Question

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.

Answer 1

1	At the time of Purchase of Machine in 2017
	Cost =	2,00,000
	Trade discount	5%
	Hence the trade discount has to be reduced from the cost of assets as per the accounting standards
	Hence cost of asset to be recorded in the books = 2,00,000*0.95 = 1,90,000
2	Depreciation on the asset = 25% p.a.
	Depreciation p.a. on machine			47,500
	Depreciated value as at 1-6-18			1,42,500
	Revalued value of Machine			1,59,000
	Revaluation reserve			16,500
	Amount to be transferred to retained earnings at the end of every year =						5,500
3	Evaluation of the Recoverable value of the asset
	Cost of asset in the books =				1,06,000
	Fari value of asset that can be realised on selling =				86,000
	Present value of cash flows to be generated over 2 years
		Yr	CF	DF	PV
		1	45000	0.91	40,909
		2	45000	0.83	37,190
				PV	78,099
	Hence it appears that it is better off to sell the asset at the relisable value of 86,000 since the PV of cash flows is 78,099.
	Hence at the end of the year, the asset has to be revalued at 78,099 if it is intended to use or it has to be valued at 86,000 if it is sold off.
a)	If the asset is sold off:
	Book value of asset			1,06,000
	Less: Revaluation reserve			11,000
	Less: Selling price			86,000
	Loss on sale of machine			9,000
a)	If the asset is further used:
	Book value of asset			1,06,000
	Less: Revaluation reserve			11,000		Revaluation reserve shall be reversed in the books since the same is not realisable now.
	Net book value			95,000
	PV of cash flows			78,099
	Provision for Impairment of assets			16,901