QUESTION 1 75 marks
THIS QUESTION COMPRISES TWO PARTS WHICH ARE UNRELATED
Multivest Ltd (‘Multivest’) is a company that is listed on the JSE Ltd. The company primarily invests in a number of diversified subsidiaries. The year end of all the companies in the group is 30 June. In addition, all group companies are incorporated in South Africa with a functional currency of rand.
PART 1 53 marks
Multivest acquired a 95% interest in Diverso (Pty) Ltd (‘Diverso’) from Investo (Pty) Ltd (‘Investo’) on 1 January 2007, subject to approval by the Competition Commission. Even though the Commission has rejected similar transactions in the past, the directors of Multivest were of the opinion that the Commission’s approval was a formality and therefore they believed that Diverso should be included in the consolidated financial statements of Multivest from 1 January 2007. The final approval of the Competition Commission was obtained on 1 February 2007.
The purchase agreement stipulated that the purchase price for the 95% interest in Diverso would be settled as follows:
• An amount of R1 million is payable in cash to Investo upon the approval by the Competition Commission.
• An amount of R2 million will be paid in cash to Investo on 30 June 2007.
• Investo owes a creditor an amount of R150 000. This amount is payable on 31 March 2007 and the effect of discounting is immaterial. Multivest will settle the debt on behalf of Investo.
• An amount of R500 000 will be paid in cash to Investo on 30 June 2009 if the profits generated by Diverso from the date of the Competition Commission’s approval until 30 June 2009 exceed R5 million. At the acquisition date this payment was considered to be probable.
• Multivest will issue 100 000 call options on its own shares to Investo on the date that the Competition Commission approves the acquisition. The options entitle Investo to acquire 100 000 ordinary shares in Multivest on 31 December 2007 at an exercise price of R10 per share.
If the share price of Multivest drops before or on 30 June 2007, additional options will have to be issued in order to maintain the original value of the options issued. The following values are relevant:
R
Fair value of Multivest shares (per share)
1 January 2007
9,50
1 February 2007
10,10
30 June 2007
9,30
Fair value of call options on Multivest shares (per option)
1 January 2007
4,00
1 February 2007
5,50
30 June 2007
3,80
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• Multivest will issue 4 000 debentures with a par value of R1 000 each to Investo on the date that the approval from the Competition Commission is obtained. These listed debentures bear interest at a coupon rate of 2% per month and will be redeemable at par value after 24 months. Multivest incurred transaction costs of R18 000 on the issue of the debentures. On 1 January 2007 the fair value of each debenture was R1 180 and on 1 February 2007 the fair value of each debenture was R1 120.
Unless stated or otherwise evident, a discount rate of 12% per annum will apply.
Multivest accounts for investments in subsidiaries on the cost basis in its company annual financial statements.
The following represents the balance sheet of Diverso on various dates:
DIVERSO (PTY) LTD
BALANCE SHEET
Carrying amount
Fair value
01/01/07
01/02/07
01/01/07
01/02/07
Notes
R
R
R
R
Recognised amounts
Shareholders’ equity
R1 ordinary shares
100 000
100 000
Retained earnings
5 151 794
5 126 075
5 251 794
5 226 075
Assets
Land
1
1 500 000
1 500 000
2 300 000
2 380 000
Buildings
1
2 800 000
2 800 000
3 900 000
3 930 000
Financial assets
Short-term trade receivables
800 000
835 000
800 000
835 000
Listed bonds
2
541 794
541 075
543 000
545 000
Inventory
Raw materials
3
500 000
480 000
*
*
Finished goods
4
850 000
850 000
*
*
Liabilities
Deferred tax
(10 000)
(12 000)
*
*
Defined benefit plan liability
5
(940 000)
(935 000)
*
*
Other liabilities
(790 000)
(833 000)
(790 000)
(833 000)
5 251 794
5 226 075
Unrecognised amounts
Unused Secondary Tax on
Companies credits
6
–
–
31 250
31 250
Intangible items
7
–
–
*
*
Contingent liability
8
–
–
*
*
* To be determined using the information presented where appropriate and applicable.
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Notes
1 Owner occupied property (land and buildings)
It is the policy of Diverso and the Multivest group to account for owner occupied property in accordance with the cost model.
The building originally cost R3 million and has a residual value of R3,6 million as at 1 January and 1 February 2007. The land originally cost R1,5 million.
There are no tax allowances on the building or the land.
2 Financial assets: listed bonds
Diverso purchased 1 000 listed bonds with a face value of R500 each on 1 January 2006 at their fair value of R535 per bond. Transaction costs amounted to R15 per bond. The bonds pay interest at a coupon rate of 12% per annum, monthly in arrears, and are redeemable at face value on 31 December 2010. Diverso has always had the positive intent and ability to keep these bonds to their maturity date and consequently they were classified as held-to-maturity investments. After the acquisition of Diverso by Multivest, the group still has the positive intent and ability to keep these bonds to maturity date. The bonds do not have any tax consequences other than the taxation of the coupon payments as earned.
3 Inventory: raw materials
The following values relate to raw materials on hand:
R
1 January 2007
Net realisable value
508 000
Replacement cost
510 000
1 February 2007
Net realisable value
491 500
Replacement cost
495 000
4 Inventory: finished goods
On 1 January 2007 and 1 February 2007 finished goods consisted of 1 000 items of product with a total cost price of R850 000. These goods are normally sold at a gross profit percentage (on sales) of 42%. If Diverso manages product sales itself, selling costs amount to R120 per unit, whereas the selling costs would amount to R128 per unit if product sales were to be managed by an external party.
3
5 Defined benefit plan liability
The carrying amount of the defined benefit plan liability has been correctly calculated in accordance with IAS 19 (AC 116), Employee benefits as follows:
01/01/07
01/02/07
R
R
Present value: defined benefit plan obligation
1 300 000
1 380 000
Fair value: plan assets
(800 000)
(890 000)
500 000
490 000
Unrecognised actuarial gains
500 000
500 000
Unrecognised past service cost
(60 000)
(55 000)
Carrying amount
940 000
935 000
6 Unused Secondary Tax on Companies credits
Diverso has excess dividends received over dividends paid for Secondary Tax on Companies (STC) purposes (i.e. unused STC credits) amounting to R250 000. The company did not recognise a deferred tax asset for these credits, as the directors of Diverso were of the opinion that dividend declarations were unlikely for the foreseeable future. The Multivest directors shared this opinion and consequently the group deemed it inappropriate to record a deferred tax asset for these credits at the acquisition date. Diverso, however, declared a dividend of R180 000 (out of post-acquisition profits) on 1 June 2007.
7 Intangible items
The management of Multivest have engaged the valuation services of Valueco for purposes of valuation of the intangible items.
7.1 Diverso has a very skilled workforce, which is one of the reasons why Multivest wanted to make the acquisition. According to Valueco, it would cost approximately R600 000 to replace (recruit, train, etc.) Diverso’s existing workforce as of the date of the business combination. Accordingly, Valueco believe this is the fair value of the workforce.
7.2 Although the Diverso trade name is well-known and according to Valueco is worth R3 million as of the date of the business combination, the management of Multivest do not intend to continue using the Diverso trade name because they believe the Multivest trade name is much stronger in the market. Therefore, the management of Multivest believe that the value should be zero for purposes of accounting for the business combination.
7.3 Diverso has an operating lease agreement with Rentco in respect of its warehouse in terms of which Diverso pays rentals of R30 085 per month. As of the date of acquisition, the remaining lease period is 54 months. Current market rentals on similar premises are R45 000 per month. The following information is available:
1 February 2007
R
Present value of the remaining lease rentals using the interest rate implicit in the lease
1 303 935
Present value of the difference between the market rentals and the rentals per the agreement for the remaining period at 12% p.a.
620 000
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8 Contingent liability
At the acquisition date, Diverso was being sued for environmental damage for an amount of R3 million. The legal advisors of Diverso are of the opinion that there is a 35% chance that the claimant will be successful with its case. Diverso is considering taking out insurance against this claim and obtained a quote from an independent insurer for a once-off premium of R180 000. The SARS will not allow any tax deductions relating to the claim or the insurance premium.
The normal tax rate for companies is 29%.
Ignore VAT.
The table of present value factors is provided on page 6.
REQUIRED
Marks
(a)
Indicate, with supporting reasons, the appropriate date of acquisition of Diverso (Pty) Ltd by Multivest Ltd.
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Irrespective of your answer to part 1(a) above, for the remainder of Part 1 assume that the date of acquisition of Diverso (Pty) Ltd by Multivest Ltd is 1 February 2007.
(b)
Calculate the cost of the acquisition of Diverso (Pty) Ltd, as recognised by Multivest Ltd, in accordance with IFRS 3 (AC 140), Business combinations.
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(c)
Describe in detail the substantive audit procedures to be performed by the external auditor of Multivest Ltd for the year ended 30 June 2007 to test the accuracy and valuation, and rights and obligations of the probable contingent consideration (payment) of R500 000 as stated in the purchase agreement with Diverso (Pty) Ltd.
10
(d)
Prepare the pro forma (i.e. consolidation) journal entries at the date of acquisition that are necessary to include Diverso (Pty) Ltd in the consolidated financial statements of Multivest Ltd.
31
5
PRESENT VALUE TABLE BY MONTH
Annual discount rate compounded monthly
9%
10%
11%
12%
13%
14%
15%
Months
1
1.00750
1.00833
1.00917
1.01000
1.01083
1.01167
1.01250
2
1.01506
1.01674
1.01842
1.02010
1.02178
1.02347
1.02516
3
1.02267
1.02521
1.02775
1.03030
1.03285
1.03541
1.03797
4
1.03034
1.03375
1.03717
1.04060
1.04404
1.04749
1.05095
5
1.03807
1.04237
1.04668
1.05101
1.05535
1.05971
1.06408
6
1.04585
1.05105
1.05628
1.06152
1.06679
1.07207
1.07738
7
1.05370
1.05981
1.06596
1.07214
1.07834
1.08458
1.09085
8
1.06160
1.06864
1.07573
1.08286
1.09002
1.09723
1.10449
9
1.06956
1.07755
1.08559
1.09369
1.10183
1.11004
1.11829
10
1.07758
1.08653
1.09554
1.10462
1.11377
1.12299
1.13227
11
1.08566
1.09558
1.10558
1.11567
1.12584
1.13609
1.14642
12
1.09381
1.10471
1.11572
1.12683
1.13803
1.14934
1.16075
13
1.10201
1.11392
1.12595
1.13809
1.15036
1.16275
1.17526
14
1.11028
1.12320
1.13627
1.14947
1.16282
1.17632
1.18995
15
1.11860
1.13256
1.14668
1.16097
1.17542
1.19004
1.20483
16
1.12699
1.14200
1.15719
1.17258
1.18815
1.20392
1.21989
17
1.13544
1.15152
1.16780
1.18430
1.20103
1.21797
1.23514
18
1.14396
1.16111
1.17851
1.19615
1.21404
1.23218
1.25058
19
1.15254
1.17079
1.18931
1.20811
1.22719
1.24655
1.26621
20
1.16118
1.18054
1.20021
1.22019
1.24048
1.26110
1.28204
21
1.16989
1.19038
1.21121
1.23239
1.25392
1.27581
1.29806
22
1.17867
1.20030
1.22232
1.24472
1.26751
1.29070
1.31429
23
1.18751
1.21031
1.23352
1.25716
1.28124
1.30575
1.33072
24
1.19641
1.22039
1.24483
1.26973
1.29512
1.32099
1.34735
25
1.20539
1.23056
1.25624
1.28243
1.30915
1.33640
1.36419
26
1.21443
1.24082
1.26775
1.29526
1.32333
1.35199
1.38125
27
1.22354
1.25116
1.27938
1.30821
1.33767
1.36776
1.39851
28
1.23271
1.26158
1.29110
1.32129
1.35216
1.38372
1.41599
29
1.24196
1.27210
1.30294
1.33450
1.36681
1.39986
1.43369
30
1.25127
1.28270
1.31488
1.34785
1.38161
1.41620
1.45161
31
1.26066
1.29339
1.32694
1.36133
1.39658
1.43272
1.46976
32
1.27011
1.30416
1.33910
1.37494
1.41171
1.44943
1.48813
33
1.27964
1.31503
1.35137
1.38869
1.42700
1.46634
1.50673
34
1.28923
1.32599
1.36376
1.40258
1.44246
1.48345
1.52557
35
1.29890
1.33704
1.37626
1.41660
1.45809
1.50076
1.54464
36
1.30865
1.34818
1.38888
1.43077
1.47389
1.51827
1.56394
6
PART 2 22 marks
Multivest acquired its 100% interest in Invest 4 Africa Ltd (‘I4A’) ten years ago.
I4A has a number of investments which it has appropriately accounted for as available-for-sale financial assets in terms of IAS 39 (AC 133), Financial instruments: Recognition and measurement, in its own financial statements. Gains or losses on available-for-sale equity investments are treated as capital gains or losses for tax purposes.
Details of I4A’s available-for-sale financial assets are as follows:
1 Equity investment in Multivest Ltd
I4A acquired a 2% interest (20 000 R1 shares) in the equity of Multivest on 1 August 2005 in the open market for R150 000. On 30 June 2006 the shares of Multivest were trading at R10,50 per share. Half of this investment was sold on 30 June 2007 into the open market for a total gain of R18 000.
2 Equity investment in Vaal Mines Ltd
The following information relates to the investment in the shares of Vaal Mines Ltd:
Acquisition date
1 January 2004
Number of shares
10 000 shares (1% effective interest)
Cost price
R180 per share
Fair value of shares (per share)
30 June 2004
R178
30 June 2005
R170
30 June 2006
R135
30 June 2007
R148
At 30 June 2004 and 2005, neither Multivest nor I4A had recognised an impairment of the investment in Vaal Mines Ltd.
On 30 June 2006, the directors of Multivest and of I4A were of the opinion that the decline in the share price of Vaal Mines Ltd represented a significant decline below the cost price of the shares.
3 Debt investment in Euro Mines Plc
On 1 July 2006, I4A purchased 1 000 Euro Mines Plc bonds with a par value of €150 each. The bonds have six years remaining until maturity date. The bonds pay interest annually in arrears at a coupon rate of 8% per annum and mature at par value.
These bonds were purchased at their market value of €162 per bond. Transaction costs of €5 000 were incurred on the acquisition of the bonds.
7
The following table sets forth the fair values and the R:€ exchange rates at various dates:
I4A expects to hold these bonds until maturity.
Fair value per bond
Exchange rate €1 = R
1 July 2006
€162
8,00
30 June 2007
€169
8,20
Average 1 July 2006 to 30 June 2007
8,10
The normal tax rate for companies is 29%. There are sufficient capital gains to absorb any capital losses.
REQUIRED
Marks
Present extracts from the consolidated statement of changes in equity of Multivest Ltd for the financial year ended 30 June 2007 to the extent that they relate to the available-for-sale financial investments (and related income taxes) of Invest 4 Africa Ltd.
• Comparative amounts are required.
• Notes are not required.
• No additional information needs to be assumed. In other words, ignore the components of the consolidated statement of changes in equity of Multivest Ltd on which the available-for-sale financial investments (and related income taxes) of Invest 4 Africa Ltd have no impact.
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