Increase the investment in Green
On 1 April 2019, DPL took control of Green, acquiring a further 45% interest for cash of Rs. 250 million and added this amount to the carrying amount of its investment in Green. On 1 April 2019, the retained earnings and other components of equity of Green were Rs. 146 million and Rs.30 million respectively and the fair value of the identifiable net assets was Rs. 531 million. The difference between the carrying amounts and the fair values was in relation to the plant with a remaining useful life of five years. The fair value of the Green’s 40% and 15% shareholding was Rs. 224 million and Rs. 84 million respectively on 01 April 2019.
Acquisition of Cheddar
The fair value of the identifiable net assets of Cheddar at 1 April 2019 was Rs. 800 million. It is a group policy to value non-controlling interests at fair value and, at the date of acquisition, this was Rs. 242 million. The excess in fair value of the identifiable net assets is due to non-depreciable land.
No impairment losses in goodwill have been necessary to date.
Summarized Statements of Financial Position of Green and Cheddar as at 31 March 2020 are as follows. (Rs.’000)
| ASSETS | Green | Cheddar |
| Non-Current Assets | | |
| Property, Plant and Equipment | 633,000 | 605,000 |
| | 633,000 | 605,000 |
| Current Assets | | |
| Inventories | 25,000 | 121,000 |
| Trade and Other Receivables | 32,000 | 140,000 |
| Other Current Assets | 18,000 | 88,000 |
| Cash and Bank Balances | 37,000 | 42,000 |
| | 112,000 | 391,000 |
| Total Assets | 745,000 | 996,000 |
| | | |
| EQUITY AND LIABILITIES | | |
| Capital and Reserves | | |
| Stated Capital | 350,000 | 360,000 |
| Revenue Reserves | 182,000 | 440,000 |
| Other Reserves | 30,000 | 39,000 |
| Total Equity | 562,000 | 839,000 |
| | | |
| Non-Current Liabilities | | |
| Interest Bearing Loans and Borrowings | 86,000 | 94,000 |
| | | |
| Current Liabilities | | |
| Interest Bearing Loans and Borrowings | 15,000 | 18,000 |
| Trade and Other Payables | 44,000 | 32,000 |
| Other Current Liabilities | 38,000 | 13,000 |
| | 97,000 | 63,000 |
| Total Equity and Liabilities | 745,000 | 996,000 |
Other information on the current business status and accounting practices
DPL attempts to remain relevant, progressive, and ready to evolve and adapt to anticipate and meet changing consumer preferences, lifestyle changes, and global trends. The company makes a significant investment in research and development for innovations. However, DPL is experiencing a lack of ability in attracting and retaining skilled workers on research and innovations who are looking for better job prospects abroad. A new data management system has been introduced, which integrates supplier and customer information with accounting software. This allows more efficient management of the customer database which is used extensively for marketing purposes, as well as providing more timely information on financial performance to management. Data from the previous system was transferred to the new system in July 2019, and the two systems ran in parallel for two months while training was given to staff.
In March 2020, the government reacted with restrictions of economic activities, which have no precedence in recent history with the out-break of Covid 19, from disruptions in conducting day- to-day business to a complete lockdown of certain industries and activities. Due to the significant reduction of demand in March, an excessive amount of dairy products stocks were remained unsold in the warehouses of DPL while most were highly perishable products with short expiry dates. Very recently with the start of the second wave of Covid-19 virus, again the government has restricted the people movements, social gatherings, and interactions which has led DPL to experience a significant drop in demand for their products especially from the corporate customers like hotels in the hospitality sector. Further, with reference to the research and development expenditure on developing eco-responsible packaging, by 31 March 2020, Rs. 35 million has been spent and capitalized with this amount being paid to TeraPack, a firm of packaging specialists, to design and develop a range of plastic-free bottles, bags, and containers. It is anticipated that the packaging will be ready for use in two years at which point the DPL will introduce it for use across its product range. TeraPack is currently testing prototypes of items that have been developed, with encouraging results.
The factory which was damaged due to the storm and flooding has not operated since then, and the CFO has performed an impairment review on the building and plant and equipment. The fair value fewer costs to selling have been estimated based on the sales proceeds which could be generated from selling the damaged machinery. The value in use is estimated based on future sales which could be generated if the damage to the building is repaired and new machinery is put into the factory. The refurbishment of the damaged factory is commenced and in addition to the maintenance expenses of this factory, a large amount of capital expenditure has been incurred with respect to restoration of the factory in which DPL expects to resume operations by the end of 2020. Biological assets balance mainly includes dairy cattle which are measured at fair value less cost to sell. DPL has used the valuation method developed based on past information, assumptions, market prices of the livestock of similar age, weight, pregnancy, lactations, and milk production. The calculation of the fair value of these biological assets involves a significant degree of judgment, particularly in respect of market prices for calves and raw milk market prices.
Court case and non-Compliance with regulatory requirements
In December 2019, a court case is being brought against DPL by an individual who suffered severe illnesses following the consumption of an expired cheese product bought from DPL’s Colombo outlet. Further, in a recent meeting with the production manager, CFO has found that the company is not complying with certain regulatory compositional requirements enforced by Sri Lanka Standard Institution in manufacturing Yoghurt which can lead to material penalties as well as losing the quality certifications currently obtained by DPL.
Preparation of consolidated financial statements
This is the first time DPL has acquired control over other entities and therefore engage in the preparation of consolidated financial statements under the full consolidation method. The group accounting team is made up of the CFO and three account executives who are currently undertaking their accountancy qualification. Further, the group instructions on the preparation of financial statements were distributed to the two components of the group on 15 April 2020 and this has led to a delay in the preparation of consolidated financial statements for the group. Consequently, in a recent board meeting, the management has emphasized the importance of having sound group-wide internal controls in place over consolidation to reduce the risk of having fraud and errors in the group financial statements and asked the CFO to propose such internal controls which can be implemented to the next board meeting.
Required:
(i) Assume you are the CFO of DPL and you have been asked to present to the board, key business risks to be considered in making the strategic decisions on future business prospects.
Evaluate four major business risks faced by DPL. (7 marks)
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