ACCT7104 Corporate Accounting

Seminar 3 Set Work Questions and Solutions

Arthur et al:
Q3.1 Describe the requirements in the Australian accounting standards for initial
recognition and subsequent measurement of non-current assets. Assume a subsidiary
revalues its land holdings from an existing carrying amount of $200,000 to a fair value
of $350,000. Describe how the revaluation increment of $150,000 must be brought to
account by the subsidiary.
Suggested Solution:
A resource (right) is recognised as an asset by an entity if, in the conditions existing at
balance date, it is controlled by the entity and from which it is probable that future economic
benefits will be derived; and the resource (right) has a cost or value that is reliably
measurable. The cost of any asset is the cash equivalent, at the date of acquisition, of all
current and future sacrifices of economic benefits which are necessarily incurred by the
acquirer to place the asset in a position to serve the function for which it is intended and
directly relate to and form part of the acquisition transaction.
In the post-acquisition period, the carrying amount of an item of property, plant or equipment
is allocated to expense or production overhead as the assets services are consumed in
operations.
The carrying amount of an item of property, plant and equipment may be determined using
the cost model or revaluation model. The choice of model is a matter of policy. As the
members of a group must adopt common accounting policies, the members of a group may
use either the cost model or revaluation model as the model for determining the carrying
amount of its property, plant and equipment.
An asset cannot be carried at more than its recoverable amount. If the cost model is used and
there are indications of the non-recoverability of the carrying amount of the asset, an
impairment is recognised equal to the difference between the carrying amount and the
recoverable amount. If the revaluation model is used, the recognition of revaluation
increments and decrements results in the assets being carried at their recoverable amount.
Journal entry to recognise a revaluation increment of $150000 on land, assuming an income
tax rate of 30%:

Land $150000
Revaluation reserve $105000
Deferred tax liability $45000
Q3.3 Gui Ltd has recently acquired a gold mining subsidiary, Cisa Ltd. The acquisition
analysis for the investment in Cisa Ltd includes the following notes:
Cisa Ltds Big M gold mine is included in the acquisition analysis as an
identifiable asset, valued at the costs incurred on mine development,
$7.5million.
The probable future success of Cisa Ltds exploration activities in
discovering new gold deposits is included in the acquisition analysis as an
identifiable asset, valued at the cost incurred on exploration activities.
Cisa Ltds unused tax losses of $13 million are not recorded as an asset in
its accounting records. Therefore it must be excluded from the acquisition
analysis.
Cisa Ltds inventory of gold cost $15million to produce but its fair value
at acquisition date is $18million. Therefore a $3million adjustment has
been recorded in the accounts of Cisa Ltd.
Evaluate whether the treatment of the items listed above is correct in accordance with
accounting standards.
Suggested Solution:
Through the acquisition of a controlling interest in a company, the parent entity acquires the
rights of the shareholders in that company and thus their equity interest in the net assets of the
company. The cost of the investment will comprise the interest in the net separable or
severable assets of the subsidiary plus (minus) any goodwill (excess) on acquisition. At the
date of acquisition, the carrying amounts of the net separable assets in the books of the
subsidiary will not usually provide an adequate basis for determining the equity acquired in
those net assets. Only if the net separable assets of the subsidiary are measured at their fair
value, from the viewpoint of the parent entity, will we be able to have reliable measures of
the shareholders equity of the subsidiary at acquisition (pre-acquisition equity), the equity
acquired in the net assets of the subsidiary and of the goodwill (gain) on acquisition.

As a general principle, at the date of acquisition, the equity acquired in the net assets of a
subsidiary means the equity acquired in the net separable assets of the subsidiary measured in
terms of their fair value from the viewpoint of the parent entity. At the date of acquisition,
therefore, the net assets of the subsidiary are restated to their fair value from the viewpoint of
the parent entity. The net assets comprise the subsidiarys separable assets, its liabilities and
contingent liabilities. An intangible asset is recognised separately only if it is identifiable,
separable and its fair value can be measured reliably (paragraphs 45 and 46]. A contingent
liability is recognised separately only if its fair value can be measured reliably [paragraph
37].

In Appendix B to AASB 3, there are a whole host of rules to be applied in determining the
fair values of specific assets and liabilities. In the case of Gui Ltd, it is a matter of applying
these rules to the various problems.
Big M gold minecosts of mine development $7.5million
The exploration, evaluation and development costs of the Big M gold mine have been
capitalised in accordance with accounting standards. These costs may be broken down into
exploration and evaluation costs, development costs and infrastructure costs. This
capitalisation results in the recognition of assets whose carrying amounts are considered
recoverable. The carrying amounts are unlikely to result in a measure of the fair value of the
mine property.
The fair values of the production facilities and infrastructure facilities may be determined on
the same basis as any other item of property, plant and equipment. The capitalised exploration
and evaluation costs represent the cost of locating a mineral resource. There is no active
market for outcome of these activities so that there is no market-based evidence of fair value.
This estimated fair value may be subject to such uncertainty that Gui Ltd may use the
recorded estimated recoverable costs as a last resort.

Probable future successes in exploration activity

In each undeveloped area of interest there are probably capitalised area of interest tenancy
costs and exploration costs. The capitalised exploration and evaluation costs represent the
cost of locating a mineral resource. As the areas of interest are still in the exploration phase,
there is no active market for outcome of these activities so that there is no market-based
evidence of fair value. This estimated fair value may be subject to such uncertainty that Gui
Ltd may use the recorded estimated recoverable costs as a last resort.

Unused tax losses$13million

The tax benefits to be derived from unused tax losses are recognised if it probable that the tax
benefits will be derived and the benefits are reliably measurable. Where a subsidiary has not
had a profit history, it is unlikely that the tax benefits of unused losses would be recognised as
a deferred tax asset. What is not probable from the subsidiary viewpoint may be probable
from the group viewpoint. If, from the group viewpoint, it is probable that the benefits from
the unused tax losses will be realised, the fair value of the tax benefits relating to the losses
must be taken into account.
According to AASB 3, the fair value of the deferred tax asset arising from tax losses is
assessed from the viewpoint of the combining entity (group) and is accounted for as per
AASB 12 Income Taxes. Assuming that the tax losses were probably recoverable and a tax
rate of 30%, a deferred tax asset of 30% of $13000000 = $3900000 would be part of the
equity acquired in the net assets of Cisa Ltd.
Inventory of gold
In the separate statement of financial position of CISA Ltd, the inventory of gold is carried at
the lower of cost and net realisable value $15000000.
In measuring the fair value of the equity acquired in the net assets of Cisa Ltd, however, any
inventory held by that company is also measured at its fair value. In the case of inventories,
the fair value is the defined in AASB 102 and may not equal net realisable value
Assuming that the fair value of the inventory of $18000000 has been calculated in
accordance with AASB 102, a valuation increment of $3000000 would be recognised
$2100000 after an assumed tax rate of 30%.

Q3.6 Explain the following propositions:

a) The balance of current tax payable for the group equals the sum of the current
tax payables recorded by the parent entity and each of its subsidiaries
b) The deferred tax liability for the group may differ from the sum of the deferred
tax liabilities recorded by the parent entity and each of its subsidiaries
c) Deferred tax assets are usually netted off against deferred tax liabilities in the
accounts of an individual entity, but rarely upon consolidation
Suggested Solution:
a) This will be true only if each subsidiary prepares its own tax return and is taxed as a
single entity. It will not necessarily be true if the parent and its wholly owned
subsidiaries adopt tax consolidation. If there are unrealised profits earned by a
subsidiary on an intragroup transaction, this profit is eliminated and the group tax
payable is reduced by the tax effect of the unrealised profit.

b) They would not differ only if there are no consolidation adjustments recognising gains
or losses with deferred tax consequences. If, for example, a revaluation increment is
recognised through a revaluation adjustment, a deferred tax liability will be
recognised on that adjustment so that the deferred tax liabilities recognised by the
group will be greater than the sum of the deferred tax liabilities recognised by the
parent and its subsidiaries in their separate statements of financial position.

c) Deferred tax assets may be netted off against deferred tax liabilities only if the income
taxes are levied by the same taxation authority and inter alia the different taxable entities
intend to settle current tax assets and liabilities on a net basis. Thus deferred tax assets
and liabilities would probably only qualify for set-off where the taxable entities are a
parent entity and its wholly owned subsidiaries adopt tax consolidation.
Q3.8 Explain how the acquisition of a subsidiary can give rise to the recognition of a
deferred tax liability (relating to the subsidiarys assets) on consolidation. Provide at
least two examples to illustrate your answer. Explain how the deferred tax liability
recognised on consolidation will be transferred to profit in future accounting periods.
Suggested Solution:
In estimating the fair value of the net assets of the subsidiary at the date of acquisition,
consolidation adjustments may be made to recognise revaluation increments on items such as
plant and land. If revaluation increments are recognised, deferred tax liabilities are also
recognised. If a land revaluation increment of $1000000 is recognised as a consolidation
adjustment and the applicable income tax rate is 30%, a revaluation reserve and deferred tax
liability of $700000 and $300000 respectively will be recognised.
Deferred tax liabilities recognised as part of consolidation adjustments at acquisition will be
consumed through profit in future periods. A deferred tax liability recognised on the
recognition of a plant revaluation increment will transfer to profit as the plant services are
consumed in operations in the form of depreciation or when the plant is sold. A deferred tax
liability recognised on the recognition of a land revaluation increment can only be transferred
top profit when the land is sold.

E3.3 and E3.7.

Please refer to Arthur et al for exercise details.
Note: Since the chapter is essentially about valuation adjustments and related tax
effects, tax effects are taken into consideration in each example, even though the data in
the example states that income tax effects should be ignored. The tax rate is always
taken to be 30% unless otherwise dictated, even though some of the valuation
adjustments are affected by capital gains taxes and not income taxes.

Consolidation adjustment in the year ended 30 June 20X3 in respect of the inventory
undervalued by $600000 (tax $180000) at the date of acquisition. 30% now sold, 70% still
on hand:
Cost of goods sold $180000
Inventory 420000
Income tax expense $54000
Deferred tax liability 126000
Fair value adjustment 294000
Retained earnings 1 July 20X2 126000
Analysis of investment (amounts in thousands):

Equity acquired in net assets of subsidiary

Share capital $3000
Revaluation surplus 1500
Fair value adjustment 294
Retained earnings 1 July 20X2 ($2500 + 126) 2626
-------
Total equity acquired $7420
Cost of investment 8000
-------
Goodwill $ 580
====

Consolidation adjustment to eliminate intragroup investment and recognise goodwill:

Share capital $3000000
Revaluation surplus 1500000
Fair value adjustment 294000
Retained earnings 1 July 20X2 2626000
Goodwill 580000
Investment in subsidiary $8000000

Consolidation adjustment to recognise the impairment of goodwill of $200000:

Goodwill impairment expense $200000
Goodwill $200000
E3.7.
Please refer to Arthur et al for exercise details.
Cost of acquisition
= 600000 $2.20 + 300000 $0.50
= $(1320000 + 150000)
= $1470000
Journal entry to record the investment in the financial database of Parramatta Ltd:
Investment in subsidiary $1470000
Share capital $1320000
Cash 150000

Consolidation adjustment to recognise the valuation increment of $800000 (tax $240000):

Land $800000
Fair value adjustment $560000
Deferred tax liability 240000

Analysis of investment (amounts in thousands):

Equity acquired in net assets of subsidiary
Share capital $ 300
Fair value adjustment 70% of $800 560
General reserve 180
Retained earnings 380
-------
Total equity acquired $1420
Cost of investment 1470
-------
Goodwill $ 50
====
Consolidation adjustment to eliminate the intragroup investment and recognise goodwill:
Share capital $300000
Fair value adjustment 560000
General reserve 180000
Retained earnings 1 January 20X1 380000
Goodwill 50000
Investment in subsidiary $1470000

Consolidation adjustment to eliminate intragroup payables and receivables of $90000:

Payable to Bankstown Ltd $90000
Receivable from Parramatta Ltd $90000
Preparation of consolidation worksheet (amounts in thousands):
Parramatta Bankstown Adjustments Group
Ltd Ltd Debit Credit Data
Shareholders equity
Share capital $1920 $ 300 300(b) $1920
Fair value 560(b) 560(a)
adjustment (FVA)
General reserve 250 180 180(b) 250
Retained earnings 450 380 380(b) 450
------- ------- -------
Total shareholders $2620 $ 860 $2620
equity
==== ==== ====
Assets
Current assets
Cash $ 40 $ 40
Accounts 21 $ 47 68
receivable
Receivable from 90 90(c)
Parramatta Ltd
Inventory 223 151 374
Non-current assets
Equipment 256 247 503
Rural and 740 370 800(a) 1910
Commercial land
Buildings 560 210 770
Investment in 1470 1470(b)
subsidiary
Goodwill 50(b) 50
------- ------- -------
Total assets $3310 $1115 $3715
==== ==== ====
Liabilities
 Current liabilities
Accounts $ 85 $ 63 $ 148
payable
Payable to 90 90(c)
Bankstown Ltd
Income tax 75 50 125
payable
Non-current
liabilities
Term borrowings 410 120 530
Deferred tax 30 22 240(a) 292
liability
------- ------- -------
Total liabilities $ 690 $ 255 $1095
==== ==== ====
Net Assets $2620 $ 860 $2620
==== ==== ====
Notes to worksheet:
(a) Adjustment to recognise the revaluation increment
(b) Adjustment to eliminate the intragroup investment and recognise goodwill
(c) Adjustment to eliminate the intragroup payables and receivables
________________________________________________________________
 Parramatta Group
Consolidated statement of financial position as at 1 January 20X1
(amounts in thousands)
Assets
Current assets
Cash $ 40
Accounts receivable 68
Inventories 374
-------
Total current assets $ 482
Non-current assets
Property, plant and equipment $3183
Intangibles 50
-------
Total non-current assets 3233
-------
Total assets $3715
====
Liabilities
Current liabilities
Accounts payable $ 148
Income tax payable 125
-------
Total current liabilities $ 273
Non-current liabilities
Borrowings $ 530
Deferred tax 292
-------
Total non-current liabilities 822
-------
Total liabilities $1095
====
Net assets $2620
====
Shareholders equity
Share capital $1920
General reserve 250
Retained earnings 450
-------
Total shareholders equity $2620
====