Explain 55-59 Flashcards
On 1 January 2016 Barbadine Ltd purchased 40% of Duku Ltd’s ordinary shares, which gave Barbadine Ltd significant influence over Duku Ltd. Barbadine Ltd paid £25,000 for the shares and intends to hold the investment for the long-term.
Barbadine Ltd’s draft consolidated financial statements for the year ended 30 June 2016 show Duku Ltd as an investment at cost
within non-current assets. Duku Ltd made a loss for the year ended 30 June 2016 of £137,600, which arose evenly over the year, and paid no dividends.
- Significant influence = associate treated under equity method
- Presented as a single line in the CSPL. Time-apportion if necessary
- ‘Investment in associate’ in SFP
- The associate should initially be recognised at cost and subsequently adjusted in each period for the parent’s share of the post-acquisition change in net assets (retained earnings).
- Same for loss but: the carrying amount of the investment in the associate has been reduced to zero no further losses
should be recognised by the group - Calculation
Per IAS 28, Investments in Associates and Joint Ventures, because this acquisition has given Barbadine Ltd significant influence over Duku Ltd, Duku Ltd should be treated as an associate in the consolidated financial statements, using the equity method.
In the consolidated statement of profit or loss, the group’s share of the associate’s profit for the period should be presented as a single line. If the associate is acquired mid-year then its
results should be time apportioned.
In the consolidated statement of financial position, the interest in the associate should be presented as ‘Investment in associate’/a single line under non-current assets.
The associate should initially be recognised at cost and subsequently adjusted in each period for the parent’s share of the post-acquisition change in net assets (retained earnings).
This figure should be reviewed for impairment at each year end. Group retained earnings should include the group’s share of the associate’s post-acquisition retained earnings.
Where an associate makes a loss, as here, the same principles apply, except that once the carrying amount of the investment in the associate has been reduced to zero no further losses
should be recognised by the group, unless the group has a contractual obligation to make good the losses.
The figure for the investment in the associate in the consolidated statement of financial position is therefore:
Cost of investment 25,000
Share of post-acquisition change in net assets (6/12 × 137,600 × 40% = 27,520, restricted to 25,000) (25,000)
Nil
The figure for the share of loss in associate in the consolidated statement of profit or loss will
be a loss of £25,000, thus reducing Barbadine Ltd’s group profit by the same amount.
Barbadine Ltd’s draft individual financial statements for the year ended 30 June 2016 include inventories of £256,700.
One product line included in year-end inventories consisted of 5,000 units measured at a cost per unit of £15. This was a higher volume of inventories than had been anticipated due to poor sales of this product in June 2016. In early July 2016 it was discovered that, from 1 June 2016, one of Barbadine Ltd’s competitors had been selling a very similar product for £12 per unit.
As a result, since the year end, Barbadine Ltd has matched its
competitor’s price. Barbadine Ltd has had to modify each unit at a cost of 50p per unit and has incurred additional packaging costs of 10p per unit.
John has included the items at cost in inventories on the grounds that no one at Barbadine Ltd was aware of this issue at the year end
- Discovery of competitor’s price is an event after the reporting period (IAS 10)
- It is an adjusting event - why?
- IAS 2 - Inventory to be held at lesser of NRV and cost
- Calculations
- Reduces group profit
- The discovery of the competitor’s cheaper prices is an event after the reporting period in accordance with IAS 10, Events after the Reporting Period, being an event which occurred between the year end and the date when the financial statements were authorised for issue.
- Furthermore, it is an adjusting event, because it provided evidence of conditions that existed at the end of the reporting period ie, evidence that the net realisable value of these inventories was lower than their cost.
- In accordance with IAS 2, Inventories, this product line should be valued at the lower of cost and net realisable value (NRV). Cost is £75,000 (5,000 × £15). NRV is defined by IAS 2 as the
estimated selling price less the estimated costs of completion and the estimated costs necessary to make the sale. - The NRV of each unit is therefore £11.40 (12 – .50 – 0.10) giving a total NRV of £57,000 (5,000 × £11.40).
- The carrying amount of inventories should therefore be reduced by £18,000 (75,000 – 57,000) to £238,700 (256,700 – 18,000) in the draft consolidated financial statements, thereby reducing group profit by £18,000.
Barbadine Ltd’s individual statement of financial position as at 30 June 2015 included a provision of £40,000 in relation to a claim for wrongful dismissal made by a former director in April 2015.
The case is due to come to court shortly after the AGM. Barbadine Ltd’s lawyers believe that the former director has a strong case and that the claim is likely to be settled in his favour.
You have established the probabilities of given levels of damages payable and these are shown in the ‘Probabilities’ table below. The provision of £40,000 made at 30 June 2015 was based on the information available at that date. John has not adjusted the provision because the lawyers cannot be certain at what amount the claim will be settled
None - 20%
£55,000 - 60%
£75,000 - 10%
£100,000 - 10%
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 (the past event is the claim); •
- an outflow of resources (payment of the claim) is probable (ie, more likely than not, as here, •
where there is only a 20% chance of no damages being payable); and
- the amount can be estimated reliably (as it has been by the lawyers). •
- Therefore, a provision should still be made at 30 June 2016.
- This is a single obligation so the
provision should be based on the most likely outcome ie, a provision of £55,000. - Since the claim is expected to be paid in less than a year’s time, the time value of money is unlikely to be material, so the provision has not been discounted.
- The provision should be included in
current liabilities. - Increasing the provision from £40,000 to £55,000 will reduce group profit by £15,000.
Due to problems with one of its products, the Isea, on 30 June 2016 Barbadine Ltd had advised the Isea’s sole customer that it will not be able to meet the terms of the contract with them.
Barbadine Ltd is in breach of the contract until its cessation on 30 June 2019. The terms of the contract do not allow Barbadine Ltd to outsource the production of the Isea.
The contract has default charges of £20,000, to be paid in arrears on an annual basis until the contract expires on 30 June 2019.
The £20,000 charge for the year ended 30 June 2016 was paid by Barbadine Ltd on 30 June 2016 and included in expenses.
No further entries have been made in respect of this contract in the draft financial statements
- Why is this an onerous contract
- What to do with an onerous contract: IAS 37, recognise and measure as a provision
- Due to the fact time value of money is material, the provision should be discounted
- Calculation
- Presentation in the SFP and the reduction to Group profits
This is an onerous contract because the unavoidable costs of meeting the obligations under the contract exceed the economic benefit expected to be received under it; ie, Barbadine Ltd will have to pay out costs of £20,000 each year for the next three years and will receive no benefit from the contract.
Per IAS 37, if an entity has an onerous contract, the present obligation under the contract should be recognised and measured as a provision. Because the contract still has three years to run, the time value of money is likely to be material, so the provision should be discounted.
- The provision as at 30 June 2016 should be calculated as:
Year Costs (£) Discount factor £
30 June 2017 20,000 1/1.07 18,692
30 June 2018 20,000 1/1.072 17,469
30 June 2019 20,000 1/1.073 16,326
52,487
£18,692 will be shown as a current liability and (52,487 – 18,692) £33,795 as a non-current liability. Creating a provision for the above amount will reduce group profit by the same amount/£52,487.
During the year ended 30 June 2016 Barbadine Ltd purchased goods costing £532,500 from Calabash Ltd, a company wholly owned by John.
On 30 June 2016 trade payables included
£101,600 due to Calabash Ltd. You have discovered from previous purchase invoices that prices charged by Calabash Ltd are significantly higher than those charged by previous suppliers.
No disclosures have been made in the individual or consolidated financial statements of Barbadine
Ltd in respect of these transactions.
You discussed these purchases with George, who said he was unaware that John owned Calabash Ltd. George leaves all purchasing decisions to Paula,
the purchasing manager.
Paula was recruited by John, with whom she regularly plays golf.
You have had a brief telephone conversation with John, who was insistent that the financial statements should not be changed for any of the above issues.
John indicated that if you make no adjustments to the financial statements, he will recommend you as his successor. With regard to the purchases from Calabash Ltd, John said that his company charged higher prices because the goods were of a higher quality, such that the sales were made at arm’s length prices.
Calabash Ltd is wholly owned by a member of Barbadine Ltd’s key management personnel, so Calabash Ltd is a related party of Barbadine Ltd.
The purchase of goods by Barbadine Ltd from
Calabash Ltd is therefore a related party transaction.
Disclosure is required of all related parties and related party transactions, even if the transactions took place on an arm’s length basis. It seems unlikely from the facts that the transactions took place on an arm’s length basis, as Paula approved the contract and she is a friend of John’s who got her job through John (ie, there is an indication that awarding this contract to John’s company may be some sort of payback for this).
Even if the transactions did take place on an arm’s length basis, that fact may only be disclosed if such terms can be substantiated.
Disclosure should be made of:
- the nature of the relationship (a company owned by a director of Barbadine Ltd); (1)
- the amount of the transactions (£532,500); and (2)
- the amount of any balances outstanding at the year end (£101,600). (3)
- There is no requirement to identify related parties by name.
On 1 October 2015 Brisco plc sold an engine, which was made to the customer’s specification, for £80,000 on an interest-free credit basis.
The engine was delivered to the customer on 1
October 2015 and the customer initially paid a deposit of £20,000 on that date.
The remaining balance will be paid on 30 September 2017. The relevant discount rate has been assessed as 7% pa.
The financial controller recognised the full amount of £80,000, payable by the customer, as revenue for the year ended 30 September 2016. £20,000 was debited to cash and the remaining balance of £60,000 was recognised as a receivable.
- Recognise revenue
- Financing benefit
- Consideration to reflect the effect of the time value of money
On 1 October 2015, Brisco plc satisfied its performance obligation, as control of the engine was passed to the customer; therefore, revenue should be recognised.
The transaction contains a significant financing component, as the customer receives a financing benefit due to not having to pay the remaining £60,000 balance until 2 years after Brisco plc has supplied the engine.
In such cases, IFRS 15 requires the consideration to be
adjusted to reflect the effect of the time value of money and revenue to be recognised at an amount equal to the cash price that a customer would pay if payment were made at the point of delivery.
In this case, the £60,000 deferred payment is discounted using the 7% discount rate and in the subsequent two years to payment the discount is unwound and recognised as finance income.
There is no financing associated with the initial £20,000 deposit; therefore, this amount should
be recognised as revenue on 1 October 2015. Brisco plc should also recognise revenue of £52,406 (£60,000/1.072 = £52,406), being the remaining £60,000 balance discounted at 7%.
A receivable for the same amount should also be recognised. Total revenue recognised immediately should be £72,406 (£52,406 + £20,000).
Therefore, £7,594 (£80,000 – £72,406) should be reversed from revenue and receivables.
In the year to 30 September 2016, Brisco plc should recognise £3,668 (£52,406 × 7%) as finance income and an increase to the receivables balance, being the unwinding of the discount for one year.
On 1 October 2015 Brisco plc entered into a contract for the right to use a machine.
The contract met the definition of a lease under IFRS 16, Leases. Under the terms of the contract, a deposit of
£6,000 was paid by Brisco plc on 1 October 2015.
Three annual lease payments of £11,600 are then payable in arrears, the first of which was paid on 30 September 2016.
The interest rate implicit in the lease is 7.8%. The financial controller recorded the payments made by Brisco plc during the year as part of ‘other operating costs’. The machine has an estimated useful life of five
years and Brisco plc has no option to purchase the machine at the end of the lease term
As the contract contains a lease, IFRS 16, Leases, requires the lessee, Brisco plc, to recognise
both a lease liability and a right-of-use asset on commencement of the lease.
Lease liability
The lease liability is initially measured at the present value of the future lease payments, based
on the interest rate of 7.8%:
30 Sept 2016 11,600/1.078 10,761
30 Sept 2017 11,600/1.078^2 9,982
30 Sept 2018 11,600/1.078^3 9,260
PVFLP = 30,003
The lease liability is subsequently measured by adding interest, calculated based on the rate of
interest implicit in the lease of 7.8%, and deducting the lease payments made.
Year b/f 7.8% payment C/f
30/9/20X6 30,003 2,340 (11,600) 20,743
30/9/20X7 20,743 1,618 (11,600) 10,761
The carrying amount of the lease liability at 30 September 20X6 should be split into its current
and non-current elements in accordance with IAS 1.
The non-current element is the amount outstanding at 30 September 20X7 = £10,761
The current element is the amount of capital repaid in the next 12-month period = £9,982
(£20,743 – £10,761)
Right-of-use asset
The right of use asset is initially measured at:
the initial measurement of the lease liability; plus •
any deposits or payments made prior to the commencement of the lease (less any lease •
incentives received); and
initial direct costs, such as legal fees; plus •
any costs required for the dismantling of the asset. •
Brisco plc’s right-of-use asset is measured at £36,003 (the sum of the deposit paid (£6,000)
and the present value of the future lease payments (£30,003)).
The right-of-use asset is subsequently depreciated over the shorter of the lease term and the
useful life of the asset. The depreciation charge will be £36,003/3 years = £12,001 on a
straight-line basis
The carrying amount of the right-of-use asset at 30 September 2016 is therefore £24,002
(£36,003 – £12,001).
On 1 January 2016 Brisco plc and two unrelated trading entities entered into an agreement to each subscribe for 40,000 £1 ordinary shares at par in Cardew Ltd.
Cardew Ltd is a newly-incorporated company with 120,000 £1 ordinary shares in issue. The three investing entities in
Cardew Ltd are entitled to an equal share of its profits and losses. A contractual agreement was set up at the time of subscribing for the shares which includes a statement that unanimous consent is required by all three investors for all key operating decisions.
For the period ended 30 September 2016 Cardew Ltd reported a profit for the period of £72,000 and paid a dividend of 15p per share on 1 September 2016.
Brisco plc recognised the cash investment in current assets. The dividend income received from Cardew Ltd was recognised in cash and as part of profit for the period
Brisco plc should recognise its investment in Cardew Ltd as a joint venture. The three entities have joint control over Cardew Ltd and there is a contractual agreement in place to share
profits and losses equally with unanimous consent required.
IFRS 11, Joint Arrangements requires the use of the equity method for accounting for joint ventures. The investment should initially be recognised at its cost, £40,000 in the consolidated
statement of financial position as part of non-current assets.
At the end of each reporting period, it should be adjusted for the investor’s share of the post-acquisition change in net assets. Essentially, this is the change in retained earnings, the profit for the period less any dividends paid, so £18,000 ((72,000 – (120,000 × 15p))/3).
The investment should therefore be reclassified from current to non-current assets and the additional £18,000 should be included to show a carrying amount of £58,000 (£40,000 +
£18,000).
The dividend of £6,000 (40,000 × 15p) should not be recognised in the consolidated financial statements of Brisco plc, as equity accounting is used; hence, the dividend income of £6,000 should be removed from consolidated profit or loss for the period.
This should instead be replaced with share of profit for the period of £72,000 × 1/3 = £24,000 resulting in an increase
to consolidated profit of £18,000. The adjustment is required to avoid double counting.
On 1 January 2016 Brisco plc acquired a factory for £420,000 in cash (including land with a (4)
carrying amount of £120,000). The factory has an estimated useful life of 25 years and is being
depreciated on a straight-line basis.
Brisco plc subsequently applied for a government grant of £100,000 towards the cost of the
factory and this cash was received on 1 April 2016. As there are no conditions attached to the
grant, the financial controller credited the full £100,000 to other income. Depreciation was
recognised in the period based on the full cost of the factory building. On further investigation it
appears that Brisco plc’s accounting policy, in relation to government grants, is to use the
netting-off method
Per IAS 20, Accounting for Government Grants and Disclosure of Government Assistance,
grants should be recognised when there is reasonable assurance that:
the entity will comply with the relevant conditions; and •
the entity will actually receive the grant. •
In respect of this grant, there are no specific conditions and the grant has been received in full by Brisco plc.
As both of the requirements have been met, the government grant should be recognised. IAS 20 requires government grants which relate to assets to be either:
recognised as deferred income; or •
recognised as a reduction to the carrying amount of the asset. •
It is not appropriate to recognise the grant on a cash receipt basis as accounted for by the financial controller.
Brisco plc’s stated accounted policy is to recognise a government grant by offsetting it against the carrying amount of the related asset. The grant will then be recognised over the life of the related asset ie, the factory, by way of a reduced depreciation charge.
As no conditions were attached to the grant it would seem appropriate to net the full £100,000 off the factory carrying amount and depreciate the remaining net figure of £200,000 over the factory’s useful life. Land is assumed to have an indefinite life and therefore the grant would not be released to profit and loss if any of it was apportioned to the land.
The grant should be removed from profit or loss (by debiting other income by £100,000) and should be credited to non-current assets, specifically the factory.
As depreciation has already been charged for the year on the full factory cost of £300,000 an adjustment will need to be made for this. £9,000 (£300,000/25 years × 9/12) was recognised by the financial controller, although only £6,000 (£200,000/25 years × 9/12) should have been recognised. £3,000 should be credited to profit for the period and debited to non-current assets to adjust for this.
At 30 September 2016 the carrying amount of the factory should be £314,000 (120,000 + 200,000 – 6,000).
During the year Whitlock plc opened a number of new sports clubs across the UK. A one-off (1)
non-refundable joining fee of £50 per member is payable in addition to an annual membership
fee of £960. The joining fee relates to an induction session provided to all new members in their
first week of membership by a qualified member of staff. At this session new members’ fitness is
assessed and an exercise programme devised that takes into account all aspects of sports
provision. By 31 March 2017, 700 new members had paid both the joining and annual
membership fees. All new members had received their induction prior to year end. The average
unexpired period of membership at 31 March 2017 is eight months. Members use the facilities
equally throughout the year. All cash receipts had been recognised as revenue.
IFRS 15, Revenue from Contracts with Customers requires that revenue in respect of the provision of goods or services should not be recognised until the relevant performance obligation has been satisfied.
Where this obligation is satisfied over time, the proportion of the
obligation satisfied during an accounting period must be measured using either the output method, which measures satisfaction of the performance obligations based on the value
transferred to the customer, or the input method, which measures satisfaction based on the entity’s efforts or inputs (eg, costs incurred, time elapsed, labour hours), and a corresponding
amount of revenue recognised.
The one-off joining fee should be recognised on provision of the induction session. This is a performance obligation satisfied at a point in time. As all new members have received their
induction prior to the year end, revenue of £35,000 (£50 × 700) can be recognised.
The membership fee is a sale of services, as it gives access to the use of the gym facilities. This is a performance obligation satisfied over time as the customer simultaneously receives and
consumes the benefits as the performance obligation is satisfied.
The membership fee revenue should be recognised using the output method based on the value of services transferred to
members ie, over the 12-month membership period, as this is the period over which Whitlock plc will satisfy its performance obligation.
The revenue should be recognised on a monthly
usage rate; however, because monthly usage is generally even throughout the year, the revenue can be recognised on a straight-line basis.
At the reporting date of 31 March 2017, as there is an average unexpired term of eight months, only four months of revenue should be recognised:
£960 × 700 members × 4/12 months = £224,000
Total revenue of £259,000 (224,000 + 35,000) should be recognised for the year ended 31 March 2017.
The remaining £448,000 (£960 × 700 × 8/12 months) should be presented as a contract liability within current liabilities, as it represents consideration received in advance of the service being provided.
Whitlock plc measures its property, plant and equipment under the historical cost model. (3)
However, on 1 April 2016 the company decided to change to the revaluation model for the land
on which its outdoor facilities are based. These facilities are all based in key locations and the
land value has risen considerably. The land cost £450,000. An independent expert valued the
land at £700,000 although Whitlock plc’s managing director says that it is worth £1 million.
The land has been recognised in the draft financial statements at £1 million and the increase
recognised as part of profit for the period. The finance director made the adjustment as a
change in accounting estimate and hence no retrospective changes were made to the financial
statements
Whitlock plc currently uses the historical cost method for its property, plant and equipment however Whitlock plc wishes to change to the revaluation model.
The revaluation model is permissible provided that it is applied to a whole class of assets.
Accounting policies should be applied consistently from one period to the next to enhance comparability. However, where a new policy will result in reliable and more relevant information a change is permitted. A change from historical cost to one of valuation will better reflect current values and hence be more relevant, and a valuation carried out by experts will be considered reliable.
Although a change in measurement basis is a change in accounting policy and not a change in accounting estimate,
where an asset is moved from historical cost to revaluation it is
specifically excluded from IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.
Changes in accounting policy are normally applied retrospectively, however in respect of this issue, IAS 16, Property, Plant and Equipment takes priority and hence the change is accounted for prospectively in accordance with this standard.
The valuation provided by the independent valuer (£700,000) should be used, as it is more reliable than the estimate of £1,000,000 the managing director thinks the land is worth.
In the financial statements at 1 April 2016, the land should be recognised at £700,000. The increase of £550,000 (1,000,000 – 450,000) currently recognised should be reversed out of
profit for the period. The increase in the carrying amount of £250,000 (700,000 valuation – 450,000 cost) should be credited to other comprehensive income and accumulated in the
revaluation surplus within equity.
There is no depreciation recognised at 31 March 2017 as land is considered to have an indefinite life. The land should be revalued with sufficient regularity to ensure that the carrying
amount does not differ materially from its fair value. Therefore, assuming the land value hasn’t changed materially by the year end it will continue to be held at £700,000.
The following costs were incurred during the year on the development of a new sports centre (4)
and capitalised as part of property, plant and equipment:
Construction costs 305,000 Assembly and installation of equipment 42,000 Allocated general overheads 39,000 Architect’s fees 3,700 Launch event costs 5,600 Advertising 2,100 Testing of equipment 1,800 Employee training 2,300 Staff relocation costs 3,500
405,000
The sports centre was ready for use on 1 October 2016. However, there was a problem with the
centre’s new manager and therefore it did not open until a month later. Five months’ depreciation
has been charged on the centre’s capitalised cost of £405,000. The centre has an estimated useful
life of 15 years and is depreciated on a straight-line basis.
On 1 April 2016 Whitlock plc had 350,000 £1 ordinary shares in issue. On 1 July 2016 Whitlock plc
issued 50,000 £1 ordinary shares for cash at their full market value of £1.85 per share. On 1 January
2017 a 1 for 4 bonus issue was made
The new sports centre should initially be recognised at cost. IAS 16 sets out that the elements of cost which should be capitalised comprise the cost directly attributable to bringing the asset
to the location and condition necessary for it to be capable of operating in the manner in which it was intended.
Capitalisation should cease when the asset is capable of operating in the manner in which it was intended. Costs incurred after this date should be expensed.
Cost should be: PPE: Construction costs 305,000 Assembly and installation of equipment 42,000 Architect's fees 3,700 Testing of equipment 1,800
Expensed: Allocated general overheads 39,000 Launch event costs 5,600 Advertising 2,100 Employee training 2,300 Relocation costs of staff 3.500
The amount which should be capitalised as part of non-current assets is £352,500, with the balance of £52,500 being recognised as part of profit or loss for the period.
The £52,500 should be reversed out of non-current assets.
Depreciation should commence once the asset is ready for use, this is on 1 October 2016, so six months depreciation should have been charged rather than only five months. Depreciation
of £11,750 (352,500 / 15yrs × 6/12) should be recognised, hence the carrying amount of £340,750 (352,500 – 11,750) should be recognised at 31 March 2017.
An adjustment should be made for the incorrect depreciation charge of £11,250 (405,000/15yrs × 5/12), crediting profit or loss and debiting non-current assets.
Historically, Kumquat Ltd purchased cars from a single UK manufacturer. However, in June (1)
2017, Kumquat Ltd began to sell cars which had been purchased from a different
manufacturer, based in Europe. The first shipment of European cars was ordered on 5 May
2017, arrived on 10 June 2017, and the purchase invoice, for €160,000, was correctly
translated and processed. No adjustments have subsequently been made to this figure.
At the year end the invoice was unpaid and all the cars were unsold. The cars have been
included in inventories in the draft financial statements using the spot rate at 30 June
2017.
The spot exchange rates were as follows:
5 May 2017 – €1:£0.85
10 June 2017 – €1:£0.90
30 June 2017 – €1:£0.95
IAS 21, The Effects of Changes in Foreign Exchange Rates, states that a foreign currency transaction should be recorded, on initial recognition in the functional currency, by applying the exchange rate between the reporting currency and the foreign currency at the date of the transaction/historic rate.
When the goods were received on 10 June 2017, they were correctly recorded in purchases and trade payables at the spot rate of €1:£0.90 ie, at an amount of £144,000 (160,000 × 0.90) on the date when the risks and rewards passed.
However, at the year end, IAS 21 requires that any foreign currency monetary items are retranslated using the closing rate.
Monetary items are defined as “units of currency held and
assets and liabilities to be received or paid in fixed or determinable number of units of currency”. The trade payable in respect of this purchase meets the definition of a monetary
item so should have been retranslated at the closing rate, giving a year-end trade payable of £152,000 (160,000 × 0.95) and an exchange loss of £8,000 (152,000 – 144,000) recognised in profit or loss.
The appropriate journal entry is:
DR Profit or loss 8,000
CR Trade payables 8,000
Because inventory does not meet the definition of a monetary item, it should have been left as originally recorded/and not been restated, therefore reverse the entry. The appropriate journal
entry is:
DR Cost of sales 8,000
CR Inventories – statement of financial position 8,000
On 1 July 2016 Kumquat Ltd purchased plant for processing used oil. The plant is (2)
expected to operate for five years. The plant cost £150,000 and the draft financial
statements include a depreciation charge based on that figure. However, it was a
condition of the purchase that Kumquat Ltd must dismantle the plant at the end of the five
years. The cost of dismantling is estimated to be £20,000 but Kumquat Ltd made no
accounting entries in respect of this cost. An applicable discount rate is 5% pa.
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 dismantling costs meet these recognition criteria/a provision should be made as:
there is an obligation to dismantle (it was a condition of the purchase); •
it arose from a past event (the purchase of the plant); and •
there is a reliably estimated outflow of resources (the £20,000 that will be paid out). •
When the plant was purchased on 1 July 2016, a provision should therefore have been made
for the discounted costs of dismantling plant in five years’ time, measured as £15,671 (20,000
× 1/(1.05)5), adding this amount to the cost of the asset/giving a total cost of £165,671
(150,000 + 15,671). The appropriate journal entries are:
Dr PPE - cost 15,671
CR Dismantling Provision 15,671
The depreciation charge for the current year will now also need to be increased by £3,134
(15,671/5). The appropriate journal entry is:
DR COS/Depreciation charge 15,671
CR PP- AD 15,671
A finance cost/interest of £784 (15,671 × 5%) should be charged in the current year to reflect the unwinding of the discount and the provision should be increased by the same amount. The appropriate journal entry is:
DR FInance Cost 784
CR Dismantling Provision 784
In the statement of financial position as at 30 June 2017 the dismantling provision will be
shown as a non-current liability of £16,455 (15,671 + 784). The carrying amount of the plant
will be £132,537 (165,671 × 4/5).
On 1 July 2016 Kumquat Ltd purchased a zero coupon bond for £45,360 which the (3)
company expects to hold to redemption. The bond had a nominal value of £49,000.
Kumquat Ltd also paid broker’s fees of £1,250 in relation to the bond which it recognised
in other operating expenses. The bond is redeemable on 30 June 2019 at a premium of
7% and has an effective interest rate of 4% pa. In the draft financial statements, the bond
was included in cash and cash equivalents at its cost of £45,360.
The zero coupon bond is a financial asset and should be recognised when Kumquat Ltd enters
into a contractual provision of the financial instrument, which we assume to be 1 July 2016.
The bond should initially be measured at its fair value. Fair value is the price you would receive
to sell the financial asset in an orderly transaction between market participants at the
measurement date. Fair value is assumed to be the price paid for the bond as it is quoted in an
active market, being £45,360.
Transaction costs, such as brokers’ and professional fees, should be included in the bond’s
initial carrying amount. Hence the bond should initially have been recognised at £46,610
(£45,360 + £1,250).
After initial recognition at fair value the financial asset should be measured at amortised cost
using the effective interest method.
Amortised cost is:
the initial amount recognised for the financial asset, being £46,610; less •
any repayments of the principal sum, of which there are none as the bond is zero coupon; •
plus
any amortisation, using the effective interest rate of 4%.
Initial fair value 46,610
Add: Amortisation (46,610 × 4%) 1,864
Carrying amount at 3 June 2017 48,474
The year-end carrying amount should be recognised as part of non-current assets. Income of
£1,864 should be recognised in the statement of profit or loss in the period
