Question 1b
Alpha’s investments include subsidiaries, Beta and Gamma. The statements of profit or loss and other comprehensive income and summarised statements of changes in equity of the three entities for the year ended 31 March 2016 were as follows:
Statements of profit or loss and other comprehensive income
| Alpha | Beta | Gamma | |
|---|---|---|---|
| $’000 | $’000 | $’000 | |
| Revenue (Notes 3 and 4) | 360,000 | 210,000 | 190,000 |
| Cost of sales (Notes 1–3) | (240,000) | (110,000) | (100,000) |
| –––––––– | –––––––– | –––––––– | |
| Gross profit | 120,000 | 100,000 | 90,000 |
| Distribution costs | (20,000) | (16,000) | (15,000) |
| Administrative expenses | (30,000) | (19,000) | (18,000) |
| Investment income (Notes 5 and 6) | 19,800 | Nil | Nil |
| Finance costs (Note 7) | (12,000) | (17,000) | (13,000) |
| –––––––– | –––––––– | –––––––– | |
| Profit before tax | 77,800 | 48,000 | 44,000 |
| Income tax expense | (15,000) | (12,000) | (11,000) |
| –––––––– | –––––––– | –––––––– | |
| Profit for the year | 62,800 | 36,000 | 33,000 |
| Other comprehensive income: | |||
| Items that will not be reclassified to profit or loss | |||
| Gains/(losses) on financial assets designated at fair | |||
| value through other comprehensive income (Note 5) | Nil | Nil | Nil |
| –––––––– | –––––––– | –––––––– | |
| Total comprehensive income | 62,800 | 36,000 | 33,000 |
| –––––––– | –––––––– | –––––––– | |
| Summarised statements of changes in equity | |||
| Balance on 1 April 2015 | 200,000 | 150,000 | 130,000 |
| Comprehensive income for the year | 62,800 | 36,000 | 33,000 |
| Dividends paid on 31 December 2015 | (30,000) | (12,000) | (11,000) |
| –––––––– | –––––––– | –––––––– | |
| Balance on 31 March 2016 | 232,800 | 174,000 | 152,000 |
| –––––––– | –––––––– | –––––––– |
Note 1 – Alpha’s investment in Beta
On 1 April 2004, Alpha acquired 80% of the equity shares of Beta and gained control of Beta. Alpha paid $64 million in cash for these shares.
On 1 April 2004, the net assets of Beta had a fair value of $70 million. None of the assets and liabilities of Beta which existed on 1 April 2004 were still assets or liabilities of Beta on 31 March 2015.
Alpha measured the non-controlling interest in Beta using the proportion of net assets method. The resulting goodwill on acquisition of Beta was correctly recognised in the consolidated financial statements of Alpha. No impairment of goodwill on acquisition of Beta has been necessary up to and including 31 March 2015.
On 31 March 2016, the annual impairment review of the goodwill on acquisition of Beta indicated that the recoverable amount of the total net assets of Beta (including the goodwill) at that date was $180 million. Beta is regarded as a single cash generating unit for impairment purposes. Any impairment of goodwill should be charged to cost of sales.
Note 2 – Alpha’s investment in Gamma
On 1 October 2015, Alpha acquired 60% of the equity shares in Gamma and gained control of Gamma. Gamma had 50 million equity shares in issue on 1 October 2015 and has not issued any new shares since that date. The acquisition was financed as follows:
– Alpha issued two new shares to the former shareholders of Gamma for every three shares Alpha acquired in Gamma. On 1 October 2015, the fair value of an equity share in Alpha was $2·80 and the fair value of an equity share in Gamma was $3·70.
– Alpha agreed to pay a total of $24·2 million to the former shareholders of Gamma on 30 September 2017.
Alpha’s incremental borrowing rate at 1 October 2015 was 10% per annum.
– Alpha agreed to pay a further amount to the former shareholders of Gamma on 31 December 2019 if the cumulative profits of Gamma for the four-year period from 1 October 2015 to 30 September 2019 exceed $150 million. On 1 October 2015, the fair value of this obligation was measured at $40 million. On 31 March 2016, this fair value was remeasured at $42 million.
Alpha has resolved to use the fair value method for measuring the non-controlling interest when recognising the goodwill on acquisition of Gamma. The fair value of an equity share in Gamma on 1 October 2015 can be used for this purpose. No impairment of the goodwill on acquisition of Gamma is necessary in the consolidated financial statements of Alpha for the year ended 31 March 2016.
On 1 October 2015, the fair values of the net assets of Gamma were the same as their carrying amounts in the financial statements of Gamma with the exception of:
– Property – whose fair value exceeded the carrying amount by $25 million ($10 million of this excess relates to land). The estimated remaining useful life of the buildings element of the property at 1 October 2015 was 20 years.
– Plant and equipment – whose fair value exceeded the carrying amount by $8 million. The estimated remaining useful life of the plant and equipment of Gamma at 1 October 2015 was four years.
All depreciation of property, plant and equipment is charged to cost of sales. You can assume that the profit of Gamma for the year ended 31 March 2016 accrued evenly over the year.
Note 3 – Intra-group trading
Alpha supplies a component used by both Beta and Gamma. Alpha earns a profit margin of 10% on these supplies.
Details of the sales of the component, and the holdings of inventory of the component by group entities, are as follows:
| Beta | Gamma | |
|---|---|---|
| $’000 | $’000 | |
| Sales of the component (for Gamma all sales since 1 October 2015) | 15,000 | 8,000 |
| Inventory of component at 31 March 2015 (at cost to Beta/Gamma | 2,000 | Nil |
| Inventory of component at 31 March 2016 (at cost to Beta/Gamma) | 3,000 | 2,800 |
Note 4 – Revenue of Alpha
On 1 October 2015, Alpha sold a large machine to a customer for a total price of $51·2 million and credited $51·2 million to revenue. As part of the sales agreement, Alpha agreed to provide annual servicing of the machine for four years from 1 October 2015 for no additional payment. The normal selling price of this without any annual servicing would have been $60 million and Alpha would normally charge the customer an annual fee of $1 million to service the machine. You should ignore the time value of money in respect of this transaction.
Note 5 – Alpha’s other investment
Apart from its investments in Beta and Gamma, Alpha has one other investment – in entity X. Alpha purchased this equity investment on 1 July 2015 for $40 million and designated the investment as fair value through other comprehensive income. In order to protect against a prolonged decline in the fair value of the investment in entity X, Alpha purchased a put option to sell this investment. The cost of the option was $6 million and the option was regarded as an effective hedge against a prolonged decline in the fair value of the investment in entity X. On 31 March 2016, the fair value of the equity investment in entity X was $37 million and the fair value of the put option was $8·7 million. Apart from recognising the investment in entity X and the put option at cost, Alpha has made no other entries in its draft financial statements. Alpha wishes to use hedge accounting whenever permitted by International Financial Reporting Standards.
Note 6 – Investment income
All of the investment income of Alpha has been correctly recognised in the individual financial statements of Alpha.
Note 7 – Bond issue
On 1 April 2015, Alpha issued a convertible zero-coupon bond to a single institutional investor. The bond was issued for total proceeds of $250 million and will be redeemed or converted into equity shares on 31 March 2020. If the investor chooses to redeem the bond on 31 March 2020, the investor will receive $362·32million. The incremental borrowing rate of Alpha on 1 April 2015 is 10% per annum. The present value of $1 received in five years at a discount rate of 10% per annum is 62·1 cents.
Required:
(b) Prepare the consolidated statement of profit or loss and other comprehensive income of Alpha for the year ended at 31 March 2016. You do not need to consider the deferred tax effects of any adjustments you make.
(25 marks)
Note: You should show all workings to the nearest $’000.