Section A – THIS ONE question is compulsory and MUST be attempted
1、(a) The following draft statements of financial position relate to Diamond, Spade and Club, all public listed entities, as at 31 March 2017.
The following information is relevant to the preparation of the group financial statements:
1. On 1 April 2016, Diamond acquired 70% of the equity interests of Spade paying cash of $1,140 million. At 1 April 2016, the retained earnings and other components of equity of Spade were $780 million and $64 million respectively.
The fair value of the identifiable net assets of Spade at 1 April 2016 was $1,600 million. It is group policy to value non-controlling interests at fair value and, at the date of acquisition, this was $485 million. The excess in fair value of the identifiable net assets is due to non-depreciable land.
2. On 1 April 2015, Diamond acquired 40% of the equity interests of Club for cash consideration of $420 million. At this date the carrying amount and fair value of the identifiable net assets of Club was $1,032 million. Diamond treated Club as an associate and equity accounted for Club up to 31 March 2016. On 1 April 2016, Diamond took control of Club, acquiring a further 45% interest for cash of $500 million and added this amount to the carrying amount of its investment in Club. On 1 April 2016, the retained earnings and other components of equity of Club were $293 million and $59 million respectively and the fair value of the identifiable net assets was $1,062 million. The difference between the carrying amounts and the fair values was in relation to plant with a remaining useful life of five years. The share prices of Diamond and Club were $5 and $1·60 respectively on 1 April 2016. The fair value of the original 40% holding and the fair value of the non-controlling interest should both be estimated using the market value of the shares.
3. Diamond has owned a 25% equity interest in Heart for a number of years. Heart had profits for the year ended 31 March 2017 of $20 million which can be assumed to have accrued evenly. Heart does not have any other comprehensive income. On 30 September 2016, Diamond sold a 10% equity interest for cash of $42 million. Diamond was unsure of how to treat the disposal and so has deducted the proceeds from the carrying amount of the investment at 1 April 2016 which was $110 million (calculated using the equity accounting method). The fair value of the remaining 15% shareholding was estimated to be $65 million at 30 September 2016 and $67 million at 31 March 2017. Diamond no longer exercises significant influence and has designated the remaining shareholding as fair value through other comprehensive income.
4. Goodwill has been reviewed for impairment and no impairment was deemed necessary.
5. On 1 April 2015, Diamond acquired $50 million of 6% listed bonds at their nominal value. Diamond may sell or hold bonds to maturity and so, based on this business model, has designated the bonds as fair value through other comprehensive income. The effective rate of interest on the bonds is also 6%. The bonds had a fair value of $42 million at 31 March 2016 and were correctly treated in the financial statements of that year.
On 31 March 2017, Diamond received the coupon interest of $3 million, which was recorded within interest received, and then sold the bonds on the same day for $35 million. The disposal proceeds were substantially below the fair value of the bonds which was $38 million at 31 March 2017. A $7 million loss on disposal was charged against profits. Diamond has an option to repurchase the bonds at any time up to 31 December 2018 for $36 million. The fair value is expected to increase in the future and it is highly likely that Diamond will exercise this option.
6. Diamond operates a defined benefit pension scheme. On 31 March 2017, the company announced that it was to close down a business division and agreed to pay each of its 150 staff a cash payment of $50,000 to compensate them for loss of pension arising from wage inflation. It is estimated that the closure will reduce the present value of the pension obligation by $5·8 million. Diamond is unsure of how to deal with the settlement and curtailment and has not yet recorded anything within its financial statements.
7. On 1 April 2016, Diamond acquired a manufacturing unit under an eight-year finance lease. The lease rentals have been recorded correctly in the financial statements of Diamond. However, Diamond could not operate effectively from the unit until alterations to its structure costing $6·6 million were completed. The manufacturing unit was ready for use on 31 March 2017. The alteration costs of $6·6 million were charged to administration expenses. The lease requires Diamond to restore the unit to its original condition at the end of the lease term. Diamond estimates that this will cost a further $5 million. Market interest rates are currently 6%.
Note: The following discount factors may be relevant:
(a) Diamond Group
Consolidated statement of financial position as at 31 March 2017
Working 1 – Goodwill on acquisition of Spade
Working 2 – Club
Diamond initially has equity accounted for its 40% interest in Club. This would have been accounted for as follows: (Note that the carrying amount of net assets at 31 March 2016 would be $1,052 million ($700m + $293m + $59m))
When purchasing the extra 45% the $500 million cash has been added, hence the investment in Club is $928 million in Diamond’s financial statements. However, on obtaining control in Club, Diamond should have restated the value of its original 40% investment to fair value. The fair value is best estimated using the share price of Club and is calculated as (40% x $700 million x $1·60) = $448 million. The investment should have been debited with a further $20 million and credited to profit or loss (W12). Goodwill will be calculated as follows:
Total goodwill is therefore $79 million ($25m + $54m).
Additional depreciation will charged on the plant of $2 million ($10m/5) (W7).
Working 3 – Disposal of Heart
Diamond would originally have significant influence over Heart via its 25% holding. Diamond has equity accounted for Heart up to 31 March 2016 giving an equity value of $110 million. Diamond should have equity accounted right up to 30 September 2016, at which point significant influence is lost. A further $2·5 million (25% x $20m x 6/12) should have been added to the investment and included within retained earnings (W12).
On losing significant influence, a profit or loss on disposal should be calculated as follows:
The remaining 15% holding is restated to fair value of $67 million at 31 March 2017 (W8). A gain is to be recorded in other components of equity of $2 million ($67m – $65m) (W15).
Working 4 – Bonds
The substance of the transaction appears to be that of a secured loan rather than a disposal of bonds. This is evidenced by the sale being below fair value and the fact that the repurchase price is also below expected fair value, such that the option is highly likely to be exercised. The proceeds of $35 million should therefore be treated as a current liability (it is repayable at any time) rather than as a disposal of the bonds.
At 31 March 2016, prior to the loss, the bonds had a carrying amount of $42 million. Interest received and taken to profit or loss (and retained earnings) is $3 million (6% x $50m). The carrying amount of the bonds should be restated to fair value of $38 million at 31 March 2017. A loss of $4 million should be recorded in other components of equity calculated as follows:
Tutorial note: The following correcting entry is required to the financial statements of Diamond:
Working 5 – Pension adjustment
The estimated settlement on the pension liability is $7·5 million (150 x $50,000) and should be included within current liabilities (W11). As this is $1·7 million more than the estimated curtailment gain of $5·8 million, a loss of $1·7 million should be included within retained earnings (W12). Non-current liabilities are reduced by the reduction in pension obligations of $5·8 million (W10).
Working 6 – Leased manufacturing unit
The alteration costs of $6·6 million should be capitalised, and not charged as an expense. A provision for restoration costs of $3·3 million ($5m x 0·665) should also be recognised and capitalised as part of the carrying amount of the asset.
Adjustments required:
