Advanced Financial Accounting

Unit 1 Practice Questions

Question 1

Investor A holds 70% of the voting rights of an investee. Investor B has 30% of the voting
rights of the investee as well as an option to acquire half of investor A’s voting rights. The
option is exercisable for the next two years at a fixed price that is deeply out of the money
(and is expected to remain so for that two-year period). Investor A has been exercising its
votes and is actively directing the relevant activities of the investee.

Required:
Discuss whether Investor A has power over the investee.

Question 2

Investor A and two other investors each hold a third of the voting rights of an investee. The
investee’s business activity is closely related to investor A. In addition to its equity
instruments, investor A also holds debt instruments that are convertible into ordinary shares
of the investee at any time for a fixed price that is out of the money (but not deeply out of the
money). If the debt were converted, investor A would hold 60% of the voting rights of the
investee.

Required:
Discuss whether Investor A has power over the investee.

Question 3

Is there a parent-subsidiary relationship in each of the situations below? If the situation is

ambiguous, identify the factors that will determine if a parent-subsidiary relationship exists.

(a) Company A signs an agreement with Company B to set up Company C in China. Both
Company A and Company B will have 50% voting rights in Company C.

(b) Company A buys 100% of the net assets of Company B. The purchase price includes
goodwill. Company B is subsequently dissolved.

(c) Company A arranges to have its shares acquired by Company B who issues new shares
to the owner of Company A. The owners of Company A are also the executive directors
of Company A. Company B gives three of five seats on the board of directors to the
executive directors of Company A.

(d) Company B owes $20m to Company A. As a result of financial difficulties, Company A

agrees to accept shares issued by Company B as settlement of the liabilities. After the
share issue, Company A owns 60% of Company B.

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 Advanced Financial Accounting
Unit 1 Practice Questions

Question 4

Space Ltd has acquired, during the current year, the following investments in the shares
issued by other companies:

Tom Ltd $120,000 (40% of issued capital)

Conga Ltd $117,000 (35% of issued capital)

Space Ltd is unsure how to account for these investments and has asked you, as the auditor,
for some professional advice.

Specifically, Space Ltd is concerned that it may need to prepare consolidated financial
statements under HKFRS 10. To help you, the company has provided the following
information about the two investee companies:

Tom Ltd
– The remaining shares in Tom Ltd are owned by a diverse group of investors who each
hold a small parcel of shares.
– Historically, only a small number of the shareholders attend the general meetings or
question the actions of the directors.
– Space Ltd has nominated three new directors and expects that they will be appointed at
the next annual general meeting. The current board of directors has five members.

Conga Ltd
– The remaining shares in Conga Ltd are owned by a small group of investors who each
own approximately 15% of the issued shares. One of these shareholders is Tom Ltd,
which owns 17%.
– The shareholders take a keen interest in the running of the company and attend all
meetings.
– Two of the shareholders, including Tom Ltd, already have representatives on the board
of directors who have indicated their intention of nominating for re-election.

Required:
1. Advise Space Ltd as to whether, under HKFRS 10, it controls Tom Ltd and/ or Conga Ltd.
Support your conclusion.

2. Would your conclusion be different if the remaining shares in Tom Ltd were owned by
three institutional investors each holding 20%? If so, why?

Question 5

State true or false to the below statement and the reason for your response.

The book value of shares issued in exchange for control rights should be used as the basis of
measuring the initial cost.

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Unit 1 Practice Questions

Question 6

During Jan 20X5, P performed due diligence tests on S. On 1 Feb 20X5, P completed the
purchase of 80% of S from V, the existing owner of S.

The following expenditures were incurred by P during Jan 20X5:-

Payment to consultants to conduct due diligence checks on S $200,000

No. of ordinary shares issued by P to V 6,000,000
FV per share of P at date of share issue, reliably measured $3
Salary of business development manager of P for Jan 20X5 $20,000
Travelling and hotel expenses incurred by the business development $15,000
manager in relation to the acquisition
Undiscounted cash payment payable to V at the end of 5 years $1,000,000
Interest payable to V for deferred payment 6% per annum
Legal fees to execute sales agreement with V $30,000
Assumption of the liabilities of V (P assumes legal obligation to pay off the $200,000
short-term liabilities of V in settlement of purchase price)
Stamp duties and other incidentals of share issue to V $10,000

Details relating to S Co as at 1 February 20X5:

Share capital $4,000,000
Retained earnings 5,600,000
Other reserves 1,200,000
As reported in the interim financial statements of S Co $10,800,000

Fair value of unrecognized intangible asset $2,000,000

▪ Estimated useful life of intangible asset from 1 February 20X5 was five years.

▪ Fair value of non-controlling interests as at 1 February 20X5 was $4,700,000.

▪ The financial year-end is 31 December. Tax rate is 20%. Recognize tax effects on fair
value adjustments.

Required:
1. Determine the consideration transferred in accordance with HKFRS 3 Business
Combinations.

2. Show the journal entry or entries in P’s books to record the expenditures incurred by P
Co in Feb 20X5.

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 Advanced Financial Accounting
Unit 1 Practice Questions

Question 7

On 1 July 2009 Alive Ltd, a listed company, acquired all of the issued capital of Blue Ltd
from the company’s sole shareholder White Ltd. Alive paid a fee of $161,703 to Bull & Bear, a
firm of investment consultants, for advice concerning the investment in Blue Ltd. The
consideration accepted by White Ltd for the shares in Blue Ltd was as follows:

– Alive Ltd transferred a block of industrial land to White Ltd. The fair value of the land
was $3,500,000 and its carrying amount $2,800,000.

– $2,000,000 cash payable on 1 July 2009 and $10,000,000 payable at the end of three
years. The appropriate discount rate was 8% per annum.

– Alive Ltd issued 500,000 ordinary shares (with $1 par value) to White Ltd. The market
value of Alive’s shares was $5.00 per share on 1 July 2009. Costs associated with the
share issue were $35,000.

– At 1 July 2009 White Ltd owed $1,500,000 to Black Ltd (a company not related to
either Alive Ltd or White Ltd). Alive agreed to settle White’s obligation as part of the
acquisition cost. The fair value of White’s debt to Black was $1,500,000.

– On 1 July 2009, White Ltd owed Alive Ltd $300,000 (recorded at fair value) for
purchases of goods. Alive Ltd agreed to forgive the debt in partial settlement of the cost
of acquiring Blue’s share capital.

Alive Ltd paid $99,975 to Daisy, Compute & Associate, public accountants, for the conduct of
a “due diligence” investigation of Blue Ltd.

Required:
Prepare journal entries for Alive Ltd on the date of acquisition of Blue Ltd and calculate the
total consideration transferred related to the acquisition cost.