Barking, an unlisted company, operates in the house building and commercial property investment development sector. The sector has seen an upturn in activity during recent years and the directors have been considering future plans with a view to determining their impact on the financial statements for the financial year to 30 November 20X4.
(a) Barking wishes to obtain a stock exchange listing in the year to 30 November 20X4. It is to be acquired by Ash, a significantly smaller listed company in a share for share exchange whereby Barking will receive sufficient voting shares of Ash to control the new group. Due to the relative values of the companies, Barking will become the majority shareholder with 80% of the enlarged capital of Ash. The executive management of the new group will be that of Barking.
As part of the purchase consideration, Ash will issue zero dividend preference shares of $1 to the shareholders of Barking on 30 June 20X4. These will be redeemed on 1 January 20X5 at $1.10 per share. Additionally Ash will issue convertible interest free loan notes. The loan notes are unlikely to be repaid on 30 November 20X5 (the redemption date) as the conversion terms are very favourable. The management of Ash have excluded the redemption of the loan notes from their cash flow projections. The loan notes are to be included in long-term liabilities in the statement of financial position of Ash. As part of the business combination Ash will change its name to Barking Inc.
(b) The acquisition will also have other planned effects on the company. Barking operates a defined benefit pension scheme. On acquisition the scheme will be frozen and replaced by a group defined contribution scheme, and as a result no additional benefits in the old scheme will accrue to the employees. Ash's employees are also in a defined benefit scheme which has been classified as a multi-employer plan but it is currently impossible to identify its share of the underlying assets and liabilities in the scheme. After acquisition, Ash's employees will be transferred to the group's defined contribution scheme, with the previous scheme being frozen.
(c) As a result of the acquisition the company will change the way in which it recognizes sales of residential properties. It used to treat such properties as sold when the building work was substantially complete, defined as being when the roof and internal walls had been completed. The new policy will be to recognize a sale when a refundable deposit for the sale of the property has been received and the building work is physically complete. Legal costs incurred on the sale of the property are currently capitalized and shown as current assets until the sale of the property has occurred. Further, it has been decided by the directors that as at 30 November 20X4, the financial year-end, some properties held as trading properties of both companies would be moved from the trading portfolio to the investment portfolio of the holding company, and carried at fair value.
(d) The directors intend to carry out an impairment review as at 30 November 20X4 in order to ascertain whether the carrying amount of goodwill and other non-current assets can be supported by their value in use. The plan is to produce cash flow projections up to 20X4 with an average discount rate of 15% being used in the calculations. The ten-year period is to be used as it reflects fairly the long-term nature of the assets being assessed. Any subsequent impairment loss is to be charged against the statement of comprehensive income.
Required:
Draft a report to the directors of Barking, setting out the financial reporting implications of the above plans for the financial statements for the year to 30 November 20X4.