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Question (Reckon Plc). You are the Chief Accountant of Reckon Plc and are supposed to advise...

Question (Reckon Plc).

You are the Chief Accountant of Reckon Plc and are supposed to advise the board of Reckon Plc on the following.

(a)

Reckon Plc had decided to expand its business as a result of which, the company is in need of a new machinery that cost £700,000. While one of the option is to purchase the asset, some of the directors in a board meeting have suggested that it would be better to lease the asset. Assuming that Reckon decides to lease the machinery, it will have to do so for at least four years. Beckon Plc is willing to offer its unused machinery (fair market value £700,000) on lease for four years at a minimum lease rentals of £200,000 per year. Assume that the lease term will begin on 1 October 2019 and lease rentals are to be paid in advance. The board of Reckon has recommended that since four years is a short period of time, they could record the lease as an operating lease (reporting the lease rent as expenses) which will not only simplify the accounting, at the same time will not have an impact on the gearing to hinder its ability to borrow in the future. In any case, the board has expressed their disappointment over the complexity of reporting standards and claim that they are unable to understand the need for companies to report different option like operating and finance lease, differently. The cost of capital can be assumed to be 9%. (consider discount factors upto 3 decimal points)

  1. Provide your comment to the concerns of the board of directors of Reckon with regards to the complexity of reporting standards and explain how IFRS 16 Leases has attempted to simplify the reporting. Advise the board whether their option of treating the lease as operating lease and expensing the lease instalment is correct.
  2. Demonstrate how Reckon Plc will record the above lease in the financial statements in the next four years ending 30 September (2020, 2021, 2022 and 2023) based on your suggestions in (i).

(b) Reckon Plc obtained a government grant of £400,000 which represents 50% of the cost of the asset. The asset was acquired on 1 January 2018 with a useful life of 5 years and zero residual value. A straight line method is to be used to depreciate the asset.

Demonstrate with reference to IAS 20 Government Grants how the asset and the grant will be reported in the financial statements of Reckon Plc for the year ended 30 September 2019 using both the methods.  

(Total 35 marks)

Solutions

Expert Solution

(a) (i) IFRS is a international reporting standard which bring fairness, comparability and truthness in the financial statement. earlier IFRS 17- Lease dealing with Leases seperated the lease between financing and operating and provided recognition criteria for the Finance Leases assessment adding to complexity.

IFRS 16- Leases which has replaced the IfRS 17 provides for single model of lease accounting from the perspective of lessee. Lessee shall record the right to use asset for an asset which is in control of lessee for the period of control and corresponding credit shall be given to lease liability. ROU assets shall be recorded at fair value of the minimum lease payments. ROU assets shall be depreciated over the life of asset/leases and interest expense shall be recorded for unwinding of the liability.

(ii) Following Journal entry shall be recorded along with workings is as follows-

Date Account Name Debit Credit
01-01-2020 ROU Assets A/c---Dr 7,06,259
To Lease Liability A/c 7,06,259
(Being leases recorded)
01-01-2020 Lease Liability A/c---Dr 2,00,000
To Bank A/c 2,00,000
(Being lease payments made)
31-12-2020 Depreciation A/c---Dr 1,26,564.73
To ROU Assets A/c 1,26,564.73
(Being depreciation recorded)
31-12-2020 Interest Exp---Dr           45,563
To Lease Liability A/c           45,563
(Being interest recorded)
01-01-2021 Lease Liability A/c---Dr 2,00,000
To Bank A/c 2,00,000
(Being lease payments made)
31-12-2021 Depreciation A/c---Dr 1,26,564.73
To ROU Assets A/c 1,26,564.73
(Being depreciation recorded)
31-12-2021 Interest Exp---Dr           31,664
To Lease Liability A/c           31,664
(Being interest recorded)
01-01-2022 Lease Liability A/c---Dr 2,00,000
To Bank A/c 2,00,000
(Being lease payments made)
31-12-2022 Depreciation A/c---Dr 1,26,564.73
To ROU Assets A/c 1,26,564.73
(Being depreciation recorded)
01-01-2022 Interest Exp---Dr           16,514
To Lease Liability A/c           16,514
(Being interest recorded)
01-01-2023 Lease Liability A/c---Dr 2,00,000
To Bank A/c 2,00,000
(Being lease payments made)

Working-

No. Date Actual paid Rental payment PV factor Present value @ 9% Interest Cumm Amortised Cost Depreciation WDV ROU assets
5,06,259
1 01-01-2020 2,00,000 2,00,000               1.00 2,00,000     45,563 3,51,822 1,26,564.73 3,79,694
2 01-01-2021 2,00,000 2,00,000               0.92 1,83,486     31,664 1,83,486 1,26,564.73 2,53,129
3 01-01-2022 2,00,000 2,00,000               0.84 1,68,336     16,514 0 1,26,564.73 1,26,565
4 01-01-2023 2,00,000 2,00,000               0.77 1,54,437 0 1,26,564.73 0

(b) IAS 20 allows two methods of accounting for grant-

i. Reduce the grant received from the gross block of the assets ; or

ii. Defer the grant and recognise in the pattern of the Depreciation

Hence, as on 30 September, the Company shall present either the Grant reduced from the Gross block and reduced value being depreciated over the period of the lease or grant being deferred and recognised over the pattern of the depreciation.


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