D. FINANCIAL STATEMENTS OF GROUPS OF ENTITIES - GROUP ACCOUNTING

Question 1

Business combination:

Answer 1

Business combination: a transaction or other event in which an acquirer obtains control of one or more businesses. A group is a result of a business combination.

Question 2

Business

Answer 2

Business: an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in a form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants.

Question 3

Is transaction a business combination

Answer 3

IFRS 3 provides guidance on determining whether a transaction meets the definition of a business combination, and so accounted for in accordance with its requirements. This guidance includes:
 Business combinations can occur in various ways, such as by transferring cash, incurring liabilities, issuing equity instruments (or any combination thereof), or by not issuing consideration at all (i.e. by contract alone)
 Business combinations can be structured in various ways to satisfy legal, taxation or other objectives, including one entity becoming a subsidiary of another, the transfer of net assets from one entity to another or to a new entity
 The business combination must involve the acquisition of a business, which generally has three elements:
o Inputs – an economic resource (e.g. non-current assets, intellectual property) that creates outputs when one or more processes are applied to it
o Process – a system, standard, protocol, convention or rule that when applied to an input or inputs, creates outputs (e.g. strategic management, operational processes, resource management)
o Output – the result of inputs and processes applied to those inputs (not necessary).

Question 4

Business combination vs asset acquisition.

Answer 4

Business combination vs asset acquisition. Firstly, a screening test: is substantially all of the fair value of the assets acquired concentrated in a single identifiable asset (or group of similar identifiable assets)? If yes, then the acquisition is not a business and no further testing is required. If no, then consideration is given as to whether the acquisition contains a substantive process that has the ability to convert inputs to outputs. If it does, it is a business.

Question 5

Acquisition method

Answer 5

All business combinations are accounted for using the acquisition method in IFRS 3. Steps in applying the acquisition method are:
 Identification of the ‘acquirer’
 Determination of the ‘acquisition date’. This is generally the date the consideration is legally transferred, but it may be another date if control is obtained on that date.
 Recognition and measurement of the identifiable assets acquired, the liabilities assumed and any non-controlling interest (NCI, formerly called minority interest) in the acquiree
 Recognition and measurement of goodwill or a gain from a bargain purchase

Question 6

Identifying an acquirer.

Answer 6

Identifying an acquirer. This is generally the party that obtains ‘control’ of the acquiree. IFRS 3 provides additional guidance:
 The acquirer is usually the entity that transfers cash or other assets
 The acquirer is usually, but not always, the entity issuing equity interests where the transaction is effected in this manner
 Also consider:
o Relative voting rights in the combined entity after the business combination
o The existence of any large minority interest if no other owner or group of owners has a significant voting interest
o The composition of the governing body and senior management of the combined entity
o The terms on which equity interests are exchanged
 The acquirer is usually the entity with the largest relative size (assets, revenues or profit)
 For business combinations involving multiple entities, consideration is given to the entity initiating the combination, and the relative sizes of the combining entities.

Question 7

Goodwill

Answer 7

When a company buys another - it is not often that it does so at the fair value of the net assets only. This is because most businesses are more than just the sum total of their ‘net assets’ on the SFP. Customer base, reputation, workforce etc. are all part of the value of the company that is not reflected in the accounts. This is called “goodwill”. Goodwill only occurs on a business combination. Individual companies cannot show their individual goodwill on their SFPs. This is because they cannot get a reliable measure. On a business combination the acquirer (Parent) purchases the subsidiary - normally at an amount higher than the FV of the net assets on the SFP, they buy it at a figure that effectively includes goodwill. Therefore, the goodwill can now be measured and so does show in the group accounts.

Question 8

recognition and measurement criteria for identifiable acquired assets and

Answer 8

The general rule under IFRS 3 is that, on acquisition, the subsidiary’s assets and liabilities must be recognized and measured at their acquisition date fair value except in limited, stated cases. To be recognized in applying the acquisition method the assets and liabilities must:
 Meet the definition of assets and liabilities in the revised Conceptual Framework; and
 Be part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination rather than the result of separate transactions.
This includes intangible assets that may not have been recognized in the subsidiary’s separate financial statements, such as brands, licenses, trade names, domain names, customer relationships and so on.

Question 9

Exceptions to the recognition and/or measurement principles in IFRS 3 are as follows:

Answer 9

Exceptions to the recognition and/or measurement principles in IFRS 3 are as follows:
 Contingent liabilities. Can be recognized providing it is a present obligation and its fair value can be measured reliably.
 Deferred tax assets/liabilities. Measurement based on IAS 12 values (not IFRS 13)
 Employee benefit assets/liabilities. Measurement based on IAS 19 values (not IFRS 13)
 Indemnification assets (amounts recoverable relating to contingent liability). Valuation is the same as the valuation of contingent liability indemnified less an allowance for any uncollectable amounts.
 Reacquired rights (eg license granted to subsidiary before it became a subsidiary). Fair value is based on the remaining term, ignoring the likelihood of renewal.
 Share-based payment. Measurement based on IFRS 2 values (not IFRS 13)
 Assets held for sale. Measurement at fair value less costs to sell per IFRS 5.

Question 10

Fair value -goodwill.

Answer 10

Fair value -goodwill. Normally goodwill, is a positive balance which is recorded as an intangible non-current asset. Occasionally it is negative and arises as a result of a ‘bargain purchase. In this instance, IFRS 3 requires reassessment of the calculations to ensure that they are accurate and then any remaining negative goodwill should be recognized as a gain in profit or loss and therefore also recorded in group retained earnings.
If the initial accounting for business combination is incomplete by the end of the reporting period in which the combination occurs, provisional figures for the consideration transferred, assets acquired, and liabilities assumed are used. Adjustments to the provisional figures may be made up to the point the acquirer receives all the necessary information, with a corresponding adjustment to goodwill, but the measurement period cannot exceed one year from the acquisition date. Thereafter, goodwill is only adjusted for the correction of errors.

Question 11

Fair value – consideration transferred.

Answer 11

Fair value – consideration transferred. The consideration transferred is measured at fair value, calculated as the acquisition date fair values of assets transferred, liabilities incurred and equity interests issued by the acquirer.
Specifically:
 Deferred consideration. Discounted to present value to measure its fair value.
 Contingent consideration (to be settled in cash or shares). Measured at fair value at the acquisition date. Subsequent measurement:
o if the change is due to additional information obtained that affects the position at the acquisition date, goodwill should be remeasured
o If the change is due to any other change:
 Consideration is equity instruments – not remeasured
 Consideration is cash – remeasure to fair value with gains or losses through profit or loss
 Consideration is a financial instrument – account for under IFRS 9
Costs involved in transaction are charged to profit or loss (unless debt or equity instruments).

Question 12

The non-controlling interest

Answer 12

The non-controlling interest forms part of the calculation of goodwill. IFRS 3 allows non-controlling interests in subsidiary to be measured as the acquisition date in one of two ways:
 At proportionate share of fair value of net assets (‘partial goodwill method’). This is a percentage of net assets (capital+retained).
 At fair value (‘full goodwill method’). Based on share value.
The closest approximation to fair value will be the market price of the shares held by the non-controlling shareholders just before the acquisition by the parent.
At the year end, the non-controlling interest will have increased by its share of the subsidiary’s post acquisition retained earnings.
Use of full method increases the goodwill and NCI by the same amount

Question 13

business combination achieved in stages

Answer 13

A parent company may build up its shareholding with several successive purchases rather than purchasing the shares all on the same day. Where a controlling interest in a subsidiary is built up over a period of time, IFRS 3 Business Combinations refers to this as ‘business combination achieved in stages’ (also known as step or piecemeal acquisition).

Question 14

For any change in group structure (step acquisition or disposal):

Answer 14

For any change in group structure (step acquisition or disposal):
 The entity’s status (investment, subsidiary, associate) during the year will determine the accounting treatment in the consolidated statement of profit or loss and other comprehensive income (SPLOCI) (prorated)
 The entity’s status at the year end will determine the accounting treatment in the consolidated statement of financial position (SOFP) (never prorate).

Question 15

There are 3 possible scenarios where significant influence or control is achieved in stages:

Answer 15

There are 3 possible scenarios where significant influence or control is achieved in stages:
 Investment to associate (eg 10% to 30%)
 Investment to subsidiary (eg 10% to 80%)
 Associate to subsidiary (eg 30% to 80%)

Question 16

Investment to associate step acquisitons. .

Answer 16

Investment to associate. Where an investment in equity instruments becomes an associate, the investment (measured either at cost or at fair value) is treated as part of the cost of the associate.
 SPLOCI: Equity account as an associate from the date of significant influence
 SOFP: Equity account as an associate.
There are two possible treatments in group accounts:
 Follow IFRS 3 principles for step acquisitions. Remeasure the existing investment to fair value on the date significant influence is achieved with any corresponding gain or loss recognized in profit or loss or other comprehensive income (depending on whether the investment was previously measured per IFRS 9 at fair value through profit or loss, or at fair value through OCI).
 Follow IAS 28 principles for equity accounting. Record both the original investment and the new investment at cost on the basis that IAS 28 states, ‘under the equity method, on initial recognition the investment in an associate or a joint venture is recognized at cost’.

Question 17

Investment to subsidiary step acquisitons. .

Answer 17

Investment to subsidiary.
 SPLOCI
o Remeasure the investment to fair value at the date the parent achieves control
o Consolidate as a subsidiary from the date the parent achieves control
 SOFP
o Calculate goodwill at the date the parent achieves control
o Consolidate as a subsidiary at the year end

Question 18

Associate to subsidiary step acquisitons. .

Answer 18

Associate to subsidiary.
 SPLOCI
o Equity account as an associate to the date the parent achieves control
o Remeasure the associate to fair value at the date the parent obtains control
o Consolidate as a subsidiary from the date the parent obtains control
 SOFP
o Calculate goodwill at the date the parent obtains control
o Consolidate as a subsidiary at the year end

Question 19

Accounting concept - step acquisitions.

Answer 19

Accounting concept. Investment to subsidiary and associate to subsidiary are accounted for in the same way. The concept of substance over form drives the accounting treatment. The legal form is that some shares have been purchased. However the substance, which should be reflected in group accounts, is that because the control boundary has been crossed:
 An investment or associate has been ‘sold’ – the investment previously held is remeasured to fair value at the date of control (and a gain or loss reported); and
 A subsidiary has been ‘purchased’ – goodwill is calculated including the fair value of the investment previously held

Question 20

A step acquisition where control is retained:

Answer 20

A step acquisition where control is retained: This occurs when there is an increase in the parent’s shareholding in an existing subsidiary through the purchase of additional shares. It is sometimes known as ‘an increase in a controlling interest’.
As for step acquisitions where control is achieved, the accounting treatment is driven by the concept of substance over form. In substance, there has been no acquisition because the entity is still a subsidiary. Instead this is a transaction between group shareholders. Therefore, it is recorded in equity as follows:
 Decrease non-controlling interests (NCI) in the consolidated SOFP
 Recognise the difference between the consideration paid and the decrease in NCI as an adjustment to equity (post to the parent’s column in the consolidated retained earnings working).

Question 21

A step acquisition where control is retained: Accounting treatment in group financial statements

Answer 21

Accounting treatment in group financial statements.
 SOPLOCI
o Consolidate as a subsidiary in full for the whole period – no time apportioning
o Time apportion non-controlling interests based on percentage before and after the additional acquisition
 SOFP
o Consolidate as a subsidiary at the year end
o Calculate non-controlling interests
o Calculate the adjustment to equity

Question 22

Subsidiary:

Answer 22

Subsidiary: an entity that is controlled by another entity.

Question 23

Control:

Answer 23

Control: The power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

Question 24

Power:

Answer 24

Power: Existing rights that give the current ability to direct the relevant activities of the investee.

Question 25

An investor controls an investee if, and only if, the investor has all of the following:

Answer 25

An investor controls an investee if, and only if, the investor has all of the following:
 Power over the investee to direct the relevant activities +
o Examples of power: voting rights; rights to appoint, reassign and remove key management personnel (another entity; management contract
o Examples of relevant activities: sell and purchase of goods/services; manage financial assets; select, acquire, dispose of assets; research and develop new products/processes; determine funding structure/obtain funding
 Exposure or rights to variable returns from its involvement with the investee +
o Examples of variable return: dividends; interest from debts; changes in value of investments, fees/exposure to loss from providing credit/liquidity support; residual interest in assets and liabilities on liquidation, tax benefits etc
 The ability to use its power over investee to affect the amount of the investor’s returns.
o An investor can have the current ability to direct the activities of an investee even if it does not actively direct the activities of the investee.
o Only principal may control an investee when exercising its decision-making powers

Question 26

procedures to be used in preparing consolidated financial statements.

Answer 26

Consolidated financial statements:
 Combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries
 Offset (eliminate) the carrying amount of the parent’s investment and portion of equity of each subsidiary
 Eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows.

Question 27

Consolidated statement of financial position.

Answer 27

Consolidated statement of financial position.
 Assets and liabilities. Always 100% of parent plus 100% of the subsidiary, providing P controls S.
 Goodwill. Consideration transferred plus non-controlling interest less fair value of net assets at acquisition (shows the value of the reputation).
 Share capital. Parent only (as consolidated statements are simply reporting to the parent’s shareholders in another form)
 Reserves. 100% of parent plus group share of post-acquisition retained earnings of subsidiary, plus consolidations adjustments (to show the extent to which the group actually owns the assets and liabilities).
 Non-controlling interests. NCI at acquisition plus NCI share of post-acquisition changes in equity (show extent to which other parties own assets under the control of the parent)

Question 28

Consolidated statement of profit or loss and other comprehensive income.

Answer 28

Consolidated statement of profit or loss and other comprehensive income.
The consolidated statement of profit or loss and other comprehensive income shows a true and fair view of the group’s activities since acquisition of any subsidiaries.
Basic rules.
 Add across 100%. All the items from revenue down to Profit after tax are added together (S+P), except for dividends from subsidiaries and associates.
 NCI. This is an extra line added into the consolidated income statement at the end. It is calculated as NCI% x S’s PFY. The reason for this is because we add across all of S even though we not necessarily own 100%.
 Associates. Simply show one line called “Share in Associates’ Profit after tax”.
 Time apportioning. The problem arises when we acquire the sub or the associate mid-year. Just remember to only add across profits made after acquisition. The same applies to NCI (as after all this just a share of S’s PFY). One final point to remember here is adjustments such as unrealised profits / depreciation on FV adjustments are entirely post - acquisition and so are NEVER time apportioned.
 Unrealised profit. Profit is only ‘unrealised’ if it remains within the group. Profit x how much still remains in stock.
Reduce Profit of Seller Increase SELLERS Cost of Sales
Reduce Inventory  No adjustment required
 Depreciation. Just add to admin or where specified.

Question 29

Intragroup transactions.

Answer 29

Intragroup transactions. On consolidation, the financial statements of a parent and its subsidiaries are combined and treated as a single entity. As a single entity cannot trade with itself, the effect of any intragroup transactions must be eliminated:
 All intragroup assets, liabilities, equity, income, expenses and cash flows are eliminated in full
 Unrealised profits on intragroup transactions are eliminated in full

Question 30

Disposals:

Answer 30

Disposals: These occur when the parent company sells some or all of its shareholding in a group company. When the full shareholding is sold, this is known as a full disposal. When only some of the shareholding is sold, this is referred to as a partial disposal.

Question 31

There are four possible scenarios where control or significant influence is lost.

Answer 31

There are four possible scenarios where control or significant influence is lost.

 Full disposal (from 80% to 0%)
 Subsidiary to associate (from 80% to 30%)
 Subsidiary to investment (from 80% to 10%)
 Associate to investment (from 30% to 10%)

Question 32

Accounting treatment in group financial statements-disposal.

Answer 32

Accounting treatment in group financial statements. With a partial disposal, the accounting treatment in the group accounts is driven by the concept of substance over form. While the legal form is that the parent company has sold some shares, the substance is that subsidiary/associate has been sold and associate/investment purchased.

Question 33

Full disposal.

Answer 33

Full disposal.
 SPLOCI
o Consolidate the results and non-controlling interests to the date of disposal
o Show a group profit or loss on disposal
 SOFP
o No consolidation (and no non-controlling interests as there is no subsidiary at the year end.

Question 34

Subsidiary to associate - disposal.

Answer 34

Subsidiary to associate. ‘Sold’ a subsidiary – deconsolidate the subsidiary (goodwill, NCI and 100% of net assets) and recognize a group profit or loss on disposal. ‘Purchased’ an associate – remeasure the investment retained to fair value.
 SPLOCI
o Treat as a subsidiary to the date of disposal; ie consolidate pro-rata and show non-controlling interests for that period.
o Show a group profit or loss on disposal
o Treat as an associate thereafter (ie equity account)
 SOFP
o Remeasure the investment retained to fair value at the date of disposal
o Equity account (fair value at date of control lost=cost of associate) thereafter

Question 35

Subsidiary to investment - disposal

Answer 35

Subsidiary to investment. ‘Sold’ a subsidiary – deconsolidate the subsidiary (goodwill, NCI and 100% of net assets) and recognize a group profit or loss on disposal. ‘Purchased’ an investment – remeasure the investment retained to fair value.
 SPLOCI
o Consolidate as a subsidiary to the date of disposal
o Show a group profit or loss on disposal
o Show fair value changes (and any dividend income) thereafter
 SOFP
o Remeasure the investment retained to fair value at the date of disposal
o Investment in equity instruments (IFRS 9) thereafter.

Question 36

Associate to investment - disposal.

Answer 36

Associate to investment. ‘Sold’ an associate –recognize a group profit or loss on disposal. ‘Purchased’ an investment – remeasure the investment retained to fair value.
 SPLOCI
o Equity account as an associate to date of disposal
o Show a group profit or loss on disposal
o Show fair value changes (and any dividend income) thereafter
 SOFP
o Remeasure the investment retained to fair value at the date of disposal
o Investment in equity instruments (IFRS 9) thereafter.

Question 37

Disposals where control is retained:

Answer 37

Disposals where control is retained: This occurs when there is a decrease in the parent’s shareholding in an existing subsidiary through the sale of shares. It is sometimes known as ‘a decrease in a controlling interest
The accounting treatment is driven by the concept of substance over form. In substance, there has been no disposal because the entity is still a subsidiary so no profit on disposal should be recognized. Instead this is a transaction between group shareholders. Therefore, it is recorded in equity as follows:
 Increase non-controlling interests (NCI) in the consolidated SOFP
 Recognise the difference between the consideration received and the increase in NCI as an adjustment to equity (post to the parent’s column in the consolidated retained earnings working).

Question 38

Accounting treatment in group financial statements disposal retained.

Answer 38

Accounting treatment in group financial statements.
 SOPLOCI
o Consolidate as a subsidiary in full for the whole period
o Time apportion non-controlling interests based on percentage before and after the acquisition
 SOFP
o Consolidate as a subsidiary at the year end
o Calculate non-controlling interests
o Calculate the adjustment to equity

Question 39

Deemed disposal:

Answer 39

Deemed disposal: This occurs when a subsidiary issues new shares and the parent does not take up all of its rights such that its holding is reduced. In substance this is a disposal and is therefore accounted for as such. The percentages owned by the parent before and after the subsidiary issues shares must be calculated, and, where control is lost, a group profit on disposal must be calculated.

Question 40

Discontinued operation:

Answer 40

Discontinued operation: a component of an entity that either has been disposed of or is classified as held for sale and:
 Represents a separate major line of business or geographical area of operations;
 Is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations; or
 Is a subsidiary acquired exclusively with a view to resale.

Question 41

Component of an entity:

Answer 41

Component of an entity: a part that has operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity.

Question 42

Presentation and disclosure (discontinued operations).

Answer 42

Presentation and disclosure. The general requirement is that an entity shall present and disclose information that enables users of financial statements to evaluate the financial effects of discontinued operations and disposals of non-current assets and disposal groups. The following apply:
 On the face of SPLOCI a single amount comprising the total of:
o The post-tax profit or loss of discontinued operations; and
o The post-tax gain or loss recognized on the remeasurement to fair value less costs to sell or on disposal of assets/disposal groups comprising the discontinued operation.
 On the face of the financial statements or in the notes
o The revenue, expenses and pre-tax profit or loss of discontinued operations, and the related income tax expense
o The gain or loss recognized on the measurement to fair value less costs to sell or on the disposal of assets/disposal groups comprising the discontinued operation, and the related income tax expense; and
o The net cash flows attributable to the operating, investing, and financing activities of discontinued operations.

Question 43

A subsidiary that is acquired exclusively with a view to its subsequent disposal

Answer 43

A subsidiary that is acquired exclusively with a view to its subsequent disposal is classified on the acquisition date of the subsidiary as a non-current disposal group ‘held for sale’ (if it is expected that the subsidiary will be disposed of within one year and the other IFRS 5 criteria are met with within three months of the acquisition date).

Question 44

Classification as a discontinued operation - subsidiary

Answer 44

Classification as a discontinued operation. A subsidiary classified as ‘held for sale’, is included in the definition of a discontinued operation, with treatment as follows:
 SPLOCI
o Single Line “Discontinued operations” - PAT of the Sub + gain/loss on re-measurement to held for sale
o The income and expenses of the subsidiary are therefore not consolidated on a line-by-line basis with the income and expenses of the holding company.
 SFP
o The assets and liabilities classified as ‘held for sale’ presented separately (the assets and liabilities of the same disposal group may not be offset against each other).
o The assets and liabilities of the subsidiary are therefore not consolidated on a line-by-line basis with the assets and liabilities of the holding company.
 Statement of Cashflows. No need to disclose the net cash flows attributable to the operating, investing and financing activities of the discontinued operation (which is normally required) but is not required for newly acquired subsidiaries which meet the criteria to be classified as ‘held for sale’ on the acquisition date.

Question 45

the circumstances in which a group is required to prepare consolidated financial statements.

Answer 45

IFRS 10 Consolidated Financial Statements requires a parent to present consolidated financial statements in which the accounts of the parent and subsidiary (or subsidiaries) are combined and presented as a single economic entity. The individual financial statements of parents, subsidiaries, associates and joint ventures should be prepared to the same reporting date. Where this is impracticable, the most recent financial statements are used, and:
 The difference must be no greater than 3 months
 Adjustments are made for the effects of significant transactions in the intervening period
 The length of reporting periods and any differences in the reporting dates must be the same from period to period.
Uniform accounting policies should be used. Adjustments must be made where members of a group use different accounting policies, so that their financial statements are suitable for consolidation.

Question 46

the circumstances when a group may claim and exemption from the preparation of consolidated financial statements

Answer 46

A parent need not present consolidated financial statements providing:
 It is itself a wholly owned subsidiary, or is partially-owned with the consent of the non-controlling interests; and
 Its debt or equity instruments are not publicly traded; and
 It did not file or is not in the process of filing its financial statements with a regulatory organization for the purpose of publicly issuing financial instruments; and
 The ultimate or intermediate parent produces financial statements available for public use that comply with IFRSs including all subsidiaries.

Question 47

why directors may not wish to consolidate a subsidiary

Answer 47

IFRS 10 does not permit entities meeting the definition of a subsidiary to be excluded from the consolidated financial statements. The rules on exclusion of subsidiaries from consolidation are necessarily strict, because this is a common method used by entities to manipulate their results. The reasons directors may not want to consolidate a subsidiary and why that would not be appropriate under IFRS:
 The subsidiary’s activities are not similar to the rest of the group. Subsidiary should be consolidated: adequate disaggregated information is provided by disclosures under IFRS 8 Operating Segments.
 Control is temporary as the subsidiary was purchased for re-sale. Subsidiary should be consolidated: the principles in IFRS 5 Non-current assets geld for sale and discontinued operations should be applied
 To reduce apparent gearing by not consolidating the subsidiary’s loans or subsidiary is loss-making. Subsidiary should be consolidated: excluding the subsidiary would be manipulating the group’s results and would not give a true and fair view.
 Severe long-term restrictions limit the parent’s ability to run the subsidiary: Consider parent’s ability to control the subsidiary; if it is not controlled, it should not be consolidated.

Question 48

An exception to the ‘no exclusion from consolidation’ principle

Answer 48

An exception to the ‘no exclusion from consolidation’ principle is made where the parent is an investment entity. Investments in subsidiaries are not consolidated, and instead are held at fair value through profit or loss. This allows an investment entity to account for all of its investments, whatever interest is held, at fair value through profit or loss. The accounting treatment is mandatory for entities meeting the definition of an investment entity, ie an entity that:
 Obtains funds from one or more investors for the purpose of providing those investors with investment management services;
 Commits to its investors that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both; and
 Measures and evaluates the performance of substantially all of its investments on a fair value basis.

Question 49

Typical characteristics of an investment entity are:

Answer 49

Typical characteristics of an investment entity are:
 It has more than one investment
 It has more than one investor
 It has investors that are not related parties to the entity
 It has ownership interests in the form of equity or similar interests.

Question 50

Users of cash flow information.

Answer 50

Users of cash flow information.
Management.
 Cash flow provides more relevant information on which decisions should be taken
 Cash flow accounting can be both retrospective and include a forecast for the future.
 Forecasts can subsequently be monitored by the use of variance statements which compare actual cash flows against the forecast
Shareholders
 Survival of a company depends on its ability to generate cash. Cash flow accounting directs attention towards this critical issue.
 Cash flow accounting can be better for stewardship as cash flows are objective and not subject to manipulation.
 Cash flow reporting provides a better means of comparing the results of different companies than traditional profit reporting
 It helps manage expectations about potential dividend payments (shows impact of cash payments)
Creditors
 More interested in ability to repay debts than profitability
 Could be mislead by profit accounting eg that profitable company is a going concern

Question 51

Cash:

Answer 51

Cash: both cash on hand and demand deposits.

Question 52

Cash equivalents:

Answer 52

Cash equivalents: short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

Question 53

Cash flows:

Answer 53

Cash flows: inflows and outflows of cash and cash equivalents.

Question 54

Cash flow classification

Answer 54

IAS 7 Statement of Cash Flows requires statements of cash flows to report cash flows during the period classified by operating, investing and financing activities.

Question 55

Operating activities.

Answer 55

Operating activities. The principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Most of the components of cash flows from operating activiyies will be those items which determine the net profit or loss of the entity. Examples:
 Cash receipts from the sale of goods and rendering of services, royalties, fees, commissions and other revenue
 Cash payments to suppliers for goods and services and to and on behalf of employees
 Cash payments/refunds of income taxes unless they can be identified with financing or investing activities
 Cash receipts and payments from contracts held for dealing or trading purposes.

Question 56

Investing activities:

Answer 56

Investing activities: The acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples:
 Cash payments to acquire or receipts from sales of PPE, intangibles and other long-term assets
 Cash payments to acquire or receipts from sales of shares or debentures of other entities
 Cash advances and loans made to other parties and cash receipts from repayments.
 Cash payments for or receipts from futures/forward/option/swap contracts except where the contracts are held for dealing purposes, or the payments/receipts are classified as financing activities

Question 57

Financing activities:

Answer 57

Financing activities: Activities that result in changes in the size and composition of the equity capital and borrowings of the entity. Examples:
 Cash proceeds from issuing shares and cash payments to owners to acquire or redeem the entity’s shares
 Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings
 Cash repayments of amounts borrowed
 Cash payments by a lessee for the reduction of the outstanding liability relating to a lease

Question 58

CF - Taxes on income.

Answer 58

Taxes on income. Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financning and investing activities.

Question 59

Reporting cash flows from operating activities.

Answer 59

Reporting cash flows from operating activities. The standard offers a choice of method for this part of the statement of cash flows.
 Direct method: disclose major classes of gross cash receipts and gross cash payments. It is a preferred method as it discloses information not available elsewhere in the financial statements, which could be of use in estimating future cash flows.
 Indirect method: net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows. This is most used in practice as is easier to prepare, less costly, however could be open to manipulation and harder to understand.

Question 60

Consolidated statement of cash flows.

Answer 60

Consolidated statement of cash flows. Both direct and indirect method of preparing group statements of cash flows is acceptable. A group’s statement of cash flows should only deal with the flows of cash external to the group. Cash flows that are internal to the group should be eliminated.

Question 61

CF - Dividends paid to NCI.

Answer 61

Actual cash payments made in the form of dividends paid to NCI are shown in the consolidated statement of cash flows.

Question 62

CF - Acquisitions and disposals of associates and joint ventures.

Answer 62

Acquisitions and disposals of associates and joint ventures. When an associate or joint venture is purchased or sold, the cash paid to acquire the shares, or the cash received from selling the shares must be recorded in the ‘cash flows from investing activities’ section.

Question 63

CF - Adjustment required under indirect method for associates and joint ventures.

Answer 63

Adjustment required under indirect method for associates and joint ventures. Under the indirect method of preparing a group statement of cash flows, the group share of the associate’s/joint venture’s profit or loss for the year must be removed from the group profit before tax figure as an adjustment in the ‘cash flows from operating activities ‘section.

Question 64

Cash flows on acquisition or disposal of a subsidiary.

Answer 64

There are two cash flows associated with the acquisition or disposal of a subsidiary:
 The cash paid to buy the shares (for an acquisition) or the cash received from selling the shares (for a disposal)
 The cash or overdraft balance consolidated for the first time (for an acquisition) or deconsolidated (for a disposal)
These two cashflows should be netted off and shown as a single line in the consolidated statement of cash flows under ‘investing activities’.
Proceeds of a sale of subsidiary X

Question 65

CF - The effect on assets and liabilities if subsidiaries are acquired or disposed of

Answer 65

The effect on assets and liabilities if subsidiaries are acquired or disposed of. When calculating cash flows (eg balancing figures) in asset and liability workings, the workings need to be adjusted for assets and liabilities acquired (or disposed of) as a result of the acquisition (or disposal) of a subsidiary (simply show increase or decrease on a separate line in workings).
 The subsidiary’s PPE, inventories, payables, receivables at the date of acquisition should be added in the relevant cash flow working. The new subsidiary’s assets and liabilities have been consolidated for the first time in the period, so we need to take account of that when we look at the movement in group assets and liabilities.
 The subsidiary’s PPE, inventories, payables, receivables at the date of disposal should be deducted in the relevant cash flow working. The assets and liabilities of the sold subsidiary have been deconsolidated in the period, so we need to take account of that when we look at the movement in group assets and liabilities.

Question 66

CF -Impairment losses under the indirect method.

Answer 66

Impairment losses under the indirect method. Impairment losses like depreciation and amortisation, are accounting expenses rather than cash flows and therefore must be added back to profit before tax when calculating cash generated from operations.

Question 67

CF - Foreign currency translation.

Answer 67

Foreign currency translation. The value of assets and liabilities denominated in a foreign currency will be subject to exchange rate fluctuations. These are non-cash movements and should be factored into workings when calculating the actual cash movement in the year. The exception to this is if cash balances are denominated in a foreign currency. In this case, the effect of the exchange rate movement should be included in the reconciliation of opening to closing cash and cash equivalents. For the group consolidated statement of cash flows, IAS 7 requires that all cash flows relating to an overseas subsidiary be translated at the exchange rates between the functional currency and the foreign currency at the date of cash flows.

Question 68

Disclosure - CF

Answer 68

Disclosure. There are additional disclosure requirements in respect of acquisitions and disposals of subsidiaries or other business units during the period. The following amounts should be disclosed
 Total purchase/disposal consideration
 Portion of purchase/disposal consideration discharged by means of cash/cash equivalents
 Amount of cash/cash equivalents in the subsidiary or business unit disposed of
 Amount of assets and liabilities in the subsidiary or business unit acquired or disposed of
Entities must disclose the following changes in liabilities arising from financing activities:
 Changes from financing cash flows
 Changes arising from obtaining or losing control of subsidiaries or other businesses
 The effect of changes in fair values
 Other changes.
The disclosures also apply to changes in financial assets if cash flows arising from those financial assets are classified as ‘cash flows from financing activities.
One way to fulfil the new disclosure requirements is to provide a reconciliation of cash flows arising from financing activities to the corresponding liabilities in the opening and closing statement of financial position.
Changes in liabilities arising from financing activities must be disclosed separately from changes in other assets and liabilities.