at the end of the reporting period | My Assignment Tutor

Additional revision question – suggested solution week 12Employee BenefitsQuestion 1(a) The accounting entry at the end of the reporting period to recognise eight days salaryand wages expense would be (this assumes a ten-day working week, of which 8 daysremain unpaid at the end of the reporting period):30 June DrWages and salaries expense24 000CrPAYG tax payable8 000CrWages and salaries payable16 000 ($24 000 = $30 000 x 8/10)(b) When the amount is ultimately paid to employees on 2 July, the entry would be:2 July DrWages and salaries expense6 000DrWages and salaries payable16 000CrPAYG tax payable2 000CrCash at bank20 000 $6000 represents two days salary, which would be included as an expense of the new financialperiod. The employees would receive the net amount after deduction of the PAYE tax, that is,$30 000 less $10 000. This entry assumes that no reversing entries were made on 1 July.(c) When the amounts are paid to the ATO on Monday, the entry would be:6 July DrPAYG tax payable10 000CrCash10 000 Question 2a)$104,000 x 4/52 = $8000$8000 x 1.175 = $9400= $9400/52 weeks = $181 per weekTherefore – total amount paid to Fitzgerald each year would be:For 48 weeks at normal pay rate ($104 000 x 48/52) = $ 96,000 For 4 weeks inclusive of loadingTotal salary and annual leave= $ 9 400= $ 105 400 Additional revision question – suggested solution week 12b) DrProvision for annual leave2350CrPAYG tax payable900CrCash at bank1450 Question 3 I.Accumulating sick leave may be carried forward to a future period if the employee hasnot taken the leave in the current period. Non-accumulating sick leave may not becarried forward to a future period.A liability must be recognised for accumulating sick leave when the employee rendersII. services that increase the entitlement. The liability is measured as the amount that theentity expects to pay. If the leave is non-vesting, the amount recognised is affected bythe probability that the leave will be taken.Question 4Step 1: Estimation of projected salary: The projected salary at Y12:$104,936 = $83,119 (1.06)4Step 2: Determine the Accumulated Benefit8/15 x 10/52 x $104,936 = $10,763Step 3: Measure the present value of the Accumulated Benefit =Accumulated Benefit = 10,763 = $8,211(1 + i)(1.07) n 4Step 4: Probability that Long Service Leave will be taken60% ($8,211) = $4,926.Current financial year LSL expense = 4926 – 2000 = 2926Dr LSL expense 2926Cr Provision for LSL 2926 DrAnnual leave expense181CrProvision for annual leave181 Additional revision question – suggested solution week 12Question 5A defined benefit plan or fund is one in which the amount of benefits to be paid to members,i.e., employees, is determined by a formula, such as a multiple of the employee’s averagesalary; whereas in a defined contribution plan or fund, the amount of benefits paid to themember comprises the contributions paid by and/or for that member and the net returnachieved by the fund. The accounting treatment for a defined contribution plan is relativelysimply relative to defined benefit plans. With a defined contribution plan, the investment riskfalls with the employee and the commitment of the employer is restricted to the amount ofthe agreed contributions.For a defined benefit plan, the employee has to determine the amount to contribute toensure that sufficient benefits are available to pay employees the agreed amount uponretirement. Many actuarial assumptions are necessary. The risks tend to fall on the employer.Additional revision question – suggested solution week 12Earnings Per ShareQuestion 1It should be noted that given that the preference dividends are cumulative, it does not matter whetheror not they have been paid. If they were non-cumulative, the right to the preference dividend wouldbe lost if they had not been declared, and, hence, for non-cumulative preference shares, the dividendwill be deducted from earnings only if the dividend has been appropriated. Hence, earnings would becalculated as: After-tax net profit$1 200 000less Preference share dividends(50 000)Earnings for basic EPS$1 150 000 Determination of the weighted-average number of ordinary shares PeriodPortion ofyearNo. outstandingWeightedaverage no. ofsharesFully paid ordinary shares1/7/19–31/10/19123/365400 000134 7951/11/19–28/2/20120/365480 000157 8081/3/20–30/6/20122/365430 000143 726Partly paid ordinary shares1/6/19–30/6/2030/365100 000 ($1.00/$2.00)4110Total weighted-average number of ordinary shares440 439 Basic earnings per share, therefore, is $1 150 000 ÷ 440 439 = 261 centsQuestion 2Earnings calculation Net profit after tax$1 000 000less Preference share dividends(6000)Net profit after-tax less preference dividends$994 000 Theoretical ex-bonus price=($3.00)(5) + 0=2.505 + 1 Adjustment factor = 2.50 ÷ 3.00 = 0.8333Additional revision question – suggested solution week 12Calculation of the weighted-average number of ordinary shares and ordinary shareequivalents PeriodPortionof yearNo.outstandingAdjustmentfactorWeightedaverage no. ofsharesFully paid ordinary shares1/7/18–30/9/1892/365600 0000.8333181 4871/10/18–30/4/19212/365750 0000.8333522 7611/5/19–30/6/1961/365900 000150 411854 659 Basic earnings per share for 2019 would be: $994 000 ÷ 854 659 = 116 centsThe comparative figures for 2018 would be adjusted for the bonus issue. The adjustedfigure would be: $2.30 × 0.8333 = 192 cents. Note that when determining theweighted-average number of shares for the current financial year, the number ofshares outstanding prior to the bonus issue is divided by the adjustment factor.Failure to adjust the previous period’s earnings would provide misleading figures as itwould appear that the company was not performing as well, when in fact thereduction in EPS may be due to the bonus issue.Question 3 365 days/365 days×9 750 000*=9 750 00051 days/365 days×$2.00**/$2.30 × 3 250 000=394 87810 144 878EPS=$3 750 000***/10 144 878=37 cents Question 4Earnings calculation Profit after taxless Preference share dividendsProfit after tax less preference dividends$500 000($10 000)$490 000 Additional revision question – suggested solution week 12Theoretical ex-right price = ($2.00)(4) + 1.54 + 1= 1.90Adjustment factor = 1.90 ÷ 2.00= 0.95 PeriodProportion ofyearNo. ofoutstandingsharesAdjustmentfactorWeightedaverage1/7 – 31/8/1762/365800 0000.95143 0431/9/11 – 30/6/18303/3651 000 000830 137973 180 Basic earnings per share for 2018 would be:$490 000 ÷ 973 180 = 50 centsThe comparative figures for 2017 would be adjusted for the rights issue. The adjusted figurewould be $1.95 × 0.95 = 185 centsQuestion 5 Profit before tax6,500,000(1,500,000)5,000,000(100,000)4,900,000TaxPreference dividend Proportion of year# Shares outstandingWeighted average365 days×10 000 000=10,000,000365 days51 days×$2.00** × 3 000 000=335,342365 days$2.5010,335,342EPS=$4,900,00010,335,342=47 cents Additional revision question – suggested solution week 12ii) Earnings per share=5,000,00010,835,34246 cents iii) Diluted EPS must be shown where an entity has on issue potential ordinary shares thatare dilutive. An entity shall present basic and diluted earnings per share with equalprominence for all periods presented. An entity shall also present basic and dilutedearnings per share, even if the amounts are negative.iv) Yes, if there is a bonus issue we need to adjust the previous period’s EPS. This is done forcomparative purposes. EarningsSharesBasic EPS$4,900,00010,335,342Conversion of preference shares (1 000000 × ½)100,000500 0005,000,00010,835,342 Additional revision question – suggested solution week 12Intangible assetsQuestion 1Research is original and planned investigation undertaken with the prospect of gainingnew scientific or technical knowledge and understanding.Development is the application of research findings or other knowledge to a plan ordesign for the production of new or substantially improved materials, devices, products,processes, systems or services before the start of commercial production or use.Para 56 gives examples of research activities:(a) activities aimed at obtaining new knowledge;(b) the search for, evaluation and final selection of, applications of research findings orother knowledge;(c) the search for alternatives for materials, devices, products, processes, systems orservices; and(d) the formulation, design, evaluation and final selection of possible alternatives fornew or improved materials, devices, products, processes, systems or services.Para 59 gives examples of development activities:(a) the design, construction and testing of pre-production or pre-use prototypes andmodels;(b) the design of tools, jigs, moulds and dies involving new technology;(c) the design, construction and operation of a pilot plant that is not of a scaleeconomically feasible for commercial production; and(d) the design, construction and testing of a chosen alternative for new or improvedmaterials, devices, products, processes, systems or servicesQuestion 2i. Research$ 235,000DevelopmentAmount to be recoupedR&D expensed in 2018$500,000*$469,707$30,293265,293 • 70,000 * 6.7101 = 469707ii. The amortisation is therefore = 469,707 / 10 years = $46,971Additional revision question – suggested solution week 12Question 3The expenditure on the training courses may exhibit the characteristics of an asset in thatthey have and will continue to bring future economic benefits by way of increased efficiencyand cost savings to XYZ Ltd.However, the expenditure cannot be recognised as an asset on the statement of financialposition and must be charged as an expense as the cost is incurred. The main reason for thislies with the issue of ’control’; it is XYZ Ltd’s employees that have the ‘skills’ provided by thecourses, but the employees can leave the company and take their skills with them or, throughaccident or injury, may be deprived of those skills.Additionally, the capitalisation of staff training costs is specifically prohibited under AASB 38Intangible assets.Question 4a) Patents should be recognised in the statement of financial position at amortised cost. The revaluationsubsequent to acquisition would not be permitted (there would not be an ‘active market’ for suchassets).The trademarks should not be recognised, because the cost of the intangible asset was expensed in aprevious period. (AASB 138, paragraph 71 requires that expenditure on an intangible item that wasinitially recognised as an expense shall not be recognised as part of the cost of an intangible asset ata later date.)Goodwill is recognised at cost subject to an impairment test. It is assumed there has been noimpairment. It is not to be subject to any amortisation.The brand name may not be recognised because it is internally generated. Expenditure on specifiedinternally generated assets, such as brand names and customer lists, may not be recognised as anasset because the costs incurred are considered indistinguishable from expenditure incurred todevelop the business as a whole.The licence should be recognised and amortised to the extent it was externally acquired. Becausethere is an ‘active market’ for the licence, IP may choose between the cost and fair value methods.(b) PatentTrademarkGoodwillBrand nameLicenceCarryingamount$60 mNot applicable,not recognised$50 mNot applicable,not recognised$9 m or$17 mCost$80 m$50 m$10 mAccum.amort.$20 mNil$1 mFair valueNot appliedNot applied$17 m Additional revision question – suggested solution week 12 RequiredamortisationpolicyThe remainingcarryingamount of$60 m shall beamortisedover theremaininguseful life of15 years.As the asset hasnil value it is notamortised.The goodwillshould not beamortisedbut should besubject toannualimpairmenttesting.Because itcannot berecognisedthere is noamortisation.The licenceshould beamortisedover itsremaininguseful life. Additional revision question – suggested solution week 12Extractive IndustryQuestion 1At the end of the rig’s useful life, which is expected to be ten years, Cortese Limited is requiredby its resource consent to dismantle the oil rig, remove it and return the site to its originalcondition. Cortese Limited estimates that if such work was required to be done at the presenttime it would cost $25 000 000. Anticipating that inflation will average 3 per cent over thenext 10 years, the adjusted cost is expected to be $25 000 000 x (1.03)10, which equals $33597 909. If we accept that the rate on 10 year government bonds reflects the relevant timevalue of money, and if the rate is 4 per cent, then the present value of the restorationprovision would be $33 597 909 ÷ (1.04)10 which equals $22 697 543. We are now in a positionto do our journal entries. DrOil rig222 697 543CrCash/accounts payable200 000 000CrProvision for restoration costs22 697 543 Discounting the future obligation for restoration creates interest costs for futureyears. As paragraph 60 of AASB 137 states:Where discounting is used, the carrying amount of a provision increases in eachperiod to reflect the passage of time. This increase is recognised as borrowing cost.The borrowing (interest) costs are allocated to specific years as follows: DateOpening balanceInterest at 4%Balance of siterestoration costs22 697 5431 July 2018– 30 June 2019 22 697 543 907,901 23 605 44430 June 2020 23 605 444 944 218 245 496 62The journal entries to recognise the periodic interest charges are:30 June 2019 DrInterest expense907 901CrProvision for restoration costs907 90130 June 2020DrInterest expense944 218CrProvision for restoration costs944 218 Additional revision question – suggested solution week 12As we can see from the above entries, at the end of each period the amount recordedfor the provision for restoration costs increases. By the end of the final period of theproject the balance of the provision will be $33 597 909. This amount will then beeliminated when Cortese Ltd undertakes the actual restoration work.Question 2Area-of-interest method2017Initial exploration and evaluation costs incurred in each site DrExploration and evaluation assets – X20DrExploration and evaluation assets – Y8CrCash/ payables28 2018To recognise an impairment loss DrImpairment loss – exploration and evaluation assets8CrExploration and evaluation assets8 To reclassify the balance of the exploration and evaluation expenditure at X to‘assetsunder construction’ DrAssets under construction – Property Plant & Equipment12DrAssets under construction – Intangible Assets8CrExploration and evaluation assets20 To reclassify the assets as a result of the movement from the preproductionphase to theproduction phase DrProperty Plant & Equipment12DrIntangible Assets8CrAssets under construction—property, plant and equipment12CrAssets under construction – Intangible Assets8 Additional revision question – suggested solution week 12To record the depreciation and inventory cost. DrInventory of crude oil4CrAccumulated depreciation—property, plant and equipment2.4CrAccumulated depreciation—property, plant and equipment1.6 To record production and inventory cost DrInventory of crude oil1CrCash, payables1 To record sales DrCash/receivables3CrSales revenue3 To record cost of goods sold DrCost of goods sold2.5CrInventory of crude oil2.5 Additional revision question – suggested solution week 12Accounting for LeaseQuestion 1a)Bargain purchase options are included as part of the expected lease payments. In thisquestion the implicit rate is 12 per cent, proven as follows: Periodic lease payments315 000 x 3.6048 =1 135 512Bargain purchase option280 000 x 0.5674 =158 872Fair value at lease inception1 294 384 b)1 July 2019 DrLeased asset1 294 384CrLease liability1 294 384 30 June 2020 DrInterest expense155 326DrLease liability159 674DrService expenses35 000CrCash350 000 [155 326 = 1 294 384 x 0.12] DrDepreciation expense180 731CrAccumulated leasehold depreciation180 731 [180 731 = (1 294 384 – 210 000)/6] DateLeasepaymentInterestExpense12%Principal reductionOutstanding balance01/07/20191 294 38430/06/2020315 000155 326*159 674**1 134 710***30/06/2021315 000136 165178 835955 87530/06/2022315 000114 705200 295755 580 Additional revision question – suggested solution week 12Note that the useful life of the asset is used for depreciation purposes given the existence ofthe bargain purchase options, which would result in the asset being transferred to the lesseeat the end of the 5-year lease.30 June 2021 DrInterest expense136 165DrLease liability178 835DrService expenses35 000CrCash350 000 [136 165 = (1 294 384 – 159 674) x 0.12] DrDepreciation expense180 731CrAccumulated leasehold depreciation180 731 c) An extract of the statement of financial position for the year ending 30 June 2021 30 June 202030 June 2021Non-current assetsLeased asset$1 294 384$1 294 384Less accumulated depreciation$180 731$361 462$1 113 653$932 922Current liabilitiesLease liability$178 835$200 295Non-current liabilitiesLease liability$955 875$755 580 Additional revision question – suggested solution week 12Question 2a)Liability = 100,000 + 170,000 (12%, 2 year from annuity table)= 100,000 + 287,317= 387,317Alternatively:(lease liability)The lease liability would be recognised at $387,309 on initial recognition on 1 July 20X7. DatePayment$Present valuefactorPresent valuecash flow$01.10.X7100,0001100,00030.09.X8170,0000.8929151,79330.09.X9170,0000.7972135,524Total387,317 b) Lease payment scheduleThe complete lease payment schedule has been shown here for information only. [email protected] 12%$Repayment$Closingbalance$01.07.X7387,3170(100,000)287,31730.06.X8287,31734,478(170,000)151,79530.06.X9151,79518,215(170,000)– c) Journal entries for the year ending 30 September 20X8: DateDescriptionDr$Cr$01.07.X7Right of use asset387,317Lease liability387,317To record the right of use asset and lease liability Additional revision question – suggested solution week 12 DateDescriptionDr$Cr$01.07.X7Right of use asset (legal cost)10,000Cash10,000To record the right of use asset and the cash paid for legal feesDateDescriptionDr$Cr$01.07.X7Lease liability100,000Cash100,000To record the initial/advance payment made on 1 July 20X7DateDescriptionDr$Cr$30.06.X8Depreciation expense49,664Accumulated depreciation49,664To record the depreciation of the right of use asset over its useful life to the entityThis entry will be the same every year for 8 years ($397,317 ÷ 8) unless there is a changein estimate.How do we get 397,317 = 387,317 + 10,000 . DateDescriptionDr $Cr $30.06.X8Lease liability135,523Interest expense34,477Cash170,000To record lease payment made at 30 June 20X8DateDescriptionDr$Cr$30.06.X8Income tax expense58,757Deferred tax liability58,757To record the deferred tax on the lease [Working 3] Additional revision question – suggested solution week 12Working 3 for deferred tax.The net carrying amount of the lease ($195,858) exceeds the tax base of $0 because the leaseis not recognised for tax purposes. A deferred tax liability of $58,757 is recognised for thistaxable temporary difference ($195,858 × 30%).Working 4 (Net Carrying Amount)The net carrying amount of the lease = 195858Right of use asset $347,653 ($387,317 + $10,000 ‒ $49,664) minus $151,795 liability (fromlease payment schedule).Question 3(a) Lease classification• The lessor may classify a lease as either finance or operating (AASB 16).• The criteria is based on transfer of substantially all the risk and rewards incidental toownership of the underlying asset. There is an option to purchase at a price that issignificantly discounted from fair value.• The lease term is for a major part of the economic life of the asset.• The underlying asset is of a specialised nature.Therefore, XYZ should classify this lease as a finance lease(b) Value of the lease receivablePresent value of four payments of $100,000 discounted at 5% annuity factor:3.5460 x $100,000 = 354,600Present value of bargain purchase option of $300,000 at 5% discount factor:0.8227 x $300,000 = 246,810Value of the lease receivable: = 601,410Additional revision question – suggested solution week 12(c) Prepare the lease receipt schedule to calculate the value at 30 June 2019. DateOpeningbalance$Receipt$Interest$5%Reduction inprincipalClosingbalance$30.06.18601,410100,00030,07169,929531,48130.06.19531,481100,00026,57473,426458,05530.06.20458,055100,00022,90377,097380,95830.06.21380,958400,00019,048380,952– (d)Journal entry for the financial year end 2019 DetailsDrCrCash$100,000Interest revenue26,574Lease receivable73,426 (e)XYZ Limited – Extract of Statement of Financial Statement 30 June 2019AssetsCurrent assetsLease receivable $77,097Non-current assetsLease receivable $380,958Additional revision question – suggested solution week 12Required:a) Calculate the minimum lease payment (the lease liability) amount as at 1 July 2018.b) Prepare the lease payment schedule for the lessee YearLease paymentInterest expense6%Liability reductionClosing balanceFor liability1 July 2018451 32630 June 2019150 00027 080122 920328 40630 June 2020150 00019 704130 296198 11030 June 2021210 00011 890198 110 c) Prepare the journal entries in relation to the lease for the year ending 30 Jun 2019.1 July 2018 – Recognition lease asset and lease liability at the inception of the lease Account detailsDebitCreditRight – to -use machinery/lease asset451 326Lease liability451 326 30 June 2019 – First lease payment Account detailsDebitCreditLease liability122 920 $150 000 x 2.6730 [T2 3y 6%] + $60 000 x 0.8396 [T1 3y 6%]= $400 950 + $50 376= $451 326 Additional revision question – suggested solution week 12 Interest expense27 080Service cost/executory cost15 000Cash165 000 30 June 2019 – Depreciation of the Machinery Account detailsDebitCreditDepreciation expense84 265Accumulated Depreciation84 265 Part Bfinance lease is defined as lease that transfers substantially all the risks and rewardsincidental to ownership of an underlying asset.An operating lease is defined as a lease that does not transfer substantially all the risks andrewards incidental to ownership of an underlying asset.Additional revision question – suggested solution week 12Financial Instruments and Foreign Currency Transaction1. AASB 132 Financial Instruments: Presentation defines a financial instrument as anycontract that gives rise to both a financial asset of one entity and a financial liability orequity instrument of another entity. Such a definition, in turn, generates a need todefine a financial asset, a financial liability and an equity instrument.According to paragraph 11 of AASB 132, financial asset means any asset that is: (a)(b)(c)cash;an equity instrument of another entity;a contractual right:(i) to receive cash or another financial asset from another entity; or(ii) to exchange financial assets or financial liabilities with another entityunder conditions that are potentially favourable to the entity; ora contract that will or may be settled in the entity’s own equity instruments andis:(d) (i) a non-derivative for which the entity is or may be obliged to receive avariable number of the entity’s own equity instruments; or(ii) a derivative that will or may be settled other than by the exchange of afixed amount of cash or another financial asset for a fixed number of theentity’s own equity instruments. For this purpose the entity’s own equityinstruments do not include puttable financial instruments that are aderivative that will or may be settled other than by the exchange of a fixedamount of cash or another financial asset for a fixed number of the entity’sown equity instruments. For this purpose the entity’s own equityinstruments do not include puttable financial instruments that areclassified as equity instruments in accordance with paragraphs 16A and16B, instruments that impose on the entity an obligation to deliver toanother party a pro rata share of the net assets of the entity only onliquidation and are classified as equity instruments in accordance withparagraphs 16C and 16D, or instruments that are contracts for the futurereceipt or delivery of the entity’s own equity instruments.A financial liability, on the other hand, means any liability that is(a) a contractual obligation:(i) to deliver cash or another financial asset to another entity; orAdditional revision question – suggested solution week 12(ii) to exchange financial assets or financial liabilities with another entityunder conditions that are potentially unfavourable to the entity; or(b) a contract that will or may be settled in the entity’s own equity instruments andis:(i) a non-derivative for which the entity is or may be obliged to deliver avariable number of the entity’s own equity instruments; or(ii) a derivative that will or may be settled other than by the exchange of afixed amount of cash or another financial asset for a fixed number of theentity’s own equity instruments. For this purpose, rights, options orwarrants to acquire a fixed number of the entity’s own equity instrumentsfor a fixed amount of any currency are equity instruments if the entityoffers the rights, options or warrants pro rata to all of its existing ownersof the same class of its own non-derivative equity instruments. Also, forthese purposes the entity’s own equity instruments do not include puttablefinancial instruments that are classified as equity instruments inaccordance with paragraphs 16A and 16B, instruments that impose on theentity an obligation to deliver to another party a pro rata share of the netassets of the entity only on liquidation and are classified as equityinstruments in accordance with paragraphs 16C and 16D, or instrumentsthat are contracts for the future receipt or delivery of the entity’s ownequity instruments.If a financial instrument does not give rise to a contractual obligation on the part ofthe issuer to deliver cash or another financial asset, or to exchange another financialinstrument under conditions that are potentially unfavourable, then it is consideredto be an equity interest where equity is defined as the residual interest in the assetsof the entity after deduction of its liabilities.2. According to paragraph 11 of AASB 132, financial asset means any asset that is: (a)(b)(c)cash;an equity instrument of another entity;a contractual right:(i) to receive cash or another financial asset from another entity; or(ii) to exchange financial assets or financial liabilities with another entityunder conditions that are potentially favourable to the entity; ora contract that will or may be settled in the entity’s own equity instruments andis:(d) (i) a non-derivative for which the entity is or may be obliged to receive avariable number of the entity’s own equity instruments; orAdditional revision question – suggested solution week 12(ii) a derivative that will or may be settled other than by the exchange of afixed amount of cash or another financial asset for a fixed number of theentity’s own equity instruments. For this purpose the entity’s own equityinstruments do not include puttable financial instruments that are aderivative that will or may be settled other than by the exchange of a fixedamount of cash or another financial asset for a fixed number of the entity’sown equity instruments. For this purpose the entity’s own equityinstruments do not include puttable financial instruments that areclassified as equity instruments in accordance with paragraphs 16A and16B, instruments that impose on the entity an obligation to deliver toanother party a pro rata share of the net assets of the entity only onliquidation and are classified as equity instruments in accordance withparagraphs 16C and 16D, or instruments that are contracts for the futurereceipt or delivery of the entity’s own equity instruments.A financial liability, on the other hand, means any liability that is(a) a contractual obligation:(i) to deliver cash or another financial asset to another entity; or(ii) to exchange financial assets or financial liabilities with another entityunder conditions that are potentially unfavourable to the entity; or (b)a contract that will or may be settled in the entity’s own equity instruments andis: (i) a non-derivative for which the entity is or may be obliged to deliver avariable number of the entity’s own equity instruments; or(ii) a derivative that will or may be settled other than by the exchange of afixed amount of cash or another financial asset for a fixed number of theentity’s own equity instruments. For this purpose, rights, options orwarrants to acquire a fixed number of the entity’s own equity instrumentsfor a fixed amount of any currency are equity instruments if the entityoffers the rights, options or warrants pro rata to all of its existing ownersof the same class of its own non-derivative equity instruments. Also, forthese purposes the entity’s own equity instruments do not include puttablefinancial instruments that are classified as equity instruments inaccordance with paragraphs 16A and 16B, instruments that impose on theentity an obligation to deliver to another party a pro rata share of the netassets of the entity only on liquidation and are classified as equityinstruments in accordance with paragraphs 16C and 16D, or instrumentsthat are contracts for the future receipt or delivery of the entity’s ownequity instruments.Additional revision question – suggested solution week 12An equity instrument is defined in AASB 132 as ‘any contract that evidences a residualinterest in the assets of an entity after deducting all of its liabilities’.3. Examples of primary financial instruments would include receivables, payables andequity securities, such as shares. Primary financial instruments generate rights andobligations between the parties directly involved in the underlying transaction. Forexample, acquiring shares in a company gives the investor a financial asset in thecompany and the shares are considered an equity instrument of the company.Acquiring inventory on credit from a company gives the selling company a financialasset (a right to cash), and the purchaser a financial liability (an obligation to delivercash to the company).4. Derivative financial instruments have been defined as instruments which ‘create rightsand obligations that have the effect of transferring one or more of the financial risksinherent in an underlying primary financial instrument, and the value of the contractnormally reflects changes in the value of the underlying financial instrument’(International Accounting Standards Committee, Exposure Draft 40: FinancialInstruments). This is consistent with the description provided at paragraph AG 16 ofAASB 132 which states:Derivative financial instruments create rights and obligations that have theeffect of transferring between the parties to the instrument one or more of thefinancial risks inherent in an underlying primary financial instrument. Oninception, derivative financial instruments give one party a contractual right toexchange financial assets or financial liabilities with another party underconditions that are potentially favourable, or a contractual obligation toexchange financial assets or financial liabilities with another party underconditions that are potentially unfavourable. However, they generally do notresult in a transfer of the underlying primary financial instrument on inceptionof the contract, nor does such a transfer necessarily take place on maturity ofthe contract. Some instruments embody both a right and an obligation to makean exchange. Because the terms of the exchange are determined on inceptionof the derivative instrument, as prices in financial markets change, those termsmay become either favourable or unfavourable.Derivative financial instruments would include financial options, futures, forwardcontracts, and interest rate or currency swaps.5.An entity may wish to perform a set-off to reduce gearing ratios such as debt to assets, ordebt to shareholders’ funds. If Arthur Ltd was to perform a set-off, the post set-off statementof financial position would be:Additional revision question – suggested solution week 12 Statement of financial positionPost set-offLoans payable700 000Loans receivable900 000Shareholders’ equity1 000 000Fixed assets800 000$1 700 000$1 700 000 As we can see, as a result of the set-off, the debt-to-asset ratio has moved from 50% to 41.2%,while the debt to shareholders’ funds has moved from 100% to 70%.6 To calculate the issue price of the bonds we need to determine the present value of thefuture cash flows. We will use the market’s required rate of return as the interest ratenecessary to determine the present value.Present value of annual payments: $100 000 x 3.4331 $343 310Present value of principal repayment: $1 000 000 x 0.5194 $519 400$862 710Determining amortised cost using the effective-interest method*rounding error of $64 due to using present values to only 4 decimal places.The annual interest cost is measured by multiplying the effective interest rate by the amountof the liability at the beginning of each period. Any excess of interest cost over the amount ofinterest paid is accounted for as an increase in the carrying amount of the liability (which isits present value). By the maturity date, the liability will be increased to an amount equal to 1. Year ended2.Openingbondpayable$3.Payment$4. Interest at14% (column2  14%)$5. Increase inbond payable(column 4 –column 3)$6. Amortisedcost of bondpayable(column 2 +column 5)$30 June 2019862 710100 000120 77920 779883 48930 June 2020883 489100 000123 68923 689907 17830 June 2021907 178100 000127 00527 005934 18330 June 202239 June 2023934 183964 969100 000100 0001 000 000130 786135 09630 78635 095964 9691 000 06464* Additional revision question – suggested solution week 12the principal, as the discount reduces to zero.Journal entries1 July 2018 DrCash862 710CrBond payable862 710 Issuing bonds for $862 71030 June 2019 DrInterest expense120 779CrBond payable20 779CrBank100 000 Interest payment and amortisation of bond payable using effective-interest rate of 14%Question 7a) Qualifying Asset – (AASB 123) ‘an asset that necessarily takes a substantial period of time to getready for its intended use or sale.’ Although not necessary, the period would normally be longerthan 12 months.b) The two (2) key differences in accounting treatment for Qualifying Assets – (i) borrowing costsdirectly attributable to the construction of the asset can be capitalised as a part of the cost of theasset; and (ii) exchange differences arising from FOREX borrowings to the extent that they areregarded as an adjustment to interest costs are considered to be borrowing costs and thereforewill be capitalised as a part of the cost of the asset. Normally (ie: for non-qualifying assets),borrowing costs and FOREX gains or losses will be treated as an expense (or gain in the case of aFOREX gain) via the Profit & Loss Account.c) A hedging transaction occurs when an entity enters an agreement that takes a positionopposite to the original transaction. Hedge accounting is undertaken to account for thehedging transaction.The purpose of hedge accounting is described at paragraph 85 of AASB 139 and is torecognise ‘the offsetting effects on profit or loss of changes in the fair values of thehedging instrument and the hedged item’.Additional revision question – suggested solution week 12According to paragraph 86 of AASB 139/AASB 9 there are three main types of hedges,these being:• fair value hedges;• cash-flow hedges; and• hedges of net investments in a foreign operation.d) A compound instrument is a financial instrument that contains both a financial liabilityand an equity element. There is a requirement that the debt and equity components of acompound instrument be accounted for separately.Some examples of compound instruments include such things as:• convertible notes• convertible bondsQuestion 8a)Compound financial instruments include both equity instruments and financial liabilities. Thedebt and equity components of a compound security should be accounted for and disclosedseparately on the basis of the economic substance of the security at the time of its initialrecognition. As paragraph AG31 of AASB 132 states:A common form of compound financial instrument is a debt instrument with an embedded conversionoption, such as a bond convertible into ordinary shares of the issuer, and without any other embeddedderivative features. Paragraph 28 requires the issuer of such a financial instrument to present theliability.We must determine the fair value of the liability component—which is recognised within the financialstatements—and allocate the difference between the fair value of the liability component and the fairvalue of the entire instrument to the equity component. That is, the amount attributed to the equitycomponent is the residual.b)Generally, we would expect a reporting entity to prefer to classify a financial instrument as equity ratherthan debt. Leverage, measured through such ratios as debt divided by equity, or debt divided by assets,is often used as a measure of the risk inherent within an organisation. Leverage is also often used withinvarious debt covenants negotiated between reporting entities and their lenders. Hence, we can expectthat for a given financial instrument, there would be a preference from management that the instrumentbe presented as equity.Further, once an instrument is classified as equity, then the related payments will be classified asdividends—which do not reduce profits. By contrast, if the instrument is considered to be debt then therelated payments will be deemed to be interest expense, which will reduce profits. Again, this meansAdditional revision question – suggested solution week 12that managers would typically prefer a financial instrument to be presented as equity, and this preferencewill potentially be magnified if the managers are receiving bonuses tied to some measure of profit.Question 9(a) The convertible bonds will be shown as part debt and part equity. The amount attributedto the liability will be the present value of the contractually required cash flowsdiscounted at the market’s required rate of return. The difference between this liabilitycomponent and the issue price of the securities would represent the equity component.(b) No, the probability of conversion to equity does not influence whether they are disclosedas debt or equity. This is specifically stated in the accounting standard AASB 132.(c) Yes it will. The balance existing in the liability account (Convertible bonds liability), andthe balance in the existing equity account (Convertible bonds) would be transferred toShare capital. The entry would be:Dr Convertible bonds liability xDr Convertible bonds xCr Share capital xQuestion 10(a)Present value of principal discounted a 6 per cent: $5 000 000 x 0.8396 =$4 198 000 Present value of interest stream discounted at 6 per cent: $200 000 x 2.6730 =$ 534 600 Total present value of bonds liability$4 732 600Equity component$ 267 400Total face value of convertible bonds$5 000 000 Additional revision question – suggested solution week 12The accounting entries could therefore be:1 July 2019 DrCash at bank5 000 000CrConvertible bonds liability4 732 600CrOption to convert bonds liability—equity267 400 (to record the issue of the convertible bonds and the recognition of the liability and equitycomponents) (b)30 June 2020 DrInterest expense283 956CrCash200 000CrConvertible bonds liability83 956 (to recognise the interest expense, where the expense equals the present value of theopening liability multiplied by the market rate of interest—see table below)The stream of interest expenses across the 3 years can be summarised as in the tablebelow, where interest expense for a given year is calculated by multiplying the presentvalue of the liability at the beginning of the period by the market rate of interest, thisbeing 6 per cent. DatePaymentInterest expenseBond liability1 July 20194 732 60030 June 2020200 000283 9564 816 55630 June 2021200 000288 9934 905 54930 June 2022200 000294 3334 999 882* * $118 rounding error due to using tables rounded to 4 decimal places.(d) If the holders of the options elected to convert the options to ordinary shares on 1 July2020, the entries would be:(to recognise the conversion of the bonds into shares of Woodie Ltd) DrConvertible bonds liability4 816 556DrOption to convert bonds liability—equity267 400CrShare capital5 083 956 Additional revision question – suggested solution week 12e) Extract from the financial statements of XYZ LtdIncome statement for the year ended 30 June 2020 Note$Finance costs2283 956 2. $4 732 600 x 6 % = 283 956Statement of financial position as at 30 June 2020Note $Non- current liabilitiesConvertible notes 3 4 816 556EquityEquity option 267 4003. 4732 600 x 1.06 – 200,000 =4 816 556Question 11Given that this has been designated as a cash flow hedge, and it has also been assumed thatthe hedge is ‘effective’, then any gains or losses on the hedging instrument shall initially berecognised in equity (and therefore in ‘other comprehensive income’) and then ultimatelytransferred to the cost of inventory. It should be noted that as this hedging arrangementrelates to a highly probable forecast transaction, which would also be considered in this caseto be an unrecognised firm commitment, then AASB 9 permits the hedge arrangement to betreated either as a cash flow hedge or a fair value hedge. In this example, the entity haselected to treat it as a cash flow hedge.Additional revision question – suggested solution week 12Gains/losses on the hedged item (the inventory purchase) are calculated as follows: DateSpot rateAmount payable in $AForeign exchangegain/(loss)15 June 2018$A1.00 = US$0.78–30 June 2018$A1.00 = US$0.76$5 263 15830 August 2018$A1.00 = US$0.71$5 633 803(370 645) Note: the purchase is not recognised until such time as the engines are shipped on 30 June2018.Gains/losses on the hedging instrument (the forward rate contract) are calculated asfollows: DateFwd rate fordelivery of US$ on30 Aug 2018Receivable onfwd contract (a)Amountpayable in$A onforward.contract (b)Fair value offorwardcontract (c)Gain/(loss)on forwardcontract (d)15 June 2018$A1.00 = US$0.75$5 333 333$5 333 333030 June 2018$A1.00 = US$0.73$5 479 452$5 333 333$146 119$146 11930 August2018$A1.00 = US$0.71$5 633 803$5 333 333$300 470$154 351$300 470 Notes to the above table(a) Determined by dividing $4.0m by the respective dates’ forward rate. This right refers tothe amount to be received from the bank, the value of which will fluctuate as the forwardrate changes. Although Brisbane Ltd has been able to ‘lock in’ a particular forward rate(being 0.75), because the bank will negotiate different forward rates at different times,the fair value of the receivable will change across time. For example, if the forward ratethat was available on 30 June had changed from $0.75 to $0.73 then anybody entering aforward rate on 30 June to receive US$4.0m on 30 August would need to ultimately pay$5 479 452. This means that the existing forward rate contract has a fair value of $146 119because it will provide $4.0m for the ‘old’ negotiated forward rate of $0.75, which is betterthan what is currently available (being $0.73). Gains or losses in the value of this receivablewill act to offset the gains or losses in the value of the amount payable to the overseassupplier.(b) The obligation (amount payable) represents the amount that must be paid to the bankusing the forward rate negotiated with the bank and is fixed in absolute terms for thecontracted party. This amount is fixed regardless of what happens to spot rates, or whatforward rates the bank offers on other forward rate contracts.Additional revision question – suggested solution week 12(c) We have calculated a fair value for the hedging instrument (the hedging instrument beingthe forward rate contract). It is a requirement of AASB 9 that a fair value be attributed tothe hedging instrument. In this situation, the fair value will change as the available forwardrate being offered by the bank changes. For example, when the contract is originallynegotiated, the bank is assumed to be offering the forward rate of $A1.00 = US$0.75 forthe delivery of US dollars on 30 August 2018 to any interested parties. Therefore, thecontract itself has no fair value. However, if on 30 June 2018 the bank is only prepared tooffer a forward rate for delivery of US dollars of $A1.00 = US$0.73, then if Brisbane Ltdwas able to transfer its contract to another party needing US dollars on that date, then,given the other options available to that other party, that party would be prepared to payup to $146 119 for the contract, which equates to ($4 000 000  0.75) – ($2 000 000 0.73). The fair value of the contract would be deemed to be $146 119. There is also arequirement that the financial instrument—in this case the forward contract—bemeasured at the present value of the future cash flows. Because the life of the forwardcontract is less than 12 months it has been decided on the basis of materiality not todiscount the associated cash flows to present value.(d) The gain or loss on the forward rate contract represents the change in the fair value ofthe forward rate contract.In the calculations above we have calculated a fair value for the hedging instrument (whichin this case is the forward contract) at each reporting date. It is a requirement of AASB 9that a fair value be attributed to the forward contract. The changing fair value representshow much it would cost the entity to take out a forward rate agreement for the deliveryof US$4 000 000. For example, if the entity, or perhaps another entity, were to negotiatethe forward rate agreement at 30 June 2018, it would have cost them $5 479 452 for US$4000 000 rather than the $5 333 333 they were able to ‘lock in’ on 15 June 2018. The changein the fair value represents the gain or loss on the forward contract. As we can see fromthe above table, the amount payable for US$4 000 000 (the commitment) has been lockedin at $5 333 333 regardless of what subsequently happens to spot rates and forward rates.The required journal entries would be as follows:15 June 2018No entry is required here as the fair value of the forward rate agreement is assessed asbeing zero given that the fair value of the foreign currency receivable is the same as the fairvalue of the commitment, both being $5 333 333. 30 June 2018DrForward rate contract (financial asset)146 119CrCash flow hedge reserve (would be a gain recorded inother comprehensive income)146 119 (to recognise the fair value of the forward contract, which is the difference between the relatedreceivable on the contract and the related commitment) DrInventory5 263 158CrForeign currency payable5 263 158 Additional revision question – suggested solution week 12(to recognise the acquisition of inventory using the relevant spot rate) DrCash flow hedge reserve (gain recorded in othercomprehensive income)146119CrInventory146119 (to transfer the gain/loss on the forward contract to the cost of inventory as at the date ofinventory acquisition)Following the date of acquisition of the inventory, all gains and losses on the forward ratecontract and the foreign currency payable with the supplier are transferred directly to profitor loss just as they would be for a fair value hedge. 30 August 2018DrForward rate contract (financial asset)154 351CrGain on forward contract154 351DrForeign exchange loss370 645CrForeign currency payable370 645 DrCash at bank300 470CrForward rate contract (financial asset)300 470 (in this situation the other party to the forward rate contract has actually lost money on thetransaction and therefore provides funds to the entity) DrForeign currency payable5 633 803CrCash at bank5 633 803 (this represents the amount paid to the overseas engine supplier. As we can see from theabove two entries, the net amount paid for the inventory was $5 333 333 (which is $5 633 803less $300 470), which equates to the amount originally negotiated in the forward ratecontract)Additional revision question – suggested solution week 12Construction contracts1) The percentage of completion 20X120X220X3Contract price$72 000 000$72 000 000$72 000 000Less estimated cost:Costs to date (Actual)16,000 00046,000 00066,000 000Estimated costs tocomplete46,000 00020,000 0000Estimated total cost62 000 00066 000 00066 000 000Estimated total gross profit10 000 000$ 6 000 000$ 6 000 000Per cent complete25.81%69.70%100% 2) The gross profit and revenue for year 20X1, 20X2 & 20X3. 20X120X220X3Contract price$72 000 000$72 000 000$72 000 000Costs to date (Actual)16,000 00046,000 00066,000 000Estimated costs tocomplete46,000 00020,000 0000Estimated total cost62 000 00066 000 00066 000 000Estimated total gross profit10 000 000$ 6 000 000$ 6 000 000Per cent complete25.81%69.70%100%Gross profit recognised to date2,580,6454,181, 8186,000,000Less profit already recognised:–2,580,6454,181, 818Profit recognised for the year2,580,6451,601,1731,818,182 Additional revision question – suggested solution week 12 20X120X220X3Revenue recognised to date18,580, 64550,181,81872,000,000Less revenue already recognised:–18,580,64550,181,818Revenue recognised for the year18,580 ,64531,601,17321,818 ,182 Working for year 20X1:16,000,000/62,000,000 x 72,000,000 = 18,580 645Working for year 20X2:46,000,000/66,000,000 x 72,000,000 = 50,181,8183) The appropriate journal entries 20X120X220X3(i)To record costs incurred:Dr Construction in progress16,000 00030,000 00020,000 000Cr Cash, accounts payable, etc.16,000 00030,000 00020,000 000(ii)To record billings to customersDr Accounts receivable24,000 00024,000 00024,000 000Cr Billings on contracts inprogress24,000 00024,000 00024,000 000(iii)To record cash collections:Dr Cash24,000 00024,000 00024,000 000Cr Accounts receivable24,000 00024,000 00024,000 000 Additional revision question – suggested solution week 12 (iv)To record periodic income recognised:20X120X220X3TotalDr Construction in progress2,580,6451,601,1731,818,1826,000 000Dr Construction expenses16,000 00030,000 00020,000 00066,000 000Cr Revenue from long-term contracts18,580, 64531,601,17321,818 ,18272,000 000 Question 2(a) Assuming stage of completion can be reliably determined. 201920202021Contract price$10 000 000$10 000 000$10 000 000less Estimated costCosts to date2 500 0006 500 0008 000 000Estimated costs to complete5 500 0001 500 000_________Estimated total cost8 000 0008 000 0008 000 000Estimated total gross profit$ 2 000 000$ 2 000 000$2 000 000Per cent complete31.25%81.25%100% Gross profit recognised pursuant to the percentage-of-completion method(assuming that the stage of completion can be reliably estimated). 2019$2 000 000 × 31.25%$625 0002020$2 000 000 × 81.25%$ 1 625 000Less gross profit already recognised625 000Gross profit in 2019$ 1 000 0002021$2 000 000 × 100%$ 2 000 000Less gross profit already recognised1 625 000Gross profit in 2020$ 375 000 Additional revision question – suggested solution week 12Journal entries: POC method 201920202021(i)To record costs incurred:DrConstruction in progress (contract asset)2.54.01.5CrCash, accounts payable, accum. deprec.2.54.01.5(ii)To record billings to customers:DrAccounts receivable2.05.03.0CrConstruction in progress (contract asset)2.05.03.0(iii)To record cash collections:DrCash2.05.03.0CrAccounts receivable2.05.03.0(iv)To record periodic income recognised:DrConstruction in progress (contract asset)0.6251.00.375DrConstruction expenses2.5004.01.500CrRevenue from long-term contracts3.1255.01.875 (b) Stage of completion cannot be reliably determined. In this case, contract costs mustbe recognised as an expense in the financial year in which they are incurred and,where it is probable that the costs will be recovered, revenue must be recognised onlyto the extent of costs incurred. 201920202021(i)To record costs incurred:DrConstruction in progress (contractasset)2.54.01.5CrCash, accounts payable, etc.2.54.01.5(ii)To record billings to customers:DrAccounts receivable2.05.03.0CrConstruction in progress (contractasset)2.05.03.0(iii)To record cash collections:DrCash2.05.03.0 Additional revision question – suggested solution week 12 CrAccounts receivable2.05.03.0(iv)To record periodic expenses and revenues:DrConstruction expenses2.54.01.5CrRevenue from long-term contracts2.54.01.5(v)Because the ‘contract asset’ has a creditbalance a contract liability needs to berecognised:DrCrConstruction in progress (contractasset)Contract liability0.50.5(vi)Reversal of adjusting entry in 2020:DrContract liability0.5CrContract in progress (contract asset)0.5(vii)To record the profit on the project:DrConstruction in progress (contractasset)——2.0CrRevenue from long-term contracts——2.0

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