Question

The Wholesale Ltd acquired 80 per cent of the shares of House Construction Ltd on 30 June 2020 for a consideration of $800,000. The share capital and reserves of House Construction Ltd at the date of acquisition were: Share capital $550,000 Retained earnings $100,000 Revaluation surplus $150,000 All assets of House Construction Ltd were fairly valued at the date of acquisition, except for a major plant that had a fair value $26,000 greater than its carrying amount. The cost of the plant was $100,000 and it had accumulated depreciation of $85,000. There were no transactions between Wholesale Ltd and House Construction Ltd at the date of acquisition. In addition, the Wholesale Ltd acquired 100 per cent of the shares of Queensland Retail Ltd on 1 July 2018-that is two years earlier. The cost of investment was $650,000. At that date the capital and reserves of Queensland Retail Ltd were: Share capital $235,000 Retained earnings $115,000 At the date of acquisition all assets of Queensland Retail Ltd were considered to be fairly valued. 2 Wholesale Ltd incurred the following transactions with Queensland Retail Ltd during financial year 2018-2019: • On 1 September 2018 Wholesale Ltd sold a machinery to Queensland Retail Ltd for $136,000 when its carrying value in Wholesale Ltd’s book was $100,000 (original cost $200,000 and original estimated life of 8 years). • From January to June in 2019, Wholesale Ltd made sales of inventory $50,000 to Queensland Retail Ltd for on-sale to external parties. The inventory had originally cost Wholesale Ltd $40,000. At 30 June 2019, Queensland Retail Ltd still had 40 per cent of the inventory on hand. On-hand inventory was expected to be sold in the subsequent financial year. Wholesale Ltd incurred the following transactions with Queensland Retail Ltd during financial year 2019-2020: • During the year Wholesale Ltd made total sales of inventory $70,000 to Queensland Retail Ltd for on-sale to external parties. The inventory had originally cost Wholesale Ltd 61,000. At 30 June 2020, half of the inventory was still on hand. On-hand inventory was expected to be sold in the subsequent financial year. • Wholesale Ltd provided management consultation to Queensland Retail Ltd and this was the first time that Wholesale Ltd provided such service to Queensland Retail Ltd. At the end of 2020, Queensland Retail Ltd paid $3,000 for these services and has a balance of $2,000 payable at year end. • Queensland Retail Ltd has several long-term loans, including a five-year loan for $55,000 from Wholesale Ltd. This loan was effective from 1 July 2019. Interest rate was 3.5% per annum. During the year ending 30 June 2020, Queensland Retail Ltd paid $1,000 interest on this loan. You were appointed as the financial accountant at Wholesale Ltd. As you may have noticed, Wholesale Ltd acquired 80% shares of House Construction Ltd to extend its operation in Australia and it also has an existing wholly owned subsidiary (Queensland Retail Ltd) operating in Queensland.

You were requested to prepare the followings: I. acquisition analysis at 1 July 2018 and adjustment/elimination journal entries for consolidation as at 30 June 2019. II. acquisition analysis and adjustment/elimination journal entries for consolidation as at 30 June 2020.

Answer 1

Ans. I]

Acquisition analysis of Queensland on 1st Jul 2018

A good analysis should enable management to answer such questions as:

• What is the maximum price that should be paid for the target company?

It is the prime and most important factor in acquisition analysis . For evaluating the purchase price we need to see the worth of total aseets of Queensland. The cost of total investment is given as $650000. It is also given that the assets are fairly valued . As we dont have detailed informtion , we will rely on given information and assume that the price paid for the purchase of the company may be fair.

• What are the principal areas of risk?

In the above point we just saw the total value of assets of Queensland which we assumed fair valued as per given info. But now in this point we have to identify main risk factors involved if any. If we see the liabilities side of the B/S of Queensland we get Share Capital $235000+ Retained Earnings $115000. So total of it comes to $350000. As assets side total is $650000 same will be of liabilities side i.e $650000. It means if we exclude Share Capital & Retained Earnings from $650000 we get balance $300000[ 650000-350000]. As we dont have detailed information we have to assume that the balancing figure $300000 is nothing but Loans.

So it is a very crucial risk factor that the company has a sizable debt amount . We agree that it is less than the total of Share Capital and Retained Earnings , still it may create burden of interest and cash crunch due to interest payments and payment of any loans if due for repayment. It also indicate that Wholsale Ltd paid 300000 as Goodwill to Queensland [ 650000 total assets - Share Capital & Retained Earnings 350000]. Its comparatively high price paid.

• What are the earnings, cash flow, and balance sheet implications of the acquisition?

This aspect is also very important in acuqisition analysis. Even if the purchaser has paid high price for acquisition we cand consider the proposal at that price is sales income is excellent , profit ratios are excellent. Unfortunately in the given problem there is no specific information given on which we can evaluate P/E ratio, Price/Share ratio and other profitability ratios.

• What is the best way of financing the acquisition?

The best way of financing the acquisition can be taken by analysing the financial statements of Queensland. But again we have inadequate information for the same.

Acquisition analysis of House Construction Ltd. on 30th Jun 2020

• What is the maximum price that should be paid for the target company?

It is the prime and most important factor in acquisition analysis . For evaluating the purchase price we need to see the worth of total aseets of the H.C Ltd  The purchase price of 80% share given as $800000. As we dont have much information we will assume that 80% assets are $ 800000 , so 100% assets are $1000000. If we take the total of item of liabilities it comes to 800000 [ Share Capital 550000+ R.E 100000 + Reval. Surplus 150000] . If we deduct 800000 from total of liabilites 1000000 we get difference 200000 whcih we can assume as Loans.It is also given that the assets are fairly valued . As we dont have detailed informtion , we will rely on given information and assume that the price paid for the purchase of the company may be fair.

• What are the principal areas of risk?

In the above point we just saw the total value of assets of H.C Ltd which we assumed fair valued as per given info. But now in this point we have to identify main risk factors involved if any. If we see the liabilities side of the B/S of H,C Ltd we get get balance $200000[ 1000000-800000]. As we dont have detailed information we have to assume that the balancing figure $200000 is nothing but Loans.

So it is a very crucial risk factor that whether the company has a sizable debt amount which  may create burden of interest and cash crunch due to interest payments and payment of any loans if due for repayment. But the loan amount is comaparatively smller than equity. It may create taxation problems as interest will be less availabe as deduction due to low debt. Again Return on Euqity will be low due to high equity. It also indicate that Wholsale Ltd paid at par value of assets to H.C Ltd.

• What are the earnings, cash flow, and balance sheet implications of the acquisition?

This aspect is also very important in acuqisition analysis. Even if the purchaser has paid high price for acquisition we cand consider the proposal at that price is sales income is excellent , profit ratios are excellent. Unfortunately in the given problem there is no specific information given on which we can evaluate P/E ratio, Price/Share ratio and other profitability ratios.

• What is the best way of financing the acquisition?

The best way of financing the acquisition can be taken by analysing the financial statements of H.C Ltd. But again we have inadequate information for the same.

Journal entries for adjustments/eliminations in consolidations 2019

• Date	Particuars	Posting Ref	Debit	Credit
  Jun 30 2019	Profit & Loss To Machinery [For elimination of profit on sale of mancinery by Wholesales to Queensland]		36000	36000
  Jun 30 2019	Profit & Loss To Inventory [For adjustment of profit on sale of goods by Wholesales to Queensland 40% of which is lying in stock] 4000 4000

• Journal entries for adjustments/eliminations in consolidations 2020

  Jun 30 2020	Profit & Loss To Inventory [For adjustment of profit on sale of goods by Wholesales to Queensland 50% of which is lying in stock]		4500	4500
  Jun 30	Profit & Loss To Consilting Service To Consulting Services Payable [For elimination of sale of services by Wholesales to Queensland 50% of which is lying in stock] 5000 3000 2000
  Jun 30	Profit & Loss To Interest to Interest Payable [For adjustment of interest charged by Wholesales to Queensland at 3.5%] 1925 1000 925
  Jun 30	Plant A/c To H.C Ltd [For recording of undervalu of plant of H.C Ltd at the time of acquisiton.] 26000 26000