Question 1a i
Background
Carbise is the parent company of an international group which has a presentation and functional currency of the dollar. The group operates within the manufacturing sector.
On 1 January 20X2, Carbise acquired 80% of the equity share capital of Bikelite, an overseas subsidiary. The acquisition enabled Carbise to access new international markets.
Carbise transfers surplus work-in-progress to Bikelite which is then completed and sold in various locations.
The acquisition was not as successful as anticipated and on 30 September 20X6 Carbise disposed of all of its holding in Bikelite. The current year end is 31 December 20X6.
Bikelite trading information
Bikelite is based overseas where the domestic currency is the dinar. Staff costs and overhead expenses are all paid in dinars.
However, Bikelite also has a range of transactions in a number of other currencies. Approximately 40% of its raw material purchases are in dinars and 50% in the yen.
The remaining 10% are in dollars of which approximately half were purchases of material from Carbise. This ratio continued even after Carbise disposed of its shares in Bikelite.
Revenue is invoiced in equal proportion between dinars, yen and dollars. To protect itself from exchange rate risk, Bikelite retains cash in all three currencies.
No dividends have been paid by Bikelite for several years. At the start of 20X6 Bikelite sought additional debt finance.
As Carbise was already looking to divest, funds were raised from an issue of bonds in dinars, none of which were acquired by Carbise.
Acquisition of Bikelite
Carbise paid dinar 100 million for 80% of the ordinary share capital of Bikelite on 1 January 20X2. The net assets of Bikelite at this date had a carrying amount of dinar 60 million.
The only fair value adjustment deemed necessary was in relation to a building which had a fair value of dinar 20 million above its carrying amount and a remaining useful life of 20 years at the acquisition date.
Carbise measures non-controlling interests (NCI) at fair value for all acquisitions, and the fair value of the 20% interest was estimated to be dinar 22 million at acquisition.
Due to the relatively poor performance of Bikelite, it was decided to impair goodwill by dinar 6 million during the year ending 31 December 20X5.
| Rates of exchange between the $ and dinar are given as follows: | |
|---|---|
| 1 January 20X2: | $1:0·5 dinar |
| Average rate for year ended 31 December 20X5 | $1:0·4 dinar |
| 31 December 20X5: | $1:0·38 dinar |
| 30 September 20X6: | $1:0·35 dinar |
| Average rate for the nine-month period ended 30 September 20X6 | $1:0·37 dinar |
| Disposal of Bikelite | |
|---|---|
| Carbise sold its entire equity shareholding in Bikelite on 30 September 20X6 for $150 million. Further details relating to the disposal are as follows: | |
| Carrying amount of Bikelite’s net assets at 1 January 20X6 | dinar 48 million |
| Bikelite loss for the year ended 31 December 20X6 | dinar 8 million |
| Cumulative exchange gains on Bikelite at 1 January 20X6 | $74·1 million |
| Non-controlling interest in Bikelite at 1 January 20X6 | $47·8 million |
Required:
(a) Prepare an explanatory note for the directors of Carbise which addresses the following issues:
(i) what is meant by an entity’s presentation and functional currency. Explain your answer with reference to how the presentation and functional currency of Bikelite should be determined. (7 marks)
Note: Any workings can either be shown in the main body of the explanatory note or in an appendix to the explanatory note.