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EQUITY ACCOUNTING

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Title: EQUITY ACCOUNTING


1
EQUITY ACCOUNTING TEXT CHAP 20
2
Accounting for Investments
  • Cost method
  • used in the purchasing companys books
  • Equity method - AASB 1016
  • applied when a significant interest exists
  • often described as one-line consolidation
  • Consolidation - control
  • applied when control exists

3
Application of Equity Accounting
  • Purpose of the standard is to prescribe the
    circumstances in which investors must apply the
    equity method to account for investments in
    associates
  • Associates defined
  • Investment not being
  • a Subsidiary
  • not a partnership
  • investment not acquired for resale

4
Application of Equity Accounting
  • Significant influence
  • equity accounting is to be applied when a entity
    has significant influence over an associate
    company
  • Defined as
  • the capacity of an entity to affect substantially
    (but not control) financial operation of
    another entity
  • 20 test
  • where a company holds 20 or more (without
    control) then a presumption that significant
    influence exist

5
General description
  • The investor will bring to account, in each
    period, its share of the profits or losses of the
    other company - other than income already
    received by way of dividends.
  • AASB 1016
  • If the investor prepares consolidation then
    adjust in accounts
  • or
  • if not a holding company then adjust in the
    books of the investor

6
example
  • Investee Ltd- Profit Loss (25)
  • Operating Profit 100 000
  • Dividend Paid 20 000

  • 80 000
  • Share of profit 25 100 000 25 000
  • already recorded Dividend Paid
  • 25 of 20 000 5 000
  • still to be recorded 20 000

7
example
  • Investee Ltd- Profit Loss (25)
  • Operating Profit 100 000
  • Dividend Paid 20 000

  • 80 000
  • Share of profit 25 100 000 25 000
  • already recorded Dividend Paid
  • 25 of 20 000 5 000
  • still to be recorded 20 000
  • DR Investment in Associate 20 000
  • CR Share of Profits in Associate 20 000

8
Example- Goodwill
  • At 1 July 2000 Teddy Ltd acquired 25 of Bear
    Ltds share capital for 49 375. At this date the
    shareholders equity section of Bear Ltd consisted
    of-
  • Share Capital 100
    000
  • Reserves
    50 000
  • Retained Profits 20
    000
  • All assets _at_ Fair Values except Plant has a fair
    value of 10 000 greater than carrying amount
    Inventory 5 000 greater than cost.
  • Tax Rate 30 -Plant 5 year life- Inventory sold
    2001
  • Any goodwill over 10 years

9
Example- Goodwill
  • Fair Value of Assets acquired
  • Capital 100 000
  • Reserves 50 000
  • Retained Profits 20 000
  • Plant .710 000 7 000
  • Inventory .75000 3 500
  • 180 500
  • 25 45 125
  • Cost 49375
  • Goodwill 4 250
  • At 1 July 2000 Teddy Ltd acquired 25 of Bear
    Ltds share capital for 49 375. At this date the
    shareholders equity section of Bear Ltd consisted
    of-
  • Share Capital 100
    000
  • Reserves
    50 000
  • Retained Profits 20
    000
  • All assets _at_ Fair Values except Plant has a fair
    value of 10 000 greater than carrying amount
    Inventory 5 000 greater than cost.
  • Tax Rate 30 -Plant 5 year life- Inventory sold
    2001
  • Any goodwill over 10 years

10
Example- Goodwill
  • Fair Value of Assets acquired
  • Capital 100 000
  • Reserves 50 000
  • Retained Profits 20 000
  • Plant .710 000 7 000
  • Inventory .75000 3 500
  • 180 500
  • 25 45 125
  • Cost 49375
  • Goodwill 4 250
  • At 1 July 2000 Teddy Ltd acquired 25 of Bear
    Ltds share capital for 49 375. At this date the
    shareholders equity section of Bear Ltd consisted
    of-
  • Share Capital 100
    000
  • Reserves
    50 000
  • Retained Profits 20
    000
  • All assets _at_ Fair Values except Plant has a fair
    value of 10 000 greater than carrying amount
    Inventory 5 000 greater than cost.
  • Tax Rate 30 -Plant 5 year life- Inventory sold
    2001
  • Any goodwill over 10 years

Amortisation of Goodwill 10 4 250
425 Depreciation 20 (25 7 000)
350 Inventory 25 3 500 875
11
Calculation of Profit
  • Assume Bear Ltds profit after tax 15 000
  • Recorded profit
  • 25 of 15 000 3 750
  • Pre-acquisition Adjustments
  • Goodwill 425
  • Depreciation 350
  • Inventory 875
  • 1 650
  • Net Adjustment 2 100

Amortisation of Goodwill 10 4 250
425 Depreciation 20 (25 7 000)
350 Inventory 25 3 500 875
12
Entry in Books or Consolidation Adjustment
  • Assume Bear Ltds profit after tax 15 000
  • Recorded profit
  • 25 of 15 000 3 750
  • Pre-acquisition Adjustments
  • Goodwill 425
  • Depreciation 350
  • Inventory 875
  • 1 650
  • Net Adjustment 2 100

Entry Dr Investment in Bear Ltd 2 100 Cr
Revenue from Associate 2 100
13
Consolidation Adjustment - following year
  • Assume Bear Ltds profit after tax 15 000
  • Recorded profit
  • 25 of 15 000 3 750
  • Pre-acquisition Adjustments
  • Goodwill 425
  • Depreciation 350
  • Inventory 875
  • 1 650
  • Net Adjustment 2 100

Entry Dr Investment in Bear Ltd 2 100 Cr
Retained profits 2 100 (No entry
if adjusted in BOOKS!!)
14
Example- Discount
  • At 1 July 2000 Teddy Ltd acquired 25 of Bear
    Ltds share capital for 44 125. At this date the
    shareholders equity section of Bear Ltd consisted
    of-
  • Share Capital 100
    000
  • Reserves
    50 000
  • Retained Profits 20
    000
  • All assets _at_ Fair Values except Plant has a fair
    value of 10 000 greater than carrying amount
    Inventory 5 000 greater than cost.
  • Tax Rate 30 -Plant 5 year life- Inventory sold
    2001
  • Any goodwill over 10 years

15
Example- Discount
  • At 1 July 2000 Teddy Ltd acquired 25 of Bear
    Ltds share capital for 44 125. At this date the
    shareholders equity section of Bear Ltd consisted
    of-
  • Share Capital 100
    000
  • Reserves
    50 000
  • Retained Profits 20
    000
  • All assets _at_ Fair Values except Plant has a fair
    value of 10 000 greater than carrying amount
    Inventory 5 000 greater than cost.
  • Tax Rate 30 -Plant 5 year life- Inventory sold
    2001
  • Any goodwill over 10 years

Carrying Fair
Amount Value Plant 86 000 96
000 Inventory 21 000 26 000
16
Example- Discount
  • Fair Value of Assets acquired
  • Capital 100 000
  • Reserves 50 000
  • Retained Profits 20 000
  • Plant .710 000 7 000
  • Inventory .75000 3 500
  • 180 500
  • 25 45 125
  • Cost 44 125
  • Discount 1 000
  • At 1 July 2000 Teddy Ltd acquired 25 of Bear
    Ltds share capital for 44 125. At this date the
    shareholders equity section of Bear Ltd consisted
    of-
  • Share Capital 100
    000
  • Reserves
    50 000
  • Retained Profits 20
    000
  • All assets _at_ Fair Values except Plant has a fair
    value of 10 000 greater than carrying amount
    Inventory 5 000 greater than cost.
  • Tax Rate 30 -Plant 5 year life- Inventory sold
    2001
  • Any goodwill over 10 years

17
Allocation of Discount
  • Fair Value 25 Discount Cost
    BV(25) Adj
  • Plant 96 000 24 000 797
    23203
  • Inventory
  • 24 500 6 125 203
    5922 5250 672
  • 120 500 30 125 3 000
  • 21 000.75000

18
Allocation of Discount
  • Fair Value 25 Discount Cost
    BV(25) Adj
  • Plant 96 000 24 000 797
    23203
  • Inventory
  • 24 500 6 125 203
    5922 5250 672
  • 120 500 30 125 3 000
  • 21 000.75000

Depreciation of Plant 20 of 797
159 Inventory adjustment 672
19
Calculation of Profit
Depreciation of Plant 20
of 797 159 Inventory adjustment 672
  • Assume Profit - 15 000
  • (after tax)
  • Share of Recorded Profit
  • 25 15 000 3 750
  • Pre-acquisition Adjustment
  • Depreciation 191
  • Cost of Sales 672
  • 2 887
  • 20 of 25 (.7 10 000)-159

20
Calculation of Profit
  • Assume Profit - 15 000
  • (after tax)
  • Share of Recorded Profit
  • 25 15 000 3 750
  • Pre-acquisition Adjustment
  • Depreciation 191
  • Cost of Sales 672
  • 2 887
  • 20 of 25 (.7 10 000)-159

entry Investment in Bear Ltd 2 887 Revenue
from Associate 2 887
21
Additional Adjustments
  • Interim Dividends Paid
  • The carrying amount has to be reduced for any
    dividend adjustments- otherwise the profit would
    be double counted
  • ie Company has recorded as Dividend Income
    Equity accounting has recorded total profit
  • Dividends Provided
  • accounted for as for interim dividend as assumed
    that investor records as dividend receivable ie
    taken up as income
  • Preference Dividend
  • If regarded as equity then this must be deducted
    fron the profit to arrive at the profit available
    to ordinary shareholders

22
example
  • Investee Ltd- Profit Loss (25)

  • Year 1 Year 2
  • Operating Profit 100 000 200
    000
  • Dividend Provided 20 000
    -

  • 80 000 200 000
  • Share of profit 25 300 000 75 000
  • Recorded as follows-
  • Year 1 Equity 25(100 000-20 000) 20 000
  • plus in books as Dividend Receivable 5 000
  • Year 2 Equity 25(200 000) 50
    000

  • 75 000

23
Example- dividend paid or provided
  • Recorded Profit
    100 000
  • Less- Adjustments
  • Dividends Paid or Provided
    20 000
  • Total
    80 000
  • Share of Profit 25
    20 000

24
Example- dividend paid or provided
  • Recorded Profit
    100 000
  • Less- Adjustments
  • Dividends Paid or Provided
    20 000
  • Total
    80 000
  • Share of Profit 25
    20 000

entry Investment in Bear Ltd 20 000 Revenue
from Associate 20 000
25
Increase/Decrease in Reserves
  • Asset Revaluation Reserve
  • Carrying amount must be increased/ decreased for
    adjustments to reserves
  • eg Company has revalued its assets by 100 000
  • Dr Investment in Associate 25 000
  • CR Asset Revaluation Reserve 25 000

26
Inter-entity transactions
  • Like consolidations we have to remove the
    unrealised profits between the investor the
    investee
  • sale of inventory
  • sale of depreciable asset

27
Sale of Inventory
  • Investee Ltd sells goods to Investor Ltd 5 000.
    Cost Investee 3 000. Unsold at end of period
  • Tax 30
  • Recorded profit 30 000
  • Adjustment
  • Inventory in Closing stock -1 400

  • 28 600
  • Unrealised Profit .72 000

28
Sale of Inventory
  • Investee Ltd sells goods to Investor Ltd 5 000.
    Cost Investee 3 000. Unsold at end of period
  • Tax 30
  • Recorded profit 30 000
  • Adjustment
  • Inventory in Closing stock -1 400

  • 28 600
  • Unrealised Profit .72 000

entry Investment in Bear Ltd 7 150
Revenue from Associate 7 150 25 28600
29
Sale of Inventory- opening inventory
  • Investee Ltd sells goods to Investor Ltd 5 000.
    Cost Investee 3 000. Unsold at end of period
  • Tax 30
  • Recorded profit 30 000
  • Adjustment
  • Inventory in Closing stock -1 400

  • 28 600
  • Following period
  • Recorded Profit 40 000
  • Adj- Opening Inventory 1 400

  • 41 400

30
Sale of Inventory- opening inventory
  • Investee Ltd sells goods to Investor Ltd 5 000.
    Cost Investee 3 000. Unsold at end of period
  • Tax 30
  • Recorded profit 30 000
  • Adjustment
  • Inventory in Closing stock -1 400

  • 28 600
  • Following period
  • Recorded Profit 40 000
  • Adj- Opening Inventory 1 400

  • 41 400

entry Investment in Bear Ltd 10 350 Revenue
from Associate 10 350 25 41 400
31
Sale of Depreciable Asset
  • Investee Ltd sells an item of Plant to Investor
    for 8 000. Book value 3 000. Further 5 years
    life. (tax 30)
  • Recorded Profit 40 000
  • Adjustments
  • Unrealised profit -3 500 (Gain
    .7 5 000)
  • Realised Profit
  • (3500/5) 700
    (Depreciation)
  • 37
    200
  • Following Year
  • Recorded Profit 40 000
  • Realised Profit 700
  • 40
    700

32
Losses
  • Losses
  • Losses should also be adjusted BUT once asset
    reduced to Zero suspend AASB 1016.

33
  • Investee Ltd- Profit Loss (25)
  • Operating Loss 400 000
  • Share of Loss 25 400 000 100 000
  • Assume paid 50 000
  • General ledger
  • Shares in Investee Ltd

  • dr cr Balance
  • 1/1/xx Cash 50 000
    50 000
  • 30/6/99 Equity -loss
    100 000 (50 000) ???

34
  • Investee Ltd- Profit Loss (25)
  • Operating Loss 400 000
  • Share of Loss 25 400 000 100 000
  • Assume paid 50 000
  • General ledger
  • Shares in Investee Ltd

  • dr cr Balance
  • 1/1/xx Cash 50 000
    50 000
  • 30/6/99 Equity -loss
    50 000 Nil
  • ie SUSPEND using equity accounting

35
Tutorial Questions
  • Exercise 20.1
  • Exercise 20.3
  • Exercise 20.4
  • Problem 20.1
  • Problem 20.3
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