QUESTION THREE (35 MARKS)
Big Boy Ltd acquired an 80% interest in Tiny Ltd on 1 January 2006. This was the incorporation date of Tiny limited. Big Boy limited sold 25% of its share in Tiny Limited on 1 January 2009 for R50 000.
The trial balances of Big Boy Limited and Tiny Limited as at 31 December 2009, the companies’ financial year end, showed the following amounts:
Big Boy Limited Tiny Limited
R R
Share Capital 200 000 100 000
Retained Earnings 375 000 125 000
Long-term Loan - 30 000
Trade and other payables 75 000 15 000
Current portion of long-term borrowings 5 000
Profit for the year 45 000 20 000
Gain on sale of investment in Tiny Limited 30 000 -
725 000 295 000
Property plan and equipment 225 000 200 000
Investment in Tiny Limited 60 000 -
Other investment 90 000 -
Inventory 50 000 25 000
Trade and other receivables 100 000 40 000
Cash and cash equivalents 200 000 30 000
725 000 295 000
REQUIRED:
3.1 Calculate the equity adjustment the group will recognise, in the retained earnings, on the sale of their interest in Tiny Limited. (5 Marks)
3.2 Prepare the consolidated statement of Changes in Equity for the year ended 31 December 2009, of Big Boy Limited Group. (15 Marks)
Notes are not required
Comparatives are not required
3.3 Discuss what effect will be in the consolidated, as well as separate, financial statements if Big Boy Limited sold 50% of its interest in Tiny Limited, and not only 25%. Assume a selling price of R100 000 and that the fair value of the remaining 40% interest in Tiny Limited is R95 000. (support yours discussion with calculations) (15 Marks)
3.1 The equity adjustment that the group will recognize on the sale of their interest in Tiny Limited can be calculated by determining the gain on the sale of investment.
The gain on the sale of investment is given as R30,000. Since Big Boy Ltd sold 25% of its share in Tiny Ltd, we can calculate the total gain on the sale as follows:
Total gain on sale = Gain on sale of investment * (Percentage of shares sold/100)
Total gain on sale = R30,000 * (25/100)
Total gain on sale = R7,500
The equity adjustment that the group will recognize in the retained earnings is equal to the total gain on sale. Therefore, the equity adjustment is R7,500.
3.2 Consolidated Statement of Changes in Equity for the year ended 31 December 2009 of Big Boy Limited Group:
Equity at beginning:
Share Capital - R200,000
Retained Earnings - R375,000
Total Equity at beginning - R575,000
Profit for the year:
Profit for the year - R45,000
Equity adjustment:
Equity adjustment - R7,500
Equity at end:
Share Capital - R200,000
Retained Earnings - R375,000 + R45,000 + R7,500
Total Equity at end - R627,500
3.3 If Big Boy Limited sold 50% of its interest in Tiny Limited, the effect on the consolidated financial statements would be different compared to selling only 25%.
If Big Boy Limited sold 50% of its interest, the gain on the sale would be higher. We can calculate the gain on the sale as follows:
Total gain on sale = Selling price - Book value of the shares sold
Total gain on sale = R100,000 - (50% of Share Capital + 50% of Retained Earnings)
Total gain on sale = R100,000 - (50% of R200,000 + 50% of R375,000)
Total gain on sale = R100,000 - R287,500
Total gain on sale = -R187,500 (Loss on sale)
Since the calculation results in a loss on the sale, the group would recognize a loss rather than a gain on the sale of their interest in Tiny Limited.
In the consolidated financial statements, this loss would decrease the retained earnings and overall equity of the group. However, the effect on the separate financial statements of Big Boy Limited and Tiny Limited would be different.
For Big Boy Limited, the loss on the sale would decrease the retained earnings and overall equity. For Tiny Limited, the remaining interest in Tiny Limited would need to be revalued to its fair value, which is R95,000.
Therefore, the effect on the consolidated financial statements is a decrease in overall equity due to the loss on the sale and the revaluation of the remaining interest in Tiny Limited. However, the effect on the separate financial statements of each company would depend on their individual financial positions and any adjustments made as a result of the sale.