Tutorial 9 Practice Questions Solutions PDF

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Tutorial 9 Practice Question Solutions...

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TUTORIAL SOLUTIONS TOPIC 9 – GROUPS: ORIGINS AND ISSUES

QUESTION 1 Describe the major factors to be considered when determining which are the entities to be consolidated by the parent company to produce consolidated financial statement. The parent company shall include in the consolidated financial statement all the entities (subsidiaries) that it CONTROLS The definition of Control has three elements (AASB10.6 and .7): 1) The parent has power of the subsidiary: That is, the parent has existing rights that give it the ability to direct the relevant activities that significantly affect the returns the subsidiary (AASB10.10). This means the parent has the power to make decisions relating to the subsidiary, and impose those decisions on the subsidiary. 2)

The parent is exposed to variable returns from the subsidiary; and That is, the returns (dividends, profit distributions, capital gains) the parent receives from the subsidiary are variable because they depend upon the subsidiary’s performance (profitability) (AASB10.15).

3)

The parent has the ability to use its power of the subsidiary to affect the variable returns it receives from the subsidiary That is, if the parent uses its power of the subsidiary to make good decisions relating to the subsidiary, the parent benefits via higher variable returns, but if the parent uses its power of the subsidiary to make bad decisions relating to the subsidiary, the parent suffers via lower variable returns, (or losses) (AASB10.17).

Usually, a parent entity has control of a subsidiary, if holds the majority of the voting power in the subsidiary Determining whether a parent-subsidiary exits, depends upon professional judgement considering all the circumstances. For example, a parent can control a subsidiary by holding less than 50% of voting power, (e.g.35%), if the remaining voting power is distributed amongst many small shareholders. (2 marks) QUESTION 2 On 30 June 2015, Holding Ltd has the following investments in other companies: a) 90% shares of Apple Ltd; b) 100% shares of Pear Ltd, which in turn owns the 80% shares of Carrot Trust; c) 50% shares of Orange Ltd, whose other 50% shares are owned by Market Ltd; d) 10% shares of Avo Ltd.

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REQUIRED: 1) List the entities that are subsidiaries of Holding Ltd and are to be consolidated in the consolidated financial report (check for control) The subsidiaries are a) Apple Ltd b) Pear Ltd b) Carrot Trust (Holding Ltd has indirect control via Pear Ltd) [Note a subsidiary entity can take any legal form: company, trust, partnership. The issue is whether the investor (Holding Ltd) has control]. c) Orange Ltd is not a subsidiary but a joint venture. [Note as Holding Ltd and Market Ltd each hold 50% of the voting power in Orange Ltd, neither has power over Orange Ltd to unilaterally make the major decisions relating to Orange Ltd’s operations and finances. Therefore, Orange Ltd is not controlled by Holding Ltd, it is not a subsidiary. Holding Ltd and Market Ltd will need to cooperate to make major decisions relating to Orange Ltd, that is they jointly control Orange, which means Orange Ltd is a Joint Venture]. d) Holding Ltd has a non-controlling interest in Avo which is recognised as a financial asset in the accounts of Holding Ltd (Investment in Avo), (because Holding Ltd has little or no influence over Avo) (2 marks) 2)

Based on the subsidiaries you have listed in point 1), draw the structure of the group held by Holding Ltd and indicate the interest (% of share capital) in each of the subsidiaries

Holding 90% Apple

100%

Pear 80% Carrot

QUESTION 3 Bold Ltd had acquired 100% share capital of Silver Ltd on 1 July 2015 at a cost of $7,000,000. At that date the capital and reserves of Silver Ltd consisted of: Share capital Retained earnings

$4,500,000 $1,900,000 $6,400,000 2

Additional Information All the assets of Silver Ltd were valued at fair value at acquisition date, but Silver Ltd has internally generated a brand name, which has a fair value of $300,000, but it is not recognised in the accounts of Silver Ltd.

REQUIRED 1) Is Bold Ltd required to prepare the consolidated financial statement including Silver Ltd? Yes, Bold has the control over Silver, because Bold holds 100% of the shares in Silver, and therefore holds 100% of the voting power in Silver. (1 mark) 2)

Is there any goodwill arising from the business combination? If so, determine its amount. Fair Value of Purchase Consideration Less Fair Value of Net identifiable assets acquired (100%) Recorded Equity Brand Name Deferred Tax Liability relating to Brand Name (300,000 x 30% tax) Goodwill

7,000,000 6,400,000 300,000 (90,000)

6,610,000 390,000

The difference is goodwill because Fair Value of Purchase Consideration > Fair Value of Net identifiable assets acquired (100%) (2 marks) NOTE: no penalty for omitting the Deferred Tax Asset relating to the Brand name. (assume tax rate is 30%) 3)

If goodwill arises from the business combination, explain how it will be amortised for accounting purposes. Goodwill has an indefinite life; therefore, amortisation of goodwill is prohibited. Instead, goodwill is subject to annual impairment testing (2 marks)

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QUESTION 4 On 30 June 2019, to expand its business internationally, Expand Ltd purchased 80% of the shares of Overseas Ltd for $950,000 cash. At acquisition date, Overseas Ltd’s Statement of Financial Position was as follows: Overseas Ltd Statement of Financial Position as at 30 June 2019 $ Assets Liabilities Cash 69,000 Accounts Payable Accounts Receivable 173,000 Mortgage Loans Inventory 218,000 Deferred Tax Liability Land 800,000 Shareholder’s Equity Share Capital General Reserve Revaluation Surplus . Retained Earnings Total Assets 1,260,000 Total Equities

$ 164,000 386,000 120,000 300,000 80,000 80,000 130,000 1,260,000

All the assets and liabilities of Overseas are fairly stated at acquisition date. REQUIRED 1) Is Expand required to prepare the consolidated financial statement including Overseas Ltd? Yes, because Expand has the control over Overseas, as Expand holds 80% of the shares of Overseas, and therefore holds the majority (80%) of the voting power in Overseas. (1 mark) 2)

Is there any goodwill arising from the business combination? If so, determine its amount. Fair Value of Purchase Consideration Less Fair Value of Net identifiable assets acquired (80%) Fair Value of Assets 1,260,000 Less Fair Value of Liabilities (164,000 + 386,000 + 120,000) 670,000 Fair Value of Net identifiable assets 590,000 Fair Value of Net identifiable assets acquired (80% x 590,000) Goodwill

950,000

472,000 478,000

The difference is goodwill because Fair Value of Purchase Consideration > Fair Value of Net identifiable assets acquired (80%) (2 marks)

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3)

There can be peculiar circumstances when a gain on bargain purchase arises from a business combination. Explain why it is considered to be a gain, and how the gain on bargain purchase is accounted for in the consolidated financial statement. The gain on bargain purchase is a gain because the Net Identifiable Assets acquired have been purchased for consideration less than their fair value, that is: Fair Value of Purchase Consideration < Fair Value of Net identifiable assets acquired The parent entity could make an immediate profit by selling all the assets of the new subsidiary for their fair values and discharging the liabilities. The Gain on Bargain Purchase is recognised as an income (gain) in the Consolidated Statement of Profit or Loss at acquisition date Note: the Gain on Bargain Purchase is only recorded in the consolidated accounts, not in the separate accounts of the Parent entity or subsidiary. (2 marks)

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