8. Further fixed assets - hire, purchase, leasing, grants and intangibles

Question 1

What is ‘hire purchase’?

Answer 1

-The trader obtains the use of the asset in exchange for a periodic rental payment
-at the end of the rental period, the trader has an option to purchase the asset

Question 2

How does hire purchase differ from purchasing an asset outright?

Answer 2

-the legal position is the title of the business does not pass from seller to buyer until the final hire purchase instalment is paid
-but, the buyer has enjoyed the full use of the asset just as if he had purchased it outright

Question 3

how have accounting procedures been designed to reflect the economic reality of hire purchase?

Answer 3

FRS 102 Section 20 - Leases
FRS 102 Section 2 - qualitative characteristic of substance over form
Both of these two sections determine we should treat the transaction in accordance with the economic substance rather than the strict legal position

Question 4

How is the hire purchase treated in the accounts?

Answer 4

Treated as if it has been purchased outright with a loan being provided by the hire purchase company. The periodic payments are treated as repayments of this loan

Question 5

What are two forms of leasing?

Answer 5

-Short term leasing (operating lease)
-Long term leasing (finance lease)

Question 6

What is short term leasing (operating lease)?

Answer 6

e.g. hire of a machine for 6 months.
-the lessee/hirer pays rental on an asset for a period which is normally substantially less than its useful life

Question 7

What is long term leasing (finance lease)?

Answer 7

e.g. a car being leased for three or more years
-The lease term is likely to be for the major part of the asset’s economic life

Question 8

How is the operating lease recorded in the double entry?

Answer 8

-Payments are treated as a revenue expense; the business is paying for a service which it is currently using
-Dr Operating lease rental expense (P&L account)
-Cr Bank account

Question 9

How is the finance lease accounted for?

Answer 9

-It is different to operating lease but very similar to hire purchase, aside from the fact there is no option to buy at the end of the lease term
-the total of rent payments will normally equate the cash purchase price plus an extra amount (although asset only leased)

Question 10

What is a distinguishing feature of the finance lease compared to the operating lease?

Answer 10

Substantially all the risks and rewards of asset transfers to the lessee (hirer)

Question 11

How is finance leasing accounted for?

Answer 11

In a similar manner as HP, as per FRS 102

Question 12

What is the legal form of the finance leasing transfer?
How will this be accounted for?

Answer 12

-Simply renting the asset but effect is the trader is borrowing money and purchasing the asset (given future liability to finance company)
-accounted for by showing the asset in the balance sheet at normal cost as if it has been purchased outright and then, recognising the loan for future payments

Question 13

What is the main problem accounting for finance leases and HP agreements?

Answer 13

-The total of future payments will exceed cash price of asset due to interest on finance/loan.
-thus, the excess should be charged as an expense to P&L account
-For exam purposes, assume interest spread evenly over period of contract

Question 14

What is the double entry for GP for finance lease?

Answer 14

Refer to book

Question 15

Explain government grants

Answer 15

• Businesses may qualify for certain types of expenditure (as encouragement
  -Dealt with by FRS 102 Section 24 and requires grants to be treated as performance model or accrual model

Question 16

What is the performance model (government grants)?

Answer 16

Grants should only be recognised when future performance-related conditions are met.
-If no such conditions, grant should be recognised when received

Question 17

What is the accrual model (gvt grants)?

Answer 17

Using the accrual model, grants are classified as either: a revenue or a grant relating to assets

Question 18

What are revenue grants?
How is this accounted for?
(check what model relates to, accrual right?)

Answer 18

-Received in respect of revenue expenditure e.g. contribution towards wages/salaries of employing someone currently unemployed.
-recognised in the P&L account in which expenses are incurred (usually year of receipt)
-Credited as sundry income:
Dr Bank
Cr Grant income account (P&L a/c)

Question 19

What are asset grants?

Answer 19

-if adder received in respect of capital expenditure, grant should not be recognised in P&L account in year of receipt as depreciated charge (the expense) is spread over asset’s useful life
-Thus, grant held on balance sheet as ‘deferred income’ and each year, a relevant portion is released to P&L account, matching it with depreciation charge

Question 20

What are common examples of intangible fixed assets?
Why are they called fixed assets?

Answer 20

-R&D expenditure
-Goodwill
-Patents, knowhow, copyrights and trademarks
-fixed asset as purpose is to generate revenue in future years

Question 21

What does FRS 102 section 18 state?

Answer 21

-That intangible assets shall be considered to have a finite useful life. if this cannot be estimated, shall not exceed 10yrs
-the intangible then amortised on systematic basis over its useful life (same principle as depreciation)
-starts in same period available to use

Question 22

What does FRS 102 section 18 state?

Answer 22

-That intangible assets shall be considered to have a finite useful life. if this cannot be estimated, shall not exceed 10yrs
-the intangible then amortised on systematic basis over its useful life (same principle as depreciation)
-starts in same period available to use

Question 23

What does FRS 102 section 18 state?

Answer 23

-That intangible assets shall be considered to have a finite useful life. if this cannot be estimated, shall not exceed 10yrs
-the intangible then amortised on systematic basis over its useful life (same principle as depreciation)
-starts in same period available to use

Question 24

What does FRS 102 section 18 state?

Answer 24

-That intangible assets shall be considered to have a finite useful life. if this cannot be estimated, shall not exceed 10yrs
-the intangible then amortised on systematic basis over its useful life (same principle as depreciation)
-starts in same period available to use

Question 25

How does FRS 102 Section 18 define research

Answer 25

• original investigations undertaken to gain new scientific or technical knowledge
• the search for applications of research findings
  -searching for alternative materials, products, systems, processes etc

Question 26

How does FRS 102 Section 18 define development?

Answer 26

-the use of scientific or technical knowledge to produce new or substantially improved materials, devices, products, processes, systems or services prior to the commencement of commercial production

Question 27

What are requirements or RESEARCH expenditure under FRS 102?

Answer 27

-Research expenditure should always be written off or expensed as it is incurred
-There is no certainty research expenditure will provide a business with future revenues, hence these are written off as incurred.
-An exception is expenditure on tangible fixed assets acquired to provide research facilities (capitalised as normal under FRS 102 Section 17.

Question 28

What are requirements of DEVELOPMENT expenditure under FRS 102?

Answer 28

-Should also be written off as incurred unless can be clearly related to a project that is technically feasible and commercially viable.
-Can only be capitalised in balance sheet if business if certain expenditure will result in economic benefits to the asset

Question 29

What should be done if development costs are shown as an asset?

Answer 29

-Amortisation starts in the period of commercial production of the product or process
-Should be charge on a systematic basis to each accounting period expected to benefit from development expenditure (useful life)

Question 30

What is goodwill?

Answer 30

-another name for name/reputation
-difference between value of the business on a whole and sum of values of individual assets shown on business’s balance sheet

Question 31

Why is it difficult to place a value on goodwill for an ongoing business?

Answer 31

• because goodwill is subjective and any value placed on goodwill (usually referred to as inherent or unique) would be unreliable
  -Consequently, not placed as an asset on balance sheet

Question 32

What is ‘purchased’ goodwill?

Answer 32

-‘purchased’ goodwill is not subjective; when someone is buying a business alongside its goodwill
-thus, a cost will incurred in buying this capital asset
-FRS 102 Section 19 shows us how this is accounted for

Question 33

What does FRS 102 - Section 19 sell us about goodwill

Answer 33

-Purchased goodwill should be capitalised and classified as an intangible fixed asset on the balance sheet
-Considered to have a finite useful life and goodwill should be amortised over this period
-Again, in cases a reliable estimate for goodwill cannot be made, it should not exceed 10 yrs.

Question 34

What does FRS 102 - Section 27 tell us?

Answer 34

FRS 102, Section 27 - Impairment of assets
-Requires all assets should be reviewed annually for impairments and written down as necessary
-Impairment occurs when the value of an asset drops below value recorded in balance sheet
-Relevant to goodwill as impacted by internal and external factors e.g. publicity

Question 35

Explain the taxation of goodwill (accounting perspective)

Answer 35

-Chargeable business asset for an individual and will become chargeable as a gain/loss upon disposal, regardless whether purchased or inherent
-if purchased, will have a base cost, if inherent, unlikely to have one

Question 36

Explain the taxation of goodwill (tax perspective)

Answer 36

When disposing of goodwill, will either results in chargeable gain/loss or in an income P&L depending on whether the goodwill was purchased/created by the company