HI6025 Accounting Theory And Current Issues 3

Question:

Week 4

Snowy Ltd acquires Pax Ltd on 1 July 2018 for $5,000,000 being the fair value of the consideration transferred. At that date, Pax Ltd’s net identifiable assets have a fair value of $4,400,000. Goodwill of $600,000 is therefore the difference between the aggregate of the consideration transferred and the net identifiable assets acquired.

The fair value of the net identifiable assets of Pax Limited are determined as follows:

($000)

Patent rights	200
Machinery	1,000
Buildings	1,500
Land	2,300
	5,000
Less: Bank loan 600
Net assets	4,400

 

At the end of the reporting period of 30 June 2019, the management of Snowy Ltd determines that the recoverable amount of the cash-generating unit, which is considered to be Pax Ltd, totals $4,500,000. The carrying amount of the net identifiable assets of Pax Ltd, excluding goodwill, is unchanged and remains at $4,400,000.

Required:

a) Prepare the journal entry to account for any impairment of goodwill.

b) Assume instead that at the end of the reporting period the management of Snowy Ltd determines that the recoverable amount of the cash-generating unit, which is considered to be Pax Ltd, totals $4,200,000. Determine the impairment of goodwill amount. (No journal entries required)

Week 5

On 1 July 2019, Fisher Ltd decides to lease a cargo ship from XFinance Ltd. The term of the lease is 20 years. The implicit interest rate in the lease is 10 per cent. The fair value of the cargo ship at the commencement of the lease is $2,215,560. The lease is non-cancellable, and requires a lease payment of $300,000 on inception of the lease (on 1 July 2019) and lease payments of $250,000 on 30 June each year (starting 30 June 2020). Included within the $250,000 lease payments is an amount of $25,000 representing payment to the lessor for the insurance and maintenance of the cargo ship. There is no residual payment required. Annuity factor, n=20; r = 10% is 8.5136.

Required:

a) Prove that the interest rate implicit in the lease is 10 per cent.

b) Provide the entries for the lease in the books of Fisher Ltd as at 1 July 2019, and 30 June 2020.

c) Provide the entries for the lease in the books of XFinance Ltd as at 1 July 2019, and 30 June 2020.

 

Answer:

Week 1

Answer (a) - One example where the information is relevant but is not faithfully represented is the information regarding an increase in the Earnings Per Share (EPS) of a company since the last reporting period is a relevant piece of information for the investors in the sense that they would be able to analyse the past results and make informed decisions about the future performance of the company. However, lack of proper audit coupled with under reporting of expenses like depreciation, interest etc. in order to manipulate the profits unreasonably renders the information unreliable or not faithfully represented as the information is not free from errors.

Answer (b) - One example where the information is not relevant but is faithfully represented is an estimate regarding defaults by customers amounting to $1000 for a company having net assets of $10 million supported by adequate disclosures and measurements based on past trends is certainly a piece of information that is faithfully represented. In this case, the default cannot be expected to have any real economic impact on the financial position of the company. Thus, in the context of the financial position of the company, the information is not relevant to satisfy the decision-making requirements of the users of the financial statements because the information is not material, i.e., not capable of influencing the decision making pattern of the users.

Answer (c) - One example where the information is relevant and faithfully represented is that of a comprehensive balance sheet duly audited by independent parties representing information about income, existing debt obligations, cash and other liquid assets is an example of a piece of information that is relevant for the creditors for determining the financial health of the business. This kind of information can help the creditors to calculate various ratios, viz, debt-equity ratio, total assets-debt ratio and decide the terms and conditions of the credit accordingly. Such a balance sheet also highlights secondary sources of payment of debt for the creditors. Since, the balance sheet is duly audited by independent parties, the neutrality and reliability of the information is also established, and hence, the information is also faithfully represented. 

Week 2

Answer (a)

The relationship and the co-existence between a business and the society is determined by the means of Social Contract. The social contract is nothing but what the society demands from the organisations and adequately and appropriately describes the norms placed by the society. This link between the both is served by the means defined as Social Contract. The procedures and steps applied in order to achieve the norms of social contract is defined as legitimacy of the organisation. The legitimacy describes the state in how an organisation is complying with social contract and that conduct of the organisation is accurate and appropriate. The organisation existence is dependent upon the legitimate actions of the organisation which in turn defines the compliance with the social contract. Thus, whether the terms of social contract is achieved or sustained is determined by its legitimacy. If there is a gap between the act that should take place and the act that has taken place leads to legitimacy gap.

Thus, in order to have a long term growth and perspective an organisation should not ignore its organisational legitimacy and its obligation to comply with social norms created by the social contract. This social contract and legitimacy may have either the positive impact or the negative impact on the operations of the organisation. Therefore, every organisation should have proper planning on how to achieve or comply with these norms with appropriate use of resources.

Answer (b)

An organisation needs to preserve or obtain legitimacy where it has been inferred that it is in variance with the expectations of the society. Two ways an organization can obtain or preserve legitimacy are -  

• An organisation should try to find out way to educate the society about the real and genuine changes in the actions of the organisation so that the gap that arises does not portray the negative impact on the organisation which in turn may impact the overall operations of the organisation;  

• An organisation should try to manage the opinion by seeking to divert attention from the matter of concern to other related matters and arguments that are also in relation to the society which may create positivity in the society. (Guthrie, 2006)

Disclosures in these all the techniques play a very important role in each of these policies. Corporate disclosures presents a technique to change the view point of society about the legitimacy of the company.  

Week 3

Answer (i)

Journal Entries in the books of Diamond Ltd.

Date	Particulars	Debit ($)	Credit ($)
01-07-2015	Equipment A/c	4,40,000
	To Bank A/c (Being polishing equipment acquired)		4,40,000

 

Depreciation as per Straight Line Method (Kennon, 2020)

Cost of the equipment = $ 4,40,000

Salvage Value = $ 40,000

No. of years of useful life = 10

Therefore, Depreciation = Cost Less Salvage Value / No. of years

    = $ (4,40,000 – 40,000) / 10

    = $ 40,000 per year

Entry for Depreciation shall be as follows at the following dates –

Date	Particulars	Debit ($)	Credit ($)
30-06-2016	Depreciation A/c	40,000
	To Accumulated Depreciation A/c (Being Depreciation charged)		40,000
30-06-2017	Depreciation A/c	40,000
	To Accumulated Depreciation A/c  (Being Depreciation charged)		40,000

  

Answer (ii)

Fair Value of the Equipment as on 01/07/2017 = $ 4,24,000

The Net Method as prescribed under AASB 116 guiding Property, Plant and Equipment (AASB, n.d.) has been used for treating the PPE–

 

Date	Particulars	Debit ($)	Credit ($)
01-07-2017	Accumulated Depreciation A/c	80,000
	To Equipment A/c		80,000
	(Being Acc. Depreciation eliminated against gross carrying amount of the equipment)
01-07-2017	Equipment A/c (4,24,000 – 3,60,000)	64,000
	To Revaluation Reserve A/c		64,000
	(Being fair value of equipment recognised)

 

Depreciation as per Straight Line Method

Fair Value of the equipment = $ 4,24,000

Salvage Value = $ 0

No. of years of useful life = 8

Therefore, Depreciation = Cost Less Salvage Value / No. of years

    = $ (4,24,000 – 0) / 8

    = $ 53,000 per year

Entry for Depreciation shall be as follows at the following dates –

Date	Particulars	Debit ($)	Credit ($)
30-06-2018	Depreciation A/c	53,000
	To Accumulated Depreciation A/c		53,000
	(Being Depreciation charged)
30-06-2019	Depreciation A/c	53,000
	To Accumulated Depreciation A/c		53,000
	(Being Depreciation charged)

Answer (iii)

Sale Value of the Equipment as on 01/07/2019 = $ 3,56,000

Following are the journal entries on sale of Equipment as on 01/07/2019 –

 

Date	Particulars	Debit ($)	Credit ($)
01-07-2019	Bank A/c	3,56,000
	To Equipment A/c		3,18,000
	To Gain on sale of Equipment		38,000
	(Being equipment sold)
01-07-2019	Revaluation Reserve A/c	64,000
	To Retained Earnings		64,000
	(Being revaluation reserve recognised on fair value t/f to Retained Earnings on sale)

Week 4

• Prepare the journal entry to account for any impairment of goodwill.

Answer

Snowy Ltd. acquired Pax Ltd. for $ 50,00,000 and the Net Identifiable Assets of Pax Ltd. amounts to $ 44,00,000. The difference is the goodwill on acquisition amounting to $ 6,00,000. (BDO, n.d.) 

The basic rule behind allocating the impairment loss to the CGU is that it shall first be allocated 100 % towards goodwill and then the balance shall be allocated to other assets. (AASB, n.d.)

The following is the treatment of goodwill of the for the reporting period on 30-06-2019 –

Carrying Amount of CGU excluding goodwill = $ 44,00,000

Goodwill recorded at acquisition = $ 6,00,000

Total carrying amount of CGU = $ 5,000,000

Recoverable amount of CGU = $ 45,00,000

Therefore, Impairment Loss = Carrying Amount – Recoverable Amount

          = $ (50,00,000 – 45,00,000)

          = $ 5,00,000

Since, the impairment loss is than the value of goodwill therefore entire amount of loss shall be allocated to goodwill.

 

Date	Particulars	Debit ($)	Credit ($)
30-06-2019	Impairment Loss A/c	500,000
	To Goodwill A/c		500,000
	(Being Goodwill impaired recorded )

Answer (b)

If at the end of the reporting period, the management determines the recoverable amount of the CGU to be $ 4,200,000 then the following shall be the treatment for impairment -

Carrying Amount of CGU excluding goodwill = $ 4,400,000

Goodwill recorded at acquisition = $ 600,000

Recoverable amount of CGU = $ 4,200,000

Therefore, Impairment Loss = Carrying Amount – Recoverable Amount

          = $ (5,000,000 – 4,200,000)

          = $ 800,000

This amount of impairment shall first be allocated towards goodwill and then the balance towards other assets. Therefore, in this case $ 800,000 shall first be allocated to goodwill amounting to $ 600,000 and then the balance to other assets. Therefore, the impairment of goodwill shall be equivalent to $ 600,000.

Week 5

Answer (a)

In order to prove the implicit rate of interest is 10%, the fair value of the ship shall be equivalent to the Lease Income at inception along with lease income for future period when discounted at the rate of 10%. (OHM, 2020)

Fair Value of the Ship = Inception Value + Present Value of Future Lease Income

 = 3,00,000 + (2,50,000 – 25,000) * Annuity Factor (10% , 20)

 = 3,00,000 + 2,25,000 * 8.5136

 = 3,00,000 + 19,15,560

 = $ 22,15,560

Further, Repairs and Maintenance are not taken into consideration for calculating the present value of the future Lease Income.

Since the present value of the Lease Income is equivalent to Fair Value of the ship therefore it is proved that implicit interest rate is 10%. (AASB, n.d.)

Answer (b)

Journal Entries in the Books of Lessee (Fisher Ltd.)

Date	Particulars	Debit ($)	Credit ($)
01-07-2019	Right to Use Asset A/c	22,15,560
	To Lease Liability		22,15,560
	(Being Asset acquired on Lease)
01-07-2019	Lease Liability A/c	3,00,000
	To Bank A/c		3,00,000
	(Being Lease payment made)
30-06-2020	Interest A/c	1,91,556
	To Lease Liability A/c		1,91,556
	(22,15,560 – 3,00,000)*10%
	(Being Interest Expense recorded on Lease Liability)
30-06-2020	Lease Liability A/c	2,25,000
	To Bank A/c		2,25,000
	(Being Lease payment made)
30-06-2020	Repairs & Maintenance A/c	25,000
	To X Finance Ltd.		25,000
	(Being repair & maintenance expense incurred by lessor recorded)
30-06-2020	X Finance Ltd.	25,000
	To Bank A/c		25,000
	(Being amount paid to X Ltd. for Repairs and Maintenance)
30-06-2020	Depreciation A/c	1,10,778
	To Right to Use Asset (22,15,560 / 20)		1,10,778
	(Being Depreciation booked on Right to Use Asset)

Answer to (c)

Journal Entries in the Books of Lessor (X Finance Ltd.)

Date	Particulars	Debit ($)	Credit ($)
01-07-2019	Net Investment on Lease A/c	22,15,560
	To Asset A/c		22,15,560
	(Being Asset provided on Lease)
01-07-2019	Bank A/c	3,00,000
	To Net Investment on Lease A/c		3,00,000
	(Being amount received on Lease)
30-06-2020	Net Investment on Lease A/c	1,91,556
	To Profit & Loss A/c		1,91,556
	(Being Interest Income recorded on Lease)
30-06-2020	Bank A/c	2,25,000
	To Net Investment on Lease A/c		2,25,000
	(Being amount received on Lease)
30-06-2020	Repair & Maintenance A/c	25,000
	To Bank A/c		25,000
	(Being amount paid for repair & maintenance)
30-06-2020	Fisher Ltd.	25,000
	To Repair & Maintenance A/c		25,000
	(Being repair & maintenance expense incurred by lessor on behalf of lessee)
30-06-2020	Bank A/c	25,000
	To Fisher Ltd.		25,000
	(Being amount received for Repair & Maintenance)

References

AASB, n.d. Goodwill and Impairment. [Online] Available at: https://www.aasb.gov.au/admin/file/content102/c3/8.2_ASAF_Goodwill_impairment_April%202018_M165.pdf [Accessed 11 May 2020].

AASB, n.d. Leases. [Online]  Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB16_02-16.pdf [Accessed 11 May 2020].

AASB, n.d. Property, Plant and Equipment. [Online]  Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB116_08-15_COMPoct15_01-18.pdf
[Accessed 11 May 2020].

BDO, n.d. Impairment. [Online]  Available at: https://www.bdo.com.au/en-au/accounting-news/accounting-news-november-2016/blind-freddy [Accessed 20 May 2020].

Guthrie, P. J., 2006. Legitimacy Theory. [Online]  Available at: https://www.csringreece.gr/files/research/CSR-1290000469.pdf [Accessed 11 May 2020].

Kennon, J., 2020. Straight Line Depreciation. [Online]  Available at: https://www.thebalance.com/straight-line-depreciation-method-357598 [Accessed 20 May 2020].

OHM, M., 2020. Leases. [Online]  Available at: https://www.hlb.com.au/new-leasing-standard-aasb-16-brings-significant-impacts/[Accessed 20 May 2020].