Question

QUESTION 1 (IFRS 10, IAS 28) (20)
Invincible Ltd, a company registered in Namibia, is at the early stages of producing group financial statements. The company’s first Audit Committee meeting to discuss the financial statements is scheduled for in a few weeks’ time and you have been asked to prepare a paper for presentation at the meeting to discuss the appropriate basis for accounting for entities mention below:
Waka Ltd:
Waka ltd.’s relevant activities are directed by ordinary shareholders votes. Invincible owns a controlling 60% of the shares in Cresta Ltd. Cresta Ltd owns 45% of the shares in Waka Ltd and Invincible owns a further 20% of Waka Ltd. The remaining shares in Waka Ltd are held by an empowerment group that also owns a golden share. The golden share entitles the empowerment group to veto any decisions made by vote at the shareholders meetings. The Audit Committee has specifically asked what the effect of the golden share is I.e. what treatment would be both with the golden share and assuming that the golden share did not exist.
Space Pty Ltd:
Invincible Ltd has recently designed a very powerful telescope that it plans to target at the astronomy market. In order to launch, manufacture and sell the product it incorporated Space Pty Ltd (Space) with a capital injection of $10m. before being launched and sold, the right to sell the telescope is required to be registered under a license so that only holders of the license and those authorized to sell under the license can sell these telescopes.
Registration of telescope licenses is a very specialized area of law and as such Invincible Ltd partnered with Dynamic Ltd that specializes in registering licenses to sell newly developed telescopes. Although registering the license is a formality for Dynamic Ltd given its highly experienced staff, Dynamic Ltd.’s directors negotiated that it should share in 60% of Space’s after-tax operational profits for the first 3 years of Space’s operations with Invincible Ltd sharing in the other 40% of profits for the first 3 years and 100% thereafter.
In terms of the agreement for the running of Space’s operations   
 Dynamic Ltd.’s staff will register the license in its own name. after 3 years Space will have the option to buy the license from Dynamics Ltd for a stipulated nominal amount.  Space has an unconditional right to sell the telescope under Dynamic Ltd.’s license for the first 3 years of operations, unless Space does not pay Dynamics the 60% profits to

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which it is entitled, within 2 months of its year end or if Space’s current debt equity ratio doubles within the 3 years.  Invincible Ltd.’s Chief Operations Officer (COO) will coordinate the launch of the product, its manufacture and sales as soon as the license is registered.  Dynamic Ltd’s staff will assist with on-going legal and compliance work in respect of the registration of the license but will not be involved in the selling of the product. Profits are expected to be low for the first 3 years of operations and the 60% profit sharing ratio for 3 years is likely to equate to the fees that Dynamic Ltd would normally charge for its services.
Required:
Draft a memorandum to the Audit Committee explaining to the 2 companies referred to above should be treated in the group financial statements. While it is not necessary to explain the process involved in consolidating, equity accounting etc., it is necessary to include what % of the group profits will be included in the group financial statements. Your Memo should deal with the nature of the investment and the type of accounting for the investment that would be appropriate in the group financial statements. If you determine that an entity is a subsidiary briefly state the extent to which any NCI would be attributed a share of the total comprehensive income when companies should be equity accounted, the % of the investee’s profits that should be equity accounted as well as the group’s effective interest should be discussed. If consolidation is required effective interest should be calculated.
You are not required to deal with disclosure. (20)

Answer 1

IFRS 10 & IAS 28:

Invincible Ltd. , is a company registered in Namibia. The company’s first Audit Comittee meeting to discuss the financial statement is scheduled. The following are the matters to be discussed at the meeting for accounting for the entities mentioned below :-

WAKA LTD:-

Important points to be noted:

Invincible Ltd. Holds 60% share in Cresta Ltd and 20% share in Waka Ltd. and ,

Cresta Ltd. holds 40% shares in Waka Ltd.

       

                           

Invincible Ltd.         60%           Cresta Ltd

                                                         

                        20%                     40%

                                              Waka Ltd            40%    Empowerment group

As per IFRS 10 a company holds control over the another entity if it holds more than 50% of the voting right in the company’s shareholders meeting. Therefore as Invincible Ltd. holds 60% voting power of the company therefore it holds control over Cresta Ltd. and therefore Invincible is required to prepare a consolidated financial statement with Cresta Ltd.

As Cresta Ltd. , subsidiary of Invincible Ltd. holds 40% share in Waka Ltd and Invincible Ltd. holds 20% share in Waka Ltd. As Invincible Ltd together with his subsidiary Cresta Ltd. hold more than 50% of holding i.e. 60% , therefore Waka Ltd is also a subsidiary of Invincible Ltd.

It is to be noted that the empowerment group which holds 40% of the share of Waka Ltd also owns golden share and the golden share entitles the empowerment group to veto any decision made by vote at the share holders meeting .Golden share is a share in a company that gives control of atleast 51% of the voting right. As golden share is owned by empowerment group it gives them the opportunity to take the final decision of the meeting. It gives them a right to reject a decision or proposal made by the shareholders at the meeting.

If the golden share did not exist or is not owned by empowerment group then as a holding company Invincible Ltd. has the full power over the decisions of the Waka Ltd. at the meeting.

Points to be noted :

1. As Waka Ltd is a subsidiary of Invincible Ltd with more than 50% of the control and is to be included while preparing the group financial statement.
2. Full consolidation method to be applied while preparing consolidation financial statement.
3. 40% of the profit to be shown as NCI and 60% profit of Waka Ltd to be included in group profit & loss in the group financial statement.

Space Pty Ltd.

Invincible Ltd. has recently designed very powerful telescope nad in order to launch , manufacture and sale the product it incorporated it incorporated space Pty. Ltd. with a capital injection of $10m. before being launched and sold, the right to sell the telescope is required to be registered under a license so that only holders of the license and those authorized to sell under the license can sell these telescopes. For that Invincible Ltd partnered with Dynamic Ltd that specializes in registering licenses. Dynamic Ltd.’s directors negotiated with Invincible Ltd. that it should share in 60% of Space’s after-tax operational profits for the first 3 years of Space’s operations with Invincible Ltd sharing in the other 40% of profits for the first 3 years and 100% thereafter.

As per the provision of IAS 28, an associate is a company in which an investor can exercise   “ significant influence” i.e. power to participate in operating and financial decisions.In normal situation significant can be proved if an Investir has 20% to 50% voting power of an entity.

As due to the negotiation between Dynamic Ltd. and Invincible Ltd. , Invincible Ltd. holds only 40% of the share in the company Space Pty Ltd. therefore Space Pty Ltd is an associate for Invincible Ltd and therefore as per the accounting rules Consolidated Financial statement are mandatory whether the Investor has subsidiary or associate or Joint Venture.

As per IAS 28, “Investment in Associate and Joint Venture” we should apply equity method in preparing group financial statement of Invincible Ltd for 3 years.

Points to be noted:

1. Space Pty. Ltd to be treated as an associate in the group financial statement.
2. 40% of the the profit of Space Pty Ltd. to be included in the group financial statement.
3. As per IAS 28 equity method to be used for the accounting of Space Pty Ltd. in the group financial statement of Invincible Ltd.