1 Xpand is a publicly listed company which has experienced rapid growth in recent years through the acquisition and
integration of other companies. Xpand is interested in acquiring Hydan, a retailing company, which is one of several
companies owned and managed by the same family.
The summarised financial statements of Hydan for the year ended 30 September 2014 are:
Statement of profit or loss
Cost of sales (45,000)
Gross profit 25,000
Operating costs (7,000)
Directors’ salaries (1,000)
Profit before tax 17,000
Income tax expense (3,000)
Profit for the year 14,000
Statement of financial position
Property, plant and equipment 32,400
Bank 100 7,600
Total assets 40,000
Equity and liabilities
Equity shares of $1 each 1,000
Retained earnings 18,700
Directors’ loan accounts (interest free) 10,000
Trade payables 7,500
Current tax payable 2,800 10,300
Total equity and liabilities 40,000
From the above financial statements, Xpand has calculated for Hydan the ratios below for the year ended
30 September 2014. It has also obtained the equivalent ratios for the retail sector average which can be taken to
represent Hydan’s sector.
Hydan Sector average
Return on equity (ROE) (including directors’ loan accounts) 47·1% 22·0%
Net asset turnover 2·36 times 1·67 times
Gross profit margin 35·7% 30·0%
Net profit margin 20·0% 12·0%
From enquiries made, Xpand has learned the following information:
(i) Hydan buys all of its trading inventory from another of the family companies at a price which is 10% less than
the market price for such goods.
(ii) After the acquisition, Xpand would replace the existing board of directors and need to pay remuneration of
$2·5 million per annum.
(iii) The directors’ loan accounts would be repaid by obtaining a loan of the same amount with interest at 10% per
(iv) Xpand expects the purchase price of Hydan to be $30 million.
(a) Recalculate the ratios for Hydan after making appropriate adjustments to the financial statements for notes
(i) to (iv) above. For this purpose, the expected purchase price of $30 million should be taken as Hydan’s
equity and net assets are equal to this equity plus the loan. You may assume the changes will have no effect
on taxation. (6 marks)
(b) In relation to the ratios calculated in (a) above, and the ratios for Hydan given in the question, comment on
the performance of Hydan compared to its retail sector average. (9 marks)
2 After preparing a draft statement of profit or loss for the year ended 30 September 2014 and adding the year’s profit
(before any adjustments required by notes (i) to (iii) below) to retained earnings, the summarised trial balance of
Kandy as at 30 September 2014 is:
Equity shares of $1 each 40,000
Retained earnings as at 30 September 2014 17,500
Proceeds of 6% loan (note (i)) 30,000
Land ($5 million) and buildings – at cost (note (ii)) 55,000
Plant and equipment – at cost (note (ii)) 58,500
Accumulated depreciation at 1 October 2013: buildings 20,000
plant and equipment 34,500
Current assets 68,700
Current liabilities 38,400
Deferred tax (note (iii)) 2,500
Interest payment (note (i)) 1,800
Current tax (note (iii)) 1,100
The following notes are relevant:
(i) The loan note was issued on 1 October 2013 and incurred issue costs of $1 million which were charged to profit
or loss. Interest of $1·8 million ($30 million at 6%) was paid on 30 September 2014. The loan is redeemable
on 30 September 2018 at a substantial premium which gives an effective interest rate of 9% per annum. No
other repayments are due until 30 September 2018.
(ii) Non-current assets:
The price of property has increased significantly in recent years and on 1 October 2013, the directors decided
to revalue the land and buildings. The directors accepted the report of an independent surveyor who valued the
land at $8 million and the buildings at $39 million on that date. The remaining life of the buildings at 1 October
2013 was 15 years. Kandy does notmake an annual transfer to retained profits to reflect the realisation of the
revaluation gain; however, the revaluation will give rise to a deferred tax liability. The income tax rate of Kandy
Plant and equipment is depreciated at 12½% per annum using the reducing balance method.
No depreciation has yet been charged on any non-current asset for the year ended 30 September 2014.
(iii) A provision of $2·4 million is required for current income tax on the profit of the year to 30 September 2014.
The balance on current tax in the trial balance is the under/over provision of tax for the previous year. In addition
to the temporary differences relating to the information in note (ii), Kandy has further taxable temporary
differences of $10 million as at 30 September 2014.
(a) Prepare a schedule of adjustments required to the retained earnings of Kandy as at 30 September 2014 as
a result of the information in notes (i) to (iii) above.
(b) Prepare the statement of financial position of Kandy as at 30 September 2014.
Note: The notes to the statement of financial position are not required.
The following mark allocation is provided as guidance for this question:
(a) 6 marks
(b) 9 marks
3 On 1 January 2014, Plastik acquired 80% of the equity share capital of Subtrak. The consideration was satisfied by
a share exchange of two shares in Plastik for every three acquired shares in Subtrak. At the date of acquisition, shares
in Plastik and Subtrak had a market value of $3 and $2·50 each respectively. Plastik will also pay cash consideration
of 27·5 cents on 1 January 2015 for each acquired share in Subtrak. Plastik has a cost of capital of 10% per annum.
None of the consideration has been recorded by Plastik.
Below are the summarised draft financial statements of both companies.
Statements of profit or loss and other comprehensive income for the year ended 30 September 2014
Revenue 62,600 30,000
Cost of sales (45,800) (24,000)
Gross profit 16,800 6,000
Distribution costs (2,000) (1,200)
Administrative expenses (3,500) (1,800)
Finance costs (200) (nil)
Profit before tax 11,100 3,000
Income tax expense (3,100) (1,000)
Profit for the year 8,000 2,000
Other comprehensive income:
Gain on revaluation of property (note (i)) 1,500 nil
Total comprehensive income 9,500 2,000
Statements of financial position as at 30 September 2014
Property, plant and equipment 18,700 13,900
Investments: 10% loan note from Subtrak (note (ii)) 1,000 nil
Inventory (note (iii)) 4,300 1,200
Trade receivables (note (iv)) 4,700 2,500
Bank nil 300
Total assets 28,700 17,900
Equity and liabilities
Equity shares of $1 each 10,000 9,000
Revaluation surplus (note (i)) 2,000 nil
Retained earnings 6,300 3,500
10% loan notes (note (ii)) 2,500 1,000
Trade payables (note (iv)) 3,400 3,600
Bank 1,700 nil
Current tax payable 2,800 800
Total equity and liabilities 28,700 17,900
The following information is relevant:
(i) At the date of acquisition, the fair values of Subtrak’s assets and liabilities were equal to their carrying amounts
with the exception of Subtrak’s property which had a fair value of $4 million above its carrying amount. For
consolidation purposes, this led to an increase in depreciation charges (in cost of sales) of $100,000 in the
post-acquisition period to 30 September 2014. Subtrak has not incorporated the fair value property increase into
its entity financial statements.
The policy of the Plastik group is to revalue all properties to fair value at each year end. On 30 September 2014,
the increase in Plastik’s property has already been recorded, however, a further increase of $600,000 in the
value of Subtrak’s property since its value at acquisition and 30 September 2014 has not been recorded.
(ii) On 30 September 2014, Plastik accepted a $1 million 10% loan note from Subtrak.
(iii) Sales from Plastik to Subtrak throughout the year ended 30 September 2014 had consistently been $300,000
per month. Plastik made a mark-up on cost of 25% on all these sales. $600,000 (at cost to Subtrak) of Subtrak’s
inventory at 30 September 2014 had been supplied by Plastik in the post-acquisition period.
(iv) Plastik had a trade receivable balance owing from Subtrak of $1·2 million as at 30 September 2014. This
differed to the equivalent trade payable of Subtrak due to a payment by Subtrak of $400,000 made in September
2014 which did not clear Plastik’s bank account until 4 October 2014. Plastik’s policy for cash timing differences
is to adjust the parent’s financial statements.
(v) Plastik’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose
Subtrak’s share price at that date can be deemed to be representative of the fair value of the shares held by the
(vi) Due to recent adverse publicity concerning one of Subtrak’s major product lines, the goodwill which arose on the
acquisition of Subtrak has been impaired by $500,000 as at 30 September 2014. Goodwill impairment should
be treated as an administrative expense.
(vii) Assume, except where indicated otherwise, that all items of income and expenditure accrue evenly throughout
(a) Prepare the consolidated statement of profit or loss and other comprehensive income for Plastik for the year
ended 30 September 2014.
(b) Prepare the consolidated statement of financial position for Plastik as at 30 September 2014.
The following mark allocation is provided as guidance for these requirements:
(a) 10 marks
(b) 17 marks
(c) Plastik is in the process of recording the acquisition of another subsidiary, Dilemma, and has identified two items
when reviewing the fair values of Dilemma’s assets.
The first item relates to $1 million spent on a new research project. This amount has been correctly charged to
profit or loss by Dilemma, but the directors of Plastik have reliably assessed the fair value of this research to be
The second item relates to the customers of Dilemma. The directors of Plastik believe Dilemma has a particularly
strong list of reputable customers which could be ‘sold’ to other companies and have assessed the fair value of
the customer list at $3 million.
State whether (and if so, at what value) the two items should be recognised in the consolidated statement
of financial position of Plastik on the acquisition of Dilemma. (3 marks)