# 2008 University of South Africa Revised edition 2008 All rights reserved Printed and published by the University

of South Africa Muckleneuk, Pretoria ACN202R/1/2009 98316516 3B2

ACN-Style

CONTENTS

INTRODUCTION AND OVERVIEW OF THE MODULE TOPIC A TOPIC B TOPIC C TOPIC D TOPIC E TOPIC F INTRODUCTION TO GROUP ANNUAL FINANCIAL STATEMENTS STATEMENTS OF CASH FLOWS (IAS 7/AC 118) EARNINGS PER SHARE (IAS 33/AC 104) TIME VALUE OF MONEY LEASES (ONLY LESSEES) (IAS 17/AC 105) VALUATION OF FINANCIAL INSTRUMENTS

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INTRODUCTION AND OVERVIEW OF THE MODULE

A.

THE PURPOSE OF THIS MODULE

Welcome to the ACN202R module of your studies with the School of Accounting Sciences in the Department of Financial Accounting at UNISA. The purpose of this module is to provide learners with knowledge and skills to enable them to draft annual financial statements for simple groups of companies in accordance with the requirements of the Companies Act, 1973 and Statements of Generally Accepted Accounting Practice. This module will also provide learners with the knowledge and skills to enable them to apply certain statements of Generally Accepted Accounting Practice and to identify different financial instruments and apply different valuation methods and principles to the time value of money.

B.

THE TEACHING STRATEGY

The focus of our teaching role is on facilitating your learning experiences towards achieving specific assessment criteria. Furthermore, for each of the topics that comprise this module, the learning experiences are designed with the aim of enabling you to master the learning content at a predetermined competence level.

. Learning outcomes, assessment criteria and levels of mastery

Each topic dealt with in this module contains a statement of the learning outcomes that we wish to accomplish for the particular topic. In broad terms these tell you about the knowledge and skills we expect you to have mastered by the time you complete your study of each topic. These outcomes are translated into assessment criteria for the study units identified under each topic. The assessment criteria indicate a required end result, that is what you should be able to do once you have completed the study unit. The formulated assessment criteria are based on various levels of mastery which you are required to achieve when mastering the study material. The required levels of mastery for this module vary from knowledge and comprehension to the application of knowledge under given circumstances. The level of mastery that you are required to attain in the various study topics is indicated alongside each specified assessment criterion. The following levels of mastery as defined in the Education Requirements of the South African Institute of Chartered Accountants (2000:1617) are distinguished for the purposes of this module:

Level 1: Knowledge and comprehension

This calls for a knowledge and understanding of facts, methods, processes and structures and

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an ability to list and explain them. It involves memorising as well as an awareness, immediate discovery, recall or recognition of relevant information in various forms. A limited degree of interpretation is required.

Level 2: Application
This calls for a knowledge and understanding of the background and of the facts, and the ability to apply rules, principles, techniques and methods to a problem in order to find a solution based on the information which is provided. There is normally only one ideal solution to the problem and the solution therefore logically determined by the information provided. This process is also sometimes called the convergent application of knowledge.

Level 3: Integration
This calls for a full factual knowledge of the topic, of the background and of related topics, and an ability to carry out integration functions, such as analysis, interpretation, synthesis and evaluation. It includes the application of multi-disciplinary knowledge and problem solving, in cases where there are various acceptable solutions. In this sense it constitutes creative thinking, comprising fluency, flexibility, originality, critical awareness and independent thought. The process is sometimes also called the divergent application of knowledge. When you analyse the various learning outcomes expected of you, you should continually be aware of the level of mastery (level 1, 2 or 3 as defined above) linked to the learning outcome in question. To help you to identify the level, we have indicated the highest level of mastery which can be expected of you for a particular learning outcome opposite that learning outcome. Only the highest level of mastery is indicated, for example level 2 (application), but this implies that you must also be able to handle the learning content in question at level 1 (knowledge and comprehension). The learning objectives of this module are ultimately reflected in the examination paper you have to pass in order to complete the module successfully. For examination purposes questions that test the first two levels of mastery will be included. Here too, you need to bear in mind that learning outcomes merely indicate the highest level of mastery, and that questions at a lower level of mastery on the particular topic can also be asked.

C.

MEANING OF WORDS

In this module we require you to understand the meaning of certain words to enable you to interpret assessment criteria, and to interpret assignment and examination questions. To indicate the length, scope and format of answers to study activities and questions, we have deliberately built limits or restrictions into the questions by using action verbs. These action verbs give you an indication of how to tackle the given problem and what style of writing is called for. An analysis of the action verbs contained in a question will enable you to: plan the answer systematically and organise your thoughts systematically, and . ensure that you comply with the lecturer's requirements.
.

You will also save yourself time and trouble by eliminating irrelevant material that falls outside the scope of the answer.

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For the purpose of this module the following meanings will be attached to the following action words: Allocate Amortise Apply Calculate Clarify/demonstrate Complete Consolidate Define Describe Determine Discuss Draft Draw up Explain Illustrate Interpret Label List Organise Prepare Record Show Allot, assign to a place Gradually write off initial cost Use in a practical manner; use as relevant or suitable Figure out; determine by a mathematical procedure This means expound; make the meaning clear; clarify; provide proof of; argue the truth of Finish; accomplish; supply whatever is missing Combine companies into one whole Describe accurately; establish the exact meaning; explain the inherent meaning; make clear; give an account of the overall character Give an account of the respective particulars or essential characteristics, describe clearly; give an accurate account Establish; reach a conclusion or decision Examine; explain; examine by means of argument Prepare a provisional outline Compose document Make clear or comprehensible; elucidate; explain the meaning in detail Explain; shed light on; use an example to elucidate something Explain the meaning of; explicate; construe; show the nature or essence Attaching to object and indicating its nature Note/specify matters or objects that are related to one another Divide into classes or groups according to certain characteristics; place in particular order Make ready in advance; finish; get something ready on the basis of previous study To put into writing; set down for reference and preservation To make or become visible, noticeable; to exhibit or present: to indicate

Name/mention/state Specify by name; give names, characteristics, items, elements or facts

D.

PRESCRIBED TEXTBOOK

Steyn, BL, Warren, BO & Jonker, WD. Latest edition. Fundamental aspects of financial management. Pretoria: Renall Publishing. This book is prescribed as a supplement to topics D and F of this study guide, in which it is referred to as Fundamental aspects.

E.

MASTERING THE STUDY MATERIAL

This is a comprehensive module which requires careful and dedicated study. The student must become totally proficient in the field of accounting which cannot be achieved in a short period of time. A student must be diligent and thorough to be able to master this module. This study guide has been devised to guide you through your studies for this module. You should bear in mind that your prescribed textbook is also a primary source of information that

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you must study. The text book is supplemented in the study guide where necessary with further information, explanations, examples and questions, which are aimed at making the study content of the module more easily understandable. The study guide also indicates the level of mastery at which you are required to master the various study units included in the study content. You will be required to complete a series of assignments for this module. Details pertaining to the completion and submission of assignments are contained in Tutorial letter 101.

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TOPIC A

INTRODUCTION TO GROUP ANNUAL FINANCIAL STATEMENTS

Learning outcome
Learners can draft consolidated annual financial statements, in accordance with statutory requirements and Statements of Generally Accepted Accounting Practice, for simple groups once all relevant intercompany transactions have been taken into account.

CONTENTS

Study unit

Page

1 Provisions of the Companies Act, 1973 in respect of companies in group context 2 Consolidation of wholly-owned subsidiary at date of acquisition 3 Consolidation of partly-owned subsidiary at date of acquisition 4 Consolidation of wholly-owned subsidiary after date of acquisition 5 Consolidation of partly-owned subsidiary after date of acquisition 6 Acquisition of an interest in a subsidiary during the year 7 Elimination of intercompany transactions 8 Treatment of dividends during consolidation 9 Treatment of preference shares during consolidation

3 10 23 37 59 73 89 130 159

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STUDY UNIT

1
Provisions of the Companies Act, 1973 in respect of companies in group context
Learning outcome
Learners can identify and define business combinations and a subsidiary.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 1.1 1.2 1.3 1.4 1.5 Introduction Parent and subsidiaries Companies Act and accounting for groups General provisions Exercises Solutions Self-assessment

3 4 4 4 6 8 8 8 9

KEY CONCEPTS
. . . . . . . . . .

Business combination Acquires Entity Parent Subsidiary Sub-subsidiary Share capital Equity share capital Simple group Complex group

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ASSESSMENT CRITERIA After having studied this study unit you should be able to
. . . .

define business combinations define a subsidiary explain the difference between simple and complex groups describe the provisions of the Companies Act of 1973 regarding accounting and disclosure as they relate to group financial statements

1.1

INTRODUCTION

The first study unit, which deals with group financial statements, is chiefly background knowledge. You may not understand this at first but as you progress through the course you will come to understand the purpose this background knowledge serves. We refer back to certain concepts and principles in subsequent study units. These concepts and principles will then become clearer to you.

1.2

PARENT AND SUBSIDIARIES

Over the years the tendency in the business world has been to form bigger and bigger enterprises. One-man businesses combined to form partnerships which in turn amalgamated to form yet bigger partnerships. The problem with these bigger partnerships was, however, that all the partners were not equally active in the partnership. Some partners merely contributed capital whereas others were more actively involved in managing the enterprise. The result was the formation of companies to limit the liability of the inactive partners. Companies also began to combine with other companies to form larger companies and groups of companies. A business combination is regulated by IFRs 3 Business combinations that was issued in March 2004. A business combination is defined as the bringing together of seperate entities into one reporting entity.

Example
The following is an example of such a group:

1.

H Ltd

75% of the voting rights and eg 75% of the share capital

!
S Ltd

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(a) H Ltd is the parent. (H Ltd is a member of S Ltd and in this example it holds more than half of the issued equity share capital and also more than half the voting rights of S Ltd.) (b) S Ltd is the subsidiary. Where a parent is linked with a subsidiary to form a larger economic unit, it is customary to refer to the entity as a group. The above is an example of a simple group. Although you will only have to deal with accounting and disclosure for simple groups in this course, we should like to introduce you to the concept of complex groups so that this will not be an entirely new or foreign concept to you in future.

Example
The following are two examples of complex groups:

1.

H Ltd

80% of the voting rights and eg 80% of the share capital

60% of the voting rights and eg 60% of the share capital

S1 Ltd

S2 Ltd

(a) H Ltd is the parent. (b) S1 Ltd and S2 Ltd are subsidiaries. (c) H Ltd, S1 Ltd and S2 Ltd collectively form a complex group (horizontal).

2.

H Ltd

75% of the voting rights and eg 75% of the share capital

!
S1 Ltd

80% of the voting rights and eg 80% of the share capital

S2 Ltd (a) H Ltd is the parent. (b) S1 Ltd is the subsidiary and S2 Ltd is the sub-subsidiary. (c) H Ltd, S1 Ltd en S2 Ltd collectively form a complex group (vertical). It should be clear to you from the above that simple groups have only one subsidiary where complex groups have more than one subsidiary.

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Further to the above explanation we shall now discuss the following definitions:

Business combination
A business combination is defined as a transaction or other event in which an acquirer obtains control of one or more businesses.

Parent
A parent is a member of a subsidiary and holds a majority of the voting rights in the subsidiary. The parent has the right to control the composition of the board of directors of the subsidiary.

Subsidiary
A subsidiary is defined as an entity which is controlled by another entity (the parent).

Sub-subsidiary
A sub-subsidiary may be defined as a subsidiary of another subsidiary. The definition of a parent specifies that the company must possess a majority of the voting rights or voting equity shares. As you already know, the share capital of a company can be divided into par value shares (PV shares) and no par value shares (NPV shares). The issued share capital of a company may consist of both ordinary and preference shares. The Companies Act, 1973 defines equity shares as issued shares, excluding any part thereof which, either as regards dividends or as regards capital, carries any right to participate beyond a specified amount in a distribution. Preference shares are therefore excluded from the above definition. It is therefore clear from the definition that a parent can only obtain control over a subsidiary if the parent holds a majority of the equity shares (ordinary shares) of a subsidiary. Control can therefore be obtained through the possession of just over 50% of the equity shares of a company. Therefore, if a parent holds 51% of the preference shares of another company, there will be no parent-subsidiary relation. In our examples the percentages of shareholding and voting rights usually correspond, since we say that each share carries one vote. It is, however, important to know that this is not always the case in practice, and that the percentage voting right would determine the percentage equity. In study unit 3 we shall explain the calculation of the percentage interest in more detail.

1.3

COMPANIES ACT AND ACCOUNTING FOR GROUPS

The essence of consolidations is that the parent is able to control the policy and management of the subsidiary. The group should therefore be seen as an economic unit. Although the parent shows investments in its subsidiaries on its statement of financial position, it is highly probable that the value of the investments may have increased considerably since the investments were made. The statements may therefore not be an accurate reflection of the activities of the group.

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For this reason it is in the interests of the shareholders of the parent that a single set of annual financial statements should be drawn up for the group so that the shareholders can gain an idea of the earnings per share and the assets and liabilities of the group. This set of statements is known as consolidated statements, group annual financial statements, group statements, etcetera. Briefly, these are a combination of all the statements of the companies in the group or, to put it differently, they show that the investment in the parent's statements is replaced by the assets and liabilities of the subsidiary which represents these investments. Certain adjustments are, however, necessary in order to represent these combined values realistically as a single economic unit. These adjustments will be explained to you in the following study unit. The Companies Act of 1973 as well as IAS 27 (AC132) consolidated and seperate financial statements determines that a company which is not itself a wholly owned subsidiary of another company must submit group annual financial statements to the annual general meeting at the end of its financial year. Group annual financial statements may consist of consolidated financial statements, that is, a consolidated statement of comprehensive income, a consolidated statement of changes in equity and a consolidated statement of financial position . alternative forms of group financial statements:
.

more than one set of consolidated annual financial statements or separate annual financial statements dealing with each of the subsidiaries or statements which are attached to the parent's own annual financial statements and which enlarge on the information on the subsidiaries contained in the holding company's statements or a combination of all the above Alternative forms of group financial statements will be dealt with in the third-year course.

When should group statements be presented in the form of consolidated annual statements?
The Companies Act, 1973 provides that consolidated annual financial statements should be compiled, unless the directors of the parent are of the opinion that the required information could be more effectively and meaningfully shown in the alternative forms.

When are group statements not required?

.

Group annual financial statements need not deal with a subsidiary if the directors of the parent are of the opinion that 1. this would be impractical or of no real use to members (as in the case of insignificant sums) or the cost or delay would be out of proportion to the usefulness to members 2. the results would be misleading or would be prejudicial to the affairs of the parent or other subsidiaries 3. the operations of the parent and the subsidiaries are so different that they could not reasonably be treated as a single enterprise Permission from the Registrar of Companies is required in cases 2 and 3.

Group annual financial statements are not required when the parent itself is a wholly-owned subsidiary of another company.

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1.4
. .

GENERAL PROVISIONS

. . . .

Group statements should be a 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 within the group, where such profits/losses have not been realised in respect of persons outside the group, should be eliminated. The provisions of the Companies Act, 1973 must be complied with. All intercompany balances must be eliminated by determining the total assets and liabilities of the group. Dividends declared by a subsidiary out of pre-acquisition profits do not 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.

1.5

EXERCISES

We end the lecture with a few revision questions. For your own sake, try to answer them by referring to the lecture before you look at the proposed solutions.

Question

1
Explain the following concepts: (a) (b) (c) (d) Parent Subsidiary Wholly-owned subsidiary Equity share capital

Question

2
Distinguish between simple and complex groups and give a schematic representation of each.

Question

3
When are consolidated annual financial statements not drafted?

Solutions
Refer to the following sections of this study unit for answers to the questions:

Question 1
(a) (b) (c) (d) Sect Sect Sect Sect 1.2 1.2 1.2 1.2

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Question 2
Sect 1.2

Question 3
Sect 1.3

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . .

define a business combination? define a subsidiary? explain the difference between simple and complex groups? describe the provisions of the Companies Act of 1973 regarding accounting and disclosure as they relate to group financial statements?

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STUDY UNIT

2
Consolidation of wholly-owned subsidiary at date of acquisition

Learning outcome
Learners can consolidate the financial statement of a wholly-owned subsidiary at date of acquisition.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 2.1 2.2 2.3 2.4 Introduction Basic consolidation techniques Consolidation of the statement of financial position of a wholly-owned subsidiary at date of acquisition Exercises Solutions Self-assessment

10 11 11 11 15 19 20 22

KEY CONCEPTS
. . . . . . .

Net asset value Premium Discount Intercompany items Common items Goodwill ``Negative goodwill''

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ASSESSMENT CRITERIA After having studied this study unit, you should be able to
. . . .

draft the consolidated annual financial statements of a parent and its wholly-owned subsidiary at date of acquisition calculate intercompany items and common items calculate positive and ``negative goodwill'' at acquisition of a subsidiary do the consolidation journal entries

2.1

INTRODUCTION

As we explained in study unit 1, in principle the consolidated statements of a group are nothing more than the combined statements of all the companies in the group. Certain adjustments have to be made, however, before we can speak of consolidated statements. Consolidations can be schematically represented as follows: A Ltd's financial statements B Ltd's financial statements

" Adjustments to

"

Consolidated financial

A Ltd drafts its financial statements from its financial records, as does B Ltd. Once the individual statements have been completed the information from these statements is used to make the necessary consolidation adjustments; only then can consolidated statements be compiled. Note that the original financial statements of A Ltd and B Ltd are never amended during the consolidation process. This process repeats itself year after year and the adjustments have to be made afresh every year. This statement will become clearer to you as you study the following study units.

2.2

BASIC CONSOLIDATION TECHNIQUES

The basic procedures which should be applied when compiling consolidated annual financial statements comprise the following:
. . .

elimination of common items elimination of intercompany items consolidation of remaining items

2.2.1 The elimination of common items

One of the first adjustments which should be made in consolidated statements is the elimination of the investment in the parent's books and the shareholders' equity section in the subsidiary's books as at the date when the investment was made.

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Example

1
The following example illustrates the elimination of the investment in the parent's books at date of acquisition:

Statement of financial position as at 28 February 19.5

ASSETS Investment in B Ltd at fair value Cash and cash equivalents EQUITY AND LIABILITIES Ordinary shares of R1 each A Ltd R 10 000 10 000 20 000 20 000 B Ltd R 10 000 10 000 10 000

Draft a consolidated statement of financial position for A Limited and its subsidiary at 28 February 19.5. Assume that A Limited acquired its interest at that date. B Limited was incorporated on 28 February 19.5.

Journal entry
Dr R Share capital of B Ltd Investment in B Ltd Elimination of shareholders' equity of B Ltd at acquisition 10 000 Cr R 10 000

The group consolidated statement of financial position would now be drafted as follows:

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.5

ASSETS Cash and cash equivalents (10 000 + 10 000) EQUITY AND LIABILITIES Share capital R 20 000 20 000

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Example

2
The following example illustrates the elimination of the investment in the parent's books a few years after acquisition:

STATEMENTS OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.9

ASSETS Investment in B Ltd at fair value (cost price: R10 000) Trade and other receivables Cash and cash equivalents EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings 20 000 16 000 36 000 10 000 8 000 18 000 A Ltd R 10 12 14 36 000 000 000 000 B Ltd R 8 000 10 000 18 000

REQUIRED Draft the consolidated statement of financial position of A Ltd and its subsidiary at 28 February 19.9. Suppose A Ltd acquired its interest at 28 February 19.5 when B Ltd was incorporated.

Journal entry
Dr R Share capital of B Ltd Investment in B Ltd Elimination of shareholders' equity of B Ltd at acquisition 10 000 Cr R 10 000

A GROUP LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.9
ASSETS Current assets Trade and other receivables (12 000 + 8 000) Cash and cash equivalents (14 000 + 10 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings (16 000 + 8 000) Total equity and liabilities R 44 000 20 000 24 000 44 000 44 000 20 000 24 000 44 000

13

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On the basis of the above two examples the following conclusions can be made:
. . .

The journal entry for the elimination of the investment and the shareholders' equity at the date of acquisition will remain unchanged from one year to the next. The share capital on the consolidated statement of financial position is always only that of the parent. Profits made by the subsidiary after the date of acquisition become part of the retained earnings of the group and are shown as such in the consolidated statements. This principle will be discussed at greater length in study unit 4. Profits made by the subsidiary before the date of acquisition cannot form part of the retained earnings of the group. The parent pays for such profits. This principle will be dealt with in more depth in study unit 4. Since the parent obtained its interest in the subsidiary at the date of incorporation (date on which the company was established), there could not have been any retained earnings in the books of B Ltd.

2.2.2 The elimination of intercompany items

It is commonly found in practice that companies in the same group sell inventories and assets to one another. The following schematic representation of this serves as an example:

Sells machine

Sells timber

!
The actual profit the group made from the sale of goods was only the profit made from sales to the public, since all the other sales took place within the group. Sales within a group are known as intercompany sales and therefore have to be eliminated during consolidations. In some cases A Ltd may lend or sell a sum of money or an asset to B Ltd. Such transactions are also eliminated. In study unit 7 we go into intercompany transactions very thoroughly.

2.2.3 The consolidation of remaining items

Once all common items and intercompany items have been eliminated, a consolidated statement of financial position, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows can be drawn up. In this course you are only expected to be able to do all relevant journal entries for consolidation purposes and to draft the consolidated statement of financial position, consolidated statement of comprehensive income and consolidated statement of changes in equity.

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B Ltd

A Ltd

Timber to public

Wooden wagons to the public

2.3

CONSOLIDATION OF THE STATEMENT OF FINANCIAL POSITION OF A WHOLLY-OWNED SUBSIDIARY AT DATE OF ACQUISITION

The following three situations can arise if a parent obtains an interest in a subsidiary:
.

The price paid by the parent for the interest/investment in the subsidiary is equivalent to the value of the net assets acquired. An acquisition of this kind is known as an acquisition at net asset value. The price paid by the parent for the interest is higher than the net asset value. This is known as acquisition at a premium. This premium should be treated as goodwill.

AC 131/IFRS3 requires that goodwill must be recognised as an asset at cost. This is what is expected from the students to know for this module. . Take note that goodwill must not be amortised, but is subjected to impairment test, at least every year. This part of treating goodwill will be dealt with in the Accounting III modules.
.

The price paid by the parent is lower than the net asset value. This is known as acquisition of a subsidiary at a discount also referred to as ``negative goodwill''. AC 131/IFRS3 requires that, if the fair value of identifiable assets and liabilities exceeds the cost of the business combination: reassess the identity and measurement of such items recognise in profit or loss any excess after reassessment Such ``negative goodwill'' could arise from, inter alia, errors in measuring fair values of identifiable items. For the purpose of this module, take note that ``negative goodwill'' is a possibility when acquiring a subsidiary, but will be dealt with in Accounting III modules.

The following examples serve as an illustration of the situations which could arise:

Example

1
Acquisition of a subsidiary at net asset value
The following represent the abridged statements of financial position of A Limited and its wholly-owned subsidiary B Limited at 31 December 19.5, the date on which A Limited acquired its interest in B Limited.

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.5

ASSETS Investment in B Ltd at fair value (cost price: R90 000) Bank Trade and other receivables EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings A Ltd R 90 30 60 180 000 000 000 000 B Ltd R 55 000 35 000 90 000 50 000 40 000 90 000

100 000 80 000 180 000

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Calculations
1. Analysis of shareholders equity of B Ltd
Total R Share capital Retained earnings Investment in B Limited 50 000 40 000 90 000 At R 50 000 40 000 90 000 90 000 NIL Since R

2. Journal entry
Dr R Ordinary shares of R1 each (B Ltd) Retained earnings (B Ltd) Investment in B Ltd Elimination of shareholders' equity of B Ltd at acquisition 50 000 40 000 Cr R

90 000

The price paid by A Limited for the investment in B Limited is equal to the value of net assets acquired. (90 000 = 50 000 + 40 000)

CONSOLIDATED STATEMENT OF FINANCIAL POSITION OF A LTD AND ITS SUBSIDIARY AS AT 31 DECEMBER 19.5
R ASSETS Current assets Cash and cash equivalents (30 000 + 55 000) Trade and other receivables (60 000 + 35 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Total equity and liabilities 180 000 85 000 95 000 180 000

180 000 100 000 80 000 180 000

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Example

Acquisition of a subsidiary at a premium

The following represent the abridged statements of financial position of A Limited and its wholly-owned subsidiary B Limited at 31 December 19.5, the date A Limited acquired its interest in B Limited. Note that the information is the same as in the previous example except for the investment, which is now R100 000 and not R90 000.

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.5

ASSETS Investment in B Ltd at fair value (cost price: R100 000) Bank Trade and other receivables EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings A Ltd R 100 20 60 180 000 000 000 000 B Ltd R 55 000 35 000 90 000 50 000 40 000 90 000

100 000 80 000 180 000

Calculations
1. Analysis of shareholders equity of B Ltd
Total R Share capital Retained earnings Investment in B Limited Goodwill 50 000 40 000 90 000 At R 50 40 90 100 10 000 000 000 000 000 Since R

2. Journal entry
Dr R Ordinary shares of R1 each (B Ltd) Retained earnings (B Ltd) Goodwill Investment in B Ltd Elimination of shareholders' equity of B Ltd at acquisition 50 000 40 000 10 000 100 000 Cr R

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CONSOLIDATED STATEMENT OF FINANCIAL POSITION OF A LTD AND ITS SUBSIDIARY AS AT 31 DECEMBER 19.5
ASSETS Non-current assets Goodwill Current assets Cash and cash equivalents (20 000 + 55 000) Trade and other receivables (60 000 + 35 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Total equity and liabilities R

10 000 170 000 75 000 95 000 180 000 180 000 100 000 80 000 180 000

COMMENTS
. In this example the parent paid more than the net asset value for its interest in the subsidiary, which means that a premium (goodwill) was paid at acquisition. It is regarded as an intangible asset and should be shown as a non-current asset in the consolidated statement of financial position. In this module we determine the goodwill at acquisition only. We do not take care of future changes in the value of goodwill. This will be dealt with on third year level. . The revised IFR53 was issued on 10th January 2008. The implications of the statement where the two options of the calculation of goodwill. The two options are as follows: a) The partial method (the method used in this study guide) b) The full goodwill method (Here the non-controlling interest at fair value is used to derive goodwill.) However, this method will be dealt with further on third-year level.

Example

Acquisition of a subsidiary at a discount

COMMENT
This occurs when the parent paid less than the net asset value for its interest in the subsidiary. Such treatment, in terms of AC 131, will be dealt with on third-year level.

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2.4

EXERCISES

To see whether you are able to apply the content of this study unit, work out the following questions. It is important to answer the questions yourself before you look up the suggested solutions.

Question

1
The statements of financial position of H Ltd and S Ltd as at 30 June 19.6 are submitted to you:

STATEMENTS OF FINANCIAL POSITIONS AS AT 30 JUNE 19.6

H Ltd R ASSETS Investment in S Ltd 100 000 shares at fair value (cost price: R145:000) Current assets EQUITY AND LIABILITIES Ordinary share capital R1 shares Retained earnings 100 000 85 000 185 000 100 000 15 000 115 000 S Ltd R

145 000 40 000 185 000

115 000 115 000

REQUIRED Draft the consolidated statement of financial position of H Ltd and its subsidiary as at 30 June 19.6 if H Ltd acquired its interest in S Ltd at 30 June 19.6

Question

2
The following trial balances are submitted to you:

TRIAL BALANCES AT 31 MARCH 19.5

H Ltd Dr/(Cr) R (100 000) (80 000) 40 000 20 000 (15 000) (100 000) 80 000 80 000 25 000 50 000 S Ltd Dr/(Cr) R (50 000) (20 000) 15 000 35 000 (18 000) (80 000) 58 000 60 000

Ordinary shares of R1 each Retained earnings Trade and other receivables Inventories Trade and other payables Interest bearing borrowings Loan S Ltd Investment in S Ltd 50 000 shares at fair value (cost price: R80 000) Loan H Ltd Bank Property, plant and equipment

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REQUIRED Draft the consolidated statement of financial position of H Ltd and its subsidiary as at 31 March 19.5 if H Ltd acquired its interest in S Ltd at 31 March 19.5.

Solution Question 1
You should have followed the following steps:

Step 1 Determine the percentage interest

Investment in S Ltd Ordinary shares of S Ltd = 100 000 shares 100 000 shares 6 100

= 100% (therefore wholly-owned subsidiary) Note that the interest in S Limited i s determined by the amount of shares held in S Limited and not the R-value. You must use 100 000 shares and not R145 000.

Step 2 Draft the analysis of shareholders equity of S Ltd Analysis of shareholders equity of S Ltd
Total R Ordinary share capital Retained earnings Investment in S Ltd at cost Goodwill 100 000 15 000 115 000 At R 100 15 115 145 30 000 000 000 000 000 Since R

Step 3 Eliminate all common items Journal entry

Share capital S Ltd Retained earnings S Ltd Goodwill Investment in S Ltd Elimination of shareholders' equity of S Ltd at acquisition Dr R 100 000 15 000 30 000 Cr R

145 000

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Step 4 Draft the consolidated statement of financial position: CONSOLIDATED STATEMENT OF FINANCIAL POSITION OF H LTD AND ITS SUBSIDIARY AS AT 30 JUNE 19.6
ASSETS Non-current assets Goodwill Current assets (40 000 + 115 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Total equity and liabilities R 30 000 155 000 185 000 185 000 100 000 85 000 185 000

Solution Question 2
You should have followed the following steps:

Step 1 Determine the percentage interest:

Investment in S Ltd Ordinary shares in S Ltd = 50 000 shares 50 000 shares 6 100

= 100% (wholly-owned subsidiary)

Step 2 Draft the analysis of shareholders equity of S Ltd: Analysis of shareholders equity of S Ltd
Share capital Retained earnings Investment in S Ltd Goodwill Total R 50 000 20 000 70 000 At R 50 000 20 000 70 000 80 000 10 000 Since R

Step 3 Eliminate common items: Journal entries

Loan H Ltd Loan S Ltd Elimination of intercompany loans Share capital S Ltd Retained earnings S Ltd Goodwill Investment in S Ltd Elimination of shareholders' equity of S Ltd at acquisition Dr R 80 000 Cr R 80 000

50 000 20 000 10 000 80 000

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Step 4 Draft the consolidated statement of financial position: CONSOLIDATED STATEMENT OF FINANCIAL POSITION OF H LTD AND ITS SUBSIDIARY AS AT 31 MARCH 19.5
R ASSETS Non-current assets Property, plant and equipment (50 000 + 60 000) Goodwill Current assets Trade and other receivables (40 000 + 15 000) Inventories (20 000 + 35 000) Cash and cash equivalents (25 000 + 58 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Total liabilities Non-current liabilities Long-term borrowings Current liabilities Trade and other payables (15 000 + 18 000) Total equity and liabilities
.

120 000 110 000 (10 000) 193 000 55 000 55 000 83 000 313 000 180 000 100 000 80 000 133 000 100 000 33 000 313 000

You will note that in our proposed solutions to the assignments we show first the consolidated statement of financial position and then the calculations. We will not criticise your method of setting out your answer, but do make sure that you answer the question in full. . It would be perfectly acceptable to give some of the easier calculations in brackets, as in our proposed solutions.

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . .

draft the consolidated annual financial statements of a parent and its wholly-owned subsidiary at date of acquisition? calculate intercompany items and common items? calculate goodwill at acquisiton of a subsidiary? do the consolidation journal entries?

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STUDY UNIT

3
Consolidation of partly-owned subsidiary at date of acquisition

Learning outcome
Learners can consolidate the financial statements of a group at date of acquisition of a subsidiary if partly-owned.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 3.1 3.2 3.3 Introduction Consolidation of the statement of financial position of a partly-owned subsidiary at date of acquisition Exercises Solutions Self-assessment

23 24 24 24 31 33 36

KEY CONCEPTS
. . . .

Partly-owned subsidiary Outside shareholders Non-controlling shareholders Non-controlling interest

23

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ASSESSMENT CRITERIA After having studied this study unit, you should be able to
. . .

calculate the percentage applicable to non-controlling shareholders draft the consolidated annual financial statements of a group at date of acquisition if the subsidiary is partly-owned do the consolidation journal entries

3.1

INTRODUCTION

In study unit 2 we dealt only with wholly-owned subsidiaries which means that the parent has acquired the entire issued share capital of the subsidiary. There may, however, be various reasons why it is impossible for the parent to take up all the shares in the subsidiary. Some of the shareholders may not be prepared to sell their shares to the parent or the parent may not have sufficient funds to purchase all the shares. These other shareholders are known as non-controlling shareholders or outside shareholders. Noncontrolling shareholders may consist of ordinary shareholders and preference shareholders. Subsidiaries with preference shares will be dealt with in study unit 9.

3.2

CONSOLIDATION OF THE STATEMENT OF FINANCIAL POSITION OF A PARTLY-OWNED SUBSIDIARY AT DATE OF ACQUISITION

The same rules apply for consolidation purposes, except that we now have to make provision for the non-controlling shareholders' interest in the profit of the subsidiary.

Example
H Ltd 80% of voting right

!
S Ltd

20% of voting right

To make provision for the non-controlling shareholders' interest in the profit of the subsidiary, it is important to know how to calculate the percentage interest in the subsidiary.

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Non-controlling shareholders

Example

1
The following represent the condensed statements of financial position of A Ltd and its subsidiary B Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 30 JUNE 19.6

ASSETS Property, plant and equipment Investment in B Ltd 80 000 ordinary shares of R1 each at fair value (cost price: R90 000) Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings Long-term loans A Ltd R 150 000 B Ltd R 200 000

90 000 110 000 350 000 200 50 100 350 000 000 000 000

10 000 210 000 100 30 80 210 000 000 000 000

We calculate the parent's interest in the subsidiary as follows: Investment in B Ltd Issued shares of B Ltd = 80 000 shares 100 000 shares 6 100 = 80%

This is to say that A Ltd has an 80% interest in B Ltd and that the non-controlling shareholders of B Ltd have only a 20% interest in B Ltd.

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Example

2
The following represent the condensed statements of financial position of H Ltd and S Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 JULY 19.4

H Ltd R ASSETS Property, plant and equipment Investment in S Ltd 35 000 ordinary shares of R2 each at fair value (cost price: R75 000) Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R2 each Retained earnings Long-term loans 150 000 S Ltd R 200 000

75 000 125 000 350 000 200 50 100 350 000 000 000 000

10 000 210 000 100 30 80 210 000 000 000 000

In this example the par value of the shares differs, however. They are now R2 shares, so that the issued share capital of S Ltd consists of 50 000 R2 shares = R100 000. We now calculate the interest in the subsidiary as follows: Investment in S Ltd Issued shares in S Ltd = 35 000 shares 50 000 shares 6 100 = 70%

As in the case of wholly-owned subsidiaries the following three situations may occur when a parent acquires an interest in a partly-owned subsidiary:
. . .

Acquired at net asset value Acquired at a premium (Goodwill) Acquired at a discount (``negative goodwill'')

The following examples will illustrate the three situations.

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Example

3
Acquisition of a partly-owned subsidiary at net asset value
The following are the abridged statements of financial position of A Limited and it subsidiary B Limited as at 31 December 19.9, the date on which A Limited acquired its interest in B Limited.

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

A Ltd R ASSETS Property, plant and equipment Investment in B Ltd 56 000 ordinary shares at fair value (cost price: R98 000) Trade and other receivables EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings Trade and other payables 160 000 98 000 140 000 398 000 100 120 178 398 000 000 000 000 B Ltd R 160 000 110 000 270 000 80 60 130 270 000 000 000 000

We follow the basic consolidation procedures:

. . .

determine the percentage interest eliminate common items consolidation of remaining items

1. Determine the percentage interest

A Ltd acquired 56 000 shares B Ltd has 80 000 shares 56 000 100 6 = 70% ; A Ltd's interest = 80 000 1

2. Analysis of shareholders equity of B Ltd at 31 December 19.9

A Ltd Total At acquisition Since acquisition Noncontrolling interest 30% R R 24 000 18 000 42 000

70% R At acquisition Share capital Retained earnings Investment in B Ltd 80 000 60 000 140 000 56 000 42 000 98 000 98 000 NIL R

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In this question the date of acquisition and the date of consolidation are one and the same, which is why the statement of financial position does not include any of the subsidiary's reserves.

3. Journal entry
Dr R 80 000 60 000 Cr R Noncontrolling interest R

Share capital Retained earnings Investment in B Ltd Non-controlling interest (Statement of financial position) 42 000 Elimination of shareholders' equity of B Ltd at acquisition

98 000 42 000

42 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (160 000 + 160 000) Current assets Trade and other receivables (140 000 + 110 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest Current liabilities Trade and other payables (178 000 + 130 000) Total equity and liabilities 19.9 R

320 000 250 000 570 000 262 220 100 120 42 000 000 000 000 000

308 000 570 000

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Example

4
Acquisition of a partly-owned subsidiary at a premium (Goodwill)
The following are the abridged statements of financial position of A Limited and its subsidiary B Limited as at 31 December 19.9, the date on which A Limited acquired its interest in B Limited.

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in B Ltd 64 000 ordinary shares at fair value (cost price: R140 000) Trade and other receivables EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings Trade and other payables A Ltd R 160 000 B Ltd R 160 000

140 000 98 000 398 000 100 120 178 398 000 000 000 000

110 000 270 000 80 60 130 270 000 000 000 000

We once again follow the basic consolidation procedures:

. . .

determine the percentage interest eliminate common items consolidation of remaining items

1. Determine the percentage interest

A Ltd acquired 64 000 shares B Ltd has 80 000 shares 100 ; A Ltd's interest = 64 000 6 = 80% 80 000 1

2. Analysis of shareholders equity of B Ltd at 31 December 19.9

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 16 000 12 000 28 000

80% R At acquisition Share capital Retained earnings Investment in B Ltd Goodwill 80 000 60 000 140 000 64 000 48 000 112 000 140 000 28 000 R

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3. Journal entry
Noncontrolling interest R

Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest (Statement of financial position) Elimination of shareholders' equity of B Ltd at acquisition

Dr R 80 000 60 000 28 000

Cr R

140 000 28 000

28 000 28 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (160 000 + 160 000) Goodwill Current assets Trade and other receivables (98 000 + 110 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest Current liabilities Trade and other payables (178 000 + 130 000) Total equity and liabilities 19.9 R 348 000 320 000 28 000 208 000 556 000 248 000 220 000 100 000 120 000 28 000 308 000 556 000

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Example

5 Acquisition of a partly-owned subsidiary at a discount (``negative goodwill)

Acquisition of a subsidiary at a discount will be dealt with in detail at third year level and does not form part of this course.

3.3

EXERCISES

We shall now conclude this study unit with a few revision questions. It is in your own interest to try to answer these questions by referring to the study unit before you look at the proposed solutions.

Question

1
H Ltd acquired its interest in S Ltd at 30 June 19.5. Each share carries one vote. The following represent the condensed trial balances of H Ltd and S Ltd at 30 June 19.5: H Ltd R Debits Property, plant and equipment Investment in S Ltd 75 000 shares of R1 each at fair value (cost price: R90 000) 10 000 debentures of R1 each at fair value (cost price: R10 000) Bank Inventories 52 700 S Ltd R 133 900

90 000 10 000 2 500 15 800 171 000

4 200 138 100

Credits Share capital Ordinary shares of R1 each Retained earnings Debentures Trade and other payables Bank overdraft

150 000 12 200 8 800 171 000

100 000 11 300 20 000 1 200 5 600 138 100

REQUIRED Draft the consolidated statement of financial position of H Ltd and its subsidiary S Ltd as at 30 June 19.5 in compliance with the requirements of the Companies Act, 1973.

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Question

2
H Ltd acquired 40 000 ordinary shares in S Ltd at 1 January 19.5 and each share carries one vote. The following represent the condensed statements of financial position of H Ltd and S Ltd at 1 January 19.5: H Ltd R ASSETS Property, plant and equipment Unsecured loan H Ltd Investment in S Ltd 40 000 Ordinary shares at fair value (cost price: R180 000) Current assets 103 200 180 000 S Ltd R 157 300 20 000

44 000 327 200

15 500 192 800 100 000 50 000 40 000 2 800 192 800

EQUITY AND LIABILITIES Share capital Ordinary shares of R2 each Revaluation of land and buildings Retained earnings Interest bearing borrowing S Ltd Current liabilities

200 000 95 700 20 000 11 500 327 200

REQUIRED Draft the consolidated statement of financial position of H Ltd and its subsidiary S Ltd as at 1 January 19.5 in compliance with the requirements of the Companies Act, 1973.

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Solution Question 1 1. Calculate H Ltds percentage interest in S Ltd

H Ltd acquires 75 000 shares, each carrying one vote. S Ltd issued 100 000 shares, each carrying one vote. 75 000 100 ; H Ltd's share holding = 6 = 75% 100 000 1

2. Analysis of shareholders equity of S Ltd at 30 June 19.5

H Ltd Total At acquisition Since acquisition Noncontrolling interest 25% R R 25 000 2 825 27 825(a)

75% R At acquisition Share capital Retained earnings Investment in S Ltd Goodwill 100 000 11 300 111 300 75 000 8 475 83 475 90 000 6 525(b) R

3. Journal entries
Dr R 100 000 11 300 6 525 Cr R Noncontrolling interest R

Share capital Retained earnings Goodwill Investment in S Ltd Non-controlling interest Elimination of shareholders' equity of S Ltd at acquisition Debentures (S) Investment in debentures (H) Elimination of intercompany balances

90 000 27 825 10 000 10 000

27 825

27 825(a)

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H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 19.5
R ASSETS Non-current assets Property, plant and equipment (52 700 + 133 900) Goodwill Current assets Inventories (15 800 + 4 200) Cash and cash equivalents Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest Total liabilities Non-current liabilities Debentures (20 000 7 10 000) Current liabilities Trade and other payables (8 800 + 1 200) Bank overdraft Total equity and liabilities
.

193 125 186 600 6 525(b) 22 500 20 000 2 500 215 625

190 025 162 200 150 000 12 200 27 825(a) 25 600 10 000 15 600 10 000 5 600 215 625

In terms of the Companies Act debit and credit bank balances may not be set off against each other upon consolidation, and therefore the parent's favourable bank balance and the subsidiary's bank overdraft are separately shown. . The balances can only be set off against each other if the company with the favourable balance has guaranteed the overdrawn account, provided that both accounts are at the same bank.

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Solution Question 2

Calculations
1. Calculate H Ltds percentage interest in S Ltd
H Ltd obtains 40 000 R2 shares. S Ltd issued 50 000 shares (R100 000 7 R2 shares). ; H Ltd's share holding = 40 000 100 6 = 80% 50 000 1

2. Analysis of shareholders equity of S Ltd at 1 January 19.5

H Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R

80% R At acquisition Share capital Retained earnings Revaluation reserve Investment in S Ltd Goodwill 100 000 40 000 50 000 190 000 80 000 32 000 40 000 152 000 180 000 28 000(a) R

20 000 8 000 10 000 38 000(b)

3. Journal entries
Dr R 100 000 50 000 40 000 28 000 Cr R

Share capital Revaluation reserve Retained earnings Goodwill Investment in S Ltd Non-controlling interest Elimination of shareholders' equity of S Ltd at acquisition Long-term loan S Ltd Unsecured loan H Ltd Elimination of intercompany loans

Noncontrolling interest R

180 000 38 000

38 000

20 000 20 000 38 000(b)

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H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 1 JANUARY 19.5
R ASSETS Non-current assets Property, plant and equipment (103 200 + 157 300) Goodwill Current assets (44 000 + 15 500) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest Current liabilities (11 500 + 2 800) Total equity and liabilities 288 500 260 500 28 000(a) 59 500 348 000

333 700 295 700 200 000 95 700 38 000(b) 14 300 348 000

SELF-ASSESSMENT After studying this study unit, are you able to:
. . .

calculate the percentage applicable to non-controlling shareholders? draft the consolidated annual financial statements of a group at date of acquisition if the subsidiary is partly-owned? do the consolidation journal entries?

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STUDY UNIT

4
Consolidation of wholly-owned subsidiary after date of acquisition

Learning outcome
Learners can draft financial statements of a group if the interest in the whollyowned subsidiary was acquired a few years ago.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 4.1 4.2 4.3 4.4 4.5 Introduction Dividends from pre-acquisition profits Treatment of goodwill arising on acquisition Consolidation of wholly-owned subsidiary after date of acquisition Exercises Solutions Self-assessment

37 38 38 38 40 40 48 51 58

KEY CONCEPTS
. .

Pre-acquisition profits Post-acquisition profits

37

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ASSESSMENT CRITERIA After having studied this study unit you should be able to
. . . .

draft the consolidated annual financial statements of a group if the interest in the wholly-owned subsidiary was acquired a few years ago draft the consolidated annual financial statements of a group if a dividend is being declared from pre-acquisition profits calculate the goodwill which may arise at acquisition do the consolidation journal entries

4.1

INTRODUCTION

In study unit 2 we discussed the consolidation of a wholly-owned subsidiary at the date of acquisition. In this study unit we deal with the compiling of consolidated annual financial statements at any date after the acquisition of an interest in a subsidiary. The shareholders' equity (share capital and reserves) of a subsidiary, which arises upon acquisition of the subsidiary, is always eliminated against the investment in the subsidiary. It does not form part of the shareholders' equity (share capital and reserves) of the group. The parent originally paid for it. Refer to examples 1 to 3 in study unit 2 if you need to make sure of the above statement. It follows from this that all profits the subsidiary makes after the date of acquisition become profits of the group and should therefore be included as such in the consolidated statements. All reserves (distributable and non-distributable reserves) of a subsidiary which was formed after the date of acquisition form part of the total reserves of the group.

4.2

DIVIDENDS FROM PRE-ACQUISITION PROFITS

In the above introduction we explained to you that all post-acquisition profits form part of the total reserves of the group. What happens if a subsidiary pays a dividend from pre-acquisition profit? The payment of a dividend from pre-acquisition profits is brought to book as a capital receipt by the parent. The distributable reserves which existed at the date of acquisition of the subsidiary form part of the total shareholders' equity of the subsidiary. The parent paid for the shareholders' equity upon purchase of the shares in the subsidiary. The declaration of a dividend from distributable reserves, which existed at the date of acquisition of an interest in the subsidiary, is therefore nothing other than the refunding of a portion of the purchase price.

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Example

1
The following are the condensed statements of financial position of A Ltd and B Ltd as at 31 December 19.5:

STATEMENTS OF FINANCIAL POSITIONS AS AT 31 DECEMBER 19.5

ASSETS Property, plant and equipment Investment in B Ltd at fair value (cost price R110 000) Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings A Ltd R 90 110 10 210 000 000 000 000 B Ltd R 40 000 60 000 100 000 50 000 50 000 100 000

130 000 80 000 210 000

A Ltd acquired its 100% interest in B Ltd at 30 December 19.5. At 2 January 19.6 B Ltd declared a dividend of R40 000. REQUIRED Draft the statements of financial position of A Ltd and B Ltd directly after the payment of the dividend and compile an analysis of shareholders' equity, as required for consolidation purposes. The entry in the books of A Ltd immediately following the acquisition of the dividend would look like this: Dr Cr R R Bank 40 000 Investment in B Ltd 40 000 The statements of financial position would look like this:

STATEMENTS OF FINANCIAL POSITION AS AT 2 JANUARY 19.6

A Ltd R ASSETS Property, plant and equipment Investment in B Ltd at fair value Current assets (10 000 + 40 000 cash); (60 000 40 000 cash) EQUITY AND LIABILITIES Share capital Retained earnings (50 000 40 000 dividend) 90 000 70 000 50 000 210 000 130 000 80 000 210 000 40 000 20 000 60 000 50 000 10 000 60 000 B Ltd R

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Analysis of shareholders' equity of B Ltd Total R 50 000 10 000 50 000 40 000 60 000 At R 50 000 10 000 50 000 40 000 60 000 70 000 110 000 40 000 10 000 Since R

Share capital Retained earnings At acquisition Less: Dividend from pre-acquisition profits Investment in B Ltd At cost price Less: Dividend from pre-acquisition profits Goodwill

4.3

TREATMENT OF GOODWILL ARISING ON ACQUISITION

By now you should be familiar with the term goodwill. A parent may pay more or less than the net asset value of the shares acquired with the purchase of the interest in the subsidiary. This can be attributed to: specific items (for example fixed property, plant) which has a market value higher/lower than the carrying value . the value of the undertaking as a whole
.

Goodwill arising on acquisition of a subsidiary represents a payment made by the parent in anticipation of future economic benefits. Goodwill is reflected at cost price for purposes of this course. Any future adjustments in value will be dealt with on third year level. The alternative option issued by IFRS3 will also be dealt with further on third-year level.

4.4

CONSOLIDATION OF WHOLLY-OWNED SUBSIDIARY AFTER DATE OF ACQUISITION

Where consolidation takes place at date after the acquisition of the interest in the subsidiary, both the statements of financial position and the statements of comprehensive incomes of the parent and the subsidiary must be consolidated. We shall continue to follow the same consolidation procedures, namely:
. . .

elimination of common items elimination of intercompany items consolidation of remaining items

We now turn our attention to a new aspect, namely that in the analysis of shareholders' equity of the subsidiary there will have to be a division into various periods. The following serves as an example of this: Suppose A Ltd acquired its 100% interest in B Ltd at 1 January 19.1. You are required to draft

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the consolidated financial statements for the year ended 31 December 19.8. The analysis of shareholders' equity will now be divided into three parts.

Analysis of shareholders equity of B Ltd

At acquisition 1 January 19.1 Since acquisition to beginning of current year 2 January 19.1 to 31 December 19.7 Current year 1 January 19.8 to 31 December 19.8 As in the previous study units we will again deal with the three conditions under which shares can be acquired in a subsidiary. Total R At R Since R

Example

1 Acquisition of wholly-owned subsidiary at net asset value

The following are the abridged statements of financial position of A Ltd and its subsidiary B Ltd as at 31 December 19.6:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.6

A Ltd R ASSETS Property, plant and equipment Investment in B Ltd 80 000 ordinary shares at fair value (cost price: R124 000) Trade and other receivables 160 000 B Ltd R 180 000

124 000 114 000 398 000

90 000 270 000

EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings Trade and other payables

100 000 120 000 178 000 398 000

80 60 130 270

000 000 000 000

A Ltd acquired its interest in B Ltd at 1 January 19.6, when B Ltd's retained earnings amounted to R44 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof.

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STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.6

A Ltd R Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 35 000 (11 000) 24 000 24 000 B Ltd R 23 000 (7 000) 16 000 16 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.6

Share capital A Ltd B Ltd R R 100 000 80 000 100 000 80 000 Retained earnings A Ltd B Ltd R R 96 000 44 000 24 000 16 000 120 000 60 000 Total A Ltd B Ltd R R 196 000 124 000 24 000 16 000 220 000 140 000

Balance at 31 December 19.5 Total comprehensive income for the year Balance at 31 December 19.6

Presume now that you have to draft the consolidated statement of comprehensive income, consolidated statement of changes in equity and the consolidated statement of financial position at 31 December 19.6. Before you can draft these statements you have to do the following first:
. .

analysis of shareholders' equity in B Ltd consolidation journal entries

1. Analysis of shareholders equity in B Ltd

A Ltd 100% Total R At acquisition 1 Jan 19.6 Share capital Retained earnings Investment in B Ltd 80 000 44 000 124 000 80 000 44 000 124 000 124 000 NIL Current year 1 Jan 19.6 to 31 Dec 19.6 Profit for the year 16 000 140 000 16 000 16 000 At acquisition R Since acquisition R Noncontrolling interest 0% R

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2. Journal entry
Dr R Share capital (B) Retained earnings (B) Investment in B Ltd (A) Elimination of shareholders' equity of B Ltd at acquisition 80 000 44 000 124 000 Cr R

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.6
Profit before tax (35 000 + 23 000) Income tax expense (11 000 + 7 000) Profit for the period Other comprehensive income Total comprehensive income for the year R 58 000 (18 000) 40 000 40 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.6
Attributable to owners of the parent Share Retained Total capital earnings R R R 100 000 100 000 96 000* 40 000 136 000 196 000 40 000 236 000

Balance at 31 December 19.5 Total comprehensive income for the year Balance at 31 December 19.6

* Only parent's interest due to the fact that the interest was acquired on 1 Janauary 19.6

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.6
ASSETS Non-current assets Property, plant and equipment (160 000 + 180 000) Current assets Trade and other receivables (114 000 + 90 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Current liabilities Trade and other payables (178 000 + 130 000) Total equity and liabilities R

340 000 204 000 544 000 236 000 100 000 136 000 308 000 544 000

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Example

2 Acquisition of wholly-owned subsidiary at a premium

The following are the abridged statements of financial position of A Ltd and its subsidiary B Ltd as at 31 December 19.6:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.6

A Ltd R ASSETS Property, plant and equipment Investment in B Ltd 80 000 ordinary shares at fair value (cost price: R148 000) Trade and other receivables EQUITY AND LIABILITIES Ordinary shares of R1 each Retained earnings Trade and other payables 160 000 148 000 90 000 398 000 100 120 178 398 000 000 000 000 B Ltd R 180 000 90 000 270 000 80 60 130 270 000 000 000 000

A Ltd acquired its interest in B Ltd at 1 January 19.5 when B Ltd's retained earnings amounted to R26 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof.

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.6

A Ltd R Profit from operations Dividends received from subsidiary Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 25 000 10 000 35 000 (11 000) 24 000 24 000 B Ltd R 23 000 23 000 (7 000) 16 000 16 000

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STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.6

Share capital A Ltd B Ltd R R 100 000 80 000 Retained earnings Total A Ltd B Ltd A Ltd B Ltd R R R R 111 000 54 000 211 000 134 000 24 000 16 000 24 000 16 000 (15 000) (10 000) (15 000) (10 000) 120 000 60 000 220 000 140 000

Balance at 31 December 19.5 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.6

100 000

80 000

REQUIRED You are required to draft the consolidated statement of comprehensive income, consolidated statement of changes in equity and the consolidated statement of financial position at 31 December 19.6.

Calculations
1. Analysis of shareholders equity of B Ltd
A Ltd 100% Total R At acquisition 1 Jan 19.5 Share capital Retained earnings Investment in B Ltd 80 000 26 000 106 000 80 000 26 000 106 000 148 000 42 000(1) Since acquisition to beginning of current year 2 Jan 19.5 to 31 Dec 19.5 Retained earnings (54 000 31/12/19.5 26 000 1/1/19.5 Current year 1 Jan 19.6 to 31 Dec 19.6 Profit for the year Dividend paid 16 000 (10 000) 140 000 16 000 (10 000) 34 000 28 000 28 000(2) At acquisition R Since acquisition R Non-controlling interest 0% R

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2. Journal entries
Dr R Share capital (B) Retained earnings (B) Goodwill Investment in B Ltd (A) Elimination of shareholders' equity of B Ltd at acquisition Dividend received (A) Dividend paid (B) Elimination of intercompany dividend 80 000 26 000 42 000 Cr R

148 000

10 000 10 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.6
Profit before tax (25 000 + 23 000) Income tax expense (11 000 + 7 000) Profit for the year Other comprehensive income Total comprehensive income for the year R 48 000 (18 000) 30 000 30 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.6
Attributable to owners of the parent Share capital R Balance at 31 December 19.5 Total comprehensive income for the year Dividends paid Balance at 31 December 19.6
# [111 000 + 28 000(2)]

Retained earnings R 000 000# 000) 000

#

Total R 239 000 30 000 (15 000) 254 000

100 000 139 30 (15 100 000 154

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.6
ASSETS Non-current assets Property, plant and equipment (160 000 + 180 000) Goodwill (1) Current assets Trade and other receivables (90 000 + 90 000) Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Current liabilities Trade and other payables (178 000 + 130 000) Total equity and liabilities R 382 000 340 000 42 000 180 000 562 000 254 000 100 000 154 000 308 000 562 000

Example

3
Acquisition of a wholly-owned subsidiary at a discount
Acquisition at a discount does not form part of this course and will be dealt with in detail at thirdyear level.

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4.5 EXERCISES
We conclude this study unit with a few revision questions. It is important that you work through these questions carefully, paying special attention to the comments, since by this stage you have progressed so far with consolidations that it is easier to point out certain important principles to you.

Question

1
The following are the trial balances of H Ltd and its subsidiary S Ltd at 31 December 19.8: H Ltd R 100 000 250 000 410 000 30 000 80 000 50 000 30 000 950 000 152 000 150 000 180 000 190 000 15 000 100 000 15 000 108 000 40 000 950 000 S Ltd R 50 000 130 000 360 000 60 000 30 000 630 000 100 000 160 000 80 000 68 000 12 000 80 000 10 000 90 000 30 000 630 000

Credits Share capital Ordinary shares of R1 each Retained earnings 1 January 19.8 Gross profit Dividends received Trade and other payables Accumulated depreciation 31 December 19.8 Bank overdraft Debits Property, plant and equipment at cost price Investment in S Ltd 50 000 shares at fair value (cost price: R150 000) Inventories Trade and other receivables Bank Auditors' remuneration Staff cost Depreciation Taxation for the year Dividends paid

Additional information
1. H Ltd acquired its interest in S Ltd at 2 January 19.5, at which date the retained earnings of S Ltd was R80 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of S Ltd to be equal to the fair value thereof. REQUIRED Draft the consolidated statement of financial position, consolidated statement of comprehensive income and consolidated statement of changes in equity of H Ltd and its subsidiary for the year ended 31 December 19.8.

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Question

2
The following are the trial balances of A Ltd and its subsidiary B Ltd at 31 December 19.8: Credits Share capital Ordinary shares of R1 each Retained earnings 1 January 19.8 Gross profit Dividends received Trade and other payables Accumulated depreciation 31 December 19.8 Bank overdraft A Ltd R 100 000 250 000 410 000 30 000 80 000 50 000 30 000 950 000 B Ltd R 50 000 130 000 360 000 60 000 30 000 630 000

Debits Property, plant and equipment at cost price Investment in B Ltd 50 000 shares at fair value (cost price: R150 000) Inventories Trade and other receivables Bank Auditors' remuneration Staff cost Depreciation Taxation for the year Dividends paid

152 000 150 000 180 000 190 000 15 000 100 000 15 000 108 000 40 000 950 000

100 000 160 000 80 000 68 000 12 000 80 000 10 000 90 000 30 000 630 000

Additional information
1. A Ltd acquired its interest in B Ltd at 2 January 19.5, and at that date the retained earnings of B Ltd was R80 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof.

REQUIRED Draft the consolidated statement of financial position of A Ltd and its subsidiary as at 31 December 19.8.

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Question

3
The following are the trial balances of J Ltd and its subsidiary L Ltd at 31 December 19.8: Credits Share capital Ordinary shares of R1 each Retained earnings 1 January 19.8 Gross profit Dividends received Trade and other payables Accumulated depreciation 31 December 19.8 Bank overdraft Debits Property, plant and equipment at cost price Investment in L Ltd 50 000 shares at fair value (cost price: R150 000) Inventories Trade and other receivables Bank Auditors' remuneration Staff cost Depreciation Taxation for the year Dividends paid J Ltd R 100 250 410 30 80 50 30 950 000 000 000 000 000 000 000 000 L Ltd R 50 000 130 000 360 000 60 000 30 000 630 000 100 000 160 000 80 000 68 000 12 000 80 000 10 000 90 000 30 000 630 000

152 000 150 000 180 000 190 000 15 000 100 000 15 000 108 000 40 000 950 000

Additional information
1. J Ltd acquired its interest in L Ltd at 2 January 19.5, at which date the retained earnings of L Ltd was R80 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of L Ltd to be equal to the fair value thereof.

REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity of J Ltd and its subsidiary for the year ended 31 December 19.8.

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Solution Question 1

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.8
R ASSETS Non-current assets Property, plant and equipment [(152 000 + 100 000) 7 (50 000 + 30 000)] Goodwill (calculation 1) Current assets Inventories (180 000 + 160 000) Trade and other receivables (190 000 + 80 000) Cash and cash equivalents Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings Current liabilities Trade and other payables (80 000 + 60 000) Bank overdraft Total equity and liabilities 172 000 20 000 678 000 340 000 270 000 68 000 870 000 700 000 100 000 600 000 170 000 140 000 30 000 870 000 192 000

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.8
Note Gross profit (410 000 + 360 000) Administrative expenses (15 000 + 12 000 + 15 000 + 10 000 + 100 000 + 80 000) Profit before tax Income tax expense (108 000 + 90 000) Profit for the year Other comprehensive income Total comprehensive income for the year 1 R 770 000 (232 000) 538 000 (198 000) 340 000 340 000

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H LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 31 DECEMBER 19.8 1. Profit before tax
Profit before tax is arrived at after taking into account the following: Expenses Auditors' remuneration (15 000 + 12 000) Depreciation (15 000 + 10 000) Staff cost (100 000 + 80 000) R 27 000 25 000 180 000

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.8
Attributable to owners of the parent Retained earnings R 000 000 000) 000
#

Share capital R Balance at 31 December 19.7 Total comprehensive income for the year Dividends paid Balance at 31 December 19.8
# (250 000 + 50 000(1))

Total R 400 340 (40 700 000 000 000) 000

100 000 300 340 (40 100 000 600

Calculations 1. Analysis of shareholders equity of S Ltd

H Ltd 100% Total R At acquisition 2 Jan 19.5 Share capital Retained earnings Investment in S Ltd Goodwill Since acquisition to beginning of current year 3 Jan 19.5 to 31 Dec 19.7 Retained earnings (130 000 31/12/19.7 80 000 2/1/19.5 Current year 1 Jan 19.8 31 Dec 19.8 Profit for the year (calculation 1) Dividends paid 50 000 80 000 130 000 At acquisition R 50 000 80 000 130 000 150 000 20 000(1) Since acquisition R Non-controlling interest 0% R

50 000 168 000 (30 000) 318 000

50 000(1) 168 000 (30 000) 188 000

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2. Profit for the year

Gross profit Auditors' remuneration Staff cost Depreciation Taxation for the year 360 (12 (80 (10 258 (90 168 R 000) 000) 000) 000) 000) 000) 000)

3. Journal entries
Dr R 50 000 80 000 20 000 Cr R

Share capital Retained earnings Goodwill Investment in S Ltd Elimination of shareholders' equity of S Ltd at acquisition Dividends received H Ltd Dividends paid S Ltd Elimination of intercompany dividends

150 000

30 000 30 000

COMMENTS
. In this example we shall divide the analysis of shareholders' equity into three parts (periods) because we require the figure for retained earnings for the subsidiary at 31 December 19.7 in order to draft the statement of changes in equity. . Note that we eliminated the intercompany item, namely dividends of R30 000 paid by the subsidiary. . Note also that if the parent or a subsidiary has a bank overdraft, it may not be deducted from the favourable bank balance of another company in the group (even if both companies hold their accounts at the same bank). Both balances must be shown separately. The deduction is permitted only if the company with the favourable balance has guaranteed the overdrawn account.

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Solution Question 2

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.8
ASSETS Non-current assets Property, plant and equipment [(152 000 + 100 000) (50 000 + 30 000)] Goodwill (calculation 1) Current assets Inventories (180 000 + 160 000) Trade and other receivables (190 000 + 80 000) Cash and cash equivalents Total assets EQUITY AND LIABILITIES Total equity Share capital Retained earnings [(412 000 30 000 dividend received) + (188 000(1) + 30 000 dividend paid)] Current liabilities Trade and other payables (80 000 + 60 000) Bank overdraft Total equity and liabilities R 192 000 172 000 20 000 678 000 340 000 270 000 68 000 870 000 700 000 100 000 600 000 170 000 140 000 30 000 870 000

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Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd 100% Total R At acquisition 2 Jan 19.5 Share capital Retained earnings Investment in B Ltd Goodwill Since acquisition to end of current year 3 Jan 19.5 to 31 Dec 19.8 Retained earnings (31/12/19.8 Gross profit Income tax expense Auditors' remuneration Staff cost Depreciation Profit for the year Retained earnings 31/12/19.7 Retained earnings 2/1/19.5 Dividend paid 218 000 360 000 (90 000) (12 000) (80 000) (10 000) 168 000 130 000 (80 000) (30 000) 318 000 (30 000) 188 000(1) 218 000 50 000 80 000 130 000 50 000 80 000 130 000 150 000 20 000 At acquisition R Since acquisition R Non-controlling interest 0% R

2. Retained earnings of A Ltd

R Gross profit Dividends received Expenses Auditors' remuneration Staff cost Depreciation Income tax expense Dividends paid Retained earnings 1 January 19.8 410 000 30 000 (130 000) 15 000 100 000 15 000 310 000 (108 000) (40 000) 250 000 412 000

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3. Journal entries
Share capital Retained earnings Goodwill Investment in B Ltd Elimination of shareholders' equity of B Ltd at acquisition Dividends received A Ltd Dividends paid B Ltd Elimination of intercompany dividends

Dr R 50 000 80 000 20 000

Cr R

150 000

30 000

30 000

COMMENTS
. Since we merely asked for a consolidated statement of financial position in this question, the analysis of shareholders' equity looks different from that in question 1. Because the consolidated statement of comprehensive income and consolidated statement of changes in equity were not asked for, we do not require the figure for retained earnings at the beginning of the year (see (1) in question 1). The ``since acquisition'' sections in the analysis can therefore be combined and we therefore include all movements on retained earnings for the period since acquisition to the end of the current year. . Because a complete consolidated statement of changes in equity is no longer available, retained earnings should be shown separately, as in calculation 2.

Solution Question 3

J LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.8
Note Gross profit (410 000 + 360 000) Administrative expenses (15 000 + 12 000 + 15 000 + 10 000 + 100 000 + 80 000) Profit before tax Income tax expense (108 000 + 90 000) Profit for the year Other comprehensive income Total comprehensive income for the year R 770 000 (232 000) 538 000 (198 000) 340 000 340 000

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J LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 31 DECEMBER 19.8 1. Profit before tax
Profit before tax is arrived at after taking into account the following: Expenses Auditors' remuneration (15 000 + 12 000) Depreciation (15 000 + 10 000) Staff cost (100 000 + 80 000) R 27 000 25 000 180 000

J LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.8
Attributable to owners of the parent Retained earnings R
#

Share capital R Balance at 31 December 19.7 Total comprehensive income for the year Dividends paid Balance at 31 December 19.8
# (250 000 + 50 000(1))

Total R 400 000 340 000 (40 000) 700 000

100 000 300 000 340 000 (40 000) 100 000 600 000

Calculations 1. Analysis of shareholders equity of L Ltd

J Ltd 100% Total At acquisition 2 Jan 19.5 Share capital Retained earnings Investment in L Ltd Goodwill Since acquisition to beginning of current year 3 Jan 19.5 to 31 Dec 19.7 Retained earnings (130 000 31/12/19.7 80 000 2/1/19.5 Current year 1 Jan 19.8 31 Dec 19.8 Profit for the year (calc 2) Dividends paid R 50 000 80 000 130 000 At acquisition R 50 000 80 000 130 000 150 000 20 000 Since acquisition R Non-controlling interest 0% R

50 000

50 000(1)

168 000 (30 000) 318 000

168 000 (30 000) 188 000

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2. Profit for the year

Gross profit Auditors' remuneration Staff cost Depreciation Taxation for the year 360 (12 (80 (10 258 (90 168 R 000) 000) 000) 000) 000) 000) 000)

3. Journal entries
Share capital Retained earnings Goodwill Investment in L Ltd Elimination of shareholders' equity of L Ltd at acquisition Dividends received J Ltd Dividends paid L Ltd Elimination of intercompany dividends Dr R 50 000 80 000 20 000 Cr R

150 000 30 000

30 000

COMMENT
In this question you are merely expected to draft a consolidated statement of comprehensive income and a consolidated statement of changes in equity. However, you will notice that the calculations for question 1 and question 3 are very similar.

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . .

draft the consolidated annual financial statements of a group if the interest in the wholly-owned subsidiary was acquired a few years ago? draft the consolidated annual financial statements of a group if a dividend is being declared from pre-acquisition profits? calculate the goodwill which may arise at acquisition? do the consolidation journal entries?

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STUDY UNIT

5
Consolidation of partly-owned subsidiary after date of acquisition
Learning outcome
Learners can draft financial statements of a group where the interest in the partlyowned subsidiary was acquired a few years previously.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 5.1 5.2 5.3 5.4 Introduction Consolidation of partly-owned subsidiary after date of acquisition Intercompany transactions Exercises Solutions Self-assessment

59 59 60 60 63 64 66 72

KEY CONCEPTS
.

Intercompany transactions

ASSESSMENT CRITERIA After having studied this study unit you should be able to
. .

draft the consolidated annual financial statements of a group where the interest in the partly-owned subsidiary was acquired a few years previously do the consolidation journal entries

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5.1

INTRODUCTION

In study unit 3 you were introduced to the consolidation process for a partly-owned subsidiary at date of acquisition. In study unit 4 we went a step further by explaining the consolidation process for a wholly-owned subsidiary after date of acquisition. In this study unit you will learn about the consolidation process which takes place when a partly-owned subsidiary is consolidated at a date after acquisition. The same basic calculations as in study unit 4 will be followed except that you will always need to make provision for the non-controlling interest in the profit. You will notice that the profit attributable to the non-controlling shareholders is disclosed separately on the consolidated statement of comprehensive income and in the consolidated statement of changes in equity.

5.2

CONSOLIDATION OF PARTLY-OWNED SUBSIDIARY AFTER DATE OF ACQUISITION

As we said above, the consolidation process you have applied up to now remains exactly the same except for the addition of a separate calculation for non-controlling shareholders.

Example

1
The following represent the abridged financial statements of X Ltd and its subsidiary Y Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

X Ltd R ASSETS Property, plant and equipment 200 000 Investment in Y Ltd 30 000 ordinary shares of R2 each at fair value (cost price: R152 500) 152 500 Trade and other receivables 50 500 Bank 27 000 430 000 EQUITY AND LIABILITIES Issued capital Ordinary shares of R2 each Retained earnings Trade and other payables Y Ltd R 220 000 80 000 45 000 345 000

100 270 60 430

000 000 000 000

80 190 75 345

000 000 000 000

X Ltd acquired its interest in Y Ltd at 1 January 19.7 when Y Ltd's retained earnings amounted to R110 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of Y Ltd to be equal to the fair value thereof.

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STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

X Ltd R Y Ltd R Gross profit Dividends received from subsidiary Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 107 000 7 500 114 500 (34 500) 80 000 80 000 105 000 105 000 (35 000) 70 000 70 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital X Ltd Y Ltd R R 100 000 80 000 Retained X Ltd R 210 000 80 000 (20 000) 270 000 earnings Total Y Ltd X Ltd Y Ltd R R R 130 000 310 000 210 000 70 000 80 000 70 000 (10 000) (20 000) (10 000) 190 000 370 000 270 000

Balance at 31 December 19.8 Total comprehensive income for the year Dividend paid Balance at 31 December 19.9

100 000

80 000

If we were to draft the consolidated financial statements of X Ltd and its subsidiary for the year ended 31 December 19.9 we would go about it in the following manner:

Calculations 1. Analysis of shareholders equity of Y Ltd

X Ltd 75% Total At acquisition Share capital Retained earnings Investment in Y Ltd Goodwill Since acquisition to beginning of current year Retained earnings (130 000 110 000) Current year Profit for the year Dividends paid R 80 000 110 000 190 000 At acquisition R 60 000 82 500 142 500 152 500 10 000 Since acquisition R Non-controlling interest 25% R 20 000 27 500 47 500

20 000 70 000 (10 000) 270 000

15 000(2) 52 500 (7 500) 60 000

5 000(a) 17 500(1)/(b) (2 500)(c) 67 500(3)/(d)

* R80 000 7 R2 shares = 40 000 shares ; 30 000 7 40 000 = 75% interest

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2. Journal entries
Noncontrolling interest R

Share capital Retained earnings Goodwill Investment in Y Ltd Non-controlling interest Elimination of shareholders' equity of Y Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in Y Ltd for the period 1/7/19.7 to 31/12/19.8 Non-controlling interest (SCI)* Non-controlling interest (SFP)* Recording of non-controlling interest in profit after tax Dividends received X Ltd Non-controlling interest (SFP) Dividends paid Y Ltd Elimination of intercompany dividend and recording of non-controlling interest in dividend

Dr R 80 000 110 000 10 000

Cr R

152 500 47 500

47 500

5 000 5 000 5 000 52 500(a) 17 500 17 500 17 500(b)

7 500 2 500

10 000

(2 500)(c)

67 500(d)

* (SCI) = Statement of comprehensive income (SFP) = Statement of financial position

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (107 000 + 105 000) Income tax expense (34 500 + 35 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (142 500 17 500) Non-controlling interest Total comprehensive income attributable to: Owners of the parent Non-controlling interest 212 000 (69 500) 142 500 142 500 125 000 17 500(1)(b) 142 500 125 000 17 500 142 500

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X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of the parent Share Retained Total capital earnings R R R Balance at 31 December 19.8 Total comprehensive income for the year Dividend paid Balance at 31 December 19.9
# (210 000 + 15 000(2))

Noncontrolling interest R 52 17 (2 67

Total equity R 500 500 500) 500

100 000

100 000

225 000# 325 000 125 000 125 000 (20 000) (20 000) 330 000 430 000

500(a) 377 500(b) 142 500)(c) (22 500(d) 497

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
R ASSETS Non-current assets Property, plant and equipment (200 000 + 220 000) Goodwill Current assets Trade and other receivables (50 500 + 80 000) Cash and cash equivalents (27 000 + 45 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(d) Current liabilities Trade and other payables (60 000 + 75 000) Total equity and liabilities 430 000 420 000 10 000 202 500 130 500 72 000 632 500 497 430 100 330 500 000 000 000

67 500 135 000 632 500

5.3

INTERCOMPANY TRANSACTIONS

We explained to you in a previous study unit that profit which arises from a transaction within the group (where this profit has not been realised in respect of a transaction with a person outside the group) must be excluded in determining total group profit. When a parent sells inventories to a subsidiary at a profit and these inventories are still in the possession of the subsidiary at year end, this profit has not yet been realised. It is only when the subsidiary sells the inventories to a person outside the group that the profit is realised. In

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the consolidated statement of financial position inventories will therefore always be shown at the original amount for which the inventories were manufactured or purchased by a member of the group. Another intercompany transaction which frequently occurs relates to amounts which are due/ payable between the parent and the subsidiary within the group. We shall be examining this aspect more closely in study unit 7.

5.4 EXERCISES
Work through the following questions and ensure that you fully understand the way the solutions are set out, since we shall be adding more complicated aspects in the following four study units.

Question

1
H Ltd acquired 60 000 ordinary shares in S Ltd at 1 March 19.1 when the retained earnings of S Ltd was R12 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of S Ltd to be equal to the fair value thereof. The following represent the statements of financial position of H Ltd and S Ltd at 28 February 19.2: H Ltd R 30 600 127 200 S Ltd R 218 200

ASSETS Property, plant and equipment Investment in S Ltd 60 000 ordinary shares at fair value (cost price: R127 200) Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R2 each Retained earnings Interest bearing borrowings Current liabilities

8 600 166 400 100 000 24 500 30 800 11 100 166 400

10 100 228 300 200 000 20 500 2 200 5 600 228 300

REQUIRED Draft the consolidated statement of financial position of H Ltd and its subsidiary as at 28 February 19.2 in compliance with the requirements of the Companies Act, 1973 if each share carries one vote.

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Question

2
The following are the condensed trial balances of X Ltd and Y Ltd at 31 December 19.6: X Ltd R Issued capital Ordinary shares of R1 each Retained earnings 1 January 19.6 Profit before tax Current liabilities Accumulated depreciation on property, plant and equipment 100 120 120 45 20 405 000 000 000 000 000 000 Y Ltd R 20 35 80 30 40 205 000 000 000 000 000 000

Property, plant and equipment 263 000 Investment in Y Ltd at fair value 16 000 ordinary shares of R1 each (cost price: R33 600) 33 600 Taxation for the year 42 000 Current assets 66 400 405 000

117 000 28 000 60 000 205 000

Additional information
1. X Ltd acquired its interest on 1 January 19.5 when the retained earnings amounted to R22 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of Y Ltd to be equal to the fair value thereof. REQUIRED Draft the consolidated statement of financial position, consolidated statement of comprehensive income and consolidated statement of changes in equity of X Ltd and its subsidiary for the year ended 31 December 19.6.

Question

3
The following are the abridged statements of M Ltd and N Ltd for the year ended 30 June 19.8:

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.8

M Ltd R Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 90 000 (32 000) 58 000 58 000 N Ltd R 70 000 (35 000) 35 000 35 000

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STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.8

Share capital Retained earnings M Ltd N Ltd M Ltd N Ltd R R R R 100 000 80 000 56 000 54 000 58 000 35 000 (5 000) 100 000 80 000 109 000 89 000 Total M Ltd N Ltd R R 156 000 134 000 58 000 35 000 (5 000) 209 000 169 000

Balance at 30 June 19.7 Total comprehensive income for the year Dividends paid Balance at 30 June 19.8

Additional information
M Ltd acquired a 70% interest in N Ltd on 17 July 19.2. At that date the retained earnings of N Ltd was R10 000. There was no goodwill at date of acquisition. At the date of acquisition, consider the carrying amount of the assets and liabilities of N Ltd to be equal to the fair value thereof. REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity of M Ltd and its subsidiary for the year ended 30 June 19.8.

Solution Question 1

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.2
R ASSETS Non-current assets Property, plant and equipment (30 600 + 218 200) Current assets (8 600 + 10 100) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings (24 500 + 5 100(1)) Non-controlling interest(2)/(a) Total liabilities Non-current liabilities Long-term loans (30 800 + 2 200) Current liabilities (11 100 + 5 600) Total equity and liabilities

248 800 18 700 267 500 217 800 129 600 100 000 29 600 88 200 49 700 33 000 16 700 267 500

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Calculations 1. Analysis of shareholders equity of S Ltd

H Ltd Total At acquisition Since acquisition Noncontrolling interest 40% R R

60% R At acquisition Share capital R

(60 000 6 R2 6 100 ) = 60% 200 000 1

200 000

120 000

80 000

Retained earnings Investment in S Ltd

12 000 212 000

7 200 127 200 127 200 NIL

4 800 84 800

Since acquisition to end of current year Retained earnings (20 500 12 000) 8 500 220 500 5 100 6 100(1) 3 400 88 200(2)

2. Journal entries
Dr R 200 000 12 000 Cr R Noncontrolling interest R

Share capital Retained earnings Investment in S Ltd Non-controlling interest Elimination of shareholders' equity of S Ltd at acquisition

127 200 84 800

84 800

Retained earnings 3 400 Non-controlling interest Recording of non-controlling interest in S Ltd for the period 1/3/19.1 to 28/2/19.2

3 400

3 400

88 200(a)

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Solution Question 2

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.6
R ASSETS Non-current assets Property, plant and equipment [(263 000 + 117 000) (20 000 + 40 000)] Current assets (66 400 + 60 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(c) Current liabilities (45 000 + 30 000) Total equity and liabilities

320 000 126 400 446 400 371 400 350 000 100 000 250 000 21 400 75 000 446 400

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.6
Profit before tax (120 000 + 80 000) Income tax expense (42 000 + 28 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (130 000 10 400) Non-controlling interest Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 200 000 (70 000)(1)/(b) 130 000 130 000 119 600)(1)/(b) 10 400(1)/(b)) 130 000)(1)/(b) 119 600 10 400 130 000

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X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.6
Attributable to owners of the parent Share Retained Total capital earnings R R R Balance at 31 December 19.5 Total comprehensive income for the year Balance at 31 December 19.6
# (120 000 + 10 400(2))

Noncontrolling interest R

Total equity R

100 000 100 000

130 400# 119 600 250 000

230 400 119 600 350 000

11 000(a) 241 400 10 400(b) 130 000 21 400(c) 371 400

Calculations 1. Analysis of shareholders equity of Y Ltd

X Ltd 80% Total At acquisition Share capital Retained earnings Investment in Y Ltd R 20 000 22 000 42 000 At acquisition R 16 000 17 000 33 600 33 600 NIL Since acquisition to beginning of current year Retained earnings (35 000 22 000) Current year Profit for the year Profit before tax Income tax expense 13 000 52 000 80 000 (28 000) 107 000 * 16 000 100 6 = 80% 20 000 1 (7 500) 52 000 (2 500)(c) 21 400(3) 10 400(2) 41 600 2 600 10 400 Since acquisition R Non-controlling interest 20% R 4 000 4 400

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2. Journal entries
Dr R 20 000 22 000 Cr R Noncontrolling interest R

Share capital Retained earnings Investment in Y Ltd Non-controlling interest Elimination of shareholders' equity of Y Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in Y Ltd for the period 1/1/19.5 to 31/12/19.5 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax

33 600 8 400 2 600

8 400

2 600

2 600 11 000(a)

10 400 10 400

10 400(b) 21 400(c)

Solution Question 3

M LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.8
R Profit before tax (90 000 + 70 000) Income tax expense (32 000 + 35 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (93 000 10 500) Non-controlling interest 160 000 (67 000) 93 000 93 000

82 500 10 500(b) 93 000

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

82 500 10 500 93 000

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M LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.8
Attributable to owners of the parent Share Retained Total capital earnings R R R Balance at 30 June 19.7 Total comprehensive income for the year Dividends paid Balance at 30 June 19.8
# (56 000 + 30 800(d))

Noncontrolling interest R

Total equity R

100 000

100 000

86 800# 186 800 82 500 82 500 (5 000) (5 000) 164 300 264 300

40 200(a) 227 000 10 500(b) 93 000 (5 000) 50 700(c) 315 000

Calculations 1. Analysis of shareholders equity of N Ltd

M Ltd 70% Total At acquisition Share capital Retained earnings Investment in N Ltd R 80 000 10 000 90 000 At acquisition R 56 000 7 000 63 000 63 000 NIL Since acquisition to beginning of current year Retained earnings (54 000 10 000) Current year Profit for the year 44 000 35 000 169 000 30 800(d) 24 500 55 300 13 200(a) 10 500(b) 50 700(c) Since acquisition R Non-controlling interest 30% R 24 000 3 000 27 000(a)

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2. Journal entries
Dr R 80 000 10 000 Cr R

Noncontrolling interest R

Share capital Retained earnings Investment in N Ltd Non-controlling interest Elimination of shareholders' equity of N Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in N Ltd for the period 17/7/19.2 to 30/6/19.7 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit for the year

63 000 27 000

27 000

13 200

13 200

13 200 40 200(a)

10 500 10 500

10 500(b) 50 700(c)

SELF-ASSESSMENT After studying this study unit, are you able to:
. .

draft the consolidated annual financial statements of a group where the interest in the partly-owned subsidiary was acquired a few years previously? do the consolidation journal entries?

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STUDY UNIT

6
Acquisition of an interest in a subsidiary during the year
Learning outcome
Learners can draft the consolidated financial statements where the interest in a subsidiary was acquired on a date other than at the end of the financial year.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 6.1 6.2 6.3 6.4 6.5 6.6 Introduction Apportionment of statement of comprehensive income items Apportionment of items in the statement of changes in equity Presentation of the consolidated statement of comprehensive income and consolidated statement of changes in equity Effective date of acquisition Exercise Solution Self-assessment

73 74 74 74 74 74 82 83 84 88

KEY CONCEPTS
. . . .

Effective date Apportion Pre-acquisition period Post-acquisition period

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ASSESSMENT CRITERIA After having studied this study unit you should be able to
. . .

allocate the profit of the subsidiary in the year of acquisition between at and since acquisition reserves draft the consolidated financial statements where the interest in a subsidiary was acquired on a date other than at the end of the financial year do the consolidation journal entries

6.1

INTRODUCTION

In the preceding study units the date of acquisition of an interest in a subsidiary was consistently taken to be the first day of the subsidiary's accounting period. In practice it very seldom happens that the effective date on which the delivery of shares takes place coincides with the end of a financial year. The purchase of an interest in a subsidiary at a date other than the accounting date is known as an interim acquisition of a subsidiary. Allocation of statement of comprehensive income items is therefore necessary to determine the amount of retained earnings at the effective date, a prerequisite for determining the goodwill at date of acquisition.

6.2

APPORTIONMENT OF STATEMENT OF COMPREHENSIVE INCOME ITEMS

The profit or loss for any financial year of the subsidiary may, if it is not practicable to apportion it with reference to the facts, be treated as if it accrued from day to day during the year and be apportioned accordingly. Income and expenditure items must be examined individually in order to determine the basis on which each item should be apportioned between the period before acquisition and the period since acquisition.

6.3

APPORTIONMENT OF ITEMS IN THE STATEMENT OF CHANGES IN EQUITY

Preference dividends regarding issued preference shares of the subsidiary should be accounted for on a time basis. The preference dividend must be accounted for even if it has not been declared. Ordinary dividends declared are by nature year-end items and fall into the post-acquisition period.

6.4

PRESENTATION OF THE CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME AND CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

The first step in preparing the consolidated statement of comprehensive income and consolidated statement of changes in equity where the subsidiary was acquired during the current financial year, is to apportion the income and expenditure of the current year between

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pre- and post-acquisition periods. Once this has been done the consolidated statement of comprehensive income and consolidated statement of changes in equity can be drawn up according to one of two methods. The first method, where only the post-acquisition profits are included in the operating profit, is prescribed for this module.

Example

1
The following are the trial balances of Sandy Limited and South Limited for the year ended 31 December 20.2: Sandy Limited R Issued share capital R1 ordinary shares Share premium Retained earnings 1 January 20.2 Gross profit Dividends received 31 December 20.2 Auditors' remuneration Depreciation Staff costs Interest paid on bank overdraft Income tax expense Dividends declared and paid 31 December 20.2 Property, plant and equipment at carrying amount Investment in South Limited at fair value 238 000 shares purchased 1 July 20.2 (Cost price: R364 700) Cash at bank Inventory (800 000) (480 000) (422 700) (23 800) 8 500 102 000 95 000 3 800 12 000 80 000 861 600 South Limited R (340 000) (15 000) (120 000) (166 200) 5 000 42 000 35 000 4 200 34 000 426 200

364 700 126 700 72 200

51 800 43 000

Additional information
1. South Limited became a subsidiary of Sandy Limited on 1 July 20.2. The profit of South Limited was earned evenly throughout the year. At the date of acquisition, consider the carrying amount of the assets and liabilities of South Ltd to be equal to the fair value thereof. The excess of the purchase price over the net carrying amount of the assets at the date of acquisition was attributable to the difference between the carrying amount and the fair value of land and buildings. REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity of Sandy Limited and its subsidiary for the year ended 31 December 20.2. Include only the post-acquisition profit after tax in the profit after tax of the group. Do all calculations to the nearest rand.

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Solution

SANDY LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.2
Notes Gross profit [422 700 + (166 200/12 6 6)] Administrative expenses [102 000 + (42 000/12 6 6)] + [95 000 + (35 000/12 6 6)] + [8 500 + (5 000/12 6 6)] Finance costs Profit before tax Income tax expense [12 000 + (4 200/12 6 6)] Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (241 400 12 000) Non-controlling interest Total comprehensive income attributable to: Owners of the parent Non-controlling interest 229 400 12 000 241 400 229 400 12 000(b) 241 400 1 (3 800) 255 500) (14 100) 241 400) 241 400 R 505 800) (246 500)

SANDY LIMITED AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.2 1. Profit before tax
Profit before tax is arrived at after taking into account the following: Expenses Auditors' remuneration (8 500 + 2 500) Depreciation (102 000 + 21 000) Staff costs (95 000 + 17 500) 11 000 123 000 112 500 R

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SANDY LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.2
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 20.1 Equity on date of acquisition Total comprehensive income for the year Dividends paid Balance at 31 December 20.2 800 000 480 000# 1 280 000 229 400 229 400 (80 000) (80 000) 800 000 629 400 1 429 400 1 156 300(a) 12 000(b) (10 200)(c) 158 100(d) 1 Total equity R 280 156 241 (90 587 000 300 400 200) 500

Calculations: 1. Analysis of shareholders equity of South Limited

Sandy Limited Total At acquisition Since acquisition Non-controlling interest 30% R R

70%(1) R At acquisition Share capital Share premium Retained earnings 1/1/20.2 Retained earnings Revaluation of land and buildings Investment in South Ltd 340 000 15 000 120 000 40 000
(2)

238 000 10 500 84 000 28 000 4 200(3) 364 700 364 700 NIL

102 000 4 500 36 000 12 000 1 800 156 300(a)

6 000(4) 521 000

Current year Profit for the year Dividends 40 000(5) (34 000) 527 000
(1) (3)

28 000 (23 800) 4 200

12 000(b) (10 200)(c) 158 100(d)

238 000/340 000 6 100 = 70% 364 700 7 238 000 7 10 500 7 84 000 7 28 000 = 4 200 (balancing figure) 4 200/70% = 6 000

(4)

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2. Allocation of statement of comprehensive income items

Total R Gross profit Auditors' remuneration Depreciation Staff costs Income tax Profit earned throughout the year 166 200 (5 000) (42 000) (35 000) (4 200) 80 000 1/1/20.2 to 30/6/20.2 R 83 100 (2 500) (21 000) (17 500) (2 100) 40 000
(2)

1/7/20.2 to 31/12/20.2 R 83 100 (2 500) (21 000) (17 500) (2 100) 40 000(5)

3. Journal entries
Noncontrolling interest R

Dr R Share capital Share premium Revaluation reserve Retained earnings (120 000 + 40 000 ) Investment in South Limited Non-controlling interest Elimination of shareholders' equity of South Limited at acquisition Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Dividends received Sandy Limited Non-controlling interest (SFP) Dividends paid South Limited Elimination of intercompany dividend and recording of non-controlling interest in dividend 23 800 10 200 12 000
(2)

Cr R

340 000 15 000 6 000 160 000 364 700 156 300 156 300)(a)

12 000

12 000)(b)

(10 200)(c) 34 000

158 100)(d)

According to the alternative method, both the pre- and post-acquisition profits after tax of the subsidiary is included in the profit after tax for the year. Thereafter, the profit earned by the subsidiary before acquisition of the controlling interest is then deducted in order to determine the profit of the group for the year.

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Example

2
The following are the trial balances of Sandy Limited and South Limited for the year ended 31 December 20.2: Sandy Limited R Issued share capital R1 ordinary shares Share premium Retained earnings 1 January 20.2 Gross profit Dividends received 31 December 20.2 Auditors' remuneration Depreciation Staff costs Interest paid on bank overdraft Income tax expense Dividends declared and paid 31 December 20.2 Property, plant and equipment at carrying amount Investment in South Limited at fair value 238 000 shares purchased 1 July 20.2 (Cost price: R364 700) Cash at bank Inventory (800 000) (480 000) (422 700) (23 800) 8 500 102 000 95 000 3 800 12 000 80 000 861 600 South Limited R (340 000) (15 000) (120 000) (166 200) 5 000 42 000 35 000 4 200 34 000 426 200

364 700 126 700 72 200

51 800 43 000

Additional information
South Limited became a subsidiary of Sandy Limited on 1 July 20.2. The profit of South Limited was earned evenly throughout the year. At the date of acquisition, consider the carrying amount of the assets and liabilities of South Ltd to be equal to the fair value thereof. The excess of the purchase price over the net carrying amount of the assets at the date of acquisition was attributable to the difference between the carrying amount and the actual value of land and buildings.

REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity of Sandy Limited and its subsidiary for the year ended 31 December 20.2. Include both the pre- and post-acquisition profit of the subsidiary in the profit after tax of the group. Do all calculations to the nearest rand.

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Solution

SANDY LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.2
Notes Gross profit (422 700 + 166 200) Administrative expenses (102 000 + 42 000 + 95 000 + 35 000 + 8 500 + 5 000) Finance costs Profit before tax Income tax expense (12 000 + 4 200) Profit after tax Profit earned by subsidiary for 6 months before acquisition Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (241 400 12 000) Non-controlling interest Total comprehensive income attributable to: Owners of the parent Non-controlling interest 229 400 12 000 241 400 229 400 12 000(b) 241 400 1 (3 800) 297 600) (16 200) 281 400) (40 000)(3) 241 400) 241 400 R 588 900) (287 500)

SANDY LIMITED AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.2 1. Profit before tax
R Profit before tax is arrived at after taking into account the following: Expenses Auditors' remuneration (8 500 + 5 000) Depreciation (102 000 + 42 000) Staff cost (95 000 + 35 000) 13 500 144 000 130 000

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SANDY LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.2
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Total equity R 280 156 241 (90 000 300 400 200)

Balance at 31 December 20.1 Equity on date of acquisition Total comprehensive income for the year Dividends paid Balance at 31 December 20.2

800 000 480 000# 1 280 000 229 400 (80 000) 229 400 (80 000)

1 156 300(a) 12 000(b) (10 200)(c)

800 000 629 400 1 429 400

158 100(d) 1 587 500

Calculations 1. Analysis of shareholders equity of South Limited

Sandy Limited Total At acquisition Since acquisition Non-controlling interest 30% R R

70%(1) R At acquisition Share capital Share premium Retained earnings 1/1/20.2 Retained earnings Revaluation of land and buildings Investment in South Ltd 340 000 15 000 120 000 40 000
(2)

238 000 10 500 84 000 28 000 4 200(3) 364 700 364 700 NIL

102 000 4 500 36 000 12 000 1 800 156 300(a)

6 000(4) 521 000

Current year Profit for the year Dividends 40 000(5) (34 000) 527 000
(1) (4)

28 000 (23 800) 4 200

12 000(b) (10 200)(c) 158 100(d)

238 000/340 000 6 100 = 70% 364 700 7 238 000 7 10 500 7 84 000 7 28 000 = 4 200 (balancing figure) 4 200/70% = 6 000

(5)

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2. Retained earnings at acquisition

Gross profit (166 200 6 6/12) Auditors' remuneration (5 000 6 6/12) Depreciation (42 000 6 6/12) Staff costs (35 000 6 6/12) Income tax expense (4 200 6 6/12) 83 (2 (21 (17 (2 R 100 500) 000) 500) 100)

40 000

3. Profit for the year

Gross profit (166 200 6 6/12) Auditors' remuneration (5 000 6 6/12) Depreciation (42 000 6 6/12) Staff costs (35 000 6 6/12) Income tax expense (4 200 6 6/12) 83 (2 (21 (17 (2 100 500) 000) 500) 100)

40 000

4. Journal entries
Dr R Share capital Share premium Revaluation reserve Retained earnings (120 000 + 40 000(2)) Investment in South Limited Non-controlling interest Elimination of shareholders' equity of South Limited at acquisition Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Dividends received Sandy Limited Non-controlling interest (SFP) Dividends paid South Limited Elimination of intercompany dividend and recording of non-controlling interest in dividend 340 15 6 160 000 000 000 000 364 700 156 300 ) 156 300(a) Cr R Noncontrolling interest R

12 000

12 000

) 12 000(b)

23 800 10 200

34 000

(10 200)(c)

158 100(d)

6.5

EFFECTIVE DATE OF ACQUISITION

The date of acquisition is the date on which control of the net assets and operations of the subsidiary is effectively transferred to the parent. In practice there must be certainty as to the date of acquisition as this is the date from which the results of the subsidiary are to be included in the group annual financial statements. A number of possible dates can be considered, for example:

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the date on which substantial agreement is reached the date on which the control over the net assets and activities of the subsidiary is transferred to the parent . the date of signing of the agreement . the date specified in the agreement . the date of payment of the purchase consideration.
. .

6.6 EXERCISE
Question 1
West Limited became a subsidiary of East Limited on 1 January 20.2. At the date of acquisition, consider the carrying amount of the assets and liabilities of West Ltd to be equal to the fair value thereof. The following are the trial balances of East Limited and West Limited for the year ended 30 September 20.2: East West Limited Limited R R Credits Share capital Ordinary shares of R1 each 75 000 125 000 12% Preference shares of R1 each 20 000 6% Debentures 100 000 45 000 Retained earnings 1 October 20.1 800 000 305 000 Sales 607 000 428 250 Interest received 2 400 Dividends received 3 750 Trade and other payables 8 300 47 840 Shareholders for dividend 10 000 Bank 4 000 Accumulated depreciation 53 500 22 950 Long-term borrowing Bank Limited 105 000 1 681 550 Debits Property, plant and equipment Cost of sales Administrative expenses Depreciation Interest paid Income tax @ 28% Trade and other receivables Bank Dividends paid Dividends declared 30 September 20.2 Investment in West Limited (75% equity) at fair value (cost price: R349 453) Investment in South Limited 6% Debentures at fair value (cost price: R40 000) 1 081 440

481 100 390 000 65 000 15 500 4 500 36 960 314 037 15 000 10 000 349 453 1 681 550

452 000 285 500 47 000 2 300 2 700 20 202 208 738 18 000 5 000 40 000 1 081 440

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Additional information
1. West Limited applied for a loan at Bank Limited on 1 July 20.1. The loan was granted at an interest rate of 20% per annum for a period of 5 years. The interest for the year ended 30 September 20.2 is not recorded yet. 2. The sales of West Limited is seasonal, 60% of the sales was earned during the first six months of the financial year. The remaining amount of the sales figure was earned evenly spread over the rest of the financial year. West Limited maintain a gross profit percentage of 50% on the cost price. All other income and expenditure were received and spent evenly throughout the year. Income tax must be apportioned according to the profit before tax for that period. REQUIRED Draft the consolidated annual financial statements of East Limited and its subsidiary for the year ended 30 September 20.2. Your answer must comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. Include only the postacquisition profit after tax in the profit after tax of the group. Do all calculations to the nearest rand.

Solution Question 1

EAST LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20.2
ASSETS Non-current assets Property, plant and equipment (481 100 + 452 000 7 53 500 7 22 950) Goodwill Investment in South Limited 6% Debentures at fair value Current assets Trade and other receivables (314 037 + 208 738) Cash and cash equivalents Total assets R 910 008 856 650 13 358 40 000 540 775 522 775 18 000 1 450 783

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R EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital (75 000 + 20 000) Retained earnings(e) Non-controlling interest(d) Total liabilities Non-current liabilities 6% Debentures (100 000 + 45 000) Long-term loan Current liabilities Trade and other payables (8 300 + 47 840 + 21 000(f) + 1 500(g)) Dividends payable Bank overdraft Total equity and liabilities
(f) (g)

1 108 143 988 907 95 000 893 907 119 236 342 640 250 000 145 000 105 000 92 640 78 640 10 000 4 000 1 450 783

R105 000 loan 6 20% = R21 000 R100 000 debentures 66% = R6 000 In trial balance = R4 500 Additional provision = R6 000 7 R4 500 = R1 500

EAST LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 SEPTEMBER 20.2
Revenue (607 000 + 299 775(2)) Cost of sales (390 000 + 199 850) Gross profit Other income(7) Other expenses (15 500 + 1 725(5) + 65 000 + 35 250(4)) Finance charges (4 500(g) + 1 500(g) + 17 775(6)) Profit before tax Income tax expense (36 960 + 13 153(8)) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (127 362 8 495) Non-controlling interest Total comprehensive income attributable to: Owners of parent Non-controlling interest 1 Notes R 906 775 (589 850) 316 1 (117 (23 925 800 475) 775)

177 475 (50 113) 127 362 127 362

118 907 8 455(b) 127 362 118 907 8 455 127 362

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EAST LIMITED AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 30 SEPTEMBER 20.2 1. Profit before tax
Profit before tax is arrived at after taking into account the following: Income Income from investment(7) Expenses Depreciation (15 500 + 1 725(5)) R

1 800 17 225

EAST LIMITED AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 SEPTEMBER 20.2
Attributable to owners of the parent Share 12% Preference Retained Total capital share earnings capital R R R R 75 000 20 000 800 000 # 895 000 118 907 118 907 (10 000) (10 000) (15 000) (15 000) 893 907(e) 988 907 NonTotal controlling equity interest R R 895 000 112 031(a) 112 031 8 455(b) 127 362 (10 000) (c) (1 250) (16 250) 119 236(d) 1 108 143

Balance at 30 September 20.1 Equity on date of acquisition Total comprehensive income for the year Dividends declared Dividends paid Balance at 30 September 20.2

75 000

20 000

Calculations 1. Analysis of shareholders equity of West Limited

East Limited 75% Total At acquisition Share capital Retained earnings 1/10/20.1 Retained earnings Investment in West Ltd Goodwill Current year Profit for the year Dividends 33 822(10) (5 000) 476 696 25 367 (3 750) 21 617 8 455(b) (1 250) 119 236 R 125 000 305 000 18 126
(9)

At acquisition R 93 750 228 750 13 595 336 095 349 453 13 358

Since acquisition R

Noncontrolling interest 25% R 31 250 76 250 4 531 112 031(a)

447 874

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2. Allocation of statement of comprehensive income items

Total 1/10/20.1 to 31/12/20.1 R 128 475
(2)

1/1/20.2 to 30/9/20.2 R 299 775(2) (199 850) 99 925(3) (35 250)(4) (1 725)(5) 62 950 (17 775)(6) 1 800(7) 46 975 (13 153)(8) 33 822(10)

R Sales Cost of sales Gross profit 33,3% Administrative expenses Depreciation Profit from operations Finance costs (2 700 + 21 000 ) Income on investment Profit before tax Income tax Profit for the year
(f) (g) (f)

428 250 (285 500) 142 750 (47 000) (2 300) 93 450 (23 700) 2 400 72 150 (20 202) 51 948

(85 650) 42 825(3) (11 750)(4) (575)(5) 30 500 (5 925) 25 175 (7 049)
(8) (6)

600(7)

18 126(9)

R105 000 loan 6 20% = R21 000 R100 000 debentures 6 6% = R6 000 As per trial balance = R4 500 Additional provision: R6 000 R4 500 = R1 500 75% equity given Sales R428 250 6 60% = R256 950 for the first 6 months ; for the first 3 months = R256 950/2 = R128 475 ; for the remaining 9 months = R428 250 7 R128 475 = R299 775

(1) (2)

(3)

Gross profit R128 475 6 50/150 = R42 825 R299 775 6 50/150 = R99 925 Administrative expenses R47 000 6 3/12 = R11 750 R47 000 6 9/12 = R35 250

(4)

(5)

Depreciation R2300 6 3/12 = R575 R2300 6 9/12 = R1 725

(6)

Finance costs R23 700 6 3/12 = R5 925 R23 700 6 9/12 = R17 775

(7)

Income from investments R2400 6 3/12 = R600 R2400 6 9/12 = R1 800

(8)

Income tax expense R25 175 6 28% = R7 049 R46 975 6 28% = R13 153

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3. Journal entries
Noncontrolling interest R

Share capital Retained earnings (305 000 + 17 874) Goodwill Investment in West Limited Non-controlling interest Elimination of shareholders' equity of West Limited at acquisition Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Dividends received East Limited Non-controlling interest (SFP) Dividends paid West Limited Elimination of intercompany dividend and recording of non-controlling interest in dividend

Dr R 125 000 322 874 13 338

Cr R

349 453 112 031 112 031(a)

8 455 8 455 8 455(b)

3 750 1 250 5 000 (1 250)(c)

119 236(d)

SELF-ASSESSMENT After studying this study unit, are you able to:
. . .

allocate the profit of the subsidiary in the year of acquisition between at and since acquisition reserves? draft the consolidated financial statements where the interest in a subsidiary was acquired on a date other than at the end of the financial year? do the consolidation journal entries?

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STUDY UNIT

7
Elimination of intercompany transactions
Learning outcome
Learners can eliminate intercompany transactions in the financial statements of a group.

OVERVIEW
This study unit is divided into the following: Page

This topic is divided into the following: Key concepts Assessment criteria 7.1 7.2 7.3 7.4 7.5 7.6 Introduction Intercompany bills of exchange and bank overdrafts Revaluation of property, plant and equipment Unrealised profit in trading inventories Property, plant and equipment held by companies in the group Exercises Solutions Self-assessment 89 90 91 91 91 96 104 119 122 129

KEY CONCEPTS
. . .

Intercompany bills of exchange Discounting of bills of exchange Property, plant and equipment

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ASSESSMENT CRITERIA After having studied this study unit you should be able to
. . . . .

record intercompany bills of exchange and bank overdrafts correctly in consolidated annual financial statements determine the reserve when revaluing property at acquisition of an interest in a subsidiary calculate the unrealised profit in trading inventories in both the parent and the subsidiary do the consolidation journal entries draft the consolidated annual financial statements of a group if sales of property, plant and equipment have taken place between companies in the group

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7.1

INTRODUCTION

In the preceding study units we introduced you to the basic consolidation process for whollyowned and partly-owned subsidiaries. In this study unit we deal mainly with other intercompany transactions which also take place in groups and which therefore have to be eliminated for consolidation purposes. We shall be dealing with trading inventories, property, plant and equipment held in a group. We should like to emphasise that we do not deal with taxation on unrealised intercompany profits/losses in this course.

7.2

INTERCOMPANY BILLS OF EXCHANGE AND BANK OVERDRAFTS

A bill of exchange is a negotiable document. It is a written instruction directed by one person to another instructing that person to pay, upon demand, a certain sum of money to the person nominated in the bill of exchange. For example: Bill no. 111 To: H Ltd Pay on 30/11/19.8 to S Ltd the amount of R2 000 In their books S Ltd would treat it as a bill receivable and H Ltd would show it as a bill payable. Upon consolidation the subsidiary's bill receivable would be set off against the bill payable in H Ltd's books. The bill could have been converted into cash before 30/11/19.8 by S Ltd by selling it to a financial institution. This type of transaction is known as discounting. On consolidation, the bank overdraft of one company in the group should only be set off against the favourable bank balance of another company if: both companies have their accounts at the same bank and the company with the favourable balance has guaranteed the overdraft of the other company or . the bank itself would set off the two amounts against each other in terms of an agreement between the two companies and the bank.
. .

30/10/19.8 Amount: R2 000

7.3

REVALUATION OF PROPERTY, PLANT AND EQUIPMENT

It is possible that the assets of a subsidiary may be revalued at the date of acquisition of the interest, where there is a difference between the carrying amounts and market values of the assets. Two situations may arise: The subsidiary's assets may be revalued merely for the purposes of determining the purchase price, without a journal entry being made in the subsidiary's books. . The assets of the subsidiary are revalued in order to determine the purchase price and an adjustment is subsequently made in the subsidiary's books.
.

Revaluation of assets may cause capital gains tax but for this module it must be ignored. The following two questions will be used as examples to explain the two situations to you.

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Question

1
A Ltd acquired 80 000 shares in B Ltd at 1 July 19.1. Each share carries one vote. At that date the land and buildings belonging to B Ltd were valued at R200 000. No adjustment was made in the books of B Ltd. The retained earnings was R46 000. At 30 June 19.4 the trial balances of A Ltd and B Ltd were as follows: A Ltd R 300 000 121 000 140 000 15 000 576 000 250 164 80 81 576 000 800 000 200 000 B Ltd R 100 000 92 000 80 000 66 000 338 000 140 000 198 000 338 000

Credits Issued capital Ordinary shares of R1 each Retained earnings Long-term borrowings C Ltd A Ltd Current liabilities Debits Land and buildings at cost price Investment in B Ltd at fair value (cost price: R164 800) Loan B Ltd Current assets

Additional information
1. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. REQUIRED Draft the consolidated statement of financial position of A Ltd and its subsidiary as at 30 June 19.4 in compliance with the requirements of the Companies Act, 1973.

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 19.4
ASSETS Non-current assets Property, plant and equipment (250 000 + 200 000) Current assets (81 200 + 198 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings (121 000 + 36 800(b)) Non-controlling interest(a) Total liabilities Non-current liabilities Long-term loan Current liabilities (15 000 + 66 000) Total equity and liabilities R 450 000 279 200 729 200 508 200 457 800 300 000 157 800 50 400 221 000 140 000 81 000 729 200

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Calculations: 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R

80% R At acquisition Share capital Retained earnings Revaluation reserve (200 000 140 000) Investment in B Ltd 100 000 46 000 60 000 206 000 80 000 36 800 48 000 164 800 164 800 NIL Since acquisition to end of current year Retained earnings (92 000 46 000) 46 000 252 500 36 800 38 800(b) R

20 000 9 200 12 000 41 200

9 200 50 400(a)

2. Journal entries
Noncontrolling interest R

Share capital Retained earnings Revaluation reserve Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period 1 July 19.1 to 30 June 19.4 Loan A Ltd Loan B Ltd Elimination of intercompany loans

Dr R 100 000 46 000 60 000 nil

Cr R

164 800 41 200

41 200

9 200

9 200

9 200

80 000

80 000 50 400(a)

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Question

2
H Ltd acquired a 70% interest in S Ltd at 1 May 19.2. Each share carries one vote. At the date of acquisition H Ltd valued the land and buildings belonging to S Ltd, the carrying amount of which was R200 000, at R300 000. It is company policy to value the land and buildings belonging to S Ltd at 31 August every second year. At the date of acquisition the retained earnings of S Ltd was R20 000. The following represents the condensed trial balances of H Ltd and S Ltd at 31 December 19.6: H Ltd S Ltd R R Credits Issued capital Ordinary shares of R5 each 100 000 80 000 Retained earnings 160 000 40 000 Long-term borrowing H Ltd 100 000 Current liabilities 140 000 20 000 Non-distributable reserve Revaluation of land and buildings 100 000 150 000 500 000 390 000 Debits Land and buildings at valuation 200 000 350 000 Investment in S Ltd at fair value (cost price: R140 000) 140 000 Unsecured loan S Ltd 100 000 Current assets 60 000 40 000 500 000 390 000

Additional information
1. At the date of acquisition, consider the carrying amount of the assets and liabilities of S Ltd to be equal to the fair value thereof. REQUIRED Draft the consolidated statement of financial position of H Ltd and its subsidiary as at 31 December 19.6 in compliance with the requirements of the Companies Act, 1973.

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.6
ASSETS Non-current assets Property, plant and equipment (200 000 + 350 000) Current assets (60 000 + 40 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Other components of equity (100 000 + 35 000(1)) Retained earnings (160 000 + 14 000(2)) Non-controlling interest(3)/(a) Current liabilities (140 000 + 20 000) Total equity and liabilities R 550 000 100 000 650 000 490 000 409 100 135 174 000 000 000 000

81 000 160 000 650 000

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Calculations 1. Analysis of shareholders equity of S Ltd

H Ltd Total At acquisition R 56 000 14 000 70 000 140 000 140 000 NIL Since acquisition to end of current year Retained earnings (40 000 20 000) Revaluation reserve (150 000 100 000) Since acquisition R Non-controlling interest 20% R 24 000 6 000 30 000 60 000

80% R At acquisition Share capital Retained earnings Revaluation reserve (200 000 140 000) Investment in S Ltd 80 000 20 000 100 000 200 000

20 000

14 000

RE

6 000

50 000 270 000

35 000

OE

15 000 81 000(3)

14 000(2) RE 35 000(1) OE

2. Journal entries
Dr R 80 000 20 000 100 000 nil Cr R

Share capital Retained earnings Revaluation reserve Goodwill Investment in S Ltd Non-controlling interest Elimination of shareholders' equity of S Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in S Ltd for the period 1 May 19.2 to 31 December 19.6 Revaluation reserve Non-controlling interest Recording of non-controlling interest in the revaluation reserve of S Ltd for the period 1 May 19.2 to 31 December 19.6 Loan H Ltd Loan S Ltd Elimination of intercompany loans

Noncontrolling interest R

140 000 60 000

60 000

6 000

6 000

6 000

15 000

15 000

15 000

100 000

100 000

81 000(a)

95

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7.4

UNREALISED PROFIT IN TRADING INVENTORIES

As we said previously, the purpose of consolidated annual financial statements is to offer the shareholders of the group annual financial statements after the elimination of all intercompany transactions. Profits or losses on a transaction which did not take place with a person or company outside the group should be eliminated. H Ltd ? S Ltd ? X Ltd Suppose H Ltd sells inventories to S Ltd at a cost price of R1 000 plus 20% profit. S Ltd packs the inventories and sells them to X Ltd, a company outside the group, at R1 500. The following situation may arise: All the inventories have been sold to X Ltd by the end of the year no change to the consolidated annual statements. . If no inventories have been sold to X Ltd, the unrealised profit of R200 (20% 6 R1 000) should be eliminated in H Ltd's books and the inventories on S Ltd's books should also be adjusted. . If half the inventories have been sold, R100 should be eliminated.
.

A very important aspect of consolidations is that you must start by determining which company is selling the inventories and which company is buying them. H Ltd

sells to

!
S Ltd If H Ltd sells inventories to S Ltd, the profit is made by H Ltd and no adjustment to noncontrolling shareholders is necessary. H Ltd

S Ltd If S Ltd sells inventories to H Ltd, the profit is made by S Ltd and the non-controlling shareholders' interest must be adjusted by their percentage shareholding in the profit/loss. (This adjustment is made in the analysis of the shareholders' equity.) Note: Unrealised profits/losses have income tax implications, but for the purpose of this module it must be ignored. This section will be dealt with on third-year level.

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!
sells to

Example

1 Parent sells inventories to subsidiary

The following are the trial balances of A Ltd and its subsidiary B Ltd at 31 December 19.8: A Ltd R (200 000) (120 000) (80 000) 80 000 200 000 50 000 70 000 (30 000) 30 000 B Ltd R (100 000) (80 000) (60 000) 200 000 30 000 50 000 (60 000) 20 000

Issued capital Ordinary shares of R1 each Retained earnings 1 January 19.8 Profit before tax Investment in B Ltd 80 000 ordinary shares of R1 each at fair value (cost price: R80 000) Property, plant and equipment Inventories Trade and other receivables Trade and other payables Taxation for the year

Additional information
1. A Ltd acquired its interest in B Ltd at the time of incorporation of B Ltd. 2. B Ltd purchased all its inventories from A Ltd at cost price plus 25%. The inventories on B Ltd's books amounted to R20 000 at 1 January 19.8. 3. A Ltd's total sales to B Ltd during 19.8 amounted to R100 000. REQUIRED Draft the consolidated annual financial statements of A Ltd and its subsidiary for the year ended 31 December 19.8.

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.8
ASSETS Non-current assets Property, plant and equipment (200 000 + 200 000) Current assets
25 Inventories [50 000 + 30 000 7 (30 000 6 125 )] Trade and other receivables (70 000 + 50 000)

R 400 000 194 000 74 000 120 000 594 000 504 000 460 000 200 000 260 000 44 000 90 000 594 000

Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(2)/(c) Current liabilities Trade and other payables (30 000 + 60 000) Total equity and liabilities

97

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.8
Profit before tax [80 000 + 60 000 7 100 000 (sales) + 100 000 (purchases) 7 25 25 (30 000 6 125 ) + (20 000 6 125 )] Income tax expense (30 000 + 20 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (88 000 8 000) Non-controlling interest(3)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 138 000

(50 000) 88 000 88 000 80 000 ( 8 000) 88 000 80 000 8 000 88 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.8
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.7 Total comprehensive income for the year Balance at 31 December 19.8 * [120 000 7 (20 000 6
25 125

Total equity R 416 000 88 000 504 000

200 000 200 000

180 000* 80 000 260 000

380 000 80 000 460 000

36 000(a) 8 000(b) 44 000(c)

) + 64 000(1)]

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Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Non-controlling interest 20% R R 20 000

80% At acquisition Share capital Investment in B Ltd Since acquisition to beginning of current year Retained earnings Current year Profit for the year (60 000 20 000) R 100 000 R 80 000 80 000 NIL

80 000 40 000 220 000

64 000(1) 32 000 96 800(b)

16 000 8 000(3) 44 000(3)

2. Journal entries
Dr R 100 000 NIL Cr R 80 000 20 000

Share capital Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.7 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Income sales (A Ltd) Cost of sales (B Ltd) Elimination of intercompany sales Cost of sales (A Ltd) Inventory (B Ltd) Elimination of unrealised intercompany profit included in closing inventory of 25 B Ltd (30 000 6 125 ) Retained earnings (A Ltd) Cost of sales (A Ltd) Elimination of unrealised intercompany profit included in opening inventory of 25 B Ltd (20 000 6 125 )

Noncontrolling interest R

20 000

16 000

16 000

16 000 36 000(a)

8 000

8 000

8 000(b)

100 000

100 000

6 000

6 000

4 000

4 000 44 000(c)

99

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COMMENTS
. Note that in this example the parent sold inventories to the subsidiary. The unrealised profit was therefore included in the profit of A Ltd and consequently there were no adjustments in the analysis of shareholders' equity, but only in the consolidated statement of comprehensive income. . Also note that sales and cost of sales are not in all questions part of the given information. All adjustments must then be made against profit before tax.

Example

2 Subsidiary sells inventories to parent

The following are the trial balances of D Ltd and its subsidiary E Ltd at 31 December 19.8: D Ltd R (200 000) (120 000) (80 000) 80 000 200 000 50 000 70 000 (30 000) 30 000 E Ltd R (100 000) (80 000) (60 000) 200 000 30 000 50 000 (60 000) 20 000

Issued capital Ordinary shares of R1 each Retained earnings 1 January 19.8 Profit before tax Investment in E Ltd 80 000 ordinary shares of R1 each at fair value (cost price: R80 000) Property, plant and equipment Inventories Trade and other receivables Trade and other payables Taxation for the year

Additional information
1. D Ltd acquired its interest in E Ltd at the time of incorporation of E Ltd. 2. D Ltd purchased all its inventories from E Ltd at cost price plus 25%. The inventories on D Ltd's books at 1 January 19.8 amounted to R40 000. 3. Total sales of E Ltd to D Ltd amounted to R100 000 during 19.8. REQUIRED Draft the consolidated annual financial statements of D Ltd and its subsidiary for the year ended 31 December 19.8.

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D LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.8
ASSETS Non-current assets Property, plant and equipment (200 000 + 200 000) Current assets
25 Inventories [50 000 + 30 000 7 (50 000 6 125 )] Trade and other receivables (70 000 + 50 000)

R 400 000 190 000 70 000 120 000 590 000 500 000 458 000 200 000 258 000 42 000 90 000 590 000

Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(2)/(c) Current liabilities Trade and other payables (30 000 + 60 000) Total equity and liabilities

D LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.8
R Profit before tax [80 000 + 60 000 7 100 000 (sales) + 100 000 (purchases) 7 25 25 (50 000 6 125 ) + (40 000 6 125 )] Income tax expense (30 000 + 20 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (88 000 7 600) Non-controlling interest(3)/(b) 138 000

(50 000) 88 000 88 000

80 400 (7 600) 88 000

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

80 400 7 600 88 000

101

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D LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.8
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.7 Total comprehensive income for the year Balance at 31 December 19.8 * (120 000 + 57 600(1)) 200 000 177 600* 80 400 200 000 258 000 377 600 80 400 458 000 34 400(a) 7 600(b) 42 000(c) Total equity R 412 000 88 000 500 000

Calculations 1. Analysis of shareholders equity of E Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 20 000

80% At acquisition Share capital Investment in B Ltd Since acquisition to beginning of current year Retained earnings 25 [80 000 (40 000 x 125 )] Current year Profit for the year [60 000 7 20 000 25 25 + (40 000 6 125 ) 7 (50 000 6125 )] R 100 000 R 80 000 80 000 NIL

72 000 38 000 210 000

57 600(1) 30 400 88 000

14 400 7 600(3) 42 000(3)

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2. Journal entries
Noncontrolling interest R

Share capital Goodwill Investment in E Ltd Non-controlling interest Elimination of shareholders' equity of E Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in E Ltd for the period ended 31 December 19.7 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Income Sales (E Ltd) Cost of sales (D Ltd) Elimination of intercompany sales Cost of sales (E Ltd) Inventory (D Ltd) Elimination of unrealised intercompany profit included in closing inventory of D Ltd 25 (50 000 6 125 ) Retained earnings (E Ltd) Cost of sales (E Ltd) Elimination of unrealised intercompany profit included in opening inventory of D Ltd 25 (40 000 6 125 )

Dr R 100 000 NIL

Cr R

80 000 20 000

20 000

14 400 14 400 14 400 34 400(a) 7 600 7 600 7 600(b)

100 000 100 000 10 000

10 000

8 000

8 000

42 000(c)

COMMENTS
. Since the subsidiary in this example has sold the inventories, the adjustments in respect of unrealised profit should also be brought into account in the analysis of shareholders' equity. . You will probably have realised for yourself that there is a quick test one can do to see whether the analysis of shareholders' equity balances. To see whether the columns have been correctly added up we can say: 80 88 42 R210 000 000 000 000 (At acquisition) (Since acquisition) (Non-controlling interest) (Total)

103

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 To see whether the non-controlling interest column has been correctly calculated, we can say: Total = R210 000 Non-controlling interest = 20% Therefore the non-controlling interest column must be equal to R210 000 6 20% = R42 000.

7.5

PROPERTY, PLANT AND EQUIPMENT HELD BY COMPANIES IN THE GROUP

Any profit realised when an asset belonging to one company in the group is sold to another company in the group should be eliminated. The company which purchased the asset is, however, still providing too much depreciation because the profit is included in the cost price of the asset in its books. This portion of the depreciation should be written back for consolidation purposes. This unrealised profit on assets is realised by the sale of the asset to an outsider as well as through the process of depreciation. The annual depreciation includes a portion of the unrealised profit. The unrealised profit is therefore realised through the use of the asset. Four situations may arise where assets are sold within a group:
. . . .

The The The The

parent sells non-depreciable assets to the subsidiary. subsidiary sells non-depreciable assets to the parent. parent sells depreciable assets to the subsidiary. subsidiary sells depreciable assets to the parent.

Note: Unrealised profits/losses have income tax implications, but for the purpose of this module it must be ignored. This section will be dealt with on third-year level. Make a thorough study of the following examples which provide a detailed explanation of the aspect of the sale of assets within a group.

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Example

1 Parent sells non-depreciable asset to subsidiary

The following represent the abridged statements of D Ltd and its subsidiary E Ltd at 31 December 19.9:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in E Ltd 70 000 ordinary shares of R1 each at fair value (cost price: R77 000) Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings Current liabilities D Ltd R 180 000 77 000 20 000 277 000 200 29 48 277 000 000 000 000 E Ltd R 150 000 32 000 182 000 100 37 45 182 000 000 000 000

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year D Ltd R 20 000 (6 000) 14 000 14 000 E Ltd R 30 000 (9 000) 21 000 21 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital D Ltd E Ltd R R 200 000 100 000 200 000 100 000 Retained earnings D Ltd E Ltd R R 15 000 16 000 14 000 21 000 29 000 37 000 Total D Ltd E Ltd R R 215 000 116 000 14 000 21 000 229 000 137 000

Balance at 31 December 19.8 Total comprehensive income for the year Balance at 31 December 19.9

Additional information
1. D Ltd acquired its interest in E Ltd at 1 January 19.7, when E Ltd's retained earnings amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of E Ltd to be equal to the fair value thereof. 2. On 1 January 19.9 E Ltd bought property with a carrying amount of R40 000 from D Ltd. D Ltd made a R10 000 profit. REQUIRED Draft the consolidated financial statements of D Ltd and its subsidiary for the year ended 31 December 19.9.

105

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D LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (180 000 + 150 000 7 10 000 profit) Current assets (20 000 + 32 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(c) Current liabilities (48 000 + 45 000) Total equity and liabilities R

320 000 52 000 372 000 279 000 237 900 200 000 37 900 41 100 93 000 372 000

D LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
Profit before tax (20 000 + 30 000 7 10 000 profit) Income tax expense (6 000 + 9 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (25 000 6 300) Non-controlling interest(1)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 40 000 (15 000) 25 000 25 000 18 700 (6 300) 25 000 18 700 6 300 25 000

D LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.8 Total comprehensive income for the year Balance at 31 December 19.9
* (15 000 + 4 200(2))Calculations

Total equity R 254 000 25 000 279 000

200 000 200 000

19 200* 18 700 37 900

219 200 18 700 237 900

34 800(a) 6 300(b) 41 100(c)

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1. Analysis of shareholders equity of E Ltd

D Ltd Total At acquisition Since acquisition Noncontrolling interest 30% R R 30 000 3 000 33 000(a)

70% At acquisition Share capital Retained earnings R 100 000 10 000 110 000 R 70 000 7 000 77 000 77 000 NIL Since acquisition to beginning of current year Retained earnings (16 000 10 000 at acquisition) Current year Profit for the year

6 000 21 000 137 000

4 200(2) 14 700 18 900

1 800(1) 6 300(1) 41 100(3)

2. Journal entries
Noncontrolling interest R

Share capital Retained earnings Goodwill Investment in E Ltd Non-controlling interest Elimination of shareholders' equity of E Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in E Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Profit on sale of property (D Ltd) Property (E Ltd) Elimination of unrealised intercompany profit included in E Ltd's property

Dr R 100 000 10 000 NIL

Cr R

77 000 33 000

33 000

1 800

1 800

1 800 34 800(a)

6 300 6 300

6 300(b)

10 000 10 000 41 100(c)

107

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Example

2 Subsidiary sells non-depreciable asset to parent

The following represent the abridged statements of Q Ltd and its subsidiary R Ltd at 31 December 19.9:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

Q Ltd R ASSETS Property, plant and equipment Investment in R Ltd 70 000 ordinary shares of R1 each at fair value (cost price: R77 000) Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings Current liabilities 180 000 77 000 20 000 277 000 200 29 48 277 000 000 000 000 R Ltd R 150 000 32 000 182 000 100 37 45 182 000 000 000 000

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

Q Ltd R 20 000 (6 000) 14 000 14 000 R Ltd R 30 000 (9 000) 21 000 21 000

Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital Q Ltd R Ltd R R 200 000 100 000 200 000 100 000 Retained earnings Q Ltd R Ltd R R 15 000 16 000 14 000 21 000 29 000 37 000 Total Q Ltd R Ltd R R 215 000 116 000 14 000 21 000 229 000 137 000

Balance at 31 December 19.8 Total comprehensive income for the year Balance at 31 December 19.9

Additional information
1. Q Ltd acquired its interest in R Ltd at 1 January 19.7, when R Ltd's retained earnings amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of R Ltd to be equal to the fair value thereof. 2. On 1 January 19.8 Q Ltd bought property with a carrying amount of R40 000 from R Ltd. R Ltd made a R10 000 profit.

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REQUIRED Draft the consolidated financial statements of Q Ltd and its subsidiary for the year ended 31 December 19.9.

Q LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (180 000 + 150 000 7 10 000 profit) Current assets (20 000 + 32 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(c) Current liabilities (48 000 + 45 000) Total equity and liabilities 279 000 240 200 40 38 93 372 900 000 900 100 000 000 R

320 000 52 000 372 000

Q LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (20 000 + 30 000) Income tax expense (6 000 + 9 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (35 000 6 300) Non-controlling interest(1)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest 50 000 (15 000) 35 000 35 000 28 700 (6 300) 35 000 28 700 6 300 35 000

109

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Q LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.8 Total comprehensive income for the year Balance at 31 December 19.9 * (15 000 2 800(2)) 200 000 200 000 12 200* 28 700 40 900 212 200 28 700 240 900 31 800(a) 6 300(b) 38 100(c) Total equity R 244 000 35 000 279 000

Calculations 1. Analysis of shareholders equity of R Ltd

Q Ltd Total At acquisition Since acquisition Noncontrolling interest 30% R R 30 000 3 000 33 000

70% At acquisition Share capital Retained earnings Investment in R Ltd Since acquisition to beginning of current year Retained earnings (16 000 10 000 at acquisition R10 000 profit)) Current year Profit for the year R 100 000 10 000 110 000 R 70 000 7 000 77 000 77 000 NIL

(4 000)

(2 800)(2)

1 200)

21 000 127 000

14 700 11 900

6 300(1) 38 100(3)

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2. Journal entries
Dr R 100 000 10 000 NIL Cr R

Share capital Retained earnings Goodwill Investment in R Ltd Non-controlling interest Elimination of shareholders' equity of R Ltd at acquisition Non-controlling interest Retained earnings Recording of non-controlling interest in R Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Retained earnings beginning of year (R Ltd) Property (Q Ltd) Elimination of unrealised intercompany profit included in Q Ltd's property

Noncontrolling interest R

77 000 33 000

33 000

1 200

1 200

(1 200)

31 800(a) 6 300 6 300 6 300(b)

10 000 10 000 38 100(c)

Example

3 Parent sells depreciable asset to subsidiary

The following represent the condensed statements of A Ltd and its subsidiary B Ltd at 31 December 19.9:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

A Ltd R ASSETS Investment in B Ltd 16 000 ordinary shares of R1 each at fair value (cost price: R20 000) Machinery Cost price Accumulated depreciation Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings B Ltd R

20 000 8 000 14 000 (6 000) 52 000 80 000 50 000 30 000 80 000

16 000 20 000 (4 000) 19 000 35 000 20 000 15 000 35 000

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STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

Gross profit Depreciation Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year A Ltd R 20 000 (3 000) 17 000 (5 000) 12 000 12 000 B Ltd R 10 000 (2 000) 8 000 (2 000) 6 000 6 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital A Ltd B Ltd R R 50 000 20 000 50 000 20 000 Retained earnings A Ltd B Ltd R R 18 000 9 000 12 000 6 000 30 000 15 000 Total A Ltd B Ltd R R 68 000 29 000 12 000 6 000 80 000 35 000

Balance at 31 December 19.8 Total comprehensive income for the year Balance at 31 December 19.9

Additional information
1. A Ltd acquired its interest in B Ltd at 1 January 19.7 when B Ltd's retained earnings amounted to R5 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. 2. At 1 January 19.8 B Ltd purchased all its machinery from A Ltd at cost price plus 331 %. 3 3. Both companies write off depreciation on machinery at 10% per annum according to the straight-line method. REQUIRED Draft the consolidated financial statements of A Ltd and its subsidiary for the year ended 31 December 19.9.

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Machinery [(14 000 + 20 000 5 000) (6 000 + 4 000 500 500)] Current assets (52 000 + 19 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(c) Total equity and liabilities R

20 000 71 000 91 000 91 000 84 000 50 000 34 000 7 000 91 000

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
Notes R Gross profit (20 000 + 10 000) Administrative expenses (3 000 + 2 000 7 500) Profit before tax Income tax expense (5 000 + 2 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (18 500 1 200) Non-controlling interest(1)/(b) 000 500) 500 000) 500 18 500 30 (4 25 (7 18

17 300 1 200 18 500

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

17 300 1 200 18 500

A LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 31 DECEMBER 19.9
1. Profit before tax Profit before tax is arrived at after taking into account the following: Expenses Depreciation (3 000 + 2 000 500) R

4 500

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.8 (calculation 3) Total comprehensive income for the year Balance at 31 December 19.9 50 000 16 700* 17 300 34 000 66 700 17 300 84 000 5 800(a) 1 200(b) 7 000(c) Total equity R 72 500 18 500 91 000

50 000

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Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 4 000 1 000 5 000

80% At acquisition Share capital Retained earnings Investment in B Ltd Since acquisition to beginning of current year Retained earnings (9 000 5 000) Current year Profit for the year R 20 000 5 000 25 000 R 16 000 4 000 20 000 20 000 NIL

4 000 6 000 35 000

3 200(2) 4 800 8 000

800 1 200(1) 7 000(3)

2. Depreciation
Profit from sale of machinery (20 000 6 33,3/133,3) Depreciation 19.8 (5 000 6 10%) 19.9 (5 000 6 10%) Depreciation up to 31 December 19.9 which has to be adjusted R 5 000 500 500 1 000

3. Retained earnings beginning of year

Retained earnings of B Ltd(2) Retained earnings of A Ltd Given Profit on sale of machinery Depreciation realised in respect of 19.8 3 200 13 500 18 000 (5 000) 500 16 700

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4. Journal entries
Dr R 20 000 5 000 NIL Cr R Noncontrolling interest R

Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit for the year Retained earnings A Ltd Machinery B Ltd Elimination of unrealised intercompany profit included in B Ltd's assets Accumulated depreciation B Ltd Depreciation A Ltd Retained earnings A Ltd Elimination of depreciation associated with the sale of the asset

20 000 5 000

5 000

800

800

800 5 800(a)

1 200 1 200

1 200(b)

5 000 5 000

1 000 500 500 7 000(c)

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Example

4 Subsidiary sells depreciable asset to parent

The following represent the condensed statements of X Ltd and its subsidiary Y Ltd at 30 June 19.9:

STATEMENTS OF FINANCIAL POSITION AS AT 30 JUNE 19.9

ASSETS Investment in Y Ltd 15 000 ordinary shares of R1 each at fair value (cost price: R19 500) Machinery Cost price Accumulated depreciation Current assets EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings X Ltd R 19 500 8 000 14 000 (6 000) 52 500 80 000 50 000 30 000 80 000 Y Ltd R 16 000 20 000 (4 000) 19 000 35 000 20 000 15 000 35 000

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.9

Gross profit Depreciation Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year X Ltd R 20 000 (3 000) 17 000 (5 000) 12 000 12 000 Y Ltd R 10 000 (2 000) 8 000 (2 000) 6 000 6 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.9

Share capital X Ltd Y Ltd R R 50 000 20 000 50 000 20 000 Retained earnings X Ltd Y Ltd R R 18 000 9 000 12 000 6 000 30 000 15 000 Total X Ltd Y Ltd R R 68 000 29 000 12 000 6 000 80 000 35 000

Balance at 30 June 19.8 Total comprehensive income for the year Balance at 30 June 19.9

Additional information
1. X Ltd acquired its interest in Y Ltd at 1 January 19.6 when Y Ltd's retained earnings amounted to R6 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of Y Ltd to be equal to the fair value thereof. 2. At 1 January 19.8 X Ltd purchased all its machinery from Y Ltd at cost price plus 25%. 3. Both companies write off depreciation on machinery at 20% per annum according to the straight-line method.

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REQUIRED Draft the consolidated financial statements of X Ltd and its subsidiary for the year ended 30 June 19.9.

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 19.9
ASSETS Non-current assets Machinery [(14 000 + 20 000 2 800) (6 000 + 4 000 840)] Current assets (52 500 + 19 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(c) Total equity and liabilities 22 040 71 500 93 540 93 540 85 280 50 000 35 280 8 260 93 540 R

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.9
Notes Gross profit (20 000 + 10 000) Administrative expenses (3 000 + 2 000 7 560) Profit before tax Income tax expense (5 000 + 2 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (18 560 1 640) Non-controlling interest(1)/(b) R 30 000 (4 440) 25 560 (7 000) 18 560 18 560

16 920) (1 640) 18 560

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

16 920 1 640 18 560

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X LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 30 JUNE 19.9

R 1. Profit before tax Profit before tax is arrived at after taking into account the following: Expenses Depreciation (3 000 + 2 000 560)

4 440

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.9
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 30 June 19.8 Total comprehensive income for the year Balance at 30 June 19.9
* (18 000 + 360(2))

Total equity R 74 980 18 560 93 540

50 000 50 000

18 360* 16 920 35 280

68 360 16 920 85 280

6 620(a) 1 640(b) 8 260(c)

Calculations 1. Analysis of shareholders equity of Y Ltd

X Ltd Total At acquisition Since acquisition Noncontrolling interest 25% R R 5 000 1 500 6 500

75% At acquisition Share capital Retained earnings Investement in Y Ltd Since acquisition to beginning of current year Retained earnings [9 000 6 000 2 800 (profit) + 280 (depreciation)] Current year Profit for the year R 20 000 6 000 26 000 R 15 000 4 500 19 500 19 500 NIL

480

360

120

6 560 33 040

4 920 5 280

1 640(1) 8 260(3)

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2. Depreciation
25 Profit on the sale of machinery (14 000 6 125 ) Depreciation 1/1/19.8 7 30/6/19.8 (6 months) 6 2 800 6 20% 6 12 1/7/19.8 7 30/6/19.9 (12 months) 2 800 6 20% Depreciation for 18 months up to 30 June 19.9 for which an adjustment has to be made

R 2 800 280 560 840

3. Journal entries
Dr R 20 000 6 000 NIL Cr R Noncontrolling interest R

Share capital Retained earnings Goodwill Investment in Y Ltd Non-controlling interest Elimination of shareholders' equity of Y Ltd at acquisition Retained earnings Y Ltd Machinery X Ltd Elimination of unrealised intercompany profit on sale of machinery Accumulated depreciation X Ltd Depreciation Y Ltd Retained earnings Y Ltd Elimination of depreciation associated with the sale of the machinery Retained earnings Non-controlling interest Recording of non-controlling interest in Y Ltd for the period ended 30 June 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax

19 500 6 500

6 500

2 800

2 800

840 560 280

120

120

120 6 620(a)

1 640 1 640

1 640(b) 8 260(c)

7.6 EXERCISES
As you should by now have mastered all the different aspects of consolidated annual financial statements, you will find that the questions in the exercises become more integrated in the sense that more and more sections of the work are included in the individual questions. It is therefore very important that you should work through each question on your own before comparing your own solution with our proposed solution.

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Question

1
The trial balances of A Ltd and B Ltd at 30 June 19.8 are submitted to you: A Ltd R 574 000 155 000 B Ltd R 408 200 97 000

Debits Property, plant and equipment Land and buildings Motor vehicles Investment in B Ltd 70 000 ordinary shares at fair value (cost price: R290 000) Unsecured loan at fair value Trade and other receivables Inventories Bank Bills receivable B Ltd Credits Issued capital Ordinary shares of R2 each Retained earnings Revaluation of land and buildings Long-term borrowing A Ltd Bank overdraft Trade and other payables Accumulated depreciation motor vehicles Bills payable A Ltd

290 000 40 000 86 200 45 000 8 000 1 198 200 800 000 213 000 14 200 41 000 130 000 1 198 200

19 400 72 000 10 600 607 200 200 000 137 600 100 000 35 000 60 600 64 000 10 000 607 200

Additional information
1. A Ltd acquired its interest in B Ltd at 1 July 19.5 when B Ltd's retained earnings was R72 000. 2. At the date of acquisition A Ltd valued the land and buildings belonging to B Ltd, which had a carrying amount of R308 200, at R368 200. It is company policy to revalue B Ltd's land and buildings every two years, at 30 June. Since 1 July 19.5 B Ltd has not purchased or sold any land or buildings. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. 3. A Ltd discounted R2 000 of the bills receivable from B Ltd at the bank before the expiry date, 6 July 19.8. 4. Since A Ltd acquired its interest in B Ltd, A Ltd purchased all its inventories from B Ltd. B Ltd supplied the inventories at cost price plus 25% profit. Inventories on hand of A Ltd and B Ltd at 1 July 19.7 amounted respectively to R36 000 and R48 000. 5. At 29 June 19.8, B Ltd repaid R5 000 of the existing loan from A Ltd. A Ltd received this repayment on 3 July 19.8.

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REQUIRED Draft the consolidated statement of financial position of A Ltd and its subsidiary as at 30 June 19.8 in accordance with the specific requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. (Ignore taxation on unrealised profits and/or losses. Comparative figures are not required.)

Question

2
The following represent the condensed statements of comprehensive income and statements of changes in equity of G Ltd and its subsidiary L Ltd for the year ended 28 February 19.8:

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.8

G Ltd R Gross profit Other income Interest received Administration fees received Expenses Depreciation Staff cost Interest paid Auditors' remuneration Administration fees paid Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 484 680 35 750 24 000 544 430 (270 900) 158 000 60 000 28 500 12 400 12 000 273 530 (141 412) 132 118 132 118 L Ltd R 326 300 12 500 12 000 350 800 (221 650) 134 400 48 000 24 650 8 600 6 000 129 150 (64 460) 64 690 64 690

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.8

Share capital G Ltd L Ltd R R Balance at 28 February 19.7 200 000 100 000 Total comprehensive income for the year 200 000 100 000 Balance at 28 February 19.8 Revaluation of property G Ltd L Ltd R R 80 000 120 000 80 000 120 000 Retained earnings G Ltd L Ltd R R 224 690 44 000 132 118 64 690 356 808 108 690 Total G Ltd L Ltd R R 504 690 264 000 132 118 64 690 636 808 328 690

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Additional information
1. G Ltd acquired 80% of the voting rights in L Ltd at 1 March 19.5 for R250 000, at which point L Ltd's shareholders' interest consisted of the following: R Share capital 100 000 Retained earnings 64 000 Revaluation of property 120 000 At the date of acquisition, consider the carrying amount of the assets and liabilities of L Ltd to be equal to the fair value thereof. 2. At 1 December 19.6 L Ltd sold a machine with a carrying amount of R200 000 to G Ltd at a profit of R50 000. The policy of the group is to write off plant and machinery over five years according to the straight-line method. 3. G Ltd sold some of its inventories to L Ltd at a profit of 50% on cost price. L Ltd had the following inventories, purchased from G Ltd, on hand: 28 February 19.7 28 February 19.8 R 210 000 315 000

4. G Ltd lent L Ltd the sum of R150 000 on 1 August 19.7 at an interest rate of 18%. G Ltd received and banked the cheque for interest for the month in question on 28 February 19.8. REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity for G Ltd and its subsidiary for the year ended 28 February 19.8 in accordance with the specific requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. (Ignore taxation on unrealised profits and/or losses. Do all calculations to the nearest rand.)

Solution Question 1

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 19.8
ASSETS Non-current assets Property, plant and equipment [(574 000 + 408 200) + (155 000 + 97 000) (130 000 + 64 000)] Goodwill Current assets Inventories (45 000 + 72 000 9 000) Trade and other receivables (86 200 + 19 400) Cash and cash equivalents Total assets R 1 097 800 1 040 200 57 600 224 200 108 000 105 600 10 600 1 322 000

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EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Other components of equity Retained earnings (213 000 + 39 620) Non-controlling interest(a) Current liabilities Trade and other payables [41 000 + 60 600 + (10 000 8 000)] Bank overdraft (14 200 5 000) Total equity and liabilities

1 209 200 1 080 620 800 000 28 000 252 620 128 580 112 800 103 600 9 200 1 322 000

Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd 70% At acquisition R 140 000 50 400 42 000 232 400 290 000 57 600 Since acquisition R Noncontrolling interest 30% R 60 000 21 600 18 000 99 600

Total At acquisition Share capital Retained earnings 1/10/20.1 Revaluation reserve (368 200 308 200) Investment in B Ltd Goodwill Since acquisition to end of current year Revaluation reserve (R408 200 368 200) Retained earnings 137 600 At acquisition (72 000) 65 600 Unreleased profit closing inventories (9 000) R 200 000 72 000 60 000 332 000

40 000

28 000 OE

12 000

56 600 428 600

39 620 RE 28 000 OE 39 620 RE

16 980 128 580

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2. Journal entries
Noncontrolling interest R

Land and buildings B Ltd Revaluation reserve B Ltd Recording of the revaluation of land and buildings of B Ltd Share capital Retained earnings Revaluation reserve Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Land and buildings B Ltd Revaluation reserve B Ltd Recording of the revaluation of land and buildings of B Ltd Revaluation reserve B Ltd Non-controlling interest (SFP) Recording of non-controlling interest in revaluation reserve Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 30 June 19.8 Bills payable A Ltd Bills receivable B Ltd Elimination of intercompany bills Gross profit B Ltd 25 Inventories A Ltd (45 000 6 125 ) Elimination of unrealised profits in closing inventory Cash in transit Unsecured loan to B Ltd Recording of cash in transit Long-term loan A Ltd Unsecured loan to B Ltd Elimination of intercompany loans

Dr R 60 000

Cr R 60 000

200 72 60 57

000 000 000 600

290 000 99 600

99 600

40 000 40 000

12 000

12 000

12 000

16 980

16 980

16 980

8 000 8 000 9 000

9 000

5 000 5 000 35 000

35 000 128 580(a)

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COMMENTS
. A Ltd holds 70 000 of the R2 shares in B Ltd, or R140 000 of the share capital of R200 000. R140 000 = 70% R200 000 . Current value of land and buildings Valuation value at 1 July 19.5 Valuation of land and buildings since acquisition R 408 200 (368 200) 40 000

. In additional information 4 you were given A Ltd and B Ltd's inventories on hand at 1 July 19.7. This information is irrelevant, however, since we did not ask you to draft an statement of comprehensive income.

Solution Question 2

G LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.8
Note Gross profit (calculation 1) 7 Other income [35 750 + 12 500 7 (150 000 6 12 6 18%) + 24 000 + 12 000)] Administrative expenses [158 000 + 134 400 7 (50 000 6 20%) + 60 000 + 48 000 + 12 400 + 8 600 + 12 000 + 6 000] Finance cost [28 500 + 24 650 (150 000 6 Profit before tax Income tax expense (141 412 + 64 460) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (171 808 14 938) Non-controlling interest (calculation 2)
7 12

R 775 980 68 500 (429 400)

6 18%)] 1

(37 377 (205 171 171

400) 680 872) 808 808

156 870) 14 938 171 808

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

156 870 14 938 171 808

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G LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 28 FEBRUARY 19.8 1. Profit before tax
R Profit before tax is arrived at after taking into account the following: Income 7 Interest received [35 750 + 12 500 (150 000 6 12 6 18%)] Administration fees received (24 000 + 12 000) Expenses Depreciation [158 000 + 134 400 (50 000 6 20%)] Staff cost (60 000 + 48 000) Auditors' remuneration (12 400 + 8 600) Administration fees paid (12 000 + 6 000)

32 500 36 000 282 108 21 18 400 000 000 000

G LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.8
Attributable to owners of Share Revaluation capital surplus R R 200 000 80 000 200 000 80 000 the parent Retained earnings R 100 690(3) 156 870 257 560 Total R 380 690 156 870 537 560 Noncontrolling interest R 43 300(a) 14 938(b) 58 238(c) Total equity R 423 990 171 808 595 798

Balance at 28 February 19.7 Total comprehensive income for the year Balance at 28 February 19.8 (3) 224 690 54 000
(d)

70 000

(1)

Calculations 1. Gross profit

G Ltd 50 Unrealised profit in opening inventories (150 6 210 000) 50 Unrealised profit in closing inventories (150 6 315 000) L Ltd

R
484 680 70 000 (105 000) 326 300 775 980

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2. Analysis of shareholders equity of L Ltd

G Ltd 80% At acquisition R 80 000 51 200 96 000 227 200 250 000 22 800 Since acquisition R Noncontrolling interest 20% R 20 000 12 800 24 000 56 800(a)

Total At acquisition Share capital Retained earnings Revaluation reserve Investment in L Ltd Goodwill Since acquisition to beginning of current year Retained earnings Given (44 000 64 000) Unrealised profit on machinery Depreciation adjustment 3 (50 000 6 20% 6 12 ) Current year Profit for the year Given Excess depreciation (50 000 6 20) (67 500) (20 000) (50 000) 2 500 R 100 000 64 000 120 000 284 000

(54 000)(d)

(13 500)(a)

74 690 64 690 10 000 291 190

59 752

14 938(b)

5 752

58 238(c)

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3. Journal entries
Dr R 100 64 120 22 Cr R

Share capital Retained earnings Revaluation reserve Goodwill Investment in L Ltd Non-controlling interest Elimination of shareholders' equity of L Ltd at acquisition Retained earnings L Ltd Machinery G Ltd Elimination of intercompany profit on sale of machinery Accumulated depreciation G Ltd Retained earnings L Ltd Elimination of depreciation associated with sale of machinery for the period ended 28 February 19.7 Accumulated depreciation G Ltd Depreciation L Ltd Elimination of depreciation associated with sale of machinery for the current year Cost of sales G Ltd Inventory L Ltd Elimination of unrealisal profits in closing inventories Retained earnings G Ltd Cost of sales G Ltd Elimination of unrealisal profits in opening inventories Non-controlling interest Retained earnings Recording of non-controlling interest in L Ltd for the period ended 28 February 19.7 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in L Ltd for the current year Loan from G Ltd Loan to L Ltd Elimination of intercompany loans Interest received G Ltd Interest paid L Ltd Elimination of intercompany interest on loan

000 000 000 800

Noncontrolling interest R

250 000 56 800

56 800

50 000 50 000

2 500 2 500

10 000

10 000

105 000

105 000

70 000 70 000

13 500 13 500

(13 500)

43 300(a) 14 938 14 938 14 938(b)

150 000

150 000

15 750

15 750 58 238(c)

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COMMENTS
. If depreciation is written off over five years by using the straight-line method, this means that in reality the depreciation rate is 20%. 100% 7 5 = 20% per annum

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . . .

record intercompany bills of exchange and bank overdrafts correctly in consolidated annual financial statements? determine the reserve when revaluing property at acquisition of an interest in a subsidiary? calculate the unrealised profit in trading inventories in both the parent and subsidiary? do the consolidation journal entries? draft the consolidated annual financial statements of a group if sales of property, plant and equipment have taken place between companies in the group?

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STUDY UNIT

8
Treatment of dividends during consolidation
Learning outcome
Learners can record any ordinary dividend declared or paid by a subsidiary in consolidated financial statements.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 8.1 8.2 8.3 8.4 Introduction Dividends paid or declared by subsidiary Dividends distributed by subsidiary from pre-acquisition or post-acquisition profits Exercises Solutions Self-assessment

130 130 131 131 149 149 152 158

KEY CONCEPTS
. .

Dividends from pre-acquisition profits Dividends from post-acquisition profits

ASSESSMENT CRITERIA After having studied this study unit you should be able to
. . .

calculate any ordinary dividend declared or paid by a subsidiary correctly in consolidated annual financial statements record any ordinary dividend declared or paid by a subsidiary correctly in consolidated annual financial statements do the consolidation journal entries

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8.1 INTRODUCTION
Dividends paid and/or declared in the consolidated statement of changes in equity will always merely be the dividends payable to the shareholders of the parent. All dividends paid and/or declared by the subsidiary are eliminated. This principle is in accordance with the basic consolidation principle, namely that consolidated annual financial statements should be compiled after all intercompany transactions have been eliminated. Non-controlling shareholders share in the subsidiary's profit before the payment of dividends. Therefore, if a dividend is paid by a subsidiary, it means that the non-controlling shareholders have realised part of their interest in the profit in the form of a dividend. This will cause a reduction in the balance of the non-controlling interest in the consolidated statement of financial position.

8.2 DIVIDENDS PAID OR DECLARED BY SUBSIDIARY

The following are the five situations which most frequently occur with regard to dividends in consolidated annual financial statements:
. . . . .

subsidiary has made no provision and does not wish to create any provision for dividends subsidiary has paid a dividend to its shareholders subsidiary has made provision for dividend declared and parent has made provision for the appropriate dividend receivable subsidiary has made provision for dividend declared but parent has made no provision for the appropriate dividend receivable provision must be made by the subsidiary for a dividend declared

Work carefully through the following five examples which will explain the five situations in more detail.

Example

1 No dividends paid or declared by the subsidiary

The following represents the abridged financial statements of A Ltd and its subsidiary B Ltd:

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in B Ltd 80 000 shares at fair value (cost price: R88 000) Trade and other receivables Current account: B Ltd EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings Current account: A Ltd Trade and other payables A Ltd R 330 000 88 28 10 456 000 000 000 000 B Ltd R 170 000 36 000 206 000 100 38 10 58 206 000 000 000 000 000

200 000 120 000 136 000 456 000

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STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

A Ltd R Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 73 000 (22 000) 51 000 51 000 B Ltd R 33 000 (10 000) 23 000 23 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital A Ltd B Ltd R R 200 000 100 000 Retained earnings Total A Ltd B Ltd A Ltd B Ltd R R R R 84 000 15 000 284 000 115 000 51 000 23 000 51 000 23 000 (15 000) (15 000) 120 000 38 000 320 000 138 000

Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9

200 000 100 000

A Ltd acquired its interest in B Ltd on 1 January 19.7 when the retained earnings of B Ltd amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. If we must draft the consolidated financial statements, we shall do it as follows:

Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 20 000 2 000 22 000

80% At acquisition Share capital Retained earnings Investment in B Ltd R 100 000 10 000 110 000 R 80 000 8 000 88 000 88 000 NIL Since acquisition to beginning of current year Retained earnings (15 000 10 000) Current year Profit for the year

5 000 23 000 138 000

4 000(2) 18 400 22 400

1 000 4 600(1) 27 600(3)

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2. Journal entries
Noncontrolling interest R

Dr R Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in B Ltd for the current year Current account: A Limited Current account: B Limited Elimination of common items 100 000 10 000 NIL

Cr R

88 000 22 000

22 000

1 000

1 000

1 000 23 000(a)

4 600

4 600

4 600(b)

10 000

10 000 27 600(c)

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (330 000 + 170 000) Current assets Trade and other receivables (28 000 + 36 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(c) Current liabilities Trade and other payables (136 000 + 58 000) Total equity and liabilities R

500 000 64 000 564 000 370 000 342 400 200 000 142 400 27 600 194 000 564 000

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (73 000 + 33 000) Income tax expense (22 000 + 10 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (74 000 4 600) Non-controlling interest (1)/(b) 106 000 (32 000) 74 000 74 000 ( 69 400 4 600 74 000

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

69 400 4 600 74 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of the parent Share Retained Total capital earnings R R R Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9
* (84 000 + 4 000(2))

Noncontrolling interest R 23 000(a) 4 600(b) 27 600(c)

Total equity R 311 74 (15 370 000 000 000) 000

200 000

200 000

88 000* 69 400 (15 000) 142 400

288 69 (15 342

000 400 000) 400

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Example

2 Dividends paid by subsidiary

The following represents the abridged financial statements of A Ltd and its subsidiary B Ltd:

STATEMENTS OF FINANCIAL POSITION AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in B Ltd 80 000 shares at fair value (cost price: R88 000) Trade and other receivables Current account: B Ltd EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings Current account: A Ltd Trade and other payables A Ltd R 330 000 88 28 10 456 000 000 000 000 B Ltd R 170 000 36 000 206 000 100 26 10 70 206 000 000 000 000 000

200 000 129 600 126 400 456 000

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

A Ltd R B Ltd R Gross profit Dividends received Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 73 000 9 600 82 600 (22 000) 60 600 60 600

33 000 (10 000) 23 000 23 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Retained earnings Total A Ltd B Ltd A Ltd B Ltd R R R R 84 000 15 000 284 000 115 000 60 600 23 000 60 600 23 000 (15 000) (12 000) (15 000) (12 000) 200 000 100 000 129 600 26 000 329 600 126 000 Share capital A Ltd B Ltd R R 200 000 100 000

Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9

A Ltd acquired its interest in B Ltd on 1 January 19.7 when the retained earnings of B Ltd amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. If we draft the consolidated financial statements, we shall do it as follows:

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Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 20 000 2 000 22 000

80% At acquisition Share capital Retained earnings Investment in B Ltd R 100 000 10 000 110 000 R 80 000 8 000 88 000 88 000 NIL Since acquisition to beginning of current year Retained earnings (15 000 10 000) Current year Profit for the year Ordinary Dividend

5 000

4 000(2) 18 400 (9 600) 12 800

1 000 4 600(1) (2 400) 25 200(3)

23 000 (12 000) 126 000

2. Journal entries
Dr R Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in B Ltd for the current year Dividends received (A Ltd) Non-controlling interest Dividends paid (B Ltd) Elimination of intercompany dividend Current account: A Ltd Current account: B Ltd Elimination of common items 100 000 10 000 NIL Cr R

Noncontrolling interest R

88 000 22 000

22 000

1 000

1 000

1 000 23 000(a)

4 600

4 600

4 600(b)

9 600 2 400

12 000

(2 400)(c)

10 000

10 000 25 200(d)

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136

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (330 000 + 170 000) Current assets Trade and other receivables (28 000 + 36 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(d) Current liabilities Trade and other payables (126 400 + 70 000) Total equity and liabilities R

500 000 64 000 564 000 367 600 342 400 200 000 142 400 25 200 196 400 564 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (73 000 + 33 000) Income tax expense (22 000 + 10 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (74 000 4 600) Non-controlling interest(1)/(b) 106 000 (32 000) 74 000 74 000

69 400 4 600 74 000

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

69 400 4 600 74 000

137

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9
* (84 000 + 4 000(2))

Total equity R 311 74 (17 367 000 000 400) 600

88 000* 69 400 (15 000) 200 000 142 400

200 000

288 000 69 400 (15 000) 342 400

23 000(a) 4 600(b) (2 400)(c) 25 200(d)

Example

3 Parent made provision for dividend declared by subsidiary

The following represents the abridged financial statements of A Ltd and its subsidiary B Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in B Ltd 80 000 shares at fair value (cost price: R88 000) Trade and other receivables Current account: B Ltd EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each Retained earnings Current account: A Ltd Trade and other payables Dividends payable A Ltd R 330 000 88 28 19 465 000 000 600 600 B Ltd R 170 000 36 000 206 000 100 000 26 000 10 000 58 000 12 000 206 000

200 000 129 600 136 000 465 600

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

A Ltd R Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 82 600 (22 000) 60 600 60 600 B Ltd R 33 000 (10 000) 23 000 23 000

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138

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital A Ltd B Ltd R R 200 000 100 000 Retained earnings Total A Ltd B Ltd A Ltd B Ltd R R R R 84 000 15 000 284 000 115 000 60 600 23 000 60 600 23 000 (15 000) (12 000) (15 000) (12 000) 129 600 26 000 329 600 126 000

Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9

200 000 100 000

A Ltd acquired its interest in B Ltd on 1 January 19.7 when the retained earnings of B Ltd amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. If we must draft the consolidated financial statements, we shall do it as follows:

Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 20 000 2 000 22 000

80% At acquisition Share capital Retained earnings Investment in B Ltd R 100 000 10 000 110 000 R 80 000 8 000 88 000 88 000 NIL Since acquisition to beginning of current year Retained earnings (15 000 10 000) Current year Profit for the year Ordinary dividend

5 000

4 000(2) 18 400 (9 600) 12 800

1 000 4 600(1) (2 400) 25 200(3)

23 000 (12 000) 126 000

139

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2. Journal entries
Dr R Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in B Ltd for the current year Dividend received (A Ltd) Non-controlling interest Dividend paid (B Ltd) Elimination of intercompany dividend Dividends payable Current account: A Ltd Transfer of relevant share of dividend due by B Ltd to the current account of A Ltd Current account: A Ltd Current account: B Ltd Elimination of common items 100 000 10 000 NIL Cr R

Noncontrolling interest R

88 000 22 000

22 000

1 000

1 000

1 000

4 600

23 000(a) 4 600 4 600(b)

9 600 2 400

12 000

(2 400)(c)

9 600

9 600

19 600

19 600 25 200(d)

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (330 000 + 170 000) Current assets Trade and other receivables (28 000 + 36 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(d) Current liabilities Dividends payable (12 000 9 600) Trade and other payables (136 000 + 58 000) Total equity and liabilities R 500 000 64 000 564 000 367 600 342 400 200 000 142 400 25 200 196 400 2 400 194 000 564 000

ACN202R/1

140

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (82 600 9 600 + 33 000) Income tax expense (22 000 + 10 000) Profit for the year Other comprehensive income Total comprehensive income for the year 106 000 (32 000) 74 000 74 000

Profit attributable to: Owners of the parent (74 000 4 600) Non-controlling interest(1)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest

69 400 4 600 74 000 69 400 4 600 74 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of the parent Share Retained Total capital earnings R R R Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9
* (84 000 + 4 000(2))

Noncontrolling interest R 23 000(a) 4 600(b) (2 400)(c) 25 200(d)

Total equity R 311 74 (17 367 000 000 400) 600

88 000* 69 400 (15 000) 200 000 142 400

200 000

288 69 (15 342

000 400 000) 400

141

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Example

4 No provision for dividend by parent

The following represents the abridged financial statements of A Ltd and its subsidiary B Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in B Ltd 80 000 shares at fair value (cost price: R88 000) Trade and other receivables Current account: B Ltd EQUITY AND LIABILITIES Share capital Retained earnings Current account: A Ltd Trade and other payables Dividends payable A Ltd R 330 000 000 000 000 000

B Ltd R 170 000

88 28 10 456

36 000 206 000 100 26 10 58 12 206 000 000 000 000 000 000

200 000 120 000 136 000 456 000

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

A Ltd R Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 73 000 (22 000) 51 000 51 000 B Ltd R 33 000 (10 000) 23 000 23 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital A Ltd B Ltd R R 200 000 100 000 Retained earnings Total A Ltd B Ltd A Ltd B Ltd R R R R 84 000 15 000 284 000 115 000 51 000 23 000 51 000 23 000 (15 000) (12 000) (15 000) (12 000) 120 000 26 000 320 000 126 000

Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9

200 000 100 000

A Ltd acquired its interest in B Ltd on 1 January 19.7 when the retained earnings of B Ltd amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. If we must draft the consolidated financial statements, we shall do it as follows:

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Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 20 000 2 000 22 000

80% At acquisition Share capital Retained earnings Investment in B Ltd R 100 000 10 000 110 000 R 80 000 8 000 88 000 88 000 NIL Since acquisition to beginning of current year Retained earnings (15 000 10 000) Current year Profit for the year Ordinary dividend

5 000 23 000 (12 000) 126 000

4 000(2) 18 400 (9 600) 12 800

1 000 4 600(1) (2 400) 25 200(3)

2. Journal entries
Noncontrolling interest R

Dr R In the records of A Ltd Current account: B Ltd Dividend received Recording of dividend receivable In consolidated records Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 100 000 10 000 NIL 9 600

Cr R

9 600

88 000 22 000

22 000

1 000 1 000 1 000 23 000(a)

143

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Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in B Ltd for the current year Dividend received (A Ltd) Non-controlling interest Dividend paid (B Ltd) Elimination of intercompany dividend Dividends payable Current account: A Ltd Transfer of appropriate share of dividend due by B Ltd to the current account of A Ltd Current account: A Ltd Current account: B Ltd Elimination of common items

Dr R 4 600

Cr R 4 600

Noncontrolling interest R 4 600(b)

9 600 2 400 12 000 9 600

(2 400)(c)

9 600

19 600 19 600 25 200(d)

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
R ASSETS Non-current assets Property, plant and equipment (330 000 + 170 000) Current assets Trade and other receivables (28 000 + 36 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(d) Current liabilities Dividends payable (12 000 9 600) Trade and other payables (136 000 + 58 000) Total equity and liabilities

500 000 64 000 564 000 367 600 342 400 200 000 142 400 25 200 196 400 2 400 194 000 564 000

ACN202R/1

144

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (73 000 + 33 000) Income tax expense (22 000 + 10 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (74 000 4 600) Non-controlling interest(1)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest 106 000 (32 000) 74 000 74 000

( 69 400 4 600 74 000 69 400 4 600 74 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9
* (84 000 + 4 000(2))

Total equity R 311 74 (17 367 000 000 400) 600

88 000* 69 400 (15 000) 200 000 142 400

200 000

288 69 (15 342

000 400 000) 400

23 000(a) 4 600(b) (2 400)(c) 25 200(d)

145

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Example

5 No provision for dividend by subsidiary

The following represents the abridged financial statements of A Ltd and its subsidiary B Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Property, plant and equipment Investment in B Ltd 80 000 shares at fair value (cost price: R88 000) Trade and other receivables Current account: B Ltd EQUITY AND LIABILITIES Share capital Retained earnings Current account: A Ltd Trade and other payables A Ltd R 330 000 000 000 000 000

B Ltd R 170 000

88 28 10 456

36 000 206 000 100 38 10 58 206 000 000 000 000 000

200 000 120 000 136 000 456 000

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9

A Ltd R Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 73 000 (22 000) 51 000 51 000 B Ltd R 33 000 (10 000) 23 000 23 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Share capital A Ltd B Ltd R R 200 000 100 000 Retained earnings Total A Ltd B Ltd A Ltd B Ltd R R R R 84 000 15 000 284 000 115 000 51 000 23 000 51 000 23 000 (15 000) (15 000) 120 000 38 000 320 000 138 000

Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9

200 000 100 000

A Ltd acquired its interest in B Ltd on 1 January 19.7 when the retained earnings of B Ltd amounted to R10 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. On 31 December 19.9 B Ltd decided to declare a dividend of R12 000. If we must draft the consolidated financial statements, we shall do it as follows:

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146

Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 20 000 2 000 22 000

80% At acquisition Share capital Retained earnings Investment in B Ltd R 100 000 10 000 110 000 R 80 000 8 000 88 000 88 000 NIL Since acquisition to beginning of current year Retained earnings (15 000 10 000) Current year Profit for the year Ordinary dividend 5 000 23 000 (12 000) 126 000 4 000(2) 18 400 (9 600) 12 800

1 000 4 600(1) (2 400) 25 200(3)

Because B Ltd has not yet made provision for the dividend and A Ltd has not yet reacted to it, we only provide for the dividend owing to the non-controlling shareholders.

2. Journal entries
Dr R 100 000 10 000 NIL Cr R

Share capital Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in B Ltd for the current year Non-controlling interest Dividends payable Provision for dividend payable to non-controlling shareholders Current account: A Ltd Current account: B Ltd Elimination of common items

Noncontrolling interest R

88 000 22 000

22 000

1 000

1 000

1 000 23 000(a)

4 600

4 600

4 600(b)

2 400

2 400

(2 400)(4)(c)

10 000

10 000 25 200(d)

147

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (330 000 + 170 000) Current assets Trade and other receivables (28 000 + 36 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest(3)/(d) Current liabilities Dividends payable Trade and other payables (136 000 + 58 000) Total equity and liabilities R 500 000 64 000 564 000 367 600 342 400 200 000 142 400 25 200 196 400 2 400 194 000 564 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit before tax (73 000 + 33 000) Income tax expense (22 000 + 10 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (74 000 4 600) Non-controlling interest(1)/(b) 106 000 (32 000) 74 000 74 000

69 400 4 600 74 000

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

69 400 4 600 74 000

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148

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of the parent Share Retained Total capital earnings R R R 88 000* 69 400 (15 000) 142 400 288 69 (15 342 Noncontrolling interest R Total equity R 311 000 74 000 (17 400) 367 600

Balance at 31 December 19.8 Total comprehensive income for the year Ordinary dividend Balance at 31 December 19.9
* (84 000 + 4 000(2))

200 000

200 000

000 400 000) 400

23 000(a) 4 600(b) (2 400)(c) 25 200(d)

8.3

DIVIDENDS DISTRIBUTED BY SUBSIDIARY FROM PRE-ACQUISITION OR POST-ACQUISITION PROFITS

The allocation method (FIFO or LIFO) used by a subsidiary to declare dividends has no influence on the consolidated annual financial statements. However, if a subsidiary does not have sufficient post-acquisition profits when a dividend is declared, the parent should treat it as a capital receipt and reduce the cost of the investment. Refer to section 4.2 of study unit 4.

8.4
Question 1

EXERCISES

Do the following two questions for further practice.

The following balances were obtained from the books of A Ltd and its subsidiary B Ltd for the year ended 28 February 19.4: A Ltd B Ltd R R Sales 600 000 400 000 Cost of sales 340 000 220 000 Repairs and maintenance 35 000 30 000 Depreciation equipment 18 000 16 000 Dividends received 16 000 Interest received on loan to B Ltd 10 000 Loan from A Ltd 15 000 Loan to B Ltd 20 000 Staff cost 36 000 24 000 Interest paid 4 000 20 000 Auditors' remuneration 8 000 7 000 Taxation 67 600 32 800 Dividends paid 10 000 20 000 Retained earnings 1 March 19.3 45 000 59 000 Included in cost of sales: Inventories 1 March 19.3 18 000 18 000 Inventories 28 February 19.4 15 000 20 000 100 000 80 000 Share capital

149

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Additional information
1. On 1 March 19.2 when B Ltd was incorporated, A Ltd acquired 80% of the shares and voting rights in B Ltd. There was no goodwill payable by A Ltd, and at date of acquisition the carrying amount of the assets and liabilities were equal to the fair value. 2. Since incorporation A Ltd has bought all its inventories from B Ltd at cost price plus 331 %. 3 On 28 February 19.4 inventories to the value of R5 000 were still in transit. B Ltd sold inventories of R317 000 to A Ltd during the year. 3. On 1 March 19.2 B Ltd sold equipment to A Ltd at a profit of R20 000. Both companies write off depreciation on equipment at 20% per annum according to the straight-line method. 4. On 28 February 19.4 A Ltd sold property at a profit of R20 000 to B Ltd. This profit was included in the sales of the company. REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity of A Ltd and its subsidiary for the year ended 28 February 19.4 to comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. Show all your calculations and ignore taxation on unrealised profits and/or losses, as well as capital gains tax.

Question

2
The following represent the condensed statement of comprehensive income and statements of changes in equity of X Ltd and its subsidiary Y Ltd for the year ended 30 June 19.3:

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.3

Gross profit Other income Dividends received Interest received trade receivables Expenses Depreciation Staff cost Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year X Ltd R 465 000 30 000 5 000 500 000 (200 000) 120 000 80 000 300 000 (120 000) 180 000 180 000 Y Ltd R 329 000 1 000 330 000 (150 000) 100 000 50 000 180 000 (70 000) 110 000 110 000

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150

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.3

Share capital X Ltd Y Ltd R R Balance at 30 June 19.2 300 000 200 000 Total comprehensive income for the year Transfer to asset replacement reserve Dividend paid Balance at 30 June 19.3 300 000 200 000 Asset replacement reserve X Ltd Y Ltd R R 150 000 Retained earnings X Ltd Y Ltd R R 150 000 160 000 180 000 110 000 (30 000) (50 000) 250 000 (50 000) (20 000) 200 000 Total X Ltd Y Ltd R R 450 000 510 000 180 000 110 000 (50 000) 580 000 (20 000) 600 000

30 000 30 000

50 000 200 000

Additional information
1. X Ltd acquired 70% of the voting rights in Y Ltd at 1 July 19.0 for R260 000 when Y Ltd's shareholders' equity consisted of: R Share capital Retained earnings Asset replacement reserve 200 000 20 000 150 000

At the date of acquisition, consider the carrying amount of the assets and liabilities of Y Ltd to be equal to the fair value thereof. It is the policy of the group to show goodwill at cost price in the financial statements. 2. Y Ltd manufactures the same kind of heavy machinery as X Ltd uses. At 1 July 19.1 Y Ltd sold a machine which had cost R150 000 to manufacture to X Ltd for R200 000. 3. The records with regard to X Ltd's machinery contain the following particulars: Machinery purchased 1 July 19.0 Depreciation 30 June 19.1 Purchase of new machinery from Y Ltd 1 July 19.1 Depreciation 30 June 19.2 30 June 19.3 Machinery at carrying amount 30 June 19.3 Depreciation is calculated at 20% per annum on the straight-line method. 4. X Ltd sells some of its inventories to Y Ltd at a profit of 20% on cost price. Y Ltd had the following inventories, purchased from X Ltd, on hand: R 30 June 19.2 36 000 30 June 19.3 72 000 R 400 000 (80 000) 320 000 200 000 (120 000) (120 000) 280 000

REQUIRED Draft the consolidated statement of comprehensive income and consolidated statement of changes in equity of X Ltd and its subsidiary for the year ended 30 June 19.3 to comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. Show all your calculations. Ignore the taxation effect on unrealised profits and/or losses as well as capital gains tax.

151

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Solutions Question 1

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.4
Note Revenue (600 000 + 400 000 20 000 317 000) Cost of sales (340 000 + 220 000 317 000 4 500 + 5 000) Gross profit Administrative expenses [(18 000 + 16 000 7 4 000) + 8 000 + 7 000 + 36 000 + 24 000 + 35 000 + 30 000] Finance cost (4 000 + 20 000 10 000) Profit before tax Income tax expense (67 600 + 32 800) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (135 100 10 740) Non-controlling interest (calculation 1)(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 663 000 (243 500) 419 500 (170 000) (14 000) 235 500 (100 400) 135 100 135 100 124 360 10 740 135 100 124 360 10 740 135 100

A LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 28 FEBRUARY 19.4 1. Profit before tax
R Profit before tax is arrived at after taking into account the following: Expenses Auditors' remuneration (8 000 + 7 000) Depreciation (18 000 + 16 000 4 000) Staff cost (36 000 + 24 000) 15 000 30 000 60 000

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152

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.4
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R 175 124 (10 290 800 360 000) 160 Total equity R 199 500 135 100 (14 000) 320 600

Balance at 28 February 19.3 Total comprehensive income for the year Dividend paid Balance at 28 February 19.4
# 45 000 + 30 800(e)

75 800# 124 360 (10 000) 100 000 190 160 100 000

23 700(a) 10 740(b) (4 000)(c) 30 440(d)

Calculations 1. Analysis of shareholders equity of B Ltd

A Ltd Total At acquisition Since acquisition Noncontrolling interest 20% R R 16 000 16 000(a)

80% At acquisition Share capital Investment in B Ltd Since acquisition to beginning of year Retained earnings Given At acquisition Unrealised profit I in inventory QQ (18 000 6 IQQQI ) Q Unrealised profit on sale of equipment Depreciation on unrealised profit PH (20 000 6 IHH ) Current year Profit for the year Unrealised profit in opening inventory Unrealised profit in closing Iinventory QQ [(15 000 + 5 000) 6 IQQQI ] Q Depreciation on unrealised profit Dividend paid R 80 000 80 000 R 64 000 64 000 64 000 NIL

38 500 59 000 59 000 (4 500) (20 000) 4 000 53 700 50 200(1) 4 500 (5 000) 4 000 (20 000) 152 000

30 800(e)

7 700(a)

42 960

10 740(b)

(16 600) 57 760

(4 000)(c) 30 440(d)

(1)

400 000 220 000 30 000 16 000 24 000 20 000 7 000 32 800

153

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2. Journal entries
Dr R 317 000 5 000 5 000 Cr R 317 000 5 000 5 000

Sales B Ltd Cost of sales A Ltd Elimination of intercompany sales Inventory A Ltd Loan to B Ltd Recording of inventory in transit Cost of sales B Ltd Inventory A Ltd Elimination of unrealised profit in closing inventory of A Ltd Retained earnings B Ltd Cost of sales B Ltd Elimination of unrealised profits in opening inventory in A Ltd Retained earnings B Ltd Equipment A Ltd Elimination of unrealised profits on sale of equipment Accumulated depreciation A Ltd Retained earnings B Ltd Elimination of depreciation associated with sale of equipment for the period ended 28 February 19.3 Accumulated depreciation A Ltd Depreciation B Ltd Elimination of depreciation associated with sale of equipment for the year ended 28 February 19.4 Interest received A Ltd Interest paid B Ltd Elimination of intercompany interest on loan Share capital Investment in B Ltd Non-controlling interest Elimination of shareholders equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 28 February 19.3 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in B Ltd for the current year Dividend received A Ltd Non-controlling interest Dividend paid B Ltd Elimination of intercompany dividend and recording of non-controlling interest in the dividend Loan from A Ltd B Ltd Loan to B Ltd A Ltd Elimination of intercompany balances on loan accounts

Noncontrolling interest R

4 500

4 500

20 000

20 000

4 000

4 000

4 000

4 000

10 000

10 000

80 000

64 000 16 000

16 000

7 700

7 700

7 700 23 700(a)

10 740

10 740

10 740(b)

16 000 4 000

20 000

(4 000)(c)

15 000

15 000 30 440(d)

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154

Question 2

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.3
Note R Gross profit [465 000 + 329 000 + ( /120 6 36 000) 7 (20/120 6 72 000)] Other income [5 000 + 1 000 + 30 000 (20 000 6 70%)] Administrative expenses [120 000 + 100 000 7 (50 000 6 20%) + 80 000 + 50 000] Profit before tax Income tax expense (120 000 + 70 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (280 000 36 000) Non-controlling interest (calculation 1)(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest
20

788 000 22 000 (340 000) 470 000 (190 000) 280 000 280 000 244 000 36 000 280 000 244 000 36 000 280 000

X LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 30 JUNE 19.3 1. Profit before tax
Profit before tax is arrived at after taking into account the following: Income Dividends received (30 000 14 000(f)) Expenses Depreciation (120 000 + 100 000 10 000) Staff cost (80 000 + 50 000) R

16 000 210 000 130 000

X LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.3
Attributable to owners of the parent NonShare Asset replace- Retained Total controlling capital ment reserve earnings interest R R R R R # 300 000 214 000 514 000 141 000(a) 244 000 244 000 36 000(b) (50 000) (50 000) (6 000)(c) 65 000 65 000 (65 000) . 343 000 708 000 171 000(d) Total equity R 655 000 280 000 (56 000) 879 000

Balance at 30 June 19.2 Total comprehensive income for the year Dividend paid Transfer to asset replacement reserve Balance at 30 June 19.3

300 000

# 150 000 6 000 (unrealised profit in opening inventory) + 70 000(e) . [30 000 + (50 000 6 70%)]

155

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Calculations: 1. Analysis of shareholders equity of Y Ltd

X Ltd Total At acquisition Since acquisition Noncontrolling interest 30% R R 60 000 6 000 45 000 111 000(a)

70% At acquisition Share capital Retained earnings Asset replacement reserve Investment in Y Ltd Goodwill Since acquisition to the beginning of the current year Retained earnings Given At acquisition Unrealised profit on sale of machinery (200 000 150 000) Depreciation on unrealised profit 20 (50 000 6 100 ) Current year Profit for the year Profit after tax Depreciation on unrealised profit Asset replacement reserve Transfer to asset replacement reserve Dividend paid R 200 000 20 000 150 000 370 000 R 140 000 14 000 105 000 259 000 260 000 1 000

100 000 160 000 (20 000) 140 000 (50 000) 10 000 120 000 110 000 10 000 50 000 (50 000) (20 000) 570 000

70 000 RE(e)

30 000(a)

84 000 RE

36 000(b)

35 000 OE (35 000) RE (14 000) 105 000 RE 35 000 OE

15 000 (15 000) (6 000)(c) 171 000(d)

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156

2. Journal entries
Dr R Share capital Retained earnings Asset replacement reserve Goodwill Investment in Y Ltd Non-controlling interest Elimination of shareholders' equity of Y Ltd at acquisition Retained earnings Y Ltd Machinery X Ltd Elimination of intercompany profits on sale of machinery Accumulated depreciation X Ltd Retained earnings Y Ltd Elimination of depreciation associated with sale of machinery for the period ended 30 June 19.2 Accumulated depreciation X Ltd Depreciation Y Ltd Elimination of depreciation associated with sale of the machinery for the current year Cost of sales X Ltd Inventory Y Ltd Elimination of unrealised profits in closing inventories Retained earnings X Ltd Cost of sales X Ltd Elimination of unrealised profits in opening inventories Retained earnings Non-controlling interest Recording of non-controlling interest in Y Ltd for the period ended 30 June 19.2 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in Y Ltd for the year ended 30 June 19.3 Dividends received X Ltd Non-controlling interest (SFP) Dividend paid Y Ltd Elimination of intercompany dividend and recording of non-controlling interest in the dividend Transfer to asset replacement reserve (SCI) Asset replacement reserve (SFP) Recording of non-controlling interest in transfer of asset replacement reserve 200 20 150 1 000 000 000 000 Cr R Non-controlling interest R

260 000 111 000

111 000

50 000

50 000

10 000

10 000

10 000

10 000

12 000

12 000

6 000

6 000

30 000

30 000

30 000 141 000(a)

36 000

36 000

36 000(b)

14 000 6 000

20 000

(6 000)(c)

15 000

15 000

(15 000) 15 000 171 000(d)

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SELF-ASSESSMENT After studying this study unit, are you able to:
. . .

calculate any ordinary dividend declared or paid by a subsidiary correctly in consolidated annual financial statements? record any ordinary dividend declared or paid by a subsidiary correctly in consolidated annual financial statements? do the consolidation journal entries?

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STUDY UNIT

9
Treatment of preference shares during consolidation
Learning outcome
Learners can record any preference dividend declared or paid by a subsidiary in the consolidated financial statements.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 9.1 9.2 9.3 9.4 Introduction Consolidation procedures if the subsidiary's capital includes preference shares Treatment of preference dividends of subsidiary Exercises Solutions Self-assessment

159 160 160 160 166 186 191 203

KEY CONCEPTS
. . . . .

Preferential rights Non-cumulative preference shares Cumulative preference shares Participating and non-participating Arrear preference dividends

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ASSESSMENT CRITERIA After having studied this study unit you should be able to
. . . .

calculate the parent's percentage interest in the preference share capital of the subsidiary record any preference dividends paid or declared by a subsidiary in consolidated annual financial statements record arrear cumulative preference dividends payable/paid by a subsidiary in consolidated annual financial statements do the consolidation journal entries

9.1

INTRODUCTION

In study unit 8 we discussed the treatment of dividends where the subsidiary's share capital consists only of ordinary share capital. In this study unit we deal with the treatment of preference share capital and preference dividends. Preference shares bear a fixed dividend percentage. If sufficient profits are available, these shares enjoy a preferential right in respect of dividends. Cumulative preference shares differ slightly from ordinary preference shares in that the fixed preferential dividend accumulates if it is not paid out annually. A company is therefore obliged to pay all cumulative preference shares that are in arrears as soon as sufficient funds become available. Participating preference shares share in the profits of a company after the payment of the preference dividend. Convertible preference shares are convertible to ordinary shares at a specific date in future. Although a company may not buy its own shares, it may buy back (redeem) redeemable preference shares after a specific period at a predetermined price. Preference shares of a subsidiary form part of the subsidiary's shareholders' equity. Preference shareholders can, however, only participate in the profit or capital up to a fixed amount. The holder of 12% preference shares to the value of R2 000 will receive a dividend of only R240 (R2 000 x 12%) per annum. Further, if the subsidiary is liquidated the preference shareholder will receive a maximum amount of R2 000. Where preference shares in a subsidiary are held this affects the calculation of the noncontrolling interest in the consolidated statement of comprehensive income and statement of financial position. By the time you have completed this study unit this statement should be clear to you.

9.2

CONSOLIDATION PROCEDURES IF THE SUBSIDIARYS CAPITAL INCLUDES PREFERENCE SHARES

Since the parent's percentage interest in the ordinary share capital of the subsidiary is not necessarily the same as its percentage interest in the preference share capital, we recommend that you should always draw up two separate analyses of shareholders' equities, namely one for ordinary share capital and one for preference share capital. Work through the following example carefully:

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Example
The following are the condensed financial statements of H Ltd and its subsidiary S Ltd:

STATEMENTS OF FINANCIAL POSITIONS AS AT 31 DECEMBER 19.7

H Ltd R ASSETS Property, plant and equipment Land and buildings at cost price Plant at carrying amount Investment in S Ltd at fair value 75 000 ordinary shares (cost price: R120 000) 20 000 preference shares (cost price: R25 000) Current account S Ltd Inventories Trade and other receivables EQUITY AND LIABILITIES Ordinary shares of R1 each 10% Preference shares of R1 each Retained earnings Current account H Ltd Current liabilities 200 000 54 000 84 000 338 000 100 000 50 000 37 000 5 000 16 000 208 000 100 000 40 000 120 000 25 000 8 000 25 000 20 000 338 000 80 000 20 000 60 000 48 000 208 000 S Ltd R

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.7

H Ltd R 60 500 7 500 2 000 70 000 (25 000) 45 000 45 000 S Ltd R 58 000 58 000 (20 000) 38 000 38 000

Gross profit Income received from S Ltd Ordinary dividend Preference dividend Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.7

Ordinary share capital H Ltd S Ltd R R Balance at 31 December 19.6 200 000 100 000 Total comprehensive income for the year Preference dividend paid Ordinary dividend paid 200 000 100 000 Balance at 31 December 19.7 10% Preference shares H Ltd S Ltd R R 50 000 Retained earnings H Ltd S Ltd R R 24 000 14 000 45 000 38 000 (5 000) (15 000) (10 000) 54 000 37 000 Total H Ltd R 224 000 45 000 (15 000) 254 000 S Ltd R 164 000 38 000 (5 000) (10 000) 187 000

50 000

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Additional information
1. H Ltd acquired its shareholding in S Ltd on 1 January 19.5, at which time S Ltd's retained earnings was R9 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of S Ltd to be equal to the fair value thereof except for the land and buildings of S Ltd valued at R120 000. No entries had been made in the books of the subsidiary. No purchases or sales of land and buildings have taken place subsequently. 2. Since 1 April 19.7, S Ltd has been buying some of its inventories from H Ltd at cost price plus 25%. The inventories of S Ltd at 31 December 19.7 included inventories to the value of R10 000 which had been purchased from H Ltd. Inventories invoiced at R3 000 by H Ltd were in transit to S Ltd at 31 December 19.7. REQUIRED Draft the consolidated annual financial statements of H Ltd and its subsidiary for the year ended 31 December 19.7. Ignore taxation on unrealised profits and/or losses.

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.7
ASSETS Non-current assets Property, plant and equipment [100 000 + 80 000 + 40 000 (revaluation) + 40 000 + 20 000] Goodwill (8 250 + 5 000 ) Current assets Inventories [25 000 + 60 000 + 3 000 (in transit) 7 (13 000 6 Trade and other receivables (20 000 + 48 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Retained earnings Non-controlling interest (44 250(3) + 30 000(3))(d) Current liabilities (84 000 + 16 000) Total equity and liabilities
(4) (4)

R 293 250 280 000 13 250 153 400 85 400 68 000 446 650 346 650 272 400 200 000 72 400 74 250 100 000 446 650

25 125

)]

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H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.7
Profit before tax (calculation 2) Income tax expense (25 000 + 20 000) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (70 900 11 250) Non-controlling interest (9 500 1 250 + 3 000)(1)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 115 900 (45 000) 70 900 70 900 59 650 11 250 70 900 59 650 11 250 70 900

H LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.7
Attributable to owners of Nonthe parent controlShare Retained Total ling capital earnings interest R R R R Balance at 31 December 19.6 Total comprehensive income for the year Dividend paid Balance at 31 December 19.7
* (24 000 + 3 750(2))

Total equity R 296 70 (20 346 250 900 500) 650

200 000

200 000

27 750* 59 650 (15 000) 72 400

227 59 (15 272

750 650 000) 400

68 11 (5 74

500(a) 250(b) 500)(c) 250(d)

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Calculations 1. Analysis of shareholders equity of S Ltd

Ordinary shares H Ltd 75% Total At acquisition Share capital Retained earnings Revaluation reserve (120 000 80 000) Investment in S Ltd Goodwill Since acquisition to beginning of current year Retained earnings (14 000 9 000) Current year Profit for the year Preference dividend* Ordinary dividend R 100 000 9 000 40 000 149 000 At acquisition R 75 000 6 750 30 000 111 750 120 000 8 250(4) Since acquisition R Noncontrolling interest 25% R 25 000 2 250 10 000 37 260

5 000 38 000 (5 000) (10 000) 291 190

3 750(2) 28 500 (3 750) (7 500) 5 752

(1 250) 9 500(1) (1 250)(1) (2 500) 58 238(3)

Preference shares Total R 50 000

H Ltd At acquisition R 20 000 25 000 5 000(4) 5 000 (5 000) 50 000 2 000 (2 000) Since acquisition R

Noncontrolling interest 60% R 30 000

40% At acquisition Share capital Investment in S Ltd Goodwill Current year Attributable profit* Ordinary dividend

3 000(1) (3 000) 30 000(3)

2. Profit before tax

H Ltd S Ltd Ordinary dividend received from S Ltd Preference dividend received from S Ltd Unrealised profit in closing inventories 25 [(10 000 + 3 000) x 125 ]

R 70 000 58 000 (7 500) (2 000) (2 600) 115 900

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3. Journal entries
Dr R 40 000 Cr R 40 000

Land and buildings S Ltd Revaluation reserve S Ltd Valuation of land and buildings at acquisition Share capital Retained earnings Revaluation reserve Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of S Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in S Ltd for the period ended 31 December 19.6 Preference share capital Goodwill Investment in S Ltd Non-controlling interest Elimination of shareholders' equity of S Ltd at acquisition Non-controlling interest (SCI) [(38 000 5 000) 6 25%] Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax after provision for dividends of S Ltd on preference shares for current year ended 31 December 19.6 Dividends received H Ltd Non-controlling interest (SFP) Dividend paid S Ltd Elimination of intercompany dividend and recording of non-controlling interest in the dividend Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax for the current year ended 31 December 19.6 in S Ltd Dividends received (preference shares) H Ltd Non-controlling interest (SFP) Dividend paid (preference shares) S Ltd Elimination of intercompany dividend and recording of non-controlling interest in the dividend Inventory S Ltd Current account H Ltd Inventory in transit at 31 December 19.7

Noncontrolling interest R

100 9 40 8

000 000 000 250

120 000 37 250

37 250

1 250

1 250

1 250

50 000 5 000

25 000 30 000

30 000 68 500(a)

8 250 8 250 8 250(b)

7 500 2 500

10 000

(2 500)(c)

3 000

3 000

13 000(b)

2 000 3 000 5 000 (3 000)(c)

3 000

3 000

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Gross profit/Profit before tax H Ltd Inventory S Ltd Unrealised profit in closing inventory S Ltd Current account H Ltd Current account S Ltd Elimination of intercompany loans

Dr R 2 600

Cr R 2 600

Noncontrolling interest R

8 000

8 000 74 250(d)

COMMENTS
. Please note that if the parent pays more for its investment in the subsidiary's preference shares than the par value of the shares this is referred to as ``goodwill''. . Students cannot always understand why the preference dividend* is taken into account twice (as they see it) in the analyses of shareholders' equity. However, this is not the case. It is the pro rata portion (10% x 50 000) of the preference shareholders' interest in the profit which is transferred from the ordinary shareholders' analysis to the preference shareholders' analysis so that it can be distributed according to that percentage interest (40:60).

9.3

TREATMENT OF PREFERENCE DIVIDENDS OF SUBSIDIARY

The following are the three situations which most commonly arise:
.

Preference dividends outstanding at the accounting date In this case the subsidiary has declared the dividend, but it is to be paid out at a later date. Therefore, the only effect this will have on the consolidated statements is that the noncontrolling interest has to be raised by the portion of the dividend or profit which they have not yet received.

Accumulated preference dividends at acquisition of subsidiary In this case an amount in respect of accumulated preference dividends is included in the calculation of the purchase price of the preference share investment. This implies that payment is made for the preference share dividend that will be declared later in the year. If this dividend is declared, the investment will be reduced accordingly.

Arrear preference dividends Since we are dealing with cumulative preference shares here it is always necessary to make provision for any arrear preference dividends. All arrear preference dividends have to be paid before it is permissible to pay an ordinary dividend.

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Example

1 Preference dividend outstanding at accounting date

The following represent the abridged financial statements of A Ltd and its subsidiary B Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9

ASSETS Plant Investment in B Ltd at fair value 75 000 ordinary shares (cost price: R86 250) 4 000 preference shares (cost price: R4 000) Trade and other receivables EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each 12% Preference shares of R1 each Retained earnings Trade and other payables A Ltd R 50 000 86 250 4 000 26 750 167 000 100 20 35 12 167 000 000 000 000 000 B Ltd R 120 000 48 000 168 000 100 10 40 18 168 000 000 000 000 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9

Ordinary share capital H Ltd S Ltd R R Balance at 31 December 19.8 100 000 100 000 Total comprehensive income for the year 100 000 100 000 Balance at 31 December 19.9 12% Preference shares H Ltd S Ltd R R 20 000 10 000 20 000 10 000 Retained earnings H Ltd S Ltd R R 14 000 28 000 21 000 12 000 35 000 40 000 Total H Ltd R 134 000 21 000 155 000 S Ltd R 138 000 12 000 150 000

A Ltd acquired its interest in B Ltd on 1 January 19.6 when the retained earnings of B Ltd amounted to R15 000. On 1 January 19.6 no preference dividends were in arrears. Provision must still be made for the 19.9 preference dividend. At the date of acquisition, consider the carrying amount of the assets and liabilities of B Ltd to be equal to the fair value thereof. Before we can draft the consolidated financial statements we must first do the two analyses of shareholders' equity.

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Calculations 1. Analysis of shareholders equity in B Ltd

Ordinary shares Total R 100 000 15 000 115 000 Investment in B Ltd A Ltd At acquisition R 75 000 11 250 86 250 86 250 NIL Since acquisition to beginning of current year Retained earnings (28 000 15 000) Current year Profit for the year Preference dividend* (12% 6 10 000) Since acquisition R Noncontrolling interest 25% R 25 000 3 750 28 750

75% At acquisition Share capital Retained earnings

13 000 12 000 (1 200) 138 800

9 750(3) 9 000 (900) 17 850

3 250 3 000(2) (300)(2) 34 700(4)

Preference shares Total R 10 000

A Ltd At acquisition R 4 000 4 000 NIL 1 200 (1 200) 10 000 480 (480) Since acquisition R

Noncontrolling interest 60% R 6 000

40% At acquisition Share capital Investment in B Ltd Goodwill Current year Profit share* Ordinary dividend

720(2) (720)(1) 6 000(4)

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3. Journal entries
Noncontrolling interest R

Dr R Share capital ordinary shares Retained earnings Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in B Ltd for the period ended 31 December 19.8 Share capital preference shares Goodwill Investment in B Ltd Non-controlling interest Elimination of shareholders' equity of B Ltd at acquisition Non-controlling interest (SCI) [(12 000 1 200) 6 25%)] Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax of B Ltd for the current year ended 31 December 19.9 ordinary shares Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax of B Ltd for the current year ended 31 December 19.9 preference shares Non-controlling interest (SFP) Dividends payable Transfer of preference dividends proposed and due to the non-controlling shareholders 100 000 15 000 NIL

Cr R

86 250 28 750

28 750

3 250

3 250

3 250

10 000 NIL

4 000 6 000

6 000 38 000(a) 2 700(b)

2 700 2 700

720

720

720(b)

720 720

(720)(c)

40 700(d)

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A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.9
ASSETS Non-current assets Property, plant and equipment (50 000 + 120 000) Current assets Trade and other receivables (26 750 + 48 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital (100 000 + 20 000) Retained earnings Non-controlling interest (34 700(4) + 6 000(4))(d) Current liabilities Dividends payable [(20 000 6 12%) + 720(1)] Trade and other payables (12 000 + 18 000) Total equity and liabilities R 170 000 74 750 244 750 211 170 120 50 40 33 630 930 000 930 700 120

3 120 30 000 244 750

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
R Profit for the year (21 000 + 12 000) Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (33 000 3 420) Non-controlling interest (3 000 300 + 720)(2)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest 33 000 33 000 29 580 3 420 33 000 29 580 3 420 33 000

A LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Attributable to owners of the parent 12% Share Preference Retained capital shares earnings R R R 100 000 100 000 20 000 20 000 Non-controlling interest Total equity

Total R
29 580

R 38 000
(a)

R 181 750 (3 120) 211 630

33 000

Balance at 31 December 19.8 Dividend declared (20 000 6 12%) Balance at 31 December 19.9
* (14 000 + 9 750(3)) Total comprehensive income for the year

23 750* 143 750 (2 400)(1) (2 400) 50 930 170 930

29 580

(720)(c) 40 700(d)

3 420(b)

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Example 2 Accrued preference dividend on acquisition of subsidiary

The following represent the abridged financial statements of D Ltd and its subsidiary E Ltd:

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 19.7

ASSETS Plant Investment in E Ltd at fair value 80 000 ordinary shares (cost price: R96 000) 7 200 preference shares (cost price: R7 200) Trade and other receivables EQUITY AND LIABILITIES Issued capital Ordinary shares of R1 each 14% Preference shares of R1 each Retained earnings Trade and other payables D Ltd R 50 000 96 000 7 200 26 750 179 950 E Ltd R 120 000 48 000 168 000

100 000 67 950 12 000 179 950

100 18 32 18 168

000 000 000 000 000

STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.7

Ordinary share capital D Ltd E Ltd R R Balance at 31 December 19.6 100 000 100 000 Total comprehensive income for the year Preference dividend 100 000 100 000 Balance at 31 December 19.7 10% Preference shares D Ltd E Ltd R R 18 000 Retained earnings D Ltd E Ltd R R 22 950 20 000 45 000 14 520 (2 520) 67 950 32 000 Total D Ltd R 122 950 45 000 167 950 E Ltd R 138 000 14 520 (2 520) 150 000

18 000

D Ltd acquired 80% of the ordinary shares in E Ltd on 1 January 19.7. On this date the preference dividends were not in arrears. On 1 April 19.7 D Ltd acquired 40% of the issued preference shares in E Ltd for R7 452. At the date of acquisition, consider the carrying amount of the assets and liabilities of E Ltd to be equal to the fair value thereof. If we assume that the purchase price of the preference shares are calculated as follows Par-value of 7 200 preference shares Dividend for 3 months (7 200 6 14% 6 3/12) R 7 200 252 7 452

The following journal entry will appear in the books of D Ltd when the dividend was paid by E Ltd: Dr R 1 008 Cr R 252 756

Bank Investment in E Ltd Dividend received Dividend for year received from E Ltd (7 200 6 14%) The analysis of shareholders' equity will look as follows:

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Calculations 1. Analysis of shareholders equity in E Ltd

D Ltd Total R 100 000 20 000 120 000 Investment in E Ltd At acquisition R 80 000 16 000 96 000 96 000 NIL Current year Profit for the year Preference dividend* 14 520 (2 520) 132 000 11 616 (2 016) 9 600 2 904 (504) 26 400 Since acquisition R Noncontrolling interest 20% R 20 000 4 000 24 000

80% Ordinary shares at acquisition Share capital Retained earnings

A Ltd Total R 18 000 630 (630) 18 000 Investment in E Ltd (7 452 252) At acquisition R 7 200 252 (252) 7 200 7 200 NIL Current year Profit share* (2 520 630) Preference dividend 9 (18 000 6 14% 6 12 ) 1 890 (1 890) 18 000 756 (756) Since acquisition R

Noncontrolling interest 60% R 10 800 378 (378) 10 800

40% Preference shares at acquisition Share capital 3 Profit share* (18 000 6 14% 6 12 ) Preference dividend

1 134 (1 134) 10 800

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2. Journal entries
Noncontrolling interest R 630

Dr R Retained earnings at acquisition Dividends paid Recording of dividends paid from pre-acquisition retained earnings Share capital ordinary shares Retained earnings Goodwill Investment in E Ltd Non-controlling interest Elimination of shareholders' equity of E Ltd at acquisition Non-controlling interest (SCI) [(14 520 2 520) 6 20%] Non-controlling interest (SFP) Recording of non-controlling interest in preference dividend for the current year ended 31 December 19.7 ordinary shares Share capital preference shares Goodwill Investment in E Ltd Non-controlling interest Elimination of shareholders' equity of E Ltd at acquisition Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in preference dividend for the current year ended 31 December 19.7 preference shares Dividend received D Ltd Non-controlling interest (SFP) Dividend paid Elimination of intercompany dividend 630

Cr R

100 000 20 000 NIL

96 000 24 000

24 000

2 400 2 400 2 400

18 000 NIL

7 200 10 800

10 800

1 134

1 134

1 134

756 1 134

1 890

(1 134)

37 200

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Example

3 Arrear preference dividend at acquisition still in arrears

The following represent the condensed annual financial statements of F Ltd and G Ltd for the year ended 28 February 19.7:

STATEMENTS OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.7

F Ltd R ASSETS Land and buildings Investment in G Ltd at fair value 70 000 ordinary shares (cost price: R140 000) 10 000 12% cumulative preference shares (cost price: R12 500) 10% debentures (cost price: R4 000) Inventories Trade and other receivables Loan account F Ltd 475 990 140 000 12 500 4 000 15 510 21 100 669 100 308 700 45 280 12 800 21 000 387 780 G Ltd R

EQUITY AND LIABILITIES Share capital Ordinary shares of R2 each 12% Cumulative preference shares of R1 each Retained earnings Revaluation of land and buildings Bank overdraft Trade and other payables 10% Debentures Loan account G Ltd 500 000 112 600 20 000 10 890 4 610 21 000 669 100 200 000 100 000 28 400 15 000 3 280 31 100 10 000 387 780

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.7

F Ltd R 29 600 (10 400) 19 200 19 200 G Ltd R 16 300 (5 700) 10 600 10 600

Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

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STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.7

Ordinary share capital F Ltd G Ltd R R Balance at 28 February 19.6 Total comprehensive income for the year Balance at 28 February 19.7 500 000 200 000 100 000 500 000 200 000 12% Cumulative preference shares F Ltd G Ltd R R 100 000 Revaluation reserve F Ltd G Ltd R R 20 000 20 000 15 000 15 000 Retained earnings F Ltd G Ltd R R 93 400 19 200 112 600 17 800 10 600 28 400 Total F Ltd R 613 400 19 200 632 600 G Ltd R 332 800 10 600 343 400

Additional information
1. F Ltd acquired its interest in G Ltd at 1 March 19.5 when the reserves were as follows: F Ltd R 20 000 19 000 G Ltd R 8 600

Revaluation of land and buildings Retained earnings

At the date of acquisition, consider the carrying amount of the assets and liabilities of G Ltd to be equal to the fair value thereof. 2. At 1 March 19.5 the preference dividends for the previous two years were in arrears. No dividends have since been paid. 3. Land and building of G Ltd was revalued on 31 January 19.6. 4. At 28 February 19.7 there was no arrear interest on debentures.

175
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REQUIRED Draft the consolidated financial statements of F Ltd and its subsidiary at 28 February 19.7 according to the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice.

F LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.7
ASSETS Non-current assets Property, plant and equipment (475 990 + 308 700) Goodwill (10 780 + 100)(5) Current assets Inventories (15 510 + 45 280) Trade and other receivables (21 100 + 12 800) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Other components of equity Retained earnings Non-controlling interest (58 620 + 133 200)(4)/(c) Total liabilities Non-current liabilities Long-term borrowing 10% Debentures (10 000 7 4 000) Current liabilities Bank overdraft (10 890 + 3 280) Trade and other payables (4 610 + 31 100) Total equity and liabilities R 795 570 784 690 10 880 94 690 60 790 33 900 890 260 834 380 642 560 500 000 30 500 112 060 191 820 55 880 6 000 49 880 14 170 35 710 890 260

F LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.7
Profit before tax (calculation 2) Income tax expense (10 400 + 5 700) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (29 800 10 380) Non-controlling interest (3 180 3 600 + 10 800)(1)/(b) R 45 900 (16 100) 29 800 29 800

19 420 10 380 29 800

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

19 420 10 380 29 800

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F LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.7
Attributable to owners of the parent Share Revaluation Retained capital surplus earnings R R R Balance at 28 February 19.6
Total comprehensive income for the year

Total R
19 420

Noncontrolling interest R 181 440(a) 191 820

(c)

Total equity R 804 580

29 800

500 000 500 000

30 500* 30 500

92 640# 623 140

19 420

10 380(b)

Balance at 28 February 19.7

* (20 000 + 10 500 ) # (93 400 7 1 960(2) + 1 200(2))
(3)

112 060 642 560

834 380

Calculations 1. Analysis of shareholders equity of G Ltd

Ordinary shares F Ltd 70% Total At acquisition Share capital Retained earnings Given Arrear preference dividends (12% 6 100 000 6 2 years) Investment in G Ltd Goodwill Since acquisition to beginning of current year Retained earnings/(loss) Given (17 800 8 600) Arrear preference dividends (12% 6 100 000 6 1 year) Revaluation reserve Current year Profit for the year Preference dividends (2 800) 9 200 (12 000) 15 000 10 600 (12 000) 195 400 10 500(1)OE 7 420 RE (8 400) RE (2 940) RE 10 500 OE 4 500 3 180(1) (3 600)(1) 58 620(3) (1 960)(2)RE (840) R 200 000 (15 400) 8 600 (24 000) 184 600 129 220 140 000 10 780(5) 55 380 At acquisition R 140 000 (10 780) Since acquisition R Noncontrolling interest 30% R 60 000 (4 620)

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Preference shares Total R 100 000 240 000 124 000 Investment in G Ltd Goodwill Since acauisition to beginning of current year Preference dividends Current year Preference dividends 12 000 148 000 12 000

F Ltd At acquisition R 10 000 2 400 12 400 12 500 100(5) Since acquisition R

Noncontrolling interest 90% R 90 000 21 600 111 600

10% At acquisition Share capital Arrear preference dividends

1 200(2) 1 200 2 400

10 800 10 800(1) 133 200(4)

Profit before tax F Ltd G Ltd Interest received on debentures Interest paid on debentures

R 29 600 16 300 (400) 400 45 900

2. Journal entries
Dr R Share capital ordinary shares Goodwill Retained loss Investment in G Ltd Non-controlling interest Elimination of shareholders' equity of G Ltd at acquisition Non-controlling interest (SFP) Retained earnings/(loss) Recording of non-controlling interest in profit/ (loss) since acquisition to beginning of current year 200 000 10 780 15 400 140 000 56 130 Cr R

Noncontrolling interest R

55 380

840 840

(840)

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Dr R Revaluation reserve Non-controlling interest Recording of non-controlling interest in revaluation of asset for the period ended 29 February 19.6 Share capital preference shares Retained earnings Goodwill Investment in G Ltd Non-controlling interest Elimination of shareholders' equity of G Ltd at acquisition preference shares Retained earnings preference shares Non-controlling interest Recording of non-controlling interest in preference dividends for the period ended 29 February 19.6 Non-controlling interest (SFP) [(10 600 12 000) 6 30%] Non-controlling interest (SCI) Recording of non-controlling interest in profit after tax for the current year ended 28 February 19.7 Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in preference dividends for the current year ended 28 February 19.7 10% Debentures G Ltd 10% Debentures F Ltd Elimination of intercompany debentures Loan account G Ltd F Ltd Loan account F Ltd G Ltd Elimination of intercompany loans Interest received from G Ltd F Ltd Interest paid to F Ltd G Ltd Elimination of intercompany transaction 10 800 4 500

Cr R 4 500

Noncontrolling interest R 4 500

100 000 24 000 100

12 500 111 600

111 600

10 800

10 800

181 440(a) 420 420 (420)(b)

10 800

10 800

10 800(b)

4 000

4 000

21 000 21 000 400 400 191 820(c)

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Example

4 Arrear preference dividend at acquisition since paid

The following represent the condensed annual financial statements of W Ltd and V Ltd for the year ended 28 February 19.7:

STATEMENTS OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.7

W Ltd R ASSETS Land and buildings Investment in V Ltd at fair value 70 000 ordinary shares (cost price: R140 000) 10 000 12% cumulative preference shares (cost price: R12 500) 10% debentures (cost price: R4 000) Inventories Trade and other receivables Loan account W Ltd 475 990 140 000 12 500 4 000 15 510 21 100 669 100 308 700 38 280 12 800 28 000 387 780 V Ltd R

EQUITY AND LIABILITIES Issued capital Ordinary shares of R2 each 12% Cumulative preference shares of R1 each Retained earnings Revaluation of land and buildings Bank overdraft Trade and other payables 10% Debentures Loan account V Ltd Dividends payable 500 000 112 600 20 000 10 890 4 610 21 000 669 100 200 000 100 000 28 400 15 000 3 280 21 100 10 000 10 000 387 780

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.7

W Ltd R 29 600 (10 400) 19 200 19 200 V Ltd R 106 000 (37 400) 68 600 68 600

Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

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STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.7

Ordinary share capital W Ltd V Ltd R R Balance at 28 February 19.6 Total comprehensive income for the year Ordinary dividend declared Preference dividend paid Balance at 28 February 19.7 500 000 200 000 100 000 20 000 15 000 500 000 200 000 12% Cumulative preference shares W Ltd V Ltd R R 100 000 Revaluation reserve W Ltd V Ltd R R 20 000 15 000 Retained earnings W Ltd V Ltd R R 93 400 19 200 112 600 17 800 68 600 (10 000) (48 000) 28 400 Total W Ltd R 613 400 19 200 632 600 V Ltd R 332 800 68 600 (10 000) (48 000) 343 400

Additional information
1. W Ltd acquired its interest in V Ltd at 1 March 19.5 when the reserves were as follows: W Ltd R 20 000 19 000 V Ltd R 8 600

Revaluation of land and buildings Retained earnings

At the date of acquisition, consider the carrying amount of the assets and liabilities of V Ltd to be equal to the fair value thereof. Each share carries one vote. 2. At 1 March 19.5 the preference dividends for the previous two years were in arrears. All arrear preference dividends were paid on 28 February 19.7. 3. Land and buildings of V Ltd was revalued on 31 January 19.6. 4. On 28 February 19.7 a dividend of 10 cents per ordinary share was declared by V Ltd. W Ltd recorded this receivable dividend. 5. At 28 February 19.7 there was no arrear interest on debentures. REQUIRED
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Draft the consolidated financial statements of W Ltd and its subsidiary at 28 February 19.7 according to the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice.

W LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.7
R ASSETS Non-current assets Property, plant and equipment (475 990 + 308 700) Goodwill (10 780 + 100)(6) Current assets Inventories (15 510 + 38 280) Trade and other receivables (21 100 + 12 800) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital Other components of equity Retained earnings Non-controlling interest (73 020 + 90 000)(4)/(e) Total liabilities Non-current liabilities Long-term borrowing 10% Debentures (10 000 7 4 000) Current liabilities Bank overdraft (10 890 + 3 280) Trade and other payables (4 610 + 21 100) Dividends payable(5) Total equity and liabilities 795 784 10 87 53 33 570 690 880 690 790 900

883 260

834 380 671 500 30 140 163 46 6 42 14 25 3 360 000 500 860 020 380 000 880 170 710 000

883 260

W LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.7
Profit before tax (calculation 2) Income tax expense (10 400 + 37 400) Profit for the year Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (76 000 27 780) Non-controlling interest (20 580 3 600 + 10 800)(1)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 123 800 (47 800) 76 000 76 000 48 220 27 780 76 000 48 220 27 780 76 000

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W LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.7
Attributable to owners of the parent NonShare distributable Retained capital reserve earnings Total R R R R Balance at 28 February 19.6 500 000 Total comprehensive income for the year Ordinary dividend
Preference dividend

Noncontrolling interest R 181 440(a) 27 780(b) (3 000)(c) (43 200)(d) 163 020(e)

Total equity R 804 580 76 000 (3 000) (43 200) 834 380

30 500*

Balance at 28 February 19.7

* (20 000 + 10 500 ) # (93 400 7 1 960(2) + 1 200(2))
(3)

500 000

30 500

92 640# 623 140 48 220 48 220 140 860 671 360

Calculations 1. Analysis of shareholders equity of V Ltd

Ordinary shares W Ltd 70% Total At acquisition Share capital Retained earnings Given Arrear preference dividends (12% 6 100 000 6 2 years) Investment in V Ltd Goodwill Since acquisition to beginning of current year Retained earnings/(loss) Given (17 800 8 600) Arrear preference dividends (12% 6 100 000 6 1 year) Revaluation reserve Current year Profit for the year Preference dividends Ordinary dividends (2 800) 9 200 (12 000) 15 000 68 600 (12 000) (10 000) 243 400 10 500(3)OE 48 020 RE (8 400)RE (7 000)RE 30 660RE 10 500 OE 4 500 20 580(1) (3 600)(1) (3 000)(5) 73 020(4) (1 960)(2)RE (840) R 200 000 (15 400) 8 600 (24 000) 184 600 129 220 140 000 10 780(6) 55 380 At acquisition R 140 000 (10 780) Since acquisition R Noncontrolling interest 30% R 60 000 (4 620)

183

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Preference shares Total R 100 000 240 000 124 000 Investment in G Ltd Goodwill Since acauisition to beginning of current year Preference dividends Current year Preference dividends Preference dividends 12 000 (48 000) 100 000 12 000

W Ltd At acquisition R 10 000 2 400 12 400 12 500 100(6) Since acquisition R

Noncontrolling interest 90% R 90 000 21 600 111 600

10% At acquisition Share capital Arrear preference dividends

1 200(2) 1 200 (4 800) (2 400)

10 800 10 800(1) (43 200) 90 000(4)

2. Profit before tax

W Ltd V Ltd Ordinary dividend declared by V Ltd Preference dividend paid by V Ltd [(10 000 6 12%) 6 4] Interest received on debentures Interest paid on debentures

R 29 600 106 000 (7 000) (4 800) (400) 400 123 800

3. Journal entries
Dr R 200 000 10 780 Cr R 15 400 140 000 55 380

Share capital ordinary shares Goodwill Retained loss Investment in V Ltd Non-controlling interest Elimination of shareholders' equity of V Ltd at acquisition Non-controlling interest (SFP) Retained earnings/(loss) Recording of non-controlling interest in profit/ (loss) since acquisition to beginning of current year Revaluation reserve Non-controlling interest Recording of non-controlling interest in revaluation reserve for the period ended 29 February 19.6

Noncontrolling interest R

55 380

840

840

(840)

4 500

4 500

4 500

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Share capital preference shares Retained earnings Goodwill Investment in V Ltd Non-controlling interest Elimination of shareholders' equity of V Ltd at acquisition preference shares Retained earnings preference shares Non-controlling interest Recording of non-controlling interest in preference dividends for the period ended 29 February 19.6 Non-controlling interest (SCI) [(68 600 12 000) 6 30%] Non-controlling interest (SFP) Recording of non-controlling interest in profit for the year ended 28 February 19.7 Dividends received W Ltd Non-controlling interest (SFP) Ordinary dividends paid V Ltd Elimination of intercompany dividends and recording of non-controlling interest in ordinary dividends Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in preference dividends for the year ended 28 February 19.7 Dividends received W Ltd Non-controlling interest (SFP) Preference dividends paid V Ltd Elimination of intercompany dividends and recording of non-controlling interest in preference dividends 10% Debentures V Ltd 10% Debentures W Ltd Elimination of intercompany debentures Dividends payable (10 000 6 70%) Loan account of W Ltd Elimination of intercompany dividends payable Loan account V Ltd W Ltd Loan account W Ltd V Ltd Elimination of intercompany loans Take note that the two loan accounts of the parent and the subsidiary balance on R21 000. Interest received on debentures W Ltd Interest paid on debentures V Ltd Elimination of inter company interest on debentures (4 000 6 10%)

Dr R 100 000 24 000 100

Cr R

Noncontrolling interest R

12 500 111 600

111 600

10 800

10 800

10 800 181 440(a)

16 980 16 980

16 980(b)

7 000 3 000

10 000

(3 000)(c)

10 800

10 800

10 800(b)

4 800 43 200

48 000

(43 200)(d)

4 000

4 000

7 000

7 000

21 000

21 000

400

400 163 020 (e)

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9.4 EXERCISES
Now that you have studied the group statements, we are giving you three exercises to work through.

Question

1
The following represent the condensed statement of financial position of K Ltd and its subsidiary L Ltd as at 28 February 19.2: K Ltd R L Ltd R

ASSETS Property, plant and equipment Land and buildings at cost Investment in L Ltd at fair value 32 000 ordinary shares (cost price: R117 000) 8 000 8% cumulative preference shares (cost price: R13 000) Loan K Ltd Current assets Trade and other receivables Inventories

80 000 130 000 117 000 13 000 45 000 30 000 15 000 255 000

75 000 20 000 72 000 53 000 19 000 167 000

EQUITY AND LIABILITIES Issued capital Ordinary shares of R2 each 8% Cumulative preference shares of R1 each Share premium ordinary shares Retained earnings Loan L Ltd Current liabilities Trade and other payables

140 000 100 000 40 000 45 000 16 000 54 000 255 000

100 000 80 20 20 34 000 000 000 000

13 000 167 000

Additional information
1. K Ltd acquired its total shareholding in L Ltd at 1 March 19.1 when the reserves were as follows: R Retained earnings 20 000 Share premium 20 000 2. On the date of acquisition it was decided that L Ltd's land and buildings should be valued upwards by an amount of R20 000. At the date of acquisition, consider the carrying amount of the assets and liabilities of L Ltd to be equal to the fair value thereof. 3. L Ltd's preference dividends were two years in arrears, namely for the 19.1 and 19.2 financial years. 4. With effect from 1 March 19.1, K Ltd purchased some of its inventories from L Ltd. L Ltd sold its inventories to K Ltd at cost plus 331 %. On 28 February 19.2 K Ltd had inventories 3 to the value of R5 000 on hand which it had purchased from L Ltd.

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5. On 2 January 19.2 K Ltd sold a non-depreciable asset with a cost price of R10 000 to L Ltd at cost plus 25%. 6. Cash to the value of R4 000 in respect of the last consignment of inventories purchased from L Ltd by K Ltd was still in transit on 28 February 19.2. 7. Each share carries one vote. REQUIRED Draft the consolidated statement of financial position of K Ltd and its subsidiary L Ltd as at 28 February 19.2 to comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. Notes are not required. (Show all your calculations.)

Question

2
The following balances were taken from the records of P Ltd and D Ltd for the year ended 30 June 19.9: P Ltd R 600 000 300 000 100 000 204 000 1 200 124 400 190 000 100 000 40 000 12 000 1 671 600 D Ltd R 160 000 180 000 80 000 12 000 406 800 170 000 90 000 140 000 30 000 7 500 1 276 300

Debits Property at cost Equipment at cost Inventories Investment in D Ltd at fair value 30 000 ordinary shares (cost price: R204 000) Bank O Bank Trade and other receivables Income tax expense Provisional tax payments Loan to parent (interest-free) Dividends paid Ordinary shares Preference shares Credits Issued capital Ordinary shares of R2 each 15% Cumulative preference shares of R1 each Share premium Retained earnings beginning of year Accumulated depreciation Equipment Bank overdraft B Bank Trade and other payables Taxation payable Loan from subsidiary Profit before tax

200 80 40 150

000 000 000 000

100 50 20 118

000 000 000 000

128 000 48 000 175 600 190 000 120 000 540 000 1 671 600

94 000 238 300 170 000 486 000 1 276 300

187

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Additional information
1. P Ltd acquired its interest in D Ltd at 1 July 19.5. At that date D Ltd's retained earnings amounted to R35 000 and its share premium to R20 000. P Ltd paid R204 000, R75 000 of which was paid for goodwill. The balance was attributable to the revaluation of D Ltd's property. The carrying amount of the assets and liabilities was equal to the fair value thereof. At the date of acquisition there was no arrear preference dividend. Each share carries one vote. 2. P Ltd has bought all its inventories from D Ltd since 1 July 19.8. D Ltd made a profit of 25% on the cost price of inventories sold to P Ltd. 3. D Ltd paid no preference dividends for the period 1 July 19.5 to 30 June 19.7. On 30 June 19.8 D Ltd paid a preference dividend of R22 500. 4. On 29 June 19.9 D Ltd sent goods to the value of R20 000 to P Ltd, which only received them on 3 July 19.9. 5. On 2 January 19.8 P Ltd sold a machine to D Ltd at a profit of R40 000. It is group policy to provide for depreciation at 25% per annum according to the reducing balance method. REQUIRED Draft the consolidated financial statements of P Ltd and its subsidiary for the year ended 30 June 19.9 in accordance with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. No notes are required. Ignore taxation on unrealised profits and/or losses, as well as capital gains tax.

Question

3
The following balances were extracted from the records of the two companies J Ltd and T Ltd at 31 December 19.3: J Ltd R 150 000 128 400 (59 600) 7 600 T Ltd R 180 000 180 000 (95 900) 9 500

Debits Land and buildings at cost Machinery Cost price Accumulated depreciation Patents at carrying amount Investment in T Ltd 70 000 ordinary shares at fair value (cost price: R125 000) 40 000 6% cumulative preference shares at fair value (cost price: R50 000) 20 000 debentures at fair value (cost price: R20 000) Loan account T Ltd Inventories Provisional tax payments Trade and other receivables Cash in bank

125 000 50 20 53 62 14 72 69 691 000 000 400 000 000 000 000 800

62 000 17 000 100 000 452 600

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Credits Ordinary shares of R1 each 6% Cumulative preference shares of R1 each Share premium Retained earnings 6% Debentures Loan account J Ltd Trade and other payables Bank overdraft Tax payable

J Ltd R 320 000 10 000 32 000 130 450 174 350 25 000 691 800

T Ltd R 100 000 80 000 80 100 50 000 50 000 36 500 40 000 16 000 452 600

STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.3

Gross profit Expenses Auditors' remuneration Depreciation Staff cost Interest on debentures Interest on bank overdraft Other income Interest received on debentures Preference dividends received Ordinary dividends received Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year J Ltd R 106 300 (36 800) 2 000 19 800 15 000 69 500 10 600 1 200 2 400 7 000 80 100 (25 000) 55 100 55 100 T Ltd R 97 900 (29 000) 1 000 10 400 13 000 3 000 1 600 68 900 68 900 (16 000) 52 900 52 900

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STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.3

Ordinary share capital J Ltd T Ltd R R Balance at 31 December 19.2 Total comprehensive income for the year Ordinary dividend paid Preference dividend paid Balance at 31 December 19.3 320 000 100 000 10 000 80 000 32 000 320 000 100 000 6% Cumulative preference shares J Ltd T Ltd R R 10 000 80 000 Share premium J Ltd T Ltd R R 32 000 Retained earnings J Ltd T Ltd R R 95 950 55 100 (20 000) (600) 130 450 42 000 52 900 (10 000) (4 800) 80 100 Total J Ltd R 457 950 55 100 (20 000) (600) 492 450 T Ltd R 222 000 52 900 (10 000) (4 800) 260 100

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Additional information
1. At 1 January 19.1 J Ltd acquired 70 000 ordinary shares and 40 000 6% cumulative preference shares in T Ltd. All the assets and liabilities were considered to be reasonably valued with the exception of the land and buildings, which were valued at R250 000. No purchases or sales of land and buildings have taken place since then. No adjustment has yet been made in respect of this. 2. At the date of acquisition the subsidiary had retained earnings of R8 000. The preference dividend for 19.0 was in arrears. 3. J Ltd supplied goods to its subsidiary at cost plus 20%. Particulars of goods supplied to T Ltd by J Ltd during the year ended 31 December 19.3 were as follows: R Inventories 1 January 19.3 12 000 Purchases during the year 120 000 Inventories at 31 December 19.3 4 800 On 27 December 19.3 J Ltd sent goods to T Ltd which were invoiced at R1 800. However, these goods were received by T Ltd on 5 January 19.4 and were therefore not taken into inventories at 31 December 19.3. 4. T Ltd sent R1 600 to J Ltd on 28 December 19.3. This amount was only received and banked by J Ltd on 4 January 19.4. 5. J Ltd sold certain machinery to T Ltd at a price of R10 000 above the carrying amount after the date of acquisition of its interest in T Ltd. T Ltd provides for depreciation on machinery at 20% per annum on cost price, based on the assumption that the machine will still have five years of service left as from the date of purchase, namely 1 January 19.2. 6. The cost price of the patents are as follows: J Ltd T Ltd 7. Each share carries one vote. R 10 000 12 000

REQUIRED Draft the consolidated financial statements of J Ltd and its subsidiary T Ltd for the year ended 31 December 19.3 in compliance with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. Ignore taxation on unrealised profits and/or losses as well as capital gains tax.

Solution Question 1

K LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 19.2
R ASSETS Non-current assets Property, plant and equipment [80 000 + 75 000 + 20 000 (revaluation) 7 2 500(5)] Goodwill (6 280 + 4 360)(1) Current assets Trade and other receivables (30 000 + 53 000) Inventories (15 000 + 19 000 7 1 250(4)) Cash and cash equivalents Total assets EQUITY AND LIABILITIES Total equity Equity attributable to the owners of the parent Share capital (R100 000 + 40 000) Retained earnings (45 000 7 2 500(5) + 8 920(2) + 640(2)) Non-controlling interest (29 910 + 13 920) Current liabilities Trade and other payables (54 000 + 13 000) Total equity and liabilities
(3)/(a)

183 140 172 500 10 640 119 750 83 000 32 750 4 000 302 890 235 890 192 060 140 000 52 060 43 830 67 000 302 890

191

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Calculations 1. Analysis of shareholders equity of L Ltd

Ordinary shares K Ltd 80% Total At acquisition Ordinary share capital Share premium Revaluation reserve Retained earnings Given Arrear preference dividends 19.1 Investment in L Ltd Goodwill Current year Retained earnings Given At acquisition Arrear preference dividends 19.2 Unrealised profit in closing inventories (331 /1331 6 5 000) 3 3 11 150 34 000 (20 000) (1 600) (1 250)(4) 149 550 *
32Y000 40Y000

At acquisition R 64 16 16 14 000 000 000 720

Since acquisition R

Noncontrolling interest 20% R 16 4 4 3 000 000 000 680

R 80 20 20 18 20 000 000 000 400 000

(1 600) 138 400 110 720 117 000 6 280(1) 8 920 2 230 27 680

8 920(2)

29 910(3)

6 100% = 80% W Ltd Total R 20 000 1 600 21 600 At acquisition R 8 000 640 8 640 13 000 4 360(1) Since acquisition R Noncontrolling interest 60% R 12 000 960 12 960

Preference shares

40% At acquisition Preference share capital Arrear preference dividend 19.1 Investment in G Ltd Goodwill Since acquisition to end of current year Arrear preference dividend 19.2 1 600 23 200 *
8Y000 20Y000

640 640

960 13 920(3)

6 100% = 80%

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2. Profit on sale of non-depreciable asset

Cost price Profit Profit to be eliminated 10 000 x 25% = R2 500(5) R10 000 25%

3. Journal entries

Dr R Land and buildings L Ltd Revaluation reserve Recording of the revaluation of land and buildings in L Ltd Share capital ordinary shares Share premium Revaluation reserve Retained earnings Goodwill Investment in L Ltd Non-controlling interest Elimination of shareholders' equity of L Ltd at acquisition Cost of sales L Ltd Inventories K Ltd Elimination of unrealised profit on closing inventory Profit on sale of property K Ltd Property L Ltd Elimination of unrealised profit included in L Ltd's property Bank L Ltd (cash in transit) Loan K Ltd L Ltd Recording of cash in transit from K Ltd to L Ltd Loan L Ltd K Ltd Loan K Ltd L Ltd Elimination of intercompany loan accounts Retained earnings Non-controlling interest (SFP) Recording of non-controlling interest in profit/(loss) Share capital preference shares Retained earnings Goodwill Investment in L Ltd Non-controlling interest Elimination of shareholders' equity of L Ltd at acquisition preference shares Retained earnings preference shares Non-controlling interest Recording of non-controlling interest in preference dividends for the period ended 28 February 19.2 20 000

Cr R 20 000

Noncontrolling interest R

80 20 20 18 6

000 000 000 400 280

117 000 27 680

27 680

1 250

1 250

2 500

2 500

4 000

4 000

16 000

16 000

2 230

2 230

2 230

20 000 1 600 4 360

13 000 12 960

12 960

960

960

960 43 830(a)

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Solution Question 2

P LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 19.9
ASSETS Non-current assets Property, plant and equipment [(600 000 + 160 000 + 60 000) + (300 000 + 180 000 7 40 000) (128 000 + 94 000 7 5 000(4) 7 8 750(5))] Goodwill(6) Current assets Inventories (100 000 + 80 000 + 20 000 7 24 000) Trade and other receivables (124 400 + 406 800) Cash and cash equivalents (1 200 + 12 000) Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital (200 000 + 80 000) Other components of equity Retained earnings Non-controlling interest (221 000 + 50 000)(7)/(e) Current liabilities Bank overdraft Trade and other payables (175 600 + 238 300) Tax payable (190 000 + 170 000 100 000 90 000) Total equity and liabilities R 1 126 750 1 051 750

75 000 720 400 176 000 531 200 13 200 1 847 150 1 215 250 944 280 40 624 250 000 000 250

271 000 631 900 48 000 413 900 170 000 1 847 150

P LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.9
Profit before tax (calculation 2) Income tax expense (190 000 + 170 000) Profit for the period Other comprehensive income Total comprehensive income for the year Profit attributable to: Owners of the parent (632 750 121 300) Non-controlling interest (113 800 + 7 500)(2)/(b) Total comprehensive income attributable to: Owners of the parent Non-controlling interest R 992 750 (360 000) 632 750 632 750 511 450 121 300 632 750 511 450 121 300 632 750

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P LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.9
Attributable to owners of the parent Ordinary share capital R Balance at 30 June 19.8 Total comprehensive income for the year Ordinary dividend paid Preference dividend paid Balance at 30 June 19.9 200 000 15% Cum. preference shares R 80 000 Share premium R 40 000 Retained earnings R 164 800* 511 450 (40 000) (12 000) 624 250 Non-controlling Total interest equity

Total R 484 800 511 450 (40 000) (12 000) 944 250

R 169 200(a) 121 300(b) (12 000)(c) (7 500)(d) 271 000(e) 1

R 654 000 632 750 (52 000) (19 500) 215 250

200 000

80 000

40 000

(150 000 + 49 800(1) 7 40 000(3) + 5 000(4))

Calculations 1. Analysis of shareholders equity of D Ltd

Ordinary shares P Ltd 60% Total At acquisition Ordinary share capital Retained earnings Share premium Revaluation of reserve Investment in D Ltd Goodwill Since acquisition to beginning of current year Retained earnings (118 000 35 000) Current year Profit for the year Profit after tax (486 000 170 000) Unrealised profit in inventories 25 (120 000 6 125 ) Preference dividend Dividends paid oridnary R 100 35 20 60 000 000 000 000 60 21 12 36 At acquisition R 000 000 000 000 Since acquisition R 40 14 8 24 Noncontrolling interest 40% R 000 000 000 000

215 000

129 000 204 000 75 000(6)

86 000

83 000 284 500 316 000 (24 000) (7 500) (30 000) 552 500

49 800(1) 170 700

33 200 113 800(2)

(18 000) 202 500

(12 000) 221 000(7) R 204 000 (75 000) 129 000

* P Ltd paid Goodwill 60% investment 129 000 7 (60 000+ 21 000 + 12 000) = 36 000 (60%) 36 000 60 6 100 = 60 000

195

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Preference shares Total R 50 000

W Ltd At acquisition 0% R Since acquisition 0% R

Noncontrolling interest 100% R 50 000

At acquisition Preference share capital Current year Profit attributable to preference shares Dividend paid preference

7 500 (7 500) 50 000

7 500(2) (7 500) 50 000(7)

2. Profit before tax

Profit P Ltd Dividends received from D Ltd (30 000 6 60%) Adjustment for depreciation (calculation 3) Profit D Ltd Unrealised profit in closing inventories

R
540 (18 8 486 (24 992 000 000) 750 000 000) 750

3. Depreciation
Profit 2 January 19.8 Depreciation adjustment in 19.8 (40 000 x
6 12

x 25%)

40 000(3) (5 000)(4) 35 000 (8 750)(5)

Depreciation adjustment in 19.9 (35 000 x 25%)

4. Journal entries
Noncontrolling interest R

Land and buildings D Ltd Revaluation reserve Recording of the revaluation of land and buildings in D Ltd Share capital ordinary shares Share premium Revaluation reserve Retained earnings Goodwill Investment in D Ltd Non-controlling interest Elimination of shareholders' equity of D Ltd at acquisition Retained earnings Non-controlling interest Recording of non-controlling interest in retained earnings for the period ended 30 June 19.8

Dr R 60 000

Cr R 60 000

100 20 60 35 75

000 000 000 000 000

204 000 86 000

86 000

33 200

33 200

33 200

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Share capital preference shares Non-controlling interest Elimination of shareholders' equity of D Ltd at acquisition preference shares Inventories P Ltd Loan account D Ltd P Ltd Recording of inventories sent to P Ltd Cost of sales D Ltd Inventories P Ltd Elimination of unrealised profit on closing inventory Profit on sale of machinery P Ltd Machinery D Ltd Elimination of unrealised profit included in D Ltd's machinery Accumulated depreciation D Ltd Retained earnings P Ltd Depreciation P Ltd Elimination of the depreciation associated with the profit on sale of machinery Loan D Ltd P Ltd Loan P Ltd D Ltd Elimination of intercompany loan accounts Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Dividends received P Ltd Non-controlling interest (SFP) Ordinary dividends paid D Ltd Elimination of intercompany dividends and recording of non-controlling interest in ordinary dividends Dividends received P Ltd Non-controlling interest (SFP) Preference dividends paid D Ltd Elimination of intercompany dividends and recording of non-controlling interest in preference dividends Retained earnings preference shares Non-controlling interest Recording of non-controlling interest in preference dividend for the period ended 30 June 19.9

Dr R 50 000

Cr R 50 000

Noncontrolling interest R 50 000 169 200(a)

20 000

20 000

24 000

24 000

40 000

40 000

13 750

5 000 8 750

140 000

140 000

113 800

113 800

113 800(b)

18 000 12 000

30 000

(12 000)(c)

NIL 7 500

7 500

(7 500)(d)

7 500

7 500

7 500(b)

271 000(e)

197

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Solution Question 3

J LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 19.3
ASSETS Non-current assets Property, plant and equipment [(150 000 + 250 000) + 298 400 (calculation 4) 151 500 (calculation 4) + (7 600 + 9 500)] Goodwill (3 760(2) + 7 600(2)) Current assets Inventories [62 000 + 62 000 + 1 800 (in transit) 7 1 100 (unrealised profit)] Trade and other receivables (72 000 + 100 000) Cash and cash equivalents [69 000 + 1 600 (in transit)] Total assets EQUITY AND LIABILITIES Total equity Equity attributable to owners of the parent Share capital (320 000 + 10 000) Other components of equity Retained earnings Non-controlling interest (75 030 + 40 000)(4)/(e) Total liabilities Non-current liabilities Long-term borrowing 6% Debentures (50 000 7 20 000) Current liabilities Trade and other payables (174 350 + 36 500) Bank overdraft Tax payable (25 000 + 16 000 7 14 000 7 17 000) Total equity and liabilities R 575 360 564 000 11 360 367 300 124 700 172 000 70 600 942 660 651 810 536 330 32 174 780 000 000 780

115 030 290 850 30 000 260 850 210 850 40 000 10 000 942 660

J LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.3
Note Gross profit (calculation 2) Administrative expenses [2 000 + 1 000 + 19 800 + 10 400 (10 000 6 20%) + 15 000 + 13 000] Finance costs [3 000 + 1 600 (3 000 6 40%)] Profit before tax Income tax expense (25 000 + 16 000) Profit for the year Other comprehensive income Total comprehensive income for the year R 205 100 (59 200) (3 400) 142 500 (41 000) 101 500 101 500

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Profit attributable to: Owners of the parent (101 500 16 830) Non-controlling interest (14 430 + 2 400)(1)/(b)

84 670 16 830 101 500

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

84 670 16 830 101 500

J LTD AND ITS SUBSIDIARY

NOTES FOR THE YEAR ENDED 31 DECEMBER 19.3 1. Profit before tax
Profit before tax is arrived at after taking into account the following: Expenses Auditors' remuneration (2 000 + 1 000) Depreciation [19 800 + 10 400 (10 000 6 20%)] Staff cost (15 000 + 13 000) 3 000 28 200 28 000 R

J LTD AND ITS SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.3
Attributable to owners of the parent Ordinary share capital R Balance at 31 December 19.2 Total comprehensive income for the year Ordinary dividend paid Preference dividend paid Balance at 31 December 19.3 320 000 15% Cum. preference shares R 10 000 Share premium R 32 000 Retained earnings R 110 710* 84 670 (20 000) (600) 174 780 Non-controlling Total interest equity Total R 472 710 84 670 (20 000) (600) 536 780

320 000

10 000

32 000

103 600(a) 576 310 16 830(b) 101 500 (3 000)(c) (23 000) (2 400)(d) (3 000) 115 030(e) 651 810

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Calculations: 1. Analysis of shareholders equity of T Ltd

Ordinary shares Total R 100 70 3 8 000 000 200 000 J Ltd At acquisition R 70 000 49 000 2 240 Since acquisition R Noncontrolling interest 30% R 30 000 21 000 960

70% At acquisition Share capital Revaluation reserve Retained earnings Given Preference dividend Investment in T Ltd Goodwill Since acquisition to beginning of current year Retained earnings Given (42 000 3 200) Current year Profit after tax and preference dificend (52 900 4 800) Ordinary dividend paid

(4 800) 173 200 121 240 125 000 3 760(2) 51 960

38 800

27 160(3)

11 640 14 430(1) (3 000) 75 030(4)

48 100 (10 000) 250 100

33 670 (7 000) 53 830

Cumulative preference shares Total R 80 000 4 800 84 000 Investment in T Ltd Goodwill Since acquisition to beginning of current year Arrear preference dividend paid Current year Profit attibutable to preference shares Preference dividend paid

J Ltd At acquisition R 40 000 2 400 42 400 50 000 7 600 (2) Since acquisition R

Noncontrolling interest 50% R 40 000 2 400 42 000

50% At acquisition Share capital Arrear preference dividend 1/1/19.0

(4 800)

(2 400)

(2 400) 2 400(1) (2 400) 40 000(4)

4 800 (4 800) 80 000

2 400 (2 400) (2 400)

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2. Gross profit
Profit J Limited T Limited 20 Unrealised profit in opening inventories (12 000 x 120 ) Unrealised profit in closing inventories [(4 800 + 1 800) x R 106 300 97 900 2 000 (1 100) 205 100

20 120

3. Retained earnings beginning of year

Retained earnings J Limited T Limited(3) Profit on sale of machinery Depreciation adjustment on machinery sold (10 000 x 20% x 1 year) Unrealised profit in opening inventories Arrear preference dividend at acquisition received 95 950 27 160 (10 000) 2 000 (2 000) (2 400) 110 710

4. Machinery
Cost price J Limited T Limited Profit on sale Accumulated depreciation J Limited T Limited Depreciation on machinery sold 19.2 19.3 R 128 400 180 000 (10 000) 298 400 59 600 95 900 (2 000) (2 000) 151 500

5. Journal entries
Dr R Land and buildings T Ltd Revaluation reserve Recording of the revaluation of land and buildings in D Ltd Share capital ordinary shares Revaluation reserve Retained earnings Goodwill Investment in T Ltd Non-controlling interest Elimination of shareholders' equity of T Ltd at acquisition 70 000 70 000 Cr R

Noncontrolling interest R

100 70 3 3

000 000 200 760

125 000 51 960

51 960

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Retained earnings Non-controlling interest Recording of non-controlling interest in retained earnings for the period ended 31 December 19.2 Share capital preference shares Retained earnings Goodwill Investment in T Ltd Non-controlling interest Elimination of shareholders' equity of T Ltd at acquisition Preference shares Non-controlling interest Retained earnings Recording of non-controlling interest in preference dividends for the period ended 31/12/19.2 Preference shares Income sales J Ltd Cost of sales T Ltd Elimination of intercompany sales Inventories T Ltd Loan account J Ltd Recording of inventories sent to P Ltd Cost of sales J Ltd Inventories T Ltd Elimination of unrealised profit on closing inventory Retained earnings J Ltd Cost of sales J Ltd Elimination of unrealised profit on opening inventory Bank Cash in transit J Ltd Loan account T Ltd J Ltd Recording of cash sent by T Ltd to J Ltd Profit on sale of machinery J Ltd Machinery T Ltd Elimination of unrealised profit included in T Ltd's machinery Accumulated depreciation T Ltd Retained earnings J Ltd Depreciation J Ltd Eliminate the depreciation associated with the profit on sale of machinery Loan J Ltd T Ltd Loan T Ltd J Ltd Elimination of intercompany loan accounts

Dr R 11 640

Cr R 11 640

Noncontrolling interest R 11 640

80 000 4 800 7 600

50 000 42 400

42 400

2 400

2 400

(2 400)

103 600(a) 120 000 120 000

1 800

1 800

1 100

1 100

2 000

2 000

1 600

1 600

10 000

10 000

4 000

2 000 2 000

51 800

51 800

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Dr R 6% Debentures T Ltd 6% Debentures J Ltd Elimination of intercompany debentures Interest on debentures received J Ltd Interest on debentures paid T Ltd Elimination of intercompany interest on debentures Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in profit after tax Dividends received J Ltd Non-controlling interest (SFP) Ordinary dividends paid T Ltd Elimination of intercompany dividends and recording of non-controlling interest in ordinary dividends Dividends received J Ltd Non-controlling interest (SFP) Preference dividends paid T Ltd Elimination of intercompany dividends and recording of non-controlling interest in preference dividends Non-controlling interest (SCI) Non-controlling interest (SFP) Recording of non-controlling interest in preference dividends for the preference shares 20 000

Cr R 20 000

Noncontrolling interest R

1 200

1 200

14 430

14 430

14 430(b)

7 000 3 000

10 000

(3 000)(c)

2 400 2 400

4 800

(2 400)(d)

2 400

2 400

2 400(b)

115 030(e)

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . .

calculate the parent's percentage interest in the preference share capital of the subsidiary? record any preference dividends paid or declared by a subsidiary in consolidated annual financial statements? record arrear cumulative preference dividends payable/paid by a subsidiary in consolidated annual financial statements? do the consolidation journal entries?

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TOPIC B

STATEMENT OF CASH FLOWS (IAS 7/AC 118) 118)

Learning outcome
Learners should be able to draft a statement of cash flows for a company as well as a close corporation on the direct and the indirect method according to IAS 7/ AC 118.

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CONTENTS

Study unit

Page

1 Statement of cash flows

207

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STUDY UNIT

1
Statement of cash flows

Learning outcome
Learners can draft a statement of cash flows for companies and close corporations according to the direct and indirect method.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 1.1 1.2 1.3 1.4 Introduction Purpose and presentation of statement of cash flows Elements and framework of statement of cash flows Exercises Solutions Self-assessment

207 208 208 208 209 220 225 231

KEY CONCEPTS
. . . . . .

Cash Cash flow equivalents Cash flow Operating activities Investing activities Financing activities

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ASSESSMENT CRITERIA After having studied this topic you should be able to:
. .

draft a statement of cash flows for a company and a close corporation using the direct method draft a statement of cash flows for a company and a close corporation using the indirect method

1.1

INTRODUCTION

In Accounting I you were introduced to company annual financial statements. You studied aspects such as statement of financial position and statement of comprehensive income. In Accounting II you will be studying the above aspects in greater detail and you will be acquiring knowledge of Generally Accepted Accounting Practice (hereafter called GAAP). Statements of GAAP are being formulated by the South African Institute of Chartered Accountants and approved by the Accounting Practices Board and will form part of your study material in future. According to the Companies Act 61 of 1973 a company's annual financial statements have to be drawn up in accordance with Generally Accepted Accounting Practice (GAAP) as well as the specific requirements of schedule 4. Although the sections of the Companies Act of 1973 and all the paragraphs of schedule 4 are very important for your studies, you are not expected to read them all. In order to cover the ground thoroughly, we shall, however, refer to them from time to time in the study guide. Cash flow information involves the meaningful presentation of the cash generated and applied by the entity. This information is presented in the form of a statement of cash flows to the readers of financial statements. A complete set of financial statements comprises:
. . . . .

statement of financial position statement of comprehensive income statements of changes in equity statement of cash flows notes

Users of financial statements are interested in the information on cash flow which can be derived from this statement. As the name indicates, this statement has to do with the cash flow in an enterprise and all items in the annual financial statements which have nothing to do with the cash flow are omitted when the statement of cash flows is compiled.

1.2

PURPOSE AND PRESENTATION OF STATEMENT OF CASH FLOWS

The aim of the statement of cash flows is to furnish information to the various users of financial statements. Each enterprise presents its cash flow from operations, investment and financing in the way most suitable for its business. The following would be a logical presentation:

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Net cash flow from operating activities Cash receipts from customers Cash paid to suppliers and employees Investment income Interest paid Tax paid Dividends paid

. . .

Net cash flow from investing activities Net cash flow from financing activities Net change in cash and cash equivalents

Operating activities are the principal income-producing activities of the enterprise, apart from other activities which are not investing or financing activities. Investing activities are the acquisition and sale of non-current assets and other investments which are not included in cash flow equivalents. Financing activities are activities which result in changes in the size and composition of the equity capital and loans to the enterprise.

1.3

ELEMENTS AND FRAMEWORK OF STATEMENT OF CASH FLOWS

The elements of a statement of cash flows, are

. . .

operating activities investing activities financing activities

Operating activities
The amount of cash arising from operating activities is a key indicator of the extent to which the operations of the entity have generated sufficient cash to repay loans, maintain the operating capability of the entity, pay dividends and make new investments without recourse to external financing. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity. Therefore, they generally result from the transactions and other events that is included in the determination of profit or loss. Examples of cash flows from operating activities are:
. . . .

cash cash cash cash

receipts from the sale of goods and the rendering of services; payments to suppliers for goods and services; payments to and on behalf of employees; payments and refunds of income taxes

Investing activities
The disclosure of cash flows from investing activities is important because the cash flows represent the extent to which payments have been made for resources intended to generate future receipts and cash flows. Examples of cash flows arising from investing activities are:
. .

cash payments to acquire property, plant and equipment and other non-current assets; cash receipts from sales of property, plant and equipment and other non-current assets

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Financing activities
The disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity. Examples of cash flows arising from financing activities are: cash proceeds from issuing shares; cash payment to owners to acquire or redeem the entity's shares; cash proceeds from issuing debentures, loans, mortgage bonds and current or non-current borrowings; . cash repayments of amounts borrowed.
. . .

A statement of cash flows can be schematically represented as follows:

STATEMENT OF CASH FLOWS

CASH FLOW FROM OPERATING ACTIVITIES Minus CASH APPLIED IN INVESTING ACTIVITIES Plus/Minus CASH INFLOW/(OUTFLOW) FROM FINANCING ACTIVITIES Is represented by or is equal to net increase/decrease in CASH AND CASH EQUIVALENTS The statement of cash flows is not compiled from separate transactions. To draft a statement of cash flows for the year ended 31 December 19.8 we use the following:
. . .

statement of comprehensive income for the year ended 31 December 19.8 statement of financial position as at 31 December 19.7 and 31 December 19.8 additional information

Remember that amounts which are not in brackets represent the inflow of cash and amounts in brackets represent the outflow of cash. An enterprise should report cash flow from operating activities by using either the direct or the indirect method. If the direct method is used the principal categories of gross cash proceeds and gross cash payments are disclosed. According to the indirect method profit or loss is adjusted for the effect of non-cash transactions, and any deferrals or accruals of previous or future operating cash receipts or payments and income or expenditure items which are related to investment or financing cash flow.

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The only difference between the direct and indirect method lies in the presentation of the section dealing with cash flow from operating activities. The sections dealing with investing activities and financing activities are represented in the same format, irrespective of the method used. Study the frameworks of the two methods.

FRAMEWORK OF A STATEMENT OF CASH FLOWS IN ACCORDANCE WITH THE DIRECT METHOD

Cash flow from operating activities Cash receipts from customers Cash paid to suppliers and employees Net cash generated by operations Interest received Interest paid Dividends received Dividends paid Normal tax paid Net cash inflow from operating activities Cash flow from investing activities Investment to maintain production capacity Replacement of non-current assets Investment to expand production capacity Additions to non-current assets Proceeds from the sale of non-current assets Net cash outflow from investing activities Cash flow from financing activities Proceeds from the issue of shares Proceeds from long-term loans Redemption of redeemable preference shares Net cash inflow from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period R xxx (xxx) xxx xxx (xxx) xxx (xxx) (xxx) R

xxx (xxx) xxx (xxx) xxx xxx (xxx) xxx xxx (xxx) xxx xxx xxx xxx

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FRAMEWORK OF A STATEMENT OF CASH FLOWS IN ACCORDANCE WITH THE INDIRECT METHOD

Cash flow from operating activities Profit before tax Adjustments for: Depreciation Loss on sale of non-current assets Profit on sale of non-current assets Investment income Interest expense Operating profit before changes in working capital Changes in working capital Decrease/(increase) in inventory Decrease/(increase) in trade and other receivables (Decrease)/increase in trade and other payables Cash generated by operations Interest received Interest paid Dividends received Dividends paid Normal tax paid Net cash inflow from operating activities Cash flow from investing activities Investment to maintain production capacity Replacement of non-current assets Investment to expand production capacity Additions to non-current assets Proceeds from the sale of non-current assets Net cash outflow from investing activities Cash flow from financing activities Proceeds from the issue of shares Proceeds from long-term loans Redemption of redeemable preference shares Net cash inflow from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period R xxx xxx xxx (xxx) (xxx) xxx xxx xxx xxx xxx (xxx) xxx xxx (xxx) xxx (xxx) (xxx) xxx (xxx) xxx (xxx) xxx xxx (xxx) xxx xxx (xxx) xxx xxx xxx xxx R

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The following example will be used throughout to illustrate certain aspects of cash flow information. The following balances appear in the books of Ross Ltd for the financial year ended 30 June: 19.6 R 350 000 105 000 108 900 67 000 37 400 500 2 000 670 800 280 000 12 000 15 000 91 000 97 700 40 000 23 300 16 800 27 000 27 200 38 800 2 000 670 800 19.5 R 340 000 124 000 67 300 25 200 50 000 50 000 2 600 659 100 250 000 8 200 80 000 20 000 200 000 46 600 18 000 10 000 26 000 300 659 100

Land and buildings Plant and machinery Motor vehicles Investments Inventory Trade and other receivables Prepaid expenses Bank

Ordinary share capital R1 shares Share premium 12% Long-term loan Surplus from revaluation of land and buildings Reserve for asset replacement Retained earnings 10% R200 Debentures Tax payable Ordinary dividends payable Accumulated depreciation Plant and machinery Motor vehicles Trade and other payables Accrued interest Bank overdraft

ROSS LIMITED
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.6
Revenue Cost of sales Gross profit Other income (3 000 + 2 000) Administrative expenses (78 200 + 63 600) Selling expenses Other costs Interest Profit before tax R 500 000 (250 000) 250 000 5 000 (78 200) (87 400) (8 000) (7 300) 10 500

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Additional information
1. The long-term loan bears interest at 12% p.a. and was repaid on 31 December 19.5. 2. Share issue expenses of R1 200 were paid and written off. This write-off was recorded in such a way as to have the minimum effect on distributable reserves. 3. In December 19.5 a piece of land which cost R15 000 was sold at the carrying amount and replaced with another piece of land. On 30 June 19.6 the remaining land was revalued. These were the only transactions in respect of land and buildings for the current financial year. 4. During the current financial year a machine with a carrying amount of R51 000 was sold at a loss of R8 000 and replaced with a new machine which cost R62 000. The total depreciation on plant and machinery for the current financial year amounted to R39 000. 5. A motor vehicle with a cost price of R14 400 and on which depreciation of R7 400 had already been written off was traded in for R9 000 on a new vehicle which cost R35 000. 6. No other machines or motor vehicles were sold during the year, but one additional motor vehicle was purchased. 7. The provision for tax for the current financial year was R15 000. This includes an underprovision of R5 100 for the 19.5 tax year. 8. New shares were issued at a premium on 30 April 19.6. 9. On 31 December 19.5 an interim ordinary dividend of 4c per share was declared and paid. 10. Ordinary dividends of 6c per share were declared on 30 June 19.6. 11. The investments were sold at fair value. 12. During the year, dividends to the value of R3 000 were received.

Cash flow from operating activities (according to the direct method) Cash receipts from customers
This amount is determined by reconstructing the trade and other receivables account.

Cash receipts from customers

Trade and other receivables Balance Sales
* Balancing figure

b/d

R 50 000 500 000 550 000

Bank* Balance

c/d

R 512 600 37 400 550 000

Cash paid to suppliers and employees

This amount is calculated by comparing the figures for inventory and trade and other payables as given in the two statement of financial position. If inventory increased from one year to the next, the effect on cash flow would be negative. If the number of trade and other payables increased from one year to the next, this means that less cash flowed out and the figure would then be positive in respect of cash flow. All purchases of inventory and expenses which were paid for in cash are also included in the calculation.

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Cash paid to suppliers and employees R Balances b/d Inventory Prepaid expenses Bank* Balance c/d Trade and other payables 50 000 2 600 417 700 38 800 Balance b/d Trade and other payables Cost of sales Administrative expenses Selling expenses Balances c/d Inventory Prepaid expenses R 26 000 250 000 78 200 87 400 67 000 500 509 100

509 100 * Balancing figure

Depreciation to the value of R63 600, does not give rise to a cash flow. Plant and machinery Vehicles 39 000 24 600 63 600 (Given) [27 200 (10 000 7 400)]

Cash generated by operations This amount is obtained by subtracting the cash paid to suppliers and employees from cash receipts from customers. Interest paid, dividends received and paid and tax paid All payments to the SA Revenue Service and to suppliers of funds are normally made from cash generated by operating activities. Interest paid, tax and dividends paid during a year should therefore be disclosed separately from cash generated by operating activities. Dividends paid Unpaid amount at beginning of year (statement of financial position 19.5) Amount debited against income* (total dividends declared for 19.6) Unpaid amount at end of year (statement of financial position 19.6) *Ordinary dividends Interim (250 000 6 4c) Final (280 000 6 6c) R 26 800 (16 800) 10 000 10 000 16 800 26 800

Normal tax paid Unpaid amount at beginning of year (statement of financial position 19.5) Amount debited against income (additional information 8) Unpaid amount at end of year (statement of financial position 19.6)

46 15 (23 38

600 000 300) 300

We can now complete the section described as cash flow from operating activities according to the direct method.

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Cash flow from operating activities (according to the direct method)

ROSS LTD
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 JUNE 19.6
Cash flow from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated by operations Interest paid (7 300 7 2 000) Dividends received Dividends paid Normal tax paid Net cash inflow from operating activities R 512 600 (417 700) 94 900 (5 300) 3 000 (10 000) (38 300) R

44 300

Cash flow from operating activities (according to the indirect method) When the statement of cash flows is prepared according to the indirect method, you must ignore the calculations for cash received from customers and cash payments to suppliers and employees. Cash generated by operations are now calculated by adjusting profit or loss for the effect of non-cash transactions, and any deferrals or accruals of previous or future operating cash receipts or payments and income or expenditure items which are related to investment or financing cash flow. The calculations for interest, dividends and tax remain unaltered, irrespective of the method used.

Cash flow from operating activities (according to the indirect method):

ROSS LIMITED
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 JUNE 19.6
Cash flow from operating activities Profit before tax Adjustments for: Depreciation Profit on sale of non-current asset Loss on sale of non-current asset Interest expense Investment income Operating profit before changes in working capital Changes in working capital Increase in inventory (50 000 67 000) Decrease in trade and other receivables (50 000 37 400) Decrease in prepaid expenses (2 600 500) Increase in trade and other payables (38 800 26 000) Cash generated by operations Interest paid (7 300 2 000) Dividends received Dividends paid Normal tax paid Net cash inflow from operating activities R 10 500 63 (2 8 7 (3 84 10 (17 12 2 12 94 (5 3 (10 (38 600 000) 000 300 000) 400 500 000) 600 100 800 900 300) 000 000) 300) 44 300 R

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Cash flow from investing activities

Cash flow which is related to investing activities may include both the inflow and the outflow of cash. The outflow of cash includes the purchase of assets and investments, and the inflow of cash includes items such as proceeds from the sale of non-current assets. As regards the amount of assets purchased, we distinguish between the amount for replacement and that for addition to assets. Replacement refers to the maintenance of operations and replacement to the expansion of operations.
.

Assets purchased

When the increase in the balance of the accumulated depreciation accounts on the two statement of financial position is equal to the depreciation in the statement of comprehensive income then no assets were sold or written off during the year. Any increase in the asset account (at cost price) can then be directly accounted for as purchases of assets.
.

Revaluation of property

Property is quite frequently revalued, and when this happens during a particular financial year it is handled as described below. The increase in the value of the property has come about as a result of the revaluation and can be ignored when drafting the statement of cash flows since there was in fact no flow of cash. The increase in the non-distributable reserve represents the increase in the value of the property.
.

Purchase and sale of assets

If an enterprise has purchased or sold assets during the year it is desirable to reconstruct the ledger accounts concerned. Land and buildings Balance Revaluation# Replacement* Balance b/d R 340 000 15 000 10 000 365 000 350 000 Proceeds on sale Balance R 15 000 350 000 365 000

c/d

b/d

# Increase in balance of surplus on revaluation account * Balancing figure

Motor vehicles at cost price Balance Replacement (given) Addition* Balance

* Balancing figure

b/d

R 67 300 35 000 21 000 123 300 108 900

Cost of trade-in Balance

c/d

R 14 400 108 900 123 300

b/d

Accumulated depreciation: Motor vehicles Accumulated depreciation on trade-in Balance c/d R 7 400 27 200 34 600 Balance Depreciation* b/d R 10 000 24 600 34 600 Balance
* Balancing figure

b/d

27 200

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Realisation account Cost price of trade-in Profit on trade-in [(14 400 7 7 400) 7 9 000] R 14 400 2 000 16 400 Plant and machinery at carrying amount Balance Replacement (given) b/d R 106 000 62 000 168 000 Balance b/d 78 000 Realisation account Carrying amount sold R 51 000 Proceeds on sale (51 000 7 8 000) Loss on sale R 43 000 8 000 51 000 Carrying amount sold Depreciation Balance R 51 000 39 000 78 000 168 000 Accumulated depreciation on trade-in Proceeds R 7 400 9 000 16 400

c/d

51 000

We are now able to complete the section described as cash flow from investing activities.

Cash flow from investing activities (both methods)

R Investment to maintain production capacity Replacement of land Replacement of motor vehicle Replacement of machine Investment to expand production capacity Addition to motor vehicles Proceeds on sale of investments Proceeds of sale of land Proceeds on sale of motor vehicle Proceeds on sale of machine Net cash outflow from investment activities (107 000) 10 000 35 000 62 000 (21 000) 21 000 25 200 15 000 9 000 43 000 R

(35 800)

Cash flow from financing activities (both methods)

An enterprise must report separately on the main classes of gross cash receipts and gross cash payments which resulted from financing activities. The effecting of new loans, the redemption of existing loans and the issue of shares are usually derived from the given statement of financial position. 19.6 R 40 000 280 000 19.5 R 80 000 250 000 Change R 40 000 80 000 30 000

10% R200 Debentures Long-term loan Ordinary share capital R1 shares

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The ordinary share capital increased by R30 000. The total amount received upon issue of the ordinary shares was therefore R30 000 + R5 000 = R35 000. The share issue expenses amounted to R1 200 (additional information (2)) and this sum is deducted, which leaves us with net proceeds of R33 800. To complete the picture, we can now reconcile the share premium account as well. Share premium Share issue expenses written off Balance R 1 200 12 000 13 200 Balance Bank* b/d R 8 200 5 000 13 200 Balance * Balancing figure We can now complete the section which deals with cash flow from financing activities. b/d 12 000

c/d

Cash flow from financing activities (both methods)

Proceeds from debentures issued Payment on redemption of long-term loan Proceeds on issue of shares (35 000 1 200) Net cash outflow from financing activities R 40 000 (80 000) 33 800 R

(6 200)

Net change in cash and cash equivalents

The net effect of the first three sections of the statement of cash flows produced the net change. R 44 300 (35 800) (6 200) 2 300 (300) 2 000

Net cash inflow from operating activities Net cash outflow from investing activities Net cash outflow from financing activities Net increase in cash and cash equivalents Cash and cash equivalents beginning of year Cash and cash equivalents end of year

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1.4 EXERCISES
Question 1
The condensed trial balances of A Ltd at 31 October 19.3 and 19.2 are as follows: 19.3 R 1 750 000 436 000 385 000 178 000 214 000 20 000 2 983 000 19.2 R 1 400 000 410 000 370 000 154 000 220 000 76 000 40 000 2 670 000

Debits Property Motor vehicles Machinery Inventory Trade and other receivables Cash in bank Other financial assets: Investments at fair value

Credits Ordinary share capital Share premium Revaluation of property Reserve for asset replacement Retained earnings Interest free loan Accumulated depreciation Motor vehicles Machinery Trade and other payables Bank overdraft Tax payable Dividends payables (ordinary)

400 000 40 000 200 000 20 000 991 000 900 000 76 000 141 000 139 000 8 000 44 000 24 000 2 983 000

300 000 30 000 10 000 870 000 1 100 000 54 000 120 000 142 000 28 000 16 000 2 670 000

Additional information
1. The following information was obtained from the statement of comprehensive income for the year ended 31 October 19.3: R Revenue 750 000 (300 000) Cost of sales Gross profit 450 000 Other income 4 000 Administrative and selling expenses (88 000 + 48 000 + 72 000) (208 000) Other expenses (6 000) 240 000 Profit before tax Income tax expense (85 000) Profit for the year 155 000 Other comprehensive income Profit on revaluation of land 204 000 365 000 Total comprehensive income for the year

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2. Extract from the statement of changes in equity for the year ended 31 October 19.3 Reserve for asset Retained replace- earnings ment R R Total comprehensive income for the year Dividends declared Transfer to reserve 155 000 (24 000) (10 000)

Total R 155 000 (24 000)

10 000

3. A new motor car was purchased for R54 000. An old vehicle was sold at its carrying amount on 31 October 19.3. 4. A machine with a carrying amount of R60 000 and on which R51 000 had already been written off in depreciation was traded in for R54 000 and replaced with a new machine. 5. Depreciation for the current year Vehicles Machinery 6. The investment was sold on 28 February 19.3 for R24 000. R 48 000 72 000

REQUIRED Draft the statement of cash flows of A Ltd for the year ended 31 October 19.3 in accordance with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice, using the direct method. Ignore comparative figures, but show the following calculations: 1. 2. 3. 4. Cash receipts from clients Cash paid to suppliers and employees Tax paid Dividends paid

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Question

2
The following information was derived from the books of B Ltd:

TRIAL BALANCE AT 28 FEBRUARY

Land and buildings at valuation Machinery at cost price Investments Inventory Trade and other receivables Bank 19.5 R 240 000 14 800 15 000 18 000 8 000 295 800 100 000 40 000 40 000 60 500 19 500 20 000 3 400 1 000 7 400 4 000 295 800 19.4 R 200 000 52 300 2 400 19 000 15 400 14 000 303 100 100 000 50 000 107 000 15 000 10 000 4 800 1 200 11 300 3 800 303 100

Issued ordinary share capital Interest free long-term loan Revaluation of land and buildings Retained earnings Reserve for asset replacement Dividends payables Accumulated depreciation machinery Allowance for credit losses Trade and other payables Tax payable

Additional information
1. The following information was derived from the statement of comprehensive income for the year ended 28 February 19.5: R Revenue Cost of sales Gross profit Other income (1 000 + 200) Administrative and selling expenses (48 000 + 42 600) Other expenses Profit before tax Income tax expense Profit for the year Other comprehensive income Profit on revaluation of land Total comprehensive income for the year 179 500 (76 200) 103 300 1 200 (90 600) (400) 13 500 (5 500) 8 000 40 000 48 000

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2. Extract from the statement of changes in equity for the year ended 28 February 19.5 Reserve for asset replacement R Balance at 28 February 19.4 Profit for the year Dividend declared Transfer to reserve Balance at 28 February 19.5 15 000 15 000 4 500 19 500 Retained earnings R 107 8 115 (50 (4 160 000 000 000 000) 500) 500

Total R 122 000 8 000 130 000 (50 000) 80 000

3. The company grew rapidly during the year and unless otherwise indicated all assets were purchased for the purposes of expanding the enterprise. The following transactions took place during the year ended 28 February 19.5: 3.1 New machinery to the value of R8 000 was purchased during the year to replace the obsolete machinery. The cost price of the old machinery was R45 500 and it was resold for R2 500. The accumulated depreciation on the machinery that was sold was R44 000. 3.2 The company's investments were sold during the year for R2 000. REQUIRED Draft the statement of cash flows for B Ltd for the financial year ended 28 February 19.5 to comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice using the indirect method. Ignore comparative figures, but show the following calculations: 1. 2. Tax paid Dividends paid

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Question

3
The following represent the trial balances of W Close Corporation at 31 December 19.1 and 19.2 after all the closing entries have been correctly recorded. 19.2 R Credits Members' contributions Non-distributable reserve Revaluation of land and buildings Retained earnings 5% Debentures of R100,00 each Loan from Mr B Accumulated depreciation motor vehicles Bank overdraft Trade and other payables Distribution payable to members 120 000 40 000 78 800 40 000 15 000 35 500 19 500 9 300 358 100 19.1 R 90 000 52 900 50 000 9 000 20 000 12 000 16 700 4 900 255 500

Debits Motor vehicles Land and buildings at valuation Other financial assets: Investments listed Trade and other receivables Inventories Loan to Mr A Tax receivable Bank

85 500 180 000 14 000 24 000 34 000 11 000 8 700 900 358 100

60 000 100 000 18 000 16 000 42 000 11 000 8 500 255 500

Additional information
1. On 1 January 19.2 the existing members, namely Mr A and Mr B, admitted a new member, Mr C, to the close corporation. 2. R6 000 of the profit from the 19.2 financial year was distributed between the members in equal shares. 3. SA Normal tax for the year 19.2 amounts to R7 000 and consists of the current tax of R8 000 and an overprovision of R1 000 for the previous year. 4. During the year a delivery vehicle with a book value of R12 000 was written off in an accident and replaced with a new delivery vehicle. The original cost price of the vehicle that was written off was R20 000. 5. Additions were made to buildings in order to increase the production capacity of W Close Corporation. 6. On 1 January 19.2 100 debentures were redeemed at R103,00 each. The premium paid for redemption was written off against income. 7. A listed investment the cost price of which was R4 000 was sold for R12 000. Dividends received on listed investments amount to R1 800.

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8. Loans to and from members bear interest calculated at 15% per annum on opening balances. On 31 December 19.2 Mr B made an additional loan of R6 000 to the close corporation. All interest paid or received was correctly calculated and recorded in the statement of comprehensive income. 9. The following balances were taken from the books at 31 December 19.2: Sales Cost of sales Administrative expenses REQUIRED Draw up the statement of cash flows (using the direct method) of W Close Corporation for the year ended 31 December 19.2 in accordance with Generally Accepted Accounting Practice. Ignore comparative figures. R 177 400 100 000 10 800

Solutions Question 1

A LTD
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 OCTOBER 19.3
R Cash flow from operating activities Cash receipts from customers Cash paid to suppliers and employees Net cash generated by operations Dividends paid Tax paid Net cash inflow from operating activities Cash flow from investing activities Investment to maintain production capacity Replacement of machinery Replacement of motor vehicle Investment to expand production capacity Additions to property Proceeds from sale of motor vehicles (28 000 26 000) Proceeds from sale of machinery (60 000 7 6 000) Proceeds from sale of investments Net cash outflow from investing activities Cash flow from financing activities Proceeds from issue of ordinary shares Repayment of long-term loan Net cash outflow from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents beginning of year Cash and cash equivalents end of year 756 (415 341 (16 (69 000 000) 000 000) 000) R

256 000

(180 000) 126 000 54 000 (150 000) 150 000 2 000 54 000 24 000

(250 000)

110 000 (200 000) (90 000) (84 000) 76 000 (8 000)

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Calculations 1. Cash receipts from customers

Trade and other receivables R 220 000 750 000 970 000 R 756 000 214 000 970 000

Balance Sales * Balancing figure

b/d

Bank* Balance

c/d

2. Cash paid to suppliers and employees

Cash paid to suppliers and employees R 154 000 415 000 139 000 R Balance (Trade and other payables) Cost of sales Administrative & selling expenses Balance (inventory) b/d 142 000 300 000 88 000 178 000 708 000

Balance (inventory) b/d Bank* Balance (trade and other payables) c/d

c/d

708 000 * Balancing figure

3. Tax paid
Unpaid amounts beginning of year Amounts debited to income Unpaid amounts end of year 28 85 (44 69 000 000 000) 000

4. Dividends paid
Unpaid amounts beginning of year Amounts debited to income Unpaid amounts end of year 16 000 24 000 (24 000) 16 000

5. Ledger accounts
Property R 1 400 000 200 000 150 000 1 750 000 R 1 750 000

Balance Revaluation Purchases

b/d

Balance

c/d

1 750 000

Motor vehicles at cost R 410 000 54 000 464 000 R 28 000 436 000 464 000

Balance New purchases * Balancing figure

b/d

Sales* Balance

c/d

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Accumulated depreciation motor vehicles R 26 000 76 000 102 000 R 54 000 48 000 102 000

Sales* Balance * Balancing figure

c/d

Balance Depreciation

b/d

Machinery at cost R 370 000 126 000 496 000 R 111 000 385 000 496 000

Balance New purchases*

b/d

Sales (60 000 + 51 000) Balance

c/d

* Balancing figure Accumulated depreciation machinery R 51 000 141 000 192 000 R 120 000 72 000 192 000

Sales Balance

c/d

Balance Depreciation

b/d

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Solution Question 2

B LTD
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 28 FEBRUARY 19.5
R Cash flow from operating activities Profit before tax Adjustments for: Depreciation Decrease in allowance for credit losses Profit on sale of non-current assets Loss on sale of investments Operating profit before changes in working capital Changes in working capital Decrease in inventory (15 000 7 19 000) Increase in trade and other receivables (18 000 7 15 400) Decrease in trade and other payables (7 400 7 11 300) Net cash generated by operations Dividends paid Tax paid Net cash inflow from operating activities Cash flow from investing activities Investment to maintain production capacity Replacement of machinery Proceeds from sale of non-current assets Proceeds from sale of investments Net cash outflow from investing activities Cash flow from financing activities Redemption of long-term loan Net cash outflow from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents beginning of year Cash and cash equivalents end of year (8 000) 8 000 2 500 2 000 (3 500) (10 000) (10 (6 14 8 000) 000) 000 000 R 13 500 42 600 (200) (1 000) 400 55 300 (2 500) 4 000 (2 600) (3 900) 52 (40 (5 7 800 000) 300) 500

Calculations 1. Tax paid

Unpaid amounts beginning of year Amount debited to income Unpaid amounts end of year R 3 800 5 500 (4 000) 5 300 10 000 50 000 (20 000) 40 000

2. Dividends paid
Unpaid amounts beginning of year Amount debited to income Unpaid amounts end of year

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3.

Machinery R 52 300 8 000 60 300 R 45 500 14 800 60 300

Balance New purchases* * Balancing figure

b/d

Sales Balance

c/d

4.

Accumulated depreciation machinery R 44 000 3 400 47 400 R 4 800 42 600 47 400

Sales Balance

c/d

Balance Depreciation current year

b/d

Question

W CLOSE CORPORATION
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 19.2
Cash flow from operating activities Cash receipts from clients (calculation 1) Cash paid to suppliers and employees (calculation 2) Cash generated by operations Interest received (calculation 3) Interest paid (calculation 4) Dividends received Distributions paid to members (calculation 5) Normal tax paid (calculation 6) Net cash inflow from operating activities Cash flow from investing activities Investment to maintain production capacity Replacement of motor vehicle (calculation 7) Investment to expand production capacity Additions to land (calculation 7) Proceeds from sale of investments Net cash outflow from investing activities Cash flow from financing activities Decrease in long-term loan (calculation 8) Increase in members' contributions Net cash inflow from financing activities Net increase in cash and cash equivalents Cash and cash equivalents beginning of year Cash and cash equivalents end of year R 169 400 (100 69 1 (3 1 (1 (7 000) 400 650 350) 800 600) 200) 60 700 (45 500) 45 (40 40 12 500 000) 000 000 (73 500) (4 300) 30 000 25 700 12 900 (12 000) 900 R

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Calculations 1. Cash receipts from clients

Trade and other receivables R 16 000 177 400 193 400 R 169 400 24 000 193 400

Balance Sales * Balancing figure

b/d

Bank* Balance

c/d

2.

Cash paid to suppliers and employees R 42 000 100 000 19 500 161 500 R Balance (trade and other payables) Cost of sales Administrative expenses Balance (inventories) b/d 16 100 10 34 161 700 000 800 000 500

Balance (inventories) b/d Bank* Balance (trade and other payables) c/d

c/d

* Balancing figure

3. Interest received
Mr A 15% 6 11 000

R 1 650

4. Interest paid
Interest on debentures (5% 6 40 000) Interest paid to Mr B (15% 6 9 000) 2 000 1 350

5. Distributions paid to members

Unpaid at beginning of year Amount debited to profit Unpaid at end of year 4 900 6 000 (9 300) 1 600

6. Tax paid
Paid in advance at beginning of year Amount debited to profit Paid in advance at end of year (8 500) 7 000 8 700 7 200

7. Ledger accounts
Land and buildings R 100 000 40 000 40 000 180 000 R 180 000

Balance Revaluation Addition*

b/d

Balance

c/d

180 000

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Motor vehicles R 60 000 45 500 105 500 R 20 000 85 500 105 500

Balance Replacement*

b/d

Vehicle scrapped Balance

c/d

Accumulated depreciation R 8 000 35 500 43 500 R 20 000 23 500 43 500

Vehicle scrapped Balance * Balancing figure

c/d

Balance Depreciation*

b/d

8. Decrease in long-term loan

Redemption of debentures (100 6 103) Increase in loan from member (15 000 7 9 000)

R (10 300) 6 000 (4 300)

SELF-ASSESSMENT After studying this topic, are you able to:

. .

draft a statement of cash flows for a company and a close corporation using the direct method? draft a statement of cash flows for a company and a close corporation using the indirect method?

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TOPIC C

EARNINGS PER SHARE (IAS 33/AC 104) 104)

Learning outcome
Learners should be able to calculate and disclose earnings and dividends per share in accordance with IAS 33/AC 104.

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CONTENTS

Study unit

Page

Earnings per share

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STUDY UNIT

1
Earnings per share

Learning outcome
. . Learners can calculate earnings and dividends per share. Learners can disclose earnings and dividends per share.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 1.1 1.2 1.3 1.4 1.5 1.6 1.7 Introduction Scope Definitions and measurement Presentation Disclosure Different classes of shares . Participating preference shares Changes in capital structure 1.7.1 Shares issued for consideration . . . . . Shares issued at fair market value Shares issued for the acquisition of an asset Business combination which is an acquisition Rights issue at fair value Bonus issue/Capitalisation issue

236 236 236 237 237 241 241 241 241 244 244 246 247 248 250 252 253

1.7.2 Shares issued for no consideration

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. . . . 1.8 1.9

Share and capitalisation issue Rights issue at less then fair value Share split Share consolidation

254 255 259 262 264 266 269 271 274

Headline earnings Dividends per share Solutions Self-assessment

1.10 Exercises

KEY CONCEPTS
. . . . . . . . . . . .

Earnings per share Dividend per share Equity shares Earnings Share issues Rights issues Fair value Capitalisation issues Share split Share consolidation Participating shares Headline earnings

ASSESSMENT CRITERIA After studying this topic, you should be able to:
.

calculate basic earnings, headline earnings and dividends per share and disclose them in the annual financial statements according to IAS 33/AC 104.

1.1 INTRODUCTION
Earnings per share and dividends per share are two of the ratios that are most widely used by investors and analysts of financial statements when evaluating the profitability of a company. It is therefore essential that guidelines should be laid down for the calculation and disclosure of earnings and dividends per share and, where applicable, fully diluted earnings per share in order to make it easier to compare these ratios.

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1.2 SCOPE
IAS 33/AC 104 is applicable to: companies listed on a recognised stock exchange such as the Johannesburg Stock Exchange . other companies whose shares are openly traded, that is unlisted public companies . companies other than (1) and (2), such as any private company that prefers to disclose earnings and dividends per share
.

1.3 DEFINITIONS AND MEASUREMENT

Since the definitions contained in IAS 33/AC 104 are extremely important, you should study them thoroughly.

Ordinary shares
An ordinary share is an equity instrument that is subordinate to all other classes of equity instruments. Section 1 of the Companies Act 1973, defines equity shares of a company as being ``the company's issued share capital and shares, excluding any part thereof which, neither in respect of dividends nor in respect of capital, carries any right to participate beyond a specific amount in a distribution.'' Preference shares that do not share in an asset surplus or dividends over and above their fixed preference right, do not form part of a company's equity share capital. Ordinary shares can only participate in the profit for the period after other types of shares, such as preference shares, have been allocated their portion.

Potential ordinary shares

A potential ordinary share is a financial instrument or other contract that may entitle its holder to ordinary shares. Examples of potential ordinary shares are: Debt or equity instruments, including preference shares, that are convertible into ordinary shares. . Share warrants and options (these are financial instruments that give the holder the right to purchase ordinary shares). . Shares which would be issued upon the satisfaction of certain conditions resulting from contractual arrangements, such as the purchase of a business or other assets.
.

Basic earnings
Basic earnings are the profit or loss for the period attributable to ordinary shareholders after deducting preference dividends. All items of income and expense that are recognised in a period, including tax expense and non-controlling interests are included in the determination of the profit or loss for the period. The amount of preference dividends that is deducted from the profit for the period is as follows:

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Cumulative preference dividends The preference dividends for the current period are taken into account irrespective of whether or not they are paid or declared. This amount excludes any dividend paid or declared to cumulative preference shares in respect of previous periods.

Non-cumulative preference dividends This preference dividend is only taken into account if the dividend was declared during the period under review.

Where a loss is incurred for a period, the same calculation is done as for earnings per share.

Example

1
Earnings
The following is an extract from the statement of comprehensive income of a listed company: R Profit 89 500 Finance charges (interest paid) (1 500) Income from associates 4 000 92 000 Profit before tax Income tax expense 42 000 50 000 Profit for the year Other comprehensive income 50 000 Total comprehensive income for the year

The following information was obtained from the statement of changes in equity Reserve for asset replacement R Total comprehensive income for the year Dividends preference shares ordinary shares Transfer to reserve Balance end of period Retained earnings R 50 (12 (10 (5 23 000 000) 000) 000) 000

Total R 50 000 (12 000) (10 000) 28 000 R 88 000 (42 000) (12 000)

5 000 5 000

Basic earnings are defined and calculated as follows: Profit for the year, including significant items after tax after fixed preference dividends but before transfers to and from reserves and include attributable profit after tax of associates and non-consolidated subsidiaries which has been accounted for by the equity method

4 000

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Earnings

38 000

Alternative methods to calculate basic earnings:

(1) Profit for the year Preference dividends Earnings 50 000 (12 000) 38 000

(2) Retained earnings end of year Less: Retained earnings beginning of period Add back: Transfer to reserve Ordinary dividends Earnings

R 23 000 ( ) 5 000 10 000 38 000

Weighted average number of shares

Weighted average number of shares are defined as ``the number of ordinary shares outstanding at the beginning of the period, adjusted by the number or ordinary shares bought back or issued during the period multiplied by a time-weighting factor.'' The time weighting factor is the number of days that the specific shares are outstanding as a proportion of the total number of days in the period. A reasonable approximation of the weighted average is adequate in many circumstances. In most cases shares are included in the weighted average number of shares from the date consideration is receivable (which is generally the date of their issue), for example: . ordinary shares issued in exchange for cash are included when cash is receivable.

Example

2
The definition given for the weighted average number of shares may be illustrated as follows: Suppose a company had a 31 December year-end and there are 100 000 issued ordinary shares at the beginning of 19.1. On 1 April 19.1 a further 50 000 ordinary shares were issued. Since the shares issued on 1 April 19.1 were only entitled to share in profits from this date onwards, the weighted average number of shares for 19.1 would be 137 500, calculated as follows: Original number of shares Shares issued on 1 April 19.1 (50 000 6 9/12) 100 000 37 500 137 500

Basic earnings per share

Basic earnings per share should be calculated by dividing the profit or loss for the period attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period.

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Example

CAT LIMITED
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.9
Revenue Cost of sales Gross profit Operating costs Income from associates Profit before tax Income tax expense Current Deferred Profit for the year Other comprehensive income Total comprehensive income for the year R 10 000 000 (5 000 000) 5 000 000 (1 000 000) 50 000 4 050 000 (1 350 000) 1 175 000 175 000 2 700 000 2 700 000

EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.9
Retained earnings R 500 000 2 700 000 (600 000) 100 000 500 000 2 600 000

Balance at 31 December 19.8 Total comprehensive income for the year Dividends Preference Ordinary Balance at 31 December 19.9

The issued share capital of Cat Limited since incorporation is 500 000 ordinary shares of R1 each and 1 000 000 10% cumulative preference shares of R1 each. Basic earnings Profit for the period Preference dividends Basic earnings per share is therefore: R2 600 000 500 000 = 520 cents R 2 700 000 (100 000) 2 600 000

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1.4 PRESENTATION
An enterprise should present:
. . . .

on the face of the statement of comprehensive income, for each class of ordinary shares, with equal prominence, for all periods presented,

basic earnings per share (including a loss per share).

1.5 DISCLOSURE
An enterprise should disclose the following for basic earnings per share: 1. Earnings: The earnings amount used in the calculation. . Reconciliation of the earnings amounts used in the calculation to the profit or loss for the period in the statement of comprehensive income.
.

2. Per share:
. .

The weighted average number of ordinary shares used. Reconciliation between the number of shares used for basic earnings per share.

If an enterprise discloses, in addition to basic earnings per share, per share amounts using a reported component of profit other than profit or loss for the period attributable to ordinary shareholders, such amount should be calculated using the weighted average number of ordinary shares. If a component of profit is used which is not reported as a line item in the statement of comprehensive income, a reconciliation should be provided between the component used and a line item which is reported in the statement of comprehensive income.

1.6 DIFFERENT CLASSES OF SHARES

Participating preference shares
Participating preference shares are shares whose holders are entitled, in addition to receiving their fixed preference dividend, to share along with the ordinary shareholders in the remainder of the distributable profit, either pro rata or after ordinary shareholders have received a certain minimum dividend. It is important to take careful note of the conditions of issue and of the capital structure, for example: ``One cent per share for every four cents per share paid to ordinary shareholders'' does not necessarily mean that preference shareholders share one-fifth of the profits.

Example

500 000 Ordinary shares

200 000 Participating preference shares In this case the participating rights would be as follows: R 500 000 6 4 cents 200 000 6 1 cent 20 000 2 000 22 000 % Participation 90,9 9,1 100,0
20 000 ( 22 000 ) 2 000 ( 22 000)

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Example

2
500 000 Ordinary shares 500 000 Participating preference shares R 500 000 6 4 cents 500 000 6 1 cent 20 000 5 000 25 000 % Participation 80 20 100
000 ( 20 000) 25 5 000 (25 000)

Suppose the conditions of issue lay down that participating preference shares will share in dividends in the ratio of 1 of the total dividend earned by ordinary shareholders over and 8 above the fixed preference dividend and earnings of R100 000 are assumed, then the earnings allocated to each of the two classes will be calculated as follows: Ordinary shareholders Participating shareholders R 88 889 11 111 100 000 () ~ () ~

If the participating shareholders receive an additional share of profits after the ordinary shareholders have received a certain minimum dividend, the earnings are distributed between the ordinary shareholders and the participating preference shareholders, calculated after the minimum dividend of the ordinary shareholders has been deducted. This principle is illustrated in the following example:

Example

3
More than one class of equity shares
Sanfred Ltd had the following capital structure at 31 December 19.1: R 1 000 000 500 000

4 000 000 Ordinary shares of 25c each 500 000 10% R1 Cumulative participating preference shares

Each participating preference share is entitled to one-half of the ordinary dividend per share after the payment of dividends of 10 cents per share to the ordinary shareholders. Profit after tax for the year ended 31 December 19.1 amounted to R1 130 000. An ordinary dividend of 15 cents per share was paid during 19.1.

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Calculations
Total R Ordinary shares R Participating preference shares R

1. Participating rights
4 000 000 6 1 cent 500 000 6 cent Percentage
40 000 6 100% 42 500 2 500 6 100% 42 500

40 000 2 500 42 500 100% 17

40 000 40 000 94,1% 16

2 500 2 500 5,9% 1

Ratio (94,1 7 5,9); (5,9 7 5,9)

2. Earnings
Profit Fixed preference dividend (500 000 6 10%) Minimum ordinary dividend (4 000 000 6 10c) Profit to divide between ordinary and preference shares
16 Ordinary: 680 000 6 17

1 130 000 (50 000) 1 080 000 (400 000)

50 000

400 000

680 000 640 000 40 000 1 040 000 90 000

Preference: 680 000 6

1 17

3. Dividends
Ordinary shares (4 000 000 6 15 cents) Participating preference shares Fixed dividend Participating dividend ~ 6 [500 000 6 (15c 7 10c)] 600 000 600 000

50 000 12 500 662 500 600 000

50 000 12 500 62 500

4. Number of shares
Given 4 000 000 500 000

5. Figures to disclose
Earnings per share Dividend per share 26c 15c 18c 12,5c

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Disclosure
1. On the statement of comprehensive income under total comprehensive income for the year: 19.1 Basic earnings per ordinary share 26c Basic earnings per cumulative participating preference share 18c 2. Part of the notes: Earnings per share The calculation of earnings per share is based on earnings attributable to the 10% cumulative participating preference shares of R90 000 (19.0: Rxxx) and the earnings of R1 040 000 (19.0: Rxxx) on the ordinary shares. 500 000 (19.0: xxx) 10% cumulative participating preference shares and 4 000 000 (19.0: xxx) ordinary shares were issued throughout the two years ended 31 December 19.1. Reconciliation of amounts used to calculate basic earnings per share with amounts in statement of comprehensive income R Earnings used in basic earnings per ordinary share Earnings used in basic earnings per cumulative participating preference shares Profit per statement of comprehensive income 1 040 000 90 000 1 130 000

Dividends per share Dividend attributable to ordinary owners (15c per share) Dividend attributable to participating preference owners (12,5c per share)

1.7 CHANGES IN CAPITAL STRUCTURE

1.7.1 Shares issued for consideration
Shares are included in the weighted average number of shares from the date consideration is receivable. The date on which the shares were issued is not of any importance when calculating basic earnings per share if that is a different date from when the consideration is receivable. When calculating earnings per share, the new shares issued must be weighted according to the date that the consideration was receivable but the number of shares in issue in the previous year must not be weighted. The reason why the shares of the previous year are not weighted is because the consideration for the additional shares is received in the current year and therefore does not influence the calculation of the number of shares of the previous year.

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The following are examples: Consideration received for share issue 1. Cash 2. Voluntary reinvestment of dividends on ordinary or preference shares 3. Conversion of a debt instrument to ordinary shares 4. Interest on other financial instrument 5. Settlement of a liability 6. Acquisition of an asset other than cash 7. Rendering of services 8. Ordinary shares issued as part of the purchase consideration of a business combination that is an acquisition Date of inclusion in calculation of earnings per share When cash is receivable Dividend payment date

Date interest ceases to accrue

Date interest ceases to accrue Settlement date Date on which the acquisition is recognised Date or period for which the services are rendered. From the date of acquisition because the acquirer incorporates the results of the operations of the acquiree into its statement of comprehensive income as from the date of acquisition.

Please note that none of the above examples will influence the calculation of the number of shares of the previous year. Ordinary shares which are issuable upon the satisfaction of certain conditions (contingently issuable shares) are considered outstanding, and included in the computation of basic earnings per share from the date when all necessary conditions have been satisfied. The shares are therefore taken into account in the calculation of the weighted number of shares from the date that the company has additional earnings capacity because of the new shares issued, for example if the shares are issued for cash, then the earnings capacity of the company will only increase from the date that the additional cash is available to that company.

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Example

1
Share issues at fair market value
Since incorporation A Ltd has had an authorised share capital of 2 000 000 ordinary shares of R1,50 each and 250 000 8% non-cumulative preference shares of R1 each. The issued share capital was as follows: Ordinary shares Issued on incorporation 30 June 19.5 31 December 19.6 Preference shares Issued on incorporation 31 December 19.6 150 000 at R1,20 each 50 000 at R2,00 each 1 000 000 at R1,80 each 500 000 at R2,00 each 250 000 at R3,00 each

Profit/(loss) after tax amounted respectively to R500 000 and (R120 000) for the years ended 30 June 19.7 and 30 June 19.6. Since incorporation the company has paid a preference dividend every year, except the year ended 30 June 19.6.

Calculations
Equity shares Issued on incorporation 30 June 19.5 6 ) 31 December 19.6 (250 000 6
12

Total

1/7/19.6 to 30/6/19.7 1 000 500 125 1 625 000 000 000 000

1/7/19.5 to 30/6/19.6 1 000 000 500 000 1 500 000 R (120 000) (120 000)

1 000 500 250 1 750

000 000 000 000

Earnings/(loss) Profit/(loss) after tax Preference dividend [(150 000 6 8%) + (50 000 6 8% 6
6 )] 12

R 500 000 (14 000) 486 000

Disclosure
1. On the statement of comprehensive income under total comprehensive income for the year: Earnings per ordinary share (R486 000 7 1 625 000) Loss per ordinary share (R120 000 7 1 500 000) 2. Part of notes: Earnings per share The calculation of earnings/(loss)per share is based on earnings of R486 000 (19.6 loss R120 000) and a weighted number of issued ordinary shares of 1 625 000 (19.6 1 500 000). 19.7 29,91c 19.6 8c

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Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.7 19.6 R R Earnings (loss) basic earnings per share 486 000 (120 000) Preference dividends 14 000 500 000 (120 000) Profit (loss) per statement of comprehensive income

COMMENT
Since the preference shares are not cumulative preference shares, no provision is made for arrear preference dividends in respect of 19.6.

Example

2
Shares issued for the acquisition of an asset
Duffield Ltd's issued share capital consisting of ordinary shares with a nominal value of 50 cents each amounted to R2 500 000 at 31 December 19.1 and to R2 000 000 at 31 December 19.0. On 1 September 19.1 the company issued 1 000 000 ordinary shares at R1 per share (which represented the market price of the shares at closing time on 31 August 19.1) as payment for an empty industrial stand on which a factory was to be built. The risks and remuneration in relation to the right of ownership of the stand were transferred to Duffield Ltd on 1 October 19.1. The weighted average numbers of shares that will be brought into account are as follows: Total Equity shares Number of shares issued on 1 January 19.0 (R2 000 000 7 50c) Shares issued 1 September 19.1 but that will only come into consideration for dividends on 1 October 19.1 3 ) (1 000 000 6
12

19.1

19.0

4 000 000

4 000 000

4 000 000

1 000 000 5 000 000

250 000 4 250 000

4 000 000

Share issues in exchange for shares in another company are essentially the same as where shares are issued for the acquisition of an asset. As in the case of the acquisition of an asset, the equity shares for the purposes of calculating earnings per share are regarded as having been issued on the date on which the income from the investment in the shares was included in earnings. Where the income of the company whose shares have been acquired is included with that of the company which issued the shares from a date other than the date on which the shares were issued as remuneration, the shares are considered to have been issued on the same date as the date on which the income was included. This will ensure that when earnings per share are calculated the period for which income was included corresponds to the period for which the shares are weighted.

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Where preference shares or debentures are issued in part or full payment for shares acquired in another company and the date on which the preference dividends or debenture interest begins to accumulate differs from the date from which income from the investment in shares is included in earnings, the problem which arises is that the cost of acquiring the asset is not matched with the income generated by the investment (matching concept).

Example

3
Business combination which is an acquisition
Kopke Limited had the following number of issued shares at 31 December 19.0 and 19.1: Ordinary shares of 25c each 10% Cumulative preference shares of R1 each 19.1 6 000 000 1 000 000 19.0 4 000 000 500 000

On 1 April 19.1 Kopke Limited obtained full control (100%) over Oorke Limited. On 1 July 19.1 Kopke Limited issued 500 000 preference shares and 2 000 000 ordinary shares as consideration for the acquisition of the shares in Oorke Limited. The new preference shares ranked for dividends from 1 July 19.1. The profit for the year and ordinary dividends paid of Kopke Limited and Oorke Limited for the years ended 31 December 19.0 and 19.1 are as follows: Kopke Limited Profit for the year Dividends paid Oorke Limited Profit for the year Dividends paid REQUIRED Disclose the basic earnings per share in the consolidated annual financial statements of Kopke Limited and its subsidiary for the year ended 31 December 19.1 to comply with Generally Accepted Accounting Practice. Comparative figures are required. 100 000 50 000 85 000 30 000 19.1 R 475 000 200 000 19.0 R 450 000 150 000

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Solution Calculations 1. Basic earnings

19.1 R Profit for the year Kopke Limited Oorke Limited Preference dividends 475 75 550 (75 475 000 0001 000 000)2 000 450 000 450 000 (50 000) 400 000 19.0 R

2. Weighted average number of shares

Total number of shares 4 000 000 2 000 000 6 000 000 Weighted average number of shares 19.1 9.0 4 000 000 1 500 0003 5 500 000 4 000 000 4 000 000

Original number of shares at 1 January 19.0 Issued 1 July 19.1 but assumed to rank from 1 April 19.1

3. Basic earnings per share

19.1 Basic earnings per equity share (in cents) (475 000/5 500 000); (400 000/4 000 000) Explanatory notes
1

19.0 10,00

8,64

Control was effectively obtained from 1 April 19.1 and from that date the profit of Oorke Limited must be 9 included with the profit of Kopke Limited ; R100 000 6 12 = R75 000. New preference shares ranked for dividends from 1 July 19.1 ; R(500 000 6 10%) + R(500 000 6 6 10% 6 12 ) = R75 000. To accomplish the matching of cost with profit, the preference dividend should be provided for 9 months instead of 6 months when calculating earnings per share, or alternatively the fact that profit is included for 9 months and dividends are provided for only 6 months must be disclosed. 2 000 000 6
9 12

= 1 500 000 shares

Disclosure
1. On the face of the statement of comprehensive income beneath total comprehensive income for the year Basic earnings per share (in cents) 19.1 8,64 19.0 10,00

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2. As part of the notes Basic earnings per share The calculation of basic earnings per share is based on earnings of R475 000 (19.0: R400 000) and 5 500 000 (19.0: 4 000 000) ordinary shares as if the additional 2 000 000 ordinary shares issued on 1 July 19.1 had been issued on 1 April 19.1, the date from which the profit from the subsidiary was included in profit.

Reconciliation of amounts used to calculate basic earnings per share with amounts in statement of comprehensive income
Earnings basic earnings per share Preference dividends Profit per the statement of comprehensive income 19.1 R 475 000 75 000 550 000 19.0 R 400 000 50 000 450 000

Example

4
Rights issue at fair value (refer commentary)
The following abridged statement of comprehensive income of A Ltd is submitted to you:

STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.2

19.2 R 121 200 (38 200) 10 000 25 000 3 200 83 000 (50 000) 33 000 33 000 19.1 R 110 000 (32 000) 8 000 24 000 78 000 (44 000) 34 000 34 000

Income Disclosable expenses Auditors' remuneration Depreciation Loss on sale of plant Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

The issued share capital of A Ltd consisted of 100 000 ordinary R1 shares at 30 June 19.0. At 31 December 19.1 A Ltd had a rights issue of 80 000 shares at a fair value of R1,80 per share.

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EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.2
Reserve for asset replacement R Balance at 30 June 19.0 Total comprehensive income for the year Dividends paid Ordinary shares Preference shares Transfer to reserve Balance on 30 June 19.1 Total comprehensive income for the year Dividends paid Ordinary shares Preference shares Transfer to reserve Balance at 30 June 19.2 Retained earnings R 15 000 34 000 (15 000) (8 000) (5 000) 21 000 33 000 (10 000) (8 000) (5 000) 31 000

Total R 15 000 34 000 (15 000) (8 000) 26 000 33 000 (10 000) (8 000) 41 000

5 000 5 000

5 000 10 000

Calculations
Earnings Total comprehensive income for the year Preference dividends Equity Balance Issued 31/12/19.1 (80 000 x 6/12) Total 100 000 80 000 180 000 19.2 R 33 000 (8 000) 25 000 19.2 100 000 40 000 140 000 R 10 000 19.2 R25 000 140 000 = 17,85 cents R10 000 180 000 = 5,55 cents 19.1 R 34 000 (8 000) 26 000 19.1 100 000 100 000 R 15 000 19.1 R26 000 100 000 = 26 cents R15 000 100 000 = 15 cents

Dividends Given Earnings and dividend per ordinary share Basic earnings per share

Dividend per share

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Disclosure

A LTD
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.2
Profit for the year Basic earnings per equity share 19.2 R 33 000 17,85c 19.1 R 34 000 26c

NOTES FOR THE YEAR ENDED 30 JUNE 19.2

Earnings per share The calculation of earnings per share is based on earnings of R25 000 (19.1: R26 000) and on an average number of 140 000 weighted ordinary shares in issue during the year (19.1: 100 000). Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.2 R 25 000 8 000 33 000 19.1 R 26 000 8 000 34 000

Earnings basic earnings per share Cumulative preference dividends Profit per statement of comprehensive income Dividends per share Dividends attributable to ordinary owners

5,55c

15c

COMMENT
. A rights issue is an issue to existing shareholders of the company for consideration. . Since 180 000 shares were in issue at 30 June 19.2 when the dividend of R10 000 was declared, the dividend per share is calculated accordingly and the weighted average of 140 000 shares plays no part.

1.7.2 Shares issued for no consideration

Where reserves, such as non-distributable reserves, are capitalised by issuing equity shares, the earnings and dividend per share must be based on the increased weighted average number of issued shares after the capitalisation issue. When there is a capitalisation issue, no additional capital is acquired and the company merely makes a book entry. The reserves that were capitalised and for this reason the number of shares issued as a capitalisation issue are not weighted for the period of issue. The comparative figures (earnings and dividends per share) should also be adjusted by the increase in the number of shares, if they are to be comparable. Where shares are split, say from R1 shares to 50c shares, or where shares are consolidated and no repayment of capital takes place, the same principle applies as in the case of capitalisation issues.

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Ordinary shares may be issued or the number of shares outstanding may be reduced without a corresponding change in resources. This means that even though the number of shares changed during the year, no consideration was received, therefore the earnings capacity of the company did not change. Examples include the following:
. . . .

a a a a

capitalisation or bonus issue bonus element in a rights issue share split reverse share split (consolidation of shares)

Note that in the above cases the number of shares are not weighted when calculating basic earnings per share. The number of ordinary shares outstanding before the event is adjusted for the proportionate change in the number of ordinary shares outstanding as if the event had occurred at the beginning of the earliest reported period i.e. the beginning of the prior year. The number of shares are only weighted if the capitalisation issue (or other examples mentioned above) follows a rights issue in the same year. The capitalisation issue is then only weighted with regard to this rights issue. Work through the following examples carefully:

Example

1
Bonus issue/Capitalisation issue
Zinzan Limited had the following number of issued shares on 31 December 19.5 and 19.6: Ordinary shares of R1 each 19.6 600 000 19.5 200 000

On 1 April 19.6 the company made a bonus issue of 2 shares for each ordinary share outstanding on 31 March 19.6. The profit for the year amounted to R200 000 for 19.5 and R400 000 for 19.6. REQUIRED Calculate earnings per share for the years ended 31 December 19.5 and 31 December 19.6 for Zinzan Limited in accordance with the requirements of Generally Accepted Accounting Practice.

Solution

1
Bonus issue 1 April 19.6 200 000 6 2 = 400 000 shares 19.6 66,7 19.5 33,3

Basic earnings per share (in cents) (400 000/600 000; 200 000/600 000)

Note that since the bonus issue is an issue without consideration, the issue is treated as if it had occurred at the beginning of 19.5, the earliest period reported.

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Example

2 Share and capitalisation issue

Bambino Limited had the following number of issued shares on 31 December 19.0 and 19.1: 19.1 10 000 000 500 000 19.0 4 000 000 500 000

Ordinary shares of 25c each 10% Cumulative preference shares of R1 each

During 19.1 the following changes in the capital structure of Bambino Limited took place: (1) On 1 July 19.1 the company issued 1 000 000 ordinary shares at R1 per share for full value. (2) On 1 October 19.1 the company issued 5 000 000 ordinary shares by way of a capitalisation of reserves in the ratio of 1 share for every 1 share held. The profit for the period amounted to R600 000 for 19.1 (19:0: R450 000). REQUIRED Disclose the basic earnings per share in the annual financial statements of Bambino Limited for the year ended 31 December 19.1 to comply with Generally Accepted Accounting Practice. Comparative figures are required.

Solution

2 Calculations 1. Basic earnings

19.1 R 600 000 (50 000) 550 000 19.0 R 450 000 (50 000) 400 000

Profit for the year Cumulative preference dividends (500 000 6 10%)

2. Weighted average number of shares

Total Original number of shares at 1 January 19.0 6 Issued 1 July 19.1 (1 000 000 6 12 ) Capitalisation issue 1 October 19.1 4 000 000 1 000 000 5 000 000 5 000 000 10 000 000 19.1 4 000 000 500 0001 4 500 000 4 500 0002 9 000 000 19.0 4 000 000 4 000 000 4 000 0002 8 000 000

3. Basic earnings per share

Basic earnings per share (in cents) (550 000/9 000 000);(400 000/8 000 000) 19.1 6,1 19.0 5,0

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Disclosure BAMBINO LIMITED

1. On the face of the statement of comprehensive income beneath profit for the year 19.1 19.0 Basic earnings per ordinary share (in cents) 6,1 5,0 2. As part of the notes Basic earnings per share The calculation of basic earnings per ordinary share is based on earnings of R550 000 (19:0: R400 000) and a weighted average of 9 000 000 (19.0:8 000 000) ordinary shares in issue after the capitalisation issue on 1 October 19.1. The earnings per share for 19.0 has been adjusted accordingly. Reconciliation of amounts used to calculate basic earnings per share with amounts in statement of comprehensive income 19.1 19.0 R R Earnings basic earnings per share 550 000 400 000 Cumulative preference dividends 50 000 50 000 600 000 450 000 Profit per statement of comprehensive income

COMMENT
1

New share issue during the year since the shares did not contribute towards the earnings capacity of the company for the full year, the number of shares has to be weighted for the period it contributed towards earnings. It has no effect on the calculation of the number of shares for 19.0 because the shares were not issued during 19.0. The capitalisation issue was done after the new issue of shares in a 1 to 1 ratio and it is therefore necessary to consider the effect of the new issue on the capitalisation issue. Because the new shares were not issued for the full year, they have to be weighted. Therefore the capitalisation shares effected by the new issue will also have to be weighted for 19.1. 19.0 must be adjusted by the effect of the capitalisation issue in 1 to 1 ratio. This result in a different number of shares for the capitalisation issue over the two years, which would not have been the case had the capitalisation issue taken place before the new issue of shares.

Rights issue at less than fair value

If a company raises capital by means of a rights issue and the issue price is less than the fair value of the company's shares when issued, a bonus element arises. The number of ordinary shares to be used in calculating basic earnings per share for all periods prior to the rights issue is the number of ordinary shares outstanding prior to the issue, multiplied by the following factor:

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Fair value per share immediately prior to the exercise of rights Theoretical ex-rights fair value per share The theoretical ex-rights fair value per share is calculated as follows: Aggregate fair value of shares immediately prior to the exercise of the rights + Proceeds from the exercise of the rights Number of shares outstanding after the exercise of the rights OR Fair value of outstanding shares + Amount received from rights issue Number of shares outstanding prior to rights issue + Number of shares issued with rights issue

COMMENT
. Where the rights themselves are to be publicly traded separately from the shares prior to the exercise date, fair value is established at the close of the last day on which the shares with the rights are traded. . In above formula outstanding shares represent issued shares.

Example

3 Rights issue at less than fair value

The following is an extract from the statement of comprehensive income of Wesson Limited for the year ended 31 December 19.5: 19.5 R Revenue Cost of sales Gross profit Expenses Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 2 500 000 (1 500 000) 1 000 000 (400 000) 600 000 (180 000) 420 000 420 000 19.4 R 2 300 000 (1 000 000) 1 300 000 (550 000) 750 000 (300 000) 450 000 450 000

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EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.5
Retained earnings R Balance at 31 December 19.3 Total comprehensive income for the year Balance at 31 December 19.4 Total comprehensive income for the year Dividends Non-cumulative preference Ordinary Cumulative preference Balance at 31 December 19.5 The capital structure on 31 December was as follows: 19.5 Ordinary shares of R1 each 10% Cumulative preference shares at R1 each 20% Non-cumulative preference shares of R1 each 800 000 100 000 50 000 19.4 500 000 100 000 50 000 50 450 500 420 (60 000 000 000 000 000)

(10 000) (30 000) (20 000) 860 000

Additional information
1. On 30 April 19.5 Wesson Limited had a rights issue of 1 ordinary share for every 5 ordinary shares held at R2,00 per share for cash. The market price prior to the announcement of the rights issue was R3,50 per share. Management considered, that for the issue to be successful, they could have issued the shares at R3,00, which was their fair value. 2. On 30 June 19.5 Wesson Limited had a capitalisation issue of 1 ordinary share for every 3 ordinary shares held. REQUIRED Calculate and disclose basic earnings per share in the financial statements of Wesson Limited for the year ended 31 December 19.5 in accordance with Generally Accepted Accounting Practice. Notes and comparative figures are required.

Calculations
Weighted average number of ordinary shares: Theoretical ex-rights value per share: Fair value of outstanding shares + amount received from rights issue Number of shares outstanding prior to rights issue + number of shares issued with rights issue = (500 000 6 R3) + (100 000 6 R2) 500 000 + 100 000 = 2,8333333

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Adjustment factor: Fair value per share prior to rights issue Theoretical ex-rights value per share = 3 / 2,8333333 = 1,0588235 Weighted average number of shares: 19.5 Calculation Rights issue 500 000 6 1,0588235 6 4/12 600 000 6 8/12 19.5 Number of shares 176 471 400 000 576 471 576 471/3 192 157 768 628 529 412/3 19.4 Calculation 500 000 6 1,0588235 19.4 Number of shares 529 412 529 412 176 471 705 883

Subtotal Capitalisation issue Total

Basic earnings per share: 19.5 R400 000/768 628 R440 000/705 883 52,04c 19.4 62,33c

Disclosure

WESSON LIMITED
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.5
19.5 R Total comprehensive income for the year Basic earnings per ordinary share 420 000 52,04c 19.4 R 450 000 62,33c

WESSON LIMITED
NOTES FOR THE YEAR ENDED 31 DECEMBER 19.5
Basic earnings per share The calculation of basic earnings per ordinary share is based on earnings of R400 000 (19.4: R440 000) and a weighted average of 768 628 (19.4: 705 883) ordinary shares in issue during the year.

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Reconciliation of amounts used to calculate basic earnings per share with amounts in statement of comprehensive income 19.5 R Earnings basic earnings per share Cumulative preference dividend Non-cumulative preference dividend Profit per statement of comprehensive income 400 10 10 420 000 000 000 000 19.4 R 440 000 10 000 450 000

Reduction in equity share capital

Two possibilities exist, namely: reverse share split the number of shares are reduced, in which case the basic earnings per share are based on the reduced number of equity shares after the consolidation of shares. The basic earnings per share for the preceding year are adjusted proportionately. . the number of shares remain unchanged and only the nominal value per share is affected. In this case no adjustment is necessary for basic earnings per share.
.

The share split or reverse share split is the change in the nominal value of the shares leading to a change in the number of shares, for example: A Limited had 1 000 R1 issued ordinary shares. It was then decided to split the shares into 50c shares. The result being that A Limited now has 2 000 50c issued ordinary shares. The share capital remained at R1 000, but the number of shares changed.

Example

4 Share split
Y Ltd was incorporated in 19.0 with an authorised share capital of 2 000 000 ordinary shares of R1 each and 500 000 10% cumulative preference shares of R2 each. The authorised share capital was fully issued at the time of incorporation. On 1 June 19.8 the ordinary shares were split into shares of 50c each and on 1 September 19.8 a further 900 000 ordinary shares were issued for cash at a premium of 10c per share after all the legal requirements had been observed. The following information was taken from the statement of comprehensive income of Y Ltd for the year ended 31 December 19.8: 19.8 R 1 437 000 (500 000) 937 000 937 000 19.7 R 1 339 000 (490 000) 849 000 849 000

Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year

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EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.8
Retained earnings R Balance at 31 December 19.6 Total comprehensive income for the year Dividends paid Ordinary shares Preference shares Balance at 31 December 19.7 Total comprehensive income for the year Dividends paid Ordinary shares Preference shares Balance at 31 December 19.8 1 200 000 849 000 2 049 000 (240 000) (100 000) 1 709 000 937 000 2 646 000 (400 000) (100 000) 2 146 000 Total R 1 200 000 849 000 2 049 000 (240 000) (100 000) 1 709 000 937 000 2 646 000 (400 000) (100 000) 2 146 000

Calculations
Earnings Profit for the year Preference dividends R 937 000 (100 000) 837 000 Total 2 000 000 4 000 000 900 000 4 900 000 19.8 2 000 000 4 000 000 300 000 4 300 000 R 849 000 (100 000) 749 000 19.7 2 000 000 4 000 000 4 000 000

Equity At incorporation Split (2 000 000 6 R1,00/50c) Issued 1 September 19.8 (900 000 6 4/12)

Dividends Given Earnings and dividend per share Earnings per share

19.8 R 400 000

R837 000 4 300 000

19.7 R 240 000

R749 000 4 000 000

= 19,46 cents Dividend per share (paid) Dividend per share (adjusted)
R400 000 4 900 000

= 18,72 cents
R240 000 2 000 000

= 8,16 cents
R400 000 4 900 000

12 cents
R240 000 4 000 000

= 8,16 cents

6 cents

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Disclosure

Y LTD
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.8
Total comprehensive income for the year Basic earnings per equity share 19.8 R 937 000 19,46c 19.7 R 849 000 18,72c

NOTE FOR THE YEAR ENDED 31 DECEMBER 19.8

Earnings per share The calculation of earnings per share is based on earnings of R837 000 (19.7 R749 000) and 4 300 000 weighted average issued ordinary shares during the year after a share split on 1 June 19.8 (19.7 4 000 000). The earnings and dividend per share for 19.7 were adjusted accordingly. The dividend per share was adjusted as follows for the share split: Paid 8,16c 19.8 Adjusted 8,16c Paid 12c 19.7 Adjusted 6c

Final

Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.8 R 837 000 100 000 937 000 19.7 R 749 000 100 000 849 000

Earnings basic earnings per share Cumulative preference dividends Profit per statement of comprehensive income Dividends per share Dividend attributable to ordinary owners per share adjusted for the share split

8,16c

6c

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Example

5 Share consolidation
The following information was obtained from the books of Z Ltd for the year ended 30 June 19.6:

STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.6

Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 19.6 R 220 000 (80 000) 140 000 140 000 19.5 R 112 500 (50 000) 62 500 62 500

EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 19.6 Reserve for asset replacement R Balance at 30 June 19.4 Total comprehensive income for the year Preference dividends Ordinary dividends Transfer to reserve Balance at 30 June 19.5 Total comprehensive income for the year Preference dividends Ordinary dividends Transfer to reserve Balance at 30 June 19.6 20 000 20 000 20 000 25 000 45 000 Retained earnings R 50 000 62 500 112 (3 (12 (20 500 600) 000) 000)

Total R 50 000 62 500 112 500 (3 600) (12 000) 96 900 140 000 236 900 (3 600) (19 200) 214 100

76 900 140 000 216 (3 (19 (25 169 900 600) 200) 000) 100

The particulars of the issued share capital are as follows: 19.4 July 1 19.6 June 1 R Ordinary shares of 50c each 12% Cumulative preference shares of R1 each A special resolution was adopted to consolidate the ordinary shares into shares with a nominal value of R2 each. 160 000 30 000

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Calculations 1. Earnings
Profit for the year Preference dividends Earnings 19.6 R 140 000 (3 600) 136 400 19.5 R 62 500 (3 600) 58 900

2. Number of shares
Balance at 1 July 19.4 (R160 000 7 50c) 4 shares consolidated to 1 share on 1 June 19.6 (320 000 7 4) Total 320 000 19.6 320 000 19.5 320 000

80 000

80 000

80 000

3. Dividends
Given Issued shares on date of declaration of dividend Adjusted number of shares at date of declaration of dividend 19.6 R19 200 80 000 80 000 19.5 R12 000 320 000 80 000

4. Earnings and dividend per share

Basic earnings per share (R136 400 7 80 000) ( R58 900 7 80 000) Dividend per share Paid (R19 200 7 80 000) (R12 000 7 320 000) Adjusted (R19 200 7 80 000) (R12 000 7 80 000) 19.6 19.5 170,5c 73,63c 24c 24c 3,75c 15c

Disclosure
1. On the statement of comprehensive income under total comprehensive income for the year: 19.6 19.5 Basic earnings per share 170,5c 73,63c 2. Part of the notes: Earnings per share The calculation of earnings per share is based on earnings of R136 400 (19.5: R58 900) and a weighted average of 80 000 ordinary shares after adjustment for the consolidation of shares on 1 June 19.6 (19.5: 80 000). The dividend per share as adjusted for the consolidation of shares is as follows: 19.6 Paid Adjusted 24c 24c 19.5 3,75c 15c

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Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.5 R Earnings basic earnings per share Cumulative preference dividends Profit per statement of comprehensive income 136 400 3 600 140 000 19.6 R 58 900 3 600 62 500

1.8 Headline earnings

Definition
Headline earnings
Headline earnings is defined as all trading profits or losses of the company, including those items that are of such a nature and size that their disclosure is relevant to explain the performance of the enterprise, after tax, non-controlling interest and preference dividends but excluding separately identifiable remeasurements. A measurement is an amount recognised in the statement of comprehensive income relating to any change (realised or unrealised) in the carrying amount of an asset or liability that arose after the initial recognition of such asset or liability.

Disclosure
Companies should disclose the following in the annual financial statements:
. . .

earnings per share calculated in accordance with IAS 33/AC 104; headline earnings per share an itemised reconciliation between headline earnings and earnings in accordance with IAS 33/AC 104. The reconciliation should detail the nature and amount of each reconciling item.

Example
The following is the detailed statement of comprehensive income of Boxer Limited for the year ended 28 February 19.1: Revenue Cost of sales Gross profit Expenses Profit on the sale of machinery (tax R35 000) Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year R 1 000 000 (600 000) 400 000 (133 000) 80 000 347 000 (115 000) 232 000 232 000

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EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 19.1:
Retained earnings R Balance 28 February 19.0 Total comprehensive income for the year Dividends paid ordinary Balance 28 February 19.1 300 000 232 000 (32 000) 500 000

Additional information
1. The issued share capital of Boxer Limited consists of 100 000 ordinary shares of R1 each. REQUIRED Calculate and disclose earnings per share and headline earnings per share in the annual financial statements of Boxer Limited for the year ended 28 February 19.1 in accordance with Generally Accepted Accounting Practice.

Disclosure

BOXER LIMITED
EXTRACT FROM THE STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 19.1
R Total comprehensive income for the year Earnings per share (232 000 7 100 000) Headline earnings per share (187 000 7 100 000) 232 000 232c 187c

BOXER LIMITED
EXTRACT FROM THE NOTES FOR THE YEAR ENDED 28 FEBRUARY 19.1
1. Earnings per share The calculation of earnings per share is based on earnings of R232 000 (19.0: Rx) and a weighted average number of 100 000 (19.0: 100 000) ordinary shares in issue during the year. The calculation of headline earnings per share is based on earnings of R187 000 (19.0: Rxxx) and a weighted average number of 100 000 (19.0: 100 000) ordinary shares in issue during the year.

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RECONCILIATION BETWEEN EARNINGS AND HEADLINE EARNINGS

Profit before tax R Earnings per statement of comprehensive income Adjustments: Profit on sale of machinery Headline earnings 347 000 Tax R (115 000) Profit after tax R 232 000

(80 000) 267 000

35 000 (80 000)

(45 000) 187 000

1.9 DIVIDENDS PER SHARE

AC 104 does not require the disclosure of dividends per share. However par 95 of IAS 33/ AC 101 Presentation of Financial Statements requires the disclosure of dividends per share. However, there are no specific guidelines in any of the current accounting statements on the calculation of dividends per share.

Calculation
For the purpose of this course, the following guidelines should be followed on the calculation of dividends per share: Dividends declared for the period divided by the number of issued shares on the date when the dividends were declared. The calculation of dividends per share is therefore based on the number of issued shares and not on the weighted average number of issued shares. Comparative figures for dividends per share are only adjusted in the following instances:
. .

Capitalisation issues, bonus issues, a share split or a share consolidation Reduction in equity share capital

In the case where dividends are declared more than once during the period under review, a separate dividends per share must be calculated for each dividend payment. The sum of the separate dividends per share calculated can be disclosed in the statement of comprehensive income or the dividends per share for each declaration can be disclosed. An adjusted dividend per share must be calculated if the company issued capitalisation shares, bonus issues or a share split or share consolidation occurred in the current year. The result of these share transactions is that the number of shares increase or decrease but the R-value of issued share capital remains unchanged. The number of issued shares of the previous year is therefore adjusted and this requires an adjusted dividend per share calculation.

Disclosure requirement
The revised IAS1 requires disclosure of dividends per share in cents for each class of equity shares for the period under review and the corresponding prior period in the statement of changes in equity or alternatively in the notes. Work through the following example:

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Example
Novick Limited had the following number of issued shares on 31 December 19.0 and 19.1: 19.1 Ordinary shares of 25c each 10% Cumulative preference shares of R1 each 10 000 000 500 000 19.0 4 000 000 500 000

During 19.1 the following changes in the capital structure of Novick Limited took place: 1. On 1 July 19.1 the company issued 1 000 000 ordinary shares at R1 per share for full value. 2. On 1 October 19.1 the company issued 5 000 000 ordinary shares by way of a capitalisation of reserves in the ratio of 1 share for every 1 share held. The profit after tax amounted to R600 000 for 19.1 (19.0: R450 000). On 30 June 19.1 the company paid an interim dividend of R80 000 (30 June 19.0: R70 000) and on 31 December 19.1 a final dividend of R120 000 (31 December 19.0: R80 000). REQUIRED Disclose the earnings per share and dividends per share in the annual financial statements of Novick Limited for the year ended 31 December 19.1 to comply with the Generally Accepted Accounting Practice. Comparative figures are required.

Calculations 1. Earnings
19.1 R Profit after tax (given) Fixed preference dividends 600 000 (50 000) 550 000 19.0 R 450 000 (50 000) 400 000

2. Number of shares
Original issue 1 January 19.0 Issued 1 July 19.1 (1 000 000 6 6/12) 5 000 000 Capitalisation issue 1 October 19.1

Total 4 000 000 1 000 000 5 000 000 5 000 000 10 000 000

19.1

19.0

4 000 000 4 000 000 500 0001 4 500 000 4 000 000

4 500 0002 4 000 0002 9 000 000 8 000 000

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3. Earnings per share and dividends per share

Earnings per share (in cents) (550 000/9 000 000);(400 000/8 000 000) Dividends per share (in cents) Interim: Amount paid (80 000/4 000 000);(70 000/4 000 000) Adjusted figure (80 000/8 000 000);(70 000/8 000 000) Final: Amount paid (120 000/10 000 000);(80 000/4 000 000) Adjusted figure (120 000/10 000 000);(80 000/8000 000)

19.1 6,1

19.0 5,0

2,0 1,0 1,2 1,2

1,75 0,875 2,0 1,0

Explanatory notes
1. New share issue the shares did not contribute towards the earnings capacity of the company for the full year, therefore the number of shares has to be weighted for the period it contributed towards earnings. Since the shares were not issued during 19.0 it has no effect on the calculation of the number of shares. 2. The capitalisation issue was done after the new issue of shares in a 1 to 1 ratio and it is therefore necessary to consider the effect of the new issue on the capitalisation issue. Because the new shares were not issued for the full year, they have to be weighted. Therefore the capitalisation shares effected by the new issue will also have to be weighted for 19.1. 19.0 must be adjusted for the effect of the capitalisation issue in a 1 to 1 ratio. This results in a different number of shares for the capitalisation issue over the two years, which would not have been the case had the capitalisation issue taken place before the new issue of shares.

Disclosure
1. On the face of the statement of comprehensive income beneath total comprehensive income for the year 19.1 19.0 Earnings per share (in cents) 2. Notes Earnings per share The calculation of earnings per share is based on earnings of R550 000 (19.0: R400 000) and 9 000 000 (19.0: 8 000 000) ordinary shares in issue after the capitalisation issue on 1 October 19.1. The earnings per share for 19.0 have been adjusted accordingly. Dividends per share (in cents) (2,0 + 1,2);(1,75 + 2,0) 19.1 3,2 19.0 3,8 6,1 5,0

The dividends per share as adjusted by the capitalisation issue, are as follows:
19.1 Paid Interim (in cents) Final (in cents) (80 000/4 000 000) 2,0 (120 000/10 000 000) 1,20 3,2 Adjusted (80 000/8 000 000) 1,0 (120 000/10 000 000) 1,20 2,2 Paid (70 000/4 000 000) 1,75 (80 000/4 000 000) 2,0 3,75 19.0 Adjusted (70 000/8 000 000) 0,875 (80 000/8 000 000) 1,0 1,875

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Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.1 19.0 R R Earnings basic earnings per share 550 000 400 000 Cumulative preference dividends 50 000 50 000 600 000 450 000 Profit per statement of comprehensive income

1.10 EXERCISES
The following examples include multiple changes in the capital structure of companies and it is very important that you should spend some time working through questions of this nature since they represent the standard of questions you will encounter in the assignments and the examination.

Question

1 ISSUE FOR CASH DURING THE CURRENT YEAR TOGETHER WITH A CAPITALISATION ISSUE, ARREAR DIVIDENDS AND LOSSES

MASTER LTD
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.2
19.2 R Profit/(loss) before tax Income tax expense Profit/(loss) for the year Other comprehensive income Total comprehensive income for the year 530 000 (250 000) 280 000 280 000 19.1 R (130 000) (130 000) (130 000)

Statement of changes in equity for the year ended 31 December 19.2

Ordinary Share capital R 200 000 200 000 100 000 Retained earnings R 164 000 (130 000) 34 000 280 000 (60 000) (20 000) (100 000) 134 000 Total R 364 000 (130 000) 234 000 280 000 100 000 (60 000) (20 000) 534 000

Balance at 31 December 19.0 Total comprehensive loss for the year Balance at 31 December 19.1 Total comprehensive income for the year Ordinary shares issued Ordinary dividends Preference dividends Capitalisation issue Balance at 31 December 19.2

100 000 400 000

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CAPITAL STRUCTURE
ISSUED SHARE CAPITAL AT 31 DECEMBER 19.2:
100 000 10% Cumulative preference shares of R1 each 400 000 Ordinary shares of R1 each 100 000 Ordinary shares were issued for cash on 30 June 19.2, and on 30 September 19.2, 100 000 Ordinary shares were issued as a capitalisation issue. Dividends are declared on 31 December of every year. REQUIRED Show how the information on basic earnings and dividends per share should be disclosed in the annual financial statements of Master Ltd for the year ended 31 December 19.2 in order to comply with Generally Accepted Accounting Practice. Comparative figures are required.

Question

2 ISSUE FOR CASH DURING THE PREVIOUS YEAR TOGETHER WITH A CAPITALISATION ISSUE DURING THE CURRENT YEAR

MADAM LTD
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 19.2
Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 19.2 R 530 000 (250 000) 280 000 280 000 19.1 R 300 000 (150 000) 150 000 150 000

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 19.2

Ordinary Share capital R 200 000 200 000 100 000 300 000 100 000 Retained earnings R 124 000 150 000 274 000 (30 000) (10 000) (100 000) 134 000 280 000 (60 000) (10 000) 344 000 Total R 324 000 150 000 474 000 (30 000) (10 000) 434 000 280 000 100 (60 (10 744 000 000) 000) 000

Balance at 31 December 19.0 Total comprehensive income for the year Ordinary dividends Preference dividends Capitalisation issue Balance at 31 December 19.1 Total comprehensive income for the year Ordinary shares issued Ordinary dividends Preference dividends Balance at 31 December 19.2

400 000

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CAPITAL STRUCTURE
Issued share capital at 31 December 19.2:
100 000 10% Cumulative preference shares of R1 each 400 000 Ordinary shares of R1 each On 30 June 19.1 100 000 ordinary shares were issued for cash. On 30 September 19.2 100 000 ordinary shares were issued by means of a capitalisation issue. Dividends are declared on 31 December every year. REQUIRED Show how the information regarding basic earnings and dividends per share should be disclosed in the annual financial statements of Madam Ltd for the year ended 31 December 19.2 in order to comply with Generally Accepted Accounting Practice. Comparative figures are required.

Solutions Question 1 Calculations 1. Basic earnings/(loss)

Profit/(loss) before tax Income tax expense Profit/(loss) after tax Preference dividends Earnings/(loss) 19.2 R 530 000 (250 000) 280 000 (10 000) 270 000 19.1 R (130 000) (130 000) (10 000) (140 000)

2. Number of shares
Balance 1 January 6 Issued 30 June 19.2 (100 000 6 )
12

Total 200 000 100 000 300 000 100 000 400 000

19.2 200 000 50 000 250 000 83 333 333 333

19.1 200 000 200 000 66 667 266 667

Capitalisation issue on 30 September 19.2 (250 000 7 3) (200 000 7 3) Weighted number of shares

3. Dividends
Given Shares in issue on date of declaration of dividend 19.2 R60 000 400 000 19.1 NIL

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4. Earnings and dividends per share

Basic earnings /(loss) per share (R270 000 7 333 333) (R140 000 7 266 667) Dividends per share (R60 000 7 400 000) 81,0c 15,0c (52,5c) NIL

Disclosure
1. On the statement of comprehensive income under total comprehensive income for the year: 19.2 19.1 Basic earnings/(loss) per share 81,0c (52,5c) 2. Part of notes: Earnings per share The calculation of earnings per share is based on earnings of R270 000 (19.1: loss R140 000) and a weighted average of 333 333 ordinary issued shares (19.1: 266 667) after a capitalisation issue on 30 September 19.2. The loss per share for 19.1 was adjusted accordingly. Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.2 R 270 000 10 000 280 000 19.1 R (140 000) 10 000 (130 000)

Earnings (loss) basic earnings per share Cumulative preference dividends Profit (loss) per statement of comprehensive income Dividends per share Dividend attributable to ordinary owners per share

15c

NIL

COMMENT
Although the preference dividend was in arrears, the annual provision was deducted from the calculation of earnings as if it had been paid.

Solutions Question 2 Calculations 1. Basic earnings

Profit before tax Income tax expense Profit after tax Preference dividends 19.2 R 530 000 (250 000) 280 000 (10 000) 19.1 R 300 000 (150 000) 150 000 (10 000)

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Earnings

270 000 Total 200 000 100 000 300 000 100 000 400 000 19.2 200 000 100 000 300 000 100 000 400 000

140 000 19.1 200 000 50 000 250 000 83 333 333 333

2.

Number of shares
Balance 1 January 19.1 6 Issued 30 June 19.1 (100 000 6 )
12

Capitalisation issue 30 September 19.2 (300 000 7 3) (250 000 7 3) Weighted number of shares

3.

Dividends
Given Shares in issue on date of declaration of dividend

19.2 R60 000 400 000

19.1 R30 000 300 000

4.

Earnings and dividends per share

Basic earnings per share (R270 000 7 400 000) (R140 000 7 333 333) Dividends per share paid (R60 000 7 400 000) (R30 000 7 300 000) adjusted (R60 000 7 400 000) (R30 000 7 400 000) 67,5c 42,0c

15,0c 15,0c

10,0c 7,5c

Disclosure
1. On the statement of comprehensive income under total comprehensive income for the year: 19.2 19.1 Basic earnings per share 67,5c 42,0c As part of the notes: Earnings per share The calculation of earnings per share was based on earnings of R270 000 (19.1: R140 000) and a weighted average of 400 000 ordinary issued shares (19.1: 333 333) after a capitalisation issue on 30 September 19.2. The earnings per share for 19.1 were adjusted accordingly. The dividends per share as adjusted for the capitalisation issue are as follows: 19.2 Final 19.1 Final Paid 15,0c 10,0c Adjusted 15,0c 7,5c

2.

Reconciliation of amounts used to calculate basic earnings per share with amounts in the statement of comprehensive income 19.2 19.1 R R Earnings basic earnings per share 270 000 140 000 Cumulative preference shares 10 000 10 000 280 000 150 000 Profit per statement of comprehensive income

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SELF-ASSESSMENT After studying this topic, are you able to:

. .

calculate basic earnings, headline earnings and dividends per share? disclose basic earnings, headline earnings and dividends per share according to IAS 33/AC 104?

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TOPIC D

TIME VALUE OF MONEY

Learning outcome
Learners can apply the basic concepts and formulas of the mathematics of finance in practice to various financial calculations.

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Contents

Time value of money

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STUDY UNIT

1
TIME VALUE OF MONEY
Learning outcome
Learners can calculate time value of money problems.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 1.1 Overview 1.1.1 Time value of money 1.1.2 Future and present values 1.1.3 Simple and compound interest 1.1.4 The concept ``annuity'' 1.1.5 Types of interest tables published 1.2 1.3 Simple interest Compound interest 1.3.1 The future value of R1 1.3.2 The future value of R1 per annum 1.3.3 The present value of R1 1.3.4 The present value of R1 per annum 1.4 1.5 1.6 1.7 1.8 1.9 Perpetuities Nominal and effective rates of interest Summary Symbols Formulas Test yourself questions Self-assessment

278 278 278 279 279 279 279 279 279 279 279 279 280 280 280 280 280 280 280 280 280 280

1.10 Questions with answers

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KEY CONCEPTS
. . . . . . . . . . .

Time value of money Future value Present value Simple interest Compound interest Interest rate Number of periods Annuity Perpetuity The process of accumulation The process of discounting

ASSESSMENT CRITERIA Once you have studied this topic, you should be able to:
. . . .

explain basic time value of money concepts and terminology calculate simple and compound interest explain the relationship between present value, future value, interest rate and number of periods calculate any of the above variables, given three of the other variables

Study chapter 3 of Fundamental aspects in conjuction with the following:

1.1

OVERVIEW

Read through the introductionary section. When money is borrowed, a price must be paid for the use of that money. The use of the money must have a greater value than the cost of borrowing. The lender on the other hand is prepared to lend the money because the return on this investment is equal to or sometimes more than what they can earn in the same risk class. The simple market rules of supply and demand establish the price to be paid for the use of the money called the interest rate. The interest rate represents the return on the lender's money. There are three important factors which determine the rate, namely:
. . .

the time value of money because the money can be used to earn more money the risk that the capital cannot be repaid may require a premium inflation determined by spending power of money

The time value of money is very important and must be part of the calculations in capital budgeting and capital investments. Alternatives can be sorted out in financial and mathematical terms. The time value of money has nothing to do with the accounting profit but is very important to manage the cash flow situation.

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Period can mean per day, per week, per month, quarterly or annually. Term represents the number of periods involved. Interest rate is the rate of return on the capital payable at the end of a certain period, expressed as a percentage. Discounted rate is used when the return on the capital is payable in the beginning of the period (paid in advance), also expressed as a percentage.

1.1.1 Time value of money

Take note of the factors which give rise to the fact that an amount of money receivable today is worth more than the same amount receivable some time in future.

1.1.2 Future and present values

Read through this section. Distinguish between the process of accumulation and the process of discounting.

1.1.3 Simple and compound interest

Note the difference between simple and compound interest.

1.1.4 The concept ``annuity''

Read through this section and make sure that you understand the concept of an annuity.

1.1.5 Types of interest tables published

Take note of the four major tables which are published.

1.2

SIMPLE INTEREST

Study this section and work through the example. Make sure that you understand the terminology and variables, and that you are able to apply the formula.

1.3

COMPOUND INTEREST

1.3.1 The future value of R1

Study this section and make sure that you understand how to apply the formula. Study the requirements to calculate the fourth variable when three variables are given. Work through example 3.

1.3.2 The future value of R1 per annum

Study this section and make sure that you understand how to apply the formula. Work through example 4.

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1.3.3 The present value of R1

Study this section and make sure that you understand how to apply the formula. Work through example 5.

1.3.4 The present value of R1 per annum

Study this section and make sure that you understand how to apply the formula. Work through example 7.

1.4

PERPETUITIES

Study this section and make sure that you understand the concept of a perpetuity. Work through example 7. Note that the present value of the perpetuity is determined at the beginning of the first year, while the first payment is made at the end of the first year.

1.5

NOMINAL AND EFFECTIVE RATES OF INTEREST

Study this section and work through example 8. Distinguish between nominal and effective rates of interest.

1.6

SUMMARY

Read through the summary. By using discounted cash flow techniques and calculating present values, we can compare the return on an investment in capital projects with an alternative equal risk investment in the financial market. If the rate of return from the project is greater than a return from an equivalent risk investment in the financial market, the net present value will be positive and vice versa.

1.7

SYMBOLS

Make sure that you know the meaning of each symbol.

1.8

FORMULAS

Make sure that you can apply all the formulas.

1.9

TEST YOURSELF QUESTIONS

Work through these questions, making sure that you understand what you have learnt.

1.10 QUESTIONS WITH ANSWERS

Work through the questions to ensure you are able to apply the theory to practical applications.

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SELF-ASSESSMENT After studying this topic, are you able to:

. . . .

explain basic time value of money concepts and terminology? calculate simple and compound interest? explain the relationship between present value, future value, interest rate and number of periods? calculate any of the above variables, given three of the other variables?

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TOPIC E

LEASES (ONLY LESSEES) (IAS 17/AC 105)

Learning outcome
Learners should be able to account for and disclose leases, in the financial statements of lessees in terms of Generally Accepted Accounting Practice.

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Contents

Leases (only lessees)

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STUDY UNIT

1
Leases (only lessees
Learning outcome
. Learners should account for leases in the statements of lessees. . Learners should disclose leases in the statements of lessees.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 1.1 1.2 1.3 Definitions Classification of leases Finance leases in the financial statements of lessees

285 286 286 288 289 289 290 293 294 301 303 308 308

1.3.1 Introduction 1.3.2 Finance charges 1.3.3 Depreciation 1.3.4 Disclosure 1.4 1.5 Operating leases in the financial statements of lessees Schematic summary lessees Self-assessment 1.4.1 Disclosure

KEY CONCEPTS
. . . . . . . . .

Lease Finance lease Operating lease Finance cost Depreciation Amortisation table Fair value Useful life Residual value

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ASSESSMENT CRITERIA After having studied this topic you should be able to:
. .

Account for leases in the financial statements of lessees. Disclose leases in the financial statements of lessees.

IAS 17(AC 105) prescribes the appropriate accounting policies and disclosure to apply in relation to finance and operating leases in the financial statements of the lessee. Please note: For the purpose of this module all the implications of normal tax and capital gains tax can be ignored.

1.1 DEFINITIONS
A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. A finance lease is a lease that transfers substantially all risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. An operating lease is a lease where the lessee is hiring the use of an asset for the specified period, while substantially all of the risks and rewards incidental to ownership of the asset remain with the lessor. A non-cancellable lease is a lease that is cancellable only: upon the occurrence of some remote contingency; with the permission of the lessor; if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or . upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain.
. . .

The inception of the lease is the earlier of the date of the lease agreement or of a commitment by the parties to the principal provisions of the lease. As at this date:
. .

a lease is classified as either an operating or a finance lease; and in the case of a finance lease, the amounts to be recognised at the commencement of the lease term are determined.

The commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset. It is the date of initial recognition of the lease (i.e. the recognition of the assets, liabilities, income or expenses resulting from the lease, as appropriate). The lease term is the non-cancellable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise. Minimum lease payments are the payments over the lease term that the lessee is, or can be

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required, to make excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with in the case of a lessee, any amounts guaranted by the lessee or by a third party related to the lessee. However, if the lessee has an option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is reasonably certain to be exercised, the minimum lease payments comprise of the minimum payments payable over the lease term and the payment required to exercise this purchase option. Fair value is the amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Economic life is either: the period over which an asset is expected to be economically usable by one or more users, or . the number of production or similar units expected to be obtained from the asset by one or more users.
.

Useful life is the estimated remaining period, from the beginning of the lease term, without limitation by the lease term, over which the economic benefits embodied in the asset are expected to be consumed by the enterprise. Guaranteed residual value is, in the case of the lessee, that part of the residual value which is guaranteed by the lessee or by a party related to the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable). Unguaranteed residual value is that portion of the residual value of the leased asset, the realisation of which by the lessor is not assured or is guaranteed solely by a party related to the lessor. The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of the minimum lease payments and the unguaranteed residual value to be equal to the fair value of the leased asset plus any initial direct costs. The lessee's incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease, or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset. Contingent rent is that portion of the lease payments that is not fixed in amount but is based on a factor other than just the passage of time (e.g. percentage of sales, amount of usage, price indices, market rates of interest). Initial direct costs are incremental costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred by manufacturer or dealer lessors. The definition of a lease includes contracts for the hire of an asset which contain a provision giving the hirer an option to acquire title to the asset upon the fulfilment of agreed conditions. These contracts are sometimes known as hire purchase contracts. Normally when an enterprise purchases an asset for use in its business, it acquires both the legal title to the asset and the risks and rewards of ownership. The enterprise therefore raises an asset in the statement of financial position and depending on how the purchase was financed, records a liability or reduces the cash resources of the company.

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The accounting implications are not so straight forward when the right to use an asset but not the legal title of the asset is acquired. Lease agreements and instalment sale agreements often split the benefits of ownership from the legal title of an asset. The problem then arises which party should be recording the asset in its statement of financial position. IAS 17(AC 105) should be applied in accounting for all leases other than: lease agreements to explore for or use natural resources, such as oil, gas, timber, metals and other mineral rights, and . licensing agreements for such items as motion picture rights, video recordings, plays, manuscripts, patents and copyrights.
.

IAS 17(AC 105) shall not be applied as the basis of measurement for:
. . . .

property held by lessees that is accounted for as investment property; investment property provided by lessors under operating leases; biological assets held by lessees under finance leases; or biological assets provided by lessors under operating leases.

1.2 CLASSIFICATION OF LEASES

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the legal form of the contract. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. The classification of leases is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee. In considering whether the risks and rewards of ownership have been transferred from the lessor to the lessee the following points can be taken into account: Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions. . Rewards may be represented by the expectation of profitable operation over the asset's economical life and of gain from appreciation in value or realisation of a residual value.
.

Examples of situations which would normally lead to a lease being classified as a finance lease are: the lease transfers ownership of the asset to the lessee by the end of the lease term; the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable. It is therefore at the inception of the lease, reasonably certain that the option will be exercised; . the lease term is for the major part of the economic life of the leased asset even if the title is not transferred; . at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and . the leased assets are of a specialised nature such that only the lessee can use them without major modifications being made.
. .

Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are:

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if the lessee can cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee; . gains or losses from the fluctuations in the fair value of the residual value fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds, at the end of the lease); and . the lessee has the ability to continue the lease for a secondary period at a rent which is substantially lower than market rent.
.

Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the lease, other than renewing the lease, in a manner that would have resulted in a different classification of the lease, the revised agreement is considered a new agreement over its term. Changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased property) or changes in circumstances (for example, default by the lessee) however do not give rise to a new classification of a lease for accounting purposes. Leases of land and buildings are classified as operating or finance leases in the same way as leases of other assets. However a characteristic of land is that it normally has an indefinite economic life and, if title is not expected to pass to the lessee by the end of the lease term, the lessee does not receive all of the risks and rewards incidental to ownership, in which case the lease of land will be an operating lease. A premium paid for such a leasehold represents prepaid lease payments which are amortised over the lease term in accordance with the pattern of benefits provided. The land and building elements of a lease of land and buildings are considered seperately for the purpose of lease classification. If title to both elements is expected to pass to the lessee by the end of the lease term, both elements are classified as a finance lease, whether analysed as one lease or as two leases, unless it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership of one or both elements. When the land has an indefinite economic life, the land element is normally classified as an operating lease unless title is expected to pass to the lessee by the end of the lease term, in accordance with paragraph 14. The buildings element is classified as a finance or operating lease in accordance with paragraph 7 to 13. Whenever necessary in order to classify an account of lease of land and buildings, the minimum lease payments (including any lump-sum upfront payments) are allocated between the land and the buildings elements in proportion to the relative fair values of the leasehold assets (land and buildings) at the inception of the lease. If the lease payments cannot be allocated reliably between these two elements, the entire lease is classified as an operating lease. Although it is stated in previous paragraphs that a lessee should generally separate the land and building elements in respect of a single lease agreement, this split is not required if the lessee's interest in both land and buildings is classified as an investment property and carried at fair value.

1.3

FINANCE LEASES IN THE FINANCIAL STATEMENTS OF LESSEES

1.3.1 Introduction
Lessees should recognise finance leases as assets and liabilities in their statement of financial position at amounts equal at the inception of the lease to the fair value of the leased asset or, if lower, at the present value of the minimum lease payments. In calculating the present value of

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the minimum lease payments the discount factor is the interest rate implicit in the lease, if this is practical to determine; if not, the lessee's incremental borrowing rate should be used. Any initial direct costs of the lessee are added to the amount recognised as an asset. Transactions must be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form. While the legal form of a lease agreement is that the lessee may acquire no legal title to the leased asset, in the case of a finance lease the substance and financial reality are that the lessee acquires the economic benefits of the use of the leased asset for the major part of its economic life in return for entering into an obligation to pay for that right an amount approximating to the fair value of the asset and the related finance charge. The accounting implications of a finance lease are as follows: An asset is separately recognised in the statement of financial position as a leased asset. The leased asset is depreciated over the shorter of the lease term or the asset's useful life, if there is not reasonable certainty that the lessee will obtain ownership by the end of the lease term. . A liability is recognised in the statement of financial position as a secured interest bearing finance lease liability. . The interest paid/finance charges on the liability and the depreciation on the asset are separately disclosed in the statement of comprehensive income.
.

It is not appropriate to disclose the liabilities for leased assets as a deduction from the leased assets in the financial statements. Initial direct costs are often incurred in connection with specific leasing activities, as in negotiating and securing leasing arrangements. The costs identified as directly attributable to activities performed by the lessee for a finance lease, for example legal fees and commission, are included as part of the amount recognised as an asset under the lease.

1.3.2 Finance charges

Lease payments should be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge should be allocated to periods during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. An amortisation table is prepared to calculate this split. The method used to calculate the apportionment is the effective interest rate method. When calculating the interest, the following must be taken into account: The nominal interest rate is used to calculate the finance charges included in the lease payment, if the lease payments are payable more than once a year. . If the lease payments are payable annually, the nominal interest rate equals the effective interest rate. . The effective interest rate is disclosed in the note in respect of liabilities relating to capitalised leased assets. . The flat rate is the interest rate that is calculated every year of the repayment term, on the full original outstanding capital amount before taking into account any interim repayments and added to the capital amount, in order to determine the total amount to be repaid.
.

In leasing transactions, it is often practice to quote a flat rate of interest per annum based on the cash price of the asset in question.

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The following details are relevant to the lease of a motor vehicle: Cash price: Instalments: Flat rate: R16 000 Repayable in 24 equal instalments at the end of each month 10 percent per year over 2 years

The monthly instalment is determined as follows: R Cash price Interest Year 1 (16 000 6 10%) Year 2 (16 000 6 10%) ; Instalment (19 200/24) = R800 per month The following two examples illustrate the application of the effective interest rate method in the calculation of the interest portion of the lease payment. Take note of the difference in calculating the interest if the payment is made in advance or in arrears. 16 1 1 19 000 600 600 200

Example

1 Effective interest rate method payment in arrears

A company leased an asset over a period of 2 years. The cost of the asset was R40 000. An instalment of R12 600 is payable half yearly in arrears. The effective interest rate is 20,85 percent. The nominal interest rate is 19,86 percent. Required Calculate the interest and capital repayments of the above lease for the two years.

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Solution

1 Amortisation table
Opening balance outstanding R 40 31 21 11 000 372 887 460 Interest R 3 972 3 115 2 173 1 140
 1

Capital R 8 9 10 11 628 485 427 460

Instalments R 12 12 12 12 600 600 600 600

10 400
 1

40 000

50 400

[40 000 6 (19,86%/2)]

or Use HP financial calculator to prepare amortisation table: n i PV pmt FV = = = = = 4 (262) 9,93% (19,86%/2) 40 000 12 600 0 Use Sharp Financial calculator to prepare amortisation table: n i PV pmt FV = = = = = 4 9,93% 40 000 12 600 0

Then select ``OTHER'' and ``AMRT'' Insert 1#P and then choose INT in order to calculate interest and PRIN to calculate capital. Then select NEXT to calculate the same for the other 3 instalments. NB: Please ensure that the calculator is on END MODE before commencing with calculations.

Select 1 AMRT = Capital 1 AMRT = Interest 1 Select 2 AMRT = Capital 2 AMRT = Interest 2

Example

2 Effective interest rate method payment in advance

A company leased an asset over a period of 2 years. The cost of the asset was R40 000. An instalment of R11 470 is payable half-yearly in advance. The effective interest rate is 20,97% and the nominal interest rate is 19,976%. REQUIRED Calculate the interest and capital repayments of the above lease for the two years.

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Solution

2 Amortisation table
R Capital Less: Instalment (paid in advance, no interest accrued yet) Interest 1st six months Less: Instalment Interest 2nd six months Less: Instalment Interest 3rd six months Less: Instalment 40 000 (11 470) 28 530 1 2 850 (11 470) 19 910 1 989 (11 470) 10 429 1 041 (11 470)
 1

[28 530 6 (19,976%/2)]

1.3.3 Depreciation
A finance lease gives rise to a depreciation expense for the asset as well as a finance expense for each accounting period. The depreciation policy for leased assets should be consistent with that for depreciable assets which are owned, and the depreciation recognised should be calculated on the basis set out in the statement on depreciation accounting and in the statement on property, plant and equipment. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the shorter of the lease term or its useful life. The depreciable amount of a leased asset is allocated to each accounting period during the period of expected use on a systematic basis consistent with the depreciation policy the lessee adopts for depreciable assets that are owned. If there is reasonable certainty that the lessee will obtain ownership by the end of the lease term, the period of expected use is the useful life of the asset; otherwise the asset is depreciated over the shorter of the lease term or its useful life. Please note: The initial direct costs will be added to the cash price of the asset and will therefore be depreciated over the same period as the cash price of the asset The sum of the depreciation expense for the asset and the finance expense for the period is rarely the same as the lease payments payable for the period, and it is, therefore, inappropriate simply to recognise the lease payments payable as an expense in the statement of comprehensive income. Accordingly, the asset and the related liability are unlikely to be equal in amount after the inception of the lease.

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Example

3
The transactions will be recorded as follows, assuming the following information: Cost of asset: Instalment: Effective interest rate: Lease term: Depreciation: R114 000 R74 618 (payable annually in arrears) 20% per annum 2 years 20% per annum straight-line

Solution

3 Amortisation table
Date Interest R Year 0 Year 1 Year 2 22 800 12 436 35 236 Instalment R 74 618 74 618 149 236 Capital R 51 818 62 182 114 000 Dr R 114 000 114 000 51 818 22 800 Cr R Closing balance R 114 000 62 182

Journal entries
Year 1 Asset Interest-bearing borrowing Recording of lease agreement Interest-bearing borrowing (74 618 7 22 800) Interest paid (114 000 6 20%) Bank Allocation of lease instalment in year 1 Depreciation (SCI) Accumulated depreciation (SFP) Depreciation charge for the year

74 618

22 800 22 800

1.3.4 Disclosure
Lessees should, in addition to the requirements of the standard on Financial Instruments: disclosure and presentation (this standard does not form part of this module), make the following disclosures for finance leases:
. .

For each class of asset, the net carrying amount at the statement of financial position date. A reconciliation between the total of future minimum lease payments at the end of the reporting period and their present value. In addition, an enterprise should disclose the total of future minimum lease payments at the end of the reporting period, and their present value, for each of the following periods: ii(i) Not later than one year. i(ii) Later than one year and not later than five years. (iii) Later than five years.

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Contingent rents recognised as an expense for the period. The total of future minimum sublease payments expected to be received under noncancellable subleases at the statement of financial position date. . A general description of the lessee's significant leasing arrangement including, but not limited to, the following:
. .

ii(i) The basis on which contingent rent payments are determined. i(ii) The existence and terms of renewal or purchase options and escalation clauses. (iii) Restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing. In addition, the disclosure requirements of the standard on Property, Plant and Equipment IAS 16(AC 123) and Investment Property IAS 40(AC 135) apply to the amounts of capitalised finance lease assets. Work through the following detailed examples of finance leases:

Example

4 Finance lease
Cleveland Limited leased five passenger vehicles from Finance Limited on 1 January 19.8. The conditions of the lease agreement were as follows:
. . .

The cash price of each passenger vehicle is R45 000. Lease payments are made half yearly in arrears, over a period of 3 years. The annual interest rates are as follows: Flat rate Nominal rate Effective rate 12% 19,12% 20,03%

The lessee may on expiry of the contract, take over the passenger vehicle on payment of a nominal amount and has the right to cancel the contract whereby the company would be responsible for paying the total capital sum outstanding as determined by the lessor at date of cancellation.

The company provides for depreciation according to the straight-line method over the useful life of the assets. The useful life of each passenger vehicle is considered to be 5 years. The company uses the effective interest rate method to write off finance costs. Required: Disclose the lease transaction in the annual financial statements of Cleveland Limited for the year ended 30 June 19.10. Your answer must comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice. (Comparative figures are required.)

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Solution

CLEVELAND LIMITED
EXTRACT FROM STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 19.10
Notes ASSETS Non-current assets Property, plant and equipment EQUITY AND LIABILITIES Total liabilities Non-current liabilities Long-term borrowing Current liabilities Current portion of long-term borrowing 4 4 19.10 R 19.9 R

112 500

157 500

46 531 46 531

127 803 46 531 81 272

CLEVELAND LIMITED
EXTRACT FROM STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 19.10
Notes Profit before tax Income tax expense Profit for the year Other comprehensive income Total comprehensive income for the year 2 19.10 R xxx (xxx) xxx xxx 19.9 R xxx (xxx) xxx xxx

CLEVELAND LIMITED
NOTES FOR THE YEAR ENDED 30 JUNE 19.10 1. Accounting policies
The company's financial statements are prepared on the historical cost basis and conform with Generally Accepted Accounting Practice. The company incorporates the following accounting policies which are consistent with those applied in previous years:

1.1 Property, plant and equipment

Property, plant and equipment is shown at cost price less accumulated depreciation. Motor vehicles leased under capitalised finance lease agreements are written off over their useful lives according to the straight-line method. Motor vehicles 5 years

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1.2 Lease agreements

Finance costs are written off over the term of the agreement according to the effective interest rate method.

2. Profit before tax

Profit before tax is stated after taking into account the following items: 19.10 R Depreciation Interest paid (2) 45 000 20 728 19.9 R 45 000 34 293

Please note that depreciation on capitalised leased assets should be included as part of the depreciation charge for the year in respect of the relevant class of fixed assets and finance charges should be included as part of the total interest charge.

3. Property, plant and equipment

19.10 R Motor vehicles finance lease assets Carrying amount at beginning of year Cost Accumulated depreciation (3) Depreciation for the year (3) Carrying amount at end of year Cost Accumulated depreciation 157 500 225 000 (67 500) (45 000) 112 500 225 000 (112 500) 19.9 R 202 500 225 000 (22 500) (45 000) 157 500 225 000 (67 500)

The motor vehicles serve as security for a finance lease agreement. (Refer note 4.)

4. Long-term borrowing
Total liability under capitalised finance lease Current portion payable within 1 year Long-term portion of finance lease liability

19.10 R 46 531 (46 531)

19.9 R 127 803 (81 272) 46 531

The above liability is secured by finance lease agreements in respect of motor vehicles (note 3). The effective interest rate is 20,03% per annum. Half yearly instalments of R51 000 are payable commencing on 1 January 19.8 with a final payment on 30 June 19.10. The agreement does not provide for contingent rent payments. Ownership will pass to Cleveland Limited after payment of a nominal amount.

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Reconciliation between the total minimum lease payments and their present value: At 30 June 19.10 Up to 1 year R 51 000 (4 469) 46 531 1 to 5 years R Total R 51 000 (4 469) 46 531

Amount at statement of financial position Finance cost (2) Present value

At 30 June 19.9

Up to 1 year R 102 000 (20 728) 81 272

1 to 5 years R 51 000 (4 469) 46 531

Total R 153 000 (25 197) 127 803

Amount at statement of financial position date Finance cost (2) Present value

Calculations 1. Instalments
Cost price of motor vehicles (45 000 6 5) Flat rate interest (12% 6 225 000 6 3) ; R306 000/6 = R51 000 R 225 000 81 000 306 000

2. Amortisation table
(Follow the same steps as explained in example 2, in order to compile this table) Opening balance outstanding R 30.6.19.8 31.12.19.8 30.6.19.9 31.12.19.9 30.6.19.10 31.12.19.10 225 195 163 127 89 46 000 510 201 803 021 531

Interest R 21 510 1 18 691  15 602 2 3 12 218  8 510 4 4 469 81 000

Capital Instalments R R 29 32 35 38 42 46 490 309 398 782 490 531 51 51 51 51 51 51 000 000 000 000 000 000

225 000

306 000

 1

+  3 +

 2  4

= 34 293 = 20 728

3. Depreciation
Cost price of motor vehicles Depreciation per year (225 000/5) Accumulated depreciation: Year end: 30 June 19.8 (45 000 6 ) 30 June 19.9 (45 000 6 1) 30 June 19.10 (45 000 6 2)

R 225 000 45 000 22 500 67 500 112 500

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Example

5 Finance lease
A manufacturing concern, Leasecon Limited entered into a lease agreement on 1 January 19.6 whereby two machines with a cost price of R412 500 would be leased from a finance company. The period of the lease is 3 years and the lease payments of R49 205 are payable quarterly in arrears. Leasecon Limited will obtain ownership of the machines at the end of the lease term on payment of a nominal amount. Leasecon Limited paid R22 000 legal fees for negotiating the lease. The following information applies to the above lease: Nominal interest rate: 24,005% p.a. Effective interest rate: 26,25% p.a. The machines will be depreciated over their expected useful lives of 4 years on the straight-line method. The company's financial year end is 31 December. Required (a) Prepare the journal entries of Leasecon Limited for the year ended 31 December 19.6. (b) Prepare the notes to the financial statements of Leasecon Limited at 31 December 19.6 in respect of the above lease. Your answer must comply with the requirements of the Companies Act, 1973 and Generally Accepted Accounting Practice.

Solution

5 (a) Journal entries

Dr R Machinery finance lease assets Bank Machinery finance lease assets Liability under finance lease agreement Liability under finance lease agreement (B) Lease finance charges (A) Bank (4 6 49 205) Depreciation Accumulated depreciation Liability under finance lease agreement (C) Current portion of liability under finance lease agreement
A = ( +  +  + ) refer to amortisation table 1 2 3 4 B = ( +  +  + ) refer to amortisation table 5 6 7 8
10 11 12 C = ( + * + * + *) refer to amortisation table 9

Cr R 22 000 412 500

22 000 412 500 106 960 89 860 108 625

196 820 108 625

135 042

135 042

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(b) Disclosure

LEASECON LIMITED
NOTES FOR THE YEAR ENDED 31 DECEMBER 19.6 1. Accounting policy
The company's financial statements are prepared on the historical cost basis and conform with Generally Accepted Accounting Practice. They incorporate the following accounting policies which are consistent with those applied in previous years.

1.1 Property, plant and equipment leased assets

Assets under finance leases are depreciated on the straight-line method over their expected useful lives of 4 years.

1.2 Lease agreements

Lease payments are allocated between finance charges and capital reduction in the liability by means of the effective interest rate method.

2. Profit before tax

Profit before tax is stated after taking into account the following items: Depreciation (2) Finance charges R 108 625 89 860

(Shown as part of total finance charges and part of total depreciation in respect of the property, plant and equipment class, namely machinery.)

3. Property, plant and equipment

R Leased machinery Carrying amount at beginning of year Cost Accumulated depreciation Additions Depreciation Carrying amount at end of year Cost Accumulated depreciation The machinery serves as security for a finance lease (Refer note 4) 434 500 (108 625) 325 875 434 500 (108 625)

4. Long-term borrowing
Total liability under finance lease agreement Current portion payable within 1 year Long-term portion of finance lease liability

R 305 540 (135 042) 170 498

The above liability is secured by machinery (refer note 3) under a finance lease agreement. The loan bears interest at an effective rate of 26,25% per annum. The loan is repayable in 12 equal quarterly payments of R49 205 commencing on 1 January 19.6.

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The period of the lease is 3 years. Leasecon Limited will obtain ownership of the machines at the end of the lease term on payment of a nominal amount. Reconciliation between the total of minimum lease payments at 31 December 19.6 and their present value: Up to 1 1 to 5 year years Total R R R Amount at statement of financial position date 196 820 196 820 393 640 Finance cost (61 778) (26 322) (88 100) Present value 135 042 170 498 305 540

Calculations 1. Amortisation table*

Opening balance outstanding R 412 388 362 334 305 274 241 207 170 131 90 46 500 050 133 661 540 671 950 265 498 525 213 422

Interest R
1 24 755  23 288 2 3 21 733  20 084 4 18 336 16 484 14 520 12 438 10 232 7 893 5 414 2 783

Capital Instalments R R
5 24 450  25 9176 7 27 472  29 1218 9 30 869 32 721 34 685 36 767 38 973 41 312 43 791 46 422

31.3.19.6 30.6.19.6 30.9.19.6 31.12.19.6 31.3.19.7 30.6.19.7 30.9.19.7 31.12.19.7 31.3.19.8 30.6.19.8 30.9.19.8 31.12.19.8

49 49 49 49 49 49 49 49 49 49 49 49

205 205 205 205 205 205 205 205 205 205 205 205

177 960 Use financial calculator and insert the following: n = i = PV = pmt = FV = 12 (3 6 4) 6,00125% (24,005%/4) 412 500 49 205 0

412 500

590 460

Then use the AMRT function to compile table.

2. Depreciation
(412 500 + 22 000)6 25% = 108 625

1.4

OPERATING LEASES IN THE FINANCIAL STATEMENTS OF LESSEES

An operating lease is a lease whereby the risks and rewards of ownership are not transferred to the lessee but stays with the lessor. To determine whether or not a lease constitutes an operating lease, one has to subject a specific lease to the classification criteria set out in section 1.2 above. Only if it is evident that none of the criteria or set of conditions mentioned above are applicable to the specific lease agreement, can it be classified as an operating lease. The liability of the lessee is limited to the lease payment. The lease payments and initial direct costs (e.g. legal fees and commission) under an operating lease should be recognised as an expense in the statement of comprehensive income on a straight-line basis over the lease term

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unless another systematic basis is representative of the time pattern of the user's benefit. This is normally achieved by charging lease payments, as they occur. If lease payments are not directly related to the period over which the benefit is derived, the lease payments need to be deferred or provision must be made for future lease payments. The following conditions may require lease payments to be deferred or provision made for future payments in order to relate the charge of the lease payments against income to the benefits derived:
. . .

lease payments not spread equally over the lease term; lease payments made prior to bringing the leased asset into use; the initial term of the lease is significantly less than the period over which benefit is to be derived and the lease is likely to be renewed at lease payments significantly less or more than the initial lease payments.

Work through the following example:

Example

6 Operating lease
The terms of an operating lease are as follows: Lease term Initial payment Instalment payable monthly in arrears: months 1 24 months 25 48 The lessee incurred R4 800 legal fees for negotiating the lease REQUIRED Describe the accounting treatment and disclosure of this operating lease in the annual financial statements. 4 years R14 400 R2 000 R1 000

Solution

6
The payment structure of the above lease does not reflect the consumption of economic benefits (i.e. the matching of costs incurred with income earned). The lease payments are therefore equalised over the period of the lease. R Initial payment Instalments 1st two years (24 6 2 000) Instalments 2nd two years (24 6 1 000) Equalisation of lease payments (86 400/48) 14 48 24 86 400 000 000 400

1 800

The implication of the equalisation of lease payments is that a portion of lease payments will be deferred for the year or a portion will have to be provided for. If lease payments are deferred the deferred portion is described as ``Deferred lease payments'' and shown as part of current assets in the statement of financial position. If provision is made for lease payments the portion provided for is described as ``Provision for lease payments'' and shown under current liabilities in the statement of financial position.

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In the first year of the example: R Initial payment Instalments (12 6 2 000) Lease instalments paid for the year Lease payments per I/S (1 800 6 12) ; R16 800 (38 400 21 600) of the lease instalments have been deferred. Lease instalments would be disclosed in the notes to the statement of comprehensive income as follows: Included under ``Profit before tax'' R Operating lease machinery Paid for the year Deferred lease payments 21 600 38 400 (16 800) 14 400 24 000 38 400 21 600

R16 800 would be included under current assets as ``Deferred lease payments'' in the statement of financial position. The initial direct costs should also be equalised over the period of the lease. Equalisation (R4 800/48) 100

The implication of the equalisation of the legal fees is that a portion of the legal fees will be deferred for the year. The deferred portion will be described as deferred legal fees and shown as a current asset in the statement of financial position. The legal fees that will be included in the profit before tax will be R1 200 (100 6 12). R3 600 will be included under current assets as ``Deferred legal fees'' in the statement of financial position.

1.4.1 Disclosure
Lessees should, in addition to the requirements of the standard on Financial Instruments: disclosure and presentation (this standard does not form part of this module), make the following disclosures for operating leases:
.

The total of future minimum lease payments under non-cancellable operating leases for each of the following periods: ii(i) Not later than one year. i(ii) Later than one year and not later than five years. (iii) Later than five years.

The total of future minimum sublease payments expected to be received under noncancellable subleases at the statement of financial position date. . Lease and sublease payments recognised in income for the period, with separate amounts for minimum lease payments, contingent rents, and sublease payments. . A general description of the lessee's significant leasing arrangements including, but not limited to, the following:
.

ii(i) The basis on which contingent rent payments are determined. i(ii) The existence and terms of renewal or purchase options and escalation clauses.

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(iii) Restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.

Example

7 Operating lease
Edmonton Limited is a manufacturing concern involved in the production of floor tiles. Previously, all machinery purchased by the company was financed by means of hire-purchase agreements. During the year ended 30 June 19.8 Edmonton Limited acquired machinery which was obtained in terms of operating lease agreements. The following information in respect of the lease agreements is available:

Agreement 1
Monthly instalments payable in advance Cash price of asset Period of lease: 1 October 19.7 to 30 September 19.10 R15 820 R450 000

Agreement 2
Commencement date of lease: 1 August 19.7 Cash price of asset Period of lease Payments terms: Months 116 1724 R320 000 24 months R20 535 per month R4 440 per month

The bookkeeper prepared the note to be disclosed in respect of profit before tax in the annual financial statements for the year ended 30 June 19.8, as follows: R Lease instalments Agreement 1 Agreement 2 Building 142 380 225 885 174 000

Additional information
The lease instalment of the building is as a result of an operating lease and is based on a basic rental of R10 000 per month, plus 1% of the monthly manufacturing cost of production of tiles in excess of 1 000 000 tiles. The excess production of tiles for the year ended 30 June 19.8 was in total 5 400 000 tiles. Each tile costs R1 to manufacture. One floor of the building is sublet to Redman Limited for R1 900 per month. The floor was sublet from 30 November 19.7. The remaining period of this lease agreement at 30 June 19.8 is 6 years and there is an option to renew the lease thereafter at terms to be negotiated at that stage. The tax rate is 29%. The profit before tax, before taking above transactions into account is R1 050 000. REQUIRED (a) Prepare the journal entries of Edmonton Limited for the year ended 30 June 19.8. (b) Prepare the notes to the financial statements of Edmonton Limited for the year ended 30 June 19.8. Your answer must comply with the requirements of the Companies Act 1973 and Generally Accepted Accounting Practice.

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Solution

7 (a) Journal entries

Agreement 1 Lease instalments: Machinery (15 820 6 9) Bank Lease instalments paid for the year Agreement 2: Lease instalments: Machinery (20 535 6 11) Bank Lease instalments paid for the year Deferred lease payments Lease instalments: Machinery Lease instalments equalised over the lease term (calculation 1) Building: Operating lease payments Building Bank Lease payments for the year (calculation 2) Bank Rental income (1 900 6 7) Rental income received on sub-lease agreement Current tax: Current tax expense South African Revenue Service Current tax provision for the year (calculation 3) Dr R 142 380 Cr R 142 380

225 885

225 885

59 015

59 015

174 000

174 000

13 300

13 300

151 100

151 100

(b) Disclosure

EDMONTON LIMITED
NOTES FOR THE YEAR ENDED 30 JUNE 19.8 1. Accounting policy
1.1 Lease agreements
Lease instalments in respect of operating leases are charged against profit in such a way as to ensure matching of revenue and cost.

2. Profit before tax

Profit before tax is stated after taking the following items into account: R Rental income sublease a portion of building (1 900 6 7) Lease instalments on machinery (1) Paid for the year (225 885 + 142 380) Deferred Operating lease payments building (2) 13 300 309 250 368 265 (59 015) 174 000

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3. Income tax expense

SA Normal: Current tax expense (3) 151 100

4. Operating lease agreements

The company has three operating lease agreements. The details of the agreements are summarised below:

Agreement 1:
Machinery is leased at monthly instalments of R15 820, payable in advance. The period of the lease is from 1 October 19.7 to 30 September 19.10. No details regarding the renewing and purchase options are available. The future minimum lease payments are: Up to 1 year R
1 189 840
 1  2

1 to 5 years R
2 237 300

15 820 6 12 15 820 6 (36 9 12)

Agreement 2:
Machinery is leased monthly, from 1 August 19.7 to 1 July 19.9. The period of the lease is 24 months, payable in advance. The payment terms are: Month 116 Month 1724 R20 535 per month R4 440 per month

The future minimum lease payments are: Up to 1 year R

1 133 755
 1

1 to 5 years R 4 440

(16 11) 6 20 535 7 6 4 440

= 102 675 = 31 080 133 755

R Deferred lease payments in terms of operating lease agreement 2 Less: Short-term portion (calculation 1) 59 015 (48 285) 10 730

Agreement 3:
A building is leased and the lease agreement is based on a basic rental of R10 000 per month, plus 1% of the monthly manufacturing cost of production of tiles in excess of 1 000 000 tiles. One floor of the building was sublet for R1 900 per month. This lease will lapse after 6 years but the company has the option to renew the lease at terms to be negotiated at that stage. The future minimum lease payments are: Up to 1 year R 120 000 1 to 5 years R 480 000 Later than 5 years R 120 000

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Calculations 1. Equalisation of lease payments

Agreement 2
R Months: 116 (20 535 6 16) 1724 (4 440 6 8) 328 560 35 520 364 080 Spread evenly over 24 months (364 080/24) 15 170

Instalments paid Year end 30 June 19.8 Year end 30 June 19.9 Closing balance of deferred lease payments For year end 30 June 20.0 Closing balance of deferred lease payments
 1  2  3  4
1 225 885  133 755 3

Equalise lease payments

2 166 870  182 040 4

Deferred lease payments 59 015 (48 285) 10 730

5 4 440

6 15 170

(10 730) 0

20 535 6 11 15 170 6 11 (20 535 6 5) + (4 440 6 7) 15 170 6 12

 5  6

4 440 6 1 15 170 6 1

2. Lease instalments in respect of building

R Basic lease instalments (12 6 10 000) Lease based on excess production (5 400 000 6 R1 6 1%) Lease payments 120 000 54 000 174 000

3. Current tax
Profit before Plus: Rental Less: Lease Lease Lease tax (given) income received (R1 900 6 7) instalments: Agreement 1 (R15 820 6 9) instalments: Agreement 2 payments building (2) R 1 050 000 13 300 (142 380) (225 885) (174 000) 521 035 Current tax @ 29% 151 100

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1.5 SCHEMATIC SUMMARY LESSEES

The following is a schematic summary of Standard IAS 17(AC 105) in respect of the treatment of a finance or operating lease in the financial statements of lessees: Lease payments

Nature ! Finance lease ! Capitalise an asset and record liability ! Operating lease ! Payments charged against profit on a systematic basis

SELF-ASSESSMENT After studying this topic, are you able to:

. .

Account for leases in the financial statement of lessees? Disclose leases in the financial statement of lessees?

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TOPIC F

VALUATION OF FINANCIAL INSTRUMENTS

Learning outcome
Learners can determine the valuation procedures of real assets and financial assets and can determine the value of ordinary shares, preference shares and debt after applying the different valuation methods.

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Contents

1 2 3 4 5

Valuation of financial assets Shareholders' equity ordinary shares Shareholders' equity preference shares Outside funding (debt) Financial instruments

311 313 315 318 320

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STUDY UNIT

1
Valuation of financial assets
Learning outcome
Learners can explain the differences between real assets and financial assets.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 1.1 1.2 1.3 Introduction Definition of valuation Real assets and financial assets Self-assessment

311 311 312 312 312 312

KEY CONCEPTS
. . . . . . .

Valuation Financial management Market value Liquidation value Going concern value Real assets Financial assets

ASSESSMENT CRITERIA After having studied this study unit you should be able to:
. . .

define valuations explain the difference between real assets and financial assets explain the difference between the accounting implication of real assets and financial assets

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Study the relevant sections of chapter 4 of Fundamental aspects.

1.1

INTRODUCTION

Read through the introductory section. An accountant has to act sometimes as an appraiser in the semi-legal capacity especially in a case as arbitrator. In terms of the Estate Duty Act, 1955, the accountant has to give an opinion on the fair market value of a property, a business, an interest in a business or shares in a company or debentures. A valuation can also be done on commission for a specific purpose, for example, where shares are bought or sold in a company or the valuation of an interest in a company. In these instances there may be special directions on how to do the valuation. In other circumstances special valuation methods may be applied. In this context it is important that the ``appraiser'' has to make sure of the following:
. . .

the purpose of the valuation who is going to use this information the limitations (for example; presumptions or prescribed valuation methods) or if it will put a qualification on his opinion.

The accountant, as appraiser, must put it very clear in the report what the purpose of the valuation is and which method was used to determine the value.

1.2

DEFINITION OF VALUATION

Ensure that you know this definition.

1.3

REAL ASSETS AND FINANCIAL ASSETS

Read through this section and do the examples given. Make sure the examples are understood since it forms the basis of the valuation process.

ASSESSMENT CRITERIA After studying this study unit, are you able to:
. . .

define valuations? explain the difference between real assets and financial assets? explain the difference between the accounting implication of real assets and financial assets?

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STUDY UNIT

2
Shareholders' equity ordinary shares
Learning outcome
Learners can apply the different valuation methods regarding ordinary shares.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 2.1 2.2 2.3 2.4 Introduction Valuation of ordinary shares Decision diagram Questions and answers Self-assessment

313 314 314 314 314 314 314

KEY CONCEPTS
. . . . . . . . . . . . . . .

Valuations Real assets Financial assets Liquidation value Book value Going concern value Intrinsic value Goodwill Earnings yield Dividend yield Value (price) at present Expected future dividend Expected future earnings Risk adjusted interest rate Residual claim

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ASSESSMENT CRITERIA Once you have studied this study unit, you should be able to:
. . . .

define residual claims explain the importance of risk in the valuation process apply the different valuation methods regarding ordinary shares determine which valuation method is applicable under circumstances where a given set of data is presented

Study the relevant sections of chapter 4 of Fundamental aspects.

2.1

INTRODUCTION

Read through this section.

2.2

VALUATION OF ORDINARY SHARES

Ensure that you obtain an understanding of all the valuation methods discussed in this section. It is important that the procedure when to apply a certain valuation method, is fully understood. The formulas in this section must be memorised.

2.3

DECISION DIAGRAM

This diagram must be submitted because it diagramatically explains when which valuation method can be applied.

2.4

QUESTIONS AND ANSWERS

Work through these questions before looking at the answers.

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . .

define residual claims? explain the importance of risk in the valuation process? apply the different valuation methods regarding ordinary shares? determine which valuation method is applicable under circumstances where a given set of data is presented?

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STUDY UNIT

3
Shareholders' equity preference shares
Learning outcome
Learners can apply the different valuation methods regarding preference shares

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 3.1 3.2 3.3 3.4 3.5 Introduction Types of preference shares and valuation methods Advantages and disadvantages of preference shares Types of preference shares Questions and answers Self-assessment

315 316 316 316 316 316 316 317

KEY CONCEPTS
. . . . . . . . .

Preference shares Cumulative preference shares Redeemable preference shares Convertible preference shares Participating preference shares Price of preference shares Dividends of preference shares Fair dividend yield of preference shares Hybrid security

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ASSESSMENT CRITERIA Once you have studied this study unit, you should be able to:
. . . . .

define a hybrid security determine the differences between the valuation characteristics of ordinary shares and preference shares describe the different types of preference shares as well as its different characteristics calculate the value of a preference share describe the advantages and disadvantages of preference shares

Study the relevant section of chapter 4 of Fundamental aspects.

3.1

INTRODUCTION

Read through this section.

3.2

TYPES OF PREFERENCE SHARES AND VALUATION METHODS

Memorise the four different types of preference shares as well as the formula.

3.3

ADVANTAGES AND DISADVANTAGES OF PREFERENCE SHARES

Study this section thoroughly.

3.4

TYPES OF PREFERENCE SHARES

Study this section with specific emphasis on examples 8 11.

3.5

QUESTIONS AND ANSWERS

Work through these questions before looking at the answers.

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SELF-ASSESSMENT After studying this study unit, are you able to:
. . . . .

define a hybrid security? determine the differences between the valuation characteristics of ordinary shares and preference shares? describe the different types of preference shares as well as its different characteristics? calculate the value of a preference share? describe the advantages and disadvantages of preference shares?

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STUDY UNIT

4
Outside funding
Learning outcome
Learners can apply valuation procedures for ordinary shares, preference shares and debt.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 4.1 4.2 4.3 4.4 4.5 Introduction Specific types of debt Valuation procedure Applicable valuation variables Questions and answers Self-assessment

318 319 319 319 319 319 319 319

KEY CONCEPTS
. . . .

Risk Interest rate Time factor Fair rate of return

ASSESSMENT CRITERIA After having studied this study unit you should be able to:
. . . . .

determine the differences between the valuation characteristics of ordinary shares, preference shares and debt label debt into different categories list the different types of debt apply the valuation procedure define debt variables

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Study the relevant sections of chapter 4 of Fundamental aspects.

4.1

INTRODUCTION

Read through this section.

4.2

SPECIFIC TYPES OF DEBT

Study this section.

4.3

VALUATION PROCEDURE

Memorise the steps taken when valuing debt.

4.4

APPLICABLE VALUATION VARIABLES

When studying this section ensure that you obtain an understanding of the more important variables such as:
. . . .

Risk Interest rate Time factor Fair rate of return

4.5

QUESTIONS AND ANSWERS

Do all the questions before looking at the answers.

SELF-ASSESSMENT After studying this study unit, are you able to:
. . . . .

determine the differences between the valuation characteristics of ordinary shares, preference shares and debt? label debt into different categories? list the different types of debt? apply the valuation procedure? define debt variables?

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STUDY UNIT

5
Financial instruments
Learning outcome
Learners can apply different valuation procedures for different types of financial instruments.

OVERVIEW
This study unit is divided into the following: Page

Key concepts Assessment criteria 5.1 5.2 5.3 5.4 5.5 5.6 Introduction Types of financial instruments Financial risk Specific concepts Categories of financial instruments Questions with answers Self-assessment

320 321 321 321 321 321 321 321 322

KEY CONCEPTS
. . . . . . . . . . . . . . . . .

Financial asset Financial liability Equity instrument Derivative instrument Price risk Credit risk Liquidity risk Cash flow-risk Initial recognition Later measuring Trading date accounting Settlement date accounting Transaction costs Fair value Amortisation costs Effective interest method Effective interest rate

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ASSESSMENT CRITERIA Once you have studied this study unit, you should be able to:
. . . . .

describe the different types financial instruments as well as their characteristics identify and describe the financial risk in using financial instruments describe the different categories of financial assets as well as their characteristics and the financial recording describe the different categories of financial liabilities as well as their characteristics and the financial recording determine the value of a financial instrument

Study chapter 4 of Fundamental aspects.

5.1

INTRODUCTION

Read this section.

5.2

TYPES OF FINANCIAL INSTRUMENTS

Memorise the four different types of instruments.

5.3

FINANCIAL RISK

Distinguish between the four different types of risks.

5.4

SPECIFIC CONCEPTS

Study this section and make sure that you understand every concept.

5.5

CATEGORIES OF FINANCIAL INSTRUMENTS

Study this section in depth.

5.6

QUESTIONS AND ANSWERS

Work through the questions and compare your answers with the solutions.

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SELF-ASSESSMENT After studying this study unit, are you able to:
. . . . .

describe the different types financial instruments as well as their characteristics? identify and describe the financial risk in using financial instruments? describe the different categories of financial assets as well as their characteristics and the financial recording? describe the different categories of financial liabilities as well as their characteristics and the financial recording? determine the value of a financial instrument?

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