Financial Accounting, IFRS Principles Chapter 15

Tutorial 15.6 Suggested solution Advanced level

(a)

INPUTS INTO FIN CALCULATOR (MUST SHOW INPUTS/WORKINGS)

PV = -558 000
FV = 0
PMT = 146 073 (only payment for right to use asset)
N = 5
INT = 9.70%

(b)

Dr. Cr.
Depreciation (CU558 000/6) 93 000
Motor vehicle: Accumulated depreciation 93 000
Deferred profit (SFP) (CU58 000/5) 11 600
Finance costs/Depreciation/Amortisation of 11 600
deferred profit (P/L)
Finance cost/Interest expense (P/L) 54 126
Finance lease liability (CU558 000 x 9.70%) 54 126
Maintenance expense (P/L) Finance lease liability 16 230
16 230

(c)

Operating activities
Cash paid to suppliers and employees (part 1 b) (16 230)
Interest paid (part 1 b) (54 126)

Financing activities
Cash receipt on sale and finance leaseback (given) * 558 000
Capital repayment of lease liability (CU146 073 – CU54 126) (91 947)

* could be presented as investing cash flows

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
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Financial Accounting, IFRS Principles Chapter 15

Tutorial 15.7 Suggested solution Intermediate level

Sea-the-Wood-for-the-Trees Ltd
Extract from the notes to the financial statements for the year ended 31 December 20X5

Note 2: Operating costs 20X5

CU
Operating costs include the following disclosable items: -

Profit on sale – factory (WK4) 120 000

Depreciation - plant & factory (WK3 & 8) 323 333
Finance costs (WK2) 216 372
Operating lease payments 25 000
Factory buildings (WK5) 30 000
less: Portion of deferred profit recognised (WK4) 5 000

Note 3: Taxation

S A Normal taxation
Current (WK10) 237 183
Deferred taxation - current year (WK9) (13 663)
223 520

Taxation reconciliation
Effective taxation rate (WK11) 35%
The tax rate is based on taxable income as determined in accordance with the SA Income Tax Act.

Note 4: Deferred Taxation

Deferred tax balance consists of timing differences relating to:

Plant and Machinery (WK6) (25 330)
Deferred profit (WK6) (61 250)
(86 580)

Reconciliation of deferred tax asset opening and closing balances1:

Deferred tax asset opening balance 72 917
Current year deferred tax income 13 663
Deferred tax asset closing balance 86 580

Note 5: Finance Lease 20X5

CU
1
No longer required to be disclosed. IAS 12.81(g) (ii) already satisfied, as change in balance is exactly equal to deferred tax in profit or loss.
Therefore, included for information purposes only.

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.
Financial Accounting, IFRS Principles Chapter 15

Minimum lease payments 2,880,000

Finance charges allocated to future periods -863,628
PV of minimum lease payments 2,016,372

Minimum lease PV of minimum PV of

payments lease payments minimum
lease
payments
Option 1 Option 2
CU CU CU
< 1 year 576,000 545,034 467,814 W1
2-5 years 2,304,000 1,471,338 1,548,548
> 5 years
2,880,000 2,016,372 2,016,372

Secured by plant and machinery (refer note 6). The lease liability is repayable in 5 equal annual
instalments of CU576 000 (including interest) each, commencing on 30 April 20X6. Interest is charged at
an effective rate of 18,0307% p.a.

[Not part of disclosure but included for explanation purposes]:

Interest accrued to 31 Dec 20X5: 216,372
Lease liability 1,800,000
CU 2,016,372

Option 1: is PV of pmt in 4 months’ time (16 mths; 28 mths etc)

Option 2: shows how much capital will be repaid by next payment(<1 yr includes
interest accrued)
W1: 216,372 + 251,442 = 467,814

Note 6: Fixed Assets

Plant and Machinery Factory
CU CU
Gross carrying value - 1 000 000
Accumulated depreciation (416 667)
Carrying Value at beginning of year - 583 333
Sale - (500 000)
Additions during the year 1,800,000 -
Depreciation for the current year (wkg 3 & wkg 8) (240 000) (83 333)
Carrying value at the end of the year 1,560,000 0
Gross carrying value 1,800000
Accumulated depreciation (240 000)

Plant and machinery are held in terms of a finance lease agreement referred to in note 5.

Note 7: Sale and leaseback

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
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Financial Accounting, IFRS Principles Chapter 15

The factory premises was disposed of under a sale and leaseback agreement during the year at a profit of
CU300 000, of which CU120 000 was recognised immediately and CU180 000 (the amount received in
excess of market value) was deferred as a liability to be amortised against future lease expenses over the
remaining period of the lease.

CU
Liability arising from sale and leaseback (WK4) 180 000
Less amount amortised (WK4) (5 000)
Liability closing balance 175 000
Less: Short term portion (WK4) (30 000)
Long term portion 145 000

Note 8: Operating leases

Commitments under an operating lease

CU
Due within one year 180 000
Due between 2 and 5 years 720 000
Due after 5 years 180 000
1 080 000

Workings

WK1 – Amortisation table

Date Balance Interest Capital Lease Pmt

30 April 20X6 1800 000 324 558 (w1) 251 442 576 000
30 April 20X7 1548 558 279 220 (w2) 296 780 576 000
(w1) 1 800 000 x 18.031% = 324 558
(w2) 1 548 588 x 18, 03% = 279 220

WK2 – Finance costs

Interest expense 324 558
Apportioned x 8/12
216 372

WK3 – Depreciation
Cost 1800 000
Useful life 5 years
Per annum 360 000
Apportioned x 8/12
Expensed 240 000

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.
Financial Accounting, IFRS Principles Chapter 15

WK4 – Profit on sale and leaseback

Market value 620 000
Carrying amount 500 000
Profit to be recognised immediately 120 000

Selling price 800 000

Market value 620 000
Profit to be amortised 180 000

WK5 – Lease Expense

Deferred profit to be amortised for 20X5
(180 000/6 x 2/12) 5 000

(180 000 x 2/12) = 30 000 – 5 000 = 25 000

Wk 6 - Cost of factory
Carrying amount on 31/10/20X5 = R 500 000, 5 years old
Depreciate over 10 years, straight line
Cost = CU1 000 000

WK 7 - Tax base of factory on 1/1/20X5

Tax base on 31/10/20X5 = CU750 000
Wear & tear 20.X5 = R 1 000 000 x 5% x 10/12 = + CU 41 667
Tax base on 01/01/20X5 = + CU 791 667

WK 8 – Carrying amount of factory on 1/1/20X5

Carrying amount on 31/10/20X5 = CU500 000
Historic cost = 500 000 / 5 x 10 = CU1 000 000
Depreciation 20.X5 = R 1 000 000 x 10% x 10/12 = + CU83 333
Carrying amount on 01/01/20X5 = + CU583 333

WK9 – Deferred Taxation CU’000

Carrying Tax Temporary Deferred Deferred

value Base Difference Tax (B/S) Tax (P/L)

Factory building
Opening balance 583 333 791 667 (208 334) (72 917) Dr
Closing balance - - - - 72 917 Dr

Deferred profit
Opening balance - - - -
Closing balance (175 000) - (175 000) (61 250) Dr 61 250 Cr

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.
Financial Accounting, IFRS Principles Chapter 15

Accrued Lease Expense

Opening balance - - -
Closing balance (30 000) (30 000) -

Plant and Machinery

Opening balance - - - -
Plant *1 560 000 - 1 560 000 546 000Cr
Interest accrued **(216 372) (216 372) - -
Lease liability (1 800 000) (167 628) (1 632 372) (571 330)Dr 25 330Cr
-
Totals c/b: 86 580 13 663 Cr
Dr

Workings:
* 1 800 000 (cost) - 240 000 (depreciation) = 1 560 000
** Will not get interest accrual as future tax deduction - included in tax lease deduction of 384 000
(576 000 x 8/12)
*** Will not get full capital amount as future deduction. CU167 628 included in tax lease deduction of
CU384 000 (CU384 000 – 216 372 = 167 628)

Journal Entries (Not required)

Plant and machinery

Dr Plant & machinery (asset) 1 800 000

Cr Lease Liability 1 800 000

Dr Depreciation 240 000

Cr Accumulated depreciation 240 000

Dr Interest exp/ finance cost 216 372

Cr Interest accrued 216 372

WK10 – Taxable Income

Net income before tax 1 000 000
Depreciation - factory 83 333
Less wear & tear factory (41 667)
Less: Lease payment (180 000 x2/12) (30 000)
: Lease instalment (576 000 x 8/12) (384 000)
Add: Recoupment (w10A) 50 000
Taxable Income 677 666

Taxation thereon @ 35% 237 183

(W10A) Recoupment:
Sales price limited to cost minus tax value (800 (Ltd to 1 000) – 750 = 50

WK11 – Accounting Income

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.
Financial Accounting, IFRS Principles Chapter 15

Net income before taxation (given) 1 000 000

Less: Finance charges (WK2) (216 372)
: Lease rental expense (WK5) (25 000)
: Depreciation (WK3) (240 000)
Add: Profit on sale of asset (WK4) 120 000
Accounting income 638 628

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.
Financial Accounting, IFRS Principles Chapter 15

Tutorial 15.8 Suggested solution Advanced level

Both these service contracts appear to contain a lease as envisaged by IFRIC4. In both cases Carlisle Ltd
has the use of a specific asset (i.e. the distribution centre and the trucks) and no other parties are taking
more than an insignificant amount of the output of these assets (only 5% in the case of the distribution
centre and 0% in the case of the truck). Furthermore, the price paid by Carlisle Ltd in both circumstances
is neither contractually fixed per unit of output nor equal to the current market price at the time of
delivery of the output.

Thus, in terms of IFRIC4, these arrangements would both meet the requirements to be accounted for as
a lease by Carlisle Ltd.

The distribution centre would be treated as an operating lease by Carlisle Ltd as none of the
requirements in terms of IAS 17.10 (i.e. the conditions that need to be satisfied to treat a lease as a
finance lease) are met. Thus, the payments made to the third party who lease the distribution centre
would be treated as operating lease payments (recognised on a straight line basis over the lease period)
with disclosure of the future lease payments, split into the three time periods given.

The trucks would meet the definition of a finance lease as the lease period is for a major portion of the
trucks economic life (in this case 100%).

The trucks would therefore be included on Carlisle’s balance sheet as Property, plant and equipment at
an amount equal to their fair value with a similar amount being recognised as a liability. The payments
made to the truck drivers would be split between a capital portion, which would reduce the outstanding
liability, and an interest portion, which would be shown as finance charges in the income statement.
The trucks would also be subject to a depreciation charge (and impairment when necessary). All finance
lease disclosure as required by IAS 17 would also be required.

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.
Financial Accounting, IFRS Principles Chapter 15

Tutorial 15.9 Suggested solution Advanced level

Accounting implications of agreement with Tech-talk Ltd

(a) This appears to be a lease as described in IFRIC 4, as fulfilment of the arrangement is

dependent on the use of a specific asset/assets, namely the 23 identified base stations.
Connect has the right to control the use of the asset, as they have been granted exclusive
use of the telecommunication services of the asset (no other party will benefit from this
asset) and the payment is not a fixed amount per unit of output, but rather a flat fee of
CU100 000 per month (year 2: CU110 000 per month), which satisfies IFRIC 4.9(c). Note that
it appears that Connect neither operates nor controls physical access to the base station, but
it is not necessary for all the requirements in IFRIC 4.9 to be met.
Further, it appears as if this is an operating lease, as the risks and rewards of ownership
appear to remain with Tech-talk, by virtue of the fact that:
x This lease is only for two years out of the remaining estimated economic life of 9 years
(i.e. not a major portion of the assets’ economic lives).
x Also, ownership of the base stations remains with Tech-talk after the lease term as
evidenced by usage reverting back to Tech-talk at the end of two years.
x The present value of the minimum lease payments (CU100 000 discounted for 24
months) is unlikely to equal substantially all of the fair value of the base stations (cost
was CU8m a year ago).
Consequently, Connect should account for lease payments as an expense on a straight-line
basis, which would amount to CU105 000 per month ((CU100 000 x 12) + (CU110 000 x
12)/24) resulting in an expense for the 2014 financial year of CU1 155 000 (CU105 000 x 11
months).

(b) Tech-talk has an asset that is being held to earn rental income, as concluded in part (a)
above. The question is whether IAS 16 PPE or IAS 40 Investment properties should be used
to account for the base stations.

If the base station is considered to be land or buildings, it should be accounted for in terms
of IAS 40. Although this structure is unlike a commercial or residential building that
comprises bricks, windows and a roof, it is still a built structure, and therefore could
reasonably be considered to be a building. Therefore IAS 40 appears to be the relevant
standard.

Although Tech-talk is providing maintenance and repair services, and therefore has an
occasional physical presence at the base station, this is not likely to be a significant ancillary
service per IAS 40. 11-12. Consequently, the base station is not owner-occupied, and Tech-
talk will classify the base station as investment property.

© Solutions to questions in: Lubbe, I., Modack, G. & Herbert, S. 2019. Financial Accounting: IFRS Principles 5e: Cape Town: Oxford
University Press South Africa. Unless otherwise indicated, the questions and suggested solutions are copyrighted to the University of
Cape Town and reprinted by Oxford University Press South Africa with permission.