Page 1

FINANCIAL OPERATIONS

According to the following syllabus CMA (Operational Level), ICMAB Public, Private & National University BBA & BBS Honors in Accounting, Finance

Author Md. Sajjad Hossain CMA (4th Level), MBA (Accounting & Finance), BBA (Finance), LLB, ITP Income Tax Lawyer Member – Dhaka Taxes Bar Association Income Tax and Company Law Adviser

NOBBODOY PUBLICATION DHAKA, BANGLADESH


FINANCIAL OPERATIONS (AS PER IFRS)

No part of this publication may be reproduced, stored, transmitted in any form or by any means of electronic, photocopying, recording or otherwise, without the prior written permission of the Author. All rights reserved.

Edition

: July 2018

Presented By

: Nobbodoy Publication Dhaka, Bangladesh.

Copyright

: All rights reserved by the Author

Price

: BDT 290.00 Only

Financial Operations (as per IFRS), Solved By: Md. Sajjad Hossain, Presented By: Nobbodoy Publication, Dhaka, Edition: July 2018. 1


PREFACE

With the growing demand of education, Accounting has gained a huge popularity. An Accounting degree makes the candidates suitable for lots of opportunities. As more and more multi-nationals are coming into the world, demand for Accounting degree has further increased. The employment peripheries for Accountants are various and can range from holding key positions in a company. The main objective of this book is to meet the basic requirements of the Accounting courses. It is helpful to the students of Bachelor of Business Administration, and Bachelor of Business Studies. It is also helpful for professional students and the persons who are intended to get admission into a professional institute. This book is written by following the curriculum of The Institute of Cost and Management Accountants of Bangladesh, Public and Private University, and National University of Bangladesh for the relative subject. I am grateful and deserve my thanks to the publisher, printers, and designers of this book. Any criticism, favorable or unfavorable, and any constructive suggestion in regards of this book will be gratefully received.

Date: July 2018

Md. Sajjad Hossain

2


Dedicated to my parents

3


BRIEF TABLE OF CONTENTS

Chapter Title

Page No.

1. Principles of business taxation

12

2. Regulation and ethics of financial reporting

58

3. Presentation of financial statements (IAS 1)

62

4. Statement of cash flow (IAS 7)

118

5. Consolidated financial statement (IFRS 10)

189

6. Property, plant and equipment (IAS 16)

210

7. Intangible assets (IAS 38) and goodwill

236

8. Impairment of assets (IAS 36)

256

9. Inventories (IAS 2)

267

10. Construction contracts (IAS 11)

308

11. Leases (IAS 17)

333

12. Issue and redemption of shares (IAS 32)

363

4


র্঴.এম.এ প্রস্তুর্ত ক্লার঴ ভর্তি চ঱রে!

আমারের ববর্লষ্ট্যেঃ

√ আমাদের ঴ক঱ শলক্ষক ও শলক্ষার্থী প্রদেলনা঱ প্রশিষ্ঠাদনর; √ শ঴.এম.এ ব্যাদের ঴ক঱ ছাত্র–ছাত্রী আই.শ঴.এম.এ.শব্ প্রশিষ্ঠাদনর; √ শব্঳য় ও অধ্যায় শিশিক ল঱কোর শলট প্রোন করা ঵য়; √ শ঴.এম.এ শ঴দ঱ব্াদ঴র পালাপাশল শব্গি ব্ছদরর প্রশ্ন ঴মাধ্ান করা ঵য়; √ একাউশটিং শব্঳য় ঴মূদ঵ আই.এে.আর.এ঴ অনু঴রন করা ঵য়; √ গাশিশিক ঴ম঴যা ঴মাধ্াদনর ঴঵জ লকৌল঱ ললখাদনা ঵য়; √ শ঴.এম.এ পরীক্ষার অনুরূপ ক্লাল লটস্ট ও মদে঱ লটস্ট লনওয়া ঵য়।

যযাগারযারগেঃ নব্যেয় ঢাকা, ব্ািং঱াদেল। লমাব্াই঱ঃ ০১৭১১১৩৭০৩৯

শুক্রবাররর বযাচ ররেরে! ফ্রী ক্লা঴ করর ভর্তির র্঴দ্ধান্ত র্িি!

5


DETAILED TABLE OF CONTENTS

Chapter Title and Contents

Page No.

Chapter-1: 1.1. 1.2. 1.3. 1.4. 1.5. 1.6. 1.7. 1.8. 1.9. 1.10. 1.11. 1.12. 1.13. 1.14. 1.15. 1.16. 1.17.

Principles of business taxation Definition of tax Different types of tax Sources of tax revenue Meaning of tax avoidance and tax evasion Distinction between tax avoidance and tax evasion Explanation of double tax relief Effect of double tax relief Definition of accounting profit and taxable profit Differences between accounting profit and taxable profit Meaning of deferred tax assets and liabilities Definition of temporary and permanent differences Explanation of tax base Recognition of current tax assets and liabilities Recognition of deferred tax assets and liabilities Measurement of current and deferred tax Offset of tax assets and liabilities Disclosure Problems and solutions Exercises

12 12 12 12 13 14 14 14 15 15 15 15 16 16 16 17 17 18 19 51

Chapter-2: 2.1. 2.2. 2.3. 2.4. 2.5. 2.6. 2.7. 2.8.

Regulation and ethics of financial reporting Concept of GAAP Role of international accounting standard bodies Need for regulation of accounts Elements in a regulatory framework for published accounts Definition of ethics Nature of ethics IFAC code of ethics for professional accountants Provisions of CIMA code of ethics for professional accountants

58 58 58 58 58 59 59 59 60

Chapter-3: 3.1. 3.2. 3.3. 3.4. 3.5. 3.6. 3.7. 3.8. 3.9. 3.10.

Presentation of financial statements (IAS 1) Definition of financial statement Objectives of financial statement Qualitative characteristics of financial statement Components of financial statement Types of financial statement Methods of financial statement analysis Users of financial statement Definition of current and non-current assets Definition of current and non-current liabilities Explanation of off balance sheet

62 62 62 63 64 64 65 66 66 66 67 6


Chapter Title and Contents 3.11. 3.12. 3.13. 3.14.

Page No.

Information to be presented in the statement of profit or loss Information to be presented in the statement of changes in equity Information to be presented in the statement of financial position Disclosure Problems and solutions Exercises

67 68 68 68 70 97

Chapter-4: 4.1. 4.2. 4.3. 4.4. 4.5. 4.6. 4.7. 4.8. 4.9. 4.10. 4.11. 4.12.

Statement of cash flow (IAS 7) Definition of cash and cash equivalents Meaning of cash flows and statement of cash flows Benefits of statement of cash flows Presentation of statement of cash flows Reasons for preparing statement of cash flows Methods of preparing statement of cash flows Differences between direct and indirect method Limitations of statement of cash flows Explanation of free cash flow Differences between free cash flow and operating cash flow Non-cash transactions Disclosure Problems and solutions Exercises

118 118 118 118 119 120 120 121 121 122 122 122 123 127 166

Chapter-5: 5.1. 5.2. 5.3. 5.4. 5.5.

Consolidated financial statement (IFRS 10) Concept of consolidated financial statements Benefits of consolidated financial reports Meaning of associate company and subsidiary company Relationships between holding and subsidiary company Differences between holding and subsidiary company Problems and solutions Exercises

189 189 189 190 190 191 192 207

Chapter-6: 6.1. 6.2. 6.3. 6.4. 6.5. 6.6. 6.7. 6.8. 6.9. 6.10. 6.11. 6.12. 6.13.

Property, plant and equipment (IAS 16) Definition of property, plant and equipment Cost of property, plant and equipment Measurement of cost Recognition Accounting policies Meaning of depreciation Methods of depreciation Uses of two methods of depreciation Accelerated depreciation Depreciation on income statement and balance sheet differs Derecognition Explanation of depletion Methods of depletion

210 210 210 210 211 211 211 212 212 212 213 213 213 214

7


Chapter Title and Contents 6.14. 6.15. 6.16. 6.17.

Page No.

Reasons for depletion of natural resources Concept of amortization Differences among depreciation, depletion and amortization Disclosure Problems and solutions Exercises

214 215 215 215 216 230

Chapter-7: 7.1. 7.2. 7.3. 7.4. 7.5. 7.6. 7.7. 7.8. 7.9. 7.10. 7.11.

Intangible assets (IAS 38) and goodwill Definition of intangible asset Types of intangible asset Characteristics of intangible asset Differences between tangible and intangible assets Recognition of intangible asset Meaning of goodwill Features of goodwill Methods of valuation of goodwill Amortization of goodwill Explanation of negative goodwill Disclosure Problems and solutions Exercises

236 236 236 237 237 237 238 238 238 239 240 240 241 252

Chapter-8: 8.1. 8.2. 8.3. 8.4. 8.5. 8.6. 8.7. 8.8.

Impairment of assets (IAS 36) Definition of impairment Differences between impairment and depreciation Requirements for asset impairment Reasons for impairment loss Scope of asset impairment Differences between impairment and amortization Recognising an impairment loss Disclosure Problems and solutions Exercises

258 258 258 258 258 257 257 258 258 260 265

Chapter-9: 9.1. 9.2. 9.3. 9.4. 9.5. 9.6. 9.7. 9.8. 9.9. 9.10. 9.11.

Inventories (IAS 2) Definition of inventory Types of inventory Meaning of perpetual and periodic inventory systems Differences between perpetual and periodic inventory systems Advantages of perpetual inventory system Disadvantages of perpetual inventory system Advantages of periodic inventory system Disadvantages of periodic inventory system Best method of inventory system Inventory valuation method Measurement of inventory

267 267 267 267 268 268 269 269 270 271 271 272

8


Chapter Title and Contents

Page No.

9.12. 9.13. 9.14. 9.15.

Concept of lower of cost or market Recognition of inventory Explanation of retail inventory method Disclosure Problems and solutions Exercises

273 273 273 274 275 299

Chapter-10: 10.1. 10.2. 10.3. 10.4. 10.5. 10.6. 10.7. 10.8. 10.9. 10.10.

Construction contracts (IAS 11) Definition of construction contract Types of construction contract Duties of contractor in construction Meaning of principal contractor Roles of principal contractor Responsibilities of principal contractor Meaning of subcontractor Types of subcontractor Benefits of subcontractor Drawbacks of subcontractor Problems and solutions Exercises

308 308 308 309 309 309 310 311 311 311 312 314 328

Chapter-11: 11.1. 11.2. 11.3. 11.4. 11.5. 11.6. 11.7. 11.8. 11.9. 11.10. 11.11.

Leases (IAS 17) Definition of lease Types of lease Advantages of lease Disadvantages of lease Requirements of capital lease Differences between capital and operating lease Comparison between capital and operating lease Differences between lease and rent Meaning of sale and leaseback Participation in sale and leaseback Short notes Problems and solutions Exercises

333 333 333 333 334 334 335 335 335 336 336 336 338 356

Chapter-12: 12.1. 12.2. 12.3. 12.4. 12.5. 12.6. 12.7. 12.8. 12.9.

Issue and redemption of shares (IAS 32) Definition of stock Types of stock Differences between preferred and common stock Explanation of treasury stock Meaning of dividend Types of dividend Differences between cash and stock dividend Explanation of stock split Basic earnings per share

363 363 363 363 364 364 364 365 365 366

9


Chapter Title and Contents 12.10. 12.11. 12.12. 12.13. 12.14.

Page No.

Diluted earnings per share Convertible instrument Definition of bond Differences between stock and bond Disclosure Problems and solutions Exercises

366 366 367 367 367 368 387

Model exam question Model exam question solution

400 405

10


যমা঴াজ এন্ড এর঴ার্঴রেট঴

য঴বা঴মূ঵েঃ

√ শ঵঴াব্ প্রস্তুিকরন √ আশর্থিক শব্ব্রিী প্রস্তুিকরন √ ইন্টারনা঱ অশেট √ টিআইএন লরশজদেলন √ শরটানি প্রস্তুিকরন √ শরটানি অনুযায়ী কর পশরদলাধ্ করা √ শরটানি োশখ঱ করা √ কর প্রোদনর প্রাশি-স্বীকারপত্র ঴িংগ্র঵ করা √ কর পশরদলাদধ্র ঴াটিিশেদকট ঴িংগ্র঵ করা √ শরটাদনির প্রিযশয়ি কশপ ঴িংগ্র঵ করা

র্বরল঳ত্বেঃ আয়কর আইনজীব্ী ঴ে঴য – ঢাকা টযাকদ঴স্ ব্ার এদ঴াশ঴দয়লন

যযাগারযারগেঃ লমা঴াজ এন্ড এদ঴াশ঴দয়ট঴ ঢাকা, ব্ািং঱াদেল। লমাব্াই঱ঃ ০১৫১১১৩৭০৩৯

11


CHAPTER - 1 PRINCIPLES OF BUSINESS TAXATION

1.1. DEFINITION OF TAXATION Taxation is the practice of collecting taxes (money) from citizens based on their earnings and property. It is a means by which governments finance their expenditure by imposing charges on citizens and corporate entities. Government use taxation to encourage or discourage certain economic decision. For example, reduction in taxable personal (or household) income by the amount paid as interest on home mortgage loans results in greater construction activity and generates more jobs. 1.2. CONCEPT OF DIRECT AND INDIRECT TAX A direct tax is paid directly by an individual or organization to an imposing entity. A taxpayer, for example, pays direct taxes to the government for different purposes, including real property tax, personal property tax, income tax or taxes on assets. Direct taxes are different from indirect taxes, where the tax is levied on one entity, such as a seller, and paid by another, such as a sales tax paid by the buyer in a retail setting. An indirect tax is a tax that is paid to the government by one entity in the supply chain, but it is passed on to the consumer as part of the price of a good or service. The consumer is ultimately paying the tax by paying more for the product. An indirect tax is shifted from one taxpayer to another. 1.3. DIFFERENT TYPES OF TAXATION a) Progressive tax: A progressive tax is one that gets steeper for tax-payers with more money. In a progressive tax system, wealthy people are taxed at a higher rate than middle-class people and middleclass people are taxed at a higher rate than working-class people. b) Regressive tax: A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases. „Regressive‟ describes a distribution effect on income or expenditure, referring to the way the rate progresses from high to low, so that the average tax rate exceeds the marginal tax rate. c) Proportional tax: A proportional tax is the same as a flat tax. Taxpayers at all income levels would pay the same “proportion” in taxes. Proportional taxes are regressive taxes. These types of taxes are common in state-level sales taxes but not common at the federal level. d) Property tax: Property taxes are taxes paid on homes, land or commercial real estate. If you‟re deciding whether you can afford to buy a home you should take property taxes into account. Unlike a mortgage, property tax payments don‟t amortize. You have to keep paying them for as 12


long as you live in a home – unless you qualify for property tax exemptions for seniors, veterans or disabled residents. e) Capital gains taxes: Capital gains taxes are taxes on investment income after an investment is sold and a capital gain is realized. Because so many people don‟t invest at all, they don‟t pay capital gains taxes. There are also taxes on dividends and interests stemming from simple interest from a bank account or dividends and earnings from investments. f) Payroll tax: A tax an employer withholds or pays on behalf of their employees based on the wage or salary of the employee. In most countries, including the United States, both state and federal authorities collect some form of payroll tax. In the United States, Medicare and Social Security, also called FICA, make up the payroll tax. g) Sales tax: A tax imposed by the government at the point of sale on retail goods and services. It is collected by the retailer and passed on to the state. Sales tax is based on a percentage of the selling prices of the goods and services and is set by the state. h) Income taxes: Income taxes do what the name implies. They tax the money you earned. Income taxes are both progressive and marginal. Marginal means that there are different tax rates for different income brackets. The top earners pay a high tax rate, but only on the amount of money they have in that top bracket. i) Value Added Tax: A Value Added Tax (VAT) is a type of consumption tax that is placed on a product whenever value is added at a stage of production and at final sale. The amount of VAT that the user pays is the cost of the product, less any of the costs of materials used in the product that have already been taxed. 1.4. SOURCES OF TAX REVENUE The three main sources of federal tax revenue are individual income taxes, payroll taxes, and corporate income taxes; other sources of tax revenue include excise taxes, the estate tax, and other taxes and fees. Almost half of all federal revenue (47 percent) comes from individual income taxes. The income tax is generally progressive: higher-income households pay a larger share of their income in income taxes than lower-income households do. Another 33 percent of revenue comes from payroll taxes, which are assessed on the wage or salary pay checks of almost all workers and used to fund Social Security, Medicare Hospital Insurance, and unemployment insurance. By law, employers and employees split the cost of payroll taxes, but research has shown that employers pass their portion of the cost on to workers in the form of lower wages. Payroll taxes as a whole are regressive: they collect a higher percentage of total earnings from lower-income workers than higher-income ones. However, if one looks at the 13


overall impact of Social Security, Medicare, and unemployment insurance - the benefits they provide as well as the taxes they collect - these programs are progressive. Corporate income taxes make up about 11 percent of federal revenue, with the remaining 9 percent coming from excise taxes, estate taxes, and other taxes. Excise taxes are collected on the sale of certain goods (e.g., fuel, alcohol, and tobacco); they are intended to raise revenue and, in some cases, discourage consumption of the taxed product. The estate tax is a tax on assets such as cash, real estate, or stock that are transferred from deceased persons to their heirs. Another source of federal revenue is profits on assets held by the Federal Reserve System. The small remainder of federal revenues comes from various sources such as regulatory fees and custom duties. 1.5. DISTINCTION BETWEEN TAX AVOIDANCE AND TAX EVASION Basis for Comparison i. Meaning

ii. Attributes

iii. Concept

iv. Type of act v. Consequences vi. Objective

Tax avoidance Minimization of tax liability, by taking such means which do not violate the tax rules, is Tax Avoidance. Immoral in nature, which involves bending the law without breaking it. Taking unfair advantage of the shortcomings in the tax laws. Legal Deferred tax liability To reduce tax liability by applying the script of law.

Tax evasion Reducing tax liability by using illegal ways is known as Tax Evasion. Illegal and objectionable, both in script and moral. Deliberate manipulations in accounts resulting in fraud. Criminal Penalty or imprisonment To reduce tax liability by exercising unfair means.

1.6. MEANING OF DOUBLE TAX RELIEF To avoid a situation in which an assessee pay tax in several countries, he is entitled to an income tax relief in the Bangladesh, the so-called double tax relief. We calculate the double tax relief per box based on the tax that he has to pay for each box. The double tax relief cannot exceed the amount of tax he owes in the box concerned. This means that when calculating the rebate in one box no account is taken of any taxable part in the other boxes. To avoid double taxation, in order to become eligible for a rebate, however, the assessee income from abroad must have a positive balance. 1.7. EFFECT OF DOUBLE TAX TREATIES Double taxation treaties are intended to eliminate double taxation and thereby increase foreign direct investment (FDI). Double taxation treaties are also meant to prevent tax evasion which previous literature argues has a negative effect on FDI. Using matching econometrics and a large data set of developed to less developed country-pairs, I show that despite their intentions and the significant costs of entering into DTTs, the treaties have no effect on the flows of FDI. An analysis of the treaties in conjunction with the related domestic tax legislation shows why this is the case. Developed countries unilaterally provide for the relief of double taxation and the prevention of fiscal evasion regardless of 14


the treaty status of a host country. This eliminates the key economic benefit and the risk that these treaties would otherwise create for the FDI location decisions of multinational enterprises. 1.8. DEFINITION OF ACCOUNTING PROFIT AND TAXABLE PROFIT As per IAS 12, Accounting profit is profit or loss for a period before deducting tax expense. Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable). 1.9. DIFFERENCES BETWEEN ACCOUNTING PROFIT Basis for Comparison Accounting profit The term accounting i. Meaning profit refers the company's income obtained after reducing total expenses from total revenues. ii. Basis Accounting standard iii. Year Financial year

iv. Objective

v. Audit

PROFIT AND TAXABLE Taxable profit The term taxable profit refers to the profit of the business which is taxable as per income tax rules.

Income Tax Ordinance, 1984 Income of Previous Year is Taxable in Assessment Year. To know the profitability To know the taxability of the and performance of the entity. entity. Financial audit Tax audit

1.10. MEANING OF DEFERRED TAX ASSETS AND LIABILITIES Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: (a) deductible temporary differences; (b) the carry forward of unused tax losses; and (c) the carry forward of unused tax credits. Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. 1.11. DEFINITION OF TEMPORARY DIFFERENCES Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either: (a) taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or 15


(b) deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. 1.12. TAX BASE The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount. The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods. Thus, tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. 1.13. RECOGNITION OF CURRENT TAX ASSETS AND LIABILITIES The benefit relating to a tax loss that can be carried back to recover current tax of a previous period shall be recognised as an asset. When a tax loss is used to recover current tax of a previous period, an entity recognises the benefit as an asset in the period in which the tax loss occurs because it is probable that the benefit will flow to the entity and the benefit can be reliably measured. Current tax for current and prior periods shall, to the extent unpaid, be recognised as a liability. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess shall be recognised as an asset. 1.14. RECOGNITION OF DEFERRED TAX ASSETS AND LIABILITIES A deferred tax asset shall be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that: (a) is not a business combination; and (b) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). A deferred tax asset shall be recognised for the carry forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilized. An entity shall recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and IAS 12 associates, and interests in joint arrangements, to the extent that, and only to the extent that, it is probable that: 16


(a) the temporary difference will reverse in the foreseeable future; and (b) taxable profit will be available against which the temporary difference can be utilised. A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from: (a) the initial recognition of goodwill; or (b) the initial recognition of an asset or liability in a transaction which: (i) is not a business combination; and (ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). An entity shall recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, except to the extent that both of the following conditions are satisfied: (a) the parent, investor, joint venturer or joint operator is able to control the timing of the reversal of the temporary difference; and (b) it is probable that the temporary difference will not reverse in the foreseeable future. 1.15. MEASUREMENT OF CURREND AND DEFERRED TAX Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. 1.16. OFFSET OF TAX ASSETS AND LIABILITIES An entity shall offset current tax assets and current tax liabilities if, and only if, the entity: (a) has a legally enforceable right to set off the recognised amounts; and (b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. An entity shall offset deferred tax assets and deferred tax liabilities if, and only if: (a) the entity has a legally enforceable right to set off current tax assets against current tax liabilities; and (b) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority on either: (i) the same taxable entity; or (ii) different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered. 17


1.17. DISCLOSURE The major components of tax expense (income) shall be disclosed separately. Components of tax expense (income) may include: (a) current tax expense (income); (b) any adjustments recognised in the period for current tax of prior periods; (c) the amount of deferred tax expense (income) relating to the origination and reversal of temporary differences; (d) the amount of deferred tax expense (income) relating to changes in tax rates or the imposition of new taxes; (e) the amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary difference of a prior period that is used to reduce current tax expense; (f) the amount of the benefit from a previously unrecognised tax loss, tax credit or temporary difference of a prior period that is used to reduce deferred tax expense; (g) deferred tax expense arising from the write-down, or reversal of a previous writedown; and (h) the amount of tax expense (income) relating to those changes in accounting policies and errors that are included in profit or loss in accordance with IAS 8, because they cannot be accounted for retrospectively.

18


PROBLEMS AND SOLUTIONS P-1. Indicate whether each of the following items is a timing difference or a permanent difference. For each timing difference, indicate whether it is a deferred credit or a deferred charge. (a) Tax depreciation in excess of book depreciation, Tk.200,000. (b) Excess of income of installment sales over income reportable for tax purposes, Tk.230,000. (c) Premium payment for insurance policy on life of President, Tk.50,000. (d) Earnings of foreign subsidiary received in the current year but reported in a previous year, Tk.150,000. (e) Amortization of goodwill, Tk.40,000. (f) Rent collected in advance of period earned, Tk.75,000. (g) Actual expense for warranty repairs in excess of warranty provision for year, Tk.50,000. (h) Interest revenue received on municipal bonds, Tk.20,000. Solution: (a) Timing difference – Deferred credit (b) Timing difference – Deferred credit (c) Permanent difference – Not applicable (d) Timing difference – Deferred charge (e) Permanent difference – Not applicable (f) Timing difference – Deferred charge (g) Timing difference – Deferred credit (h) Permanent difference – Not applicable P-2. Pretax income of Mosaj & Associates as per book is Tk.70,000 with following facts: (a) Depreciation charged in income statement is Tk.10,000 but as per applicable tax laws it should be Tk.26,000. (b) Rent income shown in income statement is Tk.120,000 but tax authority said it should be Tk.22,000 more. (c) Fine imposed for pollution shown as expense in the income statement for Tk.11,000. (d) Applicable tax rate is 30%. Required: (i) Identify deferred tax asset item and deferred tax liability item along with amount. (ii) Compute taxable income. (iii) Journalize applicable deferred tax, tax expense and tax payable. Solution: (i) Deferred tax asset = Excess rent income charged as per Tax Authority = Tk.22,000 Deferred tax liability = Excess depreciation to be charged as per Tax Laws = Tk.26,000 – Tk.10,000 = Tk.16,000 19


(ii) Computation of taxable income: Pretax income as per book Add. Non-allowable expense: Fine imposed for pollution Add. Deferred tax asset item: Excess rent income as per Tax Authority

Tk.70,000 11,000 Tk.81,000 22,000 Tk.103,000

Less. Deferred tax liability item: Excess depreciation to be charged as per Tax Laws Taxable income

(16,000) Tk.87,000

(iii) Mosaj & Associates Journal entries Particulars Income tax expense (Tk.70,000 + Tk.11,000) X 30% Deferred tax asset (Tk.22,000 X 30%) Income tax payable (Tk.87,000 X 30%) Deferred tax liability (Tk.16,000 X 30%)

Dr. (Tk.) 24,300 6,600

Cr. (Tk.)

26,100 4,800

P-3. You have been joined in Sunlight Company to review their books of accounts. The following information is related to the book income and taxable income of the company for the year 2017. Tk. Reported book income before tax 100,000 Add. Expenses not deductible for tax purposes 20,000 Excess of book depreciation over tax depreciation 5,000 Deferred revenue tax in the period of collection 15,000 140,000 Less. Excess of reported book income over taxable income (10,000) Excess of tax depreciation over book depreciation (8,000) Taxable income 122,000 Required: Prepare necessary journal entries for the year 2017 to record the income tax liability by using separate deferred tax account. The company tax rate is 30% during the year. Solution: Sunlight Company Journal entries Particulars Income tax expense (100,000 + 20,000) X 30% Deferred income tax – Depreciation (5,000 X 30%) Deferred income tax – Deferred revenue (15,000 X 30%) Income tax payable (122,000 X 30%) Deferred income tax – Depreciation (8,000 X 30%) Deferred income tax – Installment sales (10,000 X 30%)

Dr.(Tk.) Cr.(Tk.) 36,000 1,500 4,500 36,600 2,400 3,000 20


P-4. Paradise Ltd. has a deferred tax asset account with a balance of Tk.150,000 at the end of 2016 due to a single cumulative temporary difference of Tk.275,000. At the end of 2017, this same temporary difference has increased to a cumulative amount of Tk.450,000. Taxable income for the year 2017 is Tk.820,000. The tax rate is 40% for all years. No valuation account related to the deferred tax asset is existence at the end of 2016. Required: (a) Record income tax expense, deferred income taxes and income tax payable for the year 2017, assuming that is more likely than not the deferred tax asset will be realized. (b) Assuming that more likely than not Tk.30,000 of the deferred tax asset will not be realized. Prepare the journal entry at the end of 2017 to record the revaluation account. Solution: (a) Journal entry Income tax expense (w-3) Deferred income taxes (w-1) Income tax payable (w-2) (b) Journal entry Income tax expense Allowance to reduce deferred tax asset to expected realizable value

- Dr. - Dr. - Cr. -

Tk.298,000 30,000

- Dr. -

Tk.30,000

Tk.328,000

- Cr. -

Tk.30,000

In this journal entry, income tax expense is increased in the current period because a favorable tax benefit is not expected to be realized for a portion of the deductible temporary difference. A valuation allowance is simultaneously established to recognize the reduction in the carrying amount of the deferred tax asset. Workings: 1. Deferred income taxes: Deferred tax asset at the beginning of the year Deferred tax asset at the end of the year (Tk.450,000 X 40%) Deferred tax benefit for 2017

Tk.150,000 180,000 Tk.(30,000)

2. Income tax payable for the year 2017 = Tk.820,000 X 40% = Tk.328,000 3. Income tax expense for the year 2017 = Income tax payable - Deferred tax benefit = Tk.328,000 - Tk.30,000 = Tk.298,000 P-5. A company purchases a machine for Tk.64,000 at the beginning of the year 2013. It has a useful life of five years and on 31 December 2017 the asset is disposed of at a zero residual value. The company uses straight-line depreciation. The accounting year ends on 31 December. Assume that the machine qualifies for capital allowances at a rate of 20% per annum on a reducing balance basis and the rate of tax is 30%.

21


Required: Show the deferred tax balance in the statement of financial position and the deferred tax charged for each year of assets life. Solution:

Carrying amount (w-1) Tax base (w-2) Temporary differences Taxable/ (deductible) Opening DTL/ (DTA) Deferred tax expense/ (credit) (w-4) Closing DTL/ (DTA) (w-3)

2013 Tk. 51,200 51,200 0

2014 Tk. 38,400 40,960 (2,560)

2015 Tk. 25,600 32,768 (7,168)

2016 Tk. 12,800 26,214 (13,414)

2017 Tk. 0 0 0

0 0 0

0 (768) (768)

(768) (1,382) (2,150)

(2,150) (1,874) (4,024)

(4,024) 4,024 0

Workings:

Tk.64,000 5 years = Tk.12,800

1. Depreciation expense =

Value of machine Depreciation expense Carrying amount

2013 Tk. 64,000 12,800 51,200

2014 Tk. 51,200 12,800 38,400

2015 Tk. 38,400 12,800 25,600

2016 Tk. 25,600 12,800 12,800

2017 Tk. 0 0 0

2013 Tk. 64,000 12,800 51,200

2014 Tk. 51,200 10,240 40,960

2015 Tk. 40,960 8,192 32,768

2016 Tk. 32,768 6,554 26,214

2017 Tk. 0 0 0

2013 Tk. 0

2014 Tk. (2,560)

2015 Tk. (7,168)

2016 Tk. (13,414)

2017 Tk. 0

0

(768)

(2,150)

(4,024)

0

2013 Tk. 0 0 0

2014 Tk. (768) 0 (768)

2015 Tk. (2,150) (768) (1,382)

2016 Tk. (4,024) (2,150) (1,874)

2017 Tk. 0 (4,024) 4,024

2. Tax base:

Value of machine Depreciation expense @ 20% Carrying amount 3. Closing DTL/ (DTA):

Temporary differences Taxable/ (deductible) Closing DTL/ (DTA) @ 30% 4. Deferred tax expense/ (credit):

Closing DTL/ (DTA) (w-3) Opening DTL/ (DTA) Deferred tax expense/ (credit)

22


P-6. Azgor Company purchased a non-current asset costing Tk.500,000 on January 1, 2016. It was a useful life of 5 years with no residual value. On December 31, 2017 the tax base of the asset was Tk.250,000 and it was revalued to Tk.400,000. Applicable tax rate is 35%. The company uses straight line of charging depreciation. Required: What are the deferred tax implications of the above facts as per IAS-12? Solution: Carrying amount of the asset: Cost Accumulated depreciation Carrying amount on December 31, 2017 Tax base Taxable temporary difference Tax rate Income tax

Tk.500,000 200,000 300,000 250,000 50,000 35% Tk.17,500

Deferred tax implications: Carrying amount of the asset on December 31, 2017 was Tk.300,000. After revaluation its carrying amount increased to Tk.400,000 without altering its tax base because revaluation has no immediate tax impact. This revaluation has created an additional taxable temporary difference of Tk.100,000 (Tk.400,000 – Tk.300,000). Hence, additional deferred tax liability is Tk.35,000 (Tk.100,000 X 35%). Revaluation gain is credited to revaluation reserve and deferred tax on this gain is debited to revaluation reserve. Both are shown as part of other comprehensive income. P-7. Emida Company has an asset which cost Taka 100,000 in 2017, the carrying amount was taka 80,000 and the asset was revaluated to Taka 150,000. No equivalent adjustment was made for tax purposes. Cumulative depreciation for tax purposes is Taka 30,000 and the tax rate is 30%. If the asset is sold for more than cost the cumulative depreciation of Tk.30,000 will be included in taxable income but sales proceed in excess of cost will not be taxable (IAS-12). Required: State the deferred tax contingencies of the above assuming that: (a) the company expects to recover the carrying amount through continued use of the asset. (b) the company expects to recover the carrying amount through the sale Solution: (a) Recovery through continued use: Tax base of the asset = Tk.100,000 – Tk.30,000 = Tk.70,000 Taxable temporary difference = Carrying amount – Tax base = Tk.80,000 – Tk.70,000 = Tk.10,000 23


Carrying amount of the asset in 2017 was Tk.80,000 and after revaluation its carrying amount increased to Tk.150,000. This revaluation has created an additional taxable temporary difference of Tk.70,000 (Tk.150,000 – Tk.80,000) So, the deferred tax liability = (Tk.10,000 + Tk.70,000) X 30% = Tk.80,000 X 30% = Tk.24,000 (If the entity expect to recover the carrying amount by using the asset, it must generate taxable income of Tk.150,000 but will only be able to deduct depreciation of Tk.70,000). (b) Recovery through sale: If the entity expects to recover the carrying amount by selling the asset immediately for proceeds of Tk.150,000, the taxable temporary difference is still Tk.80,000 (Tk.30,000 + Tk.50,000). Of this only the Tk.50,000 (Tk.150,000 – Tk.100,000) excess of proceeds over cost is taxable. Therefore, the deferred tax liability will be computed as follows:

Cumulative tax depreciation Proceeds in excess of cost

Taxable temporary difference (Tk.) 30,000 50,000 80,000

Tax rate 30% Nil

Deferred tax liability (Tk.) 9,000 ____9,000

P-8. Apex Company maintains a deferred tax account under liability method. You are provided the following taxation information for the year 2017. (a) Applicable tax rate for the company during the year 2016 and 2017 are 35% and 35% respectively. (b) Accounting depreciation was charged in 2017 for Tk.50,000 but tax laws allows Tk.60,000 as depreciation for the year. (c) Non-admissible amount Tk.20,000 was charged in account. (d) Profit was Tk.100,000 for the year 2017. (e) Tax liability of 2016 has been recently settled at an excess of Tk.5,000 provided in the year. Required: Prepare the current and deferred tax accounts of the Apex Company for the year ended December 31, 2017. Solution: Computation of taxable profit: Profit for the year Add. Accounting depreciation Non-admissible amount Less. Tax depreciation Taxable profit

Tk.100,000 50,000 20,000 Tk.170,000 (60,000) Tk.110,000

24


Current tax account: Tax on current year taxable profit Add. Under provision in 2016 Current tax for the year 2017

Tk.38,500 5,000 Tk.43,500

Deferred tax account: Timing difference = Accounting depreciation – Tax depreciation = Tk.50,000 – Tk.60,000 = Tk.10,000 Deferred tax for the year ended 2017 = Tk.10,000 X 35% = Tk.3,500 P-9. The following data were obtained for Magnet Ltd: (a) Deferred tax liability on 1 July 2016, Tk.90,000. (b) Deferred tax asset on 1 July 2016, Tk.15,000. (d) Cumulative taxable temporary differences as at 30 June 2017, Tk.306,000. (e) Cumulative deductible temporary differences as at 30 June 2017, Tk.70,000. (f) No other differences exist. (g) Tax rate is 30%. (h) The company is expected to conduct profitable operations in the future. Required: (i) Calculate accounting profit before tax for the year ended 30 June 2017. (ii) Prepare journal entries to record income tax expense, and current and deferred tax liabilities, assuming that deferred tax assets and liabilities are offset for the year ended 30 June 2017. Solution: (i) Calculation of accounting profit before tax for the year ended 30 June 2017: Cumulative taxable temporary differences as at 30 June 2017 Cumulative taxable temporary differences as at 1 July 2016 *Tk.90,000 ÷ 30% = Tk.300,000 Current taxable temporary differences for future years

Tk.306,000 300,000*

Cumulative deductible temporary differences as at 30 June 2017 Cumulative deductible temporary differences as at 1 July 2016 *Tk.15,000 ÷ 30% = Tk.50,000 Current deductible temporary differences for future years

Tk.70,000 50,000*

Tk.6,000

Tk.20,000

Since the taxable income for the current year is Tk.150,000, the accounting profit before tax can be determined by adjusting the taxable income with the current taxable or deductible temporary differences. Taxable income Tk.150,000 Add. Current taxable temporary differences for future years 6,000 Less. Current deductible temporary differences for future years (20,000) Accounting profit before tax 136,000 25


(ii) Journal entry Income tax expense (Tk.150,000 X 30%) Deferred tax liability (w-1) Current tax liability (Tk.150,000 X 30%)

- Dr. - Dr. - Cr. -

Tk.40,800 4,200 Tk.45,000

Working: 1. Net deferred tax liability on 30 June 2017 (Tk.306,000 – Tk.70,000) X 30% Net deferred tax liability on 1 July 2016 (Tk.90,000 – Tk.15,000) Decrease in net deferred tax liability

Tk.70,800 75,000 4,200

P-10. At 1 April, 2016 Limo Company had a deferred tax liability bought forward of Tk.91,800 that has arisen from temporary differences of property, plant and equipment and development expenditure. At 31 March, 2017 the company produces following information: (a) The carrying amount of property, plant and equipment in the statement of financial position is Tk.560,000 and the tax written down value of the same asset is Tk.364,000. (b) The company has started to amortize some development costs and at 31 March, 2014 the asset in the statement of financial position has fallen to Tk.32,000. (c) Limo Company has incurred taxable trading losses of Tk.160,000 in the year. It is confident that these losses are a one-off event and that the company will be profitable for the foreseeable future. (d) The directors have revalued some land from its original cost of Tk.80,000 to Tk.400,000. Assume a corporate tax rate of 35%. Required: Calculate the figures that will be included in the financial statement for the year ended 31 March, 2017 including the journal entry. Solution: Calculation of differences: Item Property, plant and equipment Development expenditure Losses Revaluation Total

Carrying amount (Tk.) 560,000 32,000 0 400,000 992,000

Tax base (Tk.) 364,000 0 160,000 80,000 604,000

Temporary differences Liability Asset 196,000 32,000 320,000 548,000

(160,000) _______ (160,000)

Calculation of tax: Deferred tax liability = Tk.548,000 X 35% = Tk.191,800 Deferred tax asset = Tk.160,000 X 35% = Tk.56,000 26


Movement of deferred tax liability: Deferred tax liability up to 31 March 2017 Deferred tax liability at 1 April 2016 Increase in deferred tax liability Journal entry: Deferred tax asset Revaluation reserve (320,000 X 35%) Income statement (Balance) Deferred tax liability

Tk.191,800 Tk.91,800 Tk.100,000

- Dr. - Dr. - Cr. - Cr. -

Tk.56,000 Tk.112,000 Tk.68,000 Tk.100,000

P-11. King Company began operations at the beginning of 2017. The following information pertains to this company: Pretax financial income for 2017 is Tk.100,000. Taxable income is expected for the next few years. The tax rate enacted for 2017 and future years is 40%. Differences between the 2017 income statement and tax return are listed below: (a) Warranty expense accrues for financial reporting purposes amounts to Tk.5,000. Warranty deductions as per tax return amount to Tk.2,000. (b) Gross profit on construction contracts using the percentage of completion method for books amounts to Tk.92,000. Gross profit on construction contracts for tax purpose amounts to Tk.62,000. (c) Depreciation of property, plant and equipment for financial reporting purposes amounts to Tk.60,000. Depreciation of these assets amounts to Tk.80,000 for the tax return. (d) A Tk.3,500 fine paid for violation of pollution laws was deducted in computing pretax financial income. (e) Interest revenue earned on an investment in tax exempt municipal bonds amounts to Tk.1,400. Assume (a) is short term in nature and (b) & (c) are long term in nature. Required: (i) Compute taxable income for 2017. (ii) Compute the deferred taxes at December 31, 2017, that relate to the temporary differences described above. Clearly level them as deferred tax asset or liability. (iii) Prepare the journal entry to record income tax expense, deferred taxes and income taxes payable for 2017. (iv) Draft the income tax expense section of the income statement „beginning with income before income taxesâ€&#x;. Solution: (i) Pretax financial income Permanent differences: Fine for pollution Tax exempt interest 27

Tk. 100,000 3,500 (1,400)


Temporary differences: Excess warranty expense as per books (5,000 – 2,000) Excess construction profit as per books (92,000 – 62,000) Excess depreciation as per tax laws (80,000 – 60,000) Taxable income

3,000 (30,000) (20,000) 55,100

(ii)

Temporary differences Warranty expense Construction profit Depreciation Total

Future taxable (deductible) amount Tk.(3,000) 30,000 20,000 47,000

Tax rate 40% 40% 40%

Deferred tax Asset Liability Tk.(1,200) Tk.12,000 _____ 8,000 (1,200) 20,000

(iii) Journal entry Income tax expense (100,000 + 3,500 – 1,400) X 40% Deferred tax asset Income tax payable (55,100 X 40%) Deferred tax liability

- Dr. - Dr. - Cr. - Cr. -

Tk.40,840 1,200 Tk.22,040 20,000

(iv) Draft income statement Income before tax Income tax expenses: Current Deferred (20,000 – 1,200) Net income

Tk.100,000 Tk.22,040 18,800 40,840 59,160

P-12. Following particulars are revealed from the financial statements of M/s. Pinaki Ltd. as on December 31, 2016. The company maintains accrual basis of accounting. Cumulative temporary difference giving rise to future taxable amounts of Tk.500,000; Cumulative temporary difference giving rise to future deductible amounts of Tk.250,000. Following information or transactions were reported during 2017: (a) Tax rate 40%. (b) Taxable income for the year Tk.2,000,000. (c) Depreciation as per accounting policy Tk.500,000 and as per tax rule Tk.400,000. (d) Interest income on STD accrued for the year was Tk.100,000 which will be matured in the next year and it is taxable on cash basis. There is no deduction at source. (e) Major renovation was done during the year for plant and machinery for Tk.200,000 which will spread over the years 2017 – 2021 equally in the books to charge. However, the entire expenditure was allowed for the year 2017 for income tax purpose. (f) Donation income of Tk.100,000 is not taxable. (g) Rent was received in advance Tk.180,000 in year 2014 for the years 2016 – 2018. It is taxable on cash basis. 28


The company is expected to operate profitably in the future and tax rates expected to remain unchanged for the years to come. Required: (i) Compute income tax expense to be shown in the income statement for the year ended 2017; (ii) Prepare journal entries to record income tax payable, income tax expense and deferred income taxes for year 2017; (iii) Explain how deferred tax liabilities should be presented in the financial statements of M/s. Pinaki Ltd. Solution: (i)

Deferred taxes as on Dec. 31, 16 Current tax for the year Depreciation expense Interest on STD Renovation expense 4 200,000 X 5 Rent received in advance 1 180,000 X 3 Deferred taxes as on Dec.31, 17 Income tax expense for the year 2017

Applicable amount (Tk.) 250,000; 500,000 2,000,000 100,000 100,000 160,000

60,000

Tax rate 40% 40% 40% 40% 40%

40%

Deferred tax Asset Liability (Tk.) (Tk.) 100,000 (200,000)

40,000 (40,000) (64,000)

(24,000)

Income tax expense (Tk.)

800,000 (40,000) 40,000 64,000

24,000

116,000 (304,000) 888,000

(ii) Journal entries Income tax expense Income tax payable (For recording the current tax payable to tax authority for the year 2017)

Debit (Tk.) 800,000

800,000

Deferred tax assets Income tax expense (For recording the deferred tax assets for future deductible depreciation & tax effect)

40,000

Income tax expenses Deferred tax liabilities (For recording the tax payable in future on interest on STD)

40,000

29

Credit (Tk.)

40,000

40,000


Income tax expenses Deferred tax liabilities (Tax allowed on renovation expense allocated for future periods)

64,000

Income tax expenses Deferred tax assets (Tax paid in the year of receipt of rent and now adjustment is made for current yearâ€&#x;s portion)

24,000

64,000

24,000

(iii) Deferred tax assets and liabilities should be presented separately from other assets and liabilities in the balance sheet of M/s. Pinaki Ltd. Deferred tax assets and liabilities should be distinguished from current tax assets and liabilities. M/s. Pinaki Ltd. should not classify its deferred tax assets and liabilities as current assets or liabilities. P-13. From the following information of Western Ltd. compute current tax expense, deferred tax liability at 31/12/2017 showing separately the carrying amount and tax base:

Accounting profit Tax rate Depreciation for accounting purpose Depreciation for tax purpose Charitable donations Fine for environment pollution Product development costs Health care benefits Accounts receivables Inventory Investments Property, plant and equipment (Carrying value)* Accounts payable Long-term debt Share capital Retained earnings (Carrying value) Retained earnings (Tax base)

2017 (Tk.) 8,775.00 40% 4,800.00 8,100.00 500.00 700.00 250.00 2,000.00 500.00 2,000.00 33,000.00 37,200.00 500.00 12,475.00 5,000.00 39,685.00 17,135.00

*Property, plant and equipment consists of buildings and motor vehicles. Buildings and motor vehicles are depreciated @ 5% and 10% respectively on straight-line basis for tax purposes. For accounting purposes, buildings and motor vehicles are depreciated @ 20% and 25% respectively on straight-line basis. Tax base of property, plant and equipment is Tk.12,900.00. Deferred tax liability on 31/12/2016 was Tk.8,600. Solution:

30


Computation of current tax expense at 31/12/2017: Accounting profit Add: Depreciation for accounting purpose Charitable donations Fine for environment pollution Product development costs Health care benefits Less: Depreciation for tax purpose Taxable profit Tax rate Current tax expense

Tk.8,775 4,800 500 700 250 2,000 (8,100) 8,925 40% 3,570

Computation of deferred tax liability at 31/12/2017:

Accounts receivable Inventory Product development costs Investment Property, plant and equipment Total assets Accounts payable Fine payable Current income tax payable Liability for health care benefit Long-term debt Deferred tax liability (24,550 – 2,000) X 40% Total liabilities

Carrying Amount (Tk.) 500 2,000 250 33,000 37,200 72,950 500 700 3,570 2,000 12,475 9,020 28,265

Tax base (Tk.) 500 2,000 0 33,000 12,900 48,400 500 700 3,570 12,475 9,020 26,265

Temporary differences (Tk.) 0 0 250 0 24,300 24,550 0 0 0 2,000 0 ____0 2,000

P-14. Delta Ltd. owns the following property, plant and equipment at December 31, 2015. Items Cost (Tk.) Accumulated Carrying Tax base depreciation (Tk.) amount (Tk.) amount (Tk.) Machinery 900,000 180,000 720,000 450,000 Land 500,000 500,000 Buildings 1,500,000 300,000 1,200,000 In addition: (a) Machinery is depreciated on straight-line basis over 5 years. It was acquired on January 1, 2015. (b) Land is not depreciated. (c) Buildings are depreciated on straight-line basis over 25 years. (d) Depreciation of land and buildings are not deductible for tax purposes. For machinery, tax depreciation is granted over a period of 3 years in the ratio of 50:30:20 of cost consecutively. 31


(e) The accounting profit before tax including non-taxable revenue of Tk.80,000 amounted to Tk.300,000 for the year 2016. For 2017, the accounting profit before tax including nontaxable revenue of Tk.100,000 amounted to Tk.400,000. (f) Delta Ltd. had a tax loss on December 31, 2015 of Tk.250,000. The tax rate for 2015 was 35 percent and for 2016 and 2017 it was 30 percent. Required: Calculate the deferred tax liability of Delta Ltd. as on December 31, 2017 showing the movement of deferred tax balance from January 01, 2016 to December 31, 2017. Show necessary working including income tax expenses for 2016 and 2017. Solution: Calculation of deferred tax liability as on December 31, 2017 showing the movement of deferred tax balance from 2016 to 2017: Deferred tax liability Dr./ (Cr.) Tk. Balance on Dec. 31, 2015 - Machinery (w-1) (94,500) Tax loss carried forward (250,000 X 35%) 87,500 (7,000) 1,000 35  30 Rate change ( ) X 7,000 35 Temporary differences on Dec. 31, 2016 - Machinery (w-1) (27,000) Loss amortization on Dec. 31, 2016 (w-2) (190,000 X 30%) (57,000) Balance on Dec. 31, 2016 (90,000) Temporary differences on Dec. 31, 2017 – Machinery (w-1) 0 Loss amortization on Dec. 31, 2017 (w-2) (60,000 X 30%) (18,000) Balance on Dec. 31, 2017 (108,000) Workings: 1.

Machinery Balance on Jan. 1, 2015 Depreciation on Dec. 31, 2015 Balance on Dec. 31, 2015 35  30 Rate change ( )X94500 35 Depreciation on Dec. 31, 2016 Balance on Dec. 31, 2016 Depreciation on Dec. 31, 2017 Balance on Dec. 31, 2017

Carrying amount (Tk.) 900000 (180000) 720000 -

Tax base (Tk.) 900000a (450000)b 450000 -

Temporary differences (Tk.) 0 270000 270000 -

Deferred Tax (Tk.) 0 94500 94500 (13500)

(180000) 540000 (180000) 360000

(270000)c 180000 (180000)d _____0

90000 360000 _____0 360000

27000 108000 _____0 108000

a. 450000 ÷ 50% (d) = 900000 b. 900000 X 50% (d) = 450000 c. 900000 X 30% (d) = 270000 d. 900000 X 20% (d) = 180000 32


2. Income tax expenses Accounting profit before tax Non-taxable revenue Depreciation on buildings (1,500,000 á 25 years) Accounting depreciation on machinery (w-1) Tax depreciation on machinery (w-1) Total taxable income Tax loss brought forward Taxable profit/ (Tax loss) Tax loss carried forward Tax payable/ (Tax benefit) @ 30%

2016 (Tk.) 300,000 (80000) 60000 280000 180000 (270000) 190000 (250000) (60000) (60000) (18000)

2017 (Tk.) 400000 (100000) 60000 360000 180000 (180000) 360000 (60000) 300000 _____90000

P-15. Rohan recognized a deferred tax liability for the year ended 31 December 2016 which related solely to accelerated tax depreciation on property, plant and equipment at a rate of 20%. The net book value of the property, plant and equipment at that date was Tk.300,000 and the tax written down value was Tk.200,000. The following information relates to the year ended 31 December 2017: (a) At the end of the year, the carrying value of property, plant and equipment was Tk.400,000 and their tax written down value was Tk.250,000. During the year some items were revalued by Tk.50,000. No items had previously required revaluation. In the tax jurisdiction in which Rohan operates revaluations of assets do not affect the tax base of an asset or taxable profit. Gains due to revaluations are taxable on sale. (b) Rohan began development of a new product during the year and capitalized Tk.60,000 in accordance with IAS 38. The expenditure was deducted for tax purposes as it was incurred. None of the expenditure had been amortized by the year end. (c) Rohanâ€&#x;s statement of profit or loss showed interest income receivable of Tk.40,000, but only Tk.30,000 of this had been received by the year-end. Interest income is taxed on a receipts basis. (d) During the year, Rohan made a provision of Tk.25,000 to cover an obligation to clean up some damaged caused by an environmental accident. None of the provision had been used by the year-end. The expenditure will be tax deductible when paid. The corporate income tax rate recently enacted for the following year is 35% (unchanged from the previous year). The current tax charge was calculated for the year as Tk.20,000. Current tax is settled on a net basis with the national tax authority. Required: (i) Prepare a table showing the carrying values, tax bases and temporary differences for each of the items above at 31 December 2017. (ii) Prepare the statement of profit or loss and statement of financial position notes to the financial statements relating to deferred tax for the year ended 31 December 2017. Solution: (i) Preparation of table showing the carrying values, tax bases and temporary differences at 31 December 2017: 33


Property, plant and equipment Development expenditure Interest receivable (40,000 - 30,000) Provision

Carrying values (Tk.) 400,000 60,000 10,000 (25,000)

Tax bases (Tk.) 250,000 -

(ii) Notes to the statement of financial position at 31 December 2017: Accelerated depreciation for tax purposes (150,000 – 50,000) X 35% Product development cost deducted from taxable profit 60,000 X 35% Interest income taxable when received 10,000 X 35% Provision for environmental costs deductible when paid 25,000 X 35% Revaluations (50,000 X 35%) At 1 January 2017 (300,000 – 200,000) X 35% Amount charged to equity (50,000 X 35%) Amount charged to profit or loss account (balancing figure) At 31 December 2017 (195,000 X 35%)

Temporary differences (Tk.) 150,000 60,000 10,000 (25,000) 195,000

Tk.35,000 21,000 3,500 (8,750) 17,500 68,250 Tk.35,000 17,500 15,750 68,250

Notes to the statement of profit or loss for the year ended 31 December 2017: Income tax expense Current tax Deferred tax

Tk.20,000 15,750 35,750

P-16. Following information is relevant to the AP Company: For the year ended 31 December 2016 the financial statement shows a profit before tax of Tk.150,000. Cumulative taxable temporary differences at the year-end amounted to Tk.60,000, i.e. the differences between the accounting carrying value and the tax base. Current tax for the year at 35% has been estimated at Tk.40,000. There is currently no provision for deferred tax. For the year ended 31 December 2017 the financial statement shows a profit before tax of Tk.160,000. Cumulative taxable temporary differences at the year-end amounted to Tk.80,000 and current tax for the year at 35% has been estimated at Tk.50,000. Required: Prepare relevant extracts from the financial statements for the years ending 31 December 2016 and 2017 to record the above transactions. You should assume the amounts paid for current tax are equal to the estimates made. 34


Solution: Income tax expense:

Current tax Deferred tax Tk.60,000 X 35% (Tk.80,000 X 35%) – Provision for 2016

2016 Tk. 40,000

2017 Tk. 50,000

21,000 _____ 61,000

7,000 57,000

Journal entries: Year – 2016 Income tax expense Income tax payable Deferred tax liability Year – 2017 Income tax expense Income tax payable Deferred tax liability

- Dr. - Cr. - Cr. -

Tk.61,000

- Dr. - Cr. - Cr. -

Tk.57,000

Tk.40,000 Tk.21,000

Tk.50,000 Tk.7,000

AP Company Income statement (extract)

Profit before tax Less. Income tax expense Profit for the year

2016 Tk. 150,000 61,000 89,000

2017 Tk. 160,000 57,000 103,000

AP Company Statement of financial position (extract) 2016 Tk.

2017 Tk.

Non-current liabilities: Deferred tax liability

21,000

7,000

Current liabilities: Income tax payable

40,000

50,000

P-17. ABC Company‟s financial statements show the following profit before tax figures as at: 30.06.2015 30.06.2016 30.06.2017 Tk.500,000 Tk.400,000 Tk.600,000 Income tax (calculated based on taxable profits) is as follows for the year ended: 30.06.2015 30.06.2016 30.06.2017 Tk.50,000 Tk.100,000 Tk.80,000

35


Payments of tax were made nine months following each year-end as follows: 30.06.2015 30.06.2016 30.06.2017 Tk.40,000 Tk.120,000 Tk.65,000 Cumulative taxable temporary differences at the year-ends are as follows: 30.06.2015 30.06.2016 30.06.2017 Tk.100,000 Tk.200,000 Tk.180,000 Required: Prepare the relevant extracts from the financial statements for each of the three years in respect of income tax. Assume an income tax rate of 35%. Solution: ABC Company Income statement (extract)

Profit before tax Less. Income tax expense (w-1) Profit for the year

2015 Tk. 500,000 85,000 415,000

2016 Tk. 400,000 125,000 275,000

2017 Tk. 600,000 93,000 507,000

ABC Company Statement of financial position (extract) 2015 Tk.

2016 Tk.

2017 Tk.

Non-current liabilities: Deferred tax liability

35,000

70,000

63,000

Current liabilities: Income tax payable

50,000

100,000

80,000

2015 Tk. 50,000 0 35,000 85,000

2016 Tk. 100,000 (10,000) 35,000 125,000

2017 Tk. 80,000 20,000 (7,000) 93,000

2015 Tk. 40,000 50,000 (10,000)

2016 Tk. 120,000 100,000 20,000

2017 Tk. 65,000 80,000 (15,000)

Workings: 1. Income tax expense:

Current tax Under/ (over) provision (w-2) Deferred tax (w-3)

2. Under/ (over) provision:

Payment of tax Current tax

36


These under/ (over) provision will not have an effect on the current year accounts but will have an effect on the following year accounts due to the timing of payments. 3. Deferred tax provision: 2015 Tk. Cumulative provision Tk.100,000 X 35% Tk.200,000 X 35% Tk.180,000 X 35% Provision b/d

2016 Tk.

2017 Tk.

35,000 70,000 0 35,000

35,000 35,000

63,000 70,000 (7,000)

P-18. SP Corporation had accounts receivables of Taka 8,800,000 and provision for bad debts of Taka 440,000 as on the year closing date 31 st December 2017. Tax rate was 40% up to year 2016, which was made 30% for year 2017 and it was assumed that the expected future tax rate would be continued at 30%. Income tax law was revised in year 2013 disallowing provision for bad debts and required that the same would be allowed for deduction only when it would be written off. Details of provision for bad debts:

Opening balance Written off during the year Provision made during the year Closing balance

2013 Tk. 81500 81500

2014 Tk. 81500 (43500) 132300 170300

2015 Tk. 170300 (63000) 165000 272300

2016 2017 Tk. Tk. 272300 370300 (85000) (117000) 183000 186700 370300 440000

Required: (a) Compute deferred tax amounts to be shown in the balance sheets as at end of years 2013 - 2017. (b) Prepare journal entries to record deferred income taxes for year 2017. (c) Explain when can deferred tax assets and deferred tax liabilities be offset for presentation in the financial statements. Solution: (a) Computation of deferred tax amounts:

Opening balance Written off during the year Provision made during the year Closing balance Tax rate Deferred tax assets

37

2013 Tk. 81500 81500 40% 32,600

2014 Tk. 81500 (43500) 132300 170300 40% 68,120

2015 2016 2017 Tk. Tk. Tk. 170300 272300 370300 (63000) (85000) (117000) 165000 183000 186700 272300 370300 440000 40% 40% 40% 108,920 148,120 132,000


(b) Journal entries: Tax expense 370,030 X (40% - 30%) - Dr. Tk.37,030 Deferred tax expense - Cr. Tk.37,030 (For adjusting the deferred tax opening balance for tax rate changes) Deferred tax assets (148,120 – 132,000) - Dr. Tk.20,910 Tax expense - Cr. Tk.20,910 (For recording the deferred tax assets for future deductible write-off) (c) An entity shall offset deferred tax assets and deferred tax liabilities if, and only if: (a) the entity has a legally enforceable right to set off current tax assets against current tax liabilities; and (b) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority on either: - the same taxable entity; or - different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered. P-19. Income data for Nobbodoy Company for the first three years of its operations are summarized below: 2015 2016 2017 Tk. Tk. Tk. Sales 1,000,000 1,040,000 1,120,000 Cost of goods sold 600,000 624,000 656,000 Gross profit on sales 400,000 416,000 464,000 Operating expenses 160,000 168,000 184,000 Income before income tax 240,000 248,000 280,000 Cost of goods sold includes depreciation on buildings and equipment items calculated by the straight-line method. However, for income tax purposes, the company employed the accelerated depreciation methods providing for higher charges in the early years of asset life and correspondingly lower charges in the later years. Depreciation charges on the books as compared with charges recognized for income tax purposes during the three year period were as follows: 2015 2016 2017 Tk. Tk. Tk. Depreciation as per books 132,000 136,000 136,000 Accelerated depreciation as per 216,000 180,800 144,000 tax return All of the revenue of the company is taxable; all of the expenses are deductible for income tax purposes. Income tax rates in each year were 40%. Required: (a) Give the entries that would be made by the company for the years 2015 through 2017 to record the accrual of income tax if income tax expense is debited with income tax allocable to such income. 38


(b) Prepare comparative income statements for the Nobbodoy Company for the three years period assuming the use of inter period income tax allocation procedures. (c) Prepare comparative income statements for the Nobbodoy Company for the three year period assuming the inter period income tax allocation procedures were not used and charges for income tax were recognized at the amounts actually becoming payable each year. Solution: (a) Nobbodoy Company Journal entries Year 2014

2015

2016

Particulars Income tax expense (240,000X40%) Income tax payable (240,000-84,000)X40% Deferred income tax (216,000-132,000)X40% Income tax expense (248,000X40%) Income tax payable (248,000-44,800)X40% Deferred income tax (180,800-136,000)X40% Income tax expense (280,000X40%) Income tax payable (280,000-8,000)X40% Deferred income tax (144,000-136,000)X40%

Dr. (Tk.) 96,000

Cr. (Tk.) 62,400 33,600

99,200 81,280 17,920 112,000 108,800 3,200

(b) Nobbodoy Company Comparative income statement For the years 2015 – 2017

Sales Cost of goods sold Gross profit on sales Operating expenses Income before income tax Income tax Net income

39

2015 Tk. 10,00,000 600,000 400,000 160,000 240,000 96,000 144,000

2016 Tk. 10,40,000 624,000 416,000 168,000 248,000 99,200 148,800

2017 Tk. 11,20,000 656,000 464,000 184,000 280,000 112,000 168,000


(c) Nobbodoy Company Comparative income statement For the years 2015 – 2017

Sales Cost of goods sold Gross profit on sales Operating expenses Income before income tax Income tax Net income

2015 Tk. 10,00,000 600,000 400,000 160,000 240,000 62,400 177,600

2016 Tk. 10,40,000 624,000 416,000 168,000 248,000 81,280 166,720

2017 Tk. 11,20,000 656,000 464,000 184,000 280,000 108,800 171,200

P-20. On January 2017 entity H acquired 100% of the shares of entity S, whose functional currency is different from that of H, for Tk.600 million. The tax rate in H‟s tax jurisdiction is 30% and the tax rate in S‟s jurisdiction is 40%. The fair value of the identifiable assets and liabilities (excluding deferred tax assets and liabilities of S acquired by H is set out in the following table, together with their tax base in S‟s tax jurisdiction and the resulting temporary differences (all figures in million Taka).

Plant and equipment Accounts receivable Inventory Retirement benefit obligations Accounts payable Fair value of net assets acquired excluding deferred tax

Fair value 270 210 174 (30) (120) 504

Plant and equipment Accounts receivable Inventory Retirement benefit obligations Accounts payable Fair value of net assets acquired excluding deferred tax

Tax base 155 210 124 (120) 369

Based on IAS 12, you are requested to: (a) Calculate the amount (taxable)/deductible temporary difference. (b) Calculate the amount of deferred tax. (c) Calculate the value of goodwill. Solution:

40


(a)

Plant and equipment Accounts receivable Inventory Retirement benefit obligations Accounts payable Fair value of net assets acquired excluding deferred tax

Fair value 270 210 174 (30) (120) 504

Tax base 155 210 124 (120)

All figures in million Taka (Taxable)/deductible temporary difference 115 50 (30) __-

369

135

Tax base 155 210 124 (120)

All figures in million Taka (Taxable)/deductible temporary difference 115 50 (30) __-

(b) Calculation of deferred tax:

Plant and equipment Accounts receivable Inventory Retirement benefit obligations Accounts payable Fair value of net assets acquired excluding deferred tax Tax rate Deferred tax

Fair value 270 210 174 (30) (120) 504

369

135 40% (54)

(c) Calculation of goodwill:

Plant and equipment Accounts receivable Inventory Retirement benefit obligations Accounts payable Fair value of net assets acquired excluding deferred tax Deferred tax Fair value of identifiable net assets acquired Goodwill (balancing figure) Total cost of acquisition

Fair value 270 210 174 (30) (120) 504 (54)

Tax base 155 210 124 (120) 369

All figures in million Taka (Taxable)/deductible temporary difference 115 50 (30) __135

450 150 600

P-21. The following particulars are stated in the Balance Sheet of M/s. Saiham Limited as on 30th June, 2016: Taka in lacs Deferred tax liability (Cr.) 20.00 Deferred tax assets (Dr.) 10.00 41


The following transactions were reported during 2016-2017: (a) Tax rate 40% (b) Depreciation – as per book 50.00 Depreciation – for tax purpose 30.00 There were no additions to fixed assets during the year. (c) Items disallowed in 2015-2016 and allowed for tax purposes in 2016-2017 10.00 (d) Interest to financial institutions to be accounted in the books on accrual basis, but actual payment was made on 30.09.2017 20.00 (e) Donations to private trusts made in 2016-2017 10.00 (f) Share issue expenses allowed for the year 2016-2017 (10% of Tk.50.00 lacs incurred in 2012-2013) 5.00 (g) Repairs to plant and machinery Tk.100.00 lacs was spread over the period 2016-2017 and 2017-2018 equally in the books. However, the entire expenditure was allowed for income tax purposes. Required: Indicate clearly the impact of above items in terms of deferred tax liability/deferred tax assets and the balances of deferred tax liability/deferred tax asset on 30.06.2016. Solution: Impact of items in terms of deferred tax: (i) Shortage of depreciation charge for tax purpose of Tk.20,00,000 is a deductible temporary difference and should be treated as a deferred tax asset. This shortage of depreciation would be charged in excess of the book in later year. Thereby, in later year taxable income will be lower and there will be a tax benefit. Excess of taxes paid in current year due to shortage of depreciation would be deductible in future. (ii) Lower of prior year allowed expenses has resulted a deferred tax amount and now the allow of the expenses would be a reversal of a previous year deferred tax asset. (iii) Interest expenses will be a deductible temporary difference. It will be treated as deferred tax assets. In future year‟s interest expenses would be allowed and resulting tax will be lower. (iv) Donation to private trust is not allowable expenses for tax purpose. Whereas it is an expense for the financial statement purpose, therefore it will be a permanent difference and it will not be treated as deferred tax liability and/ or asset. (v) Share issue expenses should be a reversal against the previously reported deferred tax assets. Since it was not allowed in the year 2012-2013 and it was an deductible temporary (assets) in the originating year. (vi) Repair to plant and machinery for the year 2017-2018 of Tk.50,00,000 should be treated as deferred tax liability because the amount is taxable temporary difference for the book purpose. Calculation of deferred tax asset on June 30, 2017: Addition & reversal of deductible temporary difference Deferred tax asset opening balance on June 30, 2016

Deferred tax asset balance

Tk.10,00,000 42


Add. Increase in deferred tax asset (i) Book depreciation charges not allowed in 2016-2017 for tax (ii) Interest to Financial Institute not allowed in 2016-2017 Less. Reversal of prior year deferred tax asset (i) Prior year share issue expenses allowed in 2016-2017 (ii) Items disallowed in 2015-2016 allowed in 2016-2017 Total temporary deductible difference from the current year transaction Applicable tax rate for the year Net effect on deferred tax asset Balance from the temporary deductible differences Deferred tax asset balance on June 30, 2017

Tk.20,00,000 20,00,000

(5,00,000) (10,00,000) 25,00,000 40%

Calculation of deferred tax liability on June 30, 2017: Addition & reversal of deductible temporary difference Deferred tax liability opening balance on June 30, 2016 Add. Increase in deferred tax liability (i) Repairs to plant & machinery allowed for tax purpose but not for book purpose Tk.50,00,000 Applicable tax rate for the year 40% Net effect on deferred tax liability Balance from the temporary taxable differences Deferred tax liability balance on June 30, 2017

10,00,000 20,00,000

Deferred tax liability balance Tk.20,00,000

20,00,000 20,00,000

P-22. The following information are related to M/s Jamjam Ltd. Balance sheet at January 01, 2017 Property, plant and equipment Goodwill Intangible assets Financial assets Total non-current assets (a) Trade and other receivables Other receivables Cash and cash equivalents Total current assets (b) Total assets (a+b) 43

Million (Tk.) 7,000 3,000 2,000 6,000 18,000 7,000 1,600 700 9,300 27,300


Issued capital Revaluation reserve Retained earnings Total equity (d) Interest bearing loans Trade and other payables Employee benefits Current tax liability Deferred tax liability Total liabilities (e) Total equity and liabilities (d+e)

6,000 1,500 6,130 13,630 8,000 4,000 1,000 70 600 13,670 27,300

(a) tax base of the above assets and liabilities are the same as their carrying amounts except for Tax base Million (Tk.) Property, plant and equipment 1,400 Trade receivables 7,500 Interest bearing loans 8,500 Financial assets 7,000 * The intangible assets are development costs that are allowed for tax purposes when the cost is incurred. The cost were incurred in 2015. * Included in trade and other payables in an accrual for compensation to be paid to employees. It is allowed for taxation when the payment is made and totals Tk.200 million. (b) During 2016, a building was revalued. At January 01, 2017, there was Tk.1,500 million remaining in the revaluation reserve in respect of this building. (c) The following adjustments to the financial statements will have to be made to comply with IFRS 1, First-Time Adoption of IFRS on January 01, 2017. * Intangible assets of Tk.400 million do not qualify for recognition under IFRS 1. * The financial assets are all classified as at fair value through profit or loss and their fair value is Tk.6,500 million, which is to be included in the IFRS accounts. * A pension liability of Tk.50 million is to be recognized under IFRS 1 that was not recognized under local Generally Accepted Accounting Principles (GAAP). The tax base of the liability is zero. (d) The entity is likely to be very profitable in the future. Required: Calculate the deferred tax provision at January 01, 2017, showing the amount of the adjustment required to the deferred tax provision and any amounts to be charged to revaluation reserve. (Assume a tax rate is 30%) Solution:

Property, plant & equipment Goodwill Intangible assets Financial assets Total noncurrent assets (a) Trade & other receivables Other receivables Cash & cash equivalents Total current assets (b)

Local Adjustment GAAP Million Million (Tk.) (Tk.) 7,000 3,000 2,000 (400) 6,000 500 18,000 100 7,000 1,600 700 9,300

Tax base Million (Tk.) 1,400

Temporary difference Million (Tk.) 5,600

0 7,000 8,400 7,500 1,600 700 9,800

1,600 (500) 6,700 (500) ___ 500 44


Total assets (a+b) Issued capital Revaluation reserve Retained earnings Total equity (d) Interest bearing loans Trade & other payables Employee benefits Current tax liability Deferred tax liability Total liabilities (e) Total equity and liabilities (d+e)

27,300 6,000 1,500 6,130 13,630 8,000 4,000 1,000 70 600 13,670 27,300

100 (50) (400) 500 50 50 __ 50 100

18,200

6,200

8,500 3,800 1,000 70 600 13,970 13,970

500 (200) (50) ___ 250 6,450

P-23. Mr. Noman computed his advance tax for the income year 2014-2015 based on latest regular assessment of Tk. 10,00,000 that includes Tk. 1,00,000 capital gain and Tk. 2,00,000 agricultural income. He has paid advance tax accordingly @ 25%. Regular assessment for the assessment year 2015-2016 was completed on August 31, 2017 and total assessed income was Tk. 8,00,000 where the amount of capital gain and agricultural income were Tk. 120,000 and Tk. 1,50,000 respectively. Tax rate applicable is 25%. Show the relevant calculations related to advance tax. Solution: Assessee: Mr. Noman Income year: 2014 - 2015 Assessment year: 2015 - 2016 Latest assessed income excluding capital gain and agricultural income = Tk.10,00,000 – 1,00,000 – 2,00,000 = Tk.7,00,000 Advance tax paid @ 25% = Tk.7,00,000 X 25% = Tk.1,75,000 Estimated actual income excluding capital gain and agricultural income = Tk.8,00,000 – 1,20,000 – 1,50,000 = Tk.5,30,000 Actual advance tax payable @ 25% = Tk.5,30,000 X 25% = Tk.1,32,500 Excess amount of tax paid = Tk.1,75,000 – Tk.1,32,500 = Tk.42,500 This excess amount of tax may either be adjusted with the tax liability of Mr. Noman of the next assessment year or be refunded to him as his opinion in writing including 10% interest on this excess tax. Calculation of time duration and interest amount for this excess tax: Given, regular assessment for the assessment year 2015-2016 was completed on August 31, 2017. 45


So, the required time duration = July 1, 2015 to August 31, 2017 = 2 years 2 months As per ITO 1984, 10% interest will be allowed on the excess amount of tax paid for maximum 2 years. So, the amount of interest = Tk.42,500 X 10% X 2 years = Tk.8,500 P-24. For the assessment year 2016-17, Mr. Nazmul has latest assessed income of Tk.9,00,000. He wants to pay advance tax for the year on the basis of his own estimates that amounts to Tk.7,20,000. Regular tax rate is 40%. During the year, TDS was Tk.20,000. Regular assessment for the assessment year 2016-17 was completed on March 31, 2016 resulting Tk.11,00,000 profit including Tk.70,000 from agricultural income and Tk.30,000 from capital gain. Show the relevant calculations related to advance tax. Solution: Assessee: Mr. Nazmul Income year: 2015 - 2016 Assessment year: 2016 - 2017 Advance tax paid = (Tk.7,20,000 – Tk.20,000) X 40% = Tk.2,80,000 Estimated actual income excluding capital gain and agricultural income = Tk.11,00,000 – Tk.30,000 – Tk.70,000 = Tk.10,00,000 Actual advance tax payable @ 40% = Tk.10,00,000 X 40% = Tk.4,00,000 Shortfall amount = Tk.4,00,000 – (Tk.2,80,000 + Tk.20,000) = Tk.4,00,000 – Tk.3,00,000 = Tk.1,00,000 75% test: 75% of actual tax liability (4,00,000 X 75%) Tax paid Shortfall amount

Tk.3,00,000 Tk.3,00,000 Nil

In this case, Mr. Nazmul is required to pay the shortfall amount of Tk.1,00,000. There is no question of interest resulting from 75% test. P-25. Mr. Rupom (age 70 years) purchased a machine for his workshop (a proprietorship entity) on 1st August 2013 at Tk. 1,80,000 and on 31st March 2016 it was sold. Till that date Tk. 1,20,000 was charged as accounting depreciation but as per Third Schedule, tax depreciation was Tk. 50,000. The company has not purchased or has not any plan to purchase a similar machine during the year ending 31st March, 2017. Find out the capital gain if sales proceed is: (i) Tk. 1,50,000 (ii) Tk. 2,10,000 (iii) Tk. 2,60,000. 46


Mr. Rupom had income of Tk. 2,50,000 from other heads of income except “Capital Gains”. Find out tax liability of Mr. Rupom in each of the three cases. Solution: Here, Written down value = Cost – Tax depreciation = 180,000 – 50,000 = 130,000 Assessee: Mr. Rupom Assessment year: 2016 – 2017 Computation of capital gain and taxable income

Sale price of machine Less. Written down value Capital gain Add. Income from other sources Total taxable income (N-1)

(i) 150,000 130,000 20,000 250,000 270,000

(ii) 210,000 130,000 80,000 250,000 330,000

(iii) 260,000 130,000 130,000 250,000 380,000

(i) Nil Nil Nil

(ii) Nil 3,000 3,000

(iii) Nil 8,000 8,000

Computation of tax liability On first Tk.300,000 @ 0% On balance amount @ 10% Total tax liability

Notes: 1. As, capital asset is disposed of within 5 years of acquisition, so capital gain is included with the total income and taxed at regular rate. 2. As, the assesse is more than 65 years of age, so minimum non-assessable income limit will be Tk.3,00,000. P-26. Bright Ltd. sold on 15 July, 2015 a piece of old equipment used in the business for Tk.20 million. In relation to the sale, it incurred advertisement cost of Tk. 80,000 and paid Tk.300,000 as brokerage commission. Bright Ltd. bought the equipment 6 years back at a cost of Tk.3,490,000. On 30 November, 2015 it has bought another new equipment at a cost of Tk.25 million inclusive of incidental costs. The company has duly informed the DCT about its intention to rollover the capital gain to new equipment purchased. Compute the amount of capital gain. Solution: Assessee: Bright Ltd. Income year: 2015 – 2016 Assessment year: 2016 – 2017 Capital gain (Section 31): Sale proceeds of capital asset Or, Fair market value at the time of transfer Whichever is higher is considered as disposal value of capital asset

47

Tk.20,000,000 __ 20,000,000


Less. Allowable deductions: Cost of acquisition Cost of transferring the asset (80,000 + 300,000) Capital gain Less. Reinvested gain to claim rollover relief (Note-1) Taxable capital gain

(3,490,000) (380,000) (3,870,000) 16,130,000 (16,130,000) -

Note: 1. If full amount or part of capital gain is used to purchase a new capital asset within a period of 1 year before or after the date of transfer, the assessee will get reinvested gain to claim rollover relief. P-27. On 1 July 2015, Mr. Jahan sold old equipment for Tk.250,000 that was used to serve the business. During the sale, he incurred Tk.20,000 as advertisement expense and Tk.30,000 as brokerage commission. He bought the equipment on 1 July 2007 at a cost of Tk.100,000. He also had Tk.300,000 as income from interest on securities, Tk.350,000 as income from business or profession and another Tk.200,000 as income from other sources. Required: Compute the amount of capital gain and tax liability. Solution: Assessee: Mr. Jahan Income year: 2015 – 2016 Assessment year: 2016 – 2017 Capital gain (Section 31): Sale proceeds of capital asset Or, Fair market value at the time of transfer Whichever is higher is considered as disposal value of capital asset Less. Allowable deductions: Cost of acquisition Cost of transferring the asset (20,000 + 30,000) Capital gain Determination of taxable income: Income from interest on securities (Section 22 & 23) Income from business or profession (Section 28, 29 & 30) Capital gain (Section 31) Income from other sources (Section 32 & 33) Total taxable income Computation of tax liability: Income slab On first Tk.250,000 On next Tk.400,000 On balance Tk.300,000 Total

Tax rate 0% 10% 15%

Tk.250,000 _ 250,000 (100,000) (50,000) (150,000) 100,000

Tk.300,000 350,000 100,000 200,000 Tk.950,000

Tax liability Tk.0 Tk.40,000 Tk.45,000 Tk.85,000 48


Average tax rate (Tk.85,000 รท Tk.950,000) Flat rate Applicable tax rate on capital gain (Note 1)

8.95% 15.00% 8.95%

Tax on capital gain (8.95% on Tk.100,000) Tax on remaining Tk.850,000 will be at regular rate On first Tk.250,000 @ 0% Tk.0 On next Tk.400,000 @ 10% Tk.40,000 On balance Tk.200,000 @ 15% Tk.30,000

Tk.8,950

Tk.70,000 Tk.78,950

Net tax liability

Note: 1. Here, the assesse is a person other than a company and the asset is sold after five years of purchase. So, tax rate will be the lower of average tax rate computed on tax on total income including capital gain and 15% flat rate. P-28. ABC Limited imported raw materials of Toys for Tk. 2,00,000 and sold it to MM Enterprise for Tk. 240,000. Using these materials MM Enterprise manufactured 100 pieces of Toys and sold all the toys to various customers for Tk. 300,000. In each case and each stage 15% VAT is to be considered. Compute VAT in each case. Solution: Computation of VAT Input value (Tk.)

Stage

Particulars

1 2

Import of raw materials by ABC Ltd. Sale of raw materials to MM Enterprise Ltd. Sale of Toys to customers Total

3

200,000 240,000 300,000

Value addition (Tk.) 200,000 40,000

VAT@ 15% (Tk.) 30,000 6,000

60,000 300,000

9,000 45,000

P-29. Naem purchases 100 wall clocks (WC) @ Tk.70 per clock and he sold all these WC to Saem at Tk.9,300 where he earns profit of Tk.2,000. After adding value of Tk.30 per clock, Saem sells these WC in the market. If VAT is same on all these clocks, calculate how much VAT Roman to pay and what price Saem sells these WC in the market. Solution: Calculation of VAT Stage 1 2 3

Particulars

Input value (Tk.)

Purchase of WC by Naem Sale of WC to Saem Sale of WC to market Total

a. 100 clocks X Tk.70 = Tk.7,000 b. Tk.9,300 + (100 clocks X Tk.30) = Tk.12,300 49

7,000a 9,300 12,300b

Value addition (Tk.) 7,000 2,300 3,000 12,300

VAT@ 15% (Tk.) 1,050 345 450 1,845


P-30. Fresh Food Company imported dry food in December, 2017 of Tk. 1,00,000 (C&F value determined by the Bangladesh Customs). The insurance charge is 1% of the C&F value, borne by the importer. Thereafter, 2% lending charge is applicable on these goods. Customs duty and supplementary duty rates are 10% and 20% respectively. Calculate the amount of VAT of Fresh Food Company, if VAT rate is 15%. Solution: Fresh Food Company Calculation of VAT Particulars C&F value of the imported dry food Add. Insurance charge CIF value Add. Landing charge Assessable value Add. Customs duty Base value for SD Add. Supplementary duty Base value for VAT VAT

Rate 1% 2% 10% 20% 15%

Amount (Tk.) 100,000 1,000 101,000 2,020 103,020 10,302 113,322 22,664 135,986 20,398

50


EXERCIES E-1. LSD, an entity operating in Country DHK, purchased land on March 1 2015 for Tk.850,000. LSD incurred purchase costs of surveyor‟s fees Tk.5,000 and legal fees Tk.8,000. LSD spent Tk.15,000 cleaning the land and making it suitable for development. Local tax regulations classified all of LSD‟s expenditure as capital expenditure. LSD sold the land for Tk.1,000,000 on 1 February, incurring tax allowable costs of Tk.6,000. Assume LSD had no temporary differences between taxable and accounting profit. Required: (i) Explain the meaning of a capital gain and capital gain tax. (ii) Use the above information to calculate the capital gain tax due on the disposal of LSD‟s land. CMA Adapted – June 2017 E-2. ABC imports consumer durable goods in bulk. ABC repackages the products and sells them to retailers. ABC is registered for Value Added Tax (VAT) in Country XYZ. ABC imported a consignment of sugar costing Tk.50,000, paying excise duty of 20% of cost. The consignment was subject to VAT on the total (including duty). ABC paid Tk.9,775 repackaging costs, including VAT and sold the sugar for Tk.105,800 including VAT. Required: (i) Calculate the net VAT due to be paid by ABC on the sugar consignment. (ii) Calculate ABC‟s net profit on the sugar consignment. CMA Adapted – June 2017 E-3. A Ltd. maintains deferred taxation account under liability method since 2015 and at the year end the account shows a balance of Tk. 20 million. Accounts for the year to 31 December 2016 have now been prepared and the following taxation information compiled: (i) Tax rates applicable to the company are: 2015 35.00% 2016 35.00% (ii) Accounting depreciation charged in 2016 has been Tk.60 million but taxation laws would allow Tk.100 million as depreciation for the year. (iii) Besides, non-admissible items have been charged in accounts amounting to Tk.2.50 million. (iv) Accounts show a profit of Tk.90 million for the year 2016. Tax liability of 2015 has been recently settled at an excess of Tk.0.50 million provided in the year. Required: Prepare the current and deferred taxation accounts of the company for the year ended 31 December 2016. CMA Adapted – June 2017

Contact us to collect exercises solution. Helpline: 01711137039 51


E-4. Mr. Habib is a VAT registered trader. He has the following transactions in the month of July 2016: (i) Goods purchased for Tk.57,500 including VAT. (ii) The above goods have been sold for Tk.80,500. (iii) Tk.3,000 deposied to Bangladesh Bank for VAT Current A/c. (iv) Out of the sold goods Tk.4,600 have been returned. (v) VAT return submitted after adjusting the input and outpur VAT. Compute the balance of VAT Current Account and give the journal entries of these transactions. CMA Adapted – June 2017 E-5. Mr. Chowdhury purchased one plot of land in 2000-2001 at a cost of Tk.1,00,000 in Cox‟s Bazar. The land was held by him as capital asset. He converted the plot into his stock in trade on 1st May, 2013, on which date the fair market value of the plot was Tk.15,50,000. He started constructing a building consisting of eight flats of equal size and dimension on the plot on 1st May, 2013. Cost of the construction of each flat is Tk.6,00,000. Construction was completed in June 2014. He sold five flats at Tk.12,00,000 per flat from June, 2014 to March, 2015. The remaining three flats were held as stock on 31st March, 2015. Compute Capital gain and Business Income arising from above transactions for Assessment year 2015-16. (Cost Inflation Index: 2000-01: 281 2013-14: 852 2014-15: 939) CMA Adapted – December 2016 E-6. DDD is an entity supplying goods and services to other businesses. DDD is registered for Value Added Tax (VAT) in Bangladesh. DDD is partially exempt for VAT purposes. During the last VAT period DDD purchased materials and services costing Tk.400,000 excluding VAT. DDD used these goods and services to produce both standard and exempt supplies. VAT was payable at standard rate on all purchases. DDD supplied goods and services to its customers, some of these were at standard rate VAT and some were exempt VAT. Excluding VAT: Tk. Standard rate goods and services 450,000 Exempt supplies 150,000 At the end of the period DDD prepared a VAT return. Assume DDD had no other VAT related transactions. Required: (i) Explain the difference between the treatment of items that are zero rated and items that are exempted from VAT. (ii) Calculate the net VAT balance shown on DDD‟s VAT return. CMA Adapted – June 2016 E-7. JMC commenced business in Country D on 1 July 2014 and, on that date, it acquired property, plant and equipment for Tk.440,000. JMC uses the straight line method of 52


depreciation. The estimated useful life of the assets was five years with no residual value. JMC‟s accounting year end is 30 June. All the assets acquired qualified for a first year tax allowance and then an annual tax allowance. On 1 July 2015, JMC revalued all of its property, plant and equipment. This revaluation resulted in an increase in asset values of Tk.100,000. Required: (i) Explain why JMC‟s revaluation of its assets would cause a temporary difference as defined by IAS 12 Income Taxes. (ii) Calculate the amount of the deferred tax provision that JMC should include in its statement of financial position as at 30 June 2016, in accordance with IAS 12 Income Taxes. CMA Adapted – June 2016 E-8. Beginning balance: DTL BDT 40,000.00 DTA BDT 0 Taxable income is BDT 95,000; Pretax income is BDT 2,00,000.00 Cumulative temporary difference from future taxable amount is BDT 2,40,000.00 Cumulative temporary difference from future deductible amount is BDT 35,000.00 Income tax rate is 40% Required: (i) Compute income tax payable. (ii) Journalize income tax expense, DTA, DTL, and income tax payable. (iii) Compute net income. CMA Adapted – August 2015 E-9. Suppose a company bought a car on 1 July 2007 paying BDT 50,00,000. Other relevant information is as follows: Accounting depreciation (cost method) 25% Tax depreciation (reducing balance method): Special (in 2008 only) 10% Normal 20% Maximum value chargeable for tax depreciation BDT 20,00,000 Required: Calculate deferred tax impact (expense or income) for the year ended 30 June 2010 and 2009 on the carrying value of the car. CMA Adapted – April 2015 E-10. FYR Ltd. presents the following information for the year ending 30.06.2013 and 30.06.2014. FYR Ltd. 30.06.2013 30.06.2014 Tk. (Lacs) Tk. (Lacs) Depreciation as per books 4,010.10 4,023.54 Unabsorbed carry forward business loss and 2,016.60 4,110.00 depreciation allowance Disallowed as per ITO-1984 518.35 611.45 Deferred Revenue Expenses 4.88 Provision for Doubtful Debts 282.51 294.35 Tax ax rate 30% 30% 53


Additional information: FYR Ltd. had incurred a loss of Tk.504 Lacs for the year ending 30.06.2014 before providing for Current Tax of Tk.26 Lacs. Required: Deferred Tax Asset/Liability and state how the same should be dealt with as per IAS-12: Income Taxes. CMA Adapted – December 2014 E-11. Imperial Food Products imported Dry food in December, 2013 of Tk. 15,00,000 (C&F value determined by the Bangladesh Customs). The insurance charge is 1.5% of the C&F value, borne by the importer. Thereafter, 2% lending charge is applicable on these goods. Customs duty and supplementary duty rates are 15% and 20% respectively. Calculate the amount of VAT of Imperial Food Products, if VAT rate is 15%. CMA Adapted – August 2014 E-12. Aramex Ltd imported raw materials of Toys for Tk. 5,00,000 and sold it to Matrix Enterprise Limited for Tk. 580,000. Using these materials Matrix Enterprise manufactured 500 pieces of Toys and sold it to Farhan and Sons Ltd, a wholesaler, for Tk. 620,000. Farhan and Sons sold the toys to a retail seller Tina holdings for Tk. 660,000. Tina Holdings sold all the toys to various customers for Tk. 700,000. In each case and each stage 15% VAT is to be considered. Compute VAT in each case. CMA Adapted – August 2014 E-13. Regent Company produces different consumer products. To produce their products they import some ingredients from China and use some local ingredients. To produce 10000 pieces (pcs) of AAA Makeup Box for November 2013 they procured and used following ingredient as per standard practice: Ingredient A 1200 kgs by Tk. 517,440 where VAT was Tk. 65,340, AIT (advance income tax) Tk. 16,500, Customs Duties (CD) Tk. 33,000 and Supplementary Duty (SD) Tk. 72,600; Ingredient B 600 kgs by Tk. 356,345 where VAT was Tk. 45,045, AIT Tk. 11,000, CD Tk. 66,000 and SD Tk. 14,300; Ingredient C 800 kgs by Tk. 1,50,000 (VAT- exempted); and Ingredient D 10,050 pcs by Tk. 138,000 where VAT was Tk. 18,000. Ingredient A and B were imported items and Ingredient C and D were locally procured from wholesale market. Standard Gas bill for such quantity of products was Tk. 1,20,000 and Electricity bill was Tk. 55,000 excluding VAT. Per Unit costs were: Labor cost Tk. 80, factory overhead Tk. 90. Standard marketing overhead cost in total was Tk. 50,000 and bank interest Tk. 45,000 for November 2013. Company profit markup policy is 30% after charging all costs. Company produced and sold 1000 pcs AAA Makeup Box in November 2013. As a Manager (Costing & VAT) of the company you are required to submit Form VAT-1 for Product AAA and Form VAT-19 for the month of November 2013. 54


Required: (i) Find out per unit AAA Makeup Box cost for Form VAT-1 and selling price. (ii) Determine the amount of input VAT will be allowed as rebate in Form VAT-19 and net VAT payable for November 2013. CMA Adapted – December 2013 E-14. M/S. Asa Electronics has imported electronic parts which will be assembled and packed in Bangladesh. Due to increase in the last consignment price, the company needs to increase its product price, for which it has to submit VAT FORM-1 to the VAT authority. The imported consignment consisted of 10,000 units at a C&F (cost & freight) value of USD 60 per unit. The exchange rate was Tk. 78 for 1 US dollar. Applicable duties and tax were: Custom duty @ 12%, Supplementary duty @ 10%, Advance income tax @ 5%, VAT @ 15% and ATV @ 4%. Customs authority added 1% of C&F value as insurance cost and 1% of CIF value as landing charge to determine the assessable value. After importation, the company‟s carrying and other cost was Tk. 40 per unit, labour cost Tk. 200 per unit and overhead 50% of labour cost. For assembling and packing, the company used 2 articles locally, article A at a cost of Tk. 80 per unit without any VAT for exemption and article B at a cost of Tk. 200 per unit plus 15% VAT therefor. As per management policy, the company‟s mark-up profit is 20% of cost. Required: Determine – (a) Assessable Value for Customs clearance. (b) Total duties and taxes, including VAT, AIT and ATV. (c) Per unit sales price for submission of VAT Form-1. (d) Output VAT per unit, Input VAT per unit and VAT liability per unit after input VAT credit. CMA Adapted – August 2013 E-15. You have been appointed by the Management of Moon Incorporation to review their books of Accounts and to indicate what effect in income tax allocation procedures will have on their statements. The following reconciliation of book income and taxable income are made available: Amounts in Taka 2003 2004 2005 Reported Book Income before Tax 180,000 270,000 360,000 Add Expenses not deductible for tax purposes 90,000 Excess of Book depreciation over tax depreciation - 30,000 Deferred revenue tax in the period of collection 48,000 42,000 24,000 2,28,000 402,000 414,000 Less Excess of reported book income on installment sales over taxable income (36,000) (54,000) (48,000) Excess of tax depreciation over book depreciation (36,000) (12,000) __ ___Taxable Income 1,56,000 3,36,000 3,66,000 Required: (a) Assume tax rates as 40% on taxable income for all the three years. Prepare journal entries for three years to record the income tax liability. Use separate deferred accounts where necessary. (b) Assume the rate changed in 2005 to 45%. Prepare the journal entries to record the Income Tax liability of that year. CMA Adapted – April 2012 55


E-16. Mr. Anwar imported some processed mushrooms from Thailand. C&F value of the goods were US$ 5,000 with an exchange rate of US$1 = Tk.82.50. Insurance cost was 1% of C&F value. Border taxes on this import were as follows: Customs duty @ 25%, Supplementary duty @ 20%, Value Added Tax (VAT) @ 15%, Advance income tax (AIT) @ 5%, Regulatory duty @ 5% and Advance trade VAT (ATV) @ 3%. Compute the amount of Custom duty, Supplementary duty, VAT, AIT, Regulatory duty and ATV. Also compute the total tax incidence as a percent of assessable value. CMA Adapted – April 2012 E-17. During 2009, ST. Co.‟s first year of operations, the Company reports pre-tax financial Income at Tk. 2,50,000. Tax rate is 45% for 2009 and 40% for the rest years. ST. Co. expects to have taxable income in each of the next 5 years. The effects on future tax returns of temporary differences existing at December 31, 2009 are summarized below: Future taxable (Deductible) Future years Amounts: 2010 2011 2012 2013 2014 Total Installment Sales 32,000 32,000 32,000 96,000 Depreciation 6,000 6,000 6,000 6,000 6,000 30,000 Unearned Rent (50,000) (50,000) - (1,00,000) Instructions: (i) Complete the schedule below to compute the deferred taxes at Dec. 31, 2009. (ii) Compute taxable Income for 2009. (iii) Prepare the journal entry to record Income tax payable, deferred taxes and income tax expenses for 2009. Temporary difference Installment sales Depreciation Unearned rent Total

Future taxable (deductible) amounts 96,000 30,000 (1,00,000)

December 31, 2009 Tax rate

Deferred tax Asset Liability

-------------

---------------

CMA Adapted – August 2011 E-18. A manufacturing company has imported 1 million pieces of a product at C&F cost of US$75,000. Applicable exchange rate US$ 1 = BDT 70. Insurance cost is 1% of C&F. Taxes applicable at import stage are: Custom Duty (CD) @ 15%, Supplementary Duty (SD) @ 35%, Value Added Tax (VAT) and Advance Income Tax (AIT). Determine the amount of each tax and the total import cost including all taxes and non-tax costs. Mention the application of further tax liability, if the importer was a commercial importer. CMA Adapted – April 2011 E-19. Mr. Karim import consumable item worth $ 5000, exchange rate @ 70 Tk. Calculate Customs Duty (CD), Supplementary Duty (SD),Value Added Tax (VAT), Advance Income Tax (AIT). Please consider CD=25%, SD=20%, VAT=15%, AIT=3%, 1% landing charge, 1% handling charge. CMA Adapted – December 2010 56


E-20. Givenchy Ltd imports A4 size paper from Singapore. Invoice value is $5000 (C&F), Assessable Value is $6000, Exchange rate is 1$=70Tk, Customs Duty is 25%, Supplementary Duty is 35%, Regulatory Duty is 5%, VAT is 15%, AIT is 3%, 1% handling charge and 1% landing Charge. You have to calculate total tax and other charges liabilities at the import stage. CMA Adapted – August 2010 E-21. XYZ Ltd imports A4 size paper from Singapore. Invoice value is $3000 (C&F), Exchange rate is 1$=70Tk, Customs Duty is 25%, Supplementary Duty is 35%, AIT is 3%, (Consider 1% Handling charge and 1% Insurance fees). Calculate Customs Duty, VAT, Supplementary Duty and Total Tax Liability of XYX Ltd at import stage. CMA Adapted – April 2010

57


CHAPTER - 2 REGULATION AND ETHICS OF FINANCIAL REPORTING

2.1. CONCEPT OF GAAP Generally accepted accounting principles (GAAP) are a common set of accounting principles, standards and procedures that companies must follow when they compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP improves the clarity of the communication of financial information. 2.2. ROLE OF INTERNATIONAL ACCOUNTING STANDARD BODIES a) To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their world-wide acceptance and observance. b) To work generally for the improvement and harmonization of regulations, accounting standards and procedures relating to the presentation of financial statements. 2.3. NEED FOR REGULATION OF ACCOUNTS a) Eliminate ambiguity: As an accountant, there‟ll be times when there is a confusing variation as to what accounting treatment is to be used for a particular transaction. Accounting standards come into handy then. b) Facilitate comparison: As an entrepreneur, a businessperson surely wants to compare his/her financial statements with that of other competitor‟s. If there were no standards, comparison would‟ve been difficult ‟cause there may be different accounting treatments thus resulting in different profits/different closing stock values. c) Disclosure requirements: As a company, a businessperson has responsibility to present, to his/her stakeholders, few notes which ease the understandability of the financial statements. d) Business worth and accuracy: Accountancy standards make business worthy and accurate in all manners. Improvement in process or procedure of accountancy gives more benefits then an ordinary standard. It raises business value to grow leads or generate more business in consistent way. e) Increase transparency: Another potential reason is that the business and accounting practices become increasingly complicated, so setting the accounting treatment standards is an efficient way to increase the transparency of financial reporting. 2.4. ELEMENTS IN A REGULATORY FRAMEWORK FOR PUBLISHED ACCOUNTS There are many elements in a regulatory framework for published accounts. A typical regulatory structure includes: 58


   

National financial reporting standards National law Market regulations Security exchange rules.

For example; the UK has its own national financial reporting authority, the Accounting Standards Board (part of the Financial Reporting Council) that issues financial reporting standards in the UK. The main piece of legislation affecting businesses in the UK is the Companies Act 2006. However, there are also many other pieces of UK, EU and even US legislation (such as the Sarbanes Oxley Act) that affect accountability in the UK. There are also numerous industry specific regulatory systems that affect accounting in the UK, for example; the Financial Services Authority, whose aim is to achieve public accountability of the financial services industry. Finally, there are regulations provided by the London Stock Exchange for companies whose shares are quoted on this market 2.5. DEFINITION OF ETHICS Ethics is the discipline dealing with what is good and bad and with moral duty and obligation. It is a set of moral principles, especially ones relating to or affirming a specified group, field, or form of conduct. It includes study of universal values such as the essential equality of all men and women, human or natural rights, obedience to the law of land, concern for health and safety and, increasingly, also for the natural environment. Ethics (sometimes called morals or moral philosophy): - is concerned with fundamental principles of right and wrong and what people ought to do - inform the judgments and values and help individuals decide on how to act 2.6. NATURE OF ETHICS a) Business ethics is a code of conduct. It tells what to do and what not to do for the welfare of the society. b) Business ethics is based on moral and social values. It contains moral and social principles (rules) for doing business. c) Ethics give protection to different social groups such as consumers, employees, small businessmen, government, shareholders, creditors, etc. d) It provides a basic framework for doing business. It gives the social cultural, economic, legal and other limits of business. e) Businessmen must be given proper education and guidance before introducing business ethics. 2.7. IFAC CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS A Professional Accountant should comply with the following code of ethics: (a) Integrity: Integrity is the quality of being honest and having strong moral principles; moral uprightness. It is generally a personal choice to hold oneself to consistent moral and ethical standards. In ethics, integrity is regarded by many people as the honesty and truthfulness or accuracy of one's actions.

59


(b) Objectivity: Generally, objectivity means the state or quality of being true even outside of a subject's individual biases, interpretations, feelings, and imaginings. (c) Professional competence and due care: The principle of professional competence and due care imposes the following obligations on all professional accountants: - To maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional service; and - To act diligently in accordance with applicable technical and professional standards when providing professional services. (d) Confidentiality: Confidentiality is the protection of personal information. Confidentiality means keeping a client's information between you and the client, and not telling others including coworkers, friends, family, etc. Examples of maintaining confidentiality include: individual files are locked and secured. (e) Professional behavior: A professional accountant should comply with relevant laws and regulations and should avoid any action that discredits the profession. 2.8. PROVISIONS OF CIMA CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS The provisions of the CIMA code of ethics for professional accountants: (a) Integrity: Integrity is the quality of being honest and having strong moral principles; moral uprightness. It is generally a personal choice to hold oneself to consistent moral and ethical standards. In ethics, integrity is regarded by many people as the honesty and truthfulness or accuracy of one's actions. (b) Objectivity: Generally, objectivity means the state or quality of being true even outside of a subject's individual biases, interpretations, feelings, and imaginings. (c) Professional competence and due care: The principle of professional competence and due care imposes the following obligations on all professional accountants: - To maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional service; and - To act diligently in accordance with applicable technical and professional standards when providing professional services. (d) Confidentiality: Confidentiality is the protection of personal information. Confidentiality means keeping a client's information between you and the client, and not telling others including coworkers, friends, family, etc. Examples of maintaining confidentiality include: individual files are locked and secured. 60


(e) Professional behavior: A professional accountant should comply with relevant laws and regulations and should avoid any action that discredits the profession.

61


CHAPTER - 3 PRESENTATION OF FINANCIAL STATEMENTS (IAS – 1)

3.1. DEFINITION OF FINANCIAL STATEMENT Financial statements are reports issued by companies in order to convey information about their financial health and recent results. These statements are intended to convey financial information as clearly and accurately as possible for investors, prospective investors, analysts, and any other interested parties. As per IAS 1, financial statements are those intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs. 3.2. OBJECTIVES OF FINANCIAL STATEMENT The major objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to its users in making economic decisions. Financial statements also show the results of the managementâ€&#x;s stewardship of the resources entrusted to it. Its other objectives are as follows: (a) To know profitability of business: Financial statements are required to ascertain whether the enterprise is earning adequate profit and to know whether the profits have increased or decreased as compared to the previous year(s), so that corrective steps can be taken well in advance. (b) To know solvency of business: Financial statements help to analyse the position of the business as regards to the capacity of the entity to repay its short as well as long term liabilities. (c) To judge growth of business: Through comparison of data of two or more years of business entity, we can draw a meaningful conclusion as regard to growth of the business. For example, increase in sales with simultaneous increase in the profits of the business, indicates a healthy sign for the growth of the business. (d) To judge financial strength of business: Financial statements help the entity in determining solvency of the business and help to answer various aspects viz., whether it is capable to purchase assets from its own resources and/or whether the entity can repay its outside liabilities as and when they become due. (e) To making comparison: To make a comparative study of the profitability of the entity with other entities engaged in the same trade, financial statements help the management to adopt sound business policy by making intra firm comparison. 62


(f) To forecast and prepare budgets: Financial statement provides information regarding the weak-spots of the business so that the management can take corrective measures to remove these short comings. Financial statements help the management to make forecast and prepare budgets. (g) To communicate with different parties: Financial statements are prepared by the entities to communicate with different parties about their financial position. Hence, it can be concluded that understanding the basic financial statements is a necessary step towards the successful management of a commercial enterprise. 3.3. QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENT Financial statement is an important source of information to its users both for internal and external users. So, the information presented in financial statement should follow some key qualities which make it useful to its users. Generally Accepted Accounting Principles (GAAP) outline some important qualities that must be followed by an organization in preparing its financial statement. IASB Conceptual Framework categorizes these into fundamental qualitative characteristics which are as follows: Understandability: The information presented in financial statement must be readily understandable to its users. The information must be clearly presented, with additional information supplied in the supporting footnotes as needed to assist in clarification. It should uses the words that is familiar to all. Relevance: Since, financial statements can influence the economic decision of its users, the information presented in it must be relevant to the demand of the users. Relevance means the particular information that provides actual scenario of the fact, or information whose omission or misstatement could influence the economic decisions of users. Reliability: The information must be free of material error and bias, and not misleading. Thus, the information should faithfully represent transactions and other events, reflect the underlying substance of events, and prudently represent estimates and uncertainties through proper disclosure. Faithful representation: The information reported in the financial statement must represent the purpose it wants to serve. It should show the information that actually happened. A financial statement is faithfully represented when it shows completeness, neutrality and free from error. Comparability: The information must be comparable to the financial information presented for other accounting periods, so that users can identify trends in the performance and financial position of the reporting entity.

63


3.4. COMPONENTS OF FINANCIAL STATEMENT Components of a financial statement can be described as the building blocks used for constructing the financial statement and these items represent, in words and numbers, various resources, claims to those resources, and any transactions that create changes in those resources and claims. A complete set of financial statements is made up of five components. An entity shall present all of its financial information in a complete set of financial statements which are as follows: (a) statement of financial position at the end of the period; (b) statement of profit or loss and other comprehensive income for the period; (c) statement of changes in equity for the period; (d) statement of cash flows for the period; (e) notes to the financial statements; The notes to the financial statements are also considered an integral part of the financial statements but are not an actual financial statement. The purpose of the notes is to provide informative disclosures that are required by Generally Accepted Accounting Principles (GAAP). 3.5. TYPES OF FINANCIAL STATEMENT There are four main types of financial statements, which are as follows: (a) Statement of profit or loss: This report reveals the financial performance of an organization for the entire report period. It begins with sales, and then subtracts out all expenses incurred during the period to arrive at a net profit or loss. An earnings per share figure may also be added if the financial statements are being issued by a publicly-held company. This is usually considered the most important financial statement, since it describes performance. (b) Statement of changes in equity: This report documents all changes in equity during the reporting period. These changes include the issuance or purchase of shares, dividends issued, and profits or losses. This document is not usually included when the financial statements are issued internally, as the information in it is not overly useful to the management team. (c) Statement of financial position: This report shows the financial position of a business as of the report date. The information is aggregated into the general classifications of assets, liabilities, and equity. Line items within the asset and liability classification are presented in their order of liquidity, so that the most liquid items are stated first. This is a key document, and so is included in most issuances of the financial statements. (d) Statement of cash flows: This report reveals the cash inflows and outflows experienced by an organization during the reporting period. These cash flows are broken down into three classifications, which are operating activities, investing activities, and financing activities. This document can be difficult to assemble, and so is more commonly issued only to outside parties.

64


3.6. METHODS OF FINANCIAL STATEMENT ANALYSIS The analysis and interpretation of financial statements is used to determine financial position and results of operation as well. The following methods of analysis are generally used: (a) Comparative statements: The comparative financial statements are the statements of the financial position at different periods of time. The elements are shown in a comparative form so as to give an idea of financial position at two or more periods. Generally two financial statements (balance sheet and income statements) are in comparative form for financial analysis. (b) Trend analysis: The financial statement can be analyzed by computing the trends of services of information. This method determines the direction upwards or downwards and involves the computation of percentage relationship that each statement bears to the same item in the base year. The information for number years is taken up. (c) Common size statements: A common size statement facilitates comparison of financial statements of not only a single firm over a period, but also comparison of financial statements of different companies for a given firm. Under this method all the items of the statement are presented as percentages or ratios of a particular item. Therefore even if the related absolute figures are in respect of vastly different scale of operations a common base for comparison is created. In case of a common size income statement all items are presented as percentages of net sales. A common size balance sheet shows each item as a percentage of total assets or total liabilities. A common size statement helps in determining the relative efficiency and soundless of a firm and helps in understanding its financial strategy. (d) Funds flow analysis: The funds flow statement explains the various sources from which funds are raised and uses to which funds are put. It shows the change in assets and liabilities from the end period of time to the end of another period of time i.e. between the two balance sheet dates an analysis of funds flow statement helps in answering the following questions raised (e) Cash flow analysis: It is an examination of a companyâ€&#x;s cash inflows and outflows during a specific period. The analysis begins with a starting balance and generates an ending balance after accounting for all cash receipts and paid expenses during the period. The cash flow analysis is often used for financial reporting purposes. (f) Ratio analysis: Ratio analysis is a technique of analysis and interpretation of financialstatements. It is a process of establishing and interpreting various ratios for helping in certain decisions. It is only a means of better understanding of financial strengths and weakness of a firm. (g) Cost-volume-profit analysis: Cost-volume-profit analysis is used to determine how changes in costs and volume affect a company's operating income and net income. In performing this analysis, there are several 65


assumptions made, including: Sales price per unit is constant. Variable costs per unit are constant. Total fixed costs are constant. 3.7. USERS OF FINANCIAL STATEMENT The financial statement is generally used by the following users: Investors: Investors are those persons who invested their money in the firm‟s earnings. They restore confidence in that firm‟s that show steady growth in earnings. As such they concentrate on analysis of the firm‟s present and future profitability. Employees: Employees and trade union representatives need to know if an employer can offer secure employment and possible pay rises. They will also have a keen interest in the salaries and benefits enjoyed by senior management. Information about divisional profitability will also be useful if a part of the business is threatened with closure. Trade creditors: Trade creditors are interested firm‟s ability to meet their claims over very short period of time. Their analysis will therefore be evaluation of the firm‟s liquidity position. Suppliers: Suppliers are concerned with firm‟s long-term solvency and survival. They analyze firm‟s profitability over time, its ability to generate cash to be able to pay interest and repay principal and relationship between various sources. Management: Management of the firm would be interested in every financial aspect of the financial analysis. It is their overall responsibility to see that the resources of the firm are use most effectively and efficiently and that the firm‟s financial condition is sound. 3.8. DEFINITION OF CURRENT AND NON-CURRENT ASSETS As per IAS 1, an entity shall classify an asset as current when: (a) it expects realise the asset, or intends to sell or consume it, in its normal operating cycle; (b) it holds the asset primarily for the purpose of trading; (c) it expects to realise the asset within twelve months after the reporting period; or (d) the asset is cash or a cash equivalent (as defined in IAS 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period. An entity shall classify all other assets as non-current. 3.9. DEFINITION OF CURRENT AND NON-CURRENT LIABILITIES As per IAS 1, an entity shall classify a liability as current when: (a) it expects to settle the liability in its normal operating cycle; (b) it holds the liability primarily for the purpose of trading; 66


(c) the liability is due to be settled within twelve months after the reporting period; or (d) it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period. Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification. An entity shall classify all other liabilities as non-current. 3.10. EXPLANATION OF OFF BALANCE SHEET Off balance sheet refers to those assets and liabilities not appear on an entity's balance sheet, but which is effectively belong to the enterprise. These items are usually associated with the sharing of risk or they are financing transactions. A business tries to keep certain assets and liabilities off its balance sheet in order to present to the investment community a cleaner balance sheet than would otherwise be the case. It does so by engaging in transactions that are designed to shift the legal ownership of certain transactions to other entities or the transactions are designed to sidestep the reporting requirements of the applicable accounting framework, such as GAAP or IFRS. Though off balance sheet assets and liabilities do not appear on the balance sheet, they may still be noted within the accompanying financial statement disclosures. This method of presentation is less favorable to the reader of a set of financial statements, since the issuer could bury the applicable information deep in the footnotes or use obscure wording to mask the nature of the underlying transactions. Example, Assume that Mosaj & Associates has a credit limit of Tk.40,00,000 with XYZ Bank. This credit limit requires Mosaj & Associates to stay below a 0.5 debt-to-equity ratio at all times. Mosaj & Associates wants to buy a new equipment. The cost of equipment is Tk.10,00,000, but Mosaj & Associates does not have enough cash to purchase the equipment. If it uses debt to buy it, the Mosaj & Associates will violate the covenant on its limit of credit. Therefore, it needs to find another way to purchase the machine. To overcome this problem, Mosaj & Associates creates a separate entity that will purchase the equipment and then lease it to Mosaj & Associates via an operating lease. This way, even though Mosaj & Associates has virtually complete control of and responsibility for the machine, it only records its monthly lease expense on its income statement; it does not have to record the additional debt on its balance sheet, and it does not record an increase in assets so that it does not legally own the equipment. In this case, Mosaj & Associates used off-balance-sheet financing to acquire the equipment. 3.11. INFORMATION TO BE PRESENTED IN THE STATEMENT OF PROFIT OR LOSS A statement of profit or loss shall include the following information for the period: (a) revenue; (b) gains and losses arising from the derecognition of financial assets measured at amortised cost; (c) finance costs;

67


(d) share of the profit or loss of associates and joint ventures accounted for using the equity method; (e) if a financial asset is reclassified so that it is measured at fair value, any gain or loss arising from a difference between the previous carrying amount and its fair value at the reclassification date; (f) tax expense; (g) a single amount for the total of discontinued operations. 3.12. INFORMATION TO BE PRESENTED IN THE STATEMENT OF CHANGES IN EQUITY The statement of changes in equity includes the following information: (a) total comprehensive income for the period; (b) for cash component of equity, the effects of retrospective application or retrospective restatement; and (c) for each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing changes resulting from: (i) profit or loss; (ii) other comprehensive income; and (iii) transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control. 3.13. INFORMATION TO BE PRESENTED IN THE STATEMENT OF FINANCIAL POSITION A statement of financial position shall include the following items: (a) property, plant and equipment; (b) investment property; (c) intangible assets; (d) financial assets (excluding investments accounted for using the equity method, trade and other receivables, cash and cash equivalents); (e) investments accounted for using the equity method; (f) biological assets; (g) inventories; (h) trade and other receivables; (i) cash and cash equivalents; (j) the total of assets classified as held for sale (k) trade and other payables; (l) provisions; (m) financial liabilities (excluding trade and other payables and provisions); (n) liabilities and assets for current tax; (o) deferred tax liabilities and deferred tax assets; (p) liabilities included in disposal groups classified as held for sale; (q) non-controlling interests, presented within equity; and (r) issued capital and reserves attributable to owners of the parent. 3.14. DISCLOSURE An entity shall disclose the following information: 68


(a) the measurement basis used in preparing the financial statements, and (b) the other accounting policies used in the preparation of the financial statements. An entity shall disclose the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In respect of those assets and liabilities, the notes shall include details of: (a) their nature, and (b) their carrying amount as at the end of the reporting period. An entity shall disclose the information that enables its users to evaluate the entityâ€&#x;s objectives, activities and policies for handling capital.

69


PROBLEMS AND SOLUTIONS P-1. Basic Builders Ltd. completes the handover of a new flat to a client and raises an invoice price for Tk.800,000 on the last day of its current accounting period. This price includes after-sales support for the next two years, which is estimated to cost Tk.35,000 each year. Basic Builders Ltd. normally earns a gross profit margin of 17.5% on such support activity. Calculate the revenue to be included in Basic Builders Ltd.‟s current year income statement in respect of this sale. Solution:

Tk.35,000 X 2) 100%  17.5% Tk.35,000 = Tk.800,000 - ( X 2) 82.5% = Tk.800,000 – Tk.84,848 = Tk.715,152

Revenue in the current year = Tk.800,000 – (

P-2. Anton Company is a manufacturer of televisions. The domestic market for electronic goods is currently not doing well and therefore many entities in this business are switching to exports. As per the audited financial statements for the year ended December 31, 2017 the entity had net losses of Tk.2 million. At December 31, 2017 its current assets aggregate to Tk.20 million and the current liabilities aggregate to Tk.25 million. Due to expected favorable changes in the government policies for the electronics industry, the entity is projecting profits in the coming years. Furthermore, the shareholders of the entity have arranged alternative additional sources of finance for its expansion plans and to support its working capital needs in the next 12 months. Required: Should Anton Company prepare its financial statements under the going concern assumption? Solution: The two factors that raise doubts about the entity‟s ability to continue as a going concern are: a) The net loss for the year of Tk.2 million; b) At the balance sheet date, the working capital deficiency (current liabilities of Tk.25 million) exceeds its current assets (of Tk.20 million) by Tk.5 million. However, there are two mitigating factors: i) The shareholders‟ ability to arrange funding for the entity‟s expansion and working capital needs; ii) Projected future profitability due to expected favorable changes in government policies for the industry the entity is operating within. Based on these sets of factors – both negative and positive (mitigation) factors it may be possible for the management of the entity to argue that the going concern assumption is appropriate and that any other basis of preparation of financial statements would be 70


unreasonable at the moment. However, if matters deteriorate further instead of improving, then in the future another detailed assessment would be needed to ascertain whether the going concern assumption is still valid. P-3. Raising Limited has the following post-closing trial balance for 2016: Cash Accounts receivable Merchandise inventory Land Buildings Accumulated depreciation, buildings Accounts payable Interest payable Wages payable Notes payable Capital stock Retained earnings

15,000 10,000 30,000 1,30,000 1,00,000 60,000 40,700 8,000 12,000 80,000 2,00,000 50,000

During 2017, the following transactions occurred: (a) Provided services on credit, for Tk.3,00,000. (b) Merchandise inventory amounting Tk.70,000 was purchased on credit during the year 2016. Merchandise inventory of an amount of Tk.20,000 remains unused at year-end of 2016. (c) Wages payable at the beginning of 2016 were paid in 2017. Wages earned and paid during 2017 amounting Tk.1,00,000. (d) One yearâ€&#x;s interest @10% was paid on notes payable on July 1, 2017. (e) Property taxes were paid on Land and Buildings in the amount of Tk.20,000. (f) The buildings are being depreciated over 10 years, with no residual value. (g) The income tax rate is 35%. Required: Prepare comprehensive income statement for the year ended December 31, 2017. Solution: Raising Limited Comprehensive income statement For the year ended December 31, 2017 Amount (Tk.) Revenues: Service revenues Total revenues Less. Operating expenses: Merchandise inventory Wages Depreciation expense- building Property tax Total operating expenses Income from operation Less. Interest expense (80,000 X 10%) 71

Amount (Tk.)

300,000 300,000 80,000 100,000 10,000 20,000 210,000 90,000 8,000


Income before taxes Less. Income tax expense @35% Net income

82,000 28,700 53,300

P-4. The following is the 10 months pre-audit income statement of Star Cycle Company ended on 31st December 2017, which started its operations on March 1, 2017. Star Cycle Company Income Statement For Period Ended December 31, 2017 Sales Cost of goods sold: Completed units 50,000 Ending inventory 10,000 Gross profit on sales Selling expenses: Advertising Tk.1,32,000 Miscellaneous 6,00,000 General & administrative expenses: Officers salaries 3,21,000 Depreciation 1,69,000 Miscellaneous 33,000 Income before income tax

Tk.49,70,000 Tk.40,10,000 8,02,000

32,08,000 17,62,000

7,32,000

5,23,000

12,55,000 5,07,000

During the course of the year-end audit, the auditors observed the following: (a) Factory depreciation of Tk.1,12,000 was included in general & administrative expenses. (b) Sales return and allowances of Tk.27,500 were not recorded. (c) Accrued sales commission of Tk.52,300 was not recorded of December 31, 2017. (d) Advertising expenses of Tk.1,32,000 paid on March 1, 2017, was for newspaper ads appearing each month for the next 12 months. (e) Income tax was charged at a 40% rate. Required: Prepare a corrected income statement for the year ended December 31, 2017 Solution: Star Cycle Company Income Statement For Period Ended December 31, 2017 Sales Less. Sales return and allowance Cost of goods sold: Completed units 50,000 Ending inventory 10,000 (N-1) Gross profit on sales

Tk.49,70,000 27,500 Tk.41,22,000 8,24,400

49,42,500

32,97,600 16,44,900

72


Selling expenses: Advertising (N-2) Miscellaneous (N-3) General & administrative expenses: Officer‟s salaries Depreciation (N-4) Miscellaneous Income before income tax Income tax (N-5) Net income

Tk.1,10,000 6,52,300

7,62,300

3,21,000 57,000 33,000

4,11,000

11,73,300 4,71,600 1,88,640 2,82,960

Notes:

Tk.40,10,000  Tk.1,12,000 X 10,000 = Tk.8,24,000 50,000 units 10 2. Advertising expense: Tk.1,32,000 X = Tk.1,10,000 12 3. Miscellaneous selling expense: Tk.6,00,000 + Tk.52,300 = Tk.6,52,300 1. Ending inventory:

4. Depreciation expense: Tk.1,69,000 – Tk.1,12,000 = Tk.57,000 5. Income tax: Tk.4,71,600 X 40% = Tk.1,88,640 P-5. The following is a post-closing trial balance for the Mosaj & Associates at December 31, 2017, the end of the company‟s fiscal year: Accounts Title Cash Accounts receivable Allowance for doubtful accounts Inventories Investments Prepaid expenses Notes receivable Land Building Machinery Accumulated depreciation- building and machinery Accounts payable Salaries payable Interest payable Notes payable Bonds payable Common shares Retained earnings Total

Debit (Tk.) 200,000 250,000 200,000 100,000 40,000 60,000 150,000 400,000 300,000 _____1,700,000

Credit (Tk.) 50,000 250,000 300,000 70,000 30,000 200,000 400,000 150,000 250,000 1,700,000

Required: Prepare a classified balance sheet for the Mosaj & Associates at December 31, 2017. 73


Solution: Mosaj & Associates Balance sheet As at December 31, 2017 Assets Tk. Non-current assets: Property, plant and equipment (w-1) Note receivable Investment Total non-current assets Current assets: Cash Accounts receivable 250,000 Less. Allowance for doubtful a/c (50,000)

Tk.

600,000 60,000 100,000 760,000 200,000

200,000 200,000 40,000

Inventories Prepaid expenses Total current assets Total assets

640,000 1,400,000 Stockholders’ equity and liabilities

Stockholders’ equity: Common share Retained earnings Total stockholders‟ equity Non-current liabilities: Notes payable Bonds payable Total non-current liabilities Current liabilities: Accounts payable Salaries payable Interest payable Total current liabilities Total liabilities Total stockholders‟ equity and liabilities

150,000 250,000 400,000 200,000 400,000 600,000 300,000 70,000 30,000 400,000 1,000,000 1,400,000

Working: 1. Property, plant and equipment: Land Buildings Machinery Less. Accumulated depreciation Net property, plant and equipment

Tk.150,000 400,000 300,000 Tk.850,000 (250,000) Tk.600,000 74


P-6. From the following Trial Balance of A Co. Ltd. and the additional information given below, prepare an Income Statement for the year ended on 31.12.2017 and a Balance Sheet as at that date. Trial Balance 31.12.2017 Debtor Taka Creditor Taka Purchases 60,900 Sales 275,000 Goodwill 28,000 Return Outwards 100 Accounts Receivable 25,000 Transfer Fee Income 100 Insurance Expense 1,000 Discount Income 2,200 Rent and Taxes Expense 9,000 Bank Overdraft 12,000 Opening Inventory 30,000 Accounts Payable 13,000 Labour Expense 55,200 5% Debenture 25,000 Discount Expense 1,500 Equity Share Capital: Building 70,000 1,000 shares of Tk.100 each 100,000 Carrying Cost 3,745 Investment Income 3,000 Equipment 25,000 Loose Tools 6,000 Advertisements Expense 3,000 General Expense 4,400 Uncollectible Debts Expense 1,030 Debenture Interest Expense 625 Investments 100,000 Miscellaneous Expense 3,000 Cash Balance 3,000 _____ Total 430,400 Total 430,400 Additional information: (a) The authorized capital of the company is Tk.200,000. (b) Inventory on 31.12.2017 was Tk.55,000. (c) Depreciate equipment at 10% and revalue loose tools at Tk.4,100. (d) Labour expense due Tk.4,800 and Rent & Taxes prepaid Tk.1,000. (e) Investment income due Tk.2,000. (f) Transfer Tk.10,000 to General Reserve. (g) Assume tax rate @ 40%. Solution: A Co. Ltd. Income statement For the year ended on 31.12.2017

Sales Less. Cost of goods sold (w-1) Gross profit Add. Operating and other income: Transfer fee income Discount income Investment income (e) (3,000 + 2,000) 75

Taka 275,000 39,545

Taka

235,455 100 2,200 5,000

7,300 242,755


Less. Operating and other expenses: Labour expense (d) (55,200 + 4,800) Discount expense Advertisement expense General expense Insurance expense Rent and taxes expense (d) (9,000 – 1,000) Depreciation expense - Equipment (c) (25,000 X 10%) Uncollectible debts expense Debenture interest expense Miscellaneous expense Profit before provision Less. Revaluation reserve (c) (6,000 – 4,100) Profit before taxation Less. Provision for taxation (g) (155,800 X 40%) Net profit after tax Less. Appropriation: General reserve (f) Profit for the year

60,000 1,500 3,000 4,400 1,000 8,000 2,500 1,030 625 3,000

85,055 157,700 1,900 155,800 62,320 93,480 10,000 83,480

A Co. Ltd. Balance Sheet As at 31.12.2017 Assets Non-current assets: Property, plant and equipment: Building Equipment Less. Accumulated depreciation (c) Loose tools Investments Intangible asset: Goodwill Current assets: Cash balance Accounts receivable (e) (25,000 + 2,000) Inventory (b) Prepaid rent and taxes (d)

Taka

Taka

70,000 25,000 2,500

Stockholders’ equity and liabilities Stockholders’ equity Paid-up capital 1,000 shares of Tk.100 each Reserve fund: General reserve (f) Revaluation reserve (c) Profit for the year Total stockholders‟ equity

22,500 6,000

98,500 100,000 28,000

3,000 27,000 55,000 1,000

86,000 312,500

100,000

10,000 1,900 83,480 195,380 76


Liabilities Non-current liability: 5% Debenture Current liabilities: Account payable Labour payable (d) Bank overdraft Provision for income tax

25,000 13,000 4,800 12,000 62,320

Total liabilities Total stockholdersâ€&#x; equity and liabilities

92,120 117,120 312,500

Working: 1. Computation of cost of goods sold: Opening inventory Add. Net purchase: Purchases Less. Return outward Add. Carrying cost Goods available for sale Less. Closing inventory Cost of goods sold

Tk.30,000 Tk.60,900 100 60,800 3,745

64,545 94,545 55,000 39,545

P-7. The following is the Trial Balance of Sonali Limited on 31.12.2017: Debtor Opening Inventory Purchases Accounts Receivable Share Call A/C Office Furniture (Cost Tk.14,000) Payroll Expenses Bad Debts Labour Expenses Interim Dividend Paid Insurance Office Expenses Freehold Premises Bank Balance Investment

Taka 201,980 1,457,880 174,180 2,500 7,000

Total

Creditor Sales Purchases Returns Accounts Payable Share Capital Accumulated Profit

100,000 General Reserve 2,000 Miscellaneous Income 123,160 20,000 2,920 76,840 170,000 100,240 100,000 2,538,700 Total

Taka 1,893,100 5,120 122,400 400,000 41,580 70,000 6,500

_______ 2,538,700

Prepare Income Statement for the year ended on 31.12.2017 and Balance Sheet as at that date after taking into consideration the following information: (a) Labour expenses prepaid Tk.10,000 whereas payroll expenses unpaid Tk.6,840. (b) It is the policy of the company to charge depreciation on fixed assets @ 10% on cost, and provide for bad and doubtful debts @ 5%. 77


(c) Closing inventory Tk.290,000 (market price Tk.325,000). (d) Income of investment not yet been received Tk.10,000. (e) Assume tax rate as 35%. Solution: Sonali Limited Income statement For the year ended 31.12.2017 Taka Revenues: Sales Less. Cost of goods sold (w-1) Gross profit Miscellaneous income (d) (6,500 + 10,000) Total revenues Less. Operating and other expenses: Payroll expenses (a) (100,000 + 6,840) Bad debts Labour expenses (a) (123,160 - 10,000) Interim dividend paid Insurance Office expenses Depreciation expense- Furniture (b) 14,000 X 10% Depreciation expense- Premises (b) 170,000 X 10% Provision for bad and doubtful debts (b) (d) (174,180 + 10,000) X 5% Profit before taxation Less. Provision for taxation (f) 195,491 X 35% Net profit after tax Add. Last yearâ€&#x;s profit Surplus profit Sonali Limited Balance sheet As on 31.12.2017

Taka

1,893,100 1,364,740 528,360 16,500 544,860 106,840 2,000 113,160 20,000 2,920 76,840 1,400 17,000 9,209 349,369 195,491 68,422 127,069 41,580 168,649

Assets Taka Non-current assets: Property, plant and equipment (w-2) Investment

Taka

158,600 100,000 258,600

Current assets: Accounts receivable (d) (174,180 + 10,000) Prepaid expense (a) Inventory (c) Bank balance Total assets

184,180 10,000 290,000 100,240 584,420 843,020

78


Stockholder’s equity and liabilities Stockholder’s equity: Share capital 400,000 Less. Share call a/c 2,500 General reserve Surplus profit Total stockholder‟s equity Liabilities: Accounts payable Accrued payroll (a) Provision for bad and doubtful debts (b) Provision for taxation (f) Total liabilities Total stockholder‟s equity and liabilities

397,500 70,000 168,649 636,149 122,400 6,840 9,209 68,422 206,871 843,020

Working: 1. Calculation of cost of goods sold: Taka Opening inventory Add. Net purchase: Purchase Less. Returns Goods available for sale Less. Closing inventory (c) Cost of goods sold

1,457,880 5,120

Taka 201,980

1,452,760 1,654,740 290,000 1,364,740

2. Property, plant & equipment: Office furniture Less. Accumulated depreciation (b) (7,000 + 14,000) X 10% Freehold premises Less. Accumulated depreciation (b) 170,000 X 10%

14,000 8,400 5,600 170,000 17,000

P-8. The following is the Trail Balance of A & Co. Ltd. as on 30.06.2018: A & Co. Ltd. Trial Balance As on 30.06.2018 Debit Balances Taka Credit Balances Accounts Receivable 1,120,000 Accounts Payable Advertisements 80,000 Accumulated depreciation on Buildings 1,200,000 Buildings Cash 400,000 Capital of Tk.100 each Patent 240,000 Interest Income Freight in 60,000 Mortgage Payable Insurance Expenses 24,000 Notes Payable Interest Expenses 44,000 Purchase Returns 79

153,000 158,600

Taka 600,000 230,000 3,000,000 11,000 800,000 250,000 19,000


Inventory (01.07.2017) 1,080,000 Retained Earnings (30.06.2017) 334,000 Land 1,160,000 Sales 4,123,000 Long Term Investments 210,000 Office Expenses 268,000 Purchases 2,318,000 Sales Returns 146,000 Selling Expenses 814,000 Payroll Expenses 203,000 _______ Total 9,367,000 Total 9,367,000 Additional information; (a) Inventory on hand on 30.06.2018 is Tk.1,512,000 (b) Buildings are depreciated at the rate of 3% p.a. (c) Accrued Selling Expenses are Tk.66,000 (d) Prepaid Insurance Expenses are Tk.12,000 (e) Accrued Income from Investment Tk.4,000 (f) Income Taxes are to be estimated at 30% (g) Authorized Capital of the company is divided into 50,000 shares of Tk.100 each (h) Directors decided to (i) transfer Tk.120,000 to General Reserve (ii) pay dividends of Tk.4 per share. Required: Income Statement for the year ended on 30.06.2018 and the Balance Sheet as at that date. Solution: A & Co. Ltd. Income statement For the year ended on 30.06.2018 Sales Less. Sales return Net sales Less. Cost of goods sold (w-1) Gross profit Less. Operating expenses: Advertisements Insurance expense (d) (24,000 – 12,000) Office expense Selling expense (c) (814,000 + 66,000) Payroll expenses Depreciation expense – Building (b) (1,200,000 X 3%) Total operating expenses Profit from operation Add. Other income: Income from investment (c) Interest income Less. Other expenses: Interest expense Income before tax

Taka 4,123,000 146,000 3,977,000 1,927,000

Taka

2,050,000 80,000 12,000 268,000 880,000 203,000 36,000 1,479,000 571,000 4,000 11,000

15,000 586,000 44,000 542,000 80


Less. Provision for tax (f) (542,000 X 30%) Net profit after tax Less. Appropriation: General reserve (h) Proposed dividend (h) (30,000 shares X Tk.4) Profit for the year Add. Retained earnings Surplus profit

162,600 379,400 120,000 120,000

240,000 139,400 334,000 473,400

A & Co. Ltd. Balance Sheet As at 30.06.2018 Assets Non-current assets: Property, plant and equipment: Building 1,200,000 Less. Accumulated depreciation (b) 266,000 (230,000 + 36,000) Land Long-term investments Intangible asset: Patent Current assets: Cash balance Accounts receivable (e) (1,120,000 + 4,000) Inventory (a) Prepaid expenses (d) Total assets Stockholders’ equity and liabilities Stockholders’ equity Paid-up capital 30,000 shares of Tk.100 each Reserve fund: General reserve (h) Surplus profit Total stockholders‟ equity Liabilities Non-current liabilities: Notes payable Mortgage payable Current liabilities: Account payable Accrued selling expenses (c) Proposed dividend (h) Provision for income tax (f) Total liabilities Total stockholders‟ equity and liabilities 81

Taka

Taka

934,000 1,160,000

2,094,000 210,000 240,000

400,000 1,124,000 15,12,000 12,000

3,048,000 5,592,000

3,000,000

120,000 473,400 3,593,400

250,000 800,000 600,000 66,000 120,000 162,600

1,050,000

948,600 1,998,600 5,592,000


Working: 1. Computation of cost of goods sold: Opening inventory Add. Net purchase (23,18,000-19,000) Freight-in Goods available for sale Less. Closing inventory (a) Cost of goods sold

Tk.10,80,000 Tk.22,99,000 60,000 23,59,000 15,12,000 19,27,000

P-9. The following trial balance has been extracted from the books of account of Siksha Limited as at 31 December, 2017. Particulars Debit Credit (In Taka) (In Taka) Administrative expenses 15,000 Common share (Par value Tk.1) 30,000 Accounts receivable 5,000 Bank overdraft 50,000 Distribution costs 10,000 Investment for 5 years 101,000 Finance cost 14,000 Building 100,000 Retained earnings at 1 January 2017 40,000 Purchases 60,000 Inventories at 1 January 2017 10,000 Accounts payable 20,000 Revenue 2,00,00 Interim dividend paid 25,000 340,000 340,000 Additional information: (a) Inventories at 31 December 2017 were valued at Tk.20,000. (b) The administrative expenses are to be increased by Tk.5,000. (c) Distribution costs Tk.6,000 was unrecorded. (d) The building is revalued to Tk.150,000. (e) In May 2018, a final dividend was proposed for 2017 of Tk.2 per common share. (f) The income tax rate for the year is 35%. Required: Prepare the followings for the year ended 31 December 2017. (i) Income statement (ii) Statement of changes in equity (iii) Balance sheet Solution: (i) Siksha Limited Income statement For the year ended 31 December, 2017 82


Particulars

Tk. 200,000 (50,000) 150,000 (16,000) (20,000) 114,000 (14,000) 100,000 (35,000) 65,000

Revenue Cost of sales (60,000 + 10,000 – 20,000) Gross profit Distribution costs (10,000 + 6,000) Administrative expenses (15,000 + 5,000) Profit from operations Finance cost Profit before tax Income tax @ 35% Profit for the year (ii) Siksha Limited Statement of changes in equity For the year ended 31 December, 2017 Particulars At 1 January 2017 Revaluation (150,000 – 100,000) Profit for the year Interim dividend paid At 31 December 2017

Common share 30,000

30,000

Revaluation Reserve 50,000

50,000

Retained earnings 40,000 65,000 (25,000) 80,000

(iii) Siksha Limited Balance sheet As at 31 December, 2017 Taka Assets Non-current assets: Property, plant and equipment Investment Total non-current assets Current assets: Inventories Accounts receivable Total current assets Total assets Stockholders’ equity and liabilities Stockholders’ equity: Common share Revaluation reserve Retained earnings Total stockholders‟ equity 83

Taka

150,000 101,000 251,000

20,000 5,000 25,000 276,000

30,000 50,000 80,000 160,000


0

Non-current liabilities Current liabilities: Accounts payable (20,000 + 5,000 + 6,000) Borrowings Income tax payable Total current liabilities Total liabilities Total stockholders’ equity and liabilities

31,000 50,000 35,000 116,000 116,000 276,000

P-10. P Ltd. is organized into several divisions. The following events relate to the year ended 31 December 2017: (a) The computer division supplied a computer to a customer during the year that exploded, causing a fire. P Ltd. is being sued for damages. Lawyers have advised that there is a 30% chance of successfully defending the claim. Otherwise the damages are expected to cost Tk.10 million (present value is Tk.9.5 million). The lawyers have investigated the cause of the problem with a team of accident consultants. They have concluded that parts supplied to the computer division by M Ltd. contributed to the fire. Lawyers have estimated that M Ltd.â€&#x;s contributory negligence amounted to 40% of the total damages. Negotiations have started with M Ltd. and lawyers believe that a claim is likely to succeed. (b) On 15 December 2017, the directors of P Ltd. minuted their decision to close the operations of the loss making space technology division. The decision and an outline of a plan were immediately announced to employees and a press release was issued. The closure, which began on 4 January 2018, has an estimated date for completion, including the sale of non-current assets of the division, on 30 June 2018. The costs associated with the closure includes the following: Tk.(000) Employee redundancy costs 12,000 Lease termination costs 4,000 Relocating continuing staff to other divisions 3,000 Impairment losses 2,000 21,000 (c) P Ltd.â€&#x;s retail division provides two-year warranty to its customers. Experience has shown that, on average, 10% of sales from this division result in a warranty claim. Revenue from this division in 2017 was Tk.8 million. At 1 January 2017, P Ltd. had a warranty provision in place of Tk.1 million. During the year claims of Tk.600,000 were settled by the company. Required: Prepare the provisions and contingencies notes for the financial statements of P Ltd. for the year ended 31 December 2017. Solution:

84


P Limited Notes to the financial statements As at 31 December 2017 (extract) Provisions: Warranty Compensation Provision for Provision Claim closure of division Tk.000 Tk.000 Tk.000 At 1 January 2017 1,000 Utilized in the year (600) Income statement charge 400 9,500 18,000 (beginning figure) At 31 December 2017 800 9,500 18,000 (w-1)

Total Tk.000 1,000 (600) 27,900 28,300

The warranty provision is in respect of two-year warranties provided to customers. The provision is based on the level of past claims. The compensation claim provision is in respect of a claim made by a customer for damages as a result of a faulty computer supplied by the company. It represents the present value of the amount at which the companyâ€&#x;s legal advisers believe the claim is likely to be settled. On 15 December 2017, P. Ltd. announced that it would be closing its loss making space technology division. Details of the closure have been fully communicated to those affected. The cost of the closure, which began on 4 January 2018, is estimated at Tk.18 million and completion is expected by 30 June 2018. Contingent assets: A counter claim in respect of the compensation claim provided for above has been made against the supplier of parts for the affected computer. Lawyers have advised that this claim is likely to succeed and should amount to around 40% of the total damages (Tk.3.8 million). Working: 1. Provision for closure of division: Employee redundancy costs Lease termination costs Impairment losses

Tk.000 12,000 4,000 2,000 18,000

Warranty provision: Tk.8 million X 10% = Tk.800,000 P-11. Multi Ltd commenced trading three years ago, on 1 January 2015. Its draft balance sheet at 31 December 2017 and its final balance sheets for the two previous years are as follows: 85


Non-current assets Property, plant and equipment Other Assets Current assets Total assets Capital Reserves Non-current liabilities Current liabilities Total liabilities

2017 Tk.m

2016 Tk.m

2015 Tk.m

231 169 400 800 1200 100 450 550 200 450 1200

230 120 350 800 1200 100 400 500 200 450 1150

180 120 300 800 1200 100 350 450 200 450 1100

Additional information is available as follows: 1. The profit for each of the three years was Tk.50m. 2. The movements on property, plant and equipment were as follows: 2017 2016 2015 Tk.m Tk.m Tk.m Brought forward 230 180 0 Direct cost of additions 80 90 180 Interest capitalized 10 10 20 320 280 200 Depreciation (89) (50) (20) Carried forward 231 230 180 3. Property, plant and equipment is depreciated at the rate of 10% of cost per annum. The directors now believe that more relevant information would be provided if interest was not capitalized, so the decision has been made to change the accounting policy and to recognize all interest as an expense in the year in which it is incurred. Required: Prepare the revised balance sheets at 31 December 2017 and 2016, together with extracts from the statement of changes in equity for each of the two years then ended. Solution: Multi Ltd Balance Sheet

Non-current assets: Property, plant and equipment (w-3) Other assets Current assets Total assets Capital Reserve (w-4)

2017 Tk.m

2016 Tk.m

200 169 369 800 1,169

205 120 325 800 1,125

100 419

100 375 86


519 200 450 1,169

Non-current liabilities Current liabilities

475 200 450 1,125

Workings: 1. Adjustment recapitalized interest:

Amount capitalized in the year Depreciation charges (20 X 10%) Depreciation charges (20 + 10) X 10% Depreciation charges (20 + 10 + 10) X 10% Revenues adjustment/ asset written Current live

2017 Tk.m 10 (4) 6 31

2016 Tk.m 10 (3) 7 25

2015 Tk.m 20 (2) 18 18

2. Adjustment to reported profit:

Profit for the year before adjustment Profit adjustment (w-1) Profit for the year restated

2017 Tk.m 50 (6) 44

2016 Tk.m 50 (7) 43

2017 Tk.m 231 (31) 200

2016 Tk.m 230 (25) 205

2017 Tk.m 400 (25) 375 44 419

2016 Tk.m 350 (18) 332 43 375

3. Property, plant and equipment:

An originally stated Write down (7 + 18) Write down (6 + 7 + 18) Restated 4. Statement of changes in equity:

Reserve brought forward as reported Adjustment write-off capitalized interest (w-1) As restated Profit for the year (w-2) Reserve earned forward

P-12. From the following trial balance of Ayan Co. Ltd. and additional information given, prepare a statement of comprehensive income for the year ended December 31, 2017 and a statement of financial position as at that date.

87


Ayan Co. Ltd. Trial Balance For the year ended December 31, 2017 Particulars Purchases Beginning inventory Import duty Carriage inward Carriage outward Labor Payroll Petty expenses Export duty Discount Commission Advertisement Insurance premium (upto March 31, 2017) Notes receivable Machinery Furniture & fixtures Office expenses Rent Bad debt expenses Cash Bank Accounts receivable VAT current A/c Sales Discount on purchases 10% Loan (January 01, 2016) Notes payable Depreciation reserve – Machinery Depreciation reserve – Furniture & fixtures Allowances for bad debt Capital (Tk.8 per share) Accounts payable General reserve

Debit (Tk.) 11,20,000 1,08,000 84,000 42,000 36,000 58,000 68,000 18,000 25,000 13,600 17,400 41,000 30,000 64,000 3,80,000 1,20,000 6,000 41,000 3,000 37,000 61,000 1,50,000 8,400

________ 25,31,400

Credit (Tk.)

17,400 18,600

14,92,000 9,400 1,20,000 36,000 72,200 22,800 7,000 6,40,000 70,000 26,000 25,31,400

Additional information: (a) Ending inventory Tk.1,60,000. (b) Included in the ending inventory goods of the cost of Tk.20,000, which was sold at a profit of 20% on cost. The buyer did not take the delivery. Even it is not recorded in the books. (c) Rent payable Tk.3,000, whereas payroll paid in advance Tk.1,000. (d) VAT of Tk.900 paid on advertisement, which is included in VAT current A/c. (e) VAT of Tk.3,000 collected from customer erroneously included in sales. (f) Depreciation to be charged at 10% on the book value of machinery and furniture & fixtures. 88


(g) Withdrawn by the owner goods of the value of Tk.2,000 (cost price Tk.1,500), which is included in sales at cost price. (h) General Manager is entitled to a commission of 5% net profit after charging his commission. (i) Yearly insurance premium of Tk.24,000 is paid upto March 31, 2018. (j) Bad debt expenses are to be increased to Tk.9,000, and an allowances for bad debt of 5% is to be created on accounts receivable. (k) Petty expense includes office consumable of the cost of Tk.5,000. (l) Capital of the company is consisted of Tk.1,00,00 shares of Tk.10 each. Solution: Ayan Co. Ltd. Comprehensive Income Statement For the year ended December 31, 2017 Sales revenue: Net sales (N-1) Less. Cost of goods sold (N-2) Gross profit Operating expenses: Sales and distribution expenses (N-5) Administrative expenses (N-6)

Tk.

Tk. 14,97,900 12,61,100 2,36,800

1,97,475 1,42,000 3,39,475 (1,02,675)

Operating profit or loss Add. Non-operating income: Discount Commission

17,400 18,600 36,000 (12,000) (78,675)

Less. Non-operating expenses Net profit or loss Ayan Co. Ltd. Statement of Financial Position As at December 31, 2017 Assets Non-current assets: Property, plant and equipment (N-7) Notes receivable Total non-current assets Current assets: Cash Bank Accounts receivable (N-3) VAT current A/c Less: VAT on advertisement Advance insurance Advance payroll Ending inventory Total current assets Total assets

89

Tk.

Tk. 5,00,000 64,000 5,64,000 37,000 61,000 1,55,325

8,400 900 7,500 6,000 1,000 1,40,000 4,07,825 9,71,825


Capital and liabilities Capital: Authorized capital (1,00,000 shares of Tk.10 each) Issued and subscribed capital (80,000 shares of Tk.10 each) Paid-up capital: Capital (80,000 shares of Tk.8 each) Add: General reserve Net profit or loss Less: Withdrawn Total capital Non-current liabilities: Notes payable 10% Loan Total non-current liabilities Current liabilities: Accounts payable Depreciation reserve – Machinery Add: Current year

10,00,000 8,00,000

6,40,000 26,000 (78,675)

(52,675) (1,500) 5,85,825 36,000 1,20,000 1,56,000 70,000

72,200 38,000 1,10,200

Depreciation reserve – Furniture & fixtures Add: Current year

22,800 12,000 34,800 12,000 3,000 2,30,000 3,86,000 9,71,825

Interest on loan Arrear on rent Current liabilities Total liabilities Total capital and liabilities Notes: 1. Calculation of net sales: Sales Add: Unrecorded sales Less: VAT error recorded Discount Withdrawn

Tk.14,92,000 24,000 15,16,000 Tk.3,0000 13,600 1,500 18,100 14,97,900

Net sales 2. Calculation of cost of goods sold: Beginning inventory Add: Net purchases: Purchases Labor Import duty Carriage inward

Tk.1,08,000 Tk.11,20,000 58,000 84,000 42,000 90


Less: Discount on purchases Withdrawn Cost of goods available for sale Less: Ending inventory Sale of goods

13,04,000 (9,400) (1,500) 12,93,100 14,01,100 1,60,000 20,000 1,40,000 12,61,100

Cost of goods sold 3. Calculation of total accounts receivable: Accounts receivable Add: Unrecorded sales Less: Withdrawn VAT included in sales Bad debt expenses (Tk.9,000 – Tk.3,000)

Tk.1,50,000 74,000 1,74,000 Tk.1,500 3,000 6,000 10,500 1,63,500 8,175 1,55,325

Less: Allowances for bad debt (Tk.1,66,500 X 5%) Total accounts receivable 4. Calculation of bad debt expenses: Old bad debt expenses Add. New bad debt New allowances

Tk.3,000 Tk.6,000 8,175 14,175 17,175 (7,000) 10,175

Less: Old allowances Total bad debt expenses 5. Calculation of sales and distribution expenses: Payroll Less: Advance Carriage outward Export duty Commission Advertisement Add: VAT expenses Bad debt expenses (N-4) Total sales and distribution expenses

91

Tk.68,000 (1,000) Tk.67,000 36,000 25,000 17,400 41,000 900 41,900 10,175 1,97,475


6. Calculation of administrative expenses: Petty expenses Less: Office consumable

Tk.18,000 (5,000)

Insurance expenses Less: Advance insurance

30,000 (6,000)

Tk.13,000

24,000 Office expenses Add: Office consumable

6,000 5,000 11,000

Rent Add: Arrear

41,000 3,000 44,000

Depreciation – Machinery Depreciation – Furniture & fixtures

38,000 12,000 50,000 1,42,000

Total administrative expenses 7. Calculation of property, plant and equipment: Machinery Furniture & fixtures Total property, plant and equipment

Tk.3,80,000 1,20,000 5,00,000

P-13. BD Company shows the following trial balance for the year ended December 31, 2017. BD Company Trial Balance For the year ended December 31, 2017 Particulars Purchases Opening inventory Carriage on purchases Sales return Payroll and travel expenses of salesmen Labor Payroll Materials Printing and stationery Bonus and entertainment Bad debt expenses Land and building Vehicle Patent (10 years) Furniture Share call A/c Income tax paid on source Accounts receivable

Debit (Tk.) 2,32,500 19,000 13,250 3,900 16,400 10,000 12,300 9,450 7,350 9,650 1,050 87,500 37,500 15,000 30,000 2,500 2,000 34,000

Credit (Tk.)

92


Bank Cash Notes receivable Discount allowed Demurrage Petty cash expense Payroll paid in advance Capital General reserve Employee benevolent fund Accounts payable Notes payable Commission received Purchases return Sales VAT current A/c

14,100 49,000 17,250 3,250 2,350 2,150 4,000

______ 6,35,450

1,55,000 59,100 25,350 24,000 11,500 12,000 6,350 3,34,000 8,150 6,35,450

Relevant information: (a) Closing inventory has been valued Tk.25,000 at cost and market price Tk.23,000. (b) Sales include Tk.20,000 being goods sent on sale or return basis at a profit of 25% on cost. Confirmation of these sales have not yet been received. (c) Sales return of Tk.4,000 has not been recorded. (d) A note of Tk.2,000 was discounted, which was dishonored after maturity, not recorded in the books of accounts. (e) Allowances for bad bed to be created at 5%. (f) Furniture of Tk.20,000 was bought on account at July 1, 2017. (g) The yearly rate of depreciation for land and building, vehicle and furniture is 5%, 20% and 10% respectively. (h) Outstanding labor Tk.2,000 and commission pre-received Tk.3,000. (i) Vehicle sold at Tk.12,000 (book value Tk.20,000) included in sales. (j) Stock of materials Tk.1,450. (k) Capital of the company is consisted of 50,000 equity shares of Tk.10 each. Required: You are required to prepare a multiple steps income statement for the year ended December 31, 2017 and a classified balance sheet as at that date for the company. Solution: BD Company Income Statement For the year ended December 31, 2017 Sales revenue: Sales Less: Sales return Unrecorded sales return Sales on return basis Discount Net sales revenue 93

Tk. 3,34,000 (3,900) (4,000) (20,000) (3,250)

Tk.

3,02,850


Less: Cost of goods sold: Opening inventory Add: Net purchases (N-1) Cost of goods available for sale Less: Closing inventory Sales or return basis (Tk.20,000 X 100/125) Cost of goods sold Gross profit Less: Operating expenses: Sales and distribution expenses: Payroll and travel expenses Materials less stock in hand (Tk.19,450 – Tk.1,450) Demurrage Bad debt expenses (N-3) Total sales and distribution expenses Administrative expenses: Payroll Petty expenses Printing and stationery Bonus and entertainment Income tax on source Depletion of patent Depreciation - Furniture Depreciation – Vehicle Depreciation - Land and building Total administrative expenses Total operating expenses Operating profit or loss: Add: Non-operating income: Commission received less pre-received (Tk.12,000 – Tk.3,000) Less: Non-operating expenses: Loss on sale of Vehicle

19,000 2,51,400 2,70,400 (23,000) 16,000 (2,31,400) 71,450

16,400 8,000 2,350 1,650 (28,400) 12,300 2,150 7,350 9,650 2,000 1,500 4,000 3,500 4,375 (46,825) (3,775)

9,000

(7,500) 1,500 (2,275)

Net profit or loss BD Company Balance Sheet As at December 31, 2017 Assets Non-current assets: Property, plant and equipment (N-4) Notes receivable Total non-current assets Intangible assets: Patent Less: Depletion of patent Total intangible assets

Tk.

Tk. 1,55,000 17,250 1,72,250 15,000 (1,500) 13,500

94


Current assets: Cash Add: Sale of Vehicle

49,000 12,500

Bank Less: Dishonored note

14,100 (2,000)

61,500

12,100 11,400 4,000 39,000 1,450 2,500 1,31,950 3,17,700

Accounts receivable Advance payroll Closing inventory Stock of materials Share call Total current assets Total assets Capital and liabilities Capital: Authorized capital (50,000 shares of Tk.10 each) Issued and subscribed capital Paid-up capital: Capital Add: General reserve Net profit or loss

5,00,000 ______1,55,000 59,100 (2,275) 56,825 25,350 2,37,175

Employee benevolent fund Total capital Non-current liabilities: Notes payable Total non-current liabilities Current liabilities: Accounts payable (Tk.24,000 + Tk.20,000) Depreciation reserve – Vehicle Depreciation reserve – Furniture Depreciation reserve – Land and building Commission pre-received VAT current A/c Outstanding labor Total current liabilities Total liabilities Total capital and liabilities

11,500 11,500 44,000 3,500 4,000 4,375 3,000 8,150 2,000 69,025 80,525 3,17,700

Notes: 1. Calculation of net purchases: Purchases Add: Labor Outstanding Carriage on purchases

Tk.2,32,500 Tk.10,000 2,000 13,250 25,250

95


2,57,750 (6,350) 2,51,400

Less: Purchases return Net purchases 2. Calculation of total accounts receivable: Accounts receivable Add: Dishonored note

Tk.34,000 2,000 36,000

Less: Sale or return basis Sales return

(20,000) (4,000) (24,000) 12,000 600 11,400

Less: Allowances for bad debt (Tk.12,000 X 5%) Total accounts receivable 3. Calculation of bad debt expenses: Old bad debt expenses Add: New allowances Total bad debt expenses

Tk.1,050 600 1,650

4. Calculation property, plant and equipment: Land and building Vehicle Less: Sales

Tk.87,500 Tk.37,500 (20,000) 17,500

Furniture Add: Purchases

30,000 20,000

Total property, plant and equipment

50,000 1,55,000

Contact us to collect exercises solution. Helpline: 01711137039

96


EXERCIES E-1. Hussein Ltd is a company which makes exclusive furniture to customers' precise specifications. An extract from Hussein Ltd's general ledger at 31 December 2016 is as follows: Particulars Taka Taka Raw materials and consumables 1,570,000 Salaries and wages 1,250,500 Work in progress inventories at 1 January 2016 45,600 Finished goods inventories at 1 January 2016 13,400 Land and buildings at cost (cost of land Tk.2,000,000) 3,600,000 Plant and machinery at cost 520,000 Office furniture at cost 32,000 Accumulated depreciation on buildings at 1 January 2016 640,000 Accumulated depreciation on plant and machinery at 1 January 2016 375,000 Accumulated depreciation on furniture at 1 January 2016 28,500 Intangible assets 15,000 Operating expenses 10,000 Accounts and other receivables 37,500 Accounts and other payables 25,400 Retained earnings at 1 January 2016 1,968,600 Ordinary share capital of Tk.10 each 500,000 4% Redeemable preference share capital of Tk.10 each 120,000 Share premium account 200,000 Cash and cash equivalents 263,500 Revenue _______3,500,000 7,357,500 7,357,500 The following additional information is relevant: (a) Closing inventories at cost amounted to work in progress of Tk.50,200 and finished goods of Tk.15,000. The finished goods included a table with a cost of Tk.5,000. The customer who had ordered this table has been declared bankrupt. He had paid a Tk.1,000 deposit (which has been credited to revenue) and owed Tk.10,000 at the yearend in respect of other items. It is estimated that the table can be sold for Tk.4,000. (b) The old furniture were all scrapped. During the year the company used employeesâ€&#x; idle time which amounted to a cost to the company of Tk.20,500 to produce new furniture for the companyâ€&#x;s offices. Raw materials costing Tk.54,000 were used. No adjustment has been made for these in the above. (c) Land and buildings were revalued for the first time on 1 January 2016. The surveyor performing the valuation estimated a valuation of Tk.5 million (including Tk.4 million for the land). Buildings will be continued to be depreciated on a straight line basis at a rate of 4%; but Hussein Ltd made no transfer between the revaluation reserve and retained earnings in respect of this. (d) Plant is depreciated at a reducing balance basis at a rate of 20%. Office furniture is depreciated on a 15% straight line basis. Depreciation on the building and the plant should be charged to cost of sales. (e) The intangible asset relates to a patent acquired on the purchase of a sole trader on 1 January 2016. The patent is considered to have a useful life of 20 years. The annual impairment review has indicated that the patent has a recoverable value at 31 December 2016 of Tk.14,000. (f) On 1 December 2016 the company made a 1 for 5 bonus issues of its ordinary shares against the share premium account. No entries have been made in respect of this. (g) The preference shares are redeemable in 2018. Dividends of Tk.1 per share on the ordinary shares and at the coupon rate on the preference shares were declared on 31 December 2016 and paid early in 2017. The income tax charge for the period has been estimated at Tk.250,000. 97


Requirement: (i) An income statement for Hussein Ltd for the year ended 31 December 2016. (ii) A balance sheet as at that date in a form suitable for publication. CMA Adapted – June 2017 E-2. Yeasmine Ltd. Trial Balance As at 30 September 2016 Sales Inventories at 1 October 2015 Purchases Distribution costs Salespeople commission Administrative salaries Manufacturing wages Finance costs (interest paid) Administrative expenses 3% Debenture loans Equity share capital Retained earnings at 1 October 2015 Cash Dividends paid Revaluation reserve at 1 October 2015 Trade payables Land and building- value/ cost Accumulated depreciation- Land and building Plant and equipment Accumulated depreciation- Plant and equipment Trade receivables Accruals Total

Tk.000 5,460 67,206 8,000 2,920 2,280 2,000 540 5,000 2,685 2,820 92,578 35,000 16,395 2,42,884

Tk.000 103,500 18,000 60,000 8,495 6,000 5,861 25,000 15,313 715 2,42,884

Additional Information: (a) Inventories were valued at Tk.78,50,000 on September 2016. (b) Depreciation is to be provided for the year to 30 September 2016 as follows: (i) Buildings @ 10% per annum straight line basis. (ii) Plant and equipment @ 25% per annum reducing balance basis. Depreciation is to be apportioned as follows: (i) Cost of sales @ 55% (ii) Distribution costs @ 30% (iii) Administrative expenses @ 15% (c) Land and buildings in the trial balance includes a value for land at Tk.4,25,78,000. It is to be revalued at Tk. 6,10,00,000 and this revaluation is to be included in the Financial Statements for 30 September, 2016. (d) A bed debt of Tk.21,000 which is included in trade receivables is to be written-off. (e) Administrative expenses of Tk.85,000 owing at 30 September, 2016 are to be provided for. (f) The companiesâ€&#x; tax charge for the year has been estimated as Tk.15,00,000. 98


Required: Compliance with the IAS-1: Presentation of Financial Statements, you have to prepare a Statement of Profit or Loss Accounts and a Statement of Changes in Equity for Yeasmine Ltd. for the year ended 30 September, 2016 and also a Statement of Financial Position as at that date. CMA Adapted – December 2016 E-3. OTCâ€&#x;s trial balance at 31 May 2016 is shown below: Notes Tk.000 Tk.000 5% Loan notes (issued 2013, redeemable 2024) (ix) 1,480 Administrative expenses 779 Cash received on sale of equipment (v) 23 Cash and cash equivalents 207 Cost of sales 4,080 Distribution costs 650 Equity dividend paid 1 October 2015 (vii) 335 Income tax (ii) 24 Inventory at 31 May 2016 (i) 1,055 Land and buildings at cost at 1 June 2015 5,180 Loan interest paid 37 Equity shares Tk.1 each, fully paid at 1 June 2015 5,650 RDX ordinary shares purchased (viii) 135 Plant and equipment at cost at 1 June 2015 (v) 4,520 Provision for deferred tax at 1 June 2015 (iii) 282 Provision for buildings depreciation at 1 June 2015 (iv) 262 Provision for plant and equipment depreciation at 1 June 2015 (vi) 2,260 Retained earnings at 1 June 2015 1,990 Sales revenue 6,780 Share premium 565 Trade payables 300 Trade receivables (x) 2,590 _____ 19,592 19,592 Notes: (i) OTC has always valued its inventories using a manual system. On 1 June 2015 OTC purchased and installed a computerized inventory system and changed its inventory valuation method to the industry standard method. The impact on inventory valuation due to the change in policy was calculated as: Inventory value increase at 31 May 2015 by Tk.148,000. Inventory value increase up to 31 May 2016 by Tk.210,000. (ii) The income tax balance in the trial balance is a result of the under provision for the year ended 31 May 2015. (iii) The tax due for the year ended 31 May 2016 is estimated at Tk.160,000 and the deferred tax provision should be decreased by Tk.30,000. (iv) Depreciation is charged on buildings using the straight line method at 3% per annum. The cost of land included in land and buildings is Tk.3,000,000. Buildings depreciation is treated as an administrative expense. (v) During the year OTC disposed of old equipment for Tk.23,000. The original cost of the equipment sold was Tk.57,000 and its book value at 31 May 2015 was Tk.6,000.

99


(vi) Plant and equipment is depreciated at 20% per annum using the reducing balance method. Depreciation of plant and equipment is considered to be part of cost of sales. OTC‟s policy is to charge full year‟s depreciation in the year of acquisition and no depreciation in the year of disposal. (vii) During the year OTC paid a dividend of Tk.335,000 for the year ended 31 May 2015. (viii) OTC purchased and cancelled 100,000 of its own equity shares on 31 May 2016 for Tk.135,000. These shares had originally been issued at a 10% premium. (ix) Long term borrowings consist of loan notes issued on 1 June 2013 at 5% interest per annum. (x) On 22 June 2016 OTC discovered that CIT, one of its customers, had gone into liquidation. OTC has been informed that it will receive none of the outstanding balance of Tk.230,000 at 31 May 2016. Required: (a) Explain how the change in inventory accounting policy should be recorded in OTC‟s financial statements for the year ended 31 May 2016, in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. (b) Prepare OTC‟s statement of profit and loss and statement of changes in equity for the year to 31 May 2016 and the statement of financial position at that date, in accordance with the requirements of International Financial Reporting Standards. Notes to the financial statements are not required, but all workings must be clearly shown. Do NOT prepare a statement of accounting policies. CMA Adapted – June 2016 E-4. MNC‟s trial balance at 31 March 2016 is shown below: Notes 4% Loan notes (redeemable 2024) Administrative expenses Amortization of deferred development expenditure Cash and cash equivalents Deferred development expenditure (i) Distribution costs Equity dividend paid 1 September 2015 Income tax (ii) Inventory at 31 March 2016 Cost of sales Land and buildings at cost at 1 April 2015 Loan interest paid Ordinary shares Tk.1 each, fully paid at 1 April 2015 Plant and equipment at cost at 1 April 2015 Provision for deferred tax at 1 April 2015 (iii) Provision for buildings depreciation at 1 April 2015 (v) Provisions for plant and equipment depreciation at 1 April 2015 (v) Retained earnings Sales revenue Share premium at 1 April 2015 Trade payables Trade receivables Suspense account (iv)

Tk.000

Tk.000 500

190 30 42 150 72 62 8 214 1,605 2,410 10 930 560 86 386 185 621 2,220 310 190 130 ___5 5,458

____ 5,458 100


Additional information: (i) Deferred development expenditure is being amortised at 10% p.a. on the straight line basis. (ii) The income tax balance in the trial balance is a result of the under provision of tax for the year ended 31 March 2015. (iii) The tax due for the year ended 31 March 2015 is estimated at Tk.83,000 and the deferred tax provision needs to be increased by Tk.25,000. (iv) The suspense account is comprised of two items: • Expenditure of Tk.20,000 incurred during the year on original research aimed at possibly finding a new material for MNC to use in manufacturing its products. • Tk.15,000 cash received from disposal of some plant and equipment that had an original cost of Tk.82,000 and a carrying value of Tk.3,000. The only entries made in MNC‟s ledgers for these items were in cash and cash equivalents and suspense account. (v) Depreciation is charged on buildings using the straight line method at 3% per annum. The cost of land included in land and buildings is Tk.800,000. Buildings depreciation should be included in administrative expenses. Depreciation of plant and equipment is at 12.5% on the reducing balance basis and is treated as part of the cost of sales. MNC‟s policy is to charge a full year‟s depreciation in the year of acquisition and no depreciation in the year of disposal. (vi) On 1 July 2015 one of MNC‟s customers started litigation against MNC, claiming damages caused by an allegedly faulty product. MNC has been advised that it will probably lose the case and the claim for Tk.25,000 will probably succeed. (vii) On 1 August 2016 MNC was advised that one of its customers, that had been in some financial difficulties at 31 March 2016, had gone into liquidation and that the Tk.32,000 balance outstanding at 31 March 2016 was very unlikely to be paid. MNC has not previously made any provision for legal claims or bad debts. Required: (a) Prepare journal entries, with a short narrative, to eliminate the balance on MNC‟s suspense account. (b) Prepare the statement of comprehensive income and a statement of changes in equity for MNC for the year to 31 March 2016 and a statement of financial position at that date, in accordance with the requirements of International Financial Reporting Standards. All workings must be clearly shown. CMA Adapted – June 2016 E-5. Quality Feeds Limited closed its books of Accounts as on 30.06.2014. The followings are the balances taken from the ledger of the Company: Taka Cash and Bank 240,000 Accounts Receivable 672,000 Inventory 01 July, 2013 648,000 Store Supplies 16,000 Office Supplies 5,800 Prepaid Insurance 25,000 Store Equipment 170,000 Accumulated Depreciation (Store Equipment) 45,000 Office Equipment 52,000 101


Accumulated Depreciation (Office Equipment) Accounts Payable Mortgage Notes Payable (due 2018) Capital Sales Sales Discount Sales Return Purchase Purchase Return Purchase Discount Sales Salaries Delivery Expenses Rent Expenses Freight-in Office Salaries Office Expenses Misc. General Expenses Gain on disposal of Assets Interest Expenses Land Adjustment of June 30, 2014 are as follows: a) The Inventory on hand b) Supplies on hand: Office Supplies Store Supplies c) Insurance Expires during the year: Allocable to selling expenses Allocable to general expenses d) Equipments are depreciated a the rate of 10% per annum. e) Accrued sales salaries f) Accrued office salaries g) Accrued interest on the mortgage notes payable h) Income tax is estimated at 45% of the income.

16,000 360,000 600,000 528,000 2,460,000 54,000 33,600 1,384,800 78,000 31,600 246,000 68,000 48,000 36,000 136,000 15,000 13,600 7,200 30,000 232,000 507,200 2,200 9,000 9,700 2,600 4,600 2,100 4,800

Required: (a) Prepare Income Statement for the year ended June 30, 2014 and (b) Balance Sheet as at June 30, 2014. (c) Prepare adjusting entries. CMA Adapted – April 2015 E-6. Listed below are selected items from the financial statements of RFL Ltd. for the year ended December 31, 2012:

Notes payable to Prime Bank Income taxes payable Loss contingency relating to law suit Accounts payable and accrued expenses Mortgage note payable Bonds payable

Tk. 99,000 63,000 2,00,000 1,63,230 2,40,864 22,00,000 102


Premium on bonds payable Accrued bond interest payable Pension expenses Unearned revenue

1,406 1,10,000 61,400 25,300

Other information: 1. The note payable owed to Prime Bank is due in 30 days. RFL Ltd. has arranged with this bank to renew the note for an additional two years. 2. RFL Ltd. has been sued for Tk.2,00,000 by someone claiming the company‟s products are excessively noisy. it is reasonable possible, but not probable, that a loss has been sustained. 3. The mortgage note payable Tk.8,000 per month over the next three years. During the next 12 months, the principal amount of this note will be reduced to Tk.1,69,994. 4. The bonds payable mature in seven months. A sinking fund has been accumulated to repay the full maturity of this bond issue. Required: (i) using this information, prepare the current liabilities and long-term liabilities sections of a classified balance sheet at December 31, 2102. (ii) Explain briefly how the information in each of the four numbered paragraph under the title of other information affected your presentation of company‟s liabilities. CMA Adapted – December 2013 E-7. The following is the Trial Balance of M/S Aziz & Co. as on December 31, 2010: Debit (Tk.) Credit (Tk.) Capital 7,05,000 Sales 18,98,550 Purchase 12,97,500 Sales Returns 5,250 Accounts Receivable 1,24,500 Cash 63,000 Petty Cash 7,500 Bank Account 3,67,500 Notes Receivable 18,000 Notes Receivable Discounted 15,000 Office Supplies 25,500 Prepaid Insurance 15,750 Accounts Payable 1,87,500 Notes Payable 75.000 Allowance for Bad Debts 9,000 Inventory (1-1-2010) 3,75,000 Delivery Equipment 4,05,000 Accumulated Depreciation-Delivery Equipment 2,02,500 Furniture and Fixtures 1,12,500 Accumulated Depreciation-Furniture and Fixtures 22,500 Machinery and Equipment 3,75,000 Accumulated Depreciation-Machinery and Equipment 75,000 Retained Earnings 69,000 103


Advertising Delivery Salaries Office Salaries Interest Income Interest Expenses Suspense Account

18,000 54,000 39,000 15,450 24,000 _______ 33,27,000

52,500 33,27,000

The following adjustments are to be made on December 31, 2010 before closing the books: 1. Inventory on hand at December 31, 2010 Tk. 3,90,000 2. Office supplies Tk. 10,500 3. Bad debt allowance is to be increased by Tk. 12,000 4. Depreciation is to be charged: Delivery Equipment-10%, Furniture and Fixtures-15% and Machinery and Equipment-5% 5. Accrued delivery salaries Tk. 18,000 6. Prepaid insurance Tk. 5,250 7. Unearned interest income Tk. 1,500 8. Delivery Equipment purchased 5 years back, with Book Value of Tk. 37,500 sold out at Tk. 52,500 and erroneously credited the sale proceeds to Suspense Account. 9. Advertising expense includes Tk. 8,100 for new product to be sold in 2011. Required: (i) Prepare a multiple-step income statement for the year and a classified balance sheet as on December 31, 2010. (ii) Pass adjusting and closing entries. CMA Adapted – December 2013 E-8. Square Services Ltd. has the following post-closing trial balance for 2011: Cash Accounts receivable Supplies inventory, feed Supplies inventory, straw Land Buildings Accumulated depreciation, buildings Equipment Accumulated depreciation, equipment Accounts payable Income taxes payable Interest payable Wages payable Notes payable (due in 2015) Capital stock Retained earnings

Tk.2,200 4,400 24,100 3,700 1,67,000 1,15,000 36,000 57,000 16,500 23,700 15,100 4,200 14,200 60,000 1,50,000 53,700

During 2012, the following transactions occurred: (a) Squares Services Ltd. provided services, all on credit, for Tk.2,10,300. It rented some facilities to customers and received cash Tk.20,500. It earned Tk.41,800 in cash by providing miscellaneous services. 104


(b) It collected all the account receivable outstanding at December 31, 2011. There remains Tk.15,600 of account receivable to be collected at December 31, 2012. (c) Feed amounting Tk.62,900 was purchased on credit during the year 2012. (d) Straw was purchased for Tk.7,400 cash during the year 2012. (e) Wages payable at the beginning of 2012 were paid in 2012. Wages earned and paid during 2012 amounting Tk.1,12,000. (f) The income taxes payable for 2011 were paid in 2012. The account payable remains unpaid at year-end Tk.13,600. (g) One year‟s interest @14% was paid on notes payable on July 1, 2012. (h) Property taxes were paid on Land and Buildings in the amount of Tk.14,000. (i) Dividends were declared and paid amounting Tk.7,200. The following data are available for adjustments: (a) Feed of an amount of Tk.26,000 remained unused at year-end. Straw of an amount of Tk.4,400 remained unused at year-end. (b) The buildings are being depreciated over 15 years, with a residual value of Tk.25,000. (c) The equipment is being depreciated over 10 years, with a residual value of Tk.2,000. (d) Wages of Tk.4,000 were unrecorded and unpaid at year-end. (e) Interest for 6 months @14% on notes payable is unpaid and unrecorded at year-end. (f) The income tax rate is 30%. Required: (i) Give journal entries for the transactions of 2012. (ii) Prepare the adjusting entries. (iii) Prepare Comprehensive Income Statement. CMA Adapted – December 2013 E-9. XYZ Company reported following ledger balances at December 31, 2012. Tk. Debit Credit Cost of goods sold 252,500 Accounts payable Land 400,000 Revenue Building 225,000 Allowance for doubtful Office equipment 125,000 accounts Long-term investments 56,000 8% Bonds payable Distribution costs 36,000 Share capital (Tk.10 par) Administrative expenses 56,000 Share premium Short term investments 45,000 Retained earnings Accounts receivables 20,800 Accumulated depreciation – Inventories 12,350 Equipment Patent 9,000 General reserve Losses from asset Investment income abandonment 3,800 Sinking fund Losses from earthquake 25,000 Loss on disposal of a discontinued division 30,000

Tk. 4,300 693,500 500 25,000 350,000 72,950 60,300 24,000 28,200 16,700 21,000

Additional Information: (a) Net realizable value of company‟s inventory at the year-end is Tk.11,700. (b) A full year interest on bonds payable is due and applicable income tax rate for the company is 40%. 105


(c) Allowance for bad debt has to charge @ 6% on the ending balance of account receivable. But in previous years the rate was estimated and applied as 5%. if the new rate had been used in prior years, cumulated bad debt expense would have been Tk.7,250 instead of Tk.6,425. (d) Patent (to sell and distribute a special product) was acquire on 1 July 2011 with an useful life of 5 years. The annual impairment review has indicated that the patent has a recoverable value at the end of current year Tk.6,000. (e) Depreciation on equipment has to be charged @ 20% under reducing balance method. But in previous years depreciation was charged following straight line method which resulted Tk.12,000 depreciation per year. Under the new method, depreciation expense would be Tk.22,800 for 2010 and Tk.20,440 for 2011. (f) The company identified at the year-end some unrealized holding gain on available for sale securities (included in short term investment) of Tk.12,800. (g) A transfer of Tk.20,000 for the year should be made to general reserve. (h) Bonds payable will be due in June 2013 for which XYZ has been accumulated the sinking fund. A sum of Tk.3,000 should be transferred to sinking fund at the end of the year from general reserve. Required: (i) A statement of financial position as at December 31, 2012; (ii) A statement of comprehensive income for the year ended December 31, 2012; and (iii) A statement of change in equity. CMA Adapted – August 2013 E-10. You have qualified as a CMA and joined in a company named Afnan Ltd. as an Assistant Finance Controller. As per the requirement by the management of the company you were asked for current yearâ€&#x;s position based on following data which is not representing the true position of the company: Afnan Ltd. Statement of Financial Position As on 31.12.2012 Liabilities Share Capital: Authorised 20,000, 10% redeemable preference share of Tk.10 each 180,000, Ordinary shares of Tk.10 each

Amount (Tk.) 200,000 1,800,000 2,000,000

Issued, Subscribed and Paid-up Capital: 20,000, 10% redeemable preference share of Tk.10 each 20,000, Ordinary shares of Tk.10 each Reserve and Surplus: General reserve Securities premium Profit and loss account Current liabilities & provision

200,000 200,000 240,000 140,000 37,000 23,000 840,000

Assets Fixed Assets: Gross block Less: Depreciation

Tk.600,000 200,000

400,000 106


Investment Current Assets, Loans & Advances: Inventories Debtors Cash & Bank balance Miscellaneous expenditure to the extent not written-off

200,000 50,000 50,000 100,000

200,000 40,000 840,000

For the year ended 31.12.2012, the company made a net profit of Tk. 30,000 after providing for Tk. 40,000 depreciation and writing off miscellaneous expenditure of Tk. 40,000. The following additional information is available with regard to company‟s operation. i. The preference dividend for the year ended 31.12.2012 was paid before 31.12.2012. ii. Except cash & balances, other current assets and current liabilities on 31.12.2012, was the same as on 31.12.2011. iii. The company redeemed the preference share at a premium of 10%. iv. The company issued bonus shares in the ratio of 1 share for every two ordinary shares held as on 31.12.2012. v. To meet the cash requirements of redemption, the company sold a portion of the investments, so as to leave a minimum balance of Tk. 60,000 after such redemption. vi. Investments were sold at 90% cost as on 30.12.2012. Required: (i) Necessary Journal entries. (ii) Cash and Bank Account (iii) Statement of Financial Position as on 31.12.2012. CMA Adapted – April 2013 E-11. The following trial balance has been extracted from the books of accounts of Keya International Ltd. as at 31 March, 2012. Taka Taka Purchases 960,000 Inventories (at 1 April 2011) 150,000 Accounts payable 260,000 Revenue 2,010,000 Administrative expenses 210,000 Ordinary share capital 600,000 Accounts receivable 470,000 Advance, deposit and prepayments 200,000 Bank overdraft 80,000 Provision for warranty costs 205,000 Distribution costs 420,000 Non-current asset investments 560,000 Investment income 75,000 Finance cost 10,000 Freehold land and buildings at cost 200,000 Term loan 200,000 Plant and equipment at cost 550,000 Plant and equipment – Accumulated depreciation 220,000 (at 31 March 2012) 107


Retained earnings (at 1 April 2011) Final dividend paid for 2011 Interim dividend paid for 2012

65,000 35,000 3,830,000

180,000 __ _3,830,000

Additional information: (i) Inventories at 31 March 2012 were valued at Tk. 160,000. (ii) The following items are already included in the balances listed in this trial balance. Distribution Administrative Cost Expense Depreciation charge for the year 27,000 5,000 Employee expense 150,000 80,000 (iii) The income tax charge for the year is estimated at Tk. 74,000. (iv) The warranty provision is to be increased by Tk. 16,000, charged to administrative expenses. Product warranty period is 2 years. (v) Staff bonuses totaling Tk. 40,000 are to be provided for, charged equally to distribution costs and administrative expenses. (vi) The freehold land and buildings were bought on the last day of the accounting period at a bargain price. They are to be revalued to Tk. 280,000. (vii) In May 2012 a final dividend for 2012 of 10 paisa per share was proposed on each of the companyâ€&#x;s 600,000 ordinary shares. Required: Prepare the following in the books of Keya International Ltd. (a) Statement of Comprehensive Income for the year ended 31 March 2012. (b) Statement of Changes in Equity for the year ended 31 March 2012. (c) Statement of Financial Position as at 31 March 2012 and (d) Notes to the financial statements (if required) in accordance with the requirements of BAS I. CMA Adapted – December 2012 E-12. The following trial balance was extracted from the books of Friends International Ltd., a manufacturing company, as at December 2011. Taka Taka Purchase 2,678,000 Prepayments 2,000 Selling and administrative expenses 175,000 Inventories at 1 January 2011 107,000 Land and buildings at cost 840,000 Plant and machinery at cost 714,000 Accumulated depreciation on buildings 166,000 at 1 January 2011 Accumulated depreciation on plant and 368,000 machinery at 1 January 2011 Accounts payable 80,000 Warranty provision 19,000 Loan interest 8,000 Mortgage 90,000 Mortgage interest 14,000 Administrative expense 153,000 Accounts receivables 105,000 108


Other payables Retained earnings at 1 January 2011 General reserve Ordinary share capital of Tk.10 each Bank loan Interest income Share premium account Bank deposit Bank current account Revenue

4,000 20,000 _____4,820,000

4,000 138,000 21,000 382,000 58,000 5,000 199,000 3,290,000 4,820,000

You also obtain the following information. (i) Depreciation is to be provided on the straight-line method on buildings at 2% per annum and on plant and machinery at 20% per annum. The cost of the buildings at 31 December was Tk.650,000. (ii) Inventories at 31 December 2011 comprised raw materials Tk.113,000, work in process Tk.12,000 and finished goods Tk.54,000. (iii) The original mortgage of Tk.225,000 was taken out on 1 January 2002 for a term of 15 years, repayable in equal monthly installments on the 25 th day of each month. (iv) The bank loan was granted on 1 September 2008 for a fixed term of ten years. (v) Provision is to be made for income tax @ 37.5%, based on the results of the year. (vi) A transfer of Tk.21,000 was made to the general reserve during the year. Required: Prepare Friends International Ltd.‟s Statement of Comprehensive Income for the year ended 31 December 2011 and Statement of Financial Position at that date in accordance with the requirements of BAS 1. CMA Adapted – August 2012 E-13. The following is a post-closing trial balance for the Yeasmine Corporation at December 31, 2011, the end of the company‟s fiscal year: Account Title Cash Accounts receivable Allowance for doubtful accounts Inventories Investments Prepaid expenses Note receivable (due in one month) Land Building Machinery Accumulated depreciation- building and machinery Patent (net of amortization) Accounts payable Salaries payable Interest payable 109

Debit (Tk.) 80,000 200,000 300,000 50,000 30,000 60,000 120,000 550,000 500,000 50,000 -

Credits (Tk.) 20,000 450,000 170,000 40,000 10,000


Note payable Bonds payable (due in 10 years) Common shares Retained earnings Total

_______1,940,000

100,000 500,000 400,000 250,000 1,940,000

The Tk.50,000 balance in the investment account consists of marketable equity securities of other corporations. The company‟s intention is to hold the securities for at least three years. The Tk.100,000 note payable is an installment loan. Tk.10,000 of the principal, plus interest, is due on each July 1 for the next 10 years. At the end of the year, 100,000 common shares were issued and outstanding. The company has 500,000 shares authorized. Required: Prepare a classified balance sheet for the Yeasmine Corporation at December 31, 2011. CMA Adapted – April 2012 E-14. Keya & Co. is a manufacturing company which prepares financial statements to 30 June each year. Before the draft financial statements for the year ended 30 June 2011 can be finalized and approved by the directors, the following points need to be addressed. Draft net assets at 30 June 2011 were Tk.2 million. (i) Keya & Co. has renewed the unlimited guarantee given in respect of the bank overdraft of a company (Vass Ltd.) in which it holds a significant investment. Vass Ltd.'s overdraft amounted to Tk.300,000 at 30 June 2011 and it has net assets of Tk.1 million. (ii) A former director, who was dismissed from the company‟s service on 1 June 2011 for acting outside his authority, has given notice of his intention to claim substantial damages for loss of office. On 1 November 2011 a claim was received for Tk.150,000. The company‟s legal advisers have been negotiating with the former director and believe that the claim will probably be settled at Tk.100,000. (iii) On 15 November 2011 the company sold its former head office building, for Tk.2.7 million. At the year end the building was unoccupied and Keya & Co. had not intended to sell the property for at least another year. The building's carrying amount (based on cost less accumulated depreciation) was Tk.3.1 million at the year end. (iv) An overseas division of Keya & Co. was nationalized in July 2011. The overseas authorities have refused to pay any compensation. The net assets of the division have been valued at Tk.200,000 at the year end. Required: Prepare extracts from the statement of financial position of Keya & Co. as at 30 June 2011, including any relevant notes to the financial statements. CMA Adapted – December 2011 E-15. You have been appointed as Manager Finance of a company named ZYX Ltd. The Finance Controller of that company asked you to prepare a classified Balance Sheet in good form for the year ended 31 st December-2010 based on the following data:

Descriptions Land

ZYX Ltd. Ledger Descriptions Balance (Tk.) 24,00,000 Employees‟ salary tax

Ledger Balance (Tk.) 110


Building Equipments Goodwill Inventories Accumulated dep.Building Accumulated dep.Equipment Notes receivable Notes payable to banks Income tax payable Long-term notes payable- Unsecured Long-term rental obligations Prepaid expenses

82,00,000 73,50,000 6,25,000 11,99,000 8,51,000 14,60,000 27,28,500 13,25,000 4,91,810 80,00,000 24,00,000 4,39,600

payable 0% Interest bond payable Discount on 0% int. bond payable Bank A/C- Citi N.A. Bank A/C- Standard Chartered Cash in hand Accounts payable Refundable over-paid income tax Rent payable- Shortterm Share capital @ Tk.10 par value Preferred share @ Tk.100 par value Trading securities

8,87,955 15,00,000 75,000 10,00,000 7,50,000 50,000 29,50,000 4,88,150 2,25,000 10,00,000 7,50,000 6,05,000

Additional Information: (i) Cost and fair value of marketable securities are the same. (ii) Assume that notes receivable and notes payable are short-term, unless stated otherwise. (iii) Authorized share capital was 5,00,000 no. shares. (iv) Preferred share authorized was 50,000 no. shares. CMA Adapted – August 2011 E-16. Pharmacia Ltd operates in the pharmaceutical business. The following information relates to the company's activities in research and development for the year ended 31 October 2010. (i) Commercial production started on 1 June 2006 for Formula A. By 31 October 2009 Tk.43,000 had been capitalized in respect of development expenditure on this product. During the year a further Tk.10,000 was spent on development of this product. Pharmacia Ltd has taken out a patent in respect of Formula A which will last for ten years. Legal and administrative expenses in relation to this were Tk.2,000. In the current year, sales of Formula A amounted to Tk.50,000. Sales over the next three years are expected to be Tk.150,000, Tk.200,000 and Tk.100,000 respectively. (ii) The development of Formula B is at an earlier stage. Although the company believes it has a reasonable expectation of future benefits from this project it has not as yet been able to demonstrate this with sufficient certainty. Expenditure on this project in the current year was Tk.20,000. Required: Calculate the total amount to be charged to the income statement in respect of the above in the year ended 31 October 2010. Mention reference of related IAS/IFRS to justify your answer. CMA Adapted – April 2011

111


E-17. ABC Company Ltd. has entered into the following transactions during the year ended 31 December 2010. (i) On 1 October 2010 ABC Company Ltd. received Tk.400,000 in advance subscriptions. The subscriptions are for 20 monthly issues of a magazine published by ABC Company Ltd. Three issues of the magazine had been dispatched by the year end. Each magazine is of the same value and costs approximately the same to produce. (ii) A batch of unseasoned timber, which had cost Tk.250,000, was sold to XYZ Company Ltd. for Tk.100,000 on 1 January 2010. ABC Company Ltd. has an option to repurchase the timber in 10 years' time. The repurchase price will be Tk.100,000 plus interest charged at 8% per annum from 1 January 2010 to the date of repurchase. The market value of the timber is expected to increase as it seasons. (iii) XYZ Company Ltd. made a major sale on 1 January 2010 for a fee of Tk.450,000, which related to a completed sale and after-sales support for three years. The cost of providing the after-sales support is estimated at Tk.50,000 per annum and the mark-up on similar after-sales only contracts is 20% on cost. Required: Prepare extracts from ABC Company Ltd's financial statements for the year ended 31 December 2010, clearly showing how each of the above would be reflected. Notes to the financial statements are not required. CMA Adapted – April 2011 E-18. The following trial balance relates to Infincon Bangladesh Limited as at 31 March 2010: Taka (‘000) Taka (‘000) Revenue 213,800 Cost of sales 143,800 Closing inventories at 31 March 2010 [note (i)] 10,500 Operating expenses 17,200 Rental income from investment property 1,200 Financial costs [note (ii)] 5,000 Land and building valuation [note (iii)] 63,000 Plant and equipment at cost [note (iv)] 36,000 Accumulated depreciation on plant and equipment 16,800 at 1 April 2009 Investment property at valuation on 1 April 2009 [note (v)] 16,000 Plant held for sale 8,000 Trade receivables 13,500 Bank overdrafts 900 Trade payable 11,800 Ordinary shares of Tk.10 each 20,000 10% Redeemable preference shares of Tk.10 each 10,000 Revaluation reserve [note (iii)] 21,000 Retained earnings at 1 April 2009 17,500 313,000 313,000 The following notes are relevant: (i) An inventory count at 31 March 2010 listed some damaged goods that had cost Tk.800,000. These items could be sold for an estimated amount of Tk.500,000. (ii) Finance cost include an ordinary dividend of Tk.1 per share that was paid in September 2009. 112


(iii) Land and building were revalued at Tk.15 million and Tk.48 million respectively on 1 April 2009 creating a Tk.21 million revaluation reserve. At this date the remaining life of the building was 15 years. Building is depreciated on straight line basis. The Company does not make a transfer to realized profits in respect to excess depreciation. (iv) Plant and equipment is depreciated at 12.5% on the reducing balance basis. Depreciation on both the building and the plant and equipments should be charged to cost of sales. (v) On 31 March 2010 a qualified surveyor valued the investment property at Tk.13.5 million. The Company uses the fair value model as stated in BAS 40 to value investment property. (vi) The rate of corporate income tax is 37.5%. Required: (i) Prepare the income statement for the year ended 31 March 2010; and (ii) Prepare the balance sheet as at 31 March 2010. (Notes to financial statements are not required.) CMA Adapted – December 2010 E-19. The adjusted trail balance of ZAZM & Co. and other related information for the year 2009 is presented below: ZAZM & Co. Adjusted Trial balance, December 31, 2009

Accounts Accrued Expenses Notes Payable Bonds Payable Capital Stock Premium on Capital Stock Retained Earnings Cash Accounts Receivable Allowance for Doubtful Accounts Prepaid Insurance Inventory Long-term Investments Land Construction WIP Patents Equipment Accumulated Depreciation on Equipment Unamortized Discount on Bonds Payable

Debits Tk. --------------41,000 163,500 --5,900 308,500 339,000 85,000 124,000 36,000 400,000 --20,000 1,522,900

Credits Tk. 148,000 49,200 94,000 400,000 500,000 45,000 138,000 ----8,700 --------------140,000 _____--1,522,900

Additional Information: (i) 600,000 shares of common stock at par value of Tk.1 were authorized, of which 500,000 shares were issued and outstanding. (ii) The bonds payable bear interest at 11% payable every December 31 and are due January 1, 2015. 113


(iii) The inventory has a replacement market value of Tk.353,000. (iv) The cost and fair value of the long-term investments that consist of stocks and bonds is the same. (v) The amount of the construction work-in-progress account represents the costs expended to date on a building in the process of construction. (The company rents factory space at the present time). The land on which the building is being constructed cost Tk.85,000, as shown in the trial balance. (vi) The patents were purchased by the company at a cost of Tk.40,000 and are being amortized on a straight-line basis. (vii) Of the unamortized discount on bonds payable, Tk.2,000 will be amortized in 2009. (viii) The notes payable represent bank loans that are secured by long-term investments carried at Tk.120,000. These bank loans are due in 2009. Required: Prepare a balance sheet as of December 31, 2009, so that all important information is fully disclosed. CMA Adapted – August 2010 E-20. As on December 31, 2001 the end of annual accounting period, the trial balance of the ledger of Mahmud Store are as follows:

Si. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Mahmud Store Trial Balance December 31, 2001 Name of Accounting Cash Accounts Receivable Merchandise inventory Purchase Prepaid Insurance Store Equipment Accumulated D/P – Store Equipment Accounts Payable Mahmud – Capital Mahmud – Drawings Sales Sales Return & Allowances Sales Discount Purchase Return & Allowances Purchase Discount Freight-in Freight-out Advertising Expenses Rent Expenses Salaries Expenses General Expenses Vat Current Account

Debit Tk. 90,000 166,000 300,000 3,310,000 38,000 800,000

Credit Tk.

170,000 190,000 900,000 220,000 4,830,000 150,000 72,000 100,000 64,000

Total

122,000 75,000 155,000 200,000 395,000 165,000 ______ 6,258,000

4,000 6,258,000

114


Additional information: (a) Merchandise inventory on hand at December 31, 2001 is Tk. 395,000. (b) Merchandise in transit at December 31, 2001 costing Tk. 5,000, which was shipped by a supplier under the terms F.O.B Shipping point and recorded as purchase but not included in ending Merchandise inventory. (c) Insurance expired during the period is Tk. 20,000. (d) Salaries accrued but not paid Tk. 10,000. (e) Depreciation expenses are changed during the period was Tk. 80,000. (f) General expenses include Tk. 15,000 for utilities, which is to be treated as selling expenses. Required: (i) Multiple Income Statement. (ii) Owner‟s Equity Statement. (iii) Balance Sheet. CMA Adapted – December 2009 E-21. STAR Company Private Ltd. registered under Company Act‟ 1994. following trial balance as of 31 December, 2008. Accounts Title Dr. (Tk.) Cash 1,20,000 Investment in Land 1,70,000 Customer Receivable 3,02,000 Inventory 56,000 Prepaid Expenses 54,000 Land 2,60,000 Plant & Machineries 11,67,000 Other Assets (non-current) 15,63,000 Sales on Accounts Contractor Payable Accrued Wages Unearned Revenue Debentures Other Liabilities Common Stock Retained Earnings Cash Sales Interest Revenue Gain on Condemnation of Land by Govt. Cost of Goods Sold 15,65,000 Commercial and General Overhead 6,40,000 Loss from tidal bore charge 1,50,000 Financial Expenses 70,000 Income Tax 2,73,000 Operating Loss on discontinued business 60,000 Dividends 1,00,000 Sales Allowances 50,000 Total 66,00,000 115

Submits the Cr. (Tk.)

10,50,000 2,40,000 2,20,000 33,000 12,00,000 3,36,000 2,90,000 11,08,000 19,00,000 23,000 2,00,000

______ 66,00,000


Additional Information: (i) Inventory includes spoiled & not saleable goods worth Tk.6,000. (ii) Commercial and General Overhead incorrectly includes Tk.15,000 for office furniture purposes (other assets). The purchases were made on December‟30. (iii) The prepaid expenses were paid on September‟1 and relate to a 3 years insurance policy that went into effect on September‟1. (iv) The unearned revenue relates to rental of an unused portion of the corporate offices Tk.33,000 received on April‟1 and represents payment in advance for one year‟s rental. (v) Plant & Machineries includes Tk.10,000 for equipment repairs that were erroneously recorded as machineries purchases. The repair made on December‟30. (vi) Other assets include Tk.80,000 for miscellaneous office supplies which were purchased on mid October. At the end of the year count reveals that only Tk.6,500 of office supplies remains. (vii) It has been decided that un-collectible account expenses will be Tk.2,000 for which provision was not made earlier. The account of M/s Khan & Co. will we written off for this purpose. Required: (i) Adjusting Entries needed for above transaction; (ii) Income Statement for the year ended December 31, 2008; and (iii) Balance Sheet as on December 31, 2008. CMA Adapted – December 2009 E-22. The following balances are taken from the books of accounts of Surma Ltd. on June 30, 2004: Surma Ltd. Trial Balance June 30, 2004 Name of Accounts Debit (Tk.) Credit (Tk.) Accounts Receivable 29,000 Purchases 81,000 Allowance for Doubtful Accounts 16,000 Inventories 6,000 Furniture 10,000 Accumulated Depreciation – Furniture 4,000 Building 1,40,000 Accumulated Depreciation – Building 30,000 Cash 2,000 Bad Debts 6,000 Salaries and Allowances 20,000 Interest Expenses 4,000 Rent, Rates & Taxes 6,000 Salesmen Salaries 2,000 Freight-in 7,000 Dividend 15,000 Sales 2,00,000 Interest Income 1,000 Bonds Payable 10,000 Capital 60,000 Retained Earnings, June 30, 2003 ____-__ 7,000 Total 3,28,000 3,28,000 116


Adjustments on June 30, 2004 are required as follows: (i) Inventory on hand is Tk.10,000. (ii) Depreciation on Furniture is to be 10% on original cost. (iii) Building are depreciated @ 5% per year. (iv) The allowance for doubtful accounts are to be increased to a balance of Tk.19,000. (v) Accrued salaries Tk.2,000. (vi) Accrued interest on bonds Tk.1,000. (vii) Accrued selling expenses Tk.1,500. (viii) Income taxes are estimated to be 50% of the net income before taxes. Required: (a) Prepare a Multiple Income Statement and Retained Earnings Statement for the year ended June 30, 2004. (b) Prepare a Balance Sheet as on June 30, 2004. CMA Adapted – April 2009

117


CHAPTER - 4 STATEMENT OF CASH FLOW (IAS 7)

4.1. DEFINITION OF CASH AND CASH EQUIVALENTS As per IAS 7, cash comprises cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to cash and which are subject to an insignificant risk of changes in value. An entity shall disclose the followings in respect of cash and cash equivalents: - the components of cash and cash equivalents; - a reconciliation of the amounts in its statement of cash flows with the equivalent items reported in the statement of financial position. 4.2. MEANING OF CASH FLOWS AND STATEMENT OF CASH FLOWS Cash flows are inflows and outflows of cash or cash equivalents. It is the amount of cash or cash equivalent which the company receives from the debtors or paid to the creditors. A statement of cash flows (also known as cash flow statement) is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents and breaks the analysis down to operating, investing and financing activities. 4.3. BENEFITS OF STATEMENT OF CASH FLOWS (a) A statement of cash flows provides information to its users about the changes in net assets of an entity, its financial structure and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. (b) Statement of cash flows is useful in an entity to determine the balance of cash and cash equivalents and enables users to compare the present value of the future cash flows of different entities. It eliminates the effects of using different accounting treatment for the same transactions and events. (c) Cash flow information is used to forecast the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices. (d) Statement of cash flows helps in efficient management of cash. One of the most important functions of an organization is to manage cash so that it can meet its short term liabilities. A statement of cash flows is a useful tool for doing so. (e) As the repayment of long term debts depends on the availability of cash, the cash flow analysis helps the management in determining the possibility of repayment of long term debts. It thus better predicts the amounts, timing and uncertainty of future cash flows. 118


4.4. PRESENTATION OF STATEMENT OF CASH FLOWS A statement of cash flows shall classifies and presents cash inflows and outflows during a year under following headings: (a) Cash flows from operating activities; (b) Cash flows from investing activities; and (c) Cash flows from financing activities. (a) Cash flows from operating activities: Cash flows from operating activities are derived from ongoing, regular business activities of the entity and it does not include long-term capital or investment costs. It generally results from the transactions and other events that enter into determination of profit or loss. It includes the followings: (i) cash receipts from the sale of goods and the rendering of services; (ii) cash receipts from royalty, fees, commissions and other revenue; (iii) cash payments to suppliers for goods and services; (iv) cash payments to employees; (v) cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits; (vi) cash payments or refunds of income taxes unless they can be specifically identified with investing and financing activities; and (vii) cash receipts and payments from contracts held for dealing or trading purposes. (b) Cash flows from investing activities: Cash flows from investing activities are derived from the acquisition and disposal of longterm assets and from other investments that are not included in cash equivalents. Only expenditures that result in a recognised asset in the statement of financial position are eligible to be classified as cash flows from investing activities. It includes the followings: (i) cash payments to acquire property, plant and equipment, intangible and other long-term assets; (ii) cash receipts from sale of property, plant and equipment, intangibles and other longterm assets; (iii) cash payments to acquire equity or debt instruments of other entities and interests in joint ventures; (iv) cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures; (v) cash advances and loans made to other parties; (vi) cash receipts from the repayment of advances and loans made to other parties; (vii) cash payments for future contracts, forward contracts, option contracts and swap contracts; and (viii) cash receipts from future contracts, option contracts and swap contracts. (c) Cash flows from financing activities: Cash flows from financing activities are derived from the activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

119


It includes the followings: (i) cash proceeds from issue of shares or other equity instruments; (ii) cash payments to owners to acquire or redeem the entityâ€&#x;s shares; (iii) cash proceeds from issue of debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings; (iv) cash repayments of amounts borrowed; and (v) cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease. 4.5. REASONS FOR PREPARING SATEMENT OF CASH FLOWS A complete set of financial statements is made up of five components. Statement of cash flows is one of them. An organization prepares statement of cash flows for many reasons. Some of the major ones are discussed below: (a) Explanation of the changes in cash: Statement of cash flows explains the reasons of the change in companyâ€&#x;s cash and cash equivalents during a particular accounting period by showing the details of cash generated and cash used to perform operating, investing and financing activities of the business. (b) Anticipation of future cash flows: The management, creditors, actual and perspective investors and competitors of the company are interested to know the ability of the company to generate positive cash flows in future. The statement of cash flows enables these parties to understand how company manages cash and to anticipate the impact of current cash receipts and cash disbursements on future cash flows of the business. (c) Legal requirements: In some countries, the companies are legally required to prepare and present financial statements in accordance with international financial reporting standards (IFRSs). As the statement of cash flows is one of the basic components of financial statements, its presentation is legally required in some countries. (d) Information about non-cash activities: Sometime non-cash activities have a significant impact on the future cash flows of the entity and therefore their disclosure to the users of financial statements becomes necessary. For this reason, a company disclose non-cash investing and financing activities either in the statement of cash flows or in the footnotes to the financial statements. (e) Explanation of the differences between net income: The statement of cash flows explains the reasons of the difference between the net income and the related net cash flows from operating activities. 4.6. METHODS OF PREPARING STATEMENT OF CASH FLOWS Two methods are available to prepare a statement of cash flows: (a) The direct method: The direct method is a method of creating a statement of cash flows during a given reporting period. This method uses actual cash flow information from the company's operations segment, instead of using accrual accounting values. 120


(b) The indirect method: The indirect method is a method for creating a statement of cash flows a company may use during any given reporting period. This method uses accrual accounting information to present the cash flows from the operations section of the statement of cash flows. The Financial Accounting Standards Board (FASB) prefers the direct method, while many businesses prefer the indirect method. Regardless of which method is used, the bottomline cash balance is the same. 4.7. DIFFERENCES BETWEEN DIRECT AND INDIRECT METHOD Direct method (a) The direct method of cash flow reports cash receipts and cash payments from operating activities. (b) This method adjusts the revenues and expenses directly to reflect the cash basis. (c) In case of direct method, to compute net cash flow from operating activities, the operating cash payment is deducted from operating cash receipts. (d) It requires a supplemental reconciliation of net income to cash flow from operating activities. (e) The direct method also called the income statement method.

Indirect method (a) The indirect method of cash flow starts with net income and converts it to net cash flow from operating activities. (b) This method adjusts the accrual net income. (c) In case of indirect method, to compute net cash flow from operating activities, non-cash items are added or deducted to net income. (d) It does not require any supplemental reconciliation of net income to cash flow from operating activities. (e) The indirect method also called the reconciliation method.

4.8. LIMITATIONS OF SATEMENT OF CASH FLOWS (a) Statement of cash flows shows only cash inflow and cash outflow. But, the cash balance disclosed by the statement cannot reveals the true liquid position of the business. It does not give complete picture of the financial position of the business concern. (b) Among all the basic financial statements, the statement of cash flows is least commanding, especially during the periods of high liquidity and solvency. When a business does not need external financing or investment opportunities, the cash flows statement tends to be ignored. (c) The transactions reflected in the statement of cash flows are specific. The transactions reflected in the statement of cash flows could not be extrapolated based on past trends unlike revenues and expenses). It cannot be used by the management as a forecasting tool. (d) Cash flow statement is not a substitute for income statement. Cash flow statement should not be equated with income statement. The net cash flow disclosed by cash flow statement does not necessarily mean net income of the business, because net income is determined by taking into account both cash and non-cash items. (e) Statement of cash flows does not measure the economic performance of a firm. So it is not applicable in making comparison the efficiency of an organization with others. It just provides the information about an organization how many cash it has paid and received. 121


4.9. EXPLANATION OF FREE CASH FLOW Free cash flow is the cash a company generates through its operations, less the cost of expenditures on assets. In general words, free cash flow is the cash left over after a company pays for its operating expenses and capital expenditures. It shows how efficient a company is at generating cash. Investors use free cash flow to measure whether a company might have enough cash, after funding operations and capital expenditures, to pay investors through dividends and share buybacks. To determine free cash flow from the statement of cash flows, capital expenditures are deducted from operating cash flows that can be expressed as: Free cash flow = Operating cash flow – Capital expenditure Example: Suppose, following information is gathered from a statement of cash flows of a company for the year ended December 31, 2017. Cash flows from operating activities = Tk.800,000 Capital expenditures = Tk.200,000 So, we can determine the free cash flow as below, Free cash flow = Tk.800,000 – Tk.200,000 = Tk.600,000 4.10. DIFFERENCES BETWEEN FREE CASH FLOW AND OPERATING CASH FLOW Free cash flow (a) The cash left with the company to be apportioned among the shareholders is known as free cash flow. (b) Free cash flow is the cash, a company produces through its operations after subtracting any outlays of cash for investment in fixed assets (c) It discloses the performance of the company (d) Free Cash Flow uses only cash from operating activities for its calculation. (e) It is helpful in determining a company‟s financial health.

Operating cash flow (a) The inflow and outflow of cash during a particular financial year is known as operating cash flow. (b) Operating cash flow is the net amount of cash and cash-equivalents being transferred into and out of a company. (c) It discloses the solvency of the company. (d) It is calculated by the summation of cash inflow and cash outflow activities. (e) It is helpful in determining the liquidity of a company.

4.11. NON-CASH TRANSACTIONS A non-cash transaction is an economic event in which a company doesn‟t require the use of cash or cash equivalents. Accountants sometimes call this type of transaction as a „nonmonetary transaction‟ or „non-cash item‟. Such transactions shall be excluded from a statement of cash flows. Examples of non-cash transactions are: (a) the acquisition of assets by means of a finance lease; (b) the acquisition of an entity by means of an equity issue; and (c) the conversion of debt to equity. 122


4.12. DISCLOSURE (a) Cash flows from dividends received and paid shall each be disclosed separately. Each shall be classified as either operating, investing or financing activities. Dividends received are usually classified as cash flows from operating activities for a financial institution because they enter into the determination of profit or loss. Alternatively, dividends received may be classified as cash flows from financing activities and cash flows from investing activities respectively, because they are costs of obtaining financial resources or returns on investments. Dividends paid may be classified as cash flows from financing activities because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows. (b) Cash flows from interest received and paid shall each be disclosed separately. Each shall be classified as either operating, investing or financing activities. Interest paid and received are usually classified as cash flows from operating activities for a financial institution. (c) Cash flows arises from income taxes shall be separately disclosed and shall be classified as cash flows from operating activities unless these are specifically identified with financing and investing activities.

123


FORMAT OF THE STATEMENT OF CASH FLOWS

Company name Statement of cash flows (Indirect method) For the year ended ‌‌

Currency Cash flows from operating activities: Net profit before interest and taxation Adjustments for: Depreciation/Amortisation Increase/decrease of provisions Profit/loss on disposal of assets Investment income Finance costs Operating profit before working capital changes Increase/decrease in current assets Increase/decrease in current liabilities Cash generated from operations Interest paid Taxation paid Net cash provided/used from operating activities Cash flows from investing activities: Purchase/sale of non-current assets Purchase/sale of intangibles Purchase/sale of investments Interests received Dividends received Net cash generated/used from investing activities Cash flows from financing activities: Purchase/issue of shares Proceeds/redemption of debentures Proceeds/repayments of non-current liabilities Dividends paid Net cash generated/used from financing activities Net increase/decrease in cash and cash equivalents Add. Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

Currency

X X X/(X) (X)/X (X) X X (X)/X X/(X) X (X) (X) X/(X)

(X)/X (X)/X (X)/X X X X/(X)

(X)/X X/(X) X/(X) (X) X/(X) X/(X) X X

124


Company name Statement of cash flows (Direct method) For the year ended ‌‌ Currency Cash flows from operating activities: Receipts from customers (N-1) Payments to suppliers (N-2) Payments to employees (N-3) Payment to other expenses (N-4) Interest paid (N-5) Taxation paid (N-6) Net cash provided/used from operating activities

X (X) (X) (X) (X) (X)

Cash flows from investing activities: Purchase/sale of non-current assets Purchase/sale of intangibles Purchase/sale of investments Interests received Dividends received Net cash generated/used from investing activities

(X)/X (X)/X (X)/X X X

Cash flows from financing activities: Purchase/issue of shares Proceeds/redemption of debentures Proceeds/repayments of non-current liabilities Dividends paid Net cash generated/used from financing activities Net increase/decrease in cash and cash equivalents Add. Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

Currency

X/(X)

X/(X)

(X)/X X/(X) X/(X) (X) X/(X) X/(X) X X

Notes: 1. Receipts from customers: Sales Add. Accounts receivable at beginning Less. Accounts receivable at end 2. Payment to suppliers: Cost of goods sold Add. Inventories at end Less. Inventories at beginning Purchase Add. Accounts payable at beginning Less. Accounts payable at end

125

X X (X) X X X (X) X X (X) X


3. Payment to employees: Salary expenses Add. Outstanding expenses at beginning Less. Outstanding expenses at end 4. Payment to other expenses: Other expenses Add. Increase in prepaid expenses 5. Interest paid: Interest expenses Add. Outstanding interests at beginning Less. Outstanding interests at end 6. Taxation paid: Taxation expenses Add. Outstanding taxation at beginning Less. Outstanding taxation at end

X X (X) X X X X X X (X) X X X (X) X

126


PROBLEMS AND SOLUTIONS P-1. Sonali Co. Ltd. had the following condensed balance sheet at the end of operations in 2016: Sonali Co. Ltd. Balance Sheet As on 31 December, 2016 Assets Cash Other current assets Investments Plant Land

Taka 10,500 30,000 50,000 75,000 60,000 ______ 2,25,500

Liabilities Current liabilities Long-term notes payable Bonds payable Capital stock Retained earnings Bank loans

Taka 25,000 30,500 35,000 90,000 25,000 20,000 2,25,500

During 2017, the following transactions occurred: (a) A piece of land was purchased for Tk.10,000. (b) Bonds payable for the amount of Tk.15,000 were retired at par. (c) An additional Tk.10,000 in capital stock was issued at par. (d) Dividends totaling Tk.9,375 were paid to shareholders. (e) Net income was Tk.45,250 after allowing depreciation of Tk.14,500. (f) Land purchased through issuance of bonds of Tk.25,000. (g) Sonali Co. Ltd. sold a part of its investment portfolio for Tk.12,875. This transaction resulted in a gain of Tk.2,000 for the company. (h) The premium paid on redemption of bank loans was Tk.2,000, which has been written off to income statement. Required: Prepare a statement of cash flow for the year ended 31 December, 2017. Solution: Sonali Co. Ltd. Statement of Cash Flow For the year ended 31 December, 2017 Amount Tk. Cash flows from operating activities: Net income Adjustments for: Depreciation expense Gain on sale of investment Premium paid on redemption of Bank loans Net cash provided from operating activities

127

Amount Tk.

45,250 14,500 (2,000) 2,000 59,750


Cash flows from investing activities: Purchase of land Sale of investments Net cash used from investing activities Cash flows from financing activities: Retirement of bonds payable Issue of capital stock Redemption of bank loans Cash dividends paid Net cash used from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at the end of year

(10,000) 12,875 2,875

(15,000) 10,000 (22,000) (9,375) (36,375) 26,250 10,500 36,750

P-2. The comparative balance sheet of Nixon Company as of December is presented below: Nixon Company Comparative Balance Sheet As on December 31, 2017 Assets 2017 (Tk.) 2016 (Tk.) Cash 71,000 45,000 Accounts receivable 44,000 62,000 Inventory 1,51,450 1,42,000 Prepaid expenses 15,280 21,000 Land 1,05,000 1,30,000 Equipment 2,28,000 1,55,000 Accumulated depreciation – equipment (45,000) (35,000) Building 2,00,000 2,00,000 Accumulated depreciation – building (60,000) (40,000) 7,09,730 6,80,000 Liabilities and stockholder’s equity Accounts payable 47,730 40,000 Bonds payable 2,60,000 3,00,000 Common stock Tk. 1 par 2,00,000 1,60,000 Retained earnings 2,02,000 1,80,000 7,09,730 6,80,000 Additional information: (a) Operating expenses include depreciation expenses of Tk. 42,000 and charges from prepaid expenses of Tk. 5,720. (b) Land was sold for cash at book value. (c) Cash dividends of Tk. 15,000 were paid. (d) Net income for 2017 was Tk. 37,000. (e) Equipment costing Tk. 22,000 with a book value of Tk. 10,000 was sold for Tk. 6000 cash. (f) Bonds were converted at face value by issuing 40,000 shares of Tk. 1 par value of common stock. 128


Required: Prepare a statement of cash flows using the indirect method for the year ended December 31, 2017. Solution: Nixon Company Statement of cash flow For the year ended December 31, 2017 Amount Tk. Cash flows from operating activities: Net income Adjustments for: Depreciation expense Loss on sale of equipment Operating profit before working capital changes Decrease in accounts receivable Increase in inventory Decrease in prepaid expenses Increase in accounts payable Net cash provided from operating activities Cash flows from investing activities: Sale of land Purchase of equipment {228,000 – (155,000 – 22,000)} Sale of equipment Net cash used from investing activities Cash flows from financing activities: Cash dividend paid Net cash used from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at the end of year

Amount Tk.

37,000 42,000 4,000 83,000 18,000 (9,450) 5,720 7,730 105,000

25,000 (95,000) 6,000 (64,000)

(15,000) (15,000) 26,000 45,000 71,000

P-3. Avatar Ltd. had the following statement of financial position at 31 March 2016 and 2017: 2016 2017 Tk.’000 Tk.’000 Assets Non-current assets at cost 1,000 1,300 Accumulated depreciation (400) (600) 600 700 Currents assets Inventory 800 1,400 Receivables 2,700 3,100 Bank 200 4,300 5,200 129


Equity and liabilities Share capital Share premium Retained earnings

1,000 500 1,200 2,700

1,300 700 1,240 3,240

1,300 300 _ 4,300

1,580 260 120 5,200

Currents liabilities Payables Declared ordinary dividend Bank overdrafts

During the year to 31 March 2017, non-current assets costing Tk.50,000 were sold for Tk.40,000 cash. Accumulated depreciation on these to 31 March 2016 was Tk.20,000. Required: Prepare the statement of cash flows for the year ending 31 March 2017. Solution: Avatar Limited Statement of Cash Flows For the year ended 31 March 2017 Amount Tk. Cash flows from operating activities: Increase in retained earnings Depreciation expense (600,0000 – 400,000) + 20,000 Profit on sale of non-current assets 40,000 – (50,000 – 20,000) Operating profit before working capital changes Dividend declared Increase in inventory Increase in receivables Increase in payables Net cash used from operating activities Cash flows from investing activities: Sale of non-current assets Purchase of non-current assets Net cash used from investing activities Cash flows from financing activities: Issuance of shares (1300,000 + 700,000) – (1000,000 + 500,000) Dividends paid Net cash used from financing activities Net decrease in bank balance Bank balance at beginning of year Bank balance at the end of year

Amount Tk.

40,000 220,000 (10,000) 250,000 260,000 (600,000) (400,000) 280,000 (210,000)

40,000 (350,000) (310,000)

500,000 (300,000) 200,000 (320,000) 200,000 (120,000)

130


P-4. Atlas Company manufactures sailing dinghies. During last year it ceased production of its model XII due to competition from overseas suppliers which could manufacture a similar dinghy at a much lower price. A new model the RV3 is due into production in the next month. Its classic design is expected to result in a resurgence of demand for woodenhulled dinghies. New premises and equipment were purchased during the year in order to manufacture the RV3. Atlas has prepared the following draft accounts for the year ended 31 December, 2017: Income statement Tk.’000 Revenue 11,563 Cost of sales 5,502 Gross profit 6,061 Distribution costs 402 Administrative expenses 882 Interest payable 152 1,436 Profit before tax 4,625 Taxation 2,231 Profit after tax 2,394 Statement of financial position 31 December 2017 2016 Tk.’000 Tk.’000 Assets Leasehold premises (net) Plant, machinery and equipment (net) Investment at cost Inventory Receivables Bank Equities and liabilities Share capital (25 paisa ordinary) Share premium Retained earnings Debenture (10%) Provision for deferred repairs Payables Overdraft Taxation

6,600 5,040 2,406 2,880 2,586 ____-_ 19,512

5,700 3,780 2,208 1,986 1,992 576 16,242

2,280 2,112 9,108 1,240 1,202 1,026 222 2,322 19,512

1,800 1,800 6,714 1,800 1,016 702 2,410 16,242

The following data is relevant: (a) The 10% debentures were redeemed at par. (b) Plant and equipment with a written down value of Tk.2,76,000 was sold for Tk.1,68,000. New plant was purchased for Tk.25,00,000. (c) Leasehold premises capital costs of Tk.13,00,000 were incurred during the year.

131


Required: Prepare a statement of cash flows and all supporting notes in accordance with IAS-7 statement of cash flows for 2017 for Atlas Company. Solution: Atlas Company Statement of cash flows As per IAS 7 For the year 2017 Tk.’000 Cash flow from operating activities: Profit before tax Adjustments: Interest payable Depreciation (400 + 964) (w1) Loss on sale (w2) Increase in deferred repairs provision Increase in inventory Increase in receivables Increase in payables Cash generated from operations Interest paid Tax paid (w3) Net cash from operating activities

4,625 152 1,364 108 186 (894) (594) 324 5,271 (152) (2,319) 2,800

Cash flow from investing activities: Purchase of investment Purchase of plant, machinery and equipment Proceeds from sale of plant, machinery and equipment Net cash used in investing activities Cash flow from financing activities: Issue of ordinary shares (480 + 312) (w4) Redemption of non-current interest bearing debt (1,800 – 1,240) Payment to acquire leasehold premises Net cash used in financing activities Net change in cash and cash equivalent Cash and cash equivalent at beginning Cash and cash equivalent at end

Tk.’000

(198) (2,500) 168 (2,530)

792 (560) (1,300) (1,068) (798) 576 (222)

Workings: 1. Leasehold premises Dr. Balance b/d Addition

Tk.’000 5,700 Depreciation 1,300 Balance c/d 7,000

Cr. Tk.’000 400 6,600 7,000 132


Plant, machinery and equipment Dr. Balance b/d Addition

Cr. Tk.’000 276 964 5,040 6,280

Tk.’000 3,780 Disposal 2,500 Depreciation Balance c/d 6,280

2. Disposal Dr. Plant, machinery and equipment

Cr. Tk.’000 168

Tk.’000 276 Cash Loss on sale

108 276

276 3. Taxation Dr. Cash Balance c/d

Cr. Tk.’000 2,410 2,231 4,641

Tk.’000 2,319 Balance b/d 2,322 Income statement 4,641

4. Share capital Dr.

Cr. Tk.’000 1,800 480 2,280

Tk.’000 Balance c/d

Balance b/d 2,280 Cash 2,280 Share premium

Dr.

Cr. Tk.’000 1,800 312 2,112

Tk.’000 Balance c/d

Balance b/d 2,112 Cash 2,112

P-5. Below are extracts from the financial statements of Noah Limited: Statement of comprehensive income For the year ended 31 March 2017 Sales revenue Cost of sales Gross profit Distribution costs 133

Tk.m 1,162 (866) 296 (47)


Administrative expenses Profit from operations Interest receivable Finance costs Profit before tax Income tax expenses Profit for the year Other comprehensive income Gain on revaluation Total comprehensive income for the year

(110) 139 79 (55) 163 (24) 139 251 390

Statement of financial position 31 March 2017 Tk.m

31 March 2016 Tk.m

Assets Non-current assets: Building Intangible assets Investments Current assets: Inventories Accounts receivable Cash at bank Cash at hand Total assets

1,023 277 69 1,369

600 234 68 902

246 460 180 70 956 2,325

128 373 0 124 625 1,527

29 447 251 116 843

24 377 0 26 427

755 4 759

555 _2 557

244 437 42 723 2,325

311 207 25 543 1,527

Equity and liabilities Capital and reserves: Common share Share premium Revaluation reserve Retained profit Non-current liabilities: Loan Deferred taxation Current liabilities: Accounts payable Overdrafts Taxation Total equity and liabilities

134


Additional information: (a) Profit from operation is after charging depreciation on building of Tk.22 million and amortisation on the intangible assets of Tk.7 million. The revaluation reserve relates wholly to the building. (b) The current asset investments were a 30 day government bond. (c) During the year ended 31 March 2017, building costing Tk.1,464 million, which had a carrying value of Tk.424 million, was sold for Tk.250 million. (d) During the year ended 31 March 2017, 25 million 20c common shares were issued at a premium of Tk.2.80. (e) Dividends paid during the year were Tk.51 million. Required: Prepare a statement of cash flows for Noah Limited for the year ended 31 March 2017 in compliance with IAS 7 Statement of Cash Flows using the indirect method. Solution: Noah Limited Statement of cash flows As per IAS 7 (Indirect method) For the year ended 31 March 2017 Tk.m Cash flows from operating activities: Profit before tax 163 Adjustments for: Depreciation 22 Amortisation 7 Loss on disposal of non-current assets (250 – 424) 174 Interest receivable (79) Finance costs 55 Operating profit before working capital changes 342 Increase in inventories (118) Increase in accounts receivable (87) Decrease in accounts payable (67) Cash generated from operations 70 Interest paid (55) Income tax paid (w-1) (5) Net cash provided from operating activities Cash flows from investing activities: Purchase of building (w-2) (618) Purchase of intangibles (w-3) (50) Purchase of investment 1 Proceeds of building 250 Interest received 79 Net cash used from investing activities Cash flows from financing activities: Proceeds from issue of common share 75 Proceeds from long-term borrowing 200 Dividend paid (51) Net cash provided from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year (124 – 207) Cash and cash equivalents at the end of year (180 + 70) - 437 135

Tk.m

10

(338)

224 (104) (83) (187)


Workings: 1. Income tax Bank (Balancing figure) Balance c/d (Current) Balance c/d (Deferred)

5 42 4 51

Balance b/d (Current) Balance b/d (Deferred) Income statement

25 2 24 51

2. Building Balance b/d Revaluation Bank (Balancing figure)

600 251 618 1,469

Depreciation Disposal Balance c/d

22 424 1,023 1,469

3. Intangible assets Balance b/d Bank (Balancing figure)

234 50 284

Amortisation Balance c/d

7 277 284

P-6. The following statement was prepared by Partex Textile Ltd.â€&#x;s accountant. Partex Textiles Ltd. Statement of sources and application of cash For the year ended September 30, 2017 Sources of cash Net income Depreciation and depletion Increase in long-term debt Changes in current receivables and inventories, less current liabilities (excluding current maturities of long-term debt)

Tk.1,11,000 70,000 1,79,000 14,000 Tk.3,74,000

Application of cash Cash dividends Expenditure for property, plant and equipment Investments and other uses Changes in cash

Tk.60,000 2,14,000 20,000 80,000 Tk.3,74,000 The following additional information relating to Partex Textiles Ltd. is available for the year ended September 30, 2017. (a) Salaries and wages expense attributable to stock option plans was Tk.25,000 for the year. (b) Expenditure for property, plant and equipment Tk.2,50,000 Proceeds from retirements of property, plant and equipment 36,000 Net expenditures Tk.2,14,000 136


(c) A stock dividend of 10,000 shares of Partex Textiles Ltd. common stock was distributed to common stockholders on April 1, 2017, when the per share market price was Tk.7 and par value was Tk.1. (d) On July 1, 2017, when its market price was Tk.6 per share, 16,000 shares of Partex Textiles Ltd. common stock were issued in exchange for 4,000 shares of preferred stock. (e) Depreciation expense Tk.65,000 Depletion expense 5,000 Tk.70,000 (f) Increase in long-term debt Tk.6,20,000 Less. Redemption of debt 4,41,000 Net increase Tk.1,79,000 Instructions: (i) In general, what are the objectives of a statement of the type shown above for Partex Textiles Ltd.? Explain. (ii) Identify the weakness in the form and format of Partex Textiles Ltd.â€&#x;s statement of cash flows without reference to the additional information. (Assume adoption of the indirect method.) (iii) For each of the six items of additional information for the statement of cash flows, indicate the preferable treatment and explain why the suggested treatment is preferable. Solution: (i) The main purpose of the statement of cash flows is to show the change in cash from one period to the next. Another objective of a statement of the type shown is to summarize the financing and investing activities of the entity, including the extent to which the company has generated cash or near cash assets from operations during the period. Another objective is to complete the disclosure of changes in financial position during the period. The information shown in such a statement is useful to a variety of users of financial statements in making economic decisions regarding the company. (ii) The following are weaknesses in form and format of Partex Textiles Ltd.â€&#x;s statement of cash flows: - The title of the statement should be Statement of Cash Flows. - The statement should add back to (or deduct from) net income certain items that did not use (or provide) cash during the period. The resulting total should be described as net cash provided by operating activities. The only apparent adjustments in this situation are the amounts to be added bask to net income for the depreciation and depletion expense, for any wage or salary expenses related to the employee share option plans, and for changes in current assets and liabilities. - The format used should separate the cash flows into investing, financing and operating activities. Non-cash investing and financing activities, if significant, should be shown in a note to the financial statements. - Individual items should not be grouped together, as was the case for the Tk.14,000 item.

137


(iii) (a) The Tk.25,000 option plan wage and salary expense should be included in the statement as an amount added back to net income, an expenses not requiring the outlay of cash during the period. Since the statement balances and no reference is made to the Tk.25,000 payroll expenses, it appears the expense was not recorded or that there is an offsetting error elsewhere in the statement. (b) The expenditures for plant asset acquisitions should not be reported net of the proceeds from plant asset retirements. Both the outlay for acquisitions and the proceeds from retirements should be reported as investing activities. The details provide useful information about changes in financial position during the period. (c) Share dividends or share splits need not be disclosed in the statement because these transactions do not significantly affect financial position. (d) The issuance of the 16,000 ordinary shares in exchanges for the preference shares should be shown as a non-cash financing activity. Since these transactions significantly change the corporationâ€&#x;s capital structure, they should be disclosed. (e) The presentation of the combined total of depreciation and depletion is probably acceptable. The general rule is that related items should be shown separately in proximity when the result contributes information useful to the user of the statement, but immaterial items may be combined. In this situation, it is likely that no additional relevant information would be added by showing depletion as a separate item. The total should be added back to net income in the computation of the net cash flow from operating activities. (f) The details of changes in long-term debt should be shown separately. Payments should not be netted against increases in long-term borrowings. The long-term borrowing of Tk.620,000 should be shown as cash provided and the retirement of Tk.441,000 of debt should be shown as use of cash from financing activities. P-7. The following information was assembled for M/s. ABC Pipeline Company: M/s. ABC Pipeline Company Balance Sheet December 31

Assets Cash (Overdraft in 2015) Accounts receivable Inventories Long-term investments Land, building and equipment Less. Accumulated depreciation Patents Total assets

130,000 21,500

2017 Taka

2016 Taka

38,625 82,000 73,250 12,000

(5,625) 95,500 50,000 27,000

108,500 ____-314,375

95,000 20,000

75,000 35,000 276,875 138


Liabilities and stockholders’ equity Accounts payable Bonds payable Premium on bonds payable Preferred stock, Tk.100 par Common stock, Tk.10 par Premium on common stock Retained earnings Total liabilities and stockholders’ equity Account: Retained earnings Date Item

55,875 50,000 2,375 -160,000 24,000 22,125 314,375

Debit Taka

Credit Taka

2016 Jan. 1 Oct. 15 Dec. 12 Dec. 31

Balance Cash dividends Premium on retirement of preferred stock Net loss

49,375 20,000 -50,000 100,000 -57,500 276,875

Balance

-25,000 5,000

----

Debit Taka ----

5,375

--

--

Credit Taka 57,500 32,500 27,500 22,125

Income statement data for the year ended December 31, 2017, summarized operations as follows: Loss before extraordinary items Tk.4,375 Extraordinary loss on retirement of bonds 1,000 Net loss Tk.5,375 Equipment cost Tk.15,000, book value Tk.3,000 was scrapped, salvage value of Tk.900 being recovered on the disposal. Additional equipment, cost Tk.50,000 was acquired during the year. Long-term investments cost Tk.15,000 were sold for Tk.18,250; 7% bonds, face value Tk.20,000 were called in at 105 and new 10 year, 5% bonds of Tk.50,000 were issued at 105 on July 1. Preferred stock was retired at a cost of Tk.110 while 6,000 shares of common stock were issued at Tk.14. Depreciation on building and equipment for the year was Tk.13,500. Patents costing Tk.35,000 were written off. Bonds premium was amortized for Tk.125. Required: Prepare a statement of cash flow for the year ended December 31, 2017. Solution: M/s. ABC Pipeline Company Statement of cash flow For the year ended December 31, 2017 Taka Cash flow from operating activities: Income before extraordinary items Adjustments: Depreciation (21,500 – 20,000) + (15,000 – 3,000) 139

(4,375) 13,500

Taka


Written off patent Bonds premium amortization Loss on disposal of equipment (Tk.3000 – Tk.900) Gain on sale of investment Decrease in accounts receivable Increase in inventory Increase in accounts payable

35,000 (125) 2,100 (3,250) 13,500 (23,250) 6,500

Cash from investing activities: Purchase of equipment Disposal of equipment Sale of investments

(50,000) 900 18,250

Cash flow from financing activities: Issuance of common stock (6000 X Tk.14) Retirement of preferred stock (Tk.50,000 ÷ Tk.100) X 110 Issuance of bonds (Tk.50,000 ÷ Tk.100) X 105 Retirement of bonds payable (Tk.20,000 ÷ Tk.100) X 105 Payment of dividend Change in cash and cash equivalent

43,975 39,600

(30,850)

84,000 (55,000) 52,500 (21,000) (25,000)

35,500 44,250

P-8. Below are the statements of financial position of Dhaka Company as at 31 March 2017 and 31 March 2016 together with the statement of profit or loss and other comprehensive income for the year ended 31 March 2017. Dhaka Company Statements of Financial Position As at 31 March 2017 and 31 march 2016 2017 Tk.’000

2016 Tk.’000

925 300 390 1,615

737 300 260 1,297

560 474 343 229 1,606 3,221

427 424 246 317 1,514 2,811

Assets Non-current assets: Property, plant and equipment Goodwill Development expenditure Current assets: Inventories Debtors Investments Cash

Equity and liabilities

140


Equity: Share capital – Tk.1 ordinary shares Share premium Revaluation surplus Retained earnings Non-current liabilities: 6% debentures Finance lease liabilities Deferred tax Current liabilities: Creditors Finance lease liabilities Current tax Debenture interest Bank overdraft

600 450 252 337 1,639

500 200 160 355 1,215

250 200 148 598

200 180 145 525

374 117 156 105 232 984 3,221

452 112 253 100 154 1,071 2,811

Dhaka Company Statements of Profit or Loss and Other Comprehensive Income For the year ended 31 March 2017 Tk.’000 Revenue 3,007 Cost of sales (1,962) Gross profit 1,045 Other expenses (257) Finance costs (115) Profit before tax 673 Income tax expense (262) Profit for the year 411 Other comprehensive income: Gain on revaluation of property, plant & equipment 200 Total comprehensive income for the year 611 Additional information: (a) Goodwill arose on the acquisition of unincorporated businesses. During 2017 expenditure on development projects totaled Tk.290,000. (b) During 2017 items of property, plant and equipment with a net book value of Tk.203,000 were sold for Tk.210,000. Depreciation charged in the year on property, plant and equipment totaled Tk.157,000. Dhaka transfers extra depreciation on revalued property, plant and equipment on retained earnings as allowed by IAS 16. Depreciation based on historical cost in 2017 is Tk.149,000. Dhaka purchased Tk.156,000 of property, plant and equipment by means of finance leases, payments being made in arrears on the last day of each accounting period. (c) The current asset investments are government bonds and management has decided to class them as cash equivalents. (d) The new debentures were issued on 1 April 2016. Finance cost includes debenture interest and finance lease finance charges only. 141


(e) During the year Dhaka made a 1 for 5 bonus issue capitalizing its retained earnings followed by a right issue. (f) Dividends totaling Tk.256,000 were paid during the year. Required: Prepare a statement of cash flows for Dhaka Company in accordance with IAS 7 using the indirect method. Solution: Dhaka Company Statement of cash flows As per IAS 7 (Indirect method) For the year ended 31 March 2017 Tk.’000 Cash flow from operating activities: Profit before tax Adjustments: Depreciation Amortization (w-1) Interest expense Profit on disposal of assets (210,000 – 203,000) Operating profit before working capital changes Increase in debtors Increase in inventories Decrease in creditors Cash generated from operations Interest paid (w-2) Income taxes paid (w-3) Net cash from operating activities Cash from investing activities: Development expenditure Purchase of property, plant & equipment (w-4) Proceeds from sale of property, plant & equipment Net cash used in investing activities Cash flow from financing activities: Proceeds from issue of shares (600+450)-(500+200)-(500X1/5) Proceeds from issue of debentures Payment of finance lease liabilities (w5) Payment of dividend Net cash from financing activities Net decrease in cash and cash equivalent Cash and cash equivalents at beginning Cash and cash equivalents at end

Tk.’000

673 157 160 115 (7) 1,098 (50) (133) (78) 837 (110) (356) 371 (290) (292) 210 (372) 250 50 (131) (256) (87) (88) 317 229

Note: Property, plant and equipment: During the period, the company acquired property, plant and equipment with an aggregate cost of Tk.448000 of which Tk.156,000 was purchased by means of finance leases. Cash payments of Tk.292,000 were made to acquire property, plant and equipment. 142


Workings: 1. Development expenditure amortization: Development expenditure Dr. Balance b/d Expenditure

Tk.’000 260 Amortization 290 Balance c/d 550

Cr. Tk.’000 160 390 550

2. Interest paid: Interest payable Dr. Paid Balance c/d

Tk.’000 110 Balance b/d 105 Profit or loss account 215

Cr. Tk.’000 100 115 215

3. Income taxes paid: Income tax payable Dr. Paid Balance c/d – current Deferred

Tk.’000 356 Balance b/d - current 156 deferred 148 Profit or loss account 660

Cr. Tk.’000 253 145 262 660

4. Purchase of property, plant & equipment: Property, plant & equipment Dr. Balance b/d Revaluations (252–160)+(157-149) Finance leases Purchase

Tk.’000 737 Depreciation 100 Disposals 156 Balance c/d 292 1,285

Cr. Tk.’000 157 203 925 1,285

5. Payment of finance lease liabilities: Finance lease liability Dr. Paid Balance c/d-noncurrent Current

143

Tk.’000 131 Balance b/d-noncurrent 200 current 117 New finance lease 448

Cr. Tk.’000 180 112 156 448


P-9. The financial statements of Rainbow for the year ended 31.03.2017 and 31.03.2016 are given below: Rainbow Statement of Financial Position As at 31.03.2017 and 31.03.2016 Notes 31.03.2017 31.03.2016 Tk.’000 Tk.’000 Assets Non-current assets: Property, plant and equipment (a) (b) 4,191 4,500 Intangible assets (d) 156 315 4,347 4,815 Current assets: Inventories 738 805 Trade receivables 564 480 Cash and cash equivalents 515 265 1,817 1,550 Total assets 6,164 6,365 Equity and liabilities Equity: Equity shares of Tk.1 each Preference shares Share premium Revaluation reserve Retained earnings

(e)

(g)

Non-current liabilities: 9% loan notes Deferred tax

(f)

Current liabilities: Trade payables Tax payable Provisions Interest payable Total equity and liabilities

2,180 700 968 469 901 5,218

2,180 968 353 727 4,228

225 225

1,100 220 1,320

535 84 90 12 721 6,164

500 218 99 817 6,365

Rainbow Statement of Profit or Loss For the year ended 31.03.2017 Notes Revenue Cost of sales Gross profit Administrative expenses Distribution costs

(c) (h)

Tk.’000 6,858 (3,552) 3,306 (2,042) (816) 448 144


Finance costs

(40) 408 (124) 284

Income tax expense Profit for the year Notes: (a) Property, plant and equipment includes properties which were revalued upwards during the year. (b) Property, plant and equipment disposed of in the year had a net book value of Tk.70,000; cash received on their disposal was Tk.92,000. (c) Depreciation charged for the year was Tk.675,000. (d) There were no additions or disposals of intangible assets during the year. (e) On 01.04.2016, Rainbow issued 700,000, 5% cumulative Tk.1 preference shares at par, redeemable at 10% premium on 01.04.2026. Issue costs of Tk.50,000 have been paid by Rainbow and included in administrative expenses. The effective rate of interest is 6.74%. The cash received for the issue of preference shares had been debited to cash and credited to equity. (f) On 01.05.2016, Rainbow purchased and cancelled all its 9% loan noted at par plus accrual interest (included finance costs). (g) Equity dividends paid during the year were Tk.75,000 and preference share dividends paid were Tk.35,000. (h) Rainbow has been advised that it is probably going to lose a case and at 31.03.2017 has provided Tk.90,000 for the estimated cost of this case. Required: (i) Calculate Rainbow‟s revised profit before tax for the year ended 31.03.2017. (i) Prepare Rainbow‟s statement of cash flows using the indirect method for the year ended 31.03.2017 in accordance with IAS 7 Statement of Cash Flows. Notes to the financial statements are not required, but all workings must be clearly shown. Solution: (i) Calculation of Rainbow‟s revised profit before tax: Tk.’000 408 50 (44) 414

Adjusted profit before tax as per draft income statement Add. Preference share issue costs Less. Preference share finance costs (650 X 6.74%) Revised profit before tax (ii) Rainbow Statement of cash flows As per IAS 7 (Indirect method) For the year ended 31.03.2017 Tk.’000 Cash flow from operating activities: Profit before tax Adjustments: Depreciation Impairment of intangible assets (w-1) Provision for legal claim 145

414 675 159 90

Tk.’000


Finance cost (w-2) Gain on disposal of property, plant & equipment (w-3) Operating profit before working capital changes Decrease in inventory Increase in trade receivables Increase in trade payables Cash generated from operations Interest paid (w-4) Income taxes paid (w-5) Net cash from operating activities

84 (22) 1,400 67 (84) 35 1,418 (162) (253) 1,003

Cash from investing activities: Purchase of property, plant & equipment (w-6) Proceeds from sale of property, plant &equipment Net cash used in investing activities

(320) 92 (228)

Cash flow from financing activities: Proceeds from issue of preference shares (w-7) Repayment of loans Payment of equity dividend Net cash used in financing activities Net increase in cash and cash equivalent Cash and cash equivalents at beginning Cash and cash equivalents at end

650 (1,100) (75) (525) 250 265 515

Workings: Tk.’000 1. Impairment of intangible assets: Balance b/f Impairment in the year (Balance) Balance c/f 2. Finance cost: Balance as per income statement Preference share finance charge Balance c/f

315 159 156

40 44 84

3. Gain on disposal of property, plant and equipment: Net book value of assets sold Cash received Gain

70 (92) 22

4. Interest paid: Balance b/f Income statement Balance c/f Interest paid Preference shares dividend paid (Classified as interest as per IAS 32)

99 40 (12) 127 35 162

146


5. Income taxes paid: Deferred tax: Balance b/f Income statement (Balance) Balance c/f

220 5 225

Income tax: Balance b/f Income statement (Total) Less. Deferred tax

218 124 (5)

Tax paid (Balance) Balance c/f 6. Purchase of property, plant and equipment: Balance b/f Disposal (Net book value) Revaluation (469 – 353) Depreciation for the year Balance c/f Total purchase during the year 7. Proceeds from issue of preference shares: Issue of preference shares Less. Issue costs Cash received

119 337 (253) 84

4,500 (70) 4,430 116 4,546 (675) 3,871 4,191 320

700 (50) 650

P-10. The financial statement of PLS Company are given below: Statement of Financial Position As at June 30 Notes

2017 Tk.’000

2016 Tk.’000

5,675 170 5,845

4,785 69 4,854

95 190 95 380 6,225

80 145 160 385 5,239

Assets Non-current assets: Property, plant and equipment Deferred development expenditure Current assets: Inventory Accounts receivables Cash and cash equivalents Total assets

147

(a) to (e) (f)


Equity and liabilities Equity: Share capital Share premium Revaluation reserve Retained earnings

(g) (g)

Non-current liabilities: Deferred tax Long-term debts Current liabilities: Accounts payables Income tax Interest payable Provision for restructuring costs Provision for legal claim

(i) (h)

910 665 600 2,899 5,074

760 400 0 1,982 3,142

410 250 660

0 1,500 1,500

60 321 5 0 105 491 6,225

85 305 32 100 75 597 5,239

Statement of Comprehensive Income For the year ended June 30, 2017 Revenue Cost of sales

Tk.’000 2,300 (450) 1,850 (200) (15) 1,635 (95) 1,540 (455) 1,085

Administrative expenses and distribution costs Loss on disposal of plant Profit from operations Interest Profit before tax Income tax Profit after tax Other comprehensive income: Revaluation of property (net of deferred tax Tk.200,000) 600 Total comprehensive income 1,685 Notes: (a) Non-current assets – property, plant and equipment, balances at June 30, 2016 were: Cost or valuation: Tk.’000 Tk.’000 Property 4,150 Plant 2,350 Equipment 985 7,485 Depreciation: Property 450 Plant 1,350 Equipment 900 2,700 Net book value 4,785 (b) Equipment was purchased during the year at a cost of Tk.275,000 and plant was purchased for Tk.215,000. 148


(c) During the year PLS disposed of plant with a book value of Tk.30,000 and accumulated depreciation of Tk.60,000. (d) On July 1, 2016 property was revalued to Tk.4,500,000. At that time the average remaining life of property was 90 years. property is depreciated on a straight line basis. (e) Depreciation for the year was Tk.280,000 and Tk.40,000 for plant and equipment respectively. (f) Development expenditure incurred during the year to June 30, 2017 was Tk.114,000. Deferred development expenditure is amortized over its useful economic life. (g) PLS issued equity shares during the year at a premium. (h) Provision was made by PLS for outstanding legal claims against the entity at the year end. (i) The restructuring costs relate to a comprehensive restructuring and reorganization of the entity that began in 2015. PLS‟s financial statements for the year ended June 30, 2016 included a provision for restructuring costs of Tk.100,000. Restructuring costs incurred in the year to June 30, 2017 were Tk.160,000. No further restructuring and reorganization costs are expected to occur. PLS treats restructuring costs as a cost of sales. Required: Prepare a statement of cash flows, for PLS Company for the year ended June 30, 2017 using the indirect method, in accordance with the requirements of IAS 7 Statement of Cash Flows. Solution: PLS Company Statement of cash flows For the year ended June 30, 2017 Tk.’000 Cash flows from operating activities: Profit before tax Adjustments for: Depreciation (4500,000 ÷ 90) + 280,000 + 40,000 Amortization of development expenditure (w-1) Increase in legal claim provision Restructuring provision (w-2) Finance cost Loss on disposal of non-current tangible assets Increase in inventory Increase in accounts receivable Decrease in accounts payable Cash generated from operations Interest paid (w-3) Income taxes paid (w-4)

Tk.’000

1,540 370 13 30 (100) 95 15 (15) (45) (25) 1,878 (122) (229) 1,527

Cash from investing activities: Purchase of property, plant & equipment 275,000 + 215,000 Sale of equipment Development expenditure

(490) 15 (114) (589)

149


Cash flow from financing activities: Issue of share capital (w-5) Repayment of long-term borrowings Payment of dividend (w-6)

415 (1,250) (168) (1,003) (65) 160 95

Net decreased in cash and cash equivalent Cash and cash equivalents at July 1, 2016 Cash and cash equivalents at June 30, 2017 Workings: 1. Deferred development expenses: Balance b/f Additions Less. Balance c/f Amortization in the year

Tk.69,000 114,000 Tk.183,000 170,000 Tk.13,000

2. Restructuring costs: Provision balance at June 30, 2015 Paid during the year Net charge to income statement

Tk.100,000 160,000 Tk.60,000

Charged to cash flow

Tk.100,000

3. Interest paid: Balance b/f Income statement Less. Balance c/f 4. Income taxes paid: Balance b/f – Corporate tax Income statement Deferred tax Less. Balance c/f – Corporate tax Deferred tax 5. Issue of share capital: Shares Share premium Received 6. Payment of dividends: Retained earnings balance b/f Profit for the year Less. Retained earnings balance c/f Dividends paid

Tk.32,000 95,000 Tk.127,000 5,000 Tk.122,000 Tk.305,000 455,000 200,000 Tk.960,000 321,000 410,000 Tk.229,000 Tk.150,000 265,000 Tk.415,000

Tk.1,982,000 1,085,000 Tk.3,067,000 2,899,000 Tk.168,000 150


P-11. The following information relates to the draft financial statements of Delta Limited. Statement of Financial Position As at 31.03.2017 and 31.03.2016 Notes 31.03.2017 Tk. Assets Non-current assets: Property, plant and equipment

(a)

Current assets: Inventory Trade receivables Tax refund due Bank Total assets Equity and liabilities Equity: Equity shares of Tk.2 each Share premium Retained earnings Non-current liabilities: 10% loan note Finance lease obligations Deferred tax

(b) (b)

31.03.2016 Tk.

38,000 38,000

51,000 51,000

25,000 9,000 1,000 Nil 35,000 73,000

9,200 4,000 Nil 3,000 16,200 67,200

20,000 6,400 9,000 35,400

16,000 8,000 12,600 36,600

Nil 9,600 2,400 12,000

10,000 4,000 1,600 15,600

10,000 Nil 2,800 3,400 9,400 25,600 73,000

Nil 5,000 Nil 1,600 8,400 15,000 67,200

(c)

(c) Current liabilities: 10% loan note Tax Bank overdraft Finance lease obligations Trade payables Total equity and liabilities

Statement of Profit or Loss For the year ended 31.03.2017

Revenue Cost of sales Gross profit Operating expenses Finance costs Profit (loss) before tax Income tax relief (expense) Profit (loss) for the year 151

31.03.2017 Tk. 110,000 (87,600) 22,400 (24,000) (2,000) (3,600) 1,400 2,200

31.03.2016 Tk. 80,000 (50,000) 30,000 (12,000) (1,200) 16,800 (5,600) 11,200


Notes: (a) Property, plant and equipment is made up of: As at 31.03.2017 31.03.2016 Tk. Tk. Leasehold property Nil 17,600 Owned plant 25,000 28,400 Leased plant 13,000 5,000 38,000 51,000 During the year Delta sold its leasehold property for Tk.17,000 and entered into an arrangement to rent it back from the purchaser. There were no additions or disposals of owned plant during the year. The depreciation charge (to cost of sales) for the year ended 31.03.2017 were: Tk. Leasehold property 400 Owned plant 3,400 Leased plant 3,600 7,400 (b) On 01.07.2016 there was a bonus issue of shares from share premium of one new share for every 20 held. On 01.10.2016 there was a fully subscribed cash issue of shares at par. (c) The 10% loan note is due for repayment on 30.06.2017. Delta is in negotiations with the loan provider to refinance the same amount for another five years. (d) The finance costs are made up of: For year ended Finance lease charges Overdraft interest Loan note interest

31.03.2017 Tk. 600 400 1,000 2,000

31.03.2016 Tk. 200 Nil 1,000 1,200

Required: Prepare a statement of cash flows for Delta Limited for the year ended 31.03.2017 in accordance with IAS 7 Statement of Cash Flows, using the indirect method. Solution: Delta Limited Statement of cash flows As per IAS 7 (Indirect method) For the year ended 31.03.2017 Taka Cash flow from operating activities: Loss before tax Adjustments: Depreciation (w-1) Interest expense Loss on disposal of leasehold property {17,000 – (17,600 – 400)} Operating profit before working capital changes Increase in inventory Increase in trade receivables

Taka

(3,600) 7,400 2,000 200 6,000 (15,800) (5,000) 152


Increase in trade payables Cash used in operations Interest paid Tax paid (w-2) Net cash used in operating activities

1,000 (13,800) (2,000) (3,800) (19,600)

Cash from investing activities: Proceeds from sale of leasehold property Net cash from investing activities Cash flow from financing activities: Proceeds from issue of shares (20,000 + 6,400) – (16,000 + 8,000) Repayment made under finance leases (w-3) Payment of dividend (12,600 – 9,000 – 2,200) Net cash used in financing activities Net decrease in cash and cash equivalent Cash and cash equivalents at beginning Cash and cash equivalents at end

17,000 17,000

2,400 (4,200) (1,400) (3,200) (5,800) 3,000 (2,800)

Workings: 1. Depreciation: Property, plant and equipment Dr. Balance b/d Additions (13,000 - 5,000 + 3,600)

Tk. 51,000 Disposal (17,600 - 400) 11,600 Depreciation Balance c/d 62,600

Cr. Tk. 17,200 7,400 38,000 62,600

2. Tax paid: Income tax Dr. Profit or loss account 31.03.16 – Deferred tax Tax paid

Tk. 1,400 31.03.15 – Current tax 2,400 31.03.15 – Deferred tax 3,800 Refund due 7,600

Cr. Tk. 5,000 1,600 1,000 7,600

3. Repayment of finance leases: Finance lease liability Dr. Payments Balance b/f (9,600 + 3,400)

153

Tk. 4,200 Balance b/f (4,000 + 1,600) 13,000 Additions (w1) 17,200

Cr. Tk. 5,600 11,600 17,200


P-12. Consolidated financial data of Tom Cruise Company as on December 31 appear bellow: Comparative Balance Sheet Particulars 2017 2016 Assets: Cash 92,700 47,250 Accounts receivables 90,800 57,000 Inventories 121,900 102,650 Investments 84,500 87,000 Plant assets 250,000 205,000 Accumulated depreciation (49,500) (40,000) 590,400 458,900 Liabilities & stockholders’ equity: Accounts payable 57,700 48,280 Accrued expense payable 12,100 18,830 Bonds payable 100,000 70,000 Common stock 250,000 200,000 Retained earnings 170,600 121,790 590,000 458,900 Income Statement For the year ended on December 31, 2017 Particulars Taka Sales Gain on sale of plant assets Less: COGS Operating expenses (excluding depreciation) Depreciation expense Income Taxes Interest expenses Net Income

Taka 297,500 8,750 306,250

99,460 14,670 49,700 7,270 2,940 174,040 132,210

Additional information: (a) New plant costing Tk.92,000 were purchased for cash during the year. (b) Investments were sold at cost. (c) Plant costing Tk.47,000 were sold for Tk.15,550 resulting in a gain of Tk.8,750. (d) A cash dividend of Tk.83,400 was declared and paid during the year. Required: Prepare a Statement of Cash Flow using (i) Indirect Method and (ii) Direct Method

154


Solution: (i) Tom Cruise Company Statement of cash flow (Indirect method) For the year ended December 31, 2017 Amount Tk. Cash flow from operating activities: Net income Adjustment: Depreciation expense Gain on sale of equipment Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in accrued expense

49,700 (8,750) (33,800) (19,250) 9,420 (6,730)

Cash flow from investing activities: Purchase of plant Sale of plant Sale of investment

(92,000) 15,550 2,500

Amount Tk. 132,210

(9,410) 122,800

(73,950) Cash flow from financing activities: Issue of bonds Issue of common stock Dividend paid

30,000 50,000 (83,400) (3,400) 45,450 47,250 92,700

Net increase in cash & cash equivalent Cash & cash equivalent at beginning of year Cash & cash equivalent at the end of year (ii) Tom Cruise Company Statement of cash flow (Direct method) For the year ended December 31, 2017 Amount Tk. Cash flow from operating activities: Collection from customers (w-1) 155

Amount Tk. 263,700


Payment to suppliers (w-2) Payment to other expenses (w-3) Interest paid Tax paid Cash flow from investing activities: Purchase of plant Sale of plant Sale of investment

(109,290) (21,400) (2,940) (7,270) 122,800 (92,000) 15,550 2,500 (73,950)

Cash flow from financing activities: Issue of bonds Issue of common stock Dividend paid Net increase in cash & cash equivalent Cash & cash equivalent at beginning of year Cash & cash equivalent at the end of year

30,000 50,000 (83,400) (3,400) 45,450 47,250 92,700

Workings: 1. Collection from customers: Sales Add. Accounts receivable at beginning Less. Accounts receivable at end 2. Payment to supplier: Inventories at end Add. Cost of goods sold Goods available for sale Less. Inventories at beginning Purchase Add. Accounts payable at beginning Less. Accounts payable at end 3. Payment to other expenses: Operating expense Add. Accrued expense at beginning Less. Accrued expense at end

Tk.297,500 57,000 (90,800) Tk.263,700 Tk.121,900 99,460 Tk.221,360 102,650 Tk.118,710 48,280 57,700 Tk.109,290 Tk.14,670 18,830 (12,100) Tk.21,400

P-13. 3S Excellent Company uses direct method in preparing cash flow statement. The company provided you with the following information:

156


Net credit sales Depreciation on property, plant and equipment Accounts receivable, end of the year Operating expenses Accounts receivable, beginning of the year Purchases (on account) Trade payable, end of the year Accrued expenses, beginning of the year Trade payable, beginning of the year Accrued expenses, end of the year

Tk.5,000,000 600,000 1,500,000 3,000,000 2,500,000 4,000,000 1,900,000 500,000 2,000,000 400,000

Required: For the purposes of the cash flow statement under the direct method, you are required to compute the cash collections from customers, payments to suppliers and cash paid for operating expenses. Solution: 3S Excellent Company Direct Method Cash collection from customers: Net sales Add. Accounts receivable, beginning of the year Less. Accounts receivable, end of the year Cash collection from customers Cash paid to suppliers: Purchases Add. Accounts payable, end of the year Less. Accounts payable, beginning of the year Payments to supplier Cash paid for operating expenses: Operating expenses Add. Accrued expenses, beginning of the year Less. Accrued expenses, end of the year Less. Depreciation on property, plant and equipment Cash paid toward operating expenses

Tk.5,000,000 2,500,000 7,500,000 (1,500,000) Tk.6,000,000

Tk.4,000,000 1,900,000 7,500,000 (2,000,000) Tk.3,900,000

Tk.3,000,000 500,000 7,500,000 (400,000) (600,000) Tk.2,500,000

P-14. Leads Corporation, a major retailer of Computers and accessories, operates several branches and is listed in DSE and CSE, The Income Statement for the year ended December 31, 2017 and the Comparative Statement of Financial Position as on December 31, 2016 and December 31, 2017 are given below: Leads Corporation Income Statement For the year ended December 31, 2017 157


Particulars Sales Cost of Goods Sold Gross Profit Expenses: Salary Interest Other Depreciation Total Expenses Operating Income Income tax Net Income

Taka 1,255,250 722,000 533,250 252,100 75,000 8,150 25,000 360,250 173,000 43,000 130,000

Leads Corporation Comparative Statement of Financial Position As at December 31, 2016 and December 31, 2017 Liabilities & Owners’ 2017 2016 Assets Equity (Tk.) (Tk.) Current Liabilities: Current Asset: Accounts Payable 123000 115000 Cash Outstanding: Interest Accounts Receivable expenses 47250 72000 Stock-in-trade Salary Expenses 27000 25000 Prepaid expenses Total Current Total current Liabilities: 197250 212000 Assets: LongTerm Liabilities: Long term Assets: Bond payable 70000 100000 Machinery & Equipment Total Long Term Liabilities 70000 100000 Less: Accumulated Total Liabilities: 267250 312000 Depreciation Owners’ Equity: Net Long term Common share (Tk.10 370000 280000 Assets: each) Total Assets Retained earnings 145000 120000 Total Owners’Equity: 515000 400000 Total Liabilities & Owners’ Equity 782250 712000

2017 (Tk.)

2016 (Tk.)

33250 80000 210000 9000

20000 58000 250000 7000

332250

335000

600000

502000

150000

125000

450000 782250

377000 712000

Additional information concerning Leads Corporation‟s transactions during the year ended December 31, 2017 is as follows: (a) All sales during the year were made on account. (b) All stocks were purchased on credit, comprising of total payable account. (c) Machinery & equipment costing Tk. 98,000 were purchased by paying in cash and issuing 5,000 share of Tk. 10 each. (d) The „Other Expenses „are related to prepaid items. (e) All income taxes incurred during the year were paid during the year. 158


(f) In order to supplement its cash leads corporation issued 4,000 share of common stock at par value. (g) There were no penalties assessed for the retirement of bond. (h) Cash dividend of Tk. 105,000 were declared and paid at the end of the fiscal year. Required: Prepare a Statement of Cash flow for the year ended December 31, 2017, using the Direct Method as per IAS-7. Solution Leads Corporation Statement of cash flow As per IAS-7 (Direct method) For the year ended December 31, 2017 Taka Cash flow from operation activities: Collection from customer (note-1) Payment to supplier (note-2) Payment to employees (note-3) Payment of other expenses (note-4) Interest paid (note-5) Tax paid Cash inflow from operating activities

1,233,250 (674,000) (250,100) (10,150) (99,750) (43,000)

Cash flow from investing activities: Purchase of machinery & equipment Cash outflow from investing activities

(48,000)

Cash flow from financing activities: Issue of common shares (4,000 X Tk.10) Payment of short term loan Dividend paid Cash outflow from investing activities Net increase in cash & cash equivalent Add. Cash & cash equivalent at beginning Cash & cash equivalent at end

Taka

156,250

(48,000) 40,000 (30,000) (105,000) (95,000) 13,250 20,000 33,250

Notes: 1. Collection from customers: Sales Add. Accounts receivable at beginning Less. Accounts receivable at end 2. Payment to supplier: Stock-in-trade at end Add. Cost of goods sold Goods available for sale 159

Tk.1,255,250 58,000 (80,000) Tk.1,233,250 Tk.210,000 722,000 Tk.932,000


Less. Stock-in-trade at beginning Purchase Add. Accounts payable at beginning Less. Accounts payable at end

250,000 Tk.68,200 115,000 (123,000) Tk.674,000

3. Payment to employees: Salary expense Add. Outstanding expense at beginning Less. Outstanding expense at end

Tk.252,100 25,000 (27,000) Tk.250,100

4. Payment to other expenses: Other expenses Add. Increase in prepaid expenses

Tk.8,150 2,000 Tk.1,0150

5. Interest paid: Interest expenses Add. Outstanding interest at beginning Less. Outstanding interest at end

Tk.75,000 72,000 (47,250) Tk.99,750

P-15. Financial information for Tremendous Enterprise Inc. for the year ended December 31, 2017 and 2016 are as follows: Tremendous Enterprise Inc. Statement of Financial Position As of December 31, 2017 and 2016 2017 Assets Cash and cash equivalents Trade receivables Inventory Intangible assets, net Due from associates Property, plant, and equipment, cost Accumulated depreciation Property, plant, and equipment, net Total assets Liabilities Accounts payable Income taxes payable Deferred taxes payable Total liabilities Shareholders‟ equity Share capital Retained earnings Total shareholders‟ equity Total liabilities and shareholders’ equity

2016

Tk.4,500 7,500 3,000 1,500 28,500 18,000 (7,500) 10,500 55,500

Tk.1,500 3,750 2,250 2,250 28,500 33,750 (9,000) 24,750 63,000

Tk.7,500 3,000 4,500 15,000

Tk.18,750 1,500 3,000 23,250

Tk.9,750 30,750 Tk.40,500 Tk.55,500

Tk.9,750 30,000 Tk.39,750 Tk.63,000 160


Tremendous Enterprise Inc. Income Statement For the Year Ended December 31, 2017 Sales Cost of sales Gross operating income Administrative and selling expenses Interest expenses Depreciation of property, plant, and equipment Amortization of intangible asset Investment income Net income before taxation Taxes on income Net income

Tk.45,000 (15,000) 30,000 (3,000) (3,000) (3,000) (750) 4,500 24,750 (6,000) Tk.18,750

Additional Information This additional information is relevant to the preparation of the statement of cash flows: (a) All sales made by Tremendous Enterprise Inc. are credit sales. All purchases are on account. (b) Interest expense for the year 2017 was Tk.3,000, which was fully paid during the year. (c) The company pays salaries and other employee dues before the end of each month. All administration and selling expenses incurred were paid before December 31, 2017. (d) Investment income comprises dividend income from investments in shares of Forex Company. This was received before December 31, 2017. (e) Equipment with a net book value of Tk.11,250 and original cost of Tk.15,750 was sold for Tk.11,250. (f) The company declared and paid dividends of Tk.18,000 to its shareholders during 2017. (g) Income tax expense for the year 2017 was Tk.6,000, against which the company paid Tk.3,000 during 2017 as an estimate. Required: Using the given financial information for Tremendous Enterprise Inc., prepare the statement of cash flows under the direct method. Solution: Tremendous Enterprise Inc. Statement of cash flow (Direct method) December 31, 2017 Taka Cash flow from operating activities: Cash received from customers (w1) 41,250 Cash paid to suppliers & employees (w2) (30,000) Cash provided by operations 11,250 Interest paid (3,000) Taxes paid (3,000) Cash from investing activities: Proceeds from sale of equipment Dividends received 161

11,250 4,500

Taka

5,250

15,750


Cash flow from financing activities: Dividends paid Net increase in cash and cash equivalents Cash and cash equivalents at beginning Cash and cash balance at end

(18,000)

(18,000) 3,000 1,500 4,500

Workings: 1. Cash received from customers: Sales Add. Trade receivables at beginning Less. Trade receivables at end

Tk.45,000 3,750 (7,500) Tk.41,250

2. Cash paid to supplier & employees: Inventory at end Add. Cost of goods sold Goods available for sale Less. Inventories at beginning Purchase Add. Accounts payable at beginning Less. Accounts payable at end

Tk.3,000 15,000 Tk.18,000 (2,250) Tk.15,750 18,750 (7,500) Tk.27,000 3,000 Tk.30,000

Add. Administrative and selling expenses

P-16. Financial information for Maple Leaf Company for the year ended December 31, are presented below: Maple Leaf Company Balance Sheet December 31

Assets Cash Accounts receivable Inventories Land Plant and equipment (net of accumulated depreciation) Patents Total Liabilities and equity Accounts payable Staff expense payable Future income tax liability Borrowings, bonds Ordinary shares Retained earnings Total

2017 Tk.’000

2016 Tk.’000

50.0 105.0 130.0 162.5 245.0

45.0 70.0 110.0 100.0 266.5

15.0 707.5

16.5 608.0

130.0 100.0 70.0 65.0 241.5 101.0 707.5

100.0 105.0 50.0 90.0 190.0 73.0 608.0 162


Maple Leaf Company Income Statement

Sales Cost of sales Gross margin Staff expenses Depreciation Amortization of patents Interest expenses Gain on retirement of bonds Miscellaneous expenses Loss on sale of equipment Profit before income tax Income tax – current Income tax – future Profit

2017 Tk.’000 500.0 280.0 220.0 95.0 10.0 1.5 8.0 (10.0) 3.5 2.0 110.0 29.5 20.0 60.5

Additional information: (a) On March 3, 2017, the company issued a 10% stock dividend. The market price per share of the ordinary stock was Tk.7.50 on March 3, 2017. (b) On April 2, 2017, the company issued 3,800 shares of ordinary stock for land. The company stock and land had current market value of approximately Tk.20,000. (c) On May 16, 2017, the company retired borrowings, bonds with a face value of Tk.25,000. (d) On July 31, 2017, the company sold equipment costing Tk.26,500 with a book value of Tk.11,500 for Tk.9,500. (e) On October 31, 2017, the company declared and paid a Tk.0.02 per share cash dividend. (f) On November 10, 2017, the company purchased land for Tk.42,500 cash. (g) The future income tax liability represents a temporary difference relating to the use of depreciation allowed for income tax reporting and straight-line depreciation allowed for financial statement reporting. (h) Borrowings, bonds mature December 31, 2019. (i) Ordinary shares outstanding on December 31, 2016, were 42,000 and at December 31, 2017 were 50,000. Required: (i) Prepare a statement of cash flow in good form using the direct method to present the operating activities section. (ii) Compute the 2017 ratios to evaluate solvency. (iii) Provide an assessment of the company‟s solvency and liquidity based on the two above requirements. Solution:

163


(i) Maple Leaf Company Statement of cash flow (Direct method) December 31, 2017 Taka Cash flow from operating activities: Cash received from customers (w-1) Cash paid to suppliers (w-2) Cash paid to employees (w-3) Cash paid to other expenses Interest paid Tax paid

Taka

465,000 (270,000) (100,000) (3,500) (8,000) (29,500) 54,000

Cash from investing activities: Purchase of land Sale of equipment

(42,500) 9,500 (33,000)

Cash flow from financing activities: Repayment of bonds (90 – 65) – 10 Dividends (w-4) Change in cash and cash equivalent Opening cash and cash equivalent Closing cash and cash equivalent

(15,000) (1,000) (16,000) 5,000 45,000 50,000

(ii) Tk.130,000  Tk.100,000  Tk.70,000  Tk.65,000 Tk.241,500  Tk.101,000 = 1.07 Tk.70,000  Tk.65,000 Debt to total capitalization ratio = Tk.70,000  Tk.65,000 Tk.241,500  Tk.101,000 = 0.28

Debt to equity ratio =

(iii) Maple Leaf generated Tk.54,000 from operations, spent a net Tk.33,000 on property, plant and equipment, and retired a portion of its long-term debt. The cash position showed a modest increase. Overall, the company has modest levels of long-term debt. Total debt is more significant, since there is Tk.1.07 of debt for each taka of equity. However, long-term debt only represents 28% of total capitalization and times interest earned is a healthy 15 times. Short-term debt is not excessive when viewed as part of the total picture, as debt is only 25% of total assets. Short-term debt introduces some additional risk into the financial management picture, but is low or no cost debt to the organization.

164


Workings: 1. Cash received from customers: Sales Add. Accounts receivable at beginning Less. Accounts receivable at end 2. Cash paid to suppliers: Inventories at end Add. Cost of goods sold Goods available for sale Less. Inventories at beginning Purchase Add. Accounts payable at beginning Less. Accounts payable at end

Tk.500,000 70,000 (105,000) Tk.465,000 Tk.130,000 280,000 Tk.410,000 110,000 Tk.300,000 100,000 (130,000) Tk.270,000

3. Cash paid to employees: Staff expense Add. Staff expense payable at beginning Less. Staff expense payable at end 4. Dividends: {42,000 shares + (42,000 shares X 10%) + 3,800 shares} X Tk.0.02 = 50,000 shares X Tk.0.02 = Tk.1,000

Contact us to collect exercises solution. Helpline: 01711137039

165

Tk.95,000 105,000 (100,000) Tk.100,000


EXERCIES E-1. GLORY LTD is a public listed manufacturer. Its summarized consolidated financial statements for the year ended 30 June 2017 (with 2016 comparatives) are as follows: Glory Ltd: Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June. 2017 2016 Million (Tk.) Million (Tk.) Revenue 18,410 16,200 Cost of sales (15,200) (11,100) Gross profit 3,210 5,100 Operating costs (3,750) (3,600) Gains on revaluation of financial assets 20 40 Finance costs (49) (33) Profit (loss) before taxation (569) (1,507) Income tax expense (80) (180) Profit for the year (649) (1,327) Profit for the year attributable to: Owners of the parent Non-controlling interests Profit for the year

(654) 5 (649)

Glory Ltd: Consolidated Statement of Financial Position as at 30 June: 2017 Million (Tk.) Non-current assets: Property, plant and equipment 2,360 Intangible assets 350 Goodwill 60 Financial assets 210 2,980 Current assets: Inventory 400 Trade receivables 460 Bank 860 Total assets 3,840 Equity: Equity shares of Tk.1 each Share premium Retained earnings Non-controlling interest

1,400 500 504 2,404 50 2,454

1,327 1,327

2016 Million (Tk.) 2,400 350 0 180 2,930 275 340 230 845 3,775

1,300 350 1,205 2,855 0 2,855

166


Non-current liabilities: 6% Bonds 2022 Current liabilities: Trade payables and provisions Bank overdraft Current tax payable Total equity and liabilities

680

550

466 160 80 706 3,840

280 --90 370 3,775

The following notes should be taken into account, if relevant: (i) On 1 July 2016, Glory bought an 80% stake in another equity, Dolly Ltd. The cost of the stake was Tk.200 million, satisfied by Glory issuing 48 million equity shares valued at Tk.2.50 each and Tk.80 million in cash. The fair value of the net assets acquired on the acquisition date was Tk.180 million, consisting of the following: • Property, plant & equipment Tk.120m • Intangible assets Tk.30m • Inventory Tk.25m • Cash Tk.20m • Trade payables (Tk.15m) Tk.180m The fair value of the non-controlling interest at the acquisition date was Tk.47 million. Glory Ltd. uses the full goodwill method in all acquisitions. Goodwill was impairment tested at 30 June 2017, and any impairment loss was correctly accounted for through operating expenses. (ii) There were no disposals of non-current assets during the period. No intangible assets were acquired apart from those acquired through the acquisition of Dolly Plc. Depreciation of property, plant & equipment amounted to Tk.207 million, charged to operating expenses. Amortization of intangible assets was also charged to operating expenses. (iii) There were no non-cash adjustments to the 6% Bonds. (iv) Include in the figure for “trade payables and provisions” at 30 June 2017 is a provision for warranty claims amounting to Tk.27 million (2016: Tk.14 million). (v) Equity dividends were paid during the by Glory and Dolly. (vi) Financial assets which had cost Tk.60 million, and had a carrying value on 30 June 2016 of Tk.75 million, were sold during the year for Tk.78 million. Required: (a) Prepare a Consolidated Statement of Cash Flows for the Glory Group in accordance with IAS-7. (b) Evaluate, using suitable ratios where relevant, any insights revealed by the statement of cash flows into the financial performance and position of the group as at 30 June 2017. CMA Adapted – June 2017 E-2. OMEGA‟s financial statements for 2015/2016 include the following: OMEGA statement of profit or loss and other comprehensive income for the year ended 30 November 2016

167


Revenue Cost of sales Gross profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Profit for the period Other comprehensive income – items that will not be reclassified subsequently to profit or loss Revaluation gain on properties

Note

Tk.000 58,292 (27,605) 30,687 (7,246) (2,410) 21,031 (2,461) 18,570 (1,646) 16,924

(ii)

3,750 20,674

OMEGA Statement of financial position at 30 November Note Non-current assets Property, plant and equipment Deferred development expenditure Current assets Inventories Trade receivables Investments Cash in hand and at bank Total assets Equity and liabilities Equity Equity shares Share premium Revaluation reserve Retained earnings Total equity Non-current liabilities Long-term loans Deferred tax Finance lease payable Current liabilities Total equity and liabilities

(i);(ii);(iii)&(iv) (v)

(vi)

(vii)

(ix)

2016 2015 Tk.000 Tk.000 Tk.000 Tk.000 104,450 2,150 4,664 2,901 0 237

106,600

7,802 114,402

27,350 10,835 3,750 39,119

88,680 2,548 3,780 5,046 350 712

(iv) (viii)

(i) Property, plant and equipment are comprised of: 2016 Tk.000 Property 62,120 Plant and equipment 42,330

26,350 1,258 1,491

9,888 101,116

18,350 1,835 0 24,732 81,054

(x)

91,228

29,099 4,249 114,402

44,917 49,099 890 438

50,578 5,621 101,116

2015 Tk.000 52,000 36,680

Plant and equipment with a carrying value of Tk.196,000 was sold during the year for Tk.365,000. Any gain/loss on disposal is included in profit or loss. (ii) Properties were revalued on 30 November 2016. (iii) Depreciation charged during the year to 30 November 2016 was Tk.1,040,000 for property and Tk.4,115,000 for plant and equipment. 168


(iv) OMEGA acquired new plant and equipment on a finance lease on 1 December 2015, debiting Tk.1,500,000 to plant and equipment at that date. The total interest on finance leases for the year was Tk.143,000. (v) Deferred development expenditure at 30 November 2015 comprised two projects re as follows: Project A Tk.2,260,000 – completed. Amortization commenced on 1 December 2015 at 10% per year. Project B Tk.288,000 – on 1 December 2015, OMEGA decided to discontinue project B. During the year ended 30 December 2015, OMEGA capitalized expenditure on a new project, Project C. (vi) The current asset investment, disposed of during the year, was a 30 day government bond. (vii) OMEGA issued 9,000,000 Tk.1 equity shares at a premium of Tk.1 on 30 November 2015. (viii) Current liabilities: 2016 2015 Tk.000 Tk.000 Trade payable 1,250 1,850 Loan interest payable 1,166 2,024 Tax payable 1,490 1,620 Finance lease payable 343 127 Total current liabilities 4,249 5,621 Required: Prepare OMEGA‟s statement of cash flows, using the indirect method, for the year ended 30 November 2016 in accordance with IAS 7 Statement of Cash Flows. Notes to the financial statements are not required, but all workings must be clearly shown. CMA Adapted – December 2016 E-3. The financial statements of MNC are given below: Statement of Financial Position as at: 31 Oct 2015 Tk.000 Tk.000 Non-current Assets Property, plant and equipment Development expenditure Current Assets Inventory Trade receivables Cash and cash equivalents Total Assets Equity and Liabilities Equity shares of Tk.1 each Share premium Revaluation reserve Retained earnings 169

4,676 417

606 456 1,989

3,780 1,420 560 1,314

5,093

3,051 8,144

7,074

31 Oct 2014 Tk.000 Tk.000 4,248 494

509 372 205

2,180 620 260 1,250

4,742

1,086 5,828

4,310


Non-current liabilities Long term borrowings Deferred tax Current liabilities Trade payables Current tax Accrued interest Provision for redundancy costs Total Equity and Liabilities

360 210 425 70 5 0

570

500 8,144

715 170

885

310 170 3 150

633 5,828

Statement of Comprehensive Income for the year ended 31 October 2015 Tk.000 Revenue Cost of sales Administrative expenses Distribution costs Finance cost Taxation Profit for the year Other Comprehensive Income Gain on revaluation of property, plant and equipment

(2,040) (788)

Tk.000 6,640 (3,530) 3,110 (2,828) 282 (16) 266 120 146 300 446

Additional information: (i) On 1 November 2014, MNC issued 1,600,000 Tk.1 ordinary shares at a premium of 50%. No other finance was raised during the year. (ii) MNC paid a dividend during the year. (iii) Plant and equipment disposed of in the year had a net book value of Tk.70,000; cash received on disposal was Tk.66,000. Any gain or loss on disposal has been included under cost of sales. (iv) Cost of sales includes Tk.145,000 for development expenditure amortised during the year. (v) Depreciation charged for the year was Tk.250,000. (vi) The income tax expense for the year to 31 October 2015 is made up as follows: Tk.000 Corporate income tax 80 Deferred tax 40 120 During the year to 31 October 2014 MNC set up a provision for redundancy costs arising from the closure of one of its activities. During the year to 31 October 2015, MNC spent Tk.177,000 on redundancy costs, the additional cost being charged to administrative expenses. Required: (i) Prepare a statement of cash flows, using the indirect method, for MNC for the year ended 31 October 2015, in accordance with IAS 7 Statement of Cash Flows. 170


(ii) One of your friend heard that you work for MNC, a well known international entity. There are rumors in the press that MNC‟s latest share issue was to raise cash to enable it to launch a takeover bid for another entity. Your friend wants to treat you to dinner at an expensive local restaurant, so that you can give him details of the proposed takeover before it is made public. Explain how you would respond to your friend considering Professional Ethics. CMA Adapted – December 2015 E-4. MONYEM Company had the following Balance Sheet at December 31, 2013. MONYEM Company BALANCE SHEET DECEMBER 31, 2013 Cash Accounts receivable Investments Plant assets (net) Land

Tk.20,000 21,200 32,000 81,000 40,000 Tk.194,200

Accounts payable Long-term notes payable Common stock Retained earnings

Tk.30,000 41,000 100,000 23,200 _____Tk.194,200

During the year 2014 the following events occurred: 1. MONYEM Company sold part of its investment portfolio for Tk.17,000. This transaction resulted in a gain of Tk.3,400 for the company. The company classifies its investments as available-for-sale. 2. A piece of land was purchased for Tk.18,000 by cash. 3. Long-term notes payable in amount of Tk.16,000 were retired before maturity by paying Tk.16,000 cash. 4. An additional Tk.24,000 in Common Stock was issued at par. 5. Dividends totaling Tk.8,200 was declared and paid to the Stockholders. 6. Net income for the year 2013 was Tk.32,000 after allowing for depreciation of Tk.12,000. 7. Land was purchased through the issuance of Tk.30,000 in Bonds. 8. At the December 31, 2014: - Cash was Tk.39,000 - Accounts Receivable was Tk.41,600 and - Accounts Payable remained at Tk.30,000. Required: (i) Prepare a Statement of Cash Flows for the year 2014. (ii) Prepare the Balance Sheet as it would appear at December 31, 2014. (iii) How might the statement of cash flows help the user of the financial statements? Compute any one Cash Flow Ratio. CMA Adapted – August 2015 E-5. Rahim and Karim are examining the following statement of cash flows for Jamuna Clothing Store‟s first year operations.

171


Pacific Clothing Store Statement of Cash Flows For the year ended January 31, 2012 Sources of cash From sales of merchandise From sale of capital stock From sale of investment From depreciation From issuance of note for truck From interest on investments Total sources of cash

Tk.382,000 380,000 120,000 80,000 30,000 8,000 1,000,000

Uses of cash For purchase of fixtures and equipment For merchandise of purchase For operating expenses (including depreciation) For purchase of investment For purchase of truck by issuance of note For purchase of treasury stock For interest on note Total uses of cash Net increase in cash

330,000 253,000 170,000 95,000 30,000 10,000 3,000 891,000 Tk.109,000

Rahim claims that Jamunaâ€&#x;s statement of cash flows is an excellent portrayal of a superb first year, with cash increasing Tk.109,000. Karim replies that it was not a superb first year that the year was an operating failure, the statement was incorrectly presented, and Tk.109,000 is not the actual increase in cash. Required: (a) With whom do you agree, Rahim or Karim? Explain your position. (b) Using the data provided, prepare a statement of cash flows in proper indirect method form. The only non-cash items in income are depreciation and gain from the sale of the investment (purchase and sale are related). CMA Adapted – April 2015 E-6. The following balance sheets relates to Ruma Chemical Company. Ruma Chemical Company Comparative Balance Sheets December 31 Assets Cash and cash equivalent Accounts Receivable Marketable Securities Inventories Prepaid insurance Land and buildings Equipment Treasury stock (at cost) Discount on bond payable Total

2013 Tk. 24,42,000 16,00,000 2,10,000 32,01,000 27,500 21,45,000 31,90,000 55,000 93,500 1,29,64,000

2012 Tk. 5,50,000 11,00,000 4,40,000 33,00,000 22,000 21,45,000 18,70,000 1,10,000 99,000 96,36,000 172


Liabilities and stockholder’s equity Allowance for doubtful accounts Accumulated depreciation on buildings Accumulated depreciation on equipment Accounts payable Notes payable (current) Expense payable (current) Tax payable Un-earned revenues Note payable long term Bonds payable Deferred income tax liability Common stock Retained earnings appropriated Retained earnings Paid in capital in excess of par Total

60,000 2,88,750 4,37,250 6,05,000 7,70,000 1,98,000 3,85,000 11,000 4,40,000 27,50,000 5,17,000 39,53,400 5,71,000 8,64,600 11,13,000 1,29,64,000

Income Statement For the year ended December 31, 2013 Income before extra-ordinary items Add. Gain on marketable securities Loss on sale of equipment 11,000 Decline in value of securities 44,000 Income before income tax Less: income tax Net income

55,000 2,47,000 3,02,000 6,60,000 2,20,000 95,700 1,10,000 99,000 6,60,000 27,50,000 5,86,000 22,00,000 3,63,000 12,32,000 55,000 96,36,000

Tk. 7,92,000 132,000 9,24,000 55,000 8,69,000 3,85,000 4,84,000

Additional Information: All purchases and sales were on account. A six months note payable for Tk.5,50,000 was issued toward the purchase of new equipment. Long term notes payable requires the payment of Tk.2,20,000 per year plus interest until paid. Equipment with original cost Tk.164,000 was sold for Tk.77,000. Treasury stock was sold for Tk.11,000 more than its costs and the surplus was created to additional paid in capital in excess of par. Equipment was overvalued, extending its useful life at a cost of Tk.66,000. The cost was debited accumulated depreciation equipment. During the year a 30% stock dividend was declared and issued. At the time there were 2,20,000 shares of Tk.10 per common stock outstanding. However 2,200 of those shares were held as treasury stock at the time were prohibited from the participation in the stock dividend. Market price was Tk.15 per share at the time the dividend was declared. Selling and general expenses include: building depreciation Tk.41,250, equipment depreciation Tk.2,77,750, doubtful accounts expenses Tk.44,000, interest expenses Tk.198,000. Additional 110,000 shares of common stock were sold in cash at Tk.23,10,000. A cash dividend of Tk.88,000 was paid during the year. 173


Required: From the above information, prepare a statement of cash flows using the indirect method in accordance with BAS 7 for the year ended 31 December 2013. CMA Adapted – December 2014 E-7. The net changes in the balance sheet accounts of Uttara Company for the year 2011 are shown below: Account Debit Credit Cash Tk. 94,200 Accounts receivable Tk. 48,000 Allowance for doubtful accounts 10,500 Inventory 162,900 Prepaid expenses 15,000 Long-term investments 108,000 Land 225,000 Buildings 450,000 Machinery 75,000 Office equipment 21,000 Accumulated depreciation: Buildings 18,000 Machinery 15,000 Office equipment 9,000 Accounts payable 137,400 Accrued liabilities 54,000 Dividend payable 96,000 Premium on bonds 24,000 Bonds payable 600,000 Preferred stock (Tk. 50 par) 45,000 Common stock (Tk. 10 par) 117,000 Additional paid-in capital-common stock 167,400 Retained earnings 65400 Tk.1,278,900 Tk.1,278,900 Additional Information: (i) Cash dividends of Tk. 96,000 were declared December 15, 2011, payable January 15, 2012. A 5% stock dividend was issued March 31, 2011, when the market value was Tk. 22.00 per share. (ii) The long-term investments were sold for Tk. 105,000. (iii) A building and land which cost Tk. 360,000 and had a book value of Tk. 225,000 were sold for Tk. 300,000. The cost of the land, included in the cost and book value above, was Tk. 15,000. (iv) The following entry was made to record an exchange of an old machine for a new one: Machinery ........................................................ 120,000 Accumulated depreciation- Machinery.................... 30,000 Machinery............................................... 45,000 Cash ...................................................... 105,000 (v) A fully depreciated copier machine which cost Tk. 21,000 was written off. (vi) Preferred stock of Tk. 45,000 par value was redeemed for Tk. 60,000. 174


(vii) The company sold 9,000 shares of its common stock (Tk. 10 par) on June 15, 2011 for Tk. 25 a Share. There were 65,700 shares outstanding on December 31, 2011. (viii) Bonds were sold at Tk. 104 on December 31, 2011. (ix) Land was condemned had a book value of Tk. 180,000. (x) Income statement Data for Year Ended December 31, 2011 Income before extraordinary item Tk. 204,000 Extraordinary loss: Condemnation on land 99,000 Net income Tk. 105,000 Required: Prepared a statement of cash flows for 2011 using the indirect method. CMA Adapted – August 2014 E-8. Comparative balance sheets for Eddie Murphy Company are presented below: Eddie Murphy Company Comparative Balance Sheets on December 31 Assets 2012 Cash and cash equivalent Tk. 12,21,000 Accounts receivable 8,00,000 Marketable securities 1,05,000 Inventories 16,00,500 Prepaid insurance 13,750 Land and buildings 10,72,500 Equipment 15,95,000 Treasury stock (at cost) 27,500 Discount on bond payable 46,750 Total 64,82,000 Liabilities and Stockholder’s Equity Allowance for doubtful accounts 30,000 Accumulated depreciation on buildings 1,44,375 Accumulated depreciation on equipment 2,18,625 Accounts payable 3,02,500 Notes payable (current) 3,85,000 Expense payable 99,000 Tax payable 1,92,500 Un-earned revenues 5,500 Note payable long term 2,20,000 Bonds payable 13,75,000 Deferred income tax liability 2,58,500 Common stock 19,76,700 Retained earnings appropriated 2,85,500 Retained earnings 4,32,300 Paid in capital in excess of par 5,56,500 Total 64,82,000

175

2011 Tk. 2,75,000 5,50,000 2,20,000 16,50,000 11,000 10,72,500 9,35,000 55,000 49,500 48,18,000 27,500 1,23,750 1,51,250 3,30,000 1,10,000 47,850 55,000 49,500 3,30,000 13,75,000 2,93,150 11,00,000 1,81,500 6,16,000 27,500 48,18,000


Income Statement For the year ended December 31, 2012 Income before extra-ordinary items Add: Gain on marketable securities Less: Loss on sale of equipment Decline in value of securities Income before income tax Less: Income tax Net income

Tk. 3,96,000 66,000 4,62,000

5,500 22,000 27,500 4,34,500 1,92,500 2,42,000

Additional Information: 1. All purchases and sales were on account. 2. Equipment with an original cost of Tk.82,500 was sold for Tk.38,500. 3. A six months note payable for Tk.2,75,000 was issued toward the purchase of new equipment. 4. Long term notes payable requires the payment of Tk.1,10,000 per year plus interest until paid. 5. Treasury stock was sold for Tk.5,500 more than its costs and the surplus was created to additional paid in capital in excess of par. 6. Equipment was overvalued, extending its useful life at a cost of Tk.33,000. The cost was debited accumulated depreciation equipment. 7. During the year a 30% stock dividend was declared and issued. At the time there were 1,10,000 shares of Tk.10 per common stock outstanding. However 1,100 of those shares were held as treasury stock at the time were prohibited from the participation in the stock dividend. Market price was Tk.15 per share at the time the dividend was declared. 8. A cash dividend of Tk.44,000 was paid during the year. 9. Additional 55,000 shares of common stock were sold in cash at Tk.11,55,000. 10. Selling and general expenses include: building depreciation Tk. 20,625, equipment depreciation Tk. 1,38,875, doubtful accounts expenses Tk. 22,000, interest expenses Tk. 99,000. Required: Prepare a statement of cash flows for 2012 using the indirect method. CMA Adapted – April 2014 E-9. The following is Method man Corp.â€&#x;s comparative balance sheet accounts work sheet at December 31, 2005 and 2004, with a column showing the increase (decrease) from 2004 to 2005. COMPARATIVE BALANCE SHEETS Taka Taka Increase 2005 2004 (Decrease) Cash 807,500 700,000 107,500 Accounts receivable 1,128,000 1,168,000 (40,000) Inventories 1,850,000 1,715,000 135,000 Property, plant and equipment 3,307,000 2,967,000 340,000 Accumulated depreciation (1,165,000) (1,040,000) (125,000) Investment in Blige Co. 305,000 275,000 30,000 Loan receivable 262,500 ______262,500 Total assets 6,495,000 5,785,000 710,000 176


Accounts payable Income taxes payable Dividends payable Capital lease obligation Capital stock, common, Tk.1 par Additional paid-in capital Retained earnings Total liabilities and stockholders’ equity

1,015,000 30,000 80,000 400,000 500,000 1,500,000 2,970,000 6,495,000

955,000 50,000 100,000 500,000 1,500,000 2,680,000 5,785,000

60,000 (20,000) (20,000) 400,000 2,90,000 710,000

Additional information: (1) On December 31, 2004, Method Man acquired 25% of Blige Co.‟s common stock Tk.275,000. On that date, the carrying value of Blige‟s assets and liabilities, which approximated their fair values, was Tk.1,100,000. Blige reported income of Tk.120,000 for the year ended December 31, 2005. No dividends was paid on Blige‟s common stock during the year. (2) During 2005, Method Man loaned Tk.300,000 to TLC Co., an unrelated company. TLC made the first semi-annual principal repayment of Tk.37,500, plus interest at 10%, on December 31, 2005. (3) On January 2, 2005, Method Man sold equipment costing Tk.60,000 with a carrying amount of Tk.35,000 for Tk.40,000 cash. (4) On December 31, 2005, Method Man entered into a capital lease for an office building. The present value of the annual rental payment is Tk.400,000, which equals the fair value of the building. Method Man made the first rental payment for Tk.60,000 when due on January 2, 2006. (5) Net income for 2005 was Tk.370,000. (6) Method Man declared and paid cash dividends for 2005 and 2004 as follows: 2005 2004 Declared December 15, 2015 December 15, 2004 Paid February 28, 2006 February 28, 2005 Amount Tk.80,000 Tk.100,000 Required: Prepare a statement of cash flows for Method Man Corp. for the year ended December 31, 2005, using the indirect method. CMA Adapted – December 2013 E-10. The comparative statement of Financial Position for XYZ Company shows the following information: Statement of Financial Position As on 31st December Assets Non-Current Assets Property, plant and equipment Less: Accumulated depreciation Patent 177

2012

2012

2011

280000

225000

90000

345300 Share capital (Tk.10 Par) 78000 Share premium

18000

10000

328500 65000

267300 Revaluation reserve 73000 Retained earnings

13000 123500

5000 111800

418500

2011 Equity and Liabilities Capital and Reserves


Current Assets Inventories Account receivables Cash and cash equivalent Prepaid expenses

Total Assets

30000 45000

Non-Current Liabilities 21000 8% Debentures 37000 Current Liabilities

40500

47300 Accounts payable

6500

515500

8700 Outstanding expenses Income tax liability Interest payable 454300 Total Equity and Liability

45000

65000

20500

17200

2800 12000 700 515500

4000 16000 300 454300

Additional Information: (a) Details of property, plant and equipment: Cost

Accumulated Depreciation 2011 2012 2011 2012 Freehold building 175,000 200,000 0 0 Furniture and fixtures 45,300 73,000 22,500 28,700 Equipment 125,000 145,500 55,500 61,300 Total 345,300 418,500 78,000 90,000 (i) No Depreciation has been provided for freehold building, however, during the year a professional revaluation of buildings taking account of additions during the year has been incorporated into the books of accounts. There were no disposals during the year. (ii) Account payables includes Tk.15,000 for purchase of furniture during the year. (iii) Equipment with original cost of Tk.45,000 was sold for Tk.18,000 during the year. (b) Profit before interest and tax was Tk.47,800 for the year which includes loss on sale of equipment Tk.2,500. (c) Company paid interest of Tk.1,800 on the outstanding balance of debenture. (d) Corporate tax rate applicable for the firm is 35%. (e) On February 2012 the company made a right issue of 1 for 5 shares at Tk.11.50 per share. (f) New shares were issued at June 2012. Part of the proceeds was used to redeem 8% Debenture at a Premium of 4% of their face value. (g) On November 2012 cash dividend was declared and paid by the company. Required: Prepare a statement of cash flow for XYZ Company following BAS-7. CMA Adapted – August 2013 E-11. Balance Sheet of 3M Limited is given below: 3M Limited Balance Sheet As at

178


Liabilities Share capital (50,000 shares @ Tk.10/- each) 9% Debentures Sundry creditors Profit and Loss A/c Depreciation fund Contingency reserve Outstanding expenses

31.12.2011 (Tk.) 500,000 200,000 230,000 40,000 80,000 140,000 30,000 1,220,000

31.12.2012 (Tk.) 500,000 160,000 216,000 54,000 88,000 110,000 48,000 11,76,000

300,000 164,000 200,000 170,000 120,000 262,000 4,000 1,220,000

300,000 180,000 228,000 162,000 110,000 190,000 6,000 11,76,000

Assets Land & building Machinery Stock-in-trade Sundry debtors Cash & bank balances Current investment Prepaid expenses

The following information is furnished: (i) One old machinery which has original cost of Tk.30,000 was sold for Tk.10,000. The accumulated depreciation in respect of the said machinery amounts to Tk.16,000. (ii) One new machinery was acquired for Tk.46,000. (iii) 9% Debentures were redeemed at a discount of 4% of their face value. (iv) Dividend at 12% was declared and paid in cash. (v) Income-tax liability of Tk.30,000 paid was debited to contingency reserve. Required: Prepare a Cash Flow Statement in accordance with the Bangladesh Accounting Standard – 7 (BAS-7). CMA Adapted – April 2013 E-12. The balance sheet of Shaad Chemical Industries Ltd. As at 30 June 2012, including comparative figures, is given below: Assets Non-current assets Property, plant and equipment Less: Accumulated depreciation Investment Total non-current assets Current assets Inventories Trade and other receivables Cash and cash receivables Total current assets Total assets 179

2012 (Tk.)

2011 (Tk.)

333,000 (70,000) 263,000 50,000 313,000

311,000 (69,000) 242,000 ______242,000

12,000 29,000 20,000 61,000 374,000

11,000 27,000 10,000 48,000 290,000


Equity and liabilities Capital and reserves Ordinary share capital (Tk.1 per ordinary share) 95,000 50,000 Share premium 15,000 10,000 Revaluation reserve 12,000 12,000 Retained earnings 149,000 115,000 Total Capital and reserve 271,000 187,000 Non-current liabilities Interest-bearing borrowings (12% Debenture) 50,000 60,000 Current liabilities Trade and other payables 27,000 19,000 Provisions 2,000 Accruals 19,000 19,000 Tax liability 7,000 3,000 Total current liability 53,000 43,000 Total equity and liabilities 374,000 290,000 You are also given the following information which is already reflected correctly in the accounts. (i) During the year a bonus issue of 1 for 10 was made on the ordinary shares in issue utilizing available profits at 30 June 2011. (ii) New share were issued on 1 July 2011. Part of the proceeds was used to redeem Tk.10,000, 12% debentures at par. (iii) Trade and other payable include Tk.5,000 for 2012 relating to the fixed asset purchases. (iv) During the year certain tangible non-current assets were disposed of for Tk.20,000. The assets had originally cost Tk.40,000 and had a net book value at the disposal date of Tk.18,000. (v) The corporation tax charge for the year is Tk.7,000. Required: Prepare a cash flow statement using indirect method for the year ended 30 June 2012 and the note reconciling profit before tax with cash generated from operations. CMA Adapted – December 2012 E-13. General Motors Ltd. has prepared the balance sheet as set out below: Balance Sheet as at 31 March 2011 (Tk. ’000) Assets Non-current assets Property, plant and equipment 30,946 Investments 7,100 38,046 Current assets Inventories 16,487 Trade and other receivables 12,347 Cash and cash equivalents 863 29,697 67,743

2010 (Tk. ’000)

25,141 ______25,141 15,892 8,104 724 24,720 49,861 180


Equity and liabilities Capital and reserves Ordinary share capital (Tk.1 per ordinary share) Share premium Revaluation reserve Retained earnings Non-current liabilities Current liabilities Trade payables Accruals Tax liability Total equity and liabilities

13,000 12,500 7,450 24,776 57,726 3,250

10,000 5,000 2,650 22,856 40,506 4,250

2,771 1,200 2,796 6,767 67,743

2,632 1,235 1,238 5,105 49,861

The following notes are relevant: (i) Profit before tax was Tk.5,404,000 for the year ended 31 March 2011. (ii) Provision for tax was Tk.2,634,000 for the year ended 31 March 2011. Taxation provided at 31 March 2010 was settled at a figure lower than the amount provided. (iii) Analysis of property, plant and equipment 2011 (Tk.’000) 2010 (Tk.’000) Freehold building 25,100 19,780 Fixtures and fittings 5,846 5,361 30,946 25,141 (iv) Depreciation has not been provided on freehold buildings. During the year a professional revaluation of building taking account of additions during the year has been incorporated into the books of account. There were no disposals during the year. (v) Additions to fixtures and fittings during the year totaled Tk.1,365,000 at cost. There were no disposals. (vi) During the year the company made a right issue of shares on the basis of three new shares for every ten shares held at a price of Tk.3.5 per share. Pending the purchase of new plant part of the proceeds of the issue has been invested in share in other listed companies. Required: From the above information, prepare a cash flow statement using the indirect method in accordance with BAS 7 Cash Flow Statements for the year ended 31 March 2011. CMA Adapted – August 2012 E-14. The following are the Balance Sheets of Moonlight Ltd. as at 30 June 2011 and 2010: Assets Cash in Hand Trade Debtors

2011 (Taka) 8000000 11280000

Stock in Trade Fixed Assets

18500000 33070000

Accumulated Depreciation

181

(11650000)

2010 Liabilities and (Taka) Equity 7000000 Accounts Payable 11680000 Income Tax Payable 17150000 Dividend Payable 29670000 Finance Lease Obligations (10400000) Share Capital

2011 (Taka) 10150000 300000

2010 (Taka) 9550000 500000

800000 4000000

900000 -

5000000

5000000


Investment in B Ltd. Loan Receivable Total

3050000 2700000 64950000

2750000 Share Premium _______- Unappropriated Profit 57850000 Total

15000000

15000,000

29700000 64950000

26900000 57850000

Additional information: i) On 30 June 2010, Moonlight Ltd. acquired 25% shares of B Ltd. For Tk.27,50,000. On that date the carrying value of B‟s assets and liabilities, approximately their fair value was Tk.1,10,00,000. B Ltd. reported income of Tk.12,00,000 for the year ended 30 June 2011. ii) During financial year 2011, Moonlight lent Tk.30,00,000 to sunlight Ltd. sunlight paid the 1st installment (including interest) of Tk.3,00,000 on 1st April 2011. iii) On 2 July 2010, Moonlight Ltd. sold equipment costing Tk.6,00,000 with a carrying amount of Tk.3,50,000 for Tk.4,00,000. iv) On 30 June 2011, Moonlight Ltd. entered into finance lease for machinery. The PV of the rental payment is Tk.40,00,000 which equals the fair value. Moonlight Ltd. made the first rental payment for Tk.6,00,000 when due on 2 July 2011. v) Net income for the year 2011 was Tk.36,00,000. vi) Moonlight Ltd. declared and paid cash dividend as follows: 2011 2010 Declared 15 June 2011 15 June 2010 Paid 30 August 2011 30 August 2010 Amount Tk.8,00,000 Tk.9,00,000 Required: Prepare the cash flow statement following the IAS-7 (indirect basis). Also show your workings. CMA Adapted – April 2012 E-15. From the following information, prepare a cash flow statement for Texaco Company. Texaco Company Balance Sheet as at December 31, 2010 Particulars 31.12.2010 31.12.2009 Assets: (Taka) (Taka) Cash 900,000 500,000 Account Receivable 450,000 550,000 Notes Receivable 150,000 150,000 Inventories 750,000 1,000,000 Building 1,000,000 1,000,000 Plant and Equipment 900,000 1,000,000 Accumulated Depreciation (350,000) (400,000) Land 380,000 300,000 Total 4,180,000 4,100,000 Liabilities and stockholders’ equity: Account Payable 800,000 700,000 Salaries Payable 100,000 50,000 Expense Payable 50,000 50,000 Bonds Payable 12% 1,080,000 1,100,000 Common Stock 600,000 800,000 Additional paid in Capital 300,000 400,000 Retained Earnings 1,250,000 1,000,000 Total 4,180,000 4,100,000 182


Texaco Company Income Statement for the year ended December 31, 2010 Particulars Revenues Cost of goods sold Depreciation Expense Salaries Expense Interest Expense Gain on sale of Equipment Net Income

(Taka) 2,500,000 (1,200,000) (250,000) (400,000) (100,000) 100,000 650,000

Additional information: (i) A piece of machinery with an original cost of Tk.500,000 and accumulated depreciation of Tk.300,000 was sold for Tk.300,000. (ii) Common stock originally issued for Tk.300,000 was acquired for Tk.350,000 and retired. The difference of Tk.50,000 was deleted to retained earnings. (iii) The total dividends declared and paid during 2010 was Tk.350,000. CMA Adapted – December 2011 E-16. The following balance sheet relates to Provati Housing Limited, a small private company. Provati Housing Limited Balance sheet as at 31 March 2010 and 2011 2011 (Taka) 2010 (Taka) Non-current assets 102,500 91,700 Land and building at valuation 62,300 49,200 Less. Accumulated depreciation (6,800) (5,000) 55,500 44,200 Equipment at cost 84,600 70,000 Less. Accumulated depreciation (37,600) (22,500) 47,000 47,500 Investment at cost 8,200 16,900 Current assets 100,900 87,200 Inventory 43,300 57,400 Trade receivables 50,400 28,600 Bank 1,200 Advance income tax 7,200 Total assets 211,600 195,800 Equity 142,900 112,300 Ordinary shares of Tk.1 each 50,000 25,000 Share premium 2,500 5,000 Revaluation reserve 18,000 12,000 Retained earnings 72,400 70,300 Non-current liabilities Bank loan 39,800 43,200 Current liabilities 28,900 40,300 Trade payables 26,700 31,400 Bank overdraft 1,900 Taxation 8,900 Accrued bank loan interest 300 Total equity and liabilities 211,600 195,800 183


The following notes are relevant: (i) The profit before interest and tax was Tk.22,100 for the year ended 31 March 2011. (ii) There was no disposal of land and buildings during the year. The increase in the revaluation reserve was entirely due to the revaluation of the Company‟s land. (iii) Equipments with a net book value of Tk.12,000 (cost Tk.23,000) were sold during the year for Tk.7,800. The loss on sale has been included in the profit before interest and tax. (iv) Investments with a cost of Tk.8,700 were sold during the year for Tk.11,000. The profit has been included in the profit before interest and tax. There were no further purchases of investments. (v) On 10 October 2010, a bonus issue of 1 for 10 ordinary shares was made utilizing the share premium account. The remainder of the increase in ordinary shares was due to an issue for cash on 30 October 2010. (vi) During the year Tk.20,000 and Tk.1,400 were paid as dividend and interest on bank loan respectively. Tax provision for the current year has not yet been made. Required: From the above information, prepare a cash flow statement using the indirect method in accordance with BAS 7 Cash Flow Statement for the year ended 31 March 2011. CMA Adapted – April 2011 E-17. From the following information, prepare a cash flow statement for Ranges Company Ltd: Ranges Company Ltd. Balance Sheet as at December 31, 2009 Particulars 31.12.2009 31.12.2008 Assets: (Taka) (Taka) Cash 62,000 200,000 Accounts Receivables, net 80,000 60,000 Inventories 20,000 12,000 Prepaid 10,000 6,000 Equipment (net) 500,000 300,000 Patent 70,000 90,000 Total 742,000 668,000 Liabilities and Stockholders‟ Equity: Accounts Payable 60,000 40,000 Salaries Payable 50,000 60,000 Interest Payable 9,000 6,000 Income Tax Payable 20,000 12,000 Mortgage Payable 110,000 120,000 Bonds payable 100,000 200,000 Premium on Bonds Payable 3,000 8,000 Common Stock 170,000 150,000 Retained Earnings 220,000 72,000 Total 742,000 668,000 Ranges Company Ltd. Income Statement For the year ended December 31, 2009 184


Particulars Sales Cost of goods sold Depreciation Amortization of Patent Other Expenses Gain (excess of insurance proceeds over book value of equipment destroyed) Interest Expenses Income Tax Expenses Extraordinary loss on Bond retirement (net of Tk.1,000 tax) Net Income

(Taka) 820,000 (380,000) (100,000) (20,000) (46,000) 10,000 (22,000) (72,000) (2,000) 188,000

Additional Information: (i) Ranges declared Tk.40,000 of dividends in 2009. (ii) Equipment which costs Tk.100,000 book value of Tk.40,000 was destroyed by fire. Claim proceeds from insurance company for Tk.50,000 was received by the company. (iii) Bonds were retired on January 01, 2009 at Tk.107, applicable taxes Tk.1,000. CMA Adapted – December 2010 E-18. XYZ Ltd. a major retailer of accessories operates several stores and is listed with Dhaka Stock Exchange. The comparative statement of financial position and income statement for XYZ Ltd. as a June 30, 2010 are shown below to prepare its statement of cash flow: XYZ Ltd. Comparative Statement of Financial Position As a June 30, 2009 and June 30, 2010

Current Assets: Cash Debtors Stock-in-trade Prepaid expenses Total current assets Long-term Assets: Machinery and equipments Less: Accumulated depreciation Net long-term assets Total assets Current Liabilities: Creditors Payable: Interest Salary Short-term loan Total current liabilities

185

2010 (Taka)

2009 (Taka)

33,250 80,000 210,000 9,000 332,250

20,000 58,000 250,000 7,000 335,000

600,000 (150,000) 450,000 782,250

502,000 (125,000) 377,000 712,000

123,000 47,250 27,000 70,000 267,250

115,000 72,000 25,000 100,000 312,000


Shareholders’ equity: Common shares (Tk. 10/- each) Retained earnings Total shareholders‟ equity Total liabilities and shareholders‟ equity

370,000 145,000 515,000 782,250

280,000 120,000 400,000 712,000

XYZ Ltd. Income Statement for the year ended June 30, 2010 Sales Cost of goods sold Total contribution Expenses: Payroll expenses Interest expenses Other expenses Depreciation Total expenses EBT Tax EAT

Taka 1,255,250 (722,000) 533,250 (252,100) (75,000) (8,150) (25,000) 360,250 173,000 (43,000) 130,000

Other information for consideration: (i) During the year all sales were made on account; (ii) All stocks was purchased on account, comprising trade creditors account; (iii) Machinery and equipments costing Tk.98,000/- were purchased by paying Tk.48,000/- in cash and issuing 5,000 shares of Tk.10/- each; (iv) Income taxes incurred during the year were paid during the year; (v) In order to supplement its cash, XYZ Ltd. issued 4,000 shares at par value; (vi) Cash dividends of Tk.105,000/- were declared and paid at the end of fiscal year; (vii) The „other expenses‟ are related to prepaid items. Required: Prepare a statement of cash flows as per IAS-7 for XYZ Ltd. for the year ended June 30, 2010 using the direct method. CMA Adapted – August 2010 E-19. The following schedule shows the account balance of Eldora Company at the beginning and end of the fiscal year ended October 31, 2008. Debits October November Increase 31, 2008 01, 2007 (Decrease) (Amount (Amount in (Amount in in Taka) Taka) Taka) Cash 2,26,000 50,000 1,76,000 Accounts Receivable 1,48,000 1,00,000 48,000 Inventories 2,91,000 3,00,000 (9,000) Prepaid Insurance 2,500 2,000 500 Long-term Investment (at cost) 10,000 40,000 (30,000) Sinking Fund 90,000 80,000 10,000 Land and Building 1,95,000 1,95,000 --Equipment 2,15,000 90,000 1,25,000 186


Discount on Bonds Payable Treasury Stock (Cost) Cost of Goods Sold Selling and General Expenses Income Tax Loss on Sale of Equipment Total Debits Credits

Allowance for doubtful Accounts Accumulated Depreciation- Building Accumulated Depreciation- Equipment Accounts Payable Notes Payable- Current Miscellaneous Expenses Payable Taxes Payable Unearned Revenue Notes Payable- Long-term Bond Payable- Long-term Common Stock Retained Earnings Appropriated for Sinking Fund Unappropriated Retained earnings Paid-in Capital in Excess of Par Value Sales Gain on Sale of Investments Total Credits

8,500 5,000 5,39,000 2,87,000 35,000 1,000 20,53,000 October 31, 2008 (Amount in Taka) 8,000 26,250 39,750 55,000 70,000 18,000 35,000 1,000 40,000 2,50,000 3,00,000 90,000

9,000 10,000 --------------------8,76,000 November 01, 2007 (Amount in Taka) 5,000 22,500 27,500 60,000 20,000 15,000 10,000 9,000 60,000 2,50,000 2,00,000 80,000

(500) (5,000) 5,39,000 2,87,000 35,000 1,000 11,77,000 Increase (Decrease) (Amount in Taka) 3,000 3,750 12,250 (5,000) 50,000 3,000 25,000 (8,000) (20,000) ----1,00,000 10,000

94,000 1,16,000 8,98,000 12,000 20,53,000

1,12,000 5,000 ----------8,76,000

(18,000) 1,11,000 8,98,000 12,000 11,77,000

The following information was also available: (a) All purchase and sales were on account. (b) The sinking fund will be used to retire the long term bonds. (c) Equipment with and original cost of Tk.15,000 was sold for Tk.7,000. (d) Selling and general expenses include the following expenses: Building depreciation Tk.3,750 Equipment depreciation Tk.19,250 Doubtful accounts expenses Tk.4,000 Interest expenses Tk.18,000 (e) A six month note payable for Tk.50,000 was issued forward the purchase of new equipment. (f) The long-term note payable requires the payment of Tk.20,000 per year plus interest until paid. (g) Treasury stock was sold for Tk.1,000 more than its cost. (h) All dividends were paid by cash. Required: Prepare statement of cash flow for 2008. Also show your workings. CMA Adapted – December 2009

187


E-20. Condensed financial data of Pat Metheny Company for 2005 and 2004 are given below: Pat Metheny Company Comparative Balance Sheet As of December 31, 2005 and 2004 Particulars Year 2005 Year 2004 Cash Tk.1,800 Tk.1,150 Receivables 1,750 1,300 Inventory 1,600 1,900 Plant Assets 1,900 1,700 Accumulated Depreciation (1,200) (1,170) Long-term Investments (Held to Maturity) 1,300 1,420 Total Tk.7,150 Tk.6,300 Accounts Payable Accrued liabilities Bonds Payable Capital Stock Retained Earning Total

Tk.1,200 200 1,400 1,900 2,450 Tk.7,150

Tk.900 250 1,550 1,700 1,900 Tk.6,300

Pat Metheny Company Income Statement For the year ended December 31, 2005 Sales Cost of goods sold Gross margin Selling and admin expenses Income from operation Other revenues and gains: Gain on sale of investments Income before tax Income tax expense Net income Cash dividends Income retained in business

Tk.6,900 4,700 2,200 930 1,270 80 1,350 540 810 260 550

Additional Information: During the year, Tk.70 Common Stock was issued in exchange for plant assets. No plant assets were sold in 2005. Required: A statement of Cash Flow using the indirect method. CMA Adapted – August 2009

188


CHAPTER - 5 CONSOLIDATED FINANCIAL STATEMENTS (IFRS 10)

5.1. CONCEPT OF CONSOLIDATED FINANCIAL STATEMENTS Consolidated financial statements are the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent (company) and its subsidiaries are presented as those of a single economic entity. Consolidation involves taking multiple accounts or businesses and combining the information into a single point. In business, consolidation occurs when two or more businesses combine to form one new entity, with the expectation of increasing market share and profitability and the benefit of combining talent, industry expertise or technology. Consolidated financial reports are prepared by any parent company that owns one or more subsidiaries. For example, it is common for one company to purchase smaller companies that can complement the primary business and make it even stronger. The smaller companies can help the profitability of the parent company while also continuing to operate as separate entities. Each subsidiary must prepare its own financial statements including balance sheet, income statement, statement of cash flows and statement of retained earnings. This information for each subsidiary is then combined using consolidation software to create consolidated financial reports that represent the financial position of the parent company as a whole. 5.2. BENEFITS OF CONSOLIDATED FINANCIAL REPORTS Consolidated financial reports are a GAAP requirement for good reason. Some of the many key benefits of consolidated financial reports include the following: Complete Overview – Consolidated statements allow investors, financial analysts, business owners and other interested parties to get a complete overview of the parent company. At a glance, one can view the overall health of the business and how each subsidiary impacts the parent company. Reducing Paperwork – With consolidated financial statements, there is also less paperwork involved. If the parent company owns nine subsidiaries, there are 40 separate standalone financial reports to view i.e. the four basic financial statements for each subsidiary plus the parent company. Not only would it be hard to track down all these records, it would be extremely difficult to look over each of them and try to get an overall view of how the business is performing. Consolidated financial statements cut this pile of reports down to just four consolidated reports. This means less paperwork and less effort involved in assessing a parent company‟s financial health. Simplification – Consolidation software cuts out all transactions that occur between subsidiaries and the parent company since, in the grand scheme of the business, these things cancel each other out. Eliminating these transactions gives a simplified view of business performance. 189


5.3. MEANING OF ASSOCIATE COMPANY AND SUBSIDIARY COMPANY An associate company (or associate) in accounting and business valuation is a company in which another company owns a significant portion of voting shares, usually 20–50%. In this case, an owner does not consolidate the associate's financial statements. A subsidiary is a company with voting stock that is more than 50% controlled by another company, usually referred to as the parent company or the holding company. A subsidiary is partly or completely owned by the parent company, which holds a controlling interest in the subsidiary company. In cases where a parent company owns a foreign subsidiary, the subsidiary must follow the laws of the country where it is incorporated and operates, and the parent company carries the foreign subsidiary's financials on its consolidated financial statements. 5.4. RELATIONSHIPS BETWEEN HOLDING AND SUBSIDIARY COMPANY (i) Holding companies create subsidiaries for various reasons. One common relationship between the holding company and the subsidiary is shareholding. The holding company is typically the primary and sole holder of stocks belonging to the subsidiary company. As the sole stockholder, the holding company makes decisions such as the election and appointment of the board of directors in the subsidiary company. However, the subsidiary company remains an independent and separate entity from the parent company. (ii) The autonomy of a subsidiary company may seem to be only theoretical. Besides the majority stockholding, the holding company controls important business operations of a subsidiary. For example, the holding company is in charge of preparing the by laws that govern the subsidiary, especially on matters of hiring and appointing senior management employees. The subsidiary company may not amend these by laws on its own without the consent and approval of the sole shareholder -- the parent company. (iii) The subsidiary and holding companies are separate legal entities; each may be sued by other companies or may sue others. However, the parent company has the responsibility of acting in the best interest of the subsidiary by making the most favorable decisions that affect the management and financials of the subsidiary company. The holding company may be found guilty in a court, for breach of fiduciary duty, if it does not fulfill its responsibilities. The holding company and the subsidiary are perceived to be one and the same if the holding company fails to fulfill its fiduciary duties to the subsidiary company. Both companies would share liabilities incurred by either. (iv) The parent corporation organizes the subsidiary's management structure and company by laws, setting forth rules related to corporate governance. The level of control the parent exerts over the subsidiary determines how independent both companies are when viewed by outsiders. If the parent commingles funds with the subsidiary, shares insurance contracts and employee benefit plans, markets both companies as a single entity, files consolidated income tax returns or acts as a creditor to the subsidiary, both companies will be viewed as a single entity. Such activities may cause liability issues for the parent, and a stakeholder (creditor or other party affected by the companies' business activities) can sue the parent for using the subsidiary to advance its own interests.

190


(v) Although the parent/subsidiary relationship exists through ownership, it is imperative that both entities implement protective measures to prevent stakeholders from treating the entities as one company. The parent can ensure its subsidiary operates independently by delegating more control to the subsidiary's management team, reporting financials separately, and allowing the subsidiary to hire employees and conduct its business operations as an independent entity. 5.5. DIFFERENCES BETWEEN HOLDING AND SUBSIDIARY COMPANY (i) A holding company buys, absorbs or otherwise obtains a majority percentage of stock in another company, which becomes known as its subsidiary. Typically, a holding company must control 50 percent or more of a companyâ€&#x;s stock before it's considered a subsidiary. The subsidiaries, while not independently owned, often continue to operate as individual entities, though major corporate decisions are made by the holding company. (ii) A holding company directs the management and operations of the subsidiaries it owns and maintains the authority to add or remove board members, directors and other key management and personnel. (iii) A subsidiary has little to no financial control over its operations. Even independently acting subsidiaries are ultimately financially controlled by their holding company. (iv) A holding company may invest in subsidiaries in a variety of industries to diversify its investment, lower its risk potential and, in some instances, take advantage of shared loss and tax consolidation. A subsidiary that regains a majority of its shares also regains its autonomy from its holding company.

191


PROBLEMS AND SOLUTIONS P-1. H Ltd. acquired a 70% interest in the equity shares of F. Ltd. for Tk. 750,000 on January 1, 2011. The abridged statement of financial position of both companies at the date of acquisition were as follows. H. Ltd. Tk.(000) F. Ltd. (Tk.000) Identifiable assets 8200 2000 Investment in F. Ltd. 750 8950 2000 Equity 6000 1200 Identifiable liabilities 2950 800 8950 2000 The fair value of the identifiable assets of F. Ltd. amounts to Tk. 2800,000 and the fair value of the liabilities is Tk. 800,000. The non-controlling interest will be measured as a percentage of net assets of the acquire. Demonstrate the results of the acquisition. Solution: H Limited Consideration Plus non-controlling interest (2000 x 30%) Less. Net identifiable asset of F. Ltd. Gain on bargain purchase

Tk.000 750 600 1,350 2,000 650

The abridged consolidated statement of financial position at the date of acquisition will appear as follows: Tk.000 Assets (8200 + Fair value of F. Ltd. 2800) 11,000 Shareholdersâ€&#x; equity (6,000+650) gain included in P/L Non-controlling interest Liabilities (2950 + 800) Total shareholdersâ€&#x; equities & liabilities

6,650 600 3,750 11,000

P-2. The balance sheets of A company and B Company are given below as on 30 June 2018: A Company (Taka)

B Company (Taka)

30,000 40,000 20,000 90,000

25,000 0 15,000 40,000

Assets Non-current assets: Property, plant and equipment Investment in B Company Current assets

192


Capital and liabilities Capital: Share capital Retained earnings Current liabilities

50,000 18,000 22,000 90,000

16,000 14,000 10,000 40,000

A Acquires 100% of B on 30 June 2018. Required: Prepare a consolidated statement of financial position at 30 June 2018. Solution: A Company Consolidated statement of financial position As at 30 June 2018 Assets Goodwill (w-1) Property, plant and equipment (30,000 + 25,000) Current assets (20,000 + 15,000)

Taka 10,000 55,000 35,000 100,000

Capital and liabilities Share capital Retained earnings (w-2) Current liabilities (22,000 + 10,000)

50,000 18,000 32,000 100,000

Workings: 1. Goodwill: Cost of investment Less. Fair value of net assets acquired (As calculated below) Goodwill at reporting date

Fair value of net assets acquired: Acquisition date Share capital 16,000 Retained earnings 14,000 30,000 2. Retained earnings: Parent Subsidiary (100% X Post acquired profits) Impairment

193

Tk.40,000 (30,000) Tk.10,000

Reporting date 16,000 14,000 30,000

Tk.18,000 0 0 Tk.18,000


P-3. The followings are the balance sheet of Tata Ltd. and Data Ltd. as on December 31, 2017:

Assets: Goodwill Premises Machinery Stock Sundry Debtors Investment Bills Receivable Bank Balance Capital and liabilities: Share capital Tk. 10 each General Reserve Profit and Loss Accounts (January 01, 2017) Profit for the year Sundry Creditors Bills Payable

Tata (Tk.)

Data (Tk.)

10,000 20,000 50,000 20,000 34,000 24,000 3,000 5,000 1,66,000

5,000 10,000 20,000 10,000 7,000 0 3,000 2,000 57,000

1,00,000 20,000 6,000 15,000 20,000 5,000 1,66,000

25,000 8,000 6,000 5,000 10,000 3,000 57,000

Other information: (a) Investment includes 1,500 shares of Data Ltd. by Tata Ltd Tk. 19,000 on January 01, 2017. (b) Sundry creditors of Tata ltd. includes Tk. 3,000 due to Data Ltd. whereas sundry debtors of Data Ltd. includes tk. 3,500 due from Tata Ltd. It is found that Tata Ltd. remitted a cheque of Tk. 500, which has not been received by Data Ltd. (c) Bills receivable of Data Ltd. includes Tk. 1,000 due from Tata Ltd. (d) Tata Ltd. and Data Ltd. have proposed 10% Dividend for 2017 but effects has not been given in accounts. (e) Stock of Tata Ltd. includes Tk. 600 stock purchased from Data Ltd. on which the latter made 20% profit on cost. Stock of Data Ltd. includes stock of Tk. 1,000 purchased from Tata Ltd. on which the latter made 10% profit of selling price. Solution: Workings: 1) Calculation of interest of Holding and Subsidiary Company: 1,500 Tata Ltd. = X 100 2,500 = 60%

1,000 X 100 2,500 = 40%

Tata Ltd. =

194


2) Calculation of Pre-acquisition Profit/ Capital Profit: General Reserve Tk. 8,000 Profit and Loss Account (Last year) Tk. 6,000 Total Profit 14,000 Share of Tata Ltd. = 14,000 60% = Tk. 8,400 Share of Data Ltd. = 14,000 40% = 5,600 3) Calculation of Goodwill or Capital Reserve: Face value of the share (1500 10) Add: Capital Profit Less: Cost price of Share Capital Reserve 4) Calculation of Post-acquisition Profit: Current year profit of Data Ltd. Less: Proposed Dividend (25,000 10%)

15,000 8,400 23,400 (19,000) 4,400

5,000 (2,500) 2,500

Share of Tata Ltd. = 2,500 60% = 1,500 Share of Data Ltd. = 2,500 40% =1,000 5) Calculation of Minority Interest: Value of the share of Data Ltd. (1,000 Tk.10) Add: Pre acquisition Profit Add: Post Acquisition Profit Total Minority Interest 6) Calculation of Unrealized Profit: 20 For Stock of Tata Ltd. = (Tk.600 X ) 120 For Stock of Data Ltd. = (Tk.1,000 X 10%)

10,000 5,600 1,000 16,600

= Tk. 100 =

Tk. 100 Tk. 200

7) Calculation of Profit and Loss of Tata Ltd.: Last year Profit 6,000 Current year Profit 15,000 Post-acquisition Profit 1,500 Dividend Received from Data Ltd. (2,500 X 60%) 1,500 Less: Proposed Dividend (1,00,000 X 10%) (10,000) Less: Unrealized Profit (200) Adjusted Profit 13,800

195


Tata Limited Consolidated Balance Sheet As at December 31, 2017 Assets Goodwill Premises Machinery Investment Less: Investment in Data Stock Less: Unrealized Profit Sundry Debtors Less: Inter transaction Bills Receivable Less: Inter transaction Cheques in transits Bank Balance

24,000 (19,000) 30,000 (200) 41,000 (3,500) 6,000 (1,000)

Taka 15,000 30,000 70,000 5,000 29,800 37,500 5,000 500 7,000 1,99,800

Capital and liabilities Share Capital Reserve and Surplus: Capital Reserve Proposed Dividend: For Tata Ltd For Minority Shareholder Minority Interest General Reserve Profit and Loss Account Sundry Creditors Less: Inter Transaction Bills Payable Less: Inter transaction

1,00,000 4,400 10,000 1,000

30,000 (3,000) 8,000 (1,000)

11,000 16,600 20,000 13,800 27,000 7,000 1,99,800

P-4. H Company acquired 12,000 shares in S Company for Tk. 1,70,000 on 1st April, 2017. The balance sheet of two companies on 31st December, 2017 were as follows: H Company S Company (Taka) (Taka) Assets: Goodwill 3,00,000 70,000 Land and Building 4,00,000 1,00,000 Plant and Machinery 5,00,000 1,00,000 Stock 2,00,000 40,000 Sundry Debtors 3,00,000 1,35,000 Investment 1,70,000 --Bills Receivable 50,000 30,000 Cash and Bank Balance 80,000 62,000 20,00,000 5,37,000 196


Capital and liabilities: Share Capital (Tk.10 each) General Reserve Profit and Loss Account Sundry Creditor Bills Payable

10,00,000 4,20,000 2,60,000 2,40,000 80,000 20,00,000

3,00,000 50,000 85,000 42,000 60,000 5,37,000

On 1st January, 2017 the profit and loss account of S Company showed a credit balance of Tk. 40,000 out of which a dividend of 15% on the capital of Tk. 2,00,000 was paid in June, 2016. At the same time, a bonus share of one (fully paid) for every two shares held was also made out of general reserve. Bills payable of S Company represents Bills issued in favor of H Company which the company still held Tk. 40,000 of the bills accepted by S Company. The entire closing stock of S Company represents goods supplies by H Company @ 20% profit on cost. H Company and S Company agreed that for service rendered H Company should charge Tk. 500 per month from S Company entries for this were not made when the amounts were drawn up. Prepare consolidated balance sheet as at 31st December, 2017. Solution: Workings: 1) Interest on Holding and Subsidiary Company:

12000 X 100 20,000 = 60%

Holding company =

8000 X 100 20,000 = 40%

Subsidiary company =

2) Calculation for pre-acquisition profit: Profit and Loss Account Less. Profit and Loss (1-1-16) Dividend (2,00,000 15%) Profit during the year So, Pre-acquisition profit = Tk.75,000 X

85,000 40,000 (30,000)

3 months 12months

= Tk.18,750 Post-acquisition profit = Tk.75,000 – Tk.18,750 = Tk.56,250 197

(10,000) 75,000


3) Calculation total pre-acquisition profit: General Reserve Profit and Loss Account (40,000 - 30,000) Bonus Share (3,00,000 - 2,00,000) Current year Profit Total Profit

50,000 10,000 1,00,000 18,750 1,78,750

Share of Holding Company = Tk.1,78,750 60% = Tk.1,07,250 Share of Subsidiary Company = Tk.1,78,750 = Tk.71,500 4) Calculation of Goodwill/ Capital Reserve: Paid-up Share Capital (12,000 10) Add: Capital Profit/ Pre-acquisition Profit Add: Dividend (30,000 60%) Less: Cost price of the share Capital Reserve 5) Calculation of Revenue Profit: Profit and Loss Account Less: Service Charge (500 X 9 months) Share of Holding Company = 51,750 = 31,050 Share of Subsidiary Company = 51,750 = 20,700 6) Calculation of Minority Interest: Share Capital (8,000 10) Capital Profit Revenue Profit Unrealized Profit = 40,000 X

40%

1,20,000 1,07,250 18,000 2,45,250 (1,70,000) 75,250

56,250 (4,500) 51,750 60%

40%

80,000 71,500 20,700 1,72,200

20 120

= 6,667 7) Calculation of Profit and Loss account of Holding Company: Profit in Balance Sheet 2,60,000 Less: Dividend (30,000 60%) (18,000) Less: Unrealized Profit (6,667) Add: Revenue Profit 31,050 Add: Service Charge receivable from S Ltd 4,500 Adjusted Profit 2,70,883

198


Goodwill Less: Capital Reserve Land and Building Plant and Machinery Stock Less: Unrealized Profit Sundry Debtors Bills Receivable Less: Inter Transaction Cash at bank

Consolidated Balance Sheet As at 31st December, 2017 Assets 370,000 (75,250)

240,000 (6,667) 80,000 (40,000)

Taka 294,750 500,000 600,000 233,333 435,000 40,000 142,000 22,45,083

Capital and liabilities Share Capital Reserve and Surplus: General Reserve Profit and Loss Account Minority Interest Sundry Creditors Bills Payable Less: Inter Transaction

10,00,000 4,20,000 2,70,883 1,72,200 2,82,000 140,000 (40,000)

1,00,000 22,45,083

P-5. From the following particulars prepare a consolidated Balance Sheet showing the relevant workings: Balance Sheet As at 31st December 2017 Liabilities H. Ltd. S. Ltd. Assets H. Ltd. S. Ltd. Tk. Tk. Tk. Tk. Share capital: Shares of Tk.100 500,000 200,000 Plant and Machinery 400,000 100,000 each Inventory 60,000 40,000 Reserve Fund 200,000 - 8% Debenture in S Ltd. 40,000 8% Debenture 80,000 1,500 shares in S Ltd. 105,000 Accounts payable 74,000 50,000 Loan due by S. Ltd. 5,000 Loan from H. Ltd 3,000 Accounts Receivable 70,000 40,000 Bills Payable 10,000 Bills Receivable 4,000 Profit & Loss A/c 100,000 - Advertisement carried 10,000 over 53,000 Cash at Bank 190,000 ______ ______ Profit and Loss A/c _____- 100,000 874,000 343,000 874,000 343,000 Additional information: (a) H. Ltd. acquired the shares in S. Ltd. on 1st July 2017 and on that date Profit and Loss Account showed a debit balance of Tk.1,60,000.

199


(b) Accounts payable of S. Ltd. include Tk.25,000 for goods supplied by H. Ltd. on which H. Ltd. made a profit of 25% on cost. Half of these goods wherein inventory was of S. Ltd. on 31st December 2017. (c) Out of total acceptances of S. Ltd. bills of value of Tk.8,000 were issued in favour of H. Ltd. who discounted half of them. (d) A cheque of Tk.2,000 sent to H. Ltd. by S. Ltd. in respect of loan, was not received by H. Ltd. until 5th January 2018. Solution: H. Limited Consolidated balance Sheet As at 31st December 2017 Capital and liabilities Share capital (Tk.100 each) Reserve and surplus: Reserve fund Profit & Loss account 8% Debenture 80,000 Less. Set-off (40,000) Sundry creditors: H. Ltd. 74,000 S. Ltd. 50,000 124,000 Less. Set-off (25,000) Loan from H. Ltd. 3,000 Add. Cash in transit 2,000 5,000 Less. Set-off (5,000) Bills payable 10,000 Less. Set-off (,4000) 1 (8,000 X ) 2 Minority interest

Taka Assets 500,000 Fixed Assets: Goodwill 200,000 Plant and machinery: 120,625 H. Ltd. 400,000 S. Ltd. 100,000 40,000 Stock: H. Ltd. 60,000 S. Ltd. 40,000 100,000 Less. Unrealized 99,000 profit (1,875) 8% Debentures In S. Ltd. 40,000 Less. Set-off (40,000) Nil Shares in S. Ltd 105,000 Less. Transfer to 6,000 Cost of control (105,000)

25,000 Cash in transit Debtors: H. Ltd. S. Ltd. Less. Set-off Bills receivable Less. Set-off Advertisement Cash and at bank: H. Ltd. S. Ltd. 990,625

Taka 52,500

500,000

98,125

Nil

Nil

2,000 70,000 40,000 110,000 (25,000) 4,000 (4,000)

190,000 53,000

85,000 Nil 10,000

243,000 990,625

200


Workings: 1) Pre-acquisition and post-acquisition ratio: 6 months : 6 months 1 1 or, : 2 2 Tk.1,500 2) Interest of H. Ltd. in S. Ltd. = = 75% Tk.2,000 3) Interest of Minority holders = 100 – 75 = 25% 4) Unrealized profit on stock: 1 Stock = Tk.25,000 X = Tk.12,500 2 25 Unrealized profit = Tk.12,500 X X 75% 125 = Tk.1,875 5. Profit made by S. Ltd. during the year: Loss at the end of the year Loss at the beginning Profit during the year

Tk.100,000 (160,000) Tk.60,000

6. Capital loss: Loss at the date of acquisition Less. Pre-acquisition profit Total capital loss

Tk.160,000 (30,000) Tk.130,000

Share of H. Ltd. = Tk.130,000 X 75% = Tk.97,500 Share of Minority holder = Tk.130,000 X 25% = Tk.32,500 7) Revenue Profit: Post-acquisition profit

Tk.30,000

Share of H. Ltd. = Tk.30,000 X 75% = Tk.22,500 Share of Minority holder = Tk.30,000 X 25% = Tk.7,500 8. Cost of control: Cost of shares held Less. Face value of shares held (1,500 X Tk.100) Share of capital loss Goodwill

201

Tk.105,000 Tk.150,000 (97,500)

52,500 Tk.52,500


9) Minority Interest: Value of the share (500 Tk.100) Share of capital (Loss) Share of revenue (Profit) Total Minority Interest 10) Reserve and surplus: Reserve fund (H. Ltd.) Profit & Loss account: H. Ltd. S. Ltd. Less. Unrealized profit

Tk.50,000 (32,500) 7,500 25,000

Tk.200,000 Tk.100,000 22,500 122,500 (1,875) 120,625

P-6. The following are the balance Sheets of Alpha Ltd. and Beta Ltd. as on 31.12.2017: Assets Goodwill Fixed Assets Inventory Accounts Receivable Inventory (2,000 shares in Beta Ltd.) Bank Total: Taka Capital & Liabilities Share Capital of Tk.100 each General Reserve as on 01.01.2016 Accumulated Profit Notes Payable Accounts Payable Total: Taka

Alpha Ltd. 40,000 470,000 220,000 115,000 250,000 25,000 1,120,000 Alpha Ltd. 800,000 100,000 140,000 80,000 1,120,000

Beta Ltd. 30,000 330,000 75,000 75,000 40,000 550,000 Beta Ltd. 300,000 60,000 90,000 40,000 60,000 550,000

The Income Statement of Beta Ltd. showed a profit of Tk.60,000 as on 01.01.2017. A dividend of 10% was paid on 15.10.2017 for the year 2016. Alpha Ltd. included the dividend to its Income Statement. Alpha Ltd. acquired the shares of Beta Ltd. on 01.07.2017. The Notes Payable of Beta Ltd. were all accepted in favour of Alpha Ltd. The notes were discounted by Alpha Ltd. included in the Accounts Payable of Alpha Ltd. is Tk.30,000 for goods supplied by Beta Ltd. The inventory of Alpha Ltd. includes Tk.16,000 for goods supplied by Beta Ltd. at a profit of 25% on sales. Required: Consolidated Balance Sheet of Alpha Ltd. and its subsidiary Beta Ltd. Solution: Alpha Ltd. and its subsidiary Beta Ltd. Consolidated balance Sheet As at 31.12.2017 202


Capital and liabilities Share capital (Tk.100 each) Reserve and surplus: Reserves Profit & Loss account Minority interest Current liabilities & provisions: Bills payable Creditors: Alpha Ltd. 80,000 Beta Ltd. 60,000 140,000 Less. Set-off 30,000

Taka Assets Taka 800,000 Goodwill: Alpha Ltd. 40,000 100,000 Beta Ltd. 30,000 137,856 70,000 150,000 Less. Capital reserve 50,000 20,000 Fixed assets: 40,000 Alpha Ltd. 470,000 Beta Ltd. 330,000 800,000 Stock: Alpha Ltd. 220,000 Beta Ltd. 75,000 110,000 295,000 Less. Unrealized profit 2,144 292,856 Debtors: Alpha Ltd. 115,000 Beta Ltd. 75,000 190,000 Less. Set-off 30,000 160,000 Cash at bank: Alpha Ltd. 25,000 Beta Ltd. 40,000 65,000 1337856 1337856

Workings:

Tk.2,000 = 67% Tk.3,000 2) Interest of Minority holders in Beta Ltd. = 100 – 67 = 33% 1) Interest of Alpha Ltd. in Beta Ltd. =

3) Share capital at creditors of Beta Ltd. = Tk.800,000 4. Inter company debt = Tk.30,000 Unrealized profit in stock of Beta Ltd. = Tk.16,000 X

25 X 67% 125

= Tk.2,144 5. Capital profit (Pre-acquisition profit): Reserve on 01.01.2010 Profit & Loss account on 01.01.2010 Less. Dividend paid for 2009 Half of net profit to be capitalized 1 (Tk.90,000 – Tk.30,000) X 2 Less. Share of minority (33%) Share of Alpha Ltd. 203

Tk.60,000 Tk.60,000 (30,000)

30,000 30,000 120,000 40,000 Tk.80,000


6. Revenue profit (Post-acquisition profit): 1 Net profit during the year (Tk.60,000 X ) 2 Less. Minority shares (33%) Share of Alpha Ltd.

Tk.30,000 (10,000) Tk.20,000

7. Goodwill or cost of control: Cost of shares Less. Nominal value Tk.200,000 Capital profit 80,000 Dividend received (Tk.30,000 X 67%) 20,000 8) Minority Interest: Face value of the share Share of capital Share of revenue profit Total Minority Interest

(300,000) (Tk.50,000) Tk.100,000 40,000 10,000 Tk.150,000

10) Reserve and surplus: Reserve fund Alpha Ltd. Beta Ltd. Profit & Loss account Shares of reserve profit Less. Dividend credited Unrealized profit

Tk.250,000

Tk.100,000 Nil Tk.140,000 20,000 20,000 2,144

Tk.100,000

160,000 22,144

P-7. Prepare a consolidated Balance Sheet from the following: Balance Sheet as on 31.12.2017 Assets A Co. Ltd. Goodwill 40,000 Fixed Assets 470,000 Inventory 220,000 Accounts Receivable 115,000 Inventory (2,000 shares in B Ltd.) 250,000 Bank Balance 25,000 Total 1,120,000 Capital & Liabilities Share Capital: Tk.100 per share fully paid 800,000 General Reserve as (01.01.2017) 100,000 Accumulated Profit 140,000 Notes Payable Accounts Payable 80,000 Total 1,120,000

Tk.137,856

B Co. Ltd. 30,000 330,000 75,000 75,000 40,000 550,000 300,000 60,000 90,000 40,000 60,000 550,000 204


Additional information: (a) The Income Statement of B Co. Ltd. showed a credit balance of Tk.60,000 as on 01.01.2017. (b) 10% dividend of 2016 was paid on 15.10.2017. The dividend was shown by A Co. Ltd. in its Income Statement. (c) A Co. Ltd. acquired the shares of B Co. Ltd. on 01.07.2017. (d) All the Notes Payable of B Co. Ltd. were accepted in favour of A Co. Ltd. The Notes were discounted by A Co. Ltd. (e) Tk.30,000 is included in the Account Payable of B Co. Ltd. for the goods supplied by A Co. Ltd. (f) The inventory of B Co. Ltd. includes Tk.16,000 for the goods supplied by A Co. Ltd. at a profit of 33.33% on cost. Solution: A Co. Limited Consolidated balance Sheet As at 31.12.2017 Capital and liabilities Taka Assets Share capital (Tk.100 each) 800,000 Goodwill: Reserve and surplus: A Co. Ltd. 40,000 Reserves 100,000 B Co. Ltd. 30,000 Profit & Loss account 137,320 70,000 Minority interest 150,000 Less. Capital reserve 50,000 Current liabilities & provisions: Fixed assets: Bills payable 40,000 A Co. Ltd. 470,000 Creditors: B Co. Ltd. 330,000 A Co. Ltd. 80,000 Stock: B Co. Ltd. 60,000 A Co. Ltd. 220,000 140,000 B Co. Ltd. 75,000 Less. Set-off 30,000 110,000 295,000 Less. Unrealized profit 2,680 Debtors: A Co. Ltd. 115,000 B Co. Ltd. 75,000 190,000 Less. Set-off 30,000 Cash at bank: A Co. Ltd. 25,000 B Co. Ltd. 40,000 1337320 Workings:

Tk.2,000 = 67% Tk.3,000 2) Interest of Minority holders in B Co. Ltd. = 100 – 67 = 33% 1) Interest of A Co. Ltd. in B Co. Ltd. =

3) Share capital at creditors of B Co. Ltd. = Tk.800,000 205

Taka

20,000

800,000

292,320

160,000

65,000 1337320


4. Inter company debt = Tk.30,000 Unrealized profit in stock of B Co. Ltd. = Tk.16,000 X

33.33 X 67% 133.33

= Tk.2,680 5. Capital profit (Pre-acquisition profit): Reserve on 01.01.2009 Profit & Loss account on 01.01.2009 Tk.60,000 Less. Dividend paid for 2008 (30,000) Half of net profit to be capitalized 1 (Tk.90,000 – Tk.30,000) X 2 Less. Share of minority (33%) Share of A Co. Ltd. 6. Revenue profit (Post-acquisition profit): 1 Net profit during the year (Tk.60,000 X ) 2 Less. Minority shares (33%) Share of A Co. Ltd.

40,000 Tk.80,000

Tk.250,000

(300,000) (Tk.50,000) Tk.100,000 40,000 10,000 Tk.150,000

Tk.100,000 Nil Tk.140,000 20,000 20,000 2,680

120,000

(10,000) Tk.20,000

8) Minority Interest: Face value of the share Share of capital Share of revenue profit Total Minority Interest

Retained earnings Shares of reserve profit Less. Dividend credited Unrealized profit

30,000 30,000

Tk.30,000

7. Goodwill or cost of control: Cost of shares Less. Nominal value Tk.200,000 Capital profit 80,000 Dividend received (Tk.30,000 X 67%) 20,000

10) Reserve and surplus: Reserve fund A Co. Ltd. B Co. Ltd.

Tk.60,000

Tk.100,000

160,000 22,680

Tk.137,320

206


EXERCIES E-1. The draft statements of financial position at 30 June 2017 for three entities, XXX, YYY and ZZZ are given below: Statement of Financial Position at 30 June 2017: Notes

XXX Tk.000

YYY Tk.000

ZZZ Tk.000

400

297

380

500 125 1,025

297

380

(viii)

190 144 48 382 1,407

60 63 21 144 441

160 88 73 321 701

(v)

900 300 111 1,311

100 50 112 60 322

400 100 95 595

96 1,407

119 441

106 701

Non-current Assets Property, plant and equipment (vii) Investments: 100,000 Equity shares in YYY at cost (i) to (iii) 80,000 Equity shares in ZZZ at cost (iv) Current Assets Inventory Trade receivables Cash and cash equivalents Total Assets Equity and Liabilities Equity shares of Tk.1 each Share premium Retained earnings Revaluation reserve Current Liabilities Trade payables Total Equity and Liabilities

(vi)

Additional information: (i) XXX acquired all of YYY‟s equity shares on 1 July 2016 for Tk.500,000. YYY‟s retained earnings at 1 July 2016 were Tk.38,000. (ii) XXX commissioned a professional valuer to value YYY‟s net assets at 1 July 2016. The results were as follows: Original Cost Carrying Value Valuation Tk.000 Tk.000 Tk.000 Property 100 200 300 Plant and equipment 200 97 117 All other assets and liabilities - Equal to carrying value Plant and equipment had an average remaining useful life of 5 years at 1 July 2016. XXX‟s accounting policy is to depreciate plant and equipment using the straight line basis with no residual value. (iii) XXX carried out an impairment review of the goodwill arising on acquisition of YYY and found that as at 30 June 2017 the goodwill had been impaired by Tk.20,000. (iv) XXX purchased its shareholding in ZZZ on 1 July 2016 for Tk.125,000. The fair value of all ZZZ‟s net assets was the same as their carrying value at that date. XXX exercises significant influence over all aspects of ZZZ‟s financial and operating policies. (v) The statements of comprehensive income for the year ended 30 June 2017 showed the following amounts for the profit for the year for each entity: 207


Tk.000 XXX 67 YYY 49 ZZZ 55 (vi) During May 2017 YYY sold gods to XXX for Tk.52,000 at a mark up of 33 1/3% on cost. At 30 June 2017 all of the goods remained in XXX‟s closing inventory and XXX had not paid for the goods. (vii) XXX sold a piece of machinery to YYY on 1 July 2016 for Tk.74,000. The machinery had previously been used in XXX‟s business and had been included in XXX‟s property, plant and equipment at a carrying value of Tk.50,000. The machinery had a remaining useful life of 4 years at that date. Profit on disposal was included in revenue. (viii) XXX made a payment to YYY for Tk.60,000 on 30 April 2016 which was not recorded by YYY until 5 July 2016. Required: (a) Explain the meaning of fair value according to IAS 27 Consolidated and separate financial statements. (b) Calculate the fair value of YYY‟s net assets acquired by XXX on 1 July 2016. CMA Adapted – June 2017 E-2. The Draft summarized Statement of Financial Position at 30 September 2015 for three entities, HH, SS and AA are given below: HH SS AA Tk.000 Tk.000 Tk.000 Non-current Assets Property, Plant and equipment 50,390 57,590 41,270 Investments: 48,000,000 Ordinary shares in SS at cost 75,590 Loan to SS 12,600 8,000,000 Ordinary shares in AA at cost 16,400 154,980 57,590 41,270 Current Assets Inventory 10,160 14,410 10,260 Current account with SS 10,000 Trade receivables 21,400 13,200 11,940 Cash and cash equivalent 1,260 3,600 3,580 42,820 31,210 25,780 Total Assets 197,800 88,800 67,050 Equity and Liabilities Equity shares of Tk.1 each 126,000 48,000 24,000 Retained earnings 26,500 15,600 28,800 152,500 63,600 52,800 Non-current liabilities Long term borrowings 32,700 12,600 11,800 Current liabilities Trade payables 12,600 5,400 2,450 Current account with HH 0 7,200 0 12,600 12,600 2,450 Total Equity and Liabilities 197,800 88,800 67,050 208


Additional information: (i) HH acquired all of SS‟s equity shares on 1 October 2014 for Tk.75,590,000 when SS‟s retained earnings were Tk.7,680,000. HH also advanced SS a ten year loan of Tk.12,600,000 on 1 October 2014. (ii) The fair value of SS‟s property, plant and equipment on 1 October 2014 expected its book value by Tk.1,300,000. The excess of fair value over book value was attributed to buildings owned by SS. At the date of acquisition these buildings had a remaining useful life of 20 years. (iii) At 30 September 2015 Tk.90,000 loan interest was due on the loan made by HH to SS and had not been paid. Both HH and SS had accrued this amount at the year end. (iv) HH purchased 8,000,000 of AA‟s equity shares on 1 October 2014 for Tk.16,400,000 when AA‟s retained earnings were Tk.24,990,000. HH exercises significant influence over all aspects of AA‟s strategic and operational decisions. (v) SS posted a cheque to HH for Tk.2,800,000 on 29 September 2015 which did not arrive until 7 October 2015. (vi) No dividends are posted by any of the entities. HH occasionally trades with SS. In September 2015 HH sold SS‟s goods for Tk.4,800,000. HH uses a mark-up of one third on cost. On 30 September 2015 all the goods were included in SS‟s closing inventory. Required: Prepare the consolidated statement of financial position for the HH group of entities as at 30 September 2015, in accordance with the requirements of International Financial Reporting Standards. All workings must be shown. CMA Adapted – December 2015

209


CHAPTER - 6 PROPERTY, PLANT AND EQUIPMENT

6.1. DEFINITION OF PROPERTY, PLANT AND EQUIPMENT According to IAS 16, a bearer plant is a living plant that: (a) is used in the production or supply of agricultural produce; (b) is expected to bear produce for more than one period; and (c) has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales. Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period. 6.2. COST OF PROPERTY, PLANT AND EQUIPMENT The cost of property, plant and equipment consists of: (a) its purchase price, including import duties and purchase taxes, after deducting trade discounts and rebates. (b) any costs directly attributable to bringing the asset to the business location. (c) the cost necessary for it to be capable of operating in the manner intended by management. (c) the initial estimate of the costs of removing the item and restoring the site on which it is located. The cost of property, plant and equipment are not included the followings: (a) costs of opening a new facility; (b) costs of introducing a new product or service ; (c) costs of advertising and promotional activities; (d) costs of conducting business in a new location or with a new class of customer; (e) costs of staff training; and (f) administration and other general overhead costs. 6.3. MEASUREMENT OF COST The cost of property, plant and equipment is the cash price equivalent at the recognition date. If one or more property, plant and equipment is acquired in exchange for a nonmonetary asset or assets, or a combination of monetary and non-monetary assets, the cost of such property, plant and equipment is measured at fair value unless the fair value of neither the asset received nor the asset given up is reliably measurable. If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up. Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses. The carrying amount of property, plant and equipment may be reduced by government grants.

210


6.4. RECOGNITION A property, plant and equipment shall be measured at its cost. The cost of property, plant and equipment shall be recognised as an asset if: (a) it is probable that future economic benefits associated with the item will flow to the entity; and (b) the cost of the item can be measured reliably. Spare parts, stand-by equipment and servicing equipment are recognised in accordance with property, plant and equipment when they meet the definition of property, plant and equipment. Otherwise, these are classified as inventory. 6.5. ACCOUNTING POLICIES 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: A property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses. Revaluation Model: A property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount. Revaluations shall be made with appropriate measure to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. When the fair value of a revalued asset differs materially from its carrying amount, a further revaluation is required. When a property, plant and equipment is revalued, the carrying amount of that asset is adjusted to the revalued amount. If a property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued. If an assetâ€&#x;s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. If an assetâ€&#x;s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be recognised in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognised in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus. 6.6. MEANING OF DEPRECIATION Depreciation is a measurement of loss of value of a depreciable asset arising from use or obsolescence of technology on market changes. It is to be charged in each accounting period during the expected useful life of asset. 211


Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. The depreciation charge for each period shall be recognised in profit or loss unless it is included in the carrying amount of another asset. 6.7. METHODS OF DEPRECIATION A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method. The straight-line method: It is a method of depreciation where depreciation is charged as a constant basis each year with the assumption that equal amounts of economic benefit are consumed in each year of the assetâ€&#x;s life. The diminishing balance method: It is a method of depreciation that applies a decreasing charge over the useful life of an asset. Instead of spreading the cost of the asset evenly over its life, this system expenses the asset at a constant rate, which results in declining depreciation charges each successive period. The unit of production method: This method provides for depreciation by means of a fixed rate per unit of production. Under this method, one must first determine the cost per one production unit and then multiply that cost per unit with the total number of units the company produced within an accounting period to determine its depreciation expense. The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. That method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. 6.8. USES OF TWO METHODS OF DEPRECIATION Many companies use two or more methods of depreciation. It is acceptable and common for companies to depreciate its plant assets by using the straight line method on its financial statements, while using an accelerated method on its income tax return. A company could also be depreciating its equipment over ten years for its financial statements, while using seven years for its income tax return. Even the depreciation for financial statements could consist of some assets being depreciated using the units of production or units of activity method, while other assets are depreciated using the straight line method. 6.9. ACCELERATED DEPRECIATION Accelerated depreciation refers to any one of several methods by which a company, for 'financial accounting' or tax purposes, depreciates a fixed asset in such a way that the amount of depreciation taken each year is higher during the earlier years of an asset's life. 212


Using accelerated depreciation on the income tax return will mean greater depreciation expense and smaller taxable income in the earlier years of an asset's life. However, it will be followed by smaller depreciation expense and greater taxable income in the later years of the asset's life. 6.10. DEPRECIATION ON INCOME STATEMENT AND BALANCE SHEET DIFFERS Depreciation on income statement and balance sheet differs because depreciation on the income statement is the amount of depreciation expense that is appropriate for the period of time indicated in the heading of the income statement. On the other hand, depreciation reported on the balance sheet is the accumulated or the cumulative total amount of depreciation that has been reported as expense on the income statement from the time the assets were acquired until the date of the balance sheet. Example: A company has only one depreciable asset that was acquired three years ago at a cost of Tk.10,000. The asset is expected to have a useful life of 10 years and no salvage value. The company uses straight-line depreciation on its monthly financial statements. In the asset's one year of service, the yearly income statement will report depreciation expense of Tk.1,000. On the balance sheet dated as of the last day of the second year, accumulated depreciation will be reported as Tk.2,000. In the third year, the income statement will report Tk.1,000 of depreciation expense. At the end of the third year, the balance sheet will report accumulated depreciation of Tk.3,000. 6.11. DERECOGNITION The carrying amount of a property, plant and equipment shall be derecognised: (a) on disposal; or (b) when no future economic benefits are expected from its use or disposal. The gain or loss arising from the derecognition of a property, plant and equipment shall be included in profit or loss when the item is derecognised (unless IFRS 16 Leases requires otherwise on a sale and leaseback). The gain or loss arising from the derecognition of property, plant and equipment shall be determined as the difference between the net disposal proceeds (if any), and the carrying amount of the item. The gain shall not be classified as revenue. 6.12. EXPLANATION OF DEPLETION Depletion is the actual physical reduction of a natural resource. For example, an oil field is depleted as oil is extracted from it over time. Depletion is commonly associated with all types of mining, as well as petroleum drilling and timberland usage. It is used to allocate the cost of extracting natural resources such as timber, minerals and oil from the earth. Unlike depreciation and amortization, which mainly describe the deduction of expenses due to the aging of equipment and property, depletion is the actual physical depletion of natural resources by companies.

213


6.13. METHODS OF DEPLETION Percentage depletion method: One method of calculation depletion expense is the percentage depletion method. The percentage depletion method assigns a fixed percentage to gross revenue to allocate expenses. For example, if Tk.10 million of oil is extracted and the fixed percentage is 15%, Tk.1.5 million of capitalized costs to extract the natural resource are depleted. The percentage depletion method required heavy use of estimates and is, therefore, not a heavily relied upon or accepted method of depletion. Cost depletion method: The second method of calculation depletion is the cost depletion method. Cost depletion is calculated by taking the property's basis, total recoverable units and number of units sold into account. The property‟s basis is distributed amongst the total number of recoverable units. As natural resources are extracted, they are counted and taken out from the property‟s basis. For example, the capitalized costs of Tk.1 million yields 500,000 barrels of oil. In the first year, if 100,000 barrels of oil are extracted, the depletion expense for the period is Tk.200,000 {100,000 barrels X (Tk.1,000,000 ÷ 500,000 barrels)}. 6.14. REASONS FOR DEPLETION OF NATURAL RESOURCES There are four basic reasons for the depletion of natural resources: (a) Rapid population increase: There has been a tremendous increase in world‟s population. An increase in population will decrease all types of natural resources and result in environmental pollution. Ultimately, there will be short supply, as well as deterioration in quality of natural resources. This is because increase in population will increase the demand of natural resources and environment. The world cannot meet the continuously increasing demand for natural resources. (b) Pollution: We are deteriorating our environment due to increasing population and industrial revolution. We are polluting atmosphere, lakes, streams, rivers by sewage, industrial wastes, heat, radioactive materials, detergents, fertilizers and pesticides. Besides these, we are releasing a number of toxic materials into our surroundings. The uncontrolled and indiscriminate use of pesticides has disturbed the entire food chains by which animals including man are affected. The unplanned and uncontrolled industrial growth may adversely affect or destroy the health of the society. (c) Consumption of materials: Due to tremendous increase of population, most of the natural resources are being rapidly consumed. This high rate of consumption has disturbed our ecosystems. But, on the other hand, many of the natural resources are essential basic human needs. Many industries require raw materials which are essential for the advancement of the country. However, their rapid consumption will affect adversely the quality of our environment either by unwise use of natural resources or by increasing pollution.

214


(d) Deterioration of land: Due to excessive consumption of minerals of the soil by cropping or soil erosion or other natural events, fertility of soil is lost and the land deteriorates gradually. Sometimes drought also results in deterioration of land and many nutrients of the top soil are destroyed and soil fertility is lost. As a result of cropping, the cycling of soil mineral nutrients is greatly reduced. 6.15. CONCEPT OF AMORTIZATION Amortization is an accounting term that refers to the process of allocating the cost of an intangible asset over a period of time. In business, it refers to making regular payments over a period of time. It may refers to a stream of payments that accomplish either of the reduction of book value of intangible assets or pay-off loans or other debt. It also refers to the repayment of loan principal over time. 6.16. DIFFERENCES AMORTIZATION Depreciation (a) Depreciation is decrease in value of noncurrent assets due to use or usage. (b) Depreciation refers to prorating tangible assets cost over that assets useful life. (c) Depreciation is used to expense assets. (d) Example includes buildings, vehicles, equipment, etc.

AMONG

DEPRECIATION,

DEPLETION

Depletion Amortization (a) Depletion is decrease in (a) Amortization value of natural resources. decrease in values intangible assets,

AND

is of

(b) Depletion refers to the (b)Amortization usually allocation of the cost of refers to spreading natural resources over time. an intangible asset's cost over that asset's useful life (c) Depletion is for natural (c) Amortization is used to resources. expense intangible assets. (d) Example includes mines, (d) Example includes oil, coal, etc. goodwill, copyright, patent, computer software, etc.

6.17. DISCLOSURE For each class of property, plant and equipment, the financial statements shall disclose: (a) the measurement bases used for determining the gross carrying amount; (b) the depreciation methods used; (c) the useful lives or the depreciation rates used; (d) the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; and (e) a reconciliation of the carrying amount at the beginning and end of the period showing: (i) additions; (ii) assets classified as held for sale or included in a disposal group; (iii) acquisitions through business combinations; (iv) increases or decreases resulting from revaluations and from impairment losses recognised in profit or loss; (v) the net exchange differences arising on the translation of the financial statements from the functional currency into a different presentation currency, and (ix) other changes. 215


PROBLEMS AND SOLUTIONS P-1. A fixed asset is purchased on January 1, 2015. Information relating to the asset is as follows: Cost of acquisition Tk.110,000 Residual value estimated at the time of acquisition Tk.10,000 Residual value revised estimate on January 1, 2016 Nil Useful life estimated at the time of acquisition 10 years Useful life revised estimate on January 1, 2017 8 years Required: Calculate depreciation expense for the years ended on December 31, 2015, 2016, 2017 and 2018 by using straight line method. Solution: Year 2015:

Cost  Re sidual value Useful life Tk.110,000  Tk.10,000 = 10 years = Tk.10,000

Depreciation expense =

Year 2016:

(Tk.110,000  Tk.10,000)  Tk.0 9 years Tk.100,000 = 9 years = Tk.11,111

Depreciation expense =

Year 2017:

(Tk.100,000  Tk.11,111)  Tk.0 6 years Tk.88,889 = 6 years = Tk.14,815

Depreciation expense =

Year 2018: Depreciation expense for the year 2018 is equal to the depreciation expense charged in the year 2017 because there has been no change in estimates since then. P-2. A plant costing Tk.12,00,000 was purchased on April 1, 2017. The salvage value was estimated to be Tk.200,000. The expected production was 10,000 units. The plant was used to produce 4,000 units till the year ended December 31, 2017. Calculate the depreciation on the plant for the year ended December 31, 2017. Solution:

216


Depreciation on the plant for the year ended December 31, 2017 Cost  Salvage value = X No. of units produced Life in no. of units Tk.12,00,000  Tk.200,000 = X 4,000 units 10,000 units = Tk.400,000 P-3. An asset has a useful life of 4 years. Cost of the asset is Tk.4,000. Residual value is Tk.400. Calculate depreciation expense for 4 years by using following methods: (a) Straight line method; (b) Reducing balance method; (c) Double declining balance method; (d) Sum-of-the-years‟ digit method. Solution: (a) Straight line method:

Cost  Re sidual value Useful life Tk.4,000  Tk.400 = 4 years = Tk.900

Depreciation expense each year =

(b) Reducing balance method: Here, Straight line depreciation rate = 25% Year-1: Depreciation expense = (Tk.4,000 – Tk.400) X 25% = Tk.3,600 X 25% = Tk.900 Year-2: Depreciation expense = {(Tk.4,000 – Tk.900) – Tk.400} X 25% = (Tk.3,100 – Tk.400) X 25% = Tk.2,700 X 25% = Tk.675 Year-3: Depreciation expense = {(Tk.3,100 – Tk.675) – Tk.400} X 25% = (Tk.2,425 – Tk.400) X 25% = Tk.2,025 X 25% = Tk.506 Year-4: Depreciation expense = (Tk.2,425 – Tk.506) – Tk.400 = Tk.1,919 – Tk.400 = Tk.1,519

217


(c) Double declining balance method: Here, Straight line depreciation rate = 25% So, double declining balance rate = 25% X 2 = 50% Year-1: Depreciation expense = Tk.4,000 X 50% = Tk.2,000 Year-2: Depreciation expense = (Tk.4,000 – Tk.2,000) X 50% = Tk.2,000 X 50% = Tk.1,000 Year-3: Depreciation expense = (Tk.2,000 – Tk.1,000) X 50% = Tk.1,000 X 50% = Tk.500 Year-4: Depreciation expense = (Tk.1,000 – Tk.500) – Tk.400 = Tk.500 – Tk.400 = Tk.100 (d) Sum-of-the-years’ digit method: Here, Sum of the years‟ digit = 4 + 3 + 2 + 1 = 10 Year-1: Tk.4,000  Tk.400 Depreciation expense = 10 = Tk.1,440 Year-2: Tk.4,000  Tk.400 Depreciation expense = 10 = Tk.1,080 Year-3: Tk.4,000  Tk.400 Depreciation expense = 10 = Tk.720 Year-4: Tk.4,000  Tk.400 Depreciation expense = 10 = Tk.360

X4

X3

X2

X1

P-4. On December 31, 2015, Faital Company acquired a machine from Plato Corporation by issuing a Tk.600,000 zero-interest-bearing note, payable in full on December 31, 2019. Faital Company‟s credit rating permits it to borrow funds from its several lines of credit at 10%. The machine is expected to have a 5-year life and a Tk.70,000 salvage value. 218


Instructions: (a) Prepare journal entry for the purchase on December 31, 2015. (b) Prepare any necessary adjusting entries relative to depreciation (use straight-line) and amortization (use effective-interest method) on December 31, 2016. (c) Prepare any necessary adjusting entries relative to depreciation and amortization on December 31, 2017. Solution: (a) Journal entry: Dec.31, 15

Computer - Dr. - Tk.409,806.00 Notes payable - Cr. Tk.409,806.00 (Computer capitalized at the present value of the note) Tk.600,000 X 0.68301

(b) Adjusting entries: Dec.31, 16

Dec.31, 16

Depreciation expense - Dr. - Tk.67,961.20 Accumulated depreciation - Machine - Cr. Tk.67,961.20 Tk.409,806  Tk.70,000 5 Interest expense - Dr. - Tk.40,980.60 Notes payable - Cr. Tk.40,980.60 Schedule of note discount amortization

Date December 31, 2015 December 31, 2016 December 31, 2017 December 31, 2018 December 31, 2019

Notes payable Tk.40,980.60 45,078.66 49,586.53 54,548.21

Carrying amount of note Tk.409,806 450,786.60 495,865.26 545,451.79 600,000.00

(c) Adjusting entries: Dec.31, 17

Depreciation expense - Dr. - Tk.67,961.20 Accumulated depreciation - Machine - Cr. Tk.67,961.20

Dec.31, 17

Interest expense Notes payable

- Dr. - Tk.45,078.66 - Cr. Tk.45,078.66

P-5. Prepare the machinery component of fixed asset schedule of Nixon Company for financial year ended 31 December 2017 based on the following information: (a) Cost as at 1 January 2017: Tk.85,40,000 (b) Accumulated depreciation as at 1 January 2017: Tk.24,30,000 (c) No additions to machinery made during the period. (d) Machinery costing Tk.3,50,000 with accumulated depreciation of Tk.2,00,000 disposed of on 30 June 2017. 219


(e) The company‟s policy is to charge proportionate depreciation expense in the year of disposal. (f) The machinery is depreciated on straight line method over 5 years. Solution: Cost: Balance at 1 January 2017 Add. Addition Less. Disposal Balance at 31 December 2017

Tk.85,40,000 0 (Tk.350,000) Tk.81,90,000

Accumulated depreciation: Balance at 1 January 2017 Add. Depreciation expense for the period (w-1) Less. Disposal adjustment (w-2) Balance as at 31 December 2017

Tk.24,30,000 Tk.16,73,000 (Tk.235,000) Tk.38,68,000

Carrying amount = Tk.81,90,000 – Tk.38,68,000 = Tk.43,22,000 Workings: 1. Depreciation expense for the period (Tk.85,40,000  Tk.3,50,000) Tk.3,50,000 6 = +( X ) 5 12 5 = Tk.16,38,000 + Tk.35,000 = Tk.16,73,000 Tk.3,50,000 6 X ) 5 12 = Tk.200,000 + Tk.35,000 = Tk.235,000

2. Disposal adjustment = Tk.200,000 + (

P-6. At December 31, 2016 Alex Corporation reported the following as plant assets: Equipment Less. Accumulated depreciation Total plant assets

Tk.21,00,000 5,00,000 Tk.16,00,000

During 2017, the following cash transactions occurred: April 1 – Purchased of equipment for Tk.4,00,000. July 1 – Sold equipment that cost Tk.6,00,000 when purchased on January 1, 2016. The equipment was sold for Tk.2,50,000. Sep. 1 – Purchased equipment for Tk.36,00,000. Dec. 31 – Retired equipment that cost Tk.300,000 when purchased on December 31, 2011. No salvage value was received. 220


Required: Prepare necessary journal and adjusting entries for the above transactions. Alex uses straight-line method of depreciation for equipment. Estimated useful life of equipment is 6 years with no salvage value. Solution: Alex Corporation Journal & adjusting entries Date April 1 July 1

July 1

Sep. 1 Dec 31

Dec 31 Dec 31

Particulars Equipment Cash Depreciation expense – Equipment Accumulated depreciation - Equipment 6 months 600,000 ( X = Tk.50,000) 12 months 6 yrs Cash Accumulated depreciation - Equipment Loss on sale of equipment Equipment 18 months 600,000 ( X = Tk.150,000) 12 months 6 yrs Equipment Cash Depreciation expense – Equipment Accumulated depreciation –Equipment Accumulated depreciation Equipment Depreciation expense – Equipment Accumulated depreciation - Equipment 21,00,000  600,000  300,000 = 2,00,000 6 yrs 9 months 4,00,000 X = 50,000 6 yrs 12 months 4 months 36,00,000 X = 2,00,000 12 months 6 yrs 4,50,000

Dr. (Tk.) 4,00,000

Cr. (Tk.) 4,00,000

50,000 50,000

2,50,000 1,50,000 2,00,000 6,00,000

36,00,000 36,00,000 50,000 50,000 3,00,000 3,00,000 4,50,000 4,50,000

P-7. Linux Inc. plans to acquire an additional machine on January 1, 2017 to meet the growing demand for its product. Surot Company offers to provide the machine to Linux using either of the options listed below (each option gives Linux exactly the same machine and gives Surot Company approximately the same net present value each equivalent at 10%). Option 1 – Cash purchase Tk.800,000. Option 2 – Installment purchase requiring 15 annual payments of Tk.105,179 due December 31 each year. 221


The expected economic life of this machine to Linux is 15 years. Salvage value at that time is estimated to be Tk.50,000. Straight-line depreciation is used. Interest expense under Option 2 is computed using the effective interest method. Required: Based upon current generally accepted accounting principles, state how, if at all, the book value of the machine and the obligation should appear on the December 31, 2017 balance sheet of Linux Inc., for each option. Solution: Assets Machinery Accumulated depreciation Tk.800,000  Tk.50,000 15 yrs Book value

Option 1

Option 2

Tk.800,000 50,000

Tk.800,000 50,000

750,000

Liabilities Notes payable – non-current (n-1) Notes payable – current (n-1)

750,000

-

27,697 747,124

Note: 1. Present value of the notes payable on January 1, 2017 = Tk.105,179 X 7.60608 = Tk.800,000 At December 31, 2017, first installment of Tk.105,179 has been paid of which Tk.80,000 (Tk.800,000 X 10%) is interest and Tk.25,179 (Tk.105,179 – Tk.80,000) is principal amount. So, principal remains Tk.774,821 (Tk.800,000 – Tk.25,179) of which Tk.27,697 {Tk.105,179 – (Tk.774,821 X 10%) is current and Tk.747,124 (Tk.774,821 – Tk.27,697) is non-current. P-8. On January 1, 2017, Orion Co. acquired production equipment in the amount of Tk.5,00,000. The following additional costs are incurred: Delivery costs Installation costs General administration costs of an indirect nature

Tk.38,000 24,500 3,000

The installation and setting-up period took three months and an additional Tk.21,000 was spent on costs directly related to bringing the asset to its working condition. The equipment was ready for use on April 1, 2002. Monthly managerial reports indicated that for the first five months, the production quantities from this equipment resulted in an initial operating loss of Tk.15,000 because of small quantities produced. The months thereafter showed much more positive results.

222


The equipment has an estimated useful life of 14 years and a residual value of Tk.25,000. Estimated dismantling costs are Tk.15,000. Required: As per IAS-16, what is the cost of the asset and what are the annual charges in the Statement of Comprehensive Income related to the consumption of the economic benefits embodied in the assets? Solution: Cost of the asset = Invoice price + Delivery costs + Installation costs + Other costs directly related to bringing the asset to its working condition + Initial estimate of dismantling costs = Tk.5,00,000 + Tk.38,000 + Tk.24,500 + Tk.21,000 + Tk.15,000 = Tk.5,98,500

Tk.5,98,500  Tk.25,000 14 years = Tk.40,964

Annual charges related to the asset =

The annual charge to the Statement of Comprehensive Income is Tk.40,964. However, 9 note that in the year ending December 31, 2002, the charge will be Tk.40,964 X = 12 Tk.30,723 because the equipment was ready for use on April 1, 2012 after the installation and setting-up period. P-9. On February 2, 2015, Sabir Enterprises paid Tk.76,000 cash for a piece of equipment to be used in its blast furnace facility. The equipment has an estimated useful life of seven years and an estimated residual value of Tk.6,000. The companyâ€&#x;s policy is to record a full year of depreciation in the year of purchase and no depreciation in the year of disposal. The equipment is expected to provide 33,600 hours of service over its useful life with estimated service hours of 4,200 in 2015, 4,300 in 2016, and 4,600 in 2017. The companyâ€&#x;s accountant has looked at several methods of depreciation that could be used for the equipment and has prepared the following schedule for the three most likely methods:

Estimated depreciation expense - 2015

Method 1 Tk.17,500

Method 2 Tk.8,750

Method 3 Tk,1000

After consideration of the methods, the company chose to use the straight-line method of depreciation. In 2016 an accident occurred which caused damage to the equipment. The equipment was repaired in 2016, at a cost of Tk.5,000, but it was determined in early 2017 that an impairment loss may have occurred. An analysis performed in early 2017 concluded that the equipment had a value in use of Tk.40,000, a net selling price of Tk.36,000 and a remaining useful life of two years with no residual value. Required: (a) Identify the depreciation method being used in each of methods 1, 2, and 3. (b) Prepare the journal entries to record depreciation expense and the Tk.5,000 expenditure in 2016. 223


(c) Prepare the journal entries to record the impairment loss and depreciation expense for 2017. (d) Assuming Sabir Enterprises uses the indirect method of presenting cash flows from operating activities, prepare the cash flow statement disclosures with respect to the equipment for the years 2015, 2016, and 2017. Solution: (a) Alternative 1: Sum-of-the-year‟s-digits method Tk.76,000 Tk.6,000 = X7 (7  6  5  4  3  2  1) Tk.70,000 = X7 28 = Tk.17,500 Alternative 2: Service hours method Tk.76,000  Tk.6,000 = X 4,200 hours Tk.33,600 = Tk.2.08 X 4,200 hours = Tk.8,750 Alternative 3: Straight line method Tk.76,000  Tk.6,000 = 7 years Tk.760,000 = 7 years = Tk.10,000 (b) Journal entries Depreciation expense Accumulated depreciation

- Dr. - Cr. -

Tk.10,000

Repairs and maintenance Cash

- Dr. - Cr. -

Tk.5,000

Tk.10,000

Tk.5,000

(c) Journal entries Accumulated depreciation Impairment loss (76,000-20,000-40,000) Accumulated depreciation

- Dr. - Dr. - Cr. -

Tk.20,000 Tk.16,000

Depreciation expense (40,000÷2) Accumulated depreciation

- Dr. - Cr. -

Tk.20,000

Tk.36,000

Tk.20,000 224


(d) Sabbir Enterprises Cash flow statement (Indirect method) For the year 2015 Cash flow from operating activities: Net profit Add. Depreciation expense

Tk.10,000

Cash flow from investing activities: Cash paid for equipment

(Tk.76,000)

xx

For the year 2016 Cash flow from operating activities: Net profit Add. Depreciation expense

xx Tk.10,000

For the year 2017 Cash flow from operating activities: Net profit Add. Depreciation expense Impairment loss

xx Tk.20,000 Tk.16,000

P-10. At the beginning of 2017, Farhan Company acquired a mine for Tk.1,000,000. Of this amount Tk.100,000 was ascribed to the land value and remaining portion to the minerals in the mine. Surveys conducted by geologists have indicated that approximately 4,000,000 units of the ore appear to be in the mine. Farhan incurred Tk.150,000 development costs associated with the mine prior to any extraction of minerals and estimates that it will require Tk.50,000 to prepare the land for an alternative use when all of the mineral has been removed. During 2017, 3,000,000 units of ore were extracted and 2,500,000 of these were sold. You are required to compute the followings: (a) The total amount of depletion of 2017. (b) The amount that is charged as an expense for 2017 for the cost of the minerals sold during 2017. Solution: (a) Depletion cost per unit =

Tk.1,000,000  Tk.150,000  Tk.50,000 Tk.4,000,000

225


Tk.1,200,000 Tk.4,000,000 = Tk.0.30 =

Total amount of depletion of 2016 = 3,000,000 units X Tk.0.30 = Tk.900,000 (b) The amount that is charged to the cost of the minerals sold during 2016 = 2,500,000 units X Tk.0.30 = Tk.750,000 P-11. Concord Timber Company (CTC) owns 3,000 acres of timberland on the north side of Mount Khulshi, which was purchased in 2005 at a cost of Tk.550 per acre. In 2017, CTC began selectively logging this timber tract. In May of 2017, Mount Khulshi erupted, burying the timberland of CTC under a foot of ash. All of the timber on the CTC tract was downed. In addition, the logging roads, built at accost of Tk.150,000 were destroyed, as well as the logging equipment, with a net book value of Tk.300,000. At the time of the eruption, CTC had logged 20% of the estimated 500,000 board feet of timber. Prior to the eruption, CTC estimated the land to have a value of Tk.200 per acre after the timber was harvested. CTC includes the logging roads in the depletion base. CTC estimates it will take 3 years to salvage the downed timber at a cost of Tk.700,000. The timber can be sold for pulp wood at an estimated price of Tk.3 per board foot. The value of the land is unknown, but must be considered nominal due to future uncertainties. Required: (a) Determine the depletion cost per board foot for the timber harvested prior to the eruption of Mount Khulshi. (b) Prepare the journal entry to record the depletion prior to the eruption. (c) If this tract represents approximately half of the timber holdings of CTC, determine the amount of the extraordinary loss due to the eruption of Mount Khulshi for the year ended December 31, 2017. Solution: (a) Original cost (Tk.550 X 3,000) Less. Residual value of land (Tk.200 X 3,000) Add. Cost of logging road Depletion base

Tk.1,650,000 600,000 1,050,000 150,000 Tk.1,200,000

Tk.1,200,000 500,000 feet = Tk.2.40

Depletion cost per board foot =

226


(b) Journal entry: Inventory Accumulated depreciation – Timber

- Dr. - Cr. -

Tk.240,000 Tk.240,000

Depletion for 2016: 500,000 board feet X 20% = 100,000 board feet 100,000 board feet X Tk.2.40 = Tk.240,000 (c) Determination of the extraordinary loss: Loss of timber {Tk.1,050 – (Tk.1,050,000 X 20%)} Loss of land value Loss of logging roads {Tk.150,000 – (Tk.150,000 X 20%)} Logging equipment Cost of salvaging timber Less. Recovery (400,000 board feet X Tk.3) Extraordinary loss due to the eruption of Mount Khulshi

Tk.840,000 600,000 120,000 300,000 700,000 (1,200,000) Tk.1,360,000

P-12. Gama Company has purchased a tract of mineral land for Tk.1,200,000. It is estimated that this tract will yield 240,000 tons of ore with sufficient mineral content to make mining and processing profitable. It is further estimated that 12,000 tons of ore will be mined the first and last year and 24,000 tons every year in between. The land will have a residual value of Tk.60,000. The company builds necessary structures and sheds on the site at a cost of Tk.72,000. It is estimated that these structures can serve 11 years but because they must be dismantled if they are to be moved, they have no scrap value. The company does not intend to use the buildings elsewhere. Mining machinery installed at the mine was purchased second-hand at a cost of Tk.96,000. This machinery cost the former owner Tk.200,000 and was 50% depreciated when purchased. Gama Company estimates that about half of this machinery will still be useful when the present mineral resources have been exhausted but that dismantling and removal cost will just about offset its value at that time. The company does not intend to use the machinery elsewhere. The remaining half of this machinery will last until about one-half the present estimated mineral ore has been removed and will then be worthless. Cost is to be allocated equally between these two classes of machinery. Required: As a Chief Accountant of the company, you are to prepare a schedule showing estimated depletion and depreciation costs for the year of the expected life of the mine. Solution: Schedule showing estimated depletion: Depletion base Tk.1,140,000 227

Estimated yield 240,000 tons

Cost per ton Tk.4.75

Estimated depletion 1st & 11th years 2nd to 10th years Tk.57,000 Tk.114,000


Depletion base = Tk.1,200,000 – Tk.60,000 = Tk.1,140,000 1st & 11th years = 12,000 tons X Tk.4.75 = Tk.57,000 2nd to 10th years = 24,000 tons X Tk.4.75 = Tk.114,000 Schedule showing estimated depreciation:

Asset

Cost

Building Machinery (1/2) Machinery (1/2)

Cost per ton Tk.72,000 Tk.0.30 Tk.48,000 Tk.0.20 Tk.48,000 Tk.0.40

st

1 yr 3,600 2,400 4,800

Estimated depreciation 2 to 6th yrs 7th to th 5 yrs 10th yrs 7,200 7,200 7,200 4,800 4,800 4,800 9,600 4,800 nd

11th yrs 3,600 2,400 -

Building:

Tk.72,000 240,000 tons = Tk.0.30

Cost per ton =

1st & 11th years = 12,000 tons X Tk.0.30 = Tk.3,600 2nd to 10th years = 24,000 tons X Tk.0.30 = Tk.7,200 Machinery (1/2):

Tk.48,000 240,000 tons = Tk.0.20

Cost per ton =

1st & 11th years = 12,000 tons X Tk.0.20 = Tk.2,400 2nd to 10th years = 24,000 tons X Tk.0.20 = Tk.4,800 Machinery (Remaining 1/2):

Tk.48,000 240,000 / 2 tons Tk.48,000 = 120,000 tons = Tk.0.40

Cost per ton =

228


First & last years = 12,000 tons X Tk.0.40 = Tk.4,800 Remaining Tk.38,400 (Tk.48,000 – Tk.4,800 – Tk.4,800) will depreciate Tk.38,400 ÷ Tk.9,600 = 4 years 2nd to 5th years = 24,000 tons X Tk.0.40 = Tk.9,600

Contact us to collect exercises solution. Helpline: 01711137039

229


EXERCIES E-1. Presented below is a schedule of property dispositions for ABC Co. during 2002:

Furniture Automobile Land

SCHEDULE OF PROPERTY DISPOSITIONS Cost Accumulated Cash Fair (Taka) Depreciation Proceeds Market at 12/31/01 (Taka) Value (Taka) (Taka) 10,000 8,800 8,000 3,500 3,100 3,100 40,000 92,000 100,000

Nature of Disposition (Taka) Abandonment Sale Sale

The following additional information is available: Furniture: On January 1, 2002, furniture was tossed out in the dumpster because it was no longer adequate to serve the company‟s needs. It cost Tk.10,000 when it was acquired. Depreciation of Tk.8,800 was taken in prior years. Automobile: On January 2, 2002, an automobile was sold for Tk.3,100 cash. It had a cost of Tk.8,000 and total depreciation recorded prior to the sale date amounted to Tk.3,500. Land: On February 15, 2002, land previously used in operations was subdivided and a section was sold for Tk.100,000. A commission of Tk.8,000 went to a real estate agent. The original cost of that land segment was Tk.40,000. Instructions: Prepare the appropriate journal entry for each of the dispositions. Show computations where appropriate. CMA Adapted – August 2015 E-2. On December 31, 2012, Chrysler Inc. has a machine with a book value of Tk.940,000. The original cost and related accumulated depreciation at this date are as follows. Machine Tk.1,300,000 Accumulated depreciation 360,000 Book value Tk.940,000 Depreciation is computed at Tk.60,000 per year on a straight-line basis. Instructions: Presented below is a set of independent situations. For each independent situation, indicate the journal entry to be made to record the transaction. Make sure that depreciation entries are made to update the book value of the machine prior to its disposal. 1. A fire completely destroys the machine on August 31, 2013. An insurance settlement of Tk.430,000 was received for this casually. Assume the settlement was received immediately. 2. On April 1, 2013, Chrysler sold the machine for Tk.1,040,000 to Avanti Company. 3. On July 31, 2013, the company donated this machine to the Mountain King City Council. The fair value of the machine at the time of the donation was estimated to be Tk.1,100,000. CMA Adapted – December 2014 230


E-3. A motor van was bought for Tk.20,000 on 1 September 2005 with a residual value of Tk.2,000. Depreciation was charged at 20% by the reducing balance method on yearly basis. It was sold for Tk.18,000 after three years of use on 30 September 2008. Compute the profit on sale of asset. CMA Adapted – December 2013 E-4. A company is exploring the impact of the two method of depreciation. On 1 January, it bought machinery for Tk.15,000. The methods are (i) straight line where useful life is 4 years and residual value is Tk.2,000 and (ii) reducing balance method – at the rate of 20% per annum. Show how the company‟s profit be affected if the straight line method is used rather than the reducing method? CMA Adapted – December 2013 E-5. A machine was bought for Tk.100,000. Its estimated useful life is four years with a residual value of Tk.10,000. Depreciation is charged on the straight line method. What is the percentage of depreciation rate on an annual basis? CMA Adapted – December 2013 E-6. A machine was bought for Tk.180,000 on 30 April 2008. The residual value was Tk.5,000 and depreciation rate was 25%. Depreciation is to be charged under the reducing balance method on month to month basis. Compute the depreciation at 31st December 2008. CMA Adapted – December 2013 E-7. Careg Ltd manufactures and sells heavy plant. The company also hires out plant for monthly periods (or multiples thereof). You ascertain the following details: (1) Freehold land: Freehold land was acquired on 1 February 2008 for Tk. 100,000 to build a new factory. Due to planning difficulties, building has not yet been started. The directors wish to revalue the land to its fair value of Tk.130,000 at 30 September 2009. (2) Buildings: On 1 October 2008 the directors reviewed the useful life of the buildings and determined that the remaining life was 56 years. The buildings were acquired for Tk. 200,000 on 1 October 2004, when their useful life was estimated at 40 years. (3) Plant and Machinery: Plant and machinery is accounted for under the cost model accounting policy and is depreciated at the rate of 40% per annum based on carrying amount. Such plant has an estimated life of five years. (i) Plant which cost Tk. 20,000 on 1 October 2006 was classified as held for sale on 1 February 2009. The sale was agreed at Tk. 5,600 and completed on 31 March 2009. (ii) New plant acquired cost Tk. 60,000 on 1 January 2009. At 1 October 2008 the cost of plant and machinery (not leased) was Tk. 200,000, with accumulated depreciation of Tk. 72,000. (4) Computer: Previously this has been depreciated on a straight-line basis at the rate of 10% per annum on cost. The computer was acquired on 1 January 2007 for Tk. 60,000, and by the beginning of this accounting year Tk.10,500 of depreciation had been charged. In an effort to charge out computer time to departments, a record is now kept of computer time used. Management wishes to depreciate the computer on a usage basis. The manufacturer‟s estimate of total usage time of the computer‟s life is 40,000 hours. The data processing 231


manager estimates that some 10,000 hours have been worked prior to the current accounting period. During the current year the record shows 4,800 hours worked. The computer will have a scrap value of Tk. 4,500 at the end of its useful life. Required: (i) Prepare the schedule of non-current assets which will form the note to the company‟s published balanced sheet at 30 September 2009. (ii) Briefly explain the qualitative characteristics contained in BFRS-1 Framework for the Preparation and Presentation of Financial Statements illustrating your answer with reference to the provisions of BAS 16 Property, Plant and Equipment. CMA Adapted – December 2013 E-8. On January 1, 2006, a company purchased a machinery at an acquisition cost of Tk.84,000. The machinery has been depreciated by the straight line method using a 4 year service life and a Tk.12,000 salvage value. The company‟s fiscal year ends on December 31. Required: Prepare the journal entries to record the disposal of the machinery that it was: (i) Retired and scraped with no salvage value on January 1, 2010. (ii) Sold for Tk.15,000 on July 1, 2009. (iii) Traded in on a new machinery on January 1, 2009. The fair market value of the old machinery was Tk.34,000 and Tk.6,000 was paid in cash. CMA Adapted – August 2013 E-9. A Ltd. Company depreciates its machinery at 10% on diminishing balance method, had on 1st January 2010 Tk.175,000 to the debit of machinery account. A part of machinery purchased on 1st January, 2008 for Tk.30,000 was sold for Tk.15,000 on July 01, 2010. A new machinery at of cost of Tk.35,000 was purchased and installed on the same date installation charge being Tk.2,500. The company wanted to change its method of depreciation from diminishing balance method to straight line method with effect from 1st January, 2010. The rate of depreciation is remained the same. Required: (i) Pass journal entries to record the sale of the machinery. (ii) Calculate the depreciation expense of the existing machinery to be recorded in the books for 2010. CMA Adapted – August 2013 E-10. Monyem Ltd. purchased machinery from Ananto Ltd. on 30.09.2012. The machinery was ready for use on 01.12.2010. However it was actually put to use only on 01.05.2011. The price was Tk.3,80,44,000 before charging the following: i. Truncated VAT on goods sold @ 4%. ii. Giving a trade discount @ 2% on the quoted price. iii. Transport charges @ 0.25% on the quoted price and iv. Installation charges come to 1% on the quoted price. A loan of Tk.3,10,00,000 was taken from the Sonali Bank Ltd. on which interest @ 15% per annum was to be paid. Expenditure incurred on the trial run was as follows: 232


A. Material Tk.35,000 B. Wages Tk.25,000 and C. Overhead Tk.15,005. Find out the cost of the machine and suggest the accounting treatment for the expenses incurred in the internal between the dates 01.12.2010 to 01.05.2011. The entire loan amount remained unpaid on 01.05.2011. CMA Adapted – December 2012 E-11. SBJ‟s non-current asset register gives the cost and accumulated depreciation to date for every non-current asset held by the company. Prior to charging depreciation for 20X4, the total carrying amount of all non-current assets on the register at 31 December 20X4 was $147,500. At the same date, the non-current-asset accounts in the nominal ledger showed the following balances: ________________________________________________________________________ Cost to date Accumulated depreciation Motor vehicles $48,000 $12,000 Plant and machinery 120,000 30,000 Office equipment 27,500 7,500 You are told that: (i) An item of plant costing $30,000 has been sold for $23,500 during 20X4. The loss on disposal was $800. No entries have been made for this disposal in the nominal ledger, but the asset has been removed from the non-current-asset register. (ii) A motor car was purchased on 1 October 20X4 and correctly recorded in the nominal ledger. Its cost was as follows: List price of vehicle $24,000 Trade discount 20% Sales tax added at 17.5% Insurance $360 Annual vehicle license tax $130 Painting of company name $100 (no sales tax) The vehicle has not been entered in the non-current asset register. (iii) Office equipment was purchased during 20X4, and entered on the non-current asset register but not in the nominal ledger. Until the omission can be investigated fully, its cost is deemed to be the difference between the balances on the non-current asset register and the nominal ledger at 31 December 20X4 (prior to charging depreciation for the year). (iv) Depreciation for 20X4 is to be charged as follows: Motor vehicles 25% per annum straight line on an actual time basis Plant and machinery 10% per annum straight line, with a full year‟s depreciation in the year of purchase Office equipment 10% per annum reducing balance, with a full year‟s depreciation in the year of purchase Requirements: (a) Calculate the balances at 31 December 20X4 for cost and depreciation to date on the three non-current asset accounts (prior to the charging of depreciation for 20X4). (b) Calculate the balances at 31 December 20X4 for cost and depreciation to date on the three non-current asset accounts (prior to the charging of depreciation for 20X4). CMA Adapted – December 2012 233


E-12. Sheen Owner‟s Association purchased a truck for transportation use for its own. The following facts apply for the truck: Cost of Acquisition of the Truck………………… Tk.450,000 Estimated salvage value…………………….…… Tk.50,000 Estimated life: In years………………………………………..… 4 years In Kilo-meters driven…………………...………. 160,000 kilo meters Required: (i) Calculate the depreciation for each year and make a journal entry to record straight-line depreciation method. (ii) Depreciation schedule under Straight-line Method showing annual depreciation, accumulated depreciation and book value. CMA Adapted – April 2012 E-13. PGS Mining Company has purchased a tract of mineral land for Tk.600,000. It is estimated that this tract will yield 120,000 tons of ore with sufficient mineral content to make mining and processing profitable. it is further estimated that 6,000 tons of ore will be mined in the first and last year and 12,000 tons every year in between. The land will have a residual value of Tk.30,000. Required: Prepare a schedule showing estimated depletion cost for each year of the expected life of the mine. CMA Adapted – April 2011 E-14. At December 31, 2008 Khan Corporation reported the following as plant assets: Particulars (Taka) (Taka) Land 3,000,000 Building 26,500,000 Less: Accumulated depreciation 12,100,000 14,400,000 Equipment 40,000,000 Less: Accumulated depreciation 5,000,000 35,000,000 Total plant assets 52,400,000 During 2009 the following selected cash transactions occurred: April 1 – Purchased land for Tk.2,200,000. May 1 – Sold equipment that cost Tk.600,000 when purchased on January 1, 2005. The equipment was sold for Tk.350,000. June 1 – Sold land purchased on June 1, 1999 for Tk.1,800,000. The land cost Tk.500,000. July 1 – Purchased equipment for Tk.1,200,000. Dec. 31 – Retired equipment that cost Tk.500,000 when purchased on December 31, 1999. No salvage value was received. Required: (i) Journalize the above transactions. Khan uses straight-line method of depreciation for building and equipment. Estimated useful life of building is 40 years with no salvage value. The equipment is estimated to have 10 years useful life and no salvage value. Update depreciation on assets disposed of at the time of sale or retirement. (ii) Record adjusting entries for depreciation for 2009. (iii) Prepare the plant asset section of Khan‟s balance sheet at December 31, 2009. CMA Adapted – December 2010 234


E-15. The Star Mining Company paid Tk.29,00,000 in 2001 for property with a supply of natural resource estimated at 20,00,000 tons. The estimated cost of restoring the land for use after the resources are exhausted is Tk.3,25,000. After the land is restored it will have an estimated value of Tk.2,25,000. Development costs such as drilling and road construction were Tk.8,00,000. Building, such as, bulk houses and mess hall were constructed on the site for Tk.2,00,000. the useful lives of the buildings are expected to terminate upon exhaustion of the natural resources. Operations were not began until January 01, 2002. In 2002, resources removed totaled 6,00,000 tons. During 2003, an additional discovery was made indicating that available resources subsequent to 2003 will total 18,75,000 tons. Because of a strike, only 4,00,000 tons of resources were removed during 2003. Required: Compute the depletion and also the deprecation charge for 2001, 2002 & 2003. CMA Adapted – December 2009 E-16. On 01.01.2005, a new plant was purchased by Mrs. Kalyani Basu for Tk.100,000 and a further sum of Tk.5,000 was spent on its installation. On 01.06.2006, another plant was acquired for Tk.65,000. On 02.10.2007, the first plant was totally destroyed and the amount of Tk.2,500 only was realized by selling the scrap. It was not insured. On 20.10.2007, a second hand plant was purchased for Tk.75,000 and a further sum of Tk.7,500 was spent on repairs and Tk.2,500 on its erection. It came into use on 15.11.2007. Depreciation has been provided at 10% on the original cost annually on 31 st December. It was the practice to provide depreciation for full year on all acquisitions made at any time during any year and to ignore depreciation on any item sold during the year. The accounts are closed annually on 31 st December. In December 2007, it was decided to change the method of depreciation and to follow the rate of 15% on the diminishing balance method with retrospective effect in respect of the existing items of plant and to make necessary adjustments on 31.12.2007. Required: Show Plant Account, Plant Disposal Account and Accumulated Depreciation Account for 3 years. CMA Adapted – April 2009

235


CHAPTER - 7 INTANGIBLE ASSETS (IAS 38) AND GOODWILL

7.1. DEFINITION OF INTANGIBLE ASSET An intangible asset is an identifiable non-monetary asset without physical substance. Like tangible assets, it cannot be touched. While intangible assets do not have a physical presence, they add value to the business. They are long-term assets of a company having a useful life greater than one year. A business can either develop these assets internally or can acquire them in a business combination. Examples of intangible assets: Marketing related intangible assets include trademarks, internet domain names, newspaper mastheads, etc. Customer related intangible assets include customer lists, order backlog, customer relationships, etc. Artistic related intangible assets include performance events, literary works, musical works, pictures, television programs, etc. Contract based intangible assets include licensing agreements, service contracts, lease agreements, franchise agreements, broadcast rights, employment contracts, etc. Technology based intangible assets include patented technology, computer software, secret formulas, etc. 7.2. TYPES OF INTANGIBLE ASSET Followings are the important types of intangible assets: Goodwill: Goodwill is the excess of purchase price over the fair market value of a company's identifiable assets and liabilities. It shows that a business has value beyond its actually physical assets and liabilities. Goodwill can be created from the excellence of management, customer loyalty, brand recognition, favorable location, or even the quality of employees. Anything that adds value to the company beyond its excess assets over liabilities is considered as goodwill. Franchise agreement: Franchise agreements are another type of intangible asset that grants the legal right to a business to operate using the name of another company or sell a product or service developed by another company. These are classified as assets because the business owners reap monetary gains with the help of these intangible assets. Patent: A patent is a type of intangible asset that grants a business the exclusive right to manufacture, sell or use a specific invention. A company can purchase the patent from another company or it can invent a new product and receive a patent for it. 236


Copyright: Copyright grants an extensive right to the business to reproduce and sell a software, book, journal, magazine, etc. It is an intangible asset used to secure legal protection by preventing others from reproducing or publishing a work of authorship. Trademark: A trademark is a name, symbol, figure, letter, word, or mark adopted and used by a manufacturer or merchant in order to designate his or her goods. It is capable of distinguishing the goods or services of one enterprise from those of other enterprises. Trademarks are protected by intellectual property rights. 7.3. CHARACTERISTICS OF INTANGIBLE ASSET Not tangible - Intangible asset does not take physical form in the same way as a factory, machine or retail outlet does. This type asset can not be touched as like as tangible asset. Non-monetary asset - Intangible assets are similar to tangible assets as they contribute to the entityâ€&#x;s operations. However, intangible assets are non-monetary assets without physical existence like other assets. Identifiable - An intangible asset must be identifiable to distinguish it from goodwill, i.e. it can be either separable or divided from the entity, licensed, rented or exchanged. Control - Intangible assets must be controlled by the entity, i.e. should have a power to obtain the future economic benefits flow to the entity. Future economic benefit – Entity must provide future economic benefits in many ways, such as revenue from the sale of the products, cost saving, etc. 7.4. DIFFERENCES BETWEEN TANGIBLE AND INTANGIBLE ASSETS Tangible asset Intangible asset (a) Asset that has a physical existence and (a) Asset that does not has a physical can be touched is known as tangible asset. existence and cannot be touched but at still as important is known as intangible asset. (b) The value of a tangible asset adds to the (b) The value of intangible asset, adds to current market value the potential revenue and worth. (c) It is depreciated. (c) It is amortized. (d) The cost of tangible cost can be easily (d) The cost of intangible is much harder determined. to determine. (e) Can be easily sold to raise cash in (e) May be difficult to be sold emergency. emergency. (f) Example includes plant and machinery, (f) Example includes patent, copyright, building, inventory, etc. computer software, logo, etc. 7.5. RECOGNITION OF INTAGIBLE ASSET An entity shall recognize an asset as intangible that meets: (a) the definition of an intangible asset; and (b) the recognition criteria. 237


This requirement applies to costs incurred initially to acquire or internally generate an intangible asset and those incurred subsequently to add to, replace part of, or service it. An intangible asset shall be recognised if: (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and (b) the cost of the asset can be measured reliably. An entity shall measure an intangible asset at cost. 7.6. MEANING OF GOODWILL Goodwill is an intangible asset that arises as a result of the acquisition of one company by another for a premium value. The value of a company's brand name, solid customer base, good customer relations, good employee relations and any patents or proprietary technology represents goodwill. It is recognised in a business combination as an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. The future economic benefits may result from synergy between the identifiable assets acquired or from assets that, individually, do not qualify for recognition in the financial statements. For example, if Company ABC buys Company XYZ for more than the fair value of Company XYZ's assets and debts, the amount left over is listed on Company ABC's balance sheet as goodwill. 7.7. FEATURES OF GOODWILL (a) Goodwill is an intangible asset implying that it is one cannot be seen or touched like land or building but it has certain value attached to it. (b) It can be sold or purchased with whole business and it is valuable only when entire business is sold or purchased. (c) The value of goodwill and the assessment of its existence is based upon subjective judgement of the valuer, inspite of different methods of its valuation. (d) It is dependent on various factors like location of the company, relationship with the suppliers, long term contracts of the company with customers, etc. (e) It is difficult to place an exact value to goodwill since its value fluctuates from time due to changing circumstances of business. (f) Goodwill shows a non-physical value, it does not depreciate by wear and tear. However, the goodwill becomes a fictitious asset if it appears in the books of a losing concern. (g) The value of goodwill is highly dependent on the person who is determining the value of goodwill. It is difficult to assign a specific value to goodwill because on the basis of companyâ€&#x;s performance its value can be changed. 7.8. METHODS OF VALUATION OF GOODWILL There are three methods of valuation of goodwill of the firm: (a) Average profits method: Under this method, goodwill is calculated on the basis of the average of some agreed number of past years. The average is then multiplied by the agreed number of years. This is the simplest and the most commonly used method of the valuation of goodwill. 238


Goodwill = Average profits X Number of years of purchase Before calculating the average profits the following adjustments should be made in the profits of the firm: i. Any abnormal profits should be deducted from the net profits of that year. ii. Any abnormal loss should be added back to the net profits of that year. iii. Non-operating incomes e.g. income from investments etc. should be deducted from the net profits of that year. (b) Super profits method: Super profits are the profits earned above the normal profits. Under this method goodwill is calculated on the basis of super profits i.e. the excess of actual profits over the average profits. Steps for calculating Goodwill under this method are given below: Goodwill = Super profits x No. of years purchased Here, Super profits = Actual profits - Normal profits Normal profits = Capital invested X Normal rate of return/100 (c) Capitalisation method: There are two ways of calculating goodwill under this method: i. Capitalisation of average profits: Under this method we calculate the average profits and then assess the capital needed for earning such average profits on the basis of normal rate of return. Such capital is called capitalised value of average profits. The formula isGoodwill = Capitalised value of average profits - Capital employed Here, Capitalised value of average profits = Average profits X (100 ÷ Normal rate of return) Capital employed = Assets - Liabilities ii. Capitalisation of super profits: Under this method first of all we calculate the Super Profits and then calculate the capital needed for earning such super profits on the basis of normal rate of return. This Capital is the value of our Goodwill. The formula is: Goodwill = Super profits X (100 ÷ Normal rate of return) 7.9. AMORTIZATIION OF GOODWILL As per the Financial Accounting Standards Board (FASB) Statement 142, goodwill is no longer permitted to be amortized. In accounting, goodwill is accrued when an entity pays more for an asset than its fair value based on the company‟s brand, client base or other factors. Corporations use the purchase method of accounting, which does not allow for automatic amortization of goodwill. Goodwill is carried as an asset and evaluated for impairment at least once a year. Until 2001, goodwill was an amortization expense for a period of up to 40 years. Many companies used the 40-year maximum to neutralize the periodic earnings effect and report supplementary cash earnings that they then added to net income. The FASB changed this in June 2001 with the issuance of Statement 142, which prohibits this. 239


7.10. EXPLANATION OF NEGATIVE GOODWILL Negative goodwill is a gain occurring when the price paid for an acquisition is less than the fair value of its net tangible assets. Negative goodwill implies a bargain purchase. Negative goodwill may be listed as a separate line item on the acquiring company's balance sheet and may be considered income. For the purchased company, negative goodwill often indicates a distress sale, and the unfavorable sale conditions lead to a depressed sale price. Once it is confirmed that resultant is negative goodwill than the resulting gain should be recognized in the profit and loss at the acquisition date in the books of acquirer i.e. it will be taken as a gain in the consolidated income statement of the acquirer. All of the gain should be attributed to the acquirer. 7.11. DISCLOSURE An entity shall disclose the followings for each class of intangible assets: (a) whether the useful lives are indefinite or finite; (b) the useful lives or the amortisation rates used for finite intangible assets; (b) the amortisation methods used for intangible assets with finite useful lives; (c) the gross carrying amount and any accumulated amortisation at the beginning and end of the period; (d) the line item(s) of the statement of comprehensive income in which any amortisation of intangible assets is included; (e) a reconciliation of the carrying amount at the beginning and end of the period An entity shall disclose the nature and amount of a change in an accounting estimate that is expected to has a material effect in the current period or in subsequent periods. Such disclosure may arise from changes in: (a) the assessment of an intangible assetâ€&#x;s useful life; (b) the amortisation method; or (c) residual values. An entity shall also disclose for an intangible asset: (a) the carrying amount of the asset having indefinite useful life. (b) the carrying amount and remaining amortisation period of the intangible asset that has a material effect to the financial statements. (c) the carrying amounts of intangible assets whose title is restricted. (d) the carrying amounts of intangible assets pledged as security for liabilities. (e) the contractual commitment amount for the acquisition of intangible assets.

240


PROBLEMS AND SOLUTIONS P-1. Malian Inc. has accumulated development costs that meet the criteria for capitalization at December 31, 2015, amounting to Tk.39,000. It is estimated that useful life of this intangible asset will be 6 years; accordingly, amortization of Tk.6,500 per year anticipated. Malian uses the allowed alternative method of accounting for its long-lived tangible and intangible assets. At December 31, 2017, it obtains market information regarding the then-current fair value of this intangible asset, which suggests a current fair value of these development costs is Tk.40,000; the estimated useful life, however, has not changed. Pass necessary entries assuming that accumulated amortization has been grossed up under IAS 38 to reflect the new fair value information. Solution: For the illustration, the book value (amortized cost) immediately prior to the revaluation is Tk.39,000 – (Tk.6,500 X 2) = Tk.26,000. The net upward revaluation is given by the difference between fair value and book value or Tk.40,000 – Tk.26,000 = Tk.14,000. If the grossed up method is used: Since the fair value after 2 years of the 6 years useful life have already elapsed is found to 6 be Tk.40,000, the gross fair value must be X Tk.40,000 = Tk.60,000. The entries to 4 record this would be as follows: Development cost (asset) Accumulated amortization – development cost Revaluation surplus (stockholders‟ equity)

- Dr. - Cr. - Cr. -

Tk.21,000 Tk.7,000 14,000

P-2. A patent right is acquired July 1, 2014, for Tk.250,000; while it has a legal life of 15 years, due to rapidly changing technology, management estimates a useful life of only 5 years. Straight-line amortization will be used. At January 1, 2015, Management is uncertain that the process can actually be made economically feasible, and decides to write down the patent to an estimated market value of Tk.75,000. Amortization will be taken over 3 years from that point. On January 1, 2017, having perfected the related production process, the asset is now appraised at a sound value of Tk.300,000. Furthermore, the estimated useful life is now believed to be 6 more years. Pass necessary entries to reflect the events as mentioned. Solution: Journal entries Date July 1, 2014 Dec. 31, 2014

241

Particulars Patent Cash Amortization expense Patent

Dr. (Tk.) 250,000

Cr. (Tk.) 250,000

25,000 25,000


Jan. 1, 2015 Dec. 31, 2015 Dec. 31, 2016 Jan. 1, 2017

Loss from asset impairment Patent Amortization expense Patent Amortization expense Patent Patent Gain on asset value recovery Revaluation surplus

150,000 150,000 25,000 25,000 25,000 25,000 275,000 100,000 175,000

P-3. Marlin Inc. has accumulated development costs that meet the criteria for capitalization at December 31, 2015, amounting to Tk.39,000. It is estimated that the useful life of this intangible asset will be 6 years; accordingly, amortization of Tk.6,500 per year is anticipated. Marlin uses the allowed alternative method of accounting for its long-lived tangible and intangible assets. At December 31, 2017, it obtains market information regarding the current fair value of this intangible asset which suggest a current fair value of these development costs is Tk.40,000; the estimated useful life, however, has not changed. Pass necessary entries assuming that accumulated amortization has been grossed up under IAS 38 to reflect the new fair value information. Solution: The net book value at December 31, 2017 = Tk.39,000 – (Tk.6,500 X 2 years) = Tk.39,000 – Tk.13,000 = Tk.26,000 Revaluation surplus = Tk.40,000 – Tk.26,000 = Tk.14,000 Since the fair value after 2 years of the 6 years useful life is found to be Tk.40,000; by using the grossed up method the gross fair value 6 = Tk.40,000 X 4 = Tk.60,000 Development cost (assets) = Tk.60,000 – Tk.39,000 = Tk.21,000 Journal entry: Development cost (assets) Accumulated amortization – development cost Revaluation surplus

- Dr. - Cr. - Cr. -

Tk.21,000 Tk.7,000 14,000

P-4. A Ltd. agreed to buy the business of B Ltd. For that purpose Goodwill is to be valued at three years purchase of average profits of last five years. The profits of B Ltd. for the last five years are:

242


Year 2013 2014 2015 2016 2017

Profit/ Loss (Tk.) 10,000,000 12,250,000 7,450,000 (2,450,000) 12,400,000

Following additional information is available: 1. In the year 2016 the company suffered a loss of Tk.1,000,500 due to fire in the factory. 2. In the year 2017 the company earned an income from investments outside the business Tk.4,500,250. Required: Determine the value of goodwill. Solution: Total profits earned in the past five years = 10,000,000 + 12,250,000 + 7,450,000 – 2,450,000 + 12,400,000 = Tk. 39,650,000 Total Profits after adjustments = Tk.39,650,000 + Tk.1,000,500 – Tk.4,500,250 = Tk.36,150,250

Tk.36,150,250 5 years = Tk.7,230,050

Average Profits =

Goodwill = Tk.7,230,050 × 3 = Tk.21,690,150 Thus, A Ltd. would pay Tk.21,690,150 as the price of Goodwill earned by B Ltd. P-5. The capital employed as shown by the books of ABC Ltd is Tk. 50,000,000 and the normal rate of return is 10%. Goodwill is to be calculated on the basis of 3 years purchase of super profits of the last four years. Profits for the last four years are: Year 2014 2015 2016 2017

Profit/ Loss (Tk.) 10,000,000 12,250,000 7,450,000 5,400,000

You are required to calculate the value of goodwill. Solution: Total profits for the last four years = 10,000,000 + 12,250,000 + 7,450,000 + 5,400,000 = Tk.35,100,000 243


Tk.35,100,000 4 years = Tk.8,775,000

Average Profits =

Normal Profits = 50,000,000 X 10% = Tk.5,000,000 Super Profits = Average or Actual Profits − Normal Profits = 8,775,000 − 5,000,000 = Tk.3,775,000 Goodwill = Tk.3,775,000 × 3 = Tk.11,325,000 P-6. For each of the following independent situations, calculate the amount of goodwill. (a) A firm earns Tk.40,000 as its average profits. The normal rate of return is 10%. Total assets of the firm are Tk.1,000,000 and its total external liabilities are Tk.500,000. (b) ABC Ltd earns a profit of Tk.50,000 by employing a capital of Tk.200,000, The normal rate of return of a firm is 20%. Solution: (a) Total capitalized value of the firm 100 = Tk.40,000 × 10 = Tk.400,000 Capital Employed = Tk.1,000,000 – Tk.500,000 = Tk.500,000 Goodwill = Tk.500,000 – Tk.400,000 = Tk.100,000 (b) Normal Profits = Tk.200,000 X 20% = Tk.40,000 Super profits = Tk.50,000 – Tk.40,000 = Tk.10,000 Goodwill = Tk.10,000 ×

100 20

= Tk.50,000 P-7. The following particulars are available in respect of a corporate. (a) Capital employed, Tk.500 million (b) Operating profit after tax for last three years are Tk.80 million, Tk.100 million, Tk.90 million; current year‟s operating profit after tax is Tk.105 million. 244


(c) Riskless rate of return, 10 percent (d) Risk premium relevant to the business of corporate firm, 5 per cent You are required to compute the value of goodwill, based on the present value of the super profit method. Super profits are to be computed on the basis of the average profit of 4 years. It is expected that the firm is likely to earn super profit for the next 5 years only. (Note: PV of annuity for 5 years; at 10% = 3.791 at 15% = 3.352) Solution: Tk.105 million 2 = Tk.500 million – Tk.52.5 million = Tk.447.5 million Tk.80  Tk.100  Tk.90  Tk.105 Average profit = 4 Tk.375 = 4 = Tk.93.75 Super profit: Average profit Tk.93.75 Less. Normal profit (10% of Tk.447.5) (44.75) Super profit Tk.49.00

Average capital employed = Tk.500 million -

Goodwill = Tk.49 million X 2 = Tk.98 million P-8. Given below the Balance Sheet of Madhumati Ltd. as on 31 December, 2017: Liabilities 10,000, 10% preference shares of Tk.100 each 40,000 ordinary shares of Tk.100 each, fully paid up Reserve fund Creditors Profit and Loss Account (last year) Profit for the current year Provision for Depreciation: Building Machinery

Taka Assets 10,00,000 Buildings 40,00,000 Machinery

10,00,000

10,00,000 Furniture 9,80,000 Stock (market value) 8,00,000 Investments

30,000 35,00,000 37,00,000

43,00,000 Book debts (net) Preliminary expenses 2,00,000 Cash & Bank Balance 2,50,000 12530,000

28,00,000 1,00,000 6,00,000 _______ 12530,000

Additional Information: (a) 25% of Investments represent idle fund. (b) The buildings are now worth Tk.25,00,000. 245

Taka 8,00,000


(c) The Company‟s prospects for 2018 are apparently good. (d) The profit of the company for the last years have been shown an increase of Tk.5,00,000 annually. (e) The rate of return of similar business is around 20%. Required: Find out the intrinsic value of ordinary shares after taking into consideration a reasonable amount as goodwill. Solution: Valuation of goodwill: The value of assets: Building (b) Machinery (Tk.10,00,000-Tk.2,50,000) Furniture Stock Investment (a) (37,00,000 – 25% of 37,00,000) Book debts Less. Creditors Capital employed

Tk.25,00,000 7,50,000 30,000 35,00,000 27,75,000 28,00,000 Tk.1,29,55,000 (9,80,000) Tk.1,19,75,000

Tk.43,00,000 2 = Tk.1,19,75,000 – Tk.21,50,000 = Tk.98,25,000

Average capital employed = Tk.1,19,75,000 -

Average profit: Profit for 2017 Profit for 2016 Profit for 2015

Tk.43,00,000 38,00,000 33,00,000 Tk.1,14,00,000 Tk.1,14,00,000 3 = Tk.38,00,000

Average profit =

Super profit: Average profit Less. Normal profit (e) (20% of Tk.98,25,000) Super profit

Tk.38,00,000 (18,65,000) Tk.18,35,000

Goodwill = Tk.18,35,000 X 2 = Tk.36,70,000

246


Net assets: Present value of assets: Cash at bank Stock Book debts Investment Furniture Machinery Goodwill Less. Creditors Net assets Less. Preference share capital Fund available for ordinary shares

Tk.6,00,000 35,00,000 28,00,000 37,00,000 30,000 7,50,000 36,70,000 Tk.1,75,50,000 (9,80,000) Tk.1,65,70,000 (10,00,000) Tk.1,55,70,000

Tk.1,55,70,000 40,000 shares = Tk.389.25

Intrinsic value of each ordinary share =

P-9. The Exim Corporation is considering acquisition of the Moon Company assembles the following information relating to the company: Moon Company Balance Sheet December 31, 2017 As per company As adjusted by Particulars books appraisal & audit Assets Taka Taka Current assets 96,000 92,000 Investments 32,000 28,000 Land, building & equipment (net) 279,200 260,000 Goodwill 64,000 64,000 471,200 444,000 Liabilities & stockholders equities: Current liabilities 15,000 15,000 Long term liabilities 160,000 160,000 Capital stock 160,000 160,000 Retained earnings 136,200 109,000 471,200 444,000 An analysis of retained earnings disclose the following information: As per company Particulars books Assets Taka Retained earnings, January 1, 2015 115,560 Add. Net income (2015 – 2017) (Note) 49,440 Deduct: Dividends (2015 – 2017) (28,800) Retained earnings, December 31, 2017 136,200 Note: After loss on sale of assets in 2017 48,960 247

As adjusted by appraisal & audit Taka 94,600 43,200 (28,800) 109,000 52,800


Required: (a) Calculate the amount to be paid for goodwill, assuming that earnings of the future are expected to be the same as average normal earnings of the past three years, 10% is expected as a reasonable return on net assets other than goodwill as of December 31, 2017 and average earnings in excess of 10% are capitalized at 16% in determining goodwill. (b) Give the entry on the books of Exim Corporation assuming purchase of the assets of the Moon Company and assumption of its liabilities on the basis as indicated in (a), cash is paid for net assets acquired. Solution: (a) Average earnings Normal return on net assets other than goodwill Excess annual earnings

Tk.32,000 20,500 11,500

Tk.11,500 16% = Tk.71.875

Goodwill =

Average annual earnings = Net income + Loss on sale of fixed assets Tk.43,200  Tk.52,800 = 3 Tk.96,000 = 3 = Tk.32,000 Net assets = Adjusted assets – Goodwill – Liability = Tk.444,000 – Tk.64,000 – Tk.175,000 = Tk.205,000 Return on net assets = Tk.205,000 X 10% = Tk.20,500 (b) Exim Corporation Journal Entries Date

Particulars Current asset Investment Land, building and equipment Goodwill Current liability Long-term liability Cash (Being record of acquisition of assets and assumption of liabilities)

Dr. (Tk.) 92,000 28,000 260,000 71,875

Cr. (Tk.)

15,000 160,000 276,875

248


P-10. Entity A, the entity issuing equity instruments and therefore the legal parent, is acquired in a reverse acquisition by Entity B, the legal subsidiary, on 30 September 2017. The accounting for any income tax effect is ignored. Balance sheet of Entity A and Entity B immediately before the business combination

Current assets Non-current assets Current liabilities Non-current liabilities

Entity A Taka 500 1,300 1,800 300 400 700

Owner’s equity: Issued equity 100 Ordinary shares 60 Ordinary shares Retained earnings

Entity B Taka 700 3,000 3,700 600 1,100 1,700

300 800 1,100

600 1,400 2,000

Other information: On 30 September 2017, Entity A issues 2.5 shares in exchange for each ordinary share of Entity B. All of B‟s shareholders exchange their shares in Entity B. The fair value of each ordinary of Entity B at 30 September 2017 is Tk.40. The quoted market price of Entity A‟s ordinary share at that date is Tk.12. The fair values of Entity A‟s identifiable assets and liabilities at 30 September 2017 are the same as their carrying amounts, with the exception of non-current assets. The fair value of the Entity A‟s non-current assets at 30 September 2017 is Tk.1,500. Required: (a) Calculate the cost of business combination. (b) Calculate goodwill. Solution: (a) Cost of business combination: Entity A issues 2.5 times of entity B‟s existing share i.e. 2.5 X 60 = 150 shares i.e. Entity B‟s shareholders own 60% of the issued share of the combined entity (i.e. 150 shares of 100 + 50 = 250 shares) The remaining 40% are owned by Entity A‟s shareholders. If the business combination had taken place in the form of Entity B issuing additional ordinary shares to Entity A‟s shareholders in exchange for their ordinary shares in Entity 249


A, Entity B would have had to issue 40 shares for the ratio of ownership interest in the combined entity to be the same. Entity Bâ€&#x;s shareholders would then own 60 out of the 100 issued share of Entity B and therefore 60% of the combined entity. As a result the cost of combination is USD 1,600 (i.e. 40 shares each with a fair value of USD 40) (b) Calculation of goodwill: Cost of the business combination Net fair value of Entity Aâ€&#x;s identifiable assets and liabilities: Current assets USD 500 Non-current assets 1,500 Current liabilities (300) Non-current liabilities (400) Goodwill

USD 1,600

1,300 300

P-11. The balance sheet of Eastern Co. Ltd. disclosed the following position on 31 December 2017: Assets Taka Plant and machinery 400,000 Land and building 350,000 Inventories 200,000 Accounts receivable 150,000 Cash and bank balances 50,000 1,150,000 Share capital and liabilities Common stock (10 par value) 100,000 Preferred stock (10 par value) 100,000 Retained earnings 10,000 Net profit during the year 40,000 7% Bond payable 500,000 Accounts payable 400,000 1,150,000 Additional information: (a) Adequate provision has been made in the accounts for taxation. (b) The fixed assets of the company have been adequately depreciated. (c) The present market value of plant and machinery is Taka 500,000. (d) The turnover and net profit or losses of the company since incorporation, after charging depreciation and taxation have been as follows: Year Turnover Profit/ (Losses) 2011 1,100,000 140,000 2012 1,200,000 110,000 2013 900,000 (120,000) 2014 600,000 40,000 2015 1,200,000 100,000 2016 1,400,000 150,000 2017 1,750,000 170,000 250


The reasonable return on capital invested in the class of business done by Eastern Co. Ltd. is 10 percent. The loss incurred in 2013 was due to exceptional circumstances. It is expected that the company will be able to maintain its profit for the next few years at the same level in the past. Required: Calculate the value of goodwill of Eastern Co. Ltd. (Assume that tax rate is 40% and also consider any further facts, if, necessary). Solution: Capital employed: Total assets as per balance sheet Add. Value of plant and machinery increase (400,000 – 500,000) Less. Current liabilities: Accounts payable Add. 50% of profit of 2017 (assuming that 50% of profit distributed as dividend) Average profit for the last three years: 2015 2016 2017 Tk.420,000 ) 3 Add. Interest on bond (60% of Tk.35,000)

Average profit (

Super profit: Average profit Less. Return on capital employed (10% of Tk.935,000) Value of goodwill = Tk.67,500 X 3 = Tk.202,500

251

Tk.1,150,000 100,000 1,250,000 400,000 850,000 85,000 935,000 100,000 150,000 170,000 420,000 140,000 21,000 161,000 161,000 93,500 67,500


EXERCIES E-1. East West Co. Ltd. assembles the following data relative to the North South Co. Ltd., in determining the amount to be paid for the net assets and goodwill of the later company: Taka Assets at appraised values (before goodwill) 8,20,000 Liabilities 3,60,000 Stockholders‟ Equity 4,60,000 Net Earnings (after elimination of extraordinary items) Taka 2011 80,000 2012 62,000 2013 87,000 2014 85,000 2015 91,000 Required: Compute the amount of goodwill under each of the following assumptions: (i) Average earnings are capitalized at 15% in arriving at the business worth. (ii) A return of 12% is considered normal on net assets at appraised values‟ goodwill is valued at 5 years‟ excess earnings. (iii) A return of 14% is considered normal on net assets at appraised values‟ excess earnings are to be capitalized at 20%. (iv) Goodwill is valued at the sum of the excess of a 10% annual yield on net assets at appraised values. (v) A return of 10% is considered normal on net identifiable assets at their appraised values. Excess earnings are expected to continue for 10 years. Goodwill is to be valued by present value method using a 20% rate. (The present value of 10 annual payments of Tk.1 providing a return of 20% is Tk.4.192). CMA Adapted – December 2016 E-2. TIP paid Tk.2.50 per share to acquire 100% of TOP‟s equity shares on 1 April 2015. At that date TOP‟s statement of financial position showed the following balances with equity: Tk.’000 Equity shares of Tk.1 each 180 Share premium 60 Retained earnings 40 TOP‟s net asset values were the same as their book values, except for land which was valued at Tk.70,000 more than its book value. TIP directors estimate that any goodwill arising on the acquisition will have a useful life of 10 years. Required: (i) Calculate goodwill arising on the acquisition of TOP. (ii) Explain how TIP should record the goodwill in its group financial statements for the year ended 31 March 2016, in accordance with IFRS 3 Business Combinations. CMA Adapted – June 2016 252


E-3. Information concerning Sandro Corporation‟s intangible assets is as follows: (i) On January 1, 2012, Sandro signed an agreement to operate as a franchisee of Hsian Copy Service, Inc. for an initial franchise fee of $75,000. Of this amount, $15,000 was paid when the agreement was signed and the balance is payable in 4 annual payments of $15,000 each, beginning January 1, 2013. The agreement provides that the down payment is not refundable and no future services are required of the franchisor. The present value at January 1, 2012, of the 4 annual payments discounted at 14% (the implicit rate for a loan of this type) is $43,700. The agreement also provides that 5% of the revenue from the franchise for 2012 was $900,000. Sandro estimates the useful life of the franchise to be 10 years. (ii) Sandro incurred $65,000 of the experimental and development costs in its laboratory to develop a patent that was granted on January 2, 2012. legal fees and other costs associated with registration of the patent totaled $17,600. Sandro estimates that the useful life of the patent will be 8 years. (iii) A trademark was purchased from Shanghai Company for $36,000 on July 1, 2009. Expenditures for successful litigation in defense of the trademark totaling $10,200 were paid on July 1, 2012. Sandro estimates that the useful life of the trademark will be 20 years from the date of acquisition. Instructions: 1. Prepare a schedule showing the intangible assets section of Sandro‟s balance sheet at December 31, 2012. Show supporting computations in good form. 2. Prepare a schedule showing all expenses resulting from the transactions that would appear on Sandro‟s income statement for the year ended December 31, 2012. Show supporting computations in goods form. CMA Adapted – December 2014 E-4. During the financial year 2012, Muttakeen Limited had the following transactions: (i) On 1st January 2012, Muttakeen Limited purchased new asset of Farhana PLC for Tk.720,000. The face value of Farhana PLC‟s identifiable net assets was Tk.344,000. Muttakeen Limited is of the view that due to popularity of Farhana PLC‟s products, the life of resulting goodwill is unlimited. (ii) On the February 2012, Muttakeen Limited purchased a lease license to operate toll collection service of Bahadursha Park from the Dhaka City Corporation for Tk.120,000 and at an annual fee of 1% of collecting revenue. The lease license expires after 5 years. Collecting revenues were Tk.40,000 during financial year 2012. Muttakeen Limited projects future revenue of Tk.80,000 in 2013 and Tk.120,000 per annum for 3 years thereafter. (iii) On 5th April 2012, Muttakeen Limited was granted a patent that had been applied for by Farhana PLC. During 2012, Muttakeen Limited incurred legal costs of Tk.102,000 to register the patent and an additional Tk.170,000 to successfully prosecute a patent infringement suit against a competitor. Muttakeen Limited expects the patens economic life to be 10 years. Muttakeen Limited follows an accountancy policy to amortize all intangibles on straight line basis over the maximum period permitted by accounting standard taking a full year amortization in the year of acquisition. Required: (a) Prepare a schedule showing the intangible section as per BAS in Muttakeen Limited Statement of Financial Position at 31st December 2012. (b) Prepare a schedule showing the related expenses that would appear in the Statement of Comprehensive Income of Muttakeen Limited for 2012. CMA Adapted – April 2013 253


E-5. Maritime Sea Foods Ltd. assembles the following data relative to the Bionic Foods in determining the amount to be paid for the net assets and goodwill of the later company: Assets at revalued (before goodwill) Tk.26,00,000 Less. Outside liabilities 9,00,000 Net Assets 17,00,000 Net income earned during the five years: (after elimination of extraordinary items) 1996 2,00,000 1997 1,70,000 1998 2,40,000 1999 1,90,000 2000 2,10,000 Required: Calculate the amount to be paid for goodwill under each of the following assumptions: (1) Average earnings are capitalized at 12% in arriving at the business worth. (2) A return of 10% is considered normal on net assets at revalued figures, goodwill is valued at 5 years excess earnings. (3) A return of 8% is considered normal on net assets at revalued figures; excess earnings are to be capitalized at 15%. (4) Goodwill is valued at the sum of earnings of the last three years in excess of a 10% annual yield on net assets (assume that the net assets are the same for three years period). (5) A return of 10% is considered normal on net identifiable assets at their revalued figures. Excess earnings are expected to continue for 10 years. Goodwill is to be valued by the present value method using a 20% rate. (The present value of 10 annual payments of Tk.1 providing a return of 20% is Tk.4.192). CMA Adapted – August 2009 E-6. The Anoka Corporation is considering the acquisition of the assets and business of the Cripple Corporation as of June 30, 2002. The Anoka Corporation is willing to pay the appraised value of the net identifiable assets of Cripple Corporation plus a “reasonable amount� for goodwill. The net assets other than goodwill are appraised at Tk.2,600,000 on June 30, 2002. All inclusive income statements prepared by the Cripple Corporation show the following pretax income for the four years preceding the proposed acquisition: Year ending June 30 1999 2000 2001 2002

Pretax income (Tk.) 345,000 382,000 375,000 385,000

Similar operating results are expected in the future except for the following terms: (i) A review of Cripple Corporation accounting records reveals that building and equipment acquired in July, 1997, at a cost of Tk.300,000 has been depreciated on a straight line basis with a 20 year useful life and no estimated salvage value. This equipment was included in the appraisal of net tangible assets at a current value of Tk. 452,000. Company engineers estimate that the equipment will probably be retired with an estimated salvage value of Tk.40,000 in approximately 16 years. 254


(ii) Cripple Corporation had been paying Tk.15,000 per year in interest charges on bonds that were redeemed at a gain of Tk.16,000 on June 30, 2012. Funds for bond retirement were provided by sale in June, 2002, of the companyâ€&#x;s consumer products division for Tk.500,000. This division had constant losses of approximately Tk.30,000 annually. (iii) Normal maintenance on building and equipment of Cripple Corporation has been inadequate by approximately Tk.19,000 annually. Both parties agree that return of 14% before taxes is normal on assets employed in the type of business engaged in by Cripple Corporation. Earnings in excess of this amount are expected to continue for another 4 years but since there is less certainty about excess earnings, a return of 20% is considered reasonable for an investment in above normal pretax earnings. Instruction: Prepare a summary showing how the amount to be paid for goodwill of the Cripple Corporation is determined using the present value method of calculating goodwill. (The present value of Tk.1 per year for 4 years at 20% is approximately Tk.2.5887). CMA Adapted – April 2009

255


CHAPTER - 8 IMPAIRMENT OF ASSETS (IAS 36)

8.1. DEFINITION OF IMPAIRMENT Impairment is an accounting principle that describes a permanent reduction in the value of a company's asset, normally a fixed asset. This situation exists when the cash flows or other benefits generated by an asset decline, as determined through a periodic assessment. If there is impairment, then the difference between the fair value of the asset and its carrying amount is written off. 8.2. DIFFERENCES BETWEEN IMPAIRMENT AND DEPRECIATION Impairment (a) Impairment is reduction of assets due to change in itâ€&#x;s fair value. (b) Impairment is not a systematic allocation. (c) Impairment loss is calculated as the assetâ€&#x;s carrying amount less the asset's recoverable amount. (d) Impairment takes place due to damage, obsolesce, etc. (e) The journal entry to record an impairment contains a debit to a loss, or expense account and a credit to the underlying asset.

Depreciation (a) Depreciation is a gradual reduction in the value of an asset over a period of time. (b) Depreciation is a systematic allocation. (c) As per straight-line method of calculating depreciation would be to divide the initial cost by the asset's useful life (d) Depreciation takes place due to usage, wear and tear, or obsolescence. (e) The journal entry to record a depreciation contains a debit to a depreciation expense and a credit to the accumulated depreciation.

8.3. REQUIREMENTS FOR ASSET IMPAIRMENT Assets must be properly valued in accordance with GAAP prior to testing. Groups of similar assets should be tested together, with the testing set at the lowest level of identifiable cash flows considered independent of other assets. Testing should fairly determine if the carrying amount exceeds undiscounted cash flows related to the use and disposal of the asset. If this can be demonstrated, the asset can be impaired and written down unless otherwise excluded by the IRS or GAAP. 8.4. REASONS FOR IMPAIRMENT LOSS Business assets should be tested for impairment when a situation occurs that causes the asset to lose value. An impairment loss is recognized and accrued to record the asset's revaluation. Once an asset has been revalued, fluctuations in market value are calculated periodically. Certain intangible assets, such as goodwill, are tested for impairment on an annual basis.

256


Impairment losses can occur for a variety of reasons: - when an asset is badly damaged (negative change in physical condition) - the asset's market price has been significantly reduced - legal issues have had a negative impact on the asset - the asset is set for disposal before the end of its useful life. 8.5. SCOPE OF ASSET IMPAIRMENT Impairment of assets applies to all assets except: - inventories (IAS 2) - assets arising from construction contracts (IAS 11) - deferred tax assets (IAS 12) - assets arising from employee benefits (IAS 19) - financial assets (IAS 39) - investment property carried at fair value (IAS 40) - agricultural assets carried at fair value (see IAS 41) - insurance contract assets (IFRS 4) - non-current assets held for sale (IFRS 5) Therefore, impairment applies to (among other assets): - land - buildings - machinery and equipment - investment property carried at cost - intangible assets - goodwill - investments in subsidiaries, associates, and joint ventures carried at cost - assets carried at revalued amounts under IAS 16 and IAS 38 8.6. DIFFERENCES BETWEEN IMPAIRMENT AND AMORTIZATION Impairment Amortization (a) The word impairment is normally (a) Amortization is a decrease in the value related to long-term assets and its market of an intangible asset or the manner in value lowered significantly. which to pay off a debt over a period of time by periodic payments. (b) In impairment, the value of a (b) In amortization, the value of a company's asset decreases over a period company's asset decreases in regular of time and for this reason it needs to be payments from the beginning at its fair customized at their fair market value. market value. (c) The impairment loss will reduce (c) Annual amortization expense reduces income in the income statement and net income on the income statement, which reduce total assets on the balance sheet. also reduces retained earnings in the stockholders' equity section of the balance sheet. (d) Both tangible and intangible assets (d) Intangible assets like goodwill, patent, are subject to impairment. trademark, computer software are subject to amortization. (e) Impairment occurs due to damage, (e) Amortization occurs due to consumption out dated and change in market demand or out dated of an intangible asset. of an asset. 257


8.7. RECOGNISING AN IMPAIRMENT LOSS If the market value of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its market value. That reduction amount is an impairment loss. An impairment loss shall be recognised immediately in profit or loss account, unless the asset is carried at revalued amount in accordance with another standard. Any impairment loss of a revalued asset shall be treated as a revaluation decrease in accordance with that other standard. An impairment loss on a non-revalued asset is recognised in profit or loss account. However, an impairment loss on a revalued asset is recognised in other comprehensive income. Such an impairment loss on a revalued asset reduces the revaluation surplus for that asset. When the amount estimated for an impairment loss is greater than the carrying amount of an asset, an entity shall recognise a liability if that is required by another standard. After the recognition of an impairment loss, the depreciation (amortisation) charge for the asset shall be adjusted to allocate the assetâ€&#x;s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life. If an impairment loss is recognised, any related deferred tax assets or liabilities are estimated as per IAS 12 by comparing the revised carrying amount of the asset with its tax base. 8.8. DISCLOSURE An entity shall disclose the following for each class of assets: (a) the amount of impairment losses recognised in profit or loss during the period. (b) the amount of reversals of impairment losses recognised in profit or loss during the period. (c) the amount of impairment losses on revalued assets recognised in other comprehensive income during the period. (d) the amount of reversals of impairment losses on revalued assets recognised in other comprehensive income during the period. (e) the assumption used to determine recoverable amount of assets during the period. An entity shall disclose the following for an individual asset (including goodwill) for which an impairment loss has been recognised or reversed during the period: (a) the circumstances that led to the recognition or reversal of the impairment loss. (b) the amount of the impairment loss recognised or reversed. (c) the nature of the asset. (e) the recoverable amount of the asset. (g) if recoverable amount is value in use, the discount rate(s) used in the current estimate and previous estimate (if any) of value in use. An entity shall disclose the following information for the aggregate impairment losses and reversals of impairment losses recognised during the period for which no information is disclosed: 258


(a) the main classes of assets affected by impairment losses and reversals of impairment losses. (b) the main circumstances that led to the recognition of these impairment losses and reversals of impairment losses.

259


PROBLEMS AND SOLUTIONS P-1. The management of Alex Limited was discussing whether certain equipment should be written-off as a charge to current operations because of obsolescence. This equipment has a cost of Tk.800,000 with depreciation to date of Tk.200,000 as of December 31, 2017. On December 31, 2017 management projected its future net cash flows from this equipment to be Tk.300,000 and its fair value to be Tk.250,000. The company intends to use this equipment in the future. Requirements: (a) Prepare the journal entry (if any) to record the impairment at December 31, 2017. (b) Where should the gain or loss (if any) on the write-down be reported in the income statement? (c) What accounting issues did management face in accounting for this impairment? Solution: (a) Cash Accumulated depreciation Carrying amount

Tk.800,000 200,000 600,000

As the expected future net cash flows (Tk.300,000) is less than carrying amount (Tk.600,000) of the asset, so impairment exist. Loss on impairment = Carrying amount – Fair value = Tk.600,000 – Tk.250,000 = Tk.350,000 Journal entry: Dec. 31, 17 Loss on impairment Accumulated depreciation

Tk.350,000 Tk.350,000

(b) This loss on impairment (Tk.350,000) may be reported in the other expenses and losses section or it may be highlighted as an unusual item in a separate section in the income statement. It is not reported s an extra-ordinary item. (c) At first, management need to determine whether there was an impairment or not. To evaluate this step, management estimates the expected future net cash flows from the use of that asset and its eventual disposition. If the sum of expected future net cash flows is less than the carrying amount of the asset, it indicates that an impairment exist. If an impairment occurred, management need to determine the loss on impairment. The loss on impairment takes place when the carrying amount of the asset exceeds its fair value. P-2. Presented below is information related to an equipment owned by Abro Company at December 31, 2016. Cash Tk.300,000 Accumulated depreciation to date 100,000 Expected future net cash flows 50,000 Fair market value 150,000 260


As of December 31, 2016, the equipment has a remaining useful life of 3 years. Assume that Abro will continue to use this asset in the future. Prepare the followings: (a) The journal entry (if any) to record the impairment of the asset at December 31, 2016. (b) The journal entry (if any) to record the depreciation expense for 2017. (c) The journal entry (if any) considering that fair market value of the equipment at December 31, 2017 is Tk.250,000. Solution: (a) Cash Accumulated depreciation Carrying amount

Tk.300,000 100,000 200,000

As the expected future net cash flows (Tk.50,000) is less than the carrying amount (Tk.200,000) of the asset, so impairment exist. Loss on impairment = Carrying amount – Fair market value = Tk.200,000 – Tk.150,000 = Tk.50,000 Journal entry: Dec. 31, 16 Loss on impairment Tk.50,000 Accumulated depreciation (b)

Tk.50,000

New carrying amount = Tk.200,000 – Tk.50,000 = Tk.150,000

Tk.150,000 3 years = Tk.50,000

Depreciation expense = Journal entry: Dec. 31, 17

Depreciation expense Accumulated depreciation

Tk.50,000 Tk.50,000

(c) As, Abro Company will continue to use this asset in the future, no entry is required for the change in fair market value. P-3. Followings are the information related to an equipment owned by Suroz Company at December 31, 2016. Taka Cash 90,00,000 Accumulated depreciation to date 10,00,000 Expected future net cash flows 70,00,000 Fair value 48,00,000 Assume that Suroz will continue to use this asset in the future. As of December 31, 2016, the equipment has a remaining useful life of 4 years. 261


Instructions: (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2016. (b) Prepare the journal entry (if any) to record the depreciation expense for 2017. (c) If the fair value of the equipment at December 31, 2017 is Tk.51,00,000, prepare the journal entry (if any) necessary to record this increase in fair value. Solution: (a) Cash Accumulated depreciation Carrying amount

Tk.90,00,000 10,00,000 80,00,000

As the expected future net cash flows (Tk.70,00,000) is less than the carrying amount (Tk.80,00,000) of the asset, so impairment exist. Loss on impairment = Carrying amount – Fair value = Tk.80,00,000 – Tk.48,00,000 = Tk.32,00,000 Journal entry: Dec. 31, 16 Loss on impairment Accumulated depreciation (b)

Tk.32,00,000 Tk.32,00,000

New carrying amount = Tk.80,00,000 – Tk.32,00,000 = Tk.48,00,000

Tk.48,00,000 4 years = Tk.12,00,000

Depreciation expense = Journal entry: Dec. 31, 17

Depreciation expense Accumulated depreciation

Tk.12,00,000 Tk.12,00,000

(c) As, Suroz Company will continue to use this asset in the future, no entry is required for the change in fair value. P-4. Presented below is information related to an equipment owned by Super Company at December 31, 2016. Cash Accumulated depreciation to date Expected future net cash flows Fair market value

Tk.550,000 200,000 250,000 300,000

As of December 31, 2016, the equipment has a remaining useful life of 4 years. Assume that Super intends to dispose of the equipment in the coming year. It is expected that the cost of disposal will be Tk.50,000. 262


You are required to prepare the followings: (a) The journal entry (if any) to record the impairment of the asset at December 31, 2016. (b) The journal entry (if any) to record the depreciation expense for 2017. (c) The journal entry (if any) considering that fair market value of the equipment at December 31, 2017 is Tk.400,000 and the asset was not sold on that date. The cost of disposal is still Tk.50,000. Solution: (a) Cash Accumulated depreciation Carrying amount

Tk.550,000 200,000 350,000

As the expected future net cash flows (Tk.250,000) is less than the carrying amount (Tk.350,000) of the asset, so impairment exist. Loss on impairment = Carrying amount – (Fair market value - Cost of disposal) = Tk.350,000 – (Tk.300,000 - Tk.50,000) = Tk.350,000 – Tk.250,000 = Tk.100,000 Journal entry: Dec. 31, 16 Loss on impairment Tk.100,000 Accumulated depreciation Tk.100,000 (b) As, Super Company intends to dispose of the equipment, no entry is required for the depreciation. (c) Fair market value Less. Cost of disposal

Tk.400,000 50,000 350,000

Carrying amount (Tk.350,000 – Tk.100,000) Less. Cost of disposal

250,000 50,000

Recovery of impairment loss Journal entry: Dec. 31, 17

Accumulated depreciation Recovery of loss on impairment

200,000 Tk.150,000

Tk.150,000 Tk.150,000

P-5. ABC Company uses special strapping equipment in its packaging business. The equipment was purchased in January 1, 2015 for Tk.800,000 and had an estimated useful life of 8 years with no salvage value. At December 31, 2016, new technology was introduced that would accelerate the obsolescence of ABC Company‟s equipment. ABC Company‟s cost controller estimates that expected future net cash flows on the equipment will be Tk.530,000 and fair value of the equipment is Tk.440,000. ABC Company intends to use the equipment, but it is estimated that the remaining useful life is 4 years. ABC Company uses straight-line depreciation.

263


Required: (a) Prepare the journal entry (if any) to record the impairment at December 31, 2016. (b) Prepare the journal entry (if any) for the equipment at December 31, 2017. The fair value of the equipment at December 31, 2017 is estimated to be Tk.460,000. (c) Repeat the requirements (a) and (b), assuming that ABC Company intends to dispose of the equipment. Solution: (a) Cash

Tk.800,000

Accumulated depreciation (

Tk.800,000 X 2 years) 8 years

200,000

Carrying amount

600,000

As the expected future net cash flows (Tk.530,000) is less than the carrying amount (Tk.600,000) of the equipment, so impairment exist. Loss on impairment = Carrying amount – Fair value = Tk.600,000 – Tk.440,000 = Tk.160,000 Journal entry: Dec. 31, 16 Loss on impairment Accumulated depreciation (b)

Tk.160,000 Tk.160,000

New carrying amount = Tk.600,000 – Tk.160,000 = Tk.440,000

Tk.440,000 4 years = Tk.110,000

Depreciation expense = Journal entry: Dec. 31, 17

Depreciation expense Accumulated depreciation

Tk.110,000 Tk.110,000

(c) Requirement (a) As the ABC Company intends to dispose of the equipment, no entry is required for the depreciation. Requirement (b) Fair value Tk.460,000 Carrying amount (Tk.600,000 – Tk.160,000) 440,000 Recovery of loss on impairment Tk.20,000 Journal entry: Dec. 31, 17

Accumulated depreciation Recovery of loss on impairment

Tk.20,000 Tk.20,000 264


EXERCIES E-1. Telepath acquired an item of plant at a cost of $800,000 on 1 April 2010 that is used to produce and package pharmaceutical pills. The plant had an estimated residual value of $50,000 and an estimated life of five years, neither of which has charged. Telepath uses straight-line depreciation. On 31 March 2012, Telepath was informed by a major customer (who buys products produced by the plant) that it would no longer be placing orders with others even before this information was known, telepath had been having difficulty with this regard. The net cash inflows earned from the plant for year ended: $‟000 220 180 170

31 March 2013 31 March 2014 31 March 2015

On 31 March 2015, the plant is still expected to be sold for its estimated realisable value. Telepath has confirmed that there is no market in which to sell the plant at 31 March 2012. Telepath‟s cost of capital is 10% and the following values should be used: Value of $1 at: end of year 1 end of year 2 end of year 3

$ 0.91 0.83 0.75

Telepath owned a 100% subsidiary, Tilda, that is treated as cash generating unit. On 31 March 2012, there was an industrial accident (a gas explosion) that caused damage to some of Tilda‟s plant. The assets of Tilda immediately before the accident were:

Goodwill Patent Factory building Plant Receivables and cash

$‟000 1,800 1,200 4,000 3,500 1,500 12,000

As a result of the accident, the recoverable amount of Tilda is $6.7 million. The explosion destroyed (to the point of no further use) an item of plant that had a carrying amount of $500,000. Tilda has an open offer from a competitor of $1 million for its plant. The receivables and cash are already stated at their fair values less costs to sell (net realisable values). Required: Calculate the carrying amounts of the assets in above situations at 31 March 2012 after applying any impairment losses. Calculations should be to the nearest $1,000. CMA Adapted – April 2014

265

Contact us to collect exercises solution. Helpline: 01711137039


E-2. ZIT plns to dispose of a group of net assets that form a disposal group. The net assets at December 31, 2011, are Carrying value at December 31, 2011 (Tk.) Goodwill 60,00,000 Property, plant and equipment (PPE) 180,00,000 Inventories 100,00,000 Financial assets (profit of Tk.20 lac recognized in equity) 70,00,000 410,00,000 Less. Financial liabilities (40,00,000) 370,00,000 On moving to accounting under IFRS, some of the assets has been transferred at deemed cost and had not been remeasured under IFRS. These assets were property, plant and equipment, and inventory. Under IFRS, property, plant and equipment would be stated at Tk.160,00,000 and inventory stated at Tk.90,00,000. The fair value less costs to sell of the disposal group is Tk.250,00,000. Assume that the disposal group qualifies as held for sale. Therefore, under IAS 36, any impairment loss will be allocated to goodwill and PPE. Required: Describe how the disposal group would be shown in the financial statements for the year ended December 31, 2011. CMA Adapted – December 2012

266


CHAPTER - 9 INVENTORIES (IAS 2)

9.1. DEFINITION OF INVENTORY As per IAS 2, inventories are assets: (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. Inventories encompass goods purchased and held for resale including merchandise purchased by a retailer and held for resale, or land and other property held for resale. Inventories also encompass finished goods produced or work-in-progress being produced by the entity and include materials and supplies use in the production process. In case of a service provider, inventories include the costs of service for which the entity has not yet recognized related revenue. 9.2. TYPES OF INVENTORY There are several types of inventory. We are discussing below three major types of inventory. Raw materials: Raw materials are inventory that are used in the manufacturing process to produce a component. These are the commodity that the organization or its subsidiary has produced. They also may be purchased from the outside market. If the item is partially assembled or is considered as finished goods to the supplier (not the buyer), the buyer may classify it as raw material. Example of raw materials are ore, minerals, petroleum, chemicals, wood, paper, steel, food items, etc. Work-in-process: Work-in-process is the materials that are being processed or waiting to be processed within the system. It includes all materials that has been released for initial processing and is considered as work-in-process up to inclusion in finished goods. The materials that has been completed process and is awaiting for final inspection is also known as work-in-process. Finished goods: A finished good is a completed item that is ready for use. However, finished goods is the stock of completed products. These goods have passed final inspection requirements and they can be transferred out from work-in-process to finished goods inventory. It can be sold directly to their final users. 9.3. MEANING OF PERPETUAL AND PERIODIC INVENTORY SYSTEMS Perpetual inventory is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software.

267


A periodic inventory system or the periodic inventory method is an accounting method in which the amount of inventory is determined at the end of each accounting period or in specified periods. 9.4. DISTINCTION BETWEEN PERPETUAL AND PERIODIC INVENTORY SYSTEMS Perpetual inventory system (a) Under the perpetual inventory system, there are continual updates to either the general ledger or inventory journal as inventory related transactions occur.

Periodic inventory system (a) Under a periodic inventory system, there is no cost of goods sold account entry at all in an accounting period until such time as there is a physical count, which is then used to derive the cost of goods sold. (b) It is impossible to manually maintain (b) The simplicity of a periodic inventory the records for a perpetual inventory system allows for the use of manual record system, since there may be thousands of keeping for very small inventories. transactions at the unit level in every accounting period. (c) A group of experienced permanent (c) Under periodic inventory system, no employees is needed for the application of separate group of employees is needed for the perpetual inventory system. the stocking purpose. (d) Under the perpetual system, there are (d) Under the periodic inventory system, continual updates to the cost of goods sold the cost of goods sold is calculated in a account as each sale is made. lump sum at the end of the reporting period, by adding total purchases to the beginning inventory and subtracting ending inventory. (e) Under the perpetual inventory system, (e) Under a periodic inventory system, all inventory purchases are recorded in either purchases are recorded into a purchases the raw materials inventory account or asset account, and there are no individual merchandise account (depending on the inventory records to which any unit-count nature of the purchase), while there is also information could be added. a unit-count entry into the individual record that is kept for each inventory item. 9.5. ADVANTAGES OF PERPETUAL INVENTORY SYSTEM Easier method: Perpetual inventory system is the easier and more convenient methods to keep control over merchandise inventory. It is easy to maintain and suitable for large organization. Many companies use this system - especially those using a job order cost accounting system, or selling many different types of inventory. Immediately identify balance: In a perpetual inventory system, inventories are recorded when purchased or sold. This enables an organization to immediately identify inventory balances that are running low. It also prevents being out-of-stock and losing customers because of it.

268


Prevents count error: In a periodic inventory system, the year-end inventory balance is adjusted to agree to the physical inventory count. This prevent any theft, shrinkage or even count errors as the adjustment is transferred to the account for the cost of goods sold. Produces accurate financial statement: Under perpetual inventory system, inventory value does not change during the year. As a result, both the inventory account on the balance sheet and the cost-of-goods-sold account on the profit and loss statement are incorrect throughout the year. A perpetual system keeps those balances correct and gives more accurate set of financial statements throughout the year. Provides correct turnover ratio: Under perpetual inventory system, the inventory turnover ratio can be calculated correctly. The turnover ratio tells a business owner whether sales are slowing down or whether individual products are no longer selling quickly. 9.6. DISADVANTAGES OF PERPETUAL INVENTORY SYSTEM Setup cost: One disadvantage of a perpetual inventory system involves the setup cost. Most systems require the purchase of new equipment and inventory software. Perpetual inventory systems also add to labor costs since all inventory must be entered into the system. Training on equipment: Another disadvantage to implementing a perpetual inventory system involves the increased level of training required. Employees need to know how to operate the new equipment and inventory software. Accounting personnel need training to operate the inventory system. False reliability: Perpetual inventory systems can be misleading when reviewing inventory levels. Employees can make mistakes entering quantities or recording the wrong inventory item. Monitoring cost: To overcome employee errors or customer theft, it needs continuous monitoring. Security monitors typically need to be installed and some companies hire security personnel. It needs to bear additional costs to maintain the system properly and effectively. 9.7. ADVANTAGES OF PERIODIC INVENTORY SYSTEM Easy to implement: It is remarkably easy to implement. If an organization looks for easiest inventory system, then the periodic inventory system is considered to be absolutely perfect. One can add this system to his/her business at any time. Certainly, it is less stressful than any other option for maintaining inventory. Most businesses that work with this system will roll it out once a year. Cheap to implement: To implement this inventory system, an organization needs not to invest in costly software solutions. Technically, it doesnâ€&#x;t have to invest much of anything, except for the time 269


involved in taking a physical inventory. Furthermore, as long as an organization is willing to put in that time, its costs are never technically going to go up either. Suitable for smaller businesses: Small businesses with homogeneous inventory and high inventory turnover can use periodic inventory systems easily, larger businesses can use this system, too. In this system, inventories are not recorded when purchased or sold. In periodic system, inventories are recorded after a particular time period, i.e, weekly, monthly. So few persons are required to maintain this system. Easy record keeping: The only records needed on a monthly basis for periodic inventory are the total materials purchased and total goods sold. No accounting records for inventory counts are needed. The only physical records that are kept come from the annual inventory count completed at the year-end accounting period. Best uses: Under this method, inventories can maintain with few journal entries to the general ledger. It also allows businesses to focus on selling inventory, rather than using personnel to continually count the inventory for accuracy. Larger businesses can benefit from periodic inventory systems as well, although the amount of inventory will create longer annual physical counts and larger adjustments at year-end. 9.8. DISADVANTAGES OF PERIODIC INVENTORY SYSTEM (a) Inaccuracy: One of the main disadvantages of periodic inventory system is the fact that it deals with something that can be highly inaccurate. It can‟t ensure accuracy at all times. For small businesses, this may not be a problem, However, larger businesses are need to be aware when they use this system, inaccuracies aren‟t the norm, but they aren‟t rare either. (b) Difficult to handle correctly: When a business grows, periodic inventory system can prove to be highly problematic. Taking a physical inventory can amount to a time demand that the business really shouldn‟t try to meet. Particularly with small businesses, it can be challenging to find the time and energy to make sure a periodic inventory system is handled correctly. (c) Fails to exercise control: One more thing to consider is that exercising control over inventory is something that is going to become a good deal more difficult. The business fails to know how many inventory it owns till a particular period. As a result, exercising control over inventory becomes more difficult. (d) Information are not up-to-dated: Periodic inventory is only updated after a certain amount of time. Normally, this is around inventory time. Companies manually count their inventory on a weekly, monthly, biyearly or even yearly basis. This means that in terms of the books, the information is not regularly updated. The records do not change, even when the product is shipped or received.

270


(e) Theft can be undetected: Product theft can be very difficult to notice in a periodic inventory system. Some theft will not hurt a business with several different low-cost items, but for a business that sells only valuable items the periodic system is not ideal. 9.9. BEST METHOD OF INVENTORY SYSTEM The perpetual inventory system is the most popular choice for modern businesses. This system was created when customer transactions could be completed with a digital scanner, which sends information about every sale directly to a central computer. When a product is sold, the computer system knows that there is one fewer item in the businesses inventory, and it can deduct that amount from the total number of products in stock. This method requires computer software, such as Fishbows or Inflow, for owners to access details about their inventory. The proper software can alert owners when product amounts are low, or it may even order items automatically. Once it is operational, this method helps prevent human error and keeps a continuous count of every item in stock. This method also suffer from some drawbacks. The drawback to perpetual inventory system is the initial startup cost. In order to work correctly, multiple scanners, computers, and software must be purchased before any sales can be calculated. There are also barcode expenses, which must be placed on each product, and time spent when initially entering the businessâ€&#x;s products into the computer system. However, it is considered as best method of inventory system. 9.10. INVENTORY VALUATION METHOD An inventory valuation allows a company to provide a monetary value for items that make up their inventory. Inventories are usually the largest current asset of a business, and proper measurement of them is necessary to assure accurate financial statements. If inventory is not properly valued, expenses and revenues cannot provide actual scenario of financial information and a company could make poor business decisions. The most commonly used inventory valuation methods are as follows: (a) First-in, first-out (FIFO): The First-in, first-out (FIFO) formula assumes that the items of inventory that were purchased or produced first are sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. (b) Last-in, first-out (LIFO): It is a method for inventory valuation, meaning that the most recently received items are the first to be taken out of a warehouse. This method of inventory valuation assumes that the last costs incurred to purchase merchandise or direct materials are first costs charged against revenues. In other words, it assumes that the cost of merchandise sold or the cost of materials issued to production department is the cost of most recent purchases.

271


(c) Weighted average: Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basic, or as each additional shipment is received, depending upon the circumstances of the entity. (d) Specific identification: Specific identification of cost means that specific costs are attributed to identified items of inventory. This is the appropriate treatment for items that are segregated for a specific project, regardless of whether they have been bought or produced. However, specific identification of costs is inappropriate when there are large numbers of items of inventory that are ordinarily interchangeable. In such circumstances, the method of selecting those items that remain in inventories could be used to obtain predetermined effects on profit or loss. 9.11. MEASUREMENT OF INVENTORY Generally Accepted Accounting Principles (GAAP) require that inventory should be measured at the lower of cost and Net Realisable Value (NRV). (a) Cost: The cost of inventories include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Service providers include the labour and other costs that are directly related in providing the service, including supervisory personnel and attributable overheads, in determining the cost of inventories. Labour and other costs relating to sales and general administrative are not included in the cost of inventories but are recognised as expenses in the period in which they are incurred. The service provider does not include profit margins or nonattributable overheads to the cost of inventories. Costs of purchase: The costs of purchase of inventories include the purchase price, import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items can be deducted in determining the costs of purchase. Costs of conversion: The costs of conversion of inventories include direct labour costs and fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain constant regardless of the volume of production, such as depreciation and variable production overheads are those indirect costs of production that vary directly with the volume of production, such as indirect materials and indirect labour. Other costs: Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may includes non-production overhead or the costs of designing products for specific customers in the cost of inventories.

272


(b) Net Realisable Value (NRV): Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and disposal and other estimated costs necessary to make the sale. 9.12. CONCEPT OF LOWER OF COST OR MARKET Lower of Cost or Market (LCM) is an accounting rule for valuing and reporting inventory and under certain conditions, securities holdings. Under the Lower of Cost or Market rule, inventory should be valued, at the end of an accounting period, as the lower of cost or market value. (a) Cost of inventories: The cost of inventories include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Service providers include the labour and other costs that are directly related in providing the service, including supervisory personnel and attributable overheads, in determining the cost of inventories. Labour and other costs relating to sales and general administrative are not included in the cost of inventories but are recognised as expenses in the period in which they are incurred. The service provider does not include profit margins or nonattributable overheads to the cost of inventories. (b) Market value: Market value is the price an asset would fetch in the open marketplace. It is determined by fluctuations in supply and demand. It should be noted that market value represents what someone is willing to pay for an asset, not the value it is offered for or intrinsically worth. 9.13. RECOGNITION OF INVENTORY When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. The amount of any write-down of inventories to net realisable value and all losses of inventories shall be recognised as an expense in the period the write-down of loss occurs. The amount of any reversal of any write-down of inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs. Some inventories may be allocated to other asset accounts, for example, inventory used as a component of self-constructed property, plant or equipment. Inventories allocated to another asset in this way are recognised as an expense during the useful life of that asset. 9.14. EXPLANATION OF RETAIL INVENTORY METHOD The retail inventory method permits the estimation of inventory position whenever desired. This method of inventory is based on the relationship between the cost of merchandise and its retail price. The retail inventory method is sometimes used by retailers that resell merchandise to estimate their ending inventory balances. The method is not entirely accurate, and so should be periodically supplemented by a physical inventory count. Its results are not adequate for the year-end financial statements, for which a high 273


level of inventory record accuracy is needed. To determine the value of ending inventory using retail inventory method following steps should be followed: (i) Determine the retail value of goods available for sale during the period by adding the retail value of beginning inventory and retail value of goods purchased. (ii) Subtract total sales during the period from the retail value of goods available for sale. (iii) Calculate the cost to retail ratio. It is calculated using the following formula: A B CD Here, A = Cost of beginning inventory; B = Cost of inventory purchased including incidental costs such as freight-in; C = Retail value of beginning inventory; and D = Retail value of goods purchased during the period (iv) Multiply the difference obtained in step (ii) and the cost to retail ratio to obtain estimated cost of ending inventory. Illustration: Beginning inventory Purchase Goods available for sale Less: Sales Ending inventory at retail

Cost Tk.3,000 (A) Tk.2,000 (B) Tk.5,000

Retail Tk.4,000 (C) Tk.3,000 (D) Tk.7,000 Tk.2,000 Tk.5,000

A B CD Tk.5,000 = Tk.7,000 = 71.43%

Cost percentage =

Inventory balance = Tk.5,000 X 71.43% = Tk.3,572 9.15. DISCLOSURE The financial statements shall disclose the followings: (a) the accounting policies and the cost formula used in measuring inventories; (b) the total carrying amount of inventories appropriate to the entity; (c) the fair value of inventories reduced by cost of sale; (d) the amount of inventories recognised as an expense during the period; (e) the amount of write-down of inventories recognised as an expense during the period; (f) the amount of reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period; (g) the circumstances that lead to the reversal of a write-down of inventories; (h) the carrying amount of inventories pledged as security for liabilities.

274


PROBLEMS AND SOLUTIONS P-1. Exim Company has an opening inventory of Tk.100,000 and purchases of Tk.300,000, both at cost. Sales amount to Tk.200,000. The gross-profit on selling price for the previous four years were 10%, 15%, 25% and 30% respectively. Find out the estimated closing inventory. Solution: Exim Company Estimation of closing inventory Amount (Tk.) Opening inventory Add. Purchases Goods available for sale at cost Less. Sales at cost: Sales at selling price Less. Gross profit (20% of 200,000)

100,000 300,000 400,000 200,000 40,000 160,000 240,000

Estimated closing inventory Computation:

Amount (Tk.)

10% 15%  25%  30% 4 years = 20%

Average gross profit =

P-2. For the year ending 30th June 2018, the sales, purchases, opening stock and closing stock of a trader was Tk.1,00,000, Tk.1,20,000, Tk.80,000 and Tk.20,000 respectively. Some goods were destroyed by fire during the year. If the trader earned gross profit @ 30% on sales for the year, calculate the value of goods destroyed by fire. Solution: Amount (Tk.) Opening stock Add. Purchases Goods available for sale at cost Less. Sales at cost: Sales at selling price Less. Gross profit (20% of 100,000)

80,000 120,000 200,000 100,000 30,000

Closing stock The value of goods destroyed by fire = Tk.130,000 - Tk.20,000 = Tk.110,000

275

Amount (Tk.)

70,000 130,0000


P-3. Avra Company lost all of its inventory in a fire on December 26, 2017. The accounting records showed the following gross profit data for November and December. November December (to 26/12/2017) Taka Taka Net sales 600,000 700,000 Beginning inventory 32,000 36,000 Purchases 377,000 424,000 Purchase return and allowances 13,300 14,900 Purchase discounts 8,500 9,500 Freight-in 8,800 9,900 Ending inventory 36,000 Avra Company is fully insured for fire losses but must prepare a report for the insurance company. Required: (a) Compute the gross profit rate for November. (b) Using the gross profit rate for November, determine the estimated cost of inventory lost in fire. Solution: (a) Taka Net sales Less. Cost of goods sold: Beginning inventory Add. Purchases Less. Purchase return and allowances Less. Purchase discounts Add. Freight-in Cost of goods available for sale Less. Ending inventory Cost of goods sold Gross profit Gross profit rate (240,000 รท 600,000)

November Taka 600,000

32,000 377,000 (13,300) (8,500) 8,800 396,000 (36,000) 360,000 240,000 40%

(b) Taka Net sales Less. Estimated gross profit (700,000 X 40%) Estimated cost of goods sold

December Taka 700,000 280,000 420,000

Determination of cost of goods available for sale: Beginning inventory 36,000 Add. Purchases 424,000 Less. Purchase return and allowances (14,900) Less. Purchase discounts (9,500) Add. Freight-in 9,900 276


Cost of goods available for sale Less. Estimated cost of goods sold Estimated cost of the inventory lost in the fire

445,500 (420,000) 25,500

P-4. Many of the financial records of Bright Company were recently destroyed by fire. Management has hired you to create as much financial information as possible for the month of December. You are able to find out that the company uses a weighted average inventory costing system. You also learn that Bright makes a physical count at the end of each month in order to determine monthly inventory values. By examining various documents you are able to gather the following information: Ending inventory at December 31, 2017 Gross margin on sales for December Cost of units available for sale in December Cost of goods sold during December Cost of beginning inventory at December 1, 2017 Purchases Date Units December 4, 2017 60,000 December 11, 2017 50,000 December 15, 2017 40,000 December 16, 2017 50,000

50,000 units Tk.101,000 Tk.118,800 Tk.99,000 Tk.0.35 per unit

Unit cost Tk.0.40 Tk.0.41 Tk.0.42 Tk.0.45

Required: You are asked to provide the following information: (a) Number of units on hand at December 1, 2017. (b) Number of units sold during December. (c) Unit cost of inventory at December 31, 2017. Solution: (a) Determination of total purchases: Units 60,000 50,000 40,000 50,000 200,000

Unit cost Tk.0.40 Tk.0.41 Tk.0.42 Tk.0.45

Total cost Tk.24,000 Tk.20,500 Tk.16,800 Tk.22,500 Tk.83,800

Beginning inventory + Purchases = Cost of units available for sale => Beginning inventory + Tk.83,800 = Tk.118,800 => Beginning inventory = Tk.118,800 – Tk.83,800 => Beginning inventory = Tk.35,000 Tk.35,000 Tk.0.35 = 100,000 units

Number of units on hand at December 1, 2017 =

277


(b) Sales = Beginning inventory + Purchases – Ending inventory => Sales = 100,000 units + 200,000 units – 50,000 units => Sales = 300,000 units – 50,000 units => Sales = 250,000 units Therefore, number of units sold during December = 250,000. (c) Unit cost of inventory at December 31, 2017 Cost of units available for sale = Quantity of units available for sale Tk.118,800 = (100,000  200,000) units Tk.118,800 = 300,000 units = Tk.0.396 per unit P-5. Billal Limited, a client of your consultancy firm, has approached you with the following questions regarding inventory: (a) Fabric included in year-end inventory includes fabric being shipped from USA on FOB terms (risks and rewards are therefore transferred on the date of shipment from the foreign harbour). Delivery costs associated with this special fabric are excessive (Tk.50,000 more than normal delivery costs), but are required urgently for seamless production. Can this Tk.50,000 be included in the inventory value at year-end? (b) The company used a consultant to design new baggies (a completely new product with which the company has no experience), at a total cost of Tk.30,000. This was a once-off order for a large surf store chain. The baggies were completed by year-end at a total production cost of Tk.5,00,000. Can the consultant‟s fees be included in the inventory valuation? (c) Fabric X used in production of the T-shirts, is valued at Tk.50 per metre, but can only be sold at Tk.35 per metre. Finished T-shirts are expected to sell for Tk.100 and to produce Tk.37. At what value should fabric X be recognised in the financial statements? Instruction: Respond briefly to all the above queries of your client in accordance with IAS 2. Solution: (a) In terms of IAS 2.18, any costs (regardless of the amount) that are directly attributable in bringing the inventory to the location and in a condition to be used as intended by management may be capitalised to the asset. Thus, Tk.50,000 can be included in the cost of the fabric. Note however that additional consideration must be given in calculating the net realisable value and ensuring that it is not less that this new higher cost of the fabric (or else a write down would be required). (b) Yes, the consultant‟s fees may be capitalised to the cost of the baggies inventory under IAS 2.18, any costs (regardless of the amount) that are directly attributable in bringing the inventory to the location and in a condition to be used as intended by management may be capitalised to the asset. 278


(c) Fabric X should be valued at cost because no write down below cost to NRV is permitted if the finished goods in which the fabric is used (the T-shirts) are expected to be sold at or above cost (IAS 2.32). P-6. MSR Softtech Company, a newly incorporated company, uses the latest version of a software package (EXODUS) to cost and value its inventory. The software uses the weighted-average cost method to value its inventory. The followings are the purchases and sales made by MSR Softtech Company during 2017 (as a newly set-up company, MSR Softtech Company has no beginning inventory): Purchases January 15 March 10 September 25 Sales March 15 December 15

: : :

100 units @ Tk.250 per unit 150 units @ Tk.300 per unit 200 units @ Tk.350 per unit

: :

150 units 170 units

Required: MSR Softtech Company has appointed you to compute the value of its inventory and the cost per unit of the inventory at March 31, 2017; September 20, 2017; and December 31, 2017; under the weighted-average cost method. Solution:

Date

2017 Jan.15 Jan.31 Mar.10 Mar.10 Mar.15 Mar.31 Sep.25 Sep.30 Dec.15 Dec.31

Particulars

Purchases Balance Purchases Balance Sales Balance Purchases Balance Sales Balance

MSR Softtech Company Weighted-average cost method Units Cost per Value of unit (Tk.) inventory (Tk.) 100 100 150 250 (150) 100 200 300 (170) 130

250 250 300 280 280 280 350 327 327 327

Weighted-average cost per unit (Tk.)

25,000 25,000 45,000 70,000 (42,000) 28,000 70,000 98,000 (55,590) 42,410

P-7. The following particulars are furnished in respect of material X: 2018 January 1 Stock on hand 100 units @ Tk.2.00 per unit ,, 5 Purchases 200 units @ Tk.3.00 per unit ,, 10 Issues 120 units ,, 16 Purchases 250 units @ Tk.3.20 per unit ,, 20 Issues 150 units ,, 31 Purchases 100 units @ Tk.3.40 per unit 279

280 327 327


February ,, ,, ,,

10 15 20 25

Issues Purchases Issues Purchases

300 units 200 units @ Tk.3.60 per unit 150 units 100 units @ Tk.4.00 per unit

Required: Draw up the store ledger accounts for this material using periodic simple average and weighted average method for each month. Solution: Store Ledger Periodic simple average method Date

Particulars Oty

2018 Jan.1 5 10 16 20 31 31 Feb.1 10 15 20 25

Opening Balance Purchased Issued Purchased Issued Purchases Total Opening Balance Issued Purchased Issued Purchased Total

100 200

Received Rate Value 2.00 3.00

Oty

Issued Rate Value

200 600

864

100 300 180 430 280 380 380

1,710

380 80 280 130 230 230

120 250 100 650

3.20 3.40

380

800 340 1,940

150 ___ 270 3.20a

1,076 300

200 100 680

3.60 4.00

720 400 2,196

150 ___ 450 3.80b

Oty

Balance Rate Value 2.00

200

1,076c 1,076

486d

Computations: Tk.3.00  Tk.3.20  Tk.3.40 3 = Tk.3.20

a. Issue rate of January =

Tk.3.60  Tk.4.00 2 = Tk.3.80

b. Issue rate of February =

c. Tk.1,940 – Tk.864 = Tk.1,076 d. Tk.2,196 – Tk.1,710 = Tk.486 280


Date

Particulars

2018 Jan.1 5 10 16 20 31 31 Feb.1

Opening Balance Purchased Issued Purchased Issued Purchases Total Opening Balance Issued Purchased Issued Purchased Total

10 15 20 25

Store Ledger Periodic weighted average method Received Issued Oty Rate Value Oty Rate Value 100 200

2.00 3.00

200 600

250

3.20

800

100 650

3.40

340 1,940

853

100 300 180 430 280 380 380

1,678

380 80 280 130 230 230

120

380

150 ___ 270 3.16e

1,087 300

200

3.60

720

100 680

4.00

400 2,207

150 ___ 450

3.73f

Balance Oty Rate Value 2.00

200

1087g 1,087

529h

Computations:

Tk.600  Tk.800  Tk.340 200 units  250 units  100 units Tk.1,740 = 550 units = Tk.3.16

e. Issue rate of January =

Tk.720  Tk.400 200 units  100 units Tk.1,120 = 300 units = Tk.3.73

f. Issue rate of February =

g. Tk.1,940 – Tk.853 = Tk.1,087 h. Tk.2,207 – Tk.1,678 = Tk.529 P-8. First Company uses a perpetual inventory system for its product. Its inventory, purchases, and sales during the year 2017 are as follows: Date Particulars Purchases Sales Jan.1 Opening 200 units @ Tk.10 = Tk.2,000 Inventory Feb.1 Sales 100 units @ Tk.20 Mar.1 Purchases 300 units @ Tk.20 = Tk.6,000 Apr.1 Sales 350 units @ Tk.40 May 1 Purchases 100 units @ Tk.15 = Tk.1,500 Total 600 units = Tk.9,500 450 units 281

beginning Balance 200units 100units 400units 50units 150units


Additional information for applying specific identification: (a) February 1 sale – 100 units @ Tk.10; (b) April 1 sale – 80 units @ Tk.10, and 270 units @ Tk.20. Required: Calculate the ending inventory and cost of goods sold under LIFO, FIFO, weighted average and specific identification method. Solution: First Company Perpetual Inventory System LIFO method: Date 2017 Jan. 1 Feb. 1 Mar. 1 Apr. 1

May 1

Purchases

Sales 100 @ 10 = 1,000

300 @ 20 = 6,000 300 @ 20 = 6,000 50 @ 10 = 500 100 @ 15 = 1,500 Cost of goods sold = Tk.7,500

Balance 200 @ 10 = 2,000 100 @ 10 = 1,000 100 @ 10 = 1,000 300 @ 20 = 6,000 50 @ 10 = 500 50 @ 10 = 500 100 @ 15 = 1,500 Ending inventory = Tk.2,000

FIFO method: Date 2017 Jan. 1 Feb. 1 Mar. 1 Apr. 1

May 1

Purchases

Sales 100 @ 10 = 1,000

300 @ 20 = 6,000 100 @ 10 = 1,000 250 @ 20 = 5,000 100 @ 15 = 1,500 Cost of goods sold = Tk.7,000

Balance 200 @ 10 = 2,000 100 @ 10 = 1,000 100 @ 10 = 1,000 300 @ 20 = 6,000 50 @ 20 = 1,000 50 @ 20 = 1,000 100 @ 15 = 1,500 Ending inventory = Tk.2,500

Weighted average method: Date 2017 Jan. 1 Feb. 1 Mar. 1 Apr. 1 May 1

Purchases

Sales 100 @ 10 = 1,000

300 @ 20 = 6,000 350 @ 17.5 = 6,125 100 @ 15 = 1,500 Cost of goods sold = Tk.7,125

Balance 200 @ 10 = 2,000 100 @ 10 = 1,000 400 @ 17.50 = 7,000 50 @ 17.50 = 875 150 @ 15.83 = 2,375 Ending inventory = Tk.2,375

282


Specific identification method: Date 2017 Jan. 1 Feb. 1

Purchases

Sales 100 @ 10 = 1,000

Mar. 1 Apr. 1

300 @ 20 = 6,000

May 1

100 @ 15 = 1,500

80 @ 10 = 800 270 @ 20 = 5,400

Cost of goods sold = Tk.7,200

Balance 200 @ 10 = 2,000 100 @ 10 = 1,000 100 @ 10 = 1,000 300 @ 20 = 6,000 20 @ 10 = 200 30 @ 20 = 600 20 @ 10 = 200 30 @ 20 = 600 100 @ 15 = 1,500 Ending inventory = Tk.2,300

P-9. The Neo Company had the following inventory records for the month of January 2018: Date Item Description Quantity Unit price 01/01/2018 M1 – M5 Beginning 5 Tk.20 inventory 05/01/2018 M2, M5 Sale 2 11/01/2018 M6 – M14 Purchase 9 Tk.12 28/01/2018 M1, M3, M6, M7, Sale 7 M8, M9, M14 Assuming a perpetual inventory system is used; and the store manager determine the cost of goods sold and the ending inventory as follows: Method of inventory Cost of goods sold (Tk.) Ending inventory (Tk.) FIFO 148 60 LIFO 124 84 Weighted average 138 70 Required: As a professional accountant can you agree with the above report of store manager? Determine the cost of goods sold and the ending inventory for FIFO, LIFO and weighted average. Solution: Neo Company Perpetual Inventory System FIFO method: Date 01/01/2018 05/01/2018

Purchases

11/01/2018 28/01/2018

9 @ Tk.12 = Tk.108

283

Sales 2 @ Tk.20 = Tk.40

3 @ Tk.20 = Tk.60 4 @ Tk.12 = Tk.48 Cost of goods sold = Tk.148

Balance 5 @ Tk.20 = Tk.100 3 @ Tk.20 = Tk.60 3 @ Tk.20 = Tk.60 9 @ Tk.12 = Tk.108 5 @ Tk.12 = Tk.60 Ending inventory = Tk.60


LIFO method: Date 01/01/2018 05/01/2018

Purchases

11/01/2018

9 @ Tk.12 = Tk.108

Sales 2 @ Tk.20 = Tk.40

28/01/2018

7 @ Tk.12 = Tk.84 Cost of goods sold = Tk.124

Balance 5 @ Tk.20 = Tk.100 3 @ Tk.20 = Tk.60 3 @ Tk.20 = Tk.60 9 @ Tk.12 = Tk.108 3 @ Tk.20 = Tk.60 2 @ Tk.12 = Tk.24 Ending inventory = Tk.84

Weighted average method: Date 01/01/2018 05/01/2018 11/01/2018 28/01/2018

Purchases

Sales 2 @ Tk.20 = Tk.40

9 @ Tk.12 = Tk.108 7 @ Tk.14 = Tk.98 Cost of goods sold = Tk.138

Balance 5 @ Tk.20 = Tk.100 3 @ Tk.20 = Tk.60 12 @ Tk.14=Tk.168 5 @ Tk.14 = Tk.70 Ending inventory = Tk.70

As the store managerâ€&#x;s statement is justified, I agree with his report. P-10. A Corporation that uses a perpetual inventory system has the following transactions during June: June-1 June-2 June-7 June-11 June-14 June-17 June-21 June-24 June-26 June-29

Opening balance 200 units @ Tk.3.00 per unit Purchases 500 units @ Tk.3.20 per unit Issued 400 units Purchased 300 units @ Tk.3.30 per unit Issued 400 units Purchased 400 units @ Tk.3.20 per unit Issued 200 units Purchased 300 units @ Tk.3.40 per unit Purchased 400 units @ Tk.3.50 per unit Issued 600 units

Sales were 1,600 units @ Tk.7.00 per unit; marketing and administrative expenses totaled Tk.2,100. Required: (a) Prepare a comparative income statement based on the transactions for June, using the LIFO and FIFO methods and a 40% income tax rate. (b) For each costing method, determine the cash position at the end of June, assuming that all transactions, purchases, sales, and non-manufacturing expenses were paid in cash. Solution:

284


(a) LIFO method: Date June-1

Purchases

June-2

500@ 3.20=Tk.1,600

June-7

Issue

400@3.20=Tk.1,280

June-11 June-14

300 @3.30=Tk.990

June-17

400@ 3.20=Tk.1,280

300@3.30=Tk.990 100@3.20=Tk.320

June-21

200@3.20=Tk.640

June-24

300@ 3.40=Tk.1,020

June-26

400@ 3.50=Tk.1,400

June-29 Purchases = Tk.6,290

400@3.50=Tk.1,400 200@3.40=Tk.680 Cost of goods sold = Tk.5,310

Balance 200@ 3.00 = Tk.600 200@ 3.00 = Tk.600 500@ 3.20=Tk.1,600 200@ 3.00 = Tk.600 100@ 3.20=Tk.320 200@ 3.00 = Tk.600 100@ 3.20=Tk.320 300@ 3.30=Tk.990 200@ 3.00 = Tk.600 200@ 3.00 = Tk.600 400@ 3.20=Tk.1,280 200@ 3.00=Tk.600 200@ 3.20=Tk.640 200@ 3.00=Tk.600 200@ 3.20=Tk.640 300@ 3.40=Tk.1,020 200@ 3.00=Tk.600 200@ 3.20=Tk.640 300@ 3.40=Tk.1,020 400@ 3.50=Tk.1,400 200@ 3.00=Tk.600 200@ 3.20=Tk.640 100@ 3.40=Tk.340 Ending inventory = Tk.1,580

FIFO method: Date June-1

Purchases

June-2 June-7

500@ 3.20=Tk.1,600

June-11 June-14

200@3.00=Tk.600 200@3.20=Tk.640 300@ 3.30=Tk.990 300@3.20=Tk.960 100@3.30=Tk.330

June-17 June-21

400@ 3.20=Tk.1,280

June-24

300@ 3.40=Tk.1,020

285

Issue

200@3.30=Tk.660

Balance 200@ 3.00 = Tk.600 200@ 3.00 = Tk.600 500@ 3.20=Tk.1,600 300@ 3.20=Tk.960 300@ 3.20=Tk.960 300@ 3.30=Tk.990 200@ 3.30 = Tk.660 200@ 3.30 = Tk.660 400@ 3.20=Tk.1,280 400@ 3.20=Tk.1,280 400@ 3.20=Tk.1,280 300@ 3.40=Tk.1,020


June-26 June-29

400@ 3.50=Tk.1,400

Purchases = Tk.6,290

400@3.20=Tk.1,280 200@3.40=Tk.680 Cost of goods sold = Tk.5,150

400@ 3.20=Tk.1,280 300@ 3.40=Tk.1,020 400@ 3.50=Tk.1,400 100@ 3.40=Tk.340 400@ 3.50=Tk.1,400 Ending inventory = Tk.1,740

Comparative Income Statement For the month of June

Sales (1,600 units @ Tk.7.00) Less. Cost of goods sold Gross profit Less. Marketing and administrative expenses Profit before tax Less. Income tax @ 40% Net profit

LIFO method Tk.11,200 5,310 5,890 2,100 3,790 1,516 2,274

FIFO method Tk.11,200 5,150 6,050 2,100 3,950 1,580 2,370

(b) Cash Position At the end of June

Sales (1,600 units @ Tk.7.00) Less. Purchases Marketing and administrative expenses Cash balance

LIFO method Tk.11,200 (6,290) (2,100) 2,810

FIFO method Tk.11,200 (6,290) (2,100) 2,810

P-11. You are provided with the following information for ABC Company for the month ended on June 30, 2018: Date Jan.1 Feb.1 Mar.1 Apr.1 May1 May1

Particulars Beginning Inventory Purchases Sales Sales Return Purchases Purchases Return

Quantity 40 60 80 20 30 10

Unit cost or selling Price Tk.20 Tk.15 Tk.10 Tk.10 Tk.40 Tk.20

Required: Calculate the ending inventory and cost of goods sold under the following methods by considering periodic inventory system. (a) LIFO; (b) FIFO; and (c) Average cost.

286


Solution: ABC Company Periodic inventory system Cost of goods available for sale: Jan. 1 40 units @ Tk.20 Feb. 1 60 units @ Tk.15 May 1 30 units @ Tk.40 May 1 (10) units @ Tk.40 120 units

= Tk.800 = Tk.900 = Tk.1,200 = (Tk.400) = Tk.2,500

Inventory on hand = 120 units - (80 - 20) units = 120 units – 60 units = 60 units (a) LIFO method: Ending inventory Jan. 1 40 units @ Tk.20 = Tk.800 Feb. 1 20 units @ Tk.15 = Tk.300 Tk.1,100 Cost of goods sold = Tk.2,500 – Tk.1,100 = Tk.1,400 (b) FIFO method: Ending inventory May 1 20 units @ Tk.40 = Tk.800 Feb. 1 40 units @ Tk.15 = Tk.600 Tk.1,400 Cost of goods sold = Tk.2,500 – Tk.1,400 = Tk.1,100 (c) Average cost method:

Tk.2,500 120 units = Tk.20.83

Average cost per unit =

Ending inventory = 60 units X Tk.20.83 = Tk.1250 Cost of goods sold = Tk.2,500 – Tk.1,250 = Tk.1,250

287


P-12. The followings data are related to Dragon Companyâ€&#x;s beginning inventory, purchases, and sales for the year 2018. Beginning inventory Purchases: February 1 April 2 June 8

10,000 units @ Tk.2.00 5,000 units @ Tk.3.00 8,000 units @ Tk.4.00 4,000 units @ Tk.5.00 27,000 units

Sales: March 1 May 7 July 6

12,000 units 9,000 units 1,000 units 22,000 units

Required: Compute the ending inventory and cost of goods sold under each of the following methods assuming periodic inventory procedure: (a) FIFO, (b) LIFO, and (c) Weighted average. Solution: Dragon Company Periodic inventory procedure Cost of goods available for sale: Beginning Inventory 10,000 units February 1 5,000 units April 2 8,000 units June 8 4,000 units 27,000 units

@ Tk.2.00 @ Tk.3.00 @ Tk.4.00 @ Tk.5.00

= = = = =

Tk.20,000 Tk.15,000 Tk.32,000 Tk.20,000 Tk 87,000

Inventory on hand = 27,000 units - 22,000 units = 5,000 units (a) FIFO method: Value of ending inventory: June 8 4,000 units @ Tk.5.00 = Tk.20,000 April 2 1,000 units @ Tk.4.00 = Tk.4,000 Tk.24,000 Cost of goods sold = Tk.87,000 - Tk.24,000 = Tk.63,000 (b) LIFO method: Value of ending inventory: Beginning inventory 5,000 units @ Tk.2.00 = Tk.10,000 Cost of goods sold = Tk.87,000 - Tk.10,000 = Tk.77,000 (c) Weighted average method:

Tk.87,000 27,000 units = Tk.3.22

Average cost per unit =

288


Value of ending inventory = 5,000 units X Tk.3.22 = Tk.16,100 Cost of goods sold = Tk.87,000 - Tk.16,100 = Tk.70,900 P-13. Lee Company, a wholesaler, made the following purchases of Material X during 19A. Date Units Cost per unit (Tk.) Total amount (Tk.) January 7 8,000 12.00 96,000 March 30 8,800 12.40 109,120 May 10 12,000 12.00 144,000 July 5 16,000 12.60 201,600 September 2 6,400 12.80 81,920 December 14 7,200 12.68 91,296 Total 58,400 723,936 On December 31, 19A, inventory was 15,200 units and on January 1, 19A, 4,000 units at Tk.11.92 each were on hand. The sales price during the year was stable at Tk.16. Required: (a) Prepare a schedule of inventory on December 31, 29A, assuming a periodic inventory system and weighted average costing method. (b) Prepare a statement showing material X‟s sales, cost of goods sold and gross profit for December 31, 19A, assuming the FIFO costing method. Solution: (a) Lee Company Schedule of inventory Assuming periodic inventory system As on December 31, 29A Inventory on January 1, 19A 4,000 units @ Tk.11.92 Purchase 58,400 units @ Tk.12.40* Weighted average 62,400 units @ Tk.12.37 Inventory at December 31, 19A 15,200 units @ Tk.12.37 * Tk.723,936 ÷ 62,400 units = Tk.12.40

Tk.47,680 Tk.723,936 Tk.771,616 Tk.188,024

(b) Sales (4,000 + 58,400 – 15,200) units X Tk.16 Less. Cost of goods sold: Inventory on January 1, 19A Add. Purchases Less. Inventory on December 31, 19A (w-1) Gross profit 289

Tk.755,200 Tk.47,680 Tk.723,936 Tk.771,616 Tk.193,376 Tk.578,240 Tk.176,960


Working: 1. Inventory on December 31, 19A under FIFO costing: December 14 7,200 units @ Tk.12.68 = Tk.91,296 September 2 6,400 units @ Tk.12.80 = Tk.81,920 July 5 1,600 units @ Tk.12.60 = Tk.20,160 Tk.193,376 P-14. STAR-TRACK sells satellite tracking systems for receiving television broadcasts from communication satellites in space. At December 31, 2017, the companyâ€&#x;s inventory amounted to Tk.44,000. During the first week in January 2018, STAR-TRACK made only one purchase and one sale. These transactions were as follows: January 3 - Sold a tracking system to Mystery Mountain Resort for Tk.20,000 cash. The system consisted of seven different devices, which had a total cost to STAR-TRACK of Tk.11,200. January 7 – Purchased two Model 400 and four Model 800 satellite dishes from Yamaha Corporation. The total costs of this purchase amounted to Tk.10,000, terms 2/10, n/30. STAR-TRACK records purchases of merchandise at net cost. The company has full-time accounting personnel and uses a manual accounting system. Required: (a) Prepare journal entries to record these transactions, assuming that STAR-TRACK uses perpetual inventory system. (d) Prepare journal entries to record these transactions, assuming that STAR-TRACK uses periodic inventory system. (c) Explain what information in part (a) should be posted to subsidiary ledger accounts. (d) Compute the balance in the inventory controlling account at January 7. (e) Compute cost of goods sold for the first week of January, assuming that STARTRACK uses periodic inventory system. (f) Determine the gross profit margin on January 3 sales transaction. Solution: (a) STAR-TRACK Journal Entries Perpetual inventory system Date 2017 January 3

January 7

Particulars Cash

Dr. (Tk.) 20,000

Sales (To record cash sales) Cost of goods sold Inventory (To record cost of goods sold) Inventory Accounts payable (To record credit purchase)

Cr. (Tk.) 20,000

11,200 11,200 10,000 10,000

290


(b) STAR-TRACK Journal Entries Periodic inventory system Date 2017 January 3 January 7

Particulars Cash Sales (To record cash sales) Purchases Accounts payable (To record credit purchase)

Dr. (Tk.) 20,000

Cr. (Tk.) 20,000

10,000 10,000

(c) The debits and credits of the inventory account should be posted to the appropriate account in the inventory subsidiary ledger. The information posted would be the cost and quantities of the types of merchandise purchased or sold. The accounts payable to Yamaha Corporation also should be posted to the Yamaha account in STAR-TRACK account payable ledger. No posting is required to the accounts receivable ledger, as this was a cash sale. If STAR-TRACK maintains more than one bank account, the debit to cash should be posted to the prior account in the cash subsidiary ledger. (d) The balance in the inventory controlling account at January 7 = Tk.44,000 – Tk.11,200 + (Tk.10,000 X 98%) = Tk.44,000 – Tk.11,200 + Tk.9,800 = Tk.42,600 (e) Computation of cost of goods sold: Inventory at January 1 Add. Purchases (Tk.10,000 X 98%) Cost of goods available for sale Less. Inventory at January 7 (From requirement d) Cost of goods sold

Tk.44,000 9,800 53,800 42,600 11,200

(f) Sales revenue Less. Cost of goods sold Gross profit

Tk.20,000 11,200 8,800

Tk.8,800 X 100 Tk.20,000 = 44%

Gross profit margin =

P-15. Hypo Company is a retailer that produces and sells four major products: A, B, C and D. At June 30, 2018, quantity on hand, cost per unit and Net Realizable Value (NRV) per unit of the product line are as follows: Products A B C D Quantity on hand 10 20 30 40 Cost per unit 250 100 300 200 NRV per unit 200 150 400 150 291


Required: Compute the value of inventory at June 30, 2018, under IAS-2 using “Lower of Cost and NRV‟ principle. Solution: Hypo Company Computation of the value of inventory Under IAS -2 using Lower of cost and NRV principle At June 30, 2018 Products

Cost (Tk.) 2,500 2,000 9,000 8,000

A B C D Total

NRV (Tk.) 2,000 3,000 12,000 6,000

Value of inventory (Tk.) 2,000 2,000 9,000 6,000 19,000

P-16. Royal Company has the following items as inventory as of June 30, 2018. Determine the value of inventory by applying Lower of Cost or Market. The company‟s normal profit margin is 10% of cost. Product Cost (Tk.) Replacement cost (Tk.) Estimated selling price (Tk.) Cost of completion and disposal (Tk.)

A 100 150 320 200

B 300 250 600 300

C 200 300 500 400

D 400 350 550 350

Solution: Royal Company Determination of the value of inventory By applying Lower of Cost or Market As of June 30, 2018 Product

A B C D Total

Cost (Tk.)

Replacement cost (Tk.)

100 300 200 400

150 250 300 350

NRV NRV-Profit Designated (Ceiling) (Floor) market (Tk.) (Tk.) value (Tk.) 120 110 120 300 270 270 100 80 100 200 160 200

Value of inventory (Tk.) 100 270 100 200 670

Here, NRV (Celling) = Estimated selling price - Cost of completion and disposal Floor = NRV - Normal profit margin @ 10% of cost

292


P-17. ABC Company uses perpetual inventory costing for inventory item 407, which it purchases for resale. The company began its operations on January 1 and is in the process of preparing its first financial statements. Upon examining the inventory ledger and other accounting records, the following information was gathered pertaining to the first four months of operations: Purchases Sales Months Units Cost per unit Months Units Months Units January 2 2,000 Tk.5.00 January 15 500 March 15 600 February 2 1,200 Tk.6.00 January 31 700 March 31 800 March 2 1,500 Tk.8.00 February 15 600 April 15 700 April 2 1,900 Tk.7.00 February 28 900 April 30 700 On April 30, the following additional information was obtained: - Current replacement cost, Tk.6.50 per unit. - Net realizable value, Tk.8.00 per unit. - Net realizable value reduced by a normal profit margin, Tk.5.00 per unit. Management wants to decide which of the following three inventory costing methods should be selected to evaluate the cost of goods sold: (a) Average method, (b) FIFO method, and (c) LIFO method. Required: (i) Prepare a perpetual inventory ledger for the item, using each of the above methods. (ii) Prepare a comparative statement showing the effect of each method on gross profit. The sales price is Tk.10.00 per unit. (iii) Prepare the necessary adjusting entries under each of the three inventory costing methods, assuming that the company decides to show its inventory at April 30 by using the lower of cost or market. Solution: (i) (a) Average method: Date Purchases Jan.2 2,000@ 5.00=Tk.10,000 Jan.15 Jan.31 Feb.2 1,200@ 6.00=Tk.7,200 Feb.15 Feb.28 Mar.2 1,500@ 8.00=Tk.12,000 Mar.15 Mar.31 Apr.2 1,900@ 7.00=Tk.13,300 Apr.15 Apr.30 Total 6,600 units = Tk.42,500 293

Sales 500@ 5.00=Tk.2,500 700@ 5.00=Tk.3,500 600@ 5.60=Tk.3,360 900@ 5.60=Tk.5,040 600@ 7.40=Tk.4,440 800@ 7.40=Tk.5,920 700@ 7.10=Tk.4,970 700@ 7.10=Tk.4,970 5,500 units =Tk.34,700

Balance 2,000@ 5.00=Tk.10,000 1,500@ 5.00=Tk.7,500 800@ 5.00=Tk.4,000 2,000@ 5.60=Tk.11,200 1,400@ 5.60=Tk.7,840 500@ 5.60=Tk.2,800 2,000@ 7.40=Tk.14,800 1,400@ 7.40=Tk.10,360 600@ 7.40=Tk.4,440 2,500@ 7.10=Tk.17,740 1,800@ 7.10=Tk.12,770 1,100@ 7.10=Tk.7,800 1,100 units = Tk.7,800


(b) FIFO method: Date Purchases Jan.2 2,000@ 5.00=Tk.10,000 Jan.15 Jan.31 Feb.2 Feb.15

600@ 5.00=Tk.3,000 200@ 5.00=Tk.1,000 700@ 6.00=Tk.4,200 1,500@ 8.00=Tk.12,000 500@ 6.00=Tk.3,000 100@ 8.00=Tk.800 800@ 8.00=Tk.6,400

Mar.15 Mar.31 Apr.2

1,900@ 7.00=Tk.13,300

Apr.15 Apr.30 Total 6,600 units = Tk.42,500 (c) LIFO method: Date Purchases Jan.2 2,000@ 5.00=Tk.10,000 Jan.15 Jan.31 Feb.2

600@ 8.00=Tk.4,800 100@ 7.00=Tk.7,000 700@ 7.00=Tk.4,900 5,500 units =Tk.41,100 Sales 500@ 5.00=Tk.2,500 700@ 5.00=Tk.3,500

1,200@ 6.00=Tk.7,200

Feb.15

600@ 6.00=Tk.3,600 600@ 6.00=Tk.3,600 300@ 5.00=Tk.1,500

Feb.28 Mar.2

500@ 5.00=Tk.2,500 700@ 5.00=Tk.3,500

1,200@ 6.00=Tk.7,200

Feb.28 Mar.2

Sales

1,500@ 8.00=Tk.12,000

Mar.15

600@ 8.00=Tk.4,800

Mar.31

800@ 8.00=Tk.6,400

Apr.2

1,900@ 7.00=Tk.13,300

Apr.15

Apr.30 Total

700@ 7.00=Tk.4,900

6,600 units = Tk.42,500

700@ 7.00=Tk.4,900 5,500 units =Tk.35,700

Balance 2,000@ 5.00=Tk.10,000 1,500@ 5.00=Tk.7,500 800@ 5.00=Tk.4,000 800@ 5.00=Tk.4,000 1,200@ 6.00=Tk.7,200 200@ 5.00=Tk.1,000 1,200@ 6.00=Tk.7,200 500@ 6.00=Tk.3,000 500@ 6.00=Tk.3,000 1,500@ 8.00=Tk.12,000 1,400@ 8.00=Tk.11,200 600@ 8.00=Tk.4,800 600@ 8.00=Tk.4,800 1,900@ 7.00=Tk.13,300 1,800@ 7.00=Tk.12,600 1,100@ 7.00=Tk.7,700 1,100 units = Tk.7,700 Balance 2,000@ 5.00=Tk.10,000 1,500@ 5.00=Tk.7,500 800@ 5.00=Tk.4,000 800@ 5.00=Tk.4,000 1,200@ 6.00=Tk.7,200 800@ 5.00=Tk.4,000 600@ 6.00=Tk.3,600 500@ 5.00=Tk.2,500 500@ 5.00=Tk.2,500 1,500@ 8.00=Tk.12,000 500@ 5.00=Tk.2,500 900@ 8.00=Tk.7,200 500@ 5.00=Tk.2,500 100@ 8.00=Tk.800 500@ 5.00=Tk.2,500 100@ 8.00=Tk.800 1,900@ 7.00=Tk.13,300 500@ 5.00=Tk.2,500 100@ 8.00=Tk.800 1,200@ 7.00=Tk.8,400 500@ 5.00=Tk.2,500 100@ 8.00=Tk.800 500@ 7.00=Tk.3,500 1,100 units = Tk.6,800 294


(ii) ABC Company Comparative Statement Particulars

Sales (5,500 units @ Tk.10.00) Less. Cost of goods sold: Opening inventory Add. Purchase Less. Closing inventory

Average Method Tk. 55,000

FIFO method Tk. 55,000

LIFO method Tk. 55,000

0 42,500 (7,800) 34,700 20,300

0 42,500 (7,700) 34,800 20,200

0 42,500 (6,800) 35,700 19,300

Average Method Tk. 7,806 7,150 8,800 5,500

FIFO method Tk. 7,700 7,150 8,800 5,500

LIFO method Tk. 6,800 7,150 8,800 5,500

7,150 7,150

7,150 7,150

7,150 6,800

Gross profit (iii) Particulars

Inventory at cost Replacement cost (1,100 units @ Tk.6.5) Net realizable value (1,100 units @ Tk.8) Net realizable value reduced by a normal profit margin (1,100 units @ Tk.5) Designated market value Inventory at April 30 Adjustment amount Tk.7,806 – Tk.7,150 Tk.7,700 – Tk.7,150 Tk.6,800 – Tk.6,800

656 550 0

Adjusting entries Dr.

Cr.

Average method: Cost of goods sold/ Factory overhead Tk.656 Inventory – allowances for inventory to decline in market

Tk.656

FIFO method: Cost of goods sold/ Factory overhead Tk.550 Inventory – allowances for inventory to decline in market

Tk.550

P-18. Following information are related to Agro Bazar. Assuming that Agro Bazar uses the conventional retail inventory method, compute the cost of its ending inventory at 31.12.2017.

295


Cost Tk.40,000 60,000 10,000 5,000 15,000 -

Inventory at 01.01.2017 Purchases Purchase returns Purchase discounts Freight-in Markdowns Markdowns cancellation Gross sales Sales returns Markups Markup cancellations Loss from breakage (normal)

Retail Tk.70,000 90,000 15,000 10,000 25,000 25,000 5,000 52,000 12,000 27,000 7,000 10,000

Solution: Agro Bazar Computation of the cost of ending inventory Under conventional retail inventory method At 31.12.2017 Cost Tk. 40,000 60,000 (10,000) (5,000) 15,000

Inventory at 01.01.2017 Add. Purchases Less. Purchase returns Less. Purchase discounts Add. Freight in Add. Net markups: Markups Markup cancellations ______ Total 100,000 Less. Net markdown: Markdowns Markdown cancellation Goods available for sale at selling price Less. Net sales at selling price: Gross sales Less. Sales returns Less. Loss from breakage (normal) Ending inventory at retail

Tk.

27,000 (7,000)

25,000 (5,000)

52,000 (12,000)

Retail Tk. 70,000 90,000 (15,000) (10,000) 25,000

20,000 180,000

20,000 160,000

40,000 10,000 110,000

Total cos t price Total retail price Tk.100,000 = Tk.180,000 = 0.56 or 56%

Cost to retail ratio =

Ending inventory at cost = Tk.110,000 X 56% = Tk.61,600 296


P-19. Marks Garments applies the conventional retail method but wishes to use the LIFO retail method beginning in 2018. Mark Garments has the following information at 2017:

Inventory at January 1, 2017 Net purchases in 2017 Net marks-up in 2017 Net marks-down in 2017 Sales in 2017

At cost (Tk.) 5,210 47,250 -

At retail (Tk.) 15,000 100,000 7,000 2,000 95,000

Requirements: (a) Compute the ending inventory at cost by applying conventional retail approach at 2017. (b) Compute the ending inventory at cost by using LIFO retail method at 2017. (c) Prepare and post the entry(s) for the differences (if any) between conventional and LIFO retail methods in the ending inventory at 2017. Solution: (a) Marks Garments Computation of ending inventory By applying conventional retail method At 2017

Inventory at January 1, 2017 Net purchases Net marks-up Net marks-down Sales Inventory at December 31, 2017

At cost (Tk.) At retail (Tk.) 5,210 15,000 47,250 100,000 _____7,000 52,460 122,000 (2,000) (95,000) 25,000

Total cos t price Total retail price Tk.52,460 = Tk.122,000 = 0.43 or 43%

Cost to retail ratio =

Ending inventory at cost = Tk.25,000 X 43% = Tk.10,750 (b) Marks Garments Computation of ending inventory By using LIFO retail method At 2017 297


Ending inventory at cost = Retail X Ratio = Tk.25,000 X 45%* = Tk.11,250 Here, Tk.47,250 *Cost to retail ratio = Tk.100,000  Tk.7,000  Tk.2,000 = 45% (c) Differences between two methods = Tk.11,250 – Tk.10,750 = Tk.500. Thus, adjusting entry should be as follows: Inventory Adjusting to record inventory at cost

- Dr. - Cr. -

Tk.500 Tk.500

Contact us to collect exercises solution. Helpline: 01711137039

298


EXERCIES E-1. Mr. Talha Ahmed CMA, is performing a review of Sweater Company‟s inventory account. The company did not have a good year and top management is under pressure to boost reported income. According to its records, the inventory balance at year-end was $37,00,000. However, the following information was not considered when determining that amount: 1. Included in the company‟s count were goods with a cost of $12,50,000 that the company is holding on consignment. The goods belong to Superior Corporation. 2. The physical count did not include goods purchased by Sweater Company with a cost of $2,00,000 that were shipped FOB destination on December 28 and did not arrive at Sweater Company‟s warehouse until January 3. 3. Included in the inventory account was $85,000 of office supplies that were stored in the warehouse and were to be used by the company‟s supervisors and managers during the coming year. 4. The company received an order on December 29 that was boxed and was sitting on the loading dock awaiting pick-up on December 31. The shipper picked up the goods on January 1 and delivered them on January 6. The shipping terms were FOB shipping point. The goods had a selling price of $2,00,000 and a cost of $1,50,000. The goods were not included in the count because they were sitting on the dock. 5. On December 29, Sweater Company shipped goods with a selling price of $4,00,000 and a cost of $3,00,000 to District Sales Corporation FOB shipping point. The goods arrived on January 3. District Sales had only ordered goods with a selling price of $50,000 and a cost of $40,000. However, a sales manager at Sweater Company had authorized the shipment and said that if District wanted to ship the goods back next week, it could. 6. Included in the count was $2,00,000 of goods that were parts of a machine that the company no longer made. Given the high-tech nature of Sweater Company‟s products, it was unlikely that these obsolete parts had any other use. However, management would prefer to keep them on the books at cost, “since that is what we paid for them, after all”. Required: Prepare a schedule to determine that correct inventory amount. Provide explanations for each item above, saying why you did or did not make an adjustment for each item. CMA Adapted – April 2015 E-2. Concord Ready Mix and Concerts Products Ltd. is a manufacture of Building precuts and has five major product lines: Engraved Tiles, Facing Block, Partition Block, Roof Tiles and Load Bearing Block. At December 31, 2014, quantity on hand, cost per unit and net realized value (NRV) per unit of the product lines are as follows: Product line Engraved Tiles Facing Block Partition Block Roof Tiles Load Bearing Block

299

Quantity on hand 100 200 300 400 500

Cost per unit (Tk.) 1,000 500 1,500 750 250

NRV per unit (Tk.) 1,020 450 1,600 770 200


Required: Compute the valuation of the inventory of Concord Ready Mix and Concrete Products Ltd. at December 31, 2014, under IAS 2 using “lower of cost and NRV” principle. CMA Adapted – December 2014 E-3. The Peoples Manufacturing began its operations five years ago. On august 2014 a fire broke out in the warehouse destroying all inventory and many accounting records relating to the inventory. The information available is presented below. Al sales and all purchases are on account. Period Inventory Accounts Accounts Collection on Payment of Receivable Payable Accounts suppliers Receivable January 1, $6,42,950 $6,52,950 4,40,700 (Jan 1–Aug 13, (Jan 1–Aug 2014 2014) 13, 2014) August $5,36,600 $6,14,250 $34,86,250 $24,37,500 13, 2014 Goods out on consignment at august 13 at cost $2,25,000 Preceding years sales given below: Year Sales Gross Profit on Sales 2011 $31,30,000 $10,01,600 2012 33,75,000 8,77,500 2013 34,00,000 10,88,000 Required: Determine the inventory loss caused by fire. CMA Adapted – December 2014 E-4. On April 15, 2010, fire damaged the office and warehouse of Thomson Corporation. The only accounting record saved was the general ledger, from which the trial balance prepared: Thomson Company Trial Balance March 31, 2010 Accounts Title Debits Credits Cash Tk.20,000 Accounts Receivable 40,000 Inventory, December 31, 2009 75,000 Land 35,000 Building and equipment 1,10,000 Accumulated depreciation Tk.41,300 Other assets 36,00 Accounts payable 23,700 Other expense accruals 10,200 Capital stock 1,00,000 Retained earnings 52,000 Sales 1,35,000 Purchases 52,000 Other expenses 26,600 _______ Totals Tk.3,62,200 Tk.3,62,200 300


Additional information: (i) The fiscal year of the corporation ends on December 31. (ii) An examination of the April bank statement and canceled checks revealed that checks written during the period April 1-15 totaled Tk.13,000: Tk.5,700 paid to accounts payable as of March 31, Tk.3,400 for April merchandise shipments, and Tk.3,900 paid for other expenses. Deposits during the same period amounted to Tk.12,950, which consisted of receipts on account from customers with the exception of a Tk.950 refund from a vendor for merchandise return in April. (iii) Correspondence with suppliers revealed unrecorded obligations at April 15 of Tk.10,600 for April merchandise shipments, including Tk.2,300 for shipments in transit on that date. (iv) Customers acknowledged indebtedness of Tk.36,000 at April 15, 2010. It was also estimated that customers owed another Tk.8,000 that will never be acknowledged or recovered. Of the acknowledged indebtedness, Tk.600 will probably be uncollectible. (v) The company insuring the inventory agreed that the companyâ€&#x;s fire-loss claim should be based on the assumption that the overall gross profit ratio for the past 2 years was in effect during the current year. The companyâ€&#x;s audited financial statements disclosed this information: Year Ended December 31 2009 2008 Net sales Tk.530,000 Tk.390,000 Net purchases 280,000 235,000 Beginning inventory 50,000 75,200 Ending inventory 75,000 50,000 (vi) Inventory with a cost of Tk.7,000 was salvaged and sold for Tk.3,500. The balance of the inventory was a total loss. Required: Determine the amount of inventory fire loss. The supporting schedule of the computation of the gross profit should be in good form. CMA Adapted – August 2014 E-5. Himaloy Fabrics Company lost its entire inventory in a fire on December 26, 2013. The accounting records showed the following gross profit data for November and December, 2013. November December (up to 26/12/2013) Net Sales Tk.15,00,000 Tk.12,00,000 Beginning inventory 1,02,300 93,300 Purchases 10,04,925 7,38,000 Purchase returns and 35,400 15,000 Allowances Purchase discounts 22,731 18,000 Freight in 19,206 11,100 Ending inventory 93,300 --Himaloy Fabric is fully insured for fire losses but must have to prepare a report for the insurance company.

301


Required: (i) Compute the gross profit rate for November, 2013. (ii) Using the gross profit rate for November, 2013 determine the estimated cost of the inventory lost in the fire. CMA Adapted – August 2014 E-6. Latentile Ltd is a newly-formed company, which uses a chemical process to manufacture a revolutionary new roof covering, which it sells at a markup of 25% on cost. Its inventories consist of raw material, work in progress and finished goods, and at the end of its first year of trading it is having problems valuing inventories. You ascertain the following information: (1) Raw material: (i) The process needs at least 100,000 kgs of clay to continue working, but a physical inventory count reveals that the machinery contains 108,000 kgs. (ii) The original cost of the initial 100,000 kgs to set up the process was 30p per kg and you find an invoice to show that the last consignment of 20,000 kgs cost 31p per kg. all other consignments in the year (a total of 200,000 kgs) cost 32p per kg. (2) Work in progress: (i) The work in progress is currently all 60% complete and you discover that there are 50,000 units currently going through the process. ii) The total number of complete units for the period was, as anticipated, 8,00,000. (iii) the costs for the process for the period were as follows. Tk.‘000 Raw materials 200 Direct labour 242 Factory overheads 191 Administrative expenses attributable to production 114 Distribution costs 90 (3) Finished goods: (i) There were 70,000 units in inventories. (ii) Of (i) above, it was intended to sell 20,000 units at 75p per unit, a discount of one third on normal selling price, in a future promotional campaign (a further 10p per unit distribution costs is to be incurred). Required: (a) Explain how BAS 2 Inventories applies the accrual and the going concern bases of accounting. (b) For each of the above categories of inventory, suggest a method of valuation and show the value as it would appear in the balance sheet. (c) If the information regarding costs for the period were not available, suggest an alternative method of valuing finished goods. CMA Adapted – April 2014 E-7. Revolving Chair (RC) is one of the most popular items of Home Fusion, a furniture manufacture. Most of the company‟s RCs are standard models and are sold on the basis of catalog prices. At December 31, 2012 Tk.78,000 of finished RC appears in the company‟s 302


inventory. Catalog prices of 2012 and 2013 are Tk.98,000 and Tk.92,000 respectively. Estimated current cost to manufacture the RCs is Tk.75,000 and expected sales commission and other costs of disposal is Tk.2,000. The 2012 catalog was in effect through November 2012, and the 2013 catalog is effective as of December 1, 2012. All catalog prices are net of the usual discounts. Generally, the company attempts to obtain a 30% gross profit on selling price and has usually been successful in doing so. At what amount should RC appear in the company‟s December 31, 2012, inventory assuming that the company has adopted a lower of cost or market approach for valuation of inventories? CMA Adapted – August 2013 E-8. Presented below is information related to Prince Bazar. Assuming that Prince Bazar uses the conventional retail inventory method, compute the cost of its ending inventory at June 30, 2013. Cost Retail Retail Inventory, 1.7.12 Tk.30,000 Tk.48,000 Gross sales Tk.412,000 Purchases 339,500 520,800 Sales returns 28,300 Purchase returns 25,800 36,480 Markups 32,500 Purchase discounts 7,590 - Markup cancellation 8,320 Freight-in 8,920 - Employee discount granted 3,400 Markdowns 12,000 Loss from breakage (normal) 2,400 CMA Adapted – August 2013 E-9. For the year ending 30th June 2012, the Sales, Purchases, Opening Stock and Closing Stock of a Trader was Tk.5,00,000, Tk.3,80,000, Tk.65,000 and Tk.52,000 respectively. Some goods were destroyed by fire (without realization of any value) during the year. If the Trader earned Gross Profit @ 25% on Sales for the year, calculate the value of goods destroyed by fire. CMA Adapted – December 2012 E-10. At the end of year 2011, the following information for Muttakeen Ltd. Department Store was obtained: Particulars Cost Retail (Tk.‟000) (Tk.‟000) Beginning inventory 20,460 31,000 Purchases 207,735 337,271 Purchases returns 7,320 12,021 Sales -316,148 Sales returns -3,198 Required: Prepare a schedule computing Muttakeen Ltd.‟s ending inventory at cost using the Retail Method. CMA Adapted – December 2012 E-11. Pathan Furniture Ltd. is a retailer of Italian furniture and has five major products: Sofas, Dining Tables, Beds, Office Tables and Chairs. At June 30, 2012, quantity on hand, cost per unit and net realizable value (NRV) per unit of the product line are as follows: 303


Products

Sofas

Dining Tables

Beds

Office Tables

Chairs

Descriptions Quantity on Hand Cost per unit NRV per unit

100 Tk.1,00,000 Tk.1,02,000

200 Tk.50,000 Tk.45,000

300 Tk.1,50,000 Tk.1,60,000

400 Tk.75,000 Tk.77,000

500 Tk.25,000 Tk.20,000

Required: Compute the valuation of the inventory of Pathan Furniture Ltd. at June 30, 2012, under IAS-2 using “Lower of Cost and NRV‟ principle. CMA Adapted – August 2012 E-12. A fire broke out in the warehouse of B Manufacturing Company on August 15, 2011 has destroyed all inventory and many accounting records relating to inventory. The information gathered from different sources to lodge a claim are presented below. All sales and purchases are on accounts: January 01, 2008 August 15, 2011 Inventory 1,28,600 Accounts Receivable 1,30,600 1,10,300 Accounts Payable 88,300 1,31,350 Collection on Accounts Receivable Jan. to Aug. 15, 2011 6,98,500 Payments to suppliers Jan. 01 to Aug. 15 4,88,300 Goods out on consignment at cost 43,500 Summary of previous sales: Sales Gross profit on sales

2008 Tk.6,50,000 Tk.2,10,000

2009 Tk.6,75,000 Tk.1,85,500

2010 Tk.6,90,000 Tk.2,10,000

Required: Calculate the inventory loss due to fire to lodge a claim with Insurance Company. CMA Adapted – April 2012 E-13. M/s. Monyem Ltd. has the following items as inventory as of June 30, 2011. What is the value of inventory by applying Lower of Cost or Market? Item AB BC CD DE EF FG Units 500 300 400 700 900 600 Cost (Tk.) 65.00 80.00 90.00 38.00 20.00 55.00 Current Replacement 68.00 72.00 105.00 42.00 21.00 45.00 Cost (Tk.) Estimated Selling Price 80.00 102.00 112.00 40.00 30.00 67.00 (Tk.) Completion & Disposal 3.00 8.00 10.00 4.00 2.00 2.00 Cost (Tk.) For all inventory items, Normal Profit Margin is 30% of cost. CMA Adapted – December 2011 304


E-14. STAR Manufacturing began operations five years ago. On August 13, 2010, a fire broke out in the warehouse destroying all inventories and manufacturing records relating to the inventory. The information available is presented below. All sales and all purchases are on account. Jan. 1, 2010 August 13, 2010 Inventory Tk.25,71,800 Tk. …………. Accounts Receivable Tk.26,11,800 Tk.21,46,400 Accounts Payable Tk.17,62,800 Tk.24,57,000 Collection on Accounts Receivable, January 1- August 13 Tk.1,39,45,000 Payments to suppliers, January 1- August 13 Tk.97,50,000 Goods out on consignment at August 13, at cost Tk.9,00,000 Summary of previous years‟ sales: 2007 Sales Tk.1,25,20,000 Gross profit on sales Tk.40,06,400

2008 Tk.1,35,00,000 Tk.35,10,000

2009 Tk.1,36,00,000 Tk.43,52,000

Required: Determine the inventory loss suffered as a result of the fire. CMA Adapted – December 2011 E-15. The sales and cost of goods sold for Liver Company for the past five years were as follows: Year Sales (net) Cost of goods sold 2005 Tk.89,84,960 Tk.52,40,600 2006 Tk.97,94,240 Tk.57,46,400 2007 Tk.1,13,46,560 Tk.67,16,600 2008 Tk.1,09,26,080 Tk.62,72,000 2009 Tk.1,17,47,840 Tk.69,20,000 The following information is for the seven months ended July 31, 2010: Sales Purchases Purchase returns Sales returns Merchandise inventory Jan. 1, 2011

Tk.67,48,000 Tk.34,88,800 Tk.18,200 Tk.73,760 Tk.8,48,000

To secure a loan, Liver Company has been asked to present current statements. However, the company does not wish to take a complete physical inventory as of July 31, 2010. Required: (a) Indicate how financial statements can be prepared without taking a complete physical inventory. (b) From the data given compute the estimated inventory as of July 31, 2011. CMA Adapted – April 2011

305


E-16. Cetus Corporation has a beginning inventory of Tk.60,000 and purchases of Tk.200,000, both at cost. Sales amount to Tk.280,000. The gross-profit on selling price for the previous three years were 30%, 25% and 35% respectively. Find out the estimated closing inventory. CMA Adapted – December 2010 E-17. From the following information, determine the value of inventory: Food

Cost

Spinach Carrots Beans Peas Mixed vegetables

Tk.80,000 100,000 50,000 90,000 95,000

Replacement cost Tk.88,000 90,000 45,000 36,000 105,000

Net realizable value (ceiling) Tk.120,000 100,000 40,000 72,000 92,000

Net realizable value (floor) Tk.104,000 70,000 27,500 48,000 80,000

CMA Adapted – December 2010 E-18. A portion of the Mower Company‟s Balance Sheet appears bellow: December’ 31, 2008 Assets: Cash Notes Receivable Inventory Liability: Accounts payable

3,53,300

December’ 31, 2007

To be determined

50,000 25,000 1,99,875

To be determined

50,000

Mower Company pays for all operating expenses with cash and purchases all Inventory on credit. During 2008, cash totaling of Tk. 4,71,000 was paid on accounts payable. Operating expenses for 2008 totaled Tk. 2,00,000. All sales are cash sales. The inventory was restocked by purchasing 1,500 units per month and valued by using periodic FIFO. The unit cost of inventory was 32.60 during January‟ 2008 and increased Tk. 0.10 per month during the year. All sales are made of Tk. 50 per unit. The ending inventory for 2007 was valued at Tk. 32.50 per unit. Required: (i) Compute the number of units sold during 2008. (ii) Compute the December 31, 2008 Accounts Payable Balance. (iii) Compute the beginning inventory quantity. (iv) Compute the ending inventory quantity & value. (v) Prepare an income statement for 2008 (including a detailed COGS section). Ignore income Tax. CMA Adapted – December 2009 E-19. Pretax Super Shop uses perpetual inventory costing for inventory item 450, which is a perishable inventory item to them. They purchase the inventory for ultimate sale with no 306


value addition. You have been provided with the following information regarding purchase and sale of that inventory during the month of January:

Beginning inventory Purchases: January 1 January 15 January 24 January 30

Units 2,000 4,000 3,000 5,000 1,000

Cost per unit (Tk.) Sales 10.00 Sales: January 4 12.00 January 17 13.00 January 23 15.00 January 26 14.00 January 31 Ending inventory

Units 3,000 4,000 2,000 1,000 2,000 ?

Required: (a) Calculate the value of ending inventory and cost of goods sold under perpetual FIFO as the company follows this for reporting the values of this type of inventory. (b) Determine the proper inventory price per unit under LCM (Lower of Cost or Market) rules considering the following information on January 31: (i) Current replacement cost, Tk.17. (ii) Estimated sales price, Tk.25. (iii) Costs of completion and disposal, Tk.4. (iv) Normal profit, Tk.3. (c) If the normal profit in requirement (b) were set at Tk.5 in lieu of Tk.3, what would be your decision in requirement (b)? CMA Adapted – August 2009

307


CHAPTER - 10 CONSTRUCTION CONTRACTS (IAS 11)

10.1. DEFINITION OF CONSTRUCTION CONTRACT A construction contract is a mutual or legally binding agreement between two parties based on policies and conditions recorded in document form. The two parties involved are one or more owners, and one or more contractors. The owner has full authority to decide what type of contract should be used for a specific development to be constructed and to set forth the legally-binding terms and conditions in a contractual agreement. 10.2. TYPES OF CONSTRUCTION CONTRACT Following are the major types of construction contracts generally used in construction projects: (a) Price-based construction contracts: i. Lump sum construction contract In this type the contractor bids a single fixed price for overall activities in the project scope. The contractor is responsible for estimating project costs from drawings then adds overhead and his profit to determine the price of the project. This contract is ideal when the project scope is well defined at the design stage because there is limited flexibility for modifying the design during construction period. ii. Unit price construction contract The total price of the project in unit price contract is based on the price of each item‟s unit. The contractor is paid as per the rates of items specified in the bill of quantity. The risk is shared with the contractor and the owner. This type of contract has more flexibility for design changing than the lump sum contract. (b) Cost-based construction contracts i. Cost plus construction contract The contractor is paid based on the actual cost of the project including direct and indirect costs plus specific fee. This fee could be a fixed fee or percentage of costs. All risks are assigned to the owner and he gets involved with the contractor in the management of the project. The contractor has no risk in case of increasing the cost of the project, also there isn‟t any incentive for early finish. ii. Target cost construction contract Target cost contract has mutual features of the lump sum and cost plus contracts. The contractor is paid based on the actual costs plus a certain fee either fixed or percentage of total cost in case of the cost of the project doesn‟t exceed certain target cost specified by the owner.

308


10.3. DUTIES OF CONTRACTOR IN CONSTRUCTION Contractors are required to plan, manage and monitor the construction work under their control so that it is carried out in a way that controls the risks to health and safety. The effort devoted to planning, managing and monitoring should be proportionate to the size and complexity of the project and the nature of risks involved. Planning: In planning the work, the contractor must take into account the risks to those who may be affected e.g. members of the public, and those carrying out the construction work. Planning should cover the same considerations as those for the principal, including considering the risks and ensuring the measures needed to protect those affected are in place. Managing: The arrangements for managing construction work must take into account the same issues that principal contractors must consider. It is the duty of a contractor to handle the system properly that are related with construction contract. Monitoring: The contractor should monitor their work to ensure that the health and safety precautions are appropriate, remain in place and are followed in practice. Effective monitoring by the contractor must address the same issues that principal contractors must consider. This includes using a mix of measures to check performance and taking prompt action when issues arise. Complying with directions: For projects involving more than one contractor, the contractor is required to comply with any directions to secure health and safety given to them by the principal designer or principal contractor. They are also required to comply with the parts of the construction phase plan that are relevant to their work. Drawing up a construction phase plan: For single contractor projects, the contractor must ensure a construction phase plan is drawn up as soon as practicable before the construction site is set up. The contractor must design a plan to implement the contract and provides a guideline to his subordinates about the whole task. 10.4. MEANING OF PRINCIPAL CONTRACTOR A principal contractor is the contractor with control over the construction phase of a project involving more than one contractor. They are appointed in writing by the client (commercial or domestic) to plan, manage, monitor and coordinate health and safety during this phase. A principal contractor must be able to demonstrate that they have the skills, knowledge, experience and, where an organisation, the organisational capability to carry out the work they are being appointed for. 10.5. ROLES OF PRINCIPAL CONTRACTOR The role of principal contractor is to properly plan, manage and co-ordinate work during the construction phase in order to ensure that the risks are properly controlled. Principal Contractors must: 309


- ensure that a co-ordinator has been appointed to manage the construction work - ensure that they are capable to manage the health and safety issues likely to be involved in construction - ensure that the construction phase is properly planned, managed, monitored and resourced - ensure that a suitable Construction Phase Health and Safety Plan is prepared before construction - ensure suitable welfare facilities are provided from the start of the construction phase - ensure that every sub-contractor or contractor is informed of the minimum amount of time which they will be allowed for planning and preparation before they begin work on site - ensure that all sub-contractors and contractors are promptly provided with all the information about the project that they need to enable them to carry out their work safely - ensure co-ordination and co-operation between sub-contractors and contractors - satisfy themselves that the designers and contractors that they engage are competent and adequately resourced - ensure that clients are aware of their duties - prepare and enforce site rules - provide copies of, or access to, relevant parts of the Construction Phase Health and Safety Plan and other information to contractors in time for them to plan their work - provide workers under their control with any necessary information; - ensure that all the workers have been provided with a suitable health and safety induction, information and training - ensure that the workforce is consulted about health and safety matters - display the project notification. 10.6. RESPONSIBILITIES OF PRINCIPAL CONTRACTOR Principal contractor are responsible for following activities: - management and control of the workplace - management of risks associated with the carrying out of the construction work; - management of the security of the workplace to overcome unauthorised access; - preparing and maintaining a work health and safety management plan for the workplace; - obtaining safe work method statements for all 'high risk' construction work; - installing signage on the workplace identifying the principal contractor; In addition, the principal contractor must ensure that the workplace has suitable arrangements for the following matters: - appropriate facilities and that the facilities are maintained and accessible; - appropriate first aid equipment; - an emergency plan; - provision of personal protective equipment; - managing the risk from airborne contaminants; - managing the risk from the use and storage of flammable to combustible substances; - managing the risk from falling objects and falls; - the storage, movement and disposal of materials; - the storage of plant not in use; and - traffic management.

310


The principal contractor also have following responsibilities in relation to: - consulting with designers of structures; - managing risks specific to demolition work; - ensuring that general construction induction training is provided to all workers involved in construction work. 10.7. MEANING OF SUBCONTRACTOR A subcontractor is a person who is hired by a general contractor (or prime contractor, or main contractor) to perform a specific task as part of the overall project and is normally paid for services provided to the project by the originating general contractor. Subcontractors undertake work that a contractor cannot do but for which the contractor is responsible. A subcontractor has a contract with the contractor for the services provided. 10.8. TYPES OF SUBCONTRACTOR A subcontractor is responsible to carry out his own contract work. Contractor rarely complete a building all by himself without the help of a subcontractor. A subcontractor may be an individual or an incorporated company who perform his job partly in a project. Generally, there are three types of subcontractor which are discussed below. Domestic subcontractor: A subcontractor selected from the list by the contractor known as a domestic subcontractor. They are chosen by the main contractor to carry out a package of the site works. They then enter into a contract only between themselves and the main contractor and the main contractor is responsible for the work of domestic subcontractor and for any defects therein to the employer. Nominated subcontractor: A nominated subcontractor is one that is selected by the client to carry out an element of the works and then imposed on the main contractor after the main contractor has been appointed. This allows the client to have direct, separate negotiations with major suppliers of goods or services and feed their appointment and design input into the contract after works by the main contractor have commenced. Named subcontractors: Named subcontractors are often used in public sector projects and for projects based on a form of contract where there is no provision for nomination. They allow the client to influence the main contractorâ€&#x;s selection of subcontractors, whilst leaving responsibility for their performance with the main contractor. It can be seen as an alternative to the nominated subcontractor. 10.9. BENEFITS OF SUBCONTRACTING Large projects: Businesses using subcontractors can take on projects that are much larger than those they can handle on their own. They earn a profit on the parts of the project handled by subcontractors and can greatly grow their overall revenues.

311


Save costs: Companies producing large volumes of one or a few products or services generally have lower costs than principals or main contractors who have to handle many tasks and goods. Subcontracting to these high-volume companies generally saves substantial amounts of money. Save time: Training is a necessary process that may delay the project. If the contractor hires a subcontractor for workers, they won‟t have to go through it, allowing them to focus on other important aspects of the project. This works even better when more work comes their way. Professional services: Many projects require the services of professionally qualified specialists who can efficiently manage the work. A company may not have the required professionals on employment and has no ongoing need for them. In that situation, it is better to subcontract the professional services. Access to skilled workers: Subcontractors offer skilled services because they are experts in that particular field. They will make sure the main contractor believes that they observe the highest of standards. If the work goes beyond cutting concrete with a diamond blade and your in-house workers aren‟t trained to do the job, then hiring a subcontractor is a good idea. Availability: Some subcontractors can start the work or project at short notice, even when large numbers of workers are required. As a result of availability, turnaround times are normally faster when a company hire a subcontractor. Even subcontracting allows the company to obtain temporary cover for a permanent staff job or work that needs doing. 10.10. DRAWBACKS OF SUBCONTRACTING Less control: Because the main contractor has already passed certain responsibilities to a subcontractor, they will have less control over that particular aspect of the project. Yet if something goes wrong, it is not only the subcontractor‟s reputation that gets tarnished, but also the contractor‟s. May cause delays: While it will generally hasten things as mentioned on the first part of this article, delays may still arise from disagreements and when expectations aren‟t met. Simple disputes on where to purchase tools like the diamond core bit may spark blown out arguments. In this case, not just time, but even resources may be affected. Quality problem: One of the major drawbacks of subcontracting is that this work lie in quality issues. The tasks may not be executed the way the principal company wants them done. Since the main contractor lacks the expertise in these fields, he is at the mercy of the subcontractors in that respect.

312


Higher risk: Larger projects come with higher risk. When more subcontractors receive orders, the risk that one of them will not perform as required is higher. Coordination is another headache. The company acting as the principal must ensure that the extra profit and revenue is sufficient to make the higher-risk project worthwhile. Below expected standard: Although subcontractors are perceived experts in their field, it is not a guarantee that they will meet the contractorâ€&#x;s standards. At some point the contractor may feel it would have been better had they not outsource for a specific project, especially if they have full knowledge of how things are done.

313


PROBLEMS AND SOLUTIONS P-1. During 2016, the Mosaj Construction Company entered into a contract to construct a building for Oman Company Limited for Tk.60,00,000. The building was completed in 2017. Following information is related to the construction contract. 2016 2017 Tk. Tk. Construction cost incurred during the year 10,00,000 32,00,000 Construction cost incurred in prior year 0 10,00,000 Cumulative construction cost 10,00,000 42,00,000 Estimated cost to complete at end of year 30,00,000 0 Total estimated and actual construction costs 40,00,000 42,00,000 Required: Prepare a schedule to compute the amount of revenue, expenses and profit or loss for the two years. Solution: Computation of percentage of work completion: Particulars Cost incurred during the year Add. Cost incurred in prior year Cumulative construction cost Add. Estimated cost to complete at end of year Total cost Percentage of completion of work

2016 (Tk.) 10,00,000 0 10,00,000 30,00,000 40,00,000

2017 (Tk.) 32,00,000 10,00,000 42,00,000 _______42,00,000

10,00,000 X100 40,00,000 = 25%

42,00,000 X100 42,00,000 = 100%

Mosaj Construction Company Schedule for computation of revenue, expenses and profit or loss Particulars Recognized Recognized Recognized to date (Tk.) in prior year in current (Tk.) year (TK.) Year – 2016: Revenue (60,00,000 X 25%) 15,00,000 15,00,000 Less. Expenses (40,00,000 X 25%) (10,00,000) (10,00,000) Profit 5,00,000 5,00,000 Year – 2017: Revenue (60,00,000 X 100%) Less. Expenses (42,00,000 X 100%) Profit

60,00,000 (42,00,000) 18,00,000

15,00,000 (10,00,000) 5,00,000

45,00,000 (32,00,000) 13,00,000

P-2. A fixed-price contract is entered into for the provision of services for Tk.21,000. On 31 December 2017, at the end of first accounting period, the contract is thought to be 33% complete and costs of Tk.45,000 have been incurred in performing that 33% of the work. 314


Requirements: Calculate the revenue to be recognized in 2017 on the alternative assumptions that: (a) The costs to complete are reliably estimated at Tk.90,000; and (b) The costs to complete cannot be reliably estimated and it is thought that Tk.40,000 of the costs incurred are recoverable from the customers. Solution: (a) Costs to complete are reliably estimated: Since the costs incurred, the costs to complete and total costs can be estimated reliably, revenue can be recognized by the percentage of completion method. Cost incurred during the year Add. Cost incurred in prior period Cumulative construction cost Add. Estimated cost to complete at end of year Total cost

Tk.45,000 ____ 0 45,000 90,000 135,000

Tk.45,000 X 100 Tk.135,000 = 33%

Percentage of completion of work =

Revenue to be recognized in 2017 = Tk.210,000 X 33% = Tk.69,300 (b) Costs to complete cannot be reliably estimated: Since the outcome of the overall contract cannot be estimated reliably, revenue is recognized to the extent of the costs incurred which are recoverable, i.e., Tk.40,000. Therefore, the contract recognizes loss in 2017 of Tk.5,000 (Tk.45,000 – Tk.40,000). P-3. The following figures are related to a contract: Contract price Tk.1,800,000 Work certified 990,000 Cost incurred to date 1,050,000 Estimated cots to complete 870,000 Amounts invoiced to customers 950,000 Required: Prepare extracts from the financial statements. The percentage completion should be calculated on the work certified basis. Solution: Overall contract profit or loss Contract price Less. Total costs of the contract: Cost incurred to date Estimated cots to complete Loss 315

Tk. 1,800,000 1,050,000 870,000 1,920,000 120,000


Calculation of the percentage of completion of work on the work certified basis:

Work certified to date X 100 Total contract price Tk.990,000 = X 100 Tk.1,800,000 = 55%

Percentage of completion of work =

Income statement (extract) Contract price (Tk.1,800,000 X 55%) Less. Costs (Balancing figure) Loss

Tk. 990,000 1,110,000 120,000

Statement of financial position (extract) Tk. Liability Due to customers (w-1)

20,000

Working: 1. Determination of due to customers: Tk. 1,050,000 120,000 930,000 950,000 20,000

Cost incurred to date Less. Loss recognised Less. Progress billing Due to customers

P-4. Tipu Builders Inc. is building a new home for IBB Ltd. at a contract price of Tk.800,000. The contract was signed on January 01, 2017 and the estimated cost of the contract when signed was Tk.690,000. At December 31, 2017, the total cost of the contract incurred is Tk.420,000 with estimated costs to complete of Tk.180,000. Tipu Builders Inc. has billed Tk.450,000 on the job and has received a payment of Tk.400,000. This is the only contract in-progress at year-end. Required: Prepare the sections of the balance sheet and the income statement of Tipu Builders Inc. affected by these events assuming use of: (a) the completed contract method; and (b) the percentage of completion method. Solution: (a) Tipu Builders Inc. Completed contract method

316


Balance sheet section Current assets: Accounts receivable (450,000 – 400,000) Current liabilities: Progress billing on construction contract Less. Construction in-progress

Tk.50,000

Tk.450,000 420,000 30,000

Income statement section Nothing reported since no contract was completed (b) Tipu Builders Inc. Percentage of completion method Balance sheet section Current assets: Accounts receivable (450,000 – 400,000) Construction in-progress (w-1) Less. Progress billing on construction contract

Tk.50,000 Tk.560,000 450,000 110,000 160,000

Income statement section Income recognized on construction in-progress (w-2)

Tk.140,000

Working: 1. Cost incurred during the year Add. Cost incurred in prior period Cumulative construction cost Add. Estimated cost to complete at end of year Total cost

Tk.420,000 X 100 Tk.600,000 = 70%

Percentage of completion of work =

Construction in-progress = Tk.800,000 X 70% = Tk.560,000 2. Income recognized = Revenue – Expenses = Tk.560,000 – Tk.420,000 = Tk.140,000 317

Tk.420,000 ____ 0 420,000 180,000 600,000


P-5. Hi-tech Construction started a three years contract to build a road which was started from 1 January 2017. The total contract price and estimated total cost amounted to Tk.10,00,000 and Tk.8,00,000 respectively. The following information is related to the construction activities for the year ended 31 December 2017: (a) Material, labour and operating overhead costs for the year amounted to Tk.2,50,000, Tk.1,50,000 and Tk.2,00,000 respectively. (b) Contract cost is further estimated that material cost will be Tk.1,00,000 higher than expectation, labour cost will be Tk.50,000 higher than expectation and operating cost will be Tk.50,000 lower than expectation. (c) The contract price would be increased by Tk.2,00,000. (d) On 31 December 2017, surveyors certified that 70% of the work is completed. Required: Determine the profit of the construction contract for the year ended 31 December 2017, based on the followings: (i) Contract costs in proportion to estimated contract costs. (ii) Percentage of the work certified. Solution: Contract cost to date: Material Labour Operating overhead Estimated contract cost: Initial estimate Material Labour Operating overhead Revised contract revenue: Initial amount Variation

Tk.2,50,000 1,50,000 2,00,000 Tk.6,00,000 Tk.8,00,000 1,00,000 50,000 (50,000) Tk.900,000 Tk.10,00,000 2,00,000 Tk.12,00,000

(i) Determination of the profit: Tk.600,000 Contract revenue ( X Tk.12,00,000) Tk.900,000 Less. Contract cost to date Profit

(Tk.6,00,000) Tk.200,000

(ii) Determination of the profit: Contract revenue (Tk.12,00,000 X 70%) Less. Contract cost to date Profit

Tk.840,000 (Tk.6,00,000) Tk.240,000

Tk.800,000

P-6. ST has a construction contract in progress. The contract commenced on 1 April 2016 and is scheduled to run for two years. The contract has a fixed price of Tk.9,000,000. ST uses the value of work completed method to recognize attributable profit for the year. At 31 March 2017, the proportion of work certified as completed was 35%. 318


Tk.000 4,000 6,000 3,250

Work in progress (cost incurred during year to 31 March 2017) Estimated cost to complete the contract Cash received on account from the client of contract

Required: (a) Calculate the amount of revenue and cost that ST should include in its statement of comprehensive income for the year ended 31 March 2017 in respect of the construction contract. (b) Calculate the gross amount due from/to customers to be included in STâ€&#x;s statement of financial position as at 31 March 2017. Solution: (a) ST Overall contract profit or loss Tk.000 Revenues Less. Total costs of the contract: Cost incurred to date Estimated cost to complete Total costs of the contract Gross loss

Tk.000 9,000

4,000 6,000 10,000 1,000

ST Recognized contract profit or loss Tk.000 3,150 3,500 350 650 1,000

Revenues (9,000 X 35%) Less. Costs (10,000 X 35%) Loss during the year Additional loss (10,000 – 350) Gross loss

ST Statement of comprehensive income (extract) For the year ended 31 March, 2017 Tk.000 Revenue Costs: Costs incurred to date (10,000 X 35%) Additional loss

Tk.000 3,150

3,500 650 4,150

(b) Amount due from/to customers: Costs incurred to date Gross loss 319

Tk.000 4,000 1,000


3,000 3,250 250

Less. Cash received Due to customers ST Statement of financial position (extract) As at 31 March, 2017

Tk.000 Current liability: Due to customers

250

P-7. Nobbodoy Construction Ltd. has two contracts in progress at the year ended April 2017. Following information is relevant to these contracts. M (Tk.) 320,000 40,000 416,000 312,000

Cost incurred to date Estimated cost to complete Contract price Work certified to date

N (Tk.) 260,000 120,000 400,000 200,000

Nobbodoy calculates the percentage of completion by using the work certified basis. Continuing with the above illustration, all two contracts are completed in the next year with the following cumulative results: M (Tk.) N (Tk.) Total costs incurred to date 370,000 380,000 Contract price 416,000 400,000 Progress billings 410,000 390,000 Required: Calculate the effects of the above contract upon the financial statements. Solution: Nobbodoy Construction Ltd. Overall contract profit

Revenue Less. Total costs of the contract: Cost incurred to date Estimated cost to complete Total costs of the contract Gross profit

M (Tk.) 416,000

N (Tk.) 400,000

320,000 40,000 360,000 56,000

260,000 120,000 380,000 20,000

Calculation of the percentage of completion of work by using the work certified basis: Work certified to date M= X 100 Total contract price Tk.312,000 = X 100 Tk.416,000 = 75% 320


Tk.200,000 X 100 Tk.400,000 = 50%

N=

Nobbodoy Construction Ltd. Recognised contract profit M (Tk.) Revenue (Contract price X Percentage of completion of work) 312,000 Less. Costs (Total cost of the contract X Percentage of completion of work) 270,000 Gross profit 42,000 Nobbodoy Construction Ltd. Income statement (extract)

Revenue (Contract price X 100%) - Amount recognised Less. Costs (Total cost of the contract X 100%) Amount recognised Gross profit

N (Tk.) 200,000 190,000 10,000

M (Tk.) 104,000

N (Tk.) 200,000

100,000 4,000

190,000 10,000

Nobbodoy Construction Ltd. Statement of financial position (extract)

Current asset: Due from customers (w-1)

M (Tk.)

N (Tk.)

6,000

10,000

M (Tk.) 370,000 46,000a 416,000 410,000 6,000

N (Tk.) 380,000 20,000b 400,000 390,000 10,000

Working: 1. Determination of due from/to customers: Total costs incurred to date Add. Profit recognized (cumulative) Less. Progress billings Due from customers a. 42,000 + 4,000 = 46,000 b. 10,000 + 10,000 = 20,000

P-8. On December 31, 2016, Alma Inc. borrowed Tk.3,000,000 at 12% interest, payable annually to finance the construction of a new building. In 2017, the company made following expenditures related to the building: March 1, Tk.300,000; June 1, Tk.600,000; July 1, Tk.1,000,000; December 1, Tk.1,500,000. Additional information is provided as follows: (a) Other debt outstanding: 10 years 13% bond of December 31, 2010 interest payable annually of Tk.4,000,000. 6 years 10% note dated December 31, 2014 interest payable annually of Tk.1,600,000. (b) March 1, 2017 expenditure included land costs of Tk.150,000. (c) Interest revenue earned in 2017 of Tk.49,000. 321


Required: Determine the amount of interest expense in 2017 in relation to the construction of the building. Solution: Weighted average of accumulated expenditures: Date March 1, 17 June 1, 17 July 1, 17 Dec. 1, 17

Expenditures (A) Tk.300,000 600,000 1,000,000 1,500,000

Capitalized period (B) 10 months 7 months 6 months 1 month

Weight Weighted expenditures (C = B ÷ 12) (D = A X C) 0.833 249,900 0.583 349,800 0.500 500,000 0.083 124,500 Total 1,224,200

Capitalized interest in 2017 = Tk.1,224,200 X 12% = Tk.146,904 Calculation of actual interest: Principle Tk.3,000,000 4,000,000 1,600,000 8,600,000

Rate 12% 13% 10%

Interest expense in 2017: Actual interest Capitalized interest

Actual interest Tk.360,000 520,000 160,000 1,040,000

Tk.1,040,000 Tk.146,904 Tk.893,096

P-9. Total Furniture Company started to construct a building for its own use at an estimated cost of Tk.5,000,000 on January 01, 2016. Total Furniture expects to complete the building by December 31, 2016. The followings are the debt obligations outstanding during the construction period: Construction loan Short-term loan Long-term loan

12% interest, payable semiannually, issued on December 31, 2015 – Tk.2,000,000. 10% interest, payable monthly and principal payable at maturity on May 30, 2017 – Tk.1,400,000. 11% interest, payable on January 01 of each year, principal payable on January 01, 2020 – Tk.1,000,000.

Requirements: (a) Assume that Total Furniture completed the building on December 31, 2016, as planned at a total cost of Tk.5,200,000 and the weighted average of accumulated expenditures was Tk.3,600,000. Compute the avoidable interest on this project. (b) Compute the depreciation expense for the year ended December 31, 2017. The company elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of Tk.300,000. 322


Solution: (a) Given, weighted average of accumulated expenditures was Tk.3,600,000

(Tk.1,400,000 X 10%)  (Tk.1,00,000 X 11%) Tk.1,400,000  Tk.1,000,000 Tk.140,000  Tk.110,000 = Tk.2,400,000 = 10.42%

Weighted average interest rate =

Capitalized interest on December 31, 2016 = Tk.3,600,000 X 10.42% = Tk.375,120 Calculation of actual interest: Principle Rate Tk.2,000,000 12% 1,600,000* 10% 3,600,000 *3,600,000 – 2,000,000 = 1,600,000 Avoidable interest: Actual interest Capitalized interest

Actual interest Tk.240,000 160,000 400,000

Tk.400,000 Tk.375,120 Tk.24,880

(Tk.5,200,000  Tk.400,000)  Tk.300,000 30 years = Tk.176,666

(b) Depreciation expense =

P-10. The following information is related to the construction of a building under contract during the year 2017: Particulars Work-in-progress on 01.01.2017 Materials purchased Labour Operating overhead Materials on 31.12.2017 Contract price Cash received up to 31.12.2017 Percentage of cash received to work certified Completed work not certified Required: Prepare the contract account in columnar form for the year 2017.

323

Taka 1,50,000 1,00,000 2,00,000 2,50,000 20,000 14,00,000 6,00,000 60% 50,000


Solution: Contract account For the year 2017 Particulars Work-in-progress on 01.01.2017 Materials purchased Labour Operating overhead Notional profit c/d Profit and loss account 3,70,000 X 60% Work-in-progress (Reserve) (Balancing figure)

Taka Particulars 1,50,000 Work-in-progress: Work certified 1,00,000 100 2,00,000 (6,00,000 X 60 ) 2,50,000 Work uncertified 3,70,000 Materials on 31.12.2017 10,70,000 2,22,000 Notional profit b/d 1,48,000 3,70,000

Taka 10,00,000

50,000 20,000 10,70,000 3,70,000 _______ 3,70,000

P-11. A contractor secured a contract to supply and erect machinery for the sum of Tk.750,000. He receives payment on account from time to time equal to 90% of the certified value of the work done. He commenced work on 1st January, 2017 and incurred the following expenditure during the year: Plant and tools Tk.70,000; machinery and stores Tk.200,000; wages Tk.150,000; sundry expenses Tk.30,000 and establishment charges Tk.40,000. A part of machinery costing Tk.20,000 was unsuited to the contract and immediately sold at a profit of Tk.5,000. The value of plant and tools on 31 st December, 2017 was Tk.40,000 and the value of machinery and stores in hand was Tk.30,000 on that date. By 1st January, 2018, he had received payments on account amounting to Tk.438,750 being 90% of the certified value of work done up to 31st December, 2017. In order to calculate the profit made on the contract up to 31 st December, 2017 the contractor estimated the further expenditure that would be incurred in completing the contract and took to the credit of Profit and Loss A/C for the year that proportion of the estimated net profit to be realized on contract which the certified value of the work done bore to the contract price. He estimated that: (a) the contract would be completed in a further period of six months; (b) plant and tools would have a residual value of Tk.10,000 upon the completion of contract; (c) the cost of machinery and stores required in addition to those in stock on 31 st December, 2017 would be Tk.100,000 and that further sundry expenses of Tk.20,000 would be incurred; (d) the wages on the contract for the six months to 30th June, 2018 would amount to Tk.80,000; (e) the establishment would cost the same sum per month as in the previous year; (f) 2½% of the total costs of the contract (excluding this percentage) should be provided for contingencies.

324


Required: As per IAS-11, prepare the Contract Account for the year ended 31 st December, 2017 and show your calculation regarding the Profit and Loss A/C for the year. Solution: Contract Account For the year ended 31 st December, 2017 Particulars Plant and tools Machinery and stores Wages Sundry expenses Establishment charges Profit and Loss A/C (Profit on sale of machinery) Notional profit c/d (Balance figure) Profit and Loss A/C (w-1) Work-in-progress (Reserve) (Balance figure)

Taka 70,000 200,000 150,000 30,000 40,000 5,000

Particulars Sale of machinery (20,000 + 5,000) Work-in-progress: Work certified 100 (438,750 X ) 90 Plant and tools in hand 87,500 Machinery and stores in hand 582,500 34,450 Notional profit b/d 53,050 87,500

Taka 25,000

487,500

40,000 30,000 582,500 87,500 _____ 87500

Working: 1. Calculation of Profit and Loss A/C for the year ended 31 st December, 2017: Cost to date: Plant and tools Machinery and stores Wages Sundry expenses Establishment charges

Tk.70,000 200,000 150,000 30,000 40,000 Tk.490,000 20,000 470,000

Less. Cost of machinery sold Estimated further expenditures: Machinery and stores Wages Sundry expenses Establishment charges

Less. Residual value of plant and tools Provision for contingencies (2½% of Tk.680,000) Estimated total cost Estimated profit (Balancing figure) Contract price

325

100,000 80,000 20,000 20,000 220,000 690,000 10,000 680,000 17,000 697,000 53,000 750,000


Work certified to date X Estimated profit Total contract price Tk.487,500 = X Tk.53,000 Tk.750,000 = Tk.34,450

Profit to be credited to Profit and Loss A/C =

P-12. A construction contractor called ABC Inc. has a fixed price contract for Tk.9,000,000 to build a bridge. The initial amount of revenue agreed in the contract is Tk.9,000,000. The contractor estimates that the total costs of the contract is Tk.8,000,000 and it will take 3 years to build the bridge. By the end of Year-1, the contractor has revised the total costs of the contract to Tk.8,050,000. In year 2, the customer approves a variation resulting in an increase of contract revenue of Tk.200,000 and estimated additional contract costs of Tk.150,000. At the end of Year-2, costs incurred include Tk.100,000 for standard materials stored at the site to be used in Year-3 to complete the project. The contractor determines the stage of completion of the contract by calculating the proportion that contract costs incurred for work performed to date boar to the latest estimated total contract costs. A summary of the financial data during the construction period is as follows: Year-1 Year-2 Year-3 Tk.’000 Tk.’000 Tk.’000 Initial contract revenue 9,000 9,000 9,000 Variation ____200 200 Total contract revenue 9,000 9,200 9,200 Contract costs incurred to date 2,093 6,168 8,200 Contract costs to complete 5,957 2,032 Total estimated contract costs 8,050 8,200 8,200 Estimated profit 950 1,000 1,000 Stage of completion 26% 74% 100% The contractor uses the percentages calculated as above to calculate the revenue, contract costs and profits over the term of the contract. The stage of completion for Year-2 (74%) is determined by excluding from contract costs incurred for work performed to date the Tk.100,000 of standard materials stored at the site for use in Year-3. Required: As per IAS-11, you are requested to calculate the amounts of revenue, expenses and profit recognized in the income statement in the three years.

Solution: ABC Inc. Statement of revenue, expenses and profit

326


Particulars Year-1: Revenue (9,000 X 26%) Less. Expenses (8,050 X 26%) Profit Year-2: Revenue (9,200 X 74%) Less. Expenses (8,200 X 74%) Profit Year-3: Revenue (9,200 X 100%) Less. Expenses (8,200 X 100%) Profit

327

Recognized to date

All figures in Tk.â€&#x;000 Recognized Recognized in in prior year current year

2,340 (2,093) 247

-

2,340 (2,093) 247

6,808 (6,068) 740

2,340 (2,093) 247

4,468 (3,975) 493

9,200 8,200 1,000

6,808 6,068 740

2,392 2,132 260


EXERCIES E-1. “Bob The Builder” has a construction contract in progress. The contract commenced on 1 July 2015 and is scheduled to run for two years. The contract has a fixed price of Tk.9,000,000. Bob The Builder uses the value of work completed method to recognize attributable profit for the year. At 30 June 2016 the proportion of work certified as completed was 35%. Work in progress (cost incurred during year to 30 June 2016) Tk.4,000,000. Estimated cost to complete contract Tk.6,000,000. Cash received on account from contract client Tk.3,250,000. Required: (i) Calculate the amount of revenue and cost that “Bob The Builder” should include in its statement of comprehensive income for the year ended 30 June 2016 in respect of construction contract. (ii) Calculate the gross amount due from/to customer to be included in Bob The Builder‟s statement of financial position as at 30 June 2016. CMA Adapted – June 2016 E-2. MNS sells goods to the building industry and carries out construction contracts for clients. MNS‟s trial balance at 30 September 2015 is shown below: Notes Administrative expense Cash and cash equivalents Cash received on account from construction contract clients during year to 30 September 2015-contract 1 (i) Cash received on account from construction contract clients during year to 30 September 2015-contract 2 (i) Cash received on disposal of plant and equipment (iii) Construction contract 1- work in progress for year to 30 September 2015 (i) Construction contract 2- work in progress for year to 30 September 2015 (i) Distribution costs Equity dividend paid (viii) Equity Shares Tk.1 each, fully paid at 30 September 2015 Income tax (v) Interest paid - half year to 31 March 2011 inventory at 30 September 2015 (excluding construction contracts) Long term borrowings (redeemable 2021) (iv) Plant and equipment at cost 30 September 2015 (iii) Property at valuation 30 September 2104 (ii) Provision for deferred tax at 30 September 2014 (vi) Provision for plant and equipment depreciation at 30 September 2014 (iii)

Tk.’000 Dr. 1,020 440

Tk.’000 Cr.

4,000 1,800 15 3,750 2,250 590 250 2,500 15 58 310 2,300 4,930 11,000 250 2,156 328


Provision for property depreciation at 30 September 2014 Cost of goods sold (excluding construction contracts) Retained earnings at 30 September 2014 Sales revenue Share premium at 30 September 2015 Trade payables Trade receivables

(ii)

3,750 3,210 627 9,500 1,500 235 (vii)

810 28,633

28,633

Additional information: (i) At 30 September 2015 MNS had two construction contracts in progress. Contract 1 Contract 2 Contract length 3 years 2 years Date commenced 1-Oct-10 1-Apr-11 Fixed contract value Tk.11,000,000 Tk.8,000,000 Contract detail for year ended 30 September 2015 Proportion of work certified as completed Construction contract work in progress Estimated cost to compete contract Cash received on account from construction contract clients during year

Contract 1 40% Tk.‟000 3,750 5,400 4,000

Contract 2 25% Tk.‟000 2,250 6,750 1,800

Both contracts use the value of work completed method to recognise attributable profit for the year. (ii) Property consists of land Tk.3,500,000 and buildings Tk.7,500,000. Buildings are depreciated at 5% per year on the straight line basis. No buildings were fully depreciated at 30 September 2015. (iii) Plant and equipment is depreciated at 25% per year using the reducing balance method. During the year to 30 September 2015 MNS sold obsolete plant for Tk.15,000. The plant had cost Tk.75,000 and had been depreciated by Tk.65,000. All depreciation is considered to be part of cost of sales. MNS‟s policy is to charge a full year‟s depreciation in the year of acquisition and no depreciation in the year of disposal. (iv) The long term borrowings incur annual interest at 5% paid six monthly in arrears. (v) The income tax balance in the trial balance is a result of the under provision of tax for the year ended 30 September 2014. The directors estimate the income tax charge on the profit of the year to 30 September 2015 at Tk.910,000. (vi) The deferred tax provision is to be increased by Tk.19,000. (vii) On 1 August 2015, MNS was informed that one of its customers, EF, had ceased trading. The liquidators advised MNS that it was very unlucky to receive payment of any of the Tk.25,000 due from EF at 30 September 2015. (viii) MNS made no new share issues during the year. MNS paid a final dividend for the year to 30 September 2014. Required: Prepare MNS‟s statement of comprehensive income and statement of changes in equity for the year to 30 September 2015 AND a statement of financial position at that date in accordance with the requirements of International Financial Reporting Standards. 329


Notes to the financial statements are not required, but all workings must be clearly shown. Do not prepare a statement of accounting policies. CMA Adapted – December 2015 E-3. The following particulars related to two houses which a firm of builders had in course of construction under contract: Particulars House A House B Tk. Tk. Work-in-progress on 1st January, 2013 excluding of Tk.8,000 estimated profit which was taken to Profit & loss account in 2012 140,000 Materials purchased 230,000 166,000 Wages 200,000 140,000 Electrical services and fittings 14,000 3,000 Road making charges 80,000 Contract prices (including road making) 600,000 400,000 Cash received upto 31st December 2013 600,000 240,000 Percentage of cash received to work certified 100% 66.67% st Value of materials in hand on 31 December 2013 4,000 5,400 Completed work not certified 25,000 Value of plant used on sites 120,000 60,000 Period of plant remained on sites during the year 10 months 8 months The total establishment expenses incurred during the year 2013 amounted to Tk.1,22,400. These are to be charged to the two contracts in proportion to wages. Depreciation of plant is to be taken into account at the rate of 10% per annum. Prepare the contract accounts (in columnar form) showing the profit or loss on each house for the year 2013 and the sums which you consider appropriately transferable to the profit and loss account. CMA Adapted – April 2014 E-4. National Engineers Ltd. Commenced work on 1st January 2011, on a contract of which the agreed price was Tk.50,00,000. The following expenditure was incurred during the year to 31st December 2011: Wages Plant Materials Sundry Expenses Head Office Charges

Tk.14,00,000 3,50,000 10,50,000 65,000 1,25,000

Certain of the materials costing Tk.1,00,000 proved unsuitable and were sold for Tk.1,15,000, and part of the plant was scrapped and sold for Tk.17,000. Of the contract price Tk.24,00,000 representing 80% of the work certified, had been received by 31st December 2011, and on that date the value of the plant, on the job was Tk.80,000 and the value of the materials Tk.30,000. The cost of the work done but not certified was Tk.2,50,000. 330


It was decided to estimate what further expenditure would be incurred in completing the contract, to compute from this estimate and the expenditure already incurred the total profit that would be made on the contract and to take to the credit of the Profit and Loss Account for the year ended December 31 st 2011, and that proportion of the total profit which corresponded with the work certified. The estimates were as follows: a) That the total contract would be finished by 30th June, 2012; b) That wages to complete would amount to Tk.8,49,500; c) The materials in addition to those in stock on 31 st December, 2011, would cost Tk.5,00,000, and sundry expenses on the contract Tk.35,000 further; d) That a further Tk.1,50,000 would have to be spent on plant and that the residual value of the plant on 30th June, 2012, would be Tk.60,000; e) The head office charges to the contract would be at the same annual rate as in 2011; f) That the claims, temporary maintenance and contingences would require Tk.90,000. Prepare Contract Account for the year ended 31st December, 2011 and show your calculation of the sum to be credited to Profit and Loss Account for the year. CMA Adapted – August 2013 E-5. OMX Inc. started a four-year contract to build a dam. Activities commended on February 1, 2010. The total contract price amounted to Tk.12,000,000, and it was estimated that the work would be completed at a total cost of Tk.9,500,000. In the construction agreement the customer agreed to accept increases in wage tariffs additional to the contract price. The following information refers to contract activities for the financial year ending December 31, 2010: 1. Costs for the year: Items Taka Material 1,400,000 Labor 800,000 Operating overhead 150,000 Subcontractors 180,000 2. Current estimate of total contract costs indicates the following: • Materials will be Tk.180,000 higher than expected. • Total labor costs will be Tk.300,000 higher than expected. Of this amount, only Tk.240,000 will be the result of increased wages tariffs. The remainder will be caused by inefficiencies. • A savings of Tk.30,000 is expected on operating overhead. 3. During the current financial year the customer requested a variation to the original contract, and it was agreed that the contract price would be increased by Tk.900,000. The total estimated cost of this extra work is Tk.750,000. 4. By the end of 2010, certificates issued by quantity surveyors indicated a 25% stage of completion. Required: Determine the profit to date, based on: • Option 1 – contract costs in proportion to estimated contract costs. • Option 2 – Percentage of the work certified. CMA Adapted – August 2012 331


E-6. In 2008, the Hi-tech construction Ltd. entered into a contract to construct a bridge over the Padma river for Tk.1,00,00,000. The bridge was completed in 2010. Information related to the contract is as follows: 2008 (Tk.) 2009 (Tk.) 2010 (Tk.) Cost incurred during the year 24,00,000 36,00,000 22,00,000 Estimated costs to complete off 36,00,000 20,00,000 year end Required: A schedule for computation of the revenues, expenses and profit (Loss) for years as per IAS-11. CMA Adapted – August 2011 E-7. During 2003, the Concord Construction Company entered into a fixed price contract to construct an office building for Monalisa Co. Ltd. for Tk.80,00,000. The building was completed in 2005. Information related to the contract is as follows: 2003 2004 2005 Construction costs incurred during the year 15,00,000 45,00,000 15,50,000 Construction costs incurred in prior years _______- 15,00,000 60,00,000 Cumulative construction costs 15,00,000 60,00,000 75,50,000 Estimated costs to complete at end of year 45,00,000 15,00,000 ______ Total estimated and actual construction costs 60,00,000 75,00,000 75,50,000 Required: Prepare a schedule to compute the amounts of revenue, expenses and profit (loss) for three years as per IAS-11. CMA Adapted – August 2009

332


CHAPTER - 11 LEASES (IAS 17)

11.1. DEFINITION OF LEASE A lease is a contractual agreement between a lessor (owner) and a lessee (user) that gives the lessee the right to use specific property for a specified period of time, owned by the lessor. Property, buildings and vehicles are common assets that are leased. Industrial or business equipment is also leased. 11.2. TYPES OF LEASE Leasing equipment is a common alternative to purchase. Of the two kinds of leases capital leases and operating leases - each is used for different purposes and results in differing treatment on the accounting books of a business. Capital lease: A capital lease is a lease of business equipment which represents ownership and is reflected on the company's balance sheet as an asset. A capital lease is treated as a purchase from the standpoint of the person who is leasing and as a loan from the standpoint of the person who is offering the lease, for accounting purposes. Operating lease: Operating leases are used for short-term leasing and often for assets that are high-tech or in which the technology changes often, like computer and office equipment. The lessee uses the property but does not take on the benefits or drawbacks of ownership, which are retained by the lessor. The rental cost of an operating lease is considered an operating expense. 11.3. ADVANTAGES OF LEASE (a) Easiest source of finance: Leasing provides one of the easiest sources of intermediate and long-term financing. It does not require any mortgage of the assets because the ownership of leased asset remains with the lessor and is not transferred to the lessee. (b) Preserving borrowing capacity: Leasing does not affect the borrowing capacity of the lessee firm. It is considered to be a hidden form of debt which does not appear as a liability in the balance sheet of the lessee. Thus, it does not affect the debt equity ratio of the firm acquiring use of an asset through leasing. (c) Flexibility: Operating leases are usually cancelable enabling the lessee firm to terminate the lease if it does not require the use of the asset, any more. Hence, it is very convenient and flexible mode of financing fixed assets.

333


(d) Guards the risk of obsolescence: Leasing adequately guards the lessee against the risk of obsolescence, i.e. the risk that assets may lose their utility due to rapid changes in technology. A lessee can adjust the term of the lease such that it is no longer burdened with the asset when it is no longer efficient to operate. (e) Tax benefits: The tax benefit is availed to both the parties, i.e. lessor and lessee. Lessor, being the owner of the asset, can claim depreciation as an expense in his books and therefore get the tax benefit. On the other hand, the lessee can claim lease rentals as an expense and achieve tax benefit in a similar way. 11.4. DISADVANTAGES OF LEASE (a) Loss of ownership: There are certain advantages of owning the assets, such as depreciation and investment allowance, In case of lease, the lessee does not own the asset during and after the lease term which means that he canâ€&#x;t sell or transfer or pledge it. (b) Loss of salvage value of the asset: An asset generally has certain salvage value at the expiry of the useful life. As the lessee does not become the owner of the asset, he cannot realise the salvage value at the expiry of the lease rather he has to return the asset to the lessor. (c) No alteration in asset: As the lessee is not the owner of the asset, he cannot make any substantial changes in the asset. Contrary to it, in case of outright purchase the buyer can modify or alter the asset to increase its utility. (d) Limited financial benefit: If paying lease payments towards an asset, the business cannot benefit from any appreciation in the value of the asset. The long-term lease agreement also remains a burden on the business as the agreement is locked and the expenses for several years are fixed. (e) Finance cost: Leasing has a rate of interest applicable in the required lease rentals. The lease rentals include a margin for the lessor as also the cost of risk of obsolescence. It does not only include margin towards the use of asset, it also includes a finance cost. 11.5. REQUIREMENTS FOR CAPITAL LEASE The requirements for a capital lease can be any one of the following four alternatives: Ownership: The ownership of the asset is transferred from the lessor to the lessee by the end of the lease period; or Bargain purchase option: The lessee can purchase the asset from the lessor at the end of the lease term for a below market price; or

334


Lease term: The period of the lease encompasses at least 75% of the useful life of the asset and the lease is non-cancellable during that time; or Present value: The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease. If a lease agreement contains any one of the preceding four criteria, the lessee records it as a capital lease. Otherwise, the lease is recorded as an operating lease. 11.6. DISTINCTION BETWEEN CAPITAL AND OPERATING LEASE Capital lease (a) Ownership of the asset might be transferred to the lessee at the end of the lease term. (b) The lease contains a bargain purchase option to buy the equipment at less than fair market value. (c) The lease term equals or exceeds 75% of the asset's estimated useful life. (d) The present value of the lease payments equals or exceeds 90% of the total original cost of the equipment. (e) Risk and benefits are transferred to lessee. Lessee pays maintenance, insurance and taxes. (f) Lease is considered as asset (leased asset) and liability (lease payments). Payments are shown in Balance sheet

Operating lease (a) Ownership is retained by the lessor during and after the lease term. (b) The lease cannot contain a bargain purchase option. (c) The lease term is less than 75% of the estimated economic life of the equipment (d) The present value of lease payments is less than 90 percent of the equipment's fair market value (e) Right to use only. Risk and benefits remain with lessor. Lessee pays maintenance costs. (f) No risk of ownership. Payments are considered as operating expenses and shown in Profit and Loss statement

11.7. COMPARISON BETWEEN CAPITAL AND OPERATING LEASE Which is better, a capital lease or an operating Lease – it is depends on the nature of lease. If a person leasing a high-technology piece of equipment, it will probably have an operating lease. For example, if a person leasing copiers for his office, he probably has an operating lease. If he is leasing a piece of machinery which he intends to use for a long time, it probably has a capital lease. Each type of lease is applicable to different leasing situations. 11.8. DIFFERENCES BETWEEN LEASE AND RENT Lease Rent (a) A lease is a contractual arrangement (a) A rent is an agreement where a calling for the lessee to pay the lessor payment is made for the temporary use of (owner) for use of an asset. a good, service or property owned by another. (b) It is a contract renting land, buildings, (b) It is the periodic payment made to the etc., to another; a contract or instrument owner of a property for the use of said conveying property to another for a property, as determined by a lease (rental) specified period agreement. 335


(c) The terms of the contract cannot be modified until it ceases to exist. (d) Length of agreement is often 6-12 months, but can be set for any length of time that two or more parties agree to in the lease. (e) It is managed by the property owner.

(c) The terms of the contract can be modified by the landlord. (d) Payment is made for at least as long as the lease requires it.

(e) It is managed by the tenant who pays rent to use the property (f) At the end of the lease term, the lessee (f) It provides no such offer. gets an offer to buy the leased asset by paying a residual amount. 11.9. MEANING OF SALE AND LEASEBACK Sale and leaseback is an arrangement in which a company sells an asset to another company and then leases that asset. The company that sells the asset becomes the lessee, and the company that purchases the asset becomes the lessor. In a sale and leaseback transaction, the specifics of the transaction are made immediately after the sale of the asset, with the amount of the payments and the time period specified. In this type of lease, the lessor may be an insurance company, a finance company, a leasing company, a limited partnership, or an institutional investor. 11.10. PARTICIPATION IN SALE AND LEASEBACK Commercial property owners may not be aware of a financing option that can improve their cash flow without interrupting daily operations. A sale and leaseback is a financial transaction in which the seller of an asset is able to lease out the asset from the buyer immediately after the sale is finalized. Most businesses will engage in a sale and leaseback when trying to free up capital by untying cash in an asset or other investments without getting rid of the resource that is vital to operations. While there are many motivations for engaging in a sale and leaseback arrangement for both the buyer and the seller, most arrangements are made when the seller decides to improve its financial appeal and stability by freeing up assets. In leasing the asset that has just been sold, the selling company is able to maintain business as usual with existing infrastructure, only making adjustments to ownership rights and access to capital. 11.11. SHORT NOTES (a) Minimum lease payment: Minimum lease payments are rental payments over the lease term including the amount of any bargain purchase option, premium and any guaranteed residual value and excluding any rental relating to costs to be met by the lessor and any contingent rentals. (b) Minimum rental payment: Minimum rental payments are payments in which the lessee is obligated to make to the lessor under the lease agreement for rent of lease. It does not include executor costs such as insurance, maintenance, taxes, etc. 336


(c) Bargain purchase option: A bargain purchase option is an option in a lease agreement that allows the lessee to purchase the leased asset at the end of the lease period at a price substantially below its fair market value. (d) Guaranteed residual value: The financial accounting term guaranteed residual value refers to an additional payment made by a lessee in property, cash, or both when a lease terminates. Guaranteed residual values are financial commitments made by the lessee, and factor into the calculation of the minimum lease payment. (e) Incremental borrowing rate: The rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term and with a similar security, the funds necessary to purchase the asset. (f) Executory costs: Executory costs are those expenses typically associated with owning an asset; this includes property taxes, maintenance expenses and insurance. Executory costs are sometimes referred to as "additional rent" and may be included as part of the monthly lease payment, a pass-through cost, or paid directly by the lessee.

337


PROBLEMS AND SOLUTIONS P-1. Hypo Leasing Co. signs an agreement on January 01, 2013, to lease equipment to Mosaj & Associates. The following information relates to this agreement: (a) The term of the non-cancellable lease is 5 years with no renewal option. The equipment has an estimated economic life of 6 years. (b) The equipment will revert to the lessor at the end of the lease term, at which time the equipment is expected to have a guaranteed residual value of Tk.200,000. (c) Mosaj & Associates will bear the executory cost which include insurance cost of Tk.15,000 and servicing cost of Tk.9,000 per year. The executory cost is to be paid with annual rental payment. (d) The agreement requires equal rental payments of Tk.100,000 to Hypo leasing Co. beginning on January 01, 2013. (e) Mosaj & Associates can borrow at 12% to purchase this type of equipment while Hypo Leasing Co. expects 10% returns on its investment. Hypoâ€&#x;s expected rate of return is known to Mosaj & Associates. (f) Mosaj & Associates uses the straight line depreciation method for all equipment. (Present Value of Tk.1 payable annually at beginning for 5 years at 10% interest rate is Tk.4.1699 and present value of Tk.1 payable at the end of 5th year at 10% interest rate is Tk.0.6209) Required: (i) Do you think that the lease is capital one? Explain. (ii) Compute the present value of minimum lease payment. (iii) Prepare an amortization schedule for Expo Enterprise. Solution: (i) Yes, the lease is capital one as the lease term is for 5 years which is 83% (

5 X 100) of 6

the economic life of the equipment and the lease is non-cancellable. (ii) Computation of present value (PV) of minimum lease payment: Amount Tk. 100,000 100,000 200,000

Rental payment at 0 period Rental payment for future 4 years Guaranteed residual value Total

PV factor Present value @ 10% Tk. Tk. 1.0000 100,000 3.1699 316,990 0.6209 124,180 541,170

(iii) Mosaj & Associates (Lessee) Lease amortization schedule

338


Date

Jan. 01, 13 Jan. 01, 13 Jan. 01, 14 Jan. 01, 15 Jan. 01, 16 Jan. 01, 17 Dec. 31, 17

Annual lease payment Tk. 100,000 100,000 100,000 100,000 100,000 200,000

Interest on lease liability @ 10% Tk. 44,117 38,529 32,382 25,620 18,182

Reduction of lease liability Tk. 100,000 55,883 61,471 67,618 74,380 181,818

Lease liability Tk. 541,170 441,170 385,287 323,816 256,198 181,818 -

P-2. ABC Company and XYZ Finance and Investment Ltd. sign a lease agreement. On 1 January 2013 that calls for XYZ Finance to lease equipment to ABC Company beginning January 2013. The terms and provisions of the lease agreement and other information are as follows: (a) The term of the lease is five years and the lease agreement is non-cancellable, requiring equal rental payments of Tk.200,000 at the beginning of each year. (b) The equipment has a fair value at the inception of the lease is Tk.625,485. It has an estimated economic life of five years. (c) At the end of lease term, the machine is expected to have a residual value of Tk.100,000 which is not guaranteed by ABC Company. (d) Lessee company pays all of the executory costs directly to third party except for the property taxes of Tk.50,000 per annum, which is included in the annual payments to the lessor. (e) The lease contains no renewal option and the equipment has to handover to the lessor after the lease period. (f) The lessee companyâ€&#x;s incremental borrowing rate is 11% but the lessor company sets 10% annual return on its investment. This fact is known to the lessee company. (g) The lessee company charges depreciation on this similar type of equipment under the straight line method. Required: (i) Compute the capitalized amount of the leased equipment. (ii) Prepare a table showing the interest expenses for each period. (iii) Journalize the transactions in the books of accounts of ABC Company for the year 2013 and 2014 assuming that the company follows calendar year. Solution: (i) Computation of capitalized amount of the leased equipment: Amount

Rental payment excluding executory costs at 0 period Rental payment excluding executory costs for future 4 years Total 339

Tk. 150,000

PV factor @ 10% Tk. 1.0000

Capitalized amount Tk. 150,000

150,000

3.1699

475,485 625,485


(ii)

Date

1 Jan. 13 1 Jan. 13 1 Jan. 14 1 Jan. 15 1 Jan. 16 1 Jan. 17 (iii) Date 1 Jan. 13

1 Jan. 13

31 Dec. 13

31 Dec. 13

1 Jan. 14

31 Dec. 14

31 Dec. 14

ABC Company (Lessee) Table showing interest expenses Annual lease Property Interest Reduction payment taxes expenses of lease (excluding expense @ 10% liability property taxes) Tk. Tk. Tk. Tk. 150,000 50,000 150,000 150,000 50,000 47,549 102,451 150,000 50,000 37,303 112,697 150,000 50,000 26,034 123,966 150,000 50,000 13,637 136,371 ABC Company (Lessee) Journal entries Particulars Leased equipment under capital lease Obligation under capital lease (To record the leased equipment and obligation) Obligation under capital lease Property taxes expense Cash (To record the payment from lease obligation and executory cost) Interest expense Interest payable (To recognize interest expense for the year) (Tk.625,485 - Tk.150,000) X 10% Depreciation expense – leased equipment Accumulated depreciation – leased equipment (To record depreciation expense for the year) Tk.625,485 ÷ 5 years Obligation under capital lease Property taxes expense Interest payable Cash (To record the payment from lease obligation and executory cost) Interest expense Interest payable (To recognize interest expense for the year) (Tk.625,485 - Tk.150,000 – 102,451) X 10% Depreciation expense – leased equipment Accumulated depreciation- leased equipment (To record depreciation expense for the year)

Dr. (Tk.) 625,485

Lease liability

Tk. 625,485 475,485 373,034 260,337 136,371 -

Cr. (Tk.) 625,485

150,000 50,000 200,000

47,549 47,549

125,097 125,097

102,451 50,000 47,549 200,000

37,303 37,303

125,097 125,097

340


P-3. Nobbodoy Corporation has entered into a lease agreement with Ideal Lease and Finance Ltd. on 01 January, 2015. The lease was meant for a Motor Vehicle of Ideal Lease and Finance Ltd. to be used by Nobbodoy Corporation for a period of three years. The terms and conditions of the lease are as follows: (a) The Motor Vehicle would be reverted back to the lessor after expiry of the lease agreement. (b) Fair market value of the Motor Vehicle is Tk.540,000. (iii) Three payments are due to the lessor in the amount of Tk.200,000 per year beginning 31 December, 2015. An additional sum of Tk.4,000 is to be paid annually by the lessee for insurance. (c) Nobbodoy Corporation guarantees Tk.40,000 residual value on 31 December, 2017 while the lease asset is expected to have only Tk.4,000 salvage value on that date. (d) Incremental borrowing rate for Nobbodoy Corporation is 10% (Ideal Lease and Finance Ltd.â€&#x;s implicit rate is unknown). Required: (i) Calculate the present value of lease obligation. (Present value of an amount Tk.1 due on three periods at 10% is Tk.0.7513, present value of an ordinary annuity Tk.1 for three periods at 10% is Tk.2.4869). (ii) What type of lease it is as per IAS 17? Show reason in support of your answer. (iii) Prepare the lease amortization schedule of the lessee. (iv) Pass necessary journal entries in the books of Nobbodoy Corporation covering the entry for reverting the leased asset to Ideal Lease and Finance Ltd. Solution: (i) Calculation of present value (PV) of lease obligation: Amount Tk. 200,000 40,000

Rental payment for 3 years Guaranteed residual value Total

PV factor Present value @ 10% Tk. Tk. 2.4869 497,380 0.7513 30,052 527,432

(ii) As per IAS 17, this would be treated as capital lease as the present value of the lease Tk.527,432 payment is 98% ( X 100) of the fair market value of the leased asset. Tk.540,000 (iii) Nobbodoy Corporation (Lessee) Lease amortization schedule Date Annual lease Insurance Interest Reduction Lease payment expense expense @ of lease liability 10% liability Tk. Tk. Tk. Tk. Tk. 01 Jan. 15 527,432 31 Dec. 15 200,000 4,000 52,743 147,257 380,175 31 Dec. 16 200,000 4,000 38,018 161,982 218,193 31 Dec. 17 200,000 4,000 21,807 178,193 40,000 31 Dec. 17 40,000 40,000 341


(iv)

Date 01 Jan. 15

31 Dec. 15

31 Dec. 15

31 Dec. 15

31 Dec. 16

31 Dec. 16

31 Dec. 16

31 Dec. 17

31 Dec. 17

31 Dec. 17

Nobbodoy Corporation (Lessee) Journal entries Particulars Leased vehicle under capital lease Obligation under capital lease (To record the leased vehicle and obligation) Obligation under capital lease Interest expense (Tk.527,432 X 10%) Cash (To record the payment from lease obligation) Insurance expense Cash (To record the payment of executory cost) Depreciation expense - leased equipment Accumulated depreciation – leased equipment (To record depreciation expense for the year) (Tk.527,432 – Tk.4,000) ÷ 3 years Obligation under capital lease Interest expense (Tk.527,432–Tk.147,257)X10% Cash (To record the payment from lease obligation) Insurance expense Cash (To record the payment of executory cost) Depreciation expense - leased equipment Accumulated depreciation – leased equipment (To record depreciation expense for the year) Obligation under capital lease Interest expense Cash (To record the payment from lease obligation) * (Tk.527,432 – Tk.147,257 – Tk.161,982)X10% Insurance expense Cash (To record the payment of executory cost) Depreciation expense - leased equipment Accumulated depreciation – leased equipment (To record depreciation expense for the year)

Dr. (Tk.) 527,432

Cr. (Tk.) 527,432

147,257 52,743 2,00,000 4,000 4,000 174,477 174,477

161,982 38,018 2,00,000 4,000 4,000 174,477 174,477

178,193 21,807* 2,00,000

4,000 4,000 174,477 174,477

P-4. On January 01, 2017, Zenon Corporation sells a computer to Abro Finance Co. for Tk.800,000 and immediately leases the computer back. The relevant information are as follows: (a) The computer at value of Tk.600,000 was carried in the book of Zenon. (b) The term of the non-cancellable lease is 10 years and title will transfer to Zenon. (c) The lease agreement requires equal rental payments of Tk.200,000 at the end of each year. 342


(d) The incremental borrowing rate of Zenon Corporation is 12%. Zenon is aware of that Abro Finance Co. set the annual rental rate of return at 10%. (e) The computer has a fair value of Tk.800,000 on January 01, 2017 and an estimated economic life of 10 years. (f) Zenon pays executory costs of Tk.10,000 per year. Required: Prepare journal entries for both the lessee and the lessor for 2017 to reflect the sale and leaseback agreement. No uncertainties exist and collectability is reasonably certain. Solution:

Date Jan. 01, 17

Jan. 01, 17

Dec. 31, 17

Dec. 31, 17

Dec. 31, 17

Dec. 31, 17

Date Jan. 01, 17

Jan. 01, 17

Dec. 31, 17

343

Zenon Corporation (Lessee) Journal entries Particulars Cash Computer Unearned profit on sale leaseback (To record the sale of computer) Leased computer under capital lease Obligation under capital lease (To record the leased computer and obligation) Obligation under capital lease Interest expense (Tk.800,000 X 10%) Cash (To record the payment from lease obligation) Executory costs Cash (To record the payment of executory costs) Unearned profit on sale leaseback Depreciation expense – leased computer (To recognize unearned profit for the year) Tk.200,000 ÷ 10 years Depreciation expense – leased computer Accumulated depreciation – leased computer (To record depreciation expense for the year) Tk.800,000 ÷ 10 years Abro Finance Co. (Lessor) Journal entries Particulars Computer Cash (To record the purchase of computer) Lease receivable Computer (To record the lease receivable) Cash Lease receivable Interest income (Tk.800,000 X 10%) (To record the collection from lease receivable)

Dr. (Tk.) 800,000

Cr. (Tk.) 600,000 200,000

800,000 800,000 120,000 80,000 200,000 10,000 10,000 20,000 20,000

80,000 80,000

Dr. (Tk.) Cr. (Tk.) 800,000 800,000 800,000 800,000 200,000 120,000 80,000


P-5. A manufacturing machine with a cash price of Tk.330,000 is acquired by way of a finance lease agreement under the following terms and conditions: - Effective date: January 1, 2014. - Lease term: 3 years. - Installments of Tk.72,500 are payable half-yearly in arrear. - Effective rate of interest is 20% per annum. - Deposit of Tk.30,000 immediately payable. - Depreciation on straight-line basis for six years. Required: (a) Prepare a lease amortization table for the lessee.. (b) Show the position of lessee as on December 31, 2014. (c) Show the position of lessor as on December 31, 2014. Solution: (a) Preparation of lease amortization table for the lessee: Date

Jan. 1, 14 Jan. 1, 14 July 1, 14 Jan. 1, 15 July 1, 15 Jan. 1, 16 July 1, 16 Jan. 1, 17 Total

Annual lease payment Tk. 30,000 72,500 72,500 72,500 72,500 72,500 72,500 465,000

Interest on lease liability @ 20% Tk. 30,000 25,750 21,075 15,933 10,276 31,966 135,000

Reduction of lease liability Tk. 30,000 42,500 46,750 51,425 56,567 62,224 40,534 330,000

Lease liability Tk. 330,000 300,000 257,500 210,750 159,325 102,758 40,534 -

(b) Position of lessee as on December 31, 2014: On January 1, 2014, a leased asset of Tk.330,000 will be recorded and a corresponding liability would be raised. The following expenses would be recognized in the income statement on December 31, 2014: Depreciation expenses (330,000 ÷ 6 years) Tk.55,000 Interest expenses Tk.55,750a a. {(330,000 – 30,000) X 20% X

1 1 } + {(330,000 – 30,000 – 42,500b) X 20% X } 2 2

= 30,000 + 25,750 = 55,750 b. 72,500 – 30,000 = 42,500

344


The balance sheet would reflect the following balances on December 31, 2014: Non-current asset: Leased Machine Less. Accumulated depreciation Carrying value Non-current liability: Obligation under finance lease 330,000 – (30,000 + 42,500 + 46,750) Current liability: Obligation under finance lease (72,500 – 25,750)

Tk.330,000 Tk.(55,000) Tk.275,000

Tk.210,750

Tk.46,750

(c) Position of lessor as on December 31, 2014: The total amount of Tk.465,000 due by the lessee would be recorded as a receivable at inception of the contract. The unearned interest income of Tk.135,000 is recorded as a deferred income. The deposit of Tk.30,000 and the first two installments are credited to the receivable account, which will then reflect a debit balance of Tk.290,000 {Tk.465,000 – (Tk.30,000 + Tk.72,500 + Tk.72,500)} at December 31, 2014. A total of Tk.55,750 (Tk.30,000 + Tk.25,750) of the unearned interest income has been earned in the first year, which brings the balance of this account to Tk.79,250 (135,000 – Tk.55,750) at December 31, 2014. The income statement for the year ended on December 31, 2014, would reflect interest income earned in the first year in the amount of Tk.55,750 (Tk.30,000 + Tk.25,750). The balance sheet at December 31, 2014, will reflect the non-current asset as a long-term receivable at Tk.210,750, which agrees with the liability in the books of the lessor at that stage. P-6. Sun Shine Corporation, a lessor of office machines, purchased a new machine for Tk.211,905 on January 1, 2015. The machine was delivered the same day to Galco Company, the lessee. The information relating to the lease transactions are as under: (a) The term of the non-cancellable lease is 3 years with no renewal option. The equipment has an estimated economic life of 4 years. (b) The equipment will revert to the lessor at the end of the lease term, at which time the equipment is expected to have a residual value of Tk.100,000 which is guaranteed by Galco Company. (c) Lease rentals consist of three equal annual payments of Tk.50,000, the first of which was paid on January 1, 2015. (d) Sun Shine Corporation‟s implicit interest rate (on its net investment) is 10% which is known by Galco Company. (e) Galco Company‟s incremental interest rate is 12% at December 31, 2004. (f) Galco Company uses the straight line depreciation method for all equipment. 345


(Present value of Tk.1 payable annually at the beginning for 3 years at 10% interest rate is Tk.2.7355 and present value of Tk.1 payable at the end of 3rd year at 10% interest rate is Tk.0.7513) Required: (i) Prepare balance sheet as on December 31, 2015 for Galco Company reflecting lease related items only. Assume Galco Company follows calendar year to prepare financial statements. (ii) Assume that instead of paying installment due on January 1, 2017, Galco Company offered to purchase the equipment for Tk.150,000. What journal entry would Galco Company pass on January 1, 2017? Solution: (i) Galco Company (Lessee) Balance sheet As on December 31, 2015 Assets Leased equipment Less. Accumulated depreciation (

211,905 100,000 ) 3 years

Tk. 211,905

Tk.

(37,302) 174,603

Liabilities Non-current liabilities: Obligation under capital lease (211,905 – 50,000 – 33,809) Current liabilities: Obligation under capital lease (50,000 – 16,191) Interest payable (211,905 – 50,000) X 10%

128,096

33,809 16,191 50,000

(ii) Galco Company (Lessee) Journal entries Date Jan. 1, 2017

Particulars Interest payable (128,096 X 10%) Obligation under capital lease Accumulated depreciation (37,302 X 2 years) Equipment (Balancing figure) Leased equipment Cash

Dr. (Tk.) 12,810 128,096 74,604 146,395

Cr. (Tk.)

211,905 150,000

P-7. Alco Company and Forex Finance Limited sign a lease agreement on 1st January 2017. According to the lease agreement, Forex Finance Limited delivered a machine to Alco Company on that date valued at Tk.218,840. The terms and other information regarding the lease are given below: 346


(a) The term of the lease is 3 years which is non-cancellable. (b) The machine has a useful economic life of 4 years. (c) The fair market value of the machine is Tk.218,840 on 1 st January 2017. (d) The lease contract requires annual rental payments of Tk.80,000 for three years. (e) The machine will revert to the lessor at the end of the lease term. (f) The implicit rate of interest is 10%. Required: Prepare extracts from the income statement and statement of financial position for year one and the obligations under finance leases, assuming that installments are paid in (i) arrears, and (ii) advance. Solution: Alco Company (Lessee) Income Statement (Extract)

Depreciation expense (Tk.218,840 ÷ 3 years) Interest expense Tk.218,840 X 10% (Tk.218,840 – Tk.80,000) X 10%

(i) Arrears Tk. 72,947

(ii) Advance Tk. 72,947

21,884 13,884

Alco Company (Lessee) Statement of Financial Position (Extract) (i) Arrears Tk.

(ii) Advance Tk.

218,840 (72,947) 145,893

218,840 (72,947) 145,893

Assets Non-current asset: Leased Machine Less. Accumulated depreciation Carrying value Liabilities Non-current liabilities: Obligation under capital lease Tk.218,840 – Tk.58,116 Tk.218,840 – Tk.80,000 – Tk.66,116 Current liabilities: Obligation under capital lease Tk.80,000 – Tk.21,884 Tk.80,000 – Tk.13,884 Interest payable

347

160,724 72,724

58,116 21,884

66,116 13,884


P-8. Cascade Industries and Barbara Hardy Inc. enter into an agreement that requires Barbara Hardy Inc. to build three diesel-electric engines to Cascade‟s specifications. Upon completion of the engines, Cascade has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is non-cancellable, becomes effective on January 1, 2017, and requires annual rental payments of Tk.620,956 each started on January 1, 2017. Cascade‟s incremental borrowing rate is 10%. The implicit interest rate used by Barbara‟s Inc. and known to Cascade is 8%. The total cost of building the three engines is Tk.3,900,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Cascade depreciates similar equipment on a straight-line basis. At the end of lease term, the engines have to handover to Barbara Hardy Inc. Collectability of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs. Required: (a) Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor. (b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Cascade Industries. (c) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Barbara‟s Inc. (d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017. (e) Prepare a lease amortization schedule for two years. (f) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2017. (g) Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2017 for both the lessee and the lessor. Solution: Present value of minimum lease payments = Tk.620,956 X Tk.7.2489 = Tk.4,500,000 Dealer profit: Sales Tk.4,500,000 Less: Cost of engines 3,900,000 Profit on sale 600,000 (a) The lease should be treated as capital lease by Cascade Industries (Lessee). The lease qualifies for capital lease accounting by the lessee because: (i) The lease term is equal to the estimated economic life of the leased engines, i.e., 10 years; and (ii) The present value of the minimum lease payments exceeds 90% of the fair value of the leased engines. The transactions represent a sale by installment payments over a 10 years period. The lease should be treated as sale type lease to Barbara Hardy Inc. because a manufacturer‟s profit is accrued.

348


(b) Journal entry On the books of Cascade Industries (Lessee) Jan. 1, 17

Leased engines under capital lease – Dr. – Obligation under capital lease – Cr. (To record the leased engines and obligation)

Tk.4,500,000 Tk.4,500,000

(c) Journal entry On the books of Barbara Hardy Inc. (Lessor) Jan. 1, 17

Lease receivable Cost of goods sold Sales Engines (To record the sale type lease)

– Dr. – Dr. – – Cr. - Cr. -

Tk.4,500,000 3,900,000 Tk.4,500,000 3,900,000

(d) Journal entry On the books of Cascade Industries (Lessee) Jan. 1, 17

Obligation under capital lease – Dr. – Cash – Cr. (To record the payment from lease obligation)

Tk.620,956 Tk.620,956

Journal entry On the books of Barbara Hardy Inc. (Lessor) Jan. 1, 17

– Dr. – Lease receivable – Cr. (To record the payment from lease receivable) Cash

Tk.620,956 Tk.620,956

(e) Lease amortization schedule (lessor): Date

Jan. 1, 17 Jan. 1, 17 Jan. 1, 18 Jan. 1, 19

Annual lease receipt Tk.

Interest revenue @ 8% Tk.

Reduction of lease receivable Tk.

620,956 620,956 620,956

310,324 285,473

620,956 310,632 335,483

Lease receivable Tk. 4,500,000 3,879,044 3,568,412 3,232,929

(f) Journal entry On the books of Cascade Industries (Lessee) Dec. 31, 17

349

Interest expense – Dr. – Interest payable – Cr. (To recognize interest expense for the year) (4,500,000 – 620,956) X 8%

Tk.310,324 Tk.310,324


Journal entry On the books of Barbara Hardy Inc. (Lessor) Dec. 31, 17

Interest receivable – Dr. – Interest revenue – Cr. (To recognize interest revenue for the year)

Tk.310,324 Tk.310,324

(g) Cascade Industries (Lessee) Balance Sheet As at December 31, 2017 Non-current assets: Leased engines under capital lease Less. Accumulated depreciation (4,500,000 ÷ 10 years)

Tk.4,500,000 450,000 Tk4,050,000

Non-current liabilities: Obligation under capital lease

Tk.3,568,412

Current liabilities: Obligation under capital lease (620,956 – 310,324) Interest payable (4,500,000 – 620,956) X 8%

Tk.310,632 310,324 Tk.620,956

Barbara Hardy Inc. (Lessor) Balance Sheet As at December 31, 2017 Non-current assets: Lease receivable Current assets: Lease receivable Interest receivable

Tk.3,568,412 Tk4,050,000 Tk.310,632 310,324 Tk.620,956

P-9. Wetland Enterprise entered into a lease agreement with Dryland Enterprise to acquire an equipment for its industrial use. On 1 st January 2010, they signed a contract where Wetland Enterprise agreed to pay eight annual installments of Taka 100,000 each and guarantees a residual value of Taka 60,000 at the end of eight years period on 31 st December 2017. Payments were made on 1 st day of each year starting from 1 st January 2010. Wetland Enterprise had an incremental borrowing rate of 13% and does not know the implicit rate to the lessor. Economic life of the equipment was 10 years. Wetland Enterprise uses calendar year for reporting purpose and uses straight-line depreciation to depreciate the equipment. Following is the present value table for an annuity of Taka 1: Percentage 6 year 7 year 8 year 12% 4.1114 4.5638 4.9676 13% 3.9975 4.4226 4.7988

9 year 5.3282 5.1317

10 year 5.6502 5.4262 350


Required: (a) Determine the present value of minimum lease payment. (b) What type of lease it is as per IAS 17? (c) Prepare a lease amortization schedule of the lessee. (d) Give journal entries that would be passed in the books of Wetland Enterprise for the first 2 years of the lease and balance sheet as on 31st December 2011. (e) Assume that the lessor Dryland Enterprise sells the equipment at Taka 42,000 on 31 st December 2017 to a third party. Give necessary journal entries in the books of Wetland Enterprise for the year 2017. Solution: (a) Determination of present value (PV) of minimum lease payment: Amount

PV factor Present value @ 13% Tk. Tk. 1.0000 100,000 4.4226 442,260 0.3762 22,572 564,832

Tk. 100,000 100,000 60,000

Installment at 0 period Installments for future 7 years Guaranteed residual value Total

(b) As the lease period covers 8 years out of 10 years of economic life, i.e. 80% (

8 X 10

100), it will be considered as capital lease. (c) Wetland Enterprise (Lessee) Lease amortization schedule Date 1st Jan. 10 1st Jan. 10 1st Jan. 11 1st Jan. 12 1st Jan. 13 1st Jan. 14 1st Jan. 15 1st Jan. 16 1st Jan. 17 31st Dec. 17

Annual lease payment Tk. 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 60,000

Interest expenses @ 13% Tk. 60,428 55,284 49,471 42,902 35,479 27,091 17,613 6,900

Reduction of lease liability Tk. 100,000 39,572 44,716 50,529 57,098 64,521 72,909 82,387 53,100

(d) Wetland Enterprise (Lessee) Journal entries

351

Lease liability Tk. 564,832 464,832 425,260 380,544 330,015 272,917 208,396 135,487 53,100 -


Date 1 Jan. 10 st

1st Jan. 10 31st Dec. 10

31st Dec. 10

1st Jan. 11

31st Dec. 11

31st Dec. 11

Particulars Leased equipment under capital lease Obligation under capital lease (To record the leased equipment and obligation) Obligation under capital lease Cash (To record the payment from lease obligation) Interest expense Interest payable (To recognize interest expense for the year) (564,832 – 100,000) X 13% Depreciation expense – leased equipment Accumulated depreciation – leased equipment (To record depreciation expense for the year) (564,832 – 60,000) ÷ 8 years Obligation under capital lease Interest payable Cash (To record the payment from lease obligation) Interest expense Interest payable (To recognize interest expense for the year) (564,832 – 100,000 – 39,572) X 13% Depreciation expense – leased equipment Accumulated depreciation – leased equipment (To record depreciation expense for the year)

Dr. (Tk.) Cr. (Tk.) 564,832 564,832 100,000 100,000 60,428 60,428

63,104 63,104

39,572 60,428 100,000 55,284 55,284

63,104 63,104

Wetland Enterprise (Lessee) Balance Sheet (Extract) As on 31st December 2011 Non-current assets: Leased equipment under capital lease Less. Accumulated depreciation (63,104 X 2 years) Non-current liabilities: Obligation under capital lease (564,832 – 100,000 – 39,572 – 44,716) Current liabilities: Interest payable (564,832 – 100,000 – 39,572) X 13% Obligation under capital lease (100,000 – 55,284) (e) 31st Dec. 17

Tk.564,832 (126,208)

Tk.438,624 Tk.380,544

Tk.55,284 44,716

Tk.100,000

Journal entries In the books of Wetland Enterprise (Lessee) Obligation under capital lease - Dr. - Tk.60,000 Loss on guaranteed residual value leased equipment (60,000 – 42,000) - Dr. 18,000 Leased equipment under capital lease - Cr. Tk.60,000 Cash - Cr. 18,000 352


31st Dec. 17

Profit and loss A/C Loss on guaranteed residual value – leased equipment

- Dr. - Tk.18,000 - Cr. -

Tk.18,000

P-10. On December 31, 2017 Zisan Company has been offered an electronically controlled automatic lathe (a) outright for Tk.100,000 cash or (b) on a negotiable lease whereby rental payments would be made at the end of each year for 3 years. The lathe will become obsolete and worthless at the end of 3 years. The company can borrow Tk.100,000 cash on a 3 years loan payable at maturity at 16% compounded annually. (a) Compute the annual rental payment, assuming that the lessor desires a 16% rate of return per year. (b) If the lease were accounted for as an operating lease, what annual journal entry would be made? (c) If the lease were accounted for as a capital lease, what annual journal entry would be made? (d) Consider that the lease is a capital lease. Prepare an analytical schedule of each lease payment by showing the lease liability at the beginning of the year, interest expense, lease payment and lease liability at the end of the year. (e) Prepare an analysis of transactions by considering the lease as an operating lease, using the balance sheet equation format. (f) Prepare an analysis of transactions by considering the lease as a capital lease, using the balance sheet equation format. (g) Prepare yearly journal entries. Solution: (a) Let, X = Annual rental payment Therefore, Tk.100,000 = PV of annuity due of X for 3 years at 16% => Tk.100,000 = Tk.2.2459 X Tk.100,000 => X = Tk.2.2459 => X = Tk.44,526 Annual rental payment = Tk.44,526 (b) If the lease were accounted for as an operating lease, the entry would be straightforward. Each year the following journal entry would be made: Rent expense Cash

- Dr. - Cr. -

Tk.44,526 Tk.44,526

(c) If the lease were accounted for as a capital lease, both the leasehold asset and lease liability must be placed on the balance sheet at the present value of future lease payments, i.e.,Tk.100,000 in this illustration. At the signing date, the following journal entry would be made to record the acquisition of an asset and its accompanying liability: 353


Leased asset under capital lease Obligation under capital lease

- Dr. - Cr. -

Tk.100,000 Tk.100,000

At the end of each of the three years, the leased asset must be amortized. Straight-line amortization would be Tk.100,000 ÷ 3 years = Tk.33,3333 annually. (d) Analytical schedule of each lease payment: Year

Lease liability at beginning of the year Tk. 100,000 71,474 38,384

End of year 1 End of year 1 End of year 1

Interest expense @ 16% Tk. 16,000 11,436 6,141

Lease payment

Lease liability at the end of the year

Tk. 44,526 44,526 44,526

Tk. 71,474 38,384 -

(e) Analysis of transactions by considering the lease as an operating lease:

Signing date End of year 1 End of year 2 End of year 3 Total

Assets Cash Leased asset Tk. Tk. No entry (44,526) (44,526) (44,526) (133,578)

Liabilities & equity Rent liability Interest payable Tk. Tk. (44,526) (44,526) (44,526) (133,578)

(f) Analysis of transactions by considering the lease as a capital lease: Assets Liabilities & equity Cash Leased Lease Interest Accumulated asset liability payable amortization Tk. Tk. Tk. Tk. Tk. Signing date 100,000 100,000 End of year 1 (44,526) (33,333) (28,526) (16,000)a (33,333)d b End of year 2 (44,526) (33,333) (33,090) (11,436) (33,333) End of year 3 (44,526) (33,334) (38,384) (6,142)c (33,334) Total (133,578) 0 0 (33,578) (100,000) a. Tk.100,000 X 16% = Tk.16,000 b. (Tk.100,000 – Tk.28,526) X 16% = Tk.11,436 c. (Tk.100,000 – Tk.28,526 – Tk.33,090) X 16% = Tk.6,142 d. Tk.100,000 ÷ 3 years = Tk.33,333 (g) Yearly journal entries: Dr. (Tk.) Year 1: Interest expense Lease liability Cash

Cr. (Tk.)

16,000 28,526 44,526 354


Amortization of leased asset Leased asset Year 2: Interest expense Lease liability Cash

33,333 33,333

11,436 33,090 44,526

Amortization of leased asset Leased asset Year 3: Interest expense Lease liability Cash

33,333 33,333

6,142 38,384 44,526

Amortization of leased asset Leased asset

33,334 33,334

Note: Straight-line amortization is usually followed in practice. A separate account for accumulated amortization – leased asset could be presented. Here, amortization is shown as a direct reduction of leased asset.

Contact us to collect exercises solution. Helpline: 01711137039

355


EXERCIES E-1. Don Transportation Company leases a vehicle to John Inc. for 3 years against which the lessor receives annual rental of Tk.4,000 payable at beginning of each year. The lessee agrees to guaranteed residual value of Tk.3,500 at the end of economic life, i.e. after third year. The cash price of the vehicle is Tk.13,251. The implicit interest rate is 12% which is known to the lessee and the lessee‟s incremental borrowing rate is 14%. Lessee estimates the residual value at the end of the lease to be Tk.4,200 and depreciates on a straight line basis. Required: Entries on the lessee‟s books for the first year of lease. What would be the amount of lease obligation in the Balance Sheet at the end of first year? CMA Adapted - December 2016 E-2. On January 1, 2012, FYR Ltd. the lessee, entered into an equipment lease with ULC Ltd. having the following the provisions. (1) The lease has a fixed non-cancelable term of 30 months, with rent of Tk.270 payable at the beginning of each month, starting January 1, 2012. (2) The lease guarantees a residual value of Tk.4,000 at the end of 30 months, when ULC takes possession of the equipment. (3) The lessee pays executor costs separately to the lessor and is to receive any excess of selling price of the equipment over the guaranteed residual value at the end of the lease term. (4) The lease is renewable periodically based on schedule of rentals and guarantees of the residual values, which decrease over time. Other relevant information is as follows: (a) ULC‟s interest rate implicit in the lease is 12% a year (1% a month). ULC has informed FRY Ltd. of this rate. FRY‟s incremental borrowing rate is 15% a year (1.5% a month). (b) The lessor‟s cost of the leased equipment is Tk.10,006. This is also the lessor‟s fair value at the inception of the lease, January 1, 2014. (c) The estimated economic life of the equipment is 60 months, the lessee depreciates owned equipment on a straight-line basis. (d) The residual value at the end of the lease term is estimated to be Tk.4,000; the amount guaranteed by the lessee. (e) On July 2, 2014, the end of the lease term, the equipment is sold by the lessor for Tk.4,200 to a third party. (f) The fiscal years for the lessee and the lessor end on December 31. Required: (i) Calculate the total present value of minimum lease payments. (ii) Prepare the required entries and ledger to record the lease in the books of lessee. CMA Adapted - April 2015 E-3. United Leasing Company and Square Textiles Limited sign a lease agreement for Equipment on 01 May, 2008 with the following terms and provisions: 356


• The term of the lease is 5 (five) years and the lease agreement is non-cancellable. • Annual lease payment of Tk.84,910.60. • Economic life of the leased equipment is 10 (ten) years. • Bargain purchase option price of Tk.16,000.00 at the end of lease term. • Fair value of the leased equipment is Tk.3,64,000.00 at 01 May, 2008. • United Leasing Company pays executory costs directly to third parties for property taxes of Tk.5,000.00 per year which are not included in annual lease payment. • Cost of the leased equipment is Tk.2,60,000.00 to United Leasing Company. • Incremental borrowing rate is 10% to Square Textiles Limited. The collectability of the lease payments is reasonable predictable and there are no important uncertainties surrounding the costs yet to be incurred by the United Leasing Company. It is assumed that annual lease payment is due at the inception of the lease agreement and implicit rate for United Leasing Company is also the same as assumed by Square Textiles Limited. [Present Value of Tk.1 for n=5, i=10% is 0.62092, Present Value of Annuity Due of Tk.1 for n=5, i=10% is 4.16986] Required: (i) Discuss the nature of the lease to Square Textiles Limited and United Leasing Company. (ii) Prepare a lease amortization schedule for Square Textiles Limited for 5 years lease term. (iii) Prepare journal entries in the books of Square Textiles Limited to reflect the signing of the lease agreement and to record the payments and expenses related to lease for 2008 and 2009 assuming accounting year ends on 31 December. (iv) If Square Textiles Limited has incremental borrowing rate of 9% and not known the implicit interest rate 10% used by United Leasing Company, what would be the capitalized amount for leased equipment? CMA Adapted - April 2014 E-4. The Irfan Equipment Company both leases and sells its equipment to its customers. The most popular line of equipment includes a machine that costs Tk. 140,000 to manufacture. The standard lease terms provide for five annual payments of Tk. 55,000 each (excluding executory costs), with the first payment due when the lease is signed and subsequent payments due of December 31 of each year. The implicit rate of interest in the contract is 10% per year. Ahnaf Powder Co, Leases one of these machines on January 2, 2012. Initial direct costs of Tk. 10,000 are incurred by Inrfan on January 2, 2012 to obtain the lease Ahnaf‟s incremental borrowing rate is determined to be 12%. The equipment is very specialized, and it is assumed it will have no salvage value after five years. Assume the lease qualifies as a capital lease and a sales-type lease for lessee and lessor respectively. Also assume that both the lessee and the lessor are on a calendar-year basis and that the lessee is aware of the lessor‟s implicit interest rate. Required: (i) Give all required of the books of Ahnaf Powder Co. to record the lease of equipment from Irfan Equipment Company for the year 2012. The depreciation of owned equipment is computed once a year on the straight-line basis. (ii) Give entries required on the books of Irfan Equipment Company to record the lease of equipment to Ahnaf Powder Co, for the year 2012. 357


(iii) Prepare the balance sheet section involving lease balances for both the lessees and lessor‟s financial statements at December 31, 2012. (iv) Determine the amount of expense Ahnaf Powder Co. will report relative to the lease for 2012 and the amount of revenue Irfan Equipment Company will report for the same period. CMA Adapted - December 2013 E-5. Rupa Electric Company has a policy of acquiring its equipment by leasing. On January 2, 2008, the company signed a lease for a coiling machine. The lease stipulates that payments of Tk. 45,000 (excluding executory costs) will be made annually for five years. The payments are to be made in advance of December 31 of each year. At the end of the five-year period, the company may purchase the machine for Tk.20,000. Its estimated fair market value at that date is Tk.75,000. The Company‟s incremental borrowing rate is 12%, which is less than the implicit interest rate. The estimated economic life of the equipment is eight years. Rupa uses straight-line depreciation for all equipment and uses the calendar year for reporting purposes. Required: (i) Compute the amount to be capitalized as an asset for the lease of the coiling machine. (ii) Prepare a table showing the computation of the interest expenses for each period. (iii) Give the journal entries that would be made on Rupa Electric Company‟s books for the first two years of the lease. (iv) Assume on December 31, 2012 the purchase option is exercised, give the journal entry to record the exercise of the option on Rupa Electric Company‟s books. CMA Adapted - December 2013 E-6. Purabi Leasing Co. Ltd. signs an agreement on January 01, 2008, to lease equipment to Rana Enterprise. The following information relates to this agreement: (1) The term of the non-cancellable lease is 8 years with no renewal option. The equipment has an estimated economic life of 10 years. (2) The equipment will revert to the lessor at the end of the lease term, at which time the equipment is expected to have a residual value of Tk.500,000 which is guaranteed by Rana Enterprise. (3) Rana Enterprise will bear the executory cost which include insurance cost of Tk.15,000 and servicing cost of Tk.9,000 per year. The executory cost is to be paid with annual rental payment. (4) The agreement requires equal rental payment of Tk.250,000 to Purabi leasing beginning on January 01, 2008. (5) Rana Enterprise can borrow at 12% to purchase this type of equipment while Purabi Leasing expects 10% returns on its investment. Purabi‟s expected rate of return is known to Rana Enterprise. (6) Rana Enterprise uses the straight line depreciation method for all equipment. (Present Value of Tk.1 payable annually at beginning for 8 years at 10% interest rate is 5.86842 and at 12% is 5.56376. Present value of Tk.1 payable at the end of 8 th year at 10% interest rate is 0.46651 and at 12% is 0.40388)

358


Required: (i) Do you think that the lease is capital one? Explain. (ii) Prepare an amortization schedule for Rana Enterprise. (iii) Prepare all journal entries for Rana Enterprise for the years 2008 and 2009. (iv) Prepare Balance Sheet as on December 31, 2008 for Rana Enterprise reflecting lease related items only. Assume Rana Enterprise follows calendar year to prepare Financial Statements. (v) Assume that instead of paying installment due on 01.01.2010 Rana Enterprise offered to purchase the equipment for Tk.13,40,000. What journal entry would Rana pass on 01.01.2010? CMA Adapted - August 2013 E-7. Lab Aid Company and Prime Finance and Investment Ltd. sign a lease agreement On 1 January 2013 that calls for Prime Finance to lease equipment to lab Aid beginning January 2013. The terms and provisions of the lease agreement and other information are as follows: - The term of the lease is five years and the lease agreement is non-cancellable, requiring equal rental payments of 24,33,139.00 at the beginning of each year. - The equipment has a fair value at the inception of the lease is 1,00,00,000.00. It has an estimated economic life of 5 years without any residual value. - Lessee company pays all of the executor costs directly to third parties except for the property taxes of Tk.35,000.00 per annum, which is included in the annual payments to the lessor. - The lease contains no renewal option and the equipment have to hand over to the lessor after the lease period. - The lease company incremental borrowing rate is 11% but the lessor company set the annual rental to earn a rate of return on its investment @ 10%, This fact is known to the lessee company. - The lessee company charges depreciation on its similar types of equipments under straight line method. Required: (i) Calculate the present value of the leased equipment. (ii) Journalize the transaction in the books of Accounts of Lab Aid Company for the year 2013 and 2014 assuming the company follows calendar year. (iii) Prepare a lease amortization table. CMA Adapted - April 2013 E-8. Bay Leasing Company signs an agreement on January 1, 2008, to lease equipment to KKK Company. The following information relates to this agreement. 1. The term of the non-cancelable lease is 5 years with no renewal option. The equipment has an estimated economic life of 5 years. 2. The fair value of the asset at January 1, 2008, is Tk.80,000. 3. The asset will revert to the lessor at the end of lease term, at which time the asset is expected to have a residual value of Tk.7,000, none of which is guaranteed. 4. KKK Company assumes direct responsibility for all executor costs, which include Tk.900 to Rock Mountain Insurance for insurance. 5. The agreement requires equal annual rental payments of Tk.18,142.95 to the lessor, beginning on January 1, 2008. 6. The lesseeâ€&#x;s incremental borrowing rate is 10%. 359


7. KKK Company uses the straight-line depreciation method for all equipment. 8. KKK Uses reversing entries when appropriate. • Present value of an annuity due at 10% for 5 years is Tk.4.16986. Required: (i) Prepare an amortization schedule that would be suitable for the lessee for the lease term. (ii) Prepare all of the journal entries for the lessee for 2008 and 2009 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee‟s annual accounting period ends on December 31. CMA Adapted - December 2012 E-9. SMX Leasing Company agrees to lease machinery to PMX Corporation on January 1, 2010. The following information relates to the lease agreement. 1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. 2. The cost of the machinery is Tk.420,000, and the fair value of the asset on January 1, 2010, is Tk.560,000. 3. At the end of the lease term the asset reverts to the lessor. At the end to the lease term the asset is expected to have a guaranteed residual value of Tk.80,000. PMX depreciates all of its equipment on a straight-line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2010. 5. The collectability of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amounts of costs yet to be incurred by the lessor. 6. SMX desires a 10% rate of return on its investments. PMX‟s incremental borrowing rate is 11%. • Present value of Tk.1 at 10% for 7 years is 0.51316 and 11% for 7 years is 0.48166 • Present value of an annuity due at 10% for 7 years is 5.35526 and 11% for 7 years is 5.23054. Instructions: (a) Discuss the nature of this lease for both the lessee and the lessor, according to IAS-17 Leases. (b) Calculate the amount of the annual rental payment required. (c) Compute the present value of the minimum lease payments. (d) Prepare the journal entries PMX would make in 2010 and 2011 related to the lease arrangement. CMA Adapted - August 2012 E-10. PQR Corporation, a lessor of office machines, purchased a new machine for Tk.450,000 on December 31, 2004. The machine was delivered the same day (by prior arrangement) to XYZ Company, the lessee. The information relating to the lease transactions are as under: (i) The leased asset had an estimated useful life of seven years which coincides with the lease term. (ii) At the end of lease term, the machine will revert to PQR, at which time it is expected to have a residual value Tk.60,000 (none of such is guaranteed by XYZ). (iii) PQR‟s implicit interest rate (on its net investment) is 12% which is known by XYZ. 360


(iv) XYZ‟s incremental interest rate is 14% at December 31, 2004. (v) Lease rentals consist of seven equal annual payments, the first of which was paid on December 31, 2004. (vi) The lease is approximately accounted for as a direct financing lease by PQR and as a capital lease by XYZ. Both the lessor and lessee follow the calendar years and depreciate all plant assets on the straight line basis. • Present value of Taka 1at 12% for 7 years is 0.4523. • Present value of annuity of Taka 1 in advance for 7 years @ 12% is 5.1114. Required: (i) Compute the annual rental of the lease (Round to nearest Taka). (ii) Compute the amounts of the minimum lease payments receivable and unearned interest revenue that PQR should disclose at the inception of the lease on December 31, 2004. (iii) What expense should XYZ record for the year ended December 31, 2005? CMA Adapted - April 2012 E-11. On January 01, 2010 Auto Ltd. sells a Truck to Easy Finance Co. Ltd. for Tk.13,60,000 and immediately leases the Truck back. The relevant information is as follows: (i) The Truck was carried on Auto Ltd‟s books at a value of Tk.12,00,000. (ii) The term of the non-cancellable lease is 10 years title will transfer to Auto Ltd. (iii) The lease agreement requires equal rental payments of Tk.2,21,332.62 at the end of each year. (iv) The incremental borrowing rate of Auto Ltd. is 12%, Auto Ltd. is aware that Easy Finance Co. Ltd. set the annual rental to ensure a rate of return of 10%. (v) The Truck has a fair value of Tk.60,000 on June 2010. (vi) Auto Ltd. pays executory costs of Tk.18,000 per year. Instruction: Prepare the journal entries for both the lessee and the lessor for 2010 to reflect the sale and lease back agreement. No uncertainties exist and collectability is reasonably certain. CMA Adapted - December 2011 E-12. Teledyne Distribution Center sells its four warehouses for Tk.9,00,000 to Alam Distribution Centers and immediately leases back the warehouses to obtain their continued use. The warehouses had a carrying value on Teledney‟s books of Tk.6,00,000 (original cost Tk.9,50,000). Other information: (i) The sale date is December 31, 2006. (ii) The non-cancellable lease term is 10 years and requires annual payments of Tk.1,33,155 beginning December 31, 2006. The estimated remaining useful life of the warehouses is 10 years. (iii) The annual rental payments (present value Tk.9,00,000) provides the lessor with a 10% rate of return on the financing arrangement. Teledyne‟s incremental borrowing rate is 10%. (iv) Teledyne depreciates its warehouses on a straight-line method.

361


Required: Journal entries in the books of both the companies for December 31, 2006 and 2007. CMA Adapted - December 2010 E-13. On January 01, 2008 Hein Do Corporation sells a computer to Liquidity Finance Co. for Tk.6,80,000 and immediately leases the computer back. The relevant information is as follows: (i) The computer at value of Tk.6,00,000 was carried in the book of Hein Do. (ii) The term of the non-cancellable lease is 10 years; title will transfer to Hein Do. (iii) The lease agreement requires equal rental payments of Tk.1,10,666.81 at the end of each year. (iv) The incremental borrowing rate of Hein Do. Corporation is 12%. Hein Do is aware of that Liquidity Finance Co. set the annual rental to insure a rate of return of 10%. (v) The computer has a fair value of Tk.6,80,000 on January 01, 2008 and an estimated economic life of 10 years. (vi) Hein Do. pays executor costs of Tk.9,000 per year. Required: Prepare journal entries for both the lessee and the lessor for 2008 to reflect the sale and leaseback agreement. No uncertainties exist, and collectability is reasonably certain. CMA Adapted - August 2009

362


CHAPTER - 12 ISSUE AND REDEMPTION OF SHARES (IAS 32)

12.1. DEFINITION OF STOCK A stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. A holder of stock (a shareholder) has a claim to a part of the corporation's assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. There are two main types of stock: common and preferred. 12.2. TYPES OF STOCK Preferred stock: A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights. Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price. The details of each preferred stock depend on the issue. Common stock: Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure; in the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debt holders are paid in full. Hybrid stock: Some companies also issue hybrid stocks. These are often preferred shares that come with an option to be converted into a fixed number of common stocks at a specified time. These kinds of stocks are called „convertible preferred sharesâ€&#x;. Since these are hybrid stocks, they may or may not have voting rights like common stocks. 12.3. DIFFERENCES BETWEEN PREFERRED AND COMMON STOCK Preferred stock (a) Preferred stock refers to that part of company's capital that carry preferential right, to be paid, when the company goes bankrupt or wound up. (b) Preferred stockholders are paid before common stockholders. (c) They are entitled to get arrears of dividend, if unpaid in the previous year. 363

Common stock (a) Common stock refers to the ordinary stock, representing part of ownership and offers voting rights to the person holding it. (b) Payment to common stockholders are made at the end. (c) They are not entitled to get arrears of dividend, if unpaid in the previous year.


(d) Preferred stocks are rated by credit agencies just like bonds, and the rating varies between a high quality investment stock and low quality, high yield stocks. (e) Preferred stockholders always receive dividends at a fixed rate.

(d) common stocks are not rated by any credit agency. (e) Common stockholders don‟t always receive dividends.

12.4. EXPLANATION OF TREASURY STOCK Treasury stocks (treasury shares) are the portion of shares that a company keeps in its own treasury. Treasury stock may have come from a repurchase or buyback from shareholders, or it may have never been issued to the public in the first place. These shares don't pay dividends, have no voting rights and should not be included in shares outstanding calculations. Under the cost method of recording treasury stock, the cost of treasury stock is reported at the end of the Stockholders' Equity section of the balance sheet. Treasury stock will be a deduction from the amounts in Stockholders' Equity. 12.5. MEANING OF DIVIDEND A dividend is a distribution of a portion of a company's earnings. It is a payment made to shareholders that is proportional to the number of shares owned. It is authorized by the board of directors. Companies may issue dividends in order to attract income investors, who are looking for a steady source of income, and which can be reliable long-term holders of company shares. 12.6. TYPES OF DIVIDEND Cash dividend: A cash dividend is money paid to stockholders, normally out of the corporation's current earnings or accumulated profits. Not all companies pay a dividend. Usually, the board of directors determines if a dividend is desirable for their particular company based upon various financial and economic factors. Stock dividend: A stock dividend is a dividend payment made in the form of additional shares rather than a cash payout. This type of dividend is issued when a company‟s liquid cash is in short supply, but still issues the common stock to the shareholders to keep them happy. In this case, the shareholders get additional shares in proportion to the shares already held by them and don‟t have to pay extra for these bonus shares. Scrip dividend: A firm experiencing difficulty raising cash may issue a scrip dividend instead of paying money to shareholders. Scrip dividends are similar to stock dividend, but it can be in the form of a promissory note assuring the payment of stock at a later time. This type of dividend can provide a tax benefit over cash since it does not have to claim until the shares are sold, and it can benefit the company by allowing it to use cash for other priorities in times of crisis.

364


Property dividend: Property dividends are paid in the form of a property rather than in cash. When a company suffers from the lack of operating cash, non-monetary dividends are paid to the investors. Property dividends can be paid in the form of inventory, asset, vehicle, real estate, etc. The companies record the property given as a dividend at a fair market value, as it may vary from the book value and then record the difference as a gain or loss. Liquidating dividend: Companies that are not meeting expectations and are viewed by its officials as failing will issue liquidating dividends to shareholders as a way of paying them back for their investment. Since the firm has little or no income, actual assets are used to pay the dividend. Under law, a failing company must pay all its liabilities before any liquidating dividends can be given to investors. 12.7. DIFFERENCES BETWEEN CASH AND STOCK DIVIDEND Cash dividend (a) A cash dividend payment is on a per share basis and will differ for each company. (b) Companies issue cash dividend when they have a lot of free cash flow and there are not a lot of opportunities to use all that cash up in the form of investment opportunities. (c) In case of cash dividend, the shareholders always receive cash. (d) Cash dividend needs to be accounted for when filing the tax return. (e) For example, if that company paid a semi-annual dividend of $0.88 per share, the annual dividend would be $1.76 (2 x $0.88 = $1.76).

Stock dividend (a) A stock dividend is based on a percentage and results in an increase in the number of shares owned. (b) Companies issue stock dividend to the shareholders to reward them without harming the companyâ€&#x;s own cash position.

(c) With a stock dividend, shareholders have a choice, either keep the shares or sell them if they would rather cash out. (d) Stock dividend doesnâ€&#x;t require any taxes to be paid until the position is sold. (e) For instance, if a company issued a 10% stock dividend, it would mean that a shareholder now owns one additional share for every 10 already possessed. So, owning 1,000 shares prior would give an additional 100 shares.

12.8. EXPLANATION OF STOCK SPLIT A stock split is a procedure that increases a corporation's total number of shares outstanding without altering the firm's market value or the proportionate ownership interest of existing shareholders. This action, which requires advance approval from the company's board of directors, usually involves the issuance of additional shares to existing stockholders. The split shares retain the same total stock value as before. For example, a three-for-two stock split means a corporate wishes to increase the number of stock shares on the market by giving shareholders three shares of stock in exchange for every two shares held.

365


12.9. BASIC EARNINGS PER SHARE An entity shall calculate basic earnings per share amounts for profit or loss attributable to ordinary equity holders of the parent entity and, if presented, profit or loss from continuing operations attributable to those equity holders. The objective of basic earnings per share information is to provide a measure of the interests of each ordinary share of a parent entity in the performance of the entity over the reporting period. Basic earnings per share shall be calculated by dividing profit or loss attributable to ordinary equity holders of the parent entity (the numerator) by the weighted average number of ordinary shares outstanding (the denominator) during the period. The weighted average number of ordinary shares outstanding during the period is the number of ordinary shares outstanding at the beginning of the period, adjusted by the number of ordinary shares bought back or issued during the period multiplied by a time-weighting factor. The time-weighting factor is the number of days that the shares are outstanding as a proportion of the total number of days in the period; a reasonable approximation of the weighted average is adequate in many circumstances. 12.10. DILUTED EARNINGS PER SHARE An entity shall calculate diluted earnings per share amounts for profit or loss attributable to ordinary equity holders of the parent entity and, if presented, profit or loss from continuing operations attributable to those equity holders. The objective of diluted earnings per share is consistent with that of basic earnings per share to provide a measure of the interest of each ordinary share in the performance of an entity while giving effect to all dilutive potential ordinary shares outstanding during the period. As a result: (a) profit or loss attributable to ordinary equity holders of the parent entity is increased by the after-tax amount of dividends and interest recognised in the period in respect of the dilutive potential ordinary shares and is adjusted for any other changes in income or expense that would result from the conversion of the dilutive potential ordinary shares; and (b) the weighted average number of ordinary shares outstanding is increased by the weighted average number of additional ordinary shares that would have been outstanding assuming the conversion of all dilutive potential ordinary shares. 12.11. CONVERTIBLE INSTRUMENT The dilutive effect of convertible instruments shall be reflected in diluted earnings per share. Convertible preference shares are antidilutive whenever the amount of the dividend on such shares declared in or accumulated for the current period per ordinary share obtainable on conversion exceeds basic earnings per share. Similarly, convertible debt is antidilutive whenever its interest (net of tax and other changes in income or expense) per ordinary share obtainable on conversion exceeds basic earnings per share. The redemption or induced conversion of convertible preference shares may affect only a portion of the previously outstanding convertible preference shares. In such cases, any excess consideration is attributed to those shares that are redeemed or converted for the 366


purpose of determining whether the remaining outstanding preference shares are dilutive. The shares redeemed or converted are considered separately from those shares that are not redeemed or converted. 12.12. DEFINITION OF BOND A debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. When an investor buys a bond, he/she becomes a creditor of the issuer. However, the buyer does not gain any kind of ownership rights to the issuer, unlike in the case of equities. 12.13. DIFFERENCES BETWEEN STOCK AND BOND Stock Bond (a) Stocks are the financial instrument (a) Bonds are the debt instrument issued by issued by the company in exchange for the companies to raise capital with a cash that carries ownership. promise to pay back the money after some time along with interest. (b) In case of stock, the return is not (b) In case of bond, the return is guaranteed. guaranteed. (c) Stocks pay dividends to the (c) Bonds pay interest to the bondholders. stockholders. (d) Every corporation has common (d) Many corporations do not issue bonds. stock. Some corporations issue preferred stock in addition to its common stock. (e) The holders of stock can vote on (e) Bond holders have no voting rights. certain company issues, such as the election of directors. 12.14. DISCLOSURE An entity shall disclose the following: (a) the amounts used as the numerators in calculating basic and diluted earnings per share, and a reconciliation of those amounts to profit or loss attributable to the parent entity for the period. (b) the weighted average number of ordinary shares used as the denominator in calculating basic and diluted earnings per share, and a reconciliation of these denominators to each other. (c) instruments that could potentially dilute basic earnings per share in the future, but were not included in the calculation of diluted earnings per share. (d) a description of ordinary share transactions or potential ordinary share transactions, other than those accounted for, that occur after the reporting period.

367


PROBLEMS AND SOLUTIONS P-1. 10 year bonds at par valued of Tk.800,000 dated January 1, 2017 bearing interest @ 10% payable semi-annually on January 1, and July 1, are issued on March 1, 2017, at Tk.102 plus accrued interest. Give entries on March 1, 2017. Solution: Journal entries March 1, 2007

Cash

Tk.829,333 Bonds payable Interest payable Premium on bonds payable

Tk.800,000 13,333 16,000

Computations: Tk.800,000 X 10% X

2 months = Tk.13,333 12 months

Tk.800,000 X Tk.2 = Tk.16,000 Tk.100 par P-2. On January 01, 2017 Rupali Co. Ltd. had 4,80,000 shares of common stock outstanding. During 2017, it had the following transactions that affected the common stock account: February 01 March 01 May 01 June 01 October 01

Issued 1,20,000 shares Issued a 10% stock dividend Acquired 1,00,000 shares of treasury stock Issued 3-for-1 stock split Re-issued 60,000 shares of treasury stock

Required: Compute the weighted average number of shares outstanding as of December 31, 2017. Solution: Statement showing the computation of the weighted average number of shares Dates

January 01 February 01 March 01 April 01

Shares outstanding (a) 4,80,000 1,20,000 1,00,000 60,000

Stock dividend (b) 1.10 1.10 -

Stock Split (c) 3 3 3 -

Fraction of year (d) 11/12 8/12 3/12

Weighted average (a x b x c x d) 15,84,000 3,63,000 (2,00,000) 15,000 17,62,000

P-3. The stockholdersâ€&#x; equity section of the balance sheet of Sky Company Limited includes the following accounts at December 31, 2015:

368


Shareholders’ Equity Common stock, 50,000 shares of Tk.2 par Paid-in capital – excess of par, common Retained earnings Total shareholders‟ equity

Tk. 1,00,000 80,000 2,00,000 3,80,000

Listed below are the transactions that affected the stockholders‟ equity of Sky Company Limited during the period 2016-2017. (a) November 1, 2016, the company declared a cash dividend of Tk.1 per share on common shares, payable to shareholders on December 1. (b) On December 1, the company paid the dividend declared on November 1, 2016. (c) On July 1, 2017, the company declared and distributed a 10% common stock dividend (the market value of the common stock on that date was Tk.20 per share). (d) On November 1, 2017, the company declared a cash dividend of Tk.1.5 per share on its common shares, payable to shareholders on December 1. (e) On December 1, the company paid the dividend declared on November 1, 2017. Required: Prepare journal entries for the above transactions. Solution: Sky Company Limited Journal entries Date Nov 01, 16

Dec 01, 16 July 1, 17

Nov 01, 17

Dec 01, 17

Particulars Retained earnings Cash dividend payable 50,000 shares X Tk.1 Cash dividend payable Cash Retained earnings (5,000 X Tk.20) Common stock (5,000 X Tk.1) Paid-in capital- excess of par, common 50,000 shares X 10% = 5,000 shares Retained earnings (55,000XTk.1.5) Cash dividends payable 50,000 + 5000 = 55,000 shares Cash dividends payable Cash

Dr. (Tk.) Cr. (Tk.) 50,000 50,000 50,000 50,000 100,000 5,000 95,000 82,500 82,500 82,500 82,500

P-4. Sun Shine Company reported the following amounts in the stockholders‟ equity section of its December 31, 2016, balance sheet. Preferred stock, 10%, Tk.100 par (10,000 shares authorized, 2,000 shares issued) Common stock, Tk.10 par (100,000 shares authorized, 10,000 shares issued) Additional paid in capital Retained earnings Total 369

Tk.200,000 Tk.100,000 Tk.150,000 Tk.300,000 Tk.750,000


During 2017, Sun Shine Company took part in the following transactions concerning stockholders equity. (a) Paid the annual 2016 Tk.5 per share dividend on preferred stock and a Tk.1 per share dividend on common stock. These dividends had been declared on December 31, 2016. (b) Purchased 1,000 shares of its own outstanding common stock for Tk.50 per share. Sun Shine Company uses the cost method in recording its shares. (c) Reissued 400 treasury shares for Tk.25,000. (d) Issued 1,000 shares of preferred stock at Tk.110 per share. (e) Declared a 10% stock dividend on the outstanding common stock when the stock is selling for Tk.30 per share. (f) Issued the stock dividend. (g) Declared the annual 2017 Tk.10 per share dividend on preferred stock and the Tk.1 per share dividend on common stock. These dividends are payable in 2018. Instructions: (i) Prepare journal entries to record the above transactions. (ii) Prepare the December 31, 2017, stockholdersâ€&#x; equity section. Solution: (i) Sun Shine Company Journal entries Si. No. Particulars (a) Dividends payable- Preferred (2,000XTk.5) Dividends payable- Common (10,000XTk.1) Cash (b) Treasury stock Cash (1,000XTk.50) (c) Cash Treasury stock (400XTk.50) Additional paid in capital- treasury stock (d) Cash (1,000 X Tk.110) Preferred stock (1,000XTk.100) Additional paid in capital- Preferred stock (e) Retained earnings (9400*X10%XTk.30) Common stock dividend distributable (9400X10%XTk.10) Additional paid in capital- Common stock *10,000-1,000+400 = 9,400 (f) Common stock dividend distributable Common stock (g) Retained earnings Dividends payable- Preferred stock (3,000XTk.10) Dividends payable- Common stock (10,340*XTk.1) *9,400 + 940 = 10,340

Dr. (Tk.) 10,000 10,000

Cr. (Tk.)

20,000 50,000 50,000 25,000 20,000 5,000 110,000 100,000 10,000 28,200 9,400 18,800 9,400 9,400 40,340 30,000 10,340

370


(ii) Sun Shine Company Stockholders‟ Equity December 31, 2017 Preferred stock, 10%, Tk.100 par, 10,000 shares authorized, 3,000 shares issued and outstanding Common stock, Tk.10 par, 100,000 shares authorized, 10,940 shares issued, 10,340 shares outstanding Additional paid-in capital Retained earnings Total paid-in capital and retained earnings Less. Cost of treasury stock Total stockholders‟ equity

Tk.300,000 109,400 183,800 231,460 824,660 30,000 Tk.794,660

Computations: Preferred stock = Tk.200,000 + Tk.100,000 = Tk.300,000 Common stock = Tk.100,000 + Tk.9,400 = Tk.109,400 Additional paid-in capital = Tk.150,000+Tk.5,000+Tk.10,000+Tk.18,800 = Tk.183,800 Retained earnings = Tk.300,000 – Tk.28,200 – Tk.40,340 = Tk.231,460 Cost of treasury stock = (1,000 – 400) shares X Tk.50 = Tk.30,000 P-5. Transactions of Bright Company during 2017 included the following: January 10: Purchased 200 shares of Safar Company at Tk.100 plus brokerage charges of Tk.400. July 1: Received a 50% stock dividend. September 20: Received stock rights permitting the purchase of one share at Tk.80 for every 4 shares held. On this date, rights were being traded at Tk.4 each and stock was being traded at Tk.96 per share. October 20: Exercised 200 rights which pertained to the stock acquired on January 20 and November 1: Sold remaining rights at Tk.2 each less brokerage charges of Tk.10. December 1: Sold 50 shares from the holdings acquired on January 10 at Tk.70 less brokerage charges of Tk.100. Required: Give journal entries to record the foregoing transactions. Solution:

Date 2017 Jan. 1 July 1

371

Bright Company Journal entries Particulars Investment in Safar Company Cash (200 X Tk.100) + Tk.400 Memorandum entry: Received 50% stock dividend. Now, the no. of shares = 200 X 1.5 = 300

Debit Tk. 20,400

Credit Tk. 20,400


Sep. 20

Oct. 20

Nov. 1

Safar Company stock right Investment in Safar Company Cost allocation to right: 4 Tk.20,400 X = Tk.816 (96  4) Investment in Safar Company Safar Company stock right Cash Tk.816 X 200shares = Tk.544 300shares 200 = 50 shares X Tk.80 = Tk.4,000 4 Cash Loss of sale of stock right Safar Company stock right

816 816

4,544 544 4,000

190 82 272

Remaining rights = Tk.816 - Tk.544 = Tk.272

Dec. 1

Cash = {(300 shares – 200 shares) X Tk.2} - Tk.10 = Tk.190 Cash Investment in Safar Co. Gain on sale of Stock right Cash = (50shares X Tk.70) - Tk.100 = Tk.3,400

3,400 3,264 136

Investment in Safar Co. Tk.20,400  Tk.816 = X 50 shares 300 shares = Tk.3,264 P-6. The Clawson Co. has the following securities on hand on January 1, 2017. Hicken Inc. 8% preferred stock, par Tk.100, 50 shares Mangum Inc. common stock, 200 shares

Tk.5,500 6,600

During 2017, the following transactions were completed relative to investments: Jan-29 Feb-14 Apr-25

Purchased 75 shares of Randall Inc. common for Tk.2,700. Received a cash dividend of Tk.0.60 per share and stock dividend of 20% on Mangum Inc. common. Purchased 125 shares of Randall Inc. common for Tk.5,000. 372


June-30 July-1 Aug-14 Aug-21 Sep-13 Oct-26

Nov-16 Dec-1

Received the semiannual dividend on Hicken Inc. 8% preferred. Randall Inc. common was split on a 4-for-1 basis. Received a dividend of Tk.0.50 per share on Randall Inc. common. Received a cash dividend of Tk.0.60 per share and a stock dividend of 10% on Mangum Inc. common. Sold 100 shares of Randall Inc. common for Tk.2,000 and also sold 25 shares of Hicken Inc. 8% preferred for Tk.3,000. Received rights on Randall Inc. common to subscribe for additional shares as follows: 1 share could be acquired at Tk.15 for every 4 shares held. On this date stock was selling for Tk.23 and rights were selling at Tk.2; stock cost was apportioned on this date. Exercised the Randall Inc. rights. Received a special year-end dividend on Mangum Inc. common of Tk.2.

Instructions: (a) Assuming the use of FIFO in assigning to sales, give journal entries to record the foregoing transactions. (Give calculations of your entries) (b) Give the investment account balances as of December 31, 2017, including the number of shares and costs comparison such balances. Solution: (a)

Date 2017 Jan-29 Feb-14 Feb-14

Apr-25 June-30 July-1

Aug-14

373

Clawson Company Journal Entries Particulars Investment in Randall Inc. common stock (Lot 1) Cash Cash Dividend revenue (200 X Tk.0.60) Memorandum entry: Received a 20% stock dividend (40 shares) on the 200 shares of Mangum Inc. common, now the number of shares owns: 240 at cost of Tk.27.50 per share (Tk.6,600 รท 240). Investment in Randall Inc. common stock (Lot 2) Cash Cash Dividend revenue (50 X Tk.4) Memorandum entry: Investment in Randall Inc. common stock was split 4 for 1. Now the number of shares owned: 800 as summarized below: Lot 1: 300 shares (75 X 4) X Tk.9 = Tk.2,700 Lot 2: 500 shares (125 X 4) X Tk.10 = Tk.5,000 800 shares Tk.7,700 Cash Dividend revenue (800 X Tk.0.50)

Dr. (Tk.)

Cr. (Tk.)

2,700 2,700 120 120

5,000 5,000 200 200

400 400


Aug-21 Aug-21

Sep-13

Sep-13

Oct-26

Nov-16

Dec-1

Cash Dividend revenue (240 X Tk.0.60) Memorandum entry: Received a 10% stock dividend (24 shares) on the 240 shares of Mangum Inc. common, now the number of shares owns: 264 at cost of Tk.25 per share (Tk.6,600 ÷ 264). Cash Investment in Randall Inc. common stock Gain on sale of Randall Inc. common stock 100 shares X Tk.9 = Tk.900 Cash Investment in Hicken Inc. preferred stock Gain on sale of Hicken Inc. preferred stock (Tk.5,500 ÷ 50) X 25 shares = Tk.2,750 Investment in Randall Inc. stock rights Investment in Randall Inc. common stock Tk.2 X (Tk.2,700 – Tk.900) = Tk.144 (Tk.23  Tk.2) Tk.2 X Tk.5,000 = Tk.400 (Tk.23  Tk.2) Tk.544 Investment in Randall Inc. common stock Investment in Randall Inc. stock rights Cash (175 X Tk.15) Cash Dividend revenue (264 X Tk.2)

144 144

2,000 900 1,100 3,000 2,750 250 544 544

3,169 544 2,625 528 528

(b) Investment account balances as of December 31, 2017: Tk. Investment in Mangum Inc. common stock (264 X Tk.25) Investment in Hicken Inc. 8% preferred stock (25 X Tk.110) Investment in Randall Inc.: Lot 1: 200 shares (2,700 – 900 -144) Lot 2: 500 shares (5,000 – 400) Lot 3: 175 shares Balance in investment account, December 31, 2017

Tk. 6,600 2,750

1,656 4,600 3,169 9,425 18,775

P-7. The following balances appeared in the ledger of the White Company Limited on December 31, 2016: Investment in ABC Co. common stock, par Tk.10, 500 shares………………........Tk.5,000 Investment in ABC Co. 8% preferred stock, par Tk.50, 20 shares………………...Tk.1,000 During 2017, the following transactions took place relative to the above investments: January 15 - Holders of ABC Co. 8% preferred were given the right to exchange their holdings at the rate of 5 shares of ABC Co. common for each share of preferred, and the 374


White Co. made such exchange. Common shares on the date of exchange were quoted on the market at Tk.30 per share. March 21 - Received cash dividends of Tk.1 per share on ABC Co. common. August 15 – Received additional shares of ABC Co. common in a 2-for-1 stock split. (par value of common was reduced to Tk.5). December 1 – Exercised option to receive 1 share of ABC Co. common for each 15 shares held in lieu of a cash dividend of Tk.1 per share held. The market value of ABC Co. common on the date of distribution was Tk.20 per share. Dividend revenue was recognized at the value of the shares received. Required: Prepare necessary journal entries to record the above transactions. Solution:

Date 2017 Jan. 15

Mar. 21

Aug. 15

Dec. 1

White Company Limited Journal entries Particulars

Investment in ABC Co. common stock Investment in ABC Co. preferred stock Gain on exchange of ABC Co. preferred stock 20 X 5 = 100 shares X Tk.30 = Tk.3000 20 shares X Tk.50 = Tk.1000 Cash Dividend revenue 500 + 100 = 600 shares X Tk.1 = Tk.600 Memorandum entry: ABC Co. common in a 2 for 1 stock split. Now the no. of shares = 600 X 2 = 1200 and par value reduced to Tk.5 Investment in ABC Co. common stock Dividend revenue 1200shares 1st option: = 80 shares X Tk.20 15 = Tk.1600 2nd option: 1200shares X Tk.1 = Tk.1200 1st option > 2nd option

Debit (Tk.)

Credit (Tk.)

3,000 1,000 2,000 600 600

1,600 1,600

P-8. The following transactions relate to the investments of Khan Company. (a) On January 1, the company purchased 10% bonds of ABC Company having a par value of Tk.60,000 at 100 plus accrued interest. Interest is payable on February 1 and August 1. (b) On February 1, semiannual interest is received. (c) On March 1, 20% bonds of Alco Company were purchased. These bonds with a par value of Tk.120,000 were purchased at 100 plus accrued interest. Interest dates are June 1 and December 1. (d) On June 1, semiannual interest is received. 375


(e) On July 1, bonds with a par value of Tk.30,000, purchased on March 1, are sold at 90 plus accrued interest. (f) On August 1, semiannual interest is received. (g) On December 1, semiannual interest is received. (h) On December 31, the fair value of the bonds purchased January 1 and March 1 are 80 and 90, respectively. Required: (i) Prepare all necessary journal entries, including year-end entries assuming these are available-for-sale securities. (ii) Explain how the journal entries would differ from those in part (a), if these are held-tomaturity securities. Solution: (i) Khan Company Journal entries Date (a) Jan. 1

(b) Feb. 1

(c) Mar. 1

(d) Jun. 1

(e) Jul. 1

(f) Aug. 1 (g) Dec. 1

Particulars Available-for-sale securities Interest receivable Cash Cash Interest receivable Interest revenue Available-for-sale securities Interest receivable Cash Cash Interest receivable Interest revenue Cash Loss on sale of security Available-for-sale securities Interest revenue Cash Interest revenue Cash Interest revenue

Debit (Tk.) 60,000 2,500

Credit (Tk.)

62,500 3,000 2,500 500 120,000 6,000 126,000 12,000 6,000 6,000 27,500 3,000 30,000 500 3,000 3,000 9,000

Calculation of gain or loss from change in fair value of the securities: Total value of the securities 60,000 + (120,000 – 30,000) Less. Total fair value of the securities 120,000  30,000 60,000 ( X 80) + ( X 90) 100 100 Loss

9,000

Tk.150,000 129,000

Tk.21,000

376


Date Dec. 31

Khan Company Year-end entry Particulars Unrealized holding gain or loss Securities fair value adjustment

Debit Tk. 21,000

Credit Tk. 21,000

(ii) All the entries would be same, except the account title held-to-maturity would be used instead of available-for-sale securities and last entry would not be made. P-9. Genetic Research Inc. has a significant amount of cash on hand, waiting to be invested in new research projects. Until the money is needed, the company has decided to invest some of the cash in a portfolio of equity securities. Following are the transactions in its investment portfolio during 2016 and 2017: March 12, 2016: Purchased 80,000 Dytech Ltd. ordinary shares at Tk.24 per share plus Tk.14,000 brokerage fees. June 15, 2016: Purchased 100,000 Chromo Corp. ordinary shares at Tk.15 per share plus Tk.15,000 brokerage fees. September 30, 2016: Received a Tk.0.50 per share cash dividend from Dytech. February 15, 2017: Purchased an additional 60,000 Dytech Ltd. ordinary shares at Tk.22 per share plus Tk.9,000 brokerage fees. March 31, 2017: Received a Tk.0.50 per share cash dividend from Dytech Ltd. June 22, 2017: Sold 70,000 Dytech Ltd. ordinary shares at Tk.26 per share and paid a brokerage fee at Tk.12,000 September 12, 2017: Purchased 50,000 Zytec Inc. ordinary shares for Tk.15 per share plus Tk.5,000 brokerage fees. Genetic Research Inc.â€&#x; year-end is December 31. The quoted market prices of the equity securities at December 31, 2016 and December, 31, 2017 are as follows: December 31, 2017 December 31, 2016 Chromo Corp Tk.12 Tk.17 Dytech Ltd. Tk.21 Tk.28 Zytech Inc Tk.11 Tk.16 Required: (a) How would Genetic Research Inc. classify its portfolio of equity securities? (b) Prepare the journal entries Genetic Research would make to record its 2016 transactions in equity securities, including any year-end valuation adjustments. (c) Show how the investment portfolio would be reported in the 2016 balance sheet and income statement. (d) Prepare the journal entries Genetic Research would make to record its 2017 transactions in equity securities, including any year-end valuation adjustments. Solution: (a) Genetic Research would classify its portfolio of equity securities as held for trading assets since the principal purpose of the investments is to profit from short-term price fluctuations while the cash is temporarily available. 377


(b)

Date 2016 March 12

June 15

Sept. 30

Dec. 31

Genetic Research Journal Entries Particulars Held for trading investments – Dytech Ltd. Brokerage fees expense – Dytech Ltd. Cash (To record purchase of 80,000 Dytech ordinary shares: 80,000 X Tk.24) Held for trading investments – Chromo Corp. Brokerage fees expense – Chromo Corp. Cash (To record purchase of 1,00,000 Chromo ordinary shares: 1,00,000 X Tk.15) Cash Dividend revenue (To record receipt of dividend on Dytech shares) 80,000 shares X Tk.0.50 Held for trading investments – Dytech Ltd. Held for trading investments – Chromo Corp. Gain on increase in fair value of held for trading investments (To record remeasurement of marketable equity securities to fair value at December 31, 2016) (80,000 X Tk.28) – Tk.19,20,000 = Tk.3,20,000 (1,00,000 X Tk.17) – Tk.15,00,000 = Tk.2,00,000

Dr. (Tk.)

Cr. (Tk.)

19,20,000 14,000 19,34,000

15,00,000 15,000 15,15,000

40,000 40,000

3,20,000 2,00,000 5,20,000

(c) Income statement for 2016 Gain on increase in fair value of held for trading investments Dividend revenue

Tk.5,20,000 40,000

Balance sheet as at December 31, 2016 Held for trading investments, at fair value (80,000 X Tk.28) + (1,00,000 X Tk.17)

Tk.39,40,000

(d) Genetic Research Journal Entries Date 2017 Feb. 15

Particulars Held for trading investments – Dytech Ltd. Brokerage fees expense – Dytech Ltd. Cash (To record purchase of 60,000 Dytech ordinary shares at Tk.22)

Dr. (Tk.)

Cr. (Tk.)

13,20,000 9,000 13,29,000

378


March 31

June 22

Cash

70,000

Dividend revenue 70,000 (To record receipt of dividend on Dytech shares) 1,40,000 shares X Tk.0.50 Cash 18,08,000 Brokerage fees expense – Dytech Ltd. 12,000 Gain on sale of held for trading investments – Dytech Ltd. 40,000 Held for trading investments – Dytech Ltd. 17,80,000 (To record sale of 70,000 shares of Dytech on June 22 at Tk.26) Carrying value of Dytech shares at June 22, 2017: Carrying value at December 31, 2016 (80,000 X Tk.28) = Tk.22,40,000 February 15, 2017 purchase (60,000 X Tk.22) = Tk.13,20,000 Carrying value at June 22, 2017 prior to sale = Tk.22,40,000 – Tk.13,20,000 = Tk.35,60,000 Since 50% of the Dytech shares (70,000 ÷ 1,40,000) are sold on June 22, 2017, 50% of the carrying value at that date must be removed from the investment account 50% of Tk.35,60,000 = Tk.17,80,000

Sept. 22

Dec. 31

379

Tk.18,20,000 – Tk.17,80,000 = Tk.40,000 Held for trading investments – Zytec Inc. 7,50,000 Brokerage fees expense – Zytec Inc. 5,000 Cash (To record purchase of 50,000 Zytec ordinary shares at Tk.15) Loss on decrease in fair value of held for trading 10,10,000 investments Held for trading investments – Dytech Ltd. Held for trading investments – Chromo Corp. Held for trading investments – Zytec Inc. (To record remeasurement of held for trading investments to fair value at December 31, 2017) (70,000 X Tk.21) – Tk.17,80,000 = Tk.3,10,000 (1,00,000 X Tk.12) – (1,00,000 X Tk.17) (50,000 X Tk.11) – Tk.7,50,000

7,55,000

3,10,000 5,00,000 2,00,000


P-10. On January 1, 2015, MS Holdings Ltd. (MS) purchased 20% of the outstanding ordinary shares of SUN Development Inc. (SUN) for Tk.400,000 of which Tk.100,000 was paid in cash and Tk.300,000 is payable without interest on December 31, 2017. MS‟s incremental borrowing rate at the time of the purchase was 8%. MS also paid Tk.20,000 to a business broker who helped to find a suitable business and negotiated the purchase. At the time of the acquisition, the fair value of SUN‟s identifiable assets and liabilities were equal to their carrying values except for an office building, which had a fair value in excess of book value of Tk.200,000 and an estimated remaining useful life of 20 years. SUN‟s shareholders‟ equity of January 1, 2015 was Tk.1,300,000. During 2015, SUN reported a profit of Tk.250,000 and paid dividends of Tk.100,000. Required: (a) What factor(s) should be considered in determining whether MS should classify the investment as an investment in an associate versus an available-for-sale investment? Assuming the investment is classified as an investment in an associate, what method of accounting should MS use to report its investment in SUN? (b) Prepare the journal entry to record MS‟s investment in SUN on January 1, 2015 and any year-end journal entries related to the loan payable. (c) Prepare all other journal entries related to the investment in SUN for 2015 under the: (i) Cost method (ii) Equity method (d) What is the balance in the investment in SUN account at December 31, 2015 under the: (i) Cost method (ii) Equity method Solution: (a) An associate is a company over which an investor has significant influence. Therefore, if the investment in SUN is to be classified as an investment in an associate, it must be demonstrated that MS has significant influence over the financial and operating policies of SUN. Normally, if an investor holds 20% or more of the voting equity of the investee, significant influence is assumed to exist. However, it is important to examine other factors that would be examined to assess whether significant influence exists would include - composition of remaining share ownership (for example, whether one shareholder own the remaining 80% of the shares or ownership is widely held); - representation of MS on Board of Directors; - participation in policy making processes; - significant transactions between MS and SUN; - transfer of executive personnel between MS and SUN. If these factors suggested significant influence over the financial and operating policies of SUN, the investment would be classified as an investment in an associate. If significant influence does not appear to exist, the investment would be classified as an available-forsale investment, as long as the intent of MS is to hold the investment for a long period. If the investment is classified as an investment in an associate, it will be reported by MS using the equity method of accounting.

380


(b) Date 2015 Jan. 1

Dec. 31

Journal Entries Particulars Investment in SUN Discount on note payable Cash Note payable (To record investment in 20% of shares of SUN) Tk.3,00,000 – (Tk.3,00,000X0.7938) = Tk.61,860 Interest expense Discount on note payable (To record interest expense on note payable for 2015) Tk.2,38,140 X 8%

Dr. (Tk.) 3,58,140 61,860

Cr. (Tk.)

1,20,000 3,00,000

19,051 19,051

(c) (i) If the investment is recorded in the accounting records of SUN using the cost method of accounting, the following additional entry would be made in 2015: Cash

- Dr. Investment income - Cr. (To record receipt of dividends from SUN) Tk.1,00,000 X 20%

Tk.20,000 Tk.20,000

(ii) If the investment is recorded in the accounting records of SUN using the equity method of accounting, the following additional entry would be made in 2015: Cash

- Dr. Investment income - Cr. (To record receipt of dividends from SUN) Tk.1,00,000 X 20%

Tk.20,000

Investment in SUN - Dr. Investment income - Cr. (To record MS‟s shares of SUN‟s adjusted profit)

Tk.48,000

Tk.20,000

Computation: MS‟s share of SUN reported profit (Tk.2,50,000 X 20%) Extra depreciation expense (Tk.2,00,000 X 20% X 1/20) MS‟s adjusted investment income from SUN

Tk.48,000

Tk.50,000 (2,000) Tk.48,000

(d) (i) The balance in the investment in SUN account at December 31, 2015, under the cost method is Tk.3,58,140, the original cost amount. (ii) The balance in the investment in SUN account at December 31, 2015, under the equity method is Tk.3,86,140 (Tk.3,58,140 + Tk.48,000 – Tk.20,000). 381


P-11. The Rising Sun Company ltd. has an issued, subscribed and paid up share capital comprising of 5000 equity shares of Tk. 100 each and 1000, 9% preference shares of Tk. 100 each. The following information is supplied: Average Net worth Adjusted Taxed profits (Excluding investment) 2015 Tk. 930,000 Tk. 95,000 2016 10,75,000 105,000 2017 10,95,000 125,000 As at the valuation date, the company has investment of the market value of Tk. 140,000, the yield in respect of which has been excluded in arriving at adjusted taxed figures. The company sets apart 25% of taxed profit as rehabilitation and replacement reserve. On the valuation date, net worth (excluding investments) amounts to Tk. 11,25,000. The expected rate of return in the market is 9%. The company has consistently maintained dividend levels of 8% to 10% in the past and is known for its consistency. Required: Ascertain the value of each equity share on the basis of productivity applying suitable weighted averages. Solution: Valuation of shares on productivity will involve determining the earning capacity. Since the results of 2015, 2016 and 2017 show a clear increasing tendency, weighted average of 1, 2 and 3 are applied to the same to give maximum weighted to record trends. Rate of earnings: Year 2015 2016 1017 Total Total weight

Average net Adjusted taxed Rate of worth profits earning Tk.9,30,000 Tk.95,000 10.215% X 1 10,75,000 1,05,000 9.767% X 2 10,95,000 1,25,000 11.416% X 3 30,00,000 3,25,000 31.398% 1+2+3=6 Weighted rate = 63.997 / 6

Profit available to equity shareholders: Maintainable profit @ 10.67% on Tk.11,25,000 Less. Rehabilitation = Replacement reserve @ 25% 30,000 Preference dividend @ 9% on Tk.1,50,000 13,500 Profit (excluding income on investment) Capitalization of profit: At the market expected rate of return of 9% to be capitalized Tk.76,500 X 100 9 Value of investment Number of equity shares outstanding Value of each equity share (Tk.9,90,000 รท 5,000)

Weight 10.215% 19.534% 34.248% 63.997% 10.67%

Tk.1,20,000 43,500 Tk.76,500

Tk.8,50,000

1,40,000 Tk.9,90,000 5,000 Tk.198 382


P-12. At December 31, 2017 the financial statements of Agrani Co. Ltd. included the following: Net income for 2017 Tk.5,30,000 Common stock, Tk.10 par: Share outstanding on January 01 1,50,000 shares Shares retired for cash on February 01 24,000 shares Shares sold for cash on September 01 2-for-1 split on July 23 18,000 shares Preferred stock, 10%, Tk.10 par, cumulative, non-convertible Tk.70,000 Preferred stock, 8%, Tk.1 par, cumulative, convertible into 4,000 shares of common stock Tk.1,00,000 Common stock warrants outstanding for 4,000 shares of common stock, the exercise price is Tk.15. Additional data: The market price of the common stock averaged Tk.20 during 2017. The convertible preferred stock had been issued at par in 2015. The tax rate for the year was 40%. Required: (a) Basic Earnings Per Share, and (b) Diluted Earnings Per Share for the year ended December 31, 2017. Solution: (a) Basic Earnings Per Share (EPS) Tk.5,30,000 Tk.7,000  Tk.8,000 = 11 4 (1,50,000 X 2)  (24,000 X X 2)  (18,000 X ) 12 12 Tk.5,15,000 = 2,62,000 shares = Tk.1.97 (b) Diluted Earnings Per Share (EPS) Tk.5,30,000 Tk.7,000  Tk.8,000 = 11 4 (1,50,000 X 2)  (24,000 X X 2)  (18,000 X )  (4,000  3,000) 12 12 Tk.5,15,000 = 2,63,000 shares = Tk.1.96 P-13. Balance sheet of Makim Ltd. as at 31.12.2017 is given below: Asset Taka Building at cost Furniture at cost 5% Investment in Government Bond at cost Inventory at market value Accounts Receivable- all considered good Bank

383

Taka 200,000 5,000 800,000 775,000 720,000 240,000 2,740,000


Capital & Liabilities Authorized and paid-up Capital: 10,000 shares of Tk.100 each fully paid Reserve Fund Depreciation Fund Building Investment Account Payable Allowance for Bad Debts Income Statement Balance 01.01.2017 Current year

1,000,000 400,000 30,000 80,000

920,000 180,000

110,000 114,000 16,000

1,100,000 2,740,000

It is ascertained that: (a) The Companyâ€&#x;s prospect for 2018 is equally good. (b) Profits for the last four years have shown an increase of Tk.500,000 annually. (c) Buildings are worth now Tk.240,000 and Furniture Tk.8,000. (d) Companies of similar nature are showing a profit earning capacity of 12% on the market value of shares. You are required to ascertain the value of each share. Solution: Computation of value of share of Makim Ltd.: Asset based method: Accounts receivable (720,000-16,000) Inventory Bank Investment Furniture (iii) Building (iii) Less. Accounts payable Net assets

Tk.704,000 775,000 240,000 800,000 8,000 240,000 2,767,000 (114,000) Tk.2,653,000

Tk.2,653,000 10,000 shares = Tk.265

Value of each share =

P-14. Following is the Balance Sheet of Agrani Ltd. Balance Sheet As on 31.12.2017 Assets Fixed assets 6% investment (market value Tk.38,000) at cost Inventory Account receivable

Taka 16,000 3,000 3,500 2,500 384


Bank Total

500 25,500

Capital and Liabilities 15,000 shares of Tk.10 each 3,000 number of 8% preferred shares of Tk.10 each 7% Bond Reserve fund Accounts payable Total

15,000 3,000 2,000 3,000 2,500 25,500

The following additional information are given: (a) Fixed assets include land and buildings shown in the balance sheet at Tk.12,500, but the present market value of this is Tk.14,500. (b) Profits for the last three years (before tax) were: Tk.4,500 and Tk.6,900 respectively. (c) Dividend paid on equity for the last three years were: 18%, 23% and 25% respectively; and (d) Normal return of similar equity shares is 20%. Required: Value the shares of Agrani Ltd. Solution: Computation of value of shares of Agrani Ltd. (i) On the basis of return on capital: Calculation of capital employed: Equity share capital Preferred share capital 7% bond Reserve fund

Tk.15,000 3,000 2,000 3,000 23,000 Add. Increase in the value of land and building (i) 14,500-12,500 2,000 25,000 Less. Non-trading assets: Investment (3,000) Capital employed Tk.22,000 Calculation of profit earned: 4,500  5,400  6,900 Average profit ( ) 5,600 3 Less. adjustment for depreciation on increase in the value of land and building, say 2% on 2,000 (40) Non-trading income (Interest on investment) 6% on 38,000 Add. Interest on bond (7% on 2,000) Average profit after adjustment Less. Income tax, say @ 50% Profit earned 385

(2,280) 3,280 140 3,420 (1,710) Tk.1,710


Pr ofit earned X100 Capital employed Tk.1,710 = X100 Tk.22,000 = 7.78%

Rate of return on capital =

Rate of return on capital X Paid up value per share Normal rate of return 7.78 = X10 20 = Tk.3.89

Value per share =

(ii) On the basis of dividend: 18  23  25 Average dividend = 3 = 22%

Average dividend X Paid up value per share Normal rate of return 22 = X100 20 = Tk.11

Value per share =

Contact us to collect exercises solution. Helpline: 01711137039

386


EXERCIES E-1. ABC Ltd. has Tk.10,00,000 ordinary shares of Tk.10.00 each and 2,00,000 preference shares of Tk.10.00 each. The company manufactures gas appliances. During the financial year to 31 December 2015 the company had to pay Tk.50,000 compensation from an uninsured claim for personal injuries suffered by a customer while on the company premises. The profit for year ended December 2015 was Tk.20,00,000. ABC Ltd. declared dividend on preference share @ 4%. Assuming an income tax rate of 45%, ascertain the profit from the business and calculate earnings per share. CMA Adapted - December 2016 E-2. MUTTAKEEN Company Ltd. acquired 20% of the outstanding common stock of Jamuna Company Ltd. on December 31, 2013. The purchase price was Tk.12,00,000 for 50,000 shares. Jamuna declared and paid an Tk.0.85 per share cash dividend on June 30 and on December 31, 2014 respectively. Jamuna reported net income of Tk.7,30,000 for the year 2014. The fair value of Jamunaâ€&#x;s stock was Tk.27 per share at December 31, 2014. Required: (i) Prepare the journal entries for MUTTAKEEN Company Ltd. for 2013 and 2014, assuming that MUTTAKEEN cannot exercise significant influence over Jamuna. The securities should be classified as available-for-sale. (ii) Prepare the journal entries for MUTTAKEEN Company Ltd. for 2013 and 2014, assuming that MUTTAKEEN can exercise significant influence over Jamuna. (iii) At what amount is the investment in securities reported on the Balance Sheet under each of these methods at December 31, 2014? What is the total net income reported in 2014 under each of these methods? CMA Adapted - August 2015 E-3. The treasurer of FYR Co. has read on the internet that the stock price of TATA Ltd. about to take off. In order to profit from this potential development, FYR Co. has purchased a call option on TATA common shares on July 7, 2014 for Tk.240. The call option is for 200 shares (notional value) and the strike price is Tk.70. The option expires on January 31, 2015. The following data are available with respect to the call option: Date Market price of Time value of TATA shares call option September 30, 2014 Tk.77 per share Tk.180 December 31, 2014 75 per share 65 January 4, 2015 76 per share 30 Prepare the journal entries for FYR Co. for the following dates: (i) Investment in call option on TATA shares on July 7, 2014. (ii) Prepare Financial Statements for September 30, 2014 for FYR Co. (iii) Prepare Financial Statements for December 31, 2014 for FYR Co. (iv) January 4, 2015 – FYR Co. settles the call option on the TATA shares. CMA Adapted - August 2015 387


E-4. On October 1, 2013, NM Company receives permission to replace its Tk.1 par value common stock (5,000,000 shares authorized, 3,000,000 shares issued and 2,900,000 shares outstanding) with a new common stock issue having a Tk.0.50 par value. Since the new par value is one-half the amount of the old, this represents a 2-for-1 stock split. That is, the shareholders will receive two shares of the Tk.50 per stock in exchange for each share of the Tk.1 par stock they own. The Tk.1 par stock will be collected and destroyed by the issuing company. On November 1, 2013, NM Company declares a Tk.0.05 per share cash dividend on common stock and a Tk.0.25 per share cash dividend on preferred stock. Payment is scheduled for December 1, 2013 to shareholders of record on November 15, 2013. On December 2, 2013, the NM Company declares a 1% stock dividend payable on December 28, 2013 to shareholders of record on December 14. At the date of declaration, the common stock was selling in the open market at Tk.10 per share. The dividend will result in 58,000 (0.01 * 5,800,000) additional shares being issued to shareholders. Required: (1) Prepare journal entries to record the declaration and payment of these stock and cash dividends. (2) Prepare the December 31, 2013, stockholderâ€&#x; equity section of the balance sheet to NM Company assuming net income for the fourth quarter was Tk.2,500,000. (3) Prepare a statement of stockholdersâ€&#x; equity for NM Company for 2013. CMA Adapted - April 2015 E-5. Elizabeth Company reported the following amounts in the stockholdersâ€&#x; equity section of its December 31, 2012, balance sheet. Preferred stock, 8%, Tk.100 par (10,000 shares authorized, 2,000 shares issued) Tk.200,000 Common stock, Tk.5 par (100,000 shares authorized, 20,000 shares issued) Tk.100,000 Additional paid-in capital Tk.125,000 Retained earnings Tk.450,000 Total Tk.875,000 During 2013, Elizabeth took part in the following transactions concerning stockholders equity. (i) Paid the annual 2012 Tk.10 per share dividend on preferred stock and a Tk.2 per share dividend on common stock. These dividends had been declared on December 31, 2012. (ii) Purchased 1,700 shares of its own outstanding common stock for Tk.40 per share. Elizabeth uses the cost method. (iii) Reissued 700 treasury shares for land valued at Tk.30,000. (iv) Issued 500 shares of preferred stock at Tk.105 per share. (v) Declared a 10% stock dividend on the outstanding common stock when the stock is selling for Tk.45 per share. (vi) Issued the stock dividend. (vii) Declared the annual 2013 Tk.10 per share dividend on preferred stock and the Tk.2 per share dividend on common stock. These dividends are payable in 2014.

388


Instructions: 1. Prepare journal entries to record the transactions described above. 2. Prepare the December 31, 2013, stockholders‟ equity section. Assume 2013 net income was Tk.330,000. CMA Adapted - December 2014 E-6. Dankey Corporation issued 10%, Tk.4,00,000 10-year bonds for Tk.3,85,000 on June 30, 2013. Debt issue costs were Tk.1,500. Interest is paid semi-annually on December 31 and June 30. One year from the issue date (July 1, 2014), the corporation exercised its call privilege and retired the bonds for Tk.3,95,000. The corporation uses the straight-line method both to determine interest and to amortize debt issue costs. Required: (i) Prepare the journal entry to record the issuance of the bonds. (ii) Prepare the journal entries to record the payment of interest and amortization of debt issue costs on December 31, 2013. (iii) Prepare the journal entries to record the payment of interest and amortization of debt issue costs on June 30, 2014. (iv) Prepare the journal entries to record the call of the bonds. CMA Adapted - August 2014 E-7. The stockholders‟ equity section of the balance sheet of Osmania Ltd. includes the following accounts at December 31, 2010: Shareholders’ Equity Common stock, 105,000 shares of Tk.1 par Paid-in capital – excess of par, common Retained earnings Total shareholders‟ equity

Tk. 1,05,000 6,30,000 9,70,000 17,05,000

Listed below are the transactions that affected the stockholders‟ equity of Osmania company during the period 2011-2013. (i) November 1, 2011, the board of directors declared a cash dividend of Tk.0.80 per share on common shares, payable to shareholders of record November 15, to be paid December 1. (ii) The board of directors declared a property dividend on March 1, 2012 consisting of corporate bonds of Sharif Corporation that Osmania was holding as an investment. The bonds had a fair market value of Tk.1.6 million, but were purchased two years back for Tk.1.3 million. Because they intended to be held to maturity, the bonds had not been previously written up. The property was payable to shareholders of record March 13, to be distributed April 5. (iii) On July 12, 2012, the company declared and distributed a 5% common stock dividend (when the market value of the common stock was Tk.21 per share). Cash was paid for fractional share rights representing 250 equivalent whole shares. (iv) On November 1, 2012, the board of directors declared a cash dividend of Tk.0.80 per share on its common shares, payable to shareholders of record November 15, to be paid December 1. (v) On January 15, 2013, the board of directors declared and distributed a 3-for-2 stock split effected in the form of a 50% stock dividend on the outstanding common stock when the fair market value of stock was 22 per share. 389


(vi) On November 1, 2013, the board of directors declared a cash dividend of Tk.0.65 per share on its common shares, payable to shareholders of record November 15, to be paid December 1. Required: (1) Prepare journal entries that Osmania Company recorded during the three-year period for these transactions. (2) Prepare comparative statement of stockholdersâ€&#x; equity for Osmania for the three-year period. Net income was Tk.330,000, Tk.395,000 and Tk.455,000 for 2011, 2012, and 2013, respectively. CMA Adapted - August 2014 E-8. PMG Company issued 12% bonds on June 30 2004 with a par value of Tk.800,000 due in 20 years. They were issued at Tk.98 and were callable at Tk.104 at any date after June 30, 2012. Because of lower interest rates and a significant change in the companyâ€&#x;s credit rating, it was decided to call the entire issue on June 30, 2013 and to issue the new bonds. New 10% bonds were sold in the amount of Tk.1,000,000 at Tk.102. They mature in 20 years. The company uses straight-line amortization. Interest payment dates are December 31 and June 30. Required: i) Prepare journal entries to record the retirement of the old issue and the sale of the new issue on June, 2013. ii) Prepare the entry required on December 31, 2013 to record the payment of the first 6 monthsâ€&#x; interest and the amortization of premium on the bonds. CMA Adapted - April 2014 E-9. XYZ Corporation carries an account in its general ledger called investments, which contained the following debits for investment purchases and no credits. Feb. 1, 2014 April 1

July 1

Jordy Company common stock, Tk.100 par, 200 shares U.S. government bonds, 11% due April, 2024, interest payable April 1 and October 1, 100 bonds at Tk.1,000 each Diver Company 12% bonds, par Tk.50,000, dated March 1, 2010, purchased at par plus accrued interest, interest payable annually on March 1, due March 1, 2031

Tk.37,400 1,00,000

52,000

Required: (i) Prepare the entries necessary to classify the amounts into proper accounts, assuming that all the securities are classified as available-for-sale. (ii) Prepare the entry to record the accrued interest on December 31, 2014. (iii) The fair values of the securities on December 31, 2024, were: Jordy Company common stock Tk.33,800 (1% of total shares) U.S. government bonds 1,24,700 Driver Company bonds 58,600 What entry or entries, if any, would you recommended be made? 390


(iv) The U.S. government bonds were sold on July 1, 2015 for Tk.119,200 plus accrued interest. Give the proper entry. (v) Now assume XYZ‟s investment in Jordy Company represents 30% of Jordy‟s shares. Prepare the 2014 entries for the investment in Jordy stock. In 2014, Jordy declared and paid dividends of Tk.9,000 (on September 30) and reported net income of Tk.30,000. CMA Adapted - April 2014 E-10. The shareholders‟ equity section of the balance sheet of Square Textile included the following accounts at December 31, 2009: Shareholders’ equity Tk. Preferred stock, 10% Tk.100 par 10,000 shares authorized and 3,000 3,00,000 shares issued Common stock, Tk.10 par 100,000 shares authorized, 40,000 issued 4,00,000 Paid-in capital – excess of par, preferred Paid-in capital – excess of par, common 50,000 Retained earnings 75,000 Total shareholders‟ equity 5,50,000 13,75,000 During 2010, the company involved in the following transactions concerning stockholders‟ equity: i) On May 1, the board of directors declared a cash dividend of Tk.5 per share on common stock payable on June 2 to shareholders of record May 15. ii) Purchased 2,000 shares of its own outstanding common stock Tk.40 per share on June 30. The company uses the cost method for recording treasury stock. iii) Issued 2,000 shares of preferred stock at Tk.150 per share on September 1. iv) Reissued 1,000 shares in treasury for equipment, the fair market value of equipment is not determinable but the common shares of the company are currently selling in the market at Tk.35 per share. v) On October 1, the company declared a 10% stock dividend on the outstanding common stock when the fair market value of stocks is Tk.45 per share. vi) Issued the stock dividend on October 30. vii) On December 1, the board of directors declared the cash dividend of Tk.5 per common stock and Tk.10 per share on preferred stock, payable on January 5, 2011 to the shareholders of record December 14. Required: 1) Prepare journal entries to record the transactions. 2) Prepare the December 31, 2010 stockholders‟ equity section of the balance sheet. CMA Adapted - April 2014 E-11. The stockholders‟ equity of Suttom Corporation at December 31, 1993, is shown below: Stockholders’ equity Common stock, Tk.10 par, 100,000 shares authorized, Tk.400,000 40,000 shares issued Additional paid-in capital: common stock 200,000 Total paid-in capital Tk.600,000 Retained earnings 1,500,000 Total stockholders‟ equity Tk.2,100,000 391


Transactions affecting stockholdersâ€&#x; equity during 1994 are as follows: Mar. 31 A 5-for-4 stock split proposed by the board of directors was approved by vote of the stockholders. The 10,000 new shares were distributed to stockholders. Apr. 1 The company purchased 2,000 shares of its common stock on the open market at Tk.37 per share. July 1 The company reissued 1,000 shares of treasury stock at Tk.45 per share. July 1 Issued for cash 20,000 shares of previously unissued Tk.8 par value common stock at a price of Tk.45 per share. Dec. .1 A cash dividend of Tk.1 per share was declared, payable on December 30, to stockholders of record at December 14. Dec. 22 A 10% stock dividend was declared; the dividend shares are to be distributed on January 15 of the following year. The market price of the stock on December 22 was Tk.48 per share. The net income for the year ended December 31, 2994, amounted to Tk.177,000, after an extraordinary loss of Tk.35,400 (net of related income tax benefits). Instructions: (i) Prepare journal entries (in general form) to record the transactions relating to stockholdersâ€&#x; equity that took place during the year. (ii) Prepare the lower section of the income statement for 1994, beginning with the income before extraordinary items and showing the extraordinary loss and the net income. Also illustrate the presentation of earnings per share in the income statement, assuming that earnings per share is determined on the basis of the weighted-average number of shares outstanding during the year. (iii) Prepare a statement of retained earnings for the year ending December 31, 2994. CMA Adapted - April 2014 E-12. Diversified Services, Inc. offers a variety of business services, including financial services through its escrow division, Diversified entered into the following investment activities during the last month of 2003 and the first week of 2004. Diversifiedâ€&#x;s fiscal year ends on December 31. The only securities held by Diversified at December 1 were 12 million common shares of Shelby Laminations Inc., purchased in November for Tk.48 million. 2003 Dec. 1 Purchased Tk.30 million of 12% bonds of Vince-Gill Amusement Corporation and Tk.24 million of 10% bonds of Eastern Waste Disposal Corporation, both at face value and both to be held until they mature. Interest on each bond issue is payable semiannually on November 30 and May 31. 9 Sold one-half of the Shelby Laminations common shares for Tk.25 million. 29 Received cash dividends of Tk.0.5 million from the Shelby Laminations common share. 30 Purchased treasury bonds for Tk.5.8 million as trading securities hoping to earn profits on short-term differences in prices. 31 Recorded the necessary adjusting entry(s) relating to the investment.

392


The year-end market price of the Shelby Laminations common stock was Tk.4,25 per share. The fair values of the bond investments were Tk.32 million for Vince-Gill Amusement Corporation and Tk.20 million for Eastern Waste Disposal Corporation. A sharp rise in short-term interest rates on the last day of the year caused the fair value of the treasury bonds to fall to Tk.5,7 million. 2004 Jan. 1 Sold the remaining Shelby Laminations common shares for Tk.26 million. Required: Prepare the appropriate journal entry for each transaction or event and show the amounts that would be reported in the company‟s 2003 income statement relative to these investments. CMA Adapted - December 2013 E-13. Alvi Corporation has two classes of capital stock outstanding: 12%, Tk.100 par preferred and Tk.30 par common. At December 31, 2012 the following accounts were included in stockholders‟ equity: Preferred stock, 80,000 shares Tk.8,000,000 Common stock, 800,000 shares 24,000,000 Paid-in Capital in Excess of Par – Preferred Stock 1,600,000 Paid-in Capital in Excess of Par – Common Stock 20,000,000 Retained earnings 12,500,000 The following transactions affected stockholders‟ equity during 2013. Jan. 1 25,000 shares of preferred stock issued at Tk.125 per share. Feb. 1 70,000 shares of common stock issued at Tk.80 per share. June 1 3-for-2 stock split (par value reduced to Tk.20) July 1 60,000 shares of common treasury stock purchased at Tk.90 per share. Alvi uses the cost method. Sep. 15 15,000 shares of treasury stock reissued at Tk.95 per share. Dec. 31 The preferred dividend is declared, and a common dividend of Tk.0.25 per share declared. Dec. 31 Net income is Tk.8,250,000. Required: Prepare the stockholders‟ equity section for Alvi Corporation at December 31, 2013. Show all supporting computations. CMA Adapted - August 2013 E-14. The following information relates to the debt securities investments of KK & Co. (i) On February 1, the company purchased 12% bonds of PQS & Co. having a par value of Tk.500,000 at 100 plus accrued interest. Interest is payable on April 1 and October 1. (ii) On April 1, semiannual interest is received. (iii) On July 1, 9% bonds of XYZ & Co. were purchased. These bonds with a par value of Tk.200,000 were purchased at 100 plus accrued interest. Interest dates are June 1 and December 1. (iv) On September 1, bonds with a par value of Tk.100,000, purchased on February 1, are sold at 99 plus accrued interest. (v) On October 1, semiannual interest is received. (vi) On December 1, semiannual interest is received. (vii) On December 31, the fair value of the bonds purchased February 1 and July 1 are 95 and 95, respectively. 393


Required: (1) Prepare all journal entries you consider necessary, including year-end entries (December 31) assuming these are available-for-sale securities. (2) If KK & Co. classified these are held-to-maturity securities, explain how the journal entries would differ from those in part (1). CMA Adapted - August 2012 E-15. The following balances appeared in the ledger of the Hamja Company on December 31, 2007: Investment in Belal Corp. common stock, par Tk.10, 500 shares………………..Tk.10,000 Investment in Belal Corp. 8% preferred stock, par Tk.50, 20 shares……………...Tk.1,500 The Hamja Company uses the first-in first-out method in accounting for stock transactions. In 2008, 2009 and 2010 the following transactions took place relative to the above investments: 2008 Feb.15 - Holders of Belal Corp. 8% preferred were given the right to exchange their holdings at the rate of 5 shares of Belal Corp. common for each share of preferred, and the Hamja Co. made such exchange. Common shares on the date of exchange were quoted on the market at Tk.30 per share. Nov.21 - Received cash dividends of Tk.1 per share on Belal Corp. common. 2009 June 15 – Received additional shares of Belal common in a 2-for-1 stock split. (par value of common was reduced to Tk.5). Nov. 21 – Exercised option to receive 1 share of Belal Corp. common for each 15 shares held in lieu of a cash dividend of Tk.1 per share held. The market value of Belal Corp. common on the date of distribution was Tk.20 per share. Dividend revenue was recognized at the value of the shares received. 2010 May 14 – Received a stock dividend of 20% on Belal common. Sept. 16 – Received warrants representing right to purchase 1 share of Belal Corp. common for every 6 shares held. On date of warrents issue, the market value of ex-rights was Tk.28.50, and the market value of rights was Tk.1.50. Cost of the stock was allocated on this basis. The exercise price was Tk.20 per share. Sept.30 – Exercised 900 rights identified with the first lot of stock acquired and sold remaining rights at Tk.1.25 per right less brokerage charge of Tk.75. Dec. 31 – Sold 1400 shares of Belal Corp. common at Tk.32 per share less brokerage charge of Tk.225. Required: (i) Prepare Journal entries to record the transactions in Belal Corp. holdings. (ii) Prepare a schedule showing the balance of Belal Corp. common stock held by Hamja Company on December 31, 2010. CMA Adapted - August 2011

394


E-16. The following information is pertinent to Liverich Ltd.

1 Jan.2009 1 June 2009 1 July 2009 31 July 2009

1 Sept. 2009

31 Dec. 2009

Balance at beginning of year Repurchase of shares for cash Share issued for cash Stock dividend at 1 share for every 10 outstanding shares Shares issued in consideration for a factory building acquired Balance at year end

Share Treasury Issued shares 2,000 200

Shares Preferred outstanding shares 1,800 500

-

200

1,600

-

600 260

40

2,200 2,420

-

80

-

2,500

-

2,940

440

2,500

500

On 31 October 2009 Liverich Ltd. issued 3% convertible bonds for Tk. 1 Million at par. Each bond (with a par value of Tk. 1,000) is convertible into 20 ordinary shares at October 2011. On 15 December 2009 the company declared a preferred dividend of Tk. 2.10 per preferred share and no preferred dividends were declared in the past. Net profit for 2008 is Tk. 2,100 and net profit for 2009 is Tk. 3,650. All shares were outstanding for a full period on 31 December 2008. The average fair value of the ordinary shares during 2009 amounted to Tk. 20. Required: Calculate the basic earnings per share for 2008 and 2009 as would need to be stated in the 2009 financial statement of Liverich Ltd. CMA Adapted - August 2011 E-17. ZMZS Consultant Ltd. On 01.01.2003 Issued 3,000, 7% Redeemable preference Shares of Tk.100/- each, all of which were taken up and fully paid. 31.03.2010 These are redeemable at any time after (31.03.2010) at a premium of Tk.40/- per share. 30.06.2010 The company decided to redeem the shares. For this purpose: 15.07.2010 It issued 1,800, 6% preference shares of Tk. 100/- each at a premium of Tk.10/- per share. 31.07.2010 The shares were fully subscribed and paid for (by 31.07.2010). On the same day 7% Redeemable Preference Shares were redeemed. The company had a retained earnings of Tk.280,000/- and a General Reserve of Tk.11,00,000/-. On 1st September 2010, the company decided to issue 5,000 fully paid bonus shares of Tk.100/- each to equity share holders in the ratio of 1:4. Required: Record necessary journal entries. CMA Adapted - April 2011 395


E-18. Transactions of K.C. Company during 2010 included the following: January 20: June 10: November 01:

November 18:

December 28:

Purchased 400 shares of R & S Co. at Tk.75 plus brokerage charges of Tk.600. Received a 50% stock dividend. Received stock rights permitting the purchase of one share at Tk.60 for every 4 shares held. On this date, rights were being traded at Tk.3 each and stock was being traded at Tk.72 per share. Exercised 400 rights which pertained to the stock acquired on January 20 and sold remaining rights at Tk.2 each less brokerage charges of Tk.6. Sold 100 shares from the holdings acquired on January 20 at Tk.68.25 less brokerage charges of Tk.53.

Required: (i) Give journal entries to record the foregoing transactions. (ii) Give the investment account balance on December 31, 2010 and the shares and costs making up this balance. CMA Adapted - April 2011 E-19. The Pine Company issued 7% convertible bonds worth Tk.10million with interest payment dates on April 1 and October 1. The bonds were sold on July 1, 1997, and matured on April 1, 2017. The bond discount totaled Tk.533,250. The bond contract entitles the bondholders to receive 25 shares of Tk.15 par value common stock in exchange for each Tk.1,000 bond. On April 1, 2007, the holders of bonds, face value Tk.1,000,000, exercised their conversion privilege. On July 1, 2007, the Pine Company reacquired bonds, face value Tk.500,000 on the open market. The balances in the capital accounts as of December 31, 2006 were: Common stock, Tk.15 par, authorized 3,000,000 shares, issued and outstanding, 250,000 shares………………………………...…..Tk.3,750,000 Premium on Common Stock……………………………………..….Tk.2,500,000 Market values of the common stock and bonds were as follows: Date Bonds (per Tk.1,000) Common Stock (per share) April 1,2007 Tk.1,220 Tk.47 July 1, 2007 Tk.1,250 Tk.51 Required: Prepare Journal entries on the issuer‟s books for each of the following transactions (use straight line method of amortization of amortization for the bond discount): (i) Sale of the bonds on July 1, 1997. (ii) Interest payment on October 1, 1997. (iii) Interest accrual on December 31, 1997, including bond discount amortization. (iv) Conversion of bonds on April 1, 2007 (Assume that interest and discount amortization are correctly shown as of April 1, 2007. No gain or loss on conversion is recognized). (v) Reacquisition and retirement of bonds on July 1, 2007 (interest and discount amortization are correctly reported as of July 1, 2007). CMA Adapted - December 2010

396


E-20. As per Finance Act-2010, Government has imposed tax through introducing new section u/s 53m in ITO-1984 that collection of tax from transfer of share by sponsor shareholders of a company listed with stock exchange. The SEC, at the time of transfer or according consent to transfer, by any means, the shares of a sponsor shareholder or director of a company listed with a stock exchange shall collect tax at all rate of 5% on difference between transfer value and face value of the shares. Mr. X is a sponsor shareholder of OPQ Ltd. who is the owner of 95,000 ordinary shares of Tk.100/- at par. OPQ is a publicly listed company and currently market price of that share is Tk.950/-. Last two years OPQ declared bonus share @ 40% and 30% respectively. After completion on locking period Mr. X is going to sell all of the shares that he hold in his BO A/C only for OPQ‟s shares. Required: As per Finance Act-2010, what would be the Government revenues for selling the shares in the stock market. CMA Adapted - August 2010 E-21. The Monalisa Co. Ltd. was organized in September, 2001 with an authorized capital stock of 200,000 shares of 1% cumulative preferred stock with Tk.40 par value and 1,000,000 shares of no par common stock with Tk.30 stated value. During the rest of the year, the following transactions relating to capital stock were completed. Oct.1 Subscription were received for 300,000 shares of common stock at Tk.42 and payable Tk.22 down and the balance in two equal installments due in November-1 and December-1. On the same date 16,500 shares of common stock were issued to Mr. Williams in exchange for his business. Assets transferred to company were valued as follows: Land – Tk.210,000, Buildings – Tk.250,000, Equipments – Tk.50,000, and Merchandise – Tk.110,000, Accounts Payable – Tk.11,000. Liabilities of the business assumed by the company were: Mortgage payable Tk.41,000, Accounts payable- Tk.11,000, Accrued interest on the mortgage – Tk.550. No goodwill is recognized in recording the issuance of the stock for net assets. Oct 3 Subscriptions were received for 120,000 shares of preferred stock at Tk.45, payable Tk.15 down and the balance in two equal installments due November- 1 and December- 1. Nov. 1 Amounts due on this date were collected from all common and preferred stock. Nov. 2 Subscriptions were received for 480,000 shares of common stock at Tk.44, payable Tk.22 down and the balance in two equal installments due on December – 1 and next January – 1, (2002). Dec. 1 Amounts due on this date were collected from all common stock subscriptions and stock fully paid for was issued. The final installment on preferred stock subscription was received from all subscription except on whose installment due on this date was Tk.9,000. State corporation laws provide that the company is liable for the return to the subscriber of the amount received less the loss on the subsequent resale of the stock. Preferred stock fully paid for was issued. Dec. 6 Preferred stock defaulted on December – 1 was issued for cash at Tk.36 each stock was issued and settlement was made with the defaulting subscriber. 397


Required: Journal entries to record the transactions listed above. CMA Adapted - April 2010 E-22. On January 1, 2006, H. Corporation had the following Stock Holders‟ Equity accounts: Taka Common Stock (Tk.10 par value 260 shares issued and 26,00,000 outstanding) Paid-up capital in excess of par 15,00,000 Retained Earnings 32,00,000 During the year the following transaction took places: April-1, Declared a Tk.1.50 cash dividend/share to stockholders which records on April 15, payable May-1. May-1, Paid the dividend declared in April. June-1, Announced a 2 for 1 stock split, prior to the split, the market price per share was Tk.24. August-1, Declared a 10% stock dividend to stockholders which records on August 15, distributed August 31, On August 1, the market price of the stock was Tk.10 per share. August-31, Issued the shares for the stock dividend. December-1, Declared a Tk.1.50 per share dividend to stockholders which records on December 15, payable January 3, 2007. December-31, Net Income for the year was determined as Tk.6,00,000. Required: (i) Journalize the above transactions. (ii) Prepare a Stockholders‟ equity section at December 31. CMA Adapted - August 2009 E-23. The Lanka Bangla Finance Ltd. organized on 1 st June 2006, was authorized to issue stock as follows: 60,000 shares of 9% preferred stock, Tk.100 par 220,000 share of common stock, Tk.20 par During the remainder of the Lanka Bangla Finance Ltd.‟s fiscal year the following transactions were completed in order given: (i) 30,000 shares of Preferred Stock were subscribed for at Tk.102 and 80,000 shares of Common Stock were subscribed for at Tk.23. Both subscriptions were payable 30% upon subscription, the balance in one payment. (ii) The second subscription payment was made, except on subscriber for 5,000 shares of Common Stock defaulted on payment. The full amount paid by this subscriber was returned and all of the fully paid stock was issued. (iii) 12,000 shares of Common Stock were required by purchase at Tk.17 (Treasury stock is credited at cost). (iv) Each share of preferred stock is converted into four shares of common stock. (v) The treasury stock was exchanged for machinery with a fair value of Tk.230,000. (vi) There is a 2:1 stock split and the paid value of the new common stock is Tk.10. (vii) A major stockholder donated 100,000 shares of common stock to the company. (viii) Net income was Tk.123,000. 398


Required: (i) Give the journal entries to record the transactions described above. (ii) Prepare the stockholdersâ€&#x; equity section as of 31st May, 2006. CMA Adapted - August 2009

399


MODEL EXAM QUESTION SUBJECT: FINANCIAL OPERATIONS Time: Three hours ___ Full marks: 100 * All questions are to be attempted. * Show computations, where necessary. * Answer must be brief, relevant, neat and clean. * Start answering each question from a fresh sheet __________ . PART - A Q. No. 1. The audited financial statements of Asian Trading Ltd. were approved by the shareholders at the AGM held on 3rd June 2017. On 7th June 2017, the Managing Director discovered a patty cash fraud by the cashier. It transpired that the fraud has been carried out over a period of year. Cashier made out and singed cash Expenses vouchers which were charged to motor vehicle expenses. No receipts were attached to the petty cash vouchers. The Managing Director signs all cheques for reimbursing petty cash float. The company‟s turnover was Tk. 20 crore and profit before tax was Tk. 1.50 crore. The partner-in-charge of the audit decided, at planning stage, that no audit worked need be carried out on petty cash, as he concluded that petty cash expenditure (on imprest float) was small, so the risk of material error or fraud was also small. Required: (a) You are required briefly to state auditor‟s responsibilities for detecting fraud and error in financial stamens. (b) Consider whether your firm would be negligent if the fraud was Tk. 15 lac. [Marks: 5 + 5 = 10] Q. No. 2. You are the partner in charge of the audit of TXT. The following matter has been brought to your attention in the audit working papers. During the year TXT spent Tk.500,000 on applied research, trying to find an application for a new process it had developed. TXT‟s management has capitalized this expenditure. TXT management is refusing to change its accounting treatment as it does not want to reduce the year‟s profit. The draft financial statements show revenue of Tk.40 million and net profit of Tk.4.5 million. Required: (a) Explain what is meant by “materiality” AND whether the matter highlighted above is material. (b) Identify the type of audit report that would be appropriate to the above statements, assuming that TXT‟s management continue to refuse to change the financial statements.

[Marks: 10] Q. No. 3. Income data for Dabor Company for the first three years of its operations are given below: 2015 2016 2017 Tk. Tk. Tk. Sales 1,000,000 1,040,000 1,120,000 Cost of goods sold 600,000 624,000 656,000 Gross profit on sales 400,000 416,000 464,000 Operating expenses 160,000 168,000 184,000 Income before income tax 240,000 248,000 280,000 Page 1 of 5 400


Cost of goods sold includes depreciation on buildings and equipment items calculated by the straight-line method. However, for income tax purposes, the company employed the accelerated depreciation methods providing for higher charges in the early years of asset life and correspondingly lower charges in the later years. Depreciation charges on the books as compared with charges recognized for income tax purposes during the three years period were as follows: 2015 2016 2017 Tk. Tk. Tk. Depreciation as per books 132,000 136,000 136,000 Accelerated depreciation as per tax return 216,000 180,800 144,000 All of the revenue of the company is taxable; all of the expenses are deductible for income tax purposes. Income tax rates in each year were 40%. Required: (a) Give the entries that would be made by the company for the years 2015 through 2017 to record the accrual of income tax if income tax expense is debited with income tax allocable to such income. (b) Prepare comparative income statements for the Dabor Company for the three years period assuming the use of inter period income tax allocation procedures. [Marks: 5 + 5 = 10] Q. No. 4. Hi-tech Construction started a three years contract to build a road which was started from January 1, 2017. The total contract price and estimated total cost amounted to Tk.10,00,000 and Tk.8,00,000 respectively. The following information is related to the construction activities for the year ended December 31, 2017: (a) Material, labour and operating overhead costs for the year amounted to Tk.2,50,000, Tk.1,50,000 and Tk.2,00,000 respectively. (b) Contract cost is further estimated that material cost will be Tk.1,00,000 higher than expectation, labour cost will be Tk.50,000 higher than expectation and operating cost will be lower TK.50,000 than expectation. (c) The contract price would be increased by Tk.2,00,000. (d) At the end of 2017, surveyors certified that 70% of the work is completed. Required: Determine the profit of the construction contract for the year ended December 31, 2017, based on the followings: (i) Contract costs in proportion to estimated contract costs. (ii) Percentage of the work certified. [Marks: 5 + 5 = 10] Q. No. 5. Presented below is information related to Agro Bazar. Assuming that Agro Bazar uses the conventional retail inventory method, compute the cost of its ending inventory at 31.12.2017. Cost Retail Inventory, 1.1.2017 Tk.40,000 Tk.70,000 Purchases 60,000 90,000 Purchase returns 10,000 15,000 Purchase discounts 5,000 10,000 Freight-in 15,000 25,000 Page 2 of 5 401


Markdowns Markdowns cancellation Gross sales Sales returns Markups Markup cancellations Loss from breakage (normal)

25,000 5,000 52,000 12,000 27,000 7,000 10,000 [Marks: 5]

Q. No. 6. Alco Company and Forex Finance Limited sign a lease agreement. On 1 st January 2017, Forex delivered a machine to Alco valued at Tk.218,840. The terms and other information regarding the lease are given below: (a) The term of the lease is 3 years which is non-cancellable. (b) The machine has a useful economic life of 4 years. (c) The fair market value of the machine is Tk.218,840 on 1 st January 2017. (d) The lease contract requires annual payment of Tk.80,000 for three years. (e) The machine will revert to the lessor at the end of the lease term. (f) The implicit rate of interest is 10%. Required: Prepare extracts from the income statement and statement of financial position for year one and the obligations under finance leases, assuming that installments are paid in advance. [Marks: 5] PART - B Q. No. 7. H Company acquired 12,000 shares in S Company for Tk. 1,70,000 on 1st April 2017. The balance sheet of two companies on 31st December, 2017 were as follows: H Company S Company Assets: Goodwill Tk.3,00,000 Tk.70,000 Land and Building 4,00,000 1,00,000 Plant and Machinery 5,00,000 1,00,000 Stock 2,00,000 40,000 Sundry Debtors 3,00,000 1,35,000 Investment 1,70,000 --Bills Receivable 50,000 30,000 Cash and Bank Balance 80,000 62,000 20,00,000 5,37,000 Capital and liabilities: Share Capital (Tk.10 each) Tk.10,00,000 Tk.3,00,000 General Reserve 4,20,000 50,000 Profit and Loss Account 2,60,000 85,000 Sundry Creditor 2,40,000 42,000 Bills Payable 80,000 60,000 20,00,000 5,37,000 On January 1, 2017 the profit and loss account of S Company showed a credit balance of Tk. 40,000 out of which a dividend of 15% on the capital of Tk. 2,00,000 was paid in June, 2017. At the same time, a bonus share of one (fully paid) for every two shares held was also made out of general reserve. Bills payable of S Company represents Bills issued Page 3 of 5 402


in favor of H Company which the company still held Tk. 40,000 of the bills accepted by S Company. The entire closing stock of S Company represents goods supplies by H Company @ 20% profit on cost. H Company and S Company agreed that for service rendered H Company should charge Tk. 500 per month from S Company entries for this were not made when the amounts were drawn up. Prepare consolidated balance sheet as at 31 st December, 2017. [Marks: 25] Q. No. 8. The following information relates to the financial statements of Delta Ltd. Delta Limited Statement of Financial Position As at 31.03.2017 and 31.03.2016 Notes 31.03.2017 31.03.2016 Assets Tk. Tk. Non-current assets: Property, plant and equipment (a) 38,000 51,000 38,000 51,000 Current assets: Inventory 25,000 9,200 Trade receivables 9,000 4,000 Tax refund due 1,000 Nil Bank Nil 3,000 35,000 16,200 Total assets 73,000 67,200 Equity and liabilities Equity: Equity shares of Tk.2 each (b) 20,000 16,000 Share premium (b) 6,400 8,000 Retained earnings 9,000 12,600 35,400 36,600 (c) Non-current liabilities: 10% loan note Nil 10,000 Finance lease obligations 9,600 4,000 Deferred tax 2,400 1,600 (c) 12,000 15,600 Current liabilities: 10% loan note 10,000 Nil Tax Nil 5,000 Bank overdraft 2,800 Nil Finance lease obligations 3,400 1,600 Trade payables 9,400 8,400 Total equity and liabilities 25,600 15,000 73,000 67,200 Page 4 of 5 403


Delta Limited Statement of Profit or Loss 31.03.2017 Tk. 110,000 (87,600) 22,400 (24,000) (2,000) (3,600) 1,400 2,200

31.03.2016 Tk. 80,000 (50,000) 30,000 (12,000) (1,200) 16,800 (5,600) 11,200

Revenue Cost of sales Gross profit Operating expenses Finance costs Profit (loss) before tax Income tax relief (expense) Profit (loss) for the year Notes: (a) Property, plant and equipment is made up of: As at 31.03.2017 31.03.2016 Tk. Tk. Leasehold property Nil 17,600 Owned plant 25,000 28,400 Leased plant 13,000 5,000 38,000 51,000 During the year Delta sold its leasehold property for Tk.17,000 and entered into an arrangement to rent it back from the purchaser. There were no additions or disposals of owned plant during the year. The depreciation charge (to cost of sales) for the year ended 31 March 2017 were: Tk. Leasehold property 400 Owned plant 3,400 Leased plant 3,600 7,400 (b) On 1 July 2016 there was a bonus issue of shares from share premium of one new share for every 20 held. On 1 October 2016 there was a fully subscribed cash issue of shares at par. (c) The 10% loan note is due for repayment on 30 June 2017. Delta is in negotiations with the loan provider to refinance the same amount for another five years. (d) The finance costs are made up of: For year ended 31.03.2017 31.03.2016 Tk. Tk. Finance lease charges 600 200 Overdraft interest 400 Nil Loan note interest 1,000 1,000 2,000 1,200 Required: Prepare a statement of cash flows for Delta Limited for the year ended 31.03.2017 in accordance with IAS 7 Statement of Cash Flows, using the indirect method. Page 5 of 5 [Marks: 25] 404


MODEL EXAM QUESTION SOLUTION

405


Ans. to the Q. No. 1

(a) Auditors responsibilities for detecting fraud and error: Auditor has a duty to detect frauds and errors to justify the correctness of the accounts. It is desirable that the auditor should exercise reasonable care and skill so that he may detect errors and frauds. If he carries routine checking and vouching more carefully and checks the books of accounts thoroughly, he may be successful in his duty. Whereas, in doing so, if he is not successful but he himself feels that he has not shown any negligence in his duty then he cannot be held responsible for any error or fraud which remains undetected in account. The auditor has authority to introduce remedial measures for the prevention of error and fraud. He can advise his client and suggest the way to prevent them.

(b) The firm would not be negligent if the fraud was Tk. 15 lac because it is material amount, i.e. 10% of profit before tax. An auditor is responsible for not detecting material misstatement. In addition the firm should enclose a liability caption that because audit is based on test basis all the population are not being tested for this inherent limitation may be exist after audit. To reduce the risk firm can do professional indemnity insurance.

406


Ans. to the Q. No. 2

(a) Materiality is the matter which missing or incorrect information in financial statements is considered to have an impact on the decision making of users. Example of materiality: A company reports a profit of exactly Tk.10,000, which is the point at which earnings per share exactly meet analyst expectations. Any profit below this point would have triggered a sell-off of company shares, and so would be considered material. If size is used in the case of TXT Tk.500,000 is 11% (500,000 ÷ 45,00,000) of profit and 1.25% (500,000 ÷ 400,00,000) of turnover, both would be considered as material due to the size. (b) The report category required for TXT would be “Matters that do affect the auditor‟s opinion – a qualified opinion”. A qualified opinion is expressed when the auditor concludes that an unqualified opinion can not be expressed but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion or a disclaimer of opinion.

407


Ans. to the Q. No. 3

(a)

Year 2015

2016

2017

Dabor Company Journal entries Particulars Income tax expense (240,000X40%) Income tax payable (240,000-84,000)X40% Deferred income tax (216,000-132,000)X40% Income tax expense (248,000X40%) Income tax payable (248,000-44,800)X40% Deferred income tax (180,800-136,000)X40% Income tax expense (280,000X40%) Income tax payable (280,000-8,000)X40% Deferred income tax (144,000-136,000)X40%

Dr. (Tk.) 96,000

Cr. (Tk.) 62,400 33,600

99,200 81,280 17,920 112,000 108,800 3,200

(b)

Sales Cost of goods sold Gross profit on sales Operating expenses Income before income tax Income tax Net income

Dabor Company Comparative income statement For the years 2015 – 2017 2015 Tk. 10,00,000 600,000 400,000 160,000 240,000 96,000 144,000

2016 Tk. 10,40,000 624,000 416,000 168,000 248,000 99,200 148,800

2017 Tk. 11,20,000 656,000 464,000 184,000 280,000 112,000 168,000

408


Ans. to the Q. No. 4

Calculation of contract cost to date: Material Labour Operating overhead

Calculation of estimated contract cost: Initial estimate Material Labour Operating overhead

Revised contract revenue: Initial amount Variation

Tk.2,50,000 1,50,000 2,00,000 Tk.6,00,000

Tk.8,00,000 1,00,000 50,000 (50,000) Tk.900,000

Tk.10,00,000 2,00,000 Tk.12,00,000

(i) Determination of the profit: Tk.600,000 Contract revenue ( X Tk.12,00,000) Tk.900,000 Less. Contract cost to date

(ii) Determination of the profit: Contract revenue (Tk.12,00,000 X 70%) Less. Contract cost to date

409

Tk.800,000 (Tk.6,00,000) Tk.200,000

Tk.840,000 (Tk.6,00,000) Tk.240,000


Ans. to the Q. No. 5

Computation of the cost of ending inventory under conventional retail inventory method:

Inventory, 01.01.2017 Add. Purchases Less. Purchase returns Less. Purchase discounts Add. Freight in Add. Net markups: Markups Less. Markup cancellations Total Less. Net markdown: Markdowns Less. Markdown cancellation

Cost 40,000 60,000 (10,000) (5,000) 15,000

Retail 70,000 90,000 (15,000) (10,000) 25,000 27,000 (7,000)

______ 100,000

Goods available for sale at selling price Less. Net sales at selling price: Gross sales Less. Sales returns Less. Loss from breakage Ending inventory at retail

20,000 180,000 25,000 (5,000) (20,000) 160,000 52,000 (12,000) (40,000) (10,000) 110,000

Total cos t price Total retail price Tk.100,000 = Tk.180,000 = 0.56 or 56%

Cost to retail ratio =

Ending inventory at cost = Tk.110,000 X 56% = Tk.61,600

410


Ans. to the Q. No. 6

Income statement (Extract) Depreciation expense Interest expense

Tk.72,947 Tk.13,884

Statement of financial position (Extract) Assets Non-current asset: Leased Machine Less. Accumulated depreciation Carrying value Liabilities Non-current liabilities: Lease liability Current liabilities: Lease liability Interest payable

411

Tk.218,840 (Tk.72,947) Tk.145,893

Tk.72,724 Tk.66,116 Tk.13,884


Ans. to the Q. No. 7

Consolidated Balance Sheet As at 31st December 2017

Goodwill Less: Capital Reserve Land and Building Plant and Machinery Stock Less: Unrealized Profit Sundry Debtors Bills Receivable Less: Inter Transaction Cash at bank

Assets 370,000 (75,250)

240,000 (6,667) 80,000 (40,000)

Taka 294,750 500,000 600,000 233,333 435,000 40,000 142,000 22,45,083

Capital and liabilities Share Capital Reserve and Surplus: General Reserve Profit and Loss Account Minority Interest Sundry Creditors Bills Payable Less: Inter Transaction

10,00,000 4,20,000 2,70,883 1,72,200 2,82,000 140,000 (40,000)

1,00,000 22,45,083

412


Workings: (1) Interest on Holding and Subsidiary Company:

12000 X 100 20,000 = 60% 8000 Subsidiary company = X 100 20,000 = 40% Holding company =

(2) Calculation for pre-acquisition profit: Profit and Loss Account (Balance Sheet) Less. Profit and Loss (1-1-16) Dividend (2,00,000 15%) Profit during the year So, Pre-acquisition profit = Tk.75,000 X

85,000

40,000 (30,000)

(10,000) 75,000

3 months 12months

= Tk.18,750 Post-acquisition profit = Tk.75,000 – Tk.18,750 = Tk.56,250 (3) Calculation total pre-acquisition profit: General Reserve Profit and Loss Account (40,000 - 30,000) Bonus Share (3,00,000 - 2,00,000) Current year Profit Total Profit

50,000 10,000 1,00,000 18,750 1,78,750

Share of Holding Company = Tk.1,78,750 60% = Tk.1,07,250 Share of Subsidiary Company = Tk.1,78,750 = Tk.71,500

40%

(4) Calculation of Goodwill/ Capital Reserve: Paid-up Share Capital (12,000 10) Add: Capital Profit/ Pre-acquisition Profit Add: Dividend (30,000 60%)

413

1,20,000 1,07,250 18,000 2,45,250


Less: Cost price of the share Capital Reserve

(1,70,000) 75,250

(5) Calculation of Revenue Profit: Profit and Loss Account Less: Service Charge (500 X 9 months) Share of Holding Company = 51,750 = 31,050 Share of Subsidiary Company = 51,750 = 20,700

56,250 (4,500) 51,750 60%

40%

(6) Calculation of Minority Interest: Share Capital (8,000 10) Capital Profit Revenue Profit Unrealized Profit = 40,000 X

80,000 71,500 20,700 1,72,200

20 120

= 6,667 (7) Profit and Loss account of Holding Company: Profit in Balance Sheet Less: Dividend (30,000 60%) Less: Unrealized Profit Add: Revenue Profit Add: Service Charge receivable from S Ltd Adjusted Profit

2,60,000 (18,000) (6,667) 31,050 4,500 2,70,883

414


Ans. to the Q. No. 8

Delta Limited Statement of cash flows As per IAS 7 (Indirect method) For the year ended 31.03.2017

Taka Cash flow from operating activities: Loss before tax Adjustments: Depreciation (w1) Interest expense Loss on disposal of leasehold property {17,000 – (17,600 – 400)} Operating profit before working capital changes Increase in inventory Increase in trade receivables Increase in trade payables Cash used in operations Interest paid Tax paid (w2) Net cash used in operating activities Cash from investing activities: Proceeds from sale of leasehold property Net cash from investing activities Cash flow from financing activities: Proceeds from issue of shares (20,000 + 6,400) – (16,000 + 8,000) Repayment made under finance leases (w3) Payment of dividend (12,600 – 9,000 – 2,200) Net cash used in financing activities Net decrease in cash and cash equivalent Cash and cash equivalents at beginning Cash and cash equivalents at end

415

Taka

(3,600) 7,400 2,000 200 6,000 (15,800) (5,000) 1,000 (13,800) (2,000) (3,800) (19,600)

17,000 17,000

2,400 (4,200) (1,400) (3,200) (5,800) 3,000 (2,800)


Workings:

1. Depreciation: Property, plant and equipment Dr. Balance b/d Additions (13,000-5,000+3,600)

Tk. 51,000 Disposal (17,600 - 400) 11,600 Depreciation Balance c/d 62,600

Cr. Tk. 17,200 7,400 38,000 62,600

2. Tax paid: Income tax Dr. Tk. 1,400 31.03.16 – Current tax 2,400 31.03.16 – Deferred tax 3,800 Refund due 7,600

Profit or loss account 31.03.17–Deferred tax Tax paid

Cr. Tk. 5,000 1,600 1,000 7,600

3. Repayment of finance leases: Finance lease liability Dr. Payments Balance b/f (9,600+3,400)

Tk. 4,200 Balance b/f (4,000 + 1,600) 13,000 Additions (w1) 17,200

Cr. Tk. 5,600 11,600 17,200

416


OUR PUBLICATIONS

1. Principles of Accounting 2. Fundamentals of Financial Accounting 3. Intermediate Financial Accounting 4. Fundamentals of Management Accounting 5. Management Accounting 6. Cost Accounting 7. Corporate Accounting 8. Fundamentals of Business Mathematics 9. Fundamentals of Business Economics 10. Fundamentals of Ethics, Corporate Governance and Business Law 11. Legal Environment of Business 12. Commercial and Industrial Laws 13. Enterprise Operations 14. Performance Operations 15. Financial Operations 16. Taxation

417

Financial Operations  

According to the following syllabus: CMA (Operational Level), ICMAB; Public, Private & National University; BBA & BBS Honors in Accounting,...

Financial Operations  

According to the following syllabus: CMA (Operational Level), ICMAB; Public, Private & National University; BBA & BBS Honors in Accounting,...

Advertisement