Section B questions

The following scenario relates to questions 21–25.

Figaro Co is preparing its financial statements for the year ended 31 December 20X6. A number of issues
must be accounted for before they can be finalised.
The following circumstances have arisen during the year
(i) Figaro Co has entered into a contract to supply a company in China with specialised vehicle
components. Unfortunately the raw material that it needs to manufacture these components has
risen substantially in price and Figaro Co now expects to produce and sell the components at a
loss.
(ii) Figaro Co has a machine that needs regular overhauls every year in order to be allowed to operate.
Each overhaul costs $5,000.
(iii) Figaro Co has set up a new division to produce a product for which the market is still small. It
expects this division to run at a loss for two years.
(iv) Figaro Co sells goods with a one-year warranty. Goods may require minor or major repairs during
the warranty period. If all of the goods sold during the year to 30 December 20X6 were to require
minor repairs, the total cost would be $50,000. If all of the goods sold required major repairs the
cost would be $120,000. In any year Figaro Co expects 5% of goods sold to be returned for major
repairs and 16% to be returned for minor repairs.
(v) Figaro Co has acquired 100% of a new subsidiary. At the date of acquisition the acquiree had a
contingent liability which was reliably valued at $150,000.
21 Which of circumstances (i) to (iii) above will give rise to a provision?
A (i) only
B (ii) only
C (i) and (ii)
D (ii) and (iii)
22 How do provisions differ from other liabilities?
A They do not arise as a result of past events.
B They involve uncertain timing or amount.
C An outflow of resources is not probable.
D They are not charged to profit for the year.
23 What amount should be shown as a warranty provision in the statement of financial position of
Figaro Co at 31 December 20X6?
A $2,500
B $8,000
C $14,000
D $19,200
24 A provision arises from a legal or constructive obligation. In the case of Figaro Co which of the
following would be an obligation giving rise to a provision?
A A new law will be enacted on 1 August 20X6 to combat air pollution. Figaro Co must fit new
air filters to be in compliance with this law.
B The Board of Figaro Co in a meeting on 27 June 20X6 decided to restructure and close one
of its divisions on 1 September 20X6. This will involve redundancies, but the decision has
not yet been communicated outside the Board.
C Figaro Co carries out certain work that entails environmental damage. It is not a legal
requirement to clean up this damage but most firms in the industry do so. Figaro Co does
not.
D Figaro Co is being sued by an ex-employee on health and safety grounds. Lawyers have
advised that the employee has a 55% chance of success.

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25 How should the contingent liability in (v) above be accounted for by Figaro Co?
A It should be disclosed, but not recognised
B It should be recognised
C It should be recognised if an outflow of resources is probable, otherwise just disclosed
D It should not be recognised or disclosed
The following scenario relates to questions 26–30.
Fenice Co is preparing its financial statements for the year ended 30 June 20X6. It leases the following
non-current assets:
 A company car held under an agreement that was taken out on 1 July 20X5. The interest rate
implicit in the lease is 6%. The initial measurement of the liability is $25,000. It has a five-year
useful life. Fenice Co will repay $6,000 pa in arrears for five years. The first payment was made on
30 June 20X6.
 A warehouse which has a remaining useful life of ten years. Fenice Co took out a three-year lease
on 1 January 20X6. Under the lease agreement it pays $20,000 per annum in advance. The first
instalment was paid on 1 January 20X6 and Fenice received an incentive of $5,000. The interest
rate implicit in the lease is 8%.
 A machine which Fenice Co sold to a finance house on 1 July 20X5 and then leased back.
– The carrying amount of the machine at the date of sale was $140,000.
– The sale proceeds were $200,000, the estimated fair value.
– The remaining useful life of the machine was five years.
– The lease liability at commencement was $175,234.
26 Which one of the following circumstances would indicate that an agreement should not be
classified as a lease?
A It is unlikely that the lessee will exercise any option to purchase the asset.
B The lessor can direct how the asset is used during the lease term.
C The asset is not so specialised in nature that it can only be used by the lessee.
D The lease term is for less than 50% of the useful life of the asset.
27 What amount should be shown under non-current liabilities at 30 June 20X6 in respect of the
company car?
A $25,000
B $20,500
C $21,730
D $15,730
28 What amount would be shown under non-current liabilities at 30 June 20X6 in respect of the
company car if payments were being made in advance, commencing on 1 July 20X5?
A $14,140
B $20,140
C $19,000
D $14,988
29 What is the initial measurement of the right-of-use asset in respect of the warehouse?
A $46,543
B $55,666
C $50,666
D $51,543

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 30 What is the gain that will be recognised in profit or loss on sale of the machine?
A $60,000
B $52,570
C $42,000
D $7,430
The following scenario relates to questions 31–35.
The accountant of Orfeo Co is preparing financial statements for the year ended 31 December 20X7.
Before these can be completed a number of issues need to be resolved.
(i) Orfeo Co’s head office building was revalued on 1 July 20X7, giving rise to a surplus of $100,000.
The building had an original cost of $1m on 1 January 20X0 and a 50-year life at that date. The
useful life of the building remains unchanged.
(ii) During the year one of Orfeo Co’s machines broke down and could not be fixed. The carrying
amount of the machine at that date was $30,000. The accountant must now consider the issue of
impairment.
(iii) On 10 November 20X7 Orfeo Co bought a consignment of goods from an Italian company, priced
at €150,000. Payment was due in two equal instalments – on 10 December 20X7 and 10 January
20X8. The first instalment was paid on time.
Euro to dollar rates for the last two months of 20X7 were;
10.11.20X7 €1.13 : $
10.12.20X7 €1.18 : $
31.12.20X7 €1.12 : $
31 What amount should be charged as depreciation on the building in (i) for the year ended
31 December 20X7?
A $22,300
B $22,128
C $22,000
D $21,176
32 What are the deferred tax implications of this revaluation?
A Deferred tax on the surplus of $100,000 should be charged to profit or loss for the year.
B Deferred tax on the surplus of $100,000 should be charged to the revaluation surplus.
C Deferred tax on the surplus will not arise until the building is sold.
D There are no deferred tax implications.
33 When carrying out an impairment review, assets are measured at their recoverable amount.
Which of these options describes recoverable amount?
A Higher of fair value less costs of disposal and value in use
B Higher of carrying amount and fair value less costs of disposal
C Lower of fair value less costs of disposal and value in use
D Lower of carrying amount and fair value less costs of disposal
34 Because of the loss of production caused by the damaged machine, Orfeo Co lost customers and it
was decided that the whole factory unit was impaired by $120,000. Orfeo Co’s accountant has to
decide how to allocate this impairment loss.
The carrying amounts of the assets of the factory unit at the date of the impairment review,
including the damaged machine, were:
$
Goodwill 20,000
Factory building 440,000
Plant and machinery 160,000
Net current assets 100,000
720,000

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