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Advanced Accounting, Updated Canadian Edition Solution Manual

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    CHAPTER 1 Accounting for Investments BRIEF EXERCISES B RIEF EXERCIS E 1 - 1 What is a financial asset? According to IAS 32.11 , a financial asset is defined as any of the following:  Cash  An equity instrument of another company  A contractual right to receive cash or another financial asset from another company  A contractual right to exchange financial instruments with another company under conditions that are potentially favourable. B RIEF EXERCIS E 1 - 2 What are the three main criteria to determine control? According to IFRS 10.6 , t he three main criteria that must be present in order for there to be control are that the parent company must have:  The ability to direct the financial and operating policies of another company (the power criterion) ,  The ability to obtain returns from the other company (the returns criterion) , and  The ability to use its power to affect those returns (the link criterion) .

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    B RIEF EXERCISE 1 - 3 What is an associate company? Paragraph 2 of IAS 28 defines an associate a s : A n entity , including an unincorporated entity such as a partnership, over which the investor has significant influence , and that is neither a subsidiary nor an interest in a joint venture. The key characteristic in determining whether an investment is an associate is significant influence. BRIEF EXERCISE 1 - 4 Why are associates distinguished from other investments held by the investor? The suite of accounting standards provides different levels of disclosure dependent on the relationship between the investor and the investee. Subsidiaries: a control relationship Joint arrangements : a joint control relationship Associates: a significant influence relationship Other investments: no relationship When there is a relationship, it relates to the ability of the investor to influence the direction of the investee, in comparison to a simple holding of shares as an investment. Where such a relationship exists, it is argued that the investor is affected, from an accountability perspective as well as a potential receipt of benefits perspective [why get involved if there are no benefits to doing so?]. These effects result in the need for additional disclosure about the relationship.

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    B RIEF E XERCISE 1 - 5 Discuss the similarities and differences between the criteria used to identify subsidiaries and those used to identify associates . A subsidiary is identified where another entity controls that entity. Control is defined in IFRS 10.6 . Control: Note that three criteria must be present in order for there to be control. The parent must have:  The ability to direct the financial and operating policies of another entity (the power criterion),  The ability to obtain returns from the other company (the returns criterion), and  The ability to use its power to affect those returns (the link criterion). An associate is identified where another entity has significant influence over that entity. Significant influence is defined in IAS 28.2 . Significant Influence has the following features in its definition:  The power to , or capacity, to affect the investee  To participate in the financial and operating policy decisions of the investee  There is no requirement for the investor to hold and ownership interest in the investee BRIEF EXERCISE 1 - 6 What is meant by “ significant influence ” ? Paragraph 2 of IAS 28 defines s ignificant influence as : T he power to participate in the financial and operati ng policy decisions of the investee but is not control or joint control over those policies.

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    BRIEF EXERCISE 1 - 7 What factors could be used to indicate the existence of significant influence? IAS 28 presents several factors which could be used to indicate the existence of significant influence:  Where an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that the investor has significant influence over the investee.  If the investor can demonstrate that such influence does not exist, the investee is not classified as an associate.  Where the investor owns less than 20% of another company, there is a presumption that the investee is not an associate .  A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. Some additional factors that can provide evidence of the existence of significant influence are:  Representation on the board of directors or the equivalent governing body of the investee .  Participation in the policy - making processes of the investee, including participation in decisions about dividends or other distributions .  Material transactions between the investor and the investee .  Interchange of managerial personnel .  Provision of essential technical information .

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    BRIEF EXERCISE 1 - 8 Discuss the relative merits of accounting for investments at cost, at fair value, and using the equity method . Cost Method: Advantages : – Simplicity – Reliable measure Disadvantages : – No indication of changes in value since acquisition – Revenue recognized only on dividend receipt or when the asset is sold. Fair Value Method : Advantages : – Up - to - date value, present information compared with past information – Revenue recognized as value changes, rather than waiting for dividends Disadvantages : – Reliability a function of how active the market is – Costs associat ed with regular updating, extra costs for audit and valuation fees Equity Method : Advantages : – Carrying amount related to change in wealth of the investee – Revenue recognized prior to dividend receipt Disadvantages : – Carrying amount reliant on validity of investee information – Carrying amount not based on market value – Recognitio n of revenue prior to associate declaring dividend; no transaction has yet occurred

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    BRIEF EXERCISE 1 - 9 What is a parent - subsidiary relationship? According to IFRS 10 , a parent - subsidiary relationship exists when a company has control over another company. B RIEF EXERCIS E 1 - 10 What is the key difference between a joint operation and a joint venture? According to IFRS 11 : Joint Operation  The parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Joint Venture  A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.

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    EXERCISES E XERCISE 1 - 1 – Solution assumes early adoption of IFRS 9 therefore classified as FVTPL. March 1, 2013 FVTPL — Investment 840 Cash 840 (To record the acquisition at fair value = $4.20 × 200 shares) March 1, 2013 Transaction expenses 120 Cash 120 (To record the transaction costs) December 31, 2013 FVTPL — Investment 180 Gain on Change in fair value of FVTPL Investment 180 (To record the change in fair value at year - end) [(200 × $5.10) – $840 = $180] February 1, 2014 Cash 1,020 FVTPL — Investment 1,020 (To record the sale of the investment) February 1, 2014 Transaction expenses 50 Cash 50 (To record the transaction costs)

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    EXERCISE 1 - 2 Max Inc . purchased 40% of Guarasci, with no further information the conclusion must be that the equity investment is an associate. (a) January 1, 2013 Investment in Associate 80,000 Cash 80,000 (To record the investment in Guarasci) December 31, 2013 Investment in Associate 20,000 Share of Profit of Associate 20,000 (To record the share of the associate’s profit = $50,000 × 40% = $20,000) December 31, 2013 Cash 4,000 Investment in Associate 4,000 (To record the adjustment for dividend paid by associate = 40% × $10,000 = $4,000) December 31, 2014 Share of Loss of Associate 2,000 Investment in Associate 2,000 (To record the share of the associate’s loss = $5,000 × 40% = $2,000) December 31, 2014 Cash 4,000 Investment in Associate 4,000 (To record the adjustment for dividend paid by associate = 40% × $10,000 = $4,000) (b) Beginning balance of Inves t ment in Associate — Guarasci $ 80,000 Share of 2013 associate’s profit 20,000 2013 Dividend adjustment (4,000) Share of 2014 associate’s loss (2,000) 2014 Dividend adjustment (4,000) 2014 ending balance of Investment in Associate — Guarasci $ 90,000 Or 80,000 + 40% (+ 45,000 – 20,000) = 90,000

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    EXERCISE 1 - 3 (a) Investment in Joint Venture 160,000 Cash 160,000 (To record the investment in the joint venture) Investment in Joint Venture 3,850 Share of profit of joint venture 3,850 (To record Campbell Ltd. share of the profit of the joint venture = $17,500 × 22% = $3,850) (b) If this was a joint operation, they would report its proportionate share of each asset and liability, revenue, or expense that it owns. As they obtained a 22% interest, they would record the same 22% share of the investment income as above. Any asset or liability that it owns would be recorded.

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    PROBLEMS PROBLEM 1 - 1 Parts A & B Date Description Net income Balance Sheet Net income Balance Sheet 01-Jan-10 ownership interest in Que (financial instrument) = 500/5000 = 10%; public company 500x$1.20 600 31-Dec-10 unrealized gain Que $700 - $600 100 100 dividend revenue Que $1000 x 10% 100 500x$1.40 700 04-Jan-11 ownership interest in Are = 200/3500 = 6%; public company 200x$0.84 168 31-Dec-11 unrealized gain Que $760 - $700 60 60 dividend revenue Que $1000 x 10% 100 unrealized gain Are $220 - $168 52 52 dividend revenue Are 750 x 6% 45 500x$1.52 760 200x$1.10 220 01-Sep-12 ownership interest in Que (significant influence) = 1500/5000 = 30% Share of net income $15,000x30%x4/12 1500 gain on deemed sale of FI (financial instrument) 500x($1.65-$1.52) 65 investment account 1500x$1.65 2475 Share of net income 1500 Share of dividends $1000x30% -300 31-Dec-12 Balance in the investment account 3675 200x$0.70 140 unrealized loss on Are $140 - $220 88 Dividend revenue Are $500 x 6% 30 01-Mar-13 sale of Are shares realized gain 47-.7 x 50 12 31-Dec-13 investment income Que $10,000 x 30% 3000 3000 dividends Que $1000x30% -300 Balance in the investment account 6375 unrealized loss on Are $97.50 - ($140 x 150/200) -7.5 150x$0.65 97.5 dividends Are $200 x 150/3500 8.57 Part C Since Que and Are are public companies there will be no difference in net income. Part D Assuming Aye follows ASPE, the calculations are the same as above except that Aye could elect to reflect Que at FV in 2012 and 2013 and that cost is not an option since it is a public company. Que Are

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    PROBLEM 1 - 2 (a) Calculate the balances to be reflected on the Acme December 31, 2013 statement of financial position in accordance with ASPE.  #1 — 10% interest in Plato purchased on January 1, 2013. As at December 31 , 2013 they should measure the equity instrument at the fair value ($16 ,000), as this would be considered to be a non - strate gic investment ( financial asset ) and any gain or loss would be flowed directly through net income. This investment in Plato would not be reported at the cost of $17,000 because the $16,000 fair value seems to be impaired when compared to the cost, and as such it should be recorded at the impaired value.  #2 — 40% interest in Bloor purchased 5 years ago. This investment would be considered to be an associate as they are presumed not to have control. Under ASPE, they have the choice of using the equity method or the cost method. If using the equity method, the carrying balance of the investment would be: Beginning investment balance : $250,000 Retained earnings increase : $28,000 (40% × $70,000) Ending investment balance : $278,000 The fair value of the investment is $280,000. As the investment is not impaired, it will be recorded at its carrying value of $278,000 . If using the cost method, it would be recorded at $250,000.  #3 — 50% interest in a joint venture, Rand. Under ASPE, they would have the choice of using proportionate consolidation, the equity method, or the cost method to account for their interest in Rand . If using the equity method, the carrying balance of the investment would be as follows: Beginning balance : $120,000 Net income share: $20,000(50% × $40,000) Dividend share: ($5,000) (50% × $10,000) Ending balance: $135,000 If using the cost method, the investment carrying value would be $120,000. If using proportionate consolidation, there would be no investment on the statement of financial position and it would be replaced with their proportionate share of the assets and liabilities of Rand.

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    PROBLEM 1 - 2 (Continued) (b) What will be different in the reporting of these investments for Acme if it were to become a public company? Assuming early adoption of IFRS 9:  #1 — 10% interest in Plato purchased on January 1, 2013. As at December 31 , 2013 they should measure the equity instrument at the fair value ($16 ,000), as this would be considered to be a non - strateg ic investment ( financial asset ) and any gain or loss would be flowed directly through net income.  #2 — 40% interest in Bloor purchased 5 years ago. This investment would be considered to be an associate as they are presumed not to have control. Under IFRS , they would have to use the equity method. If using the equity method, the carrying balance of the investment would be: Beginning investment balance : $250,000 Retained earnings increase : $28,000 (40% × $70,000) Ending investment balance : $278,000 The fair value of the investment is $280,000. As the investment is not impaired, it will be recorded at its carrying value of $278,000.  #3 — 50% interest in a joint venture, Rand. Under IFRS , they would have to use the equity method to account for their investment in Rand . If using the equity method, the carrying balance of the investment would be as follows: Beginning balance : $120,000 Net income share: $20,000(50% × $40,000) Dividend share: ($5,000) (50% × $10,000) Ending balance: $135,000

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    WRITING ASSIGN MENTS WRITING ASSIGNMENT 1 - 1 According to IAS 28, significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies. If an investor holds, directly or indirectly (i . e. , t hrough subsidiaries), 20% or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or indirectly (i . e. , t hrough subsidiaries), less than 20% of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. The existence of significant influence by an investor is usually evidenced in one or more of the following ways:  Representation on the board of directors or equivalent governing body of the investee;  Participation in policy - making processes, including participation in decisions about dividends or other distributions;  Material transactions between the investor and the investee;  Interchange of managerial personnel; or  Provision of essential technical information. Points of discuss ion : 1. Why the investment was undertaken by Cornett Chocolates Ltd. is irrelevant. The definition of significant influence is based on the capacity to participate, not the actual participation or intention to participate. Therefore, their intention to only invest for cash flow reasons is not relevant in determining if Cornett Chocolates Inc. has significant influence over Concertina’s Milk Ltd . 2. Whether Cornett Chocolates Ltd. Actually exerts influence is irrelevant, but rather do they have the ability to exercise influence is how the presence of significant influence is determined . 3. The 20% threshold is a guideline only and professional judgment must be exercised in determining if Cornett Chocolates Ltd. has significant influence over Concertina’s Milk Ltd. or not . 4. Factors will include those listed above. Further, an analysis of the 79.8% holding by other parties is very important. If it is closely held, then the ability for Cornett Chocolates Ltd. to participate is limited and likely cannot significantly influence the financial and operating policies .

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    WRITING ASSIGNMENT 1 - 2 Peter (technology & know - how) 45% of POPP Paul (venture capital company, financing) 55% of POPP How Peter should record its investment in POPP depends on its level of control. They are unlikely to be able to exercise control over POPP, as Paul owns more than 50% of the shares of POPP and is also involved in the business , even though Peter is appointing the managing director and the director of finance . Paul owns 55% of the shares so would need to assess if they have control of POPP , if this would be considered to be a joint arrangement, or if Peter hassignificant influence over POPP. Significant influence is defined as the power to participate in the financial and operating policy decisions of the investee, but is not control or joint control over those policies. Joint control is the contractually agreed sharing of control over an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. Paul is providing the financing and owns a majority of the shares. However, as they are a venture capital company it is unlikely that they will be involved on a day to day basis, especially since Peter is contributing the technology and know - how, as well as appointing the managing director and director of finance. This would not be considered to be a joint arrangement as there seems to be no contractually agreed sharing of control of the arrangement. Therefore, Peter would have significant influence over POPP and should therefore record its investment in POPP using the equity method. Note: Paul would treat it as FVTPL (non current) because is a venture capital company.

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    WRITING ASSIGNMENT 1 - 3 Godard Inc. sold 60% of its 100% owned Combine Ltd. to Svelte Inc. Godard Inc.’s representatives on the board of directors were replaced by representatives of Svelte Inc.In order to determine if Godard Inc. still has control over Combine Ltd., we must look at and discuss the three criteria that determine if there is control. ( a) The ability to direct the financial and operating policies of another company (the power criterion) . This is referred to as the capacity to control. Power arises from rights and these rights must exist presently so that the investor has the current ability to direct relevant activities.  Godard Inc. no longer owns 60% of Combine Ltd. as it was sold to Svelt Inc. They have retained 40% interest, which is not enough to presume that control exists.  Godard Inc.’s representatives on the board of directors were replaced with representatives appointed by Svelt Inc. Therefore, Godard Inc. no longer has the ability to direct the financial and operating policies of Combine Ltd.  Godard Inc. has provided Svelt Inc. with short - term financing and Svelt Inc. has agreed to apply certain operating decisions that Godard Inc. requires as long as the demand loan is outstanding. Godard Inc. can veto any operating decision that is contrary to Godard Inc.’s requirements. As a result, Godard Inc. can influence the financial policies of the company. However, given that it is short - term demand loan , it is unlikely that it is significant to the ongoing operations of the company and unlike lythat Godardwill control the financial policies of the company. ( b) The ability to obtain returns from the other company (the returns criterion) .  Exposure or rights to returns from an investee. As Godard Inc. still owns 40% of the common shares of Combine Ltd., it can expect to variable returns since the dividend and changes in value of the shares are variable. ( c) The ability to use its power to affect those returns ( t he link criterion) .  The ability to use power over the investee to affect the amount of the investor’s returns.  Given that Godard Inc. owns only 40% of the outstanding common shares of Combine Ltd., and the remaining 60% is owned by Svelt Inc., Godard Inc. does not have the ability to affect the returns. In conclusion, as the power criterion and the link criterion were not met, Godard Inc. no longer has control over Combine Ltd.

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