Checkpoint 3 Flashcards
(36 cards)
What is a lease and what is the accounting treatment for it?
Lease – a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration
Dr Right of use asset (PPE)
Cr Lease liability
[Cr Cash *]
* *With any payments made at the commencement date of the lease (e.g. a deposit or the first instalment if instalments are paid in advance)
How do we account for any costs of removing or dismantling an asset at the end of a lease ? (as specified in the agreement)
Dr Right of use asset (PPE)
Cr Lease liability
Cr Cash (e.g. deposit, first instalment in advance, initial direct costs)
Cr Provision (estimated removal/dismantling costs)
How do we depreciate a Right of Use Asset?
The asset will be depreciated, in the normal way, over the shorter of the lease term and its useful life.
If there is a reasonable certainty that the lessee will obtain ownership by the end of the lease term , then the asset should be depreciated over its useful life.
How do we account for lease payments?
- As the company makes its regular lease payments, the amount of the payment will pay off an element of capital and an element of interest.
- The technique that the Examiner uses to split the payment is the actuarial method. This technique involves using the “interest rate implicit in the lease” defined above.
- In order to calculate the interest charge for a period, apply the interest rate implicit in the lease to the amount of capital outstanding at the beginning of the period. This will increase the lease liability and the finance cost.
- The carrying amount of the lease liability is then reduced by the cash instalments.
What does in arrears mean?
In arrears - at the end of the period
Leases: how do we treat short life and low value assets?
If the lease is for a period of 12 months or less or the asset is of a low value then a simplified treatment is allowed.
The lessee can choose to recognise the lease payments as an expense in the statement of profit or loss on a straight line basis.
Sale and leaseback. Sometimes, a cash-poor company may need to raise finance quickly, but will not want to give up the use of its major non-current assets.
One solution here is to sell an asset and lease it back.
How do we account for this?
Transfer is not a sale
If control of the asset has not passed and no sale has taken place, the sale proceeds are treated as a loan:
Dr Cash
Cr Financial liability
Transfer is a sale
If control of the asset has passed, the seller / lessee must measure the right of use asset in relation to the rights retained and recognise a profit or loss based on the rights transferred.
(lease liability / sale proceeds) x previous carrying amount
How do we initially measure the lease liability?
It is initially measured at the present value of the lease payments that have not yet been paid. These should include:
- Fixed payments;
- Amounts expected to be payable;
- Option to purchase the asset;
- Termination penalties if certain.
Subsequent measurement for leases: how do we calculate it? Both - Payment in arrears / Payment in advance
- Payment in arrears
Year — Balance b/f — Interest — Payment — Balance c/f
1 — X — x — (x) — X (NCL) - Payment in advance
Year — Balance b/f — Payment — Subtotal — Interest — Balance c/f
1 — X — (x) — x (NCL) — X — X
What is the “Five Step” Model of recognizing revenue?
Step 1: Identify the contract(s) with the customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price. It may be affected by:
Significant financing components. [to discount back to the PV]
Variable consideration [not sure how much you’re going to receive]
Non-cash consideration. [this should be measured at fair value.]
Step 4: Allocate the transaction price to each performance obligation.
Step 5: Recognise revenue as each performance obligation is satisfied
How do we recognize the incremental costs and the costs to fulfil a contract in revenue?
The following costs must be recognised as an asset:
Incremental costs of obtaining a contract (costs that would not have been incurred if the entity had not won the contract) e.g. professional fees
Costs to fulfil a contract that do not fall within the scope of another standard and the entity expects them to be recovered. [WIP] - In the exam, it was specifically said that these will be treated as an expense, not an asset.
What is a contract asset?
An entity has a contract asset if it has recognised revenue in profit or loss but has not yet invoiced the customer for this revenue or received payment (revenue recognised to date > amounts invoiced to date).
A contract asset is separate from trade receivables (amounts invoiced less amounts received).
What is a contract liability?
An entity has a contract liability if it has invoiced the customer or has received payment but has not yet recognised the revenue/performed the work (amounts invoiced to date > revenue recognised to date).
How do you calculate a contract asset/liability? [Proforma]
Revenue recognised to date X [ % complete x price]
Less: Amounts invoiced to date (X)
Contract asset / liability X/(X)
Amounts invoiced to date X
Less: cash received (X)
Trade receivables X
When is a contract asset impaired?
A contract asset is impaired when its carrying amount is greater than the remaining consideration receivable, less directly related costs incurred. An impairment loss should be recognised in profit or loss – the whole loss is provided for immediately.
What happens if we expect to make a loss on a contract?
Loss making contracts are accounted for as onerous contracts and the whole loss is provided for immediately.
What do we do if we do NOT know the outcome or progress of a contract?
Revenue should be recognised only to the extent of the recoverable costs.
Contract costs should be recognised as an expense in the period incurred.
What is a repurchase agreement?
- A repurchase agreement is a contract in which an entity sells an asset but retains the right to repurchase it in the future.
- Therefore the customer does not obtain control of the asset even though they may have physical possession. The substance of this transaction is that of a secured loan against the asset.
- The seller must continue to recognise the asset and also recognise a financial liability for any consideration received from the customer.
- Any difference between the amount of consideration received and the amount to be repaid is treated as interest.
What are consignment inventories?
These arise when a seller delivers a product to another party (such as a dealer or a distributor) for sale to end customers, but retains control of that product.
What is a “Bill-and-hold” arrangement?
A bill-and-hold arrangement is a contract under which a seller bills a customer for a product but retains physical possession.
Revenue is recognized when the customer obtains control.
How do we measure the biological assets and agricultural produce?
Biological assets are measured on initial recognition and at each year end at their fair value less costs to sell. Fair value is essentially the price that that asset could be sold for in an active market. The movement in fair value is shown in the statement of profit or loss.
Agricultural produce is measured, at the point of harvest, at fair value less estimated costs to sell. It then becomes “inventory” and is subsequently measured at the lower of cost / initial fair value less costs to sell and net realisable value.
What are examples of financial assets?
Cash;
An equity instrument of another entity (e.g. purchase a shareholding in another company);
A contractual right to receive cash from another entity, e.g. trade receivables;
A derivative standing at a gain.
What are examples of financial liabilities? (or sometimes called a debt instrument)
A contractual obligation to deliver cash to another entity; e.g. trade payables, debenture loans (corporate loan), redeemable preference shares.
A derivative standing at a loss.
What is an equity instrument? + examples
A contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities; e.g. a company’s own ordinary shares, share options, non-redeemable preference shares.
