TOPIC TWO

COMPLEX GROUP FINANCIAL STATEMENT

2.1 Introduction
A business combination is a transaction or event in which an acquirer obtains control of
one or more businesses. A business is defined as an integrated set of activities and
assets that is capable of being conducted and managed for the purpose of providing a
return directly to investors or other owners, members or participants.
An acquirer of a business recognizes the assets acquired and liabilities assumed at their
acquisition date fair values and discloses information that enables users to evaluate the
nature and financial effects of the acquisition.

2.2 Control
An investor controls an investee when it has power over the investee, exposure, or
rights, to variable returns from its involvement with the investee and the ability to use
its power over the investee to affect the amount of the returns. An investor has power
when it has existing rights that give it the current ability to direct the relevant activities
of the investee—the activities that significantly affect the investee’s returns. Control bay
be assessed quantitatively or qualitatively.
Quantitative
Power over an investee is obtained directly and solely from the voting rights granted by
equity instruments such as shares, and can be assessed by considering the voting rights
from those shareholdings. The parent company will exercise control if it have power
over 50% plus 1 share of the voting rights whether held directly or indirectly.

A Ltd 75% B ltd 60% C ltd

NCI=25% NCI = 55%

A ltd is the parent company for both B ltd and C ltd, however the interest in C ltd is
indirectly held through B ltd and can be computed as 75% X 60% = 45%

Qualitatively
It is possible to have control with less than half the voting rights (sometimes referred to
as de-facto control). In such cases, the assessment will be more complex and require
more than one factor to be considered, for example when power results from one or
more contractual arrangements.

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2.3 Acquisition method
The acquisition method is used for all business combinations. The acquirer recognizes
the identifiable assets acquired, the liabilities assumed and any non-controlling interest
(NCI) in the acquiree. Intangible assets, including in-process research and development,
acquired in a business combination are recognized separately from goodwill if they
arise as a result of contractual or legal rights, or if they are separable from the business.
In these circumstances the recognition criteria are always considered to be satisfied (see
also IAS 38).

Assets and liabilities are measured at their fair values (with a limited number of
specified exceptions) at the date the entity obtains control of the acquiree. If the initial
accounting for a business combination can be determined only provisionally by the end
of the first reporting period, the combination is accounted for using provisional values.
Adjustments to provisional values relating to facts and circumstances that existed at the
acquisition date are permitted within one year. The acquirer can opt to measure the
components of NCI in the acquiree that are present ownership interests and entitle their
holders to a proportionate share of the entity’s net assets in liquidation either at fair
value or at the NCI’s proportionate share of the net assets.

2.4 Goodwill on consolidation

If the consideration transferred exceeds the net of the assets, liabilities and NCI, that
excess is recognized as goodwill. If the consideration is lower than the net assets
acquired, a bargain purchase is recognized in profit or loss. The consideration
transferred include any contingent consideration arising from event specified at the
date of acquisition.

Goodwill on consolidation – full consolidation

Fair value of consideration give xxx
Fair value of Non-Controlling interest (or net asset) xxx
Fair value of net assets at acquisition date (xxx)
Goodwill (positive or Negative) xxx

Positive goodwill is treated as non-monetary and non-current assets of the acquire and
evaluated for impairment annually.
Negative Goodwill is the benefit of good bargain and is recognized immediately in
profit and loss as an income.
The consolidation journal entry is as follows

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 Dr. Fair value of assets acquired (respectively) xxx
Dr. Goodwill (if positive) xxx
Cr. Fair value of the consideration given xxx
Cr. Fair value of liabilities acquired xxx
Cr. Fair value of the non-controlling interest xxx

2.5 Consolidation procedures

A subsidiary is consolidated in full, using the following procedures;
 Aggregate line by line similar items subject to elimination of intragroup balances,
transactions, income, expense, interest and dividends.
 All entities in the group use the same accounting policies and, if practicable, the
same reporting date (if different not more than three months).
 Non-controlling interests (NCI) are reported in equity separately from the equity
of the owners of the parent.
 Total comprehensive income is allocated between NCI and the owners of the
parent even if this results in the NCI having a deficit balance.

Unrealized profit
The margin relating to a transaction by one company to the other within the group is
only realized if the assets or goods are sold to a third party. If the asset or goods remain
with the group, the margin must be reversed.
Dr. Cost of sales /retained profit
Cr. The respective assets
If the transaction is upstream, ie the subsidiary selling to the parent company, the non-
controlling interest take their share of the unrealized profit.
If the asset in question is subjected to depreciation, the excess charge of depreciation
associated with the unrealized profit must be reversed.
Dr. Accumulated depreciation
Cr. Depreciation Expense (profit and loss)

Exclusion from consolidation

The parent entity should consolidate all the direct or indirect subsidiaries except where
i) The entity is held for sale (control is temporary)
ii) The parent company is an investment entity

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QUESTION ONE
HB Ltd. has been experiencing dwindling sales in its business operations due to
competition from other agents dealing in telecommunication equipment. On 1 January
2006, HB Ltd. decided to diversify its operations to the information technology (IT)
industry by acquiring SL Ltd., a company dealing in the manufacture of IT equipment
and software design. The summarized financial statements of HB Ltd., and SL Ltd.
were as follows:

Income statements for the year ended 30 September 2006:

HB Ltd. SL Ltd.
Sh.’000’ Sh.’000’
Revenue 60,000 24,000
Cost of sales (42,000) (20,000)
Gross profit 18,000 4,000
Other income: Interest received 75 -
Dividend received 400 ______
18,475 4,000
Expenses:
Distribution costs (3,500) (100)
Administrative expenses (2,500) (100)
Finance costs ______ (200)
Profit before tax 12,475 3,600
Income tax expense (3,000) (600)
Profit after tax 9,475 3,000

Statement of financial position as at 30 September 2006:

HB Ltd. SL Ltd.
Non-current assets: Sh.’000’ Sh.’000’
Property, plant and equipment 19,320 8,000
Investments 11,280 -
30,600 8,000
Current assets:
Inventories 5,000 3,000
Accounts receivable 4,200 3,400
Cash at bank 5,800 1,600
15,000 8,000
Total assets 45,600 16,000

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Equity and liabilities:
Capital and reserves:
Ordinary shares of Sh.10 each 10,000 2,000
Retained earnings 25,600 8,400
35,600 10,400
Non-current liability:
10% debentures - 2,000
Current liabilities:
Accounts payable 7,500 3,200
Current tax 2,500 400
10,000 3,600
Total equity and liabilities 45,600 16,000

Additional information:
1. HB Ltd. acquired 80% of the ordinary share capital of SL Ltd. for Sh.10,280,000
and also acquired half of the 10% debentures in the company.
2. The fair value of the assets of SL Ltd. at the date of acquisition were the same as
their book values except for plant whose fair value was more by Sh.3.2 million.
As at 1 January 2006, the plant had a remaining useful life of four years. SL Ltd.
depreciates plant on straight line basis based on cost.
3. During the post acquisition period, HB Ltd. sold goods to SL Ltd. for Sh.12
million. These goods had cost HB Ltd. Sh.9 million. Subsequently, SL Ltd. sold
some of the goods purchased from HB Ltd. at Sh.10 million for Sh.15 million.
4. On 30 June 2006, HB Ltd. and SL Ltd. paid dividends of Sh.1,000,000 and
Sh.5,000,000 respectively.
5. Included in the accounts receivable and payable is Sh.750,000 being the amount
SL Ltd. owed HB Ltd.
6. Goodwill is considered to be impaired by 25% as at 30 September 2006.
Goodwill is classified as an administrative expense by the group companies.

Required:
(a) Group income statement for the year ended 30 September 2006.
(b) Statement of changes in equity
(b) Group statement of financial position as at 30 September 2006.

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QUESTION Two

(a) ABC Ltd. purchased equity shares in XYZ Ltd. for Sh.56 million when the later’s
retained profits were Sh.88 million. The retained earnings of XYZ Ltd. now are
Sh.100 million. ABC Ltd. holds 25% of XYZ Ltd.’s equity shares and has impaired
Sh.3 million premium on acquisition. XYZ Ltd has declared ordinary dividends
of Sh.4 million.

Required:
Determine the value of ABC Ltd.’s investment in XYZ Ltd. using the equity
method of accounting for associate companies.

b) Lusiola Ltd. acquired 90% of the ordinary shares of Kacheliba Ltd. on 1 April 2003
for Sh.30 million when Kacheliba Ltd.’s retained earnings were Sh.15 million. The
balances of the two companies as at 31 March 2005 were as follows:

Lusiola Ltd. Kacheliba Ltd.

Sh.’000’ Sh.’000’
Non-current assets:
Property, plant and equipment 26,400 16,200
Investment in Kacheliba Ltd. 30,000 -
Other investments 1,000 6,000
57,400 22,200
Current Assets:
Inventory 9,500 4,000
Accounts receivable 7,200 1,500
Bank 300 _____
17,000 5,500
Total assets 74,400 27,700
Equity and liabilities:
Ordinary share capital (Sh.10 each) 10,000 5,000
Retained earnings 48,600 6,300
58,600 11,300
Non-current liabilities:
12% debentures 4,000 6,000
Current liabilities:

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Accounts payable 6,700 5,200
Taxation 4,100 700
Dividends 1,000 -
Overdraft _____ 4,500
11,800 10,400
Total equity and liabilities 74,400 27,700

Additional information:
1.The movement in Kacheliba Ltd.’s retained earnings since acquisition was as follows:
Sh.’000’
Balance as at 1 April 2003 15,000
Loss for the year ended 31 March 2004 (3,000)
Loss for the year ended 31 March 2005 (1,700)
Dividend paid in the year ended 31 March 2005 (4,000)
Balance as at 31 March 2005 6,300
2. Lusiola Ltd. accounted for its share of Kacheliba Ltd.’s dividend as a credit to
income. The group policy on dividend is to credit group income with dividend
paid out of post acquisition profit only.
3. On the date of acquisition, the fair values of Kacheliba Ltd.’s assets were
approximately equal to their book values except for:
(i) Plant which had a net replacement value of Sh.6 million in excess of its
book value and an estimated remaining useful life of 5 years.
(ii) Investments with market values of Sh.8 million.
4. There were no acquisitions or disposals of non-current assets since 1 April 2003.
5. The group policy in relation to goodwill arising from acquisition was to
capitalize it and amortise it over 6 years. However, in line with International
Financial Reporting Standard (IFRS 3), goodwill was tested for impairment from
1 April 2004 to 31 March 2005 and found to be impaired by 20%. Amortisation
for the year ended 31 March 2004 had been provided.
6. On 27 March 2005, Lusiola Ltd. sold goods to Kacheliba Ltd. for Sh.600,000.
These goods had not been received by 31 March 2005 and were excluded from
Kacheliba Ltd. inventory. Lusiola Ltd. charges goods at a standard mark-up on
cost of 20%. Prior to this transaction, the agreed purchase ledger account balance
of Kacheliba Ltd. with Lusiola Ltd. was Sh.1,400,000.
Required:
Group Statement of financial position as at 31 March 2005

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Question Three
On 1 April 2001 Mega Ltd .acquired 4,500,000 ordinary shares of Ksh.20 par value in
Lenga Ltd at a cost of Ksh.152, 000, 000.Further, on 1 July 2001 Mega Ltd acquired
15,000,000 ordinary shares of Ksh 20 par value in Tera Ltd at a cost of Ksh.716,
600,000.Directors were appointed to the boards of both companies by Mega Ltd so as to
take an active part in their management. Given below is the information extracted from
the books of the companies as at 31 March 2002.

Balance sheet as at 31 March

2002
Mega Lenga Tera
Sh.‘000’ Sh.‘000’ Sh.‘000’
720,000 200,000
Freehold property at cost 1,375,000 450,000 350,000
Plant and machinery at cost 380,000 218,000 360,600
Stock 374,800, 185,000 125,000
Debtors - - 48,000
Amount due from Mega Ltd 868000 - -
Investments _______- 9,000 40,000
Bank balances 3,717,800 862,000 1,123,600

Share capital 1,000,000 300,000 400,000

Share premium 200,000 24,000 -
Capital reserve 300,000 - 56,000
Retained profit (as at 31 March 2002) 786000 218,000 288,000
2,286,000 542,000 744,000

Creditors 590,000 110,000 152,000

Amount due to Tera Ltd. 36,000 - -
Accumulated depreciation –plant and 521,800 120,000 124,600
machinery 190,000 90,000 103,000
Taxation 94,000 - _______-
Bank balance 3,717,800 862,000 1,123,600

Additional information is given as follows

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1. Profit for the year ended 31 March 2002 after tax and before dividends were as
follows;

Sh
Mega Ltd 252,000,000
Lenga Ltd 102,000,000
Tena Ltd 128,000,000

These profits are included in the retained profits.

2. No interim dividends were paid in the year but final proposed dividends are as
follows;

Mega Ltd 20%

Lenga Ltd 10%
Tera Ltd 10%

3. Profits accrued uniformly throughout the year

4. Included in the stock of Mega Ltd. were goods purchased from Tera Ltd. at
Sh.40, 000,000.Tera had made profits of 25% on cost of the goods.
5. A Remittance of Sh 12,000,000 from Mega ltd to Tera Ltd at the end of financial
year was received in April 2002.
6. On1 April 2001 plant and machinery of Lenga Ltd was revalued upwards by Sh
240,000,000 and the revaluation was not incorporated in the books .Plant and
machinery is depreciated at the rate of 10% per annum based on cost.

Required
Consolidated statement of financial position of Mega Ltd and its subsidiary as at 31
March 2002

QUESTION Three

On 1 January 2003, H Ltd., a manufacturer of clay products, made the following

investments:

 Acquired 60% of the ordinary shares of S Ltd. for Sh.80,000,000.

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 Acquired 40% of the preference shares of S Ltd. for Sh.25,000,000
 Acquired 30% of the ordinary shares of A Ltd. for Sh.55,000,000.

H Ltd. is represented in the board of directors of A Ltd. by two directors.

The draft accounts of H Ltd., S Ltd. and A Ltd. for the year ended 31 December 2003
were as follows:

Draft profit and loss account

as at 31 December 2003
H Ltd. S Ltd. A Ltd.
Sh.’000’ Sh.’000’ Sh.’000’
Turnover 600,000 400,000 135,000
Profit before tax 200,000 180,000 100,000
Taxation (60,000) (45,000) (30,000)
Profit after tax 140,000 135,000 70,000
Less proposed dividends:
Preference - (30,000) -
Ordinary (60,000) (60,000) (40,000)
Retained profits 80,000 45,000 30,000
Balance brought forward 40,000 60,000 50,000
Balance carried forward 120,000 105,000 80,000

Draft balance sheets

as at 31 December 2003
H Ltd. S Ltd. A Ltd.
Sh.’000’ Sh.’000’ Sh.’000’
Assets:
Non-current assets 375,000 195,000 375,000
Current assets:
Stocks 90,000 85,000 60,000
Debtors 80,000 65,000 40,000
Cash at bank 75,000 50,000 45,000
245,000 200,000 145,000
Total assets 620,000 395,000 280,000
Equity and liabilities:
Equity:
Authorized and fully paid:

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3,000,000 ordinary shares of Sh.100 par 300,000
value 100,000 100,000
1,000,000 ordinary shares of Sh.100 par 50,000
value 120,000 105,000 80,000
500,000 preference shares of Sh.100 par 420,000 255,000 180,000
value
Profit and loss account balance

Liabilities: 80,000 35,000 30,000

Current liabilities: 60,000 60,000 40,000
Creditors 60,000 45,000 30,000
Proposed dividends 200,000 140,000 100,000
Taxation 620,000 395,000 280,000

Total equity and liabilities

Additional information:
1. Non-current assets of H Ltd. include the cost of investments in S Ltd. and A Ltd.
2. H Ltd. has not accounted for dividends receivable from S Ltd. and A Ltd.
accounts for dividends due to minority interests as a current liability.
3. The assets in S Ltd. were to be revalued upwards by Sh.60 million at the date of
acquisition to arrive at their fair values. This resulted in excess depreciation of
Khs 1 million in the post acquisition period.
4. Included in the stocks of S Ltd. were goods purchased from H Ltd for Sh.5
million. H Ltd. had marked up the goods by 25% of their cost.
5. On 15 January 2003, S Ltd. made a bonus issue of 2 shares for every 5 held.

Required:
(a) Consolidated income statement and statement of changes in equity, of H Ltd., its
subsidiary and associated company, for the year ended 31 December 2003.

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