Tutorial PROGRAM Block 1 - 2022 (Subject to change)

Week beginning Week – Topic Seen tuts

20 February 1 - Revision Rev Q6; Rev Q14a; Rev Q20 (part 1 and 2)

27 February 2 - Deferred Tax DT Q11; DT Q 2, DT Q16

06 March 3 - Deferred Tax DT Q12, FV Q1, Rev Q40; Rev Q34

13 March 4 - Deferred Tax June 2021Q1; DT Q20; Leases Q14

20 March 5 - Leases DT Q21, DT Q25, DT Q27

27 March 6 - Leases Leases Q12, Leases Q3, Rev Q36

03 April 7 Test 1

10 April Break

1
 WEEK 1
WEEK STARTING 20 FEB Main principles? What did I learn?

Rev Q20 (part 1 and 2)

Rev Q14a
SEEN TUTS

Rev Q6

2
REVISION QUESTION 6 (LEVEL 3) TIME: 103min

Tackle Limited (Tackle) is a manufacturer and distributor of fishing gear. Over the last couple
of years, the company established itself as a leading manufacturer of fishing rods, fishing
hooks and fishing flies. Tackle services local and international markets.
You have recently been employed as the financial manager at Tackle and your first priority is
the finalisation of the financial statements for 2009 financial year ending 31 December. Tackle
presents their statement of comprehensive income reflecting income and expenditure by
function.
The following information is relevant for the finalisation of the 2009 year end:

1. Revenue
Revenue consists of the following:

31/12/2009
Sales - fishing rods 6 259 989

Sales - hooks 1 009 988

Sales - fishing line 760 000

Dividends received (exempt from tax) 10 000

● Included in the sale of fishing rods is an amount of R180 000 (cost of inventory
R120 000) received from Fairy Flies Limited for a special order of pink carbon fibre
fishing rods for a women’s’ fly fishing competition to be held in March 2010. The R180
000 was received on the 31 December 2009. Tackle processed this sale on the same
date. The order is scheduled to be delivered in the middle February 2010.

● Tackle sells all the fishing lines it manufactures to one company called Nymphs Limited
(Nymphs) on consignment. When goods were dispatched to Nymph the following entries
were made:

Dr Accounts receivable – Nymphs

Cr Sale of fishing line

Dr Cost of Sales
Cr Inventory (Finished goods)

Nymphs have an established distribution network in all the major fishing regions in
Southern Africa. Nymph’s inventory records indicated that 10% of the fishing line
received from Tackle was not sold at 31 December 2009. Tackle marks up fishing line
sold to Nymphs by 25% on cost.

3
 ● Tackle has elected to disclose dividends received as other income in their financial
statements as this is incidental income from an insignificant investment.

2. Inventories
Inventory is recorded using the periodic method. Inventories consist of the following:

Balance as at 31/12/2009 Valuation method

as per the general ledger*
Raw materials 2 334 000 First in first out

Work in progress 2 399 243 Weighted average

Finished goods 4 980 000 Weighted average

Consumables 56 000 Weighted average

9 709 243
*The balances per the general ledger do not include the following issues listed below.

The following inventory related issues have not been recorded in the accounting records of
Tackle:
● On 10 December 2009 Tackle ordered 200 grips for fishing rods at R100 per grip from a
supplier in Lesotho. The supplier grants a 10% early settlement discount provided that
the invoice is settled within 30 days. Tackle intends to pay this invoice within the 30 days
by 9 January 2010. Tackle incurred delivery charges of R1 000 for transporting the grips
from Lesotho to Johannesburg. Goods in transit insurance relating to this delivery
amounted to R650. The grips arrived at Tackle’s warehouse on 30 December 2009. The
grips delivered on the 30th of December 2009 were excluded from the inventory count and
its net realisable value exceeded its cost.

● During the year end physical verification of inventory, the raw materials on hand was
calculated to be R2 143 500.

● The net realisable value of consumables at 31 December 2009 was R39 000.

3. Property, Plant and Equipment

Property consists of an industrial property and an administration building. Tackle
recognises property using the cost model in IAS 16.

4
Industrial property
The following information was extracted from the industrial building account in Tackle’s
general ledger:

Industrial Building
01/01/2006 Cost 9 000 000

Depreciation (320 000)

31/12/2006 Balance 8 680 000

Depreciation (320 000)

31/12/2007 Balance 8 360 000

Depreciation (320 000)

31/12/2008 Balance 8 040 000
Depreciation (320 000)
31/12/2009 Balance 7 720 000

Tackle purchased the industrial property at a cost of R11 000 000 on 1 January 2006. At
the date of purchase, the directors estimated that R2 000 000 of the cost was attributable
to the land and R9 000 000 of the cost was attributable to the factory buildings. The base
cost of both the land and buildings for taxation purposes is equal to the original purchase
price.
The factory building is depreciated on the straight-line basis over a period of twenty-five
years with a residual value of R1 000 000.
The independent valuators have correctly valued the industrial property as follows:

Valuation dated Land Buildings

Value in use Fair value less

cost to sell

31 December 2007 R2 000 000 R6 500 000 R6 980 000

31 December 2009 R2 000 000 R8 000 000 R8 200 000

The useful life and residual value of the industrial property remained unchanged at both
valuation dates. Close scrutiny of Tackle’s accounting records at 31 December 2007
revealed that the impairment that date was not recognised in Tackle’s financial records.
The tax authorities have indicated that the previous years’ tax assessments will be re-
opened. This error has not been corrected in Tackle’s financial records. Ignore deferred
tax consequences relating to this error.

5
 The recoverable amount of the industrial building approximated the carrying value for the
year ended 31 December 2008 taking into account the effect of the error.

Administration building
The administration building was constructed by Tackle Limited at a cost of R4 000 000
(base cost for taxation purposes equals construction cost) and was available for use on 1
January 2005. The useful life of this building was estimated to be twenty years. A residual
value of R500 000 was established on 1 January 2005. The recoverable amount of the
administration building approximated the carrying value during the past five years. The
administration building was sold on 30 June 2009 for R4 500 000.
The profit on the sale and the depreciation for the year relating to the administration building
have been correctly calculated and included in profit before tax.

4. Bond
Tackle issued a bond with a nominal value of R1 500 000 and a coupon rate of 10% on
1 January 2008.
The bond was issued at R1 500 000. The bond will be redeemed on 31 December 2010 at
a premium of 5%.

5. Other relevant information

The following balances have been correctly calculated, before taking into account the
adjustments required resulting from the abovementioned information.

31/12/2009

Manufacturing costs 740 000

Administration expenses 590 000

Salaries – Manufacturing 1 490 000

Salaries – Administration 880 000

Auditors fees – services as auditors 440 000

Consultation fees paid to auditors 20 000

Dividends paid 20 000

Profit before tax of R5 382 689 has been correctly calculated taking into account all
necessary adjustments.

6
6. Taxation

● The standard rate of income tax is 27% and 80%of capital gains are subject to income
tax at the standard rate. These rates have not changed in the last 3 years.

● Wear and tear allowances granted by the South African Revenue Service:

Administration buildings No tax allowance

Land No tax allowance

7
You are required to:
a) Provide the relevant journal entries relating to the issue of the bond on 1 January 2008
and the relevant journal entry/ies for the year ended 31 December 2009 in Tackle
Limited’s accounting records.

b) Provide the accounting policy for inventory in conformity with International Financial
Reporting Standards. Notes relating to the statement of compliance and the basis of
preparation are not required.

c) Disclose only the following notes to the financial statements of Tackle Limited for the
year ended 31 December 2009 in conformity with International Financial Reporting
Standards.
● Revenue
● Profit before tax
● Correction of Error
● Tax rate reconciliation (only numerical)
● Property, plant and equipment, only the total column and comparative are required)
● Inventory

(Please provide detailed workings for your solution)

8
REVISION QUESTION 6: SOLUTION

Required a

1 January 2008
Dr Bank 1 500 000

Cr Bond liability 1 500 000

Initial recognition of bond at fair value

31 December 2009

Dr Finance cost (refer to working) 174 901

Cr Bond liability 24 901

Cr Bank 150 000

Recognition of finance cost, interest paid on bond

Note: This is a financial liability and should be either measured at amortised cost (using the
effective interest rate method), or at Fair value through P/L. Does it meet the requirements to
be measured at Fair value?

Required b

Tackle Limited
Notes to the financial statements for the year ended 31 December 2009
Accounting policies
a) Inventory

Inventories are valued at the lower of cost and net realizable value using the following
valuation methods:

Raw materials: First in, first out.

Work in progress, finished goods and consumables: Weighted average method.

9
Required c
Revenue
Revenue consists of the following:

Sale - fishing rods (6 259 989 - 180 000) 6 079 989

Sales - hooks 1 009 988

Sales – fishing line (760 000 - 76 000) 684 000

7 773 977

Profit before tax note

Profit before tax has been calculated taking into account the following:

Profit on sale of administration building 1 287 500

Consumables written off to net realizable value 17 000

Depreciation – administration building (4 000-500)/20*6/12) 87 500

Depreciation – factory building 260 000

Reversal of impairment 1 260 000

Auditor’s remuneration – for services as auditors 440 000

- Other services 20 000

Salary cost (1 490+880) 2 370 000

Inventory write down 190 500

Tax rate reconciliation

Standard rate 27%

Profit before tax (5 382 689*.27) 1 453 326

Capital gain on admin building 400 000*0.27) (108 000)

Non-taxable dividend received (10 000*0.27) (2 700)

Non-deductible depreciation (87 500*0.27) 23 625

1 366 251
Effective tax rate 25.38%

Note: Why is the capital gain on admin building a reconciling item?

10
Correction of error
(Excluding tax effects)
Impairment to property was omitted from the profit for the financial year ended
31 December 2007.
The effects of this error are summarized as below:

31/12/2008 31/12/2007

R R
Statement of comprehensive income
(Increase) / decrease in impairment 60 000
expenses
Increase / (decrease) in profit for the 60 000
period

Statement of financial position

Decrease in property, plant and (1 320 000) (1 380 000)
equipment
Decrease in retained earnings (1 320 000) (1 380 000)

Property, Plant and Equipment

01/01/08 Opening balance

Net carrying amount 2 000 +6 980 +3 475 12 455 000

Accumulated depreciation -

Depreciation 260+175 (435 000)

31/12/08 Closing balance 12 020 000

Net carrying amount at BoY 12 455 000

Accumulated depreciation (435 000)

Disposal of administration building (3 212 500)

Depreciation 260 +87.5 (347 500)

Reversal of impairment 1 260 000

11
 31/12/09 Carrying amount 7 720 000

Gross carrying amount 7 720 000

Accumulated depreciation -

Inventory
Inventory consists of the following:
Raw materials (2334-190.5) 2 143 500

Work in progress 2 399 243

Finished goods 4 980 000+60 800+120 000 5 160 800

Consumables 39 000+19 650* 58 650

*Can be included in raw materials too 9 762 193

Workings

W1. Error working – Should have been

HCA CA TB

01/01/07 Carrying amount 8 680 8 680 8 550

31/12/07 Dep / W&T [(9 000 – 1 000) / (320) (320) (450)

25]

[9 000 / 20]

8 360 8 360

Impairment (1 380) -

01/01/08 Balance 8 360 6 980 8 100

31/12/08 Dep / W&T [(6 980 – 1 000) / (320) (260) (450)

23]

01/01/09 Balance 8 040 6 720 7 650

Depr/ W&T (320) (260) (450)

7 720 6 460 7 200

Reversal (6460 – 7720) 1 260

Balance 7 720 7 720 7 200

12
W2: Bond
Calculation of effective interest rate
N=3,
PV = -1 500 000
FV = 1 500 000 x 105%
PMT = 150 000
Compute i = 11.489%
Balance on the bond
Initial amount 1 500 000
31/12/08 Finance cost (1500 000*11.489%) = 172 335
Bank (150 000)
Balance as at 1 Jan 2009 1 522 335
31/12/09 Finance cost (1 522 335*11.489%) 174 901
Bank (150 000)
1 547 236

13
REVISION QUESTION 14a (LEVEL 3) (TIME: 45 min)

You are a financial expert advising your client – Bidmessy Limited (“Bidmessy”) on
finalization of their financial statements for their year ended 30 September 2012.
Bidmessy is a diversified group specializing in both the supply of consumer goods and
manufacturing of such goods. The managing director has asked you to advise her on
two unrelated issues.

Issue 1:
During September 2012, it was discovered that there was a material error in
accounting for the expenditure incurred in the research and development of a recipe
for a protein shake targeted primarily at vegetarian sporty consumers, called
ProShake. This recipe will be leased (rented out) to one licensed supplements maker
and distributor across Africa who will in turn pay monthly fees to Bidmessy for using
the recipe over the 10-year contract period. The project accountant capitalized all
costs incurred on the project, which resulted in the following balances to be reflected
in the statement of financial position for 2010 and 2011 years:

30 September 2011 30 September 2010

Intangible asset – ProShake - 1 440 000 800 000
cost
Accumulated amortisation (36 000) -

The costs incurred by Bidmessy with regards to the ProShake recipe project were as
follows:

Period Description of activities Amount

incurred for
each phase
(Rands)
01 November 2009 Research on a protein shake for
vegetarian consumers commences
01 November 2009 - Name of product – “ProShake” registered 50 000
30 November 2009 as a trademark
01 December 2009- Human studies, clinical trials, search for 500 000
31 March 2010 suitable ingredients performed. Product

14
 specifications finalized. The research
phase is endorsed as complete.
01 April 2010 - Discussions with MrMaker Ltd (MrMaker) 250 000
31 July 2010 indicate that MrMaker would like to
manufacture ProShake under licence for
retail purposes while Bismessy employed
3 new technical experts and bought the
equipment to complete the development
of the recipe. ProShake is the first
vegetarian protein shake in the market.
01 August 2010 - Finalisation of a sound business plan in
order to obtain funding from either ICD or
31 August 2010
ENF Banks necessary to complete the
project.
20 September 2010 Funding application was rejected by both
ICD and ENF Banks.
29 September 2010 The Board of Directors took a decision to
abandon further development of
ProShake recipe due to lack of funding to
complete the project and employees on
this project were re-assigned to other
projects.
Subtotal – expenditure to date 800 000
15 May 2011 Secured a loan from an Asian Bank –
HBSC, that will cover all future costs
necessary for the development of
ProShake’s recipe. The Board of
Directors decided to revive the ProShake
project.
30 June 2011 Funds were received from HBSC; *640 000
employees were re-assigned back to the
ProShake project. The Heart Foundation
has agreed to endorse ProShake which
will result in originally projected sales
figures increasing further.
30 June 2011 The recipe was launched. A 10-year
contract effective immediately, was
entered into with MrMaker, a licensed
ProShake maker that will pay monthly
fees of R50 000 to Bidmessy for the use
of the recipe.
Total R1440 000

15
*Included in the above are advertising costs of R40 000. The project accountant kept
an accurate record of all costs incurred in the ProShake recipe project and Bidmessy
has an effective financial control system in place.
Ignore current and deferred taxation implications.

16
You are required to:
i) Discuss the recognition and measurement of all the costs incurred by
Bidmessy Limited in their financial records for the year ended 30
September 2010 and 30 September 2011, in accordance with the IAS 38,
Intangible Assets. The discussion of the asset definition is not required.

ii) Provide the Correction of Error note in terms of IAS 8 Accounting policies,
changes in estimates and errors, for Bidmessy Limited for the year ended
30 September 2012. Accounting policies are not required.

17
Solution Revision Question 14a:

Part i: Issue 1
• The costs incurred by Bidmessy can be recognized as an intangible asset if they
meet the definition of the asset; that of intangible asset and the recognition
criteria thereof

• The ProShake recipe project can be classified as an intangible asset as it is an

identifiable (can be rented separately per agreement with MrMaker Ltd), non-
monetary asset without physical substance (recipe has no physical substance).
[IAS 38, par 8]

• Because the ProShake recipe is an internally generated intangible asset – it is

subject to the recognition criteria for such assets and requires that its generation
be classified into a research phase and a development phase
[IAS 38, par 52]

• Research is defined as an original and planned investigation undertaken with the

prospect of gaining new scientific or technical knowledge and understanding [IAS
38, par 8]

o The research phase for the ProShake recipe project ran from 1 November
2009 until 31 March 2010 – hence all costs incurred therein (R550 000)
should be expensed to profit or loss. [IAS 38, par 54]

• Costs classified as development costs spent on the project should be recorded

as an asset if Bidmessy can demonstrate all of the following: [IAS 38, par 57]

• The technical feasibility of completing the intangible asset so that it will be

available for use or sale: The team of experts working on ProShake established
on 31 July 2010 that it was technically possible to complete the recipe [IAS
38, par 57 a]

• Its intention to complete the intangible asset and use or sell it: Bidmessy plans
to complete the ProShaker project by 30 November 2010 as established on 31
July 2010. (1) [IAS 38, par 57 b]

• Its ability to use or sell the intangible asset: Bidmessy has signed an agreement
to “rent out the recipe” to MrMaker Limited on 1 July 2011. [IAS 38, par 57 c]

• How the intangible asset will generate probable future economic benefits: the
renting out of the recipe to MrMaker Limited will generate probable future
economic benefits, estimated at R50 000 per month for 10 years as per the
contract signed on 1 July 2011. [IAS 38, par 57 d]

18
• The availability of adequate technical, financial and other resources to complete
the development and to use or sell the intangible asset: Adequate funding was
obtained on 1 October 2010 to finance the project, which indicates that Bidmessy
has the necessary resources to complete the ProShaker recipe project. [IAS
38, par 57 e]

• Its ability to measure reliably the expenditure attributable to the intangible

asset during its development (determining its cost): Bidmessy kept accurate
records of all the project costs and has an effective financial control system in
place. [IAS 38, par 57 f]

• Since all the criteria have been meet on 30 June 2011, Bidmessy should
recognise an intangible asset as of this date and can capitalise the development
costs incurred except the following:
o Development costs incurred before the project was abandoned – because
the recognition criteria had not been met - R250 000 [IAS 38, par 71]
o Advertising costs – R40 000

• Therefore, at the date of initial recognition (30 June 2011) – Bidmessy should
measure the ProShake recipe at R600 000

• The ProShaker recipe should be amortised over a 10 year period – resulting in an

amortisation charge of R15 000 during the year ended 30 September 2011 and a
carrying amount of R585 000 for that year.

• Amortisation of R60 000 should be recognised in the profit and loss for the
current year resulting in a carrying amount of R525 000 as at
30 September 2012.

Note: Remember it is important that the intangible asset has to meet all of
the criteria as set out in IAS38.57, before it can be recognised. It cannot be
recognised if even one is not met.

Note: Advertising costs can never be capitalised as future economic benefits

cannot be seen to be probable.

19
Part ii:

Bidmessy Ltd
Notes to the financial statements for the year ended 30 September 2012
Correction of error note

During September 2012, it was discovered that expenditure incurred in the research and
development phase of the ProShake recipe was incorrectly capitalised in 2010 and 2011
resulting in an incorrect amortisation expense being recognised in 2011. The correction of
error has been done retrospectively.

2011 2010
Effect on SOCI
(Increase) / decrease in research costs 0 (550 000)
(Increase) / decrease in development
expenses (250 000)
(Increase) / decrease in advertising costs (40 000)
(Increase) / decrease in amortisation* 21 000

Increase / (decrease) in profit or loss (19 000) (800 000)

Effect on SOFP 2011 2010

(Increase)/ decrease in accumulated
amortisation 21 000 0
Increase/ (decrease) in Intangible Assets (840 000) (800 000)

Increase/ (decrease) in Retained Earnings (819 000) (800 000)

* 36K - (600K/10*3/12)

Note: Why is there a decrease in amortisation expenditure? Due to the amount capitalised
being reduced, the amount that is amortised is subsequently decreased.

Something to think about: What would the tax effects of the error be?

Remember which elements of an error note are cumulative and must be carried forward.

Remember your format marks.

20
REVISION QUESTION 20 (LEVEL 3) (75 minutes)

Hilton Limited (“Hilton”) is a South African company that manufactures trailers which are sold
to the commercial and passenger vehicle market through a branch network. All the trailers are
assembled at a warehouse in Johannesburg and then transferred to the various branches
across the country.

The company uses the weighted average cost formula for valuing inventory at each reporting
date. The company’s reporting date is 31 December 2013.

Manufactured trailers

The opening inventory on 1 January 2013 consisted of the following: -

• 80 trailers which had a weighted average cost of R27 200 each

• Raw materials that are used in the assembly of trailers which had a value of R810 000.

The trailers are assembled at the warehouse which has a normal operating capacity of 96 000
direct labour hours per annum. The company allocates its fixed overheads to the trailers on
the basis of labour hours.

The company incurred the following costs in the process of manufacturing 1 600 trailers during
the current year:

Details Total cost (R)

Variable costs, excluding raw materials (1 600 units ; R20 500 per unit) 32 800 000
Fixed overhead costs 14 540 000
Raw materials purchased 2 447 000

The cost of the raw materials purchased during the year was R2 447 000 and the cost of
unused raw materials at the end of the year amounted to R189 000. The actual direct labour
hours for the year were calculated to be 102000 hours. The trailers are transferred to the
branches at a mark-up of 20% on cost. A total of 1 475 trailers were sold during the year
across the different branches. During the year-end inventory count, it was established the 15
of the unsold trailers had minor defects and could be sold at a price of R23 400 each. The rest
of the trailers remained in condition to be sold at market prices.

21
Production machinery

The company uses specialised machinery to manufacture the trailers.

The details relating to the production machinery are as follows –

Acquisition date 2 January 2011

Acquisition cost R2 700 000
Useful life (as determined on acquisition date) 8 years
Residual value NIL
The estimated remaining useful life of the machinery was revised to 5 years on 1 January
2013 and the residual value was revised to R180 000.

Debentures

In order to raise additional funds for the expansion of their warehouse, Hilton Limited issued
5 000 R150 debentures at face value on 1 July 2013. The debentures carry a coupon interest
rate of 9% per annum which is payable annually on 30 June. Each debenture will be converted
into 2 ordinary shares on 30 June 2019. There is no option for a cash settlement. On the date
of issue, the market interest rate for debentures with similar features but without the
conversion option was 11% per annum. Hilton Limited incurred and paid transaction costs of
R6 600 relating to the issue of the debentures.

The accountant was uncertain about the accounting treatment of the transaction and has
processed only the following journal entry with regards to the debentures:

Date Account Debit (R) Credit (R)

01/07/2013 Bank 743 400
Suspense account 743 400
Issue of debentures (R750 000 – R6 600)

Ignore all forms of taxation.

22
You are required to:

1. Provide the note disclosure relating to inventory in the financial statements of Hilton
Limited for the year ended 31 December 2013, in accordance with IAS 2. Show all
calculations. Comparative figures are not required.

NB: Layout

2. Prepare all the journal entries that Hilton Limited would process relating to the
production machinery from acquisition date to the end of December 2013.

NB: Dates, narrations

3. Prepare a memorandum to the accountant of Hilton Limited detailing the correct

classification, recognition and measurement of the debentures issued in terms of
International Financial Reporting Standards. Journal entries to correct the entries
processed by the accountant are required.

NB: Layout, logical flow

23
REVISION QUESTION 20 SOLUTION (LEVEL 3) (75 minutes)

Indicate how Hilton Limited disclose inventory in the notes to the financial statements for the year
ended 31 December 2013

Hilton Limited
Notes to the financial statements for the year ended 31 December 2013
1. Inventory

R
Inventory 6 487 000
Finished goods 6 416 500
Raw materials 189 000
Write-down of inventory to net realisable value (118 500)

Workings
Finished goods
Variable overhead costs – R32 800 000
1 600 x R20 500 per unit
Fixed overheads – R14 540 000
Raw materials used – R3 068 000
R810 000 + R2 447 000 – R189 000
Total cost of manufacture (current year) R50 408 000
Opening stock – R2 176 000
80 units x R27 200
Total cost – R50 408 000 + R2 176 000 R52 584 000
Weighted average cost – R31 300 per
R52 584 000 / (80 + 1 600) = unit
Closing stock – (R351 000 + R5 947 000) R6 298 000
80 + 1600 – 1 475 = 205 units
Damaged trailers – (at net realisable value) – 15 x R351 000
R23 400 R5 947 000
Other trailers – 205 – 15 = 190 x R31 300
Damaged trailers
Cost per unit – R31 300
Net realisable value – R23 400
Write down to NRV (R31 300 – R23 400) x 15 R118 500

Prepare the journal entries that Hilton Limited would process relating to the production
machinery for the year ended 31 December 2013

24
 Details DR CR

Depreciation 337 500

Accumulated depreciation 337 500

Depreciation for 2011

Accumulated depreciation 337 500

Machinery (cost) 337 500

Depreciation 337 500

Accumulated depreciation 337 500

Depreciation for 2012

Depreciation 369 000

Accumulated depreciation 369 000

Depreciation for 2013

Workings

Cost – 2 January 2011 – R2 700 000

Depreciation – 2011
2 700 000 / 8 = R337 500
Carrying amount – 31 December 2011
2 700 000 – 337 500 = R2 362 500

Depreciation (2012)
Historic – R2 700 000/8 = R337 500

1 January 2013
Carrying amount
R2 025 000 = R2 700 000 – R337 500 – R337 500

Depreciation = (R2 025 000 – R180 000) / 5 = R 369 000

Prepare a memorandum to the accountant of Hilton Limited detailing the correct classification,
recognition and measurement of the bonds issued in terms of International Financial Reporting
Standards. Journal entries are required.

25
Identification
Hilton Limited has issued debentures which are convertible to 2 ordinary shares in 2019. The
debentures have 2 separate components – the annual coupon payment (interest) and the
conversion into ordinary shares. Each component must be considered separately for
classification
Coupon payments
Hilton has a contractual obligation to pay interest to the debenture-holders on 30 June for 6
years. This contractual obligation to pay cash is a financial liability
The financial liability component will be measured at amortised cost using the effective interest
rate method
Conversion to shares
The terms of the debenture issue indicate that the debentures are convertible into ordinary
shares in 2019. Hilton therefore has the obligation to issue (deliver) ordinary shares to the
debenture-holders on redemption date
The number of shares to be issued is fixed (2 shares for every debenture) rather than variable
The conversion of the debentures therefore represents an equity instrument
Hilton has no obligation to deliver cash or another financial asset on redemption – therefore
this is not a financial liability
The debentures issued therefore represent a compound financial instrument as they contain
an equity and a liability component
Recognition
The amounts received from the debenture issue must therefore be allocated to the liability and
the equity component on the date that the debentures are issued.
The present value of the interest payments due to the debenture-holders would be classified
as a liability with the difference (if any) being allocated to equity
Measurement
The amount of R750 000 (5 000 x R150) needs to be allocated to the liability component first.
The amount to be allocated is
PMT – R150 x 9% = R13,50
N–6
I – 11%
Comp PV = R57,112 x 5 000 = R285 561
The difference between the amount received (R750 0000) and the liability of R285 561 is
allocated to equity (R464 439)
Transaction costs
The transaction costs of R6 600 are split between the equity and liability component in relation
to the values calculated on the date of issue.
The transaction costs allocated to the equity component amount to R4 087 (R6 600 x
R464 439/R750 000) and the remainder of
R2 513 (R6 600 – R4 087) allocated to the liability
The amount allocated to the equity component is deducted from equity and the amount
allocated to the financial liability is deducted from the liability.
The correcting journal entries are as follows –
DR Preference share suspense account 750 000
CR Liability 285 561
CR Equity 464 439

DR Financial liability 2 513

DR Equity 4 087
CR Preference share suspense account 6 600

26
 WEEK 2
WEEK STARTING 27 FEB Main principles? What did I learn?

DT Q11

DT Q2
SEEN TUTS

DT Q16

27
 Concept Tutorial: Deferred Tax Question 2 (DT 2) (15min)

You are a part of the audit team assigned to Springbok Information Systems (Pty) Ltd
(Springbok). ABC auditors were appointed to perform the audit on Springbok for the year
ended 30 June 2021, as per the Companies Act No.71 of 2008. Springbok is a large entity
that operates in the IT industry, their core operations are the sale and maintenance of
computer servers to customers.
The new financial manager of Springbok is unsure of how Deferred Tax arises and the reasons
for it. He has supplied you with the deferred tax note which was correctly disclosed and relates
to the year ended 30 June 2021:

Extract from the notes to the financial statements for the year ended 30 June 2021
5. Deferred Taxation
Comprises temporary differences on: R
Administration Building1 0
Equipment2 60 750(L)
IT Infrastructure 14 000(L)
Investment Property3 223 776(L)
298 526(L)
Notes:
1. The admin building was purchased in 2011 for R3 500 000 and has a useful life of 25
years. The carrying amount at 30 June 2021 was R2 100 000. The building does not
qualify for any tax allowances from SARS.
2. Equipment was originally purchased for R 1 000 000 on the 1 July 2018 and has a
useful life of 8 years. SARS allows a 20% wear and tear deduction for tax on
equipment. .
3. Investment property is held on the Fair Value model as per IAS 40. The property was
originally purchased for R2 000 000. The fair value adjustment correctly processed by
the accountant was R800 000 for the year ended 30 June 2021. SARS does not grant
any allowances on this property.
4. Springbok received dividends from local investments amounting to R220 000. These
are exempt for tax purposes in terms of s10(1)(k).
Additional Information
5. The normal tax rate is 27% and the Capital Gains Tax inclusion rate is 80%.
6. Net profit before tax and tax expense was correctly disclosed in the Statement of
Comprehensive Income for the period ended 30 June 2021:

Net Profit before Tax R1 358 778

Tax Expense R300 470

28
YOU ARE REQUIRED TO:
Draft an email in which you help the financial manager with the disclosure of tax by preparing
only the Tax Rate Reconciliation in Rand amounts for the year ended 30 June 2021.
In your answer ALSO include the purpose of preparing a tax rate reconciliation and provide
reasons for including or excluding amounts in the tax rate reconciliation to help the financial
manager understand. (15 minutes)

29
Concept Tutorial: Deferred Tax Question 2 (DT 2): SUGGESTED SOLUTION

From: student@wits.ac.za
To: financialmanager@springbok.co.za
Date: March 2022
SUBJECT: Tax Rate Reconciliation Explanation

Dear Financial manager

I hope this email finds you well.

Kindly find a detailed explanation of the tax rate reconciliation which accompanies the
tax disclosure note.

The tax rate reconciliation is required by IAS 12 to be disclosed separately as part of

the tax disclosures.
The tax rate is 27%, however the tax expense divided by the profit before tax doesn’t
always aggregate 27%, the tax rate reconciliation is used to explain to the users of
financial statements why the effective tax rate is not 27%.
The tax rate reconciliation includes items that are in profit before tax but not in tax and
items that are included in tax but not in profit before tax.
Tax on items can either be current or deferred tax.
Below is Springbok’s tax rate reconciliation together with detailed explanations for you
to be able to understand

Tax Expense note (extract)

Tax Rate reconciliation

Tax effect
Item Rate R

Corporate tax at 27% 27% 366 870

Administration building depreciation

- p15 IAS 12 initial exemption. (1) 2,78% 37 800

Equipment
Not a recon item as deferred tax has been raised in terms of
IAS 12

IT Infrastructure
Not a recon item as deferred tax has been raised in terms of
IAS 12. No other information given to assume otherwise. (1)

Investment Property Fair Value Adjustment

Deferred tax raised on 80%. Therefore 20% will be a -3,30% -44 800
reconcilable item.

30
Dividend
Exempt income included in net profit for tax but no tax or -4,37% -59 400
deferred tax has been recognised

Tax expense as per Statement of Profit and loss and other

22%
comprehensive income. R300 470

I hope you found the above helpful. Please do not hesitate to

contact me should you have any further issues.

Kind regards,
Student

31
DEFERRED TAX: QUESTION 11 (LEVEL 3) TIME: 20 MINUTES

You are the auditor of Modmed Pty Ltd, a company that manufactures and supplies medical
equipment to hospitals.

The new financial manager of Modmed is unsure of how deferred tax arises and the reasons
for it. He has supplied you with the following schedule:

Carrying Tax
Amount Base

R R
Land (Original cost R100 000) 120 000 100 000
Manufacturing plant (Original cost R30 000) 37 000 23 000

The corporate tax rate is 27% and the capital gain inclusion is 80%.

YOU ARE REQUIRED TO:

Discuss the objective of accounting for deferred tax with respect to the above-
mentioned assets making reference to the recoverability of the assets, the meaning of
the temporary differences and the resulting deferred tax. You must include the
calculation of the deferred tax in your discussion.

Objectives:

Explain

• The objective of accounting for deferred tax

• The effect that recoverability of assets has on deferred tax

32
DEFERRED TAX: SOLUTION 11

The objective of deferred tax is to account for the future tax consequences of the future
recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an
entity’s balance sheet.

Deferred tax is calculated on the difference between the carrying amount and the tax base of
an asset. These differences are referred to as temporary differences and are multiplied by
the tax rate that will best represent the future taxation of the asset (i.e., it is based on the
manner in which the asset will be recovered).

In order to determine the future tax consequences, it is therefore necessary to determine how
the asset will be recovered for accounting purposes.

If the asset is recovered through use, the carrying amount of the asset will represent the future
taxable economic benefits, the tax base represents future deductions and the difference
(taxable temporary difference) represents future taxable income. Taxable income is taxed at
the current tax rate.

The manufacturing plant in the above schedule is recovered through use and therefore the
difference between the carrying amount and the tax base in this scenario represents future
taxable income and would be taxed at the current rate of 27% giving rise to a future tax liability
(deferred tax) of R3 780 (taxable temporary differences of R14 000 multiplied by 27%).

Note: Please note that the tax rates have changed to 27% and 80% inclusion for CGT. This was
given in the question but you should know this.

In the above schedule, land is recovered through sale, and as there are no tax allowances on
land, the tax base is the historic cost of the land. In this scenario, land must have therefore
been revalued. If this asset were sold, the tax consequences would be limited to a capital
gain on the land. Deferred tax (future tax) is therefore provided at the CGT rate and would be
calculated to be a liability of R4 320 [R20 000 (temporary difference) x 80% x 27%].

Note: Land is presumed to be recovered through sale as you cannot use the economic benefits of
land. As such, land will be realised through sale.

The future deduction on land will be the base cost when the asset is sold for capital gains tax
purposes.

33
DEFERRED TAX: QUESTION 16 (LEVEL 4) (58.5 minutes)

Games R Us (Games) design, manufacture and sell computer games to various

wholesalers as well as to the public. Over the last couple of years, the company
established itself as a leading manufacturer of computer games specifically for the
‘teenage’ market.

You have recently been employed as the assistant financial manager and you are
responsible for the finalisation of the financial statements for the 2010 financial year,
ending 31 December 2010. The following issues have been identified:

XYZ machine:
The sale of the ‘Boobaloo’ computer game has been volatile over the last few years.
As a result, it has been necessary to determine the recoverable amount of the XYZ
machine (that is used in making the Boobaloo game) on a regular basis.

‘Games’ purchased the XYZ machine on 30 June 2007 for R1 500 000. The original
expected life of the plant was 10 years. The South African Revenue Service allows a
wear and tear deduction of 20% p.a. not apportioned for time.

Games accounts for machinery using the cost model per IAS 16 Property, plant and
equipment.
During the year ended 31 December 2009, the demand for the Boobaloo Computer
game decreased considerably. Consequently, Games were forced to carry out an
impairment test on the machine at 31 December 2009. The fair value of the machine
was determined to be R900 000, which approximates the machine’s recoverable
amount. The machine’s expected remaining useful life from 31 December 2009 was
estimated to be 5 years.

On 31 December 2010 Games once again performed an impairment test on the

machine and determined the fair value and recoverable amount to be R1 000 000.
This was due to the increase in the number of teenagers that play the Boobaloo
computer game.

A summary of the fair value, recoverable amount and useful life at the following dates
are presented below:

Date Recoverable Useful lives

amount
31-Dec-09 900 000 5 years
(from 31 Dec
2009)
31-Dec-10 1 000 000

Inventory

During 2010 Games realised that products to the value of R6 500 000 already sold
during 2009 were incorrectly included in the closing inventory as at

34
31 December 2009. The sale transaction was recorded correctly. No adjustments
have been processed to correct this error in 2009 or 2010.

The South African Revenue Service has indicated that the assessment for 2009 will
be re-opened.

Games use the periodic system to record inventory. Closing inventory at 31 December
2010 represents the physical inventory on hand.

The accounting records were as follows:

Note 2010 2009

R000’s R000’s

Sales 604 000 523 500

Cost of Sales -86 500 -53 500

Operating expenses 1 -500 000 -450 000

Profit before tax 17 500 20 000

Tax expense (20 000 x 27%) ? -5 400

Profit after tax 14 600

Note:
1 Depreciation and all other movements, including impairments, in property, plant and
equipment affecting operating expenses have been correctly included in operating
expenses during 2009 and 2010.

The following information is relevant

● The current tax expense per the taxable income calculation for 2010 has been
correctly calculated as R6 636 000. You do not need to make any adjustments
to current tax expense. Deferred tax for the current financial year, 2010 has not
yet been recorded.
● Opening retained earnings for the 2009 financial year was R20 000 000
● The applicable standard tax rate is 27% and the Capital Gains Tax inclusion
rate is 80% throughout all periods.
● You may round to the nearest R’000.

35
You are required to:

1. Prepare the profit section in the statement of profit or loss and other
comprehensive income of Games R Us for the year ended 31 December 2010.

Comparative figures are required (15 minutes)

2. Prepare the statement of changes in equity of Games R Us for the year ended
31 December 2010.

Comparative figures are required

You do NOT need a total column (10.5 minutes)

3. Prepare the following notes to the financial statements of Games R Us as at

31 December 2010:
● Property, plant and equipment. Details describing any revaluations
are NOT required.
● Prior period error note

Accounting policies are NOT required

Comparative figures are required (33 minutes)

36
Deferred Tax Solution 16:

Games R Us
Statement of Profit and Loss for the year ended 31 December 2010

R'000 R'000

2009
2010 (Restated)

Sales 604 000 523 500

Cost of Sales (W1)/(W2) (80 000) -60 000

Operating Expenses (500 000) -450 000

Profit before tax 24 000 13 500

2010 (24000*27%)

Tax expense 2009 (5400-(6500x27%) -6 480 -3 645

Profit for the year 17 520 9 855

W1: 2009: 53 500 + 6 500

COS = opening balance + Purchases – closing balance
Therefore removal of incorrectly added stock from closing balance reduces the
closing balance, and a reduction in the negative has a positive impact on the COS,
that’s why COS is increasing by R6 500

W2: 2010: 86 500 - 6 500

COS = opening balance + Purchases – closing balance
2009 year’s closing stock is 2010 year’s opening stock, therefore a reduction in
opening stock is a reduction in a positive, which leads to a reduction in COS, that’s
why COS is decreasing by R6 600

37
Games R Us
Statement of changes in equity for the year ended 31 December 2010

Retained Earnings
Balance as at 1 January 2009 20 000
Total comprehensive income for the year - Restated 9 855

Balance as at 31 December 2009 - Restated 29 855

As previously reported (20 000 + 14 600 = 34 600) 34 600

Correction of error (14 600 – 9 855 = 4 745) (4 745)

Total comprehensive income for the year ending

31 December 2010 17 520

Balance as at 31 December 2010 47 375

Notes to the financial statements as at 31 December 2010

Property Plant and Equipment
R’000
Machinery 2010 2009

Carrying Amount as 1 January 900 1 275

Cost 1 500 1 500

Accumulated Depreciation 600 225

Movements during the year

Depreciation -180 -150

Impairment P/L - -225

Impairment reversal P/L 180 -

Carrying Amount as at 31 December 900 900

Cost 1 500 1 500

Accumulated Depreciation 600 600

Historic carrying amount 900 1125

38
 Cost = R1 500 000
2009 YOA
CA = R1 500 000/10*(10-2.5) =R1 125 000
Impairment = R1 125 000 – R900 000 = R225 000

2010 YOA
CA = R900 000/5*4 = R720 000
Potential Impairment reversal = R1 000 000 – R720 000 =R280 000
Limited to = R225 000/5*4= R180 000
OR Limited to = R1 125 000/5*4 = R900 000 (Historical carrying amount)
= R900 000 – R720 000 = R180 000

Material prior period error

Inventory with a value of R6 500 that was sold in the prior year was incorrectly included
in inventory as at 31 December 2010. The prior year financial statements were
restated to correct the error.

The effect of the restatement is summarized below. The error had no effect on the
2010 financial statements.

2009
Statement of comprehensive income
(Increase) in cost of goods sold -6 500
Decrease in tax expense (6 500 x 27%) 1 755

(Decrease) in profit -4 745

Statement of financial position

(Decrease) in inventory -6 500
Decrease in tax payable 1 755

(Decrease) in equity -4 745

Note: Why is there a decrease in tax expense and tax payable?

The overstatement in closing inventory in 2009 led to an understatement of Cost of Goods Sold
Closing Stock = opening stock + purchases – cost of goods sold
Cost of goods sold = opening stock + purchases – closing stock

As cost of goods sold is increasing, the profit is decreasing, and Tax treatment is the same,
reduction in Tax

39
Workings:
HCA CA TB T/diff D/tax P/L

31 Dec 09 1 125 000 1 125000 600 000

Impairment P/L (225 000)

1 125 000 900 000 600 000 300 000 81 000 L

32 400

31 Dec 10 900 000 720 000 300 000 420 000 113 400 L

Impairment 180 000 180 000 48 600 L 64 800

reversal P/L

40
 WEEK 3
WEEK STARTING 06 MAR Main principles? What did I learn?

DT Q12

FV Q1

SEEN TUTS

Rev Q40

Rev Q34

41
DEFERRED TAX: QUESTION 12 (LEVEL 3) TIME: 60 MINUTES

You were employed as the new financial director of Loyiso Limited on 1 December 20X8. The year
end is 31 December.

The accountant of Loyiso Limited, Mark Myword, presented you with following financial statements
for the year ended 31 December 20X8:

Income Statement of Loyiso Limited for the year ended 31 December 20X8

20X8 20X7

Profit before tax 97,0001 95,000

Taxation -2 -25,650

Profit for the period 97,000 69,350

1
The profit before tax figure for 20X8 includes depreciation, profit on sale of factory building, bad debts and
dividends received.

2
The accountant did not provide for tax in the current year as he was unsure of how to calculate the tax.

Statement of changes in equity of Loyiso Limited at 31 December 20X8

Share Retained
capital earnings Total

Balance at 31 December 20X6 100,000 254,000 354,000

Profit for the year 61,200 61,200

Balance at 31 December 20X7 100,000 315,200 415,200

Profit for the year 97,000 97,000

Dividends paid -10,000 -10,000

Balance at 31 December 20X8 100,000 402,200 502,200

EQUIPMENT
Loyiso Ltd purchased highly specialised equipment, the T-Mach, on 1 January 20X6 for R160 000. The
equipment had an economic useful life of 8 years from the date of purchase. The equipment is used
in the production of high-density filaments.

During 20X7, a competitor company began importing high density filaments from China at a much
lower cost than they can be manufactured locally. Consequently, the demand for the high-density
filaments from Loyiso Limited decreased significantly by the end of December 20X7 resulting in a
decrease in the production output of the equipment.

42
The fair value less cost to sell of the equipment was R100 000 and the value in use was R108 000 at
31 December 20X7. The accountant did not process any journal entries as a result of the reduced
output of the equipment.

In 20X8, Loyiso Limited began researching other niche markets for which the specialised equipment
could be used. By the end of the year, Loyiso had identified a market for fiberglass filaments which
could also be manufactured by the T-Mach. The value in use of the T-Mach increased to R142 000 at
31 December 20X8 although the fair value less costs to sell remained at R100 000.

There is a tax allowance of 20% per annum on the equipment.

The accountant provided you with the following schedule for the equipment:

Carrying amount

31-Dec-X6 140,000

Depreciation -20,000

31-Dec-X7 120,000

Depreciation -20,000

Carrying amount at year end (20x8) 100,000

FACTORY BUILDING
Loyiso Limited purchased a factory building on 1 January 20X7 for R500 000. The building had a useful
life of 50 years from the date of purchase. On 31 December 20X8, the building was sold for R517 000.
Depreciation and profit on sale of the equipment have been correctly included in the profit before tax
for the year per the income statement presented above. The receiver of revenue grants a 2% p.a. non-
apportioned deduction in respect of the factory building.

Additional information:
1. Included in profit before tax for 20X8 are dividends received of R2 000 from local investments.
2. During the current year Loyiso Limited raised an expected credit loss allowance (bad debt
allowance) of R7 500 for the first time. The receiver of revenue did not grant a deduction in
respect of the provision created.
3. Loyiso Limited uses the cost model for measuring buildings and equipment.
4. Assume a tax rate of 27%, a CGT rate of 80% inclusion applies.
5. There were no exempt items in 20X7 and 20X8 other than what is evident from the
information above.

43
You are required to:

1. Prepare the calculation of taxable income for the year ended 31 December 20X8.

2. Prepare the income tax and deferred tax notes required per IAS 12 for the year ended 31
December 20X8 only.

3. Prepare the note relating to the correction of the prior period error for the year ended 31
December 20X8.

Your solution must be in compliance with disclosure requirements per international financial reporting
standards.

Accounting policy notes are not required.

44
DEFERRED TAX: SOLUTION 12:

PART 1

Taxable income
Profit before tax 109,000
Add depreciation-equipment 18,000
Less Wear and tear -32,000
Less reversal of impairment -10,000
Less profit on sale of building -37,000
Capital gain on sale of building (517-
500)*80% 13 600
Recoupment on sale of building 20,000
Add expected credit loss allowance 7,500
Less dividends received -2,000

Taxable income 87 100

Note: Before you can start the taxable income calculation, errors need to be fixed in order
to start with the correct profit figure. See working 1

PART 2

SA Normal tax 27 972

Current Tax 23 517
Deferred tax 4,455

Tax rate reconciliation

Standard tax rate 27% 29 430
Capital gain on factory building -0.84% -918
Dividends received not taxable -0.50% -540
25.66% 27 972

Note: Capital gain included in tax rate recon at 20% of gain because 100% is
included in accounting profit but only 80% in the tax profit.

45
Deferred tax balance comprises tax on the following temporary differences:
Equipment 9,720
Expected credit loss allowance -2,025
7,695

PART 3
Correction of prior period error
During the year a correction of a prior year error was made
relating to the omission of an impairment. The opening
balance of equity at the beginning of 20X8 was adjusted.
Comparative figures were restated accordingly.
The effect of the adjustment for this error on the results of 20X7
were as follows:

Statement of Comprehensive
Income

31 December 20X7 31 December 20X6

Increase in impairment costs (12 000)

Decrease in profit before tax (12 000)

Decrease in net tax cost (12 3 240

000x27%)

Decrease in profit after tax (8760)

Statement of Financial Position

31 December 20X7 31 December 20X6

Decrease in PPE (12 000) Nil

Increase in deferred tax assets 3 240 Nil

Statement of Changes in Equity

Effect on opening balance of retained Nil

income (20X7)

Effect on opening balance of retained (8760)

income (20X8)

Note: Why is there a negative effect on Retained Earnings in 20x8?

A change in profit after tax in 20x7 will be carried through to the opening balance of
retained earnings in 20x8.

46
WORKINGS

WORKING 1

Profit before tax 97,000

Add back incorrect depreciation 20000
Less correct depreciation -18000
Add reversal of impairment 10000

Corrected profit before tax 109,000

Note: Why are we reversing the errors regarding impairments and depreciation? Profit before tax is
the starting point of the taxable income calculation and must thus be free from errors to correctly
calculate tax expense.

Working 2

Carrying Tax Temp

Deferred Tax Table HCA amount Base Dif D Tax

31-Dec-X6 140,000 140,000

140,000 140,000
Depreciation -20,000 -20,000
31-Dec-X7 120,000 120,000
Impairment (P/L) -12,000
31-Dec-X7 120,000 108,000 96,000 12,000 3,240
Depreciation -20,000 -18,000 -32,000 14,000 3,780

31-Dec-X8 100,000 90,000 64,000 26,000 7,020

Reversal impairment (P/L) 10,000 10,000 2,700
31-Dec-X8 100,000 64,000 36,000 9,720
Expected credit loss allowance -7,500 - -7,500 -2,025

Deferred tax movement through income

statement (3 780 + 2 700 – 2025) 4,455

47
Working 3

RUL

01-01- 2006 Cost

8
160 000

Dep (20 000)

31-12-2006 CA
140 000 7

Dep (20 000)

31-12-2007 CA Impair p/L Value If Never

120 000 6 Impaired

Impair (p/l) 12
(12 000)
000

31-12-2007 Recoverabl
12
e amount
108 000 6 000 120 000
(RA)_

Dep
(18 000) (2 (20 000)
000)

31-12-2008 CA 10
90 000 000 100 000

Rev Impair (10

(p/l) 10 000 000)

31-12-2008 RA
142 000 100 000

RUL = Remaining Useful Life

48
FV 1

Zlotnik Limited (“Zlotnik”) is a company listed on the JSE Securities Exchange. The company requires

advice regarding the measurement and disclosure of the following items in its group annual financial

statements:

1. Shortly before the financial year end, the company purchased a patent for ‘New-Way’

crushing machinery which has been developed by two university engineering professors.

An amount of R25 million was paid for this intellectual property in a deal negotiated at

arm’s-length with the sellers. The Zlotnik directors estimate that the net present value of

the profits the company would have lost if the patent were exploited by a third party,

amount to R45 million, as the products to which the patent relates would create direct

competition with Zlotnik – thereby reducing the profits of the company. Zlotnik will not

use the patent – the acquisition was simply to prevent anyone else using it. There will be

no income streams flowing directly from these assets, and thus the valuers appointed by

the Zlotnik group have valued the patent at R nil. The accountant has accordingly impaired

the patents to R nil in the financial statements.

2. A subsidiary of Zlotnik, Plotnik Planes (Pty) Limited owns a Spitfire aircraft, which is a

collector’s item. It is housed at a hanger in Lanseria Airport in South Africa. The main

market for such specialised collector’s items is in London. The historic aircraft dealer in

London has valued the Spitfire at £1 million, if sold in London. To ship the Spitfire to

London will cost approximately R500 000. For financial statement purposes, the aircraft is

revalued annually. The accountant has valued the Spitfire at R13m (as the exchange rate

at year-end was R13: £1) and the plane is still in South Africa.

3. A subsidiary of Zlotnik, Karbunkle Recyclers (Pty) Limited recycles old computers. As at the

year end, it had inventory on hand which had an original cost of R100 million. Costs

49
 associated with restoring the computers and retrieving the saleable parts amounted to

R10 million. To sell this inventory, commission of R10 million will be payable. Based on

the selling prices generally being achieved by the company, the stock is expected to

ultimately be sold for about R130 million. The accountant has valued the stock at

R120 million in the financial statements, which he believes is in compliance with IFRS 13

YOU ARE REQUIRED:

1. Explain how each of the items referred to above should be measured for financial

statement purposes in accordance with IFRS.

2. Briefly explain the importance of the disclosure required by IFRS 13 of valuation levels.

50
Solution – FV 1

1. ‘New-way’ patent

1.1 This should be included in the financial statements at R25 million, as that is the fair

value determined in an arm’s-length transaction. IFRS 13 par 30 specifies that the

fair value of a non-financial asset is its highest and best use by market participants,

therefore if an entity intends to use the asset defensively this is irrelevant.

1.2 IFRS 13 requires that this amount be reflected and not the value specific to Zlotnik.

2. Spitfire

2.1 In terms of IFRS 13, an asset should be valued in its principal market par 16 and it

is appropriate to take into account transport costs to transport the asset to the

market, see IFRS 13 par 24-26.

2.2 Thus, the value is R12.5 million (£1m x 13 = R13m – R500 000 transportation costs).

3. Computer stock

3.1 These should be valued at R110 million, being the cost to the company plus the

costs of conversion, in terms of IAS 2. The valuation of inventories is not at fair

value in IAS 2, which requires measurement at the lower of cost and net realisable

value, therefore excluded for IFRS 13 in par 6 (c).

3.2 It is not necessary to deduct the selling costs, in terms of IAS 2.

3.3 IFRS 13 does not apply to inventory.

51
Revision Question 34 (90 minutes)
IGNORE VAT
Chem (Pty) Ltd (Chem) is a medium-sized pharmaceutical company operating in
Southern Africa. Chem manufactures various types of medication for sale to
pharmacies. You are employed by Makanye & Associates (M&A), a consulting firm
specialising in International Financial Reporting Standards (IFRS). Chem’s
management has approached your firm for advice on three accounting issues
identified during the 31 December 2016 financial year. The issues have been
summarised in the memorandum below.

To: M&A
From: Chem
Subject: Memorandum on accounting issues
1) Contract to supply medication

During October 2016 Chem entered into a contract to supply a specific medication for
Diabetes, Sugar Guard, to a leading South African pharmacy, Glicks Ltd. The terms
of the contract are as follows:
● Chem will be the sole supplier of Sugar Guard to Glicks for a period of 3 years.
● Chem’s sales representative (sales rep) will contact Glicks on a monthly basis.
Glicks will complete a purchase order for the amount of Sugar Guard required.
However, Glicks will not be obliged to order each month.
● The price per bottle of Sugar Guard will not be fixed during the 3-year period.
Chem’s sales rep will advise Glicks of the current price per bottle at each order
date.
● If Glick’s monthly order exceeds 1 000 bottles of Sugar Guard, Glicks will
receive a 5% discount.
● Chem will deliver each order to Glick’s Boksburg warehouse free of charge.
● Glicks will have 45 days to pay from each delivery date.

Glicks placed its first order for 2 000 bottles of Sugar Guard on 15 November 2016.
The selling price per bottle sold by Chem to Glicks on 15 November was R325.
Chem delivered the medication to Glick’s warehouse on 20 November 2016 – the
warehouse is 86km away from Chem’s factory. Chem usually charges R10 per km for
deliveries.
Glicks had not yet paid for the order at 31 December 2016.
Glicks has been a target customer of Chem for a number of years. As such, Chem
incentivized its sales reps by offering a R100 000 sales commission to the rep who
secured the contract. Chem paid the commission to the particular sales rep on 25
December 2016. The contract with Glicks does not specifically allow Chem to recover

52
the sales commission directly from Glicks, however, based on Chem’s sales forecasts,
management is confident that the R100 000 cost will be recovered over the contract
term.

2) HIV project costs

Chem operates an in-house Research and Development (R&D) Centre. In 2014,

Chem began research on developing new medication for preventing the transmission
of HIV from HIV-positive pregnant women to their unborn babies. Chem embarked on
this project due to the significant need for such medication throughout Africa. The team
of pharmacists in the R&D Centre dedicated a significant amount of time and
resources to the project.
In November 2016, the pharmacists had a breakthrough. They were confident that
they had found the final formula required for the new medication. During the same
month, the pharmacists compiled a report for the Board of Directors (BOD) detailing
the activities undertaken to date, the costs incurred and the latest results of the project.
The report also set out the pharmacists’ proposed plan for the rest of the project. The
project plan included information on the following:
● Feasibility and budgeted cost of completing the development of the medication.
● Planned testing of the medication.
● Plan for obtaining approval from the Medicines Control Council of South Africa.
● Targeted sales market.

An extract of the report is provided below.

Date Activities HIV project costs
2014 financial year ● Studies on HIV ● R560 000
transmission.
● Administration of R&D
Centre. ● R80 000
● Training new
pharmacists in R&D
● R45 000
Centre.

Total costs for 2014 financial year R685 000

2015 financial year ● Studies on currently ● R770 000

available medication
● Administration of R&D
Centre ● R88 000

Total costs for 2015 financial year R858 000

53
 2016 financial year ● Formulation and final ● R955 000
selection of
medication formula
● Administration of R&D ● R96 000
Centre

Total costs for 2016 financial year R1 051 000

During the December 2016 BOD meeting, the BOD passed a resolution approving the
project plan. The BOD ring-fenced R2 000 000 of Chem’s available reserves for
completion of the project which exceeded the budgeted costs set out in the
pharmacists’ report.
All HIV project costs had previously been expensed as incurred. The BOD confirmed
that the project was now in development phase and issued an instruction that the
previously expensed costs should be capitalized in the 2016 financial year.
The SARS allowed a deduction for the HIV project costs incurred during 2014 and
2015. However, Chem was informed that the costs of R1 051 000 incurred during 2016
will only be deductible when Chem receives approval for the medication from the
Medicines Control Council. Approval had not been received by the time the AFS were
authorised for issue, but it was still considered probable that approval would be
obtained in the foreseeable future.

3) Prior period error

Chem entered into an arrangement on 1 July 2015 to lease out an item of

manufacturing equipment that it no longer required for use in its business.
Management classified the lease as an operating lease and accounted for it
accordingly in the annual financial statements (AFS) for the year ended 31 December
2015.
During the current financial year, a new financial manager was appointed to Chem.
The new financial manager reviewed the terms of the arrangement and assessed that
the lease was incorrectly classified as an operating lease. Based on his knowledge of
IFRS 16, the lease is in substance a finance lease. The management of Chem agreed
with the auditor’s assessment and concluded that the prior period error would need to
be retrospectively corrected in the 2016 AFS.
The South African Revenue Service (SARS) treats the arrangement as a standard
lease and therefore taxes Chem as it receives lease payments from the lessee. Chem
correctly reflected this tax treatment in its 2015 AFS and in its tax return.
Further details regarding the lease arrangement are set out below (all amounts have
been correctly calculated).

54
 Notes
Lease commencement date 1 July 2015
Lease term 36 months
Lease payments (payable monthly in arrears) R12 500
Unguaranteed residual value R25 000 a
Implicit interest rate 10% p.a.

Fair value of equipment on 1 July 2015 R405 934

Carrying amount of equipment on 1 July 2015 R291 667 b
Tax base of equipment:
- 1 January 2015 R300 000
- 1 July 2015 R200 000 c

Notes:
a) This was Chem’s best estimate of the unguaranteed residual value calculated
at lease commencement date. This estimate has remained unchanged.
b) The equipment was purchased on 1 January 2013 for R500 000. The original
estimated useful life was 6 years and the residual value was zero. Both
estimates have remained unchanged. Chem depreciates all equipment using
the straight-line method.
c) The SARS grants a wear and tear allowance of 20% per annum not apportioned
for time.

Below is an extract of the detailed trial balance as at 31 December 2015 showing the
amounts relating to the lease arrangement only. This trial balance was correctly
prepared based on operating lease accounting principles.
Account description Debit Credit
Equipment: cost R500 000
Equipment: accumulated R250 000
depreciation
Deferred tax liability R13 500
Depreciation expense R83 333
Lease income R75 000
Deferred tax expense R4 500

Note: The current tax expense related to the lease arrangement has not been
presented above because the current tax consequences were correctly accounted for
in 2015.

55
Additional information:
● Chem adopted IFRS 15 Revenue from Contracts with Customers and IFRS 16
Leases two years ago.
● The normal tax rate applicable to the 2015 and 2016 financial years is 27%.
The inclusion rate for Capital Gains Tax is 80%.

56
Question 1 (90 minutes)
You are required to:
a Discuss how the transactions arising from the contract to supply
medication to Glicks should be accounted for in the year ended 31
December 2016 as required by IFRS 15 Revenue from Contracts with
Customers.
Your answer MUST include the following:

● A discussion in terms of the 5-step model prescribed by

IFRS 15; and 25.5
● Any relevant calculations to support your answer. minutes

Your answer should NOT include the following:

● Identifying a contract with a customer (you may assume a

contract exists); and
● Taxation effects.

b Discuss the following with regards to the HIV project costs:

(i) Whether the project has reached the development phase per
IAS 38 Intangible Assets as at 31 December 2016 as confirmed
by the BOD, or not; 22.5
(ii) How Chem should account for the HIV project costs incurred minutes
to date; and
(iii) The current and deferred tax consequences of the HIV project
costs incurred during the 2016 financial year.
c a) Prepare the prior period error note to be disclosed in the 31 December
2016 annual financial statements of Chem as required by IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors.
42
minutes
You may ignore the accounting policy note.

57
Revision Question 34: Solution
PART A

IFRS 15 includes 5 steps for the recognition of revenue.

1) Identify contract with customer.

question specifically says this step should not be addressed.

2) Identify the performance obligations.

Chem must identify the distinct goods or services promised to Glicks. Goods or
services are distinct if both of the following are met (IFRS15.22):
a) Glicks can benefit from the good/service either on its own or together with other
resources readily available to Glicks (IFRS15.27a); and
b) Chem's promise to transfer the good/service is separately identifiable from other
promises (IFRS15.27b).
In this case, although Chem has promised to deliver the goods "for free", the delivery
service is separately identifiable from the promise to transfer goods because the
delivery does not modify the goods (IFRS15.29b) / the goods are not highly
interdependent on the delivery (IFRS15.29c) and Glicks can benefit separately
from the delivery since if not delivered by Chem, Glicks would need to collect
itself / pay someone to collect for it.

3) Determine the transaction price.

The transaction price is the amount of consideration Chem expects to be entitled

to in exchange for transferring the promised goods or services (IFRS15.47).
In this case Glicks has 45 days to pay which does not represent a significant
financing component since it is less than 1 year (IFRS15.63).
Glicks purchased 2,000 bottles which entitles it to a discount of 5%. The discount
must be excluded from the transaction price because Chem won’t be entitled to
this amount (IFRS15.51).
The transaction price is therefore R617 500 [(2,000 x R325) x95%].

4) Allocate the transaction price to the performance obligations.

The transaction price should be allocated based on the stand-alone selling prices.
The stand-alone selling prices are as follows (IFRS15.76):

58
- Bottles of Sugar Guard: R325 x 2,000 = R650 000
- Delivery: R10 x 86km = R860
- Total R650 860

Chem needs to consider whether the discount should be allocated to the bundle
of goods/services (i.e., to the delivery and the goods) or only to one of the
performance obligations. There is no information in the scenario to indicate that the
discount relates only to one or the other performance obligation and therefore the
discount should be allocated proportionately to both (IFRS15.81).
- Revenue from bottles of Sugar Guard: R617 500 x R650 000/R650 860 = R616 684-
Revenue from delivery service: R617 500 x R860/R650 860 = R816

5) Recognise revenue when the performance obligations are satisfied.

In this case both performance obligations were satisfied on delivery date being
20 November 2016 therefore revenue of R617 500 can be recognised on this date.
Since Glicks had not yet paid on 31 December 2016, Chem will also recognise a
debtor for R617 500.
The commission paid to the sales rep of R100 000 represents an incremental cost
of obtaining the contract with Glicks (IFRS15.91). The amount should be
capitalised as a contract cost / as an asset as Chem expects to recover the costs
during the contract term.

59
PART B

i) Whether the project has in fact reached the development phase per IAS 38 Intangible
Assets as at 31 December 2016
The development phase for this internally generated intangible asset was reached
at 31 December 2016 as all of the following were demonstrated (IAS 38.57):
(a) the report indicated the feasibility of completing the development of the
medication.
(b) the intention to complete the medication and sell it was evidenced by the
pharmacists planned testing, their plan for obtaining approval from the Medicines
Control Council of South Africa, and the BOD approval of the project plan.
(c) there is a significant need for the medication in Africa/ the report included the
targeted sales market which provides evidence of the ability to sell the medication
and the generation of probable future economic benefits.
(d) the BOD set aside R2M to complete the development which indicates that
adequate resources are available.
(e) the report included the cost of completing the development which indicates that
Chem can reliably measure the expenditure attributable to the medication during
its development.
[Note: 1 mark available for attempting to list the IAS 38 development criteria]
ii) How Chem should account for the HIV project costs incurred to date?
These costs were incurred during the research phase and therefore it was correct to
expense them as incurred. These costs may not be subsequently capitalised even
when the development phase is reached (IAS 38.71).
iii) The tax consequences of the HIV project costs incurred during the 2016 financial
year?
The costs incurred during 2016 will only be deductible in the future when Chem
receives approval for the medication from the Medicines Control Council. As such,
Chem will not get a deduction in its 2016 taxable tax calculation / As such, Chem
will have to add these costs back in its 2016 taxable income calculation. Even
though these costs were not capitalised to an asset in the SFP, they have a tax base
as SARS will allow a deduction in the future. The difference between the carrying
amount of nil and the tax base of R1 051 000 gives rise to a deductible temporary
difference. A deferred tax asset of R283 770 (R1 051 000 x 27%) should be
recognised at 31 December 2016.
Note: Even though the costs were not capitalised (i.e. the carrying amount of the asset is
zero), there is a tax base as SARS is allowing a deduction in future and thus DT must be
accounted for.

60
Part c

Chem (Pty) Ltd

Financial statements of the year ended 31 December 2016
Prior period error note

During the current financial year, Chem discovered that it had incorrectly accounted for one of
its lease agreements . Chem entered into an agreement during the 2015 financial year to lease
out an item of equipment. The agreement was incorrectly classified as an operating lease . The
error was retrospectively restated during 2016 .

The amount of the correction for each financial statement line item affected is shown below.

Statement of financial position 31-Dec-15

"R"
Decrease in equipment (R0 - R250,000) credit -250 000
Increase in net investment in lease (see workings) debit 350 078
Increase in deferred tax liability (42,022 - 14,000) credit -27 021
Increase in retained earnings (equal to increase in net credit 73 057
NPAT)

Statement of comprehensive income 31-Dec-15

"R"
Decrease in depreciation (500,000/6 *6/12) credit 41 667
Decrease in rental income debit -75 000
Increase in profit on sale of equipment (405,934 - 291,667) credit 114 267
Increase in finance income (see workings) credit 19 144
Increase in net profit before tax net credit 100 078

Increase in deferred tax expense debit -27 021

Increase in net profit after tax net credit 73 057

Workings

Lease commencement date 01-Jul-

15
Cost (1 January 2013)
500 000
Acc dep (2.5 out of 6 years)
208 333
Carrying amount at lease Given
commencement 291 667
W&T allowance 20% pa
TB at 1 Jan 2015 Given
300 000
TB at 1 July 2015 Given
200 000
Lease term 3
36 years

61
Remaining useful life at date of lease 3.5
commencement 42 years
Fair value at date of lease
commencement 400 000
Monthly lease payment
12 500
Unguaranteed residual value
25 000
Implicit interest rate 10% pa

Accounting done in previous year (incorrect accounting) - 31 December 2015

PPE was not derecognised on lease

commencement:
Equipment cost
500 000
Acc dep (3 years out of 6 years)
250 000
CA presented at 31 Dec 2015
250 000

Deferred tax recognised as follows: CA TB TD DT

Equipment:
Opening balance (1 Jan 2015) 333 Liability
333,33 300 000 33 333 9 000
Dep/W&T
83 333 100 000
Closing balance (31 Dec 2015) Liability
250 000 200 000 50 000 13 500

Depreciation exp recognised for full

year: 83 333
Rental income recognised for 6
months: 75 000
Deferred tax expense recognised for
the year: 4 500

Accounting that should have been done - 31 December 2015

Depreciation should only be for 6 months (1

Jan to 30 June 2015): 41 667

Equipment should have been derecognised on

1 July 2015:
Equipment cost
500 000
Acc dep (2.5 years out of 6 years)
208 333
CA that should have been
derecognised on 1 July 2015 291 667

62
Finance lease accounting on 1 DR CR Initial net investment in
July 2015: lease calc:
Gross investment in lease 475
(36*12,500 + 25,000) 000
Unearned finance income 69 066 Using CMDP function:
(475,000-405,934)
Equipment: Cost 500 pmt 12 500
000
Equipment: Acc dep 208 n 36
333
Profit on sale of equipment 114 i 0,83%
(405,934-291,667) 267 (10%/12)
FV 25 000
COMP -405 934
PV

63
PART C FV 25 000

COMP
-405 934
PV

Amortisation table for 1 July to 31 Dec 2015:

Net Finance Capital Year-end net
investment income investment in lease
in lease calc:

01-Jul-15 405 934 - 405 934

Using AMORT
July finance income 3 383 3 383 - function:
July payment -12 500 -3 383 -9 117 PM1 1

396 817 - 396 817 PM2 6

19
August finance income 3 307 3 307 - INT 144

August payment -12 500 -3 307 -9 193 BAL 350 078

387 624 - 387 624

September finance income 3 230 3 230 -

September payment -12 500 -3 230 -9 270

378 354 - 378 354

October finance income 3 153 3 153 -

64
October payment -12 500 -3 153 -9 347

369 007 - 369 007

November finance income 3 075 3 075 -

November payment -12 500 -3 075 -9 425

359 582 - 359 582

December finance income 2 997 2 997 -

December payment -12 500 -2 997 -9 503

31-Dec-15 350 078 - 350 078

Finance income should have been accounted for 6 months:

19 144

Deferred tax should have been as follows: CA TB TD DT

Opening balance (1 Jan 2015) 333 333 300 000 33 333 9 000 Liability

Closing balance (31 Dec 2015)

Equipment 0 200 000 -200 000

Net investment in lease 350 078 0 350 078

Net temporary difference 150 078 40 521 Liability

65
Revision Question 40 (60 minutes)

This question consists of two unrelated parts. Assume a corporate tax rate of
27% for both parts.

Part A
You may only ignore deferred tax for this part.
Mango (Pty) Ltd (Mango) is a fruit juice manufacturing company with a 31 December
year-end. Mango receives a wide range of fresh fruit from local farmers daily. Upon
arrival, the fruit is washed, sorted and combined into mixtures which will form the
flavours of the fruit juice, for example Berry Blaze, Cranberry Cooler and Passion
Power1. Since its incorporation in 2010, Mango has had a period of sustained growth,
and expanded their operations in late 2016 in order to accommodate the increase in
demand for freshly pressed fruit juices. As such, Mango moved operations into a larger
warehouse situated in Modderfontein.
1. Modderfontein Warehouse
On 1 January 2017, Mango moved its entire fruit juice production facility to a large
warehouse situated in Modderfontein. The total floor space of the warehouse is
3000m2. The production facility will be constructed (see point 2) on 2500m2 of the floor
space, and the remaining 500m2 contains a separate residential apartment. The
residential apartment is let to an independent third party. The lease contract has the
following terms:

• The lessee is required to make lease payments of R4 500 per month.

• The lease payments will not increase overtime.
Mango paid R3 million for the warehouse on 1 January 2017, which can be
apportioned to the floor space and the apartment based on m 2. The warehouse has
a useful life of 50 years from the date of purchase and a zero residual value.
No entries have been processed to record the effect of any of the above transactions
for the 2018 financial year. The entries relating to the 2017 financial year have been
recorded correctly.

1
Passion Power is a fruit juice blend consisting of equal parts orange, granadilla and apple juice.

66
The following fair values have been obtained regarding the Modderfontein warehouse:

Date Floor space Residential Total Space

(2500m2) Apartment (500m2)
31 December 2017 R2 750 000 R475 000 R3 225 000
31 December 2018 R2 550 000 R487 000 R3 037 000

2. Production Facility
Mango installed the production facility in the Modderfontein warehouse during the
month of January 2017 for a total cost of R1.25 million and the production facility
became available for use on 1 February 2017. At the end of the estimated useful life
of the production facility (20 years) Mango is legally obligated to dismantle the facility.
The estimated future cost of dismantling the production facility in 20 years has been
reliably assessed to be R350 000. Furthermore, the same legislation states that this
section only becomes applicable when the item required to be dismantled has been
installed. As the production facility is being dismantled at the end of its useful life, it
cannot be sold for any material value in 20 years’ time.

2.1 Revaluation
Management elected to measure the production facility on the revaluation model and
performed a revaluation for the first time on 31 December 2017. At this date the fair
value of the facility was R1 300 000. At 31 December 2018, the fair value of the
production facility approximates its carrying amount.

2.2 Change in estimate

Due to technological advancements, experts were able to predict, with greater
accuracy, that the decommissioning costs relating to the production facility will actually
cost R275 000 at the end of its useful life. Management agreed with this revised figure
when it was assessed on 1 January 2018.

3. Purchase of Shares
As a result of the large demand for freshly squeezed fruit juices, Mango had generated
large amounts of excess cash. Management of Mango were of the opinion that if they
invested the cash in a portfolio of shares, they would be able to maximise their returns
for the company. After much consideration from different banks, management of

67
Mango decided to invest R750 000 in unit trusts2 on 31 August 2018 (the unit trusts
were purchased at fair value). Transaction costs of R7 500 were incurred on the
investment. It is the intention of management at Mango to hold the unit trusts for long-
term investment purposes and has therefore designated the shares at fair value
through other comprehensive income. The only journals processed by the accountant
with regard to the unit trusts are as follows:

Date Item Debit Credit

31 Aug Investment in Unit Trusts
750 000
‘18
Bank 750 000
Investment in unit trusts.

Date Item Debit Credit

31 Aug Operating Expenses (P/L)
7 500
‘18
Bank 7 500
Transaction costs on investment
expensed.

The following fair values were determined with regard to the unit trusts:

Date Fair Value (per unit trust)

31 August 2018 R25.00
31 December 2018 R27.00

Below is an extract of Mango’s Trial Balance for the year ended 31 December 2018:

Item Debit (R) Credit (R)

Sales 850 000
Cost of Sales 370 000
Operating Expenses 240 000
Depreciation ?
Taxation* 54 250
Revaluation Surplus (31 December 2017) ?
Retained Earnings 1 750 000
Investment in Unit Trusts 750 000

2
A unit trust pools money from many investors to invest in assets like shares, bonds and property. Instead of
having to pick individual investments, a unit trust offers the company exposure to a range of assets, which are
selected and managed by investment professionals.

68
*The taxation figure has been correctly calculated and includes all the tax effects of all
items.
Additional Information

• The warehouse is measured on the cost model in terms of IAS 16.

• The production facility is measured on the revaluation model in terms of IAS 16.
• Investment property is measured using the fair value model in term of IAS 40.
• Management of Mango have elected to transfer revaluation surplus to retained
earnings upon sale of the asset.
• An applicable discount rate is 10.5% p.a where applicable.
• Ignore Value added taxation

69
Part B
You have been hired as a consultant by Flamingo Steel Producers (FSP) in order to
provide IFRS compliance advice on the following unrelated issues, a new machine
they have recently purchased as well as their provision for environmental rehabilitation
costs. FSP has a 31 August year-end.

• The machine was purchased new and unused by the company on 1 July 2018
for a cost of R500 000. The machine has a useful life of 8 years and a zero
residual value. SARS allows a S12C wear and tear allowance on the machine
of 40% in the first year and 20% in the remaining 3 years, not apportioned for
time.
• FSP has raised a provision for environmental rehabilitation costs due to the
legally binding contract they have with local authorities to restore the
environment to its original condition. The environment is often polluted and
harmed by large steel producing companies and therefore local law
enforcement had to step in. The provision is not related to any specific assets
(land etc.) The provision had a correct value of R120 000 at the beginning of
the year and R145 000 at the end of the year. SARS will allow a full deduction
for the provision when it is paid.

70
Required
Part A
In so far as the information allows, provide an extract of the Statement of Profit or Loss
and Other Comprehensive Income for Mango (Pty) Ltd for the year ended
31 December 2018. You may ignore the effects of deferred tax.

Comparative figures are NOT required

Presentation marks
In so far as the information allows, provide an extract of the Statement of Changes in
Equity for Mango (Pty) Ltd for the year ended 31 December 2018. You may ignore the
effects of deferred tax.

Comparative figures are NOT required

Presentation marks
Part B
Draft an email to management of Flamingo Steel Producers outlining the deferred tax
consequences of the two issues mentioned for the year ended 31 August 2018 in terms
of IAS 12.
Your discussion should address the relevant tax bases, temporary differences and
deferred tax movements. The management team consists of an engineers, chemical
scientists and marketing people.

71
 Revision Question 40: Solution

Part A (i)

Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2018
R

Sales 850 000

Cost of Sales -370 000

Gross Profit 480 000

Operating Expenses 240 000- 7 500 (tx costs -232 500

capitalised)
Depreciation (50 000 + 68122(working 2)) -118 122

Fair Value Adjustment - Apartment 12 000

Rent Received (4 500 x 12) 54 000

Profit before interest and tax 195 378

Interest expense -4 296

Profit before tax 191 082

Tax -54 250

Profit after tax 136 832

Other Comprehensive Income 63 676

Change in decommissioning costs -Revaluations 11 176

surplus
Fair Value adjustment - unit trusts 52 500

Total Comprehensive Income 200 508

72
Part A (ii)

Mango (Pty) Ltd

Statement of Changes of Equity for the year ended 31 December 2018

Retained Earnings Revaluation Mark-to-market

Surplus reserve
(R)
(R) (R)

Opening balance 1 750 000 61 955 -

Total comprehensive income 136 832 11 176 52 500

Closing Balance 1 886 832 73 131 52 500

Presentation

Workings OB Reval

Total

Note: Remember correct format for presentation marks. Although there was no revaluation in the current
year the change in estimate of the decommissioning costs is capitalised to the revalued asset and
should be accounted for as a revaluation (IFRIC 1 par 6)

Part B

To: FSP@Gmail.com
CC:
RE: Deferred Tax Consequences
Opening balance
Machine

As the machine is an asset of FSP, its tax base will be the amount deductible for tax purposes in the future
(IAS12.7).
The machine was granted a 40% allowance in the current year not apportioned for time and therefore 60% of the
allowances will be granted in the future at year-end.

The tax base of the machine is therefore: R300 000 (500 000 x 60%) (IAS12.7)
The carrying amount of the machine at year-end will be:
Cost = R500 000
Depreciation = R10 417 (500/8*2/12)
Carrying Amount = R489 583

The difference in carrying amount and tax base creates a temporary difference (IAS12.5).

73
As the future economic benefits expected to be received from the machine exceed the tax allowances that will be
granted, a taxable temporary difference result. (IAS12.5, IAS12.16)

A deferred tax liability of R51 187 (189 583 x 27%) results (IAS12.15).
The asset is being recovered through use; the standard tax rate applies at 27%

This movement will be recognised through profit and loss as the underlying transaction was processed through
profit or loss (IAS12.58).

Provision for Environmental Rehabilitation

The tax base of the environmental rehabilitation cost is its carrying amount less any amount deductible in the
future (IAS12.8).
As the full provision will be deductible when paid, its tax base amount is 0.

This will create a deductible temporary difference as future deductions will be received in terms of the provision.
(IAS12.24)
A deferred tax asset of R39 150 (145 000 x 27%) will be raised at year-end. (IAS12.25)

The liability will be settled at standard rate. (IAS12.51)

This movement will be recognised through profit and loss as the underlying transaction was processed through
profit or loss (IAS12.58).
Note: Part B is an email to non-accountants don’t use overly technical language

74
Workings

Working 1

Floor space
relating to
production
facility Apartment
3 000 2 500 500
Cost 3 000 000 2 500 000 500 000

Depreciation -50 000

31-Dec-17 2 450 000
Depreciation -50 000
31-Dec-18 2 400 000

Fair value adjustment -25 000

Fair Value - 31 Dec 2017 475 000
Fair value adjustment 12 000
Fair Value - 31 Dec 2018 487 000

75
Working 2
Production Facility

Cost 1 250 000

useful life 20

W1: CMPD
n 20
i 10,5%
pv (Solve) 47 514
pmt -
fv 350 000

Cost
Cash price 1 250 000 Given FV
For capitalising the
Dismantling 47 514 PV
CA divided by 20
1 297 514 *11/12

Depreciation 11 months -59 469 Opening balance CA

Opening balance
31-Dec-17 1 238 045 Reval
Reval (OCI) 61 955 Given FV

Fair Value 1 300 000 1 300 000/(20*12-11)

Depreciation -68 122,27 Depreciation in SOCI

31-Dec-18 1 231 878

76
Working 3
Decommissioning Provision
01-Feb-17 W1 47 514
Interest 11 months 4 573

Opening balance
01-Jan-18 52 087 plus interest
Adjustment (OCI) -11 176
01-Jan-18 W2 40 911
Interest 4 296
31-Dec-18 45 207

W2: CMPD
n 19,08
i 10,5%
pv 40 911
pmt -
Change in decom
fv -275 000 cost P/L
Note: Remember to only use the remaining periods in your calculation, not the original 20

77
Working 4
Unit Trusts
31-Aug-18 750 000
Transaction Costs 7 500
757 500

Difference between
O/B Plus tx cost less
Fair Value adjustment 52 500 CB

Given 750 / 25*27

31-Dec-18 810 000 (OCI in SOCI)

78
 WEEK 4
WEEK STARTING 13 MAR Main principles? What did I learn?

June 2021 Q1

DT Q20
SEEN TUTS

Leases Q14

79
June 2021 Question 1 (67.5 minutes)

Magic Carpet Ltd (MC) is a South African listed company that developed technology
to connect drivers and riders on demand. A rider (customer of MC) will request a ride
using an application on their cell phones and then be connected to one of the nearest
available drivers. Each rider and driver have the MC App installed on their smartphone.
MC is responsible for maintaining the MC App to ensure consistent and user-friendly
communication between rider and driver.

MC has a financial reporting date of 31 December. The current reporting period ended
31 December 2020.

Head office

MC acquired its head office on 1 January 2008. SARS permits an allowance of 2% p.a.
on the building. Due to recent successes with a new bundled service that MC decided to
offer, MC was able to move its head office into a larger building towards the end of 2017.
On 1 January 2018, MC entered into a lease agreement to lease the building to a third
party.

The correct carrying amount of the former head office was determined to be R900 000
on 1 January 2019 and the correct remaining useful life was 9 years (the correct
remaining economic life was determined to be 10 years).

80
The details of the lease agreement relating to the former head office are outlined in the
table below.

Date building made available for use to the lessee 1 January 2018
Contractual lease term 5 years
Option to renewal None
Timing of lease payments In arrears
Annual lease payment R100 000
Escalation clause 10% p.a.
Interest rate implicit in the lease 11% p.a.

The chief financial officer (‘CFO’), after having attended a seminar on the IFRS
updates, determined that the accounting treatment of the lease agreement means the
head office building should be derecognised on the commencement date of the lease
and, in its place, an investment in the lease should be recognised that represents the
receipt of the future lease payments. The CFO informed his accounting department
that lease accounting had radically changed with the implementation of IFRS 16
Leases, to ensure that no assets or liabilities are left off the statement of financial
position.

Consequently, MC de-recognised the building and recognized a net investment in the

lease of R391 072 on 1 January 2019 (the calculation of the net investment was
correct). The tax returns of 2018 and 2019 were reopened for reassessment.

The payments have correctly been determined as follows:

31 December 2018 R100,000

31 December 2019 R110,000
31 December 2020 R121,000
31 December 2021 R133,100
31 December 2022 R146,410
Total payments R610,510
The equalised (straight-lined) income was correctly determined to be R122,102.

MC measures investment property on the cost model.

81
Claims against MC

The following claims were filed against MC during the current reporting period.

Demand surging incident

On New Year’s Eve, before the start of 2020, a rider (customer of MC) used the MC
app to connect to a driver. Due to the heavy demand for drivers on such a busy night,
the MC app was programmed to increase the trip rate with a very high multiplier to
compensate MC for having to organise more drivers for the temporary increase in
demand. The trip had a significant number of kilometres attached to it and once the
demand surge multiplier was applied to the standard rate per kilometre, the trip fare
amounted to R95 567, where the trip fare would have been R1 592 using the normal
rate.

The rider had consumed a large quantity of alcohol, so he was not paying attention to
the amount of the trip fare on the night of the trip. When the rider woke up the next
morning, he found himself shocked by the significant charge to his credit card.

The rider immediately proceeded to contact legal counsel and filed a legal claim
against MC for the reimbursement of the trip fare, and additional compensation of
R200 000 for the emotional stress caused the morning after the trip.

The legal team of MC determined that the reporting entity would be liable (see below
for reasoning) for the portion of the trip fare that related to the demand surge. Although
the court hearing would only take place after 31 December 2020, the legal team
recommended that in the interim, MC should make a formal public apology to the rider
for the emotional stress caused and provide the additional compensation. The public
apology, which happened 31 January 2020, included a statement that the rider would
be refunded and compensated regardless of the outcome from the court hearing.

The legal team looked at all the facts and circumstances around the claim. They
discovered that the demand surge was only established and used for the first time on
the 31 December 2019. However, MC had not properly disclosed the existence of a
demand surge in its terms and conditions to their customers (riders), before applying
it.

82
Since the incident, MC has updated the MC App and its terms and conditions, with the
effect that a trip can only start once the rider has accepted any multiplier that may be
applicable at that time. MC hopes that this update will help to avoid the above situation
occurring again.

Claim for driver motor vehicle accident

During the initial lockdown, and to lower the spread of Covid-19, the South African
government prohibited businesses like MC to continue operating for a number of
weeks. This caused a large amount of stress for the drivers who still had to incur fixed
costs, for example insurance, without them earning any trip fares.

After a few weeks the government lifted the strict lockdown rules, which allowed the
drivers to return to work. For one driver, this stress of the past few weeks, and many
other stress factors in his life, caused him to have a mental breakdown while driving.
This has led to him having an accident while a rider was in the vehicle. The rider was
badly injured and had to be rushed to causality. The rider was unable to work for four
months (a woman, employed in the retail industry) and consequently lost her job.

Once the rider had recovered enough, she filed a claim against MC to cover the
medical costs and provide compensation to cover lost future income and emotional
distress. Investigating the facts and circumstances of the accident, the legal team is
of the opinion that MC would not be liable to the rider based on the reasoning below:

MC merely acts as the intermediary between the driver and rider by connecting them.
Once the rider steps into the driver’s vehicle and subsequently gets dropped off, the
rider is the responsibility of the driver, which is similar to other transportation
arrangements. In addition, the driver is required, before registration as a driving
partner with MC, to obtain insurance that not only covers motor vehicle damage but
also medical costs that might be incurred by driver and rider in the case of any
accidents.

83
Change in tax rate

The minister of finance announced on 28 February 2020 that the tax rate for
companies would decrease from 28% to 27% for all financial periods beginning on or
after 1 March 2020.

The deferred tax opening and closing balance for the 2020 reporting period was
correctly determined, including adjustments for the error on the head office building,
to be a deferred tax liability of R150 000 and R230 000 respectively.

Additional information

Profit before tax for 31 December 2020 was correctly calculated at R550 000,
including adjustments for the error on the head office building, any adjustments in
respect of land and any legal claims provisions recognised.

84
REQUIRED:

(a) Regarding the lease of the former office building, prepare the correction of
error note for the separate financial statements of Magic Carpet Limited for the
reporting period ending 31 December 2020.
43.5
minutes
Ignore VAT.
Remember correct Format.
Show all your workings.
(b) Discuss, with reference to the applicable IFRSs, the appropriate
accounting treatment of the two legal claims that have been filed against 12
Magic Carpet Ltd in its the financial statements for the reporting period minutes
ended 31 December 2020.
(c) Prepare only the tax rate reconciliation section of the taxation expense
note for the financial statements of Magic Carpet Ltd for the reporting
period ended 31 December 2020. 6
minutes
The full note is not required.
Ignore comparatives.

85
June 2021 Question 1: Solution

REQUIRED A
Notes to the separate financial statements of Magic Carpet for the reporting period ending 31 December 2020

Correction of Error Note R'

In the 2018 reporting period a lease was incorrectly classified as a finance lease. The 2019 comparative amounts and the opening balances have been
restated.

Effect on statement of profit or loss 2019

Increase in depreciation (100 000)
Decrease in finance income (43 018)
Increase in operating lease income 122 102
Decrease in taxation expense 5 856
Effect on net profit / loss (15 059)

Effect on statement of financial position 2019 2018

Increase in investment property 800 000 900 000
Decrease in the net lease investment (324 090) (391 072)
Increase in operating lease receivable 34 204 22 102
Decrease in deferred tax asset (142 832) (148 688)
Effect on retained earnings 367 282 382 342

Building workings
Remaining useful life 9 Given
Carrying amount 1 Jan 2019 900 000 Given
Depreciation 2019 100 000
Carrying amount 31 Dec 2019 800 000

86
Finance lease workings
END
PMT 1 (2018) 100 000
PMT 2 (2019) 110 000
PMT 3 (2020) 121 000
PMT 4 (2021) 133 100
PMT 5 (2022) 146 410
i 11%
Balance at 1 Jan 2019 391 072 Given
Finance income 2019 43 018
Balance at 31 Dec 2019 324 090

Operating lease workings

Total payments 610 510 Given
Equalised income 122 102 Given
Operating lease receivable 1 Jan 2019 22 102
Operating lease receivable 31 Dec 2019 34 204

Deferred tax workings

Incorrect CA TB TD Rate DT
2018
Net investment 391 072 - 391 072 28% 109 500 DTL
PPE - 1 560 000 (1 560 000) 28% (436 800) DTA
(327 300) DTA
2019
Net investment 324 090 - 324 090 28% 90 745 DTL
PPE 1 520 000 (1 520 000) 28% (425 600) DTA
(334 855) DTA

87
Correct CA TB TD Rate DT
2018
PPE 900 000 1 560 000 (660 000) 28% (184 800) DTA
Operating lease receivable 22 102 - 22 102 28% 6 189 DTL
(178 611) DTA
2019
PPE 800 000 1 520 000 (720 000) 28% (201 600) DTA
Operating lease receivable 34 204 - 34 204 28% 9 577 DTL
(192 023) DTA

Decrease in DTA 2018 to correct 148 688

Decrease in DTA 2019 to correct 142 832
Decrease to tax expense in 2019 for note 5 856

Tax base of PPE

Cost 2 000 000
Tax base at 31 Dec 2018 1 560 000
Tax base at 31 Dec 2019 1 520 000

88
REQUIRED B
A provision is a liability of uncertain timing and amount and a liability is a present obligation that is
arising from past events, the settlement of which is expected to result in an outflow of economic
benefits.
Demand surging incident
A present obligation exists due to the fact that there is:
There is a past obligating event in overcharging the customer without properly forewarning
the public. [IAS 37.10]
There is a possible legal obligation through operation of the South African court to refund the
customer the overcharged portion. [IAS 37.10 & 14(a)]
Based on the review of the claim by the legal team (expert opinion) and the announcement, it is
probable that there will be an outflow
of an uncertain amount of economic benefits in the form of cash to refund the customer and provide
compensation. [IAS 37.10 & 14(b) & 15]
There is a constructive obligation, after making the announcement to the public, to
compensate the customer for the emotional stress. [IAS 37.10 & 14(a)]
Based on the review of the claim by the legal team (expert opinion) and the announcement, it is
probable that there will be an outflow of an uncertain amount of economic benefits in the
form of cash to refund the customer and provide compensation. [IAS 37.10 & 14(b) & 15]
Based on the above a present obligation exists.
It is probable that an outflow of economic benefits/resources will take place based on the review
of the claim by the legal team (expert opinion).
A reliable estimate can be made based on the advice from the legal team on how much is
expected and/or likely to be paid to the customer. [IAS 37.14(c)]
Claim relating to demand surge: 95 567 - 1 592 = 93 975
Claim relating to compensation: Maximum of 200 000
Therefore, a provision should be recognised in the current reporting period.
Motor vehicle accident - (Also marked if Contingent liability discussed correctly - no
obligation)
There is no obligating event as MC was not responsible for the motor vehicle accident. They were
merely the agent for connecting the driver to the rider. [IAS 37.10]
MC has no legal or constructive obligation for the medical costs as the costs will be covered
by the insurance the driver is required to have. [IAS 37.10 & 14(a)]
MC's legal team believes MC has neither a legal nor a constructive obligation to cover the
rider's lost income and compensate for the emotional distress. [IAS 37.10 & 14(a)]
Since there is no obligating event there is no liability and therefore, no provision.

REQUIRED C
Tax Rate Reconciliation

Profit before tax at standard rate 154 000

Add back: Fines 14 000
Rate change (2 300)
Taxation expense 165 700

Change in tax rate

Deferred tax liability closing balance 230 000
Decrease in deferred tax liability 2 300

89
DEFERRED TAX QUESTION 20: (49,5 minutes)

You have recently been appointed as the group accountant of Toll Build (Pty) Ltd (TB), a company
which provides building materials to the National Road Agency. TB has a February year-end.

The previous accountant of TB left suddenly after having to return urgently to her home university to
write a Financial Accounting supplementary exam. As a result of this, management feared that the
company’s accounts may be incomplete, inaccurate or both.

You have been able to extract the following summarised trial balance from the Pastel system with the
help of Dr Mama, a Pastel master user.

Notes 28 Feb 2014 28 Feb 2013

R R

Stated capital -1 250 000 -1 250 000

Retained earnings -557 500 -1 253 750

Loss before tax 4 380 000 696 250

Warehouse 1 ??? ???

Intangible asset 2 200 000 0

Net Accounts receivable 3 336 000 264 000

Other net assets 4 000 623 500

Dr Mama managed to extract the following information from the asset register of TB:

1. Warehouse:
TB purchased a warehouse on 1 March 2009 for R997 060. At the date of purchase, the
residual value was R200 000 and the estimated useful life was expected to be 20 years. There
had been no change to the expected remaining life. The Receiver of Revenue grants a
deduction of 5% per annum on the building. The depreciation has been correctly accounted
for and has been included in the above trial balance.

90
2. The Intangible Asset consists of a patent acquired on 1 March 2013 to allow the exclusive use
of a new bonding additive for cement. The patent cost R200 000. The life of the patent is 3
years and the market for the bonding agent is expected to last for 5 years. Included in the cost
of the Intangible asset is R10 000 incurred in registering the patent, and R5 000 for marketing
the new product on the company website.

The South African Revenue Services (SARS) has ruled that it will not grant any tax deductions
on this intangible asset but reserves the right to look into this again in the future.

3. It is the accounting policy of TB to impair accounts receivable for which loss indicators are
expected. This has resulted in an effective 7.5% of debtor balances being provided for in 2013
and 2014 using the 12-month expected credit loss allowance (ECLA) model. The expected
credit loss allowance has been correctly accounted for during the period under review and
has been included in the net accounts receivable as per the summarised trial balance.

SARS does allow a 25% deduction in respect of the expected credit loss allowance raised.

4. TB had an assessed loss of R667 500 at 28 February 2013. At that date, due to uncertainties
with the National Roads Agency, there was no reasonable expectation of achievable profits.
As paid tolling was officially launched in December 2013, management are now of the opinion
that TB is highly likely to reach breakeven midway through 2015 with a profit expected
thereafter.

5. On 21 February 2014, the new Minister of Finance, HEWN, announced a change in the
company tax rate from 28% to 29%. The change in rate is effective for all companies whose
financial year ends on or after 30 April 2014.

Furthermore, there has been speculation in the press that the rate at which Capital Gains are
to be included in taxable income will be increased from 2/3 to 7/10 at the forthcoming
Treasury Committee meeting scheduled to take place in May 2014.

6. There are no temporary differences in the 2014 financial year other than those which pertain
to the matters noted above.

91
You are required to:

1. Prepare the taxable income calculation of TB for the year ended 29 February2014
(15 minutes)

2. Prepare all the tax and deferred tax notes of TB that pertain to both the Statement of
Comprehensive Income and the Statement of Financial Position, in terms of International Financial
Reporting Standards (IFRS), for the year ended 29 February 2014. Comparative figures are not
required (34.5 minutes)

92
DEFERRED TAX QUESTION 20: Solution

Part 1

Correction of Net Income (Loss)

Net Loss per trial balance -380 000

Advertising Incorrectly Capitalised -5 000

Amortisation of Intangible Processed -65 000

Revised Net Loss -450 000

Taxable income

Corrected loss per accounting records -450 000

Depreciation warehouse 39 853

Wear and tear on warehouse -49 853

Amortisation intangible 65 000

Expected credit loss allowance-accounting 5 838

movement

ECLA-2013 allowed by SARS 5351

ECLA-2014 allowed by SARS -6811

-390 622

Assessed loss brought forward -667 500

-1 058 122

93
Part 2

Extract from the Financial Statements of TB for the year-ended 28 Feb 2014 –

Notes to the financial statements

Accounting Policy - Taxation

Toll Build accounts for taxation and its related effects in terms of the Income Tax Act 62 of 1973.

Deferred Taxation is accounted for in terms of International Accounting Standards (IAS 12)

on the comprehensive basis under the statement of financial position liability method.

Deferred tax assets are raised only to the extent that future profits are deemed probable.

Current and deferred taxation

SA Normal Tax -298 281

Current tax -

Deferred tax -298 281

Temporary differences 1 574

Assessed loss -289 569

Tax rate change -10 286

Tax rate reconciliation

Net loss at standard rate (-450 000*28%) -126,000

Amortisation not allowed for tax purposes (65 000*28%) 18,200

Tax rate change (refer to DT calculation) -10 286

Assessed loss not recognised in previous year (643 554*28%) -180 195

Effective tax expense -298 281

94
Deferred Tax Comprises of the following temporary differences:

Warehouse (14 000*29%/28%) 14 500

Expected credit loss allowance (-5,721*29%/28%) -5,925

Assessed Loss (-296 274*29%/28%) -306 855

-298 280

CA TB TD D-Tax

Warehouse 837 648 797 648 40 000 11 200(L)

Expected credit loss

-21,405 -5,351 -16,054 -4,495(A)
allowance

23 946 6 705(L)

Assessed loss (limited) 667,500 -23 946 -6 705

Deferred tax table-2014

CA TB TD D-Tax

Warehouse 797 795 747 795 50 000 14 000(L)

Expected credit loss

-27,243 -6,811 -20,432 -5,721(A)
allowance

571,112 8 279(L)

Assessed loss -1 058 122 -1 058 122 -296 274

Closing at 28% -455,907 -287 995(A)

Closing at 29% -298 281(A)

Total rate change -10 286

Only the change in Standard tax rate has been accounted for as the new Minister of Finance,
HEWN, announced a change in the company tax rate from 28% to 29%.

95
There was an adjustment to the closing balance only as it is not effective in the current year of
assessment, but The change in rate is effective for all companies whose financial year ends on or
after 30 April 2014.

No accounting for speculated change in capital gains tax rate as it has not been announced nor
effective in the current year of assessment.

Assessed Loss (Limited)

IAS 12 par 24
TB had an assessed loss of R667 500 at 28 February 2013. At that date, due to uncertainties with
the National Roads Agency, there was no reasonable expectation of achievable profits
For the 2013 year of assessment, there were no foreseeable future profits, hence the Deferred tax
asset raised could only be raised to the extent of available taxable temporary differences available.

96
LEASES QUESTION 14 (Level 4): (38 minutes)

Introduction
Falange Ltd (“Falange”) is listed on the JSE Ltd. Falange is a capital-intensive business and
is primarily involved with manufacturing and supplying equipment to circuses around the world.
The equipment that it manufactures and sells is diverse and includes self-assembling tents.

Lease to Juntas (Pty) Ltd (“Juntas”)

In 2009, Juntas, a competitor of Falange, required a new tent making machine. As Falange
was using its tent making machine far less than in previous years, it was prepared to lease
the machine to Juntas. At 1 July 2009, the machine had a cost of R100 000, accumulated
depreciation of R40 000 and a remaining useful life of 3 years. There were no temporary
differences on the machine at 1 July 2009.

The lease agreement is structured as follows:

• The lease commences on 1 July 2009 and terminates on 30 June 2012.

• Payments of R40 000 will be made by Juntas to Falange on 30 June 2011 and 2012.
No payment will be made in 2010.

• On 30 June 2012, Juntas have an option to acquire legal ownership of the machine in
return for paying Falange an amount equal to the machine’s residual value at that date.
Juntas intends to exercise this option.

• As at 1 July 2009 the estimated residual value of the machine at the end of the lease
is R10 000.

• As at 31 December 2009 the estimated residual value of the machine at the end of the
lease is R15 000.

• The interest rate implicit in the lease is 8%.

• The Receiver of revenue will allow a wear and tear allowance of R15 000 for the year
ended 31 December 2009.

Sale of land
On 30 August 2009, Falange sold owner-occupied land with a cost of R3 000 000 and a base
cost of R3 450 000 to a third party for R3 740 000 cash.

97
Additional information

• Ignore VAT

• Falange accounts for Property, plant and equipment on the cost model in terms of IAS
16.

• The normal tax rate has always been 27%. Capital gains are included in taxable
income at a rate of 80%.

• Falange does not change the effective interest rate when accounting for a change in
residual value.

• Falange has a 31 December year end.

• For the year ended 31 December 2009:

o Falange earned profit before tax of R5 400 000.

o All items included in this profit before tax figure attract tax at 27%.

o This profit calculation was performed before accounting for the sale of land and
the lease to Juntas.

98
You are required to:

1. Prepare, in as much detail as the above information allows, the statement of profit or
lossof Falange Ltd for the year ended 31 December 2009 in accordance with
International financial reporting standards. Ignore comparative figures.
(22.5 minutes)

2. Prepare tax rate reconciliation of Falange Ltd for the year ended 31 December 2009
in accordance with International financial reporting standards. Ignore comparative
figures.
(4.5 minutes)

3. Provide the note disclosure required by IFRS 16 leases, with respect to the agreement
between Falange and Juntas. Accounting policies are not required.
(10.5 minutes)

(Total: 38 minutes)

99
LEASES SOLUTION 14

Falange Limited Statement of Profit or Loss for the year ended

31 December 2009

Profit before tax (5 400’+ 13.986 + 740’) 6 153 986

Gain on change in residual value (PV of 15’ – 10’ at 8% for 2.5 4 125
years)
Finance income (73 986 x 8% x 6/12) 2 959

6 161 070
Tax expense (1 526 329)

Current 1 516 590

Deferred 9 739

Profit for the year 4 658 231

Extract note disclosure:

Tax rate reconciliation:

Profit before tax at standard rate (6 161 070x R1 663 489 27%
27%)

Less capital gain on sale of land (290 000 x (15 660) (0.254%)
20% x 27%)
Less non taxable profit on sale of land (121 500) (1.972%)
(450 000 x 27%)

Effective tax R1 526 329

24.774%

Financial accounting gain = R3 740 000 – R3 000 000(Cost) = R740 000

SARS capital gain = R3 740 000 – R3 450 000(Base Cost) = R290 000
Difference between SARS and Accounting = R450 000
There is no deferred Tax to fix this difference.

100
 Less capital gain on sale of land
For the R290 000
Accounting included 100% PBT when SARS taxes only 80% of the gain, no deferred tax
to fix the difference, therefore, 20% is a reconciling item
Less non-taxable profit on sale of land
For the R450 000
Accounting included 100% in PBT when SARS did not include anything, there is no
deferred tax to fix this difference, therefore, 100% of this amount is a reconciling item.

Net investment in finance lease

Gross Unearned Net
investment in finance income investment in
lease lease
December X10 0 0
December X11 40 000 4 361 35 639
December X12 55 000 9 626 45 374

Total 95 000 13 987 81 013

Interest is payable at a rate of 8% p.a. compounded on an annual basis. The lessee has
guaranteed a residual equal to the fair value of the machine on 30 June 2012. The
estimated fair value of the residual at 31 December 2009 is R15 000.

Workings:
 (40 000 + 40 000 + 15 000) = 95 000
 Calculation of PV:

Old RV : 10 000 New RV : 15 000

FV = 40 000 FV = 50 000 FV = 55 000

n = 1.5 n = 2.5 n = 2.5

i = 8% i = 8% i = 8%

PV = 35 639 PV = 41 249 PV = 45 374

101
 Total Old PV =
R76 888 (35 639 +
41 249)
Total New PV =
R81 013
(35 639+45 374)
Gain on change in RV
= 81 013-76 888 = 4
125

Working – finance lease profit on sale calculation

FV = 40 000; n = 2; i = 8% PV = 34 294
FV = 50 000; n = 3; i = 8% PV = 39 692
34 294 + 39 692 = 73 986 (Total PV)
73 986 – (100 000 – 40 000) = 13 986

Calculation of taxable income:

Profit before tax per question R5 400 000

Add capital gain (290 000 x 80%) 232 000
Add lease income -
Less wear and tear (15 000)

Taxable income R5 617 000

Tax at 27% R1 516 590

102
 SP 3 740 000
290 000 x 80% x 27% = R62 640
Base cost 3 450 000
450 000 x 0% = R0
Historic cost 3 000 000

Deferred tax:
CA TB T/Diff D/Tax
31/12/09

Net investment in lease 81 070 0 81 070

Machinery 0 45 000 (45 000)

36 070 27% 9 739

Land is recovered through sale (Presumption)

Therefore, we use the CGT rate
Thus, as land was on the cost model, the carrying amount will never exceed the base cost,
thus, no deferred tax as there is no temporal difference.
Machinery
To SARS, a finance lease is not an actual disposal, hence, Falange is still entitled to wear
and tear, thus, a tax base still exists, and this tax base creates a temporal difference.

103
 WEEK 5
WEEK STARTING 20 MAR Main principles? What did I learn?

DT Q21

DT Q25
SEEN TUTS

DT Q27 (Part A)

104
 DT: Question 21 (75 minutes)

Paint Galore Ltd (Paint) is a retail store that specialises in mixing different colour paints
and selling the paints to the public.

You have recently been employed as the assistant financial manager and you are
responsible for the finalisation of the financial statements for the 2016 financial year,
ending 31 March 2016.The following issues have been identified:

1. Factory Building

Paint owned a factory building used for mixing different paint products. The building had a
carrying value of R560 000 and a tax base of R540 000 on
31 March 2015.The factory building has an estimated remaining useful life of 30 years and
qualifies for a 5% per annum wear and tear allowance. The allowance is not
apportioned for time.

On 2 April 2015, the directors of Paint decided that they do not need a factory building to
mix the paint anymore as this can be done in the individual retail stores.

Paint is going to rather rent the building to Bricks Galore (Pty) Ltd (Bricks) an independent
party. This will result in cost savings relating to distribution of the mixed paint.

This will also increase the level of customer satisfaction as there will be no waiting period
to distribute mixed products from the factory. At that date the fair value of the
property was R750 000.

The fair value at the end of the year, 31 March 2016, was R780 000.

The base cost of R600 000 is equal to the original cost of the property, which included
non-refundable transfer taxes of R80 000. .

2. Head Office Building

Paint owns a head office building that they use for all their administrative purposes.
The following details relate to the building:
Cost 1 April 2013 R10 200 000
Estimated useful life 15 years
Residual value R nil
Wear and Tear allowances granted by R nil
SARS

105
 Due to the extreme weather conditions and an unexpected earthquake during
March 2016, the building was severely damaged and Paint could not use the
building to its full potential.
The following information related to the building may be relevant
31 March 2016
Fair Value R10 425 000
Costs to sell R25 000
Value in use 10 300 000

No adjustments in respect of the damage to the building have been made to the
accounting records of Paint. Depreciation has also not yet been provided for the
2016 financial year.

3.Expected Credit Loss Allowance (ECLA)

An extract of the trial balance as at 31 March 2016 indicated there is an expected
credit loss allowance of R140 000 calculated on the 12 month ECLA model. The
opening balance of the ECLA was R100 000. SARS allows 25% of the 12 month
expected credit loss as a deduction.
4.Taxation rate
During the budget speech on 28 February 2016, the Minister of Finance, announced
a change in the tax rate from 28% to 29% for years of assessment commencing on
or after 1 April 2016 in order to fund tertiary education and infrastructure
developments.

The CGT rate has remained constant as 66.67% (2/3)

5.Assessed loss:

Paint has an assessed loss of R3 600 000 brought forward from the 2015 year of
assessment. At the beginning of the year Paint expected to return to profitability but
due to the tough economic times and a decrease in the paint market, management
are now uncertain if Paint will return to profitability.

106
Additional information:
● It is the policy of Paint to account for all buildings on the cost model in terms
of IAS 16 Property, plant and equipment and to account for investment
property on the fair value model in terms of IAS 40 Investment property.
● SARS does not grant any tax allowances on head office buildings.
● Profit before tax, excluding any transactions regarding the head office
building for 2016, has correctly been determined to be R450 000.
● Paint prepares financial statements in accordance with International Financial
Reporting Standards.

107
You are required to:
For the year ended 31 March 2016 of Paint Galore (Ltd):
a. Calculate the current tax expense

b. Prepare the taxation notes to the Statement of Profit and Loss and other
comprehensive income, including the tax rate reconciliation.

Comparative figures are NOT required

Accounting policies are NOT required
Suggestion: Draw up a timeline for/including each asset

108
DT: Question 21
Solution
Part A

Current Tax Computation

Or

Correct PBT -230,007 450,000

Fair Value adjustment on Fair Value adjustment on

Factory Building -30,000 Factory Building -30,000

Wear and Tear on the Factory Wear and Tear on the

Building -30,000 Factory Building -30,000

Depreciation Head Office Depreciation Head Office

Building 680 000 Building -

- -

Provision Accounting Entry

Provision Accounting Entry 40,000 (140' - 100') 40,000

Provision Prior Year 25,000 Provision Prior Year 25,000

Provision Current Year -35,000 Provision Current Year -35,000

Taxable income 420,000 Taxable income 420,000

-
Assessed Loss b/f -3,600,000 Assessed Loss b/f 3,600,000

-
Assessed Loss c/f -3,180,000 Assessed Loss c/f 3,180,000

Current Tax Payable - -

Note: In terms of exam technique – Adjust the PBT first with the items that were
not taken into account to get the correct PBT.

109
Part B

Notes to the financial Statements of Paint Galore

for year ending 31 March 2016

3. Taxation

SA normal taxation
comprises: Tax rate recon

Profit before tax (-230 000 x

Current Tax - 0.28) -64,400

FV adjustment at CGT (30' x 28%

Deferred Tax 982,800 x 1/3) -2,800

Historic depreciation on H/o

Temporary Differences 5,600 (680' x 28%) 190,400

Assessed Loss 978,600 Rate change -1,400

Rate Change (700 + 0 - 1

050 - 1 050) -1,400 Assessed loss not recognised 861,000

Effective tax expense 982,800

Tax expense as per

statement of profit and
loss and OCI 982,800

No current tax is payable due to the existence of an assessed loss.

An increase in the tax rate from 28% to 29% was announced on 28 February 2016. The
increase will only be effective in the 2017 financial year. Deferred tax balances have been
restated at year end to reflect the change in tax rate.

Note: Why is the rate change a reconciling item?

110
Workings

Factory Building

BOY 1 April 2015

CA TB TD DT RS

Factory Building 560,000 540,000 20,000 5,600 0 L

(30,000) 8,400 P/L +tax exp

2 April 2015 560,000 510,000 50,000 14,000

Revaluation (OCI) 190,000 - 39,200 150,800 OCI

Carrying Amount 750,000 510,000 240,000 53,200

P/L + tax
5,600 exp

Balances 780,000 510,000 270,000 58,800 150,800 Liability

0.29 60,900 -1,400

149,400

Rate Change 2,100 1,400 OCI

P/L + tax
700 exp

Note: There is a change in use from owner occupied IAS16 PPE to Investment property
under the fair value model IAS40.
Per IAS12.51.c there is a presumption that the IAS 40 property will be held for sale, and
therefore the CGT rate should be used.
Capital gain:(750000-600000)*0.28*2/3=28000
Recoupment:(600000-510000)*0.28=25200
Deferred tax =28000+25200=53200

The deferred tax relating to the reval OCI, is calculated as

53200-14000=39200

Remember when determining where the movement in deferred tax should be recognised ask
yourself:
What caused the change in the CA? In this case it’s the reval OCI
Therefore, the movement in DT should follow the underlying.

It is now investment property so there is a dual rate change.

FV= 750
BC= 600
CA=560

The difference between the FV and the BC is 150 x 66.6%x1% = 1000

The difference between the BC and the CA is 40 x 1% = 400
Therefore, the total rate change through OCI is 1400

( When moved from PPE to IP – changed the way you recovered the asset)

111
Head Office Building

CA TB TD DT

Initial recog (HC)p.15 8,840,000 - 8,840,000 - Paragraph 15

Initial recog (HC)p.15 8,160,000 - 8,160,000 - Paragraph 15

Balance before impairments 8,160,000 8,160,000 - Paragraph 15

Since the recoverable amount

exceeds the CA ,there is no
impairment

ECLA

CA TB TD DT

ECLA -100,000 -25,000 -75,000 -21,000

-8,400

-140,000 -35000 -105,000 -29,400 P/L - Tax exp

0.29 -30,450

Rate Change
- 1,050

112
BOY CA TB TD DT

Factory Building 560,000 540,000 20,000 5,600 L

Head Office -P 15 8,840,000 - 8,840,000 - p.15

ECLA -100,000 -25,000 -75,000 -21,000 A

Total Taxable Temporary Differences 3,100,000 -15,400

Assessed Loss -3,600,000 -3,600,000 -1,008,000

-1,023,400

End of Year CA TB TD 28% 29%

Factory Building 780,000 510,000 270,000 58,800 60,900 L

Head Office Building - P 15 8,160,000 - 8,160,000 - 0

AL P/L + tax
ECLA -140,000 -35,000 -105,000 -29,400 -30,450 A exp

Total Taxable Temporary Differences 165,000 29,400 30,450 L

Assessed Loss -3,180,000 -3,180,000 -890,400 -922,200 Rate Change effect

-861,000 –891,750 P/L- tax exp

Not recognised

Recognised as a D/tax asset 29,400 30,450 -1 050

113
Assessed loss

Total brought forward 3,600,000

Correct Loss Before tax

Profit Before Tax 450,000

Depreciation - Head Office Building -680,000

-230,000

The AL can be tricky when it comes to being limited and subject to rate change. Therefore:

Get the c/bal of the AL at the old rate, to find the movement in AL that will be shown as a separate line item in the tax expense note.

Then calculate the rate change on that, that will be aggregated with the rate change on taxable TD in P/L.

114
Deferred Tax Question 25 (60 minutes)

Mamela Limited is a South African listed company. The company manufactures

equipment for a variety of sports and sells its products in South Africa and Namibia.
You have been asked to assist with the preparation of the annual financial statements
for the year ended 31 December 2015 in your capacity as the trainee accountant in
the company’s finance division.

The following extract from the audited statement of financial position of Mamela as at
31 December 2014 has been presented to you. All figures have been correctly
calculated unless indicated otherwise.

Balance as at 31 December 2014 Note DR CR

Production plant – net carrying amount 3 14 408 800

Provision for dismantling costs 3 137 760

Accumulated loss 5 951 000

Deferred tax 1 ???

Notes

1. Deferred tax
The deferred tax balance for the financial year ended 31 December 2014 was
correctly calculated as follows –

Asset/liability – closing Carrying Temporary Deferred

Tax base
balance amount difference Tax

Production plant 14 408 800 12 510 000 1 898 800 512 676

Provision for dismantling costs 137 760 0 (137 760) (37 195)

Assessed loss 4 945 000 ??? ???

115
2. Profit before tax
The profit before tax for the 2015 financial year has been provisionally calculated
at R4 673 000 and includes dividend income of R812 000 relating to various
investments from South African companies.

Fines totalling R61 000 have been included in the calculation of profit before tax.
These fines relate to price collusion in the sports equipment industry and are not
deductible for tax purposes.

The profit before tax does not include any of the effects of the transactions
mentioned in notes 3 and 4, in respect of the current financial year, unless
indicated.

3. Production plant
Mamela Limited manufactures its inventory in a production facility located in
Sharpeville. The facility was constructed during the 2013 financial year and total
construction costs of R13 900 000 were incurred. In addition, Mamela incurred
qualifying borrowing costs of R1 415 000 which were capitalised onto the plant on
1 January 2014 when the plant became available for use. The depreciation for
2015 has not been accounted for in ‘profit before tax’. The plant has a useful life of
15 years and a residual value of nil.

As a consequence of emitting hazardous fumes from its production processes,

Mamela is required to dismantle the plant at the end of its useful life. The costs of
dismantling the plant were estimated at R673 250 on 1 January 2014.
On 31 December 2015, the costs were revised to R721 000. An appropriate pre-
tax discount rate is 12% p.a. compounded annually which has remained constant
since 2013.

4. Midrand storage facility

The company has historically rented a storage facility in Midrand under an
operating lease agreement which was renewed on 1 January 2014 for a 4-year
period. The monthly rental throughout the lease term is fixed at R96 000. Only the

116
 lease expense for 2015 has been correctly accounted for in the profit before tax
calculation.

On 31 December 2015, Mamela decided to store its inventory at the head office
and no longer had a use for the Midrand storage facility. The landlord confirmed
that the company has the following 2 options relating to the lease agreement –

a) The company could sublet the facility to an independent third party for a R75
000 per month from 1 January 2016 until the end of the lease term
b) Alternatively, if the company does not sublet the facility and also does not use
it in its own capacity then it will be liable for an immediate cancellation fee of
R545 000 payable in January 2016. It is the intention of the financial director to
select the more economically feasible option in accounting for the operating
lease obligation relating to the storage facility.

An appropriate pre-tax discount rate is 12% p.a. compounded monthly.

5. Accumulated loss
Due to its poor operations in 2014 the company made a net loss after tax which
created an accumulated loss of R951 000. As a result of this, the company had an
assessed tax loss of R4 945 000 and net taxable temporary differences of
R1 761 040 (refer to note 1) on 31 December 2014. In light of this, the directors
indicated that the company was unlikely to return to profitability in the short-term.

In March 2015, a long-term contract was signed with the Department of Sports to
supply sports equipment to schools throughout the country. As a result of this
contract, the company returned to profitability during 2015.

6. Additional information
● All items of property, plant and equipment are measured under the cost
model.
● For tax purposes, borrowing costs are deductible in the year they are
incurred, and decommissioning costs are deductible in the year they are
actually paid.

117
● Production plants are granted wear and tear allowances by SARS at a rate of
10% per annum, which are not apportioned for time.
● The corporate income tax rate is 27% and the inclusion rate for taxable
capital gains is 80%.
● VAT may be ignored.

118
You are required to
a. Discuss the accounting and tax consequences of the decision
to store inventory at the head office rather than the Midrand 16.5 minutes
storage facility on 31 December 2015
b. Prepare the journal entries relating to the future dismantling
costs of the production plant for the year ended 31 December 12 minutes
2015.
c. Calculate the taxable income for Mamela Limited for the year
ended 31 December 2015. Begin your calculation with profit 7.5 minutes
before tax
d. Prepare the deferred tax note to the financial statements for
the year ended 31 December 2015. Detailed workings and
comparatives figures are required.
24 minutes

The note that discloses the components of tax expense and

the tax rate reconciliation is not required.

119
 Deferred Tax Question 25 Solution
Solution (60 minutes)

a.) Discuss the accounting treatment (including tax consequences) of the decision to store
inventory at the head office rather than the Midrand storage facility on 31 December 2015

The company has 2 options in respect of the operating lease agreement for the Midrand facility:
1. The option of subletting the store yields a benefit of R75 000 per month against a cost of
R96 000 per month for the remaining lease term, and
2. The option of cancelling the lease results in a penalty fee of R545 000 with no accompanying
benefit.
Under both options, the unavoidable costs of meeting the obligations under the contract exceed the
economic benefits to be received under it. The contract has therefore become onerous (IAS 37.68).
In terms of IAS 37.66, the present obligation under the contract should be recognised as a provision
at 31 December 2015; based on the lower of the costs of fulfilling the contract versus any cash flows
from non-performance

The provision for option 1 shall be measured at the present value of the net cost of rental after setting
off the amounts to be received from subletting the store for 24 months.

N=24; pmt= (96 000 – 75 000) = R21 000 solve PV = 446 111

Had the company elected option 2 to abandon the store then the present value of the penalty fees
would have been R545 000.

The lowest cost is option 1 subletting the storage facility.

The provision to be raised at 31 December 2015 is a liability of R 446 111 recognised through profit
and loss.

Tax consequences:
The recognition of the onerous contract does not represent expenditure incurred by the company;
therefore the R 446 111 expense is not deductible in the computation of taxable income in 2015 but
when the operating lease payments are made.

The provision has a carrying amount of R446 111 and a tax base of nil as the costs will be deductible
in the future.
The provision creates a deductible temporary difference of R 446 111 and a deferred tax asset of
R120 450 should be raised through the p/l tax expense.

120
 2. Prepare the journal entries relating to the future dismantling costs of the production
plant for the year ended 31 December 2015. (8)
J1 Interest expense 16 530

Provision for dismantling costs 16 530

Interest expense for the year – R137 760 x 12%

J2 Production plant 10 945

Provision for dismantling costs 10 945

IFRIC 1 adjustment – increase of future dismantling costs capitalized to the

production plant
Narrations, dates

Note: Unwinding the Discount IFRIC 1

N=14 (as 1 year has already passed)
I=12%
FV=673250
Pv=SOLVE?=137760

Provision for
Reconciliation of provisions
dismantling costs

Opening balance (1/1/2015)

Movements for the year 137 760
Interest – R137 760 x 12% IFRIC 1 adjustment
Balance – R137 760 + R16 530 = R154 290
Adjusted balance – 16 530
N = 13; I = 12%; FV = R721 000; Comp PV R165 235
IFRIC 1 adjustment = R165 235 – R154 290

Closing balance 10 945

165 235

Workings
Production plant
Carrying amount (31/12/2014) = R15 438 000 x 14/15 = R14 408 800 (given).
Tax treatment – R13 900 000 capitalised – deductible over 10 years
Provision – deductible in the future (include in tax base)
2014 tax base – R13 900 000 x 90% = R12 510 000
2015 tax base – R13 900 000 x 80% = R11 120 000
IFRIC 1 adjustment – capitalised to the plant (increase carrying amount, no change in tax
base, increase in temporary difference).

121
 Calculate the taxable income for Mamela Limited for the year ended 31
December 2015.
Begin your calculation with profit before tax (9 marks)

Profit before tax (given) 4 673 000

Adjusted for:

Dividend income (812 000)

Fines 61 000

Depreciation – no adjustment

Capital allowance – production plant R13 900 000 x 10% (1 390 000)

Operating lease expense – correctly accounted for 0

IFRIC 1 adjustment – capitalised to the asset, no expense 0

Provision for onerous contract – not deductible, no expenditure 0

incurred

Taxable income 2 532 000

Assessed loss brought forward (4 945 000)

Taxable income/Assessed loss (2 413 000)

122
 3. Prepare the following deferred tax note to the financial statements for the year 16
ended 31 December 2015.
The deferred tax balance of R203 526 (2014: NIL) comprises of the following –

2015 2014
Production plant 613 047 L 512 676 L
Provision for onerous contract (120 450) A 0
Provision for dismantling costs (44 613) A (37 195) A
Assessed loss (651 510) A (475 481) A

(203 526) A Nil

At 31 December 2014, the company had an assessed loss of R4 945 000. Due to the
low probability of future taxable profits, deferred tax was recognised to the extent of
the taxable temporary differences of R1 761 040 only. R3 183 960 (after tax R859
669) was available for set off against future taxable income.
In 2015, the company had an assessed loss of R2 413 000 and the deferred tax asset
was fully recognised due to the possibility of future profits arising from the long-term
supply contract with the Department of Sports
Presentation (comparatives, distinguish between assets and liabilities

Note: Assessed loss calculated as:

1 761 040 x 27%

OR
(512 676 - 37 195)

Asset/liability – Carrying Temporary

Tax base Deferred Tax
closing balance amount difference

Production plant 13 390 545 11 120 000 2 270 545 613 047

Provision for (165 235) 0 (165 235) (44 613)

dismantling costs

Provision for onerous (446 111) 0 (446 111) (120 450)

contract
Assessed loss (2 413 000) (2 413 000) (651 510)

Net (asset)/liability (203 526)

Production plant – add the IFRIC 1 adjustment to the cost

123
Deferred Tax Question 27 (90 minutes)
PARTS A AND B ARE UNRELATED.
Part A (75 minutes)

You are an audit manager at ABC Auditors Incorporated and have been placed on the
audit of one of the firm’s major clients, Sony Ltd (Sony) and its subsidiaries for their
2019 financial year. Sony is listed on the Johannesburg Stock Exchange (JSE). The
company has used this as a source to gain access to additional funding for expansion
and investments in research and development activities. Sony is well-known for its
diversified business which includes consumer and professional electronics, gaming,
entertainment and financial services. Sony has expanded into various countries over
the years including South Africa. The year-end of Sony is 31 March.

The financial manager of Sony’s South African gaming division is on leave and the
temporary manager is unsure of a few financial accounting implications including
deferred tax.

An extract of the trial balance of Sony’s gaming division for the 2018 and 2019
financial years

Credit balances have been indicated in (brackets). Unless there is an indication

that suggests otherwise, it can be assumed the amounts in the trial balance are
correctly determined according to IFRS.

Item Year ended 31 March Year ended 31 March

Note 2019 2018
R R
Property, plant and 1 ??? 210 900 000
equipment
Investment property 2 250 000 000 234 000 000
Unaccounted items 3 ??? ???
Deferred tax ??? 70 140 000

124
1. Property, plant and equipment

The property, plant and equipment in the gaming division consist of the following two
items ONLY:

1. Manufacturing plant
The first item of property, plant and equipment is the division’s manufacturing
plant. The plant had been constructed over a period of time and completed at
a cost of R500 million on 1 April 2006.

Sony’s intention was to ensure the division would be able to meet South African
demand for the PlayStation 3 and subsequent generations of the PlayStation.

The division estimated that the plant would have a useful life of 20 years from
1 April 2006 and has not been reassessed by management.

In the previous financial year, the production of Sony’s PS4 experienced a

decline in sales due to the launch of Microsoft’s Xbox One X. As a result, the
division’s management correctly measured the plant at its recoverable amount
of R178 million on 31 March 2018.

However, due to the release of exclusive gaming titles in the current financial
year such as Spiderman and God of War, PS4 sales increased significantly.
This market change resulted in a value in use and fair value less costs to sell
of R180 million and R170 million respectively for the plant as at 31 March
2019.

The Sony group measures the plant on the cost model in terms of IAS 16:
Property, plant and equipment. The plant has been correctly accounted in
Sony’s records.

2. Storage Warehouse:
Secondly, the division has a storage warehouse which it uses to store stock for
its retail stores and online orders. Stock includes PlayStation consoles and
Sony gaming accessories.

125
 The warehouse was purchased on 1 April 2014 for R30 million and has a total
useful of 25 years. SARS also considers the base cost of the warehouse to be
R30 million.
On 1 April 2016 the division reassessed the remaining useful life of the
warehouse and decreased it by 3 years.
On 31 March 2019 the division sold the warehouse for R35 000 000. Sony will
replace the warehouse in the next financial year with a larger storage building.

The Sony group measures the warehouse on the cost model in terms of IAS 16:
Property, plant and equipment.

2. Investment property

The division has had this property for a number of years. The building is currently
vacant but it is leased out under an operating lease. The cost and base cost of the
property is R150 million. All investment properties are held on the fair value model in
terms of IAS 40: Investment property. This has been correctly accounted in Sony’s
records.

3. Unaccounted items

The following items have NOT been accounted for in the 2018 and 2019 financial
records.

3.1 Sony became aware of an increasing number of gamers who have had their
account details hacked on their consoles. This has been reported in the news in the
first week of April 2019. An investigation by Sony has revealed that there was an error
in the security protocols of the console’s operating system that was overlooked after
the company released a software update on 15 March 2019. Sony immediately issued
statements in the press in the first week of April 2019 and committed to the following:

● Sony will compensate all affected gamers who have been hacked by 15 May
2019. This amounts to a total of R12 million.
● A recall of all shipped PS4 consoles which have the corrupted software update.
This will be done through Sony’s retailers. Sony had 8 000 consoles on hand
at the beginning of the financial year which amounted to a total of R44 million.
Sony has 10 000 units on hand at 31 March 2019. Sony sold a total of 150 000

126
 units in South Africa in the 2019 financial year. You managed to find some
costs that may be relevant:

R (per unit)

Variable manufactured costs 2 905.00

Fixed manufactured costs based 2 499.60

on a normal capacity of 145 000
units

Storage costs 250.50

Net realisable value on date of 5 150

the press release

● Sony elected to measure its inventory with the weighted average cost method
in terms of IAS 2: Inventories.

Additional information

● You can assume that the profit before tax was correctly calculated as
R78 450 230 BEFORE considering the unaccounted items.
● You can assume a current tax amount of R19 049 985.
● The financial statements for the year ended 31 March 2019 are to be authorised
for issue on 30 April 2019.
● In March 2019, the Minister of Finance announced a change in the current
corporate tax rate. The applicable tax rate for years of assessment commencing
on or after 1 April 2019 will be 30%. Prior to this, the applicable tax rate has
remained constant at 28%. The capital gains tax inclusion rate of 80% has
remained unchanged.

127
● SARS has presented the following relevant tax consequences:

Item Tax consequences

Manufacturing SARS grants an allowance of 40% p.a. in the year of

plant purchase and 20% p.a. for the remaining periods. The
allowance is not apportioned for time.

Storage SARS grants an allowance of 2% p.a. and is not apportioned

warehouse for time.

Research and SARS allows a deduction of 150% of the costs incurred for
development costs the research phase only in the year it is incurred.
For the development phase, SARS grants an allowance
which agrees with Sony’s amortisation and is therefore
apportioned for time.

Vacant buildings SARS does not grant an allowance. The base cost is
deductible upon disposal of the building.

Compensation to SARS grants a deduction when the compensation is paid.

customers

128
Part B (15 minutes)
You are the new financial manager at Sherlock (Pty) Ltd (Sherlock). Sherlock is a well-
established special detective agency which focuses on small cases in the Edenvale
area. Sherlock is intending to expand into other areas such as Bedfordview and
Germiston in the Ekurhuleni metropolitan area. The year-end of Sherlock is 31
December.

Sherlock has found a small investigative company called Holmes (Pty) Ltd (Holmes)
which is situated in the Bedfordview and Germiston areas. Holmes also has a year-
end of 31 December. Holmes incurred losses and assessed losses in their previous
two financial years. Despite these losses, Sherlock and other companies have seen
potential in Holmes’ ability to expand their respective businesses in the Bedfordview
and Germiston areas. As a result, these companies have made a bid to purchase the
shares in Holmes. On 31 December 2018, Sherlock’s bid was viewed as the most
promising to assist Holmes with its losses and was allocated 80% of the share capital
of Holmes. Sherlock has control from 1 January 2019.

Holmes has a retained loss of R52 000 in the current year and an assessed loss
amounting to R48 000 on 1 January 2019 that had arisen over the previous 2 years
and management of Holmes did not consider that the situation would improve in the
foreseeable future. The deferred tax liability, before taking into account the assessed
loss, amounted to R11 500 (in respect of taxable temporary differences of R45 000).
The directors of Sherlock are confident that the addition of Holmes to the group would
create synergies that would restore the company to profitability.

The previous financial manager processed the following preliminary at acquisition

journal entry to record Holmes in Sherlock’s consolidated financial statements. This
former manager was unsure how to treat the assessed loss from a consolidated
perspective.

129
Account details Account details Debit (R) Credit (R)
Dr Stated Capital 150 000
Cr Retained losses 52 000
Cr Investment in 140 240
Holmes
Cr Non-controlling 21 760
interest
Dr Building 15 000
Cr Deferred tax 4 200
Dr Goodwill 53 200
Additional information
● Assume a corporate tax rate of 28%.
● Sherlock elected to measure the non-controlling interest at their proportionate
share of Holmes’s identifiable net assets at acquisition date.

130
You are required to:

Part A

1 Calculate the correct profit before tax for Sony’s South African gaming 18
division for the year ended 31 March 2019. minutes
You can assume that the profit before tax was correctly calculated as
R78 450 230 BEFORE considering the unaccounted items.

2 Prepare the tax expense note to the statement of comprehensive 49.5

income of Sony’s South African gaming division for the year ended 31 minutes
March 2019.
You can assume a current tax amount of R19 049 985.
Ignore comparative figures
Presentation

3 To the extent the information allows, prepare the deferred tax note to 7.5
Sony’s statement of financial position at year ended 31 March 2019 minutes
detailing the effects of the South African gaming division.
Ignore comparative figures
Presentation

Part B

1 Prepare an email explaining to the previous financial manager how you 15

would recognise and measure the assessed loss of Holmes at minutes
acquisition, in accordance with International Financial Reporting
Standards, in the consolidated financial statements of Sherlock on
1 January 2019

Include any adjustments that will need to be made to the preliminary ‘at
acquisition’ journal entry processed by the previous financial manager.
Include any relevant calculations to support your answer.

Ignore any implications on presentation and disclosure.

Format, communication and logical argument

Total

131
Deferred Tax Question 27: Solution

Part A 1
Opening 8 000
Manufactured 152 000

Opening balance 44 000 000

plus variable 441 560 000 (152 000 * 2 905)
plus fixed 362 442 000 (145 000 * 2 499.6)
Storage indicated to be excluded -
Total 848 002 000

Cost per unit 5 300 (848 002 000 / 160

000)
NRV 5 150 Given
150 (5 300 - 5 150)
Total expense 1 500 125 (150 * 10 000)

132
Part A2
Sony Ltd
Notes to the financial statements for the year ended 31 March 2019
8. Tax expense

R
SA normal taxation 21 870 029
Current tax 16 853 229
Deferred tax
temporary differences 156 800
rate change 4 860 000

Tax rate reconciliation

Profit before tax 18 186 029 using PBT per part A @ 28%
Exempt portion of profit on sale (280 000) 5000000*0.28*0.2
Exempt portion of fair value adjustment (896 000) 16 000 000 *28% *20%
Rate change 4 860 000

Tax expense 21 870 029

Effective tax rate 33,67%

In March 2019, the Minister of Finance announced a change in the

current corporate tax rate. The applicable tax rate for years of
assessment commencing on or after 1 March 2019 will be 30%.
Closing balances have been adjusted to reflect the change in tax
rate.

133
 Deferred tax workings
Rate
Temporary differences change
28% before
Temporary differences R rate change R
Manufacturing plant (840 000) 3 500 000

Storage warehouse 772 800 -

Investment property 3 584 000 1 600 000
Provision for compensation (12
000'*0.28) (3 360 000) (240 000) 12000000 * 0.02
156 800 4 860 000

Manufacturing plant HCA CA TB TD DT

01-Apr- 178 000
18 Opening balance 200 000 000 000 - 178 000 000 49 840 000 L
- 22 250
Depreciation (25 000 000) 000
31- Balance before reversal of 155 750
Mar-19 impairment 175 000 000 000
19 250
Reversal of impairment 000
175 000
Limited to HCA 000 175 000 000 49 000 000 L
180 000
Recoverable amount 000
Limiting to HCA as accounted for on cost
model
Rate change 3 500 000
52 500 000 L

134
 Cost 500 000 000
Total Useful life 20
Remaining useful life 8

Storage Warehouse CA TB TD DT

31- 27 600 -2 760

Mar-18 Opening balance 24 840 000 000 000 -772 800 A
Depreciation for 1 for
year (1 380 000) (600 000) -218 400 P/L movement
23 460 000 27 000 000 -3 540 000 -991 200 A

Closing balance -991

before disposal 200

(27
Disposal (23 460 000) 000 000) 991 200 P/L
31-
Mar-19 Closing balance 0

Selling price 35 000 000

CA 23 460 000

Accounting profit 11 540 000

135
 Investment property CA TB TD DT
31-Mar- 150 000
18 Opening balance 234 000 000 000 84 000 000 18 816 000 L
Fair value adjustment 16 000 000 -
31-Mar- 150 000 100 000
19 Closing balance 250 000 000 000 000 22 400 000 L
Rate change 1 600 000
24 000 000 L

136
Part A3
Sony Ltd
Notes to the financial statements for the year ended 31 March 2019
9. Deferred tax

Taxable/(deductible) temporary difference have arisen on the following

items:

R
Manufacturing plant 52 500 000
Investment property 24 000 000
Provision for compensation (3 600 000)

137
Part B

To: Prevmanager@gmail.com

CC:
RE: Deferred tax consequences of assessed loss

Separate financial statements

Holmes has an assessed loss in their separate books. The management of Holmes did not
consider that the situation would improve in the foreseeable future. As a result, the deferred
tax asset that arises on the assessed loss must be limited to the deferred tax liability of R11
500.
The deferred tax asset that arises on the assessed loss amounts to: R48 000*28% = R13 440.
This means the deferred tax asset will be limited to R11 500. The excess deferred tax asset of
R1 940 will not be recognised in the separate financial statements of Holmes.

Group financial statements

IFRS 3 states that income tax consequences must be recognised and measured according to
IAS 12 and is an exception to the recognition and measurement of IFRS 3.
The directors of Sherlock are confident that the addition of Holmes to the group would create
synergies that would restore the company to profitability. Sherlock can raise the deferred
tax asset on the assessed loss to the extent it has not be recognised in the separate books of
Holmes.
Therefore, the full R1 940 can be raised in the group statements and processed in the 'at
acquisition' journal entry.

The effects of the assessed loss

As the deferred tax asset of the assessed loss has not been processed, this will affect two
accounts:
Non-controlling interest as Sherlock has elected to measure this account on the
proportionate share method.
Goodwill as this is a residual value that is affected by the adjustment of identifiable net assets
and non-controlling interest.
The adjusted identifiable net assets are 108 800 + 1 940 = R110 740 OR the adjustment to the
net identifiable assets as a result of an increase in the deferred tax asset is R1 940
The adjusted non-controlling interest is 110 740 * 0.2 = R22 148 OR the adjustment to the
non-controlling interest is 1 940 * 0.2 = R388
Goodwill should be equal to 140 240 + 22 148 - 110 740 = R50 648 OR the adjustment to
Goodwill is R1 940 - R388 = R1 552

138
 WEEK 6
WEEK STARTING 27 MAR Main principles? What did I learn?

Leases Q12

Leases Q3
SEEN TUTS

Rev Q36

139
LEASES QUESTION 12 (LEVEL 4) 45 min

The following information was extracted from the accounting records of Grootmielies (Pty)
Ltd
on 31 December 20x7.

Net Operating Expenses 550 000

Original “old” Tractor– Carrying Amount 12 950

The remaining useful life of the above-mentioned “old” tractor is 1.5 years.

Details of the lease agreement are documented below:

Lease Payments R

• 30 April 20x7 5 000

• 30 April 20x8 90 000

• 30 April 20x9 99 000
• 30 April 20y0 108 900
• 30 April 20y1 119 790
• 30 April 20y2 131 769

On 30 April 20x7 Tom Smith, owner of Grootmielies, entered into a lease agreement with
Bloubank Limited to lease a tractor. The cash price of a similar tractor is R 500 000.
The lease for the new tractor was taken out due to the theft of a significant mechanical part
of the old tractor. A replacement part for the original tractor could not be located.
In terms of the agreement, Grootmielies must make 6 annual installments. These installments
will commence on the first day of the lease and will end when the lease agreement
terminates. The payments have been determined taking interest into account at 10% per
annum. The first payment of R5 000 has been expensed and is included in “net operating
expenses”.

140
The lease agreement has the following terms and conditions:

• Bloubank will retain ownership of the tractor at the end of the lease term
• Grootmielies has an option to renew the lease with Bloubank at market related rentals
• Grootmielies is responsible for the maintenance, servicing, and insurance of the tractor

The current year annual maintenance and service cost of R 22 000 is included in “net
operating expenses”. Insurance is taken out on the tractor in case of theft, loss, or damage.
The insurance payment is R 2 000 per month and is also included in “net operating expenses”.

Risky Insurance Limited paid out R 12 950 on 30 November 20x7 on the theft of the
component from the old tractor. The payment was in full and final settlement of the old
tractor. The cash received was credited to an “Insurance pay out” balance sheet account (Dr
Bank, Cr Insurance Pay-out (B/S)).

Additional information

• Ignore any tax implications

• The company measures Property, Plant and Equipment using the cost model in terms of
IAS 16.
• The company depreciates tractors over 20 years on the straight-line basis.

141
You are required to:

Write a memo to Mr Tom Smith discussing, with reasons, the accounting implications of both
the “old” tractor and of the lease agreement on the financial statements of Grootmielies for
the year ended 31 December 20x7. Your memo should address presentation but need not
discuss note disclosure requirements.
(45 minutes)

142
 LEASES SOLUTION 12

Presentation and logical flow

As Grootmielies is the lessee in the lease agreement, they must apply the single accounting model
as set out in IFRS 16, thus there will be no classification test as is required for lessors. The company
will not be able to apply any of the exemptions in IFRS 16 as the lease term is longer than 12
months and there is no indication that the tractor is a low value item.

At the commencement of the lease, the company should recognize a right of use asset and a lease
liability.

Lease Liability
The lease liability represents the lessee’s obligation to make payments to the lessor over the lease
term.

The lease liability can be presented separately on the SFP or within another liability line item. If it is
not separately presented, Grootmielies must disclose which line item in the SFP it has been
included in.

Initial measurement
Grootmielies should measure the lease liability at the present value of the lease payments that are
not yet paid at commencement date, discounted using the interest rate implicit in the lease of
10%.

Using the Cash

Flow function:
T0 5000
T1 90 000
T2 99 000
T3 108 900
T4 119 790
T5 131 769

I 10%
NPV= SOLVE R414 091
Note: The reason the cashflow function is being used is because the annual payments
are different. If all the payments were identical the CMPD function would be quicker.

143
Subsequent measurement
Grootmielies should:

• Increase the carrying amount of the liability with interest on the liability calculated using the
interest rate implicit in the lease of 10%
(414091-5000)*10%*8/12 = 27273

• The interest expense should be presented in the SCI and should be included in the “finance
cost” line in accordance with IAS 1.
• Reduce the carrying amount of the liability to reflect the lease payments made. In the current
financial year R5 000 was paid, this will directly reduce the lease liability.
• Grootmielies incorrectly accounted for the R5 000 lease payment as an expense. Thus, the
expense should be reversed and the payment recognised as a direct reduction of the lease
liability.
• The lease liability will therefore be measured as follows on the 31 December 20X7 in the
statement of financial position
R 414091 + 27273– R5 000 = R436 364

• The current of R76 364 (R90 000 – 13 636) (13 636 calculated as (414091-5000)*10%*4/12)
and non-current portions R360 000 of the lease liability should be presented separately on
the SFP.

The right of use asset

This asset represents the lessee’s right to use the asset for the lease term.

The right of use asset can be presented separately on the SFP or within the relevant “owned” asset
line item. If it is not presented separately, Grootmielies must disclose which line item it has been
included in.

Initial measurement
Grootmielies should measure the right of use asset at cost. The cost of the asset is the amount
determined on initial measurement of the liability, R414 091.

Subsequent measurement

• The right of use asset should be measured using the cost model in terms of IAS 16 Property
plant and equipment, as the tractor does not fall in a class of owned PPE to which the lessee
applies the revaluation model and the right of use asset does not meet the definition of
investment property.
• The right of use asset will be measured at cost less accumulated depreciation and
accumulated impairment loss.

144
 • Depreciation of the tractor will be based on the earlier of the end of the useful life of the
asset or the end of the lease term. The useful life of the tractor is 20 years whereas the lease
term is 5 years, thus the right of use asset will be depreciated over 5 years.
Depreciation charge for the year: (R414 091/5) * 8/12 = R55 212

• Depreciation expense of R55212 will therefore be reflected in the SCI.

• There is no indication of impairment in accordance with IAS 36.

The maintenance and service costs are paid annually in advance. As the lease contract came into
existence on 1 April 20x7, only 8 months of the annual costs should be expensed as the other 4
months still meets the definition of an asset (prepayment of R7 333). Monthly insurance costs are
expensed as incurred.
These costs do not increase the future economic benefit of the asset and therefore cannot be
capitalized to the asset.

Treatment of “old tractor”

As a replacement part for the original tractor could not be located, it is unlikely that the tractor can still be
used. There are no longer probable future economic benefits flowing to the company as a result of the use of
the asset. This is an indicator of impairment. This is confirmed by the fact that the insurance company paid
out the exact carrying amount in full and final settlement of the old tractor.

The tractor should therefore be de-recognised from the SFP with a corresponding impairment loss recognised
in P/L. In addition, the insurance payout account should be reversed and instead reflected as income in the
current year. This does not offset against the impairment loss.

145
LEASES: QUESTION 3 (LEVEL 3) Time: 1hr 20min
Webster (Proprietary) Limited was formed on 1 July 20x2 with an authorised share
capital of R100 000 divided into 100 000 shares of R1 each. On the same day the
company started manufacturing activities.

The directors decided to acquire an automatic machine to produce their product.

Because of the nature of the product, it would not be necessary to acquire any further
equipment or any other fixed assets for at least four years. The automatic machine
was expected to have a useful life of six years and no scrap value.

Arrangements had been made with Barnato Bank that they would purchase the
machine on behalf of Webster Limited for R120 000, and then lease it to Webster
Limited. The lease agreement was signed and the machine was delivered on 2 July
20x2. In terms of the lease, Webster Limited would be required to make 60 monthly
payments of R3 000 each, with the first payment being due on 31 July 20x2. At the
end of the lease, Webster Limited would acquire ownership of the automatic machine
for no further consideration.

At 30 June 20x3, the date of the company’s financial year end, the following trial
balance was extracted from the books of the company:

TRIAL BALANCE AT 30 JUNE 20x3

Share capital 100 000
Sales 800 000
Cost of sales 400 000
Expenses 200 000
Payments on lease 36 000
Inventory 190 000
Accounts receivable 160 000
Accounts payable 60 000
Provisional tax paid - 30 June 20x3 9 800
Bank overdraft – unsecured 35 800
R995 800 R995 800

146
After the trial balance had been extracted it was realised that, except for the monthly
payments which had been debited to a “payments on lease” account, no other entries
had been made in the books in respect of the automatic machine or the lease thereof.
The following amortisation table was received from the Barnato Bank, and it was
agreed that this schedule should be used for the accounting records of Webster
Limited. The schedule had been prepared using the effective interest rate of 17,27%
set out in the lease agreement.

AMORTISATION SCHEDULE

Half year to Interest Repayments Balance

30 June 20x2 - - R120 000

31 December 20x2 R10 083 R18 000 112 083
30 June 20x3 9 375 18 000 103 458
31 December 20x3 8 602 18 000 94 060
30 June 20x4 7 761 18 000 83 821
31 December 20x4 6 846 18 000 72 667
30 June 20x5 5 845 18 000 60 512
31 December 20x5 4 757 18 000 47 269
30 June 20x6 3 572 18 000 32 841
31 December 20x6 2 280 18 000 17 121
30 June 20x7 879 18 000 0

The rate of taxation for companies is 27% and the Capital Gains Tax Rate is 80%.
There are no items of expenses that will be disallowed for taxation, and value added
tax (VAT) must be ignored. SARS allows lease costs as a deduction when paid.

Inventory is made up of raw materials valued at the latest prices.

147
YOU ARE REQUIRED TO:

Prepare the statement of financial position, income statement and notes to the
financial statements for Webster Limited at 30 June 20x3 in a form suitable for
publication. Accounting policies are not required.

Objectives:
Understand

• Correcting entries required for the lease accounting

• Disclosure for lessees

148
LEASES: SOLUTION 3
WEBSTER LIMITED

STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x3

ASSETS R’s
NON CURRENT ASSETS 100 934
Plant (120/6*5) 100 000
Deferred tax 934
CURRENT ASSETS 350 000
Inventory 190 000
Accounts receivable 160 000

TOTAL ASSETS 450 934

EQUITY AND LIABILITIES

Equity attributable to equity holders o the 217 196
parent
Share capital 100 000
Revenue reserves: retained income 117 196

83 821
NON-CURRENT LIABILITY

Lease liability (103 458 -19 637)

CURRENT LIABILITIES 149 917

Trade creditors 60 000
Lease liability (18 000*2-8 602-7 761) 19 637
Taxation (44 280 – 9800) 34 480
Bank overdraft 35 800

TOTAL EQUITY AND LIABILITIES 450 934

149
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 30 JUNE 20x3

R’s
Revenue 800 000
Cost of sales 400 000
Gross profit 400 000
Operating expenses (200’+20’) (220 000)
Operating income 180 000
Finance charges (19 458)
Net income before tax 160 542
Taxation (44 280-934) (43 346)
Net income 117 196
Note: Use your financial calculator CMPD and AMRT to solve for interest.
N= 60 i= 17,27/12 pmt=3000 pv=?
Amort
Pmt1: 1
Pmt2: 12
SumInterest= ?

150
NOTES TO THE FINANCIAL STATEMENTS

SHARE CAPITAL
The authorised and issued share capitals consist of 100 000 ordinary shares of R1
par value each.

DEFERRED TAX
Closing balance comprises
Originating taxable differences on ROU asset R27 000
Originating deductible differences on lease liability (R27 934)
Net asset at 30 June 20x3 (R934)

LEASE
Webster entered into a lease agreement for a machine over 60 months. Ownership
passes to Webster at the end of the lease term. No variable rentals, extension or options
of renewal or purchase exist.

The lease was capitalised and is included under property plant and equipment. The
lease liability bears interest at the rate of 17,27%. The finance charges presented in the
Income statement relate solely to the lease.
Leased asset
Additions to leased assets in 20x3 120 000
Carrying amount of machine and equipment at 30 100 000
June 20x3

Effect of lease on profit or loss

Depreciation charge 20 000
Interest expense 19 458

Cash flow effect of lease

Total cash outflow 36 000

151
A maturity analysis of the lease liability based on undiscounted gross cash flows is
reported in the table below:

Undiscounted lease
Payments
30 June X4 36 000
30 June X5 36 000
30 June X6 36 000
30 June X7 36 000
Total 144 000

PLANT
ROU Asset 100 000
Cost 120 000
Accumulated depreciation 20 000

INVENTORY
Raw materials 190 000

TAXATION
SA Normal taxation 43 346
Current
44 280
Deferred (934)

152
WORKINGS

1. Operating income

Sales R800 000

COS 400 000
Gross profit 400 000
Expenses 200 000
Depreciation 20 000
Finance charges 19 458 239 458
R160 542

2. Current tax
Operating income R160 542
Add – depreciation(R120 000/6) 20 000
- 19 458
Finance charges(R10 083+R9 375)
Taken from schedule given in question
200 000
Less - lease payments (36 000)
R164 000

Tax @ 27% = 44 280

ROU Asset depreciated over useful life as ownership will transfer to Webster
at no additional cost at the end.
IFRS 16 par 29
IFRS 16 par 32

153
3. Deferred tax

C.A. T.B. T.D. D.T.

ROU Asset - R100 000 27 000(L) Cr
R100 000
((120 000/6)*5 years)
Lease liability (103 458) - (103 458) (27 934)(A)Dr
(120 000+19 458-36 000)

(3 458) (934)(A) Dr

154
4. Lease

Present value of the minimum lease payments

X3 X4 X5 X6 X7

EOY

PV of lease payments LL At the end of the year:

Pmt = 3 000
N=60 Pmt = 0
I= 17.27/12 N=48
PV = R120 000 I= 17.27/12
Pmt = 3 000
Therefore, at initial recognition: PV = 103 458

RoU Asset: R120 000 OR: Interest: 1:AMRT:12 = R19 458 or

use amort schedule given: 10 083 + 9
LL R120 000
375
C/Bal: 120 000 + 19 458 – 36 000
Rou A depreciated over 6 years

However for years X5,X6,X7 we

need to bring the PV for the 12
X4 year: months of each year, to our
current EOY:
Pmt = 3 000
Pmt = 0
N=12
N=12 (X6), 24 (X7), 36 (X8)
I= 17.27/12
I= 17.27/12
PV = R32 846
FV = R32 846
The same calculation will
apply to all the year PV = 27 672; 23 311, 19 638

155
Finance Charges

Use your financial calculator CMPD and AMRT to solve for interest.
N= 60 i= 17,27/12
pmt=3000
pv=?
Amort
Pmt1: 1
Pmt2: 12
SumInterest= ?

156
Revision 36
Seabreeze Limited (Seabreeze) is a fishing company which operates from the West Coast of
South Africa and is listed on the JSE. The company is involved in the catching, processing,
marketing and distribution of canned and frozen fish and other seafood products in South
Africa. The company also exports its products to other countries in Africa and Europe. In
addition, they provide logistical support services and refrigerating warehouse facilities.
Seabreeze applies International Financial Reporting Standards (IFRS) and the company’s
financial year ends on 30 September.
Fish canning equipment
Seabreeze entered into a lease agreement with Renco Limited on 1 October 2017 to lease
canning equipment from Renco for 4 years. The economic life of the canning equipment is 8
years. Seabreeze incurred legal fees of R2 000 in order to obtain the lease agreement. Annual
lease payments of R30 000 are payable on 30 September and the rate implicit in the lease is
11% p.a. while the prime lending rate is 10.5% p.a. Mr. Ndlovu, the financial accountant of
Seabreeze, has not processed any journal entries with regards to the lease agreement for the
2019 financial year. Assume that the tax treatment for the lease agreement is the same as
the accounting treatment in all respects.
Refrigerating warehouse facility
Seabreeze owns the plot of land on which the warehouse facility is situated. The land was
purchased for R2.5 million in October 2002. It is the accounting policy of Seabreeze to
measure land using the revaluation model. The fair value of the land was determined as R4
million by an independent valuator at 30 September 2019 (2018: R3.7 million) and at R8
million using their budgeted cash flow forecasts for the next 10 years (2018: R5.6 million).
SARS does not grant any allowances in respect of land.
Seabreeze started the construction of the refrigerating warehouse facility in January 2003 and
it was completed on 1 October 2004 at a cost of R3 million. The useful life of the warehouse
was estimated on 1 October 2004 to be 25 years. Seabreeze could currently obtain R200 000
for the same building if it were in the condition and location expected at the end of its useful
life and R250 000 is the present value of what the building will be worth at the end of its
useful life, discounted back to its first day of operations.
The warehouse is still in a very good condition as it has been well maintained over the years.
The remaining useful life was therefore re-estimated to be 15 years on 1 October 2018, with
the residual value unchanged. Seabreeze measures the warehouse facility using the cost
model. SARS allows a deduction of 5% per annum on the cost of the warehouse facility.
Preference shares
Seabreeze issued 100 000 8% preference shares at R10 each (par value) on 1 October 2018 in
order to raise funds for the purchase of an additional tuna and sardine processing plant. Each
preference share held will be mandatorily converted into one ordinary share on
30 September 2024. Preference dividends are payable annually on 30 September. A market-

157
related interest rate for a similar liability (excluding the conversion feature) is 12% p.a. The
coupon payment was made on 30 September 2019. Assume that the tax treatment for the
preference shares is the same as the accounting treatment.
Ocean View claim
Ocean View, an upmarket restaurant in Cape Town has laid a claim against Seabreeze for
R500 000 in damages. Ocean View claims that 20 of their customers became seriously ill after
eating hake (bought from Seabreeze) at their restaurant. The people attended a birthday
party at Ocean View and all of them had to be hospitalized with food poisoning allegedly after
eating the hake. This has led to serious reputational damage for Ocean View despite
Seabreeze disputing being at fault. An investigation will be performed, and the matter will be
heard in court during November 2019. The legal department of Seabreeze estimate that it is
80% probable that Seabreeze will be liable to pay R500 000 in damages and 20% probable
that it will be liable to pay no damages. The entity uses the most likely outcome to measure
provisions.
The following is an extract from the notes to the draft financial statements as prepared by the
financial manager:

Seabreeze Limited
Notes to the financial statements for the year ended 30 September 2019

14. Contingent liability

The company has a possible obligation relating to a claim of R500 000 by a customer.
The matter will be heard in court during November 2019.

SARS will allow the cost of the claim as a deduction when paid.
Additional information:

• The normal tax rate is 27% and the inclusion rate of capital gains within taxable income
is 80%. These rates have remained consistent for all periods under review.

158
 You are required to:
a. Provide the journal entry/ies relating to the agreement with Renco to be processed in
the records of Seabreeze Ltd (Seabreeze) for the year ended 30 September 2019.
Narrations required
b. Prepare the note disclosure relating to the change in estimated useful life of the
warehouse in the records of Seabreeze for the year ended 30 September 2019.
c. Discuss, in terms of IAS 37 and IAS 10, whether the claim by Ocean View has been
treated correctly in the records of Seabreeze, for the year ended 30 September 2019.
d. Calculate and explain, in terms of IAS 12, the deferred tax consequences of the
warehouse, land and claim in the records of Seabreeze as at 30 September 2019.
e. Prepare the Statement of Financial Position of Seabreeze at 30 September 2019.

159
Revision 36 Solution

Part A
Debit Credit

Depreciation 23 768
Accumulated depreciation 23 768
Depreciation on ROU asset

Interest expense (p&l) 8 064

Lease liability 8 064
Interest on lease liability

Lease liability 30 000

Bank 30 000
Lease payment

Workings:
Lease liability- 1 Oct 2017 93 073
(PMT= 30 000; n=4; i=11%)

ROU Asset- 1 Oct 2017 95 073

(93 734 + 2 000)
Do not forget to include the initial direct costs
incurred to obtain the lease

Depreciation per year 23 768

(95 073/ 4 years)

Interest for 2019:

Opening liability 93 073
Interest 2018 10 238
Payment 2018 -30000
Opening balance 2019 73 311

(73 311 x 11%) or AMORT 2-2 8 064

160
Part B
Seabreeze Limited
Notes to the financial statements for the year needed 30 September 2019
Change in estimate

The remaining estimated useful life of the refrigerating warehouse facility has
changed from 11 years to 15 years on 1 October 2018. The effect of the change
is as follows:

Increase in current profits 29 867

Decrease in future profits -29 867

Workings:
Original
estimate New estimate
01-Oct-04 Cost 3 000 000

Original annual depreciation (3mill-200000)/25 -112 000

Carrying amount on 1 October 2018: 1 432 000 1 432 000

(3mill- 112 000 x 14 years)

2019 Depreciation -112 000 -82 133

(1 432 000-200 000)/15

30 September 2019- carrying amount 1 320 000 1 349 867

Future depreciation 1 120 000 1 149 867

Part C
A provision is a liability of uncertain timing or amount (IAS 37 par.10).
A liability is a present obligation of the entity to transfer an economic resource as a result of a past
event (Conceptual Framework).
The past event is Seabreeze making its customers ill from its food, which then further resulted in
Seabreeze being sued.
The transfer of economic resources is the cash that will be paid if Seabreeze is found liable.
Seabreeze is disputing liability for the claim, and uncertainty therefore exists with regards to the
existence of a present obligation.
In case of uncertainty regarding the existence of a present obligation, the entity takes into account
all available evidence, including the opinion of experts (IAS 37 p.15-16).
The legal department of Seabreeze estimate that it is 80% probable that Seabreeze will be liable to
pay damages, indicating that it is more likely than not that a present obligation exists.
A provision should therefore be recognised (IAS 37 p. 16a).
Provisions are measured at the best estimate of the expenditure required to settle the obligation (IAS
37 p. 36), ie. R500 000 (most likely outcome).
The accounting treatment by the financial manager (disclosing a contingent liability) is incorrect.

161
Part D
Deferred tax arises on the difference between the carrying amount and tax base of an asset/ liability
(temporary difference) (IAS 12 Definitions).
As the future economic benefits of both the warehouse (future revenue) and land (future sale) are
taxable, the tax base of an asset is the amount deductible for tax purposes against any taxable
economic benefits that will flow to an entity when it recovers the asset (IAS 12 par.7).

The measurement of deferred tax assets/ liabilities shall reflect the tax consequences that would
flow from the manner in which the entity expects to recover the carrying amount of the asset (IAS12
par.51).

162
 Land
Land is a non-depreciable asset and is expected to be recovered through sale, the tax
base of land is therefore the base cost of R2.5 million as this cost will be deductible
when calculation the capital gain on sale.
The carrying amount is R4 million on 30 September 2019 and a temporary difference
of R1.5 million arises.
This is a taxable temporary difference as it will result in a taxable amount when the
carrying amount of the asset is recovered, future taxable income (R4 million) exceeds
future deductions (R2.5million).
A deferred tax liability of R324 000 (1.5 million x 27% x 80%) arises.

Refrigerating warehouse facility

The carrying amount of the warehouse facility is R1 349 867 (part b)
and the tax base is R750 000 (5% x 5 years x R3million).
The warehouse facility will be recovered through use and the normal tax rate of 27% is
applied.
A deferred tax liability of R161 964 [(1 349 867-750 000) x 27%] arises on the temporary
difference.
This is a taxable temporary difference as it will result in a taxable amount when the carrying
amount of the asset is recovered, future taxable income (R1.349 million) exceeds future
deductions (R750 000).
Note: This is a different way of determining the tax base – by
calculating the remaining wear and tear allowances that Seabreeze
can still claim.
Alternative view:
3 000 000 – (3 000 000 x 0.05 x 15)

Claim- provision for damages

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax
purposes in respect of that liability in future periods (IAS 12 par. 8).
The carrying amount of the provision is R500 000 and the tax base is zero (R500 000-R500 000) as
the amount will be allowed as a deduction in a future period when Seabreeze pays the amount.
A deferred tax asset should be recognised as the R500 000 deduction will lead to a tax saving in
future periods.
The amount of the deferred tax asset will be R500 000 x 27%= R135 000

163
 Part E

Seabreeze Limited

Statement of financial position as at 30 September 2019

R
ASSETS
Non-Current Assets
Right of use asset (95 073-23 768) 71 305
Land 4 000 000
Warehouse facility 1 349 867

EQUITY AND LIABILITIES

EQUITY
Convertible preference shares 671 087

LIABILITIES
Non-Current Liabilities
Convertible preference shares 242 988
Lease liability (51376-24349) 27 027
Deferred tax (324 000+161 964-135 000) 350 964

Current Liabilities
Convertible Preference Shares 45 394
Provision 500 000
Lease Liability 24 349

Convertible Preference Shares Workings

100 000 preference shares x R10 = R1 000 000 face value.

Initial PV of Liability Portion

N=6
i = 12%
Pmt = 80 000(1 000 000 x 0.08)
FV = 0
PV = SOLVE = 328 913
Equity portion = 1 000 000 – 328 913

164
 Date Nominal Effective Difference PV
1st October 2018 - 328 913
30th September (80 000) 39 470 40 530 288 382
2019
30th September (80 000) 34 606 45 394 242 988
2020

Current and Non-Current Portion of Lease Liability

Date Payment
1st October 2018 -
30th September 2019 (30 000)
30th September 2020 (30 000)

165