Assignment 1 Is Compulsory and Due

2

Assignment 1 is compulsory and due 5th March 2010 – study topic A (study units 1 to 5)

- counts 5% towards final module mark of 10%

Assignment 2 is compulsory and due 1st April 2010 – study topics A (study units 1 to 9) & B (study unit 1)

- counts 5% towards final module mark of 10%

Assignment 3 is NOT compulsory and doesn't count towards final mark (study topics A to F)

Exam = 2 hours.

GENERALLY ACCEPTED ACCOUNTING STANDARDS

& THE VALUATION OF FINANCIAL INSTRUMENTS

TOPIC A - STUDY UNIT 1

PROVISIONS OF THE COMPANIES ACT, 1973 (COMPANIES IN GROUP CONTEXT)

Study guide pg 4

Business combination defined as bringing together of separate entities into one reporting entity – regulated by IFRS 3 Business combinations.

Parent company holds more then half of the issued equity share capital and more then half of the voting rights of the subsidiary.

When parent linked with subsidiary to form larger economic unit then entity is a group.

Simple groups – only one subsidiary

Complex groups – more then one subsidiary

Business combination – transaction or other event in which acquirer obtains control of one or more business

Parent – member of the subsidiary and holds majority of the voting rights in the subsidiary and has the right to control the composition of the board of directors of the subsidiary

Subsidiary – entity which is controlled by another entity (parent entity)

Sub-subsidiary – subsidiary of a subsidiary.

Companies Act says that equity shares are issued shares which don’t have any rights (except dividends or capital) to participate beyond a specified amount in a distribution – so NOT preference shares.

Therefore parent can only obtain control over a subsidiary if the parent holds a majority of the equity shares (ordinary shares) of the subsidiary – so even if owns 80% of the preferential shares of another company is not parent.

Although parent shows the investments in subsidiaries on the Statement of Financial Position, doesn’t account for any increase in the value of the investment and so no accurate reflection on the activities of the group. Parent company must draw up single set of financials for the group so shareholders have idea of the earnings per share and the assets and liabilities of the group. Called consolidated statements or group statements and are combination of all the statements of the companies in the group. The investment in the parent’s statements is replaced by the assets and liabilities of the subsidiary which represents these investments in the consolidated statements.

Companies Act says that company that is not a wholly owned subsidiary of another company must submit group financials to the AGM at the end of the financial year. Should be presented as consolidated annual financials unless director’s of the parent think that the required information could be more effectively and meaningfully shown in an alternative form.

Group financials don’t need to deal with subsidiary if directors think that :

·  would be impractical or of no real use to members (if sums were insignificant) or the cost of delay would be out of proportion to the usefulness of members

·  results would be misleading or prejudicial to the affairs of the parent or other subsidiaries

·  operations of the parent and subsidiary are so different that they could not reasonably be treated as a singe enterprise

Group annual financials aren’t required when the parent is also a wholly-owned subsidiary of another company.

General provisions of the Companies Act :

·  group statements should be fair reflection of the state of affairs of the parent and its subsidiaries as at the accounting date

·  profits / losses that have arisen as a result of transactions in the group must be eliminated if they have not been realised outside the group

·  all intercompany balances must be eliminated by determining total assets and liabilities of the group

·  dividends declared by subsidiary out of pre-acquisition profits don’t form part of the parent’s profits that are available for distribution

·  elimination of the carrying amount of the parent’s investment in the subsidiary

·  provisions of the Companies Act must be complied with.

STUDY UNIT 2

CONSOLIDATION OF WHOLLY-OWNED SUBSIDIARY AT DATE OF ACQUISITION

Study guide pg 10

Parent company and subsidiary company draft their financials and then these individual statements are adjusted with consolidation adjustments and then the consolidated statements are compiled.

Basic consolidation techniques :

·  elimination of common items

·  elimination of intercompany items

·  consolidation of remaining items

Elimination of common items

Need to eliminate the investment in the parent’s books and the shareholder’s equity section in the subsidiary books as at the date when the investment was made by :

dr share capital of subsidiary out of parent’s books and cr investment in subsidiary

see examples pgs 12/3 of study guide

Share capital in the consolidated Statement of Financial Position is always only the parent’s share capital.

Profits made by the subsidiary after the date of acquisition become part of the retained earnings of the group and are shown as retained earnings in the consolidated statements.

Profits made by the subsidiary before the date of acquisition cannot form part of the retained earnings of the group – the parent pays for the profits

If the parent obtained its interest in the subsidiary at the date of incorporation then there can't be any retained earnings in the books of the subsidiary.

Elimination of intercompany items

Companies in the same group often sell inventories or assets to each other, but the only actual profit made by the group will be from the sales to the public as all other sales are within the group. These intercompany sales have to be eliminated during consolidation. Also eliminate any loans or lent assets to subsidiaries.

Consolidation of remaining items

Once all common items and intercompany items have been eliminated will draw up :

·  consolidated Statement of Financial Position

·  consolidated Statement of Comprehensive Income

·  consolidated Statement of Changes in Equity

·  consolidated statement of cash flows

If parent obtains an interest in a subsidiary then either price paid by the parent for the interest / investment in the subsidiary is :

·  equivalent to the value of the net assets acquire – called acquisition at net asset value.

see example pgs 15/6 of study guide

·  higher then the net asset value – called acquisition at a premium (treated as goodwill and recognised as an asset at cost. Must not be amortised, but is subjected to impairment test at least once a year.

see example pgs 17/8 of study guide

·  lower then the net asset value – called acquisition of a subsidiary at a discount or negative goodwill and if the fair value of identifiable assets and liabilities exceeds the cost of the business combination then must :

Ø  reassess the identity and measurement of these items

Ø  recognise in profit or loss any excess after reassessment

negative goodwill can arise from errors in measuring fair values of identifiable items

see question 1 & 2 on pgs 19 to 22 of study guide

STUDY UNIT 3

CONSOLIDATION OF PARTLY-OWNED SUBSIDIARY AT DATE OF ACQUISITION

Study guide pg 23

Sometime parent doesn’t take up all the shares in the subsidiary and then the other shareholders are known as non-controlling shareholders or outside shareholders. Can be either ordinary or preference shareholders.

Before doing the consolidation we have to make provision for the non-controlling shareholder’s interest in the profit of the subsidiary.

Remember that if shares are valued over R1 per share then have to work out how many shares were issued before calculating the parent’s interest in the subsidiary.

see pgs 27 to 30 of study guide for examples of partly-owned subsidiaries consolidated financials

see question 1 & 2 on pgs 31 to 36 of study guide

Note :

·  Companies Act says cannot offset cr and dr bank balances during consolidation, so have to show overdraft and favourable balances separately, UNLESS company with favourable balance has guaranteed the overdrawn account and they are both at the same bank.

·  debentures are treated as intercompany item and must be journalled as such (along with loans)

·  revaluation reserve / revaluation of land & buildings held in subsidiary books must be proportioned by the percentage interest to the parent and non-controlling interest shareholders and not shown in the Balance Sheet.

STUDY UNIT 4

CONSOLIDATION OF WHOLLY-OWNED SUBSIDIARY AFTER DATE OF ACQUISITION

Study guide pg 37

Any equity (share capital and reserves) of a subsidiary that stands at the acquisition of the subsidiary is eliminated against the investment in the subsidiary in the consolidated financials, and doesn’t form part of the shareholder’s equity of the group.

But any profits made after the date of acquisition become profits for the group and are included in the consolidated statements. All reserves (distributable and non-distributable) of the subsidiary that were formed after the date of acquisition form part of the total reserves of the group.

Dividends from pre-acquisition profits

All post-acquisition profits form part of the total reserves of the group, but if the subsidiary pays a dividend from pre-acquisition profit then the payment of the dividend is capital receipt by the parent.

The distributable reserves existed at the date of acquisition and form part of the total shareholder’s equity of the subsidiary which was paid for by the parent when it bought the shares of the subsidiary.

So when a dividend is declared from distributable reserves that existed at the date of acquisition, then is just a refunding of a portion of the purchase price.

see example pgs 39/40 of study guide

Consolidation of wholly-owned subsidiary after date of acquisition

Still follow the same procedure of eliminating the common and intercompany items and then consolidating the remaining items, but now have to divide the analysis of shareholder’s equity into different periods (at acquisition, since acquisition to the beginning of the current year and then the actual current year).

see examples pgs 41 to 47 of study guide

Note :

·  when drawing up consolidate Statement of Changes in Equity for the year the opening balance won’t include the subsidiary’s balance if it hadn’t been bought by then.

·  do journal entry first to eliminate loans, intercompany etc and then draw up Statement of Comprehensive Income to get the total comprehensive income for the year and then use that figure in the consolidated Statement of Changes in Equity for the year. Then draw up the consolidated Statement of Financial Position.

see exercises pgs 48 to 58 of study guide

Note :

·  must divide the shareholder’s equity into 3 parts so that can get the opening balance for the Statement of Changes in Equity

·  when asked only for a consolidated Statement of Financial Position then don’t have to do consolidated Statement of Comprehensive Income and consolidated Statement of Changes in Equity, so will combine the “since acquisition” and “current year” sections of the analysis of shareholder’s equity to deduct all the expenses, tax paid & dividends paid to get a total for retained earnings for the subsidiary

STUDY UNIT 5

CONSOLIDATION OF PARTLY-OWNED SUBSIDIARY AFTER DATE OF ACQUISITION

Study guide pg 59

Have to make provision for the non-controlling interest in the profit.

Profit attributable to non-controlling shareholders is shown separately in the consolidated Statement of Comprehensive Income and the consolidated Statement of Changes in Equity.

see example pgs 60 to 63 of study guide

Intercompany transactions

If there has been a transaction within the group (purchase or sale between the subsidiary and the parent) then have to exclude that profit when determining the total group profit (cos in consolidated statements it would be the same company).

If subsidiary sells part of their inventory to a person outside the group then that profit is realised.

If the parent sells inventories to a subsidiary at a profit and the inventory is still in the possession of the subsidiary at the end of the year – then the profit hasn’t been realised, and the inventory will be shown at the original amount for which the inventories were manufactured or purchased by a member of the group in the consolidated Statement of Financial Position.

see exercises pgs 64 to 72 of study guide (go through question 3 – different format!)

STUDY UNIT 6

ACQUISITION OF AN INTEREST IN A SUBSIDIARY DURING THE YEAR

Study guide pg 73

Interim acquisition of a subsidiary – purchase of an interest in a subsidiary at a date other then the accounting date.

Need to allocate the Statement of Comprehensive Income items so that can determine the amount of retained earnings at the effective date and then the goodwill at date of acquisition.

Apportioning items in the Statement of Comprehensive Income

If it is not practicable to apportion the profit or loss for any financial year then it can be treated as if it accrued from day to day during the year and be apportioned like that.

Income and expense have to be examined individually to decide how to apportion each item (between the period before acquisition and the period since acquisition.)

Apportioning items in the Statement of Changes in Equity

Any preference dividends from issued preference shares of the subsidiary have to be accounted for on a time basis (has to be accounted for even if it hasn’t been declared).

Ordinary dividends declared are year-end items and so fall into the after-acquisition period.

When preparing the consolidated Statement of Comprehensive Income and changes in equity then need to :

·  apportion the income and expenditure of the current year between pre and post acquisition periods

·  draw up the 2 consolidated statements by including only the post-acquisition profits in the operating profit.

see example pgs 75 to 78 of study guide

Date of acquisition

The effective date of acquisition is when control of the net assets and operations of the subsidiary is transferred to the parent (and date when the results of the subsidiary will be include in the group annual financial statements).