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  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

  $’000

  Revenue 70,000

  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

  $’000 $’000

  Assets

  Non-current assets

  Property, plant and equipment 32,400

  Current assets

  Inventory 7,500

  Bank 100 7,600

  ––––––– –––––––

  Total assets 40,000

  –––––––

  Equity and liabilities

  Equity

  Equity shares of $1 each 1,000

  Retained earnings 18,700

  –––––––

  19,700

  Non-current liabilities

  Directors’ loan accounts (interest free) 10,000

  Current liabilities

  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%

  8

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  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

  annum.

  (iv) Xpand expects the purchase price of Hydan to be $30 million.

  Required:

  (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)

  (15 marks)

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  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:

  $’000 $’000

  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

  –––––––– ––––––––

  184,000 184,000

  –––––––– ––––––––

  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

  is 20%.

  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.

  Required:

  (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

  (15 marks)

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  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

  Plastik Subtrak

  $’000 $’000

  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

  Assets

  Non-current assets

  Property, plant and equipment 18,700 13,900

  Investments: 10% loan note from Subtrak (note (ii)) 1,000 nil

  ––––––– –––––––

  19,700 13,900

  ––––––– –––––––

  Current assets

  Inventory (note (iii)) 4,300 1,200

  Trade receivables (note (iv)) 4,700 2,500

  Bank nil 300

  ––––––– –––––––

  9,000 4,000

  ––––––– –––––––

  Total assets 28,700 17,900

  ––––––– –––––––

  Equity and liabilities

  Equity

  Equity shares of $1 each 10,000 9,000

  Revaluation surplus (note (i)) 2,000 nil

  Retained earnings 6,300 3,500

  ––––––– –––––––

  18,300 12,500

  ––––––– –––––––

  Non-current liabilities

  10% loan notes (note (ii)) 2,500 1,000

  ––––––– –––––––

  Current liabilities

  Trade payables (note (iv)) 3,400 3,600

  Bank 1,700 nil

  Current tax payable 2,800 800

  ––––––– –––––––

  7,900 4,400

  ––––––– –––––––

  Total equity and liabilities 28,700 17,900

  ––––––– –––––––

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  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

  non-controlling interest.

  (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

  the year.

  Required:

  (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

  $1·2 million.

  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.

  Required:

  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)

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