Strategic Business Reporting MCQ Quiz - Objective Question with Answer for Strategic Business Reporting - Download Free PDF

(a) (i) Operating segments 

Garry Co is a listed entity and therefore is required to comply with IFRS 8 

Operating Segments. The company’s view that the disclosure of segment information would be competitively harmful or misleading is difficult to understand as the IASB writes accounting standards on the basis that they provide transparent, useful information to investors. Garry Co should identify the information which would be useful to investors and how that information can 

be appropriately reported.

Tutorial note 

State the rules from IFRS 8 and then apply them to the scenario.  

IFRS 8 states that an operating segment is a component of an entity: 

•  which engages in business activities from which it may earn revenues and incur expenses 

• whose operating results are regularly reviewed by the entity’s chief operating decision maker, and 

• for which discrete financial information is available. 

An operating segment includes components of an entity which sells primarily or exclusively to other operating segments. Information about the components engaged in each stage of production is particularly important for understanding vertically integrated entities in certain businesses, for example, Garry Co. 

Therefore, the Casualwear division can be an operating segment even though it sells 90% of its production to the other divisions. 

 (ii) Garry Co appears to have four operating segments: Tennisgear, Badmintonwear,Squashracket, and Casualwear. This is because each segment: 

• engages in business activities which recognise revenues and incur expenses as a profit or loss account is prepared quarterly 

• has the CEO/chief operating decision maker reviewing their operating results quarterly to assess performance and allocate resources via the budgets, and 

• has discrete financial information available quarterly for each brand including additional performance measures such as EBITDA. 

Each of the brand managers is directly accountable to and meets quarterly with the CODM to discuss performance and compare the actual results to the budgeted figures. 

Since Casualwear is an overseas entity, it is likely that separate disclosure is necessary so that users can better assess its performance and its significance to the group. 

Separate reportable segments

(ii) Separate reportable segments 

To determine if a segment is reportable, 2 main rules are employed. 

Firstly, the 10% rule is considered.  

Then, after determining the reportable segments under the 10% rule, the 75% rule is applied.

IFRS 8 requires an entity to report financial and descriptive information about its reportable segments. Reportable segments are operating segments or aggregations of operating segments which meet any of the specified criteria: 

•  its reported revenue, from both external customers and intersegment sales or transfers, is 10% or more of the combined revenue, internal and external, of all operating segments, or 

•  the absolute measure of its reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments which did not report a loss and (ii) the combined reported loss of all operating segments which reported a loss, or 

•  its assets are 10% or more of the combined assets of all operating segments. 

Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principles of the standard, the segments have similar economic characteristics and are similar in various prescribed respects. If the total external revenue reported by operating segments constitutes less than 75% of the entity’s revenue, additional operating segments must be identified as reportable segments (even if they do not meet the quantitative thresholds set out above) until at least 75% of the entity’s revenue is included in reportable segments.

Tennisgear and Casualwear are separately reportable since they meet all three size criteria – although only need to meet one of the thresholds to be reportable. 
Badmintonwear and Squashracket do not meet any of the quantitative criteria and, on the face of it, are not separately reportable. The external revenue of 
Tennisgear is 77.7% (16/20.6) of the total external revenue so the '75% threshold' is achieved by Tennisgear alone. 
However, Badmintonwear and Squashracket are likely to share similar economic characteristics because they sell the same clothing with different brand names. 
If aggregated, they would exceed the 10% threshold for revenue, profit and net assets and so could be reported as a combined segment. 
In addition, IFRS 8 gives entities discretion to report information regarding segments which do not meet the size criteria. Entities can report on such 
segments if, in the opinion of management, information about the segment would be useful to users of the financial statements.

(b) 

Investment in Hazel Co 

In this scenario, consideration of more than one IFRS Standard is required simultaneously. Both IFRS 11 Joint arrangements and IFRS 8 Operating Segments should be discussed.  

In such circumstances, approach each standard individually. Think about the rules per 

IFRS 11 then apply it to the scenario. Is Hazel a joint arrangement as per the rules from 

IFRS 11? 

Then do the same for IFRS 8. Should Hazel be an operating segment per the rules from IFRS 8? 

Do not attempt to muddle the rules up or provide conclusions in one go. This will overcomplicate the process and likely cause you confusion.  

IFRS 11 Joint Arrangements states that a joint arrangement is an arrangement where two or more parties share joint control. Joint control exists when decisions about the relevant activities require the unanimous consent of the parties sharing control. 

Even though the call option would give an additional 10% voting interest to Garry Co, Hazel Co’s governance still requires the unanimous vote of all investors to make key decisions, as outlined in an agreement between the venturers. Therefore, the investment would be under joint control regardless of the substance of the call option, which would change only the economic ownership percentage rather than the governance to control. 

A joint venture is a joint arrangement whereby the parties who have joint control of the arrangement have rights to the net assets of the arrangement. This normally involves the establishment of a separate entity. Therefore, Garry Co should recognise its interest in Hazel Co as a joint venture. In accordance with IAS 28 Investments in Associates and Joint Ventures, it should account for this investment in the consolidated financial statements using the equity method. 

Operating segment 

In this instance, the joint venture, Hazel Co, could represent an operating segment as it engages in business activities (racket production) from which it recognises revenues and incurs expenses and the CODM regularly reviews the joint venture’s operating results to allocate resources and assess performance. Also, discrete financial information is available for the venture. 

A joint venture can be considered an operating segment even though the investor only has joint control over the performance of the investee. The operating results should be regularly reviewed by the CODM to contribute to decisions about resources to be allocated to the segment and assess its performance. Management may regularly review the operating results and performance of an equity method investee for purposes of evaluating whether to retain the relationship. However, management does not need to be responsible for making decisions about resources to be allocated or which affect its operations and performance. Therefore, control over the joint venture is not a criterion for it to be considered an operating segment.

(a) 

(i) Assessing whether the transfer qualifies as a sale 

Assessing whether a sale has occurred is the first task to perform whenever dealing with a sale and leaseback arrangement.  

The entity assesses whether the transfer qualifies as a sale by using the guidance in IFRS 15 Revenue from Contracts with Customers. A sale has occurred when the seller has satisfied a performance obligation by transferring control of the asset. Control refers to the ability to direct the use of the asset and to obtain substantially all of its remaining benefits. 

(ii) Accounting treatment if the transfer QUALIFIES as a sale 

If the arrangement qualifies as a sale, 2 steps are required.  

1 Derecognise the asset and record any gain or loss on disposal 

2 Record the lease – a right‐of‐use asset and a lease liability are recognised. 

The seller‐lessee derecognises the asset. 

A right‐of‐use (RoU) asset is recognised, and is measured at the proportion of the previous carrying amount of the asset which relates to the rights retained by the seller‐lessee. 

A lease liability is recognised, equal to the present value of the lease payments to be made. 

A profit or loss is reported in the statement of profit or loss, based on the rights transferred to the buyer‐lessor.

Proceeds in excess of the fair value are complications that may arise within a sale and leaseback arrangement and would represent prize‐winner points. Do not worry if you failed to spot this as few people did. If you answered using the basic accounting treatments described above, you would pass the requirement.  

Note that if the consideration received for the asset exceeds its fair value, this is accounted for as additional financing. If the consideration is below the asset’s fair value, then this is accounted for as a prepayment of lease payments. 

Subsequently, the RoU asset is depreciated over the lease term. Interest is charged on the lease liability using the rate implicit in the lease.

(iii)Accounting treatment if the transfer DOES NOT QUALIFY as a sale 

If the arrangement does not qualify as a sale, it is accounted for as a financing arrangement – the proceeds represent a loan.  

The seller‐lessee continues to recognise the asset on its statement of financial position. The seller‐lessee accounts for proceeds from the sale and leaseback as a financial liability in accordance with IFRS 9 Financial Instruments. 

(iv) The effect if an agreement contains a call option 

The presence of the call option to repurchase means that control of the asset will only transfer once the option expires. Therefore, the treatment is the same as if the transaction did not qualify as a sale. 

If the transaction contains a call option under which the seller‐lessee can, at its option, repurchase the property, then such an option generally precludes sale accounting under IFRS 15. This is because the existence of the call option means that the seller‐lessee retains control of the property. Therefore, sale and leaseback accounting does not apply, with the asset remaining on the statement of financial position and the cash received treated as a financial liability. 

(b) Head office transfer qualifies as a sale 

Because the consideration for the sale of the head office is not at fair value, Alaric Co recognises the $0.75 million excess over fair value ($7.5m – $6.75m) as additional financing provided by Jina Co. The present value of the annual payments amounts to $5.47 million of which $0.75 million ($7.5m – $6.75m) relates to the additional financing and $4.72 million ($5.47m – $0.75m) relates to the lease.

At 1 January 20X7, Alaric Co measures the RoU asset arising from the leaseback of the building at the proportion of the previous carrying amount of the head office which relates to the right of use retained. This is calculated as $3.75 million (the carrying amount of the head office) ÷ $6.75 million (the fair value of the building) × $4.72 million (the discounted lease payments for the RoU asset), that is $2.62 million. 

Alaric Co recognises only the amount of the gain which relates to the rights transferred to Jina Co. The gain on sale is $3 million ($6.75m – $3.75m), of which $2.1 million ($3m ÷ $6.75m × $4.72m) relates to the right to use the head office retained by Alaric Co. The rights transferred to Jina Co are measured at $0.9 million ($3m ÷ $6.75m × ($6.75m – $4.72m)). 

At 1 January 20X7, Alaric Co accounts for the transaction as follows.

(a) (i) Fair value measurement 

Fair value measurement is a popular exam topic. Make sure that you know the definition of fair value. 

IFRS 13 Fair Value Measurement defines fair value as the price which would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is therefore not supposed to be entity specific but rather market focused. Essentially the 

estimate is the amount that the market would be prepared to pay for the asset. 

The fair value of a non‐financial asset should be determined based on its highest and best use. Non‐financial assets include property, plant and equipment, inventories, intangible assets, and investment properties. 

The market would consider all alternative uses for the assessment of the price which they would be willing to pay. For non‐financial assets, fair value should therefore be measured by consideration of the highest and best use of the asset. 

There is a presumption that the current use would be the highest and best use unless evidence exists to the contrary.  

The highest and best use of the asset appears to be as residential property and not the current industrial use. The intentions of Garret Co are not relevant as fair value is not entity specific. The alternative use would need to be based upon fair and reasonable assumptions. In particular, it would be necessary to ensure that planning permission to demolish the factory and convert into residential properties would be likely. Since several nearby sites have been given such permission, this would appear to be the case. 

The fair value of the factory site should be valued as if converted into residential use. Since this cannot be determined on a stand‐alone basis, the combined value of the land and buildings is calculated. The $1 million demolition and planning costs should be deducted from the market value of $24 million. The fair value of 

the land and buildings should be $23 million. The fair value of the identifiable net assets at acquisition are $88 million ($65m + $23m). 

Depreciated replacement cost 

Depreciated replacement cost should only be considered as a possible method for estimating the fair value of the asset when other more suitable methods are not available. This may be the case when the asset is highly specialised. This is not the case with the factory site. Depreciation is unlikely to be an accurate reflection of all forms of obsolescence including physical deterioration. 

Moreover, the rise in value of land and properties particularly for residential use would mean that to use depreciated replacement cost would most likely undervalue the asset. 

(ii)  

Goodwill calculations 

This part of the question only asked for ‘calculations’. No marks are awarded for discussion of the goodwill calculations. 

Goodwill should be calculated as follows:

NCI at acquisition under proportional method is $17.6m (20% × $88m). 
The fair value of the net assets at acquisition is $88m as per part (a) (i) ($65m + $23m).  

(b)  

Impairment 

An impairment arises where the carrying amount of the net assets exceeds the recoverable amount.  

Where the cash flows cannot be independently determined for individual assets, they should be assessed as a cash generating unit. That is the smallest group of assets which independently generate cash flows. Impairments of cash generating units are allocated first to goodwill and then to the other assets in proportion to their carrying amounts. 

No asset should be reduced below its recoverable amount.

Fair value method 

The overall impairment of Garret Co is $30 million ($106m + goodwill $24m – $100m).  

The damaged building should be impaired by $4 million with a corresponding charge to profit or loss. Since $4 million has already been allocated to the land and buildings, $26 million of impairment loss remains to be allocated.  

The full $24 million of goodwill should be written off and expensed in the consolidated statement of profit or loss. 

Of the remaining $2 million impairment ($30m – $4m – $24m), $1.25 million will be allocated to the plant and machinery ((15/(15 + 9)) × 2m) and $0.75 million will be allocated to the remaining intangibles ((9/(9 + 15)) × 2m). As no assets have been previously revalued, all the impairments are charged to profit or loss.  

If the NCI has been measured at fair value at acquisition then ‘full goodwill’ has been calculated (i.e. the goodwill attributable to the owners of the parent company and the goodwill attributable to the NCI). As such, the NCI must be attributed its share of the goodwill impairment charge. 

Of the impairment loss, $24 million (80% × $30m) will be attributable to the owners of Luploid Co and $6 million (20% × $30m) to the NCI in the consolidated statement of profit or loss. 

The allocation of the impairment is summarised in this table:

Proportionate method

The basic principles and rule for impairment is the same as the fair value method and so $4 million will again first be written off against the land and buildings. 

When NCI is measured using the proportional share of net assets, no goodwill attributable to the NCI is recognised. This means that the goodwill needs to be grossed up when an impairment review is performed so that it is comparable with the recoverable amount.

 

The goodwill of $19.6 million is grossed up by 100/80 to a value of $24.5 million. This extra $4.9 million is known as notional goodwill. The overall impairment is now $30.5 million ($106m + $24.5m – $100m) of which $4 million has already been allocated to land and buildings. 

Since the remaining impairment of $26.5 million ($30.5m – $4m) exceeds the total notional goodwill, this is written down to zero. However, as only $19.6 million goodwill is recognised within the consolidated accounts, the impairment attributable to the notional goodwill is not recognised. The impairment charged in the consolidated statement of profit or loss is therefore $19.6 million and this is fully attributable to the owners of 

Louis Co.  

Of the remaining $2 million ($30.5m – $4m – $24.5m), $1.25 million will be allocated to the plant and machinery (15/(15 + 9) × 2m) and $0.75 million will be allocated to the remaining intangibles (9/(9 + 15) × 2m). As no assets have been previously revalued, all the impairments are charged to profit or loss.  

 

If goodwill is calculated using the proportionate method, then the goodwill impairment recognised in the consolidated financial statements is all attributable to the owners of the parent company. However, any impairment loss related to other assets must be allocated between the owners of the parent company and the non‐controlling interest. 

 

The impairment expense attributable to the owners of Louis Co is $24.4 million ($19.6m goodwill impairment + (80% × ($4m building + $2m plant and machinery and other intangibles))).  The impairment expense attributable to the NCI is $1.2 million (20% × $6m). This is summarised below:

(c)   (i)  Consideration 

IFRS 3 Business Combinations requires all consideration to be measured at fair value on acquisition of a subsidiary.  

Deferred shares should be measured at the fair value at the acquisition date with subsequent changes in fair value ignored. louis Co will issue 2.4 million (60% × 10m × 2/5) shares as consideration. The market price at the date of acquisition was $30, so the total fair value is $72 million (2.4m × $30).

 

Since louis Co is obliged to replace the share‐based scheme of Jack Co on acquisition, the replacement scheme should also be included as consideration (but only up to the fair value of the original scheme as at 1 July 20X7). The fair value of the replacement scheme at the grant date was $18 million. However the fair value of the original Jack Co scheme at the acquisition date was only $15 million. As such, only $15 million should be added to the consideration.  

The total consideration should be valued as $87 million ($72m + $15m). 

 

(ii)  

Expense related to replacement scheme 

The $3 million ($18m – $15m) not included within the consideration (see above) should be treated as part of the post‐acquisition remuneration package for the employees and measured in accordance with IFRS 2 Share‐based Payment. As there are no further vesting conditions it should be recognised as a postacquisition expense immediately.  

 

Expense related to additional scheme 

When dealing share‐based payment questions, students tend to provide answers that are wholly numerical. Make sure that you discuss and apply the principles from IFRS 2 Share‐based Payments or you will miss out on some very easy marks. 

The condition relating to the share price of louis Co is a market based vesting condition. These are adjusted for in the calculation of the fair value at the grant date of the option. An expense is therefore recorded in the consolidated profit or loss of louis Co (and a corresponding credit to equity) irrespective of whether the market based vesting condition is met or not. 

The additional two years’ service is a non‐market based vesting condition. The expense and credit to equity should be adjusted over the vesting period as expectations change regarding the non‐market based vesting condition.  

The correct charge to the profit or loss and credit to equity in the year ended 30 June 20X8 is $9.6 million ((10,000 × 96%) × 100 × $20 × ½).

 

a i)   The disposal of 100,000 shares by Alex Co would reduce its equity interest from  80% to 70%. This disposal would not result in a loss of control over Stark Co. 

Income and expenses should be consolidated for the entire year. Similarly, the  disposal does not affect the consolidation of Stark’s assets and liabilities, including goodwill. 

A decrease in the parent’s ownership interest which does not result in a loss of control is accounted for as an equity transaction, i.e. a transaction with owners in their capacity as owners. The carrying amounts of the controlling and non controlling interests are adjusted to reflect the changes in their relative interests 

in the subsidiary. Alex Co should recognise directly in equity any difference between the amount which the non‐controlling interest is adjusted by and the fair value of the consideration received. No gain or loss on the disposal of the  shares should be recognised within profit or loss. 

It is not clear under IFRS 10 Consolidated Financial Statements as to what happens to the non‐controlling interests’ share of goodwill when there is a change in the relative ownership of a subsidiary. However, it seems reasonable that Alex Co should reallocate 10% of the carrying amount of goodwill to the 

non‐controlling interest. This will ensure that future impairments of goodwill will reflect the revised ownership interest in the goodwill. 

The net assets of Stark Co at 1 January 20X6 should be determined as follows:

Since the non‐controlling interest is obtaining an extra 10% of the equity of Stark Co, the non‐controlling interest in the consolidated statement of 
financial position will be credited with $625,379 (10% × $6,253,792). The fair value of the consideration received is $700,000 (100,000 × $7). Alex Co should record a credit directly in equity equal to the difference of $74,621 ($700,000 – $625,379).

 
In summary 
Dr Cash 700,000  
Cr NCI 625,379  
Cr Equity 74,621

ii) Revenue should be recognised when a performance obligation is satisfied. This can be over time or at a point in time. Since the risks and rewards of ownership of the goods pass to Stark Co on 20 March 20X6, it is right that Alex Co should recognise revenue at this date and not when Stark sells the goods to the final consumer. 

The price concession which is likely to be offered by Alex Co means that the value of the consideration is variable and uncertain. IFRS 15 Revenue from Contracts with Customers requires the entity to estimate the amount of consideration to which it is entitled in exchange for the goods sold. Alex Co should either choose an expected value method or choose the most likely outcome to estimate the amount of the variable consideration. Alex Co should choose whichever method will better predict the amount of the consideration to which it is entitled. 

Since Alex Co has a history of offering price concessions but over a range from 8% to 38%, it would appear that an expected value method is probably more appropriate. In the absence of further information, it would seem reasonable to make an initial estimate of the variable consideration by using the mid‐point of the previous price concessions. This mid‐point would be a price concession equal to 23%. This would result in a revenue figure equal to $770,000 ($200 × 5,000 × 77%). 

IFRS 15 states that when estimating the amount of variable consideration, revenue must only be recognised to the extent that it is highly probable that a significant reversal of the cumulative revenue will not be required in the future. The risk of obsolescence means that the value of the consideration Alex Co is entitled to is highly contingent on factors outside the control of Alex Co. Alex Co has a history of offering price concessions of up to 38%, so it is unlikely that 

Alex Co can conclude that it is highly probable that a significant reversal in revenue will not be required. Current market data suggests that the maximum price concession is likely to be 35%. Therefore, it seems reasonable for Alex Co to revise its estimate to $650,000 ($200 × 5,000 × 65%).

This is the maximum amount that is highly probable that a significant reversal of  revenue will not be required. Since the whole $1,000,000 ($200 × 5,000) has  been included within revenue, the accounting treatment adopted is not correct.  Revenue should be reduced by $350,000 ($1,000,000 – $650,000). 

iii) 

b) Joint ventures are accounted for in the same way as associates – using the equity method. Make sure you can set out the impact on both the consolidated statement of profit or loss and consolidated statement of financial position.  

In accordance with IAS 28 Investments in Associates and Joint Ventures, Alex Co should adopt equity accounting within its consolidated financial statements for its investment in Rotate Co. Equity accounting means that in the consolidated statement of financial position the investment should be included as one figure within non‐current assets (an investment in joint venture). This figure is initially recognised at cost and will be increased by Alex Co’s 50% equity interest in the increase in Rotate Co’s net assets since incorporation.  

Within the consolidated statement of profit or loss, 50% of the profit for the year of Rotate Co will need to be included as a one line item. Since the profit is before deducting any dividend payments during the year, it is important to exclude the $15,000 dividend received by Alex Co from investment income within the consolidated statement of profit or loss.

The share of the profits of the joint venture for the year ended 31 March 20X6 should be calculated as $63,490 (50% × $126,980). Since Alex Co received a dividend of $15,000, total dividends paid by Rotate Co would have been $30,000 ($15,000 × 2). The net assets of Rotate Co would have increased by $170,430 ($73,450 + $126,980 – $30,000) since incorporation. The investment in the joint venture in the consolidated statement of financial position should be valued at $6,085,215 ($6,000,000 + (50% × $170,430)). 

This part of the question is a bit more difficult, but you can still score enough marks to pass by covering the basic treatment of the joint venture and performing the calculations. You might not know all of the detailed rules on gains and losses between a parent and joint venture, but you can always refer back to basic principles, in particular here the prudence concept. The parent company has sold a property at a loss, so there is evidence it is impaired, and therefore it would be prudent to recognise this in full in the individual and consolidated accounts.   

The joint venture is not part of the single entity concept and therefore it is not necessary to eliminate transactions and outstanding balances at the reporting date between the parent and the joint venture. However, IAS 28 does require that gains and losses arising between a parent entity and its joint venture should only be recognised to the extent of the unrelated investors’ interest in the joint venture. An exception to this rule is that losses should be recognised in full by the parent where a downstream transaction provides evidence that the asset is impaired. This is relevant to Alex Co as they have sold the property to Rotate Co (a downstream transaction) at a loss of $2 million ($10 million – $8 million). Since it is agreed that the proceeds of $8 million are equal to the market value of the property, this provides evidence that the property was indeed impaired. Alex Co should recognise the loss of $2 million within 

its individual and consolidated financial statements for the year ended 31 March 20X6. 

The investment in the joint venture and the share of the profits of the joint venture will not be affected by the transaction.

c)

A business combination, in accordance with IFRS 3 Business Combinations, is a transaction in which the acquirer obtains control over one or more businesses. For the acquisition to be treated as a business combination, it is therefore necessary to assess whether the activities of Falcon Co constituted a business in the first place. This means that the activities must have been capable of being conducted and managed in a way for the purpose of providing a return to investors or other owners and members of the 

entity. 

Once you have stated the rules, use the details of the scenario and apply them. More marks will be available for application than knowledge. 

The components of a business will consist of inputs and processes which have the ability to create outputs. Inputs are economic resources which have the ability to create outputs when one or more processes are applied to it. Processes will involve strategic management or operational processes capable of being applied to the inputs to create outputs but would not include administrative or accounting functions. 

Usually, such processes would be formally documented but an organised workforce having the necessary skills and experience, as indicated by Falcon Co, may provide the necessary processes. Output does not need to be present at the acquisition date for the activities of the entity to constitute a business. 

It can be seen that the activities of Falcon Co do constitute a business. Inputs are in place by having secured a licence to manufacture the new medicine. Operational and management processes would be associated with the performance and supervision of the clinical trials. Also, Falcon Co is pursuing a plan to produce an output which is capable of generating a return for the investors and owners of the entity. That is a commercially developed medicine to be sold on the market in the future. It is not relevant that the medicine is not yet on the market. 

A further consideration is whether Alex Co may choose to apply a concentration test which, if met, eliminates the need to consider further whether the activities of the acquiree constitute a business. Under this optional test, where substantially all of the fair value of the gross assets acquired is concentrated in a single asset (or a group of similar assets), the assets acquired would not represent a business. 

The optional concentration test can be applied when it seems unlikely that the acquiree is a business. Even if you think the test is not going to be met, it’s still worth stating the rule, applying it to the scenario and explaining how you have reached that conclusion. 

This will score marks.  

The only assets on the statement of financial position of Falcon Co relate to the licence and development of the new medicine. Additionally, in accordance with IAS 38 Intangible Assets, it would not be permitted to recognise the knowledge and skills of the workforce as a separate intangible asset within the consolidated financial statements. The workforce is not separable in that it cannot be sold, transferred, rented or otherwise exchanged without causing disruption to the acquirer’s business. Such assets tend to be subsumed into goodwill on recognition of a business combination. 

The requirement specifically asks you to consider if the team of scientists can be recognised as a separate intangible asset. Don’t miss this part out and lose out on the associated marks. You may want to use a separate sub‐heading so that the marker can clearly see you have addressed this element.

Nor does the assembled workforce represent the intellectual capital of the skilled workforce which is the specialised skills and experience that the employees bring to their jobs. However, prohibiting an acquirer from recognising an assembled workforce as an intangible asset does not prohibit the intellectual property from being recognised as a separate intangible asset. In relation to Falcon Co, it is likely that much of the processes and systems which have been undertaken to the development have been documented. Whilst some of this may have been capitalised within the development costs, much of this knowledge will have been at the research stage where IAS 38 states it is prohibited to capitalise research costs as an intangible asset. Since Alex Co acquires not just the manufacturing rights but the assembled workforce, it is unlikely that the concentration test would be met. The acquisition should therefore be treated as a business combination. 

Be sure to end your answer with a conclusion. This should flow from your discussion.

The correct option is option 4

Additional information:

• Although the estimated net realisable value is lower than it was (due to fire damage), the  entity will still make a profit on the inventory and thus it is not an indicator of impairment.

(a) (i) Operating segments 

Garry Co is a listed entity and therefore is required to comply with IFRS 8 

Operating Segments. The company’s view that the disclosure of segment information would be competitively harmful or misleading is difficult to understand as the IASB writes accounting standards on the basis that they provide transparent, useful information to investors. Garry Co should identify the information which would be useful to investors and how that information can 

be appropriately reported.

Tutorial note 

State the rules from IFRS 8 and then apply them to the scenario.  

IFRS 8 states that an operating segment is a component of an entity: 

•  which engages in business activities from which it may earn revenues and incur expenses 

• whose operating results are regularly reviewed by the entity’s chief operating decision maker, and 

• for which discrete financial information is available. 

An operating segment includes components of an entity which sells primarily or exclusively to other operating segments. Information about the components engaged in each stage of production is particularly important for understanding vertically integrated entities in certain businesses, for example, Garry Co. 

Therefore, the Casualwear division can be an operating segment even though it sells 90% of its production to the other divisions. 

 (ii) Garry Co appears to have four operating segments: Tennisgear, Badmintonwear,Squashracket, and Casualwear. This is because each segment: 

• engages in business activities which recognise revenues and incur expenses as a profit or loss account is prepared quarterly 

• has the CEO/chief operating decision maker reviewing their operating results quarterly to assess performance and allocate resources via the budgets, and 

• has discrete financial information available quarterly for each brand including additional performance measures such as EBITDA. 

Each of the brand managers is directly accountable to and meets quarterly with the CODM to discuss performance and compare the actual results to the budgeted figures. 

Since Casualwear is an overseas entity, it is likely that separate disclosure is necessary so that users can better assess its performance and its significance to the group. 

Separate reportable segments

(ii) Separate reportable segments 

To determine if a segment is reportable, 2 main rules are employed. 

Firstly, the 10% rule is considered.  

Then, after determining the reportable segments under the 10% rule, the 75% rule is applied.

IFRS 8 requires an entity to report financial and descriptive information about its reportable segments. Reportable segments are operating segments or aggregations of operating segments which meet any of the specified criteria: 

•  its reported revenue, from both external customers and intersegment sales or transfers, is 10% or more of the combined revenue, internal and external, of all operating segments, or 

•  the absolute measure of its reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments which did not report a loss and (ii) the combined reported loss of all operating segments which reported a loss, or 

•  its assets are 10% or more of the combined assets of all operating segments. 

Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principles of the standard, the segments have similar economic characteristics and are similar in various prescribed respects. If the total external revenue reported by operating segments constitutes less than 75% of the entity’s revenue, additional operating segments must be identified as reportable segments (even if they do not meet the quantitative thresholds set out above) until at least 75% of the entity’s revenue is included in reportable segments.

Tennisgear and Casualwear are separately reportable since they meet all three size criteria – although only need to meet one of the thresholds to be reportable. 
Badmintonwear and Squashracket do not meet any of the quantitative criteria and, on the face of it, are not separately reportable. The external revenue of 
Tennisgear is 77.7% (16/20.6) of the total external revenue so the '75% threshold' is achieved by Tennisgear alone. 
However, Badmintonwear and Squashracket are likely to share similar economic characteristics because they sell the same clothing with different brand names. 
If aggregated, they would exceed the 10% threshold for revenue, profit and net assets and so could be reported as a combined segment. 
In addition, IFRS 8 gives entities discretion to report information regarding segments which do not meet the size criteria. Entities can report on such 
segments if, in the opinion of management, information about the segment would be useful to users of the financial statements.

(b) 

Investment in Hazel Co 

In this scenario, consideration of more than one IFRS Standard is required simultaneously. Both IFRS 11 Joint arrangements and IFRS 8 Operating Segments should be discussed.  

In such circumstances, approach each standard individually. Think about the rules per 

IFRS 11 then apply it to the scenario. Is Hazel a joint arrangement as per the rules from 

IFRS 11? 

Then do the same for IFRS 8. Should Hazel be an operating segment per the rules from IFRS 8? 

Do not attempt to muddle the rules up or provide conclusions in one go. This will overcomplicate the process and likely cause you confusion.  

IFRS 11 Joint Arrangements states that a joint arrangement is an arrangement where two or more parties share joint control. Joint control exists when decisions about the relevant activities require the unanimous consent of the parties sharing control. 

Even though the call option would give an additional 10% voting interest to Garry Co, Hazel Co’s governance still requires the unanimous vote of all investors to make key decisions, as outlined in an agreement between the venturers. Therefore, the investment would be under joint control regardless of the substance of the call option, which would change only the economic ownership percentage rather than the governance to control. 

A joint venture is a joint arrangement whereby the parties who have joint control of the arrangement have rights to the net assets of the arrangement. This normally involves the establishment of a separate entity. Therefore, Garry Co should recognise its interest in Hazel Co as a joint venture. In accordance with IAS 28 Investments in Associates and Joint Ventures, it should account for this investment in the consolidated financial statements using the equity method. 

Operating segment 

In this instance, the joint venture, Hazel Co, could represent an operating segment as it engages in business activities (racket production) from which it recognises revenues and incurs expenses and the CODM regularly reviews the joint venture’s operating results to allocate resources and assess performance. Also, discrete financial information is available for the venture. 

A joint venture can be considered an operating segment even though the investor only has joint control over the performance of the investee. The operating results should be regularly reviewed by the CODM to contribute to decisions about resources to be allocated to the segment and assess its performance. Management may regularly review the operating results and performance of an equity method investee for purposes of evaluating whether to retain the relationship. However, management does not need to be responsible for making decisions about resources to be allocated or which affect its operations and performance. Therefore, control over the joint venture is not a criterion for it to be considered an operating segment.

(a) 

(i) Assessing whether the transfer qualifies as a sale 

Assessing whether a sale has occurred is the first task to perform whenever dealing with a sale and leaseback arrangement.  

The entity assesses whether the transfer qualifies as a sale by using the guidance in IFRS 15 Revenue from Contracts with Customers. A sale has occurred when the seller has satisfied a performance obligation by transferring control of the asset. Control refers to the ability to direct the use of the asset and to obtain substantially all of its remaining benefits. 

(ii) Accounting treatment if the transfer QUALIFIES as a sale 

If the arrangement qualifies as a sale, 2 steps are required.  

1 Derecognise the asset and record any gain or loss on disposal 

2 Record the lease – a right‐of‐use asset and a lease liability are recognised. 

The seller‐lessee derecognises the asset. 

A right‐of‐use (RoU) asset is recognised, and is measured at the proportion of the previous carrying amount of the asset which relates to the rights retained by the seller‐lessee. 

A lease liability is recognised, equal to the present value of the lease payments to be made. 

A profit or loss is reported in the statement of profit or loss, based on the rights transferred to the buyer‐lessor.

Proceeds in excess of the fair value are complications that may arise within a sale and leaseback arrangement and would represent prize‐winner points. Do not worry if you failed to spot this as few people did. If you answered using the basic accounting treatments described above, you would pass the requirement.  

Note that if the consideration received for the asset exceeds its fair value, this is accounted for as additional financing. If the consideration is below the asset’s fair value, then this is accounted for as a prepayment of lease payments. 

Subsequently, the RoU asset is depreciated over the lease term. Interest is charged on the lease liability using the rate implicit in the lease.

(iii)Accounting treatment if the transfer DOES NOT QUALIFY as a sale 

If the arrangement does not qualify as a sale, it is accounted for as a financing arrangement – the proceeds represent a loan.  

The seller‐lessee continues to recognise the asset on its statement of financial position. The seller‐lessee accounts for proceeds from the sale and leaseback as a financial liability in accordance with IFRS 9 Financial Instruments. 

(iv) The effect if an agreement contains a call option 

The presence of the call option to repurchase means that control of the asset will only transfer once the option expires. Therefore, the treatment is the same as if the transaction did not qualify as a sale. 

If the transaction contains a call option under which the seller‐lessee can, at its option, repurchase the property, then such an option generally precludes sale accounting under IFRS 15. This is because the existence of the call option means that the seller‐lessee retains control of the property. Therefore, sale and leaseback accounting does not apply, with the asset remaining on the statement of financial position and the cash received treated as a financial liability. 

(b) Head office transfer qualifies as a sale 

Because the consideration for the sale of the head office is not at fair value, Alaric Co recognises the $0.75 million excess over fair value ($7.5m – $6.75m) as additional financing provided by Jina Co. The present value of the annual payments amounts to $5.47 million of which $0.75 million ($7.5m – $6.75m) relates to the additional financing and $4.72 million ($5.47m – $0.75m) relates to the lease.

At 1 January 20X7, Alaric Co measures the RoU asset arising from the leaseback of the building at the proportion of the previous carrying amount of the head office which relates to the right of use retained. This is calculated as $3.75 million (the carrying amount of the head office) ÷ $6.75 million (the fair value of the building) × $4.72 million (the discounted lease payments for the RoU asset), that is $2.62 million. 

Alaric Co recognises only the amount of the gain which relates to the rights transferred to Jina Co. The gain on sale is $3 million ($6.75m – $3.75m), of which $2.1 million ($3m ÷ $6.75m × $4.72m) relates to the right to use the head office retained by Alaric Co. The rights transferred to Jina Co are measured at $0.9 million ($3m ÷ $6.75m × ($6.75m – $4.72m)). 

At 1 January 20X7, Alaric Co accounts for the transaction as follows.

(a) (i) Fair value measurement 

Fair value measurement is a popular exam topic. Make sure that you know the definition of fair value. 

IFRS 13 Fair Value Measurement defines fair value as the price which would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is therefore not supposed to be entity specific but rather market focused. Essentially the 

estimate is the amount that the market would be prepared to pay for the asset. 

The fair value of a non‐financial asset should be determined based on its highest and best use. Non‐financial assets include property, plant and equipment, inventories, intangible assets, and investment properties. 

The market would consider all alternative uses for the assessment of the price which they would be willing to pay. For non‐financial assets, fair value should therefore be measured by consideration of the highest and best use of the asset. 

There is a presumption that the current use would be the highest and best use unless evidence exists to the contrary.  

The highest and best use of the asset appears to be as residential property and not the current industrial use. The intentions of Garret Co are not relevant as fair value is not entity specific. The alternative use would need to be based upon fair and reasonable assumptions. In particular, it would be necessary to ensure that planning permission to demolish the factory and convert into residential properties would be likely. Since several nearby sites have been given such permission, this would appear to be the case. 

The fair value of the factory site should be valued as if converted into residential use. Since this cannot be determined on a stand‐alone basis, the combined value of the land and buildings is calculated. The $1 million demolition and planning costs should be deducted from the market value of $24 million. The fair value of 

the land and buildings should be $23 million. The fair value of the identifiable net assets at acquisition are $88 million ($65m + $23m). 

Depreciated replacement cost 

Depreciated replacement cost should only be considered as a possible method for estimating the fair value of the asset when other more suitable methods are not available. This may be the case when the asset is highly specialised. This is not the case with the factory site. Depreciation is unlikely to be an accurate reflection of all forms of obsolescence including physical deterioration. 

Moreover, the rise in value of land and properties particularly for residential use would mean that to use depreciated replacement cost would most likely undervalue the asset. 

(ii)  

Goodwill calculations 

This part of the question only asked for ‘calculations’. No marks are awarded for discussion of the goodwill calculations. 

Goodwill should be calculated as follows:

NCI at acquisition under proportional method is $17.6m (20% × $88m). 
The fair value of the net assets at acquisition is $88m as per part (a) (i) ($65m + $23m).  

(b)  

Impairment 

An impairment arises where the carrying amount of the net assets exceeds the recoverable amount.  

Where the cash flows cannot be independently determined for individual assets, they should be assessed as a cash generating unit. That is the smallest group of assets which independently generate cash flows. Impairments of cash generating units are allocated first to goodwill and then to the other assets in proportion to their carrying amounts. 

No asset should be reduced below its recoverable amount.

Fair value method 

The overall impairment of Garret Co is $30 million ($106m + goodwill $24m – $100m).  

The damaged building should be impaired by $4 million with a corresponding charge to profit or loss. Since $4 million has already been allocated to the land and buildings, $26 million of impairment loss remains to be allocated.  

The full $24 million of goodwill should be written off and expensed in the consolidated statement of profit or loss. 

Of the remaining $2 million impairment ($30m – $4m – $24m), $1.25 million will be allocated to the plant and machinery ((15/(15 + 9)) × 2m) and $0.75 million will be allocated to the remaining intangibles ((9/(9 + 15)) × 2m). As no assets have been previously revalued, all the impairments are charged to profit or loss.  

If the NCI has been measured at fair value at acquisition then ‘full goodwill’ has been calculated (i.e. the goodwill attributable to the owners of the parent company and the goodwill attributable to the NCI). As such, the NCI must be attributed its share of the goodwill impairment charge. 

Of the impairment loss, $24 million (80% × $30m) will be attributable to the owners of Luploid Co and $6 million (20% × $30m) to the NCI in the consolidated statement of profit or loss. 

The allocation of the impairment is summarised in this table:

Proportionate method

The basic principles and rule for impairment is the same as the fair value method and so $4 million will again first be written off against the land and buildings. 

When NCI is measured using the proportional share of net assets, no goodwill attributable to the NCI is recognised. This means that the goodwill needs to be grossed up when an impairment review is performed so that it is comparable with the recoverable amount.

 

The goodwill of $19.6 million is grossed up by 100/80 to a value of $24.5 million. This extra $4.9 million is known as notional goodwill. The overall impairment is now $30.5 million ($106m + $24.5m – $100m) of which $4 million has already been allocated to land and buildings. 

Since the remaining impairment of $26.5 million ($30.5m – $4m) exceeds the total notional goodwill, this is written down to zero. However, as only $19.6 million goodwill is recognised within the consolidated accounts, the impairment attributable to the notional goodwill is not recognised. The impairment charged in the consolidated statement of profit or loss is therefore $19.6 million and this is fully attributable to the owners of 

Louis Co.  

Of the remaining $2 million ($30.5m – $4m – $24.5m), $1.25 million will be allocated to the plant and machinery (15/(15 + 9) × 2m) and $0.75 million will be allocated to the remaining intangibles (9/(9 + 15) × 2m). As no assets have been previously revalued, all the impairments are charged to profit or loss.  

 

If goodwill is calculated using the proportionate method, then the goodwill impairment recognised in the consolidated financial statements is all attributable to the owners of the parent company. However, any impairment loss related to other assets must be allocated between the owners of the parent company and the non‐controlling interest. 

 

The impairment expense attributable to the owners of Louis Co is $24.4 million ($19.6m goodwill impairment + (80% × ($4m building + $2m plant and machinery and other intangibles))).  The impairment expense attributable to the NCI is $1.2 million (20% × $6m). This is summarised below:

(c)   (i)  Consideration 

IFRS 3 Business Combinations requires all consideration to be measured at fair value on acquisition of a subsidiary.  

Deferred shares should be measured at the fair value at the acquisition date with subsequent changes in fair value ignored. louis Co will issue 2.4 million (60% × 10m × 2/5) shares as consideration. The market price at the date of acquisition was $30, so the total fair value is $72 million (2.4m × $30).

 

Since louis Co is obliged to replace the share‐based scheme of Jack Co on acquisition, the replacement scheme should also be included as consideration (but only up to the fair value of the original scheme as at 1 July 20X7). The fair value of the replacement scheme at the grant date was $18 million. However the fair value of the original Jack Co scheme at the acquisition date was only $15 million. As such, only $15 million should be added to the consideration.  

The total consideration should be valued as $87 million ($72m + $15m). 

 

(ii)  

Expense related to replacement scheme 

The $3 million ($18m – $15m) not included within the consideration (see above) should be treated as part of the post‐acquisition remuneration package for the employees and measured in accordance with IFRS 2 Share‐based Payment. As there are no further vesting conditions it should be recognised as a postacquisition expense immediately.  

 

Expense related to additional scheme 

When dealing share‐based payment questions, students tend to provide answers that are wholly numerical. Make sure that you discuss and apply the principles from IFRS 2 Share‐based Payments or you will miss out on some very easy marks. 

The condition relating to the share price of louis Co is a market based vesting condition. These are adjusted for in the calculation of the fair value at the grant date of the option. An expense is therefore recorded in the consolidated profit or loss of louis Co (and a corresponding credit to equity) irrespective of whether the market based vesting condition is met or not. 

The additional two years’ service is a non‐market based vesting condition. The expense and credit to equity should be adjusted over the vesting period as expectations change regarding the non‐market based vesting condition.  

The correct charge to the profit or loss and credit to equity in the year ended 30 June 20X8 is $9.6 million ((10,000 × 96%) × 100 × $20 × ½).

 

a i)   The disposal of 100,000 shares by Alex Co would reduce its equity interest from  80% to 70%. This disposal would not result in a loss of control over Stark Co. 

Income and expenses should be consolidated for the entire year. Similarly, the  disposal does not affect the consolidation of Stark’s assets and liabilities, including goodwill. 

A decrease in the parent’s ownership interest which does not result in a loss of control is accounted for as an equity transaction, i.e. a transaction with owners in their capacity as owners. The carrying amounts of the controlling and non controlling interests are adjusted to reflect the changes in their relative interests 

in the subsidiary. Alex Co should recognise directly in equity any difference between the amount which the non‐controlling interest is adjusted by and the fair value of the consideration received. No gain or loss on the disposal of the  shares should be recognised within profit or loss. 

It is not clear under IFRS 10 Consolidated Financial Statements as to what happens to the non‐controlling interests’ share of goodwill when there is a change in the relative ownership of a subsidiary. However, it seems reasonable that Alex Co should reallocate 10% of the carrying amount of goodwill to the 

non‐controlling interest. This will ensure that future impairments of goodwill will reflect the revised ownership interest in the goodwill. 

The net assets of Stark Co at 1 January 20X6 should be determined as follows:

Since the non‐controlling interest is obtaining an extra 10% of the equity of Stark Co, the non‐controlling interest in the consolidated statement of 
financial position will be credited with $625,379 (10% × $6,253,792). The fair value of the consideration received is $700,000 (100,000 × $7). Alex Co should record a credit directly in equity equal to the difference of $74,621 ($700,000 – $625,379).

 
In summary 
Dr Cash 700,000  
Cr NCI 625,379  
Cr Equity 74,621

ii) Revenue should be recognised when a performance obligation is satisfied. This can be over time or at a point in time. Since the risks and rewards of ownership of the goods pass to Stark Co on 20 March 20X6, it is right that Alex Co should recognise revenue at this date and not when Stark sells the goods to the final consumer. 

The price concession which is likely to be offered by Alex Co means that the value of the consideration is variable and uncertain. IFRS 15 Revenue from Contracts with Customers requires the entity to estimate the amount of consideration to which it is entitled in exchange for the goods sold. Alex Co should either choose an expected value method or choose the most likely outcome to estimate the amount of the variable consideration. Alex Co should choose whichever method will better predict the amount of the consideration to which it is entitled. 

Since Alex Co has a history of offering price concessions but over a range from 8% to 38%, it would appear that an expected value method is probably more appropriate. In the absence of further information, it would seem reasonable to make an initial estimate of the variable consideration by using the mid‐point of the previous price concessions. This mid‐point would be a price concession equal to 23%. This would result in a revenue figure equal to $770,000 ($200 × 5,000 × 77%). 

IFRS 15 states that when estimating the amount of variable consideration, revenue must only be recognised to the extent that it is highly probable that a significant reversal of the cumulative revenue will not be required in the future. The risk of obsolescence means that the value of the consideration Alex Co is entitled to is highly contingent on factors outside the control of Alex Co. Alex Co has a history of offering price concessions of up to 38%, so it is unlikely that 

Alex Co can conclude that it is highly probable that a significant reversal in revenue will not be required. Current market data suggests that the maximum price concession is likely to be 35%. Therefore, it seems reasonable for Alex Co to revise its estimate to $650,000 ($200 × 5,000 × 65%).

This is the maximum amount that is highly probable that a significant reversal of  revenue will not be required. Since the whole $1,000,000 ($200 × 5,000) has  been included within revenue, the accounting treatment adopted is not correct.  Revenue should be reduced by $350,000 ($1,000,000 – $650,000). 

iii) 

b) Joint ventures are accounted for in the same way as associates – using the equity method. Make sure you can set out the impact on both the consolidated statement of profit or loss and consolidated statement of financial position.  

In accordance with IAS 28 Investments in Associates and Joint Ventures, Alex Co should adopt equity accounting within its consolidated financial statements for its investment in Rotate Co. Equity accounting means that in the consolidated statement of financial position the investment should be included as one figure within non‐current assets (an investment in joint venture). This figure is initially recognised at cost and will be increased by Alex Co’s 50% equity interest in the increase in Rotate Co’s net assets since incorporation.  

Within the consolidated statement of profit or loss, 50% of the profit for the year of Rotate Co will need to be included as a one line item. Since the profit is before deducting any dividend payments during the year, it is important to exclude the $15,000 dividend received by Alex Co from investment income within the consolidated statement of profit or loss.

The share of the profits of the joint venture for the year ended 31 March 20X6 should be calculated as $63,490 (50% × $126,980). Since Alex Co received a dividend of $15,000, total dividends paid by Rotate Co would have been $30,000 ($15,000 × 2). The net assets of Rotate Co would have increased by $170,430 ($73,450 + $126,980 – $30,000) since incorporation. The investment in the joint venture in the consolidated statement of financial position should be valued at $6,085,215 ($6,000,000 + (50% × $170,430)). 

This part of the question is a bit more difficult, but you can still score enough marks to pass by covering the basic treatment of the joint venture and performing the calculations. You might not know all of the detailed rules on gains and losses between a parent and joint venture, but you can always refer back to basic principles, in particular here the prudence concept. The parent company has sold a property at a loss, so there is evidence it is impaired, and therefore it would be prudent to recognise this in full in the individual and consolidated accounts.   

The joint venture is not part of the single entity concept and therefore it is not necessary to eliminate transactions and outstanding balances at the reporting date between the parent and the joint venture. However, IAS 28 does require that gains and losses arising between a parent entity and its joint venture should only be recognised to the extent of the unrelated investors’ interest in the joint venture. An exception to this rule is that losses should be recognised in full by the parent where a downstream transaction provides evidence that the asset is impaired. This is relevant to Alex Co as they have sold the property to Rotate Co (a downstream transaction) at a loss of $2 million ($10 million – $8 million). Since it is agreed that the proceeds of $8 million are equal to the market value of the property, this provides evidence that the property was indeed impaired. Alex Co should recognise the loss of $2 million within 

its individual and consolidated financial statements for the year ended 31 March 20X6. 

The investment in the joint venture and the share of the profits of the joint venture will not be affected by the transaction.

c)

A business combination, in accordance with IFRS 3 Business Combinations, is a transaction in which the acquirer obtains control over one or more businesses. For the acquisition to be treated as a business combination, it is therefore necessary to assess whether the activities of Falcon Co constituted a business in the first place. This means that the activities must have been capable of being conducted and managed in a way for the purpose of providing a return to investors or other owners and members of the 

entity. 

Once you have stated the rules, use the details of the scenario and apply them. More marks will be available for application than knowledge. 

The components of a business will consist of inputs and processes which have the ability to create outputs. Inputs are economic resources which have the ability to create outputs when one or more processes are applied to it. Processes will involve strategic management or operational processes capable of being applied to the inputs to create outputs but would not include administrative or accounting functions. 

Usually, such processes would be formally documented but an organised workforce having the necessary skills and experience, as indicated by Falcon Co, may provide the necessary processes. Output does not need to be present at the acquisition date for the activities of the entity to constitute a business. 

It can be seen that the activities of Falcon Co do constitute a business. Inputs are in place by having secured a licence to manufacture the new medicine. Operational and management processes would be associated with the performance and supervision of the clinical trials. Also, Falcon Co is pursuing a plan to produce an output which is capable of generating a return for the investors and owners of the entity. That is a commercially developed medicine to be sold on the market in the future. It is not relevant that the medicine is not yet on the market. 

A further consideration is whether Alex Co may choose to apply a concentration test which, if met, eliminates the need to consider further whether the activities of the acquiree constitute a business. Under this optional test, where substantially all of the fair value of the gross assets acquired is concentrated in a single asset (or a group of similar assets), the assets acquired would not represent a business. 

The optional concentration test can be applied when it seems unlikely that the acquiree is a business. Even if you think the test is not going to be met, it’s still worth stating the rule, applying it to the scenario and explaining how you have reached that conclusion. 

This will score marks.  

The only assets on the statement of financial position of Falcon Co relate to the licence and development of the new medicine. Additionally, in accordance with IAS 38 Intangible Assets, it would not be permitted to recognise the knowledge and skills of the workforce as a separate intangible asset within the consolidated financial statements. The workforce is not separable in that it cannot be sold, transferred, rented or otherwise exchanged without causing disruption to the acquirer’s business. Such assets tend to be subsumed into goodwill on recognition of a business combination. 

The requirement specifically asks you to consider if the team of scientists can be recognised as a separate intangible asset. Don’t miss this part out and lose out on the associated marks. You may want to use a separate sub‐heading so that the marker can clearly see you have addressed this element.

Nor does the assembled workforce represent the intellectual capital of the skilled workforce which is the specialised skills and experience that the employees bring to their jobs. However, prohibiting an acquirer from recognising an assembled workforce as an intangible asset does not prohibit the intellectual property from being recognised as a separate intangible asset. In relation to Falcon Co, it is likely that much of the processes and systems which have been undertaken to the development have been documented. Whilst some of this may have been capitalised within the development costs, much of this knowledge will have been at the research stage where IAS 38 states it is prohibited to capitalise research costs as an intangible asset. Since Alex Co acquires not just the manufacturing rights but the assembled workforce, it is unlikely that the concentration test would be met. The acquisition should therefore be treated as a business combination. 

Be sure to end your answer with a conclusion. This should flow from your discussion.

The correct option is option 3 

Additional Information: 

The correct option is option 4

Additional information:

• Although the estimated net realisable value is lower than it was (due to fire damage), the  entity will still make a profit on the inventory and thus it is not an indicator of impairment.

The correct option is option 1 ,i.e., $6,500

Additional information: 

• The recoverable amount of an asset is the higher of its value in use (being the present value  of future cash flows) and fair value less costs to sell. Therefore the recoverable amount is  $6,500.

The correct option is option 2

Additional information:

• ​The cash generating unit is impaired by $1,180,000, being the difference between the  recoverable amount of $4 million and the total carrying values of the assets of $5,180,000.  In a cash generating unit, no asset should be impaired below its recoverable amount,  meaning that the property and other net assets are not impaired. The impairment is allocated  to goodwill first, resulting in the entire $700,000 being written off. This leaves a remaining  impairment of $480,000 to be allocated across plant and intangible assets. 
• This should be allocated on a pro‐rata basis according to their carrying value. The plant and  intangible assets have a total carrying value of $1,750,000 ($950,000 plant and $800,000  intangible assets). Therefore the impairment should be allocated to plant as follows:  $950,000/$1,750,000 × $480,000 = $261,000.  The carrying value of plant is therefore $950,000 – $261,000 = $689,000

The correct option is option1 

Additional information:

• In a cash generating unit, no asset should be impaired below its recoverable amount. The  valuation of $2.5 million is an indication that the property is not impaired and should  therefore be left at $2.3 million.
•   $2.5 million cannot be chosen as the entity uses the cost model. If you chose item C or D then  you have impaired the asset.