On 2 January 20x4, P Co purchased from X Co, a controlling interest of 90% interest in Sapphire Co, a company that has an on-going research and development project. On 2 January 20x4, P Co entered into the following transactions relating to the acquisition and financing arrangements.

 

(1) number of P Co's shares issued to X Co : 1300 000

fair value per share of P Co: $1.40

(2) Direct costs of issuing shares to X Co: $17800

(3) transfer of land to X Co

fair value of land : $1500 000

carrying amount in P Co's book: $1350 000

(4) cash transferred to X Co: $800 000

(5)Number of shares issued to existing owners of P Co to fund the acquisition: 1200 000

(6)Conditional payment made to X Co if R&D project is successful at the end of 3 years from acquisition date: $1800 000

probability of success : 70%

payment is due at the end of 3 years: 31 Dec 2016

implicit interest rate charged by X Co: 5% p.a.

 

At the date of acquisition, the shareholders' equity of Sapphire Co was as follows:

 

shareholder's equity as at date of acquisition

share capital $1000 000

retained earnings 158 000

other comprehensive income 24 000

$ 1182 000

 

The fair value of non-controlling interests on acquisition date was $412,000. 

 

As at acquisition date, Sapphire Co had a research and development project that had the following expected outcomes:

 

Future event Present value of cash inflows Probability

 

Successful outcome $2,000,000            0.70

Not successful outcome              $0                  0.30

 

 

Prior to acquisition, Sapphire had accounted for the project expenditures as follows:

expensed research costs $650 000

expensed development costs $200 000

capitalized development cost as at 31 Dec 20x3 $350 000

 

 

The development expenditures incurred to acquisition date of $350,000 met the conditions for capitalization in International Accounting Standard (IAS) 38 Intangible Assets and was recognized in Sapphire's balance sheet at acquisition date.

 

Sapphire Co completed the research and development project on 31 December 20x5 successfully. The estimated economic life of the intangible asset was 10 years. The group and Sapphire Co use the cost model to measure intangible assets. 

 

The financial statements of Sapphire Co for the current year ended 31 December 20x6 are as follows:

 

Income statement and statement of changes in equity (partial) for the year ended 31 Dec 20x6

profit before tax $650 000

tax (130 000)

profit after tax 520 000

dividend declared (67 000)

profit retained 453 000

retained earnings,1 Jan 20x6 239 000

retained earnings,31 Dec 20x6 $692 000

 

statement of financial position as at 31 Dec 20x6

non-current asset $1560 000

amount due from P Co 79 000

inventory 237 000

accounts receivable 270 000

cash 32 000

$ 2178 000

liability 396 000

share capital 1000 000

retained earnings 692 000

other comprehensive income balance 90 000

$ 2178 000

 

other comprehensive income balance as at 1 Jan 20x6: $78 000

 

 

Additional information:

 

1. Recognize tax effects on fair value adjustments and other adjustments at the tax rate of 20%.
2. Other comprehensive income (OCI) arises from items of income that bypass net income in accordance with IAS 1 Presentation of Financial Statements. OCI is built up in separate accounts in equity. (Hint: Where OCI balance at beginning of the year is provided, separate allocation of current and change in post-acquisition OCI in the same way as for profit and post-acquisition retained earnings).

 

Required

1 . Prepare the journal entries to record investment in Sapphire, transaction costs, financing activities and other entries in P Co's books on 2 January 20x4. Recognize unamortized discount separately for future settlements.

 

2 . In the light of the successful completion of the research and development project by Sapphire at end of 20x5, record the following transactions in P Co's books for the year ended 31 December 20x6:

a) Interest expense on contingent consideration payable in 20x6;

b) Final entries relating to the contingent consideration payable on 31 December 20x6.

 

3 . Prepare consolidation entries for the year ended 31 December 20x6, with narratives (brief headers) and workings in accordance with IFRS 3 and IFRS 10.  

 

4 . Perform an analytical check on the balance of non-controlling interests as at 31 December 20x6, showing the workings clearly. 

 

5 . Perform an analytical check on the consolidated retained earnings balance as at 31 December 20x6, showing the workings clearly. The retained earnings of P Co as at 31 December 20x6 is $2,500,000.