ACC204 Accounting for Lease by Lessee Assignment Answer
Part 1: Case Study: Accounting for Leases by Lessee
AASB 16 “Lease” is the revised accounting standard and is applicable to accounting periods beginning on or after 1 January 2019. The new standard specifies a single accounting model for lessee. Leasing results in companies using the assets without increasing the risk exposure of the firm related with ownership of high value assets. Since the leasing activity forms the core of many businesses, the earlier accounting standard did not require the lessee to recognize the asset and liability related to the operating leases and hence failed in providing the required details of financial transaction of the business to the users. Thus the standard was revised to ensure that the users of the financial statement get the complete understanding of leasing activities of the business and their impact on the business. The standard requires that the lessee should recognize the assets and liabilities related to all the leases which has the term of more than 12 months unless the underlying asset of lease is of a low value (AASB 16, 2016).
As per the earlier accounting for leases the lessee would only account the payment made for operating lease in the income statement as expense. Thus the companies operating on leases had a large portion of their financing “off-balance sheet” in the form of operating leases (Deloitte, 2016). The accounting as per the new standard requires the lessee to record the leases on the balance sheet. The balance sheet will now show the underlying asset related to the lease representing the right-to-use of the asset and a liability related to the lease which represents the obligations with respect to the lease in terms of lease payments.
The value of the right-to-use assets of the concerned lease is measured similar to the other non-financial assets like the property, plant and equipment. On the similar note the valuation of lease asset also recognizes the depreciation of the right-to-use asset. The lease liability is accounting like other financial liabilities. The interest on the liabilities is duly calculated and recorded. The lease payments are classified into principal and interest portions and are accounted for in respected accounts. The value of the payments is the present value at the appropriate discount rate for the company.
This requirement will result in following changes in the balance sheet of the lessee:
- Increase in the recognized assets and liabilities in the balance sheet of the lessee. All the operating leases will have their respective assets and liabilities recorded in the balance sheet.
- The higher lease expenses are recorded in early period of lease because of high interest portion in the lease payment in initial years similar any other interest bearing liability
- The lease expenses which were earlier classified as operating expenses will now be classified as financing cost for the interest portion and amortization of liability for the principal portion.
- Change in cash flows as the operating cash flows and cash flows from financing activities will both be affected now.
Since the given airline company has a large portion of its aircrafts leased from the manufacturers, the change in accounting for leases under the new standard will increase the assets and liabilities in the balance sheet of the company significantly.
However another important aspect of this standard is that is does not apply to short term leases of less than 12 months or the leases which has the low value of the underlying assets. The standards require exercise of judgment on the part of the accountant/ management to assess whether a transaction is a lease and the term of lease. The term of the lease will affect the reporting of the leases and hence the application of the reporting requirement on the lessee. The determination of the discount rate for the lease payments is also important to calculate the fair present value of the payments.
The Leases of the airline company in consideration can be cancelled anytime with minimal penalties, this way these can be classifies as short term lease and the lessee can avoid accounting of the leases as per the new standard. However a reasonable judgment is required whether the extension of the lease is necessary or not. In this case since a major portion of the aircrafts is leased, the termination of lease will affect the business activity and hence though the leases are cancellable at any times, they need to be extended for the continuation of the business and hence will not fall under the category of short term leases.
Part Two- Case Study
Identifying the Acquirer
AASB 3 deals with Business Combinations. It helps the reporting entity to report all the relevant, reliable and comparable information in its financial statements relating to the event of business combination. The business transaction where the assets and liabilities of the business are acquired and assumed by the other entity to constitute a business is termed as a business combination. Thus business combination is merging of the two companies into one for the business purpose.
Since the two businesses become one, there will be one reporting entity who shall be preparing the accounts and financial statements. Thus one of the two combining companies will be identified as the acquirer and will be the reporting entity. According to Para 6 of AASB 3, the acquirer entity is the entity that obtains the control of the other entity which is termed as acquiree (AASB 3, 2015). AASB 10 helps in identifying the acquirer entity in the two combining entities by defining control. According to AASB 10, an entity is said to have control over the other if the first entity has right to the returns of the other entity and its involvement in the business activities of the other entity has the ability to affect the returns though its power (IAS Plus.com, 2014). Thus if White Ltd has right over the earnings and returns of Cloud Ltd and it has the power to control the decisions of Cloud Ltd in a way that the returns of Cloud Ltd are affected than White Ltd will have control over Cloud Ltd and will be termed as the acquirer of vice versa.
Since it is important to identify the acquirer in the business combination; in case where none of the combining entity tales control of the other combining entity it is unclear to identify the acquirer, in that case the acquirer is identified as par paragraphs B-14 – B18 of AASB 3. According to para B15, the entity whose owners have the larger portion of voting rights in the combined entity after the combination will be considered as the acquirer. The relative voting rights of the combining entities are evaluated and the entity whose owners as a group receive the largest portion, that entity is considered to be the acquirer.
The question arises as to why it is so important to indentify one of the combining entities as the acquirer entity? It is necessary to identify the acquirer in the business combination because the acquirer will be reporting entity for the future financial statements. The acquirer of the business combination is the entity that prepares the consolidated financial statements of the combined entity in accordance with AASB 10. The acquirer entity values the identifiable assets and liabilities of the acquiree entity at fair value or at amortized costs and combines then not its balance sheet. The accounting and reporting will differ if the acquirer entity is changed.
If White Ltd is identified as the acquirer, it will prepare the consolidated financial statements of the combined entity. White Ltd will measure the identifiable assets of Cloud Ltd and will assume its liabilities along with any non controlling interest. In this process the assets and liabilities are measured at fair value as at the acquisition date using the measurement principle. Thus the assets and liabilities of White Ltd will be reported at their book value while the assets and liabilities of Cloud Ltd will be identified and measured at the fair value. This may result in identification of few new assets and liabilities and writing off of some existing assets and liabilities or Cloud ltd. Goodwill is also recognized as the excess of the consideration paid by the acquirer company to the acquiree entity over the fair value of assets and liabilities of the acquiree (CPA Australia, 2016 ).
While if Cloud Ltd is indentified the acquirer, it will be reporting entity. The consolidated financial statements will now have the assets and liabilities of Cloud Ltd reported at their book value while the assets and liabilities of the White Ltd will be identified and measured at fair value using the measuring principle as per Para 18 of AASB3. Here the value of assets of liabilities of White Ltd will Change while it will remain same for Cloud Ltd. Goodwill amount will also change in this case based upon the consideration and fair value of assets and liabilities of White Ltd.
Thus the identification of the acquirer entity is very important as it will affect the consolidated financial statements of the combined entity and even though it is the same two entities combining together, the consolidated financial statements will reflect different amounts of assets and liabilities for different reporting entity.
Part 3- Analysis and calculations
Current Tax Liability for the year ended 30 June 2021:
Accounting Profit $40,000
Add: Donations to political Parties$5,000
Depreciation Expense 15,000
Annual leave Expense 5,600
Rent Revenue 10,000 35,600
Rent Revenue 12,000
Annual Leave paid6,500
Taxable Income 38,350
Current Tax Liability (@30% $11,505
Adjusting Journal Entry:
Income Tax expense DR. 12,000
Direct Tax Asset CR 495
Current tax Liability CR 11,505
Treatment of Rent Items:
The accounting profit measures the income on accrual basis while for the income tax purposes, the income is measured on receipt basis. Rent of $12,000 recognized by Flaxton is the earned income while the cash received is different. Thus the accrued income is reduced from the accounting profit and the received income is added to it for calculation of taxable income. The rent revenue for accounting was $12,000 and the rent received was $10,000. Thus $12,000 is reduced from accounting profit and $10,000 is added to obtain the taxable profit.
Part 4- Analysis and Calculations
Sea Horse Ltd.
1. Journal Entries for the given events:
|(Interim dividend of 10c per share on 600,000 fully paid shares and 5c per share on 400,000 partly paid shares)|
|(call of 50c per share on 400,000 partly paid shares)|
|(collected call money)|
|(1 Bonus share issued for every 10 shares for $1 for t he total issued shares of 1000,000)|
|31-Dec-20||Plant maintenance Reserve||$50,000|
|(transfer of plant maintenance reserve to general reserve)|
|Profit & Loss Summary||$60,000|
|(dividends paid form earnings)|
2. Equity Section of the Statement of financial Position as at December 31, 2020
SEA HORSE LTD
Statement of Financial Position as at December 31, 2020
Share Capital $1100,000
(1100000 shares fully paid at $1 per share)
General Reserve 150,000
Retained earnings 60,000