- 20 Marks
Question
Awa Publish has just recently acquired 18% of the shareholding in Tunbe, making it the second largest single shareholder. The majority shareholder has 58% voting shares, while the remainder of the shares is held by ten other shareholders, none holding more than 5% voting shares. The board of directors of Tunbe is made up of 12 members, with Awa Publish having 3 members and the majority shareholder having 7 members.
Awa Publish was able to negotiate its representation on the board due to its strategic importance in Tunbe’s operations and expansion plans. The directors of Awa Publish accounted for its investment in Tunbe as an equity investment. The directors feel that Tunbe should not be accounted for as an associate because Awa Publish does not have 20% of the voting interest and thus does not exercise significant influence over Tunbe.
Tunbe has been making losses for the past three years and has only returned a taxable profit once in the last five years. The projection is that Tunbe will return to making taxable profits in another five years. As part of the acquisition of shares in Tunbe, deferred tax assets for deductible temporary differences arose. The directors of Awa Publish are unsure how to account for this deferred tax asset.
Awa Publish has an item of equipment that cost N56 million. This item of plant and equipment currently has a carrying amount in the financial statements of N39.2 million. Awa Publish expects the operation of the equipment to generate undiscounted cash flows of N7 million per year for the next five years.
Awa Publish could generate immediate cash flow of N40 million if it sold the equipment today. However, if it did go ahead with the sale, it will have to pay a sales commission of 8.5%. The directors of Awa Publish are performing an annual impairment review and understand that determining the recoverable amount is an important part of this exercise.
Required:
a. Discuss how the investment in Tunbe should be accounted for in the financial statements of Awa Publish. (7 Marks)
b. Advise the directors of Awa Publish how the deferred tax asset that has arisen should be accounted for. (7 Marks)
c. Assist the directors of Awa Publish to determine the recoverable amount of the equipment. You may assume a discount rate of 10% or five-year annuity rate of 3.791, if relevant. (6 Marks)
Answer
a. Accounting for the Investment in Tunbe
Under IAS 28 (Associates and Joint Ventures), an associate is an entity over which an investor has significant influence, typically presumed to exist if the investor holds 20% or more of the voting rights. However, significant influence can also exist with a lower ownership percentage if the investor can participate in financial and operating policy decisions.
Key Considerations:
- Awa Publish holds 18% of the voting rights in Tunbe, which is below the 20% threshold.
- However, Awa Publish has 3 board members out of 12 (25%) due to its strategic importance to Tunbe.
- The majority shareholder has significant control with 58% voting rights, but the presence of Awa Publish on the board indicates participation in policy decisions.
Conclusion:
Awa Publish should account for its investment in Tunbe as an associate under IAS 28 due to its representation on the board and participation in decision-making, which establishes significant influence, despite owning less than 20% of the voting rights.
b. Accounting for the Deferred Tax Asset
Under IAS 12 (Income Taxes):
A deferred tax asset is recognized for deductible temporary differences to the extent that it is probable that future taxable profits will be available to utilize these differences.
Key Considerations:
- Tunbe has been making losses for the past three years and is projected to generate taxable profits only in five years.
- The probability of utilizing the deferred tax asset depends on convincing evidence of future taxable profits.
- If the evidence supporting profitability is insufficient or uncertain, the deferred tax asset should not be recognized or should be written down.
Conclusion:
The deferred tax asset should only be recognized if Awa Publish can provide sufficient evidence that Tunbe will return to profitability and generate taxable income to utilize the deductible temporary differences. Otherwise, it should be disclosed as an unrecognized deferred tax asset.
c. Determination of the Recoverable Amount of Equipment
Under IAS 36 (Impairment of Assets):
The recoverable amount is the higher of the fair value less costs to sell and the value in use.
- Fair Value Less Costs to Sell:
- Selling price: N40 million
- Sales commission: 8.5% of N40 million = N3.4 million
- Fair value less costs to sell = N40 million – N3.4 million = N36.6 million
- Value in Use:
- Undiscounted cash flows: N7 million per year for 5 years
- Present value of cash flows (using a discount factor of 3.791):
N7 million × 3.791 = N26.537 million
Recoverable Amount:
- Fair value less costs to sell = N36.6 million
- Value in use = N26.537 million
- Recoverable amount = N36.6 million (higher value)
- Tags: Deferred Tax, Equity Accounting, IAS 12, IAS 36, Recoverable Amount
- Level: Level 3
- Uploader: Kofi