You are a newly appointed accountant at Palvidia Ltd, who is considering purchasing the majority of the shares in Soletta Ltd. Senior management of Palvidia arranged a meeting with the executive team to discuss the effect of this decision. They asked Jane Penfold, the Chief Financial Officer, to explain a few issues about their decision to purchase shares in Soletta Ltd in preparation for their meeting with the executive team.
Required:
Draft a memorandum for Jane Penfold to sign for her presentation to the executive team that explains the following issues:
- What is the purpose of preparing consolidated financial statements
- What is a group, a parent and a subsidiary
- How many parents can a group have? Justify your answer.
- Why is it necessary to make adjustments for intragroup transactions
- When are profits realised in relation to inventories transfers within the group
Word limit: maximum 300 words
Question 2
On 1 July 2019, Paldivia Ltd acquired all the issued shares of Soletta Ltd for a cash consideration of $1 000 000. At that date, the financial statements of Soletta Ltd showed the following information.
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$
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Share capital
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650 000
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General reserve
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20 000
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Retained earnings
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250 000
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All the assets and liabilities of Soletta Ltd were recorded at amounts equal to their fair values at the acquisition date, except some equipment recorded at $50 000 below its fair value with a related accumulated depreciation of $80 000. Also, Palvidia Ltd identified at acquisition date a contingent liability related to a lawsuit where Soletta Ltd was sued by a former supplier and attached a fair value of $40 000 to that liability.
Required:
- Prepare the acquisition analysis at 1 July 2019.
- Prepare the consolidation worksheet entries for Paldivia Ltd’s group at 1 July 2019, assuming that Soletta Ltd has not revalued the equipment in its own accounts
Question 3
Patagonia Ltd owns all the share capital of Salto Ltd. The income tax rate is 30%. The following transactions took place during the periods ended 30 June 2018 to 30 June 2020.
- In February 2018, Patagonia Ltd sold inventories to Salto Ltd for $6 000, at a mark-up of 20% on cost. One-quarter of this inventories were unsold by Salto Ltd at 30 June 2018 to external parties and none at 30 June 2019.
(b) On 1 January 2018, Salto Ltd sold a new tractor to Patagonia Ltd for $20 000. This had cost Salto Ltd $16 000 on that day. Both entities charged depreciation at the rate of 10% p.a. on the diminishing balance. The tractor was still on hand with Patagonia Ltd at 30 June 2020.
(c) On 1 May 2019, Salto Ltd sold inventories costing $200 to Patagonia Ltd for $400 on credit. On 30 June 2019, only half of these goods had been sold by Patagonia Ltd, and Patagonia Ltd had paid $300 to Salto Ltd. All remaining inventories were sold to external entities by 30 June 2020 and Patagonia Ltd paid the outstanding amount to Salto Ltd on 5 May 2020.
- Patagonia Ltd provided management services to Salto Ltd during the period ended 30 June 2020. The total charge for those services was $3 000 that was unpaid at 30 June 2020.
- Patagonia Ltd borrows $50 000 from Salto Ltd on 1 July 2018 with an interest rate of 6% p.a. The loan is for 5 years. The interest is to be paid biannually in arrears, starting on 31 December 2018.
- In December 2019, Salto Ltd paid a $1 500 interim dividend.
- During March 2020, Salto Ltd declared a $3 000 dividend. The dividend was paid in August 2020.
Required:
In relation to the above intragroup transactions:
Prepare adjusting journal entries for the consolidation worksheet at 30 June 2019 and 30 June 2020.
The main purpose of the financial statements in the consolidated form is to lay down the financial performance as well as the financial position of the parent company and all of its subsidiaries. The second purpose of the consolidated financial statement is to disclose the results for the benefits of the stakeholders of the company in the manner that the group represents one single entity even though it has number of subsidiaries (Hove,2016).
Group, Parent and Subsidiary
The entity which controls the management and the functioning of the other entity is known as parent entity.
The entity which is controlled by the other entity is known as the subsidiary (AASB, 2011).
The group is the broad term and includes the parent entity and the number of subsidiaries in which the parent entity has the controlling power.
Number of Parents Group Can have
The group can have only one parent company which will be presenting the financial results of all the subsidiaries on which it exercises the control in accordance with the provisions of the Australian Accounting standard. If there is more than one parent in the group then the financial statements cannot be presented in the defined and consolidated manner. Thus, the group has only one parent company (IAS Website, 2016).
Necessity of Adjustments for intra group Transactions
Intra group transactions always occur between the subsidiary and the parent entity in the normal course of business. The adjustments relating to these transactions shall be done on the regular basis. It is because of the fact that there is the high possibility of having the transactions recorded in the books of accounts twice till the time it is knock off while preparing the financial statements (AASB 101; Accounting for Intra group Transactions, 2016).
Realization of Profit transfers within the Group
The profits are realized when the entity outside of the group is involved. It means when the inventory is sold to the other entity, which is not the part of the group, the profit will be realized.
Chief Financial Officer
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Answer 2 (a)
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PALDIVIA LIMITED
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Acquisition Anlaysis
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Cost of Acquisition
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Cash
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$ 1,000,000
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Shares in Soletta Limited
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$ -
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$ 1,000,000
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Book Value of Net Assets
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Share Capital
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$ 650,000
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General Reserve
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$ 20,000
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Retained Earnings
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$ 250,000
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Total Book Value of Net Assets
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$ 920,000
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Add:
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Fair Value Adjustments
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Increase in Equipment
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$ 30,000
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Increase in Contingent Liability
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$ (40,000)
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$ (10,000)
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Fair Value of Net Assets
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$ 910,000
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Goodwill (100% Acquisition)
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$ 90,000
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Answer 2 (b)
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General Journal
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Date
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Particulars
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Debit Amount
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Credit Amount
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PRE ACQUISITION
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1-Jul-19
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Retained Earnings
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$ 250,000
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Share Capital
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$ 650,000
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Business Combination Valuation Reserve
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$ 100,000
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Shares in Soletta Limited
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$ 1,000,000
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AT THE TIME OF ACQUISITION
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1-Jul-19
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Depreciation - Accumulated
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$ 80,000
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To Equipment
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$ 80,000
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1-Jul-19
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Equipment
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$ 80,000
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Business Combination Valuation Reserve
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$ 80,000
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1-Jul-19
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Goodwill
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$ 90,000
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Business Combination Valuation Reserve
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$ 90,000
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AFTER ACQUISITION
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1-Jul-19
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Depreciation
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$ 40,000
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Retained Earnings
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$ 40,000
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Accumulated Depreciation
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$ 80,000
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Consolidation Entries
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1
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Share Capital
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$ 1,000,000
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Share in Soletta Limited
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$ 1,000,000
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2
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Goodwill
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$ 90,000
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Share in Soletta Limited
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$ 90,000
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Answer 3
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General Journal
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S. No.
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Partiuculars
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Debit Amount
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Credit Amount
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a)
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Retained Earnings
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$ 175
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Income Tax Expense
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$ 75
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To Cost of Sales
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$ 250
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b)
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Retained Earnings
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$ 2,800
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Deferred Tax'
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$ 1,200
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To Tractor
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$ 4,000
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Accumulated Depreciation
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$ 600
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To Depreciation
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$ 400
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To Retained Earnings
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$ 200
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(10% for 1.5 years on $6000)
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Income Tax Expense
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$ 120
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Retained Earnings
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$ 60
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To Deferred Tax Asset
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$ 180
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c)
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Retained Earnings
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$ 70
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Income Tax Expense
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$ 30
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To Cost of Sales
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$ 100
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Inventory
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$ 300
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To Bank
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$ 300
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Inventory
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$ 100
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To Bank
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$ 100
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d)
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Management Services Income
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$ 3,000
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To Management Services Expense
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$ 3,000
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`
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e)
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Loan From Salto Limited
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$ 50,000
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To Loan to Patagonia Limited
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$ 50,000
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Interest Revenue
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$ 1,500
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To Interest Expense
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$ 1,500
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Interest Revenue
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$ 1,500
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To Interest Expense
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$ 1,500
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f)
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Dividend Revenue
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$ 1,500
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To Interim Dividend Paid
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$ 1,500
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g)
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Dividend Payable
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$ 3,000
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To Final Dividend declared
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$ 3,000
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Dividend Revenue
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$ 3,000
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To Dividend Receivable
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$ 3,000
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References
- Hove M, (2016), “Consolidated Financial Statements – An International Perspective”
- AASB official website, (2011), “Consolidated Financial Statements”,
- AASB official website, (2011), “AASB101 Presentation of Financial Statements”
- Accounting For Intra Group Transaction, (2016),
- IAS Website, (2016), “IAS 27 Consolidate and Separate Financial Statements”,
