Advanced Accounting, Updated Canadian Edition Solution Manual

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CHAPTER 1Accounting for InvestmentsBRIEF EXERCISESBRIEF EXERCISE 1-1What is a financial asset?According toIAS 32.11, afinancial asset isdefined asany of the following:CashAn equity instrument of another companyAcontractual right to receive cash or another financial asset fromanother companyA contractual right to exchange financial instruments with anothercompany under conditions that are potentially favourable.BRIEF EXERCISE 1-2What are the three main criteria to determine control?According toIFRS 10.6, the three main criteriathat must be present inorder for there to becontrol are that the parent company must have:The ability to direct the financial and operating policies of anothercompany(the power criterion),The ability to obtain returns from the other company (the returnscriterion), andThe ability to use its power to affect those returns (the linkcriterion).

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BRIEF EXERCISE1-3What is an associate company?Paragraph 2 ofIAS 28defines an associate as:An entity, including an unincorporated entity such as a partnership, overwhich theinvestor has significant influence,and that is neither asubsidiary nor an interest in a joint venture.The key characteristic in determining whether an investment is anassociate is significant influence.BRIEF EXERCISE1-4Why are associates distinguished from other investments held by the investor?The suite of accounting standards provides different levels of disclosuredependent on the relationship between the investor and the investee.Subsidiaries: a control relationshipJointarrangements: a joint controlrelationshipAssociates: a significant influence relationshipOther investments: no relationshipWhen there is a relationship, it relates to the ability of the investor toinfluence the direction of the investee, in comparison to a simple holdingof shares as an investment. Where such a relationship exists, it is arguedthat the investor is affected, from an accountability perspective as well asa potential receipt of benefits perspective [why get involved if there are nobenefits to doing so?]. These effects result in the need for additionaldisclosure about the relationship.

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BRIEFEXERCISE1-5Discuss the similarities and differences between the criteria used to identifysubsidiaries and those used to identify associates.A subsidiary is identified where another entity controls that entity. Controlis defined inIFRS10.6.Control:Note that three criteria must be present in order for there to becontrol. The parent must have:The ability to direct the financial and operating policies of anotherentity (the power criterion),The ability to obtain returns from the other company (the returnscriterion), andThe ability to use its power to affect those returns (the linkcriterion).An associate is identified where another entity has significant influenceover that entity. Significant influence is defined inIAS 28.2.Significant Influencehas the following features in its definition:The powerto, or capacity, to affect the investeeTo participate in the financial and operating policy decisionsof theinvesteeThere is norequirement for the investor to hold andownershipinterestin the investeeBRIEF EXERCISE1-6What is meant by“significant influence”?Paragraph 2 ofIAS 28defines significant influenceas:The power to participate in the financial andoperatingpolicy decisions ofthe investee but is not control or joint control over those policies.

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BRIEF EXERCISE1-7What factors could be used to indicate the existence of significant influence?IAS 28presents several factors which could be used to indicate theexistence of significant influence:Where an investor holds, directly or indirectly, 20% or more of thevoting power of the investee, it is presumed that the investor hassignificant influence over the investee.If the investor can demonstrate that such influence does not exist,the investee is not classified as an associate.Where the investor owns less than 20% of another company, thereis a presumption that the investee is not an associate.A substantial or majority ownership by another investor does notnecessarily preclude an investor from having significant influence.Some additional factors that can provide evidence of the existence ofsignificant influence are:Representation on the board of directors or the equivalentgoverning body of the investee.Participation in the policy-making processes of the investee,including participation in decisions about dividends or otherdistributions.Material transactions between the investor and the investee.Interchange of managerial personnel.Provisionof essential technical information.

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BRIEF EXERCISE1-8Discuss the relative merits of accounting for investments at cost, at fair value,and using the equity method.CostMethod:Advantages:–Simplicity–Reliable measureDisadvantages:–No indication of changes in value since acquisition–Revenue recognized only on dividend receiptorwhen the asset is sold.Fair Value Method:Advantages:–Up-to-date value, present informationcomparedwith past information–Revenue recognized as value changes, ratherthan waiting for dividendsDisadvantages:–Reliability a function of how active the market is–Costs associated with regular updating, extracosts for audit and valuation feesEquity Method:Advantages:–Carrying amount related to change in wealth ofthe investee–Revenue recognized prior to dividend receiptDisadvantages:–Carrying amount reliant on validity of investeeinformation–Carrying amount not based on market value–Recognition of revenue prior to associatedeclaring dividend; no transaction has yetoccurred

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BRIEF EXERCISE1-9What is aparent-subsidiary relationship?According toIFRS 10, a parent-subsidiary relationship exists when acompany has control over another company.BRIEF EXERCISE 1-10What is the key difference between a joint operation and a joint venture?According toIFRS 11:Joint OperationThe parties that have joint control of the arrangement have rights tothe assets, and obligations for the liabilities, relating to thearrangement.Joint VentureA joint arrangement whereby the parties that have joint control ofthe arrangement have rights to the net assets of the arrangement.

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EXERCISESEXERCISE 1-1–Solution assumes early adoption of IFRS 9therefore classified as FVTPL.March 1, 2013FVTPL—Investment840Cash840(To record the acquisition at fairvalue = $4.20 × 200 shares)March 1, 2013Transaction expenses120Cash120(To record the transaction costs)December 31, 2013FVTPL—Investment180Gain on Change in fair valueof FVTPL Investment180(To record the change in fair valueat year-end)[(200 × $5.10)–$840 = $180]February 1, 2014Cash1,020FVTPL—Investment1,020(To record the sale of theinvestment)February 1, 2014Transaction expenses50Cash50(To record the transaction costs)

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EXERCISE 1-2Max Inc.purchased 40% of Guarasci, with no further information theconclusion must be that the equity investment is an associate.(a)January 1, 2013Investment in Associate80,000Cash80,000(To record the investment inGuarasci)December 31, 2013Investment in Associate20,000Share of Profit of Associate20,000(To record the share of theassociate’s profit = $50,000 ×40% = $20,000)December 31, 2013Cash4,000Investment in Associate4,000(To record the adjustment fordividend paid by associate =40% × $10,000 = $4,000)December 31, 2014Share of Loss of Associate2,000Investment in Associate2,000(To record the share of theassociate’s loss = $5,000 × 40%= $2,000)December 31, 2014Cash4,000Investment in Associate4,000(To record the adjustment fordividend paid by associate =40% × $10,000 = $4,000)(b)Beginning balance of Investment inAssociate—Guarasci$ 80,000Share of 2013 associate’s profit20,0002013 Dividend adjustment(4,000)Share of 2014 associate’s loss(2,000)2014 Dividend adjustment(4,000)2014 ending balance ofInvestmentinAssociate—Guarasci$ 90,000Or 80,000 + 40% (+ 45,000–20,000) = 90,000

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EXERCISE 1-3(a)Investment in Joint Venture160,000Cash160,000(To record the investment in the joint venture)Investment in Joint Venture3,850Share of profit of joint venture3,850(To record Campbell Ltd. share of the profit ofthe joint venture = $17,500 × 22% = $3,850)(b)If this was a joint operation, they would report itsproportionateshare ofeach asset and liability, revenue, or expense that it owns.As theyobtained a 22% interest, they would record the same 22% share of theinvestment income as above. Any asset or liability that it owns would berecorded.

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PROBLEMSPROBLEM 1-1Parts A & BDateDescriptionNet incomeBalance SheetNet incomeBalance Sheet01-Jan-10ownership interest in Que (financial instrument) = 500/5000 = 10%; public company500x$1.2060031-Dec-10unrealized gain Que$700 - $600100100dividend revenue Que$1000 x 10%100500x$1.4070004-Jan-11ownership interest in Are = 200/3500 = 6%; public company200x$0.8416831-Dec-11unrealized gain Que$760 - $7006060dividend revenue Que$1000 x 10%100unrealized gain Are$220 - $1685252dividend revenue Are750 x 6%45500x$1.52760200x$1.1022001-Sep-12ownership interest in Que (significant influence) = 1500/5000 = 30%Share of net income$15,000x30%x4/121500gain on deemed sale of FI (financial instrument)500x($1.65-$1.52)65investment account1500x$1.652475Share of net income1500Share of dividends$1000x30%-30031-Dec-12Balance in the investment account3675200x$0.70140unrealized loss on Are$140 - $22088Dividend revenue Are$500 x 6%3001-Mar-13sale of Are sharesrealized gain47-.7 x 501231-Dec-13investment income Que$10,000 x 30%30003000dividends Que$1000x30%-300Balance in the investment account6375unrealized loss on Are$97.50 - ($140 x 150/200)-7.5150x$0.6597.5dividends Are$200 x 150/35008.57Part CSince Que and Are are public companies there will be no difference in net income.Part DAssuming Aye follows ASPE, the calculations are the same as above except that Aye could elect to reflect Que at FV in 2012 and 2013 andthat cost is not an option since it is a public company.QueAre

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PROBLEM 1-2(a)Calculate the balances to be reflected on the Acme December 31, 2013statement of financial position in accordance with ASPE.#1—10% interest in Platopurchased on January 1, 2013. As atDecember31, 2013 they shouldmeasure the equity instrument at thefairvalue ($16,000),as this would be considered to be a non-strategicinvestment(financial asset)and any gain or loss would be flowed directlythrough net income.This investment in Platowould not bereported atthecost of $17,000 because the $16,000 fair value seems to be impairedwhen compared tothe cost, and as such it should be recorded at theimpaired value.#2—40%interest in Bloor purchased 5 years ago. Thisinvestmentwouldbe considered to be an associate as they are presumed not to havecontrol.Under ASPE, they have the choice of using the equity method orthe cost method.If using the equity method, the carrying balance of the investment wouldbe:Beginninginvestment balance:$250,000Retainedearnings increase:$28,000(40%×$70,000)Endinginvestment balance:$278,000The fair value of the investment is $280,000. As the investment is notimpaired, it will be recorded at its carrying value of $278,000.If using the costmethod, it would be recorded at $250,000.#3—50% interest in a joint venture, Rand.Under ASPE, they would havethe choice of using proportionate consolidation,the equity method,or thecost methodto account for their interest in Rand. If using the equitymethod, the carrying balance of the investment would beas follows:Beginningbalance:$120,000Net income share:$20,000(50%×$40,000)Dividend share:($5,000)(50%×$10,000)Ending balance:$135,000If using the cost method, theinvestment carrying value would be$120,000.If using proportionate consolidation, there would be no investment on thestatement of financial position and it would be replaced with theirproportionateshare of the assets and liabilities of Rand.

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PROBLEM 1-2 (Continued)(b)What will be different in the reporting of these investments for Acme if itwere to become a public company?Assuming early adoption of IFRS 9:#1—10% interest in Plato purchased on January 1, 2013. As atDecember31, 2013 they should measure the equity instrument at thefairvalue ($16,000), as this would be considered to be a non-strategicinvestment(financial asset)and any gain or loss would be flowed directlythrough net income.#2—40% interest in Bloor purchased 5 years ago. Thisinvestmentwouldbe considered to be an associate as they are presumed not to havecontrol. UnderIFRS, theywouldhaveto usethe equity method.If using the equity method, the carrying balance of the investment wouldbe:Beginninginvestment balance:$250,000Retainedearnings increase:$28,000(40%×$70,000)Endinginvestment balance:$278,000The fair value of the investment is $280,000. As the investment is notimpaired, it will be recorded at its carrying value of $278,000.#3—50% interest in a joint venture, Rand. UnderIFRS, they would haveto usethe equity methodto account for their investment in Rand. If usingthe equity method, the carrying balance of the investment would be asfollows:Beginningbalance:$120,000Net income share:$20,000(50%×$40,000)Dividend share:($5,000)(50%×$10,000)Ending balance:$135,000

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WRITING ASSIGNMENTSWRITING ASSIGNMENT 1-1According to IAS 28, significant influence is the power to participate in thefinancial and operating policy decisions of the investee but is not control orjoint control over those policies.If an investor holds, directly or indirectly (i.e.,through subsidiaries), 20% ormore of the voting power of the investee, it is presumed that the investor hassignificant influence, unless it can be clearly demonstrated that this is not thecase. Conversely, if the investor holds,directly or indirectly (i.e.,throughsubsidiaries), less than 20% of the voting power of the investee, it ispresumed that the investor does not have significant influence, unless suchinfluence can be clearly demonstrated. A substantial or majority ownership byanother investor does not necessarily preclude an investor from havingsignificant influence.The existence of significant influence by an investor is usually evidenced inoneor more of the following ways:Representation on the board of directors or equivalent governing body ofthe investee;Participation in policy-making processes, including participation indecisions about dividends or other distributions;Material transactions between the investor and the investee;Interchange of managerial personnel; orProvision of essential technical information.Pointsofdiscussion:1.Why the investment was undertaken by Cornett Chocolates Ltd.isirrelevant. The definition of significant influence is based on the capacity toparticipate, not the actualparticipationor intentiontoparticipate.Therefore, their intention to only investfor cash flow reasons is notrelevantin determining if Cornett Chocolates Inc. has significant influenceover Concertina’s Milk Ltd.2.Whether Cornett Chocolates Ltd. Actually exerts influence is irrelevant, butrather do they have the ability to exercise influenceis how the presence ofsignificant influence is determined.3.The 20%thresholdis a guideline onlyand professional judgment must beexercised in determining if Cornett Chocolates Ltd. has significantinfluence over Concertina’s Milk Ltd.ornot.4.Factors will include those listed above. Further, an analysis of the 79.8%holding by other parties is very important. If it is closely held, then theability for Cornett Chocolates Ltd.toparticipate is limitedandlikely cannotsignificantly influence the financial and operating policies.

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WRITING ASSIGNMENT 1-2Peter (technology & know-how)45% of POPPPaul (venture capital company, financing)55% of POPPHow Peter shouldrecord its investment in POPP depends on its level ofcontrol. They are unlikely to be able to exercise control over POPP, as Paulowns more than 50% of the shares of POPP and is also involved in thebusiness, even thoughPeter isappointing the managing director and thedirector of finance.Paul owns 55% of the shares so would need to assess if they have control ofPOPP,if this would be considered to be a joint arrangement,orifPeterhassignificant influence over POPP.Significant influence isdefined asthe power to participate in the financial andoperating policy decisions of the investee, but is not control or joint controlover those policies.Joint control is the contractually agreed sharing of control over anarrangement, which exists only when decisions about the relevant activitiesrequire the unanimous consent of the parties sharing control.Paul is providing the financing and owns a majority of the shares. However, asthey are a venture capital company it is unlikely that they will be involved on aday to day basis, especially since Peter is contributing the technology andknow-how, as well as appointing the managing director and director of finance.This would not be considered to be a joint arrangement as there seems to beno contractually agreed sharing of control of the arrangement.Therefore, Peter would have significant influenceoverPOPP and shouldtherefore record its investment in POPP using the equity method.Note: Paul would treat it as FVTPL (non current) because is a venture capitalcompany.

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WRITING ASSIGNMENT 1-3Godard Inc. sold 60% of its 100% owned Combine Ltd.toSvelte Inc. GodardInc.’srepresentatives on the board of directors were replaced byrepresentatives of Svelte Inc.In order to determine if Godard Inc. still hascontrol over Combine Ltd., we must look at and discuss the three criteria thatdetermine if there is control.(a)The ability to direct the financial and operating policies of anothercompany (the power criterion). This is referred to as the capacity tocontrol. Power arises from rights and these rights must exist presently sothat the investor has the current ability to direct relevant activities.Godard Inc. no longer owns 60% of Combine Ltd. as it was sold toSvelt Inc. They have retained 40% interest, which is not enough topresume that control exists.Godard Inc.’s representatives on the board of directors were replacedwith representatives appointed by Svelt Inc. Therefore, Godard Inc. nolonger has the ability to direct the financial and operating policies ofCombine Ltd.Godard Inc. has provided Svelt Inc. with short-term financing and SveltInc. has agreed to apply certain operating decisions that Godard Inc.requires as long as the demand loan is outstanding. Godard Inc. canveto any operating decision that is contrary to Godard Inc.’srequirements.As a result,Godard Inc. can influence the financialpolicies of the company. However, given that it is short-term demandloan, it isunlikely that it is significant to the ongoing operations of thecompany and unlikelythat Godardwillcontrol the financial policies ofthe company.(b)The ability to obtain returns from the other company (the returns criterion).Exposure or rights to returns from an investee. As Godard Inc. stillowns 40% of the common shares of Combine Ltd., it can expect tovariable returns since the dividend and changes in value of the sharesare variable.(c)The ability to use its power to affect those returns (the link criterion).The ability to use power over the investee to affect the amount of theinvestor’s returns.Given that Godard Inc. owns only 40% of the outstanding commonshares of Combine Ltd., and the remaining 60% is owned by Svelt Inc.,Godard Inc. does not have the ability to affect the returns.In conclusion, as the power criterion and the link criterion were not met,Godard Inc. no longer has control over Combine Ltd.

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