Working for Property, Plant and Equipment [IAS 16] RELEVANT TO ACCA QUALIFICATION PAPER F7

		$000	$000
A	Land
	Carrying amount 01/09/2011	XXX
	Revaluation reserve	XXX
	Revalued amount 31/08/2012		XXX
B	Leased Property
	Carrying amount 01/09/2011	XXX
	Revaluation reserve	XXX
	Revalued amount 31/08/2012	XXX
	Amortization	(XXX)
	Carrying amount 31/08/2012		XXX
C	Plant and Equipment
	Carrying amount 01/09/2011	XXX
	Depreciation for the year	(XXX)
	Carrying amount 31/08/2012		XXX
D	Leased Plant (under Finance Lease)
	Fair value	XXX
	Depreciation for the year	(XXX)
	Carrying amount 31/08/2012		XXX
		Total	XXX

IAS 17 LEASES (Key Notes)

Definition of lease types:

Finance lease-lease that transfers substantially all the risks and rewards to the lessee

Operating lease-any other lease

Indicators of Finance Lease

The main indicator is that the lease term is for the major part of the useful economic life of the asset. And the indicators are:

-          at the beginning of the lease, the present value of the minimum lease payments is approximately equal to the fair value of the asset

-          The lease transfers ownership of the asset to the lessee by the end of lease term  

-          The lessee has the option to buy the asset at a price expected to be lower than fair value at the time the option is exercised

-          The lease asset is of specialized nature

Substance over form

Accounts are generally required to reflect commercial substance (reflects the financial reality of the transaction) rather than legal form (legal reality of the transaction).

IAS 17 deals with the accounting for finance lease which follow the definition of an asset in the IASB Framework for the Preparation and Presentation of Financial Statements: “an asset is a resource controlled by the entity as a result of the past events and from which future economic benefits are expected to flow the entity”. Ownership is not necessary, control is the essential feature.

 IAS 17 thus argues that an asset leased under a finance lease must be recorded as an asset and corresponding liability in the lessee’s accounting records.

ACCOUNTING ENTRIES

A.      Finance Lease

01.   At the beginning of the lease

Dr. Non-Current Asset

Cr. Finance Lease Liability

Initial recording-

NCA: at the fair value (or, if lower, the present value of the minimum lease payment)

Finance Lease Liability: liability for finance leases spilt between current liabilities and non-current liabilities

02.   At the end of each period of the lease

Dr. Depreciation expenses (Income Statement)

Cr. Non-current Asset-accumulated depreciation

(NCA should be depreciated over the shorter of the useful life and the lease term)

03.   As each rental paid

Dr. Interest Expenses (Income Statement)

Cr. Finance Lease Liability

(with the finance charge)

Dr. Finance Lease Liability

Cr. Bank/Cash

(with the rental payment)

B.      Operating Lease

Only rental payment under operating leases are charged to the income statement on straight-line-basis over the term of the lease  

Note: If a finance lease asset is incorrectly treated as an operating lease it will have the following effects on the financial statements:

- assets understated so Return on capital employed will be overstated

- liabilities understated so gearing understated

- little effect on income statement (profit will be overstated)

IAS 11 CONSTRUCTION CONTRACTS

DEFINITION

IAS 11 defines a construction contract as: a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology, and function for their ultimate purpose or use.

IAS 11 TREATMENT

Where possible, IAS 11 applies the accruals concept to the revenue earned on a construction contract. If the outcome of a project can b reasonably foreseen, then the accruals concept is applied by recognising profit on uncompleted contracts in proportion to the percentage of completion, applied to the estimated total contract profit. If, however, a loss is expected on the contract, then an application of prudence is necessary and the loss will be recognised immediately.

OUTCOME CAN BE RELIABLY MEASURED

IAS 11 only allows revenue and contract costs to be recognised when the outcome of the contract can be predicted with reasonable certainty. This means that it should be probable that the economic benefit attached to the contract will flow to the entity. If a loss is calculated, then the entire loss should be recognised immediately. If a profit is estimated, then revenue and costs should be recognised according to the stage that the project has completed. There are two ways in which stage of completion can be calculated, and, in the exam, it is important to determine from the question scenario which method the examiner intends you to use, either the:

  work certified method (sometimes referred to as the sales basis)

work certified to date / contract price

   cost method

                        costs incurred to date / total contract costs

Step approach

Step 1: Set up extracts of the financial statements and a working paper.

Step 2: Determine at W1 whether a profit or loss is expected on the contract.

Step 3: In this example a profit will be calculated, so determine the accounting policy from the question and calculate the stage of completion.

Step 4: Calculate how much profit should be shown this year from the stage of completion and include it in the income statement extract.

Step 5: ‘Build’ up the income statement. If it is a work-certified accounting policy, then the work certified for the year should be taken to the revenue line. If it is a cost-basis accounting policy, then the costs incurred should be taken to the cost of sales line.

Step 6: Depending on what approach was taken at step 5, you are now in a position to

find the balancing figure to complete the income statement.

Step 7: Calculate the asset or liability outstanding on the construction contract.

OUTCOME CANNOT BE RELIABLY MEASURED

In following prudence, where an outcome cannot be reliably measured, any costs incurred during the financial year should be expensed immediately and revenue recognised as equivalent to the contract costs expected to be recoverable.

WHAT IS INCLUDED IN CONTRACT REVENUE AND COSTS?

Contract revenue will be the amount agreed in the initial contract, plus revenue from variations in the original contract work, plus incentive payments and claims that can be reliably measured, such as contract revenue which can be valued at the fair value of received or receivable revenue. Contract costs are to include costs relating directly to the initial contract plus costs attributable to general contract activity, plus costs that can be specifically charged to the customer under the terms of the contract.