Explain 50-54 Flashcards
On 1 January 2013 Limerick plc entered into an agreement for the right to use a building for a 20-year period. The agreement meets the definition of a lease under IFRS 16, Leases. Ownership of the building passes to Limerick plc at the end of the lease term. Under the terms of the agreement, lease payments of £240,000 pa are due to be paid annually in arrears.
The building has an estimated useful life of 25 years. Limerick plc depreciates buildings on a straight-line
basis.
The present value of the future lease payments is £2,043,360 and the rate of interest implicit in the lease is 10%.
The lease payment made on 31 December 2013 was credited from cash and debited to administrative expenses.
As the agreement meets the definition of a lease under IFRS 16, the lessee must recognise a right-of-use asset and a corresponding lease liability on commencement of the lease.
The right-of-use asset is initially measured at the same amount as the initial measurement of the lease liability, adjusted for any payments made on or before the commencement of the lease, any direct costs incurred and any incentives received. There are no such adjustments required in this case and therefore the right-of-use asset and the lease liability are both initially measured at the present value of the future lease payments of £2,043,360.
The right-of-use asset is subsequently depreciated.
In this case, as the building is to pass to the lessee at the end of the 20-year lease term, the right-of-use asset should be depreciated over the useful life of 25 years.
The depreciation is therefore £2,043,360 / 25 years = £81,734 pa.
The carrying amount of the building at 31 December 2013 is therefore £1,961,626
(£2,043,360 – £81,734)
The lease liability is initially measured at the present value of the future lease payments. It is subsequently accounted for by adding interest, calculated based on the rate of interest implicit in the lease, and deducting lease payments made, as follows.
Year ended b/f Interest @10% Payment
2013 2,043,360 204,336 (240,000)
c/f = 2,007,696
2014 2,007,696 200,770 (240,000) c/f = 1,968,466
The carrying amount of the lease liability should be split between its current and non-current portions: Non-current liability (amount payable at 31 December 2014) = £1,968,466
The current liability (amount payable in the next 12 months = 2,007,696 - 1,968,466) = £39,230.
The interest of £204,336 for the year to 31 December 2013 should be recorded as a finance cost.
On 1 January 2013 Limerick plc had purchased a recycling plant for £260,000, in order to process hazardous waste generated as a by-product of its other operations.
The plant has an estimated useful life of five years after which it is expected to be superseded by new technology.
The plant was capitalised at £260,000 and the managing director has correctly calculated depreciation based on that figure.
However, he has not made any accounting entries in respect of the cost of decommissioning the plant at the end of the five-year period of operation, which was a condition of the purchase, and which you have established is expected to cost £50,000.
The relevant discount factor is 7%
Per IAS 37, Provisions, Contingent Liabilities and Contingent Assets a provision should be recognised where:
- there is a present obligation as a result of a past event;
- an outflow of resources is probable; and
- the amount can be estimated reliably.
The decommissioning costs meet these recognition criteria as:
- there is an obligation to decommission (it was a condition of the sale);
- it arose from a past event (the purchase of the plant); and
- there is a reliably estimated outflow of resources (the £50,000 that will be paid out).
When the plant was purchased on 1 January 2013, a provision should therefore have been made for the discounted costs of decommissioning the plant in five years’ time, measured as £50,000 × 1/(1.07)5 = £35,649, adding this amount to the cost of the asset. This would also have had the effect of increasing the depreciation charge for 2013 on the asset by £7,130
(35,649 ÷ 5).
A finance cost of £2,495 (35,649 × 7%) should be charged in the year ended 31 December 2013 to reflect the unwinding of the discount and the provision should be increased by the same amount. In the statement of financial position as at 31 December 2013 the provision will be shown as a non-current liability of £38,144 (35,649 + 2,495)
Limerick plc’s building division buys land and builds and fits out retail outlets which are then sold. On 1 January 2013 this division sold a plot of building land to an unconnected company for £750,000 when the market value of the land was £1 million.
The plot had originally been acquired for £500,000.
Limerick plc retains the right to build on this land until 31 December 2014 when it has the right to buy the plot back for £858,675. The managing director has recognised the profit on the sale of the land in the statement of profit or loss for the year ended 31 December 2013.
You have seen emails between the directors of Limerick plc indicating that the company is likely to repurchase the land.
Discount factor 7%
- Sale and repurchase agreement
- Not a sale as the customer does not obtain control of the land
- Limerick retains the right to build
- Transaction above market price = financing agreement
- Profit derecognised
- Loan in place
- Accrued finance cost (750,000 x 7%)
This is a sale and repurchase agreement. Per IFRS 15, Revenue from Contracts with Customers, the terms and conditions of the sale need to be considered to determine whether or not there is a sale in substance. As Limerick has the right to repurchase the land, this is a contract with a call option.
This means that the customer does not obtain control of the land, as evidenced by the fact that Limerick retains the right to build on it. As the exercise price is above the original selling price the transaction is treated as a financing arrangement.
The profit on the ‘sale’ of the land of £250,000 (750,000 – 500,000) should therefore be derecognised.
A loan of £750,000 and accrued finance cost of £52,500 (750,000 × 7%) should be recognised
The managing director included a note to the financial statements for the year ended 31 December 2013 regarding a contingent liability relating to a court case against Limerick plc which was in progress at the year end.
On 15 February 2014 the judge in the case ruled against Limerick plc and the company was ordered to pay damages of £100,000 to the claimants and legal costs of £25,000.
The managing director has not accrued for this amount in the financial statements for the year ended 31 December 2013 on the grounds that the judgment was not made until after the year end.
Discount 7%
Per IAS 10, Events After the Reporting Period, the determination of the court case is an adjusting event as it provides evidence of conditions that existed at the end of the reporting period (ie, of the court case that was already in progress).
The financial statements should therefore be adjusted to include an accrual for the total due of £125,000 and the note re the contingent liability removed.
There is no specific requirement to disclose the adjusting event.
During the year ended 31 December 2013 Limerick plc sold parts to a customer, Samuri Ltd, for £50,000, after giving Samuri Ltd a 20% discount. Limerick plc gives discounts to many customers varying between 5% and 25%.
Rio Yukon’s daughter, Aerio, owns 80% of the ordinary share capital of Samuri Ltd. At 31 December 2013 £30,000 was outstanding from Samuri Ltd as part of trade receivables.
Limerick plc will need to establish whether or not the sale of goods to Samuri Ltd is a related party transaction under IAS 24, Related Party Disclosures
Samuri Ltd is controlled by one of the close members (ie, his daughter) of the family of a member of Limerick plc’s key management personnel, so Samuri Ltd is a related party of Limerick plc under IAS 24.
Therefore, the sale of goods is a related party transaction.
Disclosure should include the nature of the related party relationship, ie, one of the director’s daughters owns a majority share in Samuri Ltd, the amount of the transaction ie, £50,000, and whether there are any outstanding balances at the year end ie, £30,000 is outstanding.
The rate of the discount and the names of the related parties do not need to be disclosed under IAS 24.
On 1 April 2014 Meitner plc received a government grant of £375,000 and credited it to other income. The grant is to help fund local employment within Meitner plc’s research facilities. A condition of the grant is that the ‘local workforce’ must make up at least one third of the total number of Meitner plc’s employees for the three years from the date of receipt of the grant.
‘Local workforce’ is defined in the grant’s terms and conditions as “living within a 10-mile radius of the research facility”. At 31 March 2015 the local workforce made up 35% of Meitner plc’s total number of employees.
This percentage is expected to rise over the next two years and Meitner plc is confident that it will not have to repay the grant.
IAS 20 requires grants to be recognised over the period in which the related expenditure is being incurred; therefore, matching the revenue and the expenses. Meitner plc expects to employ local employees over a three-year period; therefore, it would be reasonable to assume that the grant should be recognised over the three years.
The grant should not be recognised unless there is reasonable assurance that the entity will comply with any conditions attached to the grant and that the grant will be received. Meitner plc has already received the grant and has currently met the condition that the local workforce makes up a third of the total employees, as it has 35% local employees, and this is expected to rise. So, both conditions have been met.
IAS 20 also states that if there are a series of conditions to be met, then the grant income should be recognised once those conditions have been met. In this case, although Meitner has met the target of a minimum of one third of the workforce being local, the grants requires this to be for a period of three years.
Therefore, the grant should not be recognised in the statement of profit or loss in full upon receipt despite the fact that it is assessed as being not likely to be repaid. As the costs of the staff will be over the period of three years and the terms of the grant require a three-year period to be the minimum term, it is appropriate to recognise the income over this period.
£125,000 (£375,000/3yrs) of income should be recognised for the year ended 31 March 2015.
The remaining £250,000 should be reversed from other income and recognised as deferred income, as part of liabilities. The liability should be split equally between current and non-current
On 1 April 2014 Meitner plc received a government grant of £375,000 and credited it to other income. The grant is to help fund local employment within Meitner plc’s research facilities.
A condition of the grant is that the ‘local workforce’ must make up at least one third of the total number of Meitner plc’s employees for the three years from the date of receipt of the grant.
‘Local workforce’ is defined in the grant’s terms and conditions as “living within a 10-mile radius of the research facility”. At 31 March 2015 the local workforce made up 35% of Meitner plc’s total
number of employees. This percentage is expected to rise over the next two years and Meitner plc is confident that it will not have to repay the grant
IAS 20 requires grants to be recognised over the period in which the related expenditure is being incurred; therefore, matching the revenue and the expenses.
Meitner plc expects to employ local employees over a three-year period; therefore, it would be reasonable to assume that the grant should be recognised over the three years.
The grant should not be recognised unless there is reasonable assurance that the entity will comply with any conditions attached to the grant and that the grant will be received.
Meitner plc has already received the grant and has currently met the condition that the local workforce makes up a third of the total employees, as it has 35% local employees, and this is expected to rise. So, both conditions have been met.
IAS 20 also states that if there are a series of conditions to be met, then the grant income should be recognised once those conditions have been met. In this case, although Meitner has met the target of a minimum of one third of the workforce being local, the grants requires this to be for a period of three years.
Therefore, the grant should not be recognised in the statement of profit or loss in full upon receipt despite the fact that it is assessed as being not likely to be repaid. As the costs of the staff will be over the period of three years and the terms of the grant require a three-year period to be the minimum term, it is appropriate to recognise the income over this period.
£125,000 (£375,000/3yrs) of income should be recognised for the year ended 31 March 2015.
The remaining £250,000 should be reversed from other income and recognised as deferred income, as part of liabilities. The liability should be split equally between current and non-current.
Meitner plc is planning to centralise its operations in a few years’ time which will release some additional finance. However, funding is needed now to finance the initial research stage of a new drug.
In order to raise finance, Meitner plc entered into a contract with a financial institution to sell its head office building for £8 million, which was equal to its fair value, on 1 April 2014 and then immediately lease it back.
The transfer satisfied the requirements of IFRS 15, Revenue from Contracts with Customers to be a sale. Under the terms of the contract, Meitner plc will have the right to use the building for five years with lease payments of £350,000 pa payable annually in arrears.
The contract meets the definition of a lease under IFRS 16, Leases.
There is no option to purchase the building at the end of the five-year lease term.
The present value of future lease payments is £1,602,898 at the lease commencement date, and the interest rate implicit in the lease is 3%.
The carrying amount of the building at 1 April 2014 was £6.5 million, with a 30 year remaining useful life.
Meitner plc derecognised the property on 1 April 2014 and recognised a profit on disposal of £1.5 million as part of other income. The payment of £350,000 made on 31 March 2015 has been debited to administrative expenses.
Meitner plc has entered into a sale and leaseback arrangement with the financial institution.
Meitner plc is required to account for the arrangement as follows:
Derecognise the carrying amount of the building. This has been done correctly; however,
(1) the gain of £1.5 million cannot be recognised (see (4)).
2)Recognise a right-of-use asset measured as a proportion of the carrying amount of the building. The right-of-use asset is then depreciated over the shorter of the lease term and
the remaining useful life of the building.
3) Recognise a lease liability based on the present value of the future lease payments
4) Recognise a gain in respect of the rights transferred
TELLS YOU THE CA BY GIVING YOU PROCEEDS AND ‘PROFIT MADE’ - 8,000,000 - 1,500,000 = 6.5M
Calculation of the right-of-use asset
In a sale and leaseback transaction, the right-of-use asset is initially measured at a proportion of the original carrying amount of the asset:
Carrying amount × Initial measurement of Lease liability / Fair value of the asset
The initial right-of-use asset is therefore:
£6,500,000 × £1,602,898/£8,000,000 = £1,302,355
Note: The right-of-use asset will be depreciated over the lease term (there is no option to purchase and the useful life is greater than the lease term).
Depreciation for the year is therefore £1,302,355/5 years = £260,471.
The carrying amount of the right of use asset at 31
March 2015 is therefore £1,041,884 (£1,302,355 – £260,471).
Calculation of the lease liability IFRS 16 requires the lease liability to be measured at the present value of the future lease payments, which is £1,602,898.
The lease liability is subsequently accounted for by adding interest, calculated at the rate of interest implicit in the lease of 3%, and by deducting the lease payment made.
As the lease payment has been incorrectly accounted for as an administrative expense, an adjustment is required to remove the lease payment from administrative expenses, to record the interest of £48,087 as a finance cost and to debit the remainder of the payment against the carrying amount of the lease liability.
Calculation of the gain on sale
Meitner plc has recognised the full gain on sale of £1,500,000, however, this needs to be adjusted to reflect the fact that some of the right to use the asset is retained; only that part of the gain relating to the transferred rights should be recognised.
Gain attributed to the rights retained = Total gain × PVFLP /Fair value = £1,500,000 × £1,602,898/£8,000,000 = £300,543
Gain attributed to the rights transferred = £1,500,000 – £300,543 = £1,199,457
On 1 February 2015 Meitner plc repurchased 150,000 of its £1 ordinary shares for £1.40 each.
The only accounting entries made were to credit cash and debit investments.
When an entity purchases its own shares, the shares should be recognised as treasury shares as a negative reserve within equity.
The amount recognised is the amount that Meitner plc paid
to reacquire the shares, being £210,000 (150,000 × £1.40).
No gain or loss should be recognised on their repurchase or subsequent resale. The original share capital, and share premium if relevant, recognised when the shares were originally issued should remain unchanged
£210,000 should be removed from investments and instead recognised as part of equity.
On 1 June 2014 Meitner plc issued 450,000 5% £1 irredeemable preference shares at par. When the cash was received, the issue proceeds were credited to equity.
No dividend had been paid on the preference shares by 31 March 2015 and no entries had been made in the accounting records in respect of dividends.
The full annual dividend for the year was subsequently paid on 31 May 2015.
It transpires that the dividend payment on the irredeemable preference shares is mandatory and if it is not paid it becomes cumulative
The irredeemable preference shares provide the investor with the right to receive a fixed (5% pa) amount of annual dividend out of Meitner plc’s profit for the period on a mandatory basis.
If the annual dividend is not paid then it is rolled up into the following year’s payment as the dividends are cumulative in nature.
Under IAS 32, Financial Instruments: Presentation these shares should be classified as financial liabilities, as there is a contractual obligation to deliver cash.
The preference shares should therefore be accounted for at amortised cost using the effective interest rate, which is equivalent to the annual dividend rate of 5% as they are not redeemable.
This reflects the substance of the share issue.
£450,000 should therefore be recognised as part of non-current liabilities and removed from equity and the dividend payment of £18,750 (450,000 × 5% × 10/12) should be accrued for at 31 March 2015 and included within finance costs in the statement of profit or loss.
Swyre Ltd is another subsidiary of Girton plc. During the year ended 30 June 2015 Swyre Ltd sold goods to Girton plc for £15,000 earning a 15% gross margin on the sale.
All of these goods were still held by Girton plc at 30 June 2015 and the invoice remained unpaid at this date. Each company recognised the sale or purchase as appropriate in their individual financial statements, no adjustments on consolidation have been made.
Group financial statements reflect the results and net assets of group members to present the group to the parent’s shareholders as if it was a single economic entity.
This reflects the substance of the group arrangement as opposed to its legal form, where each group member is a separate legal person.
In the consolidated statement of financial position of Girton plc, all of the assets and liabilities of the group companies are added together and shown as if one.
However, the single entity concept also means that any intra-group transactions need to be eliminated, as otherwise such transactions would be double counted in the context of the group as a single entity.
There are several elements to the intra-group trading.
Revenue and costs of sales should be adjusted by the gross £15,000, as this was effectively a sale with itself under the single entity concept.
Closing inventories in cost of sales and current assets should be adjusted (reduced) by the unrealised profit element of £2,250 as the goods have not been sold outside of the group.
The unrealised profit element will also affect the group’s retained earnings, since there is no non-controlling interest.
As the invoice for £15,000 is also unpaid at 31 June 2015, this amount will need to be eliminated from both ‘Trade and other receivables’ and ‘Trade and other payables’.
On 1 February 2015 Girton plc made a one for five bonus issue of ordinary shares. Alan has not accounted for the bonus issue, although the issue was based on the correct number of ordinary shares.
Ordinary share capital (£1 shares) 650,000
Share premium 90,000
Retained earnings 890,200
The bonus issue was based on the correct number of shares (ie, 750,000 – see (b)) so 150,000 shares were issued, and ordinary share capital should be credited with this amount.
Assuming that Girton plc wishes to maximise distributable profits, the premium should firstly be charged to the share premium account, with the balance going to retained earnings.
Therefore £110,000 (90,000 + 20,000 (1)) of this should be debited to share premium and the remaining £40,000 to retained earnings.
During the year Girton plc sold goods totalling £216,700 on credit to Selwyn Ltd, a company wholly owned by Alan’s son. At 30 June 2015 there was a trade receivable of £54,400 in respect of these sales. No disclosures were made in the individual or consolidated financial statements of Girton plc for this transaction.
When you queried this Alan said that this was because the sales were made at an arm’s length price. The managing director was unaware of these sales until the credit controller asked him to review the year-end allowance for doubtful debts, which includes £20,000 in respect of this debt, as Selwyn Ltd is known to be in financial difficulties
Selwyn Ltd is wholly owned by one of the close family members of a member of Girton plc’s key management personnel, so Selwyn Ltd is a related party of Girton plc.
Alan and his son are also related parties of Girton plc. This transaction with Selwyn Ltd is therefore a related party transaction.
Disclosure is required of all related party transactions, even if the transactions took place on an arm’s length basis. The fact that the transactions took place on an arm’s length basis may be disclosed, but only if such terms can be substantiated
Disclosure should be made of:
- the nature of the relationship (a company owned by the son of a director of Girton plc); •
- the amount of the transactions (£216,700); •
- the amount of any balances outstanding at the year end (£54,400); and •
- any allowance against outstanding balances and the expense recognised for irrecoverable debts due from related parties (£20,000).
There is no requirement to identify related parties by name.
Since Selwyn Ltd is in financial difficulties, consideration should be given to making an allowance for the remainder of the debt ie, for an additional £34,400 (54,400 – 20,000)
On 1 April 2015 Girton plc sold a package of products for £191,250 cash. The package was made up of equipment and 12 months of helpdesk support. The customer took control of the equipment when it was delivered to its warehouse on 1 April 2015. The equipment normally retails at £175,000 and the support at £50,000. Alan recognised revenue of £191,250 in the financial statements for the year ended 30 June 2015, on the grounds that the equipment sale had been made in that year and the provision of helpdesk support was part of that sale
IFRS 15, Revenue from Contracts with Customers requires that, where a package of goods and services is sold, the separate performance obligations within the package should be identified.
In this case, the contract contains two performance obligations: equipment and helpdesk support.
The package has been sold for £191,250, which is a discount of 15% on the sum of the usual stand-alone selling prices of £225,000 (£175,000 + £50,000).
IFRS 15 requires the transaction price of the contract to be allocated between the performance obligations in the contract relative to their stand-alone selling prices (unless there is observable evidence that the discount given should be applied differently).
As there is no observable evidence to suggest otherwise, the 15% discount should be applied equally to the two performance obligations in the contract.
The performance obligations should be accounted for as follows:
Equipment:
- This performance obligation is satisfied at a point in time, when control of the equipment is transferred to the customer on 1 April 2015.
Revenue of £148,750 (175,000 × 85%) should be recognised in the year ended 30 June 2015.
Helpdesk support:
- A transaction price of £42,500 (50,000 × 85%) should be allocated to the helpdesk support.
- The customer consumes the benefit of the service as Girton plc supplies it; therefore, this performance obligation is satisfied over time. Girton plc should recognise revenue by measuring progress towards complete satisfaction of the performance obligation.
Here the most appropriate way to measure progress is by using the output method, which measures the value to the customer of the service provided to date as a proportion of total value of the service.
In the absence of other information, this should be on a straight-line basis over the period of the contract (12 months).
In the year ended 30 June 2015 only 3/12 of the £42,500 should be recognised as revenue ie, £10,625.
The remaining balance of £31,875 (£42,500 – £10,625) should be recognised as a contract liability within current liabilities.
Alan has therefore overstated revenue (and profit for the year) by £31,875 (191,250 – 148,750 – 10,625) and understated liabilities (contract liabilities) by the same amount.
On 1 October 2014 Chayofa Ltd began constructing a specialised piece of plant. The plant underwent a final safety inspection on 30 June 2015 and was ready for use the following day.
The plant has a useful life of 15 years, although replacement blades, which cost £14,000, will be needed every five years. No depreciation was recognised for the year ended 30 September 2015 as the plant was not working at its full capacity because staff were still being trained.
Amounts that were incurred between 1 October 2014 and 30 June 2015 and capitalised as part of property, plant and equipment are shown in the ‘Specialised plant costs’ table below.
Materials cost (including the blades) 124,000
Labour costs 41,500
Sale of by-products produced as part of testing process (450)
Staff training 1,800
Consultancy fees re installation and assembly 1,150
Professional fees 1,300
Safety inspection 1,500
Allocated overheads (50% general administration: 50% directly attributable) 14,200
——-
185,000
The labour costs consist of £31,500 in respect of the plant’s installation and assembly and a £10,000 allocated share of the sales director’s salary.
The sales director was responsible for discussing the new plant’s capabilities with existing customers.
The cost of an item of property, plant and equipment is initially recognised at cost. In the case of a specialised piece of plant which has been specifically constructed for the entity, cost will include its purchase cost and all directly attributable costs to bring the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
Directly attributable costs include:
- employee benefits arising directly from the construction of the machine; and •
- site preparation, delivery, installation and assembly costs, costs of testing and professional fees.
There are certain costs which should not be capitalised as they are not considered to be directly attributable to the item, for example the cost of introducing new products and administration and general overheads.
Any proceeds from selling products generated during testing of new property, plant and equipment should be deducted from the cost capitalised.
The following costs should therefore be capitalised as part of property, plant and equipment:
Materials cost (including blades) 124,000
Internal allocated labour costs 31,500
Sale of by-products produced as part of testing process (450)
Consultancy fees re installation and assembly 1,150
Professional fees 1,300
Safety inspection 1,500
Overheads allocated 7,100
166,100
Expense: Internal allocated labour costs 10,000 Staff training 1,800 Overheads allocated 7,100 18,900
Capitalisation ceases when the item is capable of operating in the manner intended, this was on 1 July 2015 and this is the date on which depreciation should commence.
Each significant part of an item of property, plant and equipment must be depreciated separately, although if component parts have the same useful lives and depreciation methods are the same, they may be grouped together for practical purposes. Here the cutters should be recognised as a separate component as they have a useful life of five years compared with 15 years for the rest of the asset.
Total depreciation of £3,235 (£700 + £2,535) should be recognised as part of profit or loss for the period and the carrying amount of the plant at 30 September 2015 is £162,865 (166,100 – 3,235).
Blades: (14,000/5yrs) × 3/12 = £700
Remainder: ((166,100 – 14,000) / 15yrs) × 3/12 = £2,535
