Question

c) HI, a parent entity, is planning to acquire a shareholding in ABC. The following
alternative investment strategies are being considered:
(i) HI can purchase 80,000 preferred shares in ABC;
(ii) HI can purchase 40,000 equity shares and 50,000 preferred shares in ABC;
(iii) HI can purchase 70,000 equity shares in ABC and no preferred shares.
ABC has the following issued share capital:
R
R1 Equity shares 100,000
R1 10% Preferred Shares 100,000
Holders of preferred shares do not have any votes at annual general meetings.
Required:
Identify with reasons how HI would classify its investment in ABC in its consolidated financial statements for each of the alternative investment strategies. (Total for sub-question (e) = 5 marks)

Answer 1

As per IFRS 10, An investor controls an investee if and only if the investor has all of the following elements:

a) Power over the investee

b) Exposure, or rights, to variable returns from its involvement with the investee

c) The ability to use its power over the investee to affect the amount of the investor's returns.

Generally, holding of power more than 50% of voting rights or control over Board of Directors(Management) gives power to control the operations of other company.

As per IFRS 9 / IAS 28 , an associate is an entity which it has significant influence over other entity. Significant Influence means thee power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies

1. By Purchasing 80,000 preference shares out of 1,00,000 preference shares in ABC, ABC can neither be Associate or Subsidiary of HI Limited as Preference shares have no Voting Rights and through these preference shares HI Ltd can neither have significant influence nor control over ABC Ltd. These are Inter Corporate Investments and they will be shown as Investment in Financial Assets

2.40,000 Equity Shares & 50,000 Preference Shares : 40,000 Equity Shares means 40% of ABC Ltd. Therefore HI Ltd has significant influence over ABC. The investment will be shown as Non Current Asset.

3. 70,000 Equity Shares : 70% Equity Shares. Therefore HI has control over ABC. As per IFRS 10, the investment share in ABC Limited will be shown under Reserves & Surplus after adjusting Capital Reserve or goodwill if any