Tutorial 11 (Week beginning 14th October 2019)

Topic 10: Liabilities (leases, provisions, contingent liabilities)

SOLUTIONS TO HOMEWORK QUESTIONS

1. Q9.5 (p. 604)

A provision is a liability for which the amount or timing of the future sacrifice is uncertain
(AASB 137 para 10). It requires estimation. For example, a provision for long service
leave requires estimation of the proportion of employees who will stay with the entity
long enough to receive long service leave entitlements. The amount of the future
sacrifice of other liabilities, such as trade creditors and mortgages, is quantified by an
invoice or contractual arrangement.

2. Stapleton and Sons is a business that employs five full-time staff. Under their
employment contract, each staff is entitled to ten days of sick leave each year, provided
sufficient medical certificates or similar documents are produced to confirm their ill
health. Past experience and records indicate that staff use 70% of their sick leave each
year. Staff work a five day week (Monday to Friday), and are paid a salary of $104,000
each per year. The business records wages and relevant leave entitlements on a
weekly basis.

Required:
(a) Should Stapleton and Sons record any provision for their employees’ sick leave?
Explain and justify your answer with reference to the AASB Framework and Accounting
Standards where relevant.
(b) Calculate the annual sick leave obligation for Stapleton and Sons, and provide the
general journal entries necessary to record the wages paid and leave provision for one
week.

(a) Yes. Stapleton and Sons has a present obligation (to pay staff when they are unwell)
that has come from a past event (the services provided by the staff), and will involve
an outflow of economic benefits in the future (in the form of cash when sick leave is
taken). The amount is reliably measured (weekly wages x 2), and it is more likely than
less likely that staff will take their sick leave (satisfying the requirement of probable
occurrence). In accordance with the AASB Framework, both the definition and
recognition criteria have been satisfied, so a liability should be recorded. AASB 119
also provides guidance on the recognition of such short term employee benefits. Para
10 stipulates that where an employee has rendered service to an entity during a period,
the entity shall recognize a liability and expense for that benefit.

(b) Calculation of sick leave obligation:

Annual salary $52,000 x 5 staff x 2/52 = $10,000 (Sick Leave Expense for one year)
Alternatively, staff salary $1,000 per week x 2 weeks x 5 staff = $10,000
Only 70% is expected to be taken based on past experience = .70*10,000 = $7,000
As wages are paid on a weekly basis, the business will provide for sick leave on a
weekly basis also. 7,000/52 = $134.62

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 Dr Wages Expense 5,000
Cr Bank 5,000
(wages for one week, each staff member earning $1,000 per week)

Dr Sick Leave Expense 134.62

Cr Provision for Sick Leave 134.62
(recording provision for leave on a weekly basis)

3. PSB9.8 (p. 615)

Davis Builders Pty Ltd

(a)

Warranty Provision Account

Spare parts
inventory 2019 Beginning
(amount of balance
warranty
$130,000
claims) $133,000
Warranty
Closing balance Expense
(amount of
adjusting
42,000
39,000 journal entry)
$172,000
$172,000
2020 Beginning
$39,000
balance

(b) Summary entry for the year

Warranty Provision $133,000
Spare Parts Inventory $133,000
(To record plumbing repairs under warranty)

Balance day adjustment

Warranty Expense $42,000
Warranty Provision $42,000

(To adjust the liability for Warranty Provision account to total estimated liability for
contracts outstanding at balance date).

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4. Comptex Ltd sells computers. It provides a one-year warranty on the computer by way
of parts and labour. During the year ended 30 June 2019, the company sold 1,000
computers for $1250 each. Previous experience indicates that the warranty claims
amount to 2 per cent of sales revenue. For the year ended 30 June 2019, Comptex
repaired 50 computers. The cost of repair was $10 000 in parts and $7000 in labour.

Required:
Having regard to the Framework and relevant accounting standards:
(a) Explain whether the warranty should be treated as a liability in Comptex’s financial
statements for the year ended 30 June 2019. In your answer refer to the AASB
Framework.
(b) Prepare general journal entries in relation to the warranty for the year ended 30 June
2019.

a. For the warranty to be recognised as a liability in the financial statements, it must meet
both the definition and recognition criteria.
Criteria Analysis Met/Not
met
Present The warranty is an agreement Met
Obligation which legally requires Comptex to
repair in the event of a claim under
warranty.
Future The repair will involve outflows in Met
Sacrifice of the form of labour costs and parts.
Economic
Benefit
Past Event The sale of the computer which Met
gives rise to the warranty
agreement
It meets the definition of a
liability
Probable that It is more likely than less likely that Met
the future at least some computers will not
sacrifice will work properly and require repair.
be required This is reinforced by the past
experience of claims being made.
Reliable Based on past experience, the cost Met
Measurement of warranties is 2% of sales
revenue.
It meets the recognition of a
liability and should be included
as a liability in the financial
statements.*
*Warranty is a provision because it is a liability of unknown timing and/or amount.

b.
30 June 2013 Dr Warranty expense 25,000
Cr Provision for warranty 25,000
(Adjust 2% * (1,000 x $1,250) = 25,000)

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 Date of claim Dr Provision for warranty 17,000
Cr Inventory 10,000
Cr Wages Payable 7,000
(Record the warranty claims made)

5. Hawke Ltd leased an item of machinery to Banda Ltd on 1 July 2018. The agreement
contained the following details:
Lease term 3 years
Initial lease payment $22,000 (at commencement of lease)
Annual lease payment $22,000 (due at 30 June each year)
Guaranteed residual payment $10,000 (due on 30 June 2021)
Interest rate implicit in the lease 10%
Useful life of machinery 6 years
Residual value of machinery $20,000
The lease is non-cancellable and the machinery is to be retained by Banda Ltd at the
end of the lease term
The fair value of the machinery at 1 July 2018 was $85,000 and the present value of
minimum lease payments is $84,224.

Required:
(a) Prepare a schedule of lease payments for Banda Ltd.
(b) Prepare the general journal entries required for the first year of the lease (the year
ending 30 June 2019) assuming a finance lease.
(c) Prepare an extract from the statement of financial position as at 30 June 2020
providing the figures for the leased asset.

Banda Ltd lease payments schedule

Liability at Lease Interest Reduction Liability

Date beginning payment expense in liability at end
1 July 2018 84,224 22,000 0 22,000 62,224
30 June 2019 62,224 22,000 6,222 15,778 46,446
30 June 2020 46,446 22,000 4,645 17,355 29,091
30 June 2021 29,091 32,000 2,909 29,091 0

General journal entries for the first year of the lease.

1 July 2018 Dr Leased Machinery 84,224

Cr Lease Liability 84,224
(recording the inception of the lease)
(Lower of FV and PV)

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 Dr Lease Liability 22,000
Cr Bank 22,000
(initial payment)

30 June 2019 Dr Interest Expense 6,222

Dr Lease Liability 15,778
Bank 22,000
(annual payment)

Dr Depreciation Expense 10,704

Cr Accum Dep’n 10,704
(recording depreciation (84,224 – 20,000)/6 years)
(Use entire useful life as the Machinery is to remain
With the lessee at the end of the lease term)

Statement of Financial Position (Extract)

As at 30 June 2020

Non-current assets
Lease Machinery $84,224
Less: Accumulated depreciation (21,408)
62,816

Current liabilities
Lease liability $29,091

Non-current liabilities
Lease liability Nil

6. On 1 July 2019, Busby Ltd leased an equipment from York Ltd. The fair value of the
equipment at 1 July 2019 is $300,000, and the present value of minimum lease
payment is $286,168. The agreement contained the following details:
Lease term 4 years
Initial lease payment $80,000 (at commencement of lease)
Annual lease payment $80,000 (in advance on 1 July each year)
Guaranteed residual payment Nil
Interest rate implicit in the lease 8%
Useful life of machinery 6 years
Residual value of machinery $30,000
Busby Ltd intends to return the equipment to York Ltd at the end of the lease term.

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 Required:
(a) Prepare a schedule of lease payments for Busby Ltd.
(b) Prepare the general journal entries required from 1 July 2019 to 30 June 2021.

Busby Ltd lease payments schedule

Liability at Lease Interest Reduction Liability

Date beginning payment expense in liability at end
1 July 2019 286,168 80,000 0 80,000 206,168
1 July 2020 206,168 80,000 16,493 63,507 142,661
1 July 2021 142,661 80,000 11,413 68,587 74,074
1 July 2022 74,074 80,000 5,926 74,074 0

General journal entries for the first year of the lease.

1 July 2019 Dr Leased Equipment 286,168

Cr Lease Liability 286,168
(recording the inception of the lease)
(Lower of FV and PV)

Dr Lease Liability 80,000

Cr Cash 80,000
(initial payment)

30 June 2020 Dr Interest Expense 16,493

Cr Interest Payable 16,493

Dr Depreciation Expense 64,042

Cr Accum Dep’n 64,042
(recording depreciation (286,168 – 30,000)/4 years)
(Use lease term as the equipment is to be returned to the lessor at the
end of the lease term)

1 July 2020 Dr Interest Payable 16,493

Dr Lease Liability 63,507
Cr Cash 80,000
(annual payment)

30 June 2021 Dr Interest Expense 11,413

Cr Interest Payable 11,413

Dr Depreciation Expense 64,042

Cr Accum Dep’n 64,042
(recording depreciation (286,168 – 30,000)/4 years)
(Use lease term as the equipment is to be returned to the lessor at the
end of the lease term)