Question 1
On 1 January 2014, Diamond ltd acquired 80% of the equity share capital of Gold ltd. The consideration was satisfied by a share exchange of two shares in Diamond ltd for every three acquired shares in Gold ltd. At the date of acquisition, shares in Diamond ltd and Gold ltd had a market value of R3 and R2.50 each respectively. Diamond ltd will also pay cash consideration of 27.5 cents on 1 January 2015 for each acquired share in Gold ltd. Diamond ltd has a cost of capital of 10% per annum. None of the consideration has been recorded by Diamond ltd. Below are the summarised draft financial statements of both companies.
Statements of profit or loss and other comprehensive income for the year ended 30 September 2014
Diamond Ltd Gold LTD
R'000 R'000
Revenue 62 600 30 000
Cost of Sales -45 800 -24 000
Gross Profit 16 800 6 000
Distribution cost -2 000 -1 200
Administrative expenses -3 500 -1 800
Finance Cost -200 0
Profit for the year 11 100 3 000
Income Tax Expense -3 100 -1 000
Profit for the year 8 000 2 000
Other comprehensive income:
Gain on revaluation of property (note (i)) 1 500 0
Total Comprehensive Income 9 500 2 000
Statements of financial position as at 30 September 2014
ASSETS
Non-current assets
Property, plant and equipment 18 700 13 900
Investment: 10% loan note from Subtrack (note (ii)) 1 000 0
19 700 13 900
Current Assets
Inventory (note (iii)) 4 300 1 200
rade receivables (note (iv)) 4 700 2 500
Bank 0 300
TotalAssets
Equity and Liabilities
Equity 10 000 9 000
Equity shares of R1 each 2 000 0
Revaluation surplus (note (i)) 6 300 3 500
18 300 12 500
Non-current liabilities
10% loan notes (note (ii)) 2 500 1 000
Current liabilities
Trade payable (note (iv)) 3 400 3 600
Bank 1 700 0
Current Tax payable 2 800 800
7 900 4 400
Total equity and liabilities 28 700 17 900
The following information is relevant:
(i) At the date of acquisition, the fair values of Gold Ltd.’s assets and liabilities were equal to their carrying amounts with the exception of Gold Ltd’s property, which had a fair value of R4 million above its carrying amount. For consolidation purposes, this led to an increase in depreciation charges (in cost of sales) of R100 000 in the post-acquisition period to 30 September 2014. Gold ltd has not incorporated the fair value property increase into its entity financial statements. The policy of the Diamond ltd group is to revalue all properties to fair value at each year end. On 30 September 2014, the increase in Diamond Ltd’s property has already been recorded, however, a
further increase of R600 000 in the value of Gold Ltd’s property since its value at acquisition and 30 September 2014 has not been recorded.
(ii) On 30 September 2014, Diamond ltd accepted a R1 million 10% loan note from Gold ltd.
Sales from Diamond ltd to Gold ltd throughout the year ended 30 September 2014 had consistently been R300 000 per month. Diamond ltd made a mark-up on cost of 25% on all these sales. R600 000 (at cost to Gold ltd) of Gold Ltd.’s inventory at 30 September 2014 had been supplied by Diamond ltd in the post-acquisition period.
(iii) Diamond ltd had a trade receivable balance owing from Gold ltd of R1.2 million as at 30 September 2014. This differed to the equivalent trade payable of Gold ltd due to a payment by Gold ltd of R400 000 made in September 2014 which did not clear Diamond Ltd.’s bank account until 4 October 2014. Diamond Ltd.’s policy for cash timing differences is to adjust the parent’s financial statements.
(iv) Diamond Ltd.’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose Gold Ltd.’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) Due to recent adverse publicity concerning one of Gold Ltd.’s major product lines, the goodwill which arose on the acquisition of Gold ltd has been impaired by R500 000 as at 30 September 2014. Goodwill impairment should be treated as an administrative expense.
(vi) Assume, except where indicated otherwise, that all items of income and expenditure accrue evenly throughout the year.
REQUIRED:
a) Prepare the consolidated statement of profit or loss and other comprehensive income for Diamond ltd for the year ended 30 September 2014. (20)
b) Prepare the consolidated statement of financial position for Diamond ltd as at 30 September 2014. (24)
Diamond ltd is in the process of recording the acquisition of another subsidiary, Dilemma, and has identified two items when reviewing the fair values of Dilemma’s assets. The first item relates to R1 million spent on a new research project. This amount has been correctly charged to profit or loss by Dilemma, but the directors of Diamond ltd have reliably assessed the fair value of this research to be R1.2 million. The second item relates to the customers of Dilemma. The directors of Diamond ltd believe Dilemma has a particularly strong list of reputable customers which could be ‘sold’ to other companies and have assessed the fair value of the customer list at R3 million.
REQUIRED:
State whether (and if so, at what value) the two items should be recognised in the consolidated Statement of financial position of Diamond ltd on the acquisition of Dilemma.
The first item, the research project, should not be recognized in the consolidated statement of financial position as its fair value is higher than its carrying amount. The directors of Diamond ltd have assessed the fair value to be R1.2 million, but as it has already been charged to profit or loss by Dilemma, it should not be recognized separately in the consolidated statement of financial position.
The second item, the customer list, should be recognized in the consolidated statement of financial position at a fair value of R3 million. This is because the directors of Diamond ltd have assessed the customer list to have a fair value and it represents a valuable asset of Dilemma that could be sold to other companies.
a) To prepare the consolidated statement of profit or loss and other comprehensive income for Diamond ltd for the year ended 30 September 2014, we need to adjust for the effects of the acquisition of Gold ltd.
Step 1: Calculate the fair value adjustment for Gold ltd's property
- Gold ltd's property had a fair value of R4 million above its carrying amount at the date of acquisition.
- This led to an increase in depreciation charges of R100,000 in the post-acquisition period.
- However, a further increase of R600,000 in the value of Gold ltd's property since its value at acquisition and 30 September 2014 has not been recorded.
Step 2: Calculate the goodwill impairment
- Due to adverse publicity concerning one of Gold ltd's major product lines, the goodwill arising from the acquisition has been impaired by R500,000.
Step 3: Adjust the revenue and cost of sales for intercompany transactions
- Sales from Diamond ltd to Gold ltd throughout the year were consistently R300,000 per month.
- Diamond ltd made a mark-up on cost of 25% on all these sales.
- R600,000 (at cost to Gold ltd) of Gold ltd's inventory at 30 September 2014 had been supplied by Diamond ltd in the post-acquisition period.
Step 4: Calculate the profit for the year
- Adjust the profit for the year by accounting for the fair value adjustment, goodwill impairment, and intercompany transactions.
Step 5: Calculate the total comprehensive income
- Add the profit for the year to any other comprehensive income items.
b) To prepare the consolidated statement of financial position for Diamond ltd as at 30 September 2014, we need to combine the assets, liabilities, and equity of Diamond ltd and Gold ltd, taking into account the fair value adjustments and intercompany transactions.
Step 1: Combine the assets of Diamond ltd and Gold ltd
- Add the non-current assets and current assets of both companies.
Step 2: Combine the liabilities of Diamond ltd and Gold ltd
- Add the non-current liabilities and current liabilities of both companies.
Step 3: Calculate the consolidated equity
- Add the equity of Diamond ltd, the fair value adjustment for Gold ltd's property, and the non-controlling interest.
Step 4: Prepare the consolidated statement of financial position by listing the total assets, equity, and liabilities.
For the second part of the question regarding the acquisition of Dilemma, the R1 million spent on the new research project should be recognized in the consolidated statement of financial position at its carrying amount, as it has already been correctly charged to profit or loss by Dilemma. However, the fair value of the research should not be recognized separately unless it meets the criteria for recognition as an intangible asset.
The fair value of the customer list, assessed at R3 million, should be recognized in the consolidated statement of financial position if it meets the criteria for recognition as an intangible asset. If it does not meet these criteria, it should not be recognized separately.