Section A – This ONE question is compulsory and MUST be attempted
Rose, a public limited company, operates in the mining sector. The draft statements of financial position are as follows, at 30 April 2011:
The following information is relevant to the preparation of the group financial statements:
1 On 1 May 2010, Rose acquired 70% of the equity interests of Petal, a public limited company. The purchase consideration comprised cash of $94 million. The fair value of the identifiable net assets recognised by Petal was $120 million excluding the patent below. The identifiable net assets of Petal at 1 May 2010 included a patent which had a fair value of $4 million. This had not been recognised in the financial statements of Petal. The patent had a remaining term of four years to run at that date and is not renewable. The retained earnings of Petal were $49 million and other components of equity were $3 million at the date of acquisition. The remaining excess of the fair value of the net assets is due to an increase in the value of land.
Rose wishes to use the ‘full goodwill’ method. The fair value of the non-controlling interest in Petal was $46 million on 1 May 2010. There have been no issues of ordinary shares since acquisition and goodwill on acquisition is not impaired.
Rose acquired a further 10% interest from the non-controlling interest in Petal on 30 April 2011 for a cash consideration of $19 million.
2 Rose acquired 52% of the ordinary shares of Stem on 1 May 2010 when Stem’s retained earnings were 220 million dinars. The fair value of the identifiable net assets of Stem on 1 May 2010 was 495 million dinars. The excess of the fair value over the net assets of Stem is due to an increase in the value of land. The fair value of the non-controlling interest in Stem at 1 May 2010 was 250 million dinars.
Stem is located in a foreign country and operates a mine. The income of Stem is denominated and settled in dinars. The output of the mine is routinely traded in dinars and its price is determined initially by local supply and demand. Stem pays 40% of its costs and expenses in dollars with the remainder being incurred locally and settled in dinars. Stem’s management has a considerable degree of authority and autonomy in carrying out the operations of Stem and is not dependent upon group companies for finance.
Rose wishes to use the ‘full goodwill’ method to consolidate the financial statements of Stem. There have been no issues of ordinary shares and no impairment of goodwill since acquisition.
The following exchange rates are relevant to the preparation of the group financial statements:
3 Rose has a property located in the same country as Stem. The property was acquired on 1 May 2010 and is carried at a cost of 30 million dinars. The property is depreciated over 20 years on the straight-line method. At 30 April 2011, the property was revalued to 35 million dinars. Depreciation has been charged for the year but the revaluation has not been taken into account in the preparation of the financial statements as at 30 April 2011.
4 Rose commenced a long-term bonus scheme for employees at 1 May 2010. Under the scheme employees receive a cumulative bonus on the completion of five years service. The bonus is 2% of the total of the annual salary of the employees. The total salary of employees for the year to 30 April 2011 was $40 million and a discount rate of 8% is assumed. Additionally at 30 April 2011, it is assumed that all employees will receive the bonus and that salaries will rise by 5% per year.
5 Rose purchased plant for $20 million on 1 May 2007 with an estimated useful life of six years. Its estimated residual value at that date was $1·4 million. At 1 May 2010, the estimated residual value changed to $2·6 million. The change in the residual value has not been taken into account when preparing the financial statements as at 30 April 2011.
Required:
(a) (i) Discuss and apply the principles set out in IAS 21 The Effects of Changes in Foreign Exchange Rates in order to determine the functional currency of Stem. (7 marks)
(ii) Prepare a consolidated statement of financial position of the Rose Group at 30 April 2011, in accordance with International Financial Reporting Standards (IFRS), showing the exchange difference arising on the translation of Stem’s net assets. Ignore deferred taxation. (35 marks)
(b) Rose was considering acquiring a service company. Rose stated that the acquisition may be made because of the value of the human capital and the opportunity for synergies and cross-selling opportunities. Rose estimated the fair value of the assets based on what it was prepared to pay for them. Rose further stated that what it was willing to pay was influenced by its future plans for the business.
The company to be acquired had contract-based customer relationships with well-known domestic and international companies and some mining companies. Rose estimated that the fair value of all of these customer relationships to be zero because Rose already enjoyed relationships with the majority of those customers.
Required:
Discuss the validity of the accounting treatment proposed by Rose and whether such a proposed treatment raises any ethical issues. (6 marks)
Professional marks will be awarded in part (b) for clarity and quality of the presentation and discussion. (2 marks)