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Hi Mister,
I am completely at lost for the treatment on how intra-group loan from the parent to the subsdiary for the mid-year acquistion.
I read the FTC text book example several times, but still can’t understand the solution. May I ask for your help?
Here we go:
P bough S on 1/7/2011. S’s retained earnings at 31/12/2011 are $15000 and S’s profit for the year was $8000. Immediately after acquisition, P gave S a loan of $4000 which carried interest of 10%.
What were S’s retained earnings at acquisition?Solution:
If the intra-group loan didn’t exist, then S’s post acquisition profit would be $4000 (6/12 x $8000). This would make retained earnings at acquisition $11000 ($15000 less $4000).–>This I still understand.However, the intra-group loan skews the results of S. (What does this mean?) While S has made a profit of $8000, there is a $2000 finance cost ($4000 * 10% * 6/12, seems a wrong figure if this formula is correct) in the post acquisition period which would not have existed in the first six months.
Therefore the underlying profit without that interest is $10000. $5000 must have been made in each 6 month period, with the additional $2000 interest in the post acquisition period taking the post acquisition profit down to $3000.–> This doesn’t make any sense to me.
Therefore retained earnings at acquisition will be $12000 ($15000 less $3000 post aquisition) and the post acquisition profits to go to consolidated retained earnings are $3000. –> I don’t understand this either.
Thank you.
This is a similar problem to the one in the comprehensive example in the course notes. When faced with a mid-year acquisition it’s necessary to split the profit on a time-apportioned basis bearing in mind that not all revenues / expenses accrue evenly through the year.
And here’s the example! That loan interest is only applicable to the second half of the year so we need to find what was the profit BEFORE the loan interest expense ($8,000 + $2,000 loan interest add-back) $10,000.
Now, time apportion that $10,000 = $5,000 pre-acquisition and $5,000 post acquisition
Ok so far?
Now deduct from the post-acquisition $5,000 the loan interest for half a year. It doesn’t help that you have (I assume) mis-typed a figure and the loan is in fact $40,000 so 10% for half a year is $2,000!
So the second half year post-acquisition profit comes down to $3,000 whilst the pre-acquisition profit remains at $5,000
Is that any better?
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Why the interest cost is $2000? If I use the formula given by the textbook, I arrive at $200.
@mikelittle said:
This is a similar problem to the one in the comprehensive example in the course notes. When faced with a mid-year acquisition it’s necessary to split the profit on a time-apportioned basis bearing in mind that not all revenues / expenses accrue evenly through the year.And here’s the example! That loan interest is only applicable to the second half of the year so we need to find what was the profit BEFORE the loan interest expense ($8,000 + $2,000 loan interest add-back) $10,000.
Now, time apportion that $10,000 = $5,000 pre-acquisition and $5,000 post acquisition
Ok so far?
Now deduct from the post-acquisition $5,000 the loan interest for half a year. It doesn’t help that you have (I assume) mis-typed a figure and the loan is in fact $40,000 so 10% for half a year is $2,000!
So the second half year post-acquisition profit comes down to $3,000 whilst the pre-acquisition profit remains at $5,000
Is that any better?
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Oh, okay, I get it now. I reread your explanation again. Thanks.
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