BUS 320 Lecture Notes - Lecture 16: Equity Method, Financial Statement, Mutual Fund

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Published on 29 Nov 2017
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© Dennis Chung 2016 Do not distribute
BUS320
Assignment #9
QUESTION ONE
Diamond Limited
Factors to consider:
1. In the general case, we have to consider the following questions: What is the appropriate
basis of financial reporting (i.e., type of GAAP) that the investor company has to follow?
Is the investor an incorporated company? Is the investor a reporting issuer or a non-
reporting issuer? Is the investor a publicly accountable enterprise (as defined in the CPA
Canada Handbook)? Are the investor’s shares listed or soon to be listed on a stock
exchange? Is the investor required to follow IFRS? And if the investor company is a
private enterprise and not required to follow IFRS, has the investor made the choice to
use IFRS? Are there other reasons (such as contractual or borrowing arrangements)
requiring the investor company’s financial statements to be prepared in accordance with
IFRS?
In this particular case, we are told that Diamond is listed on the TSX. Diamond is
therefore a publicly accountable enterprise, and is required to follow IFRS for financial
reporting purposes. Use of the equity method of accounting is prescribed in IAS 28:
Investments in Associates and Joint Ventures. Investments in associates are generally
accounted for using the equity method.
2. Is Galena an “associate” from Diamond’s point of view? Does Diamond have the ability
to significantly influence the decision-making process of Galena? Does Diamond have
the power to participate in Galena’s financial and operating policies? If Diamond has
significant influence, then Galena is an associate and the equity method should be used
(unless one of the exceptions applies; see #7 below).
3. Diamond directly holds 30% of the voting rights of Galena. This is within the 20% to
50% range specified in IAS28, and at this level of ownership, it is presumed that
Diamond has significant influence unless it can be clearly demonstrated this is not the
case. The question that we have to ask is: Can it be clearly demonstrated that Diamond
does not have significant influence in the financial and operating decisions of Galena? If
Diamond does not have significant influence, then Galena is not an “associate” and the
equity method should not be used.
4. Are there potential voting rights that are currently exercisable by Diamond that can
increase Diamond’s voting power over Galena’s financial and operating policies? Would
these extra voting rights give Diamond the additional power resulting in significant
influence even though at the moment it can be clearly demonstrated that the 30%
ownership does not lead to significant influence? If there is no significant influence even
with the potential extra voting rights, then Galena is not an associate” and the equity
method should not be used.
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© Dennis Chung 2016 Do not distribute
5. Are there potential voting rights that are currently exercisable by other entities that can
reduce Diamond’s voting power over Galena’s financial and operating policies? If the
potential dilution effect is sufficiently strong and to the extent of reducing Diamond’s
ability of significant influence to no significant influence, then Galena is not an
“associate” and the equity method should not be used.
6. Also need to make sure that Diamond’s investment in Galena gives rise to an investment
in an “associate” and not a “subsidiary”. Does Diamond have “control” over Galena
even with a holding of 30% of the voting power? Does Diamond have “power” over
Galena? Are the returns Diamond gets from its investment in Galena variable? Does
Diamond have the ability to use its power over Galena to affect the amount of variable
returns Diamond gets from its involvement with Galena? If Diamond has “control” over
Galena, then Galena is not an “associate” and the equity method should not be used.
7. Investments in associates are generally accounted for using the equity method. But there
are exceptions allowed under IFRS. If any of these exceptions applies, the equity method
is not used. Therefore, considering the possible applicability of these exceptions is
important.
8. Is Diamond a venture capital organization, mutual fund, unit trust or similar entity? If it
is, then IAS28 allows an election made by such an entity to account for its investment in
associates as financial assets measured at fair value through profit and loss (FV-NI) in
accordance with IFRS9 instead of using the equity method. Did Diamond make such an
election, if Diamond is in fact a venture capital organization, mutual fund, unit trust or
similar entity?
9. Does Diamond’s investment in Galena meet the criteria for the investment to be
classified as “held for sale”? For example, is the investment in Galena expected to be
sold within twelve months? If the investment meets the criteria to be classified as “held
for sale”, then the equity method is not applied. The investment will be accounted for in
accordance with IFRS5 (covered under the discontinued operations topic) as an asset held
for sale.
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© Dennis Chung 2016 Do not distribute
QUESTION TWO
GSD International, Inc.
(i) Calculation of Goodwill on January 1, 20X1:
Purchase Price paid by GSD
30,000 x $32.50 $ 975,000
Carrying amount (book value) of net assets on
associate’s books ($2,250,000 x 30%) 675,000
Purchase price discrepancy (PPD) $ 300,000
PPD allocated to fair value increments (FVI)* 0
Goodwill included in the purchase price $ 300,000
Alternative approach to obtain the amount of goodwill on January 1, 20X1:
Purchase Price
30,000 x $32.50 $ 975,000
Fair value of identifiable assets and liabilities (all equal
to book values)
$2,250,000 x 30% 675,000
Goodwill included in the purchase price $ 300,000
*No Fair Value Increments (FVI) on identifiable assets and liabilities at acquisition for this
investment in this particular case for GSD.
(ii) No “Goodwill” account will show up on the balance sheets of GSD International, Inc. The
investment in Lotus Corporation is accounted for using the equity method, and the goodwill is
included in the balance of the “Investment in Lotus Corporationasset account instead of being
separately reported on GSD International, Inc.’s balance sheet.
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