Question

Part a Donahue Ltd purchased a plant on 1 July 2018 for N$300 000. The entity incurred transfer fees of N$90 000. The expected dismantling cost at the end of the useful life of the plant is N$200 000. The applicable discount rate after tax (tax rate 25.75%) 6.3% Useful life 12 years The plant is erected on rented premises and the rental agreement requires dismantling of the plant at the end of its useful life. Assume that Inland Revenue services gives a 25% allowance on the plant and allows a deduction when dismantling costs are paid. The dismantling costs are reassessed on 1 July 2019 at N$220 000. Required: 1.1 Prepare journal entries relating to the change in dismantling cost estimate on 1 6 July 2016 Part b On 1 January 2017 Kuntan Ltd entered into an operating lease contract for premises in the Windhoek Weinhill Mall. The lease is to run for a period of 4 years (contract expires on 31 December 2020). As a result of several factors , the board of directors decided on 31 December 2018 to move the entity to Merua Mall with effect from 2 January 2019. However the lease contract determines the following: Operating lease payments per year (no escalation) N$10 000 Fine payable on early cancellation of the contract N$20 000 The premises cannot be sub-let. The company's year end is 31 December. A 12% market disc rate is expected to be applicable over a lease period. Required: 1.2 Discuss and determine the impact of the issue in the financial statements in 2019 14 and 2020.

Answer 1

Part A :- The data is for 2018 & the question is asking for the Journal Entries for 2016 hence it is inappropriate to answer the question. Both Data & question are from same platform.

Part B :- In the Financial Statement of Kuntan Ltd the following will appear.

As the company vacate the Lease hold Property before its Leasing period it has to pay the Lease amount for entire period plus fine in which year it is going to vacate the property. Accordingly in the given question the Lease Period start from 1st Jan 2017 for the period of 4 years (i.e. Calander Year 2017, 2018,2019 & 2020).

However after a period of two years due to several reason it vacate the said property. According to the Terms of lease it should pay Operating Lease of N$ 10000 on yearly basis to the Owner of the Property. Hence amount of N$10000 incurred as expense for 2017 & 2018 also and it is reflected in the Financial Statement of the Company.

In case of 2019 & 2020 the same amount (N$ 10000 each) plus Fine for canclleation of Contract N$ 20000 should be reflected as Extro-ordinary Expenses in the Financial Statement of 2019. Company can show N$10000 of 2020 as prepaid expenditure in 2019 financial statements. In 2020 it can treat the same as expenditure for that year.

Amount of N$ 20000 towards Fine for cancellation of Contract to be shown in the financial statement of 2019 itself as it incurred the expense in that year itself. It should not be treat as Prepaid expenditure of 2020.

Part A :- For Siser Ltd following is advisable.

Let us Studied & Analyze  this definition in Depth.

The Study Portion :-

Accoridng to IAS 23 -Borrowing Cost requires that "Borrowing Cost" which are directly attributable to either Acquision/Construction/Production of a "Qualifying Assets" are included in the Cost of that Assets. Other Cost which are incurred can be recognised as as Expense.

The Obective of IAS 23 is to prescribe the accounting treatment for Borrowing Cost. Borrowing Costs include a)Interest on Bank Overdraft and Borrowing , b) Finance Charges in finance lease, c) Exchange Difference on foreign currency borrowings if any where they are regarded as an adjustment to Interest Costs.

One Step further...

Borrwoing Cost may include a) interest expenses calculated by the effective interest method under IAS 39

b) Finance charges in respect of Finance Lease recognised in accordance with IAS 17 Lease, and

c) Exchange Difference arising from Foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

d) Discount on issue of loan note or Debentures

e) Premium on redemption of debentures or loan notes.

IAS -23 Borrowing Cost does not deal with either actual or imputed cost of equity , including any preferred capital not classifed as a liability pursuant to IAS 32.

Lets understand the Concept of "Qualifying Assets":-

A Qualifying Assets means that assets which takes a substantial period of time to get ready for its intended use or sale. That could be Property,Plant and Equipment, Investment Property during the construction period, intantiable assets during the development period or made -to-order Inventories.

However it exclude two types of assets that would otherwise be qualyifng assets. They Are

1) Qualifying assets measured at Fair Market Value such as biological assets

2) Inventories that are manufactured or otherwise produced, in large quantities on a repitative basis which required substantial period to get ready for sale.

The Analysis Portion & Conclusion

A] In the given Question Plant needs to be constructed in 20 Months time hence it is a Substantial period of time.Substantial period in general paralance means at least 12 month of time to get ready to use.Hence it is classified as Qualifying Assets for IAS 23. Secondly it is not covered in the excluded category list of item which is provided above. Thirdly all expenditre associated with plant are already capitalised other than Borrowing Cost.

In the Given Question Overdraft Facility drawan by the company for General Purpose use hence the interest amount of overdraft facility can be bifurcated between two parts i.e 1)which is used for the Production of Plant and 2) for the use of other general purpose.

The amount of interest which is used for production of plant can be capitalised by the effective interest method under IAS 39. Accordingly interest for the period 12th June 2019 (the Commencement date of construction of plant) till the cut of date (i.e. 31st October 2019) should be capitalised to the cost of the Plant.

B] Treatment of Interest paid on Debentures & Premium on redemption of debentures

The interest paid on Debentures & Premium on redemption of debentures are also qulafity for the Borrowing Cost under IAS 23. Accordingly in the give case interest @12 % and premium @ 5% towards redemption of debentures are qualify for the Capitalising the Cost on Plant.

Part B :- In the Books of A Ltd.

The Classification of the Instruments in Equity or Debt has been decided on the basis of Holder of the Instruments If it is held by the Share Holder of the Enterprise it is classified as Equity or Preference & If it is held by the Borrower it is classified as Debt of the Enterprise. Debt has been divided in two parts i.e. one which is converted in to equity after specified period of time & the other one which is not converted even after specified period of time. Both carry interest or coupon rate. On the other hand Equity also classified in two types i.e. Equity Share & Preference Shares. Equity share are hold by general public which is open for all and which Carries No Fixed Rate of Interest whereas Preferenctial shares are held by Specific class of people generally by the Promoter of the Company & its Friends and Close Relatives which carries fixed rate of interest.

Preferential shares have two types i.e. Convertible & Non-Convertible. Convertible Preferential Shareholder have the rights to convert the shares to equity but Non-Covertible Preferential Share Holder does not have the rights to convert its share to equity.

Accordingly the classification of the given instruments in the question are classified as follows.

A] Equity:-

i) 9% Convertible Preferential Shares as it converted into Ordinary shars after a period of 5 years.

ii) 13% Convertible Debenures but after 5 years & after the option chosen by the holder whether to convert or redeem. If the option to choose redeem is chosen then it should not be the part of Equity then it is a part of Debt.

B] Debt :-

i) 10% Redemable Preferential Shares which carry cumulative rate of dividents and compulsory redeem after 5 years.

ii) 11% Redemable Preferential Shares after chosed for redemption after a period of 5 years otherwise it is equity. Its sole discretion of A Ltd

iii) 12% Redemable Preferential Shares will redeem after a period of 5 years.

iv) 14% Debentures as it is never redeem it is treated as Debt for the Company.