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TOPIC 1Overview of Inter-Entity Relationships & Accounting for Simple InvestmentsNo special relationship (passive shareholding)Significant Influence Joint Control ControlInvestor Investor Joint Operators Joint Venturers Parent Simple Investment Associate Joint Arrangement Subsidiary Investme...

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TOPIC 1 Overview of Inter-Entity Relationships & Accounting for Simple Investments No special relationship (passive shareholding)

Significant Influence

Investor

Investor

Simple Investment

Associate

Investment AASB 9

Equity method AASB 128

At amortised cost or fair value

Proportional share of Associate’s profits

Joint Control

Control

Joint Venturers Joint Arrangement Proportional Equity method consol. AASB 128 AASB 11 Proportional share of JA’s A & L and Rev & Exp Joint Operators

Parent Subsidiary Consolidation AASB 10 Combination of all entities’ financial statements

Simple Investment - AASB 9:  Recognise financial asset when entity becomes party to the contract/transaction  date shares purchased  Measurement:

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Q1: Subsequent Measurement: Amortised Cost or Fair Value?

Q2: Fair Value through P&L or OCI?

Q3: Initial Measurement: include acquisition costs?

Classification of Financial Assets

Choice of Fair Value through OCI over P&L

Initial Measurement

At Amortised Cost (4.1.2)

N/A

At cost (FV at acquisition) + Direct Transaction Costs

At Fair Value through OCI (4.1.2A)

Elect OCI (5.7.1(b), 5.7.5): if not held for trading = e.g. short-term or speculative selling & purchasing

At cost (FV at acquisition) + Direct Transaction Costs

At Fair Value through P&L (4.1.4)

By default (5.7.1)

At cost (FV at acquisition) [no Transaction costs]

Managers prefer OCI to minimise fluctuations in profit (company perceived as less risky; shareholders demand lower return) Direct transactions costs = brokerage, stamp duty (not staff time)

FV through P&L: Dr Shares in co. Cr Bank Dr Brokerage Expenses Cr Bank 30 June Dr Shares in co. Cr Gain on investments (P&L)

FV through OCI: Dr Shares in co. Cr Bank Dr Shares in co. Cr Bank (Brokerage costs) 30 June Dr Shares in co. Cr Gain on investments (OCI)

TOPIC 2 Pre-Business Combination: Due Diligence & Takeover Laws 1. Value Proposition  Protective value (market competition)  Synergistic value (linking value chain/economies of scale)  Growth value (access new markets)  Underperformance value (e.g. remove poor management)  Risk management (diversification) 2. Due Diligence  Investigation conducted by a potential purchaser of a business prior to the acquisition of another business  Assess risks  normal business risk, financial risk (unrecognised liabilities), tax risk, legal risk  Identify value proposition  Operational aspects e.g. integration of accounting information systems  What the company is worth  value in exchange or value in use  Evaluate strategic advantages & disadvantages 3. Takeover Laws

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Corporations Act (2001)

Competition and Consumer Act (2010)

ASIC

ACCC

Ensures procedural fairness during the takeover process Protecting shareholders and capital market participants (esp. of target companies)

 

Prohibits monopoly or anti-competitive mergers Protecting competition in the market & consumers

Foreign Acquisitions and Takeovers Act (1975) Foreign Investment Review Board (FIRB)  Protecting national interests

Tax Law ATO 

Concerned with Corporate and Investor taxation issues

Corporations Act: General Prohibition  s 606 - prohibits the acquisition of ‘relevant interest’ in a company’s voting shares if it results in an increase in voting power o from 20% or below to >20% o from a starting point >20% & FVINA = goodwill  CT < FVINA = gain on bargain purchase ASSET PURCHASE 



Acquisition analysis Consideration: Cash (payable now) Cash (deferred) Shares Guarantee Total cost of acquisition

(amount) (amount / 1+r) (no. of shares * market price) (no. of shares * [market price - decreased price] * %probability) (total)

FVINA: FV of recorded net assets Add: intangible assets Less: contingent liabilities FVINA

(FV assets - FV liabilities) (trademarks, customer lists, royalty agreements, patents etc.) (FV * probability) (total)

Journal entries Acquirer  fair values: Dr Accounts receivable Dr Land Dr Vehicles Dr Equipment Dr Patent [Dr Goodwill] Cr Allowance for doubtful debts Cr Accounts payable Cr Provision for damages Cr Cash Cr Deferred consideration payable Cr Share capital Cr Provision for loss in value of shares [Cr Gain on Bargain Purchase]

(book value @ cost) (FV) (FV) (FV) (FV intangible asset) (book value @ cost - FV) (FV) (FV contingent liability) (cash consideration) (amount / 1+r) (share consideration) (re guarantee above)

[+] Dr Share capital Cr Cash/Payable

(share issue costs, stamp duty, underwriting fees, broker fees) (same)

[+] Dr Legal/Accounting expenses Cr Cash/Payable

Acquiree  book values: Dr Cash Dr Shares in ____ Ltd (asset) Dr Provision for doubtful debts Dr Accumulated deprecation - vehicles (BV) Dr Accumulated depreciation - equipment Dr Accounts payable Cr Accounts receivable Cr Land Cr Vehicles Cr Equipment [Cr Gain on sale of business]

(cash consideration) (share consideration) (BV) (BV) (BV) (BV) (BV) (BV) (BV)

(Acquiree can continue as company or liquidate)

Share Purchase Acquirer Dr Investment in co. Cr Cash Cr Allowance for doubtful debts

Acquiree * no journal entries required on acquisition date

(book value @ cost - FV)

TOPIC 4 Consolidation Introduction: Control AASB 10:  Para 4 - an entity that is a parent shall present consolidated financial statements  Para 5 - determine whether a parent by assessing whether it controls the investee  Para 6 - definition of control  Para 7 - all 3 elements must be present for control to exist  Para 8 - consider all facts & circumstances 1. Power over investee - para 10 

Existing rights that give the investor o Voting rights from shares - para 11 o Even if rights have yet to be exercised - para 12 o Other examples of rights - para B15  Potential voting rights - para B15(a)  B47 - must consider potential voting rights arising from options, only if rights are substantive  B22 - ‘substantive’ = holder must have practical ability to exercise rights  B23 - factors: o barriers preventing holder from exercising rights  financial penalties/incentives; exercise/conversion price (none if in -the-money) o mechanism enabling multiple parties to exercise the rights collectively o whether the party would benefit from exercising the rights (in-the-money)  B48 - consider purpose & design of instrument  Protective rights ≠ power (para 14, B27)  App. A - designed to protect the interest of holders  B26 - relate to fundamental changes to activities or apply in exceptional circumstances  B28 - examples: o lender can restrict borrower from certain activities o non-controlling shareholder to approve unusually large capital expenditure o rights of lender to seize assets of borrower in event of default  To appoint, reassign or remove key management personnel - para B15(b)  To appoint or remove another entity that participates in management decisions - para B15(c)  To direct the investee to enter into, or veto, transactions - para B15(d)

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Current ability to direct - para 10 o Might or might not be currently exercised - para 12



Relevant activities - para 10 o Activities of the investee that significantly affect the investee’s returns o Examples:  B11(a) - selling & purchasing goods & services  B11(b) - managing financial assets  B11(e) - determining funding structure or obtaining funding  B12(b) - appointing, remunerating & terminating key management personnel o B13 - which investor is able to direct activities that most significantly affect returns  can change over time

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Para B35 - 50% presumption (indicator, but not conclusive - para B36-B37) o B36 - voting rights must be substantive  through determining operating & financing policies o B36-B37 - if another entity has power (e.g. government, administrator, receiver, liquidator, regulator) as a result of a contract or liquidation/administration  investor has no power despite majority shareholding

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Power without majority - para B38-B42 o B41 - practical ability to direct relevant activities unilaterally o B42(a) - size & dispersion of other shareholding o B42(d) - attendance at AGMs/voting patterns o B42(c), B40 - existence of contracts o problems = temporary control; friendly relationship can turn unfriendly

2. Exposure, or rights, to variable returns from involvement with investee - para 15-16  investor’s returns have the potential to vary as a result of investee’s performance (investor’s wealth tied to investee’s performance)  B57 - examples: o dividends o increase in investment value o ‘synergy’: cost savings, economies of scale o sourcing scarce products

3. Ability to use power to affect returns - para 17-18  parent must have ability to increase its benefits & limit its losses from subsidiary’s activities  Principal  Control  Agent (delegated power)  No Control  B60 - factors: o scope of decision-making authority  broad or narrow / small interest = agent o rights held by other parties  ability to dismiss decision-maker = agent o remuneration  market based = agent o exposure to variability of returns from other interests  provides guarantee regarding investee’s performance  Intention is irrelevant

Exemption - investment entities (para 27, para’s B85A-85M)  Definition - para 27: o 27(a) - provides professional investment management services o 27(b) - invest funds solely for returns from capital appreciation, investment income or both o 27(c) - measures & evaluates the performance of substantially all investments on a fair value basis  Factors - para 28: o 28(a) - more than one investment o 28(b) - more than one investor o 28(c) - investors that are not related parties o 28(d) - ownership interests in the form of equity or similar interests  Exempt from consolidation - para 31 o measure investment in subsidiary at FV through P&L per AASB 9  Para 32: o IE parent  sub (IE & investment services) = no consolidation o IE parent  sub (investment services only) = consolidate Exemption - public & not-for-profit entities (Appendix E)  Public sector (government) issues: o often no ownership interests o ‘control’ may be exercised by legislation o some powers are ‘protective’ o some entities financially dependent on government o benefits non-financial and/or go to 3rd parties  Private not-for-profit sector (organisations, charities, clubs & associations) issues: o lack of legal identity  not incorporated o lack of clarity over who has ownership rights to assets o mixed sources of power o protective vs substantive rights 

IG4 - para 5 applies  need to determine control o power over investee - IG5-17 o rights/exposure to variable returns - IG18-19 o ability to affect returns through power - IG20

1. Power over investee  IG6 - source of power often administrative arrangements / statutory provisions  IG8 - state or territory government normally would not have power over local government re how to deploy the local government’s resources in the interests of the local community  example IG3  IG13 - rights must be substantive = practical ability to exercise & must be more than protective  Rights that give power - existing rights o IG11 - look at factors in B19  B19(a) - investee’s key management personnel are current/previous employees of the investor  B19(b)(i) - investee depends on investor to provide funding  B19(b)(ii) - investor provides critical services, technology, supplies etc. o IG12 - funding ≠ power (if discretion exists in accepting funding) o Other examples of rights - para B15  (a) - potential voting rights  (b) - to appoint, reassign or remove key management personnel  (c) - to appoint or remove another entity that participates in management decisions  (d) - to direct the investee to enter into, or veto, transactions  Protective rights o IG15 - protective rights = protect the government, beneficiaries of the entity, or public at large o IG17 - examples of protective rights:  (a) - stop non-compliance with regulations  (b) - remove members of governing body in restricted circumstances o B26 - relate to fundamental changes to activities or apply in exceptional circumstances o B28 - examples:  lender can restrict borrower from certain activities  non-controlling shareholder to approve unusually large capital expenditure  rights of lender to seize assets of borrower in event of default 2. Exposure, or rights, to variable returns from involvement with investee  IG18 - broad scope  including the achievement or furtherance of the investor’s objectives  IG19 - indirect, non-financial returns e.g.: o efficiency & effectiveness of delivery of goods & services o changes in outcomes for beneficiaries 3. Ability to use power to affect returns  IG20 - when investor can direct the investee to work with the investor to further the investor’s objectives o existence of congruent objectives alone is insufficient for a not-for-profit investor to conclude that it controls an investee o

TOPICS 5-7 Consolidation Step 1: Acquisition Analysis Consideration (for ____%: Parent) __________ + Dividend receivable (dividend payable by sub) __________ [NCI (for ____%: FV NCI or ____% of FVINA) __________] __________ (total) Book value of net assets - Share capital __________ - Retained earnings __________ - General reserve __________ Total value of net assets __________ Fair value (BCVR) adjustments - Value * (1 - Tc) __________ Add: intangible assets * (1-Tc) Less: contingent liabilities * (1-Tc) Total fair value adjustments __________ FVINA

__________

Goodwill on acquisition

__________ (+ve = goodwill / -ve = bargain purchase)

NCI  under full goodwill method: Goodwill attributable to parent Consideration transferred (for ____%: Parent) Less: FVINA acquired by parent (____% of FVINA) = Goodwill attributable to parent

__________ __________

Goodwill attributable to NCI Consideration transferred (FV of NCI) Less: FVINA acquired by NCI (____% of FVINA) = Goodwill attributable to NCI

__________ __________

* Parent & NCI’s respective share of goodwill is NOT proportional to their % shareholding  parent often has to pay above market price for shares in subsidiary, in order to obtain the controlling shareholding (control premium)

Step 2: Business Combination Valuation Entries 

Revalue assets - no depreciation (e.g. land, inventory) At date of acquisition FV > BV: Dr [Asset] (FV uplift) Cr Deferred Tax Liability (DTL) Cr Business Combination Valuation Reserve (BVCR)

(30% * FV uplift) (70% * FV uplift)

BV > FV: Dr BCVR (70% * FV decrease) Dr Deferred Tax Asset (DTA) (30% * FV decrease) Cr [Asset]

(FV decrease)

In year asset is sold FV > BV: e.g. land: Dr Gain on sale - [asset] Cr Income Tax Expense (ITE) Cr Transfer from BCVR (R/E) e.g. inventory: Dr COGS Cr ITE Cr Transfer from BCVR

(FV uplift) (30% * FV uplift) (70% * FV uplift) (FV uplift) (30% * COGS above) (70% * COGS above)

BV > FV: e.g. land: Dr Transfer from BVCR (R/E) (70% * FV decrease) Dr ITE (30% * FV decrease) Cr Loss on sale - [asset]

(FV decrease)

e.g. inventory: Dr Transfer from BVCR (R/E) (70% * FV decrease) Dr ITE (30% * FV decrease) Cr COGS

(FV decrease)

In future years after asset sold No entry

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Revalue assets - depreciation (e.g. buildings) At date of acquisition FV > BV: Dr Accumulated depreciation (total accum depr = cost - carrying amount) Cr [Asset] (same) Dr [Asset] Cr DTL Cr BCVR

(FV uplift) (30% * FV uplift) (70% * FV uplift)

BV > FV: Dr Accumulated depreciation - [asset] (total accum depr = cost - carrying amount) Cr [Asset] (same) Dr BCVR Dr DTA Cr [Asset]

(70% * FV decrease) (30% * FV decrease) (FV decrease)

1 year after acquisition FV > BV: Dr Accumulated depreciation - [asset] (total accum depr = cost - carrying amount) Cr [Asset] (same) Dr [Asset] Cr DTL Cr BCVR

(FV uplift) (30% * FV uplift) (70% * FV uplift)

[+] Dr Depreciation expense (FV/remaining useful life - BV/remaining useful life) Cr Accumulated depreciation - [asset] (same) [+] Dr DTL Cr ITE

(30% * accumulated depreciation above) (30% * depreciation expense above)

BV > FV: Dr Accumulated depreciation - [asset] (total accum depr = cost - carrying amount) Cr [Asset] (same) Dr BCVR Dr DTA Cr [Asset]

(70% * FV decrease) (30% * FV decrease) (FV decrease)

[+] Dr Accumulated depreciation - [asset] (same) Cr Depreciation expense

(BV/remaining useful life - FV/remaining useful life)

[+] Dr ITE Cr DTA

(30% * depreciation expense above) (30% * accumulated depreciation above)

2+ years after acquisition FV > BV: Dr Accumulated depreciation - [asset] (total accum depr = cost - carrying amount) Cr [Asset] (same) Dr [Asset] Cr DTL Cr BCVR

(FV uplift) (30% * FV uplift) (70% * FV uplift)

[+] Dr Depreciation expense

(FV upift/remaining useful life -OR- FV/remaining useful life - BV/remaining useful life) Dr Opening retained earnings (no. of extra years * depr. exp.) Cr Accumulated depreciation - [asset] (total) [+] Dr DTL Cr ITE Cr Opening retained earnings

(30% * accumulated depreciation) (30% * depreciation expense above) (30% * opening retained earnings above)

BV > FV: Dr Accumulated depreciation - [asset] (total accum depr = cost - carrying amount) Cr [Asset] (same) Dr BCVR Dr DTA Cr [Asset]

(70% * FV decrease) (30% * FV decrease) (FV decrease)

[+] Dr Accumulated depreciation - [asset] (total) Cr Depreciation expense Cr Opening retained earnings

(FV decrease/remaining useful life -OR- BV/remain. useful life - FV/remain. useful life) (no. of extra years * depr. exp.)

[+] Dr ITE (30% * depreciation expense above) Dr Opening retained earnings(30% * opening retained earnings above) Cr DTA (30% * accumulated depreciation above) When fully depreciated: Dr [Asset] (initial accum. depr. write-off - FV uplift) Cr Accumulated depreciation - [asset] (same) Dr BCVR Cr Transfer from BCVR

(initial BCVR amount) (same)

In year asset is sold FV > BV: Dr Gain on sale - [asset] (FV uplift - accum. depr.) Dr Depreciation expense (FV uplift/remaining useful life) Dr Opening retained earnings(balance) Cr Income Tax Expense (ITE) (0.3*gain on sale + 0.3*depr. exp.) Cr Transfer from BCVR (R/E) (FV uplift - 0.3*FV uplift)



Revalue liabilities FV > BV: Dr BCVR Dr DTA Cr [Liability] BV > FV: Dr [Liability] Cr DTL Cr BCVR



Recognise intangible asset At date of acquisition Dr [Asset] Cr DTL Cr BCVR

(FV) (30% * FV) (70% * FV)

1 year after acquisition Dr [Asset] Cr DTL Cr BCVR

(FV) (30% * FV) (70% * FV)

[+] Dr Amortisation expense (FV/useful life) Cr Accumulated amortisation - [asset]

(same)

[+] Dr DTL Cr ITE

(30% * accumulated amortisation above) (30% * amortisation expense above)

2+ years after acquisition Dr [Asset] Cr DTL Cr BCVR

(FV) (30% * FV) (70% * FV)

[+] Dr Amortisation expense (FV/useful life Dr Opening retained earnings (no. of extra years * amort. exp.) Cr Accumulated amortisation - [asset] (total) [+] Dr DTL Cr ITE...