Question

QUESTIONS BASED ON IAS 16, IAS 23, IAS 36, IAS 38 AND IAS 40

SCENARIO ONE

You are the financial controller of Mwikiti plc. Your assistant has a reasonable general accounting knowledge but is not familiar with the detailed requirements of all relevant financial reporting standards. Two issues on which he requires your advice are shown below:

Transaction (a)

On 1 October 2018 we bought a property, consisting of land and buildings, for K600 million (land element K360 million). I have the following information regarding this property:

1. The fair value of the property on 30 September 2019 was K660 million (land element K405 million) and on 30 September 2020 K720 million (land element K435 million).
2. The estimated useful economic life of the buildings on 1 October 2018 was 40 years. This estimate remains valid.
3. We make an annual transfer to retained earnings of the excess depreciation on revalued assets. I know we use the revaluation model to measure our properties but I have no experience of computing the figures and I do not know what excess depreciation means. Please show me how to compute the figures in the statement of financial position for the property and the revaluation surplus at 30 September 2019 and 2020. Please also show me how to calculate the depreciation charge that will be included in the statement of profit or loss for the years ended 30 September 2019 and 2020.                        (8 marks)

Transaction (b)

On 1 October 2017 we bought a machine for K150 million. We originally estimated a useful economic life of five years with no residual value. On 1 October 2019 we looked at these estimates again and now we think the original estimate was over optimistic. The machine is unlikely to generate economic benefits for us after 30 September 2021 but we could expect a scrap value of K6 million at today’s prices. We haven’t charged enough depreciation in the years ending 30 September 2018 and 2019 but I’m not sure how to reflect this – should I change my brought forward figures?                      (6 marks)

Required

Discuss the required accounting treatment of the above transactions to the assistant financial controller of your company for the two years ended (as described in separate scenarios).

SCENARIO TWO

Musonda Plc acquired an incomplete building from Veekay Limited on 31 December 2018 at a total cost of K200,000. On 1 January 2019 construction works on the building commenced. Musonda Plc has estimated that the building will take 15 months to be ready for use. Musonda Plc wants to sell the building immediately it is ready for use.

The constructions works are expected to cost Musonda Plc K120,000. This will be financed by Musonda Plc’s existing loans’ outlay. Musonda Plc has three (3) existing loans as shown below:

Amount                      Interest rate               Date borrowed          Loan duration

Loan 1 K150,000                   20%                             1 October 2015           5 years

Loan 2             K250,000                   12%                             1 October 2016           8 years

Loan 3             K300,000                   10%                             1 October 2017    10 years

Musonda Plc has already used K400,000 of the loans on other construction projects which are still on–going. All the loans have a fixed annual interest and principal amounts are repayable at the end of each loan period.

In the year to 30 September 2019, Musonda Plc spent K60,000 on the construction works of the building acquired from Veekay Limited. Total interest for the year to 30 September 2019 was fully paid on 30 September 2019.

The directors of Musonda Plc are not sure of how to treat the building and interest on loans in their financial statements for the year to 30 September 2019.         

Required:

Explain how the transactions would be treated in the financial statements of Musonda Plc. for the year ended 30 September 2019.                                                                     (8 marks)

SCENARIO THREE

Kaymore Plc acquired a piece of land on 1 April 2018. The purchase price of the land was K200,000. On the same date, Kaymore Plc incurred legal fees of K10,000 in relation to transfer of ownership. Kaymore Plc intends to keep the land and sell it when the market price increases substantially. The market price of land at 31 March 2019 was K225,000.

Kaymore Plc does not know how to treat the land in its financial statements for the year ended 31 March 2019.

Required:

Advise Kaymore Plc on how the above transaction should be treated in its financial statements for the year ended 31 March 2019.                                                    (6 marks)

SCENARIO FOUR

Dalaso Plc acquired a piece of machine on 1 June 2017 at a cost of K200,000. This cost is before taking into account trade discount of 5% that Dalaso Plc received on the same date. On 1 June 2018, the machine was revalued to K159,000.

During the year to 31 May 2019, there was a reduction in the use of the machine because of decline in demand for Dalaso Plc’s products as a consequence of new entrants in the market. This prompted Dalaso Plc to review the machine for impairment. At 31 May 2019, the machine had a fair value less costs to sell of K86,000. Further, Dalaso Plc expects the machine to generate net inflows of K45, 000 in each of the last two years of its remaining economic useful life.

Dalaso Plc has a policy of transferring to retained earnings an amount representing realised revaluation surplus. Machines are depreciated using straight line method at an annual rate of 25%. Dalaso Plc uses an annual discount rate of 10%.

The machine is recorded in the financial statements of Dalaso Plc based on 31 May 2018 carrying value of K142,500.

Note: Assume the machine has a nil residual value at the end of its economic useful life.

Required   

Write a report to the Chief Executive Officer that explains:

How the above transactions will be treated in the financial statements of Dalaso Plc for the year ended 31 May 2019.                                                                  (8 marks)

Note: Include relevant calculations in your explanations.

SCENARIO FIVE

Bacata Plc incurred development expenditure amounting to K150,000 and K200,000 in the year ending 30 November 2018 and 30 November 2019 respectively on the new product, ‘Foodies’, that the company has developed for two years now. The product will be ready for sale on 31st December 2019. The figure shown under non-current assets in the statement of financial position as at 31st December 2019 represents the total development expenditure to date of K350,000.

The directors of Bacata Plc, at 30th November 2018, estimated that ‘Foodies’ would generate total revenue of K400,000 over its economic life. They, at 30th November 2019, revised the figure to K500,000 owing to positive developments in the product’s market.

Estimates of costs to completion of product development are as follows:

At 30 November 2018 K270,000

At 30 November 2019 K70,000

Required: Explain the appropriate adjustments required to correctly account for the development expenditure in the financial statements of Bacata Plc for the year to 30 November 2019.

(6 marks)

SCENARIO SIX

Funama Limited borrowed K800,000 on 1st January 2014 from Palama Bank. The loan attracts interest rate of 10% per annum. The loan was for the construction of its office block.

Construction commenced on 1st April 2014 and is likely to be completed on 31st March 2016.

On 30th September 2014, construction works were suspended because of striking construction workers. However, construction works resumed on 1st January 2015.

Note: Interest for the year to 31st December 2014 has been paid.

Required

Explain the accounting treatment of interest cost in the financial statements of Funama Limited for the year to 31st December 2014.                                              (5 marks)

Answer 1

SCENARIO ONE:

Transaction a :

IAS 16 : Property, Plant and Equipment :

On 01.10.2018 Land and building purchased for K600 million - Land for K360 million and remaining building for k240 million. Every year property is revalued.

Under revaluation model, increase in revaluation asset value will be recognised as income and accumulated in equity or reverse with previous revaluation loss, if any.

Therefore, difference between (carrying amount - revalued amount = / - is gain or loss):

date	Total	Land	building		gain
01.10.2018	600	360	240	purchase value
30.09.2019	660	405	255		15
30.09.2020	720	435	285		30

For both year there is revaluation gain of building K45 million and there is no depreciation for Land.

Accounting entry for revaluation of asset

Building Account Dr (K240-K255) K15

Revaluation reserve Accounnt Cr K15

and depreciation on straight line basis:

Depreciation Account Dr K6

Accumulated depreciation Cr K6

Transaction b :

Previous useful life of the asset is five years and revised to four years at the end of 30.09.2021. Accumulated depreciation upto 30.09.2021 is K120 (K150/5 yrs = K30 each year on straight line basis) (K30*4 years = K120).

As per useful life revised then the depreciation will be calculated as WDV on 30.09.2020 = K60 - depreciation for that year is K37.5 plus difference of depreciation accounted as per previous useful life is K22.5(7.5*3) = K60

K6 scrap will be realised in income statement.