ltd given the arrangements with the bank. Relevant activities over which a parent should have power include: (a) selling and purchasing of goods or services; (b) managing financial assets during their life (including upon default); (c) selecting, acquiring or disposing of assets; (d) researching and developing new products or processes; and (e) determining a funding structure or obtaining funding. Decisions about relevant activities include: (a) establishing operating and capital decisions of the investee, including budgets; and (b) appointing and remunerating an investee s key management personnel or service providers and terminating their services or employment. The key issue then is whether Chuck Jones Ltd has the ability to direct the relevant activities ie those activities that most significantly affect the investee s returns. It is probable that Chuck Jones Ltd no longer controls Road Ltd as the bank can:veto any changes to significant transactions for the benefit of Chuck Jones Ltd. It can deny the company its ability to make acquisitions, and it can reject moves within a budget to undertake changes in inventory production. B. Runner Ltd 80% Beep Beep 00% Ltd Looney Ltd The issue is whether Beep Beep Ltd needs to prepare a set of consolidated financial statements for itself and Looney Ltd. Note that paragraph 4 of AASB 0 states that an entity that is a parent shall present consolidated financial statements except: (a) a parent need not present consolidated financial statements if it meets all the following conditions: (i) it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements; (ii) its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets); (iii) it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and (iv) its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with International Financial Reporting Standards (IFRSs).

6 Note all criteria are required to be met. In this example: (i) Looney Ltd is a wholly owned subsidiary of Beep Beep Ltd (ii) The ultimate parent, Runner Ltd, prepares reports under AASs, which comply with IFRSs However, the debt instruments of Beep Beep Ltd are traded publicly which means that it breaches 4(a)(iii) above. Hence Beep Beep Ltd is not exempt from preparing consolidated financial statements. Both Runner Ltd and Beep Beep Ltd would be required to prepare consolidated financial statements. C. Coyote Ltd currently holds 52% of the shares of Tunes Ltd. It does not want to become involved in the management of Tunes Ltd, and the directors are appointed by the noncontrolling interest (NCI). Control is not based on actual control but on the capacity to control. Coyote Ltd - has power over the investee via its share ownership - is exposed to variable returns via dividends arising from its share ownership - has the ability to affect those returns as it can become involved in management whenever it wishes, given its superior voting power. Coyote Ltd is a parent of Tunes Ltd and hence must prepare consolidated financial statements. Further, when Coyote Ltd held a 35% interest in Tunes Ltd it also held convertible debt in that entity which could, if converted, give it an equity interest of 52%. In this situation, Coyote Ltd was a parent of Tunes Ltd and should have prepared consolidated financial statements. It would appear under the circumstances that the conversion was substantive ie economically feasible, and currently exercisable. Case Study 3 Determining subsidiary status Required In the following independent situations, determine whether a parent subsidiary relationship exists and which entity, if any, is a parent required to prepare consolidated financial statements under AASB 0. A. Tom Ltd and Toots Ltd each hold 50% of the shares in Jerry Ltd, all companies being involved in the computer software industry. Tom Ltd agrees that Toots Ltd should provide the management of Jerry Ltd because of the expertise provided by its managing director, Bob Gates. Toots Ltd receives a management fee for providing its expertise. B. Spike Ltd has recently acquired a 35% interest in Tyke Ltd, a company that has discovered large deposits of iron ore. Spike Ltd has extensive experience in the mining industry and, as a result, has been able to have four of its directors elected to the board of Tyke Ltd, which has six directors in total. C. Butch Ltd holds 30% of the shares issued by Toodles Ltd. The other shareholders come from mixed backgrounds, but each holds on average 0% of shares in Butch Ltd. There are seven directors of Toodles Ltd. Four of these are appointed by Butch Ltd. The other three directors are appointed by three of the other shareholders who

7 have an interest in the management of the company. Most of the remaining shareholders live outside Australia and rarely attend board meetings of Butch Ltd unless they have other business to attend to in Australia around the same time as the board meetings are held. In each of these circumstances the following principles from the Basis of Conclusions to AASB 0 should be used: B2 To determine whether it controls an investee an investor shall assess whether it has all the following: (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee; and (c) the ability to use its power over the investee to affect the amount of the investor s returns. B3 Consideration of the following factors may assist in making that determination: (a) the purpose and design of the investee; (b) what the relevant activities are and how decisions about those activities are made; (c) whether the rights of the investor give it the current ability to direct the relevant activities; (d) whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; and (e) whether the investor has the ability to use its power over the investee to affect the amount of the investor s returns A. Both Tom Ltd and Toots Ltd hold 50% of the shares in Jerry Ltd, with Toots Ltd actually directing Jerry Ltd because of its management expertise. In this circumstance, Jerry Ltd is not a subsidiary of either company. Neither investor has the power over Jerry Ltd, as neither investor holds existing rights to enable it to direct the relevant activities of Jerry Ltd. Although Tom Ltd allows Toots Ltd to currently manage the investee, it can step in at any time and challenge the management arrangements. As neither investor holds more than 50% of the shares, neither has power. Hence there is no need for any consolidated financial statements to be prepared. B. Spike Ltd currently has the ability to elect a majority of directors of Tyke Ltd. This has occurred potentially just because of its expertise in the mining industry. As in (a) above, this does not give it power over Tyke Ltd. There is no information to suggest that the other 65% of shareholders in Tyke Ltd could not get together and change the management of Tyke Ltd. Spike Ltd does not have power over Tyke Ltd. Spike Ltd does not have to prepare consolidated financial statements. C. Currently Butch Ltd holds 30% of the shares of Toodles Ltd. The remaining shareholders consist of 7 shareholders having on average 0% of Toodles Ltd s shares. In relation to these investors: - most live outside Australia

8 - most do not attend AGMs Where an investor has less than a 50% holding of shares in the investee, judgement is required to determine whether control exists. It is necessary to examine the potential actions of the holders of the other shares in Toodles Ltd. In this case, it is difficult to make a decision as: - The fact that there are only 7 others shareholders with 0% each, only 3 of these need to get together to have the same voting capacity as Butch Ltd. This lessens the likelihood of Butch Ltd having control. - The fact that most live outside Australia lessens the probability of these shareholders getting together to take control. However, they could give their proxies to each other. - The attendance at AGMs is low by the other shareholders. This however can change if these shareholders become dissatisfied with Butch Ltd as a manager. - The other shareholders have an interest in management shown by their appointing 3 of the directors only less than Butch s 4 directors. As the shareholders have an interest as opposed to being apathetic the probability of becoming involved if they become dissatisfied with Butch Ltd is higher. On balance, Butch Ltd is probably not a parent of Toodles Ltd as it does not have sufficient power to continue to direct the relevant activities of Toodles Ltd. Question 9.4 Worksheet entries at acquisition date and in subsequent year, no fair value/carrying amount differences at acquisition date, bargain purchase On July 206, John Ltd acquired all the issued shares of Robert Ltd for $ At this date the equity of Robert Ltd was recorded as follows: Share capital $ General reserve Retained earnings All the identifiable assets and liabilities were recorded at amounts equal to their fair values. Required A. Prepare the consolidation worksheet entries at July 206 and July 207 assuming John Ltd paid $ for the shares in Robert Ltd. B. Prepare the consolidation worksheet entries at July 206 and July 207 assuming John Ltd paid $ for the shares in Robert Ltd. C. Prepare the consolidation worksheet entries at July 206 assuming John Ltd paid $ for the shares in Robert Ltd and at that date Robert Ltd had recorded goodwill of $4000.

9 A: Consideration of $ Acquisition analysis: At July 206: Net fair value of identifiable assets and liabilities of Robert Ltd = ($ $ $40 000) (equity) = $ Consideration transferred = $ Goodwill acquired = $ $ = $3 000 Worksheet entries at July 206: Business combination valuation entries Goodwill Dr Business combination valuation reserve Cr Pre-acquisition entries Retained earnings (/7/6) Dr Share capital Dr General reserve Dr Business combination valuation reserve Dr Shares in Robert Ltd Cr Worksheet entries at July 207 The entries are the same as those above. B: Consideration of $ Acquisition analysis: At July 206: Net fair value of identifiable assets and liabilities of Robert Ltd = ($ $ $40 000) (equity) = $ Consideration transferred = $ Gain on bargain purchase = $ $ = $2 000 Worksheet entries at July 206: Pre-acquisition entries Retained earnings (/7/6) Dr Share capital Dr General reserve Dr Gain on bargain purchase Cr Shares in Robert Ltd Cr Worksheet entries at July 207 Retained earnings (/7/7) Dr Share capital Dr General reserve Dr Shares in Robert Ltd Cr

10 C: Consideration of $ and recorded goodwill of $4000 Acquisition analysis: At July 206: Net fair value of identifiable assets and liabilities of Robert Ltd = ($ $ $40 000) (equity) - $4 000 (goodwill) = $ Consideration transferred = $ Gain on bargain purchase = $ $ = $ 000 Worksheet entries at July 206:. Business combination valuation reserve entries Business combination valuation reserve Dr Goodwill Cr Pre-acquisition entries Retained earnings (/7/6) Dr Share capital Dr General reserve Dr Business combination valuation reserve Cr Gain on bargain purchase Cr 000 Shares in Robert Ltd Cr Question 9.6 Business combination valuation entries, pre-acquisition entries On July 206, Mutt Ltd acquired all the issued shares of Jeff Ltd for $ At this date the equity of Jeff Ltd consisted of share capital of $ and retained earnings of $ All the identifiable assets and liabilities of Jeff Ltd were recorded at amounts equal to fair value except for: Carrying amount Fair value Patent $ $ Plant (net of $ depreciation) Inventory The patent was considered to have an indefinite life. It was calculated that the plant had a further life of 0 years, and was depreciated on a straight-line basis. All the inventory was sold by 30 June 207. In June 207, Jeff Ltd conducted an impairment test on the patent, as it was considered to have an indefinite life, and the goodwill. As a result, the goodwill was considered to be impaired by $200. In May 207, Jeff Ltd transferred $ from the retained earnings on hand at July 206 to a general reserve. The tax rate is 30%. Required Prepare the consolidation worksheet adjustments entries at July 206 and 30 June 207.

11 At July 206: Net fair value of identifiable assets and liabilities of Jeff Ltd = ($ $68 800) (equity) +$6 400 ( 30%) (inventory) + $2 000 ( 30%) (patent) + $8 000 ( 30%) (plant) = $ Consideration transferred = $ Goodwill = $7 520 Worksheet entries at July 206 Business combination valuation entries Inventory Dr Deferred tax liability Cr 920 Business combination valuation reserve Cr Patent Dr Deferred tax liability Cr Business combination valuation reserve Cr *Accumulated depreciation - equipment Dr Equipment Cr Deferred tax liability Cr Business combination valuation reserve Cr *refer to end of solution for an alternative to this journal entry Goodwill Dr Business combination valuation reserve Cr Pre-acquisition entries Retained earnings (/7/6) Dr Share capital Dr Business combination valuation reserve Dr Shares in Jeff Ltd Cr Worksheet entries at 30 June 207 Business combination valuation entries The entries at July 203 are affected by: - the sale of the inventory - the depreciation of the plant - the impairment of the goodwill Cost of sales Dr Income tax expense Cr 920 Transfer from business combination valuation reserve Cr Patent Dr Deferred tax liability Cr Business combination valuation reserve Cr 8 400

12 Accumulated depreciation - equipment Dr Equipment Cr Deferred tax liability Cr Business combination valuation reserve Cr Depreciation expense Dr 800 Accumulated depreciation Cr 800 (0% x $8 000) Deferred tax liability Dr 240 Income tax expense Cr 240 (30% x $ 000) Goodwill Dr Business combination valuation reserve Cr Impairment loss goodwill Dr 200 Accum. impairment losses goodwill Cr 200 Pre-acquisition entries The pre-acquisition entries are affected by: - transfer from business combination valuation reserve Retained earnings (/7/6) Dr Share capital Dr Business combination valuation reserve Dr Shares in Jeff Ltd Cr General reserve Dr Transfer to general reserve Cr Transfer from business comb. valuation reserve Dr Business combination valuation reserve Cr *Alternative BCVR entry for Equipment Accumulated depreciation - equipment Dr Equipment Cr Equipment Dr Deferred tax liability Cr Business combination valuation reserve Cr The above BCVR entry demonstrates the 2 steps for the recognition of a change in fair value on consolidation.. Write back all of the accumulated depreciation for the asset at date of aqusition. 2. Recognise the increase/decrease to the asset s fair value with the tax effect. NB: From these 2 journal entries it is easier to see that the depreciation adjustments then required at the end of each year for consolidation purposes are based on the $8 000 increase to fair value. That is, the additional amount of the asset that needs to be depreciated. In this question.$8,000 / 0years = $800 per year.

13 Question 9.7 Business combination valuation entries and preacquisition entries at acquisition date, previously held shares In 202, Stan Ltd acquired 40% of the issued shares for $ This acquisition did not give Stan Ltd control of Lee Ltd as the ownership of Lee Ltd was held by a small number of shareholders as Lee Ltd was developed as a family company in 200. On July 206, Stan Ltd approached these family members following a death in the family and persuaded them to sell the remainder of the shares in Lee Ltd to Stan Ltd for $ on a cum div. basis. Information about the two companies at July 206 included the following. Stan Ltd recorded its original investment in Lee Ltd at fair value, with changes in fair value being recognised in profit or loss. At July 206, the asset was recorded at $ The equity of Lee Ltd at July 206 consisted of $ capital and $ retained earnings. Included in the assets and liabilities recorded by Lee Ltd at July 206 were goodwill of $5400 (net of accumulated impairment losses of $3600) and dividend payable of $4500. On the acquisition date all the identifiable assets and liabilities of Lee Ltd were recorded at carrying amounts equal to their fair values except for inventory for which the fair value of $ was $3600 greater than its carrying amount, and equipment for which the fair value of $ was greater than the carrying amount, this being cost of $ less accumulated depreciation of $ Besides determining the fair values of the recorded assets and liabilities of Lee Ltd, Stan Ltd discovered that Lee Ltd had two assets that had not been recorded by Lee Ltd. These were internally generated patents that had a fair value of $ and in-process research and development for which Lee Ltd had expensed $90 000, but which Stan Ltd valued at $ Further in the financial statements of Lee Ltd at 30 June 206 Lee Ltd had reported the existence of a contingent liability relating to guarantees for loans. Stan Ltd determined that this liability had a fair value of $9000. The tax rate is 30%. Required Prepare the consolidation worksheet entries for consolidated financial statements prepared by Stan Ltd at July 206. Acquisition analysis: July 206 Net fair value of identifiable assets and liabilities of Lee Ltd = $ $ $3 600 ( 30%) (BCVR inventory) + $4 500 ( 30%) (BCVR plant) - $5 400 (goodwill) + $ ( 30%) (BCVR - patents) + $8 000 ( 30%) (BCVR research) - $9 000 ( 30%) (BCVR liability) = $ Consideration transferred = $ $4 500 (dividend receivable) = $ Previously held equity interest = $9 800 (fair value) Goodwill acquired = ($ $9 800) - $ = $6 930 Unrecorded goodwill = $ $5 400 = $ 530

14 Business combination valuation entries at July 206 Inventory Dr Deferred tax liability Cr 080 Business combination valuation reserve Cr Accumulated depreciation Dr Plant Cr Deferred tax liability Cr 350 Business combination valuation reserve Cr 3 50 Patents Dr Deferred tax liability Cr Business combination valuation reserve Cr In-process research Dr Deferred tax liability Cr Business combination valuation reserve Cr Business combination valuation reserve Dr Deferred tax asset Dr Guarantee payable Cr Accumulated impairment losses goodwill Dr Goodwill Cr Goodwill Dr 530 Business combination valuation reserve Cr 530 Pre-acquisition entries at July 206 Retained earnings (/7/6) Dr Share capital Dr Business combination valuation reserve Dr Shares in Lee Ltd Cr Dividend payable Dr Dividend receivable Cr Question 9.0 Consolidation worksheet, previously held investment in subsidiary On August 202, Erik Ltd acquired 0% of the shares in Finn Ltd for $8000. Erik Ltd used the fair value method to measure this investment with movements in fair value being recognised in profit or loss. At July 204, the fair value of this investment was $ The original investment in Finn Ltd was due to the fact that Finn Ltd was undertaking research into particular microbiological elements that could influence the profitability of Erik Ltd. With the continuing success of this research, Erik Ltd decided to acquire the remaining shares (cum div.) in Finn Ltd. On July 204, Erik Ltd made an offer to buy the remaining shares in Finn Ltd for $5 000 cash. This offer was accepted by the shareholders of Finn Ltd. On July 204, immediately after the business combination, the statement of financial position of Finn Ltd was as follows:

15 On analysing the financial statements of Finn Ltd, Erik Ltd determined that all the assets and liabilities recorded by Finn Ltd were shown at amounts equal to their fair values except for: Carrying amount Fair value Plant and equipment (cost $46 000) $ $ Inventory The plant and equipment is expected to have a further 4-year life and is depreciated on a straight-line basis. The inventory was all sold by 30 June 205. Finn Ltd had expensed all the outlays on research and development. Erik Ltd placed a fair value of $2 000 on this asset. Finn Ltd also had reported a contingent liability at 30 June 204 in relation to claims by customers for damaged goods. Erik Ltd placed a fair value of $3000 on these claims. The research and development is amortised evenly over a 0-year period. The claims by customers were settled in May 205 for $2800. The company tax rate is 30%. Required A. Prepare the consolidated financial statements of Erik Ltd at July 204, immediately after the business combination. B. Prepare the consolidation worksheet entries at 30 June 205.

16 At July 204: Net fair value of identifiable assets and liabilities of Finn Ltd = ($ $ $36 000) (equity) + $4 000 ( 30%) (inventory) + $8 000 ( 30%) (plant) + $2 000 ( 30%) (R&D) - $3 000 ( 30% (claims) = $ Consideration transferred = $ $2 600 (dividend receivable) = $ Previously acquired equity interest = $5 400 Goodwill = ($ $5 400) - $ = $ 00 A. WORKSHEET ENTRIES AT JULY 204. Business combination valuation entries Accumulated depreciation Dr 000 Plant Cr Deferred tax liability Cr Business combination valuation reserve Cr Inventory Dr Deferred tax liability Cr 200 Business combination valuation reserve Cr Deferred research and development Dr Deferred tax liability Cr Business combination valuation reserve Cr Business combination valuation reserve Dr 2 00 Deferred tax asset Dr 900 Provision for customer claims Cr Goodwill Dr 00 Business combination valuation reserve Cr Pre-acquisition entries Retained earnings (/7/4) Dr Share capital Dr General reserve Dr Business combination valuation reserve Dr Shares in Finn Ltd Cr Dividend payable Dr Dividend receivable Cr 2 600

17 Erik Finn Adjustments Group Ltd Ltd Dr Cr Cash Receivables Other assets Inventory Shares in Finn Ltd Plant Accum depreciation (85 000) (22 000) 000 (96 000) Dividend payable Other liabilities Share capital Retained earnings General reserve Business combination valuation reserve FINN LTD Consolidated Statement of Financial Position as at July 204 Current assets: Cash and equivalents $3 600 Receivables Inventories Total current assets Non-current assets: Plant and equipment Accumulated depreciation (96 000) Other assets Total non-current assets Total assets $ Equity Share capital Retained earnings General reserve Total equity Current liabilities: Dividend payable Other liabilities Total liabilities Total equity and liabilities $45 200

18 B. WORKSHEET ENTRIES AT 30 JUNE 205. Business combination valuation entries Accumulated depreciation Dr 000 Plant Cr Deferred tax liability Cr Business combination valuation reserve Cr Depreciation expense Dr Accumulated depreciation Cr (/4 x $8 000) Deferred tax liability Dr 600 Income tax expense Cr 600 Cost of sales Dr Income tax expense Cr 200 Transfer from business combination valuation reserve Cr Deferred research and development Dr Deferred tax liability Cr Business combination valuation reserve Cr Amortisation expense Dr 200 Accumulated amortisation Cr 200 Deferred tax liability Dr 360 Income tax expense Cr 360 Transfer from business combination valuation reserve Dr 2 00 Income tax expense Dr 900 Damages expense Cr Gain on claims settlement Cr Pre-acquisition entries Retained earnings (/7/4) Dr Share capital Dr General reserve Dr Business combination valuation reserve Dr Goodwill Dr 800 Shares in Finn Ltd Cr Transfer from business combination valuation reserve Dr 700 Business combination valuation reserve Cr 700