2238 – Financial Reporting, 3.

5 ECTS
Semester 1 First Half (T1)
2023-2024

Exercises – Lecture 5

• Exercise 1 (Equity Method)

On January 1, 20X3 your company acquired 100,000 shares of another company at a price of 5 Euros per
share. The shareholding is giving your company the power to have a significant influence in the acquired
company, even if not the control (the total shares of the acquired company are 400,000). On December 31,
20X3 this “affiliated” company recorded a loss of 20,000 Euros. On April 1, 20X4 the affiliated company paid
dividends of 0.5 Euros per share. On December 31, 20X4, the affiliated company recorded a profit for 50,000
Euros.

Provide the journal entries of your company for the events above. The journal is made of four columns: date,
account, debit and credit and it must be specified the type of each account (Asset, Liability, Equity, Revenue
and Cost).

• Exercise 2 (Accounting for consolidation)

Forest Ltd acquired 75% of shares in Tree Ltd on 1 January 2022.

Below the statement of financial position at 1 January 2022, immediately after the acquisition with the
payment already made in cash.

Forest Ltd Tree Ltd

Assets
Non-current assets 225 100
Investment in Tree Ltd 110
Inventories 100 30
Trade receivables 80 40
Bank 16 8
Total Assets 531 178

Equity and liabilities

$1 common shares 176 40
General reserve 45 14
Retained earnings 100 60
Total Equity 321 114
Taxes Payable 60 46
Trade payables 150 18
Total Liabilities 210 64
Totale Equity and Liabilities 531 178
The fair value of Tree Ltd’s asset and liabilities at the date of the acquisition is the same as their book value.

Answer to the following questions:

1. Prepare a consolidated statement of financial position assuming that non-controlling interests are
measured as a proportional share of net assets of subsidiary.
2. Prepare a consolidated statement of financial position assuming that non-controlling interests are
measured as at their fair value. In particular, the fair value of non-controlling interests is estimated
to be 40.

• Exercise 3 (Accounting for consolidation – Book value and Fair Value)

Alpha Ltd acquired 85% of shares in Beta Ltd on 1 January 20X2.

Below the statement of financial position at 1 January 20X2, immediately after the acquisition with the
payment already made in cash.

Alpha Ltd Beta Ltd

Assets
Non-current assets 130 70
Investment in Beta Ltd 110
Inventories 65 40
Trade receivables 90 60
Cash 40 30
Total Assets 435 200

Equity and liabilities

Common shares 250 80
Retained earnings 60 15
Total Equity 310 95
Wage Payable 40 65
Trade payables 85 40
Total Liabilities 125 105
Totale Equity and Liabilities 435 200
At the acquisition date, the following differences between the book value and fair value of the assets and
liabilities of Beta ltd are recorded:

- The building with a book value of 50 has a market value of 60;

- The fair value of inventory using the replacement cost (fair value) is 50 compared to the book value
of 40;
- After properly accounting for the credit risk of customer, the fair value of trade receivables has
been estimated to be 50;
- The fair value of tax payables is 45.

Answer to the following questions:

1. Prepare a consolidated statement of financial position assuming that non-controlling interests are
measured as a proportional share of net assets of subsidiary.
 [Suggestion: replace the book values with the fair values in the statement of financial position of Beta
Ltd and then follow the usual steps in the consolidation process.]
2. Assume now that there are no differences between fair value and book value of the subsidiary i.e.
the statement of financial position of Beta Ltd is already at fair value. Prepare a consolidated
statement of financial position assuming that non-controlling interests are measured as a
proportional share of net assets of subsidiary.
3. Is the goodwill greater in point 1 or point 2 above? Explain.

• Exercise 4 (Accounting for consolidation – Shares vs Cash payment)

Below the statement of financial position at 1 January 20X1 of two distinct companies, ABC Ltd and XYZ
Ltd.

ABC Ltd XYZ Ltd

Assets
Non-current assets 350 40
Inventories 240 80
Trade receivables 120 90
Cash 230 140
Total Assets 940 350

Equity and liabilities

Common shares 400 90
Retained earnings 250 20
Total Equity 650 110
Tax Payable 50 165
Trade payables 240 75
Total Liabilities 290 240
Totale Equity and Liabilities 940 350
On the same day, 1 January 20X1, ABC Ltd acquired 100% of the shares of XYZ Ltd for an acquisition price of
150.

The fair value of XYZ Ltd’s asset and liabilities at the date of the acquisition is the same as their book value.

Answer to the following questions:

1. Assume that the consideration has been paid entirely in cash.

a. Update the statement of financial position of ABC Ltd to account for the acquisition of the
equity stake in XYZ Ltd and the corresponding payment.
b. Prepare the consolidated statement of financial position.
2. Assume that the consideration has been paid by giving to the shareholders of XYZ Ltd newly issued
common shares of ABC Ltd.
a. Update the statement of financial position of ABC Ltd to account for the acquisition of the
equity stake in XYZ Ltd and payment through the issue of new common shares.
b. Prepare the consolidated statement of financial position.
3. Please compare the consolidated statement of financial position in point 1 and point 2. What are the
main differences? Explain.
• Exercise 5 (Accounting for consolidation – Theory)

For each statement, indicate if it is true or false, and explain your choice.

1. You company acquired 30% of the total shares of another company. From an accounting point
of view, the equity method should be used for subsequent valuation of the investment.
2. If your company has an equity stake in another company and is able to exert significant influence,
this company should be considered a subsidiary of your company and therefore it is required to
prepare a consolidated financial statement.
3. Regarding the equity method, eventual dividends paid by the affiliated company should increase
the accounting value of the account investment in affiliate.
4. Your company has 40% of total shares of another company; the remaining 60% shares belong to
an individual shareholder. It is reasonable to assume that your company is able to exercise
control in the company in which has invested.
5. If the book value of the assets and liabilities of the subsidiary is equal to their fair value, then
there is no need to compute the goodwill as it is zero.