BAO2203 Corporate Accounting

CASE STUDY – Consolidation, impairment and Intragroup Transactions

BAO2203 Corporate Accounting

Mohammed Sami M Fitaehi s4612289

Alessandra Malibiran s4618672

Eunhye Son s4581496

PART A: (40 marks). CONSOLIDATIONS AND INTER-COMPANY TRANSACTIONS

The financial information for Master Ltd and its 100% owned subsidiary, Chef Ltd, for the period ended 31 December 2022 is as follows:



Master Ltd
Chef Ltd

Sales revenue $ 70 000

$ 67 000


Dividend revenue
13 000


0


Gain on sale of property, plant and equipment
13 000


15 000


Other income
14 000


16 000


Total income
110 000


98 000


Cost of sales
30 000


26 000


Other expenses
11 000


7 000


Total expenses
41 000


33 000


Profit before income tax
69 000


65 000


Income tax expense
10 200


7 200


Profit for the period
58 800



57 800



Retained earnings (1/1/22)
22 000


15 000




80 800


72 800


Interim dividend paid
14 000


9 000


Retained earnings (31/12/22)
66 800


63 800











Master Ltd acquired its shares in Chef Ltd at 1 January 2022 for $90 000 on a cum div. basis. At that date, Chef Ltd recorded share capital of $40 000. Chef Ltd had declared prior to the acquisition a dividend of $9 000 that was paid in April 2022.

At 1 January 2022, all identifiable assets and liabilities of Chef Ltd were recorded at fair value except for inventories, for which the carrying amount was $800 less than fair value. There was a fall in sales due to some negative google reviews and hence, 10% of inventories was still on hand at 31 December 2022. Inventories on hand in Chef Ltd at 31 December 2022 also includes some items acquired from Master Ltd during the period ended 31 December 2022. These were sold by Master Ltd for $16 000, at a profit before tax of $6 000.

Half of the goodwill on acquisition of Chef Ltd by Master Ltd was written off as the result of an impairment test on 31 December 2022.

During March 2022, Master Ltd provided some management services to Chef Ltd at a fee of $8 500 paid by 31 December 2022.

On 1 July 2022, Chef Ltd sold equipment to Master Ltd for a gain of $14 000. This equipment had a carrying amount to Chef Ltd of $70 000, and was considered by Master Ltd to have a 5-year life. By 31 December 2022, the financial assets acquired by Master Ltd and Chef Ltd from external entities increased in value by $6 000 and $2 000 respectively with gains and losses being recognised in other comprehensive income.

The income tax rate is 30%.

With your group partners you are required to:

1. Prepare the acquisition analysis at 1 January 2022.

2. Prepare the business combination valuation entries and pre-acquisition entries at 1 January 2022.

3. Prepare the business combination valuation entries and pre-acquisition entries at 31 December 2022.

4. Prepare the consolidation worksheet journal entries to eliminate the effects of intragroup transactions at 31 December 2022.

Date/ Question number Account Debit ($) Credit ($)
31/12/22 Sales
16,000

Cost of sales

10,000

Inventory

6,000

(Sale of inventory items from Master Ltd to Chef Ltd)









Deferred tax asset
1,800

Income tax expense

1,800

(6,000 x 30%)









Management fees income
8,500

Management fees expense

8,500

(Eliminating the management services intragroup transaction)









Gain on sale of equipment
14,000

Equipment

14,000







Deferred tax asset
4,200

Income expense

4,200

(14,000 x 30%)





Accumulated depreciation
1,400

Depreciation expense

1,400

(14,000/5 years/2)









Income tax expense
420

Deferred tax asset

420

(1,400 x 30%)









Dividend revenue
13,000

Interim dividend paid

13,000

5. Discuss the concept of ‘realisation’ using the intragroup transactions in this question to illustrate the concept.

Any profit or losses incurred by the group can only be confirmed as realised once an external entity gets involved (Loftus 2019). Meanwhile, in the event that inventory goods are sold to the parent company from the subsidiary, and no outside entities are present, then any gains that come from that are unrealised.

For example, during the period of 31 December 2022, the acquisition of some items by Chef Ltd from Master Ltd required an adjustment entry because the profit gained is unrealised. As it is a non depreciable asset, the sale will be realised once a third party purchases it. However, if Master Ltd was to sell some of their inventories to another buyer outside the group even after the initial intra group transaction, then the profit received from it can be realised.

Furthermore, a company’s stock of goods is known as a current asset because it is expected that they will be brought by customers within a year (Is Inventory a Current Asset? n.d.). Therefore, the assumption can be made that the amount of unrealised profits for opening inventories will eventually be realised before the period ends.

On the other hand, the basis used for realisation on depreciable assets is the group’s usage of it (Loftus 2019). Since the likelihood of the depreciable asset being sold to an external party is low, it will stay within the group and may be used for manufacturing purposes. As such, determining the realisation isn’t as simple as relating it back to a transaction with an outside firm.

Additionally, there may be cases where depreciation is used to determine profit realisation because it might be sold to external parties before the asset’s expected life. For example in the consolidated journal entry for gain on sale of equipment of $14,000, the full amount was still unrealised, but as depreciation occurred, the group realised it. As a result, the group’s profit increased because of the credited amount in depreciation expense.

6. Prepare the consolidation worksheet for the preparation of the consolidated financial statements for the period ended 31 December 2022.



Financial statements


Master Ltd


Chef Ltd


Ref
Adjustments Group
Dr ($) Cr ($)
Sales revenue 70,000
67,000
16,000
121,000
Dividend revenue
13,000
13,000
Gain on sale of property, plant and equipment
13,000 15,000
14,000
14,000
Other income
14,000 16,000
8,500
21,500
Total income 110,000 98,000


156,000







Cost of sales
30,000 26,000
720 10,000 46,720
Other expenses
11,000 7,000
12,720 9,900 20,820
Total expenses 41,000 33,000


67,540







Profit before income tax 69,000 65,000


88,960
Income tax expense
10,200 7,200
420 6,216 11,604
Profit for the period
58,800 57,800


77,356
Transfer from business combination valuation reserve



504 504
Retained earnings (1/1/2022)
22,000 15,000
15,000
22,000

80,800 72,800


99,356







Interim dividend paid
14,000 9,000

13,000 10,000
Retained earnings (31/12/2022)
66,800 63,800


89,356

7. Prepare the consolidated Statement of Profit or Loss and Other Comprehensive Income for Master Ltd and its subsidiary, Chef Ltd, at 31 December 2022.

Master Ltd.
Consolidated statement of profit or loss and other comprehensive income
for the period ended 31 December 2022


($)
Sales revenue
121,000
Other income
21,500



142,500


Cost of sales
46,720
Other expenses
20,820



67,540


Gain on sale of property, plant and equipment
14,000




Profit before income tax
88,960
Income tax expense
11,604
Profit after tax
77,356




Gain on financial assets
8,000
Total other comprehensive income
8,000




Total comprehensive income (77,356 + 8,000)
85,356

PART B: 20 marks (1000 words): Virgin Australia and administration

Read the attached article and download other relevant articles to gain some background information on the collapse of Virgin Australia and answer the following questions:

https://www.smh.com.au/business/companies/virgin-australia-confirms-collapse-appoints-administrators-20200421-p54lnd.html

1.Describe the main differences between voluntary administration, receivership and liquidation (5 marks).

2.What was the reason (s) for the collapse of Virgin Airlines? Are these reasons relevant for other airlines? Then why have these other airlines not collapsed? (5 marks)

3.Download the Financial Statements of Virgin Airlines for the last 3 years (2017, 2018 and 2019) and identify material items, how they have changed over the three years, and whether these help explain the circumstances in which Virgin finds itself in now. Calculating some relevant ratios would be useful for this analysis (10 marks).

Referencing

Is Inventory a Current Asset? n.d., FreshBooks, viewed 11 October 2020.

Loftus, J 2019, Financial Reporting, 3rd Edition, Wiley, Melbourne.

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