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If you look up the Jocatt question in the BPP revision kit, note (viii) reads:
“(viii) Deferred tax of $1 million arose in the year on the gains on investments in equity in the year where the
irrevocable election was made to take changes in fair value through other comprehensive income”Now, this note is slightly changed by BPP because the original question doesn’t talk about changes in fair value taken to other comprehensive income. So when the examiner, in his original answer, included the “Profit on AFS investments (working (ii)) (1)” under operating activities, as an adjustment for non cash items, this is understandable.
Actually, this $1m relates to the step acquisition in Tigret when the fair value of the original consideration on 1. DEC. 2009 was $5M and the original value on 1.Dec.2008 was $4M, so hence the revaluation gain.
But my query is, in BPP’s answer, given their amendment to the note, if this changes are taken through other comprehensive income then why account for them at all under operating activities? This is because we start operating activities with “profit before tax” but this “profit before tax” comes before other comprehensive income, meaning that the revaluation gain hasn’t been taken into account at all so why adjust for it as a deduction under operating activities in the first place? BPP have adjust for it yet they have said in their amended note that these changes go to OCI, so could you please explain this confusion to me?
Thanks,
Gabriel
Hi Gabriel.
In brief, “No” I can’t explain it. What you have written seems perfectly logical to me (I don’t have a BPP revision kit to hand) so, no, the suggested BPP solution as explained by you appears to lack any logical foundation
Thank you Mike for your answer.
I had some additional doubts regarding the answer to this question and these doubts are not related to any specific BPP amendment to the question but just related to the answer to this question:
Under investing activities we have “Purchase of subsidiary (15 – 7) (working (ii)) (8)” this line in the examiner’s answer
I don’t understand why the purchase of subsidiary is 8. Is it because we paid 15 to acquire the subsidiary and the subsidiary already had cash of 7 so in essence we just paid 8? Is it something like that?
Also in financing activities we have rights issue to NCI (40%*5m) OF $2 but why is this not a negative figure? Is it that the NCI gave us it’s share of the rights issue?
The way I understand this is that since the NCI is the part owner so we need to give it it’s share of the NCI, so the figure should be in brackets (negative) but the answer has it in positive terms. What’s the logic and reasoning behind this?
Thanks,
Gabriel.
Hi Gabriel
“Is it because we paid 15 to acquire the subsidiary and the subsidiary already had cash of 7 so in essence we just paid 8? Is it something like that?”
That is exactly the reason! We show in Investing Activities the NET CASH FLOW on the acquisition or disposal of a subsidiary. This is explained in the free course notes available on this site! So it could be that, on acquisition, we bought the subsidiary by an issue of shares, a deferred cash payment payable in X years’ time and 10c per share acquired (cash element of 10c x number of shares = say $50,000). The assets of the newly acquired subsidiary on acquisition included a balance of cash of say $80,000.
In the cash flow, under investing activities will appear “Cash flow on acquisition of subsidiary $30,000 INFLOW”
“Also in financing activities we have rights issue to NCI (40%*5m) OF $2 but why is this not a negative figure? Is it that the NCI gave us it’s share of the rights issue?
The way I understand this is that since the NCI is the part owner so we need to give it it’s share of the NCI, so the figure should be in brackets (negative) but the answer has it in positive terms. What’s the logic and reasoning behind this?”
An issue of shares, whether it’s at full price or at a discount on market price (a rights issue) involves the inflow of funds. And this is a statement of CASH flows that we’re preparing. Exceptionally, a bonus issue involves no cash movement, neither in nor out, so a bonus issue is not reflected within a statement of cash flows.
BUT, we do need to take account of a bonus issue when preparing the statement, for two reasons.
1) it accounts for some (or all) of the increase in the issued share capital when comparing this year with last year, and
2) it accounts for some of the difference in the balance on Share Premium Account (or Retained Earnings – wherever the bonus was financed from)
OK?
I understood the thing relating to the investing activities but for financing activity (the rights issue) I still have a doubt. You see you said a rights issue involves the inflow of funds, then why not just take the whole figure of the rights issue of $5M? Why take the NCI proportion of the rights issue of 40 per cent and then recognize the rights issue figure of $2, what’s the use of involving the NCI? Isn’t the cash flow statement for the Parent and not NCI? And if we have shown the NCI share of the rights issue then this is what belongs to the NCI so why not deduct this from the statement of cash flow but instead it’s being added. So are we paying the NCI cash or it’s it paying us? What’s this whole NCI involvement significance?
Hi
I said right at the start of this thread that I don’t have the Jocatt question to hand
Which company is making the rights issue – I presume that it’s the parent. In that case, the NCI is not involved at all, this would be a rights issue to our own shareholders.
If the rights issue is by the subsidiary, then it would be correct to show the parent taking up 60% of the rights at a cash cost of 65% x $5m = $3m (your figures)
But in addition, there is a further $2m coming into the group because the NCI is also taking up their rights
Does that answer it?
The note about the rights issue in the question was
” On 30 November 2010,Tigret made a rights issue on a 1 for 4 basis. The issue was fully subscribed and raised $5 million in cash.”The examiner’s answer is below:
Cash flows from financing activities:
Repayment of long-term borrowings (4)
Rights issue NCI (working (v)) 2
Non-controlling interest dividend (working (v)) (13)
Dividends paid (5)
––––––
Cash flow from financing activities (20)
––––––Yes, now I have a clearer picture that the NCI is subscribing to the subsidiaries (Tigret in that case) rights issue and because Jocatt controls the cash of Tigret, we consolidate this cash received, subscribed by the NCI, into our statements of cash flows.
But based on your answer I have a further doubt. You said that the parent will also show (when the rights issue is by the subsidiary) it’s share of the cash by 60% of $5M, = $3M but like you can see above, the examiner’s answer doesn’t show this calculation. Why?
My error – if it’s a subsidiary rights issue, the money paid by the parent for its share is simply cash paid within the group. It would have helped if I’d been able to see the question!
Sorry to have misled you
No problem. I knew there was something fishy there as the examiner’s published answers are always correct.
Anyway, to wrap up the discussion. I had a doubt (my final doubt on this question) regarding the working of investments in equity instruments. The thing in this question was that there was a step acquisition, and when Tigret, the original investment, became a subsidiary, we (in calculating the investments in equity instruments) derecognize the original investment we made in Tigret when it was a normal investment, that is we deduct the figure for the original investment.
However, in calculating the investments in equity instruments, we still do recognize the gain from $4 to $5 on the step acquisition. Why do we recognize the gain when we have already de-recognized the original investment. This doesn’t make sense at all. Here is an illustration, from the examiner’s answer, to what I’ve talked about above:
(x) Available for sale financial assets
Opening balance at 1 December 2009 90
Acquisitions (cash) 5
Tigret (4)
Gain (including tax) 3
–––
Closing balance at 30 November 2010 94
–––And I’ve solved this problem like this:
Opening 90
Gain on step acquisition of Tigret 1 (5-4)
Gain in other comprehensive income, Gain on available for sale financial assets (AFS) 2
Gain relating to deferred tax 1
Derecognition of equity investment (5) (I don’t understand this entry as what is this whole derecognition thing and why has BPP used 5 when the examiner has used 4 above, what’s the logic behind this whole thing?)
Total = 89
Closing = 94
So cash paid for new acquisitions = 5 (which is the same answer the examiner got)
So what’s this whole thing of de-recognizing, and regarding this equity instruments, I just saw the original question and the examiner has written:
“Other comprehensive income after tax:
Gain on available for sale financial assets (AFS) 2”But the gain on this available for sale financial assets (like for Tigret in the step acquisition from 4 to 5) is then recognized in operating activities despite the fact that the gain was never included because we started with “profit before tax” so why has the examiner included the gain o $1M in operating activities as an adjustments regarding this step acquisition?
Wow! That’s taken me some time to work out!
I’ll repeat what you say the examiner has first:
Brought forward 90
Acquired for cash 5
Derecognise Tigret (4)
Gain including tax on AFS 3Closing balance 94
Now BPP:
Opening balance 90
Gain on step acqn 1 (which takes Tigret to 5, and now derecognise) (5) (which is the same as the (4) above)
Gain on AFS 2
Deferred tax on AFS gain 1Balance of 89 which must mean a
Purchase 5 (to give aClosing balance 94
It’s actually the same as the ACCA answer but tackled from a different angle
Is that ok?
That’s fine but if the examiner hasn’t recognized the gain then why in the operating activities he has written this “Profit on AFS investments (working (ii)) (1)” (He has written this in his published ACCA answer)
Why is this not reflected in the working above? And what’s the reasoning and logic behind de-recognizing this Tigret thing. Why do the thing in the first place?
Also, if you look at the original question (i.e. you look at the P&L account then gains on available for sale investments are recognized in OCI, the examiner writes “Other comprehensive income after tax: Gain on available for sale financial assets (AFS) 2”) so why account for the gain of 1 (from 4 to 5) when it’s not just reflected in “profit before tax” in the first place but is reflected in OCI? This is my major doubt and concern.
But it IS reflected in the movement of AFS on the statement of financial position and surely that’s all the working is trying to do – find the amount of cash spent acquiring new AFS
Don’t forget I’m batting in the dark here (very much like the Indian cricket team at Old Trafford these last few days) so I could be way off track
Yes I guess you are batting in the dark. I didn’t quite get what you said above. My inquiry was that if the appreciation on AFS investments (from 4 to 5 in the step acquisition of Tigret, the subsidiary) goes to other comprehensive income (as evidenced by the P&L a/c given by the examiner in his question) then why deal with this (as an adjustment in the operating activities) because for operating activities we start with “profit before tax” and not “comprehensive income before tax”. I hope you get a better understanding from the above regarding my query.
That’s clearer, thanks. Well, I mean the question is clearer!
That increase of $1m in the fair value of the AFS – when the step acquisition took place, that gain of $1m in the fair value of the investment would have been accounted for by the parent when in the process of determining the overall cost of the (now) subsidiary Tigret
So the parent will have recorded the gain (Dr investment AFS $1m Cr Gain on AFS $1m
Then , on disposal of the AFS investment in Tigret (replacing it with a newly acquired subsidiary) the AFS (now $5m) will need to be eliminated
Hence in the working for AFS we have +1m and -5m (according to my post 4 higher)
So the effect of the step acquisition, the parent will have added the $1m increase into retained earnings and that’s part of the profit before tax. And that’s why there is a $1m adjustment within operating activities.
Does that make sense?
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