On 1 October 2012, Paradigm acquired 75% of Strata’s equity shares by means of a share exchange…

On 1 October 2012, Paradigm acquired 75% of Strata’s equity shares by means of a share exchange of two new shares in Paradigm for every five acquired shares in Strata. In addition, Paradigm issued to the shareholders of Strata a $100 10% loan note for every 1,000 shares it acquired in Strata. Paradigm has not recorded any of the purchase consideration, although it does have other 10% loan notes already in issue

The market value of Paradigm’s shares at 1 October 2012 was $2 each.

The summarised statements of financial position of the two companies as at 31 March 2013 are:

The following information is relevant:

(i) At the date of acquisition, Strata produced a draft statement of profit or loss which showed it had made a net loss after tax of $2 million at that date. Paradigm accepted this figure as the basis for calculating the pre- and post-acquisition split of Strata’s profit for the year ended 31 March 2013.

Also at the date of acquisition, Paradigm conducted a fair value exercise on Strata’s net assets which were equal to their carrying amounts (including Strata’s financial asset equity investments) with the exception of an item of plant which had a fair value of $3 million below its carrying amount. The plant had a remaining economic life of three years at 1 October 2012.

Paradigm’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose, a share price for Strata of $1.20 each is representative of the fair value of the shares held by the non-controlling interest.

(ii) Each month since acquisition, Paradigm’s sales to Strata were consistently $4.6 million. Paradigm had marked these up by 15% on cost. Strata had one month’s supply ($4.6 million) of these goods in inventory at 31 March 2013. Paradigm’s normal mark-up (to third party customers) is 40%.

(iii) Strata’s current account balance with Paradigm at 31 March 2013 was $2.8 million, which did not agree with Paradigm’s equivalent receivable due to a payment of $900,000 made by Strata on 28 March 2013, which was not received by Paradigm until 3 April 2013.

(iv) The financial asset equity investments of Paradigm and Strata are carried at their fair values as at 1 April 2012. As at 31 March 2013, these had fair values of $7.1 million and $3.9 million respectively.

(v) There were no impairment losses within the group during the year ended 31 March 2013.

Required:

Prepare the consolidated statement of financial position for Paradigm as at 31 March 2013.

(b) Paradigm has a strategy of buying struggling businesses, reversing their decline and then selling them on at a profit within a short period of time. Paradigm is hoping to do this with Strata.

Required:

As an adviser to a prospective purchaser of Strata, explain any concerns you would raise about basing an investment decision on the information available in Paradigm’s consolidated financial statements and Strata’s entity financial statements.

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