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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