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ACC204 Accounting for Lease by Lessee Assignment Answer

ACC204 Assignment 40

Please attach one cover sheet with your SID and name, please answer questions including all working process, 

Use your SID and name to be the name of the file.

Part one – case study (10 marks)

Answering the following questions in essay format, word limit: 500-1000 words. ACCOUNTING FOR LEASES BY LESSEE

Alan Tan is the CEO for an airline company. The company has a large proportion of its aircraft leased from manufacturers under lease agreements that can be cancelled at any time with minimal penalties. At the end of the period starting on 1 January 2019, looking at the statement of financial position prepared by the company accountant, Joyce Maine, Alan noticed a large increase in the total assets and liabilities.

Not being aware of any major restructuring activities or investments during the period but having heard about a change in the accounting rules governing leases, Alan asks Joyce to prepare a report describing how the changes in those accounting rules affect the company. Required

Joyce approaches you, a junior accountant, to summarise the changes in the treatment of some leases that caused the large increase in the total assets and liabilities. Provide a short description of those changes to Joyce.

Part Two – case study (10 marks)

Answering the following questions in essay format, word limit: 500-1000 words IDENTIFYING THE ACQUIRER

White Ltd has been negotiating with Cloud Ltd for several months, and agreements have finally been reached for the two companies to combine. In considering the accounting for the combined entities, management realises that, in applying AASB 3/IFRS 3, an acquirer must be identified. However, there is debate among the accounting staff as to which entity is the acquirer.

Required

  1. What factors/indicators should management consider in determining which entity is the acquirer?
  2. Why is it necessary to identify an acquirer? In particular, what differences in accounting would arise if White Ltd or Cloud Ltd were identified as the acquirer?

Part 3 -analysis and calculation (10 marks)

Flaxton Ltd made an accounting profit before tax of $40 000 for the year ended 30 June 2021. Included in the accounting profit were the following items of revenue and expense.

items of revenue and expense.

For tax purposes the following applied.

tax purposes

Required

Calculate the current tax liability for the year ended 30 June 2021, and prepare the adjusting journal entry.

Explain your treatment of rent items in your answer to requirement 1.

Part 4-analysis and calculation (10 marks)

The equity of Sea Horse Ltd at 1 January 2020 was as follows.

equity of Sea Horse Ltd

The following events occurred during the year.

 events occurred

Required:

  1. Prepare the journal entries to give effect to the above events.
  2. Prepare the equity section of the statement of financial position at 31 December 2020.

Answer

ACC204 Assignment

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     

Less: 

        Rent Revenue                                         12,000

       Annual Leave paid6,500

      Depreciation- Machinery18,750(37,250)


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:

DateAccountDRCR
25-Jun-20Dividend Paid$80,000

     Cash
$80,000

(Interim dividend of 10c per share on 600,000 fully paid shares and 5c  per share on 400,000 partly paid shares)





10-Jul-20 Final Call $200,000

     Share capital
$200,000

(call of 50c per share on 400,000 partly paid shares)




31-Jul-20Cash$200,000

  Final Call
$200,000

(collected call money)





15-Sep-20General Reserve$100,000

     Share Capital
$100,000

(1 Bonus share issued for every 10 shares for $1 for t he total issued shares of 1000,000)





31-Dec-20Plant maintenance Reserve$50,000

    General Reserve
$50,000

(transfer of plant maintenance reserve to general reserve)






Profit & Loss Summary$60,000

   Retained earnings
$60,000

(earned profit)






Retained earnings$80,000

    Dividends paid
$800,000

(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

Total equity$1310,000

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