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Background of the assignment

This assignment forms Part 2 (final part) of the major assignment. Students are provided with a business case in which an entrepreneur, Xiaojing Wu, from China immigrated to Australia and considered setting up a small business in South Australia. Xiaojing decided to start her business as a partnership but decided to dissolve the partnership after one of the partners was dismissed for conducting an unauthorised transaction. Subsequently, Xiaojing formed a public company named ChiHerbal Ltd. In Part 1 of the assignment, students are required to discuss the accounting regulation and reporting requirements for companies.


In Part 2, students are required to prepare journal entries to account for a range of transactions undertaken by ChiHerbal Ltd.Business Case Refer to the transcripts for Modules 2, 3, and 4 (except Impairment of Assets)


Learning Outcomes 1. Explain the regulatory framework that governs financial reporting in Australia with emphasis on the Conceptual Framework for financial reporting
3. Apply accounting principles and standards when accounting for non-current assets, revenue and liabilities and recognise the judgements required in a range of diverse business contexts

5. Differentiate between shares and debentures and apply appropriate accounting procedures

Instructions:
Students are expected to review the content of Modules 2, 3, and 4 (except Impairment of Assets in Module 4). Students are required to account for the formation and operations of ChiHerbal Ltd, i.e. transactions regarding the company’s financing activities, fixed assets, and intangible assets.


Assignment Part 2 Questions
Assume you were the accountant of ChiHerbal Ltd, address the requirements of the following independent scenarios for the company.Scenario 1 Financing Company Operations
On 1 August 2017, ChiHerbal Ltd issued a prospectus inviting applications for 800,000
ordinary shares to the public at an issue price of $12.87, payable as follows:
$4.20 on application (due by closing date of 1 November)
$4.90 on allotment (due 1 December)
$3.77 on future call/calls to be determined by the directors


By 1 November, applications had been received for 860,000 ordinary shares of which applicants for 100,000 shares forwarded the full $12.87 per share, applicants for 300,000 shares forwarded $9 per share and the remainder forwarded only the application money.At a directors’ meeting on 7 November, it was decided to allot shares in full to applicants who had paid either the $12.87 or $9 on application, to reject applications for 20,000 shares and to proportionally allocate shares to all remaining applicants. According to the company’s constitution, all surplus money from application can be transferred to Allotment and/or Call accounts.


Share issue costs of $12,000 were also paid on 7 November. All outstanding allotment money was received by the due date.A first call for $1.66 was made on 1 February 2018 with money due by 1 March. All money was received by the due date. A second and final call for $2.11 was made on 1 June with money due by 18 June. All money was received by the due date.


Required:
a) Prepare the journal entries to record the above transactions of ChiHerbal Ltd.
b) Prepare the equity section of ChiHerbal’s statement of financial position once the above transactions have been recorded. 

Scenario 2 Property, Plant and Equipment 
In the 30 June 2016 annual report of ChiHerbal Ltd, the equipment was reported as follows:
Equipment (at cost) $500,000
Accumulated depreciation 150,000   350,000
The equipment consisted of two machines, Machine A and Machine B. Machine A had cost $300,000 and had a carrying amount of $180,000 at 30 June 2016, and Machine B had cost $200,000 and was carried at $170,000. Both machines are measured using the cost model, and depreciated on a straight-line basis over a 10-year period. On 31 December 2016, the directors of ChiHerbal Ltd decided to change the basis of measuring the equipment from the cost model to the revaluation model. Machine A was revalued to $180,000 with an expected useful life of 6 years, and Machine B was revalued to $155,000 with an expected useful life of 5 years.

Background of the assignment

No. of Shares applied for

No. of Shares Allotted

Money Received

Application

$4.2

Allotment

$4.9

Call 1

$1.66

Call 2

$2.11

100 000

100 000

1 200 000

420000

490, 000

166,000

211,000

300 000

  300 000

2 700 000

1 260 000

  1470 000

           -

440 000

400 000

1 760 000

1 680 000

160 000

20 000

0

80 000

860 000

800 000

$5 740 000

$3 360 000

$2,120,000

$166,000

$211,000

General Journal

2018

To 1 November 15      Cash Trust       Dr        5,919,000

                                        Application Cr                    5,919,000

                        (Cash received on application)

November 7                  Application   Dr        84,000

                                    Cash Trust       Cr                    84,000

                        (Refund to 20 000 applicants)

                                 Application        Dr        3 360 000

                                    Allotment        Dr        4,214,000

                                          Share Capital        Cr                    7, 574,000

                        (Allotment of 860 000 shares)

                                          Cash          Dr        5857000

                                    Cash Trust       Cr                    5857000                     

(Transfer of trust funds)

                        Application *                          Dr        2 420 000

                                            Allotment            Cr                    2,120,000

                                    Calls in Advance        Cr                    377,000

                        (Allocation of application

                        across allotment and calls in advance)

                        * please see on the working table

                        Share Issue Costs/Share Capital         Dr        12 000

                                                                 Cash           Cr                    12 000

                        (Payment of share costs $12 000)

December 1                     Cash            Dr        1,932,000

                                    Allotment        Cr                    1,932,000

                        (Cash received on allotment)

2018

February 1                      Call 1           Dr        1,427,600

                                    Share Capital  Cr                    1,427,600

                        (Call of $1.66 per share)

                        Calls in Advance        Dr        166 000

                                        Call 1          Cr                    166 000

                        (Transfer of calls received

                        in advance)

March 1           Cash    Dr        1,162,000

                                    Call 1  Cr                    1,162,000                   

June 1  Call 2  Dr        1,814,600

                                    Share Capital  Cr                    1,814,600

                        ($1.40 per share)

                        Calls in Advance        Dr        211,000

                                    Call 2  Cr                    211,000

                        (Transfer of calls received

                        in advance)

June 28            Cash    Dr        1,477,000

                                    Call 2  Cr                    1,477,000                     

Chi Herbal Ltd

Equity

(as at 1st June 2018)

                        Contributed equity:

                            (800 000 shares paid to $12,87)                            $10,296,000

                        Less Share issue costs                                                           12,000                  

  Total Equity                                                                                                        $10,284,000

Scenario 2: Property, Plant and Equipment

CHIHERBAL LTD

During 31 December 2016, there was a Change from the cost model to the revaluation model

            Depreciation expense – Machine A             Dr                  15,000

                     Accumulated depreciation                  Cr                                    15,000

            (1/2 x 10% x $300 000)

            Depreciation expense – Machine B             Dr                  10,000

                     Accumulated depreciation                  Cr                                    10,000

            (1/2 x 10% x $200 000)

            Machine A                                                   Machine B

            Cost                                  300,000               Cost                               200,000

            Accum depn                     135,000               Accum depn                    40,000

                                                     165,000                                                     160,000

            Fair value                         180,000               Fair value                      155,000

            Increment                           15,000               Decrement                         5,000

            Accumulated depreciation – Machine A              Dr       135,000

                     Machine A                                                   Cr                         135,000

            (Writing the asset down to carrying amount)

            Machine A                                                            Dr         15,000

                     Gain on revaluation of machinery (OCI)    Cr                           15,000

            (Revaluation of asset)

            Income tax expense – gain on

                     revaluation of asset (OCI)                           Dr           4,500

                     Deferred tax liability                                    Cr                             4,500

            (Tax-effect of revaluation)

            Gain on revaluation of machinery (OCI)             Dr         15,000

                     Income tax expense (OCI)                          Cr                             4,500

                     Asset revaluation surplus – Machine A       Cr                           10,500

            (Accumulation of net revaluation gain in equity)

            Accumulated depreciation – Machine B              Dr         40,000

Requirements and Learning outcomes of the assignment

                     Machine B                                                   Cr                           40,000

            (Writing the asset down to carrying amount)

            Loss – revaluation decrement (P/L)                     Dr           5,000

                     Machine B                                                   Cr                             5,000

            (Revaluation of machine from $200 000

            to $155 000)

                      Depreciation expense of Machine A Dr                  15,000

                     Accumulated depreciation                  Cr                                    15,000

            (1/6 x 0.5x $180,000)

           Depreciation expense of Machine B            Dr                  15,500

            Accumulated depreciation                           Cr                                    15,500

            (0.2 x 0.5x $155 000)

             Machine A                                    $             Machine B                              $

             Carrying amount                165,000            Carrying amount          139 500

             Fair value                           163,000            Fair value                     136,500

             Decrement                              2,000            Decrement                        3,000                                                                    

            Accumulated depreciation for Machine A  Dr                  15,000

                     Machine A                                          Cr                                    15,000

            (The writing down to the carrying amount)

            Loss on revaluation of machinery (OCI)     Dr                    2,000

                     Machine A                                          Cr                                      2,000

            (Revaluation downwards)

            Tax liability Deferred                                  Dr                      600

                     Income tax                                          Cr                                        600

            Asset revaluation surplus for Machine A    Dr                   1,400

            Expense (Income tax                                   Dr                      600

                     Loss on revaluation of machinery      

                                                                                  Cr                                     2,000

            (Reduction in accumulated equity due

            to revaluation decrement)

            Accumulated depreciation – Machine B     Dr                 15,500

                     Machine B                                          Cr                                   15,500

            (Writing down to carrying amount)

 The loss by revaluation decrement of                    Dr                    3,000

                     Machine B                                          Cr                                      3,000

                        (Writing down to fair value) 

Scenario 3: Leases

Part A

Chi Herbal Ltd should base their classification criteria on the following:

  • The lessee cannot cancel the lease contract. A finance lease cannot be canceled as the lessee has the ownership of the property for the time agreed.
  • The lessee enjoys all the rewards and takes all the risks of the asset until it is returned, on the date agreed.
  • The finance lease treatment is similar to that of the loan as It appears in the balance sheets.
  • Linhong, G., & Jun, L.  (2017) stated that, the present value of the minimum lease payments is substantial all the economic

                       life of the leased asset.

                          PV of MLP = 30,500 x 2.8550 + 3,115 x 0.4972

                                              = 30,500 + 85,650+ 1,350

                                               =103,791

           Present Value of Minimum Lease Payment ÷ Future Value= 103,791÷ 129,000 = 80.5%

(v)        The five-year lease term represents the asset life (i.e. 5/6*100 =83.3%)

(vi)    The lessee bears all maintenance and insurance costs consistent with ownership. The lessee incurs all          insurance and maintenance cost just like the owner of the asset.

The Chi herbal should classify as a finance lease.

PV of MLP = 30 500 x 3.3522 + 3,115 x 0.4972

= 1,022,42.1 + 1548.778 =

=103790.9

=103,791

Chi Herbal Ltd (Lessee)

Schedule of lease payments

                                             MLP                            Interest                         Liability                       liability

                                                                            expense                        reduction                        balance

                                                $                                    $                                        $                                       $

 31 Dec 2015                                                                                                                                              103,791

31 Dec 2015                     30 500                                                                      30 500                              73,291

31 Dec 2016                     30 500                          10,994                                 19,506                             62,297

31 Dec 2017                     30 500                          9,345                                  21,155                             52,952

31 Dec 2018                     30 500                          7,943                                  22,557                            30,395

31 Dec 2019                     30 500                          4,559                                   25,941                            4,454

31 Dec 2020                     3115                              668*                                    4,454

*Includes adjustment for the effect of rounding

PART C

31 December 2016

Lease Liability                                                   Dr                                19,506

Interest Expense                                              Dr                                10,994

Cash                                                                   Cr                                                             30,500

(Second lease payment in advance)

Depreciation Expense                                     Dr                                20,135

Instructions

Accumulated Depreciation                            Cr                                                            20,135

(Depreciation for year 1, [$103,791– 3,115] ÷ 5)

31 December 2017

Lease Liability                                                    Dr                                 21,155

Interest Expense                                                Dr                                  9,345

Cash                                                                      Cr                                                            30,500

(Third lease payment in advance)

Depreciation Expense                                       Dr                                   20,135

Accumulated Depreciation                              Cr                                                             20,135

(Depreciation for year 2, [[$103,791– 3,115] ÷ 5))

31 December 2018

Lease Liability                                                     Dr                                  22,557

 Interest Expense                                               Dr                                    7,943

Cash                                                                     Cr                                                               30,500

(Fourth lease payment in advance)

Depreciation Expense                                       Dr                                 20,135

Accumulated Depreciation                              Cr                                                             20,135

(Depreciation for year 3, [$103,791– 3,115] ÷ 5)

31 December 2019

Lease Liability                                                     Dr                                 25,941

Interest Expense                                                Dr                                   4,559

Cash                                                                     Cr                                                                  30,500

(Fifth lease payment in advance)

Depreciation Expense                                    Dr                                 20,135

Accumulated Depreciation                            Cr                                                                20,135

(Depreciation for year 4, [$103,791– 3,115] ÷ 5)

31 December 2020

Depreciation Expense                                     Dr                                  20,135 

Accumulated Depreciation                             Cr                                                                20,135

(Depreciation for year 5, [$103,791– 3,115] ÷ 5)

Lease Liability                                                    Dr                                   4,454

Interest Expense                                               Dr                                       668

Leased Equipment                                             Cr                                                                  3,115

(Return of leased asset at guaranteed residual value)

Accumulated Depreciation                              Dr                                98,669

Leased Equipment                                             Cr                                                                    98,669

(De-recognition of leased asset) 

Scenario 4: Intangible Assets

Introduction

In the 2014/2015, the chi herbal had finished the project believing that, it was going to be successful. Although the company had the freedom to do what it takes to make sure that, the problem is solved, but had to follow the guidelines provided in paragraph 57 of the AASB 138. The start and the end of the project should be predetermined in accordance with some factors listed and explained below. It is accountable for its outlay in the following ways (.

Technical feasibility

Linhong, G., & Jun, L.  (2017) explained that, The company will be accountable for the unproductivity of the project if it occurs. It is very difficult to forecast the future of any business in terms of profitability or ability to serve what it is supposed. To reduce this, the Chi herbal must do some research. Regarding the international financial reporting standards, the carrying cost must be equal to the fair value of the asset.

During the viable period of the asset to be introduced, the chi herbal should make sure that the revaluation is taken into account. The revaluation process helps the owner of the asset to keep its updated value anytime and therefore avoid unproductive projects. The workability and flexibility are the other important aspects of the business projects to consider. It is not sensible when the machine that is not operable is introduced in the market for serving other people.

According to paragraph 57 of AASB, the asset should be categorized as either intangible or not tangible in nature. Intangible assets are like goodwill, permits, patents, copywrites and trademarks. This intangible asset is also considered in the valuation of the asset. Other intangible assets like the trademarks should be measured initially at cost according to the paragraph 58 of AASB. The chi herbal is accountable for such costs and should be taken care of at the start of the business. Both types of the assets should be well categorized so as for the project to be recognizable as stated by Linhong, G., & Jun, L. (2017). The fixed asset is considered as the asset that can be transferred and the intangible asset is known by its nature of not able to see, touch or physically transfer it. This is in accordance with paragraph 57 of AASB.

Scenario 1 Financing Company Operations

Intention to complete and sell

The chi herbal does the research, prepares the patent, and until it is complete, it can be used. It must be clear that the intention of the business is to complete and also to sell. Paragraph 34 of AASB states that the cost of research on an internal project should be considered when incurred. The chi herbal must have considered this during the research period of 2011 and 2012. From where it now moves to the testing period. Wong, K., & Joshi, M. (2015) stated that, for the patenting, the government will make sure that every move until the time it is complete is countable and it followed the provisions of AASB and the law.

Chi herbal will keep records of the patent administration so as to keep evidence of ownership. Bear in mind that, anybody can claim for the properties that are viable economically and hence still the innovative or incentive techniques of the other. The chi herbal should be accountable for any error or misrepresentation until it is complete.

The project must be able to sell and being used

In the year 2016/2017, the project was modified to make it sellable due to arising design problems. The chi herbal must reduce the claims related to the warranty regarding the operation of the filter system. The chi herbal is accountable for such claims and should make sure that everything operates at a very high efficiency. The project must have the demand, and the filter system usable by the users. The intangible assets are acquired when the government is sure that, what you did is viable and carries an economic value.

A good invention or innovation attracts the economic factors and therefore, its survival will be based on them and their fore leads to the legal ownership. The invention and innovation show a unique acquired skill of a person that should be protected. The chi herbal must have come up with the solution to solve the existing problem, and therefore, the solution must be usable by the whole community as should be researched in 2011 to 2012 and 2012 to 2013. And, the testing in 2014 and 2015 should ensure the compatibility between the customer and the problem.

The existence of a market

Chi herbal is accountable to make sure that there is a market for their product. There must be a customer and a certain price which the customer is supposed to pay. As done in 2026/2017, the research done to modify the design may be meant to enhance the market share, ore to attract hire price. More so, the chi herbal identified the market before, in connection to the available gap for the need for filters, to eliminate the iron content.

Linhong, G., & Jun, L. (2017) also concluded that, for the market to exist, there must be a high demand for the product is started. Chi herbal had been looking at what the farmers are going through and thereafter came the solution to solve this and enable the customers to use the clean water in their production and hence increases the productivity. This company had also helped to curb the problem that could arise due to shortages of the farming products in the market. The shortage is also the determinant what the customers want from the filter system

Availability of resources

The chi herbal will be accountable for the resources available. This company had enough resources when they were making this product. The resources include human resource and the raw materials. The company used the raw materials in a way that could help them achieve what they wanted. This means that they could be able to budget for the available resources and come up with a sensible product that can boost the economy.

More so, the resources also include the acceptance of the project by the government that could lead to the patent offers. In 2016/2017, the company had prepared some fees to pay for the patent. In 2017/2018, the company had to pay some fees for the patent, so that, no one could come up with the fake product like that. Chi herbal also had enough financial resources to cater for every activity needed regarding this project.

Ability to measure costs reliably

After the modification of the design in 2016/2017, the product cost was readily available. According to the paragraph 57 of AASB 138. Linhong, G., & Jun, L. (2017) explained that, It is advisable to record and measure the cost outlay appropriately, whether intangible or tangible. This will help with the knowledge of patent cost and other intangible assets. It also helps the project to run in a way that is profitable and accountable.

Conclusion

The cost incurred in 2017/2018 is the only amount that can be capitalized. The expensed money is all the amount of money incurred until 2016 and 2017.

Reference

Linhong, G., & Jun, L. (2017). A Case Study of Successful Financial Leasing Project. INNOVATION AND MANAGEMENT.

Wong, K., & Joshi, M. (2015). The impact of lease capitalization on financial statements and key ratios: Evidence from Australia. Australasian Accounting, Business and Finance Journal, 9(3), 27-44.

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