Gaap Graded2016

GAAP:
Graded Questions
2016
David Kolitz
B Comm (Natal), B Comm (Hons) (SA), M Com (Wits)
Senior Lecturer
Business School, University of Exeter
Cathrynne Service
B Compt (UNISA), B Compt (Hons) (CTA) (UNISA), CA (SA)
Independent IFRS consultant and trainer
GAAP:
Graded Questions
First edition 2002

Second edition 2003
Third edition 2004
Fourth edition 2005
Fifth edition 2006
Sixth edition 2007
Seventh edition 2008
Eighth edition 2009
Ninth edition 2010
Tenth edition: 2011
Eleventh edition: 2012
Twelfth edition 2013
Thirteenth edition 2014
Fourteenth edition 2015
Fifteenth edition 2016
© 2016
ISBN 9780409120974
Ebook ISBN 9780409121193
Copyright subsists in this work. No part of this work may be reproduced in any form or by any means
without the publisher’s written permission. Any unauthorised reproduction of this work will constitute
a copyright infringement and render the doer liable under both civil and criminal law.
Whilst every effort has been made to ensure that the information published in this work is accurate, the
editors, authors, publishers and printers take no responsibility for any loss or damage suffered by any
person as a result of the reliance upon the information contained therein.
Printed and bound by Interpak Books, Pietermaritzburg
ii
GAAP: Graded Questions
Contents
1 Financial reporting environment 1
2 Conceptual framework for financial reporting 6
3 Presentation of financial statements 12
4 Revenue from contracts with customers 20
5 Taxation: various types and current taxation 37
6 Taxation: deferred taxation 47
7 Property, plant and equipment: cost model 67
8 Property, plant and equipment: revaluation model 82
9 Intangible assets 94
10 Investment property 105
11 Impairment of assets 118
12 Non-current assets held for sale and discontinued operations 129
13 Inventories 150
14 Borrowing costs 164
15 Government grants and government assistance 173
A Integrated questions: chapters 1 - 15 181
16 Leases: lessee accounting 198
17 Leases: lessor accounting 207
18 Provisions, contingencies and events after the reporting period 211
19 Employee benefits 222
20 Foreign currency transactions 233
21 Hedge accounting 239
22 Financial instruments 249
23 Share capital: equity instruments and financial liabilities 263
24 Earnings per share 272
25 Fair value measurement 286
26 Accounting policies, estimates and errors 293
27 Statement of cash flows 305
28 Financial analysis and interpretation 319
B Integrated questions: chapters 1 - 28 328
29 Separate financial statements of a parent 348
30 Wholly owned subsidiaries 353
31 Partly owned subsidiaries 362
iii
Preface
Pedagogical philosophy
This book has been designed to meet the needs of students studying financial accounting at a
second year, third year or intermediate honours level. It can be successfully used with the
accounting textbooks:
• ‘Gripping GAAP’ by CL Service; and

• ‘Gripping Groups’ by CL Service and M Wichlinski.
Changes made for the 2016 (fifteenth) edition

Keeping this book up to date is a never-ending task, dictated by the flow of new standards and
interpretations coming from the International Accounting Standards Board (IASB).
The nature of the resulting changes range from significant amendments of fundamental principles
to some minor changes from the annual improvements process.
In recent years, we have seen some sweeping changes resulting from the new IFRS 15 Revenue
from contracts with customers together with the much awaited final and complete version of
IFRS 9 Financial instruments. These are resulting in the annual creation of entirely new
questions for chapter 4 (Revenue), chapter 22 (Financial instruments) and extensive reworking of
chapter 21 (Hedge accounting) and many of the other chapters.
In addition to the above, we have also updated existing questions for changes from the annual
improvement process, incorporating any new standards or amendments that may have occurred
up to and including 10 December 2015. We have also removed some questions and added many
new questions. The new questions were included to add variety, extend the range and to enable
even more effective grading of the questions. Most of our chapters now start with a crucial set of
core-concept questions.
We have moved the position of the two chapters of integrated questions – now simply called
Chapter A and Chapter B. Their positioning within the body of chapters rather than at the end is
intended to highlight the importance and relevance of these chapters in relation to the other
chapters in the book. Chapter A integrates the topics covered in the first fifteen chapters, whilst
Chapter B integrates the topics across the entire book (with the exception of the last 3 chapters
that deal with issues related to group accounting).
On-going changes
In ensuring that the book is user-friendly and to enable both lecturers and students to identify
questions easily, the contents page of each chapter includes the name of the relevant entity and a
detailed description of the key issues in each question. We have started a project that involves
continually reworking these key issues to ensure that they are described in the most succinct yet
useful way.
In April 2012, South Africa replaced STC with dividends tax. However, STC remains a tax used
by certain other countries and even in South Africa, where STC has been replaced, the effects of
unutilised STC credits existing on 1 April 2012 will be felt by shareholders for the next three
years and deferred tax assets that were recognised on these unutilised credits will need to be
derecognised with immediate effect. For this reason the principles are worth understanding and
thus, whilst all detailed questions involving STC have been removed, reference to STC may still
exist in some questions.
iv
Facebook page
We have a Facebook page, called ‘Accounting

911 by Kolitz and Service’. Go to our page, ‘like’ Please visit our facebook page!
it and keep yourself up to date with all Accounting 911 by Kolitz and
developments relating to Gripping GAAP, GAAP: Service
Graded Questions and Gripping Groups. We post
summaries of various topics to the site, interesting
stories relating to IFRSs and are able to respond to short questions of principle relating to
material from our books.
Assumptions for international students

Since GAAP: Graded Questions has gained international interest, the questions have been
updated to be more country non-specific in terms of tax legislation. In this regard, students may
assume that the business entity is subjected to the following taxes (unless otherwise indicated):
z A tax on taxable profits at 30% (referred to as income tax); and

z A transaction tax levied at 14% (referred to as VAT or value added tax).
Students may assume that taxable profits are calculated as:
Profit before tax (accounting profits) adjusted for:
z Differences caused by non-taxable income and non-deductible expenses

z Temporary differences (caused by current income that won’t be taxed in the current year and
current expenses that won’t be deductible in the current year).
Students may further assume that where accounting profits include capital profits, the taxable
profit would include only a portion of this capital profit, referred to as a taxable capital gain.
Students may further assume, unless otherwise stated, that this taxable capital gain is calculated
as follows:
z (Proceeds from the sale – Base cost) x 50% inclusion rate

z Unless otherwise stated, students may assume that the base cost equals cost.
Students may also assume that a transaction tax (referred to as VAT) is levied on certain
transactions by business entities that are registered as VAT vendors. VAT vendors are allowed to
claim back from the tax authorities any VAT that they may have paid. Business entities that are
not registered as VAT vendors do not charge VAT on any transactions and may not claim back
from the tax authorities any VAT that they may have paid.
Certain chapters include unavoidable reference to South African legislation. Whilst the principles
are international, parts of these chapters may possibly not be relevant to some of the countries
using this book. These chapters are:
z Financial reporting environment (chapter 1)

z Share capital (chapter 23)
Currency has been denoted by the symbol ‘C’.
v
Outline
• Chapter 1 provides questions on the environment within which a ‘reporting accountant’
finds himself, including issues related to legislation and the IASB.
• Chapter 2 provides questions on the Conceptual Framework, which reflects the basic logic
underpinning all other IFRSs.
• Chapter 3 provides questions on how financial statements should be presented.
• Chapter 4, 5 and 6 involve questions on revenue and taxes. Since tax is integral to all
topics, the chapters on tax are included early on in the book. However, before one can
understand the differences between accounting profit and taxable profit, students need to
understand the concept of accrual. An ideal standard to illustrate the concept of accrual and
the differences between the accrual basis of accounting and tax legislation is the revenue
standard.
• Chapters 7 – 13 provide questions relating to various assets. We start with non-current
assets and proceed to current assets (inventory). Impairment of assets is also included in
this set of chapters but it is inserted after the chapters covering property, plant and
equipment, intangible assets and investment properties but before non-current assets held
for sale and inventories. This is because the standard on impairments applies to the former
assets but not the latter assets.
• Chapter 14 – 17 provide questions on borrowing costs, government grants and leases.
These chapters may have an impact on the recognition and measurement of assets.
• Chapters 18 – 19 provide questions on provisions, contingencies and events after the
reporting period and employee benefits. Both these chapters relate largely (although not
exclusively) to liabilities.
• Chapters 20 – 24 provide questions covering foreign currency transactions, forward
exchange contracts, financial instruments, share capital and finally earnings per share
• Chapter 25 contains questions on fair value measurement and is placed here as it affects
numerous prior chapters.
• Chapter 26 provides questions on the standard covering accounting policies, estimates and
errors. This chapter is placed here since all prior standards can be affected by this standard.
This chapter of questions focuses on the implications involving the standards on inventory
and property, plant and equipment. More complex questions involving other standards may
be found in Appendix B.
• Chapter 27: Questions relating to statements of cash flows are quite distinct from the
principles covered in all prior chapters since it applies the cash concept rather than the
accrual concept and is thus placed near the end of the book.
• Chapter 28: Financial analysis and interpretation is not related to an IFRS and questions
here deal with how the financial statements are analysed by users.
• Chapters 29 – 31 provide questions on group accounting, starting with the separate
financial statements of a parent and then including two chapters on wholly-owned
subsidiaries and partly-owned subsidiaries.
• Integrated questions Chapter A and Chapter B are our integrated chapters providing the
important skills required in being able to integrate knowledge over various topics.
Integrated questions Chapter A covers chapters 1 to 15 and Integrated questions Chapter B
covers chapters 1 to 27, in other words, the second set includes questions on a cumulative
basis from the beginning of the book.
vi
Supplements
A detailed set of solutions, in electronic format, is available from the publishers to the
relevant lecturers at those institutions that prescribe this book.
We welcome comments from lecturers, tutors and students to assist us in improving future
editions.
Facebook page: Accounting 911 by Kolitz and Service
Publisher’s webpages www.myacademic.co.za

www.myacademic.mobi
Publisher’s email address: administrator@myacademic.co.za
Dedication and acknowledgements

Dedication
To
Maeve
Tarqui and Guy
To our families, a big thank you for your support and encouragement and for coping with the
long hours expended as well as the many and ongoing crises related to the production of this
work.
Acknowledgements
A big thank you for assisting with the current edition, and under immense time pressure
involving many very early mornings and very late nights, goes to a talented team who
dedicated an enormous amount of their personal time to the clarification of the IFRSs for the
sake of future students:
Muhammad Muheeb Buckas, Muhammad Shihaab Buckas,
Sally Grinham,
Andile Ngwenya, Farnaaz Shaikjee, Yusuf Seedat and our
senior editors,
Dietmar Paul and Khaya Sithole, both working on their third editions.
Thank you for your dedication and expertise.
We also wish to specially acknowledge the valuable contribution of Khaya Sithole of the
University of the Witwatersrand for his work in editing and also developing a number of new
questions and the many long hours he dedicated to the process of ‘pulling the final book
together’ in the last few days before printing.
Thank you also to Súne Diedericks and Suzette Snyders from Nelson Mandela Metropolitan
University for their valuable suggestions and kind permission to adapt two questions.
vii
We would also like to thank our talented assistants for the many hours spent in the production
of the earlier editions of this book:
14th edition
Troy Halliday, Thivesan Govender, Errol Prawlall, Zaheer Bux, Kamantha Vengasamy, Deepika
Panday, Dietmar Paul,Zahra Moorad, Vidhur Sunichur, and Yusuf Seedat
13th edition
Tanweer Ansari, Trixy Cadman, Aphrodite Contogiannis, Zaid Ebrahim, Susan Flack, Haseena Latif,
Daleshan Naidoo, Thabo Ndimande, Dietmar Paul, Kate Purnell, Johannes Rice, Yusuf Seedat and
Khaya Sithole
12th edition:
Jade Archer, Trixy Cadman, Albertus Louw, Ayanda Magwaza, Adrian Marcia and Carla Tarin
11th edition:
Jade Archer, Prekashnee Brijlall, Susan Flack, Ruan Gertenbach, Fathima Khan, Albertus Louw,
Adrian Marcia, Preshan Moodliar, Khaya Sithole, and Carla Tarin
10th edition:
Prekashnee Brijlall, Gareth Edwardes, Susan Flack, Ruan Gertenbach, Artur Mierzwa,
Preshan Moodliar, Nabilah Soobedaar and Nikky Valentine
9th edition:
Steve Carew, Justin Cousins, Jarrod Viljoen and Craig Wallington.
8th edition:
Warren Kemper, Byron Cowie, Alastair Petticrew, Gary Klingbiel, Catherine Friggens and
Shiksha Ramdhin
7th edition:
Tiffiny Sneedon, Ryan Wheeler, Nick Matulovich and Joel Stuhler
6th edition:
Warren Maroun, Trixy Cadman, Dhiren Sivjattan, Clive Kingsley, Tarryn Altshuler and
Phillipe Welthagen
5th edition:
Derek Alston, Praneel Nundkumar, Brian Nichol, Kelly McKinnon, Craig Irwin, Lara Williams,
Pawel Szpak,
4th edition:
Warren Maroun, Maria Kritikos, Lara Williams, Blake Davidson, Neil Graham, Pawel Szpak,
Tanya Mauer, Megan Bovey,
3rd edition:
-
2nd edition:
Richard Currie
1st edition:
Michael Schwenke, Chris Nicholson, Gavin McAllister, Reshagan Moodley
We hope you enjoy your study of financial accounting and that you find our questions and
solutions helpful in clarifying the explosion of recent accounting standards (both the new and
the improved!).
Dave Kolitz
and
Cathy Service
December 2015
2015
viii
GAAP: Graded Questions Financial reporting environment
Chapter 1
Financial reporting environment
Question Key issues

1.1 True/ false History of modern-day accounting
1.2 Lincoln Abrahams IFRSs, the various related acronyms and who is responsible for the
development thereof
1.3 True / false The IASB: structure, objectives and due process
1.4 True / false Companies Act 2008: profit versus non-profit companies:
which financial reporting standards to use
1.5 BitsyBusiness Differential reporting: IFRSs for SMEs
1.6 - Brief history of internationlisation of accounting standards
1.7 Short questions Companies Act 2008: various sections affecting financial statements
1.8 Dodgy Wodgy Legal backing for accounting standards
1.9 The Reporting Overview of the use and application of IFRS in South Africa
Consultancy
1.10 - Success criteria for global standards
Chapter 1 1
Question 1.1
Indicate whether the following are true or false. Where necessary, provide a brief explanation
to support your answer:
a) The earliest evidence of accounting is the double-entry system used in the thirteenth
century.
b) The double entry system was developed by Luca Pacioli.
c) The internationalisation of the various forms of GAAP into a single set of accounting
standards began in 1993 as a direct result of the famous ‘Daimler-Benz saga’.
d) The International Accounting Standards Committee was the first international accounting
body, having been established in 1973.
Question 1.2
Lincoln Abraham is a friend of yours. He is just starting his studies in accounting whereas
you have just completed your degree. He tends to over-react to things and his accounting
studies are no different. He has just dropped you an email in which he says:
‘I cannot believe what they are expecting me to study! I registered for a financial accounting
course and yet we haven’t done a single debit or credit for the last 2 weeks. Accounting
seems to be acronym-heaven! It is all about GAAP, IFRSs, SICs, IFRICs and IASs. And
then there is this ‘framework’. I frankly have no idea what is going on. Do you think I
should perhaps give up and maybe study something else...or maybe I could just sell hot dogs.
This is all too much for me!’
Required:
Draft an email to Lincoln in which you explain the various acronyms and how they came
about and the purpose of the Conceptual Framework for Financial Reporting and how it ‘fits
in’ with these various acronyms.
Question 1.3
Indicate whether the following are true or false. Where necessary, provide a brief explanation
to support your answer.
a) The IASB is responsible for ensuring compliance with the IFRSs.

b) One of the objectives of the IASB is to ensure convergence between the national
accounting standards and IFRSs.
c) Members of the IASB are appointed by the Monitoring Board.
d) The IASB develop and publish standards and interpretations.
e) The Monitoring Board is responsible for raising finance for the IFRS Foundation.
f) The members of the Monitoring Board only include representatives from the US, Europe
and Japan.
g) The IASB follows what is referred to as due-process when developing its standards. Due
process simply requires that an exposure draft be submitted to the Advisory Council for
comments before it is issued as a standard.
h) The IASB is the standard-setting body of the IFRS Foundation, publishing both standards
and interpretations where these standards and interpretations are said to have equal
authority.
2 Chapter 1
i) Compliance with IFRSs is legally enforced through the application of IAS 1.

j) There is no legal requirement in South Africa to comply with IFRSs.
Question 1.4
With reference to the Companies Act 2008, indicate whether the following are true or false
and briefly explain why:
a) All profit companies that are public companies must comply with IFRSs.
b) Profit companies that are public companies may never use IFRS for SMEs.
c) Profit companies that are not public companies and are also not state-owned may choose
between using IFRSs, IFRS for SMEs and SA GAAP.
d) Some profit companies are allowed to make up their own financial reporting standards.
e) State-owned companies must always use IFRSs.
f) Non-profit companies are not required to use IFRSs.
Question 1.5
S Mallfry is the director of BitsyBusiness Limited. He has been doing some reading into
differential reporting after having become interested in this topic due to the following excerpt
that he found on SAICA’s website regarding the new IFRSs for Small and Medium-sized
Entities (SMEs):
The long awaited final accounting requirements for Small and Medium Entities (SMEs)
has finally arrived.
Following from significant worldwide demand by users, pro-active consultation by
SAICA with South African stakeholders, as well as substantive input by SAICA to the
International Accounting Standards Board (IASBs) process, the IASB published an
International Financial Reporting Standard (IFRS) for SMEs on the 9th July 2009.
This is the first set of international accounting requirements developed specifically for
SMEs.
Required:
S Mallfry is unsure of some of the issues and terminologies that he came across whilst reading
up on this topic and has asked that you provide brief explanations to the following questions:
a) What is differential reporting and briefly explain its purpose.

b) What was significant with regard to South Africa and the IFRSs for Small and Medium-
sized Entities (SMEs) project?
c) How has the IFRSs for Small and Medium-sized Entities (SMEs) benefited the companies
it applies to? Explain the inter-relationship with other IFRSs.
d) What type of entity would an SME refer to?
e) What does public accountability mean?
Question 1.6
The rapid globalisation and resulting increased financial information requirements of global
investors from the 1950s onwards led to the need for a single global accounting language,
without which comparability of financial results of global companies seemed impossible.
Chapter 1 3
Required:
Briefly describe the history of the internationalisation of accounting standards from the 1950s
to the present day.
Question 1.7
The Companies Act 2008 includes a number of requirements that affect both the accounting
records to be kept and the financial statements.
a) How long should a company retain its accounting records and financial statements?
b) What must appear on the first page of the annual financial statements?
c) How soon must annual financial statements be prepared after the financial year-end?
d) The Companies Act 2008 requires that the annual financial statements include 3 other
documents. List these extra documents.
e) Explain what the legal requirements are regarding the approval and presentation of
financial statements.
Required:
Provide a brief answer to each of the questions posed.
Question 1.8
The financial director of Dodgywodgy Limited has always been of the opinion that his
company’s financial statements need not comply with any specific financial reporting
standards since there is no legal requirement to do so. He has heard, however, that the
Companies Act, 2008 has, in some or other way, provided legal backing for reporting
standards.
Required
Discuss the manner in which the Companies Act 2008 proposes to achieve legal backing for
accounting standards and the measures that will be in place to enforce compliance.
Question 1.9
You are employed as an IFRS consultant at The Reporting Consultancy, a firm providing
specialist financial reporting advice. You have been asked to present a high level overview of
the application of IFRS in South Africa, covering the following key points:
x The key changes in the status of SA GAAP, IFRS and IFRS for SMEs in the South
African context over the past twenty years.
x The impact that listing of a company’s shares on the stock exchange has on the choice of
financial reporting framework.
x The measures that exist to ensure endorsement and backing for IASB standards.
Required:
Prepare notes covering the above issues that will form the basis for your presentation.
4 Chapter 1
Question 1.10
On 9 September 2015, Michael Prada, Chairman of the IFRS Foundation Trustees delivered a
speech at the Eurofi Financial Forum in Luxembourg entitled “The success criteria of global
standards”. In the speech he identified three success criteria for global standards.
Required:
Access the speech on the internet at (http://www.ifrs.org/Alerts/PressRelease/Pages/Michel-

Prada-speaks-at-the-Eurofi-Financial-Forum.aspx) and discuss the three success criteria
identified.
Chapter 1 5
GAAP: Graded Questions The conceptual framework
Chapter 2
The Conceptual Framework for Financial Reporting
Question Key issues
2.1 Short questions Core concepts

2.2 Short questions Core concepts involving the characteristics, the definitions and
recognition criteria of accounting elements.
2.3 Little Lord Fauntleroy Fundamental and enhancing characteristics
2.4 Herbert Holdings Users and their needs.
2.5 - Comparison between cash and accrual basis accounting
2.6 Little Voyage Ltd .Recognition of an expense and a liability
2.7 Fleesum Recognition and disclosure of audit work
2.8 BGD Recognition of a purchased brand name
2.9 McDonalds Farm Recognition of a river: definition and recognition criteria
2.10 Brown Onion Recognition of a share issue
2.11 Lumber Jacks Recognition and measurement of the costs incurred in planting and
maintaining a tree plantation
2.12 Happy Homes Recognition of advertising
2.13 - Proposed changes to asset and liability definitions
6 Chapter 2
Question 2.1
Consider the following issues relating to The Conceptual Framework for Financial
Reporting:
a) Is the Conceptual Framework an IFRS?

b) Many users of financial statements cannot require reporting entities to provide
information which is specific to their needs, thus would they rely on general purpose
financial statements?
c) Are general purpose financial statements designed to show the value of the reporting
entity?
d) Is financial information based on exact information with the aim of minimising the use of
estimates and judgement?
e) Is the ‘matching principle’ included within the Conceptual Framework?
f) What are the fundamental qualitative characteristics?
g) When is financial information relevant?
h) What elements create faithfully represented information? Briefly discuss the elements.
i) What are the enhancing qualitative characteristics? Briefly describe each characteristic.
Required:
With reference to The Conceptual Framework for Financial Reporting, provide the answers
to the above questions.
Question 2.2
“The Conceptual Framework sets out the concepts that underlie the preparation and
presentation of financial statements for external users.”
“The Conceptual Framework deals with:

x the objective of financial reporting;
x the qualitative characteristics of useful financial information;
x the definition, recognition and measurement of the elements from which financial
statements are constructed; and
x concepts of capital and capital maintenance.”
(Extract from the Conceptual Framework: “Purposes and status” and “Scope”)
Required:
a) Explain the objective of financial reporting as outlined in the Conceptual Framework.

b) Briefly outline the qualitative characteristics of useful financial information as given in
the Conceptual Framework.
c) List the elements of financial statements provided in the Conceptual Framework.
d) Define an asset and an expense per the Conceptual Framework.
e) List the recognition criteria that must be met before an element is recognised in the
Question 2.3
Little Lord Fauntleroy is in a real state of panic! He is trying as best he can, to prepare all
g,
financial information for the current year end but is struggling to work out which information
Chapter 2 7
is more important in the financial statements. He has a short list of highly pertinent questions
which need to be solved:
a) In preparing the description of a very complex transaction he has two options:
i) to use information from a close friend who holds shares in the company: the
information prepared by his friend is somewhat biased but is very clear and concise; or
ii) to use the information prepared by an independent analyst: this information is
complex to the average person.
Which piece of information is more appropriate for use in the financial statements?
b) A transaction took place during the year which is capable of impacting the economic
decisions of the users, both currently and potentially in the future. The exact details of the
transaction are still not available but are likely to be finalised half way through the next
financial year. Should the information, in its current state, be included in the current
financial statements?
c) Two transactions took place in the year which met the definition and recognition criteria
of an expense. The transactions did, however, have a distinct difference which is
highlighted below:
i) Transaction one resulted in the decrease of the bank account, an asset; and
ii) Transaction two resulted in a loan liability being created
As Little Lord Fauntleroy was confused with the conceptual treatment of the transactions,
he examined another set of financial statements, showing non-compliance with IFRS,
which treated transaction one as an expense but transaction two as the issue of equity
preference shares. Little Lord Fauntleroy has therefore decided to follow this treatment
but is concerned it is not correct. Do you agree with the treatment?
Required:
Provide an answer, based on the Conceptual Framework, to each of Little Lord Fauntleroy’s
questions.
Question 2.4
A director of Herbert Holdings Limited has requested your help on a particular matter. He
understands that the Tax Authorities use the Income Tax Act as a guideline, and he is asking
why accountants use International Financial Reporting Standards instead. He is under the
impression that it would be “easier and would fulfil all the needs of the main user - the tax
man” if the Income Tax Act was also used as an accounting guideline.
Required:
Write a letter to the director where you discuss the users identified by the Conceptual
Framework and their information needs, and whether the Tax Authorities are considered to be
a user of accounting information.
Question 2.5
The Conceptual Framework for Financial Reporting refers to financial performance

measured by using both accrual accounting and financial performance measured by past cash
flows.
(The Conceptual Framework for Financial Reporting, October 2010, pOB17-20)
Required:
8 Chapter 2
Compare the nature of the information provided to users by accrual accounting and by past
cash flows.
Question 2.6
On 30 November 20X5, Little Voyage Limited received an invoice for C5 500 from their
travel agent, for travel that was undertaken by the directors during the year for business
purposes. The payment was made in the following financial period.
Required
Discuss whether Little Voyage Limited can recognise the transaction in the 20X5 financial
year end in terms of the Conceptual Framework.
Question 2.7
Fleesum Limited has a 28 February year-end. Fleesum’s auditors, Tikenbash, performed the
audit of the financial statements for the period ended 28 February 20X6 during March and
April of 20X6. The auditors presented Fleesum Limited with an invoice for C250 000 on
21 April 20X6.
The financial statements were authorised for issue on 30 April 20X6.
The auditors and the accountant of Fleesum Limited are currently arguing about whether or
not this invoice should be recognised in the financial statements for the year ended
28 February 20X6.
Required:
Explain, with reference to the Conceptual Framework, whether or not the invoice should be
recognised in the financial statements of Fleesum Limited for the year ended 28 February
20X6.
Question 2.8
In an effort to increase lagging sales, BGD Limited acquired a new brand for C1 500 000
from a successful start-up company that complements BGD Limited’s existing brands. Sales
have almost doubled and according to the directors this is ascribed solely to the new brand
name. Accordingly, the C1 500 000 has been capitalised as an asset.
Required:
Discuss the recognition of the C1 500 000 costs with reference to the Conceptual Framework.
Question 2.9
McDonald’s Farm needs to raise a loan from the bank to buy a new irrigation plant. The
statement of financial position, however, shows large liabilities and too few assets according
to the farmer. He tells you that the biggest asset that the farm owns does not appear in the
statement of financial position - the river that runs right through the centre of the farm.
Chapter 2 9
Required:
Discuss how the river should be recognised in the financial statements with reference to the
Conceptual Framework.
Question 2.10
Brown Onion Limited issued 100 000 ordinary shares at an issue price of C1,20 each, during
the year. The following is the journal entry passed by the accountant:
Dr Cr
Bank 120 000
Share capital 120 000
Issue of 100 000 shares at C1,20 per share.
Required:
State what element the credit entry represents. Discuss, by way of a process of elimination,
the reason for your answer. A discussion of the relevant definitions provided in the
Conceptual Framework is required.
Question 2.11
Lumber Jacks Limited is a company with a primary interest in the forestry industry. The
company purchases large tracts of land and plants scores of trees on these lands. When the
trees reach a certain age, they are either sold to a major paper milling company or to
manufacturers of cheap furniture. The company employs the best lumber jacks in the
business and also boasts the best pine wood in the country. The founder and managing
director, Jim Duggan, attributes the excellent quality of the wood to their sophisticated
planting process and regular maintenance and weed control.
You have been approached by the company to help resolve certain accounting issues
pertaining to the year ended 31 December 20X5:
x Lumber Jacks Limited bought a farm in the Mpumalanga area that is suitable for growing
pine trees. They paid for the farm and immediately started to develop the land and plant
young pine trees. This involved the construction of roads to the various planting areas,
dividing the farm into sections, and creating fire and wind breaks. Holes were also dug
into which young trees were planted and fertilised. This was done at a cost of
C100 000 per hectare.
x Once the trees were planted they had to be watered and the weeds had to be controlled.
The trees also had to be pruned to ensure that they grew straight and tall. This was an
ongoing operation with costs continually being incurred.
x After a period of approximately 10 years the trees will be ready for harvest and are
expected to yield a return in excess of 20% per annum on the costs incurred to establish
them.
x During the financial year ended 31 December 20X5, Lumber Jacks Limited developed
10 hectares at a total cost of C1 million and also spent C300 000 on watering and
maintaining the trees.
x The accountant reflected the cost of C1,3 million as an expense in the statement of
comprehensive income. The financial director, however feels that there are enough
reasons to justify the capitalisation of the C1,3 million as an asset in the statement of
financial position of Lumber Jacks Limited at 31 December 20X5.
10 Chapter 2
Required:
Discuss the appropriate recognition of the costs incurred in planting and maintaining the
plantation in the financial statements of Lumber Jacks Limited for the year ended
31 December 20X5. Specific reference should be made to the Conceptual Framework.
Question 2.12
Happy Homes Limited is a new real estate agency that specialises in finding holiday homes
for the upper middle class market. As part of its aggressive product development strategy, a
decision has been taken by the management team of the company to open a new office in
Ballito.
In order to gain market share in Ballito and achieve a strong opening, the company decided to
engage the services of renowned advertising firm Sand & Sea Inc. On 31 August 20X5 the
company paid C550 000 to Sand & Sea Inc. for the design and printing of advertising
brochures to be distributed to homes in Johannesburg and Pretoria. The brochures were
delivered on the same day. The brochures will be distributed from 1 November 20X5 until 28
February 20X6, at which point they will have distributed all the brochures.
In addition, Happy Homes Limited paid C75 000 to Ballito News for advertisements in the
newspaper, to appear during November 20X5. The amount was paid on 25 October 20X5.
Required:
Discuss, in terms of the Conceptual Framework, how these two payments should be
accounted for in the financial statements of Happy Homes Limited for the year ended
31 October 20X5.
Question 2.13
The International Accounting Standards Board (IASB) issued Exposure Draft (ED)
ED/2015/3 Conceptual Framework for Financial Reporting on 28 May 2015, which proposes
comprehensive changes to its Conceptual Framework. The ED proposes, inter alia, revisions
to the definitions of elements in the financial statements.
Required:
State the proposed new definitions of an asset and a liability and briefly discuss the changes.
Chapter 2 11
GAAP: Graded Questions Presentation of financial statements
Chapter 3
Presentation of financial statements
Question Key issues

3.2 Discussion Comparison of terms used in financial statements and the
usefulness of distinguishing comprehensive income.
3.3 Discussion Link between IAS 1 and the Conceptual Framework
3.4 Discussion Fair presentation and compliance with IFRS
3.5 Discussion Current Assets vs non-current assets
3.6 Garmin Statement of changes in equity and share capital note. (Issue of
ordinary shares and non-redeemable preference shares).
3.7 Discussion Breaches of loan covenants and offsetting assets and liabilities.
3.8 Wand Limited Statement of comprehensive income (expenses by function and
revaluation of land), Statement of financial position
(reclassification of loan) and Statement of changes in equity and
Notes (analysis of expenses by function and profit before tax):
3.9 St Andrews Statement of comprehensive income (expenses by function and
revaluation of depreciable asset), Statement of changes in equity,
and Notes (statement of compliance, profit before tax and
dividends declared after year end)
3.10 Nordic Statement of comprehensive income (expenses by function and
write-down of inventory), Statement of financial position
(borrowings only), Notes (statement of compliance, profit before
tax and dividends declared after year end)
12 Chapter 3
Question 3.1
a) State the purpose of financial statements per IAS 1 Presentation of Financial Statements.
b) List the five statements that make up, at a minimum, a complete set of financial
statements.
c) The statement of comprehensive income is separated into two sections: profit or loss and
other comprehensive income and concludes with total comprehensive income. Define
each of these three terms.
d) List the general features as set out in IAS 1 Presentation of Financial Statements.
e) Fair presentation, which is listed in IAS 1 as a general feature, is the same as ‘faithful
representation’, which is listed in the Conceptual Framework as a fundamental qualitative
characteristic. True/ False? Explain.
f) If one wishes to be able to conclude that the financial statements comply with IFRSs,
departure from IFRSs is expressly prohibited. True/ False. Explain.
g) It is management’s responsibility to ensure that the entity is a going concern. True/ False?
Explain.
h) Explain the difference between the nature method and the function method.
Required:
Provide the answers to the above questions using the guidance found within IAS 1
Presentation of Financial Statements.
Question 3.2
IAS 1 Presentation of Financial Statements requires a statement of comprehensive income to

be presented as part of a complete set of financial statements.
Required:
a) Define and explain the difference between the terms profit or loss, other comprehensive
income and total comprehensive income.
b) Discuss the benefits of a statement of comprehensive income in providing useful
information to users.
Question 3.3
“Fair presentation requires the faithful representation of the effects of transactions, other
events and conditions in accordance with the definitions and recognition criteria for assets,
liabilities, income and expenses set out in the Framework.”
(IAS 1, paragraph 15)
Required:
Discuss the implications of the above quote in the context of the relationship between the
Conceptual Framework and IFRS (International Financial Reporting Standards).
Question 3.4
IAS 1 Presentation of Financial Statements states that “financial statements shall present
fairly the financial position, financial performance and cash flows of an entity. The
application of IFRSs, with additional disclosure when necessary, is presumed to result in
financial statements that achieve a fair presentation.”
Chapter 3 13
Required:
Discuss the issues relating to fair presentation and compliance with International Financial
Reporting Standards. Your answer should address the following:
x the requirements for fair presentation to be achieved,
x inappropriate accounting treatments, and
x where management believes that departure from a requirement in a statement is necessary.
Question 3.5
"Each entity shall present current and non-current assets, and current and non-current
liabilities, as separate classifications on the face of its statement of financial position . . .
except where a presentation based on liquidity provides information that is reliable and more
relevant."
Required:
a) List the criteria applied by IAS 1 in classifying assets as current or non-current.
b) List the criteria applied by IAS 1 in classifying liabilities as current or non-current.
c) Discuss what is meant by the operating cycle of a business.
d) State the classification of inventories that are not expected to be realised within twelve
months of the financial reporting date.
e) State the classification of accounts payable that are not expected to be settled within
twelve months of financial reporting date.
f) Discuss your answers to (d) and (e) above from the perspective of the users of financial
statements.
Question 3.6
Garmin Limited has the following capital structure at 1 January 20X5:
Authorised share capital Qty

Ordinary shares of no par value 300 000
12% Preference shares of no par value 100 000
10% Preference shares of no par value 100 000
500 000
Shareholders equity C
Ordinary shares (120 000 issued) 170 000
12% Preference shares (100 000 issued) 100 000
Revaluation surplus 50 000
Retained earnings 140 000
460 000
x The preference shares are non-redeemable.

x The following information relates to the year ended 31 December 20X5:
x A new share issue of 80 000 ordinary shares at C1,20 each, of which the Managing
Director purchased 1 500 shares.
x A new share issue of 50 000 10% non-redeemable preference shares at C1,50 each
x Profit for the period amounts to C70 000.
x Interim dividends of C5 000 were declared on 30 June 20X5. No final dividend was
declared.
14 Chapter 3
x Property, plant and equipment was revalued upwards by C30 000. This revaluation
surplus had no tax effect
x There were no other movements in other comprehensive income during the year.
Required:
Disclose the above information in the statement of changes in equity and the note to share
capital in the financial statements for the year ended 31 December 20X5 in terms of
International Financial Reporting Standards.
Accounting policies are not required.
Question 3.7
You have been asked to help provide the answers to the following questions:
a) An entity holds a long term loan, classified at year end as a non-current liability. The loan
has a covenant attached to it which is tested annually at its financial year-end. If the
covenant is breached the loan is repayable on demand. After reporting date, but before
the date the financial statements are authorised for issue, the financial director realises that
the covenant was, in fact, breached at year-end. Should the loan, having been presented
as non-current at the financial year-end, be reclassified as a current liability?
b) Two entities, Entity A and Entity B, owe each other C1 000 000. In the event of either
party going insolvent (liabilities exceeding assets) the debts due will be settled net.
Neither party was insolvent at year end. Can the liabilities and assets be offset?
Required:
Provide the answers to the questions posed.
Question 3.8
Wand Limited is a company retailing in children’s toys. The bookkeeper has prepared the
following draft trial balance at 28 February 20X8:
WAND LIMITED
TRIAL BALANCE AT 28 FEBRUARY 20X8
Debit Credit
Land 130 000
Equipment (Carrying amount) 40 000
Vehicles (Carrying amount) 30 000
Inventories 129 000
Bank 3 000
Accounts receivable 150 000
Electricity and water prepaid – 1/3/20X7 1 000
Cost of sales expense 142 500
Depreciation expense 100 000
Salaries and wages expense 250 000
Electricity expense 25 000
Interest expense 9 500
Rates expense 10 000
Income tax expense 17 500
Long-term borrowings 54 000
Current tax payable 29 500
Accounts payable 62 750
Salaries and wages payable – 1/3/20X7 2 000
Chapter 3 15

Retained earnings – 1/3/20X7 100 250
Revaluation surplus on land 52 500
Revenue from sales 600 000
1 037 500 1 037 500
The following additional information has not yet been taken into account:
x The land was revalued by C50 000 during the current year. There are no tax
consequences relating to this revaluation surplus.
x Half of the long-term borrowing is repayable on 31 August 20X8. There is no provision
to roll over this loan.
x Wand Limited uses the function method to allocate expenses into the categories of
marketing, distribution and administration.
x Salaries and wages are to be split between marketing, distribution and administration on a
37,5:25:37,5 basis. Advances of C500 have been paid to employees in respect of the
following year’s wages.
x Rates should be allocated between marketing, distribution and administration on the basis
of floor area used: the marketing department uses 25% of the floor area, the distribution
department 15% and the administration department the balance.
x Electricity and water should be allocated between the marketing, distribution and
administration departments in the ratio of 40:30:20. Electricity of C2 000 is unpaid at
28/2/20X8.
x Depreciation comprises depreciation on office equipment (30%) and depreciation on
vehicles (70%). The office equipment is used equally by marketing and administration.
Depreciation on vehicles constitutes 80% delivery vans (considered a distribution
expense) and 20% depreciation on directors’ company vehicles (considered to be an
administration expense).
x There is no other movement in other comprehensive income during the year other than
that which is evident from the information provided.
Required:
Prepare the statement of comprehensive income and the statement of changes in equity for the
year ended 28 February 20X8 and the statement of financial position at that date in
accordance with IAS 1 Presentation of Financial Statements. Only the following notes are
required:
x Analysis of expenses by function
x Profit before tax
Ignore comparatives and value-added tax.
Question 3.9
St Andrews Limited is a retailer listed on the Johannesburg Securities Exchange’s AltX

Listing. The following information has been given to you:
16 Chapter 3
x The authorised share capital comprises 10 000 000 ordinary shares of no par value.
1 000 000 shares were issued at C1 on 30 November 20X5. At 28 February 20X6 there
are 3 000 000 shares in issue.
x The land and buildings are used for the supply of goods and for administration purposes.
The buildings were revalued on 28 February 20X6 to a fair value of C6 720 000. This
represented an increase of C160 000 over the previous carrying amount. This has already
been processed. There are no deferred tax consequences from this revaluation.
x All property, plant and equipment is depreciated using the straight-line method.
x The building is 320 square metres in area, of which 180 square metres are used for the
warehouse (used to store goods prior to despatch) and the remaining 140 square metres is
used as the company head office.
x The equipment consists of items used in the despatch area and office equipment. The
office equipment accounts for 60% of the depreciation of equipment and the balance
relates to depreciation of the equipment used in the despatch area.
x C570 000 of the salaries and wages relates to the employees hired in the despatch area and
C642 000 relates to employees employed in the head office.
x Postage and packaging for purposes of safe transport relate purely to the despatch area.
x Telephone of C27 000 was incurred during the year. Of this, C15 000 was incurred in the
despatch department and C12 000 was incurred in the head office.
x Electricity of C51 000 was incurred during the year. Of this, C35 000 was incurred in the
despatch department and C16 000 was incurred in the head office.
x Dividends of C100 000 were declared on 18 March 20X5 in respect of the year ended
28 February 20X5. Dividends of C150 000 were declared on 15 March 20X6 in respect
of the year ended 28 February 20X6.
x The income tax expense for the year ended 28 February 20X6 is C353 220. This expense
has not yet been recorded.
The trial balance of the company at 28 February 20X6 is shown below:
ST ANDREWS LIMITED
Debit Credit
Ordinary share capital 4 000 000
Retained earnings 1 250 000
Dividends 100 000
Land: cost 140 000
Buildings: cost 8 000 000
Buildings: accumulated depreciation 1 280 000
Equipment: cost 500 000
Equipment: accumulated depreciation 200 000
Long term borrowings 1 100 000
Inventory 258 000
Bank 131 000
Sales 10 500 000
Cost of sales 7 500 000
Depreciation – buildings 160 000
Depreciation – equipment 100 000
Salaries and wages 1 212 000
Postage of marketing pamphlets 20 000
Chapter 3 17
Packaging for purposes of safe transport 30 000

Telephone 27 000
Electricity 51 000
Finance costs 140 000
18 631 000 18 631 000
Required:
a) Prepare the statement of comprehensive income of St Andrews Limited for the year ended
28 February 20X6 in conformity with International Financial Reporting Standards and
using the function method.
b) Prepare the statement of changes in equity of St Andrews Limited for the year ended
28 February 20X6 in conformity with International Financial Reporting Standards.
c) In so far as information is available, prepare the following notes to the financial
statements for the year ended 28 February 20X6 in conformity with International
Financial Reporting Standards:
x Statement of compliance,
x Basis of preparation,
x Profit before tax, and
x Dividends declared.
Ignore comparatives and value-added tax.
Question 3.10
Nordic Limited is a company that distributes a range of thermal and fleece clothing to
retailers around the country. The company is listed on the AltX. You have been provided
with the following information together with a draft trial balance at 31 March 20X6:
x The ordinary share capital consists of 2 000 000 shares.
x The net realisable value of the inventory at the reporting date was estimated at C2 080 000
and thus a write-down of C120 000 was required. This has not yet been processed.
x The borrowings represent a loan of C900 000. The loan agreement was signed on
1 October 20X5 and is repayable in three equal annual arrear instalments. Interest on the
loan is at 12% and payable on the first day of each month. The first instalment is due to
be paid on 30 September 20X6. The existing loan agreement provides Nordic Limited
with the option to refinance the first instalment for a further seven months and the
directors exercised this option before the end of the current reporting period.
x Nordic Limited classifies expenses according to their function. The financial director
categorises the functions of the business into three areas, namely sales, distribution and
administration.
x The distribution department specially wraps all items in a protective wrapping before the
items are shipped. The goods are transported by an independent road transport entity to
the retailers.
x The administrative department issue stationery, provide refreshments and are responsible
for the cleaning of the head office.
x The depreciation expense is allocated C50 000 to distribution and C25 000 to
administration. The salaries are allocated C250 000 to distribution and C450 000 to
administration. The bad debts are a distribution expense and the donations are an
administration expense. The income tax expense has been correctly calculated at
C180 000.
18 Chapter 3
x A final dividend of C75 000 was declared on 15 April 20X6. No interim dividends were
declared.
x There are no components of other comprehensive income.
x The financial statements have not yet been authorised for issue.
x The draft trial balance of Nordic Limited at 31 March 20X6 is as follows:
NORDIC LIMITED
TRIAL BALANCE AT 31 MARCH 20X6
Debit Credit
Equipment: carrying amount 6 800 000
Inventory 2 200 000
Bank 370 000
Borrowings 900 000
Sales 12 100 000
Packing expense 300 000
Road transport costs 232 000
Stationery expense 436 000
Staff canteen expenses 213 000
Cleaning expenses 110 000
Depreciation: equipment 75 000
Salaries 700 000
Bad debts 10 000
Donations 50 000
Finance cost 54 000
Profit on the sale of equipment 400 000
22 100 000 22 100 000
Required:
a) Prepare the statement of comprehensive income of Nordic Limited for the year ended
31 March 20X6 in conformity with International Financial Reporting Standards.
b) Show how the borrowings are disclosed on the statement of financial position of Nordic
Limited at 31 March 20X6 in conformity with International Financial Reporting
Standards.
c) In so far as information is available, prepare the relevant notes to the financial statements
of Nordic Limited for the year ended 31 March 20X6 in conformity with International
Financial Reporting Standards.
The statement of compliance note is required.

No accounting policy notes are required.
The revenue note is not required.
The statement of financial position notes are not required.
Ignore comparatives.
Chapter 3 19
GAAP: Graded Questions Revenue from contracts with customers
Chapter 4
Revenue from contracts with customers
Question Key issues

4.1 Short questions Core concepts: theory
4.2 Orchard Core concepts: calculating the transaction price involving:
- settlement discounts
- rebates
- financing components
4.3 Spry TP: involving a settlement discount (settlement discount is forfeited)
PO: satisfied at a point in time
4.4 Destination Comparison of terms: receivable, contract asset and contract liability
Recognition of the asset: receivable or contract asset
Timing of recognition of revenue and the related asset:
- cancellable contract versus
- non-cancellable contract
4.5 Space Part A: Contract is cancellable
- Variable consideration: discount – granted versus not granted
Part B: Contract is non-cancellable
- Variable consideration: discount – granted versus not granted
4.6 Treasure Part A:
- TP involving a rebate (variable consideration)
- PO satisfied over time
- Refund liability
Part B:
- TP involving a rebate (variable consideration): Variable
consideration changes
- PO satisfied over time
- Refund liability
4.7 Megatim Collectability issues – impairments for credit losses (doubtful/ bad debts):
Part A: Collectability concerns only arise after inception
Part B: Collectability concerns exist at inception (price concession versus
impairment for credit loss) and get worse after inception
4.8 Lexer a) Identification of performance obligations
b) Bill and hold sale (insignificant)
c) Bill and hold sale (significant) resulting in contract modification
4.9 AB Contractors Contract involves services over a 3-year period
Part A: Services considered to be three separate POs (satisfied at a point in
time – no stand-alone selling prices available)
Part B: Services considered to be one single PO (satisfied over time)
4.10 Shops Sale of goods involving:
Part A: Warranty
Part B: Right of return
4.11 Gripper Butchery TP: involves volume rebates and advance payments
4.12 Fleet Street TP: allocation of a discounted TP to POs in a bundle
4.13 Fitness Limited Contract involves two fees (joining and membership) and a financing benefit
Contract provides gym access and renewal option
Option to renew provides customer with services similar to original contract
20 Chapter 4
Question Key issues continued …
4.14 Taver Construction Variable consideration and calculation of significant financing component
4.15 Coolio Refund liability, sale with right of return and journals for actual returns
4.16 Macrohard Identification of performance obligations
Allocation of TP and discount based on stand-alone prices
4.17 Your People Advance payment
Allocation of transaction price to multiple performance obligations
4.18 Supasave & Customer loyalty programme
Nu-Kinekor
4.19 BlackRock Multiple performance obligations involving goods and services
4.20 Caravan Instalment sale transaction with significant financing component
4.21 Network TV Allocation of discounted TP to multiple performance obligations
4.22 JP Construct Construction contract with advance payments
Chapter 4 21
Question 4.1
a) Define the term ‘revenue’ and briefly explain how it differs from the term 'income'.
b) State whether the following is true or false and briefly explain your answer:
IFRS 15 applies to the recognition and measurement of revenue from all contracts
involving customers.
c) Briefly outline the process involved in the recognition and measurement of revenue?
d) Define the term 'customer' in terms of IFRS 15.
e) Define the term 'contract' in terms of IFRS 15.
f) Briefly explain how we would account for a receipt from a customer if we concluded that
the definition of a contract was not met?
g) Describe the criteria that must be met when identifying a contract that would fall within
the scope of IFRS 15.
h) Define the term 'performance obligation' in terms of IFRS 15.
i) Define the term 'transaction price' in terms of IFRS 15.
j) Calculate the transaction price and briefly explain your answer assuming that the contract
price is set at C120 000 and that, based on the customer’s credit risk profile at contract
inception, the entity expects that C30 000 of the contract price will not be recoverable.
k) What does IFRS 15 mean by 'constraining estimates' and in what context is the process of
constraining an estimate necessary?
l) Briefly describe the two-step process involved in calculating the amount of the variable
consideration to be included in the transaction price.
m) Briefly explain when a contract is said to contain a 'financing component'.
n) Describe under what circumstances the existence of a financing component would or
would not affect the determination of the transaction price.
o) Briefly explain how to calculate how much of a transaction price relates to the financing
component of the contract.
p) When calculating the cash price of a transaction, we must calculate the present value of
the consideration to which the entity expects to be entitled, discounted at an appropriate
rate. Briefly explain how to determine an appropriate discount rate.
q) In one sentence, explain what is meant by the allocation of a transaction price.
r) In one sentence, briefly describe how a transaction price is normally allocated (assuming
it does not include variable consideration or an inherent discount).
s) In one sentence, briefly explain when revenue is recognised.
t) Performance obligations can be classified based on how they are satisfied. List these
classifications.
u) Which type of performance obligation would require us to measure the entity's 'progress
towards complete satisfaction of a performance obligation'?
v) Describe the two methods of measuring progress and give an example of each.
w) Identify the essential difference between the two methods of measuring progress.
x) What is the essential difference between a contract asset and a receivable?
Required:
Answer the above short questions.
Question 4.2
Orchard Limited entered into four separate revenue transactions with four different customers
on 1 January 20X3, details of which, determined at contract inception, are presented below:
22 Chapter 4
Customer A Customer B Customer C Customer D

Contract price C350 000 C350 000 C350 000 C350 000
Early settlement discount Note 1 10% N/A N/A N/A
Rebate Note 2 N/A C140 000 N/A N/A
Goods delivered 01/01/20X3 01/01/20X3 01/01/20X3 01/01/20X3
Payment due 31/01/20X3 31/01/20X3 30/06/20X3 31/12/20X4
Note 1. Orchard expects customer A to pay within the required period and thus to qualify for
the settlement discount.
Note 2. The rebate offered to customer B is dependent on customer B complying with certain
terms and conditions. Orchard expects that the customer will comply with these terms
and conditions and thus that the rebate will be granted. This rebate is considered to be
a price reduction.
The appropriate discount rate, determined at contract inception, is 10%.
Required:
a) Calculate the transaction price for the contract involving customer A, provide the
journal/s and briefly explain your answer.
b) Calculate the transaction price for the contract involving customer B, provide the
journal/s and briefly explain your answer.
c) Calculate the transaction price for the contract involving customer C, provide the
journal/s and briefly explain your answer, assuming:
i) The effect of financing is considered to be insignificant;
ii) The effect of financing is considered to be significant.
d) Calculate the transaction price for the contract involving customer D, provide the
journal/s and briefly explain your answer, assuming:
i) The effect of financing is considered to be insignificant;
ii) The effect of financing is considered to be significant.
Question 4.3
Spry Limited entered into a sale agreement with Power Limited on 3 March 20X3:
x The terms of the agreement were that Spry will:
supply 3 300 light fittings to Power in exchange for C330 000;
grant a 10% early settlement discount for full payment received before 3 May 20X3.
x On 3 March 20X3, Spry Limited fully anticipated that it would receive payment within
the required period and thus that the discount offered would be granted.
x Spry Limited:
delivered the light fittings to Power Limited on 5 April 20X3; and
received the payment due from Power Limited on 31 May 20X3.
Required:
a) Using Spry Limited’s general journal, prepare all journals necessary for the year ended
31 December 20X3. Ignore tax.
b) Provide a brief explanation to support your journals.
Question 4.4
Destination Limited entered into an agreement on 5 January 20X3 to supply 420 000 widgets
to a customer in exchange for C420 000, to be paid in full on 20 January 20X3. Destination
Limited delivered the widgets on 31 January 20X3, but at 28 February 20X3, its financial
year-end, Destination has still not received any payment from the customer.
Chapter 4 23
The accountant has processed the following journal entry to account for this information.
Debit Credit
5 January 20X3
Receivable (A) 420 000
Revenue from customer contract Transaction price 420 000
Revenue from customer contract satisfied at a point in time
The financial director is concerned that this journal should not have been processed at
5 January 20X3 but that it should have been processed on 20 January 20X3, instead, and at
which point a contract asset should have been debited instead of a receivable.
Required:
a) Provide the definitions for the terms 'contract asset', 'receivable' and 'contract liability' and
then briefly identify the essential difference between these items.
b) List the steps that must be followed before revenue may be recognised in terms of
IFRS 15 Revenue from contracts with customers.
c) Prepare a document that explains whether the director is correct that a contract asset
should be recognised instead of a receivable.
d) Prepare a document explaining when the revenue should be recognised, and showing the
journal/s that you believe should have been processed, assuming:
x the contract is cancellable; and
x the contract is non-cancellable.
Question 4.5
Part A:
Space Limited signed a sales agreement with a customer on 1 May 20X1, the terms of which
are as follows:
x Space Limited will supply 32 000 widgets to the customer;
x The contract price is C1 per widget;
x The total contract price is due and payable by the customer on 18 May 20X1.
The customer requested a 10% discount when signing the contract. However, the sales
representative who was assisting the customer did not have the necessary authority to grant
the discount but managed to convince the customer to sign the contract anyway and assured
him that he would speak to his manager to try to secure the requested discount.
At contract inception, it was considered likely that the customer would be granted the discount.
The batch of widgets was delivered to the customer on 31 May 20X1 and the customer settled
his balance on 4 July 20X1.
The contract is cancellable.
Required:
Prepare all journals relevant to the information provided above assuming that on 4 July 20X1:
a) A decision was made to grant the discount.
b) A decision was made to not grant the discount.
Part B:
Use the same information as that provided in part A with the exception that the contract is
non-cancellable.
24 Chapter 4
Required:
Prepare all journals relevant to the information provided above assuming that on 4 July 20X1:
a) A decision was made to grant the discount.
b) A decision was made to not grant the discount.
Question 4.6
Part A:
Treasure Limited entered into a contract with a customer on 1 January 20X1, agreeing to
provide cleaning services over a two-month period, ending 28 February 20X1. The contract
price was set at C100 000.
At contract inception, Treasure Limited estimated that the customer will qualify for a rebate
(price reduction) of C40 000. Whether or not the customer will obtain a rebate depends on
whether the customer can produce certain documentation before 28 February 20X1.
Treasure Limited provided the services for the months of January and February 20X1.
The customer made a partial payment of C70 000 on 5 February 20X1 but had still not
presented Treasure Limited with the required documentation by 28 February 20X1.
Required:
a) Show the journals that Treasure Limited must process relating to the information
presented above. Treasure Limited has a 28 February year-end.
b) Explain the reasoning behind each of your journals with reference to IFRS 15 Revenue
from contracts with customers.
Part B:
Treasure Limited entered into a contract with a customer on 1 January 20X1, agreeing to
provide cleaning services over a three-month period, ending 31 March 20X1. The contract
price is C300 000.
Treasure Limited offers rebates depending on the customer’s BEE ratings, for which the
customer needs to produce key documentation within a certain period of time. The rebate on
this particular contract could be C120 000, C90 000 or nil. At contract inception, Treasure
expects that the customer will qualify for a rebate of C120 000.
Treasure provided the services for the months of January and February 20X1.
The customer presented the necessary documentation on 2 February 20X1. Upon an analysis
thereof, it was determined that this customer qualified for a rebate of C90 000.
Required:
a) Show the journals that Treasure Limited must process relating to the information
presented above. Treasure Limited has a 28 February year-end.
b) Explain the reasoning behind each of your journals with reference to IFRS 15 Revenue
from contracts with customers.
Question 4.7
Megatim Limited entered into a cancellable contract with a customer on 1 January 20X2 for
the supply of 200 000 dongles at C2,75 each.
Chapter 4 25
The customer took delivery on 31 January 20X2, but on 15 February 20X2, a letter was
received from the customer's legal representative indicating that the customer had gone into
provisional liquidation. The letter explained that the customer would be able to pay a
maximum of 40% of the contract price.
The customer was experiencing cash flow problems and, as a result, had not made any
payments by the year ended 30 June 20X2 and then made payment of C82 500 on
5 July 20X2. The remainder of the balance owing was considered to be a bad debt.
Part A:
Assume that, at contract inception there had been no indication of a possible credit loss.
Required:
Using Megatim Limited's general journal, prepare all journal entries to account for the above
information for the financial year ended 31 August 20X2.
Part B:
Assume that, at contract inception, the entity was aware of the customer’s pre-existing cash
flow problems and expected that the customer would only pay only an estimated C385 000.
Required:
Using Megatim Limited's general journal, prepare all journal entries to account for the above
information for the financial year ended 31 August 20X2, assuming that the uncertainty at
contract inception regarding the payment of the remaining C165 000 is to be accounted for as:
a) a price concession.
b) a collectability issue.
Question 4.8
Lexer Limited manufactures specialised plant and equipment for manufacturing companies
across the country. On 15 October 20X0, Lexer Limited entered into an agreement with
Klim Limited to design and construct a plant, which Klim Limited will be installing on a local
oil rig. The contract price was set at C770 000.
The plant was designed by 30 November 20X0 and the manufacture thereof was complete on
2 January 20X1. Klim immediately sent a team of engineers to inspect the plant. The
inspection revealed that certain of the plant’s required specifications had not been met. Lexer
immediately went to work to rectify the situation.
The subsequent inspection by Klim, on 8 January 20X1, found that all problems had been
rectified, at which point, Klim immediately signed all paperwork thus obtaining legal title
over the plant, Lexer presented Klim with an invoice and Klim made full and final payment.
However, owing to delays in the construction of the oil rig, Klim requested that Lexer retain
the plant for a few more days until the construction of the oil rig had been completed. Lexer
has agreed to store the plant in the secure storage area of the company warehouse, which the
company dedicates to storage of completed plant and equipment awaiting collection by
customers. Lexer normally charges a fee of C5 000 per month for storage, but since Klim is a
long-standing and valuable customer, Lexer agreed to waive this extra cost.
Required:
a) Discuss in detail whether the promise to design the plant and the promise to manufacture
the plant would be considered to be one or two performance obligations.
26 Chapter 4
b) Discuss how Lexer Limited should account for this contract in its financial statements for
the year ended 28 February 20X1.
c) Discuss how your answer to (b) would change if Klim Limited requested Lexer Limited
to store the plant for a 6-month period ending 30 June 20X1 (i.e. not just for a few days).
Question 4.9
Part A:
On 1 January 20X8, AB Contractors signed a contract with a customer agreeing to provide
services over a 3-year period at a contract price of C48 000, payable in advance.
x The estimated costs of providing the annual services is as follows:
C12 000 for the first year,
C18 000 for the second year and
C27 000 for the third year.
x A reasonable mark-up on cost is considered to be 20%.
x The effect of any financing benefit is considered to be insignificant.
x Assume the following:
All services are performed at year-end.
The three annual services are considered to be three separate performance obligations.
Required:
Prepare the journal entries that AB Contractors should process for the year ended
31 December 20X8 in order to account for the three-year service contract.
Part B:
Use the same information given in Part A, except that the contract involves the provision of
car engine maintenance services over a 3-year period for a fee of C48 000 (in other words, the
contract does not separately identify each service). Each chronological service has been
carefully designed to attend to different aspects of the vehicle engine as it ages and thus it is
imperative that the services are performed timeously and in the correct sequence.
Required:
To the extent that information is available, show the journals that AB Contractors would need
to process for the year ended 31 December 20X8 in order to account for the three-year
maintenance contract referred to above.
Question 4.10
Part A:
Shops Limited, a retailer, sold goods to a customer on 1 January 20X9. The selling price of
C300 000 was received and the customer took delivery on the same day. Shops Limited
deposited this money into their current account. This bank account pays interest at 3,5% per
annum. The money remained in the deposit for the entire year. The cost of the inventory
(using a weighted average cost formula) is C87 000.
The product comes with a 9-month warranty:
x If the item is found to be defective and is thus returned in terms of the warranty, the
C300 000 plus 2% interest earned will have to be returned to the buyer. As this is the first
time Shops Limited has entered into a transaction with a warranty, they had no past
experience on which to assess the probability of return.
x The warranty expired on 1 October 20X9 without the goods having been returned.
Chapter 4 27
Required:
Prepare the journal entries to record this transaction for the year ended 31 December 20X9 in
terms of the relevant International Financial Reporting Standards.
Part B:
Use the information provided in Part A except for the information regarding the 9-month
warranty. Instead of the product being sold with a 9-month warranty, it is sold with a 9-month
right of return, details of which are as follows:
x The goods sold may be returned for exchange with any other product or for a full refund.
x As this is the first time Shops Limited has entered into a transaction with a right of return,
they have no past experience on which to assess the probability of return.
x The right of return expired on 1 October 20X9 without any goods having been returned.
Required:
Prepare the journal entries to record this transaction for the year ended 31 December 20X9 in
terms of the relevant International Financial Reporting Standards.
Question 4.11
The Gripper Butchery sells burger patties to restaurants in the Johannesburg area. The
company has a large client base and has not experienced any problems meeting its obligations
towards clients. The company provides its major clients with a rebate system whereby the
prices per unit declines as the volumes ordered increase.
The pricing model in use is as follows –
Annual volumes (units) Price per unit
0 – 500 000 C6,00
500 001 – 999 999 C5,75
1 000 000 + C5,40
During January 20X9, the company’s 3 major clients ordered the following volumes
Client Volumes ordered Expected annual volumes
(units) (units)
Mickey Donalds 184 000 2 225 000
Woompy 99 000 980 000
Primis 34 500 475 800
Generally, Gripper Butchery invoices its clients as soon as the patties are delivered. However,
Primis has paid a consideration of C1 600 000 in January as they anticipate they will be
making a substantial number of orders during the next few weeks.
Required:
Prepare the journal entries that Gripper Butchery should process in January 20X9 in order to
account for the information provided above.
Question 4.12
Part A:
The Fleet Street Company is a media company that owns various newspaper and magazine
titles that are distributed throughout the country. The company sells each of its titles based on
readily available selling prices.
28 Chapter 4
Its most popular titles, and the related stand-alone selling price for each, are as follows:
Title Selling price
Vuvuzela magazine C25
Dabble magazine C18
Special edition newspaper C12
Mainstream newspaper C14
Digital newspaper Not sold on its own
The company offers two types of bundles: a magazine bundle (i.e. containing Vuvuzela and
Dabble) that retails for C39 and the newspaper bundle (i.e. containing the Special Edition and
Mainstream newspaper) that retails for C21.
During the festive season, the company offered its customers a chance to buy a bundle of all
the newspaper and magazine titles for a fee of C63. This offer, which is marketed as the
Festive Bundle, also includes one-month’s access to the digital newspaper. The digital
newspaper was launched during the festive season and has never been sold on its own before.
The company estimates that the cost of providing access to the digital newspaper is C3 for
each user. A profit margin of 16% is considered appropriate.
Required:
a) Show how the transaction price for the magazine bundle, the newspaper bundle and the
festive bundle should be allocated.
b) Briefly explain how the prices of each of the three bundle prices are allocated.
Part B:
Use the same information as provided in Part A, together with the following:
During December 20X1, a total of 100 festive bundles were sold, all for cash. All the items
within the bundle, with the exception of the Vuvuzela magazine and the Digital newspaper,
had been posted to the customers by 31 December 20X1.
x The Vuvuzela magazine is only published every 2 months with the next edition due to be
published on 10 January 20X2 and thus the 100 customers who purchased the Festive
bundle in December 20X1 will receive their Vuvuzela magazines in January 20X2.
x The Digital newspaper is provided for a period of one month from the date on which the
Festive bundle was purchased. Customers purchased their Digital newspapers at various
stages during the month. It was estimated that, on average, 60% of the promised access to
the digital newspaper had been provided by 31 December 20X1.
Required:
Prepare the journal entry to account for the receipt from the sale of 100 festive bundles during
the financial year ended 31 December 20X1.
Question 4.13
Fitness Limited began operations in 20X7. The company operates nine gyms around the
country (one in each province). The gyms are specifically designed to meet the fitness needs
of busy women and offer a trademark ‘30 minute workout for women’.
Until recently, the company charged members per workout at C10 a workout. In 20X8, due to
the growing demand, a membership scheme was introduced:
x New members are charged a non-refundable once-off joining fee of C100 and an annual
membership fee of C1 500 per member.
Chapter 4 29
x Both the joining fee and the annual membership fee are paid upfront by members.
x The membership period is from 1 January to 31 December each year.
x The membership fee remains the same regardless of what time of year the member joins.
x In exchange, members get unlimited use of the gym facilities during the period ending
31 December. The cost of providing access to a member is estimated at C720 per annum.
x Members are given the option to renew their contracts for another year. The last day for
paying for renewal of memberships is 31 January. Members who renew by the due date
are able to pay 80% of the membership fees for the year.
Fitness Limited sold 300 memberships countrywide during 20X8 (spread across 9 branches).
It is anticipated that 55% of the members will renew their membership before 31 January and
qualify for the reduced membership fees.
The following amounts were received for the year ended 31 December 20X8:
Joining fees received C30 000
Annual membership fee income C450 000
Income from non-members C200 000
The accountant of Fitness Limited is inexperienced but overconfident and, instead of seeking
advice, has gone ahead and recognised all joining and membership fees as revenue on receipt.
Required:
Discuss, with reasons, the appropriateness of the recognition and measurement of joining fees
and membership fees adopted by Fitness Limited, in terms of IFRS 15 Revenue from
Contracts with Customers. Your answer should address each of the following:
a) An introduction briefly explaining whether or not the recognition of the receipt of the
joining fees and membership fees as revenue on the date of receipt was correct.
b) Identification of the transaction price together with a brief explanation.
c) Identification of the performance obligation/s in the contract, with a brief explanation.
d) Allocation of the transaction price to the performance obligation/s, with a brief explanation.
e) The journals that will be processed for the years ended 31 December 20X8 and 20X9.
(Source: SAICA QE 2010 paper 1 question 3: Adapted)
Question 4.14
Part A
Taver Construction entered into an agreement with Prancer Properties for the construction of
a shopping centre in Johannesburg for C8 000 000.
The contract includes a performance bonus of C800 000 (10% of the contract price) if the
shopping centre is completed within 24 months. The terms of the contract stipulate that
Prancer Properties will be required to make monthly progress payments during the period of
construction and that, if it fails to make these payments on due date, Taver Construction
would be entitled to 100% of the contract price if it completes the construction.
At contract inception, and after finalising the construction schedule, Taver Construction
believes there is a 95% chance the construction will be completed on time and that the
company will qualify for the entire bonus amount.
Required:
Discuss how Taver Construction should calculate the transaction price from the contract with
Prancer Property Holdings for the year ended 31 December 20X9.
30 Chapter 4
Part B
Taver Construction sold idle construction machinery in January 20X9 to Groove Property
Holdings, a new start-up company in the construction sector.
The machinery had a cash selling price of C750 000 but was sold to Groove Property
Holdings for C960 000. Groove Property Holdings will pay for the machinery in 3 equal
instalments at the end of each year.
Required:
a) Discuss how Taver Construction should calculate and allocate the transaction price from
the contract with Groove Property Holdings for the year ended 31 December 20X9.
b) Prepare the journal entries to account for the contract with Groove Property Holdings for
the year ended 31 December 20X9.
Question 4.15
Coolio Traders sold inventory on 1 March 20X9 to Sisqo Ltd for C307 800 (including VAT).
The inventory had a cost of C135 000. This customer must pay for the inventory 24 months
after delivery. The product is sold subject to a right of return up to 3 months after the date of
sale. Coolio estimates that 5% of goods sold will be returned for a full refund. It is expected
that the cost to recover the returned stock (including an allowance for loss of value) is 6% of
the original cost of the stock. The appropriate discount rate is an effective 8% per annum and
the VAT rate is 14%.
Required:
a) Prepare the journal entries for Coolio Traders to account for the sale of the inventory to
the customer. Provide a brief explanation for the journals.
b) Prepare the journal entries for Coolio Traders to account for the return of the inventory on
the assumption that the customer returns -
i. nothing within the 90-day period.
ii. 5% of the goods within the 90-day period.
iii. 3% of the goods within the 90-day period.
iv. 7% of the goods within the 90-day period.
Question 4.16
Macrohard is a supplier of computer software. Macrohard sold software to the Congolese

branch of an international, blue chip company called Plentyhandle.
Plentyhandle and Macrohard are business partners: Plentyhandle contracts only with
Macrohard for their computer software requirements.
A C1 million sale contract was signed on 22 December 20X6. Part of the sale agreement
involves Macrohard providing a software license, successfully installing the software at the
Congolese branch of Plentyhandle, and providing maintenance services for three years
whereby Macrohard will be expected to provide backup whenever needed. The three-year
maintenance programme is very popular with all Macrohard customers.
The stand-alone prices of the various components of the contract are as follows –
Software license C160 000
Installation services C420 000
Maintenance services C660 000
Chapter 4 31
The software was physically delivered to the Congolese branch on 28 December 20X6. The
installation team arrived in the Congo on 9 January 20X7 and successfully completed the
installation on the same day.
Plentyhandle paid half the total contract price (C500 000) on 28 December 20X6. The balance
of the contract price is due in two equal annual instalments on 31 December 20X7 and
31 December 20X8. Macrohard offers the option to pay in instalments to all its customers.
The contract does not contain a significant financing component.
Required:
a) Define what is meant by the terms 'performance obligation' and 'distinct'.
b) Identify the performance obligations in the contract, together with a brief explanation.
c) Determine the transaction price and provide a detailed explanation.
d) Explain how the transaction price is to be allocated.
e) Prepare the journals for Macrohard for the years ended 31 December 20X6 and 20X7.
Question 4.17
Your People Limited (YP) creates customised IT solutions for the corporate market. Projects
are governed by a contract and normal terms and conditions require a 35% deposit to be paid
on signing of the contract with the residual amount due on completion of the project. In the
event that the contract is cancelled by either party, YP will be entitled to compensation based
on its costs incurred to date plus 20%, which YP considers to be a reasonable profit margin.
Your People Limited has one project in progress at its financial year-end 31 March 20X9.
This project entails the creation of customised call-centre software for Kwin Limited.
Kwin Limited signed the contract on 1 September 20X8 at a contract price of C900 000. Your
People Limited expects that a discount of C60 000 will be granted to Kwin Limited. The
decision on whether to grant the discount will be made by Your People Limited on
completion of the contract.
The customisation of the software involves completing the following six modules:
Module 1 – Welcoming of customer and fact finding
Module 2 – Software trouble shooting
Module 3 – User training
Module 4 – Frequently asked questions
Module 5 – Logging of unresolved helpdesk queries
Module 6 – Feedback from call centre to customer
The customer is unable to ‘go live’ with the software until module 6 has been completed.
Your People Limited estimated that it would take 560 hours to customise the software and the
average cost of the programmers is C900 per hour.
Your People Limited estimated that Module 4 will account for 25% of the time. The rest of
the time will be spent equally across the other modules. All other costs relating to the project
are known.
At 31 March 20X9, Your People Limited had spent 476 hours and completed Modules 1 to 5.
Kwin Limited have accepted and signed off on Modules 1 to 4. Module 5 has not been
accepted as Kwin Limited is of the opinion that the work performed has not been in
accordance with their specification. Your People Limited conceded to this and agreed to re-
work Module 5 at no additional cost to Kwin Limited.
Required:
a) Discuss how many performance obligations are in the contract between Your People
Limited and Kwin Limited in terms of IFRS 15 Revenue from Contracts with Customers.
32 Chapter 4
b) Determine the transaction price and provide a detailed explanation.

c) Prepare the journals showing how the deposit and the revenue from services from the
Kwin Limited project should be recognised and measured in the financial records of Your
People Limited for the year ended 31 March 20X9.
Question 4.18
Part A
Supasave supermarket has recently launched a customer loyalty programme that rewards a
customer with one customer loyalty point for every C15 of purchases. Each point is
redeemable for a C1 discount on any future purchases of Foody products. During a reporting
period, customers purchase products for C150 000 and earned 15 000 points that are
redeemable for future purchases. The consideration is fixed and the stand-alone selling price
of the purchased products is C150 000. Supasave expects 14 250 points to be redeemed. The
entity estimates a stand-alone selling price of C1 per point (i.e. totalling C14 250, assuming
14 250 points are redeemed).
Required:
Briefly explain how Supasave should account for the customer loyalty programme, and
provide the necessary journal entries to correctly account for the transactions.
Part B
Nu-Kinekor Limited has several movie houses in shopping malls around the country. It
derives its revenue from two sources: the sale of movie tickets, and the sale of popcorn and
sweets from its confectionary counter.
Nu-Kinekor also operates a customer loyalty programme. The terms of the programme are as
follows:
x It grants customers loyalty points when customers spend a specified amount on popcorn
and sweets at the movie house, which can be redeemed for further items at the
confectionary counter.
x The purchases made with points themselves do not generate any loyalty points.
x The points have no expiry date and management has reliably measured the stand-alone
selling price of each loyalty point to be C1.
x One point is awarded for every C10 the customer spends.
During the year ended 31 December 20X8, Nu-Kinekor Limited sold popcorn and sweets for
a total consideration of C1 300 000. The sales of the popcorn and sweets resulted in the
award of 130 000 points.
x The 20X8 management expectations were that a total of 80% of these outstanding loyalty
points would be redeemed (i.e. 20% of the points would never be redeemed).
x At the end of 20X8, 52 000 points had been successfully redeemed by customers.
x In the 20X9 year, management revised its expectations and now expects 90% of all points
arising from the 20X8 sales to be redeemed.
x Actual points earned in 20X8 and successfully redeemed in 20X9: 41 000.
Required:
Provide the journal entries to account for the customer loyalty programme offered by Nu-
Kinekor for the 20X8 and 20X9 financial years.
Chapter 4 33
Question 4.19
The BlackRock Company successfully tendered for a government contract to supply and
maintain air-conditioning units for all state-owned buildings in the city. The terms of the
agreement are as follows:
x The government will place a non-cancellable order for 80 air-conditioning units with
BlackRock on 01 October 20X4.
x BlackRock will acquire each unit from a supplier for C6 600 per unit and deliver them to
the government on 30 December 20X4, supplied at C15 000 per unit.
x The initial fitment of the unit and the maintenance services for 2 years will be provided
free to the government. The costs of the fitment are currently C900 per unit and the
initial maintenance costs are currently C2 916 per unit per annum. The maintenance costs
are increased at 8% per annum at the end of each year. It is the accepted industry practice
to apply an 18% profit margin on similar services.
x The selling price will be settled in full on 30 June 20X5. No interest will be charged on
the transaction. (Assume the financing component is insignificant).
Required:
a) Discuss, with reference to IFRS 15, how BlackRock Company should calculate and
allocate the transaction price for the contract to supply the air-conditioning units.
b) Prepare the journal entries to account for the contract with the government in the
financial statements of BlackRock for the year ended 31 December 20X4 and
31 December 20X5
Question 4.20
Caravan Limited entered into a sale of ten caravans to Outdoors Limited, a national vehicle
retailer, at a selling price of C87 500 per caravan. The normal cash selling price per caravan
is C102 375 (based on cost price plus a 30% mark-up) but a trade discount of C14 875 per
caravan was given since Outdoors Limited is a regular customer and generally buys in bulk.
The sale agreement was signed on 1 March 20X5, and the caravans were transported by truck
to Outdoors Limited on the same day. The transport costs and related transport insurance are
to be paid for by Outdoors Limited.
The sale agreement involves instalments (based on interest of 15% per annum) as follows:
x 1 March 20X5 – C175 000 (received on 1 March 20X5)
x 28 February 20X6 – C350 000
x 28 February 20X7 – C523 250
Caravan Limited uses a perpetual inventory system.
Required:
Prepare all related journal entries in the general journal of Caravan Limited for the year ended
31 December 20X5 and 31 December 20X6.
Ignore tax.
34 Chapter 4
Question 4.21
The Network TV Company (NTC) is a television network company listed on the JSE. The
company manufactures and sells digital decoders to the Southern African market. Its financial
year ends on 31 December.
The company prides itself on providing a comprehensive package solution to its clients that
includes the following:
x Satellite dish
x Portable TV decoder
x Monthly magazine
x Network access
The company’s customers have the option of acquiring the different elements of the package
from independent distributors or buying the full package from NTC subject to signing a 12-
month contract.
The comprehensive package was introduced on 1 November 20X4, details of which are as follows:
x A subscription fee of C800 per month, payable in arrears (“monthly subscription”).
x This monthly subscription fee entitles the customer to the following products:
Contract offering Stand-alone selling price Note Cost price
Satellite dish C1 899 1 C880
Portable TV decoder C765 C412
Access to the satellite network C680 per month 2 Unknown
Monthly TV guide magazine* Unknown 2 C30
Magazine delivery* Free C10 per delivery
* A general mark-up percentage of 20% is applicable.
Additional information:
x Customers are allowed to return damaged/defective satellite dishes for a refund within 60
days of purchase. The cost of manufacturing a new dish is C880. NTC estimates that 6%
of the satellite dishes are returned with 60 days of purchase. NTC’s management does not
consider the 6% possible returns to have a significant impact on revenue recognition. The
ability of customers to return satellite dishes does not constitute a warranty.
x The cost of access to the satellite network is not separately calculated as it forms part of
the general overhead costs.
x An appropriate discount rate is 12% per annum.
x All customers who signed up on 1 November 20X4 took up the arrear subscription offer.
NTC’s accountant studied IFRS 15 and correctly identified the following 4 distinct
performance obligations – the satellite dish, TV decoder, access to the network, and the
magazine delivered to a customer.
Required:
a) Determine the transaction price for Network TV Company's comprehensive subscription
contracts, show how Network TV Company should allocate this transaction price and
provide an explanation for your answer.
b) Prepare the journal entry in the financial records of Network TV Company for the year
ended 31 December 20X4 to account for the revenue from one single monthly
subscription contract taken up on 1 November 20X4.
All elements of revenue should be journalised separately. Detailed workings are required.
Chapter 4 35
Question 4.22
On 1 February 20X7, JP Construct Limited enters into a contract with Sheldon Estate Limited
to construct a bridge that would connect Sheldon Estate to the highway. Sheldon Estate
agreed to pay consideration amounting to C12 000 000.
Construction of the bridge began on 1 March 20X7. The payment schedule specifies that
Sheldon Estate must make an advance cash payment at contract inception of 20% of the
contract price, regular payments throughout the construction period amounting to 60% of the
contract price and a final payment of 20% of the contract price after construction is completed
and the bridge has passed the prescribed performance tests. At contract inception, JP
Construct estimated it would take 24 months to complete the construction of the bridge.
Sheldon Estate settled the last 20% of the consideration by issuing its own equity shares. The
total fair value of the shares issued by Sheldon Estate was C2 500 000.
The construction of the bridge occurred between 1 March 20X7 and 30 November 20X8. The
work certified as complete was 30% on 30 June 20X7 and 85% on 30 June 20X8. The bridge
was completed on 30 November 20X8.
The payments received by JP Contruct are non-refundable unless JP Construct fails to
perform as promised. Should Sheldon Estate terminate the contract, JP Construct is entitled
only to retain any progress payments received from the Sheldon Estate, and would have no
further rights to any compensation from Sheldon Estate.
JP Construct Limited has a 30 June year end. An appropriate discount rate is 11% per annum.
Required:
a) Discuss whether JP Construct Limited has an enforceable right to payment for
performance at 30 June 20X7 and 30 June 20X8.
b) Prepare the journal entries that JP Construct Limited should process relating to the
construction of the bridge at Sheldon Estate for the year ended 30 June 20X7 and 20X8.
36 Chapter 4
GAAP: Graded Questions Taxation: various types and current income taxation
Chapter 5
Taxation:
Various types and current income taxation
Question Key issues

5.1 - Core concepts
5.2 Bah-Gin VAT, employees’ tax, dividends tax
5.3 Walnut Conceptual Framework and IAS 12: Current tax for the current year and
under-provision of prior year
5.4 Koogi Current tax: taxable profit calculation
Provisional payments, balance on current income tax payable/ receivable
5.5 Raison Discussion: provisional payments
5.6 Puppy Love Current tax (non-temporary difference)
- non-taxable income: dividend income
Dividends tax
5.7 Gennie Current tax: taxable profit: calculation (non-temporary difference)
- non-taxable income: dividend income
- non-deductible expenses: donations
5.8 Big Blue Current tax: taxable profit: calculation: (non-temporary differences)
- non-taxable income: capital profit and dividend income
- non-deductible expenses: fines
Sale of asset above cost: non-depreciable and non-deductible
5.9 Zac Current tax: taxable profit: calculation (non-temporary differences and
temporary differences)
- non-deductible expenses: donations, fines
- non-taxable income: capital profit, dividend income
- temporary differences: depreciation, profit on sale
Sale of asset above cost: depreciable and deductible
5.10 Sak Current tax: over or under-provision and provisional payment refund or top-up
5.11 Plum Current tax: taxable profit: calculation (non-temporary differences)
- non-taxable income: dividend income only
Current tax: under-provisions or overprovisions: calculation
5.12 Gripping Current tax: taxable profit: calculation (non-temporary differences and
temporary differences)
- non-taxable income: capital profit
- temporary differences: depreciation, profit on sale and accruals
Current tax: under-provisions or overprovisions: calculation
Provisional payment system: refunds or top-ups: calculation
5.13 The Tea Current tax: taxable profit: calculation (non-temporary differences and
Party temporary differences):
- non-taxable income: exempt capital gain
- temporary differences: depreciation, impairments, profit on sale, accruals
Sale of asset below cost: depreciable and deductible
Chapter 5 37
Question 5.1
a) In your own words, explain the meaning of income tax.

b) Briefly explain the difference between taxable profit and profit before tax.
c) If a new tax rate is proposed during the year, do we use the currently enacted tax rate or
the proposed new tax rate when calculating the income tax payable on the taxable profits?
d) Profit before tax is seldom equal to the taxable profit. The difference between these two
profits is sometimes considered to be a temporary difference and sometimes not. Explain
this in your own words and include an example of each.
e) List two items of income that are generally not taxed in terms of income tax.
f) List two items of expense that are generally not deductible in terms of income tax.
g) Show how each of the following is calculated:
Capital gain, taxable capital gain and recoupment/ scrapping allowance.
h) Show how each of the following is calculated:
Profit on sale, capital profit, non-capital profit and exempt capital profit.
i) Which year-end accruals would cause temporary differences between profit before tax
and taxable profits? Indicate how you would adjust profit before tax for these accruals
when calculating taxable profits.
j) Show the journal entry that you would process to account for the current income tax
estimate for the current year should the entity achieve a taxable profit.
Required:
Provide answers to each of the questions posed above.
Question 5.2
Bah-Gin Limited is registered as a vendor for VAT purposes. The following are extracts from
the asset and liability balances at 28 February 20X9:
x Employees’ tax payable: C6 000 (credit)
x VAT control: C2 000 (debit)
x Bank: C130 000 (debit)
x Property, plant and equipment: Vehicle: Cost: C100 000 and Vehicle: Accumulated
depreciation: C20 000
x Inventories: C80 000
x Accounts receivable: C80 000
x Accounts payable: C20 000.
During March 20X9, Bah-Gin Limited:
x Purchased inventories on credit from Pencil Limited, a non-VAT vendor. The marked
price was C200 000.
x Purchased inventories from Lighter Limited, a VAT vendor. The cash invoice price was
C33 000.
x Sold inventories on credit to High Limited (a non-vendor) with an invoice value of C800.
The cost of the inventories sold was C300.
x Sold inventories invoiced at C12 000 to Low Limited (a VAT vendor). Low Limited paid
in cash. The cost of the inventories sold was C7 000.
38 Chapter 5
x Paid electricity and water of C420 (includes VAT of 14%).

x Paid telephone of C190 (includes VAT of 14%).
x Purchased a single cab truck for C57 000 in cash from a vendor. The truck does not meet
the definition of a ‘motor car’ provided in the VAT legislation and thus the VAT paid
may be claimed back from the tax authorities.
x Purchased a double cab truck for C120 000 in cash from a vendor. The truck meets the
definition of a ‘motor car’ provided in the VAT legislation and thus the VAT paid may
not be claimed back from the tax authorities.
x Paid salaries of C8 000 in cash. Employees’ tax owing to the tax authority as a result
came to C2 000. VAT is not levied on salaries.
x Paid C5 000 employees’ tax during the month.
x A VAT refund of C5 000 was received during the month of March 20X9.
x Dividend income of C12 000 was received during the month. The dividend income is
exempt from both dividends tax and income tax.
x Dividends of C18 000 were declared during the month. Dividends tax is levied at 15% of
the dividend declaration.
VAT of 14% is levied by entities classified as VAT-vendors (the total invoiced price includes
VAT unless otherwise indicated).
There are no components of other comprehensive income.
Required:
a) Journalise the above transactions.
b) In so far as the information is available, prepare an extract from the statement of financial
position at 31 March 20X9, in accordance with international financial reporting standards.
Question 5.3
Walnut Limited has a new and inexperienced financial accountant who insists that an estimate
of current income tax should not be processed in its financial statements for the year ended
31 December 20X3. His reasoning is that the official 20X3 tax assessment has not yet arrived
and he believes that it is only once this official assessment has been received that the amount
will be known and a liability can be recognised.
Current income tax has not yet been processed in Walnut Limited’s 20X3 financial
statements. The auditors are therefore requesting that Walnut Limited include the following
in the 20X3 financial statements:
x Current income tax of C80 000 in respect of 20X3;
x An under-provision of current income tax relating to 20X2 of C7 000.
Required:
a) Explain by way of a discussion of the relevant definitions and recognition criteria whether
or not the current income tax liability and related tax expense of C80 000 should be
recognised in the 20X3 financial statements.
You are not required to discuss the under-provision of prior year current tax of C7 000.
b) Provide all relevant tax-related journal entries that you believe should be processed by
Walnut Limited in order to finalise its financial statements for the year ended
31 December 20X3.
Closing transfer entries are not required.
Chapter 5 39
Question 5.4
Part A
The accountant of Koogi Limited makes the following estimates of the taxable profit for the
year ended 31 December 20X8:
x At 30 June 20X8: estimated taxable profit for the year of C40 000
x At 31 December 20X8: estimated taxable profit for the year of C50 000
x At 30 April 20X9 (when preparing the financial statements for the year ended
31 December 20X8): estimated taxable profit for the 20X8 year of C40 000.
Tax on taxable profits is levied at 30%.
Part B
Assume the same information in part A above, with the exception that the estimated taxable
profit at 31 December 20X8 for the purpose of calculating provisional tax amounted to
C30 000.
Part C
Assume the same information in part A above, with the exception that the estimated taxable
profit at 31 December 20X8 for the purpose of calculating provisional tax amounted to
C15 000.
Required:
For each of Part A, B and C:
a) prepare the current tax payable/ receivable ledger account.
b) indicate the amount that would be presented as:
- the income tax expense line item in the statement of comprehensive income for the
year ended 31 December 20X8; and
- the current tax payable/ receivable line item in the statement of financial position as at
31 December 20X8, assuming a zero opening balance at the beginning of the year.
Question 5.5
The following discussion took place between the MD and FD of Raison Limited:
MD: “I see our statement of comprehensive income shows an under-provision for current tax
in respect of last year.”
FD: “Correct.”
MD: “But our statement of financial position at the end of last year showed a current tax
asset.”
FD: “Correct.”
Required:
Explain how the above situation could have arisen and how the under-provision should be
accounted for.
40 Chapter 5
Question 5.6
Puppy Love Limited is an online pet shop store with a difference. Customers can place an
order online for a puppy of their choice, and the company will source puppies to customers’
specifications and conveniently deliver puppies to customers’ desired locations. The
company is well established and has experienced profitable years through aggressive
marketing campaigns at schools and through social media. This has allowed the company to
accumulate retained earnings of C1 550 000 since inception until 1 January 20X8, being the
beginning of the current year.
The majority shareholder of the company, Ms Poodle contributed C2 000 to form the
company a few years ago. The company performed well in the current year, having achieved
a profit before tax of C300 000 and a dividend of C100 000 was declared to Ms Poodle at
year-end.
The income tax rate was 30% and the dividends tax rate was 15%.
There were no temporary or non-temporary differences during 20X8 and no components of
other comprehensive income.
Required:
a) Show the journal entry to record the current income tax and dividend for the year ended
31 December 20X8.
b) Prepare an extract from the statement of comprehensive income of Puppy Love Limited
for the year ended 31 December 20X8.
c) Prepare an extract from the statement of changes in equity of Puppy Love Limited for the
year ended 31 December 20X8.
d) Prepare an extract from the current liabilities section of the statement of financial position
of Puppy Love Limited as at 31 December 20X8.
Ignore comparatives.
Question 5.7
Gennie Limited is in its first year of operation and manufactures and sells generators to
hardware stores and retails them online. With the influx of demand for generators in the
country, Gennie Limited achieved a profit before tax for the year ended 28 February 20X5 of
C1 900 000. This profit before tax included dividend income of C100 000 from its
investments in listed companies (exempt from income tax) and donations of C50 000 which
are considered to be non-deductible.
The income tax rate was 30%.
There were no temporary differences during 20X5 and no components of other
comprehensive income.
Required:
a) Prepare the current income tax computation for the year ended 28 February 20X5.
b) Show the journal entry to record the current income tax for the year ended
28 February 20X5.
c) Prepare an extract from the statement of comprehensive income of Gennie Limited for the
year ended 28 February 20X5.
d) Prepare an extract from the statement of financial position of Gennie Limited at
28 February 20X5.
Chapter 5 41
e) Prepare the income tax expense note (including the tax rate reconciliation) of
Gennie Limited for the year ended 28 February 20X5.
Question 5.8
The following information has been provided in respect of Big Blue Limited, a company that
began operations in 20X2:
x Profit before tax in 20X3 amounts to C300 000 (20X2: C290 000).
x The income tax expense in the statement of comprehensive income for 20X3 is C83 650
(20X2: C87 000).
x The balance owing to the tax authority for current tax per the statement of financial
position at 31 December 20X2 was C5 000.
x The income tax on the taxable profit for 20X2, according to the official assessment that
arrived during 20X3, amounted to C85 900.
x The payments made to the tax authority during 20X3 in respect of income tax amounted
to a total of C80 000 (i.e. this includes the provisional payments for 20X3 and any top-up/
refund in respect of 20X2).
x A capital profit of C26 000 arose on the sale of land during 20X3. This profit equals the
capital gain in terms of the tax legislation (no such profits or gains were made in 20X2).
x Dividend income of C5 000 (non-taxable) and a fine of C500 (non-deductible for tax
purposes) arose in 20X3 (neither dividend income nor fines arose in 20X2).
x Dividends of C30 000 were declared during 20X3 (20X2: nil).
x The rate of income tax is 30% on taxable profits.
x The capital gains inclusion rate is 50%. The company has no assessed capital loss
brought forward.
x The income tax rate and the capital gains inclusion rate have both remained unchanged
since 20X2.
x Dividends tax is levied at 15% on dividends declared.
Required:
Prepare, in accordance with the International Financial Reporting Standards, and to the extent
that information is available:
a) all tax-related journals for the year ended 31 December 20X2 and 31 December 20X3.
b) the income tax expense note for inclusion in the financial statements of Big Blue Limited
c) the statement of financial position of Big Blue Limited at 31 December 20X3.
Accounting policy notes are not required.
Comparative figures are required.
Question 5.9
The profit before tax of Zac Limited for the year ended 31 December 20X2 of C500 000
includes the following items:
x Profit of C100 000 on sale of a building. The original cost was C300 000 and its carrying
amount and tax base were both C280 000 on the date of the sale. Both the depreciation
and tax allowance amounted to C10 000 during the current year. The capital gain
calculated in accordance with the tax legislation equalled the capital profit.
x Dividend income of C10 000 (not taxable).
x Donations of C50 000 (not deductible).
x Traffic fines of C30 000 (not deductible).
42 Chapter 5

The applicable tax rate was 30% on taxable profits. The inclusion rate for capital gains made
by companies is 50% and there was no assessed capital loss brought forward. There are no
other differences between accounting profit and taxable profit other than what is evident from
the information provided above.
Required:
a) Calculate the taxable profit and current tax.
b) Show how taxation will be disclosed in the statement of comprehensive income and in the
taxation note for the year ended 31 December 20X2, in accordance with International
c) Determine the capital profit, non-capital profit, capital gain and recoupment or scrapping
allowance if the base cost amounted to C310 000 and the tax base amounted to C260 000.
Question 5.10
Sak Limited is a company with a financial year ending on 28 February. The following
information relates to the financial years 20X6, 20X7 and 20X8:
20X8 20X7 20X6
C C C
Profit before tax 16 700 15 200 12 000
Current income tax 5 845 5 320 4 200
Tax payments made during the year 5 950 5 000 4 000
The amount of assessed income tax on taxable profit for:
x 20X6 – received during 20X7 financial year 4 600
x Any amounts owing to or by the tax authorities (as a result of the tax authority’s amount
of assessed income tax on taxable profit not equalling the accountant’s estimate) are
settled in the year the assessment is received.
x There was no amount owing to the tax authority in respect of years prior to 20X6.
x Except for the above information, there were no other non-taxable items.
x The tax on taxable profit remained 35% over the three years.
Required:
For each of the financial years in question, prepare journal entries to record the above
transactions, enter the journal entries in the relevant ledger accounts, and show how the above
information would be disclosed in the annual financial statements of Sak Limited.
Question 5.11
The following was extracted from the accounting records of Plum Limited at 31 May 20X6:
C
Profit before tax 115 000 Cr
Dividends paid – 30 November 20X5 15 000 Dr
Current tax payable/ receivable: income tax (constituted purely of provisional 43 000 Dr
tax payments)
Chapter 5 43
x Included in the profit before tax are dividends received of C8 000, operating expenses of
C40 000 and interest paid of C2 000.
x The company declared a final dividend of C10 000 on 31 May 20X6.
x Income tax expense for the year has not yet been calculated. Assume all income (other
than the dividends received) included in profit for the year to be taxable and all expenses
to be deductible. The corporate tax rate is 35% on taxable profits.
x Income tax expense of C25 000 was provided when preparing the financial statements for
the year ended 31 May 20X5. The amount owing to the tax authorities for the 20X5 year
was assessed during 20X6 and amounts to C26 500.
x Ignore the effects of dividends tax.
Required:
a) Prepare all the journals relating to current tax for the year ended 31 May 20X6.
b) Prepare the statement of comprehensive income of Plum Limited for the year ended
31 May 20X6 (starting with the gross profit).
c) Prepare, in as much detail as possible, the statement of financial position of Plum Limited
at 31 May 20X6.
d) Prepare the income tax expense note for inclusion in the financial statements of
Plum Limited for the year ended 31 May 20X6.
Question 5.12
Gripping Limited has provided you with the following extracts of its draft financials for the
20X1 20X2 20X3
C C C
Profit before tax 300 000 400 000 450 000
Included in the profit before tax is:
- donations to various charities 40 000 0 0
- profit on sale of vehicle (capital profit: 20 000) 50 000 0 0
- depreciation on machine (purchased in 20X2) 0 15 000 15 000
(wear and tear: 25 000 in 20X2 and 25 000 in 20X3)
- profit on sale of this machine (cost price 70 000; base cost 0 0 40 000
75 000)
Income received in advance (closing balance) 20 000 10 000 40 000
Expenses prepaid (closing balance) 30 000 40 000 20 000
The following tax related information has been provided to you:

20X1 20X2 20X3
C C C
Capital gain on sale of vehicle/ machine 15 000 n/a ?
Provisional tax payments (first and second provisional payments) 60 000 70 000 100 000
Tax assessed for 20X1 (per assessment received during 20X2) 94 000
Tax assessed for 20X2 (per assessment received during 20X3) 114 500
x There were no other assets or liabilities other than those mentioned above.
44 Chapter 5
x There were no differences between accounting profit and taxable profit other than those
mentioned above.
x 20X1 is the first year of operations.
x Current income tax is levied at 30% and the inclusion rate for capital gains tax is 50%.
x Gripping Limited did not pay any top-up payments to the tax authorities and nor did it
receive any tax refunds from the tax authorities in 20X1, 20X2 and 20X3.
Required:
Provide all journal entries relating to the current income tax for each of the years ended
31 December 20X1, 20X2 and 20X3.
Ignore deferred tax.
Question 5.13
The Tea Party Limited has a correctly calculated profit before tax of C535 000. The
following lists of balances have been extracted from the statement of comprehensive income
for the year ended 30 June 20X6 and the statement of financial position at that date.
LIST OF BALANCES FROM STATEMENT OF COMPREHENSIVE INCOME
20X6
C
Donation (non-deductible: to a non-registered PBO) 30 000
Donation (deductible: to a registered PBO) 50 000
Depreciation on plant and machinery 190 000
Profit on sale of plant 30 000
Impairment of machinery 20 000
Profit on sale of machine ?
LIST OF BALANCES FROM STATEMENT OF FINANCIAL POSITION

20X6 20X5
C C
Accrued expenses 4 000 11 000
Expense prepaid 17 000 18 000
Income received in advance 5 500 8 900
Current tax payable: income tax ? 11 350
x The profit on sale relates to plant that was sold for C230 000 and had originally cost
C800 000. Total capital allowances claimed to date on the plant are C400 000 (up to and
including the 20X6 financial period).
x An item of machinery (not the item impaired above) was sold during the year. The
depreciation on this machine is included in the C190 000 depreciation above. The capital
profit realised was C120 000. It originally cost C100 000 (also the base cost), had a
carrying amount of C80 000 and a tax base C90 000 on the date of sale.
x Total wear and tear claimable for the year of assessment is C170 000.
x The 20X5 tax assessment reflected an assessed tax on taxable profit of C234 000.
x The first provisional tax payment was made on 31 December 20X5 on an estimated
taxable income of C600 000.
x The second provisional tax payment was made on 30 June 20X6 on an estimated taxable
income of C405 000.
Chapter 5 45
x The C11 350 owing to the tax authorities at the beginning of the year was paid on
1 September 20X5.
x The corporate income tax rate is 30%. Capital gains are taxed at an inclusion rate of 50%.
x There are no differences between accounting profit and taxable profit other than those
evident from the information above.
Required:
a) Calculate the current income tax for the year ended 30 June 20X6.
b) Prepare all the journals relating to current tax for the year ended 30 June 20X6.
Ignore deferred tax.
46 Chapter 5
GAAP: Graded Questions Taxation: Deferred taxation
Chapter 6
Taxation:
Deferred taxation
Question Key issues

6.1 - Core questions
6.2 Leaf - Current tax: taxable profit: calculation (temporary differences)
- Deferred tax: calculation (PPE, interest income receivable, provision for
warranty costs)
6.3 Blue Cheese - Current tax: taxable profit: calculation (temporary differences)
- Deferred tax: calculation (PPE, rent received in advance, interest income
receivable)
6.4 Eye - Current tax: taxable profit: calculation (temporary differences: PPE only)
- Deferred tax: calculation (PPE)
6.5 Phobie - Current tax: taxable profit: calculation (temporary differences)
6.6 Fish - Current tax: taxable profit: calculation (temporary differences and exempt
income)
- Deferred tax: calculation (PPE, revenue received in advance, expenses
prepaid)
6.7 Sweatshop - Current tax: taxable profit: calculation (temporary differences only)
- Deferred tax: calculation (PPE)
A: No rate change
B: Rate change
6.8 Root - Current tax: taxable profit: calculation (capital profit/ gain and temporary
differences)
- Current tax: underprovisions or overprovisions: calculation
- Deferred tax: calculation (deferred tax opening and closing balance given)
- Sale of asset above cost: depreciable and deductible
6.9 Bean - Current tax: taxable profit: calculation (exempt income and temporary
differences)
- Deferred tax: calculation
(PPE, rent received in advance, rent expense prepaid)
- Sale of asset below cost: depreciable and deductible
- Effect of tax on cash flow from operating activities: disclosure
(Includes loss on sale and recoupment)
6.10 Perfect Body - Current tax: taxable profit: calculation (exempt income, non-deductible
donations, exempt depreciation)
- Deferred tax: calculation (PPE, revenue received in advance, prepaid
expenses )
6.11 Reflection - Current tax: taxable profit / loss: calculation (temporary differences and
exempt income)
- Deferred tax: calculation (PPE and tax loss)
- Deferred tax assets: not recognised
6.12 Stalk - Current tax: taxable profit / loss: calculation (exempt income)
- Deferred tax: calculation (tax loss)
- Deferred tax assets: recognised, not recognised, recognised
Chapter 6 47
6.13 Disnee - Current tax: taxable profit: calculation (exempt income and temporary
differences)
- Current tax: under/over provisions
- Deferred tax: temporary differences (PPE and prepaid expenses)
- Deferred tax: rate change
- Sale of asset below cost: depreciable and deductible
6.14 Flawless - Current tax: taxable profit: calculation (non-deductible expenses, exempt
income and temporary differences)
prepaid)
- Sale of asset above cost: depreciable and deductible
6.15 Balboa - Current tax: taxable profit: calculation
(exempt income and temporary differences)
prepaid)
- Sale of assets above cost: depreciable and deductible
6.16 Basic - Current tax: taxable loss: calculation (exempt income and temporary
differences)
- Deferred tax: calculation (tax loss)
- Deferred tax: recognised, used, written down
6.17 Jay - Current tax: taxable profit/ loss: calculation (temporary and non-temporary
differences)
- Deferred tax: temporary differences (PPE, research, revenue received in
advance, tax loss)
- Deferred tax asset: recognised
6.18 Gerald’s - Current tax: taxable profit/ loss: calculation (temporary differences)
Gofers - Deferred tax: calculation (PPE, tax loss)
- Deferred tax asset: not recognised, then used
Further questions incorporating this topic with other topics can be found in Chapter A (after
Chapter 15) and in Chapter B (after Chapter 28). Chapters A and B are the Integrated Questions
chapters.
48 Chapter 6
Question 6.1
Answer the following short questions:
a) Define a temporary difference.

b) Define a tax base of an asset.
c) Define a tax base of a liability.
d) Define a taxable temporary difference and give an example of when one might arise.
e) Define a deductible temporary difference and give an example of when one might arise.
f) Define a deferred tax liability.
g) Define a deferred tax asset.
h) Deferred tax liabilities must always be recognised. True/ False?
i) Deferred tax assets must always be recognised. True/ False?
j) The portion of a capital profit that is exempt from tax will cause a temporary difference
and deferred tax. True/ False?
k) The income receivable balance will cause a temporary difference and deferred tax. True/
False?
l) Deferred tax relating to an asset is always measured based on management's intentions
with regard to the future recovery of the asset's carrying amount. True/ False?
m) Explain what tax rates to use when measuring deferred tax balances.
n) The taxable temporary differences at 31 December 20X5 were C100 000 and the taxable
temporary differences at 31 December 20X6 were C120 000. The tax rate is 30% in both
20X5 and 20X6.
Show the journal entry and identify the deferred tax balance in the statement of financial
position.
o) The deductible temporary differences at 31 December 20X5 were C100 000 and the
deductible temporary differences at 31 December 20X6 were C120 000. The tax rate is
30% in 20X5 but a new tax rate of 40% was announced in the Minister of Finance's
budget speech on 15 December 20X6.
Show the journal entry and identify the deferred tax balance in the statement of financial
position.
Question 6.2
The trial balance of Leaf Limited at 31 March 20X5 together with comparative figures at
31 March 20X4 is shown below:
LEAF LIMITED
TRIAL BALANCE AS AT 31 MARCH 20X5
31 March 20X5 31 March 20X4
Dr Cr Dr Cr
Plant and equipment (carrying amount) 200 000 300 000
Interest receivable 40 000 -
Bank 120 000 104 000
Ordinary stated capital 100 000 100 000
Retained earnings 345 000 290 000
Chapter 6 49
Provision for warranty costs 10 000 -

Current tax receivable/payable 95 000 14 000
455 000 455 000 404 000 404 000
The following information is relevant:

x All of the plant and equipment was purchased on 31 March 20X4. Depreciation is
provided on the straight-line basis over a three year period, with no residual value. The
tax authority has allowed a tax deduction for the year ending 31 March 20X5 of
C180 000.
x The interest receivable is taxed by the tax authority when the cash is actually received.
x The provision for warranty costs is allowed as a deduction by the tax authority when the
cash is actually paid.
x The profit before tax for the year ended 31 March 20X5 is C500 000.
x The corporate income tax rate is 30%.
All of the accounting entries for the current year have been correctly processed except for the
entries relating to current and deferred taxation.
Required:
a) Prepare a deferred tax computation for Leaf Limited using the balance sheet approach
for the year ended 31 March 20X5.
b) Prepare a current tax computation for Leaf Limited for the year ended 31 March 20X5.
c) Prepare an extract from the statement of comprehensive income of Leaf Limited for the
year ended 31 March 20X5.
d) Prepare the statement of financial position of Leaf Limited as at 31 March 20X5.
Comparative figures are not required.
Question 6.3
The following deferred tax working papers of Blue Cheese Limited have been partially
prepared at 28 February 20X2.
Carrying Tax Temporary Deferred
amount base difference tax
Property, plant &
equipment:
Balance – 28/02/20X1 145 000 115 000
Balance – 28/02/20X2 120 000
Rent received in advance:
Balance – 28/02/20X1 (2 000)
Balance – 28/02/20X2 (5 000)
Interest income receivable:
Balance – 28/02/20X1 0
Balance – 28/02/20X2 20 000
50 Chapter 6
Property,
plant and Rent received Income
Deferred tax summary equipment in advance receivable Total
Balance – 28/02/20X1 ? ? ? ?
Balance – 28/02/20X2 ? ? ? ?
There were no purchases or sales of property, plant and equipment during the year ended
28 February 20X2. The company tax consultant has confirmed the income tax treatment of
the above items for the year ended 28 February 20X2 as follows:
Statement of financial position item Income tax treatment
Rent received in advance Taxable in the year of receipt
Interest income receivable Taxable in year interest is earned
Wear and tear C30 000
The profit before tax is C100 000 and there are no other differences between accounting profit
and taxable profit other than those evident from the information given.
The corporate income tax rate is 30% (levied on taxable profits).
The ‘current tax payable: income tax’ account had a credit balance of C10 000 on
1 March 20X1. No payments were made to the tax authority during the year ended
28 February 20X2.
Required:
a) Complete the deferred tax working paper.
b) Calculate current income tax.
c) Show the related ledger accounts for current tax and deferred tax.
d) Disclose all information possible in the statement of financial position of Blue Cheese
Limited as at 28 February 20X2.
Notes are not required.
e) Show the deferred tax note in the financial statements of Blue Cheese Limited for the year
ended 28 February 20X2.
f) For each statement of financial position item on the deferred tax working paper, explain
the conceptual meaning of the carrying amount and tax base, and thereby justify the
resulting temporary difference and deferred tax. In preparing your answer, bear in mind
the following quotation:
“The objective of this IFRS is to prescribe the accounting treatment for income taxes.
The principal issue in accounting for income taxes is how to account for the current
and future tax consequences of the future recovery (settlement) of the carrying amount
of assets (liabilities) that are recognised in an entity’s statement of financial position.”
(IAS 12, Income taxes, Objective)
Question 6.4
At 30 June 20X6 the statement of financial position of Eye Limited included a deferred tax
liability amounting to C11 152. The deferred tax relates to the only item of equipment owned by
the company.
Chapter 6 51
Year ended 30 June

20X8 20X7
Profit before tax 282 000 252 000
Wear and tear allowance 40 000 50 000
Depreciation 48 000 48 000
x The tax base of the equipment at 30 June 20X6 was C356 120.
x The current income tax for the year ended 30 June 20X7 is paid in August 20X7. No other
tax payments were made.
Required:
a) Show the journals relating to depreciation and tax for the years ended 30 June 20X7 and
30 June 20X8.
b) Prepare extracts from the statement of comprehensive income for the year ended 30 June
20X8 in accordance with International Financial Reporting Standards.
c) Prepare extracts from the statement of financial position of Eye Limited at 30 June 20X8 in
accordance with International Financial Reporting Standards.
d) Prepare extracts from the notes to the financial statements of Eye Limited. Your notes
should include the following:
x Accounting policies for statement of compliance, basis of preparation as well as for
equipment, deferred tax, current tax and income tax expense
x The notes to profit before tax, income tax expense and deferred tax
Question 6.5
Phobie Limited, with no expenses and no income other than rent income, received the
following cash over two years:
x Received in 20X1: rent income of C10 000 in respect of 20X2
x Received in 20X2: rent income of C110 000 in respect of 20X2
The corporate income tax rate has remained constant at 30% over both years.
Required:
a) Calculate profit before tax, as it would appear in the statement of comprehensive income.
b) Calculate the taxable profit and current taxation for both 20X1 and 20X2.
c) Calculate the effective rate of tax over both years (separately and in total) assuming that
only current tax is recognised (no deferred tax is recognised).
d) Show the journal entries relating to tax and year end accruals for 20X1 and 20X2.
e) Show the ledger accounts for 20X1 and 20X2, taking deferred tax into account.
f) Show how the above will be disclosed in the tax expense note.
Question 6.6
Fish Limited is a company operating in the food industry. The following information has been
presented to you:
52 Chapter 6
FISH LIMITED
EXTRACT FROM STATEMENT OF FINANCIAL POSITION
AT 31 DECEMBER 20X3
20X3 20X2
C C
Property, plant and equipment ? 355 000
Expenses prepaid (this is allowed as a deduction for tax purposes in 20X3) 10 000 0
Revenue received in advance (taxable in the year of receipt) 28 000 15 000
x The tax base of the property, plant and equipment balance at 31 December 20X2 was
C290 000.
x During 20X3 depreciation was C35 000 and wear and tear allowed was C25 000. There
was no other movement of property, plant and equipment during 20X3.
x Profit before tax is C300 000.
x Dividend income of C5 000 was earned during 20X3.
x There are no other temporary or non-temporary differences other than those evident from
the information provided.
Required:
a) Calculate the deferred income tax balance at 31 December 20X2 and 31 December 20X3.
Calculate the current income tax for the year ended 31 December 20X3.
b) Journalise the current and deferred income tax adjustments for the year ended
31 December 20X3.
c) Prepare the deferred tax note to the statement of financial position at 31 December 20X3
in accordance with International Financial Reporting Standards.
Question 6.7
The information given below is in respect of Sweatshop Limited, a manufacturing company:

x Sweatshop Limited owned two manufacturing plants: one had been purchased on
1 January 20X1 for C200 000 and the company then built a second plant at a cost of
C500 000. The first plant was put into operation on 1 January 20X1 (the same day of
acquisition), whereas the second plant was completed on 30 June 20X1 but only became
available for use on 1 January 20X2, on which date it was brought into production.
x Depreciation is provided at 20% per annum on the straight-line basis to nil residual
values. The tax authorities grant a wear and tear allowance on the full cost of plant over
four years, apportioned from the date on which it was brought into use.
x The company earned profits before taxation and before depreciation of C200 000 in all
three years.
x The opening balance on the deferred tax account in the statement of financial position
was zero on 1/1/20X1.
x There are no other differences between accounting profit and taxable profit other than those
evident from the information given.
Part A:
The income tax rate remained at 35% for all years affected:
Chapter 6 53
Part B:
The income tax rate 40% in 20X1, 45% in 20X2 and 35% in 20X3.
Required (For both parts A and B):
a) Calculate the current income taxation for the years ending 31 December 20X1, 20X2 and
20X3.
b) Journalise the entries for current tax and deferred tax for each of the years ended
c) Calculate the deferred tax asset/ liability balances and movements using the balance sheet
approach (comparing the carrying amounts and tax base of the machines).
d) Prepare extracts from the statement of comprehensive income for the years ended
31 December 20X1, 20X2 and 20X3 in accordance with International Financial Reporting
Standards.
e) Prepare extracts from the statement of financial position of Sweatshop Limited at
Standards.
f) Prepare the notes to taxation expense and deferred tax of Sweatshop Limited at
Standards.
Question 6.8
The following information relates to Root Limited for its financial year ended
31 December 20X6:
x Profit before tax for the year ended 31 December 20X6 has been correctly calculated at
C344 000.
x Included in the profit before tax for the year ended 31 December 20X6 are the following
items, amongst others:
C
Dividend income 200 000
Profit on sale of vehicle 100 000
Depreciation (150 000)
x The following balances have been extracted from the trial balance at 31 December 20X6:
C
Revenue received in advance (31 December 20X5: C10 000) 130 000
Expenses prepaid (31 December 20X5: C15 000) 7 000
x The tax authorities:

- granted a wear and tear allowance of C270 000 as a deduction in 20X6;
- tax revenue received in advance in the year of receipt; and
- allow the expenses prepaid as a deduction for tax purposes in the year in which they
are paid.
x A vehicle was sold during 20X6. On the date of sale, its carrying amount was C700 000,
its tax base was C650 000 and its base cost was C760 000. Its original cost was C750 000.
x The tax assessment for the 20X5 tax year was received in August 20X6 and showed an
assessed tax on taxable profit amounting to C48 000. The total tax expense as reported on
54 Chapter 6
the 20X5 statement of comprehensive income amounted to C98 000, comprising current
income tax of C52 000 and deferred income tax of C46 000. No journal entries have yet
been processed to take into account any adjustments that may be necessary.
x The deferred tax balance at the beginning of the year is C16 500 (credit) whereas the
deferred tax balance at the end of the year is C900 (debit).
x The income tax rate is 30% and the inclusion rate for purposes of capital gains tax is 50%.
evident from the information given. All amounts are considered material.
Required:
a) Show how the tax expense note is disclosed in the annual financial statements of Root
Limited for the year ended 31 December 20X6 in accordance with International Financial
Reporting Standards.
Comparatives are not required.
b) Prepare an extract from the statement of comprehensive income of Root Limited for the
year ended 31 December 20X6 beginning with the line item ‘profit before tax’.
Question 6.9
Bean Limited is a company that assembles, distributes and rents cappuccino and espresso
machines for the burgeoning coffee shop society and the home market. It began operations on
1 July 20X4 and uses one major item of equipment to assemble its products.
x The company purchased the assembly equipment on 1 July 20X4 at a cost of C900 000.
The equipment is depreciated on the straight line basis over its estimated useful life of ten
years, with no residual value. The tax authority grants an allowance of 20% per annum,
not apportioned for time.
The financial accountant has prepared the following schedule relating to deferred taxation
at 30 June 20X6, before the impairment of the asset:
CA TB TD DT
(X29%)
Equipment
01/07/X4 Cost 900 000 900 000
30/06/X5 Depreciation / tax allowance (90 000) (180 000)
810 000 720 000 90 000 26 100
Preliminary balance 720 000 540 000 180 000 52 200
At 30 June 20X6, there are indications that the equipment is impaired. An impairment test
is performed and the recoverable amount is estimated at C600 000.
The remaining useful life is estimated to be five years with no residual value. The
impairment is recorded correctly in the accounting records.
The equipment was sold on 30 October 20X6 for an amount of C500 000.
x The directors decided to rent equipment rather than buying new equipment. The rent is
payable six monthly in advance and an amount of C270 000 was paid on
Chapter 6 55
1 November 20X6 and on 1 May 20X7. Expenses paid in advance are deductible for tax
purposes when paid.
x Bean Limited receives rental income in advance in relation to coffee machines that it rents
to coffee shops.
Rental income received in advance at 30 June 20X7 amounts to C20 000. There was no
rental income received in advance at 30 June 20X6.
Rental income received in advance is taxed when received.
The financial accountant has prepared the following schedule relating to current taxation:
Year end Year end Year end
30/06/X7 30/06/X6 30/06/X5
Amount provided for current income tax ? ? 135 100
1st and 2nd provisional payments 146 000 142 000 130 000
Balance on current tax payable account ? ? 5 100
Amount of assessed income tax on taxable profit Not yet 162 100 132 200
received
The company paid the balance owing on assessment in December 20X5 (for the year
ended June 20X5) and in December 20X6 (for the year ended June 20X6).
x The profit before taxation of the company has been correctly calculated at C520 000 for
the year ended 30 June 20X6 and at C700 000 for the year ended 30 June 20X7.
x All accounting entries relating to the equipment, the rent paid and the rent received have
been correctly included in the calculation.
x The profit before tax for both years also includes dividend income of C40 000 for 20X6
and C30 000 for 20X7.
x The financial accountant has extracted the following balances relating to the trading
activities:
Year end 30/06/X7 Year end 30/06/X6
Debit Credit Debit Credit
Sales 3 500 000 2 600 000
Accounts receivable 196 000 184 000
Bad debts expense 14 000 9 000
Inventory 240 000 115 000
Accounts payable 174 000 102 000
x The corporate income tax rate for all years is 29%.
Required:
a) Prepare an extract from the statement of comprehensive income of Bean Limited for the
year ended 30 June 20X7.
b) Show how current income tax and deferred income tax would be reported on the
statement of financial position of Bean Limited at 30 June 20X7.
56 Chapter 6
c) Prepare the accounting policies note (incorporating policies for basis of preparation,
deferred tax and equipment) and the taxation note of Bean Limited for the year ended
30 June 20X7.
d) Prepare the operating activities section of the statement of cash flows of Bean Limited for
the year ended 30 June 20X7.
Question 6.10
Perfect Body Limited is a company that operates a chain of fitness studios in Gauteng. An
extract from the statement of financial position of Perfect Body Limited at 31 December
20X6 is as follows:
PERFECT BODY LIMITED

STATEMENT OF FINANCIAL POSITION
AT 31 DECEMBER 20X6
20X6
ASSETS C
Non-current assets
Land at cost 2 964 000
Administration buildings (at carrying amount) 1 920 000
Equipment (at carrying amount) 756 000
Current assets
Trade and other payables 456 000
Prepaid expenses 30 000
EQUITY AND LIABILITIES
Equity
Ordinary stated capital 240 000
Retained earnings (31/12/20X5) 2 124 870
Non-current liabilities
Long-term loan 600 000
Deferred tax: income tax (31/12/20X5) 79 830
Current liabilities
Income received in advance 76 500
Current tax payable: income tax 122 400

x Profit before interest of C2 892 000 has been correctly calculated and includes the
following:
- dividend income of C18 000 (which was received during the year);
- a donation to ‘The Bodybuilding Championships’ of C24 000: ‘The Bodybuilding
Championships’ is not a recognised charity in terms of the Income Tax Act; and
- depreciation on the administration building of C144 000 and depreciation on the
equipment of C204 000.
x Interest of C90 000 was incurred during the year.
x The company declared dividends of C36 000.
x The tax assessment for the 20X5 year was received during 20X6 and showed that the
amount of the assessed tax on taxable profit was C6 000 less than the amount provided
for current income tax in the previous year.
Chapter 6 57
x The deferred tax balance at 31 December 20X5 comprises:

- a taxable temporary difference on the equipment of C297 600 and
- a deductible temporary difference on the revenue received in advance of C31 500.
x The tax base of the equipment at 31 December 20X6 is C436 800.
- will tax the income received in advance in the year of receipt;
- will allow the deduction of the prepaid expenses in the year of payment;
- do not grant tax allowances on the company’s administration buildings; and
- will grant a tax allowance on the equipment of C225 600 during 20X6.
x There are no other temporary differences and non-temporary differences other than those
x The income tax rate is 30%.
Required:
a) Prepare the journal entries to be processed in Perfect Body Limited’s general journal at
31 December 20X6 to account for the current tax, deferred tax and the overprovision.
b) Prepare all the notes relating to income tax expense and deferred tax in accordance with
Question 6.11
Reflection Limited is a listed company manufacturing mirrors. The financial results for the
year ending 20X3 are:
x Profit before tax is C30 000 in 20X3 (20X2: C20 000 and 20X1: C14 000)
x Dividend income received during the year was C10 000 (20X2: C10 000 and
20X1: C10 000)
x Information relating to property, plant and equipment:
20X0 20X1 20X2 20X3
Carrying amount 70 000 64 000 48 000 36 000
Tax base 90 000 70 000 50 000 30 000
x There is insufficient evidence for Reflection Limited to realise deferred tax assets.
x The tax rate is constant at 30%
Required:
a) Prepare the current income tax and deferred income tax calculations.
b) Prepare the tax-related journals for the years ended 31 December 20X1, 20X2 and 20X3.
c) Prepare the income tax expense and deferred tax note for the years ended
Question 6.12
Stalk Limited is a listed company manufacturing coffee. Their financial results for the year
ending 20X3 are:
58 Chapter 6
x Loss before tax is C20 000 in 20X3 and 20X2: C10 000. Profit before tax is C10 000 in
20X1.
x Dividend income received during the year was C20 000 (20X2:C20 000, 20X1:C20 000).
x An assessed loss of C100 000 is carried forward from 20X0.
x Sufficient appropriate evidence was available to recognise deferred tax assets in 20X1. In
20X2, however, it did not appear probable that the tax loss would be able to be utilised.
In 20X3 evidence was once again available to recognise deferred tax assets in full.
x There are no other temporary differences and no other items of exempt income or items of
non-deductible expenses other than those evident from the information given.
x The tax rate is constant at 30%.
Required:
a) Prepare the current income tax and deferred income tax calculations.
b) Prepare the tax-related journals for the years ended 31 December 20X1, 20X2 and 20X3.
c) Prepare the income tax expense and deferred tax note for the years ended
Question 6.13
Disnee Limited operates in the movie industry. It commenced operations on 1 January 20X1.
The following information is available for its year ended 31 December 20X3:
DISNEE LIMITED
EXTRACT FROM STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 DECEMBER 20X3
20X3 20X2
C C
Investment income (being dividend income) 24 000 ?
Depreciation 60 000 ?
Profit before tax (correctly calculated) 780 000 ?
DISNEE LIMITED
AT 31 DECEMBER 20X3
20X3 20X2
C C
Property, plant and equipment ? 840 000
Expenses prepaid (tax deductible in 20X3) 36 000 0
Accrued income (taxed when earned) 12 000 24 000
The tax assessment for 20X2 arrived during 20X3 and indicated taxable profits of C780 000.
Current income tax of C234 000 was processed in 20X2.
Plant was revalued to a fair value of C72 000 on 1 January 20X3. This is the first revaluation
of any item of property, plant and equipment to date. The plant originally cost C120 000 and
had a carrying amount on 1 January 20X3 of C60 000. The revaluation surplus is to be
transferred to retained earnings on the disposal of the plant. This is the only item of property,
plant and equipment that is measured under the revaluation model.
Chapter 6 59
An item of video equipment was sold for C120 000. It was purchased for C240 000. On the
date of sale, 1 January 20X3, the equipment had a carrying amount of C144 000 and a tax
base of C156 000.
Plant was depreciated over its remaining useful life of 5 years calculated from
1 January 20X3 (consistent with previous estimates of useful life).
The tax authorities allow wear and tear on the item of plant (referred to above) at 25% p.a. on
cost, but the item of plant already had a tax base of zero on 1 January 20X3. A total of
C42 000 capital allowances were allowed by the tax authorities during 20X3 on all other
items of property, plant and equipment (i.e. other than the revalued plant).
Property, plant and equipment (including the plant and equipment) had a tax base at
31 December 20X2 of C816 000.
Further information regarding the calculation of income tax:
x income is taxed on the earlier date of earning or receipt thereof;
x the prepaid expenses in 20X3 were allowed as a deduction in 20X3
x the current income tax rate is 30% of taxable profits (20X2: 29%).
There are no differences between profit before tax and taxable profit other than those evident
from the information provided.
Required:
a) Calculate the deferred tax balance at 31 December 20X3 using the balance sheet
approach.
b) Calculate the taxable profits and current income tax charge for the year ended
31 December 20X3.
c) Calculate the total current income tax expense recognised in 20X3.
d) Calculate the adjustment to the deferred tax liability account caused by temporary
differences arising in 20X3.
e) Calculate the adjustment to the deferred tax liability account caused by the rate change.
f) Calculate the total deferred income tax expense recognised in 20X3.
g) Calculate the total income tax expense recognised in 20X3.
h) List the items that would appear as reconciling items in the rate reconciliation in the 20X3
income tax expense note.
i) Show the journal/s relating to income tax for the year ended 31 December 20X3.
Question 6.14
Flawless Limited is a plastic surgery practice owned by Dr Ken Carson which offers plastic
surgery services to high-end clientele. The practice is based in a prestigious hospital from
which it rents rooms.
Dr Ken Carson’s accountant has been placed on maternity leave and he admits to having very
limited knowledge about the calculation and treatment of company tax calculations. He has
provided you with the draft trial balance of Flawless Limited:
FLAWLESS LIMITED
DRAFT TRIAL BALANCE AT 31 DECEMBER 20X8
C
Revenue from services (3 775 000)
Dividend income (12 500)
Profit on sale of equipment (62 500)
Depreciation on equipment 125 000
Donations made (not deductible for tax purposes) 62 500
Finance charges (deductible for tax purposes) 137 500
60 Chapter 6
Other expenses (deductible for tax purposes) 1 500 000

Dividends declared 25 000
Revenue received in advance (taxable when received) (37 500)
Rent expense prepaid (deductible when paid) 75 000
Ordinary stated capital (unchanged since inception) (500 000)
Retained earnings: beginning of year (800 000)
Total non-current liabilities (including deferred tax liability) (375 000)
Equipment 2 687 500
Inventory 1 000 000
Accounts payable (100 000)
Bank overdraft (25 000)
0

x A wear and tear allowance of C75 000 was granted on equipment during 20X8. The tax
base of equipment was C2 000 000 at 31 December 20X8.
x An item of equipment was sold during the year:
C
Carrying amount at date of sale 75 000
Capital profit 50 000
Non-capital profit 12 500
Base cost 100 000
Tax base 25 000
x There was no movement in equipment during 20X8 other than is evident from the
information provided.
x The following accruals had closing balances at 31 December 20X7:
C
Revenue received in advance (12 500)
Rent expense prepaid 50 000
x Dividends of C75 000 were declared during 20X8 (C25 000 was declared on
15 May 20X8 as an interim dividend and C50 000 was declared on 29 December 20X8 as
a final dividend). The final dividend has not yet been journalised.
x Current income tax in 20X7 was recognised at C275 000. The tax assessment for 20X7,
received during late 20X8, indicated total assessed current income tax of C300 000.
x The rate of income tax is 30% (20X7: 40%) and the inclusion rate is 50% (both years).
No journal entries relating to tax have yet been processed.
x Apart from any deferred tax liabilities, the only other non-current liability is a long-term
loan.
x There are no items of other comprehensive income in 20X8.
Required:
a) Process all journal entries necessary to finalise the financial statements for the year ended
31 December 20X8
b) Prepare the statement of comprehensive income of Flawless Limited for the year ended
31 December 20X8.
c) Prepare the statement of changes in equity of Flawless Limited for the year ended
31 December 20X8.
d) Prepare the statement of financial position of Flawless Limited as at 31 December 20X8.
Chapter 6 61
e) Prepare the following notes to the financial statements of Flawless Limited for the year
ended 31 December 20X8:
x Profit before tax
x Income taxation expense
x Deferred taxation.
Comparatives are not required, except for the deferred tax note.
Ignore dividend withholding tax.
Question 6.15
Balboa Limited is a trendy new company involved in promoting the idea of ‘saving our
planet’ by selling clothing and furniture made exclusively from recycled materials. The
accountant has suddenly contracted flu and has been confined to bed for a week.
Unfortunately, the auditors are here and you have been given the urgent task of finalising the
annual financial statements.
You have been given the following documents with which he was busy before falling ill:
x trial balance – draft
x tax workings – incomplete
x tax-related journals – a complete summary of the tax-related journals processed to date.
No journal entries have yet been processed regarding deferred tax. Other than the deferred tax
journal entry/ies that is / are still required, the draft trial balance, presented below, is
otherwise complete:
BALBOA LIMITED
DRAFT TRIAL BALANCE AT 31 DECEMBER 20X8
Debit/ (Credit)
Revenue received in advance (31/12/20X8) See note 4 (400 000)
Expenses prepaid (31/12/20X8) See note 4 500 000
Vehicles: carrying amount See note 1 750 000
Investment in shares: cost 8 405 000
Deferred tax (1/1/20X8: at 25%) See note 2 12 500
Trade payables and Current tax payable See note 5 (2 700 000)
Share capital See note 6 (2 000 000)
Retained earnings (1/1/20X8) (200 000)
Sales Taxable (8 000 000)
Dividend income Not taxable (1 000 000)
Cost of sales Deductible 2 000 000
Depreciation on vehicles See note 1 300 000
Profit on sale of vehicle See note 1 (310 000)
Income tax expense See note 3 1 742 500
Bank 150 000
Inventory 750 000
TAX WORKING PAPERS

Balances 31/12/20X8 Carrying Tax Temporary Deferred tax A/L
amount base difference
Revenue received in advance (400 000) 0 400 000 120 000 A
Expenses prepaid 500 000 0 (500 000) (150 000) L
Vehicles 750 000 ? ? ?
62 Chapter 6
Note 1:
x Four identical vehicles were purchased on 1 January 20X7. These vehicles are delivery
vehicles but are all trucks that were built in 1940 and are thus collector’s items. Vehicles
are depreciated over 5 years, straight-line, to a total residual value of C100 000 (C25 000
each). One of these vehicles was sold to a collector of vintage vehicles on
30 December 20X8, on which date its carrying amount was C250 000, its base cost was
C410 000 and its tax base was C200 000.
x The company owns no other vehicles other than the remaining 3 vehicles at
31 December 20X8.
x The tax authorities allow a 25% deduction of the cost of the vehicle per annum.
Note 2:
x As mentioned earlier, the deferred tax adjustments for 20X8 have not yet been processed.
The deferred tax balance at the end of 20X7 related purely to vehicles and revenue
received in advance.
Note 3:
x All the tax-related journal entries processed during the year have been correctly
calculated, collated for perusal and presented below:
SUMMARY OF ALL TAX-RELATED JOURNALS PROCESSED IN 20X8

Debit Credit
Income tax expense (SOCI: P/L) 55 000
Current tax payable: income tax (SOFP: current A/L) 55 000
Under-provision of 20X7 tax expense
Bank (SOFP: current A/L) 900 000
First provisional payment for 20X8
Top-up payment for 20X7 tax year
Second provisional payment for 20X8
Income tax expense (SOCI: P/L) 1 687 500
Current tax payable: income tax (SOFP: current A/L) 1 687 500
Estimated current income tax for 20X8
Note 4:
x Revenue is taxed in the year it is earned or received, whichever occurs first. Expenses are
allowed as a deduction for tax purposes when incurred or paid, whichever occurs first.
Note 5:
x The current tax payable: income tax had a debit balance of 14 000 at 31 December 20X7.
Note 6:
x There was no movement in share capital during 20X8.

x There are no items of other comprehensive income.
x The income tax rate was 30% in 20X8 (25% in 20X7).
Chapter 6 63
Required:
a) Prepare any other outstanding tax-related journals that should have been processed for the
b) Prepare the statement of financial position at 31 December 20X8 together with the
deferred tax note in accordance with International Financial Reporting Standards.
Comparatives are required where possible.
c) Prepare the statement of comprehensive income for the year ended 31 December 20X8,
together with the income tax expense note, in as much detail as is possible and in
Question 6.16
Basic Limited earned a profit before tax of C8 000 000 in the year ended 31 December 20X8
(20X7: C1 000 000). Dividend income of C5 000 000 was earned in both years.
x Basic Limited made a tax loss (assessed loss) of C4 000 000 in the tax year ended
31 December 20X7. There was no tax loss brought forward from years before 20X7.
x Basic Limited made a taxable profit for the year ended 31 December 20X8 of C3 000 000,
calculated before taking into consideration the assessed loss carried forward from 20X7.
x At 31 December 20X7, management was of the opinion that there would be sufficient
future taxable profits against which the unused tax loss could be utilised. At
31 December 20X8, however, management was of the opinion that the benefit from any
remaining unused tax loss would never be realised.
- levy corporate income tax at 40% (unchanged for many years);
- allow assessed losses to be carried forward to future years where they may be
deducted against taxable profits.
Required:
a) Prepare the tax-related journal entries in Basic Limited’s general journal for the years
ended 31 December 20X7 and 31 December 20X8.
b) Prepare the tax expense note and the deferred tax asset/liability note for inclusion in
Basic Limited’s financial statements for the year ended 31 December 20X8 in compliance
with International Financial Reporting Standards.
Question 6.17
You are an accounting specialist from an advisory firm. Jay Limited requires your assistance
with current and deferred tax issues. Jay Limited began operations on 1 January 20X5. The
company has a 31 December year-end.
The financial accountant has provided you with the following extracts of property, plant and
equipment from the company’s accounting system:
64 Chapter 6
Building Land Plant

Cost C840 000 C2 400 000 C960 000
Cost of installation nil - C480 000
Depreciation 7 years, straight-line - 10 years, straight line
Residual value nil - C120 000
Date of purchase 1 March 20X7 1 January 20X5 1 April 20X6
Date available for use 1 April 20X7 1 January 20X5 I July 20X6
Brought into use 1 July 20X7 1 January 20X5 1 August 20X6
Information extracted from the company’s statement of comprehensive income for the years
from 20X5 to 20X7 show the following:
20X7 20X6 20X5
C C C
Investment income (being dividend income) 240 000 360 000 0
Research costs 720 000 480 000 0
Profit before tax (correctly calculated) 1 080 000 960 000 240 000
x Revenue received in advance at 31 December 20X7 was C960 000 (year-end balances for
20X6: C360 000 and 20X5: C1 440 000).
x A tax loss (assessed loss) of C960 000 was incurred in the tax year ended
31 December 20X5. It was considered probable, at the end of every year since
incorporation, that sufficient future taxable profits would be available to fully utilise any
deferred tax assets.
The tax department in your advisory firm have confirmed that the tax authorities:
x levy income tax at a rate of 30% (20X6: 40%);
x tax income when earned or received, whichever occurs first;
x allow the following deductions:
- a deduction of 20% of the cost of plant per annum (purchase price and installation
costs), not apportioned for part of a year;
- a deduction of research costs incurred over 4 years, straight-line (not apportioned for
part of a year);
x do not allow any deductions relating to the cost of the land or the building; and
x allow tax losses to be carried forward and set-off against taxable profits in future years.
Required:
a) Calculate the current income tax expense for the years ended 31 December 20X6 and
31 December 20X7.
b) Calculate, using the balance sheet approach, the deferred tax balance for each category of
temporary difference at 31 December 20X6 and 31 December 20X7 indicating clearly
whether the balance represents an asset or liability.
c) Provide the income tax expense note for inclusion in the financial statements for the year
ended 31 December 20X7, in accordance with International Financial Reporting
Standards.
Accounting policy note is not required.
Chapter 6 65
Question 6.18
Gerald’s Gofers Limited (GGL) trades as an engineering firm that specialises in the digging
of tunnels for trains. Their main asset comprises equipment purchased and utilised
specifically in the digging process. GGL has experienced tax losses in recent times and
requires assistance in accounting for such losses.
x Cost of equipment purchased on 1 January 20X1 C180 000
x Depreciation on equipment to nil residual value 3 years straight-line
x Capital allowance (depreciation allowed by the tax authorities) 2 years straight-line
x Income tax rate 30%
x Profit or loss before tax (after deducting any depreciation on the equipment) for the year ended:
- 31 December 20X1 Loss: C60 000
- 31 December 20X2 Loss: C30 000
- 31 December 20X3 Profit: C150 000
x The company did not expect to make future taxable profits at all and therefore did not
expect to be able to use the tax loss.
x There are no other temporary differences and no other items of exempt income or items of
non-deductible expenses other than those evident from the information given.
Required:
a) Calculate the taxable profits and current income tax per the tax legislation for each of the
years ended 31 December 20X1 to 31 December 20X3.
b) Calculate the deferred tax balances at each of the years ended 31 December 20X1 to
31 December 20X3.
c) Journalise all tax-related journals for each of the years ended 31 December 20X1 to
31 December 20X3.
d) Disclose the effect of the above tax information in the financial statements of
Gerald’s Gofers Limited for the financial year ended 31 December 20X3.
66 Chapter 6
GAAP: Graded Questions Property, plant and equipment: cost model
Chapter 7
Property, plant and equipment: cost model
Question Key issues

7.1 - Core concepts – short questions
7.2 - Core concepts – true or false
7.3 Jingle Bells Core concepts – residual value; subsequent costs (replacements and major
inspection); depreciation (idle time)
7.4 Kershaw Cost model: basic disclosure (accounting policies and notes)
7.5 Rockstar Cost model: no impairments
- Initial costs:
- internal manufacture: wastage, administration, etc
- asset exchange
- Depreciation
7.6 Huge Cost model: no impairments
- Initial costs (testing);
- Residual value (identification);
- Change in estimate (residual value, reallocation method);
- Depreciation (delayed start)
7.7 Island of Atlas Cost model: no impairments
- Initial cost: significant parts and various related costs
- Depreciation: significant parts (delay and idle time)
7.8 Large Cost model, including:
- Initial costs (significant parts including major inspection)
- Derecognition of parts not previously identified;
- Depreciation of significant parts
7.9 Rope Cost model, including:
- Initial costs (significant parts);
- Subsequent costs (repair);
- Depreciation (idle time and significant parts)
7.10 Roads Cost model, including:
- Internal manufacture (costs and depreciation);
- Initial cost (testing, depreciation of other assets);
- Depreciation (capitalisation thereof)
7.11 Coil Cost model, including:
- Initial costs (significant parts including major inspection);
- Depreciation (including units of production);
- Major inspection (derecognition);
- Residual value (identification);
- Change in estimate (residual value, reallocation method)
7.12 Minerva Cost model, including:
- Initial cost (significant parts and provision for dismantling);
- Depreciation (significant parts / straight line)
Chapter 7 67
Question Key issues continued …

7.13 Shark Cost model, involving:
- initial costs: significant parts (NO major inspection)
- depreciation: significant parts (units of production and straight-line)
- subsequent cost: major inspection (recognition, impairment & derecognition)
7.14 Moodliar Cost model, involving:

- initial cost: significant parts and a dismantling provision
- impairment: recoverable amount given for the asset as a whole
- derecognition and replacement of parts
- provision for dismantling costs: unwinding of discount
7.15 Munchen Cost model, involving:
- Initial cost: delivery, professional fees, repairs
- Recoverable amount: determination
- Impairment loss and reversal of impairment loss
7.16 Iky’s Prawns Cost model, involving:
- Initial costs (delivery, protective treatment, marketing);
- Residual value (calculation);
- Recoverable amount (calculation);
- Impairment and Insurance proceeds
7.17 Raingo Cost model, involving:
- impairments and reversals,
- pledge as security,
- future contractual commitments
Part A: Ignoring tax
Part B: With tax
chapters.
68 Chapter 7
Question 7.1
a) Provide the definition of property, plant and equipment.

b) List the recognition criteria that must be met for an item of property, plant and equipment
to be recognised as an asset.
c) List the measurement models that may be applied to property, plant and equipment.
d) List the costs that are included in the cost of an item of property, plant and equipment.
e) In one sentence, explain what is meant by the term 'depreciation'.
f) When do we use the term 'useful life' and what does it represent?
g) When do we use the term 'residual value' and what does it represent?
Required:
Provide short answers to the above questions.
Question 7.2
a) Items that meet the definition of property, plant and equipment must always be recognised
and presented as non-current assets in the statement of financial position.
b) An item of property, plant and equipment is always initially measured at cost.
c) An item of property, plant and equipment the acquisition of which is to be paid in
instalments is initially measured at its cost, being the sum total of these future instalments.
d) The three methods of depreciation listed in IAS 16, (straight-line, diminishing balance and
unit of production method) are not all based on the useful life of the asset: the straight-line
and diminishing balance are based on the useful life but the units of production method is
based on the units of output.
e) Depreciation on the diminishing balance method is the allocation of an asset’s depreciable
amount, calculated as cost less recoverable amount, over its estimated useful life.
Required:
Indicate whether the statements above are true or false. Where the statement is false, provide
a brief explanation as to why you believe it to be false.
Question 7.3
Rudolph is the internal auditor of Jingle Bells Limited. Santa Claus (the managing director) is
analysing the financial statements for the year ended 31 December 20X5. He is unsure about
a few issues and has sent Rudolph an email, extracts of which are as follows:
Hi Rudolph
Hope you are having a jolly season! I am uncertain about how the accountant should disclose
certain items of property, plant and equipment. Please can you assist us?
A. We purchased our first sleigh-making machine 5 years ago and recently sold it for
C180 000. We purchased a second sleigh-making machine 3 years ago, and it now has a
remaining useful life of 2 years. Ralphie, our financial director, has told me that in 2
years we could easily sell the second sleigh-making machine for C250 000. Which
amount shall we use as the residual value?
B. The elves in the factory have been complaining about the lack of fresh air and the
humidity levels. As a result we replaced the old and faulty ventilation system at a cost of
C170 000. Ralphie insists that we should capitalise it to the cost of the factory, I think he
fraudulently wants to overstate assets and profits, instead of reducing profits by expensing
Chapter 7 69
this cost. We are simply maintaining normal ventilation standards and have not enhanced
anything. Can you please do something about him?
C. Due to the elves being so small and not able to move the sleighs, we invested in a
computerised conveyor belt system, which picks up the sleighs, loads them on the
conveyor belt and moves them to the packaging department. It was delivered and
installed in August but we only started using it in September, when we started preparing
for the season. However, Ralphie has calculated depreciation from August! I am
convinced he is trying to sabotage this year’s financial statements!
D. Tinkerbell, the property valuation experts that we use, have just visited our factory
building and estimated that its fair value is currently C8 000 000. Last year, its fair value
was C6 000 000. They explained that the fact that our factory is unique with its castle-
themed exterior makes our property extremely valuable. However, despite this rocketing
fair value, Ralphie has gone and depreciated the property by another C50 000. The
carrying amount is sitting at a new low of C5 000 000!
E. Remember I replaced my old jet with a new one this year? Now I personally saw the
invoice for the jet and it clearly showed C3 500 000. And yet Ralphie has journalised my
jet at C2 750 000. He said something about the remaining C750 000 having to be shown
as an inspection cost. I tried to explain to him that we did not pay any inspection because
the supplier had it inspected as per the Safety Regulation for such jets. Of course, we will
have it inspected, at our cost, in 3 years again. According to Tinkerbell, the current
market price for such an inspection is C750 000 and I think this is perhaps what is
confusing Ralphie? What do you think?
Required:
Identify the issue in each of the questions posed and explain, with reference to IAS 16, the
correct accounting treatment in each case.
Question 7.4
The following is an extract from the trial balance of Kershaw Limited for the year ended
30 June 20X4:
KERSHAW LIMITED
EXTRACT FROM TRIAL BALANCE AT 30 JUNE 20X4
Debit Credit
Land (Plot 20 Melrose Estate) acquired 1/1/20X2, at cost 80 000
Office buildings available for use on 30/6/20X4, at cost 50 000
Fixtures and fittings, at cost 60 000
Accumulated depreciation of fixtures and fittings at 1/7/20X3 10 000
Depreciation is calculated at 10% per annum reducing balance on fixtures and fittings. No
depreciation is calculated on land. Buildings are depreciated at 2% per annum on the straight
line basis.
All residual values are assessed to be zero and this has remained unchanged since acquisition.
Required:
Prepare the property, plant and equipment note to the financial statements for the year ended
30 June 20X4.
Accounting policies are required.
70 Chapter 7
Question 7.5
Rockstar Manufacturing Co. Limited has presented you with the following balances from its
trial balance as at 31 December 20X0 (both balances have been classified as equipment):
Def-maker Amplifier: carrying amount (Note 1) C853 650
Universal Guitar Stringer: carrying amount (Note 2) C542 000
Note 1:
x This amplifier is specialised equipment that was manufactured during the current
financial year by Rockstar Manufacturing Co. Limited.
x Included in the cost of the amplifier are the following:
- C712 000 for inventory, including C14 000 for inventory that had to be scrapped
- C106 500 in direct labour costs, of which C6 000 is in respect of idle time
- C95 000 for allocated overheads, half of which relate to administrative overheads
- C35 000 that was spent on training staff on how to use the machine.
x The amplifier was ready for use on 1 May 20X0, but was only brought into operation on
1 July 20X0.
x The estimated useful life of the asset is 5 years with no residual value and economic
benefit is expected to flow evenly throughout its useful life.
Note 2:
x Rockstar Manufacturing Co. Limited took advantage of a supplier’s special and returned
its Universal Guitar Stringer for a newer model on the 31 December 20X0.
x The carrying amount of the stringer given up was C542 000, which Rockstar believed
they could sell for C550 000, while the fair value, per IFRS 13, of the stringer received is
C600 000.
The financial director of Rockstar Manufacturing Co. Limited has misgivings regarding the
ability of the accounting department to keep abreast of the numerous pronouncements from
the International Accounting Standards Board. He has, therefore, asked for your opinion
regarding the treatment of the above matters.
Required:
In a letter to the financial director, discuss the recognition and measurement of the above
items of equipment in terms of International Financial Reporting Standards.
Question 7.6
Huge Limited specialises in performing administrative tasks for other companies. At

31 December 20X9 (reporting date), the following details are available to you:
Machine:
x This machine was purchased for C298 000 in cash on 1 February 20X9 but needed to be
installed before it could be used. The installation cost C10 000 and was also paid for in
cash.
x The asset was in a condition ready for use in the manner intended by management on
1 May 20X9. It was not until 1 June 20X9 that it was brought into use since the directors
had an old machine they wished to use until its pistons gave up completely.
x It has an estimated useful life of 3 years and a residual value of C44 000.
Chapter 7 71
Plant:
x Plant was purchased on 1 January 20X7 at a cost of C720 000.
x The plant needed to be tested to ensure that the buns it produces were safe to eat before it
could be put into production: the cost of testing was C40 500. The buns were sold to
staff (who all survived) for C4 500.
x Its estimated useful life at acquisition is 5 years and its residual value was C36 000.
x At year-end, the accountant ascertained that similar items of plant 5 years old were
currently selling for C63 000 but his projections (using present values) suggest that he
would be able to sell this plant for C50 000 at the end of its useful life.
x The accountant believes that the residual value of C36 000 should be changed but is not
sure whether to use C63 000 or C50 000 as the new residual value.
The company uses the re-allocation method to account for changes in estimates.
Required:
Prepare all the journal entries in Huge Limited’s general journal for the year ended
31 December 20X9.
Question 7.7
Island of Atlas is a resort situated on an island just off the coast of Durban. The resort is a
first of its kind, as it has the first artificial aquarium, sporting robotic fish that look real-life,
have the ability to swim, consume other fish and move in an incredibly realistic way. The
fish are controlled by a remote server.
The cost of constructing the aquarium was C350 000. An independent valuator (approved by
the auditors) has separated the cost of the aquarium into the following parts, each of which is
considered to have a cost that is significant to the cost of the entire aquarium:
x the structure: estimated cost of C100 000,
x the server: estimated cost of C50 000, and
x the robotic fish: estimated cost of C200 000.
x The resort was open and ready for visitors from 2 January 20X3. However, a national
strike during the month of January meant that no staff arrived and thus the grand opening
was delayed until 1 February 20X3.
x The aquarium is depreciated on the straight-line method:
The structure has an estimated useful life of 100 years and a residual value of C2 000.
The server has an estimated useful life of 10 years and a residual value of C1 000.
The robotic fish have an estimated useful life of 50 years and a nil residual value.
x Other costs incurred in relation to opening the resort:
C
Delivery and electronic set-up of robotic fish 1 000
Staff training for aquarium cleaners and IT specialists 15 000
Testing to ensure aquarium was fully operational before grand opening 3 000
(this involved testing and checking the structure, server and fish)
Grand opening launch party, including costs to hire Saoki, a popular DJ 10 000
Initial operating loss 30 000
72 Chapter 7
x The resort was closed during August 20X3 for its annual maintenance programme.
x Island of Atlas measures all its property, plant and equipment under the cost model. It
owns only two other items of property, plant and equipment, the relevant details for the
current year ended 31 December 20X3 are as follows:
Land: the land was purchased many years ago for C5 000 000 and is not depreciated.
Building: construction of the building was complete at 1 January 20X2 at a cost of
C12 000 000 and it is depreciated on the reducing balance at a rate of 5% per annum.
Its residual value is C2 000 000.
Required:
a) Using Island of Atlas's general journal, show all related journal entries for the year ended
31 December 20X3.
Ignore tax.
b) Disclose the ‘property, plant and equipment’ note in the financial statements of Island of
Atlas Limited for the year ended 31 December 20X3. Comparatives are not required.
Question 7.8
Large Limited is a very lucrative business and has decided to buy special vehicles for use by
its two directors. In this regard, it invested in a supercar for the managing director and a
helicopter for the financial director, details of which are presented on the next page.
x Italian Supercar, which was purchased on 1 July 20X8 for C405 000:
- This vehicle has an estimated useful life of 4 years with a nil residual value.
- On 28 February 20X9, the tyres of the car were replaced at a cost of C36 000 (useful
life: 2 years). At acquisition, the original tyres were valued at C18 000, with a useful
life of 4 years, even though they were not a separately identified component. The
original tyres have been converted into a series of swings for a local orphanage.
- The costs of servicing the car for the year amounted to C50 000.
x Tomahawk Helicopter, which was purchased on 1 July 20X5 for C1 200 000. The
directors identified the following separate parts which have costs that are considered to be
significant relative to the total cost:
- The motor was valued at C320 000 with an estimated useful life of 5 years and a
residual value of C24 000.
- The body was valued at C640 000 with an estimated useful life of 10 years and a
residual value of zero.
- Interior fittings were valued at C80 000 with an estimated useful life of 10 years with
no residual value.
- The remainder of the value was placed on the inspection cost, which must be
performed every three years as a condition of purchase.
The second inspection was performed on 1 July 20X8 i.e. the beginning of the
current financial year for C192 000.
Required:
Prepare the following journals for Large Limited for the year ended 30 June 20X9:
a) All transactions relating to the Italian supercar.

b) All transactions relating to the Helicopter.
Chapter 7 73
Question 7.9
Rope Limited, a vendor as defined in the VAT Act, operates within the logistics sector. In
order to co-ordinate and manage its complex business network, it invested in a state-of-the-art
computer system, the details of which are as follows:
x Date of purchase and date brought into use 1 April 20X0
x Cost of hardware (including VAT) C45 600
x Cost of software (including VAT) C12 540
x Useful life of hardware 5 years
x Useful life of software 2 years
x Residual amount of hardware C1 000
The computer is not able to function without the software. This was demonstrated when the
software malfunctioned on 1 October 20X0 and the computer could not be used until
1 November 20X0, when the software was reinstalled (at no cost).
During the annual Christmas party, an employee spilt a soft drink onto part of the computer,
which necessitated a repair. This did not, however affect operations since the company had
closed for the year. The cost of repairs was C3 420 (including VAT). The asset was not
considered to be impaired.
The VAT rate is 14%.
Required:
Prepare journal entries to record the above transactions for the year ended
31 December 20X0.
Question 7.10
Roads International Limited constructed its own specially designed ‘tarring vehicle’. Details
of related costs incurred are as follows:
Description of cost: C Transaction date
Cost of raw materials purchased 500 000 1 February 20X2
Cost of raw materials used in construction of tarring vehicle 100 000
during June 20X2
Tests to ensure vehicle safe before brought into use 20 000 30 September 20X2
Depreciation on machinery to 31 December 20X2 200 000
Factory labour costs to 31 December 20X2 300 000
x Company-owned machinery was used for a quarter of the year in the construction of the
tarring vehicle.
x 80% of the total labour costs for the year were incurred on building roads and 20%
thereof were incurred in construction of the tarring vehicle. Of the total labour cost
incurred on the construction of the tarring vehicle, an estimated 5% was as a direct result
of a country-wide labour union strike during which labourers were paid but yet did not
turn up for work.
x The vehicle was first brought into use on a contract that started on 1 November 20X2,
although it was available for use from 1 October 20X2.
74 Chapter 7
x The company uses the straight-line method to depreciate its vehicles. This vehicle is
expected to be sold for C50 000 at the end of its expected useful life of 5 years. A similar
vehicle realised C7 000 when sold at the end of 20X2 after 5 years of use.
Required:
a) Journalise all related transactions for the year ended 31 December 20X2.
b) Disclose the vehicle in the ‘property, plant and equipment’ note and the separately
disclosable item: ‘depreciation’ in the notes to the financial statements of Roads
International Ltd for the year ended 31 December 20X2.
Ignore the effects of taxation.
Question 7.11
Coil Limited operates in the logistics industry. It is mainly involved in transporting food and
clothing to disaster areas nationally throughout southern Africa. To reach some of the more
desolate areas in the region, Coil Limited invested in a light aircraft, as well as vehicles for
transportation via land. The details are as follows:
x Aircraft: purchased on 1 January 20X5:
- Upon initial recognition, the following significant parts were identified:
- The body was allocated a cost of C136 000, with a useful life of 8 years and a nil
residual value.
- The motor and propeller blades were allocated a cost of C340 000, with a useful
life of 15 000 km and a residual value of C136 000.
- The capitalised inspection costs were allocated C170 000. Inspections must be
performed every 4 years.
- Additional information:
- The aircraft was used extensively during the current financial year, flying a total
of 3 000 km.
- The inspection was performed at 30 December 20X8 at a cost of C290 700
(including VAT).
- The next inspection is expected to cost C350 000 (including VAT).
x Truck: purchased on 1 January 20X7:
- The truck was purchased for C170 000 (no VAT was charged), on which date its
useful life and residual value were estimated to be 4 years and C17 000, respectively.
- The accountant estimates that he will be able to sell the asset for C42 500 at the end
of its useful life, but notes that similar vehicles that are already 4 years old are
currently selling for C29 750.
- The accountant has already processed depreciation for 20X8, but has based it on the
original residual value of C17 000.
All amounts exclude VAT unless otherwise indicated. The VAT rate is 14%.
The company uses the re-allocation method to account for changes in estimate.
Required:
Prepare the following journals for Coil Limited for the year ended 31 December 20X8:
a) All journals relating to the aircraft.
b) All journals relating to the truck.
Chapter 7 75
Question 7.12
Minerva Limited is the subsidiary of a pharmaceutical company called Pippin’ Potions.

Minerva was formed for the sole purpose of disposing of the medical waste created by the
production of certain drugs. Minerva owns only one item of property, plant and equipment,
being a medical waste disposal plant, called Firebolt 3000, which was purchased on
1 January 20X0.
All company records were destroyed in an electrical fire over the weekend. Although the
company creates back-ups that it stores safely off-site, the back-ups referring to the only item
of plant were last updated at the end of the previous financial year end, 31 December 20X3.
You, the financial accountant, approached the factory foreman to establish some of the details
needed to calculate the correct carrying amount at the current year-end, 31 December 20X4.
YOU: Hi Albus! Did you hear about the fire?

ALBUS: Hi Harry! Yes, it must be making your job a nightmare.
YOU: Yes, unfortunately. It is why I am here, actually. I need to ask you a few
questions
ALBUS: I will try my best … what can I help you with?
YOU: For starters, any idea what we decided the useful life of the Firebolt 3000 was?
ALBUS: Well, at the end of last year we said it had 4 years to go, but 10 years all-in-all.
YOU: Did we agree that we would be able to sell it after that?
ALBUS: Nope, that is not possible as the plant must be dismantled at the end of its lifespan.
YOU: Do you have any idea what the dismantling costs were estimated to be?
ALBUS: Yes, I have a breakdown of those figures … we were using them when setting
our last targets. (ALBUS pulls out a file from the filing cabinet) It says here that,
on acquisition date, the cost to dismantle was estimated at C3 400 000, but that
discounting at 10% still needed to be factored in. Does that make sense to you?
YOU: Absolutely. Does it happen to say anything about the depreciation?
ALBUS: Yip, our total depreciation per annum was C4 760 000, on the straight line basis.
YOU: Thanks, I think I have everything I need now!
Required:
Prepare the following journal entries:
the journal entry/ies that would have been processed on 1 January 20X0.
the journals to be processed during the year ended 31 December 20X4.
Ignore tax effects.
Question 7.13
Shark Limited is a national carrier of fresh produce. Due to the high incidence of road fatalities
the government introduced legislation that requires all long distance vehicles to undergo
roadworthiness inspections every two years. The details of one such vehicle are as follows:
x The truck was purchased on 1 October 20X8 for C320 000. The following significant parts
were identified:
- The engine was allocated a cost of C210 000 and expected to travel 300 000 km after
which, it would have no residual value.
76 Chapter 7
- The chassis was allocated a cost of C110 000 and had an estimated residual value of nil
and a useful life of 5 years.
x The first major inspection was performed on the 31 December 20X8, the day before the
legislation became effective, at a cost of C40 000.
x The truck travelled 40 000 km during 20X8 and 97 000 km in 20X9.
x The directors of Shark Limited felt that the previous inspection had not been performed
properly (the previous inspectors have been implicated in a fraud syndicate involving fake
inspection certifications) and, given that the safety of its employees was at stake, decided to
perform another inspection on 1 July 20X9 at a cost of C72 000.
Required:
Prepare all journals relating to the truck for the years ended 31 December 20X8 and 20X9.
Ignore tax effects
Question 7.14
Moodliar International Limited is a large multi-national manufacturing concern. Preshan

Moodliar, the company management accountant, presented you with the following spreadsheet
showing the costs that had been incurred during the construction of plant between
1 January 20X1 and 31 May 20X1. The plant began operating on 1 June 20X1.
Capital Budget: Manufacture of the Plant C
Materials Note 1 1 200 000
Direct labour Note 2 1 000 000
Allocated manufacturing expenses 130 000
Specialised foundation Note 3 1 500 000
Machine lining Note 4 40 000
Provision for dismantling costs Note 5 ?
Note 1:
x The materials are made up of externally purchased material (at a cost of C800 000) and internally
purchased material (i.e. from an internal division), purchased for C400 000. The divisional mark-up is
25% on cost.
Note 2:
x Direct labour includes an amount of C100 000 that was paid to the workers while waiting for the
specialised foundation to harden.
x It does not include payments made to Singh’s Medical Fund by Moodliar International on behalf of
employees (C600 000). The employees do not make contributions for themselves.
Note 3:
x The specialised foundation has a useful life of 10 years and a residual value of C100 000.
Note 4:
x The machine lining that had originally cost C40 000 had to be replaced on 31 December 20X1 due to
excessive wear and tear. It had been expected that the lining would last 4 years.
x The new lining cost C60 000 and had a revised useful life of only 2 years.
Note 5:
x The plant must be dismantled at the end of its useful life (20 years), and a provision for this cost must
be recognised. The expected cost of dismantling after 20 years is C6 000 000 and the present value
thereof (using an appropriate discount rate of 10% p.a.) is C891 862.
The plant had an estimated residual value of nil. At reporting date, the marketing director, Mr.
K. Amrit, informed the board that the demand for the plant’s product has decreased dramatically.
An impairment test was performed and the recoverable amount was calculated as C5 000 000.
Chapter 7 77
Required:
Provide all journals to record the above transactions in the books of Moodliar International
Limited for its year ended 31 December 20X1.
Question 7.15
Munchen Limited manufactures food processors and other small kitchen appliances. Following
the success of baking programmes on TV, Munchen Limited purchased new equipment on
2 January 20X0 to expand the range of food processers that it produces. The price of the
equipment (including VAT at 20%) amounted to C62 400. The VAT will be claimed back from
the tax authorities.
In addition, Munchen Limited paid C1 800 delivery costs to a road transport contractor and
C1 200 to a consultant for advice on installation. While the equipment was being assembled,
it was damaged, costing the company an additional C200 for repairs. The repair did not
constitute a replacement or renewal of a major component.
The equipment was delivered on 2 January 20X0 and was in a condition ready for use on that
day. It was, however, only brought into use on 1 February 20X0.
Munchen Limited measures its equipment using the revaluation model and provides for
depreciation at 10% per annum on the straight line method. The residual value at the date of
acquisition was estimated to be C5 000. The fair value of all equipment is assessed every
three years. At 31 December 20X2, the fair value of the equipment was assessed and was
considered to be equal to its carrying amount. The residual value and useful life were
unchanged.
During the year ending 31 December 20X3, the market was flooded with cheap imported food
processors. As a result, management was concerned that their market share might be eroded,
and thus performed an impairment test.
x There is an active market for this type of equipment and at 31 December 20X3 it could
have been disposed of in an orderly transaction for C27 000. The costs of dismantling
and removing the equipment were estimated at C1 500.
x The present value of the expected return from the use of the equipment over the
remainder of its useful life amounted to C25 500 and the present value of the estimated
residual value amounted to C2 500. The residual value was reassessed at C4 000 but the
useful life remained unchanged.
Over the next two years consumers realised that the quality of the food processors produced
by Munchen was superior to the cheap imports and thus demand has steadily increased. The
equipment is good quality too and at 31 December 20X5, the fair value thereof was measured
at C32 000. The residual value and useful life were unchanged.
Required:
a) State the amount to be recorded as the initial cost of the equipment in the accounting
records of Munchen Limited and provide the journal entry to record the initial
recognition in the accounting records.
b) Briefly discuss the objective of the test for impairment.
c) Calculate, using the criteria in IAS 36 Impairment of Assets, whether the equipment is
impaired at 31 December 20X3, and if so, provide the journal entry to record the
impairment in the accounting records.
78 Chapter 7
d) To the extent that information is available, prepare an extract from the notes to the
financial statements of Munchen Limited at 31 December 20X3 showing:
x The statement of compliance.
x The accounting policies, including the basis of preparation and the accounting
policy for property, plant and equipment.
x Notes for ‘profit before tax’ and for ‘property, plant and equipment’ (including
comparative figures).
e) Provide the journals to record the revaluation of the equipment at 31 December 20X5.
Ignore tax and deferred tax.
Question 7.16
Iky’s Prawns Ltd is a company that recently expanded and now delivers its prawns to coastal
restaurants from its main shop in Durban. Three vans were acquired for purposes of
facilitating this expansion. The following report has been compiled by the bookkeeper who
is not quite sure how to deal with all of the related transactions and events:
Information pertaining to the initial costs in acquiring the three delivery vans:
x Three vans were purchased on 1 July 20X9 in order to help reach the new delivery points.
x Total cost C600 000 (C200 000 per van).
x Cost of transporting the vans from the manufacturer in Gauteng was C70 000 in total.
x The cost of galvanising the vans once in Durban was C90 000.
x Galvanising provides protection against rust, (necessary since Durban is a coastal city).
x The cost of repainting the vans in the company colours to promote the new delivery
business was C30 000.
Information pertaining to the depreciation of the vans:

x The company uses the cost model to measure its assets.
x The vans have a useful life of 4 years.
x All assets are depreciated on the straight line basis unless another method is justifiable.
x The residual value of each delivery van is currently estimated to be C45 000, before
considering additional selling costs of C5 000 per van.
Information relating to a freak hail storm at the end of the financial year:
x A freak hail storm hit the coast on 31 December 20X9 and, as the vans had been
purchased so recently, no protective parking had yet been built for them.
x The vans were thus exposed to the elements during the storm and were badly damaged,
resulting in the market value of each van dropping to C100 000 (this C100 000 per van
did not take into account the expected selling costs of C20 000 per van).
x Management has calculated the remaining value in use of each van to be C150 000, (this
has been calculated by adding the present value of the cash flows from use of C120 000 to
the present value of the proceeds from sale of C30 000).
Information relating to the trade-in of the old delivery vans and purchase of the new vans:
x On 3 January 20Y0, the insurance company paid out C120 000 per van to settle the
damages caused by the hail storm.
x After intensive board meetings and discussions amongst the management of Iky’s
Prawns, it was decided that the old damaged vehicles would be traded-in on three new
vans, and the insurance money would be used to pay the balance owed on this purchase.
Chapter 7 79
x The trade-in value for the three damaged vans combined was established to be C300 000.
x Three new delivery vans were purchased for C660 000, and management decided to
depreciate these over three years to a nil residual value.
Required:
a) With regards to the first set of delivery vans, calculate the total amount at which they
should initially be measured, and their subsequent measurement up to
31 December 20X9.
b) Show all journals relating to the above information up to 31 December 20Y0.
Question 7.17
Raingo Limited applies the cost model to its property, plant and equipment. An item of plant
was purchased on 01 January 20X1 at a cost of C100 000. The estimated useful life of the
plant is 5 years.
x Details of the plants’s estimated recoverable amount are as follows:
C
31/12/20X1: 70 000
31/12/20X2: 65 000
31/12/20X3: 30 000
x All residual values are assessed to be zero and this has remained unchanged since
acquisition.
x Depreciation is provided using the straight-line method over its useful life.
x The drop in the plant’s value at the end of 20X3 was due to damage caused during a riot
on the factory premises in 20X3. Similar damage was caused during a similar riot in
20X1. The damage incurred during the 20X1 riots was repaired in 20X2.
x The company has pledged the plant as security for a loan. Details of the loan will be
provided in note 6 of the notes to the financial statements for the year ended
31 December 20X3.
x During 20X3 the company directors signed a contract involving the construction of an
additional item of plant to be completed by April 20X4 at an expected cost to the
company of C500 000. Since construction had not yet begun at year-end, a liability for
this amount has not yet been recognised.
Required:
Part A:
a) Show the journal entries for each of the years ended 31 December 20X1, 20X2 and 20X3.
b) Disclose the above in the notes to the financial statements for the year ended
31 December 20X3 in accordance with International Financial Reporting Standards.
Ignore tax.
80 Chapter 7
Part B:
Using all the above information, assume the following additional information:
- allow a deduction for tax purposes of 20% of the cost of the asset per annum;
- levy corporate income tax at 30%.
mentioned above.
Required:
a) Show the journal entries for each of the three years ended 31 December 20X3.
b) Disclose the above in the notes to the financial statements for the year ended
Accounting policies are not required
Chapter 7 81
GAAP: Graded Questions Property, plant and equipment: revaluation model
Chapter 8
Property, plant and equipment: revaluation model
Question Key issues

8.1 '- Core concepts
8.2 Amalia Working backwards to cost
Revaluations: NRVM versus GRVM
8.3 Café Company Revaluation with recoverable amounts (effect of disposal costs)
8.4 Curious Short questions introducing revaluation model versus cost model
8.5 Running Tap Discussion: Impairment with revaluation model and comparison of terms
(recoverable amount residual value, net realisable value)
8.6 Wanderers Part A: Cost model: impairment followed by impairment reversal
Part B: Revaluation model: decrease (impairment) then increase
Part C: Revaluation model: decrease (no impairment) then increase
8.7 Easy Revaluation model (gross replacement versus net replacement)
8.8 Able Revaluation model: increase followed by a further increase:
GRVM and NRVM compared
8.9 Maroon Revaluation model (revaluation increase after initial recognition, followed
by revaluation decrease, followed by revaluation increase);
No impairments and no tax
8.10 Green Peace Revaluation model: (revaluation increase then a decrease – but asset not
impaired)
A: with tax (intention to keep)
B: no tax
8.11 Wimbledon Revaluation model: (revaluation increase then a partial decrease/ no
expense)
A: with tax (intention to keep)
B: no tax
8.12 Higgins Revaluation model: increase
Tax effects: depreciable and deductible: revaluation above cost
A: intention to keep
B: intention to sell
8.13 Zeus Revaluation model: increase
Tax effects: non-depreciable and non-deductible: revaluation above cost:
A: intention to keep
B: intention to sell
8.14 Values Revaluation model (revaluation decrease with impairment, increase with
revaluation surplus): With tax
8.15 Lovenlarf Revaluation model: NRVM (small aspect of disclosure requiring
calculations using the GRVM), (revaluation increase)
Deferred tax effect of revaluation above cost:
- revaluation of depreciable and deductible asset - intention to sell,
- revaluation of depreciable and non-deductible asset - intention to sell
- revaluation of non-depreciable, non-deductible asset - intention to keep
chapters.
82 Chapter 8
Question 8.1
a) List the two measurement models allowed by IAS 16 Property, Plant and Equipment.
b) The entity may choose which measurement model to apply and may choose to apply a
different model on an item-by-item basis. True or false?
c) The net replacement value method (also known as the elimination method) and the gross
replacement value method (proportional restatement method) are two measurement models
allowed under IAS 16 Property, Plant and Equipment. True or false?
d) Describe how to increase the carrying amount to fair value when using the revaluation
model.
e) Describe how to decrease the carrying amount to fair value when using the revaluation
model.
f) Items of property, plant and equipment that are measured under the cost model must be
tested for impairment but those measured under the revaluation model are not tested for
impairment. True or false?
g) The revaluation surplus account must remain in equity until the asset is disposed of. True
or false?
Question 8.2
Amalia Limited purchased a plant on 1 January 20X1. On 31 December 20X2, this plant had
a carrying amount of C2 100 000. The plant is depreciated on the straight-line basis at 10%
per annum to a residual value of C100 000. The plant has never been considered to be
impaired.
The plant is measured under the revaluation model where revaluations are scheduled to be
performed every three years. The fair value at 31 December 20X3 was determined by an
independent valuer to be C3 000 000. The residual value remained unchanged at C100 000.
Required:
a) Calculate the cost of the plant on 1 January 20X1.
b) Prepare the journals relating to plant for the year ended 31 December 20X3 assuming that
the entity chooses to account for revaluations on the net replacement value basis.
c) Prepare the journals relating to plant for the year ended 31 December 20X3 assuming that
the entity chooses to account for revaluations on the gross replacement value basis.
Ignore tax effects.
Question 8.3
Café Company owns a plot of land that had been purchased for C750 000 on 15 June 20X4.
The land is held under the revaluation model and is not depreciated. Its fair values were :
x At 31 December 20X4: C750 000;
x At 31 December 20X5: C720 000.
The land was not considered to be impaired at 31 December 20X4.
Required:
Process the necessary journals under the following scenarios:
a) In determining the recoverable amount at 31 December 20X5, costs of disposal costs
were considered to be immaterial and the value in use is C735 000.
b) In determining the recoverable amount at 31 December 20X5, costs of disposal costs
were considered to be immaterial and the value in use is C705 000.
Chapter 8 83
c) In determining the recoverable amount at 31 December 20X5, costs of disposal costs

were estimated to be C10 000 and the value in use is C705 000.
Question 8.4
Curious Limited has a year end of 31 December. The accountant would like you to explain
and/ or calculate the following:
a) IAS 16: terms
Explain the difference between the cost model and the revaluation model, and what the
terms actually refer to.
b) IAS 16: revaluation model - increase in value; ignoring tax
Plant cost C100 000 on 1/1/20X1. Depreciation is provided at 20% per annum on the
straight-line basis. The fair value is C90 000 at 1/1/20X2. The residual value is assessed
to be zero and this has remained unchanged since acquisition. The company wishes to
apply the net replacement value method and to transfer the realised portion of the
revaluation surplus to retained earnings annually.
i. Calculate and journalise the change in value of the plant.
ii. Calculate and journalise the depreciation of the plant for 20X2.
iii. Calculate and journalise the amount of the transfer from the revaluation surplus to
retained earnings and explain why the company makes this transfer.
c) IAS 16: revaluation model - increase in value; with tax
Same information as in (b) above, except that there is a tax allowance of 20% per annum
on the straight-line method and that the applicable tax rate is 30%.
d) IAS 16: revaluation model - decrease in value; ignoring tax
straight-line basis. The fair value is C70 000 at 1/1/20X2. The residual value is assessed
to be zero and this has remained unchanged since acquisition.
The company wishes to apply the net replacement value method and to transfer the
realised portion of the revaluation surplus to retained earnings annually.
e) IAS 16: revaluation model - decrease in value; with tax
Same information as in (d) above, except that there is a tax allowance of 20% per annum
on the straight-line method and that the applicable tax rate is 30%. Show all journals.
f) IAS 16: revaluation model – impairment; ignoring tax
straight-line basis. The recoverable amount is C70 000 at 1/1/20X2.
The residual value is assessed to be zero and this has remained unchanged since
acquisition. The company transfers the realised portion of the revaluation surplus to
retained earnings annually.
84 Chapter 8
g) IAS 16: cost model - increase in value; ignoring tax

Same information as in (b) above, except that the company uses the cost model and the
recoverable amount is C90 000 at 31 December 20X1.
h) IAS 16: cost model - decrease in value; ignoring tax
Same information as in (f) above, except that the company uses the cost model and the
recoverable amount is C70 000 at 31 December 20X1.
i. Calculate and journalise the change in value.
The revaluation model is applied using the net replacement value method.
The entity intends to recover the carrying amount through use.
Question 8.5
You are the auditor of a large bathroom supplies company called The Running Tap Limited,
which has a December year-end. The accountant of The Running Tap Limited qualified in
the United States and is thus not completely familiar with IFRS. He has approached you
regarding two issues that need clarification before the current financial statements for the year
ended 31 December 20X0 may be finalised.
All of the non-current assets were revalued during the current year. For this reason no
impairment tests were performed on any assets during the year.
Required:
a) Discuss whether you agree or disagree with the decision not to perform impairment tests.
b) Although the accountant does not believe that he has to perform any impairment testing,
he has requested that you explain what this would involve were it necessary for him to
perform an impairment test.
c) Explain to the accountant the meaning and use of the following three terms: recoverable
amount, residual value and net realisable value. Your answer should include an
explanation as to how each of these amounts are used, and how they would be calculated.
Question 8.6
Part A:
Wanderers Limited is a small listed company producing components for satellites that monitor
pollution levels across the globe. Its financial year end is 30 June.
The accounting policy of Wanderers Limited relating to equipment reads as follows:
‘Equipment is measured at cost less accumulated depreciation and accumulated
impairment losses. Depreciation is provided at 20% per annum to a nil residual value
using the straight line basis.’
The company purchased an item of specialised equipment at a cost of C800 000 on 1 July 20X0.
The company measures its fair values using the cost approach using level one inputs and the
value in use is calculated by an independent actuary using observable market inputs.
Details regarding this equipment follow:
x At 30 June 20X1, significant developments in technology by competitors led management
to assess the recoverable amount of the equipment.
The fair value (C460 000) less costs of disposal (C20 000) is C440 000.
The value in use of the equipment was measured at C380 000.
Chapter 8 85
x Towards the end of the 20X3 financial year, it became apparent that the competitors’ new
technology developed in 20X1 was not commercially viable.
The fair value (C500 000) less costs of disposal (negligible) is C500 000.
x The estimated useful life has remained unchanged throughout. The residual value is
estimated to be nil (unchanged).
Profit before tax for the year ended 30 June 20X3 before accounting for any expenses or
income relating to the equipment amounts to C300 000. The current tax payable balance of
C33 000 at 30/06/20X2 had been paid off during the year.
The tax authorities grant a tax allowance of 33,3% per annum on the straight line basis in
relation to this equipment. The income tax rate is 30%. There are no other non-temporary or
temporary differences other than those evident from the information provided.
Required:
a) To the extent of the information available, prepare extracts from the statement of
comprehensive income, statement of financial position and notes to the financial statements
of Wanderers Limited for the June 20X3 financial year in accordance with International
Accounting policies and comparatives are not required.
b) To prepare the journal entry to account for the change in the recoverable amount of the
equipment at 30 June 20X3.
Part B:
The same situation applies as in Part A above, except that management of Wanderers Limited
decide to adopt the following accounting policy relating to equipment:
‘Equipment is measured at its fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment losses. Depreciation is
provided at 20% per annum to a nil residual value on the straight line basis.’
x At 30 June 20X1 the equipment was revalued to a fair value of C440 000.
x At 30 June 20X3 the equipment was revalued to a fair value of C500 000.
x At no stage was this asset considered to be impaired (i.e. the recoverable amount was
greater than its carrying amount in each year affected).
estimated to be nil (unchanged).
x The entity intends to recover the carrying amount of the equipment through use and
transfers the realised portion of the revaluation surplus to retained earnings when the
equipment is disposed of.
Required:
Prepare the journal entries to account for the equipment for the years ending 30 June 20X1 and
30 June 20X3 assuming that the net replacement value method is used.
Part C:
The same situation applies as in Part A above, except that management of Wanderers Limited
decide to adopt the following accounting policy relating to equipment:
86 Chapter 8
‘Equipment is measured at its fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment losses. Depreciation is
provided at 20% per annum to a nil residual value on the straight line basis.’
x At 30 June 20X1, significant developments in technology by competitors led management
to assess the recoverable amount of the equipment.
The fair value (C460 000) less costs of disposal (C20 000) is C440 000.
x Towards the end of the 20X3 financial year, it became apparent that the competitors’ new
technology developed in 20X1 was not commercially viable.
The fair value (C500 000) less costs of disposal (negligible) is C500 000.
estimated to be nil and has also remained unchanged throughout.
x The entity intends to recover the carrying amount of the equipment through use and
transfers the realised portion of the revaluation surplus to retained earnings when the
equipment is disposed of.
Required:
Prepare the journal entries to account for the equipment for the years ending 30 June 20X1,
30 June 20X2 and 30 June 20X3 assuming that the net replacement value method is used.
Question 8.7
Easy Limited purchased a plant on 1 January 20X3 for C300 000, on credit. Depreciation is
provided over its useful life of 5 years to a nil residual value using the straight-line method.
Easy Limited measures plant under the revaluation model. The plant was revalued as follows:
x 1 January 20X5: C240 000
x 1 January 20X6: C200 000.
Easy Limited transfers the maximum amount from the realised portion of the revaluation
surplus to retained earnings over the useful life of the plant.
Required:
Prepare the journals for the plant for the years ended 31 December 20X3 to 20X6 assuming:
a) The gross replacement value method is used;
b) The net replacement value method is used.
Ignore tax.
Question 8.8
Able Limited purchased all its plant on 1 January 20X1. The plant is depreciated over an
expected useful life of 20 years to a nil residual value. The estimated useful life and residual
value have remained unchanged.
Able Limited revalues its plant every four years. Revaluations were performed by Trust
Valuers, an independent firm of valuers, as follows:
x 1 January 20X5: C8 000 000
x 1 January 20X9: C9 000 000.
Chapter 8 87
This plant has never been impaired or revalued downwards.
Required:
Prepare the property, plant and equipment note for 20X9 in accordance with International
Financial Reporting Standards using:
a) the gross replacement value method
b) the net replacement value method.
Question 8.9
Maroon Limited has plant that cost C100 000 on 1/1/20X1. Depreciation is provided over the
useful life of 5 years on a straight line basis to a nil residual value.
The company uses the revaluation model for subsequent measurement of its property, plant
and equipment and accounts for revaluations on the net replacement value method. The fair
values listed below were measured using the cost approach.
x The fair value, as determined by an independent valuer, at 1/1/20X2 amounts to C120 000
The company transfers the maximum amount possible from the revaluation surplus to retained
earnings on an annual basis.
Impairment testing at the end of each year found that the recoverable amounts were higher
than carrying amounts.
Required:
Journalise the transactions for the years ended 31 December 20X2, 20X3 and 20X4.
Ignore tax.
Question 8.10
Greenpeace Limited is a manufacturing entity that operates throughout the world and is dual-
listed on both the JSE Ltd and London Stock Exchange.
The company purchased an item of plant on 1 July 20X5. It was installed and available for
use in the manner intended by management on the same day. The cost of the plant was
C900 000. It has an estimated useful life of four years and a nil residual value.
Greenpeace Limited uses the revaluation model for the measurement of its property, plant and
equipment and, due to the nature of its operations, the company has a policy of revaluing its
property, plant and equipment on an annual basis. The net replacement value method is used.
The company transfers the revaluation surplus to retained earnings as the asset is used.
The fair value of the plant was estimated using discounted cash flows by an independent
valuer at 30 June 20X6 and 30 June 20X7 as shown in the following table. The useful life
and residual value remained unchanged.
Date Fair value
30 June 20X6 C825 000
30 June 20X7 C400 000
The profit before tax has been correctly calculated at C300 000 for the year ended
30 June 20X7.
88 Chapter 8
There were no indicators of impairment at any stage during the year.

Part A:
The company’s tax expense for the year ended 30 June 20X7, correctly calculated, is C87 000,
Required:
a) Prepare journal entries relating to plant for the financial year ended 30 June 20X6.
Ignore journals relating to the deferred tax effect of the revaluation.
b) Prepare relevant extracts from the:
x Statement of comprehensive income for the period ended 30 June 20X7;
x Statement of changes in equity for the period ended 30 June 20X7; and
x Statement of financial position at 30 June 20X7.
c) Prepare relevant extracts from the notes to the financial statements of Greenpeace Limited at
30 June 20X7.
The accounting policy for property, plant and equipment is required.
The statement of compliance and basis of preparation notes are not required.
Tax and deferred tax notes are not required.
Part B:
Tax-related information includes the following:
x The corporate income tax rate is 29% and has not changed since the plant was purchased.
x The tax authority allows the deduction of the plant's cost by way of an annual tax allowance
calculated at 25% per annum on cost.
There are no other temporary or non-temporary differences other than those apparent from the
information given . Greenpeace Limited intends to keep this plant.
Required:
a) Prepare all journals relating to plant for the financial year ended 30 June 20X6.
b) Prepare relevant extracts from the:
x Statement of comprehensive income for the period ended 30 June 20X7;
x Statement of changes in equity for the period ended 30 June 20X7; and
x Statement of financial position at 30 June 20X7.
c) Prepare relevant extracts from the notes to the financial statements of Greenpeace Limited at
30 June 20X7.
The accounting policy notes for property, plant and equipment and deferred tax are
required. The statement of compliance and basis of preparation notes are not required.
Question 8.11
Part A:
Wimbledon Limited is a company producing garden implements. The following information
relates to the company's plant:
x The plant originally cost C600 000 when purchased on 1 January 20X7.
x Plant is depreciated on the straight-line basis over 5 years to a nil residual value. This has
remained unchanged since acquisition.
Chapter 8 89
x The plant was revalued by Mr. K. Amrit, an independent sworn appraiser and a member
of the Institute of Valuers, as follows:
x On 1/3/20X7 to a fair value of C725 000
x On 1/3/20X8 to a fair value of C506 000
x The company adopts the revaluation model and accounts for the revaluation on the net
replacement value basis. The maximum amount is transferred from the revaluation
surplus to retained earnings on an annual basis. The company intends to keep the asset.
x There were no indicators of impairment at any stage during the year.
Required:
a) Journalise the above transactions for the financial years ended 28 February 20X7, 20X8
and 20X9.
b) Prepare the statement of changes in equity for the financial year ended February 20X9 in
c) Prepare the following notes to the financial statements in accordance with International
x Profit before tax note; and
x Property, plant and equipment note.
Part B:
Using the same information as that provided in Part A, assume the following further information:
x The corporate income tax rate is 30% and has not changed since the plant was purchased.
x A tax allowance on the plant is granted at 20% of the cost per annum, apportioned for time.
x There are no non-temporary or temporary differences other than those evident from the
information presented above.
Required:
a) Journalise the above for the financial years ended February 20X7, 20X8 and 20X9.
b) Prepare the statement of changes in equity for the financial year ended February 20X9.
c) Prepare the following notes to the financial statements for the financial year ended
28 February 20X9 in accordance with International Financial Reporting Standards:
x Profit before tax note; and
x Property, plant and equipment note;
x Tax expense note and;
x Deferred tax note
Question 8.12
Higgins Limited operates in the woodwork industry and requires many items of plant to operate
its business. The company owns an asset with the following characteristics:
x Cost: C200 000 (this is also the base cost for capital gains tax purposes)
x Fair value C220 000 (this is the first revaluation)
x Carrying amount and tax base: C120 000 (on date of revaluation)
The income tax rate is 30% and the capital gains inclusion rate is 50%.
Required:
Show the deferred tax journal assuming that the deferred tax balance was zero before the
revaluation of the asset and assuming:
90 Chapter 8
a) the entity intends to recover the carrying amount of the plant through use.
b) the entity intends to recover the carrying amount of the plant through sale.
Question 8.13
Zeus Limited is a large retail company that sells just about anything. They have recently
purchased land on which they intend to build new administrative offices. The relevant details are:
Cost (1 January 20X1) C528 000

Fair value (31 December 20X1) C580 800
Base cost Same as the cost for tax purposes
Measurement model Revaluation model
Tax allowance rate Not deductible
Corporate income tax rate 30%
Capital gains inclusion rate 50%
Required:
Show the deferred tax journal relating to the land assuming that the deferred tax balance was zero
before the revaluation of the asset and assuming:
a) the entity intends to recover the carrying amount of the land through use.
b) the entity intends to recover the carrying amount of the land through sale.
Question 8.14
Values Limited uses the revaluation model and has a policy of revaluing their assets to fair
values on a two-yearly cycle using the net replacement value method.
Plant was purchased on 1 May 20X5 at a cost of C450 000.
x It has a useful life of five years with no residual value.
x Depreciation is provided on the straight-line method over the plant’s estimated useful life.
x Values Limited intends to recover the carrying amount of their plant through use.
At 31 December 20X6, an impairment test found the plant’s recoverable amount to be C220 000.
At 31 December 20X8:
x The plant was revalued by an independent valuer to a fair value of C190 000. The valuer
used the cost approach to measure the fair value of the plant in an active market. The
revaluation surplus is transferred to retained earnings over the asset's remaining useful life.
x The recoverable amount was C205 000.
Profit before tax has been correctly calculated at C800 000 in 20X9 and C600 000 in 20X8.
At no stage was there a change in the asset's expected useful life, residual value or method of
depreciation.
The tax authorities allow wear and tear at 20% on the straight-line basis apportioned for time.
The tax rate remained 30% throughout.
There are no other temporary or non-temporary differences other than those apparent from the
information given.
Required:
a) Journalise the above transactions from date of original purchase.
b) Prepare the statement of comprehensive income for the year ended 31 December 20X9 in
Chapter 8 91
c) Prepare the statement of changes in equity for the year ended 31 December 20X9 in
d) Prepare the following notes for the year ended 31 December 20X9 in accordance with
International Financial Reporting Standards:
x Profit before taxation
x Taxation, deferred taxation and tax on comprehensive income
x Property, plant and equipment.
Comparatives are required.
All fair values are based on level one inputs per IFRS 13
Question 8.15
Lovenlarf Limited has been using the cost model to measure its property, plant and equipment
but, in 20X3, changed its accounting policy to the use of the revaluation model instead. Its
property, plant and equipment consists of a plant, a building and land.
The plant had a carrying amount of C2 100 000 at 31 December 20X2, having been:
x purchased for C2 600 000 on 1 January 20X1; and
x depreciated at 10% pa on the straight-line basis to a residual value of C100 000
(unchanged).
The building had a carrying amount of C2 200 000 at 31 December 20X2, having been:
x purchased for C3 100 000 (the portion of the cost that is attributable to the land on which
it is built is considered immaterial); and
x depreciated at 5% per annum on the straight-line basis to a residual value of C100 000 (all
unchanged since acquisition).
The land, consisting of two plots, had a carrying amount of C1 500 000 (C750 000 per plot) at
31 December 20X2. Land is not depreciated. Details of the two plots are as follows:
x Erf 167 in Durban Beach Street (5 100 m2in extent): vacant but used as a parking lot,
x Erf 300 in Durban Hill Street (5 100 m2 in extent): vacant.
None of these items have ever been impaired in the past.
The necessary valuations were done as at 31 December 20X3 by Simon Nova. Simon is an
independent valuer and a member of the Institute of Valuers. Valuations will be performed
annually hereinafter. The following fair values were measured based on an active market:
x Plant: C3 000 000;
x Building: C4 100 000; and
x Land: C2 000 000 (C1 000 000 per plot).
Revaluations are recorded using the net replacement value method. Transfers of the realised
portion of the revaluation surplus to retained earnings are to be made annually.
There was no other movement of property, plant and equipment during 20X3.
The intention is to:
x sell the plant and the building (the criteria for classification as a ‘non-current asset held
for sale’ were not met);
x keep the vacant plot of land that is currently used as a parking lot (Erf 167) but sell the
other vacant plot of land (Erf 300).
There are no differences between taxable profit and accounting profit other than those evident
92 Chapter 8
Information relating to the local tax legislation:

x Corporate income tax is levied at 30% (unchanged for many years). The inclusion rate
for capital gains is 50%.
x The tax authorities do not allow deductions for either the buildings or land. The tax
authorities allow a 10% capital allowance on the cost of plant.
x The base cost of both land and buildings equals cost whereas the base cost of plant is
C2 800 000.
Required:
a) Show the calculation of the deferred tax balances at 31 December 20X2 and
31 December 20X3 using the balance sheet approach. Your calculation must clearly
show your calculations and must clearly show what element the balances represent.
b) Show the following in the statement of financial position as at 31 December 20X3 in
accordance with International Financial Reporting Standards:
x Property, plant and equipment
x Deferred tax.
c) Disclose the building in the property, plant and equipment note as at 31 December 20X3
in accordance with International Financial Reporting Standards and the Companies Act of
2008. Comparatives are not required.
d) Show how the net carrying amount, gross carrying amount and accumulated depreciation
would change in the note in part (c) had the revaluation been recorded using the gross
replacement value method (gross method).
e) Using the general journal, provide the journal entries relating to plant for the year ended
31 December 20X3.
Chapter 8 93
GAAP: Graded Questions Intangible assets
Chapter 9
Intangible assets
Question Key issues

9.1 - Core concepts – various
9.2 Chocsnack Core concept question –
research and development;
finite and indefinite useful lives
method of acquisition and effect on recognition and measurement
9.3 Adam Discussion: market share - whether to recognise or not
9.4 Zoobob Discussion: staff skills and patent - whether to recognise or not
9.5 Conmen Discussion and calculations: Licence – measurement, involving:
finite useful life; and
change in estimate
9.6 Energised Discussion: brand name purchased: measurement and disclosure, involving
revaluation of a fully amortised brand
9.7 Bad Drivers Discussion: permit – recognition, measurement and disclosure – finite life
9.8 Ozone Journals: research and development: (involves impairments and reversals)
9.9 Quencher Discussion: accounting treatment;
purchased brand: training costs, legal fees and amortisation (finite life)
research and development
9.10 Ghostbusters Discussion: Brand (accounting treatment);
purchased brand and internally generated brand;
indefinite useful life originally, but now considered finite;
falling ticket sales;
re-launch costs
9.11 Meat Man Discussion : Brands: recognition, measurement:
purchased brand
renewable at significant cost versus insignificant cost
finite lives and indefinite useful lives
possible impairments
9.12 Beehive Discussion and journals: Brands: recognition, measurement: purchased
brand and internally generated brand and useful lives
Discussion: Research and development: recognition and measurement
Discussion: Patent: purchased; useful lives; cost of renewal is insignificant
9.13 Gummy Berry Letter: Website costs: recognition and measurement
Juice
9.14 Wonder-Sale Journals and disclosure: Websites (recognition, measurement and
disclosure): amortisation, impairment, derecognition and development costs
9.15 Alastair’s Discussion: advertising catalogues: recognition and measurement
Natural Part A: catalogues received before year end, paid for before year end, to be
Remedies used in a promotion after year end.
Part B: catalogues received after year end, paid before year end, to be used
in a promotion after year end.
chapters.
94 Chapter 9
Question 9.1
a) Define the term 'intangible asset'.

b) Indicate whether or not it is true that an entity must have control over an item before it
may be recognised as an intangible asset and briefly justify your answer.
c) Indicate whether or not it is true that an entity must have legally enforceable rights over
an item's expected future economic benefits before it may be recognised as an intangible
asset and briefly justify your answer.
d) Indicate whether the following statement is true or false and briefly justify your answer:
An intangible asset acquired in a business combination will be expensed by the acquirer if
the definition of that intangible asset is not met (e.g. the identifiability criteria is not met).
e) Indicate whether the following statement is true or false and briefly justify your answer:
Internally generated customer lists, brands and goodwill can never be capitalised.
f) Fill in the missing words: An intangible asset is __________ initially measured at
__________.
g) Indicate whether the following statement is true or false and briefly justify your answer:
Intangible assets may be initially measured at fair value, in which case the fair value must
be determined in terms of an active market.
h) List the two measurement models that may be used to subsequently measure intangible
assets.
i) Indicate which model is generally considered impractical for intangible assets together
with a brief explanation as to why it is considered to be impractical.
j) Indicate whether the following statement is true or false and briefly justify your answer:
Not all intangible assets are amortised.
k) Briefly explain what method of amortisation would be appropriate when amortising an
intangible asset.
l) Intangible assets are amortised over their useful lives. Briefly explain when one should
begin amortising an intangible asset and how to estimate its useful life.
m) Briefly explain how to calculate the residual value of an intangible asset.
Question 9.2
Aubrey, an accountant of Chocsnack Limited, is battling to understand certain aspects of

IAS 38 Intangible assets. You are employed by a firm of accounting consultants. He has sent
you an email asking for clarity on three issues. An extract of his email follows:
x Please could you briefly explain the difference between research and development and
how I should be recognising the related costs?
x Could you please also explain the difference between finite useful life and indefinite
useful life intangible assets and briefly identify what aspects of the measurement of an
intangible asset would be affected by these different categories?
x I have heard that both the recognition and measurement of an intangible asset depends on
how it was acquired. Please could you elaborate in detail? I am so worried that I have
accounted for our company's intangible assets incorrectly.
Required:
Draft an email to the accountant in which you address each of his concerns.
Chapter 9 95
Question 9.3
Adam Limited is a successful engineering business. Over the past number of years, the
company has achieved a market share for its products of 30%. At a recent board meeting, the
directors suggested recognising an intangible asset for this market share.
Required:
Briefly discuss whether the market share can be recognized as an intangible asset in terms of
IAS 38 Intangible Assets.
A discussion of the recognition criteria is not required.
Question 9.4
Zoobob Limited is a company in the IT industry. The success of the company is built around
software which it has developed internally and for which a patent is registered as well as the
skills of the staff that operate the software. Staff members are required to give one month’s
notice of their resignation.
Required:
Briefly discuss whether the patent and the staff skills can be recognised as an intangible asset
in terms of IAS 38, Intangible Assets.
A discussion of the identifiability criteria is not required.
Question 9.5
Conmen Limited manages and operates toll roads on major national routes throughout the
country. The company purchased a licence to operate a toll road in the Eastern Cape
seventeen years ago for an amount of C10 000 000, this right being correctly recognised as an
intangible asset on date of purchase.
It was expected that the toll road would be in use for twenty years and the economic benefits
will flow to the entity evenly over this period.
The estimated toll road usage is 1 000 000 cars per year. At the time, there were no plans to
construct alternate roads in the area. There is no active market for toll road licences.
During the current year, the government announced their plans, and construction began on a
bridge in the area that would significantly reduce usage of the toll road.
The directors estimate that the economic benefits flowing to the entity will decrease each year
over the remaining three years of the licence, with estimated toll road usage expected to drop
to 800 000 cars, 600 000 cars and 400 000 cars, respectively, over the remaining three years.
Required:
To discuss the accounting issues relating to the measurement of Conmen Limited’s Eastern
Cape toll road licence.
96 Chapter 9
Question 9.6
Energised Limited has owned the Mola Tonic brand name for many years, this purchased
brand name having been the mainstay of the company’s business. The brand is currently
recorded in the financial statements at a nil carrying amount (being its original cost of
C40 million less accumulated amortisation of C40 million). The directors of the company
estimate that the current value of the brand is in excess of C100 million and wish to revalue
the brand accordingly.
Required:
Discuss how to measure and disclose the brand name in the financial statements of Energised
Limited in terms of IAS 38.
Question 9.7
The following information relates to Bad Drivers Limited, a bustling and growing company
involved in the taxi industry:
x Bad Drivers Limited operates a number of taxis in the greater Durban area and is a key
player in transporting a large number of the Durban workforce to and from work daily.
x The company discovered on 2 January 20X9 that it had been successful in its application
for a special driving permit that allows its drivers to use the dedicated bus lanes so as to
shorten travelling time and thus transport more passengers and increase profitability. The
cost of this permit is C1 000 000.
x No other taxi company is able to obtain this permit, as only one is issuable by the
provincial government at any one time.
x This permit is valid for a period of 5 years, following which it will be up to the provincial
government to decide who will be able to purchase the next such permit: although Bad
Drivers Limited is sure that it will apply to have this permit renewed for the next 5 years
after the expiry of this current 5-year permit, it is not yet certain or probable that it would
be successful in such a bid.
The financial director expensed the cost of the permit in the year it was received. The
managing director believes that the permit should be capitalised.
Required:
Discuss the recognition, measurement and disclosure of the special driving permit in the
financial statements of Bad Drivers Ltd for the year ended 31 December 20X9 in terms of the
Question 9.8
Ozone Limited has been trying to develop a chemical that can be released into the atmosphere
to break the greenhouse gases into gases that are less damaging to the environment.
The accountant is aware that C1 500 000 has been incurred, and paid for, between 20X1 and
20X4 but has been told by the auditors that the manner in which he has accounted for these
costs is incorrect and, given the significant amounts involved, they will have to qualify the
report if it is not corrected. The auditors had already told him to correct this a month ago but
he has not done so, since he has lost the original detail provided to him by the chief scientist.
Chapter 9 97
The chief scientist has scribbled the following details down for you regarding the work done
on this project by his department to date:
Memorandum
From: Chief scientist
To: Chief accountant
This has to be the last time I summarise this for the accounting department! I have better things to
do with my time – like saving the planet!
20X1
x We spent C200 000 (40% on research and 60% by our chemists). We were in the early stage
of the project in 20X1 and thus we were not yet sure that it was technically feasible.
20X2
x We spent C900 000, all of which were costs incurred in our laboratories. We had a meeting
and explained that our project was definitely technically feasible and all you accountants were
going on about the definitions and recognition criteria – you decided that they were met (I am
not sure what this means to you, if anything, but I have the minutes from the meeting
scribbled in my diary).
x One of the bean counters from upstairs said something about a recoverable amount of
C800 000 at 31 December 20X2. I am not sure what he meant, but it may be important to
you…it had to do with Bluesky going into competition with us if I recall correctly.
20X3
x This was a bad year to start with: our project was suspended in January due to the significant
competition posed by Bluesky Limited. We were forced to draft budgets and perform cost
projections and such like to ensure that our project was financially viable. Obviously the
concerns were groundless and we simply ended up wasting C40 000 on this little exercise
(which wasted the entire month).
x We were given the go-ahead in February to resume our work and spent C360 000 over the rest
of the year (my records reflect that your department decided that your definitions and
recognition criteria for capitalisation were met from February – oh, and your recoverable
amount on 31 December 20X3 was calculated to be C1 300 000). By the way, of the
C360 000, C60 000 was spent on administrative tasks.
x We finished our project around Christmas time – or maybe a day or so before New Year, I
can’t recall. So we were ready to go into production from January 20X4, but for some reason
production didn’t happen until 1 April 20X4.
Hope this helps – please stick this memo onto your forehead so that you don’t lose it again: I
thought scientists were supposed to be scatter-brained…
The accountant has shown you this memorandum and has asked that you show him how he
should have accounted for this project. He tells you that the project has a useful life of
five years, a nil residual value and amortisation is calculated on the straight-line basis.
Required:
Provide all related journal entries in the general journal of Ozone Limited for each of the
financial years ended 31 December 20X1, 20X2, 20X3 and 20X4.
Question 9.9
Quencher Limited’s business involves the bottling and distribution of a wide variety of
carbonated soft drinks. Some drinks are developed internally, whilst other brands are
98 Chapter 9
purchased. The following information is relevant to the business for the year ended
30 May 20X5.
N-Gee :
x On 1 April 20X5, Quencher acquired the well known brand, N-Gee for an amount of
C2 500 000, which was paid in full at that date.
x In addition to this, an amount of C175 000 was spent on legal fees to secure the right to
use this brand. The legal fees were paid on 31 April 20X5.
x Due to the fact that Quencher’s staff had never previously been exposed to N-Gee,
extensive training (by the staff at the company from whom the N-Gee brand had been
purchased) took place during the month of April 20X5. The total cost of this training
amounted to C200 000.
x Sales of N-Gee drinks commenced on 15 May 20X5.
x The N-Gee brand has an estimated useful life of fifteen years.
Fliptop:
Fliptop is a revolutionary type of can that has been developed internally by Quencher over the
past two years. The can has a re-sealable top which allows the can to be sealed after opening
to prevent the gas escaping. In January 20X4 the idea for this new product was launched, and
a loan of C5million was obtained from Borrow Bank in order to finance this project.
The chronology of its development and associated costs for the year ended 31 May 20X5 are
as shown in the following table:
Date Nature of activity Expenditure
01/06/20X4 - 31/07/20X4 Market surveys to establish whether or not consumers C40 000
would want such a can
01/08/20X4 - 15/09/20X4 Evaluation of a number of alternative prototypes and C200 000
designs
30/09/20X4 A design is chosen and engineers produce a plan which
indicates that it is technically possible to produce the
Fliptop can.
1/10/20X4 - 31/01/20X5 Design and construction of a pilot manufacturing plant C1 100 000
01/02/20X5 - 31/05/20X5 Testing of a pilot manufacturing plant C600 000
The market surveys suggested that there is a market for the 'Fliptop Can' amongst the growing
number of environmentally aware consumers who are trying to reduce their carbon footprint.
All expenditure incurred has been confirmed by the accounting department.
Quencher has applied to register the 'Fliptop Can' as a patent.
Required:
a) Discuss, with reasons, and with reference to IAS 38: Intangible Assets,
i) whether the N-Gee brand can be recognized as an intangible asset
ii) how to measure the N-Gee brand in Quencher’s financial statements for the year ended
31 May 20X5.
b) Discuss, with reference to IAS 38: Intangible Assets, the correct accounting treatment for
all the costs incurred in relation to the Fliptop can for the year ended 31 May 20X5
(Use the definitions of ‘research’ and ‘development’ in your answer).
Chapter 9 99
Question 9.10
Ghostbusters Limited has been operating the House of Horrors theatre in Durban for 20 years.
The following information relates to the brand ‘House of Horrors’:
x The House of Horrors theatre has been in operation since the early 1950’s. The previous
owners, Mr Casper and Mr Spooky had built the brand name, making it known as the
premiere theatre, presenting live shows of only the very best quality.
x When Mr Casper and Mr Spooky sold their brand name, they felt that the offer of
C500 000 from Ghostbusters Limited was ridiculously low, but since they were under
financial pressures, they were forced to accept the offer. Being a little eccentric, however,
Casper and Spooky threatened to haunt the theatre and ensure that people went elsewhere
to enjoy live shows, announcing their threat in a widely distributed newspaper.
x Ghostbusters Limited, believing the threat to be an idle one, capitalised the cost of the
brand name upon its purchase 20 years ago.
x The brand was not amortised since the theatre had been so popular for so long that there
was no reason to believe that this would ever change and thus the management argued
that the brand should remain on their statement of financial position indefinitely.
x About five years ago, Mr Casper and Mr Spooky died unexpectedly from food poisoning
after eating at a local restaurant. Almost immediately, mysterious things began happening
at the theatre, making many of the usual patrons reluctant to return. Profits plummeted
dramatically and, whilst the company was not yet in financial difficulties, these profits
have never recovered.
x Some of the older management remembered the previous owners’ threat, and suggested
that if they changed the theatre’s brand name, that these ‘things’ may stop happening.
x The proposal was accepted and the theatre was closed on 31 May 20X9 for rebranding.
The theatre then re-opened on 1 July 20X9 with the new name ‘Opera Phantom’, the new
name created by the marketing department.
x The old brand name was written off in the current year and the cost of re-branding was
capitalised as the new brand name as it was expected that all the old patrons would return
and that even more new patrons would come to enjoy the theatre.
Required:
Critically analyse the above issue, explaining whether the treatment is correct or incorrect and
justifying your advice with reference to International Financial Reporting Standards.
Question 9.11
Meat Man Limited is a company manufacturing and retailing food products. It has, in the
past, been profitable, selling products under two popular brand names, ‘Buffalo Bull’ and
‘Kicking Kow.’ The current financial year ends on 31 July 20X6. The following is an extract
from the notes to the financial statements:
100 Chapter 9
MEAT MAN LIMITED

NOTES TO THE FINANCIAL STATEMENTS (EXTRACT)
FOR THE YEAR ENDED 31 JULY 20X6
31. Brands Buffalo Bill Kicking Kow

C C
Cost 510 000 850 000
Accumulated depreciation 0 0
Accumulated impairment 0 0
Carrying amount 510 00 850 000
Buffalo Bull information:

x A licence to sell ‘Buffalo Bull’ branded products was purchased on 1 August 20X5. The
directors intend to renew the right to sell under this brand name in 50 years, which is
when the licence expires. The cost to renew the licence is C17 000, which is regarded as
immaterial relative to the company’s net asset value.
x There seems to be no end in sight to the popularity of this brand, and thus, given all
circumstances, the estimated useful life of the Buffalo Bull brand is thought to be indefinite.
x There were no indicators of impairment at the current year-end, and thus the recoverable
amount was not determined.
Kicking Kow information:
x A licence to sell Kicking Kow branded products was purchased on 1 August 20X5. The
licence to use the Kicking Kow brand name expires after 40 years.
x At the time of acquisition, the Kicking Kow brand was a well-established brand and
considered to be so successful that the financial director declared that there was
'absolutely no end to the brand's economic useful life'.
x The licencing agreement grants Meat Man the right of first refusal to renew the license
when it expires. The cost of renewal is C1 700 000. At the time of acquisition, although
the renewal cost was considered to be significant, it was considered likely that the
directors would choose to renew the licence. However, a subsequent, recent and dramatic
drop in sales of Kicking Kow products now suggests that it would be unlikely that the
directors would renew the licence. In fact, current year profits under this brand are so low
that the directors are seeking legal counsel from their attorneys, (Lamb and Partners Inc.),
to determine if they can cancel the licence agreement.
x The valuers, Hannibill and Associates, have estimated that the present value of the
expected net future cash inflows from sales of Kicking Kow products over the remaining
useful life will not exceed C340 000. The contract does not allow the directors to sell the
right to manufacture under this brand.
Required:
Critically analyse the measurement of the ‘Buffalo Bull’ and ‘Kicking Kow’ brands in the
financial statements of Meat Man Limited.
Question 9.12
Beehive Limited is a company in the confectionery business that owns a number of intangible
assets. A list of the intangible assets owned by Beehive Limited together with some detail is
provided below:
Chapter 9 101
x The company owns a brand called ‘Orange blossom’.

- This brand was acquired on 1 April 20X6 for C2 000 000.
- The life of the ‘Orange blossom’ brand is expected to be ten years.
- There is no active market for this brand.
x The company owns a brand called ‘Infused ginger’.
- This brand has been developed by Beehive Limited and during May 20X6, further
development took place at a cost of C300000.
- The life of the ‘Infused ginger’ brand is expected to be ten years.
- There is no active market for this brand.
x A sweet bottle that glows in the in the dark is currently being developed.
- The initial research into the technical feasibility of this product and its potential
market cost C800 000 during 20X4.
- Development began on 1 March 20X4 and has cost Beehive Limited a total of
C34 000 000 to 31 December 20X6.
- All criteria were met for capitalisation of development costs in 20X4.
- Throughout 20X5, cash flow problems resulted in Beehive Limited being unsure of
their ability to continue the development of this prototype.
- The cash flow problems were resolved in early January 20X6 with the securing of a
loan liability from Dodge Bank.
- Development costs were incurred evenly over the three years.
x The company owns a right to manufacture under a patent for a period of five years.
- This patent was purchased on 1 September 20X6 for C5 000 000.
- The patent has an expected life of twenty years.
- This patent may be renewed for a further period of three years for a sum of C30 000.
Required:
a) Briefly compare aspects of the recognition and measurement of each of the two brands,
Orange blossom and Infused ginger. Your answer should consider:
i) Recognition: Infused ginger brand versus Orange blossom brand
ii) Measurement: residual value for purposes of amortising the Infused ginger brand and
Orange blossom brand
iii) Measurement models: Infused ginger brand versus Orange blossom brand
iv) Journal entries: show the journal entries (relating to both brands) that would have
been processed during 20X6
b) Briefly discuss aspects of the recognition and measurement of the research and
development of the sweet bottle that glows in the dark in the financial statements of
Beehive Limited. Your discussion should consider:
i) Recognition: research versus development of the sweet bottle that glows in the dark in
each of its years ended 31 December 20X4, 20X5 and 20X6
ii) Measurement: amortisation and impairment testing of research versus development of
the sweet bottle that glows in the dark
c) Discuss the determination of useful life for the purpose of amortising the patent in the
financial statements of Beehive Limited for the year ended 31 December 20X6.
102 Chapter 9
Question 9.13
Gummy Berry Juice Limited (GBJ) is a small, but highly successful advertising firm that has
always been operating a manual accounting system. A couple of years ago, they purchased
computers and related technical equipment, and have been in the process of computerising all
their operations. The IT manager has recently approached the financial manager to discuss
the feasibility of taking GBJ’s operations online. Their conversation was as follows:
IT manager: I think it’s time we decided to expand our business online. We could
increase our profits drastically in this way as the majority of business
seems to be concluded online nowadays.
Financial manager: That seems like a good business idea, Bob, but will cause a major
headache on my side, since I now have to find out how to account for
the costs incurred to do this whole online mumbo jumbo. I qualified
years ago before all this fancy stuff was around, and haven’t bothered
to update myself recently as I’m nearing retirement.
IT manager: I’m sorry that it will inconvenience you, but it really is in the best
interests of our business. I know of a firm that is quite up to date with
all the IFRSs and their accompanying interpretations, maybe they can
help you? Here are their contact details.
Financial manager: Thank you so much for your help Bob! Perhaps this is not so daunting
after all...perhaps we’ll even get bonuses for increasing profits!
The financial manager subsequently wrote to your firm, The Groovy Accountants, asking for
your advice on how to treat the website costs that will be incurred.
Required:
Write a letter responding to the query regarding the recognition and measurement of the
website costs, making specific reference to IAS 38 Intangible Assets and SIC 32 Website
costs. Your letter should include a discussion of all website costs.
Question 9.14
Wonder-Sale is a business that operates solely online to sell their products. It hosts its own
website from a server situated on their property and has a storage warehouse for goods that
still need to be delivered. Wonder-Sale operates two main divisions: the advertising division
that promotes their business and its products, and the sales division that handles the despatch
of products and collection of monies.
The company website is similarly split into two distinct areas: one that deals with advertising
and one that deals with sales.
A fire destroyed the premises of Wonder-Sales on 31 March 20X9 and when the employees
tried accessing the business’s website, found that it was completely corrupted, being unable to
recover any of the information off the website. Foul play was suspected from the disgruntled
accountant (it was later found that the accountant was a very sophisticated computer specialist
with pyromaniac tendencies).
A new website was created between 1 April and 30 June 20X9 and the costs incurred during
this period (all paid in cash) were as follows:
Chapter 9 103
Advertising Sales
The five payments related to the following: C C
x A feasibility study (is online business still feasible) 10 000 20 000
x Customer preference study (what would customers prefer
20 000 15 000
to see and use on a website)
x New licences (to operate on the web) 5 000 5 000
x Computer specialists’ fees for designing the websites 45 000 50 000
x Upgrade fees (this occurred on 31 December 20X9 and
5 000 5 000
will be necessary every 6 months thereafter)
This new website was available for use from 1 July 20X9 and it is estimated that it will need
to be entirely redesigned after 5 years. The new web design will not be able to be sold due to
its unique nature. The cost of the new website is considered to be material.
The previous website:
x was amortised over a total useful life of 3 years to a nil residual value; and
x had a carrying amount of C50 000 at the beginning of the year and a remaining useful life
of 2 years.
Required:
a) Show all journals that would have been processed in the year ended 31 December 20X9.
b) Disclose the intangible assets note as at 31 December 20X9 in accordance with
Question 9.15
Part A
Alastair’s Natural Remedies Limited is a retailer of health products, including vitamins and
supplements.
x The company ordered 12 000 catalogues, at a cost of C2 each, to advertise its products.
x The amount owing to the printer was settled 30 days from receipt of the catalogues.
x These catalogues are received from the printers on 1 September 20X8 and are to be
distributed to customers evenly from 1 September 20X8 to 30 November 20X8, as a
promotional activity for the holiday season.
Required:
Discuss the recognition and measurement of the cost of the catalogues in the financial
statements of Alastair’s Natural Remedies for the year ended 30 September 20X8, in terms of
IAS38 Intangible Assets.
Part B
Use the same information as that provided in Part A, except:
x the amount owing to the printer has been paid in advance on 15 August 20X8, when the
order was placed.
x Alastair’s Natural Remedies Limited has a financial year end of 31 August.
Required:
Discuss the recognition and measurement of the cost of the catalogues in the financial
statements of Alastair’s Natural Remedies for the year ended 31 August 20X8, in terms of
IAS 38 Intangible assets.
104 Chapter 9
GAAP: Graded Questions Investment properties
Chapter 10
Investment properties
Question Key issues

10.2 MyWorld Classification, recognition and measurement: various definitions
Measurement models: IAS 16 versus IAS 40
Transfers in and out
10.3 Green Tree Change in use: investment property to owner occupied property
10.4 Isca Properties Change in use: Investment property to owner occupied property
Sale of investment property: with and without development
10.5 Victoria Group Property: classification
Subsequent expenditure
Fair values unavailable
10.6 Stake Out Change in use: Owner occupied property to investment property
Investment property: fair value model
Property, plant and equipment: cost model
Inter-group lease of property
10.7 Tromp Investment property: fair value model
Fair value: indeterminable and then determinable
Initial and subsequent costs: conveyancer's fees, painting, airconditioning
10.8 Charlies Spot Fair values unavailable at acquisition, comparing:
property under construction and property not under construction
10.9 Gary Investment property: fair value model
-Joint use
-Ancillary Services
-Transfers out of investment property
10.10 Satin Recognition and measurement
Measurement models: pros and cons
Property held under an operating lease: sub-let
Joint use (separable)
10.11 Edwardes Change in use: owner occupied property to investment property
Investment property: fair value model
Property, plant and equipment: revaluation model (NRVM)
10.12 Trontheim Change in use
Deferred tax: intention to sell
10.13 Cool Investment property: fair value model;
Property, plant and equipment: cost model;
Implications of use of property on recognition and measurement
Change in use
Joint use
10.14 Gloop Two properties:
- Investment property: fair value model
- Property, plant and equipment: cost model
Change in use: investment property to owner occupied property
Impairment and derecognition
Chapter 10 105
Questions continued … Key issues
10.15 Snake Change in use: various

- Investment property: fair value model
- Property, plant and equipment: cost model
Fair value:
- Indeterminable on acquisition
- Determinable subsequent to acquisition
10.16 Lighthouse Investment property: fair value model

Deferred tax: Intention to keep
10.17 Sun Republic Investment property: fair value model
Deferred tax: intention to sell
chapters.
106 Chapter 10
Question 10.1
a) Define an investment property.

b) List the recognition criteria necessary for classification as an investment property.
c) Briefly describe the initial measurement of investment property.
d) Briefly describe the two subsequent measurement models that may be used to account for
investment property.
e) When would a property that was classified as an investment property cease to be
classified as an investment property?
f) When would a property that was not classified as an investment property become
classified as an investment property?
g) Indicate whether the following statement is true or false, and provide a brief explanation if
you believe it to be false: The choice between the subsequent measurement models is
made on a property-by-property basis.
h) An entity measures its investment properties using the fair value model. However, it
acquired an investment property which is now under construction and for which no fair
value is currently available. Explain how this property should be measured.
i) Adride Limited owns two buildings (A and B) that it rents out under operating leases:
x Building A: Adride has begun to redevelop this property with a view to selling it as
soon as the modifications are complete.
x Building B: Adride is battling to find suitable tenants and has decided to sell the
building as soon as possible.
In addition to the above two buildings that Adride has been holding to earn rental income,
Adride also buys and sells buildings as part of its business activities.
Identify how Adride should classify these two buildings.
j) Ayanda Limited owns a 20 story building in London. It leases out 5 floors under an
operating lease and uses the top 15 floors as the entity’s head office. It is not possible for
individual floors to be sold or leased under a finance lease separately from other floors.
How should this property be classified?
Required:
Provide brief answers to each of the questions above.
Question 10.2
Lucky Ndaba is the accountant of MyWorld Limited, a company specialising in property
deals. He is unsure how to differentiate between investment property (IAS 40) and property,
plant and equipment (IAS 16), arguing that many of the properties owned by MyWorld
Limited are held for rental income and could thus be recognised as property, plant and
equipment instead of investment property.
He is also unsure whether there is any difference between the measurement models offered by
IAS 40 and IAS 16.
Lucky is also extremely alarmed by the number of transfers into and out of the company’s
investment property account and seems to remember reading somewhere that there are certain
limitations on when such transfers may take place.
Chapter 10 107
Required:
Write a report for Lucky in which you succinctly address each of his concerns:
x The inter-relationship of the definitions in IAS 40 and IAS 16;
x The measurement models offered in IAS 40 and IAS 16;
x Transfers into and out of investment property.
Question 10.3
Green Tree Limited acquired a property on 1 January 20X8 at a cost of C4.2 million. It was
immediately leased out as an investment property for a period of 1½ years until
30 June 20X9. On 1 July 20X9 the company took occupation of the property as its
administrative headquarters.
The fair values of the property were determined as follows:

x On 31/12/20X8: C4 500 000
x On 01/07/20X9: C5 200 000
x On 31/12/20X9: C5 300 000
The accounting policy of the company is to depreciate buildings at 4% per annum on the
straight line basis. The company adopts the cost model for property, plant and equipment and
the fair value model for investment properties.
Required
a) Prepare an extract from the notes to the financial statements showing the ‘statement of
compliance’ and ‘basis of preparation’ notes as well as the accounting policy notes for
‘property, plant and equipment’ and for ‘investment property’
b) Prepare an extract from the profit before tax note for the year ended 31 December 20X9.
c) Prepare an extract from the statement of financial position at 31 December 20X9.
Supporting notes are not required.
Question 10.4
Isca Properties Limited is a company that has a large portfolio of investment properties.
The company uses the cost model for property, plant and equipment and fair value model for
investment properties. All assets measured on the cost basis are depreciated on the straight
line basis over the asset’s estimated useful life.
At 31 December 20X1 the investment properties had a combined fair value of C150 000 000
whereas at 31 December 20X2 the combined value was C187 500 000.
The following transactions relating to the investment properties had occurred during the year:
i) During the year to 31 December 20X2, three new investment properties were bought from
another company for a total of C25 500 000. Legal and transfer fees amounted to an
additional C600 000.
ii) On 1 August 20X2, Isca occupied for its own use a property that up until then has been
rented out as an investment property. Its fair value at 1 August 20X2 was C7 800 000
(C7 650 000 at 31 December 20X1). The property had an estimated remaining useful life
of 20 years. The land element of the property is C1 800 000 at 1 August 20X2.
108 Chapter 10
iii) On 1 December 20X2, Isca decided that two investment properties should be sold as soon
as possible:
x Southernhay Property (fair value of C4 500 000 at 31 December 20X1 and
C4 200 000 at 1 December 20X2) is to be sold after redevelopment. Redevelopment
work started on 1 December 20X2.
x Northernhay Property (fair value of C6 000 000 at 31 December 20X1 and
C6 150 000 at 1 December 20X2) is to be sold without redevelopment
Required
a) Explain how the situations in notes (i) to (iii) should be dealt with in the financial
statements of Isca Properties Limited for the year ended 31 December 20X2.
b) Calculate the fair value adjustment in respect of investment properties to be taken to the
statement of comprehensive income of Isca Properties Limited for the year to
31 December 20X2.
Question 10.5
Victoria Property Group owns three properties. The financial accountant, Angel, is in the
process of finalising the financial statements for the year ended 31 August 20X5. She has
been recently appointed because the previous financial accountant resigned. You have
requested all the information regarding the properties. Due to her busy schedule she has
scrawled some details on to a Post-It.
PPE = COST MODEL, INVEST.PROP= FV MODEL

No impairment indicators found when assessed during the year.
If asset to be depreciated, use straight-line.
Rodeo Drive: Bought 1 Sept X4 @ C7 500 000. A portion was allocated
to value of the land, calculated at C825k. Used as our warehouse. At
year-end, other similar warehouses in the area @ the same size were
being sold for C9 240 000.
Estimated UL= 40 years. Residual value = nil
Jimmy Walk: Purchased 1 March 20X3 to rent out. Cost C11 220k.
Estimated UL= 35 years. Was disclosed @ FV of C16 830k in last year’s
AFS. This year, Victoria upgraded the property (more parking plus
extra rentable rooms) at a cost of C10 230k, resulting in a new
municipal valuation at year end of C31 020k (good indication of FV)
and also resulted in increased rent.
Estimated UL = 20 years Residual value = nil
Fifth Avenue: This was purchased 8 months ago, at a cost of C13 860k,
with the intention of capital appreciation. Very specialised property
though and seems impossible to measure FV. Currently rented out to
animal lobbyist group.
Estimated useful life = 40 years Residual value = C200 000
Chapter 10 109
Required:
Describe, giving reasons, how Victoria Property Group should account for these properties in
the financial statements for the year ending on 31 August 20X5.
Question 10.6
Stake-out Limited is a wholesaler of security products. The managing director, John, has just
read an article in a local newspaper asking residents and businesses in the area to consider
offering accommodation to students attending the local university since their on-campus
accommodation was in short-supply.
John's business owns a large 5-storey building situated three roads away from the university,
which is currently housing its head office. John decided that it would make economic sense to
move the head office to one of the company's other smaller buildings and offer to lease the 5-
storey building to the university. A meeting with the vice-chancellor of the university sealed
the deal and a few months later, on 1 January 20X5, the head office was moved to the smaller
building. The operating lease over the 5-storey building, with the university as the tenant, was
effective from this same date. Details regarding the 5-storey building are as follows:
Purchase price: 1 July 20X3 C3 400 000
Total useful life 20 years
Residual value C0
Method of depreciation Straight-line
Fair values: 30 June 20X4 C1 360 000
1 January 20X5 C2 550 000
30 June 20X5 C3 740 000
The move of the head office team out of the building and the rental of the building to students
did not result in a change in the estimated useful life, residual value or method of
depreciation.
Buildings classified as property, plant and equipment are measured using the cost model
whereas investment properties are measured using the fair value model.
Required:
a) Provide the necessary journal entries in Stake-out Limited’s general journal for the year
ended 30 June 20X5.
Ignore tax.
b) Discuss how the building would be measured had Stake-out Limited decided not to lease
its buiulding to the university but had decided to lease it to one of its subsidiary
companies instead. Your explanation should include the impact on:
z Stake-out Limited’s separate financial statements; and
z Stake-out Limited’s group financial statements.
Question 10.7
Tromp Limited is an investment company that purchases buildings and holds them for a
number of purposes, such as resale, leasing and its own use.
On 1 January 20X4, Tromp Limited purchased an old building, Tromp Towers, for C300 000.
Conveyancer’s fees amounted to C20 000.
110 Chapter 10
x This building is situated in an isolated part of Durban (South Africa) and there is no
development anywhere nearby. At the time of purchase, there had been no property
transactions in this area for many years and the possibility of leasing the building to
tenants was remote.
x During November 20X4, development began of a new industrial park in the area. As a
result, the building was able to be leased to tenants involved in the development of the
industrial park. Due to the influx of people into the area, the directors decided to paint
one side of the building with the corporate logo of Tromp Limited.
x This building has never had an air-conditioning system. After numerous complaints from
tenants about not being able to tolerate the Durban heat, Tromp Limited decided to
upgrade the building by installing a ducted air-conditioning system on 1 December 20X4.
The cost of installation included the following:
Adjustments to the structure of the building C30 000
Painting C50 000
Air-conditioning system C200 000
Installation costs C50 000
The ducted air-conditioning system has a 10 year life and a nil residual value.
x As a result of the new industrial park, there was suddenly a demand for properties in the
area. As a result, the fair value of Tromp Towers was able to be determined on
31 December 20X4 at C420 000. Tromp Limited would like to measure this investment
property at fair value now that fair values have become available.
x The building has a 10 year useful life and an estimated residual value of C50 000.
Tromp Limited also holds other investment property, which is measured under the fair value
model. The fair value of this other investment property is as follows:
x 1 January 20X4 C1 000 000
x 31 December 20X4 C1 250 000
Required:
a) Journalise the entries that would arise from the above information for the year-ended
31 December 20X4.
b) Prepare the accounting policy for investment property and the investment property note
for the year-ended 31 December 20X4.
Ignore tax
Question 10.8
Charles Class the CEO of a small property company called Charlies Spot Limited (and a bit of
a gambler at heart), purchased two properties in a remote area called Een Boom Sonder Blare.
He is currently seeking advice on how to classify and measure the properties for the financial
year ending 31 December 20X2.
The details of the properties (both purchased on 1 January 20X2) are as follows:
x A block of flats, costing C500 000 (to lease out to tenants);
x An office-block, currently being constructed: costs to date are C100 000, (to lease out to
tenants). This office block is expected to be completed on 31 October 20X3. Due to the
desperate shortage of office blocks in the surrounding area, Charles is of the opinion that
a fair value for this office block will be available immediately on (or shortly before)
completion of construction.
Chapter 10 111
No-one currently lives in Een Boom Sonder Blare and, therefore, fair values for both
properties are currently not reliably determinable (there are no comparable market
transactions and, until both the block of flats and office block are occupied, an alternative
reliable estimate is not possible: a reliable estimate based on discounted future cash flows
projections is not possible until both blocks are occupied).
Charles expects that, give or take a few months after he has completed the construction of the
office block, the combined existence of these two properties will encourage developers to
construct more property in the area, in which case, the properties will become valuable and
fair values will become reliably determinable on a continuing basis.
Charles has indicated that he would want his properties to be measured at fair value.
Required:
Write a letter to Charles explaining how his properties should be classified and measured in
the financial statements for the year ending 31 December 20X2.
Question 10.9
Gary Limited and its subsidiary Fairvalue Limited need assistance in accounting for some of
their properties.
a) A block of flats of 6 storeys. The first 3 storeys are occupied by Gary Limited and used
for administration purposes. The top 3 storeys are vacant but are expected to be leased
out in the near future.
b) An office consisting of 10 rooms. Three of the rooms are used as an office by Gary
Limited while the other 7 are rented out. Ancillary services provided to the rooms are not
considered significant.
c) Fairvalue Limited, which is a subsidiary of Gary Limited, is a property dealer. Sales have
dropped recently. The directors of Fairvalue Limited have therefore decided to diversify
their business. One property, a block of flats, will now be refurbished and leased out
under operating leases. Another one of their properties that was previously held for sale,
a town house, will now be held for capital appreciation. Fairvalue Limited uses the fair
value model to measure its investment property.
Required:
For the above properties, discuss how they should be classified and measured:
in the financial statements of Gary Limited for parts (a) and (b); and
In the financial statements of Fairvalue Limited for part (c).
Question 10.10
Satin Limited purchased a 150-storey building in Dubai during 20X1 (the current financial
year). This building comprises apartments and offices, each storey being a self-contained unit
that can be sold separately. Apart from this building, Satin Limited holds a large house under
an operating lease agreement. This house, which is in Dubai, is sub-leased to a family from
Australia who has recently settled in the area.
The top 30 storeys of the building in Dubai are used by Satin Limited as its own head office.
The remaining 120 storeys are leased to tenants under non-cancellable operating leases.
112 Chapter 10
Satin Limited’s accountant is unsure how to recognise or measure these buildings. He

assumes that the cost model would be the cheapest option to implement (as the fair value
estimates will not be needed) and have the least impact on the financial statements.
Required:
Write a letter to Satin Limited’s accountant discussing the recognition and measurement of
these properties.
Question 10.11
On 31 August 20X8, Edwardes Limited moved its manufacturing division out of the property
that it owned on a freehold basis and into larger leased premises. This freehold property,
consisting of land and a factory building, was immediately leased out to an unrelated party
under a non-cancellable ten-year operating lease.
The freehold property had originally cost C10 400 000 (purchased on 1 January 20X3), on
which date its total useful life was estimated to be 25 years and its residual value was
estimated to be nil.
The freehold property was revalued for the first time on 31 December 20X6:
x the land was revalued to its fair value by C1 million and
x the factory building was impaired by C1,8 million.
Further revaluations were performed on 31 August 20X8 and 31 December 20X8.
The following details pertain to the vacated factory land and buildings:
Land Buildings (25 year useful life)
C’000 C’000
Cost 1 January 20X3 2 400 8 000
Carrying amount 31 Dec 20X7 3 400 4 686
Fair value at 31 Aug 20X8 4 000 7 500
Fair value at 31 Dec 20X8 4 180 7 900
Land and buildings that are classified as property, plant and equipment are measured under
the revaluation model, using the net replacement cost basis and are depreciated using the
straight-line basis. Investment properties are measured under the fair value model.
Required:
Prepare the journal entries to record all the matters relating to the factory land and buildings,
including its change of use, for the year ended 31 December 20X8. Ignore taxation.
Question 10.12
Trontheim Limited purchased a property at a cost of C11 000 000 on 1 July 20X6. At the
date of purchase the directors estimated that C2 000 000 of the cost was attributable to the
land and C9 000 000 of the cost was attributable to the building. The base cost of both the
land and buildings equalled the purchase cost.
The building is depreciated on the straight-line basis over a period of twenty-five years with a
residual value of C1 000 000. The tax authorities grant an allowance on buildings at 5% per
annum on the straight-line basis.
Chapter 10 113
At 30 June 20X7, there were indications that the value of the building is impaired and the
recoverable amount is estimated at C7 240 000. The useful life and residual value remained
unchanged.
The property was used as executive offices for Trontheim Limited from 1 July 20X6 until
30 June 20X8. At 30 June 20X8, Trontheim Limited moved its executive offices to rented
premises and in turn, rented this property to Bodo Limited for a period of three years.
Trontheim Limited intends to keep the building for rental and capital appreciation purposes.
Trontheim Limited uses the cost model to measure property, plant and equipment and the fair
value model to measure investment property. The fair value of the building is estimated at
C8 500 000 on 30 June 20X8 and at C9 200 000 on 30 June 20X9.
The land is not depreciated and there are no tax allowances on the land. The fair value of the
land was estimated at C2 000 000 on both 30 June 20X8 and on 30 June 20X9.
An extract from Trontheim Limited’s accounting policies reads as follows:

‘Deferred tax is provided at the normal company tax rate on temporary differences relating to
property, plant and equipment held for use and on temporary differences relating to investment
property at fair values below cost. Deferred tax is provided at the capital gains tax rate on
temporary differences relating to investment property at fair values above cost’.
The profit before tax was correctly calculated (taking into account all the information
provided above) at C3 230 000 for the year ended 30 June 20X8 and at C2 600 000 for the
year ended 30 June 20X9.
The tax rate is 28% and the inclusion rate for capital gains is 50%. There are no other
permanent or temporary differences other than those evident from the information provided.
The company uses the net replacement value method to account for changes in fair value.
Required:
a) Prepare the journal entries relating to the building for the years ending 30 June 20X7,
20X8 and 20X9.
The journal entry relating to the purchase of the property is not required.
The journal entries relating to taxation and deferred taxation are not required other than
any journal entry relating to a revaluation.
b) Show how the tax expense note is reported in the notes to the financial statements for the
year ended 30 June 20X9 (including comparative figures for 20X8) in accordance with
The tax rate reconciliation note is not required.
c) Prepare the investment property note for inclusion in the notes to the financial statements
at 30 June 20X9 in accordance with International Financial Reporting Standards.
Comparative figures and additional narrative information are not required
Question 10.13
Cool Limited had its head-office building located in Niger Street in Timbucktoo. It also
owned a building nearby in Sahara Street that it rented to Homeless Limited.
On 30 June 20X5, a tornado completely destroyed the building in Sahara Street. Since
Homeless Limited was a valued tenant, Cool Limited decided to lease 60% of its head-office
building to them as a ‘replacement’.
114 Chapter 10
Details relating to the head-office building in Niger Street are as follows:

x purchased on 1 January 20X5 for C600 000
x total useful life: 10 years (residual value: nil)
x fair values: C800 000 on 30 June 20X5 and C820 000 on 31 December 20X5.
x it is not possible to sell or lease out this 60% portion of the building separately from the
rest of the building.
Cool Limited uses:

x the fair value model to measure its investment properties; and
x the cost model to measure its property, plant and equipment.
Required:
Write a letter to the financial director of Cool Limited explaining how the building in Niger
Street should be recognised and measured in the financial statements for the year ended
31 December 20X5. Suggested journals should be included in your letter.
Use a single account to record movements in the head office’s carrying amount.
Ignore tax.
Question 10.14
Gloop Limited produces a thick, foul-smelling medicine that has been found to be excellent in
warding off Alice in Wonderland syndrome (AIWS), or micropsia, which is a disorienting
neurological condition which affects human visual perception. Patients of this disease
perceive humans, parts of humans, animals, and inanimate objects as substantially smaller
than in reality.
Gloop Limited’s factory operated from a building that it owned, situated in Sayra Street
somewhere in Guatemala. On 30 June 20X5, however, the factory building was swallowed
by a giant sinkhole caused by a tropical storm. A picture of where the factory building once
stood appears below:
This factory building had been purchased on
1 January 20X5 for C2 000 000 and was thought to
have a total useful life of 20 years and a residual
value of nil.
Thankfully this happened at night while the building

was empty. Gloop Limited was also fortunate in that
it owned another property three roads away, in
Alfonzo Lane. This other property was, at the time,
leased to Estuardo Ronaldo under an operating lease.
Estuardo was generally late in paying his lease rentals, and this natural disaster gave Gloop
Limited a perfect opportunity to evict him with immediate effect so that they could move their
factory into the undamaged building.
The building in Alfonzo Lane:
x had been purchased on 1 January 20X5 for C300 000;
x had fair values of C550 000 on 30 June 20X5 and C1 000 000 on 31 December 20X5;
x had a total estimated useful life of 6 years, estimated from date of purchase;
x had an estimated residual value of nil.
Gloop Limited measures:

x its property, plant and equipment using the cost model; and
x its investment properties using the fair value model.
Chapter 10 115
Required:
a) Journalise the above transactions in Gloop Limited’s general journal for the year ended
31 December 20X5.
Ignore tax.
b) Define fair value and explain how it is calculated.
Question 10.15
Snake Limited is in the construction industry. It constructs buildings for resale, for leasing
and for private use. A building that Snake Limited had constructed in Cape Town for sale in
the ordinary course of business (at a cost of C800 000) had been on the market for 2 years and
was still not sold.
On 1 March 20X5 Snake Limited took it off the market and instead leased it to tenants. Its
fair value was C1 500 000 on 31 December 20X5 and C1 000 000 on 1 March 20X5.
The fair value of a building in Bloemfontein (it has always been leased to tenants) has never
been determinable. This building was completed on 1 January 20X2 at a cost of C5 000 000.
Its total estimated useful life is 10 years. Fair values are now considered possible and the
accountant is adamant that the asset should either be measured under the fair value model
forthwith or that the depreciation on the building should be measured using an estimated
residual value of C1 000 000 (previously the residual value was nil). The estimated useful
life has remained unchanged.
On 30 September 20X5, Snake Limited leased its old head office building in Durban to a
tenant. The original cost was C4 000 000 (acquired on 30 September 20X3), on which date
the total useful life was 10 years and its residual value was nil. The fair value was
C3 700 000 on 31 December 20X5. The fair value on 30 September 20X5 was equal to its
carrying amount.
On 30 September 20X5, Snake Limited evicted the tenants from a building in Johannesburg
and instead moved its head office into the building. On this day, the fair value was
C4 000 000, the remaining useful life was 5 years and the residual value was C500 000. The
fair value of this building was C3 000 000 on 31 December 20X4.
The following additional information is relevant:

z All leases were operating leases.
z Rentals earned from the investment properties totalled C2 000 000.
z Rates paid totalled C1 000 000.
z Snake Limited applies the fair value model to its investment properties and the cost model
to its property, plant and equipment.
Required:
Disclose the investment property note and the profit before tax note in Snake Limited’s
financial statements for the year ended 31 December 20X5.
Ignore tax and comparatives.
Question 10.16
Lighthouse Limited owns a building called The Playroom. The Playroom is a sky-scraper in
Singapore, which is leased out to many night-club and restaurant owners. The directors
intend to keep this building and rent it over its entire useful life.
116 Chapter 10
Information relating to the building:

x A cost of C600 000 on 31 July 20X4 (date of purchase)
x A useful life of ten years and a nil residual value, unchanged since date of purchase.
x Fair values as follows:
31 December 20X4 C750 000
31 December 20X5 C? There was a deferred tax credit balance of C90 000
on this date that related purely to the temporary
differences arising from this investment property.
Information related to the company’s accounting policies:

x Measures all investment property using the fair value model;
x Measures all property, plant and equipment using the revaluation model;
Tax-related information:
x The tax authorities allow a deduction of 10% per annum on the cost of the building (not
apportioned for part of a year).
x Taxable capital gains are calculated by the tax authorities at 50% of the capital gain and
are taxed at 30%. The base cost of the Lighthouse equalled the original cost price.
Required:
Prepare the journal entries to account for The Playroom in Lighthouse Limited’s general
journal for the years ended 31 December 20X4, 20X5 and 20X6.
Question 10.17
Sun Republic Limited owns The Palms, a building situated on the Durban beachfront.
x Sun Republic Limited purchased this building on 2 January 20X5 for C200 000 cash.
x There are no tenants in the building at present and Sun Republic Limited identified that
the building would be a prime investment as the area around The Palms was being
extensively developed.
x The business plan is that, once this development is completed, this property is expected to
attract a very high price, at which point the building will be sold. The property does not
meet the criteria for classification as a non-current asset held for sale.
x The fair values of the building were as follows:
x The tax authorities allow a deduction of 5% per annum on the cost of the building (not
x The corporate income tax rate is 30%. Taxable capital gains are calculated by the tax
authorities at 50% of the capital gain. The base costs equalled the original cost price.
x The building, when purchased, was determined to have a useful live of ten years and a nil
residual value.
x Sun Republic Limited accounts for all investment property using the fair value model.
Required:
Prepare the journal entries to account for The Palms building, using Sun Republic Limited's
general journal, for the year ended 31 December 20X5, 20X6 and 20X7.
Chapter 10 117
GAAP: Graded Questions Impairment of assets
Chapter 11
Impairment of assets
Question Key issues

11.1 Power Core concepts – impairments of individual assets
11.2 Alba Determining impairment losses and impairment loss reversals :
x Cost model and impairment testing
x Investment property and impairment testing
11.3 Willie Wonker Whether the recoverable amount should be calculated:
x Previous calculation of recoverable amount is available
x External and internal indicators of impairment exist
x Intangible asset not yet available for use
11.4 Mobile Recoverable amount calculation focusing on value in use calculation:
x identifying the relevant cash flows
x calculating value in use (discount rate given)
x calculating recoverable amount
11.5 Whale Value in use calculation involving:
x an asset that generates foreign currency cash flows
11.6 Contain-it Impairment losses and reversals:
x Revaluation model
x PPE: non-depreciable asset
11.7 Webinar Core concepts – cash generating units (CGUs)
11.8 K&S Impairment testing process and disclosure – CGUs
11.9 Elna Impairment losses of a single CGU involving:
x goodwill
x scoped out assets
x recoverable amount for certain assets is known
11.10 Nicky Impairment of two CGUs:
x recoverable amounts for individual assets not known; but
x fair value less costs of disposal for certain assets is known.
Part A: with no corporate assets and with no goodwill
Part B: with corporate assets but with no goodwill
Part C: with corporate assets and with goodwill
11.11 Little Italia Impairment and impairment reversals relating to two CGUs:
x goodwill
x assets measured under the cost model and revaluation model
11.12 Miss Fortune Reversal of impairment losses of a CGU involving:
x goodwill
x assets measured under the cost model and revaluation model
x recoverable amounts for certain assets are known
chapters.
118 Chapter 11
Question 11.1
You provide consulting services to Power Limited, an energy producing company that has
recently come under the spotlight regarding its poor power-generating capabilities. Power's
finance team is concerned that the power plants are now overstated in their financial
statements. Power's finance team has just sent an email to your firm with a variety of
questions:
a) Please define the term ‘recoverable amount’.
b) When must we calculate the recoverable amount?
c) Define the term ‘value in use’.
d) When calculating the value in use, would we use a pre-tax or post-tax discount rate to
discount the future cash flows?
e) Is our understanding correct in that, when calculating the value in use, we include only
the cash flows that relate to the future use of the asset?
f) List all the assets that are scoped out from IAS 36 Impairment of assets.
g) What is the difference between fair value and fair value less costs of disposal and when
do we use each of these terms?
h) The carrying amount of an asset is C50 000, the value in use is C30 000 and the fair value
less costs of disposal is C20 000. What is the recoverable amount?
i) Please provide the journal that would be needed if an asset, measured under the cost
model, has a carrying amount and depreciated cost of C10 000 and a recoverable amount
of C8 000.
j) Please provide the journal that would be needed if an asset, measured under the cost
model, has a carrying amount of C9 000, a depreciated cost of C10 000 and a recoverable
amount of C12 000.
k) Please show us the journal that would be required if an asset, measured under the
revaluation model, has a carrying amount and fair value of C12 000, a depreciated cost of
C11 500 and a recoverable amount of C10 000.
l) Please show us the required journal if an asset, measured under the revaluation model, has
a carrying amount of C9 000 (due purely to a previous impairment), a depreciated cost of
C10 000, a depreciated fair value of C10 500 and a recoverable amount of C12 000.
m) Please show us the journal that would be required if an asset, measured under the
revaluation model, has a carrying amount and depreciated fair value of C9 000 (i.e. after a
previous devaluation), a depreciated cost of C10 000, a current fair value of C10 500 and
a recoverable amount of C12 000.
Required:
Draft answers to each of the above questions that were submitted by the finance team.
Question 11.2
Alba Limited is a mass-producer of sugar, owning many sugar cane farms located on the
northern coast of KwaZulu Natal. At the end of December 20X1, a decision was taken by
Alba Limited's Board of Directors to purchase land from another farm in the area.
Chapter 11 119
The purchase price was C225 000. Transfer of ownership was complete in September 20X2.
Alba Limited measures the land under the cost model and does not depreciate it.
The intention behind this purchase was to hold it as an investment for capital growth and
possible future development into a series of shopping complexes and factory premises that
would earn rental income. At the time of purchase, this development was not possible because
the land was zoned as agricultural land, but the local municipality was considering a proposal
that would allow the necessary rezoning due to a shortage of such commercial properties.
However, at the end of the current year (31 December 20X6) the municipality had still not yet
approved the rezoning. While waiting for the required rezoning to be approved the land was
rented as extra grazing land to neighbouring cattle farms.
During the first weeks of October 20X2, a month after transfer of ownership had been
effected, major unrest broke out in the area surrounding the newly acquired land. The unrest
damaged the local economy with many businesses closing down or moving to other areas. As
a result, the directors contracted a team of consultants to begin performing various annual
valuations on the land. By the end of the 20X5 financial year, the directors had compiled a
document summarising all the valuations performed by the consultants over the years, starting
from the year in which the land was initially purchased:
Valuation date 31/12/X2 31/12/X3 31/12/X4 31/12/X5
C C C C
Fair value less costs of disposal 292 500 202 500 180 000 270 000
Value in use 247 500 270 000 202 500 247 500
During the month of June 20X6, the directors decided to drop all plans to develop the land
due to escalating unrest which was then compounded by strike action and unsuccessful
negotiations with the various labour unions. As a consequence of the unrest, the land appears
to be unsaleable in its current form. Furthermore, the costs of developing the land will far
exceed the income that could be realised from future rental income from the shopping
complexes and factories due to newly proposed, non-negotiable, minimum wage rates. Alba
Limited is now unable to rent the land as farmland due to the escalating crime having caused
neighbouring farmers to sell their farms or scale back their farming operations.
Required
a) Briefly explain whether the newly acquired land is required to be tested for impairment in
terms of IAS 36 Impairment of assets.
b) State the carrying amount at which the land should be presented in the statement of
financial position at the end of the financial years ended 31 December 20X2 – 20X5,
inclusive.
c) Prepare any journals necessary in relation to the land for each of the financial years ended
31 December 20X2 – 20X5, inclusive.
d) Describe, giving reasons, how Alba Limited should account for the information arising in
June 20X6.
Question 11.3
Willie Wonker, a famous sweet maker, is in a sticky situation; he knows all there is to know
about making delightful confectionaries but very little (nothing in fact) about IFRS. Willie is
in a quite a state as he wants to comply with IFRS but is struggling with working out whether
his assets are impaired. Having just consumed his fourth Seriously Smart Sugar Sherbet he
had a bright idea and decided to call in an IFRS expert.
120 Chapter 11
Willie Wonker owns the following non-current assets:

x Jelly Bean Machine;
x Seriously Smart Sugar Sherbet Machine;
x Brain Boosting Bar Recipe; and
x Wonker Bar Chocolate Machine.
Jelly Bean Machine:
This machine was purchased many years ago (so many that Willie cannot remember ever
actually buying it) and has been happily producing delicious beans since that date.
At the end of the previous financial year, the accountant, Violet, who subsequently left due to
an incident with a bubble-gum machine, decided that the Jelly Bean Machine was so old it
had to be impaired. However, despite the recent rapid advancement in technology, upon
performing a detailed IFRS-compliant assessment at the end of the prior year, she determined
that its recoverable amount, being the value in use, was double that of its carrying amount. As
a result no impairment was processed.
During the current year, the market interest rate for Jelly Bean production (which Violet
originally used to calculate the value in use) had remained the same. However, because it is
now one year on and thus the machine is older than when Violet performed her assessment,
Willie is considering calculating its recoverable amount and comparing it to the carrying
amount.
Seriously Smart Sugar Sherbet Machine:
There was a recent dramatic drop in sales of Seriously Smart Sugar Sherbet, a product
historically sold in mass quantities. The drop in sales occurred after the Candy Cane Police
raised concerns that the sherbet made people less intelligent.
An urgent interdict, preventing Willie Wonker from selling the sherbet without each packet of
sherbet labelled with a health warning, was passed down by the High Candy Cane Court.
This case was a high profile case and featured on the front page of almost every newspaper at
the time. The impact of this negative publicity had an immediate and profound effect on sales
of sherbet, as evidenced by the following internal sales forecast data:
The damage to the brand name is

considered to be so severe that it is
unlikely that the sales of sherbet will ever
fully recover.
Willie is distraught as the demand,

immediately before the High Candy Cane
Courts urgent interdict, had been expected
to remain strong.
Brain-boosting Bar Recipe:
In a furious rage, Willie Wonker purchased the recipe for a Brain-Boosting Bar which he
hoped would replace the lost demand from the sherbet. Although not ready for immediate use
the recipe is sure to be a success. Willie is currently registering the recipe in his own name.
This is expected to be finalised within the next financial year.
Chapter 11 121
Wonker Choc Bar Machine:
As the financial year has been so hectic, Willie was unable to find any data for the Wonker
Choc Bar Machine. The only information that Willie has is shown below:
Net asset value of the entire ‘Willie Wonker Empire’ C150 000 000
Market price per share C 13.50
The number of shares in issue, at the end of the current financial year, are 10 000 000. The net
asset value shown above was calculated before taking into account the total impairment losses
of C5 000 000 relating to the assets other than this machine. Willie would like to test the
Wonker Choc Bar Machine for impairment but is not sure how to go about it.
Required:
Explain whether the recoverable amount must be calculated for each of these assets.
Question 11.4
Mobile Limited has been operating in the telecom industry for many years. They provide a
variety of services to customers, one of the services being printing and selling telephone
books that contain a list of landline numbers of people and businesses in the area.
Mobile Limited has recently experienced a significant decline in the demand for their
telephone books due to their customers' increasing access to the internet. The accountant has
resigned and Mobile Limited has not yet found a suitable replacement.
Joshy, a recently graduated accountant, has been assisting in the finance department as an
interim measure until a suitably qualified replacement could be sourced. He is particularly
concerned about the carrying amount of the specialised phone book printing machine, which
is not being used as frequently due to the decreasing demand for the phone books. He believes
this may be an 'impairment indicator' and has come to you for assistance in calculating the
recoverable amount of the machine.
The fair value less costs of disposal of the printing machine was easily determined with
reference to the market price and was calculated correctly at C10 000 000.
Joshy has analysed the following information relating to the machine for purposes of
calculating its 'value in use'.
Three-year projection 20X7 20X8 20X9

C C C
Inflows
Cash inflows directly attributable to the printing machine 12 000 000 9 000 000 8 000 000
Additional cash inflows from a proposed alteration that - 5 000 000 10 000 000
would enable the machine to print glossy magazines
Sale of machine in 20X9 - - 5 000 000
Outflows
Proposed alteration in 20X7 to enable the machine to print (4 000 000) - -
glossy magazines
Depreciation on the machine (700 000) (700 000) (700 000)
Increase in depreciation due to alteration (300 000) (300 000)
Maintenance costs necessary to operate the machine (800 000) (900 000) (1 000 000)
Salaries of administration staff (500 000) (600 000) (700 000)
The pre-tax discount rate is 13%.
122 Chapter 11
Required:
a) Write an email to Joshy, briefly explaining how to calculate value in use, and providing a
general overview of how to identify which cash flows should be included in this
calculation.
b) Calculate the machine's value in use at the 20X6 financial year end, followed by a brief
explanation as to why each of the items in Joshy's three-year projection were either
included or excluded from this calculation.
c) Calculate the recoverable amount of the printing machine at the 20X6 financial year end.
Question 11.5
Whale Limited is based in the United States (functional currency: $) but owns a plant in South
Africa (currency: R). Whale Limited expects to use this plant for a further two years after
which it will be sold. This expectation is reflected in the following forecast of the net cash
flows from this plant over these remaining two years:
20X1 20X2 20X3
Net cash inflows from usage R150 000 R80 000
Net cash inflow from disposal - R10 000
Expected average spot rates R8.0: $1 R9.0: $1
Expected closing spot rates R8.2: $1 R9.1: $1
Actual closing spot rates R8.5: $1
The relevant post-tax discount rate for South Africa based on risks in South Africa is 7% (pre-
tax discount rate: 10%) whereas the relevant post-tax discount rate for the United States based
on the risks in the United States is 8% (pre-tax discount rate: 9%).
Required:
Calculate the plant’s value in use to Whale Limited as at 31 December 20X1.
Question 11.6
Contain-it Limited offers safe and easily accessible container-based storage for its customers
on a piece of land situated between Durban and Umhlanga. The land was bought on the date
of the company’s incorporation (1 January 20X6) for C800 000. The land is measured under
the revaluation model and is not depreciated.
A year later, due to an influx of people and immense property development in the area, both
the value of the land and the profitability of the company increased. An independent valuer
measured the land's fair value at C1 080 000 as at 31 December 20X6. The next revaluation is
scheduled for 31 December 20X9.
During the course of 20X7, other storage companies moved into the area and reduced
Contain-it Limited's profitability. The reduced profit projections were considered to be an
indication of an impairment and thus the land's recoverable amount was calculated at
31 December 20X7. In this regard:
x the fair value less costs of disposal was found to be C525 000 (fair value C600 000 and
costs of disposal C75 000) and
x the value in use was C500 000.
Until 20X7, there had been no previous indications of an impairment.
Chapter 11 123
Required:
Show the journal entries that would be processed from 1 January 20X6 to the year ended
31 December 20X8 assuming that the following amounts apply at 31 December 20X8:
a) fair value of C780 000, costs of disposal of C0 and value in use of C700 000.
b) fair value of C840 000, costs of disposal of C0 and value in use of C700 000.
Ignore tax.
Question 11.7
You have volunteered to perform a short live webinar for third year university students. The
webinar will be focussed on IAS 36 Impairment of assets with a specific reference to cash
generating units, a section which has proved challenging for the students. In preparation for
this webinar, several students sent through questions which they have asked you to address.
a) What does a cash generating unit refer to?
b) How does one decide when the impairment test will be applied to an individual asset or
when it will be applied to a cash generating unit?
c) What is a corporate asset?
d) Briefly explain how impairment losses are allocated to the individual assets within a
CGU, where the CGU contains goodwill but no corporate assets.
e) Briefly explain how impairment loss reversals are allocated to the individual assets within
a CGU, where the CGU contains goodwill but no corporate assets.
f) Briefly explain whether IAS 36 scoped-out assets can be included in cash-generating

units and if so, what their impact is when allocating impairment loss reversals.
g) If a cash generating unit is made up of the following assets and liabilities, how much of
the CGU's impairment loss would be allocated to each asset?
Assets Carrying amounts Recoverable amount
C C
Plant A 90 000 unknown
Plant B 50 000 unknown
Machinery 10 000 unknown
Total carrying amount of CGU 150 000 120 000
h) An entity has 3 cash generating units (CGU-A, CGU-B and CGU-C) and 2 corporate
assets: a head office building and a computer system. The computer system is only used
by CGU-A and CGU-B but all three CGUs benefit from the head office building. The
corporate assets are allocated to the CGUs, where appropriate, based on their relative
carrying amounts. Please show how we should calculate the impairment loss per CGU.
Carrying amounts Recoverable amounts
C C
CGU – A (excluding corporate assets) 400 000 300 000
CGU – B (excluding corporate assets) 600 000 500 000
CGU – C (excluding corporate assets) 200 000 150 000
1 200 000 950 000
Head office building 300 000
Computer system 60 000
Total carrying amount 1 560 000
124 Chapter 11
Question 11.8
K & S is a medium sized audit and assurance practice. The partner who heads up the IFRS
division has mentioned in a recent meeting that impairment testing under IAS 36 Impairment
of assets is an important issue for many clients, and the disclosures about impairment testing
in the financial statements are often scrutinised by regulators.
This partner has appointed you as part of the development team to design the IFRS handbook
on impairment of assets for the practice. The two main areas that you will be working on
include the impairment process and impairment disclosures.
Required:
a) Discuss the process that must be followed in testing cash-generating units for
impairments.
Your answer should address each of the following issues:

x Identification of CGUs,
x Allocation of assets to CGUs,
x Identification of impairment indicators,
x Calculation of the recoverable amount of a CGU,
x Calculation of the impairment loss of a CGU and
x Allocation of impairment losses to assets within the CGU.
You may ignore corporate assets.
b) Outline the disclosure requirements.
Your answer should focus on the following:

x The recoverable amount where it is determined as the value in use,
x Periods covered by budgets,
x Sensitivity disclosures,
x Events leading to an impairment.
Question 11.9
Elna Limited has a division that is considered to be a cash-generating unit for purposes of
IAS 36 Impairment of assets. Its recoverable amount at 31 December 20X7 is C130 000.
The carrying amount of the cash-generating unit is C181 000 at 31 December 20X7,
constituted by the following individual carrying amounts as at this date:
x Goodwill (purchased goodwill): C20 000
x Investment property (measured under the cost model): C81 000
x Inventory: C20 000
x Equipment (measured under the cost model): C60 000.
The recoverable amounts at 31 December 20X7 for the goodwill and investment property
could not be estimated on an individual basis, but the recoverable amount for equipment was
estimated to be C40 000. In accordance with IAS 2 Inventory, the net realisable value of the
inventory was C15 000.
Required:
Calculate whether the cash-generating unit is impaired and process any necessary journal/s.
Chapter 11 125
Question 11.10
Part A:
Nikky Limited has two divisions:

x a Durban-based division, manufacturing a well-known brand 'Hassle-Free' computers, and
x a Cape Town-based division, manufacturing a well-known brand 'Trendy Designs' clothing.
Each of these divisions (the computer division and the clothing division) operates as a cash
generating unit (CGU). The following are the carrying amounts of the assets within each of
the CGUs as at 31 December 20X9, after depreciation had been processed:
Computer division (CGU) Clothing division (CGU)
Assets C C
Equipment 800 000 900 000
Furniture 600 000 500 000
Investment property 1 200 000 1 000 000
Vehicles 400 000 -
3 000 000 2 400 000
All the assets are measured under the cost model.
Due to the recent recession, the recoverable amounts of each of the cash-generating units
needed to be calculated, the recession being an indication of possible impairments. The
recoverable amount of each cash generating unit at 31 December 20X9 was determined as:
x the computer division recoverable amount: C2 800 000; and
x the clothing division recoverable amount: C2 175 000.
The furniture's fair value less costs of disposal at 31 December 20X9 was determinable:
x furniture in the computer division: C500 000; and
x furniture in the clothing division: C400 000.
Required:
Prepare the necessary journals for the year ended 31 December 20X9.
Part B:
Use the information provided in Part A together with the following additional information.
x The administration of the two divisions takes place in Nikky Limited’s head office.
x The following are the carrying amounts of the head office's assets (i.e. corporate assets) as
at 31 December 20X9, after depreciation had been processed:
Head office
Corporate assets C
Equipment 100 000
Investment property 800 000
Vehicles 100 000
1 000 000
x All the assets are measured under the cost model.
x The vehicles owned by the head office only benefit the clothing division.
x The remaining head office assets can be reasonably and consistently allocated to each
CGU.
Required:
126 Chapter 11
Part C:
Use the information provided in Part A and Part B together with the following information.
x Nicky Limited had acquired the divisions by purchasing them from another entity.
x The purchase consideration exceeded the fair value of the net assets by C450 000.
Required:
Ignore tax.
Question 11.11
Little Italia has a pizzeria where it sells pizzas with customers’ choice of toppings, and it also
operates a delicatessen shop with imported Italian food. The pizzeria and the shop are
separate cash-generating units (CGUs).
The buildings are measured under the cost model but the equipment is measured under the
revaluation model, with revaluations performed every 2 years.
Little Italia revalued all its equipment on 31 December 20X4, on which date the pizzeria CGU’s
equipment was revalued upward by C250 000. Although another revaluation was performed on
31 December 20X6, the carrying amount of the pizzeria CGU’s equipment was not adjusted
because its carrying amount did not differ materially from its fair value at that date.
The pizzeria has been trading very profitably, until 20X6 when a national pizza chain opened
its doors across the road. On 31 December 20X6, as a result of the fierce competition, Little
Italia impaired its pizzeria CGU down to its recoverable amount of C250 000.
During 20X8, the competitor’s service quality spiraled downwards and consumers started
preferring Little Italia’s homely atmosphere. The profitability of Little Italia’s pizzeria was
fully restored. On 31 December 20X8, the recoverable amount of the pizzeria CGU was
reliably determined at C750 000.
The equipment and building are depreciated on the straight-line method to nil residual values.
Goodwill is carried at cost and tested for impairment annually. The implied fair value of
goodwill at 31 December 20X6 was C0.
Details of the pizzeria CGU’s assets, which were acquired from the previous owners on
1 January 20X4 are as follows (the recoverable amounts were not ascertainable):
Cost Remaining useful life
1/1/X4 1/1/X4
Equipment C500 000 10 years
Building C500 000 10 years
Goodwill C142 857 Indefinite
C1 142 857
Required:
a) Provide the journal relating to impairment for the year ended 31 December 20X6.
b) Calculate the carrying amount of each of the assets within the pizzeria CGU at
31 December 20X8.
Ignore tax.
Chapter 11 127
Question 11.12
Miss Fortune, a notorious gambler and venture capitalist, purchased what appeared to be a
lucrative business venture. However, due to an unexpected legislative restriction imposed by
the courts during 20X5, the profits from this business began to drop. As a direct result, this
business, a cash generating unit (CGU) per IAS 36 Impairment of assets, was impaired for the
first time to C1 350 000 on 31 December 20X5. The details of the carrying amounts for each
of the individual assets before and after this impairment are shown below:
Carrying amount before Carrying amount after

impairment impairment
C C
Goodwill 180 000 0
Investment property 360 000 342 000
Plant 540 000 432 000
Furniture 720 000 576 000
1 800 000 1 350 000
All the assets in the cash-generating unit were measured using the cost model with the
exception of the plant, which was measured using the revaluation model.
The plant was originally purchased on 1 January 20X2 for C810 000. It was depreciated on
the straight-line basis over 10 years to a nil residual value.
This plant was revalued on 1 January 20X5, (its first revaluation), to its fair value of
C630 000 on that date. Revaluations are accounted for on the net replacement value method
(i.e. the elimination method referred to in IAS 16.35(b)) and the related revaluation surplus
will be transferred to retained earnings on disposal of the plant.
As at 1 January 20X6, the variables of depreciation for each of the depreciable assets in the
cash-generating unit were:
x Investment property: 5 years remaining useful life, straight-line to a nil residual value;
x Plant: 6 years remaining useful life, straight-line to a nil residual value;
x Furniture: 4 years remaining useful life, straight-line to a nil residual value.
During 20X6, business took a turn for the better, with the courts lifting the legislative
restriction that had been imposed in 20X5. The recoverable amount of the business was
determined to be C1 620 000 on 31 December 20X6. Although the recoverable amounts at 31
December 20X6 for some of the assets in the cash-generating unit could not be determined on
an individual basis, the recoverable amounts for each of the following assets were able to be
estimated:
x Investment property: C396 000; and
x Plant: C432 000.
The plant’s recoverable amount of C432 000 was calculated as its fair value less costs to sell
where its fair value was C450 000 and its selling costs were C18 000.
Required:
Journalise the impairment reversals at 31 December 20X6.
Ignore tax.
128 Chapter 11
GAAP: Graded Questions Non-current assets held for sale and
discontinued operations
Chapter 12
Non-current assets held for sale and
Question Key issues
Part A Individual non-current assets held for sale

12.1 Storybrooke Core concepts
12.2 Soldier Theory: measurement issues regarding PPE reclassified to NCAHFS
(measurement before, on and after reclassification), prior measurement
under the cost model
12.3 Outahere PPE reclassified to NCAHFS
- Prior measurement under the cost model
- PPE: impairment reversal before reclassification
- NCAHFS: impairment on reclassification and impairment after
reclassification
A: Without tax
B: With tax
12.4 Removal PPE reclassified to NCAHFS
- PPE: impairment before reclassification
- NCAHFS: impairment reversal after reclassification
A: Without tax
B: With tax
12.5 Jovial PPE reclassified to NCAHFS
- PPE: impairment before reclassification
- NCAHFS: no adjustment on reclassification and impairment reversal after
reclassification
With tax
12.6 Heart PPE reclassified to NCAHFS
- Prior measurement under the revaluation model
- PPE: revaluation before reclassification
- NCAHFS: impairment on reclassification and impairment reversal after
reclassification (with limitations)
A: Without tax
B: With tax
12.7 Ripcord PPE reclassified to NCAHFS
- prior measurement under the revaluation model (not previously impaired)
- PPE: revaluation before reclassification
- NCAHFS: impairment on reclassification and further impairment after
reclassification
A: Without tax
B: With tax
Part B Cash generating units held for sale

12.8 Short questions Core concepts – cash generating units for sale
12.9 Chan Measurement of a disposal group held for sale compared to the measurement
of a non-current asset held for sale
Chapter 12 129
Questions
Key issues
continued…
Part B Cash generating units held for sale

12.10 Buckas Measurement of a disposal group held for sale: initial impairment and
subsequent impairment
Allocation of impairment: includes scoped-out assets
12.11 MLF Initial impairment of disposal group held for sale and subsequent impairment
reversal: includes
- Goodwill; and
- Scoped-out assets
12.12 Tornado Allocation of the impairment of a disposal group that includes:
- Goodwill
- Scoped-out assets
12.13 Doe Plastics Allocation of the impairment of a disposal group on initial classification and
on subsequent measurement where the disposal group includes:
- Goodwill
- Scoped-out assets
12.14 Mills Allocation of the impairment of a disposal group on initial
classification and allocation of impairment reversal on subsequent
measurement where the disposal group includes:
- Goodwill
- Scoped-out assets (investment property under the fair value model)
Part C Discontinued operations

12.15 - Core concepts – discontinued operations
12.16 Jumbo Shoes Date of classification as ‘held for sale’
12.17 Conifer Identification of date from which discontinued operation is disclosed
Discontinued operation is a disposal group
No measurement adjustments
Tax effects ignored
12.18 Dorothy Identification of date from which disclosure as a discontinued operation is
required
Discontinued operation is a disposal group
Measurement adjustments: on discontinuation and afterwards
Tax effects: current and deferred
12.19 Big Nic Disposal group and discontinued operation: sale of division as a single
transaction
Measurement adjustments:
- On discontinuation: None
- After discontinuation: impairment of disposal group resulting in
adjustments to carrying amounts of assets both inside and outside the
scope of the measurement requirements of IFRS 5
12.20 Ithemba Comparison: discontinued operation and disposal group
Recreation Discontinued operation is not a disposal group
Measurement adjustments: on discontinuation and afterwards
12.21 Eagle Presentation: discontinued operation or held for sale or neither
Measurement: Impairments and change in estimate
Abandonment
Important note: Please assume in all questions that, unless otherwise stated, the estimated costs to sell
equal the estimated disposal costs.
130 Chapter 12
Part A Individual non-current assets held for sale
Question 12.1
A friend of yours is the financial director of Storybrooke Limited and he feels that he is not up
to date with IFRS 5. He has asked for your advice with the following queries:
a) Please define ‘non-current assets’ and ‘non-current assets held for sale’.
b) I have heard that certain criteria must be met before an asset is classified as 'held for sale'.
Please could you list these criteria for me?
c) What criteria must be met for a sale to be termed ‘highly probable’?
d) What happens if we have an item of property, plant and equipment that we intend to sell
but we don’t expect the sale to be concluded within a year: would this asset still be
reclassified to ‘held for sale’? Please explain.
e) I have a machine that I think needs to be classified as held for sale as at 31 March 20X1.
The details relating to the machine on this date are as follows:

x Cost: C200 000
x Accumulated depreciation: C40 000
x Fair value: C150 000
x Value in use: C120 000
x Costs to sell: C5 000
Assuming that I am correct that the machine needs to be reclassified as held for sale, what
would it be measured at in my financial statements at the year ended 31 December 20X1?
f) What are the current and deferred tax consequences of classifying an item of property,
plant and equipment as a non-current asset held for sale?
g) John, the chap from head-office, gave me the following advice regarding IFRS 5. Please
tell me if he is correct or not – and please explain why he is wrong, if he is wrong?
(i) Investment properties are never measured in terms of IFRS 5 Non-current assets held
for sale and discontinued operations, even if they happen to meet the criteria to be
classified as held for sale.
(ii) A non-current asset acquired exclusively with the intention for resale must be
classified as Property, Plant and Equipment.
(iii) After purchasing a non-current asset exclusively for the purpose for resale, it is almost
always immediately impaired.
(iv) Non-current assets are always measured at the lower of its carrying amount and fair
value less costs to sell when classified as held for sale.
Required:
Provide a brief answer to each one of your friend’s queries listed above.
Chapter 12 131
Question 12.2
Soldier Limited purchased a highly specialised machine for C1 440 000 on 1 July 20X1. This
machine was measured under the cost model with depreciation calculated on the straight-line
basis over a useful life of 6 years to a nil residual value.
This machine was damaged in a flash flood on 1 April 20X4 but was still operational. The
values immediately after the damage were as follows:
1 April 20X4: C
Fair value 672 000
Costs to sell 36 000
Value in use 702 000
Management held a meeting on 20 April 20X4 to discuss the possibility that this asset should
be sold. The reasons for the suggestion involved the damage incurred during the flood and
considerations regarding future alternative product lines for which the machine would no
longer be required. This meeting did not reach a conclusion since management could not
agree upon a suitable selling price.
A subsequent meeting was held on 1 July 20X4 where management reached agreement on the
selling price and a task team was immediately appointed to find a suitable buyer. The values
immediately after the meeting on 1 July 20X4 were as follows:
1 July 20X4: C
Fair value 672 000
Costs to sell 48 000
Value in use 480 000
Initially there seemed to be no response to the marketing of the machine at its fair value of
C672 000, but a few weeks before year end saw a sudden frenzy of offers from a number of
different parties. The highest bid was received on 30 December 20X4 of C768 000. If the
company accepts this offer, the selling costs would only be C24 000, being the legal fees to
draft the sale agreement, as this offer was made directly to the company instead of through the
sales agents and would thus not involve any sales commission.
Required:
Discuss how the machine would need to be recognised and measured in Soldier Limited’s
financial statements for the year ended 31 December 20X4.
Question 12.3
Part A: Ignoring tax effects
Outahere Limited owns only one item of property, plant and equipment being plant, which it
has always carried under the cost model, details of which follow:
Cost (1 January 20X1) C500 000
Depreciation 20% pa straight-line to a nil residual value
Recoverable amount (31 December 20X2) C210 000
x On 1 April 20X3, the company decided to sell the plant. All the criteria necessary for
reclassification as a non-current asset held for sale were met on this date. The following
information was relevant on this date:
Value in use C200 000
Fair value C200 000
Costs to sell C10 000
132 Chapter 12
x At 31 December 20X3 (the company’s year-end) the following information was relevant:
Fair value C180 000
x All impairments and/ or impairment reversals are considered material.
Required:
a) Show all journal entries relevant to the above information.

b) Disclose the effect on the statement of financial position, related notes and profit before
tax note for the year ended 31 December 20X3.
Part B: Including tax effects
Assume the following information regarding tax:

x The tax authorities allow a wear and tear deduction of 25% of cost (not apportioned).
Required:

Tax and accounting policy notes are not required.
Question 12.4
Removal Limited owns a machine (the AinChint Model) that it had purchased for C800 000
on 1 January 20X6. This machine has always been measured under the cost model where
depreciation was provided at 20% per annum to a nil residual value using the straight-line
method. None of the variables of depreciation have ever changed.
New technology has recently come about, which could increase Removal Limited’s output
substantially. The new technology is included in the latest machine called the Zappemout
Model. The excited factory manager presented the amazing abilities of this new technology at
the directors meeting held on 1 April 20X8 and then the accountant presented the following
amounts relevant to the AinChint Model:
31 December 20X6 : Recoverable amount C700 000
31 December 20X7: Recoverable amount C300 000
1 April 20X8: Fair value C250 000
31 December 20X8: Fair value C500 000
After considering all information, a unanimous decision was taken at this meeting to dispose
of the AinChint Model, which was considered to be materially impaired, and acquire the
Zappemout Model without delay. All criteria necessary for reclassification as a non-current
asset held for sale were met on this date.
Chapter 12 133
Required:
a) Prepare all related journal entries in the general journal for all years affected.
b) Disclose the effect on Removal Limited’s statement of financial position, related notes
and profit before tax note for the year ended 31 December 20X8.

Required:
a) Prepare all related journal entries in the general journal for all years affected.
b) Disclose the effect on Removal Limited’s statement of financial position, related notes
and profit before tax note for the year ended 31 December 20X8.
Tax and accounting policies notes are not required.
Question 12.5
Jovial Limited owns only one item of property, plant and equipment being a machine.
Jovial Limited purchased this machine at a cost of C250 000 on 1 January 20X5. It has
always carried this machine under the cost model.
On 1 April 20X7, the company decided to sell the machine and all the necessary criteria to
reclassify the machine as a non-current asset held for sale were met.
x The machine is expected to have a useful life of 5 years.
x The tax authority allows the machine to be deducted over 4 years (not apportioned).
The machine had the following values:

x 31 December 20X6: recoverable amount C105 000
x 1 April 20X7: fair value less costs to sell (value in use: 90 000) C 95 000
x 31 December 20X7: fair value less costs to sell (value in use: 105 000) C145 000
The income tax rate is 30%.
All impairments and/ or impairment reversals are considered material.
Required:

Notes relating to tax and accounting policies are not required.
Question 12.6
Heart Limited operates in the air industry, serving as the air-traffic controllers for a medium-
sized airport in the Australian outback. Due to the economic recession and severe cash flow
shortages, the company made a decision to sell their air-traffic control computer equipment.
134 Chapter 12
The decision was made on 1 April 20X3 on which date all the criteria to be classified as held
for sale as per IFRS 5 were met. The equipment had been:
x purchased on 1 January 20X1 for C750 000.
x depreciated at 20% per annum, straight-line to a nil residual value: these variables of
depreciation had remained unchanged since date of purchase.
x revalued to C1 200 000 on 1 January 20X2 in terms of the company’s policy of revaluing
all its computer equipment.
Heart Limited accounts for revaluations on the net replacement value method and transfers
the revaluation surplus to retained earnings on the eventual disposal of the related asset. Until
1 April 20X3, the intention was always to use the asset.
The fair value was C750 000 on 1 April 20X3 (with expected costs to sell estimated at 10% of
the fair value). The equipment was not considered to be impaired on this date.
At 31 December 20X3 the fair value had increased to C1 050 000 (with expected costs to sell
estimated at C60 000).
Any difference between the carrying amount and the fair value immediately prior to the
classification as non-current asset held for sale as well as any impairment and/ or impairment
reversals are considered to be material.
Required:

tax note for the year ended 31 December 20X3. Accounting policy notes are not required.

Required:

Notes relating to tax and accounting policies are not required.
Question 12.7
Ripcord Limited was incorporated on 1 January 20X4 due to the popular demand associated
with adventure sports. On the day of incorporation, a plant (classified as property, plant and
equipment), was purchased for C750 000. To this day, it remains as the only item of property,
plant and equipment that the company owns.
Ripcord has elected to measure all plant under the revaluation model as the financial director
believes that this is more relevant to users. Ripcord has selected the net replacement method
to account for changes in fair value and chosen to transfer any revaluation surplus to retained
earnings on disposal of the revalued assets.
Chapter 12 135
The plant is depreciated over 5 years to a nil residual value. On 1 January 20X5, an
independent valuer determined the plant’s fair value to be C1 200 000.
On 31 March 20X6, the board made a decision to sell the plant. All the criteria necessary for
reclassification in accordance with IFRS 5 were met on this date. The expected selling price
is the fair value of C975 000. Management estimates the selling costs to be C75 000. The
plant was not impaired in terms of IAS 36 Impairment of assets on this date.
On 31 December 20X6 (the company’s year-end) management had reason to believe that the
plant’s fair value had changed once again. The fair value on this date was estimated at
C750 000 and the selling costs were re-estimated to be C45 000.
Required:
a) The financial director of Ripcord is unsure of how to account for the plant. Prepare all the
relevant journal entries to assist her.

x The plant has a base cost of C795 000.
x The tax authorities allow a wear and tear deduction of 25% per annum based on the cost
of the plant (not apportioned for part of a year).
x Capital gains are included in taxable income at 50% and are taxed at 30%.
Required:
a) The financial director of Ripcord is unsure of how to account for the plant. Prepare all the
relevant journal entries to assist her.
Notes relating to tax are not required.
Part B Disposal groups held for sale
Question 12.8
a) What is the difference between a non-current asset held for sale and a disposal group
held for sale?
b) IFRS 5 Non-current assets held for sale and discontinued operations provides
measurement, classification and presentation requirements that must be applied to all non-
current assets (or disposal groups) that meet the criteria for classification as ‘held for
sale’ True or false?
136 Chapter 12
c) IFRS 5 Non-current assets held for sale and discontinued operations does not apply to
current assets. True or false?
d) Briefly compare the measurement of a non-current asset held for sale with the
measurement of a disposal group held for sale.
e) The impairment of a non-current asset held for sale that had previously been measured to
a fair value in terms of the revaluation model is first recognised as a revaluation decrease
(i.e. debited to the revaluation surplus, equity) until the revaluation surplus has a nil
balance and thereafter, the impairment is recognised in profit or loss. True or false?
Question 12.9
The director of Chan Limited has recently been asked to oversee the financial function of the
company, having previously been the director of operations. Although he is an accountant, he
has not been keeping abreast of accounting issues.
He is trying to understand how the measurement of a single non-current asset held for sale
differs from the measurement of a disposal group held for sale.
Required:
Explain how the measurement of a single non-current asset held for sale differs from the
measurement of a disposal group held for sale.
Question 12.10
Buckas International Limited is a diversified multi-national company dual listed on the

Johannesburg Stock Exchange and the New York Stock Exchange with a 31 December
financial year end.
Due to the current financial crisis, the board of directors has decided to dispose of certain
divisions that are not part of the company’s core functions. One such division identified was
the Trim division which provides management consulting services and was currently
underperforming due to clients shutting down and scaling back operations.
The proposal to sell the division was readily accepted by all of the board members at the
quarterly board meeting on 31 August 20X1. This proposal was fast-tracked by management
and on 1 October 20X2, management had just completed finalising plans to dispose of the
asset and had embarked on an active marketing programme specifically targeted at competing
management consulting businesses. Due to the long term potential of this division,
management was confident that a buyer would be obtained within the next year through their
current marketing plan.
The schedule of values (on the next page) shows the relevant asset values at 1 October 20X2
and 31 December 20X2. The values at 1 October 20X2 were obtained from the disposal plans
of Trim, which were finalised on 1 October 20X2. The values at 31 December 20X2 were the
valuators periodic assessments, which were included in the year-end report.
The accounting policy of Buckas International Limited is to measure items of property, plant
and equipment under the cost model and to measure investment property under the fair value
model. Costs to sell may be assumed to equal costs of disposal.
Chapter 12 137
No item of property, plant and equipment had been impaired before 1 October 20X2
Property, plant and equipment Investment property

Building Equipment
Cost / fair value 1 800 000 360 000 1 056 000
Accumulated depreciation 360 000 60 000 0
1 October 20X2
Carrying amount 1 440 000 300 000 1 056 000
Fair value 1 368 000 270 000 1 026 000
Costs to sell 18 000 12 000 0
Value in use 1 560 000 312 000 N/A
31 December20X2
Fair value 1 188 000 228 000 894 000
Costs to sell 24 000 8 400 0
Required:
Process all the required journals at 31 December 20X2 to account for the reclassification and
re-measurement of the Trim division.
Question 12.11
MLF Limited is a construction company operating in the southern African region. Over the
years, it has profited from numerous international donations designed to develop the region.
However, due to political unrest in some of the countries, the board of directors has decided to
divest from certain cash generating units (CGU’s) operating in sub- Saharan Africa. One such
CGU operated in Zimbabwe.
The carrying amounts on 1 January 20X8 of the Zimbabwe CGU’s only assets were as
follows (there were no liabilities):
C
Bob Cat Earth Removal Machinery Note 1 200 000
Sukdeo Concrete Mixer Note 2 150 000
Singh Cement Mix Note 3 40 000
Goodwill Note 4 20 000
Note 1: Bob Cat Earth Removal Machinery

x The Bob Cat Earth Removal Machinery was purchased on 1 January 20X5 for C500 000.
x It has been accounted for using the cost model and depreciated over a useful life of
5 years to a nil residual value.
x It had never been necessary to test the machinery for impairments.
Note 2: Sukdeo Concrete Mixer

x The Sukdeo Concrete Mixer was purchased on 30 June 20X6 for C300 000.
x It is measured under the cost model and depreciated over 3 years to a nil residual value.
x It had never been necessary to test the mixer for impairments.
Note 3: Singh Cement Mix

x The inventory of Singh Cement Mix is accounted for in terms of IAS 2 Inventory.
Note 4: Goodwill
x Goodwill arose a few years ago when MLF Limited acquired Amrit Limited, a medium
sized company operating in Zimbabwe.
x The goodwill had never been impaired.
138 Chapter 12
The Zimbabwean CGU met all the criteria to be classified ‘held for sale’ in terms of IFRS 5
on 30 June 20X8.
The fair values less costs to sell and net realisable values were as follows:
30/06/X8 31/12/X8
Inventory (cost) 50 000 50 000
Inventory (net realisable values) 28 000 55 000
Zimbabwean CGU (fair value less costs to sell) 200 000 320 000
Required:
Provide the journal entries for the above transactions for the year ended 31 December 20X8.
Question 12.12
Tornado Limited is a company established in 20X3. The company has built a good reputation
and specialises in providing a travelling bar and related services at various events, hotels and
holiday resorts along the south and north coasts of South Africa.
As part of its expansion activities, the company acquired Blue Bottles Limited, a company
that specialises in managing special events. Blue Bottles Limited owned a small property in
Margate. All of this subsidiary’s operations were moved to the Tornado Limited’s head office
and this property was then leased out to a third party.
During August 20X4, management of Tornado Limited became dissatisfied with the
performance of Blue Bottles Limited. They identified that the private/small functions division
was performing very poorly and this was affecting Blue Bottles profitability. A resolution was
passed on 30 October 20X4 to dispose of this division. All criteria for classification as held
for sale were met on this date.
x The carrying amounts on this date were as follows:
C
Inventory 350 000
Plant 750 000
Investment property – fair value model 300 000
Investment property – cost model 200 000
Goodwill 125 000
x Recoverable amounts for the following assets were determined on this date:
plant: C750 000
investment property under the cost model: C200 000.
x Inventory had a net realisable value of C375 000
x The fair value of the net assets of the division (CGU) was C1 525 000 and the estimated
costs to sell were C100 000.
Required:
Prepare the journals needed in order to reclassify and measure the disposal group on
30 October 20X4.
Chapter 12 139
Question 12.13
Doe Plastics Limited is involved in the production of plastic car parts that it supplies to
Japanese and German motor manufacturers. Due to the economic recession prevalent in
20X4, one of Doe Plastics Limited’s customers announced that it would be discontinuing the
production of all its vehicles, effective 1 January 20X5.
In order to attempt to avoid potential losses, the board of directors at Doe Plastics Limited
resolved to dispose of the asset group that had been modified specifically for the
manufacturer, in a single transaction. All criteria for reclassification as “held for sale” were
met on 31 December 20X4.
All of the assets were bought on 1 July 20X2 and have never been impaired. The details
relating to the various carrying amounts at 1 July 20X4 are provided in the following table:
Measurement Cost Depreciation Residual Carrying

model rate/ useful life value amount
Investment property Fair value 55 000 N/A N/A 88 000
Furniture Cost 110 000 10 years 0 88 000
Equipment Cost 220 000 20 years 0 198 000
The following values were determined for each of the assets on date of reclassification to non-
current assets held for sale (31 December 20X4):
Value in use Fair value Costs to sell

Investment property 66 000 77 000 5 500
Furniture 99 000 77 000 5 500
Equipment 231 000 187 000 16 500
Disposal group as a whole 320 000 6 500
During June 20X5, a smaller manufacturing company submits to Doe Plastics Limited an
offer to purchase the group of assets.
x The settlement price is agreed upon on 30 June 20X5 and is set at C300 000 (considered
to be a fair market price).
x Doe Plastics Limited has estimated that the cost to dispose of the assets would be C3 000.
x On this date, the investment property has an individual fair value of C75 900.
x The sale agreement is expected to be concluded and signed during July 20X5.
Required:
Provide all relevant journal entries for the year ended 30 June 20X5.
Question 12.14
Mills Limited is a company that specialises in manufacturing garden furniture. The company
has been very successful over the years and the shareholders are very pleased with the returns
generated.
However, the company has been battling to account for certain transactions ever since the
previous financial accountant, of many years standing, left the company unexpectedly in order
to move to England. None of the other employees have any accounting experience and the
managing director has no experience with accounting standards either.
140 Chapter 12
A suitably qualified replacement accountant has not yet been found and thus, as an interim
measure, the managing director has approached you for advice with regard to their non-
current assets held for sale and IFRS 5. The following is an extract from an email sent to you
from the managing director...
Hi
As discussed in our meeting on Monday, management have decided to dispose of some of our assets to
Invested Limited. None of our employees understand what is meant by IFRS 5 and thus we have not yet
processed any journal entries relating to this decision. The board made the decision to sell the group of
assets (investment property, plant and purchased goodwill) at a board meeting on 1 October20X3.
I discussed the matter with a friend of mine who is a Chartered Accountant and he told me that all
criteria necessary for the assets to be classified as held for sale were met on this date.
Here is some relevant information to assist you:
We measured all the assets on reclassification date (1 October 20X3) and at year-end (31 December
20X3), in terms of each asset’s own relevant IFRS – and completely ignoring the fact that these assets
have met the requirements to be reclassified as held for sale. A summary of the calculation of these
carrying amounts are as follows:
1 October 20X3 31 December 20X3
C C
Plant Note 1 150 000 120 000
Investment property Note 2 90 000 225 000
Goodwill 45 000 45 000
Note 1: We measure plant under IAS 16’s cost model and have never needed to impair it.
Note 2: We measure investment property under IAS 40’s fair value model.
We then calculated the fair value less costs to sell in terms of IFRS 5 for the group as a whole:
1 October 20X3 31 December 20X3
C C
Disposal group C210 000 C450 000
Please could you ensure that journals are prepared soon, as I would like everything to be in order
before our auditors arrive.
Regards,
Lana Mills
Required:
Assist the managing director by providing her with the journal entries and relevant workings
so as to account for the above for the year ended 31 December 20X3.
Ignore tax.
Part C Discontinued operations
Question 12.15
a) Define a discontinued operation.
b) Briefly explain how the existence of a discontinued operation affects the disclosure of
profit or loss in the statement of comprehensive income?
Chapter 12 141
c) Briefly explain how the existence of a discontinued operation affects the disclosure of
cash flows in the statement of cash flows?
d) The disclosure of a discontinued operation never requires separate disclosure of items in

the statement of financial position. True or false?
e) A discontinued operation is disclosed as a discontinued operation from the date that it

meets the definition of a discontinued operation and thus prior period information is not
re-presented. True or false?
f) IFRS 5 Non-current assets held for sale and discontinued operations provides
measurement and disclosure requirements that are specific to discontinued operations (i.e.
that are different to the requirements applied to non-current assets or disposal groups held
for sale). True or false?
g) What are the two criteria to be met before an asset (or disposal group) may be classified
as ‘held for sale’?
h) A disposal group that is to be abandoned is always presented as a discontinued operation

from the date on which it meets the definition of held for sale. True or false?
i) All discontinued operations are disposal groups. True or false?
j) A disposal group that is to be abandoned instead of sold is not covered by IFRS 5. True or
false?
Question 12.16
Jumbo Shoes Limited is a company that manufactures and distributes footwear. It has a
number of factories situated throughout the country.
A decision was made on 15 September 20X2 to close one of the factories, this one being
situated in the Epsom Valley. The directors had the factory valued by a professional firm of
business valuers and immediately advertised the factory at the price suggested by this firm.
A buyer for the factory was found on 5 October 20X2 and this buyer signed a commitment to
purchase the factory on 10 October 20X2. On this date, the factory had a backlog of orders
that the directors intend to complete before the sale, although no new orders would be
accepted from this date.
The buyer has agreed that the effective date of the sale (the date on which ownership of the
factory will be transferred) is to be delayed until all outstanding orders are completed. It is
expected that these orders will be completed on 30 April 20X3.
Required:
Discuss when this factory would meet the criteria to be classified as ‘held for sale’.
Question 12.17
Conifer Limited is a company that manufactures both soccer balls and hosepipes. The
company has two divisions: the soccer ball division and the hosepipe division.
142 Chapter 12
The following is an extract from the current trial balance at 31 December 20X7 that is
relevant to the soccer ball division:
x Income and expense items C
- Revenue 123 750
- Cost of sales 49 500
- Other expenses 89 100
- Finance costs 0 4 455
- Income tax expense 0 2 475
x Assets
- Inventory 19 800
- Accounts receivable 4 125
- Equipment (cost C4 500) 55 935
x Liabilities
- Bank overdraft 0 24 750
- Accounts payable 74 250
During 20X6, management identified a downward trend in the profitability of the soccer ball
division. This division’s profits deteriorated even further in 20X7. A number of meetings
were held to discuss the way forward. On 1 October 20X7, it was proposed that the soccer
ball division be sold. Numerous lengthy debates followed this proposal and finally, on
15 December 20X7, the proposal to sell the division was agreed upon and this decision was
documented in the minutes of the directors’ board meeting.
The formal plan of sale, which detailed all relevant aspects and involved an aggressive
approach that would have the division sold within between 5 and 7 months, was presented and
agreed upon at this same meeting.
A suitable buyer was identified in early January 20X8 and negotiations during February 20X8
culminated in the signing of a sale agreement on 23 March 20X8, effective from 1 May 20X8.
The agreement involved the buyer taking over all the division’s assets and liabilities,
including any contracts outstanding on effective date.
x The carrying amounts of all assets and liabilities are considered to reflect their fair values.
x There is no indication that this signed contract will fail to be executed.
x The financial statements at 31 December 20X7 are due to be presented to the board on
2 April 20X8 for approval.
Required:
a) Identify the year in which the financial statements must separately disclose the soccer ball
division as a discontinued operation, providing a full discussion of the relevant definitions
to support your answer.
b) Discuss how a discontinued operation could affect the presentation of and the disclosure
of information in an entity’s financial statements.
c) Disclose the above information in the notes to the financial statements of Conifer Limited
for the year ended 31 December 20X7 in conformity with International Financial
Assume that the entity does not include any detail in the statements when this detail can
be included in the notes instead. Comparatives are not required.
Chapter 12 143
Question 12.18
Dorothy Limited currently has two divisions: a manufacturing and distribution division.
On 30 August 20X1, senior management decided to sell the distribution division as studies
found that it would be more cost effective to outsource the distribution of the inventory that is
manufactured by the company.
A formal plan outlining how the division would be disposed of was presented to and agreed
upon by the board of directors on 1 October 20X1. A team was immediately appointed to
manage the disposal of the division. By the close of business, this team had already prepared
an advertisement for the sale of the division. All parties agreed that the sale would be
complete within nine months. It is expected that the team tasked with managing the disposal
of the division will be paid commission of C2 300.
Negotiations with a buyer began on 20 December 20X1 to sell the entire distribution division
for C126 500. During discussions with the potential buyer, it was agreed that all assets and
liabilities reflected in the trial balance (see extract below) were a fair reflection of their values
with no impairments considered necessary, with the exception of the following items each of
which was considered overstated by C2 875:
x accounts receivable was considered overstated due to doubtful debts that had not yet been
accounted for, and
x inventory was considered overstated due to items on hand that had been damaged in a
recent rain storm and for which no adjustments had yet been processed.
The sales contract was signed on 28 February 20X2, to be effective on 4 April 20X2.
The directors offered retrenchment packages totalling C11 500 to various employees resulting
from the discontinuance of the distribution division. The offer is legally binding and will be
paid on 4 April 20X2, when ownership of the division will be transferred. These expenses are
not allowed as a tax deduction as they are directly related to the decision to discontinue the
operation and therefore are not in the production of income.
None of the costs mentioned above have been included in the trial balance at the
31 December 20X1. The following is an extract of balances relating to the distribution and
manufacturing divisions at 31 December 20X1:
Distribution Manufacturing
Credit balances C C
Revenue (172 500) (7 500 000)
Plant: accumulated depreciation (103 500) (2 000 000)
Accounts payable (16 675) (600 000)
Debit balances:
Plant: cost 207 000 7 000 000
Deferred tax asset/ liability: 1 January 20X1 0 0
Deferred tax asset/ liability: 31 December 20X1 0 0
Inventory 28 750 1 125 000
Cost of sales 115 000 2 250 000
Other expenses 51 175 750 000
Income tax expense – current tax ? 1 350 000
Income tax expense – deferred tax ? 0
144 Chapter 12
Plant is depreciated at 10% per annum on the straight-line basis to nil residual values.
Depreciation on the plant of C20 700 up to the date it was classified as held for sale has been
included in the ‘other expenses’ line item in the distribution division’s trial balance.
x Wear and tear is allowed as a tax deduction, calculated at 10% per annum on the cost
price. This allowance is apportioned for part of a year in the event that the asset is sold.
x Expenses that are in the production of income are allowed as tax deductions in the year
that the expenses are incurred, unless the expenses relate to provisions, in which case the
expenses are allowed as tax deductions in the year that the expenses are paid.
x Income tax is levied at 30% on taxable profits.
evident from the information provided.
General information:
x There were no measurement adjustments required other than those that are evident from
the information provided.
Required:
a) Identify, with reasons, the date at which the division would be classified as ‘held for sale’.
b) Explain whether the division should be presented as a discontinued operation.
c) Prepare the statement of comprehensive income of Dorothy Limited for the year ended
31 December 20X1 and disclose the note to the discontinued operation, the disposal group
held for sale and tax in accordance with International Financial Reporting Standards.
Question 12.19
Big Nic Ltd owns many divisions across the country, some of which are involved in the
manufacture of stationery for office use and some of which are involved in the manufacture of
cosmetics.
The profits earned by one of the divisions that specialises in the manufacture of anti-ageing
cosmetics have been dropping steadily ever since the economy went into decline following a
world-wide slump in the stock markets. After reaching agreement that the economic slow-
down was not expected to end any time soon, the directors of Big Nic Limited agreed that the
anti-ageing cosmetics division should be closed, signing a formal plan for the disposal of the
cosmetics division on 01 December 20X4. This decision was announced publicly
immediately after the meeting.
x It was agreed that the sale of the division as a whole would not render the greatest profits
and thus it was agreed that the division should be sold off in a piecemeal fashion.
x All the criteria necessary for classification as held for sale were met on the date that the
agreement was signed, at which point none of the assets in the cosmetics division were
considered impaired in terms of either IAS 36 Impairment of assets or IFRS 5 Non-current
assets held for sale and discontinued operations.
Chapter 12 145
The following is the draft extract of the trial balance of this cosmetics division at
31 December 20X4:
Building: carrying amount on 31 December 20X4 Note 1 671 000

Machinery: carrying amount on 01 January 20X4 Note 2 and Note 3 74 800
Inventory Note 3 140 800
Accounts receivable Note 3 94 600
Current tax payable Note 3 48 576
Accounts payable Note 3 68 640
Revenue 2 596 000
Other expenses Note 4 2 434 080
Disposal account Note 1 924 000
Note 1. On 1 December 20X4 the division’s building was sold for C924 000. Payment for the
building was deposited in the bank and credited to a disposal account on this date. This
was the only entry processed for the sale of the building.
The building had been depreciated on the straight-line method over a useful life of ten
years to a nil residual value. The building had been purchased for C1 320 000 on
1 January 20X0.
Note 2. Machinery is depreciated on the straight-line method over a useful life of ten years to a
nil residual value. The machinery had been purchased for C105 600 on 1 January 20X2.
Note 3. All remaining assets are expected to be sold by 1 July 20X5. Similarly, all accounts
payable are expected to be paid by 1 July 20X5.
The remaining assets are considered to have the following fair values at
31 December 20X4, although no entries have yet been processed for this information:
x Machinery:
- Value in use: C110 000
- Fair value less costs to sell: C70 400
x Inventory
- Net realisable value: C129 800
x Accounts receivable:
- Cash expected to be received: C87 120
Note 4. Other expenses includes depreciation.
Other information:
x Retrenchment packages of an estimated C198 000 will have to be paid to employees who
will lose their jobs as a result of the termination of the cosmetics division. It is expected that
these packages will be paid to the employees in the first half of 20X5 after the amount is
finalised through negotiations with the trade unions. These expected costs have not been
recognised in the trial balance above.
Tax related information:

The taxation authorities:
x allow the deduction of the full cost of all non-current assets at a rate of 10% per annum (not
x allow the deduction of inventory write-downs and doubtful debts adjustments in the year in
which the adjustment was made in the financial records.
x allow the deduction of the cost of retrenchment packages in the year in which they are paid.
x levy income tax at 30%.
146 Chapter 12
There are no differences between accounting profit and taxable profit other than those evident
Required:
a) Prepare the following for inclusion in Big Nic Limited’s financial statements for the year
ended 31 December 20X4 in terms of International Financial Reporting Standards:
- the statement of comprehensive income (showing the analysis of discontinued
operations on the face thereof);
- the accounting policy notes for assets held for sale and for discontinued operations;
- the income tax expense note; and
- the discontinuing operations note.
b) Explain to what extent your answer may have changed had the building been classified as
an investment property (i.e. had been accounted for as investment property) and not as an
owner-occupied property (i.e. had not been accounted for as property, plant and equipment).
Question 12.20
Ithemba Recreation Limited currently operates in two divisions:

x Camping division: this division manufactures camping equipment;
x Cycling division: this division manufactures bicycles and related equipment.
On 30 September 20X4, the directors of Ithemba Recreation Limited drew up a formal plan to
dispose of the camping division since they wished to concentrate their resources on the more
profitable cycling division. They agreed that the disposal would take place on a piecemeal
basis. The camping division met the requirements for classification as held for sale on this
same date, at which point all necessary measurement adjustments were processed.
The camping division’s only non-current asset was machinery (original cost C200 000 on
1 January 20X2):
x Machinery is depreciated at 10% per annum on the straight-line basis.
x The following values were estimated for machinery as at 30 September 20X4:
- value in use of C180 000; and
- fair value less cost to sell of C142 000.
On 29 December 20X4 all the machinery in the camping division was sold to Mr. Holte for
C168 000 cash. This sale has not yet been processed by Ithemba Recreation Limited. The
carrying amount and tax base of the machinery equalled each other at 1 January 20X4.
Depreciation has been calculated correctly and included in “other expenses” at
31 December 20X4.
The directors of Ithemba Recreation have estimated that the disposal of the entire camping
division would be completed within the first half of 20X5. An assessment of the value of the
remaining assets within the camping division at 31 December 20X4 revealed the following:
C
x Accounts receivable at 31 December 20X4 (expected cash flow) 156 000
x Inventory at 31 December 20X4 (net replacement value) 33 000
All accounts payable balances at 31 December 20X4 will be paid by Ithemba Recreation in
January 20X5.
Chapter 12 147
The following summarised draft trial balance was extracted from the books of Ithemba at
31 December 20X4 immediately prior to processing year-end adjustments.
Information relating to
Total the camping division
included in the total
20X4 20X3 20X4 20X3
C C C C
Share capital 600 000 600 000
Revenue 3 282 000 2 334 000 582 000 601 200
Accounts payable 67 500 75 000 30 000 37 500
4 459 395 3 180 885
Machinery at carrying amount: 31 December 1 019 760 720 000 142 000 160 000
Inventory 263 685 156 000 42 000 81 000
Accounts receivable 168 000 192 000 168 000 192 000
Cash 229 650 116 895
Cost of sales 2 100 000 1 400 000 420 000 350 000
Other expenses 498 300 279 700 78 300 29 200
Dividends paid 180 000 120 000
Income tax expense 0 196 290 ? ?
4 459 395 3 180 885
Additional information about the camping division:
The other expenses of C78 300 (20X3: C29 200) in the trial balance of the camping division
include the following: 20X4 20X3
C C
Redundancy packages paid to employees 24 000 -
Impairment losses for credit risk (i.e. bad debts) 12 000

x Taxation is levied at a rate of 30%.
x The machinery's cost is deductible for tax purposes at 10% p.a. (not apportioned).
x The adjustments to inventory and accounts receivable and the redundancy costs are all
deductible for tax purposes in the year in which they were incurred.
x No tax is levied on the dividends paid.
Other information:
x No temporary differences have ever arisen within the cycling division.
Required:
a) Discuss whether the camping division can be classified and presented as:
i) a discontinued operation
ii) a disposal group held for sale
b) Prepare the statement of comprehensive income, statement of changes in equity,

discontinued operation note, income tax expense note and related accounting policies note
for the year ended 31 December 20X4, and the statement of financial position as at
31 December 20X4 for Ithemba Recreation Limited in accordance with the requirements of
148 Chapter 12
Question 12.21
Eagle Limited operates two distinct divisions:

x the ‘lighting division’, which manufactures light fittings; and
x the ‘security division’, which manufactures security systems.
Both divisions have been equally profitable over the years, although the profitability of the
security division has been under increasing strain in recent months due to competition in the
industry.
The government made an announcement on 31 May 20X6 that, due to rampant and
uncontrollable crime, all private residential security systems that involve the installation of
magnetic contacts on windows and doors would be provided by the state, free of charge. This
offer would become effective from 1 September 20X7.
Since 95% of the customer base of the security division comprised private residences
requiring magnetic contacts, the board of directors were of the opinion that this announcement
would be devastating to the division’s already dwindling profitability. An urgent directors’
meeting was scheduled the following week, on 5 June 20X6. During this meeting, a decision
was made to close this division as soon as the orders currently in the system were fulfilled. It
was decided, with immediate effect, that no further orders would be accepted.
As at 5 June 20X6, the company’s ordering system reflected zero orders for infrared beams
but reflected 4 320 currently outstanding orders for magnetic contacts. The expectation was
that these pre-existing orders would need at least 15 months to complete. None of these
existing orders were cancelled as a result of the government announcement.
The security division, which was presented separately in the financial statements as the
‘security segment’, owned the following assets:
x a plant (plant X) that manufactured infrared beams; and
x a plant (plant Y) that manufactured magnetic contacts.
Both plant X and plant Y are highly specialised and, given the impact of the government
announcement on all companies operating in the security industry, they are considered
unsaleable. The directors decided to contact a local scrap metal dealer and simply have these
plants removed from the premises. The dealer has agreed to remove both plants once the
production of all pre-existing orders for magnetic contacts has been completed.
Based on the original estimate, the remaining useful life of both the plants was estimated to be
60 months as at 1 July 20X5.
Eagle Limited’s financial year end is 30 June.
The accountant has approached you for assistance since he is of the opinion, but needs
confirmation, that the decision made by the directors will require the division to be
reclassified as a disposal group held for sale and that it will also require the division to be
presented as a discontinued operation.
Required:
Write a letter to the accountant in which you explain the implications of IFRS 5 Non-current
assets held for sale and discontinued operations resulting from the directors’ decisions.
Chapter 12 149
GAAP: Graded Questions Inventories
Chapter 13
Inventories
Question Key issues

13.1 - Core concepts
13.2 Solis Disclosure: accounting policies, basic notes
13.3 Sheikar Net realisable values: calculations
13.4 Financial Fitness Measurement: write-downs and reversals: discussion and journals
13.5 Tesla Net realisable value involving:
- Firm orders and
- Events after reporting period
13.6 Buyhouse & Settlement discounts: received and offered: journal entries
Salehouse
13.7 EPR A: Perpetual – FIFO versus WA
B: Periodic system – FIFO versus WA
13.8 Lavita Manufacturing costs – fixed only:
- Application rate
- Under-absorption
13.9 Stocky Non-manufacturing costs and manufacturing costs (fixed and variable)
- Application rate
- Under-absorption
Net realisable value and write-downs,
Including events after reporting period
Inventory pledged as security
13.10 Elder Manufacturing costs – fixed and variable:
- Application rate
- Over-absorption and under-absorption
13.11 Kudu Non-manufacturing costs and manufacturing costs (fixed and variable)
- Application rate
- Under-absorption
Net realisable value and write-downs
Inventory pledged as security
13.12 Woody Manufacturing costs involving fixed & variable overheads
- Under-absorption
- Allocation of costs between manufacturing and non-manufacturing
Complete inventory cycle: manufacture to sale
13.13 Padfoot Manufacturing costs involving fixed & variable overheads
- Allocation of costs between manufacturing and non-manufacturing
- Allocation of costs between fixed and variable
Complete inventory cycle: manufacture to sale
Net realisable values and write-downs
Imported raw materials
13.14 Bikini Excessive costs, consultant fees, fixed overhead application rate, lower
of cost and net realisable value: discussion
13.15 Ice empire Manufacturing accounts
FIFO versus. WA
150 Chapter 13
Question 13.1
Part A
a) Inventory is measured at cost but must be presented in the statement of financial position
at fair value.
b) IAS 2 Inventory applies to all goods that an entity holds for sale and all goods that are
intended to be used by the entity.
c) Cost of inventories only includes invoiced amounts.
d) Inventory that has been manufactured by the entity will be measured at cost, comprising
the total of the purchase cost of the raw materials and the direct conversion costs.
e) Normal production levels are used when allocating fixed manufacturing overheads to
inventory. In the event that actual production:
x exceeds the normal production level, an excessive amount of overhead will be
allocated to the inventory account and thus an adjustment will need to be processed in
order to reverse this excessive allocation; or
x is lower than the normal production level, a portion of the overheads will remain
unallocated, which will require the processing of an adjustment to expense this
remaining unallocated overhead.
f) The cost of inventory does not include administration and storage costs.
g) The cost of sales expense presented in the statement of comprehensive income must
include all inventory write-downs.
h) IAS 2 Inventories provides entities with the choice of four cost formulae to assign the cost
of inventories sold: the specific identification formula, weighted average formula, the
first-in-first-out formula and the last-in-first-out formula.
Required:
Indicate whether each of the above statements is true or false. If false, provide a brief
explanation as to why you believe it to be false.
Part B
Red Red Wine Limited imports oak barrels which it sells to the wine industry. It entered into
the following inventory-related transactions, listed in date order:
x 01 December 20X3: opening balance was 72 barrels, all bought on 30 November 20X3 at C36 each
x 10 December 20X3: 36 barrels were bought at C50 each
x 15 December 20X3: 144 barrels were bought at C58 each
x 21 December 20X3: 126 barrels were sold
Required:
a) Briefly describe how to calculate the net realisable value of inventory.
b) Using the first-in-first-out method, calculate:
i) the cost of the goods sold for the month ended 31 December 20X3; and
ii) the inventory balance as at 31 December 20X3.
c) Using the weighted average method, calculate:
i) the cost of the goods sold for the month ended 31 December 20X3; and
ii) the inventory balance as at 31 December 20X3.
Chapter 13 151
Question 13.2
The following draft accounting policy notes have been prepared for inclusion in Solis Limited’s
annual financial statements:
SOLIS LIMITED
NOTES TO THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED …
1. Basis of preparation
1.1 The reporting entity
…
1.2 Statement of compliance

These financial statements comply with International Accounting Standards.
2. Accounting policies
2.1 Measurement bases
The financial statements have been prepared on the historical cost basis.
2.2 Inventory
Inventory is measured at the lower of cost and net realisable value.
______________________________________________________________________________________________________________________
The following matters came to your attention:

x The company is a manufacturing concern that uses a computerised perpetual inventory
costing system based on a program which charges out the oldest inventory first. This
program was introduced 4 years ago and is running smoothly. For costing and control
purposes the variable costing system is used but, for financial reporting purposes,
manufacturing overheads are absorbed on the basis of actual production for the year.
x The company manufactures solar panels for residential use only. They source all raw
materials locally. Solis supplies individual residential-owners as well as retailers such as
hardware stores. Sales to residential-owners are on a cash basis only, sales to hardware stores
are on consignment.
x Selling price (excluding VAT) is C5 750 to residential owners, and C5 000 to hardware
stores. Cost price is C3 000. A total of 400 panels were sold to hardware stores for the year
ended 31 December 20X5. 150 solar panels were sold by the hardware stores by
31 December 20X5. The company operates a just-in-time inventory management system, and
as a result holds no raw materials on hand at the beginning or end of the year. However, at
year end 100 solar panels remain unsold.
x During the year, Solis experienced a labour strike during which damage to property and
inventory occurred. After calculating the net realisable value, management estimated that the
inventory of solar panels had to be written-down by C8 600.
x The company's main business is the sale of its finished products. However, it derives other
income from commission for introducing customers to a company servicing its products,
rental income from sub-letting a portion of its warehouse, and sales from a non-profit-making
canteen run for the benefit of the staff.
Required:
a) Redraft the accounting policy notes to comply with good disclosure and reporting practice.
b) State what further information would be disclosed in the notes to the financial statements in
respect of the items dealt with in the above accounting policy notes.
c) Draft the inventory note(s) in compliance with IAS 2 Inventories.
152 Chapter 13
Question 13.3
Sheikar Limited manufactures two product lines: a moisturising lotion and a sunblock. The
following information relates to inventory on hand at 31 December 20X8:
NRV if sold NRV if sold
Class of inventory Cost in present as completed
condition product NRV
Raw materials 140 000
Used in moisturising lotion 65 000 60 000 55 000
Used in sunblock 75 000 60 000 80 000
Work in progress 95 000

Moisturising lotion 40 000 30 000 35 000
Sunblock 55 000 45 000 50 000
Finished goods 190 000

Moisturising lotion 90 000 N/A 140 000
Sunblock 100 000 N/A 80 000
Scenario A
The lifecycle of both the products is coming to an end and the company has decided that it
will sell the more profitable class of inventory, either in its present condition or converted into
a completed product.
Required:
a) Complete the table above.
b) Determine the total write-down required.
c) Prepare the relevant journal/s.
Scenario B
It is the beginning of both of the products’ lifecycles and the company intends to complete
and sell both lines, regardless of profitability.
Required:
a) Complete the table above.
b) Determine the total write down required.
c) Prepare the relevant journal/s.
Question 13.4
You have started your own business called “Financial Fitness Limited”, an entity that
provides advice on how to comply with the International Financial Reporting Standards.
Business is booming and your latest client is Perfect Plastics Limited (a manufacturer and
retailer of various plastic products). You are known as an expert on IAS 2 Inventories. Peter
Parker, the financial manager at Perfect Plastics Limited, needs help accounting for certain
costs and has sent you an email, an extract of which follows:
Hi
We are finalising our financial statements for our reporting period ended 31 December 20X2
and I need a better understanding of accounting for certain costs associated with our
inventories. Please see my queries below:
Chapter 13 153
Query 1: Plastic buckets purchased from China:
We purchase plastic buckets from China to resell in South Africa, rather than manufacture
them ourselves. We purchase the goods from our Chinese supplier on a “free on board” basis.
As these buckets are imported, we have to pay import duties and transport costs to our
warehouse. The Customs Department will refund 100% of the import duties as soon we
submit our claim forms. The terms of the purchase agreement include a settlement discount of
5% if we pay within 60 days, and a rebate of 3% to assist us with selling costs. I am not sure
how to measure inventory that we import from overseas.
Query 2: Plastic cutlery manufactured by Perfect Plastics Limited
We manufacture plastic cutlery that is popular for picnics. I’m not sure about the accounting
treatment of the costs associated with the conversion of inventory. I have listed the costs that I
think should be recorded as inventory below:
x Labour costs of factory workers who manufacture the cutlery.
x Salaries to personnel in Human Resources whose responsibilities include the payment of
the wages to the factory workers.
x During the year, there was a strike by employees for higher wages. As a result, we had to
hire inexperienced casual labour, and additional costs were incurred when they caused
the machines to become jammed. Also, our actual production was less than expected.
x Fixed annual rent expense for the storeroom where we store the plastic pellets used to
manufacture the cutlery.
x Fixed annual rent expense for the factory.
x We’ve been having trouble selling some of the plastic cutlery and so organised a major
advertising campaign, at great expense, to promote the product in time for the summer
holiday.
Query 3: Plastic “Broc” shoes sold by Perfect Plastics Limited
We sell plastic shoes called “Brocs”. These shoes were very popular in the past, and then we
received news that our competitor was releasing a new range of shoes that were superior to
ours. As a result, the “Brocs” on hand at 31 December 20X1 were written down to a net
realisable value of C75 per pair (original cost was C105 per pair). During 20X2, it was
discovered that the shoes manufactured by our competitor were extremely uncomfortable.
Bad news for them - but good news for us! We have now determined, during 20X2, that the
net realisable value is C120 per pair!
Regards
Peter Parker
Required:
a) Discuss, with reasons and with reference to IAS 2 Inventories, the appropriate
measurement of inventory in query number (1) and query number (2) above.
b) Process the journal entries (per pair of shoes) that would have been required for query
number (3) for the years ended 31 December 20X1 and 31 December 20X2.
UKZN, 2011 test, adapted
Question 13.5
Tesla Limited is a company that is a retailer of all manner of electrical and electronic goods.
The merchandise that was on hand at 31 December 20X4 is presented on the next page.
154 Chapter 13
x Transformers: The company has 500 transformers in stock, each with a cost of C11 000
and a net realisable value of C13 400.
x Generators: There were 3 600 generators in stock, each with a cost of C18 000 and a net
realisable value of C16 400.
x Insulators: There were 1 500 insulators in stock, each with a cost of C17 000 and a net
realisable value of C14 000.
x Solar panels: There were 4 400 solar panels in stock, each with a cost of C12 800 and a
net realisable value of C16 000.
x Wind turbines: There were 2 000 wind turbines in stock, each with a cost of C30 000 and
a net realisable value of C27 000.
In order to boost sales, Tesla began an intensive marketing drive in December 20X4,
advertising all merchandise at a discount of 5% from January 20X5. The accountant did not
consider these advertised prices when calculating the abovementioned net realisable values.
Shortly before year-end, Tesla Limited received an order for 400 wind turbines to be
delivered to a new wind farm in Cape Town. The order is considered to be a firm commitment
from the farm and the purchase agreement has set the selling price per turbine at C37 000.
Selling costs on this contract total C640 000. The customer requires that these items be
painted in their own company colours. The expected repainting costs per turbine are C4 000.
Shortly after year-end, Tesla Limited experienced a strong wind storm that destroyed 10% of
the transformers that were in stock.
Required:
Calculate the inventory balance that would be presented in the statement of financial position
at 31 December 20X4.
Question 13.6
Part A:
Buyhouse Limited purchased inventory on credit from BYM Limited at a cost of C1 000
BYM Limited allows a settlement discount of 5% if payment is made within 30 days.
Buyhouse Limited uses a perpetual inventory system.
Required:
a) Prepare the journal entry to record the purchase of the goods.
b) Prepare the journal entry to record the payment of the amount owing to BYM Limited,
assuming that payment is made within 30 days.
c) Prepare the journal entry to record the payment of the amount owing to BYM Limited,
assuming that payment is made after 30 days.
Part B:
Salehouse Limited sold inventory on credit to D Thomas at a selling price of C400.

A settlement discount of 5% is allowed if payment is received within 30 days.
Required:
a) Prepare the journal entry to record the sale of the goods.
b) Prepare the journal entry to record the receipt of the amount owing from D Thomas,
assuming that payment is received within 30 days.
c) Prepare the journal entry to record the receipt of the amount owing from D Thomas,
assuming that payment is received after 30 days.
Chapter 13 155
Question 13.7
Part A:
EPR Industries is a wholesaler that distributes boxes of toy cars to local shops. The company
has a 31 December financial year-end.
The following inventory transactions occurred during January 20X5:

January Purchase descriptions January Sales descriptions
1 220 boxes at C220 10 220 boxes at C286
31 330 boxes at C308
x All purchases and sales were for cash.

x All cost prices and selling prices referred to above are shown net of a 10% cash discount.
x There was no opening inventory in January 20X5.
x The monthly stock count revealed that there were 330 boxes on hand at 31 January 20X5.
x The company uses the perpetual system to account for inventory movements.
Required:
Prepare all the inventory-related ledger accounts for month January 20X5 assuming that:
a) the FIFO formula is used.
b) the WA formula is used .
Part B:
Use the same information as that given in Part A, except assume that the periodic system was
used to account for inventory movements (i.e. not the perpetual system).
Required:
Prepare all the inventory-related ledger accounts for month January 20X5 assuming that:
a) the FIFO formula is used.
b) the WA formula is used .
Question 13.8
Lavita Limited was incorporated on 1 January 20X5. The resident accountant has provided
you with the following information regarding its manufacturing facility:
x The factory is managed by a supervisor, earning an annual salary of C144 000.
x The factory involves a single plant, which was purchased in 20X4 for C72 000, but which
was first available for use on 2 January 20X5. Depreciation is calculated using the
straight-line method over the plant's expected useful life of 15 years to a nil residual
value.
x There are no other fixed manufacturing costs other than those referred to above.
x Information relevant to the first period (8 months) of operation was as follows:
Budgeted (units) Actual (units)
Sales 27 000 18 000
Production 36 000 21 600
156 Chapter 13
Required:
In respect of Lavita Limited's year ended 31 August 20X5:

a) Calculate the application rate to be used when allocating fixed manufacturing costs to
inventory at year end.
b) Calculate the fixed manufacturing costs included in the inventory closing balance.
c) Calculate the total amount of fixed manufacturing costs expensed during the period.
Question 13.9
Stocky Limited is a manufacturing company in its first year of operations. Stocky Limited
manufactures one product and has 500 units of finished goods of this product on hand at year-end
(there was neither raw material nor work-in-progress on hand at year-end).
The bookkeeper is unsure of how to treat fixed overheads and has left the fixed overhead costs
for the year in a suspense account. He has given you the following information:
Currency Units
Finished goods (closing balance) 2 500 500
- direct labour and other indirect conversion costs (C3 per unit) 1 500
- direct materials (C2 per unit) 1 000
Fixed manufacturing overheads suspense account 20 000
Budgeted sales (12 months) 20 000
Budgeted production (12 months) 40 000
Actual production (12 months) 25 000
Actual sales (12 months) 24 500
The 500 units on hand at year-end were sold for an amount of C3 000 after year-end but
before approval of the financial statements.
Required:
a) Calculate the amount at which finished goods will be disclosed in the statement of
financial position for the first year of operations. Show all your workings.
b) Assuming that:
x the company also had work-in-progress on hand at year-end with a cost of C235 000
(correctly calculated);
x the work-in-progress requires another C12 000 costs to be incurred in order to be
completed;
x the product made by the company is fast becoming obsolete; and
x the company plans to complete the work in progress and sell it at a mark-up of 15%
on cost (below the usual mark-up) with selling costs estimated at C42 000;
calculate at what value inventories would be shown on the face of the statement of
financial position for the first year of operations. Show all your workings.
c) Assuming that the company also has raw materials of C20 000 at year-end, which had all
been offered as security for a loan, show the disclosure of inventory in the statement of
financial position, as well as the inventory note and the profit before tax note.
Question 13.10
Elder Limited manufactures Zimmer frames. The costs that have been expensed by the
bookkeeper during the current year ended 31 December 20X1 are shown on the next page:
Chapter 13 157
C
Raw materials (a direct cost) 120 000
Factory labour: wages (a direct cost) 90 000
Cleaners: wages (an indirect, variable cost) 60 000
Annual factory rent (an indirect, fixed cost) 20 000
Depreciation on plant (an indirect, fixed cost) 10 000
x Budgeted production for the year ended 31 December 20X1 was 50 000 units, but this
was the first year of operations and thus the numerous teething problems resulted in the
company operating at only 60% of its budgeted capacity.
x Sales were good during the year with only 500 Zimmer frames still unsold at year-end.
x There was no stock of raw material or work-in-progress at year-end.
Required:
Part A:
Using the information given above:

a) Calculate the value of the inventory at 31 December 20X1.
b) Calculate the portion of the fixed manufacturing overheads capitalised to inventory during
c) Calculate the portion of the fixed manufacturing overheads still in inventory at
31 December 20X1.
d) Calculate the portion of the fixed manufacturing overheads that have been expensed during
e) Show all journals possible. Assume that all transactions/ events were processed as single
transactions and that, where applicable, amounts were paid in cash.
f) Calculate the amount at which cost of inventories expense will be disclosed in the statement
of comprehensive income for the year ended 31 December 20X1.
Ignore tax.
Part B:
Assuming that actual annual production totalled 60 000 units:

a) Calculate the value of the inventory at 31 December 20X1.
b) Calculate the portion of the fixed manufacturing overheads capitalised to inventory during
c) Calculate the portion of the fixed manufacturing overheads still in the inventory asset account
at 31 December 20X1.
d) Calculate the portion of the fixed manufacturing overheads that have been expensed during
e) Show all possible journals. Assume that all transactions / events were processed as single
transactions and that, where applicable, amounts were paid in cash.
f) Calculate the amount at which cost of inventories expense will be disclosed in the statement
of comprehensive income for the year ended 31 December 20X1.
Ignore tax.
158 Chapter 13
Question 13.11
Kudu Limited produces South African-styled gifts, all pre-packaged in designer leather boxes.
x At 31 December 20X3, its inventory comprised the following:
- Consumables: C0
- Raw materials: C100 000
- Work-in-progress: C250 000
- Finished goods: C150 000.
x The bookkeeper has summarised the following costs incurred during the year ended
31 December 20X4:
- Raw materials were purchased for C1 020 000, before taking into account the trade
discount of C20 000 and the cash discount of C30 000 that were received.
- The cost of having the raw materials delivered was C100 000.
- Consumables of C800 000 were paid for during the year. Of this, 37,5% related to
packaging materials used for the designer leather boxes and the balance related to the
packaging used to prevent breakages during delivery of the gifts to customers.
- Wages of C3 000 000 were paid, 60% of which related to the factory workers and 40%
related to head-office cleaning staff.
- Salaries paid to head office management totalled C300 000.
- Salaries to sales representatives – all variable with the number of units sold by the
representative – totalled C400 000.
- The annual rent and insurance was C800 000, C100 000 of which related to storage of
raw materials prior to production and the rest related to the factory production processes.
- Costs of delivering completed gifts to customers were C50 000.
- Other variable costs of C1 000 000 were incurred, 60% of which related to the factory and
40% related to the head-office.
- Depreciation of C800 000 was incurred on the plant and depreciation of C200 000 was
incurred on office equipment (all housed at head-office). Depreciation is a fixed cost.
x Kudu Limited produced 200 000 leather-boxed gifts of biltong, which was 80% of the normal
production level expected during the year ended 31 December 20X4.
x At 31 December 20X4:
- 100% of all consumables purchased during the year had been used
- 70% of all raw materials had been used
- 80% of all work-in-progress had been completed
- 90% of all finished goods had been sold.
Required:
a) Journalise the above. You may assume that each cost / transaction was a single transaction and
that where relevant, the amount was paid in cash.
b) Soon after 31 December 20X4, the directors decided to cease the production of leather-boxed
gifts and produce shoes instead.
- It has been decided that the raw materials on hand at 31 December 20X4 will be sold as
is for C300 000. The selling costs thereof are expected to be C50 000.
- The work-in-progress on hand at year-end will be completed at an expected cost of
C100 000 and is expected to sell for C700 000 (selling costs are expected to be C20 000).
- The finished goods will sell for C1 300 000 and will result in selling costs of C80 000.
Calculate the value at which inventories should be measured at year-end and show any
journal entries that may be necessary
Chapter 13 159
c) Prepare the financial statements of Kudu Limited for the year ended 31 December 20X4 in
accordance with International Financial Reporting Standards, assuming further that C150 000
of the finished goods have been offered as security for a loan.
Ignore tax.
Question 13.12
Woody Limited manufactures toy wheelbarrows for young children. The following
information relates to its inventory for the year ended 31 December 20X3.
Quantity Details C
Beginning of the year:
- Raw materials 17 000 kg C6.80/ kg ?
- Work-in-progress 0 0
- Finished goods 34 000 units
During the year:
- Raw materials purchases ? C6.80/ kg 2 720 000
- Raw materials usage 170 000 kg ? ?
- Rent incurred 680 000
(75% used by the factory and 25% by the head office)
- Direct factory wages incurred 850 000
- Office telephone incurred 34 000
- Electricity incurred (each wheelbarrow manufactured C0.2/ kilowatt 25 500
requires 0.5 kilowatts of electricity)
- Year-end party for factory staff 13 600
x 170 000 wheelbarrows were started during the year. Of these, 90% were completed during
the year and the remaining 10% were effectively complete at year-end, merely requiring
the drying process to be finalised. This drying process does not involve any further costs.
x 70% of finished goods that were available for sale during the year remained unsold at
31 December 20X3.
x Budgeted annual fixed manufacturing costs incurred are C510 000 and a normal annual
production level is 510 000 units.
x The cost per finished wheelbarrow in the current year is the same as the cost per finished
wheelbarrow in the prior year.
x All amounts incurred were paid for in cash.
Required:
Prepare journal entries to reflect the information presented above.
Question 13.13
Padfoot Limited manufactures dog food. The following information is available:

Financial information for the year ended 20X5 C
Raw material purchased (marked price including 14% VAT) 605 000
Trade discount received (calculated on marked price excluding VAT) 8%
Settlement discounts offered on purchases of raw materials 4 200
Settlement discounts received on purchases of raw materials 3 200
160 Chapter 13
Financial information continued … C

Variable overheads (30% admin; 70% manufacturing) 100 000
Rent and insurance (see below) 200 000
Salaries and wages (see below) 500 000
Packing materials purchased (see below) 685 000
Other fixed overheads (65% manufacturing; 35% administration) 285 000
x Rent and insurance for the 20X5 year was paid in full on 3 January 20X5 for the entire
year. It consists of the following items:
Factory C140 000
Warehouse storage of work-in-progress while oils cool before colourants added C30 000
Shop where dog food is sold to the public C30 000
x Salaries and wages comprise of 55% manufacturing, 15% administration, and 30% sales
department salaries. Manufacturing salaries are considered variable with production,
while administration and sales department are fixed.
x Packing materials relate to the container in which the dog food is placed before sale.
These materials may only be imported from the USA due to their specialised nature.
- The accountant erroneously converted the dollar amount on the FOB date (free on
board) instead of the DDP (delivery duty paid) date.
- Risks and rewards of ownership were transferred on the date the inventory arrived in
the Durban harbour (goods were delivered on a DDP basis).
- This was the first (and only) purchase of the packing materials during January.
- Spot rates were as follows:
x Order date $1: C6
x Date goods were loaded in USA harbour FOB date $1: C7
x Date of arrival in Durban harbour DDP date $1: C9
x Other relevant information for the year:
- 75% of packing materials were used
- 20% of raw materials were on hand at month end
- There was no work-in-progress at month end
- 80% of the finished goods produced were sold during the year.
x Normal production levels are estimated to be 18 000 units per annum. These 18 000 units
were expected to be produced evenly over the 12 month period. The actual number of
units produced during the year was 15 500 units.
x During November, Padfoot experienced the unfortunate incident of being held up by
armed thieves. 1 550 units of finished products were stolen.
x Padfoot Limited is a VAT vendor. All amounts exclude VAT unless otherwise indicated.
x A single entry to adjust for any over- or under-absorption of fixed manufacturing
overheads is processed at period-end.
Required:
a) Calculate the carrying amount of each category of inventory at 31 December 20X5.
b) Calculate the value at which the finished goods should be measured on the statement of
financial position as at 31 December 20X5, as well as the amount of any write down (if
required) assuming that:
x on 31 December 20X5, a flood damaged most of the finished goods on hand;
x expenditure to restore the goods to saleable condition is expected to be C90 000;
x an advertising campaign for the clearance sale will cost approximately C15 000; and
x the dog food may then be sold at a discounted price of C200 000.
Chapter 13 161
c) Prepare the journals to reflect the information provided in (b) above.

d) Disclose the inventory note in the notes to the financial statements for the period ended
31 December 20X5 after taking into account the information in (b) above.
Question 13.14
Bikini Limited, an audit client of your 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 (i.e. risks and rewards are transferred on date of shipment from the foreign harbour).
x Delivery costs associated with this special fabric are excessive (C50 000 more than
normal delivery costs), but the fabric is required urgently for seamless production.
Can this C50 000 be included in the inventory value at year-end?
b) The company used a consultant to design new swimming shorts (a completely new product
with which the company has no experience), at a total cost of C30 000.
x This was a once-off order for a large surf store chain.
x The shorts were complete by year-end at a total production cost of C500 000.
Can the consultant’s fees be included in the inventory valuation?
c) During the year, the company produced 85 000 bikinis and sold 75 000 bikinis.
x Normal production is 100 000 bikinis per annum.
x Variable costs are C30 per unit, and annual fixed manufacturing overheads amount to
C700 000.
Prepare journal entries to record inventory and cost of sales for the year.
d) Fabric X, used in production of the bikinis, is valued at C40 per metre.

x Fabric X can only be sold at C35 per metre.
x Finished bikinis are expected to sell for C100 and cost C37 to produce.
At what value should Fabric X be recognised in the financial statements?
Required:
Respond briefly to all the above queries of your client.
Question 13.15
Ice Empire, a manufacturer of the famous Empire ice cream, provided you with the following
financial information pertaining to the company’s manufacturing accounts for January 20X2:
C
Raw materials purchased (44 000 kilograms) 44 000
Electricity expense (see note 1) 68 200
Wages incurred (see note 2) 110 000
Depreciation (see note 3) 55 000
Raw materials 1 Jan 20X2 balance (16 500 kilograms) 22 000

Raw materials used in January 20X2 (28 600 kilograms) ?
Work-in-progress on 1 January 20X2 38 500
Finished goods on 1 January 20X2 (3 300 units) 33 000
162 Chapter 13
Notes:
1. Electricity incurred and paid was considered to be variable.
2. Wages were incurred as follows
x 80% related to factory workers
x 6% related to cleaning staff operating in the factory
x 4% related to cleaning staff operating in the head office and
x 10% related to office workers in the administrative offices.
x All factory-related wages incurred are considered to be variable in nature.
3. The depreciation expense incurred during January 20X1 is constituted as follows:
x 80% relates to machinery used in the factory; and
x 20% relates to equipment used by head office.
The machinery was used 70% of the time in manufacturing inventory and the balance of
the time, the machinery was idle.
x The factory building is rented at C44 000 per month (and always paid in cash).
x Budgeted normal production for January 20X2 was 22 000 units.
x 23 100 units were put into production during January 20X2.
x 19 800 units were completed during January 20X2, at a cost of C178 200.
x 80% of all finished goods were sold during January 20X2.
Required:
Show the ledger accounts for raw materials, work-in-progress and finished goods using the
perpetual system and assuming that:
a) the first-in-first-out formula is used.
b) the weighted average formula is used.
Chapter 13 163
GAAP: Graded Questions Borrowing costs
Chapter 14
Borrowing costs
Question Key issues

14.2 Stars Theory: commencement, suspension and cessation of capitalisation
14.3 Tennis Specific loan: Costs incurred on specific dates, Interest compounded
annually, investment of surplus funds, Loan raised when construction
began, Construction incomplete at year end, Delays in construction
14.4 Mali Specific loan: Costs incurred on specific dates, Loan raised before
construction began, Interest compounded annually, Construction completed
before year end, Investment of surplus funds.
14.5 Butterfly Specific loan: Costs incurred evenly, Interest compounded annually, Loan
raised before construction began, Construction complete before year end,
and Investment of surplus funds, Date available for use is different to year
brought into use
Deferred tax effects thereof.
14.6 Squash Specific loan (two loans): one local and one foreign, Construction costs
incurred on specific dates, Interest compounded annually, Investment of
surplus funds, Loan raised before construction began, Construction
complete before year end, Partial repayment of loan at year end
14.7 Junk Specific debentures (compulsory redeemable): Costs incurred evenly over
time, Investment of surplus funds, Debentures issued when construction
began, Construction complete at year end
14.8 Forest General loan: Costs incurred on specific dates, Interest compounded
annually, Construction incomplete at year end
14.9 Sharks General loan: Costs incurred evenly over time, Interest compounded every
four months, Construction incomplete at year end
14.10 Yoodle General loan (more than 1): Cost incurred evenly over time, Interest
compounded annually, Construction complete after two years, Temporary
delay
14.11 Yipdeedoo General loan (three loans): Costs incurred evenly and on specific dates,
Interest compounded annually, Investment of surplus funds, Loan raised
before construction began, Construction complete before year end
14.12 Wayout General overdraft and specific loan (more than 1): Construction costs
incurred on specific dates, Interest compounded quarterly, Loan raised after
construction began, Construction complete before year end, Investment of
surplus funds.
chapters.
164 Chapter 14
Question 14.1
a) Borrowing costs are expensed unless they are incurred in connection with the construction
of a qualifying asset, in which case they may be capitalised. True or false?
b) A company financed the construction of a plant through an issue of shares. The dividends
declared on these shares may not be capitalised to the cost of the plant. True or false?
c) Qualifying assets refer to non-current assets that take a substantial period of time to get
ready for their intended use or sale. True or false?
d) Borrowing costs may never be capitalised to the acquisition of financial assets. True or false?
e) Min Limited constructed a building during 20X4, details of which are as follows:
x Min Limited secured a loan to finance the construction of a building (a qualifying
asset) on 5 January 20X4 and began incurring interest on the loan from
1 February 20X4 when the loan funds became available.
x Min Limited purchased the first batch of raw materials (sand, cement and bricks) on
10 February 20X4.
x The construction of the building began on 20 February 20X4.
Identify the date on which capitalisation of borrowing costs should commence (i.e.
identify the commencement date).
f) Max Limited was constructing a building during 20X4. A spreadsheet of outstanding
work as at 30 September 20X4 was drafted by the project manager. The date on which
each of these outstanding tasks was completed was then filled onto this spreadsheet. The
completed spreadsheet was presented to you as follows:
Outstanding work as at 30 September 20X4: Datte completed:
x Construction of the roof on the east wing 05 November 20X4
x Plumbing on all floors still to be installed 08 December 20X4
x Final documentation to be submitted for filing with the municipality. 12 December 20X4
x Painting of the interior and exterior of the building. 22 December 20X4
Identify the date on which the capitalisation of borrowing costs should cease (i.e. identify
the cessation date).
g) Arnica Limited is constructing an amusement park on the beachfront. Construction of the
park had to be suspended thrice, details of which are as follows:
Reasons for periods during which construction was suspended: Date suspended: Date resumed:
x Construction was delayed for almost 1 month because the cement 02 February 20X4 05 March 20X4
work involved in the construction of the various foundations had
to cure before construction could commence.
x Construction was delayed for almost 2 months after a minor 20 March 20X4 15 June 20X4
earthquake on 20 March 20X4 caused certain tectonic plates to tilt
in a way that caused underground water to pool. This water had
to be drained from the construction site before construction could
continue.
x Construction was delayed for almost 2 months due to the 05 September 20X4 27 October 20X4
anticipated seasonal monsoons during most of September and
October 20X4.
Explain whether the capitalisation of borrowing costs should be suspended during any of
these periods referred to above.
Chapter 14 165
h) Briefly outline the formula to use in measuring the borrowing costs that should be
capitalised when the borrowings are specific borrowings?
i) Briefly outline the formula to use in measuring the borrowing costs that should be
capitalised when the borrowings are general borrowings?
j) IAS 23 requires disclosure of the borrowing costs that are expensed as finance costs in the
statement of comprehensive income.
Required:
Answer the above short questions in as much detail as is possible.
Question 14.2
Stars Limited borrowed money on 1 February 20X5 specifically to fund the acquisition,
construction or production of the following assets:
x A factory building was being constructed in East London:
x Development and related expenditures began in December 20X4.
x Development has been slow, having been hampered by a combination of:
- seasonal wet weather that halted construction in January and February 20X5
(the project manager had anticipated this delay and built it in to his project
timeline) and
- a freak tornado on 1 May 20X5. Mopping up after the tornado took a month
and construction resumed on 1 June 20X5.
x An office park was being constructed during 20X4 and 20X5.
x This office park consists of five separate office blocks, one of which is to be used as
the company headquarters and the remaining four blocks will be rented out to tenants.
x Three of the office blocks were completed on 1 July 20X5. The other two office
blocks were still under construction at year-end.
x A factory plant was ordered from a foreign supplier in America.
x The plant was shipped on 1 February 20X5, on which date the risks and rewards of
ownership passed.
x The payment for the plant was made on 1 March 20X5. No interest was charged on
the amount owing from 1 February 20X5.
x The plant arrived on 1 June 20X5. Installation of the plant began immediately and
was complete on 1 September 20X5. Safety tests were performed on the plant during
September 20X5 and the plant was considered available for use on 1 October 20X5.
x A tract of land in Queensburgh:
x This land, purchased for C700 000, is not yet being developed since the entity is still
waiting for the plans to be passed by the local building authorities.
x The C700 000 was paid to the transferring attorneys on 1 March 20X5 and transfer of
ownership took place on 1 June 20X5.
x An architect was hired on 1 July 20X5 to design the factory building: these plans
were completed on 1 September 20X5 and were submitted to the local building
authority on 5 September 20X5. The local building authority has indicated that it will
take 4 months for the plans to be properly assessed and passed.
x A team of construction engineers was paid C200 000 as a non-refundable deposit to
secure a commitment to being available to begin construction in February 20X6.
166 Chapter 14
Required:
Write a letter to the accountant of Stars Limited advising him on the commencement,
cessation and suspension of capitalisation of borrowing costs for each of the entity’s assets.
Question 14.3
Tennis Limited borrowed C2 000 000 (at an interest rate of 14%) from Fed Bank on 1 January
20X5. These funds have been borrowed in order to build a tennis stadium, a qualifying asset
as defined by IAS 23.
x Progress payments made in 20X5 are as follows:
C
On 1 January 600 000
On 1 July 1 200 000
On 1 September 200 000
x The surplus funds were invested in a fixed deposit earning interest at 10% per annum.
x The interest on the fixed deposit and the loan are compounded annually (31 December).
x Construction began on 1 January 20X5 and was still incomplete on 31 December 20X5.
x Construction ceased between 1 June and 20 June while concrete cured (a necessary part
of the construction process).
Required:
a) Using Tennis Limited's general journal, prepare all journals relating to interest for the
year-ended 31 December 20X5.
b) Explain whether borrowing costs may be capitalised to the tennis stadium during the year-
ended 31 December 20X5 assuming the following alternative information:
x Construction had not yet begun as at 31 December 20X5 because the building plans that
were submitted during 20X5 failed to meet local authority’s basic building regulations.
x The plans were re-submitted during October 20X5 and it is expected that the local
authority will give the necessary permission to begin construction in early 20X6.
Question 14.4
In order to meet the requirements as stipulated by the tender board of the KwaZulu-Natal
provincial department, Mali Limited’s directors voted in favour of the construction of a new
building (a qualifying asset). This building will be used as a warehouse for the safe-keeping
of goods before they are despatched to all the municipalities within the province.
The pertinent financing details of the construction of the building are as follows;
x The construction was financed by a loan of C2 280 000 from Cash Limited.
x The loan was raised on 1 January 20X6 specifically to fund the construction of the building.
x Since Mali Limited is a fairly new company with no credit rating at all, the loan bears a
hefty interest rate of 30% per annum. Mali made no capital repayments during the year.
x Surplus funds were invested and earned interest at 24% per annum.
x All interest is compounded annually.
The construction began on 1 February 20X6. Construction costs incurred during 20X6 were
paid for on the first day of each of the following months:
x Progress payment in February: C600 000
x Progress payment in July: C720 000
x Progress payment in November: C960 000
Chapter 14 167
The construction of the building ended on 1 December 20X6 on which date it became ready
for use as a warehouse, and on which day the tender proposal was immediately submitted.
However due to delays in finalising the tender process, Mali was only awarded the tender on,
and thus only brought the building into use from, 1 January 20X7. Depreciation on the
building is based on a useful life of 12 years, a nil residual value and the straight-line method.
Required:
a) Calculate the borrowing costs to be capitalised during the year ended 31 December 20X5.
b) Calculate the depreciation for the year ended 31 December 20X5.
c) Calculate the carrying amount of the building as at 31 December 20X5.
d) Show all the interest related journal entries for the year ended 31 December 20X5.
Question 14.5
Butterfly Limited raised a loan of C500 000 on 1 January 20X5.
x This loan was raised specifically to fund the construction of a building (a qualifying
asset). Interest of C50 000 is charged on this loan (10% per annum) and is compounded
annually on 31 December.
x Interest income of C30 000 was earned evenly during the year. Included in this amount is
C9 000 earned by investing surplus funds from the specific loan in a fixed deposit
between 1 July – 30 September.
x Construction began on 1 March 20X5 and ended 31 August 20X5. Construction costs
totalled C410 000 during this period.
x The building was available for use on 1 September 20X5 but was only brought into use on
1 October 20X5 due to unforeseen circumstances. Buildings are depreciated at 10% per
annum, straight-line to a nil residual value.
The company owns only one other item of property, plant and equipment, this being
equipment with a carrying amount of C370 000 at 31 December 20X5 (C420 000 at
31 December 20X4).
There have been no disposals, purchases or other movements in property, plant and
equipment other than those that are evident from the information provided.
The tax authorities:

x allow the deduction of interest as it is incurred unless it relates to the construction of an
asset, in which case it is allowed in full as a deduction in the year in which the asset is
brought into use;
x allow the deduction of a capital allowance based on the cost of the building at 5% per
annum in the year that it is brought into use, not apportioned for part of a year;
x levy income tax at 30% of taxable profits.
There are no other temporary differences other than those evident from the information above.
Required:
a) Calculate the amount of borrowing costs that must be capitalised in terms of IAS 23.
b) Show all related journal entries in 20X5.
c) Provide the following disclosure in Butterfly Limited’s financial statements for the year
ended 31 December 20X5 in as much detail as is possible:
x Statement of comprehensive income
x Statement of financial position
x Notes showing the borrowing costs accounting policy, finance charges, depreciation
expensed, property, plant and equipment and deferred tax.
Comparatives are not required
168 Chapter 14
Question 14.6
You are a recently employed accountant of Squash Limited. The company had decided to
construct a more energy-efficient factory to minimise its carbon footprint. The construction
of the factory began on 1 March 20X5 and was finalised on 31 August 20X5. The
construction resulted in the costs of C300 000 being paid on 31 March 20X5, C100 000 on 30
April 20X5 and C220 000 on 31 July 20X5.
To use the most appropriate finance the company decided to use an external consultant to
determine the financing for the project.
x In line with the consultant’s suggestion, the company raised a $62 500 foreign loan on
1 January 20X5 from Green Bank at 10% interest. The exchange rates were as follows:
x 1 January 20X5 C8,00: $1 Spot exchange rates
x 1 March 20X5 C9,00: $1 Spot exchange rates
x 31 August 20X5 C10,00: $1 Spot exchange rates
x 31 December 20X5 C11,00: $1 Spot exchange rates
x 1 January – 28 February 20X5 C6,00: $1 Average exchange rates
x 1 March – 31 August 20X5 C9,20: $1 Average exchange rates
x 1 September – 31 December 20X5 C9,50: $1 Average exchange rates
The interest rate on 1 January 20X5 that would have been available on a local loan of
C500 000 (i.e. equivalent to the foreign loan of $62 500) was 18%.
x A second loan of C400 000 was raised on 1 June 20X5 from a local bank, the Peace
Bank, at an interest rate of 15%. Unfortunately, due to a breach of contract, Squash
Limited was forced to repay C100 000 of the Peace Bank loan (capital portion) on
31 July 20X5.
Interest on both loans is compounded annually. Any surplus funds from the loans are invested
in a 6% per annum interest-bearing account.
Required:
Prepare all the related journal entries for the year ended 31 December 20X5.
Ignore tax.
Question 14.7
On 1 January 20X5, Junk Limited issued 1 million C5 debentures to raise funds specifically
for the construction of a head office building, a qualifying asset as defined by IAS 23.
x The debentures are compulsorily redeemable on 31 December 20X9, at C7 each.
x Interest on debentures at 12% is payable annually. The effective interest rate is 17,6319%.
x Junk Limited spent C2 700 000 on the construction of the head office (these costs were
incurred evenly over the period of construction). Construction of the head office began
on 1 January 20X5 and was complete and available for use on 30 November 20X5.
x The total useful life of the building was 10 years and the residual value is estimated at
C1 000 000. Depreciation is provided on the straight-line method.
x Surplus funds from the debenture issue were invested and earned interest of C250 000
(earned evenly during the year).
Required:
Provide all the related journal entries for the year-ended 31 December 20X5.
Ignore tax.
Chapter 14 169
Question 14.8
Forest Limited began the construction of a new paper making machine on 1 January 20X5,
with construction costs paid as follows:
x C300 000 on 1 January 20X5,
x C200 000 on 1 April 20X5,
x C250 000 on 1 July 20X5,
x C150 000 on 1 September 20X5 and a final payment of
x C200 000 on 1 October 20X5.
The machine was still under construction at 31 December 20X5.
The construction was financed by general borrowings within the company. General loans
outstanding at any one time during 20X5 averaged C272 000 000. The interest expense
incurred on these loans during 20X5 was C35 360 000. Interest is compounded annually.
The paper making machine meets the definition of a qualifying asset per IAS 23.
Required:
a) Calculate the amount of borrowing costs that may be capitalised to the machine during
b) Calculate the depreciation for the year ended 31 December 20X5.
c) Calculate the carrying amount of the machine as at 31 December 20X5.
d) Provide the journals related to the interest expense and capitalisation of interest.
Ignore tax.
Question 14.9
Sharks Limited is a large public events business. Instead of hiring venues from other landlords at
exorbitant costs, it decided to construct a building which it would dedicate to its own publicity
events. Construction began on 1 March 20X5 and was still incomplete at 28 February 20X6.
No specific loans needed to be raised to fund the building work since Sharks had sufficient
cash available through a variety of loans that the business raised for various projects.
The balance owing on these loans averaged C45 million at any one time during the year ended
28 February 20X6. The total interest incurred on these loans during the year ended
28 February 20X6 was C5 850 000. Interest on these loans is compounded every 4 months.
Costs incurred on the construction of this building during the year ended 28 February 20X6
totalled C1 700 000. These construction costs were incurred and paid evenly during 4-month
periods as follows:
x 1 March 20X5 – 30 June 20X5: C500 000, incurred and paid evenly during this period
x 1 July 20X5 – 31 October 20X5: C800 000, incurred and paid evenly during this period
x 1 November 20X5 – 28 February 20X6: C400 000, incurred and paid evenly during this period.
Required:
a) Journalise the interest expense and capitalisation of interest for the year ended 28 February 20X6.
b) Calculate the carrying amount of the building as at 28 February 20X6.
Ignore tax.
170 Chapter 14
Question 14.10
Yoodle Limited is constructing a factory building for its own use. At 31 December 20X4, a
total of C450 000 had already been capitalised to the cost of this building.
x Cash flow was becoming problematic near the end of December 20X4 and thus, in order
to have sufficient available resources, Yoodle Limited raised an additional loan of
C400 000, costing interest of 15% per annum (these funds became available from
1 January 20X5). This loan is to be used for a variety of purposes (it has not been raised
specifically for the building costs). Interest on this loan is compounded annually.
x Yoodle Limited had an existing general loan at 1 January 20X5 of C800 000, costing
interest of 10% per annum. Interest on this loan is compounded annually.
x There are no other loans. No repayments on either loan were made during 20X5 or 20X6.
x Interest income was earned on the investment of funds from the general loans that were
surplus to requirements. Interest income earned was as follows:
Year-ended 31 December 20X5 C45 000
Year-ended 31 December 20X6 C92 000
x The following construction costs were incurred in 20X5 (paid evenly during each month):
C per month
1 January – 31 July (7 months) 70 000
1 August – 30 November (4 months) 40 000
1 – 31 December (1 month) 90 000
x No further construction costs were paid for during 20X6 although the builders completed
laying the final concrete slab around the base of the building on 3 January 20X6. This
slab required roughly 4 weeks to ‘cure’ with the result that the building was not available
for use until 1 February 20X6.
x Whilst the factory equipment should have been installed on or around 1 February 20X6,
the contractors involved in the installation were delayed on a previous unrelated job, with
the result that the equipment was only installed in the last week of February and thus the
factory building was only brought into use on 1 March 20X6.
x The building is expected to have a useful life of 10 years and a nil residual value. The
straight-line method of depreciation is considered to be appropriate.
Required:
Show the journal entries related to the above information in the books of Yoodle Limited for
the year-ended 31 December 20X5 and 20X6 and provide as much disclosure as is possible
for the year-ended 31 December 20X6. Ignore tax.
Question 14.11
Yipdeedoo Limited began construction on a building, a qualifying asset, on 1 March 20X1.

Construction was complete on 30 November 20X1 and it was brought into use on 1 January 20X2.
Depreciation is provided at 10% per annum to a C100 000 residual value.
The company had the following general loans outstanding during the year:
Bank Loan amount Interest rate Date loan raised Date loan repaid
A Bank C300 000 15% 1 January 20X1 N/A
B Bank C200 000 10% 1 April 20X1 30 September 20X1
C Bank C100 000 12% 1 June 20X1 31 December 20X1
Chapter 14 171
The interest on the loans is compounded annually. Interest income of C30 000 was earned
during the year.
Details relating to the construction costs are as follows:

Details Date incurred C Comments
Laying a slab 1 March 20X1 60 000
Waiting for slab to cure 1 March – 31 March 0 This is a normal process
Purchase of materials 1 April 20X1 120 000
Labour costs 1 April – 30 Nov 20X1 330 000 Incurred evenly over the months but
paid at the beginning of each month
Required:
a) Calculate the interest incurred for the year-ended 31 December 20X1.
b) Calculate the weighted average interest rate (i.e. the capitalisation rate).
c) Calculate the interest to be capitalised.
d) Show the journal entries to account for the interest during the year-ended
31 December 20X1.
e) Disclose the above information in the financial statements of Yipdeedoo Limited for the
year-ended 31 December 20X1. Comparatives are not required.
Ignore tax.
Question 14.12
Wayout Limited embarked on the construction of one of the world’s first rotating buildings on
1 January 20X1. The contract price is C400 000 000. Construction costs were paid as follows:
- 2 January 20X1 100 000 000
- 1 April 20X1 50 000 000
- 1 July 20X1 80 000 000
- 1 October 20X1 200 000 000
x The construction, which was complete by 1 November 20X1, was financed as follows:
x An overdraft facility limited to C160 000 000:
- the facility is used by the company for various company costs;
- the interest incurred on the overdraft was C24 million for the year and the
average overdraft balance was C150 000 000;
- Interest is compounded on a quarterly basis
x Two loans raised specifically for this project:
- C250 000 000 raised on 1 July 20X1 with the Bank of Oz at 10% per year; and
- C50 000 000 raised on 1 October 20X1 with the Bank of Wizardry at 8% pa.
- Interest is compounded on a quarterly basis
x Surplus funds were invested from 1 July to 30 September, earning interest at 5% p.a.
Required:
Provide all journal entries relating to interest for the year ended 31 December 20X1.
172 Chapter 14
GAAP: Graded Questions Government grants and assistance
Chapter 15
Government grants and assistance
Question Key issues

15.1 - Concept questions
15.2 Tukumu Grant to subsidise expenses, comparing:
- recognised as income; versus
- recognised as reduction of expenses
15.3 Poster Grant to subsidise asset, comparing:
- recognised as reduction of asset.
15.4 Green bean Journals: grant to subsidise asset and for immediate financial support:
- recognised as a reduction of asset.
15.5 Blot Grant to subsidise asset, comparing:
Repayment of grant (change in estimate).
15.6 Anthony Grant of asset:
- recorded at fair value; versus
- recorded at nominal amount
Government assistance.
15.7 Explorer Grant to subsidise an asset
15.8 Sparky Grant to subsidise asset:
Repayment of grant (change in estimate), comparing:
- partial repayment; versus
- full repayment.
15.9 Shrek Grant to subsidise a non-depreciable asset, comparing:
- secondary condition leads to future expenses (non-measurable);
- secondary condition leads to future expenses (measurable);
- secondary condition leads to future asset (depreciable).
15.10 Lavender Journals and tax disclosure: tax effects of a grant to subsidise a non-
monetary asset, comparing:
- grant is taxable; versus
- grant is exempt from tax
15.11 Snowy Low interest loan
Forgiven amounts
Capitalisation of borrowing costs (IAS 23)
15.12 Juba Grant package, including loan interest loan
Further questions incorporating this topic with other topics can be found in Chapter A
(after Chapter 15) and in Chapter B (after Chapter 28). Chapters A and B are the
Integrated Questions chapters.
Chapter 15 173
Question 15.1
a) Define the term ‘government’.

b) Explain what is meant by the term ‘government assistance’ and identify the two categories
thereof in terms of accounting requirements, explaining how the accounting of each
category differs.
c) Explain the difference between the capital approach and income approach to accounting
for government grants and explain whether IAS 20 allows a choice between these
methods.
d) A government grant received in the form of cash to be used to subsidise future expenses
must be recognised immediately in profit or loss as a credit to the ‘government grant
income’ account. True or false?
e) A cash grant received as immediate financial support where all terms and conditions have
been met must be presented as a separate line-item on the face of the statement of
comprehensive income. True or false?
f) A grant of a non-monetary asset (e.g. a plant) is recognised by debiting the asset and
crediting grant income with the fair value. True or false?
g) Explain how a government grant in the form of a non-monetary asset is measured.
h) Explain how we recognise a grant of a non-monetary asset that is non-depreciable and
how and why this differs to the recognition of a grant of a non-monetary asset that is
depreciable.
Required:
Provide answers to each of the above questions, together with a brief explanation.
Question 15.2
Tukumu Limited is a company that manufactures curios. Tukumu Limited operates in the
Natal Midlands and employs the local population to manufacture the curios.
As a result of the positive effect that Tukumu Limited has had on an otherwise impoverished
area, it was awarded a government grant of C270 000 on 1 July 20X5. This grant was given to
Tukumu Limited to subsidise 20% of future wages.
Tukumu Limited had complied with all the conditions laid out to obtain the grant during the
previous financial year (30 June 20X5). The only condition that remained on 1 July 20X5 is
to incur future wages.
Wages incurred and paid: C
30 June 20X6 360 000
30 June 20X7 450 000
30 June 20X8 720 000
Required:
a) Show the journals in the company’s general journal, for the years ended 30 June 20X6 to
20X8, assuming that the company policy is to present such a grant as grant income.
b) Show the journal entries in the company’s general journal, for the years ended 30
June 20X6 to 20X8, assuming that the company policy is to recognise government grants
as an adjustment to expenses.
174 Chapter 15
Question 15.3
Poster Limited (a local company) manufactures advertising billboards. The nature of the
manufacturing process requires a larger amount of unskilled labour than skilled labour thus
enabling the company to reduce its labour cost and, with the reinvestment of these savings,
enabling the business to grow.
The manufacturing process requires a laser machine to create a “3D” effect, which is an effect
that is highly sought after by customers. Due to the machine not being available in the
country, Poster had previously outsourced this process to Laser Light Limited, a company
based in Korea.
A local importer has now begun importing these machines and Poster Limited’s directors
wish to acquire one. The directors have also discovered that the government is offering
various grants to assist manufacturing companies that employ a significant number of
unskilled labourers. Since 80% of its labour force is unskilled, Poster Limited duly submitted
all the required documentation in application for a grant to assist it in the acquisition of this
very expensive machine.
On 1 March 20X0, Poster Limited had met all the conditions of the grant and was thus
awarded a grant of C480 000 in cash, to be used to purchase the machine. The machine was
purchased immediately at its invoiced price of C1 800 000. Poster Limited assessed the
useful life of the machine to be three years and its residual value to be nil. Depreciation will
be provided on the straight-line basis.
Required:
Show the general journals for the years ended 28 February 20X1, 20X2, 20X3 assuming:
a) The company has the policy of recognising government grants directly in income.
b) The company has the policy of recognising government grants indirectly in income.
Question 15.4
Green Bean Limited is a company specialising in nature conservation. Due to the sudden
increase in rhino poaching at a number of South African game reserves, it applied for a grant
from the government to assist in the purchase of a helicopter. This helicopter would be used
in surveillance operations with the intention to discourage and/ or apprehend the poachers.
The South African government was pleased with the proposal submitted by Green Bean
Limited in its application for the grant and immediately awarded the company C6 000 000 in
cash. The cash was deposited into Green Bean Limited’s bank account on 1 January 20X5.
The government indicated that 40% of this sum is for immediate financial support (i.e. has no
further conditions attached and may be used for any business costs) but 60% of this sum must
be used to off-set the cost of purchasing the helicopter.
Negotiations had been underway during late 20X4 for the purchase of a helicopter, with the
only delay being that Green Bean Limited was still haggling on price since it did not have
sufficient cash resources. When the cash grant was received, the director immediately phoned
the supplier and signed the purchase agreement, taking full ownership of the helicopter for an
amount of C10 800 000.
Industry norms suggest that the helicopter should probably be depreciated on the straight-line
method over an estimated useful life of 5 years and experts in the field estimate that it has a
residual value of C600 000.
Chapter 15 175
Required:
a) Provide all related journals for the year ended 31 December 20X5 using the direct method
(recognising the grant as grant income).
b) Provide all related journals for the year ended 31 December 20X5 using the indirect
method (recognising the grant as a reduction of the related costs).
Question 15.5
Blot Limited is a newly formed company that is considering entering the ink business. Blot
plans to manufacture ink and sell it to printing businesses. Due to the scarcity of businesses in
this sector, Blot Limited was awarded a government grant to purchase the machinery it
needed to start operations.
x The grant was awarded to Blot Limited on 1 January 20X6 for an amount of C250 000
and is conditional upon Blot manufacturing ink for an unbroken period of 3 years.
Should Blot Limited stop manufacturing before the end of the 3-year period, the grant
will have to be repaid in full.
x Blot Limited purchased the requisite machinery on 1 January 20X6 for C500 000. The
machinery is expected to have a useful life of 4 years and a nil residual value.
x Due to unforeseen circumstances, Blot Limited had to stop manufacturing ink on
1 January 20X8, but intends to continue on 1 January 20X9.
Required:
a) Show the general journal entries for the years ended 31 December 20X6 to 20X9 using
the direct method (recognised as grant income).
b) Show the general journal entries for the years ended 31 December 20X6 to 20X9 using
the indirect method (recognised as a reduction of the related costs).
Question 15.6
Anthony Limited wanted to start manufacturing guns and weapons, a business that requires a
government licence. Anthony was astounded when the licence application, which cost
C35 000, was awarded on 31 December 20X8, only a week after submitting the application.
x The fair value of the licence is reliably determined to be worth C630 000 (gun
manufacturing licences are sought after and easily transferable).
x The application fee of C35 000 was paid on 31 December 20X8.
x The licence must be renewed every 5 years.
Over and above the licence, the company was also given free advice, by officials from the
government military department, on the manufacture and marketing of weapons. This
assistance was given because of the company’s excellent BEE rating (a government imposed
set of criteria that companies in that country should abide by) in its other operations.
Required
a) Show the journal entries for the year ended 30 June 20X9 assuming that Anthony Limited
measures the licence at its fair value.
b) Show the journal entries for the year ended 30 June 20X9 assuming that Anthony Limited
measures the licence at its nominal amount.
c) Provide the necessary disclosure relating to the free government advice in Anthony
Limited’s accounting records.
176 Chapter 15
Question 15.7
Explorer Limited has recently commenced operations as a manufacturer. Soon after the
commencement of operations, the directors became aware of incentives being offered to
businesses pursuing sustainable development in rural areas.
As a result of the incentives being offered, management relocated the entire operation to
Qunu (Eastern Cape). As an incentive for relocating their factory, the government agreed to
subsidise 70% of the cost of constructing a new state-of-the-art factory building, which
operated exclusively on wind and solar energy.
The only term attached to the subsidy is that it is limited to a maximum of C2 000 000.
Required:
Draft a memorandum to the directors of Explorer Limited explaining how they should
account for the subsidy if the factory cost C2 500 000 to construct.
Question 15.8
Sparky Limited, a manufacturer of light bulbs, recently received a government grant of

C300 000 to assist the company in purchasing a glass blower costing C500 000. The grant
was received and the related glass blower was purchased on 1 January 20X8. The useful life
of the glass blower was 5 years, its residual value was nil and the straight-line method of
depreciation applied.
The grant was conditional upon Sparky Limited producing 10 000 light bulbs for the new
parliament buildings by 31 December 20X9. Failure to comply with part (or all) of this
condition would cause a proportionate amount of the grant to be repayable.
Sparky Limited produced and installed 6 000 light bulbs in the new parliament building
during the 20X8 financial year. However, the minimum production failed to be met in 20X9
with only 2 000 of the government light bulbs produced and installed. The reason for the
lower production was due entirely to the frequent power cuts experienced during 20X9.
Required:
a) Prepare journal entries in the general journal of Sparky Limited for the years ended
31 December 20X8 and 20X9 assuming that Sparky Limited credits government grants to
the asset. Ignore tax.
b) Prepare journal entries in the general journal of Sparky Limited for the years ended
grant income. Ignore tax.
c) Prepare journal entries in the general journal of Sparky Limited for the years ended
grant income, and that the grant became repayable in full in the event that a total of
10 000 light bulbs were not produced by 31 December 20X9. Ignore tax.
Question 15.9
On 1 January 20X1, Shrek Limited received C900 000 cash from the government of
Farfaraway. The cash is to be used by Shrek to buy a swamp from one of its government
officials.
Chapter 15 177
Ownership of the swamp was transferred into Shrek’s name on 1 April 20X1 (on which date
the full and final payment of C200 000 was made).
Shrek has received many grants in the past and has always credited them, where possible, to
the related non-monetary asset.
Part A:
Assume that the grant came with a secondary condition that required Shrek to employ ten
government officials (a list of their names has been given to Shrek) from 1 January 20X1 for
a minimum period of 3 years. Their salaries will have to be in-line with company policy and
be subject to normal increases applicable to any other person employed by Shrek Limited.
Required:
Provide all entries in Shrek Limited’s general journal for the year ended 31 December 20X1.
Part B:
Assume that the grant came with a secondary condition that required Shrek to drain the
swamp and clear it of all plant-life before 31 December 20X2.
x At 31 December 20X1, Shrek had estimated that the total cost of drainage would be
C70 000 and the total cost of removing all plant life would be C130 000. By this date,
Shrek had already incurred C40 000 in draining costs and C50 000 in removal costs.
x At 31 December 20X2, Shrek had incurred a total of C200 000 in draining costs and
C100 000 in removal costs and had completed this condition.
Required:
Provide all journals in Shrek Limited’s general journal for the years ended
31 December 20X1 and 20X2.
Part C:
Assume that the grant came with a secondary condition that required Shrek to build a small
castle in a corner of the swamp to house Shrek’s employees.
x The castle was complete on 31 March 20X2 at a total cost of C100 000 (paid in full on
this date).
x The castle was available for use immediately, is expected to have a nil residual value and
a useful life of 10 years.
Required:
Provide all entries in Shrek Limited’s general journal for the years ended 31 December 20X1
and 31 December 20X2.
Question 15.10
The government granted C114 000 in cash to Lavender Limited on 1 July 20X0. A condition
of this grant was that it be used to purchase a specific plant. Where government grants are
related to non-monetary assets, Lavender Limited’s accounting policy is to credit the grant
directly to the related non-monetary asset.
Lavender Limited purchased the specified plant on 1 August 20X0 for C570 000. It was
delivered on the same day but needed to be installed before it could be used.
178 Chapter 15
The installation was fairly technical and the only person qualified to perform it happened to
be on an extended sabbatical. However, he installed the plant immediately upon his return,
which enabled the plant to be used from 1 October 20X0. Strike action during October 20X0
resulted in the plant only being brought into use on 1 November 20X0. Depreciation is
provided on this plant on the straight-line basis over its expected useful life of 6 years to a nil
residual value.
Lavender Limited made a profit before tax of C1 520 000 for the year ended 30 June 20X1.
This profit has been correctly calculated after taking into account all adjustments necessary as
a result of this grant.

x Income tax is levied at 30% on taxable profits.
x There are no temporary differences, exempt income or non-deductible expenses other than
those evident from the information provided.
Required:
Show the tax journal entries and tax expense note for the year ended 30 June 20X1, assuming:
a) The tax authorities:
- tax the receipt of the grant as income in the year of receipt; and
- allow the deduction of 20% of the cost of the plant per year, apportioned for periods
of less than a year.
b) The tax authorities:
- do not tax the receipt of the grant; and
- allow the deduction of 20% of the cost of the plant per year, apportioned for periods
of less than a year.
Question 15.11
Snowy Limited is a South African manufacturer of marshmallows. Keen on improving its
undesirable ecological footprint, the South African government was offering loans to
qualifying companies in order to facilitate production of ‘green power’. Snowy Limited
applied for, and was duly granted, one of these government loans on the basis that it was
currently constructing a building that was completely self-sufficient in terms of power.
The government loan granted to Snowy was for a sum of C700 000 and was effective from
1 March 20X1. The market interest rate on loans of this magnitude is 14%. The conditions of
the government loan were set out in a contract, an extract of which is shown below:
Clause 1: The loan is conditional upon: Not applicable
Clause 2: The loan is to be repaid on expiry of a two year period from date the loan is granted:
refer clause 4.
Clause 3: Interest of 7% will be charged on the loan, compounded annually and payable only on
expiry of the loan: refer clause 4 and clause 5.
Clause 4: The entire capital together with accrued interest for the two year period is due and
payable on 28 February 20X3 as a bullet payment: refer clause 5 and 6.
Clause 5: Should the company have in its employ 100 or more local workers on 28 February 20X2,
the government agrees to write-off a sum equal to C140 000 (forgiven) against the capital
balance owing, effective from this date and from which date interest shall be calculated
on the reduced capital balance.
Clause 6: Should the company’s BEE rating reach Level 4 (100% compliance) as at
28 February 20X3, the government agrees to write-off a further sum (forgiven) against
the capital balance owing, effective from this date, this sum being equal to C420 000.
Chapter 15 179
x Snowy Limited had in its employ 162 local workers as at 28 February 20X2 and had
reached the required Level 4 BEE rating on 28 February 20X3.
x The building meets the definition of a qualifying asset in terms of IAS 23 Borrowing
costs and thus interest incurred on the construction thereof is capitalised as part of the
costs of construction. The building was still under construction at 28 February 20X3.
x The loan was fully utilised from the date that it was granted and thus there were no
surplus funds to be invested at any stage during the period of the loan.
Required:
Show all journals that Snowy Limited would process for the years ended 28 February 20X2
and 20X3 assuming that its policy is to recognise grants directly as grant income.
Question 15.12
Juba Limited is a construction company headed by CEO Mr R. Drake. The company is

primarily involved in the construction of buildings and stadiums. On 30 June 20X6, Juba's
board of directors decided to build a desalinating plant at the La Mercy river mouth. On
advice from a local councillor, Mr Drake applied for a government grant so as to assist with
the project. On 1 July 20X6, Juba Limited was awarded the following 'grant package':
Grant categories C
To cover general expenditure for the next 2 years 420 000
To cover construction costs 840 000
To reimburse past expenses incurred 210 000
Loan for general cash flow expenses 1 050 000
2 520 000
x The company accounting policy is to measure plant using the cost model and to recognise
grants as a credit to the related expense and assets.
x The loan bears interest at 10%, compounded annually on 30 June. The loan and related
interest is repayable on 30 June 20X8.
x The construction of the plant began on 1 July 20X6 and was completed on 30 June 20X7,
at a cost of C4 200 000. Due to administrative problems, the constructed plant only began
production of fresh water on 1 September 20X7. The plant has an expected useful life of
10 years and a nil residual value.
x The interest on the loan (for both the years ended 30 June 20X7 and 20X8) was paid on
30 June 20X8 together with the repayment of the loan principal.
allow an annual wear and tear allowance on the cost of the plant;
tax government grants in the year they are received;
levy corporate income tax at 30%.
Required:
a) Based on the above information prepare all the journal entries that Juba Limited would
process in the financial years ended 30 June 20X7, 20X8 and 20X9.
b) Draft the property, plant and equipment note for the year ended 30 June 20X8, in
accordance with International Financial Reporting Standards, assuming Juba Limited had
no other property, plant and equipment.
180 Chapter 15
GAAP: Graded Questions Integrated questions: chapters 1 - 15
Chapter A
Integrated questions: chapters 1 - 15
Question Key issues

A.1 Sailloft IAS 1: Presentation of financial statements
IAS 16: Property, plant and equipment
IAS 36: Impairments
A.2 Blue Island IAS 1: Presentation of financial statements
IAS 2: Write-down of inventory
IAS 17: Leases: Finance
IAS 40: Investment property
A.3 Mocca IAS 1: Presentation of financial statements
IAS 10: Declaration of dividends after reporting period
IAS 12: Current tax: calculation: capital gains
IAS 16: PPE: Sale of depreciable asset: above cost
IAS 32: Share issue
A.4 Electoral IAS 1: Presentation of financial statements
IAS 12: Current tax: calculation: under/overprovision, rate change
IAS 12: Deferred tax, involving:
x rate change
x PPE: sale of a depreciable asset above cost
IAS 16: PPE: Cost model
IAS 17: Leases: Operating
IFRS 15: Revenue
A.5 Antigua IAS 1: Presentation of financial statements
IAS 2: Write-down of inventory
IAS 12: Current tax: calculation: capital gains
x exempt temporary differences and
x management intentions versus presumed intentions:
- PPE: revalued above cost:
non-depreciable, non-deductible and intention to keep
IAS 16: PPE: Cost model and Revaluation model
IAS 32: Issue of ordinary shares
A.6 Murky Ether IAS 1: Presentation of financial statements
IAS 2: Inventory
IAS 16: PPE: Cost model
IAS 38: Intangible assets: Cost model
A.7 Visa IAS 12: Current tax: calculation
depreciable, deductible and intention to keep
non-depreciable, non-deductible and intention to keep
- Investment property measured under the fair value model
IAS 16: PPE: Revaluation model
IAS 40: Fair value model
Chapter A 181
Question continued… Key issues

A.8 Environmental IAS 12: Current tax: calculation: under/overprovision, provisional
payments
x PPE: revalued above cost:
depreciable, deductible and intention to keep
IAS 16: PPE: Revaluation (net replacement value method):
x increase followed by decrease
A.9 Phuza IAS 12: Deferred tax, involving:
x PPE: depreciable, deductible and intention to keep
x deferred grant income
IAS 16: PPE: cost model involving self-constructed asset
IAS 20: Grant package (including a low interest loan)
IAS 23: Borrowing costs: capitalisation of borrowing costs
IAS 36: Impairments
A.10 Steve IAS 12: Current tax: calculation
- PPE: depreciable:
deductible versus non-deductible
IAS 16: Cost model involving a self-constructed plant
IAS 23: Borrowing costs
A: Deductible plant involving borrowing costs
B: Non-deductible building involving borrowing costs
A.11 Searching IAS 12: Deferred tax, involving:
depreciable, non-deductible and intention to keep
IAS 16: Revaluation model (net replacement value method): increase
IAS 20: Government grant (immediate financial support and purchase
of asset)
IAS 23: Borrowing costs (specific borrowings for alterations to building)
182 Chapter A
Question A.1
Sail Loft Limited is a manufacturer and distributor of sails that are used by professional and
recreational windsurfers. The draft trial balance of the company for the year ended 31 March
20X5 is as follows:
SAIL LOFT LIMITED
DRAFT TRIAL BALANCE AT 31 MARCH 20X5
Debit Credit
Ordinary share capital 800 000
Land: Cost 2 000 000
Equipment and machinery: Cost 800 000
Equipment and machinery: Accumulated depreciation (31/03/X4) 272 000
Motor vehicles: Cost 440 000
Motor vehicles: Accumulated depreciation (31/03/X4) 220 000
Inventory 890 000
Cash and bank 591 000
Borrowings 2 240 000
Sales 3 650 000
Salaries expense 362 000
Litigation costs 150 000
Bad debts expense 25 000
Advertising expense 40 000
Repairs and maintenance 12 000
Fuel expense 33 000
Other costs 110 000
Dividends declared 50 000
8 051 000 8 051 000
x The ordinary share capital consists of 1 600 000 shares issued at C0,50.
x C200 000 of the borrowings are repayable on 30 September 20X5.
x Sail Loft Limited classifies expenses according to their function. Management categorise
the functions of the business into the areas of sales, administration and distribution.
- Salaries of C222 000 relate to the administrative function and C140 000 to the
distribution function.
- The bad debts, advertising and litigation costs relate to the administration function.
- The repairs and maintenance and the fuel relate to the distribution function.
- The other costs are all individually not material and relate C65 000 to administration
and C45 000 to distribution.
x The land is being held with the intention of building a new head office.
x The equipment and machinery are used in the production of inventory and were acquired
at a cost of C680 000. Additional equipment and machinery was purchased on 1 April
20X4 at a cost of C120 000. Depreciation is recognised on the straight line basis over five
years with no residual value.
x The motor vehicles are all delivery vehicles used to deliver goods to customers and cost
C440 000. Depreciation is recognised on the straight line basis over four years with no
residual value.
Chapter A 183
x On 31 March 20X5, management performed an impairment test on the vehicles after news
broke of an emissions testing scandal. The fair value was estimated at C45 000 with
C5 000 associated selling costs and the value in use was calculated to be C60 000.
x Interest of C8 000 for March 20X5 has not yet been paid.
x An amount of C12 000 of the advertising expense included on the trial balance has been
paid in advance in respect of the following period.
x The income tax expense has been correctly calculated at C64 800 and has not yet been
processed or paid.
x The final dividend for the year ended 31 March 20X4 of C50 000 was declared on
18 April 20X4. The final dividend for the year ended 31 March 20X5 of C60 000 was
declared on 15 April 20X5. No interim dividends were declared.
x The financial statements have not yet been authorised for issue.
Required:
a) Prepare the statement of comprehensive income of Sail Loft Limited for the year ended
31 March 20X5 in accordance with International Financial Reporting Standards.
b) Prepare the current assets and current liabilities sections only of the statement of financial
position at 31 March 20X5 in accordance with International Financial Reporting
Standards.
c) Prepare the statement of changes in equity of Sail Loft Limited for the year ended
31 March 20X5 in accordance with International Financial Reporting Standards.
d) Prepare the following notes to the financial statements of Sail Loft Limited for the year
ended 31 March 20X5 in accordance with International Financial Reporting Standards.
- Statement of compliance
- Basis of preparation
- Accounting policies for land, motor vehicles, equipment and machinery, and
inventory
- Profit before tax
- Land, motor vehicles, equipment and machinery
- Trade and other receivables and payables
- Dividends.
Ignore comparatives for required a) to d).
Question A.2
Blue Island Limited is a distributor of parts for yachts and sailing boats. The financial
director of Blue Island Limited is currently finalising the financial statements for the year
ended 28 February 20X5. The trial balance at that date is as follows:
BLUE ISLAND LIMITED
Debit Credit
C ’000 C ’000
Finance lease obligation 2 000
Accounts payable 795
Accrued expenses 75
Equipment: Cost 1 260
184 Chapter A
Leased vehicles: Cost 2 000

Investment property: Fair value 1 950
Accrued income 15
Inventory 1 245
Current tax payable: income tax 200
Cash at bank 1 004
Sales 9 850
Cost of sales 5 100
Rental income 100
Salaries and wages 1 200
Other costs 1 670
16 744 16 744
The following relevant information needs to be taken into account:

x The company classifies its expenses using the function method. The financial director has
identified three functions, namely sales, administration and distribution.
Salaries and wages of C1 200 000 are allocated C700 000 to the administration function
and C500 000 to the distribution function. The other costs of C1 670 000 are allocated
C1 200 000 to the administration function and C470 000 to the distribution function.
These costs include expenses for rent, advertising and repairs and are all individually
immaterial.
The equipment is all used within the administration function and the leased vehicles are
all used within the distribution function.
Any bad debts are allocated to the administration function.
The company regards any expenses over C100 000 as material.
x All the equipment was purchased on 1 March 20X4 at a cost of C1 260 000. The
equipment is depreciated over its useful life of six years on the straight line basis. The
estimated residual value is zero.
x On 28 February 20X5, the investment property was measured at its fair value of
C2 100 000. The investment property was purchased on 1 September 20X2 and is held to
earn rental income. The investment property is measured using the fair value model.
x On 1 March 20X4 Blue Island Limited entered into a lease agreement with Three Star
Limited for the lease of a fleet of vehicles. The fair value of the vehicles at the inception
of the lease is C2 000 000. The lease agreement requires Blue Island Limited to pay five
instalments of C555 000 in arrears on 28 February each year. The implicit interest rate is
12% per annum.
The estimated useful life of the vehicles is five years and the estimated residual value is
zero.
The company has not accounted for the above lease agreement other than recognising the
lease asset and lease obligation at the inception of the lease.
x The closing inventory has a net realisable value of C965 000 and the accounts receivable
are expected to realise C980 000.
x The tax expense for the year has not been recorded. The amount has been correctly
calculated to be C318 000.
x The ordinary share capital comprises 2 500 000 shares issued at C1 per share. Dividends
of six cents per share were declared and approved at a shareholder meeting on
25 March 20X5. The financial statements were authorised for issue on 30 March 20X5.
Chapter A 185
Required:
a) Prepare the statement of comprehensive income of Blue Island Limited for the year ended
28 February 20X5, in accordance with International Financial Reporting Standards.
Present your answer to the nearest C’000.
b) Prepare the statement of financial position of Blue Island Limited at 28 February 20X5, in
Present your answer to the nearest C’000.
x Accounting policy for leases
x Other income
x Profit from operating activities
x Dividends.
Question A.3
The managing director and financial director of Mocca Limited are discussing the preparation
of the company’s financial statements over a cup of coffee. Mocca Limited is involved in the
distribution of a range of wi-fi accessories for the computer industry and the year end of the
company is 28 February.
MD: “So what is the bottom line?”

FD: “I have not done the tax computation yet, but I can tell you that the profit before tax
amounts to C1 960 000 – and that takes into account all items of income and expense.
And our profits less distributions from start of business to the end of last year amount
to C2 850 000, so we are doing pretty well!”
MD: “I know that we have issued a further 500 000 ordinary shares during the year. Why
does your draft statement of ‘some change thing’ reflect C1 000 000?”
FD: “Our shares have no par value and we issued the new shares at a price of C2 each.”
MD: “How many more shares can we issue?”
FD: “We have now issued 3 000 000 shares at an issue price of C2 each from our
authorised share capital of 15 000 000 shares. We thus have 12 000 000 shares
available for issue.”
MD: “That vacant land that we purchased a while ago was a good buy!”
FD: “Yes, we bought it for C1 400 000 just over a year ago and in accordance with our
policy of measuring property using the revaluation model, the valuation from The
Institute of Valuers at the end of March showed a value fair of C1 900 000. The
valuer said he used the cost approach based on an active market to measure the fair
value.”
MD: “We must get going on constructing that new office building!”
MD: “Sorry, I have spilt coffee over this schedule of capital profits and capital gains – it
was confusing to me even without the coffee spill!”
FD: “OK, let’s try and see what we can read. . .”
186 Chapter A
Base cost is
Accounting Tax
620 000
Cost of 600 000 600 000
Equipment SP is 660 000
CA / TB 360 000 360 000

SP
Capi
FD: “Oh: that’s bad! I’ll try to read it later . . .”
MD: “What ever happened to that litigation against us?”
FD: “We settled out of court at a cost of C180 000 during the year. I have expensed it in
the current year – and the entire amount is deductible for tax purposes!”
MD: “I see that you have omitted the dividend declaration from that ‘statement of change
whatever’ of yours. Don’t forget to include it – it is now 25 April and we declared the
dividend on 10 April.”
FD: “At least I got the amount correct . . . I hope . . . the dividend was seven cents per
share.”
FD: “You will be very happy to know that our company is fully compliant with IAS 1.”
MD: “Huh?”
MD: “Never mind that IAS stuff, all we ever seem to do is to make payments to the taxation
authorities. What are the current tax rates? Didn’t the Minister announce a
reduction?”
FD: “No, the 20X8 rates are still the same as the 20X7 rates: current income tax rate is
29% and the CGT inclusion rate is 50%.”
Required:
In so far as information is available,
a) Prepare a statement of comprehensive income of Mocca Limited for the year ended
b) Prepare a statement of changes in equity of Mocca Limited for the year ended
Financial Reporting Standards
x Statement of compliance and accounting policy for basis of preparation
x Share capital, profit before tax, income tax expense and dividends
For required a) to c), ignore deferred tax and comparatives.
Chapter A 187
Question A.4
Electoral Limited is a company offering specialist services to assist in the staging of local
elections.
The following is an extract from the draft trial balance of Electoral Limited at
31 March 20X4:
ELECTORAL LIMITED
EXTRACT FROM TRIAL BALANCE AT 31 MARCH 20X4
Debit Credit
Sales of ballot papers 7 500 000
Services rendered 5 000 000
Rental income received from investment property 1 500 000
Royalties received 100 000
Interest received on debentures 10 000
Interest received from money market investment 140 000
Profit on sale of manufacturing plant 110 000
Dividends received ?
Distribution expenses 1 200 000
Administration expenses 1 000 000
Other operating expenses 2 807 000
Royalties received in advance - 1 April 20X3 30 000
Rates and taxes paid in advance - 1 April 20X3 25 000
Under provision of tax in prior years 5 000
Deferred taxation: income tax - 1 April 20X3 350 000
Manufacturing plant (carrying value) 2 000 000
Motor vehicles (carrying value) 1 000 000
Computer equipment (carrying value) 500 000
Furniture and fittings (carrying value) 500 000
Dividends ?
x The following information relating to revenue and income is relevant:
- The company sells ballot papers and renders services to local government.
- Rental income is received from investment property and has been straight-lined in the
draft trial balance above in accordance with IAS 17 Leases.
- Royalties of C10 000 are due every month per the royalty agreement.
- Electoral Limited holds 1 000 C100 12% debentures, which were purchased in 20X0.
x Electoral Limited has a 5% share in United Freedom Limited, a company listed on the
JSE Securities Exchange. United Freedom Limited paid an interim dividend of C100 000
to shareholders in September 20X3, and declared a final dividend of C600 000 on
20 March 20X4, to shareholders registered on 31 March 20X4.
x The following items of expenditure are included in the distribution, administration and
other operating expenses:
C
Audit fees
- Fee for audit 250 000
- Expenses 12 000
- Fees paid for tax consulting services 10 000
Depreciation charge for the year 900 000
Operating lease payments 600 000
Rates and taxes paid (Includes an amount of C40 000 145 000
relating to April and May 20X4)
188 Chapter A
Salaries 1 000 000

Wages 800 000
Traffic fines 10 000
Legal fees (C5 000 is not tax deductible) 75 000
Donations (C20 000 is not tax deductible) 50 000
x Property, plant and equipment:

- An item of manufacturing plant was sold during the year at a selling price of
C360 000. The plant had cost C300 000 on purchase. At the date of sale the carrying
amount of the plant was C250 000 and the tax base was C200 000. The base cost of
the plant (for capital gains tax purposes) approximated the original cost.
x Wear and tear allowances of C1 165 000 in total were allowed by the tax authorities for
the year. The tax base for the various items of non-current assets at 31 March 20X4 were
as follows:
C
Manufacturing plant 1 050 000
Motor vehicles 1 200 000
Computer equipment 300 000
Furniture and fittings 230 000
x An interim dividend of C115 000 was paid in October 20X3. A final dividend of
C130 000 was declared on 5 April 20X4, payable to shareholders registered on
14 April 20X4.
x The income tax rate for the year ending March 20X3 was 35% and decreased to 30% for
the year ended March 20X4. The CGT inclusion rate is 50%.
Required:
a) Prepare a deferred taxation computation worksheet showing the carrying amount, tax base
and temporary difference applicable to each relevant statement of financial position item,
indicating the nature of the temporary difference (taxable or deductible) as well as the
total movement in deferred taxation for the period.
b) Prepare the statement of comprehensive income of Electoral Limited for the year ended
31 March 20X4, in accordance with International Financial Reporting Standards.
c) Prepare the notes to revenue, profit before tax, taxation and dividends for the year ended
31 March 20X4, in accordance with International Financial Reporting Standards and the
Companies Act.
For required a) to c), comparatives are not required.
Question A.5
Antigua Limited is a company that specialises in the production and distribution of high-end
electronics. The company has seen successful growth in the previous years as the electronics
industry continues to become an ever more dominating factor in our everyday lives.
Antigua Limited is currently busy finalising their financial statements for the year ended
28 February 20X7.
You have been given the following information and a summarised trial balance at
28 February 20X7:
Chapter A 189
x The authorised share capital comprises 10 000 000 ordinary shares of no par value.
During the year, 1 000 000 shares were issued at a price of C2,00. The issue of the shares
has been correctly recorded in the accounting records. Share issue expenses of C150 000
were paid (not tax-deductible). 5 000 000 shares were in issue at the beginning of the
year.
x The borrowings relate to a loan taken out by Antigua Limited on 1 July 20X4 for a three
year period. The company does not have the right to defer settlement of the loan.
x The balance on the property, plant and equipment comprises land of C3 150 000 and plant
and equipment of C1 050 000. Land is measured at fair value and plant and equipment is
measured at cost. At year end, the directors engaged the services of an independent valuer
who has valued the land at a fair value of C3 950 000. The valuer used the cost approach
to measure the fair value of the land in an active market. The intention is to keep the land
for development as the company’s head office and warehouse. The base cost of the land
is C2 000 000.
x During the year, an item of plant and equipment was sold for C330 000. This item of
plant had cost C300 000 and to date of sale accumulated depreciation and tax allowances
amounted to C120 000. The base cost of the plant was determined at C310 000. The sale
of the plant has been correctly recorded in the accounting records and has been netted off
against the operating expenses.
x The inventory has a net realisable value of C1 720 000 and the accounts receivable are
expected to realise C980 000.
x Included in the operating expenses are depreciation of property, plant and equipment
amounting to C210 000, salaries of C1 800 000, advertising of C35 000, repairs to
equipment of C28 000 and auditors remuneration of C110 000.
x Dividends of C0,05 per share were declared on 25 March 20X7. The financial statements
were authorised for issue on 30 March 20X7.
x There are no other differences between accounting profit and taxable profit other than
those which is evident from the information given. There are no temporary differences
affecting other comprehensive income other than those evident from the information
provided.
x The current income tax rate is 29% and the inclusion rate for capital gains tax purposes is
50%.
x Of the “net operating expenses” of C3 480 000:
- C1 500 000 relates to administration costs;
- C1 200 000 relates to distribution costs; and
- the balance relates to other operating costs.
ANTIGUA LIMITED
SUMMARISED TRIAL BALANCE AT 28 FEBRUARY 20X7
Debit Credit
Distributable reserves 1 424 200
Borrowings 2 000 000
Accrued expenses 20 000
Property, plant and equipment: carrying amount 4 200 000
Accounts receivable 1 100 000
Accrued income 15 000
Inventory 1 800 000
Cash at bank 2 059 200
190 Chapter A
Revenue 12 000 000

Net operating expenses 3 480 000
Interest on borrowings 240 000
Share issue expenses 150 000
20 344 200 20 344 200
Required:
a) Prepare the statement of comprehensive income of Antigua Limited for the year ended
Notes and comparatives are not required.
b) Prepare the statement of changes in equity of Antigua Limited for the year ended
c) Prepare the statement of financial position of Antigua Limited at 28 February 20X7, in
d) Prepare notes to the financial statements in accordance with the International Financial
Reporting Standards that presents information relating to:
x Statement of compliance and accounting policy for basis of preparation
x Ordinary share capital
x Profit before tax
x Income tax expense
x Other comprehensive income
x Dividends.
Question A.6
The accountant of Murky Ether Limited has extracted the following balances that he proposes
to present as separate line-items on the face of the statement of financial position at
30 April 20X5:
x Accounts payable: C294 600
x Accounts receivable: C472 700
x Allowance for doubtful debts: C9 200
x Bank overdraft: C18 400
x Dividends payable: C30 000
x 8% debenture liability: C50 000
x Ordinary share capital: C26 400
x Land – carrying amount: C638 000
x Patents – carrying amount: C45 000
x Plant – carrying amount: C175 000
x Retained earnings: C1 477 800
x Inventories: C575 700
x Inventory at year end consists of raw materials of C196 400, work-in-progress of
C177 300 and finished goods of C202 000. Inventory is valued at the lower of cost and
net realisable value. The cost is measured using the FIFO basis.
Chapter A 191
x Accounts payable consists of accruals of C75 000, current tax payable of C27 520 and
trade payables of C192 080.
x The company’s land was purchased on 1 April 20X0 for C638 000 and is carried under
‘property, plant and equipment’.
x The balance on the plant’s accumulated depreciation account at 30 April 20X4 was
C50 000. The plant’s depreciation expense in the current year was C25 000.
Depreciation is provided on the straight-line basis, at 10% p.a. to a nil residual value.
x The cost model is used for all classes of property, plant and equipment.
x The carrying amount of patents amortised at 30 April 20X4 amounted to C55 000. The
life of the patents was considered to be ten years.
x Overdraft facilities of the company are secured by a notarial bond on the moveable assets
of the company.
x Accounts receivable includes an amount of C50 000 owing by the managing director.
Required:
a) Prepare the non-current assets, current assets and current liabilities sections of the
statement of financial position for Murky Ether Limited at 30 April 20X5 in compliance
b) Prepare the relevant notes to the financial statements to support the non-current assets,
current assets and current liabilities sections of the statement of financial position for
Murky Ether Limited at 30 April 20X5 in compliance with International Financial
Accounting policy notes should be provided in respect of the statement of compliance,
basis of preparation, property, plant & equipment and inventory.
Question A.7
Visa Limited owns a building that it had purchased on 1 January 20X3 for C100 000. This
building is used as Visa Limited’s head office and there is no intention to change the use of
this building. The building is classified as property, plant and equipment and measured under
the revaluation model in IAS 16 Property, plant and equipment. The company’s intention has
always been to keep the building.
The only revaluation that has been performed is a revaluation that occurred on
31 December 20X4, when the asset was revalued to C150 000. The building is depreciated
over its useful life of 10 years to a nil residual value. The revaluation surplus is to be
transferred to retained earnings on disposal of the asset.
The profit before tax for the year ended 31 December 20X5 was correctly calculated to be
C400 000.
The tax authority:
x does not allow the cost of this building to be deducted when calculating taxable profits;
x levies tax at 30% on taxable profits and taxable capital gains are included in taxable
profits using an inclusion rate of 50%;
x measures the base cost as being equal to the cost price.
192 Chapter A
There are no other differences between accounting profit and taxable profit other than those
There are no components of other comprehensive income other than those that may be evident
Required:
a) Provide all journals relating to the above information for the year ended
31 December 20X5.
b) Disclose the income tax expense note for the year ended 31 December 20X5 in
c) Explain briefly whether the measurement of the deferred tax balance would have changed
had the asset been land (i.e. a non-depreciable item of property, plant and equipment) that
had been measured at fair value in terms of IAS 16’s revaluation model and which was
not deductible for tax purposes.
d) Explain briefly whether the measurement of deferred tax would have changed had the
asset been a building that was leased to tenants (i.e. an investment property) that had been
measured at fair value in terms of IAS 40’s fair value model.
Question A.8
Environmental Limited is a small company listed on the Alt X Exchange. It manufactures a

range of energy-saving and environmentally friendly household appliances. The year-end of
the company is 30 June.
The company purchased its only item of plant on 1 July 20X5:
x It was available for use in the manner intended by management on the same day.
x The cost of the plant was C900 000.
x It has an estimated useful life of four years and zero residual value.
x The tax authorities allow a tax deduction of 25% per annum (not apportioned).
x The company’s intention has always been to keep the plant.
Environmental Limited uses the revaluation model for the measurement of its property, plant
and equipment and due to the nature of its operations, the company has a policy of revaluing
its property, plant and equipment on an annual basis.
Revaluations are accounted for on the net replacement value method and the revaluation
surplus is transferred to retained earnings over the remaining useful life of the asset.
The fair value of the plant was estimated using discounted cash flows by an independent
valuer at 30 June 20X6 and 30 June 20X7 as shown in the following table. The useful life
and residual value remained unchanged. No impairment for the plant was ever considered
necessary.
Date Fair value
30 June 20X6 C825 000
30 June 20X7 C400 000
The tax assessment for the year ended 30 June 20X6 was received on 15 October 20X6 and
reflected assessed tax of C326 750. The notes to the financial statements for the year ended
30 June 20X6 reflected a current tax provision of C322 850. The company made a third
provisional payment on 20 October 20X6.
Provisional tax payments made during the year were as follows:
Chapter A 193
Date Amount
30 June 20X7 C182 250
The corporate income tax rate is 29% and has not changed for the past three years.
An extract from the trial balances of Environmental Limited at 30 June 20X6 and 20X7 are
shown below. All amounts shown on the trial balances are correct.
ENVIRONMENTAL LIMITED
(EXTRACT FROM) TRIAL BALANCE AT 30 JUNE
20X7 20X6
Retained earnings (at beginning of year) ? 2 300 000
Profit before tax 880 000 1 100 000
Deferred tax: income tax ? ? 40 890
Plant: cost ? 825 000
Plant: accumulated depreciation ? 0
Interest received in advance 12 000 15 000
Rent prepaid 8 000 6 000
Telephone expense accrued 3 850 3 600
Required:
a) Prepare extracts from the statement of comprehensive income and statement of changes of
equity of Environmental Limited for the year ended 30 June 20X7 and extracts from the
statement of financial position at 30 June 20X7, relating to plant and to taxation.
b) Prepare extracts from the notes to the financial statements of Environmental Limited at
30 June 20X7, relating to plant and to taxation (including related accounting policy
notes).
Question A.9
Phuza Limited was unable to secure financing from a bank for the construct of a desalinating
plant at the Tugela River mouth. On 1 January 20X7 the government offered to assist Phuza
Limited by giving the company a package to the value of C1 200 000. This package consists
of the following:
x a C200 000 grant for the general expenditure over the next 2 years,
x a C100 000 grant to cover past expenses incurred by the company,
x a C400 000 grant to be used to pay for the construction of the plant, and
x a further C500 000 specific loan at 10% interest repayable in 2 years’ time, for additional
construction costs of the plant. Interest is compounded annually on 31 December. The
prevailing market interest rate is 10%.
The construction of the plant began on 2 January 20X7 and was completed on
31 December 20X7, at a cost of C2 000 000. Due to administrative problems, the constructed
plant only began production of fresh water on 1 March 20X8. The plant has an expected
useful life of 10 years and a nil residual value.
On 31 December 20X8 the plant was flooded due to a severe storm during the night. As a
result, the plant’s recoverable amount was calculated and determined to be C800 000.
194 Chapter A
The interest on the loan for both 20X7 and 20X8 was paid on 31 December 20X8 together
with the repayment of the loan principal.
The company’s accounting policy is to measure plant using the cost model and to recognise
grants as a credit to the related expense and assets.
x allow the deduction of all capitalised borrowing costs in the first year of use;
x allow an annual wear and tear allowance on the cost of the plant (excluding the borrowing
costs) of 20%;
x tax government grants in the year they are received;
Required:
a) Based on the above information prepare all the journal entries that Phuza Limited would
process in the financial years ended 31 December 20X7, 20X8 and 20X9.
b) Draft the property, plant and equipment note for the year ended 31 December 20X8, in
accordance with International Financial Reporting Standards, assuming Phuza Limited
had no other property, plant and equipment.
Question A.10
Part A:
Steve Limited made a profit before tax and before taking into account the depreciation on the
item of property, plant and equipment below, of C3 000 000 in the year ended
31 December 20X8.
Steve Limited owned only one item of property, plant and equipment, being a plant which it
constructed between 2 January 20X8 and 30 June 20X8.
x The construction costs totalled C1 000 000.
x Steve Limited incurred borrowing costs of C500 000 during this period of construction
which were correctly capitalised to the plant in terms of IAS 23 Borrowing Costs.
x The plant was available for use from 1 July 20X8.
x Depreciation on this plant is provided on the straight-line basis over the estimated 10 year
useful life to a nil residual value.
x allow the deduction of 20% of the cost of the plant (excluding the borrowing costs) per
annum, not apportioned for part of a year;
x allow the deduction of borrowing costs in the year that the underlying asset is first
available for use in the production of income
x levy corporate income tax at 30%.
There are no items of other comprehensive income.
Part B
Same information as in Part A, except that the item of property, plant and equipment is a
building that is not allowed as a deduction for the purpose of calculation of taxable profit.
Chapter A 195
Required:
a) Process the tax journals in Steve Limited’s general journal for the year ended
b) Prepare the income tax expense note for inclusion in Steve Limited’s financial statements
for the year ended 31 December 20X8 in accordance with International Financial
Question A.11
Searching Limited has only one item of property, plant and equipment, being a building. This
building was purchased on 1 January 20X7 for C1 000 000. The cost of the land on which it
was built is considered to be immaterial and thus the full cost is allocated to buildings. It was
purchased for use as the company’s head office but could only be occupied as such once
certain alterations (referred to below) had been effected.
Searching Limited measures this building on the revaluation model, accounts for revaluations
using the net replacement value method and transfers any revaluation surplus to retained
earnings over the life of the underlying asset.
Further information relating to the building:
x Government grant received:
- The building is situated in a slum area which the government is attempting to
upgrade. As a result, the government gave Searching Limited a grant of C42 000 in
cash on 2 January 20X7, C10 000 of which was for immediate financial support (and
is not associated with any future costs) and the balance of which was to assist in the
purchase of the building. All conditions attaching to the grant have been met.
- Searching Limited accounts for government grants as a reduction of the related costs
where appropriate (i.e. the indirect method).
x Alterations to the building and financing thereof:
- The building was dilapidated (run-down) and required alterations involving
significant construction-work.
- Construction began on 1 May 20X7, on which date the full cost of the alterations of
C300 000 was paid, in advance, to the construction company.
- Although construction was completed on 31 July 20X7, certain toxic paints had been
used with the result that the building was only available for use from
1 September 20X7 (i.e. once the toxic fumes had dissipated).
- Searching Limited issued 100 000 debentures on 1 April 20X7, with the specific
purpose being to finance the abovementioned construction (the building is considered
to be a qualifying asset).
x The debentures were issued at their face value of C5 each.
x The debentures were offered at a coupon rate of 10%, interest being payable
annually in arrears (on 31 March).
x The debentures are compulsorily redeemable on 31 March 20X9 (2 years later) at
C6,10 per debenture.
x The effective interest rate for these debentures is 20%.
- The funds raised from this issue of these debentures were deposited directly into a
call account (which was opened specifically and exclusively to receive these funds),
that offered a 6% rate of interest that is capitalised / compounded annually on
31 December.
196 Chapter A
- The funds raised from the debenture issue are to be used exclusively for the
abovementioned alterations (although cash flow problems in December 20X7 resulted
in the balance of the funds raised from the debenture issue being used to pay off
various unrelated debts on 31 December 20X7: as a result, the call account had a zero
balance at 31 December 20X7).
x Searching Limited capitalises borrowing costs related to specific borrowings, calculated
net of the investment income earned during the period of construction.
x Subsequent measurement of the building:
- The building was valued by an independent valuer to a fair value of C1 484 650,
being its market value as at 31 December 20X8. This was the building’s first
valuation. The intention has always been to keep the building.
- The building has never been impaired.
- The total useful life of the building was originally expected to be 10 years. The
remaining useful life was, however, re-estimated to be 20 years calculated as from
1 January 20X8. The residual value was nil and the method of depreciation was
straight-line (both unchanged).
- Searching Limited uses the re-allocation method to account for changes in estimate.
Information relating to tax:
- levy income tax at 30% (unchanged for many years);
- apply a capital gains inclusion rate of 50%;
- calculated the base cost of the building to be equal to its cost;
- tax interest income when it is earned;
- do not tax the receipt of government grants;
- do not allow any tax deductions relating to the cost of either buildings or land;
- allow the deduction of interest on the debentures as and when incurred (i.e. the tax
authorities calculate the interest to be deducted using the effective interest rate
method).
x There are no differences between taxable profit and accounting profit other than those
Required:
Show all the related journal entries for the years ended 31 December 20X7 and
31 December 20X8 that are possible from the information provided.
Chapter A 197
GAAP: Graded Questions Leases: lessee accounting
Chapter 16
Leases: lessee accounting
Question Key issues

16.1 Core concepts
16.2 Press Lease classification discussion
16.3 Moo Operating lease:
- Income tax: current and deferred
16.4 Dux Operating leases:
- With subleasing
- Income tax: current and deferred, with VAT
16.5 Kick Operating lease
- Instalments in arrears and irregular
- Contingent rent
- VAT and normal tax
16.6 Eagle Limited Finance lease
- Instalments in advance
- Guaranteed and unguaranteed residual value
- No tax
16.7 Devon Finance lease: journals and disclosure
Coaches
16.8 Tweet Finance lease:
- Instalments: in advance and regular
16.9 Quack Finance lease:
- Instalments: arrears and irregular
A: No VAT
B: With VAT
16.10 Carew Finance lease
- Instalments in arrears
-VAT
16.11 Baby Sale and operating leaseback:
a) SP greater than market-related and rentals greater than market-related
b) SP greater than market-related and rentals equal to market-related
c) SP less than market-related and rentals less than market-related
d) SP less than market-related but rentals not less than market-related
16.12 Woof Sale and finance leaseback:
- Instalments: in arrears and regular
198 Chapter 16
Question 16.1
a) “Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form of the contract.” (IAS17.10)
Required:
Discuss the meaning of this with reference to the Conceptual Framework.
b) “At the commencement of the lease term, lessees shall recognise finance leases as assets
and liabilities in their statements of financial position at amounts equal to the fair value of
the leased property or, if lower, the present value of the minimum lease payments, each
determined at the inception of the lease. The discount rate to be used in calculating the
present value of the minimum lease payments is the interest rate implicit in the lease, if
this practicable to determine, if not, the lessee’s incremental borrowing rate shall be
used.”(IAS 17.20)
Required:
Define the terms ‘minimum lease payments’ and ‘implicit interest rate’ and discuss the
importance and relevance of these terms.
c) A lease agreement states that ‘the lease guarantees a residual value, at the end of the lease
term. Of C40 000’.
Required:
Discuss the meaning of this statement.
Question 16.2
Press Limited is in the publishing business. Business has been quite slow over the past few
years but owing to upcoming elections and a host of international sporting events, the
publishing industry has suddenly begun to boom. Press Limited decided to take advantage of
the surge in the economy and upgrade its office environment. It managed to find the perfect
office furniture at Benches Galore, but given that Press Limited was still a little cash-strapped,
it decided to lease the furniture over a period of three years.
According to the lease agreement, ownership transfers from Benches Galore to Press Limited
at the end of the lease term. The lease agreement stipulated the following terms:
x 3 annual arrear instalments of C300 000 must be paid
x Commencement date: 1 January 20X0
x The interest rate implicit in the lease is 10%
x Fair value of the office equipment on the date of signing the lease is C795 800
Press Limited believes that the office furniture has a useful life of 4 years and a nil residual
value. It uses the straight-line method to depreciate its furniture.
Required:
a) Justify how Press Limited should classify the above lease agreement.
b) Show the related journal entries for the year ended 31 December 20X0.
Ignore tax.
Chapter 16 199
Question 16.3
Moo Limited is a lorry manufacturer. On 1 January 20X3, Moo Limited entered into an
operating lease (as a lessee) for a computer system. Details of the annual lease rentals,
payable in arrears, are as follows:
x 20X3 0
x 20X4 to 20X6 C30 000 per annum
x 20X7 0
x 20X8 to 20X10 C10 000 per annum
Moo Limited’s profit before tax is C900 000 in 20X3 (after correctly accounting for the
lease).
The tax authorities grant a 20% capital allowance on owned assets but allow a deduction from
taxable profits of the lease payments if the asset is leased. The income tax rate is 30%. There
are no other temporary differences other than those evident from the information provided.
Moo Limited satisfies the requirements to raise deferred tax assets.
Required:
a) Prepare the 20X3 journal entries with regard to the above lease agreement.
b) In so far as information is available, draft the following to disclose the above lease and its
tax effect in conformity with International Financial Reporting Standards:
x Statement of comprehensive income for the year ended 31 December 20X3
x Statement of financial position as at 31 December 20X3
x Notes to the financial statements for the year ended 31 December 20X3
Note that the accounting policy note is required, whilst the deferred tax note is not required.
Ignore VAT.
Question 16.4
On 2 July 20X4, Dux Limited entered into a 2-year operating lease (as lessee) over an item of
plant, which it then leased (under a 2-year operating lease) to Thick Limited (a sub-lessee).
The relevant details, from the perspective of Dux Limited, are as follows:
x Lease rentals paid by Dux Limited
30 June 20X5: C57 000
30 June 20X6: C45 600
x Lease rentals received by Dux Limited
30 June 20X5: C22 800
30 June 20X6: C34 200
The income tax rate is 30% and VAT is levied at 14%. Dux Limited is a registered VAT
vendor.
Required:
Prepare the ‘profit before tax’ note for inclusion in Dux Limited’s financial statements for the
year-ended 30 June 20X5 in conformity with International Financial Reporting Standards.
200 Chapter 16
Question 16.5
With the announcement that Russia would be hosting the 20X4 FIFA Soccer World Cup,
Kick Limited entered into a lease agreement with Round Limited to lease a mini soccer ball
manufacturing machine.
The soccer balls would be used to create an atmosphere in the build-up to the launch of the
official soccer ball to be used at this particular World Cup.
The lease agreement, which became effective on 1 December 20X0, stated that the lessee is
required to pay an annual rental of C500 000 on 30 November 20X1 and C790 000 on
30 November 20X2. Over and above the fixed rentals the lessee is required to pay an
additional C1 425 per unit produced. This additional rent is payable annually on 31
December.
The scheduled production for each year ended 31 December is as follows:
x 01/12/20X0 – 31/12/20X0: 194 444 units
x 01/01/20X1 – 31/12/20X1: 1 222 222 units
x 01/01/20X2 – 30/11/20X2: 1 000 000 units
These figures do not take into account the 10% defect rate in the machine. The additional
rental is not paid on the defective units.
x Levy normal tax at 30%
x Levy VAT at 14% (Both parties to the lease agreement are VAT vendors and thus all
amounts include VAT)
x The tax authorities levy VAT on the nominal cash value of the fixed lease payments when
the transaction was entered into. VAT on the variable portion is accounted for when the
soccer balls are sold.
x Allow a deduction from taxable profits of 20% per annum of the cost of owned assets
x Allow a deduction from taxable profits of the lease payments if the asset is leased.
Required:
Prepare the journals for Kick Limited for all years of the operating lease agreement.
Question 16.6
Eagle Limited has a factory situated away from established commuter routes and provides bus
transport for its employees from the city centre to the factory.
On 1 April 20X6, Eagle Limited leased a bus from BigFin Limited. BigFin Limited had
purchased the bus on the same day for C455 890. The lease agreement is for a period of four
years and requires four lease payments in advance of C110 000. The first payment is due on
1 April 20X6 and the remaining three payments on 31 March 20X7, 20X8 and 20X9. Eagle
Limited has guaranteed a residual value of C37 500. BigFin is of the opinion the bus will be
worth C75 000 at the end of the lease. Eagle Limited has the option to purchase the bus at the
end of the lease term for 10% of the market value on that date.
The accounting policy of Eagle Limited is to depreciate the bus to a nil residual value over the
lease term. The estimated useful life of the bus is six years
The financial year end of Eagle Limited is 31 March.
Chapter 16 201
Required
a) Calculate the implicit interest rate.
b) Determine if the lease agreement is a finance lease or an operating lease.
c) Prepare the journal entries in the accounting records of Eagle Limited for the year ended
31 March 20X7.
d) Prepare the note showing the reconciliation of future minimum lease payments to their
present values in the notes to the financial statements of Eagle Limited at 31 March 20X7
in accordance with International Financial Reporting standards.
Ignore tax and deferred tax.
Question 16.7
Devon Coach Tours Limited entered into a lease agreement with Bus Manufacturers Limited
on 1 July 20X0 for the lease of a fleet of buses. The lease agreement stipulates that the lease
is for five years and is non-cancellable. The fair value of the buses at the inception of the
lease is C492 322.
The estimated useful life of the buses is six years, with an estimated residual value of
C7 000. The buses are to be depreciated on a straight-line basis.
The lease agreement has a bargain purchase option that gives the lessee the option to purchase
the buses at the end of the fifth year for C10 000. Devon Coach Tours Limited intends to take
up this option.
Five lease payments of C135 000 are to be made annually, in arrear, the first being made on
30 June 20X1.
The interest rate implicit in the agreement is 12%. The following present value table is
provided:
PV factor
Annuity in arrears of C1 for five years, discounted at 12% 3,6048
Annuity in arrears of C1 for four years, discounted at 12% 3,0375
Annuity in arrears of C1 for three years, discounted at 12% 2,4018
Annuity in arrears of C1 for two years, discounted at 12% 1,6901
Present value of C1 in five years, discounted at 12% 0,5674
Required:
a) Prove that the rate of interest implicit in the lease is 12%.
b) Justify the treatment of this arrangement as a finance lease.
c) Prepare the journal entries to account for the lease in the accounting records of Devon
Coach Tours Limited for the year ending 30 June 20X1.
d) Prepare an extract from the statement of financial position of Devon Coach Tours Limited
at 30 June 20X2 showing the disclosure of the non-current assets, non-current liabilities
and current liabilities in accordance with International Financial Reporting Standards.
e) Prepare an accounting policy note for finance leases for inclusion in the notes to the
financial statements of Devon Coach Tours Limited.
Ignore tax.
Question 16.8
Tweet Limited is an airplane manufacturer, listed on the JSE Securities Exchange.
202 Chapter 16
On 1 January 20X3, Tweet Limited entered into a finance lease (as a lessee) over a motor
vehicle with a cash cost of C700 000.
Details of the lease agreement are as follows:
x Payments of C200 754 are made annually in advance;
x The lease term is 4 years; and
x The interest rate implicit in the lease is 10%.
Tweet Limited depreciates the motor vehicle over 4 years, on the straight-line method, to a nil
residual value. Tweet Limited’s profit before tax is C900 000 in 20X3 (correctly calculated).
x grant a 20% capital allowance on owned assets
x only allow a deduction of the lease payments from taxable profits if the asset is leased.
evident from the information provided. Tweet Limited satisfies the requirements to recognise
deferred tax assets. The income tax rate is 30%.
The only interest incurred by Tweet Limited relates to this lease.
Required:
b) In so far as the information is available, draft the following to disclose the above lease
and its tax effects:
x Statement of comprehensive income for the year ended 31 December 20X3;
x Statement of financial position as at 31 December 20X3;
x Notes to the financial statements for the year ended 31 December 20X3.
Relevant accounting policy notes are required, whilst the deferred tax note is not
required.
Ignore VAT.
Question 16.9
On 2 April 20X2, Quack Limited entered into a lease agreement (as a lessee) for a delivery
van with a cash cost of C124 343. Details of the lease agreement are as follows:
x The lease is for a three-year period;
x Lease rentals of C50 000 are payable annually in arrears;
x The first lease rental is due to be paid on 31 March 20X3;
x The interest rate implicit is 10%; and
x At the end of the three-year period, ownership of the van passes to Quack Limited.
Quack Limited has correctly classified this lease as a finance lease and depreciates the vehicle
over 3 years to a nil residual value using the straight-line method.
Quack Limited’s profit before tax for the year ended 31 March 20X3 is C300 000 (after
correctly accounting for the lease). There are no differences between accounting profit and
taxable profit other than those evident from the information provided.
The current tax payable balance at 1 April 20X2 is nil. No tax payments were made during
the year. Quack Limited meets the criteria to raise deferred tax assets.
Chapter 16 203

x grant a 20% capital allowance on owned assets but
x allow a deduction from taxable profits of the lease payments if the asset is leased
There are no other finance costs in 20X3 other than those relating to this lease.
Required:
Part A
i) Show the journals relating to this lease for Quack Limited for the year ended
31 March 20X3.
ii) Disclose the following extracts of Quack Limited’s financial statements in conformity
with International Financial Reporting Standards:
x the statement of comprehensive income for the year ended 31 March 20X3
x the statement of financial position as at 31 March 20X3
x the notes to the financial statements for the year ended 31 March 20X3, specifically:
- Finance costs;
- Income tax expense;
- Property, plant and equipment; and
- Finance lease liabilities note.
Comparatives and accounting policies are not required.
Part B
Repeat the above, assuming that VAT was levied on the transaction at 14% and that Quack
Limited is registered as a vendor for VAT purposes.
Question 16.10
Carew Limited entered into a finance lease (as a lessee) with Cousins Bank for an item of
plant that, on the date it was signed (2 January 20X8), had a cash cost of C798 000 (including
14% VAT). Both companies are vendors for VAT purposes. Instalments of C250 000 are
payable annually in arrears.
The effective interest rate is 9,67925%.
Carew Limited depreciates the plant over four years, on the straight line basis to a nil residual
value. Although it was available for use from 2 January 20X8, the plant was only brought into
use on 1 May 20X8.
The tax authorities grant a deduction of 10% per annum on the cost of the plant unless it is
leased, in which case it allows a deduction from taxable profits of the lease payments
(excluding VAT in the case of VAT vendors). The normal tax rate is 30%.
The profit before tax is C600 000 for the year ended 31 December 20X8. There are no
components of ‘other comprehensive income’. This profit has correctly taken into account
the abovementioned lease.
There are no differences between accounting profit and taxable profit other than those evident
from the information provided. Carew Limited satisfies the requirements to raise deferred tax
assets.
204 Chapter 16
Present value factors at 9,67925% for a cash flow:

After 1 year 0,911749
After 2 years 0,831287
Required:
a) Using the balance sheet method, calculate the deferred tax opening and closing balances
to be recognised as a result of the above lease for the year ended 31 December 20X8.
b) Prepare the following notes for inclusion in the financial statements of Carew Limited for
the year ended 31 December 20X8 in compliance with International Financial Reporting
Standards:
x Non-current interest-bearing liability note
x Tax expense note.
Question 16.11
Baby Limited entered into a sale and operating leaseback arrangement with Mummy Limited
over Baby Limited’s plant. Baby Limited had originally purchased the plant for C500 000 on
1 January 20X4 and had depreciated it by C100 000 by 2 January 20X5, the date on which the
sale and operating leaseback agreement was signed.
Fair market prices in respect of this sale and leaseback are as follows:
x Fair selling price C750 000
x Fair annual rental C150 000
Required:
Prepare the journals necessary to record the sale and leaseback in Baby Limited’s accounting
records for the year ended 31 December 20X5 assuming the lease agreement stipulated a:
a) selling price of C1 000 000 and an annual rental of C200 000 payable annually in arrears
for four years;
b) selling price of C1 000 000 and an annual rental of C150 000 payable annually in arrears
for four years;
c) selling price of C500 000 and an annual rental of C75 000 payable annually in arrears for
four years;
d) selling price of C500 000 and an annual rental of C150 000 payable annually in arrears for
four years.
Ignore all taxes.
Question 16.12
On 3 January 20X3, Woof Limited entered into a sale and finance leaseback (as lessee) over
one of its buildings for a four-year period. On this date, the building had
x a carrying amount of C1 000 000 (original cost is C1 250 000);
x a tax base of C1 000 000; and
x a remaining useful life of 4 years.
Chapter 16 205
The building was sold for C1 200 000 cash, and annual payments of C378 565 are required at
the end of each year. The interest rate implicit in the lease agreement is 10%.
Woof Limited’s profit before tax is C900 000 in 20X3 (correctly calculated).
x grant a 20% capital allowance on owned assets but
x allow a deduction from taxable profits of the lease payments if the asset is leased.
The income tax rate is 30%.
There are no other temporary differences other than those evident from the information
provided. Woof Limited satisfies the requirements to raise deferred tax assets.
There are no components of other comprehensive income
Required:
b) Disclose the above lease and its tax effect in the statement of comprehensive income for
the year ended 31 December 20X3, in the statement of financial position on this date, and
in the related notes, in accordance with International Financial Reporting Standards.
The accounting policy note is required, whilst the deferred tax note is not required.
Ignore comparatives and VAT.
206 Chapter 16
GAAP: Graded Questions Leases: lessor accounting
Chapter 17
Leases: lessor accounting
Question Key issues

17.1 Core concepts
17.2 Eton Operating lease, instalments in arrears and irregular, initial indirect
costs
17.3 Sleepless Operating lease:

- Instalments: arrears and with annual increase
- Transfer from PPE to Investment property (cost model)
17.4 Applebee Manufacturing finance lease, instalments in arrears and regular
17.5 Big Vans Finance lease

- Lessor manufacturer
- Lessor previously purchased asset
17.6 Midnite Finance lease

- Instalments in advance and regular, but with guaranteed residual
- Current and deferred tax
Chapter 17 207
Question 17.1
a) Briefly describe the accounting requirements for a finance lease, from the perspective of
the lessor.
b) Define the terms ‘gross investment in lease’ and ‘net investment in lease.’
c) Describe the accounting treatment for interest earned by the lessor over the lease term.
d) Describe the accounting treatment for the recovery of executory costs by the lessor.
Question 17.2
Eton Limited is a manufacturer of bulldozers, which it leases to customers for three year
periods, after which the lessee is offered a new bulldozer and the original bulldozer is then
leased to the next customer at reduced rates.
Each bulldozer has a useful life of 12 years and a residual value of nil.
Eton Limited entered into a lease agreement with a major customer, Exeter Limited. The
manufacture of the leased bulldozer was completed on 29 December 20X0 at a cost of
C600 000 (excluding VAT). The lease required 3 annual arrear instalments, including VAT:
x 31 December 20X1 62 700
The commencement date of the lease is 1 January 20X1.
In negotiating the lease, Eton Limited incurred initial direct costs of C8 550 (including VAT),
incurred and paid on 1 January 20X1.
Eton Limited is a vendor for VAT purposes.
Required:
a) Calculate the rental income that will be recognised each year.
b) Provide all related journals for the financial year ending 31 December 20X1.
Ignore tax.
Question 17.3
On 1 January 20X0, Sleepless Limited purchased two factory buildings, one in Dozey Road
and one in Wakey Road, for C2 250 000 each. Both factory buildings were initially to be
used to manufacture beds, which would then be sold to retail stores.
Sleepless Limited lost a major customer effective 1 January 20X5 and, as a result, had factory
space surplus to their requirements. Sleepless Limited managed to rent out the factory
building in Wakey Road to a tenant, the lease being effective from 1 January 20X5.
The details of this lease are as follows:
x Start of lease: 1 January 20X5
x End of lease: 31 December 20X9
x Annual lease instalment: C100 000 (increased annually by 20%), payable annually in
arrears on 31 December each year
Sleepless Limited holds all investment property under the cost model and believes that the
total useful life of each building is 15 years and that they each have a nil residual value.
These estimates remained unchanged.
208 Chapter 17
Required:
Record the journal entries in the accounting records of Sleepless Limited in respect of the
factory building in Wakey Road for the years ended 31 December 20X5, 20X6, 20X7, 20X8
and 20X9.
Ignore tax.
Question 17.4
Applebee Limited is a manufacturer of harvesting equipment. Applebee Limited sells the

equipment to farmers all around the country. Some customers purchase the equipment for
cash and others purchase under Applebee Limited’s finance lease arrangement.
Mr. Hatfield, a local farmer, purchased a harvester from Applebee Limited and made use of
their finance lease agreement. The details of the lease are as follows:
x The lease period is 5 years (signed on 1 January 20X5)
x Lease instalments of C200 000 are payable annually in arrears on 31 December.
A fair market interest rate for this type of lease is 16,9911%.
The cost to Applebee Limited to manufacture this harvester was C500 000. Applebee Limited
implements a mark-up of 28% on cost.
Required:
a) Journalise the entries required to account for the abovementioned transaction for each of
the years ended 31 December 20X5 to 20X9 in the books of Applebee Limited.
b) Prepare an extract from the statement of financial position and the note to finance lease
debtors in the financial statements of Applebee Limited at 31 December 20X9.
Ignore all taxes.
Question 17.5
Big Vans Limited entered into a finance lease in respect of a refrigerated delivery van with
Super Foods Limited on 1 January 20X1. The lease instalment amounts to C6 000 annually
in arrears for the duration of the three year lease term.
The interest rate implicit in the lease is 4,48%.
Part A
Big Vans Limited is a manufacturer of delivery vans. The van in respect of this lease was
manufactured at cost of C12 000. The company uses the gross method for recording and
disclosing the lease in their accounts.
Required:
a) Determine the gross investment in the lease, the net investment in the lease and the
unearned finance income.
b) Prepare the journal entries in the accounting records of Big Vans Limited for the year
ended 31 December 20X1.
Ignore tax.
Chapter 17 209
Part B
Big Vans Limited is a finance house and purchases the vehicle on 1 January 20X1 at a cost of
C16 500. The company uses the net method for recording and disclosing the lease in their
accounts.
Required:
a) Determine the gross investment in the lease, the net investment in the lease and the total
of the unearned finance income.
b) Prepare the journal entries in the accounting records of Big Vans Limited for the year
ended 31 December 20X1
Ignore tax.
Question 17.6
Midnite Limited is a company involved in the entertainment industry. It recently decided to

import a range of new lighting equipment costing C400 000. Once the equipment had arrived
at their premises (1 January 20X6), it became evident that Midnite Limited did not have the
expertise necessary to operate the sophisticated equipment.
The CEO then made a few calls and found a company (DAT Entertainment) that wanted to
acquire the equipment. Unfortunately, however, DAT Entertainment did not have adequate
funds to purchase the equipment immediately. The CEO was reluctant to leave the equipment
lying around, and therefore came up with the following agreement:
x Midnite Limited would lease the equipment to DAT Entertainment, immediately
(1 January 20X6).
x The equipment would be leased to DAT Entertainment for a period of 3 years.
x At the end of 3 years DAT Entertainment would have to pay an amount of C20 000 and
ownership would then transfer.
x The lease rentals are C150 000 paid annually in advance.
Other information includes:
x A fair market interest rate for agreements of the above nature is 17,082%.
x The tax authority taxes lease instalments when received.
x The normal tax rate is 30%. There is no transaction tax (i.e. no VAT).
x The useful life of the equipment is estimated to be 3 years and this is the same period over
which the tax authority allows the equipment to be written off for tax purposes.
Required:
Provide the journal entries required to account for the above information in the records of
Midnite Limited for the years ended 31 December 20X6, 20X7 and 20X8 using the gross
method.
210 Chapter 17
GAAP: Graded Questions Provisions, contingencies and events after
the reporting period
Chapter 18
Provisions, contingencies and events after the
reporting period
Question Key issues

18.1 Short questions Core concepts: Provisions
18.2 Short questions Core concepts: Events after the reporting period
18.3 Trinity Active Legislation: Identification of obligating event
18.4 Zomba Future replacement costs: recognition
18.5 Rich Kid Guarantees for refunds (recognition and measurement)
18.6 Granchester Recognition of audit fees provision
18.7 Donkey Restructuring provision: recognition and measurement
18.8 Microwave Major inspections: past and future measurements
18.9 Park Hospital Future Disposal and penalties: recognition and measurement
18.10 Care Bear Clinic Legal claims: recognition, measurement and disclosure
18.11 Highway Blitz Provision for compensation payments
18.12 Leo Decommissioning costs
18.13 Dig Deep Decommissioning costs and the cost model
18.14 Express Travel Recognition of provision and potential event after reporting
period
18.15 Melrose Events after reporting period various discussions
18.16 Fangs Earnings after reporting period: Liability and contingent
liability
18.17 Frog Events after reporting period various discussions
18.18 Lemon Events after reporting period and provisions
Chapter 18 211
Question 18.1
a) What is the difference between a liability and a provision?

b) What is an onerous contract?
c) Explain the difference between a legal obligation and a constructive obligation.
d) Define a contingent liability and explain how the treatment of a contingent liability differs
when compared to the treatment of a provision in the financial statements.
e) An entity can recognise a provision if it has a present obligation as a result of a past event
and there is remote possibility of an outflow of resources. True or false: Explain your
answer.
f) Define a contingent asset.
g) List the criteria necessary for an entity to recognise a constructive obligation to
restructure.
Question 18.2
a) Define the term ‘events after the reporting period’ as envisaged by IAS 10 Events after
the reporting period.
b) Discuss the difference between an adjusting event and a non-adjusting event.
c) If the going concern assumption is no longer appropriate the entire financial statements
will need revision. True or false.
Question 18.3
Trinity Active Limited comprises a chain of elite South African gyms. Its target market is
mainly the late teens to the mid-30 age group who are looking for a first class gym
experience.
Due to the pressure from health and safety activists, the South African Health and Safety
legislators have put forward to parliament an amendment to the Health and Safety regulations
that are required to be complied with by all gyms in South Africa. This amendment requires
that all gyms in South Africa are to put in place a state of the art air conditioning and
circulating system.
The new legislation was accepted and announced to all gym owners on
31 October 20X5. It required all gym owners to have these air conditioning and circulating
systems in place by 31 October 20X6. If a gym does not comply with this regulation, a fine
may be imposed based on the size of the gym.
The board of directors of Trinity Active Limited took a decision not to fit these new air
conditioning systems as they believed that what they had in place already did the job
sufficiently. A year ago the company hired an assessor to assess the air conditioning unit and
the report indicated that the air conditioning system, “was in proper working order, and would
continue to keep the air cool at the required temperature for the foreseeable future.” The
directors are of the opinion that the air conditioning unit therefore need not be replaced and
are simply ignoring the amendment to the Regulations.
Trinity Active Limited has a 31 December year end.
Required:
a) Discuss whether Trinity Active Limited has a present obligation from a past obligating
event at 31 December 20X5 with reference to International Financial Reporting
Standards.
212 Chapter 18
b) Discuss whether Trinity Active Limited has a present obligation from a past obligating
event at 31 December 20X6 with reference to International Financial Reporting
Standards.
Question 18.4
Zomba Limited is a company offering delivery services. The accountant of Zomba Limited,
Mr Delivery, is aware that in line with company policy, Zomba will be replacing all vehicles
in 4 years time, at which point all existing vehicles will be scrapped. It is estimated that the
new vehicles will cost C800 000 (the PV thereof is C200 000). Mr Delivery wishes to
provide for 25% of this expected cost of C800 000 in the current year ended 30 June 20X5.
Required:
Discuss whether the recognition of the provision in the financial statements for the year ended
30 June 20X5 is acceptable or not, with reference to International Financial Reporting
Standards.
Question 18.5
Rich Kid Limited sells various cheap, but expensive-looking, electronic items. All goods are
sold with a six-month guarantee, provided by Rich Kid Limited. Rich Kid Limited’s
suppliers are Money-Cruncher Limited and Super-Duper Limited. Super-Duper Limited also
offers a six-month guarantee on all goods sold to Rich Kid Limited, thus any returns by
customers to Rich Kid Limited will be passed on to Super-Duper Limited for the guarantee to
be honoured. In the event that Super-Duper Limited does not honour their guarantee,
customers are protected by Rich Kid Limited’s guarantee. Money-Cruncher offers no such
refund policy, although it has occasionally refunded customers for returned goods.
Details of sales of the three companies for the year ended 31 December 20X5 follow. All
sales are incurred evenly over the year.
C
Rich Kid Limited: 500 000
Super-Duper Limited: 7 000 000
Money-Cruncher Limited: 5 000 000
Estimates of returns to the three companies
Most likely Worst ever Best ever
Rich Kid Limited 15% 30% 10%
Super-Duper Limited 10% 18% 8%
Money-Cruncher Limited 5% 15% 1%
Required:
Discuss the recognition and measurement of the above transactions in the accounting records
of each company at 31 December 20X5.
Question 18.6
You are the partner in charge of the audit of Granchester Limited, a company listed on the
Johannesburg Stock Exchange. The financial year-end of the company is 30 September 20X5
and the directors wish to approve the financial statements for issue on 15 November 20X5.
Chapter 18 213
In finalising the financial statements, the directors wish to create an accrual for audit fees of
C1 200 000, of which C900 000 relates to audit work completed at 30 September 20X5 and
the C300 000 relates to work done between 1 October 20X5 and 31 October 20X5. All the
fees relate to the financial year ended 30 September 20X5.
Required:
Discuss, giving reasons, whether or not you agree with the directors’ treatment of the
provision for audit fees, with reference to IAS 37 Provisions, Contingent Liabilities and
Contingent Assets.
Question 18.7
Donkey Limited is relocating its large departmental store from the city centre of Durban to a
smaller store on the Umhlanga Ridge. The new store is to sell only upmarket fashion.
To this end, management has devised a detailed formal plan which was agreed to by all
directors at a meeting held before 30 September 20X5. This plan is expected to be
implemented during December 20X6. Five cashiers and five sales staff will be retrenched
whereas two cashiers and twelve sales staff will be relocated. The costs related to the
relocation of this store are expected to be as follows:
x Annual gains expected from lower store rental: C500 000;
x Retrenchment packages: C3 000 000;
x Relocation costs: C1 000 000.
The directors have decided that the plan should be announced on 31 October 20X6.
The amounts are material but the plan above has not caused a ‘going concern’ problem.
Required:
Advise the financial accountant how the plan should be accounted for in the financial
statements at year end 30 September 20X5
Question 18.8
Microwave Limited bought a nuclear plant that, for safety reasons, has to be inspected after
every 11 000 hours.
The plant's last inspection was performed on 1 September 20X5, and when Microwave
Limited bought it on 1 April 20X6, it had been operated for 3 900 hours after that inspection
(the plant operates 24 hrs a day with short periods of down-time for general maintenance).
The inspection that took place on 1 September 20X5 had cost the previous owners
C2 000 000. With the real inflation rate ranging between 10% and 12%, the accountant of
Microwave Limited expects that the next inspection will cost at least C2 200 000.
The accountant wants to raise the provision for this full amount now; and since the next
inspection may very well be necessary within 20X6, he believes that this full amount should
be expensed now, since this would surely be the most prudent thing to do (he remembers
from his accounting studies many years ago that prudence was a general principle when
deciding how to account for all transactions).
The accountant has capitalised the plant at the C10 000 000 that Microwave Limited had paid
for it and is depreciating this plant over its estimated useful life of 10 years to its nil residual
214 Chapter 18
value. He is aware that there is some new aspect in the standards regarding major inspections
and is not sure if he is dealing with the major inspections correctly.
Required:
Discuss how the previous and the future major inspections should be accounted for in terms
of International Financial Reporting Standards.
You should refer specifically to liabilities, provisions and assets.
Question 18.9
Park Hospitals Limited is a private hospital group operating five hospitals in the Cape Town
area. The following information relates to the year ended 31 December 20X6.
x In terms of environmental legislation Park Hospitals Limited is required to dispose of all
medical waste generated by the hospitals in a socially responsible manner, within two
weeks of generation, failing which penalties may be levied. The company has the
necessary permit to dispose of medical waste by incineration on the site of their hospital
in Cape Town.
Disposal of medical waste
x In terms of their permit Park Hospitals Limited is allowed to dispose of 120 tons of
medical waste per annum from 1 January to 31 December. The hospitals generate an
average of 10 tons of medical waste per month evenly. On 25 November 20X6 the
furnace used to incinerate medical waste malfunctioned and could not be repaired. A
replacement furnace was commissioned immediately but will only be completed and
installed on 31 January 20X7 at a cost of C1 500 000. A deposit of C500 000 was paid
on 15 December 20X6.
x Due to the malfunction of the furnace Park Hospitals Limited has 12 tons of un-disposed
medical waste on hand at 31 December 20X6. Management has obtained a quote from
Waste Incinerators to dispose of the waste on hand during the first week of January 20X7
at an estimated cost of C10 000 per ton.
Penalty
x On 25 January 20X7 Park Hospitals Limited received notification from the Environmental
Agency that a penalty amounting to C125 000 would be levied as a result of not disposing
of waste within the prescribed period at 31 December 20X6. Management has decided
not to raise an objection to this penalty.
x The financial statements were approved for issue on 15 February 20X7.
x Profit for the period has been correctly calculated as C2 858 500 (20X5: C2 212 000) after
taking the above information into account.
Required:
a) Discuss how the cost relating to the un-disposed medical waste on hand at
31 December 20X6 should be recognised and measured in the financial statements of
Park Hospitals Limited for the year ended 31 December 20X6 in accordance with
b) Discuss how the penalty should be recognised and measured in the financial statements of
Park Hospitals Limited for the year ended 31 December 20X6 in accordance with
International Financial Reporting Standards
Chapter 18 215
Question 18.10
The Care Bear Clinic Limited is a private care facility for the elderly. On 15 October 20X6, a
visitor to the clinic, Mr Downe, the Chief Executive Officer of a large company, slipped on a
wet floor in the clinic foyer while on his way to visit his ill mother.
As a result of his fall he sustained multiple fractures to his left leg and right arm and was
immobilised for 4 months. On 1 December 20X6 Mr Downe filed a lawsuit against the
hospital for negligence, claiming damages for the injuries sustained and loss of income
suffered as a result of his fall.
At 31 December 20X6 the Care Bear Clinic Limited attorneys have reported that it is highly
probable that Mr Downe’s claim will be successful against the company. However they are
uncertain how much would be awarded in damages as past rulings of this nature have been
inconsistent. The directors have applied their minds to the amount of damages likely to be
awarded and have decided that there is not enough information at the present to make a
reasonable estimate. The attorneys will gain a better understanding of the possible amount of
damages after the first court proceedings to be held on 1 March 20X7.
Required:
Discuss how the legal claim should be recognised, measured and disclosed in the financial
statements of Care Bear Clinic for the year ended 31 December 20X6 in accordance with
Question 18.11
Highway Blitz Limited is a bus-line that has a network of routes linking major cities around
South Africa. They operate a fleet of buses which transports passengers throughout the year.
On 24 December 20X5 one of these buses crashed into a tree while on the route between
Johannesburg and Durban, and many of the passengers on-board were injured. Highway Blitz
Limited’s year end is 31 December, and its financial statements are authorised for issue on
15 February each year.
Part A
x South African traffic law requires companies that provide transport facilities to
compensate any passengers injured while using the service.
x Highway Blitz Limited’s lawyers have estimated that the company will be obliged to pay
C2 000 000 in compensation under the relevant statute, but the amount will only be
confirmed when the company receives notice from the National Traffic Agency in
March 20X6.
Part B
x There is no law requiring Highway Blitz Limited to pay compensation, but it is common
practice in the public transport industry for companies to compensate passengers who are
injured while using their services.
x A typical pay-out for a similar accident is C2 000 000 compensation to the affected
passengers.
Part C
x There is no law or common industry practice which might require Highway Blitz Limited
to pay compensation to the injured passengers. Media reports have, however, led to
216 Chapter 18
public interest in the accident, and many groups have expressed outrage at Highway
Blitz’s lack of Christmas spirit in not assisting its customers.
x As a result, the managing director of Highway Blitz made a public announcement on
15 January 20X6, in which he stated that the company would pay compensation to those
affected by the accident. The company’s accountants have estimated that such
compensation payments will cost the company C2 000 000.
Required:
For each scenario, discuss whether a provision should be recognised in respect of the
compensation in the financial statements of Highway Blitz Limited for the year ended
31 December 20X5, in accordance with International Financial Reporting Standards.
Question 18.12
Leo Limited leases an industrial site close to a game reserve. The company recently obtained
approval for heavy plant and machinery to operate on the site for a period of five years. The
approval is in terms of a licence granted by the government. The Minister of Environmental
Affairs approved the licence because the main activity of Leo Limited is the production of
environmentally friendly paper from recycled material.
The plant and machinery was purchased on 1 October 20X2 for C1 000 000. Installation
costs of C175 480 were incurred and paid over the months of October, November and
December of 20X2. The plant and machinery was in a condition necessary to be capable of
operating in the manner intended by management on 1 January 20X3.
The plant and machinery has an estimated useful life of five years with no residual value. In
terms of the licence, Leo Limited is obliged to dismantle the plant and machinery and restore
the area at the end of its useful life. Future decommissioning costs are expected to be
C120 000. The company uses a discount rate of 10% to calculate the present value of the
decommissioning costs.
The financial accountant prepared the following schedule reflecting the unwinding of the
discounted decommissioning costs:
Years to
Date decommissioning date 10% discount factor PV
01/01/X3 5 0,621 74 520
31/12/X3 4 0,683 81 960
31/12/X4 3 0,751 90 120
31/12/X5 2 0,826 99 120
31/12/X6 1 0,909 109 080
31/12/X7 0 1,000 120 000
Required:
a) Discuss the appropriate accounting treatment for the future decommissioning costs. Your
answer should refer to the Conceptual Framework and to the relevant International
b) Prepare all the journal entries relating to the above transactions that would have been
processed in the accounting records of Leo Limited for the years ended
31 December 20X2 and 31 December 20X3.
Chapter 18 217
c) Prepare the relevant extracts from the statement of comprehensive income of Leo Limited
for the year ended 31 December 20X4 and from the statement of financial position at
31 December 20X4. Notes to the financial statements (including accounting policies) are
required in respect of provisions only.
Question 18.13
Dig Deep Limited is a company involved in extracting oil from the sea bed. It purchased an
oil drilling rig, the details of which are as follows:
Cash purchase price (1 January 20X1): C2 000 000
Depreciation straight-line to nil residual values: 5 years
The rig must be dismantled after 5 years, details of which are as follows:
Future decommissioning cost assessed on 1 January 20X1: C1 000 000
Discount rate: 10%
Dig Deep Limited uses the cost model to measure items of plant.
Required:
a) Prepare the journal entries relating to the rig for the years 20X1 and 20X2.
b) Disclose the following in the notes to the financial statements of Dig Deep Limited for the
year ended 31 December 20X4 in accordance with International Financial Reporting
Standards:
x provision for decommissioning costs,
x profit before tax: showing the finance charges and depreciation
Ignore tax.
Question 18.14
In May 20X5, a bus operated by Express Travels Limited reversed into the entrance of the
hall at The Boys School, a private school with a long and proud history. The accident
damaged the pillars and some of the brickwork of the hall. An initial assessment was that the
damage was not significant. . The trustees of the school board expressed an intention to sue
Express Travels Limited but needed time to assess the extent of the damage.
In October 20X5, Express Travels received notification from the Boys School for damages of
C1 680 000, which was based upon the estimated cost to repair the building. The school
claimed that the building was of significant historic value and that it had been damaged to a
greater extent than was originally thought. Lawyers engaged by Express Travels Limited
advised that the company was clearly negligent but the view obtained from an expert was that
the extent of the damages to the building was C1 120 000. Express Travels Limited had an
insurance policy that would cover the first C280 000 of such claims.
After the financial statements for the year ended 30 June 20X6 were authorised, the case came
to court and the judge determined that the hall and the pillars are of significant historic value.
The court ruled that Express Travels Limited was negligent and awarded C420 000 for the
damage to the building.
Required
Discuss the accounting treatment in respect of the damages and the insurance claim in the
financial statements of Express Travels Limited for the year ended 30 June 20X5 and 30 June
20X6, in accordance with International Financial Reporting Standards.
218 Chapter 18
Question 18.15
Melrose Limited is a company that manufactures and distributes computerised electronic

products. The head office is situated at The Melrose Arch with retail outlets and warehouses
in different parts of the country. The financial year end of the company is 30 June.
The management of the company completed the draft financial statements for the year ending
30 June 20X5 on 31 August 20X5. On 18 September 20X5, the board of directors reviewed
the financial statements and authorised them for issue. A profit announcement appeared in
the press on 19 September 20X5. The financial statements are made available to shareholders
on 1 October 20X5 and are approved by shareholders at the annual meeting on
5 November 20X5.
The following events occurred after the end of the reporting period:
a) A major competitor announced a reduction in the price of its blue tooth speakers during
July 20X5. The competitor was able to do this because of its ongoing investment in new
technology. Management of Melrose Limited had included the inventory of blue tooth
speakers on the draft statement of financial position at its cost of C6 500 000. It is
estimated that the net realisable value of this inventory at 30 June 20X5 is C5 000 000
because of the competitor’s price reduction.
b) One of Melrose Limited’s warehouses is situated on the Kwa-Zulu Natal north coast. A
tropical storm struck the area during late August 20X5 and flooded the warehouse,
destroying the entire inventory on the ground floor, comprising modems and lightning
protector kits. This inventory was included on the draft statement of financial position at
30 June 20X5 at a cost of C3 000 000.
c) A customer of Melrose Limited was placed into liquidation at the end of July 20X5. The
amount of C400 000 owing by this customer was included in accounts receivable on the
draft statement of financial position at 30 June 20X5.
d) Another customer of Melrose Limited, whose retail outlet was situated on the Kwa-Zulu
Natal north coast, announced early in September 20X5 that it was closing down after its
premises and all the fixtures and fittings as well as its inventory were destroyed as a result
of the August tropical storm. The company was under-insured and was forced to close
down. Management of Melrose Limited estimates that it is unlikely that more than
30cents in the C1 will be paid on liquidation. An amount of C150 000 owing from this
customer was included in accounts receivable on the draft statement of financial position
at 30 June 20X5.
e) Melrose Limited proposed a bonus scheme for all employees amounting to C200 000.
This scheme was approved by the board of directors and communicated to the employees
on 19 September 20X5.
Required:
Discuss, with reasons, the nature of each event described above in terms of IAS 10 as well as
the appropriate accounting treatment (include any necessary journal entries) and / or
disclosure in the financial statements of Melrose Limited for the year ended 30 June 20X5.
Question 18.16
Fangs Limited, a manufacturer of toothpaste, was taken to court over alleged defamation
charges when Fangs Limited accused a rival toothpaste manufacturer of industrial espionage.
Chapter 18 219
Before the year end of 31 December 20X3, the lawyers of Fangs Limited advised that,
although losing the case was unlikely, legal fees and settlement costs could amount to
C800 000 in the event that the court case was lost.
On 4 February 20X4, the judge presiding over the case ruled that Fangs should pay C900 000
to the plaintiff as well as pay all of the plaintiff’s legal fees, which amounted to C150 000.
The financial statements had not yet been authorised for issue at the time of the court ruling.
Required:
Discuss how this information should be treated in the financial statements of Fangs Limited
Question 18.17
The summarised statement of financial position of Frog Limited at 31 December 20X0 is as

follows:
FROG LIMITED
AT 31 DECEMBER 20X0
C
ASSETS 10 000 000

Capital and reserves
Liabilities 6 200 000
10 000 000
On 16 February 20X1, prior to the finalising of the financial statements for publication, the
financial director was given the following file of ‘subsequent events’:
x On 12 January 20X1 a fire destroyed one of the company’s three major production plants.
x On 25 January 20X1 the employees of the company decided to go on strike. The strike
has reduced the company’s output by approximately 25%.
At 16 February 20X1 negotiations between the union and management are still taking
place and agreement has not been reached.
x On 2 February 20X1 one of the company’s customers was declared bankrupt. At
31 December 20X0 this customer owed Frog Limited C300 000 of which C30 000 was
paid in January 20X1. The customer has been in financial difficulty for most of the past
year. Liquidators have suggested that no further payments would be forthcoming.
x On 10 February 20X1 the board of directors adopted a resolution accepting the offer from
Investors Limited, an investment banker, to underwrite the issue of 1 000 000
14% preference shares of C1 each to be issued at C1,50. The proceeds of the issue are to
be used to finance the construction of an administration building at the Lost Office Park.
Required:
Discuss the effect of each of the above events on the 20X0 financial statements in terms of the
Ignore taxation.
220 Chapter 18
Question 18.18
Lemon Limited produces jam and tinned fruit. It has a 31 December year end.
Lemon Limited purchased 200 tons of long-life limes on 2 December 20X2 for C500 000,
half of which had been used in the production of marmalade by year-end.
All the marmalade produced from this delivery of long-life limes had been sold to Pack-a-
Sack Limited by year-end. On 10 December 20X2, a customer of Pack-a-Sack Limited
suffered serious food poisoning and alleged that it was caused by a bottle of marmalade
purchased from Pack-a-Sack Limited. This customer took Lemon Limited to court over the
poisoning. Lemon Limited is not insured against the potential losses that may result from the
court case.
Due to public interest, the case went to court almost immediately. Indications during the court
proceedings held in late December 20X2 were that Lemon Limited was probably responsible
for the poisoning and would probably be found guilty: it was found that the marmalade was
poisoned because the long-life limes used in its manufacture had been contaminated. It was
not possible to reliably estimate the settlement costs at year-end.
Due to the negative publicity arising from the court case, Lemon Limited has decided not to
plead against the inevitable ‘guilty’ verdict and to willingly pay all costs, in the interests of
salvaging a positive public image.
z Estimated costs: During January 20X3, Lemon Limited’s lawyers estimated that the
court would award the plaintiff C2 500 000 whereas an out-of-court settlement would
probably be C2 200 000.
z Findings of the specialists: Specialists hired by Lemon Limited in January 20X3
confirmed that 20% of the balance of the long-life limes in stock at year-end are also
contaminated and must be destroyed.
z Warnings by lawyers: Lemon Limited has been unable to keep the case out of the media
and their lawyers warned in December 20X2 that as soon as the verdict was published in
the media, more, similar cases will probably be brought against Lemon Limited by other
aggrieved customers, although it was impossible to estimate the number of cases or their
financial impact.
z Returns: Pack-a-Sack Limited had sold all of the bottles of marmalade by
31 December 20X2. By the time the financial statements were authorised for issue on
15 February 20X3, no bottles of marmalade had been returned. It seems that there is only
a remote chance that there would be any returns at this late stage.
All amounts are material but none of the issues mentioned above have caused there to be a
‘going concern’ problem.
Required:
Discuss, with reference to IAS 10 Events after the reporting period and IAS 37, Provisions,
Contingent Liabilities and Contingent Assets, how, if at all, the events should be recognised,
measured and disclosed in the financial statements of Lemon Limited for the year ended
31 December 20X2.
You should use the following headings in your discussion:
x Estimated costs
x Findings by the specialists
x The warning
x Possible returns
Chapter 18 221
GAAP: Graded Questions Employee benefits
Chapter 19
Employee benefits
Question Key issues

19.1 - Core concepts: across the entire IAS 19
19.2 - Core concepts: termination benefits versus other employee benefits
19.3 Ask Core concepts: across the entire IAS 19
19.4 Chemco Short-term employee benefit: Short-term compensated absences: Provision for
leave pay:
- Vacation leave: accumulating but non-vesting
- Maternity leave
19.5 Truck Short-term employee benefit: Short-term compensated absences:
- Provision for leave pay - accumulating but non-vesting
19.6 HeadBook Employee benefit expense:
- Salary and bonuses
- Employee contributions (UIF, Pension, Medical aid),
- Employees tax
- Leave is accumulating (for one year) but non-vesting
19.7 Row Short-term employee benefit: Short-term compensated absences: Provision for
leave pay
- Leave is accumulating and vesting
- Leave is accumulating (for one year) but non-vesting
- Leave is non-cumulative and non-vesting
19.8 Couch Short-term employee benefit: Profit sharing: Provision for bonuses
19.9 Piglet Employee benefit expense:
- Short-term employee benefit: Short-term compensated absences
- Short-term employee benefit: Bonuses
- Defined benefit plan
- Disclosure
19.10 Campus Post-employment benefit: Defined benefit plan
- Deficit thus no effect of asset ceiling
- Asset ceiling had no opening balance
19.11 Radley Defined benefit plan
- past service costs
- changes in actuarial assumptions
- no surplus
19.12 Logic Post-employment benefit: Defined benefit plan
- Surplus thus asset ceiling is checked (limited to)
- Asset ceiling does not have an opening balance
19.13 Concerta Post-employment benefit: Defined benefit plan
- Surplus thus asset ceiling is checked (limited to)
- Asset ceiling does have an opening balance
19.14 Topdown Post-employment benefit: Defined benefit plan
- current service costs, past service costs, interest, contributions and benefits
paid, actuarial gains/ losses
- no surplus (thus this question does not involve an asset ceiling)
19.15 Arno Termination benefits recognition
19.16 Green Gables Termination benefits recognition
222 Chapter 19
Question 19.1
a) Define employee benefits.

b) List the four categories of employee benefits.
c) Define short-term benefits.
d) Define post-employment benefits.
e) Define other long-term benefits.
f) Define termination benefits.
g) List the two categories of post-employment benefit plans.
h) List the three account balances that constitute the balance on the net defined benefit plan
asset/ liability line item in the statement of financial position.
i) All adjustments affecting the net defined benefit plan asset/ liability balance in the
statement of financial position are recognised in profit or loss. True or false?
j) List the items that make up remeasurements of a defined benefit plan?
k) Explain, briefly, what is meant by the asset ceiling and how it is measured.
Required:
Provide brief answers to each of the questions posed above.
Question 19.2
You have just graduated from university and have started articles with a local accounting
firm. A nearby university requested that your firm present a guest lecture to their students
who are beginning the study of IAS 19 Employee benefits. Your manager has asked you to
present this lecture. The university asked that the lecture simply outlines the meaning of
'termination benefits' and how these differ from any other category of employee benefits.
Required:
Create a lecture slide that briefly outlines the meaning of 'termination benefits' and
diagrammatically explains the difference between 'termination benefits' and all other
categories of 'employee benefits'. There are only two definitions that must be included on
your slide: 'employee benefits' and 'termination benefits'.
Question 19.3
Mr Bewildered was recently appointed as the new accountant at Ask Limited. Whilst Ask
Limited’s HR department were explaining the various policies, procedures and forms of
benefits provided to its employees, Mr Bewildered found himself becoming more and more
confused over how the company is supposed to account for all of it. Mr Bewildered is a
family friend and since he knows you are currently studying financial accounting, he has
approached you for help, sending you the following email:
To: Joe Soap

From: V Bewildered
Subject: Application of IAS 19 to Ask Limited’s employee benefit structure
Hi
You may have heard that I have recently been appointed as the accountant of Ask Limited. It is all
very exciting. However, during my introduction to the company, the compensation policies were
explained to me and I suddenly realised how out of date I am with regard to my knowledge of IFRSs.
Frankly, I have no idea how these employee compensation policies would be accounted for! Please
could you help me by telling me if my understanding of the following issues is right or wrong?
Chapter 19 223
I have many questions, but off the top of my head are the following thoughts I had:
a) If an employee was to die in an accident at work and in terms of a company life insurance policy a
payment is then made to his/her family (where this family member is not an employee of our
company), that payment will not be accounted for as an employee benefit expense by Ask Limited.
b) The company will be providing our employees with free medical check-ups at the company clinic
once a month due to the potentially hazardous work environment. These benefits will be expensed
as incurred and will be presented as part of the employee benefit expense.
c) Any leave earned by the employees which vests at the end of the next financial year is a long-term
employee benefit since it is settled in the next financial period.
d) All our employees receive accumulating annual leave, the equivalent of 22 working days per year.
As I understand it, because this leave is termed ‘accumulating’ leave, any leave not taken at the
end of the next financial year will have to be paid out in cash.
e) Ask Limited runs a profit-sharing scheme. The terms of the scheme require participating
employees to own a minimum number of shares in the employer company and entitle these
employees to be paid a bonus under the scheme, calculated on profit after tax. The correct method
to account for the profit sharing scheme at year end would be:
Debit Credit
Profit share drawings (Equity) xxx
Provision for bonuses xxx
Suggested journal providing for the profit share
f) The terms of the abovementioned profit-sharing scheme, in which all the other executives will
participate, requires that in order to receive the bonus, they must remain in the employ of the
company for a further year after the end of the financial year in which the profit share is allocated
to the employee. It seems to me that the provision for such profit-sharing bonuses should only be
recognised based on the probable number of employees to receive them.
g) All the employees are members of a defined contribution fund to which the company will
contribute. The plan is unfunded. My understanding is that Ask Limited will be required to fund
any short-fall there may be in the fund.
h) When measuring the return on plan assets and when measuring the interest on plan obligations, we
use the rate applicable at year end on high risk unit trust funds.
i) If Ask Limited decides to terminate the services of any employee due to worsening economic
conditions, the terminated employee will receive a retrenchment package, paid as a lump sum
payment within 3 months of year-end.
However, I cannot figure out whether such a lump sum payout would be accounted for as a post-
employment benefit, since it would be paid to him after his employment, or as a short-term
employment benefit on the basis that a short-term employee benefit is defined as an employee
benefit ‘expected to be settled wholly before twelve months after the end of the annual reporting
period in which the employees render the related service’. Which one is it?
Yours sincerely
Required:
Write an email to Mr Bewildered, stating whether his understanding of how to account for the
different types of compensation is true or false, and a brief explanation as to why.
Question 19.4
You are the financial manager of Chemco Limited, a company which researches generic
medicines. One of your duties involves dealing with any aspects of IAS 19 Employee benefits.
You have the following information available to you for the year ended 31 December 20X8:
224 Chapter 19
Leave Pay:
Type Of Gross salary Number of Maximum Maximum Leave taken in

Employee: per year employees leave allowed leave allowed current year
per year to carry (days)
(days) forward (days)
Directors C350 000 8 20 15 4
Technicians C180 000 55 18 13 11
Office personnel C110 000 25 16 11 10
x The company policy is that all leave is accumulating for 1 year but is non-vesting.
x Experience indicates that only 40% of the directors will use the past leave due to them,
while technicians and office personnel still employed in 20X9 will use 90%.
x 5 technicians resigned with effect from 1 January 20X9. No other employees are
expected to resign.
Maternity Leave:
x Chemco has the following number of female employees (included in the number of
employees above): 6 directors, 20 laboratory workers and 16 office employees.
x Female employees are allowed 90 days paid maternity leave per annum.
x This leave is non-accumulating and is unable to be paid out in cash if not taken.
You may assume a 365-day year and a 5-day working week.
Required:
Prepare all the journals that would need to be processed by Chemco Limited in order to
account for the information above for the year ended 31 December 20X8.
Question 19.5
Truck Limited is a company involved in the transportation industry. Truck Ltd employs
500 drivers, 50 managers and 10 directors.
x Truck drivers work long hours, often driving through the night to ensure that
Truck Limited’s reputation of always being on time is maintained. As a result, truck
drivers are rewarded with 40 days leave per year (more than other staff members). On
average, truck drivers earn C123 000 per annum.
x Managers work in shifts and are provided accommodation near the business premises.
Managers are granted 30 days leave and earn an average of C212 000 per annum.
x Directors are an integral part of the company, and as a result, are of the opinion that they
cannot be away from work for extended periods of time. Consequently, each director only
receives 20 days of leave per year. All the directors earn an annual income of C500 000.
x Leave accruing to an employee during any given year, must be taken by the end of the next
financial year or it will be forfeited. Leave may not be converted into cash.
x Truck Limited operates on a 5 day working week and the current year is 365 days.
x On 31 December 20X6, the following information was available:
Average unused days per Average unused days per
employee at 31/12/X6 employee at 31/12/X6 that are
expected to be taken in 20X7
Drivers 10 4
Managers 7 3
Directors 5 2
Chapter 19 225
x It is expected that 50 drivers and 3 managers will resign early in 20X7 and thus are not
expected to take leave in 20X7. Therefore the employees who are expected to resign are
not included in the above averages.
Required:
Journalise the entries that would be necessary to account for paid vacation leave for the year
Question 19.6
Head Book Limited is a company involved in retailing. One of its sales representatives is
called Sheryl Sandberg. The following are the details of Sheryl’s annual salary package for
the year ended 28 February 20X8:
C
Gross Salary 240 000
UIF contributions (contributions by employee) (6 000)
Pension Fund contributions (contributions by employee) (25 000)
Employee’s tax (43 000)
Workers Union Subscription (contributions by employee) (1 000)
Medical Aid contributions (contributions by employee) (9 000)
Salary owing to employee 156 000
x As a sales representative, Sheryl’s employment contract entitles her to a bonus of 12% of
the gross profit of all sales contracts she secured during each year. During her 5 year
employment, she has secured sales contracts of C6 500 000 (cost: C5 400 000) while the
value of sales contracts that she secured during the current year ended 28 February 20X8
is C2 200 000 (cost: C1 900 000).
x The business matches Sheryl’s medical aid contributions on a 1:1 basis and paid C15 000
to the pension fund for Sheryl’s benefit.
x All deductions from gross salary are paid over to the relevant body the day after the salary
is incurred.
x Sheryl is entitled to the normal 15 days annual leave, which accumulates for one year
only, after which it is forfeited. Unused leave is not paid out upon resignation/ retirement/
retrenchment.
x Sheryl tells you that for the last 3 years she has been working on so many deadlines that
she has been unable to utilise all her annual leave. She gave you the following summary
of her unused leave at 28 February 20X8:
Unused leave during the year ended 28 February 20X6: 5 days
x She explained that she planned to use all the outstanding leave due to her in April 20X8.
x As expected, Sheryl took leave in April 20X8, using up the maximum amount of past
leave that was due and allowed to her.
x Sheryl also fell pregnant during the year ended 28 February 20X8. As a result, she took
60 days maternity leave due to her in terms of the employment policies of the company.
x Her monthly salary for the year ended 28 February 20X9 remained unchanged from her
salary for the year ended 28 February 20X8.
226 Chapter 19
x Her tax was assessed to be C43 000 for year ended 28 February 20X8 (the tax authorities
posted her tax assessment to the company’s address and this was duly received on
30 April 20X8). Employee’s tax was the only tax paid by Sheryl.
x The appropriate discount rate is 12%.
Required
a) Identify the four categories of employee benefits per IAS 19 Employee benefits, explain
in your own words the meaning of each and then, by a process of elimination, identify
which category/ies of employee benefits best describe the employee benefits evident in
the information presented.
b) Prepare the journal entries to account for Sheryl Sandberg’s employment in the records of
the HeadBook Limited for the year ended 28 February 20X8.
Note: Process the salary journal for the year as one entry and not 12 separate monthly
entries. Do the same for the cash payment to the employee and relevant authorities.
c) Prepare the journals for the utilisation of leave as well as any salary expense (but not
employer contributions) for April 20X8. Round all amounts to the nearest currency unit.
Question 19.7
Row Limited has a 31 December year end. Employees work a 5-day week and are entitled to
20 paid working days of vacation per annum.
Row Limited is a large company operating in the service industry employing 40 000 people.
The average salary paid to each employee during 20X5 is C150 000. At the end of the 20X5
financial year, each employee had an average of 10 unused vacation days and it is estimated
that, on average, each employee will take 12 days leave in 20X6 and 17 days leave in 20X7.
Management has been revising the leave policy and has identified 3 possible options for
dealing with vacation leave. The possibilities that management is considering are as follows:
x Option 1: leave accumulates and vests indefinitely;
x Option 2: leave accumulates for one year after it accrues but is non-vesting;
x Option 3: leave does not accumulate and is non-vesting.
Selecting option 1 and option 2 would result in leave being taken in the following pattern:
x Of the estimated 12 leave days that will be taken by employees in 20X6, on average:
7 days will come from leave earned in 20X6, and
5 days will come from leave earned in 20X5.
x Of the 17 leave days that will be taken by employees in 20X7, on average:

14 days will come from leave earned in 20X7, and
3 days will come from leave earned in 20X6.
If option 3 were to be selected, any leave days taken would have be taken from the years in
which they were earned.
x No employees left or joined the company in the past 2 years.
x Salaries increased by 20% on 1 January 20X6 but there was no increase in 20X7.
x Past estimates show that management is able to reliably forecast the number of vacation
days that will be used in the following financial year.
Chapter 19 227
x You may assume that the predictions regarding how leave would be taken in 20X6 were
completely accurate.
Required:
Prepare the journal entries that would be required for each of the 3 different leave pay
provision options identified by management at 31 December 20X6.
Question 19.8
Couch Limited is a company involved in the retailing of sleeper couches. Couch Limited’s
staff complement consists of 50 sales representatives.
x Each year the sales representatives are given a gross profit target to meet. If the sales
representatives surpass the target, 10% of the amount above target is distributed to them
as a bonus. The only condition is that the sales representative must still be in the employ
of Couch at the end of the year following the year in which the sales target was surpassed.
x The target for the year ended 31 December 20X0 was a gross profit of C5 000 000. The
sales representatives managed to make a gross profit of C7 000 000.
x Employment statistics reflect that an average of 10% of staff members leave annually and
are replaced by new staff members.
Required:
a) Calculate the provision that needs to be recognised at 31 December 20X0.

b) Journalise the recognition of the provision at 31 December 20X0.
c) Provide the journal entries at 31 December 20X1 to account for any adjustments to the
provision assuming that 7 sales staff members actually left during 20X1.
Question 19.9
Piglet Limited is a company that is involved in the honey industry. Piglet Limited specialises
in grading honey from ‘Beelicious’ to ‘Not worth the sting’. The directors of Piglet Limited
believe that the most important asset in any company is the employees of that company. As
such they have a number of benefits for their employees.
Vacation leave:
x All staff members are entitled to 22 days of paid leave annually.
x This leave can accumulate indefinitely, but is forfeited when an employee leaves the
company. The leave is non-vesting.
x In total, there are 320 leave days outstanding at 28 February 20X5, which were earned in
the current year.
x 10 staff members will be leaving on 30 May 20X5. Their leave details are as follows:
- On 28 February 20X4: a total of 20 days leave was due to them.
- On 28 February 20X5: a total of 40 days leave was due to them.
Bonuses:
x Every year Piglet Limited pays out 10% of its profit to its employees. The profit is shared
amongst the number of employees employed at year-end.
228 Chapter 19
x The only condition is the employee had to be employed at Piglet Limited for the entire
year. If an employee is not employed for the entire year, he forfeits his share of the profit.
The forfeited profit is not distributed amongst the other employees.
x On 26 September 20X4, Piglet Limited hired 5 new employees. No employees left
during the current year.
x The profit for the year ended 28 February 20X5 was C11 000 000.
Defined benefit plan:
x Details of the defined benefit pension plan during 20X5:

C
Present value of the pension obligation at the beginning of the year 3 300 000
Fair value of the pension assets at the beginning of the year 2 420 000
Current service cost 550 000
Benefits paid to members 1 100 000
Interest income: plan assets 110 000
Contributions paid to the fund 880 000
Interest expense: plan obligation 198 000
Return on plan asset 22 000
Actuarial loss on plan obligation 17 600
General:
x At year end Piglet Limited had a total staff complement of 80 employees.
x The average annual salary is C400 400.
x There are 260 working days in a year.
Required:
a) Calculate the employee benefit expense that will be recognised in Piglet Limited's
statement of comprehensive income for the year ended 28 February 20X5.
b) Provide the note disclosure for the defined benefit plan for inclusion in Piglet Limited's
financial statements for the year ended 28 February 20X5.
Question 19.10
Campus Limited has a defined benefit plan. The following information relates to this plan for
the year ended 31 December 20X1:
x Defined benefit plan asset opening balance: C300 000
x Defined benefit plan obligation opening balance: C400 000
x Discount rate based on market yields on high quality corporate bonds: 10% (unchanged)
x Benefits paid to employees: C100 000
x Contributions by employees into the plan assets: C150 000
x Contributions by employer into the plan assets: C250 000
x Current service costs at present value: C500 000
x Present value of plan obligation at 31 December 20X1: C800 000
x Fair value of plan assets at 31 December 20X1: C 600 000
There was a nil balance on the defined benefit plan asset ceiling adjustment account at the
beginning of the year.
The present value at 31 December 20X1 of future refunds and reductions in future
contributions is C1 000 000.
Chapter 19 229
Required:
Provide all journals relating to the defined benefit plan for the year ended 31 December 20X1.
Question 19.11
The following details relate to Radley Limited’s defined benefit pension fund:
C
Fair value of the plan assets (1/1/20X1) 6 000 000
Fair value of the plan assets (31/12/20X1) 6 700 000
Present value of the plan obligation (1/1/20X1) (7 000 000)
Present value of the plan obligation (31/12/20X1) (7 600 000)
On 1 January 20X1 Radley Limited amended the details of the plan such that the company
obligation increased by C500 000 due to services provided by employees in prior periods.
This amount has been accurately determined.
Other details relating to the movements in this plan are as follows:

C
Current service costs (accrues evenly) 1 500 000
Payments made to the fund by employer only 1 000 000
Benefits paid by the fund (1 100 000)
Rate on long term high quality bonds (unchanged throughout 20X1 and 20X0)
is 10%
x The defined benefit plan has never had a surplus since the date it was started.
x The effects of changes in actuarial assumptions on the present value of the obligation
were estimated to be as follows:
20% due to changes in the financial assumptions
80% due to changes in the demographic assumptions.
x The net re-measurements recognised on the defined benefit plan to 31 December 20X0
were C300 000, recognised in other comprehensive income.
x The pension fund is governed by the Pension Funds Act of South Africa, 1956.
x The profit for the year was C5 000 000 after correctly accounting for the defined benefit plan.
x There are no items of other comprehensive income other than those evident from the
Required:
Prepare the statement of comprehensive income and the statement of changes in equity
together with all notes relating to the defined benefit plan for inclusion in Radley Limited’s
annual financial statements for the year ended 31 December 20X1 in accordance with IFRSs.
Ignore comparatives and tax consequences.
Question 19.12
Logic Limited has a defined benefit plan. The following related balances were extracted from
the trial balance as at 1 January 20X8:
Defined benefit plan asset C1 050 000
Defined benefit plan obligation C600 000
Defined benefit plan asset ceiling 0
Other information relating to the plan for the year ended 31 December 20X8 is as follows:
x The market yield on high quality corporate bonds remained unchanged at 10% throughout
both 20X7 and 20X8.
230 Chapter 19
x Benefits paid to employees: C150 000

x A total of C600 000 was paid into the plan assets (37,5% was contributed by employees
and 62,5% by Logic Limited)
x The present value of current service costs was estimated to be C750 000.
x The company actuary provided you with the following measurements at 31 December 20X8:
- Plan obligation: present value: C1 200 000
- Plan assets: fair value: C 1 905 000
- Future refunds and reductions in future contributions: present value: C300 000.
Required:
Provide all journals relating to the defined benefit plan for the year ended 31 December 20X8.
Question 19.13
You are a first-year trainee. Due to your excellent CTA results, you have become quite
involved in the employee benefits accounting aspects of audits. One of your biggest clients is
Concerta Limited which has a defined benefit plan.
The related balances were extracted from the trial balance of Concerta Limited as at
31 December 20X8 and are presented below:
Defined benefit plan asset: closing balance At fair value C1 524 000
Defined benefit plan obligation: closing balance At present value C1 080 000
Defined benefit plan asset ceiling: opening balance C48 000
On review of your audit working papers you have determined that no adjustments to the asset
ceiling adjustment account have yet been processed during 20X8. At 31 December 20X8, the
present value of future refunds and reductions in future contributions is C360 000.
The company’s benefit plan is administered and managed by Invest Asset Management
Limited. On inspection of the annual statement from Invest Asset Management Limited for
the year ended 31 December 20X8, you confirmed that benefits of C120 000 were paid out of
the assets managed by the fund. The statement also confirms that Concerta Limited paid an
additional C240 000 into the fund assets managed by Invest Asset Management Limited.
During 20X8, interest on plan assets of C108 000 and interest on plan obligations of C96 000
were recognised in the general ledger. The financial director’s employee benefits expense
working paper for 20X8 shows the correctly calculated current service costs of C60 000.
An independent finance house identified that the market yield was 12% on high quality
corporate bonds, this yield having remained unchanged throughout 20X7 and 20X8, which
the finance house explained was due to a stable monetary policy stance by the Reserve Bank.
Required:
a) Show all journals relating to the information provided about the defined benefit plan for
b) Show the disclosure of the other comprehensive income note and the employee benefit
expense note for inclusion in Concerta Limited’s annual financial statements for the year
ended 31 December 20X8. Comparatives are not required.
Question 19.14
Topdown Limited is involved in manufacturing gizmos (these are the parts used in
convertibles that allow the roof to open and close).
Chapter 19 231
x Topdown Limited has approximately 1 000 employees, all of whom are covered by the
company’s defined benefit pension plan.
x Employees are expected to work for an average of 15 years at Topdown Limited.
x The following information pertains to this pension plan:
C
Plan assets: 1 January 20X1 300 000
Plan obligation: 1 January 20X1 400 000
Current service costs 100 000
Contributions paid during the year 200 000
Discount rate throughout 20X1 and 20X0 is 15%
Benefits paid to members during the year 100 000
Plan assets: fair value at 31 December 20X1 400 000
Plan obligation: present value at 31 December 20X1 500 000
Past service costs from amendment in plan description 450 000
Required:
Prepare the journals to account for the defined benefit plan for the year ended
31 December 20X1 in terms of IAS 19 Employee benefits.
Question 19.15
Arno Limited is a small company involved in the construction industry. Although

Arno Limited has not yet developed a detailed formal plan to restructure the business, an
internal management decision was taken in early December 20X4 to begin the process of
downsizing its operations.
As a result of this decision, Arno offered retrenchment packages on 15 December 20X4 to

three of its employees (A, B and C). The offer of these retrenchment packages is legally
binding on the entity for 6 months from the date of offer, after which the offers expire.
Shortly before the end of December, a fourth employee (D) approached management and
requested a retrenchment package.
At Arno Limited’s financial year ended 31 December 20X4:

x only one of the three employees (A) had accepted the retrenchment package, while
x the remaining two employees (B and C) were still considering their options, and
x the entity had agreed to retrench the fourth employee (D).
Required:
Explain whether termination benefits should be recognised for the retrenchment packages.
Question 19.16
Green Gables Limited has a policy of paying employees certain standard packages on
retirement date and of paying a slightly smaller package on resignation date. Packages are
also payable in the event of retrenchment. During 20X4, one employee resigned and four
employees were retrenched. The package paid to the employee who resigned was C100 000
whereas the three retrenchment packages were paid at C400 000.
Required:
a) Explain whether the following packages qualify for recognition as termination benefits
i) Packages payable on retirement date; and
ii) Packages payable on resignation date.
b) Briefly explain the measurement of the provision for the three retrenchments.
232 Chapter 19
GAAP: Graded Questions Foreign currency transactions
Chapter 20
Foreign currency transactions
Question Key issues

20.2 JKB Breweries Differences between functional currency and presentation currency
20.3 Aramis Import (FOB):
- Property, plant and equipment
- Settlement: before year-end
20.4 Behind-the- Import (DAT):
Hedge - Inventory
- Settlement: after year-end
20.5 Ghost Export (CIF):
- Inventory
- Receipt of settlement in instalments: before and after year end
20.6 Vodka Foreign loan liability:
- Accrual of interest;
- Settlement: partial repayment of capital and payment of interest
20.7 Reddington Foreign loan asset:
- Accrual of interest
- Settlement: partial receipt of loan capital
20.8 Candy Mountain Non-monetary items:
- Item held in foreign currency
- Impairment
Please note: Further questions on this topic can be found in chapter B: Integrated questions 1 - 28
Chapter 20 233
Question 20.1
a) A foreign currency transaction is a transaction that is ________________ in and/ or
requires _______________ in a foreign currency.
b) Define what is meant by a 'transaction date'.
c) Indicate whether the following statement is true or false and, if you believe it to be false,
provide a brief explanation as to why you believe it to be false:
'The acronyms 'F.O.B.' and 'C.I.F.' are Inco terms (i.e. International Chamber of
Commerce Terms of Trade) that determine when the risks and rewards of ownership will
pass and are terms that will result in the risks and rewards transferring on the same date.'
d) Define a ‘monetary item’ and give an example of both a monetary item and a non-
monetary item.
e) Indicate whether the following statement is true or false and, if you believe it to be false,
'Exchange differences on monetary items are recognised in profit or loss in the period in
which they occur.'
f) Indicate whether the following statement is true or false and, if you believe it to be false,
'A fluctuating exchange rate will affect the subsequent measurement of an imported non-
monetary item.'
g) Indicate whether the following statement is true or false and, if you believe it to be false,
'A fluctuating exchange rate may affect the subsequent measurement of foreign currency
denominated non-monetary items.'
h) Define functional currency.
i) Indicate whether the following statement is true or false and, if you believe it to be false,
'The functional currency of an entity may not be changed unless there is a change to the
underlying conditions and transactions that are used to determine the functional currency.'
j) Indicate whether the following statement is true or false and, if you believe it to be false,
'An entity must always present its financial statements in its functional currency.'
k) Briefly explain how an entity's items should be translated from its functional currency
into a different presentation currency.
Question 20.2
JKB Breweries (“JKB”) is a company that manufactures and supplies beers to South Africa.
The brewery is situated in Newlands, South Africa, since Newlands provides excellent access
to water, water being one of the most important ingredients in beer. The barley to produce
beer is also produced by local farmers.
In recent years, JKB experienced excellent growth and during the 20X6 financial year the
board of directors decided to list JKB on the London Stock Exchange. The regulators of the
London Stock Exchange require the financial reports to be presented in Pounds (£). Currently,
JKB presents their financial statements in Rands (South African Rands).
234 Chapter 20
The current financial director has not had any experience with foreign currency translations
and is not at all familiar with the requirements of IAS 21 The effects of changes in foreign
exchange rates. He is unsure how to go about presenting the financial statements in order to
comply with the regulators. He has also requested your help in understanding the terms
‘functional currency’ and ‘presentation currency’, as used in IAS 21.
Required:
Draft a letter to the director in which you explain the meaning of the terms functional
currency and presentation currency as well as how to go about presenting the financial
statements such that they comply with the regulations of the London Stock Exchange.
Question 20.3
Aramis Limited, a South African company that manufactures perfumes, bought 16 new
fragrance-testing machines for use in its laboratory in Johannesburg. The machines were
imported from Estelle Lord Limited, a company based in France that produces equipment for
companies in the perfume industry.
Details relating to the purchase of these machines are as follows:

x The machines were ordered on 25 April 20X9.
x The machines were shipped on 15 June 20X9.
x The machines arrived in South Africa on 1 September 20X9.
x The total invoice price was €30 000, invoiced on a free on board basis (FOB).
x Aramis Limited paid the French supplier on 30 September 20X9.
The machines needed to be installed before they could be put into operation:
x Installation was completed by Inandout Limited on 25 September 20X9.
x Inandout Limited furnished the company with an invoice for R60 000.
x The machines were available for use on 1 October 20X9 but due to labour unrest, these
were only brought into use on 31 October 20X9.
The machines have a residual value of R50 000 and a useful life of 8 years.
Aramis Limited's functional and presentation currency is the Rand (R).

Spot Rate
Date SA Rand (R): Euro (€)
25 April 20X9 13,50:1
15 June 20X9 13,75:1
01 September 20X9 13,80:1
31 October 20X9 14,40:1
Required:
Show all journals in the books of Aramis Limited for the year ended 31 December 20X9.
Ignore tax.
Question 20.4
The economy in South Africa has been booming and as a result, South African clients appear
to be spending more on luxuries such as garden design. The number of landscaping and
topiary specialists has been growing exponentially, all of whom require specialist garden
equipment.
Chapter 20 235
Behind-the-hedge Limited is one of very few South African companies specialising in the
sourcing and retailing of garden equipment to those in this landscaping and topiary industry.
One of the latest trends in Johannesburg is to own radio-controlled lawnmowers (which are
being marketed as great entertainment for men at Saturday barbeques). The local
manufacturers of these lawnmowers were unable to keep up with the demand and therefore
Behind-the-hedge Limited imported 200 of these radio-controlled lawnmowers from an
American company:
x The lawnmowers were ordered from the American company on 25 April 20X0.
x The total invoice price for the lawnmowers was USD 150 000.
x Shipment was to be made on a delivery at terminal basis (DAT).
x The shipment was despatched on 15 August 20X0.
x The shipment arrived in South Africa on 25 August 20X0.
x Behind-the-hedge Limited paid the American company on 2 February 20X1.
The lawnmowers are to be sold via a variety of outlets, most of which are situated in
Johannesburg, using a 20% mark-up on cost. On 31 December 20X0, 60% of the
lawnmowers had been sold. All inventory had been sold by 21 December 20X1.
Spot Rate
Date SA Rand: US Dollars
25 April 20X0 6,00: 1
15 August 20X0 7,20: 1
25 August 20X0 7,50: 1
31 December 20X0 7,10: 1
02 February 20X1 6,90: 1
Required:
Show all related journals in the general journal of Behind-the-hedge Limited for its years
ended 31 December 20X0 and 20X1.
Ignore tax.
Question 20.5
Ghost Limited is an American company that sells sheets. Ghost Limited sold a batch of
sheets to a British company for GBP 50 000.
The order from the British company was received on 25 March 20X5, the sheets were loaded
on 15 July 20X5 and were unloaded in Great Britain on 25 July 20X5. The sheets were
loaded on a 'customs, insurance and freight' basis (CIF).
The sheets (which Ghost Limited had in stock at the time of the order) cost the American
company USD 20 000.
Ghost Limited's functional and presentation currency is the dollar ($). Related exchange rates
are as follows:
Spot Rate
Date US Dollars: GB Pounds
25 March 20X5 2,00: 1
15 July 20X5 2,20: 1
25 July 20X5 2,50: 1
31 October 20X5 2,65: 1
31 December 20X5 2,40: 1
31 January 20X6 2,90: 1
236 Chapter 20
The British company paid Ghost Limited as follows:

z GBP 25 000 on 31 October 20X5
z GBP 25 000 on 31 January 20X6
Required:
Show all related journal entries in the books of Ghost Limited for its years ended
Ignore tax.
Question 20.6
Vodka Limited is a mining company operating across Europe and the Middle East. Vodka's
functional currency is the Euro (€).
On 25 March 20X7, the directors came across classified information regarding the discovery
of diamonds in Guatemala. Vodka Limited approached the two main banks in Guatemala,
Hello Bank and Diva Bank, for a loan that would fund a start-up mine in the area. The local
currency in Guatemala is the Guatemalan Quetzal (Q).
Diva Bank offered a larger loan amount, but at a relatively high 12% interest rate whereas,
after a month of negotiations, Hello Bank agreed to drop its rates to 8%, albeit on a lower
sum. Vodka signed a loan agreement with Hello Bank, the terms of which are as follows:
Terms of the Hello Bank Loan
Loan amount, effective 1 June 20X7 G48 000 000
Interest rate, capitalised annually on 31 May 8%
Loan repayments Annually, due on 31 May
Annual loan repayments to include interest for the preceding
12 months plus a set capital amount of: G960 000
Repayment term 50 years
Related exchange rates are as follows:

Exchange Rates
Date Euros 1: Quetzal
01 June 20X7 1: 8,0
31 March 20X8 1: 6,0
31 May 20X8 1: 7,5
31 March 20X9 1: 7,8
Average for 1 June 20X7 to 31 March 20X8 1: 7,0
Average for 1 April 20X8 to 31 May 20X8 1: 7,2
Average for 1 June 20X8 to 31 March 20X9 1: 7,2
Required:
Prepare the necessary journals entries in Vodka Limited's general journal for its year ended
31 March 20X8 and 31 March 20X9.
Ignore tax.
Question 20.7
Reddington Limited, a company based in Venda (South Africa), received a request for a loan
of P30 000 from Keen Limited, a subsidiary in Botswana. Reddington's functional currency is
the Rand (R) and the local currency in Botswana is the Pula (P).
Chapter 20 237
Reddington agreed to provide the loan finance on the following terms:

Terms of the loan
Loan amount, effective from 1 September 20X5 P30 000
Interest rate, compounded annually 4.24%
Annual loan repayments (8 instalments), payable on 31 August P4 500
The spot and average exchange rates on the respective dates were as follows:
Date or period R1: P
01 September 20X5 0,70
28 February 20X6 0,67
31 August 20X6 0,72
28 February 20X7 0,74
Average 1/9/20X5 to 28/02/20X6 0,69
Average 1/3/20X6 to 31/8/20X6 0,71
Average 1/9/20X6 to 28/02/20X7 0,72
Required:
Prepare all necessary journal entries to record the above information in the books of
Reddington Limited for the year ended 28 February 20X6 and 28 February 20X7.
Ignore tax.
Question 20.8
Charlie is a director of Candy Mountain Limited, incorporated in a country called Localland,

where the currency is LC.
x The company purchased a machine a number of years ago from a foreign country called
Foreignland, where the currency is FC.
The machine was purchased for FC70 000.
This machine, called the Candy Mountain machine, is permanently based in
Foreignland.
x Although the machine is situated in Foreignland, the operations of the business are
managed by Charlie from Localland. Charlie determines the prices at which all Candy
Mountain products are sold and Charlie pays the staff employed by Candy Mountain
Limited in Foreignland using the Localland currency, LC.
x According to the 31 December 20X5 trial balance of the foreign Candy Mountain
operation, the accumulated depreciation on this machine is FC20 000.
x At 31 December 20X5, one of the Candy Mountain employees noticed that the Candy
Mountain machine was full of water after a tropical storm, indicating a possible impairment.
x Experts were rushed in to determine the extent of the storm damage. The following year-
end values were determined:
fair value less costs of disposal: FC48 000; and
value in use: FC52 000.
x The exchange rate on the date that Charlie originally purchased the Candy Mountain
machine was LC13 for each FC1. At 31 December 20X5, the current financial year-end,
the exchange rate was LC11 for each FC1.
Required:
Calculate the amount by which the Candy Mountain machine needs to be impaired, if at all.
Ignore tax.
238 Chapter 20
GAAP: Graded Questions Hedge accounting
Chapter 21
Hedge accounting
Question Key issues

21.2 Growthpoint Import (CIF): Non-financial asset (PPE): Repayment after year end
Part A: No FEC
Part B: With FEC – hedge of a recognised asset (FVH)
21.3 Tubbie Import (DAT): Non-financial asset (Inventory):
- hedge of a highly probable forecast transaction (CFH) and
- hedge of a recognised asset (FVH)
Includes disclosure
21.4 Shaggy Import (DDP): Non-financial asset (PPE):
- hedge of the recognised asset (FVH) and:
Part A: hedge of the firm commitment is a CFH
Part B: hedge of the firm commitment is a FVH
21.5 Cath-Cath Import (FOB): Non-financial asset (PPE):
- hedge of a highly probable forecast transaction (CFH), and
- hedge of a recognised asset (FVH).
Includes disclosure
21.6 Lancelot Export (DAT): Financial asset (Debtor):
- hedge of a firm commitment (CFH), and
- hedge of a recognised asset/ liability (FVH).
Part A: No discontinuance of hedge accounting
Part B: Includes discontinuance of hedge accounting
21.7 Howdee Import (DAT): Non-financial asset (PPE):
- hedge of a highly probable forecast transaction (CFH),
- hedge of a transaction (FVH).
Part A: Cash flow hedge does not contain an ineffective portion
Part B: Cash flow hedge does contain an ineffective portion
21.8 Tiger Import (DAT): Non-financial asset (PPE):
- hedge of a firm commitment (FVH),
- hedge of a recognised asset or liability (FVH).
FEC matures after settlement date.
21.9 Anne Import (DAT): Non-financial asset (Inventory):
- hedge of a recognised asset or liability (FVH).
Expiry and renewal of FEC (roll-forward).
21.10 Sound Import (FOB): Non-financial asset (Inventory):
Parts (a) and (b): journals and disclosure
- hedge of a forecast transaction (CFH),
- hedge of a transaction (FVH).
Part (c): journals only
- hedge of a forecast transaction (CFH),
- hedge of a firm commitment (FVH), and
- hedge of a transaction (FVH)
Chapter 21 239
Question 21.1
a) List the three types of hedges referred to in IFRS 9 Financial instruments.
b) Define a fair value hedge.
c) Define a cash flow hedge.
d) Define a firm commitment.
e) Define, in your own words, the term 'highly probable forecast transaction'.
f) Indicate whether the following statement is true or false, and if it is false, provide a brief
reason why you believe it to be false:
'A highly probable forecast transaction will be recognised in our accounting records if it is
hedged by a forward exchange contract (FEC).'
g) Explain in your own words how we account for a firm commitment the risks of which are
hedged against using a forward exchange contract (FEC).
h) Indicate whether the following statement is true or false, and if it is false, provide a brief
'A forward exchange contract (FEC) that is entered into in order to hedge a firm
commitment must always be treated as a fair value hedge.'
i) In one sentence, explain the essential difference between how we account for a cash flow
hedge and how we account for a fair value hedge.
j) Indicate whether the following statement is true or false, and if it is false, provide a brief
'A gain or loss on a cash flow hedge never affects profit or loss.'
k) Indicate whether the following statement is true or false, and if it is false, provide a brief
'When accounting for a hedge as a cash flow hedge, we have the choice of processing a
basis adjustment or reclassification adjustment.'
Required:
Provide brief answers to each of the above questions.
Question 21.2
Part A:
Growthpoint Limited is based in Japan and has a functional currency of yen (¥). It acquired a
helicopter from a Russian company, which operated in roubles (RUB). The helicopter was
invoiced at RUB360 000. Growthpoint ordered the helicopter on 1 July 20X4. The helicopter
was then shipped on 1 October 20X4 and arrived on 24 November 20X4. The shipping terms
were 'customs, insurance and freight' (CIF). Growthpoint paid the Russian company in full
on 1 March 20X5. The date on which the helicopter became available for use was 30
November 20X4. It has a useful life of 10 years and a nil residual value.
240 Chapter 21
The relevant exchange rates are presented on the next page:

Date Spot ¥ : RUB
01 July 20X4 1,70: 1
01 October 20X4 1,75: 1
24 November 20X4 1,78: 1
30 November 20X4 1,80: 1
31 December 20X4 1,85: 1
01 March 20X5 1,90: 1
Assume all requirements for hedge accounting were met throughout the hedging relationship
and that any ineffective portion in the cash flow hedge was considered to be immaterial.
Required:
Using Growthpoint Limited's general journal, show all journals that would have been
processed for both its years ended 31 December 20X4 and 20X5.
Ignore VAT, tax and the effects of discounting.
Part B:
Use the same information as that provided in Part A together with the following:
On 1 October 20X4, in order to hedge against the related foreign currency risks, Growthpoint
signed a forward exchange contract for the exchange of RUB360 000. The contract will
expire on 1 March 20X5. The hedge will be accounted for as a fair value hedge.
The relevant exchange rates are as follows:

Date Spot ¥ : RUB FEC expiring on 1 March 20X5
01 July 20X4 1,70: 1 2,00: 1
01 October 20X4 1,75: 1 1,80: 1
24 November 20X4 1,78: 1 1,75: 1
30 November 20X4 1,80: 1 1,60: 1
31 December 20X4 1,85: 1 2,10: 1
01 March 20X5 1,90: 1 N/A
Required:
Using Growthpoint Limited's general journal, show all journals that would have been
processed for both its years ended 31 December 20X4 and 20X5.
Question 21.3
Tubbie Limited planned to purchase inventory from a foreign supplier for $270 000. This
transaction was considered to be highly probable and thus Tubbie Limited entered into a
forward exchange contract to hedge against the foreign currency risks. The FEC was signed
on 30 November 20X5 and will expire on 1 April 20X6.
The chronological sequence of events that followed is listed on the next page:
x Inventory was ordered on 8 December 20X5 (this is not a firm commitment).
x The inventory was loaded on board the ship on 15 December 20X5.
Chapter 21 241
x This inventory was shipped on a 'delivery at terminal' basis (DAT).

x The inventory arrived and was unloaded in the Port Elizabeth Harbour (South Africa) on
1 February 20X6.
x Tubbie Limited paid the foreign creditor in full on 1 April 20X6.
This entire batch of imported inventory has since been sold:

x 70% of the inventory was sold on 1 July 20X6 for R3 200 000; and
x 30% of the inventory was sold on 5 August 20X6 for R1 600 000
The hedge of the recognised asset or liability must be accounted for as a fair value hedge.
Tubbie Limited's functional currency is the Rand (R). Exchange rates were as follows:
Spot FEC expiring on 1 April 20X6
Date SA Rand: Dollar SA Rand: Dollar
30 November 20X5 14,02: 1 14,06: 1
08 December 20X5 14,16: 1 14,26: 1
15 December 20X5 14,11: 1 14,24: 1
31 December 20X5 14,09: 1 14,22: 1
01 February 20X6 14,19: 1 14,24: 1
01 April 20X6 14,26: 1 N/A
Required:
a) Using Tubbie Limited’s general journal, prepare all related journals for the years ended
b) Disclose the above information in the following extracts of Tubbie Limited’s financial
statements for the year ended 31 December 20X6 only:
x Statement of comprehensive income;
x Statement of changes in equity;
x Notes to the financial statements: just the note for 'cash flow hedge reserve'.
Question 21.4
Shaggy Limited is a retailer of various common household goods, operating in South Africa.
South Africa’s currency is the Rand (R).
Business was expanding rapidly with the result that Shaggy Limited needed new and more
sophisticated computer equipment in order to enhance the running of its accounting system.
The financial director began negotiating a contract with a German company, Fred Limited, for
the development of specialised computer equipment:
x Negotiations began on 1 September 20X5, whereupon the forecast import was considered
to be highly probable.
x Agreement on the terms of the contract was only reached on 30 September 20X5:
x The computer equipment would be developed by Fred Limited;
x The installation of this equipment would be performed by South African technicians;
x The purchase price of this new equipment (uninstalled) would be €300 000.
242 Chapter 21
The computer equipment was shipped on a 'delivery duty paid' basis (DDP):
x it was loaded on board on 1 February 20X6;
x it arrived at the local harbour on 27 March 20X6; and
x the relevant customs clearance certificates were obtained on 31 March 20X6; and
x it was transported to Shaggy Limited’s head office on 2 April 20X6.
Soon after this highly unique and complex computer equipment had arrived at the office, it
became obvious that the local technicians did not have the necessary skills to install it.
Arrangements were immediately made with Fred Limited to have a team of their own
technicians sent to South Africa.
The technicians flew over the very next day and had completed the installation by
30 April 20X6. Shaggy Limited was invoiced on 30 April 20X6 for the installation of
€80 000 and was required to pay the local accommodation costs for the technicians of
R70 000 (both bills were paid on 31 May 20X6).
This equipment is expected to have a useful life of 5 years and a nil residual value.
Depreciation using the straight-line method is considered to be appropriate.
With concerns over the generally significant fluctuations in the Rand: Euro exchange rate,
Shaggy Limited entered into a forward exchange contract to hedge this foreign exchange risk
as soon as the terms of the contract were agreed upon (i.e. 30 September 20X5). This forward
exchange contract expires on 30 June 20X6.
Shaggy Limited settled the original €300 000 payable to Fred Limited on 30 June 20X6.
The relevant exchange rates are as follows:
Spot rate FEC (expiring on 30 June 20X6)

Date
€:R €:R
01 September 20X5 1 : 8,00 1 : 8,10
30 September 20X5 1 : 7,50 1 : 7,45
01 February 20X6 1 : 7,19 1 : 7,21
28 February 20X6 1 : 7,20 1 : 7,22
27 March 20X6 1 : 7,38 1 : 7,40
31 March 20X6 1 : 7,40 1 : 7,43
02 April 20X6 1 : 8,24 1 : 8,32
30 April 20X6 1 : 8,10 1 : 8,13
30 June 20X6 1 : 7,60 N/A
Required:
Prepare the related journal entries in the books of Shaggy Limited for the years ended
28 February 20X6 and 20X7 assuming that:
a) the hedge of the firm commitment is accounted for as a cash flow hedge and the hedge of
the recognised asset or liability is accounted for as a fair value hedge.
b) the hedge of the firm commitment is accounted for as a fair value hedge and the hedge of
the recognised asset or liability is accounted for as a fair value hedge.
Chapter 21 243
Question 21.5
Cath-Cath Limited is a South African company (currency: Rands). It ordered plant for use in
its factory. Relevant details are as follows:
x The plant was ordered on 1 February 20X8. The order was not a firm commitment.
x The plant was shipped free on board on 10 February 20X8.
x The plant arrived on 28 February 20X8 and was available for use from that date.
x The invoiced price was $1 000 000.
x A 2-month forward exchange contract for the full amount of $1 000 000 was entered into
on 1 February 20X8 (expiring 31 March 20X8).
x The foreign debt was settled on 31 March 20X8.
x The financial year-end is 28 February.
x The plant has a 10-year useful life, a residual value of nil and is depreciated on the
straight-line method.
x The hedge of the highly probable forecast transaction is a cash flow hedge.
x The exchange rates were as follows:
Spot rates FEC rates *
Date
R: $ 1 R: $ 1
01 February 20X8 R5,00 R5,25
10 February 20X8 R5,80 R6,00
28 February 20X8 R7,00 R7,10
31 March 20X8 R8,80 N/A
* exchange rates for contracts expiring on 31 March 20X8
Required:
a) Show the journals relating to the import of plant for the year ended 28 February 20X8.
b) To the extent possible disclose all relevant amounts in the statement of comprehensive
income and the statement of financial position for the year ended 28 February 20X8.
Question 21.6
Lancelot Limited, a South African company manufacturing 3-D photocopy machines, secured
a contract on 15 September 20X7 to sell a machine to Guinevere Limited in Germany. The
total sales value per the confirmed order was €220 000.
The machine, which cost R1 650 000 to manufacture:

x was shipped on a delivery at terminal basis (DAT) on 2 January 20X8; and
x arrived in Germany on 1 February 20X8 and was unloaded on the same date.
On 30 September 20X7, Lancelot Limited entered into a forward exchange contract for
€220 000 to hedge against movements in the cash flows of the highly probable forecast
transaction and to hedge against movements in the fair value of the recognised asset or
liability. The forward exchange contract was set to expire on 1 March 20X8, on which date
Guinevere Limited settled in full.
Exchange rate information is presented on the next page.
244 Chapter 21
Date Spot: €1:R FEC expiring on 1 March 20X8: €1:R

15 September 20X7 12,20 12,15
30 September 20X7 12,50 12,30
31 December 20X7 13,60 13,40
02 January 20X8 13,80 13,60
01 February 20X8 14,20 14,00
01 March 20X8 13,00 N/A
Required:
a) Prepare all relevant journal entries to record the transaction in Lancelot Limited’s books
for the years ended 31 December 20X7 and 20X8.
b) Briefly explain how the journals would change if, on 5 January 20X8 (when the spot rate
was €1:R14,01 and the currently available forward rate was €1:R13,80), Lancelot decided
it would prefer not to continue hedge accounting and if, on 15 January 20X8 (when the
spot rate was €1:R14,10 and the currently available forward rate was €1:R13,90), the
qualifying criteria ceased to be met, but the forecast transaction was still expected.
Question 21.7
An Australian company, Howdee Limited, purchased a machine from a South African

company, Goonjarny Limited. Goonjarny specialises in the design and manufacture of high-
tech machinery. The functional currency of the Australian company is the Australian
dollar ($) and the local currency in South Africa is the Rand (R).
The directors of Howdee Limited decided, in a meeting on 30 September 20X4, that they
would order a much needed machine from Goonjarny Limited at the advertised price of
R540 000. At this point, the forecast transaction (an import of machinery) was considered to
be highly probable. A few weeks later, Howdee's accountant managed to convince the
directors that the company should limit their foreign currency risk by entering into a forward
exchange contract. A suitable forward exchange contract was secured on 30 October 20X4,
for the exchange of R540 000 and with an expiry date of 30 April 20X5.
Howdee's accountant placed an order for the machine (considered to be a firm commitment)
with Goonjarny Limited on 10 January 20X5. Shipping documents were received from
Goornjarny a few days later, confirming that the machine had been loaded on the ship on
12 January 20X5 on a 'delivery at terminal' basis (DAT) at an invoiced amount of C540 000.
The shipment arrived and was unloaded on 31 January 20X5. The machine was collected
immediately, installed and available for use from 15 February 20X5.
Howdee Limited paid Goonjarny Limited on 30 April 20X5.
Depreciation on the machine is provided on the straight-line basis over a 10 year useful life to
a nil residual value.
The hedge of the firm commitment was accounted for as a cash flow hedge whereas the hedge
of the recognised asset or liability was accounted for as a fair value hedge.
Chapter 21 245
Exchange rates on: Spot FEC expiring on 30 April X5

Date $: Rand $: Rand
30 September 20X4 6,14: 1 6,18: 1
30 October 20X4 6,10: 1 6,12: 1
31 December 20X4 6,19: 1 6,21: 1
10 January 20X5 6,00: 1 6,05: 1
12 January 20X5 6,08: 1 6,11: 1
31 January 20X5 5,99: 1 6,01: 1
30 April 20X5 5,96: 1 N/A
Required:
a) Provide the journal entries for the years ended 31 December 20X4, 20X5 and 20X6.
b) Explain the effect on the journal for 31 December 20X4, if any, and provide this journal if
it differs from the journal processed in part (a) above, assuming:
x the spot rate on this date was $6,16: R1 (not $6,19: R1, as shown in the table above);
x any ineffective portion in the cash flow hedge is considered material (not immaterial
as indicated above).
Question 21.8
Tiger Limited intended purchasing plant from Eagle Limited, a company in America. The
plant would be used in the manufacture of inventory. Tiger uses the Rand as its functional and
presentation currency. The following events took place, listed in chronological order:
x 28 February 20X8: Tiger Limited entered into a 12-month forward contract, at which
point the intended import was considered to be a highly probable forecast transaction.
x 1 July 20X8: The plant to the value of $320 000 was ordered (a firm commitment).
x 22 July 20X8: The plant was shipped (on a delivery at terminal basis).
x 1 September 20X8: The plant arrived at the Durban harbour.
x 2 September 20X8: The plant was available for use.
x 30 November 20X8: The plant was put into operation.
x 31 January 20X9: The foreign creditor was paid in full.
The plant is depreciated on the straight-line basis at 10% per annum to a nil residual value.
The forward exchange contract was entered into in order to hedge against movements in the
cash flows of the highly probable forecast transaction and to hedge against movements in the
fair value of the firm commitment and the recognised asset or liability.
Details of exchange rates are as follows ($1=R?):
12 months 8 months 6 months 2 months 1 month
Date Spot
forward forward forward forward forward
28 February 20X8 12,5 12,9 12,8 12,7 12,6 12,50
1 July 20X8 13,0 13,4 13,3 13,2 13,1 13,00
22 July 20X8 12,9 13,3 13,2 13,1 13,0 12,80
1 September 20X8 12,6 13,0 12,9 12,8 12,7 12,60
31 December 20X8 13,5 13,9 13,8 13,7 13,6 13,40
31 January 20X9 13,4 13,8 13,7 13,6 13,5 13,45
28 February 20X9 13,6 14,0 13,9 13,8 13,7 13,30
246 Chapter 21
Required:
a) Calculate the amount at which the machine would be measured on transaction date.
b) Journalise all aspects of the acquisition and subsequent measurement of the plant for the
years ending 31 December 20X8 and 20X9.
Question 21.9
Anne Limited purchases computer parts that are to be held as inventory and placed an order
for goods to be imported from a foreign supplier.
x The order was placed on a delivery at terminal basis (DAT).
x The order was placed on 31 May 20X1.
x The order was not considered to be a firm commitment.
x The value of the order was €30 000.
x The computer parts were loaded onto the ship on 2 June 20X1.
x The ship with the parts arrived in the local harbour and was unloaded on 31 July 20X1.
As soon as the order was placed, Frank Limited took out a 3-month forward cover contract
over the highly probable import in order to protect against foreign currency fluctuations.
On 31 August 20X1, the 3-month FEC expired and was replaced by a 2-month FEC.
The foreign creditor was finally paid on 30 October 20X1.
The forward exchange contract was entered into in order to hedge against changes to the cash
flows of the highly probable forecast transaction and to hedge against changes to the fair
value of the recognised asset or liability.
The relevant rates are as follows:
Spot rate Forward rate

(Rx: €1) (Rx: €1)
31 May 20X1 6,40 6,50 : for an FEC expiring on 31 August 20X1
02 June 20X1 6,52 6,73 : for an FEC expiring on 31 August 20X1
31 July 20X1 6,45 6,55 : for an FEC expiring on 31 August 20X1
31 August 20X1 6,60 6,65 : for an FEC expiring on 30 October 20X1
30 October 20X1 6,70 N/A
Required:
Prepare all of Anne Limited’s journal entries to account for the sale and subsequent receipt
for the year ended 28 February 20X2.
Chapter 21 247
Question 21.10
Sound Limited is a retailer of home theatre equipment, operating in South Africa (with its
presentation and functional currency being the Rand). The Hank Screen, a screen
manufactured by Spark Limited in America, is a top-selling item in South Africa. To satisfy
customers, Sound Limited planned to order a batch of these screens from Spark Limited, to
the value of $1 200 000. Spark Limited’s presentation and functional currency is the dollar.
Sound Limited was reluctant to remain exposed to currency fluctuations, which could be
detrimental to its cash flows. As a result, it entered into a forward exchange contract for
$1 200 000 on 5 December 20X7 (due to expire on 30 June 20X8) in anticipation of this
highly probable future transaction.
Sound Limited placed the order for the screens with Spark Limited on 31 January 20X8 (this
is considered to be a firm commitment).
x The screens were loaded free on board on 31 March 20X8 and arrived on 30 April 20X8.
x Sound Limited paid Spark Limited on 30 June 20X8.
At the year end on 31 December 20X8, only 30% of the screens remained unsold (selling
prices are calculated at a mark-up of 30% on cost).
The relevant exchange rates were as follows:
Exchange rates on: Spot FEC expiring on 30 June 20X8

Date Rand: Dollar Rand: Dollar
05 December 20X7 7,01: 1 7,21: 1
31 December 20X7 7,91: 1 7,12: 1
31 January 20X8 7,00: 1 7,50: 1
31 March 20X8 6,99: 1 7,10: 1
30 April 20X8 8,00: 1 8,50: 1
30 June 20X8 6,69: 1 N/A
The hedge of the highly probable future transaction and the hedge of the firm commitment
must be accounted for as cash flow hedges and the hedge of the recognised asset or liability
must be accounted for as a fair value hedge.
Required:
a) Provide all the journals that would have been processed by Sound Limited during the
years ended 31 December 20X7 and 31 December 20X8.
b) Disclose the above information for the year ended 31 December 20X8 in Sound Limited’s
statement of comprehensive income, statement of changes in equity (only the cash flow
hedge column is required), profit before tax note and other comprehensive income note.
c) Provide all the journals that would have been processed by Sound Limited during the
years ended 31 December 20X7 and 31 December 20X8, assuming that the hedge of the
firm commitment was accounted for as a fair value hedge (i.e. not as a cash flow hedge).
248 Chapter 21
GAAP: Graded Questions Financial instruments
Chapter 22
Financial instruments
Question Key issues
22.2 Genie Classification of investment portfolios – discussion and journals

22.3 Nkosana Classification and measurement of various investments – discussion
22.4 Skywise Classification and measurement of various investments – discussion and journals
22.5 Poacher Financial assets – government gilts
22.6 Horse Financial assets – bonds
22.7 Opera Financial assets – redeemable preference shares
22.8 Bingo Financial assets classified at FVPL, amortised cost and FVOCI
22.9 Sunderland Measurement of expected credit losses
22.10 Rose Financial asset with significant increase in credit risk
22.11 Sulky Financial asset with significant increase in credit risk and partial recovery
22.12 Shady Financial asset with significant increase in credit risk
22.13 Mpofana Recognition of expected credit losses
22.14 Swine Issue of redeemable participating preference shares
22.15 Bergen/ Debentures issued at a discount / premium and redeemed at a premium/ par:
Aarhus/ amortised cost and fair value through profit or loss
Peterpan
22.16 Algae Convertible instruments, journal entries
22.17 Pickle Convertible preference shares
22.18 Blooper Redeemable preference shares at FVPL
22.19 Celine/ Redeemable debentures at amortised cost – issuer and investor perspectives
Grinder
22.20 Rooney Reclassification of financial assets
- From amortised cost to FV through profit or loss
- From amortised cost to FV through other comprehensive income
22.21 Zoli Reclassification of financial assets
- From FV through profit or loss to amortised cost
- From FV through profit or loss to FV through other comprehensive income
22.22 Ocean-Wide Financial Risks, classification of preference shares
Chapter 22 249
Question 22.1
a) Define a financial asset and a financial liability.

b) Explain whether financial instruments meet the definitions of the elements listed in the
Conceptual Framework for Financial Reporting.
c) What are the requirements that need to be in place in order for a financial asset and
financial liability to be offset?
d) List the two different measurement models that IFRS 9 allows for the subsequent
measurement of financial assets.
e) The option to designate a financial asset as fair value through other comprehensive
income is revocable. True or false?
f) List the conditions that a financial asset must satisfy before being irrevocably measured at
fair value through other comprehensive income.
g) Financial assets measured under the amortised cost model and financial assets measured
at fair value need to be tested for impairment annually in terms of IAS 36 Impairment of
assets. True or false.
h) List the financial asset categories/classifications of financial assets that require the
measurement of 12-month expected credit losses on initial recognition.
i) Explain the difference between the gross carrying amount and the amortised cost of a
financial asset.
j) List the factors that must be taken into account in the measurement of expected credit
losses.
k) Explain what is meant by ‘reclassification date’.
l) When may a financial asset be de-recognised?
m) List two different types of derivatives.
n) List the 3 types of financial risks.
Question 22.2
Genie Limited holds two different portfolios.
The first portfolio consists of investments in various government bonds that are held to earn
contractual cash flows. The cash flows comprise both a return of the principal amount and
interest.
x The portfolio was entered into on 1 January 20X7 at a total investment of C2 015 000
excluding transaction costs. Transaction costs amounted to C43 000.
x The investment will mature in 10 years and will be redeemed at a premium of C135 000.
x Interest is receivable in arrears at an amount of C116 250 per annum.
The second portfolio consists of investments in various corporate bonds that are held to earn
contractual cash flows and the cash flows comprise both a return of the principal amount and
interest. It is the established practice of the company to trade in the investments in corporate
bonds if market indicators are favourable.
x At the beginning of the financial year, 1 January 20X9 the investments had a collective
fair value of C625 000 and by 31 December 20X9 it had risen to C678 000.
250 Chapter 22
x Interest received during the current financial year amounts to C120 000.
x No investments were sold in the current year due to unfavourable market conditions in the
corporate bond market.
Assume there are no expected credit losses in any of the investments.
Required:
a) Discuss fully how management should go about classifying and measuring the two
investment portfolios in terms of IFRS 9 Financial Instruments.
b) Prepare the journal entries to account for the investment portfolios for the year ended 31
December 20X9.
Question 22.3
Nkosana Limited is an investment entity with a diversified portfolio of investments. The

company’s financial director has provided you with a list of its investments which are as
follows –
Acquisition Transaction
Investment type cost costs
Investment in unlisted shares – valued by the directors using a
C1 200 000 C15 000
discounted cash flow model
Investments in listed shares – traded actively by the equities division
C960 000 C11 600
of Nkosana Limited
Investment in 10-year government bonds – held to maturity C520 000 C7 500
Investment in convertible preference shares C2 240 000 C88 600
Investment in shares in subsidiary companies C7 650 000 C812 000
Investments in corporate bonds – held for trading purposes C3 126 000 C91 300
Required:
Prepare a memorandum to the financial director of Nkosana Limited outlining the
classification and initial measurement of the various investments.
Question 22.4
Skywise Limited entered into the following transactions during 20X9:

a) Call options:
On 1 December 20X8, the company bought 10 SAFEX call options with a short term
intention to sell. This allows the company to purchase the index at 9 000 points on
31 December 20X8. The margin deposit paid was C15 000 and the option was exercised
on maturity. The index level was 9 100 on exercise date.
b) Futures:
Skywise Limited bought 10 mining share index futures on 1 November 20X8 with
speculative intentions. The futures allow the company to buy the shares at an index level
of 2 500 on 28 February 20X9.
Profits/losses are directly transferred to the company’s bank account on a daily basis.
A C40 000 margin deposit was paid on 1 November 20X8.
The index level was 2 500 on 1 November 20X8, and had increased to 2 700 by year end.
(Note: Futures are traded in multiples of 10).
Chapter 22 251
c) Preference shares:
On 30 June 20X8, the company issued 10% redeemable preference shares worth
C225 000, redeemable at the option of Skywise Limited. However, if the company’s share
price falls lower than C14, the preference shares become redeemable immediately.
Skywise Limited’s share price has never fallen below C16 since incorporation.
A final preference dividend of C17 500 was declared on 31 December 20X8. The
payment of preference dividends is non-discretionary.
d) Ordinary shares:
On 30 June 20X8, the company purchased 80 000 shares in Midway Limited at C9 per
share, with the intention to hold it as a long term investment. Transaction costs of C1 725
were incurred. By year end, the shares were trading at C11,25 per share. The company
has not elected to present fair value changes through other comprehensive income.
e) Debentures:
On 1 March 20X8, the company purchased debentures at a discount of 6% off the face
value of C540 000. A coupon rate of 9% p.a. is payable biannually in arrears on
31 August and 28 February every year. The debentures will be redeemed in 5 years at a
premium of 5%. The entity intends to hold the debentures to maturity and the cash flows
comprise the return of principal and interest. (Effective interest rate = 11,437% p.a.)
Required:
Prepare all necessary journal entries to record the above transactions in the books of Skywise
Limited for the financial year ended 31 December 20X8.
Ignore tax.
Question 22.5
Poacher Limited purchased government gilts on 1 January 20X9. The nominal value of these
gilts, C975 000, will be repaid when the gilts mature in 4 years. Poacher Limited intends to
hold the gilts to collect contractual cash flows and the redemption of capital on maturity.
Other details include:
x The purchase price was C877 500.
x The coupon interest is 8% p.a., payable bi-annually.
x The effective interest rate is 5,6199% per 6 months or 11,2398% p.a.
x On acquisition date, the 12-month expected credit losses were estimated at C16 400.
x On 30 June 20X9, the company sold 60% of the gilts at fair value of C551 000. A market-
related interest rate on the date of sale was 10,6% per annum.
Required:
Using Poacher's general journal, prepare journal entries to record the information provided for
Ignore tax.
Question 22.6
Horse Limited is a company that is involved in the packaging and retail of low-cost oriental
fast foods. Due to a year of exceptional profits, Horse Limited had excess cash on hand and
decided to acquire 1 000 bonds in Animal Farm Limited, a company listed on the JSE
Securities Exchange.
252 Chapter 22
The details of each bond when they were acquired (1 January 20X0) were as follows:
x Purchase price and face value = C600
x Future value on maturity = C660
x Coupon rate = 11%
x Coupons are paid annually, in arrears on 31 December
x The bonds are to be redeemed on 31 December 20X3.
From acquisition date, the management intention has been to trade in these bonds These
bonds are traded frequently and the quoted market values represent fair value. The relevant
fair values were:
Date Market price per bond
C
31 December 20X0 620
Required:
Provide all journal entries required to appropriately account for the above information in
Ignore taxation
Question 22.7
On 1 January 20X4, Opera Limited purchased the entire issue of 440 000 redeemable no par
value preference shares, issued by Piano Limited.
x The shares offer fixed preference dividends at 10% p.a. on the issue price of C22 each.
x Dividends are payable annually on 31 December.
x Redemption at C26.40 per share (i.e. at a premium of C4,40 per share) is compulsory and
is scheduled for 31 December 20X8.
x The effective interest rate is 13.0813%
x The ex-dividend market values of the preference shares were as follows:
Date Market price (ex-div)

C
31 December 20X4 26.40
Ignore the effect of expected credit losses.
Required:
a) Discuss the various classifications that Opera Limited could use when accounting for its
financial asset (i.e. its investment in Piano Limited’s preference shares) and the effect on
the measurement thereof.
b) Prepare all related journal entries in Opera Limited’s general journal for the years ended
31 December 20X4, 20X5, 20X6, 20X7, assuming that Opera Limited considers its
investment to be:
i) designated as fair value through profit or loss;
ii) amortised cost.
Chapter 22 253
c) Prepare Opera Limited's statement of comprehensive income for the year ended
31 December 20X7 in accordance with International Financial Reporting Standards
assuming that Opera Limited:
x earned other profit in each year (i.e. before considering any income related to the
preference shares) of C440 000; and
x designated the investment at fair value through profit and loss.
Ignore tax.
Question 22.8
Bingo Limited purchased the following instruments on 2 January 20X9:
z 15 000 bonds from Sanralia Limited at C80 per bond.
- On this date, the bonds were trading on the open market for C92 per bond.
- The bonds are classified at fair value through profit and loss.
- The fair value on 31 December 20X9 was C101 per bond.
z 6 000 shares from Uncle (Pty) Limited at C75 per share.
- Uncle (Pty) Limited is a family-owned business that is not listed on any exchange.
- The share price was determined by a firm of specialists to be C66 per share on
purchase date.
- Bingo Limited agreed to pay C75 as the directors believe that the value of the
investment will increase over time.
- The shares are classified at fair value through profit and loss.
- The fair value of these shares was C80 at 31 December 20X9.
z 20 000 Ninja Limited ordinary shares for C150.
- The fair value of the shares on this date was C155.
- Transaction costs amounted to C3 500.
- These are not held for trading and thus management elected to classify these shares as
fair value through other comprehensive income.
- The fair value of these shares was C168 at 31 December 20X9.
- Dividends of C2 per share were received on 31 December 20X9.
Required:
Provide all the necessary journal entries for the year ended 31 December 20X9.
Question 22.9
Sunderland Limited is a financier that assists the small and medium business sector. The loan
terms (e.g. interest rate and repayment periods) are determined on a client-by-client basis.
Sunderland provided loans to three clients (client A, B and C) on 2 January 20X3, details of
which are provided below:
Client A Client B Client C
Loan amount provided C7 500 000 C1 800 000 C2 500 000
Repayment date 31/12/20X7 31/12/20X7 31/12/20X7
Interest rate 12% pa, payable 15% pa, payable 17% pa, payable
annually in arrears annually in arrears annually in arrears
Origination fees C71 500 C13 000 C23 000
12-month expected credit losses 3.6% of the lifetime 2.5% of the lifetime 12% of the lifetime
expected credit losses expected credit losses expected credit losses
Lifetime expected credit losses 16% of the loan 21% of the loan 36% of the loan
provided provided provided
254 Chapter 22
Sunderland Limited settles all origination fees for each new loan.
Additional information regarding each of these clients:

x Client A: Client A has honoured all its financial obligations on time ever since the loan
was provided.
x Client B: Client B honoured all its financial obligations during 20X3 and 20X4 but then
during 20X5, notified Sunderland Limited that it would be unable to repay the loan in full
on due date. After negotiations, agreement was reached that this client would repay the
loan in full on 31 December 20X9 instead (i.e. 24 months later than originally expected).
The interest rate was decreased to 11% p.a. Sunderland's accountant determined that this
amendment to the loan terms indicated a significant increase in credit risk.
x Client C: Client C was classified as a risky client at inception due to its poor credit-rating
and thus a higher interest rate was charged in order to mitigate against this risk.
Required:
a) Discuss how Sunderland Limited should measure the expected credit losses for each of its
clients for the financial period ended 31 December 20X3.
b) Prepare the journal entries relating to all 3 clients for the years ended 31 December 20X3,
20X4 and 20X5.
Question 22.10
Rose Limited purchased 100 000 debentures that were issued by Daisy Limited on
1 January 20X5. The debentures were held to collect contractual cash flows.
x The debentures were purchased at C5 each.
x These debentures offer a 10% fixed rate of interest payable annually on 31 December.
x The debentures will be redeemed at a premium of C1 each on 31 December 20X9.
x The effective interest rate is 13.0813%
x The debentures were not considered to be credit impaired at acquisition.
During the year ended 31 December 20X7, Daisy Limited found itself in severe financial
difficulties and decided to put itself under voluntary curatorship.
x As a result, it notified Rose Limited that in order to prevent liquidation, the interest due
for the year ended 31 December 20X7 would be paid in full but thereafter, only a
percentage of the remaining dividends and principal capital would be paid.
x As a result of this notification, Rose Limited determined that there has been a significant
increase in the credit risk of the bonds and the financial asset is now credit-impaired.
x The accountant prepared the following credit loss measurements:
12-month Lifetime
Date expected credit losses expected credit losses
01 January 20X5 C3 900 C37 000
31 December 20X5 C3 900 C37 000
31 December 20X6 C13 800 C51 500
31 December 20X7 C39 000 C178 000
Required:
Prepare all related journal entries in Rose Limited’s general journal for the years ended
31 December 20X5, 20X6, 20X7, assuming that the debentures were held at amortised cost.
Chapter 22 255
Question 22.11
Sulky Limited bought a listed bond, issued by Crusader Limited, for C694 640 on
1 January 20X6. The bond is redeemable at C720 000 (being its nominal value of C640 000
plus a premium of C80 000) on 31 December 20X9. Interest is receivable based on a coupon
rate of 10% per annum, receivable annually on 31 December each year. The effective interest
rate on this bond was calculated at inception to be 10% per annum.
Crusader Limited was put under voluntary curatorship on 31 December 20X7. Although the
current year’s coupon interest was received, the future interest cash flows (contractual cash
flows) were no longer considered probable. A guarantee was obtained that the C640 000 (i.e.
nominal value excluding the premium) would still be returned on 31 December 20X9.
At 31 December 20X8, the company was in a better financial situation and expected to be
able to pay not only the nominal value of C640 000, but will also be able to pay interest of
C16 000 on 31 December 20X9.
The bond part of any portfolio is managed by Mr Timid who was in charge of long term
investment out-looks, and who managed the bonds to collect contractual cash flows. The
return on the bond compensated the holder for credit risk and the time value of money.
An analysis of the expected credit losses on the Crusader bonds were as follows –
12-month Lifetime
01 January 20X6 C16 875 C50 000
31 December 20X6 C21 800 C71 500
31 December 20X7 C38 500 C129 075
31 December 20X8 C28 575 C87 250
Required:
Journalise the related entries for each of the years ended 31 December 20X6, 20X7 and 20X8.
Question 22.12
On 1 January 20X6, Shady Limited bought listed bonds for C759 765. The bonds will mature
on 31 December 20X9 at C787 500 (including a C87 500 premium on nominal value).
Interest at the coupon rate of 10% per annum on the nominal value of C700 000 is receivable
annually in arrears on 31 December. The effective interest rate is 10%.
The bonds are held within a portfolio managed with the objective of collecting both
contractual cash flows and cash flows from selling the assets.
At 31 December 20X7 the listed company was put under voluntary curatorship. Although the
current year’s coupon interest was received, the future interest cash flows were no longer
considered probable, although a guarantee was made that the nominal value of C787 500
would be returned on 31 December 20X9.
At 31 December 20X8, the company was in a better financial situation and expected to be
able to pay not only the nominal value of C787 500, but interest of C17 500 on
31 December 20X9.
An analysis of the fair values and expected credit losses for these listed bonds is presented on
the next page.
256 Chapter 22
Fair value 12-month Lifetime

01 January 20X6 C759 765 C13 125 C67 200
31 December 20X6 C790 000 C11 800 C61 500
31 December 20X7 C600 000 C48 000 C137 365
31 December 20X8 C640 000 C28 575 C97 250
Required:
Journalise the related entries for each of the years ended 31 December 20X6, 20X7 and 20X8.
Question 22.13
Mpofana Limited invested in four financial assets on 1 January 20X1, details of which are
presented in the table below. The accountant is unsure of how to account for these
investments in terms of IFRS 9 and has thus collated all the information he has at his disposal.
He is aware that IFRS 9 also requires the recognition of expected credit losses on acquisition
but is not sure whether this applies to all investments or only some. As a result, he has
calculated the expected credit losses for each of the four assets.
Purchase 12-month expected Lifetime expected

Investment type costs credit losses credit losses
Investment in unlisted non-redeemable C520 000 C3 196 C8 900
preference shares
Investment in redeemable preference shares C350 000 C11 120 C23 250
Investment in government bonds C2 240 000 C68 000 C196 000
Investment in ordinary shares C2 812 000 C48 000 C135 000
All purchase costs were considered to reflect fair values at the date of acquisition. A
transaction cost of a further 1% was incurred on each of the purchase prices reflected in the
table above. All the transaction costs were paid in cash.
x The non-redeemable preference shares pay dividends at 10% per annum (based on the
purchase price), considered to be a market-related return. The company has no intention
to trade these shares.
x The redeemable preference shares pay dividends at 15% per annum (based on the
purchase price), considered to be a market-related return. The company intends to hold
these shares until maturity when the principal sum will be returned.
x The government bonds earn interest at 10% per annum (based on the purchase price),
considered to be a mark-related return and are held purely with the intention of trading.
x The investment in ordinary shares is held for capital appreciation.
The fair values of each of the investments at year-end, 31 December 20X1, have been
measured as follows:
C
Investment in unlisted non-redeemable preference shares 560 000
Investment in redeemable preference shares 360 000
Investment in government bonds 2 300 000
Investment in ordinary shares 2 500 000
Required:
Discuss how each of the investments must be measured in the financial statements of
Mpofana Limited, and show the journal entries where possible.
Chapter 22 257
Question 22.14
Swine Limited issued 30 000 redeemable preference shares on 1 January 20X6 at C45 each.
These shares have a deemed value of C57 for purposes of calculating the mandatory dividend
of 10% per annum, payable on 31 December each year. A further dividend is payable at 3%
of the ordinary dividends paid per share in any one year, if any. The redemption of these
shares is at the Swine's discretion. If the shares are not redeemed, they will be converted into
ordinary shares at the rate of 1 ordinary share for 1 preference share. The appropriate market
rate for similar debt instruments that do not offer the discretionary dividend or the possible
redemption or conversion is 17%.
The accountant recognised the receipt on 1 January 20X6 as a non-current interest bearing
liability and recognised the fixed 10% dividend paid on 31 December 20X6 as an interest
expense. An ordinary dividend of C0.20 per share has been declared on 22 December 20X6,
which has been recognised as a distribution of equity and a current liability No other entries
have been processed.
The tax authorities apply the effective interest rate method to financial liabilities and levy
income tax at 30%.
Required:
Discuss Swine Limited’s accounting treatment of the redeemable preference shares for the
year ended 31 December 20X6, including correcting journal entries where necessary.
Question 22.15
Part A:
Bergen Limited has a 31 December year end. The company issued 100 000 10% debentures
of C1 each at a discount of 5% on 1 October 20X1. The debentures are redeemable at a
premium of 7% on 30 September 20X5. The debentures have been issued at an effective
interest rate of 13.03192248% p.a. and are to be classified under the amortised cost category.
Interest is payable on 31 March and 30 September each year.
Required:
a) Prepare all the journal entries relating to the debentures that would be processed from
1 October 20X1 to 31 December 20X2.
b) Show how the debentures would be disclosed in the financial statements of Bergen
Limited at 31 December 20X2.
Part B:
Aarhus Limited issued 80 000 unsecured 12% debentures of C2 each on 1 July 20X3:
x The debentures were issued at a premium of 3%.
x The debentures have been issued at an effective interest rate of 11.48029%.
x These debentures will be redeemed at par in 10 years’ time, on 30 June 20Y3.
x The debentures were not designated at fair value through profit and loss on initial
recognition.
Required:
Show the relevant extracts from the statement of comprehensive income, statement of
financial position and notes to the financial statements of Aarhus Limited for the years ended
30 June 20X4 and 20X5.
258 Chapter 22
Part C:
On 2 January 20X5, Peterpan Limited issued 1 million C5 10% debentures:

x The debentures were issued at a discount of C1 per debenture.
x The debentures will be redeemed on 31 December 20X9 at a premium of C1,23 per
debenture.
x The internal rate of return is 19.992737%.
x The debentures were not designated at fair value through profit and loss on initial
recognition.
Required:
a) Provide journals for all of the years ended 31 December relating to the debentures.
b) Determine the amount to be recognised as finance costs for each of the affected financial
years ending 31 December and show how these amounts would be disclosed in the
statement of comprehensive income of Peterpan Limited, showing each affected year.
Question 22.16
Algae Limited is a company that is involved in the retail of sporting goods. Due to the
massive increase in demand for the merchandise sold by Algae Limited, it was necessary to
build a shopping mall that specialised in the sale of sporting goods.
In order to raise the required capital, Algae Limited issued 600 000 debentures at a price of
C12 per debenture issued on 1 January 20X1. The debentures charge a coupon rate of 15% on
the face value of C10.
The debentures are compulsorily convertible into ordinary shares on a 1 for 1 basis on
31 December 20X4.
The debentures were not designated at fair value through profit and loss on initial recognition.
An appropriate discount rate for debentures of this nature is 16%.
Required:
Journalise the entries required to account for the above information for the years ended
31 December 20X1 to 20X4.
Question 22.17
Pickle Limited has two types of preferences shares in issue. The terms of the preference
shares are as follows –
x 1 200 000 8% cumulative A-class preference shares at an issue price of C11 on
1 January 20X1. In order to minimise the potential liquidity problems at maturity, Pickle
Limited allowed holders the option to either convert the preference shares into ordinary
shares or redeem them at C11 each on 31 December 20X4.
x On 31 December 20X4, 75% of the shareholders decided to convert their A-class
preference shares into ordinary shares and 25% of the shareholders opted for the cash
back instead.
x The A-class preference shares were not designated at fair value through profit and loss on
initial recognition. The market interest rate for these preference shares is 12%.
Chapter 22 259
Pickle Limited had issued its B-class preference shares on 1 January 20X2. The terms of the
B-class preference shares are as follows –
x 400 000 12% compulsory convertible preference shares were issued on 1 January 20X2.
x The shares were issued at C2 each.
x The shares are convertible on 31 December 20X6 into ordinary shares.
x The market interest rate for similar shares is 15%.
These preference shares were issued in order to raise long-term capital to finance a variety of
projects.
Required:
Journalise all of the above transactions in the accounting records of Pickle Limited for the
years ended 31 December 20X1 to 20X4.
Question 22.18
On 1 July 20X5, Blooper Limited issued 500 000 redeemable preference shares at C4 each.
The shares are compulsorily redeemable at C4,40 per share on 30 June 20X9. The shares
offer dividends at a coupon rate of 10%. The market interest rate is 13% for similar
preference shares.
The preference shares were designated at fair value through profit or loss on initial
recognition. The preference shares are traded on the JSE Securities Exchange from which the
following fair values were extracted:
Date Market price per
preference share
C
30 June 20X6 4.05
30 June 20X7 4.25
30 June 20X8 4.20
30 June 20X9 4.40
Required:
Discuss in detail, in terms of the Conceptual Framework and IFRS 9 Financial Instruments,
how the share issue and dividends should be recognised and measured and provide the related
journals for the year ended 30 June 20X6.
Ignore tax
Question 22.19
On 2 January 20X4, Celine Limited issued 10 000 debentures, at a discount of C100 off their
face value of C500, details of which are as follows:
x These debentures are compulsorily redeemable at a 10% premium after 4 yrs.
x The debentures bear interest at 15% per annum payable in arrears.
x The effective interest rate on the debentures is 25.23262%.
x The debentures are not held for trading nor were they designated at fair value on initial
recognition.
Grinder Limited, an unrelated third party, acquired 80% of the debentures issued by Celine on
2 January 20X4 for the discounted price. Transaction costs of C16 000 were incurred and paid
by Grinder Limited. As Grinder’s intention is to collect contractual cash flows, the debentures
have been classified at amortised cost.
260 Chapter 22
The expected lifetime credit losses on the debentures were C8 500 and the 12-month expected
credit losses were C2 500 on 2 January 20X4.
Required
a) Prepare journals for Celine to record the financial instrument over its four-year life.
b) Prepare the journal entries to account for the debentures in the financial statements of
Grinder Limited in for the year ended 31 December 20X4
Ignore tax
Question 22.20
On 1 January 20X8, Rooney Limited purchased 3-year government bonds for C1 750 000.
The face value is C1 837 500 and the coupon interest is 8% p.a., payable annually in arrears.
The effective interest rate is 9,9119% p.a. The company’s intention was to hold the
government bonds to collect contractual cash flows, being the return of capital and interest.
At initial recognition, the company estimated the 12-month expected credit losses at C28 000.
On 30 September 20X9, the company decided to change its business model relating to the
government bonds. The fair value on this date was C2 025 000 and changed to C2 116 000 on
31 December 20X9.The 12-month expected credit losses on reclassification date were
estimated at C91 875.
Required:
Prepare all related journal entries in Rooney Limited’s general journal for the years ended
31 December 20X8 and 20X9 assuming the government bonds were:
a) reclassified to fair value through profit or loss.
b) reclassified to fair value through other comprehensive income.
Ignore tax.
Question 22.21
Zoli Limited acquired 400 000 16% listed preference shares on 1 January 20X6 at C4 each.
x The preference shares will be redeemed at C5 per share on the 31 December 20Y0.
x Zoli Limited classified the preference shares as financial assets at fair value through profit
and loss.
x On 30 June 20X8, the company decided to change its business model relating to the
preference share investment. At this date, the fair value of the preference shares was
C4,28 and the 12-month expected credit losses were estimated at C5 250.
x On 1 January 20X9 the fair value of the preference shares was C4,38 and the 12-month
expected credit losses were C4 125.
Required:
Prepare all related journal entries in Zoli Limited’s general journal for the years ended
31 December 20X8 and 20X9 assuming the preference shares were:
a) reclassified to amortised cost.
b) reclassified to fair value through other comprehensive income.
Ignore tax.
Chapter 22 261
Question 22.22
Ocean-Wide Limited is a South-African based trader in fish. Ocean-Wide Limited purchases

fish caught by local fishermen in many different countries before freezing the fish and
supplying them to local retail outlets on account.
All suppliers to Ocean-Wide Limited require settlement in their own currency.
In recent years with the dramatic decline in world fish populations, Ocean-wide limited has
struggled financially. Ocean-Wide Limited’s board of directors has decided to try to improve
profitability by diversifying operations. In this regard, Ocean-Wide Limited has begun to
provide finance to venture capital companies which yielded significant returns. Such loans
include fixed and variable rate loans.
To assist with cash flow problems, Ocean-Wide Limited issued 1 000 000 8%
C100 cumulative preference shares at a discount of 10% on the par value.
x The preference shares are compulsorily redeemable in 5 years’ time at a premium of
C10 per share. Preference dividends are payable annually in arrears.
x Share issue costs amount to C10 000.
Required:
a) Briefly define the financial risks identified by IFRS 7 and provide an example of each.
b) Based on the information provided describe the extent to which Ocean-Wide Limited is
exposed to each of the risks identified above.
c) Discuss the classification of the preference shares and the manner in which they should be
accounted for.
d) Calculate the effective interest rate to be used to measure the preference shares at
amortised cost.
262 Chapter 22
GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities
Chapter 23
Share Capital: Equity Instruments and Financial
Liabilities
Question Key issues

23.1 Counters Core questions
23.2 Pang-yin Start-up of business involving preliminary costs (expensed); share issue
costs (debited to equity); receipt of funds from interested applicants; issue
of shares and refund of non-allocated funds
23.3 Prekash Solvency and liquidity requirements
23.4 Pick n Pack Share buy-back
x buy back shares at market price that equals the average issue price
x buy back shares at market price that exceeds the average issue price
x buy back shares at market price that is less than the average issue price
23.5 Polar Ordinary shares: share issues: rights issue and then a capitalisation issue
23.6 Milk Issue of non-redeemable preference shares: equity
23.7 Fox Ordinary shares and preference shares (non-redeemable)
x share issue: normal issue and a capitalisation issue
x share issue costs
23.8 Wine Issue of redeemable preference shares
x compulsory redeemable, with cumulative dividends
x redeemable at option of shareholder, with cumulative dividends
Measurement of preference share liability at:
x amortised cost versus fair value through profit or loss
23.9 Milpark Ordinary shares:
Hospital x share issues: issue for value and then a capitalisation issue
Redemption of preference shares:
x redemption at the option of the entity
23.10 EasyFly Redemption of preference shares
x redemption is compulsory; redemption at a premium
x financing through issue of preference shares and the rest through an
issue of ordinary shares
23.11 RFK Redemption of preference shares:
x redemption at the option of the shareholders; redemption at a premium
x financing through issue of debentures and the rest through an issue of
ordinary shares
Tax calculation involving dividends and premium on a preference share
liability
23.12 Keeptrying Redemption of preference shares:
x redemption is compulsory; redemption at a premium
x redemption to take place in the future
Application of Conceptual Framework definitions: recognition
Chapter 23 263
Question 23.1
You are an auditor in the accounting firm Counters Inc. Your manager has requested that you
provide with him a list of answers to assist him in responding to queries on share capital.
a) Define an equity instrument.

b) Name two classes of shares that a company may issue.
c) Briefly explain the difference between the two classes of shares that you identified in part b)
d) State how to recognise an issue of ordinary shares and how to recognise the related dividend
declarations.
e) The recognition of an issue of preference shares is the same as the recognition of an issue of
ordinary shares. True or false? Briefly justify your answer.
f) The holder of a cumulative preference share is entitled to a distribution every year. True or
False? Briefly justify your answer.
g) IFRSs prohibit the existence of par value shares. True or false? Briefly justify your answer.
h) Identify four different ways in which a company could increase its number of issued shares.
i) Explain in what way a share consolidation and a share buy-back are similar and explain
what each involves.
j) The Companies Act of 2008 refers to a solvency and liquidity test: briefly outline what this
test involves.
k) Briefly compare the accounting treatment of share issue costs with the accounting treatment
of preliminary costs.
Required:
Question 23.2
Pang-yin Limited is a newly incorporated company with 100 000 authorised ordinary shares
with no par value.
x Legal costs (start-up/ preliminary costs) of C10 000 were paid on 2 March 20X4.
x The company has 4 directors, each of whom bought, for cash, 2 000 ordinary shares at the
initial issue price of C10 per share. This issue took place on 4 March 20X4 and resulted
in share issues costs of C1 000.
x On 1 April 20X4, the directors published a prospectus with an invitation to the public to
apply for shares in the company. This invitation offered 50 000 ordinary shares at
C12 per share and expired on 31 May 20X4. Applications for 75 000 ordinary shares had
been received by 31 May 20X4. The full value per share application was received into a
trust fund which was then transferred to the company on 3 June 20X4.
x After due consideration, the board of directors decided to limit the allotment to the
original offer of 50 000 shares and refunded the surplus cash received. The allotment and
refund took place on 5 June 20X4. Share issue costs totalling C6 000 were paid on the
same date.
Required:
a) Prepare the journal entries for the above information.
b) Prepare the statement of changes in equity for the year ended 28 February 20X5 assuming
that Pang-yin Limited correctly calculated that it had made a profit for the period of
C100 000 and had no components of other comprehensive income for the period.
264 Chapter 23
Question 23.3
Prekash Limited has 75 000 12% redeemable preference shares in issue. The redemption of
these preference shares needs to be effected at the end of the current financial period.
The financial director is aware that the Companies Act must be adhered to when redeeming these
preference shares, but is not sure of the practical implication of the relevant sections.
Required:
Explain the solvency and liquidity requirements of the Companies Act of 2008 in relation to the
upcoming redemption of preference shares.
Question 23.4
Pick n Pack Limited’s Memorandum of Incorporation states that it has 10 000 authorised
ordinary shares of no par value. Of these share, 6 000 have been issued (over a number of years
at various prices). The total balance on the ordinary share capital account for this class of share is
C12 000.
Pick n Pack directors are considering buying back 2 400 ordinary shares on 30 June 20X4.
Required:
a) Prepare the journal entries relating to the share buy-back for each of the three scenarios
below:
Scenario i: where the market price is C2 per share;
Scenario ii: where the market price is C3 per share;
Scenario iii: where the market price is C1 per share.
b) Prepare the ordinary share capital note and the statement of changes in equity for the year
Repeat for scenario i – iii as above.
Question 23.5
The following information relates to Polar Limited’s share issues during the year ended
31 December 20X4:
x Rights issue: 10 000 ordinary shares were offered to existing shareholders at C6 each on
30 May 20X4, when the market price was C9 each. All 10 000 shares offered were taken
up on this day.
x Capitalisation issue: there was a capitalisation issue of 2 ordinary shares for every
5 shares in issue on 30 November 20X4 at the current market price of C9.
x Share issue expenses were C15 000 during 20X4.

x The number of ordinary shares in issue on 1 January 20X4 was 270 000.
x There are no other share issues or reserves other than those mentioned above.
Required:
Prepare all the journal entries relating to the transactions mentioned above for the year ended
31 December 20X4.
Chapter 23 265
Question 23.6
In light of a growing health-conscious consumer market, Milk Limited, a dairy farming

company, issued 150 000 ordinary shares at C5 each, as well as 100 000 15% non-cumulative,
non-redeemable preference shares at C2,50 each on 1 January 20X3. The dividends on these
preference shares are discretionary. These shares were issued to fund long-term capital
expansion as a result of a boom in the dairy industry.
Half of the authorised ordinary and preference shares have been issued.
All preference dividends were declared and paid before year-end with the exception of 20X7,
when the preference dividend was declared but not yet paid at 31 December 20X7.
Required:
Prepare all the journal entries relating to the transactions mentioned above from the date of
issue of the preference shares to 31 December 20X7.
Question 23.7
Fox Limited is a manufacturer of specialised components used in the aircraft industry. The
company has been very profitable since its inception fifteen years ago. The company has a
31 March year-end. The financial director Logan Wolff has approached you for assistance in
preparation of the financial statements.
An extract from the statement of financial position at 31 March 20X1 is as follows:
EQUITY AND RESERVES
C
12% Non-cumulative preference share capital 500 000
11 900 000
The total comprehensive income earned for the subsequent two years is as follows:
20X3 20X2
C C
Profit for the year 1 100 000 930 000
Other comprehensive income for the year
Items that may not be reclassified to profit or loss
- Revaluation surplus - net of tax 50 000 -
Total comprehensive income for the year 1 150 000 930 000

x Ordinary share capital:
- The ordinary share capital issued at 1 April 20X1 consisted of 1 800 000 shares of no
par value. The authorised share capital has remained unchanged at 5 000 000 since
incorporation.
- On 1 July 20X1, 200 000 additional ordinary shares were issued at C1,20. The share
issue costs for this issue amounted to C10 000 and these expenses are non-deductible
for tax purposes.
- On 31 December 20X2, the directors authorised a capitalisation issue of 1 share for
every 4 held at the current market price of C1.
266 Chapter 23
- An ordinary dividend of C0,05 per share was declared on 28 February 20X3. No

dividend was declared in the 20X2 financial year.
x Preference share capital:
- The preference shares are not redeemable.
- The preference share capital issued at 1 April 20X1 consisted of 100 000 shares of no
par value. All the authorised preference share capital has been issued.
- The preference dividends were paid on 10 October in both years.
- The preference dividends are discretionary.
Required:
a) Prepare the statement of changes in equity for the year ended 31 March 20X3 in
b) Prepare the share capital note for the year ended 31 March 20X3 in accordance with
Question 23.8
On 1 January 20X4, Wine Limited, a prominent wine farm issued:

x 75 000 ordinary shares, at their market price of C1 per share; and
x 200 000 10% cumulative, redeemable preference shares, at C3,50 each.
Both share issues were in order to raise finance to alleviate temporary cash flow problems.
The directors were certain that the company’s cash flow would return to normal within the
next four years and were satisfied that the company’s assets, fairly valued, exceed its
liabilities and that the company will be able to pay its debts as they become due.
The preference shares must be redeemed on 31 December 20X7 at a premium of C0,50 per
share. The effective rate of interest paid is calculated to be 12,94787715%. The dividends on
these preference shares are non-discretionary.
There are a total of 200 000 authorised ordinary shares (unchanged since incorporation). Half
of the authorised preference shares have been issued.
Wine Limited has a 31 December year-end.
Required:
a) Prepare all journal entries relating to the preference shares from the date of issue to the
date of redemption.
b) Briefly explain how you would recognise the issue of the preference shares if the
preference shares were redeemable at the option of the shareholder and the preference
dividends remain non-discretionary.
c) Journalise the redeemable preference shares if the preference shares were designated at
fair value through profit of loss and the fair values are:
x 31 December 20X4 = C3,80 per share
x 31 December 20X7 = C4 per share
Chapter 23 267
Question 23.9
Milpark Hospitals Limited is a private hospital group operating five hospitals in the Cape
Town area. The following information relates to the year ended 31 December 20X6.
x Balances in the trial balance of Milpark Hospital Limited at 31 December 20X5:
C
Ordinary share capital (750 000 shares) 750 000
8% Preference share capital 400 000
x There were no movements in share capital during 20X5.

x The preference share capital comprises 400 000 preference shares issued at C1 each,
redeemable at the option of the company. The preference shares were issued on
1 July 20X1, redeemable on 30 June 20X6 at a premium of 5%, which is in accordance
with the original terms of issue. The dividends on these preference shares are
discretionary and non-cumulative.
x To partially finance the redemption, a rights issue of 1 ordinary share for every 5 ordinary
shares held was made on 30 June 20X6 at their market value of C2,50 each. The balance
of cash necessary to redeem the preference shares was provided from the bank account.
All the rights were taken up.
x The preference shares were redeemed on 30 June 20X6 at a premium of 5%. A
preference dividend of C32 000 was paid from the bank at the same time.
x On 30 September 20X6 a capitalisation issue of 1 share for every 3 ordinary shares held
was made out of the retained earnings at the market price of C1 per share.
x The authorised number of ordinary shares is 5 000 000 and the authorised number of non-
cumulative redeemable preference shares is 1 000 000.
x Total comprehensive income has been correctly calculated as C2 858 500
(20X5: C2 212 000) after taking the above information into account.
Required:
a) Prepare all journal entries relating to the information provided above for the year ended
31 December 20X6.
b) Prepare the statement of changes in equity of Milpark Hospitals Limited for the year
ended 31 December 20X6 in accordance with International Financial Reporting
Standards.
Comparative figures are not required. Disclosure of earnings per share is not required.
c) Prepare the share capital note to the financial statements of Milpark Hospitals Limited for
the year ended 31 December 20X6 in accordance with International Financial Reporting
Standards.
Comparative figures are not required. Disclosure of earnings per share is not required.
Question 23.10
Easyfly Limited is a small tour operator. The statement of financial position of Easyfly
Limited at 31 August 20X5 is shown below:
268 Chapter 23
EASYFLY LIMITED
AT 31 AUGUST 20X5
20X5
C
ASSETS
Non-current assets
Property, plant and equipment 125 000
Current assets
Trade and other receivables 24 150
Bank 75 850
225 000
Current liabilities
10 % Redeemable preference shares 53 770
225 000
The company issued 50 000 10% redeemable preference shares at a price of C1 each on
1 September 20X1 which are subject to compulsory redemption on 31 August 20X6 at a
premium of C0,10 per share. The effective interest rate on the preference shares is
11,5870684%. The dividends on these preference shares are non-discretionary.
The redemption of the preference shares is to be financed as follows:
x C32 500 of the existing cash reserves is to be used; and
x the remainder is to be financed by the issue of as many ordinary shares as is necessary at
a price of C1,50 per share.
The preference dividend as well as the share issue costs of C2 750 will be settled out of the
available balance of cash resources. No ordinary dividends were declared during 20X6.
The directors are satisfied that the company’s assets, fairly valued exceed its liabilities and
that the company will be able to pay its debts as they become due.
The profit before tax for the period ending 31 August 20X6 has been correctly calculated at
C120 000.
The dividends on the preference shares as well as the accrual of the premium, are not tax
deductible.
The income tax rate is 29%. Ignore the effect of a dividend withholding tax.
Required:
a) Prepare all journal entries relating to the information provided above for the year ended
31 August 20X6.
b) Show how taxation will be disclosed in the notes to the financial statements for the year
ending 31 August 20X6.
Workings are to be rounded to the nearest whole number.
Chapter 23 269
Question 23.11
On 28 February 20X5 RFK Limited had, amongst others, the following balances in its
accounting records:
C
Ordinary share capital (400 000 shares) 400 000
12% redeemable, cumulative preference shares (75 000 shares) 157 500
Bank overdraft 30 000
Profit for the year before finance charges and tax 98 000
x The authorised share capital of the company comprises 1 000 000 ordinary shares of no par
value, and 100 000 preference shares of no par value.
x The preference shares were issued on 1 March 20X0 at C2, and are redeemable at the option
of the shareholders on 28 February 20X5 at a premium of C0,10. The dividends on these
preference shares are non-discretionary. All the shareholders elected to have their
preference shares redeemed.
x The redeemable preference shares were redeemed at C2,10 per share on 28 February 20X5.
The redemption was financed as follows:
- 100 debentures of C250 each
- as many ordinary shares at an issue price of C1,25 each as are necessary to have
sufficient cash for the redemption.
These transactions relating to the redemption had not yet been processed at the date when
the balances given above were extracted.
x The directors are satisfied that the company’s assets, fairly valued, exceed its liabilities
and that the company will be able to pay its debts as they become due.
x The dividends on the preference shares must still be accounted for, and will be financed by
extending the existing bank overdraft.
x Share issue costs of C9 000 were incurred. These costs are non-deductible and are to be
financed by extending the bank overdraft.
x The normal tax rate is 29%. The dividends on the preference shares and the accrual of the
premium are not tax deductible.
Required:
Prepare the equity and liabilities section of the statement of financial position at
28 February 20X5 as well as the statement of changes in equity for the year ending on that date.
Accounting policies and notes relevant to the ordinary share capital and preference shares
are required.
Comparative figures are only required for the statement of financial position.
Question 23.12
You are the newly appointed auditor of Keeptrying Limited, charged with the responsibility
of ensuring that the equity and liabilities section of the statement of financial position is fairly
presented. The following information is relevant:
270 Chapter 23
x 100 000 ordinary shares were issued on 1 January 20X1 at C1 each.

x 300 000 redeemable preference shares with a coupon rate of 10% were issued on
1 January 20X3 at C1 each. These shares are compulsorily redeemable on
31 December 20X5 at a premium of C0,10 per share. The effective interest rate is
12,937%.
x The preference dividends are declared and paid on 31 December each year and are non-
discretionary.
x The directors are satisfied that the company’s assets, fairly valued exceed its liabilities
and that the company will be able to pay its debts as they become due.
x All amounts are considered to be material.
The following extract from the draft statement of financial position for the current financial
year ended 31 December 20X4 has been given to you:
KEEPTRYING LIMITED
EXTRACTS FROM STATEMENT OF FINANCIAL POSITION
AT 31 DECEMBER 20X4
20X4 20X3
C C
Ordinary share capital: no par value shares 100 000 100 000
Preference share capital: 10% cumulative, redeemable no par value shares 300 000 300 000
Required:
a) Discuss the recognition of the following transactions:
i) The issue of the preference shares in terms of the liability and equity definitions.
ii) The redemption of the preference shares on 31 December 20X5 in terms of the
expense definition.
b) Provide the journal entries to account for the preference shares from the time of issue to
redemption.
Ignore tax.
Chapter 23 271
GAAP: Graded Questions Earnings per share
Chapter 24
Earnings per share
Question Key issues

Section A: Basic and Headline Earnings per share
24.2 Cleopatra Restatement of comparative earnings per share
Items included in basic earnings
Usefulness of ‘earnings per share’ relative to ‘profit’ and ‘dividends per
share’
24.3 Mitch Earnings per share: basic
Share movements: issue at market price
Preference shares: non-redeemable, non-cumulative, non-participating
Dividends per share
24.4 Louisianna Earnings per share: basic (Class A and Class B ordinary shares)
Share movements: share split
Dividends per share
24.5 Yanky Part A: Earnings per share: basic
Part B: Earnings per share: basic and headline
Share movements: issue at market price, capitalisation issue
Preference shares: non-redeemable, cumulative and non-cumulative, non-
participating
Dividends per share
24.6 Far Part A: Earnings per share: basic
Share movements: capitalisation issue
24.7 Laura Earnings per share: basic
Share movements: share split
Dividends per share
24.8 Matthew Earnings per share: basic
Share movements: rights issue
Preference shares: non-redeemable, non-cumulative, participating and non-
participating
Dividends per share
24.9 Trini Part A: Earnings per share: basic
Share movements: rights issue, issues at market price, capitalisation issue,
share consolidation
272 Chapter 24

Section B: Basic, Headline and Diluted Earnings per share
24.11 Sprog Earnings per share: basic and diluted
Share movements: none
Potential shares: convertible debentures
24.12 Laser Part A: Earnings per share: basic and diluted
Part B: Earnings per share: basic, diluted and headline
Share movements: issue at market price
Potential shares: options
24.13 Chipchop Part A: Earnings per share: basic and diluted
Part B: Earnings per share: basic, diluted and headline
Share movements: rights issue, issue at market price
Potential shares: options, convertible preference shares
24.14 Cousins Earnings per share: basic and diluted
Share movements: issue at market price, capitalisation issue, share buy-back
Potential shares: options, contingent shares, convertible preference shares,
convertible debentures
Preference shares:
- non-redeemable, non-cumulative and participating;
- redeemable/ convertible, cumulative and non-participating
Chapter 24 273
Section A: Basic and headline earnings per share
Question 24.1
a) Basic earnings per ordinary share may be presented on the face of the statement of
comprehensive income, in the statement of changes in equity or in the notes to the
Indicate whether this statement is true or false. If it is false, briefly explain why it is false.
b) Earnings per share does not have to be presented in the separate financial statements of a
company that does not have its ordinary shares or potential ordinary shares traded in a
public market (e.g. the Johannesburg Stock Exchange) or that is not in the process of
filing the necessary documents for the purpose of issuing its ordinary shares in a public
market.
c) A company had profit after tax of C800 000 and a fixed preference dividend of C100 000
(based on the relevant coupon rate) for the financial year ended 31 December 20X1.
There were 250 000 ordinary shares in issue and 200 000 preference shares in issue
throughout this year. The preference shares are non-participating.
Calculate the basic earnings per ordinary share.
d) During the financial year ended 31 December 20X1, a company had profit after tax of
C1 100 000 and a fixed preference dividend of C200 000 (based on the relevant coupon
rate). It had 250 000 ordinary shares and 200 000 preference shares in issue throughout
this year. The preference shares participate to the extent of ⅛ of the ordinary shares.
Calculate the basic earnings per ordinary share.
e) If a company has ordinary shares and participating preference shares, it must present
basic earnings per ordinary share and basic earnings per participating preference share.
f) A company had 132 000 ordinary shares in issue on 1 January 20X2. On 1 April 20X2,
it issued 50 000 ordinary shares at market price and then on 1 September 20X2, it issued
another 48 000 ordinary shares at market price. The basic earnings for the financial year
ended 31 December 20X2 was correctly calculated to be C330 000.
Calculate the basic earnings per share.
g) A company had 350 000 ordinary shares in issue on 1 January 20X2.
On 1 April 20X2, it issued 50 000 shares at market price.
On 1 June 20X2, it issued 2 shares for every 5 shares held in terms of a rights issue.
On 1 September 20X2, it performed a share split in which 5 shares became 7 shares.
Calculate the number of shares issued in terms of the rights issue and in terms of the share
split and calculate the total number of shares in issue at 31 December 20X2.
h) A company had 132 000 ordinary shares in issue throughout the year ended
31 December 20X1. On 1 April 20X2, it issued 50 000 shares in terms of a capitalisation
issue. The basic earnings were correctly calculated as follows:
x for the financial year ended 31 December 20X2: C330 000 and
x for the financial year ended 31 December 20X1: C250 000.
Calculate the basic earnings per share for the years ended 31 December 20X1 and 20X2.
i) A company had 700 000 ordinary shares in issue on 1 January 20X2.
On 1 April 20X2, it issued 100 000 ordinary shares at C2 per share, in terms of a rights
issue. The fair value per share was C2,80 immediately before the issue of these shares.
The basic earnings for the financial year ended 31 December 20X2: C300 000.
Calculate the basic earnings per share for the year ended 31 December 20X2.
274 Chapter 24
Question 24.2
You have recently been appointed the accountant of Cleopatra Pet Products Limited. Your
first assignment was to draw up the financial statements of the company for the year ended
30 September 20X4. This you have done, including earnings and dividends per share.
The Managing Director, instead of praising you for your technical expertise as you expected,
wants to know why you changed last year’s number of shares when calculating the earnings
per share for the comparative statement of comprehensive income. He points out accusingly
that last year’s statement of financial position reflects only 100 000 ordinary shares and that
the 200 000 shares that you have reflected have only been in issue since half-way through the
current year. Furthermore, he wants to know why you included the profit of C80 000 made
on the sale of investments during the year. He believes that this should be excluded.
Required:
a) Explain to the managing director all the circumstances under which the previous year’s
comparative figures for basic earnings per share should be restated. Give reasons why the
restatement is necessary in each case.
b) Explain why the profit on the sale of investments was included in the amount of earnings
used for the basic earnings per share calculation.
c) Explain why the earnings per share figure is a better indicator of performance than:
x dividends per share; and
x profit after tax.
Question 24.3
The following information relates to Mitch Limited for the year ended 31 December 20X1:
x Mitch Limited earned a profit for the year of C100 000 in 20X1 (20X0: C80 000).
x Mitch Limited declared dividends in 20X1 and 20X0 as follows:
20X1 20X0
C C
Preference dividend declared on 31 December 5 000 5 000
Ordinary dividend declared on 31 December 10 000 6 000
x The balances in the share capital accounts at 1 January 20X0 were as follows:
- Ordinary shares: C200 000 (all the ordinary shares were issued at C0,20 per share).
- Non-cumulative, non-redeemable 10% preference shares: C50 000 (all the preference
shares were issued at C1 per share). The dividends on these preference shares are
discretionary.
x An issue of 500 000 ordinary shares took place on 31 March 20X1 at an issue price of
C0,20 per share.
x There was no other movement in the equity accounts other than the movements evident
from the information provided above.
Required:
Prepare extracts from the statement of comprehensive income and the statement of changes in
equity, as well as the earnings per share note and dividends per share note for inclusion in the
notes to the financial statements of Mitch Limited for the year ended 31 December 20X1, in
Chapter 24 275
Question 24.4
LOUISIANNA LIMITED
20X1 20X0
C C
Income tax expense (55 000) (35 500)
Profit for the year 100 000 190 000
Other comprehensive income for the year - -
Total comprehensive income for the year 100 000 190 000
x Issued share capital at 1/1/20X1:
- 50 000 Class A ordinary shares issued for C50 000.
- 50 000 Class B ordinary shares, issued for C100 000, which participate to the extent
of 1/9 of the dividend paid to Class A ordinary shareholders.
x There was a share split on 1/7/20X1 of 3 Class A ordinary shares for every 1 held.
x Class A ordinary dividend paid on 31/12/20X1 is C20 000 (X0: C10 000).
x There are no components of other comprehensive income in either 20X1 or 20X0.
Required:
Prepare extracts from the statement of comprehensive income and statement of changes in
notes to the financial statements of Louisianna Limited for the year ended
31 December 20X1, in accordance with International Financial Reporting Standards.
Question 24.5
The following is the abridged statement of comprehensive income and statement of changes in
equity of Yanky Limited for the year ended 30 September 20X3:
YANKY LIMITED
STATEMENT OF COMPREHENSIVE INCOME (EXTRACTS)
FOR THE YEAR ENDED 30 SEPTEMBER 20X3
20X3 20X2
C C
Profit for the period 475 000 (10 000)
Other comprehensive income 0 0
Total comprehensive income 475 000 (10 000)
YANKY LIMITED
STATEMENT OF CHANGES IN EQUITY (EXTRACTS)
Retained earnings
20X3 20X2
C C
Opening balance 940 000 950 000
Total comprehensive income/ (loss) 475 000 (10 000)
276 Chapter 24
Capitalisation issue of ordinary shares (70 000) 0

Dividends paid - 30 September 20X3 (150 000) 0
Ordinary shares 105 000 0
9% preference shares 27 000 0
12% preference shares 18 000 0
Closing balance 1 195 000 940 000
Yanky Limited was incorporated in 20X0. Details relating to its capital structure are as follows:
x 300 000 ordinary shares issued on incorporation at C1 each.
x 150 000 9% cumulative preference shares issued on incorporation at C1 each.
x 150 000 12% non-cumulative preference shares issued on incorporation at C1 each.
x 50 000 ordinary shares issued on 1 January 20X2 at a fair value of C1,50 each.
x A capitalisation issue on 15 June 20X3 of 1 ordinary share for every 5 ordinary shares
held on that date.
x Both classes of preference shares are non-redeemable and the dividends thereon are
discretionary.
The income tax rate for both years was 29%.
Part A
Required:
Disclose the earnings per share and dividends per share in the relevant extracts of the financial
statements of Yanky Limited for the year ended 30 September 20X3, in accordance with
Part B
Use the information provided above together with the following additional information:
The profit before tax in 20X2 includes:
x a profit on disposal of land of C60 000 (the tax on the capital gain is C10 150);
x an inventory write-down of C10 000 (tax deductible); and
x amortisation of a patent of C20 000 (tax deductible).
The profit before tax in 20X3 includes:
x an impairment of goodwill of 30 000: the tax authorities do not allow deductions relating to
goodwill;
x a loss on sale of land of C40 000: this loss is a capital loss that may be deducted from
future capital gains in order to reduce future tax, but at the end of 20X3, the company did
not expect any future capital profits and therefore no deferred tax was provided on the
capital loss of C40 000; and
x an increase in the doubtful debt allowance of C10 000: the tax authorities allow 20% of this
as a tax deduction when recognised as an allowance, but in full if and when the loss is
realised.
Required:
Disclose the earnings per share and dividends per share in the relevant extracts of the financial
statements of Yanky Limited for the year ended 30 September 20X3, in accordance with
International Financial Reporting Standards and in accordance with Circular 02/2013 (i.e. your
notes must include headline earnings per share).
Chapter 24 277
Question 24.6
The following information relates to Far Limited for the year ended 31 December 20X1:
FAR LIMITED
DRAFT RESULTS OF OPERATIONS
20X1 20X0
C C
Profit for the period 303 000 223 000
Preference dividends declared (3 000) (3 000)
Ordinary dividends declared (30 000) (30 000)
Retained earnings for the year 270 000 190 000
x The balances in equity at 1 January 20X0 comprised:
- 1 000 000 ordinary shares issued at C0,49 per share;
- 10 000 10% non-cumulative non-redeemable preference shares issued at C3 each (the
dividends on these preference shares are discretionary);
- Retained earnings of C60 000.
x In terms of an agreement with the bank the company undertook to make a capitalisation
issue in order to capitalise excess reserves. A capitalisation issue, utilising retained
earnings of C100 000, took place on 1 July 20X1, and involved the issue of 1 share for
every 2 shares held on this date.
Part A
Required:
Prepare extracts of Far Limited’s statement of comprehensive income, statement of changes
in equity and its earnings per share note for the year ended 31 December 20X1 in terms of
Part B
x The company had, for the first time, imported some of its inventory. A sudden collapse in
the value of the exchange rate resulted in a large foreign exchange loss of C100 000 on
the balance owing to the foreign creditor.
x Cash flow problems during 20X1 resulted in Far Limited being forced to dispose of land
at an auction. The net proceeds received on auction were C210 000 whereas the land had
cost the company C280 000. The land was measured at cost and was not depreciated.
The loss is a capital loss that may be deducted from future capital gains in order to reduce
future tax. At the end of 20X1, however, the company did not expect any future capital
profits and therefore no deferred tax was provided on the capital loss.
x During 20X1, the plant was revalued upwards by C200 000 in terms of the revaluation
model in IAS 16 Property, plant and equipment. This was recognised in other
comprehensive income.
x The deferred tax liability was increased by C30 000 as a result of the revaluation on plant.
278 Chapter 24
Required:
Prepare extracts of Far Limited’s statement of comprehensive income, statement of changes
in equity and its earnings per share note for the year ended 31 December 20X1 in terms of
International Financial Reporting Standards and in accordance with Circular 02/2013 (i.e.
your notes must include headline earnings per share).
Question 24.7
The following information relates to Laura Limited for the year ended 31 December 20X1:
x Laura Limited earned a profit for the year of C250 000 in 20X1 (20X0: C280 000).
x Laura Limited declared dividends in 20X1 and 20X0 as follows:
20X1 20X0
C C
Non-cumulative preference dividend declared on 31 December 3 000 3 000
Ordinary dividend declared on 31 December 10 000 12 000
x The balances in equity at 1 January 20X0 comprised:
- 100 000 ordinary shares issued at C1 each.
- 20 000 15% non-cumulative non-redeemable preference shares issued at C1 each.
The dividends on these preference shares are discretionary.
- Retained earnings of C120 000.
x There was a share split on 1/7/20X1 in which every 1 ordinary share became 2 shares.
Required:
Prepare extracts from the statement of comprehensive income and the statement of changes in
notes to the financial statements of Laura Limited for the year ended 31 December 20X1, in
Question 24.8
MATTHEW LIMITED
EXTRACTS FROM PRE-ADJUSTMENT TRIAL BALANCE
AT 31 DECEMBER 20X1
20X1 20X0
Debit/(Credit) Debit/(Credit)
Profit after tax (320 000) (290 000)
Non-cumulative non-redeemable preference dividend paid – 4 500 4 500
31/12
Non-cumulative non-redeemable participating preference 4 000 4 000
dividend paid – 31/12 (excluding the participating dividend)
Ordinary dividend paid – 31/12 10 000 0
The following information was extracted from the statement of financial position and related
notes:
Chapter 24 279
x Issued share capital consists of: C

- Ordinary shares, issued at 0,70 per share: 1/1/20X1 700 000
- 5% non-cumulative, non-redeemable, non-participating preference shares, 90 000
issued at C1 each: 1/1/20X1. The dividends on these preference shares are
discretionary.
- 20% non-cumulative, non-redeemable, participating preference shares, issued 20 000
at C0,50 each: 1/1/20X1 (these shares participate to the extent of 2/5 of the
ordinary dividend declared). The dividends on these preference shares are
discretionary.
x There was a rights issue on 30/9/20X1, in terms of which, each ordinary shareholder was
granted the right to purchase one share for every four shares held at C0,70. All the shares
offered were taken up on that day. The market price on this day was C1,40 per share.
Required:
a) Briefly explain the earnings per share and dividends per share disclosure requirements
relating to each of the three share types in issue and indicate where these line items
should/ may be presented.
b) Prepare, in accordance with International Financial Reporting Standards, the earnings per
share note and dividends per share note for the year ended 31 December 20X1.
Question 24.9
Trini Limited operates in the retail sector and is listed on the JSE. The following extract of
information is available for its financial year ended 31 December 20X8:
TRINI LIMITED
AS AT 31 DECEMBER 20X8
C
Capital reserves
Issued ordinary shares of C2 par value each 1 000 000
Share premium 200 000
The correctly calculated net profit after tax amounted to C3 220 000 for 20X8 (20X7:
C2 125 000).
x On 30 April 20X8, Trini Limited issued 125 000 shares at their market value of C5 per
share. Another issue of 30 000 shares took place on 30 November 20X8 at their market
value of C7 per share. A further issue of 30 000 shares took place on 20 January 20X9 at
their market value of C7 per share.
x Trini limited had a rights issue on 30 May 20X8 in terms of which one share was offered
at an exercise price of C3 for every 4 shares held on 30 May 20X8. The market price
immediately before the issue was C5 per share. All shares offered were taken up.
x On 31 October 20X8, Trini Limited consolidated its shares such that every 5 shares were
consolidated into 2 shares.
x An ordinary dividend of C275 000 was declared on 30 December 20X8. On 29 December
20X7 the ordinary dividend declared was C200 000.
280 Chapter 24
Part A
Required:
Disclose the earnings per share in the statement of comprehensive income and in the related
note to the financial statements of Trini Limited for the year ended 31 December 20X8 in
Part B
x A building was revalued up by C100 000 net of tax on 1 January 20X8. The building was
not previously impaired. The company does transfer the realised portion of the
revaluation surplus to retained earnings over the remaining useful life of the building of
8 years (straight line basis). Although this is not the first revaluation of Property, plant
and equipment, the revaluation reserve had a nil balance on 1 January 20X7. This was the
only revaluation for the 20X8 year (20X7: no revaluations).
x A goodwill impairment of C200 000 was provided for in 20X8 (20X7: C20 000).
Trini Limited also sold land at a loss of C30 000 during 20X8. Depreciation of C100 000
was provided for in 20X8 (20X7: C80 000).
Required:
Disclose the earnings per share in the statement of comprehensive income and in the related
note to the financial statements of Trini Limited for the year ended 31 December 20X8 in
accordance with International Financial Reporting Standards and in accordance with Circular
02/2013 (i.e. your notes must include headline earnings per share).
Ignore tax.
Section B: Basic, headline and diluted earnings per share
Question 24.10
a) Diluted earnings per ordinary share may be presented on the face of the statement of
comprehensive income, in the statement of changes in equity or in the notes to the
b) Diluted earnings per ordinary share and basic earnings per ordinary share must be
presented in the financial statements with equal prominence.
c) Diluted earnings per ordinary share may arise if ______________ ordinary shares exist.
Fill in the missing word and define ‘______________ ordinary shares’.
d) Diluted earnings per ordinary share will always be less than basic earnings per ordinary
share.
e) Give three examples of potential ordinary shares and briefly identify how these examples
could affect the earnings of the company.
Chapter 24 281
f) Options are only taken into consideration in the calculation of diluted earnings per share
once they have vested.
g) A potential ordinary share is anti-dilutive if the issue of this share would result in an
increase in basic earnings per ordinary share.
h) Options that are ‘out of the money’ are ignored when calculating diluted earnings per
share.
i) Options that are ‘in the money’ are always dilutive.
Question 24.11
Sprog Limited had a profit for the year ended 20X5 of C20 000. Details regarding the
company’s share capital and potential share capital at 31 December 20X5 are as follows:
x There are 200 000 authorised ordinary shares of no par value, of which 100 000 are in
issue.
x There are 500 convertible debentures in issue. These debentures may be converted into
ordinary shares in a ratio of 100 ordinary shares for every 1 debenture held, (at the option
of the debenture holder), on 31 December 20X8. Any debentures not converted at this
date will be redeemed. Finance charges of C1 505 were incurred on these debentures
during 20X5.
x There were no movements in share capital during 20X5.
x No dividends were declared in 20X5.
Required:
Disclose earnings per share in Sprog Limited’s statement of comprehensive income for the
year ended 31 December 20X5
Ignore tax.
Comparatives and notes to the financial statements are not required.
Question 24.12
Laser Limited has a profit for the year ended 31 December 20X5 of C125 000 (20X4: loss of
C50 000).
Details of Laser Limited’s share capital and potential share capital include the following:
x At 1 January 20X4 there were 100 000 ordinary shares in issue, all of which were issued
at a fair value of C1,75 per share.
x On 30 November 20X4, 12 000 ordinary shares were issued at a fair value C2,00 per
share. There have been no other issues since 30 November 20X4.
x There are 25 000 options in issue entitling the option holder to 1 ordinary share at a strike
price of C2,00 per share (the average market price of an ordinary share for 20X5: C2,75).
282 Chapter 24
x An interim ordinary dividend of C0,04 per share was declared and paid on the
30 June 20X5. On 15 December 20X5 a final ordinary dividend of C2 800 was declared.
x No dividends were declared in 20X4 due to the loss made in 20X4.
x Corporate income tax is levied at 35%.
Part A
Required:
Disclose earnings per share in the statement of comprehensive income of Laser Limited for
the year ended 31 December 20X5, in accordance with the International Financial Reporting
Standards.
Notes to the financial statements are not required.
Part B
Profit (or loss) for the year includes the following items:
x Profit on sale of plant (before tax): C25 000 (20X4: C25 000). This profit is fully taxable.
The plant was sold below cost.
x Amortisation of patent C5 000 (20X4: C0). The tax authorities do not allow deductions
relating to goodwill.
Required:
Disclose earnings per share in the statement of comprehensive income of Laser Limited for
the year ended 31 December 20X5, in accordance with the International Financial Reporting
Standards and in accordance with Circular 02/2013 (i.e. your notes must include headline
earnings per share).
Question 24.13
The following relates to Chipchop Limited for the year ended 31 December 20X5:
x Profit for the year C200 000 (20X4: C135 000).
x 1 January 20X4: 250 000 ordinary shares were issued at C5,00 each.
x 30 September 20X4: there was a rights issue on a basis of 1 ordinary share issued for
every 5 already held at a price of C6,00. The market value of the ordinary shares
immediately before the rights issue was C7,50 per share.
x 31 May 20X5: 50 000 ordinary shares were issued at price of C5 per share.
x There are 25 000 options in existence, each of which allows the holder to acquire four
shares at a strike price of C7,00 per share. The options have already vested but will only
expire in many years to come. The average market price per ordinary share for 20X4 and
20X5 was C8,00. These options were in existence throughout 20X4 and 20X5.
x Preference shares in issue are convertible (at the option of the preference shareholders)
into 50 000 ordinary shares on 31 December 20X7.
- If not converted, the preference shares will be redeemed on 31 December 20X7.
Chapter 24 283
- Dividends of C1 000 are incurred annually on these preference shares (these have
been correctly accounted for as finance charges).
- The preference shares were in existence throughout 20X4 and 20X5.
x Income tax is levied at 30%.
Part A:
For this part of the question, consider all information above.

Required:
Disclose earnings per share in the financial statements of Chipchop Limited for the year
ended 31 December 20X5 in accordance with International Financial Reporting Standards.
Part B:
For this part of the question, consider all of the relevant information, as well as the following:
x Profit for the year C200 000 (20X4: C135 000). This profit includes a profit on sale of
plant of (before tax) C30 000 (20X4: C0). The plant was sold below cost.
Required:
Disclose earnings per share in the financial statements of Chipchop Limited for the year
ended 31 December 20X5 in accordance with International Financial Reporting Standards and
in accordance with Circular 02/2013 (i.e. your notes must include headline earnings per
share).
Question 24.14
The following information is available for Cousins Limited at 31 December 20X8:
20X8 20X7 20X6
C C C
Profit for the year 650 000 550 000 400 000
Issued ordinary shares ? ? 683 750
10 000 12% participating preference shares 200 000 200 000 200 000
75 000 7% convertible preference shares 225 000 225 000 0
Options N/A N/A N/A
40 000 10% convertible debentures 16 000 0 0
x The ordinary shares were all issued at C1 each.
x The 12% participating preference shares were all issued at C20 each.
- The participating preference shares are non-redeemable and non-cumulative, and
participate to the extent of C1 for every C11 paid to ordinary shareholders. The
dividends on these preference shares are discretionary.
x The 7% convertible preference shares were all issued at C3 each.
- The convertible preference shares (recognised as a liability) are cumulative and
convertible at the option of the preference shareholder into ordinary shares at a rate of
284 Chapter 24
three ordinary shares for every four convertible preference shares on

31 December 20X8.
- The preference dividend was declared in 20X8 together with the 20X7 preference
dividends (recognised as finance costs on the preference share liability).
- Finance costs deducted in arriving at profit after tax amount to C15 750.
x The 10% convertible debentures were all issued at C4 each.
- These debentures are convertible on 28 February 20X9 at the option of the debenture
holders into Cousins Limited ordinary shares at a rate of two ordinary shares for
every seven debentures.
- If not converted into ordinary shares they will be redeemed on 28 February 20X9.
x On 31 March 20X7, 50 000 ordinary shares were issued.
x On 1 May 20X7, 165 000 ordinary shares were issued in terms of a capitalisation of
reserves.
x On 4 January 20X4, the directors of Cousins Limited were offered 25 000 shares,
contingently issuable upon Brothers Limited generating total revenue of C50 million over
five years. No such shares have yet been taken up by the directors at 31 December 20X8.
x Cousins Limited’s revenue for the year ended 31 December 20X8 was C30 million
(20X7: C20 million).
x On 1 January 20X8, options were issued offering the acquisition of 67 500 ordinary
shares in Cousins Limited after 1 January 20X9 at a strike price of C4 per share. The
average market price of the shares during 20X8 was C9 per share.
x On 30 September 20X8, Cousins Limited undertook a share buy-back of 200 000 ordinary
shares at C5 per share.
Required:
Disclose earnings per share in the financial statements of Cousins Limited for the year ended
Chapter 24 285
GAAP: Graded Questions Fair value measurement
Chapter 25
Fair value measurement
Question Key issues

25.2 Tumbleweed Measurement of fair value in terms of the principal or most

advantageous markets
25.3 Geography General understanding of the measurement of fair value in

terms of the principal or most advantageous markets
25.4 Harmon General understanding of the highest and best use principle
25.5 Jack General understanding of definitions and fundamental

concepts, with specific reference to principal and most
advantageous markets
25.6 Snow White Fair value measurement – non-financial assets
25.7 Little Red Riding Hood Fair value measurement – financial assets
Fair value hierarchy
25.8 Huntsman Fair value measurement – financial liabilities and an entity’s

own equity instruments
25.9 Magic Mirror Fair value hierarchy: assessment of the levels – financial assets
286 Chapter 25
Question 25.1
a) Define the term ‘fair value’ and briefly explain whether it is an entity-specific or a market-
specific measurement.
b) List the standards to which IFRS 13 Fair value measurement does not apply at all.
c) IFRS 13 Fair value measurement must be applied to the measurement and disclosure of
‘fair value less costs of disposal’, being a term referred to in IAS 36 Impairment of assets.
True or false? Briefly justify your answer.
d) The fair value of an asset or liability must take into consideration the specific
characteristics of that asset or liability. True or false? Briefly justify your answer.
e) Fair value is measured in terms of the most advantageous market unless a most
advantageous market does not exist, in which case we must measure the fair value in terms
of the principal market instead. True or false? Briefly justify your answer.
f) Briefly explain the difference between the term principal market and the term most
advantageous market.
g) Transport costs are considered to be a transaction cost and since fair value is measured
after taking into account all transaction costs, the transport costs that would be incurred to
sell an asset must also be taken into account when measuring fair value. True or false?
Briefly justify your answer.
h) What is the definition of ‘highest and best use’ and when do we need to consider highest
and best use?
i) List the three valuation techniques referred to in IFRS 13 Fair value measurement.
j) The inputs used when applying a valuation technique are categorised into three different
types. Briefly outline the different input types and identify how we would categorise a
quoted price of an identical asset in an inactive market.
Required:
Question 25.2
Tumbleweed Limited has an asset that needs its fair value measured in terms of IFRS 13 Fair
value measurement. The accountant is unsure what the fair value would be. He has
summarised the information he has on hand for your benefit:
The asset could be sold in either Durban or Johannesburg:

x If the asset is sold in Durban, the selling price will be C10 800, the transport costs will be
C1 200 and the transaction costs would be C1 200.
x If the asset is sold in Johannesburg, the selling price will be C10 000, the transport costs
will be C800 and the transaction costs would be C400.
Required:
Explain how the fair value should be measured assuming that:

a) Durban is the principal market;
b) Johannesburg is the principal market;
c) There is no principal market.
Chapter 25 287
Question 25.3
Geography Limited wants to sell specialty maps which contain information about a desert
area. The following information relates to two markets which Geography Limited can sell
their specialty maps to:
x Private collectors market: return of C80;
x School market: return of C50.
Geography Limited trades in the private collectors market, as it allows them to generate the
highest return. However, a higher volume of transactions occur in the school market, due to
students requiring the maps for their final exams.
Required:
Identify the fair value, and explain the reason for your answer.
Question 25.4
Harmon Limited is a business which manufactures high quality film projectors for cinemas.
When the business began, Harmon Limited purchased a machine to produce projectors.
However in the current year, due to a decrease in demand for film projectors, Harmon
Limited needed to downsize its operations.
Management decided to sell their machine in the current year. It meets all the requirements of
IFRS 5 Non-current assets held for sale. The machine is currently operating at below
capacity, producing 100 projectors a month.
When using the IFRS 13 income approach to determine the fair value of the machine, the
financial director decided to use the current production of 100 projectors a month. Using this
approach, he estimated the fair value to be C10 000 000.
If the valuation using the income approach was used based on the full capacity of the machine
(150 projectors a month), then the fair value is estimated to be C12 000 000. Note that
150 projectors produced per month is what the market participants consider to be its highest
and best use.
Required:
Discuss whether the financial director was correct in using the estimated fair value of
C10 000 000, and if not, what is a more appropriate estimate.
Question 25.5
Jack, an avid collector of beans, recently purchased a magical blue bean from a mysterious
fairy he met while travelling along a yellow brick road. Jack paid the fairy C100 000 for the
bean and happily took it back to his parents’ farm, just outside the Emerald City.
Magical blue beans are not normally purchased from fairies but rather from three areas which
are known trading hotspots. The details of the three markets are shown below:
Mr Bean’s Beanery Bean There Giant Beans

Selling price per bean C120 000 C100 000 C200 000
Average number of sales per annum 1 000 000 1 000 000 800 000
Market entry fee C20 000 C20 000 C20 000
288 Chapter 25
If Jack were to sell the blue bean he would have to pay to get the bean from his parent’s farm
to the trading hotspots. The cost to get the bean to Mr Bean’s Beanery, Bean There and Giant
Beans is C20 000, C10 000 and C10 000 respectively.
Regardless of where the asset is sold, the bean merchants charge a 10% transaction fee, based
on the selling price of the asset. Jack has a ‘magical charm’, however, and thus tends to
achieve a 5% higher selling price on his bean if he personally makes the sale, irrespective of
the market in which the sale occurs.
A leading newspaper, called the Fairy Tale Weekly, recently published a number of articles
about the fraudulent grinding of beans by Bean There, which prompted the Fairy Police to
intervene.
Bean There has since had its doors forcefully closed and is in the process of liquidating its
beans to pay the fines due to the Fairy Police. As a result the prices were reduced to a final
clearance cost, which is represented in the selling price above.
The liquidation of Bean There has caused speculation that the selling price for beans will
increase by 50%, on their current selling price, due to shortages of available bean suppliers.
Jack’s parents were less than impressed with the purchase because Jack had promised them
that he would buy something that would provide an adequate investment return to fund their
rapidly approaching retirement.
As punishment, Jack has been given two options by his parents, namely to fight the fire-
breathing Jabberwocky and bring back its scales (which are highly valuable) or to apply the
criteria of IFRS 13 Fair Value Measurement to the bean and establish its fair value.
Although Jack would have preferred to risk his life fighting the Jabberwocky, he did not have
the time to travel to Wonderland, the home of the Jabberwocky, since he works for a firm of
fairy auditors (the firm called Enchanted Accountants) who have him scheduled to attend a
bean count at a local store. Reluctantly Jack has decided to apply the criteria of IFRS 13
instead and thus spent the next few minutes drafting a document for his parents explaining
that the cost paid would adequately suffice as reflection of the fair value of the bean.
Required:
Discuss whether you agree with Jack’s measurement of the fair value. Your answer should
include a detailed analysis of all three markets, indicating the principal market and the most
advantageous market, as well as a final measurement of what the fair value of the bean should
be per IFRS 13 Fair value measurement.
Question 25.6
After settling down with Prince Charming, Snow White became somewhat bored with
‘happily ever after’ and decided to sell off some of her positions to fund a trip to Bali. Being a
princess, Snow White had countless items of jewellery but very little knowledge in what her
jewellery collection is worth. She decided that it would be best if she first determined the fair
value of her jewellery before she went ahead and sold her collection.
Upon examining her jewellery collection, Snow White identified a particular set of jewellery
(i.e. various items of jewellery that are intended to be worn together) that she wishes to sell
first. This set includes the following items of jewellery:
x seven pairs of earrings,
x seven necklaces and
x seven brooches.
Chapter 25 289
This set was received as a gift when the market value, per item, was as follows:
Market Value
Pair of earrings C30 000
Necklace C75 000
Brooch C50 000
The kingdom of Happily Ever After has a vibrant market for jewellery which Snow White has
established is, in fact, the principal market for jewellery sales. Two primary buyers exist
within this principal market, namely the Seven Dwarves (their jewellery buying has increased
drastically since they began dating) and the Queen.
The Queen primarily uses the jewellery that she buys to create malicious devices to ruin the
‘happily ever after’ dreams of others. This process is rather costly as it requires the Queen to
melt the jewellery and thus extract the raw components (gold and jewels), which are then sold
to Rumpelstiltskin, at a standard price of C120 000 per item (e.g. C120 000 for a pair of
earrings and C120 000 for a necklace), who uses them to concoct wicked tricks.
The Queen, having fallen out of grace with the kingdom after Prince Charming took control,
is financially dependent on her sale of raw components to Rumpelstiltskin to survive. If the
Queen bought the jewellery, she would typically pay the following per item:
Price
Necklace C90 000
Brooch C65 000
The queen would incur conversion costs as follows:

Conversion costs
Necklace C10 000
Brooch C70 000
As the Queen has no desire to ever wear the princess’s jewellery, if she were to transact with
the princess, she would buy the pieces on an individual basis.
The Seven Dwarves, on the other hand, adore spoiling their newfound loves and avidly hunt
beautiful collections of jewellery to give as gifts. The Seven Dwarves believe that jewellery
should be purchased as a set wherever possible but are not averse to the idea of buying the
pieces individually. As the Seven Dwarves all buy simultaneously, they often negotiate bulk
discounts on their purchases, the prices for the jewellery are seen below:
Value as a set Price in collection Price in collection with bulk discount
Pair of earrings C50 000 C45 000
Necklace C80 000 C75 000
Brooch C75 000 C70 000
Price for a set C205 000 C190 000
Value in isolation (i.e. sold as Price in isolation Price in isolation with bulk
individual items rather than as a set) discount
Pair of earrings C55 000 C50 000
Necklace C75 000 C70 000
Brooch C80 000 C75 000
290 Chapter 25
Required:
Discuss, in detail, what the measurement of fair value would be for this particular set of
jewellery that Snow White wishes to sell.
Question 25.7
Little Red Riding Hood loves her grandmother, Granny, very dearly and would do nearly
anything to help her. Recently Granny purchased 1 000 000 shares in Gingerbread Limited, a
company listed in the world renowned Fairy Tale Exchange.
Granny asked Little Red Riding Hood to determine the fair value of the shares in Gingerbread
Limited, but Little Red Riding Hood realised this would entail reading IFRS 13 Fair value
measurement and so, for the first time ever, she flatly said “No!” Surprised and very
saddened, Granny has approached you, an expert on all things abstract, arbitrary and IFRS-
related to measure the fair value of the share.
At measurement date the Fairy Tale Exchange showed the following information:
Bid price Ask price Mid
Gingerbread Limited C120 C100 C110
Granny purchased the shares in Gingerbread Limited because they have been trading,
historically, very well and the analysts at Crystal Ball Analysts convinced her that they
predict that the share will continue to do well into the future.
However, the analysts at Crystal Ball Analysts believe that, were Granny to sell all her shares,
the market would not have sufficient capacity to absorb the shares at their current price, thus a
more representative range would be:
Bid price Ask price Mid
Gingerbread Limited C110 C90 C100
Required:
Discuss what the IFRS 13 fair value should be for the shares in Gingerbread Limited,
providing both a reason for your answer as well as which level within the fair value hierarchy
the determination would fall.
Question 25.8
The Huntsman Limited is a public company that does not trade its equity actively on a stock
exchange. Being in a not-so-lucrative business of hunting, The Huntsman Limited has a
number of debts outstanding and has recently issued equity preference shares to raise funds
for the purchase of a new axe. The Huntsman Limited, although good with sharp knives, is
not very sharp when it comes to understanding IFRSs.
The debt liability arose due to a loan taken out from The Queens Bank two years ago. The
face value of the loan liability on issue date was C1 000 000. As economic conditions have
been tough on The Huntsman, they have not paid back any capital on the loan. Over the last
two years, The Queens Bank has been found to be involved in a number of shady dealings.
Its reputation has thus been tarnished with the result that there is a market discount on the
loan of 10%.
The Huntsman Limited’s equity preference shares last traded on an exchange four months ago
at C10 000 per share, after which time they were de-listed due to The Huntsman Limited not
meeting the listing requirements. The delisting value of the preference shares was C8 000 per
share. At measurement date there was no published price for the preference shares.
Chapter 25 291
The analysts at Crystal Ball Analysts have shown that the value per share from the
perspective of those who hold The Huntsman Limited preference shares is C4 500 per share.
Required:
Discuss how The Huntsman Limited should measure the fair value of its loan liability and
equity preference shares.
Question 25.9
The Magic Mirror has recently performed a number of valuations in accordance with IFRS 13
Fair value measurement. He is, however, not certain as to which level within the fair value
hierarchy the valuation techniques fall.
a) The value for a share in Heartless Limited was determined through the Fairy Tale
Exchange, an internationally compliant stock exchange and a very active market.
b) Magic Mirror issued debentures which have both an equity component and a liability
component. The liability component is held at fair value through profit and loss. The
debenture is actively traded on the Fairy Tale Exchange.
c) Magic Mirror valued the private kingdom of Almost-Happily Ever After using a
weighted average cost of capital which Magic Mirror derived.
d) Magic Mirror holds a bond asset in Poison Apple Limited. Although the bond is not
actively traded, a valuation was able to be derived through the use of a bond-yield curve
published by the Fairy Tale Exchange.
Required:
Explain what level within the fair value hierarchy the valuations would be included.
292 Chapter 25
GAAP: Graded Questions Accounting policies, Changes in accounting estimates & Errors
Chapter 26
Accounting policies,
changes in accounting estimates and errors
Question Key issues

26.2 Sue and Ru IAS 8: How to classify a change
IAS 16: Property, plant and equipment - diminishing balance to straight line
26.3 Miss Valentine IAS 8: How to classify a change
IAS 2: Inventory – change from weighted average to first-in-first-out
26.4 Dreamcoat IAS 8: Change in estimate: residual value decreases: reallocation method
Part A: Residual value decreased
Part B: Residual value increased
Part C: Residual value increased above carrying amount
26.5 Selfies IAS 8: Change in estimate: useful life
Part A: Reallocation method
Part B: Cumulative catch up method
26.6 Mild IAS 8: Change in estimate: useful life: reallocation method
26.7 Vertex IAS 8: Change in estimate: useful life, residual value and method:
reallocation method
26.8 Honest IAS 8: Correction of error: depreciable asset expensed
IAS 12: Tax assessments were correct
26.9 Hot IAS 8: Correction of error versus Change in accounting policy
IAS 2: Inventory measurement:
IAS 12: Tax assessments were incorrect and to be re-opened
Part A: Correction of error
Part B: Change in policy
26.10 Neptune IAS 8: Correction of error: expense capptalised as a depreciable asset
IAS 8: Change in estimate: useful life and residual value: reallocation method
IAS 12: Tax assessments were correct
26.11 Three Bears IAS 8: Correction of error: fictitious sales
IAS 12: Tax assessments were incorrect and to be re-opened
26.12 Cinnamon IAS 8: Change in estimate: useful life: RAM
IAS 8: Correction of error (CY): expense capitalised as a depreciable asset
IAS 8: Correction of error (CY): PAYE recognised as revenue
IAS 12: Tax assessments were incorrect but will be corrected in current year
Chapter 26 293
GAAP: Graded Questions Accounting policies, changes in accounting estimates and errors
Question 26.1
a) Define the term 'accounting policy'.

b) List the circumstances under which an accounting policy may be made.
c) In one word, explain how to account for a voluntary change in accounting policy.
d) Identify whether the following statement is true or false and if it is false, provide a brief
explanation as to why you believe it to be false:
All changes in accounting policies are accounted for in the same way.
e) List the occasions when retrospective adjustments would be required.
f) Briefly explain how to account for something 'retrospectively'.
g) Define the term 'change in accounting estimate'.
h) In one word, explain how to account for a voluntary change in accounting estimate.
i) Briefly explain how to account for a change in accounting estimate.
j) Briefly explain why we account for a change in accounting estimate in this way and not in
the way in which we account for a change in accounting policy.
k) Define the term 'error'.
l) Identify whether the following statement is true or false and if it is false, provide a brief
explanation as to why you believe it to be false:
All errors that are discovered are corrected in terms of IAS 8.
m) In one word, explain how to correct a material prior period error.
n) What is the main difference between the disclosure required for a change in accounting
policy, and a correction of material error?
o) Why is a change in estimate not considered to be a correction of error?
Required:
You are required to provide brief answers to each of the above questions.
Question 26.2
Sue and Ru are two honours students who are debating how a change from the diminishing
balance method of depreciation to the straight-line method of depreciation should be
accounted for.
Required:
Prepare a document that provides a logical argument explaining how this change should be
accounted for.
Question 26.3
Miss Valentine is the new accountant of a large chain of sweet shops ‘Sweets with Love’. It
is a legislative requirement of the National Sweets Board that sweets that have passed their
sell-by-date cannot be sold. The NSB claim that this is essential in order to prevent food
poisoning and related legal claims. Miss Valentine is convinced that this regulation is in place
simply in order to prevent a supply glut in the industry that would result in reduced prices,
which would ultimately reduce the levies that the NSB would receive from the sweet retailers.
294 Chapter 26
She has therefore insisted that her company’s inventory is actively sold on a first-in-first-out
basis. She recently noticed, however, that the inventory cost formula used by ‘Sweets with
Love’ is the weighted average method.
Not only does she believe that the first-in-first-out method should be actively followed from a
practical point of view in order to prevent spoilage, but she has also decided that her company
should use this method for accounting purposes as well. Miss Valentine is unsure how this
change should be dealt with in the financial statements, being in two minds as to whether it
should be accounted for as a change in estimate or a change in policy.
Required:
Write a letter to Miss Valentine in which you explain how she should account for the change
from the weighted average (WA) method to the first-in first-out (FIFO) method for measuring
the cost of inventory.
Question 26.4
Dreamcoat Limited purchased a vehicle for C10 000 on 1 January 20X0, when the estimated
residual value amounted to C1 000 and the estimated useful life was 10 years.
During 20X6, the estimated residual value:

Part A: decreased to C600.
Part B: increased to C1 500.
Part C: increased to C5 000.
Dreamcoat Limited uses the reallocation method to record changes in accounting estimates.
Required:
a) Disclose the ‘change in estimate’ note and the separately disclosable item: depreciation,
b) Provide the journal entries necessary assuming that depreciation had not yet been
processed in the financial records for 20X6.
c) Provide the journal entries necessary assuming that depreciation based on the old estimate
had already been processed in the financial records for 20X6.
Question 26.5
Part A:
Ms Scarlet is a very successful business woman who owns her own photo printing company,
Selfies Limited. Ms Scarlet saw a great business opportunity in the printing sector, printing
classic pictures onto different materials, such as board, canvas and fabric.
The company owns very costly printing equipment, which was purchased on 1 April 20X1 at
a cost of C1 020 000. The equipment originally had an estimated useful life of 6 years and
was depreciated to a nil residual value on the straight-line basis.
On 1 April 20X3, the total useful life of the equipment was re-estimated to be 10 years.
Selfies Limited uses the re-allocation method to account for changes in accounting estimates.
The tax authorities levy tax on taxable profits at 30% and use a 6-year period for purposes of
calculating the wear and tear allowance.
Chapter 26 295
Required:
a) Show the depreciation journals necessary from the information provided, assuming:
i) Depreciation had not yet been processed for the year ended 31 March 20X4.
ii) Depreciation based on the old estimate had already been processed for the year ended
31 March 20X4.
b) Show the related deferred tax journal for the year ended 31 March 20X4 assuming that
both depreciation and the tax for the year had already been processed.
c) Show how the above-mentioned information would be disclosed in the notes to the
financial statements of Selfies Limited for the year ended 31 March 20X4.
Include both the statement of compliance and the accounting policy note for property,
plant and equipment.
Comparatives are required
Part B:
Use the same information as that provided in Part A except that the company uses the
cumulative catch-up method to account for changes in estimate.
Required:
Repeat parts (a) – (c) shown under Part A above.
Question 26.6
You are given the following statement of comprehensive income for the year ended
31 December 20X5, drafted before adjusting for the effects of the change in estimate
described in the additional information:
MILD LIMITED
DRAFT STATEMENT OF COMPREHENSIVE INCOME
20X5 20X4
C C
Profit before taxation 500 000 650 000
Mild Limited owns vehicles (its only item of property, plant and equipment) the original
details of which are shown below.
Cost C600 000
Purchase date 1/1/20X2
Estimated useful life (estimated on date of purchase) 8 years
Depreciation to nil residual value Straight-line
On 1 January 20X5, the total estimated useful life was revised to 6 years. The company uses
the re-allocation method to account for changes in estimates. The statement of comprehensive
income had been drafted after accounting for depreciation based on the previous estimate.
The corporate tax rate is 30%.
296 Chapter 26
Required:
a) Prepare the necessary journal entries assuming that depreciation had already been
processed in the 20X5 accounting records based on the old estimate.
b) Prepare the notes to the financial statements of Mild Limited for the year ended
Include both the statement of compliance and the property, plant and equipment
accounting policy note.
c) Prepare the statement of comprehensive income of Mild Limited for the year ended
d) Disclose property, plant and equipment in the statement of financial position of
Mild Limited as at 31 December 20X5 in accordance with International Financial
Reporting Standards
Question 26.7
Vertex Limited’s draft statement of comprehensive income and statement of changes in equity
had been prepared for the year ended 31 December 20X6 by the bookkeeper before taking
into account certain decisions that had been made by the directorship.
VERTEX LIMITED
20X6 20X5
C C
Revenue 800 000 650 000
Profit before depreciation 380 200 300 000

Depreciation – plant (51 200) (64 000)
Income tax expense: (131 600) (94 400)
- Current 112 080 80 000
- Deferred 19 520 14 400
Total comprehensive income 197 400 141 600
VERTEX LIMITED
DRAFT STATEMENT OF CHANGES IN EQUITY
Retained earnings
C
Balance: 1 January 20X5 (40 000)
Total comprehensive income 141 600
Dividends (10 000)
Balance: 31 December 20X5 91 600
Dividends (15 000)
Balance: 31 December 20X6 274 000
Chapter 26 297
During 20X6 the directors decided it was necessary to change from the reducing balance
method (at a rate of 20% per annum) to the straight-line method of calculating depreciation
for its plant.
x The directors agreed that the remaining estimated life of the plant was 3 years (calculated
from 1 January 20X6) and the estimated residual value C16 000 (previously this was nil).
x This plant had been purchased on 1 January 20X3 for C500 000.
x Vertex accounts for changes in estimates using the re-allocation method.
x The tax rate has remained constant at 40%.
x The tax authority grants a 40:20:20:20 allowance over four years.
Required:
a) Provide the journal entries necessary assuming that depreciation based on the old
estimate had already been processed in the financial records for 20X6.
b) Prepare the statement of comprehensive income, extracts from the statement of changes in
equity and related notes to the financial statements of Vertex Limited for the year ended
31 December 20X6, in compliance with International Financial Reporting Standards.
Provide the statement of compliance, the property, plant and equipment accounting
policy note and the profit before tax, taxation and change in estimate notes.
Question 26.8
Honest Limited is an engineering company. It purchased its only item of equipment on

2 January 20X1 at a cost of C100 000.
During the 20X2 financial year it was discovered that:

x The purchase of this equipment had been recorded as a repair expense.
x Depreciation on the equipment should have been provided at 10% per annum to a nil
residual value on the straight-line basis.
The profit before depreciation and repair expenses for the 20X1 financial year was
C2 000 000.
The tax authorities allow a wear and tear allowance of 10% per annum on the cost of the
equipment, also on the straight-line basis. The correct information had been submitted to the
tax authorities for tax assessment purposes.
The corporate tax rate is 30% (unchanged for many years).
Required:
a) Prepare the correcting journal entries that are processed in the 20X2 year.
b) Prepare the correcting journal entries that would have been processed if the error was
discovered at the end of the 20X1 year.
c) Explain how your answer would have changed had the error made in 20X1 and
discovered in 20X2 affected the information submitted for tax assessment purposes (i.e.
the information submitted to the tax authorities was also incorrect) and that the tax
authorities would thus re-open all prior incorrect assessments and re-assess the company.
298 Chapter 26
Question 26.9
Part A:
Hot Limited has recently discovered that inventory has been incorrectly valued using the
weighted average method (WA) instead of the first-in-first-out method (FIFO) for the past
four years.
The error is considered to be material. The tax authorities will be re-opening the tax
assessments for all year/s affected. Income tax is levied at 30%.
The effect of this error is as follows:
Year-end inventory balances 20X7 20X6 20X5 20X4

C C C C
WA method (did use) 15 000 14 000 12 000 10 000
FIFO method (should have used) 18 000 15 000 14 000 11 000
The draft financial statements before correcting this error are shown below
.
HOT LIMITED
20X7 20X6
C C
Revenue 1 200 000 900 000
Cost of sales (420 000) (350 000)
Gross profit 780 000 550 000
Other costs (220 000) (200 000)
HOT LIMITED
Retained
earnings
C
Balance: 1/1/20X6 67 500
Total comprehensive income: 20X6 213 500
Balance: 31/12/20X6 281 000
Total comprehensive income: 20X7 324 800
Balance: 31/12/20X7 605 800
Required:
Prepare the statement of comprehensive income, statement of changes in equity, statement of
financial position, statement of compliance, accounting policy note for inventory and the
correction of error note for inclusion in Hot Limited's financial statements for the year ended
31 December 20X7, in terms of International Financial Reporting Standards.
Chapter 26 299
Part B
Use the information provided in part A, except that, instead of there being an error, the
accounting policy was changed from recording inventory movements using the weighted
average formula to using the first-in, first-out formula instead.
Required:
Prepare the statement of comprehensive income, statement of changes in equity, statement of
financial position, statement of compliance, accounting policy note for inventory and the change
in accounting policy note for inclusion in Hot Limited's financial statements for the year ended
31 December 20X7, in terms of International Financial Reporting Standards.
Question 26.10
Neptune Limited is a company operating in the plastic recycling industry. The following
information still needs to be accounted for before preparing the financial statements for the
During 20X6, the plant's residual value was re-estimated from C6 000 to C12 000 and the
total expected useful life of plant was re-estimated from 12 years to 20 years. The plant had
all been purchased on 1 January 20X2 (cost: C300 000). Depreciation on plant is provided on
the straight line method. The accountant has already processed the plant's depreciation for
20X6, before taking into account the changes to the residual value and useful life.
During 20X6, it was discovered that fuel purchased on 1 April 20X4 for C250 000 had been
incorrectly debited to vehicles, as a separate new vehicle. This fuel had all been used during
20X4. The cost of vehicles was otherwise C1 200 000, all having been purchased on
1 January 20X3. The company depreciates vehicles on the straight-line basis at 10% per
annum to nil residual values (apportioned for periods less than a year). The accountant has
already processed the depreciation on vehicles for 20X6, before correcting this error.
x The taxable profit and tax base were correctly calculated in all years affected.
x The opening retained earnings as at 1 January 20X5 was C800 000. There were no
dividend declarations or transfers to or from retained earnings during 20X5 and 20X6.
x The only movement in the carrying amount of plant and vehicles was depreciation and the
incorrect debit referred to above.
The following draft extracts of the statement of comprehensive income and statement of
financial position have been presented to you (the additional information above has not yet
been taken into account in preparing these statements):
NEPTUNE LIMITED
DRAFT EXTRACTS FROM STATEMENT OF COMPREHENSIVE INCOME
20X6 20X5
C C
300 Chapter 26
NEPTUNE LIMITED
DRAFT EXTRACTS FROM STATEMENT OF FINANCIAL POSITION
AT 31 DECEMBER 20X6
20X6 20X5 20X4
C C C
Property, plant and equipment 1 078 750 1 248 250 1 417 750
- Plant carrying amount 177 500 202 000 226 500
- Vehicles carrying amount 901 250 1 046 250 1 191 250
Retained earnings ? ? 800 000
Deferred tax liability 168 000 180 000 204 000
Required:
a) Calculate the effect of the change in estimate using the re-allocation method, showing
clearly the effect on the current year depreciation and the future years’ depreciation.
b) Show all the journal entries that would need to be processed to effect:
x the change in accounting estimate; and
x the correction of the error.
c) Disclose the following for inclusion in the annual financial statements for the year ended
31 December 20X6 in conformity with International Financial Reporting Standards:
x the change in estimate note;
x the correction of error note;
x the statement of comprehensive income;
x the retained earnings in the statement of changes in equity; and
x the statement of financial position.
Accounting policies are not required
Question 26.11
Three Bears Limited is a furniture retailer, which operates branches throughout South Africa.
On 28 August 20X8 the Ficksburg branch suffered heavy losses due to looters involved in
Lesotho riots coming over the border and burning and looting shops in the area.
THREE BEARS LIMITED

STATEMENT OF COMPREHENSIVE INCOME
20X8 20X7
C C
Revenue 22 000 000 20 000 000
Cost of inventory expense (16 500 000) (15 000 000)
Other expenses (7 158 000) (4 080 000)
(Loss) / profit before taxation (1 658 000) 920 000
Income tax expense 580 300 (322 000)
(Loss)/ profit for the year (1 077 700) 598 000
Total comprehensive (loss)/ income for the year (1 077 700) 598 000

x The loss suffered on 28 August 20X8 comprised the destruction of both inventory and
equipment.
Chapter 26 301
x The cost of the inventory amounted to C2 400 000.

x The equipment had a carrying amount of C562 500 and a tax base of C468 750 on
1 October 20X7. The original cost of this equipment was C750 000 and it has been
depreciated to a nil residual value at 10 % p.a. on the straight-line basis. The tax authority
has granted a wear and tear allowance of C112 500 for both 20X7 and 20X8
x These losses have been correctly calculated and are included in “loss before taxation”.
x Shortly before the end of September 20X8, management discovered that the sales
manager of the Cape Town branch had recorded several fictitious credit sales invoices,
amounting to C350 000 during the period February 20X7 to July 20X7. He did this in
order to make performance of his branch look more impressive in order to enhance his
chances of promotion. He was fired instead.
This loss is considered to be material to the results of the company.
No entries have been processed to account for this fraud.
Three Bears Limited uses the periodic system to account for inventory.
All the information needed to report the correction of the error is available.
The tax authority will re-open the tax assessment for the affected period.
x The balance on retained earnings amounted to C1 373 500 at 30 September 20X7 and to
C295 800 at 30 September 20X8.
x A dividend of C150 000 was paid for the year ended 30 September 20X7. No dividends
were paid for the year ended 30 September 20X8.
x The applicable tax rate is 35%. The company expects to make future taxable profits that
will enable the recovery of any assessed loss. There are no other temporary differences
other than those indicated by the information presented.
Required:
a) Prepare the necessary journal entries relating to the newly discovered fraud.
b) Prepare the statement of comprehensive income, the statement of changes in equity and
the notes thereto for the year ended 30 September 20X8 of Three Bears Limited, in
Comparatives are required to the extent that information has been provided. Notes
regarding the basis of preparation and significant accounting policies are not required.
Question 26.12
Cinnamon Limited is a company operating in the herbs and spices industry. The following
three items were identified during the audit of its financial statements for the current year
ended 31 December 20X3, no adjustments for which have yet been processed:
Item 1:
x The bookkeeper erroneously credited revenue with Pay-as-you-earn (PAYE) of C250 000
owing to the tax authorities in 20X2.
x As a result the current tax in 20X2 had been incorrectly estimated by the accountant and
the incorrect figures were submitted on the 20X2 tax returns.
x This error did not affect the salaries and wages expense, nor the amount paid to
employees. The tax authorities will be re-opening the tax assessment for 20X2.
302 Chapter 26
Item 2:
x A repair expense on 1 May 20X3 of C600 000 was capitalised as equipment. All other
equipment had been purchased on 1 July 20X1 at a cost of C1 200 000.
x Depreciation on equipment is calculated at 15% per annum on the straight-line basis to nil
residual values.
x Wear and tear was then erroneously claimed on this 'equipment'. This then affected the
calculation of taxable profit and also the tax base. Equipment is used to manufacture
inventory. There was no inventory on hand at year end.
Item 3:
x The total useful life of vehicles was changed from twelve years to six years.
x The method of depreciation remained the straight-line method and the residual value of
each vehicle remains nil.
x This decision was made in a management meeting in 20X3, but the accountant was not
informed.
x The entire fleet of vehicles was purchased on 1 April 20X0 at a cost of C360 000 and is
used for delivering goods to customers.
The draft financial statements relating to Cinnamon Limited are provided below.
CINNAMON LIMITED
20X3 20X2
C C
Revenue 4 572 000 3 120 000
Cost of sales (2 736 000) (1 392 000)
Gross profit 1 836 000 1 728 000
Other income 300 000 120 000
Other costs (1 068 000) (900 000)
Profit before taxation 1 068 000 948 000
CINNAMON LIMITED
Retained
earnings
C
Balance – 1 January 20X2 1 080 000
Total comprehensive income – 20X2 699 600
Balance – 31 December 20X2 1 779 600
Total comprehensive income – 20X3 829 200
Balance – 31 December 20X3 2 608 800
Additional information: 20X3 20X2

x The line item ‘other income’ includes the following C C
Profit on sale of building (exempt from tax: see note below) 180 000 0
Dividend income (exempt from tax) 120 000 120 000
Note: The capital gain on the sale of the building, as calculated in terms of the capital
gains tax legislation, was zero. There were no tax allowances allowed on the building.
Chapter 26 303
20X3 20X2
x The line item ‘other costs’ includes the following: C C
Depreciation on equipment (see above) 240 000 180 000
Depreciation on vehicles (see above) 30 000 30 000
Traffic fines (not tax deductible) 28 000 0
Directors remuneration 125 000 125 000
x The company uses the re-allocation method to adjust for changes in estimates.
x Wear and tear was granted by the tax authorities as follows:
equipment: 25% per annum straight-line (apportioned for part of a year);
vehicles: 25% per annum straight-line (not apportioned for parts of a year).
x The rate of income tax remained constant at 30%.
x There are no temporary differences, exempt income or non-deductible expenses other
than those indicated by the information presented.
Required:
a) Prepare all the adjusting journal entries necessary to prepare the financial statements for
b) Prepare the statement of comprehensive income, statement of changes in equity and
related notes of Cinnamon Limited for the year ended 31 December 20X3 in accordance
304 Chapter 26
GAAP: Graded Questions Statement of cash flows
Chapter 27
Statement of cash flows
Question Key issues

27.1 Core concept questions
27.2 Woof Comparison of direct and indirect method
27.3 Big Foot Direct method: Development costs, purchase of PPE with mortgage bond
27.4 Sauron Steel Current and deferred tax: Calculation
Indirect method
Ratio analysis
27.5 Paddock Direct method: Capitalisation issue, redemption of redeemable preference
shares, revaluation of buildings, trade-in of machine, impairment of
goodwill
Financial management
27.6 Mt Grace Direct method (operating activities section): Redeemable preference
shares in issue, deferred tax
27.7 Shine Direct method (operating and financing activities sections): Redeemable
preference shares in issue, deferred tax
27.8 Gogo Direct method: Issue of non-redeemable preference shares and issue of
redeemable debentures at a premium, sale of land & buildings
Reconciliation between profit before tax and cash generated from
operations
Ratio analysis
Note that VAT is to be ignored for all questions.
Chapter 27 305
Question 27.1
The following questions relate to the statement of cash flows:
a) State the components of cash flows according to IAS 7 and describe briefly each
component.
b) List, and describe briefly, the three main areas of business activity used to classify cash
inflows and outflows on the statement of cash flows.
c) What are the two methods permitted by IAS 7 for the preparation of a statement of cash
flows and explain briefly the main difference between these two methods.
d) Revenue from sales amounts to C200 000. The opening and closing balances on accounts
receivable are C100 000 and C220 000 respectively. Calculate the cash received from
customers for the direct method.
e) Cost of sales amounts to C700 000. The opening and closing balances on inventory are
C200 000 and C220 000 respectively. The opening and closing balances on accounts
payable are C40 000 and C20 000 respectively. Calculate the cash paid to suppliers for
the direct method.
f) A company, with the South African Rand as its functional currency, has $200 cash
reserves in an US call account, which has remained unchanged throughout the period. The
opening cash and cash equivalents balance for the current year is C12 000 – which
includes the correct translation of the $200 cash reserves. Assume the net cash movement
as per the statement of cash flows has increased by C10 000. Calculate the closing
balance of cash and cash equivalents, as presented on the face of the statement of cash
flows. The relevant spot exchange rate for the C:$ was $1:C10 at the beginning of the
year and $1:C12 at the end of the financial year.
Required:
Provide the answer to the above questions.
Question 27.2
Woof Limited is a company involved in the manufacture and distribution of dog food.
The statement of comprehensive income for the year ended 31 December 20X2 as well as
extracts from the trial balance at 31 December 20X1 and 20X2 are shown below.
WOOF LIMITED
C
Revenue 3 150 000
Cost of sales (2 152 500)
Gross profit 997 500
Distribution expenses (210 000)
Administration expenses (354 750)
Finance cost (17 250)
Profit before tax 415 500
Income tax expense (124 650)
Profit for the period 290 850
Other comprehensive income 0
306 Chapter 27
WOOF LIMITED
TRIAL BALANCE (EXTRACT)
AT 31 DECEMBER 20X2
20X2 20X1
C C
Inventories 238 500 219 000
Prepaid distribution expenses 18 000 0
Cash and cash equivalents 53 250 18 750
Accounts payable (279 750) (240 000)
Current tax payable: income tax (22 650) (15 400)
Accrued administrative expenses (33 750) (53 250)
Accrued finance costs (12 000) (10 500)
x The administrative expenses include:
- A gain on the disposal of non-current assets amounting to C3 750.
- Bad debts written off during the year amounting to C12 750.
x Cost of sales includes depreciation of C161 250.
x Assume that all transactions are for cash unless otherwise indicated.
Required:
a) Prepare the statement of cash flows showing the cash from operating activities only, using
the indirect method
b) Prepare the statement of cash flows showing the cash from operating activities only, using
the direct method.
Question 27.3
The following draft statement of comprehensive income and statement of financial position
have been prepared for Big Foot Limited for the year ended 31 December 20X8:
BIG FOOT LIMITED

20X8
C
Revenue 654 000
Cost of sales (294 000)
Gross profit 360 000
Other income
Profit on sale of plant and machinery 20 000
Other expenses (347 000)
Finance costs (17 000)
Other comprehensive income -
Chapter 27 307
BIG FOOT LIMITED

DRAFT STATEMENT OF FINANCIAL POSITION
AS AT 31 DECEMBER
Note 20X8 20X7
ASSETS C C
Non-current assets 762 964 510 000
Land 320 000 300 000
Plant and machinery 312 964 110 000
Development costs 130 000 100 000
Current assets 361 072 284 000
Bank 131 072 159 000
1 124 036 794 000

Capital and reserves 493 000 450 000
Ordinary share capital 480 000 440 000
Non-current liabilities 542 036 281 000
Long-term loans 527 036 260 000
Deferred taxation: income tax 15 000 21 000
Current liabilities 89 000 63 000
Current tax payable: income tax 12 000 5 000
Interest payable 4 500 9 000
Shareholders for dividends 17 500 29 000
1 124 036 794 000
x Included in other expenses are the following items:
- Depreciation on plant and machinery C20 222
- Impairment of plant and machinery C10 648
- Amortisation of development costs (see below) C?
x Additional land was purchased during the year and no land was sold during the year. Half
of the cost of the additional land was financed via a mortgage bond. The balance of the
cost was paid for in cash. The use of the land is undecided. The fair value of the land at
31 December 20X8 is C320 000.
x C80 000 was repaid to Sub Bank, the provider of the long-term loan. A portion of the
balance at 31 December 20X8 relates to a mortgage bond from Sub Bank that was raised
during the year in order to cover half of the cost of the additional land.
x Plant and machinery with a carrying value of C15 866 was sold during the year.
x Development costs relate to two products: Goodies and Splodgets. The development of
Goodies only began during the current year, whilst the development of Splodgets had
begun at the beginning of the prior year.
- Goodies: Development of Goodies began during the current year with all costs
incurred being capitalised. Commercial production of the Goodie is expected to
commence in July 20Y1.
- Splodgets: The company incurred a further C20 000 on developing the ‘Splodget’
during the current year, all of which was capitalised. Development of the ‘Splodget’
308 Chapter 27
was completed and commercial production commenced on 1 July 20X8. Big Foot
believes that sales of Splodgets will continue for a total of 24 months, (i.e. no sales are
expected after June 20Y0).
x The company issued 32 000 ordinary shares at an issue price of C1,25 each.
x Ordinary dividends of C10 000 were declared during the year.
Required:
Prepare the statement of cash flows of Big Foot Limited for the year ended
31 December 20X8, using the direct method, in accordance with International Financial
Question 27.4
Sauron Steel Limited is a company that manufactures and wholesales pure aluminium steel
rings and rods used in the construction industry. The main income of Sauron Steel Limited is
derived from the sale of their indestructible rings and accounts for approximately 90% of
revenue. The company has been in operation for three years and has a 31 December year-end.
The following are extracts of the financial statements for the year ended 31 December 20X2.
SAURON STEEL LIMITED
EXTRACT FROM THE STATEMENT OF COMPREHENSIVE INCOME
C
Profit for the year 58 000
Other comprehensive income
Items that may never be reclassified to profit/loss 105 000
- Revaluation surplus, net of tax 105 000

STATEMENT OF CHANGES IN EQUITY
Ordinary share Revaluation Retained
capital surplus earnings Total
C C C C
Balance at 1 January 20X1 710 000 - 25 000 735 000
Total comprehensive income - - 262 000 262 000
Balance at 31 December 20X1 710 000 - 287 000 997 000
100 000 Shares issued at C1,10 110 000 - - 110 000
Share issue costs - - (5 000) (5 000)
Total comprehensive income - 105 000 58 000 163 000
Dividends – Interim - - (10 000) (10 000)
Dividends – Final - - (10 000) (10 000)
Balance at 31 December 20X2 820 000 105 000 320 000 1 245 000
Chapter 27 309

AT 31 DECEMBER 20X2
20X2 20X1
C C
Non-current assets
Land and buildings 1 000 000 950 000
Plant - at valuation (20X1 – at cost) 650 000 600 000
Plant - accumulated depreciation (65 000) (100 000)
Furniture and fittings - cost 50 000 50 000
Furniture and fittings - accumulated depreciation (15 000) (10 000)
Machinery - cost 240 000 120 000
Machinery - accumulated depreciation (35 000) (20 000)
Investment in long-term government bonds 150 000 90 000
Current assets
Trade and other receivables 120 000 30 000
2 216 875 2 065 000
Share capital and reserves
Revaluation reserve 105 000 0
Long term loan 800 000 800 000
Deferred tax 96 000 36 000
Current liabilities
Trade and other payables 74 375 225 000
Current tax payable: income tax 1 500 7 000
2 216 875 2 065 000
The profit before tax includes interest received, depreciation and interest paid. The tax
expense has been correctly calculated and includes the deferred and current income tax, and
the adjustment to the prior year’s tax provision.
x Land and buildings are not depreciated. The tax authority does not allow any deductions
on the land and buildings. There were no disposals of buildings during the year.
x The plant was purchased on 1 January 20X0 for C600 000 and the useful life of the plant
was estimated on that date as 12 years. The tax authority considers that the useful life is
only six years and allows a wear and tear deduction accordingly.
The plant was re-valued on 1 January 20X2 by an independent valuator. The revaluation
is accounted for using the net replacement value method and the entity transfers the
realised portion of the revaluation surplus to retained earnings at the end of the plant’s
useful life. The useful life of the plant remained the same after the revaluation. There
were no additions or disposals to plant in the year. The intention is to keep the plant.
x Furniture and fittings are depreciated at 10% per annum which is equal to its wear and
tear allowance. Furniture with a carrying amount of C30 000 was exchanged for furniture
of a slightly darker colour with the same fair value.
x There were no disposals of machinery during the year, but the entity assembled new
machinery for the expansion of operations. This new machinery became available for use
310 Chapter 27
as intended by management on 30 June 20X2. The machinery assembled utilised

C100 000 of the entity’s own inventories while management paid C20 000 for external
inventories and assembly costs. Machinery is depreciated over 12 years, while the tax
authority allows wear and tear based on a six year useful life, apportioned for part periods.
x The deferred tax balance of C36 000 as at 31 December 20X1 comprises deferred tax on
plant of C30 000 and deferred tax on machinery of C6 000.
x The amount owing to the tax authorities in respect of the 20X1 year was paid in
May 20X2, after taking into account the assessment from the tax authorities. The
assessed tax for the 20X1 year according to the assessment amounts to C60 000. The
company had made provisional payments of C55 000 in that year and had provided
C62 000 in respect of current income tax.
x Two provisional payments were made in August and December 20X2 equal to the amount
provided for current income tax.
x The company has never paid dividends prior to 20X2. The company declared and paid an
interim dividend of C10 000 on 30 June 20X2 and a final dividend of C10 000 on
30 December 20X2.
x Authorised share capital consists of 1 000 000 ordinary shares of no par value.
x The share issue costs were paid in full. These costs are not deductible for tax purposes.
x The long term loan is payable in 20Y0 and interest is payable at 15% per annum. The
interest for the year has been paid.
x No investments in long-term government bonds were disposed of during the year. Interest
of C9 000 was received and earned from the long-term government bonds during the year
and there was no interest accrual at the beginning nor the end of the year.
x The company pays tax at 30%. Except for what is apparent above, no other temporary or
non-temporary differences exist.
Required:
a) Prepare the income tax expense and the deferred taxation notes to the financial statements
of Sauron Steel Limited for the year ended 31 December 20X2.
b) Prepare the statement of cash flows of Sauron Steel Limited for the year ended
31 December 20X2 according to IAS 7 Statement of Cash Flows and using the indirect
method.
c) Calculate the interest cover of Sauron Steel Limited for the year ended
31 December 20X2 and comment on whether you think it is adequate, explaining what the
ratio measures.
Notes to the statement of cash flows are not required.
Question 27.5
Paddock Limited is a company that distributes horse feed.

Its summarised financial statements for the year ended 31 December 20X3 appeared as
follows:
Chapter 27 311
PADDOCK LIMITED
SUMMARISED STATEMENT OF COMPREHENSIVE INCOME
20X3
C’000
Revenue 5 000
Income tax expense (800)
Profit for the period 725
Revaluation of land and buildings, net of tax 14,2
Total comprehensive income 739,2
PADDOCK LIMITED
SUMMARISED STATEMENT OF FINANCIAL POSITION
AT 31 DECEMBER 20X3
20X3 20X2
ASSETS C000s C000s
Non-current assets 3 024 2 795
Land 2 600 2 405
Plant and machinery 360 246
Goodwill - 100
Investment in long-term government bonds 64 44

Inventories 1 750 159
Trade and other receivables 870 500
Cash and cash equivalents 235 704
5 879 4 158
Capital and reserves 3 483,2 3 018
Preference share capital 400 500
Revaluation surplus 14,2 0
Non-current liabilities 975,8 180

Deferred tax: income tax 5,8 0
Current liabilities 1 420 960

Shareholders for dividend 150 180
5 879 4 158
x Land is measured using the revaluation model. Land, with a carrying amount of C90 000,
was sold at a profit of C50 000. The remaining land was re-valued during the year. The
deferred tax on the revaluation surplus was C5 800 and has been correctly accounted for.
Land is not depreciated.
312 Chapter 27
x Plant and machinery is measured under the cost model.

The carrying amount was calculated as follows:
20X3 20X2
Cost 590 000 426 000
Accumulated depreciation 230 000 180 000
Carrying amount 360 000 246 000
Plant with a carrying amount of C140 000 was sold during the year at a profit of C4 000.
A new machine costing C100 000 was acquired by trading in a machine at a loss of
C6 000 and paying the balance owing in cash. The machine that was traded in had
originally cost C60 000 and had been depreciated by C25 000.
x No investments in long-term government bonds were disposed of during the year. Interest
of C4 000 was earned from the long-term government bonds at 30 June 20X3 and
received on 6 July 20X3. There was no interest accrual at the beginning nor the end of the
year.
x On 1 March 20X3, the company issued 125 000 ordinary shares by way of a capitalisation
issue to its existing shareholders at the current market price of C1 each. On the same date,
a further 125 000 ordinary shares were issued at the market price of C1 each.
x The preference shares comprise 10% redeemable shares issued at C1 each. On
30 June 20X3, 100 000 shares were redeemed at a premium of 4%. The preference shares
are redeemable at the option of the company.
x Profit before tax was arrived at after taking the following into account:
C
Interest received 4 000
Profit on sale of land 50 000
Profit on sale of plant and machinery 4 000
Loss on trade in of plant and machinery 6 000
Bad debts 5 000
Depreciation 90 000
Goodwill impairment 100 000
x Ordinary dividends declared during 20X3 were C250 000 and preference dividends
declared during 20X3 were C45 000.
x There are no temporary differences.
Required:
a) Prepare Paddock Limited’s statement of cash flows and related notes for the year ended
31 December 20X3, in accordance with the direct method of IAS 7 Statement of Cash
Flows.
b) Prepare a reconciliation between profit before tax and cash generated from operations.
c) Comment on the cash management of the company on the basis of the statement of cash
flows you have prepared.
Chapter 27 313
Question 27.6
The financial director of Mt Grace Limited is in the process of preparing the statement of cash
flows for the year ended 30 June 20X5. She has prepared a set of working papers and notes,
as set out below:
30/06/X5 30/06/X4 Remember the TB

Revenue for year Accounts receivable 845 000 720 000 shows a total debit
= C5 200 000 Doubtful debts allowance 71 500 34 000 in respect of bad
debts of C55 500
30/06/X5 30/06/X4 Profit before tax =

Accounts payable 510 000 340 000 20X3 20X4 20X5
Inventory 305 000 210 000 C720 000 C590 000 C680 000
Don’t forget to take into account the redeemable preference shares. They were issued for
C200 000 on 1 July 20X2 and are subject to compulsory redemption by the company on
30 June 20X7 at a premium of 4%. The nominal interest rate is 12%. The dividends have
been paid on 30 June each year in arrears. Note that the premium accrued is not deductible
for tax purposes.
We did not declare an
30/06/X5 30/06/X4 interim dividend during
Shareholders for ordinary dividend 35 000 30 000 the current year. The final
dividend of C35 000 was
declared on 25 June 20X5
I know that deferred tax is one of your hottest topics, but I have prepared the following
schedule relating to the plant and equipment that needs to be incorporated into the taxation
calculation:
Carrying Tax base Temporary Deferred

amount difference tax
01/07/X2 Cost 800 000 800 000
600 000 320 000 280 000 81 200
500 000 160 000 340 000 98 600
30/06/X5 30/06/X4 Don’t forget the

Tax authority 125 175 190 000 corporate income
tax rate is 29%
There are no temporary or non-temporary differences other than those apparent from the
above information.
Required:
Prepare the operating activities section of the Statement of cash flows of Mt Grace Limited
for the year ended 30 June 20X5, using the direct method.
314 Chapter 27
Question 27.7
Shine Limited manufactures furniture oils products, which it sells to retailers around the
country. The following balances were extracted from its financial statements for the years
ended 30 June 20X3 and 20X4 respectively:
SHINE LIMITED
AT 30 JUNE 20X4
20X4 20X3
C C
10% Redeemable preference shares - 64 716
Administration expenses accrued 2 000 -
Current tax payable 12 925 10 000
Shareholders for dividends - 2 000
Inventory 111 500 131 500
Distribution expenses prepaid 3 000 2 000
Deferred tax asset 22 500 20 000
SHINE LIMITED
FOR THE YEAR ENDED 30 JUNE 20X4
20X4
C
Profit for the year 33 741
x The profit before tax is stated after taking into account the following expenses:
C
Cost of sales 120 000
Profit on sale of plant 3 000
Bad debts 1 500
Depreciation 15 000
Finance costs 15 784
x Inventory is sold at a markup of 110% on cost.

x Dividends were declared in the current year.
x The preference shares are measured at amortised cost using an effective interest rate of
11,255%. 60 000 10% preference shares issued at C1 were subject to a compulsory
redemption at a premium of ? % on 30 June 20X4.
x No additional ordinary or preference shares were issued during the year.
x The finance costs comprised interest on a mortgage loan and finance costs relating to the
preference shares.
Chapter 27 315
Required:
Prepare the operating activities and financing activities sections only of the Statement of cash
flows of Shine Limited for the year ended 30 June 20X4, using the direct method.
Question 27.8
Gogo Limited is a company that manufactures luxury cashmere jerseys. The following
information relates to its financial year ended 30 June 20X2:
x Land with a cost of C400 000 was sold for C400 000. No further sales of land took place.
Land is not depreciated.
x Equipment was depreciated by C48 000 during the current period. No equipment was
sold during the year.
x Vehicles were depreciated by C60 000 during the current period. No vehicles were sold
during the year.
x The doubtful debts allowance was C5 640 at 30 June 20X2 and C6 133 at 30 June 20X1.
The accounts receivable balances reflected in the statement of financial position are
reflected net of these allowances.
x 500 000 10% non-redeemable preference shares of no par value were issued at C0, 55 per
share on 5 September 20X1. Share issue costs of C2 300 were paid which are non-
deductible.
x The debentures are measured at amortised cost using an effective interest rate of
18.2725377%. These debentures were issued in the prior year, on 1 July 20X0, at a
premium of 6%, raising cash of C530 000. Each debenture has a nominal value of C100
and offers interest of 20% per annum, payable on 1 July each year. The debentures are
redeemable on 30 June 20X6 at C100.
x A further loan of C100 000 was secured during 20X2.
x There are no temporary differences.
The summarised statement of comprehensive income, statement of changes in equity and
statement of financial position for the 30 June 20X2 financial year are shown below:
GOGO LIMITED
SUMMARISED STATEMENT OF COMPREHENSIVE INCOME
20X2
C
Revenue 3 503 250
Operating expenses (339 950)
Finance cost (136 268)
316 Chapter 27
GOGO LIMITED
EXTRACT FROM SUMMARISED STATEMENT OF CHANGES IN EQUITY
Retained
earnings
C
Balance 1 July 20X1 360 755
Share issue costs (2 300)
Dividends - Ordinary (225 000)
- Preference (25 000)
Balance 30 June 20X2 507 549
GOGO LIMITED
SUMMARISED STATEMENT OF FINANCIAL POSITION
AT 30 JUNE 20X2
20X2 20X1
C C
ASSETS
Non-current assets 2 732 000 2 730 000
Land at cost 2 120 000 2 450 000
Equipment at carrying amount 312 000 280 000
Vehicles at carrying amount 300 000 0
Current tax receivable: income tax 0 6 440
Prepaid expenses 6 300 5 960
Bank 120 250 84 300
3 139 900 3 105 100

Capital and reserves 2 007 549 1 585 755
Ordinary share capital 1 225 000 1 225 000
Non-redeemable preference share capital 275 000 0
Non-current liabilities 773 113 1 151 845
Debentures 523 113 526 845
Loan 250 000 625 000
Interest payable 100 000 100 000
Current tax payable: income tax 12 888 0
3 139 900 3 105 100
Required:
a) Prepare the statement of cash flows of Gogo Limited for the year ended 30 June 20X2
using the direct method in terms of IAS 7 Statement of cash flows.
b) Prepare a reconciliation between the profit before tax and the cash generated from
operations.
Chapter 27 317
c) Calculate the following ratios:

x Return on investment ratio (ROI/ROA), defining return as profit after tax but before
finance charges.
x Return on equity ratio (ROE).
Compare the return on investment and the return on equity and discuss whether the
company is using gearing effectively.
Assume an income tax rate of 35%. Comparatives are not required.
318 Chapter 27
GAAP: Graded Questions Financial analysis and interpretation
Chapter 28
Financial analysis and interpretation
Question Key issues

28.1 Short questions
28.2 Seychelles Calculator of core ratios
28.3 Handyman Working capital
28.4 Yolo Working capital cycle
28.5 Peppermint and Return on capital employed

Rolo
28.6 A,B, C Analysis and determination of industry
28.7 MedTech / Various ratios and limitations of financial statement analysis

Computronic
Chapter 28 319
Question 28.1
a) Explain the purpose of financial statement analysis.

b) Describe horizontal financial statement analysis.
c) Describe vertical financial statement analysis.
d) Explain the debt ratio and its use in analysing a company's performance.
e) How can the current ratio be used to evaluate a company?
f) What is the purpose of the debtors collection period ratio?
g) Explain how to calculate total asset turnover and explain what it reveals about a
company's financial condition.
h) Explain how to calculate dividend yield and explain how it is used in analysis of a
company's financial condition.
i) Discuss briefly the price earnings ratio with particular reference to the shares of
companies with high or low ratios.
j) CompUs had C989 000 earnings for the year. There are 150 000 shares in issue.
The market price of a share is C63,27. Calculate the price-earnings ratio.
Question 28.2
Seychelles Limited consists of a group of companies. The financial director requires your
assistance with calculating the following key ratios for the companies within the group for the
Part A
MAHE LIMITED
(EXTRACT FROM) STATEMENT OF COMPREHENSIVE INCOME
20X5 20X4
MAHE LIMITED
(EXTRACT FROM) STATEMENT OF FINANCIAL POSITION
20X5 20X5
Preference share capital 300 000 -
Required:
Calculate the return on ordinary equity for 20X5.
320 Chapter 28
Part B
PRASLIN LIMITED
C
Sales 3 750 000
Required:
Calculate the gross profit margin for the period.
Part C
ALDABRA LIMITED
C
Current assets
Inventory 1 350 000
Accounts receivable 2 500 000
Cash 1 000 000
Current liabilities
Accounts payable 5 500 000
Shareholder for dividends 65 000
Tax payable 98 000
Required
Calculate the current ratio and acid-test ratio at the end of 20X5.
Part D
LA DIGUE LIMITED
20X5
Sales 30 000 000
Gross profit 15 000 000
LA DIGUE LIMITED
20X5 20X4
Inventory 7 500 000 9 000 000
Required
Calculate the inventory holding period for the 20X5 year.
Chapter 28 321
Part E
CERF ISLAND LIMITED

20X5
Sales 150 000 000
Gross profit 45 000 000
CERT ISLAND LIMITED

20X5 20X4
Accounts receivable 9 000 000 4 500 000
Inventory 300 000 200 000
Accounts payable 12 000 000 10 500 000
Assume that all sales and purchases are on credit.
Required:
Calculate the debtors’ collection period and the creditors’ payment period for 20X5.
Part F
SILLHOUETTE ISLAND LIMITED

20X5 20X4
Retained earnings 1 200 000 780 000
At 31 December 20X5 the market capitalisation of the shares was C900 000. During the
20X5 financial year the directors declared a dividend of C0,40 per share.
Required
Calculate the price earnings ratio for 20X5.
Part G
CONCEPTION ISLAND LIMITED

20X5 20X4
Profit for the period 3000 000 2 500 000
CONCEPTION ISLAND LIMITED

20X5 20X4
Share capital 30 000 000 30 000 000
322 Chapter 28
The issued share capital balance as at 31 December 20X5 consists of shares which were all
issued at C30 each. The company has no preference share capital. A total dividend of
C8 million was paid during 20X5 and the market value of the company is C60 million at
31 December 20X4.
Required:
Calculate the earnings yield and dividend yield for the 20X5 year.
Question 28.3
Handyman Limited is a hardware wholesaler supplying goods to ‘do-it-yourself’ retailers

around the country. The company commenced operations at the beginning of the 20X3 year.
The company has been operating successfully for a number of years. Although turnover has
increased consistently, the company has recently been experiencing cash flow problems. The
managing director has approached you for advice on how to improve this situation. The
following amounts were extracted from the records of the company:
20X3 20X4 20X5
C000s C000s C000s
Turnover 100 000 120 000 135 000

Cost of sales 75 000 90 000 101 250
Profit before interest and tax 6 000 5 500 5 600
Inventory 18 750 26 000 30 400
Bank / (overdraft) 5 000 (500) (2 000)
Required:
Identify and calculate the ratios that are needed to analyse the company’s working capital.
Comment on the company’s working capital management in the light of these ratios.
Question 28.4
The following figures are taken from the financial statements of Yolo (Pty) Ltd, a
manufacturer of stationery, for the year ended 31 July 20X5:
YOLO LIMITED
FOR THE YEAR ENDED 31 JULY 20X5
C
Sales 820 000
Cost of sales 544 000
Opening inventory 142 000
Purchases 568 000
Closing inventory (166 000)
Chapter 28 323
YOLO LIMITED
AT 31 JULY 20X5
C
Inventory 166 000
All purchases and sales are on credit. There has been no change in the level of trade
receivables or payables over the period.
Required
a) Calculate the length of the business cycle (in days).
b) Suggest how the business may seek to reduce the business cycle period.
Question 28.5
Peppermint Limited and Rollo Limited are manufacturers of luxury biscuits. The two entities
are not related in any way as they both operate in different ways. The following analysis has
been prepared for each company:
FOR THE YEAR ENDED 30 JUNE 2015
Peppermint Rollo
Limited Limited
C C
Revenue from sales 400 000 600 000
Cost of sales (300 000) (450 000)
Gross profit 100 000 150 000
Other expenses (60 000) (120 000)
Profit before finance charges 40 000 30 000
Finance charges (2 000) (2 300)
Other comprehensive income for the year 0 0
Total comprehensive income for the year 27360 19 944
The average capital employed for Peppermint Limited and Rollo Limited is C200 000 and
C150 000 respectively.
Required:
a) Calculate the following ratios for both companies:
i) Operating profit margin
ii) Sales revenue to capital employed
iii) Return on capital employed (ROCE)
b) Based on your calculations above, compare the ratios for both companies and comment.
324 Chapter 28
Question 28.6
Below are financial statements for three unrelated companies. Study the information provided
and answer the questions that follow.
STATEMENT OF COMPREHESNSIVE INCOME

FOR THE YEAR ENDED 31 MARCH 20X5
A Ltd B Ltd C Ltd
Sales 10 555 556 2 150 000 12 647 059
Cost of sales (3 166 667) (645 000) (3 794 118)
Gross profit 7 388 889 1 505 000 8 852 941
Operating expenses (7 008 889) (1 075 000) (7 992 941)
Operating profit 380 000 430 000 860 000
Finance cost (69 700) (74 100) (108 500)
Profit before taxation 310 300 355 900 751 500
Income tax expense (89 987) (103 211) (217 935)
Profit for the period 220 313 252 689 533 565
STATEMENTS OF FINANCIAL POSITION

AT 31 MARCH 20X5
A Ltd B Ltd C Ltd
ASSETS
Non-current assets
Property, plant and equipment 3 319 045 501 963 5 752 719
Current assets 1 079 103 191 585 1 686 727

Inventory 156 164 - 103 948
Accounts receivable 57 839 70 685 1 385 979
Cash 865 100 120 900 196 800
4 398 148 693 548 7 439 446

Capital and reserves 3 049 269 374 240 6 314 961
Retained earnings 3 049 169 374 140 6 314 861
Current liabilities
Accounts payable 1 348 879 319 308 1 124 485
4 398 148 693 548 7 439 446
Required
a) Calculate the following ratios for A Ltd, B Ltd and C Ltd
i) Operating profit margin
ii) Sales to total assets
iii) Inventory holding period
iv) Debtors collection period
v) Current ratio
b) Discuss with reasons, which one of the three businesses is an estate agent, which is a
supermarket chain and which is a car manufacturer.
Assume that there is no variance between the average settlement period of trade
receivables and the credit terms of all three entities.
Chapter 28 325
Question 28.7
MedTech Limited is interested in acquiring a majority shareholding in Computronic Limited.
As a financial analyst you are asked to undertake an evaluation of the company and suggest
whether MedTech Limited should go ahead with the purchase of Computronic Limited or not.
The following information is available:
COMPUTRONIC LIMITED
20X1 20X0
C C
Revenue from sales 3 850 000 3 432 000
Cost of sales (3 250 000) (2 864 000)
Gross profit 600 000 568 000
Other expenses (430 300) (340 000)
Depreciation (40 000) (38 900)
Profit before finance charges 129 700 189 100
Finance charges (56 000) (42 500)
Other comprehensive income for the year 0 0
COMPUTRONIC LIMITED
AT 30 SEPTEMBER 20X1
20X1 20X0
C C C C
ASSETS
Non-current assets
Property, plant and equipment 360 000 344 000
Current assets
Cash 52 000 1 290 000 57 600 1 124 000
1 650 000 1 468 000
Retained earnings 220 000 680 000 203 000 663 000
8% Redeemable preference shares
(Redeemable on 30/09/20X3) 225 000 200 000
Long term loan 430 000 655 000 324 000 524 000
Current liabilities
Accrued expenses 140 000 315 000 136 000 281 000
1 650 000 1 468 000
326 Chapter 28
A download from an Information Service relating to Computronic Limited at 30 September is

provided:
20X1 20X0
Share price at year end (30 Sept) C12.00 C30.00
Number of shares in issue 100,000 100,000
Dividend per share C0.22 C0.22
Industry average data for 20X1

Current ratio 2.7 : 1
Quick ratio 1.0 : 1
Inventory holding period 52 days
Accounts receivable collection period 32 days
Non-current asset turnover 10.7 times
Total asset turnover 2.6 times
Gearing ratio 50 %
Profit margin 3.5 %
Interest cover ratio 2.5 times
Operating profit margin 7.4 %
Return on assets 9.1 %
Return on equity 18.2 %
PE ratio 14.2
Extract of the press release issued by the company on 12 October 20X1:

Computronic Limited is a biotechnological company that undertakes research and development of
medical innovations. The company has completed trial runs of the long awaited anti-aging
electronic treatment device. This device stimulates the production of high growth hormone (HGH)
in your body. HGH is associated with human growth and cell health. As a mood elevator, most
people find a youthful sense of wellness and a zest for life restored when their levels of human
growth hormone are increased. The company’s clinical evidence proves that by elevating our
growth hormone levels we can significantly stop and even reverse the symptoms of aging! The
electronic device has been successfully patented in the United Kingdom but is awaiting approval
from the European Medicines Agency (EMA), for use in the European Union.
Required:
a) With reference to the objective of financial reporting as set out in the Accounting
Framework, discuss briefly the purpose of financial statement analysis.
b) Calculate the current and quick ratios for both years and briefly comment on your results.
c) Calculate the return on assets (ROA) ratio for both years and briefly analyse your results,
focusing on the possible reasons for the change in the ratio over the two years.
d) Calculate the return on equity (ROE) ratio for 20X1. Explain why this ratio will be
important to MedTech Limited or any potential investor.
e) Calculate the gearing ratio for both years and discuss its usefulness.
f) Calculate the PE ratio for both years and discuss briefly its interpretation with particular
reference to companies with high or low ratios.
g) What would your recommendation to MedTech Limited be, about their intention of
buying a majority shareholding in ComputronicLimited. Justify your recommendation.
Chapter 28 327
Chapter B
Integrated questions: chapters 1 - 28
Question Key issues

B.1 Sigh IAS 32 & IFRS 9:
Preference shares –redeemable at a premium
Debentures – issued at a discount, redeemable at a premium
B.2 Aubergine IAS 32: Ordinary shares and Preference shares (redeemable at option of
issuing company): in issue
IFRS 9: Debentures (issued and redeemable at par)
IAS 16: PPE: Land (revaluation model) and other PPE (cost model)
IAS 2: Inventory (FIFO)
B.3 Hubbard IAS 33: Earnings per share:
Basic and headline;
Share movements: fair value issue, share split;
IAS 8: Correction of error.
B.4 Read IAS 8: Change in estimate: useful life of PP&E
IAS 16: PP&E (cost model): Sale of asset above cost: depreciable and
deductible
IAS 12: current, deferred, under/overprovision, provisional payments
B.5 Espresso IAS 16: Revaluation of depreciable asset (NRVM)
IAS 8: Change in estimate (relating to revalued depreciable asset)
IAS 12: Deferred tax (PPE only: depreciable and deductible)
IAS 1: Presentation
B.6 Cutting IAS 16: PPE: Cost model
IAS 8: Correction of error: depreciated the whole instead of each
significant part
IAS 12: Current and deferred tax: tax effects of error
B.7 Softcell IAS 8: Policies, estimates and errors
Correction of error: sales
Change in estimate: useful life: RAM
IAS 16: PPE: Cost model & revaluation model
IAS 33: Earnings per share: basic and headline
Share movements: fair value issue, then capitalisation issue
Circ 02/2015: Headline earnings per share (shown as separate part)
B.8 Mckinnon IAS 16: PPE: Cost model
IAS 40: Investment property: Fair value model
IAS 8: Correction of error: Transfer from Investment Property to PPE did
not occur
IAS 12: Current and deferred tax: tax effects of error
B.9 Notachance IAS 17: Lessee (operating lease)
IAS 8: Correction of error
IAS 12: Deferred tax
B.10 Fluff IAS 32: Preference shares: convertible (compulsory) - at amortised cost
IAS 32: Financial instruments: presentation
IFRS 9: Financial instruments
IAS 8: Accounting policies, correction of errors and estimates
328 Chapter B

B.11 Mail IAS 33: Earnings per share: Basic and diluted
Circ 02/2015: Headline earnings per share (shown as separate part)
Share movements: none
Potential shares: options and convertible debentures
Part A: Basic, diluted
Part B: Basic, diluted and headline
B.12 Builder IAS 21: Non-monetary asset denominated in foreign currency
IAS 16: PPE: cost model versus revaluation model in foreign currency
IAS 40: Investment property: cost model versus fair value model
IFRS 9: Financial asset – investment in shares measured at FVOCI
IFRS 9: Financial asset – investment in shares measured at FVPL
IFRS 9: Hedge of a firm commitment accounted for as a fair value hedge
B.13 Menace Part A:

IAS 16: Cost model
IAS 37: Provision for dismantling costs
IAS 8: Change in estimate
Part B:
IAS 16: Cost model
IAS 37: Provision for dismantling costs
IAS 8: Change in estimate
B.14 Knucklehead IAS 12: Deferred tax: calculation: comprehensive

IAS 16: Property, plant and equipment (exempt temporary differences)
IAS 38 & IFRS 3: Research and Goodwill (exempt temporary difference)
IAS 17: Finance lease
IAS 37: Provision for warranties
B.15 Putu IAS 23: Borrowing costs (specific loans)

IAS 16: Property, plant and equipment (self-constructed, cost model)
IAS 12: Deferred tax (interest deducted when incurred and wear and tear from
date of use: interest capitalised and asset available for use but there is
depreciation because available for use although not brought into use in current
year)
IAS 8: Correction of error: borrowing costs were expensed now capitalised
B.16 Roo IAS 21: Import (DAT) of PPE

IAS 16: PPE (imported)
IFRS 9: Hedges of highly probable forecast transactions, firm commitments
and transactions
- Hedge of a HPFT = CFH (basis adj) and
- Hedge of a FC = CFH (basis adj) and
- Hedge of a T = FVH
IAS 8: Correction of error(reclassification adj used instead of basis adj) and
Change in accounting estimate (change in UL of PPE)
IAS 1: Presentation (particularly OCI section)
Chapter B 329
Question B.1
Sigh Limited issued 15 000 redeemable preference shares on 1 March 20X1 at C1 each. These
preference shares earn dividends at 10% on their issue price.
x The shares are subject to compulsory redemption on 28 February 20X4 at a premium of
C0.05 per share on the original issue price.
x The preference dividends are non-discretionary.
In order to obtain funds for the redemption, the company issued 20 000 unsecured,
12% debentures on 1 February 20X4. The debentures have a face value of C1 each but were
issued at a discount of 3%. These debentures will be redeemed on 31 January 20X9 at a
premium of 2% on their face value.
The balance on the retained earnings account was C120 000 at 28 February 20X4, before any
entries had been processed relating to the effect of the above transactions on the debentures,
preference shares and dividends.
Required:
Prepare an extract from the statement of financial position and notes to the financial statements
of Sigh Limited for the year ended 28 February 20X4, in terms of International Financial
Comparatives are not required. Calculations must be made to the nearest whole number.
Question B.2
Aubergine Limited is a small listed public company, situated on the KwaZulu-Natal south coast.
The following information refers to Aubergine Limited at 30 June 20X9.
x The authorised share capital consists of:
x 1 000 000 ordinary shares of no par value.
x 100 000 6% redeemable preference shares of no par value
x The company was incorporated ten years ago and shares have been issued as follows:
x ordinary shares at an issue price of C1 each. 856 800
x 6% redeemable preference shares at an issue price of C1 each redeemable at the 100 000
option of the company and at a premium of C0,30 per share at any date after
30 June 20X8.
x After all the adjustments (excepting those relating to the property, plant and equipment) at
30 June 20X9 were made, the balances on the following accounts were:-
x Revaluation surplus 150 000
x Retained earnings at 1 July 20X8 290 000
x Total comprehensive income for the year ended 30 June 20X9 78 000
x On 2 January 20X4, 1 000 10% debentures of C100 each were allotted. These debentures
are redeemable at par in equal annual instalments of C10 000. The first instalment fell due
and was paid on 31 December 20X7, and all subsequent instalments have been paid on
time. Interest is payable half yearly on 30 June and 31 December of each year.
x The 10% debentures are secured by first mortgage over land situated on Stand 842 Bazley.
The land was acquired vacant on 1 June 20X4 for C1 200 000 with the intention to use as
the site for a new factory building. Building was delayed due to the plans failing safety
standards. Land is measured under the revaluation model. In 20X6 land was revalued to a
fair value of C1 350 000. In June 20X9, Mr Eng of Consulting Engineers CC valued the
land at C1 180 000 due to a decline in the property market in the area. The company uses
the net replacement method when revaluing assets.
330 Chapter B
x Plant and machinery is measured under the cost model. Its cost less accumulated
depreciation at 30 June 20X9 amounts to C90 000. All plant and machinery was acquired on
1 July 20X7 and depreciation is written off at 20% per annum on the straight line basis.
x Furniture and fittings is measured under the cost model. Its cost at 30 June 20X9 amounts to
C14 000, and accumulated depreciation at that date amounts to C6 000 (20X8:C5 500).
New furniture costing C4 000 was purchased on 30 June 20X9.
x Accounts receivable at 30 June 20X9 amounted to C79 000.
x Inventory is measured at cost using the first in first out method and comprises finished
goods only. Total inventory at 30 June 20X9 is C65 000.
x A final dividend of C0,05 on all issued ordinary shares as well as the preference dividend
was declared but unpaid at year end. These amounts, together with a provision for current
taxation of C18 700 were included in accounts payable totalling C101 400.
x There was a bank balance at 30 June 20X9 of C64 200.
Required:
Prepare the statement of financial position and supporting notes of Aubergine Limited at
30 June 20X9 in compliance with International Financial Reporting Standards.
Accounting policies are required for statement of compliance, basis of preparation, property
plant and equipment and inventory only.Comparative figures are not required.
Question B.3
Hubbard Limited’s bookkeeper drew up the following draft statement of comprehensive income
and the draft extracts of its statement of changes in equity for the year:
HUBBARD LIMITED
20X6 20X5
C C
Sales 500 000 400 000
Cost of sales (250 000) (200 000)
Gross profit 250 000 200 000
Other expenses (110 000) (103 000)
Profit on sale of plant (taxable) 7 000 0
Interest received 3 000 3 000
Income tax expense – current (40 000) (35 000)
HUBBARD LIMITED
Retained earnings
20X6 20X5
C C
Opening balance 83 000 25 000
Ordinary dividends (10 000) (5 000)
Preference dividends (2 000) (2 000)
Closing balance 181 000 83 000
Chapter B 331
x Before the 20X6 financial statements were published, it was discovered that a deduction
of C10 000 had been omitted from the 20X5 current tax calculation. The effect of the
errors is material. All the information needed to report the correction of the error is
available without undue cost or effort.
x The company had operated with an ordinary share capital of C100 000 (200 000 shares
issued at C0,50 each) for a number of years. On 31 March 20X5, 50 000 new shares were
issued at C1.10 each. On 1 January 20X6, the directors decided to split the share capital
in such a way that one share would become two shares. This was done in order to
improve the shares’ marketability.
x The dividends paid to the ordinary shareholders were declared as follows:
20X6 20X5
31 December 4 000 -
30 June 6 000 5 000
10 000 5 000
x Hubbard has 20 000 preference shares in issue for many years. The preference shares
were issued at C20 000 and are non-redeemable, non-cumulative and preference
dividends are at Hubbard's discretion.
x There are no other forms of authorised or issued shares other than those evident from the
x The corporate tax rate for both years was 35%.
Required:
a) In so far as the information is available, prepare the statement of comprehensive income
and statement of changes in equity of Hubbard Limited for the year ended 30 June 20X6
in terms of International Financial Reporting Standards.
The only notes required are in respect of earnings per share and the correction of error.
b) Prepare the earnings per share note for the year ended 30 June 20X6 assuming
Hubbard Limited had to comply with both International Financial Reporting Standards
and Circular 02/2015 Headline earnings and explain where headline earnings per share
may be presented.
Question B.4
Read Limited publishes magazines in the areas of health and fitness. The financial director is
in the process of preparing the financial statements for the year ended 31 May 20X6.
x Profit before tax (including depreciation and profit on sale of plant) for the year ended
31 May 20X6 amounts to C1 720 000.
x All of the company’s equipment was purchased on 1 March 20X2 at a cost of C1 000 000
and at that date the residual value was estimated at C200 000. Equipment is measured
under the cost model.
x The residual value remained at C200 000 for the 20X2, 20X3 and 20X4 financial years.
At the end of the 20X5 financial year the residual value was estimated at C355 000.
x The company accounts for depreciation on plant on the straight line basis over its useful
life of ten years.
x The equipment was sold on 28 February 20X6 for C1 500 000.
332 Chapter B
x The base cost of the equipment for capital gains tax (CGT) purposes is C1 200 000.
x The directors decided to rent certain equipment (valued at C1 500 000) for a short period
instead of purchasing it as they were waiting for the latest model to be released at which
point they would purchase the latest model.
x New equipment was purchased on 1 May 20X6 at a cost of C1 800 000. Costs incurred
for testing the equipment amounted to C200 000 and costs for staff training and preparing
the manuals amounted to C10 000. The plant became available for use on 31 May 20X6.
x An extract from the current assets and current liabilities sections of the draft statement of
financial position at 31 May 20X6 is as follows:
20X6 20X5
Current assets
Rent prepaid 30 000 40 000
Interest accrued 25 000 20 000
Current liabilities
Contract liability: unearned revenue 10 000 30 000
Advertising accrued 15 000 10 000
x The following comments have been provided by the company’s tax consultant:
- Prepaid expenses are deductible for tax purposes when paid;
- Accrued income is taxed in the year of accrual;
- Unearned revenue is taxed when received;
- Expenses accrued are deductible in the year of accrual; and
- The allowance granted on the cost of equipment is 20% per annum on the straight line
basis, apportioned for time.
x Dividends declared and paid during the year ended 31 May 20X6 amount to C50 000.
Dividends received during the same period amount to C60 000.
x The tax assessment for the year ended 31 May 20X5 was received during March 20X6
and showed an assessed tax on taxable profit of C240 000 for the year. The amount
owing was paid immediately.
x The current tax provided in the 20X5 financial statements amounted to C237 250 and
provisional tax payments totalled C228 450 for that year. Provisional tax payments
amount to C450 000 for the 20X6 year of assessment, excluding the top-up payment made
during March.
x There are no other temporary differences other than those evident from the information
stated above. The rate of corporate income tax is 29% and the CGT inclusion rate is 50%.
Required:
a) Prepare an extract from the statement of comprehensive income of Read Limited for the
year ended 31 May 20X6 in accordance with International Financial Reporting Standards.
b) Prepare all the journal entries relating to taxation for the 20X6 year.
c) Prepare the notes to the financial statements for the 20X6 year in respect of income tax
expense, deferred taxation and property, plant and equipment only, in accordance with
Comparatives are not required for the taxation note. Comparatives are required for the
deferred tax note and the property, plant and equipment note.
Chapter B 333
Question B.5
Espresso Limited is a company in the food and beverage industry. The year-end of the
company is 31 December. The company purchased plant, its only item of property, plant and
equipment, on 1 January 20X2 at a cost of C250 000. Plant is depreciated on the straight line
basis over its useful life of ten years. There is no residual value. The allowance granted by
the tax authorities is 20% per annum on the straight line basis.
The plant was revalued for the first time on 1 January 20X6 to a net replacement cost of
C240 000. The company uses the net replacement value method when accounting for the
revaluation of assets. The residual value remained unchanged.
When preparing the financial statements for the year ended 31 December 20X6, the total
estimated useful life was reassessed from ten years to twelve years. Espresso Limited
accounts for changes in estimate using the re-allocation method and has a policy of
transferring the revaluation surplus to retained earnings as the asset is used. The corporate
income tax rate is 29%.
Profit for the year (before the estimated useful life re-assessment) for the year 20X6 was
C100 000 (20X5: C80 000). There are no other components of comprehensive income.
Required:
a) Prepare the following notes to the financial statements of Espresso Limited for the year
ended 31 December 20X6:
x Accounting policy for property, plant and equipment
x The property, plant and equipment note
x The deferred tax note
x The change in accounting estimate note
x The revaluation surplus note
Comparatives are required
b) Prepare an extract from the statement of the comprehensive income (starting with “Profit
for the year”) and statement of changes in equity of Espresso Limited for the year ended
31 December 20X6, showing only the retained earnings and revaluation surplus columns.
Question B.6
Cutting Limited purchased a factory plant on 1 July 20X4 for C650 000. This plant is
measured under the cost model and comprises two parts, where the cost of each is considered
significant to the cost of the whole plant:
x An engine
x A metal structure.
The auditors are currently busy completing the audit of the financial records for the year
ended 31 December 20X8 and have discovered that the accountant has been depreciating the
entire plant over 10 years to a nil residual value on the straight-line basis.
The engine is estimated to comprise 60% of the cost of the plant, the metal structure 30% of
the cost and the remaining 10% represents 3 moving parts that are considered to be
individually insignificant in terms of cost.
334 Chapter B
The engineers estimate that the engine has a useful life of 8 years, the metal structure has a
useful life of 15 years and the remaining moving parts will last for 5 years. After consultation
with the engineers, it was established that the residual value of all parts is nil with the
exception of the metal structure, which has an estimated residual value of C60 000.
None of the parts have ever been impaired, derecognised or revalued.
The tax authorities allow a deduction equal to 10% of the cost of the asset (apportioned for
part of a year). Income tax is levied at 30%.
Required:
Prepare the journal entries necessary to account for the correction of error in the general
journal of Cutting Limited for the year ended 31 December 20X8.
Question B.7
The financial director of Softcell Limited is in the process of finalising the financial
statements for the year ended 30 June 20X8.
He has the following working papers and notes on his desk:
SOFTCELL LIMITED
EXTACT FROM DRAFT STATEMENT OF COMPREHENSIVE INCOME
20X8 20X7
C C
Profit for the period 2 134 240 1 398 000
Items that will never be reclassified to profit or loss
x Revaluation of land 210 000 180 000
Items that may be reclassified to profit or loss - -
Total comprehensive income 2 344 240 1 578 000
SOFTCELL LIMITED
EXTRACT FROM NOTES TO THE FINANCIAL STATEMENTS
20X8 20X7
10. Profit for the period is stated after C C
Profit on disposal of equipment - 50 000

Impairment of plant 100 000 -
Depreciation 150 000 150 000
44. Share capital
Issued
Ordinary share capital
1 000 000 (20X7: 500 000) ordinary shares of no par value 1 000 000 500 000
Preference share capital
200 000 10% cumulative, non-redeemable preference shares of no 400 000 400 000
par value
Reconciliation of the number of shares Qty Qty
Balance at beginning of year 500 000 400 000
Issue for cash (31/03/X7) 100 000
Capitalisation issue (30/12/X7) 500 000 -
Balance at end of year 1 000 000 500 000
Chapter B 335
Extracts from minutes of directors’ meetings

June 20X7 Due to cash flow constraints, the preference dividend is not declared this year. The
ordinary dividend is also not declared.
June 20X8 The arrear preference dividend is declared as well as the preference dividend for the
current year. An ordinary dividend of 6 cents per share is declared to all shareholders
registered on 28 June 20X8.
At 30 June 20X6, the balance on the revaluation surplus amounted to C540 000 and the
balance on retained earnings amounted to C4 280 000.
All of the work has been done, except for the following items that still need to be processed:
x When considering the measurement of the property, plant and equipment, it was decided
that the estimated useful life of the company’s only motor vehicle had changed from a
total of five years to a total of eight years. The motor vehicle, a delivery van, was
purchased on 1 January 20X7 at a cost of C100 000. The residual value was estimated at
zero and this has not changed. The tax authorities allow a tax allowance of 25% per
annum, apportioned for time.
The ‘profit for the period’ in the draft statement of comprehensive income has been
computed after recording depreciation for the year on the original estimated useful life.
The company uses the re-allocation method to account for changes in estimate.
x The auditors have brought to the attention of the financial director a batch of overstated
sales invoices during the months between January 20X7 and June 20X7. The total
overstatement amounts to C275 000. The tax authorities have agreed to reopen the
assessment of the previous year. Softcell Limited uses the periodic system for inventory
measurement. The effect of these overstated sales invoices is material.
x The earnings per share calculation has not yet been done.
The corporate income tax rate is 28% and this rate remains unchanged.
Required:
a) Prepare the journal entries to record the change in estimate relating to the motor vehicle.
b) Prepare the statement of changes in equity of Softcell Limited for the year ended
30 June 20X8, showing columns for revaluation surplus and retained earnings only.
c) Prepare the following notes to the financial statements of Softcell Limited for the year
ended 30 June 20X8, in conformity with International Financial Reporting Standards :
x Change in estimate
x Correction of error
x Earnings per share.
d) Prepare the earnings per share in terms of International Financial Reporting Standards (i.e.
you may ignore Circular 02/13 on headline earnings per share).
e) Prepare the earnings per share in terms of both International Financial Reporting
Standards and Circular 02/13 (i.e. your earnings per share note should include headline
earnings per share if appropriate).
Question B.8
On 1 March 20X5, McKinnon Limited purchased a property for C138 600 with the intention
being to earning rental income and capital appreciation.
336 Chapter B
Almost as soon as ownership of the property was legally transferred, the economy took a turn
for the worse with the result that the property has remained untenanted (vacant) since
acquisition. However, McKinnon Limited decided to continue holding the property because it
is aware of the existence of plans for a new shopping complex to be constructed in the same
road, which will result not only in an increase in the property's resale value but will definitely
bring an end to the shortage of tenants in the near future. The fair values of the property were
determined by a valuator as follows:
Date of valuation Fair value
28 February 20X6 C184 800
On date of acquisition, its total useful life was estimated to be 9 years and its residual value
was estimated to be nil. These original estimates have been reassessed each year and found to
be unchanged.
For strategic reasons, McKinnon Limited moved its factory operations into this vacant
property on 1 March 20X6.
The property has been classified as investment property since date of acquisition. No entries
have yet been processed to account for the property during the year ended 28 February 20X9.
Mckinnon Limited measures investment property using the fair value model, (in terms of
IAS 40 Investment property), and measures property, plant and equipment using the cost
model (in terms of IAS 16 Property, plant and equipment).
The tax authorities levy tax at 30% on taxable profits. Capital gains are included in taxable
profit at an inclusion rate of 67%. The property qualifies for the deduction of an annual
building allowance at 10% on the cost of the property.
The building has always been held within a business model whose objective it is to consume
substantially all of the economic benefits from the investment over time.
Required:
Provide all journal entries necessary to be processed in order to finalise McKinnon Limited’s
financial statements for the year ended 28 February 20X9 such that they are in accordance
Question B.9
On 1 January 20X5, Notachance Limited entered into an operating lease over vehicles (used
by sales representatives). The terms of the lease were as follows:
x Period: 5 years (from 1 January 20X5 to 31 December 20X9
x Lease instalments payable monthly in advance
- 20X5 and 20X6: C5 000 per month
- 20X7 and 20X8: C3 000 per month
- 20X9: C1 000 per month
The financial statements had already been drafted when the accountant read Circular 12/06,
with horror: Circular 12/06 clarifies that IAS 17 has always required that operating lease
rentals be aggregated and straight-lined over the period of the lease (i.e. by dividing the total
lease rentals over the total lease period in months) whereas he had consistently been
measuring the operating lease instalments at the cash amount.
Chapter B 337
The following are the draft financial statements or extracts thereof:

NOTACHANCE LIMITED
20X9 20X8
C C
Revenue 820 000 720 000
Cost of inventory expense 300 000 220 000
Operating costs 150 000 170 000
Distribution costs 100 000 80 000
Finance costs 10 000 25 000
Income tax expense 98 000 75 000
NOTACHANCE LIMITED
AT 31 DECEMBER 20X9
20X9 20X8
C C
Prepayments 80 000 10 000
Deferred tax liability 70 000 22 000
At 31 December 20X7:
x The retained earnings had a balance of C1 300 000
x The deferred tax had an asset balance of C30 000
x The prepayments had a balance of C5 000.
The tax authorities allow the lease instalment as a tax deduction when paid. The income tax
rate is 30% (unchanged since 20X5 when the rate was 28%).
Required:
a) Process all necessary correcting journal entries for the year ended 31 December 20X9.
b) In so far as the information permits, prepare the statement of comprehensive income,
statement of changes in equity, statement of financial position and the correction of error
note for inclusion in the financial statements of Notachance Limited for the year ended
31 December 20X9.
Question B.10
Fluff Limited required long-term capital to finance a variety of projects. It managed to raise
some of this capital through a bank loan but still needed further cash. Thus, on
1 September 20X6, Fluff Limited issued 400 000 preference shares. These shares were issued
at C5 each, have a coupon rate of 10% and will be converted into ordinary shares on
31 August 20Y1. The market interest rate for similar shares is 12%. The preference
dividends, calculated by applying the coupon rate to their deemed value of C5 each, are non-
discretionary and are payable on 31 August each year until conversion.
338 Chapter B
Fluff Limited’s new and inexperienced accountant has processed the following journals since
the issue in 20X6, but after chatting to a colleague at an accounting update seminar he has
become concerned that he may have made an error. The following journals were processed in
the prior years ended 31 August 20X7 and 31 August 20X8:
Debit Credit
1 September 20X6
Bank 2 000 000
Preference shares: Equity 2 000 000
Issue of redeemable preference shares
31 August 20X7
Preference dividends 200 000
Bank 200 000
Payment of preference dividends at 10% coupon rate
31 August 20X8
Preference dividends 200 000
Bank 200 000
Payment of preference dividends at 10% coupon rate
Required:
Write a letter to the accountant, in which you explain whether or not the issue of shares and
the payment of dividends in the prior years ended 31 August 20X7 and 20X8 have been
correctly recognised and measured. If you believe the journals were not correct, include in
the letter your proposed correcting journals to be processed in the 31 August 20X9 financial
year and, if relevant, any note disclosure relating to the error to be included in the financial
statements for the year ended 31 August 20X9. Ignore tax
Question B.11
Part A
The financial director of Mail Limited is in the process of completing their financial
statements for the year ended 31 December 20X5. The financial statements are complete
other than for:
x an adjustment necessary in relation to the plant (see below) and
x the calculation and disclosure of earnings per share.
Information relating to plant:

x New technology was released during 20X5 that has affected the value of Mail Limited’s
plant. At 31 December 20X5, the following information relates to the plant:
- carrying amount was C1 500 000;
- fair value less cost of disposal was estimated at C900 000; and
- value in use was estimated at C1 000 000.
x No adjustments have yet been made for the above information.
x The following is an extract of the draft financial statements, before taking into account
any adjustments that may be needed pursuant to the information provided above:
MAIL LIMITED
STATEMENT OF COMPREHENSIVE INCOME (EXTRACT)
20X5 20X4
C’000 C’000
Chapter B 339
MAIL LIMITED
NOTES TO THE FINANCIAL STATEMENTS (EXTRACT)
20X5 20X4
54. Profit before tax C’000 C’000
Profit before tax is stated after taking into account the following separately disclosable items:
- Forex gain on cash flow hedge – reclassified from OCI 300 600
- Loss on investment property 425 0
- Loss on fair value through profit or loss financial assets 900 1 000
- Depreciation of plant 100 120
- Research costs 200 180
- Profit on sale of land 30 0
The items in the profit before tax note are either fully deductible for tax purposes or fully
taxable with the exception of the profit on sale of land, which is entirely exempt from tax.
Information relating to equity and liabilities:
The following relates to Mail Limited’s equity instruments and selected financial liabilities:
x Authorised: 5 000 000 ordinary shares (no par value),
x Issued:
x 4 000 000 ordinary shares (no par value, issued at C0.50 each): these shares were
issued before 20X4.
x 1 200 000 debentures (face value of C3 each), earning interest at a coupon rate of
6.94445% and convertible into ordinary shares at a rate of 1 ordinary share for every
5 debentures held: these debentures were issued on 1 July 20X4.
x 5 000 options were granted to each of the four company directors on 3 January 20X5.
These options, which have vested, offer the shares at an exercise price of C7 and will
expire 31 December 20X9. The average market price during 20X5 was C9 per share.
x There have been no other movements in the above shares, debentures or options during
either 20X5 or 20X4 other than those apparent from the information above.
x There are no other issued or potential shares other than those reflected in the information
above.
The corporate tax rate was 30% throughout. There are no temporary differences other than
those apparent from the information provided.
Required:
Prepare the following, in accordance with International Financial Reporting Standards for
inclusion in Mail Limited’s annual financial statements for the year ended
31 December 20X5:
x the earnings per share figures to be presented in the statement of comprehensive income
x the earnings per share note.
Ignore headline earnings per share.
Part B:
Use the same information as above except that the company must not only comply with
International Financial Reporting Standards, but in order to list on the Johannesburg Stock
Exchange, it must also present headline earnings per share in terms of Circular 02/2015,
340 Chapter B
Required:
Prepare the following, in accordance with International Financial Reporting Standards and
Circular 02/2015 Headline earnings, for inclusion in Mail Limited’s annual financial
statements for the year ended 31 December 20X5:
x the earnings per share figures to be presented in the statement of comprehensive income
x the earnings per share note.
Question B.12
The managing director of Builders Limited is concerned that his accountant has not been
correctly applying the relevant IFRSs and has sent you the following email requesting clarity.
To: Accountingexpert@accountingisfun.com
From: Bob@thebuilders.com
Subject: IFRS advice
Dear Spud,
I am concerned that my accountant, who has been with our company for years, and who has
become a dear friend of mine, is not up-to-date on the implications of the latest IFRSs. This is
a great worry to me as we are hoping to have our company listed on the JSE in the near
future, and our financial statements simply have to be fully compliant for a successful listing.
I wonder if you could take a moment to apply your mind to a few of the issues and explain to
me how they should be accounted for so that I am better equipped when checking whether the
accountant is managing the situation.
Issue # 1:
We purchased a piece of land in France for €100 000 on 3 March 20X1. Its fair value at
31 December 20X1, our financial year-end, is €120 000. The land is not depreciated.
The spot rates were as follows:
- €1: R11 on 3 March 20X1
- €1: R15 at 31 December 20X1
- €1: C14.50, being the average spot rate during 20X1.
Please explain the IFRS implications of this information and also show me the journals that
should have been processed in our books?
Issue #2:
On 1 January 20X0, we purchased 5% debentures that were issued by a company in America.
We purchased them for $250 000, which was considered to be their fair value at the time.
These debentures will be redeemed after 3 years at 110% of the issue price. Interest on the
debentures is payable annually on 31 December. The debentures were not considered to be
'credit-impaired' on the date of acquisition, although the accountant has assured me that we
needed to account for a loss allowance account based on $25 000 at 3 December 20X0 and
that this loss allowance had increased to $26 000 at 31 December 20X1.
The accountants has asked me to tell you that we intend to hold the investment within a
business model where the objective is achieved by holding financial assets to collect
contractual cash flows and selling financial asset, he said that you would understand.
The fair values of the debentures were as follows:
Date Fair values
1 January 20X0 $250 000
31 December 20X0 $255 000
31 December 20X1 $245 000
Chapter B 341
Date Exchange rates:: $1: Rx

Spot exchange rates
1 January 20X0 $1: R15,00
31 December 20X0 $1: R14,25
31 December 20X1 $1: R14,85
Average rates
31 December 20X0 $1: R14,50
31 December 20X1 $1: R14,60
Please may I ask you to draft a report explaining how to account for these issues, identifying
the relevant IFRSs that we would need to study? Also please would you also include the
journals that should have been processed in our books?
Many thanks for your time Spud.
Regards
Bob
Required:
Draft a report, addressing each of the issues referred to in the email, in which you provide:
x the required journals; and
x explanations for these journals in terms of International Financial Reporting Standards.
Question B.13
Menace Limited purchased a nuclear plant, the details of which are as follows:
Cash purchase price (1 January 20X1): C2 000 000
Depreciation straight-line to nil residual values: 5 years
The nuclear plant must be dismantled after 5 years, details of which are as follows:
Future decommissioning cost assessed on 1 January 20X1: C1 000 000
Discount rate: 10%
Part A
Menace Limited uses the cost model to measure items of plant. During 20X4, the expected
cost of decommissioning increased to C1 500 000.
Required:
a) Prepare the journal entries relating to the plant for the years 20X3 and 20X4.
b) Disclose the following in the notes to the financial statements of Menace Limited for the year
ended 31 December 20X8 in accordance with International Financial Reporting Standards:
x profit before tax: showing the finance charges and depreciation, and
x change in estimate.
Ignore tax
Part B
Assume the same as in Part A above, except that Menace Limited uses the revaluation model
to measure its items of plant. At 31 December 20X3, the plant was revalued upwards by
C400 000, and during 20X4, the expected cost of decommissioning increased to C1 500 000.
342 Chapter B
The company does not transfer the realised portion of any revaluation surplus to retained
earnings over the life of the plant.
Required:
a) Prepare the journal entries relating to the plant for the years 20X3 and 20X4.
b) Disclose the following in the notes to the financial statements of Menace Limited for the
year ended 31 December 20X8 in accordance with International Financial Reporting
Standards:
x profit before tax: showing the finance charges and depreciation, and
x change in estimate.
Ignore tax
Question B.14
The following information has been provided to you by the accountant of

Knucklehead Limited, who has asked you for help in calculating the deferred tax balance and
adjustment for the year ended 31 December 20X1:
(1) Plant:
x Plant A was purchased for C200 000 on 1 January 20X1.
x Plant B was purchased for C300 000 on 30 September 20X1.
x Both plants are depreciated to nil residual values at 10% per annum.
x The tax authorities allow wear and tear at 20% pa (apportioned for part of a year).
(2) Vehicles:
x The vehicles were purchased for C400 000 on 1 April 20X1.
x Vehicles are depreciated to nil residual values at 25% per annum.
x The tax authorities allow wear and tear at 10% p.a., not apportioned for part of a year.
(3) Land:
x The land was purchased for C800 000 on 1 October 20X1.
x Land is not depreciated.
x The tax authorities do not allow any deductions relating to the cost of the land.
(4) Buildings:
x The buildings were purchased for C900 000 on 1 October 20X1.
x Buildings are depreciated at 5% per annum to a C50 000 residual value.
x The tax authorities do not allow any deductions relating to the cost of the buildings.
(5) Goodwill:
x The goodwill arose when some of the assets listed above were purchased for
C700 000 from another company, when their individual fair values totalled C650 000.
x Goodwill is not amortised but was impaired by C20 000 at 31 December 20X1.
x The tax authorities do not allow any deductions relating to the cost of goodwill.
(6) Trade debtors:
x The trade debtors balance is C36 000 at 31 December 20X1.
x This was calculated after deducting a 10% credit loss allowance.
x The tax authorities allow the deduction of only 25% of this allowance.
(7) Inventories:
x The inventory balance is C80 000 at 31 December 20X1.
x This was calculated after deducting a 20% obsolescence allowance.
x The tax authorities allow the deduction of only 75% of this allowance.
Chapter B 343
(8) Warranty provision:

x Goods are sold with a warranty attached.
x A provision of C20 000 for the expected cost of warranties was raised at 31
December 20X1.
x The tax authorities allow the deduction of the costs of the warranty if and when the
warranty is exercised and the costs of meeting the terms of the warranty are incurred.
(9) Machinery:
x All the machinery was purchased on 1 January 20X1 under a finance lease.
x Both lessee and lessor are VAT vendors. The cash price, including 14% VAT, is
C228 000. The implicit interest rate is 8.1338%. A deposit of C50 000 was due on 1
January 20X1, after which instalments of C100 000 were due on 31 December 20X1
and 20X2. Machinery is depreciated over 5 years to a nil residual value.
x The tax authorities allow the deduction of the lease instalments (adjusted for VAT).
(10) Income receivable and income received in advance:
x Income is taxed on the earlier of the date of earning the income or receipt thereof.
x Income received in advance: C50 000 at 31 December 20X1.
x Income receivable: C40 000 at 31 December 20X1.
(11) Expenses payable and expenses prepaid:
x The tax authorities allow deductions of expenses when they are paid on condition that
they are less then C50 000 and relate to the first 6 months of the next year, otherwise
expenses are only allowed when incurred.
x Expenses prepaid: C35 000 at 31 December 20X1 (relating to rent for January 20X2).
x Expenses payable: C10 000 at 31 December 20X1.
(12) Research costs:
x Research costs of C1 000 000 were expensed during the year ended 31 December 20X1.
x The tax authorities allow the costs of research to be deducted at 20% p.a.
The income tax rate is 30%
Required:
a) Calculate the deferred tax balance at 31 December 20X1.
b) Provide the deferred tax adjustment (i.e. journal entry) for the year ended
31 December 20X1 assuming that the deferred tax balance at 31 December 20X0 was
C55 000 (liability).
Question B.15
Putu Limited has been involved in the construction of its only two items of property, plant
and equipment, both of which are qualifying assets for purposes of IAS 23 Borrowing costs:
x a desalination plant and
x a power plant.
The following are the details relating to the construction of each asset:
Desalination Plant Power plant

(D-Plant) (P-Plant)
Construction cost C900 000 C800 000
Borrowing costs C120 000 C90 000
Investment income C21 000 C0
Commencement date 01 March 20X7 01 March 20X9
Cessation date 30 April 20X8 N/A
344 Chapter B
Additional information relating to the table above:

x The commencement date referred to above is the date on which all criteria for
capitalisation were met. The cessation date referred to above is the date on which
construction was complete.
x All construction costs listed above were incurred and paid evenly between
commencement date and cessation date.
x All borrowing costs listed above had been incurred on specific loans and had been
incurred evenly between commencement date and cessation date.
x The investment income earned from the investment of surplus loan funds during the
construction of the desalination plant was comprised of the following:
Interest income: C15 000, earned evenly between 1 December 20X7 and 31 May 20X8
Dividend income: C2 500 declared on 15 December 20X7 and C3 500 declared on
5 May 20X8.
x The desalination plant was put into operation on 1 May 20X8 and is measured under the
cost model, with depreciation provided over its estimated useful life of 10 years to a nil
residual value, using the straight-line method.
x All borrowing costs incurred in the construction of these assets have been expensed. This
is an error in terms of IAS 23 Borrowing costs. The company had already begun drafting
its statement of changes in equity:
PUTU LIMITED
STATEMENT OF CHANGES IN EQUITY (extracts)
Retained Total
earnings
C C
Balance - 1 January 20X8 480 000 xxx
Total comprehensive income – 20X8 50 000 50 000
Balance - 1 January 20X9 530 000 xxx
Total comprehensive income – 20X9 30 000 30 000
Balance - 31 December 20X9 560 000 xxx

x Interest incurred is allowed as a deduction in the calculation of taxable profits in the same
year in which it is incurred.
x The cost of both the desalination plant and the power plant will be allowed as a deduction
in the calculation of taxable profits at a rate of 20% of the cost per annum, with the first
such deduction being allowed in the year in which the asset first became available for use
(not apportioned for part of a year).
x Income tax at 30% is levied on taxable profits.
x The error in the accounting records did not result in an error in the figures submitted to
the tax authorities.
There are no other temporary differences other than those evident from the information above.
There were no disposals, purchases or other movements in property, plant and equipment
other than those evident from the information provided.
Chapter B 345
Required:
a) Using the general journal, show all journals that you believe are necessary based on the
information provided above.
b) Provide the following disclosure for inclusion in the financial statements for the year
ended 31 December 20X9, in as much detail as is possible:
x Correction of error note
x Statement of changes in equity
x Statement of financial position.
Question B.16
In March 20X7, during the audit of the 20X6 financial records of Roo Limited, (an Australian
company), the auditors discovered that the accountant had made an error by using the
reclassification adjustment approach instead of the basis adjustment approach when
accounting for a hedge of a highly probable forecast transaction to acquire equipment.
Unfortunately, the accountant had been mistakenly under the impression that the previous
IAS 39 principle, which allowed the choice between using either the basis adjustment or
reclassification adjustment approach, still applied under the new IFRS 9 Financial
instruments.
The details regarding this transaction are as follows:

x A forward exchange contract was entered into on the 30 November 20X4 in anticipation
of the forecast transaction to acquire equipment for R450 000 from a SA Company called
Muzi Limited. At this point, the forecast transaction was considered to be highly probable.
x This FEC will expire on 31 May 20X5.
x Roo Limited signed a contract (considered to be a firm commitment) with Muzi Limited
on 31 January 20X5.
x The equipment was shipped on a delivery duty paid (DDP) basis and was released by
customs on the 14 February 20X5.
x The equipment was immediately available for use and was depreciated from this date on
the straight-line basis over its useful life of 10 years to its residual value of nil.
x Roo Limited paid Muzi Limited on 31 May 20X5.
x Exchange rates were as follows:
Date Spot FEC expiring on 31 May X5
$: Rand $: Rand
30 November 20X4 6.10: 1 6.12: 1
31 December 20X4 6.19: 1 6.21: 1
31 January 20X5 6.00: 1 6.05: 1
14 February 20X5 5.99: 1 6.01: 1
31 May 20X5 5.96: 1
During 20X6, the remaining useful life was changed to 5 years (calculated as from
1 January 20X6). The reallocation method is used to account for changes in estimates.
Roo Limited accounts for the hedge of the firm commitment as a cash flow hedge and the
hedge of the recognised asset as a fair value hedge.
The draft statement of comprehensive income and statement of changes in equity, before
taking into account either the change in estimate or correction of error, are presented below.
346 Chapter B
ROO LIMITED
STATEMENT OF COMPREHENSIVE INCOME (Extracts)
20X6 20X5 20X4
$ $ $
Profit for the year 280 000 160 500 100 000
Items that may be reclassified to profit or loss
x Cash flow hedge reserve 4 950 (85 669) 0
- Gain/ (loss) recognised during the year IFRS 7.23(c) 0 (90 000) 40 500
- Reclassified to profit or loss IFRS 7.23(e) 4 950 4 331 0
Items that will not be reclassified to profit or loss - - -
Total comprehensive income 284 950 74 831 140 500
ROO LIMITED
Share Retained Cash flow Total
capital earnings hedge
reserve
$ $ $ $
Balance - 1 January 20X5 100 000 400 000 40 500 540 500
Total comprehensive income - 20X5 160 500 (85 669) 74 831
Balance - 1 January 20X6 100 000 560 500 (45 169) 615 331
Total comprehensive income – 20X6 280 000 4 950 284 950
Balance - 31 December 20X6 100 000 840 500 (40 219) 900 281
Required:
a) Prepare the journal entries to account for the correction of error and change in estimate in
the books of Roo Limited for the year ended 31 December 20X6.
b) Provide the following disclosure for inclusion in the financial statements of Roo Limited
for the year ended 31 December 20X6, in as much detail as is possible:
x Correction of error note
x Change in accounting estimate note
x Statement of comprehensive income
x Statement of changes in equity
Ignore tax.
Chapter B 347
GAAP: Graded Questions Separate financial statements of a parent
Chapter 29
Separate financial statements of a parent
Question Key issues
29.1 P & various Identification of subsidiaries

companies
29.2 Plastic Pre- and post- acquisition dividends
29.3 Prior / Since Purchase of shares during the year; revaluation of non-depreciable
asset at acquisition; gain on acquisition; dividend income;
impairment of investment
29.4 Pasta / Sauce Purchase of shares during the year; revaluation of depreciable
asset at acquisition; goodwill; dividend income; impairment of
investment
348 Chapter 29
Question 29.1
The group structure the P Group is set out below:
P Limited
55% 100% 42% 35%

A Proprietary Limited B Limited S Limited R Limited
40% 20% 60%
30%
D Limited C Limited
(German company)
60%
E Limited
x P Limited owns 55% of the shares in A Proprietary Limited and has signed an agreement
with the other shareholder, relinquishing P Limited's voting power to them.
x P Limited owns 100% of the shares in B Limited.
x B Limited owns 60% of the shares in C Limited, a company registered in Germany.
x B Limited owns 20% of the shares in D Limited.
x C Limited owns 60% of the shares in E Limited.
x P Limited owns 42% of the shares in S Limited and can appoint 4 of the 7 directors. (All
the directors hold equal voting rights.)
x P Limited owns 35% of the shares in R Limited.
x S Limited owns 30% of the shares in R Limited.
One share equals one vote, unless otherwise specified.
Required:
State, giving reasons, which of the above companies are subsidiaries of P Limited and which
are not. Make reference to IFRS 10 Consolidated Financial Statements in your answer.
Question 29.2
While watching a test match at the Wanderers with a client, Mr Bag, the managing director of
the Plastic Limited group, discussed the following issue with you:
Plastic Limited group purchased a 100% share in Surgery Limited on 1 April 20X8. Two
days after this investment was acquired, Surgery Limited paid an interim dividend of C30 000
to their shareholders.
On 30 September 20X8, Surgery Limited declared a final dividend of C50 000.
Surgery Limited earned a profit for the period of C300 000, which was earned evenly
throughout the year. Mr Bag has heard about pre-acquisition and post-acquisition dividends,
but does not know what they are, or how to account for such dividends in Plastic Limited’s
Required:
a) Explain to Mr Bag what pre-acquisition and post-acquisition dividends are and how the
above dividends paid by Surgery Limited would be classified by Plastic Limited.
b) Discuss how Plastic Limited should account for pre-acquisition and post-acquisition
dividends in its separate financial statements, if Plastic Limited uses the cost method to
account for investments in subsidiaries.
Chapter 29 349
Question 29.3
Prior Limited bought all the shares in Since Limited cum div on 2 January 20X4 for C50 000
cash. All the assets and liabilities are fairly valued except for the land that has a fair value of
C24 000 above its cost. The company intends to recover the land through sale.
The land is currently being used to earn revenue from concerts and other outdoor events. All
profits are from rental activities. The rent is earned evenly throughout the year.
The summarised statement of financial position at 30 June 20X4 and an extract from the
statement of changes in equity for the years ending 30 June 20X4 and 30 June 20X5 are
shown below:
SINCE LIMITED
AT 30 JUNE 20X4
C
ASSETS
Land – at cost 28 000
Payments in advance 1 000
Bank 3 000
32 000
Share capital – authorised and issued 20 000 shares 20 000
32 000
SINCE LIMITED
EXTRACT FROM STATEMENT OF CHANGES IN EQUITY
Retained
earnings
C
Balance at 30 June 20X3 8 000
Dividends paid (4 000)
- 03 January 20X4 1 000
- 30 June 20X4 3 000

Dividends paid (15 000)
- 02 January 20X5 5 000
- 30 June 20X5 10 000
Since Limited sold all of its land during June 20X5. The profit of C26 000 for the year
ending 30 June 20X5 includes C8 000 from rental activities and C18 000 profit on the sale of
land. There are indications that the investment may be impaired as the land was a major asset
of Since Limited. The impairment is estimated at C1 500. Land is not depreciated.
350 Chapter 29
Required:
Provide the journal entries in the accounting records of Prior Limited for the 20X4 and 20X5
financial years to record:
x the purchase of the shares
x the receipts of the dividends
x any other related matters.
Ignore tax.
Question 29.4
Pasta Limited bought all the shares in Sauce Limited on 1 January 20X5 for an amount of
C1 460 000. The major asset of Sauce Limited is a piece of land on which Sauce Limited
operates a car park adjacent to a major tourist attraction. The issued share capital of Sauce
Limited at the date of acquisition amounts to C1 000 000. All the assets of Sauce Limited
were considered to be fairly valued except for the ticket equipment.
The accounting policy of Pasta Limited in relation to property, plant and equipment is to
measure property using the cost model and equipment using the revaluation model. Any
surplus on revaluation is transferred to retained earnings as the asset is used.
x The property was purchased on 1 July 20X2 at a cost of C1 500 000. The property is not
depreciated and there are no tax allowances.
x The equipment was considered to be worth C10 000 more than its carrying amount on the
date that Pasta Limited bought all the shares of Sauce Limited. On acquisition, to align
the accounting policies of Pasta Limited and Sauce Limited, the directors of Pasta
instructed the directors of Sauce to revalue the equipment. The useful life of the
equipment was increased by 1½ years.
- The equipment was purchased on 1 July 20X2 at a cost of C70 000. Sauce accounts
for depreciation on equipment on the straight line basis over its useful life of 5 years,
with a nil residual value.
- The tax authorities allow the deduction of the cost thereof at 25% pa on the straight
line basis, apportioned for time. At 31 December 20X4, the equipment had a carrying
amount of C35 000 and a tax base of C26 250.
x Both Pasta Limited and Sauce Limited have a June year end. Sauce Limited prepared
interim results for the six months from 1 July 20X4 to 31 December 20X4 as shown in the
retained earnings account below, together with the movements in retained earnings to 30
June 20X6.
x Sauce Limited has correctly accounted for the revaluation of the equipment, as instructed
by Pasta Limited. Sauce Limited uses the net replacement method to account for the
revaluation of equipment.
Chapter 29 351
RETAINED EARNINGS
Description C Description C
31/12/X4 Income tax expense 25 000 01/07/X4 Balance 152 900
03/01/X5 Ordinary dividend 10 000 31/12/X4 Profit or loss 75 000
30/06/X5 Income tax expense 15 000 30/06/X5 Profit or loss 45 000
30/06/X5 Ordinary dividend 40 000 30/06/X5 Revaluation surplus ?
30/06/X5 Balance ?
? ?
30/06/X6 Special dividend 90 000 01/07/X5 Balance ?
30/06/X6 Balance ? 30/06/X6 Profit or loss 40 000
30/06/X6 Revaluation surplus ?
? ?
01/07/X6 Balance ?
Details of the breakdown of the profit for the year ended 30 June 20X6 of Sauce Limited is
shown in the profit or loss account below. The directors of Sauce Limited, in consultation
with the directors of Pasta Limited decided to sell the property at the end of June 20X6 for an
amount of C1 600 000. This decision was taken after the projected number of tourists did not
materialise. The directors declared a special dividend from the profit on sale of the property
of C90 000. No other ordinary dividends were declared during the year.
PROFIT OR LOSS
Description C Description C
30/06/X6 Operating expenses 90 000 30/06/X6 Parking fee income 30 000
30/06/X6 Retained earnings 40 000 30/06/X6 Profit on sale of 100 000
property
130 000 130 000
The directors of Pasta Limited considered the investment in Sauce Limited to be impaired at
30 June 20X6. The recoverable amount is assessed to be C1 400 000.
The company tax rate is 29%.
Required:
a) Prepare the journal entries in the accounting records of Pasta Limited to account for its
investment in Sauce Limited for the years ended 30 June 20X5 and 20X6.
b) Prepare the journal entries that would have been processed in the accounting records of
Sauce Limited relating to the property and the equipment (including depreciation,
deferred tax and transfers to retained earnings, where applicable) from 1 January 20X5 to
30 June 20X6.
Ignore CGT.
352 Chapter 29
GAAP: Graded Questions Wholly owned subsidiaries
Chapter 30
Wholly Owned Subsidiaries
Question Key issues
30.1 Pelican / Seal Analysis of equity at acquisition; goodwill; elimination of at

acquisition accumulated depreciation; intercompany transactions.
30.2 Plum / Seed Analysis of equity at acquisition, since acquisition to beginning of

current year and current year; goodwill; intercompany transactions
30.3 Pink / Scarlet Revaluation of depreciable asset at acquisition; intercompany

transactions
30.4 Peanut / Salt / Revaluation of depreciable asset at acquisition; subsequent sale of

Smooth revalued asset; post-acquisition movement in NDR; goodwill;
intercompany transactions
30.5 Pepper / Salt Revaluation increase of non-depreciable asset recorded in

subsidiary’s records (at acquisition and subsequent to acquisition);
goodwill; intercompany transactions.
Chapter 30 353
Question 30.1
Pelican Limited purchased all the shares in Seal Limited on 1 July 20X3.
The following are the statements of financial position at 30 June 20X4 as well as the
statements of comprehensive income and statements of changes in equity of the two
companies for the year ended 30 June 20X4.
AT 30 JUNE 20X4
Pelican Seal
Limited Limited
C C
ASSETS
Non-current assets
Land, at cost 35 000 110 000
Furniture 4 200 1 400
- Cost 6 000 2 000
- Accumulated depreciation 1 800 600
Investment in Seal Limited 120 000 -
Loan to Seal Limited 10 000 -
Current assets
Inventories 80 000 -
Accounts receivables 30 000 3 600
299 500 135 000

Loan from Pelican Limited - 10 000
Current liabilities
299 500 135 000
EXTRACT FROM STATEMENTS OF CHANGES IN EQUITY

Retained earnings
Pelican Seal
Limited Limited
C C
Balance at 1 July 20X3 40 000 10 000
Balance at 30 June 20X4 68 440 16 624
354 Chapter 30
STATEMENTS OF COMPREHENSIVE INCOME

Pelican Seal
Limited Limited
C C
Gross profit 80 000 -
Rent revenue - 22 000
Interest on loan to Seal Limited 500 -
Other expenses
Property expenses - 12 000
Selling and administration expenses 25 000 -
Rent expense (paid to Seal Limited) 15 000 -
Depreciation of furniture 600 200
Audit fees and expenses 400 100
Interest on loan from Pelican Limited - 500
Taxation (11 060) (2 576)
Other comprehensive income for the period 0 0
Total comprehensive income for the period 28 440 6 624
The land is not depreciated. All the assets of Seal Limited are considered to be fairly valued.
The corporate tax rate is 28%.
Required:
Prepare the consolidated statement of comprehensive income and statement of changes in
equity for the year ended 30 June 20X4 and the consolidated statement of financial position at
that date.
Question 30.2
On 28 February 20X5 Plum Limited acquired 100% of the shares and assumed the loan in
Seed (Pty) Limited for a total of C145 000.
The equity and shareholders' loan of Seed (Pty) Limited at 28 February 20X5 was as follows:
C
20 000
Shareholders’ loan 120 000
140 000
In determining the purchase consideration, all assets were considered to be fairly valued.
The following preliminary trial balances were extracted at 28 February 20X7:
Plum Limited Seed (Pty) Limited
C C C C
Retained earnings (01/03/X6) 41 000 19 000
Loan account – Plum Limited - 120 000
Plant at cost - 10 000
Accumulated depreciation (01/03/X6) - 4 000
Chapter 30 355
Investment in subsidiary 25 000 -

Loan account - Seed (Pty) Limited 120 000 -
Current account - Seed (Pty) Limited 21 000 -
Inventories (01/03/X6) 45 000 270 000
Cash at bank 17 000 -
Bank overdraft - 2 000
Current account - Plum Limited - 12 000
Sales 120 000 720 000
Purchases 98 000 561 000
Interest paid on loan account - 12 000
Rent 4 000 15 000
Advertising 3 000 -
Wages and salaries 7 000 20 000
Administration fee 6 000 -
Interest received on loan account 12 000 -
350 000 350 000 930 000 930 000
The following information needs to be accounted for before the consolidated financial
statements are prepared:
x Depreciation on plant amounts to C1 000 p.a. No plant was purchased during the year.
x Advertising for the year was C6 000, all paid for by Plum Limited but to be borne by the
two companies equally.
x Plum Limited charged Seed (Pty) Limited an administration fee of C6 000 for the current
year.
x A dividend of C10 000 was declared by Seed (Pty) Limited on 28 February 20X7.
x Inventories at cost at 28 February 20X7
x Plum Limited : C55 000
x Seed (Pty) Limited : C285 000
x Current taxation for each company needs to be provided as follows:
x Plum Limited : C14 400
x Seed (Pty) Limited : C46 800
x The recoverable amount of goodwill is considered to be equal to its carrying amount.
Required:
a) Prepare a consolidated statement of comprehensive income and statement of changes in

equity of Plum Limited and its subsidiary company for the year ended 28 February 20X7.
b) Show how plant would appear in the consolidated statement financial position at
28 February 20X7.
Question 30.3
On 1 January 20X4 Pink Limited purchased all the shares in Scarlet Limited, cum div for an
amount of C150 000. When the shares were bought it was considered that the carrying
amounts for the tangible assets in Scarlet Limited were fairly valued with the exception of
plant which had a fair value of C36 000 ..Scarlet Limited intends to recover the plant through
use.
The statement of financial position at the date of purchase of the shares showed plant as
follows:
356 Chapter 30
C
Plant at cost 50 000
Accumulated depreciation (20 000)
30 000
Depreciation is accounted for at 10% per annum on cost.

On 2 January 20X4, Pink Limited received a dividend of C30 000 from Scarlet Limited.
The following are the draft statements of comprehensive income and extract from the
statements of changes in equity of the two companies for the year ended 31 December 20X4
and the statements of financial position at 31 December 20X4. The draft financial statements
are correct.
Pink Scarlet
Limited Limited
C C
Trading profit 192 000 40 000
Interest on loan to Scarlet Limited 3 000 -
Other expenses
Depreciation (12 000) (5 000)
Interest on loan from Pink Limited - (3 000)
Rent expense (3 000) (1 000)
Taxation (30 000) (11 000)
EXTRACT FROM STATEMENT OF CHANGES IN EQUITY

Retained earnings
Pink Scarlet
Limited Limited
C C
Balance at 1 January 20X4 185 000 50 000
Dividends (65 000) (30 000)
Balance at 31 December 20X4 270 000 40 000

AT 31 DECEMBER 20X4
Pink Scarlet
Limited Limited
C C
ASSETS
Non-current assets
Land 200 000 60 000
Plant 84 000 25 000
- Cost 120 000 50 000
- Accumulated depreciation (36 000) (25 000)
Investment in Scarlet Limited 120 000 -

Loan to Scarlet Limited 60 000 -
Chapter 30 357
Current assets
724 000 173 000

Loan from Pink Limited - 60 000
Current liabilities
724 000 173 000
z Land is not depreciated. The wear and tear allowance on plant is the same as the
depreciation charge in the records of both companies. Both Pink Limited and Scarlet
Limited make use of rented buildings.
z The recoverable amount of goodwill is considered to be equal to its carrying amount.
z The tax rate is 35%.
Required:
equity for the year ended 31 December 20X4 and the consolidated statement of financial
position at that date.
Question 30.4
Peanut Limited purchased 100% of the shares in Salt Limited for C1 763 000 on 1 July 20X4
and paid for the investment in cash. At acquisition, the balance on retained earnings
amounted to C550 000. The fair value of the plant of the subsidiary is assessed at C2 140 000
and all other assets and liabilities are fairly valued. The directors agreed with Salt Limited’s
estimated useful life of the plant.
Peanut Limited purchased 100% of the shares in Smooth Limited on 1 July 20X5 for
C2 795 000 and paid for the investment in cash. At acquisition, the balance on retained
earnings amounted to C1 650 000 and the balance on the non-distributable reserve amounted
to C550 000. All other assets and liabilities of Smooth Limited are fairly valued.
The following are the trial balances of the companies as at 30 June 20X7:
TRIAL BALANCE
AT 30 JUNE 20X7
Peanut Ltd Salt Ltd Smooth Ltd
Share capital 1 000 000 1 000 000 500 000
Retained earnings 1 July 20X6 6 200 000 930 000 4 400 000
Non-distributable reserve 1 400 000 0 1 500 000
Long term loan 1 500 000 900 000 0
Loan from Peanut Ltd - - 500 000
Accumulated depreciation - Plant 1 400 000 0 -
Accumulated depreciation - Buildings 1 250 000 - 945 000
Profit before tax 2 810 500 97 350 2 985 900
Interest received 65 000 - -
15 808 000 3 195 250 11 020 900
358 Chapter 30
Land 1 417 000 - 3 245 000

Buildings 5 000 000 - 6 300 000
Plant 2 800 000 2 800 000 0
Taxation expense 815 045 28 232 865 911
Bank 364 000 54 730 331 889
Inventory 84 705 77 988 0
Investment in Salt Ltd 1 728 000 - -
Investment in Smooth Ltd 2 795 000 - -
Dividends paid 125 000 100 000 100 000
Loan to Smooth Ltd 500 000 - -
15 808 000 3 195 250 11 020 900

x Salt Limited’s plant was purchased on 1 July 20X3 at a cost of C2 300 000. The useful
life of the plant was estimated at five years with no residual value. This item of plant was
sold on 30 June 20X7 at a selling price of C500 000. Depreciation and any profit or loss
on sale of the old plant has been correctly calculated and included in profit before
taxation.
New plant purchased on the same day for C2 800 000. The useful life of the new plant
was also estimated at five years with no residual value.
x The depreciation expense and the tax allowances are the same for both items of plant.
x The land of Peanut Limited and Smooth Limited is not depreciated and there are no tax
allowances. The buildings of both companies are depreciated at a rate of 5% p.a. and the
tax allowance is the same.
x The loan from Peanut Limited to Smooth Limited bears interest at a rate of 13% p.a. and
is repayable in two equal annual instalments commencing on 1 July 20X9. Interest has
been correctly accounted for by both companies.
x All the companies declared and paid the dividends on 15 June 20X7.
x Peanut performed an impairment test on its investment in Salt Limited following
Salt Limited’s declaration of a dividend in 20X7. This is the first time the investment’s
recoverable amount has been calculated.
x The recoverable amount of goodwill is the same as its carrying amount.
x The normal tax rate is 29% and has been in effect since the investments in Salt Limited
and Smooth Limited were acquired.
Required:
a) Prepare the journal entries in the accounting records of Peanut Limited to account for its
investment in Salt Limited for the years ended 30 June 20X5 and 30 June 20X7 only.
Narrations are not required.
b) Prepare all the pro forma consolidation journal entries at 30 June 20X7.
Narrations are required.
c) Prepare an extract from the consolidated statement of financial position of Peanut Limited
and its subsidiary companies at 30 June 20X7 showing the following items only:
x Share capital
x Non-distributable reserve
x Liabilities
Chapter 30 359
Question 30.5
Pepper Limited bought all the shares in Salt Limited on 1 January 20X3 and paid C342 500
for its investment. The retained earnings of Salt Limited at the date of acquisition amounted
to C80 000. All the assets were considered to be fairly valued except for the land.
The land is rented to a neighbouring restaurant to use as a parking lot. The land of Salt
Limited was valued by an independent valuer at C50 000 above its cost price of C90 000.
Pepper Limited uses the revaluation model according to IAS 16 and accordingly, instructed
Salt Limited to also adopt the revaluation model in its accounting records. Salt Limited
intends to recover the land through sale.
Pepper Limited purchased all of its plant and equipment on 1 January 20X2. The useful life is
estimated to be ten years with no residual value.
The trial balances of Pepper Limited and Salt Limited at 31 December 20X4 are as follows:
TRIAL BALANCE
AT 31 DECEMBER 20X4
Pepper Salt
Limited Limited
Deferred tax 8 400
Profit before taxation 132 142 64 285
Loan from Pepper Limited 50 000
Dividends payable 40 000
778 642 514 785
Land 150 000

Plant and equipment 150 000
Investment in Salt Limited 342 500
Loan to Salt Limited 50 000
Dividend receivable 40 000
Cash 54 500 263 500
Dividends declared 50 000 40 000
Taxation 27 642 19 285
778 642 514 785
During the year ended 31 December 20X3, Salt Limited earned a profit before taxation of
C46 428. Taxation expense amounted to C13 928. Salt Limited declared a dividend of
C40 000 during December 20X3.
In accordance with its policy of the revaluation model, the land of Salt Limited was revalued
during December 20X4 to an amount of C150 000. Salt Limited earned a profit before
taxation of C64 285 during the year ended 31 December 20X4. Taxation expense amounted
to C19 285. Salt Limited declared a dividend of C40 000 during December 20X4. The
dividend has been correctly recorded in the accounting records of both companies.
The loan from Pepper Limited to Salt Limited was advanced on 1 July 20X4. Interest at 9%
per annum has been paid by Salt Limited to Pepper Limited and is correctly included in the
profit before taxation of both companies.
360 Chapter 30
The corporate tax rate is 28% and the CGT inclusion rate is 50%.
The goodwill is considered to be worth its carrying amount.
Required:
a) Prepare the pro-forma consolidating journal entries for the year ended
31 December 20X4.
b) Prepare the consolidated statement of changes in equity of the group for the year ended
31 December 20X4.
c) Prepare the assets side of the consolidated statement of financial position of the group at
31 December 20X4.
Chapter 30 361
GAAP: Graded Questions Partly owned subsidiaries
Chapter 31
Partly owned subsidiaries
Question Key issues
31.1 - Theory:
x Shortcomings of consolidated financial statements;
x Non-controlling interests
31.2 Prague / Saltzberg Allocation of costs ; Revaluation increase of non-depreciable

asset
31.3 Pawpaw / Seed Revaluation increase of depreciable asset (revaluation not

recorded by subsidiary; intra-group sale of goods from subsidiary
to parent; no tax
31.4 Pineapple /Skin Revaluation increase of depreciable asset at acquisition

(revaluation not recorded by subsidiary; revaluation increase of
non-depreciable asset after acquisition (revaluation recorded by
subsidiary); I ntra-group sale of goods from parent to subsidiary
31.5 Portugal / Spain Revaluation increase of non-depreciable asset; revaluation

decrease of depreciable asset
31.6 Max / Lisa / Ape Revaluation increase of non-depreciable asset at acquisition and
subsequent to acquisition; subsidiary with losses
31.7 Hurry / Scurry Revaluation increase of depreciable assets (both deductible and
non-deductible); subsequent sale of asset; interim and final
dividends
31.8 Pink / Scarlet / Revaluation increase of non-depreciable asset; revaluation

Silver increase of depreciable asset; subsequent sale of revalued non-
depreciable asset and transfer of profit to NDR; parent investment
in subsidiary's preference shares
31.9 Phone / Skype Revaluation increase of depreciable asset recorded in subsidiary's

records (at acquisition and subsequent to acquisition); inter-
company loan (subsidiary owes parent); parent investment in
subsidiary's preference shares
31.10 Petunia/ Sweetpea/ Revaluation increase of non-depreciable asset at acquisition and

Snapdragon subsequent to acquisition (recorded by Sub); revaluation increase
of depreciable asset at acquisition and subsequent to acquisition
(not recorded by Sub)
362 Chapter 31
Question 31.1
a) Discuss the shortcomings of consolidated financial statements.

b) Discuss the treatment of non-controlling interests where:
x goodwill is paid by the parent company on acquisition of 80% of the subsidiary's shares
x the parent company pays a premium on acquisition of 80% of the subsidiary due to plant
being undervalued in the subsidiary's books
x the subsidiary sells goods at a profit to the parent company which owns 70% of the
subsidiary's shares
x the subsidiary pays interest to the parent company (which owns 65% of the subsidiary)
on a loan made by the parent company to the subsidiary.
Question 31.2
The following are the trial balances of Prague Limited and Saltzburg Limited at 30 September
20X5.
TRIAL BALANCES AS AT 30 SEPTEMBER 20X5

PRAGUE SALTZBURG
LIMITED LIMITED
Retained earnings 1 October 20X4 47 000 12 100
Rent received - 37 500
Dividend income 4 000
Accumulated depreciation – equipment 30 000 -

Accounts payable 8 000 -
Shareholders for dividend 10 000 5 000
Current tax payable 3 000 1 800
257 000 103 400
Investment property at cost - 75 000
Equipment at cost 100 000 -
Investment in Saltzburg Limited 68 000 -
Taxation expense 22 000 11 800
Inventories 35 000 -
Accounts receivable 15 000 -
Dividend receivable 4 000
Cash 3 000 11 600
Dividend - declared (30 September 20X5) 10 000 5 000

257 000 103 400
Additional information
x On 1 July 20X5 Prague Limited purchased 40 000 of the 50 000 issued shares in
Saltzburg Limited for C68 000. The fair value of the land (investment property) of
Saltzburg Limited is C83 000. All other assets and liabilities are fairly valued.
x The investment property of Saltzburg plc comprises an open piece of ground that has
been set up as a car park. Prague plc rents the entire car park from Saltzburg plc for use
Chapter 31 363
by customers shopping at its store. The profit before tax of Saltzburg is attributable
exclusively to the operation of the car park. The profit before tax from 1 October 20X2 to
30 June 20X3 amounted to C16 500. The profit before tax from 1 July 20X3 to the 30
September 20X3 amounted to C13 000.
x The tax expense has been correctly calculated. For Saltzburg plc, C6 600 relates to the
profit earned from 1 October 20X2 to 30 June 20X3 and C5 200 relates to the profit
earned from 1 July 20X3 to the 30 September 20X3. The CGT inclusion rate is 50%.
x The non-controlling interests are measured at their proportionate share of the acquiree’s
identifiable net assets.
Required:

equity of Prague Limited and its subsidiary for the year ended 30 September 20X5 and the
consolidated statement of financial position at that date.
Comparative figures and notes to the financial statements are not required
Question 31.3
Pawpaw Limited purchased 80% of the shares in Seed Limited for C1 600 000 in cash on
1 July 20X3.
The following are the trial balances of the companies at 30 June 20X6:
Pawpaw Limited Seed Limited

C C C C
Share capital 1 000 000 1 000 000
Retained earnings 2 864 000 930 000
Acc. depreciation – Buildings 1 250 000 -
Acc. depreciation – Plant 1 400 000 1 840 000
7 619 000 4 252 250
Land – cost 400 000 500 000

Buildings – cost 700 000 -
Plant – cost 2 950 000 2 300 000
Investment in Seed Limited 1 600 000 -
Inventory 85 000 107 900
Bank 1 341 750 1 067 550
7 619 000 4 252 250

x The balance on retained earnings of Seed Limited at the date of acquisition amounted to
C550 000. There was no revaluation surplus on the statement of financial position of
Seed Limited at the date of acquisition.
x The fair value of the plant of Seed Limited at the date of acquisition was assessed at
C2 140 000 while all other assets and liabilities were considered to be fairly valued. The
364 Chapter 31
directors of Pawpaw Limited agreed with Seed Limited’s estimated useful life of the
plant. No entry was recorded in the accounting records of Seed Limited in respect of the
fair value of the plant.
x The plant of Seed Limited was purchased on 1 July 20X2 at a cost of C2 300 000. The
plant is depreciated on a straight line basis over its estimated useful life of five years with
no residual value. This equates to the tax allowances granted by the taxation authorities.
x During the year ended 30 June 20X6 Seed Limited sold goods to Pawpaw Limited.
Inventory with a cost to Pawpaw Limited of C30 000 were unsold at the reporting date.
Seed Limited marks up its goods at 20% above cost.
x The dividends of both Pawpaw Limited and Seed Limited have been paid in full.
Required:
a) Prepare an extract from the consolidated statement of comprehensive income of Pawpaw

Limited and its subsidiary for the year ended 30 June 20X6 starting with ‘profit before
tax’.
b) Prepare the consolidated statement of changes in equity of Pawpaw Limited and its
subsidiary for the year ended 30 June 20X6.
c) Prepare the current assets and current liabilities sections only from the consolidated
statement of financial position of Pawpaw Limited and its subsidiary at 30 June 20X6.
Ignore tax and deferred tax
Question 31.4
Pineapple Limited purchased 80% of the shares in Skin Limited for C1 800 000 on
1 July 20X5. The investment was paid for in cash. The statements of financial position of
Pineapple Limited and Skin Limited at 30 June 20X7 appear as follows:

AT 30 JUNE 20X7
Pineapple Skin
Limited Limited
C C
ASSETS
Non-current assets 4 817 000 1 700 000
Land at fair value 1 217 000 700 000
Buildings at carrying amount 250 000 -
Plant at carrying amount 1 550 000 1 000 000
Investment in Skin Limited 1 800 000 -

Inventory 84 000 107 000
Cash in bank 386 000 528 000
5 478 000 2 500 000
Chapter 31 365
EQUITY 5 220 000 2 418 000

Share capital 1 000 000 800 000
Revaluation surplus 1 400 000 200 000
Retained earnings 2 820 000 1 418 000
LIABILITIES
5 478 000 2 500 000

x The balance on retained earnings of Skin Limited at the date of acquisition amounted to
C300 000. There was no revaluation surplus on the statement of financial position of
Skin Limited at the date of acquisition.
x The fair value of the plant of Skin Limited at the date of acquisition was assessed at
C2 400 000 while all other assets and liabilities were considered to be fairly valued. The
directors of Pineapple Limited agreed with Skin Limited’s estimated useful life of the
plant. The revaluation was not recorded in the accounting records of Skin Limited.
x The plant of Skin Limited was purchased on 1 July 20X4 at a cost of C2 500 000. The
plant is depreciated on a straight line basis over its estimated useful life of five years with
no residual value. This equates to the tax allowances granted by the taxation authorities.
x On 30 June 20X6 the land of Soup was revalued upwards by C200 000 to its fair value of
C700 000. The revaluation was recorded in the accounting records of Skin Limited.
x During the year ended 30 June 20X7 Pineapple Limited sold goods to Skin Limited.
Inventory with a cost to Skin Limited of C30 000 were unsold at the reporting date.
Pineapple Limited marks up its goods at 20% above cost.
x The non-controlling interests are to be measured at their proportionate share of the
acquiree’s identifiable net assets.
Required:
Prepare the consolidated statement of financial position of Pineapple Limited and its
subsidiary at 30 June 20X7.
Question 31.5
The following trial balances were extracted from the records of Portugal Limited and Spain
Limited at 30 June 20X9:
TRIAL BALANCES AT 30 JUNE 20X9
PORTUGAL SPAIN
LIMITED LIMITED
Asset replacement reserve 50 000 -
Retained earnings 1 July 20X8 12 000 10 000
Accumulated depreciation - plant 14 000 18 000
366 Chapter 31
Accumulated depreciation - furniture 2 500 1 000

Loan from Portugal Limited - 30 000
361 000 192 000
Land at cost 130 000 80 000

Plant at cost 35 000 60 000
Furniture at cost 5 000 4 000
Investment in Spain Limited 105 000 -
Loan to Spain Limited 30 000 -
Cash 5 000 14 000
361 000 192 000

x On 1 July 20X8 Portugal Limited purchased 75% of the shares in Spain Limited. The
following adjustments were made:
x Plant had a fair value of 20% less than its carrying amount and had a remaining life of
8 years with no residual value.
x Land had a fair value of double its carrying amount. The carrying amount of the land
shown on the trial balance at 30 June 20X9 includes additional land costing C50 000 that
was purchased during the current year.
x All other assets and liabilities were considered to be fairly valued.
x Spain Limited had purchased its plant on 1 July 20X6. At the date of purchase, the plant
had an estimated useful life of 10 years and no residual value. No plant had been sold by
either company during the current financial year.
x Furniture is depreciated by Spain Limited at the rate of C200 p.a. using the straight line
method. No furniture had been sold by either company during the current financial year.
x It was decided that each company is to transfer C10 000 to the asset replacement reserve.
No entries have been recorded in either set of accounting records for these transfers.
x The corporate tax rate is 35% and the CGT inclusion rate is 50%.
Required:
Prepare the consolidated statement of financial position of Portugal Limited and its subsidiary
company at 30 June 20X9 and the consolidated statement of comprehensive income and
consolidated statement of changes in equity for the year ended on that date.
Chapter 31 367
Question 31.6
The following balances were extracted from the records of Max Limited and its subsidiaries:
TRIAL BALANCES AT 31 OCTOBER 20X7

MAX LISA APE
LIMITED LIMITED LIMITED
Share capital 300 000 100 000 100 000
Revaluation surplus 17 200 12 900 -
Deferred tax 2 800 2 100
Asset replacement reserve - 6 000 -
Retained earnings / (accumulated loss) 30 000 16 000 (7 000)
Accumulated depreciation – plant and equipment 50 000 33 000 -
Net operating profit 52 200 50 000 5 000
Long term liability 60 000 80 000 30 000
Bank overdraft 5 000 - 3 000
Shareholders for dividends 15 000 10 000 -
547 200 320 000 135 000
Land 130 000 125 000 130 000

Plant and equipment 180 000 130 000 -
Investment in subsidiaries - Shares in Lisa Limited 68 800
- Shares in Ape Limited 78 300
- 10% loan (Lisa) 20 000 - -
Inventories 9 000 9 000 -
Dividends receivable 6 000 - -
Cash - 5 000 -
Interest paid 7 000 11 000 -
Transfer to asset replacement reserve - 6 000 -
Dividends declared 15 000 10 000 -
Tax 18 000 12 000 -
547 200 320 000 135 000
Additional information
x The revaluation surplus in both companies arose on 31 October 20X6 when the
companies revalued their respective land.
x Investment in Lisa Limited: Max Limited purchased 60% of the shares in Lisa Limited
in 20X4 for C68 800 when the only reserve in Lisa Limited was retained earnings of
C5 000. At acquisition, the fair value of the land was C10 000 above its carrying amount.
All other assets and liabilities were fairly valued. The interest due by Lisa Limited to
Max Limited had been paid by year end.
x Investment in Ape Limited: Max Limited purchased 80% of the shares in Ape Limited on
1 January 20X3 for C81 100 when Ape Limited’s retained earnings was C1 500. All assets
and liabilities were fairly valued.
An impairment in respect of the investment in Ape Limited amounting to C6 800 was
recognised at 31 October 20X6. A reversal of the impairment amounting to C4 000 was
recognised at 31 October 20X7.
368 Chapter 31
Required:
equity of Max Limited and its subsidiary companies for the year ended 31 October 20X7 and
the consolidated statement of financial position at that date in compliance with the
requirements of the Companies Act and International Financial Reporting Standards.
Question 31.7
On 1 January 20X1, Hurry Limited acquired 80% of the ordinary shares of Scurry Limited for
C995 000. The summarised statement of financial position of Scurry Limited at
31 December 20X0 is as follows :
SCURRY LIMITED
AS AT 31 DECEMBER 20X0
C
ASSETS
Property 650 000
- Cost 1 300 000
- Accumulated depreciation (650 000)
Equipment 300 000
- Cost 500 000
- Accumulated depreciation (200 000)
Current assets 320 000
1 270 000
Asset replacement reserve 40 000
Current liabilities 120 000
1 270 000

x In determining the purchase price of Scurry Limited, Hurry Limited determined the fair
value of the equipment at C380 000 and estimated the remaining life of the equipment as
four years from the date of acquisition of the subsidiary. Hurry Limited also determined
the fair value of the property at C750 000. No entries relating to the revaluations are to be
recorded in the accounting records of Scurry Limited.
x Scurry Limited provides for depreciation on the property at 5% per annum on the straight
line basis. The property is an administration building and no tax allowances are provided
by the tax authorities.
x Scurry Limited sold all its property on 31 December 20X1 for C800 000.
x Scurry Limited provides for depreciation on the equipment at 20% per annum on the
straight line basis.
identifiable net assets
x The company tax rate is 30% and the CGT inclusion rate is 50%.
Chapter 31 369
The draft statements of comprehensive incomes and statements of changes in equity of Hurry
Limited and Scurry Limited for the year ended 31 December 20X1 are as follows:
Hurry Scurry
Limited Limited
C C
Profit before sale of property 120 000 60 000
Profit on sale of property 0 215 000

HURRY LIMITED SCURRY LIMITED
Asset Asset
Share Retained replacement Share Retained replacement
capital earnings reserve capital earnings reserve
C C C C C C
Balance at 2 500 000 100 000 15 000 700 000 160 000 40 000
31/12/X0
Total 84 000 257 000
comprehensive
income
Dividends
- Interim (20 000) (25 000)
(30/06/X1)
- Final (30 000) (130 000)
(30/12/X1)
Transfer to asset (5 000) 5 000 (10 000) 10 000
replacement
reserve
2 500 000 129 000 20 000 700 000 252 000 50 000
x The interim dividend of both companies was declared on 30 June 20X1 and paid shortly
thereafter. The final dividend of both companies was declared on 30 December 20X1 and
will be paid during January 20X2.
Required:
a) Prepare the journal entries in the accounting records of Hurry Limited relating to the
investment in Scurry Limited for the year ended 31 December 20X1.
b) Prepare the consolidated statement of comprehensive income of the group for the year
c) Prepare the consolidated statement of changes in equity of the group for the year ended
31 December 20X1.
d) Prepare an extract from the statement of financial position of the group at
31 December 20X1 showing the equipment, the goodwill and the non-controlling interest.
e) Prepare the pro-forma consolidation adjusting entries relating to the interim dividend and
the final dividend declared by Scurry Limited for the year ended 31 December 20X1.
370 Chapter 31
Question 31.8
The Colour Group consists of the parent company, Pink Limited and its subsidiary
companies, Scarlet Limited and Silver Limited.
The trial balances of Pink Limited, Scarlet Limited and Silver Limited at 30 June 20X8 are as
follows:
TRIAL BALANCE AT 30 JUNE 20X8

PINK SCARLET SILVER
LIMITED LIMITED LIMITED
Ordinary share capital 550 000 100 000 100 000
Preference share capital (16% shares) - - 50 000
Retained earnings - 30 June 20X7 382 000 73 000 87 000
Asset replacement reserve 94 600 -
Profit before taxation 365 000 168 000 208 000
Profit on sale of land - 110 000 -
Accumulated depreciation
- Plant & equipment 210 000 - 101 500
Trade and other payables 123 500 26 200 68 000
Shareholders for dividends 70 000 - 40 000
1 700 500 571 800 655 000
Land 600 000 - -
Plant & equipment 400 000 - 290 000
Investment in Scarlet Limited
- 75 000 ordinary shares of 100 000 issued shares 100 000 - -
Investment in Silver Limited
- 60 000 ordinary shares of 100 000 issued shares 100 000 - -
- 20 000 preference shares of 50 000 issued shares 20 000 - -
Cash 228 911 380 960 200 760
Inventories 35 505 - 29 500
Trade and other receivables 51 500 33 800 28 500
Taxation 94 584 62 440 58 240
Transfer to non-distributable reserve - 94 600 -
Preference dividend paid - - 8 000
Ordinary dividend declared 70 000 - 40 000
1 750 500 571 800 685 000
Turnover 1 500 000 820 000 1 000 000
The following information is relevant to Scarlet Limited:

x Pink Limited purchased its shares in Scarlet Limited several years ago for C100 000. The
investment was paid for in cash. The balance on retained earnings of Scarlet Limited at
the date of acquisition amounted to C12 000.
x The fair value of the land of Scarlet Limited at the date of acquisition was assessed at
C50 000 above its cost price of C500 000. All other identifiable assets and liabilities were
considered to be fairly valued.
x Scarlet Limited sold its land on 31 December 20X7 for an amount of C610 000. The
directors transferred the after tax profit of C94 600 to an asset replacement reserve. The
directors intend to purchase another plot of land early in the new financial year.
The following information is relevant to Silver Limited:
x Pink Limited acquired its ordinary and preference shares in Silver Limited on 1 January
20X6 for C100 000 and C20 000 respectively. The investment was paid for in cash. The
Chapter 31 371
balance on retained earnings of Silver Limited at the date of acquisition amounted to

C32 000.
x The fair value of the plant & equipment of Silver Limited at the date of acquisition was
assessed to be C279 000. The directors of Pink Limited agreed with Silver Limited's
original estimated useful life of 10 years. All other assets and liabilities were considered
to be fairly valued. The future benefits will be recovered through use of the asset. No
other plant and equipment has been acquired since the date of acquisition of Silver.
x Silver Limited sold inventories during the current year to Pink Limited at a selling price
of C125 000. All the inventories were sold by Pink Limited by the end of the reporting
period.
The following information is relevant to the parent and both subsidiaries:
x The share capital has remained unchanged since incorporation.

x Pink Limited has accrued for the dividends declared by Silver Limited.
Required:
a) To prepare the consolidated statement of comprehensive income of The Colour Group for
the year ended 30 June 20X8.
b) To prepare the consolidated statement of changes in equity of The Colour Group for the
year ended 30 June 20X8
c) To prepare the non-current assets section of the consolidated statement of financial
position of The Colour Group at 30 June 20X8:
d) To prepare the pro-forma consolidating journal entries relating to the non-distributable
reserve for the year ending 30 June 20X9.
Question 31.9
Phone Limited bought 80% of the ordinary share capital of Skype Limited on 1 October 20X5
for C1 100 000. The group is known as Talk for Ever. Phone Limited does not own any of
the preference share capital of Skype Limited. The abridged trial balance of Skype Limited at
30 September 20X5 appeared as follows:
SKYPE LIMITED
ABRIDGED TRIAL BALANCE AT 30 SEPTEMBER 20X5
Debit Credit
8% Preference share capital 100 000
Equipment 1 000 000
Accumulated depreciation - Equipment 400 000
Current assets 724 000
Current liabilities 184 000
1 724 000 1774
Phone Limited uses the revaluation model to measure its equipment and, at acquisition,
instructed Skype Limited to also use the revaluation model in its company accounting records.
The fair value of Skype Limited’s equipment was estimated at C750 000, with no change in
372 Chapter 31
the estimated useful life. Skype Limited recorded the revaluation in its accounting records on
1 October 20X5, using the net replacement value method. The revaluation surplus will be
transferred to retained earnings only on disposal of the asset. Skype Limited depreciates the
equipment over its useful life of ten years with a zero residual value. The tax authority grants
a tax allowance of 10% per annum.
All other assets and liabilities are considered to be fairly valued.
The trial balances of both companies at 30 September 20X7 are shown below:
TRIAL BALANCES AT 30 SEPTEMBER 20X7
PHONE LIMITED SKYPE LIMITED
Ordinary share capital 1 200 000 800 000
8% Preference share capital - 100 000
Revaluation surplus 213 000 177 500
Non-current borrowings - 180 000
Profit before interest expense and tax 383 600 289 600
Interest expense - 18 000
Property - 1 000 000
Accumulated depreciation - 75 000
Equipment – fair value 1 200 000 600 000
Deferred taxation 65 250 58 000
Investment in Skype 1 100 000
Loan to Skype 120 000
Other investments - 120 000
Dividends - ordinary 20 000 16 000
Dividends - preference - 8 000
2 784 850 2 784 850 2 320 100 2 320 100

x Immediately after acquisition in October 20X5, Skype Limited declared and paid a
dividend of C50 000.
x The preference shares of Skype Limited are redeemable at the option of the company.
x On 30 September 20X7, the fair value of Skype Limited’s equipment was estimated at
C600 000. The revaluation was recorded in the accounting records on that date and is
incorporated in the trial balance at 30 September 20X7.
x The property of Skype Limited as shown on the trial balance was purchased during the
year ended 30 September 20X6.
x The revaluation surplus on Phone Limited’s trial balance arose from the revaluation of
Phone Limited’s plant at 30 September 20X5. On 30 September 20X7, the fair value of
Phone Limited’s plant was estimated to be equal to its carrying amount. The initial
revaluation was recorded in the accounting records on that date and is incorporated in the
trial balance at 30 September 20X7.
x The non-current borrowings of Skype Limited comprise:
Chapter 31 373
x A loan from Phone Limited of C120 000, advanced on 1 October 20X5, at an interest
rate of 9% per annum.
x A loan from Investors Bank of C60 000, advanced on 1 October 20X6, at an interest
rate of 12% per annum.
x The directors of Skype Limited declared and paid the preference dividend for the year on
20 September 20X7. The directors declared an ordinary dividend of C16 000 on
25 September 20X7, payable during October 20X7. The dividend has been correctly
recorded in the accounting records of both companies.
x The taxation expense has been correctly calculated for both companies at the company tax
rate of 29%.
Required:
a) Prepare all the journal entries in the accounting records of Skype Limited relating to the
equipment of Skype Limited, including tax consequences, for the year ended
30 September 20X7.
b) Prepare the at-acquisition, pro-forma consolidation adjusting entry relating to the
ordinary share capital of Skype Limited for the year ended 30 September 20X7.
c) Prepare the at-acquisition and current year pro-forma consolidation adjusting entries
relating to the preference share capital and preference dividends of Skype Limited for the
year ended 30 September 20X7.
d) Prepare the journal entry in the accounting records of Phone Limited and the pro-forma
consolidation adjusting entries relating to the ordinary dividends declared by Skype
Limited for the year ended 30 September 20X7.
e) Prepare the statement of comprehensive income of the Talk for Ever group for the year
ended 30 September 20X7.
f) Prepare the statement of changes in equity of the Talk for Ever group for the year ended
30 September 20X7.
Question 31.10
The Garden Group consists of the parent company, Petunia Limited and its subsidiary
companies, Sweetpea Limited and Snapdragon Limited.
The following are the trial balances of the companies at 30 June 20X9:
Petunia Limited Sweetpea Limited Snapdragon Limited
Debit Credit Debit Credit Debit Credit
Share capital 1 000 000 500 000 100 000
Revaluation surplus 1 400 000 215 000 -
Retained earnings 3 405 000 72 500 73 000
Deferred tax - 35 000 -
Accumulated depreciation - 1 250 000 - -
Buildings
Profit before tax 2 887 500 65 000 168 000
Profit on sale of plant - - 28 000
Shareholders for dividend 75 000 40 000 -
10 200 000 989 785 477 200
374 Chapter 31
Land 1 500 000 650 000 -

Buildings 5 500 000 - -
Inventory 230 000 30 000 88 000
Bank 1 021 710 155 585 100 520
Dividends receivable 32 000 - -
Investment in Snapdragon 100 000 - -
Limited
Investment in Sweetpea 600 000 - -
Limited
Taxation expense 812 040 22 200 54 880
Dividends 125 000 40 000 -
10 200 000 989 785 477 200
The following information is relevant to Sweetpea Limited:

x Petunia Limited purchased 80% of the shares in Sweetpea Limited for C600 000 on 1 July
20X7. The investment was paid for in cash. The balance on retained earnings of
Sweetpea Limited at the date of acquisition amounted to C60 000.
x The fair value of the land of Sweetpea Limited at the date of acquisition was assessed at
C150 000 above its cost price of C400 000, while all other assets and liabilities were
considered to be fairly valued. The future benefits will be recovered through sale of the
asset. Petunia Limited uses the revaluation model to measure its property and thus
instructed Sweetpea Limited to change its accounting policy to the revaluation model.
Sweetpea recorded the fair value of the land in its accounting records at acquisition. The
land is not depreciated and there are no tax allowances.
x There was no change in the value of the land at 30 June 20X8. The land of Sweetpea
Limited was revalued at 30 June 20X9 to a fair value of C650 000.
x The directors of Sweetpea Limited declared a dividend of C40 000 on 30 June 20X9.
The following information is relevant to Snapdragon Limited:
x Petunia Limited purchased 75% of the shares in Snapdragon Limited on 1 July 20X6 for
C100 000. The investment was paid for in cash. The balance on retained earnings of
Snapdragon Limited at the date of acquisition amounted to C12 000.
x At acquisition date, all the identifiable assets and liabilities of Snapdragon Limited were
considered to be fairly valued, except for the plant. Snapdragon Limited purchased all of
its plant on 1 July 20X1 at a cost of C160 000. The plant is depreciated on a straight-line
basis over its useful life of ten years to a zero residual value. The tax authorities grant a
tax allowance of 10% per annum on the straight line basis.
The fair value of the plant on 1 July 20X6 was assessed at C120 000. The total useful life
and residual value remained unchanged. The future benefits will be recovered through the
use of the asset. No entry was recorded in the accounting records of Snapdragon Limited
in respect of the fair value of the plant.
x Snapdragon Limited sold all of its plant on 30 June 20X9 for an amount of C60 000. The
directors have contracted to purchase additional plant early in the new financial year.
The following information is relevant to the parent and both subsidiaries:
x The share capital has remained unchanged since incorporation.
Chapter 31 375

x The corporate tax rate is 28% and the CGT inclusion rate is 50%. STC has been correctly
calculated and recorded by all three companies.
Required:
a) Prepare the consolidated statement of comprehensive income of The Garden Group for
the year ended 30 June 20X9, in so far as the information is available.
b) Prepare the consolidated statement of changes in equity of The Garden Group for the year
ended 30 June 20X9.
The total column is not required.
c) Prepare an extract from the consolidated statement of financial position of the Garden
Group at 30 June 20X9, showing the non-current assets section only.
d) Prepare the pro-forma consolidating entries relating to the dividends of Sweetpea Limited
for the year ended 30 June 20X9.
e) Prepare the pro-forma consolidating entry at the beginning of the year relating to the plant
of Snapdragon for the year ended 30 June 20X10.
The relevant ‘at acquisition’ entries are correctly processed and are not required.
376 Chapter 31

Gaap Graded2016

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Gaap Graded2016

Uploaded by

Copyright:

Available Formats

GAAP:

First edition 2002

Printed and bound by Interpak Books, Pietermaritzburg

• ‘Gripping GAAP’ by CL Service; and

Changes made for the 2016 (fifteenth) edition

We have a Facebook page, called ‘Accounting

Assumptions for international students

z A tax on taxable profits at 30% (referred to as income tax); and

Profit before tax (accounting profits) adjusted for:

z Differences caused by non-taxable income and non-deductible expenses

z (Proceeds from the sale – Base cost) x 50% inclusion rate

z Financial reporting environment (chapter 1)

Currency has been denoted by the symbol ‘C’.

Facebook page: Accounting 911 by Kolitz and Service

Publisher’s webpages www.myacademic.co.za

Publisher’s email address: administrator@myacademic.co.za

Dedication and acknowledgements

Question Key issues

1.5 BitsyBusiness Differential reporting: IFRSs for SMEs

1.6 - Brief history of internationlisation of accounting standards

1.8 Dodgy Wodgy Legal backing for accounting standards

1.10 - Success criteria for global standards

a) The IASB is responsible for ensuring compliance with the IFRSs.

i) Compliance with IFRSs is legally enforced through the application of IAS 1.

a) What is differential reporting and briefly explain its purpose.

Provide a brief answer to each of the questions posed.

Access the speech on the internet at (http://www.ifrs.org/Alerts/PressRelease/Pages/Michel-

Question Key issues

2.1 Short questions Core concepts

a) Is the Conceptual Framework an IFRS?

“The Conceptual Framework deals with:

a) Explain the objective of financial reporting as outlined in the Conceptual Framework.

The Conceptual Framework for Financial Reporting refers to financial performance

Question Key issues

IAS 1 Presentation of Financial Statements requires a statement of comprehensive income to

Authorised share capital Qty

x The preference shares are non-redeemable.

Share capital 136 500

Ignore comparatives and value-added tax.

St Andrews Limited is a retailer listed on the Johannesburg Securities Exchange’s AltX

Packaging for purposes of safe transport 30 000

The statement of compliance note is required.

Question Key issues

Question Key issues continued …

Customer A Customer B Customer C Customer D

Macrohard is a supplier of computer software. Macrohard sold software to the Congolese

b) Determine the transaction price and provide a detailed explanation.

Question Key issues

a) In your own words, explain the meaning of income tax.

x Paid electricity and water of C420 (includes VAT of 14%).

There are no components of other comprehensive income.

The following tax related information has been provided to you:

LIST OF BALANCES FROM STATEMENT OF FINANCIAL POSITION

Question Key issues

Answer the following short questions:

a) Define a temporary difference.

Provision for warranty costs 10 000 -

The following information is relevant:

Year ended 30 June

The information given below is in respect of Sweatshop Limited, a manufacturing company:

Required (For both parts A and B):

x The tax authorities:

PERFECT BODY LIMITED

The following information is relevant: