On January 1, 2016, Aspen Company acquired 80 percent of Birch Company's voting stock for $460,000. Birch reported a $470,000 book value and the fair value of the noncontrolling interest was $115,000 on that date. Then, on January 1, 2017, Birch acquired 80 percent of Cedar Company for $164,000 when Cedar had a $124,000 book value and the 20 percent noncontrolling interest was valued at $41,000. In each acquisition, the subsidiary's excess acquisition-date fair over book value was assigned to a trade name with a 30-year remaining life.

These companies report the following financial information. Investment income figures are not included.   

Assume that each of the following questions is independent:

1. If all companies use the equity method for internal reporting purposes, what is the December 31, 2017, balance in Aspen's Investment in Birch Company account?

2. What is the consolidated net income for this business combination for 2018?

3. What is the net income attributable to the noncontrolling interest in 2018?

4. Assume that Birch made intra-entity inventory transfers to Aspen that have resulted in the following intra-entity gross profits in inventory at the end of each year:

What is the accrual-based net income of Birch in 2017 and 2018, respectively?

On January 1, 2016, Aspen Company acquired 80 percent of Birch Company’s voting stock for $288,000. Birch reported a $300,000 book value, and the fair value of the noncontrolling interest was $72,000 on that date. Then, on January 1, 2017, Birch acquired 80 percent of Cedar Company for $104,000 when Cedar had a $100,000 book value and the 20 percent noncontrolling interest was valued at $26,000. In each acquisition, the subsidiary’s excess acquisition-date fair over book value was assigned to a trade name with a 30-year remaining life.

These companies report the following financial information. Investment income figures are not included.

Assume that each of the following questions is independent:

If all companies use the equity method for internal reporting purposes, what is the December 31, 2017, balance in Aspen’s Investment in Birch Company account?

What is the consolidated net income for this business combination for 2018?

What is the net income attributable to the noncontrolling interest in 2018?

Assume that Birch made intra-entity inventory transfers to Aspen that have resulted in the following intra-entity gross profits in inventory at the end of each year:

What is the accrual-based net income of Birch in 2017 and 2018, respectively?

Options in corporate finance

A. The CEO of a growing cyber-security firm was awarded 25,000 stock options as part of her pay package.  She can exercise the options -turn them into stock- in two years.  The company’s stock price was $35.00 per share at the time of the stock option grant.  Shortly after the option award was received, she went to an investment banking firm and bought put options at a strike price of $35.00.  The option expires in two years.

(i) What does the put option do for the CEO?  Carefully explain why your stated result occurs.

(ii) Stock options and stock ownership are included in compensation packages to create incentives for CEOs to create value for shareholders.  Does this put option purchase change those incentives? If so, how?  

(iii) If you were a shareholder in this company, would you want to be informed about these types of transactions by the CEO?

____________________________________________________________

B.  Company B is a small, publicly-traded technology company.  Company B is close to completing development of a new software/hardware product for schools that uses voice recognition to quickly translate a lecture into written notes that are projected onto a screen and automatically sent to students as PDF documents.  The lecturer can then annotate the notes with a drawing pad linked to the computer projection system.  These annotations are included in the PDF that is distributed after the lecture is complete.  

      The company needs about $30 million to complete development and begin production and marketing of this product.  The company is profitable with one other product that generates about $1,200,000 in cash flow annually.  For many reasons the company has been very secretive about its new product so its stock price is quite low, being based on the modest cash flows of its existing product.  Company officials and outside consultants agree that it is too early to reveal the new product’s details given what they know of competing products.

      The company has hired an investment banker to help it determine how to raise the $30 million.  The banker immediately recommends convertible bonds.  Current interest rates on bonds or notes for companies of this type are in the range of 8% to 10%, but convertible debt would probably have a coupon rate of 3% to 5% depending on the conversion price.  The higher the conversion price the higher the coupon rate.  

The banker says that convertible bonds are a win-win for the company in this situation.  The company can keep their product secret but issue stock at a higher price (the conversion price) than the current stock price.  In the meantime, the interest rate on the debt will be about 4% or 5%, which the company should be able to support from its cash flow.  The banker explains that if for some reason the product is not a success, and there is no conversion to stock, the company has issued debt at a very low rate. Probably 5% below the rate on non-convertible debt.  Win-win!

The company’s tax rate is about 28%.

1. Can the company afford the interest on $30 million of convertible debt?
2. Is the banker correct about this being a win-win situation for the company?  Is there a different perspective that company managers need to understand before making this decision?  Explain.
3. If convertible debt has a lower coupon rate because the conversion option has value.  Why don’t all companies issue convertible debt and save on interest costs?

Question 1

The capabilities of computer systems have advanced rapidly over the past several decades. In many organizations, the entire data has been computerised and all the information is available only in digital media. In this changed scenario, auditors have to adapt their methodology to changed circumstances. The approach of auditors to evaluate internal controls has changed accordingly. The continual development is changing the way organization works. Many companies have introduced Information Technology (IT) audit function because it is considered to be a valuable element of management control which provides assurance to the business audit committee and management and adds to the organization’s credibility with investors and creditors. Management is responsible for establishing and maintaining a system of internal financial controls and in some cases, may be required by regulators to provide written certification of the adequacy of the controls. Legal and regulatory requirements are changing fast and companies must make sure they are aware of the latest rules. Presence of controls in a computerized system is significant from the audit point of view
The Business and Financial Educational Services provider Company Limited is an organizations that do not have an IT audit function. The company is considering to establish one. They are work shopping their company size and type of business, source of capital and risk factors that warrant such an investment. They agree that the potential benefits of the IT audit function should be assessed and compared against the estimated costs. IT audit function should ensure the establishment and compliance to IT Controls in the organizations computer system. They are undecided on the decision to establish an IT audit function. They think the decision should involve the CEO, CFO, and audit committee. The following is a list of criteria they are considering:
1. The audit committee wants to get independent and objective assurance on the adequacy of internal controls from someone other than the CEO or CFO.
2. The CEO wants to get independent and objective assurance on the adequacy of internal controls from someone other than the CFO or line managers.
3. The CFO wants to get independent and objective assurance on the adequacy of internal controls from someone other than the line managers.
4. The organization gets too large or geographically dispersed for frequent and economical first-hand monitoring of controls by the audit committee, CEO or CFO.

Required:
a. You are an IT Audit consultant who is familiar with the works of the company and is well connected to the company. In a meeting with the CEO, CFO, and audit committee the CEO has asked that you name and explain the broad categories of IT Audit controls (if any) that must be put in place in their work environment.
b. Carefully consider the scenarios in the submissions provided and write out your report to be submitted to the Audit committee. From your submissions the Audit committee decided to fully contract you to support the management of the company to develop and put in place some General IT control tools. You decided to constitute and hold a sub-project committee
meeting to discuss the details on the following.
i. IT policies and standards.
ii. Physical controls (access and environment).
iii. Logical access controls.
iv. Business continuity
v. Disaster recovery controls.

QUESTION 2
In accounting, the financial transactions are recorded, processed and presented to generate financial statements that is useful to the readers, in making decisions. It is often said that both
manual and computerized accounting systems are based on the same principles, conventions and concept of accounting and auditing. However, they differ in their mechanism (devices, instruments and tools used). The manual auditor uses pen and paper, to record and document transactions. Whereas computerized auditing makes use of computers and internet, to document transactions electronically. Auditors should adequately document the audit evidence in working papers, including the basis and extent of the planning, work performed and the findings of the audit.
Documentation includes a record of:
1. The planning and preparation of the audit scope and objectives
2. The audit programme
3. The evidence collected on the basis of which conclusions are arrived at.
4. All work papers including general file pertaining to the organization and system
5. Points discussed in interviews clearly stating the topic of discussion, person interviewed,
position and designation, time and place.
6. Observations as the auditor watched the performance of work. The observations
may include the place and time, the reason for observation and the people involved.
7. Reports and data obtained from the system directly by the auditor or provided by the
audited staff. The auditor should ensure that these reports carry the source of the report,
the date and time and the conditions covered.
8. At various points in the documentation the auditor may add his comments and clarifications
on the concerns, doubts and need for additional information. The auditor should come
back to these comments later and add remarks and references on how and where these
were resolved.

Required;

It is the practice that the report should be timely, complete, accurate, objective, convincing, and as clear and concise as the subject permits. Briefly explain what the following headings entails with relevant examples how an IT Audit report can be broadly structured under the following headings:
i. IT Audit Report.
ii. Introduction.
iii. Objectives.
iv. Scope and Methodology.
v. Audit Results.
vi. Findings.
vii. Conclusions.
viii. Recommendations.
ix. Noteworthy Management Accomplishments.
x. Limitations that were faced.

QUESTION 3
You are a manager in the audit department of Huntsman & Co, a firm of Chartered Certified Accountants, responsible for the audit of several companies and for evaluating the acceptance
decisions in respect of potential new audit clients. One of your audit clients is Redback Sports Co, which operates a chain of sport and leisure centres across the country. The client invited you into a meeting with the CEO and CFO. According to the CEO of the company “the incessant development of information technology is changing the way their organization works in many ways. The pen and paper of manual transactions have made way for the online data entry of computerized applications; the locks and keys of filing cabinets have been replaced by passwords and identification codes that restrict access to electronic files. The implementation of innovative technology is helping their organizations to improve the efficiency of their business processes and considerably increase their data processing and transmission capacity, but has also introduced new vulnerabilities that need to be controlled”. The CFO was concerned about the new vulnerabilities. He is asking how these vulnerabilities could be controlled You quickly responded by saying that assessing the adequacy of each control requires new methods of auditing. With the increase in the investment and dependence on computerized systems by the company, it has become imperative for audit to change the methodology and approach to audit because of the risks to data integrity, abuse, privacy issues etc. An independent audit is required to provide assurance that adequate measures have been designed and are operated to minimize the exposure to various risks.

Required:

i. The CEO is asking if there is any difference between your regular Audit periodically conducted and an IT Audit. You are required to identify, name and explain the core
differences between your Internal Audits periodically conducted and an IT Audit.

ii. Explain 5 objectives of an IT Audit to Redback Sports Co.
iii. Explain 5 benefits that Redback Sports Co. may derive from an effective IT Audit.
iv. The CFO of Redback Sports Co. is asking that you explain the processes to follow to undertake an effective IT Audit for the company and how long you think it will take them to be ready for your audit. Name and explain the Phases of the Audit Process.

Savings-Mart (a chain of discount department stores) sells patio and lawn furniture. Sales are seasonal, with higher sales during the spring and summer quarters and lower sales during the fall and winter quarters. The company developed the following quarterly sales forecasting model:

Yˆt=7.50+1.100t−2.75D1t+0.25D2t+3.5D3t

where

Forecast Savings-Mart's sales of patio and lawn furniture for each quarter of 2020.

On January 1, 2020, Mays Leasing Company leases equipment to Brick Co. The lease term is five years, with 5 equal annual payments of $160,000 each, beginning on 1/1/2020. The equipment has an estimated economic life of 8 years and the fair value on 1/1/2020 is $800,000. Brick agrees to guarantee $150,000 residual value at the end of the lease term. The expected value of the residual value is $50,000. At the termination of the lease, the equipment reverts to the lessor. Brick’s incremental borrowing rate is 10% and Brick knows that Mays’ implicit interest rate is 8%.

Present value factors:                        Ordinary Annuity         Annuity Due        A Single Sum

5 periods 8%                                3.99271                     4.31213                 0.68058

5 periods 10%                              3.79079                     4.16986                 0.62092

1. Use lease classification tests to determine the type of lease that Brick Co. has entered into.
2. Construct the lease amortization schedule for the first two payments made by Brick Co.
3. Prepare Brick’s journal entries that relate to the lease agreement for the following three dates: January 1, 2020, December 31, 2020, and January 1, 2021.

On January 1, 2020, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of $120,987 at the beginning of each year, starting January 1, 2020. The leased equipment is to be capitalized at $550,000. The asset is to be amortized on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 6%, and the implicit rate in the lease is 5%, which is known by Cage. Title to the equipment transfers to Cage at the end of the lease. The asset has an estimated useful life of 5 years and no residual value.

a/ Prepare the journal entries that Cage should record on January 1, 2020.

b/ Prepare the journal entries to record amortization of the leased asset and interest expense for the year 2020.

c/ Prepare the journal entry to record the lease payment of January 1, 2021, assuming reversing entries are not made

d/ What amounts will appear on the lessee’s December 31, 2020, balance sheet relative to the lease contract?

e/ How would the value of the lease liability in part b change if Cage also agreed to pay the fixed annual insurance on the equipment of $2,000 at the same time as the rental payments?

Question 1 (EPS)

The following summarised information is available in relation to ‘La Scan’, a publicly listed company in Australia:

Statement of comprehensive income extracts for years ended 30th June:

* Acquired on the 1st November 2017

Analyst expect profits from the market sector in which La Scan’s existing operations are based to increase by 6% in the year to 30th June 2019 and by 8% in the sector of its newly acquired operations.

On 1st July 2016 La Scan had:

$12 million of $1 ordinary shares in issue.

$5 million 8% convertible debentures 2023; the terms of conversion are 40 equity shares in exchange for each $100 of debenture.

On 1 January 2018 the directors of La Scan were granted options to buy 2 million shares in the company for $1 each. The average market price of La Scan’s shares for the year ending 30th June 2018 was $2.50 each.

Assume an income tax rate of 30% for year 2016,2017 and 2018

Required:

(i) Calculate La Scan’s estimated profit after tax for the year ending 30 June 2019 assuming the analysts’ expectations prove correct;

(ii) Calculate the diluted earnings per share (EPS) on the continuing operations of La Scan for the year ended 30 June 2018 and the comparatives for 2017.