TEST BANK Advanced Accountin g Part 2
ZEUS VERNON B. MILLAN
ALL RIGHTS RESERVED 2015
No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means - electronic or mechanical, including photocopying – without the written permission of the author.
ISBN 978-621-95096-5-7
Published by:
BANDOLIN ENTERPRISE No. 100 Montebello Village, Bakakeng Sur, Baguio City 2600, Philippines
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TABLE OF CONTENTS CHAPTER 13 BUSINESS COMBINATIONS (PART 1).............1 OVERVIEW ON THE TOPIC...........................................1 INTRODUCTION........................................................1 OBJECTIVE..............................................................4 SCOPE...................................................................5 DEFINITION OF BUSINESS COMBINATION........................5 Essential elements in the definition of a business combination 5 ACCOUNTING FOR BUSINESS COMBINATION....................7 IDENTIFYING THE ACQUIRER........................................8 DETERMINING THE ACQUISITION DATE.........................10 RECOGNIZING AND MEASURING GOODWILL..................11 Consideration transferred...............................12 Non-controlling interest..................................12 Previously held equity interest in the acquiree13 Net identifiable assets acquired.....................13 RESTRUCTURING PROVISIONS....................................22 SPECIFIC RECOGNITION PRINCIPLES............................23 1. Operating leases.......................................23 2. Intangible assets.......................................26 EXCEPTION TO THE RECOGNITION PRINCIPLE – CONTINGENT LIABILITIES 32 EXCEPTIONS TO BOTH THE RECOGNITION AND MEASUREMENT PRINCIPLES 34 Additional concepts on Consideration transferred 37 EXCEPTIONS TO THE MEASUREMENT PRINCIPLE.............40 CHAPTER 13: SUMMARY..........................................43 CHAPTER 13: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)............................................................44 CHAPTER 13: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).........................................48 CHAPTER 13: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) 55 CHAPTER 14 BUSINESS COMBINATIONS (PART 2)............63 SHARE-FOR-SHARE EXCHANGES.................................63 BUSINESS COMBINATION ACHIEVED IN STAGES..............67 BUSINESS COMBINATION ACHIEVED WITHOUT TRANSFER OF CONSIDERATION 70 MEASUREMENT PERIOD............................................73 DETERMINING WHAT IS PART OF THE BUSINESS COMBINATION TRANSACTION 79 Reacquired rights...........................................82 Settlement of pre-existing relationships between the acquirer and acquiree...................................................82 SUBSEQUENT MEASUREMENT AND ACCOUNTING...........89 DISCLOSURES........................................................96 CHAPTER 14: SUMMARY..........................................96 CHAPTER 14: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)............................................................97 CHAPTER 14: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).........................................99 CHAPTER 14: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................108 CHAPTER 15 BUSINESS COMBINATIONS (PART 3)..........115
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SPECIAL ACCOUNTING TOPICS FOR BUSINESS COMBINATION115 GOODWILL..........................................................115 Due diligence................................................116 Methods of estimating goodwill....................117 REVERSE ACQUISITIONS.........................................122 COMBINATION OF MUTUAL ENTITIES.........................126 CHAPTER 15: SUMMARY........................................127 CHAPTER 15: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................127 CHAPTER 15: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................128 CHAPTER 15: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................132 CHAPTER 15: THEORY OF ACCOUNTS REVIEWER........134 CHAPTER 15 - SUGGESTED ANSWERS TO THEORY OF ACCOUNTS QUESTIONS ........................................................................141 CHAPTER 16 CONSOLIDATED FINANCIAL STATEMENTS (PART 1) 142 OVERVIEW ON THE TOPIC.......................................142 SCOPE...............................................................143 CONTROL...........................................................143 POWER..............................................................144 Administrative rights....................................145 Unilateral rights............................................145 Protective rights...........................................145 Substantive rights........................................146 Voting rights.................................................147 Substantive removal and other rights held by other parties .....................................................................151 EXPOSURE OR RIGHTS TO VARIABLE RETURNS............151 ABILITY TO USE ITS POWER TO AFFECT INVESTOR’S RETURNS 151 ACCOUNTING REQUIREMENTS..................................152 Uniform accounting policies.........................152 Reporting date..............................................152 Consolidation period.....................................153 Measurement................................................153 NON-CONTROLLING INTERESTS (NCI).......................154 PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS154 CONSOLIDATION AT DATE OF ACQUISITION.................155 CONSOLIDATION SUBSEQUENT TO DATE OF ACQUISITION162 Step 1: Analysis of effects of intercompany transaction 162 Step 2: Analysis of net assets.......................162 Step 3: Goodwill computation......................163 Step 4: Non-controlling interest in net assets164 Step 5: Consolidated retained earnings.......164 Step 6: Consolidated profit or loss................164 Step 7: Profit or loss attributable to owners of parent and NCI .....................................................................165 SUBSIDIARY’S OUTSTANDING CUMULATIVE PREFERENCE SHARES 180 CHAPTER 16: SUMMARY........................................181 CHAPTER 16: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................184 CHAPTER 16: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................185
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CHAPTER 16: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................190 CHAPTER 17 CONSOLIDATED FINANCIAL STATEMENTS (PART 2) 193 INTERCOMPANY TRANSACTIONS...............................193 Intercompany sale of inventory....................203 Intercompany sale of property, plant and equipment 212 Intercompany dividends...............................220 Intercompany bond transaction...................228 CHAPTER 17: SUMMARY........................................235 CHAPTER 17: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................236 CHAPTER 18 CONSOLIDATED FINANCIAL STATEMENTS (PART 3) 241 IMPAIRMENT OF GOODWILL....................................241 INTERCOMPANY ITEMS IN-TRANSIT AND RESTATEMENTS.246 CONTINUOUS ASSESSMENT.....................................255 Changes in ownership interest not resulting to loss of control .....................................................................255 Loss of control..............................................261 Derecognition of other comprehensive income266 IMPORTANCE OF CONSOLIDATION.............................269 THEORIES OF CONSOLIDATION.................................269 Historical background...................................272 Advantages and disadvantages of the entity theory 272 ADDITIONAL ILLUSTRATIONS:...................................274 CONSOLIDATION OF REVERSE ACQUISITION................288 SPECIAL PURPOSE ENTITIES....................................295 CHAPTER 18: SUMMARY........................................296 CHAPTER 18: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................297 CHAPTER 18: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................297 CHAPTER 19 CONSOLIDATED FINANCIAL STATEMENTS (PART 4) 311 COMPLEX GROUP STRUCTURES................................311 Identifying the acquisition date....................312 Consolidation of a vertical group..................313 Consolidation of a D-shaped (mixed) group. 323 Complex group structure with Associate......327 INVESTMENT IN SUBSIDIARY MEASURED AT OTHER THAN COST 333 PUSH-DOWN ACCOUNTING.....................................338 PFRS 12 DISCLOSURE OF INTERESTS IN OTHER ENTITIES344 CHAPTER 19: SUMMARY........................................346 CHAPTER 19: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................346 CHAPTER 19: THEORY OF ACCOUNTS REVIEWER........353 CHAPTER 19 - SUGGESTED ANSWERS TO REVIEW THEORY QUESTIONS ........................................................................357 CHAPTER 20 SEPARATE FINANCIAL STATEMENTS..........358 OBJECTIVE..........................................................358
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SCOPE...............................................................358 DEFINITIONS........................................................358 PREPARATION OF SEPARATE FINANCIAL STATEMENTS.....359 COST METHOD.....................................................359 FAIR VALUE METHOD.............................................359 EQUITY METHOD..................................................360 DISCLOSURE........................................................361 CHAPTER 20: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................362 CHAPTER 20: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................362 CHAPTER 20: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................363 CHAPTER 20: THEORY OF ACCOUNTS REVIEWER........364 CHAPTER 20 - SUGGESTED ANSWERS TO REVIEW THEORY QUESTIONS ........................................................................364 CHAPTER 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES .............................................................365 OBJECTIVE..........................................................365 Two ways of conducting foreign activities....365 Two main accounting issues.........................365 SCOPE...............................................................366 FUNCTIONAL CURRENCY.........................................366 CHANGE IN FUNCTIONAL CURRENCY.........................368 FOREIGN CURRENCY TRANSACTIONS.........................369 Initial recognition..........................................369 Subsequent measurement...........................370 Monetary items.............................................370 Direct and indirect quotation........................371 RECOGNITION OF EXCHANGE DIFFERENCES................371 ITEMS MEASURED AT OTHER THAN HISTORICAL COST...381 SEVERAL EXCHANGE RATES.....................................383 EXCHANGE DIFFERENCES RECOGNIZED IN OCI...........384 FOREIGN OPERATIONS...........................................385 Translation to the presentation currency......385 Translation procedures.................................386 Translation of a foreign operation.................393 Net investment in a foreign operation..........401 Disposal or partial disposal of a foreign operation 413 HYPERINFLATIONARY ECONOMY...............................414 Translation procedures – Hyperinflationary economy 414 DISCLOSURE........................................................419 CHAPTER 21: SUMMARY........................................419 CHAPTER 21: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................420 CHAPTER 21: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................424 CHAPTER 21: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................435 CHAPTER 21: THEORY OF ACCOUNTS REVIEWER........445 CHAPTER 21 - SUGGESTED ANSWERS TO REVIEW THEORY QUESTIONS ........................................................................453 CHAPTER 22
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ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 1).........................454 OVERVIEW ON THE TOPIC.......................................454 INTRODUCTION....................................................454 PURPOSE OF DERIVATIVES......................................455 Risks.............................................................455 DEFINITION OF A DERIVATIVE..................................456 COMMON TYPES OF DERIVATIVES.............................458 MEASUREMENT OF DERIVATIVES..............................461 NO HEDGING DESIGNATION....................................461 HEDGING............................................................461 Hedging instrument......................................462 Hedged items...............................................463 HEDGE ACCOUNTING.............................................464 Hedging relationships...................................466 FAIR VALUE HEDGES..............................................466 CASH FLOW HEDGES.............................................467 HEDGES OF A NET INVESTMENT IN A FOREIGN OPERATION468 CHAPTER 22: SUMMARY........................................469 CHAPTER 22: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................470 CHAPTER 22: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................473 CHAPTER 23 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 2).........................475 ACCOUNTING FOR FORWARD CONTRACTS..................475 Illustration 1: Fair value hedge of a recognized asset 475 Illustration 2: No hedging designation (Held for speculation) .....................................................................478 Illustration 3: Fair value hedge of a recognized liability 479 Illustration 4: No hedging designation (Held for speculation) .....................................................................482 FAIR VALUE HEDGE OF AN UNRECOGNIZED FIRM COMMITMENT 482 Illustration 5: Fair value hedge of a firm sale commitment .....................................................................483 Illustration 6: Fair value hedge of a firm purchase commitment .....................................................................486 Illustration 7: FV hedge - firm purchase commitment (Present value)...........................................................489 Illustration 8: FV hedge - firm purchase commitment (Present value)...........................................................492 FAIR VALUE HEDGE VS. CASH FLOW HEDGE...............494 FIRM COMMITMENT VS. FORECAST TRANSACTION........495 CHOICE TO DESIGNATE AS EITHER FAIR VALUE HEDGE OR CASH FLOW HEDGE ........................................................................496 SUBSEQUENT ACCOUNTING FOR ACCUMULATED OCI IN CASH FLOW HEDGE ........................................................................496 Illustration 9: Cash flow hedge – forecasted purchase transaction .....................................................................497 Illustration 10: Cash flow hedge of a forecasted sale transaction – Present value (Indirect quotation)................501 Illustration 11: CF hedge of a recognized liability – Present value .....................................................................503
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CHAPTER 23: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................506 CHAPTER 23: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................509 CHAPTER 23: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................518 CHAPTER 24 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 3).........................523 ACCOUNTING FOR FUTURES CONTRACT.....................523 Illustration 1: No hedging designation..........523 Illustration 2: FV hedge of a recognized asset measured at fair value.............................................................525 Illustration 3: FV hedge of a recognized asset measured at LOCON..........................................................527 Illustration 4: Fair value hedge of a firm sale commitment .....................................................................528 CASH FLOW HEDGE – SPECIFIC ACCOUNTING.............530 Illustration 5: CF hedge – Assessment of Hedge effectiveness .....................................................................531 ACCOUNTING FOR OPTIONS....................................535 Illustration 1: Fair value hedge of a recognized asset – Put option .....................................................................535 Illustration 2: No hedging designation – Call option 537 Illustration 3: CF hedge - forecasted transaction (Indirect quotation).....................................................539 ACCOUNTING FOR SWAPS.......................................541 Illustration 1: CF hedge - variable-rate debt (Payment at maturity)......................................................541 Illustration 2: CF hedge - variable-rate debt (Periodic payments) .....................................................................543 FAIR VALUE HEDGE – HEDGED ITEM IS MEASURED AT AMORTIZED COST ........................................................................547 Illustration 3: Fair value hedge of a fixed-rate debt547 CHAPTER 24: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................552 CHAPTER 24: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................560 CHAPTER 25 ACCOUNTING FOR DERIVATIVES AND HEDGING TRANSACTIONS (PART 4).........................569 ACCOUNTING FOR NET INVESTMENT HEDGES.............569 Illustration: Hedge of a net investment in foreign operation .....................................................................569 EMBEDDED DERIVATIVES........................................574 Hybrid contracts with financial asset hosts. .575 Separation of embedded derivative from host contract 575 ADDITIONAL ILLUSTRATIONS:...................................576 CHAPTER 25: SUMMARY........................................584 CHAPTER 25: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................585 CHAPTER 25: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................585 CHAPTER 25: THEORY OF ACCOUNTS REVIEWER........591
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CHAPTER 25 - SUGGESTED ANSWERS TO THEORY OF ACCOUNTS ........................................................................614
QUESTIONS
CHAPTER 26 CORPORATE LIQUIDATION AND REORGANIZATION 615 INTRODUCTION....................................................615 CORPORATE LIQUIDATION.......................................615 Measurement basis......................................615 Financial reports...........................................616 REORGANIZATION.................................................642 Types of corporate reorganization................642 CHAPTER 26: SUMMARY........................................643 CHAPTER 26: MULTIPLE CHOICE – THEORY (FOR CLASSROOM INSTRUCTION PURPOSES)..........................................................646 CHAPTER 26: MULTIPLE CHOICE – COMPUTATIONAL (FOR CLASSROOM INSTRUCTION PURPOSES).......................................651 CHAPTER 26: EXERCISES (FOR CLASSROOM INSTRUCTION PURPOSES) ........................................................................658 APPENDICES APPENDIX A...........................................664 INTERMEDIATE FINANCIAL ACCOUNTING - PART 1A CONTENTS AT A GLANCE APPENDIX B...........................................665 INTERMEDIATE FINANCIAL ACCOUNTING - PART 1B CONTENTS AT A GLANCE APPENDIX C...........................................666 INTERMEDIATE FINANCIAL ACCOUNTING - PART 2 CONTENTS AT A GLANCE APPENDIX D...........................................667 INTERMEDIATE FINANCIAL ACCOUNTING - PART 3 CONTENTS AT A GLANCE APPENDIX E............................................668 ADVANCED ACCOUNTING - PART 1 CONTENTS AT A GLANCE REFERENCES..........................................669
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Chapter 13 Business Combinations (Part 1) Chapter 13: Multiple Choice – Computational (For classroom instruction purposes) Measuring goodwill / gain on bargain purchase Use the following information for the next two questions: Fact pattern On January 1, 20x1, DIMINUTIVE Co. acquired all of the assets and assumed all of the liabilities of SMALL, Inc. As of this date, the carrying amounts and fair values of the assets and liabilities of SMALL acquired by DIMINUTIVE are shown below: Carrying Assets amounts Fair values Cash in bank 40,000 40,000 Receivables 800,000 480,000 Allowance for probable losses on (120,000) receivables Inventory 2,080,000 1,400,000 Building – net 4,000,000 4,400,000 Goodwill 400,000 80,000 Total assets 7,200,000 6,400,000 Liabilities Payables
1,600,000
1,600,000
On the negotiation for the business combination, DIMINUTIVE Co. incurred transaction costs amounting to ₱400,000 for legal, accounting, and consultancy fees. 1. Case #1: If DIMINUTIVE Co. paid ₱6,000,000 cash as consideration for the assets and liabilities of SMALL, Inc., how much is the goodwill (gain on bargain purchase) on the business combination? a. 1,200,000 b. 1,120,000 c. 1,280,000 d. 1,240,000 2. Case #2: If DIMINUTIVE Co. paid ₱4,000,000 cash as consideration for the assets and liabilities of SMALL, Inc., how much is the goodwill (gain on bargain purchase) on the business combination? a. (800,000) b. (720,000) c. (880,000) d. 1,200,000 Non-controlling interests Use the following information for the next four questions: Fact pattern On January 1, 20x1, KNAVE acquired 80% of the equity interests of RASCAL, Inc. in exchange for cash. Because the former owners of RASCAL needed to dispose of their investments in RASCAL by a specified date, they did not have sufficient time to market RASCAL to multiple potential buyers.
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As January 1, 20x1, RASCAL’s identifiable assets and liabilities have fair values of ₱4,800,000 and ₱1,600,000, respectively. Case #1: Non-controlling interest measured at fair value 3. KNAVE Co. elects the option to measure non-controlling interest at fair value. An independent consultant was engaged who determined that the fair value of the 20% non-controlling interest in RASCAL, Inc. is ₱620,000. If KNAVE Co. paid ₱4,000,000 cash as consideration for the 80% interest in RASCAL, Inc., how much is the goodwill (gain on bargain purchase) on the business combination? a. 800,000 b. 2,060,000 c. 1,440,000 d. 1,420,000 Case #2: Non-controlling interest measured at fair value 4. KNAVE Co. elects the option to measure non-controlling interest at fair value. An independent consultant was engaged who determined that the fair value of the 20% non-controlling interest in RASCAL, Inc. is ₱620,000. If KNAVE Co. paid ₱2,400,000 cash as consideration for the 80% interest in RASCAL, Inc., how much is the goodwill (gain on bargain purchase) on the business combination? a. (180,000) b. (800,000) c. (160,000) d. (200,000) Case #3: Non-controlling interest measured at fair value 5. KNAVE Co. elects the option to measure non-controlling interest at fair value. A value of ₱1,000,000 is assigned to the 20% noncontrolling interest in RASCAL, Inc. [(₱4M ÷ 80%) x 20% = 1,000,000]. If KNAVE Co. paid ₱4,000,000 cash as consideration for the 80% interest in RASCAL, Inc., how much is the goodwill (gain on bargain purchase) on the business combination? a. 200,000 b. 1,800,000 c. 2,440,000 d. 1,440,000 Case #4: Non-controlling interest’s proportionate share in net assets 6. KNAVE Co. elects the option to measure the non-controlling interest at the non-controlling interest’s proportionate share of RASCAL, Inc.’s net identifiable assets If KNAVE Co. paid ₱4,000,000 cash as consideration for the 80% interest in RASCAL, Inc. and, how much is the goodwill (gain on bargain purchase) on the business combination? a. 1,440,000 b. 800,000 c. 1,400,000 c. 960,000 Transaction costs Use the following information for the next two questions: Fact pattern
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On January 1, 20x1, SMUTTY acquired all of the identifiable assets and assumed all of the liabilities of OBSCENE, Inc. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. SMUTTY incurred the following acquisition-related costs: legal fees, ₱40,000, due diligence costs, ₱400,000, and general administrative costs of maintaining an internal acquisitions department, ₱80,000. 7. Case #1: As consideration for the business combination, SMUTTY Co. transferred 8,000 of its own equity instruments with par value per share of ₱400 and fair value per share of ₱500 to OBSCENE’s former owners. Costs of registering the shares amounted to ₱160,000. How much is the goodwill (gain on bargain purchase) on the business combination? a. 716,000 b. 556,000 c. 600,000 d. 1,200,000 8. Case #2: As consideration for the business combination, SMUTTY Co. issued bonds with face amount and fair value of ₱4,000,000. Transaction costs incurred in issuing the bonds amounted to ₱200,000. How much is the goodwill (gain on bargain purchase) on the business combination? a. 716,000 b. 556,000 c. 600,000 d. 1,200,000 Restructuring provisions 9. On January 1, 20x1, ENTREAT Co. acquired all of the identifiable assets and assumed all of the liabilities of BEG, Inc. by paying cash of ₱4,000,000. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. ENTREAT Co. has estimated restructuring provisions of ₱800,000 representing costs of exiting the activity of BEG, costs of terminating employees of BEG, and costs of relocating the terminated employees. How much is the goodwill (gain on bargain purchase)? a. 1,080,000 b. 1,280,000 c. 1,120,000 d. 1,200,000 Specific recognition principles – Operating leases Fact pattern On January 1, 20x1, HISTRIONAL Co. acquired all of the identifiable assets and assumed all of the liabilities of THEATRICAL, Inc. by paying cash of ₱4,000,000. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. Case #1: Acquiree is the lessee – terms are favorable 10. As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being rented out to THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of the operating lease on the building compared with market terms are favorable. The fair value of the differential is estimated at ₱80,000. How much is the goodwill (gain on bargain purchase)? a. 1,080,000 b. 1,280,000 c. 1,120,000 d. 1,200,000 Case #2: Acquiree is the lessee – terms are unfavorable
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11. As of January 1, 20x1, HISTRIONAL holds a building and a patent which are being rented out to THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of the operating lease on the patent compared with market terms are unfavorable. The fair value of the differential is estimated at ₱80,000. How much is the goodwill (gain on bargain purchase)? a. 1,080,000 b. 1,280,000 c. 1,120,000 d. 1,200,000 Case #3: Acquiree is the lessor 12. As of January 1, 20x1, HISTRIONAL is renting a building and a patent from THEATRICAL, Inc. under operating leases. HISTRIONAL has determined that the terms of the operating lease on the building compared with market terms are favorable. The fair value of the differential is estimated at ₱80,000. How much is the goodwill (gain on bargain purchase)? a. 1,080,000 b. 1,280,000 c. 1,120,000 d. 1,200,000 Intangible assets – separability and contractual-legal criteria 13. On January 1, 20x1, LITHE Co. paid cash of ₱6,000,000 in exchange for all of the net assets of FLEXIBLE, Inc. As of this date, the carrying amounts and fair values of the assets and liabilities of FLEXIBLE acquired by LITHE are shown below: Carrying Fair Assets amounts values Cash 40,000 40,000 1,480,00 2,760,000 Receivables 0 Allowance for probable losses on (400,000) receivables 4,400,00 4,000,000 Property, plant and equipment 0 Computer software 400,000 Patent 200,000 Goodwill 400,000 80,000 6,200,00 7,200,000 Total assets 0 Liabilities Bonds payable (w/ face amount of ₱1,600,000)
1,600,000
1,800,00 0
In applying the recognition and measurement principles under PFRS 3, LITHE Co. has identified the following unrecorded intangible assets: Fair Type of intangible asset value Research and development 200,000 projects Customer list 160,000 Customer contract #1 120,000 Customer contract #2 80,000 Order (production) backlog 40,000 Internet domain name 60,000 Trademark 100,000
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Trade secret processes Mask works Total
140,000 180,000 1,080,0 00
Additional information: The computer software is considered obsolete. The patent has a remaining useful life of 10 years and a remaining legal life of 12 years. FLEXIBLE, Inc. recognized the research and development costs as expenses when they were incurred. Customer contract #1 refers to an agreement between FLEXIBLE, Inc. and Numbers Co., a customer, wherein FLEXIBLE, Inc. is to supply goods to Numbers Co. for a period of 5 years. As of acquisition date, the remaining period in the agreement is 3 years. LITHE and FLEXIBLE believe that Numbers Co. will renew the agreement at the end of the current contract. The agreement is not separable. Customer contract #2 refers to FLEXIBLE’s insurance segment’s portfolio of one-year motor insurance contracts that are cancellable by policyholders. FLEXIBLE, Inc. transacts with its customers solely through purchase and sales orders. As of acquisition date, has a backlog of customer purchase orders from 60% of its customers, all of whom are recurring customers. The other 40% of FLEXIBLE’s customers are also recurring customers. However, as of acquisition date, FLEXIBLE has no open purchase orders or other contracts with those customers. The internet domain name is registered. How much is the goodwill (gain on bargain purchase)? a. 900,000 b. 600,000 c. 420,000 d. 1,680,000 Other recognition and measurement principles 14. On January 1, 20x1, SUBTERFUGE Co. acquired all of the identifiable assets and assumed all of the liabilities of DECEPTION, Inc. by paying cash of ₱4,000,000. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. Additional information: SUBTERFUGE intends to sell immediately a factory plant included in the identifiable assets of DECEPTION. All of the “held for sale” classification criteria under PFRS 5 are met. As of January 1, 20x1, the factory plant has a fair value of ₱1,200,000 and a carrying amount of ₱1,000,000 in the books of DECEPTION. Costs to sell the factory plant is ₱80,000. Not included in the identifiable asset of DECEPTION is a research and development intangible asset that SUBTERFUGE does not intend to use. The fair value of this asset is ₱200,000. Also, not included in the identifiable asset of DECEPTION is a customer list, with an estimated value of ₱40,000, in the form of a database where the nature of the information is subject to national laws regarding confidentiality.
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How much is the goodwill (gain on bargain purchase)? a. 1,200,000 b. 1,280,000 c. 1,080,000 1,040,000
d.
Contingent liabilities 15. On January 1, 20x1, CHIDE Co. acquired 90% of the identifiable assets and assumed all of the liabilities of SCOLD, Inc. by paying cash of ₱4,000,000. On this date, SCOLD’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively. Non-controlling interest has a fair value of ₱320,000. As of January 1, 20x1, SCOLD had the following which were not included in the acquisition-date fair value measurement of liabilities: SCOLD has an existing contract with a customer to deliver products at a specified future date. In accordance with the agreement, SCOLD shall pay a penalty for failure to deliver the said goods. CHIDE determined that the fair value of the penalty is ₱40,000. However, because CHIDE expects to comply with the agreement, it was assessed that payment of penalty is improbable. SCOLD has guaranteed a bank loan of a third party. CHIDE shall replace SCOLD as the guarantor. If the third party defaults on the loan, CHIDE will be held liable for the guarantee. CHIDE determined that the fair value of the guarantee is ₱120,000. However, both SCOLD and CHIDE believe that the third party will not default on its loan from the bank. There is a pending unresolved litigation filed by a third party against SCOLD. CHIDE determined that the fair value of settling the litigation is ₱200,000. However, because the legal counsels of both CHIDE and SCOLD strongly believe that they will win the case, it was assessed that payment for the settlement of the litigation is improbable. How much is the goodwill (gain on bargain purchase)? a. 1,880,000 b. 1,200,000 c. 1,560,000 d. 1,520,000 Consideration transferred and indemnification asset 16. On January 1, 20x1, PRODIGIOUS Co. acquired all of the identifiable assets and assumed all of the liabilities of EXTRAORDINARY, Inc. by paying cash of ₱4,000,000. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. The terms of the business combination agreement are shown below: Half of the ₱4,000,000 agreed consideration shall be paid on January 1, 20x1 and the other half on December 31, 20x5. The prevailing market rate as of January 1, 20x1 is 10%. In addition, PRODIGIOUS agrees to provide for the following: a. A piece of land with a carrying amount of ₱2,000,000 and fair value of ₱1,200,000 shall be transferred to the former owners of EXTRAORDINARY. b. After the combination, EXTRAORDINARY’s activities shall be continued by PRODIGIOUS. PRODIGIOUS agrees to provide a patented technology for use in the activities of EXTRAORDINARY. The patented technology has a carrying
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amount of ₱240,000 in the books of PRODIGIOUS and a fair value of ₱320,000. Included in the liabilities assumed is an estimated liability on a pending lawsuit filed against EXTRAORDINARY by a third party with an acquisition-date fair value of ₱400,000. The carrying amount of the liability in EXTRAORDINARY’s books immediately before the business combination is ₱480,000. EXTRAORDINARY guarantees to indemnify PRODIGIOUS for any settlement amount of the liability in excess of ₱480,000. How much is the goodwill (gain on bargain purchase)? a. 1,721,843 b. 1,561,843 c. 1,641,843 2,320,000
d.
Deferred taxes 17. On January 1, 20x1, ATTAINDER Co. acquired all of the assets and assumed all of the liabilities of DISHONOR, Inc. As of this date, the carrying amounts and fair values of the assets and liabilities of DISHONOR acquired by ATTAINDER are shown below: Carrying Assets amounts Fair values Cash in bank 40,000 40,000 Receivables 800,000 480,000 Allowance for probable losses on (120,000) receivables Inventory 2,080,000 1,400,000 Building – net 4,000,000 4,400,000 Goodwill 400,000 80,000 Total assets 7,200,000 6,400,000
Liabilities Payables
1,600,000
1,600,000
ATTAINDER Co. paid ₱6,000,000 cash as consideration for the assets and liabilities of DISHONOR, Inc. It was determined on acquisition date that DISHONOR, Inc. has an unrecorded patent with a fair value of ₱120,000 and a contingent liability with fair value of ₱80,000. Although adjustments are to be made to the carrying amounts of the assets and liabilities, no adjustments shall be made to their tax bases. All adjustments to the carrying amounts of assets and liabilities result to temporary differences. ATTAINDER’s tax rate is 30%. How much is the goodwill (gain on bargain purchase) on the business combination? a. 1,148,000 b. 1,108,000 c. 1,028,000 d. 1,240,000 Consideration transferred – Dividends on 18. On January 1, 20x1, FARCICAL Co. acquired all of the assets and liabilities of ABSURD, Inc. for ₱6.4M. As of this date, the
7
carrying amounts and fair values of the assets and liabilities of ABSURD are shown below: Carrying Assets amounts Fair values Cash in bank 40,000 40,000 Receivables 800,000 480,000 Allowance for probable losses on (120,000) receivables Inventory 2,080,000 1,400,000 Building – net 4,000,000 4,400,000 Goodwill 400,000 80,000 Total assets 7,200,000 6,400,000
Liabilities Dividends payable Other payables
400,000 1,600,000 2,000,000
400,000 1,600,000 2,000,000
The dividends payable pertain to dividends declared by ABSURD, Inc. on December 28, 20x0 to shareholders of record on January 15, 20x1. The dividends will be distributed on January 31, 20x1. How much is the goodwill (gain on bargain purchase)? a. 1,280,000 b. 2,080,000 c. 2,480,000 d. 1,680,000
8
Chapter 14 Business Combinations (Part 2) Chapter 14: Multiple Choice – Computational (For classroom instruction purposes) Consideration transferred – Measurement Use the following information for the next five questions: On January 1, 20x1, COLLOQUY Co. acquired all of the identifiable assets and assumed all of the liabilities of CONVERSATION, Inc. by issuing its own ordinary shares. Information at acquisition date is shown below: COLLOQUY CONVERSATION Combine Co. , Co. d entity (carrying amounts) (fair values) 16,000,00 9,600,000 6,400,000 Identifiable assets 0 Goodwill ? Total assets 9,600,000 6,400,000 ? Liabilities Share capital Share premium Retained earnings Total liabilities & equity
2,800,000 2,400,000 1,200,000 3,200,000
3,600,000 1,200,000 1,000,000 600,000
6,400,000 2,800,000 4,800,000 ?
9,600,000
6,400,000
?
Additional information: COLLOQUY’s share capital consists of 60,000 ordinary shares with par value of ₱40 per share. CONVERSATION’s share capital consists of 3,000 ordinary shares with par value of ₱400 per share. 1. How much is the fair value of consideration transferred on the business combination? a. 4,000,000 b . 2,400,000 c. 4,400,000 d. 4,800,000 2. How many shares were issued in the business combination? a. 40,000 b. 12,000 c. 36,000 d. 10,000 3. How much is the acquisition-date fair value per share? a. 400 b. 440 c. 280 d. 360 4. How much goodwill was recognized on acquisition date? a. 980,000 b. 1,200,000 c. 1,280,000 d. 1,080,000 5. What is the retained earnings of the combined entity immediately after the business combination? a. 3,120,000 b. 3,320,000 c. 3,280,000 d. 3,200,000 Fair value of acquirer’s shares is reliably determinable
9
Use the following information for the next three questions: On January 1, 20x1, CONJUNCTION Co., and UNION, Inc. entered into a business combination effected through exchange of equity instruments. The combination resulted to CONJUNCTION obtaining 100% interest in UNION. Both of the combining entities are publicly listed. As of this date, CONJUNCTION’s shares have a quoted price of ₱400 per share. CONJUNCTION Co. recognized goodwill of ₱300,000 on the business combination. No acquisition-related costs were incurred. Additional selected information at acquisition date is shown below: CONJUNCTION Combined Co. entity (before acquisition) (after acquisition) Share capital 2,400,000 2,800,000 Share premium 1,200,000 4,800,000 Totals 3,600,000 7,600,000 6. How many shares were issued by CONJUNCTION Co. in the business combination? a. 40,000 b. 20,000 c. 12,000 d. 10,000 7. What is the par value per share of the shares issued? a. 10 b. 40 c. 12 d. 32 8. What is the acquisition-date fair value of the net identifiable assets of UNION? a. 3,700,000 b. 3,200,000 c. 2,800,000 d. 2,400,000 Business combination achieved in stages – from PFRS 9 Use the following information for the next two questions: Fact pattern On January 1, 20x1, FORTITUDE Co. acquired 15% ownership interest in ENDURANCE, Inc. for ₱400,000. The investment was accounted for under PFRS 9. From 20x1 to the end of 20x3, FORTITUDE recognized net fair value gains of ₱200,000. On January 1, 20x4, FORTITUDE acquired additional 60% ownership interest in ENDURANCE, Inc. for ₱3,200,000. As of this date, FORTITUDE has identified the following: a. The previously held 15% interest has a fair value of ₱720,000. b. ENDURANCE’s net identifiable assets have a fair value of ₱4,000,000. c. FORTITUDE elected to measure non-controlling interests at the non-controlling interest’s proportionate share of ENDURANCE’s identifiable net assets. 9. Scenario #1: The previously held interest was initially classified as FVPL. How much is the goodwill (gain on bargain purchase)? a. 200,000 b. 420,000 c. 920,000 d. 540,000 10. Scenario #2: The previously held interest was initially classified as FVOCI. How much is the goodwill (gain on bargain purchase)? a. 200,000 b. 420,000 c. 920,000 d. 540,000
10
Business combination achieved in stages – from PAS 28 11. On January 1, 20x1, OBDURATE Co. acquired 30% ownership interest in STUBBORN, Inc. for ₱400,000. Because the investment gave OBDURATE significant influence over STUBBORN, the investment was accounted for under the equity method in accordance with PAS 28. From 20x1 to the end of 20x3, OBDURATE recognized ₱200,000 net share in the profits of the associate and ₱40,000 share in dividends. Therefore, the carrying amount of the investment in associate account on January 1, 20x3, is ₱560,000. On January 1, 20x4, OBDURATE acquired additional 60% ownership interest in STUBBORN, Inc. for ₱3,200,000. As of this date, OBDURATE has identified the following: a. The previously held 30% interest has a fair value of ₱720,000. b. STUBBORN’s net identifiable assets have a fair value of ₱4,000,000. c. OBDURATE elected to measure non-controlling interests at the noncontrolling interest’s proportionate share of STUBBORN’s identifiable net assets. How much is the goodwill? a. 320,000 b. 240,000 c. 280,000 d. 360,000 Business combination achieved without transfer of consideration 12. OBSTREPEROUS Co. and NOISY, Inc. both engage in the same business. On January 1, 20x1, OBSTREPEROUS and NOISY signed a contract, the terms of which resulted in OBSTREPEROUS obtaining control over NOISY without any transfer of consideration between the parties. The fair value of the identifiable net assets of NOISY, Inc. on January 1, 20x1 is ₱4,000,000. NOISY chose to measure non-controlling interest at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets. How much is the goodwill? a. 4,000,000 b.0 c. a or c d. This is not a business combination Business combination achieved without transfer of consideration 13. BUCOLIC Co. owns 36,000 shares representing 40% ownership interest in RURAL, Inc.’s 90,000 outstanding ordinary shares. BUCOLIC accounts for the investment under the equity method. On January 1, 20x1, RURAL reacquired 30,000 of its own shares from other investors so that BUCOLIC shall obtain control over RURAL. The following were determined as of acquisition date: a. The previously held 40% interest has a fair value of ₱720,000. b. RURAL’s net identifiable assets have a fair value of ₱4,000,000. c. BUCOLIC elected to measure non-controlling interests at the noncontrolling interest’s proportionate share of RURAL’s identifiable net assets. How much is the goodwill?
11
a. (1,680,000)
b. (1,320,000)
c. (880,000)
d. 0
Provisional amounts – identifiable assets acquired Use the following information for the next three questions: Fact pattern On September 30, 20x1, INNOCUOUS Co. acquired all of the identifiable assets and assumed all of the liabilities of HARMLESS, Inc. by paying cash of ₱4,000,000. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. Case #1: Identifiable asset recognized at provisional amount 14. INNOCUOUS engaged an independent valuer to appraise a building acquired from HARMLESS. However, the valuation report was not received by the time INNOCUOUS authorized for issue its financial statements for the year ended December 31, 20x1. As such, the building was assigned a provisional amount of ₱2,800,000. Also, the building was tentatively assigned an estimated useful life of 10 years from acquisition date. INNOCUOUS uses the straight line method of depreciation and recognized three months’ depreciation on the building for 20x1. On July 1, 20x2, INNOCUOUS finally received the valuation report from the independent valuer which shows that the fair value of the building as of September 30, 20x1 is ₱2,000,000 and remaining useful from that date is 5 years. How should INNOCUOUS account for the new information obtained? a. As a retrospective adjustment to the provisional amount of the building resulting to increase in goodwill by ₱800,000. b. As a retrospective adjustment to the provisional amount of the building resulting to decrease in goodwill by ₱800,000. c. As a retrospective restatement to the provisional amount of the building resulting to increase in goodwill by ₱800,000. The adjustment is treated as a correction of a prior period error. d. The new information obtained is ignored. No adjustment to goodwill is necessary. Case #2: Unrecorded identifiable asset acquired 15. On July 1, 20x2, INNOCUOUS obtained new information that HARMLESS has an unrecorded patent which was not identified on September 30, 20x1. It was believed that the unrecorded patent had a fair value of ₱400,000 and a remaining useful life of 4 years as of September 30, 20x1. How should INNOCUOUS account for the new information obtained? a. As a retrospective adjustment to record the previously unrecorded patent resulting to increase in goodwill by ₱400,000. b. As a retrospective adjustment to record the previously unrecorded patent resulting to decrease in goodwill by ₱400,000. c. As a retrospective restatement to record the previously unrecorded patent resulting to decrease in goodwill by ₱400,000. The adjustment is treated as a correction of a prior period error.
12
d. The new information obtained is ignored. No adjustment to goodwill is necessary. Case #3: Information obtained beyond measurement period 16. On November 1, 20x2, the internal auditors of INNOCUOUS discovered an error on the recorded identifiable assets acquired from HARMLESS on the business combination. A patent with a fair value of ₱400,000 and a remaining useful life of 4 years as of September 30, 20x1 was omitted from the valuation listing. How should INNOCUOUS account for the new information obtained? a. As a retrospective adjustment to record the previously unrecorded patent resulting to increase in goodwill by ₱400,000. b. As a retrospective adjustment to record the previously unrecorded patent resulting to decrease in goodwill by ₱400,000. c. As a retrospective restatement to record the previously unrecorded patent resulting to decrease in goodwill by ₱400,000. The adjustment is treated as a correction of a prior period error. d. The new information obtained is ignored. No adjustment to goodwill is necessary.
Provisional amounts – consideration transferred 17. On September 30, 20x1, RIBALD Co. acquired all of the identifiable assets and assumed all of the liabilities of OFFENSIVE, Inc. by issuing 10,000 shares with par value of ₱20 per share. On this date, RIBALD’s shares were assigned a provisional value of ₱400 per share. Also, because some identifiable assets acquired and liabilities assumed have fair values that were not readily available, a provisional amount of ₱2,800,000 was assigned to OFFENSIVE’s net identifiable assets. On April 1, 20x2, after RIBALD’s 20x1 financial statements were issued, new information was obtained confirming that the fair value of RIBALD’s shares on September 30, 20x1 is ₱440 per share and that the fair value of OFFENSIVE’s net identifiable assets as of September 30, 20x1 is ₱3,600,000. On July 1, 20x2, two competitors of RIBALD have also merged which led to RIBALD believing that the merger with OFFENSIVE is not as profitable as expected. RIBALD now wants to decrease the amount assigned to the consideration transferred to OFFENSIVE on September 30, 20x1 to ₱360 per share and the value of OFFENSIVE’s net identifiable assets to ₱1,600,000. How should RIBALD account for the new information obtained on July 1, 20x2? a. As a retrospective adjustment resulting to increase in goodwill by ₱400,000. b. As a retrospective adjustment resulting to decrease in goodwill by ₱400,000.
13
c. As a retrospective restatement resulting to decrease in goodwill by ₱400,000. The adjustment is treated as a correction of a prior period error. d. The new information obtained is ignored. No adjustment to goodwill is necessary. Determining what is part of the business combination transaction 18. On January 1, 20x1, DIAPHANOUS Co. acquired all of the identifiable assets and assumed all of the liabilities of TRANSPARENT, Inc. by paying cash of ₱4,000,000. On this date, the identifiable assets acquired and liabilities assumed have fair values of ₱6,400,000 and ₱3,600,000, respectively. Additional information: In addition to the business combination transaction, the following have also transcribed during the negotiation period: a. After the business combination, TRANSPARENT will enter into liquidation and DIAPHANOUS agreed to reimburse TRANSPARENT for liquidation costs estimated at ₱80,000. b. DIAPHANOUS agreed to reimburse TRANSPARENT for the appraisal fee of a building included in the identifiable assets acquired. The agreed reimbursement is ₱40,000. c. DIAPHANOUS entered into an agreement to retain the top management of TRANSPARENT for continuing employment. On acquisition date, DIAPHANOUS agreed to pay the key employees signing bonuses totaling ₱400,000. d. To persuade, Mr. Five-six Numerix, the previous major shareholder of TRANSPARENT, to sell his major holdings to DIAPHANOUS, DIAPHANOUS agreed to pay an additional ₱200,000 directly to Mr. Numerix. e. Included in the valuation of identifiable assets are inventories with fair value of ₱360,000. Ms. Vital Statistix, a former major shareholder of TRANSPARENT, shall acquire title to the goods. How much is the goodwill (gain on bargain purchase)? a. 1,680,000 b. 1,640,000 c. 1,760,000 1,240,000
d.
Settlement of pre-existing relationship - Reacquired right 19. On January 1, 20x1, THRALL Co. acquired all of the identifiable assets and assumed all of the liabilities of SLAVE, Inc. by paying cash of ₱4,000,000. On this date, SLAVE’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively. Prior to business combination, THRALL has sold a license to SLAVE. The licensing agreement granted SLAVE the right to use THRALL’s patented technology for a period of 5 years. THRALL received ₱400,000 for the license on grant date and royalty fees based on SLAVE’s sales. THRALL recognized the license fee as deferred liability and amortized it over 5 years. The carrying amount of the deferred liability on January 1, 20x1 is ₱240,000.
14
On the other hand, SLAVE recognized the license fee paid to THRALL as prepayment and amortized it based on the number of products sold. The carrying amount of the prepayment on January 1, 20x1 is ₱200,000. On January 1, 20x1, THRALL has determined that the fair value of the license agreement is ₱480,000. The fair value determined consists of ₱160,000 “at-market” (based on market participants' estimates) and ₱320,000 “off-market” (based on the excess of fair value derived from cash flow estimates over at-market values; ₱480,000 – ₱160,000) components. The off-market component is favorable to SLAVE and unfavorable to THRALL, as royalty rates have increased considerably in comparable markets since the initiation of the contract. The contract does not have any cancellation clause or any minimum royalty payment requirements. How much is the goodwill (gain on bargain purchase)? a. 1,200,000 b. 840,000 c. 980,000 d. 920,000 Settlement of pre-existing relationship – Not a reacquired right 20. MULIEBRITY Co. purchases raw materials from FEMINITY, Inc. under a five-year supply contract at fixed rates. Currently, the fixed rates are higher than the rates at which MULIEBRITY could purchase similar raw materials from another supplier. MULIEBRITY is allowed under the supply agreement to terminate the contract before the end of the five-year term, but only by paying a ₱400,000 penalty. On January 1, 20x1, with three years remaining under the supply contract, MULIEBRITY Co. acquired all of the identifiable assets and assumed all of the liabilities of FEMINITY, Inc. by paying cash of ₱4,000,000. On this date, FEMINITY’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively. Included in the total fair value of FEMINITY is ₱640,000 related to the fair value of the supply contract with MULIEBRITY. The ₱640,000 represents a ₱280,000 component that is “at market” because the pricing is comparable to pricing for current market transactions for the same or similar items (selling effort, customer relationships and so on) and a ₱360,000 component for pricing that is unfavorable to MULIEBRITY because it exceeds the price of current market transactions for similar items. There are no other assets or liabilities related to the contract in either MULIEBRITY’s or FEMINITY’s books as of acquisition date. How much is the goodwill (gain on bargain purchase)? a. 840,000 b. 1,200,000 c. 920,000 d. 980,000 Settlement of pre-existing relationship – Non-contractual 21. On January 1, 20x1, DEMULCENT Co. acquired all of the identifiable assets and assumed all of the liabilities of EMBARRASSING, Inc. by paying cash of ₱4,000,000. On this date, EMBARRASSING’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively.
15
As of January 1, 20x1, there is a pending patent infringement suit filed by EMBARRASSING, Inc. against DEMULCENT Co. DEMULCENT recognized a probable loss on the lawsuit amounting the ₱520,000. The patent in question shall be transferred to DEMULCENT after the business combination. DEMULCENT’s legal advisers determined that the fair value of the settlement of the pending lawsuit is ₱400,000. How much is the goodwill (gain on bargain purchase)? a. 840,000 b. 800,000 c. 280,000 d. 920,000 Contingent consideration – Initial and subsequent measurement 22. On January 1, 20x1, VERITY FIRMNESS Co. acquired all of the identifiable assets and assumed all of the liabilities of FIRMNESS, Inc. by paying cash of ₱4,000,000. On this date, FIRMNESS’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively. VERITY agrees to pay an additional amount equal to 10% of the 20x1 year-end profit that exceeds ₱1,600,000. FIRMNESS historically has reported profits of ₱1,200,000 to ₱1,600,000 each year. After assessing the expected level of profits for the year based on forecasts and plans, as well as industry trends, VERITY estimated that the fair value of the contingent consideration is ₱40,000. How much is the goodwill (gain on bargain purchase)? a. 1,180,000 b. 1,200,000 c. 1,240,000 980,000
d.
23. Case #1: (Refer to previous problem) The actual profit for the year is ₱2,200,000. The contingent consideration will be settled on January 15, 20x2. The entry on December 31, 20x1 includes a a. debit to loss of ₱20,000 to be recognized in profit or loss b. credit to gain of ₱20,000 to be recognized in profit or loss c. debit to loss of ₱20,000 to be recognized in OCI d. credit to gain of ₱20,000 to be recognized in OCI 24. Case #2: (Refer to previous problem) The actual profit for the year is ₱1,200,000. The entry on December 31, 20x1 includes a a. debit to loss of ₱40,000 to be recognized in profit or loss b. credit to gain of ₱40,000 to be recognized in profit or loss c. debit to loss of ₱40,000 to be recognized in OCI d. credit to gain of ₱40,000 to be recognized in OCI Contingent consideration – Initial and subsequent measurement 25. On January 1, 20x1, PRECIPITOUS Co. acquired all of the identifiable assets and assumed all of the liabilities of STEEP, Inc. by issuing 10,000 of its own shares with par value of ₱40 per share. On this date, STEEP’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively, while PRECIPITOUS’s shares have fair value of ₱400 per share. In addition, PRECIPITOUS agrees to issue additional 1,000 shares to the former owners of STEEP if the market price per share of
16
PRECIPITOUS’s shares increases to ₱480 per share as of December 31, 20x1. After consideration for the vesting conditions, PRECIPITOUS estimated that the fair value of the contingent consideration on January 1, 20x1 is ₱360,000. How much is the goodwill (gain on bargain purchase)? a. 1,200,000 b. 840,000 c. 1,560,000 d. 980,000 26. Case #1: (Refer to previous problem) The actual market price of PRECIPITOUS’s shares on December 31, 20x1 is ₱480. The contingent consideration will be settled on January 15, 20x2. The entry on December 31, 20x1 includes a. debit to loss of ₱120,000 in profit or loss b. credit gain of ₱120,000 in profit or loss c. debit to loss of ₱120,000 in OCI d. no entry is required 27. Case #2: The actual market price of PRECIPITOUS’s shares on December 31, 20x1 is ₱360. The entry on December 31, 20x1 includes a. debit to loss of ₱120,000 in profit or loss b. credit gain of ₱120,000 in OCI c. a reclassification within equity d. no entry is required Contingent payments to employees 28. On January 1, 20x1, MACABRE Co. acquired 90% of the identifiable assets and assumed all of the liabilities of HORRIBLE, Inc. by paying cash of ₱4,000,000. On this date, HORRIBLE’s identifiable assets and liabilities have fair values of ₱6,400,000 and ₱3,600,000, respectively. Non-controlling interest has a fair value of ₱320,000. Five years ago, HORRIBLE appointed Mr. Boss as the CEO under a ten-year contract. The contract required HORRIBLE to pay the CEO ₱400,000 if HORRIBLE is acquired before the contract expires. On January 1, 20x1, Mr. Boss was still employed and MACABRE assumes the obligation of paying Mr. Boss the contracted amount. How much is the goodwill (gain on bargain purchase)? a. 1,200,000 b. 1,920,000 c. 1,520,000 d. 1,120,000
17
Chapter 15 Business Combinations (Part 3) Chapter 15: Multiple Choice – Computational (For classroom instruction purposes) Applications of the Direct valuation method Use the following information for the next four questions: UNFLEDGED Co. is contemplating on acquiring IMMATURE, Inc. The following information was gathered through a diligence audit: The actual earnings of IMMATURE, Inc. for the past 5 years are shown below: Earning Year s 4,800,00 20x1 0 5,200,00 20x2 0 5,400,00 20x3 0 5,000,00 20x4 0 7,200,00 20x5 0 27,600,0 Total 00
Earnings in 20x5 included an expropriation gain of ₱1,600,000. The fair value of IMMATURE’s net assets as of the end of 20x5 is ₱40,000,000. The industry average rate of return is 12%. Probable duration of “excess earnings” is 5 years.
1. How much is the estimated goodwill using the multiples of average excess earnings method? a. 1,600,000 b. 400,000 c. 920,000 d. 2,000,000 2. How much is the estimated goodwill using the capitalization of average excess earnings method? (Assume a capitalization rate of 25%) a. 1,600,000 b. 400,000 c. 920,000 d. 2,000,000 3. How much is the estimated goodwill using the capitalization of average earnings method? (Assume a capitalization rate of 12.5%) a. 1,600,000 b. 400,000 c. 920,000 d. 2,000,000 4. How much is the estimated goodwill using present value of average excess earnings method? (Assume a discount rate of 10%) a. 1,516,136 b. 1,428,789 c. 1,516,316 d. 1,412,308
18
Applications of the Direct valuation method – Purchase price Use the following information for the next three questions: ABOMINATE Co. is estimating the goodwill in the expected purchase of DISLIKE, Inc. in January 20x6. The following information was determined. Year
Earnings
20x1 20x2 20x3 20x4 20x5 Total
480,000 520,000 540,000 500,000 560,000 2,600,000
Year-end net assets 1,920,000 2,320,000 2,160,000 2,240,000 2,360,000 11,000,000
Case #1: Excess earnings 5. If goodwill is to be measured by capitalizing excess earnings at 30%, with normal return on average net assets at 10%, how much is the purchase price in the contemplated business combination? (The year-end net assets in 20x5 approximate fair value.) a. 5,440,000 b. 2,360,000 c. 3,360,000 d. 3,250,000 Case #2.1: Average earnings 6. If goodwill is to be measured by capitalizing earnings at 16%, how much is the purchase price in the contemplated business combination? (The year-end net assets in 20x5 approximate fair value.) a. 3,360,000 b. 3,250,000 c. 5,440,000 d. 2,360,000 Case #2.2: Average earnings 7. If goodwill is to be measured by capitalizing earnings at 16%, how much is the goodwill? (The year-end net assets in 20x5 approximate fair value.) a. 890,000 b. 1,000,000 c. 3,080,000 d. 0 Applications of the Direct valuation method – Purchase price 8. CONGEAL Co. acquired the net assets of THICKEN, Inc. THICKEN has one asset whose fair value exceeds its carrying amount by ₱4,000,000. THICKEN’s equity is ₱36,000,000. CONGEAL estimated that THICKEN’s excess earnings would last for 5 years and that the return on investment is 10%. THICKEN 's average earnings for negotiation purposes is ₱5,200,000 and the industry average rate of return is 12% on the fair value of net assets. How much is the purchase price using the "present value of average excess earnings" approach to goodwill measurement? a. 1,516,315 b. 3,378,901 c. 43,378,901 d. 41,516,315 Applications of the Direct valuation method – Actual earnings 9. SIBILATE Co. acquired the net assets of HISS, Inc. for ₱41.6M. The acquisition resulted to a goodwill of ₱1,600,000 measured by capitalizing the annual superior earnings of HISS at 25%. The normal rate of return is 12% on net assets before recognition of goodwill. How much is the average earnings of HISS? a. 4,400,000 b. 4,800,000 c. 5,600,000 d. 5,200,000
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Applications of the Direct valuation method Use the following information for the next three questions: DREARY Co. and DISMAL, Inc. decided to combine and set up a new entity – Alphabets Corporation. The individual records of the combining constituents show the following: DREARY DISMAL, Co. Inc. Net assets (at fair 1,600,00 2,400, values) 0 000 Average annual 320,00 480, earnings 0 000 Alphabets Corporation shall issue 10% preference shares with par value per share of ₱400 for the net assets contributions of the combining constituents and ordinary shares with par value per share of ₱200 for the excess of total contributions (net asset contribution plus goodwill) over net assets contributions. It was agreed that the normal rate of return is 10% of net assets. Excess earnings shall be capitalized at 20%. 10. How much are the total contributions by DREARY and DISMAL, respectively? DREARY DISMAL a. 3,600,000 2,400,000 b. 2,400,000 3,600,000 c. 1,600,000 2,400,000 d. 1,800,000 2,200,000 11. How much is the goodwill generated by the contributions of DREARY and DISMAL, respectively? DREARY DISMAL a. 800,000 1,200,000 b. 400,000 600,000 c. 200,000 800,000 d. 920,000 1,360,000 12. What is the ratio of total shares (preference and ordinary) to be issued to DREARY and DISMAL, respectively? DREARY DISMAL a. 20% 20% b. 60% 40% c. 25% 75% d. 40% 60% Reverse acquisition 13. On January 1, 20x1, ZYX, Inc., an unlisted company, acquires CBA Co., a publicly listed entity, through an exchange of equity instruments. CBA Co. issues 5 shares in exchange for each ordinary share of ZYX, Inc. All of ZYX’s shareholders exchange their shares in CBA Co. Therefore, CBA Co. issues 40,000 ordinary shares in exchange for all 8,000 ordinary shares of ZYX, Inc.
20
The fair value of each ordinary share of ZYX at January 1, 20x1 is ₱800. The quoted market price of CBA’s ordinary shares at that date is ₱160. The statements of financial position of the combining entities immediately before combination are shown below: CBA Co. ZYX, Inc. (legal (legal parent, subsidiary, accounting accounting acquiree) acquirer) Identifiable assets 6,400,000 9,600,000 Total assets 6,400,000 9,600,000
Liabilities Share capital: 10,000 ordinary shares, ₱40 par 8,000 ordinary shares, ₱400 par Retained earnings Total liabilities and equity
5,200,000
2,800,000
400,000 3,200,000 800,000 6,400,000
3,600,000 9,600,000
The fair value of CBA’s identifiable assets and liabilities at January 1, 20x1 are the same as their carrying amounts. How much is the goodwill (gain on bargain purchase)? a. (880,000) b. 400,000 c. 540,000 d. 600,000 Combination of mutual entities 14. HOMILY Coop. and SERMON Coop. are cooperative institutions. On January 1, 20x1, the two entities combined, with HOMILY identified as the acquirer. HOMILY shall issue member interests to SERMON. As a result, members of SERMON become members of HOMILY. An estimated cash flow model indicates an acquisitiondate fair valuation of SERMON, as an entity, at ₱4,000,000. The fair value of SERMON’s identifiable net assets is ₱3,200,000. How much is the goodwill? a. 800,000 b. (800,000) c. 3,200,000 d. 0 Chapter 15: Theory of Accounts Reviewer 1. The method required under PFRS 3 to be used in accounting for business combinations is a. Purchase method c. Acquisition method b. Buy method d. Combination method 2. Should the following costs be included in the consideration transferred in a business combination, according to PFRS 3 Business Combinations? I. Costs of maintaining an acquisitions department. II. Fees paid to accountants to effect the combination. a. No No b. No Yes c. Yes No d. Yes Yes (Adapted) 3. PFRS 3 requires that the contingent liabilities of the acquired entity should be recognized in the balance sheet at fair value. The
21
existence of contingent liabilities is often reflected in a lower purchase price. Recognition of such contingent liabilities will a. Decrease the value attributed to goodwill, thus decreasing the risk of impairment of goodwill. b. Decrease the value attributed to goodwill, thus increasing the risk of impairment of goodwill. c. Increase the value attributed to goodwill, thus decreasing the risk of impairment of goodwill. d. Increase the value attributed to goodwill, thus increasing the risk of impairment of goodwill. (Adapted) 4. Are the following statements about an acquisition true or false, according to PFRS 3 Business combinations? I. The acquirer should recognize the acquiree's contingent liabilities if certain conditions are met. II. The acquirer should recognize the acquiree's contingent assets if certain conditions are met. a. False, False b. False, True c. True, False d. True, True (Adapted) 5. Given the following information, how is goodwill from a business combination computed under PFRS 3? A = Consideration transferred B = Non-controlling interest in net assets of subsidiary C = Previously held equity interest D = Fair value of net identifiable assets of subsidiary % = Percentage of ownership acquired by the parent in the subsidiary a. A+B+C-D b. A – (D x %)
c. (A+C) – (D x %) d. (A+B) – [(D x %) – B]
6. In a business combination, an acquirer's interest in the fair value of the net assets acquired exceeds the consideration transferred in the combination. Under PFRS 3 Business Combinations, the acquirer should a. recognize the excess immediately in profit or loss b. recognize the excess immediately in other comprehensive income c. reassess the recognition and measurement of the net assets acquired and the consideration transferred, then recognize any excess immediately in profit or loss d. reassess the recognition and measurement of the net assets acquired and the consideration transferred, then recognize any excess immediately in other comprehensive income (Adapted) 7. Which one of the following reasons would not contribute to the creation of negative goodwill? a. Errors in measuring the fair value of the acquiree’s net identifiable assets or the cost of the business combination. b. A bargain purchase. c. A requirement in an IFRS to measure net assets acquired at a value other than fair value.
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d. Making acquisitions at the top of a “bull” market for shares. (Adapted) 8. The “excess of the acquirer’s interest in the net fair value of acquiree’s identifiable assets, liabilities, and contingent liabilities over cost” (formerly known as negative goodwill) should be a. Amortized over the life of the assets acquired. b. Reassessed as to the accuracy of its measurement and then recognized immediately in profit or loss. c. Reassessed as to the accuracy of its measurement and then recognized in retained earnings. d. Carried as a capital reserve indefinitely. (Adapted) 9. This type of business combination occurs when, for example, a private entity decides to have itself “acquired” by a smaller public entity in order to obtain a stock exchange listing. a. Step acquisition c. Reverse acquisition b. Rewind acquisition d. Stock acquisition 10. Acquisition accounting requires an acquirer and an acquiree to be identified for every business combination. Where a new entity (H) is created to acquire two preexisting entities, S and A, which of these entities will be designated as the acquirer? a. H. b. S. c. A. d. A or S. (Adapted) 11. The aggregate cash flows arising from acquisitions and from disposals of subsidiaries or other business units resulting to loss or obtaining of control are presented separately and classified as a. Operating activities c. Financing activities b. Investing activities d. Disclosed only 12. Cash flows arising from changes in ownership interests in a subsidiary that do not result in a loss of control are classified as cash flows from a. Operating activities c. Financing activities b. Investing activities d. Disclosed only 13. PFRS 3 requires the acquirer in a business combination to measure the acquiree’s identifiable tangible and intangible assets and liabilities at (with some limited exceptions) a. cost c. fair value less transaction costs b. acquisition-date fair value d. some other amount 14. Which of the following accounting methods must be applied to all business combinations under PFRS 3 Business Combinations? a. Pooling of interests method. c. Acquisition method. b. Equity method. d. Purchase method. (Adapted) 15. PESTER TO ANNOY is involved in a business acquisition on January 1, 20x1. At the date of acquisition the deferred tax assets were ₱300,000. On January 1, 20x1, the directors considered that realization of the deferred tax assets were not probable. What
23
effect would this decision have on the allocation of the purchase price? a. The unrecognized deferred tax would be allocated to goodwill, which would increase by ₱300,000. b. The value of goodwill would decrease by ₱300,000. c. There would be no effect on goodwill. d. Negative goodwill of ₱300,000 would arise. (Adapted) 16. A parent entity is acquiring a majority holding in an entity whose shares are dealt in on a recognized market. Under PFRS 3 Business Combinations, which of the following measurement bases may be used in measuring the non-controlling interest at the acquisition date? I. The nominal value of the shares in the acquiree not acquired II. The fair value of the shares in the acquiree not acquired III. The non-controlling interest in the acquiree's assets and liabilities at book value IV. The non-controlling interest in the acquiree's assets and liabilities at fair value a. II only b. I, II and III c. II and IV d. IV only (Adapted) 17. ASININE STUPID Company acquired a 30% equity interest in OBTUSE TORPID Company many years ago. In the current accounting period it acquired a further 40% equity interest in OBTUSE. Are the following statements true or false, according to PFRS 3 Business Combinations? I. ASININE's pre-existing 30% equity interest in OBTUSE should be remeasured at fair value at the acquisition date. II. ASININE's net assets should be remeasured at fair value at the acquisition date. a. False, False b. False, True c. True, False d. True, True (Adapted) 18. The SKEWER Company acquired 80% of PIERCE Company for a consideration transferred of ₱100 million. The consideration was estimated to include a control premium of ₱24 million. PIERCE's net assets were ₱85 million at the acquisition date. Are the following statements true or false, according to PFRS 3 Business Combinations? I. Goodwill should be measured at ₱32 million if the noncontrolling interest is measured at its share of PIERCE's net assets. II. Goodwill should be measured at ₱34 million if the noncontrolling interest is measured at fair value. a. False, False b. False, True c. True, False d. True, True (Adapted) 19. PFRS 3 requires all identifiable intangible assets of the acquired business to be recorded at their fair values. Many intangible assets that may have been subsumed within goodwill must be now separately valued and identified. Under PFRS 3, when would an intangible asset be “identifiable”?
24
a. When it meets the definition of an asset in the Conceptual Framework document only. b. When it meets the definition of an intangible asset in PAS 38, Intangible Assets, and its fair value can be measured reliably. c. If it has been recognized under local generally accepted accounting principles even though it does not meet the definition in PAS 38. d. Where it has been acquired in a business combination. (Adapted) 20. Which of the following examples is unlikely to meet the definition of an intangible asset for the purpose of PFRS 3? a. Marketing related, such as trademarks and internet domain names. b. Customer related, such as customer lists and contracts. c. Technology based, such as computer software and databases. d. Pure research based, such as general expenditure on research. (Adapted) 21. An intangible asset with an indefinite life is one where a. There is no foreseeable limit on the period over which the asset will generate cash flows. b. The length of life is over 20 years. c. The directors feel that the intangible asset will not lose value in the foreseeable future. d. There is a contractual or legal arrangement that lasts for a period in excess of five years. (Adapted) 22. An intangible asset with an indefinite life is accounted for as follows: a. No amortization but annual impairment test. b. Amortized and impairment tests annually. c. Amortize and impairment tested if there is a “trigger event.” d. Amortized and no impairment test. (Adapted) 23. An acquirer should at the acquisition date recognize goodwill acquired in a business combination as an asset. Goodwill should be accounted for as follows: a. Recognize as an intangible asset and amortize over its useful life. b. Write off against retained earnings. c. Recognize as an intangible asset and impairment test when a trigger event occurs. d. Recognize as an intangible asset and annually impairment test (or more frequently if impairment is indicated). (Adapted) 24. If the impairment of the value of goodwill is seen to have reversed, then the company may a. Reverse the impairment charge and credit income for the period. b. Reverse the impairment charge and credit retained earnings. c. Not reverse the impairment charge.
25
d. Reverse the impairment charge only if the original circumstances that led to the impairment no longer exist and credit retained earnings. (Adapted) 25. On acquisition, all identifiable assets and liabilities, including goodwill, will be allocated to cash-generating units within the business combination. Goodwill impairment is assessed within the cash-generating units. If the combined organization has cashgenerating units significantly below the level of an operating segment, then the risk of an impairment charge against goodwill as a result of PFRS 3 is a. Significantly decreased because goodwill will be spread across many cash-generating units. b. Significantly increased because poorly performing units can no longer be supported by those that are performing well. c. Likely to be unchanged from previous accounting practice. d. Likely to be decreased because goodwill will be a smaller amount due to the greater recognition of other intangible assets. (Adapted) 26. The management of an entity is unsure how to treat a restructuring provision that they wish to set up on the acquisition of another entity. Under PFRS 3, the treatment of this provision will be a. A charge in the income statement in the postacquisition period. b. To include the provision in the allocated cost of acquisition. c. To provide for the amount and, if the provision is overstated, to release the excess to the income statement in the postacquisition period. d. To include the provision in the allocated cost of acquisition if the acquired entity commits itself to a restructuring within a year of acquisition. (Adapted) 27. MIME TO IMMITATE Co. initially tested its goodwill for impairment on September 30, 20x1. When should MIME perform its second impairment testing on its goodwill? a. on or before September 30, 20x2 b. on or before December 31, 20x2 c. at any date not earlier than September 30, 20x2 d. at any date during 20x2 28. For purposes of impairment testing, PAS 36 a. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s cash-generating units in the year of business combination. b. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s corporate assets in the year of business combination. c. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s cash-generating units 12 months after the date of acquisition.
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d. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s operating segments 3 months after the date of acquisition. 29. On September 1, 20x1, TEPID Co. acquired LUKEWARM Co. in a business combination that resulted to goodwill. By December 31, 20x1, the initial allocation of goodwill is not yet completed. According to PAS 36, TEPID should a. complete the initial allocation before the end of December 31, 20x1. b. complete the initial allocation before the end of December 31, 20x2. c. complete the initial allocation before the end of November 30, 20x1. d. complete the initial allocation before the end of September 1, 20x2. 30. Which of the following is incorrect regarding the accounting for business combinations in accordance with PFRSs? a. Any goodwill recognized on acquisition date should be allocated to the acquirer’s CGUs prior to the end of the year of acquisition. If allocation is incomplete prior to the end of the year of acquisition, the allocation should be completed prior to the end of the immediately preceding year. b. PFRS 3 requires the use of the acquisition method in accounting for business combination. c. Goodwill is computed as the difference between the consideration transferred and the acquisition-date fair value of net identifiable assets acquired. d. In applying the acquisition method, PFRS 3 requires that the acquirer should be identified. 31. For purposes of impairment testing, PAS 36 a. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s cash-generating units in the year of business combination. b. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s corporate assets in the year of business combination. c. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s cash-generating units 12 months after the date of acquisition. d. requires goodwill acquired in a business combination to be allocated to each of the acquirer’s operating segments 3 months after the date of acquisition. 32. Goodwill must not be amortized under PFRS 3. The transitional rules do not require restatement of previous balances written off. If an entity is adopting PFRS for the first time, and it wishes to restate all prior acquisitions in accordance with PFRS 3, then it must apply the PFRS to a. Those acquisitions selected by the entity. b. All acquisitions from the date of the earliest. c. Only those acquisitions since the issue of the PFRS 3 and PAS 22, Business Combinations, to the earlier ones.
27
d. Only past and present acquisitions of entities that have previously and currently prepared their financial statements using PFRS. (Adapted) 33. On September 1, 20x1, TEPID Co. acquired LUKEWARM Co. in a business combination that resulted to goodwill. By December 31, 20x1, the initial allocation of goodwill is not yet completed. According to PAS 36, TEPID should a. complete the initial allocation before the end of December 31, 20x1. b. complete the initial allocation before the end of December 31, 20x2. c. complete the initial allocation before the end of November 30, 20x1. d. complete the initial allocation before the end of September 1, 20x2. 34. PFRS 3 is mandatory for all new acquisitions from March 31, 2004. Entities have to cease the amortization of goodwill arising from previous acquisitions. The balance of goodwill arising from those acquisitions is a. Written off against retained earnings. b. Written off against profit or loss for the year. c. Tested for impairment from the beginning of the next accounting year. d. Tested for impairment on March 31, 2004. (Adapted) 35. Which of the following factors is used as multiplier of super profits in valuation of goodwill of a business? a. Average capital employed in the business d. Normal rate of return b. Simple profits e. Normal profits. c. Number of years’ purchase (Adapted)
Chapter 15 questions 1 . C 6. C 2 . A 7. D 3 . D 8. B 4 . C 9. C 5 1 . A 0. D
Suggested answers to theory of accounts 1 1. 1 2. 1 3. 1 4. 1 5.
B C B C A
16 . 17 . 18 . 19 . 20 .
C C D A D
21 . 22 . 23 . 24 . 25 .
A A D C B
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26 . 27 . 28 . 29 . 30 .
A A A B C
31 . 32 . 33 . 34 . 35 .
A B B C C
Chapter 16 Consolidated Financial Statements (Part 1)
Chapter 16: Multiple Choice – Computational (For classroom instruction purposes) Consolidation – Date of acquisition Fact pattern On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. The financial statements of ABC Co. and XYZ, Inc. immediately before the acquisition are shown below: ABC Co. XYZ, Inc. Cash 40,000 20,000 Accounts receivable 120,000 48,000 Inventory 160,000 92,000 Equipment 800,000 200,000 Accumulated depreciation (80,000) (40,000) Total assets 1,040,000 320,000
Accounts payable Bonds payable Share capital Share premium Retained earnings Total liabilities and equity
80,000 120,000 480,000 160,000 200,000 1,040,000
24,000 200,000 96,000 320,000
On January 1, 20x1, the fair value of the assets and liabilities of XYZ, Inc. were determined by appraisal, as follows:
XYZ, Inc. Cash Accounts receivable Inventory Equipment Accumulated depreciation Accounts payable Net assets
Carryi ng amou nts 20,000 48,000 92,000 200,00 0 (40,00 0) (24,00 0) 296,0 00
Fair value s 20,000 48,000 124,00 0 240,00 0 (48,00 0) (24,00 0) 360,0 00
29
Fair value increm ent 32,000 40,000 (8,000) 64,000
The equipment has a remaining useful life as of 4 years from January 1, 20x1. Case #1: NCI measured at proportionate share of parent ABC Co. elects to measure non-controlling interest as its proportionate share in XYZ’s net identifiable assets. 1. How much is the consolidated total assets as of January 1, 20x1? a. 1,436,000 b. 1,439,000 c. 1,736,000 d. 1,376,000 2. How much is the consolidated total equity as of January 1, 20x1? a. 1,200,000 b. 1,215,000 c. 1,212,000 d. 1,364,000 Case #2: NCI measured at fair value ABC Co. elects the option to measure non-controlling interest at fair value and a value of ₱75,000 is assigned to the 20% non-controlling interest [(₱300,000 ÷ 80%) x 20% = 75,000]. 3. How much is the consolidated total assets as of January 1, 20x1? a. 1,436,000 b. 1,439,000 c. 1,736,000 d. 1,376,000 4. How much is the consolidated total equity as of January 1, 20x1? a. 1,200,000 b. 1,215,000 c. 1,212,000 d. 1,364,000 Consolidation subsequent to date of acquisition (Proportionate share) Fact pattern On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. On acquisition date, ABC Co. elected to measure non-controlling interest as its proportionate share in XYZ, Inc.’s net identifiable assets. XYZ’s shareholders’ equity as of January 1, 20x1 comprises the following: (at carrying amounts) Share capital 200,000 Retained earnings 96,000 Total equity 296,000 On January 1, 20x1, the fair values of the assets and liabilities of XYZ, Inc. were determined by appraisal, as follows:
XYZ, Inc. Cash Accounts receivable Inventory
Carryi ng amou nts 20,000
Fair value s 20,000
48,000
48,000
-
92,000
124,00
32,000
30
Fair value increm ent -
Equipment Accumulated depreciation Accounts payable Net assets
200,00 0 (40,000 ) (24,000 ) 296,0 00
0 240,00 0 (48,00 0) (24,00 0) 360,0 00
40,000 (8,000) 64,000
The remaining useful life of the equipment is 4 years. During 20x1, no dividends were declared by either ABC or XYZ. There were also no inter-company transactions. The group determined that there is no goodwill impairment. ABC’s and XYZ’s individual financial statements at year-end are shown below: Statements of financial position As at December 31, 20x1 ABC Co.
XYZ, Inc.
ASSETS 92,0 00 300,0 00 420,0 00 300,0 00 800,0 00 (240,00 0) 1,672,0 00
Cash Accounts receivable Inventory Investment in subsidiary Equipment Accumulated depreciation TOTAL ASSETS
228,000 88,000 60,000 200,000 (80,00 0) 496,00 0
LIABILITIES AND EQUITY 172,0 00 120,0 00 292,00 0 680,0 00 260,0 00 440,0 00 1,380,00
Accounts payable Bonds payable Total liabilities Share capital Share premium Retained earnings Total equity
31
120,000 120,00 0 200,000 176,000 376,00
TOTAL LIABILITIES AND EQUITY
0 1,672,0 00
0 496,00 0
Statements of profit or loss For the year ended December 31, 20x1 ABC Co. 1,200, 000 (660,0 00) 540, 000 (160,0 00) (128,0 00) (12,0 00) 240, 000
Sales Cost of goods sold Gross profit Depreciation expense Distribution costs Interest expense Profit for the year
XYZ, Inc. 480,00 0 (288,00 0) 192,00 0 (40,00 0) (72,00 0) 80,0 00
5. How much is the consolidated profit for 20x1? a. 208,000 b. 280,000 c. 240,000 d. 296,000 6. How much is the consolidated total assets as of December 31, 20x1? a. 1,867,000 b. 1,907,000 c. 1,894,000 d. 1,904,000 7. How much is the consolidated total equity as of December 31, 20x1? a. 1,492,000 b. 1,415,000 c. 1,412,000 d. 1,421,000 Consolidation subsequent to date of acquisition – NCI at Fair value Fact pattern On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. On acquisition date, ABC Co. elected to measure non-controlling interest at the non-controlling interest’s fair value. A value of ₱75,000 is assigned to the 20% non-controlling interest [(₱300,000 ÷ 80%) x 20% = ₱75,000]. XYZ’s shareholders’ equity as of January 1, 20x1 comprises the following: (at carrying amounts) Share capital 200,000
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Retained earnings Total equity
96,000 296,000
On January 1, 20x1, the fair values of the assets and liabilities of XYZ, Inc. were determined by appraisal, as follows: Carrying Fair Fair value XYZ, Inc. amounts values increment Cash 20,000 20,000 Accounts receivable 48,000 48,000 Inventory 92,000 124,000 32,000 Equipment 200,000 240,000 40,000 Accumulated (40,000) (48,000) (8,000) depreciation Accounts payable (24,000) (24,000) 360,00 296,000 64,000 Net assets 0 The remaining useful life of the equipment is 4 years. During 20x1, no dividends were declared by either ABC or XYZ. There were also no inter-company transactions. The group determined that there is no goodwill impairment. ABC’s and XYZ’s individual financial statements at year-end are shown below: Statements of financial position As at December 31, 20x1 ABC Co.
XYZ, Inc.
ASSETS Cash Accounts receivable Inventory Investment in subsidiary Equipment Accumulated depreciation TOTAL ASSETS
92,000 300,000 420,000 300,000 800,000 (240,000) 1,672,000
200,000 (80,000) 496,000
LIABILITIES AND EQUITY Accounts payable Bonds payable Total liabilities Share capital Share premium Retained earnings Total equity TOTAL LIABILITIES AND EQUITY
172,000 120,000 292,000 680,000 260,000 440,000 1,380,000 1,672,000
120,000 120,000 200,000 176,000 376,000 496,000
228,000 88,000 60,000
Statements of profit or loss For the year ended December 31, 20x1 ABC Co. 1,200,00
Sales
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XYZ, Inc. 480,000
0 (660,000 ) 540,000 (160,000 ) (128,000 ) (12,000) 240,000
Cost of goods sold Gross profit Depreciation expense Distribution costs Interest expense Profit for the year
(288,000) 192,000 (40,000) (72,000) 80,000
8. How much is the consolidated profit for 20x1? a. 208,000 b. 280,000 c. 240,000 d. 296,000 9. How much is the consolidated total assets as of December 31, 20x1? a. 1,867,000 b. 1,907,000 c. 1,894,000 d. 1,904,000 10. How much is the consolidated total equity as of December 31, 20x1? a. 1,492,000 b. 1,415,000 c. 1,412,000 d. 1,495,000
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Chapter 17 Consolidated Financial Statements (Part 2) Chapter 17: Multiple Choice – Computational (For classroom instruction purposes) Fair value decrement Use the following information for the next two questions: Popo Co. acquired 80% of Momo Co. on January 1, 20x1 for ₱800,000. The following information was determined at acquisition date: Popo Momo Momo Co. Co. Co. Carryin Carryin g g Fair amount amount value 4,000,00 2,000,00 1,600,0 Equipment 0 0 00 Accumulated (800,00 (400,000 ( 320,0 depreciation 0) ) 00) 3,200,00 1,600,00 1,280,0 Net 0 0 00 Remaining useful life – Jan. 1, 20x1 10 years years
5 years
5
1. How much is the consolidated “equipment – net” in the December 31, 20x2 financial statements? a. 3,968,000 b. 3,628,000 c. 3,428,000 d. 3,328,000 2. The consolidation journal entry for the depreciation of the fair value adjustment on December 31, 20x2 includes a debit to accumulated depreciation for ₱128,000 b credit to accumulated depreciation for ₱128,000 c debit to depreciation expense for ₱64,000 d debit to retained earnings of Popo Co. for ₱51,200 Fair value increment 3. On January 1, 20x1, Donkey Co. acquired 75% of Monkey Co. At that time, Monkey’s equipment has a carrying amount of ₱400,000 and a fair value of ₱480,000. The equipment has a remaining useful life of 10 years. On December 31, 20x2, Donkey and Monkey reported equipment with carrying amounts of ₱2,000,000 and ₱1,200,000, respectively. How much is the consolidated “equipment – net” in the December 31, 20x2 financial statements? a. 3,200,0000 b. 3,384,000 c. 3,264,000 d. 3,124,000 NCI in net assets Use the following information for the next six questions:
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Owl Co. paid ₱600,000 for its 75% interest in Owlet Co. Owl elected to value NCI at fair value. Owlet’s net identifiable assets approximated their fair values at acquisition date. The acquisition resulted in a goodwill attributable to NCI of ₱40,000. Since the acquisition date, Owlet has made accumulated profits of ₱800,000. There have been no changes in Owlet’s share capital since acquisition date. The group determined that goodwill has been impaired by ₱32,000. A summary of the individual statements of financial positions of the entities as at the end of reporting period is shown below: Owlet Owl Co. Co. 4,000,0 2,000,0 Total assets 00 00 Total liabilities Share capital Retained earnings Total liabilities and equity
800,000 480,000 1,200,0 400,000 00 2,000,0 1,120,0 00 00 4,000,0 2,000,0 00 00
4. How much is the fair value assigned to NCI at date of acquisition? a. 220,000 b. 250,000 c. 268,000 d. 224,000 5. How much is the goodwill to be presented in the current-year consolidated financial statements? a. 72,000 b. 64,000 c. 56,000 d. 68,000 6. How much is the NCI in net assets? a. 304,000 b. 380,000 c. 412,000 d. 426,000 7. How much is the consolidated retained earnings? a. 2,600,000 b. 2,480,000 c. 2,576,000 d. 2,276,000 8. How much is the consolidated total assets? a. 5,468,000 b. 6,068,000 c. 5,400,000
d. 5,620,000
9. How much is the consolidated total equity? a. 6,188,000 b. 4,188,000 c. 4,156,000
d. 5,622,000
NCI in profit and comprehensive income Use the following information for the next six questions: On January 1, 20x1, Rooster Co. acquired 75% interest in Cockerel Co. for ₱600,000. At this time, Cockerel's net identifiable assets have a carrying amount of ₱720,000 which approximates fair value. NCI was assigned a fair value of ₱220,000. During 20x1, Rooster sold goods to Cockerel for ₱600,000, having bought them for ₱480,000. A quarter of these goods remain unsold at year-end. Goodwill on acquisition of Cockerel has been tested for
36
impairment and found to be impaired (in total) by ₱32,000 for the current year. The individual statements of profit or loss and other comprehensive income of the entities for the year ended December 31, 20x1 are shown below: Rooster Cockerel Co. Co. 4,000,000 2,800,000 Revenue (1,600,000) (1,200,000) Cost of sales 2,400,000 1,600,000 Gross profit 40,000 Dividend income from Cockerel Co. (800,000) (400,000) Distribution costs (320,000) (200,000) Administrative costs 1,320,000 1,000,000 Profit before tax (384,000) (300,000) Income tax expense 936,000 700,000 Profit after tax 296,000 100,000 Other comprehensive income 1,232,000 800,000 Comprehensive income 10. How much is the consolidated sales? a. 6,200,000 b. 6,350,000 c. 6,650,000 6,180,000
d.
11. How much is the consolidated cost of sales? a. 2,170,000 b. 2,230,000 c. 2,770,000 2,320,000
d.
12. How much is the consolidated profit? a. 1,574,000 b. 1,566,000 c. 1,564,000 1,534,000
d.
13. How much is the consolidated comprehensive income? a. 1,970,000 b. 1,930,000 c. 1,962,000 d. 1,960,000 14. How much is the profit attributable to owners of the parent and NCI, respectively? Owners of Parent NCI a. 1,391,000 175,000 b. 1,367,000 167,000 c. 1,391,000 173,000 d. 1,384,000 190,000 15. How much is the comprehensive income attributable to owners of the parent and NCI, respectively? Owners of Parent NCI a. 1,663,000 267,000 b. 1,778,000 192,000 c. 1,756,000 206,000 d. 1,738,000 192,000 Acquisition during the year Use the following information for the next four questions:
37
On September 1, 20x1, Pig Co. acquired 75% interest in Piglet Co. At this time, Piglet's net identifiable assets have a carrying amount of ₱720,000 which approximates fair value. During the last month of the year, Piglet sold goods to Pig for ₱324,000. Piglet had marked up these goods by 50% on cost. Onethird of these goods remain unsold at year-end. The group assessed that there is no impairment loss on goodwill for the current year. The individual statements of profit or loss of the entities for the year ended December 31, 20x1 are shown below:
Revenue Cost of sales Gross profit Distribution costs Administrative costs Profit before tax Income tax expense Profit after tax
Pig Co. 4,000, 000 (1,600 ,000) 2,400 ,000 (800 ,000) (320 ,000) 1,280 ,000 (384 ,000) 89 6,000
Piglet Co. 2,8 80,000 (1,2 00,000) 1,6 80,000
(1 80,000) 1,1 00,000 (3 80,000) 720,000
All of Piglet’s income and expenses (including profit from intercompany sale) were earned and incurred evenly during the year. 16. How much is the consolidated sales? a. 6,556,000 b. 4,852,000 c. 4,786,000 4,636,000
d.
17. How much is the consolidated cost of sales? a. 1,712,000 b. 2,530,000 c. 1,730,000 1,876,000
d.
18. How much is the consolidated profit? a. 1,100,000 b. 1,580,000 c. 1,360,000 1,420,000
d.
19. How much is the profit attributable to owners of the parent and NCI, respectively? Owners of Parent NCI a. 1,040,000 60,000 b. 1,049,000 51,000 c. 1,036,000 544,000 d. 1,049,000 311,000 Subsidiary’s outstanding cumulative preference shares
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20. Bear Co. owns 75% of Cub Co.’s ordinary shares. Cub Co. has 12%, ₱400,000 outstanding cumulative preference shares, none of which are held by Bear Co. The carrying amount of Cub’s net identifiable assets at acquisition date approximates fair value. Bear and Cub reported individual profits of ₱936,000 and ₱700,000, respectively, for the year ended December 31, 20x1. Neither company declared dividends. There are 3-year dividends in arrears on the outstanding cumulative preference shares of Cub Co. It was assessed that goodwill is not impaired. How much is the profit attributable to owners of the parent and NCI, respectively? Owners of Parent NCI a. 1,425,000 163,000 b. 1,377,000 163,000 c. 1,377,000 211,000 d. 1,425,000 211,000
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Chapter 18 Consolidated Financial Statements (Part 3) Chapter 18: Multiple Choice – Computational (For classroom instruction purposes) Impairment of goodwill On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. XYZ’s shareholders’ equity as of January 1, 20x1 comprises the following: (at carrying amounts) Share capital 200,000 Retained earnings 96,000 Total equity 296,000 On January 1, 20x1, the fair values of the assets and liabilities of XYZ, Inc. were determined by appraisal, as follows: Carrying Fair Fair value XYZ, Inc. amounts values increment Cash 20,000 20,000 48,000 48,000 Accounts receivable 92,000 124,000 32,000 Inventory 200,000 240,000 40,000 Equipment Accumulated (40,000) (48,000) (8,000) depreciation (24,000) (24,000) Accounts payable Net assets 296,000 360,00 64,000 0 The remaining useful life of the equipment is 4 years. During 20x1, no dividends were declared by either ABC or XYZ. There were also no inter-company transactions. The group determined that goodwill is impaired by ₱4,000. ABC’s and XYZ’s individual financial statements at year-end are shown below: Statements of financial position As at December 31, 20x1 ABC Co.
XYZ, Inc.
ASSETS 92, 000 300, 000
Cash Accounts receivable
40
228,0 00 88,0 00
420, 000 300, 000 800, 000 (240, 000) 1,672 ,000
Inventory Investment in subsidiary Equipment Accumulated depreciation TOTAL ASSETS
60,0 00
200,0 00 (80,0 00) 496, 000
LIABILITIES AND EQUITY Accounts payable Bonds payable Total liabilities Share capital Share premium Retained earnings Total equity TOTAL LIABILITIES AND EQUITY Statements of profit or loss For the year ended December 31, 20x1
172, 000 120, 000 292, 000 680, 000 260, 000 440, 000 1,380, 000 1,672 ,000
ABC Co. 1,200, 000 (660, 000) 540, 000 (160, 000) (128, 000) (12, 000) 240 ,000
Sales Cost of goods sold Gross profit Depreciation expense Distribution costs Interest expense Profit for the year
120,0 00 120,0 00 200,0 00 176,0 00 376,0 00 496, 000
XYZ, Inc. 480, 000 (288,0 00) 192, 000 (40,0 00) (72,0 00) 80, 000
Case #1: On acquisition date, ABC Co. elected to measure noncontrolling interest as its proportionate share in XYZ, Inc.’s net identifiable assets. 1. How much is the consolidated profit for 20x1?
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a. 296,000
b. 280,000 c. 208,000 d. 276,000
2. How much is the consolidated total assets as of December 31, 20x1? a. 1,900,000 b. 1,907,000 c. 1,903,000 d. 1,904,000 3. How much is the consolidated total equity as of December 31, 20x1? a. 1,492,000 b. 1,415,000 c. 1,488,000 d. 1,491,000 Case #2: On acquisition date, ABC Co. elected to measure non-controlling interest at fair value. A value of ₱75,000 is assigned to the noncontrolling interest. 4. How much is the consolidated profit for 20x1? a. 296,000 b. 280,000 c. 278,000 d. 276,000 5. How much is the consolidated total assets as of December 31, 20x1? a. 1,900,000 b. 1,907,000 c. 1,903,000 d. 1,904,000 6. How much is the consolidated total equity as of December 31, 20x1? a. 1,492,000 b. 1,415,000 c. 1,488,000 d. 1,491,000 Changes in ownership interest not resulting to loss of control Fact pattern On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. XYZ’s net identifiable assets have a fair value of ₱360,000. Goodwill has been computed under each of the available options under PFRS 3 as follows:
(1) (2) (3)
Consideration transferred Non-controlling interest in the acquiree Previously held equity interest in the acquire Total Fair value of net identifiable assets acquired Goodwill
Case #1 (proportionate) 300,000
Case #2 (fair value) 300,000
72,000
75,000
-
-
372,000
375,000
(360,000)
(360,000)
12,000
15,000
As of December 31, 20x1, XYZ, Inc. increased its net assets (after fair value adjustments) by ₱40,000 to ₱400,000. The NCI in net assets is updated as follows: Case #1 Case #2 (proportiona (fair te) value) NCI at acquisition date – Jan. 1, 20x1 72,000 75,000 Subsequent increase (20% x ₱40,000) 8,000 8,000
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Carrying amount of NCI – Jan. 1, 20x2
80,000
83,000
Scenario #1: Acquisition of all remaining NCI On January 1, 20x2, ABC Co. acquired all of the remaining 20% NCI in XYZ for ₱120,000. 7. If NCI is measured at “proportionate share,” how much is the gain or loss on the transaction to be recognized in the consolidated financial statements? a. 80,000 b. (80,000) c. (83,000) d. 0 8. If NCI is measured at “fair value,” how much is the gain or loss on the transaction to be recognized in the consolidated financial statements? a. (83,000) b. 83,000 c. (80,000) d. 0 9. If NCI is measured at “proportionate share,” what is the effect of the transaction on the consolidated financial statements? a ₱80,000 decrease in NCI and ₱40,000 decrease in retained earnings of ABC Co. b ₱83,000 decrease in NCI and ₱37,000 decrease in retained earnings of ABC Co. c either a or b d No effect on the consolidated financial statements 10. If NCI is measured at “fair value,” what is the effect of the transaction on the consolidated financial statements? a ₱80,000 decrease in NCI and ₱40,000 decrease in retained earnings of ABC Co. b ₱83,000 decrease in NCI and ₱37,000 decrease in retained earnings of ABC Co. c either a or b d No effect on the consolidated financial statements Scenario #2: Acquisition of part of remaining NCI On January 1, 20x2, ABC Co. acquired additional 12% equity interest held by non-controlling interests in XYZ for cash consideration of ₱80,000. 11. If NCI is measured at “proportionate share,” what is the direct adjustment in equity? a. 40,000 b. 32,000 c. 30,200 d. 38,500 12. If NCI is measured at “fair value,” what is the direct adjustment in equity? a. 40,000 b. 32,000 c. 30,200 d. 38,500 Scenario #3: Disposal of part of controlling interest – Control not lost On January 1, 20x2, ABC Co. sold its 10% interest in XYZ, Inc. for ₱80,000. The 70% (80% - 10%) ownership interest retained still gives ABC control over XYZ.
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13. If NCI is measured at “proportionate share,” what is the direct adjustment in equity? a. 40,000 b. 32,000 c. 30,200 d. 38,500 14. If NCI is measured at “fair value,” what is the direct adjustment in equity? a. 40,000 b. 32,000 c. 30,200 d. 38,500 Scenario #4: Subsidiary issues additional shares – Control not lost The 80% interest acquired by ABC in XYZ on January 1, 20x1 represents 40,000 shares of XYZ’s 50,000 outstanding shares as of that date. On January 1, 20x2, XYZ, Inc. issues additional 10,000 shares with par value per share of ₱4 to other investors for ₱10 per share. Although none of the shares were purchased by ABC, it was determined that the additional share issuance has no effect on ABC’s control over XYZ. 15. If NCI is measured at “proportionate share,” what is the direct adjustment in equity? a. 13,333 b. 11,332 c. 13,200 d. 0 16. If NCI is measured at “fair value,” what is the direct adjustment in equity? a. 13,332 b. 11,332 c. 13,200 d. 0 Loss of control – Deconsolidation 17. On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. ABC elected to measure NCI as its proportionate share in XYZ’s net identifiable assets. The acquisition resulted to goodwill of ₱12,000. There has been no impairment of goodwill. On January 1, 20x2, ABC Co. sells 60% of its interest in XYZ, Inc. for ₱400,000. ABC’s remaining 20% interest in XYZ has a fair value of ₱100,000. The remaining investment in XYZ, Inc. gives ABC significant influence over XYZ. The statements of financial position immediately before the sale are shown below:
Statements of financial position As at December 31, 20x1
ASSETS Cash Accounts receivable Inventory
ABC Co.
XYZ, Inc.
92,000 300,000 420,000
228,000 88,000 60,000
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Consolidat ed 320,000 388,000 480,000
Investment in subsidiary Equipment Accumulated depreciation Goodwill TOTAL ASSETS
300,000
-
-
800,000 (240,000 ) 1,672,00 0
200,000
1,040,000
(80,000)
(336,000)
-
12,000
496,000
1,904,000
120,000 120,000 200,000 176,000 -
292,000 120,000 412,000 680,000 260,000 472,000 80,000
376,000
1,492,000
496,000
1,904,000
LIABILITIES AND EQUITY Accounts payable 172,000 Bonds payable 120,000 Total liabilities 292,000 Share capital 680,000 Share premium 260,000 Retained earnings 440,000 Non-controlling interest 1,380,00 Total equity 0 TOTAL LIAB. & 1,672,00 EQTY. 0
How much is the gain (loss) on the disposal of controlling interest? a. (168,000) b. 168,000 c. 156,000 d. (156,000) Loss of control – Derecognition of OCI 18. On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. by issuing 5,000 shares with fair value of ₱60 per share and par value of ₱40 per share. XYZ’s net identifiable assets have a fair value of ₱360,000. ABC elected to measure NCI as its proportionate share in XYZ’s net identifiable assets (i.e., ₱360,000 x 20% = ₱72,000). Accordingly, goodwill of ₱12,000 was recognized on the business combination. There has been no impairment of goodwill. Subsequent to acquisition date, XYZ, Inc. increased its net assets (after fair value adjustments) by ₱52,000 to ₱412,000. The movement in XYZ’s net assets is shown below: Net assets (at fair value) - Jan. 20x1 Subsequent changes: Profit or loss after fair value adjustments Other comprehensive income: Gain on property revaluation Exchange differences on translation of foreign operation Total subsequent change in net assets Net assets (at fair value) - Dec. 31, 20x1
The NCI in net assets is updated as follows: NCI at acquisition date Increase (20% x ₱52,000)
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360,000 40,000 8,000 4,000 52,000 412,000
72,000 10,400
Carrying amount of NCI – Dec. 31, 20x1
82,400
Accordingly, the accumulated OCI attributable to owners of the parent presented in the consolidated financial statements comprises the following: Gain on property revaluation (8,000 x 80%) 6,400 Exchange differences on translation of foreign operation 3,200 (4K x 80%) Consolidated other components of equity – Dec. 9,600 31, 20x1 On January 1, 20x2, ABC Co. sells 60% of its interest in XYZ, Inc. for ₱400,000. ABC’s remaining 20% interest in XYZ has a fair value of ₱100,000. The remaining investment in XYZ, Inc. does not give ABC significant influence over XYZ. How much is the gain or loss on disposal of controlling interest to be recognized in profit or loss? a. 152,400 b. 156,800 c. 160,200 d. 158,400 Inter-company receivables and payables Use the following information for the next two questions: On January 1, 20x1, Dad Co. acquired 80% interest in Son Co. by issuing bonds with fair value of ₱1,000,000. The following information was determined immediately before the acquisition: Dad Co. Son Co. Son Co. Carrying Carrying amount amount Fair value 1,720,0 Total assets 4,000,000 1,600,000 00 (800,000 Total liabilities (2,400,000) (800,000) ) 920,00 Net assets 1,600,000 800,000 0 Included in Son’s liabilities is an account payable to Dad amounting to ₱80,000. Dad elected to measure NCI as its proportionate share in Son’s net identifiable assets. 19. How much is the total assets in Dad’s separate financial statements immediately after the combination? a. 6,304,000 b. 4,000,000 c. 5,000,000 d. 4,920,000 20. How much is the total assets in the consolidated financial statements? a. 6,304,000 b. 5,904,000 c. 6,054,000 d. 5,984,000 Group accounting policy Use the following information for the next five questions: On June 30, 20x1, Cockroach Co. acquired 75,000 of Nymph Co.'s 100,000 outstanding equity shares with par value per share of ₱4 for ₱16 per share. At the time of acquisition, the retained earnings of
46
Nymph were ₱320,000. The quoted price of Nymph's shares was ₱14 per share at acquisition date. Additional information: Included in the total assets of Nymph is land classified as investment property with a cost of ₱720,000. Its fair value at acquisition date was ₱800,000 and by June 30, 20x3 this had risen to ₱1,280,000. Nymph uses the cost model for its investment properties. However, the group's policy for investment properties is the fair value model. Also at acquisition date, Nymph's building classified as property, plant, and equipment had a fair value of ₱120,000 in excess of its carrying amount. The building's remaining useful life is 5 years at that date. The group's depreciation method is straight-line basis. The inter-company current accounts included receivables and payables of ₱40,000 on June 30, 20x3. An impairment test at June 30, 20x3 concluded that consolidated goodwill was impaired by ₱80,000. Cockroach elected to measure NCI at the NCI's fair value. There have been no changes in Nymph’s number of outstanding shares subsequent to date of acquisition. A summary of the individual statements of financial positions of the entities as at June 30, 20x3 is shown below: Cockroach Nymph Co. Co. 2,000,00 4,000,000 Total assets 0 Total liabilities Share capital Retained earnings Total liabilities and equity
800,000 1,200,000 2,000,000 4,000,000
480,000 400,000 1,120,00 0 2,000,00 0
21. How much is the goodwill to be presented in the June 30, 20x3 consolidated financial statements? a. 550,000 b. 620,000 c. 485,000 d. 530,000 22. How much is the NCI in net assets? a. 538,000 b. 584,000 c. 624,000 d. 638,000 23. How much is the consolidated retained earnings? a. 2,864,000 b. 2,924,000 c. 2,874,000 d. 2,984,000 24. How much is the consolidated total assets? a. 5,310,000 b. 5,942,000 c. 5,982,000
d. 5,350,000
25. How much is the consolidated total equity? a. 4,064,000 b. 4,684,000 c. 4,702,000
d. 4,724,000
Business combination achieved in stages (‘Step acquisition’) Use the following information for the next five questions:
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On January 1, 20x1, Rabbit Co. acquired 40% of Bunny Co. for ₱160,000. At this time, Bunny's net identifiable assets has a carrying amount of ₱400,000 which approximates fair value. The investment was classified as “investment in associate.” On January 1, 20x3, Rabbit Co. acquired additional 35% interest in Bunny Co. for ₱800,000. On this date, the fair value of the existing holdings of Rabbit in Bunny was ₱400,000. Bunny's net identifiable assets on January 1, 20x3, has a carrying amount of ₱720,000 which approximates fair value. Bunny’s net assets comprised of share capital amounting to ₱400,000 and retained earnings amounting to ₱320,000. Rabbit assigned a fair value of ₱220,000 to the NCI. The group determined on Dec. 31, 20x3 that there is no impairment in goodwill. A summary of the individual statements of financial positions of the entities as at December 31, 20x3 is shown below: Rabbit Bunny Co. Co. 2,000,00 4,000,000 Total assets 0 Total liabilities Share capital Retained earnings Total liabilities and equity
800,000 1,200,000 2,000,000 4,000,000
480,000 400,000 1,120,00 0 2,000,00 0
26. How much is the goodwill to be presented in the December 31, 20x3 consolidated financial statements? a. 480,000 b. 700,000 c. 300,000 d. 80,000 27. How much is the NCI in net assets? a. 380,000 b. 340,000 c. 480,000 d. 420,000 28. How much is the consolidated retained earnings? a. 2,600,000 b. 2,680,000 c. 2,740,000 d. 2,860,000 29. How much is the consolidated total assets? a. 5,460,000 b. 5,500,000 c. 4,880,000
d. 5,280,000
30. How much is the consolidated total equity? a. 4,180,000 b. 4,280,000 c. 4,420,000
d. 4,220,000
Reconstruction of financial information Use the following information for the next three questions: On January 1, 20x1, Sheep Co. acquired 75% interest in Lamb Co. for ₱600,000. At this time, Lamb's net identifiable assets have a carrying amount of ₱720,000 which approximates fair value. NCI was assigned a fair value of ₱220,000. There were no inter-company transactions during the year. Goodwill on acquisition of Lamb has been tested and found to be impaired (in total) by ₱32,000 for the current year.
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Sheep's separate financial statements reported profit of ₱866,000 for the year ended December 31, 20x1. Profit attributable to NCI was appropriately determined at ₱167,000. 31. How much is the profit of Lamb for the year ended December 31, 20x1? a. 175,000 b. 625,000 c. 700,000 d. 225,000 32. How much is the consolidated profit? a. 1,558,000 b. 1,534,000 c. 1,834,000 1,526,000
d.
33. How much is the profit attributable to owners of the parent and to NCI, respectively? Parent NCI a. 1,367,000 167,000 b. 1,391,000 167,000 c. 1,359,000 167,000 d. 1,436,000 398,000 Comprehensive problem Use the following information for the next ten questions: On January 1, 20x1, Peter Co. acquired 90% ownership interest in Simon Co. for ₱488,000. Peter Co. elected to measure NCI at fair value. NCI was assigned a fair value of ₱60,000. On January 1, 20x1, the fair values of the assets and liabilities of XYZ, Inc. were determined by appraisal, as follows: Carrying Fair Fair value Simon Co. amounts values increment Cash 40,000 40,000 Accounts 60,000 60,000 receivable 100,000 124,000 24,000 Inventory 240,000 360,000 120,000 Equipment Accumulated (120,00 (80,000) (40,000) depreciation 0) 80,000 80,000 Patent (24,000) (24,000) Accounts payable 520,00 336,000 184,000 Net assets 0 The remaining useful life of the equipment is 5 years while the patent has a remaining legal and useful life of 8 years. Simon’s share capital has a balance of ₱200,000. Among the transactions of Peter and Simon during 20x1 were the following: Peter's accounts receivable include a receivable from Simon amounting to ₱12,000 while Simon's accounts payable include a payable to Peter amounting to ₱8,000. The difference was due to a check amounting to ₱4,000 deposited by Simon directly to Peter's bank account which was not yet recorded by Peter in its
49
books. The check has already cleared in Simon’s bank account.
Peter sold goods costing ₱80,000 to Simon for ₱128,000. Onethird of the inventory remains as of Dec. 31, 20x1. Simon sold goods costing ₱40,000 to Peter for ₱60,000. One-half of the goods remain in inventory as of December 31, 20x1. On January 1, 20x1, Simon sold to Peter equipment for ₱20,000. The equipment has a historical cost of ₱40,000 and accumulated depreciation of ₱16,000 and a remaining useful life of 5 years on the date of sale. On July 1, 20x1, Simon Co. purchased 50% of the outstanding bonds of Peter Co. from the open market for ₱240,000. The interest income accruing on the bonds for the year was received by Simon from Peter. The bonds payable carry an interest rate of 10% and were originally issued by Peter at face amount. Peter declared dividends of ₱160,000. Simon declared dividends of ₱80,000. Goodwill is impaired by ₱8,000. There have been no changes in Simon’s share capital.
The individual financial statements of the entities at December 31, 20x1 are shown below:
Statements of financial position As at December 31, 20x1 Peter Co.
Simon Co.
ASSETS Cash Accounts receivable Inventory Investment in bonds Investment in subsidiary Equipment Accumulated depreciation TOTAL ASSETS
488,000 4,020,000 (1,444,000) 5,664,000
200,000 (91,200) 720,000
LIABILITIES AND EQUITY Accounts payable Bonds payable Total liabilities Share capital Retained earnings Total equity TOTAL LIABILITIES AND EQUITY
284,000 400,000 684,000 3,200,000 1,780,000 4,980,000 5,664,000
83,200 83,200 200,000 436,800 636,800 720,000
1,448,000 712,000 440,000
85,200 20,000 268,000 238,000
Statements of profit or loss For the year ended December 31, 20x1 Peter Co.
50
Simon Co.
3,728,00 0 (1,700,00 0) 2,028,00 0
Sales Cost of goods sold Gross profit Interest income
1,020,000 (472,000) 548,000 8,000
(644,000 ) (256,000 ) (40,000) 72,000 1,160,0 00
Depreciation expense Distribution costs Interest expense Loss on sale of equipment Dividend income Profit for the year
(144,000) (4,000) 380,800
34. How much is the consolidated sales? a. 4,364,000 b. 4,560,000 c. 4,540,000
d. 4,650,000
35. How much is the consolidated cost of sales? a. 1,862,000 b. 2,034,000 c. 2,128,000
d. 1,934,000
36. How much is the consolidated ending inventory? a. 708,000 b. 634,000 c. 674,000 d. 682,000 37. How much is the goodwill in the December 31, 20x1 consolidated financial statements? a. 20,000 b. 18,800 c. 22,000 d. 19,800 38. How much is the NCI in net assets as of December 31, 20x1? a. 82,080 b. 82,720 c. 82,800 d. 82,880 39. How much is the consolidated retained earnings as of December 31, 20x1? a. 1,939,200 b. 1,979,000 c. 1,946,400 d. 1,929,200 40. How much is the consolidated profit or loss in 20x1? a. 1,398,000 b. 1,263,100 c. 1,470,000 d. 1,350,000 41. How much are the profit attributable to the owners of the parent and to NCI, respectively? Owners of parent NCI a. 1,239,500 23,600 b. 1,326,400 71,600 c. 1,319,200 30,800 d. 1,432,600 37,400 42. How much is the total consolidated assets as of December 31, 20x1? a. 5,781,200 b. 5,797,200 c. 5,823,200 d. 5,689,200 43. How much is the total consolidated liabilities as of December 31, 20x1? a. 559,200 b. 567,200 c. 526,200 d. 498,600
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Reverse acquisition - NCI Fact pattern On January 1, 20x1, Small Co. issues 2.5 shares in exchange for each ordinary share of Big Co. The fair value of Big Co.'s shares on January 1, 20x1 is ₱480 while the fair value of Small Co.'s shares is ₱192. The statements of financial position of the combining entities immediately before combination show the following information:
Identifiable assets Total assets Liabilities Share capital: 100 ordinary shares 60 ordinary shares Retained earnings Total liabilities and equity
Small Co. (legal parent, accounting acquiree) 21,600 21,600
Big Co. (legal subsidiary, accounting acquirer) 44,400 44,400
8,400
20,400
3,600 7,200 9,600
16,800
21,600
44,400
The fair value of Small’s liabilities at January 1, 20x1 is the same as their carrying amount; however, the fair value of Small's identifiable assets at January 1, 20x1 is ₱24,000. Case #1: (Refer to fact pattern) All of Big Co.’s shares were exchanged for Small Co.’s shares. 44. How much is the goodwill? a. 4,800 b. 6,960 c. 3,600 d. 5,733 45. How much is the consolidated total assets? a. 72,000 b. 49,260 c. 68,443 d. 69,600 46. How much is the consolidated total share capital? a. 22,800 b. 25,680 c. 16,800 d. 26,400 47. How much is the NCI in net assets? a. 2,400 b. 3,600 c. 4,800 d. 0 48. How much is the consolidated total retained earnings? a. 9,600 b. 16,800 c. 15,120 d. 22,240 Case #2: (Refer to fact pattern) Only 54 of Big Co.’s shares were exchanged for Small Co.’s shares. 49. How much is the goodwill? a. 4,800 b. 6,960 c. 3,600 d. 5,733 50. How much is the consolidated total assets? a. 72,000 b. 49,260 c. 68,443 d. 69,600 51.
How much is the consolidated total share capital?
52
a. 22,800
b. 25,680
c. 16,800
d. 26,400
52. How much is the NCI in net assets? a. 2,400 b. 3,600 c. 4,800 d. 0 53. How much is the consolidated total retained earnings? a. 9,600 b. 16,800 c. 15,120 d. 22,240
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Chapter 19 Consolidated Financial Statements (Part 4) Chapter 19: Multiple Choice – Computational (For classroom instruction purposes) Acquisition date – Vertical group Scenario #1: 1. On January 1, 20x1, S1 acquires 60% interest in S2. On January 1, 20x3, P acquires 80% interest in S1. What is the acquisition date? a January 1, 20x1 for S1 only b January 1, 20x3 for S2 only c January 1, 20x1 for both S1 and S2 d January 1, 20x3 for both S1 and S2 e a and b 2. When is goodwill computed? a January 1, 20x1 for S1 only b January 1, 20x3 for S2 only c January 1, 20x1 for both S1 and S2 d January 1, 20x3 for both S1 and S2 e a and b Scenario #2: 3. On January 1, 20x1, P acquires 80% interest is S1. On January 1, 20x3, S1 acquires 60% interest in S2. What is the acquisition date? a January 1, 20x1 for S1 only b January 1, 20x3 for S2 only c January 1, 20x1 for both S1 and S2 d January 1, 20x3 for both S1 and S2 e a and b Acquisition date – D-shaped group Scenario #1: 4. P acquires 80% interest in S1 on January 1, 20x1. P acquires 25% interest in S2 on January 1, 20x2. S1 acquires 30% interest in S2 on January 1, 20x3. What is the acquisition date? a January 1, 20x1 for S1 only b January 1, 20x3 for S2 only c January 1, 20x2 for S2 d a and c e a and b Scenario #2: 5. S1 acquires 30% interest in S2 on January 1, 20x1. P acquires 25% interest in S2 on January 1, 20x2. P acquires 80% interest in S1 on January 1, 20x4. a January 1, 20x4 for S1 only b January 1, 20x2 for S2 only c January 1, 20x4 for both S1 and S2 d a and c e a and b
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Consolidation of a vertical group – Same acquisition date Use the following information for the next seven questions: The following transactions occurred on January 1, 20x1: P acquired 80% interest in S1 for ₱400,000 when the retained earnings of S1 were ₱120,000. NCI in S1 has a fair value of ₱100,000. S1 acquired 60% interest in S2 for ₱200,000 when the retained earnings of S2 were ₱40,000. NCI in S2 (direct and indirect) has a fair value of ₱160,000. The carrying amounts of the net identifiable assets of S1 and S2 approximate their fair values on January 1, 20x1. The group determined on December 31, 20x1 that goodwill has been impaired by 20%. There have been no changes in the share capitals of S1 and S2 during the year. A summary of the individual financial statements of the entities is shown below: Statements of financial position As at December 31, 20x1 P Investment in Subsidiary Other assets Total assets Liabilities Share capital Retained earnings Total liabilities and equity
400,0 00 800,0 00 1,200, 000
S1 200,0 00 480,0 00 680, 000
120,000 480,000 600,000
152,000 320,000 208,000
8,000 200,000 112,000
1,200,000
680,000
320,000
408, 000 (320,0 00) 88, 000
192,0 00 (120,0 00) 72, 000
Statements of profit or loss For the year ended December 31, 20x1 720, Revenues 000 (400, Expenses 000) 320 Profit ,000
S2 320,0 00 320, 000
6. How much is the goodwill as of December 31, 20x1? a. 144,000 b. 132,600 c. 112,000 d. 128,000 7. How much is the total NCI in net assets as of December 31, 20x1? a. 305,620 b. 264,320 c. 265,220 d. 236,220
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8. How much is the consolidated retained earnings as of December 31, 20x1? a. 687,680 b. 667,280 c. 698,020 d. 688,420 9. How much is the consolidated profit or loss in 20x1? a. 460,320 b. 446,000 c. 484,000 d. 452,000 10. How much is the NCI, respectively? Owners of parent a. 406,730 b. 407,680 c. 407,930 d. 408,840
profit attributable to owners of parent and to NCI in S1 15,480 15,200 15,380 15,120
NCI in S2 38,110 29,120 22,690 60,040
11. How much is the consolidated total assets as of December 31, 20x1? a. 1,712,000 b. 1,680,000 c. 1,340,000 d. 1,722,000 12. How much is the consolidated total equity as of December 31, 20x1? a. 1,060,000 b. 1,432,000 c. 1,442,000 d. 1,400,000 Consolidation of a vertical group – Different acquisition dates Use the following information for the next seven questions: The following transactions occurred during 20x1: On January 1, 20x1, P acquired 80% interest in S1 for ₱400,000. On December 31, 20x1, S1 acquired 60% interest in S2 for ₱200,000. The following information has been determined: Retained earnings S1 January 1, 20x1 120,000 December 31, 20x1 208,000 Fair value of NCI January 1, 20x1 December 31, 20x1
S1 100,000 112,000
S2 40,000 112,000 S2 192,000 168,000
A summary of the individual statement of financial position of the entities as at December 31, 20x1 is shown below: P S1 S2 Investment in 400,000 200,000 Subsidiary 800,000 480,000 320,000 Other assets 1,200,0 680,00 320,000 Total assets 00 0 Liabilities 120,000 152,000 8,000 480,000 320,000 200,000 Share capital Retained earnings 600,000 208,000 112,000 Total liabilities 1,200,0 680,00 320,000 and equity 00 0
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Statements of profit or loss For the year ended December 31, 20x1 720, Revenues 000 (400, Expenses 000) 320 Profit ,000
408, 000 (320,0 00) 88, 000
192,0 00 (120,0 00) 72, 000
The carrying amounts of the net identifiable assets of S1 and S2 approximate their fair values at their acquisition dates. The group determined that the goodwill to S1 has been impaired by ₱40,000 as at December 31, 20x1. There have been no changes in the share capitals of S1 and S2 during the year. 13. How much is the total goodwill as of December 31, 20x1? a. 28,000 b. 18,240 c. 34,000 d. 36,000 14. How much is the total NCI in net assets as of December 31, 20x1? a. 229,600 b. 237,600 c. 237,088 d. 232,680 15. How much is the consolidated retained earnings as of December 31, 20x1? a. 638,400 b. 640,000 c. 637,780 d. 639,880 16. How much is the consolidated profit or loss in 20x1? a. 368,000 b. 356,600 c. 446,000 d. 452,000 17. How much are the profit attributable to owners of parent and to the NCIs? Parent NCI in S1 NCI in S2 a. 348,200 8,400 0 b. 358,400 9,600 0 c. 407,680 15,200 29,120 d. 407,930 15,380 22,690 18. How much is the consolidated total assets as of December 31, 20x1? a. 1,680,000 b. 1,712,000 c. 1,636,000 . d. 1,722,000 19. How much is the consolidated total equity as of December 31, 20x1? a. 1,356,000 b. 1,432,000 c. 1,400,000 d. 1,442,000 Consolidation of a D-shaped (mixed) group Use the following information for the next seven questions: The following transactions occurred on January 1, 20x1: P acquired 64,000 shares in S1 for ₱400,000 and 12,500 shares in S2 for ₱160,000. S1 acquired 15,000 shares in S2 for ₱200,000. Additional information:
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Retained earnings – January 1, 20x1 Fair value of NCI – January 1, 20x1
S1 120,000 100,000
S2 40,000 160,000
The carrying amounts of the net identifiable assets of S1 and S2 approximate their fair values on January 1, 20x1. The group determined on December 31, 20x1 that there is no impairment of goodwill. There have been no changes in the share capitals of S1 and S2 during the year. A summary of the individual financial statements of the entities on December 31, 20x1 is shown below: Statements of financial position As at December 31, 20x1 P Investment in Subsidiary Other assets Total assets
Liabilities Share capital (₱4.00 par value) Retained earnings Total liabilities and equity
560, 000 800, 000 1,360 ,000
S1 200, 000 480, 000 680, 000
280, 000 480, 000 600, 000 1,360 ,000
152, 000 320, 000 208, 000 680, 000
S2 320,00 0 320,0 00 8,00 0 200,00 0 112,00 0 320,0 00
Statements of profit or loss For the year ended December 31, 20x1 720, 408, 192,0 Revenues 000 000 00 (400, (320,0 (120,0 Expenses 000) 00) 00) 320 88, 72, Profit ,000 000 000 The profits above do not include inter-company investment income. 20. How much is the total goodwill as of December 31, 20x1? a. 280,000 b. 300,000 c. 320,000 d. 360,000 21. How much is the total NCI in net assets as of December 31, 20x1? a. 232,680 b. 237,600 c. 274,320 d. 229,600
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22. How much is the consolidated retained earnings as of December 31, 20x1? a. 638,400 b. 705,680 c. 637,780 d. 698,480 23. How much is the consolidated profit or loss in 20x1? a. 368,000 b. 356,600 c. 480,000 d. 452,000 24. How much are the profit attributable to to the NCIs? Parent NCI in S1 NCI in S2 a. 324,800 15,600 b. 358,400 9,600 c. 425,680 17,600 d. 366,480 17,680 67,840
owners of parent and 27,600 0 36,720
25. How much is the consolidated total assets as of December 31, 20x1? a. 1,900,000 b. 1,712,000 c. 1,636,000 d. 1,722,000 26. How much is the consolidated total equity as of December 31, 20x1? a. 1,356,000 b. 1,282,000 c. 1,460,000 d. 1,272,000 Complex group structure with Associate Use the following information for the next eight questions: The following transactions occurred on January 1, 20x1: A acquired 80% interest in B for ₱400,000. A acquired 25% interest in C for ₱160,000. B acquired 30% interest in C for ₱200,000. B acquired 20% interest in E for ₱240,000. C acquired 40% interest in D for ₱320,000. Additional information: Retained earnings – Jan. 1, 20x1 Fair value of NCI – Jan. 1, 20x1
B 120,00 0 100,00 0
C
D
E
40,000 160,00 0
8,000
32,000 192,00 0
72,000
The carrying amounts of the net identifiable assets of each of the investees approximate their fair values on January 1, 20x1. The group determined on December 31, 20x1 that there is no impairment in goodwill. There have been no changes in the share capitals of S1 and S2 during the year. A summary of the individual financial statements of the entities on December 31, 20x1 is shown below: Statements of financial position As at December 31, 20x1 A Investments
B C 440,00 320,00 560,000 0 0
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D
E -
-
Other assets Total assets
Liabilities Share capital Retained earnings Total liabilities and equity
800,000 1,360,0 00
480,00 320,00 240,00 280,00 0 0 0 0 920,0 640,0 240,0 280,0 00 00 00 00
392,00 328,00 120,00 40,000 0 0 0 320,00 200,00 160,00 480,000 80,000 0 0 0 208,00 112,00 600,000 40,000 80,000 0 0 1,360,0 920,0 640,0 240,0 280,0 00 00 00 00 00 280,000
The investment accounts pertain solely to the investment transactions described earlier and are not adjusted for any investment income from investees. Statements of profit or loss For the year ended December A B C Reven 720,0 408,0 192,0 ues 00 00 00 Expen (400,0 (320,0 (120,0 ses 00) 00) 00) Profi 320,0 88,00 72,00 t 00 0 0
31, 20x1 D E 256,0 128,0 00 00 (224,0 (80,0 00) 00) 32,00 48,0 0 00
Profits do not include income from investments. 27. Assuming the existence of control is based solely on shareholdings, which of the entities above are considered subsidiaries of A Co.? a. B and C b. B, C and D c. B only d. A, B, C, D and E 28. How much is the total goodwill as of December 31, 20x1? a. 280,000 b. 300,000 c. 320,000 d. 360,000 29. How much is the total NCI in net assets as of December 31, 20x1? a. 282,768 b. 237,600 c. 274,320 d. 229,600 30. How much is the consolidated retained earnings as of December 31, 20x1? a. 638,400 b. 705,680 c. 719,632 d. 698,480 31. How much is the consolidated profit or loss in 20x1? a. 500,560 b. 502,400 c. 489,420 d. 399,272 32. How much are the profit attributable to owners of parent and to the NCIs? Parent NCI in B NCI in C NCI in D NCI in E
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a. 439,632 b. 358,400 c. 425,680 d. 443,932
19,520 9,600 17,600 18,768
0
43,248 31,272 36,720 37,860
0 0 6,890 0
0 2,530 0
33. How much is the consolidated total assets as of December 31, 20x1? a. 1,900,000 b. 2,482,400 c. 1,636,000 d. 1,317,600 34. How much is the consolidated total equity as of December 31, 20x1? a. 1,356,000 b. 1,482,400 c. 1,460,000 d. 1,282,000 Chapter 19: Theory of Accounts Reviewer 1. The accounting for business combinations is currently prescribed under a. PAS 22 c. PFRS 3 – revised 2008 b. PFRS 3 d. PAS 27 – revised 2011 2. KINK Co. has acquired an investment in a subsidiary, TWIST Co., with the view to dispose of this investment within six months. The investment in the subsidiary has been classified as held for sale and is to be accounted for in accordance with PFRS 5. The subsidiary has never been consolidated. How should the investment in the subsidiary be treated in the financial statements? a. Purchase accounting should be used. b. Equity accounting should be used. c. The subsidiary should not be consolidated but PFRS 5 should be used. d. The subsidiary should remain off balance sheet. (Adapted) 3. The consolidation theory currently applied under PFRSs is a. Proprietary theory/Proportionate consolidation theory/ b. Parent company theory c. Entity theory/ Contemporary theory d. Hybrid theory/ Traditional theory 4. The proprietary theory is applied under which of the following standards? a. PAS 31 b. PAS 36 c. PFRS 3d. PAS 27 5. What is the basis for consolidation? a. significant influence c. control b. joint control d. variable returns 6. FALLACIOUS Co. controls an overseas entity MISLEADING Co. Because of exchange controls, it is difficult to transfer funds out of the country to the parent entity. FALLACIOUS Co. owns 100% of the voting power of MISLEADING Co. How should MISLEADING Co. be accounted for?
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a. It should be excluded from consolidation and the equity method should be used. b. It should be excluded from consolidation and stated at cost. c. It should be excluded from consolidation and accounted for in accordance with PFRS 9. d. It is not permitted to be excluded from consolidation because control is not lost. (Adapted) 7. TIPPLE has control over the composition of DRINK’s board of directors. TIPPLE owns 49% of DRINK and is the largest shareholder. TIPPLE has an agreement with Mr. Bartek, which owns 10% of DRINK, whereby Mr. Bartek will always vote in the same way as TIPPLE. Can TIPPLE exercise control over DRINK? a. TIPPLE cannot exercise control because it owns only 49% of the voting rights. b. TIPPLE cannot exercise control because it can control only the makeup of the board and not necessarily the way the directors vote. c. TIPPLE can exercise control solely because it has an agreement with Mr. Bartek for the voting rights to be used in whatever manner TIPPLE wishes. d. TIPPLE can exercise control because it controls more than 50% of the voting power, and it can govern the financial and operating policies of DRINK through its control of the board of directors. (Adapted) 8. On January 1, 20x1, MIME Co. acquired one-third equity interest in IMITATE Co. which resulted in MIME having significant influence over IMITATE Co. On July 1, 20x4, MIME Co. acquired a further one-third equity interest in IMITATE Co. which resulted in MIME having a controlling interest over IMITATE. For financial reporting purposes, which of the following statements is correct? a. Goodwill shall be computed on July 1, 20x4 and the one-third equity interest acquired in 20x1 does not affect the goodwill computation. b. Goodwill shall be computed on July 1, 20x4 and the one-third equity interest acquired in 20x1 affects the goodwill computation. c. Goodwill shall be computed both on January 1, 20x1 and July 1, 20x4 because the transactions are considered to constitute a ‘step acquisition.’ d. Goodwill shall be computed only on January 1, 20x1. The subsequent change in ownership interest which did not result to loss of control is accounted for directly in equity. 9. LASSITUDE Co. owns 50% of WEARINESS Co.’s voting shares. The board of directors consists of six members; LASSITUDE Co. appoints three of them and WEARINESS Co. appoints the other three. The casting vote at meetings always lies with the directors appointed by LASSITUDE Co. Does LASSITUDE Co. have control over WEARINESS Co.? a. No, control is equally split between LASSITUDE Co. and FATIGUE Co.
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b. Yes, LASSITUDE Co. holds 50% of the voting power and has the casting vote at board meetings in the event that there is not a majority decision. c. No, LASSITUDE Co. owns only 50% of the entity’s shares and therefore does not have control. d. No, control can be exercised only through voting power, not through a casting vote. (Adapted) 10. VOLUBLE TALKATIVE Co. has sold all of its shares to the public. The company was formerly a state-owned entity. The national regulator has retained the power to appoint the board of directors. An overseas entity acquires 55% of the voting shares, but the regulator still retains its power to appoint the board of directors. Who has control of the entity? a. The national regulator. b. The overseas entity. c. Neither the national regulator nor the overseas entity. d. The board of directors. (Adapted) 11. A manufacturing group has just acquired a controlling interest in a football club that is listed on a stock exchange. The management of the manufacturing group wishes to exclude the football club from the consolidated financial statements on the grounds that its activities are dissimilar. How should the football club be accounted for? a. The entity should be consolidated as there is no exemption from consolidation on the grounds of dissimilar activities. b. The entity should not be consolidated using the purchase method but should be consolidated using equity accounting. c. The entity should not be consolidated and should appear as an investment in the group accounts. d. The entity should not be consolidated; details should be disclosed in the financial statements. (Adapted) 12. On January 1, 20x1, TRICE Co. obtained control of INSTANT Co. Subsequently, there have changes in the ownership interests over INSTANT; however, the TRICE’s control over INSTANT was unaffected. Which of the following statements is incorrect? a. Once control has been achieved, further transactions whereby the parent entity acquires further equity interests from noncontrolling interests, or disposes of equity interests but without losing control, are accounted for as equity transactions b. The carrying amounts of the controlling and non-controlling interests are adjusted to reflect the changes in their relative interests in the subsidiary. c. Any difference between the amount by which the noncontrolling interests is adjusted and the fair value of the consideration paid or received is recognized directly in equity and attributed to the owners of the parent. d. The carrying amount of any goodwill should be adjusted and gain or loss is recognized in profit or loss.
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13. Which of the following exemplifies the application of the ‘entity theory’ of consolidation? a. Consolidated profit = Parent’s separate profit + Share of Parent in Subsidiary’s profit b. Consolidated profit = Profit of the group c. Consolidated profit = Profit of the group – NCI profit d. Consolidated profit = Parent’s separate profit + NCI profit 14. Under the ‘entity theory’ of consolidation, the consolidated profit equals a. Parent’s separate profit + Share of Parent in Subsidiary’s profit b. Profit of the group – NCI profit c. Parent’s separate profit + NCI profit d. Profit attributable to owners of the parent + Profit attributable to NCI 15. During the year, COMITY Co. sold equipment to its subsidiary, MUTUAL COURTESY Co., at a gain. The equipment has a remaining useful life of 5 years. Which of the following statements is true in the preparation of the consolidated financial statements? a. The gain is recognized immediately. b. The gain is deferred and recognized only in the period the equipment is sold to an unrelated party. c. The carrying amount of the asset and the related depreciation are adjusted downwards. d. The carrying amount of the asset and the related depreciation are adjusted upwards. 16. During the year, BAFFLE Co. sold part of its controlling interest in TO COFUSE Co. The sale did not affect BAFFLE’s control over TO CONFUSE. Which of the following statements is true? a. The equity adjustment would be larger if BAFFLE measures NCI at the NCI’s proportionate share in the subsidiary’s net identifiable assets rather than at fair value. b. The equity adjustment would be larger if BAFFLE measures NCI at fair value rather than at the NCI’s proportionate share in the subsidiary’s net identifiable assets. c. There would be no equity adjustment if the net disposal proceeds equal the original cost of the interest sold. d. c and d 17. Which of the following terms best describes the financial statements of a parent in which the investments are accounted for on the basis of the direct equity interest? a. Single financial statements b. Combined financial statements c. Separate financial statements d. Consolidated financial statements 18. Are the following statements true or false? 1. Consolidated financial statements must be prepared using uniform accounting policies. 2. The non-controlling interest in the net assets of subsidiaries may be shown by way of note to the consolidated statement of financial position.
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a. False, False True
b. False, True c. True, False
d.
True
19. Which of the following is not a valid condition that will exempt an entity from preparing consolidated financial statements? a. The parent entity is a wholly owned subsidiary of another entity. b. The parent entity’s debt or equity capital is not traded on the stock exchange. c. The ultimate parent entity produces consolidated financial statements available for public use that comply with PFRS. d. The parent entity is in the process of filing its financial statements with a securities commission. (Adapted) 20. Where should non-controlling interests be presented in the consolidated balance sheet? a. Within long-term liabilities. b. In between long-term liabilities and current liabilities. c. Within the parent shareholders’ equity. d. Within equity but separate from the parent shareholders’ equity. (Adapted) Chapter 19 - Suggested answers to review theory questions 1 . 2 . 3 . 4 . 5 .
C
6. D
C
7. D
C
8. B
A
9. B 1 0. C
C
1 1. 1 2. 1 3. 1 4. 1 5.
A
16. A
D
17. C
B
18. C
D
19. D
C
20. D
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Chapter 20 Separate Financial Statements Chapter 20: Multiple Choice – Computational (For classroom instruction purposes) Separate financial statements Use the following information for the next four questions: Bandolin Co. had the following investment transactions during 20x1: Acquired 80% interest in Zaskar, Inc. for ₱4,000,000 on January 1, 20x1. Zaskar reported profit of ₱40M and declared dividends of ₱1,200,000 during 20x1. The fair value of the investment on December 31, 20x1 is ₱4.8M. Acquired 20% interest in Goat Co. for ₱400,000 on July 1, 20x1. Transaction costs incurred amounted to ₱80,000. Goat reported profit of ₱8M for the six months ended December 31, 20x1 and declared year-end dividends of ₱800,000. The fair value of the investment on December 31, 20x1 is ₱420,000. Bandolin’s policy is to measure investments in subsidiaries at cost and investments in associates at fair value through profit or loss in the separate financial statements. 1. How much is the carrying amount of the investment in subsidiary in the December 31, 20x1 consolidated financial statements? a. 4,000,000 b. 4,800,000 c. 36,000,000 d. 0 2. How much is the carrying amount of the investment in subsidiary in the December 31, 20x1 separate financial statements? a. 4,000,000 b. 4,800,000 c. 36,000,000 d. 0 3. How much is the carrying amount of the investment in associate in the December 31, 20x1 separate financial statements? a. 480,000 b. 420,000 c. 1,920,000 d. 0 4. How much is net investment income recognized in the 20x1 separate financial statements for the investments referred to above? a. 100,000 b. 180,000 c. 33,600,000 d. 1,060,000 Chapter 20: Theory of Accounts Reviewer 1. Which of the following are required under PAS 27 to produce separate financial statements? a. A listed entity with at least one wholly owned subsidiary b. A listed entity with at least one subsidiary, whether wholly or partially owned. c. An entity, whether listed or unlisted, with at least one affiliate (e.g., a subsidiary, an associate or an interest in a joint venture) d. PAS 27 does not mandate which entities should produce separate financial statements.
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2. These are the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. a. General purpose financial statements c. Individual financial statements b. Consolidated financial statements d. Separate financial statements 3. These are those presented by a parent (i.e., an investor with control of a subsidiary) or an investor with joint control of, or significant influence over, an investee, in which the investments are accounted for at cost or in accordance with PFRS 9 Financial Instruments. a. General purpose financial statements c. Individual financial statements b. Consolidated financial statements d. Separate financial statements 4. In the separate financial statements of a parent entity, investments in subsidiaries that are not classified as held for sale should be accounted for a. At cost. c. Using the equity method. b. In accordance with PFRS 9. d. a or b Chapter 20 - Suggested answers to review theory questions 1 . 2 . 3 . 4 .
D B D D
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Chapter 21 The Effects of Changes in Foreign Exchange Rates Chapter 21: Multiple Choice – Computational (For classroom instruction purposes) Foreign currency transaction – Direct quotation – Purchase Use the following information for the next six questions: On November 29, 20x1, ABC Co. placed a non-cancellable purchase order for the importation of a machine with a purchase price of €40,000 from a company based in France. The contract term is FOB shipping point. The machine was shipped on December 1, 20x1 and was received by ABC on December 15, 20x1. The purchase price was settled on January 3, 20x2. The following are the exchange rates: November 29, 20x1………………………………………..₱55:€1 December 1, 20x1………………………………………….₱58:€1 December 15, 20x1………………………………………..₱57:€1 December 31, 20x1………………………………………..₱60:€1 January 3, 20x2…………………………………………….₱61:€1 1. The entry on November 29, 20x1 includes a. a debit to accounts payable for ₱2,320,000. b. a credit to machinery for ₱2,320,000. c. a debit to machinery for ₱2,320,000 d. none of these 2. The entry on December 1, 20x1 includes a. a debit to accounts payable for ₱2,320,000. b. a credit to machinery for ₱2,320,000. c. a debit to machinery for ₱2,320,000 d. none of these 3. The total FOREX gain (loss) recognized in 20x1 is a. 40,000 b. (80,000) c. (200,000) d. (120,000) 4. The adjustment to the machinery account on December 31, 20x1 is – increase (decrease) a. 80,000 b. (80,000) c. 40,000 d. 0 5. The total FOREX gain (loss) recognized in 20x2 is a. (40,000) b. (80,000) c. (200,000) d. (120,000) 6. The net adjustment to the machinery account on January 3, 20x2 is – increase (decrease) a. 80,000 b. (120,000) c. (40,000) d. 0 Foreign currency transaction – Direct quotation – Sale Use the following information for the next four questions: On November 29, 20x1, ABC Co. received a non-cancellable sale order for the exportation of inventories from a UK-based company.
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The contract price is £40,000 (pound sterling). The contract term is FOB shipping point. The inventories were shipped on December 1, 20x1. The sale was settled on January 3, 20x2. The following are the exchange rates: November 29, 20x1………………………………………..₱67:£1 December 1, 20x1………………………………………….₱68:£1 December 31, 20x1………………………………………..₱70:£1 January 3, 20x2…………………………………………….₱71:£1 7. How much sale revenue is recognized in 20x1? a. 2,680,000 b. 2,720,000 c. 2,800,000
d. 2,840,000
8. How much FOREX gain (loss) is recognized in 20x1? a. 120,000 b. (120,000) c. 80,000 d. (80,000) 9. How much FOREX gain (loss) is recognized in 20x2? a. 40,000 b. (40,000) c. 120,000 d. 160,000 10. How much is the total FOREX gain (loss) resulting from the sale transaction? a. 160,000 b. 120,000 c. 80,000 d. 40,000 Foreign currency transaction – Indirect quotation Use the following information for the next two questions: ABC Co. had the following transactions during the last month of the current reporting period: Purchased raw materials from Pakistani Co., a company based in Pakistan, for 400,000 rupees on December 17, 20x1 to be settled on January 5, 20x2. Sold inventory to Swedish Co., a company based in Sweden, for 80,000 kroners on December 20, 20x1 to be settled on January 5, 20x2. The exchange rates are as follows: Rupee Kroner Dec. 17, 20x1…………Php 1 : PKR 2.04 Dec. 20, 20x1………………………………………Php 1 : SEK 0.1667 Dec. 31, 20x1…………Php 1: PKR 2 Php 1 : SEK 0.2000 Jan. 5, 20x2…………..Php 1: PKR 2.083 Php 1 : SEK 0.2400 11. How much are the total FOREX gains/losses recognized by ABC Co. from the purchase and sale transactions described above? Purchase Sales a. (4,048) 146,570 b. 4,048 (146,572) c. 3,922 (66,667) d. (3,922) 66,667 12. How much are the total FOREX gains/losses recognized by Pakistani Co. and Swedish Co. from the purchase and sale transactions, respectively? Pakistani a. (4,048) b. 3,922
Swedish 146,572 (66,667)
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c. (3,922) d. 0
66,667 0
Subsequent measurement Use the following information for the next five questions: On December 1, 20x1, ABC Co. acquired equipment for BRL 40,000 (Brazilian reals) when the exchange rate is ₱24:BRL1. ABC Co. reported foreign exchange loss of ₱80,000 in its 20x1 statement of profit or loss and a ₱20,000 foreign exchange gain of ₱20,000 in its 20x2 statement of profit or loss. 13. What is the exchange rate on December 31, 20x1? a. ₱24:BRL1 b. ₱26:BRL1 c. ₱25.5:BRL1 of these
d. None
14. What is the exchange rate on settlement date in 20x2? a. ₱24:BRL1 b. ₱26:BRL1 c. ₱25.5:BRL1 d. None of these 15. What is the carrying amount of the accounts payable in the 20x1 statement of financial position? a. 1,040,000 b. 960,000 c. 1,020,000 d. None of these 16. How much is the cost of the equipment in the 20x1 statement of financial position? a. 1,040,000 b. 960,000 c. 1,020,000 d. None of these 17. How much is the cost of the equipment in the 20x2 statement of financial position? a. 1,040,000 b. 960,000 c. 1,020,000 d. None of these Exchange rate on initial recognition 18. ABC Co. obtained a $40,000 loan at the middle of the year. At the end of the year, the loan payable is appropriately reported at ₱2,200,000. None of the principal on the loan has been paid during the year. There has been a 10% increase in the exchange rate (expressed in direct quotation) from the date the loan has been obtained to the end of reporting period. What is the exchange rate at the date the loan has been obtained? a. ₱55:$1 b. ₱50:$1 c. ₱45:$1 d. ₱60:$1 Loan transaction 19. On July 1, 20x1, ABC Co. obtained a $40,000 loan that bears 10% annual interest when the spot exchange rate is ₱50:$1. The closing rate on December 31, 20x1 is ₱55:$1. No payments had been made on the loan during the year. How much is the foreign exchange gain (loss) to be recognized in the year-end statement of profit or loss? a. (200,000) b. (220,000) c. (210,000) d. 210,000 Cash account Use the following information for the next two questions:
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ABC Co., a domestic corporation based in the Philippines, frequently sells goods overseas through the internet. All online sales are on cash basis. The movements in ABC’s US dollar account are shown below: Cash in bank - U.S. dollar $40,00 Jan. 1 (₱48:$1) 0 80,00 Sept. 30 (₱45:$1) 0 20,000 Dec. 16 (₱44:$1) $100,00 0 Dec. 31 (₱45:$1) 20. How much is the balance of cash in bank to be presented in the year-end statement of financial position? a. 4,640,000 b. 4,500,000 c. 100,000 d. 4,650,000 21. What is the net foreign exchange gain (loss) to be recognized in the year-end statement of profit or loss? a. 100,000 b. (100,000) c. (140,000) d. 140,000 Average rate Use the following information for the next two questions: On December 15, 20x1, ABC Co. sent one of its key management personnel to a seminar in Malaysia. ABC Co. advanced MYR 40,000 (ringgits) to the manager subject to liquidation. The exchange rate on December 15, 20x1 is ₱14: MYR1. The liquidation report submitted by the key manager showed the following: MYR 32,000 were spent from December 15 to December 31, 20x1. The exchange rate on December 31, 20x1 is ₱13: MYR 1. MYR 6,000 were spent from January 1, 20x2 to January 3, 20x2. The manager returned the MYR 2,000 excess to the cashier on January 3, 20x2. The exchange rate on January 3, 20x2 is ₱12: MYR 1. 22. How much is the total FOREX gain (loss) on December 31, 20x1? a. (24,000) b. (32,000) c. 24,000 d. (38,000) 23. How much is the FOREX gain (loss) on January 3, 20x2? a. (5,000) b. (4,000) c. (7,000) d. (2,000) Items measured at other than historical cost Use the following information for the next two questions: ABC Co. had the following foreign currency transactions during the year: Acquired equipment on January 1, 20x1 for THB 40,000 (bahts) from a Thailand-based company when the current exchange rate was ₱1.2: THB 1. The equipment is depreciated over 5 years using the straight-line method.
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Purchased inventories on December 1, 20x1 for ZAR 4,000 (rands) from a company based in South Africa when the current exchange rate was ₱5: ZAR 1.
Both the acquisitions described above are on cash basis. At yearend, ABC Co. determined the following: The equipment was found to have a recoverable amount of THB 28,000. The closing rate is ₱1.3: THB 1. Half of the inventories purchased remain unsold. ABC estimated that the net realizable value of the unsold inventories is ZAR 1,200. The closing rate is ₱6. 24. How much is the impairment loss on the equipment? a. 11,600 b. 2,000 c. 9,280 d. None 25. How much is the impairment loss on the inventory? a. 2,800 b. 800 c. 2,240 d. None Buying and selling rates Use the following information for the next two questions: ABC Co. had the following foreign currency transactions on April 1, 20x1: Purchased goods worth CHF 40,000 (francs) from Swiss Company, a company based in Switzerland. Sold goods with sale price of VEB 4,000 (bolivars) to Venezuelan Company, a company based in Venezuela. Both the transactions were settled on April 30, 20x1. The following were the spot exchange rates: Buying Selling Swiss Francs April 1, 20x1…………………………₱44:CHF1 ₱48: CHF1 April 30, 20x1……………………….₱47:CHF1 ₱50: CHF1 Bolivars April 1, 20x1…………………………₱10:CHF1 April 30, 20x1……………………….₱13:CHF1
₱12: CHF1 ₱16: CHF1
26. How much is the FOREX gain (loss) on the purchase transaction? a. (120,000) b. 120,000 c. 80,000 d. (80,000) 27. How much is the FOREX gain (loss) on the sale transaction? a. 16,000 b. 12,000 c. (16,000) d. (12,000) Revaluation of asset 28. On January 1, 20x1, ABC Co. acquired equipment for MWK 4,000,000 (kwachas) from a company based in Malawi. The equipment’s estimated useful life is 4 years. ABC Co. uses the straight line method of depreciation and the revaluation model. On December 31, 20x1, the equipment was determined to have a net appraised value of MWK 4,800,000 (kwachas). The relevant rates are as follows:
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Jan. 1, 20x1………………………………………….₱0.20 : MWK 1 Dec. 31, 20x1………………………………………..₱0.26 : MWK 1 How much is the revaluation surplus? a. 648,000 b. 3,461,538 c. 448,000 d. None Exchange difference recognized in OCI 29. ABC Co. has a wholly-owned subsidiary in Indonesia. The following information is available about the subsidiary for the year to December 31, 20x1: (IDR Rupiahs) 400,000,00 Net assets, Jan. 1, 20x1 0 160,000,00 Profit for the year 0 Dividends 560,000,00 Net assets, Dec. 31, 20x1 0 No goodwill arose from the business combination. The following are the relevant exchange rates: Jan. 1, 20x1………………………………₱0.003 : IDR 1 Average for the year…………………….₱0.004 : IDR 1 Dec. 31, 20x1…………………………….₱0.005 : IDR 1 How much is the total gain (loss) on translation for the year? a. 1,280,000 b. (1,120,000) c. 1,120,000 d. 960,000 Goodwill Use the following information for the next two questions: On January 1, 20x1, a Philippine holding company acquired 100% interest in a subsidiary based in Kenya for KES 40M (shillings). The fair value of the net assets of the subsidiary at that date was KES 32 million (shillings). The following are the relevant exchange rates: Jan. 1, 20x1………………………………………..₱0.04 : KES 1 Dec. 31, 20x1………………………………………₱0.05 : KES 1 The group determined that there is no impairment in goodwill. 30. How much is the goodwill as of January 1, 20x1? a. 100,000 b. 240,000 c. 320,000 d. 480,000 31. How much is the goodwill as of December 31, 20x1? a. 400,000 b. 440,000 c. 480,000 d. 560,000 Translation of a subsidiary’s financial statements Use the following information for the next nine questions: ABC Co. owns 80% of the ordinary shares of a foreign subsidiary, XYZ, Inc., a company based in Korea. XYZ, Inc.'s functional currency is won. The subsidiary was acquired at the start of the reporting period for 6,000,000 wons, when the subsidiary's retained earnings were 3,200,000 wons.
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At the date of the acquisition the fair value of the net assets of the subsidiary were 5,600,000 wons. This included a fair value adjustment in respect of land. ABC Co. elected to measure non-controlling interest at the NCI’s proportionate share of the fair value of the subsidiary‘s net assets. The group determined at year-end that goodwill is not impaired. There were no changes in the share capital of the subsidiary during the year. The relevant exchange rates are as follows: Date Exchange rates Jan. 1, 20x1………………………………….₱0.03: KRW 1 Average for the year………………………..₱0.04: KRW 1 Dec. 31, 20x1………………………………..₱0.05: KRW 1 A summary of the individual financial statements of the entities at the end of reporting period are shown below: Statements of financial position As at December 31, 20x1 ASSETS Investment in subsidiary Other assets TOTAL ASSETS
ABC Co. (pesos) 180,000 8,000,000 8,180,000
XYZ, Inc. (wons) 5,200,000 5,200,000
LIABILITIES AND EQUITY Liabilities Share capital Retained earnings Total equity TOTAL LIABILITIES AND EQUITY
1,600,000 4,000,000 2,580,000 6,580,000 8,180,000
240,000 800,000 4,160,000 4,960,000 5,200,000
Statements of profit or loss For the year ended December 31, 20x1 ABC Co. (pesos) 3,600,00 0 (2,160,0 00) 1,440,0 00
Revenues Expenses Profit for the year
XYZ, Inc. (wons) 2,400,000 (1,440,000 ) 960,00 0
32. How much is the goodwill as of December 31, 20x1? a. 45,600 b. 76,000 c. 66,500 d. 64,500 33. How much is the non-controlling interest in the net assets of the subsidiary (NCI) as of December 31, 20x1? a. 39,360 b. 56,600 c. 54,360 d. 65,600 34. How much is the consolidated retained earnings as of December 31, 20x1? a. 2,618,400 b. 2,702,400 c. 2,672,340 d. 2,610,720
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35. How much is the total translation gain (loss) to be recognized in other comprehensive income in 20x1? a. 152,000 b. 121,600 c. 161,600 d. 136,000 36. How much is the consolidated profit in 20x1? a. 1,478,400 b. 1,488,000 c. 1,596,400
d. 1,696,000
37. How much is the consolidated total comprehensive income in 20x1? a. 1,640,000 b. 1,630,400 c. 1,718,000 d. 1,832,000 38. How much is the comprehensive income attributable to owners of the parent? a. 1,592,320 b. 1,606,080 c. 1,598,400 d. 1,638,080 39. How much is the consolidated total assets as of December 31, 20x1? a. 8,416,000 b. 9,680,000 c. 8,340,000 d. 9,860,000 40. How much is the equity attributable to owners of the parent as of December 31, 20x1? a. 6,676,320 b. 6,828,320 c. 6,738,400 d. 6,804,000 Net investment in a foreign operation Use the following information for the next six questions: On January 1, 20x1, ABC Co. acquired 60% interest in XYZ, Inc., a company situated in a foreign country. The currency of this country is the Armenian Dram (AMD). ABC elected to measure noncontrolling interest as its proportionate share of the fair value of the subsidiary‘s net assets. The year-end financial statements of the combining constituents show the following information: Statements of financial position As of December 31, 20x1 ABC Co. ₱m* 8,000 1,760 12,000 21,760
Current assets Investment in subsidiary Property, plant and equipment TOTAL ASSETS Current liabilities Noncurrent liabilities Total liabilities Share capital Share premium Retained earnings Total equity TOTAL LIABILITIES AND EQUITY *Amounts in millions. Statements of profit or loss
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XYZ, Inc. ADMm* 8,800 7,200 16,000
4,000 4,800 8,800
4,000 2,800 6,800
4,000 2,000 6,960 12,960 21,760
400 800 8,000 9,200 16,000
For the year ended December 31, 20x1 ABC Co. ₱m Revenue 16,000 Cost of sales (10,000) Gross profit 6,000 Operating expenses (2,000) Dividends received 240 Interest expense (400) Interest income 160 Profit before tax 4,000 Income tax expense (1,200) Profit after tax 2,800 Extraordinary item Profit for the year 2,800
XYZ, Inc. ADMm 32,000 (16,000) 16,000 (4,000) (1,200) 400 11,200 (4,000) 7,200 (800) 6,400
The movements in retained earnings during 20x1 are shown below: Retained earnings – Jan. 1, 20x1 4,560 4,800 Dividends paid (400) (3,200) Profit for the year 2,800 6,400 Retained earnings – Dec. 31, 20x1 6,960 8,000 Additional information: a) XYZ, Inc. has applied local GAAP, but has made some attempt to adapt to IFRSs (to which PFRSs are consistent). As a result, XYZ, Inc. has written off research previously capitalized as an extraordinary item prior period adjustment in the sum of ADM400 million. The remainder of the extraordinary item is the recognition of a fall in value of some plant that was damaged during the year. b) The fair value of the net assets of XYZ, Inc. at acquisition was ADM8,000 million after taking into account the removal of capitalized research discussed above. Goodwill is unimpaired. c) The increase in the fair value of XYZ, Inc. over carrying value is attributable to machines which are depreciated over five years on the straight line basis. d) During the year, ABC Co. sold ₱120 million in goods to XYZ, Inc. at a margin of 20%. All of the goods had been utilized in production by year-end, but only one half of the relevant finished goods have been sold. XYZ, Inc. received the goods on September 1 and paid on September 21. The foreign exchange difference remains in current liabilities. e) ABC Co. made a loan of ₱200 million to XYZ, Inc. immediately after the acquisition on January 1. This is still outstanding at yearend. ABC Co. has recorded the asset in current assets. The subsidiary has recorded the liability in noncurrent liabilities at the rate ruling at year-start. f) The dividends were declared by XYZ, Inc. at year-end and received by ABC Co. on that day. The following exchange rates are relevant: ADM to ₱1.00 January 1…………………………………………………….5 September 1…………………………………………………6 September 21……………………………………………….6.5 December 31………………………………………………..8 Weighted average for year……………………………….. 7
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41. How much is the goodwill as of December 31, 20x1? a. 4,000 b. 620 c. 500 d. 1,400 42. How much is the NCI in net assets as of December 31, 20x1? a. 523 b. 553 c. 624 d. 829.50 43. How much is the consolidated retained earnings as of December 31, 20x1? a. 7,176 b. 7,214 c. 7,245 d. 7,385 44. How much is the total translation gain (loss) to be recognized in other comprehensive income in 20x1? a. (1,087) b. (1,792) c. (1,903) d. (1,093) 45. How much is the consolidated profit in 20x1? a. 3,442 b. 3,483 c. 3,647 d. 3,328 46. How much is the comprehensive income attributable to NCI? a. 36 b. 38 c. 43 d. 41 Disposal of a foreign operation 47. ABC Co. held 100% ownership interest of XYZ, Inc. but sold the entire investment on August 1, 20x1 for ₱500,000. The following information was determined as of this date: Carrying amount of XYZ’s net identifiable assets 412,000 Carrying amount of NCI (including accumulated OCI attributable to NCI) 82,400 Goodwill 12,000 ABC Co. had previously recognized translation gains of ₱3,200 in other comprehensive income on its investment in XYZ, Inc. How much is the total gain to be recognized in profit or loss on disposal date? a. 158,400 b. 161,600 c. 155,200 d. 164,800 Translation of a foreign operation – Hyperinflationary economy Use the following information for the next four questions: ABC Co., a corporation based in the Philippines, has a foreign branch that is operating in a hyperinflationary economy. The financial statements of the branch prior to restatement and translation are shown below: Statement of financial position As of December 31, 20x1 Amounts in Angolan Kwanza (AOA) Cash Accounts receivable Inventory Building Accumulated depreciation Total assets
184,000 296,000 160,000 400,000 (80,000) 960,000
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Loan payable Share capital Retained earnings Total equity Total liabilities and equity
120,000 400,000 440,000 840,000 960,000
Statement of profit or loss For the year ended December 31, 20x1 Amounts in Angolan Kwanza (AOA) Sales Cost of sales: Inventory - Jan. 1 240,000 Purchases 120,000 Total goods available for sale 360,000 Inventory - Dec. 31 (160,000) Gross profit Depreciation expense Other operating expenses Profit for the year
480,000
(200,000) 280,000 (40,000) (160,000) 80,000
Additional information: The building was acquired on January 1, 20x0. The share capital was issued on January 1, 20x0. Revenues were earned and expenses were incurred evenly during the year. Selected values of general price indices (CPI) are shown below: January 1, 20x0 100 Average for 20x0 110 January 1, 20x1 120 Average for 20x1 125 December 31, 20x1 140
The net monetary assets as of January 1, 20x1 is ₱160,000. The exchange rates are as follows: 1.00 AOA : 0.45 January 1, 20x1 PHP 1.00 AOA : 0.47 Average for 20x1 PHP 1.00 AOA : 0.50 December 31, 20x1 PHP
48. How much is the gain (loss) on net monetary position? a. (53,224) b. (51,887) c. (50,667) d. (48,333) 49. How much is the translated total assets as of December 31, 20x1? a. 552,400 b. 553,600 c. 554,800 d. 556,300 50. How much is the translated total equity as of December 31, 20x1? a. 553,600 b. 489,600 c. 495,600 d. 493,600
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51. How much is the translated profit (loss) for 20x1? a. (4,461) b. 4,240 c. (4,561) d. (4,362) Chapter 21: Exercises (For classroom instruction purposes) 1. ABC Co. is a mining company registered in Canada whose shares are traded in the Toronto Stock Exchange. ABC’s operating activities take place in the gold and silver mines in the Philippines. Requirements: a. What is the presentation currency of ABC Co.? b. What is the functional currency of ABC Co.? c. ABC acquired specialized mining equipment from Japan, invoiced in Japanese yen. What type of currency is the Japanese yen under PAS 21 definitions? 2. ABC Philippines Co. is a branch of ABC U.S. Co. ABC Philippines operates in a Philippine Economic Zone Authority (PEZA) Special Economic Zone. ABC Philippines is engaged in the apparel business. All of its raw materials are imported from its main office in the U.S. and all of its finished products are exported directly to U.S. customers. The U.S. customers remit payments to the U.S. main office. The U.S. main office will then provide the Philippine branch its working capital needs. None of ABC Philippines’ finished products are sold in the Philippines. The raw materials imported and finished goods exported are denominated in U.S. dollars. Requirements: a. What is ABC Philippines Co.’s functional currency? b. What is ABC Philippines Co.’s presentation currency? 3. ABC Co. started its operations in China, where the currency is the yuan. After several years, ABC Co. expanded and exported its product to the Philippines, and conducted business through a branch. The functional currency of the group was deemed to be the yuan but by the end of 20x1, 80% of the business was conducted in the Philippines. At the beginning of 20x1, 30% of the business was conducted in Philippine pesos. Question: Should the functional currency of the group remains at yuan or changed to Philippine pesos? 4. On November 29, 20x1, ABC Co. placed a non-cancellable purchase order for the importation of a machine with a purchase price of €20,000 from a company based in France. The contract term is FOB shipping point. The machine was shipped on December 1, 20x1 and was received by ABC on December 15, 20x1. The purchase price was settled on January 3, 20x2. The following are the exchange rates: November 29, 20x1………………………………………..₱55:€1 December 1, 20x1………………………………………….₱58:€1 December 15, 20x1………………………………………..₱57:€1
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December 31, 20x1………………………………………..₱60:€1 January 3, 20x2…………………………………………….₱61:€1 Requirement: Provide the journal entries. 5. On November 29, 20x1, ABC Co. received a non-cancellable sale order for the exportation of inventories from a UK-based company. The contract price is £40,000 (pound sterling). The contract term is FOB shipping point. The inventories were shipped on December 1, 20x1. The sale was settled on January 3, 20x2. The following are the exchange rates: November 29, 20x1………………………………………..₱67:£1 December 1, 20x1………………………………………….₱68:£1 December 31, 20x1………………………………………..₱70:£1 January 3, 20x2…………………………………………….₱71:£1 Requirement: Provide the journal entries. 6. ABC Co. had the following transactions during the last month of the current reporting period: Purchased raw materials from Pakistani Co., a company based in Pakistan, for 200,000 rupees on December 17, 20x1 to be settled on January 5, 20x2. Sold inventory to Swedish Co., a company based in Sweden, for 40,000 kroners on December 20, 20x1 to be settled on January 5, 20x2. The exchange rates are as follows: Rupee Kroner Dec. 17, 20x1…………Php 1 : PKR 2.04 Dec. 20, 20x1………………………………………Php 1 : SEK 0.1667 Dec. 31, 20x1…………Php 1: PKR 2 Php 1 : SEK 0.2000 Jan. 5, 20x2…………..Php 1: PKR 2.083 Php 1 : SEK 0.2400 Requirements: a. How much are the FOREX gains/losses recognized by ABC Co. from the purchase and sale transactions described above? b. How much are the total FOREX gains/losses recognized by Pakistani Co. and Swedish Co. from the purchase and sale transactions, respectively? 7. ABC Co. is a Philippine-based company. During the year, ABC recognized a foreign exchange gain on its $2,000 receivable and a foreign exchange loss on its ¥200,000 payable. If exchange rates are expressed in indirect quotations (i.e., $xx : ₱1.00 and ¥xx : ₱1.00), what would have been the movements in the exchange rates during the period? 8. On December 1, 20x1, ABC Co. acquired equipment for BRL 20,000 (Brazilian reals) when the exchange rate is ₱24:BRL1. ABC Co. reported foreign exchange loss of ₱40,000 in its 20x1 statement of profit or loss and a ₱10,000 foreign exchange gain of ₱10,000 in its 20x2 statement of profit or loss. Requirements: Compute for the following:
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a. Exchange rates on December 31, 20x1 and on settlement date in 20x2. b. Carrying amount of accounts payable in the 20x1 statement of financial position. c. Cost of equipment in the 20x1 and 20x2 statements of financial position. 9. ABC Co. obtained a $40,000 loan at the middle of the year. At the end of the year, the loan payable is appropriately reported at ₱2,200,000. None of the principal on the loan has been paid during the year. There has been a 10% increase in the exchange rate (expressed in direct quotation) from the date the loan has been obtained to the end of reporting period. Requirement: What is the exchange rate at the date the loan has been obtained? 10. On July 1, 20x1, ABC Co. obtained a $20,000 loan that bears 10% annual interest when the spot exchange rate is ₱50:$1. The closing rate on December 31, 20x1 is ₱55:$1. No payments had been made on the loan during the year. Requirement: Compute for the foreign exchange gain/loss to be recognized in the year-end statement of profit or loss. 11. ABC Co., a domestic corporation based in the Philippines, frequently sells goods overseas through the internet. All online sales are on cash basis. The movements in ABC’s US dollar account are shown below: Cash in bank - U.S. dollar Jan. 1 (₱48:$1) $20,000 10,00 Sept. 30 (₱45:$1) 40,000 0 Dec. 16 (₱44:$1) $50,00 0 Dec. 31 (₱45:$1) Requirements: Compute for the following: a. Amount of cash in bank to be presented in the year-end statement of financial position. b. Net foreign exchange gain or loss to be recognized in the yearend statement of profit or loss. 12. On December 15, 20x1, ABC Co. sent one of its key management personnel to a seminar in Malaysia. ABC Co. advanced MYR 20,000 (ringgits) to the manager subject to liquidation. The exchange rate on December 15, 20x1 is ₱14: MYR1. The liquidation report submitted by the key manager showed the following: MYR 16,000 were spent from December 15 to December 31, 20x1. The exchange rate on December 31, 20x1 is ₱13: MYR 1. MYR 3,000 were spent from January 1, 20x2 to January 3, 20x2. The manager returned the MYR 1,000 excess to the cashier on
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January 3, 20x2. The exchange rate on January 3, 20x2 is ₱12: MYR 1. Requirements: Compute for the following: a. FOREX gain or loss on December 31, 20x1. b. FOREX gain or loss on January 3, 20x2. 13. ABC Co. had the following foreign currency transactions during the year: Acquired equipment on January 1, 20x1 for THB 20,000 (bahts) from a Thailand-based company when the current exchange rate was ₱1.2: THB 1. The equipment is depreciated over 5 years using the straight-line method. Purchased inventories on December 1, 20x1 for ZAR 2,000 (rands) from a company based in South Africa when the current exchange rate was ₱5: ZAR 1. Both the acquisitions described above are on cash basis. At yearend, ABC Co. determined the following: The equipment was found to have a recoverable amount of THB 14,000. The closing rate is ₱1.3: THB 1. Half of the inventories purchased remain unsold. ABC estimated that the net realizable value of the unsold inventories is ZAR 600. The closing rate is ₱6. Requirement: Provide the year-end adjustments. 14. ABC Co. had the following foreign currency transactions on April 1, 20x1: Purchased goods worth CHF 20,000 (francs) from Swiss Company, a company based in Switzerland. Sold goods with sale price of VEB 2,000 (bolivars) to Venezuelan Company, a company based in Venezuela. Both the transactions were settled on April 30, 20x1. The following were the spot exchange rates: Buying Selling Swiss Francs April 1, 20x1…………………………₱44:CHF1 ₱48: CHF1 April 30, 20x1……………………….₱47:CHF1 ₱50: CHF1 Bolivars April 1, 20x1…………………………₱10:CHF1 April 30, 20x1……………………….₱13:CHF1 Requirements: transactions:
Compute
for
the
FOREX
₱12: CHF1 ₱16: CHF1 gain/loss
from
the
15. On January 1, 20x1, ABC Co. acquired equipment for MWK 2,000,000 (kwachas) from a company based in Malawi. The equipment’s estimated useful life is 4 years. ABC Co. uses the straight line method of depreciation and the revaluation model.
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On December 31, 20x1, the equipment was determined to have a net appraised value of MWK 2,400,000 (kwachas). The relevant rates are as follows: Jan. 1, 20x1………………………………………….₱0.20 : MWK 1 Dec. 31, 20x1………………………………………..₱0.26 : MWK 1 Requirement: Provide the year-end entry to account for the revaluation. 16. ABC Co. has a wholly-owned subsidiary in Indonesia. The following information is available about the subsidiary for the year to December 31, 20x1: (IDR - Rupiahs) Net assets, Jan. 1, 20x1 200,000,000 Profit for the year 80,000,000 Dividends Net assets, Dec. 31, 20x1 280,000,000 No goodwill arose from the business combination. The following are the relevant exchange rates: Jan. 1, 20x1………………………………₱0.003 : IDR 1 Average for the year…………………₱0.004 : IDR 1 Dec. 31, 20x1…………………………….₱0.005 : IDR 1 Requirement: Calculate the total gain or loss on translation for the year, analyzing it between (1) the gain or loss on re-translating the opening net assets and (2) the gain or loss on re-translating income and expenses. 17. On January 1, 20x1, a Philippine holding company acquired 100% interest in a subsidiary based in Kenya for KES 20M (shillings). The fair value of the net assets of the subsidiary at that date was KES 16 million (shillings). The following are the relevant exchange rates: Jan. 1, 20x1………………………………………..₱0.04 : KES 1 Dec. 31, 20x1……………………………………..₱0.05 : KES 1 The group determined that there is no impairment in goodwill. Requirements: Compute for the goodwill to be included in the consolidated financial statements on January 1, 20x1 and on December 31, 20x1. 18. ABC Co. owns 80% of the ordinary shares of a foreign subsidiary, XYZ, Inc., a company based in Korea. XYZ, Inc.'s functional currency is won. The subsidiary was acquired at the start of the reporting period for 3,000,000 wons, when the subsidiary's retained earnings were 1,600,000 wons. At the date of the acquisition the fair value of the net assets of the subsidiary were 2,800,000 wons. This included a fair value adjustment in respect of land.
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ABC Co. elected to measure non-controlling interest at the NCI’s proportionate share of the fair value of the subsidiary‘s net assets. The group determined at year-end that goodwill is not impaired. There were no changes in the share capital of the subsidiary during the year. The relevant exchange rates are as follows: Date Exchange rates Jan. 1, 20x1………………………………….₱0.03: KRW 1 Average for the year…………………….₱0.04: KRW 1 Dec. 31, 20x1………………………………..₱0.05: KRW 1 A summary of the individual financial statements of the entities at the end of reporting period are shown below: Statements of financial position As at December 31, 20x1 ASSETS Investment in subsidiary Other assets TOTAL ASSETS
ABC Co. (pesos) 90,000 4,000,000 4,090,000
XYZ, Inc. (wons) 2,600,000 2,600,000
LIABILITIES AND EQUITY Liabilities Share capital Retained earnings Total equity TOTAL LIABILITIES AND EQUITY
800,000 2,000,000 1,290,000 3,290,000 4,090,000
120,000 400,000 2,080,000 2,480,000 2,600,000
Statements of profit or loss For the year ended December 31, 20x1 ABC Co. (pesos) 1,800,0 00 (1,080,0 00) 720, 000
Revenues Expenses Profit for the year
XYZ, Inc. (wons) 1,200,0 00 (720,0 00) 480, 000
Requirement: Prepare the consolidated statement of financial position and consolidated statement of profit or loss and other comprehensive income. 19. On January 1, 20x1, ABC Co. acquired 60% interest in XYZ, Inc., a company situated in a foreign country. The currency of this country is the Armenian Dram (AMD). ABC elected to measure non-controlling interest as its proportionate share of the fair value of the subsidiary‘s net assets. The year-end financial statements of the combining constituents show the following information: Statements of financial position As of December 31, 20x1
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Current assets Investment in subsidiary Property, plant and equipment TOTAL ASSETS Current liabilities Noncurrent liabilities Total liabilities Share capital Share premium Retained earnings Total equity TOTAL LIABILITIES AND EQUITY *Amounts in millions.
ABC Co. ₱m* 4,000 880 6,000 10,880
XYZ, Inc. ADMm* 4,400
2,000 2,400 4,400
2,000 1400 3,400
2,000 1000 3,480 6,480 10,880
200 400 4,000 4,600 8,000
Statements of profit or loss For the year ended December 31, 20x1 ABC Co. ₱m 8,00 Revenue 0 (5,000 Cost of sales ) Gross profit 3,000 (1,000 Operating expenses ) 12 Dividends received 0 (200 Interest expense ) 8 Interest income 0 Profit before tax 2,000 (600 Income tax expense ) 1,40 Profit after tax 0 Extraordinary item 1,40 0
Profit for the year
3,600 8,000
XYZ, Inc. ADMm 16,00 0 (8,000 ) 8,000 (2,000 ) (600 ) 20 0 5,600 (2,000 ) 3,60 0 (400 ) 3,20 0
The movements in retained earnings during 20x1 are shown below: 2,40 2,280 Retained earnings – Jan. 1, 20x1 0 (1,600 (200) Dividends paid ) 3,20 1,400 Profit for the year 0 Retained earnings – Dec. 31, 20x1 3,480 4,000 Additional information:
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a) XYZ, Inc. has applied local GAAP, but has made some attempt to adapt to IFRS (to which PFRSs are consistent). As a result, XYZ, Inc. has written off research previously capitalized as an extraordinary item prior period adjustment in the sum of ADM200 million. The remainder of the extraordinary item is the recognition of a fall in value of some plant that was damaged during the year. b) The fair value of the net assets of XYZ, Inc. at acquisition was ADM4,000 million after taking into account the removal of capitalized research discussed above. Goodwill is unimpaired. c) The increase in the fair value of XYZ, Inc. over carrying value is attributable to machines which are depreciated over five years on the straight line basis. d) During the year, ABC Co. sold ₱60 million in goods to XYZ, Inc. at a margin of 20%. All of the goods had been utilized in production by the year-end, but only one half of the relevant finished goods have been sold. XYZ, Inc. received the goods on September 1 and paid on September 21. The foreign exchange difference remains in current liabilities. e) ABC Co. made a loan of ₱100 million to XYZ, Inc. immediately after the acquisition on January 1. This is still outstanding at yearend. ABC Co. has recorded the asset in current assets. The subsidiary has recorded the liability in noncurrent liabilities at the rate ruling at year-start. f) The dividends were declared by XYZ, Inc. at year-end and received by ABC Co. on that day. The following exchange rates are relevant: ADM to ₱1.00 January 1…………………………………………………….5 September 1…………………………………………………6 September 21……………………………………………….6.5 December 31………………………………………………..8 Weighted average for year…………………………….7 Requirements: Compute for the following (round-off amounts to nearest million): a. Consolidated total assets. b. Consolidated total liabilities. c. Consolidated total equity. d. Prepare the consolidation working paper for comprehensive income. 20. ABC Co. held 100% ownership interest of XYZ, Inc. but sold the entire investment on August 1, 20x1 for ₱250,000. The following information was determined as of this date: Carrying amount of XYZ’s net identifiable assets 206,000 Carrying amount of NCI (including accumulated OCI attributable to NCI) 41,200 Goodwill 6,000 ABC Co. had previously recognized translation gains of ₱1,600 in other comprehensive income on its investment in XYZ, Inc. Requirement: Compute for the total gain to be recognized in profit or loss on disposal date.
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21. ABC Co., a corporation based in the Philippines, has a foreign branch that is operating in a hyperinflationary economy. The financial statements of the branch prior to restatement and translation are shown below: Statement of financial position As of December 31, 20x1 Amounts in Angolan Kwanza (AOA) Cash
92,000
Accounts receivable
148,000
Inventory
80,000
Building
200,000
Accumulated depreciation
(40,000)
Total assets
480,000
Loan payable
60,000
Share capital
200,000
Retained earnings
220,000
Total equity Total liabilities and equity
420,000 480,000
Statement of profit or loss For the year ended December 31, 20x1 Amounts in Angolan Kwanza (AOA) Sales Cost of sales: Inventory - Jan. 1 120,000 Purchases 60,000 Total goods available for sale 180,000 Inventory - Dec. 31 (80,000) Gross profit Depreciation expense Other operating expenses Profit for the year
240,000
(100,000) 140,000 (20,000) (80,000) 40,000
Additional information: The building was acquired on January 1, 20x0. The share capital was issued on January 1, 20x0. Revenues were earned and expenses were incurred evenly during the year. Selected values of general price indices (CPI) are shown below: January 1, 20x0 100 Average for 20x0 110
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January 1, 20x1 Average for 20x1 December 31, 20x1
120 125 140
The net monetary assets as of January 1, 20x1 is ₱20,000. The exchange rates are as follows: 1.00 AOA : 0.45 January 1, 20x1 PHP 1.00 AOA : 0.47 Average for 20x1 PHP 1.00 AOA : 0.50 December 31, 20x1 PHP
Requirement: Prepare the translated financial statements of the branch. Chapter 21: Theory of Accounts Reviewer 1. The accounting for the effects of foreign currencies on financial statements is prescribed under which standard? a. PAS 12 b. PFRS 21 c. PFRS 9 d. PAS 21 2. Which of the following statements is correct regarding the preparation of financial statements in accordance with PFRSs? a. A reporting entity is encouraged under the PFRSs to identify its functional currency when preparing financial statements. b. A reporting entity is required under the PFRSs to identify its functional currency when preparing financial statements only when the entity engages in foreign activities. c. The functional currency must be the currency of the country in which the entity operates or is based. d. A reporting entity must identify its functional currency when preparing its financial statements. 3. Which of these considerations would not be relevant in determining the entity’s functional currency? a. The currency that influences the costs of the entity. b. The currency in which finance is generated. c. The currency in which receipts from operating activities are retained. d. The currency that is the most internationally acceptable for trading. (Adapted) 4. When translating foreign currency transactions in accordance with PAS 21, if exchange rates fluctuate significantly, a. the use of the average rate for a period is appropriate for as long as it remains relevant all throughout the period. b. the use of the average rate for a period is required under PAS 21 only if it can be determined without undue cost and effort. c. the use of average rate is always appropriate d. the use of the average rate for a period is inappropriate.
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5. In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, the foreign subsidiary's functional currency is the currency: a. In which the subsidiary maintains its accounting records. b. Of the country in which the subsidiary is located. c. Of the country in which the parent is located. d. Of the environment in which the subsidiary primarily generates and expends cash. (Adapted) 6. A foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating: (Item #1) Sales to customers; (Item #2) Wages expense a. No, no b. Yes, yes c. No, yes d. Yes, no 7. Monetary items are a. Cash only. b. Cash and bank balances. c. Cash, short-term receivables, and marketable securities d. Money held, assets receivable, and liabilities payable, in fixed or determinable amount of cash or cash equivalents. 8. According to PAS 21, a foreign operation is: a. an undertaking with foreigners b. a branch, associate, joint venture or subsidiary, where the activities are conducted in a different country to that of the parent undertaking. c. a foreign representative where the activities are not an integral part of the parent. d. a parent operating in foreign shores 9. The functional currency is: a. the currency which is functioning in the country where the parent operates. b. the currency of the country where an entity’s operations are based. c. the currency of the primary economic environment in which the undertaking operates. d. the currency used in the group’s consolidated financial statements. 10. The presentation currency is: a. the local currency of a foreign operation in which it reports. b. used in the parent’s and in the group’s consolidated financial statements. c. the currency which results to largest exchange gains. d. the currency of the country where an entity’s operations are based. 11. Exchange difference is a. the difference between two different currencies. b. the difference between the cost and fair value of monetary item
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c. the difference calculated from reporting the same number of units of a foreign currency, in the presentation currency, at different exchange rates. d. the average difference between the exchange rate at the beginning and end of a period. 12. a. b. c. d.
The The The The The
closing rate is: exchange rate at which all assets and liabilities are stated. average rate used in the year an entity closes its books. spot exchange rate at the end of reporting period. rate that is closed to the financial statements.
13. The net investment in a foreign operation is: a. The parent’s share of the net assets of the undertaking. b. The non-controlling interest’s share of the net assets of the undertaking. c. The amount invested in the undertaking stated at cost. d. Investments less liabilities and other costs. 14. An entity has a subsidiary that operates in a foreign country. The subsidiary issued a legal notice of a dividend to the parent of €2.4 million, and this was recorded in the parent entity’s financial statements. The exchange rate at that date was €2 = $1. The functional currency of the entity is the dollar. At the date of receipt of the dividend, the exchange rate had moved to €3 = $1. The exchange difference arising on the dividend would be treated in which way in the financial statements? a. No exchange difference will arise as it will be eliminated on consolidation. b. An exchange difference of $400,000 will be taken to equity. c. An exchange difference of $400,000 will be taken to the parent entity’s income statement and the group income statement. d. An exchange difference of $400,000 will be taken to the parent entity’s income statement only. (Adapted) 15. Transactions and investments in foreign currencies: I. Decrease business risk. II. Increase business risk. a. True, true b. True, false c. False, true d. False, false 16. The foreign operation may trade profitably, but the investment may be adversely hit by: a. Rise in the foreign currency against that of the parent. b. Fall in the foreign currency against that of the parent. c. Exchange rates remaining the same. d. a or b (Adapted) 17. An entity started trading in country A, whose currency was the dollar. After several years the entity expanded and exported its product to country B, whose currency was the euro, and conducted business through a branch. The functional currency of the group was deemed to be the dollar but by the end of 20X7, 80% of the business was conducted in country B using the euro.
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At the end of 20X6, 30% of the business was conducted in the euro. The functional currency should a. Remain the dollar. b. Change to the euro at the beginning of 20X7. c. Change to the euro at the end of 20X7. d. Change to the euro at the end of 20X7 if it is considered that the underlying transactions, events, and conditions of business have changed. (Adapted) 18. Opportunities for performance improvement will more likely come from: a. A review of the realized gains and losses. c. a or b b. A review of the unrealized gains and losses. d. neither a nor b 19. The exchange rate on the day of the transaction is called: a. The spot rate. c. The average rate. b. The closing rate. d. A rate sometime in the future. 20. a. b. c. d.
The date of the transaction is: The date cash is transferred. The date when the transaction is contracted or recognized. When the transaction is entered into the books of account. The date when the rights or obligations on the contract are settled or discharged. (Adapted) 21. If the $ (dollar) strengthens: a. Less pesos would be received from an account receivable in $. b. More pesos would be received from an account receivable in $. c. Less pesos would be paid to settle an account payable in $. d. a and c (Adapted) 22. An entity started trading in country A, whose currency was the dollar. After several years the entity expanded and exported its product to country B, whose currency was the euro. The business was conducted through a subsidiary in country B. The subsidiary is essentially an extension of the entity’s own business, and the directors of the two entities are common. The functional currency of the subsidiary is a. The dollar. b. The euro. c. a or b d. Difficult to determine. (Adapted) 23. An entity has a subsidiary that operates in a country where the exchange rate fluctuates wildly and there are seasonal variations in the income and expenditure patterns. Which of the following rates of exchange would probably be used to translate the foreign subsidiary’s income statement? a. Year-end spot rate. b. Average for the year. c. Average of the quarter-end rates. d. Average rates for each individual month of the year. (Adapted)
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24. If the $ falls in value against the peso, and you have net $ liabilities: a. An exchange loss will result. b. An exchange gain will result. c. Neither gain nor loss will result. d. a or b, depending on the movement of the $. (Adapted) 25. If the $ rises in value against the peso, and you have net $ assets: a. An exchange loss will result. b. An exchange gain will result. c. Neither gain nor loss will result. d. a or b, depending on the movement of the $. (Adapted) 26. If the $ falls in value against the peso, and you have net $ assets: a. An exchange loss will result. b. An exchange gain will result. c. Neither gain nor loss will result. d. a or b, depending on the movement of the $. (Adapted) 27. If the $ rises in value against the peso, and you have net $ liabilities: a. An exchange loss will result. b. An exchange gain will result. c. Neither gain nor loss will result. d. a or b, depending on the movement of the $. (Adapted) 28. a. b. c. d.
Monetary items will be reported: at the closing rate on the balance sheet date. at the exchange rate of the transaction. at the average rate for the year. any of these
29. a. b. c. d.
Non-monetary items should be reported: at the closing rate on the balance sheet date. at the exchange rate of the transaction. at the average rate for the year. any of these
30. Exchange differences on monetary items should be: a. Recorded in equity, until the disposal of the net investment. c. a or b b. Recognized in the period’s income statement. d. Ignored. (Adapted) 31. Where a monetary item forms part of the parent’s net investment in a foreign operation, the exchange difference should be:
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a. Recorded in equity, until the disposal of the net investment. c. a or b b. Recognized in the period’s income statement. d. Ignored. (Adapted) 32. For a Dependent Foreign Operation, each transaction is entered at: a. The exchange rate that would have been used in the parent’s books – the parent’s functional currency. b. Closing rate. c. Average rate. d. None of these (Adapted) 33. For foreign operations, closing rate should be used for: a. Income and expenses. c. Each transaction. b. Assets and liabilities. d. all of these (Adapted) 34. For foreign operations, the rate of the day of transactions should be used for: a. Income and expenses. c. Each transaction. b. Assets and liabilities. d. all of these (Adapted) 35. The opening net investment of the period needs to be restated at the: a. Closing exchange rate. c. Previous year’s opening rate. b. Average exchange rate. d. Previous year’s closing rate. 36. Exchange differences arising from changes to equity, such as capital increases or dividends, should: a. Be recognized in the period’s income statement. c. a or b b. Be transferred to equity. d. Ignored. (Adapted) 37. Where there are minority interests relating to foreign undertakings, their share of exchange gains (and losses) should be: a. Included with the parent’s share of exchange gains. b. Added to the non-controlling interests in the consolidated balance sheet. c. a or b d. Ignored. (Adapted) 38. Inter-company balances should be: a. Transferred to the Holding Company. b. Eliminated in the separate financial statements c. Ignored. d. Agreed by each party. (Adapted) 39. Exchange differences transactions should be:
on
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most
inter-company
trading
a. ignored. b. recognized in profit or loss
c. recognized in equity. d. a or c
40. On disposal of a foreign operation, all exchange differences accumulated in a separate component of equity should be: a. Added to the gain, or loss, on disposal in the income statement. b. Recognized directly in equity c. Ignored. d. b or c 41. In the case of a partial disposal, how much exchange difference should be included in the income statement? a. All. c. None. b. Proportionate share. d. Any of these 42. An entity, whose functional currency is the dollar, has a foreign subsidiary .The subsidiary declared a dividend to the parent of 9 million euros which was recorded in the parent’s financial statements. The exchange rate at that date was 1.5 euros = 1 dollar. At the date of receipt of the dividend, the exchange rate had moved to 1.6 euros = 1 dollar. The exchange difference arising on the dividend would be treated as follows in the financial statements: a. an exchange difference of $375,000 will be taken to the parent entity’s and the group’s statement of profit or loss and other comprehensive income b. an exchange difference of $375,000 will be taken to equity c. no exchange difference will arise as it will be eliminated on consolidation d. an exchange difference of $5.6 million will be taken to the parent entity’s income statement (ACCA) 43. An entity, whose functional currency is the dollar, purchases machinery from a foreign supplier for 8 million euros on 31 October 2008 when the exchange rate was 1.5 euros = 1 dollar. At the entity’s year-end of 31 December 2008, the amount has not been paid. The closing exchange rate was 1.25 euros = 1 dollar. Which of the following statements are correct? a. Cost of plant $5.33million dollars, exchange loss $1.07 million, trade payable $6.4 million b. Cost of plant $5.33 million dollars, no exchange loss, trade payable $5.33 million c. Cost of plant $6.4 million dollars, no exchange gain, trade payable $6.4 million d. Cost of plant $6.4 million dollars, exchange gain $1.07 million, trade payable $5.33 (ACCA) 44. When conversions due to exchange rates leads to disagreement on the trial balance then, which account should be opened? a. Foreign exchange account c. No account should be opened b. Suspense account d. Difference on exchange account (Adapted)
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45. According to the relevant accounting standard, when assets are bought by foreign branches on different dates how should we account for changes in the exchange rates on those dates? a. The rates on the dates of purchase should be used for each asset bought b. A weighted average should be used for the exchange rate c. An average exchange rate should be used to convert d. The exchange rate on the earliest date of purchase should be used (Adapted) 46. How should monetary asset and liabilities of foreign branches be valued? a. Using the exchange rate at the date they were incurred b. Using an average rate for the exchange rate c. Using the exchange rate at the date of the trial balance d. No attempt should be made to convert liquid resources as they will change quickly anyway (Adapted) 47. A change in the exchange rate of two currencies may not be known as: a. devaluation c. depreciation. b. amortization. d. appreciation. (Adapted) 48. An entity will primarily generate and expend cash in one primary economic environment. According to PAS 21 The Effects of Changes in Foreign Exchange Rates, the correct term for the currency of this primary economic environment is the a. presentation currency c. reporting currency b. functional currency d. foreign currency (Adapted) 49. According to PAS 21 The Effects of Changes in Foreign Exchange Rates, at which rate should an entity's non-current assets be translated when its functional currency figures are being translated into a different presentation currency? a. The historical exchange rate c. The average rate b. The closing rate d. The spot exchange rate (Adapted) 50. According to PAS 21 The effects of changes in foreign exchange rates, exchange differences should be recognized either in profit or loss or in other comprehensive income. Are the following statements about the recognition of exchange differences in respect of foreign currency transactions reported in an entity's functional currency true or false according to PAS 21? I. Any exchange difference on the settlement of a monetary item should be recognized in profit or loss. II. Any exchange difference on the translation of a monetary item at a rate different to that used at initial recognition should be recognized in other comprehensive income. a. False, False b. False, True c. True, False d. True, True (Adapted)
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51. The central bank of Country X buys and sells its own currency to ensure that the currency is always exchanged in a ratio of 2:1 with the currency of Country Y. What can we conclude about these two currencies? a. Country X is using the euro. b. Country X has pegged its currency to the currency of Country Y. c. Country X has an undesirable currency. d. Country X allows its currency to float relative to the currency of Country Y. (Adapted) 52. What is the proper treatment of unrealized foreign exchange gains? a. They should be deferred on the statement of financial position until cash is received. b. The principle of conservatism requires that they should never be recognized. c. They should not be recorded until cash is received and the exchange transaction is completed. d. They should be recognized in profit or loss on the date the exchange rate changes. (Adapted) 53. RIGHTEOUS Co., a foreign subsidiary of MORAL Co., has written down its inventory to net realizable value under the “lower of cost and NRV” rule. When consolidating RIGHTEOUS Co’s statement of financial position into the group’s financial statements, what exchange rate should be used for the inventory? a. historical rate c. closing rate b. average rate d. cannot be determined (Adapted) 54. Foreign operations that are an integral part of the operations of the entity would have the same functional currency as the entity. Where a foreign operation functions independently from the parent, the functional currency will be a. That of the parent. b. Determined using the guidance for determining an entity’s functional currency. c. That of the country of incorporation. d. The same as the presentation currency. (Adapted) Chapter 21 - Suggested answers to review theory questions 1. D 2. D 3. D 4. D 5. D
11 . 12 . 13 . 14 . 15
C C A C C
21 . 22 . 23 . 24 . 25
B A D B B
31 . 32 . 33 . 34 . 35
41 . 42 . 43 . 44 . 45
A A B A A
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B A A D A
51 . 52 . 53 . 54 .
B D C B
6. B 7. D 8. B 9. C 10 . B
. 16 . 17 . 18 . 19 . 20 .
B D B A B
. 26 . 27 . 28 . 29 . 30 .
A A A B B
. 36 . 37 . 38 . 39 . 40 .
. 46 . 47 . 48 . 49 . 50 .
B B D B A
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C B B B C
Chapter 23 Accounting for Derivatives and Hedging Transactions (Part 2) Chapter 23: Multiple Choice – Computational (For classroom instruction purposes) Fair value hedge of a recognized asset Use the following information for the next eight questions: On December 15, 20x1, ABC Co. sold goods to a Japanese firm for 4,000,000 yens. ABC Co. was concerned about the fluctuation in the Japanese yen, so on this date, ABC Co. entered into a 30-day forward contract to sell 4,000,000 yens for ₱1,880,000 to a bank at the forward rate of ₱0.47. Relevant rates are shown below: Dec. 15, 20x1 Spot rate ₱0.48 Forward rate ₱0.47
Dec. 31, 20x1 ₱0.49 ₱0.485
Jan. 15, 20x2 ₱0.46 ₱0.46
1 The entry to record the hedging instrument on December 15, 20x1 includes a a debit to accounts receivable for ₱1,880,000 b a credit to sales for ₱1,880,000 c both a and b d none 2 How much is the FOREX gain (loss) on foreign currency transaction on December 31, 20x1? a. 40,000 b. (40,000) c. 60,0000 d. (60,000) 3 How much is the gain (loss) on change in fair value of the derivative on December 31, 20x1? a. 40,000 b. (40,000) c. 60,0000 d. (60,000) 4 The derivative asset (liability) to be included in the December 31, 20x1 statement of financial position is a. 1,960,000 b. (1,920,000) c. 60,0000 d. (60,000) 5 How much is the FOREX gain (loss) on foreign currency transaction on January 15, 20x2? a. 120,000 b. (120,000) c. 100,0000d. (100,000) 6 How much is the gain (loss) on change in fair value of the derivative on January 15, 20x2? a. 120,000 b. (120,000) c. 100,0000d. (100,000) 7 If the forward contract is settled on a net cash basis, how much is the net cash settlement receipt (payment)? a. 40,000 b. (40,000) c. 100,000 d. 0
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8 The total net effect of the two contracts in 20x1 and 20x2 profit or loss is – gain (loss) a. 40,000 b. (40,000) c. 100,000 d. 0 No hedging designation (Held for speculation) Use the following information for the next five questions: ABC Co. expects the value of yens to decrease in the next 30 days. Accordingly, on December 15, 20x1, ABC Co. enters into a 30-day forward contract to sell 4,000,000 yens at the forward rate of ₱0.47. On December 31, 20x1, the forward rate was ₱0.485 and by January 15, 20x2, the spot rate moved to ₱0.46. 9 The entry to record the forward contract on December 15, 20x1 includes a a debit to forward contract for ₱60,000 b a credit to forward contract for ₱60,000 c a debit to loss on forward contract for ₱60,000 d none 10 How much is the gain (loss) on change in fair value of the derivative on December 31, 20x1? a. 60,000 in profit or loss c. (60,0000) in OCI b. (40,000) in OCI d. (60,000) in profit or loss 11 The derivative asset (liability) to be included in the December 31, 20x1 statement of financial position is a. 1,960,000 b. (1,920,000) c. 60,0000 d. (60,000) 12 How much is the gain (loss) on change in fair value of the derivative on January 15, 20x2? a. 120,000 b. (120,000) c. 100,000 d. (100,000) 13 How much is the net cash settlement receipt (payment) on January 15, 20x2? a. 40,000 b. (40,000) c. 1,840,000 d. (1,840,000) Fair value hedge of a recognized liability Use the following information for the next seven questions: On December 15, 20x1, ABC Co. purchased goods from a Korean firm for 40,000 wons. ABC Co. was concerned about the fluctuation in the Korean won, so on this date, ABC Co. entered into a 30-day forward contract to buy 40,000 wons for ₱49,600 from a bank at the forward rate of ₱1.24. Relevant rates are shown below: Spot rate Forward rate
Dec. 15, 20x1 1.20 1.24
Dec. 31, 20x1 1.26 1.27
14 The purchased inventory shall be recognized at a. 48,000 b. 49,600 c. 50,400
99
Jan. 15, 20x2 1.30 1.30 d. 50,800
15 The derivative asset (liability) to be included in the December 31, 20x1 statement of financial position is a. 2,400 b. (2,400) c. 1,200 d. (1,200) 16 The adjustment to the inventory account on December 31, 20x1 is – increase (decrease) a. 2,400 b. (2,400) c. 1,200 d. 0 17 How much is the FOREX gain (loss) on foreign currency transaction on January 15, 20x2? a. (2,400) b. (1,600) c. 1,200 d. (1,200) 18 How much is the gain (loss) on change in fair value of the derivative on January 15, 20x2? a. 1,200 b. (1,200) c. 1,600 d. (1,600) 19 The total net effect of the two contracts on profit or loss in 20x2 is – gain (loss) a. (1,600) b. (400) c. 1,600 d. 0 20 Assuming the forward contract is settled on a net cash basis, how much is the net cash settlement receipt (payment) on January 15, 20x2? a. 1,600 b. (400) c. 2,400 d. (2,400) No hedging designation (Held for speculation) Use the following information for the next two questions: ABC Co. expects the value of wons to increase in the next 30 days. Accordingly, on December 15, 20x1, ABC Co. enters into a 30-day forward contract to buy 40,000 wons at the forward rate of ₱1.24. On December 31, 20x1, the forward rate was ₱1.27 and by January 15, 20x2, the spot rate moved to ₱1.30. 21 The derivative asset (liability) to be included in the December 31, 20x1 statement of financial position is a. 2,400 b. (2,400) c. 1,200 d. (1,200) 22 The total net effect of the transaction on profit or loss in 20x2 is – gain (loss) a. 2,400 b. (2,400) c. 1,200 d. (1,200) Fair value hedge of a firm sale commitment Use the following information for the next six questions: On December 15, 20x1, ABC Co. received a sale order from a Japanese firm in the amount of 4,000,000 yens. The delivery of the goods sold is due on January 15, 20x1. ABC Co. was concerned about the fluctuation in the Japanese yen, so on this date, ABC Co. entered into a 30-day forward contract to sell 4,000,000 yens for ₱1,880,000 to a bank at the forward rate of ₱0.47. Relevant rates are shown below: Dec. 15, 20x1 Spot rate ₱0.48 Forward rate ₱0.47
Dec. 31, 20x1 ₱0.49 ₱0.485
100
Jan. 15, 20x1 ₱0.46 ₱0.46
23 The entries on December 15, 20x1 include a a debit to accounts receivable for ₱1,880,000 b a credit to sales for ₱1,880,000 c both a and b d none 24 The entry on December 31, 20x1 for the hedged item includes a debit to loss on forward contract for ₱60,000 b debit to gain on forward contract for ₱60,000 c a credit to firm commitment for ₱60,000 d a debit to firm commitment for ₱60,000 25 The derivative asset (liability) on December 31, 20x1 is a. 60,000 b. (60,000) c. 40,000 d. (40,000) 26 The effectiveness of the hedging instrument as of December 31, 20x1 is a. 60% b. 80% c. 100% d. 125% 27 The entry on January 15, 20x2 pertaining to the hedged item includes a. a credit to sales for ₱1,880,000 b. a debit to cash (foreign currency) ₱1,880,000 c. a credit to gain for ₱100,000 d. a and b 28 Assuming the forward contract is settled on a net cash basis, how much is the net cash settlement receipt (payment) on January 15, 20x2? a. 40,000 b. (40,000) c. 2,400 d. (2,400) Fair value hedge of a firm purchase commitment Use the following information for the next four questions: On December 15, 20x1, ABC Co. entered into a firm commitment to purchase goods from a Korean firm for 40,000 wons. If ABC Co. will not purchase the goods from the Korean firm, it would be required to pay a penalty of 24,000 wons (i.e., ABC’s contract with the Korean firm is a firm commitment). ABC Co. was concerned about the fluctuation in the Korean won, so on this date, ABC Co. entered into a 30-day forward contract to buy 40,000 wons for ₱49,600 from a bank at the forward rate of ₱1.24. Relevant rates are shown below: Spot rate Forward rate
Dec. 15, 20x1 1.20 1.24
Dec. 31, 20x1 1.26 1.27
Jan. 15, 20x2 1.30 1.30
29 The gain (loss) on the firm commitment on December 31, 20x1 is a. (2,400) b. (1,200) c. (800) d. 800 30 The derivative asset (liability) on December 31, 20x1 is a. 60,000 b. (60,000) c. 1,200 d. (1,200) 31 How much inventory is recognized on January 15, 20x2? a. 49,600 b. 52,000 c. 50,400 d. 48,000
101
32 Assuming the forward contract is settled on a net cash basis, how much is the net cash settlement receipt (payment) on January 15, 20x2? a. 4,000 b. (4,000) c. 2,400 d. (2,400) Fair value hedge of a firm purchase commitment – Present value Use the following information for the next six questions: ABC Co. operates a chain of coffee shops nationally. On October 1, 20x1, ABC Co. entered into a firm commitment to purchase 4,000 kilograms of coffee beans for a contract price of ₱160 per kilogram on March 31, 20x2. ABC Co. expects that there is a possible decrease in the price of coffee beans, so on this date, ABC Co. entered into a six-month forward contract with a bank to sell 4,000 kilograms of coffee beans at the current forward rate of ₱160 per kilogram.
102
Information on fair values is shown below:
Date Oct. 1, 20x1 Dec. 31, 20x1 Mar. 31, 20x2
Spot price 155 151 147
Forwa rd price 160 153 147
Fair value of forward contract (asset) 27,727 a 52,000 b
Fair value of firm commitme nt (liability) (27,727) (52,000)
a
[(160 – 153) x 4,000] x present value factor using 4%, assumed appropriate rate, for three months (or 0.9902427). b [(160 – 147) x 4,000. 33 The entry on October 1, 20x1 to record the firm purchase commitment includes a a debit to inventory for ₱640,000 b credit to accounts payable for ₱640,000 c both a and b d none 34 The entries on December 31, 20x1 includes a a a debit to loss on firm commitment for ₱27,727, recognized profit or loss b a debit to loss on firm commitment for ₱27,727, recognized OCI c a credit to gain on firm commitment for ₱27,727, recognized profit or loss d a credit to gain on firm commitment for ₱27,727, recognized OCI
in in in in
35 The derivative asset (liability) on December 31, 20x1 is a. 27,727 b. (27,728) c. 1,200 d. (1,200) 36 The debit to inventory on March 31, 20x2 is a. 640,000 b. 612,000 c. 588,000 d. 0 37 The gain (loss) on forward contract on March 31, 20x2 is a. (24,273) b. 24,273 c. 52,000 d. (52,000) 38 The net cash settlement receipt (payment) on the forward contract on March 31, 20x2 is a. 52,000 b. (52,000) c. (24,273) d. 24,273 Fair value hedge of a firm purchase commitment – Present value Use the following information for the next six questions: ABC Co. supplies cabbage to various hotels and restaurants. On October 1, 20x1, ABC Co. entered into a firm commitment to purchase 4,000 kilograms of cabbage for a contract price of ₱40 per kilogram on March 31, 20x2. ABC Co. is worried about fluctuations in the price of cabbage. Therefore, on October 1, 20x1, ABC Co. entered into a six-month, over-the-counter (OTC) forward contract with a broker to sell 4,000
103
kilograms of cabbage at the current forward rate of ₱40 per kilogram to be settled on a net cash basis on March 31, 20x2.
Date Oct. 1, 20x1 Dec. 31, 20x1 Mar. 31, 20x2
Spot price
Forwar d price
Fair value of forward contract (asset)
41
40
-
32
30
39,608
50
50
(40,000)b
a
Fair value of firm commitment (liability) (39,608) 40,000
a
[(40 – 30) x 4,000] x present value factor using 4%, assumed appropriate rate, for three months (or 0.9902427). b [(50 – 40) x 4,000. 39 The fair value of the forward contract on Oct. 1, 20x1 is a. 4,000 b. 164,000 c. 160,000 d. 0 40 The fair value of the firm commitment on Oct. 1, 20x1 is a. 4,000 b. 164,000 c. 160,000 d. 0 41 The fair value of the forward contract on Dec. 31, 20x1 is – asset (liability) a. 39,608 b. (39,608) c. 40,000 d. 0 42 The fair value of the firm commitment on Dec. 31, 20x1 is – asset (liability) a. 39,608 b. (39,608) c. (40,000) d. 0 43 The gain (loss) on the derivative on March 31, 20x2 is a. 38,608 b. (40,000) c. (79,608) d. 79,608 44 The net cash settlement – receipt (payment) – on March 31, 20x2 is a. (79,608) b. 79,608 c, 40,000 d. (40,000) Cash flow hedge of a forecasted purchase transaction Use the following information for the next eight questions: ABC Co. produces potato chips. On December 15, 20x1, ABC Co. anticipates purchasing 4,000 kilograms of potatoes on January 15, 20x2. ABC Co. is concerned about the fluctuation in the price of potatoes, so on December 15, 20x1, ABC Co. enters into a 30-day forward contract to purchase 4,000 kilograms of potatoes at a forward rate of ₱45 per kilogram (or ₱180,000). The forward contract will be settled net on January 15, 20x2. Relevant prices per kilogram of potatoes are shown below: Dec. 31, Jan. 15, Dec. 15, 20x1 20x1 20x1 Spot price 40 50 60
104
Forward price
45
55
60
45 The fair value of the hedging instrument on Dec. 15, 20x1 is a. 20,000 b. 180,000 c. 160,000 d. 0 46 The fair value of the hedged item on Dec. 15, 20x1 is a. 20,000 b. 180,000 c. 160,000 d. 0 47 The fair value of the hedging instrument on Dec. 31, 20x1 is a. 40,000 b. (40,000) c. 20,000 d. 0 48 The fair value of the hedged item on Dec. 31, 20x1 is a. 40,000 b. (40,000) c. 20,000 d. 0 49 The net effect of the derivative instrument on the 20x1 profit or loss is – gain (loss) a. 40,000 b. (40,000) c. 20,000 d. 0 50 How much is the gain (loss) on the forward contract on January 15, 20x2? a. 20,000 profit or loss c. 20,000 OCI b. (20,000) profit or loss d. (20,000) OCI 51 The net cash settlement – receipt (payment) – on January 15, 20x2 is a. 60,000 b. (60,000) c. 40,000 d. (40,000) 52 Assume that all of the potatoes purchased were used to produce potato chips at a total manufacturing cost of ₱400,000 and that all of the potato chips were sold on February 14, 20x2 for ₱1,440,000, how much cost of goods sold is recognized on February 14, 20x2? a. 400,000 b. 460,000 c. 340,000 d. 420,000 Cash flow hedge of a forecasted sale transaction – Present value (Indirect quotation) Use the following information for the next five questions: ABC Co. produces tomato paste. On October 1, 20x1, ABC Co. anticipates selling goods worth DOP 59,400,000 (Dominican Peso) on April 1, 20x2. ABC Co. enters into to a six-month forward contract to sell DOP 59,400,000 at a forward rate of ₱1:DOP 140 or ₱424,284. The appropriate discount rate is 6% per annum. The following are the relevant exchange rates: Date Spot rate Forward rate Oct. 1, 20x1 ₱1 : DOP 135 ₱1 : DOP 140 Dec. 31, 20x1 ₱1 : DOP 140 ₱1 : DOP 142 Apr. 1, 20x2 ₱1 : DOP 144 ₱1 : DOP 144 53 How much is the gain (loss) on the forward contract on December 31, 20x1? a. 5,887 profit or loss c. (5,887) profit or loss b. 5,887 OCI d. (5,887) OCI 54 How much is the gain (loss) on the hedged item on December 31, 20x1? a. 5,887 profit or loss c. (5,887) OCI
105
b. (5,887) profit or loss d. 0 55 How much sale revenue is recognized in 20x2? a. 424,286 b. 400,716 c. 406,772 d. 412,500 56 How much is the gain (loss) on the forward contract on April 1, 20x2? a. 5,899 profit or loss c. (5,899) profit or loss b. 5,899 OCI d. (5,899) OCI 57 The net cash settlement – receipt (payment) – on January 15, 20x2 is a. 60,000 b. (60,000) c. 11,786 d. (11,786) Cash flow hedge of a recognized liability – Present value Use the following information for the next seven questions: On December 1, 20x1, ABC Co. purchased goods from a Korean firm for 400,000 wons. ABC Co. was concerned about the fluctuation in the Korean won, so on this date, ABC Co. entered into a 2-month forward contract to buy 400,000 wons for ₱496,000 from a bank at the forward rate of ₱1.24.
Relevant rates are shown below: Spot rate Forward rate
Dec. 1, 20x1 1.20 1.24
Dec. 31, 20x1 1.23 1.27
Jan. 31, 20x2 1.30 1.30
Additional information: ABC Co. chooses to account for the hedging instrument as a cash flow hedge. The initial spot/forward difference (or ‘forward points’) amounts to ₱16,000 over the 2-month term of the forward contract [400,000 x (1.24 forward rate - 1.20 spot rate)]. This difference will be amortized as interest expense using the effective interest method. Given the spot/forward relationship above, the implicit interest rate is 19.84% per annum or 1.6530% per month. The following are the relevant present value factors: Dec. 31, 20x1: PV of ₱1, @ 0.5%, n=1 (1 month)………0.99502 Jan. 31, 20x2: PV of ₱1, @ 0.5%, n=0 (maturity date)…1 58 The inventory account is debited on December 1, 20x1 for a. 400,000 b. 480,000 c. 496,000 d. 0 59 The FOREX gain (loss) on the hedged item on December 31, 20x1 is a. (12,000) b. 12,000 c. 9,886 d. 60 How much is recognized in other comprehensive income on December 31, 20x1? debit (credit) a. 19,876 b. (19,874) c. 16,312 d. 0 61 The derivative asset (liability) recognized on December 31, 20x1 is
106
a. 19,876
b. (19,874) c. 11,940
d. (11,940)
62 The FOREX gain (loss) on the hedged item on January 31, 20x2 is a. (28,000) b. 28,000 c. 26,399 d. 0 63 How much is recognized in other comprehensive income on January 31, 20x2? debit (credit) a. 20,126 b. (20,126) c. 18,234 d. 0 64 The net cash settlement – receipt (payment) – on January 15, 20x2 is a. (20,130) b. 20,130 c. (24,000) d. 24,000
107
Chapter 24 Accounting for Derivatives and Hedging Transactions (Part 3) Chapter 24: Multiple Choice – Computational (For classroom instruction purposes) No hedging designation Use the following information for the next four questions: On December 1, 20x1, ABC Co. enters into a silver futures contract to purchase 4,000 ounces of silver on February 1, 20x2 for ₱200 per ounce. The broker requires an initial margin deposit of ₱80,000. The quoted prices per ounce of silver are as follows: Dec. 1, 20x1 Dec. 31, 20x1 Feb. 1, 20x2 200 190 185 1. The entries on December 1, 20x1 include a debit to “deposit with broker” for ₱80,000 b credit to cash for ₱80,000 c a and b d none 2. How much is the derivative asset (liability) as of December 31, 20x1? a. 0 b. (34,668) c. (40,000) d. 40,000 3. How much is the total net effect of the derivative on the 20x1 and 20x2 profit or loss? Gain (loss) a. (60,000) b. 60,000 c. (40,000) d. 40,000 4. How much is the net settlement on February 1, 20x2? – Receipt (payment) a. 20,000 b. (20,000) c. (60,000) d. 60,000 Fair value hedge of a recognized asset – hedged item measured at fair value Use the following information for the next seven questions: ABC Co. is a commodity trader. On December 1, 20x1, ABC Co. carries in its inventory 400 troy ounces of gold valued at ₱4,800,000 (or ₱12,000 per troy ounce). ABC Co. measures its inventory of gold at fair value less costs to sell through profit or loss. To protect the fair value of its inventory against a potential decline in prices, ABC Co. enters into a “short” futures contract on December 1, 20x1 to sell 400 troy ounces of gold at ₱12,100 per troy ounce on February 1, 20x2 (the expected date of sale of the inventory). The futures contract requires an initial margin deposit of ₱384,000. We will assume that the fair values shown below already reflect costs to sell. Dec. 1, 20x1 Dec. 31, 20x1 Feb. 1, 20x2 Spot price
12,000
12,250
108
11,800
Futures price
12,100
12,300
11,800
5. The entries on December 1, 20x1 include a debit to “deposit with broker” for ₱384,000 b credit to cash for ₱384,000 c a and b d none 6. How much is the adjustment to the inventory account on December 31, 20x1? Increase (decrease) a. 100,000 b. (100,000) c. 80,000 d. 0 7. How much is the derivative asset (liability) as of December 31, 20x1? a. (100,000) b. 100,000 c. (80,000) d. 80,000 8. How much is the gain (loss) on the futures contract on February 1, 20x2? a. 0 b. (80,000) c. (200,000) d. 200,000 9. How much is the net settlement on February 1, 20x2? – Receipt (payment) a. 120,000 b. (120,000) c. 504,000 d. 504,000 10. How much is the total net cash receipt (payment) on the two contracts? a. 4,840,000 b. (4,840,000) c. (504,000) d. 504,000 Fair value hedge of a recognized asset – hedged item measured at lower of cost or net realizable value (NRV) Use the following information for the next five questions: On December 1, 20x1, ABC Co. has a soybean inventory of 4,000 bushels carried at a cost of ₱240 per bushel (or total cost of ₱960,000). ABC Co. measures its inventory of soybeans at the lower of cost or net realizable value (NRV). ABC Co. intends to sell the whole inventory by February 1, 20x1. On December 1, 20x1, ABC Co. enters into a futures contract to sell the whole inventory on February 1, 20x1 at a price of ₱360 per bushel. The broker requires a deposit of ₱80,000. Information on fair values is as follows: Dec. 1, 20x1 Dec. 31, 20x1
Feb. 1, 20x2
Spot price
354
371
338
Futures price
360
374
338
11. How much is the adjustment to the inventory account on December 31, 20x1? Increase (decrease) a. 100,000 b. 68,000 c. (68,000) d. 0
109
12. How much is the derivative asset (liability) as of December 31, 20x1? a. 0 b. (68,000) c. (56,000) d. 56,000 13. How much is the gain (loss) on the futures contract on February 1, 20x2? a. 0 b. (56,000) c. (144,000) d. 144,000 14. How much is the net settlement on the derivative instrument on February 1, 20x2? – Receipt (payment) a. 168,000 b. (168,000) c. 88,000 d. (88,000) 15. How much gross profit from sales is recognized on February 1, 20x2? a. 0 b. 364,000 c. 388,000 d. 456,000
Fair value hedge of a firm sale commitment Use the following information on the next five questions: On December 1, 20x1, ABC Co. enters into a fixed-price contract to sell 4,000 ounces of silver on February 1, 20x2 for ₱210 per ounce. ABC Co. prefers to have the sales contract settled at market value on delivery date. Therefore, on December 1, 20x1, ABC Co. enters into a “long” futures contract to purchase 4,000 ounces of silver at ₱200 per ounce. The futures contract requires an initial margin deposit of ₱120,000. Information on market values is shown below: Dec. 1, 20x1 Dec. 31, 20x1
Feb. 1, 20x2
Spot price
210
240
250
Futures price
200
235
250
16. How much is the firm commitment asset (liability) on December 31, 20x1? a. 120,000 b. (120,000) c. (140,000) d. (100,000) 17. How much is the derivative asset (liability) on December 31, 20x1? a. 140,000 b. (140,000) c. 120,000 d. (120,000) 18. How much is the sale revenue recognized on February 1, 20x2? a. 1,000,000 b. 840,000 c. 800,000 d. 960,000 19. How much gain (loss) from firm commitment is recognized on February 1, 20x2? a. 40,000 b. (40,000) c. (60,000) d. 60,000 20. How much is the net cash settlement on the derivative instrument on February 1, 20x2?
110
a. 200,000 320,000
b. (200,000)
c. (320,000)
d.
Cash flow hedge of a forecasted purchase transaction – Assessment of Hedge ineffectiveness Use the following information for the next eleven questions: On July 1, 20x1, ABC Co., a vegetable dealer, forecasts the purchase of 4,000 kilograms of broccoli in 6 months. Because ABC Co. is worried that the price of broccoli will increase during the coming months, it enters into 10 long cauliflower futures contracts on July 1, 20x1. Each futures contract is based on the purchase of 400 kilograms of cauliflower at ₱92.98 per kilogram on July 1, 20x1. Relevant prices per kilogram of commodity are shown below: Broccoli Cauliflower Jan. 1 93.76 92.98 Mar. 31 95.18 94.52 June 30 96.20 95.36 21. What is the percentage of effectiveness of the hedging instrument on March 31, 20x1 and June 30, 20x1, respectively? March 31, 20x1 June 30, 20x1 a. 102% 96% b. 95% 103% c. 108% 98% d. 97% 85% 22. How much is derivative asset (liability) on March 31, 20x1? a. (6,160) b. 6,160 c. (5,680) d. 5,680 23. How much is the effective portion of the change in fair value of derivative recognized in other comprehensive income on March 31, 20x1? – Gain (loss) a. 5,680 b. (5,680) c. 6,160 d. (6,160) 24. How much is the ineffective portion of the change in fair value of derivative recognized in profit or loss on March 31, 20x1? – Gain (loss) a. 0 b. 560 c. 480 d. (480) 25. As of March 31, 20x1, the effect of the futures contract is referred to as a. overhedge b. underhedge c. middle hedge d. bottom hedge 26. How much is the debit to inventory on June 30, 20x1? a. 375,280 b. 371,920 c. 384,800 d. 381,440 27. How much is the effective portion of the change in fair value of derivative recognized in other comprehensive income on June 30, 20x1? – Gain (loss) a. (3,840) b. 3,840 c. (4,321) d. 0 28. How much is the ineffective portion of the change in fair value of derivative recognized in profit or loss on June 30, 20x1? – Gain (loss)
111
a. (480)
b. 480
c. (960)
d. 960
29. How much is the net cash settlement receipt (payment) on the derivative instrument on June 30, 20x1? a. 3,360 b. (3,360) c. (9,520) d. 9,520 30. How much is the total net effect of the hedging instrument on profit or loss? Favorable (unfavorable) a. 3,840 b. (3,840) c. (9,520) d. 9,520 31. If all of the inventory purchased were sold on July 15, 20x1, how much is the cost of goods sold? a. 384,800 b. 375,280 c. 381,440 d. 371,920 Fair value hedge of a recognized asset – Put option Use the following information for the next three questions: On December 15, 20x1, ABC Co. sold goods to a Japanese firm for 4,000,000 yens. ABC Co. was concerned about the fluctuation in the Japanese yen, so on this date, ABC Co. purchased a foreign currency put option for ₱30,000 to sell 4,000,000 yens at ₱0.47 on January 15, 20x2. Dec. 15, Dec. 31, Jan. 15, 20x1 20x1 20x1 Spot rate ₱0.48 ₱0.49 ₱0.46 Fair values of the foreign currency put option 30,000 20,000 32,000 32. How much is the gain (loss) on the put option on December 31, 20x1? a. 0 b. 40,000 c. (10,000) d. 10,000 33. How much is the net gain (loss) on the exercise of the put option on January 15, 20x1? a. (20,000) b. 20,000 c. 12,000 d. 8,000 34. Assume that the spot rate on January 15, 20x2 is ₱0.48. How much is the gain (loss) on the put option on January 15, 20x1? a. (20,000) b. 20,000 c. (32,000) d. (40,000) No hedging designation – Call option Use the following information for the next three questions: On April 1, 20x1, ABC Co. enters into a call option contract with an investment banker which gives ABC Co. the option to purchase 4,000 XYZ, Inc. shares of stocks at a strike price of ₱100 per share. The call option expires on July 1, 20x1. ABC Co. pays the investment banker ₱2,400 for the call option. The market price of the XYZ, Inc. shares on April 1, 20x1 is ₱100 per share. Additional information:
Market price of XYZ, Inc. shares Time value
112
April 1, 20x1
June 30, 20x1
100/sh. 2,400
106/sh. 1,600
35. How much is the gain (loss) on the call option on June 30, 20x1 arising from change in intrinsic value? a. 24,000 b. (24,000) c. 800 d. (800) 36. How much is the gain (loss) on the call option on June 30, 20x1 arising from change in time value? a. 800 b. (800) c. 24,000 d. (24,000) 37. How much is the net cash settlement receipt (payment) on the call option on July 1, 20x1? a. 24,000 b. (24,000) c. 23,200 d. (23,200) Cash flow hedge of a forecasted sale transaction (Indirect quotation) Use the following information for the next six questions: ABC Co. forecasts a sale to an Indian customer of INR 1,120,000 (Indian Rupee) in six months. On October 1, 20x1 when the spot rate is ₱1: INR 1.40, ABC Co. obtained an option to sell INR 1,120,000 for ₱783,216 (₱1 : INR1.43). The option has a cost and fair value of ₱25,600 on inception date. ABC Co. chose to base effectiveness on the changes in the intrinsic value of the option, as measured by the spot rate of the currency underlying the option (e.g., “spot” intrinsic value). Changes in the fair value of the option other than “intrinsic value” (e.g., time value, impact of counterparty nonperformance risk) are excluded from the assessment of effectiveness and will be reported in profit or loss as they occur. The following information was determined: Date
Spot rate
Time value of option a
Fair value of option a
Oct. 1, 20x1 Dec. 31, 20x1 Apr. 1, 20x2
₱1 : INR 1.40 ₱1 : INR 1.45 ₱1 : INR 1.50
25,600
25,600
13,196
24,000
-
36,552
a
These amounts are determined using an option pricing model. They are provided in order to simplify the problem. 38. How much derivative asset (liability) is recognized on October 1, 20x1? a. 23,664 b. (25,600) c. 25,600 d. 0 39. The hedging instrument is most likely designated as a a. fair value hedge b. cash flow hedge c. a or b none
d.
40. The effective portion of the hedge recognized in other comprehensive income on December 31, 20x1 is a. 10,802 b. 25,746 c. 13,366 d. 0
113
41. How much derivative asset (liability) is recognized December 31, 20x1? a. 13,196 b. (24,000) c. 24,000 d. 37,196
on
42. The effective portion of the hedge recognized in other comprehensive income on April 1, 20x2 is a. 10,802 b. 24,000 c. 12,404 d. 25,747 43. The adjusted sale revenue recognized on April 1, 20x2 is a. 798,364 b. 788,312 c. 783,215 d. 776,325 Cash flow hedge of a variable-rate debt (Swap payment at maturity) Use the following information for the next five questions: On January 1, 20x1, ABC Co. obtained a two-year, ₱4,000,000 variable-rate loan with interest payments due at each year-end and the principal due on December 31, 20x2. As protection from possible fluctuations in current market rates, ABC Co. enters into an interest rate swap for the whole principal of the loan. Under the agreement, ABC Co. shall receive variable interest and pay fixed interest based on a fixed rate of 8%. The interest rate swap will be settled net on maturity date. The following are the current market rates: Jan. 1, 20x1 8% Jan. 1, 20x2 10% 44. The hedging instrument is most likely designated as a a. fair value hedge b. cash flow hedge c. a or b none
d.
45. How much derivative asset (liability) is recognized December 31, 20x1? a. 80,000 b. (72,728) c. 72,728 d. 74,074
on
46. How much is the derivative gain (loss) recognized in profit or loss on December 31, 20x1? a. 74,074 b. (72,728) c. 72,728 d. 0 47. The net cash settlement on the interest rate swap on December 31, 20x2 is – Receipt (payment) a. 80,000 b. (80,000) c. 72,728 d. 0 48. The interest expense recognized in profit or loss in 20x2 is a. 320,000 b. 240,000 c. 335,728 d. 0 Cash flow hedge of a variable-rate debt (Swap payments at each year-end) Use the following information for the next nine questions:
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On January 1, 20x1, ABC Co. obtained a three-year, ₱4,000,000 variable-rate loan with interest payments due at each year-end and the principal due on December 31, 20x3. As protection from possible fluctuations in current market rates, ABC Co. enters into an interest rate swap for the whole principal of the loan. Under the agreement, ABC Co. shall receive variable interest and pay fixed interest based on a fixed rate of 9%. Swap payments shall be made at each year-end. The following are the current market rates: Jan. 1, 20x1 9% Jan. 1, 20x2 8% Jan. 1, 20x3 12% 49. The net cash settlement on December 31, 20x1 is a. 40,000 b. 37,037 c.36,697 d. 0 50. The derivative asset (liability) on December 31, 20x1 is a. 37,037 b. (71,331) c. 36,697 d. 40,000 51. The net cash settlement receipt (payment) on December 31, 20x2 is a. 36,697 b. (71,331) c. (40,000) d. 0 52. The balance of accumulated OCI recognized on the hedging instrument as of December 31, 20x2 is – Debit (credit) a. (67,140) b. (107,141) c. (138,472) d. 0 53. The interest expense recognized in profit or loss in 20x2 is a. 400,000 b. 387,542 c. 421,984 d. 0 54. The derivative asset (liability) on December 31, 20x2 is a. 107,141 b. (107,141) c. 138,472 d. (67,140) 55. How much is the derivative gain (loss) recognized in OCI on December 31, 20x2? a. 138,472 b. (138,472) c. 107,141 d. (107,141) 56. The net cash settlement – receipt (payment) – on the interest rate swap on December’ 31, 20x3 is a. 50,000 b. 120,000 c. 80,000 d. (120,000) 57. The interest expense recognized in 20x3 is a. 400,000 b. 240,000 c. 520,000 d. 320,000 Fair value hedge of a fixed-rate debt Use the following information for the next eight questions: On January 1, 20x1, ABC Co. obtained a three-year, ₱4,000,000, 10% fixed-rate loan with interest payments due at each year-end and the principal due on December 31, 20x3.
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ABC Co. expects that the current interest rates will decrease in the future. Thus, ABC Co. enters into a “receive fixed, pay variable” interest rate swap. Swap payments shall be made at each year-end. The following are the current market rates: Jan. 1, 20x1 10% Jan. 1, 20x2 12% Jan. 1, 20x3 14% 58. The derivative asset (liability) on December 31, 20x1 is a. 135,204 b. (135,204) c. 80,000 d. (80,000) 59. Unrealized gain (loss) on the derivative instrument recognized in profit or loss on December 31, 20x1 is a. 135,204 b. (135,204) c. 80,000 d. 0 60. Unrealized gain (loss) on the hedged item recognized in profit or loss on December 31, 20x1 is a. 135,204 b. (135,204) c. 80,000 d. 0 61. The interest expense recognized in 20x2 is a. 400,000 b. 264,796 c. 463,776 d. 535,204 62. The derivative asset (liability) on December 31, 20x2 is a. 140,352 b. (140,352) c. 168,342 d. (168,342) 63. Unrealized gain (loss) on the derivative instrument recognized in profit or loss on December 31, 20x2 is a. 140,352 b. (140,352) c. (168,342) d. 0 64. Unrealized gain (loss) on the hedged item recognized in profit or loss on December 31, 20x2 is a. 140,352 b. (140,352) c. (168,342) d. 0 65. The interest expense recognized in 20x3 is a. 400,000 b. 540,351 c. 493,867 d. 565,304
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Chapter 25 Accounting for Derivatives and Hedging Transactions (Part 4) Chapter 25: Multiple Choice – Computational (For classroom instruction purposes) Hedge of a net investment in foreign operation Use the following fact pattern for the next eight questions: Fact pattern On July 1, 20x1, ABC Co. acquired 100% interest in XYZ, Inc., a company situated in a foreign country. The currency of this country is the Armenian Dram (AMD). The business combination did not result to any goodwill. The year-end financial statements of the combining constituents show the following information: July 1, 20x1 Date of acquisition ABC Co. XYZ, Inc. (in (in AMD) pesos) 40,000,00 24,000,00 0 0
Dec. 31, 20x1 Reporting date ABC Co. XYZ, Inc. (in (in AMD) pesos) 56,000,00 40,000,00 0 0
8,000,000
-
8,000,000
-
-
-
4,000,000
-
Total assets
48,000,00 0
24,000,00 0
68,000,00 0
40,000,00 0
Liabilities
32,000,00 0
12,000,00 0
32,000,00 0
14,000,00 0
-
-
-
7,000,000
16,000,00 0
12,000,00 0
48,000,00 0
24,000,00 0
Assets Investment in subsidiary Receivable from XYZ, Inc.
Payable to ABC Co. Equity - Jan. 1, 20x1 Profit for the year Total liabilities and equity
16,000,00 12,000,00 0 0 20,000,00 7,000,000 0 68,000,00 40,000,00 0 0
The following are the relevant exchange rates: Spot rate at 7/1/20x1 Spot rate at 12/31/20x1 Average spot rate from 7/1/20x1 to 12/31/20x1 Twelve-month forward rate at 7/1/20x1 Six-month forward rate at 12/31/20x1
₱1 ₱1 ₱1 ₱1 ₱1
: : : : :
AMD AMD AMD AMD AMD
1.50 2.00 1.75 1.54 2.02
Case#1: No hedging instrument 1. How much is the FOREX gain (loss) arising from translation of inter-company accounts recognized in the subsidiary’s 20x1 separate financial statements?
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a. 2,400,000 1,000,000
b. (2,400,000)
c. (1,000,000)
d.
2. How much is the subsidiary’s 20x1 adjusted separate profit immediately before consolidation? a. 6,000,000 b. 8,000,000 c. 6,362,524 d. 8,429,824 3. How much is the translation adjustment to be recognized in OCI in the 20x1 consolidated financial statements? - gain (loss) a. (2,571,429) b. 2,571,429 c. 2,428,571 d. (2,428,571) 4. How much is the year-end consolidated total assets? a. 76,000,000 b. 80,000,000 c. 74,362,428 d. 78,522,542 5. How much is the year-end consolidated total equity? a. 37,571,428 b. 40,000,000 c. 37,000,000 d. 42,376,542 Case #2: With hedging instrument Use the same fact pattern, except that ABC Co. decided on July 1, 20x1 to limit its foreign currency exposure as it relates to the initial net investment by entering into a forward contract to sell ADM 20,000,000 (tax rate 40%) at a forward rate of 1.54 in 12 months and to designate it as a hedge of the net investment. The appropriate discount factor is 0.971286. 6. How much is the translation adjustment to be recognized in OCI in the 20x1 consolidated financial statements? - gain (loss) a. (630,124) b. 621,739 c. 428,571 d. (428,571) 7. How much is the year-end consolidated total assets? a. 72,340,242 b. 80,000,000 c. 71,798,447 78,000,000
d.
8. How much is the year-end consolidated total equity? a. 38,798,448 b. 40,000,000 c. 37,000,000 42,376,542
d.
Forward contract – Hedge of a recognized asset Use the following information for the next three questions: On March 1, 20x1, ABC Co. sold inventory to a foreign company for FC 4,000,000 (‘FC’ means foreign currency) when the spot exchange rate is FC 40: ₱1. The payment is due on April 1, 20x1. ABC Co. is concerned about the possible fluctuation in exchange rates, so on this date, ABC Co. entered into a forward contract to sell FC 4,000,000 for ₱100,000 to a broker. According to the terms of the forward contract, if FC 4,000,000 is worth less than ₱100,000 on April 1, 20x1, ABC Co. shall receive from the broker the difference; if it is worth more than ₱100,000, ABC Co. shall pay the broker the difference. 9. Case #1: If the exchange rate on April 1, 20x1 is FC35: ₱1, how much is the net cash settlement? - Receipt / (Payment) a. 14,286 b. (14,286) c. 12,366 d. (12,366)
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10. Case #2: If the exchange rate on April 1, 20x1 is FC50: ₱1, how much is the net cash settlement? - Receipt / (Payment) a. 23,478 b. (23,478) c. 20,000 d. (20,000) 11. Case #3: If the exchange rate on April 1, 20x1 is FC45: ₱1, how much is the fair value of the interest rate swap? – Asset / (Liability) a. 11,111 b. (11,111) c. 12,366 d. (12,366) Forward contract – Hedge of a forecast transaction Use the following information for the next two questions: ABC Co. does printing jobs for various customers. On January 1, 20x1, ABC Co. forecasted the purchase of 1,000 reams of paper in the next quarter. The expected purchase date is on April 15, 20x1. ABC Co. expects that the price of paper will fluctuate because of the upcoming elections. Thus, on January 1, 20x1, ABC Co. enters into a forward contract to purchase 1,000 reams of paper at a forward rate of ₱2,400 per ream. If the market price on April 15, 20x1 is more than ₱2,400, ABC Co. shall receive the difference from the broker. On the other hand, if the market price is less than ₱2,400, ABC Co. shall pay the difference to the broker. The forward contract will be settled net on April 15, 20x1. The discount rate is 10%. 12. If the price of paper is ₱2,800 per ream on March 31, 20x1, how much is the derivative asset (liability) to be recognized in ABC Co.’s first quarter financial statements? a. 367,338 b. (367,338) c. 400,000 d. (400,000) 13. If the price of paper is ₱2,200 per ream on March 31, 20x1, how much is the derivative asset (liability) to be recognized in ABC Co.’s first quarter financial statements? a. 187,333 b. (187,333) c. 200,000 d. (200,000) Forward contract – Present value Use the following information for the next three questions: ABC Co. produces feeds for hogs and chickens. In its long-term budget completed on November 1, 20x1, ABC Co. forecasts a purchase of 100,000 kilos of corn on January 1, 20x3. To protect itself from fluctuation in prices, ABC Co. enters into a forward contract on November 1, 20x1 to purchase 100,000 kilos of corn for ₱20,000,000 (or ₱200 per kilo). The forward contract will be settled net on January 1, 20x3. 14. What is the notional value of the forward contract? a. 20,000,000 b. 30,000,000 c. 40,000,000 d. 50,000,000 15. If the current market price of corn is ₱260 per kilo on December 31, 20x1, what amount of derivative asset (liability) shall be reported in ABC Co.’s 20x1 year-end financial statements? The appropriate discount rate is 10%. a. 5,454,545 b. (5,454,545) c. 6,000,000 d. (6,000,000)
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16. If the current market price of corn is ₱160 per kilo on December 31, 20x2, what amount of derivative asset (liability) shall be reported in ABC Co.’s 20x2 year-end financial statements? The appropriate discount rate is 10%. a. 3,636,364 b. (3,636,364) c. 4,000,000 d. (4,000,000) Futures contract 17. ABC Co. has the following futures contract: Futures Qua price ntity 1/1/x1 1 "Long" futures contract 400 2,000 to purchase gold 2 "Long" futures contract 800 1,600 to purchase silver 3 "Short" futures contract 4,00 250 to sell coffee beans 0 4 "Short" futures contract 6,00 60 to sell potatoes 0
Market price 12/31/x1 1,800 1,900 220 75
How much is the total net derivative asset (liability) on December 31, 20x1? a. 220,000 b. (220,000) c. 190,000 d. (190,000) Call option Use the following information for the next two questions: On May 6, 20x1, ABC Co. entered into a firm commitment to purchase equipment from a foreign company for FC 4,000,000 when the exchange rate was FC 40: ₱1. Payment is due on June 1, 20x1. ABC Co. is concerned about the possible fluctuation in exchange rates, so on this date, ABC Co. entered into a call option to purchase FC 4,000,000 for ₱100,000 to a broker. ABC Co. paid ₱4,000 for the purchased option. 18. Case #1: If the exchange rate on June 1, 20x1 is FC 35: ₱1, how much did ABC Co. save by purchasing the call option? a. 14,286 b. (14,286) c. (14,000) d. 0 19. Case #2: If the exchange rate on June 1, 20x1 is FC 50: ₱1, how much did ABC Co. save by purchasing the call option? a. 20,000 b. (20,000) c. (6,000) d. 0 Put option 20. On March 31, 20x1, ABC Co. acquired for ₱40,000 a put option which entitles ABC Co. to sell 20,000 units of a commodity for ₱880 per unit. The option expires on July 1, 20x1. On July 1, 20x1, the current market price of the commodity is ₱1,000 per unit. How much is the loss on the put option to be recognized by ABC Co. in its 20x1 financial statements? a. 40,000 b. 240,000 c. 280,000 d. 0 Call option – No hedging designation
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Use the following information for the next four questions: On October 1, 20x1, ABC Co. acquired for ₱40,000 a call option which entitles ABC Co. to purchase 20,000 units of a commodity for ₱880 per unit. The option is exercisable on March 31, 20x2. The call option was not designated as a hedging instrument. The following are the current market prices: 88 October 1, 20x1 0 96 December 31, 20x1 0 1,0 March 31, 20x1 00 21. How much is the derivative asset (liability) on December 31, 20x1? a. (1,600,000) b. 1,640,000 c. 1,600,000 d. (1,560,000) 22. How much is the unrealized gain (loss) on December 31, 20x1? a. (1,560,000) b. 1,560,000 c. 1,600,000 d. (1,600,000) 23. How much is the net cash settlement – receipt (payment) – on March 31, 20x2? a. 2,440,000 b. 2,360,000 c. (2,400,000) d. 2,400,000 24. How much is the realized gain (loss) on the call option on March 31, 20x2? a. 760,000 b. (840,000) c. (800,000) d. 800,000 Interest rate swap (swap payment at maturity) Use the following fact pattern for the next four questions: On January 1, 20x1 when the current market rate of interest was 10%, ABC Co. obtained a two-year, ₱4,000,000, variable-rate loan. Interest payments on the loan are due every year-end. ABC Co. was worried about future fluctuations in interest rates. Thus, on January 1, 20x1, ABC Co. entered into an interest rate swap wherein ABC Co. shall receive interest at whatever the current market rate of interest is at the beginning of the year and pay fixed interest at 10%. Swap payment shall be made only at maturity date. Case #1: 25. If the current market rate of interest on January 1, 20x3 is 8%, how much is the net cash settlement at maturity date? – Receipt (Payment) a. (80,000) b. 80,000 c. (30,000) d. 0 26. If the current market rate of interest on December 31, 20x2 is 8%, how much is the fair value of the interest rate swap? - Asset (Liability) a. (74,072) b. 74,072 c. (80,000) d. (72,727) Case #2: 27. If the current market rate of interest on January 1, 20x3 is 12%, how much is the net cash settlement at maturity date? – Receipt (Payment)
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a. (80,000)
b. 80,000
c. (30,000) d. 0
28. If the current market rate of interest on December 31, 20x2 is 12%, how much is the fair value of the interest rate swap? – Asset (Liability) a. (71,432) b. 71,432 c. 80,000 d. 72,727 Interest rate swap (periodic swap payments) Use the following information for the next three questions: On January 1, 20x1, ABC Co. obtained a five-year, ₱4,000,000 variable-rate loan with interest payments due at each year-end and the principal due on December 31, 20x5. As protection from possible fluctuations in current market rates, ABC Co. enters into an interest rate swap for the whole principal of the loan. Under the agreement, ABC Co. shall receive variable interest and pay fixed interest based on a fixed rate of 8%. Swap payments shall be made at each year-end. The following are the current market rates: Jan. 1, 20x1 8% Jan. 1, 20x2 9% Jan. 1, 20x3 12% 29. What is the “notional” amount of the interest rate swap agreement? a. 4,000,000 b. 320,000 c. 4,320,000 d. 0 30. How much is the fair value of the interest rate swap on December 31, 20x1? – Asset (Liability) a. 40,000 b. (36,697) c. 36,697 d. 129,589 31. How much is the fair value of the interest rate swap on December 31, 20x2? – Asset (Liability) a. 384,292 b. 202,806 c. 143,234 d. 36,697
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Chapter 25: Theory of Accounts Reviewer 1. In accordance with PFRS 7, which of the following best describes the risk that an entity will encounter if it has difficulty in meeting obligations associated with its financial liabilities? a. Liquidity risk b. Credit risk c. Financial risk d. Payment risk (Adapted) 2. In accordance with PFRS 7, which of the following best describes credit risk? a. The risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation b. The risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities c. The risk that the fair value associated with an instrument will vary due to changes in the counterparty's credit rating d. The risk that an entity's credit facilities will be withdrawn due to cash flow sensitivities (Adapted) 3. Which of the following are types of hedging relationship? I. Cash flow hedge II. Credit risk hedge III. Interest rate hedge IV. Fair value hedge a. I only b. I and II c. I and IV d. All of these (Adapted) 4. In accordance with PFRS 7, which of the following are components of market risk? I. Credit risk II. Currency risk III. Interest rate risk IV. Liquidity risk a. I only b. I and II c. I and IV d. All of these (Adapted) 5. Techniques such as hedging, forward contracts and options can: a. Reduce risk. c. Totally eliminate risk. b. Increase risk. d. Are purely for speculation. 6. Which of the following is the characteristic of a perfect hedge? a. No possibility of future gain or loss b. No possibility of future gain only c. No possibility of future loss only d. The possibility of future gain and no future loss (AICPA) 7. It is a financial instrument which its return is based on the return of some other underlying asset a. FVPL b. FVOCI c. Amortized cost d. Derivative
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8. When an entity is unable to separate an embedded derivative from its host contract, the entity should classify the hybrid instrument as a. FVPL b. FVOCI c. Amortized cost d. a or b 9. If a company having a floating-rate debt is concerned that interest rates will rise causing interest costs to increase, it would most likely to enter into a swap to a. Pay-variable rate and receive-fixed rate. b. Pay-fixed rate and receive-floating rate. c. Swaps are not used for this purpose. d. It would depend on whether the swap is in, at, or out-of-the money. 10. Arnold Co. purchased a call option on the rice field of Robert Co. on January 1, 200A exercisable on or before January 1, 200B. On December 31, 200A, the fair market value of the rice field was below the call option price, making the instrument “out of the money,” and Arnold Co. decided not to exercise the call option. Which of the following statements is correct? a. The call option does not meet the definition of a derivative under PFRSs regarding settlement at a future date. b. The call option does not meet the definition of a derivative under PFRSs regarding the absence of initial net investment or the presence of a little initial net investment c. The call option meets the definition of a derivative under PFRSs regarding settlement at a future date since expiry at maturity is a form of settlement even though there is no additional exchange of consideration. d. The call option meets the definition of a derivative; however, it should be written off on December 31, 200A and a corresponding financial liability should be recognized. 11. On January 1, 200A, Clifton Co. enters into a forward contract to purchase 10,000 shares of stock from Jane Co. on December 31, 200A at a forward price of ₱100 per share. Clifton Co. prepays the shares at ₱100 per share which is the current price of the shares on January 1, 200A. Which of the following is correct? a. The forward contract meets the definition of a derivative. b. The forward contract fails the “underlying” test for a derivative since the current price and forward price are equal on inception. c. The forward contract fails the “future settlement” test for a derivative since Clifton Co. prepaid the shares at inception at an amount equal to settlement price. Prepayment at an amount equal to settlement price is tantamount to settlement. d. The forward contract fails the “no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors” test for a derivative. 12. Which of the following may qualify as net investment in a foreign operation, of a Philippine company, to be a hedged item for hedge accounting purposes? a. fish ball and kikyam operations in the US
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b. investment in associate on a company operating in Canada c. joint venture with McDonalds to sell Mcbalut in retail stores all over the world d. investment in subsidiary on a domestic corporation selling eload and auto load only within the Philippines. 13. To be considered highly effective, actual results of the hedge should a. be 100% effective c. result to no gain or loss b. be within a range of 80 to 125% d. be documented properly 14. Which of the following is not a derivative? a. Equity contracts c. Option Contract b. Futures contract d. Swap contracts (Adapted) 15. An interest rate swap in which company has fixed rate of interest and pays a variable rate is called a : a. cash flow hedge b. fair value hedge c. deferred hedge d. hedge of foreign currency exposure of net investment in foreign operations (Adapted) 16. A derivative may be: a. an asset account c. an equity account b. a liability account d. either an asset or liability account (Adapted) 17. The PFRSs require a company to recognize in its current net income any gain or loss from a change in the fair value of the derivative for a: (Item #1) Fair Value Hedge; (Item #2) Cash Flow Hedge a. Yes, Yes b. Yes, No c. No, No d. No, Yes (Adapted) 18. Uncertainty about the future market value of an asset is referred to as a. price risk. c. interest rate risk. b. credit risk. d. exchange rate risk. (Adapted) 19. Uncertainty that the party on the other side of an agreement will abide by the terms of the agreement is referred to as a. price risk. c. interest rate risk. b. credit risk. d. exchange rate risk. (Adapted) 20. A contract, traded on an exchange, that allows a company to buy a specified quantity of a commodity or a financial security at a specified price on a specified future date is referred to as a(n) a. interest rate swap. c. futures contract. b. forward contract. d. option. (Adapted)
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21. An agreement between two parties to exchange a specified amount of a commodity, security, or foreign currency at a specified date in the future with the price or exchange rate being set now is referred to as a(n) a. interest rate swap. c. futures contract. b. forward contract. d. option. (Adapted) 22. If a cannery wanted to lock in the price they would pay for peaches in August four months before harvest (in April of the same year), they would be most likely to enter into which kind of agreement? a. Interest rate swap c. Futures contract b. Fixed commodities contract d. Option (Adapted) 23. A contract giving the owner the right, but not the obligation, to buy or sell an asset at a specified price any time during a specified period in the future is referred to as a(n) a. interest rate swap. c. futures contract. b. forward contract. d. option. (Adapted) 24. In exchange for the rights inherent in an option contract, the owner of the option will typically pay a price a. only when a call option is exercised. b. only when a put option is exercised. c. when either a call option or a put option is exercised. d. at the time the option is received regardless of whether the option is exercised or not. (Adapted) 25. Which type of contract is unique in that it protects the owner against unfavorable movements in the prices or rates while allowing the owner to benefit from favorable movements? a. interest rate swap. c. futures contract. b. forward contract. d. option. (Adapted) 26. When gains or losses on derivatives designated as fair value hedges exceed the gains or losses on the item being hedged, the excess a. affects reported net income. b. is recognized as an equity adjustment. c. is recognized as part of comprehensive income. d. is not recognized. (Adapted) 27. For which type of derivative are changes in the fair value deferred and recognized as an equity adjustment? a. Fair value hedge c. Operating hedge b. Cash flow hedge d. Notional value hedge (Adapted)
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28. Which choice best describes the information that should be disclosed related to derivative contracts? a. Fair value c. Both a and b b. Notional amount d. Neither a nor b (Adapted) 29. On February 1, Shoemaker Corporation entered into a firm commitment to purchase specialized equipment from the Okazaki Trading Company for ¥80,000,000 on April 1. Shoemaker would like to reduce the exchange rate risk that could increase the cost of the equipment in U.S. dollars by April 1, but Shoemaker is not sure which direction the exchange rate may move. What type of contract would protect Shoemaker from an unfavorable movement in the exchange rate while allowing them to benefit from a favorable movement in the exchange rate? a. Interest rate swap c. Call option b. Forward contract d. Put option (Adapted) 30. A company enters into a futures contract with the intent of hedging an account payable of DM400,000 due on December 31. The contract requires that if the U.S. dollar value of DM400,000 is greater than $200,000 on December 31, the company will be required to pay the difference. Alternatively, if the U.S. dollar value is less than $200,000, the company will receive the difference. Which of the following statements is correct regarding this contract? a. The Deutsche mark futures contract effectively hedges against the effect of exchange rate changes on the U.S. dollar value of the Deutsche mark payable. b. The futures contract is a contract to buy Deutsche marks at a fixed price. c. The futures contract is a contract to sell Deutsche marks at a fixed price. d. The contract obligates the company to pay if the value of the U.S. dollar increases. (Adapted) 31. A company enters into a futures contract with the intent of hedging an expected purchase of some equipment from a German company for DM400,000 on December 31. The contract requires that if the U.S. dollar value of DM800,000 is greater than $400,000 on December 31, the company will receive the difference. Alternatively, if the U.S. dollar value is less than $400,000, the company will pay the difference. Which of the following statements is correct regarding this contract? a. The Deutsche mark futures contract effectively hedges against the effect of exchange rate changes on the U.S. dollar value of the Deutsche mark commitment. b. The futures contract exceeds the amount of the commitment and thus hedges movements in the Deutsche mark exchange rate. c. The futures contract is a contract to sell Deutsche marks at a fixed price. d. The extra DM400,000 would be accounted for as a speculative investment.
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(Adapted) 32. A company enters into an interest rate swap in order to hedge a $5,000,000 variable-rate loan. The loan is expected to be fully repaid this year on June 10. The contract requires that if the interest rate on April 30 of next year is greater than 11%, the company receives the difference on a principal amount of $5,000,000. Alternatively, if the interest rate is less than 11%, the company must pay the difference. Which of the following statements is correct regarding this contract? a. The swap agreement effectively hedges the variable interest payments. b. The timing of the swap payment matches the timing of the interest payments and, therefore, the variable interest payments are hedged. c. The timing of the swap payment does not match the timing of the interest payments and, therefore, the variable interest payments are not hedged. d. This swap represents a fair value hedge. (Adapted) Use the following information for the next four questions: Fact pattern Hall, Inc., enters into a call option contract with Bennett Investment Co. on January 2, 2002. This contract gives Hall the option to purchase 1,000 shares of WSM stock at $100 per share. The option expires on April 30, 2002. WSM shares are trading at $100 per share on January 2, 2002, at which time Hall pays $100 for the call option. 33. a. b. c. d.
The call option would be recorded in the accounts of Hall as an asset. a liability. a gain. would not be recorded in the accounts (memorandum entry only). (Adapted) 34. Assume that the price of the WSM shares has risen to $120 per share on March 31, 2002, and the Hall is preparing financial statements for the quarter ending March 31. As regards this option, Hall, Inc., would report which of the following? a. A $20,000 realized gain. b. A $20,000 unrealized gain. c. a description of the change in price would be disclosed in the notes to the financial statements, but would not be reflected in the financial statements. d. Nothing would be reported in the financial statements or the notes thereto. (Adapted) 35. The 1,000 shares of WSM stock in this contract is referred to as a. the collateral. c. the option premium. b. the notional amount. d. the derivative. (Adapted)
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36. The $400 paid by Hall, Inc., to Baird Investment is referred to as a. the option premium. c. the strike price. b. the notional amount. d. the intrinsic value. (Adapted) 37. Assume that the price per share of WSM stock is $120 on April 30, 2002, and that the time value of the option has not changed. In order to settle the option contract, Hall, Inc., would most likely a. pay Baird Investment $20,000. b. purchase the shares of WSM at $100 per share and sell the shares at $120 per share to Baird. c. receive $20,000 from Baird Investment. d. receive $400 from Baird Investment. (Adapted) 38. Alpha Company purchases a call option to hedge an investment in 20,000 shares of Beta Company stock. The option agreement provides that if the prices of a share of Beta Company stock is greater than $30 on October 25, Alpha receives the difference (multiplied by 20,000 shares). Alternatively, if the price of the stock is less than $30, the option is worthless and will be allowed to expire. Which of the following statements regarding this call option is correct? a. The call option effectively hedges the investment in the shares of Beta stock. b. The call option is an option to sell Beta Company stock at a fixed price. c. The call option represents a speculative option rather than a hedge. d. Alpha could have purchased a put option or a call option to effectively hedge the investment in the shares of Beta stock. (Adapted) 39. Which of the following statements about options and their underlying assets is FALSE? a. The value of an option, in comparison to its underlying asset, has the potential of creating an arbitrage opportunity. b. The owner of the option is legally required to engage in a transaction involving the asset. c. The holder of a long position on an option is the only party with the right to initiate a transaction involving the asset. d. The seller of the option is legally required to engage in a transaction involving the asset. (Adapted) 40. Which of the following statements about forward and future contracts is FALSE? a. A future requires the contract purchaser to receive delivery of the good at a specified time. b. A predetermined price to be paid for a good is a necessary requirement in the terms of a forward contract. c. The future value of a financial derivative depends on the value of its underlying asset. d. The primary difference between forwards and futures is that only futures are considered financial derivatives.
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(Adapted) 41. Futures contracts differ from forward contracts in which of the following ways? a. Performance of each party in a futures transaction is guaranteed by a clearinghouse. b. All of these choices are correct. c. Futures contracts require a daily settling of any gains or loses. d. Futures contracts are standardized. (Adapted) 42. Which of the following statements accurately describes how futures contracts differ from forward contracts? a. Futures contracts are standardized. b. Futures contracts require a daily settling of gains and losses. c. All of these choices are correct. d. The performance of counterparties to a futures contract is guaranteed by a clearinghouse. (Adapted) 43. When a call option on a future is exercised, the buyer receives: a. a short position in the underlying future. b. an option to purchase the underlying future. c. the physical good. d. a long position in the underlying future and a cash payment. (Adapted) 44. Which of the following statements about swap agreements is FALSE? a. They are standardized agreements, similar to futures. b. Counterparties are the principles who engage in a swap agreement. c. They allow for the exchange of different sets of future cash flows. d. Interest rate and currency are common types of swaps. (Adapted) 45. Which of the following requires the purchase of underlying asset at a specified price? a. Purchasing a call option. c. Writing a call option. b. Writing a put option. d. Purchasing a put option. (Adapted)
the
46. Frank Jameson is a portfolio manager with 90 percent of the large-cap diversified mutual fund he controls invested in common stocks. Jameson is concerned the overall market will decline by a significant amount over the next two months due to a slowing of the general economy. Which of the following actions will provide a hedge for the mutual fund? a. Selling interest rate future contracts. b. Writing put options on the S&P 500. c. Purchasing put options on the Standard and Poor's 500 Index (S&P 500). d. Purchasing call options on the S&P 500. (Adapted)
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47. Ron Jensen is a speculator who does not currently own GHP Corporation common stock but believes it will increase in market value by 25 percent over the next month. Jensen can most likely achieve the highest percentage return on the expected stock price increase by: a. writing GHP put options. c. buying GHP put options. b. buying GHP call options. d. buying GHP common stock. (Adapted) 48. Which of the following statements about derivatives is TRUE? a. Although forwards have terms that are not standardized, the clearinghouse of that exchange still takes the opposite position of each trade, thereby protecting the counterparties from default risk. b. Although minimal, arbitragers face the risk of the market value of the underlying asset declining by an amount greater then what was protected with the hedge. c. When a call option on a future is exercised, the seller receives a short position in the underlying future plus pays cash to the holder of the option. d. The market value of a financial derivative is primarily a function of the relative demand and supply for that contract. (Adapted) 49. If an oil wholesaler expects to buy some gasoline for his customers in the future and wants to hedge his risk, he needs to: a. sell gasoline now. c. do nothing. b. sell crude oil futures contract. d. buy crude oil futures contract. (Adapted) 50. Which of the following statements about forward contracts is CORRECT? A long trader agrees to: a. take delivery, and a short trader agrees to take delivery b. take delivery, and a short trader agrees to make delivery. c. take delivery, and a short trader agrees to make delivery. d. make delivery, and a short trader agrees to take delivery. (Adapted) 51. If a farmer expects to sell his wheat in anticipation of a harvest and wants to hedge his risk, he needs to: a. sell wheat now. c. buy wheat futures contracts now. b. buy wheat now. d. sell wheat futures contracts now. (Adapted) 52. Which of the following statements about speculators and hedgers in the futures market is TRUE? a. Hedging can allow a business to guard against a price increase in a commodity without sacrificing profit if the commodity price decreases. b. A speculator would use futures to take a long position in a commodity if its price is expected to decrease. c. A speculator would use futures to take a short position in a commodity if its price is expected to increase. d. Hedgers guard against market price changes that would cause a reduction in their operating profit. (Adapted)
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53. Standardized futures contracts are an aid to increased market liquidity because: a. standardization results in less trading activity. b. uniformity of the contract terms broadens the market for the futures by appealing to a greater number of traders. c. standardization of the futures contract stabilizes the market price of the underlying commodity. d. non-standardized forward contracts are not allowed to trade. (Adapted) 54. Futures have greater market liquidity than forward contracts, because futures are: a. developed with specific characteristics to meet the needs of the buyer. b. standardized contracts. c. sold only for widely traded commodities, unlike forwards. d. written for shorter periods of time. (Adapted) 55. Standardization features of futures contracts do not include the: a. quality of the good that can be delivered. b. delivery time. c. quantity of the good to be delivered. d. delivery price of the commodity. (Adapted) 56. What is the primary difference between an American and a European option? a. American and European options are never written on the same underlying asset. b. The European option can only be traded on overseas markets. c. The American option can be exercised at any time on or before its expiration date. d. American and European options always have different strike prices when written on the same underlying asset. (Adapted) 57. American options are worth no less than European options with the same maturity, exercise price, and underlying stock because: a. purchasers of American options receive stock dividends, while purchasers of European options do not. b. American options are traded in U.S. exchanges where trading costs are less than in European exchanges. c. all of these choices are correct. d. American options can be exercised before maturity, while European options can be exercised only at maturity. (Adapted) 58. Which of the following statements about European and American options is FALSE? a. European options offer more flexible trading opportunities for speculators. b. American options can be exercised at any time on or before the expiration date. c. European options are easier to analyze and value than American options.
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d. American options are far more common than European options. (Adapted) 59. Which of the following statements regarding options is TRUE? a. An American option is worth no less than a European option with the same maturity, exercise price, and underlying stock. b. European options are always worth the same as American options with the same maturity, exercise price, and underlying stock. c. European options are always worth more than American options with the same maturity, exercise price, and underlying stock. d. All of these choices are correct. (Adapted) 60. The writer of the put option has the: a. obligation to sell the underlying asset in the future under certain conditions. b. right to buy the underlying asset in the future under certain conditions. c. right to sell the underlying asset in the future under certain conditions. d. obligation to buy the underlying asset in the future under certain conditions. (Adapted) 61. The writer of an option has: a. neither the right nor obligation. c. the right. b. both the right and obligation. d. the obligation. (Adapted) 62. John Elam has a position in an option in which Elam pays an upfront fee to receive payments if the value of a stock is below $18 at expiration. If the stock is not below $18 at expiration, Elam receives nothing. Elam’s position in the option is: a. short a put option. c. long a call option. b. short a call option. d. long a put option. (Adapted) 63. James Anthony has a short position in a put option with a strike price of $94. If the stock price is below $94 at expiration, what will happen to Anthony’s short position in the option? a. The person who is long the put option will not exercise the put option. b. He will have the option exercised against him at $94 by the person who is long the put option. c. He will exercise the option at $94. d. He will let the option expire. (Adapted) 64. Which of the following represents a long position in an option? a. Writing a call option. c. Writing a naked call option. b. Writing a put option. d. Buying a put option. (Adapted) 65.
The options market is a zero-sum game in that:
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a. whatever the long call gains, the short call loses. b. the short put position has limited gain but also has limited loss. c. the long put position can gain infinitely, but the long call position can only lose the premium. d. the long put position has limited gain but also has limited loss. (Adapted) 66. The options market is a zero-sum game because: a. there are no net profits or losses in the market. b. the profits from the buyer and seller of a call option together are always zero. c. all of these choices are correct. d. profits come only at the expense of another trader. (Adapted) 67. Which of the following statements regarding buyers of call and put options is TRUE? a. Buyers of calls anticipate the value of the underlying asset to decrease, while the buyers of puts anticipate the value of the underlying asset to increase. b. Buyers of calls anticipate the value of the underlying asset to decrease, and buyers of puts also anticipate the value of the underlying asset to decrease. c. Buyers of calls anticipate the value of the underlying asset to increase, and buyers of puts also anticipate the value of the underlying asset to increase. d. Buyers of calls anticipate the value of the underlying asset to increase, while the buyers of puts anticipate the value of the underlying asset to decrease. (Adapted) 68. Which of the following is a reason to use the swaps market rather than the futures market? To: a. maintain the firm's privacy. b. increase the liquidity of the contract. c. reduce the credit risk involved with the contract. d. provide for a standardized contract. (Adapted) 69. Which of the following statements about notional principal in swaps is TRUE? a. Notional principal is used as a base for computation of payments. b. Notional principal is useless in most swaps. c. Notional principal is not actually exchanged. d. Notional principal is not actually exchanged and notional principal is used as a base for computation of payments. (Adapted) 70. Parties agreeing to swap cash flows are: a. dealers. b. agents. c. counterparties. facilitators. (Adapted)
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d. swap
71. Consider a commercial bank that is about to make a large variable-rate loan. Which of the following would be an appropriate position for the bank to hedge its risk with this loan? Pay: a. variable to a currency swap counterparty and receive fixed. b. variable to an interest rate swap counterparty and receive fixed. c. fixed to an interest rate swap counterparty and receive variable. d. fixed to a currency swap counterparty and receive variable. (Adapted) 72. Consider a commercial bank that has many floating-rate liabilities and has many fixed-rate assets. Which of the following would be an appropriate position for the bank to hedge its risk? Pay: a. variable to an interest rate swap counterparty and receive fixed. b. fixed to a currency swap counterparty and receive variable. c. variable to a currency swap counterparty and receive fixed. d. fixed to an interest rate swap counterparty and receive variable. (Adapted) 73. A typical savings and loan association accept deposits (which is floating rate in nature) and lend those funds on fixed rate terms. As a result, it can be left with floating rate liabilities and fixed rate assets. To escape this interest rate risk, the savings and loan might be motivated to engage in: a. a currency swap. c. an interest rate swap. b. an equity swap. d. swaps can never help. (Adapted) 74. An interest rate swap: a. all of these choices are correct. b. allows a firm to convert outstanding fixed rate debt to floating rate debt. c. allows a firm to convert outstanding floating rate debt to fixed rate debt. d. obligates two counterparties to exchange cash flows at one or more future dates. (Adapted) 75. The main motivation for engaging in swap transactions is: a. commercial needs. c. both of these choices are correct. b. comparative borrowing advantages. d. none of these choices are correct. (Adapted) 76. Which of the following MUST be part of ANY swap transaction? a. Swap dealers. c. Counterparties. b. Swap facilitators. d. Counterparties and swap facilitators. (Adapted) 77.
A derivative designated as a fair value hedge must be:
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I.
Specifically identified to the hedged asset, liability or unrecognized firm commitment. II. Expected to be highly effective in offsetting changes in the fair value of the hedged item. a. I only. b. II only. c. Both I and II. d. Neither I nor II. (AICPA) 78. In order for a financial instrument to be a derivative for accounting purposes, the financial instrument must: I. Have one or more underlyings. II. Require an initial net investment. a. I only. b. II only. c. Both I and II. d. Neither I nor II. (AICPA) 79. The determination of the value or settlement amount of a derivative involves a calculation which uses: I. An underlying. II. A notional amount. a. I only. b. II only. c. Both I and II. d. Neither I nor II. (AICPA) 80. On December 31, 199X, the end of its fiscal year, Smarti Company held a derivative instrument which it had acquired for speculative purposes during November, 199X. Since its acquisition the fair value of the derivative had increased materially. On December 31, how should the increase in fair value of the derivative instrument be reported by Smarti in its financial statements? a. Recognized as a deferred credit until the instrument is settled. b. Recognized in current net income for 199X. c. Recognized as a component of other comprehensive income for 199X. d. Disregarded until the instrument is settled. (AICPA) 81. Gains and losses from changes in the fair value of a derivative designated and qualified as a fair value hedge should be: a. Disregarded until the derivative is settled. b. Recognized as a deferred debit or deferred credit in the balance sheet until the derivative is settled. c. Recognized in current net income in the period in which the fair value of the derivative changes. d. Recognized as a component of other comprehensive income in the period in which the fair value of the derivative changes. (AICPA) 82. Qualified derivatives may be used to hedge the cash flow associated with an/a: (Item #1) Forecasted; (Item #2) Asset transaction a. Yes Yes b. Yes No c. No Yes d. No No (AICPA) 83. A change in the fair value of a derivative qualified as a cash flow hedge is determined to be either effective in offsetting a change in the hedged item or ineffective in offsetting such a change. How should the effective and ineffective portions of the
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change in value of a derivative which qualifies as a cash flow hedge be reported in financial statements? Effective portion in Ineffective portion in a. Current income Current income b. Current income Other comprehensive income c. Other comprehensive income Current income d. Other comprehensive income Other comprehensive income (AICPA) 84. Which of the following risks are inherent in an interest rate swap agreement? I. The risk of exchanging a lower interest rate for a higher interest rate. II. The risk of nonperformance by the counterparty to the agreement. a. I only. b. II only. c. Both I and II. d. Neither I nor II. (AICPA) 85. Which of the following financial instruments is not considered a derivative financial instrument? a. Interest-rate swaps. c. Stock-index options. b. Currency futures. d. Bank certificates of deposit. (AICPA) 86. Derivatives that are not hedging instruments are always classified in which category of financial instruments? a. Financial assets or liabilities with fair values through profit or loss b. Held-to-maturity investments. c. Loans and receivables originated by the enterprise. d. Available-for-sale financial assets. (AICPA) 87. Which of the following is the best description of a financial instrument? a. Any monetary contract denominated in a foreign currency. b. Cash, an investment in equities, and any contract to receive or pay cash. c. Any form of a company’s own capital stock. d. Any transaction with a bank or other financial institution. (Adapted) 88. On November 1, Year One, the Jeter Company signs a contract to receive one million Japanese yen on February 1, Year Two, for $10,000 based on the three-month forward exchange rate at that time of $1 for 100 Japanese yen (1,000,000 x 1/100 or $10,000). Why would Jeter obtain this contract? a. Jeter believes the value of the Japanese yen will be increasing in relation to the value of the US dollar. b. Jeter believes the value of the Japanese yen will be decreasing in relation to the value of the US dollar. c. Jeter believes that the economy of Japan will be growing at a rate faster than that of the US economy.
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d. Jeter could be hedging a future need to make a payment in Japanese yen or it could be speculating that the Japanese yen will become more valuable. (Adapted) 89. On November 1, Year One, the Haynie Company signs a contract to receive one million Japanese yen on February 1, Year Two, for $10,000 based on the three-month forward exchange rate at that time of $1 for 100 Japanese yen (1,000,000 x 1/100 or $10,000). This contract is a derivative because its value is derived from the future value of the Japanese yen in relation to the US dollar. On December 31, Year One, the Haynie Company is producing financial statements. How is this forward exchange contract reported? a. It is shown as an asset or a liability at its fair value. b. It is shown only as an asset at its fair value. c. It is shown only as a liability at its fair value. d. It is only disclosed in the notes to the financial statements because it is a future transaction. (Adapted) 90. On December 1, Year One, a company acquires two threemonth financial instruments that qualify as derivatives. Financial instrument A was bought to serve as a fair value hedge. Financial instrument B was bought to serve as a cash flow hedge. By the end of Year One, both of these financial instruments have increased in value by $1,000. How should these gains in value be reported by the company on the Year One financial statements? a. Both gains are reported within net income. b. Both gains are reported within accumulated other comprehensive income. c. The gain on the fair value hedge is reported within net income whereas the gain on the cash flow hedge is reported within accumulated other comprehensive income. d. The gain on the fair value hedge is reported within accumulated other comprehensive income whereas the gain on the cash flow hedge is reported within net income. (Adapted) 91. Some financial instruments qualify as derivatives. Which of the following is the best description of a derivative? a. A contract denominated in two different currencies. b. A contract that derives its value from some other index, item, or security. c. A contract that may happen but is not guaranteed to happen. d. A contract made by two parties but which directly impacts a third party. (Adapted) 92. The functional currency of Nash, Inc.’s subsidiary is the French franc. Nash borrowed French francs as a partial hedge of its investment in the subsidiary. In preparing consolidated financial statements, Nash’s translation loss on its investment in the subsidiary exceeded its exchange gain on the borrowing. How should the effects of the loss and gain be reported in Nash’s consolidated financial statements?
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a. The translation loss less the exchange gain is reported separately as other comprehensive income. b. The translation loss less the exchange gain is reported in the income statement. c. The translation loss is reported separately in the stockholders’ equity section of the balance sheet and the exchange gain is reported in the income statement. d. The translation loss is reported in the income statement and the exchange gain is reported separately in the stockholders’ equity section of the balance sheet. (AICPA) 93. A gain in the fair value of a derivative may be included in comprehensive income if the derivative is appropriately designated as a a. Speculation in Foreign Currency. b. Hedge of a Foreign Currency exposure of an available-for-sale security. c. Hedge of a Foreign Currency exposure of a forecasted foreign currency denominated transaction. d. Hedge of a foreign currency firm commitment. (AICPA) 94. Shore Co. records its transactions in US dollars. A sale of goods resulted in a receivable denominated in Japanese yen, and a purchase of goods resulted in a payable denominated in euros. Shore recorded a foreign exchange transaction gain on collection of the receivable and an exchange transaction loss on settlement of the payable. The exchange rates are expressed as so many units of foreign currency to one dollar. Did the number of foreign currency units exchangeable for a dollar increase or decrease between the contract and settlement dates? (Item #1) Yen exchangeable for ₱1; (Item #2) Euros exchangeable for ₱1 a. Increase Increase c. Decrease Increase b. Decrease Decrease d. Increase Decrease (AICPA) 95. On October 1, 2003, Mild Co., a US company, purchased machinery from Grund, a German company, with payment due on April 1, 2004. If Mild’s 2003 operating income included no foreign exchange transaction gain or loss, then the transaction could have a. Resulted in an extraordinary gain. b. Been denominated in US dollars. c. Caused a foreign currency gain to be reported as a contra account against machinery. d. Caused a foreign currency translation gain to be reported as other comprehensive income. (AICPA) 96. On October 1, 2003, Velec Co., a US company, contracted to purchase foreign goods requiring payment in Qatari rials, one month after their receipt at Velec’s factory. Title to the goods passed on December 15, 2003. The goods were still in transit on December 31, 2003. Exchange rates were one dollar to twenty-
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two rials, twenty rials, and twenty-one rials on October 1, December 15, and December 31, 2003, respectively. Velec should account for the exchange rate fluctuation in 2003 as a. A loss included in net income c. An extraordinary gain. b. A gain included in net income d. An extraordinary loss. (AICPA) 97. Derivatives are financial instruments that derive their value from changes in a benchmark based on any of the following except a. Stock prices. c. Commodity prices. b. Mortgage and currency rates. d. Discounts on accounts receivable. (AICPA) 98. Derivative instruments are financial instruments or other contracts that must contain a. One or more underlyings, or one or more notional amounts. b. No initial net investment or smaller net investment than required for similar response contacts. c. Terms that do not require or permit net settlement or delivery of an asset. d. All of the above. (AICPA) 99. The basic purpose of derivative financial instruments is to manage some kind of risk such as all of the following except a. Stock price movements. c. Currency fluctuations. b. Interest rate variations. d. Uncollectibility of accounts receivables. (AICPA) 100. Which of the following statements is(are) true regarding derivative financial instruments? I. Derivative financial instruments should be measured at fair value and reported in the balance sheet as assets or liabilities. II. Gains and losses on derivative instruments not designated as hedging activities should be reported and recognized in earnings in the period of the change in fair value. a. I only. b. II only. c. Both I and II. d. Neither I nor II. (AICPA) 101. Which of the following is an underlying? a. A credit rating. c. An average daily temperature. b. A security price. d. All of the above could be underlyings. (AICPA) 102. If the price of the underlying is greater than the strike or exercise price of the underlying, the call option is a. At the money. c. On the money. b. In the money. d. Out of the money. (AICPA) 103. Which of the following is not a distinguishing characteristic of a derivative instrument? a. Terms that require or permit net settlement.
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b. Must be “highly effective” throughout its life. c. No initial net investment. d. One or more underlyings and notional amounts. (AICPA) 104. An example of a notional amount is a. Number of barrels of oil. c. Currency swaps. b. Interest rates. d. Stock prices. (AICPA) 105. Disclosures related to financial instruments, both derivative and nonderivative, used as hedging instruments must include a. A list of hedged instruments. b. Maximum potential accounting loss. c. Objectives and strategies for achieving them. d. Only a. and c. (AICPA) 106. Which of the following financial instruments or other contracts is not specifically excluded from the definition of derivative instruments in PAS 39? a. Leases. c. Adjustable rate loans. b. Call (put) option. d. Equity securities. (AICPA) 107. Which of the following is not a derivative instrument? a. Futures contracts. c. Interest rate swaps. b. Credit indexed contracts. d. Variable annuity contracts. (AICPA) 108. Which of the following criteria must be met for bifurcation to occur? a. The embedded derivative meets the definition of a derivative instrument. b. The hybrid instrument is regularly recorded at fair value. c. Economic characteristics and risks of the embedded instrument are “clearly and closely” related to those of the host contract. d. All of the above. (AICPA) 109. Financial instruments sometimes contain features that separately meet the definition of a derivative instrument. These features are classified as a. Swaptions. c. Embedded derivative instruments. b. Notional amounts. d. Underlyings. (AICPA) 110. The process of bifurcation a. Protects an entity from loss by entering into a transaction. b. Includes entering into agreements between two counterparties to exchange cash flows over specified period of time in the future. c. Is the interaction of the price or rate with an associated asset or liability. d. Separates an embedded derivative from its host contract.
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(AICPA) 111. Hedge accounting is permitted for all of the following types of hedges except a. Trading securities. b. Unrecognized firm commitments. c. Available-for-sale securities. d. Net investments in foreign operations. (AICPA) 112. Which of the following is a general criterion for a hedging instrument? a. Sufficient documentation must be provided at the beginning of the process. b. Must be “highly effective” only in the first year of the hedge's life. c. Must contain a nonperformance clause that makes performance probable. d. Must contain one or more underlyings. (AICPA) 113. For an unrecognized firm commitment to qualify as a hedged item it must a. Be binding on both parties. b. Be specific with respect to all significant terms. c. Contain a nonperformance clause that makes performance probable. d. All of the above. (AICPA) 114. A hedge of the exposure to changes in the fair value of a recognized asset or liability, or an unrecognized firm commitment, is classified as a a. Fair value hedge. c. Foreign currency hedge. b. Cash flow hedge. d. Underlying. (AICPA) 115. Gains and losses on the hedged asset/liability and the hedged instrument for a fair value hedge will be recognized a. In current earnings. b. In other comprehensive income. c. On a cumulative basis from the change in expected cash flows from the hedged instrument. d. On the balance sheet either as an asset or a liability. (AICPA) 116. Gains and losses of the effective portion of a hedging instrument will be recognized in current earnings in each reporting period for which of the following? (Item #1) Fair value hedge; (Item #2) Cash flow hedge a. Yes No b. Yes Yes c. No No d. No Yes (AICPA) 117. Which of the following risks are inherent in an interest rate swap agreement?
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The risk of exchanging a lower interest rate for a higher interest rate. II. The risk of nonperformance by the counterparty to the agreement. a. I only. b. II only. c. Both I and II. d. Neither I nor II. (AICPA) 118. Which of the following meet the definition of assets and/or liabilities? (Item #1) Derivative instruments; (Item #2) G/L on the fair value of derivatives a. Yes No b. No Yes c. Yes Yes d. No No (AICPA) 119. The risk of an accounting loss from a financial instrument due to possible failure of another party to perform according to terms of the contract is known as a. Off-balance-sheet risk. c. Credit risk. b. Market risk. d. Investment risk. (AICPA) 120. Examples of financial instruments with off-balance sheet risk include all of the following except a. Outstanding loan commitments written. c. Warranty obligations b. Recourse obligations on receivables. d. Futures contracts. (AICPA) 121. Off-balance-sheet risk of accounting loss does not result from a. Financial instruments recognized as assets entailing conditional rights that result in a loss greater than the amount recognized in the balance sheet. b. Financial instruments not recognized as either assets or liabilities yet still expose the entity to risk of accounting loss. c. Financial instruments recognized as assets or liabilities where the amount recognized reflects the risk of accounting loss to the entity. d. Financial instruments recognized as liabilities that result in an ultimate obligation that is greater than the amount recognized in the balance sheet. (AICPA) 122. Are there any circumstances when a contract that is not a financial instrument would be accounted for as a financial instrument under PAS 32 and PAS 39 (and PFRS 9)? a. No. Only financial instruments are accounted for as financial instruments. b. Yes. Gold, silver, and other precious metals that are readily convertible to cash are accounted for as financial instruments. c. Yes. A contract for the future purchase or delivery of a commodity or other nonfinancial item (e.g., gold, electricity, or gas) generally is accounted for as a financial instrument if the contract can be settled net. d. Yes. An entity may designate any nonfinancial asset that can be readily convertible to cash as a financial instrument. (Adapted)
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123. All of the following are characteristics of a derivative except: a. It is acquired or incurred by the entity for the purpose of generating a profit from short-term fluctuations in market factors. b. Its value changes in response to the change in a specified underlying (e.g., interest rate, financial instrument price, commodity price, foreign exchange rate, etc.). c. It requires no initial investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. d. It is settled at a future date. (Adapted) 124. Is a derivative (e.g., an equity conversion option) that is embedded in another contract (e.g., a convertible bond) accounted for separately from that other contract? a. Yes. PFRSs require all derivatives (both freestanding and embedded) to be accounted for as derivatives. b. No. PFRSs preclude entities from splitting financial instruments and accounting for the components separately. c. It depends. PFRSs require embedded derivatives to be accounted for separately as derivatives if, and only if, the entity has embedded the derivative in order to avoid derivatives accounting and has no substantive business purpose for embedding the derivative. d. It depends. PFRSs require embedded derivatives to be accounted for separately if, and only if, the economic characteristics and risks of the embedded derivative and the host contract are not closely related and the combined contract is not measured at fair value with changes in fair value recognized in profit or loss. (Adapted) 125. Which of the following is not a condition for hedge accounting? a. Formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge at inception of the hedging relationship. b. The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, the effectiveness of the hedge can be reliably measured, and the hedge is assessed on an ongoing basis and determined actually to have been effective. c. For cash flow hedges, a forecast transaction must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit or loss. d. The hedge is expected to reduce the entity’s net exposure to the hedged risk, and the hedge is determined actually to have reduced the net entity-wide exposure to the hedged risk. (Adapted) 126. What is the accounting treatment of the hedging instrument and the hedged item under fair value hedge accounting?
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a. The hedging instrument is measured at fair value, and the hedged item is measured at fair value with respect to the hedged risk. Changes in fair value are recognized in profit or loss. b. The hedging instrument is measured at fair value, and the hedged item is measured at fair value with respect to the hedged risk. Changes in fair value are recognized directly in equity to the extent the hedge is effective. c. The hedging instrument is measured at fair value with changes in fair value recognized directly in equity to the extent the hedge is effective. The accounting for the hedged item is not adjusted. d. The hedging instrument is accounted for in accordance with the accounting requirements for the hedged item (i.e., at fair value, cost or amortized cost, as applicable), if the hedge is effective. (Adapted) 127. What is the accounting treatment of the hedging instrument and the hedged item under cash flow hedge accounting? a. The hedged item and hedging instrument are both measured at fair value with respect to the hedged risk, and changes in fair value are recognized in profit or loss. b. The hedged item and hedging instrument are both measured at fair value with respect to the hedged risk, and changes in fair value are recognized directly in equity. c. The hedging instrument is measured at fair value, with changes in fair value recognized directly in equity to the extent the hedge is effective. The accounting for the hedged item is not adjusted. d. The hedging instrument is accounted for in accordance with the accounting requirements for the hedged item (i.e., at fair value, cost or amortized cost, as applicable), if the hedge is effective. (Adapted)
Chapter 25 - Suggested answers to theory of accounts questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
A A C B A A D A B C D A B A B D
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.
B C D D D A B C C C D C A C B A
41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56.
B C D A B C B C D B D D B B D C
61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76.
D D B D A C D A D C B D C A C C
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81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96.
C A C C D A B D A C B A C B B B
101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116.
D B B A D B D A C D A A D A A A
121. 122. 123. 124. 125. 126. 127.
C C A D D A C
17. 18. 19. 20.
B A B C
37. 38. 39. 40.
C C B D
57. 58. 59. 60.
D A A D
77. 78. 79. 80.
C A C B
146
97. 98. 99. 100.
D B D C
117. 118. 119. 120.
C A C C
Chapter 26 Corporate Liquidation and Reorganization Chapter 26: Multiple Choice – Computational (For classroom instruction purposes) Statement of affairs Use the following information for the next eleven questions: Fact pattern Andrix Asterix Co. has filed for voluntary insolvency and is about to liquidate its business. Andrix Asterix Co.’s statement of financial position immediately prior to the liquidation process is shown below: Andrix Asterix Co. Statement of financial position As of December 31, 20x0 ASSETS Current assets: Cash Accounts receivable Note receivable Inventory Prepaid assets
160,000 880,000 400,000 2,120,000 40,000 3,600,000
Noncurrent assets: Land Building, net Equipment, net
2,000,000 8,000,000 1,200,000 11,200,000 14,800,000
Total assets LIABILITIES AND EQUITY Current liabilities: Accrued expenses Current tax payable Accounts payable
884,000 1,400,000 4,000,000 6,284,000
Noncurrent liabilities: Note payable (secured by equipment) Loan payable (secured by land and building) Capital deficiency: Share capital Retained earnings (deficit)
1,200,000 8,000,000 9,200,000 2,000,000 (2,684,000) (684,000) 14,800,000
Total liabilities and equity
Additional information: The following information was determined commencement of the liquidation process: a. Only 76% of the accounts receivable is collectible.
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before
the
b. The note receivable is fully collectible. An accrued interest receivable of ₱40,000 was not yet recorded. c. The inventory has an estimated selling price of ₱1,680,000 and estimated costs to sell of ₱40,000. d. The prepaid assets are non-refundable. e. The land and building have fair values of ₱8,000,000 and ₱3,200,000, respectively. However, Andrix Asterix Co. expects to sell both the land and building for a total selling price of ₱10,400,000. Costs to sell the land and building are negligible as the prospective buyer agrees to shoulder all necessary costs of transferring title to the property. f. The equipment is expected to be sold at a net selling price of ₱800,000. g. Administrative expenses expected to be incurred during the liquidation process is ₱120,000. This amount is not yet reflected on the statement of financial position. h. Accrued expenses include accrued salaries of ₱100,000. i. Accrued interest on the loan payable amounting to ₱60,000 was not reflected in the statement of financial position. j. All of the other liabilities are stated at their expected settlement amounts. 1. How much are the total assets pledged to fully secured creditors? a. 11,200,000 b. 12,000,000 c. 10,400,000 d. 0 2. How much are the total assets pledged to partially secured creditors? a. 800,000 b. 3,140,000 c. 1,200,000 d. 400,000 3. How much are the total free assets? a. 2,788,800 b. 5,248,800 c. 4,048,800
d. 2,908,800
4. How much are the total net free assets? a. 3,682,800 b. 4,048,800 c. 2,908,800
d. 3,628,800
5. How much are the total unsecured liabilities with priority? a. 1,620,000 b. 220,000 c. 1,520,000 d. 100,000 6. How much are the total fully secured creditors? a. 8,000,000 b. 8,060,000 c. 8,800,000
d. 9,620,000
7. How much are the total partially secured creditors? a. 1,200,000 b. 1,260,000 c. 2,820,000 d. 3,920,000 8. How much are the total unsecured liabilities without priority? a. 4,784,000 b. 4,884,000 c. 4,904,000 d. 5,184,000 9. How much is the estimated deficiency to unsecured creditors without priority? a. 1,655,200 b. 1,555,200 c. 1,380,200 d. 1,456,200 10. What is the estimated recovery percentage of unsecured creditors without priority? a. 75.85% b. 31.71% c. 70% d. 24.15%
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11. How much can the shareholders expect to recover from their equity interests? a. 483 ,000 b. (478,800) c. (165,186) d. 0 Statement of realization and liquidation Use the following information for the next ten questions: Use the fact pattern in the preceding problem (Andrix Asterix Co.) in addition to the information provided below: Additional information: a. An accrued interest receivable of ₱40,000 was not yet recorded. b. Administrative expenses expected to be incurred during the liquidation process is ₱120,000. This amount is not yet reflected on the statement of financial position. c. Accrued interest on the loan payable amounting to ₱60,000 was not reflected in the statement of financial position. The following are the transactions that have transcribed during the period: a. Of the total account receivable, only ₱660,000 have been collected. The remaining balance was written-off. b. Only 90% of the note receivable was collected. The remaining balance was written-off. All of the accrued interest was collected. c. Half of the inventory was sold for ₱1,200,000. Actual costs to sell were ₱20,000. d. The balance of the prepaid assets account was written-off. e. The land and building were sold for ₱10,400,000, as expected. f. The equipment was sold for ₱880,000. g. Of the total accrued expenses, only the accrued salaries of ₱100,000 were paid. h. The current tax payable was paid in full. i. The loan payable and interest payable were paid in full. j. ₱880,000 were paid for the note payable. The lender waived payment for the balance. k. Actual administrative expenses paid amounted to ₱108,000. 12. The opening entry in the books of the receiver includes an estate equity (deficit) of a. (1,555,200) b. (684,000) c. (1,435,200) d. (1,415,200) 13. The statement of realization and liquidation will show total “assets to be realized” of a. 14,640,000 b. 14,800,000 c. 14,068,800 d. 14,234,200 14. The statement of realization and liquidation will show total “assets acquired” of a. 180,000 b. 800,000 c. 40,000 d. 0 15. The statement of realization and liquidation will show total “assets realized” of a. 13,250,000 b. 13,540,000 c. 12,920,000 d. 13,520,000 16. The statement of realization and liquidation will show total “assets not realized” of a. 1,060,000 b. 820,000 c. 724,000 d. 0
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17. The statement of realization and liquidation will show total “liabilities to be liquidated” of a. 15,664,000 b. 15,484,000 c. 15,544,000 d. 15,244,000 18. The statement of realization and liquidation will show total “liabilities assumed” of a. 60,000 b. 180,000 c. 160,000 d. 0 19. The statement of realization and liquidation will show total “liabilities liquidated” of a. 10,560,000 b. 10,548,000 c. 10,440,000 d. 10,988,000 20. The statement of realization and liquidation will show total “liabilities not liquidated” of a. 4,748,000 b. 5,104,000 c. 4,784,000 d. 0 21. The statement of realization and liquidation will show net gain (loss) for the period of a. 220,000 b. 112,000 c. (112,000) d. 0 Recovery of claims by order of priority Use the following information for the next two questions: The statement of affairs of Darrell Putix Co. indicates that unsecured creditors without priority with total claims of ₱720,000 may expect to recover ₱288,000 if all of the assets of Darrell Putix Co. were sold. Among the creditors of Darrell Putix Co. are the following: Government – taxes payable of ₱400,000, inclusive of ₱80,000 assessments and surcharges. XYZ bank – loan payable of ₱4,000,000 and accrued interest of ₱200,000, backed by collateral security with realizable value of ₱4,800,000. Alpha Financial Co. – loan payable of ₱3,200,000 backed by collateral security with realizable value of ₱2,000,000. Mr. Bombay – loan payable of ₱1,000,000 and accrued interest of ₱200,000. No collateral security. 22. How much is the expected recovery of partially secured creditors? a. 2,480,000 b. 2,160,000 c. 1,280,000 d. 0 23. Bombay? a. 780,000
How much is the expected recovery of Mr. b. 480,000 c. 288,000 d. 0
Recovery of claims Use the following information for the next five questions: Rex Toothpix Co. is undergoing liquidation. Information on Rex Toothpix Co.’s assets and liabilities is shown below: Book Realizabl ASSETS value e value Assets pledged to fully secured 360,000 480,000 creditors Assets pledged to partially secured 208,000 192,000 creditors Free assets 600,000 576,000
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1,168,000
1,248,000
LIABILITIES Unsecured liabilities with priority Fully secured creditors Partially secured creditors Unsecured creditors without priority
288,000 288,000 384,000 384,000 240,000 240,000 432,000 432,000 1,344,000 1,344,000 24. If the assets are sold at realizable values, how much cash is available to pay unsecured creditors without priority? a. 336,000 b. 384,000 c. 624,000 d. 288,000 25. What is the estimated recovery percentage of unsecured creditors without priority? a. 89% b. 78% c. 80% d. 75% 26. How much is the total estimated deficiency to unsecured creditors? a. (89,000) b. (72,000) c. (192,000) d. (96,000) 27. How much can the partially secured creditors expect to recover from their claims? a. 384,000 b.234,000 c. 230,400 d. 276,000 28. How much can the “unsecured creditors without priority” expect to recover from their claims? a. 432,000 b. 345,600 c. 384,000 d. 348,000 Recovery percentage of shareholders 29. The following summarizes the results of the liquidation process of Rhadvix Co.’s operations: Gains on realization of assets 720,000 1,280,00 Losses on realization of assets 0 Additional assets discovered and realized during 200,000 liquidation Additional liabilities recorded and settled during 120,000 liquidation 2,800,00 Share capital (at original book value) 0 1,200,00 Deficit (at original book value) 0 How much is the recovery percentage of shareholders? a. 80% b. 70% c. 76% d. 75% Recovery of shareholders’ claims Use the following information for the next two questions: Raymund Lipstix Co. owns 80% of PH Care, Inc. During the year, PH Care, Inc. filed for bankruptcy and is about to enter into liquidation. Raymund Lipstix Co. has an outstanding unsecured receivable of ₱4,000,000 from PH Care, Inc. together with an investment in subsidiary of ₱20,000,000. The statement of affairs of PH Care, Inc. shows a 100% recovery for outside creditors and a 20% recovery for inside creditors.
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30. How much can Raymund Lipstix Co. expect to recover from its receivable? a. 800,000 b. 4,800,000 c. 640,000 d.0 31. How much can Raymund Lipstix Co. expect to recover from its investment in subsidiary? a. 20,000,000 b. 4,000,000 c. 4,640,000 d. 0 Errors 32. Berns Sunog-kutix Co. has voluntarily filed petition for bankruptcy. Berns Sunog-kutix Co.’s inexperienced accountant determined that the expected recovery percentage of unsecured creditors without priority is 20%. The unsecured creditors have refuted this and demanded an audit of the accountant’s computations. The following information was determined from the accountant’s working papers: Assets and liabilities immediately before the commencement of liquidation process: Total assets - at book value 8,000,000 Unsecured creditors with priority 1,040,000 Fully secured creditors 3,600,000 Partially secured creditors 2,080,000 Unsecured creditors without priority 1,760,000 During the period, assets with total book value of ₱4,000,000 were sold for ₱3,760,000. A portion of the proceeds were used to settle fully secured liabilities of ₱2,160,000 and partially secured liabilities of ₱1,480,000. The remaining unsold assets have the following realizable values: Assets pledged to fully secured creditors 1,280,000 Assets pledged to partially secured creditors 560,000 All other assets 2,060,000 Further investigations revealed the following: a. Estimated liquidation expenses amounting to ₱160,000 were not yet recorded. b. Additional unsecured liability without priority of ₱200,000 should be accrued. What is the correct estimated recovery percentage of unsecured creditors without priority? a. 40% b. 42.53% c. 45.37% d. 47.33% Receivership – journal entry Use the following information for the next two questions: Joseph Fantastix Co. has filed a petition for insolvency. The winding up of Joseph Fantastix Co.’s affairs will be entrusted to a receiver. The following information was gathered: Book Realizable value value Assets 1,200,000 1,000,000 Liabilities: Unsecured liabilities with priority Fully secured creditors Partially secured creditors Unsecured liabilities without priority
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80,000 480,000 160,000 560,000
80,000 480,000 160,000 560,000
1,280,000 Unrecorded items: Dividend receivable Interest payable Estimated administrative expenses
1,280,000 20,000 8,000 40,000
33. How much is the estate equity (deficit) in the opening journal entry made by the receiver in its books? a. (80,000) b. 80,000 c. (308,000) d. (68,000) 34. How much is the estimated deficiency to unsecured creditors without priority in the statement of affairs? a. (308,000) b. 308,000 c. (80,000) d. (280,000) Statement of realization and liquidation Use the following information for the next two questions: The following information was taken from the statement of realization and liquidation of Jury and John Bombastix Co., which is undergoing liquidation: ASSETS: 8,000,00 Assets to be realized 0 Assets acquired 60,000 4,720,00 Assets realized 0 Assets not realized 880,000 LIABILITIES: Liabilities liquidated Liabilities not liquidated Liabilities to be liquidated Liabilities assumed SUPPLEMENTARY ITEMS: Supplementary expenses Supplementary income
8,520,00 0 4,760,00 0 11,480,0 00 128,000
100,000 72,000
35. How much is the net gain (loss) for the period? a. (4,132,000) b. (28,000) c. 4,160,000 d. (4,160,000) 36. If the estate deficit at end of the period is ₱3,480,000, how much is the ending balance of cash? a. 400,000 b. 388,000 c. 960,000 d. 460,000
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