1. EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

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

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

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

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

8. Example- Goodwill o 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 o 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 o 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 o 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

10. Example- Goodwill o 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 Amortisation of Goodwill 10% 4 250 = 425 Depreciation 20% (25% * 7 000) = 350 Inventory 25% 3 500 875 o 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 o 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

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

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

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

14. Example- Discount o 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 o 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 Carrying Fair Amount Value Plant 86 000 96 000 Inventory 21 000 26 000

16. Example- Discount o 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 o 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 o 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

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 Depreciation of Plant 20% of 797= 159 Inventory adjustment = 672

19. 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 Depreciation of Plant 20% of 797= 159 Inventory adjustment = 672 Depreciation of Plant 20% of 797= 159 Inventory adjustment = 672

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 entry Investment in Bear Ltd 2 887 Revenue from Associate 2 887

21. Additional Adjustments o 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 o Dividends Provided –accounted for as for interim dividend as assumed that investor records as dividend receivable ie taken up as income o 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 o Investee Ltd- Profit & Loss (25%) Year 1 Year 2 Operating Profit 100 000 200 000 Dividend Provided 20 000 - $80 000 200 000 o Share of profit 25% $300 000= $75 000 o 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 entry Investment in Bear Ltd 20 000 Revenue from Associate 20 000

25. Increase/Decrease in Reserves o Asset Revaluation Reserve Carrying amount must be increased/ decreased for adjustments to reserves eg Company has revalued its assets by $100 000 o 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 o Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period Tax 30% o Recorded profit 30 000 Adjustment Inventory in Closing stock -1 400 # $ 28 600 # Unrealised Profit.7*2 000

28. Sale of Inventory o Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period Tax 30% o 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 entry Investment in Bear Ltd 7 150 Revenue from Associate 7 150 25% 28600

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

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

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

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

33. o Investee Ltd- Profit & Loss (25%) Operating Loss 400 000 o Share of Loss 25% $400 000= $100 000 o 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. o Investee Ltd- Profit & Loss (25%) Operating Loss 400 000 o Share of Loss 25% $400 000= $100 000 o 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