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Accounting for Income Tax and Acquisition

 

 Corporate Accounting Systems 

Autumn 2018 

Practical Project 

Topic: Accounting for income tax and acquisition of a subsidiary and consolidation entries  
Length: 1,500 words maximum (comprising calculations and working papers in Part A equivalent to 250 words and Part B equivalent to 1000 words and a written component of 250 words in Part C)  

 

The practical project involves three parts:  

  • Part A is the preparation of a deferred tax worksheet for a single economic entity.  
  • Part B is the preparation of a selection of consolidation elimination journals for an economic entity comprising a parent and a subsidiary. 
  • Part C is an explanation of the outcome of the consolidation process undertaken in Part B.  

 Part A 

 The following represented an extract from the Statement of Financial Position of the assets and liabilities of Sunnybank Ltd for the years ending 30 June 2010 and 30 June 2011. 

Reporting date was 30 June. 

Assets 2011 2010 Liabilities 2011 2010 
Cash 110 000 87 000 Accounts payable 28 500 31 700 
Accounts receivable (net) 45 000 52 000 Accrued expenses 7 200 11 600 
Inventory 58 000 43 000 Deferred tax liability 15 150 
Interest receivable 8 400 5 000 Rent revenue in advance 12 000 
Prepaid insurance 7 000 5 000 Bank loan 50 000 50 000 
Deferred tax asset 10 470 Provision for employee benefits 21 000 17 300 
Development costs 32 000 32 000    
Less: Accumulated amortisation (8000)    
Property, plant & equipment 75 000 75 000    
Less: Accumulated depreciation (22 000) (13 500)    

 

You were appointed as a graduate accountant at Sunnybank Ltd after graduation from university in January 2011. You were requested to prepare the deferred tax worksheet for the business for year ended 2011. After a meeting with your supervisor, you gathered the following information which you might need to complete your work: 

  • The balance of allowance for doubtful debts for 2011 and 2010 was $5,000 and $6,000 respectively. 
  • Interest revenue was assessable when the cash was received. 
  • Insurance was deductible when paid. 
  • Development costs were deductible when paid together with an additional deduction of 50%. 
  • Accrued expenses were deductible when paid. 
  • Rent revenue was assessable when the cash was received. 
  • Employee benefits were deductible when the payment was made to the employee. 
  • The tax depreciation rate for plant and equipment was double the rate of accounting. 
  • The company tax rate was 30%. 
  • Worksheet template: 
 Carrying Amount Tax Base 
Deductible 
Temporary 
Differences 
Taxable 
Temporary 
Differences 
     
     
     
     
     
     
     
     
     

 Part B 

 Sunnybank Ltd acquired all issued share capital of Sunnybank Hills Ltd on 1 July 2011 for a cash payment of $885,000. Sunnybank Hills Ltd is the only subsidiary of Sunnybank Ltd. The share capital and reserves of Sunnybank Hills Ltd at the date of acquisition were: 

 Share capital $598,000 

Retained earnings $102,000 

Revaluation surplus   $50,000 

 As at the date of acquisition, all assets of Sunnybank Hills Ltd were at fair value, other than the property, plant and equipment, which had a fair value of $250,000. The cost of the property, plant and equipment was $328,000 and it had accumulated depreciation of $178,000. The property, plant and equipment were expected to have a remaining useful life of eight years. At the date of acquisition, the notes to Sunnybank Hills Ltd’s financial statements identify a contingent liability related to an unsettled legal claim with a fair value of $10,000 which would be tax deductible when paid. On 1 May 2012, the liability relating to the legal claim was settled and paid in full. There were no intra-group transactions between Sunnybank Ltd and Sunnybank Hills Ltd between 1 July 2011 and 30 June 2014. 

 On 1 March 2015 Sunnybank Hills Ltd sold an item of equipment to Sunnybank Ltd for $43,200 when its carrying value in Sunnybank Hills’s books was $36,000 (original cost $60,000 and original estimated life of ten years). There were no other intro-group transactions between Sunnybank Ltd and Sunnybank Hills Ltd for year ended 30 June 2015. 

 On 1 June 2016 Sunnybank Ltd sold an item of plant to Sunnybank Hills Ltd for $74,240 when its carrying value, and original cost, in Sunnybank’s books was $80,000 and estimated remaining useful life was four years. There were no other intro-group transactions between Sunnybank Ltd and Sunnybank Hills Ltd for year ended 30 June 2016. 

 During year 2017, Sunnybank Ltd made sales of inventory to Sunnybank Hills Ltd for onsale to external parties. The inventory had originally cost Sunnybank Ltd $26,000. At the year end, Sunnybank Hill Ltd still had a quarter of the inventory on hand. On-hand inventory was expected to be sold in the following financial period. There were no other intro-group transactions between Sunnybank Ltd and Sunnybank Hills Ltd for year ended 30 June 2017. 

 During year 2018, Sunnybank Hills Ltd made sales of inventory to Sunnybank Ltd for onsale to external parties. The inventory had originally cost Sunnybank Hills Ltd $28,000. All intra-group inventories were sold in 2018. Sunnybank Ltd provided management services to Sunnybank Hills Ltd in 2018. Sunnybank Hills Ltd paid $5,000 for those services and has a balance of 1,000 for management fees payable at the year end. Sunnybank Hills Ltd declared and paid dividend $10,000 at year end 2018. There were no other intro-group transactions between Sunnybank Ltd and Sunnybank Hills Ltd for year ended 30 June 2018. 

 You were requested to prepare the followings: 

  1. acquisition analysis and adjustment/elimination journal entries for consolidation at acquisition, 1 July 2011; 
  2. adjustment/elimination journal entries for consolidation as at 30 June 2012; 
  3. adjustment/elimination journal entries for consolidation as at 30 June 2017, and 
  4. adjustment/elimination journal entries for consolidation as at 30 June 2018. 

After meeting with your supervisor you gathered the following information which you might need to complete your work: 

  • Sunnybank Ltd has the following accounting policies for the economic entity: 
    • Revaluation adjustments on acquisition are to be made on consolidation only, not in the books of the subsidiary; 
    • All plants are depreciated using the straight-line method with no residual value. For part-years, depreciation is to be calculated on the number of months the asset is held in the relevant year. 
    • Intragroup sales of inventory are at a mark-up of 10% on cost. 
    • All calculated amounts are to be rounded to the nearest whole dollar. Companies in the group do not show cents in any journals, worksheets, or financial statements. 
  • Management team of Sunnybank Ltd believes that goodwill acquired from business combination is impaired by $2,000 in the current financial year (1 July 2017 - 30 June 2018). There is no previous impairment of goodwill. 
  • The company tax rate is currently 30% and this rate has not changed for a number of years. 
  • Reporting date is 30 June. 
  • Journal narrations are required. 
  • Number each year consolidation elimination/adjusting journal entries by 1, 2, 3, …, etc;. Where more than one journal entry is needed for an event to be completely accounted for add the letters a,b,c,…etc to them as necessary. 

Part C 

The consolidated financial statements for year ending 30 June 2018 for the economic entity were prepared on the basis of your journals from Part B (IV). These statements were presented to the Board of Directors.  

The Board noted that at date of acquisition, the carrying amount of Sunnybank Hills Ltd’s property, plant and equipment was not equal to their fair values and adjustment journals to these assets were accordingly prepared. The Board had the following question: 

‘What is ‘fair value’ and why is it relevant to consolidation accounting?’ 

After a shorting meeting with your supervisor, you were requested to prepare a response to the above question.  

You might make reference to relevant paragraphs of Australian Accounting Standards and/or AASB Framework and to other sources of material.  

Harvard Style referencing is expected. For details on the Harvard referencing system go to: http://library.westernsydney.edu.au/uws_library/guides/referencing-citation (and click on ‘Harvard’ link). 

Answer

Part B

  1. Calculation for acquisition


PP&E Revaluation:


PPE Cost Value                                       328000

Less: Accumulated Depreciation       (178000)

Carrying Value                                       150000

Fair Value                                                250000

Revaluation Surplus (positive)            100000  (net of tax: 70,000)


Hence, fair value of all the assets of Sunnybank Hill Ltd. will be:


Share capital           $598,000 

Retained earnings           $102,000 

Revaluation surplus             $50,000

PPE revaluation surplus      $70,000 

                                              $820,000

Cost of Acquisition            $885,000

Hence, Goodwill                  $65,000


                             

  1. Entries on July 1, 2011


  1.        Dr.   Accumulated depreciation- PP&E       178,000

Cr.                 PP&E                                                                178,000

(Accumulated depreciation charged to PPE account)


  1.        Dr.   PP&E                                                              100,000

Cr.          Revaluation Surplus                                                70,000

Cr.          Deferred tax liability                                               30,000

(Increased in the value of PP&E recorded)


  1. Dr.  Share capital                                                598,000 

Dr.  Retained earnings                                                102,000 

Dr.  Revaluation surplus                                                  50,000         

Dr.  PP&E Revaluation surplus                                       70,000         

Dr.  Goodwill                                                                     65,000

Cr.         Investment in Sunnybank Hill Ltd. Stocks                       885,000


(Elimination of pre-acquisition equity accounts)



  1.    Dr.  Investment in ABC’s stock       885,000

                 Cr.           Cash                                                            885,000

                (Purchase of stocks of Sunnybank Hills Ltd recorded)

        

  1. Entries as on 30 June, 2012


  1. Dr. Contingent liability      10,000

Cr.        Cash                                  10,000

(Contingent liability paid and settled)


  1. Dr.  Deferred tax gain         3,000

   Cr.        Income tax expenses             3,000

   (Deferred tax gain recorded on payment of contingent liability)


Consolidation adjustment for the first year

  1. Dr. PP&E          100,000

Cr.     PP&E   Revaluation Surplus      100,000     

(Revaluation surplus account closed and transferred to PP&E account)


  1. Dr. Depreciation on PP&E          31,250

Cr.        Accumulated depreciation      31,250             

(Depreciation charged on PP&E charged) 


     Calculation for Depreciation –

     Revalued fair value of PP&E = 250,000 

     Useful life = 8 ; Residual value = 0

     Hence, depreciation = 31,250


Calculations for 2014, 2015 and 2016

Calculation for PP&E purchased on 1 March, 2015- (in the books of Sunnybank Ltd)

Value of acquired PP&E at July 1, 2014 [250,000- (31,250*3 years)] = 156,250

Carrying Value of equipment purchased from Sunnybank Hills Ltd = 36,000

Purchase price for the equipment                                                          = 43,200


Depreciation on remaining PP&E-

Depreciation for each year (straight line method) = [Original cost – Residual value] / Useful life

                                                                                         = [60000-0] / 10 = 6,000

Depreciation for 4 months = (6000*4) /12 = 2,000

Depreciation chargable on remaining PP&E= 31,250 + 2000 = 33,250

Value of PP&E as on June 30, 2015 = [(156250 + 43200) -33250] = 166,200


Calculation for PP&E sale on 1 June, 2016-(in the books of Sunnybank Ltd)

Value of PP&E at July 1, 2015 = 166,200

Carrying Value of equipment sold to Sunnybank hills Ltd   = 80,000

Since, in the question it is mentioned that the carrying value as well as the original cost of the equipment sold on June 1, 2016 is $80,000. We are assuming that the value is before charging depreciation, hence depreciation needs to be calculated on this amount.

Depreciation for each year (straight line method) = [Original cost – Residual value] / Useful life

                                                                                         = [80000-0] / 4= 20,000

Hence, the book value = (80,000- Depreciation for 11 months)  

                                           = (80,000 - 18,333) = 61,666


Book Value of equipment sold to Sunnybank hills Ltd   = 61,666

Selling price for the equipment                                          = 74,240

Gain on sale                                                                            = 12,573         

 

Remaining PP&E (value as on 1 July, 2016) = 166,200 - 80,000 = 86,200

New Depreciation chargable on remaining PP&E= 86200/4 years = 21,550

Value of PP&E as on June 30, 2016 = (86200-21550) = 64,650


  1. Entries as on 30 June, 2017

Calculation for sale of inventory-

Cost of inventory sold = 26000/4 = 6500

Selling price = Cost + Profit markup of 10%

                      = 6500 + 650 = 7150


Calculation for depreciation expenses for 2017-

Value of PP&E as on July 1, 2016 = 64,650

Depreciation to be charged = 21,550


  1. Dr. Cash                                 7150

Cr.       Inventory                                  6500

Cr.       Profit on sale                              650

(Sale of inventory in cash recorded)

  1. Dr. Depreciation on PP&E          21,550

Cr.        Accumulated depreciation      21,550             

(Depreciation charged on remaining PP&E charged) 


  1. Entries as on 30 June, 2018

Calculation for purchase of inventory-

Cost price of inventory purchased = Original Cost + Profit markup of 10%

                                                             = 28000 + 2800 = 30800


Calculation for depreciation expenses for 2017-

Value of PP&E as on July 1, 2016 = (64,650 - 21550) = 43,100

Depreciation to be charged = 21,550


  1. Dr. Inventory                             30800

Cr.       Cash                                        30800

(Purchase of inventory in cash recorded)

  1. Dr. Depreciation on PP&E          21,550

Cr.        Accumulated depreciation      21,550             

(Depreciation charged on remaining PP&E charged) 


  1. Dr. Management fees expenses    6,000

Cr.        Cash                                                    5,000

Cr.        Management fees payable             1,000

(Management fees expenses recoded)


  1. Dr. Dividend expenses payable         10,000

Cr.        Cash                                                      10,000

(Dividend expenses paid and recorded)


  1. Dr. Capital account                              2,000

Cr. Goodwill Impairment                                  2,000

(Impairment of goodwill recorded)

Note: Since, it is mentioned in the question that the management assumes an impairment in goodwill only in the year 2017-18, hence entry is not passed in any of the previous years.

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