1On 1st April 2019 Pandar purchased 80% of the equity shares in Salva. The acquisition was through a share exchange of three shares in Pandar for every five shares in Salva. The market prices of Pandar’s and Salva’s shares at 1st April 2019 were £6 and £3.20 respectively.
The summarised income statements for the two companies for the year ended 30th September 2019 are:
Pandar Salva
£’000 £’000
Revenue 210,000 150,000
Cost of sales (126,000) (100,000)
Gross profit 84,000 50,000
Distribution costs (11,200) (7,000)
Administrative expenses (18,300) (9,000)
Investment income (interest & dividends) 9,500
Finance costs (1,800) (3,000)
Profit before tax 62,200 31,000
Income tax (15,000) (10,000)
Profit for the year 47,200 21,000
The following information for the equity of the companies at 30th September 2019 is available:
£’000 £’000
Equity shares of £1 each 200,000 120,000
Share premium 300,000 Nil
Retained earnings 1st October 2018 40,000 152,000
Profit for the year ended 30th September 2019 47,200 21,000
Dividends paid (26th September 2019) Nil 8,000
The following information is relevant:
The fair values of the net assets of Salva at the date of acquisition were equal to their carrying amounts with the exception of an item of plant which had a carrying amount of £12 million and a fair value of £17 million. This plant had a remaining life of five years (straight line depreciation) at the date of acquisition of Salva. All depreciation is charged to cost of sales.
In addition, Salva owns the registration of a popular internet domain name. The registration, which had a negligible cost, has a five-year remaining life (at the date of acquisition). However, it is renewable indefinitely at a nominal cost. At the date of acquisition, the domain name was valued by a specialist company at £20 million.
The fair values of the plant and domain name have not been reflected in Salva’s financial statements.
Immediately after its acquisition of Salva, Pandar invested £50 million in an 8% loan note from Salva. All interest accruing to 30th September had been accounted for by both companies. Salva also has other loans in issue at 30th September 2019.
Pandar has credited the whole of the dividend it received from Salva to investment income.
After the acquisition, Pandar sold goods to Salva for £15 million on which Pandar made a gross profit margin of 20%. Salva had one third of these goods still in its inventory at 30th September 2019.
The non-controlling interest in Salva is to be valued at its (full) fair value at the date of acquisition. For this purpose, Salva’s share price at that date can be taken to be indicative of the fair value of the shareholding of the non-controlling interest.
The goodwill of Salva has not suffered any impairment.
All items in the above income statements are deemed to accrue evenly over the year unless otherwise indicated.
Required
Calculate the goodwill arising on the acquisition of Salva at 1st April 2019.
Calculate the cost of sales and the breakdown of profit for the year between parent company equity holder and non-controlling interest, as per the consolidated income statement for Pandar Group ended 30th September 2019. Please justify your calculations.
QUESTION 2
Pandar has been approached by a potential new customer, Trilby, to supply them with a substantial quantity of goods on three months credit terms. Pandar is concerned at the risk that such a large order represents in the current difficult economic climate, especially as Pandar’s normal credit terms are only one month’s credit. To support its application for credit, Trilby has sent Pandar a copy of Jolly’s most recent audited consolidated financial statements. Trilby is a wholly-owned subsidiary within the Jolly group. Jolly’s consolidated financial statements show a strong statement of financial position including healthy liquidity ratios.
Required
Comment on the validity of Pandar evaluating Jolly’s consolidated financial statements when deciding on whether to accept the order and grant credit terms to Trilby.