Question

Can anyone give a detailed explanation with some examples on these questions? I am going to have an exam soon.

1. How should we account for the borrowing costs that we incurred this year on constructing the Torry warehouse facility?

2. Why would a machine, that we have started leasing on a 10 year agreement, have to be shown on our statement of financial position when we don’t own it?

3. The Board of ABC Corp., a manufacturer of electrical goods and had acquired 3 companies already, are thinking of investing in a Scottish company called DEF Corp. next year. Discuss what difficulties they might face integrating DEF into the ABC Group.

Answer 1

1. Fund can be raised from broadly two types of sources. One is called ownership sources of fund and another is called borrowed fund. Dividend on ownership fund is an appropriation of profit. On the other hand , cost of borrowed fund is called interest. It is not an appropriation of profit rather it is called an expense of the company .

a. At the time recording cost of borrowed fund i .e interest expenses, we have to debit interest expenditures and credit cash account.

b. It is booked as finance cost and comes under non operating expenses. Because it does not related with operational activities of the business .

c. At the time of tax calculation, it reduced tax liability by getting full deduction from EBIT . If capital structure have borrowed fund ,then cost of borrowed fund reduce the taxable income of the company .

2. There are two types of lease . One is operating lease and another is financial lease. In your case, it is all about financial lease and it has to be recognized as an asset. Because of the following :-

a. It use to stay with the lessee for long time and almost the whole working life of the assets. ( at least 75% of the tenure of whole working life)

b. After lease agreement ,lessee can purchase the assets at lower price than the market price

c. During the lease agreement time frame all the capital modifications expenses incurred by the lessee not the lessor just like as an owner.

3. It has some difficulty during acquisition. This are as follows.

a. Danger of inflating value of DEF corporation

b. Dishonesty in relationships

c. Ignoring integration

d. Cultural differences