Part II Answers
Answer 53
(a)(i)
Individual entity statements of financialposition after the restructuring plan
(a)(ii)
HKAS 27 (Revised) was issued on 2011 and carries forward a change made to HKAS 27 in 2008 in respect of group reorganizations. HKAS 27 effectively allows the cost of an investment in a subsidiary to be based on the previous carrying amount of the subsidiary rather than on its fair value. This is only allowed when a new parent (Ceed) is inserted above an existing parent of a group or entity (Rant), and where the following criteria are satisfied.
1.The new parent (Ceed) obtains control of the original parent or entity (Rant) by issuing equity instruments in exchange for existing equity instruments of the original parent or entity.
2.The assets and liabilities of the new group and the original group are the same immediately before and after the reorganization.
3.The owners of the original parent or entity (Decany) before the reorganization have the same absolute and relative interests in the net assets of the original group and the new group immediately before and after the reorganization.
The reorganization of the Decany group appears to meet all the above criteria. (In respect of (3), Rant has not acquired a further interest in Ceed as a result of the transfer of land because the shares in Ceed issued to Rant are non-voting).
A further amendment carried forward in the revised HKAS 27 was the removal of the cost method. This required an entity to recognize distributions as income only if they came from post-acquisition retained earnings. Distributions received in excess of such retained earnings were regarded as a recovery of investment and were recognized as a reduction in the cost of investment.
Now, however, HKAS 27 requires all dividends in profit or loss in its separate financial statements when its right to receive the dividend is established. The distinction between pre- and post- acquisition profits, which had been problematic, is no longer required.
If such dividends are paid, the entity is required to consider whether there has been an impairment. Applying HKAS 36, impairment is indicated in the following cases.
1.The dividend exceeds the total comprehensive income of the subsidiary, jointly controlled entity or associate in the period the dividend is declared.
2.The carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidated financial statements of the investee’s net assets, including associated goodwill.
Neither of these apply in the case of Ceed, and so there is no indication that Ceed is impaired.
(b)
Impact of reconstruction plan
The plan has no impact on the group financial statements as all of the internal transactions will be eliminated on consolidationbut does affect the individual accounts of the companies. The reconstruction only masks the problem facing Rant. It does notsolve or alter the business risk currently being faced by the group. The proposed provision for restructuring has to meet therequirements of HKAS 37 Provisions, Contingent Liabilities and Contingent Assets before it can be included in the financialstatements. There must be a detailed formal plan produced and a valid expectation in those affected that the plan will becarried out. The provision appears to be large considering that the reconstruction does not involve major relocation of assetsand there is a separate provision for redundancy. The transactions outlined in the plans are essentially under common control
and must be viewed in this light. This plan overcomes the short-term cash flow problem of Rant and results in an increasein the accumulated reserves. The plan does show the financial statements of the individual entities in a better light except forthe significant increase in long-term loans in Rant’s statement of financial position. The profit on the sale of the land fromRant to Ceed will be eliminated on consolidation.
In the financial statements of Rant, the investment in Ceed should be accounted for under HKFRS 9. There is now cashavailable for Rant and this may make the plan attractive. However, the dividend from Ceed to Decany will reduce theaccumulated reserves of Ceed but, if paid in cash, will reduce the current assets of Ceed to a critical level.
The purchase consideration relating to Rant may be a transaction at an overvalue in order to secure the financial stability ofthe former entity. A range of values are possible which are current value, carrying amount or possibly at zero value dependingon the purpose of the reorganisation. Another question which arises is whether the sale of Rant gives rise to a realised profit.Further, there may be a question as to whether Ceed has effectively made a distribution. This may arise where the purchaseconsideration was well in excess of the fair value of Rant. An alternative to a cash purchase would be a share exchange. Inthis case, local legislation would need to be reviewed in order to determine the requirements for the setting up of any sharepremium account.
Answer 54
(a)
Shires Property Construction
Statement of financial position at 1 January 2010 (after reconstruction)
(b)
Division or pre-tax profit
The allocation of profit, both before and after the reconstruction, reflects respective interests of those who provide the long-term finance or the entity: the debenture holders, the unsecured loan holders and provisions of equity finance.
The providers of loan finance will increase their share of available profit after the reconstruction. This could be regarded as reasonable as their continued support is required if the reconstruction is to be successful. Similarly, the proportion of available profit to which equity holders would be entitled has fallen, reflecting their relatively weak position before the reconstruction is implemented.
(c)
Gearing is
Whether gearing is viewed as high or not depends on the current economic climate. It will however reduce when the debenture loan is paid off in 2013. Indeed, dividends on equity shares will have to be very restrained if cash is to be available to redeem the debentures. Alternatively, debenture holders might agree to exchange them for equity shares.
The shareholders’ equity almost covers approximately 92% of the carrying value of the non-current assets. The capital structure is reasonably satisfactory.
The debenture holders have done very well. Their interest has been increased by 1.5% and the redemption date has not been changed.
The providers of the unsecured loan have also received an increase in the rate of interest to be charged on that loan.
Answer 55
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