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EQUITY ACCOUNTING TEXT CHAP 20

EQUITY ACCOUNTING TEXT CHAP 20. Accounting for Investments. Cost method used in the purchasing company’s books Equity method - AASB 1016 applied when a significant interest exists often described as one-line consolidation Consolidation - control applied when control exists.

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EQUITY ACCOUNTING TEXT CHAP 20

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  1. EQUITY ACCOUNTING TEXT CHAP 20

  2. Accounting for Investments • Cost method used in the purchasing company’s books • Equity method - AASB 1016 applied when a significant interest exists often described as one-line consolidation • Consolidation - control • applied when control exists

  3. Application of Equity Accounting • Purpose of the standard is to prescribe the circumstances in which investors must apply the equity method to account for investments in associates • Associates defined : Investment not being • a Subsidiary • not a partnership • investment not acquired for resale

  4. Application of Equity Accounting • Significant influence • equity accounting is to be applied when a entity has significant influence over an associate company • Defined as : • the capacity of an entity to affect substantially (but not control) financial & operation of another entity • 20% test • where a company holds 20% or more (without control) then a presumption that significant influence exist

  5. General description • The investor will bring to account, in each period, its share of the profits or losses of the other company - other than income already received by way of dividends. • AASB 1016 If the investor prepares consolidation then adjust in accounts or if not a holding company then adjust in the books of the investor

  6. example • Investee Ltd- Profit & Loss (25%) Operating Profit 100 000 Dividend Paid 20 000 $80 000 • Share of profit 25% $100 000= $25 000 already recorded Dividend Paid 25% of $20 000 = $5 000 still to be recorded = $20 000

  7. example • Investee Ltd- Profit & Loss (25%) Operating Profit 100 000 Dividend Paid 20 000 $80 000 • Share of profit 25% $100 000= $25 000 already recorded Dividend Paid 25% of $20 000 = $5 000 still to be recorded = $20 000 • DR Investment in Associate 20 000 • CR Share of Profits in Associate 20 000

  8. Example- Goodwill • At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $49 375. At this date the shareholders equity section of Bear Ltd consisted of:- Share Capital 100 000 Reserves 50 000 Retained Profits 20 000 All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost. Tax Rate 30% -Plant 5 year life- Inventory sold 2001 Any goodwill over 10 years

  9. Example- Goodwill • Fair Value of Assets acquired • Capital 100 000 • Reserves 50 000 • Retained Profits 20 000 • Plant .7*10 000 7 000 • Inventory .7*5000 3 500 • 180 500 • 25% 45 125 • Cost 49375 • Goodwill $4 250 • At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $49 375. At this date the shareholders equity section of Bear Ltd consisted of:- Share Capital 100 000 Reserves 50 000 Retained Profits 20 000 All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost. Tax Rate 30% -Plant 5 year life- Inventory sold 2001 Any goodwill over 10 years

  10. Example- Goodwill • Fair Value of Assets acquired • Capital 100 000 • Reserves 50 000 • Retained Profits 20 000 • Plant .7*10 000 7 000 • Inventory .7*5000 3 500 • 180 500 • 25% 45 125 • Cost 49375 • Goodwill $4 250 • At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $49 375. At this date the shareholders equity section of Bear Ltd consisted of:- Share Capital 100 000 Reserves 50 000 Retained Profits 20 000 All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost. Tax Rate 30% -Plant 5 year life- Inventory sold 2001 Any goodwill over 10 years Amortisation of Goodwill 10% 4 250 = 425 Depreciation 20% (25% * 7 000) = 350 Inventory 25% 3 500 875

  11. Calculation of Profit • Assume Bear Ltd’s profit after tax $15 000 • Recorded profit 25% of 15 000 3 750 • Pre-acquisition Adjustments • Goodwill 425 • Depreciation 350 • Inventory 875 1 650 Net Adjustment $2 100 Amortisation of Goodwill 10% 4 250 = 425 Depreciation 20% (25% * 7 000) = 350 Inventory 25% 3 500 875

  12. Entry in Books orConsolidation Adjustment • Assume Bear Ltd’s profit after tax $15 000 • Recorded profit 25% of 15 000 3 750 • Pre-acquisition Adjustments • Goodwill 425 • Depreciation 350 • Inventory 875 1 650 Net Adjustment $2 100 Entry Dr Investment in Bear Ltd 2 100 Cr Revenue from Associate 2 100

  13. Consolidation Adjustment- following year • Assume Bear Ltd’s profit after tax $15 000 • Recorded profit 25% of 15 000 3 750 • Pre-acquisition Adjustments • Goodwill 425 • Depreciation 350 • Inventory 875 1 650 Net Adjustment $2 100 Entry Dr Investment in Bear Ltd 2 100 Cr Retained profits 2 100 (No entry if adjusted in BOOKS!!)

  14. Example- Discount • At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $44 125. At this date the shareholders equity section of Bear Ltd consisted of:- Share Capital 100 000 Reserves 50 000 Retained Profits 20 000 All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost. Tax Rate 30% -Plant 5 year life- Inventory sold 2001 Any goodwill over 10 years

  15. Example- Discount • At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $44 125. At this date the shareholders equity section of Bear Ltd consisted of:- Share Capital 100 000 Reserves 50 000 Retained Profits 20 000 All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost. Tax Rate 30% -Plant 5 year life- Inventory sold 2001 Any goodwill over 10 years Carrying Fair Amount Value Plant 86 000 96 000 Inventory 21 000 26 000

  16. Example- Discount • Fair Value of Assets acquired • Capital 100 000 • Reserves 50 000 • Retained Profits 20 000 • Plant .7*10 000 7 000 • Inventory .7*5000 3 500 • 180 500 • 25% 45 125 • Cost 44 125 • Discount $1 000 • At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $44 125. At this date the shareholders equity section of Bear Ltd consisted of:- Share Capital 100 000 Reserves 50 000 Retained Profits 20 000 All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost. Tax Rate 30% -Plant 5 year life- Inventory sold 2001 Any goodwill over 10 years

  17. Allocation of Discount Fair Value 25% Discount Cost BV(25%) Adj Plant 96 000 24 000 797 23203 Inventory 24 500* 6 125 203 5922 5250 672 120 500 30 125 3 000 *21 000+.7*5000

  18. Allocation of Discount Fair Value 25% Discount Cost BV(25%) Adj Plant 96 000 24 000 797 23203 Inventory 24 500* 6 125 203 5922 5250 672 120 500 30 125 3 000 *21 000+.7*5000 Depreciation of Plant 20% of 797= 159 Inventory adjustment = 672

  19. Calculation of Profit Depreciation of Plant 20% of 797= 159 Inventory adjustment = 672 Assume Profit - $15 000 (after tax) Share of Recorded Profit 25% 15 000 3 750 Pre-acquisition Adjustment Depreciation 191 * Cost of Sales 672 $2 887 * 20% of 25% (.7* 10 000)-159

  20. Calculation of Profit Assume Profit - $15 000 (after tax) Share of Recorded Profit 25% 15 000 3 750 Pre-acquisition Adjustment Depreciation 191 * Cost of Sales 672 $2 887 * 20% of 25% (.7* 10 000)-159 entry Investment in Bear Ltd 2 887 Revenue from Associate 2 887

  21. Additional Adjustments • Interim Dividends Paid The carrying amount has to be reduced for any dividend adjustments- otherwise the profit would be double counted ie Company has recorded as Dividend Income & Equity accounting has recorded total profit • Dividends Provided • accounted for as for interim dividend as assumed that investor records as dividend receivable ie taken up as income • Preference Dividend If regarded as equity then this must be deducted fron the profit to arrive at the profit available to ordinary shareholders

  22. example • Investee Ltd- Profit & Loss (25%) Year 1 Year 2 Operating Profit 100 000 200 000 Dividend Provided 20 000 - $80 000 200 000 • Share of profit 25% $300 000= $75 000 • Recorded as follows:- • Year 1 Equity 25%(100 000-20 000) 20 000 • plus in books as Dividend Receivable 5 000 • Year 2 Equity 25%(200 000) 50 000 • $75 000

  23. Example- dividend paid or provided Recorded Profit 100 000 Less- Adjustments Dividends Paid or Provided 20 000 Total $ 80 000 Share of Profit 25% $ 20 000

  24. Example- dividend paid or provided Recorded Profit 100 000 Less- Adjustments Dividends Paid or Provided 20 000 Total $ 80 000 Share of Profit 25% $ 20 000 entry Investment in Bear Ltd 20 000 Revenue from Associate 20 000

  25. Increase/Decrease in Reserves • Asset Revaluation Reserve Carrying amount must be increased/ decreased for adjustments to reserves eg Company has revalued its assets by $100 000 • Dr Investment in Associate 25 000 CR Asset Revaluation Reserve 25 000

  26. Inter-entity transactions Like consolidations we have to remove the unrealised profits between the investor & the investee sale of inventory sale of depreciable asset

  27. Sale of Inventory • Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period Tax 30% • Recorded profit 30 000 Adjustment Inventory in Closing stock -1 400 # $ 28 600 # Unrealised Profit .7*2 000

  28. Sale of Inventory • Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period Tax 30% • Recorded profit 30 000 Adjustment Inventory in Closing stock -1 400 # $ 28 600 # Unrealised Profit .7*2 000 entry Investment in Bear Ltd 7 150 Revenue from Associate 7 150 25% 28600

  29. Sale of Inventory- opening inventory • Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period Tax 30% • Recorded profit 30 000 Adjustment Inventory in Closing stock -1 400 $ 28 600 • Following period Recorded Profit 40 000 Adj- Opening Inventory +1 400 $41 400

  30. Sale of Inventory- opening inventory • Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period Tax 30% • Recorded profit 30 000 Adjustment Inventory in Closing stock -1 400 $ 28 600 • Following period Recorded Profit 40 000 Adj- Opening Inventory +1 400 $41 400 entry Investment in Bear Ltd 10 350 Revenue from Associate 10 350 25% $41 400

  31. Sale of Depreciable Asset • Investee Ltd sells an item of Plant to Investor for $8 000. Book value $3 000. Further 5 years life. (tax 30%) • Recorded Profit 40 000 • Adjustments Unrealised profit -3 500 (Gain .7 *$ 5 000) Realised Profit (3500/5) +700 (Depreciation) $37 200 • Following Year Recorded Profit 40 000 Realised Profit +700 $40 700

  32. Losses • Losses Losses should also be adjusted BUT once asset reduced to Zero suspend AASB 1016.

  33. Investee Ltd- Profit & Loss (25%) Operating Loss 400 000 • Share of Loss 25% $400 000= $100 000 • Assume paid $50 000 • General ledger: Shares in Investee Ltd dr cr Balance 1/1/xx Cash 50 000 50 000 30/6/99 Equity -loss 100 000 (50 000) ???

  34. Investee Ltd- Profit & Loss (25%) Operating Loss 400 000 • Share of Loss 25% $400 000= $100 000 • Assume paid $50 000 • General ledger: Shares in Investee Ltd dr cr Balance 1/1/xx Cash 50 000 50 000 30/6/99 Equity -loss 50 000 Nil ie SUSPEND using equity accounting

  35. Tutorial Questions • Exercise 20.1 • Exercise 20.3 • Exercise 20.4 • Problem 20.1 • Problem 20.3

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