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HI6025 Accounting Theory and Current Issues | Final Assessment Solved

Question 1                                                                                                    ( 7 marks)

ABC Ltd has the following land and buildings in its financial statements as at 30 June 2022:

At 30 June 2022, the balance of the revaluation surplus is $800 000, of which $600 000 relates to the factory land and $200 000 to the buildings. On this same date, independent valuations of the land and buildings are obtained. In relation to the above assets, the assessed fair values at 30 June 2022 are:

Required:

Provide the journal entries to account for the revaluation on 30 June 2022. ABC Ltd classifies the residential land and the factory land as different classes of assets.

ANSWER:  ** Answer box will enlarge as you type

Workings

Revaluation surplus of residual land  = Fair value – carrying value

(2,200,000 – 2,000,000) = $200,000

Revaluation surplus of factory land (1,400,000 – 1,800,000) = ($400,000)

Revaluation surplus on building (1,800,000 – 1,400,000) = $400,000

Question 2                                                                                                    (7 marks)

XYZ Ltd acquires 100 per cent of Red-X Ltd on 1 July 2021. XYZ Ltd pays the shareholders of Red-X Ltd the following consideration:

There are also legal fees of $190 000 involved in acquiring Red-X Ltd.

On 1 July 2021 Red-X Ltd’s statement of financial position shows total assets of $300 000 and liabilities of $300 000. The fair value of the assets is $800 000.

Required:

Has any goodwill been acquired and, if so, how much? And discuss the potential for including associated legal fees into the cost of acquiring Red-X using appropriate accounting standard.

ANSWER: 

Calculating Goodwill

Aseets value less liabilities (800,000 -300,000) = $500,000

Goodwill = Consideration paid – net assets

 ($810,000 – $500,000) = $310,000

Goodwill = $310,000

The impact of including legal fees is essential because it is part of the acquisition cost and the asset cannot be transferred to the purchase for use without the includion of the legal fees.

Question 3                                                                                                    (7 marks)

Explain how the lease liability and a right-of-use asset would be recognised and measured at the lease inception? Explain the typical expenses recognised by a lease during lease period.

ANSWER: 

According to the provisions of the AASB 16, a lease is recognised at trhe commencement date, at this data e a lesee should recognise a right-of-use asset and lease liability. Notably, lease a right-of –use asset is recognised at this date because the asset is used by the lessee, who is the person or entity renting the property. It is also important to understand the definition of a commencement data under the AASB 16. The lease is recognised at the commencement date, which is the date on which the lessor makes the asset in question available for the use by the lessee.

At the lease inception, the initial payment made by the lessees is recognised as the lease liability. Also, the fixed payments made by the lessee during the lease period are recognised as the lease liability. In most cases, fixed payments are made in instalments after a given period of time. For instance, fixed payments on a seven year lease can be made annually. In such a case, the lessee will pay annual fixed payments which are recognised as the lease liability. Notably, lease liability is recognised as the present value of the lease payments over a given period of time. The lease payments are discounted by the implicit interest rate to determine the effective present value, which is the measure of lease liability.

As a result, the implicit rate of interest of the lessee’s incremental borrowing rate can significantly affect the measurement of leas liability. Since the net present value of the lease payments is determined by discounting the payments using implicit interest rate, the measure of lease liability is more likely to be affected by the implicit interest rate. Another important aspect in measuring lease liability is that it will be reduced by the interest expense for each period, if applicable. This applies on the leases that have interest expense payable by the lessee at given periods.  

On the other hand, the right-of-use asset is measured at cost. The cost includes the initial lease liability, the initial direct cost incurred by the lessee, an estimate of cost to be incurred by the lessee in removing the underlying asset and the lease payment made at or before the commencement date. These cost elements make up the cost for which the right-of-use asset is measured.

Notably, interest expense is one of the expenses recognised by the lease during the period. This expense is payable by the lessee and it can be included in the total lease payments for each period. Maintenance costs is another typical expenses recognised during the lease period. Such expenses are paid by the lessees and are recognised at each period of lease payment. Another typical expense that is recognised during the lease period is insurance expense. This is the expense that caters for the risks associated with the use of the underlying asset.

Question 4                                                                                                    (11 marks)

Discuss (Using Australian accounting standard) If a decision is made to abandon an area of interest, how should any pre-production costs in respect of that area be treated? Explain, what costs should be included in the cost of inventory of an entity involved in the extractive industries.

ANSWER: 

According to Australian accounting standards, the costs carried forward relating to the abandoned area should be expensed in the period in which the decision to abandon the area is made. This shows that if the decision to abandon the area is made in this financial year, the costs carried forward relating to that area should not be expensed on the following or previous years, instead it should be expensed on the year in which the decision to abandon the area is made. In most cases, expensing such costs is likely to be done through annual impairment testing because the costs carried forward would not have economic benefits in the future. The lack of future economic benefits attributes to the fact that the area has been abandoned and the entity will not benefit from it in the future. In this regard, the recoverable amount is more likely to be less than the carried forward amount and this will be recorded as an impairment loss. The impairment loss will be recorded in the entity’s financial statements for the period in which the decision to abandon the area is made. The impairment loss will be included in the inventory of an entity involved in the extractive industries.

Another important cost to be considered when the area is abandoned is the direct and indirect costs of exploration, development and evaluation of the area which were carried forward. In such a case, there would be a general requirement for these costs to be amortised against revenue earned in the area during the production phase. However, there would be no revenues during the evaluation and exploration phase for the carried forward direct and indirect costs to be amortised. The Australian accounting standard provides that the carried forward cost should be subject to regular impairment testing. The amortised costs will be included in the inventory of the entity.

The Australian accounting standard provides that the total costs carried forward to the production phase should be allocated over the life of the economically recoverable reserve in terms of the production level that would be generated from the area. The accounting standards also provides that in some cases, the total costs carried forward can be allocated in terms of time period such as a fixed period tenure over the area.

Under the AASB 102 Inventory, resources should not be classified as inventory before they are extracted. In this regard, an entity involved in the extractive industries will not record the resources as inventories before they are extracted in accordance to the Australian accounting standards. If the area is abandoned before the extraction of the resources, the resources will not be recorded in the entity’s inventory. Since the carrying amount of the exploration and evaluation of the area cannot be recovered fully, an entity involved in extractive industries should perform impairment test in accordance with AASB 136. In such a case, any impairment loss is recognised as expense in the financial statements of the entity in accordance with AASB 136. Such expenses are included in determining the present amount of the entity’s inventory.

Question 5                                                                                                    (7 marks)

Pearson Ltd is an Australian listed company. Its results for the financial year ending 30 June 2023 have exceeded expectations—profit before tax is $11.194 million and income tax expense is $2.216 million. As at 30 June 2022, there were 11.700 million ordinary shares on issue. On 11 May 2023, 4.225 million further ordinary shares were issued at a price of $2.99—paid to $2.4. The partly paid shares carry rights to dividends in proportion to the amount paid relative to the total issue price.

Required:

Calculate the basic EPS for Pearson Ltd for the year ending 30 June 2023.

ANSWER: 

Earnings per share (EPS) = (Net income / Weighted average share outstanding)

Net income = Income before tax – Income tax expense

($11.194 m – $2.216m)

= $8.978m

Weighted average share outstanding

Shares issued at 30^th June 2022, 11.700 million

Additional shares issued on May (4.225 x 50/365) = 0.579 million

Weighted average share outstanding at June 30^th 2023(11.700 + 0.579)

= $12.279 million

Earnings Per Share = ($8.978 m / $12.279 million)

$0.73 per share

Question 6                                                                                                    (11 marks)

Explain the ‘qualifying asset’ and how do we treat exchange rate differences relating to the acquisition of qualifying assets? Compare and contrast this with the treatment for assets that are not qualifying assets?

ANSWER: 

Qualifying assets includes those assets that take a reasonable amount of time for them to be ready for use by an entity. Some of the qualifying assets include intangible assets and manufacturing plants. Also, constructed asset or investment property such as bridges take a long period to complete, thus making them examples of qualifying assts. According to AASB 123, financial assets or inventories that are manufactured or produced over a short period of time are not considered as qualifying assets (AASB, 2018, P6(1)). This shows that qualifying assets are attributable to a long-term period of production or manufacturing.

Australian accounting standards provides that exchange differences arising in respect of foreign transaction relating to or can reasonably be attributed to qualifying assets shall be included in the cost of acquisition of those assets. However, this applies to an extent that the transaction arises before the assets cease to be qualifying assets. The AAS 20A requires that certain exchange differences to be included in the cost of acquisition of qualifying assets. Notably, such differences are limited to those arising in respect of monetary items that are directly related to or can reasonably be attributed to qualifying assets. This shows that the differences arising in respect to monetary items that cannot be attributed to qualifying assets will not be included in acquisition costs of the qualifying asset.

The amount difference amount included in the cost of acquisition of the qualifying asset is that amount that would have been reported in the income statement either as profit or loss. In terms of disclosures, the financial statements should disclose adjustments made regarding the exchange differences in relation to retained profits or accumulated losses and qualifying assets. This shows how to recognise the exchange differences attributable to the qualifying assets in the financial statements of the entity.

On the other hand, exchange differences relating to foreign currency monetary items attributable to assets that are not-qualifying assets shall be recognised in the profits and loss account in the period in which the difference arose. The recognition shall be done on the period when the exchange rates change, leading to a gain or loss, except where the transaction is reasonably associated with a qualifying asset.

The main difference between the treatment of exchange rate differences when acquiring qualifying assets and nonqualifying assets is the inclusion of the exchange difference in the cost of acquisition of the asset for qualifying assets. For on-qualifying assets, the difference resulting from the foreign exchange rate will not be included in the acquisition cost of the non-qualifying assets. Instead, the count will be recorded in the profit or loss account. In both cases, the exchange rate difference is recorded in the entity’s financial statements.

References

AAS20A. 1987. Foreign Currency Translation. https://www.aasb.gov.au/admin/file/content102/c3/AAS20A_12-87.pdf AASB. 2018. AASB 123. Borrowing costs. https://www.aasb.gov.au/admin/file/content105/c9/AASB123_08-15_COMPfeb18_01-19.pdf