Reference no: EM133157624
Question - Flinders Ltd is a medium-sized Australian retailing company that was registered as a proprietary company until 31 December 2021 when it changed to a public company and listed its shares on the Australian Securities Exchange (ASX). It is March 2022 and the senior management of Flinders Ltd are currently evaluating an investment in Smeg Ltd. Any investment in Smeg Ltd would occur on 1 July 2022.
A financial analyst was employed to analyse Smeg Ltd. The financial analyst has made the following projections:
On 1 July 2022, Smeg Ltd is projected to have assets of $3 million and liabilities of $1 million. The financial analyst believes that many of Smeg Ltd's assets are carried at amounts well below their fair values whilst all liabilities are carried at fair value.
Smeg Ltd has no unrecorded liabilities and only one unrecorded asset. This asset is a brand name that currently has an estimated fair value of $150,000. Flinders Ltd would like very much to obtain this brand name. However, previous offers to purchase it were unsuccessful.
Total comprehensive income for the year ending 30 June 2023 is projected to be $500,000. Of this amount, $300,000 would be net profit whilst $200,000 would be other comprehensive income.
During the year ending 30 June 2023, Smeg Ltd is projected to purchase approximately $150,000 of inventory from Flinders Ltd and sell $50,000 of non-current assets to Flinders Ltd. In addition, Smeg Ltd is expected to pay a dividend of 5 cents per share.
During the year ending 30 June 2022, Flinders Ltd made a $30,000 loan to Smeg Ltd. The loan term is five years, and the interest rate is 5%.
The investment options are as follows:
Option 1: purchase 30% of the issued shares of Smeg Ltd on 1 July 2022. This would require the purchase of 90,000 shares at a projected price of $15 each.
Option 2: purchase 80% of the issued shares of Smeg Ltd on 1 July 2022. This would require the purchase of 240,000 shares at a projected price of $15 each.
Required - The management of Flinders Ltd has asked you, as one of the company's accountants, to draft a memorandum to be distributed to the company's shareholders that explains the accounting requirements for each of these two investment options. As part of your answer, you should explain clearly:
The accounting requirements for each of the options,
How the profit of Smeg Ltd would be recognised by Flinders Ltd in the financial statements, and
Whether the investment would give Flinders Ltd control over the brand name owned by Smeg Ltd.