QUESTION THREE(20 MARKS)
P Limited acquired a 60% interest in S Limited at 1 January 2015,
1. Analyse the Equity of S Ltd
2. When analysing the equity of the subsidiary at the acquisition date, the fair value adjustment for the land would be ‘replaced’ by the revaluation surplus; draw up the proforma journal entries to record the elimination of the cost of the land.
1. Analysis of the Equity of S Ltd:
Equity of S Ltd can be analyzed by examining its components, which include:
a. Share Capital: This represents the amount of capital invested by the shareholders of S Ltd. It is initially recorded at the nominal value of the shares issued.
b. Retained Earnings: This represents the accumulated profits of S Ltd that have not been distributed as dividends. Retained earnings increase when the company generates profits and decreases when dividends are paid to shareholders.
c. Revaluation Surplus: This represents the increase in the value of assets, such as land, beyond their historical cost. Revaluation surplus is not distributable as dividends and is reflected in the statement of changes in equity.
d. Other Comprehensive Income: This includes gains or losses that are not included in the profit or loss of the company, such as revaluation gains or losses on available-for-sale financial assets. Other comprehensive income is also reflected in the statement of changes in equity.
e. Dividends: These represent the portion of earnings distributed to shareholders. Dividends reduce retained earnings.
f. Non-controlling Interest: This represents the portion of S Ltd's equity that is not owned by P Ltd, as P Ltd only acquired a 60% interest. Non-controlling interest is separately disclosed in the consolidated statement of changes in equity.
2. Proforma Journal Entries to eliminate the cost of land:
When eliminating the cost of land for the subsidiary at the acquisition date, the fair value adjustment for the land would be "replaced" by the revaluation surplus. The proforma journal entries to record this elimination would be as follows:
1) To eliminate the cost of land:
-
Dr. Land (Cost) (Current Asset)
Cr. Revaluation Surplus (Equity)
2) To record the revaluation of land:
-
Dr. Revaluation Surplus (Equity)
Cr. Land (Revaluation) (Non-current Asset)
The first journal entry removes the cost of land from the subsidiary's equity, reflecting that it is no longer an asset of the company. The second journal entry records the revalued amount of land as a new non-current asset on the balance sheet, reflecting the increase in its value.
Overall, these proforma journal entries adjust the subsidiary's equity to reflect the fair value adjustment for the land, which is replaced by the revaluation surplus.