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Week 4 Tutorial Questions and Solutions
Question 7.10
Accounting by the acquirer, liquidation of the acquiree
Hannath Ltd is a manufacturer of frozen foods in Fremantle. His products include many
forms of vegetables and meats but one item lacking in its product range is frozen fish.
The board of Hannath Ltd decided to investigate a takeover of a Perth company,
PearceLtd, whose prime product was the packaging of frozen Huon salmon. The reason
this company was of particular interest was that Hannath Ltd already owned a number
of factories in Perth some of which were under-utilized. If Pearce were acquired, then
Hannath Ltd would liquidate the company and transfer all the processing work to its
other Hobart factories.
The financial statements of PearceLtd at 1 December 2021 showed the following
information:
All the assets and liabilities of Pearce Ltd were recorded at amounts equal to fair value
except for:
Pearce Ltd also had a brand ‘Eagles West’ that was not recorded by the company because
it had been internally generated. It was valued at $20 000. Pearce Ltd had not recorded
both the interest accrued on the loans amounting to $30 000 and annual leave entitlements
of $6 000.
Hannath Ltd decided to acquire all the assets of Pearce Ltd except for the cash. In
exchange for these assets, Hannath Ltd agreed to provide:
 Two shares in Hannath Ltd for every three A ordinary shares held in Pearce Ltd.
The fair value of each Hannath Ltd share was agreed to be $2.16.
 Artworks to the owners of the B ordinary shares held in Pearce Ltd. (These
artworks were held in the records of Hannath Ltd at $40 000 and valued at $60 000.)
 Sufficient additional cash to enable Pearce Ltd to pay off its liabilities including the
expected liquidation costs of $5 000.
The business combination occurred on 1 December 2021. Legal and accounting costs
incurred by Hannath Ltd in undertaking this business combination amounted to $1300.
Costs to issue the shares to the A ordinary shareholders of Pearce Ltd were $2 000.
Required
(a) Prepare the journal entries in the records of Hannath Ltd at 1 December 2021 to
record the business combination.
(b) Prepare the following accounts for Pearce Ltd: Liquidation, Liquidator’s Cash, and
Shareholders’ Distribution.
(LO5 and LO7)
(a) Acquisition Analysis – Hannath Ltd – Pearce Ltd:
Net fair value of identifiable assets and liabilities acquired
Accounts receivable
Inventory
$44 800
28 000
Plant
112 000
Land
Brand “Eagle West”
35 800
10 000
$230 600
Consideration transferred
Shareholders
Shares
‘A’ shares of Pearce Ltd
Shares in Hannath (2/3)
to B ordinary shareholders
60 000
40 000 x $2.16
$86 400
60 000
Artworks
146 400
Creditors
Cash:
Accounts payable
Provisions
Loans
Liquidation costs
Interest on loans
Annual leave
Total cash required
Less cash already held
24 800
24 000
17 200
5 000
30 000
6 000
107 000
(16 000)
91 000
$237 400
$6 800
Goodwill
[$237 000 – $230 600]
HANNATH LTD
General Journal
Artworks
Dr
20 000
Gain
Cr
(Gain on re-measurement of asset used as
part of consideration in acquisition of
Pearce Ltd)
Accounts receivable
Dr
44 800
Inventory
Dr
28 000
Plant
Dr
112 000
Land
Dr
35 800
Brand
Dr
10 000
Goodwill
Dr
6 800
Payable to Pearce Ltd
Share capital
Artworks
(Acquisition of Pearce Ltd)
Cr
Cr
Cr
Payable to Pearce Ltd
Dr
91 000
Cash
(Payment of consideration)
Cr
Acquisition-related expenses
Cash
(Payment of acquisition-related costs)
Dr
Cr
1 300
Share capital
Dr
2 000
Cash
(Payment of share issue costs)
Cr
(b)
PEARCE LTD
General Ledger
LIQUIDATION ACCOUNT
Receivables 44 800
Retained earnings 60 400
Accumulated depreciation 32 000
Receivable from Hannath Ltd
237 400

329 800
Inventory 23 200 Plant 133 600 Land 20 800
Interest on loans 30 000
Annual leave payable 6 000
Liquidation costs 5 000
Shareholders’ distribution 66 400 329 800 LIQUIDATOR’S CASH ACCOUNT
Opening balance 16 000
Hannath Ltd 91 000
______
107 000
Accounts payable 24 800
Provisions 24 000
Loans 17 200
Liquidation costs 5 000
Interest payable 30 000
Annual leave 6 000
107 000
SHAREHOLDERS’ DISTRIBUTION
Shares in Hannath Ltd 86 400
Artworks 60 000
______
146 400
Share capital – ‘A’ shares 48 000
Shares capital – ‘B’ Shares 32 000
Liquidation 66 400
146 400
Case study 4
Voting interest widely held
Victoria Ltd is a production company that produces movies and television shows. It also
owns cable television systems that broadcast its movies and television shows. Victoria
Ltd transferred to Albert Ltd its cable assets and the shares in its previously owned and
recently acquired cable television systems, which broadcast Victoria Ltd’s movies.
Albert Ltd assumed approximately $200 million in debt related to companies it
acquired in the transaction. After the transfer date, Albert Ltd acquired additional
cable television systems, incurring approximately $2 billion of debt, none of which was
guaranteed by Victoria Ltd.
Albert Ltd was initially established as a wholly-owned subsidiary of Victoria Ltd.
Several months after the transfer, Albert Ltd issued ordinary shares in an initial public
offering, raising nearly $1 billion in cash and reducing Victoria Ltd’s interest in Albert
Ltd to 41%. The remaining 59% of Albert Ltd’s voting interest is widely held.
The managing director of Albert Ltd was formerly the manager of broadcast operations
for Victoria Ltd. Half the directors of Albert Ltd are or were executive officers of
Victoria Ltd.
Albert Ltd and its subsidiaries have entered individually into broadcast contracts with
Victoria Ltd, pursuant to which Albert Ltd and its cable system subsidiaries must
purchase 90% of their television shows from Victoria Ltd at payment terms, and other
terms and conditions of supply as determined from time to time by Victoria Ltd. That
agreement gives Albert Ltd and its cable television system subsidiaries the exclusive
right to broadcast Victoria Ltd’s movies and television shows in specific geographic
areas containing approximately 45% of the country’s population. Albert Ltd and its
cable television subsidiaries determine the advertising rates charged to their broadcast
advertisers.
Under its agreement with Victoria Ltd, Albert Ltd has limited rights to engage in
businesses other than the sale of Victoria Ltd’s movies and television shows. In its most
recent financial year, approximately 90% of Albert Ltd’s sales were Victoria Ltd
movies and television shows. Victoria Ltd provides promotional and marketing services
and consultation to the cable television systems that broadcast its movies and television
shows. Albert Ltd rents office space from Victoria Ltd in its headquarters facility
through a renewable lease agreement, which will expire in 5 years’ time.
Required
(a)
(b)
Should Victoria Ltd consolidate Albert Ltd? Why?
If Victoria Ltd had not established Albert Ltd but had instead purchased 41% of
Albert Ltd’s voting shares on the open market, does this change your answer to
requirement A? Why?
Source: Adapted from Case III issued by the FASB as a part of its Consolidations
project.
41%
Victoria Ltd
Albert Ltd
Victoria Ltd
NCI
41%
59% – widely held
(a) If the NCI is widely held then it may be argued that Victoria Ltd has the capacity to control
Albert Ltd based on the potential for the NCI to outvote Victoria Ltd in determining the
directors of Albert Ltd.
However, other factors should also be considered, such as:



historical attendance at AGMs of Albert Ltd
interest groups such as Green groups within the NCI
geographical distribution of NCI.
If the NCI were tightly held would the decision be any different?
The other key factor in the definition is the returns criterion. A parent must have the rights to
variable returns from the control exercised as well as the ability to use power to affect
returns.
In this case, many of the key policy decisions seem to have been set by contract:





must purchase 90% of TV shows from Victoria Ltd
terms & conditions of supply determined by Victoria Ltd
limited rights to engage in other businesses
provision of marketing services
lease of rental space.
Hence even if the NCI could dominate the Board of Albert Ltd, there is not much they can
change to increase or modify their benefits. Victoria Ltd is therefore running the business. The
NCI are simply investors.
(b) Whether the ownership of Albert Ltd’s shares comes from acquisition on the open market
or acquisition at incorporation of the company is not of interest as it has no effect on the
determination of control.
Case study 10
Control
Daffy Duck Ltd has acquired, during the current year, the following investments in the
shares issued by other companies:
Elmer Ltd $240  000 (40% of issued capital)
Fudd Ltd $234  000 (35% of issued capital)
Daffy Duck Ltd is unsure how to account for these investments and has asked you, as
the auditor, for some professional advice.
Specifically, Daffy Duck Ltd is concerned that it may need to prepare consolidated
financial statements under AASB 10/IFRS 10. To help you, the company has provided
the following information about the two investee companies.
Elmer Ltd
• The remaining shares in Elmer Ltd are owned by a diverse group of investors
who each hold a small parcel of shares.
• Historically, only a small number of the shareholders attend the general
meetings or question the actions of the directors.
• Daffy Duck Ltd has nominated three new directors and expects that they will be
appointed at the next annual general meeting. The current board of directors has five
members.
Fudd Ltd
• The remaining shares in Fudd Ltd are owned by a small group of investors who
each own approximately 15% of the issued shares. One of these shareholders is Elmer
Ltd, which owns 17%.
• The shareholders take a keen interest in the running of the company and attend
all meetings.

Two of the shareholders, including Elmer Ltd, already have representatives on
the board of directors who have indicated their intention of nominating for re-election.
Required
(a)
Advise Daffy Duck Ltd as to whether, under AASB 10/IFRS 10, it controls Elmer
Ltd and/or Fudd Ltd. Support your conclusion.
(b)
Would your conclusion be different if the remaining shares in Elmer Ltd were
owned by three institutional investors each holding 20%? If so, why?
(a)
Daffy Duck Ltd
40%
Elmer Ltd
35%
17%
 NCI is a diverse group.
 Low attendance at AGM.
 Daffy Duck Ltd expects to
appoint 3/5 directors.
 NCI is small group.
 Keen interest.
 Interested in directors.
Consider the definition of control.
Power to govern or capacity to control depends on an entity having the ability to direct the
policies of another entity so as to affect the returns of that entity and to be able to use that power
to increase those returns.
Determination of control is a judgement. Ability to exert control depends on such factors as:






size of the voting interest
the dispersion of other shareholdings
level of disorganisation or apathy of the NCI shareholders
attendance at AGMs
contractual arrangements
arrangements between friendly parties.
Applying these to the above example, it is expected that Elmer Ltd is a subsidiary. If Elmer
Ltd is a subsidiary, then Fudd Ltd is also a subsidiary as Daffy Duck Ltd would control 52%
(35% directly + 17% indirectly)of the vote.
(b) A change in the relative ownerships within Elmer Ltd would suggest that, dependent on
other factors, it would lose its subsidiary status. Fudd Ltd would also then lose its subsidiary
status
Case study 11
Subsidiary status
Sylvester Ltd owns 40% of the shares of Tweety Pie Ltd, and holds the only substantial
block of shares in that entity; no other party owns more than 3% of the shares. The
annual general meeting of Tweety Pie Ltd is to be held in one month’s time. Two
situations may arise.
• Sylvester Ltd will be able to elect a majority of Tweety Pie Ltd’s board of
directors as a result of exercising its votes as the largest holder of shares. As only 75%
of shareholders voted in the previous year’s annual meeting, Sylvester Ltd may have the
majority of the votes that are cast at the meeting.
• By obtaining the proxies of other shareholders and, after meeting with other
shareholders who normally attend general meetings of Tweety Pie Ltd and convincing
these shareholders to vote with it, Sylvester Ltd may obtain the necessary votes to have
its nominees elected as directors of the board of Tweety Pie Ltd, regardless of the
attendance at the general meeting.
Required
Discuss the potential for Tweety Pie Ltd being classified as a subsidiary of Sylvester
Ltd.
Sylvester Ltd
Tweety Pie Ltd
40%
Situation 1
Discuss and apply to the situation:




The concept of control.
The need for judgement.
Factors to consider when determining the existence of control:
NCI = 60%
– no other party > 3% interest
– only 75% attendance at AGM last year.
It will probably be concluded that Sylvester Ltd is the parent of Tweety Pie Ltd.
Situation 2
Consider:


The difference between actual control and capacity to control:
The party actually controlling the other entity may not have the capacity to control. Just
because Sylvester Ltd’s nominees are elected as Board members does not automatically mean
that it becomes the parent of Tweety Pie Ltd. It simply means that it actually controls that
entity. The question is whether it has the capacity to control.

Attendance at AGMs:
– If holders of 90% of the voting shares attended the AGM, then holders of 50% of the
shares could have outvoted Sylvester Ltd. They may allow Sylvester Ltd to manage Tweety
Pie Ltd because of the great managerial skills or business connections of Sylvester Ltd. In this
case, Sylvester Ltd is not the parent of Tweety Pie Ltd.
 The purpose of consolidation:
– If Sylvester Ltd is actually controlling Tweety Pie Ltd, even though it does not have the
capacity to control, would the shareholders of Sylvester Ltd be interested in a set of
consolidated financial statements for the combined group? Does the issue of accountability
provide sufficient grounds for the consolidation of the two entities?
Case study 12
Determining subsidiary status
Required
In the following independent situations, determine whether a parent–subsidiary
relationship exists, and which entity, if any, is a parent required to prepare consolidated
financial statements under AASB 10/IFRS 10.
(a) Bert Ltd is a company that was hurt by a recent global financial crisis. As a
result, it experienced major trading difficulties. It previously obtained a significant loan
from Ernie Bank, and when Bert Ltd was unable to make its loan repayments, the bank
made an agreement with Bert Ltd to become involved in the management of that
company. Under the agreement between the two entities, the bank had authority for
spending within Bert Ltd. Bert Ltd’s managers had to obtain authority from the bank
for acquisitions over $10  000, and was required to have bank approval for its budgets.
(b) Grouch Ltd owns 80% of the equity shares of Count Ltd, which owns 100% of
the shares of Big Bird Ltd. All companies prepare reports under Australian accounting
standards. Although the shares of Count Ltd are not traded on any stock exchange, its
debt instruments are publicly traded.
(c) Elmo Ltd is a major financing company whose interest in investing is return on
the investment. Elmo Ltd does not get involved in the management of its investments. If
the investees are not managed properly, Elmo Ltd sells its shares in that investee and
selects a more profitable investee to invest in. It previously held a 35% interest in
Sesame Ltd as well as providing substantial convertible debt finance to that entity.
Recently, Sesame Ltd was having cash flow difficulties and persuaded Elmo Ltd to
convert some of the convertible debt into equity so as to ease the effects of interest
payments on cash flow. As a result, Elmo Ltd’s equity interest in Sesame Ltd increased
to 52%. Elmo Ltd still wanted to remain as a passive investor, with no changes in the
directors on the board of Sesame Ltd. These directors were appointed by the holders of
the 48% of shares not held by Elmo Ltd.
In each of these circumstances the following principles from the Basis of Conclusions to AASB
10/IFRS 10 should be used:
B2 To determine whether it controls an investee an investor shall assess whether it has all
the following:
(a) power over the investee;
(b) exposure, or rights, to variable returns from its involvement with the investee; and
(c) the ability to use its power over the investee to affect the amount of the investor’s
returns.
B3 Consideration of the following factors may assist in making that determination:
(a) the purpose and design of the investee;
(b) what the relevant activities are and how decisions about those activities are made;
(c) whether the rights of the investor give it the current ability to direct the relevant
activities;
(d) whether the investor is exposed, or has rights, to variable returns from its involvement
with the investee; and
(e) whether the investor has the ability to use its power over the investee to affect the
amount
of the investor’s returns
(a) This question will be looked at under two scenarios:
(i) Bert Ltd is not a subsidiary of any other entity.
The key issue is whether the fact that the bank has authority in relation to acquisitions and
approval of budgets is sufficient to give the bank the status of a parent.
The bank will receive a return from Bert Ltd in the form of interest on the loan.
Ernie Bank has:


Power over Bert Ltd, as it has rights arising from the legal contract.
It can affect some of the relevant activities e.g. acquisitions, but not others such as
appointment of key management personnel.
Bert Ltd will not be a subsidiary of Ernie Bank because:

The bank is not exposed to variable returns from its involvement with Bert Ltd. The
interest payments are not affected by the profitability of Bert Ltd.

It cannot use its power over Bert Ltd to affect the amount of its returns, as the returns
are fixed interest payments.
(ii) Bert Ltd is a wholly owned subsidiary of another entity, Chuck Jones Ltd.
The key issue in this scenario is whether the authority given to the bank in relation to
acquisitions and budget approval is sufficient to state that Chuck Jones Ltd does not control
Bert Ltd.
The key issue is whether Chuck Jones Ltd still has power over Bert Ltd given the arrangements
with the bank.
Relevant activities over which a parent should have power include:
(a)
(b)
(c)
(d)
(e)
selling and purchasing of goods or services;
managing financial assets during their life (including upon default);
selecting, acquiring or disposing of assets;
researching and developing new products or processes; and
determining a funding structure or obtaining funding.
Decisions about relevant activities include:
(a)
(b)
establishing operating and capital decisions of the investee, including budgets; and
appointing and remunerating an investee’s key management personnel or service
providers and terminating their services or employment.
The key issue then is whether Chuck Jones Ltd has the ability to direct the relevant activities
i.e. those activities that most significantly affect the investee’s returns.
It is probable that Chuck Jones Ltd no longer controls Bert Ltd as the bank can veto any changes
to significant transactions for the benefit of Chuck Jones Ltd. It can deny the company its ability
to make acquisitions, and it can reject moves within a budget to undertake changes in inventory
production.
(b)
80% 100%
Grouch Ltd Count Ltd Big Bird Ltd
The issue is whether Count Ltd needs to prepare a set of consolidated financial statements for
itself and Big Bird Ltd.
Note that paragraph 4 of AASB 10/IFRS 10 states that an entity that is a parent shall present
consolidated financial statements except:
(a) a parent need not present consolidated financial statements if it meets all the
following conditions:
(i)it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its
other owners, including those not otherwise entitled to vote, have been informed about, and
do not object to, the parent not presenting consolidated financial statements;
(ii)its debt or equity instruments are not traded in a public market (a domestic or foreign stock
exchange or an over-the-counter market, including local and regional markets);
(iii)it did not file, nor is it in the process of filing, its financial statements with a securities
commission or other regulatory organisation for the purpose of issuing any class of
instruments in a public market; and
(iv)its ultimate or any intermediate parent produces consolidated financial statements that are
available for public use and comply with International Financial Reporting Standards
(IFRSs).
Note all criteria are required to be met. In this example:
(i)Looney Ltd is a wholly owned subsidiary of Count Ltd
(ii)The ultimate parent, Grouch Ltd, prepares reports under AASs, which comply with IFRSs
However, the debt instruments of Count Ltd are traded publicly which means that it breaches
4(a)(iii) above. Hence Count Ltd is not exempt from preparing consolidated financial
statements.
Both Grouch Ltd and Count Ltd would be required to prepare consolidated financial
statements.
(c) Elmo Ltd currently holds 52% of the shares of Sesame Ltd. It does not want to become
involved in the management of Sesame Ltd, and the directors are appointed by the noncontrolling interest (NCI).
Control is not based on actual control but on the capacity to control. Elmo Ltd:



has power over the investee via its share ownership
is exposed to variable returns via dividends arising from its share ownership
has the ability to affect those returns as it can become involved in management
whenever it wishes, given its superior voting power.
Elmo Ltd is a parent of Sesame Ltd and hence must prepare consolidated financial statements.
Further, when Elmo Ltd held a 35% interest in Sesame Ltd it also held convertible debt in that
entity which could, if converted, give it an equity interest of 52%. In this situation, Elmo Ltd
was a parent of Sesame Ltd and should have prepared consolidated financial statements. It
would appear under the circumstances that the conversion was substantive i.e. economically
feasible, and currently exercisable.

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