BRIEF EXERCISE 1-1 - Solutions Manual Copyright © 2013 John Wiley ...

Solutions Manual to accompany Advanced Accounting by Fayerman Chapter 1 Solutions Manual Copyright © 2013 John Wiley & Sons Canada, Ltd. 1

CHAPTER 1

Accounting for Investments

BRIEF EXERCISES

BRIEF EXERCISE 1-1

What is a financial asset?

According to IAS 32.11, a financial asset is defined as any of the following:

• Cash • An equity instrument of another company • A contractual right to receive cash or another financial asset from another company • A contractual right to exchange financial instruments with another company under conditions that are potentially favourable.

BRIEF EXERCISE 1-2

What are the three main criteria to determine control?

According to IFRS 10.6, the three main criteria that must be present in

order for there to be control are that the parent company must have:

• The ability to direct the financial and operating policies of another company (the power criterion), • The ability to obtain returns from the other company (the returns criterion), and • The ability to use its power to affect those returns (the link criterion).

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Solutions Manual to accompany Advanced Accounting by Fayerman Chapter 1 Solutions Manual Copyright © 2013 John Wiley & Sons Canada, Ltd. 2

BRIEF EXERCISE 1-3

What is an associate company?

Paragraph 2 of IAS 28 defines an associate as:

An entity, including an unincorporated entity such as a partnership, over which the investor has significant influence, and that is neither a subsidiary nor an interest in a joint venture.

The key characteristic in determining whether an investment is an associate is significant influence.

BRIEF EXERCISE 1-4

Why are associates distinguished from other investments held by the investor?

The suite of accounting standards provides different levels of disclosure dependent on the relationship between the investor and the investee.

Subsidiaries: a control relationship

Joint arrangements: a joint control relationship

Associates: a significant influence relationship

Other investments: no relationship

When there is a relationship, it relates to the ability of the investor to influence the direction of the investee, in comparison to a simple holding of shares as an investment. Where such a relationship exists, it is argued that the investor is affected, from an accountability perspective as well as a potential receipt of benefits perspective [why get involved if there are no benefits to doing so?]. These effects result in the need for additional disclosure about the relationship.

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Solutions Manual to accompany Advanced Accounting by Fayerman Chapter 1 Solutions Manual Copyright © 2013 John Wiley & Sons Canada, Ltd. 3

BRIEF EXERCISE 1-5

Discuss the similarities and differences between the criteria used to identify subsidiaries and those used to identify associates.

A subsidiary is identified where another entity controls that entity. Control is defined in IFRS 10.6.

Control: Note that three criteria must be present in order for there to be

control. The parent must have:

• The ability to direct the financial and operating policies of another entity (the power criterion), • The ability to obtain returns from the other company (the returns criterion), and • The ability to use its power to affect those returns (the link criterion).

An associate is identified where another entity has significant influence over that entity. Significant influence is defined in IAS 28.2.

Significant Influence has the following features in its definition:

• The power to, or capacity, to affect the investee • To participate in the financial and operating policy decisions of the investee • There is no requirement for the investor to hold and ownership interest in the investee

BRIEF EXERCISE 1-6

What is meant by “significant influence”?

Paragraph 2 of IAS 28 defines significant influence as:

The power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies.

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BRIEF EXERCISE 1-7

What factors could be used to indicate the existence of significant influence?

IAS 28 presents several factors which could be used to indicate the

existence of significant influence:

• Where an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that the investor has significant influence over the investee.• If the investor can demonstrate that such influence does not exist, the investee is not classified as an associate.• Where the investor owns less than 20% of another company, there is a presumption that the investee is not an associate.• A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence.

Some additional factors that can provide evidence of the existence of

significant influence are:

• Representation on the board of directors or the equivalent governing body of the investee.• Participation in the policy-making processes of the investee, including participation in decisions about dividends or other distributions.• Material transactions between the investor and the investee.• Interchange of managerial personnel.• Provision of essential technical information .

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