B.

com in Accounting

Module: Financial Accounting 3A

Module Code: FNA310

STUDY GUIDE
Table of Contents
STUDY UNIT 1: FINANCIAL INSTRUMENTS.................................................................... 3
[IFRS 9], [IFRS 7], [IAS 32] ................................................................................................. 3
1.1 Introduction ................................................................................................................... 3
1.2 Module overview ........................................................................................................... 3
1.3 Objective of IAS 32, IFRS 7and IFRS 9 32 ................................................................... 3
1.4 Definitions ..................................................................................................................... 4
1.5 Recognition of financial assets ..................................................................................... 5
1.6 Classification of financial assets ................................................................................... 5
1.6.1 Financial assets measured at amortised cost ............................................................ 5
1.6.2 Financial assets measured at fair value..................................................................... 6
1.7 Financial Asset De-recognition ..................................................................................... 9
1.8 Financial Liability ........................................................................................................... 9
1.9 Definitions ..................................................................................................................... 9
1.10 Financial liabilities recognition .................................................................................... 9
1.11 Financial liabilities classification .................................................................................. 9
1.11.1 Financial liabilities classified at amortisation ......................................................... 10
1.11.2 Financial liabilities classified at fair value through profit or loss ............................ 11
1.12 Financial Liabilities de-recognition ............................................................................ 11
1.13 Reclassification of financial assets ........................................................................... 12
1.14 Impairment of financial assets .................................................................................. 12
1.15 Financial Risks .......................................................................................................... 12
1.15.1 Liquidity risk ........................................................................................................... 13
1.15.3 Credit risk ............................................................................................................... 13
1.15.4 Market risk .............................................................................................................. 13
1.16 Summary ................................................................................................................... 13
1.17 Self-assessment questions ....................................................................................... 13
STUDY UNIT 2: LEASES: LESSEE ACCOUNTING: IFRS 16 ......................................... 21
1.1 Introduction ................................................................................................................. 21
1.2 Overview ..................................................................................................................... 21
2.3 Scope .......................................................................................................................... 21
2.4 Definitions ................................................................................................................... 21
2.5 Identifying if we have a lease or not ............................................................................ 22
2.6 Recognition and measurement ................................................................................... 23
2.6.1 Recognition and measurement using the simplified approach ................................ 26
2.6.2 Recognition and measurement using the general approach ................................... 26
2.7 Subsequent measurement of the lease liability .......................................................... 26
2.8 Tax consequences ...................................................................................................... 27
2.9 Presentation and Disclosure ....................................................................................... 27
2.10 Disclosure ................................................................................................................. 28
STUDY UNIT 3: LEASES: LESSOR ACCOUNTING IFRS 16 ......................................... 29
3.1 Introduction ................................................................................................................. 29
3.2 Overview ..................................................................................................................... 29
3.3 Definitions ................................................................................................................... 29
3.4 lease classification ...................................................................................................... 31
3.4.1 Finance Lease .......................................................................................................... 31
3.4.2 Operating Lease ....................................................................................................... 32
3.5 Disclosure ................................................................................................................... 32
STUDY UNIT 4: DEFERRED TAXATION [IAS 12] ........................................................... 35
4.1 Introduction ................................................................................................................. 36
4.2 Overview ..................................................................................................................... 36
4.3 Objective of IAS 12 ..................................................................................................... 36
4.4 Scope .......................................................................................................................... 36
4.5 Definitions ................................................................................................................... 37
4.6 Income tax ................................................................................................................... 37
5.7 Measurement of income tax ........................................................................................ 37
4.8 Deferred Tax ............................................................................................................... 39
4.8.1 Deferred tax measurement ...................................................................................... 40
4.9 Summary ..................................................................................................................... 44
4.10 Self evaluation questions .......................................................................................... 44
STUDY UNIT 5: GROUP OF ENTITIES & ITS FINANCIAL STATEMENTS: THEORY &
BACK GROUP .................................................................................................................. 50
5.1 Introduction ................................................................................................................. 50
5.2 Overview ..................................................................................................................... 50
5.3 Definitions ................................................................................................................... 50
5.5 Types of group structures ........................................................................................... 52
5.6 Accounting for a business combination ...................................................................... 54
5.7 Summary ..................................................................................................................... 56
STUDY UNIT 6: CONSOLIDATION AT DATE OF ACQUISITION ................................... 57
6.1 Introduction ................................................................................................................. 57
6.2 Basic consolidation procedures .................................................................................. 57
STUDY UNIT 7: CONSOLIDATION AFTER DATE OF ACQUISITION ........................... 66
7.1 Introduction ................................................................................................................. 66
7.2 Overview ..................................................................................................................... 66
7.3 Objective of IFRS 10 ................................................................................................... 66
7.4 Consolidation procedures ........................................................................................... 66
7.5 Summary ..................................................................................................................... 69
Module Information

Name of programme B.com in Accounting

Type of programme Contact (Full Time & Part Time)
NQF Level 7
Name of module Financial Accounting 3A
Credits 20
Notional hours 200
Module purpose The purpose of this module is to continue developing student’s
mental power to be able to identify, recognize, present and
disclose financial transactions with regards to the International
Financial Reporting Standards.
Learning Outcomes: At the end of this module learners should be able to:
• Understand the financial risks, categorise the financial assets,
financial liabilities;
• Be able to compound financial Instruments;
• Know derivatives, and reclassification of financial instruments;
• Understand the impairment of financial instruments, and be
able to make disclosures regarding them
• Define the objective of leases, classify leases, calculate
transaction taxes;
• Make accounting practices of lessees and disclose them;
• Know the different types of taxation;
• Compute secondary tax on companies;
• Know normal tax; and make estimation of current normal tax
and payment of current normal tax;
• Be able to disclose tax;
• Know the difference between current tax and deferred tax;
• Be able to measure deferred normal tax and disclose in the
financial statements;
• Have a theoretical background of a group of entities and its
financial statements;
• Be able to consolidate financial statements of wholly owned
subsidiary and partly owned subsidiary at the date of
acquisition;
• Be able to consolidate financial statements of partly owned
subsidiary at the date of acquisition;
• Consolidate wholly owned subsidiary after the date of
acquisition;
• Be able to Consolidation partly owned subsidiary after the
date of acquisition;

Prescribed textbooks Textbook Author Year Publisher ISBN

and other sources
Gripping
Cathrynne S 2018 LexisNexis 9780409128345
GAAP

Group
Binnekade,
Statements 2017 LexisNexis 9780409128475
C.S.
Volume 1

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Financial Accounting 3A – Study Guide
 Icons Additional information

Self-check activity

Reading in prescribed textbook

Bright ideas

Think point

Case Study

Study Group Discussion

Vocabulary

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 STUDY UNIT 1: FINANCIAL INSTRUMENTS [IFRS 9], [IFRS 7], [IAS 32]

1.1 Introduction

After studying this module, you will be able to:

• Understand the financial risks
• Categorise the financial assets and financial liabilities
• Be able to compound financial Instruments
• Know derivatives, and reclassification of financial instruments
• Understand the impairment of financial instruments
• Able to make disclosures regarding the financial instruments

1.2 Module overview

IFRS 9 Financial instruments is to be effective for financial statements to be presented

commencing after 1 January 2018.

1.3 Objective of IAS 32, IFRS 7and IFRS 9 32

IAS 32

The objective of IAS 32 Financial Instruments: Presentation is to prescribe the presentation

of financial instruments equity or liabilities and for offsetting financial assets and financial
liabilities (Cathrynne, 2018).

IAS 32 prescribes requirements for:

Presentation of financial instruments as liabilities or equity - offsetting financial assets and

liabilities

Classification of financial instruments into financial assets, financial liabilities and equity
instruments;

Classification of dividends, interest, losses and gains; including also situations in which in
which financial assets and financial liabilities should be offset (Cathrynne, 2018).

IFRS 7

The objective of IFRS 7 is to require entities to provide disclosures in their financial statements
that enable users to evaluate:

The significance of financial instruments for the entity's financial position and performance

“The nature and extent of risks arising from financial instruments to which the entity is exposed
during the period and at the reporting date, and how the entity manages those risks.”
(Cathrynne, 2018)

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IFRS 9

Essentially deals with the:

• Classification and measurement of financial instruments

• Impairment of financial assets
• Hedge accounting (Cathrynne, 2018)

1.4 Definitions

The following definitions are important for this chapter.

A financial instrument is defined as

• “any contract that gives rise to either

- a financial asset of one entity or
- A financial liability or equity instrument of another entity.” (IAS 32)

A financial asset is defined as:

• “Cash, or
• An equity instrument of another entity, or
• A contractual right to:
- receive cash or another financial asset from another entity
- or to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favorable to the entity or
• A contract that will or may be settled in the entity's own equity instruments.” (IAS 32)

A financial liability is defined as:

• “A contractual obligation to deliver cash or another financial asset to another entity

or
• a contractual obligation to exchange financial assets or financial liabilities with
another entity under conditions that are potentially unfavourable to the entity or
• a contract that will or may be settled in the entity's own equity instruments and is:
- a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity's own equity instruments; or
- a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity's own equity
instruments.” (IAS 32)

An equity instrument is any contract that evidences a residual interest in the assets of
an entity after deducting all of its liabilities.

A derivative is “ a financial instrument or other contract within the scope of this standard
with all three of the following characteristics: its value changes in response to the change in a
specified interest rate, financial instrument price, commodity price, foreign exchange rate,
index of prices or rates, credit rating or credit index, or other variable” (IAS 32)

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it requires no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have a similar response to
changes in market factors; and it is settled at a future date.

The amortised cost of a financial asset or financial liability is “the amount at which the
financial asset or financial liability is measured at initial recognition minus principal
repayments, plus or minus the cumulative amortisation using the effective interest method
of any difference between the initial amount and the maturity amount, and for financial
assets, adjusted for any loss allowance.” (IAS 32)

The effective interest method is a method of calculating the amortised cost of a financial
asset or a financial liability and of allocating the interest income or interest expense over
the relevant period.

The effective interest rate is “ the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument or, when
appropriate, a shorter period to the net carrying amount of the financial asset or financial
liability. When calculating the effective interest rate, an entity shall estimate cash flows
considering all contractual terms of the financial instrument but shall not consider future
credit losses.” (IAS 32)

1.5 Recognition of financial assets

An entity shall recognise a financial asset or a financial liability on its statement of financial
position when, and only when, the entity becomes a party to the contractual provisions of
the instrument. (IFRS 9)

1.6 Classification of financial assets

Financial assets are classified according to their contractual cash flow characteristics and the
business models under which they are held.

The tow classifications of financial assets are amortised cost, and fair value

A financial asset shall be measured at amortised cost if both of the following conditions
are met.

(a) The asset is held within a business model whose objective is to hold assets in order to
collect contractual cash flows (The business model) (IFRS 9).

(b) The contractual terms of the financial asset give rise on specified dates to cash flows that
are solely payments of principal and interest on the principal amount outstanding. (Contractual
cash flow characteristics (IFRS 9)).

If both the above mentioned conditions are not met the financial asset shall be measured
at fair value.

1.6.1 Financial assets measured at amortised cost

Assets measured at amortised cost are measured as follows

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 • Initially at fair value plus transaction cost
• Subsequently measured using the effective interest rate method

Example 1.1

Financial Asset at amortised costs: calculation of the effective interest rate

Damelin Ltd issued a bond on 1 January 2013. The following information regarding the bond
is applicable:

Nominal value R200 000

Coupon rate (annually in arrears) 10%

Date to be redeemed 31 December 2015

Required

Calculate the effective interest rate.

Solution Example 1.1

N= 3

PV= -200 000

FV= 200 000

PMT= 200 000 * 10%= 20 000

P/YR= 1 (payment per year)

Comp i= 10%

1.6.2 Financial assets measured at fair value

Financial assets are classified and measured at fair value if:

• They do not meet the criteria to be classified at amortised cost; or

• If they are designated as such on initial recognition to remedy an accounting mismatch.

Financial assets measured at fair value can be measured at fair value through:

• Fair value through profit and loss

• Fair value through other comprehensive income for debt instruments (FVOCI-debt)
• Fair value through comprehensive income equity instruments (FVOCI-equity)

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Fair value through profit and loss
All financial assets that do not meet the criteria to be classified as either amortised cost or Fair
value through other comprehensive income shall be classified as fair value through profit or
loss.

Example: Financial asset through profit and loss

Pinnacle ltd purchased shares with the intention to sell them in the short term. The details of
the shares are as follows:

100 000 shares were purchased at a total cost of 200 000 on 1 October 2015. At the financial
year ended 31 December 2015 the fair value of the shares was R250 000. Initial cost to
purchase the shares amounted to R20 000.

Required

Journalise the above transactions.

Solution:

1 October 2015 Debit Credit

Investment in shares 200 000

Bank 200 000

Purchase of shares

Direct costs (expense) 20 000

Bank 20 000

Payment of direct costs

31 December 2018

Investment in shares (asset) 250 000- 200 000 50 000

Gain on financial asset held at F.V 50 000

Re-measurement of shares.

Fair value through other comprehensive income for debt instruments (FVOCI-debt)
A financial asset shall be classified at fair value through other comprehensive income if both
the following conditions are met:

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 • The contractual cash flow
• The business model

Fair value through other comprehensive income for debt instruments (FVOCI-debt)
The classification of certain equity instruments at fair value through other comprehensive
income is regarded as a fourth classification because the measurement thereof is different
from the measurement of the classification of FVOCI-equity (Cathrynne, 2018)

An entity may elect to classify a financial asset as fair value through other comprehensive
income for equity instruments if it

• Is an investment in an equity instrument

• That is
- Not held for trading and
- Is not contingent consideration recognised by an acquirer in a business combination

Example

Fair value through other comprehensive income

Pinnacle ltd invested in the shares of Damelin Ltd on 1 January 2015. On initial recognition
the directors of Pinnacle Ltd determined that the equity investment qualified as a strategic
equity investment and elected to present the fair value changes in other comprehensive
income. The details of the investment were as follows:

The initial investment was for R100 000 with broker fees of R8 000

At 31 Dec 2015 the investment had a fair value of R120 000

Dividends of R1 000 were declared on 31 Dec 2015

Required

Journalise the above transaction

Solution: Example 1.3

1 Jan 2015-11-05 Dr Cr

Investment in Damelin 100 000

Bank 100 000

Investment in financial asset

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Financial Accounting 3A – Study Guide
Investment in Damelin 8 000

Bank 8 000

Brockers fees capitalised

31 Dec 2015

Investment in Damelin 12 000

Gian on financial asset 12 000

Fair value change at year end

Dividends received 1 000

Dividend Income 1 000

Dividends receivable for the year

1.7 Financial Asset De-recognition

De-recognition is the removal of a previously recognised item from the financial statements
of an entity.

An entity shall derecognise a financial asset when:

• Rights to the cash flow have expire

• The financial asset has been transferred and this transfer qualifies for
Derecogntion. (IFRS 9)

1.8 Financial Liability

1.9 Definitions

Note: For the definitions refer to 1.4

1.10 Financial liabilities recognition

Financial liabilities are recognised when and only when the entity becomes party to the
contractual provisions of the instrument (IFRS 9).

1.11 Financial liabilities classification

Financial liabilities are classified as:

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 • Fair value through profit or loss or
• At mortised cost

1.11.1 Financial liabilities classified at amortisation

Financial liabilities at amortised cost are not held for trading and are not otherwise designated
as fair value through profit or loss on acquisition.

Financial liabilities measured at amortised cost are:

• Initially measured at fair value less transaction costs and

• Subsequently measured at amortised cost using the effective interest rate.

Example: Financial liabilities classified at amortised cost

Limpopo Ltd issued 200 000% debentures on 1Jan 2010. The debentures were issued at R7
each and are compulsorily redeemable on 2012 for R10 i.e. at a premium.

Required

Calculate the finance cost and carrying amount for each year and show all the journal entries.

Solution Example 1.4

The effective interest rate is calculated as follows:

PV= 1 400 000 (7*200 000)

FV= -2 000 000

N= 3

Comp i= ? 12.6248%

Amortisation table

Date payment finance [email protected] balance

1 Jan 2010 1 400 000

31 Dec 2010 176 747 1 576 747

31 Dec 2011 199 061 1 775 808

31 Dec 2012 224 192 2 000 000

Redemption (2 000 000)

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1.11.2 Financial liabilities classified at fair value through profit or loss

Financial liabilities that are measured at fair value are:

• initially measured at fair value and

• subsequently measured at fair value

Example 7

Black ltd issued 200 000 debentures on 1 January 2017 for total amount of R205 000 including
transaction costs of R5000. On 31 December the debentures had a fair value of R350 000.
Black Ltd designated these debentures to be held at fair value through profit and loss.

Required

Journalise the above transaction.

Solution Example

1 Jan 2017 Dr Cr

Transaction cost Expense 5 000

Bank 5 000

Transaction cost on issue of debentures

Bank 200 000

Debentures 200 000

Issue of debentures

31 Dec 2017

Fair value adjustment on financial liabilities (p/l) 100 000

Debentures (liability) 100 000

Re-measurement of debenture at year end

1.12 Financial Liabilities de-recognition

Financial liability may only be derecognised when:

• “All obligations relating to that financial liability have been extinguished

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 • Debt instruments have been exchanged between a borrower and the lender of debt
instruments with substantially different terms, resulting in the extinguishing of the
original financial liability and the recognition of a new financial liability or
• There has been a substantial modification of the terms of a financial liability and the
recognition of a new financial liability” (IFRS 9)

1.13 Reclassification of financial assets

When and only when, an entity changes its business model then all affected financial
assets shall be reclassified. The change to the business model should be significant,
infrequent and demonstrable to external parties.

If an entity reclassifies financial assets it shall apply the reclassification prospectively

from the reclassification date. The entity shall not restate any previously recognised
gains, losses or interest.

Reclassification date is the first day of the first reporting period following the change in
business model that result in an entity reclassifying financial assets.

If a financial asset is reclassified to be carried at fair value, the fair value is determined at
the reclassification date. Any gain or loss arising from a difference between the previous
carrying amount and the fair value is recognised in profit or loss.

If an asset is reclassified to be carried at amortised cost, the fair value at reclassification

date becomes its new carrying amount.

Financial liabilities may never be reclassified.

1.14 Impairment of financial assets

Assets measured at Fair value will not be tested for impairment.

Only when an asset is measured at amortised cost will it be tested for impairment at the end
of each financial year end. Financial assets are only impaired if there is evidence suggesting
that:

• one or more events occurred after the initial recognition

• the event causes loss; and where
• the loss event has an impact on estimated future cash flows, and
• the amount of the loss can be reliably estimated.

1.15 Financial Risks

There are three categories of financial risk namely:

• liquidity risk

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 • market risk and
• credit risk (IFRS 7)

1.15.1 Liquidity risk

Liquidity risk refers to the risk or a financial position whereby an entity experience difficulties
to meet its financial obligations to the financial liability (Cathrynne, 2018).

1.15.3 Credit risk

This is the risk that “the other party to the financial instrument will fail to adhere to the obligation
resulting in the other party incurring losses” (Cathrynne, 2018).

1.15.4 Market risk

This is the risk that the fair value of the future cash flows of a financial instrument will fluctuate
because of the changes in market prices. Market risk is influenced by:

Interest rate risk (the risk that the fair value of the financial instrument will change due to
changes in market interest rates.

Currency risk (the risk that will result in change of value of a financial instrument due to
fluctuations in foreign currency and other price risk) and

Other price risks (the risk that the value or the future cash flows of the financial instrument
will fluctuate because of changes in the market prices (other than those arose from interest
rate risk)

1.16 Summary

There are three types of financial risks namely market risk, credit risk and liquidity risk.
Financial assets are classified using the contractual cash flows (CCF). Financial assets are
measured at amortised cost of fair value through OCI (for qualifying instruments) or FV through
P/L (default options)

Financial liabilities are initially recognised at FV less transaction costs and subsequently
measured at amortised cost or FV.

1.17 Self-assessment questions

Question 1

Elgrand Limited issued R100 000 debentures on 1 January 2010 at par. Interest at the rate of
12% p.a. is payable on 31 December each year. The debentures are to be redeemed at a
premium of 26.262% on 31 December each year. The premium was calculate so that the

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effective cost of the debentures after providing for the premium on redemption, would be 15%
p.a.

The amount that will be required for the premium on the redemption of the debentures is to be
provided for over the life of the debentures using the effective rate of interest method.

The debentures were not designated at fair value through profit and loss on initial recognition.

The debentures are secured over the land and buildings of the company.

The company’s financial year end is 31 December.

Required

Prepare an amortisation table showing the amount of premium that would be provided each
year over the life of the debenture.

Prepare all the journal entries relating to the debentures from the 2010 financial year to the
end of 2013, including closing entries.

Show how matters relating to the debenture will be disclosed in the financial statements and
notes of Elgrand Limited for the 2014 financial year end.

Solution Question 1

Amortisation table

Year effective interest interest paid liability

Cost 15% paid 12% balance

100 000

2001 15 000 12 000 103 000

2002 15 450 12 000 106 450

2003 15 968 12 000 110 418

2004 16 563 12 000 114 981

2005 17 247 12 000 120 228

2006 18 034 12 000 126 262

b) Journal entries

2001 Dr Cr

Jan 1

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Financial Accounting 3A – Study Guide
Bank 100 000

Debenture Liability 100 000

Issue of debentures

Dec 31

Interest expense 12 000

Bank 12 000

Payment of debentures

Interest expense 3 000

Debenture liability 3 000

Interest expense measured at amortised cost

Profit and loss 15 000

Interest exp 15 000

Closing exp to P/L

2002

Dec 31

Interest expense 12 000

Bank 12 000

Payment of debentures

Interest expense 3 450

Debenture liability 3 450

Interest expense measured at amortised cost

Profit and loss 15 450

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Interest exp 15 450

Closing exp to P/L

2003

Dec 31

Interest expense 12 000

Bank 12 000

Payment of debentures

Interest expense 3 968

Debenture liability 3 968

Interest expense measured at amortised cost

Profit and loss 15 968

Interest exp 15 968

Closing exp to P/L

Disclosure

Elgrand Ltd

Extract from statement of financial position as at 31 Dec 2003

Non-Current liabilities

Debentures 110 418

Elgrand Ltd

Extract from statement of Comprehensive income for the year ended 31 Dec 2003

Finance costs 15 968

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Elgrand Ltd

Notes to the Financial Statements for the year ended 31 Dec 2003

11. Non-current liabilities

100 00012%p.a debenture 110 418

The debentures are repayable on 31 Dec 2006 at a premium of 26,262% they are secured
over the land and buildings. The effective interest rate is 15 % p.a

Question 2

Wide River Limited is a South African based trader in Fish. Wide River Limited sources its fish
from throughout the world’s oceans. Wide River Limited purchases fish caught by local
fisherman in many different countries before freezing the fish and supplying them to local retail
outlets on account.

All suppliers to Wide River Limited require settlement in their own currency.

In recent years with the dramatic decline in world fish populations, Wide River Limited has
struggled financially. Wide River Limited’s board of directors has decided to try to improve
profitability by diversifying operations. In this regard, Wide River Limited has begun to provide
finance to venture capital companies which yielded significant returns. Such loans include
fixed and variable rate loans.

To assist with cash flow problems, Wide River Limited issued 1 000 000 8% C100 cumulative
preference shares at a discount of 10% on the par value.

The preference shares are compulsorily redeemable in 5 years’ time at a premium of R10 per
share.

Share issue costs amount to R10 000 000

Preference dividends are payable annually in arrears.

Required

Briefly define the financial risks identified by IFRS 7 and provide an example of each

Based on the information provided describe the extent to which Wide River Limited is exposed
to each of the risks identified above

Discuss the classification of the preference shares and the manner in which they should be
accounted for

Calculate the effective interest rate to be used to measure the preference shares at amortised
cost

Solution: Question 2

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a) Financial risks

IFRS 7 identifies three categories of financial risk:

Market risk

Credit risk

Liquidity risk

Market risk:

Market risk is the risk that the value of the financial instrument will fluctuate due to changes in
foreign exchange rates, market interest rates or other price risks.

Example: An exporter is faced with the risk that his products will become uncompetitive if the
exchange rate strengthens to much resulting in a decrease in demand and hence profitability.

Credit risk:

Credit risk is the risk that one party to the financial instrument will default causing the other
party to incur financial loss.

Example: An entity which provides credit facilities to customers face the risk that the customers
may go insolvent and not settle their accounts.

Liquidity risk:

The risk that an enterprise will encounter difficulty in raising funds to meet its obligations
associated with financial instruments.

Example: The entity issues debt instruments and is unable to repurchase them on maturity

b) Financial risks to which Ocean-Wide is exposed:

Market risk

Market risk is constituted by:

Foreign exchange risk (currency risk);

Interest rate risk; and

Other price risk.

Foreign exchange risk (currency risk):

Foreign exchange risk (currency risk) exposure arises from the import of fish as changes in
exchange rates affect the Rand value of foreign currency denominated creditors.

Interest rate risk:

Interest rate risk exposure exists in various loans with both fixed and variable interest rates:

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For fixed interest rate loans made to venture capital companies, Ocean-Wide Limited faces
the risk that the market interest rate may increase above the current fixed rate.

For variable rate loans made to venture capital companies, the cash flows to be received will
fluctuate with the market interest rates, and thus the risk is that the market interest rates
decrease.

The value of the issued preference shares is also affected by changes in the interest rate:
since the preference shares offer a fixed dividend based on 8%, a higher market interest rate
will decrease the value of such preference shares (and a lower market interest rate will have
the opposite effect).

Other price risk:

The performance of the entity has been affected by the decrease in fish quantities world-wide,
which affects demand and thus price.

Credit risk:

Ocean-Wide Limited supplies products to local retail outlets. It is likely that such retail outlets
(like Pick ‘n Pay and Spar) are well established and that the risk associated with the granting
of credit is decreased. Further credit risk exists in the granting of financing to venture capital
companies. This exposure would be higher due to the nature of the venture capital company.

Liquidity risk:

Liquidity risk exposure results from Ocean-Wide Limited attempting to improve its liquidity by
the issue of cumulative preference shares. If Ocean-Wide Limited is not able to improve its
cash flow situation it may not be able to meet the requirements on maturity date of the
contracts.

c) Classification of the preference share liability:

An entity shall classify financial liabilities as amortised cost using the effective interest rate
method unless management designates the financial liabilities at fair value through profit and
loss because it either:

Remedies an accounting mismatch, or

An investment strategy or risk management and the information provided internally is used to
evaluate the performance of a group of financial liabilities or financial assets. This group is
evaluated at fair value basis.

If management does not designate the financial liability at fair value, it will be measured at
amortised cost.

On initial recognition, the preference shares shall be measured net of transaction costs at C90
000 000 (100 000 000-10 000 000).

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d) Measurement of the effective interest rate for the preference share liability:

n=5 PV=90 000 000 PMT=-8 000 000 FV=-110 000 000 comp i/r=12.36% [10 marks]

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 STUDY UNIT 2: LEASES: LESSEE ACCOUNTING: IFRS 16

1.1 Introduction

After studying this learning unit you should be able to:

• Define the objective of leases,

• classify leases,
• calculate transaction taxes, and
• Make accounting practices of lessees and disclose them;

1.2 Overview

IFRS 16 was issued during 2016 replacing IAS 17. IFRS 16 is effective for periods beginning
on or after 2019/01/01 through the application of it is also recommended for any period prior
to Jan 2019. IAS 17accounts for leases based on their classification whether operating or
finance lease while IFRS 16 requires that the lessee must recognise the lease by recognising:
a lease liability and ‘a right of’ use asset.

2.3 Scope

IFRS 16 applies to all leases, except for leasing involving:

• the expropriation for or use of non-regenerative resources

• biological assets within the scope of IAS 41
• service concession arrangements within the scope of IFRIC 12
• licenses of intellectual property granted by a lessor failing within the scope of IFRS 15;
and
• rights under a licensing agreement failing within the scope of IAS 38 Intangible Assets
(Cathrynne, 2018)

2.4 Definitions

The following definitions will be used during this study unit. It is highly recommended that
you study and master these definitions before we get deep into this study unit.

A lease is:

• a contract, or part of a contract,

• that conveys
• the right to use
• an asset
• for a period of time
• in exchange for consideration (Cathrynne, 2018)

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IFRS 16 expands on this definition that the asset must be identified and have a right of use.

The asset must be identified:

• can be identified explicitly or implicitly

• can be a part, if it
- physically distinct, or
- substantially reflects all the asset’s capacity
• if the supplier has a substantive right to substitute it, then an asset is not identified.

Substantive right to use: this occurs when the supplier has the practical ability to substitute
the asset and would benefit economically from that substitution. (IFRS 16)

Study example 2 pg. 764 of the prescribed text book

Portions of the asset can be identified if part of the asset s physically distinct.

2.5 Identifying if we have a lease or not

To identify of we have a lease we need to go back to the definition again then we can feather
analyse this definition stage by stage.

A lease is defined as:

• ‘a contract or part of contract

• that conveys
- the right to use an asset
- for a period of time
• in exchange for consideration’ (IFRS 16)

Is it a contract?

A contract is an agreement between two or more parties that is enforceable by law.

Is the asset identified?

The asset must be identified:

• can be identified explicitly or implicitly

• can be a part, if it
- physically distinct, or
- substantially reflects all the asset’s capacity
• if the supplier has a substantive right to substitute it, then an asset is not identified

Is there the right to control the use of the asset?

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The lessee has the right to control the use of the asset if during the period he/she can:

• direct the use of the asset and

• substantially obtain all the economic benefits from the use of the asset (IFRS 16)

The entity has the right to control or use the asset if it:

• make decisions on how and for what the asset can be used; or
• cannot decide this because the ‘how and what’ is predetermined. But it can operate
the asset; or
• cannot decide this because the ‘how and what’ is predetermined, but this is because
the entity designed the asset and because of this design the asset has a predetermined
‘how and what’ (IFRS 16)

• Study example 4 pg. 766 of the prescribed text book

Study the flowchart on page 771 (prescribed text book) for analysis of a lease
definition.

2.6 Recognition and measurement

There are two ways in which a lease can be recognised which are:

• the optional recognition exemption (off balance sheet) or

• the lease will be recognised on balance sheet also known as the general approach

For one to understand the two approaches mentioned above we need to define the following
terms:

Lease term

A lease term is defined as:

• a non-cancellable period or term for which the lessee has the right to use the asset
• together with the period covered by
- an option to extend the contract if there is reasonable certainty to extent the lease and
- an option to terminate the lease if there is reasonable certainty not to exercise that
option

The following formula is used when calculating the lease term

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Financial Accounting 3A – Study Guide
 Non-cancelable period xx

Extension period-only if there is reasonable certainty to extent the lease xx

Termination period –only if there is reasonable certainty not to exercise that option xx

Lease term xx

Study example 12 and 13 pg. 778 – 780 of the prescribed text book

Lease payments

The definition of lease payments depends on whether it is a lessee or the lessor, for now we
are only going to look at the definition from the perspective of the lessee.

Lease payments can be defined as:

Payments made by the lessee to the lessor in return for the right to use the identified asset
under the lease term, and it comprise the following:

• “fixed payments
• variable lease payments
• the exercise price of a purchase option
• termination penalties” (IFRS 16)

Fixed payments are defined as:

• “Payments made by the lessee to the lessor

• For the right to use the asset during the lease term
• Other than variable costs” (IFRS 16)

Variable lease payments are;

• “Payments made by the lessee to the lessor

• In exchange for the right to use the asset under a lease term
• That varies due to change in facts or circumstances after the commencement date
• Other than the change in time” (IFRS 16)

Exercise price of a purchase option

If the lessee has the option to purchase the identified asset at the end of the lease, then the
total lease payments must include the exercise price of the purchase option, and it should be
reasonably certain that the lessee will exercise this option.

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Financial Accounting 3A – Study Guide
Termination penalties

If there is an option to terminate the lease, then the termination cost must be included in the
total lease payments. Remember the lessee must be reasonably certain that will exercise
the option.

Residual value guarantees

• “A residual value guarantee is defined as:

• A guarantee made by the lessor
• By a part unrelated to the lessor
• That the value
• Of an underlying asset at the end of the lease
• Will be at least a specified amount” (IFRS 16)

Below is a summary of lease payments calculation

fixed payments xx

variable lease payments xx

the exercise price of a purchase option xx

termination penalties xx

Residual guarantees xx

Total xx

Discount rate

There are two rates that can be used to calculate the discount rate and these are:

• Interest rate implicitly in the lease and the

• Lessee’s incremental borrowing rate

Interest rate implicitly in the lease

• “It is the rate that equates

• The present value of the lease payments and the unguaranteed residual value and the
• Sum of the fair value of the underlying asset and any initial direct costs of the lessor.”
(IFRS 16)

Lessee’s incremental borrowing rate

• “The rate of interest the lessee would have to pay

• To borrow over a similar term, and with similar security,
• The funds necessary to obtain an asset of a similar value to the right of use asset
• In a simmer economic environment.” (IFRS 16)

The unguaranteed residual value:

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Financial Accounting 3A – Study Guide
 • It is “the portion of the residual value of the asset
• The realisation of which by the lessor is
• Not assured or
• Is guaranteed solely by a party related to the lessor.” (IFRS 16)

Initial direct costs

• “Incremental costs of obtaining a lease

• That would not have been incurred if the lease had not been obtained” (IFRS 16)

2.6.1 Recognition and measurement using the simplified approach

This approach is applicable when leasing a low-value asset or if the lease term is short. It
expenses the lease payments over the lease term using the straight line method.

Study example 14 pg. 784 of the prescribed text book

2.6.2 Recognition and measurement using the general approach

If a lease cannot be recognised under the exemption or simplified approach, then the
general approach must be used.

Study example 15 pg. 787 of the prescribed text book

2.7 Subsequent measurement of the lease liability

The lease liability is initially measured at present value of the lease payments discounted at
the interest rate implicit in the lease or incremental borrowing rate.

Subsequently the lease liability is measured at amortisation costuming the interest rate
method. This method basically seeks to allocate the payments made between 7 those paid
towards the interest and the liability.

Study example 16 pg. 787 of the prescribed text book

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2.8 Tax consequences

Study section 12 starting on page 801 of the prescribed text book.

2.9 Presentation and Disclosure

Statement of financial position

If the lease has been recognised using the balance sheet approach, the SFP should include
the lease liability and the right of use.

Damelin limited

Statement of financial position as at 31 December 2017

Note 2017 2016

Assets

Non-current assets

Right of use asset 10 Xx xx

Investment property (section or leased properties) Xx xx

Equity and liabilities

Non-current labilities

Non-current portion of lease liability 14 Xx xx

Current liabilities

Current portion of lease liability 14 xx xx

Damelin limited

Statement of comprehensive income for the year ended 31 December 2017

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Financial Accounting 3A – Study Guide
 Profit before finance charges xx xx

Finance charges (xx) (xx)

Profit before tax xx xx

2.10 Disclosure

Study the disclosure on page 817 of the prescribed text book

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Financial Accounting 3A – Study Guide
 STUDY UNIT 3: LEASES: LESSOR ACCOUNTING IFRS 16

3.1 Introduction

After working through this study unit you will be familiar with the following:

Lease classification, recognition and disclosure in the books of the lessor

3.2 Overview

IFRS 16 replaces the previously IAS 17 Leases and it is only effective for periods on or after
1 January 2019 through the application of it prior to that is also recommended. Under IFRS
16 the lessor continues to classify the lease as either a finance lease or an operating lease.
This will definitely result in differences between the way the lessor and the lessee classify
leases.

3.3 Definitions

Please note that the following definitions apply only to lessor

“A finance lease is defined as a lease that:

• Transfers
• Substantially all the risks and rewards incidental to ownership
• Of an underlying asset.” (IFRS 16)

“An operating lease is a lease that:

• Does not transfer

• Substantially all the risks and rewards incidental to ownership
• Of an underlying asset.” (IFRS 16)

Gross investment in the lease is the aggregate of:

• “lease payments receivable by the lessor under a finance lease (which includes and
• any unguaranteed residual value accruing to the lessor.” (IFRS 16)

Net investment in the lease is

• the gross investment in the lease

• discounted at the interest rate implicit in the lease (IFRS 16).

Unearned finance income is the difference between:

• the gross investment in the lease, and

• the net investment in the lease. (IFRS 16)

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Financial Accounting 3A – Study Guide
Lease payments can be defined as:

Payments made by the lessee to the lessor in return for the right to use the identified asset
under the lease term, and it comprise the following:

• “fixed payments
• variable lease payments
• the exercise price of a purchase option
• termination penalties
• residual value guarantees provided to the lessor:
- by the lessee
- a party related to the lessee or
- a third party unrelated to the lessor

that is financially capable of discharging the obligation under the guarantee

• lease payments exclude payments allocated to non-lease components

Note: Take not of the difference between the definitions as per the lessor and the lessee.

The following definitions are the same for both the lessee and the lessor:

Lease term

A lease term is defined as:

• a non-cancellable period or term for which the lessee has the right to use the asset
• together with the period covered by
- an option to extend the contract if there is reasonable certainty to extent the lease and
- an option to terminate the lease if there is reasonable certainty not to exercise that
option

The unguaranteed residual value:

• It is “the portion of the residual value of the asset

• The realisation of which by the lessor is
• Not assured or
• Is guaranteed solely by a party related to the lessor.” (IFRS 16)

Initial direct costs

• “Incremental costs of obtaining a lease

• That would not have been incurred if the lease had not been obtained” (IFRS 16)

Interest rate implicitly in the lease

• “It is the rate that equates

• The present value of the lease payments and the unguaranteed residual value and the

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Financial Accounting 3A – Study Guide
Sum of the fair value of the underlying asset and any initial direct costs of the lessor.” (IFRS
16)

Residual value guarantees

• “A residual value guarantee is defined as:

• A guarantee made by the lessor
• By a part unrelated to the lessor
• That the value
• Of an underlying asset at the end of the lease
• Will be at least a specified amount” (IFRS 16)

The commencement date of the lease is defined as:

- “The date on which a lessor

- Makes an underlying asset available for use by a lessee.” (IFRS 16)

3.4 lease classification

3.4.1 Finance Lease

A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership.

Note: Whether a lease is a finance lease or an operating lease depends on the substance of
the transaction rather than the form of the contract.

Examples of situations that individually or in combination would normally lead to a lease being
classified as a finance lease are:

• “the lease transfers ownership of the asset to the lessee by the end of the lease term;
• the lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable for it
to be reasonably certain, at the inception of the lease, that the option will be exercised;
• the lease term is for the major part of the economic life of the asset even if title is not
transferred;
• at the inception of the lease the present value of the minimum lease payments amounts
to at least substantially all of the fair value of the leased asset; and

• the leased assets are of such a specialised nature that only the lessee can use them
without major modifications.” (IFRS 16)

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Financial Accounting 3A – Study Guide
Indicators of situations that individually or in combination could also lead to a lease being
classified as a finance lease are:

• “if the lessee can cancel the lease, the lessor’s losses associated with the cancellation
are borne by the lessee;

• gains or losses from the fluctuation in the fair value of the residual accrue to the lessee
(for example, in the form of a rent rebate equalling most of the sales proceeds at the
end of the lease); and

• if the lessee has the ability to continue the lease for a secondary period at a rent that
is substantially lower than market rent.” (IFRS 16)

Study example 2 to 5 pg. 825 to 832 of the prescribed text book

3.4.2 Operating Lease

A lease is classified as an operating lease if it does not transfer substantially all the risks and
rewards incidental to ownership. (IFRS 16)

Study example 14 pg. 861 of the prescribed text book

3.5 Disclosure

Refer to the prescribed text book for the disclosure on both finance lease and
operating lease.

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3.6 Self-assessment questions

Self-assessment questions

Question 1

In the minutes to the Annual General Meeting held for the year ended 2000 the Board
members of Million Dollar Limited have complained about the high liquidity ratio that the
company was experiencing. The financial director after analysing the financial statements
realised that the liquidity ratio was high as a result of a huge bank balance. In trying to reduce
the liquidity ratio the Financial Director purchased a boat on 1 January 2001 at a cost of
R210 000 in order to lease the bout to Fish The Shark Limited. Lease instalments of R90 000
were to be received annually in arrear for the 3 years of the lease term. Fish the shark Limited
have guaranteed a residual value of R8000 payable on 31 December 2003. The estimated
value at that date was R10 000.

The interest rate implicit in the agreement was 15, 5819%

Required

Calculate the gross investment in the lease, the net investment in the lease and the amount
of the finance income. [9]

Prepare the journal entries in the accounting records of Million Dollar Limited for the year
ended 30 December 2001. [21]

Ignore tax

Solution question 2

a) Calculation of gross investment in the lease, net investment in the lease and the amount of
finance income

Gross investment in lease = minimum lease payments + unguaranteed residual value

(270 000 + 8 000) + 2 000

280 000

Net investment in lease = Net investment in lease = present value of future lease payments,
discounted at the interest rate implicit in the lease

PV of annuity of 90 000 for 3 yrs + PV of 10 000 at end of yr 3 at 15, 5819%

210 000

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Financial Accounting 3A – Study Guide
Unearned finance income = gross investment in the lease – net investment in the lease

280000 – 210000

70 000

b) Journals

01/01/2001 Debit Credit

Machine 210 000

Bank 210 000

Recognition of cost of selling machine under finance lease

Lease debtor 280 000

Unearned finance income 70 000

Machine 210 000

Recognition of sale of machine under finance leas

31/12/2001

Bank 90 000

Lease debtors 90 000

Receipt of lease payment from lessee

Unearned finance income 32 722

Finance income 32 722

Recognition of finance income for the period

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Financial Accounting 3A – Study Guide
Workings

Interest (I)

15, 5819% Instalment Lease debtor

1/1/01 210 000

31/12/01 32 722 (90 000) 152 722

31/12/02 23 797 (90 000) 86 514

31/12/03 13 481 (100 000) 0

70 000 280 000

STUDY UNIT 4: DEFERRED TAXATION [IAS 12]

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Financial Accounting 3A – Study Guide
4.1 Introduction

After studying this learning module you should be able to:

• Identify the different types of taxation

• Compute secondary tax on companies
• Know normal tax; and make estimation of current normal tax and payment of current
normal tax
• Be able to disclose tax
• Know the difference between current tax and deferred tax
• Be able to measure deferred normal tax and disclose in the financial statements

4.2 Overview

The total income tax expense for disclosure purposes is broken down into two main
components: current tax and deferred tax. There is often a difference between the tax
expense and current tax. This is because accounting profits are calculated in accordance
with the IFRS’ and taxable profits are calculated in terms of the tax legislation.

4.3 Objective of IAS 12

The objective of IAS 12 is to prescribe the accounting treatment for income taxes. It prescribes
the treatment of both the current and future tax consequences of:

• “the future recovery (settlement) of the carrying amount of assets (liabilities) that are
recognised in an entity’s statement of financial position; and
• transactions and other events of the current period that are recognised in an entity’s
financial statements.” (IAS 12)

4.4 Scope

This Standard shall be applied in accounting for income taxes.

For the purposes of this Standard, income taxes include both domestic and foreign taxes
which are calculated based on taxable profits. Income taxes also includes withholding taxes,
which are payable by a subsidiary, associate or joint venture on allocation to the reporting
entity. (IAS 12)

This Standard is not applicable to the methods of accounting for government grants (see IAS
20 Accounting for Government Grants and Disclosure of Government Assistance) or
investment tax credits. However, this Standard does deal with the accounting for temporary
differences that may arise from such grants. (IAS 12)

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Financial Accounting 3A – Study Guide
4.5 Definitions

The following terms are used in this Standard with the meanings specified:

Accounting profit is profit or loss for a period before deducting tax expense (IAS 12).

Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the
rules established by the taxation authorities or the commissioner, upon which income taxes
will be calculated by applying a certain rate as stabilised by the tax commissioner (IAS 12).

Tax expense (tax income) is the aggregate amount included in the determination of profit or
loss for the period in respect of current tax and deferred tax. Tax expense = current tax
expense plus deferred tax expense (IAS 12).

Current tax is the amount of income taxes payable (recoverable) in respect of the taxable
profit (tax loss) for a period.

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect
of taxable temporary differences.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect
of:

• deductible temporary differences;

• the carry forward of unused tax losses; and
• the carry forward of unused tax credits (IAS 12).

The tax base of an asset or liability is the amount attributed to that asset or liability for tax
purposes.

Tax expense the summation of current tax expense (current tax income) and deferred tax
expense (deferred tax income)

4.6 Income tax

Income tax is the tax that is charged on income generated by the entity. Where this income
can result from transactions that are:

• Recognised in profit or loss; or

• Recognised in other comprehensive income
• Recognised directly in equity
When tax is charged on an entity’s income, this tax must be shown as a line item in the
statement of profit and loss.

5.7 Measurement of income tax

Current income tax is calculated by multiplying taxable profits (or tax loss) by the tax rate.

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Financial Accounting 3A – Study Guide
Current tax or current income is the tax based on the taxable profits (or tax loss) for the current
period. Taxable profits are calculated based on the rate as requested by the tax authorities
(SARS) in accordance with the act. The accountant calculates the accounting profit in
accordance with the IFRSs and will the need to convert this accounting profit into taxable profit
so as to calculate the income tax expense.

The difference between taxable profit and accounting profit is as a result of:

1) Temporary differences; and

2) Permanent differences
Temporary difference

These arises due to differences in timing for example:

•Expenses that are deducted in a particular year by the accountant in terms of IFRSs
are deducted in a different year by the tax commissioner in terms of the tax act
• Income that is recognised in a particular year by the accountant in terms of IFRSs is
taxable in a different year by the tax commissioner in terms of the tax act
Permanent differences

These arise due to differences in the accounting and tax treatments of a certain item and these
differences will never disappear over time.

Exempt income and non-deductible expenses

Exempt differences are items that are never taxable nor tax deductible and therefore no tax is
provided on them. The exempt differences are reconciling items if the total of the current and
deferred tax expenses in the statement of profit or loss and other comprehensive income do
not amount to 28% of the profit before tax.

Examples of exempt differences are

• exempt income (income that will never be taxed), namely:

– dividends received; and

– the portion of capital profits on the sale of assets that is not taxable;

• non tax deductible expenses (expenses that will never be allowed as a deduction), namely
– fines; and

– donations

Income tax expense is calculated as follows:

Profit before tax (as per the P/L) xxx

Exempt differences xxx

Profit after exempt differences Xxx

Temporary differences (taxable/deductible) Xxx

Taxable profit/tax loss Xxx

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Financial Accounting 3A – Study Guide
 Current tax expense (28% of taxable profit) Xxx

(Current tax expense is nil if there is a tax loss for the year) Xxx

Deferred tax expense (28% of temporary differences) Xxx

(Can be deferred tax credit or debit to the P/L) xxx

SA Normal tax xxx

Example

The company has profit before tax of R10 000. Included in the profit are dividends received of
R1 000 and fines paid of R200. There are no temporary differences. The tax rate is 28%.

Required
Calculate the current tax expense.
Solution
Profit before tax 10 000

Exempt differences

Dividends received – not taxable (1 000)

– Fines paid – not deductible for tax 200

Profit after exempt differences 9 200

Temporary differences -

Taxable profit 9 200

Current tax expense – 28% of taxable profit 2 576

Deferred tax expense – 28% of temporary differences -

SA normal tax 2 576

The income tax expense in the statement of profit or loss and other comprehensive income
should have been R2 800 (R10 000 x 28%). The income tax expense is currently shown as
R2 576

4.8 Deferred Tax

The total income tax for disclosure purposes is broken down into two as follows:

• Current tax and

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Financial Accounting 3A – Study Guide
 • Deferred tax
The current tax is the tax charged by the tax commissioner in the current tax period on the
taxable profits.

Deferred tax occurs due to the differences that arises:

• When income/expenses are treated differently

• Under IFRSs (accounting profit); and
• Under tax legislation (taxable profit)
• Where these differences will reverse.
Deferred tax can be a deferred tax asset or a deferred tax liability.

Deferred tax asset is defined as:

• “the amounts of taxes recoverable

• in future periods in respect of:
- deductible temporary differences
- unused tax losses carried forward;
- unused tax credits carried forward” (IAS 12)

Deferred tax liability is defined as:

• “the income taxes payable

• in future periods, in respect of
• taxable temporary differences” (IAS 12)

4.8.1 Deferred tax measurement

There are two methods that can be applied when measuring DT, and these are:

1) the income statement approach and

2) the balance sheet approach
The previous version of IAS 12 referred to the income statement approach but the latest
version only refer to the balance sheet approach. The income statement approach measures
the deferred tax based on the difference between the:

• accounting profits and

• taxable profits

Study section 2.2 page 258 for the full explanation on the income statement
approach.

Deferred tax as measured based on the difference between the:

• tax base of the asset or liability and the

• carrying amount of the asset or liability
The following examples explains the difference between the tax base and carrying amount.

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Financial Accounting 3A – Study Guide
Accounting purposes

The carrying amount of a non-current asset is calculated as follows: R

Original cost xxx

Less accumulated depreciation (xxx)
Carrying amount xxx

The profit or loss on sale of a non-current asset (capital and

non-capital portions) is as follows: R
Proceeds on sale xxx
Less carrying amount (xxx) Profit/
(loss) on sale xxx

The non-capital profit included in the profit on sale of a non-current

asset is as follows: R

Proceeds on sale, limited to original cost xxx less

carrying amount (xxx) Non-
capital profit/ (loss) xxx

Tax purposes

The tax base is calculated as follows: R

Original cost xxx

Less accumulated capital allowances (tax allowance) (xxx)

Tax base xxx

The taxable recoupment (or scrapping allowance) is calculated as follows: R

Proceeds on sale, limited to original cost (xxx

Less tax base (xxx)
Recoupment/ (scrapping allowance) xxx

Example
A manufacturing plant was purchased on 1 January 20.12 at a cost of R120 000. The
depreciation for the year amounted to R24 000 and the tax allowance to R40 000. The
company has been incorporated in the current year and has profit before tax of R100 000 for
the year ended 31 December 20.12. The tax rate is 28%.

Deferred tax is provided on all temporary differences using the statement of financial position
approach.

You are required to calculate the deferred tax expense for the year ended 31 December 2012
including the journal entry thereof.

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Solution

Carrying Tax base Temporary

amount differences

Cost 120 000 120 000 -

Depreciation (24 000) 40 000 16 000

Carrying amount 96 000 80 000 16 000

Journal entry:

Dr Cr

Deferred tax expense (P/L) 4 480

Deferred tax liability (SFP) 4 480

Deferred tax provisional

Example

A company has been incorporated in the current year and has received deposits in advance
to the amount of R20 000 from their customers to book holiday accommodation. The
accounting profit of the company amounted to R150 000 for the year ended 31 December
20.12 and the tax rate is 28%.

Deferred tax is provided on all temporary differences according to the statement of financial
position approach. There is assurance beyond reasonable doubt that there will be sufficient
taxable profit in the future to realise any tax benefits.

You are required to calculate the deferred tax expense for the year ended 31 December 2012.

Solution

The following journal entry for deposits received in advance is prepared for accounting
purposes:

Dr Cr

Bank (SFP) 20 000

Deposits received in advance (SFP) 20 000

According to the statement of financial position approach, the following are the balances for
accounting and tax purposes:

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 Carrying Tax base TD
amount

Deposits received in advance 20 000 - 20 000

(The tax base is equal to the carrying amount less the amount of revenue that will not be
taxed in future (20 000 – 20 000)).

As a result of the deposits received in advance, the carrying amount of the liability is greater
than the tax base of the liability and this will result in amounts which are deductible in
determining future taxable profit.

Journal entry: Dr Cr
Deferred tax asset (SFP) 5 600

Deferred tax (P/L) 5 600

Provision made for deferred tax.

Study example 1a to 3b chapter 6 of the prescribed text book for examples on

deferred tax asset/ liability.

Example 4.1

The following information regarding a newly formed company, Classy Ltd, is available. The
tax rate is 28%. The information is for two consecutive years.

Temporary differences are as follows:

PPE Year 1 Year 2

Carrying amount 750 000 680 000

Tax base (805 000) (700 000)

Temporary difference (55 000) (120 000)

Movement in temporary difference (55 000) 35 000

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Required

Tax calculation

Accounting loss/profit before tax (assumed) (5 000) 155 000

Movement in temporary difference 55 000 (35 000)

Taxable income 50 000 120 000

Current tax payable @ 28% 14 000 33 000

4.9 Summary

The total income tax expense for disclosure purposes is broken down into two main
components: current tax and deferred tax. There is often a difference between the tax expense
and current tax. This is because accounting profits are calculated in accordance with the IFRS’
and taxable profits are calculated in terms of the tax legislation.

4.10 Self-evaluation questions

Question 1

Glass Limited is a listed company manufacturing mirrors. The financial results for the year
ending 2003 are:

Profit before tax is R30 000 in 2003 (2002: R20 000 and 2001: R14 000)

Dividend income received during the year was R10 000 (2002: R10 000 and 2001: R10 000)

Information relating to property plant and equipment

2000 2001 2002 2003

Carrying amount 70 000 64 000 48 000 36 000

Tax base 90 000 70 000 50 000 30 000

There are no other differences between accounting profit and taxable profit other than those
evident from the information given.

There is insufficient evidence for Glass Limited to realise deferred tax assets.

The tax rate is constant at 30%

Required

Prepare the current normal tax computation and deferred tax calculation. [10]

Prepare the tax-related journals for the years ended 31 December 2001, 2002 and 2003[22]

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Financial Accounting 3A – Study Guide
Prepare the tax expense and deferred tax note for the years ended 31 December 2001, 2002
and 2003[22]

Show all your workings to earn full marks

Solution: question 1

Calculation of current tax and deferred tax

W1 Calculation of current normal tax 2003 2002 2001

Profit before tax 30 000 20 000 14000

Exempt dividend income (10 000) (10 000) (10000)

Temporary differences (PPE) (8 000) (4 000) (14 000)

Assessed tax loss brought forward (4 000) (10 000) 0

Taxable profit/ (tax Loss) 8 000 (4 000) (10000)

Current normal tax at 30% 2 400 0 0

W2 Calculation of deferred normal tax

Carrying tax base Temporary deferred

Amount difference tax

PPE

1 Jan 2001 70 000 90 000 20 000 6 000

Movement (6 000) (20 000) (14 000) (4 200)

Bal: 31 Dec 2001 64 000 70 000 6 000 1 800

Movement (16 000) (20 000) (4 000) 1 200)

Bal:31 Dec 2002 48 000 50 000 2 000 600

Movement (12 000) (20 000) (8 000) (2 400)

Bal: 31 Dec 2003 36 000 30 000 (6 000) (1 800)

W2.2 Tax loss

Bal: 1 Jan 2001 0 0 0 0

Movement 3 000

Bal:31 Dec 2001 0 10 000 10 000 3 000

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Financial Accounting 3A – Study Guide
Movement 0 (1 800)

Bal: 31 Dec 2002 0 4 000 4 000 1 200

Movement 0 (1 200)

Bal: 31 Dec 2003 0 0 0 0

Dr Cr

Income tax expense: normal tax (P/L) W2.1 4 200

Deferred tax: normal tax: PPE (SOFP) 4 200

DT adjustment caused by PPE: DTA reversing due to

temporary differences NOTE 1 reversing (20X1)

Deferred tax: normal tax: PPE (SOFP) W2.3: column (c) 4 200

Income tax expense: normal tax (P/L) 4 200

Prior year DTA recognised now that it has reversed (jnl above):
PPE (20X1)

Journals 20X2

Income tax expense: normal tax (P/L) W2.1 1 200

Deferred tax: normal tax: PPE (SOFP) 1 200

DT adjustment caused by PPE: DTA reversing due to temporary

differences reversing (20X2) NOTE 1

Deferred tax: normal tax: PPE (SOFP) W2.3: column (c) 1 200

Income tax expense: normal tax (P/L) 1 200

Prior year DTA recognised now that it has reversed (jnl above):
PPE (20X2)

Income tax expense: normal tax (P/L) W2.2 1 800

Deferred tax: normal tax: Tax loss (SOFP) 1 800

DT adjustment caused by tax loss: DTA reduces due to tax

loss partially used NOTE 1

(20X2)

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Financial Accounting 3A – Study Guide
Deferred tax: normal tax: Tax loss (SOFP) W2.3: column 1 800
(f)

Income tax expense: normal tax (P/L) 1 800

Prior year DTA recognised now that it was used (i.e. jnl
above): tax loss (20X2)

Journals 20X3

Income tax expense: normal tax (P/L) W2.1: 600 + 1 2 400

800

Deferred tax: normal tax: PPE (SOFP) 2 400

DT adjustment caused by PPE: DTA reversed (600) and a

DTL (1 800) created due to temporary differences reversing:
PPE (20X3) NOTE 1

Deferred tax: normal tax: PPE (SOFP) W2.3: column 600

(c)

Income tax expense: normal tax (P/L) 600

Prior year DTA recognised now that it has reversed (jnl

above): PPE (20X3)

Income tax expense: normal tax (P/L) W2.2 1 200

Deferred tax: normal tax: Tax loss (SOFP) 1 200

DT adjustment caused by tax loss: DTA reduces due to

remaining tax loss being used (20X3) NOTE 1

Deferred tax: normal tax: Tax loss (SOFP) W2.3: column

(f)
1 200

Income tax expense: normal tax (P/L) 1 200

Prior year DTA recognised now that it was used (i.e. jnl
above): tax loss (20X3)

Income tax expense: normal tax (P/L) W1 2 400

Current tax payable: normal tax 2 400

(SOFP)

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Financial Accounting 3A – Study Guide
Current tax payable 20X3

Two marks for every journal entry total =

22marks

Glass Limited

Notes to the Financial Statements

For the year Ended 31 December 2003

2003 2002 2001

Taxation expense R R R

Normal taxation

Current normal tax 2 400 0 0

Deferred normal tax

Current year movement in TD 3 600 3 000 1 200

Current year DTA not recognised 0 0 3 000

Prior year unrecognised DTA (1 800) (3 000) (4 200)

Tax expense per(SCI) 4 200 0 0

Tax rate reconciliation

Applicable tax rate 30% 30% 30%

Tax effects of

Profit before tax 9 000 6 000 4 200

Exempt dividend (3 000) (3 000) (3 000)

Current Year DTA not recognised 0 0 3 000

Prior year unrecognised DTA (1 800) (3 000) (4 200)

Tax expense per the SCI 4 200 0 0

Effective tax rate 14% 0%

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Deferred tax Asset/ Liability

The deferred tax balance comprises tax on the following types of temporary differences

Property, Plant and equipment (1 800) 0 0

Tax loss 0 0 0

(1 800) 0 0

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Financial Accounting 3A – Study Guide
STUDY UNIT 5: GROUP OF ENTITIES & ITS FINANCIAL STATEMENTS: THEORY &
BACK GROUP

5.1 Introduction

After studying this learning unit

• Be able to define and identify: parent, subsidiary and a business combination

• Explain the difference between simple and complex groups

5.2 Overview

The following IFRS’ and IAS’ are applicable to consolidation of financial statements.

IFRS 3 — Business Combinations prescribes the accounting treatment and initial

determination of the value attached to the subsidiary being acquired at the date of acquisition.

IFRS 10 — Consolidated Financial Statements deals with the consolidation procedures and
accounting treatment that are done after the date of acquisition. IFRS 10 prescribes the
preparation and presentation of consolidated financial statements for a group of entities under
the control of another entity (parent) (Binnekade, 2017).

IAS 28 — Investments in Associates and Joint Ventures “prescribes the accounting for
investments in associates and joint ventures, and sets out the requirements for the application
of the equity method when accounting for investments in associates and joint ventures”
(Binnekade, 2017)

IAS 27 — Separate Financial Statements “applies when an entity prepares separate

financial statements that comply with International Financial Reporting Standards. The
standard contains accounting and disclosure requirements for investments in subsidiaries,
joint ventures and associates when an entity prepares separate financial statements. The
standard requires an entity preparing separate financial statements to account for those
investments at cost or in accordance with” IFRS 9 — Financial Instruments. (Binnekade, 2017)

5.3 Definitions

Business combination

A business combination is defined as a transaction or other event in which an acquirer obtains

control on one or more businesses.

Parent

A parent is an entity that controls one or more other entities (subsidiaries).

Subsidiary

A subsidiary is an entity that is controlled by another entity (the parent)

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Financial Accounting 3A – Study Guide
Sub-subsidiary

A sub-subsidiary is a subsidiary of another subsidiary

Acquiree The business or businesses which the acquirer obtains control of in a business
combination (Binnekade, 2017).

Acquirer The company that obtains control of the acquiree.

Acquisition The date on which the acquirer obtains control of the acquiree.
date

Business These are systematically integrated activities and assets that can be managed
for the purpose of providing a return in the form of dividends, lower costs or
other economic benefits directly to some of the stake holders mostly investors
or other owners, members or participants.

Business A transaction or other event that gives an acquirer control of one or more
combination businesses.

Control An investor controls an investee when it has all three of the following

Power over the investee

“An investor has power over an investee when:

• it has existing rights

• that give it the current ability

• to direct the relevant activities of the investee

Exposure (or rights) to variable returns through its relationship with the
investee

The ability to use its power over the investee to affect the amount of returns to
which it is exposed”(IFRS 10)

Fair value The amount for which as asset could be exchanged or a liability settled
between knowledgeable, willing parties in an arm's length transaction.

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 Goodwill “An asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and
separately recognised” (Binnekade, 2017)

Identifiable An asset is identifiable if it either

“is separable, that is capable of being separated or divided from the entity and
sold, transferred, licensed, rented or exchanged, either individually or together
with a related contract, identifiable asset or liability, regardless of whether the
entity intends to do so

OR

arises from contractual or other legal rights, regardless of whether those rights
are transferable or separable from the entity or from other rights and
obligations” (Binnekade, 2017)

Non- The equity in a subsidiary not directly or indirectly attributable to a parent.

controlling
interests

Owners For the purpose of IFRS 3, "owners" is used broadly to include holders of equity
interests of investor-owned entities, and owners or members of, or participants
in, mutual entities (Binnekade, 2017).

5.5 Types of group structures

Simple group

A simple group is a group that consist of a parent and a single subsidiary.

It can be diagrammatically represented as follows:

P Ltd

51%

S Ltd

In the above diagram P Ltd holds 51% in S Ltd

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Financial Accounting 3A – Study Guide
Vertical Group

P Ltd

51%

S Ltd

80%

SS Ltd

In the above diagram P (parent) controls S (subsidiary) and S controls SS (sub-subsidiary)

Horizontal Group

P Ltd

60% 80%

S Ltd D Ltd

In the above diagram the Parent P controls the subsidiaries S Ltd and D Ltd

Mixed Group

P Ltd

60% 55%

S Ltd 20% D Ltd

30% 50%

E Ltd

To make sure that you have understood this topic, please go through the following questions.

Example 4.1

1. Define the following terms:

• Subsidiary
• Sub-subsidiary
• Parent
2. With the aid of diagrams distinguish the following:
• Simple group
• Complex group

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Financial Accounting 3A – Study Guide
5.6 Accounting for a business combination

The acquisition method

The entity shall account for each business combination by applying the acquisition method
through the following steps:

• Identify the acquirer.

• Determine the acquisition date.
• Identify the consideration transferred.
• Measure the consideration transferred.
• Identify and measure the identifiable assets acquired and liabilities assumed.
• Measure the non-controlling interests.
• Determine the amount of goodwill or the gain on a bargain purchase.

For all the steps above do the practical examples in the prescribed text book, here only the
theory part is provided.

Identifying the acquirer

For each business combination, one of the combining entities shall be identified as the
acquirer. The entity that obtains control of the acquiree is thus the acquirer.

Determining the acquisition date

The acquisition date is the date on which the acquirer obtains control of the acquiree and this
control is obtained through the acquirer transferring the consideration in return for the
acquisition of the assets and assuming the liabilities (Binnekade, 2017).

Identify the consideration transferred

If a parent obtains an equity interest in a subsidiary the parent can settle the purchase price
in different ways. The most common way is to settle it by means of cash only. The other ways
the company my settle through a transfer of assets, taking over liabilities, shares issued by
the acquirer etc.

Measure the consideration transferred

The consideration transferred is measured at fair value at the acquisition date.

Identify and measure the identifiable assets acquired and liabilities assumed

IFRS 3 requires that the identifiable assets acquired and liabilities assumed be measured at
their acquisition date fair values. As of the acquisition date, the acquirer shall recognise
(separately from goodwill) the following:

• The identifiable assets acquired

• The liabilities assumed

• Any non-controlling interests in the acquiree

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Financial Accounting 3A – Study Guide
The following adjustments are necessary at acquisition

Revaluation in the records of the subsidiary

“If a subsidiary revalues its net assets at the acquisition date to fair value and recognises the
revalued amounts in its own records at acquisition date, then no adjustments are required on
consolidation since the assets of the subsidiary are already recognised at fair values in the
records of the investee (subsidiary) and will thus be included as such in the consolidated
financial statements” (Binnekade, 2017).

Revaluation not recorded in the records of the subsidiary

If a subsidiary revalues its net assets at the acquisition date to fair value and does not
recognise the revalued amounts in its own records at acquisition date, then an adjustment is
required for consolidation purposes to recognise the revalued assets of the subsidiary. A pro
forma journal entry has to be passed on consolidation to bring the revaluation into account.

Non-depreciable asset

“If a non-depreciable asset (such as land) has been revalued to its fair value which is higher
than its carrying amount, then a revaluation surplus will be included in the calculation of the
net identifiable assets and liabilities (i.e. equity) of the subsidiary at the acquisition date. A part
of the revaluation surplus will be allocated to the non-controlling interests” (Binnekade, 2017).

If the asset that has been revalued is a non-depreciable asset, there will be tax implications
and deferred tax will need to be calculated. (Refer to subsection (d) for a discussion of the tax
implications of the revaluation.)

Depreciable asset

If a depreciable asset (such as plant and equipment) has been revalued to its fair value which
is higher than its carrying amount, then a revaluation surplus will be included in the calculation
of the net identifiable assets and liabilities (i.e. equity) of the subsidiary at the acquisition date.
The depreciation for the group must be calculated on the revalued amount. A part of the
revaluation surplus as well as a part of the depreciation of the group is allocated to the non-
controlling interests (Binnekade, 2017).

If the asset that has been revalued is a depreciable asset, then there will be tax implications
and deferred tax will need to be calculated. (Refer to subsection (d) for a discussion of the tax
implications of the revaluation.

Investment in equity instruments

When a parent acquires an investment in a subsidiary, the investment may be treated in two
ways:

The equity investment can be measured at fair value through profit or loss (FVTPL).

OR

The entity can elect to measure the equity investment at fair value through other
comprehensive income (FVTOCI).

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Financial Accounting 3A – Study Guide
Measure the non-controlling interests

Each identifiable asset and liability is measured at its acquisition-date fair value. Any non-
controlling interests in the acquiree are measured at:

• Fair value (full goodwill method)

OR

• As the non-controlling interest's proportionate share of the acquiree's net identifiable assets
(partial goodwill method).

Determine the amount of goodwill or the gain on a bargain purchase.

Goodwill

Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and separately
recognised

Gain on bargain purchase

A gain on bargain purchase occurs when the parent purchase the shares from the subsidiary
at a price below their fair value.

5.7 Summary

A business combination is a transaction or other event in which an acquirer obtains control on

one or more businesses. A business combination (Group) consists of a Parent and a
subsidiary/ies. A parent is an entity that controls one or more other entities (subsidiaries) and
a subsidiary is an entity that is controlled by another entity.

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Financial Accounting 3A – Study Guide
STUDY UNIT 6: CONSOLIDATION AT DATE OF ACQUISITION

6.1 Introduction

After studying this learning unit you should be able to:

Consolidate the financial statements of a simple group

6.2 Basic consolidation procedures

The following are the consolidation basic procedures:

• Elimination of common items

• The consolidation of the remaining items that are not common line item by line item
(i.e. liabilities, assets, expenses etc.)

Example: Consolidation of a wholly owned subsidiary at acquisition date

The following are the abridged statement of financial position as at 31 Dec 2015

Assets P Ltd S Ltd

Investment in S Ltd at fair value 20 000 -

Cash and Cash Equivalent 25 000 20 000

45 000 20 000

Equity and liabilities

Share capital- Ordinary shares (45000/10 000 shares) 45 000 20 000

Required

Prepare the consolidated Statement of financial position for P Ltd group as at 31 Dec 2015.

Assume that P Ltd acquired 100% shares of S Ltd at this date.

Solution Example 6.1

Pro-forma consolidated journal entry

Dr Cr

Share capital of S ltd 20 000

Investment in S ltd 20 000

Elimination of owners’ equity of B Ltd at acquisition

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Financial Accounting 3A – Study Guide
P Ltd Grp

Consolidated statement of financial position as at 31 Dec 2015

Assets

Cash and Cash Equivalent (20 000+ 25 000) 45 000

Equity and Liabilities

Share capital 45 000

Example: Consolidation of a partly owned subsidiary at acquisition date

The following are the condensed statements of financial position of Heavy Limited and its
subsidiary at 31 December 2013. The date on which Heavy Limited acquired the interest in
Light limited:

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2013

HEAVY LTD LIGHT

LTD

Assets

Property Plant and Equipment 100 000 80 000

Investment in Light Limited 65 000 -

Inventories 50 000 40 000

Total Assets 215 000 120 000

EQUITY AND LIABILITIES

Share Capital (50 000/30 000 shares) 100 000 60 000

Retained Earnings 50 000 35 000

Long term borrowings 30 000 10 000

Trade and other Payables 35 000 15 000

Total Equity and liabilities 215 000 120 000

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 EXTRACT FROM THE STATEMENT OF COMPREHANSIVE INCOME FOR THE YEAR

ENDED 31 DECEMBER 2013

HEAVY LTD LIGHT LTD

Profit before tax 50 000 38 500

Income tax expense (15 000) (11 500)

PROFIT FOR THE YEAR 35 000 27 000

Other comprehensive income for the year - -

Total comprehensive income for the year 35 000 27 000

EXTRACT FROM THE STATEMENTS OF CHANGES IN EQUITY FOR THE YEAR

ENDED 31 DECEMBER 2013

Retained Earnings

HEAVY LTD LIGHT LTD

Balance at 1 January 2013 20 000 10 000

Changes in Equity for 2013

Total comprehensive income for the year:

Profit for the year 35 000 27 000

Dividend Paid (5 000) (2 000)

Balance at 31 December 2013 50 000 35 000

Assume that the identifiable assets acquired and the liabilities assumed at acquisition date
are shown at their acquisition date fair values, as determined in terms of IFRS 3. Heavy Limited
elected to measure non-controlling interests at its fair value at the acquisition date.

At the acquisition date the directors were of the opinion that the fair value of the non-controlling
interest amounted to R33 000.

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Heavy Limited recognised the equity investment in Light Limited in its separate records using
the cost price method.

Ignore tax implications.

Required

Prepare the consolidated financial statements of the Heavy Limited Group for the year ended
31 December 2013.

Solution

HEAVY LIMITED GROUP

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2013

ASSETS

Non-current assets

Property, plant and equipment (100 000 + 80 000) 180 000

Goodwill (w1) 3 000

183 000

Current Assets

Inventories (50 000 + 40 000) 90 000

Total Assets 273 000

EQUITY AND LIABILITIES

Equity attributable to owners of the parent

Share Capital 100 000

Retained Earnings 50 000

150 000

Non-controlling interest (w1) 33 000

Total Equity 183 000

Non-current liabilities

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Long term borrowings (30 000 + 10 000) 40 000

Current Liabilities

Trade and other payables (35 000 + 15 000) 50 000

Total Equity and liabilities 273 000

HEAVY LIMITED GROUP

EXTRACT FROM THE CONSOLIDATED STATEMENT OF LOSS AND OTHER

COMPREHANSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2013

Profit before tax 50 000

Income tax expense (15 000)

Profit for the year 35 000

Other comprehensive income -

Total Comprehensive income for the year 35 000

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HEAVY LIMITED GROUP

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED

31 DECEMBER 2013

Share Retained Total Non-controlling

Total

Capital Earnings Interest

Equity

Balance at 1/01/13 100 000 20 000 120 000 -

120 000

Changes in Equity for

2013

Total comprehensive

Income for the year:

Profit for the year - 35 000 35 000 - 35 000

Dividend paid - (5 000) (5 000) - (5 000)

Subsidiary obtained at

The end of the reporting

Period - - - 33 000 33
000

Balance at 31/12/2013 100 000 50 000 150 000 33 000 183

000

Workings

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Working 1

Heavy Ltd’s interest in Light Ltd = 20 000/30 000=66.67%

Working 2

Analysis of owners’ equity of Light Ltd

Heavy Ltd 66.67%

Total At Since NCI

At acquisition 31/12/13 60 000 40 000 20 000

Share capital 35 000 23 333 11 667

Retained earnings 95 000 63 333 31 667

1 667 1 667 31 667

Equity represented by 1 333√ - -

Goodwill-Parent

Equity represented by Goodwill-

NCI 98 000 65 000 33 000

Consideration and NCI

Working 3

Calculation of goodwill of Light Ltd in terms of IFRS 3

Consideration transferred at acquisition date 65 000

Non-controlling interest measured at fair value 33 000

98 000

Net of the identifiable assets acquired and

Liabilities assumed at acquisition date (95 000)

Goodwill 3 000

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Working 4

Pro-foma consolidation journal entry

Dr Cr

Share capital (SCI) 60 000

Retained Earnings (SCE) 35 000

Goodwill (1 667 + 1 333) 3 000

Investment in Light Limited 65 000

Non-controlling interest 33 000

Elimination of common items and recognition of goodwill

Controlling interest measured at fair value at acquisition

Working 5

Consolidation worksheet: heavy Ltd and Subsidiary

Consolidation
adjustments
Heavy Light consolidation
Dr Cr

100 000 80 000 180 000

PPE
- - 3 000 3 000
Goodwill
65 000 - 65 000 -
Investment in
Light 50 000 40 000 90 000

Inventories 215 000 120 000 273 000

100 000 60 000 60 000 100 000

Share capital 50 000 35 000 35 000 50 000

Retained Earnings

Non-controlling - - 33 000 33 000

interest
30 000 10 000 40 000
Long term
obligation 35 000 15 000 50 000

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 Trade and other 215 000 120 000 98 000 98 000 273 000
payables

Summary

A full set of consolidated financial statements consist of the following:

Consolidated Statement of Financial Position

Consolidated Statement of Profit and Loss

Consolidated Statement of Comprehensive Income

Consolidated Statement of Cash flow

Notes to the consolidated financial Statements

Note they are no self-assessment questions for this module; however, students are
required to refer to the questions at the end of each and every topic of the prescribed
text book for revision purposes.

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 STUDY UNIT 7: CONSOLIDATION AFTER DATE OF ACQUISITION

7.1 Introduction

After studying this learning unit you should be able to:

• Prepare financial consolidated financial statements after the date of acquisition

7.2 Overview

In principle the consolidated statements of a group are nothing more than the combined
statements of all the companies in the group. However, certain adjustments need to be made
before we can speak of consolidated statements. The principles, procedures and the
adjustments that are needed in order to prepare and present the consolidated financial
statements for a group of companies will be discussed in this learning unit.

SINCE ACQUISITION — APPLICATION OF IFRS 10

7.3 Objective of IFRS 10

IFRS 10 deals with the following:

• “The circumstances in which an entity must consolidate the financial statements of

another entity (being a subsidiary)
• The principle of control and establishing control as the basis for consolidation
• How to apply the principle of control and how to identify whether an investor controls
an investee
• The accounting requirements for the preparation of consolidated financial statements
• Accounting for changes in ownership interests in a subsidiary
• Accounting for the loss of control of a subsidiary
• The information that an entity must disclose to enable users of the financial statements
to evaluate the nature of the relationship between the entity and its subsidiaries” (IFRS
10) //////’

7.4 Consolidation procedures

The consolidation procedures that should be followed are as follows:

The common items are combined and showed as a single line item while the uncommon items
are maintained separately.

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The following steps must be taken to ensure that the consolidated financial statements present
financial information about the group as that of a single entity:

The investment in the subsidiary (line item) together with the parent’s equity portion in each
subsidiary to be eliminated.

Goodwill to be treated as prescribed by IFRS 3.

Non-controlling interests to be identified.

Non-controlling interests in the net assets of consolidated subsidiaries must be identified

separately from the parent’s ownership interests in them.

Non-controlling interests in the net assets consist of:

Amount of NCI at the date of acquisition.

The non-controlling interests' share of changes in equity since the date of the combination

Intragroup transactions such as intragroup sales, expenses and income must be eliminated
including the profits and losses on these intragroup transactions. The tax implications resulting
from these intragroup transactions must also be dealt with in accordance with IAS 12.

Consolidated financial statements should be prepared using uniform accounting policies for
like transactions and other events in similar circumstances (IFRS 10)

“The results of operations of a subsidiary are included in the consolidated financial statements
from the acquisition date as defined by IFRS 3. This is the date on which control of the acquired
subsidiary is effectively transferred to the buyer” (IFRS 10)

The financial statements of the parent and its subsidiaries used in preparing the consolidated
financial statements should all be prepared as of the same reporting date, unless it is
impracticable to do so

If it is impracticable for a particular subsidiary to prepare its financial statements as of the

same date as its parent, adjustments must be made for the effects of significant transactions
or events that occur between the dates of the subsidiary’s and the parent’s financial
statements. In no case may the difference be more than three months (Binnekade, 2017)

Non-controlling interests should be presented in the consolidated statement of financial

position within equity, but separate from the parent’s owners' equity

Example 7.1

Consolidation after the date of acquisition

Statements of financial position as at 30June 2008

Assets A Ltd B Ltd

Investments in B Limited 10 000 ordinary shares at fair value 10 000 -

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Trade and other receivables 12 000 8 000

Cash 14 000 10 000

Total assets 36 000 18 000

Equity and Liabilities

Share capital- 20 000 ordinary shares 20 000 -

10 000 ordinary shares - 8 000

Total equity liabilities 36 000 18 000

Additional information

The equity investments are measured at fair value through profit and loss (FVTPL). The fair
value of the equity investment is equal to the cost price thereof.

A Ltd acquired its controlling interest on 30 June 2006 when B Ltd was incorporated.

Required

Prepare the consolidated statement of financial position of the A Ltd Grp as at 30June 2008.

Solution: Example 7.1

Pro forma consolidated Journals Dr Cr

Share capital of B Ltd 10 000

Investment 10 000

Elimination of owners' equity of B Limited at acquisition

A Ltd Grp

Consolidated Statement of Financial Position as at 30 June 2008

Assets

Current assets

Trade and other receivables (12 000+ 8 000) 20 000

Cash and Cash equivalents 24 000

Total assets 44 000

Equity and Liabilities

Total equity

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Share Capital 20 000

Retained Earnings (16 000+8 000) 24 000

Total equity and liabilities 44 000

7.5 Summary

When consolidating financial statements after the date of acquisition the retained earnings of
the subsidiary that were earned from the date of acquisition to the beginning of the current
year are shared between the subsidiary and the parent.

∞𝐸𝑛𝑑 𝑜𝑓 𝑆𝑡𝑢𝑑𝑦 𝐺𝑢𝑖𝑑𝑒∞

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