CIMA F2 - Financial Management Workbook Q & A - Mapit ...

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CIMA F2 - Financial Management

Workbook Q & A

http://www.mapitaccountancy.com


Group Accounts



Illustration 1

Additional Information

Almeria today acquired all the shares in Murcia for $300m.

The Fair Value of the NCI at acquisition was 0.

Required

Prepare the consolidated statement of financial position for the Almeria group

Almeria Murcia

Non Current Assets

Tangible 100 100

Investment in Murcia 300

Current Assets

Inventory 40 200

Receivables 60 100

Cash 200 200

700 600

Ordinary Shares 160 100

Accumulated Profits 240 200

Equity 400 300

Non Current Liabilities 100 200

Current Liabilities 200 100

700 600



Pro-Forma

Working 1 - Group Structure

Working 2 - Equity Table

Working 3 - Goodwill

Almeria

Murcia

Date Acquired

Parent Share

NCI

At Acquisition At Year End

Share Capital

Accumulated Profits

Cost of Parent Investment

Fair Value of NCI at acquisition

Less net assets at acquisition (W2)

Goodwill



Working 4 - NCI

Working 5 - Accumulated Profits

$


NCI% of Sub Post-Acq Profits

Value of NCI at Year End

$

Parent’s Accumulated Profits

Add: Parent % of the subsidiary’s post acquisition profits



SFP for Almeria Group

Almeria Murcia Group

Non Current Assets

Goodwill

Tangible 100 100

Investment in Murcia 300

Current Assets

Inventory 40 200

Receivables 60 100

Cash 200 200

700 600



Non Controlling Interest

Equity 400 300



700 600



Solution

Working 1 - Group Structure



Almeria

↓100%

Murcia

Date Acquired TODAY

Parent Share 100%

NCI 0%


Share Capital 100 100


300 300

Cost of Parent Investment 300

Fair Value of NCI 0

Less net assets at acquisition (W2) -300

Goodwill 0



Working 4 - NCI


$

Fair Value of NCI at acquisition 0

NCI% of Sub Post-Acq Profits 0

Value of NCI at Year End 0

$

Parent’s Accumulated Profits 240

Add: Parent % of the subsidiary’s post acquisition profits Nil

240



SFP for Almeria Group

Almeria Murcia Group

Non Current Assets

Goodwill None (W3) Nil

Tangible 100 100 100 + 100 200

Investment in Murcia 300 Cancel out Nil

Current Assets

Inventory 40 200 40 + 200 240

Receivables 60 100 60 +100 160

Cash 200 200 200 + 200 400

700 600 1000

Ordinary Shares 160 100 Parent 160

Accumulated Profits 240 200 W5 240

Non Controlling Interest W4 Nil

Equity 400 300 400

Non Current Liabilities 100 200 100 + 200 300

Current Liabilities 200 100 200 + 100 300

700 600 1000



Illustration 2


Ant today acquired 160m of the 200m shares in Dec.

The Fair Value of the NCI was 50.

Required

Prepare the consolidated statement of financial position for the Ant group

Ant Dec

Assets 500 500

Investment in Dec 350

850 500



Equity 350 300

Liabilities 500 200

850 500



Illustration 2 Pro-Forma

Working 1- Group Structure

Working 2- Equity Table


↓

Date Acquired

Parent Share

NCI


Share Capital

Accumulated Profits




Goodwill



Working 4 - NCI


$




$





Statement of Financial Position for Ant Group

Ant Dec Group

Goodwill

Assets 500 500

Investment in Dec

350

850 500

Ordinary Shares

100 200

Accumulated Profits

250 100

NCI

Equity 350 300

Liabilities 500 200

850 500



Illustration 2 Solution


Working 2- Equity Table


Ant

↓80%

Dec

Date Acquired TODAY

Parent Share 80%

NCI 20%

100%




300 300




Goodwill 100



Working 4 - NCI


$


NCI% of Sub Post-Acq Profits 0


$


Add: Parent % of the subsidiary’s post acquisition profits Nil

250



Statement of Financial Position for Ant Group

Ant Dec Group

Goodwill W3 100

Assets 500 500 500 + 500 1000

Investment in Dec

350 Cancelled in Goodwill W3

Nil

850 500 1100

Ordinary Shares

100 200 Parent Only 100

Accumulated Profits

250 100 W5 250

NCI W4 50

Liabilities 500 200 500 +200 700

850 500 1100



Illustration 3


Evan acquired 150m shares in Dando one year ago when the reserves of Dando were $40m. The Fair Value of the NCI on the date of acquisition was $100m.

Required

Prepare the consolidated statement of financial position for the Evan group.

Evan Dando

Assets 200 350

Investment in Dando 500

Current Assets 200 300

900 650

Ordinary Shares ($1) 200 200


Equity 450 300


Liabilities 170 150

900 650



Solution




↓

Date Acquired

Parent Share

NCI


Share Capital

Accumulated Profits




Goodwill



Working 4 - NCI


$




$





Statement of Financial Position for Evan Group

Evan Dando Group

Goodwill

Assets 200 350

Investment in Dando

500


900 650

Ordinary Shares ($1)

200 200

Accumulated Profits

250 100

NCI

Equity 450 300

Non Current Liabilities

280 200

Liabilities 170 150

900 650



Solution




Evan

↓75%

Dando

Date Acquired 1 Year Ago

Parent Share 75%

NCI 25%

100%




240 300




Goodwill 360



Working 4 - NCI


$


NCI% of Sub Post-Acq Profits (25% x 60m) 15


$



(75% x 60m) 45

295



Statement of Financial Position for Evan Group

Evan Dando Group

Goodwill W3 360

Assets 200 350 200 + 350 550

Investment in Dando

500 Cancelled out in W3.

Nil

Current Assets 200 300 200 + 300 500

1410


Parent Only 200

Accumulated Profits

W5 295

NCI W4 115

570


280 200 280 + 200 480

Liabilities 170 150 170 + 150 320

1410



Illustration 4


Virtual acquired 60m shares in Insanity one year ago when the reserves of Insanity were $60m. The Fair Value of the NCI at that date was $120m.

Required

Prepare the consolidated statement of financial position for the Virtual group

Virtual Insanity

Assets 1000 800

Investment in Insanity 600


2000 1000



Equity 1550 500


Liabilities 200 200

2000 1000



SolutionWorking 1- Group Structure



Virtual

↓60%

Insanity


Parent Share 60%

NCI 40%

100%




160 500




Goodwill 560



Working 4 - NCI


$


NCI% of Sub Post-Acq Profits (40% x (500 - 160))

136


$



(60% x (500 - 160)

204

954



Statement of Financial Position for Virtual Group

Virtual Insanity Group

Goodwill W3 560

Assets 1000 800 1000 + 800 1800

Investment in Insanity

600 Cancelled in W3

Nil

Current Assets 400 200 400 + 200 600

2000 1000 2960



Accumulated Profits

750 400 W5 954

NCI W4 256

Equity 1550 500 1954


250 300 250 + 300 550

Liabilities 200 200 200 + 200 400

2000 1000 2960



Illustration 5

Jabba acquired 100% of the shares in Hutt two years ago.

The consideration was as follows:

1. Cash of $36,000.2. 2000 Shares in Jabba (the share price is currently $3).3. $30,000 to be paid four years after the date of acquisition. The

relevant discount rate is 12%4. If the group meets certain targets there will be a further payment with

fair value of $60,000 at a later date.

Required:

(i) Calculate the fair value of the consideration which Jabba has given in purchasing the investment in Hutt.

(ii)Show the value of the liability in the Statement of Financial Position for the deferred consideration at the end of the current year.

(iii)What is the charge to the Statement of Profit or Loss in the current period related to the deferred consideration?




Illustration 6

On 1 October 2012, Paradigm acquired 75% of Strata’s 20,000 equity shares by means of a share exchange of two new shares in Paradigm for every five acquired shares in Strata. In addition, Paradigm issued to the shareholders of Strata a $100 10% loan note for every 1,000 shares it acquired in Strata. The share price of Paradigm on the date of acquisition was $2.

Calculate the consideration paid for Strata.

Solution

Share exchange ((20,000 x 75%) x 2/5 x $2) $12,00010% loan notes (15,000 x 100/1,000) $1,500

$

Cash Amount 36,000

Shares Market Value (2000 x 3) 6,000

Deferred Consideration 30,000 x (1 / (1.124) 19080

Contingent Consideration Fair Value 60,000

Total 121080

Year O’Bal Unwind (12%) C’Bal

1 19,080 2,290 21,370

2 21,370 2,564 23,934



Illustration 7

Jimmy acquired 80% of Gent 1 year ago. The following information relates to Gent at the date of acquisition.

An item of plant was valued at $200 in the Gent’s Financial Statements but had a Fair Value of $300, the plant had a remaining life of 5 yrs at the date of acquisition. Goodwill is to be calculated gross.

Accumulated profits at

acquisition

Cost of investment Fair Value of NCI at acquisition

$ $ $

150 800 160

Jimmy Gent

Investment in Gent 800

Assets 700 700

1500 700



Equity 1200 600

Liabilities 300 100

1500 700





Jimmy

↓80%

Gent


Parent Share 80%

NCI 20%

100%




Fair Value Adjustment 100 100

Additional Depreciation -20

500 680




Working 4 - NCI

Working 5 - Group Accumulated Profit

Cost of Parent’s investment 800

Fair value of NCI at acquisition (Market Value) 160

960

Less 100% net assets at acquisition in W2 -500

Gross Goodwill 460


Plus NCI share of post acquisition profits 2200 x 25% 550

850

$



80% x (680 - 500) (W2)

144

644



Statement of Financial Position for Jimmy Group

Jimmy Gent Group

Goodwill W3 460

Investment in Gent

800 Cancelled Nil

Assets 700 700 700 + 700 + 100 - 20

1480

1500 700 1940


700 250 Parent only 700

Accumulated Profits

500 350 W5 644

NCI W4 196

Equity 1200 600 1540

Liabilities 300 100 300 + 100 400

1500 700 1940



Illustration 8

Devil acquired 90% of Detail 2 years ago. The following information relates to Gent at the date of acquisition.

An item of plant was valued at $300 in the Gent’s Financial Statements but had a Fair Value of $200.

The plant subject to the fair value adjustment had a remaining life of 4 yrs at the date of acquisition. Goodwill is to be calculated Gross.

Accumulated profits at

acquisitionCost of

investmentFair Value of NCI

at acquisition

$ $ $

250 1000 55

Devil Detail

Investment in Detail 1000

Assets 600 800

1600 800



Equity 900 600

Liabilities 700 200

1500 700




Working 2 - Net Assets Subsidiary

Devil

↓90%

Detail

Date Acquired 2 Years Ago

Parent Share 90%

NCI 10%

100%




Fair Value Adjustment -100 -100

Additional Depreciation (2yrs) 50

250 550

300




Working 4 - NCI




1055


Gross Goodwill 805


Plus NCI share of post acquisition profits 10% x 300 (W2) 30

85

$



90% x 300 (W2)

270

520



Statement of Financial Position for Devil Group

Devil Detail

Goodwill 1000 W3 805

Assets 600 800 600 + 800 - 100 + 50

1350

1600 800 2155


650 100 Parent 650

Accumulated Profits

250 500 W5 520

NCI W4 85

Equity 900 600

Liabilities 700 200 700 + 200 900

1500 700 2155



Illustration 9

Evaro Co. Acquired 80% of Stando Co. one year ago and the following detail is relevant:

At the date of acquisition the following was relevant:

i) An item of plant was valued at $100m in the Gent’s Financial Statements but had a Fair Value of $50m, the plant had a remaining life of 10 yrs at the date of acquisition.

ii)Stando Co. owns an internally generated brand worth $20m on the date of acquisition that has a useful economic life of 20 years.

iii)At the date of acquisition a court case against Stando Co. is in process which has resulted in a contingent liability of $25m being disclosed in their financial statements. By the year end Stando Co. had won the court case resulting with no payment as a result.

Required

Compete the Equity Table (W2) based on the above information for Stando. Co.

At Acquisition$m

At Year End$m





Solution

At Acquisition$m

At Year End$m



Fair Value of Plant -50 -50

Remove Depreciation (50/10) 5

Brand 20 20

Amortization on Brand -1

Contingent Liability -25 0

295 574



Illustration 10

Brad acquires 80% of Angelina’s share capital in a share for share exchange. Brad gives Angelina 2 shares for every one in Angelina. Angelina has 100 shares in issue with a nominal value of $1 Angelina’s share price is $8. Brad’s share price is $5. At the date of acquisition the net assets of Angelina are $600.

Calculate the gross goodwill and the NCI.



Solution

Consideration

Brad is purchasing 80% of 100 shares = 80 shares

He is issuing 2 shares for each of the 80 he is purchasing (80 x 2) = 160

Each of the 160 shares is worth $5 so consideration is (160 x 5) = $800

Goodwill



960


Gross Goodwill 360



Illustration 11

Brad acquires 80% of Angelina’s share capital in a share for share exchange. Brad gives Angelina 2 shares for every one in Angelina. Angelina has 100 shares in issue with a nominal value of $1. Brad’s share price is $5. At the date of acquisition the net assets of Angelina are $600.

Calculate the goodwill arising using the proportionate method and the NCI.




Consideration

Brad is purchasing 80% of 100 shares = 80 shares

He is issuing 2 shares for each of the 80 he is purchasing (80 x 2) = 160

Each of the 160 shares is worth $5 so consideration is (160 x 5) = $800

Goodwill

NCI


NCI Value at acquisition (600 x 20%) 120

Net assets at acquisition (W2) -600

Goodwill 320

NCI at acquisition 600 x 20% 120

NCI% Post Acquisition Profit (800 - 600) x 20% 40

160



Illustration 12

(i)Archie acquires 60% of Mitchell’s share capital with consideration of $900. Mitchell has 200 shares in issue with a share price is $5. At the date of acquisition the net assets of Mitchell were $800 and are $950 at the year end. At the year end the retained earnings of Archie were $1,000.

An impairment review has been carried out on the goodwill at the year end which has found it to be impaired by $40.

Calculate the gross goodwill, the retained earnings and the NCI at the year end.



Solution

Goodwill

NCI


Fair value of NCI at acquisition (200 x 40% x $5) 400

1300


Gross Goodwill 500

Impairment -40

Post Impairment Goodwill 460

Dr W4 16

Dr W5 24

Fair Value of NCI at Acquisition 400


NCI Share of Impairment -16

444



Retained Earnings

Parent 1000


Parent Share of Impairment -24

1066



Illustration 12 (ii)

French acquired 75% of Shambles several years ago.

If French has $1500 of retained earnings at the year end, calculate the gross goodwill, retained earnings for the group and the NCI at the year end.

Cost of Investment

Fair Value of NCI at

acquisition

Net assets at acquisition

Net assets at year end

Goodwill Impairment at

Y/E

$ $ $ $ $

1,000 300 800 3,000 200



Solution

Goodwill

NCI

Cost of Parent’s investment 1,000


1300


Gross Goodwill 500

Impairment -200


DR W4 50

DR W5 150



Impairment -50

800



Retained Earnings

Parent 1500

NCI% Post Acquisition Profit 2200 x 75% 1650

Parent Share of Impairment -150

3000



Illustration 12 (iii)

Pinky acquired 80% of Brain 4 years ago. The following information is relevant:

Goodwill is calculated gross and is subject to an annual impairment review. In the current year goodwill has been impaired by $20.

Net Assets at year end

Net Assets at acquisition

Cost of investment

Fair Value of NCI at

acquisition

$ $ $ $

150 100 175 25

Pinky Brain

Investment in Pinky 175

Assets 100 100

Inventory 140 200

Receivables 160 100

Bank 125 200

700 600



Equity 400 150

Non current liabilities 100 250

Liabilities 300 100

700 600



Solution



Pinky

↓80%

Brain

Date Acquired 4 Years Ago

Parent Share 80%

NCI 20%

100%


Share Capital 50 50


100 150




Alternative working



200


Gross Goodwill 100

Impairment -20


Dr W4 (20%) 4

Dr W5 (80%) 16

$


Less Parent % of the net assets at acquisition (W2)

100 x 80% -80

Goodwill attributable to Parent 95


Less NCI% of the net assets at acquisition (W2)

100 x 20% -20

Goodwill attributable to NCI 5

Gross Goodwill on Acquisition 100

Impairment -20




Working 4 - NCI

or




Less Goodwill Impairment 20 x 20% -4

31

$

NCI % of the subsidiary’s net assets at the year end (W2)

150 x 20% 30

Add Goodwill attributable to NCI (W3) 5

Less Impairment of goodwill 20 x 20% -4

31

$


Less Goodwill Impairment 20 x 80% -16


80% x (100 - 150) (W2)

40

264



Statement of Financial Position for Pinky Group

Pinky Brain Group

Goodwill W3 80

Assets 100 100 100 + 100 200

Inventory 140 200 140 + 200 340

Receivables 160 100 160 + 100 260

Bank 125 200 125 + 200 325

700 600 1205



Accumulated Profits

240 100 W5 264

NCI W4 31

Equity 400 150 455

Non current liabilities

100 250 100 + 250 350

Liabilities 300 100 300 + 100 400

700 600 1205



Illustration 13

George owns 80% of the subsidiary Bungle. Goodwill has been calculated on a proportionate basis and at acquisition was $400m.

During the impairment review in the current year it was found that the carrying value of the goodwill has been impaired by $50m

What is the required treatment to deal with the impairment of goodwill?



Solution

Goodwill on Balance Sheet

Proportionate goodwill 400

Impairment -50

Goodwill after impairment 350

Treatment

DR Retained Earnings (W5) 50

CR Goodwill 50



Illustration 14A Parent company has recorded an asset of $300 goods receivable with a subsidiary.

The subsidiary had recorded this as an initial liability payable of $300 but has just recorded and sent a cheque payment to the parent of $50 leaving the payable balance of $250.

How should this be adjusted for on consolidation?



SolutionWhen cross casting assets & liabilities:

Less Payables $250 (DR)

Plus Cash at bank $50 (DR)

Less Receivables $300 (CR)



Illustration 15Parent has been selling goods to subsidiary. The parent has recorded an asset of $500 receivable from the subsidiary.

The $500 includes goods worth $100 sent prior to the year end to the subsidiary who has not received them. As a result the subsidiary has a balance of $400 recorded as a liability in payables.

How should this be treated on consolidation?



SolutionWhen cross casting assets & liabilities:

Less Payables $400 (DR)

Plus Inventory $100 (DR)

Less Receivables $500 (CR)



Illustration 16Arctic is the parent of a subsidiary Monkeys. Extracts of their SFPs are below

The trade payables of Monkeys includes $35m due to Arctic. This was after the deduction of $10m in respect of cash sent by Monkeys but not yet received by Arctic.

The receivables of Arctic at the year end include $70m due from Monkeys. $25m of these goods had been dispatched by Arctic, but were not yet received by Monkeys.

Show the treatment on consolidation.

Arctic Monkeys

Current Assets

Inventory 300 100

Receivables 200 250

Bank 100 50

600 400




SolutionRemember!

Add the goods/cash in transit

Subtract the inter company current accounts

+/- Item Where? $m

+ Cash in transit Cash at Bank 10

+ Goods in transit Inventory 25

- Inter Company Current Account Payables 35

- inter Company Current Account Receivables 70

Arctic Monkeys Group

Current Assets

Inventory 300 100 300 + 100 + Goods in transit of 25

425

Receivables 200 250 200 + 250 - 70 inter company current account

380

Bank 100 50 100 + 50 + cash in transit 10

160

600 400 965

Current Liabilities

420 220 420 + 220 - inter company current account

35

605



Illustration 17Sea is the parent of a subsidiary Lion. Extracts of their SFPs are below

The trade payables of Lion includes $20m due to Arctic. This was after the deduction of $15m in respect of cash sent by Lion but not yet received by Sea.

The receivables of Sea at the year end include $50m due from Lion. $15m of these goods had been dispatched by Sea, but were not yet received by Lion.

Show the treatment on consolidation.

Sea Lion

Current Assets

Inventory 400 250

Receivables 100 100

Bank 150 100

650 450




SolutionRemember!

Add the goods/cash in transit

Subtract the inter company current accounts

+/- Item Where? $m

+ Cash in transit Cash at Bank 15

+ Goods in transit Inventory 15

- Inter Company Current Account Payables 20

- inter Company Current Account Receivables 50

Sea Lion Group

Current Assets

Inventory 400 250 400 + 250 + Goods in transit of 15

665

Receivables 100 100 100 + 100 - 50 inter company current account

150

Bank 150 100 150 + 100 + cash in transit 15

265

650 450 965

Current Liabilities

90 140 90 + 140 - inter company current account 20

210



Illustration 18Inter company sales of $400 have occurred in Attila group at a mark up on cost of 25%. At the year end 1/4 of these goods had been sold on. Attila has an 80% interest in Hun.

I. Calculate the PURP.

II. Show the accounting treatment if the parent company is the seller.

III. Show the accounting treatment if the subsidiary company is the seller.

IV. Do parts I - III if the goods had been sold at a margin of 30%.



Solution (Mark-up)

Parent is seller

Subsidiary is seller

Unsold Inventory Mark-up PURP

(400 x 3/4) = 300 25/125 60

DR/CR Account $ $

DR Accumulated Profits (W5) to decrease 60

CR Inventory to decrease 60

DR/CR Account $ $

DR Accumulated Profits (W5) with parent share to decrease (60 x 80%)

48

DR NCI (W4) with subsidiary share to decrease 12




Solution (Margin)

Parent is seller


Unsold Inventory Margin PURP

(400 x 3/4) = 300 30% 90

DR/CR Account $ $



DR/CR Account $ $


72





Illustration 19Argentina owns an 80% share of Messi which it purchased one year ago.

The information below relates to Messi at the date of acquisition.

The income statements for both are:

Other information

I. Argentina sold goods to Messi during the year at a margin of 40% and worth $100m. Half of these goods have been sold on by Messi by the year end.

II. The fair value of Messi’s net assets were equal to their book value at the date of acquisition, with the exception of some machinery which had a useful life of 5 years.

III. Calculate goodwill using the fair value of the NCI at the date of acquisition. At the year end an impairment review has found that the goodwill has been impaired by 10%.

Produce a consolidated Income Statement for the Argentina group.

Ordinary Share Capital

Reserves Fair Value of the net assets

Fair value of the NCI

Cost of the investment

$m $m $m $m $m

200 400 800 200 1900

Argentina Messi

Revenue 8000 3000

Cost of Sales -4000 -1000

Gross Profit 4000 2000

Operating Costs -1500 -1500

Finance Costs -1000 -200

Profit Before Tax 1500 300

Tax -700 -100

Profit for the year 800 200



Illustration 19 SolutionWorking 1- Group Structure

Working 2 - Inter Company

PURP

As the Parent is seller

Remember to remove the total amount of the sales also from sales and cost of sales

Argentina

↓80%

Messi

Date Acquired 1 Year Ago (No time apportionment)

Parent Share 80%

NCI 20%

100%


(100 x 1/2) = 50 40% 20

DR/CR Account $ $

DR Cost of sales to increase 20


DR/CR Account $ $

DR Revenue to decrease 100

CR Cost of sales to decrease 100




We don’t need the net assets at the year end, but we do need them at acquisition to calculate goodwill. Be careful - we are given the total and told that the difference is machinery - this will lead to an additional depreciation expense.

The $200m asset has a useful life of 5 years so the extra depreciation will be $200m x 1/5 = $40m. The treatment for this is:

We can then use this to calculate the goodwill on acquisition


Share Capital 200 N/A

Accumulated Profits 400 N/A

Fair Value Adjustment (Balancing figure)

200 N/A

800 N/A

DR/CR Account $ $


CR Non current assets to decrease 40



2100


Gross Goodwill 1300

Goodwill impairment

Gross Goodwill 1300

Impairment Loss (1300 x 10%) 130



The treatment for this is:

Working 4 - Cost of Sales

Working 5 - NCI

DR/CR Account $ $


CR Goodwill Intangible Asset to decrease 130

$m

Parent 4000

Subsidiary 1000

Less Inter Company Sales -100

Plus the PURP 20

Plus additional depreciation 40

Plus impairment loss 130

5090

$

NCI % of the subsidiary’s profits in question 200 x 20% 40

Less NCI share of additional depreciation 40 x 20% -8

Less NCI share of Impairment of goodwill 130 x 20% -26

6



Income statement for Argentina Group

Argentina

Messi Group

Revenue 8000 3000 8000 + 3000 - 100 inter company sales

10900

Cost of Sales -4000 -1000 W4 -5090

Gross Profit 4000 2000 5810

Operating Costs -1500 -1500 1500 + 1500 -3000

Finance Costs -1000 -200 1000 + 200 -1200

Profit Before Tax 1500 300 1610

Tax -700 -100 700 + 100 -800

Profit for the year 800 200 810

Attributable to Parent (Balancing Figure) 804

Attributable to NCI (W5) 6

810



Statement of Changes in Equity Pro-forma

Share Capital

Share Premium

Revaluation Reserve

Accumulated Profits

NCI Total

O’Balance X X X X X X

Share Issues X X X

Revaluation Gains

X X X

Profit for period

X X X

Less Dividends

(X) (X) (X)

Cl’Balance X X X X X X



Illustration 20Nadal is a 90% subsidiary of Federer. It was acquired one year ago for $4000m. At that time the accumulated profits were $800m.

Income Statements

Statements of Financial Position

Federer Nadal

Revenue 20000 4000

Cost of Sales -12000 -2000


Distribution Costs -2100 -300

Admin Expenses -1400 -500

Operating Profit 1500 1200

Exceptional Gain Nil 580

Investment Income 90 Nil


Profit Before Tax 3990 1630

Tax -700 -130

Profit for the year 3290 1500

Federer Nadal

Investment in Nadal 4000

Assets 20000 5000

24000 5000



Equity 20690 3200

Liabilities 3310 1800

24000 5000



Federer Statement of changes in Equity

Nadal Statement of changes in Equity

Other Information:

In the year Federer sold goods to Nadal at a margin of 20%. The total amount sold was $100m, of which a quarter remain in inventory at the year end.

Also during the year Nadal sold $180m of goods to Federer. These goods were sold at a mark up of 50%. Half of the goods remain in inventory at the year end.

At the date of acquisition the fair values of Nadal’s net assets were equal to their book value with the exception of an item of plant that had a fair value of $200m in excess of its carrying value and a remaining useful life of 4 years. Goodwill is to be calculated on a proportionate basis.

Federer paid a dividend during the year of $200m while Nadal paid a dividend of $100m. Federer has recognised the dividend received from Nadal as investment income.

Required

Prepare the consolidated Income Statement, consolidated Statement of Changes in Equity and the consolidated Statement of Financial Position for the Federer group.

Share Capital Accumulated Profits

Total Equity

Opening Balance 5000 12600 17600

Profits for the year 3290 3290

Less Dividends -200 -200

Closing Balance 5000 15690 20690


Total Equity

Opening Balance 1000 800 1800

Profits for the year 1500 1500

Less Dividends -100 -100

Closing Balance 1000 2200 3200



SolutionWorking 1- Group Structure & PURP

PURP

Parent is seller


Federer

↓90%

Nadal


Parent Share 90%

NCI 10%

100%


(100 x 1/4) = 25 20% 5

DR/CR Account $ $




(180 x 1/2) = 90 50/150 30

DR/CR Account $ $


27






Remember to take the $50m extra dep’n to the income statement!


Working 4 - NCISFP

Income Statement




Fair Value Adjustment 200 200

Additional Dep’n (200 x 1/4) -50

2000 3350

$


Less Parent % of the net assets at acquisition (W2)

2000 x 90% -1800

Goodwill 2200

$

NCI % of the subsidiary’s net assets at the year end (W2)

3350 x 10% 335

PURP W1 -3

332

$

NCI Percentage of profit from question 1500 x 10% 150

Additional Depreciation 50 x 10% -5

PURP W1 -3

142




Income Statement

$


PURP 5 + 27 -32


90% x (2000 - 3350) (W2)

1215

16873

Federer Nadal Group

Revenue 20000 4000 20000 + 4000 - 100 - 180

23720

Cost of Sales -12000 -2000 12000 + 2000 - 100 - 180 - 35 -

50

-13805


Distribution Costs -2100 -300 2100 + 300 -2400

Admin Expenses -1400 -500 1400 + 500 -1900

Operating Profit 1500 1200 5615

Exceptional Gain Nil 580 580

Investment Income 90 Nil Nil

Finance Costs -600 -150 600 + 150 -750

Profit Before Tax 3990 1630 5445

Tax -700 -130 700 + 130 -830

Profit for the year 3290 1500 4615

Attributable to Parent (Balancing Figure)

4473

Attributable to NCI W4 142

4615



Statement of Financial Position

Statement of changes in Equity

Federer Nadal Group

Goodwill W3 2200

Investment in Nadal 4000 Cancelled Nil

Assets 20000 5000 20000 + 5000 + 200 - 50 -35

25115

24000 5000 27315

Share Capital 5000 1000 Parent Only 5000

Accumulated Profits 15690 2200 W5 16873

NCI W4 332

Equity 20690 3200 22205

Liabilities 3310 1800 3310 + 1800 5110

24000 5000 27315


NCI Total Equity

Opening Balance

5000 12600 200 17800

Profits for the year

4473 142 4615

Less Dividends

-200 -10 210

Closing Balance

5000 16873 332 22205



Associates(IAS 28)



Illustration 1 3 years ago Star Ltd. bought 25% of the share capital of Wars Ltd. for consideration of $400,000. Since that time Wars Ltd.has had the following results:

Due to poor trading results and customer service issues, Star Ltd feel that in the current year the investment in Wars Ltd. has been impaired by $20,000.

Show the treatment of War Ltd. in the statement of financial position of Star Group and in the Income statement for the 3 years of the investment.

Solution

Year Profit Dividend Paid By Associate

1 $200,000 0

2 $160,000 $150,000

3 $30,000 0

Year 1 Investment In Associate (SFP)

Initial Investment 400,000

Parent Share of Post Acquisition Profit (200,000) x 25% 50,000

Investment in Associate 450,000

Year 1 Income From Associate (Income Statement)

Parent share of Current Year Income (200,000 x 25%) 50,000





Parent Share of Post Acquisition Profit (200,000 + 160,000) x 25% 90,000

Share of Dividend (150,000 x 25%) -37,500



Parent share of Current Year Income (160,000 x 25%) 40,000



Parent Share of Post Acquisition Profit

(200,000 + 160,000 + 30,000) x 25% 97,500

Share of Dividend (150,000 x 25%) -37,500

Impairment -20,000



Parent share of Current Year Income (30,000 x 25%) 7500

Impairment -20,000

Loss From Associate -12500



Illustration 2 Inter company sales of $1,300 have occurred in Attila group at a mark up on cost of 30%. At the year end 1/2 of these goods had been sold on. Attila has an 30% interest in Hun.

I. Calculate the PURP.

II. Show the accounting treatment if the parent company is the seller.

III. Show the accounting treatment if the Associate company is the seller.



Solution (Mark-up)

Parent is seller


Unsold Inventory Mark-up PURP Group %

(1300 x 1/2) = 650 30/130 150 45

DR/CR Account $ $


CR Investment in Associate 45

DR/CR Account $ $


CR Group Inventory 45



Illustration 3 On 1 April 2009 Picant acquired 75% of Sander’s equity shares in a share exchange of three shares in Picant for every two shares in Sander. The market prices of Picant’s and Sander’s shares at the date of acquisition were $3·20 and $4·50 respectively.

In addition to this Picant agreed to pay a further amount on 1 April 2010 that was contingent upon the post-acquisition performance of Sander. At the date of acquisition Picant assessed the fair value of this contingent consideration at $4·2 million, but by 31 March 2010 it was clear that the actual amount to be paid would be only $2·7 million (ignore discounting). Picant has recorded the share exchange and provided for the initial estimate of $4·2 million for the contingent consideration.

On 1 October 2009 Picant also acquired 40% of the equity shares of Adler paying $4 in cash per acquired share and issuing at par one $100 7% loan note for every 50 shares acquired in Adler. This consideration has also been recorded by Picant.

Picant has no other investments. The summarised statements of financial position of the three companies at 31 March 2010 are:

Picant Sander Alder

Property, plant & equipment 37,500 24,500 21,000

Investments 45,000

82,500 24,500 21,000

Inventory 10,000 9,000 5,000

Receivables 6,500 1,500 3,000

Total Assets 99,000 35,000 29,000

Ordinary Shares 25,000 8,000 5,000

Share Premium 19,800 0 0

Ret. Earnings B/F 16,200 16,500 15,000

For year to 31/3/10 11,000 1,000 6,000

72,000 25500 26000

7% Loan Notes 14,500 2,000 0

Contingent Consideration 4,200 0 0

Current Liabilities 8,300 7,500 3,000

Total Equity & Liabilities 99,000 35000 29000



(i) At the date of acquisition the fair values of Sander’s property, plant and equipment was equal to its carrying amount with the exception of Sander’s factory which had a fair value of $2 million above its carrying amount. Sander has not adjusted the carrying amount of the factory as a result of the fair value exercise. This requires additional annual depreciation of $100,000 in the consolidated financial statements in the post-acquisition period.

(ii)Also at the date of acquisition, Sander had an intangible asset of $500,000 for software in its statement of financial position. Picant’s directors believed the software to have no recoverable value at the date of acquisition and Sander wrote it off shortly after its acquisition.

(iii)At 31 March 2010 Picant’s current account with Sander was $3·4 million (debit). This did not agree with the equivalent balance in Sander’s books due to some goods-in-transit invoiced at $1·8 million that were sent by Picant on 28 March 2010, but had not been received by Sander until after the year end. Picant sold all these goods at cost plus 50%.

(iv)Picant’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose Sander’s share price at that date can be deemed to be representative of the fair value of the shares held by the non-controlling interest.

(v)Impairment tests were carried out on 31 March 2010 which concluded that the value of the investment in Adler was not impaired but, due to poor trading performance, consolidated goodwill was impaired by $3·8 million.

(vi)Assume all profits accrue evenly through the year.




Consideration for Sander

Consideration for Alder

Picant

↓75% ↓40%

Sander Alder

Sander

Date Acquired 1 April 2009 (1 Yr ago)

Parent Share 75

NCI 25

100

Item $‘000

Share Exchange No. Shares Purchased (8000 x 75%) = 6000

Picant Shares Issued ((6000 / 2) x 3) = 9000

Total Value (9000 x 3.20) = $28,800 28,800

Contingent Consideration

Fair Value 4,200

Total Consideration 33,000

Item $‘000

Cash Fair Value (4 x (5000 x 40%)) 8,000

Loan Notes (5000 x 40%) / 50 x 100 4,000

Total Consideration 12,000




Working 3 - Goodwill in Sander


Share Capital 8,000 8,000

Accumulated Profits 16,500 17,500

Fair Value of Factory 2,000 2,000

Additional Dep’n -100

Software -500

26000 27400

$‘000 $‘000

Cost of Parent Investment 33,000

Fair Value of NCI at acquisition (8,000 x 25%) x $4.5

9,000

Less NCI% of the net assets at acquisition (W2)

-26,000

Gross Goodwill on Acquisition 16,000

Impairment -3,800

Goodwill at year end 12,200

Impairment to Parent in W5 (3,800 x 75%) 2,850

Impairment to NCI in W4 (3,800 x 25%) 950



Working 4 - NCI

Working 5 - PURP & Group Accumulated Profit

PURP

Group Accumulated Profit

$

Fair Value of NCI at Acquisition 9,000

NCI Share of Post Acq. Profit (25% x 1,400) 350

Goodwill Impairment to NCI (W3) -950

8400

Total Unsold Goods Profit on Goods PURP

1,800 1,800 /150 x 50 600

DR Retained Earnings (W5) 600

CR Inventory (SFP) 600

$

Parent’s Accumulated Profits 27,200

Add: Parent % of Sub’s post acquisition profits (W2)

(27,400 - 26,000) x 75%

1050

Add: Parent % of Associate post acquisition profits

(6,000 x 6/12) x 40%

1,200

PURP -600

Parent Share of goodwill impairment W3 -2850

Gain on contingent consideration 4,200 - 2,700 1,500

27500



Working 6 - Associate

SFP

$‘000

Cost of Parent’s Investment (W1) 12,000

Post Acquisition Profits ((6000 x 6/12) x 40%) 1,200

13,200

Picant Sander Group

Goodwill W3 12,200

Property, plant & equipment

37,500 24,500 37,500 + 24,500 + 2,000 - 100

63,900

Associate Investment W6 13,200

Investments 45,000 0

82,500 24,500 89,300

Inventory 10,000 9,000 10,000 + 9,000 - 600 +1,800

20,200

Receivables 6,500 1,500 6,500 + 1,500 - 3,400 4,600

Total Assets 99,000 35,000 114,100

Ordinary Shares 25,000 8,000 Parent Only 25,000

Share Premium 19,800 0 19,800

Ret. Earnings B/F 16,200 16,500

For year to 31/3/10 11,000 1,000 W5 27,500

NCI W4 8,400

72,000 25500 80,700

7% Loan Notes 14,500 2,000 14,500 + 2,000 16,500

Contingent Consideration

4,200 0 4,200 - 1,500 2,700

Current Liabilities 8,300 7,500 8,300 + 7,500 - 1,600 14,200

Total Equity & Liabilities 99,000 35000 114,100



Increasing/Decreasing Holding



Illustration 1Vic purchased 10% of the shares in Bob several years ago. The investment cost $17,000 and Vic currently carries the investment at cost in the accounts. Vic has subsequently purchased 45% of the shares in Bob for $120,000. The net assets of Bob have a fair value of $60,000 and the fair value of the original investment is $45,000. The fair value of the NCI is $90,000.

Calculate the gain or loss arising on the subsequent acquisition of shares

Solution 1

Fair value of original investment 45,000

Less the cost of the original investment -17,000

Gain taken to income statement 28,000



Illustration 2Vic purchased 10% of the shares in Bob several years ago. The investment cost $17,000 and Vic currently carries the investment at cost in the accounts. Vic has subsequently purchased 45% of the shares in Bob for $120,000. The net assets of Bob have a fair value of $60,000 and the fair value of the original investment is $45,000. The fair value of the NCI is $90,000.

Calculate the gross goodwill arising on the acquisition of Bob.

Solution 2


Working 2 - Revaluation

Vic

↓10% ↓45%

Bob

Date 10% Acquired Years Ago

Date 45% Acquired Now

Parent Share 55%

NCI 45%

1








Fair value of consideration for second investment 120,000

165,000

Fair value of NCI at acquisition 90,000

Less 100% net assets at acquisition -60,000

Gross Goodwill 195,000



Illustration 3Aldo purchased 15% of the shares in Giro several years ago. The investment cost $85,000 and they currently carry it at cost in the accounts. Aldo has subsequently purchased 75% of the shares in Giro for $700,000. The net assets of Giro have a fair value of $750,000 and the fair value of the original investment is now $145,000. The fair value of the NCI on acquisition was $180,000.

Calculate the gross goodwill arising on the acquisition of Giro.

Solution 3


Working 2 - Revaluation

Aldo

↓15% ↓75%

Giro

Date 15% Acquired Years Ago

Date 75% Acquired Now

Parent Share 90%

NCI 10%

1








Fair value of consideration for second investment 700,000

845,000

Fair value of NCI at acquisition 180,000

Less 100% net assets at acquisition -750,000

Gross Goodwill 275,000



Illustration 4A parent has owned 70% of a subsidiary for a long period of time. The NCI in the subsidiary is currently measured at $500,000. If the parent buys another 10% what will the value of the NCI fall to?

Solution 4

$

Current NCI value (30% holding) 500,000

Proportion being purchased (500,000 x 10/30) 166,667

New Value of NCI (500,000 - 166,667) 333,333



Illustration 5A parent has owned 90% of a subsidiary for a long period of time. The NCI in the subsidiary is currently measured at $300,000.

I. The parent acquires all of the remaining shares for consideration of $250,000.

II. The parent acquires 3% of the shares for $200,000 reducing the NCI to 7%.

What is the difference taken to equity in both situations?

Solution 5

I.

II.

$

Amount of cash paid for subsequent investment 250,000

Decrease in the NCI 300,000

Difference to an equity reserve 50,000

$

Amount of cash paid for subsequent investment 200,000

Decrease in the NCI 300,000 x 3/10 90,000

Difference to an equity reserve -110,000



Illustration 6Inter purchased 70% of the shares in Milan several years ago. At that time goodwill of $80,000 arose. The net assets of Milan are currently $100,000 and the NCI is $18,000.

I. Calculate the gain arising on disposal if Inter sells it’s entire holding for $350,000.

II. Calculate the gain arising on disposal if Inter sells 30% for $250,000 and the fair value of the residual value is $30,000



Solution 6I.

II.

$

Sale Proceeds 350,000

Less net assets of sub at date of disposal -100,000

Less all goodwill remaining at disposal -80,000

Plus all NCI at date of disposal 18,000

Plus fair value of any residual holding Nil

Gain to group 188,000

$

Sale Proceeds 250,000

Less net assets of sub at date of disposal -100,000

Less all goodwill remaining at disposal -80,000

Plus all NCI at date of disposal 18,000

Plus fair value of any residual holding 30,000

Gain to group 118,000



Illustration 7For several years Jeremy has owned 70% of Richard. The net assets of Richard at this time are $250,000. The NCI is $68,000 and the gross goodwill is $200,000.

Jeremy has just sold 15% to take the holding to 55% for consideration of $150,000. Calculate the difference arising that will be taken to equity.



Solution 7

$

DR Amount of cash received for sale of subsequent investment 150,000

CR Increase in the NCI (% of net assets & goodwill)

15% x (250,000 + 200,000) 67,500

CR Difference to an equity reserve (Gain) 82,500



Vertical Groups



Illustration 1Consider a group with the following structure and detail:

Required

Calculate the Goodwill & the NCI at the acquisition date.

P

↓80% - 1 Year Ago

S

↓60% - 1 Year Ago

S1

Cost of Investment

Net Assets on Acquisition

FV NCI on Acquisition

S 250 200 60

S1 220 150 100



Working 1 - Effective Interest in S1

Working 2 - Goodwill in S

Working 3 - Goodwill in S1

Working Total

P’s Direct Interest in S 80%

Non Controlling Interest in S 20%

100%

P’s indirect interest in S1 (80% x 60%) 48%

Non Controlling Interest in S1 (Balancing figure) 52%

100%

$



Less net assets at acquisition -200


$

Cost of Investment 220

Less indirect holding adjustment 220 x 20% -44


Less net assets at acquisition -150




Working 4 - NCI

$

Fair Value of NCI at Acquisition in S 60

Fair Value of NCI at Acquisition in S1 100

Less indirect holding adjustment -44

116



Illustration 2Ozzy acquired a 70% holding in Sharon 2 years ago. Sharon purchased a 60% shareholding in Jack one year ago. The following financial statements relate to the Ozzy group.

Statements of Financial Position Ozzy Sharon Jack

$ $ $

Investment in Sharon 50

Investment in Jack 17

Other assets 25 18 20

75 35 20

Ordinary Shares 50 20 8

Accumulated profits 20 12 8

Equity 70 32 16

Liabilities 5 3 4

75 35 20

Income Statements Ozzy Sharon Jack

$ $ $

Revenue 400 60 85

Operating Costs -395 55 -83

Operating Profit 5 5 2

Tax -3 -2 -1

Profit for Year 2 3 1

Accumulated Profits Sharon Jack

One year ago 3 4

Two years ago 2 3



Goods worth $8m were sold in the year by Jack to Sharon and by the year end all of these had been sold to a third party.

An impairment review at the year end found the goodwill of Sharon to be impaired by $3m, goodwill is to be calculated gross.

Prepare the consolidated statement of financial position and consolidated income statement for the Ozzy group.

Fair Value of NCI based on effective shareholdings

Sharon Jack

One year ago 8 10

Two years ago 7 6




Ozzy’s effective Interest in Jack

Ozzy

↓70% - 2 Years Ago

Sharon

↓60% - 1 Year Ago

Jack

Working Total

Ozzy’s direct interest in Jack 0%

Ozzy’s indirect interest (via Sharon)

(70% x 60%) 42%

Ozzy’s effective interest in Jack 0.42

Non Controlling Interest in Jack (Balancing figure) 0.58

100%

Ozzy’s Direct Interest in Sharon 70%

Non Controlling Interest in Sharon 30%

100%




Working 3 - Goodwill in Sharon



Sharon Jack

Share Capital 20 20 8 8

Accumulated Profits 2 12 4 8

22 32 12 16



57


Gross Goodwill 35

Impairment -3

Goodwill after Impairment 32



Working 3 - Goodwill in Jack

Working 4 - NCI


Less indirect holding adjustment -5.1


21.9


Gross Goodwill 9.9

Fair Value of Sharon’s NCI at acquisition 7

Fair Value of Jack’s NCI at acquisition 10

Less indirect holding adjustment -5.1

Plus Sharon NCI share of post acquisition profits (32-22) x 30% 3

Plus Jack NCI share of post acquisition profits (16-12) x 58% 2.32

Less NCI share of Sharon Goodwill Impairment 3 x 30% -0.9

16.32




Working 6 - NCI (Income Statement)

$


Less Goodwill Impairment 3 x 70% -2.1

Add: Parent % of Sharon’s post acquisition profits 10 x 70% 7

Add: Parent % of the Jack’s post acquisition profits 4 x 42% 1.68

26.58

Sharon Jack

NCI % of Profit in Question (30% x 3) 0.9 (1 x 58%) 0.58

NCI Share Goodwill Impairment (30% x 3) -0.9

NCI Share Group Profit -0.00 0.58

Total 0.58



Financial Statements for Ozzy Group


Ozzy Sharon Jack Group

$ $ $

Goodwill W3 41.9

Other assets 25 18 20 25 + 18 +20 63

104.9

Ordinary Shares 50 20 8 50

Accumulated profits 20 12 8 W5 26.58

NCI W4 16.32

Equity 70 32 16 92.9

Liabilities 5 3 4 5 + 3 + 4 12

104.9

Income Statement

Ozzy Sharon Jack

$ $ $

Revenue 400 60 85 400 + 60 + 85 - 8 (inter

company)

537

Operating Costs 395 55 83 395 +55 + 83 - 8 + 3 (G’will Imp)

528

Operating Profit 9

Tax -3 -2 -1 3 + 2 + 1 -6

Profit for Year 3

Attributable to parent (Balancing figure) 2.42

Attributable to NCI (W6) 0.58

3



Indirect Associates



Illustration 1

The parent has an 60% holding in the subsidiary. The subsidiary has an associate in which it holds 40%. The following information is relevant.

Show the treatment for the associate in the group financial statements.

Subsidiary’s cost of investment in associate 200

Fair value of net assets in associate at acquisition 120

Fair value of net assets in associate at year end 300



Solution 1

Effective interest & NCI

Parent’s’s indirect interest (via Sub)

(60% x 40%) 24%

NCI (Balancing figure) 16%

Parent’s effective interest 40%

Post Acquisition Profits

Fair value of net assets in associate at year end 300

Fair value of net assets in associate at acquisition -120

Post acquisition profits 180

Carrying Value of Associate $


Subsidiary share of post acquisition profits (40% x 180) 72

Carrying Value of Associate 272

Treatment

DR Investment in Associate 40% x 180 72

CR Equity W5 (Parent share of post acquisition profits)

24/40 x 72 43.2

CR NCI W4 (NCI share of post acquisition profits) 16/40 x 72 28.8



Mixed Groups



Illustration 1The statements of financial position for 3 companies are as follows:

Other information:

I. John acquired a 60% holding in Paul for $600

II. Paul acquired a 60% holding in Ringo for $200

III. John acquired a 30% holding in Ringo for $75

IV. All of the investments were made on the same date

V. Goodwill is to be calculated gross and no impairment has been recorded

VI. The carrying value of assets & liabilities were the same as the fair values on the date of acquisition

VII. On the date of acquisition the following information was correct:

Prepare the consolidated statement of financial position for John Group.

John Paul Ringo

Investments 675 200

Assets 900 700 400

1575 900 400

Share Capital 300 200 100

Accumulated Profits

700 400 100

Equity 1000 600 200

Liabilities 575 300 200

1575 900 400

Paul Ringo


Fair value of the effective NCI 100 60



Solution 1


Effective interest & NCI

Indirect Holding Adjustment

Use this to reduce the cost of investment in W3 and the NCI in W4.

John

↓ ↓60%

30% ↓ Paul

↓ ↓60%

Ringo

Control

John Controls Paul.

Paul controls Ringo and in addition John controls another 30% of Ringo.

Ringo is therefore a subsidiary of John group.

John’s direct interest in Ringo 30%

John’s indirect interest in Ringo (60% x 60%) 36%

John’s effective interest in Ringo 66%

Effective NCI in Ringo 100% - 66% 34%

NCI in Paul Paul’s investment in Ringo

40% X 200 = 80




Working 3 - Goodwill in Paul

Working 3 - Goodwill in Ringo



Paul Ringo

Share Capital 200 200 100 100

Accumulated Profits 250 400 60 100

450 600 160 200



700


Gross Goodwill 250

Cost of Paul’s investment 200

Cost of John’s investment 75



255


Gross Goodwill 95



Working 4 - NCI


Fair Value of Paul NCI at acquisition 100

Fair Value of Ringo NCI at acquisition 60


Plus Paul NCI share of post acquisition profits (600-450) x 40%

60

Plus Ringo NCI share of post acquisition profits (100 - 60) x 34%

13.6

153.6

$


Add: Parent % of Paul’s post acquisition profits 150 x 60% 90

Add: Parent % of Ringo’s post acquisition profits 40 x 66% 26.4

816.4



Statement of financial position for John Group

John Paul Ringo Group

Goodwill W3 (95 + 250)

345

Assets 900 700 400 900 + 700 + 400

2,000

2,345

Share Capital

300 200 100 Parent 300

Accumulated Profits

700 400 100 W5 816

NCI W4 154

Equity 1,270

Liabilities 575 300 200 500 + 300 +200

1,075

2,345



Changes in Mixed Groups



Solutions to Lecture Illustrations

Working Total

A’s direct interest in C 25%

A’s indirect interest (via B) (90% x 70%) 63%

A’s effective interest in C 0.88

Non Controlling Interest in C (Balancing figure) 12%

100%

Working Total

D’s direct interest in F 30%

D’s indirect interest (via E) (70% x 40%) 28%

D’s effective interest in F 0.58

Non Controlling Interest in F (Balancing figure) 0.42

100%

Action Result

D invests in E in 2008 D owns 70% of E making it a subsidiary

D invests in F in 2009 D owns 30% of F making it an associate

E invests in F in the current year This makes D’s effective interest in F 58% as per our working.

F has gone from an associate to a subsidiary.This is a step-acquisition so we need to revalue the current investment in F and take the gain or loss to the income statement.



Action Result

D invests in E in 2008 D owns 70% of E making it a subsidiary

E invests in F in 2009 E owns 40% of F making it an associate as E has significant influence and D controls that influence.

D invests in F in the current year This makes D’s effective interest in F 58% as per our working.

F has gone from an associate to a subsidiary.This is a step-acquisition so we need to revalue the current investment in F and take the gain or loss to the income statement.

Working Total

G’s direct interest in I 80%

G’s indirect interest (via H) (90% x 10%) 9%

G’s effective interest in I 0.89

Non Controlling Interest in I (Balancing figure) 0.11

100%

Action Result

G invests in H in 2008 G owns 90% of H making it a subsidiary

G invests in I in 2009 G owns 80% of I making it a subsidiary

H invests in I in the current year This makes G’s effective interest in I 89% as per our working.

I was a subsidiary before with an 80% holding.It is now still a subsidiary with an 89% holding.This is a decrease in the NCI of 9% and will be a transaction within equity.



Action Result

G invests in H in 2008 G owns 90% of H making it a subsidiary

H invests in I in 2009 I is a simple investment of 10%

G invests in I in the current year This makes G’s effective interest in I 89% as per our working.

I was an investment before.It is now a subsidiary with an 89% holding.This is a step acquisition.



IAS 21 Foreign Currency



Illustration 1Which of the following statements relating to IAS 21 The effects of changes in foreign exchange rates is correct?

A. The functional currency of a foreign subsidiary is the currency that the group financial statements are presented in.

B. A foreign subsidiary must present it’s financial statements in the presentational currency of the parent.

C. Consideration will be given to the currency of the costs and sales of the entity when determining it’s functional currency.

D. The more autonomous a subsidiary, the more likely it’s functional currency is that of the parent entity.

Answer C

Illustration 2Bulldog Ltd has a year end of 31 January.

On 13th October Bulldog Ltd buys goods from Eagle Inc. a US supplier for $250,000.

On 24th November Bulldog settles the transaction in full.

Exchange rates

13th October £1 : $1.45

24th November £1 : $1.55

Show the accounting entries for these transactions.




Agreeing Transaction Working £

On date of agreeing the transaction use the spot rate to record it

250,000 / 1.45

172,414

DR Purchases 172,414

CR Payables 172,414

On Settlement Working £

On date of agreeing the transaction use the spot rate to record it

250,000 / 1.55

161,290

DR Payables 172,414

CR Cash with amount actually paid 161,414

CR FX Gain with the difference 11,000



Illustration 3Jeff Ltd. purchases an item of plant on 1st June from a foreign supplier on one month’s credit for €100,000. Jeff is a US company.

Exchange rates

1st June $ = €1.50

21st June $ = €1.40

How will this transaction be dealt with in the accounts for the year to 21st June?



Solution to Illustration 3

At Purchase Date Working $

The rate at the time of purchase is $ : €1.50 €100,000 / 1.50 66,666

DR Asset 66,666

CR Payables 66,666

At 21st June Working $

The rate at this time is $ : €1.40 €100,000 / 1.40 71,429

The payable must be retranslated at the year end as it is a monetary balance. So........

DR FX Loss (71,429 - 66,666) 4,763

CR Payables (71,429 - 66,666) 4,763

The $4,763 is unrealised so is included in Other Comprehensive Income.



Illustration 4

Big Ltd. acquired 80% of Cahoona Inc. on 1st July 20X1.Cahoona Inc are based in Burgerland where the functional currency is Francs (Fr). The financial statements for the year to 30 June 20X2 are below.

SFP Big$

CahoonaFr

Investment in Cahoona 5000

Non Current Assets 10,000 3,000

Current Assets 5,000 2,000

20000 5,000


Retained Earnings 4,000 2,500

Liabilities 10,000 1,000

20,000 5,000

Income Statement Big$

CahoonaFr

Revenue 25,000 35,000

Operating Costs -15,000 -26,250

Profit Before Tax 10,000 8,750

Tax -5,000 -7,450

Profit for the Year 5,000 1,300



There was no other comprehensive income for either entity in the period.

Other information:

I. The fair value of the net assets of Cahoona was Fr6,000 on the date of acquisition with any increase being attributable to land held at historic cost.

II. Big sold goods to Cahoona during the year for $1,000 cash.

III.The NCI is valued using the Fair Value method at FR 2000 at acquisition.

IV. The Goodwill in Cahoona was impairment tested at the year end and was impaired by FR200. The impairment was deemed to have accrued evenly over the year so the average rate should be used to treat it.

Exchange rates to $1:

Fr 1 July 2001 1.5 Average rate 1.75 1 June 1.9 30 June 2

Prepare the group statement of financial position and statement of other comprehensive income.





Working 2 - Equity Table in Functional Currency

Big

↓80%

Cahoona


Parent Share 80%

NCI 20%

100%

At AcquisitionFr

At Year EndFr


Accumulated Profits 1,200 2,500

Fair Value Adjustment on land (Balancing figure)

3,300 3,300

6,000 7,300

Translate at 1.5 2

Total Net Assets in $ 4000 3650

Post acquisition Loss including FX movements -350



Working 3 - Goodwill in Functional Currency

Working 4 - NCI

Fr Fr

Cost of Parent Investment (5,000 @ 1.5) 7,500

Fair Value NCI 2,000

Less Parent net assets at acquisition (W2)

-6,000

Goodwill 3,500

Translated at closing rate (3500 / 2) $1,750

Impairment -$114

Remaining Goodwill To SFP $1,636

Add Back Impairment (200 / 1.75) $114

Goodwill at Opening Rate (3500 / 1.5) -$2,333

FX Loss on Goodwill for Year -$583

$

Fair Value of NCI at Acquisition Rate (2000 / 1.5) 1,333

NCI% Post Acquisition Loss (W2) (20% x -350) -70

NCI % Goodwill Impairment in Year (20% x -114) -22.8

NCI% Goodwill FX Loss (20% x -583) -117

1,124





$

Parent’s Accumulated Profits 4,000

Share of Sub Post-Acq Loss (80% x -350) -280

Parent% Goodwill Impairment in Year (80% x -114) -91

Parent% Goodwill FX loss (80% x -583) -466

3,162

SFP Big Cahoona $

Non Current Assets 10,000 ((3,000 + 3,300) / 2) = 3,150

13,150

Goodwill (W3) 1636

Current Assets 5,000 (2000 / 2) 6000

20786

Share Capital 6,000 Parent 6,000

Retained Earnings 4,000 W5 3162

NCI W4 1124

Liabilities 10,000 ((1,000 / 2) 10500

20,000 0 20786



FX Gains/Losses for year

NCI Share Profit/Loss for Period

Closing Net Assets at Cl. Rate (W2) (7300 / 2) 3650

Comprehensive Income for Year at Ave. Rate (1300 / 1.75)

-743

Opening Net Assets at Op. Rate (6000 / 1.5) -4000

FX Loss for Year on Net Assets -1,093

FX Loss for Year on Goodwill (W3) -583

Total FX Loss for the year -1,676

NCI Share Profit in Period 20% x 1300 260

NCI Share Goodwill Impairment 20% x 200 -40

Share of Profit in FR 220

Translate at Ave. Rate (220 / 1.75) 126



Statement of Comprehensive Income

Big Cahoonas Adjustment $

Revenue 25,000 (35,000 / 1.75) Inter Co-1,000

44,000

Operating Costs -15,000 (26,250 / 1.75 Inter Co-1,000

-29,000

Profit Before Tax 15,000

Tax -5000 (7,450 / 1.75) -9,257

Profit for the Year 5,743

Profit Attributable to:

Parent (Balance) 5,617

Non Controlling Interest 126

5,743

Comprehensive Income

Profit for the Year 5,743

FX differences on translation of foreign operations (W6) -1,676

4,067



IFRS 2Share Based Payments



Illustration 1

An entity grants 1 share option to each of its 100 employees on 1 January Year 1. Each grant is conditional upon the employee working for the entity over the next three years.

The fair value of each share option as at 1 January Year 1 is $8

At the end of each year the number of employees expected to take up the options are:

Year 1: 95Year 2: 97

When the rights are taken up in year 3, 98 employees actually receive the options.

Show the treatment for the employee benefits over the three years.

Solution

Year Total Employees expected to

qualify

Value of

option

Proportion of

vesting period

Total cumulative charge

Cost for each period

Dr WagesCr equity

1 95 8 1/3 253 253

2 97 8 2/3 517 517 - 253 = 264

3 98 8 3/3 784 784 - 253 - 264 = 267



Illustration 2An entity grants 1 share option to each of its 500 employees on 1 January Year 1. Each grant is conditional upon the employee working for the entity over the next three years.

The fair value of each share option as at 1 January Year 1 is $10

On the basis of a weighted average probability, the entity estimates on 1 January that 100 employees will leave during the three-year period and therefore forfeit their rights to share options.

The following actually occurs:

– 20 employees leave during Year 1 and the estimate of total employee departures over the three-year period is revised to 70 employees

– 25 employees leave during Year 2 and the estimate of total employee departures over the three-year period is revised to 60 employees

– 10 employees leave during Year 3

Solution

Year Employee Departures

Total EXPECTED to leave

TOTAL EXPECTED TO VEST AT YEAR

END

1 20 70 430

2 25 60 440

3 10 20 + 25 + 10 (Actual) 445


qualify

Value of

option

Proportion of

vesting period

Total cumulativ

e cost


Dr ExpenseCr equity

1 430 10 1/3 1433 1433

2 440 10 2/3 2933 2,933 - 1,433 = 1,500

3 445 10 3/3 4450 4,450 - 2933 = 1,517



Illustration 3

Same question with additional information of share option price at the end of each year:

Year 1 10 Year 2 12 Year 3 14

Solution


qualify

Share Option Price

Proportion of

vesting period

Total cumulativ

e cost


Dr ExpenseCr Liability

1 430 10 1/3 1433 1433

2 440 12 2/3 3520 3,520 - 1,433 = 2,087

3 445 14 3/3 6230 6,230 - 3,520 = 2,710



Financial Instruments I



Illustration 1VB acquired 40,000 shares in another entity, JK, in March 2011 for $2.68 per share. The investment was classified as available for sale on initial recognition. The shares were trading at $2.96 per share on 31 July 2011. Commission of 5% of the value of the transaction is payable on all purchases and disposals of shares.

Calculate the amount recognised in the Financial Statements on initial recognition of the Financial Asset.

Illustration 2(i) VB acquired 40,000 shares in another entity, JK, in March 2012 for $2.68 per share. The investment was classified as available for sale on initial recognition. The shares were trading at $2.96 per share on 31 July 2012. Commission of 5% of the value of the transaction is payable on all purchases and disposals of shares.

Show the treatment for the shares at 31 July 2012

(ii) VB subsequently sold the shares on 31 July 2013 when the share price was $3.00.

Show the treatment for the shares at 31 July 2013

(i)

DR CR

Recognition of Financial Asset (40,000 x $2.68) + $5,360 112,560

Cash 112,560

$

Recognition of Financial Asset (40,000 x $2.68) + $5,360

112,560

Fair Value on 31 July 2012 (40,000 x $2.96) 118400

Movement to Statement of Comprehensive Income(Gain) 5840



(ii)

$



Movement to Statement of Comprehensive Income (Gain) 1600

Previous movement shown in Statement of Comprehensive Income (Gain) 5,840

Total Taken to Income Statement when sold

DR ReserveCR Income Statement 7440



Financial Instruments II



Illustration 1A company invests $10,000 in a 3 year redeemable 10% bond which is redeemable at a premium.

The bond consists of interest payments and principle only and the company intends to hold it until it is redeemed.

The effective interest rate on the bond is 12%.

Show the treatment for the bond over the 3 year period.

O’Bal Interest (12%)DR Financial Asset

CR Income Statement

Cash Rec’d (10% x 10,000)

DR CashCR Financial

Asset

Cl’bal

10,000 1,200 -1,000 10,200

10,200 1,224 -1,000 10,424

10,424 1,251 -1,000 10,675

The Premium payable at the end of the term therefore is $675.



Illustration 2A company issues a $30,000 3 year 7% redeemable bond at a discount of 10% with issue costs of $1,000.

The bond is redeemable at a premium of $1,297.

The effective interest rate is 14%.

Show the treatment for the bond over the 3 year period.

$

Issue Proceeds 30,000

Discount -3,000

Issue Costs -1,000

Net Proceeds 26,000

O’Bal Interest (14%)DR Income StatementCR Financial Liability

Cash Paid (7% x 30,000)DR Financial Liability

CR Cash

Cl’bal

26,000 3,640 -2,100 27,540

27,540 3,856 -2,100 29,296

29,296 4,101 -2,100 31,297



Illustration 3Ambush loaned $200,000 to Bromwich on 1 December 2003. The effective and stated interest rate for this loan was 8 per cent. Interest is payable by Bromwich at the end of each year and the loan is repayable on 30 November 2007. At 30 November 2005, the directors of Ambush have heard that Bromwich is in financial difficulties and is undergoing a financial reorganisation. The directors feel that it is likely that they will only receive $100,000 on 30 November 2007 and no future interest payment. Interest for the year ended 30 November 2005 had been received. The financial year end of Ambush is 30 November 2005.

Required: (i) Outline the requirements of IAS 39 as regards the impairment of financial

assets. (6 marks)

(ii) Explain the accounting treatment under IAS39 of the loan to Bromwich in the financial statements of Ambush for the year ended 30 November 2005. (4

marks)

SolutionIAS 39 requires an entity to assess at each balance sheet date whether there is any objective evidence that financial assets are impaired and whether the impairment impacts on future cash flows. Objective evidence that financial assets are impaired includes the significant financial difficulty of the issuer or obligor and whether it becomes probable that the borrower will enter bankruptcy or other financial reorganisation.

For investments in equity instruments that are classified as available for sale, a significant and prolonged decline in the fair value below its cost is also objective evidence of impairment.

If any objective evidence of impairment exists, the entity recognises any associated impairment loss in profit or loss. Only losses that have been incurred from past events can be reported as impairment losses. Therefore, losses expected from future events, no matter how likely, are not recognised. A loss is incurred only if both of the following two conditions are met:

(i) there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’), and

(ii) the loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated

The impairment requirements apply to all types of financial assets. The only category of financial asset that is not subject to testing for impairment is a financial asset held at fair value through profit or loss, since any decline in value for such assets are recognised immediately in profit or loss.



For assets at amortised cost, impaired assets are measured at the present value of the estimated future cash flows discounted using the original effective interest rate of the financial assets. Any difference between the carrying amount and the new value of the impaired asset is an impairment loss.

There is objective evidence of impairment because of the financial difficulties and reorganisation of Bromwich. The impairment loss on the loan will be calculated by discounting the estimated future cash flows. The future cash flows will be $100,000 on 30 November 2007. This will be discounted at an effective interest rate of 8% to give a present value of $85,733. The loan will, therefore, be impaired by ($200,000 – $85,733) i.e. $114,267.



Financial Instruments III



Illustration 1QWE issued 10 million 5% convertible $1 bonds 2015 on 1 January 2010. The proceeds of $10 million were credited to non-current liabilities and debited to bank. The 5% interest paid has been charged to finance costs in the year to 31 December 2010.

The market rate of interest for a similar bond with a five year term but no conversion terms is 7%. Show the treatment for the bond in year 1.

Solution

$

First Step is to calculate debt value (Present Value of interest & Capital)

Interest for 5 Years at 5% ($10m x 5%) 500,000

Discounted Cash Flows

Discount Interest Payment at effective rate (500,000 x 4.100)

2,050,000

Discount Capital Repayment ($10m x 0.713) 7130000

Total Debt Portion 9180000

The difference between the issued value of the convertible debt and the present value of the interest and capital is the EQUITY portion of the debt

Total Convertible Debt 10,000,000

Present Value of Interest and capital from above 9180000

Total Equity Portion 820000

O’Bal Interest (7%)DR Income Statement CR Financial Liability

Cash Paid (5% x 10m)

DR Financial Liability CR Cash

Cl’bal

9,180,000 642,600 -500,000 9,322,600



Illustration 2Aron issued one million convertible bonds on 1 June 2006. The bonds had a term of three years and were issued with a total fair value of $100 million which is also the par value. Interest is paid annually in arrears at a rate of 6% per annum and bonds, without the conversion option, attracted an interest rate of 9% per annum on 1 June 2006. The company incurred issue costs of $1 million. If the investor did not convert to shares they would have been redeemed at par. At maturity all of the bonds were converted into 25 million ordinary shares of $1 of Aron. No bonds could be converted before that date. The directors are uncertain how the bonds should have been accounted for up to the date of the conversion on 31 May 2009 and have been told that the impact of the issue costs is to increase the effective interest rate to 9·38%.

Solution

Debt & Equity Split

Year Cash Flows DR 9% PV

1 6 0.917 5.50

2 6 0.841 5.05

3 6 0.772 4.63

3 100 0.772 77.20

Debt Total 92.38

Total Value 100.00

Equity Total (Bal) 7.62

Issue Costs $

Debt ($1m x 92.38/100) 923,800

Equity ($1m x 7.62/100) 76,200

Debt Equity Total

Pre- Issue Costs 92.38 7.62 100

Issue Costs 0.92 0.08 1

Net Value 91.46 7.54 99



Year O’bal Interest (9.38%)

Cash Paid Cl’bal

1 91.46 8.58 6.00 94.04

2 94.04 8.82 6.00 96.86

3 96.86 9.09 6.00 99.95

This is the $100m conversion value of the bond with slight rounding difference



IAS 33 EPS



Illustration 1An entity issued 300,000 shares at full market price on 1st July 2009. The year end of the entity is 31st December.

There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.

Calculate the EPS at 31st December 2009.

Solution

Date Shares Months Fraction Ave

1/01/09 900,000 6/12 - 450,000

1/07/09 1,200,000 6/12 - 600,000

1,050,000

EPS = 1,000,000 / 1,050,000 = 95.24c



Illustration 2ABC Ltd. makes a bonus issue of 1 for 6 on 1st July 2009. The year end of the entity is 31st December.


Calculate the EPS at 31st December 2009.

Solution


1/01/09 900,000 6/12 7/6 525,000

1/07/09 1,050,000 6/12 525,000

1,050,000

EPS = 1,000,000 / 1,050,000 = 95.24c



Illustration 3ABC Ltd. makes a rights issue of 1 for 3 on 1st July 2009. The current share price is $4 and the rights issue is at a price of $3 The year end of the entity is 31st December.


Last year’s earnings were $900,000

Calculate the EPS at 31st December 2009 and the new EPS for 2008.

Solution

No. Shares Price Total

3 4 12

1 3 3

4 15

THERP = (15 / 4) = $3.75 so rights fraction is: 4/3.75


1/01/09 900,000 6/12 4/3.75 480,000

1/07/09 1,200,000 6/12 600,000

1,080,000

December 2009 EPS = 1,000,000 / 1,080,000 = 92.59c

c

December 2008 EPS (900,000 / 900,000) 100

Inverted Bonus Fraction 3.75/4

Comparable EPS 93.75



Illustration 4

An entity issued a bonus issue of 1 for 5 of it’s shares on 1st July 2009. The year end of the entity is 31st December.

There were 1,000,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.

The entity also has convertible loan stock that if converted would create 100,000 new shares.

The interest paid on the loan each year is $90,000 with tax benefits associated of $20,000

Calculate the EPS at 31st December 2009 and the Diluted EPS.

Solution

Diluted EPS


1/01/09 1,000,000 6/12 6/5 600,000

1/07/09 1,200,000 6/12 - 600,000

1,200,000

EPS = 1,000,000 / 1,200,000 = 83.33c

Earnings

$

Basic Earnings 1,000,000

Interest Saved on Loan 90,000

Tax Benefit Lost -20,000

1,070,000



No. Shares

Basic number of shares 1,200,000

New shares created on conversion 100,000

1,300,000

Diluted EPS

Diluted Earnings 1,070,000

Diluted No. Shares 1,300,000

Diluted EPS 82.31c



Illustration 5

An entity has a basic weighted average number of shares of 2m and earnings of $1.5m. It also has in issue 300,000 share options with an exercise price of $5. The average market value of the shares in the year was $6.

Calculate the basic EPS for the entity and the diluted EPS.

Solution

Basic EPS (1,500,000 / 2,000,000) 75c

Cash Inflow (Number of Share Options x Exercise Price)

(300,000 x $5) $1,500,000

Non Dilutive Shares (Cash Inflow / Average Market Value of Share)

(1,500,000 / $6) 250,000

Dilutive Shares (No. Options - Non Dilutive Shares)

(300,000 - 250,000) 50,000

Basic Number of Shares 2,000,000

Total Shares for diluted EPS 2,050,000

Diluted EPS (1,500,000 / 2,050,000 73.2c



IAS 17Leases



Illustration 1An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay 3 annual payments of $2,500, the first of which is payable on 31/12/X0.

The actuarial interest rate is 12% (annuity rate for 3 years 2.402) and the fair value of the asset was $6,500.

Show the treatment in the lessees financial statements over the life of the asset.

Solution

Recognition of the Asset

Fair Value 6,500

PV minimum lease payments 2,500 x 2.402 6005

Recognise at lower of the two so..... 6,005

DR Asset 6,005

CR Lease Liability 6,005

Period

Opening Bal

Interest Charge(12%)DR Income Statement

CR Lease Liability

Lease PaymentDR Lease Liability

CR Cash

Closing Bal

1 6,005 721 -2,500 4,226

2 4,226 507 -2,500 2,233

3 2,233 268 -2,500 0

The asset will be depreciated over the 3 year period at (6,005 x 1/3) = 2,002



Illustration 2An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay 3 annual payments of $2,500, the first of which is payable on 31/12/X0.

The actuarial interest rate is 12% (annuity rate for 3 years 2.402) and the fair value of the asset was $6,500.

Calculate the interest payable each year over the term of the lease using the sum of digits method.

SolutionTotal Interest = Amount Payable - Asset Value

Total Interest = (2,500 x 3) - 6005 = $1,495

Sum of Digits = 3 x (3 + 1) / 2 = 6

Year Remaining / SOD Total Interest Annual Interest

1 3/6 1495 748

2 2/6 1495 498

3 1/6 1495 249



Illustration 3A company takes out a 6 year operating lease.

They pay $1,500 deposit up front on the first day of year one and $2,000 in arrears on the last day of years 1, 2, 3, 4, 5 and 6.

How much will be recognised in the Income Statement and the SFP at the end of year 1 of the lease?

Solution

Total Amount Due Under Lease (1,500 + (2,000 x 6) 13,500

Number of Years 6

Amount to Income Statement each year (13,500 / 6) 2250

Cash Paid in Period 1 (1,500 + 2,000) 3,500

Difference between Income Statement amount and actually paid is a Prepayment (3,500 - 2,250) 1250

Income Statement Amount 2250

Prepayment on SFP 1250



Illustration 4Arbie Co. has sold some plant and leased it back on a 5 year finance lease. The sale took place at the beginning of the current accounting period.

Details were as follows:

Show the treatment for the above in the financial statements in year 1.

Solution

W1 - Profit on Disposal

Proceeds of Sale 200,000

Fair Value of Machine at date of sale 200,000

Carrying Value of plant at date of sale 150,000

Annual Lease Payments (in arrears) 52,760

UEL of machine 5 years

Annuity 5yrs at 10% 3.791

Implicit rate of Interest 10%

Carrying Value of Asset 150,000

Proceeds 200,000

Profit on Disposal (200,000 - 150,000) 50,000

This profit is deferred over the length of the lease

Released in Year 1 (50,000 / 5) 10,000



W2 - Recognise New Asset

W3 - Depreciation

W4 - Lease Workings

Recognition of the Asset

Fair Value 200,000

PV minimum lease payments (52,760 x 3.791) 200,013

Recognise at lower of the two so..... 200,000

DR Asset 200,000

CR Lease Liability 200,000

Value UEL Depreciation

200,000 5 40000

Period

Opening Bal

Interest Charge(10%)DR Income Statement

CR Lease Liability

Lease PaymentDR Lease Liability

CR Cash

Closing Bal

1 200,000 20,000 -52,760 167,240

2 167,240 16,724 -52,760 131,204

3 131,204 13,120 -52,760 91,564

4 91,564 9,156 -52,760 47,961

5 47,961 4,796 -52,760 -3



Financial Statement Extracts

Income Statement

Depreciation 40,000

Finance Lease 20,000

Deferred Profit Released 10,000


Non Current Assets

Asset Under Finance Lease (200,000 - 40,000) 160,000


Finance Lease (More than 1yr) (167,240 - (52,760 - 16,724)

131204

Deferred Income (More than 1yr) (40,000 - 10,000) 30,000

Current Liabilities

Finance Lease (Less than 1yr) (52,760 - 16,724) 36,036

Deferred Income (Less than 1yr) 10,000



Illustration 5

How would the following be treated in the financial statements for the next year?

Company A has sold 6 assets with the intention of leasing them back on 5 year operating leases.

Solution

Item Carrying Value

Proceeds Fair Value Annual Lease Payments

1 360 300 400 50

2 400 300 360 50

3 300 360 400 66

4 300 400 360 70

5 360 400 300 70

6 400 360 300 66

Item Carrying Value

Proceeds Fair Value Above/Below Fair

Value?

Gain/Loss

1 360 300 400 Below -60

2 400 300 360 Below -100

3 300 360 400 Below 60

4 300 400 360 Above 100

5 360 400 300 Above 40

6 400 360 300 Above -40



Year 1 Treatment

Item

Gain/Loss Recognised

Lease Payments

1 60 loss on sale (unless lower future rentals) -60 50

2 100 loss on sale (unless 60 is for lower future rentals) -100 50

3 60 gain on sale 60 66

4 60 gain on sale; 40 to deferred income

60 + (40 /5) =68 70

5 60 impairment to income statement; 100 to deferred income

60 Impairment20 Deferred Income 70

6 100 impairment to income statement; 60 to deferred income

100 Impairment12 Deferred Income 66



Substance Over Form



Illustration 1Slick Tony sells cars from his car dealership. The car manufacturer supplies him with cars on which the purchase price is set on delivery. An element of finance is included in the purchase price.

If the car is not sold within 4 months then it must be purchased by Tony. If Tony sells a car he must pay the manufacturer the next day. Tony has to insure and maintain the cars and has no right to return them.

Who should recognise the cars on their statement of financial position and when?

Solution

Risks Faced By Dealer

Theft

Insurance

Maintenance

Slow moving stock (Tony has to buy the car!)

Therefore Tony should recognise the cars on his SFP on delivery.



Illustration 2Pinky Social Club has sold it’s building to an investment company for $300,000. They have signed an agreement that they can buy back the building at any stage over the next 5 years for the original price plus interest accrued and paid at the end of the 5 years charged at an effective rate of 5%.

The building’s current market value is $500,000.

How should Pinky show this transaction in their financial statements?

Solution

The substance of this transaction is a loan secured on the building as the expectation is that Pinky would re-purchase using the negotiated option.

A loan should be recognised in the financial statements.

DR Cash 300,000

CR Loan 300,000

DR P/L Interest (300,000 x 5%) 15,000

CR Loan 15,000



Related Parties



Revenue Recognition



Illustration 1ABC Co. has sold a large item of plant to CD Co. for $10m on the first day of their accounting period. They do not expect to receive payment for the plant for 24 months.

The relevant discount rate is 10% with rates:

Year Rate 1 0.909 2 0.826

How should ABC Co treat the revenue on the plant over the next 2 years?

Solution

Year 1 $

Create a discounted receivable ($10m x 0.826) 8260000

Dr Receivable 8260000

Cr Revenue 8260000

Unwind Discount ($8,260,000 x 10%) 826000


Cr P/L (Interest Income) 826000

Year 2 $

Opening Balance on Receivable (8,260,000 + 826,000) 9086000

Unwind Discount ($9,086,000 x 10%) 908600


Cr P/L (Interest Income) 908600

Closing Balance on Receivable (9,086,000 + 908,600) 9994600



Illustration 2A company sells an IT system to a customer on the first day of a new accounting period.

The package includes hardware delivered immediately and a contract for support over the next 3 years with that support worth $50,000 p/a.

The total cost of the contract is paid up front and is $300,000.

How much should the company recognise as revenue from the transaction in the current year?

Solution

Split of the Contract $

Total Revenue from Goods (Hardware)

(300,000 - (50,000 x 3) 150,000

Total Revenue from Services (Support)

(50,000 x 3) 150,000

Total Revenue from the transaction 300,000

Revenue for the Period

Revenue for the Period from Goods All delivered 150,000

Revenue for the Period from Services (150,000 / 3) 50,000

Total Revenue for the Period 200,000

Deferred Income (Remainder) 100,000



IAS 37Provisions



Illustration 1ABC Co. does not offer warranties with the radio’s it sells to customers, however if a customer is dissatisfied with the product for any reason they provide a refund with ‘no questions asked’. This policy is generally known by customers to be the case.

Should any provision for refunds be made at the year end?

Solution

There is no legal obligation to refund customers.

However:

This looks like a constructive obligation as the customers know of the policy creating a valid expectation.

We could estimate the returns based on past experience.

There will probably be some refunds made.

Therefore a provision should be created.



Illustration 2A company has entered into a contract to pay for specialist engineering support over the next 3 years for annual payments with a present value of £100,000. Unfortunately due to a change in the trading environment the support is no longer needed but the contract cannot be changed. The directors feel they may be able to sell the contract to another business for $50,000 but are unsure whether this is possible.

How should this be treated in the financial statements?

Solution

The onerous contract means that a provision should be recognised for the $100,000.

It would need to be assessed if the $50,000 was probable or virtually certain.

If virtually certain create an asset.

If only possible then disclose a contingent asset.

If neither then no action is required for the $50,000.



Illustration 3A company with a year end of 30th April has decided to re-organise trading in it’s UK division closing several outlets. It made the decision on the 30th April 2010 at a board meeting where the directors decided that a detailed plan for the re-structuring would be created as soon as possible. Employees affected by the re-structuring were sent notice on the 31st May 2010.

Should a provision for re-structuring be created in the financial statements at the year ended 31 April 2010?

Solution

There is no detailed plan available at 30th April 2010.

Employees were not informed until 31st May 2010.

No constructive obligation therefore exists and no provision should be made.



Illustration 4A company sells radios with a warranty offering instant replacement of any defective goods for the first year.

Sales in the year to date were $4,000,000 and past experience suggests that 1.7% of the radios sold will be replaced in the first year by the company.

What provision should be included in the financial statements?

Solution

A provision of (4m x 1.7%) $68,000 should be made.



Illustration 5A power generating company has just won a contract to build a new power station at a cost of $12m. The terms of the contract state that the company is not responsible for any environmental damage caused around the site such as pollution to the local environment.

It is estimated by the company that by the end of the useful economic life of the power station in 25 years time it will cost $2m to rectify any environmental impact of the plant. The company has a very clear environmental charter that has targets for limiting environmental impact and a policy of rectifying any environmental damage caused by their operations.

The company has a cost of capital of 10%

What entries should be included in the financial statements to deal with the above in the first year?

Solution

Journal Entries

DR CR

Non Current Asset (12m + (2m x 1 / 1.125))

12,184,592

Cash 12,000,000

Environmental Provision (2m x 1 / 1.125) 184,592

Depreciation (12,184,592 / 25) 487,383

Accumulated Depreciation 487,383

Finance Cost (Unwind Discount)

(184,592 x 10%) 18,459

Environmental Provision 18,459



Inventories & Construction Contracts



Illustration 1

ABC Co. has the following items in inventory:

i) Goods purchased for resale at a cost of $40,000. The recent downturn in the economy has meant that these goods will now sell for $42,000 with costs to sell of $2,500.

ii)Materials purchased at a cost of $30,000 per tonne which will be sold at a profit. The manufacturer of the materials has just announced that from now on they will sell these materials to you at a lower price of $28,000 per tonne.

iii)Plant constructed for a specific customer at a cost of $50,000 and an agreed price to the customer of $60,000. New health and safety requirements mean that the plant will need to be modified at a cost to ABC Co. of $4,000 before it can be delivered to the customer.

At what value should each of the above be included in the inventory of ABC Co.

SolutionGoods at $40,000

Cost 40,000

Net Realisable Value ($42,000 - 2,500) 39,500

Use Lower so value at... 39,500

The value of inventory will be reduced by $500 and this will be written off to the income statement.

Materials at $30,000 per tonne

The fact that the manufacturer has changed the cost price is irrelevant.

The goods will be sold at a profit and thus will be valued at $30,000 per tonne cost.

Plant at $50,000

Cost 50,000

Net Realisable Value ($60,000 - 4,000) 56,000

Use Lower so value at... 50,000

The value of the inventory will remain at $50,000.



Illustration 2

ABC Co. is building a football stadium under a construction contract.

The estimated costs to complete the stadium are $400,000.

The costs to date have been $350,000.

The total estimated revenue is $1,000,000.

It is estimated that the contract is 50% complete.

(i) What amounts of revenue, costs and profit will be recognised in the income statement?

(ii) If the expected revenue from the contract was $500,000 show the amounts of revenue, costs and profit that would be recognised in the income statement?

Solution

Expected Profit

$

Total Expected Revenue 1,000,000

Total Expected Costs (400,000 + 350,000) 750,000

Total Expected Profit 250,000

Recognised this year (250,000 x 50%) 125,000

Total Loss expected to be recognised immediately

$

Total Expected Revenue 500,000

Costs (400,000 + 350,000) 750,000

Loss -250,000



Illustration 3

ABC Co. is building a football stadium under a construction contract.

The estimated costs to complete the stadium are $400,000.

The costs to date have been $350,000.

It is estimated that the contract is 50% complete.

The company is not able to reliably estimate the outcome of the contract but believes it will recover all costs from the customer.

What amounts of revenue, costs and profit will be recognised in the income statement?

Solution

$

Costs to date 350,000

Revenue (Costs to be recovered) 350,000

Profit 0



Illustration 4A construction company has the following contracts in progress:

Profit is accrued on the contracts as a percentage of completion derived by comparing work certified to the total sales value.

Calculate the figures to be included in the financial statements in relation to the above contracts.

Solution

Step 1 - Calculate the expected profit on each contract

X Y Z

Costs Incurred to Date 300 200 600

Costs to complete 100 800 900

Work Certified to date 400 300 1000

Contract Price 500 600 2000

Progress billings 25 80 90

X Y Z


Costs to complete 100 800 900

Total Costs Expected 400 1000 1500


Profit Expected 100 -400 500



Step 2 - Percentage completion

Step 3 - Profit to be recognised

Step 4 - Income Statement Figures

Step 5 - Bal. Sheet Figures

X Y Z

Work Certified to date 400 300 1000


Percentage complete 80% 50% 50%

X Y Z

Profit Expected 100 -400 500

Percentage Completion 80% N/A 50%

Profit/Loss 80 -400 250

X Y Z Total

Sales (Work Certified)

400 300 1000 1700

Costs (Bal. Fig) 320 700 750 1770

Profit/Loss 80 -400 250 -70

X Y Z


Profit Recognised 80 0 250

Loss Recognised 0 -400 0

Less:Progress Billings -25 -80 -90

Balance 355 -280 760

Total Asset (355 + 760) 1115

Total Liability 280



Illustration 5On 1 October 2009 Mocca entered into a construction contract that was expected to take 27 months and therefore be completed on 31 December 2011.

Details of the contract are:$’000

Agreed contract price 12,500 Estimated total cost of contract (excluding plant) 5,500

Plant for use on the contract was purchased on 1 January 2010 (three months into the contract as it was not required at the start) at a cost of $8 million. The plant has a four-year life and after two years, when the contract is complete, it will be transferred to another contract at its carrying amount. Annual depreciation is calculated using the straight-line method (assuming a nil residual value) and charged to the contract on a monthly basis at 1/12 of the annual charge.

The correctly reported income statement results for the contract for the year ended 31 March 2010 were:

$‘000Revenue recognised 3,500Contract expenses recognised (2,680)Profit recognised 840

Details of the progress of the contract at 31 March 2011 are:$’000

Contract costs incurred to date (excluding depreciation) 4,800Agreed value of work completed and billed to date 8,125Total cash received to date (payments on account) 7,725

The percentage of completion is calculated as the agreed value of work completed as a percentage of the agreed contract price.

Required:

Calculate the amounts which would appear in the income statement and statement of financial position of Mocca, including the disclosure note of amounts due to/from customers, for the year ended/as at 31 March 2011 in respect of the above contract.

(10 marks)



Solution

Percentage Completion

Value of Work Completed to date 8,125

Contract Value 12,500

Percentage Completion (8,125 / 12,500) 65%

Expected Total Profit

Total Costs Expected 5,500

Depreciation (8/48 x 24) 4000

Total Costs 9,500

Total Revenue 12,500

Expected Total Profit (12,500 - 9,500) 3,000

Recognise to date (3,000 x 65%) 1,950

Recognised Last Year 840

Recognise this year (1,950 - 840) 1,110

Note to accounts showing amounts due to/from customers

Costs incurred to date From Question 4,800

Dep’n (8,000/48 x 15) 2500

Total 7300

Profit Recognised to Date 1,950

Progress Billings -8,125

Amount Due from Customers 1,125



Income Statement Extracts

Revenue (12,500 x 65%) - 3,500 4,625

Costs (9,500 x 65%) - 2,660 3,515

Gross Profit Recognised 1,110

SFP Extracts

Non Current Asset (8,000 - 2,500) 5500

Receivables (8,125 - 7,725) 400

Amounts due from customers 1,125



IAS 12Deferred Tax



Illustration 1An entity has profit before tax of $1,000 in it’s financial statements in each of years 1, 2, 3 and 4.

Tax allowances are allowed on an item of plant purchased for $1,000 at the start of year 1 over 3 years straight line.

The company charges depreciation on the asset at a rate of 25% straight line.

The tax rate is 30%

Solution

Net Book Value in FInancial Statements

Year 1 2 3 4

Cost 1,000 1,000 1,000 1,000

Depreciation 250 250 250 250

Accumulated Depreciation 250 500 750 1,000

Net Book Value 750 500 250 0

Tax Base

Year 1 2 3 4

Cost 1,000 1,000 1,000 1,000

WDAs 333 333 333 0

Total WDAs 333 667 1,000 1,000

Net Book Value 667 333 0 0



Compare

Year 1 2 3 4

Financial Statements NBV 750 500 250 0

Tax Base 667 333 0 0

Difference (More Asset) 83 167 250 0

Deferred Tax Liability (30%) on SFP

25 50 75 0

Movement to I/S in yearDR Income Statement Tax Chg.CR Deferred Tax Liability...or opposite to reduce...

25 25 25 -75

Tax Computation

Year 1 2 3 4

Profit Before Tax 1,000 1,000 1,000 1,000

Add Back Depreciation 250 250 250 250

WDAs -333 -333 -333

Taxable Profit 917 917 917 1,250

Tax at 30% 275 275 275 375



Income Statement Comparison

Ignoring Deferred Tax

Year 1 2 3 4 Total

Profit Before Tax 1,000 1,000 1,000 1,000 4,000

Tax (W1) 275 275 275 375 1,200

Profit After Tax 725 725 725 625 2,800

With Deferred Tax

Profit Before Tax 1,000 1,000 1,000 1,000 4,000

Tax (W1) 275 275 275 375 1,200

Deferred Tax 25 25 25 -75 0

Profit After Tax 700 700 700 700 2,800



Illustration 2At the year end ABC Co. has non current assets that have a carrying amount of $2,000,000 but a tax base of $1,400,000.

There is currently a deferred tax liability carried forward of $250,000 and the tax rate is 30%.

Tax for the year has been estimated as $500,000.

Show the treatment for deferred tax in the period and the effect this has on the financial statements.

Solution

Carrying Value of Asset 2,000,000

Tax Base 1,400,000

Difference (More Asset) 600,000

Deferred Tax Liability Required (600,000 x 30%) 180,000

Current Deferred Tax Liability 250,000

Movement Required -70,000

Treatment DR CR

Deferred Tax Liability (To reduce) 70,000

Income Statement (Income Tax Charge) 70,000

Amounts in Financial Statements

Income Statement Tax Charge (500,000 - 70,000) 430,000

Deferred Tax Liability 180,000

Income Tax Due 500,000



Interpretation of Financial Statements



Illustration 1

All sales are made on credit.

Required:

Calculate the Inventory, Receivables and Payables days for Inter Ltd. in each of the 2 years

2011 2010

ASSETS $‘000 $‘000

Non Current Assets 1000 1000

Inventory 300 400

Receivables 200 300

Cash 300 200

1800 1900

LIABILITIES


Reserves 200 100

Long term Liabilities 700 900

Payables 100 100

Overdraft -

1800 1900

$‘000 $‘000

Revenue 1000 1200

COS 800 1100


Other Costs 100 90

Net Profit 100 10



Solution

Item Working 2011 Working 2010

Inventory Period 300/800 x 365

137 400/1100 x 365

133

Collection Period 200/1000 x 365

73 300/1200 x 365

92

Less:

Payables Period 100/800 x 365

46 100/1100 x 365

34

164 259



Illustration 2

X1 X2 X3

Non Current Assets 500 700 1000

Current Assets 150 200 300

650 900 1300

Ordinary Shares ($1) 300 300 300

Reserves 100 280 430

Loan Notes 150 200 300

Payables 100 120 270

650 900 1300

Revenue 3000 3500 4200

COS 2000 2400 3200


Admin Costs 300 350 400

Distribution Costs 200 250 300

PBIT 500 500 300

Interest 100 150 220

Tax 120 90 50

Profit After Tax 280 260 30

Dividends 100 110 30

Retained Earnings 180 150 0

Share Price $3.30 $4.00 $2.20



Using the information on the previous page calculate and comment on the following Ratios:

I. Return on Capital EmployedII. Return on EquityIII. Gross MarginIV. Net MarginV. Operating MarginVI. Revenue GrowthVII. GearingVIII. Interest CoverIX. Dividend CoverX. Dividend YieldXI. P/E Ratio



SolutionROCE

X1 X2 X3

Equity + LT Liabilities

Shares 300 300 300


LT Loan Notes 150 200 300

Capital Employed 550 780 1030

Non Current Assets + Net Current Assets

Non Current Assets 500 700 1000

Net Current Assets (Current Assets - Current Liabilities)

(150 - 100) = 50 (200 - 120) = 80 (300 - 270) = 30


Total Assets - Current Liabilities

Total Assets 650 900 1300

Current Liabilities 100 120 270


PBIT 500 500 300

Return on Capital Employed

PBIT / Capital Employed

(500 / 550) = 90.91%

(500 / 780) = 64.10%

(300 / 1030) = 29.13%



ROE

X1 X2 X3

Return on Capital Employed (ROCE) 90.91% 64.1% 29.13%

In the first year the ROCE was 90.91%. At first glance this would appear to be a good return, however without industry averages or prior period information we are unable to tell if this is the case.

In year X2 the ROCE is 64.10%. This is a fall of 29.5% from the previous year indicating that the business in not able to make the same return on it’s assets that it has previously been able to do.

In the year X3 the ROCE is 29.13%. This is a fall of 54.55% indicating that there may be some serious underlying problems which are affecting the ability of the business to generate the return on capital previously generated.

X1 X2 X3


Ordinary Shares 300 300 300


Total 400 580 730

Return on Equity (PAT / Ord Shares + Reserves)

(280 / 400) = 70%

(260 / 580) = 44.8%

(300 / 730) = 41%

In the first year the ROE was 70%. At first glance this would appear to be a good return, however without industry averages or prior period information we are unable to tell if this is the case.

In year X2 the ROE is 44.8%. This is a fall of 36% from the previous year indicating that the business in not able to make the same return on the shareholders funds that it has previously been able to do.

In the year X3 the ROE is 41%. This is a fall of 8.4% indicating that the business may be having difficulty generating the returns it was able to do previously.



Margins

X1 X2 X3

Revenue 3000 3500 4200


PAT 280 260 30

PBIT 500 500 300

Gross Margin (Gross Profit / Revenue) (1000 / 3000) = 33.33%

(1100 / 3500) = 31.42%

(1000 / 4200) = 23.89%

Net Margin (PAT / Revenue) (280 / 3000) = 9.3%

(260 / 3500) = 7.4%

(30 / 4200) = 0.7%

Operating Margin (PBIT / Revenue) (500 / 3000) = 16.66%

(500 / 3500) = 14.28%

(300 / 4200) = 7.1%

The Gross Margin is 33.33% in X1 and holds reasonably steady in X2 at 31.42%. However in X3 the Gross Margin falls to 23.89% indicating that the business has either had to cut prices to sell the greater volume it has, or the cost of it’s purchases have gone up.

The Net Margin is 9.3% in X1 but begins to fall in X2 with 7.4% achieved, before falling dramatically to 0.7% in X3. The main reason for this is the fall in Gross Profit as other costs have risen in line with expectations given the increase in sales. However another point to note is that interest costs have risen with the increase in long term loans. The extra interest costs have put pressure on the business.

The Operating Margin dropped slightly in X2 to 14.28% from 16.66% the previous year - a fall of almost 15%. In X3 the Operating Margin fell away to 7.1%, a decrease of over 50%. This is due to the decreasing Gross Margin achieved as well as rises in the other expenses.



Gearing

X1 X2 X3

Debt 150 200 300

Equity Number of Shares

300 300 300

Share Price 3.3 4 2.2

Market Value (300 x 3.30) = 990

(300 x 4) = 1200

(300 x 2.20) = 660

Gearing (Debt / Equity) (150 / 990) = 15%

(200 / 1200) = 16.66%

(300 / 660) = 45.45%

Gearing levels in year X1 are 15%. Without industry averages or prior year data we are unable to assess this level although at first glance it does not seem excessive.

In year X2 gearing increases slightly to 16.66%, an increase of 11% from year X1. This is due to debt levels increasing to 200 from 150, although this is offset by the increase in the share price from $3.30 to $4.

In year X3 gearing increases dramatically to 45%, an increase of over 180%. This is due to debt levels rising to 300 from 200 and the share price dropping to $2.20 due to the deteriorating results of the business.



Interest Cover

Dividend Cover

X1 X2 X3

PBIT 500 500 300

Interest 100 150 220

Interest Cover (PBIT / Interest) (500 / 100) = 5 times

(500 / 150) = 3.33 times

(300 / 220) = 1.36 times

Interest coverage in year X1 is 5 times. Without industry averages or prior year data we are unable to assess this level although at first glance it does not seem unreasonable.

In year X2 interest coverage falls to 3.33 times. This has occurred due to the interest charge increasing in the period while PBIT has remained constant.

In year X3 interest coverage has decreased again to 1.36 times. This is caused by the PBIT achieved decreasing to 300 combined with the increase in the interest charge to 220. The increase in interest is caused by the increase in the long term debt of the company as shown by the gearing ratios calculated above.

X1 X2 X3

PAT 280 260 30


Dividend Cover (PAT / Dividends) (280 / 100) = 2.8 times

(260 / 110) = 2.36 times

(30 / 30) = 1 time

Dividend coverage in year X1 is 2.8 times. Without industry averages or prior year data we are unable to assess this level although at first glance it does not seem unreasonable.

In year X2 dividend coverage falls to 2.36 times. This would not concern investors as although coverage has gone down slightly, the dividend paid this year is greater than last.

In year X3 dividend coverage has decreased to 1 time. This is caused by the decrease in profit achieved by the company restricting the level of dividend payable. This will be of concern to investors and their concern is reflected in the fall in the share price from $4 in year X2 to $2.20 in year X3.



Dividend Yield

P/E Ratio

X1 X2 X3

Number of Shares (300 / 1) 300 300 300


Dividends Per Share (100 / 300) = 33c (110 / 300) = 36c (30 / 300) = 10c

Dividend Yield (Dividends Per Share / Share Price)

(33 / 330) = 10% (36 / 400) = 9% (10 / 220) = 4.5%

The Dividend Yield is 10% in year X1. Whilst we do not have comparatives, this seems a reasonable return.

In year X2 the Dividend Yield falls to 9%. This will not be overly concerning to investors as the increase in share price over the year will have more than made up for the slightly lower yield.

In year X3 the Dividend Yield has fallen to 4.5% which is 50% lower than the previous year. This, combined with the fall in share price and reduced profitability will be a major concern to investors.



X1 X2 X3

Share Price $3.30 $4 $2.20


No. Ordinary Shares 300 300 300

EPS (280 / 300) = 93c (260 / 300) = 86c (30 / 300) = 10c

P/E Ratio (Share Price / EPS) (330 / 93) = 3.54 (400 / 86) = 4.65 (220 / 10) = 22

The P/E Ratio in year X1 is 3.54. We do not have industry comparatives or prior year information with which to compare this.

In year X2 the P/E Ratio increases to 4.65. This indicates that the market expectations for this share have risen since X1 and that investors are now willing to pay 4.65 times what the business earns in a year to own the share.

In year X4 the P/E ratio has increased dramatically to 22. This is unusual as the earnings have decreased to 12% of the previous year. The share price has fallen to reflect this, but not by as much as would be expected. This may indicate that the market feels that the results in year X3 were perhaps a one-off and that next years results will improve.



Cash Flow Statements I



Illustration 1An entity has the following results in their financial statements:

2011 2010

ASSETS $‘000 $‘000

Non Current Assets 1000 1000

Inventory 300 400

Receivables 200 300

Cash 300 200

1800 1900

LIABILITIES


Reserves 200 199

Long term Liabilities 700 801

Payables 100 100

1800 1900

$‘000 $‘000

Revenue 1000 1200

COS 800 1100


Profit on Sale of Non Current Asset 30 0

Other Costs 70 90

PBIT 100 10

Interest Cost 10 7

PBT 90 3

Tax 30 2

PAT 60 1



Other Information:

I. Within cost of sales is depreciation of $40,000 and amortisation of an intangible asset of $30,000.

II. Within other costs is an increase in accrued admin expenses of $5,000.

Perform the reconciliation of Profit Before Tax to Cash Generated From Operations for 2011.

Solution


Finance Costs (Often accrued - not cash so add back)

10,000

Depreciation (Not Cash - add back) 40,000

Ammortisation (Not Cash - add back) 30,000

Profit On Sale of NCA (Not Cash - exclude) -30,000

Increase in Accruals (Not Cash Expenses - add back)

5,000 55,000

Operating cash flow before working capital changes 145,000

Decrease in Inventory (Sold more so cash in)(400 - 300)

100,000

Decrease in Receivables

(Collecting cash more quickly = cash in)

(300 - 200)

100,000

No Change in Payables - - 200000

Cash Generated from Operations 345000



Illustration 2An entity has the following information in their financial statements:

Other information:

I. The entity disposed of a piece of plant during the year with a carrying value of $300 for a profit of $50.

II. Intangible assets are made up of qualifying development expenditure on a product currently being sold, with amortisation in 2011 of $100.

What cash flows will appear in the statement of cash flows for the entity in the year 2011?

Solution

2011 2010

PPE 2,000 1,100

Intangible Assets 500 400

Property Plant & Equipment

Opening Balance 1,100

Closing Balance -2,000

Disposal (Remove Carrying Amount) -300

Balance -1200

This difference needs to increase the amount of PPE from 800 to 2000 to balance the account so must be additions - A CASH FLOW

We have also sold some PPE & so received cash.The amount received will be the carrying value plus the profit made.

(300 + 50) 350



Intangible Assets

Opening Balance 400

Closing Balance -500

Amortisation (Reduces the balance) -100

Balance -200

This difference needs to increase the amount of Intangible Asset by 200 to balance the account so must be development expenditure - A CASH FLOW



Illustration 3

Statement of Financial Position 2011 2010

Non Current Assets

PPE (note (i)) 32,600 24,100

Financial Assets (note (ii)) 4,500 7,000

37,100 31,100

Current Assets

Inventory 10,200 7,200

Receivables 3,500 3,700

Bank 1,400

13,700 12,300

Total Assets 50,800 43,400

Equity & Liabilities

Ordinary Shares of $1 (note (iii)) 14,000 8,000

Share Premium (note (iii)) 2,000

Revaluation Reserve (note (iii)) 2,000 3,600

Retained Earnings 13,000 10,100


Finance Lease Obligations 7,000 6,900

Deferred Tax 1,300 900

Current Liabilities

Tax 1,000 1,200

Bank Overdraft 2,900

Prov’n for warranties (note (iv)) 1,600 4,000

Finance Lease Obligations 4,800 2,100

Trade Payables 3,200 4,600

Total Equity & Liabilities 50,800 43,400



Note (i) - Property Plant & Equipment

The property disposed of was sold for $8.1 million.

Note (ii) - Investments/Investment Income

During the year an investment that had a carrying amount of $3 million was sold for $3.4 million. No investments were purchased during the year.

Investment income consists of:

Income Statement 2011 2010

$‘000 $‘000

Revenue 58,500 41,000

Cost of Sales -46,500 -30,000

Gross Profit 12,000 11,000

Operating Activities -8,700 -4,500

Investment Income (note (ii)) 1,100 700


Profit Before Tax 3,900 6,800

Income Tax -1,000 -1,800

Profit For the year 2,900 5,000

Cost

$‘000

Accumulated Depreciation

$‘000

Carrying Amount

$‘000

At 30 September 2010 33,600 -9,500 24,100

New finance lease additions 6,700 6,700

Purchase of new plant 8,300 8,300

Disposal of property -5,000 1,000 -4,000

Depreciation for the year -2,500 -2,500

At 30 September 2011 43,600 -11,000 32,600



Note (iii)

On 1 April 2011 there was a bonus issue of shares that was funded from the share premium and some of the revaluation reserve. This was followed on 30 April 2011 by an issue of shares for cash at par.

Note (iv)

The movement in the product warranty provision has been included in cost of sales.

Required:

Prepare a statement of cash flows for Mocha for the year ended 30 September 2011, in accordance with IAS 7 Statement of cash flows, using the indirect method.

(19 marks)

Year to 30 September 2011 2010

$‘000 $‘000

Dividends received 200 250

Profit on sale of investment 400 0

Increases in fair value 500 450

1100 700



SolutionW1 - Financial Assets

W2 - Shares Issued

W3 - Finance Leases

Financial Assets



Sale of Asset -3,000

Increase in Fair Value 500

Total 0

No Cash flows to deal with in Financial Assets

Ordinary Shares of $1 (note (iii)) 8,000

Share Premium (note (iii)) 2,000

Revaluation Reserve (note (iii)) 3,600

Ordinary Shares of $1 (note (iii)) -14,000

Share Premium (note (iii)) 0

Revaluation Reserve (note (iii)) -2,000

Balance -2400

The difference is the shares issued for cash in the year which is a cash flow

Opening Balance (Current Leases) 2,100

Opening Balance (Non Current Leases) 6,900

Closing Balance (Current Leases) -4,800

Closing Balance (Non Current Leases) -7,000

New Leases in Year 6,700

Balance 3,900

The difference is the leases REPAID in the year which is a cash flow



W4 - Income Tax

Opening Balance (Income Tax) 1,200

Opening Balance (Deferred Tax) 900

Closing Balance (Income Tax) -1,000

Closing Balance (Deferred Tax) -1,300

Income Statement Charge (Increase tax due) 1000

Balance 800

The difference is the tax PAID in the year which is a cash flow



$‘000 $’000


Finance Costs 500

Finance Income -1,100

Depreciation Note (i) 2,500

Profit On Sale of NCA (8,100 - 4,000) -4,100

Increase in Warranty Provision

(4,000 - 1,600) -2,400 -4600

Operating cash flow before working capital changes -700

Increase in Inventory (10,200 - 7,200) -3,000

Decrease in Receivables (3,700 - 3,500) 200

Decrease in Payables (4,600 - 1,600) -1,400 -4200

Cash Generated from Operations -4900

Interest Paid -500

Income Tax Paid (W4) -800

Net Cash Deficit from operating activities -6200

Cash flows from investing activities

Purchase of Property Plant & Equipment -8,300

Disposal of Property Plant & Equipment 8,100

Disposal of Investment 3,400

Dividends Received 200

Net cash from investing activities 3400

Cash flows from financing activities

Shares Issued (W2) 2,400

Payment of Finance Lease obligations (W3) -3,900

Net cash from financing activities -1,500

Net decrease in cash and cash equivalents -4300

Cash and cash equivalents brought forward 1,400

Cash and cash equivalents carried forward -2900



Cash Flow Statements II



Illustration 1The group financial statements for Nasser Ltd. show the following information:

What was the dividend paid to the NCI in the year X1?

Solution

X1 X0

NCI on Statement of Financial Position 820 700

NCI share of Profit after Tax 220 130

NCI

Opening Balance 700


Share of Profit 220

Total 100

Dividend to NCI was $100 = CASH OUTFLOW



Illustration 2Indigo Ltd, took up a 40% holding in Violet Ltg. for consideration of $120 in 20X1. The group financial statements for Indigo Ltd. show the following information:

What amounts will be included in the group cash flow statement in the year X1?

Solution

X1 X0

Post tax Income from Associate (Income Statement)

50 0

Investment in Associate (SFP) 150 0

Loan to Associate 20 0

Associate

Opening Balance 0


Purchase of Associate 120

Share of Profit 50

Total 20

Dividend Received from Associate was 20

Amounts for cash flow statement $

Income from Associate (Remove from profit before tax) -50

Consideration Paid (Cash paid out) -120

Dividend Received from associate 20

Loan to Associate 0 - 20 -20



Illustration 3Extracts from the group SFP of Express Ltd are outlined below:

During the period Express Ltd purchased 75% of Delivery Ltd. At the date of acquisition the fair value of the following assets and liabilities were determined:

Show the movements in cash for the 4 items outlined above.

Solution

X1 X0

Property Plant & Equipment 50,600 44,050

Inventory 33,500 28,700

Receivables 27,130 26,300

Trade Payables 33,340 32,810

Property Plant & Equipment 4,200

Inventory 1,650

Receivables 1,300

Payables 1,950

PPE INV REC PAY

Opening Balance 44,050 28,700 26,300 32,810

Closing Balance -50,600 -33,500 -27,130 -33,340

Purchase sub 4,200 1,650 1,300 1,950

Total -2,350 -3,150 470 1,420

OUT OUT IN OUT



Illustration 4Using the information in illustration 3 show the movements in cash if Express Ltd. Had already owned the subsidiary and sold it during the period.

Solution

PPE INV REC PAY

Opening Balance 44,050 28,700 26,300 32,810

Closing Balance -50,600 -33,500 -27,130 -33,340

Sale sub -4,200 -1,650 -1,300 -1,950

Total -10,750 -6,450 -2,130 -2,480

OUT OUT OUT IN



Illustration 5A Group has a foreign subsidiary which had the following FX Gains & Losses on translation into the Group presentational currency:

The Balances on these accounts in the Group Financial Statements were:

Depreciation in the period was $25m.

Show the cash flows arising from the above information to be included in the Group Statement of Cash-flows.

Solution

$m

PPE 30

Inventory 5

Receivables 18

Payables (7)

2011 2010

PPE 335 240

Inventory 70 50

Receivables 72 40

Payables -35 -25

PPE INV REC PAY

Opening Balance 240 50 40 25

Closing Balance -335 -70 -72 -35

FX Differences 30 5 18 7

Dep’n -25

Total -90 -15 -14 -3

OUT OUT OUT IN



Illustration 6Consolidated Financial Statements for Group.

Group Income Statement $m

Revenue 4,000

COS -2,200

Gross Profit 1,800

Other Expenses -789

Profit from operations 1011

Gain on sale of sub (Note i) 50

Finance cost (Note ii) -200

PBT 861

Tax -180

Profit after tax 681

Foreign Currency Translations 62

Total Comprehensive Income 743

Attributable to Parent 600

Attributable to NCI 143

Group Statement of Changes in Equity $m

Balance B/F 3,307

Profit Attributable to Parent 600

Dividends Paid -240

Issue of Shares 1000

Balance C/F 4667



(i) On 1 April 20X2 the parent disposed of a 75% subsidiary for $250m in cash which had the following net assets at the time:

$mProperty Plant & Equipment 200

20X2 20X1

Goodwill 52 72

Property Plant & Equipment 5,900 4,100

Inventories 950 800

Receivables 1,000 900

Cash 80 98

7982 5970


Retained Earnings 1,167 807

NCI 543 500

Non-Current Liabilities

Obligations under Finance Leases

225 140

Long term borrowings 1,554 1,200

Deferred Tax 278 218

Current Liabilities

Trade Payables 450 400

Accrued Interest 25 20

Income Tax 130 120

Obligations under Finance Leases

45 25

Overdraft 65 40

7982 5970



Inventory 100Receivables 110Cash 10Payables (80)Income Tax (25)Interest bearing borrowings (75)

240

The subsidiary had been purchased several years ago for a cash payment of $110m when it’s net assets had been $120m.

(ii) Goodwill is measured using the proportionate method

(iii)The following currency differences occurred

The exchange losses on borrowings relate to foreign loans taken out to finance investments in subsidiaries. The accounts assistant has offset these against the retranslation of the net investments in the subsidiaries. The exchange gain on retranslation of the income statement (from average rate for the year to the closing rate) relates to operating profit excluding depreciation.

(iv) Depreciation for the year was $320m and the group disposed of PPE with a net book value of $190m for cash of $198m. the profit on this disposal has been credited to ‘Other operating expenses’.

The group entered into a significant number of new finance leases in the period of which $250m related to additions to property, plant & equipment.

Prepare the consolidated cash flow statement for the period.

Total $m

Parent Share $m

On retranslation of net assets:

Property Plant & Equipment 25 20

Inventories 20 15

Receivables 20 16

Payables -9 -6

56 45

Retranslation of Profit for period 16 12

Offset exchange losses on borrowings (see below)

-10 -10

62 47



Solution

W1 - Goodwill

W2 - PPE

Goodwill in Disposal Subsidiary $m


Net assets acquired 120 x 75% -90

Goodwill 20

Goodwill

Opening Balance 72

Closing Balance -52

Disposal -20

Total 0

PPE



Disposal of Sub -200

Other Disposals (Note iv) -190

Exchange Differences (Note iii) 25

Additions on Finance Leases (Note iv) 250

Depreciation -320

Total -2235

Difference is Additions - CASH OUT



W3 - Working Capital Movements

W4 - Share Capital

W5 - NCI

Inventories Receivables Payables

O’Bal 800 900 400

Cl’Bal -950 -1,000 -450

Sub -100 -110 -80

FX 20 20 9

Movement -230 -190 -121

CASH OUT OUT IN

Net Movement OUT 299



Total -1,000

Shares of 1,000 issued = CASH IN

Opening Balance 500


Share of Profit 143

Disposal of Sub (240 x 25%) -60

Total 40

Dividend to NCI was 40 = CASH OUTFLOW



W6 - Finance Leases

W7 - Long Term Borrowings

Opening Balance (Current Leases) 25

Opening Balance (Non Current Leases) 140

Closing Balance (Current Leases) -45

Closing Balance (Non Current Leases) -225

New Leases in Year 250

Balance 145

The difference is the leases REPAID in the year which is a cash flow



Disposal of Sub -75

Exchange Loss 10

Total -419

New Borrowings therefore of 419 - CASH IN



W8 - Income Tax

W9 - Interest Payable

Opening Balance (Income Tax) 120

Opening Balance (Deferred Tax) 218

Closing Balance (Income Tax) -130

Closing Balance (Deferred Tax) -278

Disposal of Sub -25

Income Statement Charge (Increase tax due) 180

Balance 85

The difference is the tax PAID in the year which is a cash flow

Opening Balance 20

Closing Balance -25

Income Statement Charge 200

Total 195

This is interest paid - CASH OUT



Cash Flow Statement$m

Profit Before Tax 861

Depreciation 320

FX Differences on Profit 16

Profit on sale of PPE (198 - 190) -8

Gain on Sale of Subsidiary 250 - ((240 x 75%)+ 20)

-50

Finance Expense 200

Working Capital Movements W3 -299

Cash Generated from Operations 1040

Interest Paid W9 -195

Income Taxes Paid W8 -85

Net Cash from Operating activities 760

Cash Flow from Investing Activities

Receipts from the sale of PPE 198

Purchases of PPE (W2) -2,235

Sale of Subsidiary Less cash sold (250 - 10) 240

-1797

Cash Flow from Financing Activities

Issue of Shares (W4) 1,000

New Long Term Borrowings (W7) 419

Finance Leases Repaid (W6) -145

Dividends Paid -240

Dividend Paid to NCI (W5) -40

994

Net Decrease in Cash & Cash equivalents -43

Cash b/f (98 - 40) 58

Cash c/f (80 - 65) 15

43



Sources of Finance I



Illustration 1

XYZ Ltd. intends to raise capital via a rights issue.

The current share price is $8.

They are offering a 1 for 4 issue at a price of $6.

Calculate the Theoretical Ex-rights Price.

Solution

Number of Shares Share Price Total

4 $8 (4 x $8) = 32

1 $6 (1 x $6) = 6

5 38

We now have 5 shares in issue at total value of $38 so the THERP is (38 / 5) = $7.60



Illustration 2

ABC Ltd. has decided to raise capital via a rights issue.

The share price is currently $5.50 and ABC intends to raise $5m.

There are currently 6.25m shares in issue and ABC is offering a 1 for 5 rights issue.

Calculate the Theoretical Ex-Rights Price.

Solution

Amount of Capital to raise $5m

No. of shares issued (6.25m / 5) 1.25m

Share issue price ($5m / 1.25m) $4

Number of Shares Share Price Total

5 $5.50 (5 x 5.50) = 27.5

1 $4 (1 x 4) = 4

6 31.5

We now have 6 shares in issue at total value of $31.5 so the THERP is (31.5 / 6) = $5.25



Sources of Finance II



Weighted Average Cost of Capital



Illustration 1ABC Company has just paid a dividend of 35c.

The dividend paid has grown by 4% per year for the past 5 years.

The current share price is $3.25.

Calculate the Cost of Equity (Ke) using DVM.

Solution

Dividend 35

Share Price 325

Dividend Growth 4%

Cost of Equity (Dividend (1+g) / Share Price) +g

((35 x 1.04) / 325) + 0.04 = 0.152= 15.2%



Illustration 2ABC Company has just paid a dividend of 35c.

The ROE in recent years has been 10% and the dividend retention rate is 60%.



Solution

Dividend 35

Share Price 325

Dividend Growth (g = r x b) (0.1 x 0.6) 6%


((35 x 1.06) / 325) + 0.06 = 0.1741

= 17.41%



Illustration 2bABC Company has just paid a dividend of 30c.

The current share price is $4.25 and four years ago they paid a dividend of 22c.


Solution

Working 1 - Dividend Growth

Dividend Paid Now 30c

Dividend Paid 4 Years Ago 22c

Dividend Growth (4√(30 / 22))=1.08=8%

Dividend 30

Share Price 425

Dividend Growth 8%


((30 x 1.08) / 425) + 0.08 = 0.1562= 15.62%



Illustration 3A company has a bank loan of $2m at an interest rate of 10%.

The tax rate is 30%.

Calculate the cost of debt (Kd).

Solution

Interest Rate before Tax 10

Tax Rate 30%

After Tax Cost of Debt (10 x (1 - 0.3)) 7%



Illustration 4A company has issued 10% irredeemable debt.

The market value of the debt is $90.

The tax rate is 30%

Calculate the cost of debt (Kd).

Solution

Interest paid (Per $100 nominal) $10

Tax Rate 30%

After tax interest (Amount Paid (1 - t)) $10 x (1 - 0.30) = $7

Market Value of Debt (Per $100 nominal) $90

Cost of Debt (After tax interest / Market Value of Debt)

(7 / 90) = 7.7%



Illustration 5A Company has issued debt which is redeemable in 5 years time.

Interest is payable at 8%.

The current market value of the debt is $102.

Ignore taxation.

Calculate the Cost of Debt (Kd).

Solution

Period

Item $ DR 5% PV DR 15% PV

1 -5 Interest 8 4.329 34.63 3.352 26.82

5 Capital 100 0.784 78.40 0.497 49.70

Market Value -102 -102

11.03 -25.48

IRR Calculation: 5 + (11.03 / (11.03 - (25.48)) (15 - 5) = 8.02%



Illustration 6A Company has issued debt which is redeemable in 5 years time.



Tax is payable at 30%.


Solution

Period


1 -5 Interest (10 x (1 - 0.3)

7 4.329 30.30 3.352 23.46

5 Capital 100 0.784 78.40 0.497 49.70


4.70 -30.84

IRR Calculation: 5 + (4.7 / (4.7 - (30.84)) (15 - 5) = 6.32%



Illustration 7A Company has issued debt which is convertible in 5 years time.



On conversion, investors will have a choice of either:

I. Cash at a 15% premium; or

II. 18 shares per loan note.

The current share price is $6 and it is expected to grow in value by 4% per year.

Tax is payable at 30%.


Solution

Working 1 - Cash or Convert?

Working

Cash (15% Premium) 100 x 1.15 $115

Shares

Current Value $6

Value in 5 years with 4% growth

6 x (1.04 to the power of 5)

$7.30

Number of shares per $100

18

Conversion Value 7.30 x 18 $131.40

The conversion value is higher than the cash so the investors will choose to convert.

Do an IRR the same as for redeemable but filling $131.40 into the capital repaid



Cost of Debt

Period


1 -5 Interest (10 x (1 - 0.3)

7 4.329 30.30 3.352 23.46

5 Conversion Value 131.4 0.784 103.02 0.497 65.31


13.32 -31.23

IRR Calculation: 5 + (13.32 / (13.32 - (31.23)) (15 - 5) = 8%



Illustration 8Company A is funded as follows:

Calculate the Weighted Average Cost of Capital.

Solution

Item Capital Structure Cost

Equity 85% 15%

Debt 15% 7%

Item Capital Structure Cost Ave

Equity 85% 15 12.75

Debt 15% 7 1.05

WACC 13.8




Balance Sheet Extract

The cost to the company of each of the above items has been calculated as:

The Loan notes are currently trading at $94.

The current share price is $1.50


Ordinary Shares (50c) 3000

Loan Notes 2000

Bank Loan 1000

Ordinary Shares 13%

Loan Notes 8%

Bank Loan 5%



SolutionWorking 1 - Calculate the Market Value of Debt and Equity.

Working 2 - Weighted Average Cost of Capital

SFP Market Value

Ordinary Shares (50c)

3000 No. of shares (3000 / 0.50) = 6000Share Price = $1.50

(6000 x $1.50) = 9000

Loan Notes 2000 Loan Notes nominal value (on SFP) = 100Market Value = 94

(2000 x (94 / 100) = 1880

Bank Loan 1000 No market for this so use SFP value

1000

Item Market Value

Weighting Cost (W1)

Ave

Equity 9000 (9000 / 11,880) 13 (9000 / 11,880) x 13 = 9.85

Loan Notes 1880 (1880 / 11,880) 8 (1880 / 11,880) x 8 = 1.27

Bank Loan 1000 (1000 / 11,880) 5 (1000 / 11,880) x 5 = 0.42

11880 WACC 11.54%




Balance Sheet Extract

Details on these are as follows.

They have just paid a dividend of 15c and the dividend has grown by 5% per year for the past 5 years.

The redeemable loan notes are currently trading at $106 and are redeemable at par in 5 years time.

The irredeemable loan notes are currently trading at $92

The bank loan has an interest rate of 10%.


The tax rate is 30%.



12% Redeemable Loan Notes 1500

8% Irredeemable Loan Notes 500

Bank Loan 750



Solution Working 1 - Calculate Cost of Capital for each item.

Cost of Equity using DVM

Cost of 12% Loan Notes

Div Just Paid 15

Growth 5%

Share Price 1.25

Ke ((15 x 1.05) / 1.25) + 0.05 = 17.6%

Period Item $ DR 5% PV DR 15% PV

1 -5 Interest (12 x (1 - 0.3) 8.4 4.329 36.36 3.352 28.16

5 Capital 100 0.784 78.40 0.497 49.70


8.76 -28.14

IRR Calculation: 5 + (8.76 / (8.76 - (28.14)) (15 - 5) = 7.37%



Cost of 8% Loan Notes

Cost of Bank Debt

Working 2 - Calculate the Market Value of Debt and Equity.

Interest Paid 8

Market Value 92

Cost (Kd) (Interest Paid (1 - t) / Market Value) (8 (1 - 0.3) / 92) = 6%

Interest Rate before Tax 10

Tax Rate 30%

After Tax Cost of Debt (10 x (1 - 0.3)) 7%

SFP Market Value


No. of shares (2000 / 0.50) = 4000Share Price = $1.25

(4000 x $1.25) = 5000

12% Loan Notes 1500

Loan Notes nominal value (on SFP) = 100Market Value = 106

(1500 x (106 / 100) = 1590

8% Loan Notes 500

Loan Notes nominal value (on SFP) = 100Market Value = 92

(500 x (92 / 100)) = 460

Bank Loan 750 No market for this so use SFP figure 750



Working 3 - Calculate the weighting of each item.

Working 4 - Weighting & Weighted Average Cost of Capital

Item Market Value Weighting

Equity 5000 (5000 / 7800)

Loan Notes 1590 (1590 / 7800)

Preference Shares 460 (460 / 7800)

Bank Loan 750 (750 / 7800)

7800

Item Market Value

Weighting Cost (W1)

Ave

Equity 5000 (5000 / 7800) 17.6 (5000 / 7800) x 17.6 = 11.28

Redeemable Notes

1590 (1590 / 7800) 7.37 (1590 / 7800) x 7.37 = 1.50

Irredeemable Notes

460 (460 / 7800) 6 (460 / 7800) x 6 = 0.35

Bank Loan 750 (750 / 7800) 7 (750 / 7800) x 7 = 0.67

7800 WACC 13.8%


CIMA F2 - Financial Management Workbook Q & A - Mapit ...

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