Contemplation is a company that carries on business as film processors. For the past few years it has been making losses owing to the low price competition.
The company's statement of financial position as at 30 June 20X2 was as follows.
$'000
Non-current assets 3,600
Current assets 4,775
8,375
Equity
Ordinary shares of $1 each fully paid 10,000
Retained earnings (9,425)
575 Non-current liabilities
8% cumulative preference shares ((2,500,000 shares of $1 each) 3,300
11% Loan notes redeemable 20X9 3,500
Current liabilities 1,000
8,375 The company has changed its marketing strategy and is now aiming at the specialist portrait print market. It is expected that the company will earn annual profits after tax of $1,500,000 for the next five years; the figure is before an interest charge. Income tax is assumed to be at a rate of 35%.
The directors are proposing to reconstruct the company and have produced the following proposal for discussion.
(a) To cancel the existing ordinary shares.
(b) The 11% loan notes are to be retired and the loan note holders issued in exchange with:
(i) $3,000,000 14% redeemable loan notes 20Y5; and (ii) 2,000,000 ordinary shares of 25c each, fully paid up.
(c) The carrying value of the preference share capital above includes four years of dividends arrears. Assume that the IAS 32 definition of a liability is met. The preference shareholders are to be issued with 2,000,000 ordinary shares of 25c each fully paid up in exchange for the cancellation of these dividends arrears.
(d) The existing ordinary shareholders will be issued with 3,500,000 ordinary shares of 25c each, fully paid up.
In the event of a liquidation, it is estimated that the net realisable value of the assets would be $3,100,000 for the non-current assets and $3,500,000 for the net current assets.
Required
(a) Prepare a statement of financial position as at 1 July 20X2 after the reconstruction has been effected.
(b) Prepare computations to show the effect of the proposed reconstruction scheme on each of the loan note holders, preference shareholders and ordinary shareholders.
(c) Write a brief report to advise a shareholder who owns 10% of the issued ordinary share capital on whether to agree to the reconstruction as proposed. The shareholder has informed you that he feels the proposals are unfair.
(d) In your capacity as adviser to the shareholder, write a brief report to the directors suggesting any amendments you consider advisable.
Guidance notes
1 Layout a proforma statement of financial position for part (a) and fill in numbers as you work them out.
Clearly label and cross reference workings.
2 The acceptability of any scheme to the major parties involved will be the main issue in such reconstructions.
You must weigh up how much each group has to lose or gain and then reach a compromise.
69 Plans 27 mins
X, a public limited company, owns 100% of companies Y and Z which are both public limited companies. The X group operates in the telecommunications industry and the directors are considering two different plans to restructure the group. The directors feel that the current group structure is not serving the best interests of the shareholders and wish to explore possible alternative group structures.
The statements of financial position of X and its subsidiaries Y and Z at 31 May 20X7 are as follows:
X Y Z
$m $m $m
Property, plant and equipment 600 200 45
Cost of investment in Y 60
X acquired the investment in Z on 1 June 20X1 when the company's retained earnings balance was $20 million. The fair value of the net assets of Z on 1 June 20X1 was $60 million. Company Y was incorporated by X and has always been a 100% owned subsidiary. The fair value of the net assets of Y at 31 May 20X7 is $310 million and of Z is $80 million. The fair values of the net current assets of both Y and Z are approximately the same as their book values.
The directors are unsure as to the impact or implications that the following plans are likely to have on the individual accounts of the companies and the group accounts.
Local companies legislation requires that the amount at which share capital is recorded is dictated by the nominal value of the shares issued and if the value of the consideration received exceeds that amount, the excess is recorded in the share premium account. Shares cannot be issued at a discount. In the case of a share for share exchange, the value of the consideration can be deemed to be the book value of the investment exchanged.
The two different plans to restructure the group are as follows:
Plan 1
Y is to purchase the whole of X's investment in Z. The purchase consideration would be 50 million $1 ordinary shares of Y.
Plan 2
The same scenario as Plan 1, but the purchase consideration would be a cash amount of $75 million.
Required
Discuss the key considerations and the accounting implications of the above plans for the X group. Your answer should show the potential impact on the individual accounts of X, Y and Z and the group accounts after each plan has been implemented.
(Total = 15 marks)
70 Decany 45 mins
12/11 Decany owns 100% of the ordinary share capital of Ceed and Rant. All three entities are public limited companies.
The group operates in the shipbuilding industry, which is currently a depressed market. Rant has made losses for the last three years and its liquidity is poor. The view of the directors is that Rant needs some cash investment. The directors have decided to put forward a restructuring plan as at 30 November 20X1. Under this plan:
(a) Ceed is to purchase the whole of Decany's investment in Rant. The purchase consideration is to be $98 million payable in cash to Decany and this amount will then be loaned on a long-term unsecured basis to Rant.
(b) Ceed will purchase land with a carrying amount of $10 million from Rant for a total purchase consideration of $15 million. The land has a mortgage outstanding on it of $4 million. The total purchase consideration of
$15 million comprises both five million $1 nominal value non-voting shares issued by Ceed to Rant and the
$4 million mortgage liability which Ceed will assume.
(c) A dividend of $25 million will be paid from Ceed to Decany to reduce the accumulated reserves of Ceed.
The statements of financial position of Decany and its subsidiaries at 30 November 20X1 are summarised below.
Decany Ceed Rant
$m $m $m Non-current assets
Property, plant and equipment at cost/valuation 600 170 45
Cost of investment in Ceed 130
Cost of investment in Rant 95
Current assets 155 130 20
980 300 65
Equity and reserves
Share capital 140 70 35
Retained earnings 750 220 5
890 290 40
Non-current liabilities
Long-term loan 5 12
Current liabilities
Trade payables 85 10 13
980 300 65
As a result of the restructuring, several of Ceed's employees will be made redundant. According to the detailed plan, the costs of redundancy will be spread over two years with $4 million being payable in one year's time and $6 million in two years' time. The market yield of high quality corporate bonds is 3%. The directors feel that the overall restructure will cost $2 million.
Required
(a) (i) Prepare the individual entity statements of financial position after the proposed restructuring plan.
(13 marks) (ii) Set out the requirements of IAS 27 (Revised) Separate financial statements as regards the
reorganisation and payment of dividends between group companies, discussing any implications for
the restructuring plan. (5 marks)
(b) Discuss the key implications of the proposed plans for the restructuring of the group. (5 marks) Professional marks will be awarded in Part (b) for clarity and expression of your discussion. (2 marks)
(Total = 25 marks)
71 Lucky Dairy 45 mins
ACR, 6/02, amended The Lucky Dairy, a public limited company, produces milk for supply to various customers. It is responsible for producing twenty five per cent of the country's milk consumption. The company owns 150 farms and has a stock of 70,000 cows and 35,000 heifers which are being raised to produce milk in the future. The farms produce 2.5 million kilograms of milk per annum and normally hold an inventory of 50,000 kilograms of milk (Extracts from the draft accounts to 31 May 20X2).
The herds comprise at 31 May 20X2:
70,000 – 3 year old cows (all purchased on or before 1 June 20X1)
25,000 – heifers (average age 1½ years old – purchased 1 December 20X1) 10,000 – heifers (average age 2 years – purchased 1 June 20X1)
There were no animals born or sold in the year. The per unit values less estimated point of sale costs were as
The company has had a difficult year in financial and operating terms. The cows had contracted a disease at the beginning of the financial year which had been passed on in the food chain to a small number of consumers. The publicity surrounding this event had caused a drop in the consumption of milk and as a result the dairy was holding 500,000 kilograms of milk in storage.
The government had stated, on 1 April 20X2, that it was prepared to compensate farmers for the drop in the price and consumption of milk. An official government letter was received on 6 June 20X2, stating that $1.5 million will be paid to Lucky on 1 August 20X2. Additionally on 1 May 20X2, Lucky had received a letter from its lawyer saying that legal proceedings had been started against the company by the persons affected by the disease. The
company's lawyers have advised them that they feel that it is probable that they will be found liable and that the costs involved may reach $2 million. The lawyers, however, feel that the company may receive additional
compensation from a government fund if certain quality control procedures had been carried out by the company.
However, the lawyers will only state that the compensation payment is 'possible'.
The company's activities are controlled in three geographical locations, Dale, Shire and Ham. The only region affected by the disease was Dale and the government has decided that it is to restrict the milk production of that region significantly. Lucky estimates that the discounted future cash income from the present herds of cattle in the region amounts to $1.2 million, taking into account the government restriction order. Lucky was not sure that the fair value of the cows in the region could be measured reliably at the date of purchase because of the problems with the diseased cattle. The cows in this region amounted to 20,000 in number and the heifers 10,000 in number. All of the animals were purchased on 1 June 20X1. Lucky has had an offer of $1 million for all of the animals in the Dale region (net of point of sale costs) and $2 million for the sale of the farms in the region. However, there was a minority of directors who opposed the planned sale and it was decided to defer the public announcement of sale pending the outcome of the possible receipt of the government compensation. The board had decided that the potential sale plan was highly confidential but a national newspaper had published an article saying that the sale may occur and that there would be many people who would lose their employment. The board approved the planned sale of Dale farms on 31 May 20X2.
The directors of Lucky have approached your firm for professional advice on the above matters.
Required
Advise the directors on how the biological assets and produce of Lucky should be accounted for under IAS 41 Agriculture and discuss the implications for the published financial statements of the above events.
(Candidates should produce a table which shows the changes in value of the cattle stock for the year to 31 May 20X2 due to price change and physical change excluding the Dale region, and the value of the herd of the Dale region as at 31 May 20X2. Ignore the effects of taxation. Heifers are young female cows.) (25 marks)
72 IFRSs and SMEs 45 mins
ACR, 6/06, amended International Financial Reporting Standards (IFRSs) are primarily designed for use by publicly listed companies and in many countries the majority of companies using IFRSs are listed companies. In other countries IFRSs are used as national Generally Accepted Accounting Practices (GAAP) for all companies including unlisted entities. It has been argued that the same IFRSs should be used by all entities or alternatively a different body of standards should apply to small and medium entities (SMEs) and recently the IASB published an IFRS for SMEs.
Required
(a) Discuss whether it was necessary to develop a set of IFRSs specifically for SMEs. (7 marks) (b) Discuss the nature of the following issues in developing IFRSs for SMEs.
(i) The purpose of the standards and the type of entity to which they should apply. (7 marks) (ii) How existing standards could be modified to meet the needs of SMEs. (6 marks) (iii) How items not dealt with by an IFRS for SMEs should be treated. (5 marks)
(Total = 25 marks)
73 Whitebirk 40 mins
12/10, amended (a) The main argument for separate SME accounting standards is the undue cost burden of reporting, which is
proportionately heavier for smaller firms.
Required
Discuss the main differences and modifications to IFRS which the IASB made to reduce the burden of reporting for SME's, giving specific examples where possible and include in your discussion how the Board
has dealt with the problem of defining an SME. (9 marks)
Professional marks will be awarded in part (a) for clarity and quality of discussion. (2 marks) (b) Whitebirk has met the definition of a SME in its jurisdiction and wishes to comply with the IFRS for Small
and Medium-sized Entities. The entity wishes to seek advice on how it will deal with the following accounting issues in its financial statements for the year ended 30 November 20X2. The entity already prepares its financial statements under full IFRS.
(i) Whitebirk purchased 90% of Close, a SME, on 1 December 20X1. The purchase consideration was
$5.7 million and the value of Close's identifiable assets was $6 million. The value of the non-controlling interest at 1 December 20X1 was measured at $0.7 million. Whitebirk has used the full goodwill method to account for business combinations and the life of goodwill cannot be estimated with any accuracy. Whitebirk wishes to know how to account for goodwill under the IFRS for SMEs.
(ii) Whitebirk has incurred $1 million of research expenditure to develop a new product in the year to 30 November 20X2. Additionally, it incurred $500,000 of development expenditure to bring another product to a stage where it is ready to be marketed and sold.
(iii) Whitebirk purchased some properties for $1.7m on 1 December 20X1 and designated them as investment properties under the cost model. No depreciation was charged as a real estate agent valued the properties at $1.9m at the year end.
(iv) Whitebirk has an intangible asset valued at $1m on 1 December 20X1. The asset has an indefinite useful life, and in previous years had been reviewed for impairment. As at 30 November 20X2, there are no indications that the asset is impaired.
Required
Discuss how the above transactions should be dealt with in the financial statements of Whitebirk, with reference to the IFRS for Small and Medium-sized Entities. (11 marks)
(Total = 22 marks)