Question:(Complex Group Structure)
A acquired 60% of B and B acquired 25% of C What value should C Co be in the group accounts of A at year end? This type of question I seem to always struggle with. My answer was that A owns 15% of C and hence should report 15% of post acquisition profits. The answer indicated 25% of C's net assets plus unimpaired Goodwill Is the 15% of post acquisition profits or 25%? If B was an associate rather than a Subsidiary is the entry one of a s imple Trade Investment? Your advice may help make these combination questions clear.
Response from tutor:
The key here is that B is a subsidiary. So, when consolidated, its net assets are added to those of A, the parent. The net assets of B include the investment in C, and so this should be included in its entirety (just like any other asset - you wouldn't consolidate just 60% of, say, non - current assets). However, you then need to bear in mind that the non - controlling interest in B are entitled to a share of this asset, so adjustment needs to be made there too. If B was an associate, it would not be consolidated into the group accounts of A, so the problem does not arise - B would be equity accounted for, and there would be no need to worry specifically about C.
Question:(Foreign Subsidiary)
Could you help me understand the 'two methods' for dealing with foreign currency balance sheets and how to distinguish between the two?
Response from tutor:
The key when translating the accounts of foreign subsidiaries for consolidation is to identify the functional currency of the subsidiary - that of the primary economic environment in which it operates. Things to look out for are the currency that mainly influences selling prices and costs, and the country whose competitive forces and regulations are most relevant.
If the functional currency is the same as that of the parent, the subsidiary is effectively just an extension of the parent's activities. Changes in exchange rates will have an immediate, item - by - item effect on cash flows rather than simply affecting net investment. Companies generally present financial statements in their functional currency, in which case no translation is necessary and the consolidation proceeds as normal. If a different presentation currency has been adopted, the temporal method of translation should be used - in other words, treat transactions as if they had been entered into by the parent.
A acquired 60% of B and B acquired 25% of C What value should C Co be in the group accounts of A at year end? This type of question I seem to always struggle with. My answer was that A owns 15% of C and hence should report 15% of post acquisition profits. The answer indicated 25% of C's net assets plus unimpaired Goodwill Is the 15% of post acquisition profits or 25%? If B was an associate rather than a Subsidiary is the entry one of a s imple Trade Investment? Your advice may help make these combination questions clear.
Response from tutor:
The key here is that B is a subsidiary. So, when consolidated, its net assets are added to those of A, the parent. The net assets of B include the investment in C, and so this should be included in its entirety (just like any other asset - you wouldn't consolidate just 60% of, say, non - current assets). However, you then need to bear in mind that the non - controlling interest in B are entitled to a share of this asset, so adjustment needs to be made there too. If B was an associate, it would not be consolidated into the group accounts of A, so the problem does not arise - B would be equity accounted for, and there would be no need to worry specifically about C.
Question:(Foreign Subsidiary)
Could you help me understand the 'two methods' for dealing with foreign currency balance sheets and how to distinguish between the two?
Response from tutor:
The key when translating the accounts of foreign subsidiaries for consolidation is to identify the functional currency of the subsidiary - that of the primary economic environment in which it operates. Things to look out for are the currency that mainly influences selling prices and costs, and the country whose competitive forces and regulations are most relevant.
If the functional currency is the same as that of the parent, the subsidiary is effectively just an extension of the parent's activities. Changes in exchange rates will have an immediate, item - by - item effect on cash flows rather than simply affecting net investment. Companies generally present financial statements in their functional currency, in which case no translation is necessary and the consolidation proceeds as normal. If a different presentation currency has been adopted, the temporal method of translation should be used - in other words, treat transactions as if they had been entered into by the parent.
If the functional currency is different to that of the parent, the subsidiary is effectively a separate company, and is treated as a net investment. Assets and liabilities are translated at closing rates, amounts in the income statement are translated at actual transaction rates (an average is usually used for practical purposes). I think the second situation is far more likely to come up. If you are given a question where the subsidiary accounts are in a different currency, then assume (in the absence of further information) that this is their functional currency, so the position is the second situation described
Question:(Intra group transactions)
I have problems dealing with unrealized profit of the sale of property, plant and equipment between group entities. Can you explain how to account for unrealized profit in the consolidated balance sheet for say, the sale of a plant from parent to subsidiary, assuming the plant is subject to depreciation? If the sale is made by the subsidiary to parent, what is the difference?
Response from tutor:
The key is to ensure that the consolidated financial statements show results as if the inter - company sale had not taken place. Adjustments must be made to the carrying value of non - current assets, and
also to retained earnings. The easiest way is to calculate the carrying value of the asset as it is in the receiving company's books, and what it would have been if it had stayed in the original company's books. Adjust for the difference by debiting reserves and crediting non - current assets. If the sale is from subsidiary to parent, then only the group share needs adjustment against reserves (although the full adjustment is necessary against non - current assets). A further adjustment is then needed within the non - controlling (or minority) interest.
Question:(Net Assets Definition)
What is the correct definition of Net Assets. I have noticed that in some questions this term is used in
the context of profits i.e. profits for associates and in some other questions it is referred to as Total of Share Capital and Retained Earnings.
Response from tutor:
Net assets means total assets less total liabilities. As such, it means exactly the same as equity, therefore share capital plus reserves.
Question:(Gain on disposal)
I've just attempted the May 2010 F2 past paper Q6. In note 5 a $50,000 gain on disposal of an AFS investment occurred, but in the model answer I cannot find any adjustment made in the consolidated accounts. Please can you explain why no adjustment has been made? Is this just an error in the model answer and if so, what would the correct treatment be.
Response from tutor:
When an available for sale financial asset is revalued each period, the gains or losses are taken directly to equity. On disposal, the cumulative gain should be recognised in profit and loss. In this question, the current gain of $50,000 and the previous gains of $40,000 should, therefore, be reported in profit or loss.
If you look at the examiner’s answer, this is exactly what has happened. The $50,000 gain on disposal is already included in administrative expenses, so requires no adjustment. The previous gains of $40,000 have been credited to administrative expenses (i.e. subtracted from the expense, since they are gains rather than losses) and debited to reserves (deducted from other comprehensive income, which is where they were originally reported).
Question:(Intra group transactions)
I have problems dealing with unrealized profit of the sale of property, plant and equipment between group entities. Can you explain how to account for unrealized profit in the consolidated balance sheet for say, the sale of a plant from parent to subsidiary, assuming the plant is subject to depreciation? If the sale is made by the subsidiary to parent, what is the difference?
Response from tutor:
The key is to ensure that the consolidated financial statements show results as if the inter - company sale had not taken place. Adjustments must be made to the carrying value of non - current assets, and
also to retained earnings. The easiest way is to calculate the carrying value of the asset as it is in the receiving company's books, and what it would have been if it had stayed in the original company's books. Adjust for the difference by debiting reserves and crediting non - current assets. If the sale is from subsidiary to parent, then only the group share needs adjustment against reserves (although the full adjustment is necessary against non - current assets). A further adjustment is then needed within the non - controlling (or minority) interest.
Question:(Net Assets Definition)
What is the correct definition of Net Assets. I have noticed that in some questions this term is used in
the context of profits i.e. profits for associates and in some other questions it is referred to as Total of Share Capital and Retained Earnings.
Response from tutor:
Net assets means total assets less total liabilities. As such, it means exactly the same as equity, therefore share capital plus reserves.
Question:(Gain on disposal)
I've just attempted the May 2010 F2 past paper Q6. In note 5 a $50,000 gain on disposal of an AFS investment occurred, but in the model answer I cannot find any adjustment made in the consolidated accounts. Please can you explain why no adjustment has been made? Is this just an error in the model answer and if so, what would the correct treatment be.
Response from tutor:
When an available for sale financial asset is revalued each period, the gains or losses are taken directly to equity. On disposal, the cumulative gain should be recognised in profit and loss. In this question, the current gain of $50,000 and the previous gains of $40,000 should, therefore, be reported in profit or loss.
If you look at the examiner’s answer, this is exactly what has happened. The $50,000 gain on disposal is already included in administrative expenses, so requires no adjustment. The previous gains of $40,000 have been credited to administrative expenses (i.e. subtracted from the expense, since they are gains rather than losses) and debited to reserves (deducted from other comprehensive income, which is where they were originally reported).
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