THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG FINANCIAL ACCOUNTING JUNE 2011 Suggested Answers The suggested answers are published for the purpose of assisting students in their understanding of the possible principles, analysis or arguments that may be identified in each question 1
SECTION A Q1. You are Peter Cheung, the accounting manager of Dongguan Limited (DGL), which is a company incorporated in Hong Kong. DGL is principally engaged in the manufacturing of consumer products in the People's Republic of China. During the preparation of the financial statements of DGL for the year ended 31 March 2011, Amy Chow, a director of DGL, is concerned about the implications of several transactions. She wonders if they may have a significant impact on the profit or loss. The following is the trial balance of DGL at 31 March 2011: $ 000 $ 000 6% redeemable debentures (note (i)) 41,000 Accumulated depreciation 1 leasehold property 6,750 April 2010 Accumulated depreciation 1 April 2010 plant and equipment 27,000 Administrative expenses 79,400 Bank 9,000 Finance cost 2,400 Construction contract (note (ii)) 31,000 Cost of sales 589,000 Distribution costs 53,800 Inventory at 31 March 2011 97,000 Leasehold property at cost (note (iii)) 90,000 Redeemable debenture interest paid (note (i)) 1,230 Ordinary shares of $1 each 121,000 Plant and equipment at cost 135,000 Retained earnings at 1 April 2010 93,830 Revenue 791,000 Trade payables 101,000 Trade receivables 93,750 1,181,580 1,181,580 Ms. Chow is concerned about the following three items: (i) On 1 April 2010, a redeemable debenture with a coupon interest rate of 6% per annum was issued at its nominal value of $41 million. The direct 2
issue costs were $1,000,000 and the amount has been charged to finance costs. The redeemable debenture is not designated as part of the financial liabilities carried at fair value through profit or loss and it is expected to be redeemed on 31 March 2014 at a premium. The effective interest rate of the redeemable debenture is 8% per annum. (ii) A construction contract commenced on 1 October 2010 and it is scheduled to take 24 months to complete. The contract price is fixed at $81 million. Plant was purchased at the start of the contract for $25 million and is dedicated to this construction contract. The dedicated plant is expected to have a residual value of $7 million at the end of the contract. A surveyor has assessed that the contract is 40% complete at 31 March 2011 and the outcome of the contract is deemed to be reasonably certain as at that date. The customer has been invoiced for the progress payment of $10 million and the amount was received on 31 March 2011. The construction contract of $31 million as shown in the trial balance consists of the material and labour costs up to 31 March 2011 amounting to $16 million together with the cost of the dedicated plant ($25 million), less the progress payment ($10 million) received from the customer. Further material and labour costs amounting to $29 million are expected in order to complete the contract. (iii) On 1 October 2010, DGL decided to sell its leasehold property in order to maintain the liquidity of the company. DGL purchased this leasehold property several years ago for $90 million. On 1 October 2010, DGL commenced a rental of a comparable property. DGL has appointed a property agent to sell the leasehold property at a price of $83 million. The expected selling costs are 1% of the selling price. However, the latest market transactions indicate that the fair value of the property is only $74.7 million. At 31 March 2011, the property had not yet been sold. Depreciation and impairment has not yet been charged on the non-current assets for the year ended 31 March 2011. Depreciation is to be provided for using the straight-line method on a monthly basis. The leasehold property has a useful life of 40 years. Plant and equipment, other than the dedicated plant for the construction contract, is depreciated at 10% per annum. Depreciation and impairment charges of leasehold property are charged to administrative expenses and those for plant and equipment are charged to cost of sales. 3
REQUIRED: As the accounting manager draft a memorandum to director Amy Chow. Your memorandum should discuss the following issues associated with the financial statements of DGL for the year ended 31 March 2011: Q1 (a) discuss and advise, with calculations, the accounting treatment for the redeemable debenture; Ans (a) To : Amy Chow, Director of DGL From : Peter Cheung, Accounting Manager Date : dd/mm/yyyy Subject : Financial statements of DGL as at 31 March 2011 I refer to your message regarding your queries about the accounting treatment of the redeemable debenture, construction contract and leasehold property and their impacts on the financial statements of DGL as at 31 March 2011. Redeemable debenture HKAS 39 Financial Instruments: Recognition and Measurement specifies that when a financial liability not carried at fair value through profit or loss is recognised initially, an entity shall measure it at its fair value plus transaction costs that are directly attributable to the issue of the financial liability. Therefore, for DGL, the issue costs of $1 million should be deducted from the proceeds of the redeemable debenture. The initial cost should be measured at $41 million - $1 million = $40 million. Since the redeemable debenture is not designated as a financial liability at fair value through profit or loss, after initial recognition, the redeemable debenture should be measured at amortised cost using the effective interest method. The amortised cost of the financial liability is the amount at which the 4
financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction for impairment or uncollectibility. The finance cost of the redeemable debenture, at the effective interest rate of 8% applied to the carrying amount of the redeemable debenture of $40 million, is $3,200,000. The annual interest should be $2,460,000 ($41 million x 6%). However, the redeemable debenture interest paid, as shown in the trial balance, is $1,230,000. Therefore, a further $1,230,000 ($41 million x 6% x 6/12) should be accrued as a current liability. The difference between the total finance cost of $3,200,000 and the $2,460,000 annual coupon interest, i.e. $740,000, should be added to the carrying amount of the redeemable debenture to give $40,740,000 ($40 million + $740,000) to be included as a non-current liability in the statement of financial position. Q1 (b) discuss and advise, with calculations, the accounting treatment for the construction contract; Ans (b) Construction contract HKAS 11 Construction Contracts specifies that when the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract shall be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the end of the reporting period. The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to 5
the proportion of work completed. Contract costs are usually recognised as an expense in the profit or loss in the accounting periods in which the work to which they relate is performed. However, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately. Therefore we have to check if there is any expected excess of total contract costs over total contract revenue. In this case, Total contract revenue is the agreed contract price, i.e. $81 million Total contract cost is: Costs incurred to date = $16 million plus further costs to complete = $29 million plus *total depreciation of the plant $(25 7) million = $18 million $63 million Thus, total estimated profit = $18 million *Costs that relate directly to a specific contract include depreciation of plant and equipment used on the contract. Since there is no expected excess of contract costs over total contract revenue, under the percentage of completion method, contract revenue, expense and profit can be recognised according to the proportion of work completed. Therefore, amounts to be recognised in the income statement for the year ended 31 March 2011 would be: $ 000 Revenue ($81 million x 40%) 32,400 Cost of sales (balancing figure) (25,200) Gross profit ($18 million x 40%) 7,200 HKAS 11 Construction Contracts specifies that a contractor may have incurred contract costs that relate to future activity on the contract. Such contract costs are recognised as an asset provided it is probable that they will be recovered. Such costs represent an amount due from the customer 6
and are often classified as contract work in progress. Therefore amounts to be recognised in the statement of financial position as at 31 March 2011 would be: $ 000 Costs to date materials and labour 16,000 Plant depreciation (($25 million $7 million) x 6/24) 4,500 20,500 Profit to date 7,200 27,700 Progress billings to date (10,000) Amounts due from customer 17,700 Q1 (c) discuss and advise, with calculations, the accounting treatment for the leasehold property; and Ans (c) Leasehold property HKFRS 5 Non-current Assets Held for Sale and Discontinued Operations specifies that an entity should classify a non-current asset as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. Therefore, to classify a non-current asset to be held for sale, the asset must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets, and its sale must be highly probable. For the sale to be highly probable, the appropriate level of management must be committed to a plan to sell the asset, and an active programme to locate a buyer and complete the plan must have been initiated. Further, the asset must be actively marketed for sale at a price that is reasonable in relation to its current fair value. In addition, the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification and actions required to complete the plan 7
should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. In this case, the leasehold property is being marketed by a property agent at a reasonable price. Thus it can be classified as held for sale despite the fact that it has not yet been sold. DGL should measure the leasehold property, being a non-current asset classified as held for sale, at the lower of its carrying amount and fair value less costs to sell. The leasehold property should be depreciated for six months up to 1 October 2010 (after which depreciation ceases). This is calculated at $1,125,000 ($90 million/40 years x 6/12). Its carrying amount at 1 October 2010 is therefore $82,125,000 (90 million (6,750,000 + 1,125,000)). As the fair value less cost to sell at 1 October 2010 is $73,953,000 (($74.7 million x 99%), DGL should recognise an impairment loss for the write-down of the asset to fair value less costs to sell. The leasehold property is therefore impaired by $8,172,000 (82,125,000 73,953,000). I hope the above explanation has answered your questions. For the details, please refer to the annex. Please feel free to contact me if you have further queries. Best regards, Peter Cheung Q1 (d) prepare an annex to your memorandum showing the statement of comprehensive income and statement of financial position as at 31 March 2011. Notes to the financial statements and statement of changes in equity are not required. 8
Ans (d) DGL Statement of comprehensive income for the year ended 31 March 2011 $ 000 Revenue (791 million + 32.4 million (1(b))) 823,400 Cost of sales (w(i)) (627,700) Gross profit 195,700 Distribution costs (53,800) Administrative expenses (w(ii)) (88,697) Finance costs (2.4 million 1 million + 3.2 million (1(a))) ( 4,600) Profit for the year 48,603 DGL Statement of financial position as at 31 March 2011 $ 000 $ 000 Assets Non-current assets Property, plant and equipment (w(iii)) 115,000 Current assets Inventory 97,000 Construction contract amounts due from customer (1(b)) 17,700 Trade receivables 93,750 Bank 9,000 217,450 Non-current assets held for sale (1(c)) 73,953 Total assets 406,403 Equity and liabilities Equity Ordinary shares of $1 each 121,000 Retained earnings (93.83 million + 48.603 million) 142,433 263,433 Non-current liabilities 6% redeemable debenture (1(a)) 40,740 Current liabilities Trade payables 101,000 Accrued redeemable debenture interest (1(a)) 1,230 102,230 Total equity and liabilities 406,403 9
Workings: (i) Cost of sales $ 000 Per trial balance 589,000 Construction contract (1(b)) 25,200 Depreciation of plant and equipment (135 million x 10%) 13,500 627,700 (ii) Administrative expenses $ 000 Per trial balance 79,400 Depreciation of leasehold property (1(c)) 1,125 Impairment of leasehold property (1(c)) 8,172 88,697 (iii) Property, plant and equipment $ 000 Property, plant and equipment ((135 27 13.5) million) 94,500 Construction plant (25 million 4.5 million (1(b)) 20,500 115,000 10
SECTION B (Answer THREE questions from this section) Q2. Papaya Limited, whose subsidiary is Saga Limited, purchased 30% of the ordinary shares of Arrow Limited on 1 April 2010 for $5,000,000. The financial statements of Papaya Group (Papaya Limited and Saga Limited) and Arrow Limited are provided below: Statements of comprehensive income for the year ended 31 March 2011 Papaya Group Arrow Limited $000 $000 Sales 24,000 4,000 Cost of sales (8,000) (2,160) Gross profit 16,000 1,840 Administrative expenses (4,800) (320) Distribution costs (2,000) (300) Profit before tax 9,200 1,220 Tax (1,600) (400) Profit for the year 7,600 820 Profit attributable to: Owners of Papaya 7,200 Non-controlling interest 400 7,600 Note: Papaya Limited, its subsidiary and Arrow Limited did not recognise any components of other comprehensive income for the year ended 31 March 2011. Statements of financial position as at 31 March 2011 Papaya Group Arrow Limited $000 $000 Non-current assets Property, plant and equipment 32,000 4,000 Investment in Arrow Limited 5,000 Current assets Inventory 5,600 2,000 Trade receivables 3,200 1,600 Cash 1,200 1,200 10,000 4,800 Total assets 47,000 8,800 Equity and liabilities Equity attributable to owners of Papaya Ordinary shares, $1 each 22,000 4,000 Retained earnings 18,000 3,200 40,000 7,200 11
Non-controlling interest 2,000 Total equity 42,000 Non-current liabilities Bank loan 4,000 400 Current liabilities Trade payables 1,000 1,200 Total equity and liabilities 47,000 8,800 The following additional information is relevant: 1) Papaya Limited can exercise significant influence over the financial and operating policy decisions of Arrow Limited. 2) The carrying amounts of the assets and liabilities of Arrow Limited at the acquisition date were considered to be a reasonable approximation of their fair values. 3) Goodwill relating to an associate is to be accounted for in accordance with HKAS 28 Investments in Associates. An impairment review of Arrow Limited s goodwill was carried out at 31 March 2011 and an impairment loss of $100,000 was to be provided. 4) The inventory of Arrow Limited at 31 March 2011 included $1,440,000 in respect of sales of goods to it from Papaya Limited during the year at cost plus 20%. 5) No dividends had been paid or declared by Papaya Limited, Saga Limited or Arrow Limited for the year ended 31 March 2011. 6) Deferred tax implications can be ignored. REQUIRED: Q2 (a) For the investment in Arrow Limited as an associate, calculate the goodwill arising on the acquisition remaining unimpaired. Ans (a) Goodwill of Arrow Limited: $000 Cost of investment 5,000 12
Less: Share of associate s fair value of identifiable assets and liabilities acquired [4,000k + (3,200k 820k)] x 30% (1,914) Goodwill arising on acquisition 3,086 Less: Impairment loss (100) Goodwill arising on acquisition not impaired 2,986 Q2 (b) Prepare the consolidated statement of comprehensive income of Papaya Limited for the year ended 31 March 2011 and the consolidated statement of financial position as at that date, incorporating the associate, Arrow Limited. Ans (b) Consolidated financial statements for the year ended 31 March 2011 W1 Unrealised profit in associate s inventory = $1,440,000 x 20/120 = $240,000 W2 Consolidated retained earnings $000 $000 Balance b/f 18,000 Share of unrealised profit 72 Share of profit after tax of 246 - Inventory (240k x 30%) associate (820k x 30%) Goodwill - Impairment 100 loss Balance c/f 18,074 18,246 18,246 W3 Investment in Arrow Limited $000 $000 Balance b/f 5,000 Share of profit after tax of associate 246 Share of unrealised profit - Inventory 72 Goodwill Impairment 100 loss Balance c/f 5,074 5,246 5,246 or: Investments in associate (Arrow Limited) 13
$000 Share of identifiable assets and liabilities at year-end 2,088 [(7,200k unrealised 240k) x 30%] Goodwill arising on acquisition not impaired 2,986 5,074 Papaya Limited Consolidated statement of comprehensive income for the year ended 31 March 2011 $000 Sales 24,000 Cost of sales (8,000) Gross profit 16,000 Administrative expenses (4,800) Distribution costs (2,000) Share of profit after tax of an associate (net of unrealised profit and impairment loss) [(820k 240k (w1)) x 30% 100k] 74 Profit before tax 9,274 Tax (1,600) Profit for the year 7,674 Profit attributable to: Owners of Papaya (7,200k + associate, [(820k 240k) x 30% 100k]) 7,274 Non-controlling interest 400 7,674 Papaya Limited Consolidated statement of financial position as at 31 March 2011 $000 $000 Assets Non-current assets Property, plant and equipment 32,000 Investment in Arrow Limited (W3) 5,074 Current assets Inventory 5,600 Trade receivables 3,200 Cash 1,200 10,000 Total assets 47,074 Equity and liabilities Equity attributable to owners of the parent 14
Ordinary shares, $1 each 22,000 Retained profit (W2) 18,074 40,074 Non-controlling interest 2,000 Total equity 42,074 Non-current liabilities Bank loan 4,000 Current liabilities Trade payables 1,000 Total equity and liabilities 47,074 15
Q3. Rosemary International Ltd prepares its financial statements to 31 March each year. The financial statements for the year ended 31 March 2011 showed a net profit of $884,000. Before the financial statements were authorised for issue by the board of directors on 8 June 2011, the following material events took place: 1) A debtor was declared insolvent on 16 April 2011. The amount due from the debtor was $260,000 as at the end of the reporting period. No provision had been made as at the end of the reporting period. 2) There was a fire at the warehouse on 22 April 2011 when part of the company s inventory to the value of $1,040,000 was destroyed. The company received $650,000 compensation from the insurance company in May 2011. 3) The company sold an item of equipment with a net book value of $280,000 on 30 March 2011 but the consideration was subsequently determined as $224,000 on 1 May 2011. No gain or loss had been recognised for this disposal for the year ended 31 March 2011. 4) A rights issue of 1 for 4 shares on a share capital of 5 million ordinary shares at $1 each was announced on 3 May 2011 for a subscription price of $1.80 per new issue. All rights were taken up on 31 May 2011. REQUIRED: Q3 (a) Define events after the reporting period, adjusting events and non-adjusting events with reference to the HKAS 10 Events After the Reporting Period. Ans (a) Events after the reporting period are those events, both favourable and unfavourable, which occur between the reporting period and the date on which the financial statements are authorised for issue. There are two types of events after the reporting period: Adjusting events are those that provide evidence of conditions that existed at the reporting period. 16
Non-adjusting events are those that are indicative of conditions that arose after the reporting period. Q3 (b) State and explain whether the above events from (1) to (4) are adjusting or non-adjusting events, and advise the respective accounting treatment and disclosure required. Ans (b) (1) This is an adjusting event. The insolvency is relevant to the value which is placed on the amount owing by the debtor. The value of the debt at the end of the reporting period should reflect all information that is available before the financial statements are authorised for issue. $260,000 bad debts should be charged to the income statement for the year ended 31 March 2011. (2) This is a non-adjusting event. The fire occurred after the end of the reporting period and thus it is not a condition existing at the end of the reporting period. As the item is material, the nature of the event and the loss of $390,000 ($1,040,000 - $650,000) should be disclosed in the notes to the financial statements. (3) This is an adjusting event. The subsequent determination of the sale proceeds of the equipment disposed of before the end of the reporting period is an adjusting event. As the sale actually took place, the finalisation of the sale proceeds provides additional evidence relating to conditions existing at the end of the reporting period. Hence, the loss on disposal of $224,000 - $280,000 = $56,000 should be debited to the income statement for the year ended 31 March 2011. (4) This is a non-adjusting event. The rights issue took place after the end of the reporting period. As the item is material, it should be disclosed by way of notes to the financial statements including the details of the nature of the event, and the financial effect, that is the proceeds from the rights issue of $2.25 million (5 million x 1/4 x $1.8). 17
Q3 (c) Prepare a statement showing the calculation of the adjusted profit for the year ended 31 March 2011. Ans (c) Statement for calculation of the adjusted profit for the year ended 31 March 2011 $ Net profit before adjustment 884,000 Less: Loss on disposal of equipment (56,000) Bad debts written off (260,000) Adjusted net profit for the year 568,000 18
Q4. At 1 April 2009, the capital structure of Beauty Limited was as follows: Issued and fully paid-up capital: 6,000,000 ordinary shares at $1 each 1,500,000 10% preference shares at $1 each Share warrants: 1,000,000 warrants, each of which entitles the holder to acquire one ordinary share at $3.80. The holders may exercise their rights on or before 31 March 2020. On 1 July 2010, the company made a rights issue of one new share for each five existing ordinary shares at an exercise price of $2.50. The fair value of the ordinary shares immediately prior to the right issue was $4.50. The trading results of the company for the years ended 31 March 2011 and 2010 are as follows: 2011 2010 $ 000 $ 000 Profit before taxation 5,882 4,706 Taxation (882) (706) Profit for the year 5,000 4,000 The fair value of the ordinary shares as at 31 March 2011 was $4.20. The profit tax rate for the year of assessment 2010/11 is 16.5%. REQUIRED: Calculate the following for Beauty Limited (round your answers to four decimal places): Q4 (a) the basic earnings per share (basic EPS) for the year ended 31 March 2010 (original and restated) and 31 March 2011; and 19
Ans (a) Computation of basic earnings per share (EPS): 2011 2010 $000 $000 Profit for the year 5,000 4,000 Less: preference share dividend (150) (150) Profits attributable to ordinary shareholders 4,850 3,850 2010 EPS as originally reported: $3,850,000 / 6,000,000 = $0.6417 2010 EPS as restated: $3,850,000 / [6,000,000 x 1.08 (note 1)] = $0.5941 2011 EPS: $4,850,000 / 7,020,000 (note 2) = $0.6909 Note 1: Computation of theoretical ex-rights value per share Market value of the shares immediately before the exercise of rights + proceeds from the exercise of rights Number of shares outstanding after the exercise of rights $4.50 x 6,000,000 + $2.50 x 1,200,000 6,000,000 + 1,200,000 = $4.1667 Computation of adjustment factor Fair value per share immediately before the exercise of rights Theoretical ex-rights value per share $4.50 $4.1667 = $1.08 Note 2: Calculation of weighted average number of ordinary shares outstanding during the year ended 31 March 2011 Before rights issue 6,000,000 x 1.08 x 3/12 = 1,620,000 After rights issue (6,000,000 + 1,200,000) x 9/12 = 5,400,000 20
Weighted average number of ordinary shares 7,020,000 Q4 (b) the diluted earnings per share (diluted EPS) for the year end 31 March 2011. Ans (b) Computation of diluted earnings per share for the year ended 31 March 2011: $000 Profit attributable to ordinary shareholders $4,850 Adjusted weighted average number of ordinary shares Weighted average number of ordinary shares outstanding during the year 7,020 Number of ordinary shares issued upon the exercise of the warrants 1,000 Number of shares that would have been issued at fair value upon the exercise of the warrants (1,000,000 x $3.8/$4.2) ( 905) 7,115 Diluted earnings per share $0.6817 21
Q5. Kowloon Limited s financial year end is 31 March. On 1 April 2009, Kowloon Limited purchased a building on leasehold land for $9.8 million. Legal fees relating to the purchase amounted to $600,000. The land and buildings were revalued on 31 March 2010 to $15.2 million on an open market value basis by Chartered Surveyors, an independent firm of property valuers. On 30 September 2010, the land and buildings were revalued to $13.6 million, and on 31 March 2011 the land and buildings were sold for $12 million. The land and buildings were first depreciated on a straight-line basis over 50 years from the date of acquisition, being the terms of the lease. Upon revaluation, the re-valued land and buildings were depreciated over the remaining term of the lease. Kowloon Limited s policy is that when an item of property, plant and equipment is revalued, any accumulated depreciation at the date of the revaluation is eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset. REQUIRED: Q5 (a) Briefly explain the measurement basis after the initial recognition for property, plant and equipment in accordance with HKAS 16 Property, Plant and Equipment. Ans (a) HKAS 16 Property, Plant and Equipment states that, after initial recognition, an entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, plant and equipment. Cost model after recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses. Revaluation model after recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at 22
a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. Q5 (b) Prepare the journal entries, with narratives, to record the above transactions for the years ended 31 March 2010 and 31 March 2011. Ans (b) 2009/10 1 April 2009 $ $ Dr Land and buildings 10,400,000 Cr Cash 10,400,000 Being purchase of land and buildings at cost $10.4m (including legal fees of $0.6m) 31 March 2010 Dr Depreciation expense 208,000 Cr Accumulated depreciation 208,000 Being depreciation provided for the year ended 31 March 2010: $10,400,000/50 Dr Land and buildings 4,800,000 Dr Accumulated depreciation 208,000 Cr Asset revaluation reserve 5,008,000 Being revaluation of land and buildings at 31 March 2010 ($10.4m $0.208m) to $15.2m 2010/11 30 September 2010 Dr Depreciation expense 155,102 Cr Accumulated depreciation 155,102 Being depreciation of land and buildings provided for half-year ended 30 September 2010 (date of revaluation): $15.2m/49 x 6/12 Dr Accumulated depreciation 155,102 Dr Asset revaluation reserve 1,444,898 23
Cr Land and buildings 1,600,000 Being revaluation of land and buildings at 30 September 2010: (($15,200,000 - $155,102) to $13,600,000) 31 March 2011 Dr Depreciation expense 140,206 Cr Land and buildings - accumulated depreciation 140,206 Being depreciation of land and buildings provided for the second half year ended 31 March 2011: $13,600,000/48.5 x 6/12 Dr Cash 12,000,000 Dr Loss on disposal of land and buildings 1,459,794 Dr Accumulated depreciation 140,206 Cr Land and buildings 13,600,000 Being recognition of the loss on disposal of land and buildings on 31 March 2011. Dr Asset revaluation reserve 3,563,102 Cr Retained profits 3,563,102 Being transfer of the asset revaluation reserve to retained profits upon recognition of the disposal of the revalued land and buildings: $(5,008,000 1,444,898) on 31 March 2011. 24
Q6. The book-keeper of Chan & Lee, a CPA firm, has given you the following trial balance as at 31 March 2011. Chan & Lee Unadjusted Trial Balance as at 31 March 2011 Accounts Debit ($) Credit ($) Office equipment 600,000 Accumulated depreciation (office equipment) 80,000 Prepaid rent 7,000 Accounts receivable 382,500 Supplies at 1 April 2010 14,000 Cash 90,000 Accounts payable 47,000 Short-term bank borrowing 100,000 Capital 125,000 Retained earnings at 1 April 2010 178,000 Fees earned 800,000 Other income 20,000 Rent expense 200,000 Other expenses 56,500 Totals 1,350,000 1,350,000 The book-keeper has also given you the following additional information: 1) Included in the fees earned is a payment of $7,875 from a client. The terms of the payment stated that it is a payment for accounting services for three years starting from 1 April 2010. 2) Supplies on hand at the end of the year amounted to $3,500. 3) Prepaid rent of $4,500 was used during the year. 4) The office equipment was purchased on 1 April 2008 and has no salvage value. No depreciation has yet been recognised in 2011. Depreciation is to be made based on the straight-line method. 5) The interest rate on the short-term bank borrowing is 10%. No interest has been paid on the notes since 1 April 2010. 6) On 1 April 2010, Chan & Lee engaged Integrated Solution Limited (ISL) to develop a new accounting system. Due to insufficient know-how, ISL was unable to deliver the accounting system by 31 March 2011. Chan & Lee 25
intends to claim $12,500 against ISL for the delay. This amount has been included in the accounts receivable and other income for the year ended 31 March 2011. However, ISL has not agreed to settle the amount claimed. REQUIRED: Q6 (a) Advise the appropriate accounting treatment for the claim amounting to $12,500 (point (6) above). Ans (a) The claim by Chan & Lee represents a contingent asset. HKAS 37 Provision, Contingent Liabilities and Contingent Assets defines a contingent asset as a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. HKAS 37 quotes as an example a claim that an entity is pursuing through legal processes where the outcome is uncertain. Even if the realisation of income is virtually certain so that the related asset is not a contingent asset and its recognition is appropriate, the claim by Chan & Lee should not be recognised as income. Any agreed settlement may reduce the cost of the accounting system if the matter is finalised. However, as at 31 March 2011, the matter is not yet settled and ISL has not agreed to pay. HKAS 37 specifies that an entity should not recognise a contingent asset in these circumstances. A contingent asset should be disclosed where an inflow of economic benefits is probable. Q6 (b) Prepare the necessary adjusting entries for points (1) to (6) above. Ans (b) Dr ($) Cr ($) Fees earned 5,250 Fees unearned 5,250 Deferment of fees earned (note 1) (7,875 x 2/3) Supplies expense 10,500 26
Supplies 10,500 Supplies utilised from $14,000 to $3,500 (note 2) Rent expense 4,500 Prepaid rent 4,500 Prepaid rent last year used in current year (note 3) Depreciation expense 40,000 Accum. depreciation office equipment 40,000 Depreciation for the year ended 31 March 2011: $80,000/2 (note 4) Interest expense 10,000 Interest payable 10,000 Accrued interest $100,000 x 10% (note 5) Other income 12,500 Accounts receivable 12,500 Reversal of contingent asset recognised (note 6) Q6 (c) Prepare the income statement for the year ended 31 March 2011 and the statement of financial position as at 31 March 2011. Ans (c) Chan & Lee Income statement for the year ended 31 March 2011 $ $ Fees earned (800,000 5,250) 794,750 Other income (20,000 12,500) 7,500 802,250 Expenses Rent expense (200,000 + 4,500) 204,500 Interest expense 10,000 Depreciation expense 40,000 Supplies expense 10,500 Other expenses 56,500 Total expenses (321,500) Net profit 480,750 27
Chan & Lee Statement of financial position as at 31 March 2011 Non-current assets Office equipment 600,000 Accumulated depreciation (120,000) 480,000 (Office equipment) Current assets Prepaid rent 2,500 Supplies 3,500 Accounts receivable (382,500 12,500) 370,000 Cash 90,000 466,000 Total assets 946,000 Equity Capital 125,000 Retained earnings (178,000 + 480,750) 658,750 Total equity 783,750 Liabilities Accounts payable 47,000 Short-term bank borrowing 100,000 Fees unearned 5,250 Interest payable 10,000 Total liabilities 162,250 Total liabilities and equity 946,000 END 28