Discussion Whether Paula Ltd Is the Parent of Cook Island Ltd - Assignment Example

Bachelor of Business Assignment 2 ACC 3000 Financial Reporting Trimester 3, 2012 NAME DATE a) Paula Ltd and India Ltd own 80% and 20% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Cook Island Ltd. Paula Ltd sells half of its interest to Kobe Ltd and buys call options from Kobe Ltd that are exercisable at any time at a premium to the market price when issued and, if exercised, would give Paula Ltd its original 80% ownership interest and voting rights. At 30 June 2012, the options are out of the money. (Leo K., Hoggett J., and Sweeting J, Company Accounting 9th Edition, page 755) Discussion whether Paula Ltd is the parent of Cook Island Ltd. (300 words) (4 marks) Before discussing whether or not Paula Ltd is the parent of Cook Island, it is worth defining what is meant by the term” Parent company”. According to Rossini (1998), it is simply a firm or a company that posses another firm (its subsidiary) or a substantial amount of shares and voting rights aimed at exerting the greatest control or power over the company. In other words, a parent company is simply a body which have in its possession one or many subsidiaries entities. It is an organization which control significant voting rights or shares in a bid to influence the day to day operations of subsidiary and having some degree of influence on their decision making organs. One can therefore derive a working definition of a parent company as an entity with a higher influence associated with the governance of not only finances but also operating issues of a unit in order to accrue maximum benefits from its undertakings. These qualities are well manifested by the Paula Ltd as discussed below. Unlike India Company, Paula Ltd has significant voting rights which correspondents to its substantial amount of ordinary shares. Even if Paula Ltd sells half of its interest to Kobe Ltd, there will be still good shares left and eventually will have the full ownership of 80 % interest including voting rights which would also guarantee the company some control. Hewitt (2011) believes that voting rights is a good avenue and opportunity to supervise administrative issues and to eventually approve or disapprove such decisions, sentiment shared by Yermack (2010) who argues that voting can be adopted as a communication tool particularly with boards of directors, to bring about major changes in the overall management of the corporate. With the huge influence and significant voting rights, Paula Ltd poses the power to appoint or remove members of the board. Buying call options from Kobe Ltd still gives Paula Ltd some advantages, the right, but not the obligation, to buy shares at a preset price (Kieso, 2008) unless Paula Ltd is caught up with times since call option as vulnerable to time decay which may affect the option-value as it often decrease with expiry date thus affecting realization of any profit b) Mensa Ltd has acquired all the shares of cancer Ltd. The accountant for Mensa Ltd, having studied the requirements of AASB 3 business combination, realises that all the identifiable asset and liabilities of cancer Ltd must be recognised in the consolidated financial statements at fair value. Although he is happy about the valuation of these items, he is unsure of a number of other matters associated with accounting for thee assets and liabilities. He has approached you and asked for your advice. (Leo K., Hoggett J., and Sweeting J, Company Accounting 9th Edition, page 805) Required A report (1200 words) for the accountant at Mensa Ltd advising on the following issues :( 6 marks) i. Should the adjustment to the fair value be made in the consolidation work sheet or in the account of cancer Ltd? Fair Value refers to the resultant price for the sale of an asset or as payment to transfer a liability in a well arranged transaction between two or more parties at a particular measurement data or exit price (Ernst & Young, 2012). Fair value is quite vital for companies. Ryan (2008) explains that fair value measurement enables companies to approximate the best prices which would correspond well with their current position in an orderly or peaceful transactions based on prevailing situations and information. Therefore companies must consider the future cash flows and existing risk-adjusted discount rates into their fair value measurements. Adjustment to the fair value should not be made in the account of cancer Ltd which a subsidiary’s entity following the acquisition of all shares by Mensa Ltd but instead must be made in a consolidation worksheet. Consolidated worksheet is a representation of financial transactions carried out by one or more separate entities. This information, although accumulated by individual entity is brought forth (or consolidated) to form one economic unit. Therefore, adjustment can be made on the consolidated worksheet on the following grounds; first, when adjustment is made in a consolidation worksheet, issues of double counting can be avoided which may occur particularly when in the consolidation process, the parent and subsidiary equities are added together. Secondly, by adjustmenting the fair value in the consolidation work sheet, it is possible to eliminate either unrealised earnings or losses. This is because the profits recognized by the Mensa Ltd or cancer Ltd, due to transactions between them, needs to be eliminated from the consolidated statements. It would therefore only make some sense if the various transactions are accorded separate treatment and the differences noted in the parent’s and consolidated financials (Murphy and McCarthy, 2010). A comprehensive and full use of equity approach would amend Mensa Ltd’s books for the non- existing or unrealized revenues and cover the difference they bring on both the consolidated profits as well as that of the parent’s (Murphy and McCarthy, 2010). ii. What equity account should be used when revaluating the asset, and should different equity account such as income (similar to recognition of an excess) be used in relation to recognition of liabilities? As indicated earlier, Mensa Ltd has acquired all the shares thus rendering cancer Ltd a subsidiary entity. Since it has the full ownership, the company’s net asset requires some revaluation (Fischer, Taylor and Cheng, 2012). Revaluation takes some procedures. In order to get revalued assets /equipments and depreciation , there is need to consider the price prior to revaluation together with the original depreciated amount which is then multiplied by the revalued amount to the original carrying proportion or amount(Monday, 2009). After getting the product of the two, the accounts are then amended to take care of the changes based on the revalued amount. The surplus of the carrying amount or indexed proportion is then credited to Revaluation Surplus Equity Account (Monday, 2009). Income can be used in special cases. For instance, if the if the revaluation results in an increase indexed amount or in the carrying amount of the asset, the proportion of increase should be noted and credited to stockholders' equity under the title 'Revaluation Surplus', as already illustrated in the preceding paragraph (Ernst & Young, 2012). Nonetheless, the increase should be taken or considered as an income and recorded in profit accounts but if at all reverses a revaluation decrease of the same asset previously recognized in profit or loss then it should be entered in loss accounts. The loss is also taken as a revaluation decrease and recognized directly in other comprehensive income, reducing the revaluation surplus for the said asset (Ernst & Young, 2010). iii. Do these equity accounts remain in existence indefinitely, since they do not seem to be related to the equity accounts recognised by Cancer Ltd itself? Indefinite existence can be seen from the perspective of useful life which is defined as the time or period which a given asset is expected to be useful by a particular body or unit (Ernst & Young, 2010). For equity accounts or assets with indefinite lives, there is no need for amortization. However, they must be evaluated from time to time in order to check possible impairment adjustment. An intangible assets are said to poses an indefinite life if at all there is no any foreseeable limit whatsoever to the time which the given asset is likely to attract net cash flows or be useful for the company. There are various examples of intangible assets including Customer-related intangible assets such as Customer lists, orders among other things. There are also marketing based intangible asset which include trademarks, name of the companies and contract –related intangible assets comprising of comprising of Licensing, royalty, standstill agreements (Austin, 2007). It therefore follows that a company must evaluate as asset to determine its useful life The aforementioned equity accounts will still remain in existence indefinitely unless they exceed the time or period of the contractual or legal agreements or may be relatively shorter depending on the time over which the entity wish to use the asset. Another reason why they will remain in existence indefinitely is by the virtue of the fact that Business Combinations prohibits the amortization of certain assets. In case, recognized brand assets also presumed to have indefinite lives (Austin, 2007). END OF ASSIGNMENT Bibliography Austin, Lloyd, 2007. Accounting for intangible assets, Business Review Vol 9(1):62-72 Ernst and Young, 2012. Reflecting Credit and Funding adjustments in fair value: insight into practices, EYGM ltd, UK Fischer Paul M., Taylor William J., Cheng Rita H., 2012. Advanced Accounting, 11th edition, South –Western CENGAGE learning, USA. Hewitt, Paul, 2011. The Exercise of Shareholder Rights: Country Comparison of Turnout and Dissent, OECD Corporate Governance Working Papers, No.3, www.oecd.org/daf/corporateaffairs/wp Kieso, Warfield W, 2008. Intermediate Accounting: Principles and Analysis 2nd Edition, Coby Harmon University of Califonia Leo, K, Hogget, J & Sweeting, J 2011, Company accounting, 9th edn + wileyplus 4 card, John Wiley & Sons, Australia. ISBN 9780730304326 Monday, Sarah E., 2009. IAS 16 and the Revaluation Approach: Reporting Property, Plant and Equipment at Fair Value. University of Tennessee Honors Thesis Projects. http://trace.tennessee.edu/utk_chanhonoproj/1297 Murphy Elizabeth A.and McCarthy Mark A., 2010. Teaching Consolidations Accounting: An Approach To Easing The Challenge, American Journal of Business Education, Vol 3(11):101-11 Rossini, Christine, 1998. English as a Legal Language, USA Ryan, Stephen G. (2008).Fair Value Accounting: Understanding The Issue raised By The Credit Crunch, UK: Council of Institutional Investors Yermack, David, 2010. Shareholder voting and Corporate Governance, Available at SSRN: http://ssrn.com/abstract=1523562 or http://dx.doi.org/10.2139/ssrn.1523562 Read More