Accounting Requirements for Proposed Investment

Solution 1:
MEMORANDUM
Date: 14 September 2019
To: Angela Kirk, Chief Financial Officer
From: Chief accountant
Subject: Accounting requirements for proposed investment
Introduction:
This memorandum has been prepared to describe the accounting requirement
for proposed investment in Hobson Limited.
Investment opportunities:
As described, we are proposing to invest in Hobson Limited from the ranging
between 5% and 70%. The Hobson Limited is very profitable organization and there
are different accounting treatments and requirements as per quantum of investment.
As per the investment percentage, the accounting requirements and treatment is
done by the investing company and accounting requirements are different in each
case. The scenarios will be as below in case of investments in Wakefield Ltd.:
i. If the company invest below 20% of total shares of Wakefield Limited, then
it will be simply an investment in shares of the company as investment.
ii. If the investment percentage is between 20%-50% of total share of
Wakefield Limited, then the investment will be treated as investment in
associate company.
iii. If the investment percentage is above 50% then it will be treated as
investment in subsidiary company and accounting requirements will be
different.

Accounting requirements for investment below 20%
Under this scenario, if the investment in shares of Wakefield is made below 20%
then it is a simple investment in shares, and it will be treated as non-current
investment. The investment is recorded at fair value in balance sheet under non-
current other financial assets as investment in securities. The dividend income on
investment is recognized in income statement and gain/loss on sale of securities is
also recognized in income statement. There are no other specific accounting
requirements for investment in shares of an entity.
Accounting requirements for investment between 20%-50%
If we are planning to invest in the Wakefield Limited between 20%-50%, then it will
be treated as investment in associates because the significant influence will be
established as per accounting standard and we can exercise significant influence
through voting rights. The equity method is used for accounting of investment in
associates. The investment in associates is recorded at original costs. The
investment is increases based on pro rata share of investee’s income and decreases
on pro rata basis investee’s share in dividend distributed by the investee company.
The company has also to record the goodwill if arise at the time of investment due to
difference in cost of investment less book value of assets (AASB 2018). There is
only one line-item consolidation in income statement and balance sheet. Further
investing entity has to disclose the various accounting information in annual report
such as name of associate company, percentage hold, transaction with associates
such as sale or purchase, investment, dividend or any other transactions. The
investor has also need to adjust for upstream and downstream, unrealized profit/
losses, proportionate share of profit/ loss etc. AASB 128 will be followed for
accounting treatment/ requirements.
Accounting requirements for investment above 50%
If we are planning to invest above 50% in Wakefield Limited, then it will be treated as
investment in Subsidiary company because we will be having the control over the
investing entity and we can take decisions of the company. Under this scenario, we
can impact the returns of the entity through casting our voting powers. Accounting
requirements for subsidiary is one of the toughest challenges and there are lot of
technical requirements for consolidation of a subsidiary company. Under the
subsidiary investment, each line is consolidated, and eliminations are done for inter
group transactions and finally minority investment is calculated for shareholders
other than our company.
In consolidation of accounts of subsidiary company each line item of income
statement and balance sheet will be consolidated along with our financial
statements. After each line item consolidation, inter group transaction will be
eliminated. The elimination is one of the biggest challenges in accounting
requirement. For example, any sale or purchase between the companies have to
eliminate for each transaction, management fee income charged, calculation of profit
margin charged by either company, foreign currency translation issues, any
investment made in plant, property and equipment, goodwill elimination, loan and