Accounting for Investments – Avocado Group Ltd.

Investment in Akwadu Productions:
After the second acquisition on October 1, 2015, Avocado Ltd holds a total of 57% of the issued share capital of Akwadu Productions and so has control over Akwadu Productions from that date. The holding will be treated as an available for sale financial asset up to September 30, 2015. And as a subsidiary from October 1, 2015 under the provisions of IFRS 3 Business Combinations. From October 1, 2015, Avocado Ltd should be consolidated, pro-rating for three months control in the consolidated statement of comprehensive income for the year ended 31st December 2015.
In a step acquisition where control is acquired, IFRS 3 requires that the original investment is treated as being realized at its fair value. This fair value is added to the consideration paid for the controlling interest in the subsidiary and the proportionate non-controlling interest to calculate the goodwill arising on consolidation.

Investment in Akpakpa Ventures Ltd.:
Avocado Ltd has acquired 90% of the issued ordinary share capital of Akpakpa Ventures Ltd. Therefore it is assumed to have control of Akpakpa Ltd and should consolidate it as a subsidiary under the provisions of IFRS 10 Consolidated Financial Statements. As the subsidiary was acquired mid-year, the income, expenses and other comprehensive income should be pro-rated in the consolidated statement of profit or loss and other comprehensive income for ten months that avocado Ltd had control.

Investment in Waatre Impex Ltd.:
Although Akpakpa Ventures Ltd holds 65% of the issued ordinary share capital of Waatree Impex Ltd, the investment is held exclusively with a view to sale within the next four months. Therefore the holding will be included in the group’s financial statements under the provisions of IFRS 5 Non-current assets held for sale and discontinued operations.
Avocado Ltd holds 90% of Akpakpa’s 65% interest in Waatree Impex Ltd. As Avocado’s intends to sell the investment in the next four months and is actively marketing it, the assumption must be that it meets the IFRS 5 criteria to be treated as held for sale. The assets and liabilities of Waatre Impex Ltd will be treated as held for sale. The assets and liabilities of Waatre Impex Ltd will be treated as a disposal to the group and measured at the lower of carrying amount and fair value less costs to sell. Waatre Impex Ltd will not be consolidated line by line, but rather as two single amounts, assets held for sale and liabilities held for sale. In the consolidated statement of comprehensive income, the minimum required is to show as a single line entitled to discontinued operations the profit of Waatre Impex Ltd and any gain or loss on re-measuring the investments to fair value less costs to sell.
Investment in Akutu Brothers Ltd.:
Avocado Ltd holds 40% of the issued ordinary share capital of Akutu Brothers Ltd. Therefore it is assumed to be able to exercise significant influence over Akutu Brothers Ltd which should be treated as an associate under the provisions of IAS 28 Investments in Associates and Joint Ventures. Akutu Brothers Ltd will be included in the group’s financial statements using equity accounting. In the consolidated statement of financial position, the investment should be measured at cost on initial recognition and then in each subsequent period the group share of Akutu Brothers Ltd.’s post-acquisition retained reserves should be added less any goodwill impairment. In the consolidated statement of comprehensive income, the group share (40%) of Akutu Brothers Ltd.’s profit and other comprehensive income should be included.

There are several reasons why an accountant should study ethics. The moral beliefs that an individual holds may not be sufficient because often these are simple beliefs about complex issues. The study of ethics can sort out these complex issues by teaching the principles that are operating in these cases. Often there may be ethical principles which conflict and it may be difficult to decide on a course of action. The study of ethics can help by developing ethical reasoning in accountants by providing insight into how to deal with conflicting principles and why a certain course of action is desirable.

Another important reason to study ethics is to understand the nature of one’s own opinion and ethical values. Ethical principles should be compatible with other values in life. For example, one’s reaction to the following circumstances: the choice between keeping your job and violating professional and ethical responsibilities, the resolution of conflicts of interest if they involve family.

A good reason for studying ethics is also to identify the basic ethical principles that should be applied. Professional accountants are required to adhere to a set of fundamental principles in the course of their professional duty, such as confidentiality, objectivity, professional behaviour, integrity and professional competence and due care. The main aim of professional ethics is to serve as a moral guideline for professional accountants. By referring back to the set of ethical guidelines, the accountant is able to decide on the most appropriate course of action, which will be in line with the professional body’s stance on ethics.

Although the takeover does not benefit the company, its executives or society as a whole, the action is deceptive, unethical and hence unfair. It violates the relationship of trust, which the company has with society and the professional code of ethics. There are nothing but good reasons against the false disclosure of profits.

The directors should be persuaded that professional ethics are an inherent part of the accounting profession. Professional ethics are a set of moral standards applicable to all professionals. Each professional body has its own ethical code which requires its members to adhere to a set of fundamental principles in the course of their professional duty, such as confidentiality, objectivity, professional behaviour, integrity and professional competence and due care.

Often there may be ethical principles which conflict with the profit motive and it may be difficult to decide on a course of action. An accountant has an ethical obligation to encourage the directors to operate within certain boundaries when determining the profit figure. Users are becoming reactive to unethical behaviour by directors. This is leading to greater investment in ethical companies with the result that unethical practices can have a greater impact on the value of an entity than the reporting of a smaller profit figure. Ethical issues are becoming more and more complex and it critical to have an underlying structure of ethical reasoning, and not purely be driven by the profit motive.

i. The content of any accompanying commentary on the accounts and other statements.
ii. The age and nature of the company’s assets.
iii. Current and future developments of the company’s business interests.
iv. Any other noticeable features of the report and accounts, such as post balance sheet events, contingent liabilities, a qualified auditor’s report, the company’s taxation position, etc.

1. Inconsistent definitions of ratios
2. Financial statements may have been deliberately manipulated (creative accounting)
3. Different companies may adopt different accounting policies (e.g. use of historical costs compared to current values)
4. Different managerial policies (e.g. different companies offer customers different payment terms)
5. Statement of financial position figures may not be representative of average values throughout the year (this can be caused by seasonal trading or a large acquisition of non-current assets near the year-end)
6. The impact of price changes over time/distortion caused by inflation.

• Profitability:
  Both gross profit margin and net profit margin have fallen below the industry average. This may be the result of uncontrolled overhead cost on the presence of large obsolete equipment. Unless steps are taken quickly to improve the income account investors may shift their interest into more profitable companies in the industry.
• Liquidity:
  Both quick and current ratios fall far below those of the industry as confirmed by the fact that it takes longer to collect its debt than the industry. The problem may have been worsened by the fact that inventory stay longer at Agrimore Ltd than in the industry which is not the best use to which resources should be put.
• Efficiency:
  Even though Agrimore Ltd takes longer to collect its debts (5 days), this is compensated by an even longer time to settle the debts (20 days). This means that creditors provide free finance for its operations. However, the holding on to inventory for a long time (10 days) cannot be justified. This should be turned over in like manner as that assets turnover far exceeds that of the market.
• Shareholders’ Investment:
  Both dividend cover and dividend yield fall below that of the industry. Such a situation is not likely to excite investors especially income – oriented investors who are seeking to recoup their investment in the shortest time possible. This poor performance may be due to the fact that high gearing ratio of Agrimore Ltd has effectively put its future in the hands of debenture holders who are reaping the bulk profits in the form of interest charges.

Current Cost Accounting (CCA) also called replacement cost accounting method is a method of accounting in which assets and liabilities are valued on the basis of their current replacement cost, and increases in their value as a result of inflation are excluded from calculation of profits. CCA approach recognizes the changes in the prices of individual specific assets and liabilities due to the changes in technology, taste or other factors. CCA method revalues the assets and liabilities on current cost or replacement cost basis. It does not consider the RPI.

Profit measurement by historical cost:

Profit measured by replacement cost:

Note: The application of replacement cost values attempts to reflect economic reality by maintaining the value of asset balances in line with changes in the value of money and changes in the specific value of the assets concerned.

Monetary items are those items whose amounts are fixed by contract or otherwise in terms of numbers of currency units (e.g. cedis), regardless of changes in general price levels whiles non-monetary items are those items whose amounts changes with respect to changes in general price level. Examples of monetary items are cash, receivables, payables and loan capital. Examples of non-monetary items are PPE and inventories.

Arguments for:
• Profit is measured in real terms excluding inflationary value increments. This enables better forecasts of future prospects to be made.
• It provides a stable monetary unit with which profit and capital can be valued. It therefore measures the impact on the company in terms of shareholders purchasing power.
• By applying a single price index to all non-monetary assets, subjective valuation of current value accounting is avoided.
• The restatement of asset values in terms of a stable money value provides a more meaningful basis of comparison with other companies.
• CPP accounting is based on historical cost data which is readily verifiable and hence free from subjectivity.

Arguments against:
• The use of indices inevitably involves approximations in the measurement of value.
• CPP does not show the current values of assets and liabilities. Retail price index is not necessarily appropriate for all assets in the business. In addition, the physical capital of the business is not maintained.
• An objection of CPP accounting is raised by some authorities who believe that there is no such thing as generalised purchasing power.
• CPP deals with changes in the general price level and not with changes in prices of individual items.

Social and environmental reporting is the measurement and reporting of information concerning the impact of a business and its activities on society. It is the disclosure of information in the published annual report or in separate report, of the effect that the operations of the business have on the natural environment. In other words, it is the collation and communication of data – financial, quantitative and/or qualitative – about an organisation’s interactions with society.

The backbone of social reporting is the explicit recognition that every organisation has a wide range of stakeholders – those who are influenced by and/or, in turn, influence the organisation. In addition to shareholders and other financial participants, the most important of the other stakeholders are usually taken to be the employees, the local community (ies), customers, suppliers, the environment and government(s).

From society’s point of view, each of these stakeholders have rights to, amongst other things, information about the activities of the organisation – whether or not the organisation chooses to recognise those rights. From the organisation’s point of view, it has a range of stakeholders that it must manage and whose interests it must balance if it is to remain a successful enterprise.

Costs to Preparers:
i) the cost of developing and disseminating information,
ii) the cost of possible litigation attributable to information disclosure,
iii) the cost of competitive disadvantage attributable to disclosure.

i) The costs of developing and disseminating the information include those of gathering, creating and auditing the information. Additional costs to the preparers include training costs, changes to systems (for example on moving to IFRS), and the more complex and the greater the information provided, the more it will cost the company.

ii) Although litigation costs are known to arise from information disclosure, it does not follow that all information disclosure leads to litigation costs. Cases can arise from insufficient disclosure and misleading disclosure. Only the latter is normally prompted by the presentation of information disclosure. Fuller disclosure could lead to lower costs of litigation as the stock market would have more realistic expectations of the company’s prospects and the discrepancy between the valuation implicit in the market price and the valuation based on a company’s financial statements would be lower. However, litigation costs do not necessarily increase with the extent of the disclosure. Increased disclosure could reduce litigation costs.

iii) Disclosure could weaken a company’s ability to generate future cash flows by aiding its competitors. The effect of disclosure on competitiveness involves benefits as well as costs. Competitive disadvantage could be created if disclosure is made relating to strategies, plans, (for example, planned product development, new market targeting) or information about operations (for example, production-cost figures). There is a significant difference between the purpose of disclosure to users and competitors. The purpose of disclosure to users is to help them to estimate the amount, timing, and certainty of future cash flows. Competitors are not trying to predict a company’s future cash flows, and information of use in that context is not necessarily of use in obtaining competitive advantage. Overlap between information designed to meet users’ needs and information designed to further the purposes of a competitor is often coincidental. Every company that could suffer competitive disadvantage from disclosure could gain competitive advantage from comparable disclosure by competitors. Published figures are often aggregated with little use to competitors.

Companies bargain with suppliers and with customers, and information disclosure could give those parties an advantage in negotiations. In such cases, the advantage would be a cost for the disclosing entity. However, the cost would be offset whenever information disclosure was presented by both parties, each would receive an advantage and a disadvantage.

Benefits to users:

Increased information disclosure benefits users by reducing the likelihood that they will misallocate their capital. This is obviously a direct benefit to individual users of corporate reports. The disclosure reduces the risk of misallocation of capital by enabling users to improve their assessments of a company’s prospects. This creates three important results.

(i) Users use information disclosed to increase their investment returns and by definition support the most profitable companies which are likely to be those that contribute most to economic growth. Thus, an important benefit of information disclosure is that it improves the effectiveness of the investment process.

(ii) The second result lies in the effect on the liquidity of the capital markets. A more liquid market assists the effective allocation of capital by allowing users to reallocate their capital quickly. The degree of information asymmetry between the buyer and seller and the degree of uncertainty of the buyer and the seller will affect the liquidity of the market as lower asymmetry and less uncertainty will increase the number of transactions and make the market more liquid.

(iii) Information disclosure helps users understand the risk of a prospective investment. Without any information, the user has no way of assessing a company’s prospects. Information disclosure helps investors predict a company’s prospects. Getting a better understanding of the true risk could lower the price of capital for the company. It is difficult to prove however that the average cost of capital is lowered by information disclosure, even though it is logically and practically impossible to assess a company’s risk without relevant information. Lower capital costs promote investment, which can stimulate productivity and economic growth.

According to the International Integrated Reporting Committee (IIRC) integrated reporting is a process that results in communicating the value creation of an entity over time through an Integrated Report.

The IIRC defines an Integrated Report as ‘a concise communication about how an organization’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term’
Integrated reporting provides information not only on the financials of an entity, but also information on strategy, governance, performance and prospects.

The following issues are often the subject matter for integrated reports:

• Overview of the organisation
• The strategic direction of the entity
• Analysis of stakeholder relationships
• Overview of the external environment
• Overview of governance structures
• An explanation of the entity’s business model
• Strengths, Weaknesses , Opportunities and Threats (SWOT) analysis
• Basis of resource allocation
• Analysis of financial performance and financial position
• Sustainability projection.
  

The primary benefit of integrated reporting is that it allows a company to better understand, manage and report on multiple dimensions of value.

A properly designed set of performance measures often included in integrated reports will give management the incentive and urge to improve performance.

For other stakeholders, the report is intended to provide more and better information to increase stakeholder understanding of the company- its management, strategy and operations, and its perils and prospects.

It has been suggested that the integrated report will become an organisation’s primary report, which links in with various supporting, more detailed, reports.

Note: The finance cost in the income statement for 2012, for instance, is computed as GHC4, 402,000 x 24% = GHC1, 056,480. Meanwhile, the interest to be paid is GHC5, 000,000 x 18% = GHC900, 000. This requires an accrual of GHC156, 480 (that is, GHC1, 056,480 – 900,000). This accrual should be added to the carrying value of the debt to arrive at the amortised cost at the end of year 2012.

Dr Financial liability    5,000,000
Cr Equity                                            5,000,000

Dr Financial liability    5,000,000
Cr Cash                                             5,000,000

An intangible asset is an identifiable non-monetary asset without physical substance. Intangible assets comprise expenditure on computer software, research and development, advertising, brands, etc. It also includes rights under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights.

Recognition criteria for intangible asset:

1) The asset needs to be ‘identifiable’
An asset is identifiable either if it is separable (can be sold without disposing of the business as a whole) or if it arises from contractual or other legal rights, irrespective of separability.

2) Control over the economic benefits derivable from the asset
Control involves the power to obtain the future economic benefits flowing from the asset and to restrict the access of others to those benefits. The capacity of an entity to control the future economic benefits would normally, but not necessarily, stem from legal rights that are enforceable in a court of law.

3) Future economic benefits flowing to the entity
These benefits may include revenue from the sale of products or services, but could also include cost savings or other benefits arising from the use of the asset by the entity.

4) Cost can be measured reliably
‘Cost’ will often be the cost of purchasing or developing the asset. In the case of an asset acquired in a business combination, ‘cost’ will be the fair value of the asset at the date of acquisition, assuming this fair value can be reliably measured.