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Hi Crish, I hope you are well. I found this question in exam kit and its unusual. can you explain it.
On 1 july , X7 Parent Co. acquired 60% of equity shares of Subsidiary and on that date made a 10 million usd loan to subsidiary at rate of 8% per annum.
What will be the effect on the group RE at year end date of 31 dec X7 when this intra group transaction is cancelled ?
Option 1 = Group RE increases by 400,000 usd
opetion 2 = Group RE will reduced by 240,000 usd
option 3 = Hroup RE will reduce by 160,000 usd
Option 4= No effect on RE
Also, please clarify what ” this intra group transaction is cancelled” means
I also had this question, if the fair value of PPE goes down. So do we charge a negetive depriciation on the difference b/w carring value and fair value in Working 2 ?
Hi,
For the intra-group loan we need to record the interest in the group retained earnings as part of the parent’s retained earnings, if this has not been done already. It isn’t too clear in the scenario if this has or hasn’t been done. If we assume it hasn’t then we need to record 6 months of the interest income (8% x 10 million x 6/12), which would give 400,000 increase to the parent’s retained earnings and the same amount to group retained earnings, hence option 1 is correct.
The elimination of the amounts within the group are adjusted in any outstanding receivables/payables on the face of the group SFP. Any investment income and finance costs are adjusted through the group SPL.
Thanks
Hi , The answer with regard to first question “intra-group loan” is shown in exam kit as option 3.
It says : the loss of intrest on providing loan to subsidiary : 400,000
( 10m * 8 % * 6/12 )
Intrest recovered ( 400,000 * 60% ) : 240,000
Loss / reduction in RE : 160,000and its strange why it used 60% for RE as its group RE and shouldn’t it include full intrest amount. to me it looks like the answer is written on effects on RE of parent ( through opportunity cost) rather than group RE. Can you clarify if its wrong answer or something i missed.
Option 3 is very correct and sensible.
Interest = 10m x 0.08 x 6/12=400,000
Eliminate it from Interest income of parent (group RE) by deducting 400,000
Eliminate it from Interest expense (Subsidiary RE which is shared to group RE by adding 60% of 400,000 that is 240,000
So -400,000+240,000 equals to deducting 160,000
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