Introduction

The present report will be a presentation of answers to four (4) case studies on corporate financial reporting. The first case is concerned with consolidated financial statements and specifically asks when a business should consolidate the financial statements of other businesses. The second case tackles the related topic of business combinations the third case asks a variety of financial reporting issues for public companies. Case study 4 caps the report with the issue of the cash generating unit.

Case Study 1

A: Whether Explorer Ltd should consolidate Mouse Ltd

The decision whether or not to consolidate is dependent on the rules governing consolidation. Those rules have been developed over the years. The relevant accounting standard for the present purposes is AASB 127. It is this standard that sets out the rules governing whether an entity should consolidate or not. An answer to this question is, therefore, an analysis of the given facts against the relevant parts of AASB 127. It is a requirement under the standard that a company consolidates investments in its subsidiaries (AASB 127, par.9). It follows from this that Explorer will be required to consolidate Mouse if the latter is deemed its subsidiary. A prerequisite would, therefore, be a determination of whether Mouse Ltd is a subsidiary of Explorer Ltd.

A subsidiary is defined in the standard by reference to control as opposed to ownership (AASB 127, par.4). The definition is all encompassing to include even business structures that are not companies. Control may either be direct or indirect. A parent in the first instance would be assumed to have control if it owns more than half of the voting power of another entity (AASB 127, par.13). Voting rights in a company is determined by the ownership of ordinary shares. The facts of the case show that Explorer Ltd only has 41% of the voting power of Mouse Ltd. This means that control cannot be presumed on this basis of voting rights.

In situations where the parent does not own more than half of the voting interest in the subsidiary, a number of other factors are given which may indicate the existence of control. One such factor is the power to govern the financial and operating policies of the entity under a statute or agreement (AASB 127, par.13.b). The broadcast contracts that the entities in the case have entered into can be seen as agreements giving Explorer Ltd the power to govern the financial and operating activities of Mouse Ltd and its subsidiaries. This is particularly the case given the fact that these entities must purchase 90% of their television shows from Explorer coupled with the fact that Explorer Ltd reserves the right to change the terms and conditions of supply from time to time. The agreements effectively put the other entities under the control of Explorer Ltd. There is also the provision in the agreement with Mouse Ltd that limits the company’s ability to engage in businesses other than the sale of Explorer Ltd’s movies and television shows. All these are good indicators to presume that Explorer has control even though it only owns 41% of the voting interest in Mouse Ltd.

Control may also be presumed in situations where an entity has the power to appoint or remove the majority of the members of the board of directors (AASB, par.13.c). With only 41% of the voting rights, one can theoretically argue that Explorer Ltd does not have this power. From a practical point of view, however, Explorer Ltd does seem to have this power. For one, it is the single largest shareholder of Mouse Ltd given that the remaining 59% of the voting rights are widely held. The dispersed nature of the other 59% shareholding means that it is much easier for Explorer Ltd to control who sits in the board as the other shareholders would rarely have a common good. The current composition of the board of Mouse Ltd is just a testimony of the power of Explorer Ltd to appoint or remove the majority of the members of that board. For instance, half of that board is said to have been or present executive officers of Explorer Ltd. The essence of all these is that Explorer Ltd indeed has the power contemplated under this additional factor.

Related to the power to appoint or remove the majority of the members of the board is the power to cast the majority of the votes in the board (ASSB 127, par.13.d). Having half of the board of Mouse Ltd as either its present or formers executives, Explorer Ltd indeed has this power. It is easier for these people to lobby the other board members to vote in a particular way.

From the above analysis, Explorer Ltd should consolidate Mouse Ltd. It is true that it its voting interest in the latter is less than 50%. The other factors necessary for presuming control, however, shows that Explorer should still consolidate as it has control. For instance, it has the power to govern the financial and operating activities of Mouse Ltd. It also has the power to cast a majority votes in the board amongst other powers.

B: Whether my answer above would change if Explorer had not established Mouse?

It is clear from the discussion above that control is the determinative test in considering whether to consolidate. It never came out from the discussion that the manner in which control is achieved is relevant. The consequence of this is that the answer in (A) above would not change even if Explorer Ltd had not established Mouse Ltd but just purchased the shares from the open market as it would still have control even though achieved in a different manner.

Case Study 2

Accounting for the original 30% investment in Bream Ltd

Accounting for the original 30% investment in Bream Ltd is a classic case of business combination achieved in stages. In such cases, the acquirer is often required to once more measure the previously held equity interest in the acquiree at the acquisition date fair value (AASB, par.42). The resulting gain or loss from the additional measurement of previously held equity interest is then supposed to be recognised in the income statement (Dagwell, Wines and Lambert, 2012, p.235). In a similar vein, Bass Ltd will have to account for 30% of its previously held shares in Bream Ltd by establishing the fair values of those shares. The difference between their established fair value and their carrying amount should then be recognised as a gain or loss in the income statement of Bass Ltd.

The case has not given the carrying value of the original shares but the discussion can assume $300,000 for illustration purposes. The discussion will further assume that the fair value of the original shares on acquisition date was $450,000.

The share price to use in issuing Bass Ltd shares

A proper understanding of this issue entails elaborating some of the steps involved in accounting for business combinations to the extent that they are relevant in rendering the issue. Under AASB 3, four steps are required although the first step has no relevance in the present question. The first of these steps is for the acquirer to identify the acquisition date. This is simply the date when control of the acquiree is achieved (AASB 3, par.8). The facts given do not specify the exact point when this happened but it can reasonably be assumed that this date was 30^th September 2016 as this is the date when the deal was reached. This is true in Australia just as it is in the USA (Hoyle, Schaefer and Doupnik, 2011, pp.44-45).

The determination of the acquisition date is important because whatever value that is given as consideration must be taken as the value at the acquisition date. It follows from this that the share price to use in the present case is the price on 30 September 2016.

Effects of varying dates on accounting for business combination

It is true that the date when the net assets of the acquiree are transferred to the acquirer sometimes called the date of exchange may differ from the date of acquisition which is often the date when the acquirer effectively takes control of the acquiree.

Case Study 3: Hydroponics Company Limited

Hydroponic Company Limited

1. Classification of company

Hydroponics Company Limited is classified as a large public company. This conclusion is derived from the types of companies that one can register under the Corporations Act 2001(Cth).The term ‘small’ and ‘large’ are only used in the Act with reference to proprietary companies(Schweizer and Kobras,2010,p.4). These are generally companies that are not allowed to sell their shares to members of the public. They may, therefore, be sometimes be referred to as private companies. The fact that Hydroponics Company Limited has issued a prospectus in contemplation of inviting members of the public to subscribe for its shares clearly puts it out of the class of proprietary companies leaving it in the class of a public company.

2. Entities to which accounting standards apply and the nature of the reporting entity

Respective accounting standards normally specify the entities to which they apply in an application clause. AASB 1034 is the standard that stipulates the minimum content in financial reports. One can generalise from this standard that accounting standards apply to companies as well as entities with a duty to prepare financial reports under the Corporations Act 2001(Cth).One can, therefore, conclude that the application of accounting standards is only on reporting entities(Berrington and Bhandari,2011,p.742). This simply means that the general public would be reasonably expected to rely on the general purpose financial statements of these entities for decision making.

Two reasons have been advanced to justify the replacement of the reporting entity concept. The first of these is the subjectivity in determining what a reporting entity actual issues (Hamidi-Ravari, 2014, p.5). This subjectivity has seen some entities that would have been required to provide general purpose financial statements fail to do so on the by adopting an interpretation that includes them from the definition. The concept has also been faulted for imposing unnecessarily high costs on some entities more than the benefits.

3. Reduced Disclosure Requirements (RDR)

The nature of RDR is that it brings differential reporting obligations for entities to prepare general purpose financial statements (GPFS). It is part of the process towards a complete move away from the reporting entity concept. The regime emanated from the need to lessen the disclosure burden on some entities. The ultimate objective of the project is to eventually eliminate the need for companies to prepare special purpose financial statements (SPFS). In Australia, the changes were brought about by AASB 1053 which introduced two tiers of accounting standards together with AASB 2010-2 which amended existing accounting standards to introduce the new regime. Application of either of the two tiers to an entity largely depends on the phrase ‘public accountability.’ Entities that are not publicly accountable are eligible to take advantage of RDR which is also the Tier 2 standard. Given the definition of a publicly accountable entity as that which is accountable to its resource providers who are cannot demand for the projects, Hydroponic Company Ltd will clearly not fall under this category since it is a publicly listed company(Shilling,2015,p.2017).

4. Hydroponic Company Limited Prospectus

This is a new unlisted public company intending to raise capital from the public through the issuance of shares. The minimum number of shares to be issued as detailed in the prospectus was to be 25,000,000 but it is also noted that the company would be willing to accept oversubscription of up to 15,000,000 additional shares (Hydroponics Company Limited, 2017, p.4). The prospectus also promises that the investing public will be able to get 1 option to purchase an additional share for every two shares subscribed for with the option expiring on 31 December 2019.

When complete, the company targets to raise a minimum of $5,000,000 given the $0.2 public offer price of the shares. A further $3,000,000 could also be raised if there is the maximum oversubscription by 15,000,000 shares is actually achieved (Hydroponics Company Limited, 2017, p.36). This would bring the total amount to be raised exclusive of the options at $8,000,000.

Several reasons for seeking to raise the funds are disclosed in the prospectus. The main reasons stated are that the funds raised will be used to acquire other businesses as well as to finance the public offer itself (Hydroponics Company Limited, 2017, pp.72-81). This is in line with the fact that the company is still new and has not previously been in the business. It, therefore, seeks to rely on the capacity of the acquired businesses to carry out its objectives. See the attached prospectus as Appendix 1 for details.

5. Frequency of impairment tests and the factors to consider

Impairment refers to the writing off of the carrying amount of long lived assets (Kieso, Weygandt and Warfield, 2012, p.617). Unlike current assets such as inventories, the concept of the lower of cost-or-market value would rarely apply to these long lived assets. This creates the need for periodic impairment testing. The frequency with which impairment testing is to be should be triggered by the existence of impairment events (Kieso, Weygandt and Warfield, 2012, p.618). It follows from this that there is not agreed frequency with which impairment testing should be done except that the existence of an impairment event must exist before making the test. Examples of events that may call for impairment testing include the change in the manner in which an asset is used (Kieso, Weygandt and Warfield, 2012, p.618). The event could also be significant changes in the legal or business conditions prevailing at the time.

Case Study 4

Indentifying the cash generating unit

By definition, a cash generating unit (CGU) can be seen as the smallest unit of a group of assets that can largely generate cash flows for the entity independently of other assets (AASB 136, par.6). Identifying the CGUs in this present case is, therefore, an exercise in pointing out those groups of assets whose cash flows can be said to be independent of the other assets. Each Burger Queen outlet in the given scenario is a CGU as demonstrated below.

To begin with, one needs to consider how management in the scenario is organised. The organisation in the present case is obviously centralised. This may seem to suggest that each outlet must depend on each other. There is, however, the additional factor that the business is run on the basis of location.  This means that an outlet in one location generate cash flows that are independent those in other locations, thereby, making it the cash generating unit.

Conclusion

The various discussions in the report have presented important questions on corporate financial reporting. It is hoped that the content of the report has been successful in rendering the various issues arising from the four case studies. For instance, it has become possible to understand when a business should consolidate the financial statements of other businesses. The same can be said of the other discussions throughout the report.

 

 References

AASB 1034: Financial Report Presentation and Disclosures

AASB 1053: Application of Tiers of Accounting Standards

AASB 127: Consolidated and Separate Financial Statements

AASB 136: Impairment of Assets

AASB 2010-2: Amendments

AASB 3: Business Combinations

Berrington,M. And Bhandari,V., 2011.Pinnacle Financial Statements. Volume 2.Australian          Edition. Sydney: IFRS Sytem Pty Ltd.

Corporations Act 2001(Cth)

Dagwell, R., Wines, G. and Lambert, C., 2012.Corporate Accounting in Australia. Frenchs           Forest,New South Wales:Pearson.

Hamidi-Ravari,A., 2014.The Critical Role of the Reporting Entity Concept in Australian     Financial Reporting.AASB Research Centre.

Hoyle, J.B., Schaefer, T.F. and Doupnik, T.S., 2011.Advanced Accounting.10^th ed.Avenue of the             Americas, New York: McGraw-Hill/Irwin.

Hydroponics Company Limited Prospectus 2017

Kieso, D.E., Weygant,J.J. & Warfield,T.D., 2012.Intermediate Accounting.14^th      ed.Danvers,MA:John Wiley & Sons.

Schweizer,N. And Kobras,M.,2010.Business Structures in Australia.Schweizer Kobras.     Retrieved.

Shilling, D., 2017.Lawyer’s Desk Book. New York: Wolters, Kluwa.

 
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