Advanced Consolidation Question 55

QUESTION 55: ADVANCED CONSOLIDATION

The following group draft financial statements relate to Andash, a public limited company:

Draft group statements of financial position at 31 Oct

2006 2005
$m $m
Assets
Non current assts
Property, plant and equipment 5,170 4,110
Goodwill 120 130
Investment in associate 60 --
5,350 4,240
Current assets
Inventories 2,650 2,300
Trade receivables 2,400 1,500
Cash and cash equivalents 140 300
5,190 4,100
Total assets 10,540 8,340

Equity and liabilities

Equity attributable to owners of parent
Share capital 400 370
Other reserves 120 80
Retained earnings 1,250 1,100
1,770 1,550
Non controlling interest 200 180
Total equity 1,970 1,730
Non current liabilities
Long term borrowings 3,100 2,700
Deferred tax 400 300
Total non current liabilities 3,500 3,000
Current liabilities
Trade payables 4,700 2,800
Interest payable 70 40
Current tax payable 300 770
Total current liabilities 5,070 3,610
Total liabilities 8,570 6,610
Total equity and liabilities 10,540 8,340

Draft group statement of comprehensive income for the year 31 Oct 2006
$m
Revenue 17,500
Cost of sales (14,600)
Gross profit 2,900
Distribution costs (1,870)
Administrative expenses (490)
Finance costs – interest payable (148)
Gain on disposal of subsidiary 8
Profit before tax 400
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Advanced Consolidation Question 55

Tax (160)
Profit for the year 240
Attributable to:
Owners of the parent 200
Non controlling interest 40
Profit for the year 240

Draft statement of changes in equity of the parent for the year ended 31 Oct 2006
Share Other Retained Total
Capital Reserves Earnings
$m $m $m $m
Bal at 31 Oct 2005 370 80 1,100 1,550
Profit for the year 200 200
Dividends (50) (50)
Issue of share capital 30 30 60
Share options issued 10 10
Bal at 31 Oct 2006 400 120 1,250 1,770

The following information relates to the draft group financial statements of Andash:
(i) There had been no disposal of property, plant and equipment during the year. The
depreciation for the period included in the cost of sales was $260 million. Andash had
issued share options on 31 Oct 2006 as consideration for the purchase of plant. The value
of the plant purchased was $9 million at 31 Oct 2006 and the share options issued had a
market value of $10 million. The market value had been used to account for the plant and
share options.

(ii) Andash had acquired 25% of Joma on 1 Nov 2005. The purchase consideration was 25
million ordinary shares of Andash valued at $50 million and cash of $10 million. Andash has
significant influence over Joma. The investment is stated at cost in the draft group
statement of financial position. The reserves of Joma at the date of acquisition were $20
million and at 31 Oct 2006 were $32 million. Joma had sold inventory in the period to
Andash at a selling price of $16 million. The cost of the inventory was $8 million and the
inventory was still held by Andash at 31 Oct 2006. There was no goodwill arising on the
acquisition of Joma.

(iii) Andash owns 60% of a subsidiary Broiler, a public limited company. The goodwill
attributable to the parent company arising on acquisition was $90 million. The carrying
value of Broiler’s identifiable net assets (excluding goodwill arising on acquisition) in the
group consolidation financial statements is $240 million at 31 Oct 2006. The recoverable
amount of Broiler is expected to be $260 million and nom impairment loss had been
recorded up to 31 Oct 2005.

(iv) On 30 April 2006 a wholly owned subsidiary, Chang, was disposed of. Chang prepared
interim financial statements on that date which are as follows:
$m
PPE 10
Inventory 8
Trade receivables 4
Cash and cash equivalents 5
27

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Advanced Consolidation Question 55

Share capital 10
Retained earnings 4
Trade payables 6
Current tax payables 7
27

The consolidated carrying values of the assets and liabilities at that date were the same as
above. The group received cash proceeds of $32 million and the carrying amount of
goodwill was $10 million. The non controlling interest is not measured at fair value.

(Ignore the taxation effects of any adjustments required to the group financial statements
and round all calculations to the nearest $ million).

Required:
(a) Prepare a groups statement of cash flows using the indirect method for the Andash Group
for the year ended 31 Oct 2006 in accordance with IAS 7 after making any necessary
adjustments required to draft group financial statements of Andash as a result for the
information above.
(Candidates are not required to produce the adjusted group financial statements of
Andash). (30 marks)
(b) Discuss how and why the cash flow provides useful financial information. Include in your
answer ways of measuring cash flow performance. (10 marks)

ACCA P2 – December 2006 – Q1a

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Advanced Consolidation Question 55

ANSWER TO QUESTION 55: ADVANCED CONSOLIDATION

Part (a)
Group Statement of cash flows for the year ended 31 Oct 2006
$m $m
Cash flows from operating activities
Profit before taxation (w(i)) 323
Adjustment for profit on sale of subsidiary (8)
Depreciation 260
Impairment of goodwill (w(iv)) 78
Associate’s profit (W(iii)) (1)
Finance costs 148 477
800
Increase in trade receivables (2,400 – 1,500 + 4(w(v)) (904)
Increase in inventories (2,650 – 2,300 + 8 (w(v)) (358)
Increase in trade payables (4,700 – 2,800 + 6 (w(v)) 1,906 644
Cash generated from operations 1,444
Interest paid (40 + 148 – 70) (118)
Income taxes paid (w (vi)) (523)
Net cash from operating activities 803

Cash flows from investing activities

Purchase of associate (w(iii)) (10)
Purchase of PPE (w(ii)) (1,320)
Sale of subsidiary (32 – 5 (w(v)) 27 (1,303)

Cash flows from financing activities

Proceeds from issue of share capital (w(vii)) 10
Dividends paid to non controlling interest (180 + 40 – 200) (20)
Proceeds from long term borrowings 400
Dividends paid (50) 340

Net decrease in cash and cash equivalents (160)

Cash and cash equivalents at 1 Nov 2005 300
Cash and cash equivalents at 31 Oct 2006 140

Workings
(i) Profit
$m
Profit before tax per draft 400
Associate’s profit (iii) 1
Impairment of goodwill (iv) (78)
Profit before tax as amended 323

(ii) PPE
IFRS 2 says that the fair value of the goods and services received should be used as the
value of the share options issued. Therefore the plant should be valued at $9 million and
the share options at the same amount. There is no need to adjust depreciation because of
the date of purchase but other reserves will fall by $1 million.
$m
Balance at 31 Oct 2005 4,110

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Advanced Consolidation Question 55

Purchase – non cash 9

Other valuation 1
Depreciation (260)
Sale of subsidiary (10)
Purchases in the period (balancing figure) 1,320
PPE as per statement of financial position 5,170
The statement of financial position figure for PPE will be $5,169 million.

(iii) Associate – Joma

The investment in the associate should be measured using the equity method.
$m $m
Cost of investment 60
Share of post acquisition reserves (25% x ($32 - $20)m) 3
Inter company profit eliminated (25% x ($16 - $8)m) (2)
1
61

Alternative working
Investment in associate Joma
$m
Group% of the net assets 25% x 252 63
Plus goodwill Nil
Less provision for unrealized profit 25% x (16 – 8) (2)
Carrying value 41

Goodwill
Investment 60
Less 25% x 240* = (60)
Goodwill Nil

At acquisition At year end

Net assets 220* 220
OSC 20 32
Reserves 240 252
* balancing figures
The cash flow will be $10 million.

(iv) Impairment of Goodwill – Broiler

Goodwill Net Total
assets
$m $m $m
Carrying amount 90 240 330
Unrecognized non controlling interest 60 60
(90 x 40 / 60)
150 240 390
Recoverable amount 260
Impairment loss (130)
Goodwill will be reduced by 60% of 130, i.e. $78 million. Profit or loss will be charged with
this amount.

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Advanced Consolidation Question 55

(v) Sale of subsidiary

The sale of the subsidiary should be taken into account in the statement of cash flows as
follows:
Dr Cr
$m $m
PPE 10
Inventory 8
Trade receivables 4
Cash and cash equivalents 5
Trade payables 6
Current ax payable 7
Cash proceeds 32
Goodwill disposed of 10
Profit on sale 8
45 45

(vi) Income taxes paid

$m $m
Current tax payable 31 Oct 2005 770
Deferred tax payable at 31 Oct 2005 300
1,070
Statement of comprehensive income 160
1,230
Cash paid (balancing figure) (523)
Sale of subsidiary (7)
Current tax payable 31 Oct 2006 300
Deferred tax payable at 31 Oct 2006 400
700

(vii) Shares issued

Cash flow from issue of shares is $(60 – 50) i.e. $10 million (from the statement of changes
in equity). The shares issued for the purchase of Joma are taken out of the issue proceeds
set out in the statement of changes in equity.

Part (b)
In many cases, the business focus is solely on profitability, with the interpretation of the financial
information focusing on traditional rations such as gross margin, net margin, return on capital
employed. However, a business cannot survive without cash and cash flows be ignored when
assessing the performance of the entity.

Statement of cash flows enables users of the financial statements to assess the liquidity, solvency
and financial adaptability of the business. A statement of cash flows provides information that is
not available from the statement of financial position and the statement of comprehensive income.

A statement of cash flows is believed to provide useful information to users of the financial
statements for the following reasons:
- Unlike profits, cash flows are not affected by an entity’s choice of accounting policies or by
the exercise of judgment. Cash flows can be verified objectively and therefore they allow
little scope for creative accounting.

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Advanced Consolidation Question 55

- Cash flow information is thought to have predictive value. It may assist users of financial
statements in making the judgments on the amount, timing and degree of certainty of future
cash flows.
- It gives an indication of the relationship between profitability and cash generating ability,
and thus the quality of the profit earned. The reconciliation of operating profit to the net
cash flow generating by operating activities is particularly useful in the is context and
highlights movements in working capital.
- Cash flow may more easily be understood than profit, particularly by the users who are
unfamiliar with the technical aspects of financial reporting.
- The statement of cash flows provides information that may be useful in interpreting the
statement of comprehensive income and statement of financial position. For example it
shows cash flow from capital transaction as well as from revenue transactions. It may
highlight a company’s financial adaptability (e.g. it ability to generate future profits and cash
flows by selling non current asset or by issuing shares).

However, statements of cash flows are based on historical information and therefore do not
provide complete information for assessing future cash flows. Neither the cash flow not the
profit provides a complete picture of a company’s performance when looked at in isolation.

Measuring cash flow performance

There are number of different ways cash flow performance can be assessed:

Cash generating from operations

Cash from operations should be compared to the profit from operations. If the ratio is greater than
1 it means that all profit have been converted into cash which is a good performance.

Overtrading may be indicated by:

- high profits and low cash generation
- large increases in inventory, receivables and payables

Dividend and interest payments

These should be compared to cash generated from trading operations to see whether the normal
operations can sustain such payments. In most years they should.

Capital expenditure and financial investment

The nature and scales of company’s investment in non current assets is clearly shown in the cash
flow. This may be a cause of a net cash outflow in the period but this should pay benefits in the
future with the increased profits.

Cash flow
The statement clearly shows the end result in the cash term of the company’s activities in the year.
the importance of this figure alone must not be overstated. A decrease in the cash in the year may
be for very sound reasons (e.g. there was surplus cash last year) or may be mainly the result of
timing (e.g. a new loan was raised just after end of the accounting period).

Free cash flow

It represents the cash that an entity ahs left after paying out the cash to maintain its assets base. It
is calculated as:

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Advanced Consolidation Question 55

Free cash flow = net profit + depreciation/amortization – change in working capital – capital
expenditure
(Or FCF = operating cash flow – capital expenditure)

This is the amount of cash left over after paying expenses and operating investments. It is the
cash available to be used in the investing in new projects or repaid to share holders. A negative
free cash flow is not necessarily a bad thing, as an entity may be investing to provide increased
cash inflows in the future.

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