AdvancedAccountingCanadianE GailFayerman

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ADVANCED
ACCOUNTING
CANADIAN EDITION
This page is intentionally left blank
ADVANCED
ACCOUNTING
CANADIAN EDITION
GAIL FAYERMAN
Concordia University
With contributions from

Robert Correll
Vanessa Campbell
Jo-Ann Lempert
Partial Adaptation of
Company Accounting, Eighth Edition
Ken Leo, John Hoggett,
John Sweeting, Jennie Radford
Copyright © 2013 by John Wiley & Sons Canada, Ltd.
All rights reserved. No part of this work covered by the copyrights herein may be repro-
duced or used in any form or by any means—graphic, electronic, or mechanical—without
the prior written permission of the publisher.
Any request for photocopying, recording, taping, or inclusion in information storage and
retrieval systems of any part of this book shall be directed to the Canadian copyright licens-
ing agency, Access Copyright. For an Access Copyright licence, visit www.accesscopyright.ca
or call toll-free, 1-800-893-5777.
Care has been taken to trace ownership of copyright material contained in this text. The
publishers will gladly receive any information that will enable them to rectify any erroneous
reference or credit line in subsequent editions.
Care has been taken to ensure that the web links recommended in this text were active
and accessible at the time of publication. However, the publisher acknowledges that web
addresses are subject to change.
Library and Archives Canada Cataloguing in Publication
Fayerman, Gail, 1959-
Advanced accounting / Gail Fayerman. -- Canadian ed.
Includes bibliographical references and index.
ISBN 978-1-118-03791-1
1. Accounting--Textbooks. I. Title.
HF5636.F39 2012 657’.046 C2012-905737-1
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Dedicated to my husband Michael
And my children
Erin & Dave
Joshua
Zachary
ABOUT THE AUTHORS
Gail Fayerman, MBA, CPA, CA, is a senior lecturer of accountancy at the John Molson
School of Business at Concordia University in Montreal. She has been teaching courses in
financial accounting for more than 25 years. She has taught at the undergraduate level, in
the Graduate Diploma in Accountancy, in the executive MBA program, and the Goodman
Institute MBA program. She was the Director of the Graduate Diploma Program, which
prepares students for the Uniform Final Exam for Chartered Accountancy, for nine years.
She chairs the department curriculum committee and is a member of the faculty curriculum
committee. She has been the recipient of the faculty “distinguished teacher” award in 1993
and 2001 and now sits as a member of the committee to select the recipient. She has been
an instructor for the continuing education program, teaching both IFRS and ASPE topics,
for the Ordre des comptables professionnels agréés du Québec (CPA) for many years and
recently began instructing for the Institute of Chartered Accountants of Ontario as well. She
is involved in the development of a new education program for the Canadian Association of
Insolvency and Restructuring Professionals (CAIRP).
Ken Leo, B.Com (Hons), MBA (Qld), AAUQ, ACA, FCPA is Professor of Accounting at
Curtin University of Technology, Western Australia. In over 30 years as an academic, Ken
has taught company accounting to undergraduate and postgraduate students. He was a found-
ing member of the Urgent Issues Group, and has written books and monographs for a variety
of organisations including CPA Australia, the Group of 100 and the Australian Accounting
Research Foundation. He was a founding member of the Urgent Issues Group, serving on
that body from 1995 to 2001. Ken also served on the Australian Accounting Standards Board
from 2002 to 2007, both as a member and as deputy chair of the Board.
John Hoggett, BCom (Hons), Hogett. BCorn (Hons), BTh, MFM, AAUQ, FCPA, worked
in universities in both Western Australia and Queensland for 35 years. During this time,
he taught introductory accounting, corporate accounting, and accounting theory to under-
graduate and postgraduate students. John has written books and monographs for a variety
of organisations including CPA Australia and the Group of 100, and has been involved in
secondary education with the Curriculum Council of Western Australia.
John Sweetinq , BEc, MEc, PhD, CPA, CA, is a Senior Lecturer in Accountancy at
Queensland University of Technology. John’s background includes a mixture of academic
and business positions. He has taught at Swinburne University of Technology and the
University of Central Queensland, and has spent time with the National Companies and
Securities Commission (now the Australian Securities and investments Commission). John
has also held positions with a large international chartered accounting firm and a large manu-
facturing/retailing company listed on the Australian Securities Exchange. He has written for
professional journals, and his main area of research is external reporting and profit fore-
casts in prospectuses. In addition to running in-house courses for accounting firms, John
has also conducted Professional Development courses for CPA Australia and The Institute
of Chartered Accountants in Australia. He has also been actively involved in both the CPA
Program and the CA Program.
Jennie Radford, BCom, DipEd, MCom, ACA, recently retired from the School of Accounting
at Curtin University of Technology, Western Australia. She co-authored two research mono-
graphs published by the Group of 100 and CPA Australia. She also co-authored and co-edited
several textbooks. Jennie was for many years employed as an auditor with ‘Big 5’ chartered
accounting firms. During her academic career, Jennie taught undergraduate and postgradu-
ate courses in financial accounting and corporate accounting. She is a member of the Western
Australia Cell of the External Reporting Centre of Excellence (with CPA Australia).
vi
PREFACE
INTRODUCTION
Advanced Accounting is designed to address those advanced topics in accounting that require
knowledge of all other sections of the CICA Handbook. This text builds on the knowledge
obtained in an intermediate accounting course and is intended to extend the learning from
intermediate texts such as Intermediate Accounting by Kieso, Weygandt, Warfield, Young, and
Wiecek. This book has been designed to carry forward many of the features of that interme-
diate text.
This textbook is separated into three modules:
Module 1 – Long-term inter-corporate investments
Module 2 – Foreign currency
Module 3 – Not-for-profit and government organizations reporting
These modules can be studied independently but can also be studied in an integrated
manner. Some schools examine each of these topics in one course, whereas others may sepa-
rate the modules in different courses. When creating the format of this text, we considered
the fact that the CICA Handbook – Accounting now encompasses four sections:
Part I – International Financial Reporting Standards (IFRS)
Part II – Accounting Standards for Private Enterprises (ASPE)
Part III – Accounting Standards for Not-for-Profit Organizations
Part IV – Accounting Standards for Pension Plans
Our emphasis in the book is on Part I of the Handbook since we believe that Part I encom-
passes the major issues; however, Part II is examined for each issue where the accounting and
reporting is different. We have included material and problems that can be examined under
IFRS or ASPE. We recognize that some audiences are more interested in IFRS, whereas oth-
ers need to understand ASPE. Part III is also addressed as a separate topic in Module 3. This
textbook does not cover Part IV of the handbook.
The material covered in this text can be very complex. This textbook takes a detailed
approach to each of the topics. All aspects are examined and are separated by learning objec-
tives so that instructors can decide the level of depth they wish to cover. Links are made
throughout to the specific Handbook sections as we feel that at this level, students should
become familiar with the actual Handbook material. To help students understand the com-
plexities of these topics, all concepts are illustrated with examples and each chapter has sum-
mary illustrative examples with solutions so that students can see how these concepts are
applied.
vii
viii Preface
FEATURES OF THIS EDITION

Chapter-opening stories: Given the complexity of the material, students can often get
bogged down in the technical material. It is important for them to understand the real-world
association. As such, we have included a real-life story at the beginning of each chapter that
illustrates the material they are going to examine in the chapter.
Illustrative examples: Every major topic is followed up with at least one illustrative example
to reinforce the material. The material is complex and many students will benefit from seeing
the problem solved before attempting the end-of-chapter problems themselves.
ASPE boxes: These boxes highlight all areas where the standards are different than IFRS.
They are sufficiently detailed and include examples where necessary so that students can fully
ASPE understand how to account for and report a transaction using ASPE. There are some signifi-
cant areas in the material covered in this text that warrant a detailed treatment under ASPE.
Learning check boxes: Each learning objective is summarized in a learning check box to
reinforce the concept that has just been examined. The points in the learning check box are
sufficiently detailed to act as a good review but not detailed enough to be understood unless
students have covered the material in the learning objective.
Demonstration problems: The end of each chapter (with the exception of Chapter 1) has at
least one comprehensive problem that incorporates all the learning objectives in the chapter.
This is an extension of the illustrative problems and is particularly important as the integra-
tion of material becomes more extensive. Students can follow the demonstration as a meth-
odology to solve problems on their own.
End-of-chapter material: At the end of each chapter are different types of problems
intended to reinforce various aspects of learning. A selected number of these questions from
each chapter are programmed into the WileyPLUS course to allow for online assessment.
Brief exercises help students recap the key points in the chapter and are useful for review.
Exercises are more expanded exercises generally covering fewer learning objectives so that
students can practise a particular concept.
Problems generally cover more than one learning objective and require students to integrate
knowledge within the chapter and from previous chapters.
Writing assignments are generally shorter cases that require students to explain concepts that
they have learned in a particular application.
Cases of several types are presented so students can apply the knowledge they have obtained.
The case scenarios place students in the situation of having to solve an issue. Some cases deal
only with material from the chapter, some may incorporate material from other chapters, and
others may integrate material from courses that students have previously taken. A brief ver-
sion of our Case Primer appears on the inside front cover of this text; it is designed to provide
students with a framework for case analysis.
Preface ix
CHAPTER-BY-CHAPTER OVERVIEW
Module 1 – Long-Term Inter-Corporate Investments
This module examines the topic of long-term inter-corporate investments. The text
emphasizes the CICA Handbook, Part I (IFRS), but based on the fact that many Canadian
companies follow Part II (ASPE), each chapter includes the methodology under ASPE.
The chapters are configured to lead students through the process of a company acquiring
an investment.
Chapter 1 – Accounting for Investments introduces students to the different types of
investments and the basics of the reporting for each of them. The primary emphasis in this
chapter is the identification of the nature of the investment. ASPE is explored in this area as
there are significant differences.
Chapter 2 – Business Combinations narrows in on the investments in which an entity
gains control. The acquisition of net assets is explored with the emphasis on determining the
correct fair values and goodwill on acquisition. The chapter presents an in-depth discussion
that represents a realistic scenario that students may encounter. Different types of identifi-
able intangibles are examined and the tax effect is introduced.
Chapter 3 – Consolidation: Wholly Owned Subsidiaries continues with the investments
in which an entity gains control but deals with the accounting and reporting when shares are
acquired. We assume that the entity acquires 100% of the shares. This chapter introduces
the consolidation process. We begin with consolidation at the day of acquisition and then
look at consolidation in subsequent periods. Students focus on what happens to the fair value
adjustments.
Chapter 4 – Consolidation: Intragroup Transactions introduces intragroup transactions
and unrealized profits. We address all types of profits: inventory, land, depreciable assets, and
intangible assets. In addition we look at intragroup transactions with advances and loans. We
continue to assume that the entity owns 100% of the shares.
Chapter 5 – Consolidation: Non-controlling Interest deals with control investments
that are less than 100% owned. As such, we introduce the nature of non-controlling inter-
est, the calculation of the non-controlling interest share of net income and net assets, and
the implication on intragroup transactions and unrealized profits. Under IFRS and ASPE,
consolidated net income is shown and then allocated between the parent and the non-
controlling interest. The previous chapter completed the calculation of the consolidated
net income and this chapter deals with the allocation of this net income and consequently
the net assets.
Chapter 6 – Accounting for Investments in Associates and Joint Ventures revisits the
accounting for associates and joint ventures and focuses on the equity method, including
intragroup transactions and fair value adjustments. The distinction is made between the
reporting on non-consolidated statements and consolidated financial statements.
Module 2 – Foreign Currency

This module addresses all accounting and reporting issues as a result of an entity transacting
in a foreign currency. The discussion is based on IFRS and focuses on the functional cur-
rency, although ASPE is covered where the requirements are different.
Chapter 7 – Accounting for Foreign Currency introduces the concept of foreign cur-
rency risk and discusses how to determine the functional currency of an entity and its pre-
sentation currency. We examine the accounting for transactions in a foreign currency and
address hedging of foreign currency risk. ASPE is addressed for hedging as the rules are not
the same.
x Preface
Chapter 8 – Accounting for Foreign Investments addresses the translation of a group of

entities. We assess the functional currency for each entity in the group, translate the state-
ments into the respective functional currencies, and prepare the consolidated financial state-
ments in the presentation currency. ASPE is addressed since the process of determining the
type of investment (self-sustaining versus integrated) is not the same as IFRS.
Module 3 – Not-for-Profit and Government

Organizations Reporting
This module examines the accounting for not-for-profit or public sector entities that do not
follow Part I (IFRS) of the CICA Handbook.
Chapter 9 – Reporting for Not-for-Profit Organizations examines the accounting and
reporting for private not-for-profit organizations. In this chapter we review the specific
accounting and reporting as required under Part III of the CICA Handbook.
Chapter 10 – Reporting for Public Sector Entities examines the specific requirements of
government-controlled entities. We examine the issues that are unique to the government
sector, referencing the CICA Public Sector Accounting Handbook.
ADDITIONAL RESOURCES
The following additional resources are available to instructors via our instructors’ companion
site, which can be found at www.wiley.com/go/fayermancanada
• Solutions Manual contains worked out solutions for all end-of-chapter question material.
• Test Bank Available in both computerized and Word document formats, this test bank
offers multiple choice, true/false, short answer, and problem questions.
• PowerPoint® Presentation Slides present the major concepts from each chapter.
WileyPLUS is an innovative, research-based online environment for effective teaching and

learning.
WileyPLUS builds students’ confidence because it takes the guesswork out of studying by
providing students with a clear roadmap: what to do, how to do it, if they did it right. This
interactive approach focuses on:
CONFIDENCE: Research shows that students experience a great deal of anxiety over
studying. That’s why we provide a structured learning environment that helps students focus
on what to do, along with the support of immediate resources.
MOTIVATION: To increase and sustain motivation throughout the semester, WileyPLUS
helps students learn how to do it at a pace that’s right for them. Our integrated resources
– available 24/7 – function like a personal tutor, directly addressing each student’s demon-
strated needs with specific problem-solving techniques.
SUCCESS: WileyPLUS helps to assure that each study session has a positive outcome by
putting students in control. Through instant feedback and study objective reports, students
know if they did it right, and where to focus next, so they achieve the strongest results.
With WileyPLUS, our efficacy research shows that students improve their outcomes by
as much as one letter grade. WileyPLUS helps students take more initiative, so you’ll have
greater impact on their achievement in the classroom and beyond.
What do students receive with WileyPLUS?
Preface xi
• The complete digital textbook, saving students up to 60% off the cost of a printed text.
• Question assistance, including links to relevant sections in the online digital textbook.
• Immediate feedback and proof of progress, 24/7.
• Practice quizzes designed to provide students with further practice for problem areas.
What do instructors receive with WileyPLUS?
• Reliable resources that reinforce course goals inside and outside of the classroom.
• The ability to easily identify those students who are falling behind.
• Media-rich course materials and assessment content including—Test Bank, PowerPoint®
Slides, Learning Objectives, Solutions Manual, Checklist of Key Figures, Computerized
Test Bank, and much more
www.wileyplus.com. Learn More.
ACKNOWLEDGEMENTS
Special thanks are extended to reviewers whose contributions helped to shape the text:
George Anton, Seneca College Fred Pries, University of Guelph

Walt Burton, Okanagan College Eckhard Schumann, University of Toronto
Chuck Campbell, University of British Julia Scott, McGill University
Columbia Peter Secord, Saint Mary’s University
Wendy Doyle, Mount Saint Vincent University Glen Stanger, Douglas College
Maureen Fizzell, Simon Fraser University Deirdre Taylor, Ryerson University
Allan Foerster, Wilfrid Laurier University Kevin Jason Veenstra, University of Toronto
Heather Gillander, Brandon University Tony Vogrincic, Northern Alberta Institute of
Derrick Hayes, Cape Breton University Technology
Paul Hurley, Durham College Michael Qiao, George Brown College
Stuart Jones, University of Calgary Bill Waterman, Mount Allison University
Camillo Lento, Lakehead University Barbara Wyntjes, Kwantlen Polytechnic
Valorie Leonard, Laurentian University University
Jamal Nazari, Mount Royal University
In addition, thank you to the following contributors for preparing the ancillaries to the
book and for their useful suggestions and comments:
Stephen Bergstrom, SAIT Robert Ducharme, University of Waterloo

Vanessa Campbell Richard Michalski, McMaster University
Patricia Corkum, Acadia University Peter Doyle, Seneca College
In embarking on this project, my hope was to create a textbook that would make it easier
to master this complex material. Along the way I hope that students will appreciate the rel-
evance of the material and its importance in the business world. This project is not one that
I could have accomplished on my own. I would like to thank the following individuals who
contributed to the text.
I am grateful to Jo-Ann Lempert, CPA, CA, a partner with MNP LLP, for her help in
the area of foreign currency. In addition, there were many new issues that I was fortunate to
be able to discuss with her. I would like to thank Robert Correll, CA, for his expertise and
help in the accounting for government entities.
Creating the end-of-chapter material and providing solutions was an interesting challenge
in a first edition of a text. A lot of effort was needed to create, adjust, and correct the materials
xii Preface
and solutions. I would like to thank Vanessa Campbell, CPA, CA, for her diligent and
conscientious effort in preparing many of the end-of-chapter materials and for creating the solu-
tions manual to accompany the text. I would also like to acknowledge the efforts of Stephen
Bergstrom and Robert Ducharme who carefully checked the accuracy of these solutions.
I would like to acknowledge my three former students who were so keen to participate
in a textbook project.
Audrey Landry, CPA, CA, KPMG, for her research help and for writing many of the
chapter-opening stories; June Svetlovsky, CPA, CA, KPMG, for her research help; and
Patrick Gagnon, CPA, CA, Manager of Corporate Consolidations at Aimia Inc., for his help
in writing many of the chapter-opening stories.
I am grateful that I had the opportunity to write a textbook based on my experience
teaching this course for more than 25 years. It was nevertheless a daunting a task. This proj-
ect has been a fantastic experience due to the great support from the individuals at John
Wiley & Sons Canada, Ltd. I would particularly like to thank:
Zoë Craig, for approaching me initially and always making it seem that we were having fun.
Andrea Grzybowski, for keeping me and everyone else on track and always doing it in a
positive way.
Laurel Hyatt, for showing me her amazing skill at editing. I am convinced that she is an
accountant in real life.
I would also like to acknowledge Emma Cole, who did an amazing proofreading job, and
Belle Wong, who was the indexer for the project.
I would like to thank my husband, Michael Campbell, who thought this project was a
great idea and who promised to sing on the book tour, and my wonderful children, Erin and
Dave, Joshua, and Zachary, who promised to read the textbook now. Finally, I want to extend
my appreciation to all of my students, past, present, and future. I think I learn as much from
you as I hope you learn from me.
Gail Fayerman
Montreal, August 2012
BRIEF CONTENTS
Module 1 Long-Term Inter-Corporate Investments 1
1 Accounting for Investments 2

2 Business Combinations 46
3 Consolidation: Wholly Owned Subsidiaries 106
4 Consolidation: Intragroup Transactions 160
5 Consolidation: Non-controlling Interest 220
6 Accounting for Investments in Associates and Joint Ventures 284
Module 2 Foreign Currency 341
7 Accounting for Foreign Currency 342

8 Accounting for Foreign Investments 398
Module 3 Not-for-Profit and Government Organizations

Reporting 449
9 Reporting for Not-for-Profit Organizations 450

10 Reporting for Public Sector Entities 508
Appendix: Present Value Tables 552
Glossary 554
Credits 557
Company Index 558
Subject Index 559
xiii
CONTENTS
Module 1 Long-Term Inter-Corporate Equity Instruments 58

Liabilities Undertaken 59
Investments 1
Costs of Issuing Debt and Equity
1 Accounting for Investments 2 Instruments 59
Non-strategic Investments in Equity 5 Contingent Consideration 59
Identifying Non-strategic Investments Acquisition-Related Costs 59
in Equity 5 Recognizing and Measuring Assets
Criteria 5 Acquired and Liabilities Assumed 62
Initial Recognition 6 Recognition 62
Recording Non-strategic Equity Investments 8 Income Taxes 65
Recognizing and Measuring Goodwill or
Strategic Investments—Parent–Subsidiary a Gain from a Bargain Purchase 66
Relationship 12 Definition of Goodwill 66
Identifying Parent–Subsidiary Relationships 12 Accounting for Goodwill 67
The Power Criterion 13 Accounting for a Gain on Bargain Purchase 68
The Returns Criterion 18 Shares Acquired in an Acquiree 69
The Link Criterion 18 Existence of a Previously Held Equity
Summary of Process to Determine Control 20 Interest 70
Presentation of Consolidated Financial
Accounting in the Records of the
Statements for Controlled Entities 21
Acquiree 72
Strategic Investments—Associates 26 Purchase of Acquiree’s Assets and
Identifying Associates 26 Liabilities 72
Significant Influence 26 Purchase of Acquiree’s Shares from the
Exclusions to the Definition of Associate 27 Shareholders 72
Equity Method of Accounting 28
Rationale 28 Subsequent Adjustments to the Initial
Applying the Equity Method: Basic Method 29 Accounting for a Business Combination 73
Goodwill 73
Strategic Investments—Joint Arrangements 32 Contingent Liabilities 74
Identifying Joint Arrangements 32 Contingent Consideration 74
Joint Operations 32
Joint Ventures 33 Learning Summary 79
Accounting and Reporting for Joint Demonstration Problems 79
Arrangements 33
Joint Operations 33 3 Consolidation: Wholly Owned
Joint Ventures 33 Subsidiaries 106
Learning Summary 35 The Consolidation Process 108
The Acquisition Date 109
2 Business Combinations 46 Preparing Consolidated Financial
Nature of a Business Combination 49 Statements 111
Definition of Business Combination 49 The Acquisition Analysis 112
Forms of Business Combinations 51 Previously Held Equity Interest in the
Accounting for a Business Combination: Subsidiary 116
Basic Principles 52 Fair Value Adjustments 117
Identifying the Acquirer 53 Pre-acquisition Adjustments 118
Determining the Acquisition Date 55 Consolidated Financial Statements at
Accounting in the Records of the Acquirer 57 the Day of Acquisition 119
Consideration Transferred to the Acquiree 57 Basic Format 119
Cash or Other Monetary Assets 57 Goodwill Recorded by Subsidiary at
Non-monetary Assets 58 Acquisition Date 119
xv
xvi Contents
Dividends Recorded by Subsidiary at Realization of Profits or Losses on Depreciable

Acquisition Date 120 Asset Transfers 175
Gain on Bargain Purchase 121 Depreciation 176
Consolidated Financial Statements Adjustments for Transfers of Property,
Plant, and Equipment 177
Subsequent to the Acquisition Date 122
Parent Company Recording in its Intragroup Services 179
Own Books 122 Example 4.7: Intragroup Services 179
Cost Method 123 Example 4.8: Intragroup Rent 179
Equity Method 123 Realization of Profits or Losses 179
Fair Value Adjustments 124 Intragroup Dividends 180
1: Land 125 Dividends Declared in the Current
2: Equipment 126 Period but Not Paid 180
3: Inventory 128 Dividends Declared and Paid in the
4: Patent 129 Current Period 181
5: Bonds Payable 130 Tax Effect of Dividends 181
6: Liability—Provision for Loan Adjustments for Intragroup Dividends 181
Guarantee 131
7: Goodwill 132
Intragroup Borrowings 182
Advances 182
Preparation of Consolidated Financial
Example 4.9: Intragroup Advances
Statements in Subsequent Periods 133
with Interest 182
Learning Summary 137 Bonds 183
Demonstration Problems 138 Example 4.10: Bonds Acquired at
Date of Issue 183
4 Consolidation: Intragroup Learning Summary 184
Transactions 160
Appendix 4A Bonds Acquired on the
Adjusting for Intragroup Transactions: Open Market 186
Principles 162
Rationale for Adjusting for Intragroup
Transactions 162 5 Consolidation: Non-controlling
Income Tax Effects 163 Interest 220
Transfers of Inventory 164 The Nature of Non-controlling
Sales of Inventory 164 Interest (NCI) 222
Example 4.1: Intracompany Sale Determination of the NCI 222
of Inventory 164 Disclosure of the NCI 222
Realization of Revenues and Expenses 165 Non-controlling Share of Equity at the
Unrealized Profits in Ending Inventory 165 Acquisition Date 225
Example 4.2: Transferred Inventory Full Goodwill Method 226
Still on Hand 165 Partial Goodwill Method 227
Example 4.3: Transferred Inventories Reasons for Choosing Method 228
Partly Sold 167 Accounting at the Acquisition Date 229
Example 4.4: Transferred Inventory
Non-controlling Interest in Income
Completely Sold 168
Unrealized Profits in Beginning Inventory 169
and Equity in Subsequent Periods 234
Example 4.5: Transferred Inventory on Non-controlling Interest Affected by
Hand at the Beginning of the Period 169 Intragroup Profit 239
Adjustments for Transfers of Inventory 170 Inventory 240
Depreciable Non-current Assets 240
Intragroup Profits and Losses on
Intragroup Transfers for Services and
Transfers of Property, Plant, and
Interest 241
Equipment 172
Sale of Land 172 Non-controlling Interest Affected by a
Example 4.6: Transfer in Current Year 172 Gain on Bargain Purchase 243
Sales of Depreciable Assets 173 Changes in the Proportion Held by
Example 4.7: Transfer in Current Year 173 Non-controlling Interest 244
Depreciation and Realization of Profits Increases in Ownership 245
or Losses 175 Decreases in Ownership 245
Contents xvii
Decrease in Ownership Due to a Sale Losses Recorded by the Associate or

by Parent 246 Joint Venture 312
Subsidiary issues additional shares to
Learning Summary 314
non-controlling interest 246
Learning Summary 247 Demonstration Problems 314
Appendix 5A Concepts of Consolidation 248 Module 2 Foreign Currency 341
Entity Concept of Consolidation 248
Parent Entity Concept of Consolidation 249 7 Accounting for Foreign Currency 342
Proprietary Concept of Consolidation 250 Determining the Functional Currency
Choice of Concept 251 of a Company 345
Foreign Currency Risk 345
6 Accounting for Investments in Foreign Currency Exchange Gains
Associates and Joint Ventures 286 and Losses 346
The Equity Method of Accounting on Primary Economic Activity 347
Consolidated and Separate Financial Converting Foreign Currency
Statements 287 Transactions into a Company’s
Separate Financial Statements Versus Functional Currency 349
Consolidated Financial Statements 287 Initial Recognition 349
A Company Has an Investment in a Recognition in Subsequent Periods 350
Subsidiary Only 288 Monetary Items 351
A Company Has an Investment in an Non-monetary Items 354
Associate or a Joint Venture but Does
Not Have an Investment in a Subsidiary 288 Applying Hedge Accounting to Foreign
A Company Has an Investment in a Currency Transactions 358
Subsidiary and an Investment in an Economically Hedging Foreign
Associate or Joint Venture 288 Currency Risk 359
Applying the Equity Method: Basic Derivative Financial Instruments as
Method 289 Hedges 359
Speculating in Foreign Currency Financial
Goodwill and Fair Value Differences Instruments 359
at Acquisition Date 292 Hedging with Financial Instrument
Movements in Equity 295 Derivatives 360
Dividends 295 Definition of Hedge Accounting 363
Common Shares 295 Qualifying for Hedge Accounting 364
Preferred Shares 295 Applying Hedge Accounting 366
Reserves 296 Translating Financial Statements
Dissimilar Accounting Policies 296 from the Functional Currency to the
Different Ends of Reporting Periods 296
Presentation Currency 375
Investing in an Associate or Joint Choosing the Presentation Currency 375
Venture in Stages 300 Translating Financial Statements into a
Becoming an Associate or Joint Venture Presentation Currency 376
After Acquiring an Ownership Interest 301 Learning Summary 379
Increasing Ownership when Significant
Influence or Joint Control Already 8 Accounting for Foreign
Exists and Continues to Exist 303 Investments 398
Effects of Intercompany Transactions 304 Determining the Functional Currency
Transactions Between the Company and for Each Company in a Group 402
its Associate or Between the Company Definition of a Functional Currency 402
and its Joint Venture 304 Hierarchy of Criteria 402
Transactions Involving Inventory 305
Transactions Involving Non-current Assets 307 Determining the Foreign Currency
Transactions Involving Borrowings 308 Transactions Within the Group 405
Contributions of Nonmonetary Assets in Foreign Currency Transactions 405
Exchange for Equity Interests 309 Changes in Functional Currency 406
Transactions Between Associates or Joint Translating Individual Financial Statements
Ventures 310 into a Group Presentation Currency 407
xviii Contents
Presentation Currency Differing from the Specific Not-for-Profit Transactions 471

Functional Currency 408 Inventories Held by Not-for-Profit
Using a Currency of Convenience for Organizations 471
Translation 410 Recognition of Contributed Inventory 471
Preparing Foreign Currency Adjustments Inventories to Be Distributed at
for Consolidation or the Equity Method 411 No Charge 472
Intracompany Balances 412 Tangible Capital Assets and Intangible
Fair Value Adjustments 415 Assets Held by Not-for-Profit
Goodwill 415 Organizations 472
Fair Value Adjustments that Have a Exemption from Capitalization 473
Limited Life: Property, Plant, and Impairment 473
Equipment 416 Collections 474
Non-controlling Interest 417 Strategic Investments Held by Not-for-
Tax Effects of All Exchange Differences 418 Profit Organizations 475
Disposal or Partial Disposal of a Foreign Control 476
Operation 418 Significant Influence 477
Hedge Accounting 418 Presentation 477
Related-Party Transactions 478
Learning Summary 419 Allocated Expenses by Not-for-Profit
Appendix 8A—Hyperinflationary Organizations 479
Environment 421 Learning Summary 489
Appendix 9A—Budgeting In a
Module 3 Not-for-Profit and Not-For-Profit Organization 490
Government
Organizations Reporting 449 10 Reporting for Public Sector
9 Reporting for Not-for-Profit Entities 508
Organizations 450 The Reporting Framework for Public
Sector Entities 510
Reporting for Not-for-Profit
The Public Sector in Canada 510
Organizations 453 The Need for a Public Sector Accounting
Definition of a Not-for-Profit Framework 511
Organization 453 CICA PSA Handbook: A Primary Source
Objectives of Financial Reporting for a of GAAP 511
Not-for-Profit Organization 454 Key Characteristics of Public Sector
User Needs 454 Entities 512
Accounting Rules 455 Public Accountability 512
Financial Statements Required of a Multiple Objectives 512
Not-for-Profit Organization 456 Rights, Powers, and Responsibilities
Statement of Financial Position 456 (Constitutional or Devolved) 512
Statement of Operations 456 Lack of Equity Ownership 513
Statement of Changes in Net Assets 457 Operating and Financial Frameworks
Statement of Cash Flows 457 Set by Legislation 513
Fund Accounting 459 The Importance of the Budget 513
Description of Fund Accounting 459 Governance Structures 513
Types of Funds 460 Nature of Resources 513
Restricted Fund 460 Non-exchange Transactions 513
Endowment Fund 460 Public Sector Financial Reporting
Capital Asset Fund 461
Concepts 514
Illustration of Fund Accounting 461
Objectives of Public Sector Financial
Recording Contributions 464 Reporting 514
Definition of Contributions 464 Qualitative Characteristics of Public
Deferral Method of Fund Accounting 465 Sector Financial Reporting 515
Restricted Fund Method of Fund Elements of a Public Sector Financial
Accounting 467 Statement 517
Contents xix
Key Indicators of Public Sector Financial Portfolio Investments with

Reporting 517 Concessionary Terms 532
Other Presentation Differences 518 Loans Receivable 533
Recognition of Items in Public Sector Loans to Be Repaid Through Future
Financial Statements 519 Appropriations 533
Recent Changes to Reporting by Forgivable Loans 533
Government Not-for-Profit Organizations 519 Loans with Significant Concessionary
Net Debt Indicator 520 Terms 533
The Measure of Net Debt 520 Liability for Contaminated Sites 533
Relevance of Net Debt 520 Solid Waste Landfill Closure and
Legislative Control and Government Post-Closure Liabilities 534
Financial Accountability 520 Loan Guarantees 534
Government Transfers 535
Reporting on Government Tax Revenue 536
Organizations 524
Assessing Control of a Government Comparing Public Sector Accounting
Organization 524 with Other GAAP Frameworks 537
Types of Government Organizations 525 Learning Summary 540
Government Business Enterprises 526
Government Not-for-Profit Organizations 526 Appendix: Present Value Tables 552
Other Government Organizations 527
Reporting on the Results of Government
Glossary 554
Organizations 530 Credits 557
Reporting on Government Partnerships 531
Transactions Unique to Public Sector
Company Index 558
Entities 532 Subject Index 559
1
MODULE
Long-Term
Inter-Corporate
Investments
Companies invest in other entities for various reasons; sometimes to advance their strategic
objectives and other times to allocate excess cash. In this module, we examine the accounting and
reporting for the various types of intercompany investments made. We begin with an analysis of
the various types of investments in Chapter 1 and then focus on those strategic investments where
control exists. Business combinations are complex transactions that require knowledge of all aspects
of accounting and reporting. We look at the fundamental principles in chapters 2 and 3 and then
continue with the detailed reporting of consolidated financial statements in chapters 4 and 5.
In tackling this module it is necessary to master each chapter before attempting the next.
Each chapter is part of a process and one chapter builds from the previous one. We begin by
exploring the fair value adjustments needed to record the acquiree’s net assets at fair value at the
day of acquisition and in subsequent periods. Once this concept is understood, we introduce the
adjustments needed to remove intragroup transactions and profits. Finally, we learn how to allocate
the comprehensive income and assets to a non-controlling interest when the investment is less than
100% owned.
In our last chapter in this module, Chapter 6, we revisit investments in associates and joint
ventures, which were introduced in Chapter 1. This allows us to address in detail the equity method
of reporting.
Many of the topics in this module are new with the adoption of IFRS and ASPE, and as such,
illustrative examples are useful in understanding the intent and purpose of the CICA Handbook
sections.
Investments
in the Mining
Industry
Source: © Ugurhan Betin/iStockphoto
SCORPIO MINING CORPORATION is a Canadian- Scorpio classifies its financial instruments in

based silver and base metal producer located in accordance with IAS 39 into the following categories.
Mexico that conducts exploration and development Fair value through profit and loss instruments are
on mining properties in the United States. Through measured at fair market value, with all changes in
the years, the corporation has grown primarily by value going through profit and loss. Assets available
focusing on internal growth through aggressive for sale are measured at fair market value, with all
exploration. With its expansion to Mexico and changes recognized in other comprehensive income.
the United States, the company aims to be a low- Loans and receivables, assets held to maturity, and
cost operation with the benefit of flexible mining other financial liabilities are also measured at fair
methods and diversified metal production. value and are also recorded at amortized cost.
Scorpio holds many different types of financial In 2010, the company acquired a 70% interest
instruments, each of which is reported differently in the Mineral Ridge gold mine in Nevada and
in the financial statements based on their nature. related assets from Golden Phoenix Mineral. As a
Some examples of its financial instruments are result of the agreement with Golden Phoenix, the
investments in the different subsidiaries as well as parties jointly incorporated a new limited liability
new mines for future developments. company called Mineral Ridge Gold to own, explore,
In the mining industry, it is common to develop, and exploit the Mineral Ridge property. The
observe companies joining forces in order to ownership of Mineral Ridge Gold is proportional to
acquire new mines and develop new excavation the interest held in the property and therefore, Scorpio
facilities. As illustrated below with the acquisition Mining has significant influence in the new entity.
of Scorpio Gold, these partnerships allow entering Mineral Ridge Gold started production on
new markets without baring all the risks of the January 1, 2012. As of March 26, 2012, Scorpio Mining
large cash outflow. The agreement as well as held approximately 11.3 million shares of Scorpio
the level of ownership are the main criteria used Gold Corporation, which is involved in the acquisition,
when determining the type of investments to be exploration, and development of resource properties.
presented in the financial statements. The investment in the Mineral Ridge Gold mine
Being traded on the stock market, it is is a very important transaction for Scorpio Mining
important for Scorpio to present its financial Corporation since its ability to meets its obligations
instruments in accordance with accounting and continues as a going concern depends on
guidelines in order to present the real economic its future ability to generate cash flows from its
situation of the company to the shareholders. operations or to raise the financial required.
Sources: Scorpio Mining Corporation website, www.scorpiomining.com; Scorpio Mining Corporation audited financial statements, December 31, 2011; CICA Handbook, IAS 39.
CHAPTER
1 Accounting for
Investments
LEARNING OBJECTIVES
When you have studied this chapter, you should be able to:
1. Identify and account for non-strategic investments in equity.
2. Identify and account for parent–subsidiary relationships.
3. Identify and account for associates.
4. Identify and account for joint arrangements.
ACCOUNTING FOR INVESTMENTS
Non-Strategic Strategic Investments— Strategic

Strategic Investments—
Investments Parent–Subsidiary Investments—Joint
Associates
in Equity Relationship Arrangements
■ Identifying non-strategic ■ Identifying parent–subsidiary ■ Identifying associates ■ Identifying joint arrangements
investments in equity relationships ■ Equity method of accounting ■ Accounting and reporting for
■ Recording non-strategic equity ■ Presentation of consolidated joint arrangements
investments financial statements for
controlled entities
4 chapter 1 Accounting for Investments
In Canada, some of the most interesting business news items have been the acquisitions of
companies, mergers between companies, and divestitures. Most mergers and acquisitions
involving Canadian corporations are decided by management and the company shareholders.
Sometimes companies decide they must grow to survive, and other times they put them-
selves up for sale after deciding their survival depends on another company buying all or part
of them. Takeovers can be friendly or hostile. Deals can be structured as mergers of equals
and they can involve more than two companies. Transactions can be accomplished through
cash, shares, share exchanges, and/or debt financing. The Canadian government has even
become an interested party in these transactions as it must consider the issue of foreign con-
trol over Canadian companies.
Many people think that the typical takeover involves an American multinational buy-
ing up a smaller Canadian firm, but that is often not the case. In early 2011, for example,
Canadian-led acquisitions outnumbered foreign-led acquisitions by a 2-to-1 margin, con-
sistent with historical levels.1 American firms do account for the majority of takeovers by
foreign firms; since 1985, they have accounted for 60% of foreign acquisitions of Canadian
businesses.2 But there are still many large cross-border deals involving foreign firms outside
of the United States. Among the 228 transactions announced in the first quarter of 2011, for
example, was the London Stock Exchange Group plc’s proposed $3.2-billion merger with
the TMX Group Inc. and PetroChina Company Limited’s agreement to acquire a 50%
interest in Encana Corporation’s Cutbank Ridge business assets in British Columbia and
Alberta for $5.4 billion.3
In 2011, Montreal-based CSL Group Inc. made a key acquisition in Europe to help
it build an expanding worldwide marine transportation business. CEO Rod Jones
reported that CSL, with large international and Great Lakes-St. Lawrence Seaway
shipping businesses, had bought control of a European fleet of 11 self-unloading cargo
ships owned by Norway’s Kristian Jebsens Rederi AS.
Jones would not disclose financial details but a new subsidiary, CSL Europe, was
set up, based in London and Bergen, to service European clients. “Jebsens is a famous
name in world shipping and Abe Jensen was a pioneer in building a self-unloading busi-
ness in Europe,” Jones said. “We’ll build off the base that Jebsens has created, bringing
our own brand of self-unloader services to the new venture.”
CSL Group is the world’s largest owner and operator of self-unloaders, with activi-
ties in North America and Australasia and offices in Canada, the United States, Australia,
and Singapore. It is owned by the family of former prime minister Paul Martin.
Source: Robert Gibbens, “CSL Sets Up New Subsidiary; Buys control of European business,”
Montreal Gazette, March 31, 2011.
These transactions are all considered strategic since they further the long-term strategic
goals of the companies involved. This is the case, for example, when a company acquires
another business that has been its supplier to ensure a steady supply at reasonable prices. A
company might also want to acquire a competitor to eliminate competition and therefore
increase market share. Or a company might buy an investment in the United States and
another in France as part of its strategic plan to become a global competitor.
In today’s global business environment, many companies hold investments in other enti-
ties for strategic purposes but they may also have investments in shares of a non-strategic type.
1
Giancomelli, CROSBIE press release June 9, 2011, Q1 2011, www.crosbieco.com/ma/index.htm
2
Quarterly Statistics of Business Acquisitions Made in Canada from Other Countries, Industry
Canada, www.ic.gc.ca/eic/site/ica-lic.nsf/eng/lk-5110.html
3
Giancomelli, CROSBIE press release June 9, 2011, Q1 2011, www.crosbieco.com/ma/index.html
Non-strategic Investments in Equity 5
There are two primary reasons why a company invests in the shares of another company: to
advance strategic objectives and to invest excess cash in a non-strategic manner. The focus of
this module is the reporting for strategic investments. However, we will review the account-
ing and reporting for non-strategic investments as well since it is important to understand the
distinction between them and to assess the reporting requirements correctly. You may have
covered non-strategic investments in an intermediate accounting course; however, we review
this topic as a necessary introduction to the understanding of strategic investments. Non-
strategic investments in shares are those that a company makes as an alternative to putting
excess funds in a bank. The company hopes to obtain a return on its investment that is greater
than the bank’s interest rate.
Accounting standards provide for different methods of accounting for strategic and
non-strategic investments, depending on the nature of the investments and the relationship
between the investor and the investee. We need to remember that as accountants, our goal is
to ensure that the financial statements properly record the substance of the relationship that
exists so that the user can make informed decisions.
International Financial Reporting Standards (IFRS) identify three types of invest-
ments of a strategic nature. These are: those investments in which a company has a parent–
subsidiary relationship, a company has an associate, or a company has a joint arrangement.
To understand the types of investments, we need to understand that there are three types or
levels of control that one company can exercise over another: control or dominance (relating
to subsidiaries), significant influence (relating to associates), and joint control (relating to
joint arrangements).
Later in this chapter we will introduce you to each of the types of strategic investments
and will explore the reporting for the various types of strategic investments made in the shares
of other entities. Throughout this chapter, boxes highlight the identification of and account-
ing for each type of investment according to Accounting Standards for Private Enterprises
(ASPE), comparing ASPE with IFRS.
We begin with the discussion of non-strategic investments in equity.
NON-STRATEGIC INVESTMENTS
IN EQUITY
Identifying Non-strategic Investments in Equity
Objective 1 Companies invest in non-strategic investments to obtain a higher return than holding cash
Identify and account in a bank account.
for non-strategic The standards for reporting non-strategic investments are covered under IFRS 9 Financial
investments in Instruments, IAS 32 Financial Instruments—Presentation, and IFRS 7 Financial Instruments—
equity. Disclosure.
Under private entity GAAP (Accounting Standards for Private Enterprises or ASPE),
ASPE this topic is covered in Section 3856 Financial Instruments.
Criteria
If a company makes a non-strategic investment, it is considered a financial asset. In its simplest
terms, you may recall that a financial asset is simply a contract for cash or another financial
instrument. The shares of another company are just pieces of paper that entitle the holders to
dividends and growth. The paper itself has no value. The value of the share is derived from
the underlying worth of the company. It would follow that strategic investments in shares
would also be financial assets; however, IFRS specifically exempts strategic investments from
the definition of financial asset. This is done so that the reporting for strategic investments
can be tailored to the needs of the users.
A financial asset is defined (in IAS 32.11) as any of the following:
1. Cash
2. An equity instrument of another company
3. A contractual right to receive cash or another financial asset from another company
4. A contractual right to exchange financial instruments under conditions that are poten-
tially favourable
Investments in the equity of other companies that are non-strategic meet the second
criteria of the definition of a financial asset.
From a practical perspective, the issue is how a company is to recognize that something is
in fact a non-strategic investment. Under IFRS, an investment that does not meet the defini-
tion of strategic is classified as a financial asset.
However, IFRS provides some guidance in that respect. There is a presumption that a
company that owns less than 20% of the voting shares of another company does not have
control, joint control, or significant influence. It can therefore be inferred that the company
must have a non-strategic investment unless other factors prove otherwise (IAS 28).
Initial Recognition
A company recognizes an investment in equity instruments on its statement of financial posi-
tion when it becomes a party to the contractual provisions of the instrument. Practically
speaking, this would occur when the company is deemed to own the shares.
Until 2015, companies will be required to classify shares in equity instruments as either
“fair value through profit or loss” or “available for sale” (IAS 39).
Illustration 1.1 shows excerpts from Abitibi Mining Corporation’s financial statements,
showing the different types of investments in non-strategic equity under IAS 39.
For year ends beginning January 1, 2015, IFRS 9 Financial Instruments replaces IAS 39.4
In this textbook we assume the early adoption of IFRS 9. For a more thorough discussion of
IAS 39 please refer to the online material that accompanies the text.
When adopting IFRS 9, companies must classify their investments in equity instruments
at fair value through profit and loss (FVTPL). All equity instruments are recorded at fair
value even if a market does not exist. In limited circumstances, cost may be an appropriate
estimate of fair value. That may be the case if insufficient, more recent information is avail-
able to determine fair value, or if there is a wide range of possible fair value measurements
and if cost represents the best estimate of fair value within that range (IFRS 9 B5.5). Some
examples where cost might not be representative of fair value (under IFRS 9 B5.6) include:
• a significant change in the performance of the investee compared with budgets, plans, or
milestones
• changes in expectation that the investee’s technical milestones will be achieved
• a significant change in the market for the investee’s product
• a significant change in the market for the investee’s equity
• a significant change in the global economy or the economic environment in which the
investee operates
4
Early adoption was permitted beginning in years starting on January 1, 2011, for the section of IFRS 9
that was complete by 2011. If companies adopted the requirements of IFRS 9 related to financial asset
classification and measurement for reporting periods beginning prior to January 1, 2012, they were
not required to restate prior periods. Retained earnings and/or other relevant equity accounts were
adjusted at the beginning of the annual reporting period in which IFRS 9 was adopted. For companies
that were new or were transitioning to IFRS in 2011, it may have been more prudent to adopt early so
that they would not have to do a retrospective adjustment in 2015.
Illustration 1.1 Abitibi Mining Corp.

Excerpts from Abitibi Balance Sheets May 31 2011 May 31 2010
Mining Corp. Financial
Statements Assets
Current
Cash $ 849 $ 7,547
Sales tax receivable 68,798 11,535
Prepaid expenses 7,746 1,061
Marketable securities (Note 3) — 1,665
77,393 21,808
Due From Related Party (Note 8) — 65,252
Mineral Property Costs (Note 4) 883,537 833,474
$ 960,930 $ 920,534
Liabilities
Current
Accounts payable and accrued liabilities $ 528,979 $ 366,765
Due to related parties (Note 8) 120,103 9,912
649,082 376,677
Shareholders’ Equity
Share Capital (Note 5) 15,240,791 14,616,517
Share Subscriptions 60,000 —
Contributed Surplus 883,150 836,250
Accumulated Other Comprehensive Loss — (385)
Deficit (15,872,093) (14,908,525)
311,848 543,857
$ 960,930 $ 920,534
2. SIGNIFICANT ACCOUNTING POLICIES

c) Financial Instruments
Financial instruments are classified into one of five categories: held-for-trading, held-to-maturity invest-
ments, loans and receivables, available-for-sale financial assets, or other financial liabilities. Financial
instruments and derivatives are measured in the balance sheet at fair value except for loans and receiva-
bles, held-to-maturity investments, and other financial liabilities which are measured at amortized cost.
Subsequent measurement and changes in fair value will depend on their initial classification. Held-for-
trading financial assets are measured at fair value and changes in fair value are recognized in net income.
Available-for-sale financial instruments are measured at fair value with changes in fair value recorded in
other comprehensive income until the instrument is derecognized or impaired.
The Company has classified its cash as held-for-trading, amounts receivable as loans and receivables and
accounts payable, accrued liabilities, and due to related parties as other financial liabilities. The carrying
values of the Company’s financial instruments were a reasonable approximation of fair value.
Disclosures about the inputs to financial instrument fair value measurements are made within a hierarchy
that prioritizes the inputs to fair value measurement.
The three levels of the fair value hierarchy are:
Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2 – Inputs other than quoted prices that are observable for the asset or liability either directly or
indirectly; and
Level 3 – Inputs that are not based on observable market data.
3. MARKETABLE SECURITIES
May 31, 2011 May 31, 2010
Number Amount Number Amount
Klondike Gold Corp. — $ — 10,000 $ 300
Klondike Silver Corp. — — 2,000 90
Neodym Technologies Inc. — — 1,250 25
Strike Mineral Inc. — — 25,000 1,250
$ — $ 1,665
Marketable securities were comprised of investments in public companies. Klondike Gold Corp.,
Klondike Silver Corp., and Neodym Technologies Inc. are related by directors in common.
• a significant change in the performance of comparable entities

• internal matter of the investee such as fraud, commercial disputes, litigation, changes in
management strategy
A company is required to use all available information in order to assess if cost is a good
approximation of fair value. Cost is never considered the best estimate of fair value for shares
that are quoted on an active market.
There are possible exceptions to FVTPL. At the day of acquisition when the invest-
ment in shares is originally recorded, the company has the option of making an “irrevocable
election” where it decides that subsequent changes to fair value will be put in other com-
prehensive income rather than through profit and loss. This election cannot be made for
investments that are held for trading.5 In addition, this amount cannot be “recycled” through
profit and loss. Recycling is a new concept under IFRS that relates to items that are originally
placed in Other Comprehensive Income. Some items are recycled, which means they flow
through net income when they are realized, and others are not recycled, which means that
when realized they are flowed directly to equity.
Recording Non-strategic Equity Investments

When the non-strategic equity investment is initially recorded, it must be measured at its fair
value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. IFRS 13
Fair Value Measurement, issued in 2011 and effective for year ends beginning January 1, 2013, pro-
vides guidance on how to determine fair value. Transaction costs for investments that are FVTPL
are expensed immediately. Transaction costs are incremental costs directly attributable to the
acquisition of a financial asset. This would include legal fees, administrative costs, and broker fees.
The investment in equity must be restated to fair value at the end of each reporting
period. Any gain or loss on the change in fair value is recorded in net income (see Illustrative
Example 1.1). If the irrevocable election is made, the gain or loss is recorded in other com-
prehensive income (see Illustrative Example 1.2).
Illustrative Example 1.1 FVTPL Journal Entries

ABC acquires 500 shares in XYZ on January 1, 2013. ABC pays $10,000 to acquire the
shares. The investment represents 10% of the ownership in XYZ. The investment is clas-
sified as FVTPL. At December 31, 2013, the shares are still unsold and have a current
market value of $30 per share. On February 15, 2014, the shares are sold for $12,000.
Journal entries:
Jan. 1, 2013
FVTPL—Investment 10,000
Cash 10,000
(To record the acquisition at fair value)
Dec. 31, 2013

FVTPL—Investment (30 × 500) – 10,000 5,000
Gain on Change in Fair Value of FVTPL Investment 5,000
(To record the change in fair value at year end)
5
An investment in equity instruments is considered held for trading if it is acquired or incurred
principally for the purpose of selling or repurchasing it in the near term or if it is part of a portfolio of
identified financial instruments that are managed together and for which there is evidence of a recent
actual pattern of short-term profit taking. Trading generally reflects active and frequent buying and
selling with the objective of generating profit.
Feb. 15, 2014

Cash 12,000
Loss on Sale of FVTPL Investment 3,000
(To record the sale of FVTPL investment)
Comprehensive Income Statement

2014 2013
Unrealized gain on fair value adjustment 5,000
Realized loss on sale of FVTPL investment –3,000
Net income –3,000 5,000
Statement of Financial Position
2014 2013
Short-term FVTPL Investments 0 $15,000
If the company makes the irrevocable election to put the changes in fair value
through Other Comprehensive Income, the journal entries will be the same as those
shown in Illlustrative Example 1.1 for FVTPL except that the gains or losses will be put
in Other Comprehensive Income (OCI). The balance in the cumulative OCI will go
directly to Equity—Retained Earnings when realized through sale.
Illustrative Example 1.2 FVTPL Investment:

Irrevocable Election
ABC acquires 500 shares in XYZ on January 1, 2013. ABC pays $10,000 to acquire the
shares. The investment represents 10% of the ownership in XYZ. ABC makes the irrevo-
cable election to have the changes in fair value recognized in OCI. These shares are not con-
sidered held for trading. At December 31, 2013, the shares are still unsold and have a current
market value of $30 per share. On February 15, 2014, the shares are sold for $12,000.
The journal entries are:
Jan. 1, 2013
Cash 10,000
(To initially record the investment at fair value)
Dec. 31, 2013

FVTPL—Investment (30 × 500) – 10,000 5,000
OCI—Change in Fair Value of the Investment 5,000
(To revalue the investment to fair value at year end)
Feb. 15, 2014

OCI—Loss on Restatement of FVTPL 3,000
(To restate the investment to fair value at the day of sale)
Feb. 15, 2014

Cash 12,000
(To record cash received on sale)
Feb. 15, 2014

OCI—Restatement of FVTPL 2,000
Retained Earnings 2,000
(To reclassify the balance in the Cumulative OCI that is not recycled and therefore is put directly to
retained earnings)
2014 2013
Net income –0– –0–
Other comprehensive income $–3,000 $5,000
Reclassification of OCI –2,000 –0–
Comprehensive income $–5,000 $5,000
The dividend received is recorded through income in the year that the company is enti-
tled to it.6
Assume that XYZ paid dividends in 2013 in the amount of $600 to shareholders of record
on that date. ABC would make the following entry regardless of the classification of the gains
and losses on changes in fair values:
Cash 60
Dividend Income 60
(To record 10% of the dividend income for 2013)
There is no requirement that dividend income be disclosed separately on the statement

of comprehensive income.
Under IFRS, if the dividend is a return of capital (i.e., the dividend is paid from the
permanent capital of the investee rather than its retained earnings) and gains and losses are
put through OCI, the dividend—which is actually a refund of capital—would be recorded
in OCI.
If a non-strategic investment is reported at FVTPL, there is no requirement to test for
impairment. This is logical since the investment already reflects the fair value and any adjust-
ment, whether an increase in value or an impairment, has been reflected in net income.
Applying ASPE to Non-strategic Equity Investments

ASPE
Under ASPE, financial assets are covered in Section 3856. A company must recognize
the equity investment when the company becomes a party to the contractual provisions
of the financial instrument. This would generally be when it is deemed the property of
the acquiring company.
Upon initial recognition, all equity that is purchased in an arm’s-length transac-
tion is recorded at its fair value. If the equity will not be subsequently measured at fair
value, the transaction costs that are directly associated with the acquisition are added
to the cost of the equity (Section 3856.07). If the transaction is with a related party,
the criterion for related parties applies rather than this section. In subsequent periods,
a company must measure the equity instrument at the original cost unless there are
impairments issues. There are exceptions to this requirement:
1. Investments in equity instruments that are quoted in an active market must be
restated to fair value. Any gain or loss would be flowed directly through net income.
This should be evident as other comprehensive income does not exist under ASPE.
6
The investor is entitled to the dividend revenue once it has been declared by the investee.
2. A company may elect to measure any equity instrument at fair value by designating
that fair value measurement will apply (Section 3856.12). If a company makes this
designation, it is irrevocable.
If we examine Illustrative Example 1.1, we see that if the shares are restated to fair
value, the journal entries are the same as those proposed under IFRS for investments
that are FVTPL.
If, however, the shares are in a private company that does not trade on an active
market, the investment is subsequently recorded at cost (known as the cost method),
which results in the journal entries in Illustrative Example 1.3.
Illustrative Example 1.3 Financial Asset of a Private

Company Under ASPE Journal Entries
Let’s assume that ABC is not a publicly accountable enterprise.
ABC acquires 500 shares in XYZ, a private company, on January 1, 2013. ABC pays
$10,000 to acquire the shares. The investment represents 10% of the ownership in XYZ.
ABC records the investment at cost since there is no market for the shares of XYZ. At
December 31, 2013, the shares are still unsold. On February 15, 2014, the shares are sold
for $12,000.
The journal entries are:
Jan. 1, 2013
Investment in XYZ 10,000
Cash 10,000
(To record the acquisition at fair value)
Dec. 31, 2013
No entry since the equity investment is shown at the original cost and there is no
reason to believe it is impaired.
Feb. 15, 2014
Cash 12,000
Investment 10,000
Gain on Sale of Investment 2,000
(To record the sale of FVTPL investment)
Income Statement
2014 2013
Realized gain on sale of investment 2,000
Net income 2,000 –0–

2014 2013
Short-term or long-term investments –0– $10,000
The classification as short-term or long-term would be based on the intent of ABC.

Notice that over the entire period, the method under ASPE results in the same
amount of a $2,000 ($12,000 ⫺ $10,000) gain being reflected in net income as the
method under IFRS FVTPL. The difference is a timing issue that affects whether the
gain is recorded in 2013 or 2014.
Under ASPE, the dividend received is recorded through income in the year that
the company is entitled to it,7 which is the same as IFRS.
7
The investor is entitled to the dividend revenue once it has been declared by the investee.
Like IFRS, impairment testing is only required for investments that are not carried
ASPE at fair value. At the end of each reporting period, a company assesses whether there are
any indications of impairment (Section 3856.16). However, the measurement of the
impairment under ASPE is not the same as IFRS. When an impairment exists, the car-
rying value is reduced to the highest of:
• the present value of the cash fl ows expected to be generated by holding the
investment discounted using the current market rate of interest appropriate to
the asset or
• the amount that could be realized by selling the asset at the balance sheet date
(Section 3856.17).
Under ASPE, impairments may be reversed if the increase in value is due to an
event that occurred after the impairment was recognized. For example, an investment
that was incurring losses changes the nature of its operations and returns to profitabil-
ity. The reversal cannot result in the investment being valued at an amount greater than
the original cost. The reversal is also recognized in net income.
✓ LEARNING CHECK
• There is a general assumption that an ownership interest of less than 20% is a financial asset
and not a strategic investment.
• Entities are required to present non-strategic investments in equity as financial assets.
• Financial assets under IFRS 9 are shown at fair value with the difference in fair value going
through income.
• Entities may make an irrevocable election to show the gains and losses through other compre-
hensive income.
• Under ASPE, all financial investments in shares are reflected at cost unless the shares trade
in a public market. In that case, they are reflected at fair value and the gain or loss is flowed
through income.
STRATEGIC INVESTMENTS—
PARENT–SUBSIDIARY RELATIONSHIP
Objective 2 In the previous section we examined investments in equity that are made as an alternative to
Identify and account earning a return in the bank. In this section we begin our review of those investments that are
for parent–subsidiary made to advance the company’s strategic goals.
relationships.
Identifying Parent–Subsidiary Relationships

We begin our discussion of strategic investments with parent–subsidiary relationships. In
IFRS 10, a subsidiary is defined as an entity that is controlled by another company, the par-
ent. The criterion for identifying a parent–subsidiary relationship is control. IFRS 10 also
requires that consolidated financial statements be prepared when there is a parent–subsidiary
relationship. Determining whether one company controls another is then crucial to deter-
mining which entities should prepare consolidated financial statements.
Strategic Investments—Parent–Subsidiary Relationship 13
IFRS 10 contains the following definition of control:
An investor controls an investee when it is exposed, or has rights, to variable returns from
its involvement with the investee and has the ability to affect those returns through its power
over the investee (IFRS 10.6).
Note that three criteria must be present in order for there to be control. The parent
must have:
1. the ability to direct the financial and operating policies of another company (the power
criterion),
2. the ability to obtain returns from the other company (the returns criterion), and
3. the ability to use its power to affect those returns (the link criterion).
The rationale behind the definition of control is that consolidation should be driven by
the principle of reporting a parent and its subsidiaries as if they were a single company. If
you own shares of the parent company and that parent owns shares of a subsidiary, in sub-
stance you also own the subsidiary company. Identifying whether an entity is a subsidiary
should be based on control. Only one company can control another company; control can-
not be shared.
Note that a reporting company must assess control continuously. A company’s ability
to control another company changes as a consequence of actions by the reporting company
or because of changes in facts and circumstance. The investor must reassess if circum-
stances indicate that there are changes to one or more of the three elements of control
listed above.
The Power Criterion

The ability to direct financial and operating policies refers to a company’s capacity to control.
The capacity to control is obtained through existing rights that give the parent the ability to
direct relevant activities. One key aspect of control is the distinction between the capacity to
control and that of actual control. Capacity to control does not require the holder to actually
exercise control. Similarly, a company that is actually controlling another may not have the
capacity to control.
Power arises from rights. These rights must exist now so that the investor has the current
ability to direct relevant activities. IFRS 10 describes some examples of rights that provide
power to the investor:
• rights in the form of voting rights (or potential voting rights) of an investee;
• rights to appoint, reassign, or remove members of an investee’s key management person-
nel who have the ability to direct the relevant activities;
• rights to appoint or remove another entity that directs the relevant activities;
• rights to direct the investee to enter into, or veto any changes to, transactions for the
benefit of the investor; and
• other rights (such as decision-making rights specified in a management contract) that
give the holder the ability to direct the relevant activities (IFRS 10.B15).
Sometimes power is easy to assess if it is obtained through voting shares of an entity. In
that case the parent obtains this power through its ability to oversee financial and operating
policies, but it is not the only means of gaining this power. Power can be achieved in other
ways, including by having voting rights, options or convertible instruments, or contractual
arrangements, or a combination of these. The controlling company could have an agent with
the ability to direct the activities for the benefit of the controlling company.
These rights must give the parent power over “relevant activities.” This means that the
investor must have the ability to determine operating and financing activities of the investee
that would significantly affect their returns. IFRS 10 provides the following examples of rel-
evant activities:
• selling and purchasing of goods or services;
• managing financial assets during their life (including upon default);
• selecting, acquiring, or disposing of assets;
• researching and developing new products or processes; and
• determining a funding structure or obtaining funding (IFRS 10 B11).
IFRS provides examples of relevant decisions:
• establishing operating and capital decisions of the investee, including budgets; and
• appointing and remunerating an investee’s key management personnel or service provid-
ers and terminating their services or employment (IFRS 10 B12).
It is therefore clear that the investor must understand the design and nature of the
investee so that it can determine the relevant activities of that investee.
Passive versus active control. The company having the power to direct activities, or the
capacity to control, may not be actively involved in the management of the controlled com-
pany; the controller may play a passive role. However, in situations where another party is
actively formulating the policies of a subsidiary, in order for another company to be the con-
trolling company, it must have the ability to change or modify those policy decisions if the
need for change is seen to exist. The existence of actual control (i.e., determining the actual
policies of the subsidiary) often signals the existence of capacity to control, but the two do not
necessarily coexist.
Non-shared control. Regardless of whether the control is passive or active, there can be
only one controlling company; there cannot be two or more entities that share the control.
It is possible that one company may delegate control to another company, but the first com-
pany is considered to have the capacity to control even if it is the delegated party that actually
controls the subsidiary.
Level of share ownership. Control is presumed to exist when the parent owns, directly
or indirectly through subsidiaries, more than half of the voting power of an entity. Hence,
where the parent owns more than 50% of the shares of another entity, it is expected that the
other entity is a subsidiary of the parent. However, it is possible to own more than 50% of
the voting shares and not have control. This could occur if legal requirements, the founding
documents of the other company, or other contractual arrangements restrict the reporting
company’s power to the extent that it does not have the power to direct the company’s rel-
evant activities.
Ownership of shares normally provides voting rights that enable the holder of the major-
ity of shares to dominate the appointment of directors or a company’s governing board.
Control can exist when the parent owns half or less of the voting power of a company. IFRS
10 provides the following situations, where there is:
(a) a contractual arrangement between the investor and other vote holders that provides the
power to the investor;
(b) rights arising from other contractual arrangements that provide power to the investor to
direct the relevant activities;
(c) the investor’s voting block is sufficient to obtain the power;
(d) potential voting rights provide the substantive rights that permit the investee to have
power; or
(e) a combination of (a)–(d).
There is no debate about the existence of control where the parent has a majority
shareholding in the subsidiary. However, where the ownership interest is less than 50% or
is based on possible future actions, it is less evident as to whether control exists. A distinc-
tion needs to be made between non-shared control and what can be described as “unilat-
eral control.” Unilateral control means that the controlling party does not depend on the
support of others to exercise control, which is the case where the parent owns more than
50% of the shares of the subsidiary. Where the holding is less than 50%, the parent has
a non-shared or dominant control. This is not control in a legal sense as with unilateral
control, but is control that may be achieved both because of its own actions and because
of the actions (or inactions) of other parties. The following factors must be considered for
determining whether an investor has unilateral control even though it owns less than 50%
of the voting shares.
• Existence of contracts: The investor may have power because of the existence of contracts:
1. power over more than half of the voting rights by virtue of an agreement with other
investors; or
2. power to govern the financial and operating policies of the company under a statute
or an agreement.
The contract or agreement may take many forms; however, a contract may cover a
limited time period. Control will then exist only while the contract is current.
• Size of the voting interest: An investor with less than a majority of voting right still has
enough rights to give it power when it has the practical ability to direct the relevant
activities unilaterally (IFRS 10.B41). The assessment of this ability requires profes-
sional judgement. For example, although all shareholders may attend general meetings
and vote in matters relating to governance of a company, it is rare for this to occur. If,
therefore, only 75% of the eligible votes are cast at a general meeting and a company
has a 35% interest in that company, and three other shareholders have 5% each, it can
cast the majority of votes at that meeting. In this case, the active participation of the
other shareholders indicates that the investor would not have the ability to direct the
relevant activities unilaterally, regardless of whether the investor has directed the rel-
evant activities.
• Dispersion of other shareholders: Shareholders can be dispersed geographically as well as
in numbers of shares held. The annual general meeting may be held in Toronto, but the
majority of shareholders may live in southeast Asia. The probability of these sharehold-
ers attending the general meeting is then lessened by location. Further, even if all the
shareholders live in Toronto, if they hold small parcels of shares, then the probability of
attendance at general meetings is reduced. For example, if the number of shares issued
by the subsidiary is 1,000, the shareholders will be more dispersed if there are 1,000
shareholders with one share each than if there are four shareholders with 250 shares
each. However, assuming the prospective parent has a 40% interest, it is not clear where
the cut-off point is between lack of control when there are two other shareholders
with 30% interest each and having control when there are 60 other shareholders with
1% each.
• Level of disorganization or apathy of the remaining shareholders: This factor is affected by
the dispersion of the shareholders, and reflected in their attendance at general meet-
ings. Holders of small parcels of shares do not often form voting blocks. Shareholders
with environmental or ethical concerns about a company may be less apathetic about its
actions and management policies, and may form voting blocks.
Illustrative Example 1.4 demonstrates the application of the concept of power to
direct the relevant activities unilaterally, where the parent has less than 50% of the share-
holding in a subsidiary. In the example, the ownership by Plato Inc. of shares in Socre Ltd.
reduces over time from 100% to 60% to 45% and finally to 35%. The question is whether
Plato Inc. retains the power to direct relevant activities of Socre Ltd. as its shareholding
decreases.
Illustrative Example 1.4 Power Based on Voting Shares

Plato Inc., a cement manufacturer, acquired all of the voting shares of Socre Ltd., a rug
manufacturer, as part of a diversification program.
Several years later, Plato decided as part of its corporate strategy to commit capital
resources only to its primary line of business, and was unwilling to support the projected
growth of Socre. Plato caused Socre to issue additional shares in an initial public offer-
ing, resulting in a reduction in Plato’s ownership interest in Socre from 100% to 60%.
Shortly after the offering, the newly issued shares are widely held, and no other
party has more than 3% of Socre’s outstanding shares. Both before and after the ini-
tial public offering, Plato’s shareholding represents a majority interest in Socre, which
leads to a presumption of control in the absence of evidence to the contrary. Moreover,
there is no evidence that demonstrates that Plato, through its 60% interest, no longer
has the ability to dominate the nomination and selection of Socre’s board members.
Five years later, to raise additional capital needed to finance the growth of Socre,
Plato causes Socre to issue additional shares, which reduces Plato’s ownership of out-
standing shares to 45%. At this time, Plato’s 45% holding is the largest block of shares
held by any single party, and the remaining shares outstanding continue to be widely
held: no other party holds more than 3% of the outstanding shares. Ten days after the
public offering, Plato is able, through Socre’s board of directors, to cause the renomi-
nation of all of its choices for the 11 board members of Socre.
During the past five years, about 80% of the eligible rights to vote in an election
of Socre’s board of directors were cast at any given annual meeting. The percentage of
votes cast in each of the past five years was 76, 81, 82, 79, and, most recently, 82. Plato voted
all of its shares each year, but only about half of the other eligible votes were cast in
each of those years.
In this case, Plato no longer has legal control of Socre but, based on the facts, the
power has not been lost. Plato still has the ability to dominate the process of nominat-
ing and electing Socre’s members of the board, which is based mainly on two factors:
Plato’s large minority holding and the wide dispersion of the remaining shares.
About two years later, another issue of Socre’s shares reduces Plato’s holdings to
35%, and the voting patterns and all other facts remain constant. Plato’s 35% holding
is now less than half of the 80% of votes typically cast in past elections and may still be
nearly half of the votes cast in future elections.
In this case, Plato’s ability to maintain its power becomes questionable. However,
assurance of a company’s ability to maintain its control is not a condition for consolida-
tion. Rather, the assessment is based on whether a company has a current ability to direct
the relevant activities of another company, unilaterally. In this case, based on the facts
and the weight of evidence—the 35% voting interest, the strong ties to the directors of
Socre and the continuing success of Socre’s operations under its control—collectively
give Plato Inc. the ability to dominate the nomination and election of Socre’s board of
directors. In this case, there is no evidence that the power of Socre Ltd. has been lost.
However, in Illustrative Example 1.4, it is unclear why the other shareholders
are not voting. Do the non-voting shareholders not vote because they are happy with
Plato’s management ability as opposed to being apathetic? Would they be willing to
combine to outvote Plato if they felt its decisions were untenable? The success of Socre
Ltd.’s operations under the power of Plato Inc. is a further factor to motivate gener-
ally passive shareholders to cast a vote at the next general meeting. When shareholders
see positive results, they are less likely to react against Plato Inc. When the company
is performing poorly, the interest of shareholders increases as well as their willingness
to become involved. Poor performance with resultant lowering of share price may also
result in a current or new shareholder acquiring a large block of shares and changing
the voting mix at general meetings. As such, you would have to conclude that Plato Inc.
does not have the power to determine the relevant activities of Socre Ltd.
A number of problems arise in applying the concept of power. First, there is the question
of temporary power. Where the parent holds more than 50% of the shares of the subsidiary,
there is no danger of a change in the identity of the parent. However, if the identification of
the parent is based on factors that may change over time, the process becomes difficult. For
example, the percentage of votes cast at general meetings may historically be 70%, but in a
particular year it may be 50%. A shareholder with 30% of the voting shares has power in the
latter circumstance but not in the former. This control may, however, last for only a year
until the next general meeting.
Second, a company’s ability to control another may be affected by relationships with
other parties. For example, a holder of 40% of the voting power may be friendly with the
holder of another 11% of the votes. This friendly relationship could include a financial insti-
tution that has invested in the holder of the 40% votes and that plans to vote with that party
to increase its potential for repayment of loans. However, business relationships and loyalties
are not always permanent.
Third, a minority holder that did not have control may, due to changing circum-
stances, find itself with the capacity to control. For example, a holder of a 30% block of
shares may not have had control because the remaining shares were tightly held by a small
number of parties. However, if one or more of these parties sold their shares in small lots,
the minority holder could have the controlling parcel of shares. Regardless of whether this
shareholder wanted to exercise that power or not, he or she has the capacity to control and
is the parent.
The theoretical question is whether in these circumstances a company really controls in
its own right or in fact has control that is shared with the other shareholders, as control is
affected by their actions.
The conclusion would be that if control is affected by the actions of other shareholders,
it is shared control and therefore would not meet the definition of control.
Potential voting rights. Potential voting rights are rights to obtain substantive voting
rights of an investee, such as those arising from convertible instruments or options. A com-
pany may have share call options or convertible instruments that, if exercised or converted,
give the company voting power over the financial and operating policies of another company.
Consider the following two examples:
1. Investor A holds 70% of the voting rights of an investee. Investor B has 30% of the vot-
ing rights of the investee as well as an option to acquire half of investor A’s voting rights.
The option is exercisable for the next two years at a fixed price that is currently higher
than the market value of the shares (and is expected to remain so for that two-year period).
Investor A has been exercising its votes and is actively directing the relevant activities of
the investee. In such a case, investor A is likely to meet the power criterion because it
appears to have the current ability to direct the relevant activities. Although investor B has
currently exercisable options to purchase additional voting rights (that, if exercised, would
give it a majority of the voting rights in the investee), the terms and conditions associated
with those options are such that the options are not considered substantive.
2. Investor A and two other investors each hold a third of the voting rights of an investee.
The investee’s business activity is closely related to investor A. In addition to its equity
instruments, investor A also holds debt instruments that are convertible into voting shares
of the investee at any time for a fixed price that is higher than the current market price for
the shares (but not significantly higher). If the debt were converted, investor A would hold
60% of the voting rights of the investee. Investor A would benefit from realizing synergies
if the debt instruments were converted into voting shares. Investor A has power over the
investee because it holds voting rights of the investee together with substantive potential
voting rights that give it the current ability to direct the relevant activities (IFRS 10.B50).
It may be argued that control should be based on the actual situation at the end of the
reporting period and, as the holder of the convertible instrument has not exercised the instru-
ment, the actual situation is that the holder is not yet in control. In other words, it would
require an action on the part of the holder to have a current capacity to control. However, as
stated previously in this chapter, control exists even when the holder is passive. A holder of
51% of the shares of another company is the parent of that company even if the holder does
not attend general meetings or participate in determining the directors of the company.
There are circumstances where the voting shares of an entity do not determine which
company in effect has power. It is possible that the votes at the level of the board of directors
do not entitle the holder to any substantive power over the investee. The most common cir-
cumstance would be the case where the entity’s actions are directed by a contractual arrange-
ment. Explicit or implicit decision-making rights may be embedded in the contract. As an
example, the company could have the power to direct the manufacturing processes of another
company, appoint personnel, or direct other operating activities by virtue of an agreement.
Economic dependence of an entity on the company does not, by itself, lead to the company
having the power to direct the activities of that other company. However, the company may
have this power if this dependence is viewed in conjunction with the voting interest.
Consider the following example. Receival Inc. is formed in order to collect the accounts
receivables of Mack Inc. When considering the purpose and design of Receival, it is evident
that the only relevant activity is managing the accounts receivable of Mack Inc. if they are in
default a separate firm, Oldscool Inc., has been charged with managing the accounts receiv-
able collections. The shareholders of Receival Inc. do not have power since it is Oldscool that
manages the accounts receivable and has the power over it.
The Returns Criterion

As stated earlier, in order to have control you must meet three criteria: the power criterion,
the returns criterion, and the link criterion.
In the previous section we examined the nature of power. In this section we review the
criteria for exposure or rights to returns from an investee.
Variable returns are defined as “returns that are not fixed and have the potential to vary
as a result of the performance of the investee” (IFRS 10.B56). You will note that returns
could be both positive and negative. If a company owns common shares of another company
it can expect variable returns since the dividend and changes in value of the shares are vari-
able. If a company charges a fee based on the performance of another company, this company
is subject to variable returns since the amount it will receive is affected by the performance of
the other company, which will vary. IFRS 10.B57 provides the following examples of returns:
• dividends, other distributions of economic benefits from an investee (e.g., interest from
debt securities issued by the investee), and changes in the value of the investor’s invest-
ment in that investee;
• remuneration for servicing an investee’s assets or liabilities, fees and exposure to loss
from providing credit or liquidity support, residual interests in the investee’s assets and
liabilities on liquidation of that investee, tax benefits, and access to future liquidity that
an investor has from its involvement with an investee; and
• returns that are not available to other interest holders. For example, an investor might
use its assets in combination with the assets of the investee, such as combining operating
functions to achieve economies of scale, cost savings, sourcing scarce products, gaining
access to proprietary knowledge, or limiting some operations or assets, to enhance the
value of the investor’s other assets.
Trustees and those with fiduciary relationships with the subsidiary would not be entitled to
variable returns. These parties may be able to direct certain activities of the subsidiary, but apart
from fees for service, the activities do not lead to increased or decreased returns to these parties.
The Link Criterion

In this last section we examine the third criterion, the ability to use power over the investee
to affect the amount of the investor’s returns, which links the first two criteria (the power
criterion and the returns criterion).
When a company has more than 50% of the voting shares, and it is the votes that deter-
mine a company’s power, it is obvious that this same company will have the ability to affect
the returns since it is through their votes that relevant decisions are made. A company that
buys a bond receives the returns that can vary due to the risk of the issuer. However, this
company has no ability to affect the returns and therefore would not control the entity. In
some circumstances it is not easy to establish whether a company that receives returns has any
say in how those returns are affected.
Power by having an agent act on its behalf. IFRS 10 introduced the scenario where a
company can have “power” for purposes of determining control even if it does not own any
shares. A reporting company can have power by having an agent act on its behalf. In contrast,
a reporting company does not have power when it is acting solely as an agent. An agent is
defined in IFRS 10 as: “A party primarily engaged to act on behalf and for the benefit of
another party or parties (the principal(s)).”
It is possible that the agent has the ability to direct the activities of a company; for example,
by making decisions concerning the company’s operating and financing activities. However,
that ability is governed by an agreement, law, or fiduciary responsibility that requires the
agent to act in the best interests of the principal. The agent must use any decision-making
ability delegated to it to generate returns primarily for the principal. In substance the princi-
pal is controlling the entity through its agent.
Evidence of this type of relationship exists where the principal has the right to remove,
without cause, an agent that is empowered to direct the activities of a company for the prin-
cipal. An agent is remunerated for the services it performs by means of a fee that is com-
mensurate with those services. This fee may be fixed or performance related. If the agent
receives a performance-based fee, the agency relationship can be difficult to distinguish from
a controlling relationship. This is because the agent can use its ability to direct the company’s
activities to affect its remuneration. However, if this ability is limited by the agent’s responsi-
bility to act in the best interest of the principal, the fee that the agent receives is remuneration
for the services it performs and does not indicate involvement with the entity beyond that of
an agent.
A principal will benefit from increases in the value of the entity but will also suffer from
decreases in the value. In contrast, an agent might be paid a performance-based fee for a
specified period and the agent is unlikely to be required to contribute additional funds to the
company if there is a decrease in value.
Structured entities. With the implementation of IFRS 10 for year ends beginning January
2013, there was no need for separate guidance on special purpose entities (SPEs; see SIC 12).
A special purpose entity was defined under SIC 12 as an entity that was set up to perform a spe-
cific purpose. IFRS 10 refers to these types of arrangements as structured entities. Using the
current definition of control allows these types of entities to be dealt with in the same manner
as other types of strategic investments. The company may not own any shares of the entity
but typically the equity is not sufficient to sustain the entity. Examples might be an entity that
is formed to effect a lease or to do research and development activities. SPEs may take the
form of a corporation, trust, partnership, or unincorporated entity. However, the entity is set
up such that the operating and financial policies are virtually fixed (see Illustrative Example
1.5). An entity that engages in transactions with an SPE may in substance control the SPE.
The determination of whether the investor has control focuses on the power, exposure, or
rights to returns, and the ability to use that power to affect the returns. Previously, the cri-
terion for control of SPEs was whether the investor was able to obtain the benefits and the
exposure to risk (SIC 12).
Consider the case in Illustrative Example 1.5 of Desjardin Ltd., a sailboat manufacturer.
We see that Desjardin Ltd. does not control the board of directors of Marine Inc. However,
there are not many decisions left for Marine Inc. to make as the product and dealers are all
predetermined. In terms of returns, the investor group receives a return on the investment
when the inventory is sold. However, Desjardin receives a greater range of benefits as Marine
Inc. is acting as a sales agent for its boats. Desjardin still runs all the risks in producing the
boats and disposing of any unsold boats, and receives the major benefits from the sale of the
boats via the fee for services. Desjardin Ltd. controls Marine Inc.
Illustrative Example 1.5 Structured Entities8

Desjardin Ltd., a public company, is a boat manufacturer specializing in sailboats for
private use. Desjardin Ltd., with the assistance of an investment banker and in conjunc-
tion with an independent investor group, created Marine Inc.
The business purpose of Marine is to purchase all Desjardin’s luxury line sailboats
on completion of production. The investor group contributed $600,000 and Desjardin
contributed $400,000 to capitalize Marine. The investor group will own 60% of the
voting interest in Marine, with Desjardin having the remaining 40% voting inter-
est. Marine Inc. is governed by a board of directors and consists of 10 directors: six
appointed by the investor group and four appointed by Desjardin. All significant busi-
ness decisions must be approved by 60% of the board, except for decisions relating to
liquidation, issue of additional debt or equity capital, and changes to the size of the
board of directors. These decisions require approval by 80% of the board.
Marine Inc.’s operations consist of acquiring 100% of Desjardin Ltd.’s luxury line
sailboats at cost of production. Marine may, at its option, return any unsold inventory
to Desjardin after one year at cost. Marine is allowed to enter into other transactions
with unrelated parties, but the investor group and Desjardin have agreed that Marine
will not enter into such transactions. Desjardin has an agreement with Marine to main-
tain relationships with its dealer network. Desjardin will provide all necessary post-
production storage facilities, arrangements for shipment to dealers, incentive plans to
dealers, and manufacturer’s warranties. Apart from inventory, Marine will not have any
substantive assets.
Desjardin Ltd. receives a fee for services provided to Marine Inc. equal to the rev-
enue from sales after deducting the cost of sales, financing fees, and a facilitation fee
paid to the investor group.
Dissimilar activities. In determining the existence of a parent–subsidiary relationship,

the fact that the parent is involved in totally different activities from the subsidiary is not suf-
ficient to exclude the subsidiary from consolidating financial statements. Some have argued
that if, for example, the parent’s activities are in mining while the subsidiary’s are in retailing
clothing, the consolidated financial statements will lack meaning. However, the criterion for
consolidation is control. As the parent controls the assets of the subsidiary, regardless of the
activities of the entities within the group, consolidated financial statements are necessary to
measure performance and assess the economic responsibility of the parent’s management for
the subsidiary’s activities. For example, the disclosures required by IFRS 8 Operating Segments
help to explain the significance of different business activities within the group.
Summary of Process to Determine Control

The following are the steps to follow to determine if one company controls another and
therefore a parent–subsidiary relationship exists:
1. Determine the purpose and design of the investee.
2. Determine the relevant activities of the investee.
3. Determine how decisions are made regarding the relevant activities.
4. Determine whether the investor has the current ability to direct those relevant activities.
8
Adapted from a case written by the Financial Accounting Standards Board (FASB) as part of its
testing of the FASB exposure draft.
5. Determine whether the investor has the right and risks to the variable returns of the
investee.
6. Determine whether the investor has the ability to use its power to affect those returns.
If the answer in points 4, 5, and 6 is yes, then the investor has control over the investee.
Presentation of Consolidated Financial Statements

for Controlled Entities
When a company has control over another company, a parent–subsidiary relationship is said
to exist. Paragraph 4 of IFRS 10 details which entities are required to prepare consolidated
financial statements:
An entity that is a parent shall present consolidated financial statements.
Hence, all parents, other than the exceptions in paragraph 4, are responsible for the
preparation of consolidated financial statements.
The process of consolidation requires the parent company to combine its financial state-
ments with the financial statements of its subsidiary. The investment account as recorded
on the parent’s financial statements is eliminated and replaced on a line-by-line basis with
each asset and liability of the subsidiary. In addition, all income and expense accounts are
combined. Since the parent has the ability to control the subsidiary, from the user’s perspec-
tive they are one economic entity. By consolidating the two statements, the economic entity
is presented as one single company. Consolidated financial statements recognize that the
separate legal entities are components of one economic unit and are distinguishable from the
separate parent and subsidiary company statements.
Under IFRS there is a distinction made between separate financial statements and con-
solidated financial statements. Under IFRS a company may present consolidated and separate
financial statements. Separate financial statements are defined in paragraph 4 of IAS 27
Consolidated and Separate Financial Statements:
Separate financial statements are those presented by a parent, an investor in an associate or
a venturer in a jointly controlled company, in which the investments are accounted for on the
basis of the direct equity interest rather than on the basis of the reported results and net assets
of the investees.
Separate financial statements are issued for parent–subsidiary relationships in limited circum-
stances and are dealt with in Chapter 4. Details of the consolidation process are covered in
Chapters 3 to 5.
Under ASPE a company is only permitted to issue one general purpose financial state-
ASPE ment. If there is a parent–subsidiary relationship, this may be the consolidated state-
ment. A company that wishes to present a separate financial statement may do so as a
“special purpose” financial statement but must refer to the consolidated statements as
the general purpose financial statements. Under ASPE a company has the option to not
consolidate its subsidiary. It may choose to report using the equity method or the cost
method. If a consolidated statement is not prepared, the separate financial statement is
the general purpose financial statement.
Illustration 1.2 shows an investment note disclosure by Acme Resources Inc. (formerly
International KRL Resources Corp.), incorporated in British Columbia, which is primarily
engaged in the acquisition and exploration of mineral properties throughout Canada.
Illustration 1.2 7. INVESTMENT IN GOLDEN HARP

Sample Investment The Company recorded its investment in Golden Harp on a fully consolidated basis until February 29,
Note Disclosure—Acme 2008. Thereafter, the Company no longer had a controlling interest in Golden Harp which was then
Resources Inc. accounted for under the equity method. As of June 30, 2011, and May 31, 2010, the Company owned
10,000,000 shares of Golden Harp. The Company’s proportionate interest in Golden Harp declined from
65.32% to 40.53% during fiscal 2008 as a result of issuances of common shares by Golden Harp and
from the exercise of stock options and warrants. The Company’s proportionate interest in Golden Harp
declined further, from 40.53% to 40.51% during fiscal 2010 as a result of issuances of common shares
by Golden Harp due to the exercise of warrants. The Company, through its shareholding in Golden Harp,
exercises significant influence over that company. As a result, the investment in Golden Harp is
accounted for using the equity method.
Details of the investment in Golden Harp are as follows:
Amount $
Balance, May 31, 2009 2,291,427

Dilution loss from share issuances (269)
Proportionate share of net loss (262,037)
Proportionate share of unrealized gain on available for sale marketable securities 12,153
Write-down of investment (541,274)
Balance, May 31, 2010 1,500,000

Proportionate share of net loss (203,265)
Proportionate share of unrealized gain on available for sale marketable securities 16,307
Write-down of investment (13,042)
Balance, June 30, 2011 1,300,000
As at June 30, 2011, the Company’s investment in Golden Harp had a quoted market value of $1,300,000.
The Company’s management believes the decline in quoted market price is other than temporary and the
investment was written down to $1,300,000.
A parent need not present consolidated financial statements if and only if all of the condi-
tions listed below exist:
(a) the parent is itself a wholly owned subsidiary, or is a partially owned subsidiary of
another company and its other owners, including those not otherwise entitled to vote,
have been informed about, and do not object to, the parent not presenting consolidated
financial statements;
(b) the parent’s debt or equity instruments are not traded in a public market (a domestic or for-
eign stock exchange or an over-the-counter market, including local and regional markets);
(c) the parent did not file, nor is it in the process of filing, its financial statements with a
securities commission or other regulatory organization for the purpose of issuing any class
of instruments in a public market; and
(d) the ultimate or any intermediate parent of the parent produces consolidated finan-
cial statements available for public use that comply with International Financial
Reporting Standards. (.10 IAS 27).
As an illustration of the exemption from consolidation, consider the group structure in

Illustration 1.3, showing a wholly owned subsidiary.
A Ltd. is required to prepare consolidated financial statements combining the financial
statements of the parent A Ltd. and its subsidiaries B Ltd. and C Ltd. B Ltd. is also a parent
company, with C Ltd. being its subsidiary. Is B Ltd. also required to prepare consolidated
financial statements? If B Ltd. meets the requirements of paragraph 10, it does not have to
prepare consolidated financial statements.
Is B Ltd. itself a wholly owned subsidiary? In Illustration 1.3, B Ltd. is itself a wholly owned
subsidiary. Even in the group structure in Illustration 1.4, where A Ltd. has only an 80% inter-
est in B Ltd., B Ltd. may be exempted from preparing consolidated financial statements if,
Illustration 1.3
Exemption from
A Ltd.
Consolidation (a): Wholly
Owned Subsidiary
100%
B Ltd.
100%
C Ltd.
in accordance with paragraph 10(a), B Ltd. can persuade its other owners, the 20% non-con-
trolling interest, not to object to not presenting consolidated financial statements.
• Are the debt and equity instruments of B Ltd. traded in a public market? In Illustration 1.3,
where B Ltd. is a wholly owned subsidiary, it would be unlikely that its shares would be
traded in a public market.
• Has B Ltd. filed its financial reports with a regulatory agency for the purpose of issuing
any class of instruments in a public market?
• Has A Ltd. produced consolidated financial statements complying with International
Financial Reporting Standards?
A parent is not allowed to exclude any subsidiary from the consolidated financial state-
ments.
IAS 27 specifically notes some areas where exclusions of subsidiaries from consolidation
are not permitted, namely, where:
• the business activities of a subsidiary are different from those of other subsidiaries (para-
graph 17) and
• the investor is not a company, such as a trust, partnership, a mutual fund, or a venture
capital organization (paragraph 16).
Similarly, exclusions from consolidation do not exist where:
• there is a large non-controlling interest and

• there are severe long-term restrictions that impair the ability to transfer funds to the parent.
Illustration 1.4
Exemption from
A Ltd.
Consolidation
(a): Partially Owned
Subsidiary 80%
A 80%
B Ltd.
NCI 20%
100%
C Ltd.
Illustrative Example 1.6 shows the presentation of the consolidated statement of financial
position.
Illustrative Example 1.6 Consolidation Presentation

Assume that ABC Co. acquires its 100%-owned investment in XYZ Co. on December
31, 2013. The amount paid for the investment is equal to the book value of XYZ at
that date.
ABC CO.
As at December 31, 2013
Assets
Cash $ 1,000
Accounts receivable 2,000
Inventory 4,000
Investment in XYZ Co. 3,000
$10,000
Liabilities and Equity
Accounts payable $ 2,000
Common shares 4,500
Retained earnings 3,000
Cumulative other comprehensive income 500
$10,000
XYZ CO.
Assets
Cash $1,200
Inventory 2,000
$4,200
Accounts payable $1,200
Common shares 1,500
$4,200
ABC CO.
Consolidated Statement of Financial Position
Assets
Cash (1,000 + 1,200) $ 2,200
Accounts receivable (2,000 + 1,000) 3,000
Inventory (4,000 + 2,000) 6,000
investment disappeared $11,200
Accounts payable (2,000 + 1,200) $ 3,200
Common shares 4,500
$11,200
Applying ASPE to Each Type of Investments in Shares

ASPE
Under ASPE, the criteria for control are covered in Section 1590 Subsidiaries. The definition
of control is different than under IFRS. Section 1590.03 states that control is:
The continuing power to determine its strategic operating, investing and financing poli-
cies without the co-operation of others.
In practice, this definition should usually result in the same companies being defined
as parent–subsidiary relationships under ASPE as under IFRS. In addition, ASPE contains
accounting guideline 15, Consolidation of Variable Interest Entities, which requires the con-
solidation of special purpose entities where the reporting company is the primary benefici-
ary. It was expected that ASPE would adopt the new definition of IFRS 10 by 2014 and also
eliminate the guideline at that time.
Under ASPE, a reporting company can make an accounting policy choice to report a
subsidiary on its financial statements using the equity method or the cost method. It is not
required to consolidate subsidiaries. If the company chooses the cost or equity method, it
must provide additional disclosures to the reader. All subsidiaries of the reporting company
must use the same method. If the equity of the subsidiary is quoted on an active market, the
cost method is not an alternative. In that case, the investment would be recorded at fair value
with the gain or loss recorded in net income.
Under ASPE, a parent and its subsidiaries may prepare combined financial statements,
where the financial statements of the subsidiaries are combined but the parent’s financial
statements are excluded. This may be useful when one individual owns a controlling inter-
est in several corporations. These combined statements could also be used to present the
financial position and the results of operations of a group of subsidiaries, or to combine the
financial statements of companies under common managements (1601.04).
✓ LEARNING CHECK
• There are three characteristics of control: the power criterion, the returns criterion, and the
link between power and returns.
• Power over an investee exists when the investor has existing rights that give it the ability to
direct relevant activities.
• The investor must have the current ability to determine relevant activities in order to have
power.
• The benefit/returns that a parent may receive by obtaining control are not just dividends,
but relate to any circumstances or relationships that potentially change the parent’s earning
capacity.
• There is a presumption that control exists where the company owns more than 50% of the
voting shares of the investee.
• The parent must be able to use its power to affect the returns.
• Parent entities are required to prepare consolidated financial statements by combining the
financial statements of the parent and its subsidiaries since they are considered to be one
economic entity.
• Under ASPE, companies may report their investments using the cost method or the equity
method.
ASSOCIATES
Objective 3 The relationship between an investor and its associated entities is seen as being of special
Identify and significance so that a specific accounting method—the equity method of accounting—is
account for required to provide information about the investor and its associates. The nature of the
associates. investor–associate relationship is clearly defined, in this case in IAS 28 Investments in Associates
and Joint Ventures, and the principles of the equity method are specifically established. The
equity method is explained at the end of this section and is relevant for both associates and
joint ventures; however, the accounting for investments in associates is our first focus.
Identifying Associates
An associate is defined in paragraph 2 of IAS 28 as follows:
An associate is an entity, including an unincorporated company such as a partnership, over
which the investor has significant influence and that is neither a subsidiary nor an interest in a
joint venture.
The criteria used to identify an associate are discussed in the next section.
Significant Influence
The key characteristic determining the existence of an associate is that of significant influ-
ence. This term is defined in paragraph 2 of IAS 28 as follows:
Significant influence is the power to participate in the financial and operating policy decisions of
the investee but is not control or joint control over those policies.
Note the following features of this definition:
• The definition requires the investor to have the power, or the capacity, to affect the
investee. The definition does not require the investor to actually exercise that power,
only to possess it.
• The specific power is that of being able to participate in the financial and operating deci-
sions of the investee. Whereas the parent–subsidiary relationship is defined in terms of
the power or capacity to dominate the financial and operating decisions of the subsidiary,
the investor–associate relationship relates to the power to participate in those same deci-
sions. Hence, the investor–associate relationship is of the same nature as that existing
between a parent and subsidiary, the difference being the level of power that can be exer-
cised.
• In the definitions of an associate and significant influence, there is no requirement for
the investor to hold any shares, or have a beneficial interest, in the associate. However,
as is discussed in more detail later in this section, the application of the equity method
of accounting is based on the investor owning shares in the associate. In other words, if
significant influence is exercised by one company over another by virtue of an associa-
tion or contract other than from the holding of shares, then the equity method cannot be
applied in relation to the associate. Even in such cases, however, some of the disclosures
required by IAS 28 in relation to associates may still be required.
Assessing the existence of significant influence requires accountants to exercise judge-

ment. IAS 28 provides further guidance to help in this determination. It states that where an
investor holds, directly or indirectly (for example, through subsidiaries), 20% or more of the
voting power of the investee, it is presumed that the investor has significant influence over
the investee. However, if the investor can demonstrate that such influence does not exist, the
Strategic Investments—Associates 27
investee is not classified as an associate. Further, where the investor owns less than 20% of
another company, there is a presumption that the investee is not an associate. It is therefore
possible for more than one company to have significant influence over another company, but
there can be only one parent company in relation to a subsidiary.
IAS 28 also provides a list of factors that may provide evidence of the existence of signifi-
cant influence:
(a) representation on the board of directors or equivalent governing body of the investee
(b) participation in policy-making processes, including participation in decisions about divi-
dends or other distributions
(c) material transactions between the investor and the investee
(d) interchange of managerial personnel
(e) provision of essential technical information.
In all of these examples, the evidence relates to actual participation. In general, the most
common form of participation is that of representation on the board of directors. In other
words, because of the significance of the ownership interest of the investor in the associate,
the investor is able to obtain representation on the board of directors and hence influence the
decision-making in the investee.
The potential effect of the exercise of options or convertible securities should be con-
sidered in cases where the holder currently has the ability to exercise or convert those rights.
Where the rights are not exercisable because they are subject to a time constraint or tied to
some future event, they should not be taken into consideration. Note that there must be a
current ability to exercise power, not a future ability to do so (IAS 28.9).
Exclusions to the Definition of Associate

Some entities that would meet the definition of associates are excluded from the require-
ments of IAS 28. IAS 28 does not apply to investments in associates held by venture capital
organizations, or mutual funds, unit trusts, and similar entities, including investment-linked
insurance funds. Upon initial recognition, these entities report their associates as FVTPL
and account for them at fair value in accordance with IFRS 9.
Such entities must recognize changes in the fair values of those investments in the cur-
rent period profit or loss. These exclusions were made because of the lack of relevance of
equity-accounted information to those entities, as well as the frequent changes in the level
of ownership in these investments by such entities. Generally these types of companies are
interested in the return on their investment and therefore fair value information is considered
more useful information for their financial statement users. As of the time of writing, there
was an exposure draft outstanding that would exclude companies that meet the definition of
an investment company from the requirements of this section for the same reasons as out-
lined in the previous section.
IAS 28 also provides exclusions from applying the equity method to associates. In par-
ticular, where the investment in the associate is acquired and held exclusively with a view
to its disposal within 12 months of acquisition, and the management is actively seeking a
buyer, the equity method does not have to be applied to that associate. Appendix B of IAS 5
Non-current Assets Held for Sale and Discontinued Operations establishes criteria for classifying
assets as “held for sale.” Such assets are required to be measured at the lower of their carrying
amounts and fair values less costs to sell. If the associate is not disposed of within 12 months,
the financial statements must be restated and the investment accounted for according to the
equity method.
Where all these conditions apply, the company must account for the associate as a
FVTPL investment accounted for at fair value, with changes in fair value affecting current
period income.
There is also a list of other exemptions to the requirement to report affiliates using the
equity method. Where all the following apply, an investor need not apply the equity method
of accounting:
• The investor is a wholly owned subsidiary, or is a partially owned subsidiary of another
entity and its owners have been informed about and do not object to the investor not
applying the equity method.
• The investor’s debt or equity securities are not traded in a public market such as a domes-
tic or foreign stock exchange.
• The investor did not file, and is not in the process of filing, its financial statements with
a securities commission or other regulatory organization, for the purpose of issuing any
class of securities in a public market.
• The ultimate or any intermediate parent of the investor produces consolidated finan-
cial statements that comply with Canadian accounting standards and thus International
Financial Reporting Standards.
Illustration 1.5 is an excerpt regarding investments in associates from the financial statements
of Scorpio Mining Corporation, a Canadian-based silver and base metal producer in Mexico.
Illustration 1.5 (m) Investments

Excerpt from the Scorpio An associate is an entity over which the Corporation has significant influence and that is neither a subsidi-
Mining Corporation ary nor an interest in a joint venture. Significant influence is the power to participate in the financial and
Financial Statements operating policy decisions of the investee but is not control or joint control over those policies. Manage-
ment determined that since the Corporation holds approximately 19.4% of the outstanding shares of
Scorpio Gold and had two of Scorpio Mining’s directors seating on Scorpio Gold’s board of directors until
June 15, 2011, Scorpio Mining had significant influence over Scorpio Gold until that time. Subsequently,
the number of directors in common changed from two to one at which time the Corporation ceased to have
significant influence over Scorpio Gold. Accordingly, the results of Scorpio Gold are incorporated in these
consolidated financial statements using the equity method of accounting until June 15, 2011, and there-
after the investment in Scorpio Gold’s shares has been recorded as an available-for-sale financial instru-
ment recorded at fair value with fair value adjustments recorded in other comprehensive earnings (loss).
Investments in companies over which the Corporation exercises neither control nor significant influence
and are designated as available-for-sale financial instruments are recorded at fair value. Unrealized gains
and losses on available-for-sale financial instruments are recognized in other comprehensive earnings
(loss), unless the unrealized earnings (loss) are considered other than temporary, in which case, the earn-
ings (loss) is recorded in the statements of operations.
Equity Method of Accounting

The equity method is used for reporting of associates and joint ventures (which are discussed in
the next section). Under the equity method, the investment account is updated for the investor’s
share of profit and distributions. In this chapter we introduce the basics of the equity method.
The complexities are covered in detail in Chapter 6 since applying the equity method requires
an analysis of the acquisition similar to that undertaken when accounting for subsidiaries.
Rationale
When reflecting an investment using the cost method, the investment is initially recorded
at cost and the balance is not adjusted in subsequent periods unless there is an impairment.
Dividends are reported as income. Reflecting the investment at cost may be unsatisfactory
for associates because the recognition of dividends may not be an adequate measure of the
income earned by the investor. The distribution received may bear little relation to the per-
formance of the associate. Further, it is argued that applying the equity method provides
more informative reporting of the net assets and profit or loss of the investor.
The criterion of control used for identifying subsidiaries has similarities with the defini-
tion of significant influence used for associates. IAS 28 states:
Many of the procedures appropriate for the application of the equity method are similar to the con-
solidation procedures described in IAS 27 Consolidated and Separate Financial Statements.
Furthermore, the concepts underlying the procedures used in accounting for the acquisition of
a subsidiary are also adopted in accounting for the acquisition of an investment in an associate.
Because of the similarity with the principles and procedures used in applying the con-
solidation method to subsidiaries, the equity method of accounting has sometimes been
described as “one-line consolidation.” However, IAS 28 does not consistently use the con-
solidation principles in its application of the equity method.
Similarities and differences between the consolidation method and the equity method
are noted in Chapter 6, where the equity method is described in detail.
Applying the Equity Method: Basic Method

IAS 28 provides a description of the basics of the equity method. The key steps are:
1. Recognize the initial investment in the associate or joint venture at cost.

2. Increase or decrease the carrying amount of the investment by the investor’s share of
the profit or loss of the investee after the date of acquisition (post-acquisition profit
or loss).
3. Reduce the carrying amount of the investment by distributions (such as dividends)
received from the associate or joint venture.
4. Increase or decrease the carrying amount of the investment for changes in the investor’s
share of the changes in the investee’s other comprehensive income. This may apply to
changes arising from the revaluation of property, plant, and equipment and from foreign
exchange translation differences. The investor’s share of those changes is recognized in
other comprehensive income of the investor.
Although potential voting rights may be used in assessing the existence of significant
influence, they are not used in any of the calculations (paragraph 12 IAS 28).
Illustrative Example 1.7 demonstrates the basic application of the equity method.
Illustrative Example 1.7 Basic Application

of the Equity Method
On January 1, 2013, Flute Ltd. acquired 25% of the shares of Fife Ltd. for $42,500. At
this date, all the identifiable assets and liabilities of Fife were recorded at amounts equal
to fair value, and Fife’s equity consisted of:
Share capital $100,000
Asset revaluation—OCI 20,000
During 2013, Fife reported a profit of $25,000. The asset revaluation reserve
increased by $5,000, reported in other comprehensive income, and Fife paid a $4,000
dividend.
At January 1, 2013, Flute recorded the investment in Fife at $42,500. At December 31,
2013, the journal entries to apply the equity method in the investor’s records are:
1. Recognition of share of profit or loss of associate
Investment in Associate 6,250
Share of Profit or Loss of Associate 6,250
(Share of associate’s profit: 25% × $25,000)
The Share of Profit or Loss of Associate is disclosed as a separate line item in the
statement of comprehensive income, per IAS 1 paragraph 82(c).
2. Recognition of increase in asset revaluation reserve—OCI

Asset Revaluation Reserve 1,250

(Share of reserve: 25% × $5,000)
This increase is also disclosed as a separate line item in the statement of com-
prehensive income, per IAS 1 paragraph 82(h) Share of Other Comprehensive Income
of Associate.
3. Adjustment for dividend paid by associate

Cash 1,000
(Adjustment for dividend paid by associate: 25% × $4,000)
Because the investor has recognized its share of the equity of the associate, the
dividend is simply a receipt of equity already recognized in the investment account.
At December 31, 2013, the investment in the associate is measured at $49,000 (i.e.,
$42,500 ⫹ $6,250 ⫹ $1,250 ⫺ $1,000). The equity of Fife consists of:
Asset revaluation reserve ($20,000 + $5,000) 25,000
Retained earnings ($50,000 + $25,000 − $4,000) 71,000
$196,000
The investor’s share of the associate’s equity is 25% of $196,000 (i.e., $49,000),
which is the same as the recorded amount of the investment in the associate. In other
words, the equity method, in this case, is designed to show the investment in the associ-
ate at an amount equal to the investor’s share of the reported equity of the associate. As
will be explained in Chapter 6, this relationship is not always achieved because of the
effects of pre-acquisition equity, the existence of goodwill, and adjustments made for
the effects of inter-company transactions.
Now assume that during 2014, Fife reported a profit of $6,000. The asset revalua-
tion reserve increased by $4,000, as reported in other comprehensive income, and Fife
paid a $12,000 dividend.
At December 31, 2014, the journal entries to apply the equity method, in the
records of the investor, are:
1. Recognition of share of profit or loss of associate

(Share of associate’s profit: 25% × $6,000)
2. Recognition of increase in asset revaluation reserve—OCI

Asset Revaluation Reserve 1,000
(Share of reserve: 25% × $4,000)
3. Adjustment for dividend paid by associate

Cash 3,000
(Adjustment for dividend paid by associate: 25% × $12,000)
Note that it does not matter that the dividend is greater than the income earned in
the current period.
At December 31, 2014, the investment in the associate is measured at $48,500

(i.e., $49,000 ⫹ $1,500 ⫹ $1,000 ⫺ $3,000). The equity of Fife consists of:
Asset revaluation reserve ($20,000 + $5,000 + $4,000) 29,000
Retained earnings ($50,000 + $25,000 − $4,000 + $6,000 − $12,000) 65,000
$194,000
The investor’s share of the associate’s equity is 25% of $194,000 (i.e., $48,500),
which is the same as the recorded amount of the investment in the associate. In other
words, the equity method in this case is designed to show the investment in the associ-
ate at an amount equal to the investor’s share of the associate’s reported equity. Again,
as will be explained in Chapter 6, this relationship is not always achieved because of the
effects of fair value adjustments, the existence of goodwill, and adjustments made for
the effects of inter-company transactions.
A company is required to follow the same impairment testing as is required for tangible
capital assets (IAS 36 Impairment of Assets). However, the company may also be responsible
for losses in addition to the investment itself. The company may have guaranteed liabilities of
the associate or may have agreed to purchase goods from the associate. This issue is explored
further in Chapter 6. The measurement of the impairment is based on comparing its recover-
able amount (higher of value in use and fair value less costs to sell) with its carrying amount.
The impairment is recorded in net income and may be reversed to the extent that the recov-
erable amount of the investment subsequently increases (IAS 28.33).
Applying ASPE to Each Type of Investment

ASPE
Under ASPE, significantly influenced investments are covered in Section 3051. The criteria
are the same as those proposed under IFRS for identifying significantly influenced invest-
ments and for the equity method. The only difference is that under ASPE, the company has
the option of using the cost method rather than the equity method for reporting its invest-
ment, which is significantly influenced. This would be an accounting policy choice. If the
company chooses to use the cost method for reporting, it must use that same method for all
of its significantly influenced investments. If the company chooses to use the equity method
for reporting, it must use that method for all of its significantly influenced investments.
If the investment is in shares of a public company, the cost method is not an option. If
the equity method is not used, the available option is fair value.
Under ASPE, the treatment of impairment is the same as it was for non-strategic invest-
ments. One of the goals of ASPE was to simplify the accounting process by creating one type
of impairment testing for all investments.
✓ LEARNING CHECK
• The key criterion for identifying an investor–associate relationship is that the investor has
significant influence over the associate.
• IAS 28 provides guidelines to help determine the existence of significant influence, including
the ability to influence the investee’s board of directors and the existence of material transac-
tions between the investor and the investee.
• The investor does not need to hold shares in an associate, but where more than 20% of the
voting power is held, significant influence is presumed to exist.
• The equity method is applied from the date the investor obtains significant influence over the
investee.
• Where dividends are paid or declared by an associate, no dividend revenue is recognized by
the investor.
JOINT ARRANGEMENTS
Identifying Joint Arrangements
Objective 4 A company may engage in arrangements that provide for joint control. The defi nition
Identify and of control is the same as that used for the assessment of parent–subsidiary relationships.
account for joint IFRS 11 Joint Arrangements identifies joint control as:
arrangements.
The contractually agreed sharing of control over an arrangement, which exists only when
decisions about the relevant activities require the unanimous consent of the parties sharing
control (IFRS 11.7).
We will use the term “investors” to describe a party that has joint control over that joint
arrangement. The investors are bound by a contractual arrangement and it is the contractual
arrangement that establishes control. This contractual arrangement may be in the form of
minutes of a meeting or it may be a specific legal contract. It may be incorporated in the
articles or the by-laws of the joint arrangement.
Consider the following example: Assume that three parties establish an arrangement: A
has 50% of the voting rights in the arrangement, B has 30%, and C has 20%. The contractual
arrangement between A, B, and C specifies that at least 75% of the voting rights are required
to make decisions about the relevant activities of the arrangement. Even though A can block
any decision, it does not control the arrangement because it needs the agreement of B. The
terms of their contractual arrangement requiring at least 75% of the voting rights to make
decisions about the relevant activities imply that A and B have joint control of the arrange-
ment because decisions about the relevant activities of the arrangement cannot be made with-
out both A and B agreeing (IFRS 11.B8 application example).
All parties must unanimously agree on a decision, which also means that no one party can
have control, nor can two parties collude to outvote a third party.
Joint arrangements can take different forms and structures. There are two different
types of joint arrangements identified in IFRS 11: joint operations and joint ventures. The
nature of the joint arrangement is affected by the rights and/or obligations in the normal
course of business that the investors have. A joint arrangement is often created as a separate
legal company. When joint arrangements are established in a separate company, it will be
necessary to consider all relevant facts and circumstances to assess whether the arrangement
is a joint operation or a joint venture, including the structure and form of the arrangement
and contractual terms agreed by the parties.
Each type of joint arrangement is aligned with a distinct reporting requirement.
Joint Operations
In a joint operation, the investor has a contractual right or obligation to the assets and liabili-
ties of the operation.
A joint arrangement that is not structured as a separate entity is a joint operation.
However, a separate entity could still be a joint operation. A joint operation is usually a joint
Strategic Investments—Joints Arrangements 33
arrangement that involves the use of the assets and other resources of the parties, often to
manufacture and sell joint products.
Consider the following examples:
1. The contractual arrangement specifies the basis on which the revenue from the sale of
joint products and expenses incurred in common are shared among the parties. Two
pharmaceutical companies enter into an agreement whereby one of them develops a drug
and the other distributes the drug to customers. Each party uses its own assets, incurs its
own expenses, and receives an agreed share of the revenue from the sale of the drug.
2. The arrangement may also include an operation that is only one asset. Each party has
rights to the asset and often joint ownership. Consider the example where several tele-
communication companies jointly operate a network cable. Each party uses the cable for
data transfer, in return for which it bears an agreed proportion of the costs of operating
the cable.
3. Two investors create a separate company called Venturco. One investor owns 40% of
Venturco and the other owns 60%. There is an agreement that provides for joint control.
The incorporation documents state clearly that the assets and liabilities of Venturco are
the responsibility of one investor equal to their 40% and the other investor equal to their
60%. As such, the two venturers have the rights and obligations for the actual assets and
liabilities and this would be a joint operation.
Joint Ventures
A joint venture must be set up as a separate vehicle. This could mean that a corporation is
created but it could also take other legal forms that separate the venture from the investors.
A company is a party to a joint venture when it does not have the right to the assets or the
obligations for the liabilities. A company is a party to a joint venture if it has rights only to a
share of the outcome generated by a group of assets and liabilities carrying on an economic
activity (i.e., to share in the net income). The party does not have rights to individual assets
or obligation of the venture, only to the net assets.
Consider the following example. Stanstead Inc. starts a joint venture, Stanmod Inc., in
a foreign country in conjunction with Modern Ltd., which is incorporated in that country.
Neither company controls the individual assets or is obliged to pay for the liabilities and
expenses of the venture. Stanmod Inc. is responsible for its obligations and has the rights to
its assets. Stanstead Inc. and Modern Ltd. together govern the financial and operating poli-
cies of the venture; each is entitled to a share of the profit or loss generated by the activities
of the venture.
Accounting and Reporting for Joint Arrangements

Joint Operations
The party to the joint operation is required to report its share of each asset and liability, rev-
enue, or expense that it owns. For example, if Lonestar Inc. owns 30% of a jointly controlled
operation, it would reflect 30% of each asset, liability, income, or expense that is part of the
joint operation on its own financial statements.
Joint Ventures
Since a joint venture is normally a separate legal entity, the investor in the joint venture
will record in its own books an investment in the joint venture equal to the fair value of the
contribution made to obtain their percentage ownership. Since by definition the investor has
joint control, it follows that all parties must have significant influence, as defined earlier in
the chapter. Each investor participates in the operating and financing decisions of the joint
venture. As such, the investor is required to report the investment using the equity method.
The equity method was described in the previous section and is elaborated upon in Chapter 6.
Consolidation is not deemed appropriate since joint control implies shared control, which
means that a parent–subsidiary relationship does not exist.
Illustration 1.6 is an excerpt from the financial statements of Canadian-based Barrick
Gold Corporation, the world’s largest gold producer, showing a note on joint ventures.
Illustration 1.6 Joint Ventures

Excerpt from the Financial A joint venture is a contractual arrangement whereby two or more parties undertake an economic activ-
Statements of Barrick ity that is subject to joint control. Joint control is the contractually agreed sharing of control such that
Gold Corporation significant operating and financial decisions require the unanimous consent of the parties sharing control.
Our joint ventures consist of jointly controlled assets (“JCAs”) and jointly controlled entities (“JCEs”).
A JCA is a joint venture in which the venturers have control over the assets contributed to or acquired for
the purposes of the joint venture. JCAs do not involve the establishment of a corporation, partnership or
other entity. The participants in a JCA derive benefit from the joint activity through a share of production,
rather than by receiving a share of the net operating results. Our proportionate interest in the assets,
liabilities, revenues, expenses, and cash flows of JCAs are incorporated into the consolidated financial
statements under the appropriate headings.
A JCE is a joint venture that involves the establishment of a corporation, partnership or other entity
in which each venturer has a long term interest. We account for our interests in JCEs using the equity
method of accounting.
On acquisition, an equity method investment is initially recognized at cost. The carrying amount of eq-
uity method investments includes goodwill identified on acquisition, net of any accumulated impairment
losses. The carrying amount is adjusted by our share of post acquisition net income or loss, depreciation,
amortization or impairment of the fair value adjustments made at the date of acquisition, and our share of
post acquisition movements in Other Comprehensive Income (“OCI”).
Applying ASPE to Each Type of Joint Venture Investment

ASPE
Under ASPE the topic of joint ventures is covered in Section 3055. This section identi-
fies three types of joint ventures:
1. jointly controlled operations
2. jointly controlled assets
3. jointly controlled enterprises
Under ASPE jointly controlled operations and jointly controlled assets are report-
ed using proportionate consolidation. This means that the venturer recognizes on its
balance sheet the assets that it controls and the liabilities that it incurs. The venturer
recognizes on its income statement its share of the revenue of the joint venture and its
share of the expenses incurred by the joint venture. This result is the same as that re-
quired for jointly controlled operations under IFRS.
However, ASPE provides a choice for jointly controlled enterprises, which aligns
with the definition under IFRS of joint ventures. A company has the option of using
proportionate consolidation or the equity method to report its investment. In addition,
under ASPE a company has an accounting policy choice to report the investment using
the cost method.
A company tests for impairment if there are any indications that an interest in a
joint venture measured at cost or using the equity method may be impaired. Indicators
of impairment may be that the joint venture is having significant financial difficulties
or there may be a significant adverse change in the technological, market, economic,
or legal environment in which the joint venture operates. When the company identifies
a significant adverse change in the expected timing or amount of future cash flows, it
reduces the carrying amount to the higher of the present value of the cash flows ex-
pected to be generated by holding the interest, discounted using a current market rate
of interest appropriate to the asset, and the amount that could be realized by selling the
interest at the balance sheet date. Any impairment is recognized in net income (Section
3055.42 and .43).
Learning Summary 35
✓ LEARNING CHECK
• A joint arrangement is a contractual arrangement that provides for joint control.
• Joint control requires the unanimous agreement among the parties sharing control.
• Two types of joint arrangements exist: joint operations and joint ventures.
• The parties to a joint operation are required to report their share of each asset and liability.
• The parties to a joint venture will initially record their share of the investment at fair value. In
subsequent periods the equity method will be used for reporting purposes.
LEARNING SUMMARY
KEY TERMS
Associate (p. 26)
In this chapter we have studied the different types of investments that companies make in
Consolidated financial
other entities. We reviewed the two primary reasons for these types of investments being
statements (p. 21)
strategic or non-strategic.
Control (p. 12)
Non-strategic investments are initially recorded at fair value and then restated each year
Equity method (p. 28)
to their current fair value. The gains and losses are reflected in net income unless an election
Fair value (p. 8)
is made to record the gains and losses in other comprehensive income (OCI). If the election
Fair value through
is made, the effect in OCI is not recycled through net income.
profit and loss
When looking at strategic investments, IFRS identifies the following types of invest-
(p. 6)
ments: parent–subsidiary, associates, and joint arrangements.
Joint control (p. 32)
A parent–subsidiary relationship exists when the parent controls the subsidiary. Control
Joint operation (p. 32)
is achieved when three criteria are present: the company has power over the relevant operat-
Joint venture (p. 32)
ing and financing decisions of the investee, the company has the rights to the variable return
Proportionate
associated with the investee, and the company has the ability to affect those returns. It is pre-
consolidation
sumed that in situations where the parent owns more than 50% of the shares of the investee
(p. 34)
it controls that investee. In a parent–subsidiary relationship, the company must prepare con-
Significant influence
solidated financial statements. In preparing the consolidated financial statements, the invest-
(p. 26)
ment account on the parent’s books is replaced with the actual assets, liabilities, revenues, and
Subsidiary (p. 12)
expenses of the investee on the financial statements.
A company is deemed to have an investment in an associate when the company has sig-
nificant influence over that associate. Significant influence exists when the company has the
power to participate in the financial and operating policy decisions of the investee. It is pre-
sumed that the ownership of between 20 and 50% of the voting shares provides significant
influence. A company must report its investment in an associate using the equity method.
Under this method the investment is initially recorded at cost and is updated each year for its
share of the associate’s total income and dividends.
A joint arrangement exists when there is joint control among all the investors who
share control. Joint control requires the unanimous consent of the participants regardless
of their ownership interest. Joint arrangements can be in the form of joint operations or
joint ventures. In a joint operation the investors own the actual assets and liabilities of
the joint venture. As such, the investor must pick up its proportion of each asset, liability,
revenue, and expense on its financial statement. In a joint venture, the investor is entitled
only to the net assets of the joint venture. As such, the investor uses the equity method
to report its interest in the joint venture. As for associates, the investor in a joint venture
initially records the investment at cost and updates the investment account each year
for its share of the total income of the joint venture and any distributions by the joint
venture.
The key differences among the four types of investments discussed in this chapter are presented in the
illustration below.
Issue Non-strategic Investments Strategic Investments in Strategic Investments Strategic Investments in

in Equity (Financial a Subsidiary in Associates Joint Arrangements
Assets)
Definition Equity instrument in Exposed, or has rights, Power to participate in the Joint operation: parties
another company where to variable returns from financial and operating that have joint control
there is no power to its involvement with the policy decisions of the of the arrangement have
participate in the financial investee and has the investee rights to the assets, and
and operating decisions ability to affect those obligation for the
of the investee returns through its power liabilities
over the investee
Joint venture: parties that
have joint control of the
arrangement have rights
to the net assets of the
arrangement
Presumption Less than 20% ownership Greater than 50% of the Between 20 and 50% of Contractual agreement
of voting shares voting shares the voting shares providing joint control
Initial Fair value Cost Cost Cost

recognition
Presentation Fair value Consolidation Equity method Joint operations:

proportionate allocation
Joint ventures:
equity method
Effect on net Dividend revenue and gain Parent and subsidiary Investor share of investee Venturer share of joint
income or loss in change in fair income statement items net income venture net income
value combined on the
income statement
(If election is made
the gain or loss will go
through OCI)
Brief Exercises
(LO 1) BE1-1 What is a financial asset?
(LO 2) BE1-2 What are the three main criteria to determine control?
(LO 3) BE1-3 What is an associate company?
(LO 3) BE1-4 Why are associates distinguished from other investments held by the investor?
(LO 3) BE1-5 Discuss the similarities and differences between the criteria used to identify subsidiaries and those used to
identify associates.
(LO 3) BE1-6 What is meant by “significant influence”?
(LO 3) BE1-7 What factors could be used to indicate the existence of significant influence?
(LO 1, 3) BE1-8 Discuss the relative merits of accounting for investments at cost, at fair value, and using the equity method.
(LO 2) BE1-9 What is a parent–subsidiary relationship?
(LO 4) BE1-10 What is the key difference between a joint operation and a joint venture?
Problems 37
Exercises
(LO 1) E1-1 Skuttle Inc. buys 200 shares of Berke Inc. on March 1, 2013, for $4.20 per share. Skuttle Inc. incurs transaction
costs of $120. At December 31, 2013, the market price is $5.10 per share. Skuttle Inc. sells the shares on February 1,
2014, for $1,020 and incurs transaction costs of $50.
Required
Prepare the journal entries that Skuttle would make to record its transactions in Berke shares using IFRS 9.
(LO 3) E1-2 Max Inc. acquires 40% of the shares of Guarasci Inc. for $80,000 on January 1, 2013. During 2013, Guarasci
earned $50,000 and paid dividends to its shareholders of $10,000. During 2014, Guarasci incurred a loss of $5,000 but
continued to pay a $10,000 dividend to all shareholders.
Required
(a) Prepare the journal entries that Max Inc. would make in each of the years 2013 and 2014.
(b) Indicate the balance in the Investment in Guarasci on the balance sheet for the years ended 2013 and 2014.
(LO 4) E1-3 Campbell Ltd. invested in a joint venture by providing cash of $160,000. Campbell obtained a 22% interest in
the joint venture based on its contribution. During the year, the joint venture earned $17,500.
Required
(a) Prepare the journal entries that Campbell would make with respect to investment in this joint venture.
(b) What would the journal entries be if the arrangement was a joint operation?
Problems
(LO 1) P1-1 On January 1, 2010, Aye buys 500 shares of Que, a public company, for $1.20 per share. On January 4, 2011,
Aye buys 200 shares of Are, a public company for $0.84 per share. On September 1, 2012, Aye buys an additional
1,000 shares of Que for $1.65 per share. Aye sold 50 shares in Are on March 1, 2013 for $47.00 in total.
Below are some relevant data regarding the transactions:
Que Are
Number of shares outstanding since 2009 5,000 3,500
Net income 2010 10,000 7,000
Net income 2011 8,000 8,000
Net income 2012 15,000 ⫺2,000
Net income 2013 10,000 ⫺1,000
Dividends 2010 1,000 500
Dividends 2011 1,000 750
Dividends 2012 1,000 500
Dividends 2013 1,000 200
Market value per share, December 31, 2010 1.40 1.00
• Aye follows IFRS 9 to record its financial instruments and does not make an election.
• Income is earned evenly over the year and dividends are declared and paid at year end.
Required
Assume that no election is made.
(a) Calculate the effect on net income of Aye for each of the years 2010 to 2013.
(b) Calculate the balance in the investment account to be reflected on each December 31 from 2010 to 2013.
(c) Calculate the effect on net income for each of the years 2010 to 2013 assuming that Aye follows ASPE.
(d) Calculate the balance in the investment account to be reflected on each December 31 from 2010 to 2013 assuming
that Aye follows ASPE.
(LO 1, P1-2 Acme Corp. has a portfolio of investments purchased at the amounts shown below at December 31, 2013. Acme
3, 4) is a private company but is contemplating going public.
1. 10% interest in Plato purchased on January 1, 2013
(fair value of the 10% interest on December 31, $16,000) $ 17,000
2. 40% interest in Bloor purchased five years ago for $250,000.
During this period of ownership, Bloor’s retained earnings has grown
$70,000. The fair value of the investment at December 31 is 280,000. 250,000
3. 50% interest in a joint venture, Rand, purchased January 1, 2013.
During the ownership period, Rand had income of $40,000 and paid
dividends of $10,000. 120,000
Required
(a) Calculate the balances to be reflected on the Acme December 31, 2013, statement of financial position in accor-
dance with ASPE.
(b) What will be different in the reporting of these investments for Acme if it were to become a public company?
Writing Assignments
(LO 3) WA1-1 The accountant of Cornett Chocolates Ltd., Maria Fraulein, has been advised by her auditors that the com-
pany’s investment in Concertina’s Milk Ltd. should be accounted for using the equity method of accounting. Cornett
Chocolates holds only 20.2% of the voting shares currently issued by Concertina’s Milk. Since the investment was
undertaken purely for cash flow reasons based on the potential dividend stream from the investment, Ms. Fraulein does
not believe that Cornett Chocolates exerts significant influence over the investee.
Required
Discuss the factors that Ms. Fraulein should investigate in determining whether an investor–associate relationship
exists, and what avenues are available so that the equity method of accounting does not have to be applied.
(LO 2) WA1-2 Two entities, Peter and Paul, invest in a new company, POPP, to manufacture vintage records. Peter has
experience in manufacturing records and has developed technology to improve the sound as well as the rights to many
recording artists who are interested in preserving this nostalgic form of recording. Paul is a venture capital company
that has financed other ideas that Peter has had in the past.
Peter will contribute the technology and know-how to the new company while Paul will contribute the financing.
Peter will own 45% of POPP and Paul will own 55%. Each company will appoint directors in proportion to their own-
ership percentage. The managing director and the director of finance will be appointed by Peter.
Required
How will Peter record its investment in POPP?
(LO 2) WA1-3 Godard Inc. enters into an agreement on March 1, 2013, to sell 60% of a wholly owned subsidiary, Combine
Ltd., which it has owned for several years to Svelt Inc. Godard’s representatives on the board of directors of Combine
will immediately resign and will be replaced by Svelt Inc.
Godard has also provided Combine with short-term financing in the form of a demand loan. Svelt has agreed to
apply certain operating decisions that Godard requires as long as the demand loan is outstanding. Godard can veto any
operating decision that is contrary to Godard’s requirements.
Required
Does Godard still have control over Combine? Explain.
(LO 4) WA1-4 Companies Acorn and Magex form a company Cane, to tender for a public contract with a government to
construct a highway between two cities. Acorn and Magex have joint control of the activities of Cane. Acorn will con-
struct three bridges needed to cross rivers on the route; Magex will construct all of the other elements of the highway.
Acorn and Magex will each use their own equipment and employees in the construction activity. Cane enters into a
contract with the government for delivery of the highway. It also enters into a contract with Acorn and Magex for
performance of the government contract. Acorn and Magex will invoice Cane for their respective shares of the total
amount invoiced by Cane to the government.
Required
Discuss the nature and the reporting of this arrangement by Acorn company.
(Adapted from ED joint arrangements, IASB)
(LO 4) WA1-5 Five advertising companies jointly buy a jet aircraft. They enter into an agreement whereby each party has
the right to use the aircraft for its own purposes some days each year. The parties may decide to use that right or they
Writing Assignments 39
might lease it to a third party. The parties share decision-making regarding maintenance and disposal of the aircraft.
The decisions require the agreement of all the parties.
Required
Discuss how each company would report this arrangement.
(LO 4) WA1-6 Two real estate companies jointly buy the land and buildings that constitute a shopping centre. The compa-
nies separately financed their share of the shopping centre acquisition.
They set up a separate legal company for the purpose of operating the shopping centre business and called it
Shoppers Heaven. They transferred their ownership in the shopping centre to the company. The activities of the
Shoppers Heaven business include renting the retail units, managing the parking lot, maintaining the centre and equip-
ment such as elevators, and building the reputations and customer numbers for the centre as a whole. Strategic deci-
sions relating to the operations require the consent of both companies.
The terms of incorporation of Shoppers Heaven are such that each company receives a share of the income from
the shopping centre. The companies have the right to sell or pledge their interest in the corporation.
Required
How would the real estate companies report this arrangement?
(LO 1, WA1-7
2, 3) 1. Taub Co. and Laughlin Co. own 80% and 20%, respectively, of the common shares that carry voting rights at a
general meeting of shareholders of Renwill Co. Taub sells one half of its interest to Renwill and buys call options
from Renwill that are exercisable at any time at a premium to the market price when issued, and if exercised would
give Taub its original 80% ownership interest and voting rights.
2. Companies Taub, Laughlin, and Midas Ltd. own 40%, 30%, and 30%, respectively, of the common shares that
carry voting rights at a general meeting of shareholders of Renwill. Taub also owns call options that are exercisable
at any time at the fair value of the underlying shares and if exercised would give it an additional 20% of the voting
rights in Renwill and reduce Laughlin’s and Midas’s interests to 20% each. If the options are exercised, Taub will
have control over more than one half of the voting power.
3. Entities Taub, Laughlin, and Midas own 25%, 35%, and 40%, respectively, of the common shares that carry vot-
ing rights at a general meeting of shareholders of Renwill. Entities Taub and Laughlin also have share warrants
that are exercisable at any time at a fixed price and provide potential voting rights. Taub has a call option to pur-
chase these share warrants at any time for a nominal amount. If the call option is exercised, Taub would have the
potential to increase its ownership interest, and thereby its voting rights, in Renwill to 51% (and dilute Laughlin’s
interest to 23% and Midas’s interest to 26%).
4. Companies Taub, Laughlin, and Midas each own 331/3% of the ordinary shares that carry voting rights at a general
meeting of shareholders of Renwill. Companies Taub, Laughlin, and Midas each have the right to appoint two
directors to the board of Renwill. Taub also owns call options that are exercisable at a fixed price at any time and if
exercised would give it all the voting rights in Renwill. The management of Taub does not intend to exercise the
call options, even if Midas and Laughlin do not vote in the same manner as Taub.
Required
For each of the independent situations illustrated above, describe the reporting by Taub Co.
(Adapted from IFRS illustrative example)
(LO 2, 3) WA1-8 Nepean Corp. and Warren Inc. own 80% and 20%, respectively, of the common shares that carry voting
rights at a general meeting of shareholders of Osaka Enterprises. Nepean sells half of its interest to Warren and buys
call options from Warren that are exercisable at any time at a premium to the market price when issued, and if exercised
would give Nepean its original 80% ownership interest and voting rights. At December 31, 2013, the options are out of
the money.
Required
Discuss whether Nepean is the parent of Osaka.
(Adapted from the Implementation Guidance to IAS 27)
(LO 2, 3) WA1-9 Clarence Ltd., Nordahl Corp., and Tweed Inc. each own one third of the common shares that carry voting
rights at a general meeting of shareholders of Parenteau Ltée. Clarence, Nordahl, and Tweed each have the right to
appoint two directors to the board of Parenteau. Clarence also owns call options that are exercisable at a fixed price at
any time and, if exercised, would give it all the voting rights in Parenteau. The management of Clarence does not intend
to exercise the call options, even if Nordahl and Tweed do not vote in the same manner as Clarence.
Required
Discuss whether Parenteau is a subsidiary of any of the other entities.
(LO 2, 3) WA1-10 Daintree and Hong own 55% and 45%, respectively, of the common shares that carry voting rights at a
general meeting of shareholders of Moor. Hong also holds debt instruments that are convertible into common shares of
Moor. The debt can be converted at a substantial price, in comparison with Hong’s net assets, at any time, and if con-
verted would require Hong to borrow additional funds to make the payment. If the debt were to be converted, Hong
would hold 70% of the voting rights and Daintree’s interest would reduce to 30%. Given the effect of increasing its
debt on its debt-equity ratio, Hong does not believe that it has the financial ability to enter into conversion of the debt.
Required
Discuss whether Hong is a parent of Moor.
(LO 2, 3) WA1-11 On September 1, 2013, Franklin Inc. acquired 40% of the voting shares of Gould Ltd. Under the company’s
constitution, each share is entitled to one vote. On the basis of past experience, only 65% of the eligible votes are typi-
cally cast at the annual general meetings of Gould. No other shareholder holds a major block of shares in Gould.
Gould’s financial year ends on December 31 each year. The directors of Franklin argue that they are not required
to include Gould as a subsidiary in Franklin’s consolidated financial statements at December 31, 2013, as there is no
conclusive evidence that Franklin can control the financial and operating policies of Gould. The auditors of Franklin
disagree, referring specifically to past years’ voting figures.
Required
Provide a report to Franklin on whether it should regard Gould as a subsidiary in its preparation of consolidated finan-
cial statements at December 31, 2013.
Cases
(LO 1, 2, C1-1 Gunz Inc. is a medium-sized company involved in the manufacture of paints in northern Ontario. It has been
3, 4) owned since inception by the Gunz family. However, the younger Gunz family members are showing no interest in
carrying on the business. They have all gone to university and are pursuing their own interests. As such, Richard Gunz,
president of Gunz Inc., has decided to sell the company. Toward that end, he has hired you to advise on the financial
reporting as the sale price may be based on the net asset values.
Gunz has several investments on the statement of financial position and needs to ensure that they are in accordance
with the appropriate GAAP.
The company has a policy of placing excess funds in shares so that it can earn a higher return than normally in the
bank. They have various investments, which cost $120,000. They incurred transaction costs of $1,500 on the acquisi-
tions that are currently included in the cost. The fair value of these investments as a portfolio is $150,000, although
some specific investments have increased in value while others have decreased.
Gunz invested this year in a company, Compoundco, that supplies chemicals for its paints. It was important to
Gunz that it achieve a level of vertical integration (meaning that it is involved in various points of the production pro-
cess). Gunz provided $50,000 and received an ownership interest of 49%. The other 51% of Compoundco is owned by
the children of the original owner. They have agreed to sell 10% of their shares each year and are currently not actively
involved in the management of the company. They have hired a manager who has dealt with all issues relating to the
operations of the company. Gunz is happy with this manager and has no intention of changing. Compoundco has been
losing money for the last few years and is projected to lose an additional $40,000 this year. Gunz believes that it can turn
Compoundco around next year since most of its sales will now be to Gunz.
In order to maintain its production requirements, Gunz needed an additional manufacturing plant. The plant was
set up as a separate corporation. The financing for the acquisition of $4 million was taken out by this corporation but
has been guaranteed by Gunz. The shares of the corporation are owned by Mr. Gunz personally and amount to $3,000.
All production decisions are taken by Gunz and all production is sold to Gunz.
Required
Reply to Mr. Gunz’s request.
(LO 4) C1-2
Part 1
Three companies jointly buy a 15-floor office building. Each floor in the building has a separate legal title, which allows
a floor to be sold separately. Each company takes title of five of the floors, one of which it uses for its own purposes.
Each has a right to use that one floor for whatever purpose it chooses.
Cases 41
The companies set up a new company, Rental Inc., and each transfers its ownership of four floors of the building
to Rental. The 12 floors are rented to third parties. Rental employs a management team to manage the rental business.
Rental is controlled jointly by the three companies. The three companies are not liable for any costs of Rental.
Required
Discuss how each company would report its investment in Rental.
Part 2
Assume instead that the three companies set up Rental to purchase all 15 floors. Financing for the acquisition of the
building in the name of Rental is secured by the building.
Each company leases one floor from Rental. Each has the right to use that floor for its own purpose or to sublease
it independently to third parties. The lease term is for all of the expected useful life of the building.
Rental rents the remaining 12 floors to third parties and employs a management team. The three companies jointly
control Rental.
Required
Part 3
Assume instead that rather than all three companies each having a right to use a floor, only one of them, Socre Ltd.,
has that right. Socre Ltd. has use of three of the floors for its own purposes, and the remaining 12 floors are rented to
third parties by Rental.
Required
(LO 1, 2, C1-3 Humphrey Enterprises is a public company located in Toronto that follows IFRS and has a December 31 year
3, 4) end. It is involved in the manufacturing of pet supplies that are distributed and sold all over North America. Humphrey
has loans outstanding with the People’s Commerce Bank (PCB) and the PCB also holds preferred shares of Humphrey.
As part of Humphrey’s bank loan agreement, it has been agreed that the loan would be repayable and the PCB’s preferred
shares would be converted to common shares if ever there were two years of successive losses at Humphrey. These com-
mon shares would be surrendered by the Humphrey family; as such, they would be diluting their ownership interest and
control. Humphrey Enterprises was founded by Daniel Humphrey in 1985 and has consistently expanded and shown
financial growth. However, recently, Humphrey was not immune to the economic downfall and it had a loss this past
financial year ended December 31. Humphrey is a public company, but is owned 52.1% by Daniel Humphrey and his
immediate family.
As part of Humphrey’s business plan, it has several investments in different companies of varying levels and its
strategy is to use excess cash to invest.
One of Humphrey’s investments was Colin Industries, a private company, in which Humphrey owns 27% of the
outstanding voting shares. It also holds warrants that are convertible into an additional 5% of the outstanding common
shares at Humphrey’s option. Humphrey has the ability to appoint three of the 10 seats on Colin Industries’ board of
directors and owns the rights to a patent that Colin used to produce some of its goods, for which Colin paid royalties
to use. Humphrey had the ability to appoint the chair of the board of directors, who voluntarily resigned during the
past year in November. Due to the chair’s resignation, it became increasingly difficult to obtain information from Colin
regarding its operations and financial results. As such, Humphrey stopped using the equity method to account for this
investment and began accounting for it at cost. The prior year’s loss of Humphrey was mainly caused by Colin and
picking up its 27% share of the loss. These losses were expected to continue at Colin for the foreseeable future.
During the year, Humphrey acquired 55% of another company, Petromax Incorporated, as a way to start distrib-
uting its products in British Columbia, which has been a difficult area for Humphrey to gain access to. Petromax will
start to exclusively sell Humphrey products. It is expected that for the first two years, Petromax will generate losses by
exclusively selling Humphrey products. However, after this the brand recognition should increase and Petromax will
start to generate positive net income. This investment has been recorded initially at cost by Humphrey and then it
intends to start consolidating in two years.
The prior year, Humphrey had acquired a 15% interest in Sasha Ltd., which had been accounted for as fair value
through profit or loss, as its intention was to sell the shares when the price increased. During the current year, the fair
value of the shares of Sasha dropped significantly. Humphrey started to account for this investment as available for sale
with the loss recognized in accumulated other comprehensive income, as it is no longer sure of when it will sell this
investment due to the current year loss in its value.
Required
It is presently December, and you, the auditor, have been asked to prepare a report to the audit partner. Write a report
that outlines and discusses any accounting issues arising during the current year and their impact to Humphrey.
(LO 1, 2, C1-4 Jackson Capital Inc. ( JCI) is a new private investment company that provides capital to business ventures and is
3, 4) required to follow IFRS. It is not a venture capital organization.
JCI’s business mission is to support companies to allow them to compete successfully in domestic and international
markets. JCI aims to increase the value of its investments, thereby creating wealth for its shareholders. JCI does not
qualify as a venture capital organization or investment company.
Funds to finance the investments were obtained through a private offering of share capital, conventional long-term
loans payable, and a bond issue that is indexed to the TSX Composite Index. Annual operating expenses are expected to
be $1 million before bonuses, interest, and taxes.
Over the past year, JCI has accumulated a diversified investment portfolio. Depending on the needs of the bor-
rower, JCI provides capital in many different forms, including demand loans, short-term equity investments, fixed-term
loans, and loans convertible into share capital. JCI also purchases preferred and common shares in new business ven-
tures where JCI management anticipates a significant return. Any excess funds not committed to a particular investment
are held temporarily in money market funds.
JCI has hired three investment managers to review financing applications. These managers visit the applicants’
premises to meet with management and review the operations and business plans. They then prepare a report stating
their reasons for supporting or rejecting the application. JCI’s senior executives review these reports at their monthly
meetings and decide whether to invest and what types of investments to make.
Once the investments are made, the investment managers are expected to monitor the investments and review
detailed monthly financial reports submitted by the investees. The investment managers’ performance bonuses are
based on the returns generated by the investments they have recommended.
It is August 1, 2013. JCI’s first fiscal year ended on June 30, 2013. JCI’s draft statement of financial position and
other financial information are provided in the exhibit below. An annual audit of the financial statements is required
under the terms of the bond issue. Potter & Cimoroni, Chartered Accountants, has been appointed auditor of JCI.
The partner on the engagement is Richard Potter. You, a CA, are the in-charge accountant on this engagement.
Mr. Potter has asked you to prepare a memo discussing the significant accounting issues for this engagement.
Required
Prepare the memo requested by Mr. Potter.
JACKSON CAPITAL INC.

Draft Statement of Financial Position
As of June 30, 2013
(in thousands of dollars)
Assets
Cash and marketable securities $ 1,670
Investments (at cost) 21,300
Interest receivable 60
Furniture and fixtures (net of accumulated amortization of $2) 50
$23,080
Liabilities
Accounts payable and accrued liabilities $ 20
Accrued interest payable 180
Loans payable 12,000
12,200
Shareholders’ equity
Deficit (1,120)
10,880
$23,080
Summary of Investment Portfolio
As at June 30, 2013
Cost of Investments
15% common share interest in Fairex Resource Inc., a company listed on the
TSX Venture Exchange. Management intends to monitor the performance of this
mining company over the next six months and to make a hold/sell decision based
on reported reserves and production costs. $3.8 million
25% interest in common shares of Hellon Ltd., a private Canadian real estate
company, plus 7.5% convertible debentures with a face value of $2 million,
acquired at 98% of maturity value. The debentures are convertible into common
shares at the option of the holder. $6.2 million
Cases 43
5-year loan denominated in Brazilian currency (reals) to Ipanema Ltd., a Brazilian

company formed to build a power generating station. Interest at 7% per annum is
due semi-annually. 75% of the loan balance is secured by the power generating
station under construction. The balance is unsecured. $8 million
50% interest in Western Gas, a jointly-owned gas exploration project operating in
Western Canada. One of JCI’s investment managers sits on the three-member board
of directors. $2 million 50,000 stock warrants in Tornado Hydrocarbons Ltd.,
expiring March 22, 2015. The underlying common shares trade publicly. $1.3 million

Capital Structure
As at June 30, 2013
Loans payable
The Company has $2 million in demand loans payable with floating interest rates, and $4 million
in loans due September 1, 2017, with fixed interest rates.
In addition, the Company has long-term 5% stock indexed bonds payable. Interest at the stated
rate is to be paid semi-annually, commencing September 1, 2013. The principal repayment on
March 1, 2018, is indexed to changes in the TSX Composite as follows: the $6 million original
balance of the bonds at the issue date of March 1, 2013, is to be multiplied by the stock index
at March 1, 2018, and then divided by the stock index as at March 1, 2013. The stock-indexed
bonds are secured by the Company’s investments.
Share capital
Issued share capital consists of:
– 1 million 8% Class A (non-voting) shares redeemable at the holder’s option
on or after August 10, 2017 $7 million
– 10,000 common shares $5 million
(Adapted from CICA's Uniform Evaluation Report)
(LO 2, 3) C1-5 Lachlan Corp. establishes Serouya Ltd. for the sole purpose of developing a new product to be manufactured
and marketed by Lachlan. Lachlan engages Mr. Jiang to lead the team to develop the new product. Mr. Jiang is named
Managing Director of Serouya at an annual salary of $100,000, $10,000 of which is advanced to him by Serouya at
the time Serouya is established. Mr. Jiang invests $10,000 in the project and receives all of Serouya’s initial issue of 10
shares of voting common shares.
Lachlan transfers $500,000 to Serouya in exchange for 7%, 10-year bonds convertible at any time into 500 shares
of Serouya voting common shares. Serouya has enough shares authorized to fulfill its obligation if Lachlan converts its
bonds into voting common shares.
The constitution of Serouya provides certain powers for the holders of voting common shares and the holders of
securities convertible into voting common shares that require a majority of each class voting separately. These include:
• the power to amend the corporate purpose of Serouya, and
• the power to authorize and issue voting shares of securities convertible into voting shares.
At the time Serouya is established, there are no known economic legal impediments to Lachlan converting the debt.
Required
Discuss whether Serouya is a subsidiary of Lachlan.
(Adapted from Case V issued by the FASB as a part of its Consolidations project)
(LO 2, 3) C1-6 Endeavour Films is a production company that produces movies and television shows. It also owns cable televi-
sion systems that broadcast its movies and television shows. Endeavour transferred to Barco Ltd. its cable assets and
the shares in its previously owned and recently acquired cable television systems, which broadcast Endeavour’s movies.
Barco assumed approximately $200 million in debt related to certain of the companies it acquired in the transaction.
After the transfer date, Barco acquired additional cable television systems, incurring approximately $2 billion of debt,
none of which was guaranteed by Endeavour.
Barco was initially established as a wholly owned subsidiary of Endeavour. Several months after the transfer, Barco
issued common shares in an initial public offering, raising nearly $1 billion in cash and reducing Endeavour’s interest in
Barco to 41%. The remaining 59% of Barco’s voting interest is widely held.
The managing director of Barco was formerly manager of broadcast operations for Endeavour. Half the directors
of Barco are or were executive officers of Endeavour.
Barco and its subsidiaries have entered individually into broadcast contracts with Endeavour, pursuant to which
Barco and its cable system subsidiaries must purchase 90% of their television shows from Endeavour at payment terms,
and other terms and conditions of supply as determined from time to time by Endeavour. That agreement gives Barco
and its cable television system subsidiaries the exclusive right to broadcast Endeavour’s movies and television shows
in specific geographic areas containing approximately 45% of the country’s population. Barco and its cable television
subsidiaries determine the advertising rates charged to their broadcast advertisers.
Under its agreement with Endeavour, Barco has limited rights to engage in businesses other than the sale of
Endeavour’s movies and television shows. In its most recent financial year, approximately 90% of Barco’s sales were
Endeavour movies and television shows. Endeavour provides promotional and marketing services and consultation to
the cable television systems that broadcast its movies and television shows. Barco rents office space from Endeavour in
its headquarters facility through a renewable lease agreement, which will expire in five years.
Required
(a) Should Endeavour consolidate Barco? Why or why not?
(b) If Endeavour had not established Barco but had instead purchased 41% of Barco’s voting shares on the open mar-
ket, does this change your answer to requirement A? Why?
(Adapted from Case III issued by the FASB as a part of its Consolidations project)
(LO 2, 3) C1-7 Logan Ltd. has acquired, during the current year, the following investments in the shares issued by other companies:
Jarislowsky Corp. $120,000 (40% of issued capital)
Murray Inc. $117,000 (35% of issued capital)
Logan is unsure how to account for these investments and has asked you, as the auditor, for some professional advice.
Specifically, Logan is concerned that it may need to prepare consolidated financial statements under IFRS 10. To
help you, the company has provided the following information about the two investee companies:
Jarislowsky
• The remaining shares in Jarislowsky are owned by a diverse group of investors who each hold a small parcel of shares.
• Historically, only a small number of the shareholders attend the general meetings or question the actions of the
directors.
• Logan has nominated three new directors and expects that they will be appointed at the next annual general meet-
ing. The current board of directors has five members.
Murray
• The remaining shares in Murray are owned by a small group of investors who each own approximately 15% of the
issued shares. One of these shareholders is Jarislowsky, which owns 17%.
• The shareholders take a keen interest in the running of the company and attend all meetings.
• Two of the shareholders, including Jarislowsky, already have representatives on the board of directors who have
indicated their intention of nominating for re-election.
Required
(a) Advise Logan as to whether, under IFRS 10, it controls Jarislowsky and/or Murray. Support your conclusion.
(b) Would your conclusion be different if the remaining shares in Jarislowsky were owned by three institutional inves-
tors each holding 20%? If so, why?
(LO 2, 3) C1-8 Ord Inc. owns 40% of the shares of Derwent Co. and holds the only substantial block of shares in that entity, no
other party owning more than 3% of the shares. The annual general meeting of Derwent is to be held in a month. Two
situations that may arise are:
• Ord will be able to elect a majority of Derwent’s board of directors as a result of exercising its votes as the larg-
est holder of shares. As only 75% of shareholders voted in the previous year’s annual meeting, Ord may have the
majority of the votes that are cast at the meeting.
• By obtaining the proxies of other shareholders and, after meeting with other shareholders who normally attend gen-
eral meetings of Derwent, by convincing these shareholders to vote with it, Ord may obtain the necessary votes to
have its nominees elected as directors of the board of Derwent, regardless of the attendance at the general meeting.
Required
Discuss the potential for Derwent being classified as a subsidiary of Ord.
(LO 1, 2, C1-9 Polka Dot Enterprises is a Canadian private company located in Toronto, Ontario. Their business operations con-
3, 4) sist of event planning for corporations and fundraisers. They have recently begun the necessary steps to go public in the
near future. As part of this, they have hired you, CA, to help with all the requirements as part of the process of going public.
Enclosed, you have been given the latest year-end statement of financial position (Exhibit C1-9(a)) and extracts of
the Notes to the Financial Statements (Exhibit C1-9(b)) of Polka Dot Enterprises to review and to give your preliminary
comments on. It is presently February 2014 and the Chief Financial Officer would like to receive your comments as soon
Cases 45
as possible so that, if necessary, any changes can be incorporated. He is particularly concerned with the accounting of their
investments as he has heard that there might be some differences upon transitioning from accounting standards for private
enterprises to IFRS. It is not necessary to restate the statement of financial position, but rather simply discuss and explain
any changes required and the impacts it would have on Polka Dot Enterprises. Net income for the year was $315,665.
EXHIBIT C1-9(A)
POLKA DOT ENTERPRISES
Assets
Current Assets
Cash 82,931
Accounts Receivable 101,827
Inventory 121,844
Total Current Assets 306,602
Non-Current Assets
Property, Plant, and Equipment 141,729
Investment in Ranger Limited (at cost) 121,736 Note 1
Investment in Tulip Inc. (at cost) 102,911 Note 2
Investment in Shoes Enterprise (at cost) 156,192 Note 3
Investment in Rose Limited (at cost) 133,901 Note 4
Total Non-Current Assets 656,469
Total Assets 963,071
Liabilities & Shareholder’s Equity
Current Liabilities
Bank Indebtedness 111,009
Accounts Payable 172,619
Current Portion of Long-Term Debt 118,201
Total Current Liabilities 401,829
Long-Term Debt 226,172
Total Liabilities 628,001
Share Capital 100,000
Total Liabilities & Shareholder’s Equity 963,071
EXHIBIT C1-9(B)
Polka Dot Enterprises
Notes the to the Financial Statements
For the Year Ended December 31, 2013
Note 1 – The investment in Ranger Limited was one made during 2013 to invest excess cash on hand that Polka Dot Enterprises had. The
cost at the time of the 4% purchase of Ranger Limited’s outstanding shares was $121,736. This was a short-term investment and when the
cash is needed in 2014, it will be sold. As at December 31, 2013, the fair value of the investment was $156,212 and net income of Ranger
Limited for the year was $39,103.
Note 2 – In January 2013, Polka Dot Enterprises purchased 100% of Tulip Inc., a company engaged in a similar line of business as them.
The cost of the investment was $102,911 and its fair value as at December 31, 2013 was $147,212. In addition, due to the purchase,
Polka Dot Enterprises was allowed to appoint three of the four members to the board of directors. They have also been looking for ways to
achieve synergies and to utilize each other’s expertise. Tulip Inc.’s net income for the year was $120,921.
Note 3 – The cost of the investment in Shoes Enterprise was $156,192 and was made in January 2013 to obtain 19% ownership in Shoes
Enterprise. This was done to gain access to a supplier, as prior to this Shoes Enterprise was one of Polka Dot Enterprises1 main supplier of
party goods and decorations. The fair value of the investment as at December 31, 2013, was $199,267. Net income for Shoes Enterprise as
a whole since the date of investment was $137,934.
Note 4 – During the year, in order to expand their business into Montreal, Quebec, Polka Dot Enterprises entered into business with another
entity, Marie Inc. They in turn created a new entity, Rose Limited. Each company contributed assets worth $133,901 to the new entity and
they will share equally in the profits of Rose Limited. As at December 31, 2013, the fair value of Polka Dot Enterprise’s investment was
$176,924. Both Polka Dot Enterprises and Marie Inc. will be running Rose Limited on a day-to-day basis and no major decisions concerning
the entity can be made without the consent of the other. Net income since the creation of Rose Limited was $201,692.
Note 5 – Investment income consists of the following:

Dividend income from Ranger Limited: $71,212
Dividend income from Tulip Inc.: $48,467
Dividend income from Shoes Enterprise: $24,921
Dividend income from Rose Limited: $34,539
Combining
for Growth
in the Media
Source: Eric Audras/Getty Images
Business
ONE OF THE MAIN avenues for growth a existing stake, which was valued at $221 million.
company might take is by acquiring another At the time, CTV had assets worth approximately
one. Mergers and acquisitions make up a $3.1 billion, to which $1.4 billion of goodwill was
big part of corporate finance. By one count, added upon acquisition by BCE. As a result of
there were 3,173 such transactions involving the acquisition, BCE’s pre-existing investment
Canadian companies during the fiscal year ended in CTV was remeasured when changed from
December 31, 2011. The total value of those an available-for-sale investment to part of an
transactions was approximately $189 billion. investment in a subsidiary. BCE recognized a gain
One such transaction was undertaken by of $89 million in other income due to the increase
Bell Canada Enterprises (BCE). On April 1, 2011, in its fair value.
BCE announced an increase in its ownership of As part of the regulatory approval process,
CTV to 85%, granting it control of the television after combining with CTV, BCE was required by the
network. The move led BCE to create a new Canadian Radio-television and Telecommunications
division, Bell Media, which combined CTV’s Commission to spend $239 million over seven years
assets with BCE’s existing media content. for the benefit of the Canadian broadcasting system.
“Our acquisition of Canada’s number BCE wouldn’t stop there, though. Its acquisition
one media company leverages our strategic of CTV and creation of Bell Media were additional
investments in broadband networks and services moves in a string of transactions to expand its media
and enables our promise to deliver the content reach. In late 2011, Bell announced its acquisition
Canadians want most across every screen – for approximately $400 million of a 37.5% share
smartphone, tablet, computer and TV,” said George of Maple Leaf Sports and Entertainment, which
Cope, President and CEO of Bell Canada and BCE. in addition to Toronto’s Air Canada Centre, the
The $1.3 billion that BCE paid for the Maple Leafs, and Raptors, owns three sports-related
controlling share of CTV was added to BCE’s TV networks.
Sources: PricewaterhouseCoopers, “PwC Capital Markets Flash: Deals Quarterly, Canadian M&A Retrospective and 2012 Outlook,” Volume V, Issue 7, January 20, 2012;
BCE Inc. 2011 Annual Report; “Bell Completes Acquisition of CTV, Launches Bell Media Business Unit,” BCE news release, April 1, 2011; “Bell Acquires Ownership
Position in Maple Leaf Sports and Entertainment – MLSE,” BCE news release, December 9, 2011.
CHAPTER
2 Business
Combinations
LEARNING OBJECTIVES
1. Understand the nature of a business combination and its various forms.
2. Explain the basic steps in the acquisition method of accounting for business combinations.
3. Account in the records of the acquirer for a purchase of net assets.
4. Prepare the accounting records of the acquiree.
5. Account for subsequent adjustments to the initial accounting for a business combination.
BUSINESS COMBINATIONS
Subsequent
Accounting
Nature of a Accounting in the Accounting in the Adjustments to the
for a Business
Business Records of the Records of the Initial Accounting
Combination:
Combination Acquirer Acquiree for a Business
Basic Principles
Combination
■ Definition of business ■ Identifying the acquirer ■ Recognizing and mea- ■ Purchase of acquiree’s ■ Goodwill
combination ■ Determining the acqui- suring assets acquired assets and liabilities ■ Contingent liabilities
■ Forms of business sition date and liabilities assumed ■ Purchase of acquiree’s ■ Contingent
combinations ■ Consideration shares from the share- consideration
transferred holders
■ Recognizing and mea-
suring goodwill or a
gain from a bargain
purchase
■ Shares acquired in an
acquiree
■ Existence of a previ-
ously held equity
interest
48 chapter 2 Business Combinations
The previous chapter examined the different types of equity investments that an entity may
make. This chapter focuses on those investments in which the entity gains control. Specifically
we will examine the act of gaining control, which is called a business combination. In this
chapter we will discuss the act of gaining control through the acquisition of shares or net
assets, emphasizing the acquisition of net assets. In Chapter 3 we will explore acquisitions
that involve shares.
Companies acquire control over other entities to further their strategic plan. In Chapter 1, we
assumed that control is acquired by purchasing shares of the acquired company. As such, an invest-
ment is initially recorded at cost. In this chapter we will see that control over the net assets of an
entity can also be achieved by acquiring the actual assets and liabilities of a business. In substance,
the results are the same in that the company has gained control over the assets and liabilities.
The decision whether to buy the shares or the actual assets and liabilities requires consid-
ering various factors. Some considerations are:
1. In order to gain control through the acquisition of the assets and liabilities, a company
must purchase 100% of those net assets, whereas to gain control through the acquisi-
tion of shares, a company must purchase only 50% 1 of the voting shares. As such, the
acquisition of shares may be a less expensive option and may involve less cash outflow.
2. There are tax implications to these options. If the assets are acquired, the acquirer obtains
the higher tax base and therefore can claim higher capital cost allowance. If the shares are
acquired, the acquiree still maintains the undepreciated capital cost on the original bal-
ances. From the seller’s perspective, a sale of assets may result in recapture that is taxed
at a higher rate than the sale of shares, which will result in capital gains.
3. Purchasing shares may result in the acquirer becoming responsible for any unknown
liabilities of the acquiree.
From a reporting perspective, the important factor is that in substance both types of combi-
nations result in the acquisition of control over the net assets of the acquiree. Therefore the
financial statements should reflect the same information.
The notes to the financial statements of Calgary-based Agrium Inc., a producer of
agricultural products and services, describe its recent acquisition of AWB Limited, an
agricultural retailer in Australia (Illustration 2.1).
Illustration 2.1
BUSINESS ACQUISITIONS
Excerpts from the
On December 3, 2010, we acquired 100 percent of AWB, an agribusiness operating in Australia, for
Financial Statements of
$1.2-billion in cash and $37-million of acquisition costs. On May 11, 2011, we completed the sale of the
Agrium Inc.
majority of the Commodity Management businesses acquired from AWB, in accordance with an agreement
dated December 15, 2010 (for further discussion, see section “Discontinued Operations”). Cash received
from the sale was $694-million. We retained the Landmark retail operations, including over 200 company-
owned retail locations and over 140 retail franchise and wholesale customer locations in Australia. The
acquired business is included in the Retail operating segment.
As part of the acquisition, we acquired a 50 percent interest in Hi-Fert Pty. Ltd. (“Hi-Fert”), over which
receivers and administrators have been appointed. Previously recorded amounts have been written off.
AWB had provided guarantees for letters of credit of approximately $62-million issued by lenders support-
ing operations of Hi-Fert. The amount, if any, that we will be required to pay under these guarantees, net
of recoveries from a charge over related assets, is not determinable, pending the outcome of bankruptcy
and litigation proceedings.
On May 2, 2011, we acquired 100 percent of Cerealtoscana S.p.A. (“CT”), and its subsidiary Agroport, for
total consideration of $27-million plus working capital. CT is a fertilizer distribution company in Italy and
Agroport is its subsidiary in Romania. The acquired business is included in the Wholesale operating segment.
Preliminary estimated fair values of assets acquired and liabilities assumed on December 3, 2010
As at June As at December
30, 2011 31, 2010
Continuing operations
Working capital 736 736
Property, plant, and equipment 81 81
Intangibles 41 41
Nature of a Business Combination 49
Illustration 2.1
Goodwill 672 589
(Continued) Other financial assets 69 69
Debt and other financial liabilities (742) (744)
Assets of discontinued operations 1,086 1,128
Liabilities of discontinued operations (734) (691)
1,209 1,209
The primary drivers that generate goodwill are the acquisition of a talented workforce and the value of
synergies between Agrium and AWB, including expansion of geographical coverage for the sale of crop
inputs and cost savings opportunities. We expect to allocate the majority of goodwill to the Retail business
unit. We do not expect goodwill to be deductible for income tax purposes.
NATURE OF A BUSINESS COMBINATION

Definition of Business Combination
Objective 1 In order to account for a business combination, we must understand what it is. The account-
Understand the ing standard relevant for accounting for business combinations is IFRS 3 Business Combinations
nature of a business issued by the International Accounting Standards Board (IASB) in January 2008.1 It defines a
combination and its business combination as:
various forms.
A transaction or other event in which an acquirer obtains control of one or more businesses.
For a business combination to occur there has to be an economic transaction between

two entities. A key term in this definition is control. The meaning of control in the defi-
nition of a business combination is the same as discussed in Chapter 1 regarding invest-
ments. Control exists when the investor is exposed, or has rights, to variable returns from
its involvement with the investee and has the ability to affect those returns through its power
over the investee.
The term business is defined in IFRS 3 as:
An integrated set of activities and assets that is capable of being conducted and managed for
the purpose of providing a return in the form of dividends, lower costs or other economic ben-
efits directly to investors or other owners, members or participants.
The purpose of defining a business is to distinguish between the acquisition of a group of

assets—such as a number of desks, bookcases, and filing cabinets—and the acquisition of an
entity that is capable of producing some form of output that can yield a return. Accounting
for a group of assets is based on standards such as IAS 16 Property, Plant and Equipment
rather than IFRS 3. The accounting for a group of assets not constituting a business combi-
nation is at cost, determined by reference to the relative fair values of the individual assets
acquired.2
In order to provide a return, a business entity will normally consist of inputs, processes,
and outputs. For example, an entity will acquire raw materials that will be processed to pro-
duce finished goods that will be sold to customers. The assets of the entity, then, integrate
to generate the return to the entity. Note, however, that the definition of a business in IFRS 3
does not require the entity to create outputs. The definition only requires that the assets be
capable of providing a return. Hence, an entity that is in the development stage, such as a
1
In reading IFRS 3, it is important to note that Appendix A contains the defined terms, while
Appendix B contains application guidance. Both appendices are an integral part of IFRS 3. The IASB
has also published a Basis for Conclusions on IFRS 3, but this is not an integral part of the standard.
2
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date (that is, an exit price).
mining operation that has not yet produced ore for sale, can still be classified as a business.
It is also not necessary that the entity actually be producing outputs at the time of the acquisi-
tion, or even that the acquirer plans to use the assets in a particular fashion immediately. As
long as the assets are capable of producing a return, the assets constitute a business.
Note also the use of the phrase integrated set of activities in the definition of a business.
Goodwill arises where there is synergy between assets. Goodwill is defined in IFRS 3 as
an asset representing the future economic benefits arising from assets acquired in a busi-
ness combination that are not individually and separately recognized. A very important
principle is that goodwill can only be recognized when assets are acquired as part of a
business.
Consider the situation where A acquires a building from B and pays $100,000 for the
building. This is an acquisition of an asset and therefore the building would be recorded at
the price paid, which is $100,000. The journal entry is as follows:
Building 100,000
Cash 100,000
Consider a similar situation where A acquires an apartment building from B for $100,000.
The building has successfully rented out all of its units and has a building manager who is
responsible for renting out the units and servicing the tenants. This building would now be
considered a business as it has inputs (the rental units), processes (the rental process con-
ducted by the business manager), and outcomes (the receipt of rent). As such, it is possible to
have value due to the synergies of assets that are not separately recognized (e.g., good reputa-
tion of the management of the building, location of the building). Therefore, Goodwill of say
$20,000 will be recognized on the acquisition in the following entry.
Building Fair Value 80,000

Goodwill 20,000
Cash 100,000
Consider the situation in Illustration 2.2 in which A acquires a manufacturing division

from B by issuing its shares to B. In this situation, A is considered to be the acquirer, as it
obtains control of the manufacturing business from B. In analyzing the substance of the
transaction, A is acquiring a business from B and selling shares in itself to B. B is acquiring
shares from A and selling a manufacturing division to A. However, B is not undertaking a
business combination. It is acquiring a single asset, shares in A. In contrast, A is acquiring
a business, namely the manufacturing division, from B. Both A and B are acquiring assets
and giving up some form of consideration. However, only A is undertaking a business
combination.
The combination of separate businesses requires joining the assets and liabilities of the
acquirer with those acquired from the acquiree.
Illustration 2.2
Identification of a
Business Combination
A B
Sale of manufacturing
division to A
Issue of shares from B

Nature of a Business Combination 51
Forms of Business Combinations

Assuming the existence of two companies, A and B, the following general forms of business
combinations are covered in this chapter:
1. A acquires all the assets and liabilities of B.

B continues as a company, holding shares in A.
2. A acquires all the assets and liabilities of B.
B liquidates.
3. C is formed to acquire all the assets and liabilities of A and B.
A and B liquidate.
4. A acquires a group of net assets of B, the group of net assets constituting a business, such
as a division, branch, or segment, of B.
B continues to operate as a company.
One entity can obtain control over the net assets of another entity by acquiring enough
of its shares on the open market to control the financial and operating policies of the other
entity. We saw this in Chapter 1 where the presumption that owning more than 50% of
the voting shares provides control. Entities accounting for this form of business combi-
nation must apply the principles discussed in this chapter, and also prepare consolidated
financial statements. This is because the acquirer actually records an investment in the
acquiree in its books. Upon consolidation the investment account is replaced with the net
assets actually acquired. Accounting for these forms of business combinations is discussed
in Chapters 3 to 5.
A business combination could also occur without any exchange of assets or equity between
the entities involved in the exchange. For example, a business combination could occur where
two entities merged under a contract. The shareholders of the two entities could agree to
adjust the rights of each of their shareholdings so that they receive a specified share of the
profits of both the combined entities. As a result of the contract, both entities would be under
the control of a single management group. Business combinations are also not restricted to
transactions involving companies.3
There are many other forms of business combinations that can occur, such as A acquiring
the assets only of B, and B paying off the liabilities and then liquidating. Alternatively, A may
acquire all the assets and only some of the liabilities of B, and B pays the remaining liabilities
before liquidating. The number of possible arrangements is quite large, but most situations
are covered by consideration of the four alternatives in Illustration 2.3.
There are two exceptions where the requirements for accounting for a business combina-
tion are not used:
• Where the business combination results in the formation of a joint venture. Such a business
combination is accounted for under IFRS 11 Joint Arrangements (as discussed in Chapters 1
and 6).
• Where the business combination involves entities or businesses under common control. Such a
business combination occurs where all of the combining entities or businesses ultimately
are controlled by the same party or parties both before and after the combination, and
where control is not transitory. This situation could arise where A owns 100% of the
shares of B. The directors of A form a new entity, C, wholly owned by A, which acquires
all the issued shares of B in an internal restructuring. All the combining entities are con-
trolled by A both before and after the restructuring.
3
Mutual entities such as credit unions and mutual insurance companies that combine together, for
example to increase their market share and to lower their risk, may also have to account for the combi-
nation under IFRS 3.
Illustration 2.3 Alternative 1

General Forms of
Business Combinations A acquires net assets of B Ltd. B continues holding shares in A
A: B:
• Receipt of assets and liabilities of B • Sale of assets and liabilities to A
• Consideration transferred (e.g., shares, • Gain or loss on sale
cash, or other consideration) • Receipt of consideration transferred
(e.g., shares, cash, or other consideration)
Alternative 2
A acquires net assets of B B liquidates

A: B:
• As for alternative 1 above, A • Receipt of purchase consideration
• Distribution of consideration to
appropriate parties, including
shareholders via liquidating dividend
Alternative 3
C formed A and B liquidate

C: A and B:
• Formation of C with issue of shares • Same as for alternative 2 above, B
• Acquisition of assets and liabilities of A and B
• Payment for net assets of A and B via cash
outlays or issue of shares in C
Alternative 4
A acquires group of net assets such as a division B continues to operate
• Same as alternative 1 above, A • Same as for alternative 1 above, B
✓ LEARNING CHECK
• IFRS 3 applies only to combinations involving “businesses,” thereby excluding other exchanges
of assets between entities.
• A business generally must be capable of providing a return to the owners, and would generally
(but not always) involve entities whose activities have inputs, processes, and outputs.
• IFRS 3 excludes certain combinations of businesses from its scope, including those established
as joint ventures or under common control.
ACCOUNTING FOR A BUSINESS

COMBINATION: BASIC PRINCIPLES
Objective 2 After establishing that a business combination has occurred, the acquirer needs to determine
Explain the basic and allocate the purchase price to the actual assets and liabilities received. IFRS 3 Business
steps in the Combinations sets out the principles for accounting for a business combination.
acquisition method The required method of accounting for a business combination is the acquisition method.
of accounting
for business The key steps in applying the acquisition method are:
combinations.
1. Identify the acquirer.
2. Determine the acquisition date.
3. Recognize and measure the identifiable assets acquired, the liabilities assumed, and any
non-controlling interest in the acquiree.
4. Recognize and measure goodwill or a gain from a bargain purchase.
Accounting for a Business Combination: Basic Principles 53
The acquisition method is applied on the acquisition date, which is the date the acquirer
obtains control of the acquiree. On this date, the business combination occurs. In later chap-
ters we will examine the requirements for the subsequent measurement and accounting for
assets and liabilities recognized initially at acquisition date.
The first two steps in the acquisition method are discussed in this section, while the last
two are discussed in the next section on accounting in the records of the acquirer.
Identifying the Acquirer

The acquirer is the entity that obtains control of the acquiree. An acquirer must be identified
in every business combination.
It may be difficult to determine an acquirer in circumstances where a business combina-
tion is achieved by contract alone as there may be no exchange of readily measurable consid-
eration. However, difficulties in identifying an acquirer do not justify a different accounting
treatment. As explained in the next section of this chapter, the acquisition method requires the
assets and liabilities of the acquiree to be measured at fair value whereas the assets and liabilities
of the acquirer continue to be measured at their carrying values. As such, it is necessary in a
business combination to determine which entity is the acquirer and which is the acquiree.
Consider a situation where A enters into a business combination with B. If A were identi-
fied as the acquirer, then the assets and liabilities of B would be measured at fair value; whereas,
if B were identified as the acquirer, A’s assets and liabilities would be recorded at fair value.
The acquirer is defined (in IFRS 3) as “the entity that obtains control of the acquiree”
while an acquiree is defined as “the business or businesses that the acquirer obtains control of
in a business combination.” The key criterion, then, in identifying an acquirer is that of control.
This term is the same as that used for identifying a parent–subsidiary relation (see Chapter 1).
In some situations, it is very easy to identify an acquirer. For example, if A acquires more than
half the shares of B, then A will have control over B because its majority shareholding will give
A more than half of the voting rights of B as well as control of B’s board of directors.
In other situations, identifying an acquirer requires judgement. Consider the situation
where A combines with B. To effect the combination, a new company C is formed, which
issues shares to acquire all the shares of both A and B. The subsequent organization structure
is as shown in Illustration 2.4.
As C is created solely to formalize the organization structure, it is not the acquirer,
although it may be considered to be the legal parent of both the other entities. One of the
entities that existed before the combination must be identified as the acquirer, as C is not a
party to the decisions associated with the business combination, just a part of the form of the
organization structure created to facilitate the combination. As noted earlier, if A is identified
as the acquirer, then the assets and liabilities of B (the acquiree) are measured at fair value at
acquisition date (IFRS 3 B18).
Illustration 2.4
Identifying an Acquirer—
Situation Where C
Judgement is Required
100% 100%
A B
IFRS 3 provides some indicators to assist in assessing which entity is the acquirer:
• Is there a large minority voting interest in the combined entity? As discussed in Chapter 1, the
acquirer is usually the entity that has the largest minority voting interest in an entity that
has a widely dispersed ownership.
• What is the composition of the governing body of the combined entity? The acquirer is usually
the combining entity whose owners have the ability to elect, appoint, or remove a major-
ity of the members of the combined entity’s governing body.
• What is the composition of the senior management that governs the combined entity subsequent
to the combination? This is an important indicator given that the criterion for identifying
an acquirer is that of control. If A and B combine, is the senior management group of the
combined entity dominated by former senior managers of A or B?
• What are the terms of the exchange of equity interests? Has one of the combining entities
paid a premium over the pre-combination fair value of one of the combining entities, an
amount paid in order to gain control?
• Which entity is the larger? This could be measured by the fair value of each of the combin-
ing entities, or relative revenues or profits. In a takeover, it is normally the larger com-
pany that takes over the smaller company (that is, the larger company is the acquirer). For
example, if the global company Microsoft Corporation combines with a small computer
company operating in only one Canadian city, then it is most likely that Microsoft is the
acquirer.
• Which entity initiated the exchange? Normally the entity that is the acquirer is the one that
undertakes action to take over the acquiree.
• What are the relative voting rights in the combined entity after the business combination? The
acquirer is usually the entity whose owners have the largest portion of the voting rights
in the combined entity. In a reverse acquisition, A may issue its shares to acquire the
shares of B. However, because of the greater number of A shares given to the former B
shareholders relative to those held by the shareholders in A before the combination, the
former shareholders in B may have the majority of shares in A and be able to determine
the operating and financial policies of the combined entities.
Consider the following situation:
A B
Number of shares 100 100
Scenario 1: A enters into a transaction with the shareholders of B where A offers 50 shares
of A to the shareholders of B in exchange for their 100 shares of B.
Immediately after the transaction:
A B
A business combination has occurred, since A now controls the net assets of B because it now
owns it 100%.
The acquirer would be A since after the transaction the original A shareholders hold
more than 50% (100/150 shares) of the shares of the combined entity (150 shares). The shares
of B are not considered outstanding shares of the economic entity since they are owned by A.
Therefore the assets and liabilities of B would be recorded at fair value.
Accounting for a Business Combination: Basic Principles 55
A B
A business combination has occurred, since A now controls the net assets of B because it now
owns it 100%.
After the transaction the original A shareholders hold 50% (100/200 shares) of the com-
bined entity (200 shares). The original B shareholders also own 50% of the shares of the
combined entity. There is no evidence of an acquirer. However, an acquirer must be identi-
fied, so professional judgement should be used to analyze the qualitative characteristics as
outlined above, such as the management of the entity and the level of representation on the
board of directors, in an attempt to determine which entity controls the other.
A B
A business combination has occurred since A now controls the net assets of B because it now
owns it 100%.
The acquirer would be B since after the transaction the original B shareholders hold
more than 50% (200/300 shares) of the combined entity (300 shares). The shares of B are
not considered outstanding shares of the economic entity since they are owned by A. This
scenario is referred to as a “reverse takeover” since B used A shares to effect an acquisition of
A by B. Therefore the assets and liabilities of A would be recorded at fair value.
Determining the controlling entity is the key to identifying the acquirer. However, doing
so may not be straightforward in many business combinations, and the accountant might be
required to make a reasoned judgement based on the circumstances.
Determining the Acquisition Date

Acquisition date is defined (in IFRS 3) as follows:
The date on which the acquirer obtains control of the acquiree.
A business combination involves the joining together of assets and liabilities under the
control of a specific entity. Therefore, the business combination occurs at the date the net
assets are under the control of the acquirer. This date is the acquisition date.
Other dates that are important during the process of the business combination may be:
• the date the contract is signed

• the date the consideration is paid
• a date nominated in the contract
• the date on which assets acquired are delivered to the acquirer
• the date on which an offer becomes unconditional
These dates may be important, but determining the acquisition date does not depend
on when the acquirer receives physical possession of the assets acquired, or actually pays
out the consideration to the acquiree. The use of control as the key criterion to determine
the acquisition date ensures that the substance of the transaction determines the account-
ing rather than the form of the transaction. For example, assets acquired may be delivered
in stages, or payments made for these assets may be made over a period of time with a
number of payments being required. On the closing date of the combination, the acquirer
legally transfers the consideration—cash or shares—and acquires the assets and assumes
the liabilities of the acquiree. However, in some cases this may not be the acquisition date
(IFRS 3.09).
The definition of acquisition date then relates to the point in time when the net assets
of the acquiree become the net assets of the acquirer—in essence, the date on which the
acquirer can recognize the net assets acquired in its own records. This approach is consistent
with the conceptual framework in that an asset is defined in terms of future economic benefits
that are controlled by an entity.
There are four main areas where the selection of the date affects the accounting for a
business combination:
• The identifiable assets acquired and liabilities assumed by the acquirer are measured at
the fair value at the acquisition date. The choice of fair value is affected by the choice of
the acquisition date.
• The consideration paid by the acquirer is determined as the sum of the fair values of
assets given, equity issued, and/or liabilities undertaken in exchange for the net assets
or shares of another entity. The choice of date affects the measure of fair value. For
example, in the case of shares listed on a stock exchange, the market price of these shares
may fluctuate daily. The choice of the acquisition date affects the choice of which par-
ticular market price is used in calculating the fair value of shares issued by the acquirer as
consideration.
• The acquirer may acquire only some of the shares of the acquiree. The owners of the
balance of the shares of the acquiree are called the non-controlling interest, which are
defined in IFRS 3 Appendix A as the equity in a subsidiary not attributable, directly or
indirectly, to a parent. This non-controlling interest is also measured at the fair value at
acquisition date. (Non-controlling interest will be examined in Chapter 5.)
• The acquirer may have previously held an equity interest in the acquiree prior to obtain-
ing control of the acquiree. For example, A may have previously acquired 15% of the
shares of B, and now acquires the remaining 85%, giving it control of B. The acquisi-
tion date is the date when A acquired the 85% interest. The 15% share holding will be
recorded as a financial asset in the records of A. At acquisition date, the fair value of this
investment is measured. This situation is further examined in the next section.
The effect of determining the acquisition date is that the combined entity at the acquisi-
tion date should report the assets and liabilities of the acquiree at that date, and any prof-
its reported as a result of the acquiree’s operations within the business combination should
reflect profits earned after the acquisition date.
✓ LEARNING CHECK
• IFRS 3 requires application of the acquisition method when accounting for business
combinations.
• The acquisition method has four key steps: (1) identify the acquirer; (2) determine the
acquisition date; (3) recognize and measure the identifiable assets acquired, liabilities
assumed, and any non-controlling interest in the acquiree; and (4) recognize and measure
goodwill or a gain from a bargain purchase.
• Identifying an acquirer may require judgement by the accountant, and IFRS 3 provides
indicators to assist in making this judgement.
• Determining the acquisition date affects the measurement of fair value of a number of
amounts in the accounting for a business combination.
Accounting in the Records of the Acquirer 57
ACCOUNTING IN THE RECORDS

OF THE ACQUIRER
Objective 3 Where the acquirer purchases assets and assumes liabilities of another entity, it has to
Account in the consider:
records of the
acquirer for a • the measurement of the consideration transferred to the acquiree
purchase of net
assets. • the recognition and measurement of the identifiable assets acquired and the liabilities
assumed
• the recognition and measurement of goodwill or a gain from a bargain purchase.
Situations where the acquirer purchases the shares of the acquiree is covered in Chapters 3
to 5. In this chapter, for such business combinations, only the recognition and measurement of
the investment by the acquirer is covered.
Consideration Transferred to the Acquiree

In a business acquisition, an acquirer purchases the assets and liabilities of an entity. The
consideration transferred is the amount that the acquirer pays to obtain those net assets. This
consideration transferred is:
• measured at fair value at acquisition date

• calculated as the sum of the acquisition-date fair values of the assets transferred by the
acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the
equity interest issued by the acquirer.
In a specific exchange, the consideration transferred to the acquiree could include just
one form of consideration, such as cash, but could equally well consist of a number of forms
such as cash, other assets, shares, and contingent consideration. These are considered in the
following sections.
Cash or Other Monetary Assets

The fair value is the amount of cash or cash equivalent dispersed. The amount is usually
readily determinable. One problem that may occur arises when the settlement is deferred to
a time after the acquisition date. For a deferred payment, the fair value to the acquirer is the
amount the entity would have to borrow to settle the debt immediately. Hence, the discount
rate used is the entity’s incremental borrowing rate.
Assume A, the acquirer, pays $100 cash immediately and agrees to pay the balance of
$300 in one year. A’s incremental borrowing rate is 3.5%. Use of cash, including a deferred
payment, to acquire net assets results in the acquirer recording the following form of entry at
the acquisition date:
Net Assets 390
Cash 100
Payable to Acquiree—Amortized Cost 290
When the deferred payment is made to the acquiree, the interest component needs to be
recognized:
Payable to Acquiree 290

Interest Expense 10
Cash 300
Non-monetary Assets
Non-monetary assets are assets such as property, plant, and equipment; investments; licences;
and patents. As noted earlier, if active second-hand markets exist, fair values can be obtained by
reference to those markets. The items sold in the market may not be exactly the same as the item
being exchanged in the business combination, and an estimate of fair value for the specific item
may have to be made. Where active markets do not exist, other means of valuation, including
the use of expert valuaters, may be used. IFRS 13 Fair Value Measurement provides guidance in
determining fair value. (See WileyPLUS and www.wiley.com/go/fayermancanada for a further
discussion of fair value hierarchy.)
The acquirer is effectively selling the non-monetary asset to the acquiree. Hence, it is
earning income equal to the fair value on the sale of the asset. Where the asset’s carrying
amount in the records of the acquirer is different from fair value, a gain or loss on the asset is
recognized at acquisition date. This principle is explained in IFRS 3.38:
the acquirer shall remeasure the transferred assets or liabilities to their fair values as of the acqui-
sition date and recognize the resulting gains or losses, if any, in profit or loss.
Use of a non-monetary asset such as plant as part of the consideration to acquire net
assets results in the acquirer recording the following entries (assume a cost of plant of $180, a
carrying amount of $150, and fair value of $155):
PLANT ACCUMULATED DEPRECIATION—PLANT

180 25 30 30
155 0
Accumulated Depreciation 30
Plant 25
Gain 5
(Remeasurement as part of consideration transferred in a business combination)
Net Assets Acquired xxx

Plant 155
Other Consideration Payable xxx
(Acquisition of net assets)
The acquirer recognizes a gain on the non-current asset and the asset is then included in
the consideration transferred at fair value.
Equity Instruments
If an acquirer issues its own shares as consideration, it needs to determine the fair value of
those shares at the acquisition date. For listed entities, reference is made to the quoted prices
of the shares on that date (IFRS 3.BC342). For unlisted entities, a valuation technique would
be required.
The acquisition date is the date that control passes from the acquiree to the acquirer.
The primary reasons for the use of fair value at that date are:
• The consideration given and the assets acquired and liabilities assumed would be mea-
sured on the same date, including the residual goodwill.
• The parties to a business combination are likely to take into account expected changes
between the agreement date and the acquisition date in the fair value of the acquirer and
the market price of the acquirer’s securities issued as consideration.
Under ASPE there will be no quoted market price for equity and therefore a valuation
ASPE will be required. ASPE allows the acquirer to use the fair value of the acquiree as the
basis of the acquisition cost if it is more reliably measurable.
Liabilities Undertaken
The fair values of liabilities undertaken are best measured by the present values of expected
future cash outflows. Future losses or other costs expected to be incurred as a result of the
combination are not liabilities of the acquirer and are therefore not included in the calcula-
tion of the fair value of consideration paid. For example, a decision to restructure the acquiree
business is not a liability at the day of acquisition and therefore these costs are not considered
a part of the acquisition cost.
Costs of Issuing Debt and Equity Instruments

In issuing equity instruments such as shares as part of the consideration paid, transaction
costs such as underwriting costs and brokerage fees may be incurred. These outlays should
be treated as a reduction in the share capital of the entity as such costs reduce the proceeds
from the equity issue. Hence, if costs of $1,000 are incurred in issuing shares as part of the
consideration paid, the journal entry in the records of the acquirer is:
Share Capital 1,000
Cash 1,000
(To record the costs of issuing equity instruments) (IFRS 3.53)
Similarly, the costs of arranging and issuing financial liabilities are an integral part of the
liability issue transaction. These costs are included in the initial measurement of the liability
or expensed depending upon whether the liability is reported at amortized cost or at fair
value.
Contingent Consideration
Appendix A to IFRS 3 provides the following definition of contingent consideration:
Usually, an obligation of the acquirer to transfer additional assets or equity interests to the
former owners of an acquiree as part of the exchange for control of the acquiree if specified
future events occur or conditions are met. However, contingent consideration also may give the
acquirer the right to the return of previously transferred consideration if specified conditions
are met.
Consider two examples of contingencies:
1. When the acquiree’s future income is regarded as uncertain, the agreement may contain
a clause that requires the acquirer to provide additional consideration to the acquiree if
the income of the acquirer is not equal to or exceeds a specified amount over some speci-
fied period. For example, A may agree to pay $100,000 to acquire B and promise to pay
an additional $50,000 in two years if B earns at least $100,000 for the next two years. A is
concerned that the owners of B are integral to the success of B and may not stay involved
if they receive full payment immediately.
2. The acquirer issues shares to the acquiree and the acquiree is concerned that the issue
of these shares may make the market price of the acquirer’s shares decline over time.
Therefore, the acquirer may offer additional cash or shares if the market price falls below
a specified amount over a specified period of time. This type of contingency exists to
protect the seller against a decrease in value of the acquirer’s shares.
The acquirer must recognize the acquisition-date fair values of contingent consideration
as part of the consideration transferred (IFRS 3.39).
Acquisition-Related Costs
In addition to the consideration transferred by the acquirer to the acquiree, a further item
to be considered in determining the cost of the business combination is the costs directly
attributable to the combination, which includes costs such as “finder’s fees; advisory, legal,
accounting, valuation, and other professional or consulting fees; [and] general admin-
istrative costs, including the costs of maintaining an internal acquisitions department”
(IFRS 3.53).
In IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets, directly attributable
costs are considered a part of the cost of acquisition and capitalized into the cost of the asset
acquired. In contrast, the acquisition-related costs associated with a business combination
are accounted for as expenses in the periods in which they are incurred and the services are
received. The key reasons given for this approach are:
• Acquisition-related costs are not part of the fair value exchange between the buyer and
seller.
• They are separate transactions for which the buyer pays the fair value for the services
received.
• These amounts do not generally represent assets of the acquirer at acquisition date
because the benefits obtained are consumed as the services are received.
The accounting for these outlays is a result of the decision to record the identifiable
assets acquired and liabilities assumed at fair value. In contrast, under IAS 16 and IAS 38, the
assets acquired are initially recorded at cost (IFRS 3.BC366).
Consideration transferred in a business combination is demonstrated in Illustrative
Example 2.1.
Illustrative Example 2.1 Consideration Transferred

in a Business Combination
The trial balance below represents the financial position of Whiting Ltd. at January 1,
2013.
WHITING LTD.
Trial Balance
as at January 1, 2013
Debit Credit
Share capital
Preferred—6,000 shares $ 6,000
Common—30,000 shares 30,000
Equipment $42,000
Accumulated depreciation—equipment 10,000
Inventory 18,000
Patents 3,500
Bonds 4,000
Accounts payable 8,000
$79,500 $79,500
At this date, the business of Whiting Ltd. is acquired by Salome Ltd., with Whiting
going into liquidation. The terms of acquisition are as follows:
1. Salome is to take over all of Whiting’s assets and accounts payable.
2. Costs of liquidation of $350 are to be paid by Whiting with funds supplied by
Salome.
3. Preferred shareholders of Whiting are to receive two common shares in Salome
for every three shares held or, alternatively, $1 per share in cash payable at
acquisition date.
4. Common shareholders of Whiting are to receive two common shares in Salome for
every share held or, alternatively, $2.50 in cash, payable half at the acquisition date
and half on December 31, 2013.
5. Bond holders of Whiting are to be paid in cash out of funds provided by Salome.
These bonds have a fair value of $102 per $100 debenture.
6. All shares being issued by Salome have a fair value of $1.10 per share. Holders
of 3,000 preferred shares and 5,000 common shares in Whiting elect to receive
the cash.
7. Costs of issuing and registering the shares issued by Salome amount to $140.
8. Costs associated with the business combination and incurred by Salome were
$1,000.
The calculation of the consideration transferred in the business combination

to Salome is shown below. The incremental borrowing rate for Salome is 10% per
annum.
Consideration transferred in the business combination:
Fair value
Cash: Costs of liquidation $ 350
Preferred shareholders (3,000 $1.00) 3,000
Common shareholders
– payable immediately (1/2 5,000 $2.50) 6,250
– payable later (1/2 5,000 $2.50 .909091)∗ 5,682
Bonds, including premium ($4,000 1.02) 4,080
$19,362
Shares: Preferred shareholders (2,000 $1.10) 2,200
Common shareholders (50,000 $1.10) 55,000 57,200
Consideration transferred $76,562
* $5,682 is the cash payable in one year’s time discounted at 10% p.a.
In acquiring the net assets of Whiting, Salome records the journal entries below.
Journal entries in the acquirer’s records:
2013
Jan. 1 Net Assets Acquired1 76,562
Consideration Payable 19,362
(To record the acquisition of the net assets
of Whiting Ltd.)
Note 1: the net assets acquired would be
separated into the specific fair values for each
identifiable asset and liability and goodwill
(see Illustrative Example 2.2).
Cash 13,680
(To record payment of cash consideration
to Whiting: $19,362 less $5,682 payable later)
Share Capital 140
Cash 140
(To record share issue costs)
Acquisition-Related Expenses 1,000
Cash 1,000
(To record acquisition-related expenses)
Dec. 31 Consideration Payable 5,682
Interest Expense 568
Cash 6,250
(To record the balance of consideration paid)
Recognizing and Measuring Assets Acquired

and Liabilities Assumed
Recognition
Paragraph 10 of IFRS 3 states:
As of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable
assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. Recognition
of identifiable assets acquired and liabilities assumed is subject to the conditions specified in para-
graphs 11 and 12.
The conceptual framework specifies two recognition criteria for assets and liabilities,
stating that recognition occurs if:
• it is probable that any future economic benefit will flow to or from the entity
• the item has a cost or value that can be reliably measured.
At the acquisition date, the assets and liabilities recognized by the acquirer must meet
the definitions of assets and liabilities in the conceptual framework. Any expected future costs
cannot be included in the calculation of assets acquired and liabilities assumed.
The acquirer is required in IFRS 3 “to recognize identifiable assets acquired and liabilities
assumed regardless of the degree of probability of an inflow or outflow of economic benefits.”
The assets acquired and liabilities assumed are measured at fair value.4 In deciding whether to
recognize an asset or liability, in a business combination, it is assumed that the probability test
for the assets acquired and liabilities undertaken in a business combination is unnecessary and
that these assets and liabilities will always be able to be measured reliably. Use of estimates sim-
ply means the measure may involve uncertainty, but does not mean the measure is unreliable.
Contingent liabilities. Contingent liabilities are a particular challenge to recognize in

a business combination. The issue is whether a contingent liability that is or is not actually
measured on the books of the acquiree represents a liability to the acquirer. IAS 37 Provisions,
Contingent Liabilities and Contingent Assets paragraph 10 contains the following definition of a
contingent liability:
(a) a possible obligation that arises from past events and whose existence will be confirmed only non-liab.
by the occurrence or non-occurrence of one or more uncertain future events not wholly within contingenc
the control of the entity; or y
(b) a present obligation that arises from past events but is not recognized because: Real cont. liab.
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.
Note that there are two types of contingent liabilities: real liabilities (present obligations)
that are not recognized because of a failure to meet the recognition criteria, and non-liabilities
(possible obligations). As the contingent liabilities under (b) above are real liabilities, they are
recognized by the acquirer in a business combination and measured at fair value. The require-
ments in terms of the recognition criteria in IAS 37 do not apply for a business combination.
However, the contingent liabilities under (a) above are not real liabilities and therefore are
4
That fair value will reflect expectations about the probability of inflows or outflows of benefits. The
effects of probability are then built into the measurement of the fair value, and that amount is always
expected to be received for assets or paid out for liabilities. The probability criterion is then unneces-
sary where fair values are used as the measurement method. This is inconsistent with the treatment
in other parts of the handbook and was being reviewed so that IFRS 3 would treat the acquisition of
assets the same way as other purchased of assets.
not recognized in a business combination. At the time of writing, there was an exposure draft
outstanding that proposed a different definition of contingent liabilities and would remove
the notion of “provisions.” As part of the process, the requirements of business combinations
in IFRS 3 would be aligned with IAS 37.
In some cases the seller may include an offer to reimburse the acquirer for the outcome
of a contingency or uncertainty. In other words the seller guarantees that this contingency
will not be greater than a certain amount. This creates an asset, called an indemnification asset,
for the acquirer and would be measured at fair value.
Linking other transactions. The item acquired or assumed must be part of the business
acquired rather than the result of a separate transaction. This recognition principle is an
example of the application of substance over form in that the entities involved in the trans-
action may link another transaction with the business combination, but in substance it is a
separate transaction (IFRS 3.51 and .52).
Example 1: The business combination transaction settles pre-existing relationships between
the acquirer and the acquiree.
A potential acquiree has a receivable for an unresolved claim against the potential
acquirer. As part of the agreement to combine, the acquirer agrees to settle the claim with the
acquiree, and part of the consideration transferred is for that purpose. It is then necessary to
separate the two transactions and separate out of the consideration transferred the amount
paid to settle the claim (IFRS 3.BC 122).
Example 2: The business combination transaction remunerates employees or former owners
of the acquiree for future services.
Example 3: The business combination transaction reimburses the acquiree or its former
owners for paying the acquirer’s acquisition-related costs.
Separately identifiable intangible assets. There may be assets and liabilities recognized
as a result of the business combination that were not recognized by the acquiree. One exam-
ple of this is internally generated intangibles that were not recognized by the acquiree on the
application of IAS 38 Intangible Assets. For example, internally generated brands would not
be recognized by an acquiree but would be recognized by the acquirer. The acquirer would
measure these at fair value.
In recognizing the assets and liabilities, it is necessary to classify or designate them. The
acquirer does this based on the contractual terms, economic conditions, its operating or
accounting policies, and other pertinent conditions that exist at acquisition date. One exam-
ple of this is the classification of financial instruments, such as financial assets available for
sale or held to maturity, or at fair value through profit or loss (IFRS 3.15).5
The IASB provides examples of items acquired in a business combination that would
meet the definition of an intangible asset.6 The note in Illustration 2.5 describes intangible
assets in the financial statements of gold producer Barrick Gold Corporation.
Illustration 2.5 N) Intangible Assets

Excerpts from the Intangible assets acquired by way of an asset acquisition or business combination are recognized if the
Financial Statements of asset is separable or arises from contractual or legal rights and the fair value can be measured reliably on
Barrick Gold Corporation initial recognition.
Fair value is basically a market-based measure in a transaction between unrelated parties.

However, the process of determining fair value necessarily involves judgement and estima-
tion. The acquiring entity is not actually trading the items in the marketplace for cash, but
is trying to estimate what the exchange price would be if it did so. Hence, the determination
5
One exception to this classification requirement is leases. Leases are classified as operating or finance
leases in accordance with IAS 17 Leases.
6
This list is available in WileyPLUS and at www.wiley.com/go/fayermancanada.
of fair value involves estimation, and guidance from IFRS 13 should be adhered to. In 2011
Shoppers Drug Mart Corporation provided the note disclosure in Illustration 2.6 regarding
the net assets acquired through business acquisitions.
Illustration 2.6 In the normal course of business, the Company acquires the assets or shares of pharmacies. The total cost
Excerpts from the of these acquisitions during the 12 and 24 weeks ended June 18, 2011, of $200 and $6,465 (2010:
Financial Statements $1,623 and $11,456), respectively, was allocated primarily to goodwill and other intangible assets based
of Shoppers Drug Mart on their fair values. The goodwill acquired represents the benefits the Company expects to receive from
Corporation the acquisitions. During the 12 and 24 weeks ended June 18, 2011, the Company expects that $nil and
$38 (2010: $823 and $7,233), respectively, of acquired goodwill will be deductible for tax purposes.
The values of assets acquired and liabilities assumed have been valued at the acquisition date using fair
values. The intangible assets acquired are composed of prescription files. In determining the fair value
of prescription files acquired during the 12 and 24 weeks ended June 18, 2011, the Company applied a
pretax discount rate of 9 percent (2010: 8 percent) to the estimated expected future cash flows.
The operations of the acquired pharmacies have been included in the Company’s results of operations
from the date of acquisition.
One of the problems that may arise in measuring the assets and liabilities of the acquiree
is that the initial accounting for the business combination may be incomplete by the end of
the reporting period. For example, the acquisition date may be December 31 and the end of
the reporting period may be December 31. In this situation, the acquirer must report provi-
sional amounts in its financial statements. The provisional amounts will be best estimates and
will need to be adjusted to fair values when those amounts can be determined after the end of
the reporting period. The measurement period in which the adjustments can be made cannot
exceed one year after the acquisition date.
Illustration 2.7 shows a note in the financial statements of Bell Canada Enterprises
Inc., Canada’s largest communications company, regarding the use of estimates.
Illustration 2.7 Acquisition of CTV

Excerpts from the On April 1, 2011, BCE acquired the remaining 85% of the CTV Inc. (CTV) common shares that it did not
Financial Statements of already own. CTV is a media company that holds specialty television, digital media, conventional TV and radio
Bell Canada Enterprises broadcasting assets. We acquired CTV because it allows us to better leverage content across multiple platforms.
The purchase price allocation includes certain estimates. The final purchase price allocation for the ac-
quisition will be complete within 12 months of the acquisition date. The following table summarizes the
fair value of the consideration given and the fair value assigned to each major class of asset and liability.
Total
Cash 713
Issuance of BCE Inc. common shares1 597
Purchase consideration 1,310
Fair value of previously held interest 221
Non-controlling interest2 266
Total cost to be allocated 1,797
Non-cash working capital 95
Property, plant and equipment 454
Other non-current assets 35
Finite-life intangibles 551
Indefinite-life intangibles 1,511
Debt due within one year (1,039)
Long-term debt (762)
Other non-current liabilities (525)
320
Cash and cash equivalents 33
Fair value of net assets acquired 353
Goodwill3 1,444
Illustration 2.7
1
(Continued) We issued 21,729,239 common shares with a fair value of $764 million based on the market price of BCE Inc.
common shares on the acquisition date, of which $597 million is purchase consideration and $167 million is for the
repayment of certain acquired debt.
2
Non-controlling interest in certain CTV subsidiaries was recorded at the fair value of the proportionate share of the
corresponding net assets acquired.
3
Goodwill arises principally from the ability to leverage content, the assembled workforce reputation and future growth.
Goodwill is not deductible for tax purposes.
The acquisition date fair value of our previously held 15% equity interest in CTV immediately before the
acquisition was $221 million, resulting in a gain on remeasurement of $89 million, which was reclassified
from Accumulated other comprehensive income to Other income in the consolidated income statement in
the second quarter of 2011.
The fair value of the acquired trade receivables was $449 million net of an allowance for doubtful
accounts of $5 million.
The Canadian Radio-television and Telecommunications Commission (CRTC) approved the acquisi-
tion and ordered BCE to spend $239 million over seven years to benefit the Canadian broadcasting sys-
tem. The present value of this tangible benefits obligation, amounting to $164 million, net of $57 million
assumed by CTV’s previous shareholders, was recorded as an acquisition cost in Severance, acquisition
and other costs in the consolidated income statement for the three months and six months ended
June 30, 2011. Total acquisition costs relating to CTV amounted to $170 million for the six months
ended June 30, 2011.
Revenues of $517 million and net earnings of $62 million are included in the consolidated income
statement from the date of acquisition.
BCE’s consolidated revenues and net earnings for the six-month period ended June 30, 2011, would
have been $9,876 million and $1,248 million, respectively, if the CTV acquisition had occurred on Janu-
ary 1, 2011. These pro forma amounts reflect the elimination of intercompany transactions, financing
related to the acquisition, the amortization of certain elements of the purchase price allocation and related
tax adjustments.
As a result of the acquisition, contractual obligations increased by approximately $880 million as at
June 30, 2011.
After the end of the reporting period, as new information and facts are gathered, the
acquirer will progressively adjust the assets and liabilities acquired to fair value. This process
may also result in the recognition of new assets and liabilities previously not recognized. The
adjustments in assets and liabilities are recognized by means of an increase or decrease in
goodwill (IFRS 3.48).
Income Taxes
Upon the acquisition of another business it is possible that there are tax assets or liabilities
that the acquirer must recognize as part of the net assets acquired.
Specifically, IFRS 3 identifies the following tax effects:
• deferred tax assets due to loss carryforwards

• temporary differences due to the difference between the fair value and the undepreciated
capital cost.
Under IFRS 3.25, an acquirer is required to recognize and measure the effect of any tempo-
rary differences and carryforwards of an acquiree that exist at the acquisition date or that arise
as a result of the acquisitions.
Carryforwards. The acquiree may be an entity that has been incurring losses and there-
fore has loss carryforwards for tax purposes available to it. If the entity did not meet the
“more likely than not” criteria for recognition, this benefit would not be reflected in its finan-
cial statements. However, upon acquisition of the other entity, the acquirer may be able to
generate enough income in the acquiree to meet the “more likely than not” criteria. This is
more commonly a scenario where the shares of the acquiree are purchased rather than the
assets and liabilities. This is due to the fact that the acquiree is likely to continue as a separate
entity and therefore continue to file tax returns.
Temporary differences. The acquiree will have deferred income tax assets or liabilities
on its financial statement due to temporary differences that arise. Many of the assets that are
generating these differences will be recorded at fair value for the acquirer. These deferred
assets or liabilities have no value to the acquirer because the acquirer will establish its own
temporary differences equal to the difference between the value of the asset at acquisition and
the undepreciated capital cost. If the acquirer purchases the assets and liabilities the tempo-
rary difference will be zero since the undepreciated capital cost and the book value will be the
same. If the acquirer purchases shares, it will have an effect since the acquiree remains a sepa-
rate legal entity and therefore continues to pay tax on the original undepreciated capital cost.
However, the consolidated financial statements will reflect the asset’s fair value at the day of
acquisition. Therefore, there will be a temporary difference equal to the difference between
the fair value and the undepreciated capital cost (IAS 12.19). This issue is further addressed
in chapters that explore the acquisition of shares (Chapters 3 to 5).
Under ASPE a company has the option of using the tax payable method. If it selects this
ASPE accounting policy, there will be no temporary differences on the acquisitions of assets
or liabilities.
Recognizing and Measuring Goodwill

or a Gain from a Bargain Purchase
Definition of Goodwill
Goodwill is accounted for as an asset and is defined as:
An asset representing the future economic benefits arising from other assets acquired in a business
combination that are not individually identified and separately recognized (IFRS 3 Appendix A).
The criterion of being individually identified relates to the characteristic of identifiability

as used in IAS 38 Intangible Assets to distinguish intangible assets from goodwill.
The definition of an intangible asset requires an intangible asset to be identifiable to dis-
tinguish it from goodwill. In order to be identifiable, an asset must be capable of being sepa-
rated or divided from the entity, or arise from contractual or other legal rights. The notion of
being separately recognized is also then a part of the criterion of identifiability.
Goodwill is then a residual, after the acquirer’s interest in the identifiable tangible assets,
intangible assets, and liabilities of the acquiree is recognized.
Goodwill acquired in a business combination represents a payment made by the acquirer
in anticipation of future economic benefits from assets that are not capable of being individu-
ally identified and separately recognized. The future economic benefits may result from syn-
ergy between the identifiable assets acquired or from assets that, individually, do not qualify
for recognition in the financial statements but for which the acquirer is prepared to make a
payment in the business combination.
Paragraph 32 of IFRS 3 states:
The acquirer shall recognize goodwill as of the acquisition date measured as the excess of (a) over
(b) below:
(a) the aggregate of:
(i) the consideration transferred measured in accordance with this Standard, which gener-
ally requires acquisition-date fair value;
(ii) the amount of any non-controlling interest in the acquiree measured in accordance with
this Standard; and
(iii) in a business combination achieved in stages, the acquisition-date fair value of the
acquirer’s previously held equity interest in the acquiree.
(b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities
assumed measured in accordance with this Standard.
In relation to parts (a)(ii) and (iii), these will affect calculations only where the acquirer
obtains control by acquiring shares in the acquiree. This is discussed in Chapters 3 to 5. This
means that for business combinations discussed in this chapter, goodwill is determined by
comparing the consideration transferred by the acquirer with the net fair value of the identifi-
able assets and liabilities acquired.
Goodwill is the excess of the consideration transferred over the net fair value of the iden-
tifiable assets acquired and liabilities assumed.
Goodwill Consideration transferred

less
Acquirer’s interest in the net fair value of the acquiree’s
identifiable assets and liabilities
Accounting for Goodwill

Goodwill is calculated as the excess of the consideration transferred in the business combina-
tion over the acquirer’s interest in the net fair value of the identifiable assets acquired and
liabilities assumed from the acquiree. Hence, to calculate goodwill as a part of the acquisi-
tion analysis it is necessary to calculate the consideration transferred and the net fair value of
the identifiable assets acquired and liabilities assumed. A comparison of these two amounts
determines the existence of goodwill. The acquirer then recognizes goodwill as an asset in
the same way as for all other identifiable assets acquired.
The acquirer analyses the difference between the consideration transferred and the
fair value of the net assets received in order to determine goodwill. This is demonstrated in
Illustrative Example 2.2.
Illustrative Example 2.2 Acquisition Analysis

Using the figures from Illustrative Example 2.1, assume that Salome Ltd. assesses the
fair values of the identifiable assets and liabilities of Whiting Ltd. to be as follows:
Equipment $36,000
Inventory 20,000
Patents 4,000
Furniture 6,000
To determine the entries to be recorded by the acquirer, it is necessary to prepare

an acquisition analysis that compares the consideration transferred with the net fair
value of the identifiable assets, liabilities, and contingent liabilities acquired. The analy-
sis for this example is shown below.
Step 1: Calculate the consideration transferred.
This was calculated in Illustrative Example 2.1 as $76,562.
Step 2: Calculate the net fair value of identifiable assets acquired and liabilities
assumed.
Equipment $36,000
Inventory 20,000
Patents 4,000
Furniture 6,000
75,000
Accounts payable (8,000)
Net fair value $67,000
Step 3: Calculate the difference between the amount calculated in steps 1 and 2.
Consideration transferred $ 76,562

Net fair value acquired ($67,000)
Goodwill acquired $ 9,562
The journal entries for the acquirer, Salome Ltd., at acquisition date, including recog-
nition of goodwill, are as shown below.
Journal of Salome Ltd.
Equipment 36,000
Inventory 20,000
Patents 4,000
Furniture 6,000
Goodwill 9,562
(To record the acquisition of the assets and liabilities
of Whiting Ltd.)
Cash 13,680
(To record the payment of cash consideration)
Cash 1,000
(To record the acquisition-related costs)
Share Capital 140
Cash 140
(To record share issue costs)
Interest Expense 568
Cash 6,250
(To record the balance of consideration payable)
Accounting for a Gain on Bargain Purchase

Where the acquirer’s interest in the net fair value of the acquiree’s identifiable assets and
liabilities is greater than the consideration transferred, the difference is called a gain on a
bargain purchase. In equation format, it can be represented as follows:
Gain on bargain purchase Acquirer’s interest in the net fair value of the acquiree’s
identifiable assets and liabilities
Less
Consideration transferred
Standard setters consider the existence of a bargain purchase as an anomalous transaction
as parties to the business combination do not knowingly sell assets at amounts lower than
their fair value. However, because the acquirer has excellent negotiation skills, or because the
acquiree has made a sale for other than economic reasons or is forced to sell owing to specific
circumstances such as cash flow problems, such situations do arise.
Most business combinations are an exchange of equal amounts, given markets in which
the parties to the business combinations are informed and willing participants in the transac-
tion. Therefore, the existence of a bargain purchase is expected to be an unusual or rare event.
Before a gain is recognized, the acquirer must reassess whether it has correctly:
• identified all the assets acquired and liabilities assumed
• measured at fair value all the assets acquired and liabilities assumed
• measured the consideration transferred (IFRS 3.36).
The objective here is to ensure that all the measurements at acquisition date reflect all the
information that is available at that date.
Note that one effect of recognizing a bargain purchase is that there is no recognition of
goodwill. A gain on bargain purchase and goodwill cannot be recognized in the same business
combination.
A gain on bargain purchase is demonstrated in Illustrative Example 2.3.
Illustrative Example 2.3 Gain on Bargain Purchase

Using the information regarding the consideration transferred in a business combina-
tion from Illustrative Examples 2.1 and 2.2, assume the fair values of the identifiable
assets and liabilities of Whiting Ltd. are assessed to be the following:
Equipment $45,000
Inventory 25,000
Patents 5,000
Furniture 6,000
No goodwill recorded 90,000

8,000
The acquisition analysis now shows:

Net fair value of assets and liabilities acquired $82,000
Gain on bargain purchase $82,000 76,562
$ 5,438
Assuming that the reassessment process did not result in any changes to the fair
values calculated, the first journal entry in Salome Ltd. to record the acquisition of the
net assets of Whiting Ltd. is:
Equipment 45,000
Inventory 25,000
Patents 5,000
Furniture 6,000
Gain (Profit and Loss) 5,438
(To record the acquisition of assets and liabilities acquired from Whiting Ltd., and the gain on bargain
purchase)
Shares Acquired in an Acquiree

Where an entity acquires shares rather than the net assets of another entity, the acquirer records
the shares acquired at fair value plus transaction costs. This is because on its own books the
investment will be reflected at cost since a consolidated statement will be prepared. This was
illustrated in Chapter 1. Transaction costs include fees and commissions paid to agents, advisers,
brokers, and dealers; levies by regulatory agencies and securities exchanges; and transfer taxes
and duties. It is expected that, in the majority of cases, the fair value of the shares acquired will
equal the fair value of the consideration paid. The basic form of the journal entry in the records
of the acquirer is:
Investment in Acquiree xxx
Share Capital xxx
Cash xxx
(To record the acquisition of shares in another entity)
However, since the acquirer now has control it will be required to consolidate its finan-
cial statements with the acquiree. Consolidation is a process that takes place outside of the
record keeping of each individual company. Legally both the acquirer and the acquiree are
separate entities and are required to maintain their own records and file their own tax returns.
As such, the recording in the books of the acquirer are not the same as the presentation on
the consolidated financial statements. The presentation of the consolidated financial state-
ments will be illustrated in Chapter 3.
The accounting for the acquisition of shares is demonstrated in Illustrative Example 2.4.
Illustrative Example 2.4 Accounting for Acquisition

of Shares
Assume that on January 1, 2011, Salome Ltd. acquired all the issued shares in Whiting
Ltd. for $80,000, giving in exchange $10,000 cash and 20,000 shares in Salome, the lat-
ter having a fair value of $3.50 per share. Transaction costs of $500 were paid in cash.
Share issue costs were $1,000.
The journal entries in the records of Salome Ltd. to account for the acquisition of
shares at the acquisition date are as shown below.
Journal of Salome Ltd.
Investment in Whiting Ltd. 80,000

Cash 10,000
(To record the acquisition of shares in Whiting Ltd.)
Investment in Whiting Ltd. transaction costs 500

Cash 500
(To record transaction costs)
Share Capital issuing costs 1,000

Cash 1,000
(To record the costs of issuing shares to Whiting Ltd.)
Existence of a Previously Held Equity Interest

In Illustrative Example 2.4, the acquirer acquired all issued shares of the acquiree in one
transaction. An alternative situation could occur where the acquirer obtained its controlling
interest in the acquirer by acquiring further shares and thereby adding to its previously held
equity interest. For example, in Illustrative Examples 2.1, Salome Ltd. may have previously
held 20% of the shares in Whiting Ltd. on January 1, 2013, and at that date acquired the
remaining 80% of the shares of Whiting. As a business combination occurs when the acquirer
obtains control of the acquiree, it is on the date of the second acquisition of shares that the
business combination occurs. In IFRS 3, this is referred to as a business combination achieved
in stages, sometimes called a step acquisition. Obviously there may be a number of step pur-
chases of shares in the acquiree prior to obtaining control.
Each of the steps prior to the date where the acquirer obtains control will be accounted
for as in Chapter 1; that is, the acquirer will recognize an investment in the acquiree with
each step acquisition being measured at fair value.
It is also possible, of course, that the acquirer may obtain control of the acquiree with-
out making a further step acquisition. For example, the composition of the non-controlling
interest may change such that the acquirer becomes the controlling entity, as was discussed
in Chapter 1.
The accounting for a step acquisition is given in IFRS 3.42:
In a business combination achieved in stages, the acquirer shall remeasure its previously held
equity interest in the acquiree at its acquisition-date fair value and recognize the resulting
gain or loss, if any, in profit or loss.
Use the situation in Illustrative Example 2.4, but assume that prior to acquiring 80% of
the shares of Whiting on January 1, 2013, Salome Ltd. had acquired 20% of Whiting’s shares
on January 1, 2012, for $10,000 and this investment had a $16,000 fair value at January 1,
2013. At January 1, 2013, Salome would then record the following entry to revalue its previ-
ously held investment in Whiting:
Investment in Whiting Ltd. 6,000

bringing whatever was purchased Gain (Profit or Loss) 6,000
previously at FV (To remeasure previously held equity interest on business combination)
It would then reflect the same consideration transferred as that shown in illustrative
example 2.1.
Where the equity interest had previously been revalued with changes in fair value being
recognized in other comprehensive income using the elective exemption under IFRS 9, then
the accounting for the amounts recognized in equity will be the same as if the equity interest
was sold—in essence not recycled through net income.
✓ LEARNING CHECK
• The acquirer must recognize identifiable assets acquired and liabilities assumed of the acquiree
at fair value at acquisition date.
• The recognition of assets and liabilities are not subject to normal recognition criteria,
although IFRS 3 makes recognition subject to two main conditions: the definitions of assets
and liabilities must be met, and the item acquired or assumed must be part of the business
acquired.
• The consideration transferred is the sum of the fair values of the components given up by the
acquirer, but does not include any acquisition-related costs, which are expensed.
• Goodwill basically consists of assets that are unidentifiable, or do not meet asset recognition
criteria.
• Goodwill is not directly measured but is a residual; that is, the difference between the cost
of the combination and the sum of the net fair values of the identifiable assets acquired and
liabilities assumed.
• Where the net fair value of the identifiable assets acquired and liabilities assumed exceeds
the cost of the combination, a gain on purchase is recognized, affecting current period
income.
ACCOUNTING IN THE RECORDS

OF THE ACQUIREE
Purchase of Acquiree’s Assets and Liabilities
Objective 4 Where the acquirer purchases the acquiree’s assets and liabilities, the acquiree may continue
Prepare the to exist or it may liquidate. The journal entries required in the records of the acquiree are
accounting records shown in Illustrative Example 2.5. On the sale of a business, the acquiree recognizes a gain
of the acquiree. or loss.
Illustrative Example 2.5 Journal Entries of Acquiree on

Sale of Business
Receivable from Acquirer xxx
Liability A xxx
Liability B xxx
Liability C xxx
Asset A xxx
Asset B xxx
Asset C xxx
Gain on Sale of Operation* xxx
(To record the sale of an operation)
*Separate proceeds on sale and carrying amounts of assets sold could be recognized
Shares in Acquirer xxx

Cash xxx
Receivable from Acquirer xxx
(To record receipt of consideration from acquirer)
If the acquiree decides to liquidate, it transfers the cash remaining to the shareholders as
a liquidating dividend.
Purchase of Acquiree’s Shares from

the Shareholders
When the acquirer buys only shares in the acquiree from the shareholders of the acquiree,
there are no entries in the records of the acquiree because the transaction is between the
acquirer and the shareholders of the acquiree entity. The acquiree itself is not involved.
✓ LEARNING CHECK
• An acquiree may continue to exist as an entity subsequent to a business combination, or may
go into liquidation.
• Where the acquirer buys shares of the acquiree from the shareholders, there is no effect on
the acquiree records.
Subsequent Adjustments to the Initial Accounting for a Business Combination 73
SUBSEQUENT ADJUSTMENTS TO
THE INITIAL ACCOUNTING FOR
A BUSINESS COMBINATION
Objective 5 Earlier in the chapter, we saw that IFRS 3 allows for a “measurement period” of one year,
Account for during which time the consideration received may be adjusted due to the receipt of new infor-
subsequent mation. In this section we look beyond the measurement period. There are three areas where
adjustments to the
adjustments may need to be made subsequent to the initial accounting after acquisition date:
initial accounting
for a business • goodwill
combination.
• contingent liabilities
• contingent consideration.
Goodwill
Having recognized goodwill arising in the business combination, the subsequent accounting
is directed from other accounting standards.
• Goodwill is not subject to amortization but is subject to an annual impairment test as
detailed in IAS 36 Impairment of Assets.
• Goodwill cannot be revalued because IAS 38 Intangible Assets does not allow the recogni-
tion of internally generated goodwill.
Illustration 2.8 shows an excerpt from the financial statements of the communications
company COGECO Inc., with notes on goodwill and intangible assets. Note that COGECO
reflects an impairment of goodwill in the current period.
Illustration 2.8 Impairment of goodwill and intangible assets
Excerpts from the
(in thousands of dollars) 2010 2009
COGECO Inc. Impairment of goodwill $ $339,206
Impairment of intangible assets 60,442
399,648
During the second quarter of fiscal 2009, the competitive position of Cabovisão in Portugal further
deteriorated due to the continuing difficult competitive environment and recurring intense promotions
and advertising initiatives from competitors in the Portuguese market. In accordance with applicable
accounting standards, management considered that the continued customer, local currency revenue and
operating income before amortization decline, were more severe and persistent than expected, result-
ing in a decrease in the value of the Company’s subsidiary’s investment in the Portuguese subsidiary.
As a result, the Company’s subsidiary tested goodwill and all long-lived assets for impairment at February
28, 2009.
Goodwill is tested for impairment using a two-step approach. The first step consists of determining whether
the fair value of the reporting unit to which goodwill is assigned exceeds the net carrying amount of that
reporting unit, including goodwill. In the event that the net carrying amount exceeds the fair value, a
second step is performed in order to determine the amount of the impairment loss. The impairment loss
is measured as the amount by which the carrying amount of the reporting unit’s goodwill exceeds its fair
value. The Company’s subsidiary completed its impairment tests on goodwill and concluded that goodwill
was impaired at February 28, 2009. As a result, an impairment loss of $339.2 million was recorded in the
second quarter of fiscal 2009. Fair value of the reporting unit was determined using the discounted cash
flow method. Future cash flows were based on internal forecasts and consequently, considerable manage-
ment judgement was necessary to estimate future cash flows. Significant future changes in circumstances
could result in further impairments of goodwill.
Intangible assets with finite useful lives, such as customer relationships, must be tested for impairment by
comparing the carrying amount of the asset or group of assets to the expected future undiscounted cash
flows to be generated by the asset or group of assets. The impairment loss is measured as the amount by
which the asset or group of assets’ carrying amount exceeds its fair value. Accordingly, the Company’s
Illustration 2.8
subsidiary completed its impairment test on customer relationships at February 28, 2009, and deter-
(Continued) mined that the carrying value of customer relationships exceeded its fair value. As a result, an impairment
loss of $60.4 million was recorded in the second quarter of fiscal 2009.
At August 31, 2010 and 2009, the Company’s subsidiary tested the value of goodwill for impairment and
concluded that no impairment existed.
Goodwill and other intangible assets

Customer relationships $ 28,106 $ 32,882

Broadcasting licences 25,120 25,120
Customer base 989,772 989,772
Goodwill 1,042,998 1,047,774
144,695 153,695
$1,187,693 $1,201,469
Contingent Liabilities
Having recognized any contingent liabilities of the acquiree as liabilities, the acquirer must then
determine a subsequent measurement for the liability. The liability is initially recognized at fair
value. Subsequent to acquisition date, the liability is measured as the higher of:
• the amount that would be recognized in accordance with IAS 37; and
• the amount initially recognized less, if appropriate, cumulative amortization recognized
in accordance with IFRS 8 Revenue.
The liability would be measured at the best estimate of the expenditure required to settle the
present obligation at the end of the reporting period. This would be used, for example, where
a liability was recognized in relation to a court case, or guarantees. Any change would affect
income of that period as it represents a change in estimate.
Contingent Consideration
At the acquisition date, the contingent consideration is measured at fair value, and is classified
either as equity (e.g., the requirement for the acquirer to issue more shares subject to subsequent
events) or as a liability (e.g., the requirement to provide more cash subject to subsequent events).
Subsequent to the business combination, the accounting for contingent consideration should
be in accordance with the accounting standard that would normally apply to these accounts.
However, IFRS 3 provides guidance on the measures to be used.
Where the contingent consideration is classified as equity, no remeasurement is required,
and the subsequent settlement is accounted for within equity (IFRS 3.58(a)). This means that
if extra equity instruments are issued, they are effectively issued for no consideration and
there is no change to share capital and therefore there is no journal entry. Where the contin-
gent consideration is a financial liability, it will be accounted for under IAS 39 and measured
at fair value with movements being accounted for in accordance with that standard. So, if
there were changes in the amount of an expected cash outflow, the liability would be adjusted
and an amount recognized in profit or loss.
It should be noted that the subsequent accounting for contingent consideration is to
treat it as a post-acquisition event; that is, not affecting the measurements made at acqui-
sition date. Hence, any subsequent adjustments do not affect the goodwill calculated at
acquisition date.
Under ASPE, the impairment testing for goodwill is only done if there is reason to believe
that it is impaired. In addition, the test itself is simpler than that required under IFRS.
ASPE Under ASPE there is no subsequent reassessment of a contingent consideration
or contingent liabilities whether it is debt or equity.
A comprehensive demonstration of accounting for business combinations is in

Illustrative Example 2.6 Comprehensive Example

Labrador Ltd.’s major business is in the pet food industry. It makes a number of canned
pet foods, mainly for cats and dogs, and also has a very promising line in dry dog food.
It has been interested for some time in the operations of Pelican Ltd., an entity that
deals with the processing of grain products for a number of other industries, including
flour processing, health foods, and, more recently, the production of grain products for
feeding birds. Given its interest in the pet food industry and its desire to stay as one of
the leaders in this area, Labrador began negotiations with Pelican to acquire its bird-
seed product division.
Negotiations began in July 2012. After months of discussion between the com-
panies, an agreement was reached on December 15, 2012, for Labrador to acquire
Pelican’s birdseed division. The agreement document was taken to Pelican’s board of
directors, who ratified the agreement on January 1, 2013. The net assets were exchanged
on this date.
The statement of financial position of Labrador Ltd. at January 1, 2013, is as
shown below:
Assets
Property, plant, and equipment $134,000
Land 240,000
Inventory 92,000
Cash 72,000
Total assets $625,000
Common shares 340,000
Cumulative other comprehensive income 8,000
Total liabilities and equity $625,000
The net assets of the birdseed division at January 1, 2013, showing the carrying
amounts at that date and the fair values as estimated by Labrador from documentation
supplied by Pelican, were as shown below.
Carrying amount Fair value
Property, plant, and equipment $160,000 $167,000
Land 70,000 75,000
Motor vehicles 30,000 32,000
Inventory 24,000 28,000
Accounts receivable 18,000 16,000
Total assets 302,000 318,000
Accounts payable 35,000 35,000
Bank overdraft 55,000 55,000
Total liabilities 90,000 90,000
Net assets $212,000 $228,000
Details of the consideration Labrador agreed to provide in exchange for the net
assets of the division are described below:
• 100,000 shares in Labrador —movements in the share price were as follows:
July 1, 2012 $1.00

October 1, 2012 1.10
November 1, 2012 1.30
December 15, 2012 1.45
January 1, 2013 1.50
• Because of doubts as to whether it could sustain a share price of at least $1.50,

Labrador agreed to supply cash to the value of any decrease in the share price
below $1.50 for the 100,000 shares issued. This guarantee of the share price
would last until July 3. Labrador believed that there was a 90% chance that
the share price would remain at $1.50 or higher and a 10% chance that it would
fall to $1.48.
• Cash of $40,000, half to be paid on the date of acquisition and half in one
year’s time.
• Supply of a patent relating to the manufacture of packing material. This has a fair
value of $60,000 but has not been recognized in Labrador’s records because it
resulted from an internally generated research project.
• Pelican was currently being sued for damages relating to a claim by a bird breeder
who had bought some seed from the company, and claimed that this resulted in the
death of some prime breeding pigeons. Labrador agreed to pay any resulting dam-
ages in relation to the court case. The expected damages were $40,000. Lawyers
estimated that there was only a 20% chance of losing the case.
Labrador supplied the cash on the acquisition date and surrendered the patent. The
shares were issued on January 1, 2013, and the costs of issuing the shares amounted to
$1,000. The incremental borrowing rate for Labrador is 10% p.a. Acquisition-related
costs paid by Labrador in relation to the acquisition amounted to $5,000.
On July 31, 2013, the price of Labrador’s shares was $1.52.
Required
Prepare the journal entries in the records of the acquirer and the statement of financial
position of the acquirer at the day of acquisition.
Solution
The following is the acquisition analysis.
Step 1: Consideration transferred
Purchase consideration:
Shares: 100,000 $1.50 $150,000
Guarantee: 10% ($1.50 $1.48) 100,000 200
Cash: Payable now 20,000
Deferred ($20,000 0.909091) 18,182
Patent 60,000
$248,382
Step 2: Net fair value of assets acquired and liabilities assumed

Land 75,000
Motor vehicles 32,000
Inventory 28,000
318,000
Bank overdraft 55,000
Provision for damages (20% $40,000) 8,000
98,000
$220,000
Step 3: Goodwill $248,382

(220,000)
Goodwill $ 28,382
The 2013 journal entries of the acquirer, Labrador Ltd., are shown below.
January 1 Property, Plant, and Equipment 167,000

Land 75,000
Motor Vehicles 32,000
Inventory 28,000
Goodwill 28,382
Bank Overdraft 55,000
Provision for Damages 8,000
Provision for Loss in Value of Shares 200
Cash 20,000
Gain on Sale of Patent* 60,000
(To record the acquisition of birdseed
division from Pelican Ltd.)
Cash 5,000
(To record acquisition-related costs)
January 1 Share Capital 1,000
Cash 1,000
(To record the costs of issuing shares)
July 31 Provision for Loss in Value of Shares 200
Gain 200
(To record the contingency not having to be paid)
*Note: We could expand the journal entry regarding the patent as follows.
Patent 60,000
Gain on Sale of Patent 60,000
Net Assets Acquired 60,000
Patent 60,000
In the journal entries above, the effect on the patent is netted so that only the gain on
sale is required as an entry.
The statement of financial position of Labrador Ltd. at January 1, 2013, immedi-
ately after the business acquisition, is as shown below:
LABRADOR LTD.
January 1, 2013
Assets
Goodwill 28,382 $ 28,382

Property, plant, and equipment $134,000 167,000 301,000
Land 240,000 75,000 315,000
Inventory 92,000 28,000 120,000
Accounts receivable 87,000 16,000 103,000
Cash 72,000 20,000 1,000 5,000 46,000
Total assets $625,000 $945,382
Accounts payable $ 67,000 35,000 $102,000

Consideration payable 18,182 18,182
Provisions 8,000 200 8,200
Bank overdraft 55,000 55,000
Common shares 340,000 150,000 1,000 489,000
Retained earnings 210,000 60,000 5,000 265,000
Cumulative other comprehensive income 8,000 8,000
Total liabilities and equity $625,000 $945,382
✓ LEARNING CHECK
• Subsequent adjustment to the consideration given or received does not impact the original
investment.
• Goodwill must be tested for impairment annually.
• Contingencies that are liabilities must be reassessed and any change reflected in income.
• Goodwill is not amortized but is subject to an annual impairment test.
• Contingencies recognized at acquisition date may be affected by expected events not occur-
ring or expected estimates needing to be revised. Adjustments are regarded as being post-
acquisition effects.
• No subsequent events will require adjustments to goodwill.
Applying ASPE to Business Combinations

ASPE Under private entity GAAP, business combinations is covered in section 1582. With
the adoption of this new section, ASPE is now aligned with IFRS. ASPE follows the
acquisition method as well to account for all business combinations.
Demonstration Problem 1 79
KEY TERMS
LEARNING SUMMARY
acquirer (p. 53)
acquisition date A business combination is the acquisition of control over the net assets of another busi-
(p. 53) ness. A business combination can be achieved through the acquisition of the assets and
business (p. 49) liabilities that constitute a business or through the acquisition of a sufficient number of shares
business combination to obtain control.
(p. 49) IFRS 3 specifies accounting standards that have implications not only for the exchanges
contingent of assets between entities but also for the accounting for subsidiaries and associated entities.
consideration An acquirer accounts for the assets and liabilities acquired as well as the measurement of
(p. 59) the consideration transferred. In making these calculations, the acquirer must determine the
contingent liability acquisition date as all fair value measurements are made at acquisition date. The acquirer has
(p. 62) to recognize intangible assets and liabilities acquired in a business combination.
control (p. 49) Entities commonly trade with each other, exchanging one set of assets for another. When
fair value (p. 49) a grouping of assets constitutes a business, the accounting for the exchange transaction is
goodwill (p. 66) considered a business acquisition. IFRS 3 requires the application of the acquisition method
under which the accountant must be able to identify which of the entities involved in the
combination is the acquirer. The identifiable assets and liabilities acquired are measured at
fair value.
Goodwill or the gain on a bargain purchase is determined as a residual that, for the busi-
ness combinations considered in this chapter, is generally determined by comparing the con-
sideration transferred and the net fair value of the identifiable assets and liabilities acquired.
Where the acquirer acquires the shares in the acquiree and where the acquirer already holds
some shares in the acquiree at the acquisition date, the determination of goodwill is more
involved. Understanding the nature of goodwill is essential to understanding how to account
for it. With the existence of the accounting standard on impairment of assets, goodwill is not
required to be amortized. Where a bargain purchase arises, the gain is recognized in current
period income.
DEMONSTRATION PROBLEMS
Demonstration Problem 1
Acquisition Analyses
On January 1, 2013, Trevally Ltd. concluded agreements to take over the operations of
Laughlin Ltd. The statements of financial position of the two companies as at that date were:
Trevally Laughlin
Cash $ 20,000 $ 1,000
Inventory 52,000 26,500
Property, plant, and equipment (net) 299,500 149,500
Bonds in Oldham 45,000 18,000
$451,500 $214,000
Accounts payable $ 78,000 $ 76,000
Loan payable — 40,000
$10 Bonds—nominal value
Share capital—issued at $1 300,000 80,000
Retained earnings 73,500 18,000
$451,500 $214,000
Laughlin included in the notes to its accounts a contingent liability relating to a guarantee
for a loan. Although a present obligation existed, a liability was not recognized by Laughlin
because of the difficulty of measuring the ultimate amount to be paid. The details of the
acquisition agreements are as follows:
Laughlin
Trevally is to acquire all the assets (except cash) and all the liabilities of Laughlin. In exchange,
for every four shares in Laughlin, shareholders are to receive three shares in Trevally and
$1.00 in cash. Each share in Trevally has a fair value of $1.80. Trevally is to pay additional
cash to Laughlin to cover the total liquidation expenses of Laughlin, which are expected to
amount to $6,000. The cash already held by Laughlin is to go toward the liquidation costs.
The assets of Laughlin are all recorded in Laughlin’s records at cost (depreciated if appli-
cable). The fair values of Laughlin’s assets are:
Receivables $ 17,500
Inventory 32,000
Property, plant, and equipment 165,500
Bonds in Oldham 19,000
Laughlin had been undertaking research into new manufacturing machinery, and had
expensed a total of $10,000 research costs. Trevally determined that the fair value of this
in-process research was $2,000 at acquisition date. The contingent liability relating to the
guarantee was considered to have a fair value of $1,500.
External accounting advice and valuaters’ fees amounted to $3,000.
Required
Prepare the acquisition analysis and journal entries necessary to record the acquisition of
Laughlin in the records of Trevally. Prepare the statement of financial position of Trevally
immediately following the acquisition.
Solution
The first step in preparing the acquisition analysis is to analyze the nature of the business
combination, in particular what happens to each entity involved in the transactions. In this
example, Trevally is the acquirer. It acquires assets and liabilities of Laughlin, with the latter
entity going into liquidation.
Considering the combination between Trevally and Laughlin, the first step is to prepare
an acquisition analysis. This involves looking at the two sides of the transaction, determining
the fair value of the identifiable assets and liabilities acquired, and calculating the consider-
ation transferred. The difference between these two amounts will be goodwill or gain on
bargain purchase.
Acquisition analysis—Trevally and Laughlin
Step 1: Consideration transferred.
The consideration transferred is the purchase consideration payable to Laughlin. and is
measured as the sum of the fair values of shares issued, liabilities undertaken, and assets
given up by the acquirer. In this example, Trevally issues shares and gives up cash. The
share price is the fair value of the shares at the acquisition date.
Consideration transferred
Shares: Share capital of Laughlin $80,000

Shares issued by Trevally (3/4) 60,000 $1.80 $108,000
Cash: 80,000/4 $1.00 20,000
Liquidation costs 6,000
Less: Held by Laughlin (1,000) 25,000
Step 2: Net assets acquired.

Trevally acquired all the assets except cash, and assumed all the liabilities of Laughlin.
These assets and liabilities are now measured at fair value.
Accounts receivable $ 17,500

Inventory 32,000
Deferred research 2,000
236,000
Contingent liability 1,500
Loan payable 40,000
Net fair value $118,500
The consideration transferred is then compared with the net fair value of the identifiable
assets and liabilities acquired to determine whether goodwill or a gain arises. In this case the
consideration transferred is greater; hence, goodwill has been acquired.
Goodwill $133,000 $118,500 $14,500
The journal entries can then be created from the acquisition analysis. Note that when
shares are issued, the relevant account is Share Capital.
Inventory 32,000
Intangible Asset—Development Costs 2,000
Goodwill 14,500
Loan Payable 40,000
Provision for Guarantee 1,500
Payable to Laughlin 25,000
(To record the acquisition of net assets of Laughlin)
Payable to Laughlin 25,000
Cash 25,000
(To record payment of consideration transferred)
Cash 3,000
(To record acquisition-related costs)
Note that the costs of share issue reduce the Share Capital account, which shows the net
proceeds from share issues.
Prepare the statement of financial position immediately following the acquisition.
TREVALLY LTD.
As at January 1, 2013
Accounts receivable 35,000 17,500 $ 52,500

Inventory 52,000 32,000 84,000
Property, plant, and equipment (net) 299,500 165,500 465,000
Bonds in Oldham 45,000 19,000 64,000
Intangible asset—Development costs 2,000 2,000
Goodwill 14,500 14,500
Cash/Bank indebtedness 20,000 25,000 3,000 $ 8,000
Accounts payable 78,000 76,000 154,000
Provisions 1,500 1,500

Loan payable 40,000 40,000
Share capital 300,000 108,000 408,000
Retained earnings 73,500 3,000 70,500
Acquisition and Liquidation
On January 1, 2013, Textron Ltd. and Karpoff Ltd. sign an agreement whereby the opera-
tions of Karpoff are to be taken over by Textron. Karpoff will liquidate after the transfer is
complete. The statements of financial position of the two companies on that day were as
shown below.
Textron Karpoff
Cash $ 50,000 $ 20,000
Inventory 46,000 29,000
Land 65,000 —
Property, plant, and equipment 180,000 167,000
Accumulated depreciation—property, plant, and equipment (60,000) (40,000)
Patents 10,000 —
Investment in Cape — 26,000
Bonds in Brett (face value) 10,000 —
$376,000 $258,000
Mortgage loan 75,000 21,500
10% Bonds (face value) 100,000 30,000
Capital stock:
Common shares of $1 100,000 —
class A shares of $2 — 40,000
class B shares of $1 60,000
$376,000 $258,000
Textron is to acquire all the assets of Karpoff (except for cash). The assets of Karpoff are
recorded at their fair values except for:

Inventory $ 29,000 $ 39,200
Investment in Cape 26,000 22,500
In exchange, Karpoff ’s class A shareholders are to receive one 7% debenture in Textron,

redeemable on January 1, 2014, for every share held in Karpoff. The fair value of each deben-
ture is $3.50. Textron will also provide one of its patents to be held jointly by Karpoff ’s
class A shareholders and for which they will receive future royalties. The patent is carried at
$4,000 in the records of Textron, but is considered to have a fair value of $5,000.
Karpoff ’s class B shareholders are to receive two shares in Textron for every three shares
held in Karpoff. The fair value of each Textron share is $2.70. Costs to issue these shares
amount to $900. Additionally, Textron is to provide Karpoff with sufficient cash, additional
to that already held, to enable Karpoff to pay its liabilities. The outstanding Bonds are to be
redeemed at a 10% premium. Annual vacation pay entitlements of $16,200 are outstanding
at January 1, 2013, and expected liquidation costs of $5,000 have not been recognized by
Karpoff. Costs incurred in arranging the business combination amounted to $1,600.
Required
(a) Prepare the journal entries in the records of Textron to record the acquisition of Karpoff.
(b) Prepare the statement of financial position of Textron immediately following the acquisi-
tion of Karpoff.
Solution
(a) Prepare the journal entries of Textron.
The nature of the transaction in this question is that the acquirer, Textron, is acquiring the
operations (assets and liabilities) of Karpoff, with the acquiree going into liquidation.
The first step is to prepare the acquisition analysis, which is a comparison of the fair value
of the identifiable assets and liabilities acquired with the consideration transferred.
Acquisition analysis—Textron and Karpoff:
Note that all the assets acquired and the liabilities assumed by the acquirer are measured at
fair value.
Inventory 39,200
Investment in Cape 22,500
$272,700
Consideration transferred:
The consideration transferred is measured by calculating the fair value of the assets given up,
liabilities undertaken, and shares issued by the acquirer. In this example, the acquirer issues
shares and bonds in itself, gives up a patent, and provides cash.
Purchase consideration:
Shareholders
Bonds: A shares of Karpoff 20,000
Bonds in Textron (1/1) 20,000 $3.50 $ 70,000
Shares: B shares of Karpoff 60,000
Shares in Textron (2/3) 40,000 $2.70 108,000
Patent 5,000
Creditors 30,000
Cash: Bonds issued $ 3,000
Plus premium (10%) 33,000
Mortgage loan 21,500
Liquidation costs 5,000
Annual leave 16,200
Total cash required 106,700
Less: Already held (20,000) 86,700
Total consideration transferred $269,700
Because the total consideration transferred is less than the net fair value of the identifi-
able assets and liabilities acquired, the acquirer has to assess the measurements undertaken in
the acquisition analysis. Having been assured that all relevant assets and liabilities have been
included and that the fair values are reliable, the difference is then accounted for as a bargain
purchase, and is included in current period income.
Gain on bargain purchase [$272,700 $269,700] $3,000
The general journal entries can then be read from the acquisition analysis. Note that when
shares are issued, the relevant account is Share Capital.
In relation to the patent, prior to accounting for the business combination, the acquirer
remeasures the asset to fair value.
TEXTRON LTD.
General Journal
Patent 1,000
Gain 1,000
(Remeasurement to fair value as part of
consideration transferred on business
combination)
Inventory 39,200
Investment in Cape 22,500
Payable to Karpoff 156,700
Patent 5,000
Gain on Bargain Purchase 3,000
(Acquisition of Karpoff)
Payable to Karpoff 156,700
7% Bonds 70,000
Cash 86,700
(Payment of consideration)
Cash 1,600
(Acquisition-related costs)
Share Capital 900
Cash 900
(Payment of share issue costs)
Note that the costs of share issue reduce the share capital issued with the Share Capital
account then showing the net proceeds from share issues.
(b) Prepare the statement of financial position as at day of acquisition Textron Ltd.
TEXTRON LTD.
As at July 1, 2013
Accounts receivable $ 75,000 56,000 $131,000

Inventory 46,000 39,200 85,200
Land 65,000 65,000
Property, plant, and equipment 180,000 155,000 335,000
Accumulated depreciation—property, (60,000) (60,000)
plant, and equipment
Patents 10,000 1,000 5,000 6,000
Investment in Cape — 22,500 22,500
Bonds in Brett (nominal value) 10,000 10,000
$376,000 $594,700
Bank indebtedness $(50,000) 86,700 1,600 900 $ 39,200
7% Bonds 70,000 70,000
10% Bonds (face value) 100,000 100,000
Common shares of $1 100,000 108,000 900 207,100
Retained earnings 39,000 1,000 3,000 1,600 41,400
$376,000 $594,700
Exercises 85
Brief Exercises
(LO 1) BE2-1 What is meant by a “business combination”?
(LO 1) BE2-2 Discuss the importance of identifying the acquisition date.
(LO 2) BE2-3 What is meant by “contingent consideration” and how is it accounted for?
(LO 1) BE2-4 What recognition criteria are applied to assets and liabilities acquired in a business combination?
(LO 1) BE2-5 How is an acquirer identified?
(LO 2) BE2-6 Explain the key steps in the acquisition method.
(LO 2) BE2-7 How is the consideration transferred calculated?
(LO 2) BE2-8 How is fair value determined?
(LO 3) BE2-9 How is a gain on bargain purchase accounted for?
(LO 2) BE2-10 Why is it important to identify an acquirer in a business combination?
Exercises
(LO 2) E2-1 White Ltd. has been negotiating with McCloud Ltd. for several months, and agreements have finally been
reached for the two companies to combine. In considering the accounting for the combined entities, management real-
izes that, in applying IFRS 3, an acquirer must be identified. However, there is debate among the accounting staff as to
which entity is the acquirer.
Required
(a) What factors and indicators should management consider in determining which entity is the acquirer?
(b) Why is it necessary to identify an acquirer? In particular, what differences in accounting would arise if White or
McCloud were identified as the acquirer?
(LO 3) E2-2 On January 1, 2013, New Ltd. acquired the following assets and liabilities from Daylight Ltd.:

Land $300,000 $350,000
Plant (cost $400,000) 280,000 290,000
Inventory 80,000 85,000
Cash 15,000 15,000
Accounts payable (20,000) (20,000)
Loans (80,000) (80,000)
In exchange for these assets and liabilities, New issued 100,000 shares that had been issued for $1.20 per share but
at January 1, 2013, had a fair value of $6.50 per share.
Required
(a) Prepare the journal entries in the records of New to account for the acquisition of the assets and liabilities of
Daylight.
(b) Prepare the journal entries assuming that the fair value of New shares was $6 per share.
(LO 3) E2-3 Lai Hing Ltd. acquired all the assets and liabilities of Sound Ltd. on January 1, 2013. At this date, the assets and
liabilities of Sound consisted of:

Current assets $1,000,000 $ 980,000
Non-current assets 4,000,000 4,220,000
5,000,000 5,200,000

Liabilities 500,000 500,000
$4,500,000 $4,700,000
Share capital—100,000 shares $3,000,000
Reserves 1,500,000
$4,500,000
In exchange for these net assets, Lai Hing agreed to the following:
• Issue 10 Lai Hing shares for every Sound share. Lai Hing shares were considered to have a fair value of $10 per
share; costs of share issue were $500.
• Transfer a patent to the former shareholders of Sound. The patent was carried in the records of Lai Hing at
$350,000 but was considered to have a fair value of $1 million.
• Pay $5.20 per share in cash to each of the former shareholders of Sound. Lai Hing incurred $10,000 in costs associ-
ated with the acquisition of these net assets.
Required
(a) Prepare an acquisition analysis in relation to this acquisition.
(b) Prepare the journal entries in Lai Hing to record the acquisition.
(LO 3) E2-4 On January 1, 2013, Dmetri Ltd acquired all the issued shares of Island Ltd. At this date the equity of Island
consisted of:
Share capital—100,000 shares issued at $5 per share $500,000
Asset revaluation surplus—Cumulative 100,000
other comprehensive income
In exchange for these shares, Dmetri agreed to pay the former shareholders of Island two shares in Dmetri, with a
fair value of $4 per share, plus $1.50 cash for each share held in Island. The costs of issuing the shares were $800.
Required
Prepare the journal entries in the records of Dmetri to record these events.
(LO 3) E2-5 Lower Ltd. acquired the assets and liabilities of Audet Ltd. on July 1, 2013. These net assets measured at fair
value consisted of:
Equipment $ 50,000
Land 80,000
Trucks 40,000
Current assets 10,000
Current liabilities (16,000)
Required
Prepare the journal entries in Lower to record this business combination assuming that, to acquire these net assets,
Lower:
(a) issued 100,000 shares at $1.80 per share
(b) issued 100,000 shares at $1.60 per share.
(LO 3, 5) E2-6 On December 1, 2013, Meeru Inc. acquired all the assets and liabilities of Dory Ltd., with Meeru issuing
100,000 shares to acquire these net assets. The fair values of Dory’s assets and liabilities at this date were:
Cash $ 50,000
Furniture and fixtures 20,000
Current tax liability 8,000
Provision for vacation pay 2,000
The financial year for Meeru is January to December.

Problems 87
Required
Each transaction should be considered separately.
(a) Prepare the journal entries for Meeru to record the business combination at December 1, 2013, assuming the fair
value of each Meeru share at acquisition date is $1.90. Prepare any note disclosures for Meeru at December 31,
2013, in relation to the business combination.
(b) Assume the fair value of each Meeru share at acquisition date is $1.90. At acquisition date, the acquirer could only
determine a provisional fair value for the plant. On March 1, 2014, Meeru received the final value from the inde-
pendent appraisal, the fair value at acquisition date being $131,000. Assuming the plant had a further five-year life
from the acquisition date, explain how Meeru will account for the business combination both at acquisition date
and in the financial statements for 2014.
(c) Prepare the journal entries for Meeru to record the business combination at December 1, 2013, assuming the fair
value of each Meeru share at acquisition date is $1.70.
(LO 2) E2-7 Chevron Inc. decided on May 1, 2013, to acquire all of the outstanding shares of Chow Ltd. The preliminary
acquisition price is to be based on the year-end financial statements dated March 31, 2013. The payment will be made on
June 30, 2013, as well that will be when all the shares of Chow Ltd. will be transferred to Chevron Inc., with an acquisi-
tion price adjustment to be made for any difference between the March 31 and June 30, 2013, financial statements.
What would be the acquisition date in this scenario?
(LO 3) E2-8 Atlanta Inc. acquired a 100% interest in Paisley Limited on October 1, 2013. The price paid on October 1,
2013, was $947,695. In addition, they also paid $127,000 of legal fees and $142,679 of other consulting fees. Atlanta Inc.
has also promised to pay an additional $150,000 if net income of Paisley Limited in the year after acquisition exceeds
$500,000. The net income of Paisley Limited has historically been under $250,000.
What would be the total acquisition price in this scenario?
(LO 3) E2-9 Yves Ltd. acquired a 100% interest in Laurent Enterprises on November 4, 2013. The total price paid was
$847,103. The book value of Laurent Enterprises net assets on that date was $450,104 and the fair market value of the
net assets on that date was $678,103.
What would be the amount of goodwill in this situation?
(LO 4) E2-10 Hyacinth Enterprises acquired 100% of the net assets of Bulb Limited on July 14, 2013. The total purchase price
was $895,679, paid in cash on that date. The assets and liabilities that Hyacinth Enterprises acquired were as follows:
Accounts Receivable ⫽ $145,628
Inventory ⫽ $245,918
Property, Plant and Equipment ⫽ $501,234
Accounts Payable ⫽ $167,291
Long-Term Debt ⫽ $199,201
Record the journal entries necessary on the part of Hyacinth Enterprises.
Problems
(LO 1, P2-1 The following are the statements of financial position at September 30, 2013, of Chrapaty Ltd. and Squid Ltd.
3, 4, 5)
Chrapaty
Share capital—80,000 shares $ 80,000 Non-current assets (at $190,000
valuation less depreciation)
Asset revaluation reserve 140,000
Current assets 148,000
Liabilities and provisions 28,000
$338,000 $338,000
Squid
Share capital—60,000 shares $ 60,000 Non-current assets (at cost $ 50,000
less depreciation)
Retained earnings 45,000 Current assets 65,000
Liabilities and provisions 10,000
$115,000 $115,000
Additional information:
1. During September, the shares of the companies were selling on the stock exchange at or near the following prices:
Chrapaty $5.80 Squid $1.80
2. On September 30, the directors of Chrapaty made an offer to the shareholders of Squid to acquire their shares on
the basis of one share at $1 in Chrapaty for every two shares at $1 in Squid. The offer was open for one month and
was contingent upon being accepted by the holders of at least 75% of Squid’s capital.
3. Immediately after the announcement, Chrapaty’s shares rose in price on the stock exchange to $6.20 and the shares
of Squid rose to $3. The shares of both companies stayed at or close to this price throughout October.
4. By the end of October, holders of 90% of Squid shares accepted the Chrapaty offer and Chrapaty proceeds to
acquire these shares on the agreed basis.
5. By mid-November, Chrapaty shares dropped in price on the stock exchange to $5.50.
6. Costs of issuing and registering shares issued by Chrapaty amounted to $2,000.
Required
(a) Give the journal entries necessary to record the transactions. (Show clearly to which company particular entries relate.)
(b) State briefly why you selected the value adopted in recording the acquisition, and whether you consider there is any
acceptable alternative recording value.
(c) Show the statement of financial position of Chrapaty after the entries have been recorded.
(LO 1, P2-2 Billiardco, a supplier of snooker equipment, agreed to acquire the business of a rival firm, Qtech Ltd., taking
3, 5) over all assets and liabilities as at June 1, 2013.
The price agreed on was $60,000, payable $20,000 in cash and the balance by the issue to the selling company of
16,000 shares in Billiardco, these shares having a fair value of $2.50 per share.
The trial balances of the two companies as at June 1, 2013, were as follows:
Billiardco Qtech
Share capital $100,000 $ 90,000

Retained earnings 12,000 $ 24,000
Cash $ 30,000 —
Property, plant, and 50,000 30,000
equipment (net)
Inventory 14,000 26,000
Government bonds 12,000 —
Goodwill — 10,000
$114,000 $114,000 $110,000 $110,000
All the identifiable net assets of Qtech were recorded by Qtech at fair value except for the inventory, which was
considered to be worth $28,000 (assume no tax effect). The plant had an expected remaining life of five years.
The business combination was completed and Qtech went into liquidation. Costs of liquidation amounted to $1,000.
Billiardco incurred incidental costs of $500 in relation to the acquisition. Costs of issuing shares in Billiardco were $400.
Required
(a) Prepare the journal entries in the records of Billiardco to record the business combination.
(b) Show the statement of financial position of Billiardco after completion of the business combination.
(c) On July 31, 2013, Billiardco became aware that there had been an error in measuring the fair value of the plant at
June 1, 2013. It had in fact a fair value at that date of $36,000. Explain how Billiardco is required to adjust for that
error. Billiardco’s reporting period ends on June 30.
(LO 1, P2-3 On September 1, 2013, the directors of Halbert Corp. approached the directors of Delcon Ltd. with the follow-
3, 4) ing proposal for the acquisition of the issued shares of Delcon, conditional on acceptance by 90% of Delcon sharehold-
ers by November 30, 2013:
• Two common shares in Halbert plus $3.10 cash for every preferred share in Delcon, payable at acquisition date.
• Three common shares in Halbert plus $1.20 cash for every common share in Delcon. Half the cash is payable at
acquisition, and the other half in one year’s time.
Problems 89
By November 30, 90% of the common shareholders and all of the preferred shareholders of Delcon had accepted
the offer. The directors of Halbert decided not to acquire the remaining common shares. Share transfer forms covering
the transfer were dated November 30, 2013, and showed a price per Halbert common share of $4.20. Halbert’s incre-
mental borrowing rate is 8% p.a.
The statement of financial position of Delcon at November 30, 2013, was as follows:
DELCON LTD.
as at November 30, 2013
Current assets $120,000

Non-current assets:
Land and buildings $203,000
Less: Accumulated depreciation (45,000)
Shares in other companies listed on stock exchange
at cost (market $190,000) 30,000
Government bonds, at cost 50,000

Total non-current assets 406,000
Total assets 526,000
Current liabilities 30,000
Net assets $496,000
Equity
Share capital
80,000 common shares $160,000
50,000 6% preferred shares 100,000 $260,000
Total equity $496,000
Halbert then appointed a new board of directors of Delcon. This board took office on December 1, 2013, and
immediately:
• revalued the asset Shares in Other Companies to its market value (assume no tax effect) and
• issued common shares of $32,000 to common shareholders, each shareholder being allocated 2 common shares for
every 10 common shares held.
Required
Prepare all journal entries (in general form) to record the above transactions in the records of (a) Halbert and (b) Delcon.
(LO 1, 3) P2-4 Hastings Ltd. is seeking to expand its share of the widgets market and has negotiated to take over the opera-
tions of F-Squared Ltd. on January 1, 2013. The statements of financial position of the two companies as at December
31, 2012, were as follows:
Hastings F-Squared
Cash $ 23,000 $ 12,000
Inventory 35,500 27,600
Land 150,000 100,000
Buildings (net) 60,000 30,000
Goodwill 25,000 2,000
$383,500 $252,300
Bonds 100,000 50,000
Share capital — 100,000 shares 100,000 —
— 60,000 shares — 60,000

$383,500 $252,300
Hastings is to acquire all the assets, except cash, of F-Squared. The assets of F-Squared are all recorded at fair value
except:
Fair value
Inventory $ 39,000
Freehold land 130,000
Buildings 40,000
In exchange, Hastings is to provide sufficient extra cash to allow F-Squared to repay all of its outstanding debts and
its liquidation costs of $2,400, plus two fully paid shares in Hastings for every three shares held in F-Squared. The fair
value of a share in Hastings is $3.20. An investigation by the liquidator of F-Squared reveals that at December 31, 2012,
the following debts were outstanding but had not been recorded:

Mortgage interest 4,000
The bonds issued by F-Squared are to be redeemed at a 5% premium. Costs of issuing the shares were $1,200.
Required
(a) Prepare the acquisition analysis and journal entries to record the business combination in the records of
Hastings.
(b) Prepare the statement of financial position of Hastings immediately after the acquisition.
(LO 1, 3) P2-5 On July 1, 2013, two companies, Newstar Inc. and PLX Ltd., sign an agreement whereby the operations of
PLX are to be taken over by Newstar. PLX is to liquidate after the transfer is complete. The statements of financial
position of the two companies on that day were as follows:
Newstar PLX
Cash $ 50,000 $ 20,000
Inventory 56,000 29,000
Land 65,000 —
Accumulated depreciation—property, (60,000) (40,000)
plant, and equipment
Investment in Sefton Ltd. — 26,000
Bonds in Akaroa Ltd. (face value) 10,000 —
$376,000 $258,000
10% bonds (face value) 100,000 30,000
Share capital:
Common shares of $1 100,000 —
A class shares of $2 — 40,000
B class shares of $1 60,000
$376,000 $258,000
Newstar is to acquire all of the assets of PLX (except for cash). The assets of PLX are recorded at their fair values except
for the following:

Inventory $ 29,000 $ 39,200
Investment in Sefton Ltd. 26,000 22,500
In exchange, the A class shareholders of PLX are to receive one 7% debenture in Newstar, redeemable on July 1,
2015, for every share held in PLX. The fair value of each debenture is $3.50. The B class shareholders of PLX are to
Problems 91
receive two shares in Newstar for every three shares held in PLX. The fair value of each Newstar share is $2.70. Costs
to issue these shares will amount to $900.
Additionally, Newstar is to provide PLX with sufficient cash, additional to that already held, to enable PLX to pay
its liabilities. The outstanding bonds are to be redeemed at a 10% premium. Annual leave entitlements of $16,200 out-
standing at July 1, 2013, and expected liquidation costs of $5,000 have not been recognized by PLX. Costs to transport
and install PLX’s assets at Newstar’s premises will be $1,600.
Required
(a) Prepare the acquisition analysis and journal entries in the books of Newstar to record the acquisition of PLX.
(b) Prepare the statement of financial position of Newstar immediately after the acquisition.
(LO 1, P2-6 Ling and Morwong are small family-owned companies engaged in vegetable growing and distribution. The
3, 4) Spencer family owns the shares in Morwong and the Rokocoko family owns the shares in Ling. The head of the
Spencer family wishes to retire but his two sons are not interested in carrying on the family business. Accordingly, on
July 1, 2013, Ling is to take over the operations of Morwong, which will then liquidate. Ling is asset-rich but has lim-
ited overdraft facilities so the following arrangement has been made.
Ling is to acquire all of the assets, except cash, delivery trucks, and motor vehicles, of Morwong and will assume
all of the liabilities except accounts payable. In return, Ling is to give the shareholders of Morwong a block of vacant
land, two delivery vehicles, and sufficient additional cash to enable the company to pay off the accounts payable and the
liquidation costs of $1,500. The land and vehicles had the following values at June 30, 2013:

Land $50,000 $120,000
Delivery trucks 30,000 28,000
On the liquidation of Morwong, Mr. Spencer is to receive the land and the motor vehicles and his two sons are to
receive the delivery trucks.
The statements of financial position of the two companies as at June 30, 2013, were as follows:
Ling Morwong
Cash $ 3,500 $ 2,000
Land 250,000 100,000
Buildings (net) 25,000 30,000
Cultivation equipment (net) 65,000 46,000
Irrigation equipment 16,000 22,000
Delivery trucks 45,000 36,000
$454,500 $283,000
Loan—Bank of NB 150,000 80,000
Loan—Farinacci Bros 35,000 35,000
Loan—Long Cloud 70,000 52,500
Share capital — 100,000 shares 100,000 —
— 60,000 shares — 60,000

$454,500 $283,000
All the assets of Morwong are recorded at fair value, with the exception of:
Fair value
Land $120,000
Buildings 40,000
Cultivation equipment 40,000
Motor vehicle 34,000
Required
(a) Prepare the acquisition analysis and the journal entries to record the acquisition of Morwong’s operations in the
records of Ling.
(b) Prepare the journal entries to record the liquidation of Morwong.
(c) Prepare the statement of financial position of Ling after the business combination, including any notes relating to
the business combination.
(LO 1, 3) P2-7 Zanadu Ltd. and Corion Ltd. are two family-owned flax-producing companies in Manitoba. Zanadu is owned
by the Wood family and the Malak family owns Corion. The Wood family has only one son and he is engaged to be
married to the daughter of the Malak family. Because the son is currently managing Corion, it is proposed that, after
the wedding, he should manage both companies. As a result, it is agreed by the two families that Zanadu should take
over the net assets of Corion.
The statement of financial position of Corion immediately before the takeover is as follows:

Cash $ 20,000 $ 20,000
Land 620,000 840,000
Buildings (net) 530,000 550,000
Farm equipment (net) 360,000 364,000
Irrigation equipment (net) 220,000 225,000
Vehicles (net) 160,000 172,000
$2,050,000
Accounts payable $ 80,000 80,000
Loan—Regal Bank 480,000 480,000
Share capital 670,000
$2,050,000
The takeover agreement specified the following details:
• Zanadu is to acquire all the assets of Corion except for cash and one of the vehicles (having a carrying amount of
$45,000 and a fair value of $48,000), and assume all the liabilities except for the loan from the Regal Bank. Corion
is then to go into liquidation. The vehicle is to be transferred to Mr. and Mrs. Malak.
• Zanadu is to supply sufficient cash to enable the debt to the Regal Bank to be paid off and to cover the liquida-
tion costs of $5,500. It will also give $150,000 to be distributed to Mr. and Mrs. Malak to help pay the costs of the
wedding.
• Zanadu is also to give a piece of its own prime land to Corion to be distributed to Mr. and Mrs. Malak, this eventu-
ally being available to be given to any offspring of the forthcoming marriage. The piece of land in question has a
carrying amount of $80,000 and a fair value of $220,000.
• Zanadu is to issue 100,000 shares, with a fair value of $14 per share, to be distributed via Corion to the soon-to-be-
married daughter of Mr. and Mrs. Malak, who is currently a shareholder in Corion.
The takeover proceeded per the agreement, with Zanadu incurring incidental acquisition costs of $25,000 and
$18,000 share issue costs.
Required
Prepare the acquisition analysis and the journal entries to record the acquisition of Corion in the records of
Zanadu.
(LO 1, P2-8 Saratoga Ltd. was having difficulty in raising finance for expansion. Kingfish Ltd. was interested in achieving
3, 4) economies by marketing a wider range of products.
Accounting for Investments 93
The following shows the financial positions of the companies at December 31, 2012.
Saratoga Kingfish
Share capital
40,000 shares $ 40,000
90,000 shares $ 90,000
52,000 120,000
Liabilities:
Bonds (secured by floating charge) 20,000 —
62,000 12,000
Total equity and liabilities $114,000 $132,000
Assets:
Cash $ 12,000 $ 24,000
Inventory (at cost) 43,000 47,000
Land and buildings (at cost) 23,000 19,000
Plant and machinery (at cost) 52,000 41,000
Accumulated depreciation on plant and machinery (34,000) (19,000)
Total assets $114,000 $132,000
It was agreed that it would be mutually advantageous for Saratoga to specialize in manufacturing, and for Kingfish
to handle marketing, purchasing, and promotion. Accordingly, Kingfish sold part of its assets to Saratoga on January 1,
2013, the identifiable assets acquired having the following fair values:
Inventory, $22,000 (cost $15,000)
Land and buildings, $34,000 (carrying amount $10,000)
Plant and machinery, $27,000 (cost $38,000, accumulated depreciation $18,000)
The acquisition was satisfied by the issue of 40,000 A common shares in Saratoga.
Required
(a) Show the journal entries to record the above transactions in the records of Saratoga:
(1) if the fair value of the A common shares of Saratoga was $2 per share
(2) if the fair value of the A common shares of Saratoga was $2.20 per share. (Assume the assets acquired constitute
a business entity.)
(b) Show the journal entries in the records of Kingfish under (1) and (2) in requirement A above.
(c) Show the statement of financial position of Saratoga after the transactions, assuming the fair value of Saratoga’s A
common shares was $2.20 per share.
(LO 1, 3, P2-9 Tailor Ltd. is seeking to expand its share of the pet care market and has negotiated to acquire the operations of
4, 5) Flathead Ltd. and the shares of Flexon Ltd.
At January 1, 2013, the trial balances of the three companies were:
Tailor Flathead Flexon

Cash $145,000 $ 5,200 $ 84,000
Inventory 56,000 30,000 25,400
Shares in listed companies 16,000 22,000 7,000
Land and buildings (net) 70,000 40,000 36,000
Property, plant, and equipment (net) 130,000 105,000 25,000
Goodwill (net) 6,000 5,000 5,600
$457,000 $228,500 $195,000
Tailor Flathead Flexon

Accounts payable $ 65,000 $ 40,000 $ 29,000
Bank overdraft — — 1,500
Bonds 50,000 — 100,000
Mortgage loan 100,000 30,000 —
Contributed equity:
Common shares of $1 200,000 150,000 60,000
Other reserves 15,000 6,500 2,500
Retained earnings (31/12/13) 27,000 2,000 2,000
$457,000 $228,500 $195,000
Flathead
Tailor is to acquire all assets (except cash and shares in listed companies) of Flathead. Acquisition-related costs are
expected to be $7,600. The net assets of Flathead are recorded at fair value except for the following:

Inventory $ 30,000 $ 26,000
Land and buildings 40,000 80,000
Shares in listed companies 22,000 18,000
Accounts payable (40,000) (49,100)
Accrued vacation pay — (29,700)
In exchange, the shareholders of Flathead are to receive, for every three Flathead shares held, one Tailor share
worth $2.50 each. Costs to issue these shares are $950. Additionally, Tailor will transfer to Flathead its Shares in Listed
Companies asset, which has a fair value of $15,000. These shares, together with those already owned by Flathead, will
be sold and the proceeds distributed to the Flathead shareholders. Assume that the shares were sold for their fair values.
Tailor will also give Flathead sufficient additional cash to enable Flathead to pay all its creditors. Flathead will then
liquidate. Liquidation costs are estimated to be $8,700.
Flexon
Tailor is to acquire all the issued shares of Flexon. In exchange, the shareholders of Flexon are to receive one Tailor
share, worth $2.50, and $1.50 cash for every two Flexon shares held.
Required
(a) Prepare the acquisition analysis and journal entries to record the acquisitions in the records of Tailor.
(b) Explain in detail why, if Flathead has recorded a goodwill asset of $5,000, Tailor calculates the goodwill acquired
via an acquisition analysis. Why does Tailor not determine a fair value for the goodwill asset and record that figure
as it has done for other assets acquired from Flathead?
(c) If Tailor subsequently receives a dividend cheque for $1,500 from Flexon, how should Tailor account for that
cheque? Why?
(d) Shortly after the business combination, the liquidator of Flathead receives a valid claim of $25,000 from a creditor.
As Tailor has agreed to provide sufficient cash to pay all the liabilities of Flathead at acquisition date, the liquidator
requests and receives a cheque for $25,000 from Tailor. How should Tailor record this payment? Why?
(LO 1, P2-10 Savoie Ltée. is a manufacturer of specialized industrial machinery seeking to diversify its operations. After
3, 4) protracted negotiations, the directors decided to purchase the assets and liabilities of Blackfish Ltd. and the spare parts
retail division of Lynx Ltd.
At December 31, 2012, the statements of financial position of the three entities were as follows:
Savoie Blackfish Lynx
Land and buildings (net) $ 60,000 $ 25,000 $ 40,000
Plant and machinery (net) 100,000 36,000 76,000
Office equipment (net) 16,000 4,000 6,000
Shares in listed companies 24,000 15,000 20,800
Bonds in listed companies 20,000 — —
Inventory 150,000 54,000 30,200
Savoie Blackfish Lynx

Cash 59,000 11,000 9,000
Goodwill — 7,000 —
$464,000 $178,000 $224,000
Current tax liability 21,000 6,000 7,000
Provision for leave 36,000 10,000 17,500
Bank loan 83,000 16,000 43,500
Bonds 60,000 50,000 —
Share capital (issued at $1) 200,000 60,000 90,000
$464,000 $178,000 $224,000
The acquisition agreement details are as follows:
Blackfish
Savoie is to acquire all the assets (other than cash) and liabilities (other than bonds, provisions, and tax liabilities) of
Blackfish for the following purchase consideration:
• Shareholders in Blackfish are to receive three shares in Savoie in exchange for every four shares held. The shares in
Savoie are to be issued at their fair value of $3 per share. Costs of share issue amounted to $2,000.
• Savoie is to provide sufficient cash that, when added to the cash already held, will enable Blackfish to pay out the
current tax liability and provision for leave, to redeem the bonds at a premium of 5%, and to pay its liquidation
expenses of $2,500.
The fair values of the assets and liabilities of Blackfish are equal to their carrying amounts with the exception of the
following:
Fair value
Land and buildings $60,000
Plant and machinery 50,000
Incidental costs associated with the acquisition amount to $2,500.
Lynx
Savoie is to acquire the spare parts retail business of Lynx. The following information is available concerning that busi-
ness, relative to the whole of Lynx Ltd:
Total amount Spare parts division
Carrying amount Carrying amount Fair value
Land and buildings (net) $40,000 $20,000 $30,000

Plant and machinery (net) 76,000 32,000 34,500
Office equipment (net) 6,000 2,000 2,500
Inventory 30,200 12,000 12,000
Provision for leave 17,500 7,000 7,000
The divisional net assets are to be acquired for $10,000 cash, plus 11,000 common shares in Savoie issued at their
fair value of $3, plus the land and buildings that have been purchased from Blackfish.
Incidental costs associated with the acquisition are $1,000.
Required
(a) Prepare the acquisition analysis for the acquisition transactions of Savoie.
(b) Prepare the journal entries for the acquisition transactions in the records of Savoie and Lynx.
Writing Assignments
(LO 3) WA2-1 Silver Ltd. has acquired a major manufacturing division from Fern Ltd. The accountant, Ms. Chen, has
shown Silver’s board of directors the financial information regarding the acquisition. Ms. Chen calculated a residual
amount of $45,000 to be reported as goodwill in the accounts. The directors are not sure whether they want to record
goodwill on Silver’s statement of financial position. Some directors are not sure what goodwill is or why the company
has bought it. Other directors even query whether goodwill is an asset, with some being concerned with future effects
on the statement of comprehensive income.
Required
Prepare a report for Ms. Chen to present to the directors to help them understand the nature of goodwill and how to
account for it.
(LO 1) WA2-2 One of the responsibilities of the group accountant for Southland Ltd., Ms. Yamaguchi, is to explain the
accounting principles applied by the company in preparing the annual report to the company’s board of directors.
Having analyzed IFRS 3, Ms. Yamaguchi is puzzled by the requirement that any acquisition-related costs such as fees
for lawyers and valuaters should be expensed. Ms. Yamaguchi has analyzed other accounting standards, such as IAS 16
Property, Plant and Equipment, and notes that under this standard such costs are capitalized into the cost of any property,
plant, and equipment acquired. She therefore believes that to expense such costs in accounting for a business combina-
tion would not be consistent with accounting for acquisitions of other assets.
Further, Ms. Yamaguchi believes that to expense such costs would result in a loss being reported in the statement
of comprehensive income in the period the business combination occurs. She is not sure how she will explain to the
board of directors that the company makes a loss every time it enters a business combination. She believes the directors
will wonder why the company enters into business combinations if immediate losses occur—surely losses indicate that
bad decisions have been made by the company.
Required
Prepare a brief report for Ms. Yamaguchi on how she should explain the accounting for acquisition-related costs to the
board of directors.
(LO 3, 5) WA2-3 TC Corp. appointed a candidate as its new CEO under a 10-year contract. The contract required TC to pay
the candidate $5 million if TC is acquired before the contract expires. AC Ltd. acquires TC eight years later. The CEO
was still employed at the acquisition date and will receive the additional payment under the existing contract.
Required
Indicate how TC would account for this payment.
(Adapted from IFRS illustrative examples)
(LO 3) WA2-4 The following are independent events.
1. Ollexco acquires RAH Ltd. in a business combination on December 31, 2013. RAH has a five-year agreement to
supply goods to Bourassa Corp. Both RAH and Ollexco believe that Bourassa will renew the agreement at the end
of the current contract. The agreement is not separable.
About intangible
assets 2. Divestex Ltd. acquires Total Sporting Goods in a business combination on December 31, 2013. Total Sporting
Goods manufactures goods in two distinct lines of business: sporting goods and electronics. Wearhuis Co. pur-
chases both sporting goods and electronics from Total Sporting Goods. Total Sporting Goods has a contract
with Wearhuis to be its exclusive provider of sporting goods but has no contract for the supply of electronics to
Wearhuis. Both Total Sporting Goods and Divestex believe that only one overall customer relationship exists
between Total Sporting Goods and Wearhuis.
3. Jiwaji Corp. acquires TransOntario Ltd. in a business combination on December 31, 2013. TransOntario does
business with its customers solely through purchase and sales orders. At December 31, 2013, TransOntario has a
backlog of customer purchase orders from 60% of its customers, all of whom are recurring customers. The other
40% of TransOntario’s customers are also recurring customers. However, as of December 31, 2013, TransOntario
has no open purchase orders or other contracts with those customers.
4. Mountainex acquires Financeco, an insurer, in a business combination on December 31, 2013. Financeco has a
portfolio of one-year motor insurance contracts that are cancellable by policyholders.
Required
Discuss the proper reporting for each of the independent situations above.
WA2-5 (LO 3) Wheatnix purchases electronic components from Saluté under a five-year supply contract at fixed rates.
Currently, the fixed rates are higher than the rates at which Wheatnix could purchase similar electronic components from
another supplier. The supply contract allows Wheatnix to terminate the contract before the end of the initial five-year
term but only by paying a $6-million penalty. With three years remaining under the supply contract, Wheatnix pays $50
million to acquire Saluté, which is the fair value of Saluté based on what other market participants would be willing to pay.
Included in the total fair value of Saluté is $8 million related to the fair value of the supply contract with Wheatnix.
The $8 million represents a $3-million 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
Cases 97
a $5-million component for pricing that is unfavourable to Wheatnix because it exceeds the price of current market
transactions for similar items. Saluté has no other identifiable assets or liabilities related to the supply contract, and
Wheatnix has not recognized any assets or liabilities related to the supply contract before the business combination.
Required
Discuss how Wheatnix would account for the contract on acquisition of Saluté.
Cases
(LO 3) C2-1 Tall Ltd. has acquired all the net assets of Blacks Ltd., with the latter going into liquidation. Both companies
operate in the area of testing and manufacturing pharmaceutical products. One of the main reasons that Tall sought to
acquire Blacks was that the latter company had an impressive record in developing drugs to cure some mosquito-related
diseases. Blacks employed a number of scientists who were considered to be international experts in their area and at
the leading edge of research in their field. Much of the recent work undertaken by these scientists was classified for
accounting purposes as research, and per IAS 38 Intangible Assets was expensed by Blacks. However, in deciding what it
would pay to take over Blacks, Tall had paid a sizeable amount of money for the ongoing research being undertaken by
Blacks as it was expected that it would be successful eventually.
The accountant for Tall, Mr. El-Naggar, has suggested that the amount paid by Tall for this research should be
shown as goodwill in the company’s statement of financial position. However, the company directors do not believe
that this faithfully represents the true nature of the assets acquired in the business combination, and want to recognize
an asset separately from goodwill. Mr. El-Naggar believes that this will not be in accordance with IAS 38.
Required
Provide the directors with advice on the accounting for this transaction.
(LO 1, C2-2 Cooper Company (CC), a public company based in Western Canada, recently acquired the leasehold interests
2, 3) in 220 sites and the website of Messer Corporation (MC), a company operating a chain of bookstores and an online
bookstore in Eastern Canada. As part of CC’s expansion strategy into Eastern Canada CC must maintain its net income
figure and equity level in order to comply with the debt-to-equity covenant imposed by the lenders who are helping CC
to finance this acquisition.
MC, which was founded by George Messer in 1945 to encourage Canadians to read, has struggled to compete in
recent years due to the low prices offered by a North American online giant and CC’s online store. The Messer family
has concluded that it would be in its best interest to sell these leasehold interests and its website to CC.
CC has agreed to pay MC $150 million in two equal payments of $75 million, in addition to the acquisition-related
costs of $250,000, to acquire the leasehold interests in 220 of the sites currently operated by MC and its website. These
payments are expected to be made in May and September of 2014. The fair market value of the leasehold interests were
$80 million and the website was $15 million. The average remaining life of the leases is 10 years. MC will sublease these
sites from CC and continue to operate them under the MC brand for a period of time. The stores will then be wound
up and started to be operated as CC stores in the locations. The existing installations will be removed by CC as part of
a renovation project for all of the stores so that they are consistent with existing CC stores.
CC expects to open 100 to 150 CC stores throughout Eastern Canada in 2014 and 2015, with the remainder there-
after. The financial returns on these stores are expected to be in line with returns on new CC stores. These stores will
provide a strong, initial foundation for an increased CC presence in Eastern Canada over the next five years.
MC had 279 stores, of which 220 are being sold to CC. MC plans to wind up the remainder of the stores.
CC plans to transition the incorporation of MC’s website within its own website. For a period of time, the MC
website will still exist in online search engines. However, once at the MC website, users will be directed to CC’s website
automatically. This is for consumers who are not aware of the sale to CC.
It is presently January 2014, and the CFO of CC thought that they would be able to account for this transaction
as a business combination and recognize part of the amount paid as goodwill and also to capitalize the acquisition costs.
However, he was told by the assistant controller that this would not be considered a business combination. The CFO
and assistant controller have come to you, a consultant, for your advice concerning this transaction.
Required
Prepare a report to the CFO and assistant controller providing recommendations regarding the transaction.
(LO 2, C2-3 You, a CA, are a senior accountant employed by Terrazas & Boyer, Chartered Accountants. On a Monday morn-
3, 5) ing in March 2013, Joseph Terrazas, a partner in the firm, walked into your office and announced: “Mary, you have been
assigned to a special engagement that I believe you will find very interesting. I have a meeting set for 11:00 a.m. with Peter
Norwood, president of Abacass Company Ltd. (ACL). We will need to leave by 10:30 a.m. In the meantime, have a look
at this file (see Exhibit CA2-3(a)). It provides some background information concerning Mr. Norwood’s company.”
Following your arrival at ACL, Mr. Norwood got right to the point. “I have been approached by Mrs. Helen
Shewchuk, who is interested in selling her company, Taft Publications Incorporated (TPI). Mrs. Shewchuk assumed
ownership of TPI after the sudden death of her husband, Professor Hugh Shewchuk, in August 2011. Since that time,
the company has been managed by her son, Ryan. Ryan recently graduated in computer programming at a technical
college and was beginning his career when he had to take over for his father. I am excited about the acquisition of TPI.
The book business is a perfect fit with my magazine business. I believe that ACL’s business strengths can easily be
applied to TPI. One of the benefits ACL gains with the acquisition of TPI is access to new authors and new contacts.”
Mr. Norwood continued to describe the attributes of TPI as you took notes (see Exhibit CA2-3(b)). He then pre-
sented Joseph Terrazas with the documents he had received to date from Mrs. Shewchuk. They included TPI’s financial
statements for the years ended July 31, 2011, and 2012, and interim statements for the six months ended January 31, 2013
(see Exhibit CA2-3(c)), as well as budgeted quarterly income statements for 2013 (see Exhibit CA2-3(d)). Mr. Norwood
also provided additional notes from Jack Anasz, the accountant who prepared review engagement reports for TPI’s 2011
and 2012 financial statements (see Exhibit CA2-3(e)), and a copy of the financial statements of ACL (see Exhibit CA2-3(f)).
Mr. Norwood went on to say: “I believe that the draft agreement proposed by Mrs. Shewchuk (see Exhibit CA2-3(g))
is a good starting point in light of the valuation prepared by her consultant (see Exhibit CA2-3(h)). I would like Terrazas
& Boyer to provide a report that assesses the appropriateness of ACL making this purchase. It should analyze how the pur-
chase would fit with ACL.” Mr. Norwood continued, “I’ll need to consider how to finance this deal. Mrs. Shewchuk has
indicated she is very flexible. She has no immediate needs for the cash. She is more concerned about ensuring Ryan plays
a less demanding role in the company and in preserving the legacy of her late husband’s company.” During the return trip
to the office, Joseph Terrazas said to you, “Provide me with a draft report on the proposed TPI purchase.”
Required
Write the report requested by Joseph Terrazas.
EXHIBIT C2-3(a)
EXTRACTS FROM THE ACL FILE
1. ACL publishes and prints a widely distributed regional magazine. ACL is owned and managed by Peter Norwood, who is 52
years old, married, and has two children. In addition, the family assets include approximately $150,000 in term deposits,
RRSPs in Mr. Norwood’s name totalling $250,000, and the family home valued at $800,000.
2. Mr. Norwood would very much like to bring his children into the business in about two years, at which time they will have gradu-
ated from college. Although he would reduce his involvement in the daily operations, he would need to continue to receive in-
come from the company. Mr. Norwood currently receives $150,000 in annual salary, and bonuses from time to time. During the
past two years, earnings have been enough to allow for the payment of dividends. If Mr. Norwood’s cash requirements exceed
his compensation, he borrows money from the company.
3. Terrazas & Boyer advises ACL on important business decisions. Mr. Norwood respects our opinions and often looks for advice
from Terrazas & Boyer. In the past, the firm has provided advice on potential acquisitions, on the accounting treatment for
certain complex transactions, on system acquisitions, and on general strategy issues. ACL’s financial statements are audited by
another CA firm.
EXHIBIT C2-3(b)
NOTES FROM DISCUSSION WITH PETER NORWOOD
1. TPI was incorporated in 1983 as a book publishing and printing company. Professor Shewchuk established the business after
recognizing the need for good educational material. TPI began by publishing and selling books written by Professor Shewchuk,
but soon expanded. As a professor, and subsequently, a dean of Maple Leaf University, Professor Shewchuk was able to obtain
the rights to publish the works of several of his colleagues. He was also able to promote the use of his books within the aca-
demic community, especially at Maple Leaf University. TPI primarily publishes materials used in education and by practising
professionals in accounting, taxation, and law.
2. As a book publisher, TPI contracts with authors to write books in specific fields of study. Authors are compensated by way of a
royalty on the price paid to the publisher for each book sold. TPI typically provides each author with $8,000 to $10,000 as an
advance toward the preparation of the original manuscript. Royalty payments are then applied against the author’s advance, and
any excess royalty is paid out semi-annually to the author. The authors are not required to pay back TPI for any shortfall.
3. After the manuscript has been edited and approved, a role in which Professor Shewchuk played a large part, TPI prints an initial
run of approximately 5,000 copies. Books are printed in large batches in order to minimize setup costs. A few of these initial cop-
ies are distributed to professors to encourage orders to be placed. TPI accounts for these distributed books as part of its inventory.
4. ACL is getting close to its production capacity and may have to consider turning away new subscriptions.
5. ACL uses a PC-based accounting and information system that is essentially an off-the-shelf package designed for magazine
publishing companies. The system meets Mr. Norwood’s needs, particularly since he is a hands-on manager and the company
produces only the one magazine.
6. Mr. Norwood is generally conservative and does not like to take on too much debt. TPI’s operations are more complex than those
of ACL, and he will not be there on a day-to-day basis as he cannot be in two places at once.
7. Mr. Norwood is worried about the accounting and reporting systems of TPI. Under Professor Shewchuk, TPI did not have sophis-
ticated systems. There was no job costing system, there were few controls, and it was difficult to determine product profitabil-
ity. Ryan Shewchuk has spent over 80% of his time over the last six months writing the programs for a customized computer
Cases 99
system for TPI. In addition, TPI has acquired sophisticated computer hardware and equipment costing $250,000 related to
this project. After spending a further $150,000 for the rights to database and source programs, Ryan believes that the system
can be fully operational and fully tested within three months. Mr. Norwood wonders whether a new, fully integrated, custom-
ized system is necessary for TPI when there is an off-the-shelf system for book printing and publishing companies that can be
purchased, installed, and tested for $200,000.
EXHIBIT C2-3(c)
EXCERPTS FROM TAFT PUBLICATIONS INC. FINANCIAL STATEMENTS
TAFT PUBLICATIONS INCORPORATED BALANCE SHEET
As at (unaudited, in thousands of dollars)
January 31, 2013 July 31, 2012 July 31, 2011

Assets
Current assets
Marketable Securities $ 11 $ 11 $ 11
Author advances receivable 380 350 275
Inventory 1,931 1,073 545
Shareholder loans receivable 14 14 376
Prepaid expenses 162 171 92
5,709 4,694 3,910
Property, plant, and equipment (Note 2) 5,250 5,450 6,563
Deferred charges 13 13 150
$10,972 $10,157 $10,623
Liabilities
Current liabilities
Bank indebtedness $ 3,000 $ 2,906 $ 1,555
Current portion of long-term debt 316 305 1,280
6,083 4,485 3,936
Long-term debt (Note 3) 4,230 4,391 4,696
Future income taxes 210 388 566
$10,523 $ 9,264 $ 9,198
Shareholder’s equity
Share capital $ 720 $ 720 $ 720
Retained earnings (deficit) (271) 173 705
449 893 1,425
$10,972 $10,157 $10,623
TAFT PUBLICATIONS INCORPORATED STATEMENT OF INCOME AND RETAINED EARNINGS

For the (unaudited, in thousands of dollars)
6 months ended Year ended Year ended

January 31, 2013 July 31, 2012 July 31, 2011
Sales $ 6,531 $15,127 $16,585

Cost of goods sold
Inventory, beginning of period 1,073 545 98
Printing costs 5,788 11,255 11,283
Inventory, end of period (1,931) (1,073) (545)
4,930 10,727 10,836
Gross margin 1,601 4,400 5,749
Expenses
Selling 1,212 2,631 2,889
Administration 749 1,976 1,775
Interest 263 503 572
2,223 5,110 5,236
Income (loss) before taxes (622) (710) 513
Future income taxes 178 178 (128)
Net income (loss) (444) (532) 385
Retained earnings, beginning of period 173 705 320
Retained earnings (deficit), end of period $ (271) $ 173 $ 705
TAFT PUBLICATIONS INCORPORATED EXTRACTS FROM NOTES TO FINANCIAL STATEMENTS

(unaudited)
1. Significant accounting policies

Inventory. Inventory is valued at the lower of cost and net realizable value.
Property, plant, and equipment. Property, plant, and equipment are stated at cost less accumulated amortization. They are
amortized on a declining-balance basis in accordance with the rates stated in Note 2.
Revenue recognition. Revenue is recognized at the time the customer places an order.
Author advances receivable. These amounts represent non-interest-bearing advances, net of cumulative royalties, that are ap-
plied against individual author advances.
2. Property, plant, and equipment (in thousands of dollars)

Accumulated 2012 Net book 2011 Net book
Rate Cost amortization value value
Land — $ 183 — $ 183 $ 183
Buildings 5% 1,533 $ 499 1,034 1,088
Machinery and equipment 10% 8,665 4,507 4,158 5,198
Furniture and fixtures 20% 171 96 75 94
$10,522 $5,102 $5,450 $6,563
3. Long-term debt (in thousands of dollars)

2012 2011
Boyd’s Bank
Promissory note repayable in semi-annual payments of $51 plus interest at prime
1%, due 2017 $1,644 $1,746
Campbell Trust
Loan repayable in equal monthly installments of $6 plus interest at prime
1.5%, due in 2017 428 500
International Bank
Loan secured by land, building A, and equipment, repayable in equal monthly
installments of $25 including interest at 8% per annum, due 2016 2,342 2,450
International Bank
Mortgage on building B repayable in equal monthly installments of $4 including
interest at 10.5% per annum, due 2018 282 300
Regal Bank
Promissory note repaid on July 15, 2012 — 980
4,696 5,976
Less current portion 305 1,280
$ 4,391 $ 4,696
4. Change in accounting policy. The company has altered its policy for recognizing revenue for the year ended July 2012 from the
date of delivery to the date on which orders are placed by customers. This change has been applied prospectively.
5. Income Taxes. At July 31, 2012, the company has tax losses available of $330,000 to offset future taxes payable. These losses
will expire in 2019. The benefits arising from this tax loss carry forward have not been recognized in the financial statements.
EXHIBIT C2-3(d)
Budgeted Quarterly Income
TAFT PUBLICATIONS INCORPORATED BUDGETED QUARTERLY INCOME
For the year ending July 31, 2013
1st quarter 2nd quarter 3rd quarter 4th quarter Total

Sales $ 2,770 $ 2,770 $ 2,675 $ 9,605 $ 17,820
Cost of goods sold
Inventory, beginning 1,073 1,983 2,140 3,166 1,073
Printing costs 2,610 1,857 2,666 3,967 11,100
Inventory, ending (1,983) (2,140) (3,166) (1,250) (1,250)
1,700 1,700 1,640 5,883 10,923
Gross margin 1,070 1,070 1,035 3,722 6,897
Expenses
Selling 600 600 660 660 2,520
Administrative 375 375 375 375 1,500
Interest 150 145 140 135 570
1,125 1,120 1,175 1,170 4,590
Income (loss) before taxes $ (55) $ (50) $ (140) $2,522 $ 2,307
Cases 101
EXHIBIT C2-3(e)
Notes from Jack Anasz
TAFT PUBLICATIONS INCORPORATED NOTES FROM JACK ANASZ
1. All outstanding common shares of the company are owned by Mrs. Shewchuk. The shares were willed to Mrs. Shewchuk follow-
ing the death of her husband.
2. The bankers of the company requested that an aged accounts receivable listing be provided for the year-end balance, with com-
paratives. The following aging was provided:
Aged accounts receivable
Less than
Year 30 days 30–60 days 61–90 days Over 90 days
2012 40% 11% 21% 28%
2011 53% 15% 17% 15%
2010 62% 19% 12% 7%
Bookstores can return any book purchased within 2 years of the purchase date. TPI’s aggressive marketing practices in 2012
encouraged bookstores to over-order under the “no risk, full return” policy.
3. The company values inventory at the lower of cost and net realizable value. Cost is determined on a first-in, first-out basis.
Books produced are costed on a full absorption basis: total production costs for the year are divided by total books produced
during the year in order to obtain a cost per book. Inventory generally consists of printed and bound books. Books returned by
bookstores are returned to inventory.
4. The bank reconciliations contain a large number of outstanding cheques. Many cheques cleared the bank 30 to 50 days subse-
quent to the cheque being prepared and presented to Ryan Shewchuk for signing.
5. The employee turnover is at its highest level ever. The company’s accounting staff has been reduced significantly over the last
couple of years, and people are working longer hours. The company has not had an accounts receivable or accounts payable
clerk for the last 14 months.
6. The company’s level of production was significantly below the capacity of approximately 70,000 books per month for many
of the months during the year. Jack Anasz does not consider that this creates an impairment in the value of the capital assets
since future cash flows will eventually offset the cost of these assets.
7. The following list represents TPI’s authors and their books. (Some details are provided for the five major authors and their
works, which are published in both French and English.)
Historical
gross Sales volume
margin on (in units) for
Authors Major Works book sales 2012
Prof. Shewchuk, CA, Introduction to Accounting, 8th Ed.* 35% 22,000
Maple Leaf Advanced Accounting Issues, 33% 22,000
University 5th Ed.* 34% 30,000
Intermediate Accounting* 32% 15,000
Management Accounting, 6th Ed. * 30% 2,000
Current Value Accounting** 36% 3,000
Accounting for Not for Profits* 30% 5,000
Value for Money Auditing**
Prof. Huot, LLB, Shareholder Disputes in Canada** 31% 28,000
McMann & Tate Business Law* 27% 22,000
Corporate mergers and 28% 9,000
Acquisitions**
Prof. Friedland, CA, Introduction to Taxation in Canada* 25% 15,000
Govt. of Canada
Prof. Maher, Statistics in Business* 23% 22,000
Maple Leaf Actuarial Concepts for Managers** 21% 7,000
University
Prof. Trenholm, Market Segmentation in Canada* 30% 15,000
Maple Leaf Marketing Strategies for Success 27% 5,000
University
Others* 27% 75,000
297,000
*Primarily used by universities

**Primarily used by professionals.
8. In years prior to fiscal 2013, new book purchases were funded in part by the provincial government. Its “Read-all Program”
subsidized 5% of the cost of new-book purchase by all universities in the province. Under a new provincial government, this
program has been discontinued.
EXHIBIT C2-3(f)
Excerpts from Abacass Company Ltd. Financial Statements
ABACASS COMPANY LIMITED
BALANCE SHEET
As at December 31
(audited, in thousands of dollars)
2012 2011
Assets
Current assets
Cash $ 285 $ 274
Marketable securities 294 135
Shareholder’s advance 300 300
Inventory 172 166
2,432 1,935
Property, plant, and equipment
Machinery and equipment 145 65
Furniture and fixtures 125 93
Leasehold improvements 22 20
292 178
Less: Accumulated amortization 90 65
202 113
$2,625 $2,048
Liabilities
Current liabilities
Accounts payable $ 926 $ 639
Accrued bonus payable 150 150
Income taxes payable 200 50
Subscriptions received in advance 60 45
1,336 884
Future income taxes 40 15

25 25
Share capital 1,224 1,124
$2,625 $2,048
ABACASS COMPANY LIMITED

STATEMENT OF INCOME AND RETAINED EARNINGS
For the year ended December 31 (audited, in thousands of dollars)
2012 2011
Sales $ 5,232 $ 3,937
Cost of goods sold 2,856 2,069
Gross margin 2,376 1,868
Expenses
Selling and promotion 197 139
Office and administration 393 404
Salaries and benefits 636 476
Bonus — 150
1,226 1,169
Income before taxes 1,150 699
Income taxes 550 350
Net income 600 349
Retained earnings, beginning of year 1,124 1,075
Dividends (500) (300)
Retained earnings, end of year $ 1,224 $ 1,124
Cases 103
EXHIBIT C2-3(g)
Extracts from Draft Purchase and Sale Agreement
Memorandum of Agreement made on the _____ day of February, 2013
BETWEEN:
Mrs. Shewchuk
(referred to as the “Vendor”)
– and –
Abacass Company Limited
A corporation incorporated under the laws of Canada
(referred to as the “Purchaser”)
The parties covenant and agree as follows:

1. Defined terms
Where used in this agreement, the following terms shall have the following meanings, respectively:
1.1 “Purchased Shares” means the shares as defined in Article 2.
1.2 “Effective Date means the 31st day of July, 2013, or such earlier or later date as may be mutually agreed by the parties.
1.3 “Purchased Business” is Taft Publications Incorporated.
1.4 All dollar amounts referred to in this agreement are in Canadian funds.
1.5 Shareholder’s Equity is to be determined in accordance with generally accepted accounting principles applied on a basis
consistent with prior years.
2. Shares to be purchased and sold
2.1 The Vendor agrees to sell, assign, and transfer to the Purchaser and the Purchaser agrees to purchase from the Vendor all
common shares issued and outstanding of Taft Publications Incorporated as at the Effective Date.
3. Purchase price and allocation
3.1 The purchase price payable to the Vendor for the Purchased Shares (the “Purchase Price”) shall be the total sum of one
million dollars ($1,000,000) plus the amount of the Shareholder’s Equity at the Effective Date.
3.2 The Purchase Price as determined above shall be payable as follows:
(i) A deposit in the amount of two hundred and fifty thousand dollars ($250,000) upon the acceptance of this agree-
ment by the parties.
(ii) Seven hundred and fifty thousand dollars ($750,000) payable by certified cheque or bank draft to the Vendor at the
Effective Date.
(iii) Within 180 days of the Effective Date, a final payment shall be made equal to the Shareholder’s Equity at the Effec-
tive Date.
4. Covenants, representations, and warranty
The Vendor covenants and agrees with, represents, and warrants the following:
4.1 The books and records of the Vendor fairly and correctly set out and disclose all material transactions, in accordance with
generally accepted accounting principles, and all material transactions have been accurately recorded in the accounting
records of the Vendor’s business.
4.2 Since the latest fiscal year end, July 31, 2012, the purchased business has been carried out by the Vendor in the ordinary
and normal course and will continue to be carried on in the ordinary and normal course after the date of this agreement up
to the Effective Date.
4.3 All material liabilities of the Purchased Business (including any contingent liabilities) are disclosed in the financial state-
ments for the most recent year end.
4.4 The Vendor shall make available to the Purchaser or its authorized representatives, all records, contract agreements,
customer lists, and other relevant documents.
5. Inventory
The Vendor and Purchaser agree to the appointment of Terrazas & Boyer to verify the value of inventory at the Effective Date.
EXHIBIT C2-3(h)
Extracts from the Valuation Report of John Bondarenko, CBV, Independent Appraiser
I have estimated the fair market value of the assets upon their highest and best possible use. Based on the information and
documents reviewed, I estimate the fair market value of Taft Publications Incorporated’s assets to be $9,400,000 (Schedule I).
Extracts from Schedule I:
Fair Market values as at January 31, 2013.
Land $ 500,000
Inventory at selling price 2,400,000
Buildings 1,500,000
Machinery, equipment, furniture, and fixtures 5,000,000
$9,400,000
(Adapted from CICA’s Uniform Evaluation Report)

(LO 1, 2, C2-4 You, CA, are in charge of the audit of Fuschia Enterprises, a manufacturer of crayons in Vancouver, British
3, 5) Columbia with sales in 2012 of $75 million. This year, sales have increased due to increasing their market share in
Eastern Canada. The company has assets of $40 million and their net income last year was $6.5 million. The common
shares of the company are widely owned. In previous years, the company relied on your firm for advice.
You recently visited the company’s head office with the partner in charge of this file to discuss matters relating to
the company’s December 31, 2013, year-end. A follow-up meeting has been scheduled for two weeks from now and the
partner would like you to prepare a memo that addresses any issues identified in the meantime in preparation for this
meeting.
During the visit, you made the following notes:
• Effective June 30, 2013, Fuschia Enterprises purchased Neon Limited, a company engaged in the production and
distribution of colouring books. Management of Fuchsia Enterprises felt that Neon Limited would be a comple-
ment to their existing business. After the acquisition date, Neon Limited ceased to exist. At the date of acquisition,
the statement of financial position of Neon Limited was as follows:
Cash $ 501,633
Inventory 982,290
Property, plant and equipment (net) 627,201
Intangible assets 471,203
Goodwill 293,112
Total assets 3,350,542
Bank indebtedness 625,102
Long-term debt 901,201
Retained earnings 1,137,038
Total liabilities and shareholder’s equity $3,350,542
Intangible assets consists of research and development costs capitalized during the year relating to work that
was performed internally for developing new printing technology, the benefits of which were going to be launched
starting this fiscal year. Fuschia Enterprises had a valuation performed and it was estimated that the fair value of
this technology was $600,000.
The goodwill relates to an acquisition that Neon Limited had made several years ago to acquire a small competitor.
The assets and liabilities approximate their book values recorded above except for property, plant and equip-
ment (net), which has a fair market value of $550,000 and inventory which has a fair market value of $1,025,000.
The purchase price paid to the shareholders of Neon Limited consisted of $1,600,000 paid on June 30, 2013.
In addition, if net income of Neon Limited exceeds $1 million in the first full year after the acquisition, an addi-
tional $250,000 will be payable. Fuschia Enterprises believes that there is a 65% chance of attaining this goal.
• During the year Fuschia Enterprises instituted a new management compensation plan whereby certain members of
senior management will be paid an annual bonus based on audited net income.
Required
Prepare the report requested by the partner that addresses and discusses the accounting issues identified with respect
to Fuschia Enterprises.
Mining for
Acquisitions
Source: © Günay Mutlu/iStockphoto
IN JUNE 2011, CANADIAN mining giant A private Canadian company following Accounting
Barrick Gold Corporation began a string of Standards for Private Enterprises has the option of
acquisitions of shares of Equinox Resources accounting for a subsidiary; such as Equinox to
Limited that would see Barrick assume control Barrick, either by consolidating it or by using the cost
of Equinox. By the end of the second quarter, or equity methods. As Barrick is a publicly accountable
the Toronto-based corporation owned 96% enterprise; however, it followed the requirements
of Equinox’s voting equity and acquired the of International Financial Reporting Standards and
remaining 4% in July 2011. The U.S. $7.5-billion consolidated Equinox’s results with its own.
acquisition cost of Equinox marked this Owning 100% of the voting shares of Equinox
transaction as one of the largest mergers and makes it a wholly-owned subsidiary of Barrick. IAS
acquisitions transactions of the year in Canada. 27 Consolidated and Separate Financial Statements
In a message to shareholders, Barrick requires parents to consolidate their investments
founder and Chairman Peter Munk said, of in subsidiaries when preparing their financial
Equinox’s major acquired operations in Zambia statements. In order to do so, Barrick added,
and Saudi Arabia, “We are confident that these line by line, the assets, liabilities, revenues, and
operations will materially increase our top line expenses of Equinox as of the date of acquisition
revenue and boost our free cash flow in the to its own and eliminated the carrying amount of
years ahead.” its investment. The acquisition included U.S. $3.5
While the founder’s statement regarding billion of goodwill, and the operations formerly
combining the revenues and cash flows of owned by Equinox contributed U.S. $569 million of
the companies is fairly straightforward, the revenue and U.S. $46 million of segment income to
accounting for such combinations is somewhat the consolidated totals of the year ended December
more complex and depends on the standards 31, 2011. For users of Barrick’s financial statements,
used and policy decisions made by management. such information is a “gold mine” of data.
Sources: Barrick Gold 2011 Annual Report and Audited Financial Statements; Financial Post Crosbie Mergers and Acquisitions in Canada database, www.crosbieco.
com/ma/index.html; ASPE section 1590.15, IFRS, IAS 27.9.
CHAPTER
3 Consolidation:
Wholly Owned
Subsidiaries
LEARNING OBJECTIVES
1. Explain how the consolidation process works.
2. Prepare an acquisition analysis for the parent’s acquisition in a subsidiary.
3. Prepare a consolidated financial statement at the day of acquisition.
4. Prepare a consolidated financial statement in subsequent periods.
CONSOLIDATION
Consolidated Financial Consolidated Financial

The Consolidation Process The Acquisition Analysis Statements at the Day of Statements Subsequent to
Acquisition the Acquisition Date
■ The acquisition date ■ The acquisition analysis ■ Basic format ■ Parent company recording in its
■ Preparing consolidated financial ■ Previously held equity interest ■ Goodwill recorded by subsidiary own books
statements in the subsidiary at acquisition date ■ Fair value adjustments
■ Fair value adjustments ■ Dividends recorded by subsid- ■ Preparation of consolidated
■ Pre-acquisition adjustments iary at acquisition date financial statements in
■ Gain on bargain purchase subsequent periods
108 chapter 3 Consolidation: Wholly Owned Subsidiaries
THE CONSOLIDATION PROCESS

Objective 1 This chapter discusses the preparation of consolidated financial statements, a process neces-
Explain how the sary when the business combination is effected through the purchase of the shares of the
consolidation acquiree. Consolidated financial statements are the result of combining the financial state-
process works. ments of a parent and all its subsidiaries. (The determination of whether an entity is a parent
or a subsidiary was discussed in Chapter 1.) The two accounting standards mainly used in
this chapter are IFRS 10 Consolidated Financial Statements and IFRS 3 Business Combinations. In
Chapter 2 we examined the process of recording a business combination with the purchase of
an entity’s net assets. In that circumstance, consolidation is not necessary as the net assets of
the acquiree are now reflected in the books of the acquirer. In this chapter, the acquirer
obtains shares of the investee and therefore records an investment on its books on the day of
acquisition. Since the parent is required to report its investment on a consolidated basis, we
see that the manner in which the investment is recorded is not the same as how it is reported
on the group financial statements.
Illustration 3.1 shows an excerpt from the financial statements of Scorpio Mining
Corporation, a Canadian company which is among the best performing silver producers.
Mining companies often grow through acquisitions and have been the early adopters of IFRS
requirements in Canada.
Illustration 3.1
8. Acquisition of Platte River Gold Inc.
Excerpt from the Financial
On April 1, 2010, the Corporation acquired the assets of Platte River Gold Inc. (“Platte”) and its
Statements of Scorpio
subsidiaries through the issuance of 74,832,020 common shares of the Corporation in exchange for all
Mining Corporation
of Platte’s outstanding common shares. In addition, a further 4,414,967 shares are issuable to the
former holders of Platte’s stock options and warrants, which by their terms, became exercisable for the
Corporation’s common shares upon the closing of this acquisition. The Corporation has accounted for
this acquisition as an acquisition of assets.
The cost of the acquisition has been allocated as follows:
Purchase consideration
Issuance of Scorpio Mining common shares
(74,832,020 shares at $0.69 per share) $51,634,094
Fair value of Platte options and warrants assumed 1,259,793
Acquisition costs 436,874
$53,330,761
Scorpio Mining Corporation

Notes to the condensed consolidated interim financial statements
Six months ended June 30, 2011 and 2010
(Expressed in Canadian dollars unless otherwise indicated, unaudited)
8. Acquisition of Platte River Gold Inc (continued)

Fair value of net assets acquired is as follows:
Cash $ 410,008
Trade and other receivables 238,050
Lease receivable 1,387,024
Deferred income tax assets 4,627,712
Non-producing mining properties 48,416,666
Trade and other payables (960,429)
Long-term debt (1,257,490)
Net fair value of assets and liabilities $53,330,761
Following is the fair value that has been calculated and allocated to the Platte warrants and stock options
assumed by the Corporation in the purchase consideration.
2,966,861 warrants have an exercise price of $0.57 (U.S.$0.57) each and an expiry date of November 7,
2011. Their fair value was based on the actual value as of April 1, 2010, which was calculated at
$818,161 using the Black-Scholes Model and using the following assumptions:
The Consolidation Process 109
Illustration 3.1
Expected life 1.3 years
(Continued) Risk free interest rate 1.63%
Expected stock price volatility 74%
Dividend yield 0%
1,448,106 stock options have an exercise price of $0.85 (U.S.$0.85) each and an expiry date of May 8,
2013. Their fair value was based on the actual value as of April 1, 2010, which was calculated at
$441,632 using the Black-Scholes Model and using the following assumptions:
Expected life 2.6 years

Risk free interest rate 1.63%
Expected stock price volatility 86%
Expected forfeiture rate 3.45%
Dividend yield 0%
The fair value of the Platte warrants was $818,161 and stock options was $441,632 and have been
recorded as part of the purchase consideration.
We introduce a new situation where the manner in which the acquirer records its invest-
ment is not the same as how it reports that investment. Recording is the manner in which the
transaction is reflected in the entity’s books and records. Reporting is the manner in which the
transaction is reflected in the consolidated financial statements that are issued to outside users.
In the situation where the acquirer buys shares in the acquiree, the two entities continue
to operate as separate legal entities. Those entities will file their own tax returns. However,
as we learned in Chapter 1, the acquirer has control over the acquiree and therefore must
present a consolidated financial statement with the acquiree (in a parent–subsidiary relation-
ship). IAS 27 Separate Financial Statements requires an entity that has a subsidiary and that
reports on separate financial statements for a special purpose, in addition to its consolidated
statements (for tax purposes), to show the investment in that subsidiary at cost or fair value
(IAS 27.10). As such, we will assume that entities will record the investment at cost on their
own books and records.
The Acquisition Date

The “acquisition date” is defined as the day on which the acquirer effectively obtains control
of the acquiree. As discussed in Chapter 2, both the fair values of the subsidiary’s identifiable
assets and liabilities and the consideration transferred are measured at the acquisition date. In
this chapter, the only combinations considered are those where the parent acquires its con-
trolling interest in a subsidiary and, as a result, owns all the subsidiary’s issued shares—the
subsidiary is then a wholly owned subsidiary. This may occur by the parent buying all the
shares in a subsidiary in one transaction, or by the parent acquiring the controlling interest
after having previously acquired shares in the subsidiary.
The consolidation process will involve replacing the investment account that is recorded
in the books of the acquirer with the specific net assets acquired from the acquiree. This is
achieved by combining the financial statements of both the parent and its subsidiary. The
consolidated financial statements of a parent and its subsidiary include information about a
subsidiary from the date the parent obtains control of the subsidiary (i.e., from the acquisition
date). A subsidiary continues to be included in the parent’s consolidated financial statements
until the parent no longer controls that entity (i.e., until the date of disposal of the subsidiary).
Before undertaking the consolidation process, it may be necessary to make adjustments
in relation to the content of the subsidiary’s financial statements:
• If the end of a subsidiary’s reporting period does not coincide with the end of the parent’s
reporting period, adjustments must be made for the effects of significant transactions
and events that occur between those dates, with additional financial statements being
prepared where it is practicable to do so (IFRS 10 B.21). In most cases where there are
different dates, the subsidiary will prepare adjusted financial statements as at the end of
the parent’s reporting period, so that adjustments are not necessary on consolidation.
Where the preparation of adjusted financial statements is unduly costly, the subsidiary’s
financial statements prepared at a different date from the parent may be used, subject
to adjustments for significant transactions. However, for this to be a viable option, the
difference between the ends of the reporting periods can be no longer than three months.
Further, the length of the reporting periods, as well as any difference between the ends of
the reporting periods, must be the same from period to period.
• The consolidated financial statements are to be prepared using uniform accounting poli-
cies for like transactions and other events in similar circumstances (IFRS 10.41). Where
different policies are used, adjustments are made so that like transactions are accounted
for under a uniform policy in the consolidated financial statements.
The preparation of the consolidated financial statements involves adding together the
financial statements of the parent and its subsidiaries. As a part of this summation process, a
number of adjustments are made:
• As required by IFRS 3, at the acquisition date the acquirer must recognize the subsid-
iary’s identifiable assets and liabilities at fair value. This requires adjusting the carrying
amount of the subsidiary’s assets and liabilities to fair value and recognizing any identifi-
able assets acquired and liabilities assumed as a part of the consolidation process. The
adjustments used are referred to in this chapter as the fair value adjustments. These adjust-
ments are generally not made in the records of the subsidiary itself but in a consolidation
process since the investment account is recorded in the records at cost.
• Where the parent has an ownership interest (i.e., it owns shares) in a subsidiary, addi-
tional adjustments are made, referred to in this chapter as the pre-acquisition adjustments.
This involves eliminating the carrying amount of the parent’s investment in each subsid-
iary (i.e., cost) and the parent’s portion of pre-acquisition equity in each subsidiary (IFRS
10.B17(b)). The name of these adjustments is derived from the fact that the subsidiary’s
equity at the acquisition date is referred to as pre-acquisition equity, and it is this equity
that is being eliminated. The parent is only entitled to the equity change since the invest-
ment was made. Any equity at the acquisition date was paid for by the parent as part of
the acquisition cost. These adjustments are also made in the consolidation process and
not in the subsidiary’s records.
• The third set of adjustments to be made is for transactions between the entities within
the group subsequent to the acquisition date, including events such as sales of inventory
or non-current assets. These intragroup transactions are referred to in IFRS 10.B17(c),
and adjustments for these transactions are discussed in detail in Chapter 4.
In this chapter, the group under discussion is one where:
• There are only two entities within the group: one parent and one subsidiary (see
Illustration 3.2).
• Both entities have share capital.
• The parent owns all the issued shares of the subsidiary; that is, the subsidiary is wholly
owned. (Partially owned subsidiaries, where it is necessary to account for the non-
controlling interest, are covered in Chapter 5.)
• There are no intragroup transactions between the parent and its subsidiary after the
acquisition date.
Illustration 3.2
A Wholly Owned Group 100%
Parent Subsidiary
The Consolidation Process 111
Preparing Consolidated Financial Statements

The consolidated financial statements are prepared by adding together the financial
statements of the parent and the subsidiary. It is the financial statements of the parent and
the subsidiary, rather than the underlying accounts, that are added together. There are no
consolidated books. The financial statements that are added together are the statements of
financial position (balance sheets), statements of comprehensive income (income statements),
and statements of changes in equity prepared by the management of the parent and the sub-
sidiary. Consolidated statements of cash flows are prepared from the consolidated statement
of financial position and the consolidated statement of comprehensive income. As there are
no significantly different issues involved in the preparation of a consolidated statement of
cash flows, it is not covered in this textbook.
If a consolidation is done at the day of acquisition, only the statements of financial posi-
tion need be adjusted since all of the subsidiary’s equity will be pre-acquisition and therefore
eliminated. We see that the consolidated statement of comprehensive income and statements
of changes in equity will simply be those of the parent. The format for the process at the day
of acquisition is presented in Illustration 3.3, which contains the information used for the
consolidation of the parent, P Ltd., and the subsidiary, S Ltd.
Illustration 3.3
P + S − Pre-acquisition equity = Consolidated
Consolidation Process
Basic Format 1 2 3 4 5
Parent Subsidiary
Financial statements P Ltd. S Ltd. Consolidation
Share capital 30,000 15,000 15,0001
30,000
55,000 27,000 62,000
Investment in S Ltd. 20,000 — 20,0001 —
Other assets 35,000 27,000 62,000
55,000 27,000 0 62,000
Note the following points about the process:

• Column 1 contains the names of the accounts, as the financial statements are combined
on a line-by-line basis.
• Columns 2 and 3 contain the individual financial statements of the parent, P, and its sub-
sidiary, S. These statements are obtained from the separate legal entities. The number of
columns is expanded if there are more subsidiaries within the group.
• Column 4 is used to make the adjustments required in the consolidation process. These
include adjustments for fair value adjustments at acquisition date, pre-acquisition equity,
and intragroup transactions such as sales of inventory between the parent and subsidiary.
The adjustments could be written in the form of journal adjustments, which will be illus-
trated initially in this chapter. However, since these adjustments are not recorded in the par-
ent’s books, it is not necessary to create journal entries. We will use the “direct approach”
whereby we will make the necessary adjustments by adding or subtracting from the com-
bined financial statements. In Illustration 3.3 there is only one adjustment, hence the num-
ber “1” is entered against each adjustment item. The adjustment journal entry would be:
(1) Retained Earnings (opening balance) 5,000

Investment in S Ltd. 20,000
• As noted earlier, the process of consolidation is one of adding together the financial
statements of the group members and making various adjustments. Hence, Illustrations
for each line item in Column 5, headed “Consolidation,” arise through addition and sub-
traction as you proceed horizontally across the process. For example, for share capital:
$30,000 $15,000 $15,000 $30,000
The illustrations in the right-hand column provide the information to prepare the con-
solidated financial statements of P and S.
• In the “Consolidation” column, the totals and subtotals are the result of adding the pre-
ceding items in that column rather than totalling items across the rows. For example, the
total consolidated equity of $62,000 is determined by adding the retained earnings bal-
ance of $32,000 and the share capital balance of $30,000, both these balances appearing
in the Consolidation column. It is from this column that the information for preparing
the consolidated statement of comprehensive income, statement of changes in equity,
and statement of financial position is obtained.
In preparing the consolidated financial statements, no adjustments are made in the
accounting records of the individual entities that constitute the group. The adjustments made
for consolidation do not affect the accounts of the individual entities. Hence, where consoli-
dated financial statements are prepared over a number of years, a particular adjustment (such as
a pre-acquisition adjustment) needs to be made every time a consolidated financial statement
is prepared, because the entry never affects the actual financial statements of the individual
entities. As we will see later in the chapter, the starting point for the preparation of the consoli-
dated financial statements are the individual company statements at that date, not the previous
year’s consolidated financial statements. This is due to the fact that there is no consolidated
record keeping. It is the individual companies that record the transactions for the period.
✓ LEARNING CHECK
• Where the parent entity and the subsidiary have different ends of reporting periods, adjust-
ments must be made to the subsidiary’s statements before the preparation of the consolidated
financial statements.
• Because IFRS 3 Business Combinations requires that under the acquisition method the
acquiree’s identifiable assets and liabilities are to be reported at fair value, fair value adjust-
ments are prepared as part of the consolidation process.
• Where the parent entity holds shares in the subsidiary, pre-acquisition adjustments are a part
of the consolidation process in order to ensure no double-counting of group assets and equity.
• The consolidation process requires the addition of the financial statements of the parent and
its subsidiaries.
• Consolidation adjustments are prepared to convert the added-together financial statements
of the parent and subsidiary to the financial statements of the group.
THE ACQUISITION ANALYSIS

Objective 2 We will assume that the parent acquires all the shares of the subsidiary at the acquisition date
Prepare an in one transaction. Goodwill arises when the consideration transferred is greater than the net
acquisition analysis fair value of the identifiable assets and liabilities acquired. Where the reverse occurs, income
for the parent’s from a bargain purchase is recognized.
acquisition in a
An acquisition analysis is conducted at acquisition date because it is necessary to recog-
subsidiary.
nize the subsidiary’s identifiable assets and liabilities at fair value, and to determine whether
there has been an acquisition of goodwill or a gain. As noted in Chapter 2, this may give rise
to the recognition of assets and liabilities that are not recognized in the subsidiary’s records.
The Acquisition Analysis 113
For example, the business combination may give rise to intangibles that were not capable of
being recognized in the subsidiary’s records, such as internally generated brands.
Illustration 3.4 contains an excerpt from the financial statements of Canadian-based gold
producer Barrick Gold Corp., showing a note regarding a recent acquisition of Equinox.
Equinox was a publicly traded mining company that owned the Lumwana copper mine in
Zambia and the Jabal Sayid copper project in Saudi Arabia. The operations of Equinox were
then integrated into the Barrick group. In this manner, Barrick was able to grow its opera-
tions internationally.
Illustration 3.4
Excerpt from the Financial For the three For the nine
Statements of Barrick months ended months ended
Gold Corp. Acquisitions and Divestitures September 30 September 30
2011 2010 2011 2010

Cash paid on acquisition1
Equinox $269 $— $7,482 $ —
Cerro Casale — — — 454
Barrick Energy acquisitions 68 25 253 264
Tusker — — — 74
REN — 36 — 36
Other — — 25 —
337 61 7,760 828
Less: cash acquired — — (83) (15)
$337 $61 $7,677 $813
Cash proceeds on divesture1
Sedibelo $ — $— $ 44 $ —
IPO of African gold mining
operations2 — — — 884
Osborne — 17 — 17
Pinson 15 — 15 —
$ 15 $17 $ 59 $901
1
All amounts represent gross cash paid on acquisition or received on divestiture.
2
There was no change in control as a result of the IPO of ABG, and consequently the net proceeds received were
recorded as a financing cash inflow on the consolidated statement of cash flows.
A) Acquisition of Equinox Minerals Limited

On June 1, 2011, we acquired 83% of the recorded voting shares of Equinox Minerals Limited (“Equinox”),
thus obtaining control. Throughout June we obtained a further 13% of the voting shares and obtained the
final 4% on July 19, 2011. Cash consideration paid in second quarter 2011 was $7,213 million, with a
further $269 million paid in third quarter 2011, for total cash consideration of $7,482 million. We have
determined that this transaction represents a business combination with Barrick identified as the acquirer.
We began consolidating the operating results, cash flows, and net assets of Equinox from June 1, 2011.
Equinox was a publicly traded mining company that owns the Lumwana copper mine in Zambia and the
Jabal Sayid copper project in Saudi Arabia. The operations of Equinox are being integrated into Barrick’s
Australia Pacific business unit and the Capital Projects group.
The following tables present the purchase cost and our preliminary allocation of the purchase price to
the assets and liabilities acquired. This allocation is preliminary as we have not had sufficient time to
complete the valuation process. In third quarter 2011, we have made minor adjustments to some of the
estimated fair values and there will be further adjustments to the estimated fair values as the valuation
work is finalized.
Purchase Cost
Cash paid to Equinox shareholders in June 2011 $ 6,957

Cash paid to Equinox shareholders in July 2011 269
Cost of Equinox shares previously acquired 131
Payouts to Equinox employees on change of control 125
Total Acquisition Cost 7,482
Cash acquired with Equinox (83)
Net Cash Consideration $ 7,399
The purchase cost was funded from our existing cash balances and from proceeds from the issuance of
long-term debt of $6.5 billion.
Illustration 3.4
Preliminary Fair Value
(Continued) Summary of Preliminary Purchase Price Allocation at Acquisition
Assets
Current assets $ 411
Property plant and equipment 5,659
Other assets 66
Goodwill 3,427
Total assets 9,563
Liabilities
Current Liabilities 291
Deferred income tax liabilities 1,339
Provisions 43
Debt 408
Total liabilities 2,081
Net assets $ 7,482
In accordance with the acquisition method of accounting, the acquisition cost has been allocated on a
preliminary basis to the underlying assets acquired and liabilities assumed based primarily upon their
estimated fair values at the date of acquisition. We used an income approach (being the net present
value of expected future cash flows) to determine the preliminary fair values of mining interests. Esti-
mates of expected future cash flows for the final valuations are based on estimates of projected future
revenues, expected conversions of resources to reserves, expected future production costs, and capital
expenditures based on a finalized life of mine plan. The excess of acquisition cost over the net identifi-
able assets acquired represents goodwill.
Goodwill arose on this acquisition principally because of the following factors: 1) the scarcity of large,
long-life copper deposits; 2) the ability to capture financing, tax, and operational synergies by managing
these properties within Barrick; 3) the potential to expand production through operational improvements
and increases to reserves through exploration at the Lumwana property, which is located in one of the
most prospective copper regions in the world; and 4) the requirement to record a deferred tax liability for
the difference between the assigned values and the tax bases of assets acquired and liabilities assumed
at amounts that do not reflect fair value. The goodwill is not deductible for income tax purposes.
Since it has been consolidated from June 1, 2011, Equinox contributed revenue of $353 million and
segment income of $25 million. Revenues and net income of the combined entity would have been
approximately $10.9 billion and approximately $3.5 billion, respectively, for the nine months ended
September 30, 2011, had the acquisition and related debt issuances occurred on January 1, 2011.
Acquisition-related costs of approximately $85 million have been expensed, with approximately $39
million presented in other expense and $45 million in realized foreign exchange losses relating to our
economic hedge of the purchase price presented in gain (loss) on non-hedge derivatives.
The first step in the consolidation process, regardless of which year is being reported, is
to undertake the acquisition analysis in order to obtain the information needed to make both
the fair value and pre-acquisition adjustments for the consolidation process. Consider the
analysis in Illustrative Example 3.1.
Illustrative Example 3.1 Acquisition Analysis

On January 1, 2011, Parent Ltd. acquired all the issued share capital of Sub Ltd., giving
in exchange 100,000 shares in Parent Ltd., with a fair value of $5 per share. At acquisi-
tion date, the statements of financial position of Parent and Sub and the fair values of
Sub’s assets and liabilities were as follows:
Parent carrying Sub carrying Sub fair

amount amount value
Equity and Liabilities
Equity
Share capital $550,000 $300,000
Total equity 900,000 440,000
Liabilities
Provisions 30,000 60,000 $ 60,000
Payables 27,000 34,000 34,000
Bonds payable 100,000 92,000
Deferred income tax liabilities 10,000 6,000 6,000
Assets
Land $120,000 $150,000 172,000
Equipment—net 240,000 310,000 330,000
Investment in Sub Ltd. 500,000

Inventory 92,000 75,000 80,000
Cash 15,000 105,000 105,000
Total assets $967,000 $640,000
At the acquisition date, Sub has an unrecorded patent with a fair value of $10,000 and
a contingent liability with a fair value of $15,000. This contingent liability relates to
a loan guarantee made by Sub that did not recognize a liability in its records because
it did not consider it could reliably measure the liability. Sub has a bond outstanding,
which was initially issued at par, with a 25-year life that pays interest at 2% p.a. The
current market rate of interest is 3%. The tax rate is 30%.
The analysis at the acquisition date consists of comparing the fair value of the consider-
ation transferred and the net fair value of the subsidiary’s identifiable assets and liabilities at
the acquisition date. The subsidiary’s net fair value could be calculated by revaluing its assets
and liabilities from the carrying amounts to fair values. Under IAS 12 Income Taxes, where
there is a difference between the carrying amount and the tax base caused by the revalu-
ation, the tax effect of such a difference has to be recognized. Since taxes are paid by the
individual companies, the capital cost allowance claim is based on the amount recorded in the
acquiree’s records. The consolidated statement reflects the asset or liability at its fair value
and therefore there is a difference between the tax base and the accounting base. However,
in calculating the subsidiary’s net fair value, because particular information is required to
prepare the fair value adjustments and pre-acquisition adjustments, the calculation is done by
adding the subsidiary’s recorded equity (which represents the subsidiary’s recorded net assets
since Assets Liabilities Equity) and the differences between the carrying amounts of the
assets and liabilities and their fair values, adjusted for tax. The subsidiary’s book equity in
Illustrative Example 3.1 consists of:
$300,000 capital $140,000 retained earnings
The equity relating to the differences in fair value and carrying amounts for assets and
liabilities recorded by Sub as well as for assets and liabilities not recognized by the subsid-
iary but recognized as being acquired as part of the business combination is referred to in
this chapter as the fair value adjustment (FVA). This adjustment is not recognized in the
subsidiary’s records, but it is recognized in the consolidation process as part of the business
combination. For example, for land there is a difference of $22,000 in the fair value carry-
ing amount and, on revaluation of the land to fair value, a fair value adjustment of $15,400
(i.e., $22,000[1 30%]) is recorded.
The acquisition analysis, including the determination of the goodwill of the subsidiary, is
as shown in Illustration 3.5.
Illustration 3.5
Consideration transferred 100,000 $5
Acquisition Analysis $500,000
Net fair value of identifiable $300,000 $140,000 (recorded equity)
assets and liabilities of ($172,000 $150,000)(1 30%) (FVA—land)
Sub Ltd. (92,000 100,000)(1 30%) (FVA—bonds)
($330,000 $310,000)(1 30%) (FVA—equipment)
($80,000 $75,000)(1 30%) (FVA—inventory)
$10,000(1 30%) (FVA—patent)
$15,000(1 30%) (FVA—provision for guarantee)
$475,000
Goodwill $500,000 $475,000
$25,000
You will notice that the acquisition analysis is the same as that illustrated in Chapter 2, with
the following exceptions:
1. In Chapter 2 the fair values of Sub were listed, whereas in Illustration 3.5, the book
value of the net assets is used and then the FVA is added/subtracted to bring the asset
or liability to fair value.
2. In Chapter 2 there were no tax effects, since the net assets are actually acquired legally
and therefore the undepreciated capital cost (UCC) will equal the fair value at the day of
acquisition. As such, there will be no deferred income tax effect.
The information from the completed acquisition analysis is used to prepare the adjust-
ments for the consolidated financial statements.
Previously Held Equity Interest in the Subsidiary

The situation used in Illustrative Example 3.1 will be used here with one difference.
On January 1, 2011, Parent acquires 80% (240,000 shares) of the shares in Sub, giv-
ing in exchange 80,000 shares in Parent, with a fair value of $5 per share. Parent had
previously acquired the other 20% (60,000) shares of Sub for $75,000. At January 1,
2011, this investment in Sub was recorded at $92,000. The investment was classified as
FVTPL and measured at fair value. At January 1, 2011, these shares had a fair value of
$100,000.
In accordance with IFRS 3.42, Parent revalues the previously held investment to fair
value, recognizing the increment in current income. The journal entries in Parent at acquisi-
tion date, both for the previously held investment as well as the acquisition of the remaining
shares in Sub, are as follows:

Income—Gain 8,000
(Revaluation to fair value)
(Acquisition of shares in Sub Ltd.: 80,000 at $5 per share)
As such, Parent will record income of $100,000 $92,000 $8,000. In effect Parent is
deemed to have sold its financial asset and acquired a business instead.
At January 1, 2011, the acquisition analysis is as shown in Illustration 3.6:
Illustration 3.6
Acquisition Analysis— $500,000
Previously Held Equity Fair value of previously held equity $100,000
Interests interests
Aggregate investment $400,000 $100,000
$500,000
Net fair value of identifiable $300,000 $140,000 (recorded equity)
assets and liabilities of Sub ($172,000 $150,000)(1 30%) (FVA—land)
$92,000 100,000(1 30%) (FVA—bonds)
($330,000 $310,000)(1 30%) (FVA—equipment)
($80,000 $75,000)(1 30%) (FVA—inventory)
$10,000(1 30%) (FVA—patent)
$15,000(1 30%) (FVA—provision for
guarantee)
$475,000
Goodwill $500,000 $475,000
$25,000
As a result of the numbers used in this example, the goodwill number is the same as that
shown in Illustration 3.5. There are no subsequent effects on the consolidation process
because the parent had previously held an investment in the subsidiary.
The consolidation process does not result in any adjustments being made in the actual
records of either the parent or the subsidiary. The adjustments are made only to create a
consolidated financial statement that reflects the subsidiary’s assets and liabilities at fair value.
In the individual records of the parent, the investment in the subsidiary is recorded at cost
and therefore there is no need to identify the specific fair value amounts. In this section,
the adjustments that would be made for consolidation, immediately after the acquisition date,
are analyzed.
Fair Value Adjustments

In Illustrative Example 3.1, there are three identifiable assets recognized by the subsidiary
whose fair values differ from their carrying amounts at acquisition date, one identifiable
liability whose fair value differs from its carrying value, as well as an intangible asset and a
contingent liability recognized as part of the business combination. The identifiable assets
and liabilities that require adjustment to fair value can be easily identified by reference to
the acquisition analysis in Illustration 3.5; namely land, equipment, inventory, patent, bonds
payable, and the unrecorded guarantee. Goodwill also has to be recognized on consolidation.
You will note that a decrease in a liability has the same effect on the acquisition analysis as an
increase in an asset.
Fair value adjustments for each of these net assets and the unrecorded liability are given
in Illustration 3.7. Note that the goodwill adjustment does not give rise to a deferred tax asset
Illustration 3.7
Statement of
Fair Value Adjustments Account Financial Position DIT Liability DIT Asset
and Deferred Income Tax
1. Land $22,000 $ 6,600
Effects on the Statement
2. Equipment 20,000 6,000
of Financial Position
3. Inventory 5,000 1,500
4. Patent 10,000 3,000
5. Bonds payable 8,000 2,400
6. Provision for loan guarantee (15,000) $4,500
7. Goodwill 25,000
Total $75,000 $19,500 $4,500
or liability as it is assumed that this is an excluded difference under IAS 12. The total balance
of the fair value adjustment is $75,000.
Pre-acquisition Adjustments
The pre-acquisition adjustments are required to eliminate the carrying amount of the par-
ent’s investment in the subsidiary and the parent’s portion of pre-acquisition equity. The
pre-acquisition adjustments, then, involve three areas:
• The investment account Investment in Subsidiary, as shown in the parent’s financial

statements.
• The equity of the subsidiary at the acquisition date (i.e., the pre-acquisition equity).
• Recognition of goodwill: There is no recognition of a deferred tax liability in relation
to goodwill because goodwill is a residual, and the recognition of a deferred tax liability
would increase its carrying amount.
The pre-acquisition adjustment is necessary to avoid overstating the group’s equity and
net assets. To illustrate, consider the information in Illustrative Example 3.1 relating to
Parent’s acquisition of the shares of Sub. Having acquired the shares in Sub, Parent records
the asset Investment in Sub Ltd. at $500,000. This asset represents the actual net assets of
Sub; i.e., the ownership of the shares gives Parent the right to the net assets of Sub. To
include both the asset Investment in Sub Ltd. and the net assets of Sub in the consolidated
statement of financial position would double-count the group assets, because the investment
account is simply the right to the other assets. On consolidation, the investment account is
therefore eliminated and, in its place, the subsidiary’s net assets are included in the consoli-
dated statement of financial position.
Similarly, to include the equity of both the parent and the subsidiary in the consolidated
statement of financial position would double-count the equity of the group. In the example,
Parent has equity of $900,000, which is represented by its net assets, including the investment
in the subsidiary. Because the investment in the subsidiary is the same as the subsidiary’s net
assets, the parent’s equity effectively relates to the subsidiary’s net assets. To include in the
consolidated statement of financial position the equity of the subsidiary at acquisition date as
well as the equity of the parent would double-count equity in relation to the subsidiary’s net
assets.
✓ LEARNING CHECK
• The acquisition analysis may include the recognition of assets and liabilities not recognized in
the subsidiary’s records.
• Differences between carrying amounts and fair values of the subsidiary’s identifiable assets
and liabilities at acquisition date are recognized using fair value adjustments.
• The acquisition analysis will determine whether any goodwill or gain on bargain purchase has
arisen as a part of the business combination.
• Where at acquisition date the parent holds shares in the subsidiary that it has previously ac-
quired, this investment must be revalued to fair value and any amounts previously recognized
in other comprehensive income must be transferred to current period income.
• It is necessary to identify the fair value adjustments (FVA) and their related tax effects.
Consolidated Financial Statements at the Day of Acquisition 119
CONSOLIDATED FINANCIAL
STATEMENTS AT THE DAY
OF ACQUISITION
Basic Format
Objective 3 Illustration 3.8 contains the consolidated financial statements prepared at the acquisition
Prepare a date, based on the information from Illustrative Example 3.1, with adjustments being made
consolidated for fair value and pre-acquisition adjustments. The right-hand column reflects the consoli-
financial statement dated statement of financial position, showing the position of the group. You will note that
at the day of
acquisition.
at the day of acquisition there is no need to prepare a consolidated statement of income or
a consolidated statement of changes in equity since the entire Sub equity is pre-acquisition
at that date and therefore will be eliminated. In relation to the illustrations in this column,
note the following:
• In relation to the equity accounts—in this case, share capital and retained earnings—
only the parent’s balances are carried into the consolidated statement of fi nancial
position. At acquisition date, all the equity of the subsidiary is pre-acquisition and
eliminated.
• The subsidiary’s assets and liabilities are carried forward into the consolidated statement
of financial position at fair value.
• The adjustments total 0. This means that the adjustments have equal increases and decreases
(debits and credits), which is essential if the statement of financial position is to balance.
Illustration 3.8
Financial Statements Parent Sub Adjustments Consolidated
Consolidated Statement
of Financial Position at
Share capital 550,000 300,000 300,000 550,000
Acquisition Date
Total equity 900,000 440,000 900,000
Provisions 30,000 60,000 15,000 105,000
Bonds payable 100,000 8,000 92,000
Payables 27,000 34,000 61,000
DIT liabilities 10,000 6,000 4,500 3,000 31,000
1,500 2,400 6,000
6,600
Total equity and liabilities 967,000 640,000 (418,000) 1,189,000
Cash 15,000 105,000 120,000
Land 120,000 150,000 22,000 292,000

Equipment 240,000 310,000 20,000 570,000
Investment in 500,000 — 500,000 —
Sub Ltd.
Inventory 92,000 75,000 5,000 172,000
Patent — — 10,000 10,000
Goodwill — — 25,000 25,000
Total assets 967,000 640,000 (418,000) 1,189,000
Goodwill Recorded by Subsidiary

at Acquisition Date
In the example used in the previous section, at acquisition date the subsidiary did not have
any recorded goodwill. The subsidiary may have goodwill recorded on its own books due to a
previous business combination where it acquired the net assets of another business. Consider
the situation where the assets recorded by the subsidiary at acquisition date are the same as in
Illustrative Example 3.1 except that now there is recorded goodwill, as follows:
Sub Ltd. carrying amount Fair value

Cash $105,000 $105,000
Land 150,000 172,000
Equipment 310,000 330,000
Bonds payable (100,000) (92,000)
Goodwill 10,000
Inventory 75,000 80,000
$550,000
Assume that the retained earnings balance is now $150,000 rather than $140,000. The acqui-
sition analysis is then as follows:

$500,000
Net fair value of identifiable $300,000 $150,000 (equity)
($330,000 $310,000)(1 30%) (FVA—equipment)
($80,000 $75,000)(1 30%) (FVA—inventory)
$10,000(1 30%) (FVA—patent)
($92,000 $100,000(1 30%) (FVA—bonds payable)
$15,000(1 30%) (FVA—guarantee)
$10,000 (goodwill)
$475,000
Goodwill $500,000 $475,000
$25,000
Recorded goodwill $10,000
Unrecorded goodwill $15,000
Note that, since the calculation of the acquisition analysis relates to the fair value of the
identifiable assets, the goodwill of the subsidiary (i.e., the unidentifiable assets) must be sub-
tracted. The amount of goodwill that will appear on the consolidated statement of financial
position is the full $25,000.
The consolidated statement of financial position thus shows the total acquired goodwill
of the subsidiary.
Financial statements Parent Sub Adjustments Consolidation

Goodwill — 10,000 10,000 25,000 25,000
Dividends Recorded by Subsidiary

at Acquisition Date
Using the information in Illustrative Example 3.1, assume that one of the payables at acquisi-
tion date is a dividend payable of $10,000. The parent can acquire the shares in the subsidiary
on a cum div. or an ex div. basis.1
1
When a share is cum div., it means that it is for sale with an entitlement to the next dividend payment
attached. This dividend will already have been declared (but not paid) by the company, so the market
knows how much it is worth and the share price will reflect this. At some point shortly before pay-
ment of the dividend is actually due, the share will go ex div., meaning that it is being sold without the
dividend. If the current owner sells an ex div. share, the owner will keep the dividend payment.
Consolidated Financial Statements at the Day of Acquisition 121
If the shares are acquired on a cum div. basis, then the parent acquires the right to the
dividend declared at acquisition date. In this case, if Parent pays $500,000 for the shares in
Sub, then the entry it makes to record the business combination in its own records is:

Dividend Receivable 10,000
In other words, the parent acquires two assets: the investment in the subsidiary and the
dividend receivable. In calculating the goodwill in the subsidiary, using the information in
Illustrative Example 3.1, the acquisition analysis is:
Consideration transferred ⴝ (100,000 ⴛ $5) ⴚ $10,000 (dividend receivable)

ⴝ $490,000
($330,000 $310,000)(1 30%) (FVA—equipment)
($80,000 $75,000)(1 30%) (FVA—inventory)
($92,000 $100,000)(1 30%) (FVA—bonds payable)
$10,000(1 30%) (FVA—patents)
$15,000(1 30%) (FVA—provision for
guarantee)
Goodwill $490,000 $475,000
$15,000
In other words, the fair value of the consideration paid must be that for the investment in
the subsidiary, excluding the amount paid for the dividend receivable.
An adjustment is necessary so that the consolidated statement of financial position shows
only the assets and liabilities of the group; that is, only those benefits receivable from and
obligations payable to entities external to the group. In relation to the dividend receivable
recorded by Parent Ltd., this is not an asset of the group, because that entity does not expect
to receive dividends from a party external to it. Similarly, the dividend payable recorded by
the subsidiary is not a liability of the group. That dividend will be paid within the group, not
to entities outside the group. As such, both the dividend receivable and the dividend payable
are eliminated on the consolidated statements.
Gain on Bargain Purchase

In Illustrative Example 3.1, Parent paid $500,000 for the shares in Sub. Consider the situa-
tion where Parent paid $470,000 for these shares. The acquisition analysis is:

assets and liabilities of ($172,000 $150,000)(1 30%) (FVA—land)
Sub Ltd. ($330,000 $310,000)(1 30%) (FVA—equipment)
($80,000 $75,000)(1 30%) (FVA—inventory)
$10,000(1 30%) (FVA—patent)
($92,000 $100,000)(1 30%) (FVA—bonds payable)
$15,000(1 30%) (FVA—guarantee)
$475,000
Gain on bargain purchase $475,000 $470,000
$5,000
As the net fair value of the subsidiary’s identifiable assets and liabilities is greater than the
consideration transferred, the acquirer must firstly reassess the identification and measurement
of the subsidiary’s identifiable assets and liabilities as well as the measurement of the consider-
ation transferred. The expectation is that the excess of the net fair value over the consideration
transferred is usually the result of measurement errors rather than being a real gain to the
acquirer. However, having confirmed the identification and measurement of both amounts paid
and net assets acquired, if an excess still exists, it is recognized immediately in profit as a gain
on bargain purchase.
Existence of a gain on bargain purchase has no effect on the fair value adjustments
unless the subsidiary has previously recorded goodwill. In that case you would eliminate the
recorded goodwill first before recognizing any gain on bargain purchase.
✓ LEARNING CHECK
• Fair value adjustments are used to recognize the subsidiary’s identifiable assets and liabilities
at fair values and goodwill measured as a residual amount.
• The pre-acquisition adjustments eliminate the pre-acquisition equity of the subsidiary and the
investment account recorded by the parent.
• When the subsidiary has recorded goodwill at acquisition date, adjustments must be made in
the acquisition analysis to determine the amount of goodwill to be adjusted in the consolida-
tion process.
• When the subsidiary has recorded a dividend payable at acquisition date, this must be taken
into consideration when calculating the consideration transferred.
CONSOLIDATED FINANCIAL
STATEMENTS SUBSEQUENT
TO THE ACQUISITION DATE
Objective 4 At acquisition date, the fair value adjustments result in the economic entity recognizing
Prepare a assets and liabilities not recorded by the subsidiaries. Subsequently, changes in these assets
consolidated and liabilities occur as assets are depreciated or sold, liabilities paid, and goodwill impaired.
financial statement Movements in equity of the subsidiary also occur as income is earned and dividends are paid
in subsequent or declared and transfers are made within equity. The starting point to any consolidation is
periods.
the financial statements of the parent and the subsidiary on the date of consolidation. After
the day of acquisition, the group has now functioned as one economic entity and therefore
we must also produce a consolidated statement of comprehensive income and a statement of
changes in equity.
Parent Company Recording in its Own Books

As seen earlier in the chapter, the parent initially records the investment in the subsidiary in
its books at the amount of consideration transferred, which equals the fair value of the sub-
sidiary’s net assets at the day of acquisition. Using the example in Illustrative Example 3.1,
the initial investment is recorded at $500,000. When we consolidated the financial statements
Consolidated Financial Statements Subsequent to the Acquisition Date 123
at the day of acquisition, the investment account was eliminated against the subsidiary’s pre-
acquisition equity.
We will continue the Illustrative Example 3.1 and prepare consolidated financial state-
ments at the end of the years December 31, 2011, 2012, and 2013. Since time has now passed,
both the parent and the subsidiary have made entries in their own books that may affect the
consolidation process.
In Canada, the only financial statement presented to the public is the consolidated one.
Because all intercompany transactions will be eliminated on the consolidated financial state-
ments, since they are within the group, the parent has flexibility in how it may record transac-
tions relating to the subsidiary during the year. We see that an entity may choose to record
its investment using either the cost or the equity method.
Cost Method
When the parent is using the cost method to record its investment in the subsidiary, it is
recording any dividends received from the subsidiary as revenue. Assuming that $1,000 of
dividends were paid, the parent would make the following entry:
Cash 1,000
Dividend Revenue 1,000
Since the dividends are received from a member of the same group, on consolidation this
revenue will need to be eliminated. This is further examined in Chapter 4 on intercompany
transactions.
Equity Method
The parent may choose to record its investment using the equity method, and therefore
would record its share of the subsidiary’s net income and its share of the dividends of the sub-
sidiary. Assuming that the subsidiary earned $50,000 of net income, the parent would make
the following entries:
Investment in Subsidiary 50,000

Investment Income 50,000
Cash 1,000
Investment in Subsidiary 1,000
Since the income and dividends are intercompany, they will have to be eliminated on consoli-
dation. You will note as well that the investment account is now $549,000 and therefore it is
that amount that will have to be eliminated. The equity method was illustrated in Chapter 1
for reporting investments in which the investor has significant influence. At this point, the
methods are the same; however, we will see in Chapter 6 that the equity method for record-
ing subsidiaries and the equity method for investments in which there is significant influence
are not the same with respect to intercompany transactions.
In IAS 27 Separate Financial Statements, an entity that has a subsidiary and has presented
separate financial statements for other purposes must reflect its investment in a subsidiary
using either the cost method or fair value. As such, it is less likely that the parent will record
its investment using the equity method as it is not a permissible method of reporting on the
separate financial statements. For the purposes of this chapter, we will assume that the parent
is using the cost method to record its investment in the subsidiary and that the subsidiary has
not paid any dividends. This is done so that we can focus on the other major adjustments that
relate to the fair value adjustments. The financial statements of Parent and Sub for the three
years 2011-2013 are in Illustration 3.9.
Illustration 3.9
Parent Sub
Financial Statements
December 31, December 31, December 31, December 31, December 31, December 31,
of the Parent and
Financial Statements 2011 2012 2013 2011 2012 2013
Subsidiary
Revenues $ 113,000 $ 145,000 $ 120,000 $145,000 $164,000 $126,000
Expenses 68,000 73,000 85,000 73,000 63,000 121,000
Gain on sale of 0 0 15,000 0 0 49,000
non-current assets
Income before taxes 45,000 72,000 50,000 72,000 101,000 54,000
Income taxes 18,000 29,000 15,000 29,000 39,000 21,000
Net income 27,000 43,000 35,000 43,000 62,000 33,000
Retained earnings, 350,000 377,000 420,000 140,000 183,000 245,000
January 1
Retained earnings, 377,000 420,000 455,000 183,000 245,000 278,000
December 31
Investment in Sub 500,000 500,000 500,000
Land 60,000 60,000 60,000 150,000 150,000 0
Equipment 270,000 230,000 190,000 222,000 118,000 220,000
Inventory 156,000 137,000 122,000 182,000 269,000 173,000
Cash 41,000 127,000 217,000 132,000 188,000 365,000
Total assets $1,027,000 $1,054,000 $1,089,000 $686,000 $725,000 $758,000
Share capital $ 550,000 $ 550,000 $ 550,000 $300,000 $300,000 $300,000
Retained earnings 377,000 420,000 455,000 183,000 245,000 278,000
Provisions 50,000 28,000 40,000 53,000 42,000 40,000
Bonds payable 100,000 100,000 100,000
Payables 28,000 38,000 32,000 26,000 18,000 24,000
Deferred income taxes 22,000 18,000 12,000 24,000 20,000 16,000
Total equity and $1,027,000 $1,054,000 $1,089,000 $686,000 $725,000 $758,000
liabilities

In the example used in Illustration 3.7, there were six items for which fair value adjustments
were made: land, equipment, inventory, patent, bonds, and the guarantee. In this section, a
three-year time period subsequent to the acquisition date, January 1, 2011, is analyzed (giv-
ing an end of reporting period of December 31, 2013), with the following events occurring:
• The land is sold in 2013.
• The equipment is depreciated on a straight-line basis over a five-year period.
• The inventory on hand at January 1, 2011, is all sold by December 31, 2011, the end of
the first year.
• The patent has an indefinite life, and is tested for impairment annually, with an impair-
ment loss of $3,000 recognized in the 2011 period.
• The liability for the guarantee results in a payment of $10,000 in December 2012, with
no further liability existing.
• Goodwill is written down by $5,000 in the 2012 period as a result of an impairment test.
Each of the assets will now be analyzed separately, with the consolidation process sub-
sequently shown for the years ending December 31, 2011, December 31, 2012, and then
December 31, 2013.
We will see that the fair value adjustments will continue to be required to bring the sub-
sidiary’s net assets to fair value on the statement of financial position every year. This results
from the fact that the fair values have not been recorded on the subsidiary’s books. This is
true as long as the asset or liability to which the fair value adjustment relates still exists. To
the extent that it was sold, extinguished, or used in the current year, the fair value adjustment
is reflected in the statement of comprehensive income. To the extent that it was sold, extin-
guished, or used up in previous years, the fair value adjustment is reflected in the beginning
retained earnings on the consolidated financial statements.
1: Land
At the acquisition date, January 1, 2011, the fair value adjustment is:
Land $22,000
Deferred income tax liability 6,600
Net $15,400
2011
At December 31, 2011, because the land is still on hand, the same fair value adjustment is
made in the consolidated financial statements at that date. It is assumed in this period that the
asset is not held for sale and is recorded at cost.
The fair value adjustments for land on the statement of financial position at December 21,
2011, are:
Land 22,000 c
Deferred income tax liability 6,600 c
The fair value adjustments on the comprehensive statement of income are: nil
The fair value adjustments on the statement of changes in equity are: nil
2012
Assume in 2012 the land is classified as held for sale and is accounted for under IFRS 5
Non-current Assets Held for Sale and Discontinued Operations. The land is then recorded at the
lower of its carrying amount and fair value less costs to sell. Assuming the carrying amount
is the lower value, the fair value adjustment at December 31, 2012, is the same as that for
December 31, 2011.
The fair value adjustments for land on the statement of financial position at December 21,
2012, are:
Land 22,000 c
2013
Assume in 2013 the land is sold for $200,000, with $1,000 costs to sell incurred. Sub will
record a gain on sale of $49,000 (i.e., $200,000 $150,000 $1,000). From the group’s
perspective, the gain on sale is only $27,000 (i.e., $200,000 $172,000 $1,000). Hence, on
consolidation, an adjustment to reduce the recorded gain by $22,000 is required. The factor
causing the difference in gain on sale is the carrying amount of the land sold. The cost of the
land is greater to the group than to the subsidiary. As the asset has been sold, the deferred
tax liability is reversed, with an adjustment being made to income tax expense. The fair value
adjustment on December 31, 2013, is:
Reduce the “gain on sale” $22,000 and reduce the “tax expense” $6,600. This will create
a net decrease to net income and retained earnings of the group of $15,400. Since the
realization occurred in 2013, the statement of comprehensive income will be affected and
the ending retained earnings will be adjusted.
In 2013 there will no longer be an adjustment to the statement of financial position because
the asset itself is no longer there. In 2013 the land is no longer there but the consolidated
retained earnings will be forever different as the $15,400 will never be recorded on the subsid-
iary’s books but will always affect the consolidated financial statements. As such, for every year
after 2013 there will have to be adjustment to beginning retained earnings for $15,400.
The fair value adjustments on the statement of financial position at December 21, 2013,
are: nil
The fair value adjustments on the comprehensive statement of income are:
Gain on sale of land 22,000 T
Income tax expense 6,600 T
The fair value adjustments on the statement of changes in equity are:
Beginning retained earnings: 0
Ending retained earnings 15,400 T
Comprehensive income Statement of financial position Statement of changes in equity
Deferred Beginning Ending
Income tax income tax retained retained
Summary Gain on sale expense Land liability earnings earnings
2011 — — 22,000 6,600 — —
2012 — — 22,000 6,600 — —
2013 (22,000) (6,600) — — — (15,400)
2: Equipment
The fair value adjustment at January 1, 2011, is:
Equipment—net 20,000
Deferred income tax liability 6,000
Net 14,000
The asset is depreciated on a straight-line basis evenly over a five-year period at 20% p.a.
Because the asset is recognized on consolidation at an amount that is $20,000 greater than
that recognized in the subsidiary’s records, the depreciation expense to the group must also
be greater. The difference in depreciation reflects the extra amount paid for the equipment by
the group. The adjustment for depreciation results in changes to the asset’s carrying amount.
Differences between the tax base and the carrying amount are reflected in the deferred tax lia-
bility. As the asset is recovered by use, the deferred tax liability recognized at acquisition date
is progressively reversed, with the movement being in proportion to depreciation charges—in
this case 20% p.a. The adjustments for depreciation and the related tax effects are recognized
in the fair value adjustments in the periods subsequent to acquisition date.
2011
The fair value adjustments for equipment on the statement of financial position at December 31,
2011, are:
Equipment—net 20,000 c4,000 T (20,000 0.2) 16,000 c
Deferred income tax liability 6,000 c1,200 T (6,000 0.2) 4,800 c

Depreciation expense 4,000 c
Net income 2,800 T (4,000 1,200)
Note: Net income will be affected by 1/5 (20%) of the fair value adjustments for each of the
next five years.
The effects on consolidated retained earnings are:
Beginning retained earnings 0
Note: Retained earnings is always adjusted for the write off of any fair value adjustment to
date. Since one year has passed, the retained earnings is adjusted for one year net of tax.
2012
The fair value adjustments on the statement of financial position for equipment at December 31,
2012, are:
Equipment—net 20,000 c 8,000 T (20,000 0.2 2 years) 12,000 c
Deferred income tax liability 6,000 c 2,400 T (6,000 0.2 2 years) 3,600 c

Net income 2,800 T

Beginning retained earnings 2,800 T
2013
2013, are:
Equipment—net 20,000 c 12,000 T (20,000 0.2 3 years) 8,000 c
Deferred income tax liability 6,000 c 3,600 T (6,000 0.2 3 years) 2,400 c

Net income 2,800 T

Beginning retained earnings 5,600 T (2,800 2)
Ending retained earnings 8,400 T (2,800 3)
The equipment is fully depreciated by December 31, 2015. After that year, there is no
required adjustment on the comprehensive income statement or the statement of financial
position. The retained earnings will have to be adjusted forever for $14,000 (the original
FVA net of tax):

Depreciation Income tax Equipment— income tax retained retained
Summary expense expense net liability earnings earnings
2011 4,000 (1,200) 16,000 4,800 — (2,800)
2012 4,000 (1,200) 12,000 3,600 (2,800) (5,600)
2013 4,000 (1,200) 8,000 2,400 (5,600) (8,400)
3: Inventory
The fair value adjustment for inventory at the acquisition date, January 1, 2011, is:
Inventory 5,000 c
Net 3,500 c
2011
The key event affecting the subsequent accounting for inventory is the sale of the inventory
by the subsidiary. Assume the inventory is sold in 2011 for $90,000. The subsidiary records
cost of sales at the carrying amount of $75,000, whereas the cost to the group is $80,000. In
the consolidation process in 2011, instead of the $5,000 adjustment to inventory, a $5,000
adjustment to cost of sales is required. As the inventory is sold, the deferred tax liability
is reversed. As with land and equipment, the fair value adjustment is then transferred to
retained earnings because the asset is derecognized.
The fair value adjustments on the statement of financial position for inventory at
December 31, 2011, are: nil
The fair value adjustment on the comprehensive statement of income for inventory are:
Cost of goods sold 5,000 c
Net income 3,500 T
The effect on consolidated retained earnings is:
Beginning retained earnings: 0
2012
The fair value adjustments on the statement of financial position for inventory at December 31,
2012, are: nil
Beginning retained earnings 3,500 T or
2013
The fair value adjustments on the statement of financial position for inventory at December 31,
2013, are: nil
Note: The retained earnings will have to be adjusted for every year beginning in 2011 when
the fair value adjustment is written off. This is due to the fact that the subsidiary does not
record the fair values in its own books.
Income tax income tax retained retained
Summary Cost of sales expense Inventory liability earnings earnings
2011 5,000 (1,500) — — — (3,500)
2012 — — — — (3,500) (3,500)
2013 — — — — (3,500) (3,500)
4: Patent
The fair value entry at acquisition date, January 1, 2011, is:
Patent 10,000 c
Deferred tax liability 3,000 c
Net 7,000 c
2011
The fair value adjustments on the statement of financial position for patent at December 31,
2011, are:
Patent 10,000 c 3,000 T 7,000 c
Deferred tax liability 3,000 c 900 T 2,100 c
Impairment loss 3,000 c
Income tax expense 900 T
Net income 2,100 T
2012
2012, are:
Patent 7,000 c
Deferred tax liability 2,100 c
The fair value adjustment on the comprehensive statement of income for patent is: nil
This adjustment for the patent would be the same each year as it continues to have an indefi-
nite life. A change occurs only if there is an impairment loss. In this example, an impairment
loss of $3,000 occurs in 2011.
2013
The fair value adjustments on the statement of financial position for patent at December 31,
2013, are:
Patent 10,000 c3,000 T 7,000 c
Deferred tax liability 3,000 c 900 T 2,100 c
The fair value adjustment on the comprehensive statement of income is: nil

Impairment Income tax income tax retained retained
Summary loss expense Patent liability earnings earnings
2011 3,000 (900) 7,000 2,100 (2,100)
2012 7,000 2,100 (2,100) (2,100)
2013 7,000 2,100 (2,100) (2,100)
5: Bonds Payable
Bond payable 8,000 T
Net 5,600 T
According to IFRS 9, Financial Instruments, the bond payable must be reflected at the
amortized cost using the effective interest method. Since the parent purchased this debt at a
discount, it indicates that the current market rate of interest is higher than the coupon rate
on the bond. In this case the market rate is 3% and the coupon rate is 2%. When the parent
acquired the subsidiary’s net assets, it paid an additional $8,000 since the coupon rate was
lower than the market rate. As such, the group actually incurred debt at 3% whereas the sub-
sidiary is reflecting an interest cost of 2%. Over the remaining life of the debt of 25 years, the
interest expense will need to be adjusted annually to reflect the difference of 1% in the inter-
est rate. Since the effective interest method is required, the $8,000 difference is amortized
using the effective interest method. The deferred tax liability is reversed on the same basis.
Under ASPE the entity is not required to use the effective interest method so it may
ASPE amortize the fair value adjustment on a straight-line basis.
To illustrate the effect we will use an amortization schedule:

Date Interest Expense 3% Interest Payable 2% Premium Carrying Value
January 1, 2011 8,000 92,000
December 31, 2011 2,760 2,000 (760) 92,760
December 31, 2012 2,783 2,000 (783) 93,543
December 31, 2013 2,806 2,000 (806) 94,349
Note: The schedule was done only until December 31, 2013, since that was the requirement
of the problem; however, this schedule would continue for 25 years until the bond is fully
amortized.
2011
The fair value adjustments for bond payable on the statement of financial position at
December 31, 2011, are:
Bond payable—net 8,000 T ⫺760 c ⫽ 7,240 T
Deferred income tax liability 2,400 c ⫺228 T (760 ⫻ 0.3) ⫽ 2,172 c
Interest expense 760 c
Net income 532 T
Ending retained earnings 532 T
2012
The fair value adjustments on the statement of financial position for bond payable at
December 31, 2012 are:
Bond payable 8,000 T ⫺1,543 T (760 ⫹ 783) ⫽ 6,457 T
Deferred income taxes 2,400 c ⫺463 T (228 ⫹ (783 ⫻ 0.3) ⫽ 1,937 c

Net income 548 T

Beginning retained earnings 532 T
2013
The fair value adjustments on the statement of financial position for bond payable at
Bond payable 8,000 T 2,349 c (760 783 806) 5,651 T
Deferred income taxes 2,400 c 705 T (228 235 806 0.3) 1,695 c

Net income 564 T

Beginning retained earnings 1,080 T
The bond payable is fully amortized by December 31, 2036. After that year, there is no
required adjustment on the comprehensive income statement or the statement of financial
position. The retained earnings will have to be adjusted forever for $5,600 (the original FVA
net of tax).

Interest Income tax Bonds income tax retained retained
Summary: expense expense payable liability earnings earnings
2011 760 (228) (7,240) 2,172 — (532)

2012 783 (235) (6,457) 1,937 (532) (1,080)
2013 806 (242) (5,651) 1,695 (1,080) (1,644)
6: Liability—Provision for Loan Guarantee

Provision for loan guarantee 15,000 c
Deferred tax asset 4,500 c
Net 10,500 c
2011
The fair value adjustments on the statement of financial position for the provision at
Provision for guarantee 15,000 c
Deferred income tax asset 4,500 c
The fair value adjustment on the comprehensive statement of income for the guarantee
are: nil
The effect on consolidated retained earnings is: nil
2012
If the liability is paid or derecognized, the adjustment changes. In this example, a payment of
$10,000 is made during 2012 in relation to the liability. The subsidiary records an expense of
$10,000. There is no expense to the group since the parent reduced the purchase price for the
anticipated liability. As such, it must be eliminated on consolidation. Instead, a gain of $5,000
is recognized by the group as the liability of $15,000 is settled for $10,000.
The fair value adjustments on the statement of financial position for the provision at
December 31, 2012, are nil, since the guarantee has been settled.
The fair value adjustments on the comprehensive statement of income for the guarantee are:
Provision: guarantee expense 10,000 T
Gain on derecognition of loan guarantee 5,000 c
Income tax expense 4,500 c
Net income 10,500 c

Ending retained earnings 10,500 c
2013
The fair value adjustments on the statement of financial position for the provision at
December 31, 2013, are: nil
Beginning retained earnings 10,500 c or
Ending retained earnings 10,500 c
Note: The net gain on settlement of the loan guarantee will have to be adjusted through retained
earnings forever as the subsidiary did not have the fair value of the guarantee in its books.
Provision Deferred Beginning Ending

Guarantee Gain on Income tax for income tax retained retained
Summary expense derecognition expense guarantee asset earnings earnings
2011 — — — 15,000 4,500 — 0
2012 (10,000) 5,000 4,500 — — 0 10,500
2013 — — — — — 10,500 10,500
7: Goodwill
Goodwill 25,000 c
2011
The fair value adjustment on the statement of financial position for goodwill at December 31,
2011, is:
Goodwill 25,000 c
The fair value adjustment on the comprehensive statement of income for goodwill is: nil
The effect on consolidated retained earnings is: nil
2012
Impairment tests for goodwill are undertaken annually. Goodwill is written down by $5,000
in 2012 as a result of an impairment test.
Preparation of Consolidated Financial Statements in Subsequent Periods 133
The fair value adjustments on the statement of financial position for goodwill at
Goodwill 25,000 c ⫺5,000 T ⫽ 20,000 c
The fair value adjustment on the comprehensive statement of income is:

Goodwill impairment loss 5,000 c
Net income 5,000 T

2013
The fair value adjustments on the statement of financial position for goodwill at December 31,
2013, are:
Goodwill 25,000 c ⫺5,000 T ⫽ 20,000 c


Note: The loss on the impairment of goodwill will have to be adjusted through retained earn-
ings forever as the subsidiary did not have the goodwill in its books.

Beginning Ending
Goodwill impairment retained retained
Summary loss Goodwill earnings earnings
2011 — 25,000 — —
2012 5,000 20,000 — (5,000)
2013 — 20,000 (5,000) (5,000)
To summarize the fair value adjustment process:

• The FVA is initially recorded on the statement of financial position.
• The FVA is written off through comprehensive income as the item is written off:
• Inventory: when sold
• Land: when sold or impaired
• Depreciable asset and intangibles with a limited life: over the useful life
• Liabilities: over the life using the effective interest method
• Goodwill: when impaired
• The deferred income tax is reversed on the same basis as the FVA is written off.
Preparation of Consolidated Financial Statements

in Subsequent Periods
Using the data calculated in the previous section, we will now prepare the consolidated financial
statements for each of the years 2011, 2012, and 2013. For ease of identification, numbers in
the Adjustments column refer to the following assets: (1) land, (2) equipment, (3) inventory,
(4) patent, (5) bond payable, (6) provision for liability guarantee, (7) goodwill, and (8) pre-
acquisition adjustment.
Consolidated Financial Statements December 31, 2011

Consolidated Comprehensive Income Statement
For the year ending December 31, 2011
Parent Subsidiary Adjustments Consolidated

Revenues 113,000 145,000 258,000
Expenses 68,000 73,000 4,0002 5,0003 7605 (150,760)
Loss on patent impairment 0 0 3,0004 (3,000)
Income before taxes 45,000 72,000 104,240
Income taxes 18,000 29,000 1,2002 1,5003 9004 2285 43,172
Net income 27,000 43,000 2,8002 3,5003 2,1004 5325 61,068
Consolidated Statement of Changes in Equity


Retained earnings
January 1, 2011 350,000 140,000 140,0008 350,000
Comprehensive income 27,000 43,000 2,8002 3,5003 2,1004 5325 61,068
December 31, 2011 377,000 183,000 2,1004 5325 411,068


Investment in Sub 500,000 500,0008
Land 60,000 150,000 22,0001 232,000
Equipment—net 270,000 222,000 (20,000 4,000)2 508,000
Inventory 156,000 182,000 338,000
Cash 41,000 132,000 173,000
Goodwill 25,0007 25,000
Patent (10,000 3,000)4 7,000
Total assets 1,027,000 686,000 1,283,000
Share capital 550,000 300,000 300,0008 550,000
Retained earnings 377,000 183,000 Per above 411,068
Provisions 50,000 53,000 15,0006 118,000
Bonds payable 0 100,000 (8,000760)5 92,760
Payables 28,000 26,000 54,000
Deferred income taxes 22,000 24,000 6,6001 (6,000 1,200)2
(3,000 900)4 4,5006 (2,400
228)5 57,172
Total equity and liabilities 1,027,000 686,000 1,283,000
Consolidated Financial Statements


Revenues 145,000 164,000 309,000
Gain on reduction in 5,0006 5,000
guarantee 4,0002 10,0006 7835
Expenses 73,000 63,000 5,0007 (130,783)
Impairment of goodwill 0 0 (5,000)
Income taxes 29,000 39,000 1,2002 2355 4,5006 71,065
Net income 43,000 62,000 2,8002 5485 10,5006 5,0007 107,152
Preparation of Consolidated Financial Statements in Subsequent Periods 135


Retained earnings 377,000 183,000 2,800 3,500 2,100
2 3 4
411,068
January 1, 2012 5325 140,0008
Comprehensive income 43,000 62,000 Per above 107,152
Retained earnings 420,000 245,000 (2 2,800)2 3,5003 518,220
December 31, 2012 2,1004 (532 548)5 10,5006
5,0007 140,0008


Investment in Sub 500,000 500,000 8
Land 60,000 150,000 22,0001 232,000

Equipment—net 230,000 118,000 (20,000 2 4,000)2 360,000
Inventory 137,000 269,000 406,000
Cash 127,000 188,000 315,000
Goodwill (25,000 5,000)7 20,000
Patent (10,000 3,000)4 7,000
Total assets 1,054,000 725,000 1,340,000
Share capital 550,000 300,000 300,0008 550,000
Provisions 28,000 42,000 70,000
Bonds payable 0 100,000 (8,000 760 783)5 93,543
Payables 38,000 18,000 56,000
Deferred income taxes 18,000 20,000 6,6001 (6,000 2 1,200)2 52,237
(3,000 900)4 (2,400
228 235)5


Revenues 120,000 126,000 246,000
Expenses 85,000 121,000 4,0002 8065 210,806
Gain on sale of
non-current assets 15,000 49,000 22,0001 42,000
Income taxes 15,000 21,000 6,6001 1,2002 2425 27,958
Net income 35,000 33,000 15,4001 2,8002 5645 49,236


Retained earnings 420,000 245,000 (2 2,800) 3,500
2 3
518,220
January 1, 2013 2,1004 (532 548)5 10,5006
5,0007 140,0008
Comprehensive income 35,000 33,000 As above 49,236
Retained earnings 455,000 278,000 15,400 (3 2,800)
1 2
567,456
December 31, 2013 3,5003 2,1004 (532 548 564)5
10,5006 5,0007 140,0008


Investment in Sub 500,000 500,000 8
Land 60,000 0 60,000

Equipment—net 190,000 220,000 (20,000 3 4,000)2 418,000
Inventory 122,000 173,000 295,000
Cash 217,000 365,000 582,000
Goodwill (25,000 5,000)7 20,000
Patent (10,000 3,000)4 7,000
Total assets 1,089,000 758,000 1,382,000
Share capital 550,000 300,000 300,0008 550,000
Provisions 40,000 40,000 80,000
Bonds payable 0 100,000 (8,000 760 783 806)5 94,349
Payables 32,000 24,000 56,000
Deferred income taxes 12,000 16,000 (6,000 3 1,200)2 (3,000 34,195
900)4 (2,400 228
235 242)5
✓ LEARNING CHECK
• Fair value adjustments after the acquisition date change as the assets or liabilities held by the
subsidiary at that date are either consumed, sold, or settled.
• The pre-acquisition adjustments continue to be made each year to eliminate the subsidiary’s
equity at acquisition.
• Fair value adjustments are adjusted on the statement of financial position to the extent that
the asset or liability still exists.
• To the extent that the asset or liability is either consumed, sold, or settled in the current
period, the comprehensive income statement is affected.
• To the extent that the asset or liability is either consumed, sold, or settled in prior periods, the
beginning retained earnings is affected.
Consolidation Process
ASPE The consolidation process is essentially the same under ASPE. However, under ASPE
the parent has the option of not consolidating with its subsidiary. The entity has the
choice to report this investment using either the cost or the equity method. It should
be noted that if the subsidiary’s shares trade in an active market, the cost option is not
available. In that circumstance the entity has the option of choosing the equity method
or fair value for presentation purposes.
Comprehensive Revaluation of Net Assets

ASPE IFRS does not discuss whether the valuation of the subsidiary’s assets at acquisition
date should be done in the subsidiary’s records as well. This is because under IFRS the
option is always available to use a revaluation approach. However, under ASPE section
1625, comprehensive revaluation permits the revaluation of net assets under very spe-
cific circumstances. One of the conditions allowed is where:
All or virtually all of the equity interest in the enterprise have been acquired, in one or more
transactions between non-related parties, by an acquirer who controls the enterprise after the
transaction or transactions (1625.04).
In the above-mentioned circumstance, the subsidiary is permitted to comprehen-
sively revalue the identifiable net assets using the fair values that were established for
consolidation. This method has commonly been referred to as “push-down accounting”
since the values established at acquisition are pushed down to the subsidiary’s financial
books and records.
The principal reason to apply push-down accounting is to facilitate consolidation.
It should be evident that if the subsidiary reflects the net assets at fair value, the con-
solidation adjustments for fair value would no longer be necessary. The adjustment for
goodwill will still need to be made since goodwill is not an identifiable asset and there-
fore cannot be pushed down to the subsidiary’s books.
KEY TERMS
LEARNING SUMMARY
consolidated financial
This chapter covers the preparation of the consolidated financial statements for a group con-
statements (p. 108)
sisting of a parent and a wholly owned subsidiary. Because of the requirements of IFRS 3 to
control (p. 109)
recognize the identifiable net assets of an acquired entity at fair value, adjustments to be made
group (p. 110)
on consolidation concerns any assets or liabilities for which there are differences between fair
parent (p. 108)
value and carrying amounts at the acquisition date. Further, although some intangible assets
recording (p. 109)
and liabilities of the subsidiary may not have been recognized in the subsidiary’s records, they
reporting (p. 109)
are recognized as part of the business combination.
subsidiary (p. 108)
At acquisition date, an acquisition analysis is undertaken. The key purposes of this
analysis are to determine the fair values of the subsidiary’s identifiable assets and liabilities,
and to calculate any goodwill or gain arising from the business combination. From this analy-
sis, the main adjustments at acquisition date are the fair value adjustments (to adjust carrying
amounts of the subsidiary’s assets and liabilities to fair value) and the pre-acquisition adjustments.
In preparing consolidated financial statements in periods after acquisition date, the
consolidation process will contain fair value adjustments and pre-acquisition adjustments.
However, these adjustments are not necessarily the same as those used at acquisition date. If
there are changes to the subsidiary’s assets and liabilities since acquisition date, or there have
been movements in pre-acquisition equity, changes must be made to these adjustments.
The adjustments to key accounts in the form of an equation are:

Consolidated statement of financial position:
Consolidated Assets or Liabilities:
P at BV S at BV / FVA still remaining
Consolidated retained earnings:
P’s R/E at BV S’s R/E at BV S’s R/E at acquisition / amortization, or
write off of FVA (net of tax) to date
Consolidated statement of comprehensive income:
Revenues or expenses
P at BV S at BV / FVA amortized or written off in the current year
Net income
P at BV S at BV / FVA amortized or written off in the current year net of tax
DEMONSTRATION PROBLEMS
Consolidation
On January 1, 2012, Pelan Ltd. acquired 100% of the issued shares of Taurus Ltd. on a cum
div. basis. The fair value of the consideration paid was measured at $335,000. At this date, the
records of Taurus included the following information:
Dividend payable 20,000
Goodwill 5,000
The dividend liability at January 1, 2012, was paid in February 2012. At January 1, 2012,
all the identifiable assets and liabilities of Taurus were recorded in the subsidiary’s books at
fair value except for the following assets.
Inventory $ 40,000 $ 43,000
Plant (cost $240,000) 180,000 185,000
The inventory was all sold by December 31, 2012. The plant has a further five-year life
and is depreciated on a straight-line basis. Goodwill was not impaired in any period. The tax
rate is 30%.
The summarized financial statements of the entities within the group at December 31,
2013, are as shown in Illustration 3.10.
Required
Prepare the consolidated financial statements for Pelan Ltd. at December 31, 2013.
Solution
Step 1: Calculate the fair value adjustments FVA at the acquisition date.
The first step in the consolidation process is acquisition analysis. This involves comparing
the net fair value of the subsidiary’s identifiable assets and liabilities with the consideration
transferred, and determining the existence of goodwill or gain on bargain purchase. So it is
necessary to identify:
• The equity of the subsidiary at acquisition date: This consists of $200,000 share capital and
$105,000 retained earnings.
• Differences between the carrying amounts of the subsidiary’s recorded assets and liabilities and
their fair values, as well as the fair values of any unrecorded assets and liabilities of the subsidiary
recognized as part of the business combination: This consists of inventory for which there is
$3,000 difference (i.e., $43,000 $40,000) and plant for which there is a $5,000 differ-
ence (i.e., $185,000 $180,000). These differences are recognized in the acquisition
analysis as fair value adjustments, the amount being on an after-tax basis. The differences
are multiplied by (1 tax rate).
• Any goodwill recorded by the subsidiary at acquisition date: Because it is the fair value of iden-
tifiable assets being considered and goodwill is an unidentifiable asset, goodwill must be
adjusted for in the calculation; in this problem, the subsidiary has goodwill of $5,000.
• Dividends payable recorded by the subsidiary at acquisition date: If dividends have been issued
on an ex div. basis, they have no effect on the acquisition analysis. The dividends of
$20,000 in this problem were issued on a cum div. basis. This means that the cost of the
combination of $335,000 paid by the parent was for both the shares in the subsidiary and
the dividends receivable. Hence, the consideration transferred must be adjusted for the
amount paid for the dividends receivable; i.e., $20,000.
Acquisition analysis
At January 1, 2012:
Consideration transferred ⫽ $335,000 ⫺ $20,000 (dividend receivable)

⫽ $315,000
Net fair value of identifiable assets ⫽ $200,000 ⫹ $105,000 (equity)
and liabilities of Taurus Ltd.
⫺ $5,000 goodwill recorded
⫹ ($5,000)(1 ⫺ 30%) (FVA—plant)
⫹ ($3,000)(1 ⫺ 30%) (FVA—inventory)
⫽ $305,600
Goodwill ⫽ $315,000 ⫺ 305,600
⫽ $9,400
Unrecorded goodwill ⫽ $9,400 ⫺ 5,000
⫽ $4,400
When the net fair value of the identifiable assets and liabilities acquired is compared with
the consideration transferred, it is found that the latter is the greater amount—the differ-
ence between the two numbers is goodwill. In this problem, the goodwill of the subsidiary
is $9,400. This is the amount that will be reported in a consolidated statement of financial
position if prepared at acquisition date.
Step 2: Analyze each fair value adjustment and decide when it will be written off.
Consolidation adjustments at December 31, 2013

The consolidation adjustments should be determined from the acquisition analysis, as the
latter contains the information necessary to prepare the fair value adjustments and the pre-
acquisition adjustments.
(1) Fair value adjustments at December 31, 2013
Since the consolidated financial statements are being prepared after acquisition date, the
business combination adjustments at December 31, 2013, are affected by changes in the
assets and liabilities existing at acquisition date.
With inventory, since it has been sold by December 31, 2012, there is no longer any
need to prepare a fair value adjustment for this asset on the statement of financial position.
Retained earnings are adjusted for the original FVA net of tax, or 2,100.
With the plant, it is still on hand within the group; however, the plant has depreciated
two years. As such, the plant will be adjusted on the statement of financial position for the
amount that is still remaining (5,000 ⫺ 2 ⫻ 1,000 ⫽ 3,000) and the deferred income tax
account will be adjusted for 1,500 ⫺ 2 ⫻ 300 ⫽ 900.
The current period depreciation is adjusted via depreciation expense (1,000), whereas
prior period depreciation net of tax affects retained earnings, 700 (700 ⫺ 300). The current
period income tax expense is adjusted for 300.
The final fair value adjustment relates to the recognition of goodwill acquired in the
business combination. At acquisition date, the parent acquired $9,400 goodwill in the subsid-
iary. However, as the subsidiary had already recognized $5,000 goodwill, on consolidation,
an additional $4,400 goodwill is recognized as having been acquired by the group. In effect,
the $5,000 on the subsidiary’s books is removed and the $9,400 acquired is added. The fair
value adjustments at December 31, 2013, are then as follows:
Comprehensive Beginning retained Statement of financial
FVA income earnings position
Inventory 0 (3,000) 0
Plant/depreciation 1,000 (1,000) 3,000
Income tax (300) 900 ⫹ 300 900
Goodwill 0 0 9,400
Total 700 (2,800) 13,300
Note: The adjustments to retained earnings could have been made net of tax rather than as
two separate calculations.
(2) Pre-acquisition adjustments at December 31, 2013
The pre-acquisition adjustment eliminates the subsidiary’s pre-acquisition equity and the
investment by the parent in the subsidiary. The pre-acquisition adjustment at the acquisition
date can be determined from the acquisition analysis.
(Note that there would be a further adjustment relating to the $20,000 dividend, but
because it is paid in 2012 it has no further effect.)
The pre-acquisition adjustment at the beginning of 2013 is then:
Share Capital $200,000
Retained earnings $105,000
Investment in Taurus $315,000
Step 3: Prepare the consolidated financial statements; P ⴙ S ⴙ/ⴚ FVA and

pre-acquisition adjustments.
Illustration 3.10 Pelan

Consolidation Financial statements Pelan Taurus Adjustments Consolidated
Process Revenues 125,000 90,000 215,000
Expenses 85,000 65,000 1,000 151,000
Profit before tax 40,000 25,000 64,000
Income tax expense 15,500 10,200 300 25,400
Profit for the period 24,500 14,800 38,600
Retained earnings (1/1/13) 170,000 169,800 2,100 700 105,000 232,000
Share capital 500,000 200,000 200,000 500,000
694,500 384,600 770,600
Deferred tax liabilities 11,000 16,000 1,500 600 27,900
Other liabilities 50,000 20,000 70,000
Total liabilities 61,000 36,000 97,900
Total equity and liabilities 755,500 420,600 868,500
Cash 26,000 80,800 106,800

Inventory 60,000 85,000 145,000
Financial assets 50,000 40,000 90,000
Plant 279,000 184,000 5,000 2,000 466,000
Investment in Taurus Ltd. 315,000 — 315,000 —
Furniture and fixtures 25,500 25,800 51,300
Goodwill — 5,000 5,000 9,400 9,400
Total assets 755,500 420,600 0 868,500
The consolidated financial statements of Pelan at December 31, 2013, are as shown below.
PELAN LTD.
Consolidated Statement of Comprehensive Income
for the year ended December 31, 2013
Revenues $215,000
Expenses 151,000
Profit before tax 64,000
Income tax expense 25,400
Total Comprehensive Income for the Year $ 38,600
PELAN LTD.
Retained earnings balance at January 1, 2013 $232,000

Profit for the period 38,600
Retained earnings balance at December 31, 2013 $270,600
PELAN LTD.
as at December 31, 2013
Equity and Liabilities

Equity
Total equity 770,600
Non-current liabilities
Deferred tax liabilities 27,900
Other 70,000
Total non-current liabilities 97,900
Total equity and liabilities $868,500
Assets
Non-current assets
Plant $466,000
Furniture and fixtures 51,300
Goodwill 9,400
Current assets
Cash 106,800
Inventory 145,000
Financial assets 90,000
Total current assets 341,800
Unrecognized Intangible, Unrecognized Liability, Step Acquisition
On January 1, 2011, Daverin Ltd. acquired 80% of the shares of Aquila Ltd. for $3 per share
in cash. The equity of Aquila at that date was:
Share capital—10,000 shares $10,000
Daverin had previously acquired 20% of the shares of Aquila for $4,000. The fair value
of this investment at January 1, 2011, was $6,000.
At acquisition date, all the identifiable assets and liabilities of Aquila were recorded at
fair value except for machinery and inventory, whose carrying amounts were each $2,000
less than their fair values. All this inventory was sold by Aquila before December 2011. The
machinery had a further five-year life. The tax rate is 30%.
In a previous period, Aquila had purchased some goodwill that had been written down to
a carrying amount of $2,000 as at January 1, 2011. Aquila had developed a business magazine
containing economic indicators for the coal industry. The magazine was widely sought after.
Daverin placed a value of $1,500 on the nameplate, which is the line of type on the front
cover stating the name of the magazine. This nameplate meets the definition of an intangible
asset. The intangible asset, not recognized by Aquila at January 1, 2011, was considered to
have an indefinite life.
At January 1, 2011, Crater Corp. had sued Aquila for alleged damaging statements
made in the magazine, and a court case was in progress. Although it considered that a
present obligation for damages existed, Aquila had not recognized any liability because
it did not believe that the liability recognition criteria could be met. Daverin assessed
potential damages at a fair value of $2,000. In January 2013, the court handed down its
decision, and Aquila was required to pay damages of $2,500.
Required
Prepare the acquisition analysis and the consolidation adjustments of Daverin Ltd. and Aquila
Ltd. at December 31, 2013.
Solution
Step 1: Calculate the fair value adjustments FVA at the acquisition date.
This requires the identification of:
• The recorded equity of the subsidiary at acquisition date: This consists of $10,000 share capital
and $15,000 retained earnings.
• Differences between carrying amounts and fair values for assets recorded by the subsidiary: The
differences arise for inventory ($2,000) and plant ($2,000).
• Identifiable assets and liabilities not recognized by the subsidiary but recognized as part of the busi-
ness combination at their fair values: The group recognizes a nameplate at $1,500 fair value
and a provision for damages at $2,000 fair value.
• Any goodwill recorded by the subsidiary at acquisition date: The subsidiary has recorded good-
will of $2,000.
• Any dividends payable by the subsidiary at acquisition date: There are none in this problem.
Acquisition analysis at January 1, 2011

80% 10,000 $3
$24,000
Fair value of previously held
investment $6,000
Aggregate amount of investment $24,000 $6,000
$30,000
Net fair value of identifiable assets
and liabilities of Aquila ($10,000 $15,000) (equity)
$2,000(1 30%) (machinery)
$2,000 (goodwill)
$2,000(1 30%) (inventory)
$1,500(1 30%) (nameplate)
$2,000(1 30%) (provision for damages)
Goodwill acquired $30,000 $25,450
$4,550
Unrecorded goodwill $4,550 $2,000
$2,550
The aggregate of the investment in Aquila is $4,550 greater than the net fair value of the sub-
sidiary’s identifiable assets and liabilities. The goodwill acquired by the group is then $4,550.
Step 2: Analyze each fair value adjustment and decide when it will be written off.
(1) Fair value adjustments
The adjustment calculated at acquisition date for the machinery is still used. The depre-
ciation now, however, is for three years since acquisition date. Current period depreciation
expense is adjusted for a full year’s depreciation and the prior period depreciation expense
Brief Exercises 143
for two year affects retained earnings. The using up of the asset results in changes in the
asset’s carrying amount, and further results in reversing the deferred tax liability created at
the acquisition date. The current period income tax expense is affected by the reversal due
to the current period depreciation, and the adjustment for the previous year depreciation,
affecting retained earnings, affects last year’s income tax expense, also requiring an adjust-
ment to retained earnings.
The inventory on hand at acquisition date is all sold by December 2011. The adjustment
is then made to cost of sales instead of inventory, because the cost of sales to the group is
$2,000 higher than that recorded by the subsidiary on sale of the inventory. On sale of the
inventory, the deferred tax liability is reversed, and affects income tax expense. As the asset
is sold, the group transfers the fair value adjustment to retained earnings. As such, for the
December 31, 2013, year end the effect is only in retained earnings.
There is no change to the fair value adjustment for the nameplate. This adjustment
changes only if the asset is amortized, or adjusted as a result of an impairment loss.
In January 2013, the court determined that the subsidiary was to pay damages of $2,500.
As the liability is settled, the fair value adjustment is transferred to net income. Further, the
deferred tax asset is reversed on settlement of the liability, requiring an adjustment to income
tax expense. In settling the liability, the subsidiary recorded a damages expense of $2,500
and paid cash to external entities. Since the group recognized the liability for damages at
acquisition date of $2,000, the expense to the group on payment of $2,500 is only $500. In
other words, to the group, the $2,500 outflow is a reduction in the liability of $2,000 and
an expense of $500. Since $2,500 damages expense was recorded by the subsidiary, and the
group wants to report only $500 damages expense, the consolidation adjustment is a $2,000
reduction in damages expense.
There is no change to the goodwill. This would change if the goodwill were impaired.
Summary of adjustments for period ending December 31, 2013
Beginning retained Statement of financial

FVA Comprehensive income earnings position
Inventory (2,000)
Machinery/depreciation ⫺400 (800) 800
Nameplate 1,500
Damages expense 2,000
Income tax expense/Future
income tax asset (liability) 120 ⫹ (600) 600 ⫹ 240 (240) ⫹ (450)
Goodwill 2,550
Total 1,120 (1,960) 4,160
Note: The adjustments to retained earnings could have been made net of tax rather than as
two separate calculations.
(2) Pre-acquisition adjustment
The pre-acquisition adjustment can be determined from the acquisition analysis. The adjust-
ment eliminates the subsidiary’s pre-acquisition equity, and the investment account as
recorded by the parent.
Brief Exercises
(LO 1) BE3-1 Explain the purpose of the pre-acquisition adjustments in the preparation of consolidated financial statements.
(LO 2) BE3-2 When there is a dividend payable by the subsidiary at acquisition date, under what conditions should the
existence of this dividend be taken into consideration in preparing the fair value adjustments?
(LO 3) BE3-3 If the subsidiary has recorded goodwill in its records at acquisition date, how does this affect the preparation
of the fair value adjustments?
(LO 3) BE3-4 Explain how the existence of a bargain purchase affects the fair value adjustments, both in the year of acquisi-
tion and in subsequent years.
(LO 2) BE3-5 At the date the parent acquires a controlling interest in a subsidiary, if the carrying amounts of the subsidiary’s
assets are not equal to fair value, explain why adjustments to these assets are required in the preparation of the consoli-
dated financial statements.
(LO 1) BE3-6 How does IFRS 3 Business Combinations affect the acquisition analysis?
(LO 1) BE3-7 What is the purpose of the fair value adjustments?
(LO 1) BE3-8 Using an example, explain how the business combination adjustments affect the fair value adjustments.
(LO 4) BE3-9 Why are some adjustments in the previous period’s consolidated financial statements also made in the current
period’s financial statements?
Exercises
(LO 2) E3-1 On January 1, 2013, Pyxis Ltd. acquired all the share capital of Gemini Ltd. for $218,500. At this date, Gemini’s
equity comprised:

All Gemini’s identifiable assets and liabilities were recorded at fair value as at January 1, 2013, except for
the following:

Inventory $27,000 $35,000
Land 35,000 90,000
Equipment (cost $100,000) 50,000 60,000
The equipment is expected to have a further 10-year life. All the inventory was sold by December 31, 2013. The tax
rate is 40%.
Required
Prepare the acquisition analysis and calculate the fair value adjustments for the preparation of consolidated financial
statements for Pyxis and its subsidiary Gemini as at:
(a) January 1, 2013.
(b) December 31, 2013.
(LO 2, 3) E3-2 On January 1, 2013, Serpens Ltd. acquired the issued shares (cum div.) of Vela Ltd. for $120,000. At that date,
the financial statements of Vela included the following items:

At January 1, 2013, Vela had recorded goodwill of $2,000, and all its identifiable assets and liabilities were recorded
at fair value. Share capital represents 75,000 shares. The dividend was paid on June 30, 2013. The tax rate is 30%.
Required
Prepare the pre-acquisition adjustments for the preparation of consolidated financial statements at:
(a) January 2013, immediately after combination.

(LO 2, 4) E3-3 On January 1, 2013, Sculptor Ltd. acquired all the share capital (cum div.) of Virgo Ltd., giving in exchange
50,000 shares in Sculptor, with a fair value at acquisition date of $5 per share. The retained earnings of Virgo at that date
were $50,000. Costs incurred in undertaking the acquisition amounted to $10,000. The dividend payable at the acquisi-
tion date was paid in February 2013. At December 31, 2013, the statement of financial position of Virgo was as follows:
Problems 145

Sculptor Virgo Sculptor Virgo

Plant and equipment $ 125,000 $218,000 Share capital (Sculptor $400,000 $150,000
500,000 shares, Virgo
150,000 shares)
Goodwill 0 6,000 Retained earnings 100,000 84,000
Current assets 175,000 44,000 Dividend payable 30,000 10,000
Investment in Virgo 240,000 $268,000 Other liabilities 10,000 24,000
$540,000 $540,000 $268,000
The recorded amounts of Virgo’s identifiable assets and liabilities at the acquisition date were equal to their fair
values. Virgo had not recorded an internally developed trademark. Sculptor valued this at $20,000. It was assumed to
have a four-year life.
The tax rate is 30%.
Required
Prepare the consolidated statement of financial position as at December 31, 2013.
(LO 2, E3-4 At January 1, 2013, Berke Ltd. acquired all the shares of Tauber Ltd. for $283,000. At this date the equity of
3, 4) Tauber consisted of:
All of Tauber’s identifiable assets and liabilities were recorded at amounts equal to fair value except for the
following assets:
Inventory $ 65,000 $ 70,000
Plant (cost $280,000) 200,000 210,000
The inventory was all sold by June 30, 2013. The plant has a further five-year life, and depreciation is calculated on
a straight-line basis.
Required
(a) Prepare the acquisition analysis at January 1, 2013.
(b) Calculate the fair value adjustments for 2013.
Problems
(LO 2, 4) P3-1 Retic Ltd. acquired 100% of the share capital of Dorado Ltd. for $102,000 on January 1, 2011, when the equity
of Dorado consisted of:
All of Dorado’s identifiable assets and liabilities were recorded at amounts equal to fair value, except as follows:

Inventory $20,000 $25,000
Plant (cost $80,000) 60,000 70,000
The plant is expected to have a further useful life of five years. All the inventory on hand at January 1, 2011,
was sold by December 31, 2011. The income tax rate is 40%. At December 31, 2013, the following information was
obtained from both entities.
Retic Dorado
Profit before tax $ 50,000 $ 40,000
Income tax expense 20,000 15,000
Retic Dorado
Profit 30,000 25,000
Retained earnings (1/1/13) 65,000 35,000
Total equity 245,000 110,000
Payables 20,000 5,000
Cash $ 13,000 $ 14,000
Inventory 70,000 50,000
Investment in Dorado Ltd. 102,000 —
Plant net 115,000 36,000
Total assets $330,000 $125,000
Required
(a) Prepare the consolidation process adjustments for the preparation of consolidated financial statements for
Retic and its subsidiary, Dorado, as at January 1, 2011.
(b) Prepare the consolidated financial statements for Retic and its subsidiary, Dorado, as at December 31, 2013.
(LO 2, P3-2 As part of a corporate expansion plan, Volans Ltd. acquired the shares (cum div.) of Tucana Ltd. on
3, 4) January 1, 2012, for $138,000 cash. The statements of financial position of both companies at December 31, 2011,
were as follows:
Volans Ltd. Tucana Ltd.

Share capital $180,000 $ 80,000
Other components of equity 23,800 15,000
Total equity 262,000 125,000
Dividend payable 20,000 10,000
Cash $150,000 $ 10,000
Receivables 40,000 25,000
Inventory 55,000 42,000
Plant 125,000 85,000
Total assets $370,000 $162,000
All of Tucana’s identifiable assets and liabilities were recorded at fair value as at January 2012, except for
the following:
Inventory $42,000 $45,000
Plant (cost $100,000) 85,000 90,000
The plant is expected to have a further useful life of five years. Inventory held at January 1, 2012, was all
sold by December 31, 2012. The dividend payable at January 1, 2012, was paid in June 2012. The company tax
rate is 30%.
Required
(a) Prepare the consolidated statement of financial position for Volans and its subsidiary, Tucana, as at
January 1, 2012.
(b) Prepare the consolidated financial statement adjustments for Volans and its subsidiary, Tucana, as at December
31, 2012, and 2013.
Problems 147
(LO 2, 4) P3-3 The statement of financial position of Columba Ltd. at December 31, 2011, was as follows:
COLUMBA LTD.
Share capital (150,000 shares) $150,000

Other liabilities 24,000
Inventory $ 44,000
Non-current assets:
Plant and equipment $232,000
Goodwill 6,000 238,000
The recorded amounts of Columba’s identifiable assets and liabilities at this date were equal to their fair values except
for inventory and plant and equipment, whose fair values were $50,000 and $236,000, respectively. The plant and equip-
ment has a further five-year life. All the inventory was sold by Columba by December 2012. The tax rate is 40%.
On January 1, 2012, Centaurus Inc. acquired all the shares (cum div.) in Columba, giving in exchange 50,000
shares in Centaurus, with a fair value at acquisition date of $5 per share. Costs incurred by Centaurus in undertaking the
acquisition amounted to $10,000. The dividend payable was paid in August 2012.
Required
Prepare the consolidation process adjustments for the preparation of consolidated financial statements at
December 31, 2013.
(LO 2, 4) P3-4 Oakridge Ltd. gained control of Ventnor Ltd. by acquiring its share capital on January 1, 2009. The state-
ment of financial position of Ventnor at that date showed:
Share capital $ 60,000 Land $ 20,000

Retained earnings 60,000 Plant and machinery 100,000
Liabilities 15,000 Inventory 15,000
$135,000 $135,000
At January 1, 2009, the recorded amounts of Ventnor’s assets and liabilities were equal to their fair values
except as follows:
Plant and machinery $100,000 $102,000
Inventory 15,000 18,000
All this inventory was sold by Ventnor in the following three months. The depreciable assets have a further five-
year life, benefits being received evenly over this period. The tax rate is 30%.
At December 31, 2013, the following information was obtained from both entities:
Oakridge Ventnor
Profit before tax 100,000 15,000
Profit for the year 80,000 10,000
700,000 138,000
Land — 20,000
Plant and machinery 571,000 95,000
Inventory 15,000 23,000
Investment in Ventnor Ltd. 114,000 —
700,000 138,000
Required
Prepare the consolidated financial statements for Oakridge Ltd. at December 31, 2013.
(LO 2, P3-5 The account balances of Islewood Ltd. and Richmond Ltd. at January 1, 2013, were as follows:
3, 4)
Islewood Richmond
Share capital—600,000 shares 600,000 —
—200,000 shares — 200,000
1,480,000 480,000
Land 400,000 200,000
Machinery 400,000 200,000
Inventory 480,000 75,000
Cash 200,000 5,000
1,480,000 480,000
The fair values of Richmond’s assets at January 1, 2013, were:
Land 240,000
Machinery 220,000
Inventory 95,000
The two companies decided to combine on January 1, 2013, with Islewood issuing one share (fair value $2) and
$0.50 cash for each share in Richmond. Richmond’s shares were acquired cum div. The tax rate is 30%.
Required
(a) Prepare the consolidated statement of financial position immediately after Islewood’s acquisition of shares in
Richmond.
(b) Prepare the consolidation process adjustments required for the consolidation at December 31, 2014, assuming
both dividends were paid during September 2013. Assume all inventory on hand at January 1, 2013, was sold in the
following three months, and that the machinery has a further four-year life.
(LO 2, 3) P3-6 An extract from the consolidated statement of Triangle Holdings Inc. and its subsidiary, Trico Ltd., as at
December 31, 2013, is shown below.
Financial statements Triangle Holdings Inc. Trico Ltd. Adjustments Consolidation

Profit 6,000 4,000
Triangle Holdings acquired all the share capital (cum div.) of Trico on January 1, 2013, for $127,000 when Trico’s
equity consisted of:

All the identifiable assets and liabilities of Trico at January 1, 2013, were recorded at fair value except for:

Plant (cost $100,000) $80,000 $82,000
Inventory 6,000 7,000
The plant had a further six-year life. All the inventory was sold by Trico by September 22, 2013. The tax rate is 40%.
Trico’s liabilities included a dividend payable of $6,000. Trico had not recorded any goodwill. At January 1, 2013, Trico
had incurred research and development outlays of $5,000, which it had expensed. Triangle Holdings placed a fair value
of $2,000 on this item. The project was still in progress at December 31, 2013, with Trico capitalizing $3,000 in 2013.
Required
(a) Prepare the consolidation process adjustments at December 31, 2013.
(b) Complete the consolidated financial statement extract above.
Problems 149
(LO 2, 3) P3-7 On January 1, 2011, Delphin Ltd. acquired all the share capital of Telescon Ltd. when Telescon’s equity
consisted of:
100,000 common shares issued at $0.75 each $75,000

All identifiable assets and liabilities of Telescon were recorded at fair value except:
Inventory $20,000 $25,000

Machinery (net) 80,000 95,000
The machinery has a further 10-year life. Of the inventory on hand at January 1, 2011, 90% was sold by December
31, 2011.
At January 1, 2011, Telescon was involved in a court case with an entity that was claiming damages from it.
Telescon had not recorded a liability in relation to any expected damages. Delphin measured the liability’s fair value at
$5,000. By December 31, 2013, the expectation of winning the court case had improved, so the fair value was consid-
ered to be $1,000.
At December 31, 2013, Delphin’s statement of financial position showed an investment in Telescon at $147,250.
Required
Prepare the fair value adjustments for the preparation of the consolidated financial statements for Delphin Ltd. and its
subsidiary, Telescon, as at December 31, 2013.
(LO 2, 4) P3-8 The financial statements of JEZ Ltée. and its subsidiary, Fornax Ltée., at December 31, 2013, contained the
following information:
JEZ Fornax
Income tax expense 1,300 240
3,400 3,660
Dividend paid 500 0
$41,900 $18,460
Land $ 8,600 $ 5,100
Plant 12,000 7,000
Financial assets 3,000 2,000
Cash 300 360
Investment in Fornax Ltée 15,000 —
$41,900 $18,460
JEZ had acquired all the share capital of Fornax on January 1, 2010, for $15,000 when the equity of Fornax
consisted of:
At the acquisition date by JEZ, Fornax’s non-monetary assets consisted of:
Land $4,000 $6,000

Plant (cost $6,000) 5,500 6,700
The plant had a further six-year life. All the inventory was sold by December 31, 2010. The land was sold in
January 2013 for $6,000.
Required
Prepare the consolidated financial statements for the year ended December 31, 2013.
(LO 2, P3-9 Laughlin Ltd. gained control of Harwood Ltd. by acquiring all its shares on January 1, 2010. The equity at that
3, 4) date was:
At January 1, 2010, all the identifiable assets and liabilities of Harwood were recorded at fair value except for:

Inventory $ 18,000 $ 22,000
Land 120,000 130,000
Plant (cost $120,000) 95,000 98,000
The inventory was all sold by December 31, 2010. The plant had a further five-year life but was sold on January 1,
2013, for $50,000. The land was sold in March 2011 for $150,000.
At January 1, 2010, Harwood had guaranteed a loan taken out by Swede Ltd. Harwood had not recorded a liability
in relation to the guarantee but, as Swede was not performing well, Laughlin valued the contingent liability at $5,000.
In January 2013, Swede repaid the loan. Harwood had also invented a special tool and patented the process. No asset
was recorded by Harwood, but Laughlin valued the patent at $6,000, with an expected useful life of six years. The tax
rate is 30%.
Financial information for these companies for the year ended December 31, 2013, is as follows:
Laughlin Harwood
Income tax expense (20,000) (6,000)
Retained earnings (January 1, 2013) 37,000 25,000
Dividend paid 20,000 —
Retained earnings (December 31, 2013) $ 47,000 $ 34,000
Share capital $150,000 $100,000
Total equity 197,000 134,000
Payables 61,000 32,000
Loan 25,000 —
Cash $ 5,000 $ 14,000
Available-for-sale financial assets 10,000 5,000
Inventory 30,000 21,000
Plant and equipment 78,000 126,000
Investment in Harwood Ltd. 160,000 —
Total assets $283,000 $166,000
Required
Prepare the consolidated financial statements for Laughlin Ltd. as at December 31, 2013.
Writing Assignments
(LO 2) WA3-1 Lynx Ltd. has just acquired all the issued shares of Indus Ltd. The accounting staff at Lynx has been
analyzing the assets and liabilities acquired in Indus. As a result of this analysis, it was found that Indus had been
expensing its research outlays in accordance with IAS 38 Intangible Assets. Over the past three years, the company
has expensed a total of $20,000, including $8,000 immediately before the acquisition date. One of the reasons that
Lynx acquired control of Indus was its promising research findings in an area that could benefit the products being
produced by Lynx.
There is disagreement among the accounting staff as to how to account for the research abilities of Indus. Some of
the staff argue that, since it is research, the correct accounting is to expense it, and so it has no effect on accounting for
the group. Other members of the accounting staff believe that it should be recognized on consolidation, but are unsure
of the accounting adjustments to use, and are concerned about the future effects of recognition of an asset, particularly
as no tax advantage remains in relation to the asset.
Required
Advise the group accountant of Lynx on what accounting is most appropriate for these circumstances.
(LO 2) WA3-2 MEZ Ltd. has finally concluded its negotiations to take over Norma Ltd., and has secured ownership of all the
shares of Norma. One of the areas of discussion during the negotiation process was the current court case that Norma
was involved in. The company was being sued by some former employees who were terminated, but are now claiming
damages for wrongful dismissal. The company did not believe that it owed these employees anything. However, real-
izing that industrial relations was an uncertain area, it had recorded a note to the financial statements issued before the
takeover by MEZ reporting the existence of the court case as a contingent liability. No monetary amount was disclosed,
but the company’s lawyers had placed a $56,700 amount on the probable payout to settle the case.
The accounting staff of MEZ is unsure of the effect of this contingent liability on the accounting for the consoli-
dated group after the takeover. Some argue that it is not a liability of the group and so should not be recognized on
consolidation, but are willing to accept some form of note disclosure. A further concern being raised is the effects on the
financial statements, depending on whether Norma wins or loses the case. If Norma wins the court case, it will not have
to pay out any damages and could get reimbursement of its court costs, estimated to be around $40,000.
Required
Give the group accountant your opinion on the accounting at the acquisition date for consolidation purposes, as well as
any subsequent effects when the entity either wins or loses the case.
(LO 1) WA3-3 Smensa Ltd. has acquired all the shares of Carljad Ltd. The accountant for Smensa, having studied the
requirements of IFRS 3 Business Combinations, realizes that all the identifiable assets and liabilities of Carljad must be
recognized in the consolidated financial statements at fair value. Although he is happy about the valuation of these
items, he is unsure of a number of other matters associated with accounting for these assets and liabilities. He has
approached you and asked for your advice.
Required
Write a report for the accountant at Smensa advising on the following issues:
(a) Should the adjustments to fair value be made only in the consolidated financial statements or in the books and
records of Carljad?
(b) What equity accounts should be used when revaluing the assets, and should different equity accounts such as in-
come (similar to recognition of an excess) be used in relation to recognition of liabilities?
(c) Do these equity accounts remain in existence indefinitely, since they do not seem to be related to the equity
accounts recognized by Carljad itself?
(LO 3) WA3-4 When Hydra Ltd. acquired the shares of Draco Ltd., one of the assets in Draco’s statement of financial posi-
tion was $15,000 goodwill, which had been recognized by Draco upon its acquisition of a business from Valhalla Ltd.
Having prepared the acquisition analysis when preparing the consolidated financial statements for Hydra, the group
accountant has asked for your opinion.
Required
Provide advice on the following issues:
(a) How does the recording of goodwill by the subsidiary affect the accounting for the group’s goodwill?
(b) If, in subsequent years, goodwill is impaired, for example by $10,000, should the impairment loss be recognized in
the books and records of Hydra or as a consolidation adjustment?
(LO 2) WA3-5 The accountant for Carina Ltd., Ms. Finn, has sought your advice on an accounting issue that has been puz-
zling her. When preparing the acquisition analysis relating to Carina’s acquisition of Lyra Ltd., she calculated that
there was a gain on bargain purchase of $10,000. Being unsure of how to account for this, she was informed by account-
ing acquaintances that this should be recognized as income. However, she reasoned that this would have an effect on
the consolidated profit in the first year after acquisition date. For example, if Lyra reported a profit of $50,000, then
consolidated profit would be $60,000. She is unsure of whether this profit is all post-acquisition profit or a mixture of
pre-acquisition profit and post-acquisition profit.
Required
Compile a detailed report on the nature of an excess, how it should be accounted for, and the effects of its recognition
on subsequent consolidated financial statements.
Cases
(LO 2, 3) C3-1 Bass Industries (BI) is a large public company with its head office located in Canada that prints and sells pub-
lished goods, such as books and magazines, all over the world. As part of its business strategy, Bass operates each prod-
uct as a separate company that is run independently and it has an investment in them of varying levels. BI is hoping to
expand in the near future by looking for additional bank financing and issuing additional shares. The bank has indicated
that it will be concerned with BI’s level of debt, the need to minimize its debt-to-equity ratio, and the need to ensure
that the net income level is at least maintained in the future.
During the year, BI bought all 1 million of the outstanding shares of another publishing company, Thorpe Industries
(TI), that had been suffering difficulties due to a decreased demand in published products. Revenues have stabilized and
customers have started to not renew their subscriptions to TI’s published materials. BI had hopes of turning it around,
integrating it within its existing products, and using economies of scale to lower costs. BI paid $5.60 per share to acquire
all of the outstanding shares of TI, to be paid over the next two years. In addition, if net income exceeds $2 million in
each of the next five years, it will make an additional payment to the former shareholders of TI for $0.25 per share.
BI made the offer to purchase TI’s shares on May 1, 2013. The price was to be based on TI’s June 30, 2013,
audited financial statements with the payment to be made on that day, when BI will then be incorporating TI’s opera-
tions with its own. The tax rate is 40%.
You, CA, are the controller of BI and have been asked by the VP Finance to prepare a report discussing the impli-
cations of the acquisition. The VP would like know your thought process for your conclusions and recommendations.
You have been supplied with TI’s balance sheet as of June 30, 2013, and that of the prior year.
June 30, 2013 June 30, 2012

Cash 575,000 465,000
Accounts receivable 2,320,000 2,091,000
Other current assets 766,000 392,000
Property, plant, and equipment 4,030,000 3,905,000
Accumulated amortization (2,910,000) (2,810,000)
Goodwill 670,000 595,000
Other long-term assets 275,000 215,000
Total assets 6,621,000 5,628,000
Bank indebtedness 872,000 997,000
Accounts payable 1,213,000 1,109,000
Other current liabilities 625,000 600,000
Long-term debt 872,000 897,000
Shareholders’ equity 100,000 100,000
Retained earnings 2,939,000 1,925,000
Total liabilities and equity 6,621,000 5,628,000
TI’s net income was $1,014,000 this past year and $962,000 the year before.
The carrying values of TI approximate their fair values, except for property, plant, and equipment (which has a
remaining useful life of five years) being higher by $199,000, long-term debt (which is to be paid in three years) being
higher by $172,000, and prepaid expenses being lower by $27,000.
In addition, TI had subscriber lists that were not recognized on its balance sheet. One expert placed a value on
them of $825,000. If BI were to incur these costs itself, it would have cost $950,000. During the due diligence process,
TI disclosed that it had spent $895,000 over the past two years on these subscriber lists. BI expects to use these lists
over the next five to seven years. TI had expected to benefit from these subscriber lists over the next three to five years.
Acquisition-related costs incurred by BI included lawyers’ fees of $150,000 and valuation consultant fees of
$200,000, which the VP Finance would like to capitalize to help adhere to the debt-to-equity ratio.
Required
Prepare the report requested by the VP Finance.
(LO 2, C3-2 You, CA, are employed at Beaulieu & Beauregard, Chartered Accountants. On November 20, 2013, Dominic
3, 4) Jones, a partner in your firm, sends you the following e-mail: “Our firm has been reappointed auditors of Floral
Impressions Ltd. (FIL) for the year ending December 31, 2013. I met with the president and major shareholder of FIL,
Cases 153
Liz Aronovitch, last week, and I toured the Vancouver warehouse and head office. I have prepared some background
information on FIL for you to review, including the company’s October 31, 2013, internal non-consolidated financial
statements (Exhibit C3-2(a)). FIL is increasing the amount of business it does on the Internet, and Liz would like us
to provide comments on the direction in which FIL is moving. I made notes on her plans for FIL’s increasing use of
the Internet (Exhibit C3-2(b)). I also met with Craig Ottenbreit, the controller, and I made notes from that meeting
(Exhibit C3-2(c)). Once you have reviewed the material, I would like you to draft an audit planning memo identifying
the new accounting issues for the 2013 audit. I would also like the memo to address Liz’s specific requests. I’d like to
receive something by next week. Let me know if you have any questions.”
Required
Draft the audit planning memo requested by Liz Aronovitch.
EXHIBIT C3-2(a)
Background Information
FIL, a small public company listed on a Canadian stock exchange, is a wholesaler of silk plants with three warehouses located in
Ontario, Alberta, and British Columbia. It imports its inventory of silk flowers and accessories from Indonesia. FIL employees ar-
range bouquets, trees, wreaths, and decorative floral products for sale in Canada to flower shops, grocery stores, and other retailers.
The silk-plant concept was novel when FIL was incorporated in 2005. For the first three fiscal years, sales grew at approxi-
mately 40% per year, and FIL expanded to meet the demand. However, increased competition resulted in declining sales and
operating losses over the next six years. Liz inherited the shares of the company in 2011. She had just completed a marketing
course and was very excited about becoming involved in the business and applying her new skills. The fiscal year ended Decem-
ber 31, 2012, brought a return to higher sales levels and a modest net income. Liz’s management contract, which was renegoti-
ated in 2012, provides for stock options to be granted to her each year based on the percentage increase of FIL’s revenue from
one year to the next. On October 31, 2013, Liz was granted stock options for the first time. She received 4,500 stock options at
$2.25 each, the market price on that date.
On January 15, 2013, when shares were trading at $4 each, FIL announced an agreement with the shareholders of Rest-
EZE Wreath Corporation (RWC) whereby FIL would acquire 100% of the voting shares of RWC by issuing 200,000 FIL common
shares. The acquisition of RWC was completed on October 31, 2013. The market value of FIL’s shares has declined significantly
since the announcement. RWC, a small private Canadian corporation, sells funeral wreaths, made with fresh flowers, on the
Internet. The suppliers, florists throughout Canada, advertise their wreath models on RWC’s website, which is targeted at funeral
homes and their customers. These clients order their flowers through RWC’s website. RWC records 100% of the sale, invoices
the clients for the same amount, and remits 85% of the proceeds to the supplier. RWC absorbs any bad debts. RWC is in the
process of installing a billing system on its website that would allow customers to pay by credit card, but is still working out
some bugs. RWC’s assets (mainly accounts receivable and office equipment) less the liabilities assumed have a fair value of
$150,000, as established by an independent evaluator. RWC has never been audited and its year end is November 30.
FLORAL IMPRESSIONS LTD.

Non-Consolidated Balance Sheet
As at
October 21, 2013 October 31, 2012

(unaudited) (audited)
Assets
Current assets
Accounts receivable $ 2,003 $1,610
Inventory 610 420
2,613 2,030
Property, plant, and equipment 216 239
Computer development costs 32 22
Intangibles—customers list 20 —
$ 2,881 $2,291
Liabilities
Current liabilities
Bank indebtedness $ 1,850 $1,520
3,103 2,719
Shareholders’ deficiency
Common shares (2013: 600,000; 2012: 400,000) 400 400
Deficit (622) (828)
(222) (428)
$ 2,881 $2,291
FLORAL IMPRESSIONS LTD

Non-Consolidated Income Statement
For the
Ten months ended Year ended

October 31, 2013 December 31, 2012
Sales $24,950 $22,119
Cost of goods sold 20, 630 18,801
General and administrative expenses 4,114 3,229
Income before income taxes 206 89
Income taxes — —
Net income $ 206 $ 89
EXHIBIT C3-2(b)
Notes from Dominic Jones’ Conversation with Liz Aronovitch
Liz believes the acquisition of RWC provides an opportunity to expand into a less cyclical market and to sell on the Internet.
RWC has well-established relationships with two major funeral home chains. Liz is excited about benefiting from RWC’s website
because the site fits perfectly with FIL’s new direction and allows FIL to gain access to the Internet immediately. So far, the site
has not generated significant new business for FIL, but Liz is confident that, with time, sales will increase. As soon as RWC’s
billing system allows payments by credit card, FIL also intends to link directly into RWC’s accounting system to invoice its own
clients. Liz anticipates that RWC will account for about 40% of FIL’s consolidated revenue this year. Liz expects that the share
price of FIL will increase substantially with the acquisition of RWC and plans to exercise her stock options and sell the shares
acquired as soon as the share price reaches $9 or more.
To gain greater exposure on the Internet, FIL is also developing its own website. FIL will pay for the costs of running the
site by selling advertising spots on the site to home decorating companies. Liz believes she can generate $80,000 in advertising
revenue over a 12-month period once the site is up and running. So far, FIL has pre-sold 10 spots for $200 each. The advertise-
ments are to run for one month. Unfortunately, the site delays have caused some advertisers to cancel their contracts. Others are
threatening to cancel their contracts unless FIL gets the site up and running within the next month. The controller has recorded
the advertising revenue as sales.
FIL has two technicians working in its computer department. Most of their time is spent keeping the network up and run-
ning. Since developing an Intranet two months ago to give all employees access to the Internet, the network has been bom-
barded with junk mail and has slowed down or crashed regularly. As a result, the two technicians have not had time to develop
the website or to upgrade the firewall as planned. Liz wants the website up and running right away and has threatened to hire
RWC’s programmers to develop the website if FIL’s technicians don’t do it quickly enough.
Very recently, Liz spoke to a representative from a company offering to perform all of FIL’s accounting over the Internet.
Now Liz’s new vision for FIL is to do everything on the Internet. The representative says that his company will maintain, on its
own website, the latest version of whatever standard accounting package FIL uses. FIL would access the site and post the trans-
actions (accounts receivable, accounts payable, and payroll). His company would generate the accounting books and records
and would generate FIL’s monthly financial statements. Liz likes this plan because she could reduce both administrative staffing
costs and the amount of time she spends managing the administration group. It would allow Liz to better focus her efforts on
developing FIL’s Internet site and related sales.
EXHIBIT C3-2(c)
Notes from Dominic Jones’ Conversation with Craig Ottenbreit
Craig Ottenbreit was hired by FIL in September 2013 as the controller. FIL’s previous controller resigned in June 2013 due to
illness, and the position was temporarily filled by the accounts payable clerk. Craig anticipates that he will have all year-end
information ready for our audit team by March 15, 2014.
In February 2013, Liz outsourced FIL’s payroll function to a service bureau that offered an exceptional price if FIL signed
a five-year contract. The payroll consists of 50 employees. Craig has heard rumours that the service bureau is experiencing
financial difficulties.
Historically, FIL’s sales are highest during February and March, and August to October. Accounts receivable consist of a
large number of small-dollar-value accounts, with the exception of five large chain-store customers that account for approxi-
mately 40% of the total accounts receivable. The allowance for returns typically has been 1% of fourth quarter sales.
Management counts inventory at the end of each quarter and cost of goods sold is adjusted accordingly. At September 30,
2013, inventories held at each location were as follows: 55% of the total dollar value in British Columbia, 35% in Alberta, and
10% in Ontario. By year end, Craig expects inventory at all sites to be at much lower levels. While visiting the warehouse,
Cases 155
I observed that physical security over inventory was tight. Craig commented that FIL has never written down inventory in the past
but that he estimates about 2% of the current inventory is obsolete because it is out of style.
During the year, management negotiated an operating line of credit with a new financial institution. The amount authorized
is limited to 75% of accounts receivable under 90 days old and 50% of inventory, to a maximum of $2 million. The loan bears
interest at prime plus 3%. Under this agreement, FIL is required to provide audited financial statements within 90 days of its
fiscal year end.
Craig did not record the investment in RWC, since the only change was in the number of common shares issued.
On October 1, 2013, FIL purchased a customer list for $20,000 from a former competitor that was going out of business.
FIL has not yet determined an amortization policy for this purchase.
Some employees and board members have questioned FIL’s sudden focus on the Internet when other companies seem to
be moving away from it and back to traditional sales methods. Craig raised the same concern. He doesn’t understand why FIL is
changing direction when the new management’s marketing changes produced such good results in 2012.
(LO 2, C3-3 You are a CA who has just been hired by Saskatoon Fields Forever Inc. (SFF), formerly MUGS Partnership
3, 4) (MUGS) as the controller. It is August 1, 2014, your first day at SFF. You are meeting with Meghan Gebhardt, the
company president. Meghan began, “I’m sure glad that you joined SFF. SFF acquired all of Biosfair Inc.’s (BFI) out-
standing shares on July 1, 2014. I will be relying on your financial skills and leadership to guide us through this time of
change.” Meghan continued, “Perhaps we should focus on preparing for our first board of directors meeting, which is
scheduled for September 27, 2014. I will need input from you concerning all financial matters that should be reported
to the board in light of the recent transactions. We should send the mailing to the directors at least two weeks in
advance of the meeting. But I’m getting ahead of myself. First you need some background information.” Meghan pro-
ceeded to hand over stacks of paper.
The first is a memo from Meghan describing the history of MUGS and its continuation as SFF (Exhibit C3-3(a)).
Meghan added, “You will need to know some of the background.” The financial statements for MUGS for the six
months ended June 30, 2014, were for its last reporting period as a partnership (Exhibit C3-3(b)). Meghan stated,
“These statements provide you with a starting point, but the board will need to see the consolidated opening balance
sheet as at July 1, 2014.” Information relating to the purchase of BFI is in Exhibit C3-3(c) and the financial statements
of BFI for the six months ended June 30, 2014, are in Exhibit C3-3(d). The current intention is to operate SFF and BFI
as two separate corporations.
Required
Prepare the report to be presented to the board of directors.
EXHIBIT C3-3(a)
Historical Information About MUGS and SFF
MUGS was established in January 2000 as a biotechnology partnership in Saskatoon, Saskatchewan, with the mission of
enhancing yield, hardiness, and flavour of berry crops. To achieve its mission, MUGS conducts research into the biological com-
position of various berries. MUGS owns a biotechnological laboratory where experiments, biotechnological grafts, and tests are
carried out. MUGS focuses most of its research on the Saskatoon berry, which is prominent in the region. The MUGS laboratory
and head office are located in a local research park. MUGS also owns two rural plots of land, one for testing and development,
and another for production of commercially saleable berries.
MUGS has been owned by three equal partners since its inception. I, Meghan, am a biologist with several years of experi-
ence in biological engineering. I manage the business and oversee the research operations. I contributed $150,000 cash for a
one-third share of the partnership in 2000. My two partners, Arthur and Matthew, are my brothers. Arthur completed a Masters
in Agricultural Studies in the months prior to the commencement of the partnership and acts as my assistant in the day-to-day
operations. In return for his one-third share of the partnership, Arthur contributed the two parcels of land that MUGS operates
on. Matthew, a doctor residing in Saskatoon, is an inactive member of the partnership. His professional corporation contrib-
uted $150,000 cash for his one-third interest in the partnership. Arthur and I drew some money each year for the work done
at MUGS. Matthew, however, has received no cash from the partnership since its inception as there have yet to be earnings to
distribute.
In 2013, a report from a marketing research firm hired by MUGS concluded that consumption of berries is increasing.
Its research showed that, due to flavour enhancements made through biotechnology, customer demand is growing rapidly. It
is expected that berry consumption will increase by 300% to 500% over the next five to 10 years. The report also stated that
increasing demand will cause berry prices to increase 20% in 2015.
On July 1, 2014, each partner exchanged his or her partnership interest for 100,000 voting shares of a new corpora-
tion, Saskatoon Fields Forever Inc. (SFF). In addition, 220,000 non-voting shares of SFF were issued to VC (a venture capi-
tal firm) for $220,000 cash. SFF then purchased the shares of BFI. I was appointed President and Chief Executive Officer
of SFF and Arthur the Vice-President of Operations. Both of us are members of the board of directors and Matthew is the
chair of the board. The current president of BFI, the president of VC, and a university professor fill the remaining directors’
positions.
EXHIBIT C3-3(b)
MUGS PARTNERSHIP
Balance Sheet
(unaudited)
June 30, December 31, December 31,

2014 2013 2012
Current assets
Cash $ 99,000 $110,000 $124,000
Supplies inventory 10,000 10,000 10,000
141,000 142,000 149,000
Property, plant, and equipment (note 1) 235,080 234,860 222,700
$376,080 $376,860 $371,700
Current liabilities
Accounts payable $ 55,000 $ 28,000 $ 25,000
Deferred credits (note 2) 108,000 80,000 —
Partners’ contributions 450,000 450,000 450,000
Partners’ deficit (236,920) (181,140) (103,300)
213,080 268,860 246,700
$376,080 $376,860 $371,700
MUGS PARTNERSHIP
Income Statement and Changes in Partners’ Deficit
(unaudited)
Six months Year ended Year ended

ended June 30, December 31, December 31,
2014 2013 2012
Revenues
Berry Sales $ 125,000 $ 155,000 $ 115,000
Expenses
Research and development (note 3) 100,000 85,000 65,000
Operating and administrative costs (note 4) 15,000 22,000 18,000
Seasonal labour wages (note 5) 10,000 45,000 45,000
Amortization (note 1) 5,780 10,840 10,300
Total expenses 130,780 162,840 138,300
Net loss (5,780) (7,840) (23,300)
—Partners’ deficit—beginning of period (181,140) (103,300) (10,000)
Partners’ drawings (50,000) (70,000) (70,000)
—Partners’ deficit—end of period $(236,920) $(181,140) $(103,300)
MUGS PARTNERSHIP
Notes to the Financial Statements
(unaudited)
1. Property, plant, and equipment

2014 2013 2012
Land $ 150,000 $ 150,000 $ 150,000
Berry plants 30,000 30,000 30,000
Farm and research equipment 102,000 96,000 73,000
Farm and research equipment amortization (46,920) (41,140) (30,300)
$ 235,080 $ 234,860 $ 222,700
The land was appraised at December 31, 2013, at $600,000 and future-oriented appraisals anticipate continued growth in
the land value over the next decade.
Amortization is taken at capital cost allowance rates so that no adjustments are required in allocating losses to the partners.
2. Deferred credits
2014 2013 2012
Deferred government grants $108,000 $80,000 —
Cases 157
Deferred government grants represent the proceeds of conditional grants received under the federal government’s BioSearch
program. As part of the program, MUGS is committed to a minimum of $400,000 of direct and indirect research and devel-
opment (R&D) spending between January 1, 2010, and December 31, 2014. Once $400,000 has been spent, the federal
government will pay MUGS a total of $320,000. Installments of $108,000 have been received from the government to date
and are being deferred until the full amount of the grant has been received. The balance of the grant will not be paid and the
installments must be refunded if the government does not receive the audited R&D cost report.
3. Research and development

All research and development costs are expensed. Research and development costs are related to the following projects:
Six months Year ended Year ended

2014 2013 2012
Project More Berries $ 60,000 $25,000 —
Project Crantoon 15,000 40,000 40,000
Project Better Berries 5,000 — —
Discarded endeavors 20,000 20,000 25,000
$100,000 $85,000 $65,000
Prior to 2012, MUGS spent an average of $60,000 per year on direct and indirect R&D. MUGS has never claimed R&D tax
credits.
Project More Berries

Project More Berries has worked toward modifying the genetic code of Saskatoon berries so that the quantity of berries per
plant can be increased. This project is a cost-shared venture between MUGS and a local investor. The local investor agreed to
fund 50% of costs attributable to the project (costs above are shown net recoveries from the investor). In return, the investor
will receive 10% of gross revenue from the first two years of production of the new plants. Originally, the project had a five-
year scope and anticipated commercial sales in 2018. However, due to a research breakthrough in late 2013 that resulted
in tripled production of berries from test plots, MUGS has intensified its efforts on Project More Berries. Marketing efforts to
alert retailers of the upcoming product and trade-show displays of the research results represent approximately 25% of the
costs incurred in 2014. The remaining costs relate to testing, grooming, and monitoring the new plants. Arthur has devoted
almost all of his time in 2014 to Project More berries. Berries from the modified plants will be available for market in early
2015. Arthur believes that More Berries plants will allow MUGS to increase total production by 30% in 2015 with no ad-
ditional cost or change in the quality of the berries. Additional costs of $20,000 on this project are expected by the end of
2014 and should cease by December 31, 2014.
Project Crantoon
The scientific research component was essentially completed in late 2013. MUGS developed a hybrid berry that was a cross
between a cranberry and a Saskatoon berry (the crantoon). Costs in 2014 relate to market development studies and efforts
to test the market receptiveness to the new product. To date, the product has not been especially well received. But, Meghan
is optimistic that foreign markets will be more receptive than the Canadian market. Market development efforts will continue
until December 2014 when the project will be re-evaluated.
Project Better Berries

Project Better Berries has just been started. This project investigates the resistance of plants to diseases.
Discarded Endeavours
MUGS starts several projects each year that are discarded due to poor test results. Additionally, some of the research MUGS
does is general in nature and is not tied to any specific project.
4. Operating and administrative costs

Operating costs include maintenance of the plants, fertilizer application, and selling costs associated with the berries. Dona-
tions, both charitable and political, are also made by the partnership.
5. Seasonal labour
Seasonal labour is highest in the second half of the year during the harvesting of berries, with 75% of costs incurred in the
period.
EXHIBIT C3-3(c)
Information Relating to the Purchase of Biosfair Inc.
Biosfair Inc. (BFI) focuses all of its research on the enhancement and hardiness of raspberries and strawberries, and has been
very commercially successful. Additionally, BFI has made biotechnological manipulations in raspberry and strawberry plants that
have resulted in much larger and juicier fruit, even in adverse growing conditions. SFF bought BFI because of a belief that the
research breakthroughs made by BFI on raspberries and strawberries will be applicable to Saskatoon berries and because the
existing relationships BFI has with grocers will benefit berry sales.
The acquisition of BFI closed on July 1, 2014. The purchase price for BFI of $650,000 was financed as follows:
Cash $ 80,000
Proceeds from issuance of 220,000 non-voting shares of SFF to VC 220,000
Loan from VC at 10% interest repayable in 6 months 350,000
Purchase price $650,000
The purchase and sale agreement also provided for the president of BFI to be terminated on July 31, 2014, for a payment of
$100,000. In addition, he will remain as a consultant for an eight-month consulting contract for $10,000 per month.
Arthur notes that there is value to SFF in having access to the research that BFI has done. Subsequent to the deal going
through, Project ABC, a project touted by BFI as one with lots of potential, was abandoned by SFF. Arthur doubts SFF will
continue with any of the raspberry and strawberry research BFI has undertaken. Arthur believes that by combining the efforts of
both companies, the 2015 R&D costs will amount to $230,000 for the group.
EXHIBIT C3-3(d)
BIOSFAIR INC.
Balance Sheet
(unaudited)
June 30,
2014
Current assets
Cash $ 6,000
Accounts receivable (note 1) 180,000
186,000
Property, plant, and equipment (note 2) 255,000
Other assets (note 3) 260,000
$701,000
Current liabilities
Notes payable (note 4) 300,000
317,000
Future income taxes (not 5) 60,000
Share capital 100,000
324,000
$701,000
BIOSFAIR INC.
Income Statement
(unaudited)
Six months ended

June 30, 2014
Revenues
Berry sales (note 1) $380,000
Expenses
Salaries $ 57,000
Other operating costs 12,000
Research costs (note 6) 22,000
Administration 8,000
Amortization 10,500
Interest expense 4,500
$114,000
Income before taxes 266,000
Income taxes 53,000
Net income $213,000
BIOSFAIR INC.
Notes to the Financial Statements
(unaudited)
1. Accounts receivable and sales

Approximately 45% of BFI’s sales are made to Foodmart, a leading national grocery chain, under an exclusive supply agree-
ment in force until June 30, 2016. Over the course of a fiscal year, BFI sells an average of $1,500 of product to Foodmart
Cases 159
each day. Sales are highest in the late summer and autumn months, resulting in 75% of total sales recorded in the last half
of the year and lowest sales in the January-to-June period. A large portion of accounts receivable are due from Foodmart. No
allowance for doubtful accounts has been established due to a strong collection history.
On June 20, 2014, Foodmart signed contracts with BFI. In these contracts, Foodmart guaranteed to purchase at least
$80,000 of product from BFI in the 61 days in October and November. Should the purchases not reach $80,000, Foodmart
will make up the deficiency to BFI with a payment on December 15, 2014. The full amount has been booked to receivables
and revenue in June as a reflection of the certainty of receipt of cash.
2. Property, plant, and equipment

June 30, 2014
Land $ 85,000
Berry plants 40,000
Farm and research equipment 215,000
Farm and research equipment amortization (135,000)
Information system 50,000
$255,000
Land was purchased in 1991 and has been independently appraised at $300,000 at June 30, 2014. Farm equipment com-
prises all equipment used in the fields to plant, tend, and harvest berries. Research equipment is used in laboratories and
in the fields to conduct scientific research and development. It is recorded net of any related investment tax credits. At June
30, 2014, the fair value of BFI’s farm and research equipment is $70,000.
Information system includes the cost of a new system acquired in June 2014. The system now tracks invoicing and pur-
chase orders better and has an automated back-up system. It can now produce financial statements for up to five companies.
One of the advantages of buying BFI is that SFF will use the new system for both companies.
3. Other assets
June 30, 2014

Deferred development costs $200,000
Patents 60,000
$260,000
Deferred development costs relate to Project ABC, in which BFI has been working on creating strawberries and raspberries
that will grow in half the time of the traditional berries
Patents include various patents that BFI owns relating to enhancements and improvements in strawberry and raspberry
production and quality. The patents expire in 2025.
4. Notes payable
The notes are payable to Foodmart. They bear interest at 3% per annum, and are due on June 30, 2015. Interest is payable
monthly and the principal is due upon maturity.
5. Future income taxes

BFI computes future income taxes using the assets and liability method. Substantially all of the balance relates to differ-
ences between the tax and accounting value of other assets. The remaining balance relates to differences between the tax
and accounting values of farm and research equipment.
6. Research costs
Research costs are $42,000 gross less $20,000 of government grants received during the period.

Transactions
Inside a
Global
Company
Courtesy of Research In Motion
RESEARCH IN MOTION® (RIM®) revolutionized For simplicity purposes, RIM is organized and
the mobile industry when it introduced the managed as a single reportable business segment.
BlackBerry® device in 1999. Founded in 1984, The operations are substantially all related to
RIM has become a leader in the worldwide mobile research, design, manufacture, and sales of wireless
communications market by developing integrated communications products, services, and software. As
hardware, software, and services that support such, intercompany transactions often occur in the
multiple wireless network standards. With the normal course of business throughout RIM’s different
headquarters located in Waterloo, Ontario, RIM’s subsidiaries and segments.
shares are traded on the Toronto Stock Exchange For reporting purposes, any intercompany
as well as on the NASDAQ Global Select Market. balances are eliminated for consolidation purposes.
RIM’s portfolio of products, services, and These balances are verified by the auditors to
embedded technologies are used by thousands or ensure that any profit/loss is eliminated and that
organizations and millions of consumers around the financial statements are presented fairly in
the world to stay connected on the go. accordance with accounting guidelines. As such,
RIM has offices and subsidiaries located in any transfer of knowledge, technology, and
North America, the Asia-Pacific region, and products within the entity is not reflected in the
Europe. All of its subsidiaries are wholly owned consolidated financial statements presented to the
and therefore all entities are consolidated for shareholders. In this way, they are presented with
presentation purposes. Per IFRS 10 or ASPE a fair representation of the company’s actual success
Section 1601 Consolidated Financial Statements, in the market.
the consolidated financial statements include RIM’s management hopes that each subsidiary
the accounts of all of the subsidiaries of the and each segment of the entity contributed and will
company, with the intercompany transactions continue to contribute to the company’s success in
and balances eliminated on consolidation. the future.
Sources: Research In Motion’s 2011 annual financial statements; CICA Handbook. BlackBerry®, RIM®, Research In Motion® and related trademarks, names and logos are the
property of Research In Motion Limited and are registered and/or used in the U.S. and countries around the world. Used under license from Research In Motion Limited.
CHAPTER
4 Consolidation:
Intragroup
Transactions
LEARNING OBJECTIVES
1. Explain the principles behind making adjustments for intragroup transactions.
2. Adjust for intragroup transactions involving profits and losses in beginning and ending inventory.
3. Adjust for intragroup transactions involving profits and losses on the transfer of property, plant,
and equipment in both the current and previous periods.
4. Adjust for intragroup services such as management fees.
5. Adjust for intragroup dividends.
6. Adjust for intragroup borrowings.
7. Adjust for intragroup bonds acquired on the open market.
CONSOLIDATION
Intragroup Profits Appendix

Adjusting for
and Losses on 4A—Bonds
Intragroup Transfers of Intragroup Intragroup Intragroup
Transfers of Acquired on
Transactions: Inventory Services Dividends Borrowings
Property, Plant, the Open
Principles
and Equipment Market
■ Rationale for ■ Sales of inventory ■ Sale of land ■ Dividends ■ Advances

adjusting for ■ Realization of ■ Sales of depre- declared in ■ Bonds
intragroup revenues and ciable assets the current
transactions expenses period but not
■ Depreciation paid
■ Income tax ■ Unrealized and realization of
effects profits in ending profits or losses ■ Dividends
inventory declared and
paid in the
■ Unrealized prof- current period
its in beginning
inventory
162 chapter 4 Consolidation: Intragroup Transactions
One of the primary reasons that an entity obtains control of another entity is to further its
strategic objective. A company may decide to vertically integrate operations and therefore
acquire its major supplier. The company determines that this will allow it to manage the
inventory flow in a much more efficient manner. In addition, it believes that it can reduce
costs in a significant manner. For example, say that a toy importer decides to enter the retail
market. To achieve its goal, the importer buys a large retail operation that owns stores across
Canada. In these types of parentsubsidiary relationships, it is expected that transactions
between the two separate legal entities will occur. However, from the perspective of the
group, many of these transactions are not with an outside party and therefore must be elimi-
nated on the consolidated financial statements.
In this chapter, the group under discussion is restricted to one where:
• there are only two entities within the group (e.g., one parent and one subsidiary) and
• the parent owns all the shares of the subsidiary.
Diagrammatically, then, the group is as shown in Illustration 4.1.
Illustration 4.1
Definition of Group Group
100%
Parent Subsidiary
Chapter 3 explained that the process of consolidation involves adding together the financial
statements of a parent and its subsidiaries to reflect an overall view of the financial affairs of the
group of entities as a single economic entity. The chapter also pointed out that two major adjust-
ments are necessary to effect the consolidation:
1. Adjustments must be made involving equity at the acquisition date, namely the fair value
adjustments (if any) and the pre-acquisition adjustment, that eliminate the investment
account in the parent’s financial statements against the pre-acquisition equity of the sub-
sidiary (see Chapter 3).
2. Adjustments must be made to eliminate intragroup balances and the effects of transac-
tions whereby profits or losses are made by different members of the group through trad-
ing with each other.
This chapter focuses on the second type of adjustment, adjustments for intragroup balances
and transactions. The chapter analyzes transactions involving inventory, depreciable and
non-depreciable assets, services, dividends, and borrowings.
ADJUSTING FOR INTRAGROUP

TRANSACTIONS: PRINCIPLES
Rationale for Adjusting for Intragroup Transactions
Objective 1 Whenever related entities trade with each other, or borrow and lend money to each other,
Explain the the separate legal entities disclose the effects of these transactions in the assets and liabilities
principles behind recorded and the revenues and expenses reported. For example, if a subsidiary sells inventory
making adjustments to its parent, the subsidiary records a sale of inventory, including the profit on sale and reduc-
for intragroup
transactions.
tion in inventory assets, and the parent records the purchase of inventory at the amount paid
to the subsidiary. What happens when, in preparing the consolidated financial statements,
the separate financial statements of the legal entities are simply added together without any
Adjusting for Intragroup Transactions: Principles 163
adjustments for the effects of the intragroup transactions? In that case, the consolidated
financial statements include not only the results of the group transacting with external enti-
ties (i.e., entities outside the group) but also the results of transactions within the group. This
conflicts with the purpose of the consolidated financial statements to provide information
about the financial performance and financial position of the group as a result of its dealings
with external entities. Hence, the effects of transactions within the group must be adjusted
for when preparing the consolidated financial statements.
The requirement for the full adjustment for the effects of intragroup transactions is stated
in paragraph B86c of IFRS 10 Consolidated Financial Statements: “Eliminate in full intragroup
assets and liabilities, equity, income, expenses and cash flows relating to transactions between
entities of the group.”1
Besides adjusting for the effects of transactions occurring in the current period, it is also
necessary to adjust the current period’s consolidated financial statements for the ongoing
effects of transactions in previous periods. Because the consolidation adjustments are applied
on the consolidated financial statements only and not in the accounts of either the parent or
the subsidiary, any continuing effects of previous periods’ transactions must be considered.
This affects transactions such as loans between, say, a parent and a subsidiary where a bal-
ance owing at the end of a number of periods is reduced over time as repayments are made.
Similarly, where assets such as inventory are transferred at the end of one period and then are
still on hand at the beginning of the next period, consolidation adjustments are required to
be made in both periods.
Some intragroup transactions do not affect the carrying amounts of assets and liabilities
(e.g., where there is a management fee paid by one entity to another within the group). In
that case, the items affected are fee revenue and fee expense. However, in other circum-
stances, there are assets and liabilities recognized by the group at amounts different from
the amounts recognized by the individual legal entities. For example, consider the situation
where a subsidiary sold an item of inventory to the parent for $1,000, and the inventory had
cost the subsidiary $800. The parent recognizes the inventory at cost of $1,000, whereas the
cost of the inventory to the group is only $800. As is explained in more detail later in this
chapter, consolidation adjustments are necessary to adjust for both the profit on the intra-
group transaction and the carrying amount of the inventory.
Income Tax Effects

Under IAS 12 Income Taxes, deferred tax accounts must be created where there are temporary
differences between the carrying amount of an asset or liability and its tax base. Any differ-
ence between the carrying amount of an asset or a liability and its tax base in a legal entity
within the group is accounted for by the legal entity. However, on consolidation, in rela-
tion to intragroup transactions, adjustments may be made to the carrying amounts of assets
and liabilities. Hence, in adjusting for intragroup transactions wherever there are changes to
the carrying amounts of assets and liabilities, any associated tax effect must be considered.
Paragraph B86c of IFRS 10 recognizes the need to apply tax-effect accounting for temporary
differences arising from the elimination of profits and losses from intragroup transactions.
For example, assume an asset is recorded by a subsidiary at a carrying amount of $1,000,
and that the tax base is $1,000. In the records of the subsidiary, there is no temporary differ-
ence. If, on consolidation, an adjustment is made to reduce the carrying amount of the asset,
say to $950, and assuming a tax rate of 30%, on consolidation we must adjust for the tax
effect of the change in the asset’s carrying amount, namely the creation of a deferred tax asset
of $15 (i.e., 30% $50). The tax-effect adjustments on consolidation will account for the
temporary difference caused by the group showing the asset at $950 and the tax base being
$1,000, namely a deferred tax asset of $15 (i.e., 30% [$950 $1,000]).
1
The requirement to adjust for the full effects of the transactions is consistent with the entity concept of
consolidation, as the whole of the parent and the subsidiary are within the group. For a full discussion of
the various theories of consolidation, see Appendix 5A.
In this textbook, it is assumed that each subsidiary is a tax-paying entity. Under the tax
consolidation system in some countries, groups comprising a parent and its wholly owned
subsidiaries can elect to consolidate and be treated as a single entity for tax purposes. Such
entities prepare a consolidated tax return, and the effects of intragroup transactions are elimi-
nated. Under such a scheme, the tax-effect adjustments demonstrated in this chapter would
not apply. However, in Canada, the legal entity pays its own taxes and therefore temporary
differences will arise on intragroup transactions.
Just as the pre-acquisition adjustment is done on consolidation to eliminate the invest-
ment and to adjust for pre-acquisition equity, adjustments are prepared for intragroup trans-
actions and are reflected in the consolidated financial statements. For example, if it were
necessary to adjust the sales revenue recorded by the legal entities downwards by $10,000, the
consolidated financial statement would show the following line:
Parent Subsidiary Adjustments Consolidated Group
Sales revenue 100,000 80,000 10,000 170,000
In the following sections of this chapter, three types of intragroup transactions are dis-
cussed: transfers of inventory; transfers of property, plant, and equipment; and intragroup
services. Each of the specific sections covering these transactions discusses the process of
determining when profits are unrealized and subsequently realized for the different types of
transactions.
✓ LEARNING CHECK
• The consolidated financial statements report only the effects of transactions between the
group and entities outside the group.
• Adjustments are required for both previous period transactions and current period transac-
tions.
• Where adjustments affect the carrying amounts of assets and liabilities, further adjustments
are made for the tax effect of those adjustments.
TRANSFERS OF INVENTORY
Objective 2 Many strategic investments are made that promote either vertical or horizontal integra-
Adjust for intragroup tion. In these circumstances, we would expect to see many intracompany transfers of
transactions inventory, where it is a sale of inventory for one party and a purchase of inventory of the
involving profits and other party.
losses in beginning
In the following examples, assume that Petro (P) owns all the share capital of Sumco
and ending
inventory. (S), and that the consolidation process is being carried out on December 31, 2013, for the
year ending on that date. Assume also a tax rate of 30%. All adjustments shown as being
for the individual entities assume the use of a perpetual inventory system, and adjust-
ments will be made, where necessary, to cost of sales. (Note that in a periodic inventory
system, any adjustments would be made to either beginning inventory, or purchases, or
ending inventory.)
Sales of Inventory
Example 4.1: Intracompany Sale of Inventory
On January 1, 2013, P acquired $10,000 worth of inventory for cash from S. The inventory
had previously cost S $8,000.
Transfers of Inventory 165
In the accounting records of S, the following journal entries are made on January 1, 2013:
Cash 10,000
Sales Revenue 10,000
Cost of Sales 8,000
Inventory 8,000
In P, the journal entry is:
Inventory 10,000
Cash 10,000
From the viewpoint of the group in relation to this transaction, no sales of inventory
were made to any party outside the group, nor has the group acquired any inventory from
external entities. Hence, if the financial statements of P and S are simply added together for
consolidation purposes, sales, cost of sales, and inventory will need to be adjusted on the con-
solidated financial statements, which must show only the results of transactions with entities
external to the group.
Realization of Revenues and Expenses

Revenues and expenses resulting from intragroup transactions that require consolidation
adjustments to be made are those “recognized in assets” (IFRS 10.B86). These profits
can be described as “unrealized profits.” The test for realization is the involvement of an
external party in relation to the item involved in the intragroup transaction. If an item of
inventory is transferred from a subsidiary to the parent entity (or vice versa), no external
party is involved in that transaction. The profit made by the subsidiary is unrealized to
the group. If the parent then sells that inventory item to a party external to the group, the
intragroup profit becomes realized to the group. For example, assume the subsidiary, S,
sells inventory to its parent, P, for $100, and that inventory cost S $90. The profit on this
transaction is unrealized. If P sells the inventory to an external party for $100, the intra-
group profit is realized. The group sold inventory that cost the group $90 to an external
party for $100. The group has made $10 profit. Hence, the consolidation adjustments for
profits on intragroup transfers of inventory depend on whether the acquiring entity has
sold the inventory to entities outside the group. In other words, the adjustments depend
on whether the acquiring entity still carries some or all of the transferred inventory as
ending inventory at the end of the financial period.
Unrealized Profits in Ending Inventory

We continue using the information in the previous example, 4.1, and provide information
about whether the inventory transferred is still on hand at the end of the financial period.
Example 4.2: Transferred Inventory Still on Hand

On December 31, 2013, all the inventory sold by S to P is still on hand. The adjustments in
the consolidated financial statement at December 31, 2013, are:
Statement of comprehensive income:
Sales revenue 10,000 T
Cost of sales 10,000 T 2,000 c 8,000 T
Statement of financial position:
Ending inventory 2,000 T
The sales and cost of sales adjustment is necessary to eliminate the effects of the original sale
in the current period. S recorded sales of $10,000 and P recorded purchases of $10,000. From
the group’s viewpoint, as no external party was involved in the transaction, no sales or purchases
should be shown in the consolidated financial statements. The effect of this adjustment on the
consolidation process is seen in Illustration 4.2.
Using similar reasoning as the adjustment for sales revenue, the subsidiary has recorded
cost of sales of $8,000, but the group has made no sales to entities external to the group.
Hence, the consolidated financial statement needs to have an additional reduction in cost
of sales of $2,000 in order to show a zero amount on the consolidated financial statement.
In addition, a reduction in ending inventory of $2,000 is required since the cost of this
inventory to the group was $8,000, not $10,000. Note that adjusting sales by $10,000 and
cost of sales by $8,000 effectively reduces consolidated profit by $2,000. In other words,
the $2,000 profit recorded by S on selling inventory to P is eliminated and a zero profit
is shown on consolidation. As no external party was involved in the transfer of inventory,
the whole of the profit on the intragroup transaction is unrealized. This is illustrated in
Illustration 4.2.
Illustration 4.2
Extract from Consolidated
Financial Statement— Sales revenue 0 10,000 ⴚ10,000 —
Profit in Closing Inventory Cost of sales 0 8,000 ⴚ8,000 —
2,000
Tax expense 0 600 ⴚ600 —
Profit 1,400 —
Inventory 10,000 — ⴚ2,000 8,000
Deferred tax asset — — ⴙ600 600
The previous explanation dealing with the effect on profit covers only the statement of
comprehensive income part of the adjustment. Under the historical cost system, assets in the
consolidated statement of financial position must be shown at cost to the group. Inventory
is recorded in P at $10,000, the cost to P. The cost to the group is, however, $8,000, the
amount that was paid for the inventory by S to entities external to the group. Hence, if inven-
tory is to be reported at $8,000 in the consolidated financial statements, and it is recorded in
P’s records at $10,000, an adjustment of $2,000 is needed to reduce the inventory to $8,000,
the cost to the group. This effect is seen in Illustration 4.2.
P has recorded the inventory in its books at $10,000. This amount is probably also its tax
base. On consolidation, a tax-effect adjustment is necessary where an unrealized profit causes
a difference between the carrying amount of an asset or a liability in the records of the legal
entity and the carrying amount shown in the consolidated financial statements. In the adjust-
ment relating to profit in ending inventory in the above example, the carrying amount of
inventory is reduced downward by $2,000. The carrying amount and tax base of the inventory in
P is $10,000, but the carrying amount in the group is $8,000. This $2,000 difference is a deduct-
ible temporary difference giving rise to a deferred tax asset of $600 (i.e., 30% $2,000), as well
as a corresponding decrease in income tax expense. The appropriate consolidated financial
statement adjustment is:
Deferred tax asset c 600
Income tax expense T 600
The effects of this adjustment are shown in Illustration 4.2.
The deferred tax asset recognizes that the group is expected to earn profits in the future
that will not require the payment of tax to the Canada Revenue Agency. When the inven-
tory is sold by P in a future period, this temporary difference is reversed. To illustrate this
effect, assume that in the following period P sells this inventory to an external entity for
$11,000. P will record a before-tax profit of $1,000 (i.e., $11,000 $10,000) and an associ-
ated tax expense of $300. From the consolidated group position, the profit on sale is $3,000
(i.e., $11,000 $8,000). The group will show current tax payable of $300, reverse the $600
deferred tax asset, and recognize an income tax expense of $900. These effects are illustrated
in Illustration 4.2.
Example 4.3: Transferred Inventories Partly Sold

had previously cost S $8,000. By the end of the year, December 31, 2013, P had sold $7,500
of the transferred inventory for $14,000 to external entities. Thus, $2,500 of the inventory is
on hand in P at December 31, 2013.
The adjustment for the preparation of consolidated financial statements at December
31, 2013, is:
Sales T 10,000
Cost of sales T 10,000 500 c 9,500 T
Ending inventory T 500
The total sales recorded by the legal entities are $24,000 (i.e., $10,000 by S and $14,000 by P).
The sales by the group, being those sold to entities external to the group, are $14,000. The
consolidation adjustment to sales revenue is then $10,000, being the amount that is necessary
to eliminate the sales within the group.
The total cost of sales recorded by the legal entities is $15,500 (i.e., $8,000 by S and $7,500 by
P [75% $10,000]). The cost of sales to the group, being sales to entities external to the group,
is $6,000 (i.e., 75% $8,000). Hence, the consolidation adjustment is $9,500; in other words,
$15,500 (sum of recorded sales) less $6,000 (group). The adjustment is necessary to adjust the sum
of the amounts recorded by the legal entities to that to be recognized by the group.
Note that the combined adjustments to sales and cost of sales result in a $500 reduction in
before-tax profit. Of the $2,000 intragroup profit on the transfer of inventory from S to P, since
three quarters of the inventory has been sold by P to an external party, $1,500 of the profit is real-
ized to the group and only $500, the profit remaining in ending inventory, is unrealized. It is the
unrealized profit that is adjusted for in the consolidated financial statement.
The group profit is then $500 less than that recorded by the legal entities. The sum
of profits recorded by the legal entities is $8,500, consisting of $2,000 recorded by S and
$6,500 (being sales of $14,000 less cost of sales of $7,500) recorded by P. From the group’s
viewpoint, profit on sale of inventory to external entities is only $8,000, consisting of sales
of $14,000 less cost of sales of $6,000 (being 75% of the original cost of $8,000). Hence,
an adjustment of $500 is necessary to reduce recorded profit of $8,500 to group profit of
$8,000.
The $500 adjustment to inventory reflects the proportion of the total profit on sale of the
transferred inventory that remains in the inventory on hand at the end of the period. Since 25%
of the transferred inventory is still on hand at the end of the period, then 25% of the total profit
on transfer of inventory (i.e., 25% $2,000) needs to be adjusted at the end of the period. The
adjustment reduces the inventory on hand at December 31, 2013, from the recorded cost to P of
$2,500 to the group cost of $2,000 (being 25% of the original cost of $8,000).
The adjustments above have been determined by comparing the combined amounts recorded
by the parent and the subsidiary with the amounts that the group wants to report in the consoli-
dated financial statements. This process could be shown in the form of a table, as follows:
Parent Subsidiary Total Recorded Consolidated Group Adjustment
Sales 14,000 10,000 24,000 14,000 T 10,000

Cost of sales 7,500 8,000 15,500 6,000 T 9,500
Profit 6,500 2,000 8,500 8,000
Inventory 2,500 0 2,500 2,000 T $500
Consider the tax effect of this adjustment. The inventory’s carrying amount is reduced by
$500, reflecting the fact that the carrying amount to the group is $500 less than the carrying
amount in P. This gives rise to a deductible temporary difference of $500. Hence, a deferred
tax asset of $150 (i.e., 30% $500) must be recorded on consolidation with a corresponding
effect on income tax expense. The expectation of the group is that, in some future period, it
will recognize the remaining $500 profit in transferred inventory when it sells the inventory
to an external party, but will not have to pay tax on the $500 as S has already paid the relevant
tax. This expected tax saving to the group will be shown in the consolidated financial state-
ments by an adjustment of $150 to the Deferred Tax Asset account.
The tax-effect adjustment is then:
Example 4.4: Transferred Inventory Completely Sold

had previously cost S $8,000. By the end of the year, December 31, 2013, P had sold all of the
transferred inventory to an external party for $18,000.
S records a profit of $ 2,000 (i.e., $10,000 less $8,000)

P records a profit of $ 8,000 (i.e., $18,000 less $10,000)
Total recorded profit is $10,000
Profit to the group Selling price to external entities less cost to the group
$18,000 $8,000
$10,000
Since the recorded profit equals the profit to the group, there is no need for a profit adjust-
ment on consolidation. Further, as there is no transferred inventory still on hand, there is no
need for an adjustment to inventory. Because all the inventory has been sold to an external
entity, the whole of the intragroup profit is realized to the group. Note, however, that an
adjustment for the sales and cost of sales is still necessary. As noted previously, the sales within
the group amount to $18,000, whereas the sales recorded by the legal entities total $28,000
(i.e., $10,000 $18,000). Hence, sales must be reduced by $10,000. The total recorded cost
of sales is $18,000, being $8,000 by S and $10,000 by P. The group’s cost of sales is the origi-
nal cost of the transferred inventory, $8,000. Hence, cost of sales is reduced by $10,000 on
consolidation. The adjustment is then:
Sales T 10,000
Cost of sales T 10,000
Since there is no adjustment to the carrying amounts of assets or liabilities, there is no
need for any tax-effect adjustment.
Where inventory is transferred in the current period and some or all of that inventory
is still on hand at the end of the period, the general form of the financial statement
adjustment is:
Sales revenue T
Cost of sales T for the cost of sales Cost of sales c for the unrealized
profit
Inventory T
(The adjustment to inventory is based on the profit remaining in inventory on hand at
the end of the period)
Deferred tax asset c
Income tax expense T
(The tax rate times the adjustment to ending inventory)
Unrealized Profits in Beginning Inventory

Any transferred inventory remaining unsold at the end of one period is still on hand at the
beginning of the next period. Because the consolidation adjustments are made only in a con-
solidated financial statement and not in the records of any of the legal entities, any differences
in balances between the legal entities and the consolidated group at the end of one period
must still exist at the beginning of the next period.
Example 4.5: Transferred Inventory on Hand

at the Beginning of the Period
On January 1, 2013, the first day of the current period, S has on hand inventory worth $7,000,
transferred from P in December 2012. The inventory had previously cost P $4,500. The tax
rate is 30%.
In this example, in the preparation of the consolidated financial statements at December
31, 2012, the following adjustment for the $2,500 profit in ending inventory would have been
made in the consolidated financial statement:
Sales T 7,000
Cost of sales T 7,000 c 2,500 T 4,500
Inventory T 2,500
(30% $2,500)
Since the ending inventory at December 31, 2012, becomes the beginning inventory for
the next year, an adjustment is necessary in the consolidated financial statements prepared at
December 31, 2013. The required adjustment is:
Retained earnings (1/1/13) T 2,500
In making this consolidated financial statement adjustment, it is assumed that the inven-
tory is sold to external entities in the current period. It is then said that the unrealized profit
has become realized. If this is not the case, then the adjustment to inventory as made at
December 31, 2012, will need to be made again in preparing the consolidated financial state-
ments at December 31, 2013.
The cost of sales recorded by S in the 2013 period is $2,500 greater than that which the
group wants to show, because the cost of sales recorded by P is $7,000, whereas the cost of
sales to the group is only $4,500. A reduction in cost of sales means an increase in profit.
Hence, in the 2013 period, the group’s profit is greater than the sum of the legal entities’
profit.
The adjustment to the opening balance of retained earnings reduces that balance; that is,
the group made less profit in previous years than the sum of the retained earnings recorded
by the legal entities. This is because, in December 2012, P recorded a $2,500 profit on the
sale of inventory to S, this profit not being recognized by the group until the 2013 period.
Consider the tax effect of these adjustments. If the previous period’s tax-effect adjustment
were carried forward into this year’s financial statement, it would be:
Retained earnings (1/1/13) T 750
On sale of the inventory in the 2013 period, the deferred tax asset is reversed, with a
resultant effect on income tax expense:
Income tax expense c 750
Deferred tax asset T 750
On combining these two adjustments, the financial statement adjustment required is:

Retained earnings (1/1/13) T 750
In summary, the adjustment to cost of sales, retained earnings, and income tax expense
can be combined into one adjustment as follows:
Retained earnings (1/1/13) T 2,500 c 750 T 1,750

Note that this adjustment has no effect on the closing balance of retained earnings at
December 31, 2013. As the inventory has been sold outside the group, the whole of the profit
on the intragroup transaction is realized to the group. There is no unrealized profit to be
adjusted for at the end of the period and therefore no adjustment to inventory on the state-
ment of financial position.
Where inventory was transferred in a previous period and some or all of that inven-
tory is still on hand at the beginning of the current period, the general form of the
adjustments is:
Retained earnings (opening balance) T amount unrealized net of tax
Cost of sales T realized profit
Income tax expense c tax on the realized profit
You can see that the consolidated financial statement adjustments for inventory trans-
ferred within the current period are different from those where the inventory was transferred
in a previous period. Before preparing the adjustments, it is essential to determine the timing of the
transaction. It is important to note the unrealized and/or realized profits that occurred in any given
period.
Adjustments for Transfers of Inventory

Consolidated financial statement adjustments for intragroup transactions involving transfers
of inventory are further demonstrated in Illustrative Example 4.1.
Illustrative Example 4.1 Intragroup Transactions

Involving Transfers of Inventory
Tilford acquired all the issued shares of Manfred on January 1, 2012. The following
transactions occurred between the two entities:
1. On December 1, 2012, Tilford sold inventory to Manfred for $12,000, this inventory
previously costing Tilford $10,000. By December 31, 2012, Manfred had sold 20%
of this inventory to other entities for $3,000. The other 80% was all sold to external
entities by December 31, 2013, for $13,000.
2. During the 2013 year, Manfred sold inventory to Tilford for $6,000, this being
at cost plus 20% markup. Of this inventory, $1,200 (20%) remained on hand in
Tilford at December 31, 2013.
Required
Prepare the consolidated financial statement adjustments for Tilford on December 31, 2013,
in relation to the intragroup transfers of inventory.
Solution
The required consolidated financial statement adjustments are:
1. Sale of inventory in previous period
Retained earnings (1/1/13) T 1,600 c 480 T 1,120
Explanation
• This is a prior period transaction. The original profit was 12,000 10,000 2,000.
• Profit after tax remaining in inventory at 1/1/13 is $1,120 ( 80% $2,000
[1 30%])
• Cost of sales recorded by Manfred is $9,600 ( 80% $12,000); cost of sales to
the group is $8,000 ( 80% $10,000). The adjustment is then $1,600.
• Tax on this realized profit is 0.3 $1,600 $480.
2. Sale of inventory in current period
Sales T 6,000
Cost of sales T 6,000 c 200 T 5,800
Inventory T 200
Explanation
• This is a current period transaction.
• Sales within the group are $6,000.
• Cost of sales recorded by the members of the group are $6,000/1.2 $5,000 for
Manfred and $4,800 ( 80% $6,000) for Tilford, a total of $9,800. Cost of sales
for the group is $4,000 ( 80% $5,000). The adjustment is then $5,800.
• The inventory remaining at December 31, 2013, is recorded by Tilford at $1,200.
The cost to the group is $1,000 ( 20% $5,000). The adjustment to inventory is
then $200.
• As the inventory is adjusted by $200, the tax effect is $60 ( 30% $200).
✓ LEARNING CHECK
• Adjustments for current period inventory transfers affect current period profit accounts such
as sales and cost of sales.
• Adjustments for prior period inventory transfers relate to prior period profits remaining in
opening inventory, with adjustments being made to retained earnings. If this inventory is sold
during the current year, income statement accounts such as cost of goods sold will be affected.
• Where unrealized profit remains in inventory, the carrying amount of inventory is affected and
a tax-effect adjustment is required.
INTRAGROUP PROFITS AND LOSSES

ON TRANSFERS OF PROPERTY, PLANT,
AND EQUIPMENT
Objective 3 Besides transferring inventory, it is possible for property, plant, and equipment to be
Adjust for intragroup transferred within the group. It is necessary to distinguish between a sale of land, which
transactions is a non-depreciable asset, and the sale of a depreciable asset. The realization of profit
involving profits on land occurs when the asset is subsequently sold to a party that is outside the group,
and losses on
whereas the profit on a depreciable asset is realized as the asset is depreciated. As long as
the transfer of
property, plant, and the sale of a depreciable asset is within the group, it will initially be considered unreal-
equipment in both ized. The financial statement adjustments are shown in two parts: (1) the adjustments to
the current and adjust for any profit or loss on sale of the assets, and (2) the adjustments relating to any
previous periods. depreciation of the assets after sale. As realization of the profit or loss on sale is related
to the depreciation of the transferred asset, the depreciation adjustments are covered in
conjunction with the discussion on realization. If a non-depreciable asset is transferred,
only the first of these adjustments is required, and realization of the profit or loss occurs,
as with inventory, on sale of the asset to an external party.
Sale of Land
Example 4.6: Transfer in Current Year
P sold S land for $22,000 cash on January 1, 2013. It had cost P $20,000 when acquired. The
income tax rate is 30%.
The journal entries in the records of P and S at the date of sale, January 1, 2013, are:
P
Cash 22,000
Land 20,000
Gain on sale of land 2,000
S
Land 22,000
Cash 22,000
From the group’s viewpoint, there is no sale of land to entities external to the group. Since
the legal entity P recorded such a sale, the consolidation adjustment involves eliminating the
effects of the sale. The adjustment includes the elimination of the gain on sale of the land. As
a result of the sale, the land is recorded by S at a cost of $22,000. From the group’s perspec-
tive, the cost of the asset at the time of transfer within the group is the carrying amount in
the records of the selling company, P; i.e., $20,000. So that the asset is reported in the con-
solidated financial statements at cost to the group, an adjustment reducing the asset from a
recorded amount of $22,000 to the group’s cost of $20,000 is necessary. Hence, a decrease to
the asset of $2,000 is required.
Gain on sale of land T 2,000

Land T 2,000
The consolidation adjustment reduces land by $2,000. As with inventory, any adjust-
ment on consolidation to the carrying amount of an asset provides a difference between
the carrying amount and the tax base of the asset. Hence, there is a deductible temporary
difference in relation to the land. It is then necessary to recognize a deferred tax asset and
Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment 173
an adjustment to income tax expense equal to the tax rate times the temporary difference,
namely 30% $2,000 $600. The consolidated financial statement adjustment is:
(30% $600)
A deferred tax asset is recognized because there is a reduction in the asset’s carrying
amount. This may in fact be a reduction in a deferred tax liability recorded by the legal entity
if for some reason the carrying amount of the asset in the legal entity is greater than the
asset’s tax base. Because deferred tax assets and liabilities are netted off for disclosure purposes,
a problem as to whether the adjustment is reducing a deferred tax liability or increasing a
deferred tax asset is not important.
As long as the land remains within the group, an adjustment is necessary to reduce P’s
recorded prior-period profits and to reduce the cost of the land as recorded by S. The adjust-
ment in years after the year of sale of the asset is:
Retained earnings (opening balance) T 2,000
Land T 2,000
In periods after the year of sale, as long as the asset remains on hand, the tax-effect
adjustment is:
Retained earnings (opening balance) c 600
If the land is sold for $30,000 in a given year, the unrealized profit of $2,000 and the tax of
$600 now becomes realized. The adjustment is the same as that made for inventory. When S
sells the land it records a gain of $30,000 $22,000 $8,000 and tax of 30% $8,000 $2,400
(we assume for purposes of simplicity that an ordinary tax rate is applied rather than capital gains
tax). However, from the group’s perspective, the gain is actually $10,000 (30,000 20,000) and
the tax to pay is 30% $10,000 $3,000. By realizing the profit of $2,000, the gain will be
reflected on the consolidated financial statements as $8,000 $2,000 $10,000 and the tax will
be $2,400 $600 $3,000.
Gain on sale of land c 2,000
There will be no effect on the retained earnings or the statement of financial position at
year end as the profit is now realized.
Sales of Depreciable Assets

Example 4.7: Transfer in Current Year
P sold S a plant for $18,500 cash on January 1, 2013. It had cost P $20,000 when acquired one
year previously. At the day that P purchased the plant, it had a useful life of 10 years. Depreciation
charged on plant by P is straight line with no salvage value. The income tax rate is 30%.
The journal entries in the records of P and S at the date of sale, January 1, 2013, are:
P
Cash 18,500
Accumulated Depreciation 2,000
Plant 20,000
Gain on Sale of Plant 500
S
Plant 18,500
Cash 18,500
From the group’s viewpoint, there is no sale of plant to entities external to the group.
Since the legal entity P recorded such a sale, the consolidation adjustment involves eliminat-
ing the effects of the sale. The adjustment includes the elimination of the gain on sale of the
plant. As a result of the sale, the plant is recorded by S at a cost of $18,500. From the group’s
perspective, the cost of the asset at the time of transfer within the group is the carrying
amount in the records of the selling company, P; i.e., $18,000. So that the asset is reported in
the consolidated financial statements at cost to the group, an adjustment reducing the asset
from a recorded amount of $18,500 to the group’s cost of $18,000 is necessary. Hence, a
decrease to the asset of $500 is required.
Gain on sale of plant T 500
Plant T 500
The consolidation adjustment reduces plant by $500. As with inventory, any adjustment
on consolidation to the carrying amount of an asset provides a difference between the asset’s
carrying amount and tax base. Hence, there is a deductible temporary difference in relation
to the plant. It is then necessary to recognize a deferred tax asset and an adjustment to income
tax expense equal to the tax rate times the temporary difference, namely 30% $500
$150. The consolidated financial statement adjustment is:
(30% $500)
A deferred tax asset is recognized because there is a reduction in the asset’s carrying
amount. This may in fact be a reduction in a deferred tax liability recorded by the legal entity
if for some reason the carrying amount of the asset in the legal entity is greater than the
asset’s tax base. Because deferred tax assets and liabilities are netted off for disclosure purposes,
a problem as to whether the adjustment is reducing a deferred tax liability or increasing a
deferred tax asset is not important.
As long as the depreciable asset remains within the group, an adjustment is necessary to
reduce P’s recorded prior-period profits and to reduce the cost of the asset as recorded by S.
The adjustment in years after the year of sale of the asset is:
Retained earnings (opening balance) T 500
Plant T 500
In periods after the year of sale, as long as the asset remains on hand, the tax-effect
adjustment is:
Retained earnings (opening balance) c 150
In summary, in the year of transfer, the general form of the consolidated financial state-
ment adjustments is:
Gain on sale of asset T amount of the unrealized profit
Property, plant, and equipment T amount of the unrealized profit
Deferred tax asset c tax on the unrealized profit
Income tax expense T tax on the unrealized profit
In years after the transfer, the adjustments become:
Retained earnings (opening balance) T unrealized profit remaining net of tax
Property, plant, and equipment T unrealized profit remaining
Deferred tax asset c tax on unrealized profit remaining
If a loss is made on transfer of property, plant, and equipment, consolidation adjust-

ments are needed to eliminate the loss in the year of transfer and bring the asset back
to cost to the group. The tax-effect financial statement adjustment then recognizes a
deferred tax liability. The consolidation adjustments are:
Property, plant, and equipment c unrealized loss
Loss on sale of asset T unrealized loss
Income tax expense c tax on unrealized loss
Deferred income tax liability c tax on unrealized loss
In years after the transfer, the adjustments become:
Property, plant, and equipment c unrealized loss remaining
Retained earnings (opening balance) c unrealized loss remaining net of tax
Deferred tax liability c tax on unrealized loss remaining
Paragraph B86c of IFRS 10 notes that intragroup losses may indicate an impairment. In
that case, an impairment loss and related accumulated impairment loss would be recognized
in the consolidated financial statement.
Depreciation and Realization of Profits or Losses

Realization of Profits or Losses on Depreciable Asset Transfers
For intragroup transactions such as inventory transfers or sale of land, the determination of
whether the profit on the intragroup sale is realized is simple. The profit is realized when
the buying entity, say the parent, sells the transferred inventory or land to an external party.
However, where transactions occur involving depreciable assets, no external party ever
becomes directly involved in these transactions, as the transferred item remains within the
group. Hence, either the profits or losses on transfer of these items are to be regarded as never
being realized, or some assumption is made about the point of realization. The former course
of action is impractical because adjustments for the profit would have to be made for every
year in the life of the group after the transaction occurred. In practice, the second course of
action is followed.
The realization of the profit or loss on a depreciable asset transferred within the group
is assumed to occur when the future benefits embodied in the asset are consumed by the
group. In other words, the depreciable asset transferred within the group will never be sold
to an external party, but will be used up within the group to generate benefits for the group.
As the asset is used up within the group, the benefits are received by the group. A useful
measure of the pattern of benefits received by the group can be obtained by reference to
the depreciation charged on the asset, since the depreciation allocation is related to the pat-
tern of benefits from the use of the assets. Hence, for depreciable assets, the involvement
of external entities in the transaction occurs on an indirect basis with the assumption being
made that realization occurs in a pattern consistent with the allocation of the depreciation
of the non-current asset.
Assume a subsidiary sells a depreciable asset to the parent at a profit of $100, and the
parent depreciates the asset on a straight-line basis over 10 years. On the date of sale, the
unrealized profit is $100. In the first year after the sale, $10 (i.e., 10% $100) of that profit
is realized, leaving $90 unrealized profit at the end of the year. In that year the group shows
$90 less profit than the sum of the profits of the parent and the subsidiary. In the second year,
the group realizes a further $10 profit, and shows $10 more profit than the sum of the profits
of the parent and the subsidiary. The process of realization occurs via the adjustments for the
depreciation of the asset subsequent to the point of sale, and is explained in the following sec-
tion on depreciation.
Depreciation
In Example 4.7, plant was transferred from P to S for $18,500 at a before-tax gain of
$500. Since the asset is transferred at the beginning of the current period, assume that
S uses the asset and decides that the remaining useful life is still 10 years and therefore
charges depreciation over 10 years on a straight-line basis. The adjustment for deprecia-
tion at the end of the first year after the sale is determined by comparing the deprecia-
tion charge on the cost to the legal entity with the depreciation charge on the cost to the
group:
S Cost of asset $18,500

Depreciation expense $1,850
Group: Cost of asset $18,000
Depreciation expense $18,000/10
$1,800
Adjustment $1,850 $1,800
$50
On consolidation, depreciation is reduced by $50. The financial statement adjustment is:

Plant T 50 OR Accumulated depreciation c 50
(Note: The account to adjust is based on whether plant is presented net of accumulated depre-
ciation on the statement of financial position.)
Depreciation expense T 50
This adjustment increases the group’s profit by $50; that is, the group has realized $50 of
the $500 profit on sale of the plant. The adjustment for the gain on sale reduces the group’s
profit by $500, and the adjustment for depreciation results in recognizing some of that profit
being realized as the asset is used up. The amount of profit realized is in proportion to the
depreciation charged, namely 10% p.a. straight line ($500/10).
In determining whether the depreciation rate used should be P’s or S’s, remember that
P sold the asset to S. The purpose of making the consolidation adjustments is not to show
the financial statements as they would have been if the transaction had not occurred, but to
eliminate the effects of the intragroup transactions. Within the group, the plant has been
transferred from one place of use to another, namely from P to S. As a result, the plant is
subject to the wear and tear, life expectations, and so on associated with S’s assets rather than
P’s assets. Hence, the appropriate depreciation rate for consolidation purposes is that of the
entity in which the asset is used.
The difference between the carrying amount in the legal entity and that in the group at
date of sale was $500 (i.e., $18,500 $18,000). At the end of the first year after sale, the dif-
ference is $450 (i.e., by adjusting for 10% depreciation, 90% $18,500 less 90% $18,000).
The reduction in the carrying amount difference is $50, giving rise to a reversal of the initial
temporary difference of $15 (i.e., 30% $50). The financial statement adjustment for the tax
effect of the depreciation adjustment is:
The tax-effect adjustment is calculated as the tax rate times the adjustment to deprecia-
tion (i.e., 30% $50). This depreciation adjustment causes the carrying amount to change
each period, thus reducing the temporary difference created on the initial transfer of the
asset. The net effect of the depreciation and the tax-effect adjustment on the group’s profit is
an increase of $35 (i.e., $50 $15). The $350 after-tax profit on the sale of the plant is being
realized at $35 (i.e., 10% $350) p.a.
While the asset remains on hand, depreciation will be charged. Hence, when preparing
the consolidated financial statements for the year 2014, the adjustment for depreciation must
reflect the effects of the differences in depreciation for both the current year and the previous
year. The adjustment relating to the previous period’s depreciation is made against retained
earnings (opening balance). The adjustment at December 31, 2014, is:
Plant c 100
Retained earnings (1/1/14) c 50
Both the current period’s and the previous period’s accounting profit is increased by
the reduction in depreciation expense. From a tax-effect accounting perspective, there
must be an increase in income tax expense both for the current period and for the previous
period. Reversal of the deferred tax asset recorded in relation to the gain on sale occurs
throughout the life of the asset as it is depreciated, causing its carrying amount to fall. The
consolidation adjustment on December 31, 2014, for the tax effect of the depreciation
adjustment is:
Retained earnings T 15
It can be seen that over the asset’s expected life, as it is depreciated the deferred tax asset
created on the intragroup sale of the asset is progressively being reversed.
In relation to the realization of the profit on sale, the unrealized after-tax profit on the sale
of the plant is $350 (i.e., $500 [1 0.3]). The profit is being realized at $35 ($50 $15) p.a.
At the end of the second year after the sale, a total of $70 is realized—$35 in the previous
year and $35 in the current year. When the asset is fully depreciated, the whole of the profit
on sale is realized. (Again for simplicity, we assume an ordinary tax rate rather than capital
gains tax.)
In the year of transfer, the general form of consolidation adjustments for depreciation of
a transferred asset is:
Plant and equipment—net T unrealized profit remaining
Depreciation expense T realized profit during the year
Income tax expense T tax on unrealized and c for realized profit during
the year
Deferred tax asset c tax on unrealized profit still remaining
In the years after the transfer, the adjustments are:
Plant and equipment—net T unrealized profit remaining
Depreciation expense T realized profit during the year
Income tax expense c tax on realized profit during the year
Deferred tax asset c tax on unrealized profit still remaining
Retained earnings—opening T unrealized profit remaining net of tax
balance
Note that, if a loss were made on the transfer, these adjustments would be reversed and
the tax-effect adjustment would reduce the deferred tax liability created as a result of the loss
on transfer. Again, intragroup losses may indicate an impairment loss that requires recogni-
tion on consolidation.
Adjustments for Transfers of Property, Plant, and Equipment

Consolidated financial statement adjustments for intragroup transactions involving transfers
of property, plant, and equipment are further demonstrated in Illustrative Example 4.2.
Illustrative Example 4.2 Intragroup Transactions

Involving Transfers of Property, Plant, and Equipment
South owns all the issued shares of North. The following transactions occurred:
1. On January 1, 2011, North sold an item of plant to South for $120,000. At the time
of sale, this asset had a carrying amount in North’s records of $115,000. The asset
is depreciated on a straight-line basis at 10% p.a.
2. On January 1, 2012, South sold land to North for $50,000. The carrying value in
South’s records was $43,000. The land is still held by North.
Required
Prepare the consolidated financial statement adjustments for the preparation of con-
solidated financial statements at December 31, 2013. The tax rate is 30%.
Solution
The required adjustments are:
1. Sale of plant in January 2011
Retained earnings (1/1/13) T 3,500 2 350
Deferred tax asset c 1,500 3 150
Plant (net) T 5,000 3 500
Note: In 2013 only a realized gain exists. The remaining unrealized balance is
adjusted through retained earnings.
Explanation:
Original gain 120,000
(115,000)
Unrealized profit 5,000/ 10 years 500 per year realized
Tax @ 30% (1,500)/ 10 years 150 per year realized
Net 3,500 / 10 years 350 per year realized
2. Sale of land in January 2012

Retained earnings (1/1/13) T 7,000 2,100 4,900
Land T 7,000
Deferred tax asset c 2,100
Explanation
The unrealized profit is $50,000 $43,000 $7,000 and the tax on that profit is 30%
7,000 2,100. Since the land is still unsold it remains unrealized and therefore the opening
retained earning is adjusted and the land is reduced on the statement of financial position.
✓ LEARNING CHECK
• Adjustments for the gain/loss on sale of property, plant, and equipment are made in all periods
in which the assets are within the group.
• Where the transferred assets are depreciable, adjustments are made to depreciation accounts,
the adjustments being in proportion to the gain/loss on sale.
• The gain/loss on sale is realized to the group as the asset is used up by the group, with profit
being realized in proportion to the rate of depreciation of the asset.
Intragroup Services 179
INTRAGROUP SERVICES
Objective 4 Many different examples of services between related entities exist. For instance:
Adjust for intragroup
• P may lend to S some specialist personnel for a limited period of time to perform a par-
services such as
management fees. ticular task by S. For this service, P may charge S a certain fee, or expect S to perform
other services in return.
• One entity may lease or rent an item of plant or a warehouse from the other.
• A subsidiary may exist solely for the purpose of carrying out some specific task, such as
research activities for the parent, and a fee for such research is charged. In this situa-
tion, all service revenue earned by the subsidiary is paid for by the parent, and must be
adjusted in the consolidation process.
Example 4.7: Intragroup Services

During 2013, P offered the services of a specialist employee to S for two months, in return
for which S paid $30,000 to P. The employee’s annual salary is $155,000, paid for by P.
The journal entries in the records of P and S in relation to this transaction are:
P
Cash 30,000
Service Revenue 30,000
S
Service Expense 30,000
Cash 30,000
From the group’s perspective there has been no service revenue received or service
expense made to entities external to the group. Hence, to adjust from what has been recorded
by the legal entities to the group’s perspective, the consolidation adjustment is:
Service revenue T 30,000
Service expense T 30,000
No adjustment is made in relation to the employee’s salary since, from the group’s view,
the salary paid to the employee is a payment to an external party.
Since there is no effect on the carrying amounts of assets or liabilities, there is no tempo-
rary difference and no need for any income tax adjustment.
Example 4.8: Intragroup Rent

P rents office space from S for $150,000 per year.
In accounting for this transaction, P records rent expense of $150,000 and S records rent
revenue of $150,000. From the group’s view, the intragroup rental scheme is purely an inter-
nal arrangement, and no revenue or expense is incurred. The recorded revenue and expense
therefore need to be eliminated. The appropriate consolidation adjustment is:
Rent revenue T 150,000
Rent expense T 150,000
There is no tax-effect adjustment necessary as assets and liabilities are unaffected by the
adjustment.
Realization of Profits or Losses

With the transfer of services within the group, the consolidation adjustments do not affect
the group’s profit. In a transaction involving a payment by a parent to a subsidiary for services
rendered, the parent shows an expense and the subsidiary shows revenue. The net effect on
the group’s profit is zero. Hence, from the group’s view, with intragroup services there are
no realization difficulties.
✓ LEARNING CHECK
• Adjustments for intragroup services may affect only statement of financial position accounts,
or only statement of comprehensive income accounts.
• It is generally not necessary to have a tax-effect adjustment when adjusting for intragroup
transfers of services.
• Profits/losses on intragroup services are immediately realized to the group.
INTRAGROUP DIVIDENDS
Objective 5 In this section, consideration is given to dividends declared and paid after P’s acquisition of S.
Adjust for intragroup All dividends received by the parent from the subsidiary are accounted for as revenue by the
dividends. parent since the parent has been recording its investment using the cost method on its own
non-consolidated financial statements. Two situations are considered in this section:
• dividends declared in the current period but not paid
• dividends declared and paid in the current period.
It is assumed that the company expecting to receive the dividend recognizes revenue
when the dividend is declared.
Dividends Declared in the Current Period

but Not Paid
Assume that, on December 31, 2013, S declares a dividend of $4,000. At the end of the
period, the dividend is unpaid. The journal entries recorded by the legal entities are:
S
Dividend Declared (in retained earnings) 4,000
Dividend Payable 4,000
P
Dividend Receivable 4,000
The adjustment made by S both reduces retained earnings and records a liability account.
From the group’s perspective, there is no reduction in equity and the group has no obligation
to pay dividends outside the group. Similarly, the group expects no dividends to be received
from entities outside the group. Hence, the appropriate consolidation adjustments are:
Dividend payable T 4,000
Dividend declared T 4,000
(To adjust for the effects of the adjustment made by S)
Dividend revenue T 4,000
Dividend receivable T 4,000
(To adjust for the effects of the adjustment made by P)
In the following period when the dividend is paid, no adjustments are required in the
consolidated financial statement. As there are no dividend revenues, dividend declared, or
Intragroup Dividends 181
receivable items left open at the end of the period, then the position of the group is the same
as the sum of the legal entities’ financial statements.
Dividends Declared and Paid in the Current Period

Assume S declares and pays an interim dividend of $4,000 in the current period. Entries by
the legal entities are:
P
Cash 4,000
S
Interim Dividend Paid (in retained earnings) 4,000
Cash 4,000
From the outlook of the group, no dividends have been paid and no dividend revenue has
been received. Hence, the adjustment necessary for the consolidated financial statements to
show the affairs of the group is:
Dividend declared and paid T 4,000
Tax Effect of Dividends

Generally, dividends are tax-free. There are, therefore, no tax-effect adjustments required in
relation to dividend-related consolidation adjustments.
Adjustments for Intragroup Dividends

Consolidated financial statement adjustments for intragroup transactions involving intra-
group dividends are further demonstrated in Illustrative Example 4.3.
Illustrative Example 4.3 Intragroup Dividends

Elsmere owns all the issued shares of Oakridge, having acquired them for $250,000 on
January 1, 2011. In preparing the consolidated financial statements at December 31, 2013,
the accountant documented the following transactions:
2012
June 15 Oakridge paid an interim dividend of $10,000.
December 25 Oakridge declared a dividend of $15,000, this being recognized in
the records of both entities.
2013
February 1 The $15,000 dividend declared on December 25, 2012, was paid by
Oakridge.
June 18 Oakridge paid an interim dividend of $12,000.
December 23 Oakridge declared a dividend of $18,000, this being recognized in
the records of both entities.
Required
Prepare the consolidated financial statement adjustments for the preparation of con-
solidated financial statements at December 31, 2013.
Solution
The required adjustments are:
1. Interim dividend paid
Dividend declared and paid T 12,000
Note: There is no effect on the ending retained earnings as the adjustment to revenue
offset the adjustment to the dividends declared in retained earnings.
2. Final dividend declared

Note: There is no effect on the ending retained earnings as the adjustment to revenue
offset the adjustment to the dividends declared in retained earnings.
✓ LEARNING CHECK
• Dividends from subsidiary equity are recognized as revenue by the parent and do not affect
the investment in the subsidiary since the parent is using the cost method to record its invest-
ment in the subsidiary.
• Adjustments affect both the dividend accounts reported by the subsidiary and those reported
by the parent.
• Consolidated financial statements show only the effects of dividends paid or payable to enti-
ties outside the group.
• Generally there are no tax-effect adjustments relating to adjustments for dividends.
INTRAGROUP BORROWINGS
Objective 6 Members of a group often borrow and lend money among themselves and charge interest on
Adjust for intragroup the money borrowed. In some cases, an entity may be set up within the group solely for the
borrowings. purpose of handling group finances and for borrowing money on international money markets.
Consolidation adjustments are necessary in relation to these intragroup borrowings and interest
thereon because, from the stance of the group, these transactions create assets and liabilities and
revenues and expenses that do not exist in terms of the group’s relationship with external entities.
Advances
Example 4.9: Intragroup Advances with Interest
P lends $100,000 to S, with S paying $15,000 interest to P. The relevant journal entries in
each of the legal entities are:
P
Advance to S 100,000
Cash 100,000
Cash 15,000
Interest Revenue 15,000
Intragroup Borrowings 183
S
Cash 100,000
Advance from P 100,000
Interest Expense 15,000
Cash 15,000
The consolidation adjustments involve eliminating the monetary asset created by P, the
monetary liability recorded by S, the interest revenue recorded by P, and the interest expense
paid by S:
Advances from P T 100,000
Advances to S T 100,000
Interest revenue T 15,000
Interest expense T 15,000
The adjustment to the asset and liability is necessary as long as the intragroup loan exists.
In relation to any past period’s payments and receipt of interest, no ongoing adjustment
to accumulated profits (opening balance) is necessary as the net effect of the consolidation
adjustment is zero on that item.
Because the effect on net assets of the consolidation adjustment is zero, no tax-effect
adjustment is necessary.
Bonds
Example 4.10: Bonds Acquired at Date of Issue
On July 1, 2013, P issues 1,000 $100 bonds with an interest rate of 5% p.a. payable on July 1
of each year. S, a wholly owned subsidiary of P, acquires half the bonds issued.
The journal adjustments made by P and S for the year ended December 31, 2013, are:
P
1/7/13 Cash 100,000
Bonds 100,000
(Issue of bonds)
31/12/13 Interest Expense 2,500
Interest Payable 2,500
(Accrued interest payable of 5%
for 6 months; 0.05 $100,000 6/12)
S
1/7/13 Bonds in P 50,000
Cash 50,000
(Bonds acquired)
31/12/13 Interest Receivable 1,250
(Accrued interest revenue)
The consolidation adjustments are:

Bonds T 50,000
Bond investment T 50,000
Interest payable T 1,250
Interest receivable T 1,250
It is possible for an entity to acquire the bonds of another entity in the group on the open
market. In effect the group has now retired the bonds. The consolidation adjustments are
shown in Appendix 4A to the chapter as they involve complex adjustments not usually cov-
ered in an advanced accounting course.
✓ LEARNING CHECK
• Intragroup borrowings result in assets in one member of the group and liabilities in another.
• Interest payments result in revenues in one member of the group and expenses in another.
KEY TERMS
LEARNING SUMMARY
Consolidated financial
statements (p. 163)
Intragroup transactions can take many forms and may involve transfers of inventory or prop-
Entity concept of con-
erty, plant, and equipment, or they may relate to the provision of services by one member of
solidation (p. 163)
the group to another member. To prepare the relevant financial statement adjustments for
Group (p. 162)
a transaction, it is necessary to consider the accounts affected in the entities involved in the
transaction.
Intragroup transfers of inventory; property, plant, and equipment; services; divi-
dends; and bonds and their adjustment in the consolidation process are associated with a
need to consider the implications of applying tax-effect accounting in the consolidation
process.
The basic approach to determining the consolidation adjustments for intragroup
transfers is:
1. Analyze the events within the records of the legal entities involved in the intragroup
transfer. Determine whether the transaction is a prior period or current period
event.
2. Analyze the position from the group’s viewpoint.
3. Create adjustments to change from the legal entities’ position to that of the group.
4. Consider the tax effect of the adjustments.
Note again that there are no actual adjustments made in the records of the individual
legal entities that constitute the group.
We can summarize these adjustments as a series of equations that are representative of
the consolidation process.
For any intercompany unrealized profits:

In the year that the intercompany transfer occurs and the profit becomes unrealized from
the group perspective:
T Decrease the profit for the amount of unrealized profit.
T Decrease the tax on the unrealized profit.
T Decrease the asset for the amount of the unrealized profit that still remains.
c Increase a deferred tax asset for the amount of unrealized profit that still remains.
T Decrease retained earnings (ending) for any unrealized profit net of tax that exists at
that date.
In subsequent periods, and as long as the profit is still unrealized:

There is no effect on the statement of comprehensive income.
Statement of retained earnings:
T Decrease retained earnings (beginning) for any unrealized profit net of tax that
exists at that date.
T Decrease the asset for the amount of the unrealized profit that still remains.
c Increase a deferred tax asset for the amount of unrealized profit that still remains.
T Decrease retained earnings (ending) for any unrealized profit net of tax that exists at
that date.
Note: This is the same adjustment that was made in the previous year and will be made each
year until the profit is realized.
In the year that the unrealized profit is realized:

c Increase income for the amount of realized profit.
c Increase taxes on the amount of realized profit.
Statement of retained earnings:
T Decrease retained earnings (beginning) for the amount of unrealized profit net of
tax that exists at that date.
There is no effect on the statement of financial position as the profit is now realized.
APPENDIX 4A BONDS ACQUIRED

ON THE OPEN MARKET
Objective 7 On January 1, 2013, P issued 1,000 5% bonds of $100 at par value. Interest is payable half-yearly
Adjust for intragroup on June 30 and December 31. Bonds are to be redeemed after 10 years. Assume that S acquired
bonds acquired on 400 of these bonds on the open market on June 30, 2013, when the market rate of interest was
the open market. 6%. It is assumed that S records this investment at amortized cost in accordance with IFRS 9.
Journal adjustments made by P and S for the year ended December 31, 2013, are:
P
1/1/13 Cash 100,000
Bonds 100,000
(Issue of bonds)
Cash 2,500
(Interest paid on 30/06/13 0.05 $100,000 6/12)
Cash 2,500
(Interest paid on 31/12/13)
S
30/6/13 Bonds in P 38,294
Cash 38,294
(400 bonds acquired includes a discount of $1,706)
($40,000 $38,294 $1,706)
31/12/13 Cash 1,000
Bonds in P 149
(Per Illustration 4A.1)
Illustration 4A.1
Cash Interest Revenue
Amortization Schedule
Date 2.50% 3% Discount Carrying Value
June 30, 2013 1,706.00 38,294.00

Dec. 31, 2013 1,000.00 1,148.82 148.82 38,442.82
June 30, 2014 1,000.00 1,153.28 153.28 38,596.10
Dec. 31, 2014 1,000.00 1,157.88 157.88 38,753.99
June 30, 2015 1,000.00 1,162.62 162.62 38,916.61
Dec. 31, 2015 1,000.00 1,167.50 167.50 39,084.11
June 30, 2016 1,000.00 1,172.52 172.52 39,256.63
Dec. 31, 2016 1,000.00 1,177.70 177.70 39,434.33
June 30, 2017 1,000.00 1,183.03 183.03 39,617.36
Dec. 31, 2017 1,000.00 1,188.52 188.52 39,805.88
June 30, 2018 1,000.00 1,194.12 194.12 40,000.00
From the group’s perspective, the purchase by S on the open market effectively redeemed
400 of the bonds issued by P. The group has redeemed 400 of the bonds at a price less than
par value and is entitled to recognize income in the consolidated financial statement to the
extent of the discount received on purchase or redemption. The consolidation adjustments
necessary at December 31, 2013, are:
Bonds T 40,000
Income on redemption c 1,706 T 149 c1,557
(Per Illustration 4A.1)
The net effect on net profit in 2013 is the recognition of the income on redemption
of $1,706 and the amortization of that profit for six months, shown through the difference
between interest revenue and interest expense using the effective interest method.
In future periods, while the bonds are still outstanding in the records of P, the consolida-
tion adjustments for bonds and interest must continue to be made. However, the income on
redemption of bonds is considered to have occurred on September 30, 2013, and has been
amortized each year. Hence, in future periods, an adjustment is made to retained earnings
(opening balance) for the amount of the income still available. To illustrate, the consolidation
adjustments necessary at December 31, 2014, are as follows:
Bonds T 40,000
Retained earnings (1/1/14) c 1,557
Interest revenue T 1,153 1,158 2,311
(full year’s interest on 400 bonds)
The difference between the interest revenue and interest expense of $311 will reduce
income in 2014 (see Illustration 4A.1; there is a slight difference due to rounding). Each year
the consolidated income will be reduced for the difference between the interest revenue and
the interest expense per Illustration 4A.1 using the effective interest method.
There is a tax effect in the group because the assets and liabilities are not reduced equally.
If we assume a 30% tax rate, the following adjustments are made to taxes in 2013:
Income tax expense c 0.3 1,706 0.3 149 467

Future income tax liability c 467
In 2014 the following adjustments are made for taxes:
Retained earnings c 467
Income tax expense T 0.3 (153 158) 93
Future income tax liability c 93
Under ASPE, the process is the same except that companies are permitted to amortize
ASPE the discount on a straight-line basis.
Intragroup Transfers of Assets
The following example illustrates procedures for preparing a consolidated statement of com-
prehensive income, a consolidated statement of changes in equity, and a consolidated state-
ment of financial position where the subsidiary is 100% owned. The consolidated financial
statement adjustments for intragroup transactions, including inventory and non-current asset
transfers, are also demonstrated.
On January 1, 2009, Mobel acquired all the share capital of Incentem for $472,000. At
that date, Incentem’s equity consisted of the following.
At January 1, 2009, all of Incentem’s identifiable assets and liabilities were recorded at
fair value.
Financial information for Mobel and Incentem for the year ended December 31, 2013, is
presented in the left-hand columns of the financial statement illustrated in Illustration 4.3. It
is assumed that both companies use the perpetual inventory system.
1. On June 30, 2013, Incentem sold merchandise costing $30,000 to Mobel for $50,000.
Half this merchandise was sold to external entities for $28,000 before December 31, 2013.
2. On September 30, 2013, Mobel sold plant to Incentem for $6,000, which was $1,000 below
its carrying amount to Mobel at that date. The plant had a remaining life of 10 years.
3. In 2010, Mobel sold land to Incentem at $20,000 above cost. The land is still held by
Incentem.
4. At January 1, 2013, there was a profit in Mobel’s inventory of $6,000 on goods acquired
from Incentem in the previous period.
5. The tax rate is 30%.
Required
Solution
A. The first step is to determine the fair value adjustments at December 31, 2013. These
adjustments are prepared after undertaking an acquisition analysis. At January 1, 2009:
Consideration transferred ⫽ $472,000
Net fair value of Incentem’s identifiable ⫽ $300,000 ⫹ 152,000
assets and liabilities ⫽ $452,000
Goodwill ⫽ $ 20,000
Goodwill c 20,000
Investment T 472,000
Share capital T 300,000
Retained earnings T 152,000
The next step is to prepare the adjustments arising because of the existence of intragroup
transactions. It is important to classify the intragroup transactions into current period
and previous period transactions. The resultant adjustments should reflect those deci-
sions, because previous period transactions would be expected to affect accounts such as
retained earnings rather than accounts such as sales and cost of sales.
1. Profit in ending inventory—unrealized
The transaction occurred in the current period. The adjustments are:
Sales T 50,000
Cost of sales T 50,000 ⫺ c 10,000 ⫽ T 40,000
($10,000 ⫽ ½ ⫻ [$50,000 ⫺ $30,000])
Inventory T 10,000
Income tax expense T 3,000
(30% ⫻ $10,000)
Sales: The members of the group have recorded total sales of $78,000—$50,000 by
Incentem and $28,000 by Mobel. The group recognizes only sales to entities outside
the group, namely the sales by Mobel of $28,000. Hence, in preparing the consolidated
financial statements, sales must be reduced by $50,000.
Cost of sales: Incentem recorded cost of sales of $30,000 and Mobel recorded cost of sales
of $25,000 (being half of $50,000). Recorded cost of sales then totals $55,000. The cost
of the sales to entities external to the group is $15,000 (being half of $30,000). Cost of
sales must then be reduced by $40,000.
Inventory: At December 31, 2013, Mobel has inventory on hand from intragroup trans-
actions, and records them at cost of $25,000 (being half of $50,000). The cost of this
inventory to the group is $15,000 (being half of $30,000). Inventory is then reduced by
$10,000.
Deferred tax asset/income tax expense: Under tax-effect accounting, temporary differ-
ences arise where an asset’s carrying amount differs from its tax base. In the first adjust-
ment above, inventory is reduced by $10,000; that is, the carrying amount of inventory
is reduced by $10,000. This then gives rise to a temporary difference, and because the
carrying amount has been reduced, tax benefits are expected in the future when the asset
is sold. Hence a deferred tax asset, equal to the tax rate times the change to the carry-
ing amount of inventory (30% $10,000), of $3,000 is recorded. Given that there is no
deferred tax asset in the financial statement in Illustration 4.3, the adjustment is made
against the deferred tax liability line item.
2. Loss on sale of plant
This is a current period transaction. The consolidated financial statement adjustments are:
Plant and equipment—net c 1,000
Loss on sale of plant T 1,000
Deferred tax liability c 300
(30% $1,000)
Plant and equipment: The plant is recorded by Incentem at a cost of $6,000. The cost to
the group is $7,000. Hence, plant must be increased by $1,000.
Loss from sale: Mobel recorded a loss on sale of the plant to Incentem of $1,000. Because
the sale did not involve entities external to the group, the loss on sale must be eliminated.
Note that we are assuming that this loss is not a real impairment.
Deferred tax liability: As the carrying amount of the plant sold is increased by $1,000, a
temporary difference between carrying amount and tax base is created. This has to be
tax-effected. As the asset’s carrying amount is increased, a deferred tax liability of $300
(being 30% $1,000) must be recorded, reflecting the lower depreciation charge being
made by the entity.
Depreciation on plant
The transferred asset is being depreciated by Incentem on a straight-line basis, over
10 years. The consolidated financial statement adjustment is:
Depreciation expense c 25
Plant—net c 25
Deferred tax liability T 8
(30% $25 7.5 round to 8)
The asset was transferred on September 30, requiring depreciation for the remaining
three months of the year. Incentem is depreciating the asset based on cost of $6,000, and
the group cost is $7,000. A comparison of the relative depreciation charges is:
Recorded depreciation Group depreciation
10% $6,000 ¼ year $150 10% $7,000 ¼ year $175
Depreciation expense: As the group depreciation expense exceeds the recorded deprecia-
tion by $25, depreciation expense is increased by $25. The unrealized loss of $1,000 is
being realized over 10 years $100 per year ¼ year $25.
Plant—net: This is also decreased by $25.
Deferred tax liability: The $25 adjustment to accumulated depreciation changes the asset’s
carrying amount, giving rise to a temporary difference between this and the tax base. The
deferred tax liability is debited for $8 (i.e., 30% $25) to reflect that the depreciation
being charged by the legal entity is lower than that to the group.
3. Profit on sale of land in previous period

This is a previous period transaction. The consolidated financial statement adjustment is:

Land T 20,000
(30% $20,000)
Retained earnings: In the previous period, Mobel recorded a profit on sale of land of
$20,000. This sale did not involve entities external to the group, and hence must be
eliminated on consolidation. A further adjustment to retained earnings is required to
reflect the tax on this profit. A net adjustment of $14,000 is then made to retained
earnings.
Land: Incentem records the land at a cost of $20,000 greater than that to the group.
Hence, the land must be reduced by $20,000 so that the consolidated statement of financial
position shows assets at cost to the group.
Deferred tax asset: The reduction to the carrying amount of the land creates a temporary
difference between carrying amount and tax base. A deferred tax asset is recorded to
reflect the future tax benefits when the asset is sold.
4. Profit in beginning inventory
This is a previous period transaction. The required consolidated financial statement

adjustment is:
Income tax expense c 1,800
Retained earnings: In the previous period, Incentem recorded a $6,000 before-tax profit,
or a $4,200 after-tax profit on sale of inventory within the group. Because the sale did not
involve external entities, the profit must be eliminated on consolidation.
Cost of sales: In the current period, the transferred inventory is sold to external entities.
Mobel records cost of sales at $6,000 greater than to the group. Hence, cost of sales is
reduced by $6,000. Note that this increases group profit by $6,000, reflecting the realiza-
tion of the profit to the group in the current period, when it was recognized by the legal
entity in the previous period.
Income tax expense: At the end of the previous period, in the consolidated statement of
financial position, a deferred tax asset of $1,800 was recorded because of the difference
in cost of the inventory recorded by the legal entity and that recognized by the group.
This deferred tax asset is reversed when the asset is sold. The adjustment to income tax
expense reflects the reversal of the deferred tax asset recorded at the end of the previ-
ous period.
Illustration 4.3 shows the completed consolidated financial statements of Mobel and its sub-
sidiary Incentem at December 31, 2013. Once the effects of all adjustments are added or
subtracted horizontally to calculate figures in the right-hand “Adjustments Consolidation”
column, the consolidated financial statements can be prepared, as shown in Illustration 4.4(a),
(b), and (c).
Illustration 4.3
Financial Statements Mobel Incentem Adjustments Consolidation
Consolidated Financial
Statement—Intragroup Sales revenue 1,196,000 928,000 50,0001 2,074,000
Transfers of Assets
Cost of sales (888,000) (670,000) 50,0001 10,0001 (1,512,000)
6,0004
Wages and salaries (57,500) (32,000) (89,500)
Depreciation (5,200) (4,800) 252 (10,025)
Other expenses (4,000) — (4,000)
Total expenses (954,700) (706,800) (1,615,525)
Gain (loss) (1,000) — 1,0002 —
Income before income tax 240,300 221,200 458,475
Income tax expense (96,120) (118,480) 3,0001 82 (213,692)
3002 1,8004
Net income 144,180 102,720 244,783
Retained earnings (1/1/13) 235,820 166,280 152,000A 231,900
20,0003 6,0003
6,0004 1,8003
Dividend paid (80,000) — (80,000)
(31/12/13)
Share capital 500,000 300,000 300,000A 500,000
Other components of equity 4,000 10,000 14,000
(1/1/13)
Revaluation of property 1,000 3,000 4,000
Other components of equity 5,000 13,000 18,000
(31/12/13)
Total equity 805,000 582,000 914,683
Deferred tax liability 52,000 30,000 3,0001 3002 73,292
82 6,0003
Investment in Incentem 472,000 — 472,000A —
Cash 80,000 73,000 153,000
Inventory 168,000 36,000 10,0001 194,000
Other current assets 10,000 300,000 310,000
Financial assets 15,000 68,000 83,000
Land 70,000 120,000 20,0003 170,000
Plant and equipment 42,000 15,000 1,0002 252 57,975
Goodwill — — 20,000A 20,000
857,000 612,000 987,975
Illustration 4.4a
Consolidated Statement MOBEL
of Comprehensive Income Consolidated Statement of Comprehensive Income
Revenues $2,074,000
Expenses 1,615,525
Income before income tax 458,475
Net income $ 244,783
Other comprehensive income
Revaluation of property 4,000
TOTAL COMPREHENSIVE INCOME FOR THE YEAR $ 248,783
Illustration 4.4b
of Changes in Equity Consolidated Statement of Changes in Equity
Total comprehensive income for the year $ 248,783

Retained earnings at January 1, 2013 $231,900
Net income 244,783
Dividend paid (80,000)
Retained earnings at December 31, 2013 $396,683
Other components of equity at January 1, 2013 $ 14,000
Revaluation of property 4,000
Other components of equity at December 31, 2013 $ 18,000
Share capital at January 1, 2013 $500,000
Share capital at December 31, 2013 500,000
Illustration 4.4c
of Financial Position Consolidated Statement of Financial Position
Current assets
Cash assets $153,000
Inventories 194,000
Other 310,000
Non-current assets
Property, plant, and equipment:
Plant and equipment—net $ 57,975
Land 170,000 227,975
Goodwill 20,000
Net assets $914,683
Equity
Other components of equity 18,000
Dividends and Borrowings
On January 1, 2013, Letni acquired all the share capital of Atemico for $187,500. At that
date, equity of the two companies was:
Letni Atemico
Share capital $150,000 $100,000
At January 1, 2013, the identifiable net assets of both companies were recorded at fair
values.
For the year ended December 31, 2013, the summarized financial information for the
two companies shows the following details:
Letni Atemico
Sales revenue $390,000 $200,000
Dividend revenue 7,500 —
Other revenue 10,000 —
Total revenues 407,500 200,000
Total expenses (360,000) (176,000)
Profit before income tax 47,500 24,000
Profit 32,500 14,000
Interim dividend paid (7,500) (2,500)
Final dividend declared (15,000) (5,000)
(22,500) (7,500)
Investment in Atemico $187,500 —
Dividend receivable 5,000 —
Loan receivable 7,000 —
Total assets 218,000 205,000
Final dividend payable 15,000 5,000
Loan payable — 7,000
Other non-current liabilities 23,000 9,000
Net assets $180,000 $184,000
Total equity $180,000 $184,000
1. Letni has lent $7,000 to Atemico, at an interest rate of 10%.
2. Letni has recognized both the interim and final dividends from Atemico as revenue.
Required
Prepare the consolidated financial statements as at December 31, 2013, for Letni and its
subsidiary Atemico.
Solution
Note: The dividends paid and declared by the parent to its shareholders are not adjusted for
in the consolidated financial statements, because these dividends are paid by the group to
external entities.
Acquisition analysis: Letni and Atemico

At January 1, 2013:

Net fair value of identifiable assets and $100,000 $77,500
liabilities of Atemico
$177,500
Goodwill $10,000
Consolidated financial statement adjustments

(A) Business combination fair value adjustment at December 31, 2013, is then:
Investment in Atemico T 187,500
Goodwill c 10,000
1. Interim dividend: Atemico
This is a current period transaction. The consolidated financial statement adjustment is:
Atemico paid a dividend in cash to Letni. Letni recognized dividend revenue and Atemico
recognized dividends paid. From the group’s perspective, there were no dividends paid to
entities external to the group. Hence, on consolidation it is necessary to eliminate both the
Dividend Paid and Dividend Revenue accounts raised by the parent and the subsidiary.
2. Final dividend declared: Atemico
This is a current period transaction. The consolidated financial statement adjustment is:
The subsidiary declares a dividend, recognizing a liability to pay the dividend and reduc-
ing retained earnings. The parent, which expects to receive the dividend, records a receiv-
able asset and recognizes dividend revenue. From the group’s point of view, because the
dividend is not receivable or payable to entities external to the group, it does not want
to recognize any of these accounts. Hence, on consolidation, all the accounts affected by
this transaction in the records of the parent and the subsidiary are eliminated.
3. Loan: Letni to Atemico
The loan may have been made in a previous period or the current period. The consoli-
dated financial statement adjustment is the same:
Loan payable T 7,000
Loan receivable T 7,000
This adjustment eliminates the receivable recorded by the parent and the payable
recorded by the subsidiary. From the group’s point of view, there are no loans payable or
receivable to entities external to the group.
4. Interest on loan
The interest paid/received is a current period transaction. In some situations where
interest is accrued, interest may relate to previous or future periods. The consolidated
financial statement adjustment is:
Interest revenue T 700
Interest expense T 700
(10% $7,000)
The parent records interest revenue of $700 and the subsidiary records interest expense of
$700. No interest was paid or received by the group from entities external to the group, so
these accounts must be eliminated on consolidation.
From Illustration 4.5, after all adjustments have been entered in the financial statement
and amounts totalled across to the consolidation column, the consolidated financial state-
ments can be prepared in suitable format, as shown in Illustration 4.6(a), (b), and (c).
Illustration 4.5
Financial statements Letni Atemico
Statement—Dividends Sales revenue 390,000 200,000 590,000
Dividend revenue 7,500 — 2,5001 5,0002 —
Other revenue 10,000 — 7004 9,300
407,500 200,000 599,300
Expenses (360,000) (176,000) 7004 (535,300)
Profit before income tax 47,500 24,000 64,000
Income tax expense (15,000) (10,000) (25,000)
Profit 32,500 14,000 39,000
Retained earnings (1/1/13) 20,000 77,500 77,500A 20,000
52,500 91,500 59,000
Interim dividend paid (7,500) (2,500) 2,5001 (7,500)
Final dividend declared (15,000) (5,000) 5,0002 (15,000)
22,500 7,500 22,500
Share capital 150,000 100,000 100,000A 150,000
Final dividend payable 15,000 5,000 5,0002 15,000
Loan payable — 7,000 7,0003 —
Other non-current liabilities 23,000 9,000 32,000
Investment in Atemico 187,500 — 187,500A
—
Dividend receivable 5,000 — 5,0002 —
Loan receivable 7,000 — 7,0003 —
Goodwill — — 10,0001 10,000
Total assets 218,000 205,000 233,500
Illustration 4.6a
Consolidated Statement LETNI
of Comprehensive Income Consolidated Statement of Comprehensive Income
For the year ended December 31, 2013
Revenues $599,300
Expenses 535,300
Net income 39,000
Other comprehensive income —
TOTAL COMPREHENSIVE INCOME FOR THE YEAR $ 39,000
Illustration 4.6b
of Changes in Equity Consolidated Statement of Changes in Equity
Total comprehensive income for the year $ 39,000

Retained earnings at January 1, 2013 20,000
Net income 39,000
Interim dividend paid (7,500)
Final dividend declared (15,000)
Retained earnings at December 31, 2013 36,500
Share capital as at January 1, 2013 150,000
Share capital at December 31, 2013 $150,000
Illustration 4.6c
of Financial Position Consolidated Statement of Financial Position
Non-current assets
Goodwill 10,000
Current liabilities
Final dividend payable 15,000
Non-current liabilities 32,000
Net assets $186,500
Equity
Brief Exercises
(LO 1) BE4-1 Why is it necessary to make adjustments for intragroup transactions?
(LO 1) BE4-2 In making consolidated financial statement adjustments, sometimes tax-effect adjustments are made. Why?
(LO 1) BE4-3 Why is it important to identify transactions as current or previous period transactions?
(LO 3) BE4-4 Where an intragroup transaction involves a depreciable asset, why is depreciation expense adjusted?
(LO 1) BE4-5 What is meant by “realization of profits”?
(LO 2) BE4-6 When are profits realized in relation to inventory transfers within the group?
(LO 3) BE4-7 When are profits realized on transfers of depreciable assets within the group?
(LO 4) BE4-8 Why is it necessary to eliminate services charged by one company in a group to another company in the same
group?
(LO 6) BE4-9 (a) Why would companies within the same group lend money to each other? (b) Should these borrowings be
eliminated on a consolidated statement? Why or why not?
Exercises
(LO 2) E4-1 Piros Ltd. sold inventory to its wholly owned subsidiary, Stanimir, for $15,000. These items previously cost
Piros $12,000. Stanimir subsequently sold half the items to Nova for $8,000. The tax rate is 30%.
The group accountant for Piros, Li Chen, maintains that the appropriate consolidation adjustments are as follows:
Sales T 15,000
Required
(a) Discuss whether the adjustments suggested by Li Chen are correct, explaining on a line-by-line basis the correct
adjustments.
Exercises 197
(b) Determine the consolidated financial statement adjustments in the following year, assuming the inventory is sold,
and explain the adjustments on a line-by-line basis.
(LO 2, E4-2 Rentech owns all the share capital of Inced. The following intragroup transactions took place.
3, 5) 1. During the year ending December 31, 2013, Inced sold $50,000 worth of inventory to Rentech. Inced recorded a
$10,000 profit before tax on these transactions. At December 31, 2013, Rentech has one quarter of these goods still
on hand.
2. Inced sold land to Rentech for $100,000. This had originally cost Inced $82,000. The transaction took place on
July 1, 2012.
3. During 2013, Rentech sold inventory costing $12,000 to Inced for $18,000. One third of this was sold to Olivia for
$9,500.
4. On June 30, 2012, Inced sold inventory costing $6,000 to Rentech at a transfer price of $8,000. Half was sold in
January 2013 to Anon at a loss of $200.
5. On December 15, 2013, Rentech declared a dividend of $10,000. On the same day, Inced declared a $5,000 dividend.
6. On June 30, 2013, Rentech issued 1,000 5% bonds of $100 at nominal value. Inced acquired 400 of these. Interest
is payable half-yearly on December 31 and June 30.
7. During 2012, Rentech sold inventory to Inced for $10,000, recording a before-tax profit of $2,000. Half this inven-
tory was unsold by Inced at December 31, 2013.
Required
Prepare the adjustments for the consolidated financial statement at December 31, 2013. Assume an income tax rate of
30% and that all income on sale of assets is taxable and expenses are deductible.
(LO 2, 3) E4-3 Addison owns all of the share capital of Erin. The following intragroup transactions, all parts of which are inde-
pendent unless specified, took place.
1. In January 2013, Addison sold inventory to Erin for $15,000. This inventory had previously cost Addison $10,000,
and it remained unsold by Erin at the end of the period.
2. All the inventory in (1) above was sold to Olivia, an external party, for $20,000 on February 2, 2013.
3. Half the inventory in (1) above was sold to Taylah, an external party, for $9,000 on February 22, 2013. The
remainder was still unsold at the end of the period.
4. Addison, in March 2013, sold inventory for $10,000 that was transferred from Erin three years ago. It had origi-
nally cost Erin $6,000, and was sold to Addison for $12,000.
5. Erin sold some land to Addison in December 2012. The land had originally cost Erin $25,000, but was sold to
Addison for only $20,000. To help Addison pay for the land, Erin gave Addison a loan of $12,000, and the balance
was paid in cash. Addison has as yet made no repayments on the loan.
6. On January 1, 2013, Addison sold a depreciable asset costing $10,000 to Erin for $12,000. Addison had not charged
any depreciation on the asset before the sale. Both entities depreciated assets at 10% p.a. on cost.
7. On January 1, 2012, Addison sold a machine to Erin for $6,000. This item had cost Addison $4,000. Both companies
charged depreciation at the rate of 10% p.a. on cost.
Required
Prepare the consolidated financial statement adjustments as at December 31, 2013. Assume an income tax rate of 40%
and that all income on sale of assets is taxable and expenses are deductible.
(LO 2, 3) E4-4 Tians owns all the share capital of Veronisi. The following transactions relate to the period ended December
31, 2013.
1. On January 1, 2012, Tians sold a motor vehicle to Veronisi for $15,000. This had a carrying amount to Tians of
$12,000. Both entities depreciate motor vehicles on a straight-line basis over 10 years.
2. On June 30, 2013, Veronisi sold machinery to Tians for $62,000, its cost to Veronisi being only $55,000. Tians
charges depreciation on these machines at 20% p.a. on cost.
3. Tians manufactures certain items that it then markets through Veronisi. During the current period, Tians sold for
$12,000 items to Veronisi at cost plus 20%. Veronisi has sold 75% of these transferred items at December 31, 2013.
4. Veronisi also sells second-hand machinery. Tians sold one of its depreciable assets (original cost $40,000, accu-
mulated depreciation $32,000) to Veronisi for $5,000 on June 30, 2013. Veronisi had not resold the item by
December 31, 2013.
5. Veronisi sold a depreciable asset (carrying amount of $22,000) to Tians on January 1, 2012, for $25,000. Both enti-
ties charge depreciation at a rate of 10% p.a. on cost in relation to these items. On June 30, 2013, Tians sold this
asset to Avonara for $20,000.
Required
Assuming an income tax rate of 30%, provide adjustments to be included in the consolidated financial statement as at
December 31, 2013.
(LO 2, 3, E4-5 For each of the following intragroup transactions, assume that the consolidation process is being undertaken at
4, 5) December 31, 2013, and that an income tax rate of 40% applies.
1. On January 1, 2013, Campism sold an item of plant to Velvel for $1,000. Immediately before the sale, Campism
had the item of plant on its accounts for $1,500. Campism depreciated items at 5% p.a. on cost and Velvel used the
straight-line method over 10 years.
2. A non-current asset with a carrying amount of $1,000 was sold by Campism to Velvel for $800 on June 30, 2013.
Both entities charged depreciation at the rate of 10% p.a. on cost. The item was still on hand at December 31, 2013.
3. On November 1, 2013, Velvel sold inventory costing $200 to Campism for $400 on credit. On December 31,
2013, only half of these goods had been sold by Campism, but Campism had paid $300 back to Velvel.
4. During September 2013, Velvel declared a $3,000 dividend. The dividend was paid in February 2014.
5. In June 2013, Velvel paid a $1,500 interim dividend.
6. In August 2012, Campism sold inventory to Velvel for $6,000, at a gross profit of 20%. One quarter of this inven-
tory was unsold by Velvel at December 31, 2012.
7. On July 1, 2010, Velvel sold land to Campism for $20,000. This had cost Velvel $16,000 on that day.
8. Velvel rented a spare warehouse to Campism and also to Rolo during 2013. The total charge for the rental was
$300, and Campism and Rolo both agreed to pay half of this amount to Velvel.
Required
Calculate the consolidated financial statement adjustments for these transactions. All parts are independent unless spec-
ified. Campism owns all the share capital of Velvel.
(LO 2, E4-6 On January 1, 2010, Excelate acquired all the share capital of Tryon for $300,000. The equity of Tryon at
4, 5, 6) January 1, 2010, was:

$270,000
At this date, all identifiable assets and liabilities of Tryon were recorded at fair value. Goodwill is tested annu-
ally for impairment. By December 31, 2013, no impairment has occurred. At January 1, 2010, no goodwill had been
recorded by Tryon.
1. At December 31, 2013, Tryon holds $100,000 of 7% bonds issued by Excelate on January 1, 2012. All necessary
interest payments have been made.
2. At the end of the reporting period, Tryon owes Excelate $1,000 for items sold on credit.
3. Tryon undertook an advertising campaign for Excelate during the year. Excelate paid $8,000 to Tryon for this
service.
4. The beginning and ending inventories of Excelate and Tryon in relation to the current period included the follow-
ing unsold intragroup inventory:
Excelate Tryon
Beginning inventory:
Transfer price $2,000 $1,200
Original cost 1,400 800
Ending inventory:
Transfer price 500 900
Original cost 300 700
Excelate sold inventory to Tryon during the current period for $3,000. This was $500 above the cost of the inventory
to Excelate. Tryon sold inventory to Excelate in the current period for $2,500, recording a pre-tax profit of $800.
Problems 199
5. Excelate sold an item to Tryon on January 1, 2013, for use as part of plant and machinery. The item cost Excelate
$4,000 and was sold to Tryon for $6,000. Tryon depreciated the item straight line over 10 years.
6. Excelate received dividends totalling $63,000 during the current period from Tryon. All of this is related to divi-
dends declared in the current period.
Required
The current tax rate is 30%. Assuming consolidated financial statements are required for the period January 1, 2013,
to December 31, 2013, calculate the adjustments (including the pre-acquisition adjustment) that would be made in the
consolidated financial statements.
(LO 1, E4-7 Alexis owns 100% of the shares of Ruby. During 2013, the following events occurred:
2, 3) 1. Alexis sold inventory for $10,000 that had been sold to it by Ruby in December 2012. The inventory originally cost
Ruby $6,000 and was sold to Alexis for $9,000.
2. Alexis recorded depreciation of $10,000 on machinery sold to it by Ruby on January 1, 2012. The machinery had a
carrying amount in Ruby at the date of sale of $80,000. Both entities apply a depreciation rate of 10% p.a. on cost
on a straight-line basis for this type of machinery.
Required
(a) For each of the above transactions, calculate the adjustments required in the consolidated financial statement at
December 31, 2013, assuming an income tax rate of 40%.
(b) Explain the rationale behind each of the adjustments you have prepared.
(LO 7) E4-8 Using the information from E 4-6, assume that instead of Tyron acquiring the bonds from Excelate, it acquired
the bonds on the open market for $95,000. The market rate of interest at January 1, 2012 was 8%.
Required
Calculate the adjustments regarding the bonds that would be required for the consolidated financial statements at
December 31, 2013.
Problems
(LO 1, 2, P4-1 On January 1, 2011, Devco acquired cum div. all the shares of Brooke, at which date the equity and liability sec-
3, 4, 5) tions of Brooke’s statement of financial position showed the following balances:

The dividend payable was subsequently paid in February 2011.

On January 1, 2011, all the identifiable assets and liabilities of Brooke were recorded at fair value except for:

Inventory $120,000 $130,000
Machinery (cost $200,000) 160,000 165,000
The inventory was all sold by October 2011. The machinery had a further five-year life but was sold on June
30, 2013. At the acquisition date, Brooke had a contingent liability of $20,000 that Devco considered to have a
fair value of $12,000. This liability was settled in December 2011. At January 1, 2011, Brooke had not recorded
any goodwill.
On December 31, 2013, the trial balances of Devco and Brooke were as follows:
Trial Balances
Devco Brooke
Investment in Brooke $ 396,000 $ —
Inventory 180,000 160,000
Cash 25,000 10,000
Devco Brooke
Land 154,200 65,000
Dividend declared 10,000 4,000
$1,401,700 $706,000
Share capital $ 800,000 $330,000
Income before income tax 80,000 90,000
Bonds 100,000 40,000
Accumulated depreciation—plant and machinery 212,000 110,000
$1,401,700 $706,000
1. On January 1, 2012, Devco sold an item of plant to Brooke at a profit before tax of $4,000. Devco depreciates this
particular item of plant straight line over 5 years and Brooke depreciates straight line over 10 years.
2. At December 31, 2013, Devco had on hand some items of inventory purchased from Brooke in June 2013 at a
profit of $500.
3. Devco charged a management fee of $2,000 per month to Brooke. As of year end, Brooke had not paid the fee for
three months.
Required
(a) Prepare the consolidated statement of comprehensive income, consolidated statement of changes in equity, and
the consolidated statement of financial position at December 31, 2013.
(b) In relation to part (1) in the additional information, explain why you made the consolidated financial statement
adjustments at December 31, 2013.
(LO 2, P4-2 Summer Corp. owns all the shares of Keira Ltd. The shares were acquired on July 1, 2011, by Summer at a
4, 6) cost of $60,000. At acquisition date, the capital of Keira consisted of 44,000 common shares at $1. There were retained
earnings of $4,000. All the identifiable assets and liabilities of Keira were recorded at amounts equal to fair value,
except for:

Inventory $12,000 $15,000
Land 60,000 70,000
Machinery (cost $100,000) 80,000 82,000
The land was sold on June 1, 2012, for $94,000. The machinery had a further five-year life. The inventory
was all sold by December 31, 2011. Keira has not recorded any goodwill at July 1, 2011. Goodwill has not been
impaired.
The trial balances of the two entities at June 30, 2013, are shown below.
1. Intragroup sales of inventory for the year ended June 30, 2013, from Summer to Keira were $14,000 and from
Keira to Summer were $3,000.
2. Intragroup inventory on hand:
(a) at July 1, 2012: held by Keira, purchased from Summer at a profit of $400.
(b) at June 30, 2013: held by Summer, purchased from Keira at a profit of $200.
3. Intragroup machinery on hand at June 30, 2013:
(a) Summer: purchased from Keira on July 1, 2012, for $10,000 at a profit to Keira of $500. Depreciation rate is
straight line over 10 years.
(b) Keira: purchased from Summer on January 1, 2012, for $12,000, at a loss to Summer of $500. Depreciation rate
is 20% p.a. on cost.
Problems 201
4. Summer advanced $5,000 to Keira on January 1, 2013. Summer charges 5% interest annually. Kiera had not yet
paid the interest or the principal.
5. Keira paid a royalty fee of $1,000 to Summer during 2013.
6. The income tax rate is 30%.
Trial Balances
as at June 30, 2013
Summer Keira
Share capital $ 64,000 $ 44,000
Current liabilities 21,400 17,000
Machinery $ 38,000 $ 71,500
Investment in Keira 60,000 —
Inventory 19,000 16,400
Revenue 43,000 52,000
Cost of sales 20,600 30,900
Selling expenses 3,200 6,000
Administrative expenses 5,300 2,700
Depreciation/amortization expenses 1,200 2,600
Accumulated depreciation—machinery 12,200 22,300
Deferred tax assets 5,400 6,300
Plant (net of depreciation) 8,000 7,400
Gain/loss on sale of machinery 1,000 500
$173,600 $173,600 $156,800 $156,800
Required
Prepare consolidated financial statements (excluding the Statement of Cash Flows) of Summer and Keira as at
June 30, 2013.
(LO 2, P4-3 On December 31, 2009, Jupiter Inc. purchased all of the shares of Europa Ltd. for $4,760,000. On that date,
3, 6) the carrying amount of Europa’s identifiable net assets was $4,080,000. The carrying amount of Europa’s identifiable
net assets were equal to their fair values except that the carrying amount of Europa’s inventory was $2,000,000 while
its fair value was $2,119,000, and Europa had unrecognized trademarks that were worth $138,000. On the acquisi-
tion date, Europa’s retained earnings were $1,080,000. The trademarks were being amortized over 6 years. During
2013, an impairment loss of $170,000 occurred for the goodwill. Prior to 2013 there had not been any goodwill
impairment.
Following are separate entity financial statements for 2013:
JUPITER INC. & EUROPA LTD.

Statements of Income and Retained Earnings
year ended December 31, 2013
Jupiter Europa
Sales $12,280,000 $7,370,000
Investment income 240,000 12,000
12,520,000 7,382,000
Cost and expenses
Cost of goods sold 7,859,000 5,159,000
Depreciation and amortization expense 531,000 350,000
Interest expense 212,000 152,000
Other expenses 793,000 356,000
Income tax expense 1,250,000 546,000
10,645,000 6,563,000
Net income 1,875,000 819,000
Retained earnings, beginning of year 1,722,000 1,300,000
3,597,000 2,119,000
Dividends 625,000 240,000
Retained earnings, end of year $ 2,972,000 $1,879,000
JUPITER INC. & EUROPA LTD.

Balance Sheets
December 31, 2013
Jupiter Europa
Assets
Cash and receivables $ 1,516,000 $ 976,000
Inventory 4,124,000 2,850,000
Investment in Europa 4,716,000
Loan to Jupiter (non-current) 300,000
Property, plant and equipment (net) 4,716,000 5,756,000
$15,116,000 $9,882,000
Liabilities and shareholders’ equity
Current liabilities $ 2,844,000 $1,203,000
Long-term liabilities 5,300,000 3,800,000
Common shares 4,000,000 3,000,000
$15,116,000 $9,882,000
1. On January 1, 2013, Europa loaned Jupiter $300,000, none of which has been paid back. Europa earned $12,000 in
interest on the loan, which has been reported as investment income. The interest has not yet been received.
2. Europa regularly sells inventory to Jupiter at a price that earns a gross profit of 30% for Europa. During 2013
Jupiter purchased $1,000,000 of inventory from Europa and $400,000 of it remained unsold at December 31, 2013.
Jupiter did not have any inventory from Europa on hand.
3. On December 31, 2011, Europa had sold some equipment to Jupiter for $700,000 (equipment is still being used by
Jupiter). Europa’s carrying amount for this equipment just prior to its sale was $400,000. The remaining useful life
of the equipment was 15 years on the date of the sale.
4. Land that originally cost $390,000 had been sold by Jupiter to Europa in 2011 for $490,000. This land is still held
by Europa at December 31, 2013.
5. The tax rate is 40%
Required
Prepare Jupiter’s consolidated balance sheet as at December 31, 2013.
(Adapted from CGA-Canada)
(LO 2, P4-4 On December 31, 2008, HIT Company purchased all of the outstanding common shares of PUC Company for
3, 5) $12 million in cash. On that date, the shareholders’ equity of PUC consisted of $2 million in retained earnings. Both
companies use the FIFO method to account for inventory and the straight-line method to calculate depreciation.
For the year ended December 31, 2013, the income statements for HIT and PUC were as follows:
HIT PUC
Sales and other income $28,800,000 $13,000,000
Less expenses
Cost of goods sold 18,000,000 8,200,000
Depreciation expense 3,400,000 1,800,000
Income tax and other expenses 4,200,000 1,600,000
Net income $ 3,200,000 $ 1,400,000
At December 31, 2013, the condensed balance sheets for the two companies were as follows:
HIT PUC
Current assets $15,000,000 $ 8,800,000
Total assets $43,600,000 $26,200,000
Liabilities $26,400,000 $13,800,000

Common Shares 4,000,000 2,000,000
Retained Earnings 13,200,000 10,400,000
Total liabilities and shareholders’ equity $43,600,000 $26,200,000
Problems 203
1. On December 31, 2008, PUC had inventory with a fair value that was $100,000 less than its carrying value.
2. On December 31, 2008, PUC had equipment with a fair value that was $400,000 greater than its carrying value.
The equipment had an estimated remaining useful life of 8 years.
3. Each year, goodwill is evaluated to determine if there has been a permanent impairment. Goodwill has a value of
$3,580,000 at December 31, 2012 and $3,200,000 at December 31, 2013.
4. On January 2, 2011, PUC sold a machine to HIT for $1,200,000. PUC purchased the machine on January 1, 2006
for $1,800,000 and was depreciating the machine over 10 years. There was no change in the estimated service life
at the time of the intercompany sale.
5. During 2013, HIT sold merchandise to PUC for $600,000, 75% of which remains in PUC’s inventory at December
31, 2013. On December 31, 2012, the inventory of PUC contained $100,000 of merchandise purchased from HIT.
HIT earns a gross margin of 30% on its intercompany sales.
6. During 2013, HIT declared and paid dividends of $2,600,000 while PUC declared and paid dividends of $800,000.
7. Both companied pay income tax at the rate of 40%.
Required
(a) Prepare HIT’s consolidated income statement for the year ended December 31, 2013. Show supporting calculations.
(b) Calculate HIT’s consolidated retained earnings at December 31, 2013. Show supporting calculations.
(LO 2, P4-5 On January 1, 2013, Sienna acquired all the shares of Danon for $160,000. The financial statements of the two
3, 5, 6) entities at December 31, 2013, contained the following information:
Sienna Danon
Sales revenue $234,800 $190,000
Other income 6,600 10,000
258,400 200,000
Cost of sales (123,000) (120,000)
Other expenses (34,600) (20,000)
(157,600) (140,000)
Net income (32,000) (20,000)
Total available for appropriation 144,800 72,000
Dividend declared (16,000) (7,200)
(50,000) (17,000)
Retained earnings (31/12/13) $ 94,800 $ 55,000
Current assets
Cash $ 1,000 $ 40
Allowance for doubtful accounts (500) (300)
Inventory 48,000 47,000
Total current assets 95,500 68,840
Non-current assets
Accumulated depreciation (40,000) (26,000)
Land 99,300 190,000
Bonds in Danon 60,000 —
Investment in Danon 160,000
Total non-current assets 379,300 234,000
Total assets 474,800 302,840
Sienna Danon
Current liabilities
Bank overdraft — 14,840
Current tax liabilities 11,000 10,000
Total current liabilities 39,000 40,840
5% mortgage bonds — 80,000
Deferred tax liabilities 13,000 5,000
Total non-current liabilities 13,000 85,000
Net assets $422,800 $177,000
Equity
Share capital $320,000 $120,000
Total equity $422,800 $177,000
1. At January 1, 2013, all identifiable assets and liabilities of Danon were recorded at fair value except for inventory,
for which the fair value was $1,000 greater than the carrying amount. This inventory was all sold by December 31,
2013. At January 1, 2013, Danon had research and development outlays that it had expensed as incurred. Sienna
measured the fair value of the in-process research and development at $8,000. By December 31, 2013, it was assessed
that $2,000 of this was not recoverable. At January 1, 2013, Danon had reported a contingent liability relating to
a guarantee that was considered to have a fair value of $7,000. This liability still existed at December 31, 2013. At
January 1, 2013, Danon had not recorded any goodwill.
2. The bonds were issued by Danon at par value on January 1, 2012, and are redeemable on December 31, 2016.
Sienna acquired its holding ($60,000) of these bonds when Danon initially issued them. All interest has been paid
and reflected in the records of both entities.
3. During 2013, Sienna sold inventory to Danon for $40,000, at a markup of cost plus 25%. At December 31, 2013,
$10,000 worth of inventory was still held by Danon.
4. On June 30, 2013, Danon sold land to Sienna. Sienna paid $30,000 for this land, with Danon having a cost of $24,000.
5. The Other Components of Equity account relates to financial assets, for which an election under IFRS 9 was
taken. For 2013, Sienna recorded an increase in these assets of $3,000, and Danon recorded a decrease of $2,000.
Required
Prepare the consolidated financial statements for Sienna and its subsidiary for the year ended December 31, 2013.
(LO 1, 2, P4-6 Financial information for Coltron and its 100% owned subsidiary, Tara, for the year ended December 31,
3, 4, 5) 2013, is provided below:
Coltron Tara
Sales revenue $25,000 $23,600
Gain on sale of property, plant, and equipment 1,000 2,000
Total 28,000 27,600
Total expenses 24,000 19,000
Profit for the period 2,650 6,650
8,650 9,650
Dividend paid 2,500 1,000
Problems 205
Coltron acquired its shares in Tara on January 1, 2013, buying the 10,000 shares for $20,000. Tara recorded share
capital of $10,000. The shares were bought on a cum div. basis as Tara had declared a dividend of $3,000 that was not
paid until March 2013.
At January 1, 2013, all identifiable assets and liabilities of Tara were recorded at fair value except for inven-
tory, for which the carrying amount of $2,000 was $400 less than fair value. Some of this inventory has been a little
slow to sell, and 10% of it was still on hand at December 31, 2013. Inventory on hand in Tara at December 31,
2013, also includes some items acquired from Coltron during the year. These were sold by Coltron for $5,000, at
a profit before tax of $1,000. Half the goodwill was written off as the result of an impairment test on December
31, 2013.
During March 2013, Coltron provided some management services to Tara at a fee of $500.
On July 1, 2013, Tara sold machinery to Coltron at a gain of $2,000. This machinery had a carrying amount to
Tara of $20,000, and was considered by Coltron to have a five-year life.
By December 31, 2013, the financial assets acquired by Coltron and Tara increased by $1,000 and $650, respec-
tively. The tax rate is 30%.
Required
(a) Prepare the consolidated statement of comprehensive income for Coltron and its subsidiary, Tara, at December
31, 2013.
(b) Discuss the concept of “realization” using the intragroup transactions in this question to illustrate the concept.
(LO 2, P4-7 Financial information for Jasmine and Lessard for the year ended December 31, 2013, is shown below:
3, 4, 5)
Jasmine Lessard
Revenue $78,000 $40,000

Gain on sale of office furniture — 3,000
Dividend revenue 4,400 1,600
Total income 82,400 44,600
23,100 7,700
Interim dividend paid 4,000 2,000
Final dividend declared 8,000 2,400
12,000 4,400
Retained earnings (31/12/13) $11,100 $ 3,300
1. On January 1, 2012, Jasmine purchased 100% of the shares of Lessard for $50,000. At that date the equity of the
two entities was as follows:
Jasmine Lessard
At January 1, 2012, all the identifiable assets and liabilities of Lessard were recorded at fair value except for the
following:

Plant and equipment (cost $80,000) $60,000 $61,000
All of this inventory was sold by December 2012. The plant and equipment had a further five-year life.
2. Jasmine records dividends receivable as revenue when dividends are declared.
3. The opening inventory of Lessard included goods that cost Lessard $2,000. Lessard purchased this inventory from
Jasmine at cost plus 33 1/3%.
4. Intragroup sales totalled $10,000 for the year. Sales from Jasmine to Lessard, at cost plus 10%, amounted to $5,600
and are still in the closing inventory of Lessard. The closing inventory of Jasmine included goods that cost it
$4,400. Jasmine purchased this inventory from Lessard at cost plus 10%.
5. On December 31, 2012, Lessard sold Jasmine office furniture for $3,000. This furniture originally cost Lessard
$3,000 and was written down to $2,500 when sold. Jasmine depreciates furniture at the rate of 10% p.a. on cost.
6. During the year, Jasmine paid rent of $7,000 to Lessard.
Required
Prepare the consolidated statement of comprehensive income for the year ended December 31, 2013.
(LO 2, P4-8 On April 1, 2013, Abbots acquired all the issued common shares (cum div.) of Evion for $100,000. At that date,
3, 5) relevant balances in the records of Evion were:

All the identifiable assets and liabilities of Evion were recorded at fair value except for the following:

Inventory $10,000 $12,000
Plant (cost $80,000) 50,000 53,000
The plant was expected to have a further five-year life. All the inventory on hand at April 1, 2013, was sold by the
end of the financial year.
At April 1, 2013, Evion had recorded goodwill of $2,000. As a result of an impairment test on March 31, 2014,
Evion wrote goodwill down by $1,500 in its books.
The dividend payable was subsequently paid in June 2013.
During the period ending March 31, 2014, intragroup sales consisted of $40,000 from Abbots to Evion at a
profit to Abbots of $10,000. These were all sold to external entities by Evion for $42,000 before March 31, 2014.
Evion also sold some inventory to Abbots for $10,000. This had cost Evion $6,000. Abbots since has sold all the
items to external entities for $8,000, except one batch on which Evion recorded a $500 profit before tax (original cost
to Evion was $1,000).
On October 1, 2013, Abbots sold an item, regarded by Abbots as a non-current asset, to Evion. At the time of sale,
the item’s carrying amount to Abbots was $28,000, and it was sold to Evion for $30,000. Abbots was using a 10% p.a.
depreciation rate applied to cost.
The following information was obtained from the companies for the year ended March 31, 2014:
Abbots Evion
Sales $146,000 $120,000
Gain on sale of non-current asset 2,000 —
157,000 120,000
104,000 87,000
Required
Prepare the consolidated statement of comprehensive income as at March 31, 2014. Assume a tax rate of 40%.
(LO 2, P4-9 On December 31, 2009, Lara acquired all the issued shares of Jade. On this date, the share capital of Jade con-
3, 5) sisted of 200,000 shares paid at $0.50 per share. Retained earnings of Jade at this date were $45,000.
At December 31, 2009, all the identifiable assets and liabilities of Jade were recorded at fair value except for some
plant and machinery. This plant and machinery, which cost $100,000, had a carrying amount of $85,000 and a fair value
of $90,000. The estimated remaining useful life was 10 years.
Immediately after acquisition, a dividend of $10,000 was declared and paid out of retained earnings.
The trial balances of Lara and Jade at December 31, 2013, were as shown below:
Trial Balances
Lara Jade
Credits
Share capital $500,000 $100,000
Payables 22,000 14,000
Sales revenue 250,000 120,000
$910,240 $368,200
Debits
Income tax expense $ 20,000 $ 10,000
Dividend declared and paid 10,000 8,000
Property, Plant, and Equipment—net 125,000 76,000
Motor vehicles—net 124,200 52,600
Inventory 106,440 72,000
Cash 46,900 5,990
Investment in Jade 160,000 —
Cost of sales 188,000 80,000
Loss on sale of property, plant, and equipment sold 4,000 5,000
$910,240 $368,200
1. During the current period, Lara sold inventory to Jade for $20,000. This had originally cost Lara $18,200. Jade
has, by December 31, 2013, sold half this inventory for $12,310.
2. One of the plant items held by Lara at December 31, 2013, had been purchased from Jade on July 1, 2010, for
$25,000. It had a carrying amount to Jade of $17,500. Lara depreciates straight line over 10 years.
3. At January 1, 2011, Jade sold land to Lara for $50,000. This item cost Jade $55,000.
Required
Prepare the consolidated financial statements as at December 31, 2013.
(LO 2, P4-10 On January 1, 2012, Tilford acquired all the shares of Sifton for $137,200. At acquisition date, the equity of
3, 4, 6) Sifton consisted of:

On this date, all the identifiable assets and liabilities of Sifton were recorded at fair value except for the following
assets:
Inventory $50,000 $56,000
Motor vehicles (cost $18,000) 15,000 16,000
Furniture and fixtures (cost $30,000) 24,000 32,000
Land 18,480 24,480
The inventory and land on hand in Sifton at January 1, 2012, were sold during the following 12 months. The
motor vehicles, which at acquisition date were estimated to have a four-year life, were sold on June 30, 2013. The
furniture and fixtures were estimated to have a further eight-year life. At January 1, 2012, Sifton had not recorded
any goodwill.
The following trial balances were prepared for the companies at December 31, 2013:
Tilford Sifton
Credits
Share capital $170,000 $ 80,000
Bonds 120,000 —
Final dividend payable 10,000 3,000
Other payables 34,800 10,100
Advance from Tilford — 10,000
Accumulated depreciation
Furniture and fixtures 2,000 6,000
$513,800 $252,100
Debits
Cost of sales $ 65,000 $ 53,500
Investment in Sifton 137,200 —
Land — 24,480
Furniture and fixtures 34,000 37,300
Inventory 171,580 70,320
Other assets 8,620 3,100
Advance to Sifton 10,000 —
$513,800 $252,100
1. Intragroup transfers of inventory consisted of:
2012:
Sales from Tilford to Sifton $12,000
Profit in inventory on hand 31/12/12 200
2013:
Sales from Tilford to Sifton 15,000
Profit in inventory on hand 31/12/13
(incl. $50 from previous period sales) 1,000
2. On June 30, 2013, Sifton sold furniture and fixtures to Tilford for $8,000. This had originally cost Sifton $12,000
and had a carrying amount at time of sale of $7,000. Both entities charge depreciation at the rate of 10% p.a. on cost.
Required
Prepare the consolidated financial statements for the period ended December 31, 2013.
Cases 209
(LO 2, P4-11 On January 1, 2013, Miran acquired all the shares of Winter for $160,000. The financial statements of the two
3, 7) entities at December 31, 2013, contained the following information:
Miran Winter
Sales revenue $234,800 $190,000
258,400 200,000
Cost of sales (123,000) (120,000)
(157,600) (140,000)
Income taxes (32,000) (20,000)
(50,000) (17,000)
Current assets
Cash $ 1,000 $ 40
Allowance for doubtful accounts (500) (300)
Inventory 48,000 47,000
Non-current assets
Land 99,300 190,000
Bonds in Winter 60,000 —
Investment in Winter 160,000
Total non-current assets 379,300 234,000
Total assets 474,800 302,840
Current liabilities
Bank overdraft — 14,840
5% mortgage bonds — 80,000
Net assets $422,800 $177,000
Equity
Share capital $320,000 $120,000
Total equity $422,800 $177,000
1. At January 1, 2013, all identifiable assets and liabilities of Winter were recorded at fair value except for inventory,
for which the fair value was $1,000 greater than the carrying amount. This inventory was all sold by December 31,
2013. At January 1, 2013, Winter had research and development outlays that it had expensed as incurred. Miran
measured the fair value of the in-process research and development at $8,000. By December 31, 2013, it was assessed
that $2,000 of this was not recoverable. At January 1, 2013, Winter had reported a contingent liability relating to
a guarantee that was considered to have a fair value of $7,000. This liability still existed at December 31, 2013. At
January 1, 2013, Winter had not recorded any goodwill.
2. The bonds were issued by Winter at par value on January 1, 2012, and are redeemable on December 31, 2016.
Miran acquired its holding ($60,000) of these bonds on the open market on January 1, 2013. All interest has been
paid and reflected in the records of both entities.
3. During 2013, Miran sold inventory to Winter for $40,000, at a markup of cost plus 25%. At December 31, 2013,
$10,000 worth of inventory was still held by Winter.
4. On June 30, 2013, Winter sold land to Miran. Miran paid $30,000 for this land, with Winter having a cost of $24,000.
5. The Other Components of Equity account relates to financial assets, for which an election under IFRS 9 was
taken. For 2013, Miran recorded an increase in these assets of $3,000, and Winter recorded a decrease of $2,000.
Required
Prepare the consolidated financial statements for Miran and its subsidiary for the year ended December 31, 2013.
Writing Assignments
(LO 1, 3) WA4-1 At the beginning of the current period, Perfect Products Inc. (PPI) sold a used depreciable asset to its wholly
owned subsidiary, Simply Scrumptious Ltd. (SSL), for $80,000. PPI had originally paid $200,000 for this asset, and at time
of sale to SSL had charged depreciation of $150,000. This asset is used differently in SSL from how it was used in PPI;
thus, whereas PPI used a 10% p.a. straight-line depreciation method, SSL uses a 20% straight-line depreciation method.
In calculating the depreciation expense for the consolidated group (as opposed to that recorded by SSL), the group
accountant, Max Stern, is unsure of which amount the depreciation rate should be applied to ($200,000, $50,000, or
$80,000) and which depreciation rate to use (10% or 20%).
Required
Provide a detailed response to Max, explaining which depreciation rate should be used and to what amount it should
be applied.
(LO 6) WA4-2 Blackwell, Whitewater, and Greenberg are all part of a group of related companies. Whitewater owns
100% of Blackwell and Blackwell owns 100% of Greenberg. Last year Whitewater borrowed $100,000 from the
Roymont Bank to finance Whitewater operations. The loan is still unpaid; however, Whitewater has paid the
interest required. In the current year Whitewater advanced $50,000 to Blackwell and $40,000 to Greenberg.
As required by the bank loan agreement, Whitewater provided Roymont Bank with a copy of the audited con-
solidated financial statements within two months subsequent to the year end. This week Whitewater received
notice from Roymont Bank that it is calling the loan to Whitewater. The bank maintains that Whitewater did not
use the funds in the manner that was agreed to. Furthermore, the bank maintains that Whitewater falsified the
financial statements by not reflecting the fact that the funds were given to Blackwell and Greenberg. Whitewater
states that it consolidated in accordance with GAAP and eliminated intragroup loans and therefore did not do
anything misleading.
Required
Assume the role of the advisor to Whitewater. Discuss both sides that could be raised should this case come to trial.
(LO 1, 2) WA4-3 Logan regularly sells inventory to its 100% owned subsidiary, Newton. It sells at a gross profit of 40%.
Newton sells inventory to its customers at a gross profit of 30%. Logan pays tax at a rate of 40% and Newton pays a
lower tax rate of 28%. Sara Beghetto, the accountant for Logan, is preparing the consolidated financial statements of
Logan and its subsidiary Newton. She is unclear as to which gross profit and tax rate to use in the elimination of any
intragroup profit.
Required
Provide an explanation to Sara regarding the correct treatment of these intragroup profits.
(LO 1, WA4-4 The parent entity, JEZ, has purchased on the open market, for an amount less than par value, some bonds
6, 7) previously issued at par, by its wholly owned subsidiary, Northco. The group accountant for JEZ, James Cong, has
stated that the adjustment in the consolidated financial statement includes the recording of an account called Income on
Redemption. He is unsure whether this is correct.
Required
(a) What does this account represent?
(b) Would an adjustment to income, or subsequently to retained earnings, have to be made for the rest of the life of
the group? If not, what event would cause the discontinuation of this adjustment?
Cases
(LO 1, 2) C4-1 Traveller Bus Lines Inc. (TBL) is a wholly owned subsidiary of Canada Transport Enterprises Inc.
(CTE). CTE is a publicly traded transportation and communications conglomerate. TBL is primarily in the
business of operating buses over short and long-distance routes in central and western Canada and the United
States. TBL also has a school bus division operating in Eastern Canada. CTE and its subsidiaries are audited by
DeBoy Shoot, which issued an unqualified audit opinion on CTE’s June 30 year-end consolidated financial state-
ments. This was the only audit opinion issued on the CTE group of companies. TBL has a July 31 year end. It is
now September 8, 2012. CTE has been reporting operating losses for several years and has put TBL up for sale
as part of a strategy to change its focus. This is the first of several planned divestitures, designed to restore CTE’s
lackluster stock price.
Currently, the only interested party is an employee group led by TBL’s president, Dan “Driver” Williams.
Williams’ management buy-out team consists of the vice-president of operations and the chief financial officer.
Handling the negotiations at CTE’s corporate office is Andrew Roche, vice-president of strategic divestitures.
The first draft agreement of purchase and sale has been submitted by the buy-out team for review. Exhibit C4-1(a)
contains extracts from the draft agreement; notes made by CTE’s lawyer are shown in italics.
Andrew wants to maximize the total selling prices. He asked the partner in charge of the CTE audit to review the
information given and provide his analysis and recommendations on how CTE can maximize the total selling price. In
addition, he would like a summary of the accounting issues of significance to CTE that will arise on the sale of TBL.
The partner has asked you, CA, to prepare the draft report to Andrew.
You have gathered some additional background information from the CTE permanent file and other sources
(Exhibit C4-1(b)).
Required
Prepare the draft report.
EXHIBIT C4-1(a)
EXTRACTS OF DRAFT PURCHASE AND SALE AGREEMENT
Agreement of purchase and sale between the employee group (hereinafter the Purchaser) and Canada Transport Enterprises Inc.
(hereinafter CTE) for the assets and liabilities of the business known as Traveller Bus Lines inc. (TBL).
1. The assets and liabilities of TBL are those included in its draft July 31, 2013 financial statements.
2. Excluded from the liabilities to be assumed by the purchaser are all environmental liabilities including, but not limited to,
gasoline and diesel fuel spills and tank leakage, pesticide residues, and all other chemical contamination.
3. The purchase price is determined by the sum of:
(a) The book value of the net assets at July 31, 2013 which is twelve million dollars ($12 million), plus
(b) 55% of the net reported income after taxes, for the twelve month period ending July 31, 2014 (the contingent consideration).
Lawyer’s Note – The contingent consideration should be worth at least $3.6 million since the division’s earnings computed on this
basis have averaged more than $6.6 million for the last four years before deducting head office charges.
4. This agreement is conditional on the Purchaser obtaining adequate financing, and, after inspection, finding TBL’s records
satisfactory.
5. CTE agrees not to compete with the Purchaser for 10 years.
6. US dollar amounts will be converted at the exchange rate determined by the Purchaser.
7. CTE will provide a loan guarantee for up to 25% of the purchase price for the Purchaser.
8. The Purchaser agrees to provide full maintenance services to the truck and trailer fleet of one of CTE’s other subsidiaries for
five years. Charges will be based on cost plus 10%.
9. The central bus station will be restored by CTE to its original condition by December 31, 2013.
10. CTE will provide free advertising to the Purchaser, on request, for one year following the closing date. The Purchaser will cre-
ate all the advertising material, including TV commercials.
11. All bus route rights will be assigned to the Purchaser.
12. The purchase price will be allocated based on book values.

13. The sale will close on October 1, 2013, at 12:01 a.m., and the entire consideration with the exception of the contingent con-
sideration will be due and payable one (1) month after closing. The contingent consideration is due one (1) month after the
July 31, 2014 financial statements are finalized.
14. Overdue amounts will be charged interested at a rate of 11% per annum.
15. CTE will act in a consulting capacity to advise the Purchaser for a fee of $25,000 per annum.
16. Representation, warranties, and non-disclosure.
Lawyer’s note – The details have yet to be discussed.
EXHIBIT C4-1(b)
INFORMATION GATHERED
1. Exclusive rights to most bus routes were obtained in the 1950s when the provincial governments were handing out the routes at
no cost to the local bus lines. They had no competition at that time. Other similar bus routes were subsequently purchased for
significant amounts.
2. TBL’s summary draft financial statements for July 31, 2013 are as follows (in thousands of dollars):
Revenue $ 48,123
Expenses (including $2,403 of head office charges) 40,239
Income before income taxes 7,884
Current taxes 2,995
Deferred taxes 567
Net income $ 4,322
Current assets $ 14,133

Long-term assets 25,131
Liabilities (21,264)
Deferred taxes (6,000)
Equity $ 12,000
3. The TBL Maintenance Department has recently completed a study that demonstrated that the school buses will last 15 years
rather than the 10 years on which the straight-line depreciation rates have always been based.
4. All school boards pay a non-refundable deposit, three months before the beginning of the school year in September, to guaran-
tee bus service for the coming school year.
5. TBL ran a “Travel the Country” promotion in June 2013. Sales of the three-month passes for unlimited travel, costing $400,
were brisk. The passes are punched by the driver each time the holders take a trip. To compensate travelers who use their
passes fewer than 10 times in the three-month period, TBL permits them to trade in their passes for either a pair of skis or a
pair of in-line skates or the case value of these items ($150).
6. CTE’s consolidation entries for 2013 related to TBL are a fair value increment of $432,300 for capital assets; and goodwill,
recorded at $2,332,000.
7. Included in TBL’s long-term assets is a note receivable for $3.1 million, secured by the real property of a chain of four gas sta-
tions. Because of fierce competition from stations owned by the large oil companies, the value of the properties has declined
from $4.2 million, the amount stated in the May 2012 appraisal, to $2.4 million, according to the May 2013 appraisal
released on July 22, 2013. The payments on the note are being made on schedule.
8. On August 18, 2013, the Panamee School District announced the cancellation of all school bus services previously contracted
for 2013–14 in the school district.
9. The management buyout team plans to spend $500,000 on TV advertisements that promote bus trael in a national advertising
campaign, starting in early 2014. The team also plans to retrofit all long-distance buses at substantial cost.
10. TBL moved all maintenance operations to a new facility in June 2013. The building was purchases for $3.4 million, and the
company had to vacate a leased facility 18 months before the end of the lease. The prospects of sub-letting the facility do not
look good.
(LO 1, 2) C4-2 Aquatic Biotechnology Inc. (ABI) is a medium-sized, public company operating an aquaculture business in east-
ern Canada. The company has been in operation since the mid-1990s, and during the latter half of the 2000s it grew at
a rapid pace through both increased sales and the acquisition of minor competitors.
ABI has an October 1 year end. It is now November 15, 2013 and you, CA, are working on the 2013 audit.
Your firm, Linkletter & Cormier Chartered Accountants, has conducted the audit of ABI for several years and
has always considered it to be a routine audit engagement. The audit senior on the engagement recently resigned
Cases 213
from the firm, and you have been asked to act as senior on the audit. All October 31 inventory counts and routine
confirmations have been dealt with, and you have been provided with the audit planning files. These files are sum-
marized in Exhibit C4-2(a).
The corporate structure of ABI is based on management’s philosophy that vertical integration will allow
this growth-oriented business to achieve its objectives. ABI controls nearly all aspects of the supply chain, from
growth of the product to processing and delivery to the customer. ABI operates the hatchery, where each of
the three major products (salmon, trout, scallops) are hatched, the fish farms where growth takes place, and the
processing plant where smoking and packaging occur. ABI also owns Marine Tech Limited (MTL), a supplier
of boats, nets, and gear to the Canadian market. MTL provides nearly all supplies, repairs, and maintenance for
the corporate group.
Scallop farming is a relatively new area of aquaculture, in which ABI has invested a substantial amount of capital for
research and development. Scallops are grown in a “cage” which sits on the ocean floor in an area that does not experience
problems such as strong tides and bacteria which could destroy the crop. As with many other aquaculture products, scal-
lops can take from 24 to 30 months to reach a marketable size. ABI has yet to earn any revenue from scallop farming, but
it is confident that its new system will be successful.
ABI has been working on scallop farming technologies for about five years. Previous years’ audit files indicate that
the costs related to scallop farming had been expensed, as the company lost much of its stock during the winter months.
ABI is confident that its new cage style, developed in 2012, will result in a tremendous crop ready for harvest in 2013.
At the year end, the scallop stocks were checked by the company and by an aquaculture expert hired by your firm, and
it was determined that the stock is at 75% of its marketable size. However, the aquaculture expert would not comment
on the likelihood that the stock would reach full maturity. At maturity, it is estimated that the crop will be 500,000
kilograms. Costs to date related to the 2013 harvest have been $1.425 million, of which $1.2 million has been incurred
in fiscal 2013.
Salmon and trout farming are major divisions of ABI. Both have been successful for a number of years, although
the selling price of salmon decreased slightly in 2013. The salmon division has provided substantial cash flow to the
company, due to the perfected method of growth and the low market costs associated with the product. Trout farm-
ing is a relatively new division of the company and has been moderately successful for the past two years.
Despite the positive cash flows generated by the salmon division, ABI has had difficulty in managing its cash flows
due to its substantial investment in scallop farming. In August 2013 ABI decided to refinance much of its debt to con-
solidate loans. The Business Development Bank, a federal government agency, agreed to consolidate most of ABI’s debt
and loaned ABI an additional $5 million for five years, with the first year to be interest-free. The bank further agreed
to extend the interest-free period for each fiscal year that ABI is able maintain net income at $1 million or more. A loan
arrangement fee of $500,000 was paid in order to cover the bank’s costs to consolidate the debt. The bank requires ABI
to maintain a current ratio above 1, given the current level of debt. The new debt structure has allowed ABI to improve
its cash situation.
You have just reviewed the working paper files and have met with ABI’s controller, Jim Gibbins, to gather a set of
draft financial statements [Exhibit C4-2(a)]. The engagement partner has asked you to prepare a memo summarizing
the relevant accounting issues in preparation for her meeting with ABI.
Required
Prepare the memo.
EXHIBIT C4-2(a)
INFORMATION OBTAINED FROM JIM GIBBINS
1. During the year ABI acquired Bay Mussels Limited (BML), a large mussel grower in the area, to diversify its prod-
uct lines, ABI paid $4.7 million to acquire 100% of the outstanding shares of BML. BML’s net tangible assets
were valued as follows on the date of acquisition:
Book Value Market Value

Current assets $ 1,986,773 $ 1,968,773
Current liabilities 2,089,657 2,089,657
Non-current liabilities 10,768,540 11,239,415
2. Jim has not yet recorded revenue for the scallop production, but would like to record as much revenue as possible
in 2013, since the product is 75% of its marketable size and orders for the coming year are already being re-
ceived. The price per kilogram can be reasonably estimated at approximately $20.00, although supply may affect
the market price.
3. Since early November ABI has been holding discussions with a major competitor to sell its trout division. ABI
believes that, although the division has been relatively successful, scallop farming is much more attractive in
the long run. The buyer has made a preliminary offer of $2.8 million for the trout division, and ABI management
expects that the cash flow will assist the company in getting through the winter until scallop sales begin. The
buyer’s offer expires on November 30, but the buyer may be open to further negotiations.
EXHIBIT C4–2(b)
AQUATIC BIOTECHNOLOGY INC.
Extracts From Consolidated Balance Sheet
As at October 31
2013 2012
Assets
Current
Cash $ 115 $ 283
Accounts receivable, net 1,650 1,030
Inventory – salmon and other 4,568 4,396
Inventory – scallops 1,425 —
Prepaid expenses 543 555
8,301 6,264
Property and equipment, net 67,913 64,423

Deferred costs – scallop cages 3,007 500
Other 2,684 3,774
$81,905 $74,961
Liabilities
Current
Bank indebtedness $ 2,103 $ 1,131
Accounts payable and accruals 2,804 2,332
Current portion of long-term debt 3,145 2,365
8,052 5,828

Future income taxes 1,345 1,297
Share capital
Retained earnings 10 10
10,998 9,583
11,008 9,593
$81,905 $74,961
AQUATIC BIOTECHNOLOGY INC.

Extracts From Consolidated Income Statement
For the years ending October 31
2013 2012 2011

(unaudited) (audited) (audited)
Revenue
Salmon $27,345 $29,879 $26,567
Trout 13,588 10,673 9,453
Mussels 1,647 — —
Fishing gear and other 32,486 30,788 29,453
75,066 71,340 65,785
Cost of goods sold

Salmon 15,714 15,917 13,359
Trout 6,280 5,140 7,860
Mussels 1,400 — —
Cases 215
2013 2012 2011

(unaudited) (audited) (audited)
Scallops — 1,310 1,260
Fishing gear and other 22,962 21,899 20,324
46,356 44,266 42,803
Gross margin 28,710 27,074 22,982

Expenses
Salaries and benefits 12,879 10,547 9,643
Selling and advertising 5,225 3,426 2,784
General, administrative, and other 3,423 2,879 1,866
Interest on long-term debt 4,288 4,562 4,848
Research – scallop cages — 5,250 3,078
Loan arrangement fee 500 — —
Total expenses 26,315 26,664 22,219
Income from operations 2,395 410 763

Gain on acquisition of BML 345 — —
Net income before income taxes 2,740 410 763
Income taxes 1,325 156 298
Net income $ 1,415 $ 254 $ 465
(LO 1, 2, C4-3 On January 1, 2013, Houston Inc., a public company located in Toronto that imports and distributes vari-
4, 6) ous teas and tea products and accessories, acquired all of the common shares of Persia Enterprises. Persia Enterprises
operates a chain of cafés and restaurants in the Maritimes and had been reluctant to purchase products from
Houston Inc.
The price paid was $1,234,299 and was paid in cash on the day of acquisition. In addition to diversifying its opera
tions, Houston Inc. is planning to start selling its products to Persia Enterprises for use in its cafés and restaurants.
The assets and liabilities of Persia Enterprises as at the acquisition date was as follows:
Book Value Fair Value

Inventory $376,019 $425,174
Prepaid expenses $256,103 $256,103
Favourable leases — $375,103
Accounts payable $401,208 $401,208
Net assets $230,914 $655,172
The leases of Persia Enterprises expire on average within five years. The company was able to sign and secure
favourable leases during a time when not many businesses were doing so.
You have been hired by Houston Inc. to help within the accounting and finance department. With the acquisition
of Persia Enterprises, Houston’s employees have become overwhelmed with the additional work and most are not up
to date with current accounting for business acquisitions and what happens subsequent to the acquisition. Houston has
also been subject to additional requirements from its bank and other creditors who loaned Houston the funds to acquire
Persia. Management is particularly concerned with the effects of this transaction being recorded correctly as they are
looking to acquire additional companies in the near future and their financial statements will be heavily analyzed and
scrutinized.
Subsequent to the acquisition date, Persia Enterprises opened a new café on the main floor of a building owned by
Houston. The rent expense for the year was $125,000.
On October 31, 2013, Houston Inc. was presented with an opportunity to acquire a shipment of rare and
desirable teas. However, the supplier wanted to be paid in cash on delivery. Since Houston did not have sufficient
cash on hand at that time, Persia Enterprises loaned it the $225,000 required, bearing zero interest, to be repaid on
January 31, 2014.
Also subsequent to the acquisition date, Houston sold $450,000 of products to Persia Enterprises, which had a cost
of $250,000. As at December 31, 2013, $300,000 still remained on hand by Persia.
The tax rate for both entities is 30%. Houston Inc.’s net income for the year was $862,349 and that of Persia
Enterprises was $422,325.
Exhibit C4-3(a) contains the statement of financial position of Houston Inc. as at December 31, 2013. Exhibit
C4-3(b) contains the statement of financial position of Persia Enterprises as at December 31, 2013.
Required
Prepare a report that analyzes the effects that the acquisition of Persia Enterprises has on Houston Inc.
EXHIBIT C4-3(a)
STATEMENT OF FINANCIAL POSITION
Houston Inc.
Cash $ 119,247
Trade and other receivables 501,248
Inventory 642,941
Prepaids 124,998
Other current assets 99,481
Total current assets $1,487,915
Property, plant, and equipment (net) $ 692,019

Intangible assets (net) 324,102
Investment in Persia Enterprises (at cost) 1,234,299
Total non-current assets $2,250,420
Total assets $3,738,335
Liabilities and shareholder’s equity

Other payables 201,992
Payable to Persia Enterprises 225,000
Total liabilities $ 876,219
Retained earnings $2,762,116

Total liabilities and shareholder’s equity $3,738,335
EXHIBIT C4-3(b)
STATEMENT OF FINANCIAL POSITION
Persia Enterprises
Cash $ 119,688
Inventory 388,091
Prepaids 199,201
Other current assets 47,192
Receivable from Houston Inc. 225,000
Total assets $ 979,172
Liabilities and shareholder’s equity

Total liabilities and shareholder’s equity $ 979,172
(LO 2, 6) C4-4 Fusion Industries (FI) is a public company located in Canada that specializes in the computer hardware and
software industry. It is always on the lookout to acquire other companies or divisions of other companies as part of its
expansion strategy in order to grow its business and global presence. During the year, on June 30, 2013, FI acquired
a private company, Runway Incorporated (RI), which specializes in manufacturing components that could be used by
Fusion Industries in its business.
The bank lent FI the funds needed to acquire RI and imposed a strict covenant concerning its maximum debt to
equity ratio. FI paid $10.00 per share to acquire all of the 100,000 outstanding shares of RI. In addition, FI will have to
pay an additional $1.00 per share if the net income of RI exceeds $100,000 in 2014. As at December 31, 2013, the prob-
ability of achieving this was high, while at the acquisition date it was low. The tax rate is 40%.
All of the book values of RI’s net assets approximate their fair market values at the acquisition date, except for
inventory, which had a fair market value $75,000 higher, and the property, plant, and equipment, which had a higher
fair market value by $125,000. Inventory typically turns twice a year within FI and the property, plant, and equipment
had a remaining useful life of five years. In addition, while FI follows the FIFO method of costing its inventory, RI
follows the average cost method, as it believes that it better reflects the true costs of its inventory.
As at the acquisition date, there were no amounts owed to RI by FI and no inventory on hand by FI that was
purchased from RI. However, during the six-month period, RI had $10,000 of sales to FI with a cost of $5,000. This
amount remained unpaid as at year end and was also still on hand by FI.
RI had been developing a new technology that, if proven successful, would be very beneficial to FI as it would be
able to use components that have a longer useful life. This would cut down on warranty expenses, and it would also cost
less for FI to purchase the components itself. FI estimates that it will buy these components for the next five years. Up
until the acquisition date, RI has expensed $125,293 of costs associated with this project. RI spent an additional $15,000
on costs until September 2013 from the acquisition date, which were also expensed, and then started manufacturing the
components commercially in September 2013. These components will also be sold to outside parties and contribute to
an increase in net income of RI.
The Vice-President of Finance of FI has asked you to prepare a report that discusses the impacts of this acquisition
on its financial statements during the year. In addition, he would like to know what FI’s financial statements would look
like after the acquisition, so he would like to see consolidated financial statements on the date of acquisition and as at the
end of the year. You have been provided with the financial statements of FI (Exhibit C4-4[a]) and RI (Exhibit C4-4[b])
as at the acquisition date and at year end.
Required
Prepare the report requested by the Vice-President of Finance.
EXHIBIT C4-4(a)
FUSION INDUSTRIES UNCONSOLIDATED FINANCIAL STATEMENTS
June 30, 2013 December 31, 2013

Cash 475,000 501,020
Inventory 692,671 710,293
Total current assets 1,621,671 1,683,899
Property, plant, and equipment 4,103,739 4,205,182
Accumulated depreciation (2,225,690) (2,301,292)
Intangible assets 1,201,955 1,201,955
Accumulated amortization (173,090) 201,219
Goodwill 609,621 609,621
Investment in RI 1,000,000 1,000,000
Total long-term assets 4,516,535 4,916,685
Total assets 6,138,206 6,600,584

Total current liabilities 1,248,745 1,322,431
Long-term debt 2,500,000 2,500,000
Total liabilities 3,748,745 3,822,431

Shareholder’s equity 1,000,000 1,000,000
Total liabilities and shareholder’s equity 6,138,206 6,600,584
EXHIBIT C4-4(b)
RUNWAY INCORPORATED UNCONSOLIDATED FINANCIAL STATEMENTS
June 30, 2013 December 31, 2013

Cash 234,222 222,123
Inventory 275,148 281,728
Intangible assets 195,475 195,475
Accumulated amortization (52,442) (59,201)
Goodwill 79,248 79,248
Total long-term assets 821,001 849,699
Total assets 1,698,897 1,753,052

Total liabilities 1,193,946 1,218,094

Shareholder’s equity 100,000 100,000
Total liabilities and shareholder’s equity 1,698,897 1,753,052

Distinguishing
Ownership
Source: © Dimitrije Paunovic/iStockphoto
COMPANIES DON’T ALWAYS acquire 100% announced in October 2011 that it would acquire a
of subsidiaries in a transaction. Reasons to controlling share of Colombia’s fifth-largest bank
purchase less include risk mitigation, budgetary for approximately $1 billion (all amounts are in U.S.
considerations, or the evolution of a carefully dollars). The deal, which closed in January 2012, saw
planned acquisition in steps. Scotiabank pay $500 million in cash and 10 million
There are several concepts regarding how to shares valued at approximately $518 million for the
present the results of a subsidiary that is less than controlling interest in Colpatria.
100% owned. On the one hand, it makes sense to In the financial statements presented for the
present only those results that the parent company first quarter of 2012, Scotiabank consolidated an
is entitled to, which is called the proprietary concept. estimated $7.1 billion of assets and $6.5 billion of
This, however, doesn’t reflect the control the parent Colpatria’s liabilities. However, it also recognized
company exerts over the entire operations of a $200 million in equity related to the non-controlling
subsidiary. The entity concept, which IFRS has interests’ 49% share of those net assets.
adopted, does take this control into account while While Scotiabank disclosed only negligible
still distinguishing partial ownership through the earnings from Colpatria, its consolidated statement
recognition of non-controlling interests. of earnings for the first quarter still allocated $38
In following the entity concept, parent million of earnings, mostly related to Scotiabank’s
companies recognize a subsidiary’s results and other holdings. This is because while its investment in
net assets in their entirety. In order to distinguish Banco Colpatria may have been Scotiabank’s largest
what is attributable to non-controlling interests, international investment to date, as of the end of
however, parent companies segregate a portion fiscal 2011, the bank already had at least seven other
of equity to which they are not entitled and foreign subsidiaries that were not 100%-owned.
disclose what portion of earnings is attributable While accounting for non-controlling interests
to shareholders of the parent and what portion is can become quite complex in the case of large
attributable to non-controlling interests. companies with multiple subsidiaries, doing so
Such was the case in the Bank of Nova provides vital information to stakeholders as it
Scotia’s acquisition of a controlling (51%) stake differentiates between financial results they are
in Banco Colpatria of Colombia. Scotiabank entitled to, and those they are not.
Sources: Bank of Nova Scotia 2011 Annual Report; Bank of Nova Scotia Interim Consolidated Financial Statements, First Quarter 2012; Sean B. Pasternak and
Blake Schmidt, “Scotiabank Buys Colpatria in Biggest International Purchase,” Bloomberg news, October 20, 2011.
CHAPTER
5 Consolidation:
Non-controlling
Interest
LEARNING OBJECTIVES
1. Discuss the nature of the non-controlling interest (NCI).
2. Calculate the NCI share of equity at the day of acquisition.
3. Calculate the NCI share of income and equity in subsequent periods.
4. Calculate NCI that is affected by the existence of intragroup profits.
5. Calculate NCI that is affected by the existence of a gain on bargain purchase.
6. Calculate the effect on NCI due to changes in ownership.
7. Understand the concepts of consolidation.
CONSOLIDATION
Non-controlling Changes in
Non-controlling Non-controlling Non-controlling
The Nature of Interest in Income the Proportion Appendix 5A —
Share of Interest Affected Interest Affected
Non-controlling and Equity in Held by Concepts of
Equity at the by Intragroup by a Gain on
Interest Subsequent Non-controlling Consolidation
Acquisition Date Profit Bargain Purchase
Periods Interest
■ Determination ■ Full goodwill ■ Inventory ■ Increases in ■ Entity concept

of the NCI method ■ Depreciable ownership of consolidation
■ Disclosure of ■ Partial goodwill non-current ■ Decreases in ■ Parent entity
the NCI method assets ownership concept of
■ Reasons for ■ Intragroup consolidation
choosing transfers for ■ Proprietary
method services and concept of
■ Accounting at interest consolidation
the acquisition ■ Choice of
date concept
222 chapter 5 Consolidation: Non-controlling Interest
THE NATURE OF NON-CONTROLLING

INTEREST (NCI)
Objective 1 In Chapters 3 and 4, the group under consideration consisted of two entities where the par-
Discuss the nature ent owned all the share capital of the subsidiary. In this chapter, the group under discussion
of the non- consists of a parent that has only a partial interest in the subsidiary; that is, the subsidiary is
controlling interest less than wholly owned by the parent.
(NCI).
Determination of the NCI

Ownership interests in a subsidiary other than the parent are referred to as the non-controlling
interest, or NCI. IFRS 10 Consolidated Financial Statements defines NCI as “the equity in a sub-
sidiary not attributable, directly or indirectly, to a parent.”
In Illustration 5.1, the group shown is illustrative of those discussed in this chapter. In
this case, the parent entity owns 75% of the shares of a subsidiary. Under the entity concept
of consolidation,1 the group consists of the combined assets and liabilities of the parent and
the subsidiary. There are two owners in this group: the parent shareholders and the NCI.
The NCI is a contributor of equity to the group.
Illustration 5.1
The Group Group
75%
Parent Subsidiary
The NCI is to be identified and presented within equity, separately from the parent share-
holders’ equity (paragraph 22 of IFRS 10). In other words, it is regarded as an equity contribu-
tor to the group, rather than a liability of the group. This is because the NCI does not meet
the definition of a liability as contained in the conceptual framework, because the group has
no present obligation to provide economic outflows to the NCI. The NCI receives a share of
consolidated equity, and is therefore a participant in the residual equity of the group. IFRS
10, although not explicitly recognizing the fact, adopts the entity concept of consolidation as
it adjusts for the effects of intragroup transactions in full and categorizes the NCI as equity.
Classification of the NCI as equity affects both the calculation of the NCI as well as how
it is disclosed in the consolidated financial statements.
The NCI is entitled to a share of consolidated equity, because it is a contributor of equity
to the consolidated group. Because consolidated equity is affected by profits and losses made
in relation to transactions within the group, the calculation of the NCI is affected by the
existence of intragroup transactions. In other words, the NCI is entitled to a share of the sub-
sidiary’s equity adjusted for the effects of profits and losses made on intragroup transactions.
This is discussed in more detail later in the chapter.
Disclosure of the NCI

According to paragraph 22 of IFRS 10, “Non-controlling interests shall be presented in the
consolidated statement of financial position within equity, separately from the equity of the
owners of the parent.” This is required even if the NCI will be in a deficit position.
1
See Appendix 5A of this chapter for a detailed discussion on the theories of consolidation.
The Nature of Non-controlling Interest 223
Illustration 5.2
Disclosure of NCI RASHI LTD.
in the Statement of Consolidated Statement of Comprehensive Income
Comprehensive Income for the year ended December 31, 2013
(in $ millions)
2013 2012
Revenue 500 450
Expenses 280 260
Gross profit 220 190
Finance costs 40 35
Income from operations 180 155
Income from associates 30 25
Income before tax 210 180
Income tax expense 28 22
NET INCOME 182 158
Other comprehensive income 31 24
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 213 182
Net income attributable to:
Owners of the parent 151 140
Non-controlling interests 31 18
182 158
Total comprehensive income attributable to:
Owners of the parent 179 160
213 182
IAS 1 Presentation of Financial Statements confirms these disclosures. Paragraph 83 of

IAS 101 requires the profit or loss for the period as well as the comprehensive income
for the period to be disclosed in the statement of comprehensive income, showing sepa-
rately the comprehensive income attributable to non-controlling interest, and that attrib-
utable to owners of the parent. Illustration 5.2 shows how the statement of comprehensive
income may be shown. Note that in terms of the various line items in the statement, such
as revenues and expenses, it is the total consolidated amount that is disclosed. It is only
the consolidated net income and comprehensive income that is divided into parent share
and NCI share.
According to paragraph 106(a) of IAS 1, the total comprehensive income for the period
must be disclosed in the statement of changes in equity, showing separately the total amounts
attributable to owners of the parent and to non-controlling interests. Illustration 5.3 provides
an example of disclosures in the statement of changes of equity. Note that the only line item
for which the NCI must be shown is the total comprehensive income for the period. There is
no requirement to show the NCI share of each equity account.
Similarly, paragraph 54(q) of IAS 1 requires disclosure in the statement of financial posi-
tion of the total NCI share of equity while paragraph 54(r) requires disclosure of the issued
capital and reserves attributable to owners of the parent. The equity section of the statement
of financial position could then appear as in Illustration 5.4. In the statement of financial posi-
tion, only the total NCI share of equity is disclosed, rather than the NCI share of the different
categories of equity. The NCI share of the various categories of equity and the changes in
those balances can be seen in the statement of changes in equity. Note that the consolidated
assets and liabilities are those for the whole of the group; it is only equity that is divided into
parent and NCI shares.
An example from a real-world disclosure of NCI is shown in Illustration 5.5, which con-
tains excerpts from the financial statements of Barrick Gold Corporation.
Illustration 5.3
in the Statement of Consolidated Statement of Changes in Equity (excerpt)
Changes in Equity for the year ended December 31, 2013
(in $ millions)
Attributable to owners of the parent
Non-con
Share Revaluation Translation Retained trolling Total
capital surplus reserve earnings Total interest equity
Balance at 400 120 100 250 870 130 1,000
January 1, 2013
Changes in — — — — — — —
accounting policy
Total comprehensive — 19 9 151 179 34 213
income for the
period
Dividends — — — (150) (150) (10) (160)
Issue of share — — — — — — —
capital
Balance at 400 139 109 251 899 154 1,053
December 31, 2013
Illustration 5.4
in the Statement of Statement of Financial Position (excerpt)
Financial Position as at December 31, 2013
(in $ millions)
2013 2012
EQUITY
Equity attributable to owners of the parent
Share capital 400 400
Cumulative other comprehensive income 248 220
Retained earnings 251 250
899 870
Total equity 1,053 1,000
Illustration 5.5
Excerpt from the Financial Pueblo Viejo ABG1 Cerro Casale2 Total
Statements of Barrick At January, 2010 $500 $ 22 $ — $ 522
Gold Corporation Share of net earnings (loss) (3) 52 — 49
(in millions of U.S. $) Cash contributed 101 — 13 114
Other increase in non-controlling interest — 606 454 1,060
At December 31, 2010 598 680 467 1,745
Share of net earnings (loss) (11) 64 — 53
Cash contributed 269 — 29 298
Other increase (decrease) in non-controlling interest — (7) — (7)
At September 30, 2011 $856 $737 $496 $2,089
1
Represents non-controlling interest in ABG. The balance at January 1, 2010, includes the non-controlling interest of
30% of our Tulaweka mine. Refer to note 4E.
2
Represents non-controlling interest in Cerro Casale. Refer to note 4F.
Non-controlling Share of Equity at the Acquisition Date 225
✓ LEARNING CHECK
• In a subsidiary that is not wholly owned by the parent, there are two ownership interests: the
parent and the non-controlling interest (NCI).
• The NCI consists of the accumulation of all the interests in the subsidiary other than the
parent.
• The NCI is classified as a contributor of equity to the group.
• The NCI is not entitled to a share of the equity of the subsidiary because its ownership interest
is in the group, not the subsidiary.
• The NCI share of equity is calculated as a share of the consolidated equity of the group, which
requires any intragroup transactions that affect the subsidiary’s equity to be taken into con-
sideration.
NON-CONTROLLING SHARE OF EQUITY

AT THE ACQUISITION DATE
Objective 2 Paragraph 32 of IFRS 3 states:
Calculate the NCI The acquirer shall recognize goodwill as of the acquisition date measured as the excess of (a) over
share of equity
at the day of
(b) below:
acquisition. (a) the aggregate of:
(i) the consideration transferred measured in accordance with this Standard, which
generally requires acquisition date fair value;
(ii) the amount of any non-controlling interest in the acquiree measured in accordance with
this Standard; and
(iii) in a business combination achieved in stages, the acquisition date fair value of the
acquirer’s previously held equity interests in the acquiree.
(b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities
assumed measured in accordance with this Standard.
Consider a situation where Acorn acquires 70% of the shares of Brown. Holding 70% of
the shares of Brown gives Acorn control of that entity. At acquisition date, there is an NCI of
30%. Note: Where the parent acquires less than all the shares of a subsidiary, it acquires only
a portion of the total equity or total net assets of the subsidiary. Hence, the consideration
transferred is for only a portion of the subsidiary’s net assets; in this example, 70%.
The next step is to measure the amount of the 30% non-controlling interest in the sub-
sidiary. The problem with this step is that IFRS 3 allows alternative treatments. Paragraph
19 of IFRS 3 states:
For each business combination, the acquirer shall measure at the acquisition date components of
non-controlling interests in the acquiree that are present ownership interests and entitle their
holders to a proportionate share of the entity’s net assets in the event of liquidation at either:
(a) fair value; or
(b) the present ownership instruments’ proportionate share in the recognized amounts of the
acquiree’s identifiable net assets.
All other components of non-controlling interests shall be measured at their acquisition-date fair
values, unless another measurement basis is required by IFRSs.
Which alternative is chosen affects the determination of goodwill and the subsequent
consolidation adjustments. Where the first alternative is used, the goodwill attributable to
both the NCI and the parent is measured. Under the second alternative, only the goodwill
attributable to the parent is measured. The methods are sometimes referred to as the “full
goodwill” and the “partial goodwill” methods.2 These terms are used in this chapter to dis-
tinguish between the two methods. The methods are demonstrated in the following sections,
and the reasons for the standard setters allowing optional measurements, as well as factors to
consider in choosing between the methods, is discussed in the last section.
Full Goodwill Method

Under the full goodwill method, at the acquisition date, the NCI in the subsidiary is mea-
sured at fair value. The fair value is determined on the basis of the market prices for shares
not acquired by the parent, or, if these are not available, a valuation technique is used.
It is not sufficient to use the consideration paid by the acquirer to measure the fair value
of the NCI. For example, if a parent paid $80,000 for 80% of the shares of a subsidiary, then
the fair value of the NCI cannot be assumed to be $20,000 (i.e., 20/80 $80,000). It may
be that the acquirer paid a control premium in order to acquire a controlling interest in the
subsidiary. Relating this to the nature of goodwill discussed in Chapter 2, goodwill includes
the component relating to synergies arising because of the combination of the parent and the
subsidiary. The parent would increase the consideration it was prepared to pay due to these
synergies. However, these synergies may result in increased earnings in the parent and not
the subsidiary. In this case, the NCI does not receive any share of those synergies. Hence,
the consideration paid by the parent could not be used to measure the fair value of the NCI
in the subsidiary.
To illustrate the method, assume that P paid $169,600 for 80% of the shares of S on
January 1, 2013. All identifiable assets and liabilities of the subsidiary were recorded at fair
value, except for land for which the fair value was $10,000 greater than cost. The tax rate is
30%. The NCI in S was considered to have a fair value of $42,000 based on the current mar-
ket price of the S shares. At acquisition date, the equity of S consisted of:
The acquisition analysis is as follows:

(a) Consideration transferred $169,600
(b) Non-controlling interest in S $ 42,000
Aggregate of (a) and (b) $211,600
Net fair value of identifiable $100,000 $100,000
assets and liabilities of S $10,000(1 30%) (FVA—land)
$207,000
Goodwill $211,600 $207,000
$ 4,600
Goodwill attributable to parent:
Net fair value acquired 80% $207,000
$165,600
Goodwill—parent $169,600 $165,600
$ 4,000
Goodwill attributable to NCI $ 4,600 $4,000
$ 600
OR $ 42,000 20% $207,000
Note the following:

• FVA refers to the business combination fair value adjustment.
• Goodwill is calculated as the excess of the sum or aggregate of the consideration transferred
and the fair value of the NCI over the net fair value of the subsidiary’s identifiable assets and
liabilities at acquisition date. This goodwill is the goodwill of the subsidiary as a whole.
2
See paragraph BC205 in the Basis for Conclusions on IFRS 3 for further elaboration.
• As the fair value of the NCI (20%) is determined to be $42,000, if P were to acquire
80% of S it would expect to pay $168,000 (i.e., 80/20 $42,000). As P paid $169,600,
it then paid a control premium of $1,600. Effectively, the goodwill of $4,600 is broken
down into:
Control premium paid by P $1,600
Parent share of S’s goodwill $2,400 [$4,000 $1,600]
NCI share of S’s goodwill $ 600
The control premium is recognized as part of goodwill on consolidation, but is not

attributable to the NCI.
Hence, the fair value adjustment relating to goodwill recognized on consolidation is
attributed $4,000 to the parent and $600 to the NCI. The earnings from the control pre-
mium must flow into the parent’s earnings and not that of the subsidiary; otherwise, it would
be included in the valuation of the NCI interest in the subsidiary. The consolidated financial
statement adjustments are as follows:
1. Fair value adjustments:
Land c 10,000
Deferred tax liability c 3,000
Goodwill c 4,600
Two fair value adjustments are required: one for the revaluation of the land to fair value,
and the second to recognize the total goodwill of the subsidiary.
2. Pre-acquisition adjustments:
Investment in S T 169,600
Non-controlling interest in equity c 42,000
In relation to the equity on hand at acquisition date, only 80% is attributable to the par-
ent, and 20% is attributable to the NCI. The pre-acquisition adjustment includes the invest-
ment by the parent in the subsidiary, and thus relates to 80% of the amounts shown in the
acquisition analysis. At acquisition the claim on equity by the non-controlling interest must
reflect its share of the fair value of the net assets at the day of acquisition. This would equal
20% (100,000 100,000 7,000) 600 of goodwill 42,000. This amount would be
reflected in the equity section of the statement of financial position.
Partial Goodwill Method

Under the second option, the NCI is measured at the NCI’s proportionate share of the
fair value of the acquiree’s identifiable net assets. The NCI therefore does not get a share
of any equity relating to goodwill as goodwill is defi ned in Appendix A of IFRS 3 as
the future economic benefi ts arising from assets not individually identified. The only
goodwill recognized is that acquired by the parent in the business combination—hence
the term “partial” goodwill. According to paragraph 32 of IFRS 3, using the measurement
of the NCI share of equity based on the NCI’s proportionate share of the acquiree’s iden-
tifiable net assets:
Goodwill consideration transferred plus previously acquired investment by parent plus
NCI share of identifiable assets and liabilities of subsidiary less net fair value of
identifiable assets and liabilities of subsidiary.
As the last two items can be netted off to be the parent’s share of the net fair value of the
subsidiary’s identifiable net assets, the calculation of goodwill is:
Goodwill consideration transferred plus previously acquired investment by parent less
parent’s share of the net fair value of the subsidiary’s identifiable net assets.
To illustrate, using the same example, assume that P paid $169,600 for 80% of the shares
of S on January 1, 2013. All identifiable assets and liabilities of the subsidiary were recorded
at fair value, except for land for which the fair value was $10,000 greater than cost. The tax
rate is 30%. At acquisition date, the equity of S consisted of:
The acquisition analysis is as follows:
Net fair value of identifiable assets and liabilities of S $100,000 $100,000
$10,000(1 30%) (FVA—land)
$207,000
Net fair value acquired by the parent 80% $207,000
$165,600
Previously acquired investment by the parent 0
Goodwill acquired $169,600 $165,600
$ 4,000
Note that the $4,000 goodwill is the same as the parent’s share calculated in the previous
example. The consolidated financial statement adjustments are:
1. Fair value adjustments:
Land c 10,000
Goodwill c 4,000
Two fair value adjustments are required: one for the revaluation of the land to fair value,
and the second to recognize the total goodwill of the subsidiary.
2. Pre-acquisition adjustments:
Investment in S T 169,600
Non-controlling interest in equity c 41,400
Note firstly that only the parent’s share of the goodwill is recognized.
In relation to the equity on hand at acquisition date, only 80% is attributable to the par-
ent, and 20% is attributable to the NCI. The pre-acquisition adjustment includes the invest-
ment by the parent in the subsidiary, and thus relates to 80% of the amounts shown in the
acquisition analysis. At acquisition the claim on equity by the non-controlling interest must
reflect its share of the fair value of the identifiable net assets at the day of acquisition. This
would equal 20% (100,000 100,000 7,000) 41,400. This amount would be reflected
in the equity section of the statement of financial position.
Reasons for Choosing Method

IFRS 3, as revised in 2011, was issued by the IASB. The project on determining a new stan-
dard on business combinations was conducted jointly by the FASB and the IASB in the hope of
achieving convergence on the standard between the two boards. Both boards issued Exposure
Drafts on business combinations, and, in both these documents, the full goodwill method was
recommended. However, when the final standards were issued, the FASB standard required the
accounting for all business combinations to use the full goodwill method, whereas the IASB stan-
dard provided for optional treatments in the measurement of the NCI share of the subsidiary.
Paragraphs BC209–BC221 of IFRS 3 explain why the IASB chose to provide optional
methods. As noted in paragraph BC210, the IASB recognizes that to allow optional methods
does reduce the comparability of financial statements:
[T]he IASB was not able to agree on a single measurement basis for non-controlling interests
because neither of the alternatives considered (fair value and proportionate share of the acquiree’s
identifiable net assets) was supported by enough board members to enable a revised business com-
binations standard to be issued.
The IASB supports the principle of measuring all components of a business combination
at fair value (paragraph BC212); however, paragraph BC213 notes some arguments against
applying this to the NCI in the acquiree:
• It is more costly to measure the NCI at fair value than at the proportionate share of the
net fair value of the acquiree’s identifiable net assets.
• There is not sufficient evidence to assess the marginal benefits of reporting the acquisi-
tion date fair value of NCIs.
• Respondents to the Exposure Draft saw little information of value in the reported NCI,
regardless of how it is measured.
One of the options considered by the IASB in writing the standard was to require the use
of the fair value method for measuring the NCI but allowing entities to use the proportionate
method where there exists “undue cost or effort” in measuring the fair value. However, the
IASB rejected this option as it did not think the term “undue cost or effort” would be applied
consistently (paragraph BC215).
The IASB noted three main differences in outcome that occur where the partial goodwill
method is used instead of the full goodwill method:
1. The amounts recognized for the NCI share of equity and goodwill would be lower.
2. Where IAS 36 Impairment of Assets is applied to a cash generating unit containing good-
will, as the goodwill recognized by the cash generating unit is lower, this affects the
impairment loss relating to goodwill.
3. There is also an effect where an acquirer subsequently obtains further shares in the sub-
sidiary at a later date. An explanation of this effect is described in a later section of this
chapter.
In choosing which method to use—full or partial goodwill—it is these three effects on

the financial statements, both current and in the future, that must be taken into consider-
ation. For example, if management has future intentions of acquiring more shares in the
subsidiary (i.e., by acquiring some of the shares held by the NCI), then the potential impact
on equity when that acquisition occurs will need to be considered. We will examine this later
in the chapter.
Accounting at the Acquisition Date

When allocating the subsidiary’s equity to the NCI, we include the subsidiary’s equity con-
tained in the subsidiary’s actual records as well as any fair value adjustments at the acquisition
date, where the subsidiary’s identifiable assets and liabilities are recorded at amounts different
from their fair values.
This section illustrates the effects that the existence of an NCI has on the fair value
adjustments, as well as the calculation of the NCI share of equity at acquisition date. The
acquisition analysis and subsequent consolidated financial statement adjustments are affected
by whether the full goodwill or partial goodwill option is used when measuring the NCI’s
share of the subsidiary at the acquisition date. The choice of method affects the accounting
at the acquisition date but has an effect on accounting subsequent to acquisition date only if
there is an impairment of goodwill or the parent changes its equity interest in the subsidiary.
Neither of these events is covered in this text.
Illustrative Example 5.1 demonstrates the full goodwill method for consolidation adjust-
ments at the acquisition date.
Illustrative Example 5.1 Full Goodwill Method

On January 1, 2011, Magpie acquired 60% of the shares (cum div.) of Trestone for
$45,000 when the equity of Trestone consisted of:
All of Trestone’s identifiable assets and liabilities were recorded at fair value except
for equipment and inventory:
Equipment (cost $250,000) $180,000 $200,000
Inventory 40,000 50,000
The tax rate is 30%. The fair value of the NCI in Trestone at January 1, 2011, was
$28,000.
Required
Calculate the consolidation adjustments at the day of acquisition.
Solution

(b) Non-controlling interest in Trestone $28,000 (40%)
Aggregate of (a) and (b) $73,000 (100% of fair value Trestone)
Net fair value of identifiable assets $40,000 (capital)
and liabilities of Trestone $4,000 (retained earnings)
$20,000(1 30%) (FVA—equipment)
$10,000(1 30%) (FVA—inventory)
$65,000
Goodwill $73,000 $65,000
$ 8,000
Net fair value acquired by Magpie parent 60% $65,000
$39,000
Consideration transferred by Magpie $45,000
parent
Goodwill—parent $45,000 $39,000
$ 6,000
Goodwill—NCI $ 8,000 $6,000
$ 2,000
Where an NCI exists, because the parent acquires only a part of the ownership
interest of the subsidiary, the parent acquires only a proportionate share of each of the
equity amounts in the subsidiary. The process of consolidation remains the same as that
first introduced in Chapter 3 with one additional adjustment needed to allocate 40% of
subsidiary equity to NCI.

The fair value adjustments are unaffected by the existence of an NCI. The purpose of
these adjustments, in accordance with IFRS 3, is to show the subsidiary’s assets and
liabilities at fair value at acquisition date. The adjustments for a consolidated financial
statement prepared at acquisition date are:
Equipment—net c 20,000
Inventory c 10,000
Goodwill c 8,000
The NCI is entitled to a proportionate share of these fair value adjustments, except
that relating to goodwill where, in the acquisition analysis, the NCI share has been
allocated a specific amount calculated as $2,000. Because the fair values and goodwill
are recognized by the group, but not in the records of the subsidiary, this affects later
calculations for the NCI share of equity.
(2) Pre-acquisition adjustments
The pre-acquisition adjustment is determined from the pre-acquisition analysis. The
various recorded equity accounts of the subsidiary are eliminated against the invest-
ment account in the pre-acquisition adjustment. In this illustrative example, the
pre-acquisition adjustment is:
Investment in Trestone T 45,000
(3) Calculation of non-controlling interest

An additional calculation required is to divide the equity of the consolidated group into
that belonging to the parent and that belonging to the NCI. The NCI at acquisition
date is determined as the proportional share of the equity recorded by the subsidiary at
that date and the fair value adjustments recorded on consolidation:
Share capital 40% 40,000 $16,000
Retained earnings 40% 4,000 1,600
Fair value adjustments 40% (14,000 7,000) 2,000 10,400
$28,000
Magpie’s share of the consolidated equity will be its own equity, because the equity of the
subsidiary Trestone is all pre-acquisition.
Illustration 5.6 shows an excerpt from a consolidated financial statement for Magpie and
its subsidiary, Trestone, at acquisition date using the full goodwill method. Only the equity
section of the statement of financial position is shown.
Illustration 5.6
Consolidated Statement Financial Consolidated
of Financial Position statements Magpie Trestone Adjustments group
(Excerpt) at Acquisition Retained earnings 70,000 4,000 4,000 70,000
Date Share capital 100,000 40,000 40,000 100,000
NCI—equity .4 (40,000 4,000 14,000
7,000) 2,000 28,000
Total equity 170,000 44,000 198,000
Note that in Illustration 5.6, the adjustment column eliminates the pre-acquisition equity
accounts and the NCI share of equity account is created. The other accounts, in equity, con-
tain only the parent’s share of post-acquisition equity, which in this case, being at acquisition
date, is zero.
Illustrative Example 5.2 demonstrates the partial goodwill method for consolidation
adjustments at acquisition date.
Illustrative Example 5.2 Partial Goodwill Method

On January 1, 2011, Magpie acquired 60% of the shares (cum div.) of Trestone for
$45,000 when the equity of Trestone consisted of:
All the identifiable assets and liabilities of Trestone were recorded at fair value
except for equipment and inventory:
Equipment (cost $250,000) $180,000 $200,000
Inventory 40,000 50,000
Required
Calculate the consolidation adjustments at the acquisition date.
Solution
Net fair value of identifiable assets
and liabilities of Trestone $40,000 (capital) $4,000 (retained earnings)
$20,000(1 30%) (FVA—equipment)
$65,000
Net fair value acquired by Magpie 60% $65,000
$39,000
Goodwill acquired by Magpie $ 6,000
Where an NCI exists, because the parent acquires only a part of the ownership
interest of the subsidiary, the parent acquires only a proportionate share of each of
the equity amounts in the subsidiary. The process of consolidation is the same as that
illustrated in Chapter 3 with one additional adjustment needed to allocate 40% of the
subsidiary to the NCI.
The fair value adjustments are unaffected by the existence of an NCI. The purpose of
these adjustments, in accordance with IFRS 3, is to show the subsidiary’s assets and
liabilities at fair value at acquisition date. The adjustments for a consolidated financial
statement prepared at acquisition date are:
Equipment—net c 20,000
Inventory c 10,000
Goodwill c 6,000
Only the parent’s share of goodwill is recognized. The NCI is entitled to a pro-
portionate share of the fair value adjustments. Because the fair value adjustments are
recognized by the group, but not in the records of the subsidiary, this affects later cal-
culations for the NCI share of equity.
The first pre-acquisition adjustment is determined from the pre-acquisition analysis.
The various recorded equity accounts of the subsidiary, as well as the parent’s share of
the fair value adjustments, are eliminated against the investment account in the pre-
acquisition adjustment, and the parent’s share of goodwill is recognized. In this illustra-
tive example, the pre-acquisition adjustment is:
(3) Calculation on non-controlling interest

There is a new adjustment required to allocate a portion of the equity to the NCI at
the day of acquisition. The NCI at acquisition date is determined as the proportional
share of the equity recorded by the subsidiary at that date and the fair value adjustments
recorded on consolidation:
Share capital 40% $40,000 $16,000
Retained earnings 40% $4,000 1,600
Fair value adjustments 40% ($14,000 $7,000) 8,400
$26,000
Illustration 5.7 shows an excerpt from a consolidated financial statement for Magpie
and its subsidiary, Trestone, at acquisition date, using the partial goodwill method. Only the
equity section of the statement of financial position is shown.
Illustration 5.7
Excerpt of Consolidated Financial statements Magpie Trestone Adjustments Group
Financial Statement Retained earnings 70,000 4,000 4,000 70,000
Equity Section for Share capital 100,000 40,000 40,000 100,000
Magpie—Partial NCI—equity .4 (40,000 4,000 26,000
Goodwill Method 14,000 7,000)
Total equity $170,000 $44,000 $196,000
Note that in Illustration 5.7, the adjustment columns eliminate the pre-acquisition equity
accounts and a new account is created to reflect the NCI share of equity. The equity account
contains only the parent’s share of post-acquisition equity, which in this case, being at acqui-
sition date, is zero.
✓ LEARNING CHECK
• IFRS 3 provides two alternative methods for calculating the NCI at acquisition date: the full
goodwill and the partial goodwill methods.
• Under the full goodwill method, the NCI is measured at fair value at acquisition date, and
goodwill is recognized at 100%.
• Under the partial goodwill method, the NCI is measured as a proportion of the net fair value
of the subsidiary’s identifiable net assets at acquisition date, and only the parent’s share of
goodwill is recognized on consolidation.
• Because it is necessary to distinguish between the parent’s share and the NCI share of equity
in the consolidated financial statements, additional calculations are required to divide the
group equity into the NCI share and the parent’s share.
NON-CONTROLLING INTEREST IN INCOME

AND EQUITY IN SUBSEQUENT PERIODS
Objective 3 Non-controlling interests in the net assets consist of:
Calculate the NCI (1) the amount of those non-controlling interests at the date of the original combination
share of income and
equity in subsequent
calculated in accordance with IFRS 3; and
periods. (2) the non-controlling interests’ share of changes in equity since the date of the combination.
Both of the above added together will equal the NCI share of the group equity at the
year-end date. Note that these changes are not only in the recorded equity of the subsidiary,
but also relate to other changes in consolidated equity, such as fair value adjustments.
The calculation of the NCI is necessary both for the statement of changes in equity and
for the statement of financial position. The NCI must be allocated its share of the change in
equity. The process we follow is:
1. The NCI share of recorded income is determined after adjustment for fair values.
2. The NCI share is adjusted for the effects of intragroup transactions.
We will then allocate the NCI on the statement of changes in equity. The NCI share of
equity will also be calculated to reflect the NCI on the statement of financial position.
Because the disclosure requirements for the NCI require the extraction of the NCI share
of various equity items, additional calculations are necessary on consolidation to enable this
information to be produced. This involves calculating the amount of net income and compre-
hensive income to be allocated to the non-controlling interest and to the parent. In addition,
the equity will have to be separated between the equity belonging to the non-controlling
interest and to the parent.
The first line in Illustration 5.8 is the consolidated net income/loss for the period. This
amount is then attributed to the parent and the NCI. The NCI share of retained earnings
is increased by subsidiary profits, and decreased by payments and declarations of dividends.
The total NCI share of equity is then the sum of the NCI share of capital, other reserves, and
retained earnings. The assets and liabilities of the group are shown in total and not allocated
to the equity interests in the group.
Using the consolidated financial statement adjustments—FVA and pre-acquisition
adjustments in Illustrative Example 5.2, the consolidated financial statement adjustments
three years after the acquisition date are now considered. These adjustments are based on the
partial goodwill method. However, the effects of the events occurring subsequent to acquisi-
tion date on the pre-acquisition adjustments and fair value adjustments are the same for the
full goodwill method. Assume that:
• All inventory on hand at January 1, 2011, is sold by December 31, 2011.
• The equipment has an expected useful life of five years.
• Goodwill has not been impaired.
• In the three years after the acquisition date, Trestone recorded the changes in equity
shown in Illustration 5.8.
Illustration 5.8
Magpie Trestone
Equity for Trestone and
Magpie for 2013 Net income $ 20,000 $15,000
Retained earnings (opening balance) 25,000 16,000
45,000 31,000
15,000 3,500
Retained earnings (closing balance) 30,000 27,500
Total equity $130,000 $67,500
Non-controlling Interest in Income and Equity in Subsequent Periods 235
In preparing the consolidated financial statements at December 31, 2013, the consolidated
financial statement contains the fair value adjustments, the pre-acquisition adjustments, the NCI
adjustments, and the adjustments for the intragroup dividend transactions. We will see that the
consolidation process is the same as that introduced in Chapter 3 with the addition of the adjust-
ment to record NCI. We now need to record the NCI share of comprehensive income as well as
the NCI share of equity. In Illustrative Examples 5.1 and 5.2, there was no NCI in comprehen-
sive income as the consolidated statement was prepared at the day of acquisition.

The fair value adjustments for the 2013 year differ from those prepared at acquisition date
in that the equipment is depreciated and the inventory has been sold. The adjustments at
Equipment
Equipment—net c (20,000 3 4,000)
Deferred tax liability c 30% (20,000 3 4,000)
Retained earnings—beginning T 60% 70% (2 4,000)
60% (2 2,800)*
* adjusted for two years of depreciation net of tax; retained earnings represents only the parent’s share of
the equity (60%)
Depreciation expense c 4,000

NCI—net income T 40% (2,800)
NCI—equity beginning c 40% 70% (20,000 2 4,000)
40% (14,000 2 2,800) 3 2,800*
* represents the remaining FVA
Inventory
Retained earnings—beginning T 60% (10,000 3,000)*
* parent’s share of the FVA of inventory written off
Goodwill
Goodwill c 6,000
If the full goodwill approach had been taken per Illustrative Example 5.1, the following
adjustment would have been made:
Goodwill c 8,000
NCI—equity c 2,000
This would have resulted in a net amount of goodwill belonging to the parent of $6,000.
Retained earnings—beginning T 4,000
(3) Calculation of NCI at December 31, 2013
The NCI is required to be shown on the statement of changes in equity and on the statement
of financial position. As outlined above, every effect on the group will also affect the alloca-
tion to the NCI.
To calculate this adjustment, it is necessary to note any changes in subsidiary equity. The
changes will generally relate to movements in retained earnings, but changes in share capital
could occur.
In this example, there are three changes in subsidiary equity:

1. Retained earnings increased from $4,000 to $27,500. This will increase the NCI
share of retained earnings.
2. The sale of inventory in 2011 resulted in a transfer of $7,000 from inventory to
retained earnings. Because the profits from the sale of inventory are recorded in
the profits of the subsidiary, the NCI receives a share of the increased wealth relat-
ing to inventory. The NCI share of the fair value adjustment must be reduced,
with a reduction in NCI in total.
3. Adjustments relating to the equipment on hand at acquisition date need to be
considered. In the fair value adjustment, the equipment on hand at acquisi-
tion date was revalued to fair value and the increase made to equipment—net.
By recognizing the asset at fair value at acquisition date, the group recognizes
the extra benefits over and above the asset’s carrying amount to be earned
by the subsidiary. As expressed in the depreciation of the equipment, the
group expects the subsidiary to realize extra after-tax benefits of $2,800 (i.e.,
$4,000 depreciation expense less the credit of $1,200 to income tax expense)
in each of the five years after acquisition. Whereas the group recognizes these
extra benefits at acquisition date, the subsidiary recognizes these benefits as
profit in its records only as the equipment is used. Hence, the profit after tax
recorded by the subsidiary in each of the five years after acquisition date will
contain $2,800 benefits from the equipment that the group recorded in the
asset at acquisition date.
1. Calculations of Non-controlling interest.

In Illustrative Example 5.2, the NCI share of retained earnings is determined by calculating
the retained earnings (1/1/13) including any adjustments to write off fair value adjustments at
that date. The retained earnings (1/1/13) belonging to the NCI is calculated as follows:
40% × (16,000 − [2,800 × 2] − [10,000 − 3,000]) = $1,360
In calculating the NCI share of equity at January 1, 2013, the NCI calculation will
double count the benefits from the equipment if there is no adjustment for the deprecia-
tion of the equipment. This occurs because the share of the NCI in equity calculated at
acquisition date includes a share of the fair value adjustments created at that date in the
consolidated financial statement. Therefore, giving the NCI a full share of the recorded
profits of the subsidiary in the five years after acquisition date double counts the ben-
efits relating to the equipment. The NCI has already received a share of the fair value.
Hence, in calculating the NCI share of equity at the beginning of the year, there needs
to be an adjustment for the extra depreciation of the equipment in relation to each of the
years since acquisition date.
The adjustment for depreciation is calculated based on the depreciation on the equip-
ment since acquisition date. In the adjustment required for the 2013 consolidated financial
statements, there is a net decrease to retained earnings (1/1/13) of $5,600 (i.e., the $8,000
adjustment for previous periods’ depreciation less the $2,400 adjustment for previous peri-
ods’ tax effect) in relation to the after-tax effects of depreciating the equipment. This reflects
the extra benefits received by the subsidiary as a result of using the equipment and recorded
by the subsidiary in its retained earnings account.
The adjustment for inventory is calculated in the retained earnings (1/1/13) as 7,000
(10,000 less the tax of 3,000). Since the inventory has been sold, the group no longer has the
benefit of that fair value increase.
In this example, the adjustments to retained earnings (1/1/13) are those relating to
the inventory and the equipment. In other examples, there may be a number of adjust-
ments to retained earnings depending on the number of assets being revalued. All such
adjustments must be taken into account in order not to double count the NCI share of
equity.
Non-controlling Interest in Income and Equity in Subsequent Periods 237
The consolidated financial statement adjustments for NCI are:

NCI equity January 1, 2013:
Retained earnings (1/1/13) 16,000
FVA equipment 14,000 2 2,800 8,400
Equity based on fair value 64,400
40%
NCI equity 1/1/13 25,760
2. NCI share of current period changes in equity

You can see in Illustration 5.8 that there are three changes in equity in 2013:
1. Trestone has reported net income of $15,000.
2. The subsidiary has paid a dividend of $1,500.
3. The subsidiary has declared a dividend of $2,000 for a total of $3,500.
The NCI receives a share of all equity accounts regardless of whether it existed before
acquisition date or was created after that date.
The NCI share of current period profit is based on a 40% share of the recorded net income
of $15,000. However, there must be an adjustment made to avoid the double counting caused
by the subsidiary recognizing profits from the use of the equipment, these benefits having
been recognized on consolidation. There is an adjustment to depreciation expense of $4,000
and an adjustment to income tax expense of $1,200. In other words, in the current period,
Trestone recognized in its profit an amount of $2,800 from the use of the equipment that was
recognized by the group. Since the NCI has been given a share of the fair value adjustment,
to give the NCI a share of the recorded profit without adjusting for the current period’s
depreciation would double count the NCI share of equity. The NCI share of current period
profit is, therefore, 40% of the net of recorded profit of $15,000 less the after-tax deprecia-
tion adjustment of $2,800.
The consolidated financial statement adjustment to allocate the net income to the
NCI is:
Trestone net income $15,000
FVA equipment (2,800)
Adjusted net income 12,200
40%
4,880
The second change in equity in the current period relates to dividends paid and declared.
Dividends are a reduction in retained earnings. The NCI share of equity is reduced as
a result of the payment or declaration of dividends. Where dividends are paid, the NCI
receives a cash distribution as compensation for the reduction in equity. Where dividends
are declared, the group recognizes a liability to make a future cash payment to the NCI
as compensation for the reduction in equity. The consolidated financial statement adjust-
ments are:
NCI: T 40% (1,500 2,000)
3. Intragroup dividends
Where an NCI exists, any dividends declared or paid by a subsidiary are paid proportionately
(to the extent of the ownership interest in the subsidiary) to the parent and proportionately
to the NCI. In adjusting for dividends paid by a subsidiary, the dividend paid or payable to
the parent is eliminated on consolidation. However, there is a proportional adjustment of the
dividend paid or declared. As with other intragroup transactions, the adjustment relates to
the flow within the group. A payment or a declaration of dividends by a subsidiary reduces
the NCI share of subsidiary equity because the subsidiary’s equity is reduced by the payment
or declaration of dividends. Where a dividend is declared, the NCI share of equity is reduced,
and a liability to pay dividends to the NCI is shown in the consolidated statement of financial
position.
The intragroup dividends to be eliminated are:

Dividend revenue T 900
Dividend paid T 900
A statement of changes in equity showing the effects of the adjustments developed in
Illustrative Example 5.2 is given in Illustration 5.9. It uses the figures for the subsidiary for the year
ended December 31, 2013, as given in Illustration 5.8, and assumes information for the parent.
Illustration 5.9
Attributable to owners of the parent
Extract from Consolidated
Financial Statement— Share Retained Non-controlling
Profit in Closing Inventory capital earnings (R/E) Total interest Total equity
Balance at
January 1, 2013 100,000 24,640a 124,640 25,760b 150,400
Comprehensive
income
Net income 25,220c 25,220 4,880d 30,100
Dividends (15,000)e (15,000) (1,400)f (16,400)
Balance at
December 31,
2013 100,000 34,860g 134,860 29,240h 164,100
a
P’s R/E P’s % S’s R/E since acquisition (R/E today – R/E at acquisition) adjusted for FVA written off
to date
25,000 .6[(16,000 4,000) (2 2,800) 7,000] 24,640
b
NCI % of S equity adjusted for FVAs that still exist
.4[40,000 16,000 [14,000 2 2,800)] 25,760
c
P’s income dividend revenue P’s % S’s NI adjusted for FVA written off in the current period
20,000 900 1,200 .6[15,000 2,800] 25,220
d
NCI % S’s NI adjusted for FVA written off in the current period
.4[15,000 2,800] 4,880
e
P’s dividends declared
15,000
f
NCI % of S’s dividends
.4[3,500] 1,400
The year-end balances could be calculated independently.
g
P’s R/E P’s % of S’s R/E since acquisition adjusted for FVAs written off
30,000 .6[(27,500 4,000) (3 2,800) 7,000] 34,860
h
NCI % S’s equity adjusted for FVAs that still exist
.4[40,000 27,500 (14,000 3 2,800)] 29,240
✓ LEARNING CHECK
• The NCI is entitled to a share of consolidated equity.
• To calculate the NCI share of equity, it is necessary to calculate the NCI share of equity at the
beginning of the year and then add the NCI share of net income, other comprehensive income,
and dividends.
• The NCI share of income is equal to its percentage of the subsidiary’s net income adjusted for
any write off of fair value adjustments.
• The NCI share of equity is equal to its percentage ownership of the subsidiary’s equity adjusted
for any fair value adjustments that still remain to the group.
Non-controlling Interest Affected by Intragroup Profit 239
NON-CONTROLLING INTEREST
AFFECTED BY INTRAGROUP PROFIT
Objective 4 Because IFRS 10 adopts the entity concept of consolidation, the full effects of transac-
Calculate NCI that tions within the group are adjusted on consolidation. In essence, the adjustments used in
is affected by Chapter 4 are the same regardless of whether the subsidiary is wholly or partly owned by
the existence of its parent.
intragroup profits.
The justification for considering adjustments for intragroup profits in the calculation
of the NCI share of equity is that, under the entity concept of consolidation, the NCI is
classified as a contributor of capital to the group. Thus, the calculation of the NCI is based
on a share of consolidated equity and not equity as recorded by the subsidiary. Consolidated
equity is determined as the sum of the equity of the parent and the subsidiaries after making
adjustments for the effects of intragroup transactions. The NCI share of that equity must,
therefore, be based on subsidiary equity after adjusting for intragroup profits that affect the
subsidiary’s equity.
To illustrate, assume that during the current period, a subsidiary in which there is an NCI
of 20% has recorded net income of $20,000, which includes a before-tax profit of $2,000 on
sale of $18,000 inventory to the parent. The inventory is still on hand at the end of the cur-
rent period. In the consolidated financial statement, the adjustments for the sale of inventory,
assuming a tax rate of 30%, are:
Sales T 18,000
Cost of sales T 18,000 c 2,000 T 16,000
Ending inventory T 2,000
The group does not regard the after-tax profit of $1,400 as being a part of consolidated
profit. Hence, in calculating the NCI share of consolidated profit, the NCI is entitled to
$3,720; i.e., 20% ($20,000 recorded profit $1,400 intragroup profit).
The NCI share of equity is therefore adjusted for the effects of intragroup transactions.
However, note that the NCI share of consolidated equity is essentially based on a share of
subsidiary equity. Therefore, only intragroup transactions that affect the subsidiary’s equity
need to be taken into consideration. Profits made on inventory sold by the parent to the sub-
sidiary do not affect the calculation of the NCI because the profit is recorded by the parent,
not the subsidiary. The subsidiary equity is unaffected by the transaction.
The NCI share of the equity recorded by the subsidiary is calculated based on the recorded
subsidiary equity; i.e., equity that will include the intragroup transactions. The subsidiary
therefore needs to make further adjustments to eliminate the effects of intragroup transac-
tions as discussed in Chapter 4.
The NCI totals $3,720; i.e., $4,000 less $280. Thus the NCI is given a share of recorded
profit adjusted for the effects of intragroup transactions.
Not all transactions require an adjustment to the NCI. For a transaction to require an
adjustment to the calculation of the NCI share of equity, it must have the following charac-
teristics:
• The transaction must result in the subsidiary recording a profit or a loss.

• After the transaction, the other party to the transaction (for two-company structures, this
is the parent) must have on hand an asset (e.g., inventory) on which the unrealized profit
is accrued.
• The initial consolidation adjustment for the transaction should affect both the statement
of financial position and the statement of comprehensive income, unlike payments of
management fees, which affect only the statement of comprehensive income.
In determining the transactions requiring an adjustment for the NCI, it is important to

work out which transactions involve unrealized profit. The concept of realization was discussed in
Chapter 4. The test for realization is the involvement of a party external to the group, based
on the concept that the consolidated financial statements report the affairs of the group in
terms of its dealings with entities external to the group. Consolidated profits are therefore
realized profits as they result from dealing with entities external to the group. Profits made
by transacting within the group are unrealized because no external entity is involved. Once
the profits/losses on an intragroup transaction become realized, the NCI share of equity no
longer needs to be adjusted for the effects of an intragroup transaction because the profits/
losses recorded by the subsidiary are all realized profits.
In this section, the key point to note is when, for different types of transactions, unreal-
ized profits on intragroup transactions become realized. A sale made from the parent to the
subsidiary would be considered to be a “downstream” sale, whereas a sale from the subsidiary
to the parent would be considered “upstream.”
Inventory
Inventory is realized when the acquiring entity sells the inventory to an entity outside the
group. Consolidation adjustments for inventory are based on the profit/loss remaining in
inventory on hand at the end of a financial period. If inventory is sold in the current period
by the subsidiary to the parent at a profit, giving the NCI a share of the recorded profit will
overstate the NCI share of consolidated equity, because the group does not recognize the
profit until the inventory is sold outside the group. Hence, whenever consolidated adjust-
ments are made for profit remaining in inventory on hand at the end of the period, an NCI
adjustment is necessary to reduce the NCI share of current period profit and the NCI total.
Following the consolidation adjustment for the unrealized profit in inventory, net of tax, an
NCI adjustment is made:
NCI—equity; ending T x
NCI—net income T x
If there is inventory on hand at the beginning of the current period, the NCI share of the
previous period’s profit must be reduced as the subsidiary’s previous year’s recorded profit
contains unrealized profit. As the group realizes the profit in the current period when the
inventory is sold to external parties, the NCI share of the current period’s profit, net of tax,
must be increased. Following the adjustment for the profit remaining in beginning inventory,
an NCI adjustment is made:
NCI—equity; beginning T x
NCI—net income c x
Depreciable Non-current Assets

With depreciable non-current assets, profit is realized as the asset is used up within the group.
Realization of the profit occurs as the future benefits embodied in the asset are consumed by
the group, and occurs in proportion to the depreciation of the asset. If the subsidiary sells a
non-current asset in the current period to the parent, an adjustment is made for the profit
on sale, net of tax, because the profit is unrealized to the group. The NCI share of current
period profit must then be reduced. Following the adjustment for the profit on sale, an NCI
adjustment is made:
NCI—equity; ending T x
NCI—net income T x
Non-controlling Interest Affected by Intragroup Profit 241
As the asset is depreciated, some of the profit becomes realized, net of tax, increasing the
NCI share of profit. Following the adjustment for depreciation, an NCI adjustment is made:
NCI—equity; ending c x/years
NCI—net income c x/years
You can see that the NCI adjustment for the profit on sale reduces the NCI share of
equity, and the NCI adjustment relating to depreciation increases the NCI share of equity,
and is consistent with the effect to the parent. This reflects the fact that as the asset is used up,
the profit becomes realized.
Intragroup Transfers for Services and Interest

For transactions involving services and interest, the group’s profit is unaffected because the
general consolidation adjustment reduces both expense and revenue equally. However, from
the NCI’s perspective, there has been a change in the subsidiary’s equity; for example, the
subsidiary may have recorded interest revenue as a result of a payment to the parent entity
relating to an intragroup loan. The revenue is unrealized in that no external entity has been
involved in the transaction. Theoretically, the NCI should be adjusted for such transactions.
However, as noted in paragraph B86c of IFRS 10, it is profits and losses “recognized in
assets” that are of concern. In other words, where there are transfers between entities that do
not result in the retention within the group of assets on which the profit has been accrued, it
is assumed that the profit is realized by the group immediately on payment within the group.
For transactions such as payments for intragroup services, interest, and dividends, there are
no assets recorded with accrued profits attached, since the transactions are cash transactions.
Hence, the profit is assumed to be immediately realized. The reason for the assumption of
immediate realization of profits on these types of transactions is a pragmatic one based on the
cost benefit of determining a point of realization.
An example of the process of calculating NCI when intragroup transactions exist is given
in Illustrative Example 5.3.
Illustrative Example 5.3 NCI and Intragroup Transactions

Kickstone owns 80% of the issued shares of Pasolet. In the year ending December 31,
2013, the following transactions occurred:
1. In January 2013, Kickstone sold $2,000 worth of inventory that had been sold to it
by Pasolet in November 2012 at a profit to Pasolet of $500.
2. In August 2013, Kickstone sold $10,000 worth of inventory to Pasolet, recording a
profit before tax of $2,000. At December 31, 2013, 20% of this inventory remained
unsold by Pasolet.
3. In September 2013, Pasolet sold $12,000 worth of inventory to Kickstone at a
markup of 20%. At December 31, 2013, $1,200 of this inventory remained unsold
by Kickstone.
4. Pasolet recorded a gain before tax of $10,000 in 2011 in relation to a plant sold to
Kickstone on January 1, 2011. Pasolet depreciates straight line over 10 years for a
plant. At date of sale to Kickstone, this plant had a carrying amount of $90,000 in
the books of Pasolet.
Required
Given a tax rate of 30%, prepare the consolidated financial statement adjustments for
these transactions as at December 31, 2013.
Solution
(a) Sale of inventory in previous period: Pasolet to Kickstone (upstream)

This profit was unrealized in 2012 and becomes realized in 2013.
Profit $500
Tax 30% (150)
Net 350
Because the sale was from the subsidiary to the parent, an adjustment is required
to NCI.
(b) Sale of inventory in current period: Kickstone to Pasolet (downstream)
Profit $2,000 20% 400
Tax 30% (120)
Net 280
Because the sale was from the parent to the subsidiary, there is no NCI adjustment
required.
(c) Sale of inventory in current period: Pasolet to Kickstone (upstream)
Profit 12,000/1.2 10,000 cost
12,000 10,000 2,000
Tax 30% (600)
Net 1,400
Because the sale was from the subsidiary to the parent, an adjustment is required
to NCI.
(d) Sale of plant in prior period: Pasolet to Kickstone (upstream)
Profit 10,000/10 years 1,000 realized/year
Tax 30% (3,000)/10 years (300) realized /year
Net 7,000 700
Adjustments to the financial statements for the year ending December 31, 2013:
Income Statement
Sales T 10,000 12,000
Cost of sales T 10,000 12,000 500 c 400 2,000
Depreciation T 1,000
Tax expense T 120 600 c 150 300
NCI T .2 1, 400 c .2 (350 700)
Statement of Changes in Equity

Retained earnings—beginning T .8 [350 (7,000 2 700)]
NCI—beginning equity T .2 [350 (7,000 2 700)]

Inventory T 400 2,000
Plant—net T 10,000 3 1,000
Deferred tax asset c 120 600 [3,000 3 3,000]
NCI—ending equity T .2 (1,400 7,000 3 700)
Since the plant was sold by the subsidiary to the parent, there will be an adjustment
to NCI.
Non-controlling Interest Affected by a Gain on Bargain Purchase 243
✓ LEARNING CHECK
• Since the NCI is entitled to a share of consolidated equity, it is necessary to adjust for the
effects of intragroup transactions in calculating the NCI share of equity.
• Since the NCI is calculated in relation to subsidiary equity, not all intragroup transactions
affect the calculation of the NCI, only those where the equity of the subsidiary is affected.
• In adjusting for intragroup transactions it is necessary to determine the flow of the
transaction—parent to subsidiary or subsidiary to parent—in order to determine whether an
NCI adjustment is required.
• The NCI share of equity is affected by the realization of profit on intragroup transactions.
• With intragroup transfers for services and interest, the NCI is unaffected because income/loss
is assumed to be immediately realized.
NON-CONTROLLING INTEREST
AFFECTED BY A GAIN ON
BARGAIN PURCHASE
Objective 5 This chapter has used examples of business combinations where goodwill has been acquired. In
Calculate NCI that the rare case that a gain on bargain purchase may arise, such a gain has no effect on the calculation
is affected by the of the NCI share of equity. Further, whereas the goodwill of the subsidiary may be determined
existence of a gain by calculating the goodwill acquired by the parent entity and then grossing this up to determine
on bargain purchase.
the goodwill for the subsidiary, this process is not applicable for the gain on bargain purchase.
The gain is made by the parent paying less than the net fair value of the acquirer’s share of the
subsidiary’s identifiable assets, liabilities, and contingent liabilities. The NCI receives a share of
the fair value of the subsidiary, and has no involvement with the gain on bargain purchase.
To illustrate, assume a subsidiary has the following statement of financial position/
balance sheet:
Equity $80,000
Identifiable assets and liabilities $80,000
Assume all identifiable assets and liabilities of the subsidiary are recorded at amounts
equal to fair value. If a parent acquires 80% of the subsidiary’s shares for $63,000, then the
acquisition analysis, assuming the use of the partial goodwill method, is:
Net fair value of subsidiary $80,000
Net fair value acquired by parent 80% $80,000
$64,000
$64,000 $63,000
Gain on bargain purchase $1,000
Assuming all fair values have been measured accurately, the consolidated financial state-
ment adjustments at acquisition date are:
Fair value adjustment
No adjustment is required in this simple example.
Pre-acquisition adjustment
Equity T 80,000
Investment in subsidiary T 63,000
Gain on bargain purchase c 1,000
Non-controlling interest c 16,000
(20% 80,000)
Note that the NCI does not receive any share of the gain on bargain purchase.
✓ LEARNING CHECK
• Any gain on bargain purchase adjusts for the parent’s share of pre-acquisition equity only.
• The NCI is unaffected by the existence of any gain on bargain purchase.
CHANGES IN THE PROPORTION HELD

BY NON-CONTROLLING INTEREST
Objective 6 We have assumed that the proportion of the subsidiary owned by the parent remains con-
Calculate the stant. In this section we look at the effects of the parent changing its ownership and as a result
effect on NCI due changing the NCI in the group. A company will often buy shares of another entity in stages or
to changes in
will divest itself of ownership interest in stages. In Chapter 3 we examined the step acquisition
ownership.
when the investor increases its ownership from that of a financial asset or significant influence
to the receipt of control. We saw that in that circumstance, the investment that is owned cur-
rently is valued at fair value and a gain or loss is recorded. The acquisition is then deemed to
have occurred on the day that control was obtained and the subsidiary is valued at fair value
at that date. In Chapter 6 we will examine changes in ownership for affiliates or joint arrange-
ments but there is no NCI in those circumstances. In this chapter we examine the specific
cases where an entity that already has control either increases or decreases its ownership.
Illustration 5.10 illustrates a change in ownership of Scorpio Gold Corporation by
Scorpio Mining Corporation, a Canadian-based gold producer.
Illustration 5.10
7. Investment in Scorpio Gold
On March 10, 2010, Scorpio Gold, then a subsidiary of the Corporation, issued an aggregate
Statements of Scorpio
35,600,194 shares, none of which were subscribed by the Corporation. As a result, Scorpio Mining’s
Mining Corporation
ownership interest of 27,901,106 shares in Scorpio Gold decreased from approximately 75% to ap-
proximately 38%. As of that date, the Corporation determined that it no longer controlled the operations
of Scorpio Gold, and, as a consequence, would no longer consolidate the operations of Scorpio Gold.
As a result, the Corporation derecognized the carrying amounts of assets, liabilities, and non-controlling
interest related to Scorpio Gold and recognized its retained investment in Scorpio Gold at its fair value
as at the date of deconsolidation of Scorpio Gold. The difference of $19,792,237 is recorded as a gain
in the statements of operations in the period ended June 30, 2010.
During the six-month period ended June 30, 2011, Scorpio Gold issued approximately 21.9 million
shares, none of which were subscribed by the Corporation, which resulted in the Corporation’s investment
in Scorpio Gold decreasing from approximately 35% to approximately 27% and creating a gain on dilution
of $1,051,039. In March 2011, the Corporation disposed of 8,139,568 million shares of Scorpio Gold for
proceeds of $5,172,695 and recognized a loss on disposal of $945,009.
As at June 30, 2011, the Corporation’s 19,761,538 common shares held in Scorpio Gold represent approxi-
mately 19.4% of Scorpio Gold’s outstanding shares. As at June 15, 2011, the Corporation no longer maintains
significant influence over the operations of Scorpio Gold as there is only one director in common and the
Corporation does not exercise significant influence over operational and financial activities of Scorpio Gold.
Accordingly, as of that date, the Corporation has recorded its investment in Scorpio Gold shares as an available-
for-sale financial instrument which resulted in a loss of $738,897 recorded in the statements of operations and
subsequent adjustments to fair value of $395,231 which is recorded in other comprehensive earnings (loss).
Balance at December 31, 2009 $20,646,818

Fair value upon deconsolidation (822,880)
Share of loss of Scorpio Gold for the period 432,488
Gain on dilution following Scorpio Gold share issuance 432,488
Balance at December 31, 2010 20,256,426
Share of loss of Scorpio Gold for the period (617,793)
Gain on dilution following Scorpio Gold share issuance 1,051,039
Disposition of shares (6,117,698)
Fair value adjustment on classification as available-for-sale instrument (738,897)
Balance at June 15, 2011 13,833,077
Loss on fair value adjustment of available-for-sale securities (395,231)
Fair value at June 30, 2011 $13,437,846
Changes in the Proportion Held by Non-controlling Interest 245
Under ASPE, changes in non-controlling interest are dealt with under section 1602
ASPE Non-controlling Interest but the requirements are in essence the same as IFRS.
Increases in Ownership
According to IFRS 10.23, changes in a parent’s ownership interest in a subsidiary that do
not result in the parent losing control of the subsidiary are equity transactions. We continue
with the information in Illustrative Example 5.2 and assume that on January 1, 2014, Magpie
acquires an additional 10% of Trestone for $10,000. It follows that if Magpie’s ownership
increases by 10%, the NCI must decrease by 10%. However, Magpie already had control
and therefore there is no basis to revalue the net assets of Trestone since the acquisition actu-
ally took place in 2011. What has happened is that the consolidated group has transferred
net assets from the non-controlling interest to the parent. The total net assets of the group
have not increased. IFRS 10.B.96 states that the parent must adjust the carrying amount of
non-controlling interest to reflect the changes in its relative interests in the subsidiary. The
parent recognizes in consolidated equity any difference between the amount by which the
non-controlling interests are adjusted and the fair value of the consideration paid.
Illustrative Example 5.4 examines the amount transferred from the non-controlling
interest to the parent.
Illustrative Example 5.4 Increase in Ownership;

Transfer from NCI to Parent
Required
Calculate the effect on NCI of an increase in ownership.
Solution
Using the information from illustrations 5.7 and 5.8:
Net assets of Trestone on December 31, 2013, at book value $67,500
Share capital, 40,000; Retained earnings, 27,000
Fair value adjustments remaining
Equipment 14,000 3 2,800 5,600
Net assets at fair value at December 31, 2013 73,100
NCI share of equity at December 31, 2013 40%
NCI at December 31, 2013 29,240
Transfer to parent 10% 73,100 (7,310)
NCI share of equity at January 1, 2014 $ 21,930
Additional cash by the parent $10,000
Amount transferred from NCI (7,310)
Loss to parent recorded directly in equity $ 2,690
In 2014 the consolidated retained earnings will reflect a decrease in retained earn-
ings in the amount of $2,690 since the retained earnings represents those that belong
to the parent. NCI for 2014 will be based on the new ownership percentage of 30%. In
the situation where the cash transferred is less than the net assets transferred, the gain
would be allocated directly to contributed surplus.
Decreases in Ownership
As stated earlier, if the parent retains control over the subsidiary, the parent is not deemed
to have sold any interest. In substance the group has transferred net assets from the parent to
the non-controlling interest.
Decrease in Ownership Due to a Sale by Parent

We continue with the information in Illustrative Example 5.3 and assume that on January
1, 2014, Magpie sells 5% of Trestone for $12,000. It follows that if Magpie’s ownership
decreases by 5%, the NCI must increase by 5%. However, Magpie still has control and
therefore there is no basis to record a gain or a loss on sale. What has happened is that the
consolidated group has transferred net assets from the parent to the NCI.
IFRS 10.B.96 states that the parent must adjust the carrying amounts of the non-controlling
interests to reflect the changes in its relative interests in the subsidiary. The parent recognizes
in consolidated equity any difference between the amount by which the non-controlling inter-
ests are adjusted and the fair value of the consideration paid. Illustrative Example 5.5 demon-
strates the situation where the parent decreases its ownership interest but has retained control.
If we refer to Illustrative Example 5.5, when the parent loses control, the gain of $8,345
would be recorded in income as a gain on sale of investment. Magpie would no longer pre-
pare consolidated financial statements.
Illustrative Example 5.5 Decrease in Ownership;

Control Retained
Required
Calculate the effect on the financial statements when the parent decreases its ownership
but still retains control.
Solution
Cash received by the parent $12,000
Net assets transferred:
Book value $67,500
FVA—equipment 5,600
73,100
Percentage transferred 5% (3,655)
Gain to equity—contributed surplus $ 8,345
In 2014 the consolidated financial statements will reflect an increase of $8,345 in equity.
The 2014 consolidated statements will have an NCI based on its new ownership of 45%.
If the parent sells enough of an ownership such that control is now lost, IFRS 10.25 indi-
cates that the parent does the following:
a) Derecognizes the assets and liabilities of the former subsidiary from the consolidated state-
ment of financial position.
b) Recognizes any investment retained in the former subsidiary at its fair value when control is
lost and subsequently accounts for it and for any amounts owed by or to the former subsidi-
ary in accordance with relevant IFRSs. That fair value shall be regarded as the fair value
on initial recognition of the financial asset in accordance with IFRS 9 or, when appropriate,
the cost on initial recognition of an investment in an associate or joint venture.
c) Recognizes the gain or loss associated with the loss of control attributable to the former con-
trolling interest.
Subsidiary issues additional shares to non-controlling interest

It is possible that the subsidiary issues additional shares on the market that the parent does
not purchase. In this case the parent’s ownership will decrease despite the fact that it did not
participate in the transaction. It is necessary to determine the gain or loss on the decrease
in ownership. If the parent still has control then the gain or loss is not recognized and a
transfer is recorded as above. Using the information again from Illustrative Example 5.2,
let us assume that on January 1, 2014, Trestone issues additional shares for $14,000, which
results in Magpie now owning 55% of Trestone. The effect is the same as that recognized in
Illustrative Example 5.5 in that Magpie still has control; however, there has been a transfer
of 5% to the NCI.
Cash received by the parent 55% $14,000 $7,700
Net assets transferred as above (3,655)
Contributed surplus $4,045
In the consolidated statements of 2014, the equity is increased by $4,045 and the NCI is
reflected at 45%.
✓ LEARNING CHECK
• When a parent increases its ownership interest, the difference between the amount that was
paid by the parent and the amount that was transferred from the non-controlling interest is
allocated to equity.
• When a parent decreases its ownership interest but still retains control, the difference between
the amount that was received and the amount that was transferred to the non-controlling
interest is allocated to equity.
• When a parent decreases its ownership interest and loses control, the difference between the
amount that was received and the amount that was transferred to the non-controlling inter-
est is recorded in net income.
KEY TERMS
LEARNING SUMMARY
entity concept of
consolidation
Where a subsidiary is not wholly owned, the subsidiary’s equity is divided into two parts: the
(p. 222)
parent’s share and the non-controlling interest (NCI) share. IFRS requires that the parent’s
non-controlling
share and the NCI share in equity be separately disclosed. This affects the consolidation
interest (NCI)
process. The NCI is classified as equity with the result that in statements of comprehensive
(p. 222)
income and statements of financial position, where equity amounts are disclosed the parent’s
share and the NCI share are separately disclosed.
The existence of an NCI will have different effects on the consolidated financial state-
ment adjustments used depending on whether the full goodwill or partial goodwill method is
used. Under the full goodwill method, goodwill is recognized in the fair value adjustments and
shared between the parent and the NCI—but not necessarily on a proportionate basis. Where
the partial goodwill method is used, the existence of an NCI has no effect on goodwill.
The adjustments for intragroup transactions also affect the calculation of the NCI share
of equity. There is no effect on the adjustment for an intragroup transaction itself—this is the
same regardless of the ownership interest of the parent in the subsidiary. However, the adjust-
ment for an intragroup transaction affects the calculation of the NCI share of equity. Since
the NCI is entitled to a share of consolidated equity rather than the recorded equity of the
subsidiary, where an intragroup transaction affects the equity of the subsidiary, adjustments
to NCI are required. It is then necessary to observe the flow of the transaction—upstream
or downstream—to determine whether an NCI adjustment is necessary. One area where the
NCI is unaffected is where a gain on bargain purchase arises, because the pre-acquisition
adjustment adjusts for the parent’s share only. The gain calculated relates only to the parent
and not the NCI.
Changes in NCI result when the parent changes ownership interest in the subsidiary.
If the parent retains control, any changes in ownership are reflected as transfers to or from
the parent to the NCI. Any difference between the amount received or paid and the amount
transferred is reflected in equity.
APPENDIX 5A CONCEPTS
OF CONSOLIDATION
Objective 7 Having decided on the criterion for consolidation, and hence the definitions of “parent” and
Understand the “subsidiary,” the standard setters decided on the choice of a concept of consolidation. The
concepts of accounting literature refers to many concepts of consolidation, most commonly the propri-
consolidation etary concept, the parent company concept, and the entity concept.
Differences in consolidation arise under these concepts only if the parent does not own
all the equity in a subsidiary; in other words, a non-controlling interest (NCI) does not exist.
As mentioned in the chapter, an NCI is defined in IFRS 10 as the equity in a subsidiary not
attributable, directly or indirectly, to a parent.
In Illustration 5A.1, you can see that in B the parent (A) has an ownership interest of 60%
and there is an NCI of 40%. Similarly in Y there is a parent interest of 35% and an NCI of 65%.
Illustration 5A.1
Non-controlling A Ltd. X Ltd.
Interest
60% 35%
A Ltd. 60% X Ltd. 35%

B Ltd. Y Ltd.
NCI 40% NCI 65%
The main areas affected in the preparation of consolidated financial statements by the
choice of concept of consolidation are:
• The assets and liabilities of a subsidiary included in the consolidated financial statements. This
relates to whether all the net assets of a subsidiary are included in the consolidated group
or just those attributable to the parent interest.
• The classification of the NCI as equity or liability, and the measurement of the NCI. The con-
solidated assets consist of the sum of the assets of the parent and those of the subsidiar-
ies. The choice of concept affects the amount shown as total consolidated liabilities and
equity, since the choice of concept affects the category into which the NCI is placed as
well as the calculation of the amount of the NCI.
• The adjustments for the effects of transactions within the group. The consolidated financial
statements show the performance and financial position of the group in its dealings with
parties external to the group. Where, for example, profits are made by one part of the
group, such as a subsidiary, in selling inventory to another part of the group, such as the
parent, the effects of these transactions must be eliminated with adjustments being made
to the profits recorded by the subsidiary. The choice of concept affects whether all the
profit on such transactions is adjusted for or whether only part of the profit is eliminated.
No specific concept of consolidation is explicitly recognized in IFRS 10. However, the
accounting treatments adopted in IFRS 10 are consistent with the adoption of the entity
concept of consolidation. This appendix gives only a brief outline of the alternative concepts
of consolidation.
Entity Concept of Consolidation

Under the entity concept of consolidation:
• The group consists of the assets and liabilities of the parent as well as all the assets and
liabilities of the subsidiaries.
Appendix 5A Concepts of Consolidation 249
• The NCI is classified as an equity holder or contributor of capital to the group in the
same capacity as the equity holders/owners of the parent.
Diagrammatically, the group under the entity concept is as shown in Illustration 5A.2.
Illustration 5A.2
Group Under the Group
Entity Concept
Assets,
Assets, liabilities, and
liabilities, and equity of
equity of parent subsidiary—NCI
is part of equity
Parent Subsidiary
The implications of adopting the entity concept of consolidation for the preparation of
the consolidated financial statements are as follows:
• Where there are transactions between members of the group, the effects of these trans-
actions are adjusted in full, as required by paragraph B86c of IFRS 10. This accords with
the view that the consolidated financial statements should show the results of transac-
tions between the group and entities external to the group. The adjustments are then
unaffected by the extent of the parent’s ownership interest in the subsidiary.
• Because the NCI is classified as a contributor of equity to the group, it is disclosed in the
equity section of the consolidated financial statements, per paragraph 54(q) of IFRS 1
Presentation of Financial Statements and IFRS 10.
• Because of the classification of the NCI as equity, its measurement is based on a share of
consolidated equity and not on a share of the recorded equity of the subsidiary in which
the NCI ownership interest is held.
Parent Company Concept of Consolidation

Under the parent company concept:
• The consolidated group consists of the assets and liabilities of the parent and all the
assets and liabilities of the subsidiaries.
• The NCI is classified as a liability.
Diagrammatically, the group under the parent entity concept is as shown in
Illustration 5A.3.
Illustration 5A.3
Group Under the Parent Group
Entity Concept
Assets,
Assets, liabilities, and
liabilities, and equity of
equity of parent subsidiary—NCI
is a liability
Parent Subsidiary
Under this concept:

• Adjustments for transactions within the group involve both partial (i.e., to the extent of
the parent’s interest in the subsidiary) and total elimination procedures. Only the parent’s
share of the intragroup profit is eliminated where the subsidiary is the selling entity, but
all the profit is eliminated where the parent is the seller. The rationale for this is based on
the classification of the NCI as a liability, and the need to increase the share of the NCI
when the subsidiary makes a profit on transacting with the parent. The justification is
based on the need to report accurately the liability to the NCI.
• The NCI is reported in the liability section of the consolidated statement of financial
position.
• The NCI is calculated as its proportionate share of the recorded equity of the subsidiary,
with no adjustments for transactions within the group.
The focus of the parent entity concept is on the parent’s owners as the main user group.
All controlled assets and liabilities are included in the consolidated financial statements, but
the claim by the parent’s owners is net of the liability claim of the NCI.
Proprietary Concept of Consolidation

The proprietary concept is sometimes referred to as “proportional consolidation” or “pro
rata consolidation.” Under the proprietary concept:
• The group consists of the assets and liabilities of the parent and the parent’s proportional
share of the assets and liabilities of the subsidiary; hence, the consolidated financial state-
ments do not include all the net assets of a subsidiary, only the parent’s share.
• As the NCI is outside the group, the NCI share of subsidiary equity is not disclosed, and
neither is the NCI share of the subsidiary’s net assets.
Diagrammatically, the group under the proprietary concept is as shown in Illustration

5A.4. Under this concept:
• Transactions between the parent and the subsidiary are adjusted proportionally (i.e., to
the extent of the parent’s ownership interest in the subsidiary).
• NCI is not disclosed.
Illustration 5A.4
Group Under the
Proprietary Concept Group
Parent NCI share

Assets, share of of assets
liabilities, and assets and and
equity of parent liabilities liabilities
of sub. of sub.
Parent Subsidiary
Under ASPE, this concept is permitted for the reporting of joint ventures on the basis
ASPE that in a joint venture no party has unilateral control and therefore consolidation should
be based on ownership.
Choice of Concept
As noted earlier in this section, the IASB has effectively chosen the entity concept of con-
solidation. The main reasons for this are probably (the standard setters have not stated any
reasons in IFRS 10) that under the entity concept:
• The consolidated financial statements include all the assets and liabilities of the group.
Given the choice of control as the criterion for consolidation, it seems appropriate that
all the consolidated financial statements include all the assets under the parent’s control.
• The NCI does not fit into the definition of a liability under the conceptual framework.
The group has no obligation to outlay resources to the NCI. The NCI has the same
claim on the net assets of a subsidiary as does the parent. The NCI does not have a prior-
ity claim, which is normally the case with liability claims. In the Basis for Conclusions on
IAS 27, which preceded IFRS 10, the IASB made the following comments in relation to
the NCI:
BC30. The Board decided to amend this requirement to require minority (non-controlling)
interests to be presented in the consolidated balance sheet [statement of financial position]
within equity, separately from the equity of the shareholders of the parent. The Board
concluded that a minority (non-controlling) interest is not a liability of a group because
it does not meet the definition of a liability in the Framework for the Preparation and
Presentation of Financial Statements.
BC31. Paragraph 49(b) of the Framework states that a liability is a present obligation of the
entity arising from past events, the settlement of which is expected to result in an outflow
from the entity of resources embodying economic benefits. Paragraph 60 of the Framework
further indicates that an essential characteristic of a liability is that the entity has a pres-
ent obligation and that an obligation is a duty or responsibility to act or perform in a
particular way. The Board noted that the existence of a minority (non-controlling) interest
in the net assets of a subsidiary does not give rise to a present obligation of the group, the
settlement of which is expected to result in an outflow of economic benefits from the group.
BC32. Rather, the Board noted that a minority (non-controlling) interest represents the resid-
ual interest in the net assets of those subsidiaries held by some of the shareholders of the
subsidiaries within the group, and therefore meet the Framework’s definition of equity.
Paragraph 49(c) of the Framework states that equity is the residual interest in the assets
of the entity after deducting all its liabilities.
✓ LEARNING CHECK
• There are three main concepts of consolidation: proprietary, entity, and parent company.
• The choice of concept affects how consolidated financial statements are prepared, but only
where the subsidiary is less than wholly owned by the parent.
• The IASB has chosen to adopt the entity concept of consolidation, mainly because of the con-
ceptual framework decision that financial statements are prepared for a wide range of users.
Seal acquired 80% (8,000 shares) of the shares of De Zwaan on January 1, 2010, for $540,000,
when the equity of De Zwaan consisted of:
All identifiable assets and liabilities of De Zwaan are recorded at fair value at this date
except for inventory, for which the fair value was $10,000 greater than carrying amount, and
plant, which had a carrying amount of $150,000 (net of $40,000 accumulated depreciation)
and a fair value of $170,000. The inventory was all sold by December 31, 2010, and the plant
had a further five-year life with depreciation based on the straight-line method.
Financial information for both companies at December 31, 2013, is as follows:
Seal De Zwaan
Sales revenue $720,000 $530,000
Other revenue 240,000 120,000
960,000 650,000
Cost of sales (610,000) (410,000)
Other expenses (230,000) (160,000)
(840,000) (570,000)
Income before tax 120,000 80,000
Tax expense (40,000) (25,000)
Net income 80,000 55,000
Retained earnings at 1/1/13 280,000 212,000
360,000 267,000
Dividend paid (20,000) (10,000)
(45,000) (25,000)
Retained earnings at 31/12/13 315,000 242,000
Cumulative other comprehensive income 20,000* 60,000*
Total equity 935,000 802,000

Other liabilities 25,000 25,000

Accounts receivable $ 80,000 $ 30,000
Inventory 100,000
Plant and equipment (net) 85,000 412,000
Land 100,000 80,000
Investment in De Zwaan 540,000 —
Total assets $985,000 $842,000
* The balances of the cumulative other comprehensive income at January 1, 2013, were $35,000 (Seal) and $50,000 (De Zwaan).
The following transactions took place between Seal and De Zwaan:

1. During 2013, De Zwaan sold inventory to Seal for $23,000, recording a profit before tax
of $3,000. Seal has since resold half of these items.
2. During 2013, Seal sold inventory to De Zwaan for $18,000, recording a profit before tax
of $2,000. De Zwaan has not resold any of these items.
3. On June 1, 2013, De Zwaan paid $1,000 to Seal for services rendered.
4. During 2012, De Zwaan sold inventory to Seal. At December 31, 2012, Seal still had
inventory on hand on which De Zwaan had recorded a before-tax profit of $4,000. This
inventory was subsequently sold to external parties in 2013.
5. On January 1, 2011, De Zwaan sold a plant to Seal for $150,000, recording a profit of $20,000
before tax. Seal depreciates on a straight-line basis over 10 years in relation to these assets.
Required
(a) Given an income tax rate of 40%, prepare the consolidated financial statements for Seal
for the year ended December 31, 2013, using the partial goodwill method to measure the
non-controlling interest at acquisition date.
(b) What differences would occur in the consolidated financial statement adjustments at
December 31, 2013, if the full goodwill method was used to calculate the non-controlling
interest at acquisition date? Assume the value of the non-controlling interest in the subsid-
iary at acquisition date is $134,500 based on the market value of the De Zwaan shares.
Solution
(a) Consolidated financial statements using partial goodwill method
The first step is to prepare the acquisition analysis. Determining the net fair value is the same
as for wholly owned subsidiaries. Where an NCI exists, it is necessary to determine the net
fair value acquired by the parent.
In this problem, the parent acquired 80% of the subsidiary’s shares. The net fair value
of what was acquired is then compared with the consideration transferred, and a goodwill
or gain is determined. Note that the goodwill or gain is only that attributable to the parent,
since the residual relates to what was paid by the parent and the proportion of net fair value
of the subsidiary acquired by the parent.
Net fair value of the identifiable assets and
liabilities of De Zwaan $500,000 $130,000 $20,000
$20,000(1 40%) (FVA—plant)
$668,000
Net fair value acquired by Seal 80% $668,000
$534,400
Goodwill $5,600
Consolidation adjustments at December 31, 2013

(a) The fair value adjustments are unaffected by the existence of an NCI. Under IFRS 3,
all identifiable assets and liabilities acquired in the acquiree/subsidiary must be mea-
sured at fair value. This principle is unaffected by the existence of an NCI.
Comprehensive income statement

Depreciation expense c 4,000
20,000/5 years 4,000 per year. Tax 40% 4,000 1,600
NCI T 480
20% (4,000 1,600) 480
Statement of changes in equity
Retained earnings—beginning T 80% [6,000 3 2,400] 10,560
NCI—beginning c 20% [12,000 3 2,400] 960
Statement of financial position
Plant—net c 20,000 4 4,000 4,000
Deferred tax liability c 8,000 4 1,600 1,600
Goodwill c 5,600
Retained earnings—ending T 80% [6,000 4 2,400] 12,480

NCI—ending c 20% [12,000 4 2,400] 480
These adjustments differ from the adjustments prepared for a wholly owned subsidiary
in that the adjustment to equity accounts is measured as the parent’s share of the equity
accounts.
(2) Non-controlling interest
(b) Opening balance in equity
20% [500,000 212,000 50,000] 152,400
The NCI is allocated a portion of the opening equity balance of the statement of changes
in equity.
(c) Profit for the period
The NCI receives a share of recorded profit of the subsidiary. The NCI share is then:
20% [$55,000]
(d) Cumulative other comprehensive income (COCI)
The balance of the subsidiary’s COCI at January 1, 2013, was $50,000. The balance at
December 31, 2013, is $60,000. The NCI share of equity is increased by 20% of the change
during the period. The adjustment is recognized in the gains/losses on other comprehensive
income. The adjustment reduces the group gain so that the statement shows the parent share
of the gain. The adjustment to NCI columns on the statement of changes in equity is:
NCI—COCI c 20% [60,000 50,000]
(3) Intragroup transactions

(e) Dividends
Dividend paid
The dividend paid by the subsidiary reduces the subsidiary’s equity. The adjustment to the
NCI share of equity as a result of the dividend paid must take into consideration the full
dividend paid with the effect of reducing the NCI share of total equity. The adjustment on
the consolidated financial statement to adjust for the $10,000 dividend paid is:
Dividend revenue T 80% 10,000 8,000
Dividend paid T 10,000
NCI—dividends T 20% 10,000 2,000
Dividend declared
As with the dividend paid, the NCI has been given a full share of equity before the declaration
of dividends. Because the dividend declared reduces the subsidiary’s equity, the NCI share
of equity is also reduced. The subsidiary declared a dividend of $15,000, of which $12,000 is
payable within the group. The adjustments are:

NCI—dividends T 20% 15,000 3,000
(f ) Sale of inventory: De Zwaan to Seal (upstream)

Comprehensive income
Sales T 23,000
Cost of sales T 23,000 c 1,500 T 21,500
(1/2 3,000)

(40% 1,500)
NCI—net income T 180
20% (1,500 600)
Statement of financial position
Inventory T 1,500
NCI—equity T 180
Retained earnings—ending T 720
(80% 900)
The profit on sale was made by the subsidiary. The NCI is therefore affected. The total
after-tax profit on the intragroup sale of inventory was $1,800 (i.e., $3,000 $1,200 tax).
However, since half the inventory is sold to an external entity, this portion is realized. The
adjustment to the NCI relates only to the unrealized profits remaining in the inventory still
on hand (half of $1,800, or $900).
The transaction occurs in the current period. Therefore, it is the NCI share of cur-
rent period profit that is affected. The NCI is given a share of the total recorded sub-
sidiary profit for the current period. Because the realized profit is less than the recorded
profit, the NCI share of equity must be reduced, specifically the NCI share of current
period profit.
(g) Sale of inventory: Seal to De Zwaan (downstream)

Sales T 18,000
Cost of sales T 18,000 c 2,000 T 16,000

Inventory T 2,000
Retained earnings—ending T 1,200
Because the profit on the transaction is made by the parent entity and does not affect the
subsidiary’s equity, there is no need to make any adjustment to the NCI.
(h) Payment for services: De Zwaan to Seal

Other revenue T 1,000
Other expenses T 1,000
The subsidiary’s profit is affected by the transaction even though the payment may, in
effect, be from the parent to the subsidiary. However, if it is assumed that realization occurs
on payment for the services for this type of transaction, then no unrealized profit/loss exists
in the subsidiary. Hence, there is no need to make any adjustment to NCI.
(i) Sale of inventory in previous period: De Zwaan to Seal (upstream)

Retained earnings—beginning T1,920
80% (4,000 60% net of tax) 80% 2,400
NCI—beginning equity T 480
(20% 2,400)

Income tax expense c 1,600
NCI—net income c 480
The profit on this transaction was made by the subsidiary, so an adjustment to the NCI
share of equity is required. There are two effects on the NCI because the transaction affects
both last year’s and the current period’s figures.
First, the profit made by the subsidiary in the previous period was unrealized last year.
Hence, the subsidiary’s retained earnings (1/1/13) account contains $2,400 unrealized profit.
An adjustment is necessary to reduce the NCI share of the previous period’s profit.
Second, in relation to the current period, because the inventory transferred last period is
sold in the current period to an external entity, the profit previously recorded by the subsid-
iary becomes realized in the current period. Since the profit is realized to the NCI in the cur-
rent period but was recorded by the subsidiary last period, the NCI share of current period
profit needs to be increased.
This adjustment has no effect on the total NCI share of equity at the end of the year. It
simply reduces the NCI share of equity recorded last period and increases the NCI share of
current period profit. This reflects the fact that the subsidiary recorded the profit in the pre-
vious period whereas the group recognized the profit in the current period.
(j) Sale of depreciable asset in previous period: De Zwaan to Seal (upstream)

The sale occurred on January 1, 2011.

Retained earnings—beginning T 7,680
80% (20,000 60% 2 2,000 60%)
NCI—equity; beginning T 1,920
20% (20,000 60% 2 2,000 60%)
Depreciation expense T 2,000
NCI—net income c 240
(20% 1,200)
Plant—net T 14,000
(20,000 3 2,000)
(8,000 3 800)
Retained earnings—ending T 6,720
(80% [20,000 .6] [ 3 1,200])
NCI—equity; ending T 1,680
(20% 8,400)
The subsidiary recorded the profit on the transaction, so the NCI is affected. Because the
transaction occurred in a previous period, the subsidiary’s recorded retained earnings (1/1/13)
balance contains an after-tax unrealized profit of $12,000 2 1,200 9,600. The NCI share
of the 2011 profits that is still unrealized must then be reduced by $1,920 (i.e., 20% $9,600).
The assumption made in relation to the $12,000 unrealized profit is that realization will
occur over the life of the asset as the benefits of the depreciable asset are consumed by the
group. The profit is then realized in proportion to the depreciation charged on the asset.
The after-tax adjustment is $1,200 (being $2,000 $800). In other words, the $12,000 profit
recognized in 2011 by the subsidiary will be recognized as realized to the extent of $1,200
p.a. over the next 10 years. Hence, $1,200 is realized in 2011, $1,200 is realized in 2012, and
a further $1,200 is realized in 2013. The NCI share of the previous two years’ profits is there-
fore increased, as is the NCI share of the current period’s profits.
In each of the 10 years following the transfer of the asset, the group realizes an extra
$1,200 profit. This increases the NCI share of profit by $240 per year, and effectively reverses
the reduction in the NCI share of profit relating to the gain on sale in 2011. As the profit
becomes realized over time, the NCI share of equity increases. The effect on NCI share of
retained earnings (beginning balance) over time is as follows:
NCI share of retained earnings (1/1/12) $2,400 less $240
NCI share of retained earnings (1/1/13) $2,400 less (2 $240)
In 2020, the profit becomes fully realized as the asset becomes fully depreciated. The
consolidated financial statement for Seal at December 31, 2013, is shown in Illustration 5.11.
Illustration 5.11
Consolidated Financial Sales revenue 720,000 530,000 23,000f 18,000g 1,209,000
Statement Showing NCI Other revenues 240,000 120,000 8,000e 339,000
and the Effects of 12,000e 1,000h
Intragroup Transactions Total revenues 1,548,000
Cost of sales 610,000 410,000 23,000f 1,500f 978,500
18,000g 2,000g 4,000i
Other expenses 230,000 160,000 4,000a 391,000
1,000h 2,000j
Total expenses 1,369,500
Income before tax 178,500
Tax expense 40,000 25,000 1,600a 600f 64,400
800g 1,600i 800j
Net income 114,100
NCI—income .2 [55,000]c 480a 180f 11,060
480i 240j
Seal share net income 80,000 8,000e 12,000e 1,200g 103,040
.8 [55,000 2,400a 900f
2,400i 1,200j]
Retained earnings 1/1/13 280,000 .8 (212,000 130,000) 325,440
10,560a 1,920i 7,680j
Dividend paid 20,000 10,000 10,000e 20,000
Dividend declared 25,000 15,000 15,000e 25,000
Retained earnings 12/31/13 315,000 .8 [242,000 130,000] 383,480
12,480a 720f 1,200g 6,720j
Share capital 600,000 500,000 500,000 600,000
Cumulative other
comprehensive income 1/1/13 35,000 .8 [50,000 20,000] 59,000
Gain/loss on asset revaluation 15,000 .8 [10,000] 7,000
Cumulative other
comprehensive income 31/12/13 20,000 .8 [60,000 20,000] 52,000
NCI—equity; beginning of year .2 [500,000b 212,000 150,960
50,000] 960a 480i 1,920j
NCI share of income As above 11,060
NCI—share of dividends 2,000e 3,000e 5,000
NCI—share of OCI .2 10,000d 2,000
NCI—equity .2 [500,000 242,000 60,000] 159,020
480a 180f 1,680j
Total equity 1,194,500
Illustration 5.11
Dividends payable 25,000 15,000 12,000e 28,000
(Continued)
Other liabilities 25,000 25,000 50,000
Total equity and liabilities 1,272,500
Accounts receivable 80,000 30,000 12,000e 98,000
Inventory 100,000 1,500f 2,000g 96,500
Plant and equipment—net 85,000 412,000 4,000a 14,000j 487,000
Land 100,000 80,000 180,000
Investment in De Zwaan 540,000 540,000 0
Deferred tax asset 50,000 40,000 1,600a 600f 95,400
800g 5,600j
Goodwill 5,600a 5,600
Other assets 30,000 280,000 310,000
Total assets 1,272,500
The consolidated financial statements for Seal and its subsidiary, De Zwaan, for the year
ended December 31, 2013, are as shown in Illustration 5.12(a), (b), and (c).
Illustration 5.12(a)
SEAL
Consolidated Statement Consolidated Statement of Comprehensive Income
of Comprehensive Income for the year ended December 31, 2013
Revenue:
Sales $1,209,000
Other 339,000
Total revenue 1,548,000
Expenses:
Cost of sales (978,500)
Other (391,000)
Total expenses (1,369,500)
Tax expense (64,400)
Net income 114,100
Other comprehensive income (5,000)
TOTAL COMPREHENSIVE INCOME $ 109,100
Net income attributable to:
Parent $ 103,040
Non-controlling interest 11,060
114,100
Comprehensive income attributable to:
Parent $ 96,040
$ 109,100
Illustration 5.12(b)
Cumulative other Total: Non-
Consolidated Statement Share Retained comprehensive Owners of controlling
of Changes in Equity capital earnings income the parent interest Total equity
Balance at
January 1, 2013 $600,000 $325,440 $59,000 $ 984,440 $150,960 $1,135,400
Total
comprehensive
income 103,040 (7,000) 96,040 13,060 109,100
Dividends paid (20,000) (20,000) (2,000) (22,000)
Illustration 5.12(b)
Cumulative other Total: Non-
(Continued) Share Retained comprehensive Owners of controlling
capital earnings income the parent interest Total equity
Dividends
declared (25,000) (25,000) (3,000) (28,000)
Balance at
December
31, 2013 $600,000 $383,480 $52,000 $1,035,480 $159,020 $1,194,500
Illustration 5.12(c)
Consolidated Statement of SEAL
Financial Position Consolidated Statement of Financial Position
ASSETS
Current assets
Inventory 96,500
Non-current assets
Plant and equipment—net 487,000
Land 180,000
Deferred tax asset 95,400
Goodwill 5,600
Other 310,000
Total non-current assets 1,078,000
Total assets $1,272,500
LIABILITIES
Current liabilities: Dividend payable $ 28,000
Non-current liabilities 50,000
Net assets $1,194,500
EQUITY
Share capital $ 600,000
Parent interest 1,035,480
Total equity $1,194,500
(b) Consolidation adjustments under full goodwill method

Under the full goodwill method, the acquisition analysis would change as goodwill is calculated
by taking into consideration the fair value of the NCI in the subsidiary, De Zwaan, for the year
ended December 31, 2013. The calculations are as shown in Illustration 5.12(a), (b), and (c).
(b) Non-controlling interest in subsidiary $134,500
(c) Aggregate of (a) and (b) $674,500
Net fair value of the identifiable assets
and liabilities of De Zwaan $500,000 $130,000 $20,000
$20,000(1 40%) (FVA—plant)
$668,000
Goodwill $674,500 668,000
$ 6,500
Net fair value acquired by parent 80% 668,000
$534,400
Goodwill—parent $ 5,600($3,600 goodwill 2000 premium)

Goodwill—NCI $ 6,500 $5,600
$ 900
Consolidation adjustments at December 31, 2013: Fair value adjustments
Because the full goodwill method is used, there will need to be an adjustment in relation to
goodwill for the NCI:
Goodwill c 6,500
NCI—equity c 900
No other changes are required.
Changes in Ownership
Each of the following situations should be considered independently.
Situation 1
On January 1, 2014, Seal buys 1,000 shares of De Zwaan in the open market for $80,000.
Required
Determine the effect on equity for the consolidated group.
Solution
Since Seal already has control, any difference between the amount paid by Seal and the
amount transferred from the NCI is allocated to equity. We can consider both scenarios
where the full goodwill method is used as well as where the partial goodwill method is used.
Partial goodwill method Full goodwill method
Consideration paid by Seal 80,000 80,000

Fair value of net assets transferred
from the NCI
Book value (242,000 802,000 802,000
500,000 60,000)
FVA remaining plant 2,400 2,400
Goodwill 4,500
Total fair value 804,400 808,900
Percentage transferred 10% 80,440 10% 80,890
Equity: contributed surplus 440 890
The premium paid by Seal of $2,000 would not be transferred under the full goodwill method.
Situation 2
On January 1, 2014, Seal sells 2,000 shares in De Zwaan on the open market for $200,000.
Required
Determine the effect on equity for the consolidated group.
Solution
Since Seal still has control over De Zwaan, any difference between the amount received and the
amount transferred to the NCI is allocated to equity. We can consider two scenarios: one where
the full goodwill method is being used and one where the partial goodwill method is being used.
Consideration received by Seal 200,000 200,000

to the NCI
Book value (242,000 802,000 802,000
500,000 60,000)
Brief Exercises 261

Goodwill 4,500
Equity: contributed surplus 39,120 38,220
Situation 3
On January 1, 2014, De Zwaan issued an additional 1,430 shares, which were acquired by
outside parties, for $100,000.
Required
Determine the effect on equity of the consolidated group due to the issuance by De
Zwaan.
Solution
As a result of the issuance of shares by De Zwaan, Seal now owns the same 8,000 shares
of a total now of 11,430 shares (10,000 1,430) of De Zwaan shares. Seal’s ownership has
now decreased from 80% to 70% (8,000/11,430). Seal maintains control and therefore any
difference between the amount received and the amount transferred to NCI is allocated
to equity.
Consideration received by Seal 70,000 70,000

.7 100,000
to the NCI
Book value (242,000 802,000 802,000
500,000 60,000)
Goodwill 4,500
Equity: retained earnings 10,440 10,890
Brief Exercises
(LO 1) BE5-1 What is meant by the term “non-controlling interest” (NCI)?
(LO 1) BE5-2 Explain whether the NCI is better classified as debt or equity.
(LO 1) BE5-3 Explain whether the NCI is entitled to a share of subsidiary equity or some other amount.
(LO 1) BE5-4 How does the existence of an NCI affect the business combination fair value adjustments?
(LO 4) BE5-5 Explain how the adjustment for intragroup transactions affects the calculation of the NCI share of equity.
(LO 4) BE5-6 Explain whether an NCI adjustment needs to be made for all intragroup transactions.
(LO 4) BE5-7 What is meant by the term “realization of profit”?
(LO 4) BE5-8 When is profit realized on an intragroup transaction involving a depreciable asset?
(LO 4) BE5-9 When is profit realized on an intragroup transaction involving the parent renting a warehouse from the
subsidiary?
(LO 3) BE5-10 What are two events that could occur between the acquisition date and the beginning of the current period
that could affect the calculation of the NCI share of retained earnings?
(LO 1) BE5-11 What lines in the financial statements are necessary to provide a breakdown of parent entity share and NCI
share?
(LO 5) BE5-12 Explain whether NCI would share in a gain on purchase.
(LO 6) BE5-13 When a parent increases its ownership in a subsidiary, the consolidated equity is affected. Explain how.
Exercises
(LO 2, 3) E5-1 Cogesco purchased 75% of the capital of Securenet for $250,000 on January 1, 2008. At this date the equity of
Securenet was:
At this date, Securenet had not recorded any goodwill, and all identifiable assets and liabilities were recorded at fair
value except for the following assets:

Inventory $ 70,000 $100,000
Plant (cost $170,000) 150,000 190,000
Land 50,000 100,000
The plant has a remaining useful life of 10 years. As a result of an impairment test, all goodwill was written off in
2012. All the inventory on hand at January 1, 2008, was sold by December 31, 2008. The tax rate is 30%.
The trial balances of Cogesco and Securenet at December 31, 2013, are:
Cogesco Securenet
Investment in Securenet $ 250,000 —
Plant 425,500 $190,000
Land 110,000 50,000
Current assets 162,000 84,000
Cost of sales 225,000 35,000
1,287,500 371,000
Accumulated depreciation (plant) 124,000 24,000
$1,287,500 $371,000
Required
(a) Prepare the acquisition analysis at the acquisition date. Assume that Cogesco uses the partial goodwill method.
(b) Prepare the consolidated financial statements as at December 31, 2013.
(LO 2, E5-2 On July 1, 2012, Norilsk acquired 90% of the capital of Rudny for $290,160. The equity of Rudny at this date
3, 6) consisted of:
The carrying amounts and fair values of the assets and liabilities recorded by Rudny at July 1, 2012, were as follows:

Equipment $ 20,000 $ 20,000
Land 90,000 100,000
Inventory 10,000 12,000
Machinery (net) 200,000 220,000
Exercises 263
1. The machinery and equipment have a further 10-year life, benefits to be received evenly over this period. Norilsk
uses the partial goodwill method.
2. The tax rate is 30%. All inventory on hand at July 1, 2012, is sold by June 30, 2013.
3. On July 1, 2013, Norilsk sold a 10% interest in Rudny for $30,000.
Required
(a) What are the adjustments for the consolidated financial statements if prepared immediately after July 1, 2012?
(b) What are the adjustments for the consolidated financial statements if prepared at June 30, 2013? Assume a profit
for Rudny for the 2012–13 period of $20,000.
(c) If the non-controlling interest had a fair value of $31,800 on July 1, 2012, and the full goodwill method had been
used, what adjustments in parts (a) and (b) above would change? Prepare the changed adjustments.
(d) What is the effect on equity of the sale of shares on July 1, 2013?
(LO 3, 5) E5-3 On January 1, 2010, Ejez acquired 75% of the shares of Campbell for $123,525. At this date, the statement of
financial position of Campbell consisted of:
Share capital— $100,000 Cash $ 5,000

100,000 shares Inventories 20,000
Retained earnings 60,000 Plant (cost $100,000) 80,000
Liabilities 60,000 Equipment (cost $80,000) 50,000
Land 60,000
$220,000 $220,000
In relation to the assets of Campbell, the fair values at January 1, 2010, were:
Cash $ 5,000
Inventories 25,000
Plant 86,000
Equipment 51,000
Land 80,000
The inventories were all sold and the accounts receivable all collected by December 31, 2010. The plant and
equipment each have an expected useful life of five years. The plant was sold on December 31, 2013. The tax rate
is 30%.
1. At January 1, 2013, the retained earnings of Campbell were $80,000.
2. During 2013, Campbell recorded net income of $18,000.
3. In December 2012, a dividend of $8,000 was declared by Campbell, and was paid in March 2013. An interim divi-
dend of $5,000 was paid in July 2013, and a final dividend of $4,000 was declared in December 2013.
Required
(a) Prepare the consolidated financial statement adjustments of Ejez and its subsidiary, Campbell, at December 31,
2013.
(b) Calculate the balances in the following statement of financial position accounts as at December 31, 2013 with
respect to the Campbell net assets that would be included on the Ejez consolidated financial statements:
• Retained Earnings
• NCI
(LO 2, E5-4 On January 1, 2010, Septor acquired 75% of the issued shares of Zejest for $125,750. At this date, the records
3, 6) of Zejest included the following balances:
All the identifiable assets and liabilities of Zejest were recorded at fair value except for the following:
Plant (cost $50,000) $35,000 $41,000
Land 50,000 70,000
Inventory 20,000 24,000
The plant has a further three-year life. All the inventory was sold by December 31, 2010. Septor uses the partial
goodwill method.
During the four years since acquisition, Zejest has recorded the following annual results:
Year ended Net income (loss)
December 31, 2010 $10,000
December 31, 2011 23,000
December 31, 2012 (6,000)
December 31, 2013 22,000
1. There have been no dividends paid or declared by Zejest since the acquisition date.
2. The land owned by Zejest on January 1, 2010, was sold on September 1, 2011, for $75,000.
4. On January 1, 2014, Septor paid $50,000 on the open market to acquire an additional 10% of Zejest.
Required
(a) Prepare the consolidated financial statement adjustments as at January 1, 2010.
(b) Prepare the consolidated financial statement adjustments for the year ended December 31, 2013.
(c) Calculate the effect on equity due to the additional purchase by Septor on January 1, 2014.
(LO 2, E5-5 In December 2012, Kandlin made an offer to the shareholders of Delvco to acquire a controlling interest in the
3, 4) company. Kandlin was prepared to pay $1.50 cash per share, provided that 70% of the shares could be acquired (enough
shares to gain control).
The directors of Delvco recommended that the offer be accepted. By January 1, 2013, when the offer expired,
75% of the shares had changed hands and were now in the possession of Kandlin. The statement of financial position
of Delvco on that date is shown below.
Current assets $368,000
Non-current assets 244,000
$612,000
Current liabilities 52,000
$612,000
At January 1, 2013, all the identifiable assets and liabilities of Delvco were recorded at amounts equal to fair
value. Kandlin uses the full goodwill method. The fair value of the non-controlling interest at January 1, 2013, was
$147,000.
The draft financial statements of the two companies on December 31, 2013, revealed the following details:
Kandlin Delvco
Sales revenue $ 878,900 $388,900
Cost of sales (374,400) (112,400)
Gross profit 504,500 276,500
Other income 302,100 112,500
806,600 389,000
Other expenses (216,200) (115,800)
Profit 478,000 223,200
590,000 353,200
Exercises 265
Kandlin Delvco
90,000 40,000
Share capital 1,200,000 400,000
Current liabilities 177,000 124,400
$2,001,000 $897,600
Financial assets $ 280,000 204,000
Inventory 287,500 210,600
Investments—shares in Delvco 450,000 —
Other investments 47,000 —
Equipment 400,000 200,000
Land 216,500 108,000
$2,001,000 $897,600
1. Kandlin had made an advance of $80,000 to Delvco. This advance was repayable in December 2014.
2. The directors of Kandlin and Delvco had declared dividends of $50,000 and $10,000, respectively.
3. Delvco holds at the end of the reporting period inventory purchased from Kandlin during the year for $55,000.
Kandlin invoices goods to its subsidiary at cost plus 10%.
4. On January 1, 2013, Delvco sold to Kandlin some display equipment for $60,000. At that date, the equipment’s
carrying amount was $52,000 and the equipment was estimated to have a useful life of 10 years if used constantly
over that period.
5. Assume a tax rate of 30%.
6. For Kandlin, balances of cumulative other comprehensive income at January 1, 2013, was $25,000.
Required
Prepare the consolidated financial statements for Kandlin and its subsidiary, Delvco, as at December 31, 2013.
(LO 2, 3) E5-6 On January 1, 2011, Koosib acquired 80% of the shares (cum div.) of Turtle for $202,000. At this date, the
equity of Turtle consisted of:
The carrying amounts and fair values of Turtle’s assets were as follows:
Carrying value Fair value

Land $70,000 $90,000
Plant (cost $100,000) 80,000 85,000
Equipment (cost $40,000) 20,000 20,000
Goodwill 5,000 10,000
Koosib uses the partial goodwill method.

Both plant and equipment were expected to have a further five-year life, with benefits being received evenly over
those periods. The plant was sold on July 1, 2013. At January 1, 2011, Turtle had not recorded an internally generated
trademark that Koosib considered to have a fair value of $50,000. This intangible asset was considered to have an indefi-
nite useful life. Both companies pay tax at a rate of 30%.
1. The following profits were recorded by Turtle:
For the 2011 period $20,000

For the 2012 period 25,000
2. In March 2010, the dividend payable of $5,000 on hand at January 1, 2010, was paid by Turtle.
3. Other dividends declared or paid since January 1, 2011, are:

• $8,000 dividend declared in December 2011, paid in February 2012
• $5,000 dividend paid in June 2013
• $8,000 dividend declared in December 2013, expected to be paid in February 2014
Required
(a) Prepare the adjustments for the preparation of the consolidated financial statements of Koosib and its subsidiary,
Turtle, at December 31, 2013.
(b) Assume Koosib uses the full goodwill method and the value of the non-controlling interest at January 1, 2011,
was $49,250. Prepare the adjustments that would differ from those in part (a) above.
(LO 2, 3) E5-7 On January 1, 2011, Dataworx acquired 60% of the shares of Glider for $111,700. At this date, the equity of
Glider consisted of:

At this date, the identifiable assets and liabilities of Glider were recorded at fair value except for the following
assets:
Equipment (cost $80,000) $65,000 $75,000
Land 80,000 90,000
Inventory 45,000 50,000
The equipment has a further five-year life. Half the inventory on hand at the acquisition date was sold by December
31, 2011, with the remainder being sold in 2012. At December 31, 2013, the goodwill was written down by $3,000 as
the result of an impairment test.
Dataworx uses the full goodwill method. The fair value of the non-controlling interest at January 1, 2011, was
$74,100.
During the three years since acquisition, Glider has recorded the following annual results:
Year ended Profit
December 31, 2011 $15,000
December 31, 2012 27,000
December 31, 2013 12,000
There has been no dividend paid or declared by Glider since the acquisition date.
The equipment owned by Glider on January 1, 2011, was sold on June 30, 2012, for $70,000. The tax rate is 30%.
Required
(a) Prepare the consolidated financial statement adjustments as at January 1, 2011.
(b) Prepare the consolidated financial statement adjustments for the year ended December 31, 2011.
(c) Prepare the consolidated financial statement adjustments for the year ended December 31, 2012.
(d) Prepare the consolidated financial statement adjustments for the year ended December 31, 2013.
(LO 3, 4) E5-8 Several years ago, Revnon Co. acquired a 60% interest in Aumets Inc. at book value. During 2012 and 2013,
intragroup sales of merchandise amounted to $120,000 and $180,000. On December 31, 2012, and December 31, 2013,
one third of each year’s intragroup sales remained in that year’s ending inventory. Intragroup sales were made at the
same rate of gross margin as sales to non-affiliates. January 1, 2012, inventories contained no unrealized intragroup
profits.
The following data are taken from the financial statements of the two companies for 2012 and 2013:
Revnon Co. Aumets Inc.
2012 2013 2012 2013
Sales $1,500,000 $2,200,000 $900,000 $1,200,000
Cost of sales 1,000,000 1,540,000 540,000 780,000
Expenses 300,000 360,000 160,000 170,000
The tax rate for both companies is 40%.
Problems 267
Required
Calculate Revnon’s share of consolidated net income for 2012 and 2013 assuming:
(a) the intragroup sales were upstream.
(b) the intragroup sales were downstream.
Problems
(LO 2, 3) P5-1 On January 1, 2011, Fox acquired 70% of the shares (cum div.) of Logan for $141,950. At this date, the equity
of Logan consisted of:
Logan’s records showed a dividend payable at January 1, 2011, of $10,000. The dividend was paid on
April 1, 2011.
A comparison of the carrying amounts and fair values of Logan’s assets at January 1, 2011, revealed the following:
Plant (cost $75,000) $45,000 $60,000
Vehicles (cost $40,000) 23,000 23,000
Goodwill 10,000
Both plant and vehicles were expected to have a further five-year life, with benefits being received evenly over
those periods. Logan had not recorded an internally generated brand name for an item that was considered by Fox to
have a fair value of $20,000. The brand name is regarded as having an indefinite useful life. At December 31, 2011,
goodwill was considered to be impaired by $1,000, and a further impairment loss of $2,000 was recognized in 2012.
Fox uses the full goodwill method. The fair value of the non-controlling interest at January 1, 2011, was $57,000 based
on the market value of the Logan shares. Both companies pay tax at a rate of 30%.
1. The dividends paid and declared since January 1, 2011, are:
• $10,000 dividend declared in December 2011, paid in April 2012
• $5,000 dividend declared in December 2012, paid in March 2013
• $8,000 dividend paid in October 2013
2. The plant on hand at January 1, 2011, was sold on December 31, 2013.
3. The cumulative other comprehensive income account reflects movements in the fair values of financial assets. The
balances of this account at January 1, 2013, were $4,000 (Fox) and $11,000 (Logan).
4. On December 31, 2013, the financial data of both companies were:
Fox Logan
Revenues $280,000 $190,000
Expenses 220,000 140,000
Net income 34,000 36,000
$260,000 $225,000
Cash $ 22,050 $ 43,000
Vehicles—net 23,000 20,000
Plant and equipment—net 30,000 45,000
Land 30,000 —
Fox Logan
Goodwill — 10,000
Accumulated impairment — (3,000)
Trademarks — 80,000
Investment in Logan 134,950 —
$260,000 $225,000
Required
Prepare the consolidated financial statements of Fox as at December 31, 2013.
(LO 2, P5-2 On January 1, 2009, Zaldivar acquired 75% of the share capital of Burran at a cost of $27,600. At this date, the
3, 4) capital of Burran consisted of 30,000 common shares, and retained earnings were $6,000.
At January 1, 2009, Burran had not recorded any goodwill, and all of its identifiable net assets were recorded at fair
value except for inventory, which had a fair value of $10,000 and a carrying value of $14,000, and plant, which had a fair
value of $20,000 and a carrying value of $15,000. The plant has a remaining life of four years. The inventory is recorded
on a FIFO (first-in, first-out) basis. Zaldivar uses the partial goodwill method. The fair value of the non-controlling
interest at January 1, 2009, was $9,000.
The trial balances of the two companies as at December 31, 2013, are as shown below.
Trial Balances
Zaldivar Burran
Share capital $ 40,000 $ 30,000

Retained earnings (January 1, 2013) 19,000 14,500
Cumulative other comprehensive income — 5,000
Income tax payable 8,500 2,900
Plant net $ 13,000 $ 29,500
Investment in Burran 27,600
10% bonds in Burran 2,500
Inventory 12,000 15,500
Cash 14,050 500
Financial assets — 11,000
Deferred tax asset 2,000 5,000
Selling expenses 4,000 6,000
Financial expenses 1,500 2,000
Interest received from bonds 250
Dividend revenue 1,800
Dividend paid 2,400
10% bonds 2,400 5,000
$119,550 $119,550 $137,400 $137,400
1. Intragroup sales of inventory for the year ended December 31, 2013, from Burran to Zaldivar were $19,000.
2. Unrealized profits on inventory held at January 1, 2013: inventory held by Zaldivar purchased from Burran at a
profit before tax of $800.
3. Unrealized profits on inventory held at December 31, 2013: inventory held by Zaldivar purchased from Burran at
a profit before tax of $1,200.
4. The cumulative other comprehensive income account relates to financial assets held by Burran. The balance of this
account at January 1, 2013, was $4,000.
5. The tax rate applicable is 30%.
Required
Problems 269
(LO 3, P5-3 On January 1, 2013, Lessard acquired 80% of the share capital of Honey for $264,800. This was sufficient for
4, 6) Lessard to gain control over Honey. On that date, the statement of financial position of Honey consisted of:
Liabilities 197,000
$465,000
Cash $ 35,000
Inventories 70,000
Land 65,000
Plant and equipment—net 170,000
Trademark 100,000
Goodwill 25,000
$465,000
All of Honey’s identifiable assets and liabilities were recorded at fair value except for:
Inventories $ 70,000 $ 80,000
Land 65,000 85,000
Plant and equipment (cost $200,000) 170,000 190,000
Trademark 100,000 110,000
1. The plant and equipment had a further five-year life and was expected to be used evenly over that time. The trade-
mark was considered to have an indefinite life.
2. Lessard uses the partial goodwill method.
3. During the year ended December 31, 2013, all inventories on hand at the beginning of the year were sold, and the
land was sold on October 1, 2013, to another company for $80,000.
4. The income tax rate is assumed to be 40%.
5. During the current year, Honey sold a quantity of inventory to Lessard for $8,000. The original cost of these items
to Honey was $5,000. One third of this inventory was still on hand at the end of the year.
6. On January 1, 2013, Honey transferred an item of plant with a carrying amount of $10,000 to Lessard for $15,000.
The item was still on hand at the end of the year. Honey depreciates the plant straight line over five years.
7. On January 1, 2014, Honey issued additional shares, which caused Lessard’s ownership to decrease to 75%. Honey
now has shares of $300,000.
8. Financial information for Lessard and Honey for the year ended December 31, 2013, is shown below.
Lessard Honey
Sales revenue $200,000 $172,000
285,000 207,000
Cost of sales 162,000 128,000
215,000 159,000
Net income 50,000 30,000
80,000 48,000
18,000 14,000
Required
(a) Prepare the consolidated statement of comprehensive income and statement of changes in equity for Lessard and
its subsidiary at December 31, 2013. Lessard’s share capital at December 31, 2013 is $300,000.
(b) Calculate the adjustments to be made to the following accounts on the statement of financial position accounts as
at December 31, 2013 with respect to the Honey net assets that would be included on the Lessard consolidated
financial statements:
• Plant and Equipment (net)
• Inventory
• Goodwill
• Non-controlling Interest
(c) Calculate the effect on consolidated equity of the issuance of the additional shares on January 1, 2014.
(LO 3, 4) P5-4 On January 1, 2009, Plexon acquired 75% of the shares of Jayden for $40,000. The following balances appeared
in the records of Jayden at this date:
At January 1, 2009, all the identifiable assets and liabilities of Jayden were recorded at fair value except for the following:

Machinery (cost $36,000) $30,000 $40,000
Inventory 16,000 20,000
The machinery had a remaining useful life of five years. The machinery was sold by Jayden on July 1, 2013, for
$4,000. By December 31, 2009, accounts receivable had all been collected and inventory sold.
For the year ended December 31, 2013, the following information is available:
1. Intragroup sales were: Jayden to Plexon—$40,000. The markup on cost of all sales was 25%.
2. At December 31, 2013, inventory of Plexon included $2,000 of items acquired from Jayden.
3. At December 31, 2012, inventory of Plexon included goods of $1,000 resulting from a sale on September 1, 2012,
by Jayden at a before-tax profit of $200. These items were sold by Plexon on February 1, 2013.
4. On July 1, 2013, Jayden sold an item of plant to Plexon for $2,000 at a before-tax profit of $800. For plant assets,
Jayden applies a 10% p.a. straight-line depreciation rate, and Plexon uses a 2.5% p.a. straight-line method.
5. The current tax rate is 30%.
6. Financial information for the year ended December 31, 2013, includes the following:
Plexon Jayden
Sales revenue $ 88,000 $52,000
Other revenue 12,000 8,000
Total revenue 100,000 60,000
Other expenses:
Selling and administrative (including depreciation) 4,000 2,000
Financial 8,000 6,000
70,000 34,000
Gross profit 30,000 26,000
Net income 19,800 15,600
Retained earnings at January 1, 2013 40,000 20,000
59,800 35,600
11,800 13,000
Retained earnings at December 31, 2013 $48,000 $22,600
Required
(a) Prepare the consolidated statement of comprehensive income of Plexon for the year ending December 31, 2013,
using the partial goodwill method.
(b) Prepare the consolidated statement of changes in equity of Plexon for the year ending December 31,
2013. Plexon’s share capital has always been $100,000.
(c) What differences would exist in parts (a) or (b) above, if the full goodwill method were used? The fair value of the
non-controlling interest at January 1, 2011, was $12,900.
Problems 271
(LO 2, P5-5 At January 1, 2010, ILS acquired 80% of the share capital of LBEX for $290,000. At this date the statement of
3, 4) financial position of LBEX, including comparative information on fair values for assets, was as follows.

Current assets
Inventory $ 60,000 $ 65,000
Allowance for doubtful accounts 5,000 35,000 35,000
Non-current assets
Land 50,000 50,000
Plant and equipment (at cost) 200,000
Accumulated depreciation 125,000 75,000 90,000
Vehicles (at cost) 30,000
Buildings (at cost) 120,000
Trademark 100,000 100,000
Goodwill 20,000
Equity
Current liabilities
Total current liabilities 60,000
Bonds: 10-year, 5%, mature in 2020 155,000 175,000
At January 1, 2010, it was expected that the depreciable assets had the following remaining useful lives:
Plant and equipment 5 years

Vehicles 10 years
Trademark 100 years
Buildings 10 years
The market rate for similar bonds at the day of acquisition was 4%. All the inventory on hand at January 1, 2010,
was sold by LBEX by December 31, 2010. The tax rate is 40%.
1. The dividend payable in the records of LBEX at January 1, 2010, was paid in March 2011.
2. On July 1, 2013, equipment that was on hand in LBEX at January 1, 2010, was sold for $6,000. At January 1, 2010,
the equipment was recorded at cost of $50,000 with accumulated depreciation of $30,000, and had a fair value of
$9,000.
3. Information on dividends paid and declared by LBEX is as follows:
2011 period:
paid a $5,000 dividend (excluding dividend in point 1)
2012 period:
paid a $4,000 interim dividend
declared, in December 2012, a $6,000 dividend
2013 period:
paid the $6,000 dividend declared in the previous period
paid a $5,000 interim dividend
declared, in December 2013, an $8,000 dividend
4. Information on inventory sold by LBEX to ILS at cost plus 25%:

• At January 1, 2013, ILS had $10,000 of inventory on hand.
• During 2013, $50,000 worth of inventory was sold intragroup, with 10% still on hand in ILS at December 31,
2013.
5. On January 1, 2013, ILS bought land from LBEX for $25,000. The carrying value of the land on that date was
$30,000.
6. The retained earnings balance at December 31, 2013, in LBEX was $60,000. The total comprehensive income for
the year ended December 31, 2013, was $28,000. The retained earnings of ILS at December 31, 2013 was $78,000.
Required
(a) Determine the consolidation adjustments for preparing the consolidated financial statements of ILS at December
31, 2013, using the full goodwill method. Assume the fair value of the non-controlling interest at January 1, 2010,
was $67,000.
(b) Calculate the NCI—equity as at December 31, 2013.
(c) Calculate the balance in consolidated retained earnings as at December 31, 2013.
(d) Assuming the following balances in the accounts of LBEX and ILS, respectively, calculate the balances in each of
these accounts on the statement of financial position as at December 31, 2013.
LBEX ILS
Account—December 31, 2013
Plant and equipment 575,000 230,000
Accumulated depreciation—plant and equipment 323,000 183,000
Inventory 140,000 72,000
Bonds 155,000
(LO 3, P5-6 On January 1, 2009, Kundi acquired (cum div.) a 70% interest in Eagle. The following balances appeared in the
4, 5) records of Eagle at this date:
At January 1, 2009, the carrying amounts and fair values of Eagle’s identifiable assets and liabilities were as shown
below.

Cash $ 10,000 $ 10,000
Inventory 51,000 55,000
Vehicles (cost $25,000) 17,000 18,000
Plant (cost $100,000) 66,000 70,000
Furniture and fixtures (cost $60,000) 34,500 34,500
206,500 213,500
38,000 38,000
Identifiable assets and liabilities $168,500 $175,500
Any differences between carrying amounts at acquisition and fair values are adjusted on consolidation. The non-
current assets were deemed to have the following remaining useful lives:
Vehicles 5 years
Plant 8 years
Furniture and fixtures 7 years
Problems 273
In addition, Eagle had recorded goodwill of $3,500 at January 1, 2009. Kundi uses the partial goodwill method.
The following events occurred between the acquisition date and December 31, 2012.
1. By December 31, 2012, 80% of the inventory on hand at January 1, 2009, had been sold, and all accounts receiv-
able deemed to be collectable at January 1, 2009, had been received.
2. On February 15, 2011, the dividend declared as at January 1, 2010, was paid.
3. On 15 September 2011, Eagle paid a $12,000 dividend.
4. On December 20, 2012, Eagle declared a dividend of $5,000 from pre-acquisition profits. The dividend was paid
on February 10, 2013.
For the year ended December 31, 2013, the following information is available:
1. Kundi recognizes dividend revenue when the dividends are declared by Eagle.
2. The balance of the Investment in Eagle account was $119,380 at December 31, 2013.
3. On December 31, 2013, vehicles on hand at the acquisition date were sold for $6,500.
4. The company tax rate is 30%.
5. Kundi’s share capital has always been $200,000.
6. Financial information for the year ended December 31, 2013, included the following:
Kundi Eagle
Income before tax $42,000 $36,000
Net income 25,200 21,600
Total available 80,800 98,400
25,000 24,000
Retained earnings (31/12/13) $55,800 $74,400
Required
Prepare the consolidated statement of changes in equity of Kundi at December 31, 2013.
(LO 2, P5-7 On December 31, 2011, Perseus Ltd. acquired 64% of the common shares of Miram Ltd. for $576,000. The
3, 4) carrying amount of Miram’s identifiable net assets at the acquisition date was $735,000. Miram’s common shares and
retained earnings were $500,000 and $235,000, respectively. The fair values of Miram’s identifiable net assets were
equal to their carrying amounts on December 31, 2011, except for the following:
Fair value Carrying amount

Land $300,000 $175,000
Buildings 850,000 910,000
The building had 15 years remaining in its useful life.

Following are separate entity financial statements for 2013:
PERSEUS LTD. AND MIRAM LTD.

Statements of Income
Perseus Ltd. Miram Ltd.

Sales revenue $6,042,000 $1,952,000
Management fee revenue 420,000 0
Investment income 32,000 0
6,494,000 1,952,000
Cost of goods sold 3,440,000 885,000
Depreciation expense 325,000 156,000
Other expenses, gains, and losses 1,529,000 596,000
Total expenses 5,774,000 1,763,000
Net income $ 720,000 $ 189,000
PERSEUS LTD. AND MIRAM LTD.

Balance Sheets
December 31, 2013
Perseus Ltd. Miram Ltd.

Assets
Cash and receivables $ 735,000 $ 77,000
Inventory 840,000 235,000
Total current assets 1,575,000 312,000
Investment in Miram Ltd. 576,000 —
Property, plant, and equipment (net) 3,384,000 1,645,000
Total assets $5,535,000 $1,957,000
Liabilities and shareholders’ equity
Liabilities $1,870,000 $1,050,000
Common shares 2,000,000 500,000
Retained earnings 1,665,000 407,000
Total shareholders’ equity 3,665,000 907,000
Total liabilities and shareholders’ equity $5,535,000 $1,957,000
1. Goodwill was assessed at $27,000 on December 31, 2013. There had not been any goodwill impairment prior to
2013.
2. During 2013, Perseus had sales of $270,000 to Miram. At December 31, 2013, $70,000 of this inventory remained
unsold. The gross profit on this inventory was $30,000. At the beginning of 2013, Miram held $106,000 of inven-
tory that had been purchased from Perseus. The gross profit relating to this beginning inventory was $50,000.
3. On January 2, 2013, Miram sold some equipment to Perseus for $315,000. Miram’s carrying amount just prior to
the sale was $225,000. The gain is included in Miram’s income statement under “other expenses, gains, and losses.”
At the time of the sale, the equipment had six years of remaining useful life.
4. During 2013, Perseus earned $420,000 in management fees from Miram. Miram reports management fee expenses
as part of “other expenses, gains, and losses.”
5. During 2013, Miram paid dividends of $50,000 and Perseus paid dividends of $100,000.
6. The tax rate for both companies is 40%.
7. Perseus uses the partial goodwill concept to value non-controlling interest (NCI).
Required
(a) Prepare Perseus’s consolidated income statement for the year ended December 31, 2013.
(b) Calculate the balances in the following consolidated balance sheet line items as at December 31, 2013:
1. Property, plant, and equipment—net
2. Retained earnings
(LO 2, 3, P5-8 On January 1, 2011, Prado acquired 80% of the share capital of Lalli for $198,000. At this date, the equity of
4, 6) Lalli consisted of:
At January 1, 2011, all of Lalli’s identifiable assets and liabilities were recorded at fair value except for the following assets:

Plant (cost $120,000) $90,000 $100,000
Land 80,000 120,000
The plant had a further five-year life, with benefits expected to be received evenly over that period. The land was
sold by Lalli in July 2013 for $150,000. Prado uses the partial goodwill method.
Financial information for these two companies at December 31, 2013, included:
Prado Lalli
Sales revenue $920,000 $780,000
985,000 862,000
Cost of sales 622,000 580,000
Problems 275
Prado Lalli
845,000 742,000
Net income 110,000 80,000
190,000 168,000
45,000 50,000
1. During 2012, Lalli sold some inventory to Prado for $8,000. This inventory had originally cost Lalli $6,000. At
December 31, 2012, 10% of these goods remained unsold by Prado.
2. The ending inventory of Prado included inventory sold to it by Lalli at a profit of $3,000 before tax. This had cost
Lalli $32,000.
3. On January 1, 2012, Lalli sold a plant to Prado for $50,000. This asset had a carrying value of $40,000. Prado
depreciates it on a straight-line basis over a six-year period.
5. Prado’s share capital has always been $100,000.
6. On January 1, 2014, Prado sold 15% of its ownership in Lalli so that it now owns 65%. Prado received $20,000 for
the shares.
Required
(a) Prepare the consolidated statement of comprehensive income and statement of changes in equity at December 31, 2013.
(b) Calculate the effect on consolidated equity in 2014 from the sale of shares.
(c) What would be the effect if Prado lost control at 65% ownership due to an agreement?
(LO 2, P5-9 Financial information at December 31, 2013, of Spider and its subsidiary company, Hudson, includes the
3, 4) following.
Spider Hudson
Sales revenue $314,500 $220,000
Other revenue:
Bond interest 5,000 —
Management and consulting fees 6,500 —
Dividend from Hudson 12,000 —
Total revenues 338,000 220,000
Cost of sales 130,000 85,000
Manufacturing expenses 90,000 60,000
Depreciation on plant 15,000 15,000
Administrative 15,000 8,000
Financial 11,000 5,000
Net income 38,000 18,000
88,000 63,000
23,000 15,000
Debentures 200,000 100,000
Current tax liability 25,000 17,000
Deferred tax liability — 7,000
$753,000 $309,000
Spider Hudson
Financial assets $ 50,000 $ 60,000
Bonds in Hudson 100,000 —
Investment in Hudson 131,600 —
Plant—net 55,000 47,000
Other depreciable assets—net 36,000 30,000
Inventory 89,500 85,000
Deferred tax asset 85,900 30,000
Land 201,000 57,000
Dividend receivable 4,000 —
$753,000 $309,000
At January 1, 2010, the date Spider acquired its 80% shareholding in Hudson, all of Hudson’s identifiable assets
and liabilities were at fair value except for the following assets:

Plant (cost $75,000) $50,000 $55,000
Land 30,000 38,000
The plant has an expected life of 10 years, with benefits being received evenly over that period. Differences
between carrying amounts and fair values are adjusted on consolidation. The land on hand at January 1, 2010, was sold
on November 1, 2010, for $40,000.
Spider uses the full goodwill method. The fair value of the non-controlling interest at January 1, 2010, was
$31,500.
1. At the date of acquisition of 80% of its issued shares by Spider, the equity of Hudson was:

2. Inventory on hand of Hudson at January 1, 2013, included a quantity priced at $10,000 that had been
sold to Hudson by its parent. This inventory had cost Spider $7,500. It was all sold by Hudson during
the year.
3. In Spider’s inventory at December 31, 2013, were various items sold to it by Hudson at $5,000 above cost.
4. During the year, intragroup sales by Hudson to Spider were $60,000.
5. It was also learned that Hudson had sold to Spider an item for $20,000 on July 1, 2012. Spider had treated this item as
an addition to its plant and machinery. The item was put into service as soon as received by Spider and depreciation
charged straight line over five years. The item had been fully imported by Hudson at a landed cost of $15,000 on the
day of the sale.
6. Management and consulting fees derived by Spider were all from Hudson and represented charges made for
administration $2,200 and technical services $2,800. The latter were charged by Hudson to manufacturing
expenses.
7. All bonds issued by Hudson are held by Spider.
8. Cumulative other comprehensive income relates to movements in the fair values of the financial assets. The bal-
ance of this account at January 1, 2013, was $10,000 (Spider) and $8,000 (Hudson).
Required
Prepare the consolidated financial statements for Spider and its subsidiary, Hudson, for the year ended December 31,
2013.
(LO 2, P5-10 On December 31, 2010, Peat Limited purchased 70% of the outstanding common shares of Soap Limited for
3, 4) $7 million. On that date, Soap’s shareholders’ equity consisted of common shares of $5 million and retained earnings
of $1.6 million.
Problems 277
The financial statements for Peat and Soap for the year ended December 31, 2013, are as follows:
PEAT AND SOAP

Balance Sheet
December 31, 2013
(in $000s)
Peat Soap
Cash $ 680 $ 140
Accounts receivable 1,600 900
Equipment—net 4,680 10,800
Investment in Soap 7,000 —
$16,760 $13,000
Current liabilities $ 400 $ 1,020
Notes payable 5,800 4,740
Common shares 2,000 5,000
$16,760 $13,000
PEAT AND SOAP

Statement of Income and Retained Earnings
Year ended December 31, 2013
(in $000s)
Peat Soap
Sales $6,300 $10,840
Other revenue 500 —
Net income 1,460 800
Retained earnings, beginning 7,200 2,040
Dividends paid (100) (600)
Retained earnings, end $8,560 $ 2,240
1. In negotiating the purchase price, it was agreed that the fair value of all of Soap’s assets and liabilities was equal to
their carrying values except for the following:
Asset Carrying value Fair value
Inventory $ 940,000 $1,000,000
Equipment 2,200,000 2,600,000
2. Both companies use first-in, first-out (FIFO) to account for their inventory and the straight-line method for depre-
ciating their equipment. Soap’s equipment at the date of acquisition had a remaining useful life of five years.
3. Each year, goodwill is evaluated to determine if there has been impairment. Goodwill impairment was $100,000 in
2011 and zero for 2012 and 2013.
4. On January 2, 2011, Peat sold equipment to Soap for $552,000. Peat had paid $600,000 for this equipment on
January 2, 2009, and had been depreciating the equipment on a straight-line basis over 10 years. There was no
change in the estimated useful life of this equipment at the time of the purchase by Soap.
5. During 2013, Peat purchased merchandise from Soap for $600,000. Of this merchandise, 60% was resold by Peat
and the other 40% remains in its December 31, 2013, inventory. On December 31, 2012, the inventories of Peat
contained $400,000 of merchandise purchased from Soap. Soap earns a gross margin of 25% on its sales to Peat.
6. Ignore income taxes.
Required
(a) Calculate the following amounts for the consolidated income statement for the year ended
December 31, 2013:
1. Sales
2. Cost of sales
3. Consolidated net income attributable to Peat’s shareholders
(b) Calculate the following amounts for the consolidated balance sheet at December 31, 2013:
1. Inventory
2. Equipment—net
3. Common shares
4. Retained earnings, beginning of year
(c) As a financial analyst, you notice that many companies report non-controlling interests using the partial goodwill
method. Briefly explain the impact of using the partial goodwill approach instead of the full goodwill approach on
the return on total assets.
Writing Assignments
(LO 4, 7) WA5-1 The consolidated financial statements of Dataserve Submarine Works are being prepared by the group
accountant, Raz Kawatra. He is currently in dispute with the auditors over the need to adjust for the NCI share
of equity in relation to intragroup transactions. He understands the need to adjust for the effects of the intragroup
transactions, but believes that it is unnecessary to adjust for the NCI share of equity. He argues that the NCI group
of shareholders has its interest in the subsidiary and as a result is entitled to a share of what the subsidiary records as
equity. He also disputes with the auditors about the notion of “realization” of profit in relation to the NCI. If realiza-
tion requires the involvement of an external entity in a transaction, then in relation to transactions such as intragroup
transfers of vehicles and services such as interest payments, there is never any external party involved. Those trans-
actions are totally within the group and never involve external entities. As a result, Raz thinks the more appropriate
accounting is to give the NCI a share of subsidiary equity and not be concerned with the fictitious involvement of
external entities.
Required
Write a report to Raz convincing him that his argument is fallacious.
(LO 4) WA5-2 Because the Moth Cement Works has a number of subsidiaries, Star Lin is required to prepare a set of
consolidated financial statements for the group. She is concerned about the calculation of the NCI share of equity, par-
ticularly where there are intragroup transactions. The auditors require that when adjustments are made for intragroup
transactions the effects of these transactions on the NCI should also be adjusted for. Star has two concerns. First, why is
it necessary to adjust the NCI share of equity for the effects of intragroup transactions? Second, is it necessary to make
NCI adjustments in relation to all intragroup transactions?
Required
Prepare a report for Star, explaining these two areas of concern.
(LO 1, 7) WA5-3 Len Innsbruck is the accountant for Wallex Trucks. This entity has an 80% holding in the entity Tires-
R-Us. Len is concerned that the consolidated financial statements prepared under IFRS 10 may be misleading. He
believes that the main users of the consolidated financial statements are the shareholders of Wallex Trucks. The key
performance indicators are then the profit numbers relating to the interests of those shareholders. He therefore wants
to prepare the consolidated financial statements showing the non-controlling interest in Tires-R-Us in a category other
than equity in the statement of financial performance. He also wants the statement of changes in equity to show the
profit numbers relating to the parent shareholders only.
Required
Discuss the differences that would arise in the consolidated financial statements if the non-controlling interest
were classified as debt rather than equity, and the reasons the standard setters have chosen the equity classification
in IAS 27.
(LO 6) WA5-4 Bass Ltd. has recently undertaken a business combination with Fong Ltd. At the start of negotiations, Bass
owned 70% of the shares of Fong. The current discussions between the two entities concerned Bass’s acquisition
of the remaining 30% of shares of Fong. The negotiations began on January 1, 2013, and enough shareholders in
Fong agreed to the deal by September 30, 2013. The purchase agreement was for shareholders in Fong to receive in
exchange shares in Bass. Over the negotiation period, the share price of Bass shares reached a low of $5.40 and a high
of $6.20.
Cases 279
The accountant for Bass, Joel Spencer, knows that IFRS 3 has to be applied in accounting for business combinations.
However, he is confused as to how to account for the original 70% investment in Fong, what share price to use to
account for the issue of Bass’s shares, and how the varying dates such as the date of exchange and acquisition date will
affect the accounting for the business combination.
Required
Provide Joel with advice on the issues that are confusing him.
Cases
(LO 1, 2) C5-1 It is Monday, September 16, 2013. You, CA, work at Fahmy & Gingras LLP, a CA firm. Ken Ndiaye, one of the
partners, approaches you mid-morning regarding Brennan & Sons Limited (BSL), a private company client for which
you performed the August 31, 2012, year-end audit.
“It seems there have been substantial changes at BSL this year,” Ken explains. “I’m going there tomorrow, and since you will
be on the audit again this year, it would be beneficial for you to come. I took the liberty of retrieving information from last
year’s files so you can refresh your memory about this client (Exhibit C5-1(a)).”
The next day, you and Ken meet with Jack Wright, the accounting manager at BSL. Jack gives you the internally pre-
pared financial statements (Exhibit C5-1(b)). To your surprise, there are also financial statements for two new compa-
nies. Jack quickly explains that BSL incorporated two subsidiaries in January 2013, each with the same year end as BSL:
Brennan Transport Ltd. (Transport) 100% owned by BSL
Brennan Fuel Tank Installations Inc. (Tanks) 75% owned by BSL
You diligently take notes during the meeting (Exhibit C5-1(c)). Jack states that BSL will prepare consolidated finan-
cial statements for audit based on Canadian Generally Accepted Accounting Principles (GAAP) to satisfy the bank’s
request.
Ken asks that you work on the overall planning for these engagements. As part of your planning, he asks you to
discuss the new accounting issues that arise as a result of the changes during the year and to evaluate their implications
for the engagements.
Later that day, Ken also forwards you an email from Jack (Exhibit C5-1(d)).
Required
Prepare the report requested by Ken.
EXHIBIT C5-1(a)
INFORMATION FROM LAST YEAR’S AUDIT FILES
EXCERPT FROM PERMANENT FILE
Date of incorporation: October 27, 1982

Year end: August 31
Ownership: 50 common shares Harold Thomas
50 common shares Kayla Nyenhuis
Nature of the business: BSL operates as a scrap metal dealer and processor. It buys used scrap metal from individuals and
businesses, then bundles the different metals and sells them in larger quantities at a higher price to bigger recycling businesses.
BSL’s revenue fluctuates significantly because of the volatility in the market rates for steel and non-ferrous metals. To help
control costs, BSL uses its own trucks and trailers to do the pickups. BSL earns additional revenue by providing transportation
services to other businesses and by renting out the trucks during slower periods.
As part of BSL’s overall strategy, the owners admit a willingness to take risks. They monitor the marketplace and are always
on the lookout for new business opportunities. They even found a piece of land on the outskirts of the city that they thought
would be great for a dump they considered operating themselves. They decided not to make an offer, but may reconsider in
2014.
EXCERPT FROM 2012 AUDIT FILE
For BSL’s 2012 audit, materiality was set at $70,000.

EXHIBIT C5-1(b)
INTERNAL FINANCIAL STATEMENTS
BRENNAN & SONS LIMITED
BALANCE SHEET
As at August 31
2012 2013
(audited) (unaudited)
BSL BSL Transport Tanks
Assets
Cash $ 467 $ 75 $ 67 $ 82
Accounts receivable 970 603 119 —
Inventory 10 500 — 15
1,447 1,178 186 97
Note receivable — 431 (note 1) — —
Property, plant & equipment 4,768 13,400 400 80
Investment in subsidiaries — 2 — —
Intangible asset — — — 20 (note 2)
$6,215 $15,011 $586 $197
Liabilities
Accounts payable $ 315 $ 813 $ 128 $ 166
Note payable — — 431 (note 1) —
Mortgage payable 100 6,500 — —
415 7,313 559 166
Common stock 1 1 1 1 (note 3)
Retained earnings 5,799 7,697 26 30
5,800 7,698 27 31
$6,215 $15,011 $586 $197
Notes:
1. Note receivable/payable for sale of trucks and trailers from BSL to Transport, interest at 8%.
2. Training costs for Sean Garlappi, owner/installer.
3. Includes Sean’s equity interest.
2012 2013
(audited) (unaudited)
BSL BSL Transport Tanks
(12 months) (12 months) (8 months) (8 months)
Revenue
Scrap metal $11,000 $10,003 $ — $ —
Transportation services 900 300 (note 4) 700 (note 4) —
Fuel tank installations — — — 320
11,900 10,303 700 320
Cost of sales
Scrap metal 1,600 1,440 — —
Transportation services 700 340 550 —
Fuel tank installations — — — 220
Gross margin 9,600 8,523 150 100
General & administration (note 5) 8,491 7,930 90 50
Interest expense 9 120 16 —
Income before other income 1,100 473 44 50
Other income
Gain on sale of equipment — 84 — —
Gain on sale of property — 2,500 — —
Interest income — 16 — —
Property rental — 90 (note 6) — —
Income before income tax 1,100 3,163 44 50
Income tax 440 1,265 18 20
Net income $ 660 $ 1,898 $ 26 $ 30
Notes:
4. Transport took over transportation services in January.
5. 2013 general and administration includes amortization.
6. $10,000 per month from Transport and $5,000 per month from Tanks for six months.
Cases 281
EXHIBIT C5-1(c)
NOTES FROM YOUR MEETING WITH JACK WRIGHT
BSL continues to operate the scrap metal business. BSL’s management thinks the price of metal is going to go up in the near
future, and has therefore started stockpiling for the first time. Unfortunately BSL doesn’t really have an inventory tracking sys-
tem in place.
As soon as it was incorporated on January 1, 2013, Transport took over BSL’s transportation operations. Transport provides
transportation services to BSL and external customers, the same as BSL did. BSL sold the trucks to Transport in late January at
fair market value (Exhibit C5-1(d)); however, Transport didn’t have the funds to buy the equipment, so BSL issued a note receiv-
able at what Jack believed to be the market interest rate.
Tanks installs and maintains pre-engineered, above-ground fuel storage tank systems, a new line of business for BSL. Sean
Garlappi, a good friend of one of BSL’s owners, approached BSL last fall with the idea. Sean was willing to take the necessary
training to become a certified fuel tank installer, and he wanted 50% ownership in Tanks. The owners of BSL agreed it was a
great opportunity but wanted more control. The parties settled on Sean’s receiving 25% ownership of Tanks.
As part of the agreement, BSL was required to provide a guarantee pertaining to Tanks’ licensing application to the envi-
ronmental authority since Tanks was a newly formed corporation. Although other vendors sell the same tanks and installation
services separately, Tanks only sells the tank combined with installation and service. The tank is marked up by 20% on the price
paid and is sold including installation and a five-year maintenance package for a total of $40,000. One hundred percent of the
revenue is recognized when the sales agreement is signed by the client. The tank is then delivered and installed at the client’s
site within two to three weeks of signing. The fuel tanks need to be pressure-tested every year and the measurement gauge
needs to be checked. Tanks will perform the maintenance services for clients for the first five years. Thereafter, Tanks will offer
to continue to perform the maintenance for a contract price of $5,000 a year.
BSL’s owners decided it was time to move to a bigger location, so in March 2013 the company sold its land and building
on Cohen St. and bought land and a building in the Johnson Industrial Park. The new building is large enough to accommodate
all the companies’ operations, and more. BSL’s owners are thinking of renting some of the extra space to other businesses and
have already been approached by a few interested parties. All tenants, including BSL’s subsidiaries, will be charged the same
rent per square foot, based on current market rates.
The next venture the owners are thinking of pursuing is to use part of the new building to run a used furniture store, which
they would operate in another subsidiary company.
EXHIBIT C5-1(d)
EMAIL FROM JACK WRIGHT
Hi Ken,
Further to our discussion this morning, I thought I’d send over the details of the vehicles we sold to Transport. We had them
valued in January when we made the transfer. I’ve included their net book value, fair market value, and undepreciated capital
cost at that time.
NBV FMV UCC

Trailers $ 37,000 $ 41,000 $ 46,000
Trucks 310,000 390,000 450,000
347,000 431,000 496,000
I thought while I was at it I would give you some details on the land and buildings sold and acquired.
Acquisition Cost NBV/UCC Sales Proceeds

Cohen St. Building $ 4,500,000 $3,000,000 $5,250,000
Land 500,000 500,000 750,000
$ 5,000,000 $3,500,000 $6,000,000
Johnson Building $ 9,000,000
Land 1,000,000
$10,000,000
Thanks again for all your help,

Jack

(LO 2, 6) C5-2 Naya Ltd. is a public company that manufactures components used in cellular telephones and other mobile
devices. Its head office is in Mississauga, Ontario, and its year end is December 31. It is currently January 5, 2014,
and you, Controller, CA, have just been called into the office of Renald Ménard, the Vice-President of Finance, for a
meeting to discuss two transactions that have just taken place. He is particularly concerned with the effects that these
transactions will have on the year-end financial statements. Refer to Exhibit 5-2(a) for Naya Ltd.’s December 31, 2013
year-end financial statements. The details are as follows:
1. On November 1, 2013, Naya Ltd. acquired an 80% interest in Mac Enterprises, a company in a similar line of busi-
ness as Naya, for $575,000. This is the first time that Naya has obtained control of another company without pur-
chasing 100% of it and as such, Mr. Ménard is unsure of what the repercussions are. The share capital and retained
earnings of Mac Enterprises at the date of acquisition were $100,000 and $325,000, respectively. The net assets were
equal to their acquisition date fair market values. There were two exceptions. The first was inventory, which had a
fair market value $10,000 higher than its book value and was expected to be sold by December 31, 2013. The second
exception was property, plant, and equipment, with a remaining useful life of five years, which had a fair market value
$50,000 higher than its book value. Mac Enterprises earns income evenly over the year.
2. Naya sold 10% of its wholly owned subsidiary Icebreaker Inc. on December 31, 2013, for $25,000. Naya will retain
control. This 100%-owned company was acquired three years ago for $400,000. At that time, its share capital was
$100,000 and its retained earnings were $125,000. Its book values were equal to fair market value, with the exception
of inventory, whose fair market value was $20,000 higher and was sold within one year, and property, plant, and equip-
ment, whose fair market value was $100,000 higher and had a remaining useful life of 10 years at the time. Naya has
recorded a gain of $5,000 on its December 31, 2013 statement of comprehensive income (45,000 10% 400,000).
Required
Prepare a report to Renald Ménard, the Vice-President of Finance, that discusses the repercussions of the two transac-
tions and addresses his concerns. As well, address how the above transactions will affect the statement of changes in
equity at December 31, 2013. Ignore the effects of income taxes.
EXHIBIT 5-2(a)
Financial Statement Information
Naya Ltd. Mac Enterprises Icebreaker Ltd.

Assets
Current assets
Cash $ 421,203 $219,230 $109,203
Inventory 811,283 201,920 301,006
Total current assets $1,605,117 $593,761 $612,146
Non-current assets
Investment in Mac Enterprises $ 575,000 $ -0- $ -0-
Investment in Icebreaker Ltd. 400,000
Total non-current assets $1,646,321 $250,191 $221,902
Total assets $3,251,438 $843,952 $834,048
Liabilities and Shareholder’s Equity

Current liabilities $ 615,231 $176,029 $199,280
Non-current liabilities 1,052,012 117,923 249,465
Total liabilities $1,667,243 $293,952 $448,745
Share capital $ 200,000 $100,000 $100,000
Retained earnings beginning* $ 908,072 $325,000 $209,103
Net income during the year 476,123 125,000 76,200
Retained earnings (12/31/2013) 1,384,195 450,000 285,303
Total shareholder’s equity $1,584,195 $550,000 $385,303
Total liabilities and shareholder’s equity $3,251,438 $843,952 $834,048
* For Mac Enterprises, this is the net income since the date of acquisition for two months.
Joining
Forces
Source: Fred Lum/The Globe and Mail
JOINT VENTURES are common in the In the first phase, the tools will be developed
engineering and construction industry, partly by SNC-Lavalin, whereas Aecon will focus on
because large projects require expertise and constructing a full-scale reactor to be used for testing
resources that an individual firm may not have. purposes. The first phase is expected to bring in more
In 2012, a transaction was announced between than $600 million in revenues for the joint venture,
two of the world’s leading firms in engineering and of which approximately $100 million will go to
construction to create a joint venture to work on Aecon. The second phase, consisting of the actual
a project awarded by Ontario Power Generation. refurbishment of all four reactor cores, will be carried
The joint venture will refurbish all four reactors out by the joint venture and the costs and profits
at the Darlington nuclear generating station. will be shared equally between the two entities. No
The first member of the venture is SNC Lavalin, figures were announced for the second phase.
a major player in the ownership of infrastructure According to IFRS 11, this arrangement meets the
and in the provision of operations and maintenance definition of a joint venture because an agreement
services. It has grown by acquiring smaller was signed between the two entities and the
engineering firms to gain expertise and clientele in arrangement established joint control. Furthermore,
different fields. The second one, Aecon Group Inc., the entities are entitled to a share of the outcome
Canada’s largest publicly traded construction and generated by a group of assets and liabilities and
infrastructure development company, is made up of therefore this arrangement would be considered a
a diverse portfolio of companies and subsidiaries. joint venture.
The Darlington refurbishment project has an 11- Under IFRS, the entities have adopted the equity
year time frame that will be divided in two phases: method to record the income from the joint venture.
the definition phase (four years) and execution Therefore, they will record the investment initially
phase (seven years). Under the joint arrangement, at cost and will adjust on a yearly basis to reflect
Aecon will provide primarily construction and the income from the joint venture as well as any
fabrication services to the joint venture, while dividends paid out.
SNC-Lavalin will focus on specialty tooling and Because the nuclear industry is very specialized,
engineering. Project management and procurement the companies expect to benefit from sharing
will be provided jointly by Aecon and SNC-Lavalin their expertise and hope that the joint venture will
since it represents their fields of expertise. continue long after the Darlington project.
Sources: SNC Lavalin website, “About Us,” available at www.snclavalin.com, accessed on June 26, 2012; “Aecon / SNC-Lavalin Joint Venture Signs Major Contract for
Darlington Refurbishment Project,” Aecon company news release, March 1, 2012; Aecon Group website, “Companies and Subsidiaries,” available at www.aecon.com,
accessed on June 26, 2012.
CHAPTER
6 Accounting for
Investments in
Associates and
Joint Ventures
LEARNING OBJECTIVES
1. Apply the equity method on consolidated or separate financial statements.
2. Adjust for goodwill and fair value differences at acquisition date.
3. Adjust for movements in equity from dividends and reserves, and the effects of dissimilar
accounting policies and different ends of reporting periods.
4. Account for the investing in an associate or joint venture in stages.
5. Adjust for the effects of intercompany transactions.
6. Account for losses recorded by the associate or joint venture.
ACCOUNTING FOR INVESTMENTS IN

ASSOCIATES AND JOINT VENTURES
Equity Method
Goodwill and Investing in an Effects of Losses Recorded
of Accounting on Movements in Equity
Fair Value Associate or Joint Intercompany by the Associate or
Consolidated and from Dividends
Differences at Venture in Stages Transactions Joint Venture
Separate Financial
Acquisition Date
Statements
■ Separate financial ■ Dividends ■ Becoming an associ- ■ Transactions between

statements versus ■ Reserves ate or joint venture the company and its
consolidated after acquiring an associate or between
statements ■ Dissimilar accounting ownership interest the company and its
policies joint venture
■ Applying the ■ Increasing owner-
equity method: ■ Different ends of ship when sig- ■ Contributions of
Basic method reporting periods nificant influence nonmonetary assets
or joint control in exchange for
already exists and equity interests
continues to exist ■ Transactions
between associates
or joint ventures
286 chapter 6 Accounting for Investments in Associates and Joint Ventures
A subsidiary is seen as having a special relationship with its parent so that a particular form
of accounting is required to provide the necessary information about those companies. The
form of accounting required is consolidation. The relationship between a company and
its associate or joint venture is also seen as being of special significance so that a specific
accounting method—the equity method of accounting—is required to provide information
about the company and its associate or joint venture.
In paragraph 11 of IAS 28, it is argued that:
The recognition of income on the basis of distributions received may not be an adequate mea-
sure of the income earned by an entity on an investment in an associate or joint venture
because the distributions received may bear little relation to the performance of the associate
or joint venture.
Further, it is argued that applying the equity method extends the scope of the company’s
financial statements to include its share of the profit or loss of such an investee. As a result,
applying the equity method provides more informative reporting of the company’s net assets
and profit or loss.
As with subsidiaries, the nature of the company–associate or joint venture relationship is
clearly defined, in this case in IAS 28 Investments in Associates and Joint Ventures. In this same
section, the principles of the equity method are specifically established. The nature of an
associate or joint venture and the criteria for identification of an associate or joint venture
were introduced in Chapter 1. The accounting for these investments is the focus of this
chapter. We see in Illustration 6.1 the sample note disclosure of Barrick Gold, a Canadian
mining company, for its various investments in affiliates.
Illustration 6.1
Excerpt from the Financial 14 > EQUITY IN INVESTEES
Statements of Barrick Equity Method Investment Cerro Donlin
Gold Corporation Continuity Highland Atacama1 Casale Gold Kabanga Total
(in U.S. $ millions)
At January 1, 2010 $ 96 $131 $828 $67 $2 $1,124
Equity pick-up (loss) from equity 12 (19) (1) (10) (6) (24)
investees
Funding — 12 12 22 5 51
Impairment (charges) reversals 84 — — — — 84
Derecognition on acquisition of — — (839) — — (839)
controlling interest2
At December 31, 2010 $192 $124 $ — $79 $1 $ 396
Equity pick-up (loss) from equity 22 (8) — (1) — 13
investees
Funding — 6 — 17 8 31
At September 30, 2011 $214 $122 $ — $95 $9 $ 440
Publicly traded Yes No No No No
1
Represents our investment in Reko Diq.
2
The carrying amount of the Cerro Casale investment has been derecognized as a result of our obtaining control over
the entity due to the acquisition of an additional 25% interest and is now consolidated. See note 4F for further details.
Applying the equity method requires an analysis of the acquisition similar to that
undertaken when accounting for subsidiaries. Whether there is any goodwill or income to be
accounted for is determined by this analysis.
As we saw in Chapter 1, the criterion of control used for identifying subsidiaries has
similarities with the definition of significant influence used for associates and for the defini-
tion of a joint venture.
Because of the similarity with the principles and procedures used in applying the con-
solidation method to subsidiaries, the equity method of accounting has sometimes been
The Equity Method of Accounting on Consolidated and Separate Financial Statements 287
described as “one-line consolidation.” However, we will see in this chapter that IAS 28 does
not consistently use the consolidation principles in its application of the equity method.
THE EQUITY METHOD OF ACCOUNTING

ON CONSOLIDATED AND SEPARATE
FINANCIAL STATEMENTS
Objective 1 In this section we will see that a parent company accounts for affiliates or joint ventures in a
Apply the equity different manner if the parent is presenting a consolidated financial statement or a separate
method on financial statement.
consolidated or
separate financial
statements.
Separate Financial Statements Versus
Before we begin the discussion of the equity method, you should understand the reporting
circumstances that apply to a particular company. Under IFRS, a distinction is made between
reporting on a consolidated statement versus reporting on separate financial statements.
There are several scenarios that could be considered:
1. A company has an investment in a subsidiary only.
Parent
Subsidiary
2. A company has an investment in an associate or a joint venture but does not have an
investment in a subsidiary.
Company
Investment in Investment in joint

associate venture
3. A company has an investment in a subsidiary and an investment in an associate or joint

venture.
Parent
Investment in Investment in
Subsidiary
associate joint venture
A Company Has an Investment in a Subsidiary Only

A company that has an investment in a subsidiary is a parent and must prepare consolidated
financial statements for reporting purposes. However, under IFRS, a parent is also permitted
to present separate financial statements. Separate financial statements are defined in IAS
27 Separate Financial Statements as:
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 IFRS 9 Financial Instruments.
IFRS does not mandate which companies should prepare separate financial statements.
The requirements of IAS 27 apply whenever separate financial statements are prepared in
accordance with IFRS. In Canada, companies are required to file their tax returns based on
separate financial statements; however, if they are also a parent company they will have to
prepare consolidated financial statements as well. A parent may be dealing with a bank that
requests separate financial statements for each member of the group. There may be other
local regulations that require the parent to prepare separate financial statements in addition
to consolidated financial statements or to elect to do so.
When a parent prepares a separate financial statement, it must report its investment in that
subsidiary either at cost or at fair value (in accordance with IFRS 9). Earlier versions of IAS 27
permitted the parent to use the equity method as well to report its investment in the subsidiary on
the separate financial statements. It was decided that the focus in the separate financial statement
is upon the performance of the assets as investments (IAS 27, BC 66). We saw in Chapter 3 that
the parent can still record its investment in the subsidiary in its own books at cost or using the
equity method. In Chapter 3 we assumed that the parent would record its investment in the sub-
sidiary at cost, because on the separate financial statement, it would need to be reflected at cost. It
is possible that a company may still choose to record its investment using the equity method for
internal purposes so that it can reflect the same net results as its consolidated statement.1
A Company Has an Investment in an Associate or a Joint

Venture but Does Not Have an Investment in a Subsidiary
When the company is not a parent and therefore is not preparing a consolidated financial
statement, that company reports its investments in affiliates and joint ventures using the
equity method. These financial statements are not considered to be separate financial state-
ments (IAS 27.7). Since the company is reporting using the equity method, it is also likely
that it will record its investment in affiliate or joint venture using the equity method as well.
A Company Has an Investment in a Subsidiary and an

Investment in an Associate or Joint Venture
It is possible that a parent also owns investments in associate or joint ventures. The parent
will be presenting a consolidated financial statement that will include the subsidiary, associate,
and joint venture. The consolidated statement will reflect the investments in the associate and
joint venture using the equity method. If the parent elects or must prepare a separate finan-
cial statement in accordance with IFRS, all investments will show on that statement at either
cost or fair value, in accordance with IFRS 9. The company applies the same accounting for
each category of investments (IAS 27.10). The equity method may not be used in the parent’s
own financial statements to account for investments in associates or joint ventures since these
would need to be reported at cost or fair value. If the parent does not record its investments
using the equity method, the adjustments to reflect the investment using the equity method
will have to be done on consolidation.
1
If the equity method is used for internal purposes only, it would reflect the same adjustments as those
done on the consolidated statements. This would not be the same method used to reflect investments
in associates or joint ventures per IAS 28.
A parent will recognize a dividend received from an investee as revenue in net income in
its separate financial statements when its right to receive the dividend is established (IAS 27,
paragraph 12). We saw in Chapter 3 that when the subsidiary paid a dividend, we needed to
eliminate it on consolidation. This may also be necessary for affiliates and joint ventures.
Investments in associates and joint ventures are accounted for by the equity method, but
under IFRS 10, there are some cases where a parent is exempted from consolidation with a
subsidiary (see Chapter 1). In that case, the separate financial statement is the only financial
statement.
The use of separate financial statements under ASPE

ASPE There is no section equivalent to IAS 27 in ASPE. The company is able to present
subsidiaries, affiliates, or joint ventures under various options as presented earlier in the
textbook (Section 3051). The parent is not required to prepare consolidated financial
statements. As such, there is much more reporting flexibility for investments on finan-
cial statements.
The only requirement under ASPE is that a company that prepares more than one
set of financial statements, for special purposes, must designate one of the statements
as the primary financial statements. All other statements must refer to the primary
statement. We would expect that a parent that consolidates with its subsidiary would
designate the consolidated financial statements as the primary financial statement. A
statement prepared under ASPE for just the parent, for the purpose of obtaining a bank
loan, would state that the company has prepared a consolidated statement.
ASPE Section 3051 Investments does not require the use of the cost method or fair
value in the individual financial statement of an investor in an affiliate or joint venture. As
such, a company that will prepare a consolidated financial statement may record the invest-
ment on its own books using one of the cost method, the equity method, or fair value.
The accounting for joint ventures is covered in Section 3055. An investor can
report its investment in joint ventures on a consolidated basis using the proportionate
consolidation method. Under this method, the proportion of the joint venture owned
by the venturer is consolidated with the net assets of the investor. This method follows
the proprietary method of consolidation as illustrated in Appendix 5A in Chapter 5. At
the time of printing, the ASPE standards committee was divided as to whether to elimi-
nate the option of proportionate consolidation.
For a parent company, which will prepare consolidated financial statements, investments in
associates or joint ventures held by the parent or its subsidiaries are accounted for in the consoli-
dated financial statements by the equity method. Therefore, the accounting adjustments applying
the equity method to the investment in the associate or joint venture usually are made in the con-
solidated financial statements only. The adjustments are made on a year-to-year basis, because no
permanent adjustments for the equity accounting are made in the books of the parent.
Where the company does not prepare consolidated financial statements—that is, it is not a
parent—the company usually applies the equity method to its associate or joint ventures in its own
books. The books of the company are then affected when applying the equity method, in contrast
to the situation where the equity method adjustments are made in the consolidation process.
Applying the Equity Method: Basic Method

We begin the discussion with a review of the basic method introduced in Chapter 1. Paragraph
10 of IAS 28 describes the basics of the equity method. The key steps are:
1. Recognize the initial investment in the associate or joint venture at cost.

2. Increase or decrease the carrying amount of the investment by the company’s share of the
profit or loss of the investee after the date of acquisition (post-acquisition profit or loss).
3. Reduce the carrying amount of the investment by distributions (such as dividends)

received from the associate or joint venture.
4. Increase or decrease the carrying amount of the investment for changes in the com-
pany’s share of the changes in the investee’s other comprehensive income. This applies
to amounts where changes in the associate or joint venture’s equity have not already been
included in profit or loss. Hence, changes in asset revaluation and foreign currency trans-
lation are recognized.
Although potential voting rights may be used in the assessment of the existence of sig-
nificant influence, they are not used in any of these calculations (IAS 28.12).
The basics of the equity method are further explained in Illustrative Example 6.1.
Illustrative Example 6.1 Basic Application

of the Equity Method
The data for this example are replicated from Chapter 1 (Illustrative Example 1.7).
I. Company does not prepare consolidated financial statements
On January 1, 2013, Quewest acquired 25% of the shares of Reyse for $42,500. At this
date, all the identifiable assets and liabilities of Reyse were recorded at amounts equal to
fair value, and the equity of Reyse consisted of:
During 2013, Reyse reported net income of $25,000. The Cumulative Other
Comprehensive Income increased by $5,000, this being reported in Other Comprehensive
Income. Reyse paid a $4,000 dividend.
At January 1, 2013, Quewest recorded the investment in Reyse at $42,500. At
December 31, 2013, the journal entries to apply the equity method, as recorded in the
books of the company, are:
(1) Recognition of share of profit or loss of associate
(Share of associate net income: 25% × $25,000)
The Share of Profit or Loss of Associate is disclosed as a separate line item in the
statement of comprehensive income, per IAS 1 paragraph 82(c).
(2) Recognition of increase in cumulative other comprehensive income
Other Comprehensive Income 1,250
(Share of other comprehensive income: 25% × $5,000)
This increase is also disclosed as a separate line item in the statement of compre-
hensive income, per IAS 1 paragraph 82(h)—Share of Other Comprehensive Income
of Associate.
(3) Adjustment for dividend paid by associate or joint venture
Cash 1,000
(Adjustment for dividend paid by associate or joint venture: 25% $4,000)
Because the company has recognized its share of the equity of the associate or joint
venture, the dividend is simply a receipt of equity already recognized in the investment
account.
At December 31, 2013, the investment in the associate or joint venture is measured
at $49,000 (i.e., $42,500 $6,250 $1,250 $1,000). The equity of Reyse consists of:
Cumulative other comprehensive income ($20,000 + $5,000) 25,000
Retained earnings ($50,000 + $25,000 − $4,000) 71,000
$196,000
The company’s share of the equity of the associate or joint venture is 25% of
$196,000 (i.e., $49,000), which is the same as the recorded amount of the investment
in the associate or joint venture. In other words, the equity method, in this case, is
designed to show the investment in the associate or joint venture at an amount equal
to the company’s share of the reported equity of the associate or joint venture. As
explained later in this chapter, this relationship is not always achieved because of the
effects of fair value adjustments, the existence of goodwill, and adjustments made for
the effects of intercompany transactions.
II. Company prepares consolidated financial statements
In this circumstance, the adjustments are not made in the books of the companies them-
selves but on consolidation instead. The consolidation adjustment is:
Investment in associate c 6,250 1,250 1,000
Share of profit c 6,250
Other comprehensive income c 1,250
(Adjustment for dividend paid by associate or joint venture: 25% $4,000)
When Reyse paid the $4,000 dividend, Quewest recorded the receipt of cash and
recognized dividend revenue. The effect of the above adjustment on the application of
the equity method is to eliminate the dividend revenue previously recognized by the
company. Because the company recognizes a share of the whole of the net income of
the associate or joint venture, the dividend revenue cannot also be recognized as income
by the company. However, the payment of the dividend reduces the investment in the
associate or joint venture.
✓ LEARNING CHECK
• The equity method is applied from the date the company obtains significant influence over the
investee or joint control in the joint venture.
• Where a company prepares consolidated financial statements, the equity method is usually
applied to associates or joint ventures of the parent and its subsidiaries in the consolidated
financial statements, and not in the books of the parent itself.
• Where a company does not prepare consolidated financial statements, the equity method is
usually applied to investments in associates or joint ventures and joint ventures in the books
of the company itself.
• The equity method requires the investment in an associate or joint venture to be adjusted for
the company’s share of the post-acquisition equity of the associate or joint venture.
• Where dividends are paid/declared by an associate or joint venture and the company does not
prepare consolidated financial statements, no dividend revenue is recognized by the company.
• Where dividends are paid/declared by an associate or joint venture and the company prepares
consolidated financial statements, the dividend revenue recognized in the parent’s books is
eliminated on consolidation.
GOODWILL AND FAIR VALUE

DIFFERENCES AT ACQUISITION DATE
Objective 2 The description of the equity method in IAS 28.11 refers to requiring the recognition
Adjust for goodwill of the company’s share of the profit or loss of such an investee. Further, paragraph 26 of this
and fair value standard notes that many of the procedures appropriate to the application of the equity
differences at method are similar to the consolidation procedures described in IAS 27. The procedures
acquisition date.
used in accounting for the acquisition of a subsidiary are also adopted in accounting for
the acquisition of an investment in an associate or joint venture. To this end, any dif-
ferences between fair values and carrying amounts of identifiable assets and liabilities
acquired, as well as any goodwill or income on acquisition, must be taken into account.
IAS 28.32 states:
An investment in an associate or joint venture is accounted for using the equity method
from the date on which it becomes an associate or joint venture. On acquisition of the
investment any difference between the cost of the investment and the company’s share
of the net fair value of the investee’s identifiable assets and liabilities is accounted for as
follows:
(a) Goodwill relating to an associate or a joint venture is included in the carrying amount of
the investment. Amortization of that goodwill is not permitted.
(b) Any excess of the company’s share of the net fair value of the investee’s identifiable assets
and liabilities over the cost of the investment is included as income in the determination of
the company’s share of the associate or joint venture’s profit or loss in the period in which
the investment is acquired.
Appropriate adjustments to the company’s share of the associate or joint venture’s prof-
its or losses after acquisition are also made to account, for example, for depreciation of the
depreciable assets, based on their fair values at the acquisition date. Similarly, appropriate
adjustments to the company’s share of the associate or joint venture’s profit after acquisition
are made for impairment losses recognized by the associate or joint venture, such as for good-
will or property, plant, and equipment.
As with consolidated financial statements, at acquisition date the cost of the investment
is compared with the net fair value of the identifiable assets and liabilities of the associate
or joint venture acquired by the company in order to determine whether any goodwill is
acquired or whether there is an excess to be included as income.
The purpose of this acquisition analysis is to determine the real post-acquisition equity
of the associate or joint venture. Because the cost of the investment is the amount paid for
the net fair value of the identifiable assets and liabilities acquired and the goodwill (if any),
then the recorded profits of the associate or joint venture after the acquisition date are not
all post-acquisition equity. They will include profits recognized and paid for by the acquiring
company at acquisition date. Hence, in determining the company’s share of post-acquisition
profits of the associate or joint venture, adjustments will have to be made for differences
between carrying amounts and fair values at the acquisition date, as well as for any goodwill
impairment or excess.
These adjustments are only notional adjustments; they are not made in the records of the
associate or joint venture, but are made in calculating the incremental adjustment to the share
of profit of the associate or joint venture. Because the adjustment is made to a share of profit
or loss, the adjustment is calculated on an after-tax basis. Therefore, adjustments relating to
the depreciation of non-current assets or the cost of inventory sold must be calculated on an
after-tax basis. This is the same adjustment that is required on consolidation in situations
where control exists.
Adjusting for goodwill and fair value differences at the acquisition date is further demon-
strated in Illustrative Example 6.2.
Goodwill and Fair Value Differences at Acquisition Date 293
Illustrative Example 6.2 Goodwill and Fair Value

Adjustments
On January 1, 2013, Proulx acquired 25% of the shares of Recorder for $49,375. At this
date, the equity of Recorder consisted of:
At the acquisition date, all the identifiable assets and liabilities of Recorder were
recorded at fair value, except for plant whose fair value was $10,000 greater than its
carrying amount, and inventory whose fair value was $5,000 greater than its cost. The
tax rate is 30%. The plant has a further five-year life. The inventory was all sold by
December 31, 2013.
In the reporting period ending December 31, 2013, Recorder reported net income
of $15,000.
The acquisition analysis at January 1, 2013, is as follows:
Cost of investment = $49,375
Net fair value of the identifiable assets
and liabilities of Recorder = ($100,000 $70,000) (equity)
$10,000(1 30%) (plant)
$5,000(1 30%) (inventory)
= $180,500
Net fair value acquired by Proulx = 25% $180,500
= $45,125
Goodwill = $4,250
Depreciation (net of tax) of plant p.a. = 1/5 (25% [$10,000(1 30%)])
= $350
Effect of sale of inventory (net of tax) = 25% $5,000(1 30%)
= $875
The amount of the adjustment needed in applying equity accounting to the invest-
ment in the associate or joint venture at December 31, 2013, is determined as follows:
Share of profit recorded by associate or joint venture
(25% $15,000) $3,750
Fair value adjustments:
Depreciation of plant $(350)
Sale of inventory (875) (1,225)
Share of post-acquisition profit of associate or joint venture $2,525
The journal adjustment to reflect the application of the equity method to the
investment in the associate or joint venture is:
Investment in Recorder 2,525
(Recognition of share of post-acquisition profit of associate or joint venture)
This adjustment is the same whether or not the company prepares consolidated
financial statements. However, if the company prepares consolidated financial state-
ments, the adjustment of $2,525 would not be recorded in Proulx’s books. It would be
an adjustment to the consolidated financial statements as follows:
Investment in Recorder c 2,525
Share of profit or loss of associate c 2,525
Illustrative Example 6.3 shows how to recognize a bargain purchase through
income.
Illustrative Example 6.3 Excess of Net Assets Acquired

over Cost
Any excess of the company’s share of the net fair value of an associate or joint venture’s
identifiable assets and liabilities over the cost of the investment is to be recognized as
income in the determination of the company’s share of the associate or joint venture’s
net income or loss in the period in which the investment is acquired (IFRS 28.32b).
This is consistent with treatment of a bargain purchase in a business acquisition.
Assume in Illustrative Example 6.2 that the cost of the investment was $45,000.
The acquisition analysis would then show:
Cost of investment $45,000
Net fair value acquired by Proulx 25% $180,500
$45,125
Excess $125
Depreciation (net of tax) of plant p.a. 20% (25% [$10,000(1 30%)])
$350
Effect of sale of inventory (net of tax) 25% $5,000(1 30%)
$875
The amount of the adjustment needed in applying equity accounting to the invest-
ment in the associate or joint venture at December 31, 2013, is then as follows:
Share of profit recorded by associate or joint venture (25% $15,000) $3,750
Pre-acquisition adjustments:
Excess $ 125
Depreciation of plant (350)
Sale of inventory (875) (1,100)
Share of post-acquisition profit of associate or joint venture $2,650
The journal adjustment to reflect the application of the equity method to the
investment in the associate or joint venture is:
Investment in Recorder 2,650
(Recognition of share of post-acquisition profit of associate or joint venture)
If the adjustment for the equity pickup were made on consolidation only, the effect
would be:
Investment in Recorder c 2,650
Under ASPE Section 3051.11, the company is required to depreciate and amortize the
ASPE investee assets based on the assigned costs of such assets at the date of acquisition. No part of an
impairment write-down of an investment accounted for by the equity method is presented in the
income statement as a goodwill impairment loss. This will result in the same adjustments
required under IFRS and described in this section.
✓ LEARNING CHECK
• Where differences between fair values and carrying amounts exist at acquisition date for the
investee’s identifiable assets and liabilities, subsequent equity recognized by the associate or
joint venture may include fair value adjustments relating to these differences.
Movements in Equity 295
• Calculation of adjustments for differences between carrying amounts and fair values is always
on an after-tax basis.
• Adjustments for any goodwill arising on acquisition would occur on impairment of goodwill.
MOVEMENTS IN EQUITY
Objective 3 It is possible that there are differences that exist between the investor and the investee that
Adjust for affect the investor’s pick up of its share of profit and loss. In this section we examine those areas
movements in equity that may require adjustments prior to including the profit or loss of the affiliate or joint venture.
from dividends and
reserves, and the
effects of dissimilar
accounting policies Dividends
and different ends of
reporting periods. Common Shares
All dividends paid or payable by a subsidiary to a parent are to be recognized as revenue by
the parent in its own financial statements.
When the associate or joint venture pays or declares a dividend, the company records
dividend revenue. As noted earlier in this chapter, because the investment account has been
adjusted for the company’s share of all post-acquisition equity, applying the equity method
requires the investment account to be adjusted for dividends paid or declared.
Where no consolidated financial statements are prepared, the adjustment in the com-
pany’s books is:
Cash xxx
Investment in Associate xxx
Where consolidated financial statements are prepared, the consolidation adjustment to

remove the dividend revenue, which is included in the company’s net income for its separate
financial statements, is:
Dividend revenue T xxx

Investment in associate or joint venture T xxx
Preferred Shares
IAS 28.37 states:
If an associate or joint venture has outstanding cumulative preference shares that are held
by parties other than the company and classified as equity, the company computes its share of
profits or losses after adjusting for the dividends on such shares, whether or not the dividends
have been declared.
This discussion relates only to dividends that are classified as equity because, for those
preferred shares classified as debt, the payments to the holders are treated as interest and
deducted before calculating net income for the period. For preferred shares treated as equity,
the payments to holders are classified as dividends and are appropriated after the calculation
of net income.
The equity attributable to the common shareholders in the associate or joint venture is
net of dividends to the preferred shareholders. Hence, in calculating the share of the current
period equity attributable to the company, adjustments need to be made for:
• preferred dividends paid or declared in the current period
• preferred dividends that are cumulative in the current period, but have not been paid or
declared.
This applies to preferred dividends relating to preferred shares regardless of whether the
company owns the preferred shares in the associate or joint venture or other parties own the
shares. The calculation is then (assuming the dollar amounts):
Net income of associate or joint venture $100

Less: Preferred dividends paid/declared 20
80
Company’s share: 20% of $80 $ 16
Reserves
The equity of the investee may also increase or decrease via changes in reserve balances,
included in Cumulative Other Comprehensive Income, in the associate or joint venture.
An example of this is where the associate or joint venture recognizes an increase in the
asset revaluation reserve—the increase in equity is recognized directly in equity. The com-
pany’s share of the asset revaluation reserve is recognized when applying the equity method
via the following adjustment:
Investment in Associate xxx

Asset Revaluation Reserve xxx
This adjustment is the same regardless of whether it is made in the company’s records or
in the consolidated financial statements. This increment is then disclosed as a separate line
item in other comprehensive income in the statement of comprehensive income (IAS 1 para-
graph 82(h)), and as a movement in the asset revaluation reserve in the statement of changes
in equity.
Dissimilar Accounting Policies

IAS 28.35 and .36 state:
35. The company’s financial statements shall be prepared using uniform accounting policies
for like transactions and events in similar circumstances.
36. If an associate or joint venture uses accounting policies other than those of the company for like
transactions and events in similar circumstances, adjustments shall be made to conform the
associate or joint venture’s accounting policies to those of the company when the associate or
joint venture’s financial statements are used by the company in applying the equity method.
When calculating the company’s share of the net income of the associate or joint ven-
ture, adjustments must then be made to the recorded net income of the associate or joint
venture where that figure has been measured based on policies that are different from those
applied by the company.
Different Ends of Reporting Periods

In applying the equity method, the company should use the most recent available financial
statements of the associate or joint venture. When the end of the reporting period of the
company is different from that of the associate or joint venture, the associate or joint venture
prepares, for the use of the company, financial statements as of the same date as the financial
statements of the company, unless it is impracticable to do so. Where the financial state-
ments of the associate or joint venture are prepared as of a different date, in applying the
equity method, adjustments should be made for significant transactions or events that have
occurred between the dates of the statements of the two entities. There is a maximum dif-
ference between the ends of the reporting periods of the company and the associate or joint
venture of no more than three months (IAS 28.34, .35).
Accounting for dividends, reserves, and dissimilar accounting policies is shown in

Illustrative Example 6.4 Dividends, Reserves, and

Dissimilar Accounting Policies
On January 1, 2011, Picher acquired 40% of the shares of Savard for $122,400. The
equity of Savard at acquisition date consisted of:
Common share capital $200,000

10% preferred share capital 100,000
At January 1, 2011, all the identifiable assets and liabilities of Savard were recorded
at fair value except for the following:

Machinery $140,000 $160,000
Inventory 60,000 70,000
By December 31, 2011, the inventory on hand at January 1, 2011, had been sold
by Savard. The machinery was expected to provide future benefits evenly over the next
two years. The tax rate is 30%.
In relation to the preferred shares, there were no arrears of dividend outstanding at
January 1, 2011. However, no dividends were paid in 2012, and the shares are cumula-
tive. The dividends paid in 2013 included the previous period’s arrears.
Dividends declared at December 31 are paid within the following three months,
with liabilities being recorded at the date of declaration.
In June 2013, Savard revalued furniture upwards by $6,000, affecting the asset
revaluation reserve.
Both companies have interests in exploring mining leases. Whereas Picher has
adopted a policy of capitalizing its exploration expenditure, Savard has adopted a pol-
icy of expensing exploration outlays. This has resulted in Savard expensing $4,500 and
$6,500 in 2012 and 2013, respectively.
The financial statements of Savard over three periods contained the following
information:
December December December

31, 2011 31, 2012 31, 2013
Profit $ 40,000 $ 60,000 $ 70,000
Retained earnings (opening balance) 80,000 98,000 133,000
120,000 158,000 203,000
Common dividend paid 5,000 10,000 15,000
Common dividend declared 7,000 15,000 20,000
Preferred dividend paid 10,000 — 20,000
22,000 25,000 55,000
Retained earnings (closing balance) $ 98,000 $133,000 $148,000
Required
Calculate the investment income, as well as the balance in the Investment in Savard
account that Picher would report when applying the equity method on its consolidated
financial statement for each of the three years ending December 31, 2011, 2012, and
2013.
Solution
Cost of investment $122,400
Net fair value of identifiable assets ($200,000 $80,000) (equity)
and liabilities of Savard $20,000(1 30%) (machinery)
$10,000(1 30%) (inventory)
$301,000
Net fair value acquired by Picher 40% $301,000
$120,400
Goodwill $2,000
Depreciation of machinery p.a. after tax 50% [40% $20,000(1 30%)]
$2,800
Fair value after-tax inventory effect 40% $10,000(1 30%)
$2,800

Recorded net income $40,000
Adjustments:
Preferred dividend paid $(10,000) (10,000)
30,000
Company’s share—40% 12,000
Sale of inventory (2,800)
Depreciation of machinery (2,800) (5,600)
$ 6,400
The adjustments in the consolidated financial statements of Picher at December

31, 2011, are:
Investment in Savard c 6,400
(recognition of equity-accounted profit of associate)
Investment in Savard T 4,800
(adjustment for common dividends from associate: 40% (5,000 7,000)
Note that the net increase in equity and the investment account for the year is
$1,600 (i.e., $6,400 $4,800).

Adjustments:
Expensing of exploration outlays net
of tax effect (4,500 [1 30%]) $ 3,150
Preferred dividend in arrears (10,000) (6,850)
53,150
Depreciation of machinery (2,800) (2,800)
$18,460

31, 2012, are:
Retained earnings 1/1/12 c 1,600
Note that this adjustment is necessary because we assume that the equity account-
ing adjustments are made in the consolidated financial statements and not in the actual
records of the company. The investment in Savard would be reflected at its original
cost on the separate financial statements of Picher. If Picher were to record its invest-
ment in Savard in its own books using the equity method, the adjustments would not
be necessary as each year the journal entries would be made in the actual books of
Picher.

(adjustment for common dividends from associate: 40% [10,000 15,000])
Note that the net increase in equity and in the investment account as a result of
applying the equity method is $10,060 (i.e., $1,600 $18,460 $10,000).

Adjustments:
Expensing of exploration outlays ($6,500 [1 30%]) $ 4,550
Preferred dividend paid in relation to current year (10,000) (5,450)
64,550
Company’s share—40% $25,820

31, 2013, are:
Retained earnings 1/1/13 c 10,060
(share of previous period’s equity of the associate)
(adjustment for common dividends from associate: 40% [$15,000 $20,000])
Asset revaluation reserve c 1,680
(share of associate’s revaluation increments: 40% $6,000[1 30%])
The ASPE requirements are the same under Section 3051.

ASPE
✓ LEARNING CHECK
• In calculating the company’s share of equity of the associate or joint venture, cumulative
preferred dividends may have to be taken into account.
• Adjustments are made where the accounting policies of the company differ from those applied
by the associate or joint venture.
• Dividend revenue will need to be removed from the company’s consolidated financial state-
ments since the equity method will now replace the cost method of accounting for the
investment.
INVESTING IN AN ASSOCIATE OR JOINT

VENTURE IN STAGES
Objective 4 A complication arises when the company’s investment in the associate or joint venture is
Account for the achieved in stages before obtaining a sufficient investment in the investee to wield significant
investing in an influence or joint control. This topic was introduced in Chapter 1 and we now expand that
associate or joint discussion to include all issues that may affect an investment in an associate. The accounting
venture in stages.
for this is not covered in IAS 28. The principles for business combinations involving stages,
as outlined in IFRS 3.41 and 3.42, must be applied. Paragraph 42 of IFRS 3 states:
In a business combination achieved in stages, the acquirer shall remeasure its previously held
equity interest in the acquiree at its acquisition-date fair values and recognize the resulting
gain or loss, if any, in profit or loss. In prior reporting periods, the acquirer may have recog-
nized changes in the value of its equity interest in the acquiree in other comprehensive income
(for example, because the investment was classified as available for sale). If so, the amount
that was recognized in other comprehensive income shall be recognized on the same basis as
would be required if the acquirer had disposed directly of the previously held equity interest.
In Chapter 5 we examined acquisitions in stages when the parent already has control over
the subsidiary. In this section we expand our discussion to situations where a company had pre-
viously held an investment in another company and then by a further investment, that investee
became an associate or joint venture of the company. At the date of the second investment:
• the previously held investment is revalued to fair value with any gain/loss being taken to
net income and
• if the previously held investment had been measured at fair value with changes in fair
value being recognized directly in equity (e.g., IFRS 9- with the election to include gains
or losses in Other Comprehensive Income), those amounts are transferred to current
period retained earnings.
Accounting for acquisitions in stages is shown in Illustrative Example 6.5.
Illustrative Example 6.5 Acquisitions in Stages

Assume Lopez acquired 10% of the shares of Horn on January 1, 2012, for $13,000. At
December 31, 2012, the end of the company’s reporting period, the investment’s fair
value was $16,200. The investment was designated as fair value through profit and loss
based on IFRS 9.
On July 1, 2013, Lopez acquired a further 10% of the share capital of Horn for
$17,200 (this also being the fair value of the initial investment in Horn at this date),
when the equity of Horn consisted of:
Asset revaluation reserve 12,000
Net income (1/1/13 to 30/6/13) 8,000
Horn’s identifiable assets and liabilities were recorded at fair value at this date
except for inventory whose fair value was $15,000 greater than carrying amount. This
acquisition gives Lopez significant influence over Horn.
Investing in an Associate or Joint Venture in Stages 301
The accounting adjustments for these events would be determined as follows:

At January 1, 2012:
Lopez would record its investment in Horn at $13,000.
At December 31, 2012:
Lopez would revalue its investment to $16,200, recognizing $3,200 in net income.
At July 1, 2013:
At this date Horn becomes an associate. In accounting for its previously held investment
in Horn, Lopez will remeasure its investment to fair value, recognizing any change in
profit or loss:
Investment in Horn 1,000
Income: Remeasurement of Investment 1,000
(Remeasurement of investment on investee
becoming an associate: $17,200 $16,200)
The previously held investment is now recorded by the company at fair value,
$17,200. At July 1, 2013, Lopez also recognizes its further investment in Horn:
Investment in Horn 17,200
Cash 17,200
(Acquisition of further shares in Horn)
To assist in its application of the equity method to account for its investment sub-
sequent to July 1, 2013, Lopez would prepare the following acquisition analysis:
Acquisition-date fair value of investment $34,400
Net fair value of identifiable assets and liabilities $100,000 $12,000 $38,000
of investee $8,000 $15,000 (1 30%)
$168,500
Net fair value acquired 20% $168,500
$33,700
Goodwill $34,400 $33,700
$700
If Horn then recorded net income of $22,000 for the second half of 2013, at
December 31, 2013, Lopez would recognize its 20% share of that amount, adjusted for
the after-tax profit on the sale of inventory on hand at July 1, 2013, assuming it was all
sold by December 31, 2013:
(Recognition of share of post-acquisition profits
of associate: 20% [$22,000 $15,000(1 30%)])
The first 2 adjustments are the same regardless of whether the equity accounting
is being applied in the consolidated financial statements or in the actual accounts of the
company.
Becoming an Associate or Joint Venture

After Acquiring an Ownership Interest
A company may acquire an ownership interest in an investee on a certain date, but the
investee may not be classified as an associate or joint venture until a later date. For example,
assume Sitar acquired a 20% ownership interest in Merk on January 1, 2013, but, because of
the particular distribution of the balance of voting power, Sitar did not significantly influ-
ence the decisions of Merk. However, on July 1, 2013, as a result of sales of certain large
shareholdings in Merk, Sitar was able to significantly influence Merk’s decisions. Hence,
January 1, 2013, is the date of exchange (the date the shares were acquired), and July 1, 2013,
is the acquisition date (the date significant influence is achieved).
The initial accounting for this investment is governed by IFRS 9. The company initially
recognizes its investment in the investee at its cost of investment, based on the fair value of
what was given up to acquire the investment. The company classifies the investment as fair
value through profit and loss and accounts for it accordingly. It will be measured at fair value
and changes in fair value will be recognized in profit or loss for the period (unless the com-
pany makes an election to classify the gains and losses through equity). If the company obtains
significant influence or joint control over the investee, the latter becomes an associate or joint
venture and the accounting for the investment by the company is governed by IAS 28.
The equity method is applied at the date the company obtains significant influence or
joint control over the investee. At this date, the company completes the following procedure:
Step 1 Remeasures the investment to fair value, taking any change to profit and loss for the
period.
Step 2 Measures the fair values of the investee’s identifiable assets and liabilities.
Step 3 Measures any goodwill or income excess as the difference between the cost of the
investment and the company’s share of the net fair value of the identifiable assets and
liabilities acquired.
How to account for obtaining significant influence after acquiring an ownership interest
is shown in Illustrative Example 6.6.
Illustrative Example 6.6 Obtaining Significant Influence

After Acquiring an Ownership Interest
July 1, 2013, Lopez obtained significant influence over Horn. The investment in Horn
had been classified as fair value through profit or loss with movements in fair value
being recognized in profit and loss for the period, and at July 1, 2013, the investment
had a fair value of $28,000. At this date, the company measured the fair values of the
identifiable assets and liabilities of Horn at $138,000.
At July 1, 2013, the acquisition date, Lopez would undertake an acquisition analysis:
Acquisition-date fair value of investment previously held $28,000
Net fair value of identifiable assets and liabilities of Horn $138,000
Net fair value acquired by Lopez 20% $138,000
$27,600
Goodwill $28,000 $27,600
$400
Lopez would apply the equity method to the investment from July 1, 2013. Assume
that Horn reported $10,000 net income for the six months to December 2013, and that
at the acquisition date there were no differences in the fair values and carrying amounts
in relation to the assets and liabilities of the investee. The journal entries in the books
of Lopez to apply the equity method are:
July 1 Investment in Associate 500
Income: Gain on Investment 500
(Remeasurement of investment on adoption of equity method: $28,000 $27,500)

Note: This entry would be made in the books of Lopez even if the equity method were only applied
on consolidation.
Dec. 31 Investment in Associate 2,000

(Share of profit of associate: 20% $10,000)

If the equity method pickup is only reflected on consolidation, the adjustment is:
Investment in associate c 2,000
Investing in an Associate or Joint Venture in Stages 303
Increasing Ownership when Significant Influence or

Joint Control Already Exists and Continues to Exist
It is possible that a company that has an affiliate increases its ownership in the associate but
still has significant influence. Since control has not been obtained, there is no basis to revalue
the entire company. The investor is deemed to have acquired an additional share and would
calculate a new acquisition analysis for the additional purchase.
Illustrative Example 6.7 demonstrates how to account for obtaining additional ownership
interest after acquiring significant influence.
Illustrative Example 6.7 Obtaining Additional Ownership

Interest After Acquiring Significant Influence
January 1, 2013, Lopez obtained an additional 5% of the shares of Horn for $10,000.
The investment in Horn had been classified as an associate on January 1, 2012. At
January 1, 2012, the company measured the fair values of the identifiable assets and
liabilities of Horn at $138,000. At January 1, 2013, the company measured the fair val-
ues of the identifiable assets and liabilities of Horn at $154,000.
At January 1, 2012, the first acquisition date, Lopez would undertake an acquisition
analysis:
Acquisition-date consideration transferred $56,000
$55,200
Goodwill $56,000 55,200
$800
At January 1, 2013, the second acquisition date, Lopez would undertake another
acquisition analysis:
Acquisition-date consideration transferred $10,000
$7,700
Goodwill $10,000 7,700
$2,300
Lopez would now have to keep track of two goodwill amounts. In 2013 Lopez
would now be entitled to 45% of the profit of its associate of Horn.
The ASPE requirements under Section 1602 Non-controlling Interest provide the same
ASPE requirements for acquisitions in stages.
✓ LEARNING CHECK
• Where significant influence or joint control is achieved in stages, the company remeasures
the existing investment to fair value at the day that significant influence or joint control is
achieved.
• The difference between the investment’s fair value and the carrying value is a gain or loss
through the profit and loss of the company.
• The company establishes the fair values for the purposes of performing the acquisition analy-
sis at the day that significant influence or joint control is established.
EFFECTS OF INTERCOMPANY
TRANSACTIONS
Objective 5 A company is able to influence the activities of its affiliate or joint venture. As such, we need
Adjust for the effects to examine whether intercompany transactions are realized. The issue of concern is whether
of intercompany the company can manipulate earnings of its associate or joint venture in a manner that dis-
transactions. torts the actual activities of the company.
Transactions Between the Company

and its Associate or Between the Company
and its Joint Venture
Paragraph 28 of IAS 28 states:
Profits and losses resulting from ‘upstream’ and ‘downstream’ transactions between an entity
(including its consolidated subsidiaries) and an associate or joint venture are recognized in the
company’s financial statements only to the extent of unrelated investors’ interests in the associ-
ate or joint venture. ‘Upstream’ transactions are, for example, sales or contributions of assets
from an associate or joint venture to the investor. ‘Downstream’ transactions are, for example,
sales of assets from the company to its associate or its joint venture. The investor’s share in the
associate’s or joint venture’s gains and losses resulting from these transactions is eliminated.
As detailed in Chapter 4 of this text, in the preparation of consolidated financial state-
ments, adjustments are made to eliminate the effects of transactions between the parent and
its subsidiaries. This procedure requires the full effect of the transactions to be eliminated,
and the adjustments are made against the particular accounts affected by the transactions.
Under IAS 28, the adjustments for the effects of intercompany transactions are not consistent
with those used on consolidation. The principles for adjusting for the effects of intercompany
transactions under IAS 28 are as follows:
• Adjustments must be made for transactions between the associate or joint venture and the
company that give rise to unrealized profits or losses. Realization of such profits or losses
occurs when the asset on which the profit or loss accrued is sold to an external party or as
the future benefits embodied in the asset are consumed. Unlike consolidation, there is no
need to adjust for all transactions between the company and the associate or joint venture;
only the transactions where profit is affected require adjustment. Therefore, transactions
such as the holding of bonds by one company in another company, and the payment of
interest on those bonds, do not require an adjustment under equity accounting.
• Unlike adjustments for unrealized profits and losses within a consolidated group, adjust-
ments for transactions between a company and an associate or joint venture are done on
a proportional basis, determined in accordance with the company’s ownership interest
in the associate or joint venture. This is reasonable given that, under the equity method,
only the company’s share of the equity of the associate or joint venture is recognized and
not the full equity of the associate or joint venture.
• IAS 28 does not detail which accounts should be adjusted in this process. For example,
if the associate or joint venture sells an item of inventory to the company at a profit, it
is necessary to adjust the company’s share of the recorded net income of the associate or
joint venture. However, should the other side of the adjustment be to the inventory of
the company, because it is this asset that is affected by the intercompany transaction? In
this chapter, the adjustments are made on an after-tax basis to the accounts Investment
in Associate or Joint Venture and Share of Net Income or Loss of Associate or Joint
Venture. In other words, there are no adjustments to specific asset accounts, such as
Inventory or Property, Plant, and Equipment.
The effect of this is that the adjustments are the same for upstream and downstream
transactions, because the only accounts affected by the adjustments are the carrying amount
Effects of Intercompany Transactions 305
of the investment and the company’s share of profit or loss. Hence, the direction of the trans-
action is irrelevant in determining the accounts affected by applying the equity method.
There are no good arguments for this method apart from simplicity. If the adjustments
were consistent with those used under the consolidation method, then:
• where the company transferred inventory to the associate or joint venture, adjustments
would be made to sales and cost of sales of the company and the carrying amount of the
investment in the associate or joint venture, because the latter reflects the assets of the
associate or joint venture, or
• where the associate or joint venture transferred inventory to the company, the adjust-
ments would be made to the share of net income of the associate or joint venture and the
inventory account of the company.
Failing to adjust the individual accounts where appropriate departs from the approach of
applying the equity method as a one-line consolidation method. It also makes it more equiva-
lent to a measurement method or valuation technique.
Another effect of the approach to adjust only the two accounts for all intercompany
transactions relating to downstream transactions is seen where the company records a profit
on the sale of inventory to an associate or joint venture. Under equity accounting, an adjust-
ment is made to the account Share of Net Income or Loss of Associate. This account is
affected even though the profit is made by the company and the profits of the associate or
joint venture are unaffected by the transaction. The incremental change in the investment
account does not therefore reflect only changes in the equity of the associate or joint venture,
but includes unrealized profits made by the company.
In illustrative examples 6.8, 6.9, 6.10, and 6.11, assume that the reporting period is for
the year ending December 31, 2013, and that the company, Savon, owns 25% of Coquille.
Savon acquired its ownership interest in Coquille on January 1, 2012, when Coquille’s
retained earnings balance was $100,000. At this date, all the identifiable assets and liabilities of
Coquille were recorded at fair value. At December 31, 2012, the retained earnings balance in
Coquille is $140,000, and the net income recorded for 2013 is $30,000. The tax rate is 30%.
The adjustments may differ according to whether they are made in the consolidated
financial statements or in the accounting records of the company. Differences in particular
arise where the effects of a transaction occur across two or more years.
Transactions Involving Inventory

The accounting for the movement of inventory between the company and its associate or
joint venture is demonstrated in Illustrative Examples 6.8, 6.9, 6.10, and 6.11.
Illustrative Example 6.8 Sale of Inventory from Associate or

Joint Venture to Investor (Upstream) in the Current Period
During 2013, Coquille sold $5,000 worth of inventory to Savon. These items had pre-
viously cost Coquille $3,000. All the items remain unsold by the company at December
31, 2013.
The calculations for applying the equity method are as follows:
2012
Change in retained earnings since acquisition date:
$140,000 $100,000 $40,000
Company’s share—25% $10,000
2013
Current period’s profit $30,000
Adjustments for intercompany transactions:
Unrealized after-tax profit in ending inventory
$2,000(1 30%) (1,400)
28,600
Company’s share—25% $ 7,150
If the company prepares consolidated financial statements, the adjustments

in the consolidated financial statements to apply the equity method to its associate are:
If the company does not prepare consolidated financial statements, the first
of the two adjustments is recorded by the company in its own books at December 31,
2012 (except that the credit is made to Share of Profit or Loss of Associate instead of
Retained Earnings), and the second adjustment is recorded at December 31, 2013.
Illustrative Example 6.9 Sale of Inventory from

Company to Associate or Joint Venture
(Downstream) in the Current Period
Details are the same as in Illustrative Example 6.8, except that Savon sells the inventory
to Coquille.
The calculations and adjustments are exactly the same as in Illustrative Example
6.8. The flow of the transaction, whether upstream or downstream, does not affect the
accounting for the transaction.
Illustrative Example 6.10 Sale of Inventory in the Current

Period, Part Remaining Unsold
During 2013, Coquille sold $5,000 worth of inventory to Savon. These items had pre-
viously cost Coquille $3,000. Half of the items remain unsold by Savon at December
31, 2013.
The increment to the investment account is calculated in a similar way to Illustrative
Example 6.8 but the adjustment is based only on the profit remaining in inventory on
hand at the end of the period because it is this inventory that contains the unrealized
profit. The calculations are as follows:
2012
As for Illustrative Example 6.8
Increment $10,000
2013
Current period’s recorded profit $30,000
Adjustment for intercompany transactions:
Unrealized after-tax profit in ending inventory $1,000(1 30%) (700)
29,300
If the company prepares consolidated financial statements at December

31, 2013, the adjustments in the consolidated financial statement to apply the equity
method to its associate are:

Share of profit or loss in associate c 7,325
If the company does not prepare consolidated financial statements, in 2013
only the second of these two adjustments is required as a journal entry. The first
adjustment was recorded through income in 2012.
Illustrative Example 6.11 Sale of Inventory

in the Previous Period
During 2012, Savon sold $5,000 worth of inventory to Coquille. These items had pre-
viously cost Savon $3,000. All the items remain unsold by Coquille at December 31,
2012. These were eventually sold in the following period.
2012
Change in retained earnings since acquisition
date: $140,000 $100,000 $40,000
Unrealized after-tax profit in ending inventory
$2,000(1 30%) (1,400)
38,600
2013
Current period’s profit $30,000
Realized after-tax profit in opening inventory $2,000(1 30%) 1,400
31,400
In 2013, the profit that was unrealized in the previous period becomes realized.
Hence, the amount is added back in the calculation of the 2013 share of equity. The
addition of the 2012 and the 2013 increments results in the intercompany transaction
having a zero effect since, by December 31, 2013, the profit on the sale is realized.
Retained earnings c 9,650
If the company does not prepare consolidated statements, the first of the two
adjustments is recorded in the books of the company at December 31, 2012 (except that
the credit is made to Share of Profit or Loss of Associate), and the second adjustment
at December 31, 2013.
Transactions Involving Non-current Assets

The accounting for transactions involving non-current assets between the company and its
associate or joint venture is demonstrated in Illustrative Example 6.12.
Illustrative Example 6.12 Sale of Depreciable

Non-current Asset
On January 1, 2012, Coquille sold an item of plant to Savon for $8,000. The asset’s car-
rying amount on this date in Coquille’s records was $3,000. The plant had a remaining
useful life of five years.
2012
Change in retained earnings since acquisition date $40,000
Unrealized after-tax profit on sale of plant
$5,000(1 30%) (3,500)
Realized profit on sale of plant: 1/5 $3,500 700
37,200
Note that the profit on the sale of the plant is unrealized because the plant was not
sold to external parties. It is expected to be realized as the asset is consumed. The con-
sumption of benefits is measured by the depreciation of the asset. Hence, as the plant
is depreciated on a straight-line basis over a five-year period, one fifth of the profit is
realized in each year after the intercompany transfer.
2013
Current period’s recorded profit $30,000
Realized after-tax profit on sale of plant
1/5 $3,500 700
30,700
A further one fifth of the unrealized profit is realized in the 2103 period as the
benefits from the asset are further consumed. After a five-year period, the whole of the
profit is realized.

Share of profit or loss in associate c 7,675
If the company does not prepare consolidated statements, the first of the two
adjustments is recorded in the books of the company at December 31, 2012 (except that
the credit is made to Share of Profit or Loss of Associate), and the second adjustment
at December 31, 2013.
Transactions Involving Borrowings

The accounting for transactions involving borrowings between the company and its associate
or joint venture is demonstrated in Illustrative Example 6.13.
Illustrative Example 6.13 Payment of Interest

On January 1, 2013, Savon lent $10,000 to Coquille. Interest of $1,000 p.a. was paid by
Coquille.
Although the net income of Coquille includes the interest expense from this trans-
action, no adjustment is required because the revenue or expense on the transaction
is assumed to be realized. Profits are considered to be unrealized only when there
remains an asset in the company/associate or joint venture transferred at a profit or loss
from the associate or joint venture/company.
Contributions of Nonmonetary Assets

in Exchange for Equity Interests
A unique type of intercompany transaction may occur on the initial acquisition of equity in
the associate or joint venture. If the company contributes a nonmonetary asset rather than
cash to acquire the share of the investment, IAS 28.30 states that the treatment is the same as
for other transactions between the company and its associate or joint venture. That is to say,
the investor’s share in the associate’s or joint venture’s gains or losses resulting from these
transactions is eliminated (IAS 28.28).
An exception to this requirement is where the transaction lacks commercial substance
(IAS 16 Property, Plant, and Equipment). In that case, the entire gain or loss is regarded as
unrealized and is not recognized. This unrealized gain or loss is eliminated against the
investment account using the equity method. IAS 28.30 specifically prohibits presenting a
deferred gain or loss in the company’s consolidated statement of financial position or in the
company’s statement of financial position in which investments are accounted for using the
equity method.
To the extent that the company receives cash in addition to the equity interest, in
exchange for the nonmonetary asset, the company would record a proportion of the gain or
loss based on the portion relating to the cash received.
Nonmonetary contributions are demonstrated further in Illustrative Example 6.14.
Illustrative Example 6.14 Nonmonetary Contributions

Campbell contributed some specialized equipment to receive a 40% interest in a joint
venture, Zippo. The equipment has a fair value of $600,000 and a carrying value of
$400,000. Campbell also received $120,000 in cash from Zippo. The other party to the
joint venture, Yafe, contributed cash of $720,000 for the 60% interest. It is deemed that
the transaction has commercial substance.
Calculations of the equity adjustments:

Cash from other venture $120,000
Fair value of asset contributed 600,000
Percentage of transaction that relates to cash:
120,000/600,000 20%
Gain on exchange
600,000 400,000 200,000
20%
Gain to recognize immediately $ 40,000
Balance of gain to be unrealized $160,000
Share of unrealized gain 40%
$ 64,000
The entry to be made in Campbell’s books:

Cash 120,000
Investment in Zippo 416,000
(600,000 120,000) 64,000
Equipment—Net 400,000
Gain on Sale of Equipment 136,000
(160,000 64,000) 40,000
In the following years, the unrealized gain of $64,000 will be amortized based on
the equipment’s useful life. It should be noted that since Campbell owns only 40% of
the joint venture, the 60% owned by the other party is considered realized.
If the transaction is deemed to lack commercial substance, the entire gain—other
than that sold for cash—is considered to be unrealized. As such, the journal entry would
be as follows:
Cash 120,000
Investment in Zippo 320,000
(600,000 120,000) 160,000
Equipment—Net 400,000
Gain on Sale of Equipment 40,000
Initial Contributions using Proportionate

ASPE Consolidation under ASPE
If the company has chosen to use proportionate consolidation, it follows Section 3055.
This section provides specific guidance where assets are contributed to the joint ven-
ture. In substance, the results are the same as those under the equity method under IAS
28 except that there is not a single investment account or a single account for invest-
ment income. As such, the section states:
3055.27
When a venture transfers assets to a joint venture and receives in exchange an interest in
the joint venture, any gain that occurs shall be recognized in the financial statements of the
venture only to the extent of the interest of the other non-related venturers.
3055.29
Any remaining portion of the gain shall be deferred and amortized to income in a rational
and systematic manner over the life of the contributed assets.
As such, the unrealized profit on the initial transfer will be reflected as a deferred
gain account on the financial statements rather than as part of the investment
account.
Transactions Between Associates or Joint Ventures

Assume that Savon owned 25% of the shares of Coquille as well as 40% of the shares of
Oboe. Where transactions occur between two associates or joint ventures, the proportional
adjustment is 10% (i.e., 25% 40%), which is the product of the ownership interests in the
associate or joint venture.
The case of the sale of inventory between associates or joint ventures is shown in
Illustrative Example 6.15 Sale of Inventory Between

Associates or Joint Ventures
In the current period, Coquille sold inventory to Oboe at an after-tax profit of $100.
The inventory remains unsold at the end of the period.
The unrealized profit on the transaction is $100. The adjustment affects Share of
Net Income or Loss of Associate and the carrying amount of the investment. However,
is it the investment in Coquille or the investment in Oboe? Where transactions are
between associates or joint ventures, the flow of the transaction is of concern. In this
example, the unrealized profit relates to Coquille because it was Coquille that sold the
inventory to Oboe. Therefore, if Coquille recorded $1,000 net income:
Recorded net income $ 1,000
Unrealized profit in inventory (25% 40%) $100 10
990
Company’s share—25% $247.50
The equity accounting adjustment is:
Investment in Associate—Coquille 247.50
Share of Profit or Loss of Associate—Coquille 247.50
(Share of profit of associate or joint venture)
ASPE Intercompany transactions under ASPE

ASPE Section 3051 does not have the same requirements for intercompany transac-
tions as those found in IAS 28. Section 3051.14 states:
The elimination of an unrealized intercompany gain or loss has the same effect on net income
whether the consolidation or equity method is used. However, in consolidated financial state-
ments, the elimination of a gain or loss may affect sales and cost of sales otherwise to be
reported. In the application of the equity method, the gain or loss is eliminated by adjustment
of investment income from the investee or by separate provision in the investor’s financial
statement as is appropriate in the circumstances.
Prior to the requirements of IFRS or ASPE, Canadian companies have interpreted this
section to mean that downstream sales would be eliminated 100% from investment
income whereas upstream sales would be eliminated based on the percentage owned
by the investor. This would result in the same net income effect (parent’s share of con-
solidated net income) as the consolidated financial statements. As such, for Canadian
companies, the net income of the investor that is recording the investment using the
equity method will be the same as that same investor using consolidation to report its
investments. This is not the case under IFRS, as the equity method removes only the
investor’s share whether upstream or downstream. Under IFRS there is a distinction
made between the equity method used for investments in affiliates or joint ventures
versus the equity method used to replace the accounting for a subsidiary that might be
consolidated. This distinction is not made under ASPE.
With the implementation of ASPE, companies may continue to reflect the equity
method in the same manner as the consolidated statements would reflect the parent’s
share of consolidated net income.
✓ LEARNING CHECK
• The company is entitled to a share of realized equity of an associate or joint venture; hence,
adjustments are made for unrealized profits.
• Adjustments to the company’s share of the equity of the associate or joint venture are made
for the effects of both upstream and downstream transactions even though a downstream
transaction does not affect the equity of the associate or joint venture.
• Adjustments are not made to accounts such as sales and cost of sales as would occur under
the consolidation method.
• The decision of whether to record profit on the initial contribution to the affiliate or joint
venture is based on whether the transaction has commercial substance.
LOSSES RECORDED BY THE ASSOCIATE

OR JOINT VENTURE
Objective 6 A company recognizes losses only to the point where the investment’s carrying amount
Account for losses reaches zero. The company discontinues the use of the equity method when the share of
recorded by the losses equals or exceeds the investment’s carrying amount (IAS 38.28).
associate or joint The investment’s carrying amount is not just the balance of the account Investment in
venture.
Associate or Joint Venture. The company’s interest in the associate or joint venture also includes
other long-term interests in the associate or joint venture, such as preferred shares or long-
term receivables or loans. The base against which the losses are offset is then the company’s net
investment in the associate or joint venture. Where the associate or joint venture incurs losses,
the carrying amount of the Investment in Associate or Joint Venture is first reduced to zero. If
losses exceed this carrying amount, they are then applied against the other components of the
company’s interest in the associate or joint venture in the reverse order of their seniority, or pri-
ority in liquidation. The logic is that, if the associate or joint venture is making losses, then the
probability of the other investments in the associate or joint venture being realized is lessened.
After the company’s interest is reduced to zero, additional losses are recorded if the company has
a legal or constructive obligation to make payments on behalf of the associate or joint venture.
Paragraph 39 of IAS 28 states:
If the associate or joint venture subsequently reports profits, the company resumes recogniz-
ing its share of those profits only after its share of the profits equals the share of losses not
recognized.
Once the equity-accounted balance of the investment returns to a positive amount,
equity accounting resumes.
In situations where the associate or joint venture records losses, if there are indications
that the investment may be impaired, the company should apply IFRS 9 Financial Instruments:
Recognition and Measurement.
The accounting for losses by the associate or joint venture is demonstrated in Illustrative
Example 6.16.
Illustrative Example 6.16 Share of Losses of the Associate

or Joint Venture
On January 1, 2009, Farnham acquired 25% of the shares of Grantham for $100,000.
At that date, the equity of Grantham was $400,000, with all identifiable assets and lia-
bilities being measured at amounts equal to fair value. The following table shows the
profits and losses made by the associate or joint venture over the first five years of opera-
tions after January 1, 2009, with their effects on the carrying amount of the investment.
Losses Recorded by the Associate or Joint Venture 313
Equity-accounted
Net income/ Share of net Cumulative balance of
Year loss income/loss share investment
2009 $ 20,000 $ 5,000 $ 5,000 $105,000
2010 (200,000) (50,000) (45,000) 55,000
2011 (250,000) (62,500) (107,500) 0
2012 16,000 4,000 (103,500) 0
2013 20,000 5,000 (98,500) 1,500
The table shows that the investment account is initially recorded by Farnham at
$100,000, and is progressively adjusted for Farnham’s share of the net income and losses
of Grantham. In the 2011 year, when the cumulative share of the losses of the associ-
ate exceeds the cost of the investment, the company discontinues recognizing its share
of future losses. Even though profits are recorded by the associate in 2012, the balance
of the investment stays at zero because the profits are not sufficient to offset losses not
recognized.
If Farnham records its investment in Grantham in its books, it makes the following
entries in each of the years 2009 to 2013.
2009:
Share of Profit of Associate 5,000
2010:
Share of Loss of Associate 50,000
2011:
Share of Loss of Associate 55,000
2012:
No entry
2013:
Share of Profit of Associate 1,500
The adjustments in the consolidated financial statements of Farnham over these

periods are:
December 31, 2009:
December 31, 2010:
Share or profit or loss of associate T 50,000
Investment in associate T 45,000
December 31, 2011:
Share of profit or loss T 55,000
December 31, 2012:
December 31, 2013:
✓ LEARNING CHECK
• The company’s share of losses of an associate or joint venture is recognized but only to the
point where the carrying amount of the investment in the associate or joint venture is zero.
• The share of losses may be offset against other investments the company has in the associate
or joint venture, such as long-term receivables.
• If, after reporting losses, an associate or joint venture earns a profit, the company recognizes a
share of profits only after the share of profits exceeds the share of past losses not recognized.
KEY TERMS
LEARNING SUMMARY
associate (p. 286)
equity method
In 2011, the IASB merged the requirements for the use of the equity method for affiliates
(p. 286)
and joint ventures. IAS 28 and IAS 27 distinguish between application of the equity method
joint control (p. 300)
depending on whether it is applied in a consolidated financial statement or in the financial
joint venture (p. 286)
statements of a company that does not prepare consolidated financial statements because it
separate financial
is not a parent company. In both cases, the principle is that the company should be allocated
statements
its share of the post-acquisition realized equity of the associate or joint venture. In using the
(p. 288)
recorded equity of the associate or joint venture to determine this share, adjustments must be
significant influence
made for fair value elements in recorded equity as well as unrealized profits or losses resulting
(p. 286)
from intercompany transactions. The adjustments are essentially the same as those required
on consolidation of a subsidiary. The primary difference would be in respect to downstream
sales, which are eliminated 100% on a consolidated statement but which are only eliminated
to the extent of the investor’s ownership under the equity method. Having made the appropri-
ate calculations, the resultant adjustments are relatively simple, because the disclosure about
associate or joint ventures in the company’s financial statements affects only a small number
of lines, focusing on the Share of Profit or Loss account on the statement of comprehensive
income and the Investment account on the statement of financial position.
There are several differences in the application of the equity method under ASPE. There
is no equivalent requirement for separate financial statements under ASPE and therefore com-
panies may report their investments using the equity method when presenting special financial
statements. In addition, the equity method mirrors consolidation so that companies may adjust
the investment accounts for 100% of downstream unrealized profits under the equity method.
DEMONSTRATION PROBLEM
Equity Method of Accounting

On January 1, 2012, Omnex paid $2,696,000 for 40% of the shares of Prolift, a company involved
in the manufacture of garden equipment. At that date, the equity of Prolift consisted of:
Share capital—3,000,000 shares $3,000,000
Retained earnings 3,000,000
At January 1, 2012, all the identifiable net assets of Prolift were recorded at fair value
except for the following:
Inventory $1,000,000 $1,200,000
Plant (cost $3,200,000) 2,500,000 3,000,000
The inventory was all sold by December 31, 2012. The plant had a further expected use-
ful life of five years.
1. On January 1, 2013, Omnex held inventory sold to it by Prolift at a profit before income
tax of $200,000. This was all sold by December 31, 2013.
2. In August 2013, Prolift sold inventory to Omnex at a profit before income tax of $600,000.
Half of this was still held by Omnex at December 31, 2013.
3. On December 31, 2013, Prolift held inventory sold to it by Omnex at a profit before
income tax of $200,000. This had been sold to Prolift for $2 million.
4. On January 2, 2012, Prolift sold some equipment to Omnex for $1.5 million, with Prolift
recording a profit before income tax of $400,000. The equipment had a further four-year
life, with benefits expected to occur evenly in these years.
5. In December 2013, Prolift declared a dividend of $1 million. This dividend was paid in
February 2014. Dividend revenue is recognized when the dividend is declared.
7. Each share in Prolift has a fair value at December 31, 2013, of $4.
8. The consolidated financial statements of Omnex and the financial statements of Prolift at
December 31, 2013, not including the equity-accounted figures, are as follows:
Statement of Comprehensive Income

($ thousands)
Omnex Prolift
Revenue $25,000 $18,600
Expenses 19,200 13,600
Net income 3,600 3,900
Other comprehensive income 0 400
Total comprehensive income 3,600 4,300

($ thousands)
Omnex Prolift
Total comprehensive income $3,600 $4,300
Retained earnings as at 1/1/13 5,000 4,000
Net income 3,600 3,900
8,600 7,900
4,500 3,500
Retained earnings as at 31/12/13 4,100 4,400
Cumulative other comprehensive income as at 1/1/13 — 200
Increase in 2013 400
Cumulative other comprehensive income as at 31/12/13 600

($ thousands)
Omnex Prolift
EQUITY AND LIABILITIES
Equity
Share capital $ 8,000 $ 3,000
Cumulative other comprehensive income — 600
Total equity 12,100 8,000
Total equity and liabilities 13,600 11,900
Omnex Prolift
ASSETS
Non-current assets
Investment in Prolift 2,696
8,600 9,000
Current assets
Accounts receivable 1,000 900
5,000 2,900
Total assets 13,600 11,900
Required
Prepare the consolidated financial statements of Omnex at December 31, 2013, applying the
equity method of accounting to the Investment in Prolift.
Solution
The first step is to prepare an acquisition analysis that compares at acquisition date (January
1, 2012) the cost of the investment in Prolift and the share of the net fair value of the identifi-
able assets and liabilities of Prolift. This analysis is the same as the acquisition analysis used in
preparing consolidated financial statements, and results in the determination of any goodwill
or income on acquisition.
At January 1, 2012:
Cost of investment $2,696,000
Net fair value of identifiable assets and liabilities ($3,000,000 $3,000,000) (equity)
$200,000(1 30%) (inventory)
$500,000(1 30%) (plant)
$6,490,000
Fair value acquired by Prolift 40% $6,490,000
$2,596,000
Goodwill $100,000
As a result of the analysis, the effects of the adjustments to assets on hand at acquisition
date can be calculated. In relation to the plant, there is a $500,000 difference between the
fair value and the carrying amount at acquisition date. As a result, the recorded profits of the
associate or joint venture after acquisition date will include amounts that were paid for by
the company at acquisition date. The equity method recognizes a share of post-acquisition
equity only. The plant is being depreciated by the associate or joint venture at 20% p.a.
straight-line. Since the company acquired 40% of the shares of the associate or joint ven-
ture, the after-tax effect of the depreciation each year is calculated as:
Depreciation of plant p.a. 20% $500,000(1 30%)
$70,000
Company’s share 40% $70,000
$28,000
In each of the five years subsequent to the acquisition date, the company’s share of the
recorded net income of the associate or joint venture is then reduced by $28,000 p.a.
In relation to inventory, there is a $200,000 difference between fair value and carry-
ing amount at acquisition date. When the associate or joint venture sells the inventory, it
will record a profit that includes pre-acquisition equity to the company. Since the company
acquired 40% of the shares of the associate or joint venture, the after-tax effect on profit on
sale of the inventory is:
Fair value inventory effect $200,000(1 30%)
$140,000
Company’s share 40% $140,000
$56,000
In the year of sale of the inventory, the company’s share of the recorded profit of the
group is reduced by $56,000.
Consolidated financial statement adjustments—December 31, 2013

The company’s share of the post-acquisition equity of the associate or joint venture to be rec-
ognized on consolidation is calculated in two steps: a share of post-acquisition equity between
the acquisition date and the beginning of the current period, and a share of the current peri-
od’s post-acquisition equity.
(1) Share of changes in post-acquisition equity in previous periods

The calculation is based on post-acquisition movements in the Retained Earnings account,
and adjusted for the effects of intercompany transactions. The consolidated financial state-
ment adjustment for the company’s share of the associate or joint venture’s post-acquisition
equity recognized between the date of acquisition and the beginning of the current period is
calculated as follows:
($thousands) ($thousands)
Retained earnings:
Post-acquisition retained earnings from acquisition
date to beginning of the current period:
$4,000,000 $3,000,000 $1,000
Inventory on hand at 31/12/12: $200,000(1 30%) $(140)
Unrealized profit on sale of equipment:
Original gain $400,000(1 30%) less (210) (350)
depreciation p.a. of ¼ $280,000 650
Company’s share—40% 260
Sale of inventory (56) (84)
Company’s share of retained earnings at 1/1/13 176
Cumulative other comprehensive income:

Share of cumulative other comprehensive income in previous
periods: 40% $200 80
Total increase in equity-accounted carrying amount in previous periods $ 256
The consolidation adjustments in relation to the previous period’s equity is:

Investment in associate or joint venture c 256,000
Cumulative other comprehensive income c 80,000
In relation to these calculations, note the following:
Retained earnings (1/1/13):
• Retained earnings: The change is calculated as the difference between the recorded bal-
ance at acquisition date and the balance at the beginning of the current period.
• Intercompany transactions: Where either the associate or joint venture or the investee has
recognized profits or losses on transactions with the other party, and these are not real-
ized, adjustments are made because the recorded equity of the associate or joint venture
includes these unrealized profits or losses. In this problem, the additional information
details four intercompany transactions, only two of which relate to previous periods,
namely 1 and 4:
1. On January 1, 2012, the associate or joint venture sold inventory to the company at a
profit before tax of $200,000. This was unrealized at December 31, 2012. The recorded
change in equity is then reduced by $140,000 after-tax profit as the profit is not yet
realized.
4. On January 2, 2012, the associate or joint venture recognized an after-tax profit of

$280,000 on the sale of equipment to the company. This profit is realized as the benefits
from the asset are consumed by use. The rate of consumption is measured via depre-
ciation. As the asset has a four-year life, one quarter of the profit is realized each year.
Hence, the unrealized portion at December 31, 2012, is the original after-tax profit of
$280,000 less one quarter of $280,000, namely $210,000.
The change in realized equity in previous periods is then $650,000. The company’s share
(40%) is $260,000.
However, this is not all post-acquisition equity. The company recognized the fair value of
the assets and liabilities of the associate or joint venture at acquisition date, and not the carry-
ing amount in the associate or joint venture. Where there are movements in these assets and
liabilities, some of the profits recognized by the associate or joint venture are pre-acquisition
and not post-acquisition. There were two assets at acquisition date for which the fair value
differed from carrying amount:
• Plant: The fair value was $500,000 greater than the carrying amount. As calculated in the
acquisition analysis, since the asset has a five-year life, in relation to the company’s share
the pre-acquisition amount included in recorded equity of the associate or joint venture
is $28,000 p.a.
• Inventory: The fair value was $200,000 greater than the carrying amount. As calculated in
the acquisition analysis, since the asset was sold after the acquisition date, in relation to
the company’s share the pre-acquisition effect is $56,000.
Hence, the company’s share of changes in retained earnings between acquisition date
and the beginning of the current period is $176,000.
Cumulative other comprehensive income:
There was no cumulative other comprehensive income recognized in the associate or joint
venture at acquisition date. Per the statement of comprehensive income, the balance at
December 31, 2012, was $200,000. Hence, the change over the period is $200,000. The com-
pany’s share of this is 40%, namely $80,000.
Investment in associate or joint venture—Prolift:
The company’s total share of post-acquisition equity of the associate or joint venture up to
the beginning of the current period is, therefore, $256,000. This amount is then added to the
investment in associate or joint venture account.
(2) Share of profit in current period
In part (1), the company’s share of previous period’s post-acquisition equity was calculated.
In this part, the calculation is of the company’s share of the post-acquisition equity of the
associate or joint venture relating to the current period. In this problem, increases in equity
arise owing to the associate or joint venture’s earning a profit and recording other income as
increments in the asset revaluation reserve.
The calculations and required consolidation adjustment is shown below.
($thousands) ($thousands)
Recorded profit: $3,900
Realized profit in opening inventory $ 140

Unrealized profit in Omnex’s ending inventory: ½ $600,000(1 30%) (210)
Unrealized profit in Prolift’s ending inventory: $200,000(1 30%) (140)
Realized profit on plant: ¼ $280,000 70 (140)
3,760
Company’s share of profit of associate or joint venture 1,476
Other income:
Share of increment in cumulative other comprehensive income: 40% $400,000 160
Total increase in equity-accounted carrying amount in current period $1,636
The consolidated financial statement adjustment is:
Investment in associate—Prolift Inc. c 1,636,000

Share of profit or loss of associate c 1,476,000
Asset revaluation reserve c 160,000
In relation to these calculations and adjustment, note the following:
• Share of profit or loss of associate or joint venture: The associate or joint venture records net
income for the year of $3.9 million. This net income needs to be adjusted where there
have been transactions between the company and the associate or joint venture. At the
end of the reporting period, profits/losses on these transactions are unrealized.
In this problem there are four transactions noted in the additional information that affect
the current period, namely 1–4.
1. The inventory on hand at January 1, 2013, is all sold by December 31, 2013. The profit on the
intercompany sale was unrealized at the beginning of the current period but is realized in the
current period. The after-tax profit on sale of the inventory was $140,000. Since the profit is
realized in the current period, it is added to the recorded profit of the associate or joint ven-
ture. Note that $140,000 is subtracted in the calculation of the company’s share of previous
period equity and is added to the calculation of the company’s share of current period profit.
Since the profit is now realized, there is no need to make an adjustment in future periods.
2. In August 2013, the associate or joint venture sold inventory to the company at an after-
tax profit of $420,000. Since half of the inventory is still on hand at December 31, 2013,
there is unrealized profit at the end of the reporting period of $210,000. This amount is
subtracted from recorded profit because the company’s share relates to realized profit only.
3. In the current period, the company sold inventory to the associate or joint venture for
an after-tax profit of $140,000. Since this inventory remains on hand at the end of the
reporting period, the unrealized profit is subtracted from recorded profit.
4. The gain on sale of equipment was adjusted for in the calculation of the company’s share of
previous period equity. As noted in that calculation, the unrealized profit on sale is realized
as the asset is used up and depreciated. The amount realized each year is in proportion to
depreciation, namely one quarter p.a. The amount of the gain realized in the current period
is then ¼ $280,000; i.e., $70,000. Being realized profit, it is added back to recorded profit.
The total realized profit of the associate or joint venture is then $3,760,000, and the
company’s share (40%) is $1,504,000.
However, this profit is not all post-acquisition profit. Movements in assets and liabilities
on hand at acquisition date when fair values differed from carrying amounts give rise to pre-
acquisition elements in recorded profits. In the current period, because the plant on hand at
acquisition date was recognized by the company at fair value, the extra depreciation on the
plant reflects pre-acquisition equity. As calculated in the acquisition analysis, the fair value
effect is $28,000 p.a. This is subtracted from the company’s share of realized profit to give the
company’s share of realized post-acquisition profit.
• Cumulative other comprehensive income: From the statement of changes in equity, note that
the cumulative other comprehensive income has increased by $400,000 in the current
period. The company is entitled to 40% of this; i.e., $160,000.
The company’s share of current period post-acquisition equity is then $1,636,000, which
increases the company’s investment in the associate or joint venture. For the profit portion, this
is recognized by a separate line item in the consolidated statement of comprehensive income.
(3) Dividends paid and provided for by associate or joint venture

A further adjustment is necessary to take into account reductions in the associate or joint
venture’s equity in the current period because of dividends. In the current period, Prolift paid
a $2.5-million dividend and declared a $1-million dividend. Assuming the company recog-
nizes dividend revenue in relation to the declared dividend, it would recognize dividend of
$1.4 million (i.e., 40% [$2.5 million $1 million]). The following adjustment eliminates,
on consolidation, the dividend revenue recorded by the company. This is because in parts
(1) and (2), the company’s equity has been increased by its share of the equity of the associate
or joint venture from which the dividends were paid or declared. Similarly, it is also neces-
sary to reduce the investment in the associate or joint venture as the share of equity in the
associate or joint venture as calculated in parts (1) and (2) has been reduced by the payment or
declaration of the dividend. The consolidated financial statement adjustment is:
Dividend revenue T 1,400,000
Investment in associate T 1,400,000
(40% [$2,500,000 $1,000,000])
Total investment
On the basis of these financial statement adjustments, the carrying amount of the investment
in the associate or joint venture, Prolift, is:
$3,188,000 $2,696,000 $256,000 $1,636,000 $1,400,000
And the share of profit or loss of the associate or joint venture is: $1,476,000.
The consolidated financial statements of Omnex at December 31, 2013, including the
investment in the associate or joint venture accounted for under IAS 28, are as follows:
OMNEX
for year ended December 31, 2013
($ thousands)
Revenue [$25,000,000 $1,400,000] $23,600

Expenses 19,200
4,400
Share of profit or loss of associate or joint venture accounted for
using the equity method 1,476
Net income 3,676
Other comprehensive income:
Share of other comprehensive income of associate or joint venture
accounted for using the equity method 160
Total comprehensive income $ 3,836
OMNEX
for year ended December 31, 2010
($ thousands)

Retained earnings at 1/1/13 [$5,000,000 $176,000] 5,176
Net income 3,676
8,852
Dividend paid (3,000)
Dividend provided (1,500)
Retained earnings at 31/12/13 4,352
Cumulative other comprehensive income at 1/1/13 80
Revaluation increments 160
Cumulative other comprehensive income at 31/12/13 240
Exercises 321
OMNEX
($ thousands)
EQUITY AND LIABILITIES

Equity
Total equity 12,592
ASSETS
Non-current assets
Property, plant, and equipment $ 5,904
Investment in associate and joint venture 3,188
9,092
Current assets
Inventories 4,000
5,000
Brief Exercises
(LO 5) BE6-1 Outline the accounting adjustments required in relation to transactions between the company and an associate
or joint venture. Explain the rationale for these adjustments.
(LO 5) BE6-2 Compare the accounting for the effects of intercompany transactions for transactions between parent entities
and subsidiaries and between companies and associates or joint ventures.
(LO 1) BE6-3 Discuss whether the equity method should be viewed as a form of consolidation or a valuation technique.
(LO 1, 2) BE6-4 Why is the equity method of accounting sometimes referred to as “one-line consolidation?”
(LO 1) BE6-5 What are the differences between applying the equity method of accounting in the records of the company
and applying it in the consolidated financial statement of the company?
(LO 3) BE6-6 Explain the treatment of dividends from the associate or joint venture under the equity method of accounting.
(LO 4) BE6-7 What is the effect of an investment increasing from 20% to 40% where there was significant influence upon
the purchase of 20%?
(LO 3) BE6-8 What is the effect when a company that uses FIFO inventory costing acquires an affiliate that uses average
costing for the same type of inventory?
(LO 5) BE6-9 How would an investor account for the transfer of a piece of equipment in exchange for a 30% interest in a
joint venture?
(LO 6) BE6-10 Explain the reporting implication of losing significant influence over an affiliate due to a conflict with the
other shareholders.
Exercises
(LO 1) E6-1 Baldwin acquired a 30% interest in a joint venture, Celdron, for $50,000 on January 1, 2011. The equity of
Celdron at the acquisition date was:
$150,000
All the identifiable assets and liabilities of Celdron were recorded at fair value. Net income and dividends for the
years ended December 31, 2011 to 2013 were as follows:
Income before tax Income tax expense Dividends paid

2011 $80,000 $30,000 $80,000
2012 70,000 25,000 15,000
2013 60,000 20,000 10,000
Required
(a) Prepare journal adjustments in the books of Baldwin for each of the years ended December 31, 2011, to 2013, in
relation to its investment in the joint venture, Celdron. (Assume Baldwin does not prepare consolidated financial
statements.)
(b) Prepare the consolidated financial statement adjustments to account for Baldwin’s interest in the joint venture,
Celdron. (Assume Baldwin does prepare consolidated financial statements.)
(LO 1, 3) E6-2 Harwood acquired a 40% interest in Lexor for $170,000 on January 1, 2013. The share capital, cumulative
other comprehensive income, and retained earnings of Lexor at the acquisition date and at December 31, 2013, were as
follows:
January 1, 2013 December 31, 2013

Share capital $300,000 $300,000
Cumulative other comprehensive income — 100,000
$400,000 $524,000
At January 1, 2013, all the identifiable assets and liabilities of Lexor were recorded at fair value. The following is
applicable to Lexor for the year to December 31, 2013:
1. Net income (after income tax expense of $11,000): $39,000
2. Increase in cumulative other comprehensive income
• Asset revaluation (revaluation of land and buildings at December 31, 2013): $100,000
3. Dividends paid to shareholders: $15,000.
Additionally, depreciation is provided by Lexor on the diminishing-balance method, whereas Harwood uses the
straight-line method. Had Lexor used the straight-line method, the accumulated depreciation on non-current assets
would be increased by $20,000 (in 2012—$10,000 increase in accumulated depreciation). The tax rate is 40%.
Harwood does not prepare consolidated financial statements.
Required
(a) Prepare the journal adjustments in the books of Harwood for the year ended December 31, 2013, in relation to its
investment in the associate, Lexor.
(b) Calculate the share of profit or loss in Lexor for the year ended December 31, 2013.
(LO 2, E6-3 Ludowicz acquired 20% of the common shares of Sitar on January 1, 2012 for $22,000. At this date, all the
3, 5) identifiable assets and liabilities of Ludowicz were recorded at fair value. An analysis of the acquisition showed that
$2,000 of goodwill was acquired.
Ludowicz has no subsidiaries, and records its investment in the associate, Sitar, in accordance with IAS 28. During
2012, Sitar reported net income of $120,000. In 2013, Sitar recorded a profit of $100,000, paid an interim dividend
of $10,000, and in December 2013, declared a further dividend of $15,000. In December 2012, Sitar had declared a
$20,000 dividend, which was paid in February 2013, at which date it was recognized by Ludowicz.
The following transactions have occurred between the two entities (all transactions are independent unless
specified):
1. In June 2013, Sitar sold inventory to Ludowicz for $15,000. This inventory had previously cost Sitar $10,000, and
remains unsold by Ludowicz at the end of the period.
2. In July 2013, Ludowicz sold inventory to Sitar at a before-tax profit of $5,000. Half of this was sold by Sitar before
December 31, 2013.
3. In December 2012, Sitar sold inventory to Ludowicz for $18,000. This inventory had cost Sitar $12,000. At
December 31, 2012, this inventory remained unsold by Ludowicz. However, it was all sold by Ludowicz before
December 31, 2013.
Exercises 323
Required
(a) Calculate the balance in the Investment in Sitar account on the statement of financial position at December 31,
2013, under IAS 28.
(b) Calculate the balance in the Investment in Sitar account on the statement of financial position at December 31,
2013, under ASPE.
(LO 3, 5) E6-4 Peyton owns 25% of the shares of its associate, Merk. At the acquisition date, there were no differences between
the fair values and the carrying amounts of the identifiable assets and liabilities of Merk. Peyton paid $40,000 for the
investment.
For 2013, Merk recorded net income of $100,000. During this period, Merk paid a $10,000 dividend, declared in
December 2013, and an interim dividend of $8,000. The tax rate is 30%.
The following transactions have occurred between Peyton and Merk:
1. On January 1, 2012, Merk sold a non-current asset costing $10,000 to Peyton for $12,000. Peyton applies
a 10% p.a. on cost using the straight-line method of depreciation.
2. On June 30, 2013, Merk sold an item of plant to Peyton for $15,000. The asset’s carrying amount to Merk at time
of sale was $12,000. Peyton applies a 15% p.a. on cost using the straight-line method of depreciation.
3. Inventory that cost $20,000 was sold by Merk to Peyton for $28,000 on December 1, 2013. Peyton still had the
inventory on hand at December 31, 2013.
4. On January 1, 2012, Peyton sold an item of machinery to Merk for $6,000. This item had a carrying value to
Peyton of $4,000. Peyton depreciates straight line over 10 years.
5. The Balance in the Investment account under the equity method at Janaury 1, 2013 was $70,000.
Required
(a) Peyton applies IAS 28 in accounting for its investment in Merk. Assuming Peyton does not prepare consolidated
financial statements, prepare the journal entries in the records of Peyton for the year ended December 31, 2013, in
relation to its investment in Merk.
(b) Calculate the balance in the Investment in Merk on the statement of financial position at December 31, 2013.
(LO 1, E6-5 On January 1, 2011, Violet purchased 30% of the shares of Demster for $60,050. At this date, the account bal-
2, 3) ances of Demster were:
Share capital $150,000 Assets $225,000
Cumulative other comprehensive income 30,000 Less: Liabilities 30,000
Retained earnings 15,000 —
$195,000 $195,000
At January 1, 2011, all the identifiable assets and liabilities of Demster were recorded at fair value except for plant,
whose fair value was $5,000 greater than carrying amount. This plant has an expected future life of five years, the benefits
being received evenly over this period. Dividend revenue is recognized when dividends are declared. The tax rate is 30%.
The results of Demster for the next three years were:
December 31, 2011 December 31, 2012 December 31, 2013
Profit/loss before income tax $50,000 $40,000 $(5,000)
Income tax expense 20,000 20,000 —
Profit/loss 30,000 20,000 (5,000)
Dividend declared 15,000 5,000 2,000
Dividend declared and paid 10,000 5,000 1,000
Required
(a) Calculate the share of profit or loss from Demster for each of the years ending December 31, 2011, 2012, and 2013.
(b) Calculate the balance in the Investment in Demster account for each of the years ending December 31, 2011, 2012,
and 2013.
(LO 6) E6-6 JEM acquired an interest of 25% in RET on January 1, 2010, for $50,000. At that date, JEM considered RET
to be an associate. At the start of 2013, RET had no net assets. However, during the year RET incurred a loss of
$75,000 resulting in liabilities at the end of the year of $75,000. JEM funded this loss as a long-term loan and therefore
the net liabilities of RET reflect a loan from JEM of $75,000.
Required
Assuming that JEM is also a parent company and would be preparing consolidated financial statements, calculate the
share of profit or loss of RET that would appear on the consolidated comprehensive income statement and the balances
in the loan to affiliate and the investment in affiliate accounts on the consolidated statement of financial position.
(LO 4) E6-7 Acme acquired a 10% interest in Becon for $1,000 on January 1, 2012. The investment in Becon is accounted
for as fair value through profit or loss. Becon recognized an increase in fair value of $600 at the year ended December
31, 2012. On January 1, 2013, Acme acquired an additional 25% interest in Becon for $4,000 and achieved significant
influence. The fair value of Becon’s net assets was $5,000 at January 1, 2012, and increased to $8,000 at January 1, 2013.
Becon recorded net income of $2,000 between January 1, 2012, and January 1, 2013.
Required
(a) Calculate the balance in the Investment in Associate account using the equity method at January 1, 2013.
(b) Calculate the amount of goodwill in the Investment in Associate account.
(LO 5) E6-8 Several years ago, Revnon acquired a 30% interest in Aumet at book value. During 2012 and 2013, intercom-
pany sales of merchandise amounted to $120,000 and $180,000. On December 31, 2012, and December 31, 2013, one
third of each year’s intercompany sales remained in that year’s ending inventory. Intercompany sales were made at the
same rate of gross margin as sales to non-affiliates. January 1, 2012, inventories contained no unrealized intercompany
profits.
The following data are taken from the financial statements of the two companies for 2012 and 2013:
Revnon Aumet
2012 2013 2012 2013
Sales $1,500,000 $2,200,000 $900,000 $1,200,000
Cost of sales 1,000,000 1,540,000 540,000 780,000
Expenses 300,000 360,000 160,000 170,000
The tax rate for both companies is 40%.
Required
Calculate Revnon’s share of profit or loss of Aumet for 2012 and 2013 assuming:
(a) the intercompany sales were upstream.
(b) the intercompany sales were downstream.
Provide your analysis based on IAS 28 and ASPE.
(LO 1, E6-9 On January 1, 2011, Rexol acquired 35% of the shares of Birch for $65,158. At this date, the equity of Birch
2, 6) consisted of:
At this date, the identifiable assets and liabilities of Birch were recorded at fair value. At December 31, 2013, the
goodwill was written down by $3,000 as the result of an impairment test.
During the three years since acquisition, Birch has recorded the following annual results:
Year ended Profit(Loss)
December 31, 2011 $ 5,000
December 31, 2012 (27,000)
December 31, 2013 (12,000)
There have been no dividends paid or declared by Birch since the acquisition date.
Required
(a) Calculate the share of profit or loss in Birch for each of the years 2011 to 2013.
(b) Calculate the balance in the Investment in Birch account as at December 31, 2013.
(LO 3) E6-10 Taft and Luxor decided to incorporate a joint venture on January 1, 2013. On that date, Taft contributed a piece
of equipment that had a carrying value of $350,000 and a fair value of $700,000 for a 60% ownership in the joint venture.
Luxor contributed $400,000 in cash for a 40% interest. Taft received $100,000 cash from the joint venture. The equip-
ment has a four-year remaining life and is depreciated straight line. During 2013, the joint venture had net income of
$30,000. Taft does not prepare consolidated financial statements. The sale is deemed to lack commercial substance.
Required
In preparing Taft’s financial statements:
(a) Calculate the balance in the Investment in Joint Venture account as at December 31, 2013.
(b) Calculate the share of profit or loss in joint venture for 2013.
Problems 325
(c) Calculate the amount of any gain or loss to be recorded by Taft in 2013.
(d) What would change in the calculations if the sale was deemed to have commercial substance?
Problems
(LO 1, 2, P6-1 On January 1, 2011, Vairvais acquired 30% of the shares of Clarys for $60,000. At this date, the equity of Clarys
3, 4, 5) consisted of:

At this date, all the identifiable assets and liabilities of Clarys were recorded at fair value.
The fair value of the investment at December 31, 2011 was $62,000 and at December 31, 2012 it was $66,000.
On January 1, 2013, the ownership interest of 30%, together with board representation and a diverse spread of
remaining shareholders, was sufficient for the company to demonstrate significant influence, and accordingly to begin
accounting for the investment as an associate. At this date, the equity of Clarys consisted of:


Machinery $20,000 $25,000
Inventory 10,000 12,000
The machinery was expected to have a further five-year life, benefits being received evenly over this period. The
inventory was all sold by December 31, 2013.
Dividends declared and paid by Clarys in 2011 were $10,000, and $12,000 was paid in 2012. In December 2012,
Clarys declared a dividend of $10,000. Dividend revenue is recognized when dividends are declared.
During the period ending December 31, 2013, the following events occurred:
1. Clarys sold to Vairvais some inventory, which had previously cost Clarys $8,000, for $10,000. Vairvais still had one
quarter of these items on hand at December 31, 2013.
2. On July 1, 2013, Vairvais sold a non-current asset to Clarys for $50,000, giving a profit before tax of $10,000 to
Vairvais. Clarys applied a 12% p.a. on cost straight-line depreciation method to this asset.
3. On June 30, 2013, Clarys paid an interim dividend of $5,000.
4. At December 31, 2013, Clarys calculated that it had earned net income of $32,000, after an income tax expense of
$8,000. Clarys then declared a $5,000 dividend, to be paid in March 2014.
Required
(a) Calculate the share of profit or loss from Clarys for the year ended December 31, 2013.
(b) Calculate the balance in the Investment in Clarys account at December 31, 2013.
(LO 1, P6-2 On January 1, 2012, Bélanger acquired a 30% interest in one of its suppliers, Chime, at a cost of $13,650. The
2, 3) directors of Bélanger believe they exert significant influence over Chime.
The equity of Chime at acquisition date was:

$30,000
All the identifiable assets and liabilities of Chime at January 1, 2012, were recorded at fair values except for some
depreciable non-current assets with a fair value of $15,000 greater than carrying amount. These depreciable assets are
expected to have a further five-year life.
1. At December 31, 2013, Bélanger had inventory costing $100,000 on hand (2012 inventory on hand
costing—$60,000) that had been purchased from Chime. A profit before tax of $30,000 (2012—$10,000) had been
made on the sale.
2. Assume a tax rate of 30% applies.
3. Information about income and changes in equity of Chime as at December 31, 2013, is:
Income before tax $360,000

Profit 180,000
Retained earnings at 1/1/13 50,000
Dividend paid $50,000
Retained earnings at 31/12/13 $130,000
4. Dividend revenue is recognized when declared by directors.

5. The equity of Chime at December 31, 2013, was:
$180,000
The cumulative other comprehensive income arose from a revaluation of land made at December 31, 2013.
Required
(a) Assume Bélanger does not prepare consolidated financial statements. Prepare the journal entries in the books of
Bélanger for the year ended December 31, 2013, in relation to the investment in Chime.
(b) Assume Bélanger does prepare consolidated financial statements. Calculate the share of profit or loss from Chime
on the consolidated comprehensive income statement for the year ending December 31, 2013, and the balance in
the Investment account on the consolidated statement of financial position.
(LO 1, P6-3 On January 1, 2010, Ejez acquired 40% of the shares of Campbell for $65,880. At this date, the statement of
2, 5) financial position of Campbell consisted of:
Share capital—100,000 shares $100,000 Cash $ 5,000
Inventories 20,000
Retained earnings 60,000 Plant (cost $100,000) 80,000
Liabilities 60,000 Equipment (cost $80,000) 50,000
Land 60,000
$220,000 $220,000
In relation to the assets of Campbell, the fair values at January 1, 2010, were:
Cash $ 5,000
Inventories 25,000
Plant 86,000
Equipment 51,000
Land 80,000
The inventories were all sold and the accounts receivable all collected by December 31, 2010. The plant and equip-
ment each have an expected useful life of five years. The plant was sold on December 31, 2013. The tax rate is 30%.
1. At January 1, 2013, the retained earnings of Campbell were $80,000.
2. During 2013, Campbell recorded net income of $18,000.
3. In December 2012, a dividend of $8,000 was declared by Campbell, and was paid in March 2013. An interim divi-
dend of $5,000 was paid in July 2013, and a final dividend of $4,000 declared in December 2013.
Problems 327
Required
(a) Calculate the share of profit or loss of Campbell that Ejez would reflect on its consolidated statement of compre-
hensive income for the year ending December 31, 2013.
(b) Calculate the balance in the Investment in Campbell account on the consolidated statement of financial position of
Ejez as at December 31, 2013.
(LO 1, P6-4 On January 1, 2011, Cynna purchased 40% of the shares of Eckers for $63,200. At that date, equity of Eckers
3, 5) consisted of:
At January 1, 2011, the identifiable assets and liabilities of Eckers were recorded at fair value. Information about
income and changes in equity for both companies for the year ended December 31, 2013, was as shown:
Cynna Eckers
Income before tax $26,000 $23,500
Net income 15,400 18,100
33,400 34,100
15,000 9,000
1. Cynna recognized dividend revenue from Eckers before receipt of cash. Eckers declared a $5,000 dividend in
December 2013, this being paid in February 2014.
2. On June 30, 2011, Eckers sold Cynna a motor vehicle for $12,000. The vehicle had originally cost Eckers $18,000
and was written down to $9,000 for both tax and accounting purposes at time of sale to Cynna. Both companies
depreciated motor vehicles straight line over five years.
3. The beginning inventory of Eckers included goods at $4,000 bought from Cynna; their cost to Cynna was $3,200.
4. The ending inventory of Cynna included goods purchased from Eckers at a profit before tax of $1,600.
Required
(a) Prepare the journal adjustments in the books of Cynna to account for the investment in Eckers in accordance
with IAS 28 for the year ended December 31, 2013, assuming Cynna does not prepare consolidated financial
statements.
(b) Calculate the balance in the investment in Eckers at December 31, 2013, under IAS 28.
(c) Calculate the balance in the investment in Eckers at December 31, 2013, under ASPE.
(LO 1, 2, P6-5 Ridgemont acquired 90% of the common shares of Gourmand on January 1, 2009, at a cost of $150,750. At
3, 5) that date the equity of Gourmand was:

At January 1, 2009, all the identifiable assets and liabilities of Gourmand were at fair value except for the following
assets:
Inventory $10,000 $15,000
Depreciable assets 25,000 35,000
The inventory was all sold by December 31, 2009. Depreciable assets have an expected further five-year life, with
depreciation being calculated on a straight-line basis.
Ridgemont uses the partial goodwill method.
On January 1, 2012, Gourmand acquired 25% of the capital of Primo for $3,500. All the identifiable assets and
liabilities of Primo were recorded at fair value except for the following:

Inventory $1,000 $1,500
Depreciable assets 6,000 7,000
All this inventory was sold in the 12 months after January 1, 2012. The depreciable assets were considered to have
a further five-year life.
Information on Primo’s equity position is as follows:
January 1, 2012 December 31, 2013

Share capital $10,000 $10,000
For the year ended December 31, 2013, Primo recorded a profit before tax of $2,600 and an income tax expense of
$600. Primo paid a dividend of $200 in June 2013. Ridgemont regards Primo as a joint venture.
During the year ended December 31, 2013, Primo sold inventory to Gourmand for $6,000. The cost of this inven-
tory to Primo was $4,000. Gourmand has resold only 20% of these items. However, Gourmand made a profit before tax
of $500 on the resale of these items.
On June 30, 2012, Gourmand sold Primo a motor vehicle for $4,000, at a profit before tax of $800 to Gourmand.
Both companies treat motor vehicles as non-current assets. Both companies charge depreciation at 20% p.a. on cost
straight line. Assume a tax rate of 30%.
Information about income and changes in equity for Ridgemont and its subsidiary, Gourmand, for the year ended
December 31, 2013, is as follows:
Ridgemont Gourmand
Sales revenue $200,000 $60,000
Less: Cost of sales 110,000 30,000
Less: Depreciation 16,000 4,000
38,000 7,000
52,000 23,000
Plus: Other revenue 30,000 5,000
Less: Income tax expense 20,000 10,000
Net income 62,000 18,000
Plus: Retained earnings (1/1/13) 120,000 80,000
182,000 98,000
Less: Dividend paid 20,000 4,000
$162,000 $94,000
Required
(a) Prepare the consolidated statement of comprehensive income and statement of changes in equity of Ridgemont
and its subsidiary Gourmand as at December 31, 2013. Ridgemont’s share capital is $100,000.
(b) In the consolidated statement of financial position, what would be the balance of the investment in Primo as at
December 31, 2013?
(LO 1, 2, P6-6 On January 1, 2010, Lakemead acquired 45% of the issued shares of Dakota for $75,450. At that date, Lakemead
3, 4) considers that it has significant influence. At this date, the records of Dakota included the following balances:

All the identifiable assets and liabilities of Dakota were recorded at fair value except for the following:
Plant (cost $50,000) $35,000 $41,000
Land 50,000 70,000
Inventory 20,000 24,000
Problems 329
The plant has a further three-year life. All the inventory was sold by December 31, 2010.
During the four years since acquisition, Dakota has recorded the following annual results:
Year ended Net income (loss)

December 31, 2010 $10,000
December 31, 2011 23,000
December 31, 2012 (6,000)
December 31, 2013 22,000
1. There have been no dividends paid or declared by Dakota since the acquisition date.
2. The land owned by Dakota on January 1, 2010, was sold on September 1, 2011, for $75,000.
4. On January 1, 2014, Lakemead paid $50,000, on the open market, to acquire an additional 10% of Dakota.
Required
(a) Calculate the balance in the Investment in Dakota account at December 31, 2013.
(b) Calculate the balance in the Investment in Dakota account at January 1, 2014.
(c) What would be the impact on the financial statement presentation for Lakemead in 2014?
(LO 1, 2, P6-7 You are given the following details for the year ended December 31, 2013:
3, 5)
Grantham Co. Lopez Inc. Ceylon Ltd.
Income before tax $100,000 $30,000 $25,000
Income tax expense 31,000 10,000 6,000
Net income 69,000 20,000 19,000
Retained earnings at January 1, 2013 20,000 12,000 11,000
89,000 32,000 30,000
Dividend paid 14,000 6,000 2,000
Dividend declared 15,000 4,000 8,000
29,000 10,000 10,000
Retained earnings at December 31, 2013 $ 60,000 $22,000 $20,000
1. Grantham owns 80% of the common shares in Lopez and 20% of the common shares in Ceylon (enough to cause
Grantham to have significant influence over Ceylon).
2. On January 1, 2012, all identifiable assets and liabilities of Lopez were recorded at fair value. Lopez’s retained
earnings at that date were $10,000 and the capital stock was $5,000. Grantham purchased 80% of Lopez’s shares
on January 1, 2012, and paid $5,000 for goodwill, none of which had been recorded on Lopez’s records. Grantham
uses the partial goodwill method.
3. At the date Grantham acquired its shares in Ceylon, Ceylon’s recorded equity was:
All the identifiable assets and liabilities of Ceylon were recorded at fair value.
Grantham paid $25,000 for its shares in Ceylon on January 1, 2012.
4. Included in the beginning inventory of Grantham were income before tax made by Lopez: $5,000; and Ceylon:
$3,000.
5. Included in the ending inventory of Lopez were profits before tax made by Ceylon: $4,000.
6. Ceylon had recorded a profit (net of $500 tax) of $2,000 in selling certain non-current assets to Grantham on July
1, 2013. Grantham treats the items as non-current assets and charges depreciation straight line over four years
from that date.
7. Grantham purchased for $10,000 an item of plant from Lopez on March 1, 2012. The asset’s carrying amount at
that date was $7,000. The asset was depreciated at the rate of 20% p.a. straightline from March 1, 2012.
8. Dividend revenue is recognized when dividends are declared.
Required
(a) Calculate the share of profit or loss in Ceylon on the consolidated financial statements for the year ended December
31, 2013.
(b) Calculate the balance in the Investment in Ceylon account on the statement of financial position as at December
31, 2013.
(c) Calculate the consolidated retained earnings as at December 31, 2013.
(LO 1, 2, P6-8 On January 1, 2011, Stone acquired 30% of the shares of Lake for $75,750. At this date, the equity of Lake
3, 4, 6) consisted of:
The carrying amounts and fair values of the assets of Lake were as follows:
Carrying value Fair value
Land $70,000 $90,000
Plant (cost $100,000) 80,000 85,000
Equipment (cost $40,000) 20,000 20,000
Both plant and equipment were expected to have a further five-year life, with benefits being received evenly over
those periods. The plant was sold on July 1, 2013. At January 1, 2011, Lake had not recorded an internally generated
trademark that Stone considered to have a fair value of $50,000. This intangible asset was considered to have an indefi-
nite useful life.
1. The following profits were recorded by Lake:
For the 2011 period $20,000
For the 2013 period (30,000)
2. Other dividends declared or paid since January 1, 2011, are:
• $5,000 dividend paid in June 2013
• $8,000 dividend declared in December 2013, expected to be paid in February 2014.
3. On January 1, 2012, Stone acquired an additional 5% of shares in Lake for $17,000. The fair values of the identifi-
able net assets have remained the same as those originally established in 2011 less any amortization.
4. Both companies pay tax at the rate of 30%.
Required
(a) Prepare the Investment in Lake account under the equity method at December 31, 2013.
(b) Calculate the share of profit or loss in Lake under the equity method for each of the years 2011, 2012, and 2013.
(LO 1, P6-9 Parent has one subsidiary, Subsidiary; one associate, Associate; and one joint venture, Joint Venture. Subsidiary
2, 5) has one associate, Subassociate.
Subsidiary Subassociate Associate Joint Venture
Share capital Common:
Held by group $1,200 $ 250 $200 $ 250
Held by other interests 800 750 600 750
$2,000 $1,000 $800 $1,000
Information about the companies for the year ended December 31, 2013, is as follows:
Parent Subsidiary Subassociate Associate Joint Venture
Profit (loss) $ 200 $1,000 $600 $2,400 $1,200
Dividend revenue 600 400 100 — —
Income before tax 800 1,400 700 2,400 1,200
Income tax expense 100 500 300 1,200 600
Net income 700 900 400 1,200 600
Dividend paid 500 500 200 1,000 200
200 400 200 200 400
Retained earnings (1/1/13) 6,800 3,600 430 2,000 1,210
Retained earnings (31/12/13) 7,000 4,000 630 2,200 1,610
Problems 331
Parent Subsidiary Subassociate Associate Joint Venture

Investments 4,008 3,000 800 — —
Other non-current assets (net) 6,000 3,000 400 $2,000 $2,400
Current assets 1,992 2,000 800 1,600 1,000
Total assets $12,000 $8,000 $2,000 $3,600 $3,400
Share capital $ 1,000 $2,000 $1,000 $ 800 $1,000
Cumulative other 1,000 — — — —
comprehensive income
Retained earnings 7,000 4,000 630 2,200 1,610
Total equity 9,000 6,000 1,630 3,000 2,610
Liabilities 3,000 2,000 370 600 790
Total equity and liabilities $12,000 $8,000 $2,000 $3,600 $3,400
1. Subsidiary: Parent acquired a 60% interest on December 31, 2005, for $3,000. Shareholders’ equity at December
31, 2005, was:
$4,000
At the acquisition date, Subsidiary had not recorded any goodwill. All the identifiable assets and liabilities of
Subsidiary were recorded at fair value except the following:
Inventory $ 500 $ 600
Non-current assets (net) 1,200 1,500
By December 31, 2005, all the inventory had been sold by Subsidiary. The non-current assets had a further
expected life of 10 years, with benefits from use being received evenly over these years. The partial goodwill method
is used.
2. Subassociate: Subsidiary acquired, on January 1, 2012, 25% of the share capital for $400. Equity at December 31,
2011, was:
Retained earnings 230
At December 31, 2011, Subassociate had not recorded any goodwill. All the identifiable assets and liabilities
were recorded at fair value except for the following:
Inventory $500 $600
Non-current assets (net) 200 400
By December 31, 2013, half the inventory had been sold to external parties. The non-current assets have an
unlimited life.
3. Parent: Included in current assets of Parent at December 31, 2013, is inventory that was purchased from Subsidiary
for $900. Subsidiary sells its goods at cost plus 50% markup.
4. Parent: Included in current assets of Parent at December 31, 2012, was inventory that was purchased from
Subsidiary for $600.
5. Subsidiary: Included in the non-current assets of Subsidiary at December 31, 2013, is an item of plant that was sold
to Subsidiary by Subassociate on January 1, 2013, for $1,200. At the date of sale, this asset had a carrying amount to
Subassociate of $1,000. It had an expected future useful life of five years, with benefits being received evenly over
these years.
6. Associate: Parent acquired a 25% interest on December 31, 2010, for $400. Equity at December 31, 2010, was:
Share capital $800
Retained earnings 600
At this date, Associate had not recorded any goodwill. All the identifiable assets and liabilities of Associate
were recorded at fair value except for the following assets:
Inventory $100 $120
Non-current assets (net) 500 600
The inventory was all sold by December 31, 2011. The non-current assets had a further useful life of four years.
7. Joint Venture: Parent acquired a 25% interest on January 1, 2012, for $600. A comparison of carrying amounts and
fair values at December 31, 2011, is shown below:
Liabilities 790 $ 790
$3,000
Inventory $ 800 1,000
Non-current assets:
Plant 1,000 1,200
Equipment 1,200 1,500
$3,000
The plant had a further five-year life and the equipment had a further six-year life. By December 31, 2013, all
the undervalued inventory had been sold.
8. Associate: On January 1, 2011, Associate sold a non-current asset to Parent for $500. At the time of sale, this asset
had a carrying amount of $450. Parent depreciated this asset evenly over a five-year period.
9. Joint Venture: At December 31, 2013, Parent held inventory that was sold to it by Joint Venture at a profit before
tax of $200 during the previous period.
10. Parent: On December 31, 2013, Parent held inventory that had been sold to it during the previous six months by
Associate for $1,000. Associate made $400 profit before tax on the sale.
Required
In preparation for the consolidated financial statements of Parent for the year ended December 31, 2013:
(a) Calculate the income from Associate, Subassociate, and Joint Venture.
(b) Calculate the balances in the investments in Associate, Subassociate, and Joint Venture as at December 31, 2013.
Writing Assignments
(LO 1, WA6-1 Amalgamated Holdings provided the following information in Note 1 Significant Accounting Policies in its 2013
3, 5) Annual Report:
(ii) Associates
Associates are those entities for which the Group has significant influence, but not control, over the financial and
operating policies. The consolidated financial statements include the Group’s share of the total recognized gains
and losses of associate on an equity accounted basis, from the date that significant influence commences until the
date that significant influence ceases. When the Group’s share of losses exceeds its interest in an associate, the
Group’s carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent
that the Group has incurred legal or constructive obligations or made payments on behalf of an associate.
In the Parent Company’s financial statements, investments in associates are initially recognized at cost, being
the fair value of the consideration given and including acquisition charges associated with the investment. Where
necessary, the cost is adjusted for any subsequent impairment.
(iii) Joint ventures
In the consolidated financial statements, investments in joint ventures are accounted for using equity accounting
principles. Investments in joint ventures are carried at the lower of the equity accounted amount and recoverable
amount after adjustment for revisions arising from notional adjustments made at the date of acquisition.
The Group’s share of ventures’ net profit or loss is recognized in the consolidated Income Statement from
the date joint control commenced until the date joint control ceases. Other movements in reserves are recognized
directly in consolidated reserves.
(iv) Transactions eliminated on consolidation
Intragroup balances, and any unrealized gains and losses or income and expenses arising from intragroup transac-
tions, are eliminated in preparing the consolidated financial statements.
Unrealized gains arising from transactions with associates and partnerships are eliminated to the extent of the
Group’s interest in the company. Unrealized losses are eliminated in the same way as unrealized gains, but only to
the extent that there is no evidence of impairment.
Cases 333
Gains and losses are recognized as the contributed assets are consumed or sold by the associate or partnerships
or, if not consumed or sold by the associate or partnership, when the Group’s interest in such entities is sold.
Required
Some companies in Amalgamated Holdings who have limited accounting knowledge, particularly about equity account-
ing, have asked you to provide a report to them. Write the report, commenting on:
• the differences between associates and joint ventures
• the determination of the date of significant influence
• realization of profits/losses on intercompany transactions
• recognition of losses of an associate or joint venture.
Cases
(LO 1, 2) C6-1 Nici Limited (NL) is a Canadian public company that operates in the swimsuit industry. They design, develop,
and manufacture swimsuits that are then sold to retail stores across Canada. In the past, the manufacturing and delivery
to retail stores was outsourced by NL to Chin Enterprises (CE). However, during the current year, NL acquired 55%
of CE by acquiring the shares so that NL can have more control over the entire process, instead of outsourcing. The
remaining 45% was acquired by another company, Gil Incorporated, as NL will not be able to use all of the manufac-
turing facilities and capabilities.
The total acquisition price was $3,200,000 with NL paying $1,760,000 and Gil paying $1,440,000. The fair market
values as at the acquisition date were $1,750,000 for the warehouse, $800,000 for the machinery and equipment, and
$200,000 for the delivery vehicles. The corresponding book values and useful lives were $1,200,000 and 10 years for the
warehouse, $500,000 and 5 years for the machinery and equipment, and $100,000 and 3 years for the delivery vehicles.
NL recognized its 55% share of the investment on its balance sheet as Investment in CE and they plan to use the
equity method to account for the investment, arguing that it is a joint venture, with Gil being the other venturer.
The owner of CE had recently passed away and there was no succession plan in place. CE had no liabilities at the time
of the sale of the shares. NL will have first priority over manufacturing availabilities and its company president and the vice-
president of finance will be overseeing CE’s operations. Gil’s controller will be assisting with CE’s accounting function and
will be able to appoint two of the six seats of the board of directors, while NL can appoint the remaining four seats.
NL’s bank agreed to help finance this acquisition; however, as part of the agreement, NL agreed to allow a con-
sultant appointed by the bank to examine the details of the acquisition in order to determine if it was accounted for
correctly. You are the consultant and have obtained the relevant information from NL’s controller. After discussions
with NL’s controller, it was also revealed that NL employees are entitled to an annual bonus based on net income.
Required
Prepare a report that analyzes the transaction and how it was accounted for by NL in net income . Discuss the effect on
the bonus calculation as a result of the presentation chosen for the transactions.
(LO 1, C6-2 John “Calc” Gossling is one of Canada’s foremost real estate investment analysts. He works for the firm of
4, 6) Bouchard Wiener Securities Inc. (BWS). His job is to do research and make recommendations on the stock of publicly
traded companies, independent of any interest his employer may have in the companies. The research gets published and
is used by investors in making their investment decisions. He is noted for his superb number-crunching ability, scathing
comments, and accurate analysis. In late 1989, he correctly predicted the end of the real estate bubble, which occurred
about two years later. His writing style is in marked contrast to the traditional dry prose of most investment analysts.
Major Developments Corporation (Major) is a publicly traded company operating primarily in the real estate sec-
tor. Major has a March 31 year end and in 2013 reported revenues of $704 million and after-tax income of $118 million.
The company buys and sells commercial real estate properties and manufactures commercial elevator components, its
original business before it got into real estate. Major survived the recession of the 1990s, and during that time pur-
chased a number of commercial “jewels” at bargain prices. In 2012, Major ventured overseas, acquiring properties in
three Asian countries.
Major’s share price climbed steadily from 2008 until July 11, 2013. On that date, BWS released a stunning research
report by Gossling on Major (see the extracts in Exhibit C6-2(a)). The report caused an uproar, as it claimed that many
of Major’s accounting policies in fiscal 2013 were misleading and therefore not in accordance with Canadian generally
accepted accounting principles. It further claimed that the company was overvalued and had poor prospects because of
its real estate portfolio mix.
The stock had been trading in the $15–16 range but immediately dropped to around $9. BWS profited from the
decline in the stock price because it held a significant short position in Major’s stock. Within four days, lawyers work-
ing for Major launched a legal action against BWS, claiming damages plus a full retraction of all statements made and
published in a national newspaper.
BWS’s legal counsel is now examining various courses of action. To help prepare for the case, counsel has hired
Rohailla & Mortar, Chartered Accountants, to provide a report on the validity of the positions of each of the parties on
the disagreements over accounting policies as well as any other relevant advice. You, CA, work for Rohailla & Mortar.
You have obtained a copy of Major’s 2013 annual report (see extracts in Exhibit C6-2(b)). Major’s lawyers have pro-
vided the information in Exhibit C6-2(c).
Required
Prepare a draft report to legal counsel for the partner to review.
EXHIBIT C6-2(a)
EXTRACTS FROM JOHN GOSSLING’S RESEARCH REPORT
…I have done a detailed review of Major’s 2013 annual report. I approached management of the company with a detailed list of
further questions, but management didn’t respond in the four days I gave them…
…It is my contention that in 2013, Major clearly violated International Financial Reporting Standards (IFRS), as set out
by the International Accounting Standards Board, on a number of issues. I am saying that the accounting is wrong, not
just aggressive…
…Major’s accounting for its real estate loans really takes the cake for non-compliance. The company consolidates the assets and
results of two corporations to whom it has granted loans when it does not own any shares in either of the companies.
…I don’t like the accounting in Major’s non-real estate business. There is no question it is misleading. Starting in 2013, the
company specifically states in the financial statement notes that revenue (and profit I might add) is recognized on product that
is still sitting in the company’s warehouse!
…How can Rely Holdings, a company that lost $750,000, in which Major had acquired an additional 25% interest for $5 mil-
lion, be valued at over $29 million? The valuation of Rely Holdings makes no sense…
…How can a company capitalize costs incurred for properties that were never acquired? Clearly these costs cannot be consid-
ered assets, and it is misleading to do so…
…It is absurd that Major continues to recognize the revenue from properties in certain economically unstable Asian countries. It
is unlikely that the money will be collected. Major should write off these buildings immediately instead of recognizing revenue
from them…
…Major has not followed IFRS in its accounting for the dividend in kind declared during the year. Thirteen days after the divi-
dend was declared, the only tenant in the only property owned by NC Tower Inc. went bankrupt (reference The Financial Journal,
February 26, 2013, p. 13), so the value attributed cannot be accepted. Furthermore, the dividend has still not been paid, as the
regulators are still looking into it…
Recommendation on Major Developments Corp.

Price earnings multiplier based on last fiscal year: 12.7
Overall rating on the stock: underperform
Recommendation: sell
EXHIBIT C6-2(b)
EXTRACTS FROM MAJOR DEVELOPMENTS CORPORATION’S 2013 ANNUAL REPORT
Note 1: Accounting policies
The company incurs significant costs in investigating new properties for purchase. Costs incurred in investigating any and all
properties, whether or not these properties are ultimately purchased by the company, are capitalized as part of the cost of prop-
erties actually acquired. These costs are amortized over the useful lives of the properties acquired.
Economic problems in certain Asian countries where the company owns properties have made collection of rental revenues from
these properties difficult at this time. The company expects that, once the difficulties in these countries have been resolved,
amounts owed will be collected in full. It is the company’s policy to accrue the revenue from these properties.
Revenue on product sales is recognized when goods are shipped to the customer. In the case of “bill and hold” sales, revenue is
recognized when the goods are placed in the company’s designated storage area.
The consolidated financial statements include the accounts of Major and its majority owned subsidiaries and, commencing
prospectively in fiscal 2013, the accounts of companies in which Major has no common share ownership but to which it has
advanced loans that are currently in default. The equity method is used for investments in which there is significant influence,
considered to be voting ownership of 20% to 50%.
Note 14: Investments
2013 2012
Rely Holdings Inc. $29,640,000 $25,000,000
Cases 335
In 2013, Major purchased an additional 25% interest in Rely Holdings Inc. for $5 million. Major now owns 48% of Rely
Holdings Inc. Major accounts for its investment on an equity basis. In 2013 Major recorded a loss of $750,000 from Rely
Holdings Inc.
Note 24: Dividend in kind
On February 10, 2013, the Board of Directors of Major declared a $0.20 dividend in kind on each common share, consisting of
five common shares of NC Tower Inc. The NC Tower Inc. shares had an appraised value of $0.04 each and a carrying value of
$0.018 per share. The stock exchange on which Major is listed has raised certain objections to the transaction, and the matter
is currently being investigated. Management expects approval for the transaction to be granted in the near future. During the
year, Major reported a gain on disposal of $11 million and a charge to retained earnings of $20 million to account for the decla-
ration of the dividend.
EXHIBIT C6-2(c)
EXTRACTS FROM INFORMATION PROVIDED BY MAJOR’S LAWYERS
1. Major’s auditor has always provided an unqualified report on the audited financial statements of Major, including the 2013
financial statements. The unqualified opinions prove conclusively that the statements were in accordance with International
Financial Reporting Standards.
2. Major has a legal opinion that the two loans are in default (Item A), and a third-party accounting opinion (Item B) that this
default permits consolidation of those companies.
Item A
“…In my opinion, loan 323 to Skyscraper Inc., and loan 324 to Wenon Corporation are in default as of February 1, 2012, under
the aforesaid terms of default of the respective loan agreements, dated the 12th day of August, 2010. The lender has the right
under law and contract to repossess said aforementioned properties, for the purposes of realization on the loans, subject to
restrictions of right under clause 43.(b)…” Matthew Krebs, Q.C.
Item B
“Based on the facts set out in the attached document, we concur that it is acceptable under International Financial Reporting
Standards for Major to consolidate Skyscraper Inc., and Wenon Corporation.” Jesse & Mitchell, Chartered Accountants.
3. “Bill and hold” refers to a practice whereby a customer purchases goods but the seller retains physical possession until the
customer requests shipment. Delivery is delayed at the purchaser’s request, but the purchaser accepts both title to the goods
and the related billing.
(LO 3, 4) C6-3 You, CA, have been working for Plener and Partners, Chartered Accountants (P&P), a mid-size CA firm,
for three years. You have been assigned a new project for a long-term client of your firm, Oxford Developments Inc.
(ODI). For the last two years, you have worked on ODI’s file, and for its most recent year ended November 30, 2012,
you were the audit senior on the job. Information on ODI’s operations and the property development industry can be
found in Exhibit C6-3(a).
It is now September 5, 2013. You and Wendy Yan, the engagement partner, just sat down with Mike D’Silva,
Chief Executive Officer of ODI. Mike came in to discuss a new business opportunity that ODI has recently undertaken.
“At ODI, we are always searching for new opportunities related to property development. ODI’s focus is on
providing a superior return on investment for its shareholders. ODI leverages existing equity with an appropriate
amount of debt to acquire and develop properties for resale. As I’ve mentioned to you before, we have been thinking
of getting into the hotel market for a couple of years now, but we were unsure how to get started. A little while ago,
I had a chance meeting with Linda Kim, the general manager of Hospitality Management Inc. (HMI). After many
meetings and much research, we decided that ODI and HMI are a good fit, and we have started working together on
the development and operation of a boutique hotel. Our hotel will have a special feature—the hotel rooms will be sold
to individual investors.
“We have established a separate company, Genuine Investments Inc. (GI), for this unique project. HMI agreed to
contribute cash and ODI contributed the land and the building. To be successful and profitable, the hotel will require
excellent marketing and management. HMI has a good track record in these areas, and I’m confident they will be able
to achieve similar results for this property. HMI will operate the hotel under a management contract. I’ve provided
some excerpts from the finalized agreement between ODI and HMI (Exhibit C6-3(b)).”
After Mike leaves, Wendy says to you, “It is likely that we will be asked to perform the annual audit engagement of
GI’s IFRS financial statements, so I would appreciate your analysis of the accounting implications for the initial trans-
actions and ongoing operations of GI. I had a chance to meet with ODI’s Chief Financial Officer, Amber Wolfe. My
notes from that conversation are attached (Exhibit C6-3(c)).”
Required
Prepare the report requested by Wendy Yan.
EXHIBIT C6-3(a)
INFORMATION ON OXFORD DEVELOPMENTS INC. AND THE PROPERTY DEVELOPMENT INDUSTRY
Oxford Developments Inc. (ODI) is a mid-size real estate development and sales company. It was founded by a small group of
individuals who felt there was a significant amount of money to be made in real estate, and it has been in business for 10 years.
As the company grew, it brought in additional investors, and it is now owned by 25 individual shareholders. The investors have
never been involved in the day-to-day management of the company; rather, it is professionally managed.
Over the past several years, ODI has acquired over 100 commercial and industrial properties all over Canada, which showed sig-
nificant potential. ODI has renovated these properties and resold them, usually for a substantial gain. The average time between
acquisition and sale of the properties has been 12 months, and the average profit margin has been over 12%.
Between 2004 and 2012, the Canadian real estate industry has been strong. The average annual increase in the value of com-
mercial real estate has been 8.2% over this time period, compared with the historical annual rate of 4.6% in the 1980s and
1990s. ODI has been able to achieve a profit margin of over 12% due to its strategic acquisitions and its strong control of the
renovation costs associated with these properties.
The hotel industry in Canada is fragmented, and significant differences exist between the various geographical areas of the country
as well as the quality of hotel properties. Overall, the industry has achieved an occupancy rate of 76% over the past decade. This
percentage has been steadily increasing over the past 10 years, with the occupancy rate going from 72% in 2003 to 79% in 2012.
More recently, the Canadian economy has slowed. The difficulties in the U.S. housing market caused by the subprime lending
fiasco, as well as the uncertainties surrounding the financial industry in the United States, have precipitated a worldwide eco-
nomic slowdown. Canada is not immune to these events.
ODI believes it is well situated to take advantage of the opportunities that a declining real estate market may present. ODI’s
strategy is to maintain a strong balance sheet, purchase strategic properties at distressed prices, renovate these properties at low
costs using well-priced labour and construction materials, and resell the properties as the real estate market starts to recover.
EXHIBIT C6-3(b)
EXCERPTS FROM GENUINE INVESTMENTS INC. AGREEMENT
Incorporation
Genuine Investments Inc. (GI) was incorporated on December 1, 2012, to develop and operate a boutique hotel known as “The
Genuine Hotel.” The financial year end for GI will be November 30.
Authorized share capital of GI
There are two classes of shares, as follows:
• Class A voting common shares—20,000 shares authorized
• Class B non-voting shares—an unlimited number of shares authorized
Contributions
Oxford Developments Inc. (ODI) will contribute the land and building and $1,000 in cash to GI in exchange for 1,000 Class A
shares and 100,000 Class B shares. The building is expected to have a useful life of 40 years.
Hospitality Management Inc. (HMI) will contribute cash equal to the fair value of the land and building contributed by ODI plus
$1,000 in exchange for 1,000 Class A shares and 100,000 Class B shares.
Restriction on share sale

Shares cannot be sold or traded without the approval of both ODI and HMI. Both companies agree to hold the shares for five
years. After that period, if either party wants to sell, the other party will have the right to purchase the shares at 90% of the
market value at the time of sale.
Loans
ODI and HMI may periodically loan funds to GI. If funds need to be advanced to GI, both investors will provide an equal amount. Any
funds advanced will bear interest at the prevailing market rate, and will be repayable on demand at the request of either ODI or HMI.
Board of directors
ODI and HMI will each appoint two individuals to the board of directors of GI. A fifth member, who will act as board chair, will
be jointly appointed by ODI and HMI.
Profit distribution
GI will distribute 90% of its net earnings on an annual basis provided there is cash available. The distributions will be performed
on a tax-effective basis in the form of either dividends or management fees. If the company is wound up or dissolved for any rea-
son, the final distribution of any amounts remaining shall be made in proportion to the Class B shareholdings of each investor.
Transactions between GI and ODI

All sales (and subsequent resales) of rooms will be done through the real estate division of ODI. ODI will receive a commission on
initial sales from GI of 2.5% and on subsequent resales by room owners of 5%. These rates are based on existing market rates.
Operation
Operation of The Genuine Hotel will be contracted to HMI at a fee approximating the current market rate for management fees.
HMI will be responsible for reservations, guest services, housekeeping, regular ongoing maintenance of the hotel, and security.
Cases 337
GI will be responsible for general administration. The contract will be renegotiated every five years. The management fee for the
first five years is set at $75 per night per occupied hotel room.
EXHIBIT C6-3(c)
NOTES FROM CONVERSATION WITH AMBER WOLFE, CHIEF FINANCIAL OFFICER OF OXFORD DEVELOPMENTS INC.
“Thanks so much for meeting with me. Ever since this project began, I’ve had more work than I can handle. GI has minimal
staff right now, including a manager looking after the construction and some secretarial and administrative support, so I’ve been
helping out. As a result, I have questions about both ODI and GI.
“I’m hoping that P&P can take over the day-to-day bookkeeping for the next several months until GI can hire an experienced
controller. On the bright side, a marketing person was recently hired, and we are actively hiring additional staff as required.
“Extensive renovations were required on the building, and they are now complete. Most of the furnishings, fixtures, and equip-
ment have been installed, and we are busy planning for the grand opening. Since we wanted to get the project started quickly,
ODI and HMI provided all of the initial financing. However, in the future, we would like GI to obtain its own bank financing. If GI
does obtain financing, it would like to repay the amounts owing to ODI and HMI and repurchase 50% of the Class B shares held
by each company at book value. I have brought along some financial information related to GI (Exhibits C6-3(d) and C6-3(e)).
“Given that this investment is new and unique for ODI, it could become a model for future investments. Our shareholders are
therefore very interested in how the accounting for our investment in GI will affect ODI’s financial statements for the November
30, 2013, year end and in the future. I expect the gain on the sale of the land and building transferred to GI to improve ODI’s
overall financial position and increase its net income. I think it should also increase ODI’s net assets, which is a key financial
indicator reported to ODI’s shareholders and ODI’s bank.
“I think that’s it for now. Again, thanks for your help with all of this, as my time seems to be at a premium these days.”
EXHIBIT C6-3(d)
TRIAL BALANCE FOR GENUINE INVESTMENTS INC.
Generated for internal purposes only.
GENUINE INVESTMENTS INC.
TRIAL BALANCE
For the nine months ended August 31, 2013
($ thousands)
Account Description Note Debits Credits

Cash (overdraft) A $ 24
Construction in progress A $10,034
Land A 1,890
Building A 4,560
Furnishings and equipment—rooms A 5,082
Furnishings and equipment—common areas A 2,100
Furnishings and equipment—restaurant/retail space A 0
Accounts payable and accruals L 1,425
Loan—ODI L 2,922
Loan—HMI L 2,922
Class A shares E 2
Class B shares E 12,900
Room sales R 4,000
Other income R 348
Cost of room sales X 0
Operating expenses X 243
Architect and project management fees X 137
Landscaping fees X 87
Financing arrangement fees X 63
Incorporation costs X 54
Property taxes X 41
Building permits X 50
Insurance X 27
Interest expense related to construction X 175
$24,543 $24,543
Note:
A – Asset
L – Liability
E – Equity (net asset)
R – Revenue/Income
X – Expense
EXHIBIT C6-3(e)
FINANCIAL INFORMATION ABOUT GENUINE INVESTMENTS INC.
1. Details of the land and building transferred from ODI to GI are as follows (in thousands):
Asset transferred Carrying value Market value
Land $ 480 $1,890
Building 4,000 4,560
Total $4,480 $6,450
2. Twenty-five hotel rooms have been sold to date at the listed price. Deposits of 5% of the sales price have been received for an
additional 40 rooms. Investors interested in 7 of these 40 rooms have recently backed out. The deposits are non-refundable and
are included in other income. GI expects that all hotel rooms will be sold to investors within the next three months.
3. All of the owners of the hotel rooms that have been sold to date (25 owners) have also entered into management contracts with
GI to rent out their hotel rooms on their behalf. We anticipate that the buyers of the remaining 75 rooms will enter into manage-
ment contracts as well. This is consistent with what similar projects have experienced: a very high percentage of owners have
entered into management contracts to rent out their rooms.
4. GI retains 100% of the gross room rental revenue related to unsold rooms.
5. Room owners will be charged $2,000 per year to fund renovations and major furniture and equipment purchases (the “Reserve
Fund Contribution”). The monies collected will be paid to GI and put into a reserve fund to be drawn upon as needed. The fund
will not be used for ongoing maintenance, which will be done by HMI as part of its management responsibility. The $2,000
amount charged to each owner may be adjusted in future years to ensure the reserve fund is adequate to cover the costs associ-
ated with renovations and major furniture and equipment purchases.
Industry data indicate that annual major renovations typically amount to approximately 1% of the original cost of the building in
the first five years of a building’s life, and increase to 5% after five years.
6. Annual operating and administrative expenses are estimated at $360,000 and $300,000, respectively. These estimated
expenses include property taxes, insurance, interest charges on shareholder and bank loans, accounting fees, and salaries as-
sociated with the overall administrative and financial areas of GI.
7. The hotel will include retail space and a restaurant. Agreements are in place with two retailers, and GI is in the process of sort-
ing out the details of an agreement with Gizmos, a great restaurant chain. We anticipate that all the commercial operators will
be in place by November 30, 2013. Budgeted sales revenue (annual) for each of these establishments is as follows:
Restaurant $2,500,000
Convenience store 700,000
Art gallery 1,500,000
GI will receive a percentage of the operators’ gross revenue. That percentage is 3% for the restaurant, 5% for the convenience
store, and 3% for the art gallery.
8. GI intends to capitalize all the costs associated with the building renovations for accounting purposes. Many of the soft costs,
such as interest and landscaping fees, will be expensed for tax purposes, if possible.
(LO 1) C6-4 A group of five successful business people were awarded the franchise for one of two new expansion teams in the
North American Sports League (NASL). The professional sports franchise was named the Rockets Franchise (RF). The
Rockets are scheduled to begin playing in the 2013/14 season. It is now June 2013, three months away from opening
night. The group formed a joint venture to operate RF. The main reason for doing so was to gain the flexibility that
they believed this structure could offer them.
RF has appointed your accounting firm as auditors for the year ending December 31, 2013. RF has also requested
your firm’s assistance with the development of RF’s accounting policies. You, CA, assigned to the job, and the partner
have met with the client. The following are notes from that meeting.
1. The venturers have various business backgrounds, and not all of them are looking for substantial financial reward.
However, there are limits to how much they are willing to invest if the project is not financially successful. Most
have successful businesses already established and are looking for ways to get public exposure. Three of the ven-
turers have each contributed $2 million in cash, which will be used for start-up costs. One of the venturers has
contributed a parcel of land on which the new stadium will soon be built. The fifth venturer has contributed a
combination of cash, office equipment, time, and industry knowledge.
2. A management group has been hired to operate RF on a day-to-day basis. However, any major decisions must have
the approval of the five venturers.
3. Before the expansion team franchise was awarded, a proposal to the league’s board of governors was prepared. As
part of the proposal, RF had to commit to paying a $50-million franchise fee and had to meet other conditions. All
these other conditions have been met. To strengthen its bid, RF took out local newspaper advertisements request-
ing signatures from the public and organized a local parade to demonstrate the enthusiasm of the city’s sports fans.
Cases 339
The venturers spent a total of $3 million of their personal funds in their bid to obtain the franchise in addition to
the funds invested in RF for start-up costs.
4. A new stadium is planned, to be ready by the beginning of the fourth season. In the meantime, RF has signed a
five-year lease for the existing 10,500-seat stadium. As part of the lease, RF will be responsible for ensuring that the
existing stadium meets local fire and safety regulations. It is estimated that $500,000 will have to be spent to meet
these standards.
5. The Rockets’ logo and colour scheme have been scientifically developed by psychologists employed by a product
design firm owned by one of the venturers. The cost was $1 million.
6. The $50-million franchise fee has been partially financed through several sources.
Advance season ticket and advertising sales have accounted for $10 million; the NASL has provided an interest-free
loan of $15 million, payable at the end of the third season; and the city provided a $5-million grant with no conditions.
RF has until the end of this calendar year to arrange the financing of the remaining funds or it will lose the franchise.
7. Revenues will be generated from several sources, as follows:
a. Ticket sales. Ticket sales will be in the form of pre-sold season tickets and game-day tickets. Thus far, 8,000
season tickets have been sold for the first season. Fans can also purchase the right to use private boxes through-
out the stadium, at a premium. Five of the exclusive private boxes are reserved for the venturers, and 1,000
seats are restricted for promotional purposes and for players’ families and friends at no charge. Ticket sales are
handled by a local ticket agency for a fee of 5% of sales.
b. Advertising space. As part of a promotion to increase sales of advertising space in the stadium, RF has offered
a discount of 15%, for the first year, to advertisers who purchase advertising space for two seasons. The adver-
tisers are billed on an annual basis. There are 100 advertising spaces in the stadium, of which 25% have been
purchased at the discounted price and 25% at the regular price. The regular price for an advertising space
is about $80,000 per season. Any unsold space will be occupied by advertisements from the venturers’ other
businesses at no charge.
c. Merchandising sales. RF has sold the exclusive right to sell products using the Rockets’ logo and design to a
large sports clothing manufacturer for $5 million plus a royalty of 5% of gross sales for five years. If at the end
of the five years the manufacturer has not sold $50 million worth of merchandise, RF will have to refund half of
the 5% royalty payments made during the contract period. The $5 million is due immediately; the 5% royalty
will be paid quarterly, commencing with the last quarter of this year.
d. Concession booth sales. During games, fans will be able to purchase hot dogs and popcorn at various conces-
sion stands. RF will operate the booths and pay the stadium a royalty of 10% of sales.
8. The major expense besides rent will be the players’ salaries. RF has been able to acquire the rights to 15 vet-
eran players from other established teams at no cost, except that RF must now honour the individual players’
contracts. There are no real superstars in this group of players. Their average salary is about $200,000 per
year, and the average remaining life of the contracts is 2½ years. Contracts are guaranteed whether or not the
players play.
9. In June of every year the NASL holds its annual entry draft where the rights to young sports players from minor
league teams, with no previous NASL experience, are acquired by NASL teams. Since the Rockets is an expansion
team, they were awarded the first pick in this year’s draft, enabling them to select one of the most promising play-
ers in the minor league. The Rockets have drafted 12 players in all, only three or four of whom are likely to see
action in the fall of 2013 when the season begins. The remaining players will be sent to the minor league team for
further development. The minor league team is owned by a local business that covers all costs except the players’
salaries. As RF owns the players’ contracts, it is responsible for their salaries.
Historically, 35% of all players selected play more than one season in the major league. The Rockets are
confident that they have selected five players this year who are likely to see action in the next couple of years. They
group the players in three categories (A, B, and C), which are also used to determine the players’ compensation for
their first contracts. Each player selected has signed a contract, as outlined in Exhibit C6-4(a).
10. To ensure that the Rockets become successful, RF has acquired Kelly McDowell from another team. Kelly was
named last year’s most valuable player in the league. In exchange, RF gave up two veteran players, as well as one
Group B player from the entry draft, and its first-round draft pick for the next five years. Since Kelly is considered
the best player in the league, RF also paid $5 million as part of the trade. Kelly’s former team owners were offered
$15 million in cash by another team, but they felt that RF’s offer was slightly better, and could be extremely ben-
eficial if one of the future prospects ends up being a superstar.
Kelly’s contract has five years remaining, at a guaranteed U.S. $1.2 million per year plus a bonus for 2013–14
of up to U.S. $500,000 if he repeats last year’s performance. RF is trying to renegotiate Kelly’s contract, which has a
clause allowing him to negotiate a new deal with any other team in the league at the end of the 2013–14 season. RF
has the right to match any offer but, if it does not, it will lose Kelly’s rights and receive no compensation in return.
11. RF has also been able to sign a deal with a very talented Swiss player. The player was still under contract with the
Swiss National Team at the time of signing. Claims for damages under similar circumstances in the past have been
made against other teams by the Swiss National Team.
Historically, these claims have averaged about $100,000, but in recent cases the claims have reached $250,000.
No claim has yet been made by the Swiss.
12. RF does not expect to be able to generate revenue from television or radio contracts for several years.
The partner has asked you to prepare a memo identifying the relevant accounting issues that are likely to arise dur-
ing the audit of RF and discussing how they should be resolved.
Required
Prepare the memo to the partner.
EXHIBIT C6-4(a)
CONTRACT SUMMARY
1. Three Group A players have been signed by RF. These players are likely to play in the Rockets’ major league team in the 2013–
14 season. It is anticipated that RF’s first selection overall in the draft will be the top rookie of the year and the scoring leader
among the first-year players. The contracts of the Group A players contain the following terms:
$100,000/year guaranteed for three years

$50,000 signing bonus
$50,000 performance bonus based on points
$100,000 for Rookie-of-the-Year award
$25,000 if they play 50 or more games the first year
Free apartment, to be shared with another player
Free use of a company car for the first year
2. Four Group B players have been signed by RF. These players will generally play in the minor league for the first year and then will
probably join the Rockets’ major league team in the following season.
However, there may be one player who proves talented enough to play in the major league this year.
Their contracts provide:

$2,000 per game if they get called up to play for the Rockets.
3. Five Group C players have been signed by RF. These players will play in the minor league and usually have only a remote chance
of ever making it to the major league. It is likely that they will not be re-signed when the contract has expired. Their contracts
provide:

$2,000 per game if they get called up to play for the Rockets
If they play more than 15 minor league games in a season, they get a new contract at the Group B level.

2
MODULE
Foreign Currency
The global economy has changed dramatically over the past decade. Fewer barriers to international
trade and investment and major technological advances in transportation and communications mean
commercial activity is increasingly taking place on a global scale.
Globally engaged companies are not only selling internationally, but also investing in production
facilities and forming new kinds of partnerships with suppliers, producers, distributors, and innovators
located around the world.
As companies enter the global market, physical borders cease to exist. A Canadian company
may be required to trade in a currency other than the Canadian dollar. The company has assumed
additional risk as the currencies fluctuate. In some circumstances, a company’s success may hinge on
the volatility of a foreign currency, with constant rate fluctuations contributing to unexpected gains
and losses.
From a reporting perspective, this module will examine the issues that arise when various
currencies are used to transact business. In Chapter 7, we will look at simple structures where
Canadian companies buy or sell in a foreign currency. In Chapter 8, we examine the more complex
structures where groups of companies with different functional currencies present together. In
addition, we review the accounting and reporting for companies hedging their foreign currency
risk. For certain aspects of this material, it is helpful to first master Module 1 on inter-corporate
investments.
Making Cents
of Foreign
Exchange
Source: © narvikk/iStockphoto
IN TODAY’S ECONOMY, globalization has been As an example of the impact this rise could have,
likened to a force of nature that can’t be stopped. a U.S.-denominated sale worth C$100,000 recorded
In such a context, once a company reaches a in March 2009 might have been worth less than
certain size, the road to additional profits or cost C$91,000 if settled in May of the same year.
savings will likely pass through another country. The strengthening of the loonie hurt Canadian
From a Canadian perspective, the first exporters in their efforts to compete with their
country that comes to mind as a business partner American counterparts for U.S. market share. The
is the United States. Transactions with American pervasive and lasting effect this shift can be seen in
companies are often denominated in U.S. dollars, the changes it brought to CommuniMax Direct.
which adds a layer of complexity to accounting CommuniMax Direct is a privately owned and
for them. Transactions denominated in foreign Montreal-based advertising agency specializing
currencies must be recorded in a company’s in direct marketing strategic planning, project
functional currency at the date of the transaction management, and printing services. In the early
by using the spot exchange rate of that date. 2000s, CommuniMax earned approximately 65% of its
Business transactions are rarely settled on the revenue by providing creative and print subcontracting
same date they are recorded, however. Foreign services to American clientele. The strengthening of
exchange gains and losses arise when the value the Canadian dollar over the years amounted to a 39%
of the money received is no longer the same price increase to CommuniMax’s U.S. customers from
as what was initially expected. If the Canadian 2002 to 2006. By the end of that period, CommuniMax
dollar appreciates against the U.S. dollar after the earned 100% of its revenue from Canadian clients.
price of a sales transaction has been agreed upon When asked about the long-term impact foreign
but before it is settled, for instance, the Canadian exchange had on CommuniMax, co-owner Len
company would suffer a foreign exchange loss. Luckie said, “The rise of the Canadian dollar not only
A look at this movement in the exchange rate nullified the price advantage we had over American
from U.S. to Canadian dollars over the past decade competitors, it created a currency risk on all of our
would indicate that such losses were likely the contracts. We saw our profits all but wiped out by
norm. The Canadian dollar has appreciated against foreign exchange on our contracts over a few months
its American counterpart from an annual average in 2005. We had no choice but to concentrate our sales
of U.S. $0.64 in 2002 to U.S. $1.01 in 2011. and marketing efforts on the domestic market instead.”
Sources: Bank of Canada, “Monthly Average Exchange Rates,” available at http://www.bankofcanada.ca/rates/exchange/monthly-average-lookup/; KPMG Issues and Insights,
“Canadian Manufacturing Outlook: Balancing Volatility and Cautious Optimism,” 2011, available at http://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/
Documents/Canadian-Manufacturing-Outlook-web-v4.pdf.
CHAPTER
7 Accounting for
Foreign Currency
LEARNING OBJECTIVES
1. Determine the functional currency of a company.
2. Convert transactions denominated in a foreign currency into a company’s functional currency.
3. Apply hedge accounting to transactions denominated in a foreign currency.
4. Translate financial statements from the functional currency to the presentation currency.
ACCOUNTING FOR FOREIGN CURRENCY
Converting Foreign Currency Translating Financial

Applying Hedge Accounting
Determining the Functional Transactions into a Statements from the
to Foreign Currency
Currency of a Company Company’s Functional Functional Currency to the
Transactions
Currency Presentation Currency
■ Foreign currency risk ■ Initial recognition ■ Economically hedging foreign ■ Choosing the presentation
■ Foreign currency exchange ■ Recognition in subsequent currency risk currency
gains and losses periods ■ Derivative financial ■ Translating financial
■ Primary economic activity instruments as hedges statements into a
presentation currency
344 chapter 7 Accounting for Foreign Currency
Many companies that are located in Canada buy and sell goods or services from other
Canadian companies. Such transactions usually imply relatively straightforward accounting
in Canadian dollars. However, when Canadian companies decide to conduct business outside
of Canada, they may enter into transactions that are denominated in a foreign currency. For
instance, when a Canadian company (“Canada Co.”) agrees to pay for merchandise in euros
because its supplier, who is located in France, demands payment in its local currency, Canada
Co. will need to obtain this currency. As a result, Canada Co. may need to buy euros with its
own Canadian cash. This creates an additional risk to Canada Co. Not only does it have to
be concerned with its ability to pay, it now has the risk that the amount to pay in Canadian
dollars will vary from the day that it committed to buy the merchandise until the day that it
settles the payments. Buying euros and paying Canadian dollars will yield foreign exchange
gains or losses for Canada Co.
Due to constantly changing foreign exchange rates, buying euros one day may be more
expensive than buying euros on another day. This volatility leaves Canada Co. exposed to
foreign currency risk and companies have varying levels of acceptable foreign currency risk.
In order to protect itself from having to pay more for its merchandise, Canada Co. may
choose to fix the price it will have to pay to obtain the required euros by entering into a for-
ward contract, future contract, or option contract. A forward contract is a type of derivative
that is often sold by a financial institution. This contract requires the financial institution to
sell to Canada Co. a fixed amount of euros on a specified date for a predetermined amount
of Canadian dollars. Entering into this type of transaction will allow Canada Co. to know
exactly how much it will cost in Canadian dollars to obtain the required amount of euros in
the future.1
From an accounting perspective, this chapter will explain how foreign exchange risk is
measured and realized in the financial statements. It will also explain how the derivative,
the merchandise, and the amount payable to the French supplier described above would be
accounted for. The accounting requirements will differ depending on whether Canada Co.
chooses to apply a special type of accounting referred to as hedge accounting or not. This
concept will be explained later in this chapter.
As a result of globalization, the frequency of transactions denominated in foreign cur-
rencies is increasing. Accounting standards provide guidance on how to translate foreign
currency transactions into a company’s functional currency for inclusion in its accounting
records and financial statements.
Furthermore, sometimes an investor or lender will request to see financial statements
that are presented in a currency that differs from a company’s functional currency, perhaps
because the company has significant operations in a foreign market, and so it becomes more
relevant to present financial statements in the currency that is most common to the majority
of transactions that form part of the statements. Or, sometimes the investor or lender them-
selves lives in a foreign country and likes to read financial statements in the currency that they
are more familiar with and as such the financial statements need to be presented in a currency
that differs from its functional currency.
Accounting standards provide guidance on how to translate a set of financial statements
from a functional currency to a different currency for presentation purposes.
In this chapter we will understand the principal issues surrounding the translation of
transactions denominated in a foreign currency, the impact of using hedge accounting to
reflect the economic impact of modifying a foreign currency risk exposure, and the transla-
tion of financial statements into a currency that differs from a company’s functional currency
(referred to as a presentation currency).
In order for us to be able to identify foreign currency transactions, we first need to
determine a company’s functional currency. Once identified, the foreign exchange can be
1
Future contracts and option contracts are derivatives as well and can serve the same purpose as
a forward contract. However, the forward contract is the most effective as it can be tailored to the
company’s needs. Futures and options are generally traded on an open market and are accessible to all
companies. In this textbook we will assume that the company is using a forward contract; however, the
accounting is the same for the other contracts.
Determining the Functional Currency of a Company 345
calculated and presented in the financial statements. Once you understand the accounting
for foreign exchange, we can take the next step of discussing why it might be useful to use
hedge accounting when a company has taken measures to modify its exposure to foreign
currency risk.
Lastly, when the financial statements are prepared in a different currency, foreign
exchange will be created by the translation into a different presentation currency. This chap-
ter will demonstrate how to calculate these exchange differences and where they should be
presented in the financial statements.
DETERMINING THE FUNCTIONAL

CURRENCY OF A COMPANY
Objective 1 Under IAS 21 The Effects of Changing Foreign Exchange Rates, a company must prepare its
Determine the financial statements using its functional currency to measure its results. As such, we must first
functional currency determine the functional currency of a company to understand where the foreign currency
of a company. risk arises.
Foreign Currency Risk

For many companies operating in Canada, their offices are located in Canada and their cus-
tomers are Canadian. However, some companies do business outside the country and decide
they are willing to accept payment in a currency other than Canadian dollars. When a com-
mercial transaction is denominated in another currency, foreign exchange gains and losses
are realized. When a company’s books and records are maintained in Canadian dollars,
transactions that took place in another currency must be translated into Canadian dollars
for inclusion in the company records. For example, when a Canadian seller decides to accept
payment in U.S. dollars for its products, as a result of the accounting records being main-
tained in Canadian dollars, the U.S. dollars need to be converted into Canadian dollars. This
is accomplished by converting U.S. dollars to Canadian dollars using the current foreign
exchange rate. Illustrative Example 7.1 demonstrates a foreign exchange transaction between
Canadian and U.S. dollars.
Illustrative Example 7.1 Foreign Exchange Transaction

You work at a convenience store located in Montreal’s Trudeau airport. A customer
walks in to buy a bottle of water but realizes once he is about to pay that he has run
out of Canadian currency and offers to pay you in U.S. dollars. The price of the bottle
of water is $3.00 denominated in Canadian currency. The store accepts U.S. dollars;
however, it has a posted rate of U.S. $1.00 ⫽ C$0.90.2 This means that if the customer
wants to pay for the bottle of water in U.S. dollars, you will ask him to give you U.S.
$3.33 (3.00/0.90). The customer therefore hands you a $5 bill denominated in U.S. dol-
lars. You accept his bill and as a result, you calculate that he has paid you the equivalent
of C$4.50 (5.00 ⫻ 0.90) based on the store’s posted rate. You then give him C$1.50
back as his change (which is the U.S. $1.67 change [1.50/0.90]).
2
In this chapter, the symbol “C$” is used in the text and in some journal entries to distinguish
amounts in Canadian dollars from U.S. dollars and other currencies using the dollar symbol.
Foreign Currency Exchange Gains and Losses

Canadian companies may transact with foreign suppliers or sell to customers located in a dif-
ferent country. In these cases, companies may transact in a currency other than the Canadian
dollar. Once a transaction is denominated in a currency that a company does not typically
deal in, the company has now exposed itself to foreign currency risk. This means that the
transaction the company entered into involves the typical risks of a regular commercial trans-
action, like the risk that the customer will not pay for what they bought (known as credit
risk). But the company is also affected by the changes in the foreign currency relative to its
domestic currency. Once a Canadian company sells its products to a European customer
and fixes the prices of its products in euros, the seller is at risk that the euro currency will
weaken between the time the goods are sold and the company receives its payment. Say the
company sold merchandise worth €10,000 when the foreign exchange rate was €1 C$1.30.
This means that when the merchandise was sold, the seller would have sold the equivalent
of $13,000 of merchandise reflected in Canadian dollars. However, the seller only collects
the euros one month later when the foreign exchange rate has weakened to €1 C$1.27.
This means that if the seller decided to go to the bank immediately, upon receipt of payment
from its customer, to convert the €10,000 into Canadian dollars, the bank would give him
only C$12,700. The company has just lost C$300 because the exchange rate changed. If the
Canadian company had made the sale in Canadian dollars, it would not have incurred this
loss of C$300. Illustrative Example 7.2 examines different ways that a company may experi-
ence foreign currency gains or losses.
Illustrative Example 7.2 Foreign Currency Gains

and Losses
You have just started up your own Internet-based business selling trendy toys world-
wide. You have a local Canadian toy supplier. You believe you will be most profitable
selling online and so you have created a website where people can order directly
from you.
Scenario 1:
At first you decide that all toys on the website will sell for C$5.00. Because your com-
pany always gets paid in Canadian dollars, you do not have to worry about accounting
for any type of foreign currency associated with your sales.
Scenario 2:
You believe your toys will be very popular in the United States and that in general, U.S.
dollars is a more recognized currency for your toys, so you consider selling your toys
for U.S. $5.00 per toy. In this case, since your company is Canadian and you are selling
in U.S. dollars, there will be foreign currency accounting issues to consider. When you
sell one toy, you will record the following accounting entry when the current foreign
exchange rate is U.S. $1.00 C$0.975:
Accounts Receivable U.S. $5.00 0.975 C$4.88
Sales C$4.88
To record the sale of one toy at U.S. $5.00, which is equivalent to C$4.88.
Two days later, the customer pays for the toy when the foreign exchange rate is
U.S. $1.00 C$0.98.
Determining the Functional Currency of a Company 347
Cash C$4.90
Accounts Receivable C$4.88
Foreign Exchange gain C$0.02
To record the collection of accounts receivable.
Therefore, due to changes in the foreign currency rate between the time of the toy’s
sale and the collection of your money, you realized a foreign exchange gain of $0.02.
Scenario 3:
You are considering setting up your website such that your customers will be able to
see the prices of your toys in their local currency. You design your website to ensure
that when a customer wants to see the price of your toys, your website will automati-
cally display the local equivalent of C$5.00. The website is therefore designed to
automatically calculate the equivalent of C$5.00 into the local rate using the current
foreign exchange rate. As a result, when you sell a toy through the website, your website
captures this local equivalent price and this is the amount recorded as a sale in your
accounting records.
For example, a customer in Europe purchases a toy through your website. At the
time of sale, the foreign exchange rate is C$1.00 €0.73. Therefore, the customer sees
a price of €3.65. You record the following accounting entry:
Accounts Receivable 5.00
Revenue 5.00
To record the sale of one toy.
A few days later, the customer pays €3.65 for the toy when the exchange rate is
$1.00 €0.70. You record the following accounting entry:
Cash 5.21
Accounts Receivable 5.00
Foreign Exchange Gain 0.21
To record collection of accounts receivable.
This exposure can have a positive or negative effect on your company. If the U.S.
dollar is stronger than the Canadian dollar, for example, and the company decides to
sell its products in U.S. dollars yet it operates in Canada, a stronger U.S. dollar would
mean that a company’s profitability would partially be due to the stronger U.S. dollar
(i.e., there would be a foreign exchange gain included in its profits). If the U.S. dollar
weakens such that the Canadian dollar becomes stronger than the U.S. dollar, and the
company continues to sell in U.S. dollars but does not adjust its sales prices to consider
the foreign currency exposure, profits will be lower in Canadian dollars as a result of
this foreign exchange loss.
Primary Economic Activity

In order to identify the foreign exchange component of a transaction, a company must estab-
lish the currency in which its books and records should be maintained. This is the currency of
the primary economic environment in which a company operates. It cannot be assumed that
a company’s domestic currency is the currency in which it normally operates. Sometimes,
a company’s domestic currency can be the Canadian dollar because that is where its offices
are located. But if the company sells most of its products to another country such that the
economic activities of that foreign country mainly influence the pricing and sales of the com-
pany’s products and services, that foreign currency likely would be determined to be its func-
tional currency (IAS 21.9 and .10). Illustrative Example 7.3 demonstrates how to determine
the location where the primary economic activity occurs.
Illustrative Example 7.3 Primary Economic Activity

Oilco operates out of Calgary, exporting oil-related products all over the world. The
international pricing currency of oil is the U.S. dollar. This means that the U.S. dol-
lar is the currency in which all of Oilco’s products are denominated since it is widely
accepted as the currency in which oil is priced globally. However, Oilco is located in
Alberta, and therefore all of the costs it incurs to run its business are denominated
in Canadian dollars. Oilco must therefore determine which currency, either Canadian
dollars or U.S. dollars, would most faithfully represent its functional currency. It must
decide where it conducts its primary economic activity.
If Oilco determined that U.S. dollars was the most relevant currency, all of its over-
head costs (e.g., salaries, rent, utilities), which are naturally denominated in Canadian
dollars, would need to be converted into U.S. dollars for accounting purposes since all
of its books and records are reflected in U.S. dollars. However, if Canadian dollars were
determined to be the most relevant currency, then all of Oilco’s sales, which are natu-
rally denominated in U.S. dollars, would need to be converted into Canadian dollars for
accounting purposes.
Example 1: U.S. dollars is the functional currency where the primary business activity occurs
On June 30, 2013, Oilco pays rent for its head office space to its landlord in the amount
of C$10,000. The average foreign exchange rate for the month of June is C$1.00
U.S. $1.05. As a result, rent in the amount of U.S. $10,500 (i.e., $10,000 $1.05) is
recorded in the accounts of Oilco.
Example 2: Canadian dollars is the functional currency where the primary business activity
occurs
Oilco’s sales for the month of June 2013 totalled $1,200,000 denominated in U.S.
dollars. The average foreign exchange rate for the month of June is the same as in
example 1 above (C$1.00 U.S. $1.05). As a result, Oilco records C$1,142,857 (i.e.,
$1,200,000/$1.05) in its accounts.
Once the functional currency is determined, it is not changed unless there is a change in
the underlying transaction, events, and conditions (IAS 21.13). Any change in a company’s
functional currency is handled prospectively. A company whose primary economic activity
was in the United States may now have expanded its business in Canada so that the com-
pany decides that the primary business activity is in Canada. At the day of the change in
functional currency, items are translated using the exchange rate at the day of the change.
The resulting amounts, for the non-monetary items, are deemed to be its historical cost
going forward.
It is imperative that a functional currency be identified first in order to determine what
is considered to be a foreign currency. Once a company’s functional currency is identified,
then inherently, all other currencies are considered to be foreign. (This is discussed further
in Chapter 8).
ASPE: Functional Currency

ASPE
Under ASPE, this topic is covered in Section 1651 Foreign Currency Translation.
The determination of a company’s functional currency in order to be able to iden-
tify foreign currency transactions is not clearly addressed. For Canadian companies, the
Canadian dollar is assumed to be a company’s functional currency or what ASPE refers
to as the “unit of measure.”
Converting Foreign Currency Transactions into a Company’s Functional Currency 349
✓ LEARNING CHECK
• Functional currency is the currency of the country where the company conducts its primary
business activity.
• Foreign currency exists when a company transacts in a currency other than its functional currency.
• The currency of the country in which a company normally operates is not necessarily its func-
tional currency.
• Functional currency must be determined first before foreign currency transactions can be
identified.
CONVERTING FOREIGN CURRENCY

TRANSACTIONS INTO A COMPANY’S
FUNCTIONAL CURRENCY
Objective 2 Once a company’s functional currency is identified, all transactions denominated in another
Convert transactions currency are considered to be foreign currency transactions.
denominated in a Examples of foreign currency transactions are as follows:
foreign currency
into a company’s • A company buys or sells goods or services whose price is denominated in a foreign currency.
functional currency.
• A company borrows or lends money when the amounts payable or receivable are denom-
inated in a foreign currency.
• A company acquires or disposes of assets, or incurs or settles liabilities, denominated in a
foreign currency.
(IAS 21.20)
Initial Recognition
When a company enters into transactions denominated in a foreign currency, it is required
to translate those transactions into the company’s functional currency for inclusion in its
accounting records and financial statements. An exchange rate is the price to change one
currency into another. When initially entered into, the transaction is converted at the spot
exchange rate at the date of the transaction. The spot exchange rate is the price to change
one currency into another today (i.e., at the time of the transaction). The transaction date
is the date when the transaction is first recognized in the company’s books and records.
Illustrative Example 7.4 demonstrates the concept of the spot rate.
Illustrative Example 7.4 Spot Exchange Rate

Last week you and your friends decided to drive to the nearest U.S. border town for the
weekend. During the trip, your friend asked you if he could borrow U.S. $5 to buy a cup
of coffee. You lent him the money. You and your friends are now back in Canada and your
friend hands you a $5 bill denominated in Canadian dollars. How do you know whether
he paid you back in full? You decide to go to the bank and ask the teller if you had given
her a $5 bill denominated in U.S. dollars and wanted the Canadian-dollar equivalent, how
much she would have given you. The teller informs you that the exchange rate at that
moment (i.e., the spot rate) is U.S. $1 ⫽ C$0.98, and as such, if you had given her a U.S.
$5 bill and asked for the Canadian equivalent, she would have given you back C$4.90.
You immediately determine that you have made $0.10 on the transaction.
Companies may have thousands of transactions in a given week and may choose to use the
average spot rate for the week to translate the transactions. In general, for practical purposes,
this rate is often estimated using an average rate for a period of time surrounding the transac-
tion assuming that the rate was relatively constant during that time, as shown in Illustrative
Example 7.5. When exchange rates fluctuate significantly, using an average rate may not
result in a materially accurate reflection of the value of the transaction denominated in the
company’s functional currency.
Illustrative Example 7.5 Average Exchange Rate

Canadian Corporation (“Canco”) sold several products to customers located in the
United States during the month of September 2013 totalling U.S. $200,000. Canco
maintains its accounting records in Canadian dollars. As a result of moderately fluc-
tuating currency exchange rates between the Canadian and U.S. dollars during the
month of September 2013, Canco decides to use the average foreign exchange rate for
the month of September 2013 to translate its sales for the month. The monthly aver-
age foreign exchange rate for September 2013 is U.S. $1.00 ⫽ C$0.97. Canco there-
fore reports $194,000 Canadian-denominated sales for the month of September 2013.
The journal entry to record this is as follows:
Sales 194,000
When translating from one currency into another, for example Canadian to U.S. dollars, the
foreign exchange rate may be presented in either of the following ways:
1. C$1.00 ⫽ U.S. $1.03 (referred to as a direct rate) or
2. U.S. $1.00 ⫽ C$0.9709 (referred to as an indirect rate).
The exchange yields the same result; however, care should be taken as a direct rate is divided
to obtain the Canadian value and an indirect rate is multiplied to obtain the Canadian value.
In reality the exchange rate to buy or sell Canadian dollars may not be the same. Using the rates
determined above as if they were the spot exchange rate, you decide to buy a bottle of wine from
your favourite vineyard in California, and its website advertised it at U.S. $28 a bottle or C$25.
The most favourable pricing to you at the time of purchase would be determined as follows:
U.S $28 ⫻ 0.9709 ⫽ C$27.19
C$25 ⫻ 1.03 ⫽ U.S $25.75
This means that since you have the option of either paying either U.S. $28 or C$25 for the
same bottle, the best price would be to pay in Canadian dollars since it would cost you more
to pay in U.S. dollars at the time of purchase ($25.00 vs. $27.19). The reasons for this vari-
ance may be complex. Simply stated, it might be attributed to bank costs.
Recognition in Subsequent Periods

When financial statements are prepared, transactions that were initially denominated in a
foreign currency need to be reviewed to determine whether any further foreign currency
adjustments are necessary to their balances. The company must determine if there is any risk
due to the change in foreign currency rate that has occurred.
Monetary items are identified as money held and items to be received or paid in money or
in a fixed or determinable number of units of currency (IAS 21.16). Monetary items cause a
foreign currency risk because their value is fixed by contract or in terms of a monetary unit.
If the exchange rate fluctuates, the value in the company’s functional currency will change,
which causes risk. As such, when a monetary item is denominated in a foreign currency, it is
relevant to represent those values in the company’s functional currency at the financial state-
ment presentation date.
Non-monetary items are all items other than monetary items. Their values are not fixed by
contract or in a determinable number of currency units. In principle the amount of the item
will fluctuate in terms of the foreign currency so as to maintain the Canadian value.
Monetary Items
Monetary items that are denominated in a foreign currency must be translated using the
closing rate of exchange at the end of the reporting period. Any resulting foreign exchange
gains or losses are recognized in income. Examples of monetary versus non-monetary items
are provided in Illustration 7.1.
Illustrative Example 7.6 examines the journal entries required subsequent to the trans-
action date as well as the financial statement reporting implications for a current monetary
transaction. A gain of $2,280 is recorded in net income and the account receivable is reflected
on the statement of financial position at the closing rate of $140,100.
Illustration 7.1
Monetary Non-monetary
Listing of Accounts
on the Statement of Cash and other similar deposits Prepaid expenses
Financial Position Accounts receivable and payable Inventories
Classified as Monetary or Investments in bonds or guaranteed investment
Non-monetary Items certificates Property, plant, and equipment
Loans and notes receivable and payable Intangible assets including goodwill
Cash dividends receivable and payable Equity investments
Pensions and other employee benefits to pay Provisions that are to be settled by the
in cash delivery of a non-monetary item
Illustrative Example 7.6 Reporting Current Monetary Item

Subsequent to the Transaction Date
On November 15, 2013, Local Corporation sold merchandise to a customer located
in Europe. The sale, denominated in euros, amounted to €100,000. On November 15,
2013, the foreign currency rate was €1 C$1.3782. At December 31, 2013, Local’s
year end, the account still had not been collected, and the foreign currency rate was
€1 $1.4010.
The following entries would be required to record the transaction in Local’s account-
ing records in Canadian dollars (assuming that the functional currency is the Canadian
dollar):
November 15, 2013
Sales 137,820
To record merchandise sold in the amount of €100,000 in Canadian dollars (100,000 1.3782).
Note: this entry assumes the use of a periodic inventory system. If a perpetual system
were in place, the company would also make an entry to remove the inventory at cost:
Cost of Goods Sold XXX
Inventory XXX
December 31, 2013

Foreign Exchange (NI)3 2,280
To record fluctuation in foreign currency rate on monetary item denominated in a foreign currency at
year end.
You will note that this gain goes directly to net income (100,000 ⫻ [1.4010 ⫺ 1.3782]).
Effect on the financial statements at December 31, 2013:

Statement of Financial Position Statement of Comprehensive Income
Current assets Sales $137,820

Accounts receivable $140,100 Cost of sales x
Gross profit
Operating expenses
Equity $140,100 Financing costs
Foreign exchange 2,280
Net income $140,100
Illustrative Example 7.7 examines the journal entries required subsequent to the transaction
date as well as the financial statement reporting implications for a long-term monetary trans-
action. Each year there will be a foreign exchange effect on the restatement of the loan to the
current closing rate. In addition, there will be a foreign exchange gain or loss on the restate-
ment of the interest payable, also a monetary balance.
Illustrative Example 7.7 Reporting Long-Term Monetary

Items Subsequent to the Transaction Date
On January 1, 2013, Canadian Corporation (“Cancorp”) borrows U.S. $1,000,000 from
a U.S. bank. The loan must be repaid in five years and carries a fixed interest rate of
3% payable each December 31. Cancorp maintains its accounting records in Canadian
dollars. The following entries are recorded to account for the loan:
January 1, 2013, spot rate U.S. $1 = C$0.975
Cash 975,000
Loan Payable 975,000
To record issuance of loan payable (1,000,000 ⫻ 0.975).
December 31, 2013, average rate for 2013 U.S. $1 = $0.9800; spot rate U.S. $1 = $0.9820
Interest Expense (1,000,000 ⫻ 3% ⫻ .9800) 29,400

Foreign Exchange Loss 60
Cash (1,000,000 ⫻ 3% ⫻ .982) 29,460
To record interest paid on the loan.
Foreign Exchange Loss 7,000
Loan Payable 7,000
To adjust monetary item to its current price in Canadian dollars (1,000,000 ⫻ [0.9820 ⫺ 0.9750]).
3
For brevity, “NI” in the journal entries in this chapter means the item will appear in net income.
On the statement of financial position at December 31, 2013:
Loan payable balance is $982,000.
On the statement of comprehensive income for the year ending December 31, 2013 (likely in the “finance cost”
section):
Interest expense $29,400

Foreign exchange loss $ 7,060
December 31, 2014, yearly average rate U.S. $1 = $0.9885; spot rate U.S. $1 = $0.9900
Interest Expense (1,000,000 3% 0.9885). 29,655
Cash (1,000,000 3% 0.9900) 29,700
Loan Payable 8,000
To adjust monetary item to its current price in Canadian dollars (1,000,000 [0.9900 0.9820]).
section):

Foreign exchange loss $ 8,045
Interest Expense (1,000,000 3% 0.9975) 29,925

Cash (1,000,000 3% 1.0200) 30,600
Loan Payable 30,000
Loan payable balance is $1,020,000.
section):

Foreign exchange loss $30,675
Interest Payable (1,000,000 3% 0.9800) 29,400
Foreign Exchange Gain 330
Loan Payable 40,000
Foreign Exchange Gain 40,000
On the statement of comprehensive income for the year ended December 31, 2016 (likely in the “finance cost”
section):
Foreign exchange gain $40,330

Foreign Currency Gain 240
Cash (1,000,000 3% 0.9810) 29,430

Loan Payable 1,000
Loan Payable 981,000

Cash 981,000
To record payment of loan at the spot exchange rate (U.S. $1,000,000 0.9810).
On the statement of financial position December 31, 2017:

Loan payable balance is 0.
section):
Foreign exchange loss $760
Non-monetary Items
Non-monetary items that are measured in terms of historical cost in a foreign currency were
initially translated at the spot rate at the day of the transaction. These items are not subject to
foreign currency risk since the company has the ability to affect the amount the item is sold
or bought for since it is not fixed in amount by contract. In theory, the item should main-
tain its Canadian value. Consider Quebeco Corporation, which buys a pencil for U.S. $1 on
January 1 when U.S. $1 C$1. The amount that the pencil will sell for is not fixed in the
foreign currency by contract so, in theory, at the end of the year if the exchange rate is now
U.S. $1.20 C$1, Quebeco should be able to sell the pencil for U.S. $1.20 and therefore
maintain its Canadian value of $1. In reality this phenomenon is very difficult to see as there
are many other factors affecting the selling price of the pencil, considering the most basic
principles of supply and demand. However, the point is that it is not a foreign currency risk
that is affecting the value of the pencil.
IAS 21 requires that in subsequent periods, the non-monetary items be translated using
the exchange rate at the date of the original transaction. This spot rate is referred to as the
historical exchange rate in subsequent periods as it has not changed since the transaction
date. Once these transactions are translated initially at the spot exchange rate, no adjustment
is required for these transactions at the end of the reporting period, as reflected in Illustrative
Examples 7.8 and 7.9.
Illustrative Example 7.8 Subsequent Reporting

of Current Non-monetary Items
On November 15, 2013, Local Corporation purchased inventory from a supplier
located in Europe. The purchase, denominated in euros, amounted to €100,000 and
was paid for immediately in cash. On November 15, 2013, the foreign currency rate was
€1 C$1.3782. At December 31, 2013, Local’s year end, the foreign currency rate was
€1 $1.4010.
The following entries would be required to record the transaction in Local’s
accounting records in Canadian dollars:
November 15, 2013

Inventory 137,820
Cash 137,820
To record purchase of inventory in the amount of €100,000 in Canadian dollars (1,000,000 1.3782).
December 31, 2013

No entry since inventory is non-monetary and is not re-translated at year end.
Illustrative Example 7.9 Subsequent Reporting

of Long-Term Non-monetary Items
On April 15, 2013, a Canadian company, Nussbaum Enterprises, purchases a machine
for use in its factory located in Toronto from an overseas company for U.S. $2,000,000.
At the date the company purchases the machine, the exchange rate is C$1 U.S.
$0.9800. The purchase price is to be settled in three months, although the machine is
delivered immediately.
Nussbaum records both the machine and the monetary liability at C$2,040,816
(U.S. $2,000,000/C$0.9800) as follows:
Machine 2,040,816
Accounts Payable 2,040,816
To record the purchase of the machine in Canadian dollars (the company’s functional currency) and the
related amount payable in Canadian dollars at the time of the transaction, which in this case is when the
machine was delivered.
The company will not need to translate the machine again since the machine is
non-monetary.
At Nussbaum’s year end of June 30, 2013, the exchange rate is C$1 U.S. $0.9915.
The following entry will be required to adjust the accounts payable denominated in
U.S. dollars (C$2,040,816 C$2,017,146 [U.S. $2,000,000/C$0.9915]:
To adjust the monetary liability to the exchange rate in effect at the statement of financial position date.
On July 15, 2013, the settlement date, the exchange rate is C$1 U.S. $0.9850. The
actual amount that Nussbaum will pay to settle the liability is therefore C$2,030,457
(U.S. $2,000,000/C$0.9850). The company should make the following entries to
account for the change in foreign currency of C$13,311 (C$2,017,146 C$2,030,457):
To adjust the monetary liability to account for the changes in foreign exchange rate from the statement of
financial position to the date of settlement.

Cash 2,030,457
To account for payment of U.S. $2,000,000 at its Canadian dollar equivalent using the spot exchange
rate in effect at the payment date.
In following IFRS, companies may record some non-monetary items at fair value in the cur-
rency of the transaction. Inventory must be reflected at the lower of cost and net realizable
value; property, plant, and equipment may be reflected using the revaluation model; and
investment property may be reflected using the fair value method. Non-monetary items that
are measured at fair value in a foreign currency must be translated using the exchange rates
at the date when the fair value was determined. It is counterintuitive to apply a historical
rate to an asset that is reflected at a current value. Any resulting foreign exchange gain or
loss is recognized in income unless the transaction giving rise to this foreign exchange is rec-
ognized in Other Comprehensive Income, in which case, the foreign exchange component
is also recognized in Other Comprehensive Income. Illustrative Examples 7.10 and 7.11
examine the journal entries and effects on the financial statements when the item is reflected
at fair value.
Illustrative Example 7.10 Non-monetary Items Reflected

at Fair Value in Subsequent Periods: Effect in Income
Local Corporation owns a building in Europe that is considered investment property
and is accounted for using the fair value model. The investment property was valued at
€100,000 on December 15, 2013. The property’s carrying amount at December 15,
2013, was C$125,000, which was €95,000 converted at the last valuation date’s spot
foreign currency rate of €1 ⫽ C$1.3158.
On December 15, 2013, the spot rate was €1 ⫽ C$1.3902. At December 31, 2013,
Local’s year end, the spot rate was €1 ⫽ C$1.4010.
The following entries would be required in Local’s accounting records in Canadian
dollars:
December 15, 2013
Investment Property 14,020
Foreign Exchange (NI) 7,069*
Fair Value Increase (NI) 6,951*
To record investment property at fair value in Canadian dollars (€100,000 ⫻ 1.3902) ⫺ C$125,000 ⫽
C$14,020.
Foreign exchange gain is calculated as follows: €95,000 ⫻ (1.3902 ⫺ 1.3158) ⫽ C$7,069 .
Fair value change is calculated as follows: (€100,000 ⫺ €95,000) ⫻ 1.3902 ⫽ C$6,951.
* Note that it is not necessary to present these items separately. They may be combined and shown
together as part of the unrealized fair value change in investment property. This is a presentation choice
based on qualitative principles of relevance and reliability.
December 31, 2013

No entry because IAS 21 paragraph 23 (c) requires non-monetary items that are measured at fair value in a
foreign currency to be translated using the exchange rates at the date when the fair value was determined.
Illustrative Example 7.11 Non-monetary Items Reflected

at Fair Value in Subsequent Periods: Effect Through
Other Comprehensive Income
Local Corporation owns 2% of the voting common shares of a large European public
company. This investment is accounted for as a financial instrument.
Scenario 1:
Local Corporation accounts for this investment at fair value in accordance with IFRS 9.
The investment was purchased on December 15, 2013, and cost €95,000. The invest-
ment’s carrying amount at December 15, 2013, was C$132,069, which was €95,000
converted at the spot foreign currency rate of €1 ⫽ C$1.3902.
On December 31, 2013, the investment’s fair value has increased to €100,000 and
the spot rate was €1 ⫽ $1.4010.4
dollars:
December 31, 2013
Equity Investment—Financial Instrument 8,031
Fair Value Increase 8,031
To record investment in equity at fair value in Canadian dollars calculated as follows: (€100,000 ⫻ 1.4010)
⫺ C$132,069 ⫽ C$8,031 (per IFRS 9 paragraph 5.7.1, the gain or loss is included in profit or loss).
4
IAS 21 paragraph 23 (c) requires non-monetary items that are measured at fair value in a foreign cur-
rency be translated using the exchange rates at the date when the fair value was determined.
Scenario 2:
Local has made an irrevocable election at initial recognition to present the changes in
fair value of this investment in Other Comprehensive Income (OCI), as permitted by
IFRS 9.
The investment was purchased on December 15, 2013, and cost €95,000. The
investment’s carrying amount at December 15, 2013, was C$132,069, which was
€95,000 converted at the spot foreign currency rate of €1 C$1.3902.
On December 31, 2013, the investment’s fair value has increased to €100,000 and
the spot rate was €1 C$1.4010.
dollars:
December 31, 2013

Equity Investment—Financial Instrument 8,031
Other Comprehensive Income 8,031
To record investment in equity at fair value in Canadian dollars calculated as follows: (€100,000
1.4010) C$132,069 $8,031 (per IFRS 9 paragraph B5.7.3, the gain or loss that is presented
in Other Comprehensive Income in accordance with IFRS 9 paragraph 5.7.5 includes any related
foreign exchange component).
It is possible that when comparing the net realizable value of inventory with its carry-
ing amount denominated in a foreign currency, no impairment is apparent, but when
these amounts are converted into a company’s functional currency, impairment is real-
ized. In this case, an impairment loss is recognized even when it is strictly due to the
foreign exchange component. The treatment of the impairment is shown in Illustrative
Example 7.12.
Illustrative Example 7.12 Impairment

A Canadian company, Beauchamp Ltd., sells its products to both Canadian and U.S.
customers. As a result, it maintains two warehouses, one in Montreal and another in
New York City.
During the year, Beauchamp purchased inventory denominated in U.S. dollars in
the amount of U.S. $1,000,000 when the exchange rate was C$1 U.S. $0.9800. As
a result, the inventory is recorded in Beauchamp’s accounting records at C$1,020,408
(U.S. $1,000,000/0.98).
At Beauchamp’s year end of December 31, 2013, this inventory has not yet been
sold, and its net realizable value has decreased to U.S. $950,000. The exchange rate has
increased to C$1 U.S. $0.9700. As a result, since the inventory is carried at its net
realizable value, it must be translated using the exchange rate in effect when the net real-
izable value is determined (which is essentially the statement of financial position date).
In this example, the inventory is therefore carried at C$979,381 (U.S. $950,000/0.97).
The change in inventory, however, is not entirely represented by impairment but is
partially offset by the change in the foreign exchange rate. This change of C$41,027
(C$1,020,408 C$979,381) can be analyzed as follows:
• Impairment: $50,000 decrease in inventory ((U.S. $1,000,000 U.S. $950,000) /
$0.9700) C$51,546.
• Increase in exchange rate: (U.S. $1,000,000 / $0.9700) (U.S. $1,000,000 / $0.9800)
C$10,520.
ASPE: Foreign Currency Transactions

ASPE ASPE requires that transactions denominated in a foreign currency be translated using
the exchange rate in effect at the date of the transaction is referred to as the “temporal
method.”
The temporal method is the same process as that required under IFRS as described
in Illustrative Examples 7.1 7.9. The only difference in translation relates to non-
monetary items carried at market, which are required to be translated using the closing
rate at the statement of financial position date instead of the exchange rate when the fair
value was determined. The temporal method is summarized as follows:
• Monetary items are translated at the exchange rate in effect at the statement of
financial position date.
• Non-monetary items are translated at historical exchange rates, unless such items
are carried at market, in which case they are translated at the exchange rate in effect
at the statement of financial position date.
• Revenue and expense items are translated at the exchange rate in effect on the dates
they occur.
• Depreciation or amortization of assets translated at historical exchange rates is
translated at the same exchange rates as the assets to which it relates.
✓ LEARNING CHECK
• Transactions denominated in a foreign currency are translated at the date the transaction is
initially recognized in the company’s accounts using the spot exchange rate.
• At the statement of financial position date:
• Monetary items are translated using the exchange rate at the statement of financial posi-
tion date. Any resulting foreign exchange gain or loss is recorded in income.
• Non-monetary items carried at cost are not adjusted to take into account changes in for-
eign exchange rates.
• Non-monetary items carried at fair value are translated using the exchange rate in effect
when the fair value was determined. Any resulting foreign exchange gain or loss is recorded
in income unless the transaction to which the foreign exchange relates was initially recog-
nized in comprehensive income, in which case the foreign exchange component is recog-
nized in comprehensive income as well.
APPLYING HEDGE ACCOUNTING TO

FOREIGN CURRENCY TRANSACTIONS
Objective 3 In this section we examine the accounting for foreign currency derivative financial instru-
Apply hedge ments. This topic is dealt with under IFRS 39 and IFRS 9. Our discussion will assume early
accounting to implementation of IFRS 9. In its simplest terms, hedging means the elimination of risk.
transactions There are many different types of risk that a company may face and various manners of elimi-
denominated in a
foreign currency. nating that risk. A company may eliminate the credit risk on its account receivable, which is
the risk that the customer will not pay, by factoring its account receivable to another com-
pany. A company may eliminate an interest rate risk on its variable rate loan by entering into
an interest rate swap to fix the interest payment. The elimination of all types of risk, however,
costs money and a company must determine whether the cost of eliminating the risk is worth
the benefit. Every company has its own risk tolerance level and will determine its hedging
policy. In this section we examine hedging of foreign currency risk.
Applying Hedge Accounting to Foreign Currency Transactions 359
Economically Hedging Foreign Currency Risk

A company that enters into several transactions denominated in foreign currencies exposes
itself to risks that the foreign currencies will fluctuate, thereby causing it to realize foreign
exchange losses. As a result, a company may decide to protect itself from this risk exposure by
entering into transactions that cause an offsetting risk exposure.
Sometimes, companies enter into transactions that naturally achieve offsetting risks. For
example, a Canadian company, Abco Ltd., entered into a transaction to purchase merchandise
from a supplier located in Mexico. The transaction is denominated in Mexican pesos (Mex$),
and the purchase order is for Mex$50,000. The merchandise is scheduled to be delivered
in one week and the payment is due in 30 days. At the same time, Abco receives a purchase
order to sell goods to a customer located in Mexico. The order is denominated in Mexican
pesos and is for Mex$50,000. The merchandise is required to be delivered in one week and
payment is due to be collected in 30 days. The entries to record these transactions in Abco’s
books are shown in Illustrative Example 7.13.
Illustrative Example 7.13 Natural Hedges

Today (the day the transactions are initiated)
Purchase transaction Sales transaction

No entry required since no exchange has No entry required since no exchange has
taken place taken place
One week’s time: merchandise is received from Mexican supplier and merchandise is delivered to Mexican
customer (rate: Mex$1 C$0.08)
Inventory 4,000 Trade Receivable 4,000

Trade Payable 4,000 Sales 4,000
30 days’ time: cash is paid on the purchase and received on the sale (rate: Mex$1 C$0.085)
Trade Payable 4,000 Cash 4,250

Foreign Exchange Loss 250 Trade Receivable 4,000
Cash 4,250 Foreign Exchange Gain 250
As a result of Abco entering into two offsetting transactions, the company naturally pro-
tected itself from exposure to foreign currency fluctuations. This is commonly referred to as
economically hedging risk. In this case, the change in value of the Canadian dollar relative
to the Mexican peso on the purchase transaction was offset by an equal change in value on
the sale. In addition, this hedge does not cost the company anything. Usually theses hedges
will not eliminate all risk as the timing and amount of the receivable and the payable will
not be exactly the same. A profitable company will always have sales that are larger than its
purchases so it will still be subject to risk on the profit. In recent years, as the Canadian dollar
fluctuates widely relative to the U.S. dollar, many companies have tried to offset as much as
possible to eliminate this fluctuation.
Derivative Financial Instruments as Hedges

Speculating in Foreign Currency Financial Instruments
Companies sometimes purchase derivative financial instruments to speculate on future for-
eign currency movements, or to protect themselves from future fluctuations in currency
rates. There are several different types of derivative financial instruments, such as financial
options, futures or forward contracts, interest rate swaps, and currency swaps. These con-
tracts create rights and obligations that have the effect of transferring between the parties to
the instrument one or more of the financial risks inherent in an underlying primary financial
instrument. Derivatives are normally sold by a broker or financial institution.
A forward contract, for example, is a contract where two parties agree to exchange cur-
rencies at a set price in the future. A company may agree with a bank that in one month, the
company will pay the bank C$100,000 and it will receive from the bank $102,000 denomi-
nated in U.S. currency. However, since the foreign currency rate fluctuates constantly, this
contract will also fluctuate in value. If the Canadian dollar strengthens during the month
against the U.S. dollar, then the set price determined by the contract may become less favour-
able. For example, had the company not entered into the contract but decided to simply go
to the bank in one month and pay C$100,000 to receive the current value of U.S. dollars,
the bank would pay the company based on the spot rate at that moment, which may be more
like U.S. $104,000 due to the strengthening over the month. In this case, had the company
entered into a forward contract, it would have lost the opportunity to make an additional
U.S. $2,000 ($104,000 $102,000). The value of forward contracts (which are considered a
type of derivative financial instrument) is required to be recorded in the accounting records.
If the company were to try to sell the forward contract to someone else today, nobody
would buy it since a new contract might have cost closer to U.S. $1.04. It will never be exactly
1.04 since the bank is trading on a future value. This future value is referred to as the for-
ward rate, which factors in the time effect of the risk. As such, just by holding the contract,
the company has lost money. From a business point of view, this represents risk and there-
fore must be reflected on the financial statements. Under IFRS 9, it is clear that this risk on
financial instruments must be reflected as the company holds the instrument. It is not timely
information to wait until disposal of the instrument to reflect the gain or loss.
Hedging with Financial Instrument Derivatives

Companies often do not have natural hedges that inherently protect them from foreign cur-
rency fluctuations. In this case, a company would have to create an offsetting risk exposure. In
other words, to hedge the risk of currency fluctuations, a company creates a foreign currency
position opposite to that it wishes to protect.
One way of doing this is as follows. A Canadian company commits to purchasing a
machine from a U.S. supplier for $1,000,000 denominated in U.S. dollars. The machine
will only be delivered in two months, at which point payment will be due within 30 days
of receipt of the machine. The company is worried that the foreign exchange rate between
the Canadian dollar and U.S. dollar will fluctuate, causing it to have to pay more money
for the machine. It would like to minimize this risk. As a result, the day that the company
sends the purchase order for the machine, it also buys a forward foreign exchange contract
from a bank. This contract commits the company to buy U.S. $1,000,000 in three months for
a fixed amount of C$1,020,000.
Entering into this transaction effectively fixes the company’s foreign currency exposure
as follows. Since the company is required to purchase and pay for a machine whose price is
U.S. $1,000,000, it has now entered into a transaction to buy the required U.S. $1,000,000 for
a fixed price of C$1,020,000. If at the time that the machine is purchased, the spot exchange
rate is higher than the fixed rate, then the company will have protected itself against the
increased price. Similarly, by the time the company has to pay for the machine, if the foreign
exchange rate has increased, the company will have protected itself from further foreign cur-
rency exposure on the amount payable. It does not matter what happens to the U.S. dollar
relative to the Canadian dollar over the three-month period, since it has fixed the amount
at C$1,020,000. However, it is also possible that the exchange rates on the purchase and
payment dates will have decreased, thereby indicating that the company did not adequately
protect itself, but rather exposed itself to foreign exchange losses. This is an opportunity cost
that is not reflected on financial statements. This opportunity cost is less important to the
company. What it wants to do is eliminate “risk,” which is the unknown.
By hedging, the company is aware at the purchase date of the exact amount that it will have
to pay in Canadian dollars in three months. There is, however, a cost to eliminating this risk.
As we see in Illustrative Example 7.14, the overall loss is reflected as $1,040. This is referred to
as the cost of the hedge. It will equal the difference between the forward rate and the spot rate
at the inception of the hedge. The difference between the two rates is referred to as a discount
(premium) if the forward rate is less than (greater than) the spot rate, as shown below.
Exchange Rate
Forward rate $.172 .004 premium
Spot rate .168
Forward rate .160 .008 discount
Transaction Net Position Forward Contract

Export goods Account Receivable Sell Foreign Currency
Import goods Account Payable Buy Foreign Currency
Forward rate Spot rate Forward rate

to sell foreign currency to purchase foreign currency
<-------------.160------------------------------.168-----------------------------------.172------------------->
Discount Premium
Illustrative Example 7.14 Hedging with a Derivative:

No Hedge Accounting
ABC Corporation purchases a machine on April 15, 2013, to be delivered on June 15,
2013, in the amount of $1,000,000 denominated in U.S. dollars. Immediately thereaf-
ter, ABC enters into a forward foreign exchange contract to buy $1,000,000 denomi-
nated in U.S. dollars on July 15, 2013, for $1,020,408 denominated in Canadian dollars.
The invoice is payable July 15, 2013.
The following rates apply to the transaction:
Date C$1 U.S. $X spot rate C$1 U.S. $X forward rate
April 15, 2013 .9810 .9800
April 30, 2013 .9822 .9815
May 31, 2013 .9807 .9789
June 15, 2013 .9810 .9805
June 30, 2013 .9830 .9825
July 15, 2013 .9820 .9820
Note: the forward rate will converge to the spot rate at the settlement date, because at
that point there is no “future” and therefore no difference in value.
ABC would be required to make the following journal entries to account for these
transactions, assuming it prepared monthly financial statements:
April 15, 2013—no entry is required at this point since there is no gain or loss on
the day that the contract is entered into.
April 30, 2013—assume that a monthly financial statement is required:
Fair Value Loss (NI) 1,559
Derivative Liability 1,559
(U.S. $1,000,000/0.9815 U.S. $1,000,000/0.9800)
The change in the fair value of the derivative is realized in net income according to IFRS 9.
The offsetting amount in this situation is a liability. If the company had incurred a fair
value gain, it would have resulted in an asset on the statement of financial position. You
will note that this derivative is treated as a speculative contract.
May 31, 2013—assume that a monthly financial statement is required:
Derivative Liability (SFP)5 1,559
Derivative Asset (SFP) 1,147
Fair Value Gain (NI) 2,706
(U.S. $1,000,000/0.9789 U.S. $1,000,000/0.9815 C$2,706)
The change in the fair value for the month of May is recorded in net income. Note that
the derivative has now shifted from being a liability in April to being an asset in May.
5
For brevity, “SFP” in the journal entries in this chapter mean the item will appear on the statement
of financial position.
ABC is reflecting the volatility in the value of the derivative contract as it is treated as a
speculative contract.
June 15, 2013—receipt of the machine and recognition in the books of ABC:
Derivative Asset 1,147
Derivative Liability 520
(U.S. $1,000,000/0.9805 U.S. $1,000,000/0.9789 C$1,667)
The change in fair value for the 15 days in June is recorded since this is the day that the
machine is recognized. This entry does not need to be made as the month-end adjust-
ment could have been made for the 30 days at June 30. It is done in this problem for
ease of comparison.
Machine 1,019,368
(U.S. $1,000,000/0.9810)
This entry is made to record the acquisition of the machine at the day the transaction is
recorded. You will note that this is the same treatment as for regular foreign currency
transactions.
June 30, 2013—assume that the month-end financial statement is required:
(U.S. $1,000,000/0.9825 U.S. $1,000,000/0.9805 C$2,076)
To record the additional loss on the derivative from June 15 to June 30. The volatility is again reflected
through income.

(U.S. $1,000,000/0.983 U.S. $1,000,000/0.981)
ABC must restate the account payable to its current Canadian equivalent as it is a mon-
etary item. The change due to the exchange rate is flowed through net income.
You will note that since June 15, the fair value losses on one side almost completely
offset the foreign currency gains on the other side. This is due to the fact that ABC now
has a natural hedge on its books since the derivative receivable from the bank is offset-
ting the account payable, which is also now on the books. The slight difference is due
to the fact that the forward rates do not equal the spot rates until settlement. We will
examine this difference on July 15.
Depreciation Expense 4,189
(C$1,019,368/10 years 15/365)
In this example we will assume that the machine has a 10-year life with no residual value
and is being depreciated on a straight-line basis.
July 15, 2013—settlement date:
Fair Value Gain (NI) 518
(U.S. $1,000,000/0.982 U.S. $1,000,000/0.9825)
This entry is made to update the value of the forward contract so that the settlement
can now be recorded.
Cash U.S. $ 1,018,330
(U.S. $ cash received of $1,000,000 divided by the spot rate at that date of 0.982.)

Cash C$ 1,020,408
The contract is settled. ABC pays $1,020,408 as was agreed in the contract and the bank
gives U.S. $1,000,000, which is the equivalent of C$1,018,330. The derivative is now
gone, so any balance is eliminated.
Now that ABC has the U.S. dollars, it will pay the supplier and record the follow-
ing entries:
(U.S. $1,000,000/0.982 U.S. $1,000,000/0.983)
To update the account payable to the spot rate at the day of settlement.
Cash U.S. $ 1,018,330
This entry reflects the fact that ABC has paid the balance in the account payable with
U.S. $1,000,000, which is translated at the spot rate at the day of payment.
It is useful now to look at the financial statement impact at June 30, 2013.
Statement of financial position:
Machine $1,019,368
Accumulated depreciation (4,189)
Net $1,015,179
Derivative liability $ 2,596
Accounts payable 1,017,294
Comprehensive income statement:

Fair value loss $2,596
Foreign exchange gain 2,074
Net loss $ 522
Depreciation expense 4,189
It appears that without hedge accounting, ABC has incurred a net loss due to foreign
exchange fluctuations of $522. However, by continuing until the settlement date, we
can see that ABC incurred an additional net loss of $518 from June 30 until April 15.
Fair value gain $ 518
Foreign currency loss 1,036
Net loss $ 518
In total, it appears as if ABC has incurred a net loss of $1,040 (522 518). However, as
stated earlier, there is a cost to ABC of eliminating the risk. The important item is that
ABC knew that the loss of $1,040 would be incurred at the point that it entered into
the hedge on April 15. This is referred to as the cost of the hedge. It can be calculated
as the difference between the forward rate and the spot rate at the day of entering into
the hedge:
U.S. $1,000,000/0.981 U.S. $1,000,000/0.98 1,040
As such, ABC has eliminated risk at a cost of $1,040. The reader cannot see this easily
on the financial statements as the total effect is occurring in two different periods.
Definition of Hedge Accounting

Hedge accounting refers to the application of special accounting rules that allow a company
to modify the regular accounting for foreign exchange gains and losses. For the purpose of
hedge accounting, the item that creates a risk exposure for the company is referred to as the
“hedged item,” while the offsetting position created is referred to as the “hedging item.” You
can see in Illustration 7.2 a sample note disclosure from Bombardier Inc.’s financial state-
ments regarding its hedging policy. Bombardier Inc. manufactures a large range of regional
and business aircraft including the Learjet and Canadair aircraft.
Illustration 7.2
Hedge accounting
Excerpt from the
Financial Statements Designation as a hedge is only allowed if, both at the inception of the hedge and throughout the hedge
of Bombardier Inc. period, the changes in the fair value of the derivative financial instruments are expected to substantially
offset the changes in the fair value of the hedged item attributable to the underlying risk exposure.
The Corporation formally documents all relationships between the hedging instruments and hedged items,
as well as its risk management objectives and strategy for undertaking various hedge transactions. This
process includes linking all derivatives to forecasted foreign currency cash flows or to a specific asset or
liability. The Corporation also formally documents and assesses, both at the hedge’s inception and on
an ongoing basis, whether the derivative financial instruments that are used in hedging transactions are
highly effective in offsetting the changes in the fair value or cash flows of the hedged items. There are
three permitted hedging strategies:
Fair value hedges—The Corporation designates certain interest-rate derivatives and forward foreign
exchange contracts as fair value hedges. In a fair value hedge relationship, gains or losses from the
measurement of derivative hedging instruments at fair value are recorded in net income, while gains or
losses on hedged items attributable to the hedged risks are accounted for as an adjustment to the
carrying amount of hedged items and are recorded in net income.
Cash flow hedges—The Corporation designates forward foreign exchange contracts and interest-rate
swap agreements as cash flow hedges. In a cash flow hedge relationship, the portion of gains or losses
on the hedging item that is determined to be an effective hedge is recognized in OCI, while the ineffective
portion is recorded in net income. The amounts recognized in OCI are reclassified in net income when
the hedged item affects net income. However, when an anticipated transaction is subsequently recorded
as a non-financial asset, the amounts recognized in OCI are reclassified in the initial carrying amount
of the related asset.
Hedge of net investments in self-sustaining foreign operations—The Corporation designates certain cross-
currency interest-rate swap agreements and long-term debt as hedges of its net investments in self-sus-
taining foreign operations. The portion of gains or losses on the hedging item that is determined to be an
effective hedge is recognized in OCI, while the ineffective portion is recorded in net income. The amounts
recognized in OCI are reclassified to net income when corresponding exchange gains or losses arising from
the translation of the self-sustaining foreign operations are recorded in net income.
The portion of gains or losses on the hedging item that is determined to be an effective hedge is recorded
as an adjustment of the cost or revenue of the related hedged item. Gains and losses on derivatives not
designated in a hedge relationship and gains and losses on the ineffective portion of effective hedges are
recorded in other expense (income), or in financing income or financing expense for the interest
component of the derivatives or when the derivatives were entered into for interest rate management
purposes. Hedge accounting is discontinued prospectively when it is determined that the hedging instru-
ment is no longer effective as a hedge, the hedging instrument is terminated or sold, or upon the sale or
early termination of the hedged item.
Qualifying for Hedge Accounting

In order to qualify to use special hedge accounting rules, the hedge must be highly effective.6
This means that the strategy used by the company to protect itself from foreign currency risk
exposure was highly effective at achieving an offsetting risk exposure. For example, when
the critical terms of the hedging item exactly match those of the hedged item, the hedge is
considered highly effective. Critical terms may include that the currencies are the same and
the length of time is the same. The intent is to use the hedge to offset the risk on the item the
company is hedging. Illustrative Example 7.15 demonstrates the process of determining the
effectiveness of a hedge.
Illustrative Example 7.15 Determining Hedge Effectiveness

ABC Company receives an order to deliver goods, the price of which is denominated in
a foreign currency: €100,000. The goods must be delivered within five days and ABC
expects to receive payment in one month. In order to protect itself from fluctuations
in the foreign currency rate, the same day ABC receives the order from its customer, it
enters into a forward contract to pay to the bank €100,000 in 30 days.
6
Some interpret highly effective to mean that the actual results are within a range of 80–125%
effective in achieving offsetting cash flows.
In this case, the hedging item (the forward contract) is expected to exactly offset the
hedged item (the receivable). However, should ABC receive payment earlier or later
than 30 days’ time, ineffectiveness will result due to changes in the foreign exchange
rates between the date that the forward contract settles and the date that the monetary
item (the receivable) is still outstanding. Any foreign exchange gain or loss recognized
on the receivable between this time will be realized in profit or loss as the ineffective
portion of the hedge.
Another criterion for being able to apply hedge accounting is that the hedging
relationship must be formally documented at the inception of the hedging relationship.
The formal hedge documentation should include the following:
• the company’s risk management objective and strategy for undertaking the hedge
• the nature of the risk being hedged
• the hedged item
• the hedging instrument
• how the company will assess the hedging instrument’s effectiveness in offsetting
the exposure to changes in the hedged item’s fair value or cash flows attributable to
the hedged risk.
A hedge relationship cannot be designated retrospectively. Illustration 7.3 provides an

example of the documentation required to designate a hedging relationship.
Illustration 7.3
Risk management objective and strategy
Hedging Documentation
In order to comply with ABC Company’s foreign exchange risk management strategy, the foreign exchange
Required to Achieve
risk arising from the highly probable forecast purchase is designated as being in a qualifying hedging
Effectiveness
relationship.
Type of hedging relationship

Cash flow hedge: hedge of the foreign currency risk arising from highly probable forecast purchase.
Nature of risk being hedged

Canadian/U.S. spot exchange rate risk arising from a highly probable forecast purchase denominated in
U.S. dollars that is expected to occur on June 15, 2013, and to be settled on July 31, 2013.
Identification of hedged item

Purchase of 100,000 units of raw material for U.S. $50 per unit.
Forecast transaction
Hedged amount: U.S. $5,000,000
Nature of forecast transaction

Purchase of 100,000 units of raw material
Expected timescale for forecast transaction to take place

Delivery: June 15, 2013
Cash payment: July 31, 2013
Expected price
$50 per unit
High probability of forecast transaction occurring due to:

• Sales order must be filled by July 15, 2013.
• The supplier is in good standing with the company.
• The supplier has historically delivered on time and has a reputation for being reliable.
Identification of hedging instrument
Forward contract reference number ABCD12345.
The hedging instrument is a forward contract to buy U.S. $5,000,000 with the following characteristics:
• Price in Canadian to buy U.S. $5,000,000 is fixed at C$4,995,000
• Forward rate: C$1 ⫽ U.S. $0.9990
• Spot rate at inception: C$1 U.S. $0.9900

• Spot component of notional amount C$4,945,050
• Start date: May 15, 2013
• Maturity date: July 31, 2013
Hedge designation
The spot component of forward contract ABCD12345 is designated as a hedge of the change in the
present value of the cash flows on the forecast purchase identified above that is attributable to
movements in the Canadian/U.S. spot rate, measured as a hypothetical derivative.
The hypothetical derivative that models the hedged cash flows is a forward contract to pay U.S.
$5,000,000 in return for C$. The spot component of this hypothetical derivative is C$4,945,050
(that is, U.S. $5,000,000 at the spot rate on May 15, 2013).
Description of prospective testing

Dollar offset method, being the ratio of the change in the fair value of the spot component of forward
contract ABCD12345, divided by the change in present value of the hedged cash flows (hypothetical
derivative) attributable to changes in spot U.S./Canadian rate.
Frequency of testing
At inception of the hedge and then at each reporting date.
Description of retrospective testing

Dollar offset method, being the ratio of the change in fair value of the spot component of the forward
contract, divided by the change in present value of the hedged cash flows (hypothetical derivative)
attributable to changes in spot U.S./Canadian rate, on a cumulative basis.
Frequency of testing
At every reporting date after inception of the hedge.
Applying Hedge Accounting

IAS 39 Financial Instruments: Recognition and Measurement, IFRS 9 Financial Instruments, and
ASPE Section 3856 Financial Instruments require derivative financial instruments to be mea-
sured at fair value, with changes in fair value recognized in income (unless they are desig-
nated in effective hedging relationships). As seen previously, insofar as a forward foreign
exchange contract purchased for speculative reasons is concerned, changes in the foreign
currency rate will directly impact the fair value of the forward contract, which is normally
recognized in income.
Applying hedge accounting allows a company to achieve a smoother impact on earnings
by changing the normal basis for recognizing foreign exchange gains or losses. Usually, the
fair value of the forward contract is required to be recognized in income. Therefore, con-
tinuing our example from above, during the two months that the ordered machine is not yet
delivered, the fair value of the forward contract is recognized in income, creating income
volatility throughout the life of the forward contract, as seen in Illustrative Example 7.14.
Applying hedge accounting allows the fair value of the forward contract to be deferred until
the offsetting foreign exchange impacts income. At that point, the fair value of the forward
contract will be recognized in income, thereby smoothing the impact of volatility regarding
foreign exchange recognized in income for the period.
During the time that the hedge is effective, the changes in the fair value of the forward
contract (referred to as the “hedging item”) are recognized in Other Comprehensive Income.
These amounts are transferred to income when the item that causes the original foreign cur-
rency risk exposure (referred to as the “hedged item”) is recognized in income.
Hedges can be designated for hedge accounting purposes as being either cash flow
hedges or fair value hedges. In cash flow hedges, a company uses a hedging item (that is,
it creates an offsetting risk exposure by purchasing a derivative contract) to hedge against
future fluctuations in the Canadian dollar value of future cash flows (a risk exposure already
faced by the company, such as future payments). The gain or loss on the hedging item is
initially reported in Other Comprehensive Income and subsequently reclassified to net
income when the hedged item affects net income. Illustrative Example 7.16 demonstrates a
cash flow hedge.
In fair value hedges, a company uses a hedging item to protect itself against the fluctua-
tions in the fair value of a hedged item (a risk exposure that already exists). The gain or loss
on both the hedged and hedging items are recognized in profit or loss at the same time so
that the impact on profit or loss are offset. This is rarely used for hedging foreign currency
risk and is therefore not considered in this textbook.
Illustrative Example 7.16 Hedge Accounting:

Cash Flow Hedge
We will examine the same example of ABC Corporation as in Illustrative Example 7.14,
using the same data except that ABC decides to use hedge accounting. ABC determines
that the hedge is effective and prepares the necessary documentation. The U.S. $1,000,000
forward contract is the hedging item and the U.S. $1,000,000 payable to the supplier is
the hedged item. ABC would make the following journal entries each month:
Fair Value Loss—Other Comprehensive Income 1,559
(U.S. $1,000,000/0.9815 U.S. $1,000,000/0.9800)
The change in the derivative’s fair value is realized in Other Comprehensive Income.
The offsetting amount in this situation is a liability. If the company had incurred a fair
value gain, it would have resulted in an asset on the statement of financial position.
Derivative Liability (SFP) 1,559
Fair Value Gain—Other Comprehensive Income 2,706
(U.S. $1,000,000/0.9789 U.S. $1,000,000/0.9815 C$2,706)
The change in the fair value for the month of May is recorded in Other Comprehensive
Income. Note that the derivative has now shifted from being a liability in April to being
an asset in May. ABC does not reflect the volatility in the value of the derivative con-
tract through net income.
Fair Value Loss—Other Comprehensive Income 1,667
Derivative Asset 1,147
(U.S. $1,000,000/0.9805 U.S. $1,000,000/0.9789 C$1,667)
The change in fair value for the 15 days in June is recorded in Other Comprehensive
Income since this is the day that the machine is recognized.
Machine 1,019,368
(U.S. $1,000,000/0.9810)
This entry is made to record the acquisition of the machine at the day the transaction
is recorded.
Machine 520
Fair Value Loss—Other Comprehensive Income 520
There are two ways to treat this accumulation of fair value gains or losses in cumulative
other comprehensive income once the machine is finally recorded. The total amount
accumulated in cumulative other comprehensive income (1) can be transferred into the
carrying amount of the machine on initial recognition (as illustrated above) or (2) can
be amortized into income to offset the depreciation on the machine. The accounting
treatment would be an accounting policy choice based on judgement.
June 30, 2013—assume that the month end financial statement is required:
(U.S. $1,000,000/0.9825 U.S. $1,000,000/0.9805 C$2,076)
To record the additional loss on the derivative from June 15 to June 30. The volatility is again reflected
through income because there is now an offsetting position since the accounts payable is being recorded
as well.
(U.S. $1,000,000/0.983 U.S. $1,000,000/0.981)
ABC must restate the account payable to its current Canadian equivalent as it is a mon-
etary item. The change due to the exchange rate is flowed through net income.
ABC now has a natural hedge on its books since the derivative receivable from the
bank is offsetting the account payable, which is also now on the books. The slight dif-
ference is due to the fact that the forward rates do not equal the spot rates until settle-
ment. We will examine this difference on July 15.
([C$1,019,368 C$520]/10 years [15/365])
In this example we will assume that the machine has a 10-year life with no residual value
and is being depreciated on a straight-line basis. In effect, $520 of the cost of the hedge
is included in the asset acquired and will only flow through net income as the asset itself
flows through income.
(U.S. $1,000,000/0.982 U.S. $1,000,000/0.9825)
This entry is made to update the value of the forward contract so that the settlement
can now be recorded.
Cash U.S. $ 1,018,330
(U.S. $ cash received of $1,000,000 divided by the spot rate at that date of 0.982.)
Cash C$ 1,020,408
The contract is settled. ABC pays C$1,020,408 as was agreed in the contract and the
bank gives U.S. $1,000,000, which is the equivalent of C$1,018,330. The derivative is
now gone so any balance is eliminated.
Now that ABC has the U.S. dollars, it will pay the supplier:
Foreign Exchange Loss (NI) 1,036
(U.S. $1,000,000/0.982 U.S. $1,000,000/0.983)
Cash U.S. $ 1,018,330
This entry reflects the fact that ABC has paid the balance in the account payable with
U.S. $1,000,000, which is translated at the spot rate at the day of payment.
Machine $1,019,888
Net $1,015,697

Fair value loss $ 2,076
Net loss $ 2
Fair value $ 0
It appears that with hedge accounting, ABC has incurred a net loss due to foreign
exchange fluctuations of $2. However, by continuing until the settlement date we can
see that ABC incurred an additional net loss of $518 from June 30 until April 15.
Net loss $ 518
In total it appears as if ABC has incurred a net loss of $520 (518 2). However, as
ABC knew that the cost of $1,040 would be incurred at the point that it entered into the
hedge on April 15. The difference by using hedge accounting is that $520 of this cost
is in the cost of the machine and the other $520 is the net loss effect, which together
equals the same cost of $1,040 as seen in Illustrative Example 7.14.
The financial statements, however, have eliminated the volatility that was seen
when hedge accounting was not used.7
In order for a cash flow hedge to be effective, the changes in the cash flows of the hedge
and the item it is hedging must offset during the term of the hedge and occur during the
term of the relationship. In other words, when a hedge is perfectly effective, there are no
overall exchange gains or losses reflected in profit. It is possible that a hedge is only partially
effective. This is examined in Illustrative Example 7.17.
Illustrative Example 7.17 Partially Ineffective Hedge

Using Illustrative Example 7.16, assume that ABC settled the payable on June 30, 2013,
instead of July 15, 2013. ABC would clearly have had to acquire the $1,000,000 from
another source since the forward contract will not be settled until July 15, 2013. The
following ineffectiveness would be recognized in net income:
To record change in fair value of forward contract.

Foreign Exchange Gain (NI) 2,074
To record change in foreign currency on monetary liability.

Cash 1,017,294
To record payment of accounts payable.
7
IAS 39 par. 87 allows the above type of transaction to be accounted for as a fair value hedge. This
is because hedges of firm commitments (such as a committed forecast purchase as illustrated above)
are accounted for as fair value hedges when the company is exposed to changes in fair value of that
commitment since the price of the machine may change as a result of foreign currency fluctuations.
IAS 39 par. 89 requires that the fair value of the forward in this case be recorded through income and
the change in value of the hedged risk—the price of the machine in this case—be recorded through
income as well, thereby offsetting each other and smoothing income volatility.
Derivative Liability (SFP) 518

Fair Value Loss (NI) 518
To record change in fair value of forward contract.
Cash U.S. $ 1,018,330
Cash C$ 1,020,408
To record settlement of forward contract.
Impact July 15, 2013:
Machine $1,019,888
Net 1,015,697
Fair value loss $518
Net loss $518
Fair value $0
A net foreign exchange loss of $518 is recorded in net income, which represents the
ineffective portion arising from exchange rate fluctuations between the settlement of
the account payable and the settlement of the forward contract.
ASPE: Hedge Accounting for Foreign Currency Transactions

ASPE Under ASPE, like IFRS, hedge accounting is always optional and is applied only when
accounting requirements for both the hedged item and hedging item create an account-
ing mismatch. To prevent abuse, ASPE requires strict adherence to a number of quali-
fying conditions.
When hedge accounting is applied to an anticipated transaction, derivatives that
are designated in a qualifying hedging relationship are not required to be accounted for
at fair value.
To qualify for hedge accounting, the derivative must exactly offset a specific risk of
the hedged item. Only in this way does the company mitigate the volatility inherent in
either the hedged item or the hedging item.
Also, other comprehensive income does not exist under ASPE.
We will examine the same example of ABC Corporation as in Illustrative Example
7.16, using the same data except that ABC follows ASPE. ABC determines that the
hedge is effective and prepares the necessary documentation. The U.S. $1,000,000 for-
ward contract is the hedging item and the U.S. $1,000,000 payable to the supplier is the
hedged item. ABC would make the following journal entries each month:
Fair Value Loss (equity) 1,559
(U.S. $1,000,000/0.9815 U.S. $1,000,000/0.9800)
The change in the fair value of the derivative is realized in equity since other
comprehensive income does not exist under ASPE. If ABC had decided not to use
hedge accounting, the results would be the same as those in Illustrative Example 7.14
under IFRS.
Fair Value Gain (equity) 2,706
(U.S. $1,000,000/0.9789 U.S. $1,000,000/0.9815 C$2,706)
The change in the fair value for the month of May is recorded in equity. ABC does
not reflect the volatility in the value of the derivative contract through net income.
Fair Value Loss (equity) 1,667
Derivative Asset (B/S) 1,147
Derivative Liability (B/S) 520
(U.S. $1,000,000/.9805 U.S. $1,000,000/0.9789)
To change the fair value of the derivative to the day that the machinery is acquired.
Machine 1,019,368
(U.S. $1,000,000/0.9810)
This entry is made to record the acquisition of the machine at the day the transac-
tion is recorded.
Machine 520
Fair Value Loss (equity) 520
To transfer the balance in the derivative account to the machine.

There are two ways to treat this accumulation of fair value gains or losses in equity,
once the machine is finally recorded. The total amount accumulated in equity can (1)
be transferred into the carrying amount of the machine on initial recognition (as illus-
trated above) or (2) this amount can be amortized into income to offset the depreciation
on the machine. The accounting treatment would be an accounting policy choice based
on judgement.
June 30, 2013—assume that the month-end financial statement is required:
(U.S. $1,000,000/0.9825 U.S. $1,000,000/0.9805 C$2,076)
To record the additional loss on the derivative from June 15 to June 30. The vola-
tility is again reflected through income because there is now an offsetting position since
the accounts payable is being recorded as well.
(U.S. $1,000,000/0.983 U.S. $1,000,000/0.981)
ABC must restate the account payable to its current Canadian equivalent as it is
a monetary item. The change due to the exchange rate is flowed through net income.
ABC now has a natural hedge on its books since the derivative receivable from
the bank is offsetting the account payable, which is also now on the books. The slight
difference is due to the fact that the forward rates do not equal the spot rates until
settlement. We will examine this difference on July 15.
([C$1,019,368 C$520]/10 years [15/365])
In this example we will assume that the machine has a 10-year life with no residual
value and is being depreciated on a straight-line basis. In effect, $520 of the cost of the
hedge is included in the asset acquired and will only flow through net income as the
asset itself flows through income.
(U.S. $1,000,000/0.982 U.S. $1,000,000/0.9825)
This entry is made to update the value of the forward contract so that the settle-
ment can now be recorded.
Cash U.S. $ 1,018,330
(U.S. $ cash received of $1,000,000 divided by the spot rate at that date 0.982)
Cash C$ 1,020,408
The contract is settled. ABC pays C$1,020,408 as was agreed in the contract and
the bank gives U.S. $1,000,000, which is the equivalent of C$1,018,330. The derivative
is now gone so any balance is eliminated.
Now that ABC has the U.S. dollars, it will pay the supplier:
Foreign Exchange Loss (NI) 1,036
(U.S. $1,000,000/0.982 U.S. $1,000,000/0.983)
Cash U.S. $ 1,018,330
This entry reflects the fact that ABC has paid the balance in the account payable
with U.S. $1,000,000, which is translated at the spot rate at the day of payment.
Machine $1,019,888
Net $1,015,697
Income statement:
Fair value loss $ 2,076
Net loss 2
It appears that without hedge accounting, ABC has incurred a net loss due to for-
eign exchange fluctuations of $2. However, by continuing until the settlement date we
can see that ABC incurred an additional net loss of $518 from June 30 until April 15.
Net loss $ 518
In total it appears as if ABC has incurred a net loss of $520 (518 2). However, as
ABC knew that the loss of $1,040 would be incurred at the point that it entered into the
hedge on April 15. The difference by using hedge accounting is that $520 of this cost
is in the cost of the machine and the other $520 is the net loss effect, which equals the
same cost of $1,040 as seen in Illustrative Examples 7.14 and 7.16.
To summarize the illustrative examples regarding ABC’s hedge accounting, ABC would be
required to make the following accounting entries to account for these transactions assuming
it prepared monthly financial statements:
Without hedge accounting With hedge accounting: IFRS With hedge accounting: ASPE
April 15, 2013
No entry required for the forward contract since the fair value on inception is $0.
April 30, 2013

Fair Value Loss (NI) 1,559 Fair Value Loss (OCI) 1,559 Fair Value Loss (equity) 1,559
Derivative Liability (SFP) 1,559 Derivative Liability (SFP) 1,559 Derivative Liability (SFP) 1,559
To record change in fair value of forward To record change in fair value of forward To record change in fair value of forward
contract. contract. contract.
Notice that without hedge accounting, the change in fair value of the forward contract is
realized in earnings, whereas with the application of cash flow hedge accounting, the change
in fair value of the forward contract bypasses profit and is realized in Other Comprehensive
Income. Under ASPE hedge accounting requirements, the change in fair value of the forward
contract is recognized in equity since OCI does not exist. Had hedge accounting not been
used under ASPE, the accounting would be the same as that in the left-hand column entitled
“without hedge accounting” and earnings volatility would have resulted.
May 31, 2013
Derivative Asset (SFP) 1,147 Derivative Asset (SFP) 1,147 Derivative Asset (SFP) 1,147
Fair Value Gain (NI) 2,706 Fair Value Gain (OCI) 2,706 Fair Value Gain (equity) 2,706
Notice that without the use of hedge accounting, there would be volatility realized through
earnings since last month where a loss of $1,559 had been recognized in April 2013 and now
a gain of $2,706 is being realized. With hedge accounting, this volatility accumulates in OCI,
while under ASPE, it is accumulated in equity.
June 15, 2013
Fair Value Loss (NI) 1,667 Fair Value Loss (OCI) 1,667 Fair Value Loss (equity) 1,667
Derivative Asset (SFP) 1,147 Derivative Asset (SFP) 1,147 Derivative Asset (SFP) 1,147
Derivative Liability (SFP) 520 Derivative Liability (SFP) 520 Derivative Liability (SFP) 520
To record change in fair value of forward To record change in fair value of forward To record change in fair value of forward-
contract. contract. contract to the machine (the hedged item).
Machine 1,019,368 Machine 1,019,368 Machine 1,019,368

Accounts Payable 1,019,368 Accounts Payable 1,019,368 Accounts Payable 1,019,368
To record purchase of machine. To record purchase of machine. To record receipt of machine.
No entry Machine 520 Machine 520

Fair Value Loss (OCI) 520 Fair Value Loss (equity) 520
To transfer accumulated fair value To transfer accumulated fair value changes
changes in OCI to price of machine. in equity to price of machine.
Notice that without the use of hedge accounting, additional volatility is realized since last month
where a loss is now realized (as compared with a gain realized last month and a loss in the month
prior), whereas these changes are accumulated in OCI under IFRS and equity under ASPE.
June 30, 2013
Fair Value Loss (NI) 2,076 Fair Value Loss (NI) 2,076 Fair Value Loss (NI) 2,076
Accounts Payable 2,074 Accounts Payable 2,074 Accounts Payable 2,074
Foreign Exchange Foreign Exchange Foreign Exchange
Gain (NI) 2,074 Gain (NI) 2,074 Gain (NI) 2,074
To record change in foreign currency on To record change in foreign currency on To record change in foreign currency on
monetary liability. monetary liability. monetary liability.
Without hedge accounting, since the monetary liability (the account payable) is not settled, it
must be retranslated at the current spot rate with foreign exchange gains or losses being real-
ized through income. However, due to the fact that the changes in fair value of the forward
contract are also realized through income, a natural hedge is realized, which effectively elimi-
nates the impact of foreign currency fluctuations realized in profit. In this case, when hedging
monetary items, it is evident that hedge accounting is not specifically advantageous.
July 15, 2013
Derivative Liability (SFP) 518 Derivative Liability (SFP) 518 Derivative Liability (SFP) 518
Fair Value Gain (NI) 518 Fair Value Gain (NI) 518 Fair Value Gain (NI) 518
Cash U.S. $ 1,018,330 Cash U.S. $ 1,018,330 Cash U.S. $ 1,018,330
Derivative Liability 2,078 Derivative Liability 2,078 Derivative Liability 2,078
Cash C$ 1,020,408 Cash C$ 1,020,408 Cash C$ 1,020,408
To record settlement of forward contract. To record settlement of forward contract. To record settlement of forward contract.
Foreign Exchange Loss (NI) 1,036 Foreign Exchange Loss (NI) 1,036 Foreign Exchange Loss (NI) 1,036
Accounts Payable 1,036 Accounts Payable 1,036 Accounts Payable 1,036
To record change in foreign To record change in foreign To record change in foreign
currency on monetary liability. currency on monetary liability. currency on monetary liability.
Accounts Payable 1,018,330 Accounts Payable 1,018,330 Accounts Payable 1,018,330
Cash 1,018,330 Cash 1,018,330 Cash 1,018,330
To record payment of accounts payable. To record payment of accounts payable. To record payment of accounts payable.
As you can see above, all accounts are settled at this point since the forward contract has
matured and the accounts payable is paid. As mentioned above, the use of hedge accounting
with monetary items is not advantageous.
Net Impact
At year end, June 30, 2013
Machine 1,019,368 Machine 1,019,888 Machine 1,019,888

Accumulated Accumulated Accumulated
depreciation (4,189) depreciation (4,191) depreciation (4,191)
Derivative liability 2,596 Derivative liability 2,596 Derivative liability 2,596
Accounts payable 1,017,294 Accounts payable 1,017,294 Accounts payable 1,017,294
Income Statement
Fair value loss 2,596 Fair value loss 2,076 Fair value loss 2,076
Foreign exchange gain 2,074 Foreign exchange gain 2,074 Foreign exchange gain 2,074
Net loss 522 Net loss 2 Net loss 2
Other Comprehensive Income
Fair value 0
✓ LEARNING CHECK
• Companies try to manage their foreign currency risk by entering into transactions that cause
offsetting risk exposures. This is sometimes referred to as economically hedging a risk.
• Hedge accounting refers to a special set of accounting rules that allow a company to smooth
the impact of foreign currency fluctuations on income.
• Without the use of hedge accounting, an increased volatility on income would be realized
resulting from a company’s exposure to foreign currency risk.
• Under hedge accounting—cash flow hedge, IFRS records the changes in the hedging item (the
forward contract) in Other Comprehensive Income until the hedged item (the balance exposed to
foreign currency risk) affects income. Once foreign currency risk affects income on the hedged
item (i.e., once foreign exchange gains and losses are realized), the corresponding fair value
changes on the hedging item that have been accumulating in Other Comprehensive Income are
transferred to income to offset the foreign exchange, thereby eliminating income volatility.
Translating Financial Statements from the Functional Currency to the Presentation Currency 375
TRANSLATING FINANCIAL STATEMENTS

FROM THE FUNCTIONAL CURRENCY
TO THE PRESENTATION CURRENCY
Choosing the Presentation Currency
Objective 4 Entities may choose to present their financial statements in any currency. Given the rising
Translate financial trend toward globalization, management may like to present their financial statements in a
statements from the currency different from their functional currency in order to attract investors or because it
functional currency is required by local law or other regulation. A company may present its statements in a cur-
to the presentation
currency. rency more common in the global marketplace, which is used to viewing financial informa-
tion denominated in a currency not functional to the company. Illustration 7.4 contains a
note disclosure by Rio Tinto, an international mining group headquartered in London, in
its 2010 annual report regarding foreign currency. Illustration 7.5 contains the disclosure of
Canadian drugstore retailer The Jean Coutu Group (PJC) Inc. on its 2010 financial state-
ment regarding translation of foreign currency.
Illustration 7.4
(i) Foreign exchange risk
Statements of Rio Tinto Rio Tinto’s shareholders’ equity, earnings, and cash flows are influenced by a wide variety of currencies
due to the geographic diversity of the Group’s sales and the countries in which it operates. The US dollar,
however, is the currency in which the great majority of the Group’s sales are denominated. Operating
costs are influenced by the currencies of those countries where the Group’s mines and processing plants
are located and also by those currencies in which the costs of imported equipment and services are
determined. The Australian and Canadian dollars and the Euro are the most important currencies (apart
from the US dollar) influencing costs. In any particular year, currency fluctuations may have a significant
impact on Rio Tinto’s financial results. A strengthening of the US dollar against the currencies in which
the Group’s costs are denominated has a positive effect on Rio Tinto’s underlying earnings.
Given the dominant role of the US currency in the Group’s affairs, the US dollar is the currency in which
financial results are presented both internally and externally. It is also the most appropriate currency for
borrowing and holding surplus cash, although a portion of surplus cash may also be held in other currencies,
most notably Australian dollars, Canadian dollars, and the Euro. This cash is held in order to meet short term
operational and capital commitments and, for the Australian dollar, dividend payments. The Group finances
its operations primarily in US dollars, either directly or using cross currency interest rate swaps.
Illustration 7.5
h) Foreign currency translation
Statements of Jean Coutu The non-consolidated financial statements of the parent corporation, its subsidiaries, and its investments
subject to significant influence are prepared based on their respective functional currencies, which is the
Canadian dollar for Canadian operations and corporate activities and the US dollar for its investment sub-
ject to significant influence in Rite Aid.
The financial statements of entities with the functional currency not the Canadian dollar are translated
into the reporting currency according to the current rate method. Under this method, statement of earn-
ings and statement of cash flow items of each year are translated to the reporting currency at the average
monthly exchange rates and asset and liability items are translated at the exchange rate in effect at the
Statement of Financial Position date. Translation adjustments resulting from exchange rate fluctuations are
recorded in foreign currency translation adjustments in the accumulated other comprehensive income.
Transactions denominated in currencies other than an entity’s functional currency are translated accord-
ing to the temporal method. Under this method, monetary assets and liabilities in foreign currencies are
translated at the exchange rate in effect at the Statement of Financial Position date, non-monetary assets
and liabilities in foreign currencies at their historical rates, and statement of earnings items in foreign
currencies at the average monthly exchange rates. All exchange gains and losses are included in the
consolidated statements of earnings, unless subject to hedge accounting.
When a company’s financial statements are translated, for presentation purposes, into a cur-
rency that differs from its functional currency, the translation of these financial statements
for presentation purposes is referred to as presenting the financial statements in a “presenta-
tion currency.”
The mechanics of translating financial statements to a presentation currency tries to
ensure that the financial and operational relationships between the amounts established in
the company’s primary economic environment and measured in a company’s functional cur-
rency are preserved when translated into a different currency for the sake of presentation.
The method used to translate financial statements from a functional currency into a presenta-
tion currency is discussed further below.
Translating Financial Statements

into a Presentation Currency
The translation of the financial statements into a presentation currency is completed (accord-
ing to IAS 21.39) as follows:
1. Assets and liabilities (including comparatives) are translated at the closing rate at the date
of the statement of financial position.
2. Income and expenses (including comparatives) for each statement of comprehensive
income presented are translated at exchange rates at the dates the transactions took place.
3. All resulting exchange differences are recognized in Other Comprehensive Income.
For practical purposes, an average rate to approximate the actual exchange rate at the date of
the transactions for income and expenses may be used as long as these items basically occur
evenly over the period being presented.
Using a constant rate of exchange for all items appearing on the statement of financial
positions maintains the relationship in the retranslated financial statements (into the presen-
tation currency) as that that existed in the foreign operation’s financial statements (using the
functional currency). Therefore, each item maintains its same proportions on the statement
under the presentation currency as it did under the functional currency. Using a closing rate
is more likely to preserve the financial results and relationships that existed prior to transla-
tion, but the use of an actual or average rate, which is used on the statement of comprehen-
sive income, reflects more accurately the performance and cash flows as they accrue to the
group throughout the period. Illustrative Example 7.18 examines the translation from the
functional currency to the presentation currency.
Illustrative Example 7.18 Translation of Financial

Statements from Functional Currency to Differing
Presentation Currency
Mayer Company has a functional currency of the Canadian dollar. In order to attract
U.S. investors, it decides it wants to present its financial statements in U.S. dollars
instead of Canadian dollars.
Mayer’s year end is December 31, 2013. The closing rate at that date is U.S. $1
C$0.9800. The average yearly foreign currency rate is C$1 $0.9820. The rate at
the beginning of the year was U.S. $1 C$0.99. Since the exchange rate is expressed
in terms of one U.S dollar, the Canadian balances are divided by the U.S. exchange
rate to arrive at the U.S. amount. Mayer’s financial statements are translated as
follows.
Translating Financial Statements from the Functional Currencyto the Presentation Currency 377
MAYER COMPANY
Balance C$ Rate Balance U.S. $

Assets
Cash $ 1,000 0.98 $ 1,020
Accounts receivable 115,000 0.98 117,347
Inventory 200,000 0.98 204,082
Total current assets 316,000 0.98 322,449
Equipment 150,000 0.98 153,061
Loan receivable 75,000 0.98 76,531
Total non-current assets 225,000 0.98 229,592
$541,000 0.98 $ 552,041
Liabilities
Trade payables $ 50,000 0.98 $ 51,020
Provisions 30,000 0.98 30,612
Total current liabilities 80,000 0.98 81,632
Mortgage payable 225,000 0.98 229,592
Total non-current liabilities 225,000 0.98 229,592
305,000 0.98 311,224
Equity
Share capital 10,000 1.15a 8,696a
Retained earnings 226,000 1.10b 205,455b
Other components of equity — 26,666c
Total equity 236,000 240,817
Total liabilities and equity $ 541,000 $ 552,041
a
There is no guidance provided on how to translate equity items. Management, therefore, must make an ac-
counting policy choice. This can be, for example, using either the historical rate or the closing rate for equity
items. The chosen policy should be applied consistently. In this example, we used a historical rate. For share
capital, this would be the rate when the shares were issued.
b
This balance will be a buildup of the various average rates used throughout the years when profit or loss was
translated. Retained Earnings is actually an accumulation of the previous year’s income less dividends. In the
real world, the opening retained earnings would be obtained from a previous year’s file. It would then be increased
by this year’s income translated at the average rate and decreased by any dividends declared at the rate on the
declaration date. We can see this from the statement of changes in equity.
c
This amount of $26,666 can be considered a plug figure to balance the statement of financial position but
the amount can be proven. The gain or loss for the current year can be determined by comparing the net assets
at the historical rate when each item occurred with the year-end rate. For Mayer, you can see below that this is
a gain since the net assets are actually U.S. $240,817. However, when they would theoretically have originally
been recorded, the amount was $238,682.
C$ Exchange rate U.S. $ balance

Net assets—beginning of year 199,750 0.990 201,768
Net income 36,250 0.982 36,914
238,682
Net assets—end of year 236,000 0.980 240,817
Foreign currency translation gain 2,135
If the gain for the current period is $2,135 and the overall gain in Mayer at year end
is $26,666, the opening balance (which represents gains or losses from previous years)
must be $24,531. In the real world, the amount of $24,531 in the opening balance of
Cumulative Other Comprehensive Income would be available from the previous years’
financial statements.
You will note that in this problem Mayer did not declare any dividends. Since divi-
dends declared affect the net assets, they would have been included in the calculation
above to analyze the change in the net assets.


Revenue $1,250,000 0.9820 $1,272,912
Cost of sales 825,000 0.9820 840,122
Gross profit 425,000 0.9820 432,790
Other income 55,000 0.9820 56,008
Distribution costs 150,000 0.9820 152,749
Administrative expenses 225,000 0.9820 229,124
Other expenses 45,000 0.9820 45,825
Finance costs 15,750 0.9820 16,039
Income before tax 44,250 0.9820 45,061
Income tax expense 8,000 0.9820 8,147
Net income 36,250 0.9820 36,914
Exchange differences on
translating foreign operations — 2,135
Total comprehensive income for the year $ 36,250 $ 39,049


Share capital $ 10,000 1.15 $ 8,696
Retained earnings:
Opening balance 189,750 1.1258a 168,540
Net income 36,250 0.9820 36,914
Closing balance $ 226,000 $ 205,454
Other components of equity
Opening balance: translation gain $ 24,521
Translation gain 2013 2,135
Closing balance: translation gain $ 26,666
a
This amount would normally be provided from the previous year’s file. In this example we identified this amount
as the balancing figure.
Under ASPE, there is no method specified for converting financial statements from a
ASPE company’s functional currency to a different presentation currency.
✓ LEARNING CHECK
• Financial statements can be presented in any currency.
• When a company selects a presentation currency for its financial statements that is differ-
ent than its functional currency, the statements must be translated into the presentation
currency.
• Upon translation, assets and liabilities are translated at the closing rate at the presentation
date and income statement items are translated using the average rate for the period.
• Any gain or loss on translation is considered part of other comprehensive income since there
is no real effect on present or future cash flows of the company.
KEY TERMS
LEARNING SUMMARY
Closing rate (p. 351)
Exchange rate
Companies transact all over the world in currencies other than the Canadian dollar. A com-
(p. 344)
pany must determine its functional currency, which is the currency in which it conducts its
Foreign currency
primary economic activity. This first step is necessary as the financial reporting for the com-
(p. 348)
pany must reflect its functional currency. Transactions that are not in the functional currency
Foreign exchange gain
are considered to be foreign currency transactions.
or loss (p. 344)
Foreign currency transactions are translated at the spot rate at the day of the transaction.
Functional currency
The average rate may be used to approximate the actual spot rate. At subsequent reporting
(p. 345)
dates, monetary items are restated to the current Canadian amount and non-monetary items
Highly effective hedge
are kept at the historical rate. This is because the monetary items are exposed to foreign cur-
(p. 364)
rency risk.
Historical exchange
A company may wish to eliminate the risk it is exposed to when transacting in a for-
rate (p. 354)
eign currency. If it is possible, the company will create a natural hedge in (that is, it will
Monetary items
economically hedge) its business environment to offset foreign payables with foreign
(p. 351)
receivables.
Non-monetary items
When a company does not have the ability to naturally eliminate risk, it will manufacture
(p. 351)
an offsetting position through the acquisition of foreign currency derivatives. In this textbook
Presentation currency
we have examined forward contracts that are purchased to eliminate this risk. The company
(p. 344)
makes a decision as to whether the cost to acquire the hedge item is worth the benefit of
Spot exchange rate
eliminating the risk.
(p. 349)
Hedge accounting is a method of accounting that allows the company to defer recogni-
tion of gains or losses on the hedging item until the hedged item is reflected in the books
and records. This method requires that the hedge be effective and that there be sufficient
documentation regarding the hedging relationship. Companies that apply hedge account-
ing eliminate the volatility in the fair value of the derivative being reflected in the financial
statements.
Companies are permitted to present their fi nancial statements in any currency. If
the company’s presentation currency is different than its functional currency, it must
translate these statements from the functional currency into the presentation currency.
Statement of Financial Position items are translated at the closing rate for the day and
income statement items are translated at the average rate for the year. Any gain or loss on
this translation is recorded in Other Comprehensive Income as there is no real cash flow
effect to the company. Here are the basic steps for translating foreign currency into the
functional currency.
Basic Steps for Translating Foreign Currency Amounts

into the Functional Currency
1. The reporting company determines its functional currency.

2. The company translates all foreign currency items into its functional currency at the spot
rate and the day of the transaction (use of averages is permitted if they are a reasonable
approximation of actual).
At each subsequent statement of financial position date:
3. Foreign currency monetary amounts should be reported using the closing rate.
4. Non-monetary items carried at historical cost should be reported using the exchange
rate at the date of the transaction.
5. Non-monetary items carried at fair value should be reported at the rate that existed when
the fair values were determined.
Brief Exercises
(LO 1) BE7-1 What is meant by the “functional currency” of a company?
(LO 1) BE7-2 When a company that has the Canadian dollar as the functional currency transacts in Canadian dollars with a
U.S. company, would this be a foreign currency transaction? Why or why not?
(LO 3) BE7-3 A Canadian company has purchased €15,000 of inventory that has been delivered and must be paid for in
three months. The company is very risk averse. How might it eliminate the foreign currency risk?
(LO 2) BE7-4 A company bought a machine for U.S. $50,000 on January 1, 2013. The machine is to be delivered in one
week and is payable upon receipt of the machine. The company has not yet paid for the machine. It is now January 15,
2013, and the company must present a financial statement. What would be reflected on the financial statements regard-
ing this transaction?
(LO 3) BE7-5 Assuming the same scenario as BE7-4, the company also buys a derivative contract on January 1, 2013, for
U.S. $50,000 to be received in one month. What would be reflected on the financial statements of January 15, 2013,
regarding this transaction?
(LO 3) BE7-6 Assume the same scenario as BE7-5 but the company chooses to use hedge accounting. What would be
reflected on the financial statements at January 15, 2013, regarding this transaction?
(LO 4) BE7-7 What is meant by presentation currency?
(LO 4) BE7-8 Why would a company present its financial statement in a currency that is different than its functional currency?
(LO 1) BE7-9 What is meant by foreign currency risk for a company?
(LO 3) BE7-10 Why would a company want to eliminate foreign currency risk?
Exercises
(LO 2) E7-1 Sando Ltd. made the following sales in euros during 2013 and collected the amounts owed based on the follow-
ing schedule:
Date Sales—euros Collections—euros 1 euro = × C$
February 1, 2013 1,265,000 1.315
February 20, 2013 830,000 1.376
February 25, 2013 2,756,000 1.428
February 28, 2013 750,000 1.345
Required
(a) Prepare the journal entries to be made during the month of February assuming that Sando must prepare a month-
end financial statement.
(b) Indicate the balance in the Accounts Receivable account on the statement of financial position as at the month end
February 28, 2013.
(LO 2) E7-2 Craiton Ltd. made the following purchases in Brazilian reals (BRL) during 2013 and paid the amounts owed
based on the following schedule:
Date Purchases (BRL) Payments (BRL) BRL1 = × C$

April 1, 2013 875,000 .548
April 15, 2013 450,000 .552
April 23, 2013 925,000 .591
April 30, 2013 380,000 .578
Required
(a) Prepare the journal entries to be made during the month of April assuming that Craiton must prepare a month-end
financial statement.
(b) Indicate the balance in the Accounts Payable account on the statement of financial position as at the month end
April 30, 2013.
Exercises 381
(LO 2) E7-3 On January 1, 2010, Edmon Inc. borrowed 5,000,000 Swedish krona (SEK) from a bank in Sweden. The loan
has a four-year life and requires an annual interest payment of 4% (payable on the first of the year). The following
exchange rates exist for the krona relative to the Canadian dollar:
Date SEK 1 = × C$
January 1, 2010 .154
December 31, 2010 .157
Average 2010 .161
January 1, 2011 .167
December 31, 2011 .162
Average 2011 .159
January 1, 2012 .153
December 31, 2012 .149
Average 2012 .145
January 1, 2013 .147
December 31, 2013 .154
Average 2013 .152
Required
(a) Prepare the journal entries with respect to the loan and interest for each of the years 2010 to 2013.
(b) Indicate the foreign currency gain or loss in each of the years 2010 to 2013.
(c) Calculate the balance in the loan account on the statement of financial position for each of the years 2010 to 2013.
(LO 2) E7-4 Campbell Inc. regularly buys materials in Argentina for use in its Canadian manufacturing facility. During
2013, Campbell made two acquisitions, one on February 1, 2013, and another on November 1, 2013, each for 10,000
units at 500 Argentine pesos (ARS) each. At year end there are 12,000 units remaining. The net realizable value at year
end is 510 ARS per unit. None of the purchases had been paid for by the year end December 31, 2013. The following
exchange rates exist for 2013:
February 1, 2013 ARS 1 5 C$.231

November 1, 2013 ARS 1 5 C$.240
December 31, 2013 ARS 1 5 C$.229
Required
(a) Prepare the journal entries for 2013 (assume the weighted average method of costing inventory).
(b) Indicate the foreign currency effect on the comprehensive income statement for the year ending December 31,
2013.
(c) Indicate the inventory and accounts payable balances on the statement of financial position as at December 31,
2013.
(LO 2) E7-5 Esson Oil buys oil at market prices and sells it at market price plus a profit margin of U.S. $5 per barrel.
On January 1, Esson buys 10 barrels of oil at a price of U.S. $30 per barrel when the Canadian dollar is on par with
the U.S. dollar. On January 2, Esson sells 2 barrels for U.S. $35 each (the market price is still U.S. $30). On January 3,
the price of oil increases to U.S. $32 per barrel. On January 4, Esson sells 5 more barrels at U.S. $37. No cash was either
received or paid. The following exchange rates exist:
January 1 C$1 5 U.S. $1.00

January 2 C$1 5 U.S. $0.90
January 3 C$1 5 U.S. $0.92
January 4 C$1 5 U.S. $0.88
Required
Prepare the journal entries to reflect these transactions assuming the functional currency is the Canadian dollar and
Esson uses a perpetual inventory system.
(LO 2) E7-6 On December 1, 2013, Mayberry Inc. purchased inventory on account from a U.S. supplier for U.S. $40,000
when the exchange rate was U.S. $1 5 C$0.97. The inventory was still on hand at Mayberry’s year end, December
31, 2013, and the account had not been paid. The exchange rate at December 31, 2013, was U.S. $1 5 C$1.02. The
account was paid on February 1, when the exchange rate was U.S. $1 5 C$1.06.
Required
(a) At what amounts should the inventory and the account payable relating to the above transactions be reported on
the December 31, 2013, statement of financial position?
(b) What exchange gain or loss will be reported in 2013 relating to the above transactions?
(LO 3) E7-7 On October 2, 2013, a Canadian company contracts with a U.S. winery for delivery from the winery of 1,000
cases of wine at a price of U.S. $100,000. The wine is to be delivered February 1, 2014, and payment made in U.S.
dollars on March 31, 2014. In order to hedge this future commitment, the Canadian company purchases U.S. $100,000
for delivery in 180 days at a forward exchange rate of $C1 = $US 0.775. The company has a December 31 year end.
Oct. 2, 2013 Dec. 31, 2013 Feb. 1, 2014 Mar. 31, 2014
Spot Rate $0.75 $0.74 $0.73 $0.72

60-days future $0.77 $0.75 $0.74 $0.73
90-days future $0.78 $0.76 $0.75 $0.76
180-days future $0.775 $0.73 $0.735 $0.735
Required
(a) Prepare the journal entries in 2013 and 2014 assuming that hedge accounting is not used.
(b) Prepare the journal entries in 2013 and 2014 assuming that the Canadian company has elected to use hedge accounting.
(c) Prepare the journal entries in 2013 and 2014 assuming that the Canadian company has elected to follow ASPE and
uses hedge accounting.
(d) Indicate the balances in inventory, derivatives on the statement of financial position and the foreign exchange gains
or losses on the statement of comprehensive income for 2013 and 2014 year-end under each of the scenarios above.
(LO 3) E7-8 A company purchases a piece of equipment from a German supplier for €100,000, payable one month later.
The company enters into a foreign-exchange forward contract whereby it agrees to purchase the euros on the payment
date for the equipment.
When the order was placed: €1 C$1.293
When the equipment was received: €1 C$1.301
When the payment was made: €1 C$1.3566
Foreign-exchange contract rate: €1 C$1.2967
Required
What will the carrying value of the equipment be after the transaction has taken place (assuming the company uses
hedge accounting)?
(LO 2, 3) E7-9 Chretien Co., a Canadian company, sold iron ore to a foreign company for U.S. $100,000, with payment to be
received on February 1, 2013. Chretien entered into a contract to deliver U.S. $100,000 in exchange for Canadian dol-
lars but decided not to apply hedge accounting. The following are the events related to this sale and the exchange rates
during 2012 and 2013:
Date Event Spot Rates Future Rates
October 1, 2012 Received order for goods U.S. $1 C$0.988 U.S. $1 C$0.984
November 1, 2012 Delivered goods and signed
forward contract U.S. $1 C$0.987 U.S. $1 C$0.981
December 31, 2012 Year end for Chretien U.S. $1 C$0.985 U.S. $1 C$0.987
February 1, 2013 Received cash U.S. $1 C$0.989 U.S. $1 C$0.989
Required
For contracts expiring on February 1, 2013:
(a) What is the amount of revenue for this sale on Chretien’s income statement?
(b) What is the final amount of cash received in Canadian dollars from the combination of the sale and the forward
contract?
(c) What is the exchange gain or loss on the accounts receivable for the year ended December 31, 2012?
(d) How should the exchange gain or loss on the accounts receivable be reported?

Problems 383
Problems
(LO 2) P7-1 Craigs Inc. had the following transactions:
1. On September 1, Craigs Inc. purchased parts from an Indian company for a Canadian dollar equivalent value
of $8,000, to be paid on February 20. The exchange rates between the Indian rupee (INR) and the Canadian
dollar were:
September 1 INR 1 C$.022

December 31 INR 1 C$.024
February 20 INR 1 C$.021
2. On November 1, Craigs Inc. sold products to a Swiss customer for a Canadian dollar equivalent of 10,000 SF, to
be received on March 10. The exchange rates between the Swiss franc (SF) and Canadian dollar were:
November 1 SF 1 C$0.70
December 31 SF 1 C$0.66
March 10 SF 1 C$0.68
Required
(a) Assume the functional currency is the Canadian dollar. Prepare the entries required for the dates of the transac-
tions and their settlement in Canadian dollars.
(b) Assume the two transactions are denominated in the applicable local currency units of the foreign entities. Prepare
the entries required for the dates of the transactions and their settlement in the local currency units of the Indian
company (rupees) and the Swiss customer (SF).
(LO 3) P7-2 On November 15, 2013, Nizker Ltd., a Canadian company that follows IFRS, entered into a firm commitment
to purchase inventory from a European supplier for €250,000, which will be paid in euros upon delivery on January 31,
2014. Nizker hedges this commitment by purchasing a €250,000 term deposit on November 15, 2013. The hedge is
designated as a cash flow hedge and Nizker will apply hedge accounting.
The exchange rate on November 15, 2013, was €1 C$1.33. At Nizker’s year end, December 31, 2013, the
exchange rate was €1 C$1.30. At January 31, 2014, the exchange rate was €1 C$1.35.
Required
(a) Prepare journal entries to record the events from November 15, 2013, to December 31, 2013. (Another employee
will record the interest on the term deposit, so you will not need to do this.)
(b) Discuss the effectiveness of this euro term deposit as a hedge against foreign currency risk.
(c) Explain how using hedge accounting is superior to not using hedge accounting in this situation with respect to the
financial statements’ portrayal of the company’s currency risk exposure.
(LO 3) P7-3 On December 1, 2012, Sycamore Company acquired a 90-day speculative forward contract to sell 120,000
British pounds (£) at a forward rate of £1 C$1.61. The rates are as follows:
Forward Rate
Date Spot rate For March 1
December 1, 2012 £1 C$1.61 £1 C$1.61
December 31, 2012 £1 C$1.65 £1 C$1.62
March 1, 2013 £1 C$1.585 £1 C$1.585
Required
(a) Prepare the journal entries for the period of December 1, 2012, through March 1, 2013.
(a) Show the effects of this speculation on both the 2012 and 2013 comprehensive income statements.
(LO 3) P7-4 Berke Company purchased equipment from Norway for 140,000 krones (NOK) on December 16, 2013, with
payment due on February 14, 2014. On December 16, 2013, Berke also acquired a 60-day forward contract to purchase
krones at a forward rate of NOK 1 C$.182. On December 31, 2013, the forward rate for an exchange on February 14,
2014, is NOK 1 C$.192. The spot rates were:
December 16, 2013 NOK 1 C$.187
December 31, 2013 NOK 1 C$.195
February 14, 2014 NOK 1 C$.192
Required
(a) Prepare journal entries for Berke Company to record the purchase of equipment, all entries associated with the
forward contract, the entries on December 31, 2013, and entries to record the payment on February 14, 2014.
(b) What was the effect on the income statement of the hedged transaction for the year ended December 31, 2013?
(c) What was the overall effect on the income statement of this transaction from December 16, 2013, to February 14,
2014?
(LO 2, P7-5
3, 4) 1. On December 1, 2013, a Canadian company purchased inventory for €500,000 payable on March 1, 2014 (the
transaction is denominated in euros). It also entered into a forward contract on that date.
2. The company’s fiscal year end is December 31.
3. The spot rate for euros (C$/euro) and the forward rates for euros on March 1, 2014, at various times is as follows:
Forward Rate
Spot Rate (for 3/1/2014 euros)
Transaction date: December 1, 2013 C$1.05 C$1.052

Statement of financial position date: C$1.06 C$1.059
December 31, 2013
Settlement date: March 1, 2014 C$1.07
Required
(a) Prepare the journal entries for 2013 and 2014 regarding this transaction under each of the following situations:
1. The company does not use hedge accounting.
2. The company does use hedge accounting.
3. The company follows ASPE.
(b) Indicate the balance in inventory at December 31, 2013, under each of the circumstances outlined above.
(c) Calculate the income statement effect for 2013 and 2014 under each of the circumstances above.
(LO 2, 3) P7-6 GOW Inc. purchases used mining equipment, refurbishes it, and sells it to mining companies around the world.
On October 31, 2013, GOW ordered some used mining equipment from a company in a foreign country for 100,000
foreign currency units (FC). On December 31, 2013, the equipment was delivered with payment made on delivery. On
October 31, 2013, GOW entered into a forward contract with a bank to buy FC 100,000 on December 31, 2013. On
December 31, 2013, GOW settled the forward contract with the bank, paid the supplier, and recorded year-end adjust-
ing journal entries relating to these accounts.
Exchange rates were as follows:
Forward Rates
Spot Rates (for contracts expiring on December 31, 2013)
October 31, 2013 FC 1 5 C$5.40 FC 1 5 C$5.30
December 31, 2013 FC 1 5 C$5.22 FC 1 5 C$5.22
Required
(a) Determine the net cash outflow in Canadian dollars for the combined purchase of the equipment and the forward
contract, assuming that the forward contract is designated as:
1. a cash flow hedge
2. a speculative contract
(b) Determine the carrying amount of the equipment at December 31, 2013, the exchange gains or losses reported in
net income for 2013, and the exchange gains or losses reported in other comprehensive income for 2013, assuming
that the forward contract is designated as:
1. a cash flow hedge
2. a speculative contract
(c) Briefly explain which of the reporting methods in part (b) better reflects the economic substance of the situation.
(LO 2, P7-7 On December 1, 2013, Xanadu Corporation entered into a forward contract to buy €500,000 on March 1, 2014,
3, 4) for C$1.52.
Problems 385
On March 1, 2013, Xanadu enters into a forward contract to sell 200,000 Chilean pesos (CLP) in 12 months at the
forward rate of C$0.39.
Assume that Xanadu has a December 31 year end.
Spot rates and the forward rates for euros and pesos relative to the Canadian rate on selected dates are:
Euro spot Euro 31/2013 CLP Spot CLP 31/2013

Date Exchange 1€ Forward 1€ Exchange 1 CLP Forward 1 CLP
March 1, 2013 C$1.418 C$1.43 C$0.400 C$0.390
December 31, 2013 C$1.529 C$1.57 C$0.395 C$0.385
March 1, 2014 C$1.581 C$0.380
Required
(a) Prepare the journal entries to record the transactions in 2013 and 2014 assuming that :
1. hedge accounting is not used.
2. hedge accounting is used.
3. ASPE is followed.
(b) Calculate the gain or loss to be recorded in income under each of the scenarios above.
(c) Was hedge accounting useful for this company?
(LO 2, 3) P7-8 On November 1, 2013, JEZ corporation contracted to purchase William and Kate memorabilia from England
for 30,000 pounds (£). The memorabilia was to be delivered on January 30, 2014, and payment would be due on
March 1, 2014. On November 1, 2013, JEZ corporation entered into a 120-day forward contract to receive £30,000
at a forward rate of £1 C$1.59. The forward contract was acquired to hedge the financial component of the foreign
currency commitment. JEZ follows IFRS.
Additional information and data for the exchange rate is:
Spot and exchange rates are:
Forward Rate
Date Spot Rate For March 1, 2014
November 1, 2013 £1 C$1.61 £1 C$1.59

December 31, 2013 £1 C$1.65 £1 C$1.62
January 30, 2014 £1 C$1.59 £1 C$1.60
March 1, 2014 £1 C$1.585 £1 C$1.585
Required
(a) What is JEZ’s net exposure to changes in the exchange rate of pounds for dollars between November 1, 2013, and
March 1, 2014?
(b) Prepare all journal entries from November 1, 2013, through March 1, 2014, for the purchase of the memorabilia, the
forward exchange contract, and the foreign currency transaction. Assume JEZ’s fiscal year ends on December 31, 2013.
(LO 2, 3) P7-9 On December 1, 2013, Maclan Ltd. estimates that at least 5,000 units of inventory will be purchased from a
company in the Netherlands during January 2014 for €500,000. The transaction is probable and the transaction is to be
denominated in euros. Sales of the inventory are expected to occur in the six months following the purchase. Maclan’s
functional currency is the Canadian dollar.
On December 1, 2013, Maclan enters into a forward contract to purchase €500,000 on January 31, 2014, for
C$1.01. This is the date on which the inventory will have to be paid for.
Spot rates and the forward rates at the January 31, 2014 settlement were as follows (dollars per euro):
Forward Rate
Spot Rate For 1/31/14
December 1, 2013 C$1.03 C$1.01

Statement of financial position date C$1.00 C$0.99
(12/31/13)
January 31, 2014 C$0.98
Required
(a) Prepare the journal entries to record the transaction in 2013 and 2014 assuming that Maclan:
1. follows ASPE and uses hedge accounting.
2. follows IFRS and has selected to use hedge accounting.
3. follows IFRS and has not used hedge accounting.
(b) Which accounting framework and accounting policy will yield the best results for Maclan?
(LO 4) P7-10 Plaxton Inc. is a company located in Canada and uses the Canadian dollar as the functional currency. Plaxton
began operations January 1, 2012. Its shareholders are American and would like the statement to be presented in U.S.
dollars. The following is an excerpt from Plaxton’s financial statements for 2012 and 2013. The changes in Other
Comprehensive Income occur evenly over the year. Dividends were declared at year end. There was no other compre-
hensive income at the day of acquisition.
2013 2012
Inventory $ 180,000 $160,000
Cash 420,300 10,000
Land 154,900 65,000
$1,401,700 $706,000
Share capital $ 330,000 $330,000
Retained earnings (1/1/13) 46,000 0
Bonds 100,000 40,000
$1,401,700 $706,000
The following exchange rates exist for the U.S. dollar relative to the Canadian dollar:
Date U.S. $1 = × C$
January 1, 2012 1.02
December 31, 2012 1.11
Average 2012 1.01
December 31, 2013 1.21
Average 2013 1.004
Required
Translate the Plaxton financial statements as at December 31, 2013 from its functional currency to its presentation cur-
rency.
(LO 4) P7-11 Shelton Ltd. records its transactions in euros since that is its functional currency but must present its financial
statements in Canadian dollars as a requirement for the Canadian Securities and Exchange Commission. Shelton has a
December 31 year end. Below is a trial balance for Shelton for 2013 in euros.
Sales revenue €234,800
Dividend revenue 17,000
Other income 6,600
258,400
Cost of sales (123,000)
Other expenses (34,600)
(157,600)
Income tax expense (32,000)
Net income 68,800
Total available for appropriation 144,800
Interim dividend paid (34,000)
Dividend declared (16,000)
(50,000)
Retained earnings (31/12/13) € 94,800
Current assets
Cash € 1,000
Receivables 27,000
Allowance for doubtful accounts (500)
Problems 387

Inventory 48,000
Non-current assets
Plant and machinery 100,000
Land 99,300
Bond investments 60,000
Investments in equity instruments 160,000
Current liabilities
Provisions 12,000
Bank overdraft —
Current tax liabilities 11,000
Total current liabilities 39,000
Total non-current liabilities 13,000
Net assets €422,800
Equity
Share capital €320,000
Total equity €422,800
The following exchange rates exist for the euro relative to the Canadian dollar:
January 1, 2013 C$1.00 ⫽ €1.315
Average 2013 C$1.00 ⫽ €1.25
December 31, 2013 C$1.00 ⫽ €1.2
The rate when the common stock was issued was C$1.00 ⫽ €1.18 and the beginning retained earnings was earned at the
average exchange rate of C$1.00 ⫽ €1.22 The other component of equity balance was created on the last day of 2012
due to a fair value change in a financial asset on which an election was taken..
Required
Translate the Shelton financial statement into its presentation currency.
(LO 2, 3) P7-12 MacDonald’s Highland Shoppe Ltd. (MHS) imports top quality kilts and accessories directly from Scotland
for sale to Canadian and American customers. Because of its international suppliers and customers, MHS uses IFRS.
It is October 18, 2013, and on November 1, 2013, MHS plans to enter into a firm commitment to purchase inventory
from a supplier in Scotland for £100,000.
Payment is to be made upon delivery of the inventory on February 28, 2013. Because of uncertain foreign cur-
rency markets, the owner-manager, Mac, is considering entering into a forward contract to hedge the currency risk
but is uncertain how this will affect the financial statements. He wants you, the company accountant, to determine the
effect of these transactions on MHS’s 2013 and 2014 income statements (year end is December 31) under the following
assumptions:
1. On November 1, 2013, MHS enters into a forward contract with a bank to buy £100,000 at the four-month
forward rate.
2. The payment to the supplier is made on February 28, 2014.
3. All the inventory obtained in this purchase is sold in 2014.
Mac would like you to use the following assumed exchange rates in your calculations:
Spot Rates Forward Rates

November 1, 2013 1.50 1.54 (4-month forward)
December 31, 2013 1.42 1.44 (2-month forward)
February 28, 2014 1.62 1.62
Mac would also like you to provide some information about hedge accounting, so the company can make an informed
decision on whether or not to use this approach.
Required
(a) Calculate the effect of exchange rate changes for the above scenario on MHS 2013 and 2014 income statements,
assuming that hedge accounting is not used. Your calculations should include both the income effect of exchange
gains and losses and cost of goods sold. Ignore income taxes.
(b) Explain how hedge accounting would avoid the income statement effects calculated in part (a) assuming that the
forward contract is designated as a cash flow hedge.
Writing Assignments
(LO 1) WA7-1 There is a debate about whether a company should be permitted to present its financial statements in a cur-
rency (or currencies) other than its functional currency. Some believe it should not. They believe that the functional
currency, being the currency of the primary economic environment in which the entity operates, most usefully portrays
the economic effect of transactions and events on the entity. For a group that comprises operations with a number of
functional currencies, they believe that the consolidated financial statements should be presented in the functional cur-
rency that management uses when controlling and monitoring the group’s performance and financial position. They
also believe that allowing an entity to present its financial statements in more than one currency may confuse, rather
than help, users of those financial statements. Supporters of this view believe that any presentation in a currency other
than that described above should be regarded as a “convenience translation” that falls outside the scope of IFRS.
Required
Express your opinion on the debate raised above and support the presentation style that you feel will be the most useful
to the reader.
(LO 1) WA7-2 Jan Leskewitch has approached you for advice on how to record transactions for her company. She has just
started an Internet-based business in her basement and is surprised to see that she has a great deal of interest from
customers in Europe. She is considering recording her prices in euros on the website and allowing her clients to pay in
euros. She would like to understand the accounting implications of setting up her business in this manner.
Required
Provide the advice requested from Jan.
(LO 3, 4) WA7-3 Sailaway Boats is a new client of yours. Sailaway makes custom boats for specific orders. It will have to follow
Canadian GAAP but is unsure if ASPE or IFRS will be required. The manufacturing facility is in Germany but most of
the clients are in the United States and Canada. Sailaway bills for orders in U.S. dollars and takes advantage of forward
contracts to hedge against foreign exchange fluctuations. Sailaway was recently bought out by a Canadian owner who
wants to see financial statements in Canadian dollars. Sailaway wants to understand the accounting implications for its
foreign currency risk in the business.
Required
Explain the foreign currency accounting issues to Sailaway Boats.
Cases
(LO 2, C7-1 Sasha Inc. (SI) is a public company located in Canada that operates a chain of retail stores. SI reports its financial
3, 4) statements in Canadian dollars and has recently started to purchase goods from the United States payable in U.S. dol-
lars to sell in its stores.
You, CA, are the controller of SI and have been approached by the Vice-President Finance to explain the impacts
of the foreign currency purchases and to find a solution to SI’s exposure to the fluctuations in exchange rates. He has
heard from a friend who works at a bank that they could potentially use derivative instruments in order to minimize
their exposure to fluctuations in foreign exchange rates. However, the VP is unsure how to go about this, what it
would entail, and what would be the impact to SI. He has asked you for your assistance in these matters. In addition,
he would like to know what the impacts are on the annual management bonus, which is based on audited net income.
Furthermore, if SI were following ASPE, would the transactions be accounted for in the same manner?
Cases 389
You have been provided in Exhibit C7-1(a) with the U.S. dollar purchases since May 31, 2013, and the actual
closing foreign exchange rates in Exhibit C7-1(b). Exhibit C7-1(c) includes the forward contracts that were available
as at May 31, 2013. It is currently November 30, 2013. SI’s year end is December 31 and it prepares monthly financial
statements.
Required
Prepare the analysis requested by the Vice-President of Finance.
EXHIBIT C7-1(a)
Purchases Since May 31, 2013
Transaction #1, June 15, 2013: Purchase of U.S. $995,000 to be paid 30 days subsequent to the purchase date (July 15, 2013)
Transaction #2, July 15, 2013: Purchase of U.S. $875,000 to be paid 30 days subsequent to the purchase date (August 15, 2013)
Transaction #3, August 15, 2013: Purchase of U.S. $925,000 to be paid 30 days subsequent to the purchase date (September
15, 2013)
EXHIBIT C7-1(b)
Actual Closing Foreign Exchange Rates
Date Spot Rate C$ to U.S. $
June 15, 2013 1 to 0.95
June 30, 2013 1 to 0.97
July 15, 2013 1 to 0.99
July 31, 2013 1 to 0.98
August 15, 2013 1 to 0.96
August 31, 2013 1 to 0.95
September 15, 2013 1 to 0.99
September 30, 2013 1 to 0.97
EXHIBIT C7-1(c)
Available One-Month Forward Contracts as May 31, 2013
Date One Month Forward Rate C$ to U.S. $
June 15, 2013 1 to 1.01
June 30, 2013 1 to 0.98
July 15, 2013 1 to 1.02
July 31, 2013 1 to 0.99
August 15, 2013 1 to 0.97
August 31, 2013 1 to 0.96
(LO 1, 2) C7-2 You, CA, are the audit senior of Ball Construction Corporation (BC), a small public company. It is September
19, 2013, and the year-end audit fieldwork has just been completed. The audit partner, Reena Sidhu, phones to say,
“The client has requested we meet next Thursday to complete the audit so BC can provide financial statements to its
bank. Based on our discussions, I’m comfortable with the amount of fieldwork performed, but I’d like to see the com-
pleted files. Please prepare a memo discussing the accounting issues I need to bring to the attention of management.”
You set to work finalizing the files. You review the audit planning information (Exhibit C7-2[a]) and the financial
statements as prepared by management (Exhibit C7-2[b]), and then review the audit file, flagging important items
(Exhibit C7-2[c]). The CFO was quite adamant that no adjustments be made to the financial statements, declaring that
“the statements fairly and accurately represent the financial situation of BC.”
Required
Prepare the memo requested by Reena Sidhu.
EXHIBIT C7-2(a)
SUMMARY OF AUDIT PLANNING INFORMATION
Company Background
BC, a Canadian construction company, enters into construction contracts with individuals and developers and builds to their
specifications. The company subcontracts some aspects of a project when required, but primarily uses its own labour force. It
has 180 employees, many of whom are long-term employees. BC does not own or manage properties once they have been built.
The company recently opened a branch in the southwestern United States. Most of BC’s management believed the com-
pany should jump into the U.S. market before a slowdown, so the expansion was approved without much discussion. Similar to
its Canadian operations, BC enters into contracts in the United States, but instead of hiring employees, it subcontracts all the
labour required for its U.S. projects.
In 2012, BC purchased a patented foundation process (classified on the statement of financial position as an intangible
asset) designed to improve the durability of a building’s foundation. The process has full regulatory approval in Canada and has
been used successfully. Management saw the U.S. expansion as an opportunity to launch BC’s patented foundation process
outside of Canada by using it for the foundations of multi-unit housing projects. As part of obtaining regulatory approval for the
process in the United States, an engineer inspected the design of BC’s first planned multi-unit housing project to be built there.
He expressed concerns regarding the quality of the foundation process in a letter sent to BC. To date in the United States, BC
has only built single-unit projects that did not use the process.
New Programs
This year, to enhance teamwork and effectiveness, the CEO introduced a program called “Walk a Mile in Your Co-worker’s
Shoes.” Managers must spend one week per month in a different department manager’s position to better understand the issues
faced by other departments.
BC also implemented a non–interest-bearing employee housing loan program on February 1, 2013. Individual loans of up
to $36,000 were offered to long-term employees to assist with housing needs, such as buying a new home or reducing an exist-
ing mortgage. The CFO considered the possibility of obtaining security for the loans, but thought that the paperwork would be
too time-consuming.
Risk Assessment
Although BC’s audit is recurring and we are familiar with its operations and systems, we determined that the audit risk for this
year has increased from medium to high. There are three main reasons for the change:
1. Recent declines and significant instability in the U.S. housing market have created a high credit-risk situation.
2. BC’s controller left in March 2013, and the position had not been filled by fiscal year end.
3. Even though BC enjoys a good relationship with its bank, the bank increased the interest rate on the company’s operating line
during the fiscal year, suggesting that it views BC as a higher risk than before.
The bank requires audited financial statements, and has now put the following covenants in place:
The operating line limit is 80% of trade accounts receivable, plus 50% of inventory, plus 30% of construction in progress.
The working capital ratio must be 1.35 or better.
The operating line and long-term debt are secured by a general security agreement over BC’s assets.
EXHIBIT C7-2(b)
BC FINANCIAL STATEMENTS AS PREPARED BY MANAGEMENT
BALL CONSTRUCTION CORPORATION
Balance Sheet
As at July 31
2013 2012
Assets
Current assets
Cash and cash equivalents $ 15 $ 30
Trade accounts receivable from developers, net 20,100 19,081
Employee receivables 3,832
Prepaid expenses and other assets 353 250
Construction in progress 31,844 26,000
65,399 50,505
Property, plant and equipment, net 3,279 4,230
Intangible assets, net 9,500 10,000
$78,178 $64,735
Liabilities
Current liabilities
Operating line of credit $30,200 $22,227
Accounts payable, accrued liabilities, and deposits 16,958 12,423
Income taxes payable 120 2,080
Current portion of long-term debt 265 280
47,543 37,010
Long-term debt 843 1,123
48,386 38,133
Cases 391
2013 2012
29,792 26,602
$78,178 $64,735
BC FINANCIAL STATEMENTS AS PREPARED BY MANAGEMENT

BALL CONSTRUCTION CORPORATION
Income Statement
For the years ended July 31
2013 2012
Revenue $108,401 $95,967
Operating expenses
Administration, salaries, and benefits 2,498 1,958
Amortization 1,451 1,044
Bad debt expense 2,668 544
Equipment maintenance and rentals 956 684
Foreign exchange losses 130 42
Interest 1,623 1,250
Supplies and services 1,000 422
Travel and other 325 150
10,651 6,094
Income tax 2,260 4,185
Net income $ 3,190 $ 6,277
EXHIBIT C7-2(c)
ITEMS OF NOTE FROM THE AUDIT FILE
1. Internal Control
(a) When the controller left, the finance department staff took on additional duties, and often ended up working overtime. We
noted that during the latter part of the year, the same individual was creating purchase orders, entering invoices into the
system, and preparing the cheque runs. The CFO said the situation was unavoidable, and noted that the accounting manager
reviewed the cheque runs and prepared the bank reconciliations.
(b) We noted that many journal entries had not been approved. The CFO said that he trained most of the employees responsible
for the entries, so he knows what the entries are for. He also said, “Our management review of reports and financial state-
ments would uncover any incorrect entries.”
(c) The CFO relies on senior management to review, approve, and sign reports generated by the finance department, such as
the “Costing Report by Project.” Testing of a sample of reports indicated that most reports had been appropriately approved.
However, some reports were found on a construction manager’s desk. When asked about them, she explained, “I’m so busy
managing the jobs that I have and ’walking in someone else’s shoes’ that I haven’t had time yet to look them over.” The
signed reports were provided to the audit team the next day and the audit testing was completed.
2. Analytical Review
We noted a decline in gross profit from 17% to 15%. Salaries and most operating expenses increased from the prior year. Bad
debt expense increased almost 500% over 2007. According to the CFO, these trends are related to the U.S. contracts, which
have lower margins. Expanding to the United States also contributed to the increase in operating costs. In addition, the U.S.
economy deteriorated during the year, resulting in an increase in the number of customer accounts written off. We believe the
explanations are satisfactory because they are consistent with other audit findings.
Inventory increased because BC anticipated a large increase in the cost of some of the materials used in the foundation
process, and purchased $1.25 million of foundation materials before year end. This extra inventory was stored on the site of
the multi-unit housing project in the United States. When asked about the risk of the materials not being usable due to the
problems with receiving U.S. regulatory approval, the CFO responded that the material would eventually be used: “There’s about
a 50/50 chance that the process will be approved for use in the U.S. If it is not approved, we could ship the material back to
Canada and use it here.”
Another reason for the increase in total inventory is an error made by a construction manager who was “walking a mile”
in the purchasing manager’s shoes. He incorrectly authorized the purchase of $900,000 of construction project materials as
a result of misunderstanding a submitted purchase request. To make matters worse, the price of these particular construction
project materials has recently declined 25% due to increased overseas competition.
3. Accounts Receivable and Allowance for Doubtful Accounts
We sent confirmations to a sample of accounts receivable and noted two issues based on responses received:
(a) One confirmation was returned stating that a receivable balance, related to a $1,542,000 contract, was overstated based
on the progress report. Upon examination of the relevant report, we noted that a transposition error had occurred (86%
completion was used when it should have been 68%). The CFO agreed that it was an error, but was satisfied that this was an
isolated issue and would have normally been caught by the supervisor’s review. The CFO does not want to adjust for this error.
(b) Even though the company’s policy is to translate foreign currency receivables at the year-end rate, we noted that the U.S.
subledger had not been translated. The entire U.S. receivable amount related to one contract, which was progress-billed U.S.
$601,055 when the exchange rate was C$1.103 for each U.S. dollar. The year-end rate of exchange was C$1.045 for each
U.S. dollar. When the oversight was brought to the attention of the assistant responsible for the U.S. subledger, she immedi-
ately asked the CFO if she should make the adjustment. He replied that she couldn’t book it because he had already closed
the subledger for the year.
4. Employee Housing Loans
We examined a standard loan agreement, and the terms of the loan stipulate repayment in yearly installments over a 15-year
period. As at July 31, 2013, 110 employees had received loans. Testing has proven the validity of the amounts shown on the
balance sheet, except for an outstanding loan due from a recently retired employee. The CFO explained, “The total amount of
these loans should be shown as current on the balance sheet because they are demand loans. As for the retiree, I know that
we’ll get the $35,400 out of him sooner or later.” Further examination of the agreement indicates that the loan becomes pay-
able on demand once the employee leaves the company. As of the close of fieldwork, the retiree has not repaid his loan. Audit
work indicates that a taxable benefit has been appropriately recorded on the employees’ T-4 slips.
5. Inventory
We noted discrepancies when test-counting inventory. When we discussed them with the CFO, he said, “Most employees are re-
luctant to complete a materials sign-out sheet. They claim they are too busy. I’m confident, though, that the proper materials get
charged to the right project because the construction managers must account for project inventory usage at our monthly inventory
count. They make a big fuss about how much work it is, but they always manage to account for all the used items.” The audit file
noted that all the discrepancies were accounted for, and adjustments to the accounting records had been appropriately made.
(LO 2, 3) C7-3 You, CA, an audit senior at Grey & Co., Chartered Accountants, are in charge of this year’s audit of Plex-Fame Cor-
poration (PFC). PFC is a rapidly expanding, diversified, publicly owned entertainment company with operations through-
out Canada and the United States. PFC’s operations include movie theatres, live theatre production, television production,
and a 60% interest in Media Inc., a company that specializes in entertainment-related advertising and promotion.
It is June 22, 2013, the week before PFC’s year end. You meet with the chief financial officer of PFC to get an
update on current developments and learn the following.
PFC acquires real estate in prime locations where an existing theatre chain does not adequately serve the market. After
acquiring a theatre site, the company engages a contractor to construct the theatre complex. During the year, the company
received a $2-million payment from one such contractor who had built a 10-theatre complex for PFC in Montreal. This
payment represents a penalty for not completing the theatre complex on time. Construction began in June 2012 and was
to have been completed by December 2012. Instead, the complex was not completed until the end of May 2013.
The company is staging a Canadian production of “Rue St. Jacques,” which is to open in November 2013. The
smash-hit musical has been running in Paris for three years and is still playing to sold-out audiences. PFC started receiv-
ing advance bookings in November 2012, and the first 40 weeks of the show’s run are completely sold out. Average ticket
prices are $65; the show will play seven nights a week. The theatre used for the production is relatively small, with about
1,200 seats. As at June 22, 2013, PFC had included in revenue $1.7 million of interest collected on the funds received
from advance ticket sales. In addition to the substantial investment in advertising for this production ($4 million), the
company will have invested $15 million in pre-production costs by November 2013 and will incur weekly production
costs of $250,000 once the show opens.
About 80% of Media Inc.’s business is directly related to promoting PFC’s activities. Media bills PFC’s corporate
office for all advertising and promotion related to PFC’s activities. Advertising and promotions have significantly in-
creased this year, in part due to large costs associated with the forthcoming opening of Rue St. Jacques. Media has billed
PFC $12 million this year for advertising and promotion, an increase of $7 million over the preceding year.
PFC has $43 million invested in Government of Canada treasury bills. During the past year, a portion of these
treasury bills was set aside to cover interest and principal obligations on the company’s syndicated loan of U.S. $25 mil-
lion. At the time the loan agreement was signed, PFC entered into a forward contract to buy U.S. dollars for the same
amounts as the obligations under the syndicated loan and for the same dates as the obligations came due. PFC considers
that in substance the debt has been settled and, as a result, both the treasury bills and the syndicated loan have been
removed from the company’s balance sheet.
PFC started selling some of its movie theatres a couple of years ago. Each theatre’s contribution to long-run operat-
ing cash flow is assessed and, if the value of the real estate is greater than the present value of future theatre operating
profits, the theatre is sold. In the past, revenue from these sales has been relatively minor, but this year 25% of net
Cases 393
income (i.e., $6 million) came from the sale of theatres. Since these sales are considered an ongoing part of the com-
pany’s operations, proceeds from the sale of theatres are recorded as revenue in the income statement.
On May 31, 2013, PFC and an unrelated company, Odyssey Inc., formed a partnership, Phantom. Odyssey con-
tributed $40 million in cash. PFC contributed the assets of its TV production company, which had a net book value of
$65 million. The $90 million value assigned to PFC’s contribution may be adjusted if the net income of Phantom earned
between July 1, 2013, and June 30, 2014, does not meet expectations. PFC has recorded a gain of $25 million. The
partnership agreement states that PFC is permitted to withdraw the $40 million for its own use, and it has done so. As
a result, Odyssey has a 45% interest in the partnership and PFC has the remaining 55% interest.
When you return to the office, you discuss these issues with the partner in charge of the PFC audit. She asks you to
prepare a report on the accounting implications of the issues you have identified as a result of your meeting.
Required
Prepare the report to the partner.

(LO 1, 2) C7-4 Dam Design Inc. (DDI) is a privately owned Canadian engineering and project management company. DDI
has been in business since 1948 and is involved primarily in designing and building small and large hydro and irrigation
dams. The company is currently owned by members of the family of the late founder, Dick Hydraul (64%), and three
outside investors (36%). The company has a December 31 year end, and it has always been audited by Price, Cappuccitti
& Co., Chartered Accountants.
Historically, the company has been fairly conservative in its business and accounting decisions. In April 2013, the
company’s board of directors decided to look beyond North America and to actively pursue international business op-
portunities. To assist with this expansion, the board further resolved that the company would either seek to be sold to
a large international engineering firm within a year or go public, given the stock market success of a number of other
Canadian engineering firms.
In July 2013, DDI submitted a bid to design and build the Super Dam in a developing Asian country. The dam
is intended to generate electricity, control floods, and provide irrigation. On August 13, 2013, DDI was awarded the
design and construction contract, and work started almost immediately in conjunction with another contractor. The
customer is the Northern Province of the country. The other contractor’s role is to carry out the earth-moving work in
a separate contract with the province.
Environmental and human rights groups around the world are up in arms about the project. They claim that it will
cause forced, uncompensated displacement of 140,000 local farmers and their families, as well as major disruption of
local ecosystems.
It is now September 16, 2013. You, CA, work for Price, Cappuccitti & Co. The partner has asked you to meet with
DDI to review the accounting issues raised by the Asian Super Dam project, so as to get this work done before year
end. The partner has requested a memo discussing and making recommendations on the accounting issues and covering
other relevant matters. You visit DDI and gather the information contained in Exhibits C7-4(a) and C7-4(b).
Required
Prepare the memo requested by the partner.
EXHIBIT C7-4(a)
CA’S NOTES ON SUPER DAM PROJECT
1. There are two contracts with the customer. The design contract is priced in U.S. dollars and has a total value of U.S. $26.4 mil-
lion. Payments will be received 30 days after each of eight milestone-based invoices. The construction contract, worth C$915
million over the seven years of the project life, will be paid for under a more complex arrangement. The contract specifies a 10%
down payment. For 60% of the contract value, payments will be made pro-rata, based on time, over the project life. The final
payment of 30% of the contract value is due five years after project completion and is guaranteed by the Canadian government.
DDI will receive interest on the final payment at 7% per annum, payable at the end of the term. Interest will be calculated from
the date the project is completed.
In order to win the contracts, DDI entered into a separate agreement to purchase 12 million tonnes of coal for C$40.80/tonne,
from Northern Province. The purchase will be delivered to a Northern Province port in four equal shipments on December 31,
2013, through December 31, 2014. At the time the contract was signed, the current market price of such coal was C$37.05/
tonne. The requirement to purchase coal from Northern Province was never spelled out in the project master contracts, and the
coal purchase agreement does not mention any link with the master contracts. However, DDI understood from the negotiations
that this purchase was required. DDI will not use the coal in the Super Dam project.
2. As is standard practice in the country, local construction workers are paid weekly in U.S. dollars cash or cigarettes at the remote
job site. Cigarettes are the most stable form of local currency after the U.S. dollar. Cigarettes are the preferred medium of pay-
ment, because the company can make a small profit given that the company can buy the cigarettes at a cheaper price.
3. The World Bank is financing 50% of the U.S. $26.4-million design contract. DDI paid the World Bank a C$3.2-million financing
fee for this assistance.
4. To fund local expenses, Alexandre Laurier, the on-site project manager, has opened a bank account at a local bank in his name,
as the paperwork for a corporate account was too complicated. He did this on his own initiative. The average balance in the
account is about U.S. $3 million.
The standard procedure is for Laurier to send a wire when he needs the account to be replenished. Expenditures from the
account will be primarily cash for the local payroll, but payments will be made by cheque for other purchases, some local
materials, and the living expenses of the Canadian workers at the job site.
5. The Governor of the Northern Province has approached Laurier for a Canadian university scholarship for his daughter, in
exchange for facilitating the release of the remaining construction permits.
6. DDI uses the percentage-of-completion method, based on costs relative to budget, to report revenue on all long-term con-
tracts, including the Super Dam project. To date the project is tracking approximately to budget. The company’s project
management costs, budgeted to be C$32.04 million, are 55% labour and benefits and 45% other costs.
7. Local materials will be purchased in U.S. dollars on the Super Dam project. The U.S. dollar can currently be purchased for C$1.05.
8. The country’s tax code is virtually incomprehensible even when translated. Therefore it was necessary to meet with the
country’s tax authorities to clarify how DDI would be taxed. DDI’s controller met with the authorities on September 15, 2013.
Based on her fax to head office, taxation of foreign entities engaged in projects works as follows. The foreign entity must pay
tax each year ended February 28. The tax rate in the country is 48.4%.
The taxable amount is calculated as:
Gross amount received by DDI from Northern Province
Less: — local and foreign materials purchased for use in the project
— payroll to citizens of the Asian country
— foreign project management costs attributable to the project, excluding payroll
9. The summary budget for DDI’s design contract is as follows (in thousands of Canadian dollars):
Canadian design costs $ 9,390

Subcontract costs 8,320
Other costs 1,470
Contingency 300
$19,480
10. DDI’s construction contract summary budget is as follows (in thousands of Canadian dollars):
Canadian project management costs $ 32,040

Local materials 439,280
Canadian materials 61,360
Local payroll 170,040
Canadian labour in Northern Province 32,920
Estimated proceeds on disposal of equipment (2,040)
Provision for income taxes 68,118
Contingency 20,000
$821,718
11. Northern Province will reimburse DDI for the first C$10 million of income taxes paid to the Asian country, under the terms of
the construction contract.
12. It was not possible to read the entire 3,027-page contract, including engineering drawings, during my brief visit.
13. Some old, specialized equipment will be taken overseas and used in the project. DDI plans to sell it there on project comple-
tion rather than ship it back.
EXHIBIT C7-4(b)
OTHER INFORMATION GATHERED BY THE CA
1. There is no tax treaty between Canada and the Asian country.

2. Northern Province’s debt has not been rated by any large credit agency since a default two years ago.
3. Ignoring the Super Dam project, revenues are expected to be about C$110 million this fiscal year and C$130 million the year
after. DDI’s revenues to date are C$62 million, with net income of C$6.9 million. In fiscal 2012, revenues of C$98 million
were reported, with net income of C$5.7 million.
4. The current market price of coal is C$38.10/tonne.
5. The client’s controller has not spent much time looking at the implications of the April decisions of the Board.

(LO 1, C7-5 The United Football League (UFL), a North American professional football league, has been in work stoppage
2, 3) since July 1, 2013, immediately after the six-week training camp ended. Faced with stalled negotiations, the players’
union representing the league’s 28 teams, the UFL Players’ Association (UFLPA), called a general strike. It led to the
Cases 395
cancellation of games scheduled for the beginning of the regular season, which was to start on July 5 and end with play-
offs in mid-December.
The main disputed issue is player compensation. According to the team owners, the current compensation system
has created an excessive increase in players’ salaries (more than 300% in 10 years), which has most teams incurring net
losses and several facing extinction. Currently, players are contracted by the teams for fixed periods. Owners are free to
negotiate personalized compensation terms with each player. The UFLPA likes the current system and wants it main-
tained for the duration of the next collective bargaining agreement.
The team owners are proposing a new compensation system. Under this new system, owners and players would
still be free to negotiate, but the annual amount each team could spend on payroll could not be outside a predetermined
range. The lower limit of this range would be based on a percentage of the annual “gross football revenues” generated
by the team. The owners’ last proposal suggested this percentage should be 55%. The upper limit of this range, also
known as the salary cap, was proposed at U.S. $30 million. Therefore, the annual amount each team could spend on
payroll would be no less than 55% of the team’s gross football revenues, but no more than U.S. $30 million.
The UFLPA objects to this system for two reasons. First, the players are against the salary cap because they see it
as a way for owners to pay players less than market value. They contend that owners wouldn’t enter into these contracts
if they didn’t receive sufficient value for the high salaries they pay. Second, since the players’ compensation would be
based on the teams’ gross revenues, the players are not convinced that the owners will properly account for revenues.
The dispute is dragging on: more than half of the current season games have already been cancelled, and some
players and owners are growing impatient with the slow progress at the negotiating table. Faced with these pressures,
the UFLPA’s executive committee has decided to take a closer look at the owners’ proposal, but wants to consult with
public accountants to get a clearer picture. The team owners have, for the first time, agreed to show the UFLPA their
financial statements. The Calgary Cowboys, one of the teams that has incurred major losses in the last few seasons and
claims that it is going under, has already handed over its unaudited GAAP financial statements to the UFLPA.
You, CA, are employed by McMaster & Caisse, Chartered Accountants (M&C). Your boss, Marie Caisse, calls you
into a meeting with Billy Baker, star quarterback for the Regina Rebels and chair of the UFLPA executive committee.
Billy is asking M&C to analyze the financial statements submitted by the Cowboys so that he can formulate sound argu-
ments to bring to the negotiating table. Given the financial statements provided were unaudited, Billy wants M&C to
evaluate the financial viability of the team and determine whether the Cowboys have a net loss in accordance with IFRS.
Marie asks you to draft a report that will address Billy’s requests.
Following the meeting, you receive the unaudited financial statements of the Cowboys for the year ended December
31, 2012 (Exhibit C7-5[a]), and meet with the team’s financial controller to obtain additional information (Exhibit C7-5[b]).
Required
Draft the memo requested by Marie Caisse.
EXHIBIT C7-5(a)
CALGARY COWBOYS LIMITED STATEMENT OF LOSS AND DEFICIT
For the year ended December 31
(in thousands of Canadian dollars)
2012 2011
(unaudited) (unaudited)
Revenue
National TV broadcast rights $19,500 $19,500
Local TV broadcast rights 1,500 1,250
Ticket sales 21,154 18,653
Corporate boxes 3,546 2,436
Advertising revenue 2,100 1,876
$47,800 $43,715
Expenses
Signing bonuses $ 5,000 $ 4,000
Salaries and benefits (players) 38,540 34,767
Other salaries and benefits 661 547
Stadium rental 375 375
Business taxes 90 89
Miscellaneous supplies 91 76
Administration 1,099 1,548
Interest on advance from parent company 344 551
Travel 2,610 3,267
Amortization—capital assets 15 19
Amortization—non-competition clause 5,000 5,000
53,825 50,239
Loss before income taxes (6,025) (6,524)
2012 2011
Income taxes — —
Net loss (6,025) (6,524)
Deficit, beginning of year (6,524) —
Deficit, end of year $(12,549) $ (6,524)
CALGARY COWBOYS LIMITED

Balance Sheet
As at December 31
(in thousands of Canadian dollars)
2012 2013
Assets
Current assets
Cash $ — $ 55
Accounts receivable 380 320
Prepaid expenses 177 170
557 545
Capital assets
Furniture and equipment (net) 96 91
Other asset
Non-competition clause (net) 90,000 95,000
$90,653 $95,636
Liabilities
Current liabilities
Bank overdraft $ 110 $ —
Accounts payable 36 28
GST and withholding taxes payable 13 12
Accrued liabilities 3,343 657
3,502 697
Advance from parent company 1,567 3,772
Deferred exchange gains 566 124
Share capital 567 567
Deficit (12,549) (6,524)
Revaluation adjustment 97,000 97,000
85,018 91,043
$90,653 $95,636
EXHIBIT C7-5(b)
NOTES FROM DISCUSSION WITH THE FINANCIAL
CONTROLLER OF CALGARY COWBOYS LIMITED
1. Calgary Cowboys Limited (CCL) was created in 1988 by Crystal Roberts, a wealthy businesswoman from Calgary, when the com-
pany acquired the UFL franchise. On January 1, 2011, Crystal sold all her shares in CCL to Crystal Roberts Management Inc.
(CRM). She is the sole shareholder of CRM. Following the sale, a comprehensive fair value revaluation of CCL’s assets and liabil-
ities was undertaken. On January 1, 2011, the fair values of CCL’s assets and liabilities approximated their book value, except
for the non-competition clause, which had a fair value of $100 million and a book value of $3 million. This clause, included in
the Cowboys’ contract, states that no other UFL team can be established within a 200-kilometre radius of the Cowboys stadium
until 2027. As a result of the revaluation, the intangible asset related to the non-compete clause was increased by $97 million,
with a corresponding amount disclosed as a separate equity item. The balance of retained earnings was reduced to zero and a
corresponding amount was transferred to share capital. Before the revaluation, the non-compete clause was being amortized at
a rate of $150,000 a year.
2. CRM is a financial holding company that owns several other subsidiaries, including the Calgary Sports Channel, which broad-
casts all of the Cowboys games in the Calgary area. The amount billed by CCL was recorded under “Local TV broadcast rights” in
the statement of income. Calgary Sports Channel’s main competitor made an offer of $8 million per year to broadcast Cowboys
games locally, but Crystal felt it would be more profitable to have the Calgary Sports Channel benefit from the team’s popularity.
3. CRM leases the huge parking lot adjacent to the stadium from the city for $1 per year and charges $10 per car. The parking lot
can hold over 15,000 cars and is always full for Cowboys games. CRM owns the company that operates all the food concessions
in the stadium where the Cowboys play.
Cases 397
4. Players who sign long-term contracts often ask for a signing bonus in addition to their annual salary. A typical contract is for
two to four years with an additional one-year renewal option. When a player signs a contract, CCL expenses the bonus. Bonuses
are disclosed separately in the statement of income to facilitate financial analysis. These bonuses are refundable if the player
leaves within the first year of the contract.
5. UFL players are all paid in U.S. dollars, since most of the teams are American. The spectacular volatility of the Canadian dollar
against the U.S. dollar in 2012 triggered a number of exchange gains and losses in the salaries payable. The net gains were
shown separately as deferred exchange gains on the balance sheet.
6. Travel expenses include all costs related to the private jet owned by Crystal, which she graciously allows CCL to use during the
football season. The team uses it for all out-of-province trips. The plane’s operating costs are approximately $2 million per year.
Without the plane, players would fly business class at an average return fare of $2,000 per trip.
7. The advance from the parent company bears interest at the annual rate of 20% due to the significant risk of operating a
football team.
8. Accrued liabilities include C$3 million in salary for defensive tackle Jimmy Swagger for the 2013 and 2014 seasons ($1.5 mil-
lion per season). Swagger, one of the best tackles in the UFL, was paid a signing bonus of $1 million at the start of the 2012
season. However, he has formally asked to be traded to another team because of a run-in with the Cowboys’ head coach during
the last game of 2012. The UFL has declared a trade moratorium until the strike is settled. Since Swagger will probably not
provide any future benefit to the Cowboys, CCL has expensed the salary remaining in his contract. Once Swagger is traded to
another team, CCL will no longer have an obligation to him.
9. The Cowboys’ stadium seats 40,000 spectators and is almost always full. The team plays 10 home games per season and as
many on the road. Spectators pay approximately $53 per ticket and around $25 for food and beverages per game. The team has
40 players, as well as 10 coaches and trainers who travel with the team.
(LO 1, C7-6 Shreky Enterprises is a private Canadian company located in Ottawa, Ontario. It was incorporated nine years
2, 3) ago to manufacture and distribute products to be sold to hardware stores in Canada. All its inventory purchases are
made and paid in Canadian dollars. Shreky Enterprises has grown at a steady pace and the company is looking to start
the process of going public next year, as they would like to have additional sources of financing to continue growing the
company.
You are the vice president of finance at Shreky Enterprises, a position you have held since the company’s inception.
The owner, Mr. Fenster, has always looked to you for accounting and financial advice and guidance. It's first thing
Monday morning, your first day back after a nice vacation. All of a sudden, Mr. Fenster calls you into his office. He is
very excited as he has just created a new division, Bailey Limited, which will be located in Toronto, Ontario. The divi-
sion was created as a way to continue the growth and expansion of Shreky Enterprises. It was created immediately with
a U.S. $1 million cash infusion from Shreky Enterprises. Shreky obtained this financing by securing a bank loan from a
U.S. bank designed to encourage investment. The loan is repayable in five years in U.S. dollars. Interest expense is 5%
to be paid annually on December 31.
This division will purchase some of its inventory in the United States and pay in U.S. dollars. It will also sell its
products all over the world and allow the customers to pay in their local currency. Mr. Fenster is particularly concerned
with the accounting implications of this type of transaction since has not encountered it before. He has also heard that
there might be ways to protect the company from fluctuations in foreign currencies.
Mr. Fenster asks you to prepare a report to him that addresses the accounting implications of this transaction as
he has heard that there might be some foreign currency repercussions but is not sure what that means. He reminds you
that next year the company will begin the process of taking Shreky Enterprises public and he would like you to keep that
in mind when preparing your report.
Required
Prepare the requested report.
Translating for
Stakeholder
Clarity
Source: Courtesy of Aimia Inc.
AS DISCUSSED IN CHAPTER 2, acquiring an- transaction). Parent companies, however, must con-
other company is often the most expedient way tinue to report subsidiaries’ results over time. Much
for a business to grow. It might be, however, that like a sales transaction that doesn’t settle immedi-
in a company’s home country there are no desir- ately, this exposes parent companies to exchange
able targets or the company has “cornered” the risk due to the fluctuation of foreign exchange rates.
domestic market and its only avenue of growth When a foreign subsidiary transacts largely in its
lies elsewhere. own currency, independently of its parent, the dif-
Such was the case of Aimia Inc., formerly ferences resulting from foreign exchange translation
Groupe Aeroplan. Its flagship coalition loy- of assets and results do not give a true picture of
alty program, Aeroplan, had a solid foothold in operating results. In this case, the two entities have
Canadian households in 2007. At that time, man- different reporting currencies and any gains or losses
agement and ownership had decided that the best resulting from the translation of foreign operations
way to increase shareholder return was to acquire are not reported in earnings.
another loyalty marketing company overseas: Aimia’s foray into the United Kingdom exposed
Loyalty Management Group (LMG), headquartered it to foreign currency translation differences as the
in London, England. LMG founded the Nectar UK pound fluctuated in value. “Operating in many
points program, the most popular loyalty program different countries continuously exposes our con-
in the U.K., and the concept is expanding to new solidated results to foreign exchange gains and
markets both in Europe and South America. losses. Since our foreign subsidiaries generate net
Over the next three years, Aimia went from an cash flows independently of the parent, however,
exclusively Canadian company to one operating in our earnings are only affected by the settlement of
more than 20 countries through a series of acquisi- day to day transactions,” said Vice-President and
tions and start-ups. Corporate Controller Steven Leonard.
Accounting for such investments on the In 2010 and 2011, Aimia reported foreign cur-
transaction date is no different from any other rency translation differences in equity amounting to a
transaction. That is, if the acquisition is de- $36.3-million loss and a $7.3-million gain, respectively.
nominated in a foreign currency, such as The financial independence of its subsidiaries allowed
Aimia’s acquisition of LMG, which was in UK those large fluctuations to be reported in a way that did
pounds sterling, it would be translated at the not cloud the bottom line to investors, resulting in a
spot rate (the exchange rate at the date of the more representative view of the company’s operations.
Sources: Aimia Inc. 2011 audited financial statements; Aimia company website, “Fact Sheet,” available at http://www.aimia.com/Theme/Aimia/files/doc_downloads/
AimiaFactSheetEN2012.pdf; IFRS IAS 21 The Effects of Changes in Foreign Exchange Rates.
CHAPTER
8 Accounting
for Foreign
Investments
LEARNING OBJECTIVES
1. Determine a company’s functional currency, within a group, by applying a hierarchy of indicators.
2. Determine the foreign currency transactions for each company in the group.
3. Translate group financial statements into a group presentation currency.
4. Prepare the foreign currency adjustments necessary for the purposes of consolidation or the
application of the equity method.
ACCOUNTING FOR FOREIGN INVESTMENTS
Determining the Determining the Translating Individual Preparing Foreign

Appendix 8A—
Functional Currency Foreign Currency Financial Statements Currency Adjustments
Hyperinflationary
for Each Company in Transactions Within into a Group for Consolidation or
Environment
a Group the Group Presentation Currency the Equity Method
■ Definition of a ■ Foreign currency ■ Presentation currency ■ Intracompany balances ■ Hyperinflationary

functional currency transactions differing from the ■ Fair value adjustments economies
■ Hierarchy of criteria ■ Changes in functional functional currency ■ Preparing financial
■ Non-controlling interest
currency ■ Using a currency statements
of convenience for ■ Tax effects of all
translation exchange differences
■ Disposal or partial
disposal of a foreign
operation
■ Hedge accounting
400 chapter 8 Accounting for Foreign Investments
In the hopes of extending their commercial reach, companies are expanding their corporate
structures to include subsidiaries and branch offices located in foreign countries. In Canada
there are additional concerns when foreign investors invest here. As seen in Illustration 8.1,
some foreign investments are required under the Investment Canada Act to be reviewed by
the Canadian government.
Illustration 8.1
Foreign investments are deemed reviewable, meaning that they are subject to approval by the federal
Foreign Investment in
government, if at least one of the following three scenarios arises:
Canada Requiring Review
Scenario 1: The investor is from a World Trade Organization (WTO) member country and the investment
is made to directly acquire ownership and control of a non-cultural Canadian business that has assets
over $312 million (in 2011). In the case of investors from non-WTO countries, the threshold is $5 mil-
lion or more for direct acquisitions and $50 million or more for indirect acquisitions.
Foreign investments can be approved only if the Minister of Industry is satisfied that the transaction is
likely to be of “net benefit” to Canada. Factors that are considered in the net benefit “test” under the
Act are:
• the effect of the investment on economic activity in Canada;
• the degree of participation by Canadians in the business in question;
• the effect of the investment on productivity, efficiency, technological development, product
innovation, and product variety in Canada;
• the effect of the investment on competition;
• the compatibility of the investment with national industrial, economic, and cultural policies; and
• the contribution to Canada’s ability to compete globally.
In making a determination, the minister consults with provincial governments, other federal
departments, and the federal Competition Bureau. Also, the minister examines in detail the foreign
investor’s future plans for the Canadian business. The foreign investor may offer legally binding
undertakings (e.g., job creation, R&D activities, or new investments) to demonstrate “net benefit”
to Canada.
Scenario 2: The investment is made to directly acquire control of a Canadian cultural business that has
assets of $5 million or more, or the Government of Canada considers that an investment in a cultural
business should be reviewed in the public interest.
Scenario 3: The Government of Canada considers that the investment may be injurious to national
security.
Acquisitions of Canadian Businesses by Foreign Investors, 1985–2010
120
Resources
Manufacturing
90 Wholesale and retail
trades
Business and services
$ billions
industries
60
Other services
30
0
1985 1990 1995 2000 2005 2010
Source: Mathieu Frigon, “Foreign Investment in Canada: The Net Benefit Test,” Parliament of Canada,
Library of Parliament, 2011, available at http://www.parl.gc.ca/Content/LOP/ResearchPublications/
cei-22-e.htm.
Accounting for Foreign Investments 401
In addition, Canadian companies may make investments in other countries. Accounting stan-
dards provide guidance on how to incorporate the activities of foreign operations into the
financial statements of a company and how to translate a group’s financial statements into a
presentation currency.
In this chapter we continue our discussion of the accounting for foreign exchange and
the more in-depth complexities of how to account for foreign exchange in group financial
statements. This will include the accounting for foreign exchange in consolidated financial
statements.
As we saw in Chapter 7, in order to be able to identify foreign currency transactions, we
need to determine a company’s functional currency. Once identified, the calculation and pre-
sentation of foreign exchange in financial statements can be accomplished.
In this chapter we will have the additional step of combining several different company
financial statements, which may all have different functional currencies. We will account for
foreign exchange on the translation of consolidated financial statements into a single group
presentation currency. We see in Illustrations 8.2 and 8.3 how two companies—global min-
ing company Rio Tinto plc and Canadian-based transport manufacturer Bombardier Inc.,
respectively—describe the functional currencies of the companies in the group.
Illustration 8.2
(viii) Identification of functional currencies
Excerpt from the 2010
The functional currency for each company in the Group, and for jointly controlled entities and as-
sociates, is the currency of the primary economic environment in which it operates. Determination of
Rio Tinto
functional currency involves significant judgement and other mining companies may make different
judgments based on similar facts. For many of Rio Tinto’s entities, this is the currency of the country
in which they operate. The Group reconsiders the functional currency of its entities if there is a
change in the underlying transactions, events, and conditions which determine their primary economic
environment.
Illustration 8.3
Foreign currency translation
Excerpt from the Second
The interim consolidated financial statements are expressed in U.S. dollars, the functional currency
Quarter 2011 Financial
of Bombardier Inc. The functional currency is the currency of the primary economic environment in
Statements of Bombardier
which an entity operates. The functional currency of most foreign subsidiaries is their local currency,
mainly the U.S. dollar in BA [Bombardier Aerospace], and the euro, various other Western European
currencies, and the U.S. dollar in BT [Bombardier Transportation].
Foreign currency transactions — Transactions denominated in foreign currencies are initially recorded
in the functional currency of the related entity using the exchange rates in effect at the date of the
transaction. Monetary assets and liabilities denominated in foreign currencies are translated using the
closing exchange rates. Any resulting exchange difference is recognized in income except for exchange
differences related to retirement benefits assets and liabilities, as well as financial liabilities desig-
nated as hedges of the Corporation’s net investments in foreign operations, which are recognized in
OCI. Non-monetary assets and liabilities denominated in foreign currencies and measured at historical
cost are translated using historical exchange rates, and those measured at fair value are translated
using the exchange rate in effect at the date the fair value is determined. Revenues and expenses
are translated using the average exchange rates for the period or the exchange rate at the date of the
transaction for significant items.
Foreign operations — Assets and liabilities of foreign operations whose functional currency is other
than the U.S. dollar are translated into U.S. dollars using exchange rates in effect at period end.
Revenues and expenses, as well as cash flows, are translated using the average exchange rates for the
period. Translation gains or losses are recognized in OCI and are reclassified in income on disposal or
partial disposal of the investment in the related foreign operation.
Fluctuations in foreign exchange gains and losses arise at two different levels: on transactions
with foreign operations, or through the consolidation process. This chapter will focus on
these specifics.
DETERMINING THE FUNCTIONAL

CURRENCY FOR EACH COMPANY
IN A GROUP
Definition of a Functional Currency
Objective 1 In order to determine what is considered to be a “foreign currency,” a “functional currency”
Determine a must be first identified. Once a company’s functional currency is identified, then inherently,
company’s functional all other currencies are considered to be foreign.
currency, within a The definition of functional currency is discussed in IAS 21 The Effects of Changes in
group, by applying
a hierarchy of
Foreign Exchange Rates. Functional currency is determined on a company-by-company basis,
indicators. and reflects the primary economic environment in which a company operates. We examined
the functional currency for a single company in Chapter 7. We now expand the criteria to
relate to a group of companies that are required to report together. This could be due to the
fact that there is a parent–subsidiary relationship or it could be an associate or joint arrange-
ment. The relationships discussed are introduced in Illustration 8.4, showing the group
structure of a hypothetical company, Canada Company. The primary economic environment
is the one in which a company primarily generates and expends cash.
Illustration 8.4
Canada Company (“Canada Co.”) has the following wholly owned organizational structure:
Sample Group Structure
Canada Co.
U.S. European China Mexico

subsidiary subsidiary subsidiary branch
The determination of functional currency should be done on a company-by-company basis

taking into account the circumstances of each company using the hierarchy discussed below.
Hierarchy of Criteria
A company’s functional currency is determined through a hierarchy. IAS 21 proposes a
hierarchy of criteria to be reviewed in assessing the functional currency of each company in
the group. You will note that Steps 1 and 2 are repeated from Chapter 7 as these same criteria
are used when only a single company is involved.
Step 1 Consider the primary indicators, which require the determination of the functional
currency to be based on the currency:
• that mainly influences sales prices for goods and services
• of the country whose competitive forces and regulations mainly determine the sales
prices of its goods and services
• that mainly influences labour, material, and other costs of providing goods or services
(this will often be the currency in which such costs are denominated and settled).
Step 2 When the functional currency is not clearly evident from the primary indicators, con-
sider the following secondary indicators:
Determining the Functional Currency for Each Company in a Group 403
• the currency in which funds from financing activities are generated and
• the currency in which receipts from operating activities are usually retained.
The functional currency will normally be evident at this point. However, when it is not,
judgement will be required to determine which currency provides the most relevant measure
of the company’s primary economic environment, taking into account the economic effects
of the underlying transactions, events, or conditions.
The above two steps may be required even in circumstances where there is no group, as
was discussed in Chapter 7.
Step 3 When the functional currency is being determined for a foreign operation (i.e., a
subsidiary, branch, associate, or joint venture of a parent company), 1 IFRS 21 provides
additional criteria to the primary and secondary indicators in assessing the functional
currency of those foreign operations. When a foreign operation’s functional currency
is different from that of its parent, it is inherently considered to be a foreign company.
In addition to the primary and secondary indicators, the company should consider whether:
• The foreign operation’s activities are relatively autonomous of those of the parent com-
pany or whether they are carried out as an extension thereof.
• Transactions with the parent company are a high or a low proportion of the foreign
operation’s activities.
• Cash flows from the foreign operation’s activities directly affect the cash flows of the par-
ent company and whether they are readily available for remittance to it.
• Existing and normally expected debt obligations can be serviced by cash flows from the
foreign operation’s activities (not including any funds being made available by the parent
company).
This process can be understood as a decision tree as outlined in Illustration 8.5.
Illustration 8.5
Hierarchy of Criteria to Step 1: Apply the primary indicators. YES
STOP!
Determine Functional Is the functional currency clearly evident?
Currency
NO
Step 2: Apply the secondary indicators. YES

STOP!
Is the functional currency clearly evident?
NO
Step 3: Apply the indicators relevant to YES

foreign operations. Is the functional STOP!
currency evident?
NO
Judgement is required based on the

economic effects of the underlying
transactions, events, and conditions.
1
There is no distinction between integrated foreign operations and foreign companies. In the past, in
Canada, a distinction was made between integrated and self-sustaining entities. Rather, a company that
is considered to be an integrated foreign operation, meaning that it carries on business as if it were an
extension of the parent company, will naturally have the same functional currency as its parent com-
pany (referred to as the “reporting company”) since it will be carrying on business in the same primary
economic environment. It is therefore unnecessary to distinguish between an integrated foreign opera-
tion and a foreign company.
We will now apply this hierarchy to the group identified in Illustration 8.4. Illustrative
Example 8.1 determines the functional currency for each of the companies in the
group.
Illustrative Example 8.1 Determining the Functional

Currency for a Group of Entities
Canada Company (“Canada Co.”) has the following organizational structure and levels
of ownership:
Canada Co.
U.S. European China Mexico joint

subsidiary subsidiary associate venture
(80%) (100%) (40%) (50%)
Using the following facts and circumstances, the functional currency for each company
is determined as follows:
Company Facts Functional currency

U.S. • Located in the United Application of the primary indicators
subsidiary States. is unclear, prices are denominated in
• All products are priced Canadian dollars, but costs are settled
based on the Canadian in U.S. dollars. Based on the secondary
dollar but sold in $US indicators, since funds from financing
since this is its target activities are denominated in U.S. dol-
market for its products lars, U.S. dollars is determined to be
• Obtains its own financing the functional currency.
locally.
European • Located in the United Application of the primary indicators
subsidiary Kingdom clearly establishes the British pound
• All products are priced as the functional currency since the
based on the British pound pound is the currency that influences
and sold in British pounds the prices of the products and costs are
since this is its target settled in this currency.
market for its products.
China • Located in China. Application of the primary indicators
associate • All products are priced is unclear. Prices are denominated in
based on the U.S. dol- U.S. dollars, but Canada is the country
lar since this is its target whose competitive forces and regula-
market for its products. tions mainly determine the sales prices
(All goods are exported to of its goods and costs are settled in
Canadian customers but yuan. Based on the secondary indicators,
orders are denominated in since U.S. funds are normally translated
U.S. dollars.) into yuan to service its operating activi-
• Operating activities are ties, the yuan is determined to be the
paid for in yuan. functional currency.
Determining the Foreign Currency Transactions Within the Group 405
Company Facts Functional currency

Mexico • Located in Mexico. Application of the primary
joint • All products are priced based indicators is unclear. Prices
venture on the peso since Mexico is its are denominated in pesos, but
target market for its products the branch does not function
that are imported from Canada autonomously. It is an extension of
Co. However, the only employee Canada Co. and remits all proceeds
works from home and is paid to it. Therefore, Canadian dollars
in Canadian dollars, and all is determined to be the functional
cash collected is remitted to the currency.
Canadian parent and immediately
converted into Canadian dollars.
ASPE: Determining Foreign Currency for Companies Within a Group

ASPE
Under ASPE, this topic is covered in Section 1651 Foreign Currency Translation.
ASPE does not require the determination of functional currency using a hierar-
chy. ASPE lists certain factors for determining whether a foreign operation is inte-
grated into a parent company (the “reporting company”) or is a self-sustaining foreign
operation. Under ASPE, the assessment is done from the perspective of the reporting
company, and the subsidiary, associate, or joint arrangement is evaluated based on its
relationship to the reporting company. ASPE sometimes refers to functional currency
as the “reporting currency” or the “currency of measurement.”
✓ LEARNING CHECK
• The functional currency for each company in the group must be determined first before for-
eign currencies can be identified.
• The determination of a company’s functional currency requires the application of a hierarchy
to determine the primary economic environment in which a company operates.
Under ASPE:
• The Canadian dollar is assumed to be the reporting currency, although any currency can be
determined to be the reporting currency.
• The guidance on the determination of functional currency is from the perspective of the
reporting company and is limited to whether a foreign operation is fully integrated or self-
sustaining.
DETERMINING THE FOREIGN

CURRENCY TRANSACTIONS
WITHIN THE GROUP
Foreign Currency Transactions
Objective 2 As discussed in detail in Chapter 7, foreign currency transactions are initially recorded
Determine the foreign using the exchange rate at the date of the transaction (i.e., spot rate). For practical purposes,
currency transactions an average rate to approximate the actual exchange rate at the date of the transaction may
for each company in
be used. If a parent company is transacting with a subsidiary that has a functional currency
the group.
different than theirs, both companies may potentially have foreign currency transactions.
We can take the same example that was used in Illustrative Example 7.5 but now in
Illustrative Example 8.2, we will assume that the transaction is between Canco and its sub-
sidiary, USco.
Illustrative Example 8.2 Foreign Currency Transactions

in a Group
Canadian Corporation (“Canco”), whose functional currency is the Canadian dol-
lar, sold several products to its 80%-owned subsidiary, United States Corporation
(“USco”). Canco maintains its accounting records in Canadian dollars.
Subsequently, at each reporting date, monetary items (assets and liabilities)
denominated in a foreign currency should be translated using the closing rate (i.e., the
rate at the balance sheet date). Non-monetary assets and liabilities that are measured
at historical cost should be translated at rates in effect at the date the transaction took
place (the historical rate). Balances measured at fair value are translated at rates appli-
cable when the fair values were determined.
At Canco’s year ended December 31, 2013, total sales denominated in U.S. dollars
were approximately $2.4 million, while accounts receivable denominated in U.S. dollars
totalled $220,000. The spot rate at December 31, 2013, was U.S. $1.00 ⫽ C$0.982 and
the average yearly rate was U.S. $1.00 ⫽ C$0.9820. Since these balances are denomi-
nated in U.S. dollars, the following entries would be required to translate the balances
into Canadian dollars:
(To record U.S.-denominated monetary item at its current value in Canadian dol-
lars at year end.)
The functional currency of USco from Illustrative Example 8.2 is the U.S. dol-
lar. As such, from its perspective it is not a foreign currency transaction. There would
not be any foreign currency adjustment for the purchases or the account payable on
its books. If it was determined that the functional currency of USco was the Canadian
dollar as well, it, too, would record this transaction as a foreign currency transaction.
As the account payable is a monetary item, it would be restated using the closing rate
and a gain would be recorded on its books. The entries would be the opposite to those
recorded by Canco, as for USco this is a purchase transaction.
If the transaction had taken place in Canadian dollars, Canco would not have had
a foreign currency transaction. However, from USco’s perspective, since its functional
currency is the U.S. dollar, it would now have a foreign currency transaction and the
monetary account payable would be restated on its books.
Changes in Functional Currency

Changes in functional currency occur only if there are significant economic changes in a
company’s operations. Any change in a company’s functional currency is accounted for
prospectively. We can see in Illustrative Example 8.3 the circumstances under which the
functional currency may change.
2
In this chapter, the symbol “C$” is used in the text and in some journal entries to distinguish
amounts in Canadian dollars from U.S. dollars and other currencies using the dollar symbol.
Translating Individual Financial Statements into a Group Presentation Currency 407
Illustrative Example 8.3 Change in Functional Currency

Canco has determined that Canadian dollars is the functional currency of USco. Due to
changes in economic circumstances, Canco has decided that the U.S. subsidiary would
now target the U.S. market for its sales and as such product pricing will be determined
based on the U.S. dollar and what the market would bear. Also, cash will be retained
in U.S. dollars to service its overhead expenses. As such, the Canadian dollar no longer
represents the underlying economic transactions, events, and conditions of this subsid-
iary and the U.S. dollar is determined to be the new functional currency.
At this point in the chapter, the entries we are preparing are the same as those when there
is only one company involved. We need to consider, though, that these two companies will
have to consolidate, since Canco owns 80% of USco. In the following sections, we examine
the additional foreign currency issues in combining companies that have different functional
currencies.
✓ LEARNING CHECK
• Each company in the group records its foreign currency transactions at the rate when the
transaction occurred.
• Monetary items are restated at the closing rate at the financial statement date and any gain
or loss is recorded in income.
• Changes in functional currency occur only if there are significant economic changes in a
company’s operations, and the changes are accounted for prospectively.
TRANSLATING INDIVIDUAL FINANCIAL

STATEMENTS INTO A GROUP
PRESENTATION CURRENCY
Objective 3 Most large corporate structures do not share the same functional currency among all entities
Translate group within the group. Such structures normally comprise operations with a number of functional
financial statements currencies. In the second quarter financial statements of Bombardier Inc., the company dis-
into a group closed that it had several investments, each with a functional currency different than that of
presentation
currency.
Bombardier Inc. The Bombardier Inc. financial statements are expressed in U.S. dollars, the
functional currency of Bombardier Inc. The functional currency of most foreign subsidiaries
is their local currency, mainly the U.S. dollar in Bombardier Aerospace, and the euro, vari-
ous other Western European currencies, and the U.S. dollar in Bombardier Transportation.
We saw in Chapter 7 that the functional currency may not be the same as the presenta-
tion currency. When a group is involved, one presentation currency must be selected for
presentation of the entire group. Given the rising trend toward globalization, entities may
choose to present their financial statements in any currency based on management’s moni-
toring of the performance and financial position of entities within such a group.
When the financial statements of foreign operations are included in the group’s finan-
cial statements by consolidation or the equity method, they are translated for presentation
purposes into a single currency, called the presentation currency. It is the currency used for
group financial statements for presentation purposes. We will use the group structure from
Illustration 8.4 to show the process of deciding the presentation currency for the group in
Illustrative Example 8.4 Determining the Presentation

Currency for the Group
Canada Co. has the following organizational structure with the following functional
currencies on a company-by-company basis:
Canada Co.
(Canco)
C$
U.S. European China Mexico joint

subsidiary subsidiary associate venture
(USco) (Euroco) (Chinaco) (Mexico)
U.S. $ British £ yuan (¥) C$
For monitoring purposes, management decides to present the group’s consolidated

financial statements in Canadian dollars. This requires the translation of all companies’
financial statements into Canadian dollars for presentation purposes. For Canco there
is no impact, since the functional currency is the same as the presentation currency.
For the other entities, there will be a foreign currency gain or loss on the translation
into the presentation currency. This gain or loss is not actually presented by the indi-
vidual entities but each statement will be used for consolidation purposes or the equity
method pickup on the consolidated Canco financial statements.
Presentation Currency Differing

from the Functional Currency
Financial statements can be presented in any currency. When the currency selected for pre-
sentation purposes differs from a company’s functional currency, the financial statements
need to be translated into this selected presentation currency. The translation of the financial
statements into a presentation currency is completed in the following steps:
1. Assets and liabilities (including comparatives) are translated at the closing rate at the date
of the statement of financial position.
2. Income and expenses (including comparatives) for each statement of comprehensive
income or separate income statement presented are translated at exchange rates at the
dates the transactions took place.
3. All resulting exchange differences are recognized in other comprehensive income.
For practical purposes, an average rate to approximate the actual exchange rate at the
date of the transactions for income and expenses may be used.
Using the criteria outlined above, we will apply it to Parent Company PC and its subsid-
iary SL in Illustrative Example 8.5.
Translating Individual Financial Statements into a Group Presentation Currency 409
Illustrative Example 8.5 Translation into Presentation

Currency Where the Functional Currency Is Different
Parent Company (PC) has the euro as its functional currency and acquired 100% of
Subsidiary Limited (SL), a Canadian company with the Canadian dollar as its func-
tional currency, on November 1, 2013.
At acquisition, PC paid $100. PC determined that the fair value of the net assets of
SL were equal to their carrying value of $100. The goodwill arising on acquisition was
therefore $0.
The exchange rates were as follows:
At acquisition, November 1, 2013 C$1 €0.6993

Average through the two month period C$1 €0.7201
Closing rate, December 31, 2013 C$1 €0.7233
Since the group’s presentation currency is the same as PC’s functional currency
(the euro), the following is required to be performed to represent SL’s financial state-
ments in the group’s presentation currency:
Statement of November 1, December 31, Translation Balance
financial 2013 2013 Rate December
position C$ C$ € 31, 2013 €
Current assets 14,000 8,000 0.7233 5,786
Non-current assets 3,000 15,000 0.7233 10,850
Total assets 16,636
Current liabilities 2,000 2,500 0.7233 1,808
Non-current liabilities 5,000 5,500 0.7233 3,978
Opening equity 10,000 10,000 0.6993 6,993
Cumulative translation 256a
account
Profit 0 5,000 0.7201 3,601
Total liabilities and equity 16,636
Statement of
comprehensive
income
Revenue 20,000 0.7201 14,402
Costs 15,000 0.7201 10,801
Net income 5,000 0.7201 3,601
Cumulative translation 256a
gain
Comprehensive income 3,857
a
The amount in the cumulative translation account represents the difference in exchange rates
used to convert the assets and liabilities at the spot rate at the reporting date and the rate used
to convert income and expense items that are translated at the historical rate. The calculation
of this translation gain or loss was illustrated in Chapter 7.
Opening equity $10,000 (0.6993 0.7233) 240
Net income $5,000 (0.7201 0.7233) 16
Foreign currency gain 256
Note that in this example, the gain of 256 for the month is the same as the cumulative foreign
currency gain since PC only acquired SL at the beginning of the month. When PC consoli-
dates with SL, it will use this translated statement for the purpose of consolidating with SL.
As such, the € 256 gain in the cumulative translation account will carry forward to the consoli-
dated statements.
When a company is in a hyperinflationary environment, it must translate all items on its finan-
cial statements following IAS 29 Hyperinflationary Economic Environment. As the Canadian
environment is not hyperinflationary, this situation is covered in Appendix 8A of this
chapter.
ASPE: Presentation Currency

ASPE
Under ASPE, there is no discussion of the presentation currency. For the purpose
of consolidation or the equity method, the reporting company determines if the
investee is integrated or self-sustaining. If the investee is integrated, it is considered
as if all the transactions are foreign currency ones. The monetary balances are trans-
lated at the current rate and the non-monetary ones are at the historical rate. The
results are the same where IFRS requires translation of a company into its functional
currency.
If the investee is considered self-sustaining, the translation procedure is the same as
that shown in Illustrative Example 8.5. It should be noted that ASPE requires use of the
period-end rate, whereas IFRS refers to the closing rate for the period.
Using a Currency of Convenience for Translation

Companies may choose to present financial statements or other financial information in a
currency that differs from their functional or presentation currency. When a company pres-
ents its financial statements in a currency that is different from its functional currency, it
must convert the balances to a presentation currency using the guidance provided by IAS 21.
When only selected financial information is translated into another currency, the company
is not following the requirements of IAS 21 because not all of the information is translated
as required by IAS 21 or because the financial statements are being presented in a currency
other than the functional or presentation currency (i.e., an additional currency altogether).
For example, a company may translate its debt only at a specific rate of exchange for a par-
ticular lender.
The standard therefore requires the following disclosures to notify the user of the finan-
cial statements of how this translation was accomplished and that it is not necessarily in
accordance with IFRS:
• clear indication that the information is supplementary and is distinct from the informa-
tion that complies with IFRS;
• identification of the currency in which the supplementary information is displayed; and
• the company’s functional currency and the method of translation used to determine the
supplementary information.
We can see an example of convenience reporting in the excerpt from Rio Tinto’s annual
report in Illustration 8.6.
Illustration 8.6
In general, financial data in pounds sterling (£) and Australian dollars (A$) have been translated from
Excerpts from the 2010
the consolidated financial statements and have been provided solely for convenience; exceptions arise
where data can be extracted directly from source records. Certain key information has been provided
Rio Tinto
in all three currencies in the 2010 financial statements.
ASPE ASPE does not address the concept of a convenience translation currency.
Preparing Foreign Currency Adjustments for Consolidation or the Equity Method 411
✓ LEARNING CHECK
• When the functional currency is not the same as the presentation currency, the investee must
translate the financial statements using the year-end closing rate for balance sheet accounts
and the rate when the transaction occurred for income statement accounts.
• Any gain or loss on translation into the presentation currency is recorded in other comprehen-
sive income.
• When a company chooses to report using a currency of convenience, it must provide sufficient
disclosure to the reader.
PREPARING FOREIGN CURRENCY

ADJUSTMENTS FOR CONSOLIDATION
OR THE EQUITY METHOD
Objective 4 Consolidated financial statements are required to be prepared when a company controls
Prepare the foreign one or more other entities (otherwise known as financial statements for a group). With
currency adjustments increased globalization, companies are expanding to include more entities within their
necessary for corporate structure than they have in the past, requiring the preparation of consolidated
the purposes of
financial statements. The incorporation of the results and financial position of a foreign
consolidation or the
application of the operation with those of the parent follows normal consolidation procedures, which include
equity method. the following:
• eliminating all intragroup balances and transactions;
• recording fair value adjustments;
• amortizing fair value adjustments; and
• allocating non-controlling interest.
For the purposes of consolidation, a foreign operation’s assets and liabilities are trans-
lated at the exchange rate at the end of its reporting period. However, sometimes, the finan-
cial statements of the foreign operation are prepared within three months of the reporting
period of that of the reporting company. In this case, adjustments are made for significant
changes in exchange rates up to the end of the reporting period of the reporting company.
The same approach is used in applying the equity method to associates and joint ventures.
The process of consolidation is very procedural; that is, there are several steps involved
in producing consolidated financial statements that reflect appropriate balances where trans-
actions denominated in foreign currencies are concerned.
Step 1: Translate foreign currency transactions into a company’s functional currency.
Step 2: Translate balances into the presentation currency for the purposes of consolida-
tion or the equity method.
Step 3: Execute consolidation adjustments.
• Eliminate intercompany balances and transactions.
• Account for any fair value adjustments.
• Account for any non-controlling interests.
In this section we examine the additional adjustments necessary if the consolidation or equity
pickup involves acquisitions that took place in a foreign currency. After having completed the
translation to presentation currency, we examine the consolidation adjustments to be made.
Intracompany Balances
Intracompany balances and transactions may arise as a result of sales or purchases between
the parent and subsidiary companies. They may also arise from financing transactions; for
example, when the parent company lends money to the subsidiary to help finance its working
capital requirements, or the parent company makes additional capital injections to help the
subsidiary meet its ongoing cash flow requirements. When these transactions are denomi-
nated in a currency foreign to either the parent or the subsidiary company, there are foreign
exchange implications that need to be considered for consolidation or equity pickup.
An investment in a subsidiary will likely include some type of investment in shares or
other equity interest (which would be considered a non-monetary item). A parent company
may lend money to (or receive money from) a foreign subsidiary where the settlement terms
are neither planned nor likely to occur in the foreseeable future. When such is the case, IAS
21 par. 15 considers this type of monetary intercompany transaction to be, in substance,
a part of the company’s net investment in that foreign operation. (A regular trade payable
or receivable would not be considered part of a company’s net investment in a foreign
operation.) This loan would likely be denominated in either the parent company’s functional
currency or that of the subsidiary. Where these functional currencies differ, an exchange dif-
ference will result due to the fact that the monetary item represents a commitment to convert
one currency into another, which exposes the parent company to either a gain or loss through
currency fluctuations.
In the consolidated financial statements of the parent company, when the monetary item
is not considered to be part of the net investment, exchange differences are recognized in
profit or loss. When the exchange difference arises on a monetary item that forms part of the
parent company’s net investment in the foreign operation, it is recognized in other compre-
hensive income and accumulated in a separate component of equity until the disposal of the
foreign operation. This is shown in Illustrative Example 8.6.
Illustrative Example 8.6 Intracompany Transactions

Parent Corporation (“Parentcorp”), whose functional currency is the British pound,
is preparing its individual and consolidated financial statements as at December 31,
2013. The group’s presentation currency for its consolidated statements is also the
British pound. It has a loan receivable in the amount of C$1 million from its foreign
subsidiary, Subsidiary Company (“Subco”) located in Canada, whose functional cur-
rency is the Canadian dollar. The loan has been outstanding for a long time.
The relevant exchange rates are as follows:
December 31, 2013 January 1, 2013
£1 C$1.5595 £1 C$1.5513
The following exchange differences will arise in the financial statements of the
individual entities when the loan is retranslated at the closing rate as required.
Scenario 1:
Parentcorp does not consider the loan to be part of its net investment in Subco since it
is likely to be repaid in the near future.
Subco’s accounting records:
No exchange difference arises in the foreign subsidiary as the loan payable is denomi-
nated in its functional currency (Canadian dollars).
Parentcorp’s accounting records:
Long-term loan receivable at Dec. 31, 2013 £641,231.16
Long-term loan receivable at Jan. 1, 2013 £644,620.64
Exchange loss £ 3,389.48
In Parentcorp’s stand-alone financial statements, the exchange loss is recognized

in income since it is recognized on a monetary item.
In the group’s consolidated financial statements, the loan itself will be elimi-
nated in accordance with IFRS 10 par. B86 (c) since it is an intragroup transaction,
while the foreign exchange loss of £3,389.48 will be recognized in income. The
foreign exchange component will continue to be recognized since an intragroup
monetary item, whether short-term or long-term, cannot be eliminated against the
corresponding intragroup liability (or asset) without showing the results of currency
fluctuations in the consolidated financial statements. The monetary item repre-
sents a commitment to convert one currency into another and therefore exposes
Parentcorp in this case to a gain or loss through currency fluctuations. Accordingly,
in the consolidated financial statements, such an exchange difference is recognized
in net income.
Scenario 2:
Parentcorp notified Subco at the beginning of 2013 that for the foreseeable future,
Subco will not be required to repay the loan receivable. As such, Parentcorp consid-
ers the loan to be part of its net investment in Subco.
Subco’s accounting records:
No exchange difference arises in the foreign subsidiary as the loan payable is denomi-
nated in its functional currency (Canadian dollars).
Parentcorp’s accounting records:
Long-term loan receivable at Dec. 31, 2013 £641,231.16
Long-term loan receivable at Jan. 1, 2013 £644,620.64
Exchange loss £ 3,389.48
In Parentcorp’s stand-alone financial statements, the exchange loss is recognized
in income since it is recognized on a monetary item.
In the group’s consolidated financial statements, the loan itself will be
eliminated in accordance with IFRS 10 par. B86 (c) (same as in scenario 1).
The foreign exchange loss of £3,389.48 will be recognized in other compre-
hensive income and accumulated as a separate component of equity. Upon dis-
posal, the accumulated balance in equity will be reclassified (transferred) into
net income for the period.
The foreign exchange component will continue to be recognized for the same
reason cited above in scenario 1, except that in the consolidated financial statements,
such an exchange difference is recognized in other comprehensive income since
exchange differences arising on equivalent financing with equity capital would be
taken to equity on consolidation.
When non-monetary transactions are recognized in other comprehensive income, such as

revaluations of property, plant, and equipment, any related foreign exchange component is
recognized in other comprehensive income. Similarly, when a non-monetary item is recog-
nized in net income, such as investment property, any related foreign exchange component is
recognized in net income.
The consolidation of a foreign operation follows normal consolidation procedures, such
as the elimination of intragroup balances and intragroup transactions. However, when it
comes to an intragroup monetary balance, it cannot simply be eliminated without reflecting
the related currency fluctuations in the consolidated financial statements. Any amounts accu-
mulated in other comprehensive income will be recycled into profit or loss when the foreign
operation is disposed. This is demonstrated in Illustrative Example 8.7.
Illustrative Example 8.7 Intercompany Monetary Balances

Parent Company (PC) has the euro as its functional currency. It acquired 100% of
Subsidiary Limited (SL), a Canadian company with the Canadian dollar as its functional
currency, on November 1, 2013.
At acquisition, PC paid $1 million. PC determined that the fair value of SL’s net assets
were equal to their carrying value of $1 million. At year end, PC has loaned SL C$25,000.
At December 31, 2013, the group’s year end, SL’s equity is C$1,020,000.
The relevant exchange rates at year end, December 31, 2013, are as follows:
Spot rate at loan date of December 1, 2013 C$1 ⫽ €0.7211
Closing rate December 31, 2013 C$1 ⫽ €0.7233
Average rate for the two months ended December 31, 2013 C$1 ⫽ €0.7222
The impact of this monetary intragroup balance on consolidation is as follows:
1. This balance is not considered to be part of PC’s net investment in SL.
PC’s books SL’s books

December 31, 2013: December 31, 2013:
Loan receivable C$25,000 ⫻ 0.7233 ⫽ Loan payable C$25,000
€18,083 December 1, 2013:
December 1, 2013: Loan payable C$25,000
Loan receivable C$25,000 ⫻ 0.7211 ⫽ Foreign exchange loss ⫽ C$0
€18,028
Foreign exchange loss ⫽ €55a
From PC’s perspective, this is a foreign From SL’s perspective, this is not a
currency transaction. foreign currency transaction.
In preparation for consolidation, SL
translates its financial statements
into the euro presentation currency.
The loan payable is restated at the
year-end closing rate:
Loan payable C$25,000 ⫻ 0.7233 ⫽ €18,083
A foreign currency gain of €55 is recorded
in OCI.
On consolidation, PC and SL are both presented in euros.

T Loan payable to PC €18,083
T Loan receivable SL €18,083
(To eliminate the intragroup loan)
a
Notice that when the loan is not considered part of the net investment, the foreign exchange
loss of €55 that PC recorded flows through net income in the consolidated financial statements.
It is not offset by the €55 that SL reflects in OCI.
2. This balance is part of PC’s net investment in SL.
PC’s books SL’s books

December 31, 2013: December 31, 2013:
Loan receivable C$25,000 ⫻ 0.7233 ⫽ Loan payable C$25,000
€18,083 December 1, 2013:
December 1, 2013: Loan payable C$25,000
Loan receivable C$25,000 ⫻ 0.7211 ⫽ Foreign exchange loss ⫽ C$0
€18,028
Cumulative translation loss (recorded in In preparation for consolidation, SL trans-

other comprehensive income) ⫽ €55b lates its financial statements into the euro
presentation currency. The loan payable is
restated at the year-end closing rate:
Loan payable C$25,000 ⫻ 0.7233 ⫽ €18,083
A foreign currency gain of €55 is recorded
in OCI.
On consolidation :
b
Notice that when the loan is considered part of the net investment, the foreign exchange
flows through other comprehensive income in the consolidated financial statements, thereby
offsetting the amount included in other comprehensive income in SL’s books. Notice that
when the loan is not considered part of the net investment, the foreign exchange flows
through net income in the consolidated financial statements since the amount included in
other comprehensive income in SL’s books will be eliminated with the Investment in SL upon
consolidation.
Upon consolidation, it is necessary to eliminate any unrealized profits that exist on intra-
group transactions. IAS 21 is silent with respect to which exchange rate to use when eliminat-
ing the transaction. If we assume that the parent has a foreign currency transaction and the
subsidiary does not, the parent has already translated the intercompany transaction at the
rate when the transaction occurred or at the average rate as an approximation. At year end
the parent has translated any monetary balance at the year-end rate. The subsidiary will use
the average rate to translate the transaction on its books into the presentation currency at
year end. As such, the elimination of any intragroup profits will be at the rate when the trans-
action occurred or the average rate of exchange.
Let’s use the example of an intragroup unrealized profit in inventory of €6,000. The trans-
action took place in euros. The parent’s functional currency is the Canadian dollar and the sub-
sidiary’s functional currency is the euro. On consolidation, the following adjustment is made:
T inventory €6,000 ⫻ average rate
c cost of goods sold €6,000 ⫻ average rate
Conceptually, it is logical that the unrealized profit is removed from the cost of goods sold
at the average rate since the purchases and sales to which it relates were also translated at the
average rate. However, the adjustment to the inventory on the statement of financial position is
not as clear. If the inventory is on the books of the reporting enterprise, the unrealized profit and
the inventory itself are both measured at the average rate (which becomes the historical rate at
year end). However, if the inventory is on the books of the subsidiary, it is translated at the clos-
ing rate for presentation purposes, whereas the unrealized profit is removed at the average rate.

When any fair value adjustments exist on the carrying amounts of assets and liabilities arising
on the acquisition of a foreign operation, they are treated as assets and liabilities of the for-
eign operation for the purposes of translation. Therefore, they are carried in the functional
currency of the foreign operation and are translated at the closing rate (using the current rate
method) for the purposes of presentation on consolidation.
Goodwill
Each item that has a fair value different than its carrying value and any goodwill established
must be converted into the functional currency of the foreign operation. Illustrative Example
8.8 examines the translation of goodwill established in a business acquisition.
Illustrative Example 8.8 Foreign Currency Adjustment,

on Consolidation, for Goodwill
Recall that Parent Company (PC) has the euro as its functional currency and acquired
100% of Subsidiary Limited (SL), a Canadian company with the Canadian dollar as its
functional currency. Let’s assume now that the acquisition occurred on January 1, 2011.
At acquisition, PC paid $150,000. PC determined that the fair value of SL’s net
assets were equal to their carrying value of $100,000. The goodwill arising on acquisi-
tion was therefore $50,000.
At acquisition, January 1, 2011 C$1 ⫽ €0.6993
At December 31, 2012 C$1 ⫽ €0.7182
Average through the year C$1 ⫽ €0.7201
Closing rate on December 31, 2013 C$1 ⫽ €0.7233
Goodwill will have initially been recorded at $50,000 ⫻ 0.6993 ⫽ €34,965. Upon
consolidation, the goodwill will be retranslated at the closing rate for the purposes of
consolidation as follows:
Goodwill C$50,000 ⫻ 0.7233 ⫽ €36,165. The foreign exchange gain of €1,200
would be recorded as part of the cumulative translation account.
Opening balance cumulative exchange (C$50,000 ⫻ [0.7182 ⫺ 0.6993]) €945
Other comprehensive income: foreign currency (C$50,000 ⫻ [0.7233 ⫺ 0.7182]) €255
Ending balance cumulative exchange gain, cumulative OCI €1,200
Fair Value Adjustments that Have a Limited Life:

Property, Plant, and Equipment
We will now examine the adjustment on consolidation for the foreign currency effects of fair
value adjustments on depreciable assets. It is more complex than those that do not depreci-
ate since the foreign currency effect must be separated from the depreciation as well. Using
the same example as in Illustrative Example 8.8, in Illustrative Example 8.9 we now assume
that the fair value adjustment arising on acquisition is due to a piece of equipment that has a
five-year remaining life. We will ignore the income tax effect for purposes of illustrating the
adjustment.
Illustrative Example 8.9 Foreign Currency Adjustments

for Depreciable Assets
Assume again that Parent Company (PC) acquired 100% of Subsidiary Limited (SL)
on January 1, 2011.
At acquisition, PC paid $150,000. PC determined that the fair value of SL’s net
assets were equal to their carrying value of $100,000. The difference of $50,000 is
determined to arise due to fair value increase in equipment, which has a remaining life
of five years.
At acquisition, January 1, 2011 C$1 ⫽ €0.6993
At December 31, 2012 C$1 ⫽ €0.7182
Average through the year C$1 ⫽ €0.7201
Closing rate on December 31, 2013 C$1 ⫽ €0.7233
The equipment will have initially been recorded at C$50,000 ⫻ 0.6993 ⫽ €34,965.
Upon consolidation, the net book value of the equipment will be retranslated at the
closing rate for the purposes of consolidation as follows:
Equipment: (50,000 ⫺ 3 ⫻ 10,000) ⫻ 0.7233 ⫽ €14,466. The amount of €14,466
cannot be compared simply with €34,965 as part of the difference is due to deprecia-
tion and part is due to a foreign currency gain or loss.
Canadian Canadian amount

amount accumulated Canadian Exchange Euro
Date original cost depreciation amount net rate amount
January 1, 2011 50,000 0 50,000 .6993 34,965
December 31, 2012 50,000 20,000 30,000 .7182 21,546
December 31, 2013 50,000 30,000 20,000 .7233 14,466
At the end of 2013, the equipment fair value adjustment would be added on con-
solidation at the amount of €14,466 net book value.
The depreciation expense on the comprehensive income statement would be
adjusted for $10,000 ⫻ 0.7201 ⫽ €7,201.
The amount that the statement of financial position
was adjusted at acquisition ⫽ €34,965
Minus: the depreciation for the year for 2 years
assuming the same average rate for each year 20,000 ⫻ .7201 (14,402)
Balance in equipment as calculated on
December 31, 2012 20,563
Balance that should be reflected at the closing rate 21,546
Foreign currency gain in OCI to bring the
balance to closing rate in 2012 € 983
The amount that the 2012 statement of financial
position was adjusted ⫽ €21,546
Minus: the depreciation for the year (7,201)
Balance in equipment as calculated 14,345
Balance that should be reflected at the
closing rate in 2013 14,466
Foreign currency gain in OCI to bring the
balance to closing rate € 121
Opening balance cumulative exchange € 983
Other comprehensive income: foreign currency 121
Ending balance cumulative exchange gain,
cumulative OCI €1,104
Non-controlling Interest
In Chapter 5 we learned that the non-controlling interest must be allocated a portion of the
group’s comprehensive income as well as a portion of the group’s net assets. When a sub-
sidiary has foreign currency transactions and records foreign currency gains or losses, the
non-controlling interest will be allocated a portion of those gains or losses since it shares in
the net income of the subsidiary. In addition to foreign currency transactions, the subsidiary
may have a functional currency that is different than the parent’s functional currency. For the
purpose of allocating to the non-controlling interest, the subsidiary’s financial statement is
first translated into the presentation currency. As such, the non-controlling interest is allo-
cated a portion of the foreign currency translation adjustment that is part of cumulative other
comprehensive income.
The rationale is that the parent company is only at risk of the foreign currency fluc-
tuating to the extent of its ownership in the subsidiary. If we look back at Illustrative
Example 8.5 but assume that PC owns 70% of SL, the non-controlling interest would be
calculated as follows:
Non-controlling interest share of opening net asset position €6,993 .3 2,098
Share of comprehensive income €3,857 .3 1,157
Non-controlling interest ending net asset position €3,255
You will note that the calculation is performed using the translated statement of SL.
Tax Effects of All Exchange Differences

Gains and losses on foreign currency transactions and exchange differences arising on trans-
lating the results and financial position of a company (including a foreign operation) into a
different currency may have tax effects. If the presentation currency is not the same as the
functional currency in which the company paid tax, deferred income tax will occur on the
temporary difference between the exchange rates.
Disposal or Partial Disposal of a Foreign Operation

When a company disposes of a foreign operation, the cumulative amount of the exchange
differences relating to that foreign operation, recognized in other comprehensive income
and accumulated in the separate component of equity, will be reclassified from equity
to profit or loss (as a reclassification adjustment) when the gain or loss on disposal is
recognized.
According to IFRS 21.48A, in addition to the disposal of a company’s entire interest in a
foreign operation, the following are accounted for as disposals even if the company retains an
interest in the former subsidiary, associate, or jointly controlled company:
(a) the loss of control of a subsidiary that includes a foreign operation,
(b) the loss of significant influence over an associate that includes a foreign opera-
tion, and
(c) the loss of joint control over a jointly controlled company that includes a foreign
operation.
Hedge Accounting
In Chapter 7 we examined the various hedging opportunities available to a company to elimi-
nate foreign currency risk. There are additional issues that must be addressed when a group
of companies prepares a consolidated financial statement.
For hedge accounting purposes, only instruments that involve a party external to the
group or individual company that is being reported on can be designated as hedging instru-
ments. Although individual entities within a consolidated group or divisions within a company
may enter into hedging transactions with other entities within the group, any such intragroup
transactions are eliminated on consolidation. Therefore, such hedging transactions do not
qualify for hedge accounting in the consolidated financial statements of the group. However,
they may qualify for hedge accounting in the individual or separate financial statements of
individual entities within the group provided they are external to the individual company that
is being reported on (IAS 39.72).
An exception to the rule above is when the foreign currency risk of an intragroup mon-
etary balance is not fully eliminated on consolidation because the intragroup monetary item
is transacted between two group entities that have different functional currencies. In that
case, the monetary balance will qualify for hedge accounting.
IAS 39 identifies a hedge of a net investment in a foreign subsidiary as a possible hedging
relationship. This is a relationship that is other than the fair value hedge or cash flow hedge
that were discussed in Chapter 7. When an item is deemed to hedge a net investment in a
foreign subsidiary, any gain or loss on the hedging items is recorded in Other Comprehensive
Income. Since the gain or loss on the net investment due to foreign currency is also recog-
nized in Other Comprehensive Income, the amounts will offset. The gain or loss on the
hedging item is reclassified on disposal of the net investment (IAS 39.101).
ASPE: Foreign Currency Adjustments

ASPE Under ASPE:
• The specific aspects discussed above regarding the translation of monetary inter-
company transactions are not particularly addressed.
• Significant events between the reporting dates of the foreign operation and the
reporting company are required to be recognized or disclosed as appropriate.
• Specific guidance on the translation of goodwill and fair value adjustments are not
particularly addressed, although in practice the same methodology is used.
• It is possible to hedge a foreign currency risk on the net investment in another
company. Any gain or loss on foreign exchange fluctuations is included in
equity.
✓ LEARNING CHECK
• Consolidation adjustments must be restated to the presentation currency.
• Intercompany transactions are eliminated at the rate when the transaction occurred.
• Monetary balances are eliminated using the year-end rate.
• Fair value adjustments must be reflected on the balance sheet at the closing rate for the year.
• Non-controlling interest is allocated its portion of group comprehensive income and net
assets based on the statement prepared for presentation purposes.
• Intragroup monetary balances are translated, with the resulting exchange gain or loss being
reflected in net income, unless it forms part of the net investment in the foreign operation, in
which case it is reflected in other comprehensive income.
• When the financial statements of a foreign operation are prepared as of a different date (but
within three months of the reporting company), they are translated at the exchange rate at
the end of the reporting period of the foreign operation, with adjustments being made for any
significant events or other transactions between the different dates.
• Goodwill and fair value adjustments related to a foreign operation are treated as assets and
liabilities of the foreign operation for the purposes of foreign currency translation.
LEARNING SUMMARY
KEY TERMS
Foreign currency When a company conducts business in a currency other than its functional currency, for-
transactions eign currency gains and losses are recognized. In Chapter 7, we examined the foreign cur-
(p. 405) rency effects on an individual company. In this chapter we understand the foreign currency
Foreign operation effects that are particular to a group of companies that have to present one set of financial
(p. 403) statements.
Functional currency Initially each company in the group translates its foreign transactions into its functional
(p. 402) currency. This results in monetary items being restated to the closing rate for the reporting
Group (p. 402) date. Any gains or loss are flowed through net income in the books of the individual company.
Monetary items A presentation currency is then selected for the group. This would most often be the
(p. 406) functional currency of the reporting company in the group but is not required to be so.
Net investment in a Each company in the group that has a functional currency that is different than the presenta-
foreign operation tion currency must restate its financial statement to conform to the presentation currency.
(p. 412) This will result in foreign currency gains or losses that are included in other comprehensive
Presentation currency income and represent the cumulative translation gain or loss.
(p. 407) In the group, there will be a parent–subsidiary relationship. As such, the reporting com-
pany will have to prepare the necessary adjustments for the equity method and/or consolida-
tion. Specifically, any foreign fair value adjustments will have to be restated to the closing
balance, any intercompany transactions will be eliminated using the exchange rate when the
transaction occurred, and the non-controlling interest must be allocated a portion of the
subsidiary’s net income and net assets based on the presentation values. The equity pickup of
the investor is based on the presentation of the financial statements of the associate or joint
venture.
Appendix 8A—Hyperinflationary Environment 421
APPENDIX 8A—HYPERINFLATIONARY
ENVIRONMENT
Hyperinflationary Economies
A hyperinflationary economy is one in which there is a loss of purchasing power of money
at such a high rate that to compare amounts from transactions and other events that have
occurred at different times, even within the same accounting period, would be misleading.
Judgement is required to determine whether an economy is considered to be hyperinflationary.
IAS 29 provides guidance in identifying a hyperinflationary economic environment. The fol-
lowing guidance is provided in IAS 29 to identify a hyperinflationary economic environment:
• The general population prefers to accumulate wealth in non-monetary assets or in a rela-
tively stable foreign currency to preserve its purchasing power.
• Monetary amounts and prices are expressed in terms of a relatively stable foreign cur-
rency instead of the local currency.
• Prices for credit sales and purchases are calculated to compensate for the expected loss of
purchasing power during the credit period, even when such period is short.
• Interest rates, wages, and prices are linked to a price index.
• The cumulative inflation rate over three years is approaching, or exceeds, 100%.
A company cannot avoid restatement in accordance with IAS 29 Financial Reporting in
Hyperinflationary Economies by, for example, adopting a stable currency (such as the functional
currency of its parent) as its functional currency (IAS 21.14).
Preparing Financial Statements

If the functional currency is that of a hyperinflationary economy, a company should restate its
financial statements in terms of the measuring unit current at the end of the reporting period
(this applies to comparative figures as well). In Step 1, the company determines its functional
currency and restates all foreign currency monetary items in the functional currency. In a hyper-
inflationary economy, all items are restated based on the general price index. These financial
statements are sometimes referred to as “purchasing power adjusted financial statements.”
To prepare such statements, a company does the following:
• Selects a general price index.

• Segregates financial statement elements into monetary and non-monetary items because
monetary items are not restated, while non-monetary items are.
• Identifies and restates assets and liabilities linked by agreement to changes in prices in
accordance with the agreement.
• Restates non-monetary items using the application of a general price index except for
those carried at current amounts.
• Restates the income statement using the general price index.
• Calculates the net monetary gain or loss.
• Restates the cash flow statement.
• Restates the comparative figures.
ASPE requires that financial statements of a foreign operation in a highly inflationary

ASPE economy be translated using the temporal method. Under the temporal method, mon-
etary items are translated at the closing rate and non-monetary items are reflected at
the historical rate.
When a company’s functional currency is that of a hyperinflationary economy, the

company’s financial statements are first restated in accordance with IAS 29, then the results
and financial position are translated into the presentation currency as follows. All amounts
(assets, liabilities, equity items, revenues, and expenses) are translated at the closing rate at
the date of the most recent balance sheet. There is one exception: When amounts are trans-
lated into the currency of a non-hyperinflationary economy, comparative amounts are those
that were presented in the relevant prior year financial statements as current amounts. (That
is, figures are not adjusted for subsequent changes in the price level or subsequent changes in
the exchange rates.)
We will now examine a group consolidation where the individual companies have differing
functional currencies and a single presentation currency for the purpose of consolidation.
We will follow these steps:
Step 1: Identify all foreign currency transactions in both the parent and subsidiary enti-
ties and translate them using the spot rate at the dates of the transactions.
At the period end, adjust all monetary balances to reflect the foreign currency rate at the
end of the reporting date (or date of fair valuation where relevant).
Step 2: Translate all balances into the group’s presentation currency.
Step 3: Consider consolidation adjustments and prepare the consolidated financial
statements.
Solar Company, having a functional currency of the U.S. dollar, is an 80% subsidiary of
Energy Corporation, whose functional currency is the Canadian dollar. The group’s presenta-
tion currency is the Canadian dollar. When Energy acquired Solar three years ago on January
1, 2011, it paid cash consideration of U.S. $220,000, which it determined to be fair value at the
time. Energy and Solar pay tax at a rate of 40%. The relevant exchange rates were as follows:
Date C$1
January 1, 2011 U.S. $ 1.1
December 31, 2011 U.S. $ 0.97
December 31, 2012 U.S. $ 0.99
December 31, 2013 U.S. $ 0.98
Average 2011, 2012, and 2013 U.S. $ 0.982
ENERGY CORPORATION SOLAR CORPORATION

Statement of Financial Position Statement of Financial Position
December 31, 2013 December 31, 2013
Assets C$ Assets U.S. $
Cash C$ $100,000 Cash $ 1,000
Cash U.S. $ 75,000 Accounts receivable 115,000
Accounts receivable 85,000 Inventory 200,000
Investment in Solar 200,000 Total current assets 316,000
Total current assets 460,000 Equipment 150,000
Equipment 225,000 Loan receivable 75,000
Intangibles 125,000 Total non-current assets 225,000
Total non-current assets 350,000 $541,000
$810,000 Liabilities
Liabilities Trade payables $ 50,000
Trade payables $110,000 Provisions 30,000
Provisions 25,000 Total current liabilities $ 80,000
Total current liabilities $135,000 Mortgage payable $225,000
Long-term debt U.S. $ 250,000 Total non-current liabilities 225,000

Total non-current liabilities 250,000 $305,000
$385,000 Equity
Equity Share capital $ 10,000
Share capital $100,000 Retained earnings 226,000
Other comprehensive
income 5,000 Total equity 236,000
Total equity 425,000 $541,000
$810,000
Energy Comprehensive Income Statement Solar Comprehensive Income Statement

Revenue $5,900,000 Revenue $1,250,000
Cost of sales 4,800,000 Cost of sales 825,000
Gross profit 1,100,000 Gross profit 425,000
Other income 120,000 Other income 55,000
Distribution costs (180,000) Distribution costs (150,000)
Administrative expenses (170,000) Administrative expenses (75,000)
Other expenses (130,000) Other expenses (45,000)
Finance costs: including Finance costs:
foreign exchange and including foreign
interest expense (300,000) exchange (21,350)
Income before tax 440,000 Income before tax 188,650
Income tax expense (240,000) Income tax expense (8,000)
Comprehensive income $ 200,000 Comprehensive income $ 180,650
Since the exchange rate is expressed in terms of Canadian dollars, the U.S. dollar bal-
ances are divided by the exchange rate to arrive at the Canadian amount.
The book value of Solar upon acquisition was U.S. $165,000 (U.S. $10,000 common
shares and U.S. $155,000 retained earnings). The excess in Solar is determined to be attribut-
able as follows:
• Fair value increments attributable to a patent of U.S. $25,000. The patent had a useful
life of four years
• Goodwill
During 2013, Energy sold U.S. $50,000 of goods to Solar and made a profit of U.S.
$20,000 on the sale. All of the goods are still in Solar’s inventory at year end. There is a bal-
ance of U.S. $30,000 remaining to be paid at year end.
During 2013, Solar sold goods to a European company for €70,000. The amount has not
been collected by year end. The exchange rate for the euro relative to the U.S. dollar is the 2013
average of €1 ⫽ U.S. $0.74 and at year end, the rate of €1 ⫽ U.S. $0.72. Since the exchange rate is
expressed in terms of the euro, the balances are multiplied by the rate to arrive at the U.S. amount.
Interest on the U.S. debt held by Energy was U.S. $12,000 during 2013.
Both companies paid their dividends at year end (Energy $80,000, Solar $20,000).
Energy and Solar have a year end of December 31, 2013.
Step 1:
We assume that each company translated its foreign currency transactions into the functional
currency at the day of the transaction using the same process discussed in Chapter 7. We
will assign an exchange rate of U.S. $1 ⫽ C$1 at the day of the transaction to simplify the
process. If the company had not translated the transactions at the day of the transaction, this
would have to been done as part of Step 1. Each company then restates its monetary foreign
currency year-end balances into its respective functional currency. These adjustments are
recorded in the books of the respective companies.
Energy Corporation: The functional currency is the Canadian dollar so the U.S. dollar
transactions are foreign currency transactions. Energy has the following U.S. dollar mon-
etary balances at year end:
1. Cash
2. Intercompany receivable from Solar
3. Long-term debt
ENERGY CORPORATION
December 31, 2013
Step 1: Translate the foreign currency transaction into the functional currency.
Assets Rate C$
Cash C$ $100,000 1.00 $100,000
Cash U.S. $ 75,000 0.98 76,531
Accounts receivable 85,000 55,000 ⫹30,000/.98 85,612
Investment in Solar 200,000 1.00 200,000
Equipment 225,000 1.00 225,000
Intangibles 125,000 1.00 125,000
$810,000 $812,143
Liabilities
Trade payables $110,000 1.00 $110,000
Provisions 25,000 1.00 25,000
Long-term debt U.S. $ 250,000 0.98 255,102
385,000 390,102
Equity
Share capital 100,000 1.00 100,000
Retained earnings 320,000 Calculated below 317,041
Cumulative other
comprehensive income 5,000 1.00 5,000
Total equity 425,000 422,041
$810,000 $812,143
The monetary items are restated using the closing rate at December 31, 2013, of .98.
Energy Comprehensive Income Statement
Revenue $5,900,000 1.00 $5,900,000
Cost of sales 4,800,000 1.00 4,800,000
Gross profit 1,100,000 1,100,000
Other income 120,000 1.00 120,000
Distribution costs (180,000) 1.00 (180,000)
Administrative expenses (170,000) 1.00 (170,000)
Other expenses (130,000) 1.00 (130,000)
Finance costs: including foreign exchange
and interest expense (300,000) ⫹2,959.00a (302,959)
Income tax expense (240,000) 1.00 (240,000)
Comprehensive income $ 200,000 $ 197,041
Note: the foreign currency gain or loss is flowed through net income.
a
Energy would make the following entry in its books to restate the monetary items to the closing rate
at December 31, 2013:
Cash, U.S. $ 1,531 (75,000/.98 ⫺ 75,000/1)
Accounts Receivable, U.S. $ 612 (30,000/.98 ⫺ 30,000/1)
Long-Term Debt, U.S. $ 5,102 (250,000/.98 ⫺ 250,000/1)
(To translate foreign-denominated balances into Energy’s functional currency)
Energy Statement of Changes in Equity
Cumulative Other
Capital Stock Retained Earnings Comprehensive Income Total
Balance January 1, 2013 $100,000 $200,000 $5,000 $305,000
Comprehensive income 197,041 197,041
Dividends paid (80,000) (80,000)
Balance December 31, 2013 $100,000 $317,041 $5,000 $422,041
The Energy financial statement now reflects the year-end balances in the Canadian dol-
lar functional currency.
Solar Company: Solar restates its monetary foreign transactions to its U.S. dollar functional
currency.
It has one foreign monetary balance, which is the account receivable from the euro trans-
action. Again we assume for ease of demonstration that Solar has already recorded the sale
and the account receivable in U.S. dollars at the day of the transaction and we will use the
rate of U.S. $1 €1 at that date for simplicity.
SOLAR CORPORATION
December 31, 2013
Assets U.S. $ Rate U.S. $

Cash $ 1,000 1 $ 1,000
Accounts receivable 115,000 45,000 70,000 * .72 95,400
Inventory 200,000 1 200,000
Equipment 150,000 1 150,000
Loan receivable 75,000 1 75,000
Total non-current assets 225,000 1 225,000
$ 541,000 $ 521,400
Liabilities
Trade payables $ 50,000 1 $ 50,000
Provisions 30,000 1 30,000
Total current liabilities 80,000 1 80,000
Mortgage payable 225,000 1 225,000
Total non-current liabilities 225,000 1 225,000
305,000 1 305,000
Equity
Share capital 10,000 1 10,000
Retained earnings 226,000 calculated below 206,400
Total equity 236,000 216,400
$ 541,000 $ 521,400
SOLAR CORPORATION
Revenue $1,250,000 1 $1,250,000
Cost of sales 825,000 1 825,000
Gross profit 425,000 1 425,000
Other income 55,000 1 55,000
Distribution costs (150,000) 1 (150,000)
Administrative expenses (75,000) 1 (75,000)
Other expenses (45,000) 1 (45,000)
Finance costs: including
foreign exchange (21,350) 19,600b (40,950)
Income tax expense (8,000) 1 (8,000)
Comprehensive income $ 180,650 $ 161,050
SOLAR CORPORATION
Capital Stock Retained Earnings
Balance January 1, 2013 $10,000 $ 65,350
Comprehensive income 161,050
Dividends paid (20,000)
Balance December 31, 2013 $10,000 $206,400
b
Solar Company would make the following entry in its books to restate the foreign monetary item to the closing
rate at December 31, 2013:
Foreign Currency Loss 19,600 (70,000 .72 70,000 1)
Accounts Receivable, Euros 19,600
(To record the loss on the monetary account receivable)
To summarize Step 1:
Each company adjusts its books to reflect the functional currency of that company.
Monetary items are restated to the closing rate and any gain or loss is flowed through net
income.
Step 2:
Energy and Solar will be consolidated as Energy controls Solar. As such the group must
select a presentation currency. In this example we determine that the presentation currency
will be the same as the functional currency of the reporting company. Since Energy is the
parent company, the presentation currency is deemed to be the Canadian dollar.
Energy’s financial statements already reflect the functional currency of the Canadian
dollar, therefore Energy does not have to adjust its financial statements. The presentation
currency is the same as the functional currency.
Solar’s financial statements are prepared using the U.S. dollar as the functional currency.
As such, Solar will have to translate its financial statements from the U.S. dollar (prepared in
Step 1) to the Canadian dollar presentation currency.
We start with the U.S. dollar functional currency financial statement of Solar as pro-
duced in Step 1. The items on the statement of financial position are restated at the closing
rate at the year end and items on the comprehensive income statement are translated at the
rate when the transaction occurs. We assume an average rate for the rate when the transac-
tion occurred.
SOLAR CORPORATION
December 31, 2013
U.S. $ Rate C$
Assets
Cash $ 1,000 0.98 $ 1,020
Accounts receivable 95,400 0.98 97,347
Inventory 200,000 0.98 204,082
Total current assets 296,400 0.98 302,449
Equipment 150,000 0.98 153,061
Loan receivable 75,000 0.98 76,531
$521,400 0.98 $532,041
Liabilities
Trade payables $ 50,000 0.98 $ 51,020
Provisions 30,000 0.98 30,612
Total current liabilities 80,000 0.98 81,632
Mortgage payable 225,000 0.98 229,592
Total non-current liabilities 225,000 0.98 229,592
305,000 0.98 311,224
Equity
Share capital 10,000 1.1 9,091
Total equity 216,400 220,817
$521,400 $532,041
SOLAR CORPORATION
Revenue $1,250,000 0.982 $1,272,912
Cost of sales 825,000 0.982 840,122
Gross profit 425,000 0.982 432,790
Other income 55,000 0.982 56,008
Distribution costs 150,000 0.982 152,749
Administrative expenses 75,000 0.982 76,375
Other expenses 45,000 0.982 45,825

Finance costs 40,950 0.982 41,701
Income before tax 169,050 0.982 172,148
Income tax expense 8,000 0.982 8,146
Net income 161,050 0.982 164,002
Foreign currency gain 1,111
Solar translates its assets and liabilities at the closing rate on December 31, 2013,
which is .98.
Solar translates its income and expenses at the average rate of .982.
The equity of Solar is translated at the historical rate so as to measure the amount of
foreign currency gain or loss since Energy acquired the investment. We see that there is a
cumulative balance of $18,516, which can be proven as follows. (This was first introduced in
Chapter 7 when an individual company translates its statements from the functional currency
to the presentation currency. We repeat the process here.)
Net assets, January 1, 2013 $ 75,350 0.99 $ 76,112
Comprehensive income 161,050 0.982 164,002
Dividends (20,000) 0.98 (20,408)
Calculated balance 219,706
Net assets, December 31, 2013 216,400 0.98 220,815
Foreign currency gain 2013 1,111
Cumulative foreign currency gain, December 31, 2013 18,516
Cumulative foreign currency gain, January 1, 2013 $ 17,405
In this example, we are told that the dividends were paid on the last day of the year.
Since we do not have the previous years’ translated statements, we treat the amount of
$17,405 as a balancing amount. This is the amount that would appear on the December 31,
2013 statement of financial position in other components of equity. Note that the amount of
$18,516 is not recorded in Solar’s books. This amount must be adjusted only on the consoli-
dated statement for the purpose of presentation.
c Cumulative other comprehensive income, opening balance 17,405
c Other comprehensive income 1,111
SOLAR CORPORATION
Retained Other Components
Capital Stock Earnings of Equity Total
Balance, January 1, 2013 $ 9,091 $ 49,616 $ 17,405 $ 76,112
Comprehensive income -0- 164,002 1,111 165,113
Dividends paid -0- (20,408) -0- (20,408)
Balance, December 31, 2013 $ 9,091 $ 193,210 $ 18,516 $ 220,817
Step 3:
Energy and Solar are now presented in Canadian dollars. The next step is to perform the
consolidation. We use the same procedures as those illustrated in Module 1 of this textbook.
The additional requirement will be to translate the intercompany eliminations, translate the
fair value adjustments, and then allocate the comprehensive income and net assets to the non-
controlling interest.
(a) Calculate the acquisition analysis:
January 1, 2011 U.S. $
If we assume the partial goodwill method:
Consideration transferred U.S. $ $ 220,000
Net identifiable assets U.S. $ $165,000
80% .8 (132,000)
88,000
FVA—Patent goodwill 25,000 .8 .6 U.S. $ (12,000)
$ 76,000
The patent will be amortized over four years and there are no impairments of goodwill.
The partial goodwill method is being used and therefore the goodwill was based solely
on the 80% purchased by Energy.
(b) Intercompany sale and account receivable:
The following intercompany eliminations must be performed on consolidation:
T Sales 50,000 / .982 50,917
T Cost of goods sold 50,917
To eliminate the intercompany sales and purchases at the average rate. We use the aver-
age to approximate the date when the transaction occurred.
T Ending inventory 20,000/.982 20,367

c Cost of goods sold 20,367
c Future income tax asset 8,147
T Income tax expense 8,147
(40% 20,367)
To eliminate the unrealized profit in Solar’s ending inventory. We use the average
rate to eliminate the profit as this is the same rate that was used to translate the sale.
Note that the elimination against the inventory is not as conceptually sound because
the inventory itself on Solar’s financial statements has been translated at the closing
year-end rate of .98.
T Accounts receivable 30,000/.98 30,612

T Accounts payable 30,612
To eliminate the intercompany balance at the closing year-end rate.

(c) Fair value adjustments:
In this example we have two FV adjustments: Patent of U.S. $25,000 with a four-year
life and no residual value and goodwill of U.S. $76,000. The fair value adjustments are
deemed to be the assets of Solar. Since Solar’s functional currency is the U.S. dollar, it
translated its accounts at the closing rate into the Canadian dollar presentation currency.
As such, the FVAs must also be shown at the closing rate at year end.
Goodwill:
January 1, 2011 76,000 /1.10 69,091
December 31, 2012 76,000 /0.99 76,768
December 31, 2013 76,000 /0.98 77,551
Cumulative foreign currency gain,

December 31, 2012 7,677
(76,768 69,091)
Foreign currency gain 2013,
other comprehensive income 783
(77,551 76,768)
Cumulative foreign currency gain,
December 31, 2013 8,460
Since the goodwill is reflected at the year-end closing rate, there is a foreign currency
effect each year due to the difference in the closing rates. The 2013 effect of $783 is
reflected in other comprehensive income and Energy’s share of the balance of $8,460 is
allocated to the cumulative foreign currency gain or loss reflected in cumulative other
comprehensive income on the consolidated statements. Since Energy is using the par-
tial goodwill method, the entire amount calculated was based on Energy’s ownership and
therefore is entirely allocated to Energy. There is no tax effect as illustrated in Chapter 3,
as the goodwill is considered a residual amount.
Patent:
Net Book Value

Date Original cost Amortization U.S. $ NBV C$ Tax 40% Net
$25,000 $25,000 /1.1 $22,727 9,091 13,636
(assuming the
average rate is
the same in
all years) ⫺$6,250 (6,250) /.982 (6,364) (2,546) (3,818)
Calculated NBV,
December 31,
2011 $18,750 16,363 6,545 9,818
Foreign currency gain 2,967 1,187 1,780
NBV at closing rate,
December 31,
2011 we assume a rate for purposes /.97 19,330 7,732 11,598
of this example
6,250 (6,250) /.982 (6,365) (2,546) (3,819)
Calculated NBV,
December 31,
2012 12,965 5,186 7,779
Foreign currency
loss (339) (136) (203)
December 31,
2012 12,500 /0.99 12,626 5,050 7,576
6,250 (6,250) /0.982 (6,364) (2,545) (3,819)
Calculated NBV,
December 31,
2013 6,250 6,262 2,505 3,757
Foreign currency
gain 116 46 70
December 31,
2013 $ 6,250 /0.98 $ 6,378 $2,551 $3,827
Cumulative foreign
currency gain,
December 31,
2012 $ 2,628 $1,051 $1,577
(2,967 ⫺ 339)
Foreign currency
gain 2013, other
comprehensive
income 116 46 70
Cumulative foreign
currency gain,
December 31,
2013 $ 2,744 $1,097 $1,647
The net book value of the patent and the related future income tax liability are shown
on the statement of financial position at the closing rate. As such there will be a foreign
currency effect due to the change in rates over the year from the original cost and the
amortization of the patent. This amount of $116 net of tax of $46 is included in the 2013
comprehensive income and the balance of $1,646 net of tax, which belongs to Energy,
is reflected in other comprehensive income on the consolidated statement of financial
position.
The following adjustments are made on the consolidated financial statements:

c Goodwill 77,551
c Patent 6,378
c Future income tax liability 2,551
Statement of changes in equity:

T Retained earnings—beginning 7,638
(2 ⫻ 3,819)
c Cumulative other comprehensive income 9,254
(7,677 ⫺ goodwill foreign currency adjustment ⫹ 1,577 ⫺ patent FVA net of tax)
Net income
c Amortization expense—patent 6,364
T Income tax expense 2,545
Other comprehensive income
c Foreign currency translation gain—net of tax 853
(783 ⫺ goodwill ⫹ 70 ⫺ patent)
(d) Non-controlling interest:
The non-controlling interest in the comprehensive income and the net asset is calculated.
NCI, January 1, 2013
Common stock 9,091
Fair value adjustments net of tax—patent 7,576
83,688
⫻ .2 16,738
NCI—share of comprehensive income

Net income Solar 164,002
Amortization of patent net of tax (3,819)
160,183
Other comprehensive income Solar 1,111
Foreign currency gain—patent 70
1,181
⫻ .2 32,273
NCI—share of Solar dividends .2 ⫻ 20,408 (4,082)
NCI, December 31, 2013 44,929
Energy makes the following adjustment to the consolidated statements:

c Non-controlling interest—beginning of period 16,738
c Non-controlling interest in comprehensive income 32,273
T Non-controlling interest in dividends 4,082
44,929
The non-controlling interest share of comprehensive income is based on its percentage
ownership in Solar. It would be allocated its share of:
1. Solar’s net income
2. Amortization of the patent
3. Foreign currency translation gains or losses for the year
4. Foreign currency translation gains or losses on fair value adjustments
5. Realized or unrealized upstream profits (in this example the unrealized profit is
downstream and therefore there is no adjustment to the non-controlling interest)
The non-controlling interest on the statement of financial position is based on Energy’s
share of the net assets at the closing date. Energy would be allocated its share of:
1. Solar’s common shares
2. Solar’s retained earnings
3. Solar’s cumulative other comprehensive income (excluding foreign currency trans-

lation effects)
4. The remaining fair value adjustment for patent and goodwill (when the full good-
will method is used)
5. Unrealized upstream profits (in this example there are none)
Energy now consolidates with Solar:
Consolidated
Energy Solar Adjustments Energy
Assets
Cash C$ 100,000 100,000
Cash U.S. $ 76,531 1,020 77,551
Inventory 204,082 ⫺20,367B 183,715
Accounts receivable 85,612 97,347 ⫺30,612B 152,347
Investment in Solar 200,000 ⫺200,000A -0-
Total current assets 462,143 302,449 513,613
Loan receivable 76,531 76,531
Equipment 225,000 153,061 378,061
Intangibles 125,000 6,378C 131,378
Future income tax asset 8,147B 8,147
Goodwill 77,551C 77,551
Total non-current assets 350,000 229,592 671,668
812,143 532,041 1,185,281
Liabilities
Trade payables 110,000 51,020 ⫺30,612B 130,408
Provisions 25,000 30,612 55,612
Total current liabilities 135,000 81,632 186,020
Mortgage payable 229,592 229,592
Future income tax liability 2,551C 2,551
Long-term debt U.S. $ 255,102 255,102
Total non-current liabilities 255,102 229,592 487,245
Total liabilities 390,102 311,224 673,265
Equity
Share capital 100,000 9,091 ⫺9,091A 100,000
Retained earnings 317,041 193,210 (See A) 337,496
Other components of equity 5,000 18,516 (See B) 29,591
Non-controlling interest Calculated above 44,929
Total equity 422,041 220,817 512,016
812,143 532,041 1,185,281
ENERGY CORPORATION
Energy Solar
Revenue 5,900,000 1,272,912 ⫺50,917B 7,121,995
Cost of sales 4,800,000 840,122 ⫺30,550B 5,609,572
Gross profit 1,100,000 432,790 1,512,423
Other income 120,000 56,008 ⫺.8 x 20,408 159,682
Distribution costs (180,000) (152,749) (332,749)
Administrative expenses (170,000) (76,375) (246,375)
Other expenses (130,000) (45,825) 6,364C (182,189)
Finance costs:
including foreign
exchange and
interest expense (302,959) (41,701) (344,660)
Profit before tax 437,041 172,148 ⫺8,147B 566,132
Income tax expense (240,000) (8,146) ⫺2,545C (237,454)
Net income 197,041 164,002 328,678
Other comprehensive
income
Foreign currency
translation gain 1,111 853C 1,964
Total comprehensive
income 165,113 330,642
Energy’s share of
consolidated
comprehensive
income 197,041 .8(20,408)
.8(164,002 6,365 2,546)
20,367 8,147 296,641
.8(1,111 70) 783 1,728 298,369
NCI share of
consolidated
comprehensive
income .2(164,002 6,365 2,546) 32,037
.2(1,111 70) 236 32,273
ENERGY CORPORATION
Capital Retained Non-controlling Cumulative
Stock Earnings Interest OCI Total
Balance, January
1, 2013 100,000 120,855 16,738 27,863 265,456
Comprehensive
income 296,641 32,273 1,728 330,642
Dividends paid (80,000) (4,082) (84,082)
Balance, December
31, 2013 100,000 337,496 44,929 29,591 512,016
A
Retained earnings—beginning
Energy retained earnings, January 1, 2013 200,000
Energy’s share of Solar’s retained earnings since acquisition 49,616
(140,909)
(91,293)
Energy’s share of amortization of FVA patent net of tax (7,638)
(98,931)
Energy’s share .8 (79,145)
120,855
Energy’s share of consolidated net income
Energy net income 2013 197,041
Less: dividend revenue 20,408 .8 (16,326)
Less: unrealized profit net of tax 20,367 .6 (12,220)
Energy’s share of Solar’s net income
Net income Solar 164,002
Amortization of patent net of tax (3,819)
160,183
Energy’s share .8 128,146 296,641
Retained earnings—ending 337,496
B
Cumulative other comprehensive income—beginning
Energy, January 1, 2013 5,000
Energy’s share of Solar since acquisition 17,405
-0-
17,405
Cumulative gain—translation patent net 1,577
18,982
Energy’s share .8 15,186
Cumulative translation gain—goodwill 7,677
27,863
Exercises 433
Energy’s share of Solar translation gain 1,111

to functional currency
Energy’s share of translation of FVA—patent 70

1,181
Energy’s share ⫻ .8 945

Translation of goodwill 783 1,728
Cumulative other comprehensive income, December 31, 2013 29,591
Brief Exercises
(LO 1) BE8-1 How is the functional currency determined for each company in a group?
(LO 1) BE8-2 Explain the role that professional judgement plays in determining a company’s functional currency.
(LO 1) BE8-3 Provide some examples of secondary indicators in determining functional currency.
(LO 2) BE8-4 Describe a circumstance that may cause the functional currency to change.
(LO 2) BE8-5 Does Cool Company have a foreign currency transaction if it sells goods in Canadian dollars to a U.S. com-
pany and Cool’s functional currency is the Canadian dollar? Explain.
(LO 2) BE8-6 Maggi Ltd. has a bank account in euros at the end of the reporting period. Maggi’s functional currency is the
U.S. dollar. How will it report its bank account at year end?
(LO 3) BE8-7 Assume that Maggi in BE8-6 will be combined with its parent company that will present consolidated finan-
cial statements using the Canadian dollar. How will the bank account be presented for purposes of consolidation?
(LO 3) BE8-8 What rate of exchange would be used to translate purchases into a presentation currency?
(LO 3) BE8-9 If a branch office has the same functional currency as the reporting company, what exchange rate is used to
translate the branch into the presentation currency?
(LO 4) BE8-10 What rate of exchange would be used to eliminate intercompany monetary balances on the consolidated
statement of financial position?
(LO 4) BE8-11 Would the non-controlling interest be allocated a portion of any gain or loss on the foreign currency gain or
loss on translation to the presentation currency?
Exercises
(LO 3) E8-1 XYZ, a Canadian company, has a subsidiary located in Europe that owns land. The land was purchased on
January 1 for €1 million when the euro to Canadian dollar direct rate was $1. On December 31, it is $0.9091.
Required
How would you reflect this land on XYZ’s financial statements if the subsidiary’s functional currency is the Canadian
dollar? If the subsidiary’s functional currency is the euro?
(LO 3) E8-2 Omar Co. is a wholly owned foreign subsidiary of Trot Corporation, a Canadian company. Omar Co.’s trans-
actions and financial statements are denominated in the local (functional) currency, the omnit (OM).
Consider the following information:

1. Omar Co.’s common stock was issued in 2012 when the exchange rate was C$1.00 ⫽ OM 1.20.
2. Fixed assets of OM 380,000 were acquired in 2012 when the exchange rate was C$1.00 ⫽ OM 1.10. They had a life
of 10 years and are depreciated straight line. A full year’s depreciation is taken in the year of purchase.
3. As of January 1, 2013, the Retained Earnings balance was translated at $350,000 (OM 400,000).
4. Dividends of OM 40,000 were declared on March 15, 2013, and equipment of OM 54,000 net of depreciation was
sold on October 1, 2013. No depreciation was taken in the year of sale.
5. The following direct exchange rates were in effect during the year:
Date C$ OM
Average 2013 1 1.15
March 15, 2013 1 1.23
October 1, 2013 1 1.24
December 31, 2013 1 1.22
OMAR INC.
As at December 31, 2013 (OM)
Assets
Cash 241,000
Inventory 64,000
Fixed Assets –net 256,000
561,000
Liabilities
Accrued Liabilities 23,000
Shareholders’ Equity
561,000
Required
Using the above information, translate the Omar Statement of Financial Position into Canadian dollars.
(LO 2, 4) E8-3 Smart Inc. is a wholly owned subsidiary of Wealth Corporation. Smart operates in Canada and is deemed to
have a functional currency of the Canadian dollar. Wealth is a Chinese company that has a functional currency of the
yuan (¥). During the year, Smart sold $50,000 of merchandise to Wealth for a profit of $10,000 on the sale. Wealth has
20% of the merchandise still in inventory. Each company pays tax at the rate of 30%. For the consolidated financial
statements, the functional currency of Wealth will be used as the presentation currency. The following exchange rates
exist:
Date C$1
Transaction date ¥6.377
Average ¥6.151
Year end closing ¥6.542
Required
Prepare the consolidation adjustments that will be required.
(LO 1, 3) E8-4 ROS Inc. is located in Switzerland. ROS, whose currency is the Swiss franc (SF), is wholly owned by CRO Ltd.
Its functional currency is the SF. The summarized balance sheet for ROS at December 31, 2013, was as follows:
Monetary assets SF 100,000
Non-monetary assets 200,000
SF 300,000
Monetary liabilities SF 190,000

Non-monetary liabilities 30,000
Shareholders’ equity 80,000
SF 300,000
None of the non-monetary assets or liabilities are reported at market value.

Required
What is the exchange gain or loss in Canadian dollars for ROS on January 1, 2014, if the exchange rate changes from
SF 1 C$1.50 to SF 1 C$1.52 and this is the only event affecting ROS for that day?
(LO 3) E8-5 Rolan acquired 80% of Ditto on January 1, 2011. At that date, the book value of Ditto’s net assets was equal
to their fair value. Rolan is a Canadian company that acquired ownership in Ditto, located in Russia, in order to have a
local distribution centre for its product. Ditto has determined that the functional currency is the Russian ruble (RUB).
Exercises 435
Rolan has been consolidating with Ditto and presents using the Canadian dollar.
Rolan C$ Ditto RUB
Profit 30,000 25,000
Total equity 245,000 110,000
Payables 20,000 5,000
Total equity and liabilities 330,000 125,000

Cash 13,000 14,000
Inventory 70,000 50,000
Investment in Ditto 102,000 —
Plant net 115,000 36,000
Total assets 330,000 125,000
The following exchange rates are relevant:

January 1, 2011 RUB 1 ⫽ C$0.034
December 31, 2011 RUB 1 ⫽ C$0.047
December 31, 2012 RUB 1 ⫽ C$0.053
Average 2013 RUB 1 ⫽ C$0.055
December 31, 2013 RUB 1 ⫽ C$0.062
The retained earnings balance was C$875.
Required
Translate the 2013 Statement of Financial Position of Ditto for the purpose of consolidation in Canadian dollars.
(LO 4) E8-6 On January 1, 2013, Polaris acquired all the share capital of Gordon for U.S. $249,800. Polaris has a functional
currency of the Canadian dollar and Gordon has the U.S. dollar as the functional currency. At this date, Gordon’s
equity comprised:
Share capital—100,000 shares U.S. $100,000
Retained earnings U.S. $86,000
All identifiable assets and liabilities of Gordon were recorded at fair value as at January 1, 2013, except for the fol-
lowing:
In U.S. $ Carrying amount Fair value
Inventory $27,000 $35,000
Land $35,000 90,000
Equipment (cost $100,000) 50,000 60,000
The equipment is expected to have a further 10-year life. All of the inventory was sold by December 31, 2013. The
tax rate is 40%. The following exchange rates exist:
Date U.S. $1
January 1, 2013 C$0.989
Average 2013 C$0.925
December 31, 2013 C$01.01
Required
Prepare the acquisition analysis and calculate the fair value adjustments for the preparation of consolidated financial
statements in Canadian dollars for Polaris and its subsidiary Gordon as at:
(a) January 1, 2013.
(LO 3, 4) E8-7 The statement of financial position of Column Ltd. in Belize dollars, at December 31, 2013, was as follows:
COLUMN LTD.
as at December 31, 2013 (in BZ$)

Other liabilities 24,000
Inventory $ 44,000
Non-current assets:
Plant and equipment $232,000
Goodwill 6,000 238,000
On January 1, 2011, Centaur acquired all the shares in Column, giving in exchange 50,000 shares in Centaur, these
having a fair value at acquisition date of BZ$5 per share. At that date the book value of Column was BZ$100,000
(BZ$20,000 common shares and BZ$80,000 retained earnings).
The recorded amounts of Column’s identifiable assets and liabilities at the day of acquisition were equal to their
fair values except for inventory and plant and equipment, whose fair values were higher by BZ$10,000 and BZ$100,000,
respectively. The plant and equipment had a further five-year life. All the inventory was sold by Column by December
The following exchange rates exist:
January 1, 2011 BZ$1 C$0.517
December 31, 2011 BZ$1 C$0.62
December 31, 2012 BZ$1 C$0.58
December 31, 2013 BZ$1 C$0.60
Average 2011, 12, 13 BZ$1 C$0.59
Required
(a) Translate Column’s statement of financial position into Canadian dollars as at December 31, 2013. The ending
retained earnings balance is C$52,000.
(b) Calculate the consolidation adjustments for the fair value adjustments that would be required in 2013.
PROBLEMS
(LO 1, 3) P8-1 Investco Ltd. is a Canadian real estate and property developer that decided to hold a parcel of land in downtown
Munich, Germany, for speculative purposes. The land, costing €12 million, was financed by a five-year bond (€9 mil-
lion), which is repayable in euros, and an initial equity injection by Investco of €3 million. These transactions took place
on January 1, 2013, at which time a German subsidiary company was created to hold the investment. Investco plans to
sell the land at the end of five years and use the euro proceeds to pay off the bond. In the interim, rent is being collected
from another company that is using the land as a parking lot.
The 2013 year-end draft financial statements of the German subsidiary company are shown below. (Assume that
rental revenue is collected and interest and other expenses are paid at the end of each month.)
INVESTCO LTD.
Income Statement
(in €)
Rental revenue 1,000,000

Other expenses 10,000
1,000,000
Net income -0-
Problems 437
INVESTCO LTD.
Balance Sheet
(in €)
Land 12,000,000
12,000,000
Bond (due December 31, 2017) 9,000,000
Common stock 3,000,000
12,000,000
Assume the following exchange rates:
January 1, 2013 €1 C$0.45
December 31, 2013 €1 C$0.60
Average, 2013 €1 C$0.53
Required
(a) Prepare the translated Canadian-dollar 2013 income statements and balance sheets following Part I of the CICA
Handbook and assuming:
1. the German subsidiary’s functional currency is the Canadian dollar; and
2. the German subsidiary’s functional currency is the euro.
(b) Which translation method better reflects Investco’s economic exposure to exchange rate movements? Explain.
(c) Which translation method would Investco be required to use? Explain.
(Adapted from CMA Canada)
(LO 3) P8-2 On December 31, 2011, Sask Company, a Canadian company, purchased 60% of the outstanding com-
mon shares of Alto Limited for €7 million. Alto was incorporated in France and operates primarily in that country.
The condensed financial statements for Alto for 2013 were as follows:
ALTO LIMITED
Balance Sheet
December 31
2013 2012
Monetary assets € 4,004,000 € 1,844,000
Inventory 3,400,000 3,600,000
Equipment—net 6,000,000 7,500,000
Total €13,404,000 €12,944,000
Monetary liabilities € 7,300,000 € 7,100,000

Common shares 1,000,000 1,000,000
Total €13,404,000 €12,944,000
ALTO LIMITED
Sales €23,520,000
Cost of sales 14,800,000
Gross profit 8,720,000
Depreciation expense 1,500,000
Other expenses 6,460,000
Net income 760,000
Retained earnings, beginning of year 4,844,000
Retained earnings, end of year € 5,104,000
1. Inventory was purchased as follows:
Beginning inventory (purchased in fourth quarter of 2012) € 3,600,000
Purchases (purchased evenly throughout the year) 14,600,000
Ending inventory (purchased in fourth quarter of 2013) 3,400,000
2. The equipment was purchased for €12 million on January 1, 2010. It is being depreciated on a straight-line basis
over eight years.
3. Sales and other expenses occurred evenly throughout the year.
4. Dividends were declared on December 15, 2013, and paid on December 31, 2013.
5. The exchange rates were as follows:
January 1, 2010 €1 ⫽ C$1.70

December 31, 2011 €1 ⫽ C$1.36
Average for quarter 4 for 2012 €1 ⫽ C$1.35
December 31, 2012 €1 ⫽ C$1.34
December 15, 2013 €1 ⫽ C$1.31
Average for quarter 4 for 2013 €1 ⫽ C$1.32
Average for 2013 €1 ⫽ C$1.33
December 31, 2013 €1 ⫽ C$1.30
6. Alto’s translated financial statements will be used by Sask when it prepares consolidated financial statements. Alto’s
functional currency is the Canadian dollar (that is, Alto is an integrated foreign operation per ASPE). The trans-
lated retained earnings at the beginning of 2013 in Canadian dollars were $6,656,960.
Required
(a) Prepare a schedule to calculate the foreign exchange gain or loss to be reported by Alto on its Canadian-dollar
income statement for 2013.
(b) Translate Alto’s statement of income and retained earnings for 2013 into Canadian dollars.
(LO 3, 4) P8-3 Saturn Ltd., a Canadian company, purchased 100% of the common shares of a New Zealand company, Tethys
Ltd., on December 31, 2012, for NZ$125,000 (New Zealand dollars). The entire purchase discrepancy was attributed
to a patent that was not recognized in Tethys’s accounts. The patent had a remaining useful life of three years. Tethys’s
functional currency is the Canadian dollar. Tethys’s comparative balance sheet information at December 31, 2012, and
2013, and its income statement for the year ended December 31, 2013, are as follows:
TETHYS LTD.
Balance Sheet
December 31, 2013 with comparative figures for 2012 (NZ$)
2013 2012
Monetary assets $ 78,000 $ 55,000
Total assets $254,000 $210,000
Liabilities (all monetary) $120,000 $100,000
Shareholders’ equity 80,000 80,000
Total liabilities and shareholders’ equity $254,000 $210,000
TETHYS LTD.
Income Statement
year ended December 31, 2013 (NZ$)
Revenue $285,000
Total expenses 257,000
Net income $ 28,000
1. Equipment was purchased on April 23, 2013, when the exchange rate was NZ$1 ⫽ C$0.72. The equipment cost
NZ$50,000.
2. Sales and other expenses occurred evenly throughout the year.
3. A dividend of NZ$4,000 was declared and paid on December 31, 2013.
Problems 439
4. Exchange rates are as follows:

December 31, 2012 NZ$1 ⫽ C$0.70
December 31, 2013 NZ$1 ⫽ C$0.76
Average for 2013 NZ$1 ⫽ C$0.73
5. The account history of property, plant, and equipment (PPE) and accumulated depreciation from December 31,
2012, to December 31, 2013 (in NZ$), was as follows:
Accumulated Accumulated Depreciation Carrying
Original Depreciation Depreciation Expense Amount
Cost December 31, 2012 December 31, 2013 December 31, 2013 December 31, 2013
Relating to PPE owned at December 31, 2012:

270,000 115,000 134,000 19,000 136,000
Relating to equipment purchased on April 23, 2013:
50,000 0 10,000 10,000 40,000
Required
(a) Prepare Tethys’s 2013 income statement in Canadian dollars (including the exchange difference, if applicable).
(b) Saturn has no patents of its own. Calculate the amount for patent amortization in Saturn’s 2013 consolidated income
statement and the December 31, 2013, balance in the patent account on Saturn’s consolidated balance sheet.
(c) Recalculate the requirements from part (b), assuming that Tethys’s functional currency is the New Zealand dollar.
(LO 2, P8-4 Using the demonstration problem, assume that the functional currencies remain the same but the presentation
3, 4) currency of Energy Corporation is the U.S. dollar. Translate the Energy Corporation statement into U.S. presentation
currency for the purpose of consolidation. The beginning retained earnings of Energy Corporation accumulated at an
average rate of 0.982.
(LO 3, 4) P8-5 Aries Inc. holds a 90% interest in Sharatan Ltd., a corporation based in France. The functional currency of
Sharatan (self-sustaining subsidiary) is the euro. Aries’s interest in Sharatan was purchased on December 31, 2012, for
€1,485,000. The carrying amount of Sharatan’s identifiable net assets was €1,425,000 at the acquisition date. The entire
purchase discrepancy was attributed to goodwill and no impairment of goodwill has occurred. Aries uses the full good-
will method to value non-controlling interest, fair valued at €165,000.
SHARATAN LTD.
Balance Sheet
December 31, 2013 with comparative figures for 2012
2013 2012
Cash and receivables €1,950,000 € 800,000
Inventory 975,000 475,000
Property, plant, and equipment (net) 1,750,000 2,250,000
Total assets €4,675,000 €3,525,000
Liabilities €3,000,000 €2,100,000
Common shares 1,000,000 1,000,000
Total shareholders’ equity 1,675,000 1,425,000
Total liabilities and shareholders’ equity €4,675,000 €3,525,000
SHARATAN LTD.
Revenue €5,000,000
Cost of goods sold 2,500,000
Total expenses 4,600,000
Net income € 400,000
1. All of Sharatan’s property, plant, and equipment was purchased on the date of its incorporation, January 1, 2010.
2. Sharatan’s ending inventory was purchased on September 30, 2013.
3. Dividends of €150,000 were declared and paid by Sharatan on December 31, 2013.
4. Exchange rates are as follows:
January 1, 2010 €1 C$1.40
December 31, 2012 €1 C$1.46
September 30, 2013 €1 C$1.54
December 31, 2013 €1 C$1.56
Average for 2013 €1 C$1.51
Required
(a) Calculate Sharatan’s other comprehensive income in Canadian dollars.
(b) Prepare Sharatan’s December 31, 2013, balance sheet in Canadian dollars.
(c) Aries’s separate entity financial statements do not contain any other comprehensive income. Calculate Aries’s con-
solidated other comprehensive income and determine how much is attributable to the equity holders of Aries.
(LO 2,
3, 4) P8-6 On January 1, 2011, Vair, a Canadian company, acquired all the shares of Logan, a company in Brazil, at
which date the equity and liability sections of Logan’s statement of financial position showed the following balances in
reals (BRL):
Share capital (300,000 shares) 300,000
On January 1, 2011, all the identifiable assets and liabilities of Logan were recorded at fair value except for:
Inventory BRL 120,000 BRL 130,000
Machinery (cost BRL 200,000) 160,000 165,000
The inventory was all sold by October 2011. The machinery had a further five-year life but was sold on
June 30, 2013.
On December 31, 2013, the trial balances of Vair and Logan were as follows:
Trial Balances
Vair C$ Logan BRL

Investment in Logan 396,000 -0-
Inventory 180,000 160,000
Cash 25,000 10,000
Land 154,200 65,000
1,401,700 706,000
Bonds 100,000 40,000
1,401,700 706,000
1. On January 1, 2012, Vair sold an item of plant to Logan at a profit before tax of $4,000. Vair depreciates this par-
ticular item of plant straight line over five years and Logan depreciates straight line over 10 years.
2. At December 31, 2013, Vair had on hand some items of inventory purchased from Logan in June 2013 at a profit
of BRL 500. The sales were BRL 1,000 and the cost of sales were BRL 500.
3. Vair charged a management fee of BRL 2,000 per month to Logan. As at year end, Logan had not paid the fee for
three months.
Problems 441

5. The following exchange rates exist:
January 1, 2011 BRL 1 C$0.533

December 31, 2011 BRL 1 C$0.56
Average 2011-2013 BRL 1 C$0.70
6. The retained earnings of BRL 42,000 at January 1, 2013 and the other components of equity of BRL 70,000 at
January 1, 2013 accumulated at the rate of C$0.67.
7. Dividends were declared on the last day of the year.
Required
(a) Translate the financial statements of Logan in preparation for the consolidation with Vair. Vair will be presenting
in Canadian dollars.
(b) Calculate the adjustments for the consolidated financial statements for the year ending December 31, 2013.
(LO 3, 4) P8-7 Olive Inc., a Canadian company whose functional currency is Canadian dollars, acquired 100% of the
outstanding common shares of Oil Ltd. on January 1, 2013. At the date of acquisition, Olive Inc. paid U.S. $250,000
to the former shareholders of Oil Ltd. The net assets of Oil Ltd. at that date totalled $200,000 U.S. dollars and was
comprised of U.S. $100,000 common shares and U.S. $100,000 retained earnings (all of which was earned in 2012). Of
that difference, U.S. $25,000 was due to an increase in the fair market value of a plant located in Connecticut, which has
a remaining useful life of 10 years. Oil Ltd.’s income tax rate is 30%. All of the main operations of Oil Ltd. take place in
Connecticut, USA and most of its sales and input costs are also within the USA.
The financial statements of Oil Ltd. are as follows:
OIL LTD.
As at December 31
In U.S. $
2013 2012
Cash $150,000 $200,000
Accounts Receivable 300,000 450,000
Inventory 500,000 475,000
Total Current Assets 950,000 1,125,000
Property, Plant and Equipment (net) 675,000 725,000
Total Assets $1,625,000 $1,850,000
Bank overdraft $275,000 $325,000

Accounts Payable 350,000 375,000
Total Liabilities 1,300,000 1,650,000
Common Shares 100,000 100,000
Retained Earnings 225,000 100,000
Total Shareholder’s Equity 325,000 200,000
Total Liabilities & Shareholder’s Equity $1,625,000 $1,850,000
OIL LTD.
Income Statement
In US $
Total Revenues 675,000

Cost of goods sold 300,000
Gross profit 375,000
Selling expenses 100,000

General and administrative expenses 100,000
Income before income taxes 175,000
Net income $125,000
Foreign exchange rates between the Canadian dollar and U.S. dollar are as follows:
January 1, 2013: U.S. $1 C $1.03

December 31, 2013: U.S. $1 C $0.96
Average 2012 rate: U.S. $1 C $1.01
Average 2013 rate: U.S. $1 C $0.98
Required
(a) Calculate the acquisition analysis and adjustments as at December 31, 2012 and December 31, 2013.
(b) Prepare the translated financial statements of Oil Ltd. As at December 31, 2013 into Canadian dollars.
(LO 1, 3) P8-8 On January 1, 2013, Zoe Ltd. purchased all of the outstanding common shares of Noah Inc., a company based
in the United States. This is the first time that Zoe Ltd. has acquired a company that is located outside of Canada and
that deals primarily in a currency other than the Canadian dollar.
It is now December 31, 2013 and you have been provided with Noah Inc.’s statements of financial position as at
December 31, 2013 and 2012 and their income statement for the year ended December 31, 2013 as follows.
NOAH INC.
As at
In US $
2013 2012
Cash $ 800,000 $ 900,000
Accounts Receivable 5,900,000 6,100,000
Inventory 5,600,000 5,300,000
Plant and Equipment (Net) 8,000,000 7,900,000
Total Assets $20,300,000 $20,200,000
Current Liabilities 6,100,000 5,900,000

Long-Term Liabilities 7,000,000 7,500,000
Common Shares 1,000,000 1,000,000
Retained Earnings 6,200,000 5,800,000
Total Liabilities and Shareholder’s Equity $20,300,000 $20,200,000
NOAH INC.
Income Statement
In US $
Sales $9,000,000
Cost of Sales 6,200,000
Gross Profit 2,800,000
Other expenses $2,100,000
Income taxes $ 300,000
Net Income $ 400,000
Other Information:
Foreign Exchange Rates
January 1, 2013: U.S. $1 C $0.98

December 31, 2013: U.S. $1 C $1.04
2013 Average Rate: U.S. $1 C $1.01
1. Zoe Ltd.’s functional and presentation currency is the Canadian dollar and Noah Ltd.’s is the U.S. dollar. Explain
the impacts of this.
2. Calculate the 2013 foreign exchange gain or loss that will arise due to translation and explain where it will be
recorded.
Required
Translate Noah Ltd.’s 2013 financial statements into Canadian dollars.
(LO 1, 3) P8-9 On January 1, 2013 Alex Ltd. purchased 100% of the outstanding common shares of Coco George Inc., a com-
pany based in Paris, France. Alex Ltd. is located in Canada and has a Canadian dollar functional and presentation currency.
This is the first time that Alex Ltd. has purchased a foreign company and as such, management has several questions.
It is now January, 2014, and you have been provided with the financial statements of Coco George Inc. at the
acquisition date and as at December 31, 2013. Please note that the price paid by Alex Ltd. to acquire Coco George Inc.
was equal to its book value of 1.5 million Euros.
COCO GEORGE INC.

In Euros
Cash $ 450,000
Inventory 1,110,000
Prepaid Expenses 490,000
Property, plant and equipment (net) 1,500,000
$4,450,000
Total Liabilities 2,800,000

Common Shares 1,000,000
Total Liabilities and shareholder’s equity $4,450,000
COCO GEORGE INC.

Income Statement
In Euros
Sales $10,000,000
Cost of Sales 7,500,000
Gross Profit 2,500,000
Income taxes 250,000
Net Income $ 150,000
Other Information:
Foreign Exchange Rates
January 1, 2013: €1 C $1.38

December 31, 2013: €1 C $1.34
2013 Average Rate: €1 C $1.31
Required
(a) Since Alex Ltd.’s functional currency has already been assessed as the Canadian dollar, is it necessary to assess the
functional currency of Coco George Inc.?
(b) What is the impact if Coco George Inc.’s functional currency is assessed as the Euro?
(c) What is the impact if Coco George Inc.’s functional currency is assessed as the Canadian dollar?
(d) Translate the financial statements of Coco George Inc. assuming its functional currency is the Euro.
WRITING ASSIGNMENTS
(LO 1, 3) WA8-1 ABC Co. has a foreign operation, XYZ Co., located in Australia. XYZ Co. sells goods to the local market and
in the past had financed its own operations through operating income and local borrowing. In fiscal 2013, ABC Co.
decided that, in order for XYZ Co. to maximize its profitability, ABC Co. management would become actively engaged
in the operations, and all financing would be sourced through ABC Co.
Required
Which approach should ABC Co. use to report XYZ’s results for fiscal 2013?
(LO 4) WA8-2 Alamco is a Canadian public company with its head office located in Saskatoon, Saskatchewan. Its common
shares are listed on both the Toronto and Shanghai stock exchanges. Alamco has a wholly owned subsidiary in China.
The subsidiary uses accounting principles consistent with Canadian GAAP except for one item. It expenses all research
and development costs whereas IFRS would allow certain development costs to be capitalized and amortized over the
period when the development costs provide benefit. The controller would like to understand the currency of financial
reporting that would be required for presentation to the users of Alamco’s financial statements. In addition, she is
unsure of the accounting effect of the difference in the treatment of the research and development costs.
Required
Respond to the controller’s questions.
(LO 1, 2) WA8-3 Care Inc. (CI), a national manufacturer and retailer of women’s shoes, purchased 100% of the common shares
of ShoeCo, a footwear manufacturing company located in a foreign country. CI financed the purchase of ShoeCo’s
shares through a loan from a Canadian bank. To obtain this financing, CI had to offer one of its Canadian manufac-
turing plants as security. ShoeCo will continue to be managed and operated by locals and be responsible for obtaining
operational loans.
ShoeCo sells most of its production to its domestic market. Previously a supplier of CI’s, ShoeCo will continue to
supply about 10% of its production to CI. CI has established a contract with ShoeCo fixing the quantity and the price
in Canadian dollars.
Required
(a) State whether the functional currency of ShoeCo is the local or the foreign currency, and explain how you reached
your conclusion.
(b) Describe both the temporal and current rate translation methods. Which method would CI use?
CASES
(LO 1, C8-1 Terrier Enterprises (TE) is a family-owned company founded by Bob Terrier that owns and operates many
2, 3) well-known consumer product brands that are sold throughout Canada. Its head office is located in Montreal and it
is considering going public in the near future. As such, TE would like to present favourable financial statements. In
anticipation of going public, it has already adopted IFRS. TE sells goods to Canadian retailers and in order to expand,
it is going to start selling internationally.
During the past year, TE has entered into three new transactions and Bob Terrier has asked you, CA controller,
for assistance on how they should be accounted for. He would also like to know what the impacts are due to these being
foreign transactions, as this is the first time the company has done such transactions. He would like to continue to make
foreign investments in the future as he feels it is a good expansion strategy. He would like you to remember that TE
is considering going public and that when a competitor recently went public, its financial statements, especially its net
income figure, were heavily scrutinized.
TE’s first transaction was an investment of 19% in Dachsund Incorporated (DI), a company located in the United
States. In addition, TE also obtained two of the eight seats on the board of directors. DI operates a chain of pet stores
in the United States that has always been profitable and TE intends to use this investment as an opportunity to start
selling its brands of dog toys and accessories in DI’s stores in the United States, among the many other brands of pet
products carried by DI. Goods supplied by TE are payable in U.S. dollars by DI. TE believes that this will be a strong
foundation to creating a presence for itself in the United States.
The second transaction was an investment of a 100% interest in Bernard Industries (BI), a company located
in Brazil that sells children’s toys in its retail stores and worldwide on its website. TE took out debt, payable in
Brazilian reals, in order to pay for this acquisition from a bank in Brazil to help stimulate foreign investment in
Brazil. TE will be helping to build a new plant for manufacturing in Brazil. The bank account balances will be main-
tained in Brazilian reals and then transferred weekly to the Canadian bank account so that the accounting functions
can be done centrally by TE. TE will send management from Canada to help teach BI the TE way of doing business
and to help integrate them within the company. BI will stop selling TE’s competitors’ products and instead will
focus exclusively on selling TE’s goods, both in its retail stores and on BI’s website. TE will invoice BI in Canadian
dollars.
In addition to expanding by making foreign investments, TE has also started selling goods directly to a leading
low-cost mass retailer in the United States, which will be invoiced and will pay TE in U.S. dollars.
Required
Prepare the analysis requested by Bob Terrier.
Cases 445
(LO 1, 2, C8-2 Global Touch Corporation (GTC) is one of Canada’s largest public companies. GTC provides end users with
3, 4) networking capabilities through its system of copper and coaxial cable lines. GTC operates in Canada through a variety
of subsidiaries and divisions. GTC is looking to expand into the more lucrative U.S. marketplace. Its common shares
are among the most widely held shares in Canada; no single shareholder owns more than 5% of the company. GTC
owns or has investments in various high-technology companies. Since 2007, the share price has ranged between $55 and
$60 per share.
Electro Buzz Inc. (EBI) is a Canadian public company. EBI manufactures digital equipment used primarily by cable
television companies for their networks. EBI was incorporated in 1991 by GTC as a wholly owned subsidiary. In 2006,
EBI issued common shares to the public, raising $295 million in cash. As a result, GTC’s ownership interest in EBI
dropped to 25% of the total outstanding share capital.
The shareholders of GTC have expressed concern that there has been no significant increase in GTC’s share
price since 2007. On May 10, 2013, at GTC’s annual shareholders’ meeting, Shayna Evan was elected chair of
GTC’s board of directors and was also named GTC’s chief executive officer (CEO). Ms. Evan signed a three-year
employment contract with GTC. She had previously been the CEO of EBI since 2004. In 2004, EBI’s share price
had reached an all-time low of $2.25 per share. When Ms. Evan left EBI in April of 2013, EBI shares were trading
at $32 per share. At the news conference announcing her appointment, Shayna Evan stated that her mission was
to significantly increase the value of GTC shares by the year 2014. Ms. Evan predicted considerable growth in net
income.
You are a CA with the firm of Rousseau and Singh (RS), Chartered Accountants. RS has been the auditor of GTC
since the late 1970s. In addition, RS currently audits most of GTC’s subsidiaries through its own offices across Canada
and through international firms affiliated with RS.
It is now October 17, 2013, and GTC is preparing its quarterly consolidated financial statements for filing
with various securities commissions. RS normally performs review engagement procedures on quarterly results
and issues an audit opinion only at year end, based on the annual financial statements. GTC has a December 31
year end. Extracts from the draft income statement for the fi rst nine months have been prepared by your staff
(Exhibit C8-2[a]).
You have been provided with a summary of issues for your consideration (Exhibit C8-2[b]).
The partner responsible for the GTC audit will be meeting with the Chief Financial Officer and Controller of
GTC on October 19, 2013, to discuss the third-quarter financial statements and potential year-end issues. Accordingly,
she has asked you to prepare a memo summarizing any significant accounting issues that will have to be addressed for
year end. The GTC audit committee and board of directors are scheduled to review the third quarter financial state-
ments on October 20 and 21, respectively. A press release discussing results will be made available to the public imme-
diately after the board of directors’ meeting.
Required
Prepare the memo requested by the partner.
EXHIBIT C8-2(a)
GLOBAL TOUCH CORPORATION
Extracts from the Draft Consolidated Income Statement
For the nine-month period ended September 30
(in millions of dollars, Canadian)
2013 2012
Revenues $5,542 $5,342
Cost of generating revenues 3,279 3,001
Amortization expense 1,135 1,056
Selling, general, and administration expenses 621 599
Interest and financing charges 210 205
1,966 1,860
Net income before income taxes, EBI equity 297 481
income, and special charges
Equity income—EBI 195 165
Restructuring charges 65 -0-
427 646
Income taxes 170 258
Net income $ 257 $ 388
EXHIBIT C8-2(b)
NOTES BASED ON THIRD-QUARTER REVIEW
EBI
Accounting staff at GTC complained quite openly about how difficult it has become to get timely financial information from EBI
in the last year. Previously, EBI’s net income was reported to GTC by the 15th of the month following the end of the quarter. Now,
the information is made available only three days before GTC publicly announces its net earnings for a quarter, usually on the
28th of the month. EBI’s staff has told GTC that EBI will announce its year-end results only on January 26, 2014, and such re-
sults will be made available to GTC on January 25. Shayna Evan has called a news conference on January 28 to announce GTC’s
2013 consolidated results. GTC’s board of directors is scheduled to approve the annual financial statements on January 27.
As part of EBI’s initial public offering, GTC received options to purchase additional EBI shares that would allow it to
increase its interest in EBI to 40% of the outstanding shares. The options became exercisable on July 8, 2013, and expire
December 31, 2015. If the options are exercised, GTC must pay EBI a price equal to 90% of the stock price quoted on the date
the options are exercised. GTC intends to exercise the options before year end if EBI’s stock price remains below $50 per share.
GTC accounted for its investment in EBI using the equity method.
GTC’s share of EBI earnings for 2013 was $100 million up to July 7, 2013. After July 7, 2013, GTC calculated its share
of EBI earnings based on a 40% ownership interest, resulting in income of $95 million from July 8 to September 30, 2013.
Historically, GTC has not shown its share of EBI’s earnings at the after-tax amount.
Investment in STI
In late 2012, GTC decided to enter the U.S. high-speed broadband market by opening up a fibre optic subsidiary called STI,
Inc. (STI). Based in San Diego, STI is a wholly owned subsidiary providing high-speed Internet access services to residential and
commercial customers throughout the U.S. southwest. GTC invested U.S. $60 million in STI. All accounting for STI is carried
out by GTC head office personnel. As of September 30, 2013, the U.S. $60 million has been spent on the following:
U.S. $ millions
Customer sales and marketing $15
Fibre optic lines $35
Administrative costs $10
All costs were capitalized during the first nine months of 2013. The customer sales and marketing costs were incurred primarily to
recruit customers. It is anticipated that such costs will decrease over time as STI’s services become more widely known. Most of the
costs related to advertisements on local television and radio. The administrative costs include U.S. $5 million of salaries and wages
for administrative personnel and U.S. $5 million of payments made to attract and relocate senior management of some of GTC’s
other subsidiaries to San Diego. Managers who have relocated have signed three-year contractual commitments to remain with STI.
If they do not abide by their commitment to stay, managers must refund any signing bonuses or relocation reimbursements.
The U.S. $35 million expenditure on fibre optic lines was for the acquisition, from an unrelated company, of the right to
use the lines, which connect customers to the Internet. Ownership of the fibre optic lines remains with the unrelated company,
which is also responsible for all maintenance. If properly maintained, the lines can last for more than 20 years.
The U.S. $35 million was paid on September 1, 2013. Under the terms of the agreement, the third party will provide
STI with an exclusive right to use two fibre optic lines over a five-year period beginning September 1, 2013. The right-to-use
agreement can be extended for another five years on September 1, 2018, for an additional payment of U.S. $30 million.
On September 1, 2013, STI began providing Internet access service to its customers. To attract subscribers, any customers
who signed up prior to September 1, 2013, were given one month of free service. Accordingly, no revenue was recorded in
September. As of October 1, 2013, STI had signed up 12,000 residential customers to one-year contracts at an average rate
of U.S. $25 per month. In addition, as at October 1, 2013, some 150 commercial contracts had been signed for one year at
an average rate of U.S. $2,250 per month. The commercial rate represents the rate to provide an entire office location with
Internet access.
As at October 1, 2013, only one of the fibre optic lines was being used because there were not enough customers to justify
using the second line. STI has capitalized the U.S. $35 million and allocated U.S. $17.5 million to each line. For the month of
September 2013, amortization was charged for the one line. STI plans to amortize each line over five years, starting on the date
on which they are first used. Currently, the one line being used is at 65% capacity, and GTC has charged to income only 65% of
the amortization that would otherwise be charged.
GTC is not expecting STI to pay any dividends until both fibre optic lines are at 85% capacity. Until that time, any earnings
will be reinvested to cover operating costs, including additional costs required for customer sales and marketing.
Restructuring
The restructuring charges shown on the income statement are based on GTC’s plans to better integrate the operations of its
wholly owned subsidiaries. For example, as a result of acquisitions over the last five years, two of GTC’s wholly owned subsidi-
aries provide Internet access to the same market. GTC will amalgamate these two subsidiaries within two years and will, as a
result, reduce its staff in Canada by some 4,000 employees or roughly 15% of its workforce. GTC will be meeting with senior
management at these subsidiaries in the coming months to discuss staff reductions. The charge for estimated severance costs is
about $10,000 per employee. The human resources department has calculated the provision based on job functions targeted to
be abolished. Severance costs are included in the restructuring charges.
GTC and its subsidiaries own very little real estate and mainly rent office space for lease terms of 10 to 25 years. GTC
believes that the personnel reductions will result in excess space at several locations. Accordingly, GTC has also accrued for
Cases 447
the costs associated with lease cancellation penalties. These penalties are estimated at about $10 million, with an additional
$15 million to be spent for moving and site restoration. The site restoration costs include the costs associated with getting the
properties to specific standards as defined by the leases.
According to GTC’s controller, the restructuring charges have been discussed and approved at the highest levels within
GTC and were approved at a special GTC board meeting in August. Shayna Evan was very anxious to record the restructuring
charges in the third-quarter financial statements as a sign that “things are getting done at GTC.” She is concerned that GTC’s
landlords should not know too far in advance that GTC is planning to vacate space. She does not want to say too much about
the charges because she has not yet met with senior management of the wholly owned subsidiaries and does not want the
employees’ unions to know too much at this point since some of the employees involved are unionized.
Other
EBI’s shares were trading at approximately $40 per share on September 30, 2013. On September 30, 2013, GTC owned
11.5 million shares of EBI or 25% of the total outstanding share capital of the company.
At a GTC board meeting in July 2013, it was agreed that beginning with the year ending in 2013, executive bonuses will
no longer be based on net income, but will be based on net income before taxes and special charges. An additional special
bonus of $1 million will be paid to Shayna Evan if net income increases to $700 million in the year 2014.
(LO 1, C8-3 Multi-Communications Ltd. (MCL) is a Canadian-owned public company operating throughout North
2, 4) America. Its core business is communications media, including newspapers, radio, television, cable, and Internet. The
company’s year end is December 31.
You, CA, have recently joined MCL’s corporate office as a finance director, reporting to the chief financial officer,
Dasan Sudjic. It is October 2013. Mr. Sudjic has asked you to prepare a report that discusses the accounting issues that
might arise with the auditors during their visit in November.
MCL’s growth in 2012 was achieved through expansion into the United States by acquiring a number of newspa-
pers, television, and cable operations. Since the U.S. side of MCL’s operations is now significant, management will be
reporting its financial statements in U.S. dollars. Shareholders’ equity at the beginning of the period was stated in U.S.
dollars. Shareholders’ equity at the beginning of the period was $220 million, including a separately disclosed cumulative
foreign exchange gain of $45 million. Management merged this balance with retained earnings because “the operations
it relates to are no longer considered foreign for accounting purposes, and as a result, no foreign currency exposure
will arise.”
With recent trends to international free trade, MCL decided to position itself for future expansion into the South
American market. Therefore, in 2013, MCL bought a company that owns a radio network in a country in South America
that has high inflation. MCL was willing to incur losses in the start up since it was confident that in the long run it would
be profitable. The South American country has had a democratic government for the last two years. Its government’s
objectives are to open the country’s borders to trade and lower its inflation rate. The government was rather reluctant to
let a foreign company purchase such a powerful communication tool. In exchange for the right to buy the network, MCL
agreed, among other conditions, not to promote any political party, to broadcast only pre-approved public messages, and
to let the government examine its books at the government’s convenience. Management has recorded this investment on
the books at cost.
In 2013, MCL acquired a conglomerate, Peters Holdings (PH), which held substantial assets in the communications
business. Over the past three months, MCL has sold off 80% of PH’s non–communications-related businesses. In the
current month, MCL sold PH’s hotel and recreational property business for $175 million, realizing a gain of $22 mil-
lion ($14.5 million after tax). The assets related to the non-communications businesses were scattered throughout the
United States and MCL lacked the industry expertise to value them accurately. Management therefore found it difficult
to determine the net realizable value of each of these assets at the time PH was acquired.
Newspaper readership has peaked, leaving no room for expansion. In 2012, to increase its share of the market, MCL
bought all the assets of a competing newspaper for $10 million. In 2013, MCL ceased publication of the competing
newspaper and liquidated the assets for $4.5 million.
In 2013, MCL decided to rationalize its television operations. Many of PH’s acquisitions in the television business
included stations in areas already being served by other stations operated by MCL. MCL systematically identified sta-
tions that are duplicating services and do not fit with MCL’s long-range objectives. These assets have been segregated on
the balance sheet and classified as current. The company anticipates generating a gain on the disposal of the entire pool
of assets, although losses are expected on some of the individual stations. Operating results are capitalized in the pool.
Once a particular station is sold, the resulting gain or loss is reflected in income.
Nine stations are in the pool at the present time. In 2013, three were sold, resulting in gains of $65,000 after tax.
Losses are expected to occur on several of the remaining stations. Although serious negotiations with prospective buyers
are not underway at present, the company hopes to have disposed of them in early 2014. In order to facilitate the sale of
these assets, MCL is considering taking back mortgages.
In 2013, MCL estimated the fair value of its intangible assets at $250 million. Included as intangibles are newspaper
and magazine circulation lists, cable subscriber lists, and broadcast licences. Some of these assets have been acquired
through the purchase of existing businesses; others have been generated internally by operations that have been part of
MCL for decades.
Amounts paid for acquired intangibles are not difficult to determine; however, it has taken MCL staff some time to
determine the costs of internally generated intangibles. In order to increase subscriptions for print and electronic media,
MCL spends heavily on subscription drives by way of advertisements, cold calls, and free products. For the non-acquired
intangibles, MCL staff have examined the accounting records for the past 10 years and have identified expenditures totaling
$35 million that were expensed in prior years. These costs relate to efforts to expand customer bases. In addition, indepen-
dent appraisers have determined the fair market value of these internally generated intangibles to be in the range of $60 to
$80 million. In order to be conservative, management has decided to reflect these intangibles on the December 31, 2013,
balance sheet at $60 million.
The market value of companies in the communications industry has been escalating in the past few years, indicating
that the value of the underlying assets (largely intangibles) is increasing over time. MCL management would prefer not
to amortize broadcasting licences, arguing that these licences do not lose any value and, in this industry, actually increase
in value over time.
One of the items included in the intangible category is MCL’s patented converter, which was an unplanned by-
product of work being done on satellite communications devices a few years ago.
MCL has sold $25 million of its accounts receivables to a medium-sized financial intermediary, PayLater Corp. The
receivables are being resold to a numbered company whose common shares are owned by PayLater Corp. MCL receives
one half of the consideration in cash and one half in subordinate non-voting, redeemable shares of the numbered com-
pany, bearing a dividend rate of 9%. The dividend payments and share redemption are based on the collectability of the
receivables. The purchase price is net of a 4% provision for doubtful accounts. MCL has recorded a loss of $1 million on
this transaction. PayLater has an option to return the receivables to MCL at any time for 94% of their face value.
The arrival of Internet video streaming services has revolutionized the entertainment industry. In response to this
new development, which is seen as a threat, the communication industry is developing its own interactive services at a
cost of over $6 billion. This service will allow viewers to access television services through their computers. MCL hopes
this will allow it to maintain its market share of viewers.
MCL has invested in equipment allowing it to offer Internet customers “turbo” high-speed so they can receive their
regular TV channels on their computers. The cost of the equipment itself is negligible. MCL will be using it for all its
major Canadian cities. MCL needed servers in only six cities but decided that it might as well put them in 36 cities since
it was doing line upgrades anyway. To date, MCL has rolled out the turbo service in six cities and charges a monthly fee
to new owners to cover their share of all maintenance expenses. MCL is leasing 10 other servers for 15-year periods.
Required
Prepare the report to the CFO, Dasan Sudjic.
(LO 1, 2, C8-4 Straw Hat Enterprises is a private company located in Toronto, Ontario created 12 years ago to import and dis-
3, 4) tribute products from all over the world to be sold to dollar stores in Canada and denominated in Canadian dollars. All
of its inventory purchases are made and paid in Canadian dollars. You, CA, have been the financial controller there for
five years. It has grown at a steady pace for the past 12 years. Next year, Straw Hat is looking to start the process of going
public, as it would like to have additional sources of financing to continue growing the company.
The owner of Straw Hat Enterprises calls you into his office. He is very excited as he has just purchased a new
company located in Mexico called Piñata Limited.
The sales of Piñata Limited take place in Mexico and are denominated in Mexican Pesos. All of its purchases of
goods to be sold are also locally sourced in Mexico. Piñata Limited has recently signed an exclusivity agreement with a
large local department store.
The acquisition closed immediately when the payment of 1 million Mexican Pesos was made. This was financed
by obtaining a bank loan from a Mexican bank to encourage foreign investment in Mexico. This loan is repayable in
5 years in Mexican pesos. The foreign exchange rate at the time of the acquisition of Piñata Limited and when the bank
loan was obtained was 0.07. Interest expense is 5% to be paid annually on December 31. The net assets at the time of
acquisition had a fair market value of Mex $600,000. The acquisition was made as it was felt that Piñata Limited would
be a good way to expand and grow the business of Straw Hat Enterprises.
This is the first time Straw Hat has purchased another company. The owner asks you to prepare a report to him
that addresses the accounting implications of this transaction as this is a particular area of concern for him. He has
heard that there might be some foreign currency repercussions but is unsure of the details. He reminds you that next
year they will begin the process of taking Straw Hat Enterprises public and would like you to keep that in mind when
preparing your report.
Required
Prepare the report requested by the owner.
3
MODULE
Not-for-Profit
and Government
Organizations
Reporting
In this module, we explore the specific reporting needs of entities that are not in the business of
making a profit: not-for-profit and public sector organizations. These organizations provide goods
and services to meet the needs of society, such as roads and sewers, health care, safety regulations,
recreation, or the arts.
In this module we will cover the private sector not-for-profit organizations in Chapter 9, and
public sector organizations, including governments, in Chapter 10.
There are primarily two types of not-for-profit organizations that we identify in this book:
those carried on in the private sector and those under the control of the government. A significant
difference between governments and not-for-profit private organizations is the source of their
revenues and their ability to raise them. A private not-for-profit organization’s revenue is based on
its ability to raise funds, whereas governments have the power to tax. In both cases, stakeholders
expect accountability for resources provided.
As we look at the not-for-profit sectors, it is important to understand that the financial state-
ment users’ needs are very different than those in the private sector. As a stakeholder, if you were
to donate funds to a particular cause, your primary interest would be to ensure that the funds were
being disbursed in the most efficient manner and in a way that supported the organization’s mission.
In this module, we examine the unique reporting requirements needed to convey the infor-
mation to the financial statement user regarding the use of funds toward the achievement of an
organization’s mission.
Reporting
on Health
Promotion
Source: © Marcela Barsse/iStockphoto
THE CANADIAN BREAST Cancer Foundation is a into funds: capital assets, externally restricted, board
nationwide organization founded in 1986 to raise restricted, and unrestricted. These funds are held
awareness and mobilize action on breast cancer. according to the objectives specified by the donors or
Through the years, the foundation has become with directives issued by the board of governors.
the leading organization in Canada dedicated to In accordance with the CICA Handbook,
creating a future without breast cancer. the foundation follows the restricted method
The foundation uses the money collected for recording restricted donations and records
through its various fundraising events and unrestricted donations as revenue in the year
campaigns to invest in research, education, and received. This method was selected by the board to
health promotion programs that have led to present the most reliable picture of the foundation’s
progress in breast cancer prevention, diagnosis, current financial position. As at March 31, 2011, the
treatment, and care. users of the financial statements would have seen
The accounting for not-for-profit organizations that there was around $23.6 million of unrestricted
(NPOs) is specified in the CICA Handbook, Part funds whereas $20 million was restricted for
III. These types of organizations are often not different predetermined uses. These uses were also
subject to the same exchange mechanisms as disclosed in the notes to the financial statements.
profit-oriented enterprises. However, NPOs are As for most not-for-profit organizations, it is not
often restricted by spending mandates imposed practical to satisfy the varied information needs of
by their members and contributors. As such, the all external users. That means that the focus of the
information must be presented in a manner that is foundation’s financial statements is to meet the
the most useful to its users. information needs of members, contributors, and
The Canadian Breast Cancer Foundation creditors.
prepares yearly audited financial statements. The The foundation relies on the contributions of
revenues are presented by different fundraising private donors as well the many corporate sponsors,
events, with the “Run for the Cure” being the and therefore, the financial statements represent
largest. a reliable source for these contributors to see the
The foundation has decided to adopt the impact of their donations. For example, an individual
fund accounting method in order to observe the who raised money for an event such as “Run for
limitations and restrictions placed on its use of the Cure” can see the actual amounts of donations
available resources. Accordingly, resources are collected and the related costs to determine the funds
classified for accounting and reporting purposes generated from that event.
Sources: Canadian Breast Cancer Foundation website, “About Us,” available at www.cbcf.org, accessed on June 15, 2012; Canadian Breast Cancer Foundation, 2011
audited financial statements.
CHAPTER
9 Reporting for
Not-for-Profit
Organizations
LEARNING OBJECTIVES
1. Explain the need for a unique reporting for not-for-profit organizations.
2. Describe the concept of fund accounting.
3. Record contributions using both the deferral and restricted fund methods.
4. Record specific transactions unique to not-for-profit organizations.
5. Apply the budgeting process in a not-for-profit organization (Appendix 9A).
REPORTING FOR NOT-FOR-PROFIT

ORGANIZATIONS
Reporting for Specific

Recording Appendix 9A—
Not-for-Profit Fund Accounting Not-for-Profit
Contributions Budgeting
Organizations Transactions
■ Definition ■ Description ■ Definition ■ Inventories ■ Budget to actual

■ Objectives of financial ■ Types of funds ■ Deferral method of ■ Tangible capital analysis
reporting ■ Illustration of fund fund accounting assets and intangible ■ Internal budget
■ Financial statements accounting ■ Restricted fund assets restrictions
required method of fund ■ Strategic investments ■ Encumbrance
accounting ■ Related-party accounting
transactions
■ Allocated expenses
452 chapter 9 Reporting for Not-for-Profit Organizations
Many services and goods in our society would not be properly supplied if left to the for-profit
sector to administer. Not-for-profit organizations fill this need. The key characteristics about
a not-for-profit organization are that it is led by its mission, is based on volunteers, enhances
our society, and is not formed to benefit its owners. A not-for-profit organization may be
incorporated but it does not have to be. The not-for-profit sector contributes significantly to
Canada’s economy and social programs. An article published by The Philanthropist indicates
that Canada has “created the second largest volunteer sector in the world.”1
There are several different types of not-for-profit organizations, including the following:2
1. Charities: The Income Tax Act considers an organization to be a charity if its goal is the
relief of poverty, the advancement of education, the advancement of religion, or other
purposes that benefit the community in a way the courts have said are charitable.
The organization’s purposes must be exclusively and legally charitable. Therefore,
all the purposes of the charity must be charitable, not just most purposes. In addition, the
organization must be established and located in Canada.3
Furthermore, there is a public benefit test: the charity must benefit the public or a
sufficient segment of the public to be a registered charity in Canada. Individuals and cor-
porations that give money to these organizations can deduct the value of gifts from their
taxable income, provided they file itemized tax returns. According to the Canada Revenue
Agency, there were more than 85,800 registered charities in Canada as of June 2012.4
2. Foundations: Foundations are formed to support causes or charities. They can be created
by individuals, families, corporations, or other entities. The classification of a foundation
is determined by the Canada Revenue Agency and is a complex taxation mechanism.
3. Welfare organizations: These organizations are concerned with the welfare of others and
may advocate on behalf of a group of individuals. They may be involved in lobbying and
political campaign activities.5
4. Professional and trade associations: These associations are normally created to con-
trol entry into a profession, maintain standards, educate, and represent the profession
in discussions with other bodies. The professional accounting association that you may
become a member of is an example of a professional association.
5. Institutions: Educational institutions, such as private schools, along with health institu-
tions such as private clinics or hospitals, are also considered not-for-profit organizations.
Most public institutions are considered to be under the mandate of the government.
In 2009, the Accounting Standards Board (AcSB) and the Public Sector Accounting Board
(PSAB) jointly issued the document “Financial Reporting by Not-for-Profit Organizations.”
The study estimates there are 161,000 not-for-profit organizations in Canada, reporting
$112 billion in revenues and having 139 million members. Approximately one third of all
revenue is earned by hospitals, universities, and colleges, leaving $75 billion reported by all
the other not-for-profit organizations. The study showed that 49% of all revenues come
from governments, mostly provincial governments. Earned income from non-governmen-
tal sources accounts for 35%; gifts and donations account for 13%. According to the study,
not-for-profit organizations employ just over 2 million staff and draw on 2 billion volunteer
1
“Supporting Financial Vibrancy in the Quest for Sustainability in the Not-For-Profit Sector” by
Marilyn Struthers, Program Manager, Ontario Trillium Foundation, who conducts independent
research with the support of her employer. “Financial Reporting by Not-for-Profit Organizations,”
June 2009, Accounting Standards Board and Public Sector Accounting Board jointly issued document.
2
Board Source website, available at http://www.boardsource.org/000nowledge.asp
3
Canada Revenue Agency website, available at http://www.cra-arc.gc.ca/chrts-gvng/chrts/plcy/cps/
cps-024-eng.html
4
Canada Revenue Agency website, available at http://www.cra-arc.gc.ca/ebci/haip/srch/
advancedsearchresult-eng.action?n&b&q&sregistered&d&e&c&v
&o&z&g&t&y&p1
5
Board Source website, available at http://www.boardsource.org/000nowledge.asp
Reporting for Not-for-Profit Organizations 453
hours, the equivalent of 1 million full-time jobs, and more than $8 billion in individual
donations.6
As we can see from Illustration 9.1, almost 80% of not-for-profit organizations report
less than $250,000 in revenue.
Illustration 9.1
Annual Revenues of $10,000,000+
Not-for-Profit
Organizations in Canada $1,000,000–$9,999,999
$500,000–$999,999
$250,000–$499,999
$100,000–$249,999
$30,000–$99,999
$0–$29,999
0 10 20 30 40 50
Source: “Financial Reporting by Not-for-Profit Organizations,” June 2009, Accounting Standards Board and
Public Sector Accounting Board jointly issued document.
REPORTING FOR NOT-FOR-PROFIT

ORGANIZATIONS
Definition of a Not-for-Profit Organization
Objective 1 The CICA Handbook defines not-for-profit organizations as follows:
Explain the need for
Not-for-profit organizations (NFPO), are entities, normally without transferable own-
a unique reporting
for not-for-profit ership interests, organized and operated exclusively for social, educational, professional, reli-
organizations. gious, health, charitable or any other not-for-profit purpose. A not-for-profit organization’s
members, contributors and other resource providers do not, in such capacity, receive any
financial return directly from the organization.
We can separate the not-for-profit sector into two categories: those that operate in the public
sector and those that are private. Public sector not-for-profit organizations include govern-
ment entities such as municipal or local governments or any agency run by the government.
All other not-for-profit organizations are considered private. A significant difference between
the sectors is that the public sector not-for-profit entity has the ability to obtain revenues
through taxation. A private sector not-for-profit must obtain its revenues through fundraising.
A government not-for-profit organization is defined by the CICA Public Sector
Accounting Handbook as:
A government organization that meets the definition of a not-for-profit organization in the
CICA Handbook – Accounting and that has counterparts outside the public sector. “Public
sector” refers to federal, provincial, territorial and local governments, government organiza-
tions, government partnerships, and school boards.
These government entities are further divided based on whether they are government busi-
ness organizations or government other organizations. Government business organizations
must follow IFRS, whereas government not-for-profit organizations and government other
6
“Financial Reporting by Not-for-Profit Organizations,” June 2009, Accounting Standards Board and
Public Sector Accounting Board jointly issued document.
organizations follow the Public Sector Accounting Standards. These organizations and the
related standards will be covered in Chapter 10.
The Canadian Accounting Standards Board (AcSB) is mandated to develop standards
only for private not-for-profit organizations. Until 2010, private not-for-profit organizations
followed the same CICA Handbook as all companies in Canada, with an additional specific set
of sections (the 4000 series) dealing with reporting issues particular to the nature of these
entities. With the required implementation of IFRS for year ends beginning 2011, the AcSB
was faced with deciding whether private not-for-profit organizations would be required to
follow IFRS as well. Under IFRS, there is no specific guidance for not-for-profit organiza-
tions. Those entities are required to follow IFRS in the same way as profit-oriented entities.
The AcSB undertook a project to evaluate the best reporting practices for the private
not-for-profit sector, similar to the Canadian project that developed ASPE.
The AcSB assessed three possible options for private not-for-profit organizations:
1. Required adherence to IFRS (CICA Handbook, Part I).
2. A new Handbook developed specifically for not-for-profit organizations.
3. Required adherence to ASPE (CICA Handbook, Part II), with additional guidance for
issues specific to not-for-profit organizations.
The consultation process yielded a very important conclusion: the nature of not-for-profit
organizations varies dramatically and one method would not meet the needs of all entities. As
such, the AcSB concluded that not-for-profit organizations would have the option to follow:
1. IFRS (Part I) or
2. ASPE (Part II) plus a new section, Part III, of the CICA Handbook dealing with issues
specific to not-for-profit organizations. If a not-for-profit organization adopts Part III, it
must also adopt Part II for any issues not covered in Part III.
These choices were relevant for year ends beginning on or after January 1, 2012. You have cov-
ered IFRS and ASPE in previous courses and in previous chapters of this text and therefore in
this chapter we examine Part III of the CICA Handbook. For the remainder of this chapter, any
reference to not-for-profit organizations assumes that it is a private not-for-profit organization.
Objectives of Financial Reporting for

a Not-for-Profit Organization
The objectives of financial reporting for a not-for-profit organization and a profit-oriented
entity are essentially the same. Both are required to present information that would be useful
to the user of the financial statements. The Handbook Section 1001.12 states:
The objective of financial statements is to communicate information that is useful to mem-
bers, contributors, creditors and other users (“users”) in making their resource allocation
decisions and/or assessing management stewardship. Consequently, financial statements
provide information about:
(a) an entity’s economic resources, obligations and net assets;
(b) changes in an entity’s economic resources, obligations and net assets; and
(c) the economic performance of the entity.
User Needs
The reader of the financial statement needs to be able to:
• assess management performance
• assess stewardship
• make resource allocation decisions.
In reviewing the results of a profit-oriented entity, the user of the financial statement is
interested in whether the entity has made a profit and whether the return on investment is
positive. In reviewing the results of a not-for-profit organization, the user of the financial
statement is interested in how well the entity used its funds to achieve its objectives. The goal
of a not-for-profit organization is to fulfill its mission in the most cost-efficient way.
Because not-for-profit organizations depend on government funding (typically the larger
organizations) and non-governmental sources such as gifts and donations (typically those
with relatively smaller annual revenues), governments and donors, together with lenders, are
primary external users of not-for-profit organizations’ financial statements.
Not-for-profit organizations are diverse and therefore there will be a large number of
users with different needs. As such, the organization must determine the type of information
to provide on the financial statements to satisfy its particular user needs. Part III of the CICA
Handbook is based on the premise that the primary users of the financial statements will be the
organization’s members, contributors, and creditors. However, there may be other outside
parties that rely on the financial statements.
A not-for-profit organization may be restricted in how it collects or distributes funds
based on the requirements of members, contributors, or creditors. These parties are often
not part of the management of the not-for-profit organization and therefore rely on these
external reports for assessing the organization’s stewardship and management abilities. These
users make resource allocation decisions based on how the entity has managed its costs and
whether it has achieved its goals.
Consider the following example. The Sun Youth organization raises money every year
to purchase bicycles for needy children. Those who donate funds to Sun Youth would want
to see how much money was raised but they would also want to ensure that the funds were
spent on bicycles and that the bicycles were given to needy children only. If this were a profit-
oriented entity, the user would typically only want to know how much the entity bought and
sold the bicycle for.
Accounting Rules
The CICA Handbook, Part III follows the same conceptual framework as ASPE and IFRS. As
such, a not-for-profit organization follows the same rules of accounting as those required for
all entities. The definitions of assets and liabilities are the same and the not-for-profit organi-
zation must also follow accrual accounting.
The revenue recognition criteria are the same as those of profit-oriented enterprises
except that contributions to a not-for-profit organization are considered revenue. As stated
in 4410.02:
A contribution is a non-reciprocal transfer to a not for profit organization of cash or other
assets or a non-reciprocal settlement or cancellation of its liabilities. Government funding
provided to a not for profit organization is considered to be a contribution.
A profit-oriented organization would consider donations to be part of equity, and govern-
ment funding would be revenue. The criteria for recognizing revenue from contributions are
discussed later in the chapter in the section “Recording Contributions.”
In addition to contributions, a not-for-profit organization may have revenues from
investment income or the sale of goods or services. The revenue recognition criteria for
a not-for-profit organization in these situations are the same as those for a profit-oriented
enterprise.
Many not-for-profit organizations receive membership fees. These fees are considered
service revenue to the extent that the service that the member is receiving is equal to what
they would have paid for the same service in a profit-oriented entity. As such, the revenue
would be recorded when the service is performed. For example, a community recreation
facility may charge a membership fee to use the gym facilities. This fee is similar to what a
profit-oriented gym would charge. The not-for-profit organization would recognize revenue
over the period of the membership. In other cases, all or part of the membership fee would
be considered a contribution and revenue would be recorded in line with contributions dis-
cussed in the “Recording Contributions” section of this chapter. An individual may pay an
annual membership to be part of a society but receive no benefit from that society. This
society would help serve other people with the funds received from the membership. In this
case, the membership fee would be considered a contribution.
Financial Statements Required of

a Not-for-Profit Organization
The CICA Handbook requires that a not-for-profit organization present the following state-
ments in its set of financial statements (1001.4):
1. Statement of financial position
2. Statement of operations
3. Statement of changes in net assets
4. Statement of cash flows
The not-for-profit organization is not required to use the titles as presented above. It must,
however, prepare the information that is required for each statement.

The statement of financial position is required to indicate the assets and liabilities at a point
in time, as is done for a profit-oriented organization. The significant difference is that there
is no shareholder equity because a not-for-profit organization has no “shareholders.” The
difference between the assets and liabilities is shown as the net assets (or fund balance).
Not-for-profit organizations also have an option of presenting their statement of financial
position using fund accounting. This is a method whereby the assets and liabilities are sep-
arated into different funds to reflect a particular objective of the not-for-profit organiza-
tion. You will note in Illustration 9.2 that Centraide (United Way) of Greater Montreal
uses fund accounting, separating the general fund, the stabilization fund, the capital asset
fund, and the development fund. This method of presentation is elaborated upon in the next
section, “Fund Accounting.”
The Handbook Section 4400.19 states:
The statement of financial position should present the following:
(a) net assets subject to restrictions requiring that they be maintained permanently as
endowments;
(b) other restricted net assets;
(c) unrestricted net assets; and
(d) total net assets.
It is important for the user of the financial statement to know whether the entity can sustain
itself. This information is normally provided by grouping similar amounts not significant
in themselves as financial statement items (for example, cash, capital assets, accounts pay-
able, and deferred contributions) and providing totals for all funds related to each of these
financial statement items reported. In addition, assessing the liquidity of the not-for-profit
organization is enhanced by segregating assets and liabilities based on the ability to liqui-
date them.
Statement of Operations
The statement of operations reflects the net income from operations for the period. This
net income may also be segregated into distinct funds, as will be discussed in the next section
titled “Fund Accounting.” You will note again in Illustration 9.2 that Centraide of Greater
Montreal has separated the statement of operations by funds as well.
Statement of Changes in Net Assets

“Total net assets” represents the organization’s residual interest in its assets after deduct-
ing its liabilities. The statement of changes in net assets replaces the statement of changes
in retained earnings and the statement of changes in equity that you would see in a profit-
oriented entity. This statement may be shown separately or may be shown as a continuation
of the statement of operations. The net assets change provides information about how the
net resources the organization has available for carrying out its activities in the future have
changed. In Illustration 9.2, we see that Centraide of Greater Montreal has chosen to present
the statement of changes in net assets as a continuation of the statement of operations. In this
financial statement, the net assets are referred to as “fund balances.”
Statement of Cash Flows

The statement of cash flows is the same as that shown for profit-oriented entities. When this
text went to press, Centraide of Greater Montreal had not produced a statement of cash flows
as this was a requirement for year ends beginning January 2013. Cash from operations would
include those funds and expenditures arising from the normal activities of the operation.
Cash from investing usually involves the acquisition and sale of capital assets, and invest-
ments and cash from financing activities would include contributions that are endowments or
are restricted for the purchase of capital assets as well as debt financing.
Centraide of Greater Montreal collects public donations to promote involvement in
society through sharing and volunteer and community activities, as shown in Illustration 9.2.
Illustration 9.2
Excerpts from the OPERATING FUND
Financial Statements Statement of operations and fund balance
of Centraide of Greater year ended March 31, 2011
Montreal, 2010–2011 2011 2010
$ $
Revenue
Subscriptions 56,120,451 53,252,623
Uncollectible subscriptions (1,775,711) (1,767,409)
54,344,740 51,485,214
Interest and other revenue 135,541 120,850
54,480,281 51,606,064
Expenses
Fundraising, communication and
administrative costs (Note 8) 6,948,441 6,499,521
Result before allocations and assistance to agencies 47,531,840 45,106,543
Allocations to agencies (Note 4) 42,773,710 42,824,130
Assistance to agencies, social research and
community services (Note 8) 3,409,968 3,136,092
46,183,678 45,960,222
Net result (deficit) 1,348,162 (853,679)
Fund balance at beginning 43,088,363 43,942,042
Interfund transfers (Note 6) (814,500) —
Fund balance at end 43,622,025 43,088,363
STABILIZATION FUND
Statement of operations and fund balance
year ended March 31, 2011
2011 2010
$ $
Revenue
Investments 439,621 814,053
Net result 439,621 814,053
Interfund transfer (Note 6) 271,500 (600,000)
CAPITAL ASSET FUND

2011 2010
$ $
Revenue
Donations
Fondation Centraide du Grand Montréal — 600,000
2,397 602,690
Expenses
Amortization of fixed assets 277,815 271,159
Other 53,272 51,043
331,087 322,202
(Deficit) net result (328,690) 280,488
Interfund transfer (Note 6) 271,500 600,000
DEVELOPMENT FUND
2011 2010
$ $
Revenue
Expenses
Training, research and development expenses 154,595 304,471
Deficit (151,302) (299,551)
Fund balance at beginning 523,265 822,816
Interfund transfer (Note 6) 271,500 —
Fund balance at end 643,463 523,265
BALANCE SHEET
as at March 31, 2011
Operating Stabilization Capital Asset Development Total Total

Fund Fund Fund Fund 2011 2010
$ $ $ $ $ $
Assets
Current assets
Cash 326,330 — — — 326,330 631,687
Investments, 1.08% to
1.15% (0.26% to
0.34% in 2010)
until June 2011 27,762,016 — — — 27,762,016 25,392,692
Subscriptions receivable 20,016,860 — — — 20,016,860 20,243,356
Interfund receivable 600,000* 271,500* 603,339* 643,463* — —
Other assets (Note 5) 465,090 — — — 465,090 978,444
49,170,296 271,500 603,339 643,463 48,570,296 47,246,179
Investments — 5,783,112 — — 5,783,112 5,336,891
Fixed assets (Note 3) — — 5,004,118 — 5,004,118 4,132,666
49,170,296 6,054,612 5,607,457 643,463 59,357,526 56,715,736
Liabilities
Current liabilities
Accounts payable
and accrued
liabilities (Note 5) 2,137, 615 6,600 — — 2,144,215 1,977,241
Balance payable to
agencies 210,440 — — — 210,440 118,430
Interfund payable 1,518,302* 600,000* — — — —
Deferred revenue 1,681,914 — — — 1,681,914 606,899
5,548,271 606,600 — — 4,036,569 2,702,570
Fund Accounting 459
Commitment (Note 9)
Fund balances
Invested in fixed assets — — 5,607,457 — 5,607,457 5,664,647
Externally restricted — — — 643,463 643,463 523,265
Internally restricted 43,622,025 5,448,012 — — 49,070,037 47,825,254
43,622,025 5,448,012 5,607,457 643,463 55,320,957 54,013,166
49,170,296 6,054,612 5,607,457 643,463 59,357,526 56,715,736
* These items are not reported in the Total column on the balance sheet because they offset each other.
✓ LEARNING CHECK
• Private not-for-profit organizations may follow IFRS (Part I) or Part III of the CICA Handbook.
If a not-for-profit organization selects Part III, it must also adopt Part II for all issues not
covered in Part III.
• All not-for-profit organizations should apply similar accounting treatments to like transac-
tions when the needs of the users are aligned.
• Revenue recognition criteria mirror those of profit-oriented entities except for contributions.
• A not-for-profit organization may disaggregate its financial statements into funds based on
its legal, contractual, or voluntary actions.
FUND ACCOUNTING
Description of Fund Accounting
Objective 2 The CICA Handbook, Part III defines fund accounting as:
Describe the concept
of fund accounting. The collective accounting procedures resulting in a self-balancing set of accounts for each fund
established by legal, contractual or voluntary actions of an organization. Elements of a fund
can include assets, liabilities, net assets, revenues and expenses (and gains and losses, where
appropriate). Fund accounting involves an accounting segregation, although not necessarily a
physical segregation, of resources.
A not-for-profit organization may choose to disaggregate, or separate, its assets and liabili-
ties by the activity that they belong to and/or to disaggregate the operating activities by the
nature of the activity. For example, a church organization may wish to separate its activities
by function such as holiday events, meals for the needy, book sale, and building maintenance.
For this church it is important to show its members how much money has been raised for
each activity and how those funds were spent. One way to clearly reflect the results is to
keep each activity in a separate fund. You could liken this to setting up four different sets of
statements, one set for each activity. As an example, the book sale would have a statement of
operations that would reflect the revenues earned from the sale of books less the cost to buy
any of these books (often there is no cost as the books would be donated). The balance would
reflect the net profit on the activity. In addition, this fund would have its own statement of
financial position, which would probably have only two assets: cash and inventory—books. A
similar set of funds would be set up for each activity. Each fund would then be added together
to present the overall financial statements of the church.
Suppose the net profit of the book sale is required to be used to pay for building reno-
vations. This would represent an inter-fund transfer. The net profit of the book sale fund
would then be transferred to the building renovation fund as an increase in the net assets
of that fund. When all the funds are added together, these inter-fund transfers are in effect
eliminated as they are inter-entity. These inter-fund transfers are not considered revenue
or expenses of the entity and as such are reflected only in the statement of changes in net
assets.
The basic accounting equation is applied to not-for-profit organizations:
Assets − Liabilities = Fund Balances (net assets)

In the two situations illustrated below, we examine an organization’s fund profile.
Situation 1 is an example of an organization’s fund profile in a perfect world: it has four
funds: a general fund, a building fund, a missions fund, and a memorial fund. It has one asset
account, the chequing account. It has no liabilities; this is where the scenario is unrealistic.
Situation 1
Chequing account $16,000 General fund $4,000
Building fund $5,000
Missions fund $3,000
Memorial fund $4,000
Situation 2 is an example of a more complicated, typical organization: it also has four

funds, but in addition it has a liabilities account, the deductions at source tax account, and
an additional asset account: the savings account.
Situation 2
Chequing account $4,000 General fund $3,000
Savings account $12,000 Building fund $5,000
Missions fund $3,000
Memorial fund $4,000
Deductions at
source payable $1,000
Types of Funds
Restricted Fund
A restricted fund is a segregation of funds that are externally or internally restricted for a
particular purpose. This restriction may be imposed externally by the donors, by the legal
requirements of the not-for-profit organization, or by the creditors. Alternatively, the not-
for-profit organization can internally restrict contributions for the purpose that it deems
appropriate. This restriction usually requires the approval of the board of directors. When
Centraide of Greater Montreal requests donations, the options available for allocating a
donation ensures that those funds will be restricted to the activity the donor has requested. In
fact, fundraisers have found that people are more willing to donate if they can specify where
their funds will be spent. For example, a hospital may receive a donation that is given for the
purpose of cancer research, or an association may internally restrict funds for developing a
new education program for its members.
Consider the following example where a foundation grants $35,000 to the church’s edu-
cational arm for curriculum development, teacher recruitment and training, and some capital
expenses to support teaching. The grant must follow a timeline and be used within a three-
year period. These funds are restricted by nature and by time. Expenses charged to the grant
must be documented so that the church can prove to the grant maker that the funds were
used appropriately, and not to cover a shortfall in another area.
Endowment Fund
An endowment fund is a type of restricted fund where, even though funds are collected, the
principal is not allowed to be spent. The not-for-profit organization is only permitted to use
the growth in the funds for selected purposes. Many not-for-profit organizations have argued
that they may have a great deal of assets but they are “cash poor.” This may be a result of the
endowment funds not earning a sufficient return to manage operations. If a donor provides
an endowment fund of $100,000, the not-for-profit organization is entitled to use the interest
Fund Accounting 461
earned in operations. At an interest rate of 2%, this may mean that annually the not-for-
profit organization will only have $2,000 to add to its operating budget.
By the same token, endowment funds can be the best way to ensure the long-term via-
bility of the not-for-profit organization. As the endowment grows, the annual allocation to
income will also increase. One of the things that financial statement users will want to assess
is whether these funds were invested in the best possible way to maximize the return on those
investments and limit the risk of loss.
Capital Asset Fund

A capital asset fund is another type of restricted fund. This is a fund that must be used
for the acquisition and maintenance of capital assets. This would be an interesting fund
for readers of the financial statements if the not-for-profit organization has major capital
assets. A not-for-profit organization may in any given year decide to do a capital campaign.
This would be an effort to raise funds to improve the entity’s capital. This fund may or
may not be central to the mission of the not-for-profit organization. For example, a school
clearly has a building that it must maintain and upgrade but its central mission is to edu-
cate. In another example, a not-for-profit organization may be set up to build and maintain
a sports arena for the local area. In this case, the building is central to the organization’s
objective.
Consider the following example of how a capital asset fund works. A member of a men’s
lodge donates $10,000 for the lodge to buy and install a new lighted outdoor sign. The lodge
creates a restricted fund for the sign project, and records the donation as revenue to that
fund. When the sign needs to be paid for, the restricted donation is freed for use. When pos-
sible, the donor is notified that the donation is being used. Often, when the item is installed,
a plaque or other marker is placed nearby to acknowledge the donation.
The above are types of funds that any given not-for-profit organization may select. The
not-for-profit organization is not required to disaggregate based on these funds nor is it
restricted to only these types of funds. It is up to the not-for-profit organization to determine
the best way to convey information to the user.
Illustration of Fund Accounting

If we examine Illustration 9.2, we see that Centraide of Greater Montreal has decided that
it is important information to disclose separately the transactions of the Stabilization Fund
activity. Centraide of Greater Montreal states in its annual report that the Stabilization Fund
was created to provide financial stability to agencies that it finances, to satisfy new initiatives
and urgent needs of the community, to answer needs considered urgent and approved by
the board of directors, and to satisfy the normal expenses associated with its activities during
periods where fundraising campaigns raise less money than anticipated. The Capital Asset
fund is also separated to indicate to the reader the activities of a capital nature. And lastly,
the Development Fund was separated to show the amounts created to fund research and
development activities and pilot and other projects that are not considered part of Centraide
of Greater Montreal’s usual activities, where the ultimate goal is to significantly increase the
funds donated to it.
Since each not-for-profit organization determines its own funds, note disclosure is
required describing the nature of the funds segregated.
Fund accounting can perhaps best be understood through a look at a trial bal-
ance. Examine the 2013 trial balance for Tutorial Associates Inc. (TAI) in Illustrative
Example 9.1. TAI is a tutorial service that provides help for students at all school levels.
Students are recommended by specific schools and must meet a financial need. Students pay
a nominal fee based on their ability to pay. The objective of the program is to encourage
students to reach the highest level of education possible. Its primary focus is ensuring that
students complete secondary school. Some teachers volunteer their time but the majority of
tutors are paid university students. TAI receives its funding partially through provincial gov-
ernment allocations and local fundraising initiatives.
Illustrative Example 9.1 Fund Accounting

TUTORIAL ASSOCIATES INC.
Trial Balance
December 31, 2013
Account
Bank—operating account 12,250
Bank—capital account 13,700
Bank—endowment account 82,320
Contributions receivable 1,230
Textbook inventory 2,400
Capital assets 22,300
Accumulated depreciation 2,200
Bank loan—current portion 2,000
Bank loan 8,000
Deferred capital contributions 10,700
Deferred contributions 3,000
Net assets—(capital fund: 14,330) 19,040
Net assets—endowment 78,400
Book sale revenue 15,100
Book sale cost of sales 13,750
Capital contributions recognized 1,800
Unrestricted contributions 1,300
Tutorial revenue 19,320
Interest revenue—endowments 3,920
Administration expenses 7,200
Depreciation 1,800
Tutoring salaries 8,000
166,180 166,180
TAI currently only has one fund, a general fund. But we can separate the capital activities
from other activities. We could also separate the endowment fund. We can now easily cre-
ate three funds for this organization—an operating fund, a capital fund, and an endowment
fund—and present three self-balancing sets of accounts. In doing so, we have to split the
opening net asset balance into opening fund balances for the operating, capital, and endow-
ment funds. Alternatively we can present one trial balance composed of three funds, as shown
in Illustrative Example 9.2.
Illustrative Example 9.2 Fund Accounting:

Trial Balances of Three Funds
Operating Fund
Trial Balance
December 31, 2013

Operating fund—opening balance 4,710
Contributions revenue 1,300
Tutorial revenue 19,320
Administration expense 7,200
44,830 44,830
Fund Accounting 463

Capital Fund
Trial Balance
December 31, 2013

Capital assets—cost 22,300
Accumulated depreciation 2,200
Bank loan 8,000
Capital fund—opening balance 14,330
Depreciation 1,800
39,030 39,030

Endowment Fund
Trial Balance
December 31, 2013
Bank—endowment account 82,320

Endowment fund—opening balance 78,400
Increase in net assets—interest 3,920
82,320 82,320
Another form of presentation, shown in Illustrative Example 9.3, is to present one trial
balance divided by fund.
Illustrative Example 9.3 Fund Accounting: One Trial

Balance Divided by Fund
Trial Balance—All Funds
December 31, 2013
Opening balance—Operating fund 4,710
Contributions revenue 19,320
Tutorial revenue 100
Administration expense 7,200
Capital assets 22,300
Accumulated amortization 2,200
Bank loan 8,000
Opening balance—Capital fund 14,330
Depreciation 1,800
Bank—endowment 82,320
Opening balance—Endowment fund 78,400
Increase in net assets—interest 3,920
166,180 166,180
Note that TAI could have set up a fund for the book sale as well if it felt that disaggregating
this activity would be useful to the users of the financial statements.
✓ LEARNING CHECK
• Fund accounting is a self-balancing set of accounts created for each fund.
• Net assets and net income are segregated based on the activity or the nature of the activity.
• Common funds are restricted funds, endowment funds, and capital asset funds.
RECORDING CONTRIBUTIONS
Objective 3 In this section we will examine the unique accounting issue with respect to contributions that
Record contributions a not-for-profit organization receives. Unlike profit-oriented entities, not-for-profit orga-
using both the nizations may receive funds where the contributor has no intention of requesting anything
deferral and in return.
restricted fund
methods.
Definition of Contributions
Contributions are considered revenue to the not-for-profit organization. Contributions
may be made by governments (in the form of grants and loans), individuals, or corporations,
or may be interest or gains on investments. Contributions may be given in cash, assets, or
settlement of debt. In the previous section we saw that contributions may be restricted or
they may be in the form of an endowment. A contribution that has no caveats attached to it
is considered a non-restricted contribution. There are two methods to account for contribu-
tions: the deferral method or the restricted fund method.
Before deciding how to record the contribution, the not-for-profit organization must
determine whether it is a contribution yet. At what point can a not-for-profit consider that
the contribution has in fact been received? Specifically, it needs to look at the situation where
a promise is made to provide a contribution in the future. These contributions may be in the
form of a pledge. A pledge is a promise to contribute cash or other assets. From the organiza-
tion’s perspective, the question is whether revenue is recognized at the time that a promise is
made or when the organization actually receives the contribution. Handbook Section 4420.03
indicates that a contribution receivable should be recognized as an asset if it meets both of the
following two criteria:
1. The amount to be received can be reasonably estimated.

2. Ultimate collection is reasonably assured.
A not-for-profit organization receives a government grant each year based on meeting some
criteria. This organization has received this grant for many years and is aware of the criteria
that need to be met. This year the organization has applied for the grant and has submitted
the required documentation indicating that the criteria are met. The government agency
only meets subsequent to the not-for-profit organization’s year end. This organization will
record the contribution receivable since it can reasonably estimate the amount and ultimate
collection is reasonably assured.
Organizations that have large, annual fundraising campaigns may determine that
they can estimate the amount of pledges that will be received based on historical results.
These organizations will record the receivable less an allowance for uncollectible amounts.
Bequests are often subject to considerable uncertainty regarding the amount and timing
of the receipt and therefore will not meet the criteria for recognition.
Centraide of Greater Montreal provided a note disclosure regarding revenue recognition
on its 2011 financial statement, as shown in Illustration 9.3.
Recording Contributions 465
Illustration 9.3
Note to the 2011 Financial Revenue recognition
Statements of Centraide Unrestricted contributions are recognized as revenue of the Operating Fund in the year they are received
of Greater Montreal or receivable if the amount to be received can be reasonably estimated and collection is reasonably
Regarding Revenue assured. Restricted contributions are recognized as revenue of the Fund corresponding to their
Recognition restriction.
Deferral Method of Fund Accounting

Using the deferral method of accounting, expenses are recorded in the period in which
they occur and restricted contributions are then brought into income to match against those
expenses. If the expenses will only be incurred in a future period, the contribution is shown
as a deferred liability until such point as the expenses are incurred. For example, consider
a not-for-profit organization that is planning its annual golf tournament, which is going to
take place in August. The not-for-profit organization has a July 31 year end. As of July 31,
the organization has received the donations from all participants; however, the event will
only be taking place subsequent to year end. Under the deferral method, all revenues for this
event will appear on the statement of financial position as a deferred liability. When the golf
tournament takes place, the revenues will be brought into income to offset the tournament
expenses.
Externally restricted resources would be presented as deferred contributions. A govern-
ment grant may be given to retrain people to work in a plant to be built in a northern region
of Canada. Any funds received would be deferred until the employees are hired for this new
plant.
Internally restricted resources are determined by the entity. One common type of inter-
nal restriction is to present net assets invested in capital assets as a component of net assets
separately from the unrestricted net assets balance. Not-for-profit organizations that adopt
this form of internal restriction consider that the internally restricted amount represents net
assets that are not available for other purposes because they have been invested in capital
assets and the contribution is therefore deferred to offset against the asset. This is sometimes
referred to as “appropriation.”
In Illustrative Examples 9.1 to 9.3, Tutorial Associates Inc. is presented using the defer-
ral method of accounting for contributions. Capital contributions have been deferred, set
aside as liabilities, until recognized as revenue. These contributions will be brought into rev-
enue to offset the related amortization of the assets purchased with these contributions. Only
$1,800 of these contributions has been recognized in the current period, to match $1,800 of
the amortization of the assets that were purchased with these contributions.
Illustrative Example 9.4 reviews the accounting for different types of contributions
received under the deferral method of contribution recognition, using the example of Help
For All, a not-for-profit organization that funds health research.
Illustrative Example 9.4 Accounting for Transactions

Using the Deferral Method of Fund Accounting
1. Help For All receives a $2,000 donation to spend as needed.
This donation is unrestricted, so the not-for-profit organization makes the
following journal entry:
Cash 2,000
Unrestricted Revenue 2,000
Since Help For All has the discretion to spend the funds as it sees fit, this is an
increase in its economic resources in the current period.
2. Help For All receives a $2,000 donation for research. The allocation for research
funding to specific scientists will be conducted in six months. The not-for-profit
organization makes the following journal entry:
Cash 2,000
Deferred Revenue—Research 2,000
Help For All initially defers this revenue since the activity has not been conducted.
When the research begins, Help For All will make the following entry:
Deferred Revenue—Research 2,000
Research Revenue 2,000
This revenue will offset the expenses incurred to perform the research and the not-for-
profit organization will be able to assess the net costs to conduct this research activity.
3. Help For All receives $2,000 as an endowment contribution. Help For All makes
the following entry:
Cash 2,000
Net Assets 2,000
An endowment received is a direct increase in net assets since Help For All will not
be able to spend it. The return on this money will then be accounted for based on
the restriction in the initial endowment contribution. If interest is earned on the
endowment fund at 4% annually and there are no restrictions on this money, then
Help For All makes the following entry at year end:
Cash 80
Interest Revenue 80
(.04 2,000)
If the interest must be spent on a future event, then Help For All makes the follow-
ing entry:
Cash 80
Deferred Revenue—Interest 80
4. Help For All receives $2,000 to buy a printer at a later date. Help For All makes the
following entry:
Cash 2,000
Deferred Revenue 2,000
Since the money is received for a future event, the amount is deferred. When the
printer is purchased, Help For All makes the following entry:
Printer 2,000
Cash 2,000
If we assume that the printer has a two-year life, Help For All will make the follow-
ing entries in each of the next two years:
Depreciation Expense—Printer 1,000
Accumulated Depreciation—Printer 1,000
Deferred Revenue—Printer 1,000
Revenue—Printer 1,000
The deferred revenue is brought into income at the same rate as the depreciation
expense so that the revenue will offset the expense.
5. Help For All receives $2,000 to buy land adjacent to its current premises. The land
does not depreciate. As such the contribution is considered to be a direct increase
in net assets.
Cash 2,000
Net Assets 2,000
When the land is acquired, Help For All makes the following journal entry:
Land 2,000
Cash 2,000
6. Help For All receives a contribution of $2,000 to repay the mortgage, which has a
remaining life of 10 years. Help For All makes the following entries:
Cash 2,000
Deferred Revenue—Mortgage 2,000
This contribution is considered restricted for the same purpose as the debt financ-
ing was for. If the debt financing were used to acquire a building that depreciates,
the deferred revenue would be recognized as the building is depreciated. Assuming
the building has a 20-year life and is being amortized on a straight-line basis, Help
For All would make the following entry:
Deferred Revenue—Mortgage 100
Revenue 100
(2,000/20 years)
If the debt is used to purchase land, the original entry would have been to a direct
increase in net assets rather than Deferred Revenue—Mortgage since the revenue
will never be able to offset the expense.
If the debt is taken out for general operating activities, and not for the acquisi-
tion of any particular asset, the not-for-profit organization considers the activities
that the debt will finance and matches the revenue with the expenses of that activity
in the same period.
Restricted Fund Method of Fund Accounting

Under the restricted fund method, the organization classifies its restricted operations by
fund and recognizes the contributions immediately as revenue of that particular fund. The
“restricted fund method” should not be confused with “fund accounting” as illustrated previ-
ously. A not-for-profit organization may present its financial statements on a fund basis with-
out using the restricted fund method. As seen in Illustrative Examples 9.1 to 9.3, Tutorial
Associates Inc. uses fund accounting under the deferral method.
When using the Restricted Fund method, the organization will have at least a general
fund, which is composed of non-restricted contributions, and an endowment fund. Any other
funds that it uses must be restricted by an external source. It is up to the not-for-profit orga-
nization to decide how many restricted funds it wants to report. Any restricted funds that do
not have a separate fund are reported using the deferral method through the general fund. If
the organization decides to internally restrict funds, under the restricted fund method, the
organization reflects this as an inter-fund transfer.
Under the restricted fund method, net assets (fund balances) invested in capital assets
may also be internally restricted and generally represent the net book value of all capital
assets, less related debt.
In Illustration 9.2, we saw that Centraide of Greater Montreal uses the restricted fund
method of accounting. You will note that investment income that is for the Stabilization
activity is shown as revenue of that fund. The contribution of the Foundation to the Capital
Asset Fund is shown as revenue of the Capital Asset Fund. In this method of accounting,
inter-fund transactions are significant information to the reader as revenues from one fund
may be used to pay expenses of another fund. These transfers are not considered revenue
to the fund that actually uses the money because the original fund recorded it as revenue.
Centraide of Greater Montreal disclosed the note to its financial statements regarding inter-
fund transfers as shown in Illustration 9.4.
Illustration 9.4
Interfund transfers
Note to the 2011 Financial
The Board of Directors approved the following interfund transfers:
Statement of Centraide
of Greater Montreal 2011 2010
Regarding Interfund $ $
Transfers From the Operating Fund to the Stabilization Fund 271,500 —
From the Operating Fund to the Capital Asset Fund 271,500 —
From the Operating Fund to the Development Fund 271,500 —
From Stabilization Fund to Capital Asset Fund — 600,000
Illustrative Example 9.5 examines the same transactions for Help For All from Illustrative
Example 9.4, assuming that it is following the restricted fund method.
Illustrative Example 9.5 Journal Entries Using

the Restricted Fund Method
1. Help For All receives a $2,000 donation to spend as needed.
This donation is unrestricted so Help For All makes the following journal entry:
Cash 2,000
Unrestricted Revenue—General Fund 2,000
Since Help For All has the discretion to spend the funds as it sees fit, this is an
increase in its economic resources in the current period and therefore is recorded
as revenue to the general fund.
2. Help For All receives a $2,000 donation for research. Help For All maintains a sep-
arate restricted fund for research since it is required by an external party. The allo-
cation for research funding to specific scientists will be conducted in six months.
Help For All makes the following journal entry:
Cash 2,000
Revenue—Restricted Research Fund 2,000
Help For All records this as revenue of the research fund when a separate fund has
been created for research activity. If there is no specific fund for research, the con-
tribution is treated as a deferred contribution in the general fund and the journal
entries are the same as those shown in Illustrative Example 9.4.
This revenue will offset the expenses incurred to perform the research in the
restricted research fund and Help For All will be able to assess the net costs to con-
duct this research activity.
3. Help For All receives $2,000 as an endowment contribution. Help For All makes
Cash 2,000
Revenue—Endowment Fund 2,000
An endowment contribution received is revenue to the endowment fund. This is

often useful information to the not-for-profit organization in evaluating a fund-
raiser’s ability to generate endowment funds. Unlike the deferral method, which
does not recognize this as revenue, the restricted fund method acknowledges the
increase in economic benefit.
The return on this money will then be accounted for based on the restrictions
of the contribution. If interest is earned on the endowment fund at 4% annually
and there are no restrictions on this money, then Help For All makes the following
entry at year end:
Cash 80
Interest Revenue—General Fund 80
(.04 2,000)
If the interest must be spent on a future event, and there is no separate fund for that
event, then Help For All makes the following entries:
Cash 80
Deferred Revenue—General Fund 80
It the interest must be added to the endowment received, Help For All makes the
following entry at year end:
Cash 80
Revenue—Endowment Fund 80
If the interest must be used to fund research, which is a separate restricted fund,
Help For All makes the following journal entry at year end:
Cash 80
Revenue—Restricted Research Fund 80
4. Help For All receives $2,000 to buy a printer at a later date. Help For All maintains
a separate capital asset fund. Help For All makes the following entry:
Cash 2,000
Revenue—Capital Asset Fund 2,000
When the printer is purchased, Help For All makes the following entry:
Printer—Capital Asset Fund 2,000
Cash 2,000
If we assume that the printer has a two-year life, then Help For All will make the
following entries in each of the next two years:
Depreciation Expense—Printer; Capital Asset Fund 1,000
Accumulated Depreciation—Printer; Capital Asset Fund 1,000
The depreciation expense is an expense of the capital asset fund in this example.
5. Help For All receives $2,000 to buy land next to its current premises. The land
does not depreciate. Help For All maintains a capital fund. As such the contribu-
tion is considered revenue to the capital fund. It makes the following entry:
Cash 2,000
When the land is acquired, Help For All makes the following journal entry:
Land 2,000
Cash 2,000
The contribution is considered revenue to the capital asset fund even though it
does not depreciate.
6. Help For All receives a contribution of $2,000 to repay the mortgage, which
has a remaining life of 10 years. Help For All maintains a capital fund. Since the
mortgage was assumed in order to acquire capital assets, Help For All makes the
following entry:
Cash 2,000
Revenue—Mortgage; Capital Asset Fund 2,000
If the debt were used to purchase land, the original entry would have been revenue
of the capital fund as well.
If the debt is taken out for general operating activities, and not to acquire any
particular asset, the not-for-profit organization considers the activities that the debt
will finance and matches the revenue with the expenses of that activity in the same
period. A summary of the deferral method and the restricted fund method are pro-
vided in the CICA Handbook, Part III, as shown in Illustration 9.5.
Illustration 9.5
Organization following the deferral method
CICA Handbook, Part III,
Section 4410
Endowment Restricted Unrestricted

contribution contribution contribution
For expenses For expenses For the For the

of the of a purchase of a repayment of
current period future period capital asset debt
Recognize as Recognize as Defer and recognize Defer contribution Recognize based on Recognize
direct increase revenue as revenue in the and recognize as purpose of the debt as revenue
in net assets (paragraph same period the revenue on the (paragraphs (paragraph
(paragraph 4410.45) expenses are same basis as 4410.38–.40) 4410.47)
4410.29) recognized amortization expense
(paragraph (paragraph 4410.33).
4410.31) If capital asset will
not be amortized,
recognize as direct
increase in net assets
(paragraph 4410.34)
Organization following the restricted fund method
Endowment contribution Restricted contribution Unrestricted contribution
For which there For which is

is an appropriate not an appropriate
restricted fund restricted fund
Recognize as revenue of Recognize as revenue of the Recognize in the general fund Recognize as revenue
the endowment fund appropriate restricted fund in accordance with the deferral of the general fund
(paragraph 4410.60) (paragraph 4410.62) method (paragraph 4410.65) (paragraph 4410.68)
Specific Not-for-Profit Transactions 471
✓ LEARNING CHECK
• Not-for-profit organizations have the option of selecting the deferral method or the restricted
fund method to record contributions.
• Under the deferral method, restricted contributions are recorded as revenue in the same period
as the related expense is recorded.
• Under the restricted fund method, the not-for-profit organization creates, at least, a general
fund and an endowment fund.
• Under the restricted fund method, contributions to the restricted funds are considered
revenues to those funds. Unrestricted contributions are revenues to the general fund.
SPECIFIC NOT-FOR-PROFIT
TRANSACTIONS
Objective 4 The AcSB recognizes that, based on the nature of a not-for-profit organization, there may be
Record specific unique transactions that affect its reporting. In this section we examine some specific issues
transactions unique related to a not-for-profit organization.
to not-for-profit
organizations.
Inventories Held by Not-for-Profit Organizations
Section 3032 addresses specific issues with respect to inventory that the not-for-profit orga-
nization receives. The CICA Handbook, Part II provides the general guidance for the valua-
tion and presentation of inventory. A company records the inventory at its fair value, which
would normally be the amount paid. The difficulty for a not-for-profit organization is that if
the inventory is contributed, it may be difficult to assess the value. Specifically, Section 3032
addresses the following circumstances:
1. Recognition and measurement of inventory that has been contributed
2. Recognition and measurement of inventory that will be distributed at no charge or for a
nominal charge
Recognition of Contributed Inventory

A not-for-profit organization is not required to record materials or services that are donated
to it. In fact, it can only recognize materials or services if the fair value can be reasonably
estimated and when the materials and services are used in the normal course of the organiza-
tion’s operations and would otherwise have been purchased (4410.16). If the not-for-profit
organization records the inventory, it measures it at fair value at the date of the contribu-
tion. For example, a not-for-profit soup kitchen may have received vegetables from a local
farmer at no cost. The soup kitchen may choose not to recognize the vegetables or, since a
fair value can be determined and the vegetables are used in the normal course of its opera-
tions, it may choose to recognize the vegetables at fair value. The soup kitchen would make
Inventory—Vegetables Fair value
Revenue—Contribution Fair value
A not-for-profit organization typically will not recognize the value of volunteers when it is
heavily reliant on volunteer services. In keeping with the cost-benefit principle, generally, the
cost necessary to determine the fair value is considered to be greater than the benefit to be
derived from reporting the fair value.
Inventories to Be Distributed at No Charge

When the not-for-profit organization distributes inventory at no charge or at a nominal
charge, it measures the inventory (if it has decided to recognize the inventory) at the lower of
cost and current replacement cost. The logic is that since the not-for-profit is giving away the
inventory, there is no relation to the organization’s ability to generate cash flows. As such, the
benefit of the inventory is the amount that the organization saved if it would have to replace
this inventory so as to complete its objective.
We need to re-examine the soup kitchen, which generally gives away free meals or
charges a nominal fee. If this organization chooses to recognize the vegetable inventory, it
would record it at the cost to replace this inventory since it needs the vegetables to continue
to provide meals to those who need it.
Tangible Capital Assets and Intangible Assets

Held by Not-for-Profit Organizations
Not-for-profit organizations basically follow the same criteria as profit-oriented companies
with respect to the recognition and measurement of tangible capital assets and intangibles;
that is, they are capitalized at cost and then amortized. Or, in the case of land or an intan-
gible that has a non-determinable life, at cost. If the capital asset is contributed, or if the
organization purchases the asset at an amount significantly below fair value, cost is consid-
ered to be the fair value at the date of the contribution. If in the rare circumstance that the
fair value cannot be determined, the capital asset is recorded at a nominal value.
When an asset is to be constructed, the contribution of labour is measured at the fair
value of that labour. We see in Illustration 9.6 that Centraide discloses the policy with respect
to its capital assets.
Illustration 9.6
Fixed assets
Fixed assets are recorded at cost. Amortization is based on their estimated useful lives using the
Statements of Centraide
straight-line method over the following periods:
of Greater Montreal
Regarding Fixed Assets Building 40 years
Furniture and equipment 8 years
Computer equipment 4 years
Fixed assets
2011 2010
Accumulated
Cost amortization Net book value Net book value
$ $ $ $
Building 6,240,918 1,466,275 4,774,643 3,806,937
Furniture and equipment 619,586 525,864 93,722 126,502
Computer equipment 2,124,943 1,989,190 135,753 199,227
8,985,447 3,981,329 5,004,118 4,132,666
During the year, the purchase of fixed assets totalled $1,149,267 ($42,058 in 2010).
Capital assets and intangibles with a limited life are amortized over the useful life to the orga-
nization. If the organization uses fund accounting, it decides which fund should be allocated
the amortization. The not-for-profit organization does not have to allocate the amortization
to the capital asset fund. It may decide to allocate to the general fund as an expression that
amortization is a cost of running the operations. Under the CICA Handbook, Part III, the
not-for-profit organization follows Part II with respect to intangible assets and goodwill. Of
particular concern to the organization is that the Handbook specifically requires all promotion
and advertising costs to be expensed immediately. If an organization is planning a fundrais-
ing activity and advertises in a local newspaper for $2,000 to encourage people to attend,
it is required to expense those costs immediately. It cannot defer these costs until the event
occurs. The entry would be as follows:
Advertising Expense 2,000
Cash 2,000
Exemption from Capitalization

Section 4431 allows for an important exception for not-for-profit organizations to the
requirements of capital asset recognition. If the organization’s average annual revenues rec-
ognized in the statement of operations for the current and preceding period are less than
$500,000, it does not have to capitalize and depreciate its capital assets. This exception is pre-
mised on the cost-benefit principle. An organization with revenues less than $500,000 would
be considered a small operation. This organization may not derive much benefit from capi-
talizing capital assets and then depreciating them. It may be much more interested in cash
flow. As such it is allowed to immediately expense these costs, or to capitalize these assets and
not depreciate them. Consider the example where a local theatre group buys a photocopy
machine to distribute flyers for advertising events. This organization receives contributions
of approximately $60,000 annually. The cost of the printer is $1,200. The theatre group
decides to expense the cost of the printer immediately.
Office Expense 1,200
Cash 1,200
If the not-for-profit organization subsequently has revenues more than $500,000, it must
begin to capitalize and depreciate assets going forward. If the revenues then fall below
$500,000 again, the organization still continues to capitalize and depreciate assets. The
exception is no longer available to it.
Note that the $500,000 revenue threshold exemption also applies to intangible assets
held by a not-for-profit organization. A small organization would not have to capitalize and
amortize intangible assets that it may own. For example, a local theatre group may own the
rights to a local playwright’s copyrighted material. This group would not have to capitalize
the costs they incurred to buy the copyright if its revenues are less than $500,000 per year.
Impairment
The CICA Handbook, Part III requires a not-for-profit organization to follow this section of
the Handbook rather than Part II with respect to impairments. Under Part III, the organization
writes down the capital asset or intangible asset when the asset no longer has any long-term
service potential to the organization. At that point, the carrying amount is written down to
its residual value. Once the asset is written down, it cannot be reversed. It is possible that the
organization has deferred revenue that corresponds to that asset that is impaired. The orga-
nization recognizes the revenue for the amount of the impairment. Illustrative Example 9.6
examines the accounting for an impairment of capital assets.
Illustrative Example 9.6 Impaired Capital Asset

Worldsave is a Canadian not-for-profit organization committed to providing food
in countries faced with famine. Worldsave received a warehouse from a donor on
January 1, 2010, to store goods in the Sudan that were intended for distribution to local
communities. At the time of receipt, the warehouse’s fair value was $48,000 and it was
determined that the warehouse had a useful life of 10 years. On December 31, 2013,
the Worldsave board of directors decided to leave the Sudan and concentrate efforts
in Ethiopia. They believe that the warehouse could be given to local companies but do
not anticipate receiving any funds for it. Worldsave would make the following journal
entries assuming it uses the deferral method of accounting:
January 1, 2010
Cash 48,000
Warehouse—Capital Asset 48,000
Cash 48,000
In each of the years December 31, 2010, December 31, 2011, December 31, 2012,
and December 31, 2013:
Accumulated Depreciation—Warehouse 4,800
$48,000/10 years $4,800 per year
Revenue 4,800
Since four years has passed, the total revenue recognized is $19,200 and $28,800
remains deferred.
December 31, 2013:
Loss on Impairment of Warehouse 28,800
Accumulated Depreciation—Warehouse 19,200
($48,000/10 years 4,800 per year 4 years $19,200)
Warehouse 48,000
This entry is made to impair the warehouse to its residual value, which is 0.
Revenue 28,800
This entry is made to record the amount of revenue on the impaired asset equal to the
impairment.
Collections
A not-for-profit organization may have works of art and historical treasures that have a vir-
tually unlimited life as long as the asset is properly cared for. The CICA Handbook, Part III
recognizes these unique capital assets as requiring different reporting than may be given for
land or buildings. Works of art and historical treasures are those that have cultural, aesthetic,
or historical value that is worth preserving perpetually (4431.21). These are referred to as
collections in Part III. In order for these items to be classified as collections, the organiza-
tion must show a commitment to protecting and preserving them. It is acting as a custodian
for the public interest. Handbook Section 4440.03 states:
Collections are works of art, historical treasures or similar assets that are:
(i) held for public exhibition, education or research;
(ii) protected, cared for and preserved; and
(iii) subject to an organizational policy that requires any proceeds from their sale to be used
to acquire other items to be added to the collection or for the direct care of the existing
collection.
A strong indicator that an organization is holding a collection is a written policy that
states that any funds received on sales of any of the items are to be reinvested in acquiring
other items for the collection or for the maintenance of the remaining items.
The difficult aspect in presenting these collections is valuation. These items are usually
received as a contribution and as such the organization does not have the benefit of an arm’s-
length transaction to determine fair value. Part III allows a not-for-profit organization to
not record any cost for these collections. The organization decides whether the benefit to be
derived from the fair value outweighs the cost to determine the fair value.
We can see in Illustration 9.7 that the Canadian Museum of Civilization in Ottawa
received a new item in its collection. The museum decided to record items contributed for a
collection at the nominal value of $1.
Illustration 9.7
2010–2011 Highlights
Excerpts from the 2011
Financial Statements Collections
of the Canadian Museum When King Edward VIII unveiled the Canadian National Vimy Memorial on July 26, 1936, he was
of Civilization wearing a Royal Canadian Legion Vimy Pilgrimage Medal. This year, the War Museum acquired that
historic medal, which symbolized the King’s admiration and respect for Canada’s great achievement
and sacrifice at Vimy Ridge.
Significant accounting policies

Collection: The artifact collection forms the largest part of the assets of the Corporation and is
presented in the balance sheet at a nominal value of $1, due to the practical difficulties of determin-
ing a meaningful value for these assets. Objects purchased for the collection of the Corporation are
recorded as an expense in the year of acquisition. Objects donated to the Corporation are recorded, as
assets, at a nominal value.
Notes to the financial statements

Collection: The Corporation maintains the material culture collections of artifacts, objects, specimens,
and their related information. These collections are developed by various research areas within the
Corporation. The collections are divided into the following eight discipline-related groups:
Ethnology—ethnographic and fine art collections principally related to North American First Peoples in
post-European contact
Folk Culture—folk culture and fine craft collections illustrating the diversity of cultural influences on
Canadian culture
History—collections which illustrate the experience of the common person as well as famous
Canadians
Canadian Postal Museum—collections of philatelic, artwork, and material culture which serve to illus-
trate the role of postal communication in defining and shaping a nation
Canadian Children’s Museum—collections which emphasize intercultural understanding and experience,
as well as supporting a rich animation programme
Living History—collection of properties, costumes, and didactic resources which are used by animators,
educators and other staff to promote and enliven the Museum’s programming
Canadian War Museum—collections of weapons and technological artifacts illustrating the development
of military technologies, dress and insignia collections of uniforms, medals, accoutrements, and rega-
lia of the Canadian Armed Forces and its allies, and war art collections of paintings, drawings, prints,
and sculptures from the Canadian War Artist programmes and modern art works illustrating Canadian
Peacekeeping efforts
Archaeology—archaeological collections of material culture, physical anthropology, flora, and fauna

recovered from dig sites and principally illustrating indigenous North American culture prior to
European contact
Strategic Investments Held by

Not-for-Profit Organizations
In module 1 of this textbook, we examined the accounting and reporting for strategic invest-
ments for profit-oriented companies. If the not-for-profit organization elects to follow the
CICA Handbook, Part III, it is not to follow Part II of the Handbook with respect to strategic
investments. Rather, the organization adopts section 4450 of Part III. There is an impor-
tant reason for this. Remember that for profit-oriented companies, the company deter-
mines whether it has control, significant influence, or joint control over an investee. The
criteria for control under ASPE (Part II) is based largely on the company’s ability to control
the board of directors through a majority of voting shares. A not-for-profit organization is
usually formed without a transferable ownership interest and therefore the criteria to deter-
mine control under ASPE would not work for not-for-profit organizations.
Not-for-profit organizations may invest in profit-oriented entities, other not-for-profit
entities, or other economic interests. The CICA Handbook, Part III defines an economic
interest as an organization:
1. that holds resources that must be used to produce revenue or provide services for the
reporting organization or
2. whose liabilities the reporting organization is responsible for (4450.02f).
The Handbook describes the following indicators of an economic interest:
(a) The other organization solicits funds in the name of and with the expressed or
implied approval of the reporting organization, and substantially all of the funds
solicited are intended by the contributor or are otherwise required to be transferred
to the reporting organization or used at its discretion or direction;
(b) The reporting organization transfers significant resources to the other organiza-
tion, whose resources are held for the benefit of the reporting organization;
(c) The other organization is required to perform significant functions on behalf of the
reporting organization that are integral to the reporting organization’s achieving
its objectives; or
(d) The reporting organization guarantees significant liabilities of the other organiza-
tion (4450.10).
The organization would consider whether the entity is required to transfer resources to or
perform significant functions for the organization.
Control
The not-for-profit organization must determine if it controls the other entity. There is a pre-
sumption that control exists if the organization has the right to appoint the majority of the other
entity’s board of directors. What is unique to the not-for-profit organization is the manner in
which it obtains this right. When two organizations have the same board of directors, the pre-
sumption is that one organization controls the other. It is very common for a not-for-profit orga-
nization to create a separate entity to hold its investments and major capital assets. This entity is
often referred to as the foundation, which was introduced at the beginning of the chapter.
For example, Lindsay School, a private school, may be one not-for-profit organization
and there might also be a Lindsay School Foundation set up as a separate not-for-profit orga-
nization. This is done for various reasons, mainly having to do with obtaining government
grants and fundraising. If both of these organizations have the same board of directors, it is
presumed that Lindsay School controls Lindsay School Foundation. The presumption of
control could be overcome if there is clear evidence that control does not exist.
When there is no specific right to appoint the board of directors, the organization looks
at other characteristics of its relationship with the other entity to determine whether or not it
controls it. The following examples of other indicators are provided in 4450.06:
(a) a significant economic interest in the other organization;
(b) provisions in the other organization’s charter or bylaws that cannot be changed
without the reporting organization’s consent and that limit the other organization
to activities that provide future economic benefits to the reporting organization; or
(c) the other organization’s purpose is integrated with that of the reporting organiza-
tion so that the two organizations have common or complementary objectives.
If an entity is only able to raise funds and transfer them exclusively to the other organiza-
tion, the economic interest may be so significant that the organization may have control
even without the ability to appoint the majority of the other entity’s board of directors. In
the Lindsay School example above, if the Foundation is only able to raise funds for Lindsay
School (which is likely the case), then Lindsay School would have control even if the board of
directors had different members.
Significant Influence
In the case that control does not exist, the not-for-profit organization may be able to exercise
significant influence over the strategic operating, financing, and investing activities of the
other entity. The criteria are similar to that under ASPE. The organization looks at the fol-
lowing factors:
1. Representation on the board of directors
2. The existence of an economic interest
3. Participation in policy-making processes
4. Material inter-entity transactions
5. Interchange of managerial personnel (4450.09).
A temporary ability to affect the other entity’s strategic policies would not be considered
significant influence.
The fact that a not-for-profit organization relies on another entity for resources does not
in itself imply that the entity has control or significant influence over the organization. For
example, many organizations rely on government funding to exist; however, the government
is not considered to control or significantly influence the organization.
Presentation
Control. The organization has options for presenting controlled investments, which are differ-
ent options than those available under ASPE. The CICA Handbook, Part III distinguishes between
controlled profit-oriented organizations and controlled not-for-profit organizations. A private
plastic surgery clinic may control the coffee shop in the building, which is a profit-oriented orga-
nization, and it may also control another local clinic, which is a not-for-profit organization.
Section 4450.30 provides the following regarding controlled profit-oriented organizations:
An organization should report each controlled profit-oriented enterprise in either of the
following ways:
(a) by consolidating the controlled enterprise in its financial statements; or
(b) by accounting for its investment in the controlled enterprise using the equity method
and providing the disclosure set out in paragraph 4450.32.
Section 4450.14 provides the following regarding controlled not-for-profit organizations:
An organization should report each controlled not-for-profit organization in one of the
following ways:
(a) by consolidating the controlled organization in its financial statements;
(b) by providing the disclosure set out in paragraph 4450.22; or
(c) if the controlled organization is one of a large number of individually immaterial
organizations, by providing the disclosure set out in paragraph 4450.26.
Section 4450.22 provides the following regarding the required disclosure if the organization
is not consolidated:
(a) total assets, liabilities and net assets at the reporting date;
(b) revenues (including gains), expenses (including losses) and cash flows from operat-
ing, financing and investing activities reported in the period;
(c) details of any restrictions, by major category, on the resources of the controlled orga-
nizations; and
(d) significant differences in accounting policies from those followed by the reporting
organization.
Joint ventures. Part III provides an organization with the option of reporting a joint ven-
ture either using proportionate consolidation or the equity method. Regardless of which
method is chosen, the organization is required to provide additional note disclosure.
Related-Party Transactions
The disclosure requirements for related-party transactions are basically the same as those for
a profit-oriented company. The definition is adjusted to include entities where one has an
economic interest in the other.
Section 4460.04 of the CICA Handbook, Part III provides guidance on the identification
of a related party:
(a) an entity that directly, or indirectly through one or more intermediaries, controls,
or is controlled by, or is under common control with, the reporting organization;
(b) an individual who directly, or indirectly through one or more intermediaries, con-
trols the reporting organization;
(c) an entity that, directly or indirectly, is significantly influenced by the reporting
organization or has significant influence over the reporting organization or is
under common significant influence with the reporting organization;
(d) the other organization when one organization has an economic interest in the other;
(e) management: any person(s) having authority and responsibility for planning, direct-
ing and controlling the activities of the reporting organization. (Management would
include the directors, officers and other persons fulfilling a senior management function.)
(f ) an individual that has either significant influence or joint control over the reporting
organization;
(g) members of the immediate family of individuals described in paragraphs (b), (e)
and (f). (Immediate family comprises an individual’s spouse and those dependent on
either the individual or the individual’s spouse.);
(h) the other party, when a management contract or other management authority
exists and the reporting organization is either the managing or managed party; and
(i) any party that is subject to joint control by the reporting organization (In this
instance a party subject to joint control is related to each of the venturers that share
that joint control. However, the venturers themselves are not related to one another
solely by virtue of sharing of joint control.).
Illustration 9.8 contains a disclosure by Centraide of Greater Montreal regarding related-
party transactions.
Illustration 9.8
Related party transactions
Statements of Centraide Fondation Centraide du Grand Montréal, a related organization, is a registered charity incorporated
of Greater Montreal under Part III of the Companies Act (Quebec) where the goal is to collect donations, legacies, or other
Regarding Related-Party contributions, manage its assets and give all net proceeds generated by the capital without expending
Transactions any portion thereof to Centraide of Greater Montreal. The net assets of Fondation Centraide du Grand
Montréal total $28,674,888 as at March 31, 2011 ($25,944,717 in 2010), revenue amounted to
$3,621,259 ($5,501,521 in 2010), and expenses including donations to Centraide of Greater Montreal
amounted to $891,088 ($1,399,648 in 2010).
During the year, the transactions between Centraide of Greater Montreal and Fondation Centraide du
Grand Montréal were:
2011 2010
$ $
Revenue
Donations Capital Asset Fund — 600,000
Donations Operating Fund Annual campaign 500,000 500,000
Administrative fees presented in deduction of fundraising, communication, 9,000 9,000
and administrative costs
In the other assets balance, an amount of nil ($607,498 in 2010) is receivable from Fondation
Centraide du Grand Montréal.
The balance of accounts payable and accrued liabilities include an amount of $48,778 ($77,729 in
2010) due to Fondation Centraide du Grand Montréal.
These transactions were made in the normal course of operations and have been recorded at the ex-
change amount, which is the amount of consideration established and agreed to by the parties.
Allocated Expenses by Not-for-Profit Organizations

Section 4470 of the CICA Handbook, Part III is the newest section to be added to the specific
not-for-profit reporting. This section is only relevant for organizations that have chosen to
separate their financial statements by function. For example, in Illustration 9.2 we see that
Centraide of Greater Montreal has highlighted two functions:
• fundraising, communication, and administrative costs, and
• allocations to agencies and assistance to agencies, social research, and community services.
Some expenses contribute to or produce the output of more than one function. For Centraide,
some of the fundraising expenses are incurred to generate revenues to support agencies
and some fundraising expenses are used to provide revenue for community services. The
not-for-profit organization may consider it important information to the reader to allocate
these common costs to the specific functions. An incident in Canada caused a great deal of
uproar when donors heard that the administrative costs to put on a walk to raise money for
cancer were greater than the revenues earned. The financial statements did not reflect this
fact as the administrative costs were not allocated to the walk for cancer activity. We have
also heard of charity fundraising concerts that do not actually net any profit for the charity.
To prevent this lack of transparency, a not-for-profit organization is able to allocate these
administrative costs to the specific functions. Illustration 9.9 contains the note disclosure that
Centraide of Greater Montreal has provided to inform the reader of how its expenses were
allocated to the various functions.
Illustration 9.9
Allocated expenses
Expenses are accounted for in the statement of operations of the Operating Fund and are allocated
Statements of Centraide
as follows:
of Greater Montreal
Regarding Allocated Assistance to
Expenses Fundraising, agencies, social
communication and research and
administrative costs community services
% %
Annual campaign and Major donors 100 —

Allocation and Effect in the community — 100
Communication 85 15
General management 60 40
Administration 75 25
Expenses related to each function include all direct costs related to this function, including salaries and
other direct charges, and a portion of shared and indirect costs.
When shared or indirect costs are related to more than one function, such as the management and ad-
ministration of these activities, Centraide of Greater Montreal allocates these costs among the functions.
These costs include payroll and other expenses that cannot be directly charged to specific activities.
These expenses are allocated among the functions according to the percentage of direct costs attribut-
able to each function.
The financial statements do not include the cost of services rendered by individual volunteers and staff
loaned to Centraide of Greater Montreal by businesses and public institutions.
Allocated expenses
As provided in Note 2, on accounting policies, the expenses related to a number of functions are
allocated as follows:
Assistance to
Fundraising, agencies, social
communication and research and
administrative costs community services Total
$ $ $
Annual campaign and Major donors 2,685,619 — 2,685,619

Allocation and Effect in the community — 1,662,980 1,662,980
Communication 1,053,053 185,833 1,238,886
General management 1,473,696 982,464 2,456,160
Administration 1,736,073 578,691 2,314,764
6,948,441 3,409,968 10,358,409
Handbook Section 4470.A3 provides guidance as to how an organization may perform this
allocation. Expense allocation may be based on:
(a) time—on the basis of hours incurred directly in undertaking a function;
(b) usage—on the basis of measured or estimated consumption attributable to the function;
(c) per capita—on the basis of the number of people employed within a function; and
(d) space—on the basis of floor area occupied by a function.
For example, rent of a building may be allocated to each function based on the space that it
uses in the building or it may be based on the number of people employed in each of those
functions. The salary of a secretary in the fundraising department may be allocated based on
the time he or she spends on each function.
✓ LEARNING CHECK
• The CICA Handbook, Part III includes sections that deal with issues of particular interest to a
not-for-profit organization.
• Valuation of contributed assets such as inventory, capital assets, or intangible assets is
generally difficult since a contribution lacks the arm’s-length valuation of fair value.
• Not-for-profit organizations generally have the option of determining a fair value at the day
of receipt or recording it at a nominal value if it is materials or services.
• Not-for-profit organizations reflect capital assets and intangibles at the fair value at the
transaction date.
• Not-for-profit organizations determine control based on the ability to control the board
of directors of the other entity. This ability is achieved in various ways other than through
voting shares.
• Not-for-profit organizations require additional disclosure with respect to strategic investments,
related party transactions, and allocated expenses.
Comprehensive Illustrative Example 9.1 Financial

Statement of a Not-for-Profit Organization
Quality of Life (QOL) is a not-for-profit organization formed on January 1, 2013. The
organization’s motto is “local is global.” QOL was formed to help people who live
in hospices obtain additional materials and services in order to improve their qual-
ity of life. The organization is funded largely by the federal government and private
donations through funds, goods, and services. QOL has created a significant network
of local offices that recruit volunteers and provide pets, MP3 players, computers, cell
phones, and any other needs identified. It is also involved in training professionals,
raising awareness of needs in the local community hospices, and working with schools
and clubs to increase commitments. During 2013, the following transactions occurred:
1. QOL was awarded a grant of $2 million from the federal government. Of that,
$1 million was provided for office space: an estimated $650,000 to acquire a head
office in Toronto, and $350,000 to cover rent in the other cities for local branches
for the next two years. The remaining $1 million is given to fund operations for
the year. The first instalment of the operating grant, $500,000, was received imme-
diately and the other half will be received on January 1, 2014. In order to receive
the second instalment, QOL must show that it spent the $500,000 in pursuit of its
mission by September 30, 2013.
2. QOL bought a building in downtown Toronto for $740,000. The property’s actual
fair value is $860,000 but the owner sold it for a lower amount since he is commit-
ted to the cause. The building is expected to have a 20-year life.
3. QOL paid salaries of $150,000 for office personnel during the year, $105,000 for a
fundraiser hired to raise funds for endowments and yearly operations, and $175,000
for the executive director.
4. QOL paid $25,000 to train volunteers in an effort to improve the services in the
hospices.
5. QOL held a marathon at the end of August in each city. It incurred costs of
$45,000 and raised $80,000 in donations. The contributions on these marathons
are restricted by the donors for the “Furry Friends” project to provide pets to visit
hospice patients.
6. The annual campaign, which began in September and ended in December, yielded
pledges of $482,000, of which $367,000 had been collected by year end.
7. QOL has decided to allocate $10,000 of the general fund to the Furry Friends pet
project as seed money for the project. QOL also used $90,000 cash of the general
fund to acquire the head office building.
8. The QOL fundraiser secured a major endowment of $450,000 on October 1, 2013,
from an individual whose relative had spent several months in a hospice affiliated
with QOL. The interest on the endowment can be used at QOL’s discretion. The
funds were invested in government bonds. The bonds pay an annual interest of 4%.
9. QOL uses fund accounting and is required to create separate funds for capital
assets, endowments, and the Furry Friends pet project.
Required
(a) Prepare the journal entries for QOL for 2013 assuming the organization uses the:
1. deferral method.
2. restricted fund method.
(b) Prepare the financial statements of QOL for the year ended December 31, 2013,
assuming that QOL uses fund accounting for both the deferral method and the
restricted fund method.
Solution
Journal entries using the deferral method of accounting:
1. Cash 1,000,000
Deferred Revenue—Capital Asset Fund 650,000
Deferred Revenue—General Fund 350,000
The receipt of $1 million is deferred initially; $650,000 is restricted for the pur-
chase of a building (see point 3) and $350,000 is deferred until the rent is incurred.
If we assume that QOL actually incurred rent costs of $122,000 in the various
locations during 2013, QOL makes the following entries:
Rent Expense 122,000
Cash 122,000
Revenue—Government Grant 175,000
Since the grant is for rent for two years, QOL would recognize half of the grant in
the first year ($350,000/2 $175,000). (An assumption is made that QOL does not
have to return any excess funds to the government.) This revenue is recognized in
the general fund to offset the rent, which has also been allocated to the general fund.
2. Cash 500,000
Government Grant Receivable 500,000
Revenue—Government Grant 1,000,000
QOL records the grant for operations. The second instalment of $500,000 is
accrued since QOL can establish the amount and has reasonable assurance of
receiving the amount since it has met the criteria. At December 31, 2013, QOL
knows that it has fulfilled the requirements for the second instalment.
3. Building—Capital Asset Fund 860,000
Cash 740,000
Deferred Contribution—Capital Asset Fund 120,000
Deferred Contribution—Capital Asset Fund 32,500
($650,000/20)
Deferred Revenue—Capital Asset Fund 6,000
($120,000/20)
($860,000/20)
QOL records the acquisition of the capital asset at its fair value at the day of acqui-
sition. The difference between the fair value and the amount paid is a contribution.
This contribution, as well as the government grant, which is for a capital asset, is
recorded in income as the building is depreciated. In this particular case, the depre-
ciation is allocated to the capital asset fund but QOL could have decided to allocate
to the general fund as a cost of operations.
4. Salaries Expense—General Fund 380,000
($150,000 $55,000 $175,000)
Salaries Expense—Endowment Fund 50,000
Cash—General Fund 380,000
Cash—Endowment Fund 50,000
QOL has decided that $50,000 of the fundraiser’s salary should be allocated to the
endowment fund activity based on the amount of time spent on this activity. The
balance is considered to be a general cost of operations.
5. Training Expense 25,000
Cash 25,000
This is a cost of the general fund in the current period since QOL has not identi-
fied the training as a separate activity.
6. Marathon Expense—Pet Project Fund 45,000
Cash 45,000
Cash 80,000
Marathon Revenue—Pet Project Fund 45,000
Deferred Revenue—Pet Project Fund 35,000
QOL records the funds received and disbursed for Furry Friends in a separate fund
call the Pet Project. Since all of the expenses have been incurred, the revenues
equal to the expenses are recorded in income. The balance is deferred until the pets
are acquired for the hospices.
7. Cash 367,000
Revenues—Donations 367,000
QOL recognizes revenue when it is received rather than when it is pledged since
QOL has no experience with an annual campaign and does not have reasonable
assurance that it will receive the balance of $115,000. It records the entire amount
as income since there are no restrictions on the funds received.
8. Net Assets—General Fund 100,000
Cash—Capital Asset Fund 90,000
Cash—Pet Project Fund 10,000
Net Assets—Capital Asset Fund 90,000
Net Assets—Pet Project Fund 10,000
QOL transfers $90,000 to the capital asset fund to complete the payment for the head
office building and $10,000 to the pet project to provide seed money for Furry Friends.
9. Cash 450,000
Net Assets—Endowment Fund 450,000
Accrued Interest Receivable 4,500
($450,000 .04 3/12)
QOL records the endowment received as a direct increase in net assets. QOL has
the ability to use the interest earned in the general operations and therefore records
it as revenue to the general fund.
Journal entries using the restricted fund method of accounting:

1. Cash 1,000,000
Revenue—General Fund 350,000
The $650,000 is restricted for the purchase of a depreciable capital asset for which
there is a separate fund and therefore it is recorded as revenue to the capital asset
fund. The $350,000 is deferred until the rent is incurred since it is a cost of the gen-
eral fund and deferral accounting is used if there is no separate fund. If we assume
that QOL actually incurred rent costs of $122,000 in the various locations during
2013, QOL makes the following entries:
Rent Expense 122,000
Cash 122,000
Revenue—Government Grant 175,000
Since the grant is for rent for two years, QOL would recognize half of the grant in
the first year ($350,000/2 $175,000). This revenue is recognized in the general
fund to offset the rent, which has also been allocated to the general fund.
2. Cash 500,000
Government Grant Receivable 500,000
Revenue—Government Grant 1,000,000
QOL records the grant for operations. The second instalment of $500,000 is
accrued since QOL can establish the amount and has reasonable assurance of
receiving the amount since it has met the criteria. At December 31, 2013, QOL
knows that it has fulfilled the requirements for the second instalment.
3. Building—Capital Asset Fund 860,000
Cash 740,000
($860,000/20)
QOL records the acquisition of the capital asset at its fair value at the day of acqui-
sition. The difference between the fair value and the amount paid is a contribution.
This contribution, as well as the government grant, which is for a capital asset, is
recorded in income to the capital asset fund. In this particular case, the deprecia-
tion is allocated to the capital asset fund but QOL could have decided to allocate to
the general fund as a cost of operations.
4. Salaries Expense—General Fund 380,000
($150,000 $55,000 $175,000)
Salaries Expense—Endowment Fund 50,000
QOL has decided that $50,000 of the fundraiser’s salary should be allocated to the
endowment fund activity based on the amount of time spent on this activity. The
balance is considered to be a general cost of operations.
5. Training Expense 25,000
Cash 25,000
This is a cost of the general fund in the current period since QOL has not identi-
fied the training as a separate activity.
6. Marathon Expense—Pet Project Fund 45,000
Cash 45,000
Cash 80,000
Marathon Revenue—Pet Project Fund 80,000
QOL records the funds received and disbursed for Furry Friends in a separate fund call
the Pet Project. In this case, we assume that the Pet Project is an externally required
restricted fund. As such the funds received are revenues to the Pet Project fund.
7. Cash 367,000
Revenues—Donations 367,000
QOL recognizes revenue when it is received rather than when it is pledged since
QOL has no experience with an annual campaign and does not have reasonable
assurance that it will receive the balance of $115,000. It records the entire amount
as income since there are no restrictions on the funds received.
8. Net Assets—General Fund 100,000
Cash—Capital Asset Fund 90,000
Cash—Pet Project Fund 10,000
Net Assets—Capital Asset Fund 90,000
Net Assets—Pet Project Fund 10,000
QOL transfers $90,000 to the capital asset fund to complete the payment for the
head office building and $10,000 to the pet project to provide seed money for Furry
Friends.
9. Cash 450,000
Revenue—Endowment Fund 450,000
Accrued Interest Receivable 4,500
($450,000 .04 3/12)
QOL records the endowment received as income to the endowment fund. QOL
has the ability to use the interest earned in the general operations and therefore
records it as revenue to the general fund.
It is useful to compare the journal entries.
Transaction The Deferral Method The Restricted Fund Method

QOL was awarded a grant of $2 million Cash 1,000,000 Cash 1,000,000
from the government; $1 million was Deferred Revenue—Capital Asset Revenue—Capital Asset Fund
provided for office space: an estimated Fund 650,000 650,000
$650,000 to acquire a building, and Deferred Revenue—General Fund Revenue—General Fund
$350,000 to cover rent for the next 350,000 350,000
two years.
QOL actually incurred rent costs of Rent Expense 122,000 Rent Expense 122,000
$122,000 during 2013. Cash 122,000 Cash 122,000
Deferred Revenue—General Fund Deferred Revenue—General Fund
175,000 175,000
Revenue—Government Grant Revenue—Government Grant
175,000 175,000
($350,000 / 2 years $175,000) ($350,000 / 2 years $175,000)
The remaining $1 million is given to fund Cash 500,000 Cash 500,000
operations for the year. The first instal- Government Grant Receivable Government Grant Receivable
ment, $500,000, was received immedi- 500,000 500,000
ately and the other half will be received Revenue—Government Grant Revenue—Government Grant
on January 1, 2014. In order to receive 1,000,000 1,000,000
the second instalment, QOL must show
that it spent the $500,000 in pursuit of
its mission by September 30, 2013.
QOL bought a building for $740,000. Building—Capital Asset Fund Building—Capital Asset Fund
The property’s actual fair value is 860,000 860,000
$860,000 but the owner sold it for a Cash 740,000 Cash 740,000
lower amount since he is committed to Deferred Contribution Revenue—Capital
the cause. —Capital Asset Fund 120,000 Asset Fund 120,000
The building is expected to have a Deferred Contribution—Capital Asset
20-year life. Fund 32,500
Revenue—Capital Asset Fund
32,500
(650,000 /20)
Deferred Revenue—Capital Asset
Fund 6,000
Revenue—Capital Asset Fund
6,000
(120,000 /20)
Depreciation Expense Depreciation Expense
4,300 4,300
Accumulated Depreciation 4,300 Accumulated
(860,000 /20) Depreciation 4,300
(860,000 /20)
QOL paid salaries of $150,000 for Salaries Expense—General Salaries Expense—General Fund
office personnel during the year, and Fund 380,000 380,000
$175,000 for the executive director; (150,000 55,000 175,000) (150,000 55,000 175,000)
$55,000 is allocated for annual fun- Cash—General Fund Cash—General Fund 380,000
draising, and $50,000 for fundraising 380,000 Salaries Expense—Endowment Fund
for endowments. Salaries Expense—Endowment Fund 50,000
50,000 Cash—Endowment Fund 50,000
QOL paid $25,000 to train volunteers Training Expense—General Fund Training Expense—General Fund
in an effort to improve the services in 25,000 25,000
the hospices. Cash—General Fund 25,000 Cash—General Fund 25,000
QOL held a marathon at the end of Marathon Expense—Pet Project Marathon Expense—Pet Project Fund
August in each city. It incurred costs Fund 45,000 45,000
of $45,000 and raised $80,000 in Cash 45,000 Cash 45,000
donations. The contributions on these Cash 80,000 Cash 80,000
marathons are restricted by the donors Marathon Revenue—Pet Project Fund Marathon Revenue—Pet Project Fund
for the pet project. 45,000 80,000
Deferred Revenue—Pet Project Fund
35,000
The annual campaign yielded pledges Cash 367,000 Cash 367,000
of $482,000, of which $367,000 had Revenue—Donations 367,000 Revenue—Donations 367,000
been collected by year end.
QOL has decided to allocate $10,000 Net Assets—General Fund Net Assets—General Fund
of the general fund to the pet project 100,000 100,000
as seed money for the project. QOL also Cash—General Fund 100,000 Cash—General Fund 100,000
used $90,000 cash of the general fund Cash—Capital Asset Fund Cash—Capital Asset Fund
to acquire the head office building. 90,000 90,000
Cash—Pet Project Fund Cash—Pet Project Fund
10,000 10,000
Net Assets—Capital Asset Fund Net Assets—Capital Asset Fund
90,000 90,000
Net Assets—Pet Project Fund Net Assets—Pet Project Fund 10,000
10,000
The QOL fundraiser secured a major Cash 450,000 Cash 450,000
endowment of $450,000 on October Net Assets—Endowment Fund Net Assets—Endowment Fund
1, 2013, from an individual whose 450,000 450,000
relative had spent several months in Accrued Interest Receivable Accrued Interest Receivable
a hospice affiliated with QOL. The 4,500 4,500
interest on the endowment can be used Interest Revenue 4,500 Interest Revenue 4,500
at QOL’s discretion. The funds were (450,000 .04 3/12) (450,000 .04 3/12)
invested in government bonds with an
annual interest of 4%.
Financial statements of QOL using the deferral method:
QUALITY OF LIFE
Statement of Operations and Net Assets
For the Year Ending December 31, 2013
General Fund Pet Project Fund Capital Asset Fund Endowment Fund Total
Revenues
Government grants $ 1,175,000 $ 32,500 $ 1,207,500
Donations 367,000 $ 45,000 6,000 418,000
Total revenues 1,546,500 45,000 38,500 $ -0- 1,630,000
Expenses
Salaries 380,000 50,000 430,000
Training 25,000 25,000
Depreciation 43,000 43,000
Rent 122,000 122,000
Marathon 45,000 45,000
Total expenses 527,000 45,000 43,000 50,000 665,000
Net income 1,019,500 -0- 4,500 50,000 965,000
Transfer to Capital Asset fund 90,000 90,000 -0-
Transfer to Pet Project fund 10,000 10,000 -0-
Endowment contribution 450,000 450,000
Change in net assets 919,500 10,000 85,500 400,000 1,415,000
Net assets January 1, 2013 0 0 0 0 0
Net assets December 31, 2013 $ 919,500 $ 10,000 $ 85,500 $ 400,000 $ 1,415,000
QUALITY OF LIFE
Statement of Financial Position as at December 31, 2013
Assets General Fund Pet Project Fund Capital Asset Fund Endowment Fund Total
Cash $ 590,000 $ 45,000 - $ 400,000 $ 1,035,000
Contribution receivable—
government grant 500,000 500,000
Accrued interest receivable 4,500 4,500
Building 860,000 860,000
Accumulated depreciation—
building 43,000 43,000
Total assets $ 1,094,500 $ 45,000 $ 817,000 $ 400,000 $ 2,356,500
Liabilities
Deferred revenue—government
grants $ 175,000 $ 617,500 $ 792,500
Deferred revenue—donations $ 35,000 114,000 149,000
Total liabilities 175,000 35,000 731,500 941,500
Net assets
Net assets—General fund 919,500 919,500
Net assets—Pet Project fund 10,000 10,000
Net assets—Capital Asset fund 85,500 85,500
Net assets—Endowment fund 400,000 400,000
Total net assets 919,500 10,000 85,500 400,000 1,415,000
Total liabilities and net assets $ 1,094,500 $ 45,000 $ 817,000 $ 400,000 $ 2,356,500
QUALITY OF LIFE
Statement of Cash Flow
Cash flow from operations

Cash received from government grants $ 850,000
Cash received from donations 447,000
Cash paid to employees 430,000
Cash paid for fundraising activities 45,000
Cash paid for operations 122,000
Cash paid for training 25,000
Net cash flow from operations 675,000
Cash flow from investing
Cash paid for capital asset—building 740,000
Net cash flow from investing 740,000
Cash flow from investing
Cash Flow from financing
Cash received from government grant for building 650,000
Cash received from endowment donation 450,000
Net cash from financing 1,100,000
Net increase in cash 1,035,000
Cash balance January 1, 2013 -0-
Cash balance December 31, 2013 $ 1,035,000
Note that QOL is not required to present the statement of cash flow on a fund basis.
Financial statements using the restricted fund method:

QUALITY OF LIFE
Statement of Operations
Revenues
Government grants $1,175,000 $650,000 $1,825,000
Donations 367,000 $80,000 120,000 $450,000 1,017,000
Total revenues 1,546,500 80,000 770,000 450,000 2,846,500
Expenses
Salaries 380,000 50,000 430,000
Training 25,000 25,000
Depreciation 43,000 43,000
Rent 122,000 122,000
Marathon 45,000 45,000
Total expenses 527,000 45,000 43,000 50,000 665,000
Net income 1,019,500 35,000 727,000 400,000 2,181,500
Transfer to Capital Asset fund 90,000 90,000 -0-
Transfer to Pet Project fund 10,000 10,000 -0-
Endowment contribution
Change in net assets 919,500 45,000 817,000 400,000 2,181,500
Net assets January 1, 2013 -0- -0- -0- -0- -0-
Net assets December 31, 2013 $ 919,500 $45,000 $817,000 $400,000 $2,181,500
QUALITY OF LIFE
General Pet Project Capital Asset Endowment

Fund Fund Fund Fund Total
Assets
Cash $ 590,000 $ 45,000 $ -0- $ 400,000 $1,035,000
Contribution receivable—
government grant 500,000 500,000
Accrued interest receivable 4,500 4,500
Building 860,000 860,000
Accumulated depreciation—
building 43,000 43,000
Total assets $1,094,500 $ 45,000 $ 817,000 $ 400,000 $2,356,500
Liabilities
Deferred revenue—
government grants $ 175,000 $ 175,000
Total liabilities 175,000 -0- $ -0- 175,000
Net assets
Net assets—General fund 919,500 919,500
Net assets—Pet Project fund 45,000 45,000
Net assets— Capital Asset fund 817,000 817,000
Net assets—Endowment fund 400,000 400,000
Total net assets 919,500 45,000 817,000 400,000 2,181,500
Total liabilities and net assets $1,094,500 $ 45,000 $ 817,000 $ 400,000 $2,356,500
Note that the statement of cash flow is the same under either method of accounting since it
is based on the actual cash. The major difference under the two methods is the timing of the
recognition of revenue. Under the deferral method, a liability is created initially and revenues
that are restricted are matched with the future expenses.
KEY TERMS
capital asset fund
(p. 461)
LEARNING SUMMARY
collections (p. 474)
contributions (p. 464)
Not-for-profit organizations that are not in the public sector may report their financial state-
deferral method
ments using either IFRS or the CICA Handbook, Part III. Organizations that choose to follow
(p. 465)
Part III must also adhere to ASPE for any topics not covered under Part III. The organiza-
economic interests
tion decides the extent and manner of reporting that would be the most useful to the reader
(p. 476)
of those financial statements.
endowment fund
A not-for-profit organization may decide to report using “fund accounting,” which is a
(p. 460)
method of segregating the financial statements into different activities. It is up to the orga-
fund accounting
nization to determine which funds it would like to segregate. This decision should be based
(p. 459)
on the need to present useful information. On the financial statements, each fund is added
government not-for-
together to present a total for the organization.
profit organization
Contributions to a not-for-profit organization are considered revenue. The organiza-
(p. 453)
tion has the option of using the deferral method of accounting or the restricted fund method
not-for-profit
of accounting for these contributions. Under the deferral method of accounting, restricted
organizations
revenues are matched to the related expenses. The funds received are deferred and shown
(p. 453)
as liabilities on the statement of financial position until the expense is incurred. Under the
pledge (p. 464)
restricted fund method, funds are created for activities that have restrictions that are exter-
restricted fund
nally imposed. Contributions to these funds are considered revenues to these funds imme-
(p. 460)
diately. Any contributions for which there is no fund are accounted for using the deferral
restricted fund
method in the general fund.
method (p. 467)
A not-for-profit organization may record materials and services at zero value or, if a fair
value can be determined, it may record the materials and services at fair value at the day of
the transaction. Capital assets and intangible assets should be recognized at fair value at the
transaction date. Any difference between the fair value and the amount paid by the organiza-
tion is considered a contribution to the organization. Collections are usually recorded at a
zero value since fair value cannot be established. Small organizations are exempt from the
requirement to capitalize and amortize capital assets and intangibles due to the cost-benefit
constraint.
A not-for-profit organization has unique difficulty in determining control or significant
influence for strategic investments as it is rarely achieved through share ownership. It is nec-
essary to examine the ability to direct activities through the board of directors. The organiza-
tion has reporting options with corresponding note disclosure based on its assessment.
A not-for-profit organization has flexibility in reporting since it is recognized that these
organizations can vary significantly in terms of nature, size, and types of interested users.
Each organization needs to assess the best method of reporting to convey to the reader that
funds were used in the most cost-efficient way to achieve the goals of the organization.
APPENDIX 9A—BUDGETING IN A
NOT-FOR-PROFIT ORGANIZATION
Objective 5 In this chapter and in Chapter 10, we examine the external financial reporting for a
Apply the budgeting non-business type of organization. In this appendix we look at the internal reporting for the
process in a not-for- organization as it plays an important role in the financial reporting requirements.
profit organization. All entities budget as part of their planning process. However, budgeting in a not-for-
profit organization is particularly important as the entity’s liquidity is usually a constant issue.
In addition, you may recall that users are interested in knowing that the organization used the
funds in the manner in which it was intended. It is very difficult for a not-for-profit organiza-
tion to take funds from one activity to compensate for losses in another. As such, planning is
vital in these types of organizations. Consider the example of a private school that each year
plans for a zero net income budget. The board of directors needs to determine the amount
of school fees to charge so that the revenues will be sufficient to cover costs. It is imperative
that the budget be accurate because these figures will determine the expenses. Furthermore,
the school has no option but to ensure that the budget is strictly adhered to so that it does not
end up with a deficit at year end.
There are several ways that an organization may choose to incorporate its budget into its
recording system:
1. Budget to actual analysis
2. Internal budget restrictions
3. Encumbrance accounting
Budget to Actual Analysis

Using this method, the organization reports the budgeted figures along with the actual fig-
ures to date and a projected actual figure to year end. This is usually done monthly but can
be done as often as the organization requires it. Some not-for-profit organizations produce
this information for each board of directors’ meeting. This enables the board members to
see how the organization is tracking against what they had projected in the budget. Problem
areas can be identified on a timely basis and remedied.
This is a relatively simple method of reporting as the budgeted figures are shown as a sec-
ond column next to the actual trial balance results. It might look something like that shown in
Illustrative Example 9A.1. You will note that some accounts are equal each month so the pro-
jection is simpler. In this organization, the donations are not expected to be received equally
each month. Although both accounts below are “over” the budgeted amounts, in a revenue
account it would be a good thing, whereas in an expense account it would not.
Illustrative Example 9A.1 Example of Budgeted

Compared with Actual Figures
Budget Projected Actual
Actual to December December
Account May 31, 2013 31, 2013 31, 2013 Over/under
Donations $32,340 $70,000 $72,340 $2,340
Salaries $15,623 $35,000 $37,500 $2,500
The difficulty with this kind of internal reporting is that commitments may be made already
by the time that the managers realize that they are going over budget. For some organiza-
tions, it may not be a quick enough way to resolve potential overage problems.
Appendix 9A—Budgeting in a Not-for-Profit Organization 491
Internal Budget Restrictions

It is possible to create a budget system where the budgeted amounts are set up as opposite
entries to the account. For example, the budgeted salaries expense above of $37,500 is set
up as a credit to the expense account. As the salaries are paid, the account is debited. The
account is not permitted to become negative. This method ensures that all entries are flagged
as soon as they are going over budget and can be dealt with quicker than in the first scenario.
This is typically only used for expense accounts as it is not a dangerous issue to be over bud-
get on a revenue account. An example of an internal budget restriction is shown in Illustrative
Example 9A.2.
Illustrative Example 9A.2 Internal Budget Restriction

Alcor University provides all faculty members with a professional development allow-
ance of $1,000 annually. Alcor sets up each professor’s professional development
account with a credit balance of $1,000. Professor Charles submits an invoice for air-
fare of $650 on May 1, photocopying of $250 on June 1, and a conference registration
fee charge of $530 on December 1. The accounting system will report the following:
January 1 (1,000)
May 1 650
June 1 250
December 1 rejected as the account is now over.
Professor Charles is then informed that the conference charge will only be accepted
for $100.
Again, the difficulty with this method is that commitments may have already been made
before the organization realizes that it is going over budget. Some organizations may con-
sider this to be too late.
Encumbrance Accounting
An encumbrance is any pre-expenditure, such as a purchase order, that will lead to a charge
against an account. Consider that when you put money into an envelope to hold it to pay a
bill, you have encumbered that money. You probably don’t use budget codes, but if you have
an envelope in your dresser drawer marked “Phone Bill,” the money you put away for the
next bill is your encumbrance. How much should be encumbered? How much do you think
your bill is going to be? That is the encumbrance.
Encumbrance accounting is the creation of accounting journal entries earlier in the docu-
ment cycle than with standard accrual accounting (i.e., during the time of the purchase order
or requisition instead of the time of the receipt or invoice). Using this method of accounting
allows the organization to control the budget at the point that it commits to a transaction
because it allows it to keep track of amounts and determine if there are available funds within
a given budget. Government organizations are the most frequent users of this type of internal
accounting. Encumbrance accounting as an integral part of the accounting system is used as
a means of enhancing budgetary control.
The equation used for record-keeping purposes is:
Funds Available Budget Actual Encumbrance
You can have budgetary control without encumbrance accounting, which we saw in
illustrative examples 9A.1 and 9A.2 where:
Funds Available Budget Actual
Referring to the equation Funds Available Budget Actual Encumbrances again,

the budget amount is always unaltered and Encumbrances is reversed when matching to the
Account Payable invoice recorded. For example, in the public sector, an encumbrance is cre-
ated when a purchase order is issued to buy goods or services. The money has not yet been
spent, but is earmarked for that purchase and no one else can use it.
Encumbrances help manage budget balances more effectively. When an encumbrance is
posted to an organization’s financial records, the amount of money available for spending by
the organization is reduced by the amount of the encumbrance. By recording the estimated
cost of purchase orders and contracts as encumbrances, managers are aware of the future
impact of previous financial decisions.
Illustration 9A.1 shows how expenses and encumbrances affect budget balances.
Illustration 9A.1
Item Effect on the Budget Balance
Effects of Expenses and
Encumbrance ↓
Encumbrances on the
Expenses not previously encumbered ↓
Budget Balance
Decreased encumbrance ↑
Expenses previously encumbered No effect
Illustrative Example 9A.3 demonstrates encumbrance accounting.
Illustrative Example 9A.3 Encumbrance Accounting

Lester Healthcare, a not-for-profit organization that provides nursing visits to low-
income new mothers, has the following activity in the purchases account:
The budgeted purchases for the year, as approved by the board of directors,
are $350,000.
The purchasing manager has committed to buy $45,000 of materials in the
month of January and has issued purchase orders for that amount. During the month
of January, $22,000 of the materials has been received and the organization has paid
$10,000 of the invoiced amounts.
The purchase manager commits to an additional $75,000 of materials in February.
Of this $75,000, $48,000 has been received and $20,000 has been paid out. In addition,
the balance of the materials on the $45,000 purchase order of January has been received
and an additional $10,000 has been paid on that amount.
Using encumbrance accounting, Lester Healthcare makes the following entries:
January:
Purchases 45,000
Encumbered Purchases 45,000
Lester Healthcare records the obligation to purchase $45,000 of materials. For
external reporting purposes, these two accounts offset each other and there are no
purchases actually recorded on the financial statements. This is in line with accrual
accounting, as no material has been received.
Cash 10,000
At the end of January, the financial statements will reflect purchases of $22,000
as the netting of the purchases and the encumbered purchases yields a net of $22,000
($45,000 $23,000).
In addition, the purchasing manager, Brenda Schlabitz, knows that as of the end
of January, she has (budgeted amount encumbered amounts amounts received)
Exercises 493
$350,000 ⫺ $23,000 ⫺ $22,000 ⫽ $305,000 available to purchase. Another way of

calculating this is budgeted amount ⫺ encumbered amount $350,000 ⫺ $45,000 ⫽
$305,000.
February
Purchases 75,000
Cash 20,000
Cash 10,000
At the end of February, the financial statements will reflect $93,000 of purchases:
$48,000 ⫹ $45,000, which represents the actual materials received OR
$45,000 ⫹ $75,000 ⫺ $0 ⫺ $27,000, which is the amounts ordered encumbered ⫺
balance.
Brenda also knows that she can purchase an additional $350,000 ⫺ $45,000 ⫺
$75,000 ⫽ $230,000 of materials.
Using this method, the organization can ensure that it does not make commit-
ments that will cause it to go over budget.
Brief Exercises
(LO 1) BE9-1 What are the needs of the users of a not-for-profit organization’s financial statement versus those of a profit-
oriented company?
(LO 2) BE9-2 Under what circumstances would you advise a not-for-profit organization to use fund accounting?
(LO 3) BE9-3 What is the difference between the deferral method and the restricted fund method?
(LO 4) BE9-4 What type of organization would reflect collections on its financial statements?
(LO 4) BE9-5 How would a not-for-profit organization report inventory that was donated to it?
(LO 4) BE9-6 How would a not-for-profit organization determine whether it controls another not-for-profit organization?
(LO 4) BE9-7 How would a not-for-profit organization identify an investment over which it has significant influence?
(LO 3) BE9-8 Strathern Community Services receives a donated car to help for transportation. The fair value of the asset at
that date is $3,000. How would Strathern reflect this donation?
(LO 3) BE9-9 Under the deferral method, how should endowment contributions be recognized?
(LO 1) BE9-10 How is the financial statement of a not-for-profit organization different than that of a profit-oriented company?
Exercises
(LO 3) E9-1 Below is a set of transactions that are independent of each other:
1. A university receives a collection of ancient Roman history books from a donor.
2. A school receives a contribution to buy land and the land is bought in the same period.
3. A hospital receives a contribution to buy a building.
4. Volunteers contribute about 300 hours per year to cook meals for the elderly.
5. An estate of a retired professor makes a $5-million endowment contribution to the professor’s university.
Required
How should the above transactions be accounted for? Answer the question above assuming:
(a) The organization uses the deferral method of accounting for contributions.
(b) The organization uses the restricted fund method of accounting for contributions.
(LO 3) E9-2 You are the accountant for a local church and are being asked the following questions by church staff and
volunteers:
1. I bought office supplies and a filing cabinet at the office supply store with the church’s credit card. How do I record
this transaction?
2. My church borrowed money for a new sign. How do I record the complete transaction?
3. I made an error in recording a church business transaction in our church account and did not discover it until a
month later. How do I correct this error?
4. I need to transfer funds from one fund to another. Is this legal? How would I record it?
Required
Respond to each question asked.
(LO 4) E9-3 Pure Joy (PJ) is a not-for-profit organization and has a relationship with Quick Kids (QK), another not-for-
profit organization. This relationship gives PJ the continuing power to determine the strategic operating, investing, and
financing policies of QK without the co-operation of others. This control of PJ over QK is evidenced in part by PJ’s
ability to appoint 8 of the 12 members of QK’s board of directors.
Required
How should PJ report its relationship with QK?
(LO 3) E9-4 Save the Elephants organization has completed its annual fundraising drive in June 2013. It received $50,000
in cash donations and an additional $20,000 in pledges, up slightly from 2012, when it had collected all but $2,800 of
its pledges. In preparing its June 30, 2013, financial statements, the controller noted that $18,000 of pledges remained
uncollected as of June 30, 2013.
Required
What would be the recommended accounting treatment for contributions receivable?
(LO 4) E9-5 Esther Smith takes a three-month leave of absence from her job to work voluntarily, full-time, for Oldfarm, a
not-for-profit organization that rescues abused horses. Smith is filling the position of director of operations because the
regular employee is on paid sick leave. This position normally pays $85,000 per year.
Required
Prepare the journal entry to record the transaction.
(LO 4) E9-6 In 2013, Bestofcare, a not-for-profit health care facility, received an unrestricted bequest of common shares
with a fair market value of $320,000 in accordance with the will of a deceased benefactor. The deceased person had paid
$20,000 for the shares in 1995. There are no restrictions on the use of the common shares.
Required
Prepare the journal entries to reflect the transaction.
Problems 495
(LO 1) E9-7 The Roger family lost everything in a fire in their home at the beginning of December 2012. On December 23,
2012, a fundraiser was held and an anonymous donation was made to the Sunworld charity to purchase furniture and
appliances for the Roger family. During January 2013, Sunworld purchased this furniture for the Roger family.
Required
Prepare the journal entries that Sunworld would make in 2012 regarding this transaction.
(LO 3, 4) E9-8 Food Services (FS) collects food for distribution to people in need. During November 2013, its first month of
operations, the organization collected a substantial amount of food and also $54,000 in cash from a very wealthy donor.
The donor specified that the money was to be used to pay down a loan that the organization had with the local bank.
The loan had been taken out to buy land, on which the organization plans to build a warehouse facility. A warehouse is
needed since, although the organization does not plan to keep a lot of food in stock, sorting and distribution facilities
are crucial. FS has also received $100,000, which according to the donor is to be invested and maintained, with any
income earned to be used as FS sees fit.
Required
(a) Prepare the journal entries that FS would make assuming that it uses the deferral method of accounting and does
not maintain separate funds.
(b) Prepare the statement of financial position after the transactions have occurred.
(LO 4) E9-9 Home Care Services Inc. (HCS), a not-for-profit organization, has a roster of volunteers who visit sick and
elderly people to provide companionship. These volunteers do not provide any other services. HCS staff estimate that
these services have a fair value of $6.00 an hour.
Required
If these services were not contributed on a volunteer basis, HCS would not pay for them. How should HCS account for
these contributed services?
(LO 5) E9-10 Ace Training supplies clothing to qualified low income families. Ace buys damaged lots from suppliers and sells
them to local organizations at small markups. Ace has committed to a break even budget for this year and as such uses an
encumbrance system to manage its expenses. The board has approved an annual budget of $47,000 for the purchase of
clothing, most of which is expected to arrive in the first quarter of the year. Ace has set an internal allowance of $15,000
per month for each of the first three months. During the month of January, 2013, the following transactions occurred:
January 2, 2013 ordered $25,000 of clothing to be shipped in 4 lots in each of the next 4 months
January 12, 2013 received $5,000 of goods
January 14, 2013 returned $2,000 of goods as not saleable
January 31, 2013 received another $3,000 of goods
Janaury 31, 2013 paid $5,000 for the goods received
Required
Prepare the journal entries that would be made using the encumbrance system.
Problems
(LO 2, P9-1 The Amity Community Centre (ACC) has decided that it will proceed with a capital campaign this year. The
3, 4) building that it uses is in dire need of major repair and the board of directors feels that this is a good time to expand by
adding an extra floor, creating a gym, and upgrading the cafeteria. ACC uses the restricted fund method of accounting
and has a separate capital asset fund. The fund is currently in a zero balance as the building is fully depreciated and the
organization follows the policy of allocating depreciation to the capital asset fund. The other capital assets are immaterial.
The plan calls for a $3.8-million expansion. In the current year, ACC has managed to collect pledges of $2 million
in donations from large private investors; however, only $500,000 has actually been received. The balances are payable
over a five-year period. The director of finance has also negotiated a $1-million interest-free loan from the government,
payable over 4 years. The current market rate of interest is 4% for similar loans. The balance of $800,000 is still to
be solicited from smaller donors. A key supplier of iron for construction has donated all the metal required, which is
valued at approximately $50,000. Another supplier donated the labour of some skilled electricians valued at $25,000.
The architect on the project is providing her services for free. She would normally charge $32,000 for this type of work.
ACC has always relied on volunteers to solicit donations; however, given the large commitment for a capital campaign,
ACC hired a professional fundraiser mandated to carry out the campaign as well as all the annual giving. Her annual
salary is $100,000 and she required an assistant at $30,000 per year as well as part-time secretarial help at $10,000 per
year. They will spend approximately 75% of their time on the capital campaign.
Required
(a) Prepare the journal entries that ACC would make for the above-mentioned transactions.
(b) Prepare ACC’s statement of operations and the statement of financial position for the capital asset fund.
(LO 2, P9-2 Actuaries of the World (AW), a not-for-profit organization whose objective is to provide actuarial services to
3, 4) developing countries, was organized early in 2013 by a group of Canadian actuaries. They initially thought that they
would use the restricted fund method to account for restricted contributions and so they drafted the 2013 financial
statements on that basis. The board is, however, now considering a single-column presentation using the deferred con-
tribution method of accounting for restricted contributions. You, as a member of AW’s board, have volunteered to help
with the board’s decision by redrafting the statements.
AW’s statements using the restricted fund method are as follows:
ACTUARIES OF THE WORLD

Statement of Operations and Changes in Fund Balances
Year Ended December 31, 2013
Endowment Special Capital

General Fund Fund Project Fund Asset Fund
Revenues
Government grants (unrestricted) $140,000 $ -0- $ -0- $ -0-
Restricted contribution for endowment 250,000
Interest on endowment 10,000
Restricted contribution for special project 65,000
Restricted contribution for office equipment 15,000
150,000 250,000 65,000 15,000
Expenses
Special project expenses 50,000
Amortization of office equipment 3,000
Excess of revenues over expenses 62,000 250,000 15,000 12,000
Fund balances beginning of year -0- -0- -0- -0-
Fund balances end of year $ 62,000 $250,000 $15,000 $12,000
ACTUARIES OF THE WORLD

December 31, 2013
Endowment Special Capital

General Fund Fund Project Fund Asset Fund
Cash $62,000 $ -0- $15,000 $ -0-
Investments 250,000
Office equipment—net 12,000
Total assets $62,000 $250,000 $15,000 $12,000
Liabilities $ -0- $ -0- $ -0- $ -0-

Fund balances
Endowment fund 250,000
Special project fund 15,000
Capital asset fund 12,000
Unrestricted 62,000
Total liabilities and fund balances $62,000 $250,000 $15,000 $12,000
Problems 497
Required
(a) Prepare a revised statement of operations and a statement of financial position using the deferred contribution
method.
(b) Contrast the approaches of the deferred contribution method and the restricted fund method to communicate
information to stakeholders about restricted contributions and their utilization.

(LO 1, 2, P9-3 Big Bucks (BB) is an association formed in 2013 by wealthy individuals wanting to network with other wealthy
3, 4) individuals. An individual applies to be a member in the association and must supply financial data indicating their net
worth. The board of directors decides admission based on criteria established. A member of the BB association has
access to the coordinates of the other members, is provided with a webpage about them, participates in events that are
exclusive to its members, and receives the monthly newsletter. The organization is funded largely by private donations
from large family foundations. Membership in the association has a certain elite appeal. During 2013, the following
transactions occurred:
1. BB received $2 million from a family foundation as seed money to start the website. BB has hired a programmer
who has started work on the site. The total cost of the job is $575,000 and to date, the programmer has charged
$235,000.
2. BB has an office in a building owned by one of its starting members, who is also a member of the board of
directors. BB is not paying any rent for the office. Under normal circumstances, these premises would rent for
$50,000/month.
3. Another member has agreed to loan her collection of art to BB to display in the offices. BB will own the art as long
as it continues to exist. Should the association fold, the art will revert to the member’s family. The art has not been
evaluated in many years but in 1985 it was appraised at $13.5 million.
4. The director of the association is paid biweekly for an annual salary of $50,000.
5. Membership in BB is $10,000 annually with an additional initiation fee of $50,000. In its first year, BB attracted
300 members. All fees must be paid immediately.
6. BB held one major event during the year to introduce all the members to each other. The event cost $60,000 and
the revenues from tickets received were $100,000. A raffle was also held during the event for a Porsche automobile
that was donated. The Porsche was appraised at $150,000. BB raised $200,000 from the raffle.
7. BB uses fund accounting and the restricted fund method for each fund that requires restrictions. The restricted
funds are the endowment funds and the capital funds. BB also has a separate fund for the major event held.
8. BB secured a major endowment of $3.2 million on July 1, 2013, in the form of shares of TST Inc., a public com-
pany controlled by one of the members in the association. The original cost of these shares was $1,000. The shares
cannot be sold for 10 years but BB can use any dividends paid at its discretion. In 2013, BB received $20,000 in
dividends on these shares.
Required
(a) Prepare the journal entries that BB would make in 2013.
(b) Prepare the financial statements for BB as at December 31, 2013.
(LO 1, 2, P9-4 Savior is a not-for-profit organization formed on January 1, 2013. It is committed to helping children who are
3, 4) in danger due to family abuse situations. The organization is funded by the provincial government and private dona-
tions. Savior is in touch with all the local schools and community centres. It is also involved in referring families to the
various agencies and in creating awareness of problems that exist. During 2013, the following transactions occurred:
1. Savior was awarded a grant of $50,000 from the provincial government. Of that, $10,000 was provided for the
rent of office space. The remaining $40,000 is given to fund operations for the year. An instalment of $25,000 was
received immediately and the other half will be received on January 1, 2014. In order to receive the second instal-
ment, Savior must show payroll receipts of at least $10,000 by November 30, 2013.
2. Savior bought a photocopy machine for $3,000. The machine’s actual fair value is $5,000 but the office machine
company owner sold it for a lower amount since he is committed to the cause. The machine is expected to have a
two-year life.
3. Savior paid salaries of $15,000 for office personnel during the year, $10,000 for a part-time fundraiser hired to raise
funds for endowments and yearly operations, and $5,000 for the part-time director.
4. Savior paid $2,000 to train volunteers to work with at-risk children.
5. Savior held a bake sale at the end of August specifically for a project to create an after-school program. It incurred
costs of $500 and raised $8,000 in donations.
6. The fundraiser secured a major endowment of $50,000 on September 1, 2013. The interest on the endowment
can be used at Savior’s discretion. The funds were invested in government bonds. The bonds pay an annual inter-
est of 3%.
7. Savior does not use fund accounting.
Required
(a) Prepare the journal entries that Savior would make in 2013.
(b) Prepare the financial statements for Savior as at December 31, 2013.
(LO 1, P9-5 The Nova Community Association was established in January 2013. Its mandate is to promote cultural and
3, 4) recreational activities in the small community of Nova. With the support of the local government, local businesses, and
many individuals, the association raised sufficient funds to build a community centre and operate the association for the
current year.
The following schedule summarizes the cash flows for the year ended December 31, 2013 (in $000s):
Operating Fund Capital Fund
Cash inflows
Government grant for operating costs $180 $ -0-
Government grant for community centre 1,000
Corporate donations for community centre 800
Registration fees 100
Rental of community centre 140
420 1,800
Cash outflows
Construction of community centre 1,800
Operating expenses 410
410 1,800
Cash, end of year $ 10 $ -0-
1. The new community centre was completed in late August 2013. The official opening was held on August 31 with
a barbecue. The centre is expected to have a 40-year useful life and no residual value.
2. A long-time resident of Nova donated the land on which the centre was built. The land was valued at $200,000.
3. On July 1, 2013, a former resident of Nova donated office equipment to the association. The equipment was valued
at $20,000. The equipment has a useful life of five years and no residual value.
4. The local government pledged $200,000 a year in support of operating costs, of which 90% is advanced through-
out the year. The government will issue the last 10% of the annual grant to the association upon receipt of the
association’s annual report.
5. Registration fees are charged for fitness classes and other recreational activities. Of the $100,000 collected during
2013, $10,000 were paid in advance for classes and activities beginning in January 2014.
6. The association rents the centre out for dinners and dances. At December 31, 2013, a local sports team owed
the association $5,000 for the rental of the centre in November 2012. The association expects to collect the full
amount owing.
7. At the end of the year, the association owed $7,000 to instructors for various classes and activities.
8. The association uses two separate funds—an operating fund and a capital fund—and uses the deferral method of
accounting for contributions for both funds. All capital assets are to be capitalized and depreciated, as applicable,
over their estimated useful lives.
Required
Prepare Nova’s statement of financial position at December 31, 2013, in accordance with the CICA Handbook, Part III.
(LO 1, 2, P9-6 Enviroclean is a not-for-profit organization formed on January 1, 2010. The organization’s motto is “clean
3, 4) your environment.” Enviroclean was formed to help people and organizations that want to clean up their local environ-
ments. The organization is funded largely by the municipal government and private donations through funds, goods,
and services. Enviroclean is involved in training volunteers, raising awareness of cleanup requirements in the local
communities, and working with schools and clubs to undertake cleanup programs. They are well known for the annual
downtown cleanup after the winter. During 2013, the following transactions occurred:
1. Enviroclean was awarded a grant of $1 million from the municipal government for annual operations. This is a
grant that has been received each year. The first instalment, $500,000, was received immediately and the other half
will be received on January 1, 2014. In order to receive the second instalment, Enviroclean must show that it spent
the $500,000 in pursuit of its mission by September 30, 2013. Enviroclean has been able meet the requirements in
the past.
2. Enviroclean started a new program in 2013. It launched a contest among local high schools challenging them
to improve the environmental footprint of their respective schools. Enviroclean’s board of directors committed
$100,000 to this initiative from the general fund. Enviroclean also raised $50,000 through private donations. There
were 10 schools involved in the contest. Each school was given $10,000 to create the program and the winner was
given another $5,000. Enviroclean also agreed to purchase any required supplies and provide volunteer supervi-
sors when necessary. The supplies used cost $13,000 and the volunteer time was calculated as 25 hours at $12.00
per hour.
3. Enviroclean paid salaries of $50,000 for office personnel during the year, $30,000 for a fundraiser hired to raise
funds for endowments and yearly operations, and $75,000 for the executive director. The office personnel and the
fundraiser spent 20% of their time this year on the new contest.
4. Enviroclean held its annual winter cleanup. It incurred costs of $40,000 and raised $50,000 in donations. The con-
tributions on these winter cleanups are restricted by the donors for the annual cleanup project.
5. The annual campaign, which began in September and ended in December, yielded pledges of $52,000, of which
$34,000 had been collected by year end.
6. The Enviroclean fundraiser secured a major endowment of $120,000 on June 1, 2013, from a corporate founda-
tion. The interest on the endowment can be used at Enviroclean’s discretion. The funds were invested in govern-
ment bonds. The bonds pay an annual interest of 4%.
7. Enviroclean uses fund accounting and is required to create separate funds for capital assets, endowments, the
annual winter cleanup, and the school cleanup project.
Required
Prepare the journal entries that Enviroclean would make during 2013.
(LO 5) P9-7 David Soul, a not-for-profit organization that provides healthcare to the elderly, has the following activity in
the purchases account:
• The budgeted purchases for the year, as approved by the board of directors, are $260,000.
• The purchasing manager has committed to buy $30,000 of materials in the month of January and has issued pur-
chase orders for that amount. During the month of January, $20,000 of the materials has been received and the
organization has paid $15,000 of the invoiced amounts.
• The purchase manager has committed to an additional $30,000 of materials in February. Of this $30,000, $28,000
has been received and $20,000 has been paid out. In addition, the balance of the materials on the $30,000 purchase
order from January has been received and an additional $10,000 has been paid on that amount.
Required
(a) Using encumbrance accounting, provide the journal entries that David Soul would make in January and February.
(b) Indicate the balance that would appear on the David Soul Statement of Operations for purchases for the two
months.
Writing Assignments
(LO 4) WA9-1 You are the accounting advisor for Mr. and Mrs. Hawthorne. Mr. Hawthorne has left you a message with the
following questions:
“My wife and I have a small non-profit where we receive donations of pet food and supplies and then redistribute
them to people who are in financial hardships. We are tracking the inflows and outflows of supplies, but since they are
donated, do we need to place an estimated value on our ‘inventory’ as there is no money exchanged?”
Required
Respond to Mr. Hawthorne.
(LO 1) WA9-2 You, a CGA, are the audit partner on the audit of Favour Care Homes, a not-for-profit organization that
helps seniors remain in their own homes. Favour has been an audit client of your firm for a number of years. As a
condition for a substantial amount of government funding, Favour must follow accounting standards for not-for-profit
organizations as specified in the CICA Handbook, Part III.
While reviewing the general journal, the senior auditor noted an entry to reverse rent payable of $160,000 to
Forgetful Inc.
When following up with the controller, the senior auditor was informed of the following:
• Favour has leased office space from Forgetful for the past six years. Last year, a new five-year lease was signed with
an increase in rent from $100,000 per month to $110,000 per month, effective September 1, 2012.
• Even though a new lease had been signed, Favour continued to pay $100,000 per month because it had provided
postdated cheques to the end of 2012. The $10,000 shortfall in monthly rent was accrued as rent payable since
September 1, 2012.
• It appears that Forgetful has not noticed the shortfall in monthly rent since it has not followed up with Favour.
• You raise the issue with the controller. He indicates that Favour is experiencing some difficulty in paying
its suppliers on a timely basis and Forgetful seems to be fi nancially very strong. Favour intends to con-
tinue making payments of $100,000 a month and has reversed the accrued rent payable of $160,000 as of
December 31, 2012.
Required
Recommend how your firm should respond to this situation.
(LO 2, 3) WA9-3 Trudel Drama Club is a drama club for people under the age of 30. It provides an opportunity for young
people to learn about drama and perform in the theatre at levels consistent with their skills and commitment. The club
has operated as a not-for-profit organization since its inception in 1994.
In an effort to enhance the club’s image and to promote club members’ careers in theatre, Trudel initiated a fund-
raising program in July 2012 to raise $1.5 million to build a theatre and to create an endowment fund for scholarships.
The fundraising program was a huge success. By May 31, 2013, the club had received the following contributions:
• $1 million in cash contributions that were specifically designated for the construction of the theatre;
• $400,000 in cash contributions plus $100,000 in pledges that were specifically designated for the scholarship
fund; and
• sound system equipment valued at $200,000.
On June 15, 2013, at the closing ceremony for the major drama festival of the year, the director of the club, Edmund
Bangura, thanked the parents, students, alumni, and staff for all of their support and officially closed the capital cam-
paign. He provided the following details of the campaign:
• The construction of the theatre is nearing completion and will be ready for use in September 2013. The final con-
struction cost for the theatre will be approximately $1.1 million.
• The sound system will adequately equip the theatre.
• The $400,000 of cash on hand plus the cash to be received when the pledges are collected will be invested and
managed by a professional investment advisor. The income earned on the endowment fund will be used to provide
scholarships of $5,000 to $10,000 for one to three students a year attending an arts college.
You are proud to be an alumnus of Trudel. You attended the closing ceremony. At the reception after the formal cer-
emonies, you accepted Edmund’s request to help with the accounting for the capital campaign and related events. He
was unsure whether the club should use the restricted fund or deferral method of accounting for contributions. You
agreed to write a memo providing recommendations for accounting policies for the transactions described above. The
memo should discuss policies to be applied for the year ended June 30, 2013, and for future years when the theatre is
being used, and when the scholarships are disbursed.
Required
Write the memo to the director, Edmund Bangura. Explain the rationale for your recommendations and state your
assumptions. Your memo should be no more than 500 words.
(LO 5) WA9-4 Phoenix Ltd. is a not-for-profit organization that began operations on January 1, 2013. The organization
provides support for individuals who are trying to start a new life after experiencing poverty. You are the organization’s
accountant. The CEO, Marijke de Waal, is interested in demonstrating accountability to the organization’s various
funding agencies and private donors. She has heard that some not-for-profits prepare formal budgets for upcoming
periods, something that Phoenix has not yet done. She is interested in implementing a system of budgetary control and
wonders if such a system would affect Phoenix’s recordkeeping and financial reporting. Marijke would like to meet with
Cases 501
you to discuss it further in a month from now. For now, she would like a brief memo to update her on budgetary control
systems.
Required
Write a memo to the CEO. In this memo you should do the following:
(a) Explain budgetary control systems and the possible impact of a budgetary control system on Phoenix’s record
keeping and its financial reports.
(b) Describe how a budgetary control system would be useful for demonstrating accountability to Phoenix’s funding
agencies and private donors.
(LO 3, 4) WA9-5 Gold Development Inc. (GDI), a newly incorporated not-for-profit organization with a December 31 year
end, will offer low-rent housing services for people with low income.
GDI reports to Logimex, a government agency that requires audited annual financial statements to be filed.
Michel Bilodeau, GDI’s project originator and administrator, is not familiar with the preparation of financial
statements.
GDI received a non-repayable grant from Logimex in February 2013 for the construction of an eight-storey apart-
ment building. Construction began in April 2013. Residents will start to move into the apartment building between
October and December 2013, although it will not be entirely completed until the end of December 2013. By December
2013, all the apartments should be rented.
GDI receives donations from companies and individuals in the region. It has received pledges from large, well-
known companies for the next five years, and pledges from individuals for the current and next year.
Pledge amounts have been set out in writing on forms signed by the donors.
For a nominal salary, Mr. Bilodeau manages the organization with the help of his wife and the local priest, both of
whom are volunteers.
Required
(a) Explain to Mr. Bilodeau what is meant by “reporting on a restricted fund accounting basis.”
(b) Advise Mr. Bilodeau on how GDI will account for the above facts if GDI decides to report on a restricted fund
accounting basis.
Cases
(LO 2, 3) C9-1 Trenholm School has been approached by its parents’ association with a proposal for the coming school year.
As the school is committed to accepting students with varying financial ability, parents have begun to notice that many
students cannot afford the cost of the school uniform. The association is proposing starting a “gently used” uniform
store. The parents are proposing to take over a supply closet on the third floor of the school and having it staffed by vol-
unteers. The plan is to ask graduating students to donate their uniforms to the school. These uniforms would then be
sold to parents at a significantly discounted price. The association would have minimal costs associated with the project.
They would have to do some renovation to the supply closet to make it look like a store. They would have to employ
a seamstress to mend some of the uniforms and they would need some advertising. They have also indicated that any
funds that they make should be used to provide financial aid to students.
The bookkeeper for Trenholm School has approached you, the auditor for the school, for some guidance as to how
she should account for this new venture. Specifically she is unsure whether to set up a separate fund for the store and
how to report the uniforms that are being donated. Trenholm School uses the restricted fund method of accounting.
Required
Respond to the bookkeeper’s request.
(LO 1, C9-2 Crestview Secondary Academy is a private non-profit high school offering grades 9 to 12. It has just imple-
2, 3) mented a laptop program in the school. Every student from Grade 11 and up will receive a laptop that they will use for
their time at the school. The academy will own these laptops but the student will be able to buy it for $1 at the end of
secondary school.
The board of directors is currently discussing the implementation of this program and how to reflect it on the
academy’s financial statements. They have agreed that they will need to increase school fees to pay for the cost of these
laptops but do not want to bill it as a separate cost. The director of finance suggested that the cost be allocated over
the years at school. The president of the board is proposing that the school fees in Grade 11 be increased by the cost of
the laptops since that is the year that the student will actually receive the laptop. The IT director points out that the stu-
dents in grades 9 and 10 will still get access to laptops, which are on carts and brought to the classrooms. She maintains
that the laptop program actually begins in Grade 9. The board members are also interested in ensuring that they have
a mechanism to evaluate the laptop program financially.
You have been called to the most recent board of directors meeting to discuss the accounting and reporting of the
laptop program. The members would be interested in hearing your opinion.
Required
Prepare the report to the board of directors.
(LO 2, C9-3 You, CA, have recently been assigned as audit senior for the audit of Open Arms Society (OAS), a not-for-profit
3, 4) organization set up three years ago to help integrate students with disabilities in schools. OAS lobbies educational lead-
ers, organizes seminars, and provides small grants to help schools provide aid to students with disabilities.
OAS was 100% funded by the government when it was originally established. However, in the current year, gov-
ernment funding has been reduced to 75% of capital and operating expenditures, and funding will be reduced by a
quarter of the full amount for each of the next three years until OAS is completely self-sufficient. The government will
continue to fund specific events and projects undertaken by OAS. If OAS is unable to generate sufficient funds from
these and other sources, the government may cut future funding altogether. In the past, the OAS financial statements
were reviewed, but starting with the 2013 year the government has required an unqualified audit report as a condition
for funding. The prior years’ review engagements were completed by your firm.
In addition to the government funding, the organization also receives funding from corporations and not-for-
profit organizations for special projects, such as retreats and seminars attended by educators. Any funds remaining after
a project is completed must be repaid to the funding entity. Some have asked for assurance on the financial information
provided by OAS for the projects they funded. They would like to ensure that the expenses actually relate to the project
sponsored. Cathy Letourneau, office manager and accountant at OAS, is not sure how to meet the requirements of
these organizations.
OAS has three employees: Cathy, who works part-time and handles all accounting and finance; Jameel, an edu-
cational therapist who specializes in children with disabilities; and Zarqa, who is the executive director of OAS and
performs most of the organizational tasks as well as soliciting contributions and donations.
OAS is overseen by a board that is made up of five members from the local community, mostly from educational
fields. The board is responsible for approving the budget and the financial statements at its monthly meeting. Very
little time is spent on other financial matters, as most board members are more interested in the operational issues and
fundraising activities. They told Cathy, “We will rely on you to keep our sponsors happy.”
OAS’s fiscal year ended June 30, 2013. It is now July 25, 2013. A junior has completed most of the field work. You
have been provided with the details of the government funding (Exhibit C9-3 [a]), extracts from the audit file (Exhibit
C9-3[b]), and other information from various sources (Exhibit C9-3[c]).
The partner requests that you prepare a memo to her detailing any concerns regarding the reporting. Also, she asks
that your memo include responses to concerns raised by Cathy.
Required
Prepare the memo to the audit firm partner.
EXHIBIT C9-3(a)
DETAILS OF GOVERNMENT FUNDING
OAS must submit a detailed operating and capital budget six months before the start of any year. It must be approved in order
for OAS to receive government funding. Initial funding for the first two months of this year is based on the budget, the formula
being:
Operating funding total operating budget 1/6 75%

Capital funding total capital budget 1/6 75%
Subsequent funding, paid every other month, must be supported by actual invoices and cancelled cheques from the previ-
ous two-month period. This year’s maximum annual funding is 75% of the total approved budget.
OAS’s 2013 budget was approved with budgeted operating expenditures of $100,000 and capital expenditures of
$11,000. Accordingly, OAS received its first operating instalment of $12,500 ($100,000 1/6 75%) on July 2, 2012.
The capital funding amount was received a few days later. Subsequent operating payments, summarized by the junior, were as
follows:
Date Invoices and cancelled Date Funding

submitted cheques submitted received received
Sept. 4/12 $15,000 Sept. 10/12 $11,250
Nov. 1/12 22,000 Nov. 8/12 16,500
Jan. 6/13 20,000 Jan. 15/13 15,000
Mar. 3/13 10,000 Mar. 7/13 7,500
May 1/13 16,000 May 9/13 12,000
July 2/13 14,000 Outstanding Outstanding
Cases 503
All funding for the 2011–12 year has been received.

The junior noted that no funding was received before year end for the July 2, 2013, submission. He wrote the following
note: “From examination of cancelled cheques, the reimbursement from the government should be part of the 2012–13 year.
Accordingly, I have posted an accrual for $10,500 as a receivable from the government.”
In June 2013, OAS received approval from the government for its 2013–14 budget, with planned operating expenditures
of $110,000 and capital expenditures of $9,000. OAS received a payment of $9,167 for operating expenditures on June 30,
2013. The payment has been set up as deferred revenue on the June 30, 2013, balance sheet.
The government responded to the confirmation request from OAS with the following letter:
“We confirm operational funding from July 1, 2012, to June 30, 2013, in the amount of $83,917.
[Signed] Nathan Shu”
The junior has been unable to reconcile this confirmation to the records of OAS.
EXHIBIT C9-3(b)
EXTRACTS FROM AUDIT FILE
1. Funding from the government has been confirmed. Other significant revenues have been vouched to deposit slips and bank
statements.
2. Expenses have been tested by analytical review, comparing current year with prior year, with explanations sought for signifi-
cant variances. Explanations for many of the variances consist of “one-time project in 2011–12; not repeated in 2012–13
year” or “one-time project in 2012–13; not done in 2012–13.”
3. Bank confirmation has been sent to the bank.
4. There were no significant additions to capital assets. Three computers were sold to a school for use by children with disabili-
ties. A gain of $3,500, an amount equal to the proceeds, has been recorded. The units were part of a donation to OAS of five
computers made by a local company last year.
5. Accounts receivable, except for the $10,500 booked by the junior, were not considered significant. Inventory and prepaids
were also not significant.
6. Accounts payable were tested by vouching to invoices. The junior performed a search for unrecorded liabilities by reviewing
all invoices received after June 30. He found nothing significant.
7. The only other liability on the books of OAS is the deferred funding for the $9,167.
8. Planning in all other respects reflects a typical recurring audit engagement. Audit risk was assessed as low. A substantive
audit approach has been used. There is no comment on internal controls in the file.
9. No work has been done on the capital funding received by OAS.
EXHIBIT C9-3(c)
OTHER INFORMATION
In prior years, OAS had very few projects funded by corporate and non-profit sponsors. Each sponsor received a schedule pre-
pared by Cathy of revenues and expenses for the project. Expenses on the schedule include an amount for overhead admin-
istration (mostly salaries and office rent). Your firm did not comment on the schedules, although Cathy informed you that she
attached a copy of the review engagement report to the schedules when sending them to sponsors.
Cathy sets up a receivable for additional funding when a project does not break even. OAS has successfully solicited addi-
tional funding from sponsors for about half of the projects for which a receivable was set up. The receivables from prior years still
remaining on the books total about $7,500. In the 2012–13 year, OAS continued to pursue corporate sponsorships in an effort
to be more self-sufficient. Five out of eight new projects did not break even for a total of $6,900, and a receivable was set up.
OAS’s financial statements do not distinguish between operating and capital funding. However, when she has time, Cathy
updates a listing that tracks capital funding and expenditures.
OAS had total operating revenues for 2012–13, before adjustments made by the junior, of $140,000.
(LO 2, C9-4 City Youth Services (CYS) is a not-for-profit organization established to provide counselling and other services
3, 4) to children under the age of 18. It concentrates on troubled teenagers who are typically referred to CYS by the courts,
police, and hospitals. In years past, the majority of the operating budget of CYS has been funded by the provincial gov-
ernment; increasingly, however, CYS is turning to private donors for support.
Two years ago, CYS engaged in a major funding drive in order to raise funds for a group home for troubled teen-
agers. The drive was a success; $110,000 was raised during 2012 and a mortgage of $90,000 was negotiated so that CYS
was able to purchase a house for $200,000 in January 2013. Since then, CYS continued its fundraising activities and was
able to raise $125,000 in donations in 2013. The funds raised annually for the group home are used to employ several
in-house social workers on an hourly basis and pay the home’s operating expenses.
CYS has continued to operate in separate rented premises and employs 12 social workers to provide counselling.
Increasingly, time spent by the regular social workers has involved overload group home related work that cannot be
handled by in-house social workers. As a result of the increase in group home related work, and the corresponding
increase in the payroll costs of regular CYS social workers, CYS is currently running a deficit in its operating fund.
Fundraising for the counselling activities, which is separate from fundraising for the group home, has been insufficient
to offset the operating deficit.
A major fundraising drive to secure donations for CYS and the group home is planned for 2014.
Twenty volunteers from the community have assisted the social workers in the group home and in the regular
counselling services. Two of these volunteers have also helped with clerical duties in the office.
You are Mary Roussopoulos, CMA, a friend of the Executive Director of CYS, James Bonucci. You attend a meet-
ing of the CYS board of directors, where James says the following: “As you know, Mary, our needs for private dona-
tions are greater than ever, especially with government funding freezes. The trouble with private donations is that we
are competing with so many other worthwhile causes. Some of the people we approach for donations have complained
about a lack of information regarding where we spent past donations, our current financial position, and our effective-
ness in achieving the purposes for which we receive money. Accordingly, we have decided to provide all donors in 2013
with a copy of our 2013 annual report. Since you are an accounting expert, perhaps you could advise us on ways in
which we might improve our annual report to enhance the information value for donors.” He then gave you the state-
ment of operations and the balance sheet of CYS (see Exhibit C9-4[a]).
Required
As Mary Roussopoulos, comment in a memo to James Bonucci on ways in which the reporting of CYS might be
improved to enhance the informational value for donors.
EXHIBIT C9-4(a)
CITY YOUTH SERVICES
Statement Of Operations
Operating Fund
Revenues:
Donations to City Youth Services $104,500
Program funding from provincial government 300,000
Investment income 500
405,000
Expenses: 70,000
Staff salaries 300,000
Payroll—social workers 50,000
Office expenses 420,000
Excess of expenses over revenues (15,000)
Operating fund balance (deficit)—January 1 (7,000)
—December 31 $(22,000)
Capital Fund
Revenues:
Donations to group home $125,000
Expenses:
Payroll—social workers 50,000
Operating expenses 30,000
Home purchase 200,000
Mortgage payments 10,000
290,000
Excess of expenses over revenues (165,000)
Capital fund balance (deficit)—January 1 110,000
—December 31 $(55,000)
Assets
Cash $ 6,000
Donor pledges 10,000
$ 16,000
Liabilities
Mortgage 90,000
93,000
Fund balance (deficits)
Operating fund (22,000)
Capital fund (55,000)
$ 16,000
(Adapted from CMA Canada)
Cases 505
(LO 1, C9-5 In the fall of 2012, eight wealthy businesspeople from the same ethnic background formed a committee (CKER
2, 3, 4) committee) to obtain a radio licence from the Canadian Radio-television and Telecommunications Commission
(CRTC). Their goal is to start a non-profit, ethnic community radio station for their area. They plan to call the sta-
tion CKER-FM Ethnic Radio (CKER). It will broadcast ethnic music, news, and sports from their country of origin,
cultural information, ethnic cooking, and other such programs, seven days a week.
The station’s capital requirements are to be financed by memberships, donations, and various types of loans.
It is expected that ongoing operations will be supported by advertising paid for by businesspeople from that eth-
nic community and by the larger business community targeting that ethnic audience, as well as by donations and
memberships.
It is now March 2013, and the CRTC has announced that hearings will start in one month on a number of broad-
casting licence applications, including the CKER committee’s application. The CKER committee members are fairly
confident about the viability of their proposal; however, they have decided to seek the advice of a professional account-
ing firm to assist with the endeavour. The CKER committee has engaged Maria & Casano, Chartered Accountants, for
the assignment, as three of the five partners of the firm are from the same ethnic community. The partner in charge of
the assignment has stated that the firm will donate half its fee for the work.
You, CA, work for Maria & Casano and have been put in charge of the assignment. You have met with the CKER
committee and various volunteers associated with the project. Information gathered on station start-up is contained
in Exhibit C9-5(a). Exhibit C9-5(b) provides other information on the CKER committee’s proposal. The partner has
asked you to prepare a draft report to the committee members discussing the viability of the proposed radio station over
the initial three-year period. Since the committee is fairly confident that they will receive the licence, the partner has
also asked you to recommend accounting policies for the transactions that CKER is contemplating. Your report must
also cover other significant issues that the station will face after it begins operations.
Required
Prepare the draft report.
EXHIBIT C9-5(a)
INFORMATION ON STATION START-UP
1. Costs to date have totalled $50,000 and are mostly transportation and meeting costs, as well as postage. These costs have
been paid for personally by the CKER committee members.
2. To approve the licence application, the CRTC must see written commitments to finance the station’s start-up costs and operat-
ing losses in the first two years. Remaining costs to obtain the licence, excluding donated legal work, are expected to be about
$8,000, and will be paid by CKER committee members.
3. If the CRTC approves the licence application, the CKER committee will immediately set up a non-profit organization and apply
to the Canada Revenue Agency for charitable status, which it will likely receive.
4. Fairly exhaustive efforts to obtain commercial financing have failed. As a result, four wealthy individuals have volunteered to
provide CKER with the financing for the start-up costs. They will each personally borrow $25,000 from financial institutions
and give the funds to the station. These individuals expect the loans to be cost-free to them as the station will make the interest
and principal payments.
5. A “Reverse Life-Time Contribution” program will also be instituted. Under this program, a donor will pay the station a capital
sum of at least $50,000. The station can do whatever it wants with the funds, but it will repay the donor an equal annual
amount calculated as the capital sum divided by 90 years less the individual’s age at the time of contribution. Upon the death
of the donor, the station will retain the balance of the funds. Currently, a 64-year-old station supporter has committed $78,000,
and seven other individuals are considering this method of assisting the station.
6. Initially, the station is to broadcast with a 2,500-watt signal. It is hoped that within three to four years it will be possible to
obtain commercial financing for a second transmitter that will boost the power of the signal and the broadcast range.
EXHIBIT C9-5(b)
OTHER INFORMATION ABOUT PLANS FOR STATION
1. The CKER committee has analyzed census and other data to determine the potential market for the station. Engineering stud-
ies have mapped out the area that will be covered by the broadcast signal. There are about 1.1 million people in the target
listening area. The latest Canadian census shows that 14% of the population comes from the target ethnic group. A number
of surveys have shown that, of a given population, nearly 80% listen regularly to the radio. By applying a conservative factor of
50% to these findings, the CKER committee has arrived at a listenership figure of 5.6% or about 62,000 people. The CKER
committee has found that about one in five of the businesses in the area are run by members of the ethnic community, many of
whom would like a medium for reaching their own people through direct advertising.
2. The amount of time expected to be devoted to commercials per hour is four minutes in year one, five minutes in year two, and
six minutes in year three. Advertising cost per minute, discounted to 25% below the current market rate, will be:
Prime time (6 hours a day) $40

Regular time (10 hours a day) $30
Off-peak (8 hours a day) $25
Advertising time will be sold by salespeople whose remuneration will be a 15% commission.
3. Miscellaneous revenue from renting out the recording studio when not in use by CKER could approach $3,000 per month in
year three but will start out at about $2,200 per month.
4. At least 120 people have committed to pay a $125 annual membership fee. Membership carries no special privileges other
than to be identified as a supporter of the station. Membership is expected to grow by 20% per year.
5. Start-up capital expenditures are as follows: transmission equipment $61,000; broadcast studio equipment $62,000; and
production studio equipment $40,000. Administration and other costs, including rent, are expected to total about $1,237,000
per year and will not increase when advertising sales increase.
6. The committee believes that there are no HST implications related to running the station, since it is a non-profit venture.
7. About one third of the person-hours needed to run the station are expected to come from volunteers.
Meeting High
Standards of
Accountability
Source: © Kristian Sekulic/iStockphoto
CHAMPLAIN REGIONAL COLLEGE is a public, the college’s ability to finance its activities and to
English-language, post-secondary institution meet its liabilities and contractual obligations as well
that provides pre-university and technical as the ability to provide future services.
college-level education and training. It has three The government’s objective for all its entities is
locations across Quebec: St. Lawrence in Quebec to provide services and redistribute resources rather
City, St. Lambert on the south shore of Montreal, than make a profit. Therefore, budgets are carefully
and Lennoxville, near Sherbrooke. scrutinized and yearly audits are performed to ensure
Being regulated under the legislation and the efficient use of resources. Funds are also care-
reporting guidelines put in place by the Quebec fully allocated based on needs and specific projects
government for all its organizations, Champlain rather than a more general allocation. As such,
Regional College must follow strict guidelines Champlain Regional College reports its financial per-
not only for resource management but also for formance based on the different funds—general and
recording and reporting. There is a greater need capital—in order to present more useful information
for transparency since government agencies are to the users. Since the capital fund is restricted to
subject to higher standards of accountability capital investments such as buildings and equipment,
than any other types of entities. approval from higher level government is required
As a public entity, the college must report before spending and must be disclosed separately.
annually to the government on its financial As seen in its 2010-2011 annual report, the col-
performance but also on its fund management lege discloses additional information on how it spends
and administrative practices. Since education at both provincial and federal government investments.
this level is still free in the province, all educa- These would be allocations in addition to those for
tional programs are funded by the government. normal operations of the college. Specifically high-
The budget of each college in Quebec’s system lighted are funds spent on increasing accessibility to
of CEGEPs (which are the equivalents of Grades students and student services, as well as funds spent
12 and 13) is reviewed yearly based on past on information technology and related services. These
performance. For this reason, strict guidelines funds are further broken down into expenses related
are put in place in order for reporting to be done to these endeavours, the largest being for salaries. As
consistently through all CEGEPs in the province part of its reporting, the college needs to show that it
to ensure fairness of budget allocation. spent government funds on these projects resulting
Being financed by the provincial govern- in positive outcomes. One would expect, for example,
ment, Champlain Regional College must follow that student services had improved and that informa-
accounting guidelines for public sector entities. tion flow was better. With greater transparency at the
Annual financial statements are a fundamental base of higher reporting standards for public sector
component of a government financial report. The entities, Champlain College is able to show taxpayers
annual report should present information about exactly how tax dollars are being put to work.
Sources: Champlain Regional College website, “About,” available at http://crc.sher.qc.ca, accessed on June 29, 2012; Champlain Regional College 2010–2011 annual report.
CHAPTER
10 Reporting for
Public Sector
Entities
LEARNING OBJECTIVES
1. Evaluate the need for a reporting framework for public sector entities.
2. Describe public sector financial reporting concepts.
3. Define the net debt indicator and describe its relevance.
4. Describe the reporting on government organizations.
5. Record transactions unique to public sector entities.
6. Compare and contrast differences between GAAP frameworks.
REPORTING FOR PUBLIC

SECTOR ENTITIES
Reporting Comparing Public

Public Sector Reporting on Transactions
Framework for Net Debt Sector Accounting
Financial Reporting Government Unique to Public
Public Sector Indicator with Other GAAP
Concepts Organizations Sector entities
Entities Frameworks
■ Public sector in ■ Objectives ■ The measure ■ Assessing control ■ Portfolio invest-

Canada ■ Qualitative of net debt ■ Types of ments with conces-
■ Need for a public characteristics ■ Relevance of government sionary terms
sector accounting ■ Elements of a public net debt organizations ■ Loans receivable
framework sector financial ■ Legislative control ■ Reporting on ■ Liability for contami-
■ CICA PSA statement and government the results of nated sites
Handbook—a ■ Key indicators financial government ■ Solid waste landfill
primary source of accountability organizations closure and post-
GAAP ■ Reporting on closure liabilities
■ Key characteristics government ■ Loan guarantees
of public sector partnerships
entities ■ Government transfers
■ Tax revenue
510 c h a p t e r 1 0 Reporting for Public Sector Entities
This chapter addresses financial reporting by public sector entities. Public sector entities
include government and organizations controlled by government. This text ends by extend-
ing our discussion of financial reporting by profit-oriented enterprises to examine the public
sector, which is significant in scope. An accountable public sector is a platform for economic
expansion and sustainable public services.
The public sector in Canada is large and diverse. It comprises three levels of govern-
ment (federal, provincial/territorial, and local), and a wide range of organizations controlled
by the government that provide public services. Many entities in the health care and educa-
tion sectors are public sector entities. In many provinces, these entities account for over half
of public sector spending.
According to recent data published by Statistics Canada, expenditure by governments
comprises more than a quarter of Canada’s expenditure-based gross domestic product. One
in five Canadians works in the public sector. Although many of us will not seek a career in
the public sector, each of us is a user of public sector financial reports, if only indirectly
through media coverage of public affairs. We use public services and pay taxes to support
those services.
The preparers of public sector financial reports serve a diverse group of users seeking a
broader range of information than investors, who are the principal users of financial reports
of profit-oriented enterprises. As well, the aims of government vary from the objectives of
profit-oriented enterprises. Over the last 30 years, the reports issued by governments have
evolved from cash-based fund accounting to modern full accrual reporting.
This new financial reporting model has served Canadians well, as it has supported a
public focus on managing government deficits, measured in relation to full accrual principles.
In 1995, an editorial in the Wall Street Journal dubbed Canada an “honorary member of
the Third World” due to our high level of public debt in relation to GDP. However, just a
decade later Canada had among the lowest debt-to-GDP ratios of the G7 developed nations.
This gave our leaders added flexibility during the 2008 economic crisis.
THE REPORTING FRAMEWORK

FOR PUBLIC SECTOR ENTITIES
Objective 1 The term “public sector” refers to federal, provincial, territorial, and local governments,
Evaluate the need government organizations, government partnerships, and school boards. Together, these are
for a reporting described as public sector entities. The accounting standards and guidance for application
framework for public by public sector entities are contained in the Canadian Institute of Chartered Accountants’
sector entities.
CICA Public Sector Accounting Handbook (CICA PSA Handbook).
The Public Sector in Canada

Under our Constitution, the national Parliament has broad powers to legislate “for the peace,
order and good government of Canada” except in regard to those “subjects assigned exclu-
sively to the legislatures of the provinces.” The provinces enjoy sovereign power over direct
taxation in the provinces for provincial purposes and a wide scope of activities.1 On the other
hand, local governments are given no specific or exclusive area of authority. The powers of
local governments in Canada are those granted by the provinces.
Governments are not necessarily dependent on the profitable sales of goods and services
to finance their operations. Governments have the right to tax. As long as they are fiscally
responsible, the right to tax provides the opportunity to issue significant amounts of debt
in the capital markets at preferential interest rates. As well, governments and their agencies
finance their operations by levying fees and incurring liabilities.
1
Eugene A. Forsey, How Canadians Govern Themselves (Ottawa: Library of Parliament, 2010), p. 20.
The Reporting Framework for Public Sector Entities 511
The board of directors of a business is accountable to its shareholders. Membership-

based not-for-profit organizations, such as golf clubs, are primarily accountable to their
members. Charities and not-for-profit organizations with broad communities of service may
have a wide range of direct and indirect accountabilities. A government is accountable to
all members of society, as well as its resource providers, which may include businesses, debt
holders, and other levels of government.
The Need for a Public Sector

Accounting Framework
A public sector financial reporting framework is needed because governments differ in their
aims and objectives from business. As well, their operations differ in their nature. Governments
receive certain revenues, such as taxes, that businesses and not-for-profit organizations do
not have access to. Governments often price their goods and services with the aim of promot-
ing access rather than maximizing economic returns. Assets may be held strictly to provide
a service. Consequently, the issue of impairment must be evaluated in relation to the future
service potential (rather than the cash flows) associated with the asset.
The need for accounting standards has long been recognized. Issuers of securities traded
in public markets are generally subject to Canada’s security regulations and are required to
report in accordance with generally accepted accounting principles. Although the authority
of Canada’s security regulators does not extend to governments and their agencies, boards,
and commissions, there is a need for financial reporting to support accountability to the pub-
lic and holders of the debt securities issued by governments.
One may argue that the public’s principal interest is in the sufficiency and outcomes
associated with government programs and services. Indeed it is for this reason that pub-
lic accountability is enhanced when governments report comprehensively on their opera-
tions. They do this by reporting both financial and non-financial performance information.
To address this need, the Public Sector Accounting Board (PSAB) issues Statements of
Recommended Practice (SORPs). SORPs address specific aspects of supplementary report-
ing on topics such as financial condition, and financial and non-financial performance.
Many governments use SORPs as a framework to communicate information about the
services provided in relation to their plans and past results. However, the application
of SORPs is not mandatory, and the PSAB does not have the authority to require the use
of SORPs.
Many citizens are concerned about the sustainability of public programs, and for good
reason. Programs are not sustainable unless the government has the financial strength to
deliver on its promises. Consequently, financial reporting by governments is a relevant and
needed element of public accountability. Beyond the legislators to whom government man-
agers are accountable and the investors in its securities, there is a broad body of users who
have an interest in governments applying high quality accounting standards. It is for this
reason, and because the aims and nature of government are different from both the profit-
oriented sector and the not-for-profit sector, that the CICA PSA Handbook exists.
CICA PSA Handbook: A Primary Source of GAAP

All public sector entities apply the CICA PSA Handbook issued by the PSAB unless the
introduction to the CICA PSA Handbook states otherwise. The types of government orga-
nizations and exceptions to the general requirement to apply the CICA PSA Handbook are
discussed in greater detail in the section “Reporting on Government Organizations” later
in this chapter.
The PSAB’s standard-setting activities are conducted based on a public due process that
is similar in many ways to Canada’s other accounting standard-setting board, the Accounting
Standards Board (AcSB). Both the PSAB and the AcSB are accountable to an independent
oversight body, the Accounting Standards Oversight Council (AcSOC). The AcSOC tries
to ensure the AcSB and PSAB bear in mind that the needs of users of financial information
should be met and the most appropriate issues should be suitably addressed.
Several international standard setters, the PSAB among them, are reviewing their con-
ceptual frameworks. A conceptual framework is a statement of the concepts and objectives
intended to underlie the standards. A conceptual framework is not a standard in itself, but it
provides guidance to standard setters when developing standards to promote their harmo-
nization. It may also be useful when resolving reporting issues not covered in the detailed
standards, as GAAP hierarchies typically require any policy adopted to be consistent with the
conceptual framework.
Key Characteristics of Public Sector Entities

In 2011, the PSAB began a consultation process to support its conceptual framework review.
It issued a paper identifying nine key characteristics of public sector entities,2 which are sum-
marized below.
Public Accountability
The rights, powers, and responsibilities of all three levels of government—whether constitu-
tional or devolved—involve broad accountability to the public and their elected representa-
tives. Similarly, the governing bodies of the organizations governments control and use to
deliver services are given public resources and are accountable to the public for their use.
Many view public accountability as the overriding characteristic of public sector entities.
Providing information that demonstrates such accountability is the primary objective of pub-
lic sector reporting.
Multiple Objectives
In contrast with business, most public sector entities are not focused on generating profit.
Public sector entities seek to provide services and goods to society in the manner determined
through political consensus, in an efficient and effective manner.
Rights, Powers, and Responsibilities

(Constitutional or Devolved)
Although a government’s rights, powers, and responsibilities may vary according to the
authority given to it under the Constitution or granted to it by another government (a
devolved authority), these are rights unique to government. They are unique as they are
not enjoyed by businesses or private not-for-profit organizations. These powers include the
right to:
• Tax
• Penalize and fine
• License
• Legislate activities
• Set monetary and fiscal policy
A government may choose to exercise these powers directly, or to the extent permitted by
legislation, to delegate its authorities to other governments, or to a public sector entity it
controls.
2
Conceptual Framework Task Force, “Consultation Paper 1, Characteristics of Public Sector Entities,”
PSAB, August 25, 2011, accessed on April 12, 2012, from http://www.frascanada.ca/
standards-for-public-sector-entities/index.aspx.
The Reporting Framework for Public Sector Entities 513
Lack of Equity Ownership

Public sector entities owe their origins to the Constitution (as is the case with the federal and
provincial governments), through legislation (territorial, local governments, and many pub-
lic sector entities) or incorporation. When incorporated, they are often organized without
share capital (equity), or when shares are issued they are held by the government controlling
the entity.
Operating and Financial Frameworks Set by Legislation

Public sector entities must operate and illustrate compliance, not only in accordance with
the law, but also in relation to the operating and financial frameworks of their government
and the legislation that applies to them. Compliance with the letter and spirit of those
frameworks is integral to the requirements and must be demonstrated in public account-
ability reporting.
The Importance of the Budget

The financial budget of governments at all levels is a public document communicating the
government’s plans for the reporting period. As such, the budget is a policy document, a
product of the political process. Budgets reflect choices made regarding the allocation of
financial resources among competing priorities. Once adopted, the budget is a key tool used
by government managers for financial management and control. Public accountability is
provided by comparing the budget with the actual results. As the activities of government
organizations generally reflect the priorities and policies of the governments that control
them, these organizations often use their budgets as policy documents and publish them.
Governance Structures
In the case of the federal, provincial, and territorial governments, governance is provided by
the legislature. The legislature provides an executive council or cabinet with the authority to
administer the government’s financial affairs. These officials are responsible for the provision of
programs and services within the laws, the administration of government spending, and devel-
oping tax measures for approval by the legislature. For local governments, the elected council
provides governance. In all cases, the governance structure is made up of elected officials.
Within government organizations, a board of directors or other body provides oversight
over the entity’s financial and operating policies. Often members of the oversight body of a
government organization are appointed, although some communities directly elect members
to certain local authorities.
Nature of Resources
Consistent with their objectives, the resources that public sector entities hold often relate to
their role as service providers. Consequently, these resources may or may not generate future
cash flows. Road infrastructure, heritage, and cultural resources are examples of important
public resources whose ongoing value may not be susceptible to an evaluation based on the
cash flows they generate.
Non-exchange Transactions
Many government revenues are confiscatory by nature. Governments have the right to tax
and do not directly exchange or give up economic resources when they levy taxes or impose
fines and penalties. Rates or charges associated with the services that public sector entities
offer are not set to maximize the return to shareholders. Instead, often they are set to pro-
mote access to a basic public service, such as transit, or to ensure the availability of essential
services to remote areas. A public sector entity may be granted the authority to collect fees
when granting a non-exclusive right or privilege such as a driver’s licence.
✓ LEARNING CHECK
• Governments are accountable to all members of society and government resource providers.
• A public sector reporting framework is needed because governments differ in their aims and
objectives from businesses.
• The CICA PSA Handbook is a primary source of GAAP.
• The key characteristics set out the environment within which a public sector entity operates.
PUBLIC SECTOR FINANCIAL

REPORTING CONCEPTS
Objectives of Public Sector Financial Reporting
Objective 2 The objectives of public sector financial reporting focus on the needs of the users of general
Describe public purpose financial statements. The CICA PSA Handbook identifies four financial statement
sector financial objectives, summarized in Illustration 10.1.
reporting concepts.
Illustration 10.1
Objective Value to users
Objectives of Public
Sector Financial Reporting Financial statements should provide an account- A user can appreciate the extent of the govern-
ing of the full nature and extent of the financial ment’s obligations and resources only when a set
affairs and resources that the government con- of financial statements presents the full nature
trols, including those related to the activities of and extent of a government’s financial affairs,
its agencies and enterprises. through inclusion by consolidation or use of the
modified equity method of all entities a govern-
ment controls.
Financial statements should present information Reporting on financial position provides users
to describe the government’s financial position at with information about the capacity of the public
the end of the accounting period. Such informa- sector entity to provide future services. A net
tion should be useful in evaluating the govern- debt position (described in the section “Net Debt
ment’s ability to: Indicator” later in this chapter) constrains a gov-
ernment due to obligations associated with past
• finance its activities and meet its liabilities events and transactions. Although a statement of
and contractual obligations, and financial position is drawn from information that
• provide future services. is historic, it is among the most decision useful of
the financial statements. This is because it pro-
vides readers with insights into the entity’s capac-
ity or constraints, which is particularly relevant to
future decision-making. The statement of financial
position highlights two types of resources:
• net financial resources or net debt, and

• non-financial resources, being assets held
to provide future services (such as supplies,
buildings and equipment).
Financial statements should present informa- Reporting on operating results provides users with
tion to describe the changes in a government’s information on three aspects.
financial position in the accounting period. Such
• Operations: the extent to which the revenues
information is useful in evaluating:
raised were sufficient to meet expenses. This
• the sources, allocation, and consumption section of the financial statements explains
of the government’s recognized economic the sources of revenue and the nature and
resources in the accounting period; purpose of the expenses.
Public Sector Financial Reporting Concepts 515
Illustration 10.1
(Continued) Objective Value to users
• how the activities of the accounting period • Change in net debt: accounts for changes in
have affected the net debt of the govern- this key indicator. Users can obtain valuable
ment; and insights into the relationship between changes
• how activities have been financed and cash in net future obligations and the entity’s oper-
requirements have been met. ating surplus or deficit.
• Cash flow: the source and application of cash
provides important information. Unlike the
cash flow statement of a business, in the
public sector, cash flows applied to the acqui-
sition of capital assets are reported separately
as they are not generally oriented to earning
future cash flows (as are investments).
Financial statements should demonstrate the To support broader measures of accountability,
accountability of a government for the resources, public sector financial reporting includes informa-
obligations, and financial affairs for which it is tion about results in relation to the spending
responsible by providing information useful in: authorities (budget) on both the statement of
operations and the statement of changes in net
• evaluating the financial results of the govern- debt. As budget estimates may not be on an ac-
ment’s management of its resources, obliga- crual basis or may vary in other ways from GAAP,
tions, and financial affairs in the accounting the report may need to reconcile the budget infor-
period; and mation in some manner to the operating results to
• assessing whether resources were adminis- support comparability.
tered by the government in accordance with
the limits established by the appropriate
legislative authorities.
Qualitative Characteristics of Public Sector

Financial Reporting
In their conceptual frameworks, standard setters frequently identify the qualitative character-
istics associated with financial reporting. Qualitative characteristics are the essential character-
istics of public sector financial reporting. Although a financial report is composed of balances,
judgement is needed as few amounts reported on are as certain as cash. When preparing
financial statements, trade-offs amongst the qualitative characteristics are often required. For
example, to make a financial statement complete and entirely verifiable, it might be desirable
to wait until uncertainties are resolved. However, timeliness would be diminished.
The qualitative characteristics of public sector financial reports, as set out in the Financial
Statement Concepts section of the CICA PSA Handbook, appear in Illustration 10.2.
Illustration 10.2
Relevance
Qualitative Characteristics
• Predictive value and feedback value
of Public Sector Financial
• Accountability value
Reporting
• Timeliness
Reliability
• Representational faithfulness
• Completeness
• Neutrality
• Conservatism
• Verifiability
Comparability
Understandability and clear presentation
Information shows relevance when it can influence the decisions of users by helping
them evaluate the financial impact or potential impact of past, present, or future transactions
and events or confirm, or correct, previous evaluations. Information with predictive value
and feedback value, as well as accountability value, that is made available in a timely fashion
contributes to relevance.
To have predictive value, information must help users predict future financial results
and cash flows. Although amounts based on past transactions may not themselves be predic-
tive, the information contained in a financial report can be useful in making predictions.
As well, when the information is presented in a manner that allows readers to identify
non-recurring or abnormal items, its predictive value may be enhanced. Information has
feedback value when it confirms or corrects previous predictions.
Accountability value is in evidence when information helps users assess a public sector
entity’s stewardship of the resources entrusted to it, including how resources are applied or
consumed in service provision. Including financial objectives and targets established by formal
process in financial statements alongside actual results can enhance its accountability value.
Similarly, including financial analysis in the public accounts or an annual report explaining
financial results and non-financial performance information can enhance accountability value.
Timeliness enhances the decision usefulness of financial information. Although prepar-
ing public sector financial reports is often a complex process, reports issued long after the end
of a reporting period may be of historical interest only.
Factors considered to contribute to the reliability of information are: representational
faithfulness, completeness, neutrality, conservatism, and verifiability. Unless information
demonstrates these qualitative characteristics, decision-making may be adversely affected.
Representational faithfulness requires that the transactions and events reported on agree
with the underlying facts and circumstances. Their presentation must convey the substance
and not just their legal or other form. In some cases, the legal or other form of a transaction
may not be consistent with its substance. When knowledgeable and independent observers
feel the presentation of a transaction or event agrees with the actual underlying transaction or
event, there is evidence of representational faithfulness.
Completeness is satisfied when none of the information needed to achieve representa-
tional faithfulness is omitted. There are practical constraints on the information that can be
provided in general purpose financial statements, due to cost/benefit constraints, and judge-
ment needs to be applied in balancing the qualitative characteristics. To illustrate, there is
often a trade-off between the timeliness of producing financial statements and the reliability
of the information being reported on.
Neutrality means the information given is free from a bias that would lead users towards
making decisions influenced by the way the information is measured or presented. Use of a
measure that consistently overstates or understates items introduces bias in measurement.
The presentation of transactions and events in financial statements is viewed as neutral when
economic activity is reported as faithfully as possible and does not colour the situation for the
purpose of influencing behaviour.
The application of conservatism means that judgments needed when uncertainty exists
should not be made in a manner that affects the neutrality of the information presented. The
proper application of conservatism seeks to ensure that assets, revenues, and gains are not
overstated and, conversely, that liabilities, expenses, and losses are not understated. At the
same time, assets and revenues must not be intentionally understated, nor should liabilities
and expenses be deliberately overstated.
Verifiability is present when knowledgeable and independent observers would concur
with how a transaction or event is represented in the financial statements. Measurement of
an item is verifiable when the basis of measurement is correctly applied. Whether the basis of
measurement is appropriate is evaluated in relation to other qualitative characteristics.
Comparability supports the aims of users who seek to identify similarities and differences
between two or more pieces of information. There are two aspects to comparability:
• Uniformity supports comparisons between entities.
• Consistency supports comparisons over two or more periods of time.
Financial statements are viewed to have understandability and clear presentation when their
presentation is straightforward and easily understood. Vague wording, unnecessary use of
technical terms, or even excessive detail can diminish understandability. At the same time,
it can be assumed that users have a reasonable understanding of economic activities and
accounting and exercise reasonable diligence in their review of the information provided.
Elements of a Public Sector Financial Statement

The public sector financial reporting framework includes four primary elements:
1. Assets
2. Liabilities
3. Revenues
4. Expenses
Following from a characteristic of public sector reporting, as noted earlier, equity is not
among the elements of a public sector financial statement. When a public sector entity’s
assets are deducted from its liabilities, the residual is its accumulated surplus or deficit.
The asset element comprises two sub-elements:
1. Financial assets
2. Non-financial assets (including tangible capital assets)
The CICA PSA Handbook defines a public sector entity’s financial assets as assets that could
be used to discharge existing liabilities or finance future operations and are not for consump-
tion in the normal course of operations.
Public sector entities distinguish financial assets from non-financial assets to help users
identify the entity’s financial capacity. As many of the non-financial assets of a public sector
entity are held for service provision, they will not be available to generate future cash flows or
pay bills. Identifying financial assets separately in a public sector financial statement is one of
the two components of net debt, a critical indicator of a public sector entity’s financial posi-
tion (described further in the next section).
The definition of a financial asset in the CICA PSA Handbook is not the same as applied
in the Financial Instruments accounting standards that appear in the CICA Handbook,
Parts I–V. Within the CICA PSA Handbook, financial assets include:
• cash
• a realizable asset that is convertible to cash
• a contractual right to receive cash or another financial asset from another party
• a portfolio investment
• an investment in a government business enterprise or government business partnership
• a financial claim on an outside organization or individual
• an inventory or item for resale that meets the criteria set out in paragraph PS 1200.51.
All assets of a public sector entity are either financial or non-financial assets. Non-financial
assets include tangible capital assets and those other assets that are not used to discharge
liabilities, such as inventories of supplies.
The CICA PSA Handbook does not require the separate presentation of current and non-
current items. Liquidity risk is addressed in the notes to the financial statements.
Key Indicators of Public Sector Financial Reporting

The Financial Statement Presentation section of the CICA PSA Handbook requires govern-
ments and public sector entities to include indicators of financial position, the measure of
operating surplus or deficit, and other information for the benefit of financial statement
users. The statement of financial position must include two indicators: net debt and accu-
mulated surplus/deficit. The statement of operations measures operating surplus or deficit.
The statement of changes in net debt explains the difference between the operating surplus
or deficit and the change in net debt. Finally, the statement of cash flows reports on how cash
and cash equivalents were generated and used and on the change in cash and cash equivalents
during the period.
Other Presentation Differences

Applying the CICA PSA Handbook does not give rise to other comprehensive income.
However, remeasurement gains and losses can arise when there are unrealized gains and
losses associated with financial instruments or the translation of amounts denominated in a
foreign currency. When they arise, remeasurement gains and losses are reported in a separate
financial statement, the statement of remeasurement gains and losses.
As capital assets are generally acquired to provide services rather than to serve as an
investment, amounts associated with capital assets are reported in a separate category when
reporting on cash flows.
Illustration 10.3 compares and contrasts the elements and indicators of the public sector
reporting framework and other frameworks in use in Canada.
Illustration 10.3
Presentation PSAa NPOb IFRSc ASPEd
Contrasting the Elements
and Indicators Among Assets • Financial assets • Current assets • Current assets • Current assets
Reporting Frameworks • Non-financial • Non-current assets • Non-current assets • Non-current
assetse assets
Liabilities Liabilities • Current liabilities • Current liabilities • Current liabilities
• Non-current • Non-current • Non-current
liabilities liabilities liabilities
Financial • Net debt Net assets: • Shareholder • Shareholder
position • Accumulated • Permanently equity equity
surplus/deficit restricted • Retained • Retained
• Internally earnings earnings
restricted • Accumulated
• Unrestricted other
comprehensive
income
Separate funds No Optional, using
reported? either deferral Not applicable Not applicable
method or
restricted
fund method
Approaches to • Revenues • Revenues • Revenues • Revenues
presenting • Expenses • Expenses • Expenses • Expenses
changes in • Remeasurement • Amounts added • Other comprehensive
assets and gains and directly to income
liabilities losses net assets
Reporting • Operating • Operating • Operating • Operating
cash flow • Capital • Investing • Investing • Investing
• Investing • Financing • Financing • Financing
• Financing
a
The Public Sector Accounting (PSA) reporting framework applies to public sector entities except those govern-
ment organizations presenting their financial statements in accordance with standards that apply to publicly
accountable enterprises in the CICA Handbook, Part I (i.e., IFRS) or government not-for-profit organizations
that have elected to present their financial statements in accordance with the NPO reporting framework. The
application of GAAP by organizations controlled by governments is discussed in more detail in the section
“Reporting on Government Organizations” later in the chapter.
b
A government not-for-profit organization (NPO) applying the not-for-profit presentation model presents its cash
flows according to the PSA presentation model and when applicable, prepares a statement of remeasurement
gains and losses. The NPO reporting framework may be applied by not-for-profit organizations in both sectors.
c
International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards
Board in the CICA Handbook, Part I.
d
Accounting Standards for Private Enterprises (ASPE), the standards applicable to private enterprises, are
found in the CICA Handbook, Part II.
e
Recognition excludes art and historical treasures, intangible assets (other than software), and natural re-
sources and Crown lands (unless purchased).
Recognition of Items in Public Sector Financial Statements

Public sector entities applying the PSA reporting framework apply the recognition criteria
set out in the Financial Statement Concepts section of the CICA PSA Handbook. Recognition
is the process of including an item in the financial statements.
Two requirements must apply for an item to be recognized in public sector financial
statements.
1. The item must have an appropriate basis of measurement, and a reasonable estimate can
be made of the amount involved.
2. For an item that involves obtaining or giving up future economic benefits, it is expected
that such benefits will be obtained or given up.
The CICA PSA Handbook uses the word “expected” to convey that it is possible an item will
meet the definition of an element but still not be recognized in the financial statements
because it is not expected that future economic benefits will be obtained or given up or
because a reasonable estimate cannot be made of the amount involved. Expected is used with
its usual general meaning and refers to that which can reasonably be anticipated, contem-
plated, or believed based on available evidence or logic but is neither certain nor proved.
Specifically, the PSA reporting framework requires the following:
• Natural resources and Crown lands (other than assets that have been purchased) are not
recognized in the financial statements as assets because the costs, benefits, and economic
value of such items cannot be reasonably and verifiably quantified using existing methods.
• Art and historical treasures are not recognized in the financial statements as assets.
• Intangibles (other than computer software), including those that have been purchased,
developed, constructed, or inherited, are not recognized in the financial statements
as assets.
Recent Changes to Reporting by Government

Not-for-Profit Organizations
Government not-for-profit organizations (GNFPOs) adopted public sector accounting stan-
dards effective with fiscal years starting on or after January 1, 2012. However, as a transitional
step pending completion of a review of not-for-profit accounting, the PSAB determined
that it would allow those GNFPOs that choose not to immediately adopt the PSA reporting
framework to continue to apply the NPO reporting framework. The review is a joint effort
of the PSAB and the AcSB to improve accounting standards that apply to not-for-profit orga-
nizations in both the private and public sectors. Until this review is completed, GNFPOs
may elect to base their reporting on the CICA PSA Handbook, Sections PS 4200 to PS 4270.
The Handbook section Introduction to Accounting Standards that Apply only to Government
Not-for-Profit Organizations includes a table that sets out the applicability of other CICA
PSA Handbook sections to GNFPOs applying Sections PS 4200 to PS 4270.
✓ LEARNING CHECK
• The needs of users are the focus of the four objectives of public sector financial reporting.
• The qualitative characteristics describe the essential qualities of public sector financial
reporting.
• The elements of a public sector financial statement are assets, liabilities, revenues, and
expenses.
• The key indicators in a statement of financial position are net debt and accumulated surplus
(deficit). The key measure in the statement of operations is operating surplus (deficit).
NET DEBT INDICATOR

The Measure of Net Debt
Financial Assets − Liabilities = Net Debt
Objective 3 The measure of net debt is an indicator of a public sector entity’s financial position. Required
Define the net under the PSA reporting framework, it is an indicator of financial capacity or constraints
debt indicator facing the public sector entity. A net debt position is effectively a lien on the public sec-
and describe its
tor entity’s financial capacity. This is because the entity’s future revenue requirements are
relevance.
constrained by obligations associated with past decisions and events. In planning its future
revenue requirements, the entity will need to take into account the past obligations as well as
amounts needed to finance current services. As such, it is an important indicator of financial
sustainability. When an entity’s financial assets exceed its liabilities, it has net financial assets.
Unlike a business, a public sector entity’s non-financial assets may not generate signifi-
cant cash flows. Consequently, non-financial assets are not part of this financial indicator.
The PSA reporting framework requires that this indicator be prominently displayed and
that an additional financial statement, the statement of changes in net debt, be presented to
inform users and support trend analysis. An illustration is provided in Illustration 10.4.
Illustration 10.4
Statement of financial position
Simplified Illustration of
Net Debt Indicator 3 2013 2012
Financial assets $10,912 $ 10,348
Net debt (7,350) (8,823)
Non-financial assets 7,360 7,457
Accumulated surplus (deficit) $ 10 $ (1,366)
Relevance of Net Debt

Due to the nature of their mandates or constraints placed upon them, many government orga-
nizations are not financially self-sustaining and are dependent on grants or appropriations to
continue operations. Although the financial position of these organizations may be such that
their financial assets exceed their liabilities (a “net financial asset” position), the indicator pro-
vides useful information as it indicates financial capacity available for service provision.
The non-financial assets of the public sector entity are valuable, but they are often by
nature prepaid service potential and are not as liquid as financial assets.
Legislative Control and Government

Financial Accountability
Governments and government organizations continue to make widespread use of fund
accounting. In some cases, the application of fund accounting as a management tool flows
from budget processes that require more information about the sources and their applica-
tion (i.e., operating or capital). In many cases, legislative requirements underlie these budget
processes. Alternatively, the use of fund accounting may reflect a structural approach to the
entity’s management of finances.
3
Source: “PSAB–What It Is and What It Does,” PSAB, 2007, p. 6. Reprinted by permission of PSAB.
Net Debt Indicator 521
Although public sector entities make widespread use of fund accounting, it is not well
understood by most financial statement users. Under fund accounting, it can be difficult for
users to quickly ascertain an entity’s financial position or operating results, as the focus is on
reporting results associated with individual funds. Funds may appear to be restricted in their
use and not available, when those restrictions are largely in the hands of managers and/or
those in an oversight role. It is for these reasons that the PSA reporting framework shows
funds on a combined basis. Under the PSA reporting framework, the operating surplus or
deficit is a measure that demonstrates whether the asset position of the public sector entity
has been maintained.
In support of public accountability, the PSA reporting framework requires the operating
and change in net debt statements to include a comparison of the results of the accounting
period with those originally planned. When the basis of a budget preparation varies from
generally accepted accounting principles, the public sector entity shows the planned results
on the same basis it used to report the results of the current period. As well, when a public
sector entity has exceeded its revenue, borrowing, expense, or expenditure authority limits,
this is disclosed in the notes to the financial statements.
Due to the size and complexity of government, managers may employ other techniques,
such as encumbrance accounting, for control and management purposes. Encumbrance
accounting assists managers by establishing earmarks against approved spending. Often, these
earmarks are recorded at the point in the accounting cycle when a purchase order is approved.
The encumbrance is recorded before there is a liability, as the goods ordered have not yet been
delivered. The earmark serves to remind managers that a commitment to spend budgeted funds
has been made. This helps ensure that at the end of the accounting cycle, a budget amount is
not exceeded. Although some governments apply encumbrance accounting for management
purposes, encumbrances are not liabilities and consequently are not recorded in ledger balances
reported on in general purpose financial statements (as discussed in Appendix 9A).
To help in understanding the typical layout of a set of public sector financial statements,
we present two examples. Illustration 10.5 provides the financial statements of a local gov-
ernment, the City of Winnipeg. The financial statements of another government organi-
zation prepared in accordance with the public sector reporting framework appear later in
Illustration 10.9. The PSAB does not prescribe the form of financial statements presented in
accordance with its framework; however, the key indicators must be evident. Other presenta-
tion approaches are possible.
Illustration 10.5
Excerpts from the
Consolidated Financial As of December 31 (in thousands of dollars) 2010 2009
Statements: City of Financial Assets
Winnipeg Cash and cash equivalents $ 422,125 $ 401,145
Land held for resale 15,150 12,467
Investment in government businesses 23,563 23,266
953,103 897,528
Liabilities
Accounts payable and accrued liabilities 145,266 139,020
Deferred revenue 71,428 50,943
Debt 496,402 479,492
Retirement allowance, vacation, compensated
absences and other 145,873 144,288
904,500 860,625
Net Financial Assets 48,603 36,903
Non-Financial Assets
Tangible capital assets 4,447,995 4,291,354
Inventories 16,043 15,333
Prepaid expenses and deferred charges 6,073 5,906
4,470,111 4,312,593
Accumulated Surplus $ 4,518,714 $ 4,349,496
Illustration 10.5
Consolidated Statement of Operations and Accumulated Surplus
(Continued)
For the years ended December 31 Budget Actual Actual
(in thousands of dollars) 2010 2010 2009
Revenues
Taxation $ 549,330 $ 550,994 $ 534,571
Sales of services and regulatory fees 443,640 425,164 413,243
Government transfers 142,092 144,910 134,710
Land sales and other revenue 53,057 47,914 28,573
Investment income 36,381 34,769 39,488
Total revenues 1,224,500 1,203,751 1,150,585
Expenses
Protection and community services 386,050 390,421 362,341
Utility operations 310,509 301,637 278,848
Public works 261,291 264,543 270,877
Property and development 116,842 101,588 97,958
Finance and administration 73,486 66,405 61,575
Civic corporations 25,786 31,532 29,582
General government 30,405 28,512 49,252
Total Expenses 1,204,369 1,184,638 1,150,433
Excess Revenues Over Expenses
Before Other 20,131 19,113 152
Other
Government transfers related
to capital 130,871 106,976 122,113
Developer contributions-in-kind
related to capital 25,000 43,129 70,950
155,871 150,105 193,063
Excess Revenues Over Expenses $ 176,002 169,218 193,215
Accumulated Surplus, Beginning of Year 4,349,496 4,156,281
Accumulated Surplus, End of Year $ 4,518,714 $ 4,349,496
Consolidated Statement of Change in Net Financial Assets
Budget
For the years ended December 31 2010 Actual Actual
(in thousands of dollars) (unaudited) 2010 2009
Excess Revenues Over Expenses $ 176,002 $ 169,218 $ 193,215
Amortization of tangible capital assets 168,452 165,857 155,382
Proceeds on disposal of tangible capital assets 25,000 28,178 6,018
(Gain) loss on sale of tangible capital assets (23,784) (20,525) 1,875
Change in inventories, prepaid expenses,
and deferred charges 2,600 (877) (1,127)
Acquisition of tangible capital assets (439,548) (333,851) (384,110)
Other — 3,700 (12,200)
Increase (Decrease) In Net Financial Assets (91,278) 11,700 (40,947)
Net Financial Assets, Beginning Of Year 36,903 36,903 77,850
Net Financial Assets, End Of Year $ (54,375) $ 48,603 $ 36,903
Consolidated Statement of Cash Flows

For the years ended December 31
Net Inflow (Outflow) of Cash Related To The Following Activities:
Operating
Excess Revenues Over Expenses $ 169,218 $ 193,215
Non-cash charges to operations
Amortization 165,857 155,382
Other (17,956) 20,804
317,119 369,401
Net change in non-cash working capital
balances related to operations (27,635) (29,497)
Cash provided by operating activities 289,484 339,904
Capital
Acquisition of tangible capital assets (333,851) (384,110)
Proceeds on disposal of tangible capital assets 28,178 6,018
Cash used in capital activities (305,673) (378,092)
Net Debt Indicator 523
Illustration 10.5
(Continued) Financing 2010 2009
Increase in sinking fund investments (19,662) (27,386)
Sinking fund investments applied to debt redemption — 104,519
Debenture and serial debt retired (19,931) (149,878)
Sinking fund and serial debenture issued 60,000 48,480
Other (3,405) 26,864
Cash provided by financing activities 17,002 2,599
Investing
Decrease of investments 20,167 12,141
Cash provided by investing activities 20,167 12,141
Increase (decrease) in cash and cash equivalents 20,980 (23,448)
Cash and Cash Equivalents, Beginning of Year 401,145 424,593
Cash and Cash Equivalents, End of Year $ 422,125 $ 401,145
The City of Winnipeg’s key indicators of financial position are readily evident on its
consolidated statement of financial position. As the city’s financial assets exceed its liabili-
ties, in 2010 it had net financial assets of $48,603. This is an increase of $11,700 over the
2009 balance of $36,903. This indicates that the city’s ability to finance future services
has increased modestly. In 2010, the city reported an accumulated surplus of $4,518,714.
The increase in the accumulated surplus over the 2009 balance of $4,349,496 is due to an
excess of revenues over expenses of $169,218, as reported on the statement of operations.
As municipalities are not sovereign governments, they face constraints on their ability to
issue debt. As a result, municipalities often report “net financial assets,” unlike most sover-
eign governments, which are in a financial position of “net debt” (financial assets exceeding
liabilities).
The consolidated statement of change in net financial assets explains why the City’s
2010 surplus of $169,218 is substantially greater than its increase in net financial assets of
$11,700. Much of this difference is accounted for by the spending of $333,851 on capital
assets, whereas the amortization of its current stock of tangible capital assets amounts to
only $165,857. Governments are under constant pressure to spend to improve infrastruc-
ture. However, unlike the private sector, spending on capital does not usually improve the
government’s future cash flows. Because spending on infrastructure does not immediately
affect the measure of annual surplus or accumulated surplus or deficit, it is important to
monitor the change in a government’s net debt (or in the case of Winnipeg, its net financial
assets), to determine whether spending on infrastructure is outpacing increases in financial
capacity.
In Winnipeg’s case, the fact that the city’s financial assets exceed its liabilities suggests
that its residents need not be concerned. Users can see from the consolidated statement of
change in net financial assets that 2010’s spending on tangible capital assets of $333,851 is
significantly less than the amount council budgeted, which was $439,548. It is not unusual for
capital projects to proceed more slowly than budgets allow for. As well, the cost of replacing
infrastructure is generally higher than when it was originally constructed, so it is common for
capital spending to exceed amortization expense.
From the statement of operations and accumulated surplus, users can see that in 2010,
the city recognized $150,105 in revenue associated with transfers from governments and
developer contributions in support of its capital spending. From the statement of operations,
it is apparent that much of the city’s operating surplus of $169,218 is attributable to the
capital contributions of $150,105, as the excess of revenues before these items is $19,113.
Including budget figures alongside each line of revenue and expense supports accountability
for the spending approved by council in the budget.
The statement of cash flows confirms the information about the city’s capital activities
and provides other insights into its operating results. As the CICA PSA Handbook requires,
the city presents cash used in capital activities separately from its financing activities.
Accordingly, it is evident that the city raised net financing in the amount of $17,002 in 2010
by issuing new debentures totalling $60,000 net of contributions made to sinking funds, debt
retirement, and other applications of cash.
A full discussion and analysis of these financial statements would be significantly more exten-
sive. These observations illustrate key differences between private and public sector financial
reporting that enhance a reader’s understanding of a government’s financial position and results.
✓ LEARNING CHECK
• Net debt is an indicator of the financial capacity or constraints facing the public sector entity.
• Funds are presented on a combined basis in financial statements under the PSA reporting
framework. This aids in understanding financial capacity or constraints facing the public
sector entity.
• To support accountability, the operating and change in net debt statements include a
comparison of results with budget.
REPORTING ON GOVERNMENT
ORGANIZATIONS
Assessing Control of a Government Organization
Objective 4 Sovereign governments—the federal government and the provinces—are large and complex.
Describe the In addition to the ministries and departments that report to the legislature, the reporting
reporting on entity comprises those organizations that a government controls.
government
Properly defining the reporting entity is of fundamental importance to the integrity of
organizations.
financial reporting for all sectors. One of the factors that led to the downfall of energy giant
Enron Corporation was that many users of its financial statements felt they were incom-
plete when it was revealed that obligations associated with certain related partnerships were
not included in the consolidated accounts. In the case of governments, a critical element of
accountability is a complete accounting for the use of resources and the degree to which bor-
rowing has occurred. The omission of an organization with significant debt obligations or
operating deficits may affect the usefulness of the financial statements, because the picture
presented to users is incomplete.
The CICA PSA Handbook defines a government organization as an organization that
is controlled by the government. Determining whether or not an entity is controlled can
be challenging. Unlike the private sector, many government organizations are organized
without share capital. Funding by a government is not an indicator of control as financial
dependence alone may not provide a government with the ability to control an organization’s
financial and operating policies.
Who gets to control an organization’s financial and operating policies is the focus when
assessing control because that determines how an organization conducts its activities. There
are a variety of ways the financial and operating policies of an organization may be set. The
facts and circumstances are assessed at two levels in the Government Reporting Entity section
of the CICA PSA Handbook. If any one of the primary criteria is met, as set out in Illustration
10.6, the organization is considered to be controlled by the government and no further
consideration need be given.
Illustration 10.6
Any of the following three criteria4 are considered to be evidence that a government organization is con-
Primary Criteria when trolled by a government. The government may:
Evaluating Control
1. establish an organization’s fundamental purpose and eliminate or significantly limit the organiza-
tion’s ability to make future decisions by predetermining its financial and operating policies;
2. direct the financial and operating policies of an organization on an ongoing basis; or
3. veto, overrule, or modify the financial and operating policies established by an organization.
4
CICA PSA Handbook, Section PS 1300, par. 14.
Reporting on Government Organizations 525
If none of the primary criteria is met, an organization may still be part of the govern-
ment reporting entity. The CICA PSA Handbook requires a further evaluation to determine
whether other indicators of control are present. This secondary evaluation involves consider-
ing indicators that constitute “persuasive evidence” and “other indicators” of control. The
criteria are summarized in Illustration 10.7. When it is necessary to make an assessment apply-
ing the indicators of control, the CICA PSA Handbook states that “professional judgment must
be applied in assessing the particular circumstances in each case. In some situations, a particu-
lar indicator may provide a high degree of evidence of control whereas, in other situations, the
importance of the same indicator may not be as significant.”5
Illustration 10.7
When none of the primary criteria is in evidence, the process of assessing control extends to evaluating
Secondary Criteria when
secondary criteria. These secondary criteria are divided into those that contribute persuasive evidence
Evaluating Control
and other indicators.6 They are summarized below.
Persuasive
• Power to unilaterally appoint or remove a majority of the members of the organization’s governing body
• Ongoing access to the organization’s assets, the ability to direct the ongoing use of those assets, or
ongoing responsibility for losses
• Voting control arising from share ownership that confers the power to govern the organization’s
financial and operating policies
• Unilateral power to dissolve the organization and thereby access its assets and become responsible
for its obligations
Other indicators involve the power to:

• Provide significant input into the appointment of members of the organization’s governing body by
appointing a majority of those members from a list of nominees provided by others or being other-
wise involved in the appointment or removal of a significant number of members
• Appoint or remove the CEO or other key personnel
• Establish or amend the organization’s mission or mandate
• Approve the business plans or budgets and require amendments
• Establish borrowing or investment limits or restrict the organization’s investments
• Restrict the organization’s revenue-generating capacity, notably its sources of revenue
• Establish or amend management policies, such as those relating to accounting, personnel, compen-
sation, collective bargaining, or deployment of resources
Types of Government Organizations

When a government organization is required or chooses to issue general purpose financial
statements, it consults the Introduction to Public Sector Accounting Standards in the CICA
PSA Handbook to ascertain an appropriate basis of GAAP. The Introduction describes three
types of government organizations:
1. government business enterprises
2. government not-for-profit organizations
3. other government organizations
The Introduction sets out the characteristics of each of the three types of government orga-
nizations and the source of GAAP applicable to those organizations. Illustration 10.8 sum-
marizes the criteria that determine the category of the government organization, the source
of GAAP the government organization applies in reporting to its stakeholders, and how the
results of the government organization are reported on within the summary financial state-
ments of a government.
5
CICA PSA Handbook, Section PS 1300, par. 21.
6
CICA PSA Handbook, Section PS 1300, par. 18–19.
Illustration 10.8
Presentation in
Types of Government
Source of GAAP Government Financial
Organizations and Their
Type of Organization and Defining Characteristics (for the Entity) Statements
Financial Reporting
Government Business Enterprises IFRS Modified Equity
All of the following apply:
1. Separate legal entity with the power to

contract in its own name and that
can sue and be sued
2. Delegated the financial and operational

authority to carry on a business
3. Sells goods and services to individuals and

organizations outside of the government
reporting entity as its principal activity
4. Can maintain operations and meet its liabilities

from revenues received from sources outside
of the government reporting entity
Government Not-for-Profit Organizations
Has the characteristics of a not-for-profit organization PSA Consolidate
and has counterparts outside the public sector or on a line-by-line basis
PS 4200 ⴙ PSA
Other Government Organizations PSA Consolidate
All other organizations controlled by the government. or IFRS on a line-by-line basis
Government Business Enterprises

Government organizations are created to manage and conduct activities within their area
of authority. Although the activities of some government organizations may be quasi-
commercial, public policy may dictate that government control the operations for social pol-
icy reasons or to ensure public access. When the government organization meets all of the
four criteria set out in Illustration 10.8, for financial reporting purposes it is a government
business enterprise (GBE).
In many cases, government organizations that conduct lotteries, distribute liquor, and
generate or distribute electricity fulfill the four criteria. It is important to note that the orga-
nization is a GBE not because of the nature of the service it provides, but because all four
criteria are met. For example, entities offering public transit services rarely qualify as GBEs
because few are fully self-sustaining. As well, when governments create organizations to man-
age their real estate holdings, such entities are rarely GBEs as their primary customers are the
government organizations and ministries that are their tenants.
When the PSAB deliberated on the accounting framework for GBEs, it focused on the
needs of users. It directed GBEs to apply the standards applicable to publicly accountable
enterprises in the CICA Handbook, Part I (i.e., IFRS), because a principal focus of a GBE is to
sell goods and services. The PSAB felt this enables comparisons between entities providing
similar services, whether part of the public sector or the private sector.
Government Not-for-Profit Organizations

Many government organizations fall into this category. This is because a primary func-
tion of government is the provision of services, often for little or no charge. A government
not-for-profit organization (GNFPO) is an organization that has the characteristics of a
not-for-profit organization and has counterparts outside the public sector. Private sector not-
for-profit organizations report to their stakeholders using Part III of the CICA Handbook. In
support of comparability, the PSAB established the GNFPO category and allows GNFPOs
to use the not-for-profit presentation model.
The not-for-profit presentation model was introduced to support the needs of organiza-
tions applying fund accounting. Other standards applicable only to not-for-profit organi-
zations address topics of specific interest to them, including accounting for contributions,
capital assets held by not-for-profit organizations, and reporting on controlled and related
organizations. Until the PSAB added the CICA PSA Handbook sections addressing matters
that are unique to not-for-profit organizations,7 GNFPOs were directed to use what were the
standards applicable to not-for-profit organizations in the CICA Handbook.
Since 2012, GNFPOs have been directed to apply:
• the CICA PSA Handbook without reference to Sections PS 4200 to PS 4270; or
• Sections PS 4200 to PS 4270, referencing other sections in the CICA PSA Handbook
when a matter is not addressed by requirements in the PS 4200 series.
Using the standards applicable to not-for-profit organizations by GNFPOs has been con-
troversial, as those standards use the matching concept (which is not among the concepts
underlying PSA, IFRS, or ASPE). As well, comparability among not-for-profit organizations
is diminished by choices provided within these standards, such as the option to recognize
revenues using either the deferral method or the restricted fund method.
Given these issues and the need to update the standards applicable to not-for-profit orga-
nizations, a review of the content of Sections PS 4200 to PS 4270 is underway. The review is
a joint effort of the PSAB and the AcSB. As replacement standards are approved, the current
sections in the PS 4200 series are likely to be withdrawn. Ultimately, it is expected that all
government organizations (other than GBEs) will present their results based on a common
framework. The GNFPO category could then disappear. Given this expectation, some gov-
ernments have already directed GNFPOs they control to apply the CICA PSA Handbook
without reference to Sections PS 4200 to PS 4270.
Other Government Organizations

The final category of government organization comprises all organizations that are not
GBEs or GNFPOs. The CICA PSA Handbook is considered to generally meet the needs of
users of general purpose financial statements of other government organizations (OGOs).
The Introduction to the CICA PSA Handbook recognizes that there may be circumstances
when the use of IFRS standards applicable to publicly accountable enterprises in the CICA
Handbook, Part I may be a more appropriate reporting framework. The factors that are con-
sidered are set out in the Introduction.
All OGOs issuing general purpose financial statements must apply either the CICA PSA
Handbook or IFRS. Illustration 10.9 illustrates application of the PSA reporting framework by
a public sector entity in the category of other government organization, the Yukon Housing
Corporation. Other presentation approaches are possible.
Illustration 10.9
Excerpts from the YUKON HOUSING CORPORATION
Financial Statements Statement of Financial Position
of the Yukon Housing as of March 31, 2010
Corporation 2010 2009
(thousands of dollars)
Financial Assets
Cash and cash equivalents $ 11,106 $ 3,241
Due from Canada Mortgage and Housing Corporation 308 365
Accounts receivable–other 1,709 688
Housing held for sale 358 982
Loans receivable 44,070 52,888
57,551 58,164
Liabilities
Bank indebtedness — 1,950
Accounts payable and accrued liabilities 3,700 1,576
Due to Government of Yukon 1,152 3,363
Deferred revenues 1,193 955
Deferred revenues–economic stimulus funding 10,543 —
Deferred revenues–Seniors’ Housing Management Fund 3,609 3,609
7
CICA PSA Handbook, Sections PS 4200 to PS 4270.
Illustration 10.9
2010 2009
(Continued)
Post-employment benefits 1,331 809
Advances–Government of Yukon 11,125 10,510
69,644 71,158
Net debt (12,093) (12,994)
Non-financial assets
Tangible capital assets 34,840 24,548
Less deferred capital contributions (22,826) (11,554)
Prepaid expenses 79 —
12,093 12,994
Accumulated surplus $ — $ —
YUKON HOUSING CORPORATION

Statement of Operations and Accumulated Surplus
for the year ended March 31, 2010
2010 2009
Main Estimates Actual Actual
Revenues
Rental income $3,577 $4,565 $4,433
Funding from Canada Mortgage and
Housing Corporation
- Social Housing Agreement 4,456 4,561 4,566
- Economic stimulus funding — 2,795 —
Interest income 2,371 2,158 2,275
Recovery from Government of Yukon, — 1,145 —
Department of Health and Social Services
Recovery of corporate services costs — 1,107 —
Recovery for Flood Relief program 1,135 696 676
Recovery of subsidy expense — 185 86
Amortization of deferred Canada Mortgage
and Housing Corporation capital contributions 48 52 10
Other 20 33 83
11,607 17,297 12,129

Expenses
Program costs 12,200 14,760 12,789
Corporate services costs — 2,472 —
Administration 1,893 1,505 1,307
Interest on long-term debt 1,628 1,342 1,464
Grants to flood victims 1,261 1,218 1,052
Construction costs for Children’s Receiving
Home — 1,145 —
Shared services costs 1,787 — 1,676
18,769 22,442 18,288
Deficit for the year before government funding $(7,162) (5,145) (6,159)
Government of Yukon funding
Operating grant 3,138 4,874
Amortization of deferred capital contributions 1,505 783
Rental assistance – in-kind 502 502
5,145 6,159
Surplus for the year — —
Accumulated surplus at beginning of year — —
Accumulated surplus at end of year $ — $ —
Illustration 10.9
(Continued)
Statement of Change in Net Debt
2010 2009
Main Estimates Actual Actual
Surplus for the year $— $— $—
Effects of change in tangible capital assets
Acquisitions (9,200) (12,829) (1,943)
Capital contributions received and deferred 9,200 12,829 1,943
Amortization of tangible capital assets 2,162 2,199 2,082
Amortization of deferred capital contributions — (1,219) (793)
Write-down of tangible capital assets — 233 38
Disposal of tangible capital assets (net
book value) — 105 99
Reduction of deferred capital contributions — (338) (95)
2,162 980 1,331
Effect of change in other non-financial assets
(Increase) decrease in prepaid expenses — (79) 133
— (79) 133
Decrease in net debt $2,162 901 1,464
Net debt at beginning of year (12,994) (14,458)
Net debt at end of year $(12,093) $(12,994)

Statement of Cash Flow
2010 2009
Operating transactions
Surplus for the year $ — $ —
Government of Yukon funding (5,145) (6,159)
Recovery of non-capitalized expenditures (2,795) —
Adjustments for non-cash items
Building services – in-kind 502 502
Increase in post-employment benefits 522 93
Amortization of tangible capital assets 2,199 2,082
Amortization of deferred Canada Mortgage and Housing
Corporation capital contributions (52) (10)
Mortgages receivable valuation (recovery) expenses (253) 39
Loss on disposal and write-down of tangible capital assets 272 42
Loss on disposal of housing held for sale 9 —
(4,741) (3,411)
Changes in non-cash components of working capital (892) 2,668
Cash used for operating transactions (5,633) (743)
Capital transactions
Acquisition of tangible capital assets (12,809) (1,874)
Government of Yukon funding received for acquisition of tangible
capital assets 537 1,943
Proceeds on sale of tangible capital assets 13 —
Cash (used for) provided by capital transactions (12,259) 69
Investing transactions
Proceeds on sale of housing held for sale 572 —
Additions to housing held for sale — (961)
Additions to mortgages and agreement receivable (7,314) (17,505)
Repayments of mortgages and agreements receivable 18,348 14,049
Cash provided by (used for) investing transactions 11,606 (4,417)
Financing transactions
(Decrease) increase in bank indebtedness (1,950) 1,950
Repayment of long-term debt (13,282) (2,529)
2010 2009
Advances–economic stimulus funding 25,630 —
Advances from the Government of Yukon 3,753 5,811
Cash provided by financing transactions 14,151 5,232
Increase in cash and cash equivalents 7,865 141
Cash and cash equivalents at beginning of year 3,241 3,100
Cash and cash equivalents at end of year $11,106 $3,241
Supplemental disclosure of cash flow information
Interest paid $1,364 $1,488
Interest received 2,332 2,393
Other government organizations, such as the Yukon Housing Corporation, use the same
presentation model as governments. The key indicators—net debt and accumulated surplus
(deficit)—need to be evident on the statement of financial position. In 2010, the Corporation
reported a net debt of $12,093, representing a decrease of $901 from 2009. Net debt can be
important in understanding the financial position of a government organization. In this case, it
illustrates that the non-financial assets, essential to the organization’s service delivery functions,
are financed through its debt obligations. Under its funding model, no surplus is retained.
The statement of operations provides insights into how the Corporation’s programs are
funded. While a portion of its operating funds comes from rental income, funds also come
from the Canada Mortgage and Housing Corporation and the government that controls the
Corporation, the Government of Yukon. Inclusion of budget figures (described as “main esti-
mates”) helps readers identify differences between planned and actual results. To highlight
certain financial support provided by the Government of Yukon, management has included a
line showing the deficit before government funding. The reporting model allows public sec-
tor entities a reasonable degree of flexibility in presenting their operating results, as funding
arrangements vary among government organizations. When government organizations can
retain a surplus or deficit, the financial statements will report this amount.
The statement of cash flows illustrates the Corporation’s significant capital activity
undertaken in 2010 and its funding. Under the PSA presentation framework, cash applied to
capital activities is reported on in a separate category, with $12,829 applied in 2010 to acqui-
sitions. The statement also shows that advances through economic stimulus funding and the
Government of Yukon were important sources of cash to finance the entity’s activities.
Reporting on the Results

of Government Organizations
As Illustration 10.8 shows, all government organizations other than GBEs are consolidated
line by line when a government prepares its summary financial statements. The modified
equity basis is used when governments report on their GBEs.
The mechanics of the consolidation requirements are indicated in the sections Basic
Principles of Consolidation and Additional Areas of Consolidation, in the CICA PSA
Handbook. Requirements are generally similar to those applied by profit-oriented enterprises.
Unrealized gains and losses are eliminated as well as transactions and balances between
governmental units. Differences arise when a government accounts for a non-controlling
interest, where proportionate consolidation applies, and in how the purchase method is
applied, where any residual or goodwill is expensed at the date of acquisition. A more detailed
discussion of consolidation is beyond the scope of this text.
When a government reports on a GBE, it does so applying the modified equity method.
Under the modified equity method, financial position and operating results are presented as
they are using the equity method, in that the net asset position is shown as a single line on the
statement of financial position and the operating results are shown as a single line on the state-
ment of operations. When a GBE reports other comprehensive income, under the CICA PSA
Handbook it is reported on a single line on the statement of remeasurement gains and losses.
What makes modified equity accounting different from equity accounting? Under the modi-
fied equity method, no adjustments are made to conform the financial position or operating
results of the GBE to the accounting principles followed by the government. This differ-
ence is significant as the CICA PSA Handbook requires GBEs to base their financial reporting
on the IFRS standards applicable to publicly accountable enterprises in the CICA Handbook,
Part I. The modified equity method relieves governments from undertaking to conform
accounts prepared in accordance with IFRS with the CICA PSA Handbook.
Reporting on Government Partnerships

Public sector entities may involve themselves in economic activities where the parties share
control. These economic interests or investments are described as government partnerships.
This definition is provided in the section Government Partnerships in the CICA PSA Handbook:
A government partnership is a contractual arrangement between the government and a party
or parties outside of the government reporting entity that has all of the following characteristics:
(a) the partners cooperate toward achieving significant clearly defined common goals;
(b) the partners make a financial investment in the government partnership;
(c) the partners share control of decisions related to the financial and operating policies of the
government partnership on an ongoing basis; and
(d) the partners share, on an equitable basis, the significant risks and benefits associated with
the operations of the government partnership.
There are also requirements that apply to a specialized form of government partnership
defined as a government business partnership. The definition is provided in the section,
Government Partnerships, in the CICA PSA Handbook:
A government business partnership is a government partnership that has all of the
following characteristics:
(a) it is a separate legal entity with the power to contract in its own name and that can sue
and be sued;
(b) it has been delegated the financial and operational authority to carry on a business;
(c) it sells goods and services to individuals and organizations other than the partners as its
principal activity; and
(d) it can, in the normal course of its operations, maintain its operations and meet its
liabilities from revenues received from sources other than the partners.
Government partnerships may take various forms, including:
• operations under shared control
• assets under shared control
• organizations under shared control
A government reports on its economic interest in a government partnership in two ways.
Government business partnerships are reported on using the modified equity method.
Government partnerships other than government business partnerships are reported on
using proportionate consolidation.8 The CICA PSA Handbook does not specify the appro-
priate source of GAAP to be applied when a government partnership reports to its stakehold-
ers. When a government partnership issues general purpose financial statements, legislation
or the partners themselves determine the appropriate source of GAAP.
Although public-private partnerships can be government partnerships, upon closer
examination many of these arrangements do not evidence shared control over decision-
making. Understandably, few private sector contractors are willing to enter into business
8
Application of the proportion consolidation method is described in Additional Areas of Consolida-
tion, Section PS 2510, par. 06. Generally, accounting policies are conformed to those used by the
reporting entity and a proportionate share of the assets, liabilities, revenues, and expenses is included
on a line-by-line basis after eliminating any interorganizational balances.
arrangements that share decision-making with governments. For this reason, many accountants
view the term “public-private partnership” to be a misnomer. Government partnerships are
most commonly partnerships between governments, such as when two or more local govern-
ments share control over a recycling collection program or a landfill site. A partnership between
entities within the same government reporting entity is not a government partnership.
✓ LEARNING CHECK
• Control of financial and operating policies is the focus when assessing control.
• Three types of government organizations are described in the Introduction to the CICA PSA
Handbook.
• Except for GBEs, all government organizations are consolidated. GBEs are accounted for using
the modified equity method.
• Government partnerships evidence shared control between the parties.
TRANSACTIONS UNIQUE TO
PUBLIC SECTOR ENTITIES
Objective 5 As we have seen, the CICA PSA Handbook exists because governments are inherently different
Record transactions from businesses. Governments and their organizations exist to provide services and redistribute
unique to public resources, not to make a profit. They have different relationships with their stakeholders, many
sector entities. of whom are interested in the capacity of government to provide services in a sustainable manner.
In this section, we will explore transactions unique to public sector entities. As the focus
here is on the concepts, we will refer to the underlying standards if you wish to explore these
topics in greater detail. Topics addressed within the CICA PSA Handbook include:
• Portfolio investments with concessionary terms
• Loans receivable, including:
• loans to be repaid through future appropriations
• forgivable loans
• loans with significant concessionary terms
• Liability for contaminated sites
• Solid waste landfill closure and post-closure liabilities
• Loan guarantees
• Government transfers
• Tax revenue
Portfolio Investments with Concessionary Terms

For public policy reasons, governments will on occasion invest in outside entities. When the
investment represents less than a control position, it is considered a portfolio investment
(unless there is shared control that constitutes a government partnership). In some cases the
nature of the investment can be considered so concessionary that little or no financial return
is expected and the circumstances may be such that it is unlikely that the invested capital will
be recovered. When this is the case, the substance of the transaction is that all or a significant
part of the investment may be a grant.
The section Portfolio Investments in the CICA PSA Handbook requires that the portion of
portfolio investment that the government does not expect to recover (the grant) be recognized
as an expense. Further, if there is a remaining portion upon which repayment is expected, this
portion is discounted using present value techniques, when the terms are concessionary. Loans
with interest rates less than prevailing commercial conditions are viewed as concessionary.
Transactions Unique to Public Sector Entities 533
Loans Receivable
The section Loans Receivable in the CICA PSA Handbook addresses the accounting for vari-
ous types of loan arrangements that governments may enter into for public policy reasons.
Loans to Be Repaid Through Future Appropriations

When it is expected that loan repayments will be made from future appropriations (grants
or other transfers), the loan receivable is accounted for as expense. A financial asset is not
recorded by the government making the loan as the government will not receive any resources
from the loan transaction that could be used to discharge existing liabilities or finance future
operations. As such, the loan does not meet the definition of a financial asset.
Forgivable Loans
The accounting for forgivable loans is also addressed in the section Loans Receivable of the CICA
PSA Handbook. Paragraph PS 3050.18 states “a forgivable loan is one which includes, in the terms
of the loan agreement, conditions under which the principal and any accrued interest would be
forgiven.” A forgivable loan is accounted for as a grant (i.e., expensed) unless it qualifies as a loan
receivable (i.e., can be considered a financial asset) and there is sufficient evidence of its recovery.
Loans with Significant Concessionary Terms

The third specialized topic addressed in Loans Receivable in the CICA PSA Handbook is loans
with significant concessionary terms. The requirements that apply are equivalent to those
that apply to portfolio investments with concessionary terms. That is, paragraph PS 3050.20
states: “when the terms of a loan are so concessionary that the substance of the transaction is
more in the nature of a grant, the grant portion of the transaction should be recognized as an
expense when the loan is made.”
Liability for Contaminated Sites

The recommendations contained in the section Liability for Contaminated Sites in the CICA
PSA Handbook were developed to address the reality that governments at all levels manage
sites that are contaminated and that will at some point require remediation. Contamination
can be due to air, soil, water, or sediment of a chemical, organic, or radioactive material
or live organism. A liability for remediation is recognized when all of the following criteria
are met:
• an environmental standard exists
• the contamination exceeds an environmental standard
• a public sector entity is directly responsible, or accepts responsibility
• economic benefits are expected to be given up
• a reasonable estimate of the costs can be made
The liability is measured based on the costs directly attributable to the anticipated remedia-
tion activities. This includes operation, maintenance, and monitoring of the site. The cost
of any assets dedicated to these purposes that do not have an alternative use form part of the
amount accrued. This is noteworthy because recording the value of these assets as part of
liability means that they are expensed when this liability is set up. When these activities are
expected to occur over a long period, net present value techniques are used to discount the
liability. The liability is reduced by any recoveries expected to be received.
It is important to note that the focus of the standard is on environmental contamination
that currently exists, not the accounting for obligations associated with the retirement of an
asset in the future (as is the case with asset retirement obligation standards). In December
2011, the PSAB approved a project aimed at developing an asset retirement obligation stan-
dard for the public sector.
Solid Waste Landfill Closure and

Post-Closure Liabilities
The section Solid Waste Landfill Closure and Post-Closure Liability in the CICA PSA
Handbook addresses the recognition and measurement of closure and post-closure care of
these specialized facilities. Accounting for these obligations can be challenging as closure
costs can be difficult to estimate and post-closure care can extend well into the future. A
liability is recorded as soon as the site starts accepting waste. The expense reported is based
on a proportion of the waste accepted in each period of operation. The liability builds as
capacity diminishes. The liability at each financial reporting date is based on the formula set
out in Illustration 10.10.
Illustration 10.10
Accumulating the
° ¢
Estimated total Cumulative capacity used Expenditures previously
Closure and Post-Closure ⫻ ⫺
expenditure Total estimated capacity recognized
Liability
The value attributable to estimated total expenditure is based on the sum of the esti-
mated future cash flows discounted at the government’s average long-term borrowing rate.
Illustration 10.11 illustrates the information disclosed when reporting on closure and post-
closure liabilities by the City of Peterborough, Ontario.
Illustration 10.11
Solid waste landfill closure and post closure
Excerpt from the City
The solid waste landfill closure and post-closure liability of $3,919,468 (2009 ⫺ $3,576,737) is for
of Peterborough 2010
closure and post-closure costs of the Peterborough County-City Waste Management Facility. During
2010, the site currently referred to as the North Fill Area received waste for the first time. The site
Statements: Note 10
referred to as the South Fill Area (SFA) is expected to reach capacity in 2012 at which time the North
Fill Area (NFA) will begin to receive the balance of waste and continue for at least 15 years.
The net present value of estimated closure and post-closure costs as at December 31, 2010, is
$11,594,220 (2009 ⫺ $7,771,490). The estimated total expenses represent the sum of the dis-
counted future cash flows using an inflation factor of 2.1% (2009 ⫺ 2.1%), discounted at a rate of
5% (2009 ⫺ 5%). As the ownership of the facility is shared equally between the County and City of
Peterborough, the liability recorded in these financial statements represents 50% of the estimated
actual liability pro-rated on the basis of capacity used at the site. Estimated utilization of existing site
capacity of the SFA at December 31 is 97% (2009 ⫺ 92%) and at the NFA is 1% (2009 ⫺ 0%).
Landfill closure and post-closure care requirements have been defined in accordance with industry stand-
ards and include final covering and landscaping of the landfill, pumping of ground water and leachates
from the site, ongoing environmental monitoring, site inspection, and maintenance. The reported liability
is based on estimates and assumptions with respect to events extending over a period of 174 years.
Future events may result in significant changes to the estimated total expenses, capacity used, or total
capacity. The estimated change in liability would be recognized prospectively, when applicable.
Loan Guarantees
When public sector entities guarantee loans to persons and organizations outside of the gov-
ernment reporting entity, they apply the section Loan Guarantees in the CICA PSA Handbook.
When it is determined that losses are likely, the public sector entity establishes a liability
and records an expense. The provision takes into account the expected loss both in terms of
principal owing and accrued and unpaid interest. As such, the accounting for loan guarantees
is equivalent to the treatment accorded contingent liabilities. Illustration 10.12 illustrates the
information disclosed when reporting on loan guarantees by the Province of Ontario.
Illustration 10.12
Obligations Guaranteed by the Province
Excerpt from the Province
The authorized limit for loans guaranteed by the Province as at March 31, 2011, was $773 million
of Ontario 2010–2011
(2010, $826 million). The outstanding loans guaranteed and other contingencies amounted to $631
million as at March 31, 2011 (2010, $734 million). A provision of $16 million (2010, $26 million)
Statements: Note 12
based on an estimate of the likely loss arising from guarantees under the Student Support Programs has
been reflected in these financial statements.
Transactions Unique to Public Sector Entities 535
Government Transfers
Reporting on government transfers has been and continues to be contentious. In 2011, the
PSAB issued the section Government Transfers in the CICA PSA Handbook, following a
lengthy effort aimed at achieving consensus as to their accounting. Transfers of economic
resources are an important part of the public sector fiscal landscape in Canada, given imbal-
ances in fiscal capacity on both a regional basis and between levels of government.
It will take time to determine whether the reporting of government grants is improved
by these new requirements. Early indications are that some governments are interpreting the
new standard in such a way that users will need to continue to diligently review the financial
statements and supporting disclosures to understand the present and future implications of
transfer arrangements.
The new requirements address reporting by the government making the transfer and the
government receiving it. In the case of a transferring government, the key issue is when is a trans-
fer authorized (and consequently recognized as an expense, or if yet to be paid out, a liability).
In the case of the recipient, the key issue is whether stated or unstated provisions associated with
the transfer can give rise to a liability. These are contentious questions because governments
seek predictability in the results they report, as both deficits and surpluses can be perceived in a
negative light. While accountability over public finances has generally benefited from the media
attention given to deficits, the informed user seeks to understand the story behind the number.
A government making a transfer records an expense in the period the transfer is authorized
and all eligibility criteria are met by the recipient. It is important to understand that authoriza-
tion can be met in one of two ways. In the case of many transfers, authorization occurs once there
is an enabling authority (i.e., legislation, regulation, or by-law) and a decision to exercise that
authority. However, a transfer can also be considered authorized when the authorization process
is completed in the stub period. This stub period is defined as the period between the financial
statement date and the date the financial statements are completed.
A government receiving an authorized transfer records it as revenue unless there are
eligibility criteria or stipulations that have not yet been met. Similarly, unless stipulations are
associated with a transfer, it is recognized as revenue when authorized and any eligibility cri-
teria are met. The challenging aspect of accounting for transfers by a recipient is evaluating
whether there are stipulations and whether the substance of those stipulations gives rise to a
liability when the transfer is initially recognized. To apply the standard properly, one must
understand that a stipulation must create a liability for the recipient, as not all obligations are
liabilities. For an obligation to be a liability, it must meet the three characteristics of liabilities
set out in the section Liabilities in the CICA PSA Handbook.
Determining what constitutes a stipulation can involve the exercise of professional judge-
ment. When the stipulations of a transfer are too broad to create an obligation that meets
the definition of a liability, the standard provides that a government reviews its own actions
and communications. When such a review is necessary, the focus is on assessing whether
the actions and communications are consistent with the substance and intent of the transfer
stipulations in a manner that creates an obligation meeting the definition of a liability.
When the initial recognition of a transfer results in the creation of a liability, the liabil-
ity is measured in subsequent periods in a manner consistent with the circumstances and
evidence used to support its initial recognition. To affect this, the government receiving the
transfer would reduce the liability, recognizing revenue as the stipulations are satisfied.
Consider Illustrative Example 10.1.
Illustrative Example 10.1 Recognizing Grant Revenue

In August 2012, the provincial Minister of Municipal Affairs announced that mayors
may apply by October 31, 2012, for a grant to promote tourism within their municipali-
ties. In her announcement, the minister indicated the money is for print, broadcast, and
Internet advertising placed during the 2013 calendar year. By November 30, 2012, the
Ministry of Municipal Affairs has determined that the qualified applications will receive
a total of $15 million. There are various matters that both the province and the munici-
palities will need to consider when reporting on this program in accordance with the
section Government Transfers in the CICA PSA Handbook. The fiscal year end of the
province is March 31; for the municipalities it is December 31.
In the province’s March 31, 2013, financial statements, a liability for $15 million
is recorded even if the transfer has not been paid out, as long as there is evidence that
there is authority for the transfer and an exercise of the authority has occurred. For this
liability to be recorded, the government must have lost its discretion to avoid proceeding
with the transfer. Discretion is considered to have been lost when the government has
no realistic alternative but to settle an obligation. If the province pays the transfer before
March 31, the province expenses the transfer, as it no longer has control over the funds.
But in many cases, passage of the legislation or some other authority delays things. If the
transfer is unpaid as at March 31, a liability is recorded as long as evidence demonstrates
that the province has lost is discretion to avoid the transfer through its actions and com-
munications, and the authority for the transfer (legislation or a regulation) is in place by
March 31 or prior to the completion of the financial statements.
Among the successful grant applications was that from the Town of Wemigwan.
Its accountants must consider in what financial reporting period the transfer should be
recorded as revenue. This requires a review to assess whether there are eligibility crite-
ria or stipulations associated with the transfer. Several scenarios are possible:
(a) As the ministry had determined which municipalities qualify for transfers by
November 30, the Town of Wemigwan may have met the eligibility criteria. If this
is the case, the town would record a receivable and revenue by December 31 if the
transfer was without stipulations.
(b) In many cases, stipulations are imposed by the transferor but they can also occur
when a recipient by its own actions and communications creates an obligation. For
example, if the ministry required that any funds used on qualifying advertising in
2013 be repaid, this would constitute a stipulation. Alternatively, if the town council’s
budget by-law indicated that the funds were to be used only for advertising in 2013,
this would be a stipulation created by the recipient’s own actions. Although the
town is eligible for the transfer in 2012, it would not record revenue until stipula-
tions associated with the transfer are satisfied.
(c) In considering when to record the transfer, the town’s accountants would also need
to determine when the transfer is authorized by the province. Under scenarios (a)
and (b), it was assumed that authorization occurred by November 30. However, if
the legislation or other authority authorizing the transfer did not occur until 2013,
the town would not record the transfer in 2012 unless it received the funds in 2012.
Note the accountants for the province and the municipalities assess the accounting for
the grant independently. The accounting by each party may mirror the other (that is,
when the grantor reports a liability, the recipient records an asset), but the require-
ments do not assure this.
Tax Revenue
Governments are unique in their power to tax. The section Tax Revenue in the CICA PSA
Handbook establishes when taxes are recognized, how they are measured, and how they are
reported on. A government recognizes tax revenue when a tax is authorized and the taxable
event associated with the tax occurs. For each type of tax, the taxable event must be identified.
In the case of a customs duty, for example, it is the movement of dutiable goods or services
across a customs boundary. In the case of an income tax, it is the earning of taxable income by
a taxpayer, attributable to the reporting period.
Comparing Public Sector Accounting with Other GAAP Frameworks 537
The value associated with the tax is initially measured at its realizable value. Accordingly,
taxes receivable are not recognized when unlikely to be collected, as is the case with forms of
income that go unreported. Subsequent to initial recognition, a government evaluates whether
its receivables are collectible and whether any taxes collected will need to be refunded.
Governments can use their tax systems to facilitate the redistribution of income. To
enhance the comparability of financial statements, the standard requires payments or reduc-
tions in taxes payable to be classified as either transfers through a tax system or tax concessions.
Transfers through a tax system are provisions that do not change the amount of tax
assessed. An individual or entity may receive a transfer through a tax system even when, for
example, their income is below the threshold that gives rise to a tax liability. In such a case,
the benefit would be provided through a cheque or some other means. An example is the
quarterly GST rebate administered through the income tax system.
A tax concession is a provision that reduces a taxpayer’s tax liability. Tax concessions
are available only to taxpayers or their direct beneficiaries, represent foregone revenue for
the government, can only be accessed through the tax system, reduce taxes owing, and can
be applied only to taxes owing of the government offering the tax concession. The federal
tuition tax credit is an example of a tax concession.
Tax concessions are accounted for as a reduction in tax revenue as they represent fore-
gone revenue. On the other hand, transfers made through a tax system are accounted for as
expenses as they are viewed as being a program expense.
✓ LEARNING CHECK
• Concessionary terms may indicate that all or a significant part of a portfolio investment may
be a grant.
• The terms of loans receivable are examined to ensure the public sector entity may expect to
receive resources from the transaction.
• A public sector entity records a liability for contaminated sites.
• A public sector entity records solid waste landfill closure and post-closure liabilities.
• A liability is recorded when a loss is likely on a loan guarantee.
• Accounting for a government transfer requires analysis of the basis for its authorization and
in the case of a recipient, an understanding of stipulations that may govern its use.
• The nature and terms of a tax govern how it is recognized and recorded.
COMPARING PUBLIC SECTOR

ACCOUNTING WITH OTHER
GAAP FRAMEWORKS
Objective 6 A comparison should allow you to quickly understand how reporting in accordance with one
Compare and GAAP framework might differ from another. Before there were differing GAAP frameworks
contrast differences in use in Canada, GAAP comparisons were used to identify how reporting in accordance with
between GAAP U.S. GAAP might be different from Canadian GAAP. However, with the specialization in
frameworks.
the GAAP frameworks, comparisons that highlight differences between the frameworks are
now being sought.
Direct comparisons can be challenging, as each GAAP framework has its own reasons for
being. For example, banks issue loans to earn income but loan issuance by governments can
be for reasons of public policy. Naturally, the accounting considerations are going to vary.
However, to properly interpret financial position and the results associated with the measures
and indicators reported on in financial statements, a user needs to be aware of the potential
for differences between GAAP frameworks and understand their affects.
No doubt you will seek to understand the PSA reporting framework in relation to GAAP
frameworks used by profit-oriented entities, with which you are likely much more familiar. The
discussion that follows has been prepared with this objective in mind. However, it is not a com-
prehensive listing of differences. It builds on, but does not repeat, matters covered in the previous
section, transactions unique to public sector entities. The charts in Illustration 10.13 compare
how PSA, IFRS, and ASPE approach seven topics of concern to those using financial reports.
Each GAAP framework has been developed with a specified user group in mind. The
International Accounting Standards Board issues IFRS “to help participants in the various
capital markets of the world and other users of the information to make economic decisions.”9
Many users of general purpose financial statements will not have access to other infor-
mation. Consequently, the disclosures and information must be as complete as possible to
ensure their usefulness. The CICA PSA Handbook and IFRS share this common assumption.
This is why the PSAB determined that public sector entities with commercially oriented
operations should apply IFRS. As cited earlier, the PSAB requires the use of IFRS by GBEs
and permits the use of IFRS for those OGOs when their circumstances dictate.
The overview comparisons in Illustration 10.13 refer to differences between ASPE and
the CICA PSA Handbook based on an expectation that many of you will seek to understand
the PSA reporting framework in relation to standards you have learned and frequently apply.
However, such comparisons will have limited application in practice as the PSAB does not
direct public sector entities to apply ASPE. ASPE is not an accepted framework for public
sector reporting as many users of public sector financial statements will not have access to
additional information. At the time ASPE was developed, a justification for condensing dis-
closures was that users could request and obtain more information when they needed it.
Illustration 10.13
Key Differences in
PSA compared to IFRS
and ASPE
Topic PSA IFRS ASPE

Recognition of Intangible assets (other than Items are recognized as intangible Requirements in ASPE are
intangible assets and software) are not recognized in public assets when it is demonstrated that similar to IFRS but less
rights held by the sector financial statements.a the item meets the definition of an detailed
detailed.
Crown As well, when natural resources and intangible asset (i.e., is identifiable,
Crown lands are inherited by the is separable from the entity, or arises
government in right of the Crown and from other contractual or legal rights)
have not been purchased, they are and meets the recognition criteria. The
not given accounting recognition as recognition criteria require that it is
assets. probable that the expected economic
benefits attributable to the asset will
flow to the entity and the cost of the
asset can be measured reliably.
Purchase Any purchase premium arising from Goodwill arising from a business The recognition of goodwill
premiums arising the acquisition of a governmental acquisition is recognized as an asset. arising from a business
on an acquisition unit (a public sector entity other In subsequent periods it is subject to combination is similar but
than a GBE) is accounted for as an an annual impairment test. ASPE applies a different
expense upon acquisition. impairment testing model.
Presentation of a When a non-controlled interest exists Under IAS 27, Consolidated and Under ASPE, an enterprise may
non-controlled interest in an entity controlled by a govern- Separate Financial Statements, a consolidate its subsidiaries or
ment, the proportionate consolidation non-controlled interest is presented account for them using either
method is used to account for the separately within equity, separately the equity method or the cost
portion of the entity controlled by the from owners’ equity. method. When a subsidiary
government. is consolidated, any non-
controlled interest is presented
as a component of equity.
a
Does not apply when GNFPOs elect to apply the NPO reporting framework in the CICA PSA Handbook.
9
International Financial Accounting Standards 2010, Preface to IFRS, par. 6(a).
Comparing Public Sector Accounting with Other GAAP Frameworks 539
Topic PSA IFRS ASPE

Gains and losses An exchange gain or loss that arises Exchange gains and losses are gener- Exchange gains and losses are
arising from foreign prior to settlement (i.e., that is ally recognized in profit or loss. In the generally recognized in profit or
currency translation unrealized) is recognized in the case of exchange differences arising loss. An exception applies in the
statement of remeasurement gains on a monetary item that forms part of case of most self-sustaining for-
and losses.b a reporting entity’s net investment in eign operations, in which case
a foreign operation, the consolidated exchange gains and losses are
financial statements initially recognize recognized in a separate compo-
exchange gains and losses in OCI. nent of shareholders’ equity.
Evaluating the Since tangible capital assets may be The carrying value of a capital asset Requirements in ASPE are
continuing benefit held in whole or in part due to the is assessed in relation to its recover- similar to IFRS but less
of tangible capital goods or services they provide, the able amount. This assessment is detailed.
assets continuing benefit of a tangible capital based on the higher of the asset’s fair
asset is assessed in relation to the: value less costs to sell and its value
• asset’s ability to provide goods or in use.
services relevant to the operations of
the public sector entity, or
• value of the economic benefits
associated with the asset relative to
its book value.
Accounting for Some smoothing is permitted when Amendments to IAS 19, Employee Amendments are pend-
retirement benefits entities elect to measure plan assets Benefits, effective in 2013, requires ing that would require all
at market-related values (fair value the immediate recognition of changes changes arising from the
averaged over five years). Discount rates in defined benefit obligations and remeasurement of a defined
used to measure plan obligations are the fair value of plan assets. Plan benefit pension liability
determined in relation to plan asset assets are measured at fair value (or asset) to be recognized
earnings or the government’s cost of and plan obligations are discounted immediately in income.
borrowing. Recognition of actuarial at a market risk-free rate. Entities Deferral of a portion of
gains and losses is deferred over the disaggregate changes into three actuarial gains and losses
expected average remaining life of categories and present them as would no longer be permitted.
the related employee group. However, follows: a service cost component Past service costs would be
when changes are attributable to a plan (in profit or loss), a net interest recognized immediately in
amendment, past service costs are component (in profit or loss), and a income.c
recognized immediately in operations. remeasurement component (in OCI).
The PSAB continues to study the recent
amendments made by other standard
setters and at a future date may begin a
project to amend its standards.
Financial instruments Under Financial Instruments, Section The IASB continues to study and Amortized cost is the default
and hedge accounting PS 3450, cost or amortized cost is the amend IFRS 9, Financial Instruments. basis of measurement. Fair
default category; only derivatives and At the date of publication, financial value measurement applies to
equity instruments that are portfolio assets are classified into one of three most derivatives (unless desig-
investments quoted in an active market categories in accordance with the nated in a qualifying hedging
are required to be included in the fair entity’s business model and the item’s relationship) and investments
value category. Realized gains and cash flow characteristics. Financial in equity instruments quoted
losses are presented in the statement liabilities are carried at amortized cost in an active market. Gains and
of operations as well as losses due to unless the item is held for trading and losses are reported in income.
impairment. Gains and losses attribut- the entity has not elected the fair value Hedge accounting can be
able to fair value remeasurement are option. An entity may elect, upon the designated in a limited set of
presented in a statement of remeasure- initial recognition of an equity instru- circumstances
ment gains and losses. Hedge account- ment, to present gains and losses
ing is discontinued when an entity attributable to that instrument in OCI
adopts Financial Instruments, Section until it is derecognized. The portion
PS 3450.d of a fair value change in a financial
liability attributable to a change in an
entity’s own credit status is reclassified
from profit and loss to OCI.
b
Based on the section Foreign Currency Translation in the CICA PSA Handbook, Section PS 2601, effective fiscal years beginning on or
after April 1, 2012, for government organizations; in the case of governments, fiscal years beginning on or after April 1, 2015.
c
Comments reflect proposals issued in January 2012 for adoption in January 2014.
d
In the case of government organizations, CICA PSA Handbook Section PS 3450 is effective for fiscal years beginning on or after April 1, 2012.
Governments apply the standard for fiscal years commencing on or after April 1, 2015.
✓ LEARNING CHECK
• The standards underlying individual GAAP frameworks introduce differences that warrant
understanding to properly interpret financial results.
KEY TERMS
. LEARNING SUMMARY
control (p. 513)
The public sector financial reporting framework is a primary source of GAAP designed to
element (p. 517)
address the needs of the broad community of users that public sector entities are accountable
financial assets
to. The indicators of net debt and accumulated surplus (deficit) support an assessment of
(p. 517)
financial position. The measure of operating surplus (deficit), the statement of changes in net
government (p. 510)
debt, and changes in cash flows inform users about activities in the reporting period.
government business
The need to make trade-offs among competing priorities is a common occurrence within
enterprise (GBE)
public sector entities. The inclusion of a comparison to budget is an important feature of the
(p. 526)
public sector reporting framework to support accountability in relation to a government’s
government business
stated plan.
partnership
When an organization is controlled by the government, its results are included in the
(p. 531)
government’s summary financial statements. Government organizations are consolidated
government not-for-
unless they are classified as government business enterprises. The modified equity method is
profit organization
used to report on government business enterprises. It differs from the equity method as the
(GNFPO) (p. 526)
underlying transactions are not conformed to the public sector financial reporting framework.
government
The CICA PSA Handbook includes detailed standards that address transactions unique to
organization
public sector entities. Requirements in these detailed standards can give rise to GAAP dif-
(p. 524)
ferences because the frameworks were originated to support the reporting needs of different
government
groups of users. It is important to consider the potential for GAAP differences when analyz-
partnership
ing financial reports.
(p. 531)
government reporting
entity (p. 525)
governmental unit Brief Exercises
(p. 530)
liquidity risk (p. 517) (LO 2) BE10-1 Identify differences apparent to readers of a financial statement prepared based on
modified equity the PSA reporting framework compared with a financial statement prepared for a publicly
method (p. 530) accountable profit-oriented enterprise. Explain their significance.
net debt (p. 520)
non-financial assets (LO 3) BE10-2 (a) What is the measure of net debt? (b) Why is it a useful indicator of a
(p. 517) government’s financial position? (c) When a public sector entity does not have net debt, how
is the equivalent measure described and what use is it to the users of financial statements?
other government
organization (OGO) (LO 3) BE10-3 Although fund accounting remains in widespread use in managing public funds,
(p. 527) explain why funds are not presented in financial statements prepared in accordance with the
proportionate PSA reporting framework.
consolidation
(LO 1, BE10-4 Compare the needs of the users of a financial statement of a government organi-
(p. 531)
2, 3) zation with those of a membership-based not-for-profit organization.
public sector entity
(p. 510) (LO 1, BE10-5 Set out advantages and disadvantages associated with public sector entities using
shared control (p. 531) 2, 3, 4) a separate reporting framework. Cite examples in support of each advantage or disadvantage
given.
(LO 3) BE10-6 Discuss why a government might record encumbrances in its records and what
role these amounts would have in the (a) management of a government and (b) general
purpose financial statements issued to legislators and the public.
(LO 4) BE10-7 How does the modified equity method of accounting differ from the equity
method? Explain the implications of this difference.
Exercises 541
(LO 4, 5) BE10-8 Economic interests (investments) held by governments in other entities fall into three broad categories:
controlling interests, interests involving shared control, and portfolio investments. (a) Describe the characteristics of
each category of economic interest in a manner that distinguishes it from an investment that would fall into one of the
other categories. (b) Explain how each category of economic interest would be accounted for in the summary financial
statements of a government.
(LO 5) BE10-9 You are the provincial controller responsible for preparing the government’s financial statements. You are
aware that at an election rally, a member of the legislature promised that if elected, the site of a former steel mill would
be cleaned up and made into a waterfront park. This member was re-elected and is a member of a majority governing
party. Discuss both the present and future financial reporting implications.
(LO 6) BE10-10 (a) Discuss the implications for financial statement users when there are differences in GAAP among finan-
cial reporting frameworks. (b) Outline the advantages and disadvantages.
Exercises
(LO 2, 4) E10-1 Transactions and items for a public sector entity applying the CICA PSA Handbook (not referring to Sections
PS 4200 to PS 4270) are as follows:
1. Issue of a debenture
2. Inventories of goods for sale
3. A historical monument
4. Purchase of road salt or other supply inventories
5. An expenditure on road construction
6. Trees growing on Crown land
7. Disposal of a tangible capital asset
8. Acquisition of a government business enterprise
Required
Indicate the financial statements that would report on each item or transaction described and its classification. For
example, when a portfolio investment is acquired, it is reported on the statement of financial position as a financial asset
and on the statement of cash flow as an investing transaction.
(LO 4) E10-2 You are a senior member of the financial reporting team reporting to the Commissioner of Finance of the
Town of Greenville. The following is a list of units and their relationship with the town council.
Unit Relationship with Town Council

1. Roads department Department head prepares an annual budget for approval by council and
manages the department in accordance with town policies.
2. Blood donor clinic Residents come to the public health office to donate blood. The clinic is
operated and funded by a federal agency.
3. Public library Library CEO is appointed by council. The annual budget is approved by
council. Although the library is operated in accordance with town policies,
aspects of its operations are subject to provincial legislation.
4. Electric utility Distributes electricity to residents of Greenville and two neighbouring
municipalities. No municipal shareholder has a majority interest; Greenville
holds 25% of the equity. The electric utility is self-sustaining. Town council
appoints two of the seven board members.
5. Bike sharing program Town has a contract with a private operator who leases space behind the
arena and at kiosk locations throughout town. Private operator hires own staff.
6. Seniors’ home Operated in accordance with provincially set standards for long-term care
facilities. A day rate set by the province is received for each resident in
care. One board member is appointed by the province, one is a resident,
one is appointed by town council, and two others are community members.
The town is responsible for any operating deficit.
7. Blue box curbside recycling Operates in the town and two neighbouring municipalities. Each municipality
program appoints one member of the board, funding operations in accordance with a
service agreement. Each municipality shares the operating surplus or deficit
based on the volume of recycling materials collected within its boundary.
Unit Relationship with Town Council
8. Water commission Board members are elected by residents. Council approves the commission’s
mandate and its annual budget. The utility pays an annual dividend to the
town and has not received operating or capital grants from the town since it
was established.
9. Transit commission Commission is composed of two town councillors, two citizens appointed
by council, and a union representative. Operating budget and fares are
approved by council. The CEO is appointed by council.
10. Transit for disabled residents A private operator provides vehicles and staff, collecting fares and operating
in accordance with a service agreement that requires the transit commission
to fund the operating deficit.
Required
Provide advice to the Commissioner of Finance, who has asked you, for each of the units above, to:
(a) indicate whether the unit is controlled by the town, subject to joint control, or not controlled; and
(b) in the case of units that are controlled or jointly controlled, indicate how the unit would be accounted for in the
town’s consolidated financial statements.
(LO 5) E10-3 The following transactions pertain to the March 31, 2013, year end, for a province reporting in accordance
with the CICA PSA Handbook:
1. Assume the accrual for the year-end estimate of income tax revenue has already been recorded. Since the accrual was
recorded, tax officials have learned the reduction in tuitions implemented by the government in September 2012 has
given rise to increased enrolment in the fall semester. Claims for the tuition tax credit are expected to increase by
$10 million. The tuition tax credit can only be used to reduce income taxes payable by either the student or a relative.
2. On March 31, 2013, a $50-million loan at an interest rate of 4% was given to a school board to build a new school.
On the same date, the Ministry of Education executed a funding agreement starting April 1, 2013, with the school
board. Under the funding agreement, the school board will receive a special grant equal to the interest and princi-
pal repayment due during the term of the loan.
3. A new program providing a refund of $1,000 payable to any individual who installs a solar panel on their roof is
introduced during the year. The refund is paid by the Ministry of Revenue when individuals file an income tax
return, and is paid whether or not the individual has taxable income. Based on sales reported by retailers, officials
of the Ministry of Revenue estimate the program will cost $10 million in the fiscal year ending March 31, 2013.
Required
Prepare the journal entries to record the above transactions.
(LO 5) E 10-4 Below are a series of transactions which are independent of each other.
(a) A government makes a $10-million loan to a manufacturer, repayable in 5 years with an interest rate of 2%.
Current borrowing rates to a company with equivalent credit quality are 6.5%.
(b) A government agency guarantees a $500,000 loan made by a bank to a farmer to buy a new combine.
(c) Personal papers belonging to a former prime minister are donated to the government archivist. An independent
appraiser has placed a value of $250,000 on the papers.
(d) A city invests $10,000 in a production of a local theatre company. The investment must be returned if the directors
of the theatre company do not stage the production locally.
(e) Contamination that exceeds provincial environmental regulations is found on the site of a former gas station. The
city owns the land as it exercised its right to assume title to the property for unpaid real estate taxes.
Required
Indicate how each transaction should be accounted for under the CICA PSA Handbook.
(LO 5) E 10-5 You are the Director of Finance for a township. Several months ago you prepared a grant application request-
ing funds to improve the filtration system at the local water treatment plant. The application was made under a new
infrastructure improvement program that simply asked municipalities with ‘shovel ready’ programs to apply, with terms
to follow. Yesterday, the Mayor received a call advising him that the grant has been approved, asking him to attend a
news conference tomorrow at which time the Minister of Municipal Affairs will present the cheque.
Required
What additional information will you seek in order to properly account for receipt of this grant?
Problems 543
Problems
(LO 5) P10-1 You are a financial accountant with the Town of Willow Creek, preparing for the upcoming year
end of December 31, 2013.
Required
(a) The balance recorded for the closure and post-closure liability associated with the town’s landfill site needs to
be updated. As the last comprehensive review of the site’s capacity and the future costs associated with closure
and post-closure maintenance was completed three years ago, you arranged for a consultant to complete a new
study and the results are now in. Describe the approach you would take to updating the current liability. Consider
the information that you would seek from the report and other sources, and explain the accounts that would be
affected.
(b) The Commissioner of Finance has advised you that during the year, the province has approved the town’s applica-
tion to open a financial counselling service for individuals who are at risk of defaulting on their debts. Funding of
$100,000 was received and deposited in the town’s bank account last week. For each of the following situations,
prepare the journal entry and describe how any portion that is not immediately recognized as revenue would be
accounted for in future periods:
1. The province placed no stipulations on the use of the funds.
2. The Town’s approved budget indicated that any grant received from the province would be dedicated to pay
costs incurred to operate the service.
3. To receive the grant, the town had to agree to hire and apply the funds to pay the salary of a financial counsellor.
(c) Your file contains a copy of an approved by-law stating that repayment of the advances made to a local service club
amounting to $50,000 will be recovered by increasing the operating grant given to the service club in this year and
next year. Prepare the journal entry to record the effect of the resolution for the 2013 fiscal year.
(d) A cheque requisition is on your desk. Council approved making an investment of $250,000 in a company that has
promised to start a bicycle-sharing service. In order to be the first municipality in the county to have this service,
council agreed to make the loan without interest and to forgive any balance if the service continues to operate in
five years. Prepare the journal entry.
(LO 5) P10-2 The Frontier Health Centre (FHC) is a health clinic controlled by a provincial government. You are senior
financial analyst reporting to the Director of Finance. FHC applies the CICA PSA Handbook and does not refer
to Sections PS 4200 to PS 4270 as a source of GAAP. Under the accounting policies followed by FHC, it applies
Government Transfers, Section PS 3410 as though it was a recipient government.
Debit (Credit) in thousands

Account Opening Transactions Closing
Cash and cash equivalents 3,537 97 3,634
Fees receivable 2,177 (1,019) 1,158
Grants receivable 6,692 6,692
Supplies inventories 2,006 309 2,315
Tangible capital assets 74,590 21,350 95,940
Accumulated amortization (25,191) (3,486) (28,677)
Bank indebtedness (4,322) (14,155) (18,477)
Accounts payable (8,325) 1,031 (7,294)
Employee future benefit obligations (1,863) (316) (2,179)
Deferred revenue (192) (243) (435)
Deferred grant (5,325) (5,325)
Opening accumulated surplus (43,784) -- (43,784)
Grants received (44,160) (44,160)
Patient fees (3,694) (3,694)
Donations (828) (828)
Compensation and benefits 29,249 29,249
Supplies 6,962 6,962
Contracted services 3,267 3,267
Fundraising expense 161 161
There were no disposals of tangible capital assets during the year.

Other information (all amounts in thousands):
(a) Grants received is comprised of:
(i) An operating grant of $3,000 per month, repayable in part if the operating expenses for year are less than the
amount of the grant.
(ii) A one-time grant of $2,500 from the Town of Saint Anthony. The Town forwarded the funds when the
expansion commenced but did not attach any stipulations to the use of the funds.
(iii) A one-time grant of $1,160 from Veterans Services to provide counselling services to discharged soldiers.
FHC has not yet commenced offering this program as it is still recruiting suitable counsellors. The agreement
with Veterans Services contains a clause requiring the return of monies advanced if the program is not offered.
(iv) A one-time grant of $4,000 from the City of Freeport. The funding was solicited by the Directors of FHC to
support the initial startup costs once the expansion is completed. The City remitted the funds shortly after the
expansion was started.
(v) A one-time grant of $500 from the provincial government. Under the funding agreement, the money must be
used to buy new medical equipment associated with the expansion. As the expansion has not yet been finished,
FHC has not taken delivery of the new medical equipment.
(b) In January 2012 the provincial government approved an expansion grant. Construction started in the current fiscal
year but is not yet complete. The grant is payable in stages as FHC reports completion of construction milestones
certified by the architect. The first such milestone certificate has been received but FHC has not yet filed a claim.
Once the claim is processed, FHC will be eligible for a transfer of $15,000 on account of work completed as at
March 15, 2013.
(c) During its 2009 fiscal year, FHC received a multi-year transfer in the amount of $21,300 from the federal gov-
ernment to support specialized cancer care. The grant indicated that it was to fund services to be provided from
April 1, 2009 to March 31, 2013. The deferred portion of this grant has been recorded in the accounts.
(d) In March 2013 a senior official of the federal government wrote to the Chief Executive Officer indicating that
a FHC has qualified for an unconditional regional development grant of $1,800. The department indicated
the funds could not be forwarded immediately as the legislation authorizing these special one-time grants was
still in the Senate. The Senate approved the Bill on April 5, 2013, and the Bill received Royal Assent shortly
thereafter.
Required
Your Director has asked you to:
(a) Prepare any necessary adjusting entries based on the information provided; and
(b) Prepare a draft statement of financial position, statement of operations and statement of changes in net debt as at
March 31, 2013.
(LO 2, 3) P10-3 Small College was founded in 1977 to offer paroled offenders basic job skill training. The Ministry of
Education and Training requires the board of directors for Small College to issue general purpose financial state-
ments. Small College applies the CICA PSA Handbook and does not refer to Sections PS 4200 to PS 4270 as a source
of GAAP.
The following summarizes information drawn from the general ledger of Small College for the year ending
March 31, 2013.
Debit (Credit)
Cash and cash equivalents 100 (10) 90
Grants receivable 1,500 50 1,550
Investment in bonds 500 500
Inventory of supplies 50 5 55
Prepaid expenses 40 (10) 30
Building 15,000 — 15,000
Equipment 750 100 850
Accumulated amortization (7,700) (535) (8,235)
Accounts payable (480) (45) (525)
Vacation pay owing (345) (25) (370)
Pension and employee future benefit obligations (6,000) (1,575) (7,575)
Debenture payable (2,500) 500 (2,000)
Opening accumulated surplus (415) — (415)
Problems 545
Operating grant from Ministry (15,000) (15,000)

Interest income (20) (20)
Retraining program expense 13,900 13,900
Administration expense 1,505 1,505
Amortization expense 535 535
Interest expense 125 125
Small College did not issue any debenture debt and had no disposals of capital assets during the year.
Required
Prepare the statement of financial position, statement of operations, and statement of changes in net debt for Small
College for the year ended March 31, 2013.
(LO 2, P10-4 Capital Region is a local government. It prepares general purpose financial statements in accordance with
3, 4) the CICA PSA Handbook. The following is a summarized adjusted trial balance for the year ending December 31, 2013
(amounts in thousands).
Debit (Credit) in thousands
Cash and cash equivalents 875 (10) 865
Taxes receivable 10,321 2,475 12,796
Investment in long-term bonds 5,000 (400) 4,600
Investment in CRISP Inc. 63 -- 63
Supplies inventories 843 50 893
Tangible capital assets 257,450 22,250 279,700
Accumulated amortization (86,765) (12,000) (98,765)
Accounts payable (5,943) (273) (6,216)
Employee future benefit obligations (14,987) (1,321) (16,308)
Deferred revenue (7,700) (535) (8,235)
Debentures payable (45,000) (17,500) (62,500)
Opening accumulated surplus (114,157) -- (114,157)
Tax revenues (52,800) (52,800)
Service and fees levied (37,986) (37,986)
Government transfers (14,544) (14,544)
Protection and community services 46,680 46,680
Public works 31,928 31,928
Property and development services 8,654 8,654
Finance and administration expense 6,336 6,336
General government 4,211 4,211
Interest expense 2,785 2,785
The following is a continuity analysis of Capital Region’s tangible capital assets, net of accumulated amortization:
January 1, 2013 $170,685,000
Additions 22,250,000
Amortization (12,000,000)
December 31, 2013 $180,935,000
Capital Region controls a government business enterprise, the Capital Region Internet Service Provider Inc. (CRISP
Inc.). The following information has been obtained from the audited financial statements of CRISP Inc., prepared in
accordance with IFRS.
CRISP INC.
(in thousands)
Current assets:
Cash and cash equivalents $ 75
Accounts receivable 765
Inventories 105
945
Non-current assets:
Total assets $5,895
Current liabilities:
Accounts payable and accrued liabilities $ 332
Deferred revenue 700
1,032
Non-current liabilities:
Long-term borrowings 3,500
4,532
Equity:
Share capital 1
1,363

(in thousands)
Sales $7,650
Administrative expenses 1,720
Distribution costs 3,830
Amortization of property, plant,
and equipment 550
Interest 250
6,350
Profit and comprehensive income
for the year $1,300
Required
Prepare the statement of financial position, statement of operations, and statement of changes in net debt for Capital
Region for the year ended December 31, 2013.
Writing Assignments
(LO 1, WA10-1 Explain how the four objectives of public sector financial reporting support public accountability. Illustrate
2, 3) your points with examples.
(LO 1) WA10-2 Choose a well-known public sector entity (such as a local municipality, provincial healthcare body, or Crown
Corporation such as the Canada Mortgage and Housing Corporation).
(a) Obtain publicly available information about its structure and accountabilities and describe them in relation to the
key characteristics of public sector entities (in the first section of the chapter).
(b) Contrast each characteristic with the structure and accountabilities found in a publicly accountable profit-oriented
corporation.
(LO 2, 3) WA10-3 You work in the finance department of the City of Oldhaven. Denis Dubé, the owner of a successful local
car dealership, has just started as a new city councillor. He is confused by the city’s financial statements. Denis uses
ASPE in the accounting for his business and is not familiar with the public sector accounting framework.
Required
Prepare a briefing note (a concise summary, generally not more than 500 words) for Denis setting out the key indicators
and other information found in a municipal financial statement, what they mean, and how they might be different from
the financial statements of a profit-oriented enterprise.
(LO 2, 3) WA10-4 As your summer job, you work as a researcher in a consulting firm with clients who are citizen advocacy
groups in Manitoba and the Yukon. They want to know how taxpayers’ money is being spent on public services. Your
boss asks you to review and analyze the financial statements of the City of Winnipeg (Illustration 10.5) and the Yukon
Housing Corporation (Illustration 10.9).
Required
Write a report for your boss to present to the clients, covering the following:
(a) Identify the amounts each entity has reported in the current year in relation to the two key indicators of financial
position and the measure of operating surplus or deficit that must be reported.
(b) As a reviewer of these financial statements, outline observations and questions you have about each entity’s finan-
cial performance arising from these key indicators/measures and changes reported on in these financial statements.
(LO 1, 2, WA 10-5 Jacques Martin, MP, is preparing for a town hall meeting in his riding. He is a member of the governing
3, 4) party. In advance of these meetings, Jacques asks his staff to prepare short memoranda, known as briefing notes, on top-
ics he expects to receive questions on. These briefing notes must be no more than a page and contain short, meaningful
statements in non-technical language. As a member of Jacques’ staff you have been asked to prepare one of these brief-
ing notes.
Required
Prepare a briefing note for the MP outlining the value and limitations of the audited public accounts. Present your
answer in terms of speaking points that Jacques might use in speaking with an audience comprised of people who will
not be able to relate to technical terms such as “financial position” and “net debt”. In framing your speaking points,
remember the audience is comprised primarily of constituents, not investors.
(LO 4) WA 10-6 Identifying the entities to be included in the reporting entity is a critical part of public sector financial
reporting.
Required
(a) Explain some inherent challenges faced in defining the reporting entity.
(b) Explain why it is important to users of public sector financial statements that the reporting entity be described
properly.
(c) Under the CICA PSA Handbook, identify the principle used when assessing whether an organization is part of the
reporting entity.
(d) Explain the practical issues encountered by those applying the principle.
(e) Explain how the primary and secondary criteria are applied.
(f) From the secondary criteria shown in Illustration 10.7, select one of the persuasive indicators and one of the other
indicators. Explain how each indicator might support application of the principle used to assess control.
(LO 2) WA 10-7 Consider the elements and indicators among reporting frameworks (Illustration 10.3).
Required
(a) Describe key financial indicators given in a financial statement presented in accordance with the CICA PSA
Handbook. Contrast these indicators with indicators provided in the NPO, IFRS, and ASPE frameworks.
(b) Explain why net debt, the difference between liabilities and financial assets, bears directly on future revenue
requirements and acts as a constraint upon the public sector’s entity’s ability to finance its activities, as well as
meeting its liabilities and future commitments.
(c) Indicate how approaches under the frameworks vary when presenting changes in assets and liabilities and what
challenges this can provide to users seeking to understand the results being reported by entities using these differ-
ent frameworks.
(LO 1, 2) WA 10-8 Federal, provincial, and territorial governments in Canada are now applying the accrual based financial
reporting model used in the CICA PSA Handbook. This significant transformation in public sector financial reporting
occurred after reporting for decades using a modified cash basis for financial reporting. Among the items that were not
recognized when modified cash basis reporting was prevalent include tangible capital assets and employee benefit obli-
gations.
Required
(a) Use the qualitative characteristics (Illustration 10.2) to evaluate accrual based financial reporting as compared to
the modified cash basis. Explain how accrual based financial reporting enhances the relevance, reliability, and com-
parability of public sector financial reports.
(b) Identify three key indicators that would change when accrual based financial reporting is applied. Explain how each
measure would be affected when tangible capital assets and employee future benefit obligations are recognized.
(LO 5) WA 10-9 You work in the Office of the Comptroller General. The Director to whom you report has recently returned
from a conference on public sector financial reporting. Among the topics discussed was a new standard, Liability for
Contaminated Sites, a standard your government has not yet implemented. Your Director has several questions about
this new standard. She has asked you to explain:
(a) The circumstances that would give rise to the need to record a liability.
(b) Why a contaminated site could give rise to a liability.
(c) If remediation is not expected to occur for many years, implications for the measurement of the liability.
(d) Information the government would need to gather in order to implement the standard.
(LO 4) WA 10-10 The Introduction to Public Sector Accounting Standards in the CICA PSA Handbook sets out the account-
ing standards applied by various types of government organizations. The sources of generally accepted accounting
principles government organizations are directed to apply include: the CICA PSA Handbook and the CICA Handbook,
Part I (i.e., IFRS).
Required
(a) Identify the various types of government organizations. For each type of government organization, identify the
corresponding set of accounting standards that it can use.
(b) Explain why the CICA Handbook, Part II and Part III are not frameworks recommended for use by government
organizations.
(LO 3) WA 10-11 According to the CICA PSA Handbook, “One important indicator of a government’s financial position is
its net debt, calculated as the difference between its liabilities and financial assets. The statement of financial position
must account for and clearly present that difference because it bears directly on future revenue requirements and on a
government’s ability to finance its activities and meet its liabilities and commitments.” (PS 1201.037)
Required
Discuss the validity of the statement that net debt bears directly on future revenue requirements and affects a govern-
ment’s ability to finance its activities and meet its liabilities and commitments.
Cases
(LO 4) C10-1 Marine Atlantic Inc. (MA) is a federal Crown corporation that reports to Parliament through the Minister of
Transport. MA is a separate legal entity with delegated financial and operational authority to provide a constitution-
ally mandated passenger and commercial marine transportation system between the Island of Newfoundland and the
Province of Nova Scotia. According to its 2010-2011 annual report, MA earned $95,763,000 in operating and other
revenues. Operating expenses and amortization totaled $222,454,000. MA receives annual parliamentary appropria-
tions for operations from the Government of Canada to the extent the cost of providing ferry services is not recovered
from commercial revenues.
Required
(a) For purposes of preparing its own financial statements, consider what type of government organization MA is.
Explain alternative classifications that might apply. Indicate what classification(s) you recommend and the reasons.
(b) Explain how MA should be accounted for in the Government of Canada’s financial statements.
(c) Based on your analysis from (a), indicate possible financial reporting frameworks available to MA to apply when
preparing its own financial statements. Recommend a specific reporting framework and state reasons in support of
your recommendation.
(LO 4, 5) C10-2 Metrosport is a city located in the most populous census district in Canada. Its mayor and council are ambi-
tious and want to attract an NHL team to their community. Although Metrosport’s population is only about 200,000
people, about 5 million people live within one hour’s drive. The mayor and her staff have done a lot of homework on
this project. They have met with several wealthy entrepreneurs who are seeking an expansion team but are in need of an
NHL- calibre rink to call home. The market is hockey crazy and the general consensus is that it will not be difficult to
attract 13,000 season ticket subscribers, a league requirement. The most significant challenge is financing the construc-
tion of a suitable facility.
Cases 549
The business community is supportive, particularly those in the hospitality trade. The mayor considers the team an
economic development project as an NHL team would put Metrosport “on the map”. Many view Metrosport as just a
“bedroom community”, a city made up primarily of commuters. For this reason it has been difficult for the city to attract
major hotel chains. A major league sports venue would be a destination, leading to the construction of top-notch hotels
with conference facilities which could encourage businesses to relocate their head offices.
The city has retained architects who have estimated the cost of the arena to be $1.2 billion. Metrosport has never
undertaken a project of this size on its own. When the mayor approached officials of the federal and provincial govern-
ments for financial support, she received a cool reception. The Director of Finance has met informally with the agency
that rates the city’s debt. It was clear that if Metrosport undertook this project on its own there would be adverse con-
sequences for the city’s debt rating.
To overcome these challenges, the mayor has sought partners. The arena would be operated by a partnership.
Any key decisions would be subject to reaching a consensus among the partners. The projected capital cost of the arena
would be financed by debt, guaranteed by the partners. Any surplus or deficit would be shared by the partners according
to their partnership interest. One option would be to enter into a public-private partnership with Droid Industries in
which the city and Droid would be equal partners. A second option would be to partner with the regional municipality
and neighbouring cities. These communities are anxious for the project to succeed due to the potential for spin-off eco-
nomic benefits coming their way. Under this alternative, Metrosport retains a 40% interest, the regional municipality
30%, and the neighbouring cities divide the remaining 30%.
As a senior financial analyst, you have been meeting with an arena management company to develop a finan-
cial projection representative of a normal operating year. The following annual cash flows are anticipated for either
partnership:
(in thousands)
Inflows:
Rent from team $17,500
Naming rights 5,000
Rent from concerts and other events 8,500
Concessions and parking 12,000
$43,000
Outflows:
Management fees $1,000
Concession and parking operations 2,500
Building operations and maintenance 3,500
Interest 36,000
$43,000
The mayor views this as a business venture, in keeping with her economic development agenda. Although there is great
enthusiasm for the project, the municipal council has asked the Director of Finance to explain how proceeding with the
project would affect the finances of Metrosport.
Required:
The Director of Finance has asked you to address the following matters to support a report to Council.
(a) Explain how the city’s partnership interest would be accounted in the city’s financial statements and your reason-
ing. Identify any differences that might arise depending on the partner(s) the city selects.
(b) Explain the financial reporting implications of guaranteeing the partnership’s debt obligations. Consider the
immediate implications and explain what would happen if the projected inflows are too optimistic and the partner-
ship runs into financial difficulties.
(c) Use the information provided and the summarized financial information provided below to prepare pro-forma
statements of financial position and operations for the city of Metrosport based on council’s acceptance of a
partnership with Droid Industries. Pro-forma financial statements are used to show the effects of proposed
transactions. Prepare two sets of pro-forma statements, the first based on a government business partnership
and the second based on a government partnership. Assume the partners provide the partnership with a working
capital advance of $2,000 and the partnership’s financial position is: $500 cash, $3,000 in receivables, and $1,500
in accounts payable, in addition to debt obligations to finance the construction and start-up costs for the arena
indicated by the architect. Use the arena partnership’s inflows and outflows as the basis for the partnership’s
revenues and expenses. State any other assumptions you make. Comment on the changes in the city’s financial
position that would arise from adoption of either of the partnership proposals.
CITY OF METROSPORT
Summarized Statement of Financial Position
Year ended December 31
(in thousands)
Financial assets $
Cash and cash equivalents 335,550
Tax and other receivables 103,765
Investment in government business enterprise 190,650
629,965
Liabilities
Accounts payable and accrued liabilities 228,634
Pension and employee benefit obligations 18,975
Long-term debt 15,000
262,609
Net financial assets 367,356
Tangible capital assets 3,180,435
Accumulated surplus 3,547,791
Summarized Statement of Operations

Year ended December 31
(in thousands)
Revenues $
Taxes 113,098
Fees and other revenues 139,120
Contributions from developers 53,867
306,085
Expenses
General government 42,572
Protection to persons and property 33,069
Transportation services 27,514
Environmental services 25,786
Recreation and cultural services 40,278
Other services 7,414
Amortization of capital assets 53,366
229,999
Annual surplus 76,086
Accumulated surplus at beginning of year 3,471,705
Accumulated surplus at end of year 3,547,791
APPENDIX: PRESENT VALUE TABLES
TABLE 1 Present value of $1: PVIF ⫽ 1/ 11 ⫹ K2 t
Period 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.8929 0.8772 0.8696 0.8621 0.8475 0.8333 0.8065 0.7813 0.7576 0.7353
2 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8673 0.8417 0.8264 0.7972 0.7695 0.7561 0.7432 0.7182 0.6944 0.6504 0.6104 0.5739 0.5407
3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7118 0.6750 0.6575 0.6407 0.6086 0.5787 0.5245 0.4768 0.4348 0.3975
4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6355 0.5921 0.5718 0.5523 0.5158 0.4823 0.4230 0.3725 0.3294 0.2923
5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5674 0.5194 0.4972 0.4761 0.4371 0.4019 0.3411 0.2910 0.2495 0.2149
6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5066 0.4556 0.4323 0.4104 0.3704 0.3349 0.2751 0.2274 0.1890 0.1580
7 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4523 0.3996 0.3759 0.3538 0.3139 0.2791 0.2218 0.1776 0.1432 0.1162
8 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4039 0.3506 0.3269 0.3050 0.2660 0.2326 0.1789 0.1388 0.1085 0.0854
9 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3606 0.3075 0.2843 0.2630 0.2255 0.1938 0.1443 0.1084 0.0822 0.0628
10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3220 0.2697 0.2472 0.2267 0.1911 0.1615 0.1164 0.0847 0.0623 0.0462
11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 0.2875 0.2366 0.2149 0.1954 0.1619 0.1346 0.0938 0.0662 0.0472 0.0340
12 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 0.2567 0.2076 0.1869 0.1685 0.1372 0.1122 0.0757 0.0517 0.0357 0.0250
13 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 0.2292 0.1821 0.1625 0.1452 0.1163 0.0935 0.0610 0.0404 0.0271 0.0184
14 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 0.2046 0.1597 0.1413 0.1252 0.0985 0.0779 0.0492 0.0316 0.0205 0.0135
15 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 0.1827 0.1401 0.1229 0.1079 0.0835 0.0649 0.0397 0.0247 0.0155 0.0099
16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 0.1631 0.1229 0.1069 0.0930 0.0708 0.0541 0.0320 0.0193 0.0118 0.0073
17 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 0.1456 0.1078 0.0929 0.0802 0.0600 0.0451 0.0258 0.0150 0.0089 0.0054
18 0.8630 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 0.1300 0.0946 0.0808 0.0691 0.0508 0.0376 0.0208 0.0118 0.0068 0.0039
19 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 0.1161 0.0829 0.0703 0.0596 0.0431 0.0313 0.0168 0.0092 0.0051 0.0029
20 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784 0.1486 0.1037 0.0728 0.0611 0.0514 0.0365 0.0261 0.0135 0.0072 0.0039 0.0021
25 0.7798 0.6095 0.4776 0.3751 0.2953 0.2330 0.1842 0.1460 0.1160 0.0923 0.0588 0.0378 0.0304 0.0245 0.0160 0.0105 0.0046 0.0021 0.0010 0.0005
30 0.7419 0.5521 0.4120 0.3083 0.2314 0.1741 0.1314 0.0994 0.0754 0.0573 0.0334 0.0196 0.0151 0.0116 0.0070 0.0042 0.0016 0.0006 0.0002 0.0001
40 0.6717 0.4529 0.3066 0.2083 0.1420 0.0972 0.0668 0.0460 0.0318 0.0221 0.0107 0.0053 0.0037 0.0026 0.0013 0.0007 0.0002 0.0001 – –
50 0.6080 0.3715 0.2281 0.1407 0.0872 0.0543 0.0339 0.0213 0.0134 0.0085 0.0035 0.0014 0.0009 0.0006 0.0003 0.0001 – – – –
60 0.5504 0.3048 0.1697 0.0951 0.0535 0.0303 0.0173 0.0099 0.0057 0.0033 0.0011 0.0004 0.0002 0.0001 – – – – – –
n
1
TABLE 2 Present value of an annuity of $1 per period for n periods: PVIFA ⫽ a
t⫺1 11 ⫹ k2 t
1
1⫺
11 ⫹ k2 n
⫽
k
Number of
payments 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 12% 14% 15% 16% 18% 20% 24% 28% 32%
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.8929 0.8772 0.8696 0.8621 0.8475 0.8333 0.8065 0.7813 0.7576
2 1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591 1.7355 1.6901 1.6467 1.6257 1.6052 1.5656 1.5278 1.4568 1.3916 1.3315
3 2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.5313 2.4869 2.4018 2.3216 2.2832 2.2459 2.1743 2.1065 1.9813 1.8684 1.7663
4 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.2397 3.1699 3.0373 2.9137 2.8550 2.7982 2.6901 2.5887 2.4043 2.2410 2.0957
5 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897 3.7908 3.6048 3.4331 3.3522 3.2743 3.1272 2.9906 2.7454 2.5320 2.3452
6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.4859 4.3553 4.1114 3.8887 3.7845 3.6847 3.4976 3.3255 3.0205 2.7594 2.5342
7 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.0330 4.8684 4.5638 4.2883 4.1604 4.0386 3.8115 3.6046 3.2423 2.9370 2.6775
8 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348 5.3349 4.9676 4.6389 4.4873 4.3436 4.0776 3.8372 3.4212 3.0758 2.7860
9 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952 5.7590 5.3282 4.9464 4.7716 4.6065 4.3030 4.0310 3.5655 3.1842 2.8681
10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177 6.1446 5.6502 5.2161 5.0188 4.8332 4.4941 4.1925 3.6819 3.2689 2.9304
11 10.3876 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.8052 6.4951 5.9377 5.4527 5.2337 5.0286 4.6560 4.3271 3.7757 3.3351 2.9776
12 11.2551 10.5753 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607 6.8137 6.1944 5.6603 5.4206 5.1971 4.7932 4.4392 3.8514 3.3868 3.0133
13 12.1337 11.3484 10.6350 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869 7.1034 6.4235 5.8424 5.5831 5.3423 4.9095 4.5327 3.9124 3.4272 3.0404
14 13.0037 12.1062 11.2961 10.5631 9.8986 9.2950 8.7455 8.2442 7.7862 7.3667 6.6282 6.0021 5.7245 5.4675 5.0081 4.6106 3.9616 3.4587 3.0609
15 13.8651 12.8493 11.9379 11.1184 10.3797 9.7122 9.1079 8.5595 8.0607 7.6061 6.8109 6.1422 5.8474 5.5755 5.0916 4.6755 4.0013 3.4834 3.0764
16 14.7179 13.5777 12.5611 11.6523 10.8378 10.1059 9.4466 8.8514 8.3126 7.8237 6.9740 6.2651 5.9542 5.6685 5.1624 4.7296 4.0333 3.5026 3.0882
17 15.5623 14.2919 13.1661 12.1657 11.2741 10.4773 9.7632 9.1216 8.5436 8.0216 7.1196 6.3729 6.0472 5.7487 5.2223 4.7746 4.0591 3.5177 3.0971
18 16.3983 14.9920 13.7535 12.6593 11.6896 10.8276 10.0591 9.3719 8.7556 8.2014 7.2497 6.4674 6.1280 5.8178 5.2732 4.8122 4.0799 3.5294 3.1039
19 17.2260 15.6785 14.3238 13.1339 12.0853 11.1581 10.3356 9.6036 8.9501 8.3649 7.3658 6.5504 6.1982 5.8775 5.3162 4.8435 4.0967 3.5386 3.1090
20 18.0456 16.3514 14.8775 13.5903 12.4622 11.4699 10.5940 9.8181 9.1285 8.5136 7.4694 6.6231 6.2593 5.9288 5.3527 4.8696 4.1103 3.5458 3.1129
Appendix
25 22.0232 19.5235 17.4131 15.6221 14.0939 12.7834 11.6536 10.6748 9.8226 9.0770 7.8431 6.8729 6.4641 6.0971 5.4669 4.9476 4.1474 3.5640 3.1220
30 25.8077 22.3965 19.6004 17.2920 15.3725 13.7648 12.4090 11.2578 10.2737 9.4269 8.0552 7.0027 6.5660 6.1772 5.5168 4.9789 4.1601 3.5693 3.1242
40 32.8347 27.3555 23.1148 19.7928 17.1591 15.0463 13.3317 11.9246 10.7574 9.7791 8.2438 7.1050 6.6418 6.2335 5.5482 4.9966 4.1659 3.5712 3.1250
50 39.1961 31.4236 25.7298 21.4822 18.2559 15.7619 13.8007 12.2335 10.9617 9.9148 8.3045 7.1327 6.6605 6.2463 5.5541 4.9995 4.1666 3.5714 3.1250
60 44.9550 34.7609 27.6756 22.6235 18.9293 16.1614 14.0392 12.3766 11.0480 9.9672 8.3240 7.1401 6.6651 6.2402 5.5553 4.9999 4.1667 3.5714 3.1250
553
GLOSSARY
acquirer The entity that obtains control of the acquiree, 53 economic interests An organization that holds resources that
acquisition date The date on which the acquirer obtains control must be used to produce revenue or provide services for the
of the acquiree, 53 reporting organization, or an organization whose liabilities the
associate A company, including an unincorporated company reporting organization is responsible for, 476
such as a partnership, over which the investor has significant element A grouping of items sharing similar economic characteris-
influence and that is neither a subsidiary nor an interest in a tics into a broad classification to meet the objectives of financial
joint venture, 26, 286 statements. There are two types of elements: those that describe
business An integrated set of activities and assets that is capable the economic (financial and non-financial) resources, obligations,
of being conducted and managed for the purpose of providing a and accumulated surplus or deficit of a government at a point
return in the form of dividends, lower costs, or other economic in time (such as assets and liabilities), and those that describe
benefits directly to investors or other owners, members, or par- changes in economic resources, obligations, and accumulated
ticipants, 49 surplus or deficit over a period of time (such as revenues and
business combination A transaction or other event in which an expenses), 517
acquirer obtains control of one or more businesses, 49 endowment fund A type of restricted fund where, even though
capital asset fund A type of restricted fund where the funds must funds are collected, the principal is not allowed to be spent, 460
be used for the acquisition and maintenance of capital assets, 461 entity concept of consolidation Concept in which the group
closing rate The spot exchange rate at the end of the reporting consists of the assets and liabilities of the parent as well as all
period, 351 the assets and liabilities of the subsidiaries and the non-
collections Works of art and historical treasures that have cul- controlling interest is classified as a contributor of equity to the
tural, aesthetic, or historical value that is worth preserving group, 163, 222
perpetually, 474 equity method A method of accounting whereby the investment
consolidated financial statements The financial statements of a is initially recognized at cost and adjusted thereafter for the
group presented as those of a single economic entity, 21, 108, 163 post-acquisition change in the investor’s share of net assets
contingent consideration Usually, an obligation of the acquirer of the investee. The profit or loss of the investor includes the
to transfer additional assets or equity interests to the former investor’s share of the profit or loss of the investee, 28, 286
owners of an acquiree as part of the exchange for control of the exchange rate The ratio of exchange for two currencies, 344
acquiree if specified future events occur or conditions are met. fair value The price that would be received to sell an asset or
However, contingent consideration also may give the acquirer paid to transfer a liability in an orderly transaction between
the right to the return of previously transferred consideration if market participants at the measurement date (i.e., an exit
specified conditions are met, 59 price), 8, 49
contingent liability Either a possible obligation that arises from fair value through profit and loss The method of accounting
past events and whose existence will be confirmed only by the required for financial assets. The equity investment is restated
occurrence or nonoccurrence of one or more uncertain future each year to its fair value with the gains or losses going through
events not wholly within the control of the entity; or a present net income, 6
obligation that arises from past events but is not recognized financial assets As defined by the CICA PSA Handbook, assets that
because it is not probable that an outflow of resources could be used to discharge existing liabilities or finance future
embodying economic benefits will be required to settle the operations and are not for consumption in the normal course of
obligation or the amount of the obligation cannot be measured operations, 517
with sufficient reliability, 62 foreign currency A currency other than the functional currency
contributions Revenue to a not-for-profit organization that can of the company, 348
come from government grants and loans, donations by individu- foreign currency transactions Transactions denominated in a
als or corporations, or interest or gains on investments, 464 currency that is different than the functional currency of the
control (as defined by the CICA PSA Handbook) The power to reporting entity, 405
govern the financial and operating policies of another organiza- foreign exchange gain or loss The difference resulting from
tion with the expected benefits or the risk of loss to the govern- translating a given number of units of one currency into another
ment from the other organization’s activities, 513 currency at different exchange rates, 344
control The situation when an investor is exposed, or has rights, foreign operation A company that is a subsidiary, associate, joint
to variable returns from its involvement with the investee and venture, or branch of a reporting company, the activities of
has the ability to affect those returns through its power over the which are based or conducted in a country or currency other
investee, 12, 109 than those of the reporting company, 403
deferral method A method of accounting for contributions under functional currency The currency of the primary economic
fund accounting. Restricted contributions related to expenses environment in which the company operates, 345, 402
of future periods are deferred and recognized as revenue in the fund accounting The collective accounting procedures resulting
period in which the related expenses are incurred. Endowment in a self-balancing set of accounts for each fund established by an
contributions are reported as direct increases in net assets. organization’s legal, contractual, or voluntary actions. Elements
All other contributions are reported as revenue of the current of a fund can include assets, liabilities, net assets, revenues,
period. Organizations that use fund accounting in their financial and expenses (and gains and losses, where appropriate). Fund
statements without following the restricted fund method would accounting involves an accounting segregation, although not
account for contributions under the deferral method, 465 necessarily a physical segregation, of resources, 459
Glossary 555
goodwill An asset representing the future economic benefits aris- joint venture A joint arrangement whereby the parties that have
ing from other assets acquired in a business combination that joint control of the arrangement have rights to the net assets of
are not individually identified and separately recognized, 66 the arrangement, 32, 286
government An entity that is a federal, provincial, territorial, or liquidity risk As defined by the CICA PSA Handbook, the risk that
local government, 510 a government will encounter difficulty in meeting obligations
government business enterprise (GBE) As defined by the CICA associated with financial liabilities, 517
PSA Handbook, an organization that is a separate legal entity modified equity method A method of accounting whereby the
with the power to contract in its own name and that can sue investment is initially recognized at cost and adjusted thereaf-
and be sued, has been delegated the financial and operational ter for the post-acquisition change in the public sector entity’s
authority to carry on a business, sells goods and services to indi- share of the net assets of the investee, without adjustment to
viduals and organizations outside of the government reporting conform the entity’s results to the basis of accounting followed
entity as its principal activity and can, in the normal course of by the investor. When reporting on its operations, the pub-
its operations, maintain its operations and meet its liabilities lic sector entity includes its share of the profit or loss of the
from revenues received from sources outside of the government investee, 530
reporting entity, 526 monetary items Units of currency held and assets and liabilities
government business partnership As defined by the CICA PSA to be received or paid in a fixed or determinable number of
Handbook, a government partnership that is a separate legal units of currency, 351, 406
entity with the power to contract in its own name and that can net debt A measure of the future revenues needed to pay for past
sue and be sued, has been delegated the financial and operational transactions and events. It is the difference between a public
authority to carry on a business, sells goods and services to indi- sector entity’s liabilities and its financial assets, 520
viduals and organizations other than the partners as its principal net investment in a foreign operation The amount of the
activity, and can, in the normal course of its operations, main- reporting company’s interest in the net assets of that operation,
tain its operations and meet its liabilities from revenues received 412
from sources other than the partners, 531 non-controlling interest (NCI) The equity in a subsidiary not
government not-for-profit organization (GNFPO) As defined attributable, directly or indirectly, to a parent, 222
by the CICA PSA Handbook, an organization that has counter- non-financial assets Those assets recognized in the financial
parts outside of the public sector; is an entity normally without statements of a public sector entity that are not financial assets.
transferable ownership interests; is an entity organized and Typically, non-financial assets are assets that are used to provide
operated exclusively for social, educational, professional, reli- services and may be consumed. Generally, non-financial assets
gious, health, charitable, or any other not-for-profit purpose; are not available for sale, 517
and its members, contributors, and other resource providers do non-monetary items Units of measurement that are not fixed by
not, in such capacity, receive any financial return directly from contract or in a determinable number of currency units, 351
the organization, 453, 526 not-for-profit organizations Entities, normally without transfer-
government organization An organization controlled by a gov- able ownership interests, organized and operated exclusively for
ernment (control is determined in accordance with the section social, educational, professional, religious, health, charitable, or
Government Reporting Entity in the CICA PSA Handbook), 524 any other not-for-profit purpose. A not-for-profit organization’s
government partnership As defined by the CICA PSA Handbook, members, contributors, and other resource providers do not,
a contractual arrangement between the government and a party in such capacity, receive any financial return directly from the
or parties outside of the government reporting entity where the organization, 453
partners co-operate toward achieving significant clearly defined other government organization (OGO) A government organi-
common goals, make a financial investment in the government zation that is not a GBE or GNFPO, 527
partnership, share control of decisions related to the financial parent An entity that has one or more subsidiaries, 108
and operating policies of the government partnership on an pledge A promise to contribute cash or other assets, 464
ongoing basis, and share, on an equitable basis, the significant presentation currency The currency in which the financial state-
risks and benefits associated with the operations of the governments are presented, 344, 407
ment partnership, 531 proportionate consolidation for joint ventures A method of
government reporting entity The government and the organi- reporting, only available under ASPE, whereby a venturer’s
zations it controls, 525 share of each of the assets, liabilities, income, and expenses
governmental unit As defined by the CICA PSA Handbook, a of a jointly controlled company is combined line by line with
government organization that is not a government business similar items in the venturer’s financial statements or reported
enterprise, 530 as separate line items in the venturer’s financial statements,
group A parent and all its subsidiaries, 110, 162, 402 34, 531
highly effective hedge The strategy used by the company to proportionate consolidation in the public sector A method of
protect itself from foreign currency risk exposure was able to reporting whereby the public sector entity’s share of the assets,
achieve an offsetting risk exposure, 364 liabilities, revenue, and expenses of an investee is combined
historical exchange rate The spot rate at the transaction date as on a line-by-line basis with similar items in the public sector
reflected in subsequent periods, 354 entity’s financial statements, 34, 531
joint control The contractually agreed sharing of control over public sector entity An entity that is a government or a govern-
an arrangement, which exists only when decisions about the ment organization, 510
relevant activities require the unanimous consent of the parties recording The manner in which the transaction is reflected in the
sharing control, 32, 300 entity’s books and records, 109
joint operation A joint arrangement where the investor has a reporting The manner in which the transaction is reflected in
contractual right or obligation to the assets and liabilities of the the consolidated financial statements that are issued to outside
operation, 32 users, 109
556 Glossary
restricted fund A segregation of funds that are externally or separate financial statements Financial statements presented
internally restricted for a particular purpose. Stipulations are by a parent (i.e., an investor with control of a subsidiary) or
imposed that specify how resources must be used. External an investor with joint control of, or significant influence over,
restrictions are imposed from outside the organization, usually an investee, in which the investments are accounted for at cost
by the contributor of the resources. Internal restrictions are or in accordance with IFRS 9 Financial Instruments, 288
imposed in a formal manner by the organization itself, usually shared control An arrangement whereby no partner can exercise
by resolution of the board of directors. Restrictions on con- unilateral control over decisions as to the financial and operat-
tributions may only be externally imposed. Net assets or fund ing activities of the government partnership, 531
balances may be internally or externally restricted. Internally significant influence The power to participate in the financial
restricted net assets or fund balances are often referred to as and operating policy decisions of the investee but without hav-
“reserves” or “appropriations,” 460 ing control or joint control over those policies, 26, 286
restricted fund method A method of accounting for contributions spot exchange rate The exchange rate for immediate delivery,
under fund accounting. Details of financial statement ele- 349
ments are reported by fund in such a way that the organization subsidiary An entity, including an unincorporated company such
reports total general funds, one or more restricted funds, and an as a partnership, that is controlled by another entity (known as
endowment fund, if applicable, 467 the parent), 12, 108
CREDITS
The following questions were adapted from FA4 Exams, published by the Certified General Accountants Association of Canada © 2008 to
2011 CGA-Canada. Reproduced with permission.
Chapter 4 P8-5 September 2011

P4-3 June 2011 WA8-2 December 2011
P4-4 June 2011
Chapter 9
Chapter 7 E9-4
E7-6 June 2011 E9-5
E7-9 December 2011 E9-6
P7-2 June 2011 E9-7
P7-6 March 2011 E9-8
P7-12 September 2011
Chapter 10
Chapter 8 WA10-8 March 2011
E8-4 March 2011 WA10-10 March 2011
P8-2 December 2011 WA10-11 June 2011
P8-3 June 2011
The following questions were adapted with permission from the Uniform Evaluation Report, published by The Canadian Institute of
Chartered Accountants, Toronto, Canada. Any changes to the original material are the sole responsibility of the author (and/or publisher)
and have not been reviewed or endorsed by the CICA.
Chapter 1 Chapter 6
C1-4 Uniform Evaluation Report, 1997 C6-2 Uniform Evaluation Report, 1999
C6-3 Uniform Evaluation Report, 2009
Chapter 2 C6-4 Uniform Evaluation Report, 1994
Chapter 7
Chapter 3 C7-2 Uniform Evaluation Report, 1993
Chapter 4
C4-2 Uniform Evaluation Report, 1997 Chapter 8
C4-3 Uniform Evaluation Report, 1997 WA8-3 Uniform Evaluation Report, 1994
Chapter 5
The following questions were adapted from material provided by CMA Canada. Used with the permission of CMA Canada
Chapter 8
P8-1 Entrance Examination, 2006
The following questions were adapted from material provided by IFRS Foundation. Copyright © 2012 IFRS Foundation. All rights
reserved. No permission granted to reproduce or distribute.
Chapter 1
WA1-4, WA1-5, WA1-6, WA1-7,WA1-8, WA1-9, WA1-10, C1-2
Chapter 2
WA2-3
COMPANY INDEX
A City of Peterborough, 534, 534f M
Abitibi Mining Corporation, 6, 7f City of Winnipeg, 521, 521f–523f, 523 Maple Leaf Sports and Entertainment, 46
Accounting Standards Board (AcSB), 452, CMA Canada, 437n, 504n Microsoft Corporation, 54
453n, 454, 471, 511–512, 519, 527 COGECO Inc., 73, 73f–74f
Accounting Standards Oversight Council College of Business (Auburn University), 2
(AcSOC), 511 CommuniMax Direct, 342 N
CROSBIE, 4n, 106n NASDAQ Global Select Market, 160
Acme Resources Inc., 21, 22f
CSL Group Inc. (CSL), 4 Neodym Technologies Inc., 7f
Aecon Group Inc., 284, 284n
Agrium Inc., 48, 48f–49f CTV Inc., 46, 64f–65f
Agroport, 48f O
Aimia Inc., 398, 398n D Ontario Power Generation, 284
Air Canada Centre, 46 Department of Health and Social Services
AWB Limited, 48, 48f–49f (Yukon), 528f P
Peterborough County-City Waste
B E Management Facility, 534f
Banco Colpatria, 220 Encana Corporation, 4 PetroChina Company Limited, 4
Bank of Canada, 342n Enron Corporation, 524 Platte River Gold Inc., 108f–109f
Bank of Nova Scotia (Scotiabank), 220, 220n Equinox Minerals Limited, 113f–114f PricewaterhouseCoopers, 46n
Barrick Gold Corporation, 34, 34f, 63, 63f, Equinox Resources Limited, 106, 113 Province of Ontario, 534, 534f
106, 106n, 113, 113f–114f, 221, 224f, Public Sector Accounting Board (PSAB),
286, 286f 452, 453n, 511–512, 512n, 519, 520n,
Bell Canada Enterprises (BCE), 46, 46n, 64, F 526, 527, 533, 535, 538, 539f
64f–65f Financial Accounting Standards Board
(FASB), 20n, 43n
Bell Media, 46
Fondation Centraide du Grand Montréal, R
Board Source, 452n Reko Diq, 286f
Bombardier Aerospace (BA), 401f, 407 458f, 478f
Research In Motion (RIM), 160, 160n
Bombardier Inc., 361, 364f, 401, 401f, 407 Rio Tinto plc, 375, 375f, 401, 401f, 410f
Bombardier Transportation (BT), 401f, 407 G Rite Aid, 375f
Golden Harp, 22f
Government of Yukon, 528f, 529f, 530
C Groupe Aeroplan, 398 S
Cabovisão, 73f–74f Scorpio Gold Corporation, 28f, 244
Canada Mortgage and Housing Corporation, Scorpio Mining Corporation, 28, 28f, 108,
528f, 529f, 530, 546 H 108f–109f, 244, 244f
Canada Revenue Agency, 166, 452, 452n Hi-Fert Pty. Ltd., 48f Shoppers Drug Mart Corporation, 64,
Canadian Accounting Standards Board 64f
(AcSB), 454 SNC Lavalin, 284, 284n
Canadian Breast Cancer Foundation, 450
I
Industry Canada, 4n Statistics Canada, 510
Canadian Institute of Chartered Accountants Strike Mineral Inc., 7f
International Accounting Standards Board
(CICA), 155n, 159n, 160n, 212n, 215,
(IASB), 38n, 39n, 41n, 49, 63,
335n, 338n, 340n, 391n, 392n, 394n,
397n, 437, 444n, 446n, 448n, 495n,
228–229, 314, 538, 539f T
International KRL Resources Corp., 21 TMX Group Inc., 4
501n, 503n, 506n, 510
Toronto Maple Leafs, 46
Canadian Museum of Civilization, 475, 475f
J Toronto Raptors, 46
Canadian Radio-television and
The Jean Coutu Group (PJC) Inc., 375, 375f Toronto Stock Exchange, 160
Telecommunications Commission
(CRTC), 46, 505
Centraide (United Way) of Greater
K U
Montreal, 456–457, 457f–459f, 460, University of Arkansas, 2
Klondike Gold Corp., 7f
461, 464, 465f, 467–468, 468f, 472,
Klondike Silver Corp., 7f
472f, 478, 478f, 479, 479f
Cerealtoscana S.p.A., 48f
KPMG, 342n W
Kristian Jebsens Rederi AS (Jebsens), 4 Wall Street Journal, 510
Cerro Casale, 224f, 286f
CGA-Canada, 380n, 383n, 384n, 388n, 438n,
439n, 494n, 495n, 497n, 498n, 500n, L Y
547n, 548n London Stock Exchange Group plc, 4 Yukon Housing Corporation, 527,
Champlain Regional College, 508, 508n Loyalty Management Group (LMPG), 398 527f–530f, 530
SUBJECT INDEX
A purchase premiums arising on an non-monetary assets, 58, 309–310
accountability, 508, 512 acquisition, 538 purchase of acquiree’s assets, 72
accountability value, 516 reporting currency, 405 recognition of assets acquired, 62–65
accounting equation, 460 retirement benefits, 539 separately identifiable intangible assets,
accounting standards, 5 separate financial statements, 289 63–65
see also Accounting Standards for Private significantly influenced investments, 31 share purchase vs. asset purchase, 48
Enterprises (ASPE); International subsidiary, accounting for, 106 tangible capital assets, 472–475, 539
Accounting Standards (IAS); tangible capital assets, 539 associates, 26–31, 286
International Financial Reporting tax payable method, 66 additional ownership interest after
Standards (IFRS) temporal method, 358, 421 acquisition of significant influence,
Accounting Standards Board (AcSB), 452, translation from functional currency to 303
454, 511, 527 presentation currency, 378 after acquisition of ownership interest,
Accounting Standards for Private Enterprises unit of measure, 348 301–302
(ASPE), 5 Accounting Standards Oversight Council borrowings, 308–309
acquirer, and fair value, 58 (AcSOC), 511–512 consolidated financial statements,
acquisition in stages, 303 acquiree, 53 288–289
associates, and goodwill, 294 accounting in records of acquiree, 72 different ends of reporting periods,
business combination, 78 consideration transferred to acquiree, 296–299
vs. CICA Public Sector Accounting 57–61 dissimilar accounting policies, 296,
Handbook, 538 purchase of acquiree’s assets and liabilities, 297–299
comprehensive revaluation of net assets, 72 dividends, 295–296, 297–299
136–137 purchase of acquiree’s shares from equity method, 27–31, 288
consolidation of variable interest shareholders, 72 exclusions to definition, 27–28
entities, 25 shares acquired in an acquiree, 69–70 fair value differences, 292–294
consolidation process, 136 acquirer, 53–55, 57–71 goodwill, 292–294
control, criteria for, 25, 475 acquisition analysis, 67–68, 112–118, identifying associates, 26–28
convenience translation currency, 410 286, 292 intercompany transactions, 304–312
currency of measurement, 405 acquisition date, 53, 55–56, 109–110 inventory transactions, 305–307
derivative financial instruments, and fair acquisition method, 52–56 investment in stages, 300–303
value, 366 acquisition-related costs, 59–61 losses, 312–314
fair value adjustments, 130 acquisitions, 4, 46 movements in equity, 295–299
financial instruments, 539 see also business combination non-current assets, 307–308
foreign currency adjustments, 417 active control, 14 non-monetary assets, contributions of,
foreign currency for companies within advances, 182–183 309–310
group, 405 agent, 19 reserves, 296, 297–299
foreign currency transactions, 358, allocated expenses, 479–480 significant influence, 26–27
370–372, 373, 378 American dollar, 342 transactions between, 310–311
foreign currency translation, 539 anomalous transactions, 68 average exchange rate, 350
functional currency, 348 ASPE. See Accounting Standards for Private
general purpose financial statement, 21 Enterprises (ASPE) B
goodwill, 75 assets bonds
hedge accounting, 539 accounting for, 49 acquired at date of issue, 183–184
hedge accounting for foreign currency capital assets, 518 acquired on open market, 186–187
transactions, 370–372, 373 collections, 474–475 bonds payable, and fair value adjustments,
hyperinflationary environments, 421 comprehensive revaluation of net assets, 130–131
impairment testing, 12, 31, 34, 75 136–137 intragroup transactions, 183–184
impairments, reversal of, 12 deferred tax asset, 173, 174 borrowings
intangible assets, 538 depreciable assets, 173–175, 308, advances, 182–183
intercompany transactions, 311 416–417 associates, 308–309
joint ventures, 34, 289, 294 depreciable non-current assets, 240–241 intragroup borrowings, 182–184
non-controlling interest, 303 excess of net assets acquired over cost joint ventures, 308–309
non-strategic equity investments, 5, income, 294 budget, 513
10–12 financial assets, 6, 519 budget to actual analysis, 490
not-for-profit organizations (NFPO), 454 goodwill. See goodwill budgeting (NFPOs), 490–493
parent-subsidiary relationship, 25 held for sale, 27 budget to actual analysis, 490
presentation currency, 410 impairment. See impairment encumbrance accounting, 487–489
presentation of non-controlling interest, impairment testing. See impairment internal budget restrictions, 487
538 testing business, 49–50
primary financial statements, 289 intangible assets, 63–65, 472–475, 538 business combination
proportionate consolidation, 34, 310 monetary assets, 57 accounting in records of acquiree, 72
proportionate consolidation method, 289 non-current assets, 307–308 accounting in records of acquirer, 57–71
proprietary concept of consolidation, 250 non-financial assets, 517 achieved in stages, 70
560 Subject Index
business combination (continued) revenue recognition criteria, 455 equity instruments, 58

acquirer, identification of, 53–55 significant influence, 477 and fair value of non-controlling interest
acquisition date, 53, 55–56 statement of financial position, 456 (NCI), 226
acquisition method, 52–56 strategic investments, 475 liabilities undertaken, 59
under ASPE, 78 user needs, 455 non-monetary assets, 58
basic principles, 52–56 CICA Public Sector Accounting Handbook, 453, transferred to a business combination,
and common control, 51 510, 511–512, 532 60–61
comprehensive example, 75–78 consolidation, 530 transferred to acquiree, 57–61
consideration transferred to a business contaminated sites, liability for, 533 consolidated equity, 239
combination, 60–61 control, 524–525 consolidated financial statements, 21–24,
consideration transferred to acquiree, financial assets, 519 106, 108, 163
57–61 financial instruments, 539 see also consolidation
consolidation. See consolidation financial statement presentation, 517 adjustments, 110
contingent consideration, 59, 74 foreign currency translation, 539 basic format, 119
contingent liabilities, 62–63, 74 forgivable loans, 533 consolidated retained earnings, 137
definition, 49–50 government business enterprise (GBE), consolidated statement of comprehensive
Exposure Drafts, 228 532–533 income, 111, 137
forms of, 51–52 government business partnership, 531 consolidated statement of financial
gain on bargain purchase, 68–69 government not-for-profit organization, position, 111, 137
goodwill, 66–67, 73–74 519, 527 at day of acquisition, 119–122
identification of, 50 government organization, 524 dividends recorded by subsidiary at
income taxes, 65–66 government partnerships, 531 acquisition date, 120–121
joint venture, formation of, 51 government transfers, 537 equity method, 287–291
nature of a business combination, hedge accounting, 539 exclusion of subsidiary, 23–24
49–52 intangible assets, 538 exemption from, 22
previously held equity interest, 70–71 liabilities, 535 fair value adjustments, 124–133
purchase of acquiree’s assets and loan guarantees, 534 gain on bargain purchase, 121–122
liabilities, 72 loan repayments through future goodwill recorded by subsidiary at
purchase of acquiree’s shares from appropriations, 533 acquisition date, 119–120
shareholders, 72 loans receivable, 533 and intercompany transactions, 123
recognition of assets and liabilities, loans with significant concessionary terms, parent company recording in its own
62–65 533 books, 122–124
reporting perspective, 48 vs. other GAAP frameworks, 537–540 preparation, 111–112
shares acquired in an acquiree, 69–70 other government organizations (OGOs), preparation, in subsequent periods,
stages, 300 527 133–136
subsequent adjustments to initial portfolio investment with concessionary purpose, 163
accounting, 73–78 terms, 532 vs. separate financial statements,
post-closure liabilities, 534 287–289
presentation of non-controlling interest, subsequent to acquisition date, 122–136
C 538 unrealized profits, 167
Canadian dollar, 342, 345n, 406n purchase premiums arising on an consolidation
capital asset fund, 461 acquisition, 538 see also consolidated financial statements
capital assets qualitative characteristics of public sector acquisition analysis, 112–118
public sector entities, 518 financial reporting, 515 acquisition date, 109–110
tangible capital assets, 472–475, 539 recognition of items, 521 under ASPE, 136
carryforwards, 65 retirement benefits, 539 choice of concept, 249
cash, as consideration, 57 solid waste landfill closure, 534 concepts of consolidation, 248–251
cash flow hedges, 366, 367–369 tangible capital assets, 539 consolidated financial statements at day of
charities, 452 tax revenue, 536–537 acquisition, 119–122
CICA Handbook (Part III), 454 types of government organizations, consolidated financial statements
capitalization, exemption from, 473 525 subsequent to acquisition date,
collections, 474–475 closing rate, 351 122–136
conceptual framework, 455 collections, 474–475 consolidation process, 108–112, 136,
contributed inventory, 471 common control, 51 162
control, 476 common shares, 295 entity concept of consolidation, 163n,
controlled investments, 477 comparability, 516 222, 248–249
deferral method, 470 completeness, 516 fair value adjustments, 117–118, 124–133
economic interests, 476 comprehensive revaluation of net assets, foreign currency adjustments, 411–417
expense allocation, 479–480 136–137 foreign operation, 411–417
financial statements, 456–459 confiscatory revenues, 513 government organizations, 530
fund accounting, 459 conservatism, 516 intragroup transactions. See intragroup
goodwill, 472 consideration transactions
impairment, 473–474 acquisition-related costs, 59–61 intragroup transfers of inventory,
intangible assets, 472 cash or other monetary assets, 57 164–171
joint ventures, 477 contingent consideration, 59, 74 non-controlling interest (NCI). See
related party, 478 costs of issuing debt and equity non-controlling interest (NCI)
restricted fund method, 470 instruments, 59 one-line consolidation, 287
Subject Index 561
parent entity concept of consolidation, derivative financial instruments, 359–363, foreign currency adjustments, 411–417
249–250 366 and joint control, 34
pre-acquisition adjustments, 118 derivatives, 344, 344n modified equity method, 530
preparation of consolidated financial direct approach, 111 rationale, 28–29
statements, 111–112 disclosure equity transactions, 245
preparation of consolidated financial convenience translation currency, 410 exchange rate, 344, 349
statements, subsequent periods, non-controlling interest (NCI), 222–224 average exchange rate, 350
133–136 disposal of foreign operation, 418 closing rate, 351
previously held equity interest in dissimilar accounting policies, 296, historical exchange rate, 354
subsidiary, 116–117 297–299 spot exchange rate, 349–350
proportionate consolidation, 310, 531 dissimilar activities, 20 exchange risk, 398
proprietary concept of consolidation, dividends expense allocation, 479–480
250 associates, 295–296, 297–299 expenses
Constitution, 510 declared and paid in current period, allocation of, 479–480
construction industry, 284 181 intragroup transactions, 165
contaminated sites, 533 declared in current period but not paid,
contingent consideration, 59, 74 180–181
contingent liabilities, 62–63, 74 dividend income, and disclosure, 10 F
contracts, existence of, 15 intragroup dividends, 180–182, 237–238 fair value, 8, 49n, 60, 62n, 63
contributed inventory, 471 from investee, 289 adjustments. See fair value adjustments
contributions, 464–471 joint ventures, 295–296, 297–299 derivative financial instruments, 366
control, 12–13, 49, 109 preferred shares, 295–296 differences, associates and joint ventures,
under ASPE, 25 recorded by subsidiary at acquisition date, 292–294
business combination. See business 120–121 of non-controlling interest (NCI), 226
combination shares, 295 non-monetary items, 355–356
capacity to control, 13 tax effect, 181 fair value adjustments, 110, 117–118,
common control, 51 downstream transactions, 304, 306 124–133, 293
consolidated financial statements, 21–24 bonds payable, 130–131
continuous assessment of, 13 depreciable assets, 416–417
disorganization or apathy of E equipment, 126–127
shareholders, 15 economic interests, 476 foreign investments, 415–417
existence of contracts, 15 educational institutions, 452 goodwill, 132–133, 227, 415–416
of government organization, 524–525 elements, 517 inventory, 128–129
joint control, 32, 34, 300 encumbrance accounting, 487–489 land, 125–126
level of share ownership, 14–17 endowment fund, 460–461 liabilities, 131–132
link criterion, 13, 18–20 engineering industry, 284 limited life, 416–417
non-shared control, 14 entity concept of consolidation, 163n, 220, non-controlling interest (NCI), 229,
not-for-profit organizations (NFPO), 222, 248–249 235
475, 476 equipment, 126–127 property, plant, and equipment,
passive vs. active control, 14 see also property, plant, and equipment 416–417
power criterion, 13–18 equity fair value hedges, 367
process to determine control, 20–21 consolidated equity, 239 fair value through profit and loss (FVTPL),
purpose of acquiring control, 48 movements in equity, 295–299 6–10, 27
returns criterion, 13, 18 non-controlling interest (NCI), fiduciary relationships, 18
shared control, 531–532 classification as equity, 222 Financial Accounting Standards Board
size of voting interest, 15 non-controlling interest (NCI) in equity, (FASB), 228
unilateral control, 15 in subsequent periods, 234–238 financial assets, 6, 519
control premium, 227 ownership, and public sector entities, financial instruments, 6, 539
convenience reporting, 410 515 financial statements
convertible instruments or options, 17 post-acquisition equity, 292 under ASPE, 21
cost equity instruments, 58, 59 consolidated financial statements. See
acquisition-related costs, 59–61 equity interest, previously held, 70–71, consolidated financial statements
and fair value, 6, 8 116–117 hyperinflationary environment, 419–420
of issuing debt and equity instruments, 59 equity investments not-for-profit organizations (NFPO),
transaction costs, 8 see also investments 454–456, 456–459, 480–488
cost method, 25, 28, 123 business combination. See business other government organizations (OGOs),
credit risk, 358 combination 527
non-strategic equity investments, 5–12 primary financial statements, 289
in stages, 300–303 public sector entities, 514–521, 521–523
D strategic investments. See strategic purchasing power adjusted financial
debt instrument, 59 investments statements, 421
deferral method, 465–467, 470 equity method, 25, 27–31, 123, 286–291, separate financial statements, 21, 109,
deferred tax accounts, 163 288n 123, 287–291
deferred tax asset, 173, 174 application of, 302 statement of cash flows, 457, 517–518,
depreciable assets, 173–175, 308, 416–417 basic method, 29–31, 289–291 523
depreciable non-current assets, 240–241 different ends of reporting periods, statement of changes in net assets, 457,
depreciation of profits or losses, 176–177 296–299 517, 523
562 Subject Index
financial statements (continued) fair value adjustments, 415–417 full goodwill method, 226–227, 228–229,
statement of financial position, 351, 361n, foreign currency adjustments, 411–417 230–231
456, 517, 523 foreign currency transactions within joint ventures, 292–294
statement of operations, 456, 517, 523 group, 405–407 not-for-profit organizations (NFPO),
of subsidiary, 109–110 functional currency, 402–405, 406–407 472
translation from functional currency to hedge accounting, 418–419 partial goodwill method, 227–229,
presentation currency, 375–378 hyperinflation, 409 232–233, 234
user needs, 454–455 intracompany balances, 412–413 recognition, 66–67, 118, 225
foreign currency, 348 non-controlling interest, 417–418 recorded by subsidiary at acquisition date,
see also foreign currency transactions presentation currency differing from 119–120
foreign currency adjustments, 411–417 functional currency, 408–410 government, 510
foreign currency risk, 345, 359 reviewable, 400 see also public sector entities
foreign currency transactions, 405 tax effects of all exchange differences, government business enterprise (GBE), 526,
see also foreign investments 418 530–531
under ASPE, 348, 358, 370–372, 373, translation of individual financial government business partnership, 531
378, 405 statements into group presentation government not-for-profit organization, 453,
convenience translation currency, 410 currency, 407–409 519, 526–527
conversion into functional currency, foreign operation, 403, 403n, 412 see also public sector entities
349–358 see also foreign investments government organizations, 524–532
currency of measurement, 405 forgivable loans, 533 see also public sector entities
current monetary item subsequent to forward contract, 344, 344n consolidation, 530
transaction date, 351–352 foundations, 452 control, 524–525
current non-monetary items subsequent to full goodwill method, 226–227, 228–229, definition, 524
transaction date, 354 230–231 government business enterprise (GBE),
examples of, 349 functional currency, 344, 345–349, 402 526, 530–531
foreign currency adjustments, 411–417 changes in, 406–407 government business partnership, 531
foreign currency derivative financial conversion of foreign currency government not-for-profit organization,
instruments, 359–363 transactions, 349–358 526–527
functional currency, 344, 345–349, definition, 402 government partnerships, 531–532
375–378, 379 determination of, for each company in government reporting entity, 527
gains and losses arising from translation, group, 402–405 modified equity method, 530
539 differing from presentation currency, other government organizations,
within the group, 405–407 408–410 527–530
hedge accounting, 358–374 hierarchy of criteria, 402–403 reporting on results of, 530–531
impairment, 357 translation into, 379 types of, 525–530
initial recognition, 349, 405 translation to presentation currency, government partnerships, 531–532
long-term monetary items subsequent to 375–378 government reporting entity, 527
transaction date, 352–354 fund accounting, 459–464 government structures, 513
long-term non-monetary items subsequent capital asset fund, 461 government transfers, 537–538
to transaction date, 355 deferral method, 465–467, 470 governmental units, 530
monetary items, 351–354 definition, 459 grant revenue, 535–536
non-monetary items, 351, 354–357 endowment fund, 460–461 group, 110, 162, 402
non-monetary items reflected at fair value illustration of, 461–464 group presentation currency, 407–409
in subsequent periods, 356–357 interfund transfers, 464 group structure, sample, 402
presentation currency, 344, 375–378, public sector entities, 521
407–409 restricted fund, 460
primary economic activity, 347–348 restricted fund method, 467–470 H
recognition in subsequent periods, types of funds, 460–461 hedge accounting, 358–374
350–355 future contracts, 344n application of, 366–370
reporting currency, 405 under ASPE, 370–372, 373
temporal method, 358 cash flow hedges, 366, 367–369
translation differences, 398 G comparison of GAAP frameworks, 539
translation from functional currency to gain on bargain purchase, 68–69, 112, definition, 363–364
presentation currency, 375–378 121–122, 243–244 derivative financial instruments as hedges,
translation to functional currency, 379 gains, foreign exchange, 344, 346–347, 359–363
foreign exchange, 342 355, 401 economically hedging foreign currency
see also foreign currency transactions generally accepted accounting principles risk, 359
foreign exchange gains or losses, 344, (GAAP). See specific accounting effectiveness of hedge, 364–366
346–347, 355, 401 standards fair value hedges, 367
foreign investments globalization, 342, 344 firm commitments, 369n
see also foreign currency transactions goodwill, 50, 73–74, 75, 112 foreign investments, 418–419
changes in functional currency, 406–407 adjustments, 293 hedging item, 366
convenience translation currency, 410 associates, 292–294 highly effective hedge, 364, 364n
depreciable assets, 416–417 control premium, 227 natural hedges, 359
disposal or partial disposal of foreign fair value adjustments, 132–133, 227, no hedge accounting, 361–363
operation, 418 415–416 partially ineffective hedge, 369–370
Subject Index 563
qualifying for, 364–366 contingent liabilities, 62 functional currency, 402, 403

where no hedge accounting, 373–374 deferred tax accounts, 163 goodwill, 50, 225, 227
highly effective hedge, 364, 364n derivative financial instruments, and fair government business organizations, 453
historical exchange rate, 354 value, 366 hedge accounting, 358, 539
horizontal integration, 164 dissimilar accounting policies, 296 intangible assets, 538
hyperinflationary environment, 409, equity instruments, classification of intragroup losses, 175
419–420 shares in, 6 intragroup transactions, 110, 163
equity method, 28–29, 29, 289–290, 292 joint control, 32
exclusions of subsidiaries from joint operations, 32
I consolidation, 23–24 joint ventures, 32, 284
IAS. See International Accounting Standards fair value hedge, 369n non-controlling interest (NCI), 222, 225,
(IAS) financial asset, 6 227, 228–229, 241, 246
IFRS. See International Financial Reporting foreign currency transactions, examples, non-monetary items, 355
Standards (IFRS) 349 non-strategic investments in equity, 5
impairment functional currency, 345 not-for-profit organizations (NFPO),
foreign currency transactions, 357 goodwill, 73 454
intragroup loss, and impairment, 175 hedge accounting, 418–419 ownership interest, 302
not-for-profit organizations (NFPO), historical exchange rate, 354 parent-subsidiary relationships, 12
473–474 hyperinflation, 409 presentation of non-controlling interest,
reversal, 12 impairment testing, 31 538
impairment testing, 12, 31, 34, 75 intercompany transaction, 304 previously held equity interest in
income joint ventures, 284, 286, 292, 295, 304, subsidiary, 116
dividend income, and disclosure, 10 309, 312 purchase premiums arising on an
net income, 352n leases, 63n acquisition, 538
non-controlling interest (NCI) in income, net investment in foreign operation, 412 relevant activities, 14, 15
in subsequent periods, 234–238 non-controlling interest (NCI), 221 relevant decisions, 14
non-monetary items reflected at fair value non-monetary items, 354, 356n retirement benefits, 539
in subsequent periods, 356 non-strategic investments in equity, 5 returns, examples of, 18
other comprehensive income, 355, separate financial statements, 21, 109, revaluation approach, 136
356–357, 518, 530 123, 288 rights that provide power to investor, 13
income taxes separately identifiable intangible sale by parent, 246
business combination, 65–66 assets, 63 separate financial statements, 21, 288
carryforwards, 65 translation to presentation currency, 376 step acquisition, 70, 71
deferred tax accounts, 163 upstream and downstream transactions, strategic investments, 6
deferred tax asset, 166, 173, 174 304 structured entities, 19–20
dividends, 181 International Financial Reporting Standards subsidiary, accounting for, 106
exchange differences, tax effects of, 418 (IFRS), 5 tangible capital assets, 539
intragroup transactions, 163–164 acquirer, 53, 54 temporary differences, and tax-effect
tax revenue, 536–537 acquirer, and fair value, 58 accounting, 163
temporary differences, 66, 163 acquisition date, 55, 56 unrealized profits, 165
institutions, 452 agent, 19 variable returns, 18
intangible assets business, defined, 49 intracompany balances, 412–413
comparison of GAAP frameworks, 538 business combination, 52, 62, 65, 66–67, intragroup profit, 239–243
not-for-profit organizations (NFPO), 108, 300 depreciable non-current assets,
472–475 business combination achieved in stages, 240–241
separately identifiable intangible assets, 70 inventory, 240
63–65 vs. CICA Public Sector Accounting Handbook, transfers for services and interest, 241
integrated foreign operations, 403n, 405 538 intragroup transactions, 110
integrated set of activities, 50 consolidated financial statements, 21, 106, advances, 182–183
intercompany monetary balances, 414–415 108, 110 bonds, 183–184
intercompany transactions, 304–312, 311 consolidated financial statements vs. borrowings, 182–184
interest separate financial statements, 287 depreciable assets, sales of, 173–175
intragroup, 241 contingent consideration, 59, 74 depreciation of profits or losses, 176–177
payment of, 241 control, 13, 14 dividends, 180–182, 237–238
interest rate risk, 358 convenience translation currency, 410 dividends declared and paid in current
internal budget restrictions, 487 derivative financial instruments, and fair period, 181
International Accounting Standards Board value, 366 dividends declared in current period but
(IASB), 228–229 disposal of foreign operation, 418 not paid, 180–181
International Accounting Standards (IAS) dividend income, 10 income tax effects, 163–164
acquisition-related costs, 60 entity concept, 220, 251 interest, 241
assets, accounting for, 49 equity transactions, 245 land, sale of, 172–173
assets held for sale, 27 fair value, and associates, 27 non-controlling interest (NCI), 239–243
associates, 26, 27, 28–29, 286, 292, 295, fair value measurement, 8, 58 principles, 162–164
304, 309, 312 financial asset, 6 profits and losses on transfers of property,
consolidation procedures, 292 financial instruments, 6, 539 plant, and equipment, 172–178
contingent consideration, 74 foreign currency translation, 539 rationale for adjustments, 162–163
564 Subject Index
intragroup transactions (continued) consolidated financial statements, M

realization of profits or losses, 175, 288–289 mergers, 4, 46
179–180 different ends of reporting periods, see also business combination
realization of revenues and expenses, 296–299 modified equity method, 530
165 dissimilar accounting policies, 296, monetary assets, 57
rent, 179 297–299 monetary items, 351–354, 406, 421
sales of inventory, 164–165 dividends, 295–296, 297–299
services, 179–180, 241 equity method, 288
transfers of inventory, 164–171 fair value differences, 292–294 N
unrealized profits, 184–185 goodwill, 292–294 natural hedges, 359
unrealized profits in beginning inventory, intercompany transactions, 304–312 NCI. See non-controlling interest (NCI)
169–170 inventory transactions, 305–307 net assets
unrealized profits in ending inventory, investment in stages, 300–303 comprehensive revaluation of net assets,
165–168 losses, 312–314 136–137
inventory movements in equity, 295–299 excess of net assets acquired over cost
associates, 305–307 non-current assets, 307–308 income, 294
contributed inventory, 471 non-monetary assets, contributions of, net debt, 520
distributed at no charge, 472 309–310 government financial accountability,
fair value adjustments, 128–129 not-for-profit organizations (NFPO), 520–524
intercompany transactions, 305–307 477 legislative control, 520–524
intragroup profit, 240 reserves, 296, 297–299 measure of net debt, 520
intragroup transfers of inventory, transactions between, 310–311 net debt indicator, 520–524
164–171 relevance of net debt, 520
joint ventures, 305–307 net income, 352n
non-controlling interest (NCI), 240 L net investment in foreign operation, 412
not-for-profit organizations (NFPO), land neutrality, 516
471–472 fair value adjustments, 125–126 non-controlling interest (NCI), 220, 248
sale, in previous period, 307 intragroup transactions, 172–173 accounting at acquisition date, 229–233
sale in current period, part remaining leases, 63n calculation of, 235–237
unsold, 306–307 legislative control, 520–524 changes in proportion held by, 244–247
transferred inventories partly sold, liabilities classification as equity, 222
167–168 contaminated sites, 533 comparison of GAAP frameworks, 538
transferred inventory completely sold, contingent liabilities, 62–63, 74 decreases in ownership, 245–247
168 fair value adjustments, 131–132 and definition of liability under conceptual
transferred inventory on hand at non-liabilities, 62 framework, 251
beginning of period, 169–170 post-closure liabilities, 534 depreciable non-current assets, 240–241
unrealized profits in beginning inventory, purchase of acquiree’s liabilities, 72 determination of, 222
169–170 real liabilities, 62 disclosure, 222–224
unrealized profits in ending inventory, recognition of liabilities assumed, 62–65 fair value adjustments, 229, 235
165–168 undertaken, 59 foreign investments, 417–418
investments link criterion, 13, 18–20 full goodwill method, 226–227, 228–229,
business combination. See business liquidity risk, 517 230–231
combination loan guarantees, 534 gain on bargain purchase, 243–244
foreign investments. See foreign loan repayments through future in income and equity in subsequent
investments appropriations, 533 periods, 234–238
net investment in foreign operation, loans increases in ownership, 245
412 loan guarantees, 534 intragroup dividends, 237–238
non-strategic investments in equity, loans receivable, 533 intragroup profit, 239–243
5–12 repayments through future appropriations, intragroup transfers for services and
reasons for, 5 533 interest, 241
in stages, 300–303 with significant concessionary terms, inventory, 240
strategic investments. See strategic 533 nature of, 222–225
investments loans receivable, 533 in net assets, 234
investors, 13, 32 loans with significant concessionary terms, partial goodwill method, 227–229,
533 232–233, 234
location of primary economic activity, pre-acquisition adjustments, 235
J 347–348 presentation of, 538
joint arrangements, 32–35 loss reasons for choosing method, 228–229
joint control, 32, 34, 300 associates, 312–314 sale by parent, 246–248
joint operations, 32–33 depreciation of, 176–177 share of current period changes in equity,
joint ventures, 32, 33–34, 51, 284, 286 foreign exchange loss, 342, 344, 346–347, 237
additional ownership interest after 355, 401 share of equity at acquisition date,
acquisition of significant intragroup loss, and impairment, 175 225–233
influence, 303 intragroup transfers of property, plant, subsidiary's issue of shares to, 246–247
after acquisition of ownership interest, and equipment, 172–178 non-current assets, 307–308
301–302 joint ventures, 312–314 non-exchange transactions, 513
borrowings, 308–309 realization of, 179–180 non-financial assets, 517
Subject Index 565
non-liabilities, 62 tangible capital assets, 472–475 post-closure liabilities, 534

non-monetary assets, 58, 309–310 types of, 452 power
non-monetary items, 351, 354–357, 421 types of funds, 460–461 by having agent act on behalf, 19
non-shared control, 14 welfare organizations, 452 voting shares, power based on, 14–17
non-strategic equity investments nuclear industry, 284 power criterion, 13–18
accounting standards, 5, 10–11 level of share ownership, 14–17
criteria, 5–6 non-shared control, 14
held for trading, 8n
O passive vs. active control, 14
one-line consolidation, 287
identifying, 5–8 potential voting rights, 17–18
opportunity cost, 360
initial recognition, 6–8 voting shares, power based on, 14–17
option contracts, 344n
not-for-profit organizations (NFPO) pre-acquisition adjustments, 110, 118,
other comprehensive income, 355, 356–357,
accounting equation, 460 235
518, 530
accounting standards. See CICA Handbook predictive value, 516
other government organizations (OGOs),
(Part III) preferred shares, 295–296
527–530
budgeting, 490–493 presentation currency, 344, 375–378,
ownership
capital asset fund, 461 407–409
additional ownership interest after
capitalization, exemption from, 473 primary economic activity, 347–348
acquisition of significant influence,
charities, 452 primary financial statements, 289
303
collections, 474–475 private companies. See Accounting Standards
associate, after acquisition of ownership
contributed inventory, 471 for Private Enterprises (ASPE)
interest, 301–302
contributions, 464–471 private sector not-for-profit organization,
decreases in ownership, 245–247
control, 476 453
increases in ownership, 245
controlled investments, 477 professional associations, 452
joint venture, after acquisition of
deferral method, 465–467, 470 profits
ownership interest, 301–302
definition, 453–454 depreciation of, 176–177
sale by parent, 246–248
economic interests, 476 intragroup profit, 239–243
share ownership, and control, 14–17
endowment fund, 460–461 intragroup transfers of property, plant,
expense allocation, 479–480 and equipment, 172–178
financial statement user needs, 454–455 P realization of, 175, 179–180
financial statements, 456–459, 480–488 parent, 108, 288 property, plant, and equipment
foundations, 452 see also consolidation adjustments for transfers, 177–178
fund accounting, 459–464, 465–470 cost method, 123 fair value adjustment, 416–417
goodwill, 472 decreases in ownership, 245–247 foreign investments, 416–417
government not-for-profit organization, dividend from investee, 289 intragroup transactions, 172–178
453, 519, 526–527 entity concept, 220 proportionate consolidation, 34, 310,
impairment, 473–474 equity method, 123 531
institutions, 452 increases in ownership, 245 proportionate consolidation method, 289
intangible assets, 472–475 ownership interest in subsidiary, 110 proprietary concept, 220
inventories, 471–472 pre-acquisition adjustments, 110 proprietary concept of consolidation, 250
inventory distributed at no charge, 472 recording in its own books, 122–124 public accountability, 508, 512, 520–524
joint ventures, 477 reporting company, 403n, 405 public-private partnership, 532
key characteristics, 452 sale by parent, 246–248 Public Sector Accounting Board (PSAB),
membership fees, 455–456 separate financial statement, 288 452, 511, 519, 526, 527
objectives of financial reporting, 454–456 parent entity concept of consolidation, Public Sector Accounting Standards, 454
pledge, 464 249–250 public sector entities, 510
presentation of investments, 477 parent-subsidiary relationships, 12–25 accounting standards, 511
private sector not-for-profit organization, consolidated financial statements, see also CICA Public Sector Accounting
453, 454 21–24 Handbook
professional and trade associations, 452 control, 12–13 budget, importance of, 513
public sector not-for-profit organizations, dissimilar activities, 20 comparison of elements and indicators,
453 identification of, 12–21 518
related-party transactions, 478 link criterion, 13, 18–20 constitutional rights, 512
reporting, 453–459 power by having agent act on its behalf, contaminated sites, liability for, 533
restricted fund, 460 19 control of government organization,
restricted fund method, 467–470 power criterion, 13–18 524–525
revenue recognition criteria, 455 process to determine control, 20–21 devolved rights, 512
significant influence, 477 returns criterion, 13, 18 elements, 517
specific not-for-profit transactions, structured entities, 19–20 elements of financial statement, 517
471–476 partial disposal of foreign operation, 418 financial assets, 519
standards for, 454 partial goodwill method, 227–229, financial framework set by legislation,
statement of cash flows, 457 232–233, 234 513
statement of changes in net assets, 457 passive control, 14 financial reporting concepts, 514–519
statement of financial position, 456 perpetual inventory system, 2 financial statement presentation,
statement of operations, 456 pledge, 464 517–518
strategic investments, 475–477 portfolio investment with concessionary financial statements, 521–523
study, 452 terms, 532 forgivable loans, 533
566 Subject Index
public sector entities (continued) purchasing power adjusted financial shares

fund accounting, 521 statements, 421 acquired in an acquiree, 69–70
government business enterprise (GBE), common shares, 295
526, 530–531 cum div, 120–121, 120n
government business partnership, 531
R ex div, 120
radio-frequency identification (RFID), 2
government not-for-profit organization, preferred shares, 295–296
real liabilities, 62
453, 519, 526–527 purchase of acquiree’s shares from
realization of profits or losses, 175,
government partnerships, 531–532 shareholders, 72
179–180
government reporting entity, 527 share ownership, and control, 14–17
recognition
government structures, 513 share purchase vs. asset purchase, 48
assets acquired, 62–65
government transfers, 537–538 significant influence, 26–27, 31, 286, 300,
contingent liabilities, 62–63
grant revenue, 535–536 302, 303, 477
contributed inventory, 471
key characteristics, 512–513 solid waste landfill closure, 534
foreign currency transactions, 349–355,
key indicators of financial reporting, special purpose entity, 19–20, 25
405
517–519 spot exchange rate, 349–350
gain on bargain purchase, 68–69
lack of equity ownership, 515 stages, 300–303
goodwill, 66–67, 118, 225
liquidity risk, 517 statement of cash flows, 457, 517–518, 523
grant revenue, 535–536
loan guarantees, 534 statement of changes in net assets, 457,
liabilities assumed, 62–65
loan repayments through future 517, 523
linking other transactions, 63
appropriations, 533 statement of financial position, 351, 361n,
public sector financial statements, 521
loans receivable, 533 456, 517, 523
separately identifiable intangible assets,
loans with significant concessionary statement of operations, 456, 517, 523
63–65
terms, 533 Statements of Recommended Practice
recording, 109
modified equity method, 530 (SORPs), 511
recycling, 8
multiple objectives, 512 step acquisition, 70
related-party transactions, 478
nature of resources, 513 strategic investments
relevance of information, 515
need for public sector accounting associates, 26–31
relevant activities, 13–14, 15
framework, 511 and IFRS's definition of financial asset, 6
relevant decisions, 14
net debt indicator, 520–524 joint arrangements, 32–35
reliability of information, 516
non-exchange transactions, 513 not-for-profit organizations (NFPO),
rent, intragroup, 179
non-financial assets, 517 475–477
reporting, 109
objectives of public sector financial parent-subsidiary relationships, 12–25
reporting company, 403n, 405
reporting, 514–515 structured entities, 19–20
representational faithfulness, 516
operating framework set by legislation, subsidiary, 12, 108
reserves, 296, 297–299
513 adjustments to content of financial
restricted fund, 460
vs. other GAAP frameworks, 537–540 statements, 109–110
restricted fund method, 467–470
other government organizations, dividends recorded by subsidiary at
retirement benefits, 539
527–530 acquisition date, 120–121
return, 18, 49
portfolio investment with concessionary fair value adjustments, 110
returns criterion, 13, 18
terms, 532 issue of additional shares to non-
revenues
post-closure liabilities, 534 controlling interest, 246–247
confiscatory revenues, 513
presentation differences, 518 parent-subsidiary relationships. See
intragroup transactions, 165
public accountability, 508, 512 parent-subsidiary relationships
not-for-profit organizations (NFPO), 455
public sector in Canada, 510–511 previously held equity interest in
tax revenue, 536–537
qualitative characteristics of financial subsidiary, 116–117
rights that provide power to investor, 13
reporting, 515–516 wholly-owned subsidiaries. See
risk
recognition of items, 521 consolidation
credit risk, 358
reporting framework, 510–514
elimination of, 358
reporting on government organizations,
524–532
exchange risk, 398 T
foreign currency risk, 345, 359 takeover, 4
rights, powers, and responsibilities, 512
interest rate risk, 358 tangible capital assets, 472–475, 539
solid waste landfill closure, 534
liquidity risk, 517 tax concessions, 537
statement of cash flows, 517–518, 523
tax payable method, 66
statement of changes in net assets, 517,
tax revenue, 536–537
523 S taxes. See income taxes
statement of financial position, 517, 523 self-sustaining entities, 403n, 405
temporal method, 358, 421
statement of operations, 517, 523 separate financial statements, 21, 109, 123,
temporary differences, 66, 163
tax revenue, 536–537 287–291
timeliness, 516
transactions unique to, 532–537 separately identifiable intangible assets,
trade associations, 452
types of government organizations, 63–65
transaction costs, 8
525–530 services, intragroup, 179–180, 241
transfers through a tax system, 537
public sector in Canada, 510–511 share ownership, and control, 14–17
trustees, 18
public sector not-for-profit organizations, shared control, 531–532
453 shareholders
see also public sector entities disorganization or apathy of shareholders, U
purchase premiums arising on an acquisition, 15 unilateral control, 15
538 dispersion of other shareholders, 15 United States, 342
Subject Index 567
unrealized profits, 165, 184–185 V power based on voting shares, 16

adjustment, in consolidated financial variable returns, 18 voting interest, size of, 15
statement, 167 verifiability, 516
in beginning inventory, 169–170
in ending inventory, 165–168
vertical integration, 164 W
voting welfare organizations, 452
upstream transactions, 304, 305–306 potential voting rights, 17–18, 29 wholly-owned subsidiaries. See consolidation
A S UMMARY OF THE C ASE P RIMER *
Case analysis is important in accounting education. It 1. Assessment of the reporting environment/

mirrors the complexities of real-life in-context decision- framework/overview
making, and it encourages critical thinking and the a. Potential for bias (Look for sensitive numbers
development of judgement. It also allows students to and/or financial statement items. Identify and
test how deeply they know their theory and technical articulate the bias and related key numbers.)
material. Knowledge of the CICA Handbook, various
accounting methods, bookkeeping, financial statement i. Users and the decisions they are making.
analysis, discounting, and fair value estimation methods Who is using the information and for what
is important to a good accounting education. These are purpose? Are there any key numbers/ratios
crucial building blocks, but, at the same time, they are that will be the focus of these users?
only a means to an end. The real goal is to develop Are there any contracts that refer to the
judgement and insight into the issues that are faced by financial reporting (such as debt covenants,
individuals and society in relation to accounting. payout ratios, etc.)?
ii. Financial statement preparers.
FRAMEWORK FOR CASE ANALYSIS Consider management compensation such
Decision-making must be done in the context of the as bonuses that are based on net income,
situation at hand. We have to consider the accounting stock options that are based on the value
body of knowledge (CICA Handbook, accounting of the stock (and are affected by the
methods, etc.) and must do this within a specific financial information), the need to obtain
scenario. Who is in charge of preparing the financial financing, etc.
information? Who will be using the information
iii. Business/economic reporting
(and for what purpose)? Are there any circumstances
environment.
either inside the company or outside it that may
Is the company experiencing a decline in
lead to bias?
profitability or cash flows due to increased
competition, less demand for services,
STAGES
internal problems, etc.? What are the key
Case analysis can be seen as having three main stages: numbers/ratios that users focus on to assess
1. Assessment of the reporting environment/ the financial health of the company?
framework/overview
b. GAAP constraint
2. Identification and analysis of the financial If the company’s shares trade on a stock
reporting issues exchange, there is normally a legal requirement
3. Recommendations to follow IFRS. Otherwise, the GAAP constraint
would depend on what the users want from the
A short version of the case primer follows. A more statements. As a general rule, GAAP statements,
detailed version is available in WileyPLUS and on the by definition, are reliable, relevant, comparable,
Student Website <www.wiley.com/canada/kieso> consistent, and understandable. Private entities
accompanying Intermediate Accounting, Ninth may choose to follow private entity GAAP (ASPE)
Canadian Edition. or IFRS.
*This primer is a summary of the case primer document on the Student Website.
c. Overall conclusion/financial reporting objective issue from different perspectives. For example, in
Based on your role in the case and the above a revenue recognition issue, should the revenue
information, conclude on whether the financial be recognized now or later? Consider only the
reporting will be more aggressive or conservative relevant alternatives.
or somewhere in between. Note that aggressive
accounting tends to overstate net income/assets Qualitative:
and present the company in the best light. • Each perspective must be supported by
Conservative accounting ensures that net making reference to GAAP and accounting
income/assets are not overstated and that all theory (including the conceptual framework).
pertinent information (positive or negative) For example, recognize the revenue now
is disclosed. because… or recognize it later because…
2. Identification and analysis of the financial • Make sure the analysis is case specific—i.e.,
reporting issues that it refers to the facts of the specific case.
a. Issue identification • Make strong arguments for both sides of the
Read the case and look for potential financial discussion. If the issue is a real issue, there is
reporting issues. To do this, you need to know often more than one way to account for the
the accounting principles and rules and have an transaction or event.
understanding of the business and the business
• Make sure that the analysis considers the
transactions. Issues are usually about deciding
substance of the transaction from a business
whether or not to recognize something
and economic perspective.
(revenues, liabilities etc.), deciding how to
measure financial statement elements (leave Quantitative:
them as they are or write them down or off), or • Calculate the impact of the different
how to present/disclose these items in the perspectives on key financial statement
financial statements (treat them as current or numbers/ratios. Would this decision be
long-term, debt or equity, discontinued or relevant to users?
continuing operations, etc.). • Calculate what the numbers might look like
b. Ranking issues under different accounting methods, if they
Focus on the more important issues. In other are relevant.
words, focus first on the issues that are material
to the users of the information (those that are 3. Recommendations
more complex and/or those that affect any of After each issue is analyzed, conclude on how the
the key numbers or ratios identified above). You items should be accounted for. Your conclusion
should identify right away what you consider to should be based on your role and the financial
be material. reporting objective that you identified earlier.
c. Analysis
The analysis should consider both qualitative and
quantitative aspects. It should also look at the Written by Irene Wiecek. Copyright © 2010 John Wiley & Sons Canada, Ltd.

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George Anton, Seneca College Fred Pries, University of Guelph

Stephen Bergstrom, SAIT Robert Ducharme, University of Waterloo

Module 1 Long-Term Inter-Corporate Investments 1

1 Accounting for Investments 2

Module 2 Foreign Currency 341

7 Accounting for Foreign Currency 342

Module 3 Not-for-Profit and Government Organizations

9 Reporting for Not-for-Proﬁt Organizations 450

Appendix: Present Value Tables 552

Company Index 558

Subject Index 559

Module 1 Long-Term Inter-Corporate Equity Instruments 58

Dividends Recorded by Subsidiary at Realization of Proﬁts or Losses on Depreciable

Decrease in Ownership Due to a Sale Losses Recorded by the Associate or

Presentation Currency Differing from the Speciﬁc Not-for-Proﬁt Transactions 471

Key Indicators of Public Sector Financial Portfolio Investments with

SCORPIO MINING CORPORATION is a Canadian- Scorpio classifies its financial instruments in

ACCOUNTING FOR INVESTMENTS

Non-Strategic Strategic Investments— Strategic

Illustration 1.1 Abitibi Mining Corp.

2. SIGNIFICANT ACCOUNTING POLICIES

• a signiﬁcant change in the performance of comparable entities

Recording Non-strategic Equity Investments

Illustrative Example 1.1 FVTPL Journal Entries

Dec. 31, 2013

Feb. 15, 2014

Comprehensive Income Statement

Illustrative Example 1.2 FVTPL Investment:

Dec. 31, 2013

Feb. 15, 2014

Feb. 15, 2014

Feb. 15, 2014

There is no requirement that dividend income be disclosed separately on the statement

Applying ASPE to Non-strategic Equity Investments

Illustrative Example 1.3 Financial Asset of a Private

Statement of Financial Position

The classiﬁcation as short-term or long-term would be based on the intent of ABC.

Identifying Parent–Subsidiary Relationships

IFRS 10 contains the following deﬁnition of control:

The Power Criterion

Illustrative Example 1.4 Power Based on Voting Shares

The Returns Criterion

The Link Criterion

Illustrative Example 1.5 Structured Entities8

Dissimilar activities. In determining the existence of a parent–subsidiary relationship,

Summary of Process to Determine Control

Presentation of Consolidated Financial Statements

Illustration 1.2 7. INVESTMENT IN GOLDEN HARP

Balance, May 31, 2009 2,291,427

Balance, May 31, 2010 1,500,000

Balance, June 30, 2011 1,300,000

As an illustration of the exemption from consolidation, consider the group structure in

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